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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ---- to ----
Commission File Number 1-12306
INTEGRATED HEALTH SERVICES, INC.
(Exact name of registrant as specified in its charter)
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<S> <C>
DELAWARE 23-2428312
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
10065 RED RUN BLVD.
OWINGS MILLS, MARYLAND 21117
(Address of principal executive offices) (Zip code)
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Registrant's telephone number, including area code: 410-998-8400
Securities registered pursuant to Section 12(b) of the Act:
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Name of each exchange
Title of each class on which registered:
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Common Stock, par value
$.001 per share New York Stock Exchange
10 1/4% Senior Subordinated
Notes due 2006 New York Stock Exchange
9 1/2% Senior Subordinated
Notes due 2007 New York Stock Exchange
9 1/4% Senior Subordinated
Notes due 2008 New York Stock Exchange
5 3/4% Convertible Senior
Subordinated Debentures due 2001 New York Stock Exchange
6% Convertible Subordinated
Debentures due 2003 New York Stock Exchange
</TABLE>
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ].
Aggregate market value of the Registrant's Common Stock held by
non-affiliates at March 18, 1998 (based on the closing sale price for such
shares as reported by the New York Stock Exchange): $1,651,788,293.
Common Stock outstanding as of March 18, 1998: 44,269,033 shares.
Documents Incorporated by Reference:
Portions of the Registrant's definitive proxy statement for its 1998 Annual
Meeting of Stockholders are incorporated by reference into Part III of this
report.
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PART I
ITEM 1. BUSINESS
GENERAL OVERVIEW
Integrated Health Services, Inc. ("IHS" or the "Company") is one of the
nation's leading providers of post-acute healthcare services. Post-acute care is
the provision of a continuum of care to patients following discharge from an
acute care hospital. IHS' post-acute care services include subacute care,
skilled nursing facility care, home respiratory care, home health nursing care,
other homecare services and contract rehabilitation, hospice, lithotripsy and
diagnostic services. The Company's post-acute care network is designed to
address the fact that the cost containment measures implemented by private
insurers and managed care organizations and limitations on government
reimbursement of hospital costs have resulted in the discharge from hospitals of
many patients who continue to require medical and rehabilitative care. IHS'
post-acute healthcare system is intended to provide cost-effective continuity of
care for its patients in multiple settings and enable payors to contract with
one provider to provide all of a patient's needs following discharge from acute
care hospitals. The Company believes that its post-acute care network can be
extended beyond post-acute care to also provide "pre-acute" care, i.e., services
to patients which reduce the likelihood of a need for a hospital stay. IHS'
post-acute care network currently consists of over 2,000 service locations in 48
states and the District of Columbia.
The Company's post-acute care network strategy is to provide cost-effective
continuity of care for its patients in multiple settings, using geriatric care
facilities as platforms to provide a wide variety of subacute medical and
rehabilitative services more typically delivered in the acute care hospital
setting and using home healthcare to provide those medical and rehabilitative
services which do not require 24-hour monitoring. To implement its post-acute
care network strategy, IHS has focused on (i) developing market concentration
for its post-acute care services in targeted states due to increasing payor
consolidation and the increased preference of payors, physicians and patients
for dealing with only one service provider; (ii) expanding the range of home
healthcare and related services it offers to patients directly in order to
provide patients with a continuum of care throughout their recovery, to better
control costs and to meet the growing desire by payors for one-stop shopping;
and (iii) developing subacute care units. Given the increasing importance of
managed care in the healthcare marketplace and the continued cost containment
pressures from Medicare, Medicaid and private payors, the Company has been
restructuring its operations to enable IHS to focus on obtaining contracts with
managed care organizations and to provide capitated services. IHS' strategy is
to become a preferred or exclusive provider of post-acute care services to
managed care organizations and other payors.
In implementing its post-acute care network strategy, IHS has recently
focused on expanding its home healthcare services to take advantage of
healthcare payors' increasing focus on having healthcare provided in the
lowest-cost setting possible, recent advances in medical technology which have
facilitated the delivery of medical services in alternative sites and patients'
desires to be treated at home. Consistent with the Company's strategy, IHS in
October 1996 acquired First American Health Care of Georgia, Inc. ("First
American"), a provider of home health services, principally home nursing, in 21
states, primarily Alabama, California, Florida, Georgia, Michigan, Pennsylvania
and Tennessee. IHS in October 1997 acquired RoTech Medical Corporation
("RoTech"), a provider of home healthcare products and services, with an
emphasis on home respiratory, home medical equipment and infusion therapy,
principally to patients in non-urban areas (the "RoTech Acquisition"). In
October 1997, IHS also acquired (the "Coram Lithotripsy Acquisition") the
lithotripsy division (the "Coram Lithotripsy Division") of Coram Healthcare
Corporation ("Coram"), which provided lithotripsy services and equipment
maintenance in 180 locations in 18 states, in order to expand the mobile
diagnostic treatment and services it offers to patients, payors and other
providers. Lithotripsy is a non-invasive technique that utilizes shock waves to
disintegrate kidney stones. IHS intends to use the home healthcare setting and
the delivery franchise of the home healthcare branch and agency network to (i)
deliver sophisticated care, such as skilled nursing care, home respiratory
therapy and rehabilitation, outside the hospital or nursing home; (ii) serve as
an entry point for patients into the IHS post-acute care network; and (iii)
provide a cost-effective site for case management and patient direction.
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IHS has also continued to expand its post-acute care network by increasing
the number of facilities it operates or manages. In September 1997, IHS acquired
Community Care of America, Inc. ("CCA"), which develops and operates skilled
nursing facilities in medically underserved rural communities (the "CCA
Acquisition"). IHS believes that CCA will broaden its post-acute care network to
include more rural markets and will complement its existing home care locations
in rural markets as well as RoTech's business. In addition, in December 1997,
IHS acquired from HEALTHSOUTH Corporation ("HEALTHSOUTH") 139 owned, leased or
managed long-term care facilities and 12 specialty hospitals, as well as a
contract therapy business having over 1,000 contracts and an institutional
pharmacy business serving approximately 38,000 beds (the "Facility
Acquisition").
The Company provides subacute care through medical specialty units
("MSUs"), which are typically 20 to 75 bed specialty units with physical
identities, specialized medical technology and staffs separate from the
geriatric care facilities in which they are located. MSUs are designed to
provide comprehensive medical services to patients who have been discharged from
acute care hospitals but who still require subacute or complex medical
treatment. The levels and quality of care provided in the Company's MSUs are
similar to those provided in the hospital but at per diem treatment costs which
IHS believes are generally 30% to 60% below the cost of such care in acute care
hospitals. Because of the high level of specialized care provided, the Company's
MSUs generate substantially higher net revenue and operating profit per patient
day than traditional geriatric care services.
IHS presently operates 312 geriatric care facilities (260 owned or leased
and 52 managed), excluding 18 facilities acquired in the CCA Acquisition and 20
facilities acquired in the Facility Acquisition which are being held for sale,
and 158 MSUs located within 84 of these facilities. Specialty medical services
revenues, which include all MSU charges, all revenue from providing
rehabilitative therapies, pharmaceuticals, medical supplies and durable medical
equipment to all its patients, all revenue from its Alzheimer's programs and all
revenue from its provision of pharmacy, rehabilitation therapy, home healthcare,
hospice care and similar services to third-parties, constituted approximately
65%, 70% and 79% of net revenues during the years ended December 31, 1995, 1996
and 1997, respectively. IHS also offers a wide range of basic medical services
as well as a comprehensive array of respiratory, physical, speech, occupational
and physiatric therapy in all its geriatric care facilities. For the year ended
December 31, 1997, approximately 35% of IHS' revenues were derived from home
health and hospice care, approximately 44% were derived from subacute and other
ancillary services, approximately 19% were derived from traditional basic
nursing services, and approximately 2% were derived from management and other
services. On a pro forma basis after giving effect to the acquisitions
consummated by IHS in 1997, for the year ended December 31, 1997, approximately
30% of IHS' revenues were derived from home health and hospice care,
approximately 43% were derived from subacute and other ancillary services,
approximately 26% were derived from traditional basic nursing home services and
the remaining approximately 1% were derived from management and other services.
INDUSTRY BACKGROUND
In 1983, the Federal government acted to curtail increases in healthcare
costs under Medicare, a Federal insurance program under the Social Security Act
primarily for individuals age 65 or over. Instead of continuing to reimburse
hospitals on a cost plus basis (i.e., the hospital's actual cost of care plus a
specified return on investment), the Federal government established a new type
of payment system based on prospectively determined prices rather than
retrospectively determined costs, with payment for inpatient hospital services
based on regional and national rates established under a system of
diagnosis-related groups ("DRGs"). As a result, hospitals bear the cost risk of
providing care inasmuch as they receive specified reimbursement for each
treatment regardless of actual cost.
Concurrent with the change in government reimbursement of healthcare costs,
a "managed care" segment of the healthcare industry emerged based on the theme
of cost containment. The health maintenance organizations and preferred provider
organizations, which constitute the managed care segment, are able to limit
hospitalization costs by giving physicians incentives to reduce hospital
utilization and by negotiating discounted fixed rates for hospital services. In
addition, traditional third party indemnity insurers began to limit
reimbursement to pre-determined amounts of "reasonable charges," regardless
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of actual cost, and to increase the amount of co-payment required to be paid by
patients, thereby requiring patients to assume more of the cost of hospital
care. These changes have resulted in the earlier discharge of patients from
acute care hospitals.
At the same time, the number of people over the age of 65 began to grow
significantly faster than the overall population. Further, advances in medical
technology have increased the life expectancies of an increasingly large number
of medically complex patients, many of whom require a high degree of monitoring
and specialized care and rehabilitative therapy that is generally not available
outside the acute care hospital. However, the changes in government and
third-party reimbursement and growth of the managed care segment of the
healthcare industry, when combined with the fact that the cost of providing care
to these patients in an acute care hospital is higher than in a non-acute care
hospital setting, provide economic incentives for acute care hospitals and
patients or their insurers to minimize the length of stay in acute care
hospitals. The early discharge from hospitals of patients who are not fully
recovered and still require medical care and rehabilitative therapy has
significantly contributed to the rapid growth of the home healthcare industry,
as have recent advances in medical technology, which have facilitated the
delivery of services in alternate sites, demographic trends, such as an aging
population, and a preference for home healthcare among patients. As a result,
home healthcare is among the fastest growing areas in healthcare.
However, for some of these patients home healthcare is not a viable
alternative because of their continued need for a high degree of monitoring,
more intensive and specialized medical care, 24-hour per day nursing care and a
comprehensive array of rehabilitative therapy. As a result, IHS believes there
is an increasing need for non-acute care hospital facilities which can provide
the monitoring, specialized care and comprehensive rehabilitative therapy
required by the growing population of subacute and medically complex patients.
Recent healthcare reform proposals, which have focused on containment of
healthcare costs, together with the desire of third party payors to contract
with one service provider for all post-acute care services, the increasing
complexity of medical services provided, growing regulatory and compliance
requirements and increasingly complicated reimbursement systems, have resulted
in a trend of consolidation of smaller, local operators who lack the
sophisticated management information systems, operating efficiencies and
financial resources to compete effectively into larger, more established
regional or national operators that offer a broad range of services, either
through its own network or through subcontracts with other third party service
providers.
The Balanced Budget Act of 1997 (the "BBA"), enacted in August 1997, makes
numerous changes to the Medicare and Medicaid programs that could significantly
affect the delivery of subacute care, skilled nursing facility care and home
healthcare. With respect to Medicare, the BBA provides, among other things, for
a prospective payment system for skilled nursing facilities to be implemented
for cost reporting periods beginning on or after July 1, 1998, a prospective
payment system for home nursing to be implemented for cost reporting periods
beginning on or after October 1, 1999, a reduction in current cost reimbursement
for home nursing care pending implementation of a prospective payment system,
reductions in reimbursement for oxygen and oxygen equipment for home respiratory
therapy and a shift of the bulk of home health coverage from Part A to Part B of
Medicare. With respect to Medicaid, the BBA repeals the so-called Boren
Amendment, which required state Medicaid programs to reimburse nursing
facilities for the costs that are incurred by efficiently and economically
operated providers in order to meet quality and safety standards. As a result,
states now have considerable flexibility in establishing payment rates.
COMPANY STRATEGY
The Company's post-acute care network strategy is to provide cost-effective
continuity of care for its patients in multiple settings, using geriatric care
facilities as platforms to provide a wide variety of subacute medical and
rehabilitative services more typically delivered in the acute care hospital
setting and using home healthcare to provide those medical and rehabilitative
services which do not require 24-hour monitoring. IHS believes that the success
of its post-acute care network strategy will depend in large part on its ability
to control each component of the post-acute care delivery system in order to
provide low-cost, high quality outcomes. The central elements of the Company's
business strategy are:
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Vertical Integration of Post-acute Care Services. IHS is expanding the
range of home healthcare and related services it offers to its patients directly
in order to serve the full spectrum of patient needs following acute
hospitalization. In addition to subacute care, the Company is now able to offer
directly to its patients, rather than through third-party providers, home
respiratory care, home nursing care, other homecare services, rehabilitation
(physical, occupational and speech), hospice care, lithotripsy services and
mobile x-ray and electrocardiogram services. As a full service provider, IHS
believes that it is better able to respond to the needs of its patients and
referral sources. In addition, the Company believes that by offering managed
care organizations and insurance companies a single source from which to obtain
a full continuum of care to patients following discharge from the acute care
hospital, it will attract healthcare payors seeking to improve the management of
healthcare quality as well as to reduce servicing and administrative expenses.
IHS also believes that offering a broad range of services will allow it to
better control certain costs, which will provide it with a competitive advantage
in contracting with managed care companies and offering capitated rates, whereby
the Company assumes the financial risk for the cost of care.
Expansion of Home-Based Services. The Company's strategy is to expand its
home healthcare services to take advantage of healthcare payors' increasing
focus on having healthcare provided in the lowest-cost setting possible and
patients' desires to be treated at home. IHS believes that the nation's aging
population, when combined with advanced technology which allows more healthcare
procedures to be performed at home, has resulted in an increasingly large number
of patients with long-term chronic conditions that can be treated effectively in
the home. In addition, a significant number of patients discharged from the
Company's MSUs require home healthcare. IHS also believes that it can expand its
home healthcare services to cover pre-acute, as well as post-acute, patients by
having home healthcare nurses provide preventive care services to home-bound
senior citizens. In addition, the Company believes that home healthcare will
help IHS contain costs, thereby providing it with a competitive advantage in
contracting with managed care companies and offering capitated rates. IHS
believes that the changing healthcare reimbursement environment, with the focus
on cost containment, will require healthcare providers to go "at risk" under
capitated service agreements, and that home healthcare will be a critical
component of its ability to do so. However, until a prospective payment system
for home nursing services is implemented under Medicare, IHS does not expect to
acquire additional home nursing companies and is currently exploring a
"spin-off" or other divestiture of its home nursing operations. IHS will,
however, continue to offer home nursing services as part of its post-acute care
services either by managing home nursing for third parties or contracting with
home nursing agencies for such services.
Focus on Managed Care. Given the increasing importance of managed care in
the healthcare marketplace and the continued cost containment pressures from
Medicare and Medicaid, IHS has, during 1996 and 1997, restructured its
operations to position IHS to focus on obtaining contracts with managed care
organizations and to provide capitated services. IHS' strategy is to become a
preferred or exclusive provider of post-acute care services to managed care
organizations and other payors. Although to date there has been limited demand
among managed care organizations for post-acute care services, IHS believes
demand will increase as HMOs continue to attempt to control healthcare costs and
to penetrate the Medicare market. As part of its focus on managed care and
capitated rates, IHS spent several years collecting outcome data for more than
80,000 patients. To date, the Company has service agreements with approximately
550 managed care organizations. In January 1996, IHS was chosen as the exclusive
capitated provider for five years of long-term care, subacute care and therapy
services to Sierra Health Plan's Health Plan of Nevada ("Sierra Health"), the
largest HMO in Nevada with approximately 28,000 Medicare enrollees and 145,000
commercial enrollees. As the exclusive provider, IHS provides all contracted
services to the HMOs' members; as a capitated provider, the Company accepts full
risk of patient care in exchange for a flat fee per enrollee. The agreement with
Sierra Health provides for annual capitation adjustments and the ability to
increase revenue through non-capitated services, although there can be no
assurance that these provisions will be effective to protect IHS. In September
1997, this agreement was extended through December 2002. In addition, in October
1996 the Company entered into a three-year agreement to provide, on an exclusive
basis, long-term and subacute care to patients of Foundation Health Corporation,
an HMO located in Florida, on a capitated basis. Foundation Health currently has
24,500 Medicare and 60,000 commercial enrollees. The agreement provides for
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increased revenues to IHS for reduced hospital utilization. Although IHS has
attempted to minimize its risk under the contract, there can be no assurance
that safeguards it implemented will be effective. In March 1998, the Company
entered into a one-year agreement with Prudential HealthCare(Reg. TM) pursuant
to which IHS will become a national provider of subacute care, long-term care,
home respiratory services, mobile diagnostic services (where available) and home
health services to Prudential HealthCare plan members. The agreement provides
that IHS will be presented to each local Prudential HealthCare plan as one of
two choices to provide such services to plan members. Generally, the local plan
will be required to sign one of the two national providers presented to it. See
"-- Cautionary Statements -- Risks Related to Managed Care Strategy."
Provide Subacute Care. The Company's strategy is designed to take advantage
of the need for early discharge of many patients from acute care hospitals by
providing the monitoring and specialized care still required by these persons
after discharge from acute care hospitals at per diem treatment costs which IHS
believes are generally 30% to 60% below the cost of care in acute care
hospitals. IHS also intends to continue to use its geriatric care facilities to
meet the increasing need for cost-efficient, comprehensive rehabilitation
treatment of these patients. To date, IHS has used MSUs as subacute specialty
units within its geriatric care facilities. The primary MSU programs currently
offered by IHS are complex care programs, ventilator programs, wound management
programs and cardiac care programs; other programs offered include subacute
rehabilitation, oncology and HIV. The Company opened its first MSU program in
April 1988 and currently operates 158 MSU programs in 84 facilities. IHS also
emphasizes the care of medically complex patients through the provision of a
comprehensive array of respiratory, physical, speech, occupational and
physiatric therapy. The Company intends that its MSUs be a lower cost
alternative to acute care or rehabilitation hospitalization of subacute or
medically complex patients. IHS intends to expand its specialty medical services
at its existing and newly acquired facilities. The Company believes that its
subacute care programs also serve as an important referral base for its home
healthcare and ancillary services. While IHS added 1,098 MSU beds in 1994 and
938 MSU beds in 1995, it added only an additional 383 MSU beds in 1996 and 185
beds in 1997. With the implementation of a prospective payment system for
skilled nursing facilities under Medicare, which will begin for IHS in 1999, IHS
intends to continue to provide subacute care services in its skilled nursing
facilities, although it does not anticipate continuing to expand significantly
its MSUs to provide such services.
Concentration on Targeted Markets. The Company has implemented a strategy
focused on the development of market concentration for its post-acute care
services in targeted states due to increasing payor consolidation. IHS also
believes that by offering its services on a concentrated basis in targeted
markets, together with the vertical integration of its services, it will be
better positioned to meet the needs of managed care payors. The Company now has
approximately 2,000 service locations in 48 states and the District of Columbia,
including 312 geriatric care facilities in 36 states (52 of which IHS manages),
with 63 service locations, including 12 geriatric care facilities (10 of which
IHS manages), in California, 46 service locations, including 13 geriatric care
facilities, in Colorado, 246 service locations, including 35 geriatric care
facilities (eight of which IHS manages), in Florida, 30 service locations,
including seven geriatric care facilities, in Kansas, 50 service locations,
including 16 geriatric care facilities, in Louisiana, 18 service locations,
including 11 geriatric care facilities, in Nebraska, 26 service locations,
including 15 geriatric care facilities, in Nevada, 42 service locations,
including 24 geriatric care facilities, in New Mexico, 97 service locations,
including 34 geriatric care facilities (13 of which IHS manages), in Ohio, 121
service locations, including 15 geriatric care facilities (three of which IHS
manages), in Pennsylvania, and 244 service locations, including 50 geriatric
care facilities (seven of which IHS manages), in Texas.
Expansion Through Acquisition. IHS has grown substantially through
acquisitions and the opening of MSUs and the acquisition of home healthcare and
related service providers, and expects to continue to expand its business by
acquiring additional geriatric care facilities in which to provide subacute care
and rehabilitation services, by expanding the amount of home healthcare and
related services it offers directly to its patients rather than through
third-party providers and by expanding the subacute care and rehabilitation
services in its existing geriatric care facilities. From January 1, 1991 to
date, IHS has increased the number of geriatric care facilities it owns or
leases from 25 to 260 (excluding the 38 facilities held for sale), has increased
the number of facilities it manages from 18 to 52 and has increased the number
of MSU programs it operates from 13 to 158. In addition, the Company now offers
certain
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related services, such as home healthcare, rehabilitation, lithotripsy, x-ray
and electrocardiogram, directly to its patients rather than relying on
third-party providers. See "-- Cautionary Statements -- Risks Associated with
Growth Through Acquisitions and Internal Development."
PATIENT SERVICES
BASIC MEDICAL SERVICES
IHS provides a wide range of basic medical services at its geriatric care
facilities which are licensed as skilled care nursing homes. Services provided
to all patients include required nursing care, room and board, special diets,
and other services which may be specified by a patient's physician who directs
the admission, treatment and discharge of the patient.
SPECIALTY MEDICAL SERVICES
Medical Specialty Units
IHS' MSUs are typically 20 to 75 bed subacute specialty care units located
within discrete areas of IHS' facilities, with physical identities, specialized
medical technology and medical staffs separate from the geriatric care
facilities in which they are located. An intensive care unit nurse, or a nurse
with specialty qualifications, serves as clinical coordinator of each unit,
which generally is staffed with nurses having experience in the acute care
setting. The operations of each MSU are generally overseen by a Board certified
specialist in that unit's area of treatment. The patients in each MSU are
provided with a high degree of monitoring and specialized care similar to that
provided by acute care hospitals. The physiological monitoring equipment
required by the MSU is equivalent to that found in the acute care hospital. IHS
opened its first MSU program during April 1988 and currently operates 158 MSUs
at 84 facilities. Approximately one-third of all of the Company's MSU patients
are under the age of 70.
Although each MSU has most of the treatment capabilities of an acute care
hospital in the MSU's area of specialization, IHS believes the per diem
treatment costs are generally 30% to 60% less than in acute care hospitals.
Additionally, the MSU is less "institutional" in nature than the acute care
hospital, families may visit MSU patients whenever they wish and family
counseling is provided. In marketing its MSU programs to insurers and healthcare
providers, IHS emphasizes the cost advantage of its treatment as compared to
acute care hospitals. IHS also emphasizes the improved "quality of life"
compared to acute care and long-term care hospitals in marketing its MSU
programs to hospital patients and their families. The primary MSU programs
currently offered by IHS are complex care programs, ventilator programs, wound
management programs and cardiac care programs; other programs offered include
subacute rehabilitation, oncology and HIV.
Complex Care Program. This program is designed to treat persons who are
generally subacute or chronically ill and sick enough to be treated in an acute
care hospital. Persons requiring this care include post-surgical patients,
cancer patients and patients with other diseases requiring long recovery
periods. This program is designed to provide the monitoring and specialized care
these patients require but in a less institutional and more cost efficient
setting than provided by hospitals. Some of the monitoring and specialized care
provided to these patients are apnea monitoring, continuous peripheral
intravenous therapy with or without medication, continuous subcutaneous
infusion, chest percussion and postural drainage, gastrostomy or naso-gastric
tube feeding, ileostomy or fistula care (including patient teaching),
post-operative care, tracheostomy care, and oral, pharyngeal or tracheal
suctioning. Patients in this program also typically undergo intensive
rehabilitative services to allow them to return home.
Ventilator Program. This program is designed for persons who require
ventilator assistance for breathing because of respiratory disease or
impairment. Persons requiring ventilation include sufferers of chronic
obstructive pulmonary disease, muscular atrophy and respiratory failure,
pneumonia, cancer, spinal cord or traumatic brain injury and other diseases or
injuries which impair respiration. Ventilators assist or effect respiration in
patients unable to breathe adequately for themselves by injecting heated,
humidified, oxygen-enriched air into the lungs at a pre-determined volume per
breath and number of
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breaths per minute and by controlling the relationship of inhalation time to
exhalation time. Patients in this program undergo respiratory rehabilitation to
wean them from ventilators by teaching them to breathe on their own once they
are medically stable. Patients are also trained to use the ventilators on their
own.
Wound Management Programs. These programs are designed to treat persons
suffering from post operative complications and persons infected by certain
forms of penicillin and other antibiotic resistant bacteria, such as methicillin
resistant staphylococcus aureus ("MRSA"). Patients infected with these types of
bacteria must be isolated under strict infection control procedures to prevent
the spread of the resistant bacteria, which makes MSUs an ideal treatment site
for these patients. Because of the need for strict infection control, including
isolation, treatment of this condition in the home is not practical.
Cardiac Care Program. This program is designed to treat persons suffering
from congestive heart failure, severe cardiac arrhythmia, pre/post transplants
and other cardiac diagnoses. The monitoring and specialized care provided to
these patients includes electrocardiographic monitoring/telemetry, continuous
hemodynamic monitoring, infusion therapy, cardiac rehabilitation, stress
management and dietary counseling, planning and education.
The Company believes that MSU programs can be developed to address a wide
variety of medical conditions which require specialized care. In addition, IHS
has developed MSU programs for subacute rehabilitation, oncology and HIV.
Rehabilitation
IHS provides a comprehensive array of rehabilitative services for patients
at all of its geriatric care facilities, including those in its MSU programs, in
order to enable those persons to return home. These services include respiratory
therapy with licensed respiratory therapists, physical therapy with a particular
emphasis on programs for the elderly, speech therapy, particularly for the
elderly recovering from cerebral vascular disorders, occupational therapy, and
physiatric care. A portion of the rehabilitative service hours are provided by
independent contractors. In order to reduce the number of rehabilitative
services hours provided by independent contractors, IHS began in late 1993 to
acquire companies which provide physical, occupational and speech therapy to
healthcare facilities.
The Company also offers a rehabilitation program to stroke victims and
persons who have undergone hip replacement.
The Company also offers rehabilitation services to skilled nursing
facilities not operated or managed by the Company. IHS believes that by offering
a comprehensive array of rehabilitative services through one provider, skilled
nursing facilities can provide quality patient care more efficiently and
cost-effectively. The Company believes that demand for a single provider for a
comprehensive array of rehabilitative services will increase as a result of the
prospective payment system being implemented under the BBA, which provides for a
fixed payment for these services.
Home Healthcare Services
IHS provides a broad spectrum of home healthcare services to the
recovering, disabled, chronically ill or terminally ill person. Home healthcare
services may be as basic as assisting with activities of daily living or as
complex as cancer chemotherapy. Care involves either or both a service component
(provided by registered nurses, home health aides, therapists and technicians
through periodic visits) and a product component (drugs, equipment and related
supplies). Time spent with a patient may range from one or two visits to
around-the-clock care. Patients may be treated for several weeks, several months
or the remainder of their lives. The home healthcare market is generally divided
into four segments: nursing services; infusion therapy; respiratory therapy; and
home medical equipment.
Home Nursing. Home nursing is the largest component of home healthcare, the
most labor-intensive and generally the least profitable. Home nursing services
range from skilled care provided by registered and other nurses, typically for
those recently discharged from hospitals, to unskilled services delivered by
home health aides for those needing help with the activities of daily living.
Home nursing also
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includes physical, occupational and speech therapy, as well as social worker
services. IHS substantially expanded its home nursing services through the
acquisition of First American, and currently provides home nursing services at
approximately 500 locations in 29 states. IHS is currently exploring a
"spin-off" or other divestiture of its home nursing operations, although IHS
intends to continue to offer home nursing services as part of its post-acute
care services either by managing home nursing for third parties or contracting
with home nursing agencies for such services. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Acquisition and Divestiture History."
Infusion Therapy. Infusion therapy, the second largest home healthcare
market, involves the intravenous administration of anti-infective, biotherapy,
chemotherapy, pain management, nutrition and other therapies. Infusion therapy
generally requires patient training, specialized equipment and periodic
monitoring by skilled nurses. Technological advances such as programmable pumps
that control frequency and intensity of delivery are increasing the percentage
of infections and diseases that are treatable in the home; previously these
infections and diseases generally required patients to be hospitalized. Home
infusion therapy is more skilled-labor-intensive than other home healthcare
segments. The acquisition of RoTech significantly expanded IHS' home infusion
therapy services.
Respiratory Therapy. Respiratory therapy is provided primarily to older
patients with chronic lung diseases (such as chronic obstructive pulmonary
disease, asthma and cystic fibrosis) or reduced respiratory function. The most
common therapy is home oxygen, delivered through oxygen gas systems, oxygen
concentration or liquid oxygen systems. Respiratory therapy is monitored by
licensed respiratory therapists and other clinical staff under the direction of
physicians. The acquisition of RoTech significantly expanded IHS' respiratory
therapy services.
Home Medical Equipment. Home medical equipment consists of the sale or
rental of medical equipment such as specialized beds, wheelchairs, walkers,
rehabilitation equipment and other patient aids. The acquisition of RoTech
significantly expanded IHS' provision of home medical equipment.
Lithotripsy Services
Lithotripsy is a non-invasive technique that uses shock waves to
disintegrate kidney stones. Depending on the particular lithotripter used, the
patient is sedated using either general anesthesia or a mild sedative while
seated in a bath or lying on a treatment table. The operator of the lithotripter
machine locates the stone using fluoroscopy and directs the shock waves toward
the stone. The shock waves then fragment the stone, thereby enabling the patient
to pass the fragments through the urinary tract. Because lithotripsy is
non-invasive and is provided on an outpatient basis, lithotripsy is an
attractive alternative to other more invasive techniques otherwise used in
treating urinary tract stones.
IHS currently owns a controlling interest in 10 lithotripsy partnerships as
well as two wholly owned lithotripsy partnerships and a wholly owned
lithotripter maintenance company. The Company's lithotripsy businesses currently
consist of an aggregate of 35 lithotripsy machines that provide services in 170
locations in 17 states. The other owners of the partnerships are primarily
physicians, many of whom utilize the partnership's equipment to treat their
patients. Seventeen of the 35 lithotripsy machines are stationary and located at
hospitals or ambulatory surgery centers, while the other 18 machines are mobile,
allowing them to be moved in order to meet patient needs and market demands.
IHS' lithotripsy businesses typically lease the machine on a per procedure basis
to a hospital, ambulatory surgery center or other facility providing care to the
patient. In some cases, the lithotripsy businesses bill the patient directly for
the use of the partnership's machine. The Company also provides maintenance
services to its own and third-party equipment.
The Company's agreements with its lithotripsy physician partners
contemplate that IHS will acquire the remaining interest in each partnership at
a defined price in the event that legislation is passed or regulations are
adopted that would prevent the physician from owning an interest in the
partnership and using the partnership's lithotripsy equipment for the treatment
of his or her patients. While current interpretations of existing law are
subject to considerable uncertainty, IHS believes that its partnership
arrangements with physicians in its lithotripsy business are in compliance with
current law. If, however, the Company were required to acquire the minority
interest of its physician partners in each of its lithotripsy partnerships, the
cost in aggregate would be material to IHS.
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In 1993, the Health Care Financing Administration ("HFCA") released a
proposed rule defining the rate at which ambulatory surgery centers and certain
hospitals would be reimbursed for the technical component of a lithotripsy
procedure. This proposed rule has not been finalized. IHS cannot predict what
the final rate for such reimbursement will be or what effect, if any, the
adoption of this proposed rule would have on lithotripsy revenue and whether
this decreased reimbursement rate will be applied to lithotripsy procedures
performed at hospitals, where a majority of IHS' lithotripsy machines are
currently utilized.
Mobile Diagnostic Services
The Company provides on-call mobile x-ray and electrocardiogram services,
both to its own facilities as well as to facilities operated by others. These
services are provided year round to over 8,100 facilities.
Alzheimer's Program
IHS also offers a specialized treatment program for persons with
Alzheimer's disease. This program, called "The Renaissance Program," is located
in a specially designed wing separated from the remainder of the facility. The
physical environment is designed to address the problems of disorientation and
perceptual confusion experienced by Alzheimer's sufferers. The Renaissance
Program is designed to help reduce the stress and agitation of Alzheimer's
disease by addressing the problems of short attention spans and hyperactivity.
The staff for this program is specially recruited and staff training is highly
specialized. This program is designed not only to provide care to persons
suffering from Alzheimer's disease, but also to work with the patient's family.
IHS currently offers The Renaissance Program at 12 of its geriatric care
facilities with a total of 345 beds. Patients pay a small premium to IHS' per
diem rate for basic medical care to participate in this program.
Hospice Services
IHS provides hospice services, including medical care, counseling and
social services, to the terminally ill in the greater Chicago metropolitan area,
Michigan and Pennsylvania. Hospice care is a coordinated program of support
services providing physical, psychological, social and spiritual care for dying
persons and their families. Services are provided in the home and/or inpatient
settings. The goal of hospice care is typically to improve a terminal patient's
quality of life rather than trying to extend life. IHS also provides hospice
care to the terminally ill at its facility in Miami, Florida.
MANAGEMENT AND OTHER SERVICES
The Company manages geriatric care facilities under contract for others to
capitalize on its specialized care programs without making the capital outlay
generally required to acquire and renovate a facility. IHS currently manages 52
geriatric care facilities with 6,212 licensed beds. IHS is responsible for
providing all personnel, marketing, nursing, resident care, dietary and social
services, accounting and data processing reports and services for these
facilities, although such services are provided at the facility owner's expense.
The facility owner is also obligated to pay for all required capital
expenditures. The Company manages these facilities in the same manner as the
facilities it owns or leases, and provides the same geriatric care services as
are provided in its owned or leased facilities. Contract acquisition costs for
legal and other direct costs incurred to acquire long-term management contracts
are capitalized and amortized over the term of the related contract.
IHS receives a management fee for its services which generally is equal to
4% to 8% of gross revenues of the geriatric care facility. Certain management
agreements also provide the Company with an incentive fee based on the amount of
the facility's operating income which exceeds stipulated amounts. Management fee
revenues are recognized when earned and billed generally on a monthly basis.
Incentive fees are recognized when operating results of managed facilities
exceed amounts required for incentive fees in accordance with the terms of the
management agreements. The management agreements generally have an initial term
of ten years, with IHS having a right to renew in most cases. The management
agreements expire at various times between December 1998 and February 2006
although all can be terminated earlier
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under certain circumstances. The Company generally has a right of first refusal
in respect of the sale of each managed facility. IHS believes that by
implementing its specialized care programs and services in these facilities, it
will be able to increase significantly the operating income of these facilities
and thereby increase the management fees the Company will receive for managing
these facilities.
IHS also manages private duty and Medicare certified home health agencies
in the Dallas/Fort Worth, Texas market.
QUALITY ASSURANCE
The Company has developed a comprehensive Quality Assurance Program to
verify that high standards of care are maintained at each facility operated or
managed by IHS. The Company requires that its facilities meet standards of care
more rigorous than those required by Federal and state law. Under the Company's
Quality Assurance Program standards for delivery of care are set and the care
and services provided by each facility are evaluated to insure they meet IHS'
standards. A quality assurance team evaluates each facility bi-annually,
reporting directly to IHS' Chief Executive Officer and to the Chief Operating
Officer, as well as to the administrator of each facility. Facility
administrator bonuses are dependent in part upon their facility's evaluation.
The Company also maintains an 800 number, called the "In-Touch Line," which is
prominently displayed above telephones in each facility and placed in patients'
bills. Patients and staff are encouraged to call this number if they have any
problem with nursing or administrative personnel which cannot be resolved
quickly at the facility level. This program provides IHS with an early-warning
of problems which may be developing at the facility.
IHS has also developed a specialized Quality Assurance Program for its MSU
programs. IHS has begun a program to obtain accreditation by the Joint
Commission on Accreditation of Healthcare Organizations ("JCAHO") for each of
its facilities. At March 1, 1998, 88 of the Company's facilities had been fully
accredited by the JCAHO.
OPERATIONS
The day-to-day operations of each facility are managed by an on-site state
licensed administrator, and an on-site business office manager monitors the
financial operations of each facility. The administrator of each facility is
supported by other professional personnel, including the facility's medical
director, social workers, dietician and recreation staff. Nursing departments in
each facility are under the supervision of a director of nursing who is
state-registered. The nursing staffs are composed of registered nurses and
licensed practical nurses as well as nursing assistants.
The Company's home healthcare businesses are conducted through
approximately 500 branches which are managed through three geographic area
offices. The area office provides each of its branches with key management
direction and support services. IHS' organizational structure is designed to
create operating efficiencies associated with certain centralized services and
purchasing while also promoting local decision making.
IHS' corporate staff provides services such as marketing assistance,
training, quality assurance oversight, human resource management, reimbursement
expertise, accounting, cash management and treasury functions, internal auditing
and management support. Financial control is maintained through fiscal and
accounting policies that are established at the corporate level for use at each
facility and branch location. The Company has standardized operating procedures
and monitors its facilities and branch locations to assure consistency of
operations. IHS emphasizes frequent communications, the setting of operational
goals and the monitoring of actual results. The Company uses a financial
reporting system which enables it to monitor, on a daily basis, certain key
financial data at each facility such as payor mix, admissions and discharges,
cash collections, net revenue and staffing.
Each facility and branch location has all necessary state and local
licenses. Most facilities are certified as providers under the Medicare and
Medicaid programs of the state in which they are located.
SOURCES OF REVENUE
IHS receives payments for services rendered to patients from private
insurers and patients themselves, from the Federal government under Medicare,
and from the states in which certain of its facilities are located under
Medicaid. The sources and amounts of the Company's patient revenues are
determined by a
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number of factors, including licensed bed capacity of its facilities, occupancy
rate, the mix of patients and the rates of reimbursement among payor categories
(private, Medicare and Medicaid). Changes in the mix of IHS' patients among the
private pay, Medicare and Medicaid categories can significantly affect the
profitability of the Company's operations. Generally, private pay patients are
the most profitable and Medicaid patients are the least profitable. See "--
Federal and State Assistance Programs."
During the years ended December 31, 1995, 1996 and 1997, IHS derived
approximately $509.3 million, $562.5 million and $656.6 million, respectively,
or 44.7%, 40.5% and 33.6%, respectively, of its patient revenues from private
pay sources and approximately $629.8 million, $826.4 million and $1.3 billion,
respectively, or 55.3%, 59.5% and 66.4%, respectively, of its patient revenues
from government reimbursement programs. Patient revenues from government
reimbursement programs during these periods consisted of approximately $387.2
million, $516.7 million and $963.0 million, or 34.0%, 37.2% and 49.3% of total
patient revenues, respectively, from Medicare and approximately $242.6 million,
$309.7 million and $334.4 million, respectively, or 21.3%, 22.3% and 17.1% of
total patient revenues, respectively, from Medicaid. The increase in the
percentage of revenue from government reimbursement programs is due to the
higher level of Medicare and Medicaid patients serviced by the respiratory
therapy, rehabilitative therapy, home healthcare and mobile diagnostic companies
acquired beginning in 1994. In addition, IHS received payments from third
parties for its management and other services, which constituted approximately
3.3%, 3.2% and 2.0% of total net revenues for the years ended December 31, 1995,
1996 and 1997, respectively.
On a pro forma basis after giving effect to the acquisitions consummated by
IHS in 1997, during the year ended December 31, 1997, IHS derived approximately
$1.1 billion, or 31.1%, of its patient revenues from private pay sources and
approximately $2.4 billion, or 68.9%, of its patient revenues from government
reimbursement programs. Pro forma patient revenues from government reimbursement
programs during 1997 consisted of approximately $1.6 billion, or 44.5%, from
Medicare and approximately $857.3 million, or 24.4% from Medicaid.
Gross third party payor settlements receivable, primarily from Federal and
state governments (i.e., Medicare and Medicaid cost reports), were $58.5 million
at December 31, 1997, as compared to $42.6 million at December 31, 1996 and
$33.0 million at December 31, 1995. Approximately $12.8 million, or 21.9%, of
the third party payor settlements receivable, primarily from Federal and state
governments, at December 31, 1997 represent the costs for its MSU patients which
exceed regional reimbursement limits established under Medicare, as compared to
approximately $15.6 million, or 37%, at December 31, 1996 and approximately $7.6
million, or 23%, at December 31, 1995.
The Company's cost of care for its MSU patients generally exceeds regional
reimbursement limits established under Medicare. The success of IHS' MSU
strategy depends in part on its ability to obtain per diem rate approvals for
costs which exceed the Medicare established per diem rate limits and by
obtaining waivers of these limitations. IHS has submitted waiver requests for
325 cost reports, covering all cost report periods through December 31, 1996. To
date, final action has been taken by HCFA on all 325 waiver requests. The
Company's final rates as approved by HCFA represent approximately 95% of the
requested rates as submitted in the waiver requests. There can be no assurance,
however, that IHS will be able to recover its excess costs under any waiver
requests which may be submitted in the future. IHS' failure to recover
substantially all these excess costs would adversely affect its results of
operations and could adversely affect its MSU strategy. The implementation of a
prospective payment program for skilled nursing facilities under Medicare, which
IHS will begin in 1999, will significantly change the way IHS is paid for its
MSU care.
The BBA, enacted in August 1997, provides, among other things, for a
prospective payment system for skilled nursing facilities to be implemented for
cost reporting periods beginning on or after July 1, 1998, a prospective payment
system for home nursing to be implemented for cost reporting periods beginning
on or after October 1, 1999, a reduction in current cost reimbursement for home
nursing care pending implementation of a prospective payment system, reductions
(effective January 1, 1998) in Medicare reimbursement for oxygen and oxygen
equipment for home respiratory therapy and a shift of the bulk of home health
coverage from Part A to Part B of Medicare. The inability of IHS to provide
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home healthcare and/or skilled nursing services at a cost below the established
Medicare fee schedule could have a material adverse effect on IHS' home
healthcare operations, post-acute care network and business generally. In
addition, the BBA's repeal of the Boren Amendment, which required state Medicaid
programs to reimburse nursing facilities for the costs that are incurred by
efficiently and economically operated providers in order to meet quality and
safety standards, gives states considerable flexibility in establishing payment
rates.
Both private third party and governmental payors have undertaken cost
containment measures designed to limit payments made to healthcare providers
such as IHS. Furthermore, government programs are subject to statutory and
regulatory changes, retroactive rate adjustments, administrative rulings and
government funding restrictions, all of which may materially increase or
decrease the rate of program payments to facilities managed and operated by IHS.
There can be no assurance that payments under governmental and third-party
private payor programs will remain at levels comparable to present levels or
will, in the future, be sufficient to cover the costs allocable to patients
participating in such programs. In addition, there can be no assurance that
facilities owned, leased or managed by IHS now or in the future will initially
meet or continue to meet the requirements for participation in such programs.
The Company could be adversely affected by the continuing efforts of
governmental and private third party payors to contain the amount of
reimbursement for healthcare services. In an attempt to limit the Federal and
state budget deficits, there have been, and IHS expects that there will continue
to be, a number of additional proposals to limit Medicare and Medicaid
reimbursement for healthcare services. The Company cannot at this time predict
whether this legislation or any other legislation will be adopted or, if adopted
and implemented, what effect, if any, such legislation will have on IHS. See "--
Government Regulation" and "-- Cautionary Statements -- Risk of Adverse Effect
of Healthcare Reform."
GOVERNMENT REGULATION
The healthcare industry is subject to extensive federal, state and local
statutes and regulations. The regulations include licensure requirements,
reimbursement rules and standards and levels of services and care. Changes in
applicable laws and regulations or new interpretations of existing laws and
regulations could have a material adverse effect on licensure of IHS'
facilities, eligibility for participation in Federal and state programs,
permissible activities, costs of doing business, or the levels of reimbursement
from governmental, private and other sources. Political, economic and regulatory
influences are subjecting the healthcare industry in the United States to
fundamental change. It is not possible to predict the content or impact of
future legislation and regulations affecting the healthcare industry.
Most states in which IHS operates have statutes which require that prior to
the addition or construction of new beds, the addition of new services or
certain capital expenditures in excess of defined levels, the Company must
obtain a certificate of need ("CON") which certifies that the state has made a
determination that a need exists for such new or additional beds, new services
or capital expenditures. These state determinations of need or CON programs are
designed to comply with certain minimum Federal standards and to enable states
to participate in certain Federal and state health-related programs. Elimination
or relaxation of CON requirements may result in increased competition in such
states and may also result in increased expansion possibilities in such states.
Of the states in which the Company operates, the following require CONs for the
facilities that are owned, operated or managed by IHS: Alabama, Colorado,
Connecticut, Delaware, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky,
Louisiana, Maryland, Massachusetts, Michigan, Mississippi, Missouri, Montana,
Nebraska, Nevada, New Hampshire, New Jersey, North Carolina, Ohio, Oklahoma,
South Carolina, Tennessee, Texas, Virginia, Washington, West Virginia and
Wisconsin. To date the conversion of geriatric care beds to MSU beds has not
required a CON.
The Company's facilities are also subject to licensure regulations. Each of
IHS' geriatric care facilities is licensed as a skilled care facility and
substantially all are certified as a provider under the Medicare program and
most are also certified by the state in which they are located as a provider
under the Medicaid program of that state. IHS believes it is in substantial
compliance with all material statutes and regulations applicable to its
business. In addition, all healthcare facilities are subject to various local
building codes and other ordinances.
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State and local agencies survey all geriatric care centers on a regular
basis to determine whether such centers are in compliance with governmental
operating and health standards and conditions for participation in government
medical assistance programs. Such surveys include reviews of patient utilization
of healthcare facilities and standards for patient care. IHS endeavors to
maintain and operate its facilities in compliance with all such standards and
conditions. However, in the ordinary course of its business the Company's
facilities receive notices of deficiencies for failure to comply with various
regulatory requirements. Generally, the facility and the reviewing agency will
agree upon the measures to be taken to bring the facility into compliance with
regulatory requirements. In some cases or upon repeat violations, the reviewing
agency may take adverse actions against a facility, including the imposition of
fines, temporary suspension of admission of new patients to the facility,
suspension or decertification from participation in the Medicare or Medicaid
programs, and, in extreme circumstances, revocation of a facility's license.
These adverse actions may adversely affect the ability of the facility to
operate or to provide certain services and its eligibility to participate in the
Medicare or Medicaid programs. In addition, such adverse actions may adversely
affect other facilities operated by IHS. See "-- Federal and State Assistance
Programs."
The operations of the Company's home healthcare branches are subject to
numerous Federal and state laws governing pharmacies, nursing services, therapy
services and certain types of home health agency activities. Certain of IHS'
employees are subject to state laws and regulations governing the professional
practice of respiratory therapy, physical, occupational, and speech therapies,
pharmacy and nursing. The failure to obtain, to renew or to maintain any of the
required regulatory approvals or licenses could adversely affect the Company's
home healthcare business and could prevent the branch involved from offering
products and services to patients. Generally, IHS is required to be licensed as
a home health agency in those states in which it provides traditional home
health or home nursing services. IHS' ability to expand its home healthcare
services will depend upon its ability to obtain licensure as a home health
agency, which may be restricted by state CON laws.
In September 1997, President Clinton, in an attempt to curb Medicare fraud,
imposed a moratorium on the certification under Medicare of new home healthcare
companies, which moratorium expired in January 1998, and implemented rules
requiring home healthcare providers to reapply for Medicare certification every
three years. In addition, HCFA will double the number of detailed audits of home
healthcare providers it completes each year and increase by 25% the number of
home healthcare claims it reviews each year. IHS cannot predict what effect, if
any, these new rules will have on IHS' business and the expansion of its home
healthcare operations.
Various Federal and state laws regulate the relationship between providers
of healthcare services and physicians or others able to refer medical services,
including employment or service contracts, leases and investment relationships.
These laws include the fraud and abuse provisions of Medicare and Medicaid and
similar state statutes (the "Fraud and Abuse Laws"), which prohibit the payment,
receipt, solicitation or offering of any direct or indirect remuneration
intended to induce the referral of Medicare or Medicaid patients or for the
ordering or providing of Medicare or Medicaid covered services, items or
equipment. Violations of these provisions may result in civil and criminal
penalties and/or exclusion from participation in the Medicare and Medicaid
programs and from state programs containing similar provisions relating to
referrals of privately insured patients. The Department of Health and Human
Services ("HHS") and other federal agencies have interpreted these provisions
broadly to include the payment of anything of value to influence the referral of
Medicare or Medicaid business. HHS has issued regulations which set forth
certain "safe harbors," representing business relationships and payments that
can safely be undertaken without violation of the Fraud and Abuse Laws. In
addition, certain Federal and state requirements generally prohibit certain
providers from referring patients to certain types of entities in which such
provider has an ownership or investment interest or with which such provider has
a compensation arrangement, unless an exception is available. The Company
considers all applicable laws in planning marketing activities and exercises
care in an effort to structure its arrangements with healthcare providers to
comply with these laws. However, there can be no assurance that all of IHS'
existing or future arrangements will withstand scrutiny under the Fraud and
Abuse Laws, safe harbor regulations or other state or federal legislation or
regulations, nor can IHS predict the effect of such rules and regulations on
these arrangements in particular or on IHS' operations in general.
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The Company's healthcare operations generate medical waste that must be
disposed of in compliance with Federal, state and local environmental laws,
rules and regulations. IHS' operations are also subject to compliance with
various other environmental laws, rules and regulations. Such compliance has not
materially affected, and IHS anticipates that such compliance will not
materially affect, the Company's capital expenditures, earnings or competitive
position, although there can be no assurance to that effect.
In addition to extensive existing government healthcare regulation, there
are numerous initiatives on the Federal and state levels for comprehensive
reforms affecting the payment for and availability of healthcare services. It is
not clear at this time what proposals, if any, will be adopted or, if adopted,
what effect such proposals would have on IHS' business. Aspects of certain of
these healthcare proposals, such as cutbacks in the Medicare and Medicaid
programs, containment of healthcare costs on an interim basis by means that
could include a short-term freeze on prices charged by healthcare providers, and
permitting greater state flexibility in the administration of Medicaid, could
adversely affect IHS. See "-- Sources of Revenue" and "-- Cautionary Statements
- -- Uncertainty of Government Regulation." There can be no assurance that
currently proposed or future healthcare legislation or other changes in the
administration or interpretation of governmental healthcare programs will not
have an adverse effect on the Company. Concern about the potential effects of
the proposed reform measures has contributed to the volatility of prices of
securities of companies in healthcare and related industries, including IHS, and
may similarly affect the price of the Company's securities in the future. IHS
cannot predict the ultimate timing or effect of such legislative efforts and no
assurance can be given that any such efforts will not have a material adverse
effect on the Company's business, results of operations and financial condition.
FEDERAL AND STATE ASSISTANCE PROGRAMS
Substantially all of IHS' geriatric care facilities are currently certified
to receive benefits as a skilled nursing facility provided under the Health
Insurance for the Aged and Disabled Act (commonly referred to as "Medicare"),
and substantially all are also certified under programs administered by the
various states using federal and state funds to provide medical assistance to
qualifying needy individuals ("Medicaid"). Both initial and continuing
qualification of a skilled nursing care facility to participate in such programs
depend upon many factors including, among other things, accommodations,
equipment, services, patient care, safety, personnel, physical environment, and
adequate policies, procedures and controls.
Services under Medicare consist of nursing care, room and board, social
services, physical and occupational therapies, drugs, biologicals, supplies,
surgical, ancillary diagnostic and other necessary services of the type provided
by extended care or acute care facilities. Under the Medicare program, the
federal government pays the reasonable direct and indirect allowable costs
(including depreciation and interest) of the services furnished and, through
September 30, 1993, provided a rate of return on equity capital (as defined
under Medicare). However, IHS' cost of care for its MSU patients generally
exceeds regional reimbursement limits established under Medicare. The Company
has submitted waiver requests to recover these excess costs. See "-- Sources of
Revenue." There can be no assurance, however, that IHS will be able to recover
its excess costs under the pending waiver requests or under any waiver requests
which may be submitted in the future. IHS' failure to recover substantially all
these excess costs would adversely affect its results of operations and could
adversely affect its MSU strategy. Even though the Company's cost of care for
its MSU patients generally exceeds regional reimbursement limits established
under Medicare for nursing homes, IHS' cost of care is still lower than the cost
of such care in an acute care hospital.
Under the new prospective payment system for Medicare reimbursement to
skilled nursing facilities, facilities will receive a pre-established daily rate
for each individual Medicare beneficiary being cared for, based on the activity
level of the patient. The pre-established daily rate will cover all routine,
ancillary and capital costs. This prospective payment system will be phased in
over four years on a blended rate of the facility-specific costs and the new
federal per diem, which has not to date been established. The blended rate for
the first year of transition will take 75% of the facility-specific per diem
rate and 25% of the federal per diem rate. In each subsequent transition year,
the facility-specific per diem rate component will decrease by 25% and the
federal per diem rate component will increase by 25%, ultimately resulting in a
rate based 100% upon the federal per diem. The facility-specific per diem
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rate is based upon the facility's 1995 cost report for routine, ancillary and
capital services, updated using a skilled nursing market basket index. The
federal per diem is calculated by the weighted average of each facility's
standardized costs, based upon the historical national average per diem for
freestanding facilities. Prospective payment for IHS' owned and leased skilled
nursing facilities will be effective beginning January 1, 1999 for all
facilities other than the facilities acquired from HEALTHSOUTH in the Facility
Acquisition, which will become subject to prospective payment on June 1, 1999.
Prospective payment for skilled nursing facilities managed by IHS will be
effective for each facility at the beginning of its first cost reporting period
beginning on or after July 1, 1998. The new prospective payment system will also
cover ancillary services provided to patients at skilled nursing facilities.
The Medicare program reimburses for home healthcare services under two
basic systems: cost-based and charge-based. Under the cost-based system, IHS is
reimbursed at the lowest of IHS' reimbursable costs (based on Medicare
regulations), cost limits established by HCFA or IHS' charges. While a small
amount of corporate level overhead is permitted as part of reimbursable costs
under Medicare regulations, such costs consist predominantly of expenses and
charges directly incurred in providing the related services, and cannot include
any element of profit or net income to IHS. Under the charge-based system,
Medicare reimburses the Company on a "prospective payment" basis, which consists
in general of either a fixed fee for a specific service or a fixed per diem
amount for providing certain services. As a result, IHS can generate profit or
net income from Medicare charge-based revenues by providing covered services in
an efficient, cost-effective manner. All nursing services (including related
products) are Medicare cost-based reimbursed, except for nursing services
provided to hospice patients. Hospice care and all other home healthcare
services (including non-nursing related products) are Medicare charge-based
reimbursed. The BBA provides for a reduction in current cost reimbursement for
home nursing care pending implementation of a prospective payment system.
The BBA requires that Medicare implement a prospective payment system for
home nursing services for cost reporting periods beginning on or after October
1, 1999, and implementation of a prospective payment system will be a critical
element to the success of the Company's expansion into home nursing services.
Based upon prior legislative proposals, IHS believes that a prospective payment
system would most likely provide for prospectively established per visit
payments to be made for all covered services, which are then subject to an
annual aggregate per episode limit at the end of the year. Home health agencies
that are able to keep their total expenses per visit during the year below their
per episode annual limits will be able to retain a specified percentage of the
difference, subject to certain aggregate limitations. Such changes could have a
material adverse effect on the Company and its growth strategy. The
implementation of a prospective payment system will require the Company to make
contingent payments related to the acquisition of First American of $155 million
over a period of five years. The failure to implement a prospective payment
system for home nursing services in the next several years could adversely
affect IHS' post-acute care network strategy. See "-- Cautionary Statements --
Risks Related to Recent Acquisitions." There can be no assurance that Medicare
will implement a prospective payment system for home nursing services in the
next several years or at all. The inability of IHS to provide home healthcare
services at a cost below the established Medicare fee schedule could have a
material adverse effect on the Company's home healthcare operations and its
post-acute care network.
Under the various Medicaid programs, the federal government supplements
funds provided by the participating states for medical assistance to qualifying
needy individuals. The programs are administered by the applicable state welfare
or social service agencies. Although Medicaid programs vary from state to state,
typically they provide for the payment of certain expenses, up to established
limits. The BBA repeals the so-called Boren Amendment, which required state
Medicaid programs to reimburse nursing facilities for the costs that are
incurred by efficiently and economically operated providers in order to meet
quality and safety standards. By repealing the Boren Amendment, the BBA eases
the impediments on the states' ability to reduce their Medicaid reimbursement
for such services and, as a result, states now have considerable flexibility in
establishing payment rates. The majority of the MSU programs are not required to
participate in the various state Medicaid programs. However, should the
Company's MSU programs be required to admit Medicaid patients as a condition to
continued participation in such programs by the facility in which the MSU
program is located, IHS' results of operations
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could be adversely affected since IHS' cost of care in its MSU programs is
substantially in excess of state Medicaid reimbursement rates.
Funds received by the Company under Medicare and Medicaid are subject to
audit with respect to the proper preparation of annual cost reports upon which
reimbursement is based. Such audits can result in retroactive adjustments of
revenue from these programs, resulting in either amounts due to the government
agency from IHS or amounts due IHS from the government agency.
Both the Medicare and Medicaid programs are subject to statutory and
regulatory changes, administrative rulings, interpretations of policy
determinations by insurance companies acting as Medicare fiscal intermediaries
and governmental funding restrictions, all of which may materially increase or
decrease the rate of program payments to healthcare facilities. Since 1985,
Congress has consistently attempted to limit the growth of Federal spending
under the Medicare and Medicaid programs. IHS can give no assurance that
payments under such programs will in the future remain at a level comparable to
the present level or be sufficient to cover the operating and fixed costs
allocable to such patients. Changes in reimbursement levels under Medicare or
Medicaid and changes in applicable governmental regulations could significantly
affect IHS' results of operations. It is uncertain at this time whether
legislation on healthcare reform will ultimately be implemented or whether other
changes in the administration or interpretation of governmental healthcare
programs will occur. There can be no assurance that future healthcare
legislation or other changes in the administration or interpretation of
governmental healthcare programs will not have an adverse effect on the results
of operations of IHS. The Company cannot at this time predict whether any
healthcare reform legislation will be adopted or, if adopted and implemented,
what effect, if any, such legislation will have on IHS. See "-- Cautionary
Statements -- Risk of Adverse Effect of Healthcare Reform."
COMPETITION
The healthcare industry is highly competitive and is subject to continuing
changes in the provision of services and the selection and compensation of
providers. IHS competes on a local and regional basis with other providers on
the basis of the breadth and quality of its services, the quality of its
facilities and, to a limited extent, price. The Company also competes with other
providers in the acquisition and development of additional facilities and
service providers. IHS' current and potential competitors include national,
regional and local operators of geriatric care facilities, acute care hospitals
and rehabilitation hospitals, extended care centers, retirement centers and
community home health agencies and similar institutions, many of which have
significantly greater financial and other resources than IHS. In addition, the
Company competes with a number of tax-exempt nonprofit organizations which can
finance acquisitions and capital expenditures on a tax-exempt basis or receive
charitable contributions unavailable to IHS. New service introductions and
enhancements, acquisitions, continued industry consolidation and the development
of strategic relationships by the Company's competitors could cause a
significant decline in sales or loss of market acceptance of the Company's
services or intense price competition, or make IHS' services noncompetitive.
Further, technological advances in drug delivery systems and the development of
new medical treatments that cure certain complex diseases or reduce the need for
healthcare services could adversely impact the business of IHS. There can be no
assurance that the Company will be able to compete successfully against current
or future competitors or that competitive pressures will not have a material
adverse effect on the Company's business, financial condition and results of
operations. IHS also competes with various healthcare providers with respect to
attracting and retaining qualified management and other personnel. Any
significant failure by IHS to attract and retain qualified employees could have
a material adverse effect on its business, results of operations and financial
condition.
The geriatric care facilities operated and managed by IHS primarily compete
on a local and regional basis with other skilled care providers. The Company's
MSUs primarily compete on a local basis with acute care and long-term care
hospitals. In addition, some skilled nursing facilities have developed units
which provide a greater level of care than the care traditionally provided by
nursing homes. The degree of success with which IHS' facilities compete varies
from location to location and depends on a number of factors. The Company
believes that the specialized services and care provided, the quality of care
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provided, the reputation and physical appearance of facilities and, in the case
of private pay patients, charges for services, are significant competitive
factors. In light of these factors, IHS seeks to meet competition in each
locality by improving the appearances of, and the quality and types of services
provided at, its facilities, establishing a reputation within the local medical
communities for providing competent care services, and by responding
appropriately to regional variations in demographics and tastes. There is
limited, if any, competition in price with respect to Medicaid and Medicare
patients, since revenues for services to such patients are strictly controlled
and based on fixed rates and cost reimbursement principles. Because IHS'
facilities compete primarily on a local and regional basis rather than a
national basis, the competitive position of IHS varies from facility to facility
depending upon the types of services and quality of care provided by facilities
with which each of IHS' facilities compete, the reputation of the facilities
with which each of IHS' facilities compete, and, with respect to private pay
patients, the cost of care at facilities with which each of IHS' facilities
compete.
The home healthcare market is highly competitive and is divided among a
large number of providers, some of which are national providers but most of
which are either regional or local providers. IHS believes that the primary
competitive factors are availability of personnel, the price of the services and
quality considerations such as responsiveness, the technical ability of the
professional staff and the ability to provide comprehensive services.
The market for specialty medical services is highly fragmented and
competitive. The Company believes the primary competitive factors are quality of
services, charges for services and responsiveness to the needs of patients,
families and the facilities in which such services are provided.
EMPLOYEES
As of March 15, 1998, IHS had approximately 86,000 full-time and regular
part-time employees. Full-time and regular part-time service and maintenance
employees at 54 facilities, totaling approximately 4,100 employees, are covered
by collective bargaining agreements. IHS' corporate staff consisted of
approximately 1,900 people at such date. The Company believes its relations with
its employees are good.
IHS seeks the highest quality of professional staff within each market.
Competition in the recruitment of personnel in the health care industry is
intense, particularly with respect to nurses. Many areas are already facing
nursing shortages, and it is expected that the shortages will increase in the
future. Although the Company has, to date, been successful in hiring and
retaining nurses and rehabilitation professionals, IHS in the future may
experience difficulty in hiring and retaining nurses and rehabilitation
professionals. The Company believes that its future success and the success of
its MSU programs will depend in large part upon its continued ability to hire
and retain qualified personnel.
INSURANCE
Healthcare companies are subject to medical malpractice, personal injury
and other liability claims which are generally covered by insurance. The Company
maintains liability insurance coverage in amounts deemed appropriate by
management based upon historical claims and the nature and risks of its
business. There can be no assurance that a future claim will not exceed
insurance coverage or that such coverage will continue to be available. In
addition, any substantial increase in the cost of such insurance could have an
adverse effect on IHS' business, results of operations and financial condition.
CAUTIONARY STATEMENTS
This Annual Report on Form 10-K contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. All statements regarding the Company's
expected future financial position, results of operations, cash flows, financing
plans, business strategy, competitive position, plans and objectives and words
such as "anticipate," "believe," "estimate," "expect," "intend," "plan" and
other similar expressions are forward-looking statements. Such forward-looking
statements are inherently uncertain, and stockholders must recognize that actual
results could differ materially from those projected or contemplated in the
forward-looking statements as a result of a variety of factors, including the
following:
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Risks Related to Substantial Indebtedness. The Company's indebtedness is
substantial in relation to its stockholders' equity. At December 31, 1997, IHS'
total long-term debt, including current portion, accounted for 74.8% of its
total capitalization. IHS also has significant lease obligations with respect to
the facilities operated pursuant to long-term leases, which aggregated
approximately $704.9 million at December 31, 1997. For the year ended December
31, 1997 the Company's rent expense was $105.1 million ($163.7 million on a pro
forma basis after giving effect to the acquisitions consummated by IHS in 1997).
In addition, IHS is obligated to pay up to an additional $155 million in respect
of the acquisition of First American during 2000 to 2004 under certain
circumstances, of which $113.0 million (representing the present value thereof)
has been recorded at December 31, 1997. The Company's strategy of expanding its
specialty medical services and growing through acquisitions may require
additional borrowings in order to finance working capital, capital expenditures
and the purchase price of any acquisitions. The degree to which the Company is
leveraged, as well as its rent expense, could have important consequences to
securityholders, including: (i) IHS' ability to obtain additional financing in
the future for working capital, capital expenditures, acquisitions or general
corporate purposes may be impaired, (ii) a substantial portion of IHS' cash flow
from operations may be dedicated to the payment of principal and interest on its
indebtedness and rent expense, thereby reducing the funds available to IHS for
its operations, (iii) certain of IHS' borrowings bear, and will continue to
bear, variable rates of interest, which expose IHS to increases in interest
rates, and (iv) certain of IHS' indebtedness contains financial and other
restrictive covenants, including those restricting the incurrence of additional
indebtedness, the creation of liens, the payment of dividends and sales of
assets and imposing minimum net worth requirements. In addition, IHS' leverage
may also adversely affect IHS' ability to respond to changing business and
economic conditions or continue its growth strategy. There can be no assurance
that IHS' operating results will be sufficient for the payment of IHS'
indebtedness. If IHS were unable to meet interest, principal or lease payments,
or satisfy financial covenants, it could be required to seek renegotiation of
such payments and/or covenants or obtain additional equity or debt financing. If
additional funds are raised by issuing equity securities, the Company's
stockholders may experience dilution. Further, such equity securities may have
rights, preferences or privileges senior to those of the Common Stock. To the
extent IHS finances its activities with additional debt, IHS may become subject
to certain additional financial and other covenants that may restrict its
ability to pursue its growth strategy and to pay dividends on the Common Stock.
There can be no assurance that any such efforts would be successful or timely or
that the terms of any such financing or refinancing would be acceptable to IHS.
See "-- Risks Related to Capital Requirements."
In connection with IHS' offering of its 9 1/4% Senior Subordinated Notes
due 2008 (the "9 1/4% Senior Notes"), Standard & Poors ("S&P") confirmed its B
rating of IHS' other subordinated debt obligations, but with a negative outlook,
and assigned the same rating to the 9 1/4% Senior Notes. In November 1997, S&P
placed the Company's senior credit and subordinated debt ratings on CreditWatch
with negative implications due to the proposed Facility Acquisition and in
January 1998 S&P downgraded IHS' corporate credit and bank loan ratings to B+
and its subordinated debt ratings to B- as a result of the Facility Acquisition.
S&P stated that the speculative grade ratings reflect the Company's high debt
leverage and aggressive acquisition strategy, uncertainties with respect to
future government efforts to control Medicare and Medicaid and the unknown
impact on IHS of recent changes in healthcare regulation providing for a
prospective payment system for both nursing homes and home healthcare. S&P noted
IHS' outlook was stable. In connection with the offering of the 9 1/4% Senior
Notes, Moody's Investors Service ("Moody's") downgraded to B2 the Company's
other senior subordinated debt obligations, but noted that the outlook for the
rating was stable, and assigned the new rating to the 9 1/4% Senior Notes.
Moody's stated that the rating action reflects Moody's concern about the
Company's continued rapid growth through acquisitions, which has resulted in
negative tangible equity of $114 million, making no adjustment for the $259
million of convertible debt of IHS outstanding. Moody's also stated that the
availability provided by the Company's new credit facility and the 9 1/4% Senior
Notes positioned the Company to complete sizable acquisition transactions using
solely debt. Moody's further noted that the rating reflects that there are
significant changes underway in the reimbursement of services rendered by IHS,
and that the exact impact of these changes is uncertain.
Risks Associated with Growth Through Acquisitions and Internal Development.
IHS' growth strategy involves growth through acquisitions and internal
development and, as a result, IHS is subject to
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various risks associated with this growth strategy. The Company's planned
expansion and growth require that the Company expand its home healthcare
services through the acquisition of additional home healthcare providers and
that the Company acquire, or establish relationships with, third parties which
provide post-acute care services not currently provided by the Company and that
the Company acquire, lease or acquire the right to manage for others additional
facilities. Such expansion and growth will depend on the Company's ability to
create demand for its post-acute care programs, the availability of suitable
acquisition, lease or management candidates and the Company's ability to finance
such acquisitions and growth. The successful implementation of the Company's
post-acute healthcare system, including the capitation of rates, will depend on
the Company's ability to expand the amount of post-acute care services it offers
directly to its patients rather than through third-party providers. There can be
no assurance that suitable acquisition candidates will be located, that
acquisitions can be consummated, that acquired facilities and companies can be
successfully integrated into the Company's operations, or that the Company's
post-acute healthcare system, including the capitation of rates, can be
successfully implemented. The post-acute care market is highly competitive, and
the Company faces substantial competition from hospitals, subacute care
providers, rehabilitation providers and home healthcare providers, including
competition for acquisitions. The Company anticipates that competition for
acquisition opportunities will intensify due to the ongoing consolidation in the
healthcare industry. See "-- Risks Related to Managed Care Strategy" and "--
Competition."
The successful integration of acquired businesses, including First
American, RoTech, CCA, the Coram Lithotripsy Division and the facilities and
other businesses acquired from HEALTHSOUTH, is important to the Company's future
financial performance. The anticipated benefits from any of these acquisitions
may not be achieved unless the operations of the acquired businesses are
successfully combined with those of the Company in a timely manner. The
integration of the Company's recent acquisitions will require substantial
attention from management. The diversion of the attention of management, and any
difficulties encountered in the transition process, could have a material
adverse effect on the Company's operations and financial results. In addition,
the process of integrating the various businesses could cause the interruption
of, or a loss of momentum in, the activities of some or all of these businesses,
which could have a material adverse effect on the Company's operations and
financial results. There can be no assurance that the Company will realize any
of the anticipated benefits from its acquisitions. The acquisition of service
companies that are not profitable, or the acquisition of new facilities that
result in significant integration costs and inefficiencies, could also adversely
affect the Company's profitability.
IHS' current and anticipated future growth has placed, and will continue to
place, significant demands on the management, operational and financial
resources of IHS. The Company's ability to manage its growth effectively will
require it to continue to improve its operational, financial and management
information systems and to continue to attract, train, motivate, manage and
retain key employees. There can be no assurance that IHS will be able to manage
its expanded operations effectively. See "-- Risks Related to Capital
Requirements."
There can be no assurance that the Company will be successful in
implementing its strategy or in responding to ongoing changes in the healthcare
industry which may require adjustments to its strategy. If IHS fails to
implement its strategy successfully or does not respond timely and adequately to
ongoing changes in the healthcare industry, the Company's business, financial
condition and results of operations will be materially adversely affected.
Risks Related to Managed Care Strategy. Managed care payors and traditional
indemnity insurers have experienced pressure from their policyholders to curb or
reduce the growth in premiums paid to such organizations for healthcare
services. This pressure has resulted in demands on healthcare service providers
to reduce their prices or to share in the financial risk of providing care
through alternate fee structures such as capitation or fixed case rates. Given
the increasing importance of managed care in the healthcare marketplace and the
continued cost containment pressures from Medicare and Medicaid, IHS has been
restructuring its operations to enable IHS to focus on obtaining contracts with
managed care organizations and to provide capitated services. The Company
believes that its home healthcare capabilities will be an important component of
its ability to provide services under capitated and other alternate fee
arrangements. However, to date there has been limited demand among managed care
organizations for post-acute care network
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services, and there can be no assurance that demand for such services will
increase. Further, IHS has limited experience in providing services under
capitated and other alternate fee arrangements and setting the applicable rates.
Accordingly, there can be no assurance that the fees received by IHS will cover
the cost of services provided. If revenue for capitated services is insufficient
to cover the treatment costs, IHS' operating results could be adversely
affected. As a result, the success of IHS' managed care strategy will depend in
large part on its ability to increase demand for post-acute care services among
managed care organizations, to obtain favorable agreements with managed care
organizations and to manage effectively its operating and healthcare delivery
costs through various methods, including utilization management and competitive
pricing for purchased services. Additionally, there can be no assurance that
pricing pressures faced by healthcare providers will not have a material adverse
effect on the Company's business, results of operations and financial condition.
Further, pursuing a strategy focused on risk-sharing fee arrangements
entails certain regulatory risks. Many states impose restrictions on a service
provider's ability to provide capitated services unless it meets certain
financial criteria, and may view capitated fee arrangements as an insurance
activity, subjecting the entity accepting the capitated fee to regulation as an
insurance company rather than merely a licensed healthcare provider accepting a
business risk in connection with the manner in which it is charging for its
services. The laws governing risk-sharing fee arrangements for healthcare
service providers are evolving and are not certain at this time. If the
risk-sharing activities of IHS require licensure as an insurance company, there
can be no assurance that IHS could obtain or maintain the necessary licensure,
or that IHS would be able to meet any financial criteria imposed by a state. If
the Company were precluded from providing services under risk-sharing fee
arrangements, its managed care strategy would be adversely affected. See "--
Uncertainty of Government Regulation."
Risks Related to Capital Requirements. IHS' growth strategy requires
substantial capital for the acquisition of additional home healthcare and
related service providers and geriatric care facilities. The effective
integration, operation and expansion of the existing businesses will also
require substantial capital. The Company expects to finance new acquisitions
from a combination of funds from operations, borrowings under its bank credit
facility and the issuance of debt and equity securities. IHS may raise
additional capital through the issuance of long-term or short-term indebtedness
or the issuance of additional equity securities in private or public
transactions, at such times as management deems appropriate and the market
allows. Any of such financings could result in dilution of existing equity
positions, increased interest and amortization expense or decreased income to
fund future expansion. There can be no assurance that acceptable financing for
future acquisitions or for the integration and expansion of existing businesses
and operations can be obtained. The Company's bank credit facility limits the
Company's ability to make acquisitions, and certain of the indentures under
which the Company's outstanding senior subordinated debt securities were issued
limit the Company's ability to incur additional indebtedness unless certain
financial tests are met. See "-- Risks Related to Substantial Indebtedness."
Risks Related to Recent Acquisitions. IHS has recently completed several
major acquisitions, including the acquisitions of First American, RoTech, CCA
and the Coram Lithotripsy Division and the Facility Acquisition, and is still in
the process of integrating those acquired businesses. The IHS Board of Directors
and senior management of IHS face a significant challenge in their efforts to
integrate the acquired businesses, including First American, RoTech, CCA, the
Coram Lithotripsy Division and the facilities and other businesses acquired from
HEALTHSOUTH. The dedication of management resources to such integration may
detract attention from the day-to-day business of IHS. The difficulties of
integration may be increased by the necessity of coordinating geographically
separated organizations, integrating personnel with disparate business
backgrounds and combining different corporate cultures. There can be no
assurance that there will not be substantial costs associated with such
activities or that there will not be other material adverse effects of these
integration efforts. Further, there can be no assurance that management's
efforts to integrate the operations of IHS and newly acquired companies will be
successful or that the anticipated benefits of the recent acquisitions will be
fully realized.
IHS has recently expanded significantly its home healthcare operations.
During the years ended December 31, 1996 and 1997, home healthcare accounted for
approximately 16.3% and 35.4%, respectively, of IHS' total revenues. On a pro
forma basis, after giving effect to the acquisitions and divesti-
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tures consummated by IHS in 1996 and 1997, home healthcare accounted for
approximately 28.8% and 29.6% of IHS' total revenues in 1996 and 1997,
respectively. On a pro forma basis, approximately 70.7% and 73.0% of IHS' home
healthcare revenues were derived from Medicare in the years ended December 31,
1996 and 1997, respectively. On a pro forma basis, after giving effect to the
acquisitions and divestitures consummated by IHS in 1996 and 1997, home nursing
services accounted for approximately 64.2% and 56.2%, respectively, of IHS' home
healthcare revenues in these periods. Medicare has developed a national fee
schedule for infusion therapy and home medical equipment which provides
reimbursement at 80% of the amount of any fee on the schedule. The remaining 20%
is paid by other third party payors (including Medicaid in the case of
"medically indigent" patients) or patients. With respect to home nursing,
Medicare generally reimburses for the cost of providing such services, up to a
regionally adjusted allowable maximum per visit and per discipline with no fixed
limit on the number of visits prior to 1998. There generally is no deductible or
coinsurance. As a result, there is no reward for efficiency, provided that costs
are below the cap, and traditional home healthcare services carry relatively low
margins. The BBA provides for a reduction in current cost reimbursement for home
nursing care pending implementation of a prospective payment system. The BBA
provides for implementation of a prospective payment system for home nursing
services for cost reporting periods beginning on or after October 1, 1999, and
implementation of a prospective payment system will be a critical element to the
success of IHS' expansion into home nursing services. Based upon prior
legislative proposals, IHS believes that a prospective payment system would most
likely provide a healthcare provider a predetermined rate for a given service,
with providers that have costs below the predetermined rate being entitled to
keep some or all of this difference. There can be no assurance that Medicare
will implement a prospective payment system for home nursing services in the
next several years or at all. The implementation of a prospective payment system
will require IHS to make contingent payments related to the First American
Acquisition of $155 million over a period of five years. Until a prospective
payment system for home nursing services is introduced, IHS anticipates that
margins for home nursing will remain low and may adversely impact its financial
performance. IHS is currently exploring ways to reduce the impact of its home
nursing business on its financial performance. See "-- Patient Services --
Specialty Medical Services -- Home Healthcare Services -- Home Nursing." In
addition, the BBA reduces the Medicare national payment limits for oxygen and
oxygen equipment used in home respiratory therapy by 25% in 1998 and 30% (from
1997 levels) in 1999 and each subsequent year. Approximately 50% of RoTech's
total revenues for 1997 were derived from the provision of oxygen services to
Medicare patients. The inability of IHS to realize operating efficiencies and
provide home healthcare services at a cost below the established Medicare fee
schedule could have a material adverse effect on IHS' home healthcare operations
and its post-acute care network. See "-- Risk of Adverse Effect of Healthcare
Reform."
Reliance on Reimbursement by Third Party Payors. The Company receives
payment for services rendered to patients from private insurers and patients
themselves, from the Federal government under Medicare, and from the states in
which it operates under Medicaid. The healthcare industry is experiencing a
trend toward cost containment, as government and other third party payors seek
to impose lower reimbursement and utilization rates and negotiate reduced
payment schedules with service providers. These cost containment measures,
combined with the increasing influence of managed care payors and competition
for patients, has resulted in reduced rates of reimbursement for services
provided by IHS, which has adversely affected, and may continue to adversely
affect, IHS' margins, particularly in its skilled nursing and subacute
facilities. Aspects of certain healthcare reform proposals, such as cutbacks in
the Medicare and Medicaid programs, reductions in Medicare reimbursement rates
and/or limitations on reimbursement rate increases, containment of healthcare
costs on an interim basis by means that could include a short-term freeze on
prices charged by healthcare providers, and permitting greater state flexibility
in the administration of Medicaid, could adversely affect the Company. There can
be no assurance that adequate reimbursement levels will continue to be available
for services to be provided by IHS which are currently being reimbursed by
Medicare, Medicaid or private payors. Significant limits on the scope of
services reimbursed and on reimbursement rates and fees could have a material
adverse effect on the Company's results of operations and financial condition.
See "-- Risk of Adverse Effect of Healthcare Reform." During the years ended
December 31, 1995, 1996 and 1997, the Company derived approximately 55%, 60% and
66%, respectively, of its patient revenues from Medicare and Medicaid. On a pro
forma basis
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after giving effect to the acquisitions and divestitures consummated by IHS in
1996 and 1997, approximately 69% of the Company's patient revenues have been
derived from Medicare and Medicaid during the years ended December 31, 1996 and
1997, respectively.
The sources and amounts of the Company's patient revenues derived from the
operation of its geriatric care facilities and MSU programs are determined by a
number of factors, including licensed bed capacity of its facilities, occupancy
rate, the mix of patients and the rates of reimbursement among payor categories
(private, Medicare and Medicaid). Changes in the mix of the Company's patients
among the private pay, Medicare and Medicaid categories can significantly affect
the profitability of the Company's operations. The Company's cost of care for
its MSU patients generally exceeds regional reimbursement limits established
under Medicare. The success of the Company's MSU strategy will depend in part on
its ability to obtain per diem rate approvals for costs which exceed the
Medicare established per diem rate limits and by obtaining waivers of these
limitations. There can be no assurance that the Company will be able to obtain
the waivers necessary to enable the Company to recover its excess costs.
Managed care organizations and other third party payors have continued to
consolidate to enhance their ability to influence the delivery of healthcare
services. Consequently, the healthcare needs of a large percentage of the United
States population are provided by a small number of managed care organizations
and third party payors. These organizations generally enter into service
agreements with a limited number of providers for needed services. To the extent
such organizations terminate IHS as a preferred provider and/or engage IHS'
competitors as a preferred or exclusive provider, the business of IHS could be
materially adversely affected.
Risk of Adverse Effect of Healthcare Reform. In addition to extensive
existing government healthcare regulation, there are numerous initiatives on the
federal and state levels for comprehensive reforms affecting the payment for and
availability of healthcare services, including a number of proposals that would
significantly limit reimbursement under Medicare and Medicaid. It is not clear
at this time what proposals, if any, will be adopted or, if adopted, what effect
such proposals would have on the Company's business. Aspects of certain of these
healthcare proposals, such as cutbacks in the Medicare and Medicaid programs,
containment of healthcare costs on an interim basis by means that could include
a short-term freeze on prices charged by healthcare providers, and permitting
greater state flexibility in the administration of Medicaid, could adversely
affect the Company. The BBA provides, among other things, for a prospective
payment system for skilled nursing facilities to be implemented for cost
reporting periods beginning on or after July 1, 1998, a prospective payment
system for home nursing to be implemented for cost reporting periods beginning
on or after October 1, 1999, a reduction in current cost reimbursement for home
nursing care pending implementation of a prospective payment system, reductions
(effective January 1, 1998) in Medicare reimbursement for oxygen and oxygen
equipment for home respiratory therapy and a shift of the bulk of home health
coverage from Part A to Part B of Medicare. The BBA also instituted consolidated
billing for skilled nursing facility services, under which payments for
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, effective
for items or services furnished on or after July 1, 1997. The inability of IHS
to provide home healthcare and/or skilled nursing services at a cost below the
established Medicare fee schedule could have a material adverse effect on IHS'
home healthcare operations, post-acute care network and business generally. IHS
expects that there will continue to be numerous initiatives on the federal and
state levels for comprehensive reforms affecting the payment for and
availability of healthcare services, including proposals that will further limit
reimbursement under Medicare and Medicaid. It is not clear at this time what
proposals, if any, will be adopted or, if adopted, what effect such proposals
will have on IHS' business. See "-- Risks Related to Recent Acquisitions" and
"-- Reliance on Reimbursement by Third Party Payors." There can be no assurance
that currently proposed or future healthcare legislation or other changes in the
administration or interpretation of governmental healthcare programs will not
have an adverse effect on the Company or that payments under governmental
programs will remain at levels comparable to present levels or will be
sufficient to cover the costs allocable to patients eligible for reimbursement
pursuant to such programs. Concern about the potential effects of the proposed
reform measures has contributed to the volatility of prices of securities of
companies in healthcare
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and related industries, including the Company, and may similarly affect the
price of the Company's securities in the future. See "-- Uncertainty of
Government Regulation."
Under the new prospective payment system for Medicare reimbursement to
skilled nursing facilities, facilities will receive a pre-established daily rate
for each individual Medicare beneficiary being cared for, based on the activity
level of the patient. The pre-established daily rate will cover all routine,
ancillary and capital costs. It is anticipated that this prospective payment
system will be phased in over four years on a blended rate of the
facility-specific costs and the new federal per diem, which has not to date been
established. The blended rate for the first year of transition will take 75% of
the facility-specific per diem rate and 25% of the federal per diem rate. In
each subsequent transition year, the facility-specific per diem rate component
will decrease by 25% and the federal per diem rate component will increase by
25%, ultimately resulting in a rate based 100% upon the federal per diem. The
facility-specific per diem rate is based upon the facility's 1995 cost report
for routine, ancillary and capital services, updated using a skilled nursing
market basket index. The federal per diem is calculated by the weighted average
of each facility's standardized costs, based upon the historical national
average per diem for freestanding facilities. Prospective payment for IHS' owned
and leased skilled nursing facilities will be effective beginning January 1,
1999 for all facilities other than the facilities acquired from HEALTHSOUTH,
which will become subject to prospective payment on June 1, 1999. Prospective
payment for skilled nursing facilities managed by IHS will be effective for each
facility at the beginning of its first cost reporting period beginning on or
after July 1, 1998. The new prospective payment system will also cover ancillary
service provided to patients at skilled nursing facilities.
IHS anticipates that the prospective payment system for home nursing will
provide for prospectively established per visit payments to be made for all
covered services, which will then be subject to an annual aggregate per episode
limit at the end of the year. Home health agencies that are able to keep their
total expenses per visit during the year below their per episode annual limits
will be able to retain a specified percentage of the difference, subject to
certain aggregate limitations. Such changes could have a material adverse effect
on the Company and its growth strategy. The implementation of a prospective
payment system will require the Company to make contingent payments related to
the acquisition of First American of $155 million over a period of five years.
The failure to implement a prospective payment system for home nursing services
in the next several years could adversely affect IHS' post-acute care network
strategy. See "-- Risks Related to Recent Acquisitions."
With respect to Medicaid, the BBA repeals the so-called Boren Amendment,
which required state Medicaid programs to reimburse nursing facilities for the
costs that are incurred by efficiently and economically operated providers in
order to meet quality and safety standards. As a result, states now have
considerable flexibility in establishing payment rates.
Uncertainty of Government Regulation. The Company and the healthcare
industry generally are subject to extensive federal, state and local regulation
governing licensure and conduct of operations at existing facilities,
construction of new facilities, acquisition of existing facilities, additions of
new services, certain capital expenditures, the quality of services provided and
the manner in which such services are provided and reimbursement for services
rendered. Changes in applicable laws and regulations or new interpretations of
existing laws and regulations could have a material adverse effect on licensure,
eligibility for participation, permissible activities, operating costs and the
levels of reimbursement from governmental and other sources. There can be no
assurance that regulatory authorities will not adopt changes or new
interpretations of existing regulations that could adversely affect the Company.
The failure to maintain or renew any required regulatory approvals or licenses
could prevent the Company from offering existing services or from obtaining
reimbursement. In certain circumstances, failure to comply at one facility may
affect the ability of the Company to obtain or maintain licenses or approvals
under Medicare and Medicaid programs at other facilities. In addition, in the
conduct of its business the Company's operations are subject to review by
federal and state regulatory agencies to assure continued compliance with
various standards, their continued licensing under state law and their
certification under the Medicare and Medicaid programs. In the course of these
reviews, problems are from time to time identified by these agencies. Although
the Company has to date been able to resolve these problems in a manner
satisfactory to the regulatory agencies without a material adverse effect on its
business, there can be no assurance that it will be able to do so in the future.
23
<PAGE>
In 1995 HCFA implemented stricter guidelines for annual state surveys of
long-term care facilities and expanded remedies available to enforce compliance
with the detailed regulations mandating minimum healthcare standards. Remedies
include fines, new patient admission moratoriums, denial of reimbursement,
federal or state monitoring of operations, closure of facilities and termination
of provider reimbursement agreements. These provisions eliminate the ability of
operators to appeal the scope and severity of any deficiencies and grant state
regulators the authority to impose new remedies, including monetary penalties,
denial of payments and termination of the right to participate in the Medicare
and/or Medicaid programs. The Company believes these new guidelines may result
in an increase in the number of facilities that will not be in "substantial
compliance" with the regulations and, as a result, subject to increased
disciplinary actions and remedies, including admission holds and termination of
the right to participate in the Medicare and/or Medicaid programs. In ranking
facilities, survey results subsequent to October 1990 are considered. As a
result, the Company's acquisition of poorly performing facilities could
adversely affect the Company's business to the extent remedies are imposed at
such facilities.
In September 1997, President Clinton, in an attempt to curb Medicare fraud,
imposed a moratorium on the certification under Medicare of new home healthcare
companies, which moratorium expired in January 1998, and implemented rules
requiring home healthcare providers to reapply for Medicare certification every
three years. In addition, HCFA will double the number of detailed audits of home
healthcare providers it completes each year and increase by 25% the number of
home healthcare claims it reviews each year. IHS cannot predict what effect, if
any, these new rules will have on IHS' business and the expansion of its home
healthcare operations.
The Company is also subject to federal and state laws which govern
financial and other arrangements between healthcare providers. These laws often
prohibit certain direct and indirect payments or fee-splitting arrangements
between healthcare providers that are designed to induce or encourage the
referral of patients to, or the recommendation of, a particular provider for
medical products and services. These laws include the federal "Stark Bills,"
which prohibit, with limited exceptions, financial relationships between
ancillary service providers and referring physicians, and the federal
"anti-kickback law," which prohibits, among other things, the offer, payment,
solicitation or receipt of any form of remuneration in return for the referral
of Medicare and Medicaid patients. The Office of Inspector General of the
Department of Health and Human Services, the Department of Justice and other
federal agencies interpret these fraud and abuse provisions liberally and
enforce them aggressively. The BBA contains new civil monetary penalties for
violations of these laws and imposes an affirmative duty on providers to insure
that they do not employ or contract with persons excluded from the Medicare
program. The BBA also provides a minimum 10 year period for exclusion from
participation in Federal healthcare programs of persons convicted of a prior
healthcare violation. In addition, some states restrict certain business
relationships between physicians and other providers of healthcare services.
Many states prohibit business corporations from providing, or holding themselves
out as a provider of, medical care. Possible sanctions for violation of any of
these restrictions or prohibitions include loss of licensure or eligibility to
participate in reimbursement programs (including Medicare and Medicaid), asset
forfeitures and civil and criminal penalties. These laws vary from state to
state, are often vague and have seldom been interpreted by the courts or
regulatory agencies. The Company seeks to structure its business arrangements in
compliance with these laws and, from time to time, the Company has sought
guidance as to the interpretation of such laws; however, there can be no
assurance that such laws ultimately will be interpreted in a manner consistent
with the practices of the Company.
Many states have adopted certificate of need or similar laws which
generally require that the appropriate state agency approve certain acquisitions
or capital expenditures in excess of defined levels and determine that a need
exists for certain new bed additions, new services and the acquisition of such
medical equipment or capital expenditures or other changes prior to beds and/or
services being added. Many states have placed a moratorium on granting
additional certificates of need or otherwise stated their intent not to grant
approval for new beds. To the extent certificates of need or other similar
approvals are required for expansion of the Company's operations, either through
facility acquisitions or expansion or provision of new services or other
changes, such expansion could be adversely affected by the failure or inability
to obtain the necessary approvals, changes in the standards applicable to such
approvals and possible delays in, and the expenses associated with, obtaining
such approvals.
24
<PAGE>
The Company is unable to predict the future course of federal, state or
local regulation or legislation, including Medicare and Medicaid statutes and
regulations. Further changes in the regulatory framework could have a material
adverse effect on the Company's business, results of operations and financial
condition. See "-- Risk of Adverse Effect of Healthcare Reform."
Competition. The healthcare industry is highly competitive and is subject
to continuing changes in the provision of services and the selection and
compensation of providers. The Company competes on a local and regional basis
with other providers on the basis of the breadth and quality of its services,
the quality of its facilities and, to a more limited extent, price. The Company
also competes with other providers in the acquisition and development of
additional facilities and service providers. The Company's current and potential
competitors include national, regional and local operators of geriatric care
facilities, acute care hospitals and rehabilitation hospitals, extended care
centers, retirement centers and community home health agencies, other home
healthcare companies and similar institutions, many of which have significantly
greater financial and other resources than the Company. In addition, the Company
competes with a number of tax-exempt nonprofit organizations which can finance
acquisitions and capital expenditures on a tax-exempt basis or receive
charitable contributions unavailable to the Company. New service introductions
and enhancements, acquisitions, continued industry consolidation and the
development of strategic relationships by IHS' competitors could cause a
significant decline in sales or loss of market acceptance of IHS' services or
intense price competition or make IHS' services noncompetitive. Further,
technological advances in drug delivery systems and the development of new
medical treatments that cure certain complex diseases or reduce the need for
healthcare services could adversely impact the business of IHS. There can be no
assurance that IHS will be able to compete successfully against current or
future competitors or that competitive pressures will not have a material
adverse effect on IHS' business, financial condition and results of operations.
IHS also competes with various healthcare providers with respect to attracting
and retaining qualified management and other personnel. Any significant failure
by IHS to attract and retain qualified employees could have a material adverse
effect on its business, results of operations and financial condition.
Effect of Certain Anti-Takeover Provisions. IHS' Third Restated Certificate
of Incorporation and By-laws, as well as the Delaware General Corporation Law
(the "DGCL"), contain certain provisions that could have the effect of making it
more difficult for a third party to acquire, or discouraging a third party from
attempting to acquire, control of IHS. These provisions could limit the price
that certain investors might be willing to pay in the future for shares of
Common Stock. Certain of these provisions allow IHS to issue, without
stockholder approval, preferred stock having voting rights senior to those of
the Common Stock. Other provisions impose various procedural and other
requirements that could make it more difficult for stockholders to effect
certain corporate actions. In addition, the IHS Stockholders' Rights Plan, which
provides for discount purchase rights to certain stockholders of IHS upon
certain acquisitions of 20% or more of the outstanding shares of Common Stock,
may also inhibit a change in control of IHS. As a Delaware corporation, IHS is
subject to Section 203 of the DGCL, which, in general, prevents an "interested
stockholder" (defined generally as a person owning 15% or more of the
corporation's outstanding voting stock) from engaging in a "business
combination" (as defined) for three years following the date such person became
an interested stockholder unless certain conditions are satisfied.
Possible Volatility of Stock Price. There may be significant volatility in
the market price of the Common Stock. Quarterly operating results of IHS,
changes in general conditions in the economy, the financial markets or the
healthcare industry, or other developments affecting IHS or its competitors,
could cause the market price of the Common Stock to fluctuate substantially. In
addition, in recent years the stock market and, in particular, the healthcare
industry segment, has experienced significant price and volume fluctuations.
This volatility has affected the market price of securities issued by many
companies for reasons unrelated to their operating performance. In the past,
following periods of volatility in the market price of a company's securities,
securities class action litigation has often been initiated against such
company. Such litigation could result in substantial costs and a diversion of
management's attention and resources, which could have a material adverse effect
upon IHS' business, operating results and financial condition.
25
<PAGE>
EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth certain information with respect to the
executive officers of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION
- --------------------------------- ----- -----------------------------------------------
<S> <C> <C>
Robert N. Elkins, M.D. .......... 54 Chairman of the Board,
Chief Executive Officer and President
W. Bradley Bennett .............. 32 Executive Vice President -- Chief Accounting
Officer
Brian K. Davidson ............... 40 Executive Vice President -- Development
Marshall A. Elkins .............. 50 Executive Vice President and General Counsel
Stephen P. Griggs ............... 40 President of RoTech Medical Corporation
Marc B. Levin ................... 43 Executive Vice President -- Investor Relations
Anthony R. Masso ................ 56 Executive Vice President -- Managed Care
C. Taylor Pickett ............... 36 Executive Vice President -- Chief Financial
Officer
C. Christian Winkle ............. 35 Executive Vice President -- Chief Operating
Officer
</TABLE>
- ----------
The officers of the Company are elected annually and serve at the pleasure of
the Board of Directors.
Robert N. Elkins, M.D. has been Chairman of the Board and Chief Executive
Officer of the Company since March 1986 and President since March 1998 and also
served as President from March 1986 to July 1994. From 1980 until co-founding
IHS with Timothy F. Nicholson, a director of the Company, in 1986, Dr. Elkins
was a co-founder and Vice President of Continental Care Centers, Inc., an owner
and operator of long-term healthcare facilities. From 1976 through 1980, Dr.
Elkins was a practicing physician. Dr. Elkins is a graduate of the University of
Pennsylvania, received his M.D. degree from the Upstate Medical Center, State
University of New York, and completed his residency at Harvard University
Medical Center. Dr. Elkins is the brother of Marshall Elkins, Executive Vice
President and General Counsel of the Company.
W. Bradley Bennett has been Executive Vice President -- Chief Accounting
Officer of the Company since September 1996. From April 1996 to September 1996,
he served as Senior Vice President -- Chief Accounting Officer of the Company,
as Senior Vice President -- Corporate Controller from November 1995 to April
1996, and as Vice President -- Corporate Controller from December 1992 to
November 1995. From October 1991, when he joined IHS, to December 1992, he
served as Assistant Corporate Controller. For five years prior to joining IHS,
Mr. Bennett was with KPMG Peat Marwick LLP, Certified Public Accountants. Mr.
Bennett is a Certified Public Accountant and a Summa Cum Laude graduate of
Loyola College, receiving a B.A. in Accounting.
Brian K. Davidson has been Executive Vice President -- Development of the
Company since November 1995. From January 1993 to November 1995 he served as
Senior Vice President -- Development. From January 1991, when he joined IHS, to
January 1993 he served as Senior Vice President -- Managed Operations of the
Company. For more than five years prior to joining IHS, Mr. Davidson served as
Chief Operating Officer of the Tutera Group, a management company operating
skilled nursing beds and retirement apartment units. Mr. Davidson received B.S.
and M.S. degrees from Central Missouri State University.
Marshall A. Elkins has been Executive Vice President and General Counsel of
the Company since November 1995. From July 1992 to November 1995 he served as
Senior Vice President and General Counsel of the Company and from January 1990
to July 1992 he served as General Counsel and Vice President of the Company.
From July 1987 until joining IHS in 1990, Mr. Elkins was in private practice in
New York City. Mr. Elkins served as General Counsel to US West Capital
Corporation and later as Assistant General Counsel of US West Financial Services
Corporation from July 1985 to July 1987. Prior thereto, Mr. Elkins was associate
counsel at CIT Corporation from 1980 to 1985. Mr. Elkins received a B.A. degree
from the University of Wisconsin and a J.D. from New York Law School. Mr. Elkins
is the brother of Robert N. Elkins, Chairman, Chief Executive Officer and
President of the Company.
26
<PAGE>
Stephen P. Griggs has served as President of RoTech Medical Corporation,
which was acquired by IHS in October 1997, since 1992. Prior to joining RoTech
in 1988, where he also was a director and Chief Operating Officer, Mr. Griggs
was controller for Church Street Station. Mr. Griggs received a B.A. in Business
Administration from East Tennessee State University and a degree in Accounting
from the University of Central Florida.
Marc B. Levin has been Executive Vice President -- Investor Relations since
November 1995. From March 1993 to November 1995 he served as Senior Vice
President -- Investor Relations and from May 1991 to March 1993 he served as
Vice President -- Investor Relations of the Company. From March 1989 until May
1991, Mr. Levin served as Vice President -- Corporate Controller/Administration
of the Company. Prior to joining IHS in 1989, Mr. Levin served in various
capacities with Beverly Enterprises for six years, most recently as Assistant to
the President -- Eastern Division. Mr. Levin is a Certified Public Accountant
and received B.S. and M.B.A. degrees from the University of Maryland.
Anthony R. Masso has been Executive Vice President -- Managed Care since
June 1994. Prior to joining IHS, Mr. Masso served in several managed care
operating roles as Senior Vice President of American MedCenters, an HMO company
in Minneapolis and as Regional Vice President of Aetna Health Plans for the
Midwest and Eastern Divisions. He had operational responsibility for thirteen
HMOs, serving on the boards of ten. For twelve years, Mr. Masso served as a
senior executive in the federal HMO office of the Department of Health and Human
Services. Mr. Masso is a graduate of the University of Rhode Island and holds a
masters degree from Syracuse University.
C. Taylor Pickett has been Executive Vice President -- Chief Financial
Officer since January 1998. From November 1996 to January 1998 he served as
Executive Vice President -- Symphony Health Services, and from February 1995 to
November 1996 he served as Senior Vice President -- Symphony Health Services.
Mr. Pickett joined IHS in September 1993 as Vice President of Acquisitions and
Taxes. Prior to joining IHS, Mr. Pickett was Director of Taxes for PHH
Corporation. Mr. Pickett is a Certified Public Accountant and received a B.S.
degree in Accounting from the University of Delaware and a J.D. from the
University of Maryland School of Law.
C. Christian Winkle has been Executive Vice President -- Chief Operating
Officer since April 1997. From November 1995 to April 1997 he served as
Executive Vice President -- Field Operations of the Company's owned and leased
facilities, and from March 1994 to November 1995 he served as Senior Vice
President -- Operations. Mr. Winkle joined IHS in September 1990 as Regional
Vice President of Operations and President -- MSU Product Development. Prior to
joining IHS, Mr. Winkle was the Executive Director of the Renaissance
Rehabilitation & Diagnostic Hospital in Chattanooga, Tennessee. Mr. Winkle is a
graduate of Case Western Reserve University in Cleveland, Ohio.
ITEM 2. PROPERTIES
The Company owns 86 geriatric care facilities with 13,215 licensed beds,
leases 174 geriatric care facilities with 22,468 licensed beds and manages 52
geriatric care facilities with 6,212 licensed beds. The leases for the leased
facilities have terms of four to 20 years, expiring on various dates between
1998 and 2020. The leases generally can be renewed and the Company generally has
a right of first refusal to purchase the leased facility. The Company is
obligated with respect to many of the leased facilities to pay additional rent
in an amount equal to a specified percentage of the amount by which the
facility's gross revenues exceed a specified amount (generally based on the
facility's gross revenues during its first year of operation). The Company
leases its headquarters in Owings Mills, Maryland under an eight year lease
expiring in May 2001.
27
<PAGE>
The following table presents certain information regarding the Company's
owned, leased and managed service locations (excluding the 38 facilities with
3,746 licensed beds held for sale) as of March 15, 1998.
<TABLE>
<CAPTION>
OWNED LEASED MANAGED
---------------------- ----------------------- ----------------------- OTHER
LICENSED LICENSED LICENSED SERVICE
STATE FACILITIES BEDS FACILITIES BEDS FACILITIES BEDS LOCATIONS(1)
- ------------------------------ ------------ --------- ------------ ---------- ------------ ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Alabama ...................... 5 562 63
Arizona ...................... 35
Arkansas ..................... 43
California ................... 2 249 10 1,239 51
Colorado ..................... 3 459 10 1,480 33
Connecticut .................. 3 585 4
Delaware ..................... 1 153 2
District of Columbia ......... 2
Florida ...................... 19 2,409 8 1,033 8 755 211
Georgia ...................... 7 905 1 62 109
Idaho ........................ 1 218 7
Illinois ..................... 1 140 1 55 1 150 73
Indiana ...................... 1 145 39
Iowa ......................... 2 221 5 352 18
Kansas ....................... 1 149 6 654 23
Kentucky ..................... 1 100 37
Louisiana .................... 1 189 15 1,653 34
Maine ........................ 1
Maryland ..................... 11
Massachusetts ................ 1 201 4 583 8
Michigan ..................... 3 395 3 361 77
Minnesota .................... 8
Mississippi .................. 5 651 35
Missouri ..................... 1 176 4 552 33
Montana ...................... 3 220 1 278 23
Nebraska ..................... 9 571 2 130 7
Nevada ....................... 2 220 13 1,877 11
New Hampshire ................ 2 180 1 68 6
New Jersey ................... 1 58 16
New Mexico ................... 2 157 22 2,258 18
New York ..................... 2
North Carolina ............... 2 275 9 1,092 61
North Dakota ................. 1
Ohio ......................... 6 590 15 1,520 13 1,269 63
Oklahoma ..................... 1 174 1 60 45
Oregon ....................... 1
Pennsylvania ................. 4 831 8 1,094 3 440 106
Rhode Island ................. 1
South Carolina ............... 1 160 26
South Dakota ................. 9
Tennessee .................... 1 124 60
Texas ........................ 22 3,188 21 2,705 7 993 194
Utah ......................... 12
Vermont ...................... 1
Virginia ..................... 1 114 28
Washington ................... 1 210 18
West Virginia ................ 1 126 12
Wisconsin .................... 1 111 10
Wyoming ...................... 2 220 19
</TABLE>
- ----------
(1) Represents locations within the state from which the Company offers home
respiratory services (656 service locations), home healthcare services (548
service locations, including 19 hospice locations), contract rehabilitation
and respiratory services (278 service locations), mobile diagnostic services
(94 service locations, including 10 fixed lithotripsy service locations),
pharmacy services (35 service locations) and physician practices and
outpatient clinics (91 service locations). In addition, other service
locations includes 13 specialty hospitals. The majority of these facilities
are leased. Substantially all of these service locations are small agencies
which are administrative in function, with substantially all healthcare
services being provided at the patient's home or in a geriatric care
facility, rather than the service location. The only exceptions are the 10
fixed lithotripsy centers, 13 specialty hospitals and 19 hospice facilities,
where services are provided at the locations. The physician practices and
outpatient clinics are being held for sale.
28
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings that are incidental to
the conduct of its business. The Company is not involved in any pending or
threatened legal proceedings which the Company believes could reasonably be
expected to have a material adverse effect on the Company's financial condition,
liquidity or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
a. A special meeting of the stockholders of Integrated Health Services,
Inc. was held on October 21, 1997.
c. The proposal to approve the acquisition of RoTech Medical Corporation
was approved, with 18,981,517 shares voted in favor, 36,421 shares voted
against, 81,925 shares abstaining and 6,557,749 broker nonvotes.
29
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Common stock is traded on the New York Stock Exchange under the symbol
"IHS". The following table sets forth for the periods indicated the high and low
last reported sale prices for the Common Stock as reported by the New York Stock
Exchange.
<TABLE>
<CAPTION>
HIGH LOW
---------- ----------
<S> <C> <C>
CALENDAR YEAR 1996
First Quarter .......... $26 $20 1/8
Second Quarter ......... 27 7/8 23 3/8
Third Quarter .......... 25 7/8 20 1/2
Fourth Quarter ......... 27 22
</TABLE>
<TABLE>
<CAPTION>
HIGH LOW
---------- -----------
<S> <C> <C>
CALENDAR YEAR 1997
First Quarter .......... $32 3/8 $23 3/4
Second Quarter ......... 39 26 7/8
Third Quarter .......... 39 1/8 32 11/16
Fourth Quarter ......... 33 7/8 28 5/16
</TABLE>
As of March 18, 1998, there were approximately 1,752 record holders of the
Common Stock.
In 1996 and 1997 the Company declared a cash dividend of $0.02 per share.
The payment of any future dividends will be at the discretion of the Company's
Board of Directors and will depend upon, among other things, future earnings,
operations, capital requirements, the general financial condition of the
Company, contractual restrictions and general business conditions. The Company's
term loan and revolving credit facility prohibits the payment of dividends
without the consent of the lenders, and the indentures under which the Company's
10 1/4% Senior Subordinated Notes due 2006, 9 1/2% Senior Subordinated Notes due
2007 and 9 1/4% Senior Subordinated Notes due 2008 limit the payment of
dividends unless certain financial tests are met.
30
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following tables summarize certain selected consolidated financial
data, which should be read in conjunction with the Company's Consolidated
Financial Statements and related Notes and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere herein. The
selected consolidated financial data set forth below for each of the years in
the five-year period ended December 31, 1997 and as of the end of each of such
periods have been derived from the Consolidated Financial Statements of the
Company which have been audited by KPMG Peat Marwick LLP, independent certified
public accountants. The consolidated financial statements as of December 31,
1996 and 1997 and for each of the years in the three year period ended December
31, 1997, and the independent auditors' report thereon, are included elsewhere
herein.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------
1993 1994 1995 1996 1997
-------------- -------------- -------------- ------------ -------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA(1)(2):
Net revenues: .....................................
Basic medical services ........................... $ 113,508 $ 269,817 $ 368,569 $ 389,773 $ 382,274
Specialty medical services ....................... 162,017 404,401 770,554 999,209 1,571,704
Management services and other .................... 20,779 37,884 39,765 45,713 39,219
---------- ---------- ---------- ---------- ----------
Total ........................................... 296,304 712,102 1,178,888 1,434,695 1,993,197
Cost and expenses:
Operating expenses ............................... 212,936 528,131 888,551 1,093,948 1,479,006
Corporate administrative and general ............. 16,832 37,041 56,016 60,976 76,824
Depreciation and amortization .................... 8,126 26,367 39,961 41,681 70,750
Rent ............................................. 23,156 42,158 66,125 77,785 105,136
Interest, net .................................... 5,705 20,602 38,977 64,110 115,201
Loss from impairment of long-lived assets and
other non-recurring charges (income)(3) ......... -- -- 132,960 (14,457) 133,042
---------- ---------- ---------- ---------- ----------
Earnings (loss) before equity in earnings
of affiliates, income taxes, extraordinary
items and cumulative effect of account
ing change ..................................... 29,549 57,803 (43,702) 110,652 13,238
Equity in earnings of affiliates .................. 1,241 1,176 1,443 828 88
---------- ---------- ---------- ---------- ----------
Earnings (loss) before income taxes, ex-
traordinary items and cumulative effect
of accounting change ........................... 30,790 58,979 (42,259) 111,480 13,326
Income tax provision (benefit) .................... 12,008 22,117 (16,270) 63,715 24,449
---------- ---------- ---------- ---------- ----------
Earnings (loss) before extraordinary items
and cumulative effect of accounting
change ......................................... 18,782 36,862 (25,989) 47,765 (11,123)
Extraordinary items(4) ............................ 2,275 4,274 1,013 1,431 20,552
---------- ---------- ---------- ---------- ----------
Earnings (loss) before cumulative effect of
accounting change .............................. 16,507 32,588 (27,002) 46,334 (31,675)
Cumulative effect of accounting change(5) ......... -- -- -- -- 1,830
---------- ---------- ---------- ---------- ----------
Net earnings (loss) ............................. $ 16,507 $ 32,588 $ (27,002) $ 46,334 $ (33,505)
========== ========== ========== ========== ==========
Per Common Share(6):
Basic:
Earnings (loss) before extraordinary items
and cumulative effect of accounting
change ......................................... $ 1.50 $ 2.18 $ (1.21) $ 2.12 $ (0.39)
Earnings (loss) before cumulative effect of
accounting change .............................. 1.32 1.93 (1.26) 2.06 (1.12)
Net earnings (loss) ............................. $ 1.32 $ 1.93 $ (1.26) $ 2.06 $ (1.19)
Diluted:
Earnings (loss) before extraordinary items
and cumulative effect of accounting
change ......................................... $ 1.36 $ 1.77 $ (1.21) $ 1.83 $ (0.39)
Earnings (loss) before cumulative effect of
accounting change .............................. 1.23 1.61 (1.26) 1.78 (1.12)
Net earnings (loss) ............................. $ 1.23 $ 1.61 $ (1.26) $ 1.78 $ (1.19)
Weighted average number of common shares
outstanding(6) ...................................
Basic ........................................... 12,522 16,910 21,463 22,529 28,253
Diluted ......................................... 17,101 26,558 21,463 31,564 28,253
========== ========== ========== ========== ==========
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------------------
1993 1994 1995 1996 1997
----------- ------------ ------------ ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and temporary investments .................... $ 65,295 $ 63,347 $ 41,304 $ 41,072 $ 61,007
Working capital ................................... 69,495 76,383 136,315 57,549 63,117
Total assets ...................................... 776,324 1,255,989 1,433,730 1,993,107 5,063,144
Long-term debt, including current portion ......... 402,536 551,452 770,661 1,054,747 3,238,233
Stockholders' equity .............................. 216,506 453,811 431,528 534,865 1,088,161
</TABLE>
- ----------------
(1) The Company has grown substantially through acquisitions and the opening of
MSUs, which acquisitions and MSU openings materially affect the
comparability of the financial data reflected herein. In addition, IHS sold
its pharmacy division in July 1996, a majority interest in its assisted
living services subsidiary ("ILC") in October 1996 (the "ILC Offering") and
the remaining interest in ILC in July 1997 (the "ILC Sale"). See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Acquisition and Divestiture History."
(2) In 1995, the Company merged with IntegraCare, Inc. ("IntegraCare") in a
transaction accounted for as a pooling of interests. Accordingly, the
Company's historical financial statements for all periods prior to the
effective date of the merger have been restated to include the results of
IntegraCare. See Note 1(o) of Notes to Consolidated Financial Statements.
(3) In 1995, consists of (i) expenses of $1,939,000 related to the merger with
IntegraCare, (ii) a $21,915,000 loss on the write-off of accrued management
fees ($8,496,000), loans ($11,097,000) and contract acquisition costs
($2,322,000) related to the Company's termination of its agreement, entered
into in January 1994, to manage 23 long-term care and psychiatric
facilities owned by Crestwood Hospital, (iii) the write-off of $25,785,000
of deferred pre-opening costs resulting from a change in accounting
estimate regarding the future benefit of deferred pre-opening costs and
(iv) a loss of $83,321,000 resulting from the Company's election in
December 1995 of early implementation of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of. In 1996, consists primarily of (i) a gain of $34,298,000 from the sale
of its pharmacy division, (ii) a loss of $8,497,000 from its sale of shares
in its assisted living services subsidiary, (iii) a $7,825,000 loss on
write-off of accrued management fees and loans resulting from the Company's
termination of its ten year management contract with All Seasons,
originally entered into during September 1994 and (iv) a $3,519,000 exit
cost resulting from the closure of redundant home healthcare agencies.
Because IHS' investment in the Capstone common stock received in the sale
of its pharmacy division had a very small tax basis, the taxable gain on
the sale significantly exceeded the gain for financial reporting purposes,
thereby resulting in a disproportionately higher income tax provision
related to the sale. In 1997, consists primarily of (i) a gain of
$7,580,000 realized on the shares of Capstone common stock received in the
sale of its pharmacy division, (ii) the write-off of $6,555,000 of
accounting, legal and other costs resulting from the proposed merger
transaction with Coram, (iii) the payment to Coram of $21,000,000 in
connection with the termination of the proposed merger transaction with
Coram, (iv) a gain of $3,914,000 from the ILC Sale, (v) a loss of
$4,750,000 resulting from termination payments in connection with the
RoTech Acquisition and (vi) loss of $112,231,000 resulting from its plan to
dispose of certain non-strategic assets to allow the Company to focus on
its core operations. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Acquisition and
Divestiture History" and "-- Results of Operations" and Notes 1(g), 1(k),
1(o) and 19 of Notes to Consolidated Financial Statements.
(4) In 1993, the Company recorded a loss on extinguishment of debt of
$3,730,000 relating primarily to the write-off of deferred financing costs.
Such loss, reduced by the related income tax effect of $1,455,000, is
presented for the year ended December 31, 1993 as an extraordinary loss of
$2,275,000. In 1994, the Company recorded a loss on extinguishment of debt
of $6,839,000 relating primarily to the write-off of deferred financing
costs. Such loss, reduced by the related income tax effect of $2,565,000,
is presented for the year ended December 31, 1994 as an extraordinary loss
of $4,274,000. In 1995, the Company recorded a loss on extinguishment of
debt of $1,647,000 relating primarily to prepayment charges and the
write-off of deferred financing costs. Such loss, reduced by the related
income tax effect of $634,000, is presented for the year ended December 31,
1995 as an extraordinary loss of $1,013,000. In 1996, the Company recorded
a loss on extinguishment of debt of $2,327,000, relating primarily to the
write-off of deferred financing costs. Such loss, reduced by the related
income tax effect of $896,000, is presented in the statement of operations
for the year ended December 31, 1996 as an extraordinary loss of
$1,431,000. In 1997, IHS recorded a loss on extinguishment of debt of
$33,692,000, representing approximately (i) $23,554,000 of cash payments
for premium and consent fees relating to the early extinguishment of
$214,868,000 aggregate principal amount of IHS' senior subordinated notes
and (ii) $10,138,000 of deferred financing costs written off in connection
with the early extinguishment of such debt and the Company's revolving
credit facility. Such loss, reduced by the related income tax effect of
$13,140,000, is presented in the statement of operations for the year ended
December 31, 1997 as an extraordinary loss of $20,552,000.
(5) Represents the write-off, net of income tax benefit, of the unamortized
balance of costs of business process reengineering and information
technology projects. See Note 20 of Notes to Consolidated Financial
Statements.
(6) The share and per share information for the years ended December 31, 1993,
1994, 1995 and 1996 have been restated to reflect share and per share
information in accordance with Statement of Financial Accounting Standards
No. 128, "Earnings per Share," which was required to be adopted by the
Company effective with its financial statements for the year ended December
31, 1997. See Notes 1(m) and 12 of Notes to Consolidated Financial
Statements. The diluted weighted average number of common shares
outstanding for the years ended December 31, 1993, 1994 and 1996 includes
the assumed conversion of the convertible subordinated debentures into IHS
Common Stock. Additionally, interest expense and amortization of
underwriting costs related to such debentures are added, net of tax, to
income for the purpose of calculating diluted earnings per share. Such
amounts aggregated $4,516,000, $10,048,000 and $9,888,000 for the years
ended December 31, 1993, 1994 and 1996, respectively. The diluted weighted
average number of common shares outstanding for the years ended December
31, 1995 and 1997 does not include the assumed conversion of the
convertible subordinated debentures or the related interest expense and
underwriting costs, as such conversion would be anti-dilutive.
32
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Statements in this Annual Report on Form 10-K concerning the Company's
business outlook or future economic performance; anticipated profitability,
revenues, expenses or other financial items; and product line growth, together
with other statements that are not historical facts, are "forward-looking
statements" as that term is defined under Federal Securities Laws.
Forward-looking statements are subject to risks, uncertainties and other factors
which could cause actual results to differ materially from those stated in such
statements. Such risks, uncertainties and factors include, but are not limited
to, the Company's substantial indebtedness, growth strategy, managed care
strategy, capital requirements and recent acquisitions as well as competition,
government regulation, general economic conditions and the other risks detailed
in the Company's filings with the Securities and Exchange Commission, including
this Annual Report on Form 10-K. See "Item 1. Business -- Cautionary
Statements."
INTRODUCTION
In the past 15 years, the number of people over the age of 65 began to grow
significantly faster than the overall population. At the same time, advances in
medical technology have increased the life expectancies of an increasingly large
number of medically complex patients. This trend, combined with the
implementation of healthcare cost containment measures by private insurers and
government reimbursement programs, has created a need for a more cost efficient
alternate site for the provision of a wide range of medical and rehabilitative
services which traditionally have been provided in an acute care hospital. To
address this need, the Company began in the late 1980s to develop medical
specialty units within its geriatric care facilities. The Company opened its
first MSU in April 1988 in conjunction with HEALTHSOUTH, and as of December 31,
1997 operated 158 MSUs totaling 3,740 beds. Beginning in 1993, the Company began
to expand the range of related services it offers to its patients directly in
order to serve the full spectrum of patients' post-acute care needs. The Company
is now able to offer directly to its patients, rather than through third party
providers, a continuum of care following discharge from an acute care hospital.
IHS' post-acute services include subacute care, home care, skilled nursing
facility care, home respiratory care, home health nursing care, other homecare
services and contract rehabilitation, hospice, lithotripsy and diagnostic
services.
The Company's post-acute care network strategy is to provide cost-effective
continuity of care for its patients in multiple settings, using geriatric care
facilities as platforms to provide a wide variety of subacute medical and
rehabilitative services more typically delivered in the acute care hospital
setting and using home healthcare to provide those medical and rehabilitative
services which do not require 24-hour monitoring. To implement its post-acute
care network strategy, the Company has focused on (i) developing market
concentration for its post-acute care services in targeted states due to
increasing payor consolidation and the increased preference of payors,
physicians and patients for dealing with only one service provider; (ii)
expanding the range of home healthcare and related services it offers to
patients directly in order to provide patients with a continuum of care
throughout their recovery, to better control costs and to meet the growing
desire by payors for one-stop shopping; and (iii) developing subacute care
units. Given the increasing importance of managed care in the healthcare
marketplace and the continued cost containment pressures from Medicare, Medicaid
and private payors, IHS has been restructuring its operations to enable IHS to
focus on obtaining contracts with managed care organizations and to provide
capitated services. IHS' strategy is to become a preferred or exclusive provider
of post-acute care services to managed care organizations and other payors.
The Balanced Budget Act of 1997 (the "BBA"), enacted in August 1997, makes
numerous changes to the Medicare and Medicaid programs which could significantly
affect the delivery of subacute care, skilled nursing facility care and home
healthcare. With respect to Medicare, the BBA required the establishment of a
prospective payment system for skilled nursing facilities, under which such
facilities will be paid a federal per diem rate, based on level of medical
acuity, for virtually all covered services provided to Medicare patients. The
prospective payment system will be phased in over three cost reporting periods,
starting with cost report periods beginning on or after July 1, 1998. The BBA
also instituted consolidated billing for skilled nursing facility services,
under which payments for non-physician Part B services for beneficiaries no
longer eligible for Part A skilled nursing facility care will
33
<PAGE>
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, effective for items or services furnished on or after
July 1, 1997. The BBA also reduced the Medicare national payment limits for
oxygen and oxygen equipment used in home respiratory therapy by 25% in 1998 and
30% (from 1997 levels) in 1999 and each subsequent year. In addition, the BBA
requires the Secretary of the Department of Health and Human Services to
establish a prospective payment system for home nursing services starting with
cost report periods beginning after October 1, 1999. Based upon prior
legislative proposals, IHS anticipates that the prospective payment system for
home nursing will provide for prospectively established per visit payments to be
made for all covered services, subject to an annual aggregate per episode unit,
with providers having costs below the predetermined rate being able to keep some
or all of the difference. Under the BBA, home health agencies are also required
to submit claims for all services, and all payments will be made to the home
health agency regardless of whether the item or service was furnished by the
agency or others. The BBA also contains provisions affecting outpatient
rehabilitation providers, including a 10% reduction in operating and capital
costs in 1998, a fee schedule for therapy services beginning in 1999, and the
application of per beneficiary caps beginning in 1999. With respect to Medicaid,
the BBA repeals the so-called Boren Amendment, which required state Medicaid
programs to reimburse nursing facilities for the costs that are incurred by
efficiently and economically operated providers in order to meet quality and
safety standards. As a result, states now have considerable flexibility in
establishing payment rates.
GENERAL
Basic Medical Services
The Company includes in basic medical services revenues all room and board
charges for its geriatric care patients (other than patients in its MSU and
Alzheimer's programs) at its owned and leased geriatric care and assisted living
facilities.
The following table sets forth the Company's sources of basic medical
services revenues by payor type for the periods indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, PRO FORMA
-------------------------------------------------------------- ----------
1993 1994 1995 1996 1997 1997(1)
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Private Pay(2) ......... 52.9% 40.8% 37.4% 37.0% 37.6% 28.4%
Medicare ............... 12.6 9.9 11.5 12.2 12.0 24.3
Medicaid ............... 34.5 49.3 51.1 50.8 50.4 47.3
----- ----- ----- ----- ----- -----
Total ................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== ===== =====
</TABLE>
- ----------------
(1) Gives effect to acquisitions consummated by IHS in 1997.
(2) The Company classifies revenues from commercial insurers, health
maintenance organizations (HMOs) and other charge-based sources and from
individuals (including the co-insurance portion of Medicare paid by
individuals) as private pay.
The decrease in the percentage of basic medical services revenues received
from private pay sources and Medicare from 1993 to 1997 and the commensurate
increase in the percentage received from Medicaid was primarily the result of
the higher level of Medicaid patients in the geriatric care facilities in which
the Company acquired ownership or leasehold interests. The Company seeks to
increase the percentage of basic medical services revenues received from private
pay sources and Medicare.
Changes in the mix of the Company's patients among the private pay,
Medicare and Medicaid categories can significantly affect the profitability of
the Company's operations. Generally, private pay patients constitute the most
profitable category of patients and Medicaid patients the least profitable.
The occupancy percentages for those beds from which basic medical services
revenues are derived are shown in the table below. The percentages are
calculated both on the basis of the weighted average number of beds licensed
(regardless of whether such beds are actually available for the provision of
basic medical services) and the weighted average number of beds in service for
the period. In certain
34
<PAGE>
facilities the Company temporarily operates fewer beds than it is licensed to
operate so as to permit routine maintenance and to accommodate patients desiring
private rooms. In addition, the Company has removed beds from service for
extended periods as certain facilities have undergone construction projects for
expansion purposes and to implement its medical specialty units. All revenues
derived from licensed beds located in MSUs or used in the Renaissance Program
are included in specialty medical services revenues; accordingly, such beds are
not considered beds licensed or beds in service for purposes of determining
occupancy for those beds from which basic medical services revenues are derived.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, PRO FORMA
-------------------------------------------------------------- ----------
1993 1994 1995 1996 1997 1997(1)
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Beds Licensed ........... 80.6% 83.2% 81.7% 82.7% 83.2% 85.6%
Beds in Service ......... 87.4 92.2 92.7 93.1 93.3 93.9
----- ----- ----- ----- ----- -----
</TABLE>
- ----------
(1) Gives effect to acquisitions consummated by IHS in 1997.
Specialty Medical Services
Specialty medical services revenues include all charges to the Company's
MSU patients for room and board as well as all revenues from providing
rehabilitative therapies, pharmaceuticals, medical supplies and durable medical
equipment to all its patients. The Company also includes in this classification
all revenues from its Alzheimer's programs and all revenue from its provision of
pharmacy, rehabilitative, home healthcare, lithotripsy, mobile x-ray and
electrocardiogram and similar services.
The following table sets forth the Company's sources of specialty medical
services revenues by payor type for the periods indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, PRO FORMA
-------------------------------------------------------------- ----------
1993 1994 1995 1996 1997 1997(1)
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Private Pay(2) ......... 51.6% 47.6% 48.2% 45.0% 32.7% 32.0%
Medicare ............... 45.4 48.2 44.8 48.0 58.3 51.6
Medicaid ............... 3.0 4.2 7.0 7.0 9.0 16.4
----- ----- ----- ----- ----- -----
Total ................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== ===== =====
</TABLE>
- ----------------
(1) Gives effect to acquisitions consummated by IHS in 1997.
(2) The Company classifies revenues from commercial insurers, health
maintenance organizations (HMOs) and other charge-based sources and from
individuals (including the co-insurance portion of Medicare paid by
individuals) as private pay.
The decrease in the percentage of specialty medical services revenues
received from private pay sources from 1993 to 1997 and the commensurate
increase in Medicare and Medicaid was primarily the result of the higher level
of Medicare and Medicaid patients serviced by the facilities and related
services companies acquired during this period, as well as the opening of new,
and the expansion of existing, MSU programs. The Company's experience has been
that Medicare patients constitute a higher percentage of an MSU program's
initial occupancy.
The average occupancy rate of the Company's MSU beds (on a weighted average
basis) was 80.0% in the year ended December 31, 1997 as compared with 76.9% in
the year ended December 31, 1996, 72.0% in the year ended December 31, 1995 and
71.4% in the year ended December 31, 1994. Average occupancy in the Alzheimer's
programs in the Company's owned and leased facilities, which had an average of
345 beds in the years ended December 31, 1997 and 1996, 394 beds in the year
ended December 31, 1995 and 314 beds in the year ended December 31, 1994, was
78.8%, 77.2%, 77.9% and 83.4%, respectively.
35
<PAGE>
The following table sets forth the percentage of specialty medical services
revenues generated by the Company's MSU programs, rehabilitation and other
services and Alzheimer's programs for the periods indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, PRO FORMA
-------------------------------------------------------------- ----------
1993 1994 1995 1996 1997 1997(1)
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
MSU Programs .................. 71.1% 47.5% 37.7% 37.5% 24.1% 14.5%
Other Ancillaries (1) ......... 25.1 50.8 61.0 61.4 75.1 85.0
Alzheimer's Programs .......... 3.8 1.7 1.3 1.1 0.8 0.5
----- ----- ----- ----- ----- -----
100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== ===== =====
</TABLE>
- ----------------
(1) Gives effect to acquisitions consummated by IHS in 1997.
(2) Consists of pharmacy, rehabilitative, home healthcare, lithotripsy, mobile
x-ray and electrocardiogram and similar services. The Company sold its
pharmacy division in July 1996. See "-- Acquisition and Divestiture
History."
The percentage decrease in MSU revenue in 1995, 1996 and 1997 was primarily
the result of the acquisition of rehabilitation, home healthcare and similar
service companies in connection with the Company's vertical integration strategy
and the implementation of the Company's post-acute care network. MSU revenue as
a percentage of total revenues and as a percentage of specialty medical revenues
is expected to continue to decrease as the Company implements its vertical
integration strategy and continues to expand its post-acute care network through
the acquisition of rehabilitation, home healthcare and similar service
companies. While IHS added 1,098 MSU beds in 1994 and 938 MSU beds in 1995, it
added only an additional 383 beds in 1996 and 185 beds in 1997. With the
implementation of a prospective payment system for skilled nursing facilities
under Medicare, which will begin for IHS in 1999, IHS intends to continue to
provide subacute care services in its skilled nursing facilities, although it
does not anticipate continuing to expand significantly its MSUs to provide such
services.
IHS had home healthcare revenues of approximately $234.0 million and $704.9
million in the years ended December 31, 1996 and 1997, respectively,
representing approximately 16.9% and 35.4%, respectively, of IHS' total revenues
in those periods. Home nursing services accounted for approximately 98.6% and
84.0% of IHS' home healthcare revenues in 1996 and 1997, respectively,
respiratory therapy accounted for approximately 0% and 13.7%, respectively,
infusion therapy accounted for approximately 0% and 1.7%, respectively, and home
medical equipment accounted for approximately 1.4% and 0.6%, respectively. On a
pro forma basis after giving effect to the acquisitions consummated by IHS in
1997, IHS had home healthcare revenues of approximately $1.1 billion in 1997,
representing approximately 30.0% of IHS' total revenues in 1997. On a pro forma
basis, home nursing services, respiratory therapy, infusion therapy and home
medical equipment accounted for approximately 56.2%, 27.0%, 6.1% and 10.7%,
respectively, of IHS' home healthcare revenues in 1997.
Until a prospective payment system for home nursing services is introduced,
IHS anticipates that margins for home nursing will remain low and may adversely
impact its financial performance. IHS is currently exploring ways to reduce the
impact of its home nursing business on its financial performance.
IHS is continuing to expand its home respiratory therapy services. The BBA
reduces the national payment limits for oxygen and oxygen equipment used in home
respiratory therapy services by 25% in 1998 and 30% (from 1997 levels) in 1999
and each subsequent year. Approximately 50% of RoTech's total revenues for 1997
were derived from the provision of oxygen services to Medicare patients.
MANAGEMENT SERVICES AND OTHER
The Company's management agreements for its geriatric care facilities
provide for a management fee to the Company generally equal to 4% to 8% of the
gross revenues of the facility. In addition, certain of such agreements contain
a provision wherein the Company may earn an incentive fee based on certain
levels of performance. See "Item 1. Business -- Management Services." At
December 31, 1997, the Company was managing 57 geriatric care facilities with a
total of 6,546 beds. Also, all revenue derived from Health Care Consulting,
Inc., a specialty reimbursement and consulting company with expertise in
subacute rehabilitation programs which was acquired effective September 30,
1993, is included in this revenue category.
36
<PAGE>
The revenues derived from certain activities relating to the operation of
the Company's facilities such as patient laundry, vending sales, guest meals,
and beauty and barber services are classified in this category as other revenue.
Other revenue constituted approximately 16.9%, 16.3% and 15.8%, respectively, of
management services and other revenues during the years ended December 31, 1995,
1996 and 1997. The Company expects other revenue to continue to decrease as a
percentage of management services and other revenues.
ACQUISITION AND DIVESTITURE HISTORY
Facility Expansion
The Company commenced operations on March 25, 1986. From inception to June
30, 1988, the Company acquired seven geriatric care facilities with a total of
900 beds and acquired leasehold interests in seven geriatric care facilities
having a total of 1,050 beds. The Company initiated its MSU program in April
1988, in conjunction with HEALTHSOUTH Rehabilitation Corporation, with a 16 bed
unit serving patients with traumatic brain injury.
During the fiscal year ended June 30, 1989 the Company acquired leasehold
interests in six geriatric care facilities having 974 beds and entered into an
agreement to manage one geriatric care facility having 121 beds. One of the six
leased facilities, having 143 beds, was subject to a sublease to a third party
and was managed by the Company for such third party. The sublease terminated
February 2, 1991 and the facility was treated as a leased, rather than a
managed, facility. In addition, the Company opened two MSU programs totalling 35
beds.
During fiscal year ended June 30, 1990 the Company acquired one geriatric
care facility having 101 beds, a leasehold interest in one facility having 210
beds, and a 49% joint venture interest in a 160 bed geriatric care facility
which was managed by the Company until its purchase in September 1994. IHS also
entered into agreements to manage three other geriatric care facilities having
468 beds and acquired 90% (assuming the exercise of all options and related
exchange rights) of the stock of Professional Community Management
International, Inc. ("PCM"), which managed residential retirement community
living units in Southern California. The Company sold PCM in 1994. The Company
also opened six MSU programs totalling 77 beds.
In December 1990 the Company acquired leasehold interests in four geriatric
care facilities having 328 beds and received by assignment management agreements
covering 12 facilities having 1,403 beds. On July 24, 1990, the Company assumed
the management of 14 of these 16 facilities and, subsequent to July 24, 1990,
assumed the management of the remaining two facilities, pending the consummation
of the acquisition. In 1991 the owners of four of these managed facilities
terminated the Company's management agreement for those facilities. During the
six months ended December 31, 1990 the Company opened four MSU programs
totalling 71 beds.
In December 1991 the Company leased two geriatric care facilities having a
total of 258 beds. The Company also opened six MSU programs totalling 106 beds.
During 1992 the Company expanded its MSU focus by opening thirteen MSU
programs totaling 250 beds at its facilities, expanding seven MSU programs by 61
beds and converting its neuro-rehabilitation MSU program for the treatment of
patients with traumatic brain injury, which was operated in conjunction with
HEALTHSOUTH Rehabilitation Corporation, to a 16 bed complex care MSU program.
Also the Company expanded by acquiring one geriatric care facility with a total
of 120 beds, leasing five facilities having a total of 640 beds and entering
into thirteen management contracts having a total of 1,481 beds. The total cost
of the aforementioned acquisitions was approximately $13.9 million, which
includes all costs to secure the facility or leasehold interest. None of the
acquisitions were individually significant and all were financed with cash flow
from operations and borrowings under the Company's line of credit.
During 1993, the Company expanded its MSU focus by opening 30 MSU programs
totaling 442 beds (including four MSU programs totalling 84 beds at its managed
facilities) and expanding 24 MSU programs by 140 beds. On December 1, 1993 the
Company acquired substantially all of the United
37
<PAGE>
States operations of Central Park Lodges, Inc. ("CPL"), consisting of 30
geriatric care facilities (24 owned and 6 leased) and nine retirement
facilities, totaling 5,210 beds, a division which provides pharmacy consulting
services and supplies, prescription drugs and intravenous medications to
geriatric care facilities through five pharmacies in Florida, Pennsylvania and
Texas, and a division which provides healthcare personnel and support services
to home healthcare and institutional markets through five branch locations
located in Florida and Pennsylvania. The Company disposed of seven retirement
facilities and five of the geriatric care facilities acquired from CPL that the
Company did not consider to fit within its post-acute care strategy. The total
cost of the CPL acquisition was approximately $185.3 million, including $20.1
million in assumption of indebtedness, warrants to purchase 100,000 shares of
common stock of the Company at a purchase price per share of $28.92 (valued at
$1.4 million), and other direct acquisition costs. The $163.8 million cash paid
to purchase CPL was financed using the Company's term loan and revolving credit
facility. The number of shares and price per share are subject to adjustment
under certain circumstances. In addition, the Company agreed to provide
consulting services to Trizec for the development of subacute care programs at
its Canadian facilities. The Company received a consulting fee of $4.0 million
and $3.0 million in 1994 and 1995, respectively.
During 1993, the Company also acquired eight geriatric care facilities (two
of which had previously been leased by IHS), leased one facility and entered
into nine management contracts.
During 1994, the Company continued to expand its MSU focus by opening 49
MSU programs totalling 998 beds (including four MSU programs totalling 102 beds
at its managed facilities which includes 33 beds located at a facility no longer
managed by the Company as of August 1994) and expanding 18 MSU programs by 100
beds. During the same period, the Company acquired five geriatric care
facilities (two of which had been previously leased and three of which had been
managed by IHS), leased 49 (three of which had been previously owned and seven
of which had been previously managed) and entered into 42 management contracts
(five of which have become leased facilities, one of which has become an owned
facility and one of which was terminated).
Effective January 1, 1994, the Company entered into an agreement to manage
23 facilities in California, consisting of 14 geriatric care facilities having
1,875 beds and nine psychiatric facilities having 1,265 beds (the "Crestwood
Facilities"), owned by certain affiliated partnerships (the "Crestwood
Partnerships") and leased by Crestwood Hospitals, Inc. ("Crestwood"). The
management agreement had a term of ten years and provided for payments to IHS
based upon a percentage of the gross revenues of the Crestwood Facilities.
Pursuant to this transaction, IHS had agreed to loan Crestwood up to $11
million, including a $7 million line of credit. IHS was granted purchase options
whereby it had the option upon expiration of its management agreement to
purchase certain partnership interests of the partnerships which own 19 of the
23 Crestwood Facilities at a purchase price equal to the product determined by
multiplying (i) the sum of (a) ten times the net cash flow of the 19 facilities
for the year ended December 31, 2003, plus (b) the amount of the outstanding
mortgages on the 19 facilities, by (ii) a percentage equal to the percentage
ownership of the partners whose interests IHS chooses to purchase. IHS also had
an option to purchase Crestwood on the expiration of the management agreement at
a purchase price equal to fair market value determined by an appraisal. If IHS
elected to purchase Crestwood prior to the expiration of the management
agreement, it was obligated to pay Crestwood a break-up fee of $6 million. The
Company was obligated to purchase Crestwood if it elected to purchase the
partnership interests of the partnerships which own the Crestwood Facilities.
IHS paid the stockholders of Crestwood a non-refundable purchase option deposit
consisting of $3 million in cash and 168,067 shares of IHS Common Stock. This
agreement was terminated in 1995 and, as a result, the Company incurred a loss
of $21.915 million. See Note 19 of Notes to Consolidated Financial Statements.
In February 1994 the Company entered into management agreements to manage,
on an interim basis, eight geriatric care facilities, aggregating 1,174 beds, in
Delaware, Massachusetts, New Jersey and Pennsylvania previously operated by
IFIDA Health Care Group Ltd. ("IFIDA"). Upon the earlier of the completion by
the owners of the eight facilities of the refinancing of certain debt or May 18,
1995, IHS was obligated to lease and operate these facilities, and was granted
an option to purchase any or all of these facilities. Five of these facilities
were subsequently leased by the Company in July 1994 and one management
agreement for a facility was terminated in August 1994. The remaining two
facilities were
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leased in 1995. The annual lease payments for these facilities currently are
$4.1 million. The purchase price per facility is equal to the greater of its
fair market value or its allocable percentage (as agreed to by the parties) of
$59.5 million ($57 million if the option is exercised prior to the seventh year
of the lease). The Company has to date made purchase option deposits aggregating
$6.6 million with respect to these facilities, and is obligated to make
additional purchase option deposits aggregating $500,000 during each year of the
agreement. IHS has agreed to loan the owners of the eight facilities an
aggregate of up to $3.5 million for working capital purposes, and issued to the
owners of the eight facilities an aggregate of 90,000 shares of Common Stock.
In May 1994 the Company sold its 49% interest in two separate joint
ventures formed with Sunrise Terrace, Inc. ("Sunrise") to develop and operate
two assisted living facilities. Each facility was to be managed by Sunrise;
Sunrise had a 51% interest in, and the Company had a 49% interest in, the
venture's capital, earnings and losses. Sunrise had an option to purchase the
Company's interest in either venture at any time, and the Company had a right to
require Sunrise to purchase the Company's interest in the Fairfax, Virginia
venture. The assisted living facility in Fairfax, Virginia opened in October
1990; the second facility was being constructed in Bound Brook, New Jersey at
the time of sale.
In May 1990, a wholly owned subsidiary of IHS, Integrated of Amarillo, Inc.
("IAI"), purchased a geriatric care facility in Amarillo, Texas, and contributed
the facility to a joint venture in exchange for a 49% interest therein. The
Company managed the facility, for which it received a management fee equal to 6%
of gross revenues. The venturers shared in the venture's capital, earnings and
losses in accordance with their respective interests in the venture except that
net taxable operating losses were borne 100% by the other venturer. In September
1994, the Company purchased the remaining 51% interest in this joint venture.
As of August 31, 1994 the Company entered into a Facilities Agreement,
Lease Agreement and certain other agreements with Litchfield Asset Management
Corp. ("LAM") pursuant to which it leased, effective September 1, 1994, on a
triple net basis, 43 geriatric care facilities (consisting of 41 skilled nursing
facilities and two retirement centers), including two facilities previously
leased and two facilities previously managed by the Company (the "LPIMC
Facilities"), aggregating approximately 5,400 beds located in 12 states. The
Company and Litchfield Investment Company, L.L.C., the successor to LAM ("LIC"),
subsequently amended and restated these agreements effective October 1, 1997.
The Company's current annual lease payments are approximately $13.7 million,
based upon the annual debt service of monies borrowed by LIC to refinance the
LPIMC Facilities. In addition, the Company made refundable lease deposits
aggregating $33 million, and will make additional refundable deposits during the
initial term (including any extension thereof) of the leases aggregating
approximately $4 million per annum. Rent payments are subject to escalation
commencing October 1998 in an amount equal to two percent (three percent if the
Company elects to pay such increase in shares of the Company's Common Stock) of
the net annual incremental revenues of the LPIMC Facilities (subject to certain
maximums). The leases have initial terms of eleven years, subject to renewal by
the Company for one additional period of seven years and three additional
periods of five years each, and the Company has guaranteed all lease payments.
The Company has also received options to purchase each of the LPIMC Facilities,
at any time after nine months prior to the end of the fourth lease year, for a
purchase price that will represent (i) during the fourth through tenth years
following the lease commencement date, such facility's allocable percentage of
the total amount of $343 million (to be increased annually after the fifth year
by the rate of increase in the consumer price index) and (ii) beginning in the
twelfth year following the lease commencement date, the greater of (a) fair
market value, (b) 125% of the release cost of the monies borrowed by LIC which
are applicable to such facility or (c) five times the contribution margin of
such facility. The Company loaned LIC's principal stockholders an aggregate of
$3 million. In addition, the Company issued LAM warrants to purchase 300,000
shares of the Company's Common Stock at an exercise price of $31.33 per share,
and has granted LAM "piggy-back" registration rights with respect to the shares
of Common Stock issuable upon exercise of such warrants. The Company has agreed
to issue up to an additional 50,000 shares of Common Stock if the leases are
terminated prior to October 1, 2006. The agreement with LAM requires that the
Company meet certain financial tests. IHS has sublet two of these facilities to
Integrated Living Communities, Inc. ("ILC"), formerly the Company's wholly-owned
assisted living services subsidiary.
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In September 1994, the Company entered into a management agreement with All
Seasons to manage six geriatric care facilities with 872 beds located in the
State of Washington. During the fourth quarter of 1996 the Company terminated
its management contract with All Seasons. As a result of the termination, the
Company incurred a $7.8 million loss on the termination. See Note 19 of Notes to
Consolidated Financial Statements.
In February 1995, the Company entered into a management agreement to manage
a 190 bed geriatric care facility located in Aurora, Colorado.
In March 1995, the Company entered into a management agreement to manage 34
geriatric care facilities in Texas, California, Florida, Nevada and Mississippi
(the "Preferred Care Facilities"). The management agreement has a term of ten
years and provides for payments to the Company based upon a percentage of
adjusted gross revenues and adjusted earnings before interest, taxes,
depreciation and amortization of the Preferred Care Facilities. The Company has
also been granted an option to purchase the Preferred Care Facilities, between
March 29, 1996 and the date of the termination of the management agreement, for
$80 million net of purchase option deposits plus adjustments for inflation. The
Company has a non-refundable purchase option deposit of $20.6 million which will
be applied against the purchase price if the Company elects to acquire the
facilities.
During 1995, the Company purchased five geriatric care facilities (two of
which were previously leased). Also, the Company leased three facilities, all of
which were previously managed. The total cost of these acquisitions was
approximately $30.6 million, which includes legal fees and other costs incurred
to secure the facilities or leasehold interests in the facilities.
During 1995, the Company continued to expand its MSU focus by opening 31
MSU programs totalling 691 beds (including two MSU programs totalling 63 beds at
its managed facilities) and expanding existing programs by 177 beds (including
17 beds at managed facilities).
In January 1996, the Company entered into agreements to manage four
assisted living facilities in California and Ohio having a total of 234 beds.
The management agreements subsequently were transferred to ILC.
In January 1996, the Company purchased Vintage Health Care Center, a 110
bed skilled nursing and assisted living facility in Denton, Texas for $6.9
million. A condominium interest in the assisted living portion of this facility,
as well as in the assisted living portion of the Company's Dallas at Treemont
and West Palm Beach facilities, were transferred as a capital contribution to
ILC in June 1996.
In May 1996, the Company assumed leases for a 96 bed skilled nursing
facility and a 240 bed residential facility located in Las Vegas, Nevada.
In July 1996, the Company assumed a lease for a skilled nursing facility in
Chicago, Illinois.
In October 1996, ILC completed its initial public offering, which reduced
IHS' ownership in ILC to approximately 37%. IHS sold its remaining 37% interest
in ILC in July 1997. See "-- Divestitures."
In December 1996, the Company sold its Palestine facility located in
Palestine, Texas. Total proceeds from the sale were $1.3 million.
In addition, in 1996 the Company transferred to ILC, as a capital
contribution, ownership of three facilities.
During 1996, the Company opened MSU programs totalling 184 beds (including
one MSU program totalling 28 beds at a managed facility) and expanding existing
programs by 199 beds.
On September 25, 1997, the Company acquired, through a cash tender offer
and subsequent merger, Community Care of America, Inc. ("CCA") for a purchase
price of approximately $34.3 million in cash. In addition, in connection with
the CCA Acquisition IHS repaid approximately $58.5 million of indebtedness
assumed in the CCA Acquisition (including restructuring fees of $4.9 million)
and assumed approximately $17.3 million of indebtedness. CCA develops and
operates skilled nursing facilities in medically underserved rural communities.
CCA currently operates 53 licensed long-term care facilities
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with 4,390 licensed beds (of which 18 facilities are being held for sale), one
rural healthcare clinic, two outpatient rehabilitation centers (one of which is
being held for sale), one child day care center and 124 assisted living units
within seven of the facilities which CCA operates. CCA currently operates in
Alabama, Colorado, Florida, Georgia, Iowa, Kansas, Louisiana, Maine, Missouri,
Nebraska, Texas and Wyoming.
On December 31, 1997, IHS acquired from HEALTHSOUTH 139 owned, leased or
managed long-term care facilities (of which 20 facilities are being held for
sale), 12 specialty hospitals, a contract therapy business having over 1,000
contracts and an institutional pharmacy business serving approximately 38,000
beds. IHS paid approximately $1.16 billion in cash and assumed approximately $91
million in debt. IHS intends to dispose of the institutional pharmacy business.
During 1997, the Company extended existing MSU programs by 185 beds, but
did not open any new MSU programs.
In January 1998, IHS formed Lyric Health Care LLC, a limited liability
company ("Lyric"), and transferred five geriatric care facilities to Lyric,
which then sold the five facilities to Omega Healthcare Investors, Inc.
("Omega"), a publicly-traded real estate investment trust, for approximately
$44.5 million. Lyric immediately leased back the five facilities from Omega. IHS
manages the facilities for Lyric, pursuant to which it receives 4% of the
facilities' revenues as well as an incentive fee equal to 70% of Lyric's excess
cash flow (which is generally defined as Lyric's gross revenues less operating
expenses (including the base management fee and debt service)). In a related
transaction Lyric in February 1998 sold a 50% membership interest to TFN
Healthcare Investors, Inc. ("TFN Healthcare"), an entity controlled by Timothy
Nicholson, a director of the Company, for $1.0 million. As a result, IHS now
owns a 50% interest in Lyric. Mr. Nicholson is the Managing Director of Lyric.
The Company recorded a $2.5 million loss on the sale of these facilities in
1997. IHS expects to sell additional facilities to real estate investment
trusts, which Lyric may then lease back, all of which IHS will manage. IHS also
expects that Lyric will also acquire facilities from third parties.
In February 1998, the Company leased a 100 bed skilled nursing facility,
and in March 1998 leased seven skilled nursing facilities having a total of 816
beds. IHS has also reached a definitive agreement to purchase a company
operating 44 skilled nursing facilities having a total of 5,622 beds for a
purchase price of approximately $70.4 million. There can be no assurance the
transaction will close on these terms on different terms or at all.
Vertical Integration
During 1993 the Company began to implement its strategy of expanding the
range of related services it offers directly to its patients in order to serve
the full spectrum of patient needs following acute hospitalization. As a result,
the Company is now able to offer directly to its patients, rather than through
third-party providers, home healthcare, rehabilitation (physical, occupational
and speech), lithotripsy, and mobile x-ray and electrocardiogram and similar
services. See "Item 1. Business -- Company Strategy."
In June 1993, the Company acquired all of the outstanding stock of Patient
Care Pharmacy, Inc. ("PCP"), a California corporation engaged in the business of
providing pharmacy services to geriatric care facilities and other healthcare
providers in Southern California. The Company combined the operations of PCP
with CPL's pharmacy operations. The total cost for PCP was $10.4 million
including $9.84 million representing the issuance of 425,674 shares of the
Company's Common Stock. In addition, the Company had agreed to make contingent
payments in the shares of the Company's Common Stock following each of the next
three years based upon the earnings of PCP. On March 3, 1995, the Company and
the PCP stockholders terminated all rights to contingent payments in
consideration for a payment of $3.5 million in the form of 92,434 shares of IHS
Common Stock. IHS sold this business in July 1996. See "-- Divestitures."
In July 1993, Comprehensive Post Acute Services, Inc. ("CPAS"), a newly
formed subsidiary 80% owned by the Company and 20% owned by Chi Systems, Inc.,
formerly Chi Group, Inc. ("Chi"), acquired joint ventures and contracts to
develop and manage subacute programs from Chi. Chi is a healthcare consulting
company in which John Silverman, a director of the Company, is President and
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Chief Financial Officer and an approximately 16% stockholder. The purchase price
was $200,000 and IHS had made available a loan commitment of $300,000 for
working capital purposes, which loan bore interest at a rate equal to Citicorp's
base rate plus four percent. As of July 21, 1994, the Company purchased the
remaining 20% of CPAS from Chi for 5,200 shares of IHS Common Stock valued at
$159,900. In connection with this transaction, the Company engaged Chi to act as
consultant with respect to the Company's transitional care units. The consulting
agreement, which expired June 30, 1997, provides for the payment, in four equal
installments, of a $100,000 annual consulting fee.
In October 1993, the Company acquired, effective as of September 30, 1993,
Health Care Systems, Inc., which owns Health Care Consulting, Inc. ("HCC") and
RMi, Inc., a Rehabilitation Company ("RMI"), for $1.85 million in cash and a
five-year earnout, up to a maximum of $3.75 million based upon achievement of
pre-tax earnings targets. HCC is a specialty reimbursement and consulting
company with expertise in subacute rehabilitation programs. RMI provides direct
therapy services, including physical therapy, occupational therapy and speech
pathology, to healthcare facilities. RMI also provides management and consulting
services in the oversight and training of therapists employed by geriatric care
facilities to facilitate higher quality patient care. In July 1996, the Company
issued warrants to purchase 20,000 shares of Common Stock at a purchase price
per share of $37.88 to each of Scott Robertson, Gary Kelso and Grantly Payne in
exchange for their rights under the five-year earn-out agreement.
In December 1993, the Company purchased all of the capital stock of
Associated Therapists Corporation, d/b/a Achievement Rehab ("Achievement"), a
provider of rehabilitation therapy services on a contract basis to various
geriatric facilities in Minnesota, Indiana and Florida. The purchase price of
$22.5 million consisted of 839,865 shares of the Company's Common Stock (based
on the average price of the stock of $26.79), plus a contingent earn-out
payment, also payable in shares of Common Stock, based upon increases in
Achievement's earnings in 1994, 1995 and 1996 over a base amount. The total cost
was applied primarily to intangible assets. The final earn-out amount of
approximately $26.44 million was paid in March 1997 through the issuance of
976,504 shares of IHS Common Stock.
On July 7, 1994, the Company acquired all the outstanding capital stock of
Cooper Holding Corporation ("Cooper"), a Delaware corporation engaged in the
business of providing mobile x-ray and electrocardiogram services to long-term
care and subacute care facilities in California, Florida, Georgia, Indiana,
Nebraska, Ohio, Oklahoma, Texas and Virginia. The purchase price for Cooper was
approximately $44.5 million, including $19.9 million representing the issuance
of 593,953 shares of the Company's Common Stock and options to acquire 51,613
shares of Common Stock (based on the average closing price of the Common Stock
of $30.81 over the 30 day period prior to June 2, 1994, the date on which the
Cooper acquisition was publicly announced). In addition, the Company repaid
approximately $27.2 million of Cooper's debt.
On August 8, 1994, the Company acquired substantially all the assets of
Pikes Peak Pharmacy, Inc., a company which provides pharmacy services to
patients at nine facilities in Colorado Springs, Colorado which have an
aggregate of 625 beds, for $646,000. The Company subsequently sold this business
as part of the sale of the pharmacy division.
On September 23, 1994 the Company acquired substantially all of the assets
of Pace Therapy, Inc., a company which provides physical, occupational, speech
and audiology therapy services to approximately 60 facilities in Southern
California and Nevada. The purchase price for Pace was $5.8 million,
representing the issuance of 181,822 shares of the Company's Common Stock. In
addition, the Company repaid approximately $1.6 million of Pace's debt.
On October 7, 1994 the Company acquired all of the outstanding stock of
Amcare, Inc., an institutional pharmacy serving approximately 135 skilled
nursing facilities in California, Minnesota, New Jersey and Pennsylvania. The
purchase price for Amcare was $21.0 million, including $10.5 million
representing the issuance of 291,101 shares of the Company's Common Stock. The
Company subsequently sold this business in the sale of its pharmacy division.
On October 11, 1994 the Company acquired substantially all of the assets of
Pharmaceutical Dose Service of La., Inc., an institutional pharmacy serving 14
facilities. The purchase price for PDS was $4.2
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million, including $3.9 million representing the issuance of 122,117 shares of
the Company's Common Stock. The Company subsequently sold this business in the
sale of its pharmacy division.
On November 2, 1994 the Company acquired all of the outstanding stock of
CareTeam Management Services, Inc., a home health company serving Arizona,
Kansas, Missouri, New Mexico, North Carolina and Texas. The purchase for
CareTeam was $5.9 million, including $5.2 million representing the issuance of
147,068 shares of the Company's Common Stock.
On November 3, 1994 the Company acquired all of the outstanding stock of
Therapy Resources, a company which provides physical, occupational, speech and
audiology services to approximately 22 geriatric care facilities and operates
seven out-patient rehabilitation facilities. The purchase price was $1.6
million.
On November 3, 1994 the Company acquired all of the outstanding stock of
Rehab People, Inc., a company which provides physical, occupational and speech
therapy services to approximately 38 geriatric care facilities in Delaware, New
York, North Carolina and Pennsylvania. The purchase price for Rehab People was
$10 million representing the issuance of 318,471 shares of Common Stock.
On November 3, 1994, the Company acquired certain assets of Portable X-Ray
Service of Rhode Island, Inc., a mobile x-ray company, for a purchase price of
$2.0 million including $700,000 representing the issuance of 19,739 shares of
the Company's Common Stock.
On November 18, 1994 the Company acquired substantially all of the assets
of Medserv Corporation's Hospital Services Division, which provides respiratory
therapy. The purchase price was $21.0 million.
On December 9, 1994, the Company acquired all rights of Jule Institutional
Supply, Inc. under a management agreement with Samaritan Care, Inc. ("Samaritan
Care"), an entity which provides hospice services, for a purchase price of $14.0
million, representing the issuance of 375,134 shares of the Company's Common
Stock. In addition, the Company acquired the membership interests in Samaritan
Care for no additional consideration.
On December 23, 1994, the Company acquired all of the outstanding stock of
Partners Home Health, Inc., a home health infusion company operating in seven
states. The purchase price was $12.4 million, representing the issuance of
332,516 shares of the Company's Common Stock.
Between August 1994 and January 1995, the Company acquired six additional
radiology and diagnostic service providers for an aggregate consideration of
$3.8 million. These entities provide radiology and diagnostic services in
Indiana, Louisiana, North Carolina, Pennsylvania and Texas.
In January 1995, the Company acquired four ancillary services companies
which provide mobile x-ray and electrocardiogram services to long-term care and
subacute care facilities. The total purchase price was $3.6 million, including
$300,000 representing the issuance of 7,935 shares of the Company's Common
Stock.
In February 1995, the Company acquired all of the assets of ProCare Group,
Inc. and its affiliated entities, which provide home health services in Broward,
Dade and Palm Beach counties, Florida. The total purchase price was $3.9
million, including $3.6 million representing the issuance of 95,062 of the
Company's Common Stock.
In March 1995, the Company purchased Samaritan Management, Inc., which
provides hospice services in Michigan, for $5.5 million, and acquired
substantially all of the assets of Fidelity Health Care, Inc., a company which
provides home healthcare services, temporary staffing services and infusion
services in Ohio, for $2.1 million.
In June 1995, the Company acquired three ancillary services companies which
provide mobile x-ray and electrocardiogram services to long-term and subacute
care facilities. The total purchase price was $2.2 million.
In August 1995, the Company acquired all of the outstanding stock of Senior
Life Care Enterprises, Inc., which provides home health, supplemental staffing,
and management services. The total purchase price was $6.0 million representing
the issuance of 189,785 shares of the Company's Common Stock.
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In September 1995, the Company merged with IntegraCare, Inc.
("IntegraCare"), which provides physical, occupational and speech therapy to
skilled nursing facilities in Florida and operated seven physician practices, in
a transaction that was accounted for as a pooling of interests. Accordingly, the
Company's historical financial statements for all periods prior to the effective
date of the merger have been restated to include the results of IntegraCare. In
addition, the Company incurred $1.9 million of costs as a result of the
IntegraCare merger. This amount is included as a non-recurring charge in the
Company's Statement of Operations for the year ended December 31, 1995. The
Company intends to dispose of the physician practices acquired in this
acquisition.
During 1995, the Company acquired 12 companies providing primarily home
healthcare, x-ray and electrocardiagram services. The total purchase price for
these companies was $8.7 million, and no single acquisition had total costs in
excess of $2.0 million.
In March 1996, the Company acquired all of the outstanding stock of Rehab
Management Systems, Inc., which operates outpatient rehabilitative clinics and
inpatient therapy centers. The total purchase price was $10.0 million, including
$8.0 million representing the issuance of 385,542 shares of the Company's Common
Stock.
In May 1996, the Company acquired all of the assets of Hospice of the Great
Lakes, Inc., which provides hospice services in Illinois. The total purchase
price was $8.2 million representing the issuance of 304,822 shares of the
Company's Common Stock.
In July 1996, the Company sold its pharmacy division. See "--
Divestitures."
In August 1996, the Company acquired all of the outstanding stock of J.R.
Rehab Associates, Inc., which provides rehab therapy services to nursing homes,
hospitals and other healthcare providers. The total purchase price was $2.1
million.
In August 1996, the Company acquired the assets of ExtendiCare of
Tennessee, Inc., which provides home healthcare services, for $3.4 million, and
the assets of Edgewater Home Infusion Services, Inc., which provides home
infusion services, for $8.0 million.
In September 1996, the Company acquired the assets of Century Health
Services, Inc., which provides home healthcare services, for $2.4 million, and
all of the outstanding stock of Signature Home Care, Inc., which provides home
healthcare and management services, for $9.2 million, including $4.7 million
representing the issuance of 196,374 shares of the Company's Common Stock. In
addition, the Company repaid approximately $1.6 million of Century's debt and
$1.9 million of Signature's debt.
In October 1996, the Company acquired, through merger, First American
Health Care of Georgia, Inc. ("First American"), a provider of home health
services in 21 states, principally Alabama, California, Florida, Georgia,
Michigan, Pennsylvania and Tennessee. The purchase price for First American was
$154.1 million in cash plus contingent payments of up to $155 million. The
contingent payments were to become payable if (i) legislation was enacted that
changed the Medicare reimbursement methodology for home health services to a
prospectively determined rate methodology, in whole or in part, or (ii) in
respect of any year the percentage increase in the seasonally unadjusted
Consumer Price Index for all Urban Consumers for the Medical Care expenditure
category (the "Medical CPI") was less than 8% or, even if the Medical CPI was
greater than 8% in such year, in any subsequent year prior to 2004 the
percentage increase in the Medical CPI was less than 8%. As a result of the
enactment of the BBA in August 1997, which requires the implementation of a
prospective payment system for home nursing services starting with cost
reporting periods beginning after October 1, 1999, the contingent payments
became payable and will be paid as follows: $10 million for 1999, which must be
paid on or before February 14, 2000; $40 million for 2000, which must be paid on
or before February 14, 2001; $51 million for 2001, which must be paid on or
before February 14, 2002; $39 million for 2002, which must be paid on or before
February 14, 2003; and $15 million for 2003, which must be paid on or before
February 14, 2004. IHS borrowed the cash purchase price paid at the closing
under its revolving credit facility. $115 million of the $154.1 million paid at
closing was paid to HCFA, the Department of Justice and the United States
Attorney for the Southern District of Georgia in settlement of claims by the
United States
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government seeking repayment from First American of certain overpayments and
unallowable reimbursements under Medicare. The total settlement with the United
States government was $255 million; the remaining $140 million will be paid from
the contingent payments.
In November 1996, the Company acquired the assets of Mediq Mobile X-ray
Services, Inc., which provides mobile diagnostic services, for $10.1 million,
including $5.2 million representing the issuance of 203,721 shares of the
Company's Common Stock, and the assets of Total Rehab Services, LLC and Total
Rehab Services 02, LLC, which provide contract rehabilitative and respiratory
services, for $8.0 million, including $2.7 million representing the issuance of
106,559 shares of the Company's Common Stock. In addition, the Company repaid
approximately $3.9 million of Total Rehab's debt.
In November 1996, the Company acquired all of the outstanding stock of
Lifeway, Inc., which provides physician and disease management services. The
total purchase price was $900,000 representing the issuance of 38,502 shares of
the Company's Common Stock. IHS also issued 48,129 shares of Common Stock to
Robert Elkins, Chairman and Chief Executive Officer of the Company, in payment
of outstanding loans of $1.1 million from Mr. Elkins to LifeWay.
During 1996, the Company acquired seven companies providing primarily
mobile x-ray services. The total purchase price was $2.6 million, and no single
acquisition had total costs in excess of $2.0 million.
In January 1997, the Company acquired all of the outstanding stock of
In-Home Healthcare, Inc., which provides home healthcare services. The total
purchase price was $3.2 million.
In February 1997, the Company acquired the assets of Portable X-Ray Labs,
Inc., which provides mobile x-ray services, for $4.9 million.
In June 1997, the Company acquired all the outstanding capital stock of
Health Care Industries, Inc., a home health company in Florida, for $1.8
million, and substantially all the assets of Rehab Dynamics, Inc. and
Restorative Therapy, Ltd., related contract rehab companies, for $19.7 million,
including $11.5 million representing the issuance of 331,379 shares of the
Company's Common Stock.
In August 1997, IHS acquired all the outstanding capital stock of Arcadia
Services, Inc., a home health company, for $17.2 million representing the
issuance of 581,451 shares of the Company's Common Stock, and all the
outstanding capital stock of Ambulatory Pharmaceutical Services, Inc. and APS
American, Inc., related home health companies, for $36.3 million, including
$18.1 million representing the issuance of 532,240 shares of the Company's
Common Stock.
In September 1997, the Company acquired all the outstanding capital stock
of Barton Creek Health Care, Inc., a home health company. Total purchase price
was $4.9 million.
In October 1997, IHS acquired RoTech through merger of a wholly-owned
subsidiary of IHS into RoTech (the "RoTech Merger"), with RoTech becoming a
wholly-owned subsidiary of IHS. RoTech provides home healthcare products and
services, with an emphasis on home respiratory, home medical equipment and
infusion therapy, primarily to patients in non-urban areas. IHS issued
approximately 15,598,400 shares of Common Stock in the RoTech Merger, and
reserved for issuance approximately 1,737,476 shares of Common Stock issuable
upon exercise of RoTech options. The RoTech Merger consideration aggregated
approximately $506.6 million, substantially all of which was recorded as
goodwill. IHS repaid the $201.0 million of RoTech bank debt assumed in the
transaction and repurchased $107.836 million of RoTech's convertible
subordinated debentures; $2.164 million principal amount of RoTech debentures,
convertible into approximately 47,865 shares of Common Stock, remains
outstanding.
In October 1997, IHS acquired substantially all of the assets of Coram's
Lithotripsy Division, which operated 20 mobile lithotripsy units and 13
fixed-site machines in 180 locations in 18 states. The Coram Lithotripsy
Division also provides maintenance services to its own and third-party
equipment. Lithotripsy is a non-invasive technique that utilizes shock waves to
disintegrate kidney stones. IHS paid approximately $131.0 million in cash for
the Coram Lithotripsy Division, including the payment of $1.0 million of
intercompany debt to Coram.
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In November 1997, IHS purchased the remaining 60% interest in HPC America,
Inc., an operator of home infusion and home healthcare companies, for $26.1
million. IHS purchased a 40% interest in HPC America in September 1995 for $8.2
million.
In November 1997, the Company acquired the assets of Durham Meridian
Limited Partnership, owner of Treyburn Nursing Center, a skilled nursing
facility, for $4.8 million. The Company also acquired the assets of Richards
Medical Company, Inc. for $2.0 million, Central Medical Supply Company, Inc. for
$1.9 million and Hallmark Respiratory Care for $3.8 million, which are all home
healthcare providers. In addition, the Company purchased a leasehold interest in
Shadow Mountain, a skilled nursing facility, for $4.0 million.
In December 1997, the Company purchased the assets of Sunshine Medical
Equipment, Inc., a home healthcare provider, for $3.3 million and the assets of
the Quest entities of Bradley Medical, Inc., home respiratory care businesses,
for $33.0 million.
During 1997, the Company acquired 17 companies providing primarily home
healthcare and diagnostic services. The total purchase price for these companies
was $9.0 million, and no single acquisition had total costs in excess of $2.0
million.
In January 1998, the Company acquired all the outstanding capital stock of
Paragon Rehabilitative Services, Inc., an Ohio corporation which provides
contract rehabilitation services to nursing homes, long-term care facilities and
other healthcare facilities. The merger consideration was $10.8 million, which
was paid through the issuance of 361,851 shares of the Company's Common Stock.
In January 1998, the Company acquired the assets of nine respiratory
companies for approximately $9.4 million. In February 1998, the Company acquired
the assets of 12 additional respiratory companies for approximately $18.9
million. In March 1998 (through March 20, 1998), IHS acquired two respiratory
companies for approximately $1.8 million.
In addition, at March 20, 1998, IHS had reached agreements in principle to
acquire a lithotripsy company for approximately $10.5 million and 15 respiratory
companies for approximately $42.4 million. There can be no assurance that any of
these pending acquisitions will be consummated on the proposed terms, on
different terms or at all.
Divestitures
On July 11, 1991, the Company sold its audiology business to Hearing Health
Services, Inc., a newly-formed affiliate of privately-held Foster Management
Company. The sale involved all customer lists, license agreements, store leases,
property and equipment, accounts receivable and merchandise inventory. The
Audiology Division's products and services, which were offered at 34 retail
outlets (of which 12 were located in speech pathologist/professional/doctor
offices) in Florida and Illinois, included hearing aids, protective and
assistive listening devices, and hearing, testing and aural rehabilitation
services. The Company received $5 million for substantially all the assets of
the Audiology Division as follows: $1 million in cash and a combination of
common and preferred stock valued by independent financial advisors at $4
million. The common stock was repurchased for $2.6 million plus interest in July
1996 and the preferred stock is convertible under certain conditions and has a
liquidation preference of $2 million. Approximately $450,000 of the cash
proceeds were paid to NovaCare, Inc., an affiliate of Foster Management Company,
representing amounts owed by IHS to NovaCare, Inc. for services rendered. The
Company determined to discontinue the audiology business in June 1990 because it
could not be integrated effectively into its primary business. A substantial
portion of the audiology business had been acquired from Dr. Thomas F. Frist,
Jr., who was a director of the Company until June 1993.
On April 27, 1994, the Company sold its approximate 92% interest in
Professional Community Management International, Inc. ("PCM") to PCM at its book
value of $4.3 million. The Company accepted a promissory note for the full
amount of the purchase price, which note bears interest at 6.36% per annum and
is payable by PCM in installments over a 40 year period. The promissory note is
secured by a pledge of PCM stock held by certain PCM stockholders and a security
interest in all tangible and intangible assets of PCM. Certain stockholders of
PCM also executed personal guarantees with respect
46
<PAGE>
to the payment of $1.2 million over a period of six years, subject to reduction
in an amount equal to the amortization of the principal amount of the note. PCM
manages residential condominium units in retirement communities in Southern
California.
In July 1996, IHS sold its pharmacy division to Capstone Pharmacy Services,
Inc. ("Capstone") for a purchase price of $150 million, consisting of cash of
$125 million and shares of Capstone common stock having a value of $25 million.
In connection with the sale of the pharmacy division, IHS agreed that prior to
July 2001 neither it nor any of its subsidiaries would be involved, directly or
indirectly, in the operation, management or conduct of any business that
provides institutional pharmacy dispensing or consulting services to long-term
care facilities (including skilled nursing facilities) located within a 150 mile
radius of any IHS long-term care facility or any pharmacy sold to, or operated
by, Capstone, except in certain limited circumstances. The Company's pharmacy
division operated institutional pharmacies in eight states providing service to
over 40,000 beds within 379 facilities. Approximately 17% of the beds were then
owned, leased or managed by IHS. IHS' revenues for the years ended December 31,
1995 and 1996 included revenue generated by the pharmacy division of
approximately $91.0 million (of which $17.5 million was revenue from services to
IHS facilities) and approximately $63.6 million (of which $11.3 million was
revenue from services to IHS facilities), respectively. The Company's earnings
(loss) before income taxes for the years ended December 31, 1995 and 1996
included earnings before income taxes generated by the pharmacy division of
approximately $6.6 million and $6.4 million, respectively. IHS has determined
that its ownership of pharmacy operations is not critical to the development and
implementation of its post-acute care network strategy.
On October 9, 1996, Integrated Living Communities, Inc. ("ILC"), at the
time a wholly-owned subsidiary of IHS which provides assisted living and related
services to the private pay elderly market, completed an initial public offering
of ILC common stock. IHS sold 1,400,000 shares of ILC common stock in the
offering, for which it received aggregate net proceeds of approximately $10.4
million. In addition, ILC used approximately $7.4 million of the proceeds from
the offering to repay outstanding indebtedness to IHS. IHS recorded a pre-tax
loss of approximately $8.5 million in the fourth quarter of 1996 as a result of
this transaction. On July 2, 1997, IHS sold the remaining 2,497,900 shares of
ILC common stock it owned, representing 37.3% of the outstanding ILC common
stock, for $11.50 per share in a cash tender offer (the "ILC Sale"). IHS
recorded a gain of approximately $3.9 million from the ILC Sale in 1997. IHS'
revenues for the years ended December 31, 1995 and 1996 include revenue
generated by ILC of approximately $16.3 million and $17.1 million, respectively.
The Company's earnings (loss) before income taxes for the years ended December
31, 1995 and 1996 include earnings (loss) before income taxes generated by ILC
of approximately $(4.0) million and $1.7 million, respectively. IHS has
determined that the direct operation of assisted-living communities is not
required for its post-acute care network strategy.
In developing its post-acute healthcare system, IHS continuously evaluates
whether owning and operating businesses which provide certain ancillary
services, or contracting with third parties for such services, is more
cost-effective. As a result, the Company is continuously evaluating its existing
operations to determine whether to retain or divest operations. To date, IHS has
divested its pharmacy division and its assisted living services division, and
may divest additional divisions or assets in the future. IHS is currently
pursuing the sale of the pharmacy operations acquired in the acquisition of
certain businesses from HEALTHSOUTH, the sale of approximately 46 facilities
(excluding the 38 facilities held for sale) to real estate investment trust(s)
which would then lease the facilities to Lyric with IHS managing such
facilities, and a "spin-off" of its home nursing operations, although there can
be no assurance it will successfully complete any or all of these transactions.
47
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth for the fiscal periods indicated the
percentage of net revenues represented by certain items reflected in the
Company's statement of operations and the percentage change in such items from
the prior corresponding fiscal periods.
<TABLE>
<CAPTION>
PERIOD TO PERIOD
PERCENTAGE OF NET REVENUES INCREASE (DECREASE)
-------------------------------- -----------------------
YEAR YEAR
ENDED ENDED
DECEMBER DECEMBER
31, 1996 31, 1997
COMPARED COMPARED
YEARS ENDED DECEMBER 31, TO 1995 TO 1996
-------------------------------- ---------- ------------
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Net revenues:
Basic medical services ................................... 31.3% 27.2% 19.2% 5.8% ( 1.9)%
Specialty medical services ............................... 65.4 69.6 78.9 29.7 57.3
Management services and other ............................ 3.3 3.2 1.9 15.0 ( 14.2)
----- ----- ----- ----- -------
Total Revenues .......................................... 100.0 100.0 100.0 21.7 38.9
----- ----- ----- ----- -------
Costs and Expenses:
Operating expenses ....................................... 75.4 76.2 74.2 23.1 35.2
Corporate administrative and general ..................... 4.8 4.3 3.9 8.9 26.0
Depreciation and amortization ............................ 3.4 2.9 3.5 4.3 69.7
Rent ..................................................... 5.6 5.4 5.3 17.6 35.2
Interest, net ............................................ 3.3 4.5 5.8 64.5 79.7
Loss from impairment of long-lived assets and other
non-recurring charges (income) .......................... 11.2 ( 1.0) 6.7 * *
----- ----- ----- ----- -------
Earnings (loss) before equity in earnings of affiliates,
income taxes, extraordinary items and cumulative
effect of accounting change ............................ ( 3.7) 7.7 0.6 353.2 ( 88.0)
Equity in earnings of affiliates .......................... 0.1 0.1 0.0 (42.6) ( 89.4)
----- ----- ----- ----- -------
Earnings (loss) before income taxes, extraordinary
items and cumulative effect of accounting change ....... ( 3.6) 7.8 0.6 363.8 ( 88.0)
Federal and state income taxes ............................ ( 1.4) 4.5 1.2 491.6 ( 61.6)
----- ----- ----- ----- -------
Earnings (loss) before extraordinary items and cumu-
lative effect of accounting change ..................... ( 2.2) 3.3 ( 0.6) 283.8 ( 123.3)
Extraordinary items ....................................... 0.1 0.1 1.0 41.3 1,336.2
----- ----- ----- ----- -------
Earnings (loss) before cumulative effect of account-
ing change ............................................. ( 2.3) 3.2 ( 1.6) 271.6 ( 168.4)
Cumulative effect of accounting change .................... -- -- 0.1 -- *
----- ----- ----- ----- -------
Net earnings (loss) ..................................... ( 2.3) 3.2 ( 1.7) 271.6 ( 172.3)
===== ===== ===== ===== =======
</TABLE>
- ----------
* Not meaningful.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Net revenues for the year ended December 31, 1997 increased $558.50
million, or 38.9% to $1,993.20 million from the comparable period in 1996. Such
increase was attributable to (1) growth in revenues from facilities and
ancillary companies in operation in both periods and facilities and ancillary
companies acquired during 1996 and (2) the addition of new facilities acquired
or leased and ancillary service businesses acquired in 1997 which increased
revenue by $203.31 million. The growth in revenues from facilities was primarily
the result of increased occupancy in the Company's MSUs and the growth in
revenues from ancillary companies was primarily the result of additional service
contracts entered into in 1997. Net revenues in 1996 include revenue of $63.61
million from the pharmacy division prior to its sale in July 1996 and revenues
of $17.1 million from ILC prior to its initial public offering in October 1996.
Basic medical services revenue decreased $7.50 million, or 1.9%, from $389.77
million in 1996 to $382.27 million in 1997. This decrease was attributable to
the conversion of existing basic medical services beds to MSU beds during 1997,
partially offset by the acquisition of 33 owned or leased long-term care
facilities in September 1997 in the CCA Acquisition. Specialty medical services
revenue increased from $999.21 million to $1,571.70 million. Of the $572.50
million increase, $181.53 million, or 31.7%, was attributable to revenue from
acquisitions subsequent to December 31, 1996. The remainder of the increase is
due to increased revenue at facilities in operation in both periods, facilities
and ancillary
48
<PAGE>
companies acquired during 1996, and the conversion of basic medical services
beds to MSU beds, which results in higher revenue per day, in 1996 and 1997
partially offset by the sale of the pharmacy division in 1996. Management
services and other revenues decreased from $45.71 million to $39.22 million as a
result of the termination of 12 management agreements during 1997 and the
transfer of management agreements for eight facilities to Integrated Living
Communities, Inc. in connection with its initial public offering in October
1996.
Total expenses for the period increased from $1,324.04 million to $1,979.96
million, an increase of 49.5%. Of the $655.92 million increase, $166.11 million,
or 25.3%, was attributable to expenses from acquisitions subsequent to December
31, 1996. The remainder of this increase was due to the acquisition of
facilities and ancillary companies during 1996, increased expenses at facilities
and ancillary companies in operation in both periods, partially offset by the
sale of the pharmacy division and a majority interest in ILC in 1996. Salaries,
wages and benefits paid to personnel increased $268.75 million, or 38.7%, from
the year ended December 31, 1996. The increase resulted from salary increases
for existing employees, increases in salaries due to facilities and ancillary
companies acquired during 1996 and 1997, as well as additional personnel needed
due to increased census and the increased medical acuity level of the Company's
patients. Other operating expenses, which include physician fees and fees paid
to independent contractors providing rehabilitative therapy, utilities, food
supplies and facility maintenance, increased $116.31 million, or 29.1%, in 1997
as compared to 1996. This increase was attributable to the aforementioned
facilities and ancillary companies acquired in 1996 and 1997.
Corporate administrative and general expenses for the year ended December
31, 1997 increased by $15.85 million, or 26.0%, over the comparable period in
1996. This increase primarily represents additional operations, information
systems, finance, accounting and other personnel to support the growth of owned
and leased facilities and related services businesses. Depreciation and
amortization increased to $70.75 million during the year ended December 31,
1997, a 69.7% increase as compared to $41.68 million in 1996. Of the $29.07
million increase, $11.15 million, or 38.3%, was attributable to depreciation and
amortization at facilities and ancillary businesses acquired in 1997. The
remaining increase was primarily due to the amortization and depreciation
related to increased routine and capital expenditures at existing facilities,
increased debt issue costs and depreciation and amortization of facilities and
ancillary companies acquired during 1996. Rent expense increased by $27.35
million, or 35.2%, over the comparable period in 1996, primarily as a result of
increased rental equipment at ancillary companies acquired during 1997 and 24
additional facilities leased in 1997. Net interest expense increased $51.09
million, or 79.7%, during the year ended December 31, 1997 to $115.20 million.
The increase was primarily the result of the full year effect of the 10 1/4%
Senior Subordinated Notes due 2006 issued in May 1996, the 9 1/2% Senior
Subordinated Notes due 2007 issued in May 1997, the 9 1/4% Senior Subordinated
Notes due 2008 issued in September 1997 and the $750 million term loan borrowed
in September 1997, partially offset by the repurchase of substantially all the
Company's outstanding 9 5/8% Senior Subordinated Notes due 2002 and the 10 3/4%
Senior Subordinated Notes due 2004, the payoff of the Company's $700 million
revolving credit facility and lower interest rates.
During 1997 the Company recorded non-recurring charges of $133.04 million.
During 1997, the Company recorded a $27.55 million non-recurring charge
resulting from the termination of its proposed merger with Coram, recognized a
$7.58 million gain on the sale of shares received on the sale of the pharmacy
division and a $3.91 million gain on the sale of its remaining interest in ILC
and recorded a $4.75 million charge resulting from termination payments in
connection with the RoTech acquisition. In addition, in connection with the
acquisitions of CCA, RoTech, the Coram Lithotripsy Division and certain
businesses from HEALTHSOUTH Corporation, the Company has chosen to dispose of
certain business activities, including the Company's physician practices,
outpatient clinics, selected nursing facilities in nonstrategic markets, as well
as all international activities. In addition, the Company terminated a national
purchasing contract and wrote-off a purchase option deposit on certain managed
facilities. As a result the Company recorded a non-recurring charge of $112.23
million. In 1996, IHS had non-recurring income of $14.46 million, consisting
primarily of a gain of $34.30 million from the sale of the pharmacy division,
partially offset by a loss of $8.50 million from its sale of shares of ILC, a
$7.82 million loss related to the termination of a management contract and a
$3.52 million non-recurring charge resulting from the closure of certain
redundant home health agencies.
49
<PAGE>
Earnings before income taxes and extraordinary items decreased by 88.0% to
$13.33 million for the year ended December 31, 1997 from $111.48 million for the
comparable period in 1996. The decrease was primarily due to certain
non-recurring charges discussed above. Excluding the non-recurring income and
charges, earnings before income taxes and extraordinary items in 1997 increased
$49.35 million, or 50.9%, over 1996. Of this increase, $37.20 million, or 75.4%,
resulted from acquisitions consummated subsequent to December 31, 1996. The
remaining increase was due to acquisitions consummated during 1996 and improved
operations from facilities and ancillary companies in operation during both
periods. The provision for state and federal income taxes decreased from $63.72
million in 1996 to $24.45 million in 1997. This decrease was primarily the
result of the non-recurring charge in 1997 and the disproportionately high
income tax provision related to the sale of the Company's pharmacy division in
1996. Because the Company's investment in the common stock received in the sale
of the Company's pharmacy division had a very small tax basis, the taxable gain
on the sale significantly exceeded the gain for financial reporting purposes.
Net loss and diluted loss per share for 1997 was $33.51 million and $1.19 per
share, respectively, compared to net earnings and diluted earnings per share for
1996 of $46.33 million and $1.78 per share. During the year ended December 31,
1997, the Company incurred a $20.55 million (net of tax benefit), or 73 cents
per share (diluted), extraordinary loss on the extinguishment of debt, as
compared to $1.43 million, or 6 cents per share (diluted), in 1996. During 1997
the Company incurred a $1.83 million (net of tax benefit), or 7 cents per share
(diluted), loss on a cumulative effect of accounting change related to the
Company's adoption of EITF 97-13, which required the Company to write-off the
unamortized balance of costs of business process engineering and information
technology projects. Weighted average shares decreased from 31,563,585 (diluted)
in 1996 to 28,253,218 (diluted) in 1997. The weighted average shares decreased
because the impact of the convertible debentures and options outstanding were
not included in weighted average shares in 1997 because they were anti-dilutive.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Net revenues for the year ended December 31, 1996 increased $255.81
million, or 21.7%, to $1,434.70 million from the comparable period in 1995. Such
increase was attributable to (1) growth in revenues from facilities and
ancillary companies in operation in both periods and facilities and ancillary
companies acquired during 1995, as well as the conversion of MSU beds at
existing facilities of $78.17 million, (2) the addition of new facilities
acquired or leased and ancillary service businesses acquired in 1996 which
increased revenue by $171.69 million, and (3) increased management services and
other revenue of $5.95 million. The growth in revenues from facilities was
primarily the result of increased occupancy in the Company's MSUs and the growth
in revenues from ancillary companies was primarily the result of additional
service contracts entered into in 1996. The increase in revenues was partially
offset by the sale of the pharmacy division in July 1996, which generated
revenues of $91.0 million in 1995 and $63.6 million in 1996. In addition, net
revenues include revenues for ILC of $16.3 million, and $17.1 million in 1995
and 1996 (through October 9, 1996). Basic medical services revenue increased
$21.20 million, or 5.8%, from $368.57 million in 1995 to $389.77 million in
1996. Of the $21.20 million increase, $12.20 million, or 57.5%, was attributable
to the addition of 391 leased and 110 owned beds in 1996. The remainder of the
increase was due to the addition of facilities during 1995, partially offset by
the conversion of existing basic medical services beds to MSU beds. Specialty
medical services revenue increased from $770.55 million to $999.21 million. Of
the $228.66 million increase, $158.87 million, or 69.5%, was attributable to
revenue from acquisitions subsequent to December 31, 1995. The remainder of the
increase is due to increased revenue at facilities in operation in both periods,
facilities and ancillary companies acquired during 1995, and the conversion of
basic medical services beds to MSU beds, which results in higher revenue per
day, in 1996 partially offset by the sale of the pharmacy division and a
majority interest in ILC. Management services and other revenues increased from
$39.77 million to $45.71 million. The increase was due to the addition of four
management contracts in 1996, 43 management contracts during 1995 and improved
operating results at facilities managed in both periods, partially offset by the
termination in December 1995 of an agreement to manage 23 facilities.
Total expenses for the period increased from $1,222.59 million to $1,324.04
million, an increase of 8.3%. This increase was due to the acquisition of
facilities and ancillary companies subsequent to December 31, 1995, partially
offset by the sale of the pharmacy division and a majority interest in ILC.
50
<PAGE>
Salaries, wages and benefits paid to personnel increased $144.37 million, or
26.3%, from the year ended December 31, 1995. Of the $144.37 million increase,
approximately $86.50 million was attributable to facilities and ancillary
companies acquired subsequent to December 31, 1995. The remaining increase
resulted from salary increases for existing employees, increases in salaries due
to facilities and ancillary companies acquired during 1995, as well as
additional personnel needed due to increased census and the increased medical
acuity level of the Company's patients. Other operating expenses, which include
physician fees and fees paid to independent contractors providing rehabilitative
therapy, utilities, food supplies and facility maintenance, increased $61.03
million, or 18.0%, in 1996 as compared to 1995. Of this increase, approximately
$58.79 million was attributable to the aforementioned facilities and ancillary
companies acquired in 1996.
Corporate administrative and general expenses for the year ended December
31, 1996 increased by $4.96 million, or 8.9%, over the comparable period in
1995. This increase primarily represents additional operations, information
systems, finance, accounting and other personnel to support the growth of owned,
leased and managed facilities and related services businesses. Depreciation and
amortization increased to $41.68 million during the year ended December 31,
1996, a 4.3% increase as compared to $39.96 million in the comparable period of
1995. Of the $1.72 million increase, $4.01 million was attributable to
depreciation and amortization at facilities and ancillary businesses acquired in
1996. The remaining increase was primarily due to the amortization and
depreciation related to increased routine and capital expenditures at existing
facilities, increased debt issue costs and increases in depreciation and
amortization of facilities and ancillary companies acquired during 1995,
partially offset by a change in accounting method in 1996 from deferring and
amortizing pre-opening costs to expensing them when incurred. Rent expense
increased by $11.66 million, or 17.6%, over the comparable period in 1995,
primarily as a result of increased rental equipment at ancillary companies
acquired during 1996, two leaseholds acquired in 1996 and increases in
contingent rentals based on gross revenues. Net interest expense increased
$25.13 million during the year ended December 31, 1996 to $64.11 million. The
increase was primarily the result of the full year effect of the 9 5/8% Senior
Subordinated Notes due 2002 issued in May 1995, the 10 1/4% Senior Subordinated
Notes due 2006 issued in May 1996, and increased borrowings under the Company's
$700 million revolving credit facility which closed in May 1996.
In the fourth quarter of 1995, the Company, as well as industry analysts,
concluded that Medicare and Medicaid reform was imminent. Both the House and
Senate balanced budget proposals proposed a reduction in future growth in
Medicare and Medicaid spending from 10% a year to approximately 4-6% a year.
While Medicare and Medicaid reform had been discussed prior to the fourth
quarter, the Company came to believe that a future reduction in the growth of
Medicare and Medicaid spending was virtually a certainty. Such reforms include,
in the near term, a continued freeze in the Medicare routine costs limit
("RCL"), followed by reduced increases in later years, more stringent
documentation requirements for Medicare RCL exception requests, reductions in
the growth in Medicaid reimbursement in most states, as well as salary
equivalency in rehabilitative services, and, in the longer term (2-3 years), a
switch to a prospective payment system for home care and nursing homes, and
repeal of the "Boren Amendment", which requires that states pay hospitals
"reasonable and adequate" rates. The Company estimated the effect of the
aforementioned reforms on each nursing and subacute facility, as well as on its
rehabilitative services, respiratory therapy, home care, mobile diagnostic and
pharmacy divisions by reducing (or in some cases increasing) the future revenues
and expense growth rates for the impact of each of the aforementioned factors.
Accordingly, these events and circumstances triggered the early adoption of
Statement of Financial Accounting Standards ("SFAS") No. 121 in the fourth
quarter of 1995. In accordance with SFAS No. 121, the Company estimated the
future cash flows expected to result from those assets to be held and used.
In estimating the future cash flows for determining whether an asset is
impaired, and if expected future cash flows used in measuring assets are
impaired, the Company grouped its assets at the lowest level for which there are
identifiable cash flows independent of other groups of assets. These levels were
each of the individual nursing/subacute facilities, and each of the home health,
rehabilitative therapy, respiratory therapy, pharmacy and mobile diagnostics
divisions. The results of comparing future undiscounted cash flows to historical
carrying value were that some individual nursing facilities and one assisted
living facility were identified for an impairment charge. None of the remaining
facilities or
51
<PAGE>
business units were eligible since only those facilities or business units where
the carrying value exceeded the undiscounted cash flows are considered impaired.
Prior to adoption of SFAS 121, the Company evaluated impairment on the entity
level. Such an evaluation yielded no impairment as of September 30, 1995.
After determining the facilities identified for an impairment charge the
Company determined the estimated fair value of such facilities. Also, the
Company obtained valuation estimates prepared by independent appraisers or had
received offers from potential buyers on six of the facilities eligible for
impairment, comprising 72.4% of the total charge. Such valuation estimates were
obtained to corroborate the Company's estimate of value. The excess carrying
value of goodwill, buildings and improvements, leasehold improvements and
equipment above the fair value was $83.32 million (of which $1.53 million
represented goodwill and $81.79 million represented property and equipment) and
is included in the statement of operations for 1995 as loss on impairment of
long-lived assets.
In 1996, IHS had non-recurring income of $14.46 million, consisting
primarily of a gain of $34.30 million from the sale of the pharmacy division,
partially offset by a loss of $8.50 million from its sale of shares of ILC, a
$7.82 million loss related to the termination of a management contract and a
$3.52 million non-recurring charge resulting from the closure of certain
redundant home health agencies. During the fourth quarter of 1995, the Company
terminated a 10 year contract entered into in January 1994 to manage 23
long-term care and psychiatric facilities in California owned by Crestwood
Hospital. The terms of the contract required the payment of a management fee to
IHS and a preferred return to the Crestwood owners. IHS terminated the
management contract with Crestwood Hospital due primarily to changes in
California Medicaid rates which no longer provided sufficient cash flow at the
facilities to support both IHS' management fee and the preferred return to the
owners. As a result, the Company incurred a loss of $21.92 million. Such loss
consists of the write-off of $8.50 million of management fees, $11.10 million of
loans made to Crestwood Hospital and the owners of Crestwood, as well as the
interest thereon, and $2.32 million of contract acquisition costs. During the
third quarter of 1995, the Company merged with IntegraCare, Inc. in a
transaction accounted for as a pooling of interests. In connection with this
transaction, the Company incurred merger costs of $1.94 million for accounting,
legal and other costs. In addition, in the fourth quarter of 1995 IHS changed
its accounting estimate regarding the future benefit of deferred pre-opening
costs. This change was made in recognition of the change in the estimated future
benefit of such costs resulting from the effect of the aforementioned Medicare
and Medicaid reforms. As a result, the Company wrote-off $25.78 million of
deferred pre-opening costs. See "-- Acquisition and Divestiture History."
Equity in earnings of affiliates decreased by 42.6% to $828,000 from $1.44
million in the comparable period of 1995. Equity in earnings of affiliates
include for 1996 IHS' 37.3% interest in the earnings (loss) of ILC from October
9, 1996, the closing date of ILC's initial public offering, which resulted in
ILC no longer being a wholly owned subsidiary of IHS.
Earnings before income taxes and extraordinary item increased by 363.8% to
$111.48 million for the year ended December 31, 1996, as compared to a loss of
$42.26 million for the comparable period in 1995. The increase was primarily due
to certain non-recurring charges and income discussed previously as well as
significant acquisitions during 1996. The provision for state and federal income
taxes increased from a benefit of $16.27 million in 1995 to an expense of $63.72
million in 1996. Net earnings and diluted earnings per share for 1996 were
$46.33 million and $1.78 per share, respectively, compared to a net loss and
diluted loss per share for 1995 of $27.00 million and $1.26 per share. During
the year ended December 31, 1996, the Company incurred a $1.43 million (net of
tax benefit), or 4 cents a share (diluted), extraordinary loss on the
extinguishment of debt, as compared to $1.01 million, or 5 cents a share
(diluted), in 1995. Weighted average shares increased from 21,463,464 (diluted)
in 1995 to 31,563,585 (diluted) in 1996. The weighted average shares increased
because the impact of the convertible debentures and options outstanding were
not included in weighted average shares in 1995 because they were anti-dilutive.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had net working capital of $63.12
million, as compared with $57.55 million at December 31, 1996. There are no
material capital commitments for capital expendi-
52
<PAGE>
tures as of the date of this filing. Patient accounts receivable and third-party
payor settlements receivable increased $276.55 million to $603.43 million at
December 31, 1997, as compared to $326.88 million at December 31, 1996. The
entire increase resulted from patient accounts receivable and third-party payor
settlements of facilities and ancillary service businesses acquired in 1997,
partially offset by a $12.70 million decrease in patient accounts receivable and
third-party payor settlements of facilities and ancillary service businesses in
operation during both years and $11.68 million of patient accounts receivable
and third-party payor settlements at December 31, 1996 of facilities and
ancillary service businesses sold in 1997. Gross patient accounts receivable
were $726.15 million at December 31, 1997 as compared with $340.8 million at
December 31, 1996. Third-party payor settlements receivable from federal and
state governments (i.e., Medicare and Medicaid cost reports) were $58.55 million
at December 31, 1997 as compared to $42.59 million at December 31, 1996.
Approximately $12.80 million, or 21.9%, of the third-party payor settlements
receivable at December 31, 1997 represent the costs for its MSU patients which
exceed regional reimbursement limits established under Medicare, as compared to
approximately $15.6 million, or 36.7%, at December 31, 1996. The Company's cost
of care for its MSU patients generally exceeds regional reimbursement limits
established under Medicare. The success of the Company's MSU strategy will
depend in part on its ability to obtain reimbursement for those costs which
exceed the Medicare established reimbursement limits by obtaining waivers of
these cost limitations. The Company has submitted waiver requests for 325 cost
reports, covering all cost report periods through December 31, 1996. To date,
final action has been taken by the Health Care Financing Administration ("HFCA")
on all 325 waiver requests. The Company's final rates as approved by HCFA
represent approximately 95% of the requested rates as submitted in the waiver
requests. There can be no assurance, however, that the Company will be able to
recover its excess costs under any waiver requests which may be submitted in the
future. The Company's failure to recover substantially all these excess costs
would adversely affect its results of operations and could adversely affect its
MSU strategy.
All remaining balance sheet increases were due to acquisitions and normal
growth in operations in both years which was consistent with the growth in
revenues of such operations in 1997.
The Company recorded deferred tax assets in connection with business
acquisitions of $32.09 million in 1997, which, net of a valuation allowance of
$24.40 million related thereto, has been applied as a reduction in goodwill. The
valuation allowance is necessary because it relates to net operating loss
carryforwards of acquired companies and therefore realization is subject to
various limitations under the Internal Revenue Code. In addition, the Company is
still in the process of reviewing the acquired companies' operations in
connection with its integration plans and will be re-evaluating its assessment
of recoverability in 1998 in accordance with Accounting Principles Board (APB)
Opinion No. 16, Business Combinations, and SFAS No. 38, Accounting for
Preacquisition Contingencies of Purchased Enterprises. Any reduction in the
valuation allowance will be recorded as a reduction of goodwill recorded on such
1997 acquisitions. The pre-acquisition separate company net operating loss
carryforwards expire in years 1998 through 2009.
On May 30, 1997, IHS issued $450 million aggregate principal amount of its
9 1/2% Senior Subordinated Notes due 2007 (the "9 1/2% Senior Notes"). Interest
on the 9 1/2% Senior Notes is payable semi-annually on March 15 and September
15. The 9 1/2% Senior Notes are redeemable for cash at any time after September
15, 2002, at IHS' option, in whole or in part, initially at a redemption price
equal to 104.75% of the principal amount and declining to 100% of the principal
amount on September 15, 2005, plus accrued interest thereon to the date fixed
for redemption. In addition, the Company may redeem up to $150 million principal
amount of the 9 1/2% Senior Notes at any time prior to September 15, 2000 at a
redemption price equal to 108.50% of the aggregate principal amount so redeemed,
plus accrued interest thereon, out of the net cash proceeds of one or more
Public Equity Offerings (as defined in the indenture under which the 9 1/2%
Senior Notes were issued). In the event of a change in control of IHS (as
defined in the indenture under which the 9 1/2% Senior Notes were issued), each
holder of 9 1/2% Senior Notes may require IHS to repurchase such holder's 9 1/2%
Senior Notes, in whole or in part, at 101% of the principal amount thereof, plus
accrued interest to the repurchase date. The Company used approximately $247.2
million of the net proceeds from the sale of the 9 1/2% Senior Notes to
repurchase substantially all its outstanding 9 5/8% Senior Subordinated Notes
due 2002 and 10 3/4% Senior Subordi-
53
<PAGE>
nated Notes due 2004 and the remaining $191.0 million of net proceeds to pay
down borrowings under its $700 million revolving credit facility.
On September 11, 1997, IHS issued $500 million aggregate principal amount
of its 9 1/4% Senior Subordinated Notes due 2008 (the "9 1/4% Senior Notes").
Interest on the 9 1/4% Senior Notes is payable semi-annually on January 15 and
July 15. The 9 1/4% Senior Notes are redeemable in whole or in part at the
option of IHS at any time on or after January 15, 2003, at a price, expressed as
a percentage of the principal amount, initially equal to 104.625% and declining
to 100% on January 15, 2006, plus accrued interest thereon. In addition, IHS may
redeem up to $166,667,000 aggregate principal amount of 9 1/4% Senior Notes at
any time and from time to time prior to January 15, 2001 at a redemption price
equal to 109.25% of the aggregate principal amount thereof, plus accrued
interest thereon, out of the net cash proceeds of one or more Public Equity
Offerings (as defined in the indenture under which the 9 1/4% Senior Notes were
issued). In the event of a change in control of IHS (as defined in the indenture
under which the 9 1/4% Senior Notes were issued), each holder of 9 1/4% Senior
Notes may require IHS to repurchase such holder's 9 1/4% Senior Notes, in whole
or in part, at 101% of the principal amount thereof, plus accrued interest to
the repurchase date. The Company used approximately $321.5 million of the net
proceeds to repay all amounts outstanding under the Company's $700 million
revolving credit facility, and used the remaining approximately $164.9 million
to pay a portion of the purchase price for the acquisition of the businesses
acquired from HEALTHSOUTH and for general corporate purposes, including working
capital.
The indentures under which the 9 1/2% Senior Notes and the 9 1/4% Senior
Notes were issued contain certain covenants, including, but not limited to,
covenants with respect to the following matters: (i) limitations on additional
indebtedness unless certain ratios are met; (ii) limitations on other
subordinated debt; (iii) limitations on liens; (iv) limitations on the issuance
of preferred stock by IHS' subsidiaries; (v) limitations on transactions with
affiliates; (vi) limitations on certain payments, including dividends; (vii)
application of the proceeds of certain asset sales; (viii) restrictions on
mergers, consolidations and the transfer of all or substantially all of the
assets of IHS to another person; and (ix) limitations on investments and loans.
On September 15, 1997, the Company entered into a $1.75 billion revolving
credit and term loan facility with Citibank, N.A., as Administrative Agent, and
certain other lenders (the "New Credit Facility") to replace its existing $700
million revolving credit facility. The New Credit Facility consists of a $750
million term loan facility (the "Term Facility") and a $1 billion revolving
credit facility, including a $100 million letter of credit subfacility and a $10
million swing line subfacility (the "Revolving Facility"). The Term Facility,
all of which was borrowed on September 17, 1997, matures on September 30, 2004
and will be amortized beginning December 31, 1998 as follows: 1998 -- $7.5
million; each of 1999, 2000, 2001 and 2002 -- $7.5 million (payable in equal
quarterly installments); 2003 -- $337.5 million (payable in equal quarterly
installments); and 2004 -- $375 million (payable in equal quarterly
installments). Any unpaid balance will be due on the maturity date. The Term
Facility bears interest at a rate equal to, at the option of IHS, either (i) in
the case of Eurodollar loans, the sum of (x) one and three-quarters percent or
two percent (depending on the ratio of the Company's Debt (as defined in the New
Credit Facility) to earnings before interest, taxes, depreciation, amortization
and rent, pro forma for any acquisitions or divestitures during the measurement
period (the "Debt/EBITDAR Ratio")) and (y) the interest rate in the London
interbank market for loans in an amount substantially equal to the amount of
borrowing and for the period of borrowing selected by IHS or (ii) the sum of (a)
the higher of (1) Citibank, N.A.'s base rate or (2) one percent plus the latest
overnight federal funds rate plus (b) a margin of one-half percent or
three-quarters of one percent (depending on the Debt/EBITDAR Ratio). The Term
Facility can be prepaid at any time in whole or in part without penalty.
In connection with the acquisition of certain businesses from HEALTHSOUTH,
IHS and the lenders under the New Credit Facility amended the New Credit
Facility to provide for an additional $400 million term loan facility (the
"Additional Term Facility") to finance a portion of the purchase price for the
acquisition and to amend certain covenants to permit the consummation of the
acquisition. The Additional Term Facility, which was borrowed at the closing of
the acquisition, will mature on December 31, 2005, and will be amortized
beginning December 31, 1998 as follows: 1998 -- $4 million; each of 1999, 2000,
2001, 2002 and 2003 -- $4 million (payable in equal quarterly installments);
2004 -- $176 million (payable in equal quarterly installments); and 2005 -- $200
million (payable in equal quarterly installments). The Additional Term Facility
bears interest at a rate equal to, at the option of IHS, either (i) in the case
of Eurodollar loans, the
54
<PAGE>
sum of (x) two and one-quarter percent or two and one-half percent (depending on
the Debt/EBITDAR Ratio) and (y) the interest rate in the London interbank market
for loans in an amount substantially equal to the amount of borrowing and for
the period of borrowing selected by IHS or (ii) the sum of (a) the higher of (1)
Citibank, N.A.'s base rate or (2) one percent plus the latest overnight federal
funds rate plus (b) a margin of one percent or one and one-quarter percent
(depending on the Debt/EBITDAR Ratio). The Additional Term Facility can be
prepaid at any time in whole or in part without penalty.
The Revolving Facility will reduce to $800 million on September 30, 2001
and $500 million on September 30, 2002, with a final maturity on September 15,
2004; however, the $100 million letter of credit subfacility and $10 million
swing line subfacility will remain at $100 million and $10 million,
respectively, until final maturity. The Revolving Facility bears interest at a
rate equal to, at the option of IHS, either (i) in the case of Eurodollar loans,
the sum of (x) between three-quarters of one percent and one and three-quarters
percent (depending on the Debt/EBITDAR Ratio) and (y) the interest rate in the
London interbank market for loans in an amount substantially equal to the amount
of borrowing and for the period of borrowing selected by IHS or (ii) the sum of
(a) the higher of (1) Citibank, N.A.'s base rate or (2) one percent plus the
latest overnight federal funds rate plus (b) a margin of between zero percent
and one-half percent (depending on the Debt/EBITDAR Ratio). Amounts repaid under
the Revolving Facility may be reborrowed prior to the maturity date.
The New Credit Facility limits IHS' ability to incur indebtedness or
contingent obligations, to make additional acquisitions, to sell or dispose of
assets, to create or incur liens on assets, to pay dividends, to purchase or
redeem IHS' stock and to merge or consolidate with any other person. In
addition, the New Credit Facility requires that IHS meet certain financial
ratios, and provides the banks with the right to require the payment of all
amounts outstanding under the facility, and to terminate all commitments under
the facility, if there is a change in control of IHS or if any person other than
Dr. Robert N. Elkins, IHS' Chairman and Chief Executive Officer, or a group
managed by Dr. Elkins, owns more than 40% of IHS' stock. The New Credit Facility
is guaranteed by all of IHS' subsidiaries (other than inactive subsidiaries) and
secured by a pledge of all of the stock of substantially all of IHS'
subsidiaries.
The New Credit Facility replaced the Company's $700 million revolving
credit facility (the "Prior Credit Facility"). As a result, the Company recorded
an extraordinary loss on extinguishment of debt of approximately $2.39 million
(net of related tax benefit of approximately $1.52 million) in the third quarter
of 1997 resulting from the write-off of deferred financing costs of $3.91
million related to the Prior Credit Facility.
Net cash provided by operating activities was $46.15 million for the year
ended December 31, 1997 as compared to $33.83 million provided by operating
activities for the comparable period in 1996. Cash provided by operating
activities for the year ended December 31, 1997 increased from the comparable
period in 1996 primarily as a result of an increase in net earnings before
non-cash charges, partially offset by an increase in patient accounts and
third-party payor settlements receivable and a decrease in accounts payable and
accrued expenses.
Net cash provided by financing activities was $1,688.83 million for the
year ended December 31, 1997 as compared to $249.53 million for the comparable
period in 1996. In both periods, the Company received proceeds from long-term
borrowings. In addition, in 1996 IHS reissued in connection with contingent
earnouts all 400,600 shares of its common stock in treasury, which shares were
repurchased in 1995 for $12.79 million. In 1997 the Company repurchased 548,500
shares of its Common Stock for approximately $19.81 million.
Net cash used by investing activities was $1,721.04 million for the year
ended December 31, 1997 as compared to $283.25 million for the year ended
December 31, 1996. Cash used for the purchase of property, plant and equipment
was $126.86 million for the year ended December 31, 1997 and $145.90 million in
the comparable period in fiscal 1996. During 1996, the Company sold a majority
interest in its assisted living division and its pharmacy division for
approximately $136.71 million. Cash used for business acquisitions was $1,560.40
million for 1997 as compared to $242.82 million for 1996.
IHS' contingent liabilities (other than liabilities in respect of
litigation and the contingent payments in respect of the First American
acquisition) aggregated approximately $86.60 million as of December 31, 1997.
The Company is obligated to purchase its Greenbriar facility upon a change in
control of IHS. The net price
55
<PAGE>
of the facility is approximately $4.01 million. The Company has guaranteed
approximately $6.60 million of the lessor's indebtedness. IHS is required, upon
certain defaults under the lease, to purchase its Orange Hills facility at a
purchase price equal to the greater of $7.13 million or the facility's fair
market value. The Company has guaranteed approximately $4.02 million owed by
Tutera Group, Inc. and Sunset Plaza Limited Partnership, a partnership
affiliated with a partnership in which IHS has a 49% interest, to Finova Capital
Corporation. IHS has established several irrevocable standby letters of credit
with the Bank of Nova Scotia totaling $32.37 million at December 31, 1997 to
secure certain of the Company's self-insured workers' compensation obligations,
health benefits and other obligations. In addition, IHS has several surety bonds
in the amount of $32.47 million to secure certain of the Company's health
benefits, patient trust funds and other obligations. In addition, with respect
to certain acquired businesses IHS is obligated to make certain contingent
payments if earnings of the acquired business increase or earnings targets are
met. The Company is also obligated under certain circumstances to make
contingent payments of up to $155 million in respect of IHS' acquisition of
First American, of which $113.04 million (representing its present value) was
recorded on the balance sheet at December 31, 1997. The Company is obligated to
purchase the remaining interests in its lithotripsy partnerships at a defined
price in the event legislation is passed or regulations adopted that would
prevent the physician partners from owning an interest in the partnership and
using the partnership's lithotripsy equipment for the treatment of his or her
patients. See " -- Acquisition and Divestiture History -- Acquisitions." In
addition, IHS has obligations under operating leases aggregating approximately
$704.89 million at December 31, 1997.
The liquidity of the Company will depend in large part on the timing of
payments by private third-party and governmental payors. In addition, the
Company's liquidity is dependent upon the timing of the approvals, if any, of
waivers of Medicare regional cost reimbursement limitations which exceed the
limits established under Medicare. Costs in excess of the regional reimbursement
limits relate to the delivery of services and patient care to the Company's MSU
patients.
The Company anticipates that working capital from operations and borrowings
under revolving credit facilities will be adequate to cover its scheduled debt
payments and future anticipated capital expenditure requirements throughout
1998. The Company will fund future acquisitions with a combination of cash flow
from operations, bank borrowings and debt and equity offerings.
YEAR 2000 COMPLIANCE
The Company has conducted a comprehensive review of its computer systems to
identify the systems that are affected by the "Year 2000" issue and has
substantially completed an implementation plan to resolve this issue. This issue
affects computer systems that have date sensitive programs that may not properly
recognize the year 2000. Systems that do not properly recognize such information
could generate erroneous data or cause a system to fail, resulting in business
interruption. In 1997, the Company commenced a year 2000 conversion project for
all of its locations to address necessary software upgrades, training, data
conversion, testing and implementation. The Company will incur internal staff
costs as well as consulting and other expenses to complete the project by the
middle of 1999. Costs related to the year 2000 issue are being expensed as
incurred. The Company does not expect the amounts required to be expensed during
the project to have a material effect on its financial position or results of
operation.
The year 2000 issue is expected to affect the systems of various entities
with which the Company interacts, including payors, suppliers and vendors. There
can be no assurance that the systems of other companies on which the Company's
systems rely will be timely converted, or that a failure by another company's
systems to be year 2000 compliant would not have a material adverse effect on
the Company.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130 "Reporting
Comprehensive Income," which establishes standards for reporting and display of
comprehensive income and its components (revenue, expenses, gains, and losses)
in a full set of general purpose financial statements. Also, the FASB recently
issued Statement of Financial Standards No. 132, "Employers' Disclosure About
Pensions and Other Post Retire-
56
<PAGE>
ment Benefits," which revises employers' disclosures about pensions and other
post retirement benefit plans. It is anticipated that SFAS No. 130 and No. 132
will have no material effect on current or future financial statements of the
Company. The Company will adopt SFAS No. 130 and No. 132 in its fiscal year
1998.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of
an Enterprise and Related Information," which changes the way public companies
report information about operating segments. SFAS No. 131, which is based on the
management approach to segment reporting, establishes requirements to report
selected segment information quarterly and to report entity-wide disclosures
about products and services, major customers and the material countries in which
the entity holds assets and reports revenue. The Company has elected to early
adopt SFAS No. 131 in 1997. See Note 22 to Notes to Consolidated Financial
Statements.
57
<PAGE>
QUARTERLY RESULTS (UNAUDITED)
Set forth below is certain summary information with respect to the
Company's operations for the last eight fiscal quarters.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
---------------------------------------------------
1996
---------------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
------------ ------------- ------------ -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net revenues:
Basic medical services ...................... $ 97,216 $ 98,063 $ 101,189 $ 93,305
Specialty medical services .................. 219,525 226,868 211,904 340,912
Management services and other ............... 10,532 10,849 12,572 11,760
--------- --------- --------- --------
Total ..................................... 327,273 335,780 325,665 445,977
Cost and Expenses:
Operating expenses .......................... 249,895 254,274 241,177 348,602
Corporate administrative and general ........ 15,093 14,854 14,943 16,086
Depreciation and amortization ............... 8,274 8,505 9,130 15,772
Rent ........................................ 17,656 17,879 18,445 23,805
Interest, net ............................... 14,214 15,888 15,931 18,077
Other non-recurring charges (in-
come)(1) ................................... -- -- (34,298) 19,841
--------- --------- --------- --------
Earnings (loss) before equity in earnings
(loss) of affiliates, income taxes,
extraordinary items and cumulative
effect of accounting change ................ 22,141 24,380 60,337 3,794
Equity (loss) in earnings of affiliates ...... 300 460 323 (255)
--------- --------- --------- --------
Earnings (loss) before income taxes,
extraordinary items and cumulative
effect of accounting change ................ 22,441 24,840 60,660 3,539
Income tax provision (benefit)(1) ............ 8,640 9,563 44,149 1,363
--------- --------- --------- --------
Earnings (loss) before extraordinary
items and cumulative effect of ac-
counting change ............................ 13,801 15,277 16,511 2,176
Extraordinary items)(2) ...................... -- 1,431 -- --
--------- --------- --------- --------
Earnings (loss) before cumulative effect
of accounting change(2) .................... 13,801 13,846 16,511 2,176
Cumulative effect of accounting change(3) -- -- -- -
--------- --------- --------- --------
Net earnings (loss) ......................... $ 13,801 $ 13,846 $ 16,511 $ 2,176
========= ========= ========= ========
Per Common Share-basic(4):
Earnings (loss) before extraordinary
items and cumulative effect of ac-
counting change(2) ......................... $ .64 $ .68 $ .72 $ .09
Earnings (loss) before cumulative effect
of accounting change(3) .................... .64 .62 .72 .09
Net earnings (loss) ......................... $ .64 $ .62 $ .72 $ .09
========= ========= ========= ========
Per Common Share-diluted(4):
Earnings (loss) before extraordinary
items and cumulative effect of ac-
counting change(2) ......................... $ .54 $ .56 $ .60 $ .09
Earnings (loss) before cumulative effect
of accounting change(3) .................... .54 .51 .60 .09
Net earnings (loss) ......................... $ .54 $ .51 $ .60 $ .09
========= ========= ========= ========
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------
1997
-----------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
---------- ----------- ---------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net revenues:
Basic medical services ...................... $ 88,755 $ 88,055 $ 91,458 $ 114,006
Specialty medical services .................. 362,689 360,113 370,769 478,133
Management services and other ............... 9,499 9,805 10,694 9,221
-------- -------- -------- ---------
Total ..................................... 460,943 457,973 472,921 601,360
Cost and Expenses:
Operating expenses .......................... 352,412 338,736 348,470 439,388
Corporate administrative and general ........ 18,016 18,135 19,917 20,756
Depreciation and amortization ............... 15,030 15,814 16,974 22,932
Rent ........................................ 24,009 25,786 25,527 29,814
Interest, net ............................... 21,421 23,224 27,346 43,210
Other non-recurring charges (in-
come)(1) ................................... (1,025) 21,072 -- 112,995
-------- -------- -------- ---------
Earnings (loss) before equity in earnings
(loss) of affiliates, income taxes,
extraordinary items and cumulative
effect of accounting change ................ 31,080 15,206 34,687 (67,735)
Equity (loss) in earnings of affiliates ...... 181 (83) (811) 801
-------- -------- -------- ---------
Earnings (loss) before income taxes,
extraordinary items and cumulative
effect of accounting change ................ 31,261 15,123 33,876 (66,934)
Income tax provision (benefit)(1) ............ 12,192 5,898 13,212 (6,853)
-------- -------- -------- ---------
Earnings (loss) before extraordinary
items and cumulative effect of ac-
counting change ............................ 19,069 9,225 20,664 (60,081)
Extraordinary items)(2) ...................... -- 18,168 2,384 --
-------- -------- -------- ---------
Earnings (loss) before cumulative effect
of accounting change(2) .................... 19,069 (8,943) 18,280 (60,081)
Cumulative effect of accounting change(3) - - -- 1,830
-------- -------- -------- ---------
Net earnings (loss) ......................... $ 19,069 $ (8,943) $ 18,280 $ (61,911)
======== ======== ======== =========
Per Common Share-basic(4):
Earnings (loss) before extraordinary
items and cumulative effect of ac-
counting change(2) ......................... $ .81 $ .37 $ .81 $ (1.55)
Earnings (loss) before cumulative effect
of accounting change(3) .................... .81 (.36) .72 (1.55)
Net earnings (loss) ......................... $ .81 $ (.36) $ .72 $ (1.59)
======== ======== ======== =========
Per Common Share-diluted(4):
Earnings (loss) before extraordinary
items and cumulative effect of ac-
counting change(2) ......................... $ .64 $ .32 $ .63 $ (1.55)
Earnings (loss) before cumulative effect
of accounting change(3) .................... .64 (.18) .57 (1.55)
Net earnings (loss) ......................... $ .64 $ (.18) $ .57 $ (1.59)
======== ======== ======== =========
</TABLE>
- ----------
(1) In 1996, consists of (i) a gain of $34,298,000 in the third quarter from
the sale of its pharmacy division, (ii) a loss in the fourth quarter of
$8,497,000 from its sale of shares in the ILC offering, (iii) a $7,825,000
loss on write-off of accrued management fees and loans resulting from the
Company's termination of its 10-year agreement to manage six geriatric care
facilities owned by All Seasons in the fourth quarter and (iv) a $3,519,000
exit cost resulting from the closure of redundant home healthcare agencies
in the fourth quarter. Because IHS' investment in the Capstone common stock
received in the sale of its pharmacy division had a very small tax basis,
the taxable gain on the sale significantly exceeded the gain for financial
reporting purposes, thereby resulting in a disproportionately higher income
tax provision related to the sale in the third quarter of 1996. In 1997,
consists primarily of (i) a gain in the first quarter of $7,580,000
realized on the shares of Capstone common stock received in the sale of its
pharmacy division, (ii) the write-off in the first quarter of $6,555,000 of
accounting, legal and other costs resulting from the proposed merger
transaction with Coram, (iii) the payment in the second quarter to Coram of
$21,000,000 in connection with the termination of the proposed merger
transaction with Coram, (iv) a gain in the third quarter of $3,914,000 from
the ILC Sale, (v) a loss in the third quarter of $4,750,000 from
termination payments in connection with the RoTech acquisition and (vi) a
loss in the fourth quarter of $112,231,000 resulting from its plan to
dispose of certain non-strategic assets to allow the Company to focus on
its core operations. See Note 19 of Notes to Consolidated Financial
Statements.
(2) Extraordinary items relate to extinguishment of debt. See Note 16 of
Consolidated Financial Statements.
(3) Represents the write-off, net of income tax benefits, of the unamortized
balance of costs of business process engineering and information technology
projects. See Note 20 of Notes to Consolidated Financial Statements.
58
<PAGE>
(4) The share and per share information have been restated to reflect share and
per share information in accordance with Statement of Financial Accounting
Standards No. 128, "Earnings per Share," which was required to be adopted
by the Company effective with its financial statements for the year ended
December 31, 1997. See Notes 1(m) and 12 of Notes to Consolidated Financial
Statements. The diluted weighted average number of common shares
outstanding for each quarter other than the quarters ended December 31,
1996 and 1997 includes the assumed conversion of the convertible
subordinated debentures into IHS Common Stock. Additionally, interest
expense and amortization of underwriting costs related to such debentures
are added, net of tax, to income for the purpose of calculating diluted
earnings per share. The diluted weighted average number of common shares
outstanding for the quarters ended December 31, 1996 and 1997 does not
include the assumed conversion of the convertible subordinated debentures
or the related interest expense and underwriting costs, as such conversion
would be anti-dilutive.
From January 1, 1996 through December 31, 1997, the Company acquired 81
geriatric care facilities (including 29 facilities which it had previously
managed but excluding the 38 facilities held for sale), leased 105 geriatric
care facilities (26 of which had previously been managed) and entered into
management agreements to manage 63 geriatric care facilities. During this
period, the Company sold its interest in two geriatric care facilities and seven
retirement facilities (five owned and two leased) and agreements to manage 88
facilities were terminated. In addition, during this period the Company opened
15 MSUs totalling 184 beds and expanded existing MSUs (including MSUs opened
during this period) by 384 beds. During this period, the Company's sold its
pharmacy and assisted living divisions. See "-- Acquisition and Divestiture
History -- Divestitures."
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Independent Auditors' Report ................................................. 60
Consolidated Balance Sheets at December 31, 1996 and 1997 .................... 61
Consolidated Statements of Operations for the years ended December 31, 1995,
1996 and 1997 .............................................................. 62
Consolidated Statements of Stockholders' Equity for the years ended Decem-
ber 31, 1995, 1996 and 1997 ................................................ 63
Consolidated Statements of Cash Flows for the years ended December 31, 1995,
1996 and 1997 .............................................................. 64
Notes to Consolidated Financial Statements ................................... 65
Schedule II -- Valuation and Qualifying Accounts ............................. 103
</TABLE>
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission have been
omitted because they are not required under the related instructions, are
inapplicable or the information has been provided in the Consolidated Financial
Statements or the Notes thereto.
59
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Integrated Health Services, Inc.:
We have audited the accompanying consolidated financial statements of Integrated
Health Services, Inc. and subsidiaries (the Company) as listed in the
accompanying index. In connection with our audits of the consolidated financial
statements, we also have audited the financial statement schedule listed in the
accompanying index. These consolidated financial statements and the financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and schedule 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 financial position of Integrated Health
Services, Inc. and subsidiaries at December 31, 1996 and 1997 and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1997, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
As discussed in notes 1(k) and 19 to the consolidated financial statements, in
1995 the Company adopted the provisions of the Financial Accounting Standards
Board's Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
Also, effective January 1, 1996, the Company changed its accounting method from
deferring and amortizing pre-opening costs of medical specialty units to
recording them as an expense when incurred.
KPMG PEAT MARWICK LLP
Baltimore, Maryland
March 25, 1998
60
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1996 1997
------------- --------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents .......................................... $ 39,028 $ 52,965
Temporary investments .............................................. 2,044 8,042
Patient accounts and third-party payor settlements receivable,
net (note 3) ..................................................... 326,883 603,432
Inventories, prepaid expenses and other current assets ............. 26,243 53,152
Income tax receivable .............................................. 20,992 --
---------- ----------
Total current assets ............................................. 415,190 717,591
Property, plant and equipment, net (note 5) ......................... 864,335 1,318,633
Assets held for sale (note 2) ....................................... -- 111,629
Intangible assets (notes 2 and 6) ................................... 572,159 2,815,272
Investments in and advances to affiliates (note 4) .................. 76,047 19,527
Other assets ........................................................ 65,376 80,492
---------- ----------
Total assets ..................................................... $1,993,107 $5,063,144
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt (note 8) ...................... $ 16,547 $ 36,081
Accounts payable and accrued expenses (note 7) ..................... 341,094 615,967
Income tax payable ................................................. -- 2,426
---------- ----------
Total current liabilities ........................................ 357,641 654,474
---------- ----------
Long-term debt (note 8):
Revolving credit and term loan facility less current maturities..... 342,650 1,673,500
Mortgages and other long-term debt less current maturities ......... 71,800 167,606
Subordinated debt .................................................. 623,750 1,361,046
---------- ----------
Total long-term debt ............................................. 1,038,200 3,202,152
---------- ----------
Other long-term liabilities (note 9) ................................ 33,851 113,042
Deferred income taxes (note 13) ..................................... 22,283 --
Deferred gain on sale-leaseback transactions ........................ 6,267 5,315
Commitments and contingencies (notes 4, 9, 10, 11, 14 and 21)
Stockholders' equity (note 11):
Preferred stock, authorized 15,000,000 shares; no shares issued
and outstanding in 1996 and 1997 ................................. -- --
Common stock, $0.001 par value. Authorized 150,000,000 shares;
issued 23,628,250 shares in 1996 and 43,098,373 shares in 1997
(including 548,500 treasury shares in 1997) ...................... 24 43
Additional paid-in capital ......................................... 445,667 1,062,436
Retained earnings .................................................. 79,814 45,495
Unrealized gain on available for sale securities ................... 9,360 --
Treasury stock, at cost (548,500 shares in 1997) ................... -- (19,813)
---------- ----------
Total stockholders' equity ....................................... 534,865 1,088,161
---------- ----------
Total liabilities and stockholders' equity ....................... $1,993,107 $5,063,144
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
61
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------
1995 1996 1997
-------------- ------------- -------------
<S> <C> <C> <C>
Net revenues:
Basic medical services .................................. $ 368,569 $ 389,773 $ 382,274
Specialty medical services .............................. 770,554 999,209 1,571,704
Management services and other ........................... 39,765 45,713 39,219
---------- ---------- ----------
Total revenues ........................................ 1,178,888 1,434,695 1,993,197
---------- ---------- ----------
Costs and expenses:
Operating expenses:
Salaries, wages, and benefits ......................... 549,766 694,137 962,886
Other operating expenses .............................. 338,785 399,811 516,120
Corporate administrative and general .................... 56,016 60,976 76,824
Depreciation and amortization ........................... 39,961 41,681 70,750
Rent (note 10) .......................................... 66,125 77,785 105,136
Interest (net of investment income of $1,876 in 1995,
$2,233 in 1996 and $7,629 in 1997) (note 8) ........... 38,977 64,110 115,201
Loss on impairment of long-lived assets and other
non-recurring charges (income), net (notes 6 and 19) 132,960 (14,457) 133,042
---------- ---------- ----------
Total costs and expenses .............................. 1,222,590 1,324,043 1,979,959
---------- ---------- ----------
Earnings (loss) before equity in earnings
of affiliates, income taxes,
extraordinary items and cumu-
lative effect of accounting change ................... (43,702) 110,652 13,238
Equity in earnings of affiliates (note 4) ................ 1,443 828 88
---------- ---------- ----------
Earnings (loss) before income taxes, extraordinary
items and cumulative effect of accounting change. (42,259) 111,480 13,326
Federal and state income taxes (note 13) ................. (16,270) 63,715 24,449
---------- ---------- ----------
Earnings (loss) before extraordinary items and cu-
mulative effect of accounting change ................. (25,989) 47,765 (11,123)
Extraordinary items (note 16) ............................ 1,013 1,431 20,552
---------- ---------- ----------
Earnings (loss) before cumulative effect of account-
ing change ........................................... (27,002) 46,334 (31,675)
Cumulative effect of accounting change (note 20) ......... -- -- 1,830
---------- ---------- ----------
Net earnings (loss) ................................... $ (27,002) $ 46,334 $ (33,505)
========== ========== ==========
Per Common Share -- basic:
Earnings (loss) before extraordinary items and cumu-
lative effect of accounting change .................... $ (1.21) $ 2.12 $ (0.39)
Earnings (loss) before cumulative effect of accounting
change ................................................ ( 1.26) 2.06 ( 1.12)
Net earnings (loss) ..................................... $ (1.26) $ 2.06 $ (1.19)
========== ========== ==========
Per Common Share -- diluted:
Earnings (loss) before extraordinary items and cumu-
lative effect of accounting change .................... $ (1.21) $ 1.83 $ (0.39)
Earnings (loss) before cumulative effect of accounting
change ................................................ ( 1.26) 1.78 ( 1.12)
Net earnings (loss) ..................................... $ (1.26) $ 1.78 $ (1.19)
========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
62
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONAL
PREFERRED COMMON PAID-IN
STOCK STOCK CAPITAL
----------- -------- --------------
<S> <C> <C> <C>
Balance at December 31, 1994 .................... $-- $21 $ 392,402
Issuance of 385,216 common shares in
connection with acquisitions .................. -- 1 9,794
Issuance of warrants in connection with
acquisitions .................................. -- -- 339
Issuance of 49,377 common shares in con-
nection with employee stock purchase
plan .......................................... -- -- 1,339
Acquisition of 400,600 common shares of
treasury stock ................................ -- -- --
Exercise of employee stock options for
340,244 common shares ......................... -- -- 5,676
Exercise of warrants for 44,181 common
shares ........................................ -- -- 795
Declaration of cash dividend, $0.02 per
common share .................................. -- -- --
Net loss ....................................... -- -- --
--- --- ----------
Balance at December 31, 1995 .................... -- 22 410,345
--- --- ----------
Issuance of 1,632,873 common shares in
connection with acquisitions and man-
agement agreements ............................ -- 2 35,435
Re-issuance of 400,600 common shares of
treasury stock in payment of earn-out in
connection with prior acquisitions ............ -- -- (3,592)
Issuance of 68,661 common shares in con-
nection with employee stock purchase
plan .......................................... -- -- 1,401
Exercise of employee stock options for
141,382 common shares ......................... -- -- 2,078
Unrealized gain on available for sale secu-
rities ........................................ -- -- --
Declaration of cash dividend, $0.02 per
common share .................................. -- -- --
Net earnings ................................... -- --
--- ----------
Balance at December 31, 1996 .................... -- 24 445,667
--- --- ----------
Issuance of 976,504 shares of common
stock in payment of earn-out in connec-
tion with prior acquisition ................... -- 1 26,438
Issuance of 16,993,217 common shares in
connection with acquisitions .................. -- 17 553,385
Issuance of 81,434 common shares in con-
nection with employee stock purchase
plan .......................................... -- -- 1,757
Exercise of employee stock options for
1,418,968 common shares ....................... -- 1 28,169
Tax benefit arising from exercise of em-
ployee stock options .......................... -- -- 7,020
Reversal of unrealized gain on available for
sale securities ............................... -- -- --
Acquisition of 548,500 common shares of
treasury stock ................................ -- -- --
Declaration of cash dividend, $0.02 per com-
mon share ..................................... -- -- --
Net loss ....................................... -- -- --
--- --- ----------
Balance at December 31, 1997 .................... $-- $43 $1,062,436
=== === ==========
<CAPTION>
UNREALIZED
GAIN ON
AVAILABLE FOR
RETAINED SALE TREASURY
EARNINGS SECURITIES STOCK TOTAL
------------ -------------- ------------ --------------
<S> <C> <C> <C> <C>
Balance at December 31, 1994 .................... $ 61,388 $ -- $ -- $ 453,811
Issuance of 385,216 common shares in
connection with acquisitions .................. -- -- -- 9,795
Issuance of warrants in connection with
acquisitions .................................. -- -- -- 339
Issuance of 49,377 common shares in con-
nection with employee stock purchase
plan .......................................... -- -- -- 1,339
Acquisition of 400,600 common shares of
treasury stock ................................ -- -- (12,790) (12,790)
Exercise of employee stock options for
340,244 common shares ......................... -- -- -- 5,676
Exercise of warrants for 44,181 common
shares ........................................ -- -- -- 795
Declaration of cash dividend, $0.02 per
common share .................................. (435) -- -- (435)
Net loss ....................................... (27,002) -- -- (27,002)
---------- --------- --------- ----------
Balance at December 31, 1995 .................... 33,951 -- (12,790) 431,528
---------- --------- --------- ----------
Issuance of 1,632,873 common shares in
connection with acquisitions and man-
agement agreements ............................ -- -- -- 35,437
Re-issuance of 400,600 common shares of
treasury stock in payment of earn-out in
connection with prior acquisitions ............ -- -- 12,790 9,198
Issuance of 68,661 common shares in con-
nection with employee stock purchase
plan .......................................... -- -- -- 1,401
Exercise of employee stock options for
141,382 common shares ......................... -- -- -- 2,078
Unrealized gain on available for sale secu-
rities ........................................ -- 9,360 -- 9,360
Declaration of cash dividend, $0.02 per
common share .................................. (471) -- -- (471)
Net earnings ................................... 46,334 -- -- 46,334
---------- --------- --------- ----------
Balance at December 31, 1996 .................... 79,814 9,360 -- 534,865
---------- --------- --------- ----------
Issuance of 976,504 shares of common
stock in payment of earn-out in connec-
tion with prior acquisition ................... -- -- -- 26,439
Issuance of 16,993,217 common shares in
connection with acquisitions .................. -- -- -- 553,402
Issuance of 81,434 common shares in con-
nection with employee stock purchase
plan .......................................... -- -- -- 1,757
Exercise of employee stock options for
1,418,968 common shares ....................... -- -- -- 28,170
Tax benefit arising from exercise of em-
ployee stock options .......................... -- -- - 7,020
Reversal of unrealized gain on available for
sale securities ............................... -- (9,360) -- (9,360)
Acquisition of 548,500 common shares of
treasury stock ................................ -- -- (19,813) (19,813)
Declaration of cash dividend, $0.02 per com-
mon share ..................................... (814) -- -- (814)
Net loss ....................................... (33,505) -- -- (33,505)
---------- --------- --------- ----------
Balance at December 31, 1997 .................... $ 45,495 $ -- $ (19,813) $1,088,161
========== ========= ========= ==========
</TABLE>
See accompanying notes to consolidated financial statements.
63
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------
1995 1996 1997
-------------- ------------- ---------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss) ................................................ $ (27,002) $ 46,334 $ (33,505)
Adjustments to reconcile net earnings (loss) to net cash pro-
vided by operating activities: ...................................
Extraordinary items .............................................. 1,647 2,327 33,690
Loss from impairment of long-lived assets and other non-
recurring charges (income) ...................................... 131,021 (14,457) 133,042
Cumulative effect of accounting change ........................... -- -- 3,000
Undistributed results of affiliates .............................. (431) 2 157
Depreciation and amortization .................................... 39,961 41,681 70,750
Deferred income taxes and other non-cash items ................... (22,920) 3,462 (30,139)
Amortization of deferred gain on sale-leaseback .................. (1,018) (982) (1,035)
Increase in patient accounts and third-party payor settlements
receivable ...................................................... (62,512) (44,232) (50,041)
(Increase) decrease in supplies, inventories, prepaid expenses
and other current assets ........................................ (6,121) 82 (14,403)
Increase (decrease) in accounts payable and accrued expenses 1,177 4,086 (88,789)
(Increase) decrease in income taxes receivable ................... (16,517) (4,475) 20,992
(Decrease) increase in income taxes payable ...................... (5,686) -- 2,426
---------- ---------- ------------
Net cash provided by operating activities ....................... 31,599 33,828 46,145
---------- ---------- ------------
Cash flows from financing activities: ...............................
Proceeds from issuance of capital stock, net ....................... 8,399 3,479 29,927
Proceeds from long-term borrowings ................................. 510,659 1,087,175 3,280,565
Repayment of long-term borrowings .................................. (307,440) (830,434) (1,532,276)
Deferred financing costs ........................................... (5,512) (10,251) (45,500)
Payment of prepayment premiums and fees on debt extinguish-
ment ............................................................. -- -- (23,598)
Purchase of treasury stock ......................................... (12,790) -- (19,813)
Dividends paid ..................................................... (398) (435) (471)
---------- ---------- ------------
Net cash provided by financing activities ....................... 192,918 249,534 1,688,834
---------- ---------- ------------
Cash flows from investing activities: ...............................
Purchases of temporary investments ................................. (401) (5,645) (828,505)
Sales of temporary investments ..................................... 672 5,988 822,507
Business acquisitions .............................................. (82,686) (242,819) (1,560,396)
Purchases of property, plant, and equipment ........................ (145,065) (145,902) (126,860)
Disposition of assets .............................................. 33,153 136,709 54,137
Payment of termination fees and other costs of terminated
merger ........................................................... -- -- (27,555)
Payments of severance fees related to acquisition and other
costs ............................................................ -- -- (10,492)
Intangible assets .................................................. (14,183) -- --
Investment in affiliates and other assets .......................... (37,779) (31,582) (43,878)
---------- ---------- ------------
Net cash used by investing activities ............................ (246,289) (283,251) (1,721,042)
---------- ---------- ------------
Increase (decrease) in cash and equivalents ...................... (21,772) 111 13,937
Cash and cash equivalents, beginning of period ...................... 60,689 38,917 39,028
---------- ---------- ------------
Cash and cash equivalents, end of period ............................ $ 38,917 $ 39,028 52,965
========== ========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
64
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Organization and Basis of Presentation
Integrated Health Services, Inc. (IHS), a Delaware corporation, was formed
on March 25, 1986. The consolidated financial statements include the accounts of
IHS and its majority-owned and controlled subsidiaries (the Company). In
consolidation, all significant intercompany balances and transactions have been
eliminated. Investments in affiliates in which the Company has significant
influence but less than majority ownership and control are accounted for by the
equity method (see note 4).
(b) Medical Services Revenues
Medical services revenues are recorded at established rates and adjusted
for differences between such rates and estimated amounts reimbursable by
third-party payors when applicable. Estimated settlements under third-party
payor retrospective rate setting programs (primarily Medicare and Medicaid) are
accrued in the period the related services are rendered. Settlements receivable
and related revenues under such programs are based on annual cost reports
prepared in accordance with Federal and state regulations, which reports are
subject to audit and retroactive adjustment in future periods. In the opinion of
management, adequate provision has been made for such adjustments and final
settlements will not have a material effect on financial position or results of
operations. Basic medical services revenues represent routine service (room and
board) charges of geriatric and assisted living facilities, exclusive of medical
specialty units. Specialty medical services revenues represent ancillary service
charges of geriatric and assisted living facilities, revenues generated by
medical specialty units and revenues of pharmacy, rehabilitation, diagnostic,
respiratory therapy, home health, hospice and similar service operations.
(c) Cash Equivalents and Investments in Debt and Equity Securities
Cash equivalents consist of highly liquid debt instruments with original
maturities of three months or less at the date of investment by the Company.
Temporary investments, consisting primarily of preferred stocks and municipal
bonds, are classified as a trading security portfolio and are recorded at their
fair value, with net unrealized gains or losses included in earnings.
(d) Property, Plant and Equipment
The Company capitalizes costs associated with acquiring health care
facilities and related interests therein. Pre-acquisition costs represent direct
costs of the investigation and negotiation of the acquisition of operating
facilities and ancillary business units; indirect and general expenses related
to such activities are expensed as incurred. Pre-construction costs represent
direct costs incurred to secure control of the development site, including the
requisite certificate of need and other approvals, and to perform other initial
tasks which are essential to the development and construction of a facility.
Pre-acquisition and pre-construction costs are transferred to construction in
progress and depreciable asset categories when the related tasks are completed.
Interest cost incurred during construction is capitalized. Non-refundable
purchase option fees related to operating leases are generally classified as
leasehold interests and treated as deposits until (1) the option is exercised,
whereupon the deposit is applied as a credit against the purchase price, or (2)
the option period expires, whereupon the deposit is written off as lease
termination expense.
Total costs of facilities acquired are allocated to land, land
improvements, equipment and buildings (or leasehold interests therein) based on
their respective fair values determined generally by independent appraisal. Cost
in excess of such identified fair values is classified as intangible assets of
businesses acquired.
65
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
(e) Depreciation
Depreciation is provided on the straight-line basis over the estimated
useful lives of the assets, generally 25 years for land improvements, 10 years
for equipment, 40 years for buildings and the term of the lease for costs of
leasehold interests and improvements.
(f) Deferred Financing Costs
The Company defers financing costs incurred to obtain long-term debt and
amortizes such costs over the term of the related obligation. Debt discount is
amortized using the debt outstanding (interest) method over the term of the
related debt.
(g) Deferred Pre-opening Costs
Through December 31, 1995, direct costs incurred to initiate and implement
new medical specialty units (MSUs) at nursing facilities (e.g., respiratory
therapy, rehabilitation and Alzheimers' units) were deferred during the
pre-opening period and amortized on a straight-line basis over five years, which
corresponded to the period over which the Company receives reimbursement from
Medicare. Effective January 1, 1996, the Company changed its policy to expense
such costs when incurred (see note 19).
(h) Intangible Assets Acquired
Intangible assets of businesses acquired (primarily goodwill) are amortized
by the straight-line method primarily over 40 years, the period over which such
costs are recoverable through operating cash flows (see note 6).
(i) Deferred Gains on Sale-Leaseback Transactions
Gains on the sales of nursing facilities which are leased back under
operating leases are initially deferred and amortized over the terms of the
leases in proportion to and as a reduction of related rental expense.
(j) Stock-Based Compensation
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," ("APB No. 25") in accounting for its stock
options and warrants issued to employees. Additional information required by
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," ("SFAS No. 123") is discussed in note 11.
(k) Impairment of Long-Lived Assets
Management regularly evaluates whether events or changes in circumstances
have occurred that could indicate an impairment in the value of long-lived
assets. In December 1995, the Company adopted SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." In
accordance with the provisions of SFAS No. 121, if there is an indication that
the carrying value of an asset is not recoverable, the Company estimates the
projected undiscounted cash flows, excluding interest, of the related individual
facilities and business units (the lowest level for which there are identifiable
cash flows independent of other groups of assets) to determine if an impairment
loss should be recognized. The amount of impairment loss is determined by
comparing the historical carrying value of the asset to its estimated fair
value. Estimated fair value is determined through an evaluation of recent
financial performance and projected discounted cash flows of its facilities and
business units using standard industry valuation techniques, including the use
of independent appraisals when considered necessary. If an asset tested for
recoverability was acquired in a business combination accounted for using the
purchase method, the related goodwill is included as part of the carrying value
and evaluated as described above in determining the recoverability of that
asset.
66
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(k) Impairment of Long-Lived Assets -(CONTINUED)
In addition to consideration of impairment upon the events or changes in
circumstances described above, management regularly evaluates the remaining
lives of its long-lived assets. If estimates are changed, the carrying value of
affected assets is allocated over the remaining lives.
Prior to adoption of SFAS No. 121 in 1995, the Company performed its
analyses of impairment of long-lived assets by consideration of the projected
undiscounted cash flows on an entity-wide basis. The effect of the adoption of
SFAS 121 in December 1995 required the Company to perform this analysis on a
facility-by-facility and individual business unit basis. This resulted in the
recognition of a loss on impairment of long-lived assets (see note 19). If the
facility-by-facility and individual business unit analysis had been adopted
prior to December 1995, the Company may have incurred the loss on impairment of
long-lived assets prior to December 1995.
(l) Income Taxes
Deferred income taxes are recognized for the tax consequences of temporary
differences between financial statement carrying amounts and the related tax
bases of assets and liabilities. Such tax effects are measured by applying
enacted statutory tax rates applicable to future years in which the differences
are expected to reverse, and the effect of a change in tax rates is recognized
in the period the legislation is enacted.
(m) Earnings Per Share
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS No. 128") during the fourth quarter of the year
ended December 31, 1997. SFAS No. 128 establishes revised standards for
computing and presenting earnings per share ("EPS") data. Additional information
required by SFAS No. 128 is discussed in Note 12.
(n) Business and Credit Concentrations
The Company's medical services revenues are generated through approximately
2,000 service locations in 48 states and the District of Columbia, including 312
owned, leased and managed geriatric care facilities (excluding 38 facilities
held for sale). The Company generally does not require collateral or other
security in extending credit to patients; however, the Company routinely obtains
assignments of (or is otherwise entitled to receive) benefits receivable under
the health insurance programs, plans or policies of patients (e.g., Medicare,
Medicaid, commercial insurance and managed care organizations) (see note 3).
(o) Merger with IntegraCare, Inc.
In August 1995, the Company merged with IntegraCare, Inc. (Integra) which
provides physical, occupational and speech services to skilled nursing
facilities, hospitals, outpatient clinics, home health agencies and schools in
Florida. The Company exchanged 681,723 shares of its Common Stock for all of the
outstanding stock of Integra. The merger was accounted for using the pooling of
interests method and the consolidated financial statements and related notes for
1995 have been restated to combine the financial data of the Company and Integra
for those periods. The accounting practices of the Company and Integra were
comparable; therefore, no adjustments to net assets of either enterprise were
required to effect the combination. The consolidated statements of operations
include revenues of $17,886 in 1995 and net earnings of $891 in 1995 related to
the operations of Integra prior to the date of the merger.
(p) Management Agreements
IHS manages geriatric care facilities under contract for others for a fee
which generally is equal to 4% to 8% of the gross revenue of the geriatric care
facility. Under the terms of the contract, IHS is responsible for providing all
personnel, marketing, nursing, resident care, dietary and social services,
67
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(p) Management Agreements -(CONTINUED)
accounting and data processing reports and services for these facilities,
although such services are provided at the facility owner's expense. In
addition, certain management agreements also provide IHS with an incentive fee
based on the amount of the facility's operating income in excess of stipulated
amounts. Management fee revenues are recognized when earned and billed,
generally on a monthly basis. Incentive fees are recognized when operating
results of managed facilities exceed amounts required for incentive fees in
accordance with the terms of the management agreement. Management agreements
generally have an initial term of ten years, with IHS having a right to renew in
most cases. Contract acquisition costs for legal and other direct costs incurred
by IHS to acquire long-term management contracts are capitalized and amortized
over the term of the related contract. Management periodically evaluates its
deferred contract costs for recoverability by assessing the projected
undiscounted cash flows, excluding interest, of the managed facilities; any
impairment in the financial condition of the facility will result in a writedown
by IHS of its deferred contract costs.
(q) Assets held for Sale
Assets held for sale represent the assets of 19 geriatric care facilities
and one outpatient clinic acquired in connection with the acquisition of
Community Care of America, Inc., 20 geriatric care facilities acquired in
connection with the acquisition of certain businesses from HEALTHSOUTH
Corporation and 26 physician practices acquired in the acquisition of RoTech
Medical Corporation which are intended to be sold within the next year (see note
2). Such amounts are carried at estimated net realizable value, less estimated
carrying costs to be incurred during the holding period.
(r) Derivative Financial Instruments
The Company utilizes interest rate swap agreements to manage market risks
and reduce its exposure resulting from fluctuations in interest rates. Amounts
currently due to or from interest rate swap counterparties are recorded as
adjustments to interest expense in the period in which they accrue. Gains or
losses on terminated agreements are included in accounts payable and accrued
expenses and amortized to interest expense over the shorter of the original term
of the agreements or the life of the financial instruments to which they are
matched.
(s) Reclassifications
Certain amounts presented in 1995 and 1996 have been reclassified to
conform with the presentation for 1997.
68
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
(2) BUSINESS ACQUISITIONS
ACQUISITIONS DURING THE YEAR ENDED DECEMBER 31, 1997
Acquisitions in 1997 and the manner of payment are summarized as follows:
<TABLE>
<CAPTION>
MONTH TRANSACTION DESCRIPTION
- ----------- --------------------------------------------------------------------
<S> <C>
January Stock of In-Home Health Care, Inc., a home healthcare services
provider
February Assets of Portable X-Ray Labs, Inc., a mobile x-ray services
provider
March Payment of earnout in connection with Achievement Rehab acquisi-
tion in December 1993
June Stock of Health Care Industries, Inc., a home healthcare services
provider
June Assets of Rehab Dynamics, Inc. and Restorative Therapy, Ltd.,
contract rehabilitation companies(2)
August Stock of Ambulatory Pharmaceutical Services, Inc. and APS
American, Inc., home healthcare services providers
August Stock of Arcadia Services, Inc., a home healthcare services
provider September Stock and assets of Barton Creek Healthcare,
Inc., a home healthcare services provider
September Stock of Community Care of America, Inc., an operator of skilled
nursing facilities
October Assets of Coram Lithotripsy Division, an operator of lithotripsy
units
October Stock of RoTech Medical Corporation, a respiratory therapy
company
November Assets of Durham Meridian Limited Partnership (Treyburn) November
Stock of HPC America, Inc., an operator of home infusion and home
healthcare companies
November Assets of Richards Medical Company, Inc., a respiratory therapy
company
November Assets of Central Medical Supply Company, Inc., a respiratory
therapy company
November Assets of Hallmark Respiratory Care, a respiratory therapy
company
November Leasehold interest in Shadow Mountain, a skilled nursing facility
December Assets of certain businesses owned by HEALTHSOUTH Corporation
December Assets of Sunshine Medical Equipment, Inc., a
respiratory therapy company
December Assets of Quest, Inc., a respiratory therapy company
Various 17 acquisitions, each with total costs of less than $2,000
Various Cash payments of acquisition costs accrued
<CAPTION>
COMMON
CASH STOCK ACCRUED
MONTH PAID ISSUED(1) LIABILITIES TOTAL COST
- ----------- ------------ ----------- ------------- -------------
<S> <C> <C> <C> <C>
January $ 3,200 $ -- $ 250 $ 3,450
February 4,900 -- 1,300 6,200
March -- 26,439 -- 26,439
June 1,825 -- 500 2,325
June 8,203 11,460 2,500 22,163
August 18,125 18,125 1,950 38,200
August -- 17,169 3,000 20,169
September 4,857 -- 280 5,137
September 99,883 -- 5,995 105,878
October 131,000 -- 7,500 138,500
October -- 506,648 22,597 529,245
November 4,775 -- -- 4,775
November 26,127 -- 825 26,952
November 1,993 -- 160 2,153
November 1,872 -- 178 2,050
November 3,768 -- 145 3,913
November 4,020 -- 42 4,062
December 1,159,142 -- 50,980 1,210,122
December 3,290 -- 270 3,560
December 33,000 -- 385 33,385
Various 9,010 -- 894 9,904
Various 41,406 -- (41,406) --
---------- -------- ---------- ----------
$1,560,396 $579,841 $ 58,345 $2,198,582
========== ======== ========== ==========
</TABLE>
- ----------
(1) Represents shares of IHS common stock as follows: 976,504 shares for the
Achievement Rehab earnout; 331,379 shares for Rehab Dynamics and
Restorative Therapy; 532,240 shares for Ambulatory Pharmaceutical Services
and APS American; 531,198 shares for Arcadia Services; and 15,598,400
shares for RoTech Medical Corporation. Subsequent to December 31, 1997, the
Company issued an additional 50,253 shares to the stockholders of Arcadia
Services.
(2) Pursuant to an agreement with the former owners of Rehab Dynamics, Inc., an
earnout of up to $11.7 million is potentially payable, 60% of which is to
be in the Company's common stock.
69
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(2) BUSINESS ACQUISITIONS -(CONTINUED)
The allocation of the total costs of the 1997 acquisitions to the assets
acquired and liabilities assumed is summarized as follows:
<TABLE>
<CAPTION>
PROPERTY,
CURRENT PLANT AND ASSETS HELD OTHER
ASSETS EQUIPMENT FOR SALE ASSETS
----------- ----------- ------------- ------------
<S> <C> <C> <C> <C>
In-Home Health Care, Inc. ........... $ 989 $ 229 $ -- $ 7
Portable X-Ray Labs, Inc. ........... 1,309 -- -- 11
Achievement Rehab ................... -- -- -- --
Health Care Industries, Inc. ........ 805 204 -- 41
Rehab Dynamics, Inc. & Restor-
ative Therapy, Ltd. ................ 4,140 954 -- 107
Ambulatory Pharmaceutical Ser-
vices, Inc. & APS America, Inc. . 1,987 48 -- 8
Arcadia Services, Inc. .............. 3,980 348 -- 2,464
Barton Creek Healthcare, Inc. ....... 884 96 -- --
Community Care of America, Inc. . 12,022 39,286 12,030 (11,111)
Coram Lithotripsy Division .......... 6,286 5,775 -- 3,736
RoTech Medical Corporation .......... 95,274 119,724 16,000 10,086
Durham Meridian Limited Partner-
ship ............................... 1,325 8,453 -- 102
HPC America, Inc. ................... 3,882 754 -- (5,756)
Richards Medical Company, Inc. ...... 228 279 -- --
Central Medical Supply Company,
Inc. ............................... 283 173 -- --
Hallmark Respiratory Care ........... 617 391 -- 3
Shadow Mountain ..................... -- 4,062 -- --
HEALTHSOUTH
Corporation businesses ............. 176,031 232,864 80,647 --
Sunshine Medical Equipment, Inc...... 374 200 -- --
Quest Inc. .......................... 3,164 2,207 -- 17
Other acquisitions .................. 734 933 -- 38
-------- -------- -------- ----------
$314,314 $416,980 $108,677 $ (247)
======== ======== ======== ==========
<CAPTION>
INTANGIBLE CURRENT LONG-TERM TOTAL
ASSETS LIABILITIES LIABILITIES COST
------------ ------------- ------------- ------------
<S> <C> <C> <C> <C>
In-Home Health Care, Inc. ........... $ 3,856 $ (797) $ (834) $ 3,450
Portable X-Ray Labs, Inc. ........... 5,653 (297) (476) 6,200
Achievement Rehab ................... 26,439 -- -- 26,439
Health Care Industries, Inc. ........ 2,505 (1,080) (150) 2,325
Rehab Dynamics, Inc. & Restor-
ative Therapy, Ltd. ................ 21,478 (3,204) (1,312) 22,163
Ambulatory Pharmaceutical Ser-
vices, Inc. & APS America, Inc. . 41,624 (5,467) -- 38,200
Arcadia Services, Inc. .............. 39,233 (24,724) (1,132) 20,169
Barton Creek Healthcare, Inc. ....... 7,293 (3,136) -- 5,137
Community Care of America, Inc. . 109,682 (38,768) (17,263) 105,878
Coram Lithotripsy Division .......... 162,625 (39,422) (500) 138,500
RoTech Medical Corporation .......... 669,615 (244,665) (136,789) 529,245
Durham Meridian Limited Partner-
ship ............................... -- (1,072) (4,033) 4,775
HPC America, Inc. ................... 28,480 -- (408) 26,952
Richards Medical Company, Inc. ...... 1,646 -- -- 2,153
Central Medical Supply Company,
Inc. ............................... 1,625 (31) -- 2,050
Hallmark Respiratory Care ........... 2,902 -- -- 3,913
Shadow Mountain ..................... -- -- -- 4,062
HEALTHSOUTH
Corporation businesses ............. 979,691 (158,068) (101,043) 1,210,122
Sunshine Medical Equipment, Inc...... 2,986 -- -- 3,560
Quest Inc. .......................... 27,997 -- -- 33,385
Other acquisitions .................. 9,755 (1,476) (80) 9,904
---------- ---------- ---------- ----------
$2,145,085 $ (522,207) $ (264,020) $2,198,582
========== ========== ========== ==========
</TABLE>
70
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(2) BUSINESS ACQUISITIONS -(CONTINUED)
ACQUISITIONS DURING THE YEAR ENDED DECEMBER 31, 1996
Acquisitions in 1996 and the manner of payment are summarized as follows:
<TABLE>
<CAPTION>
MONTH TRANSACTION DESCRIPTION
- ----------- ----------------------------------------------------------------------
<S> <C>
January Assets of Vintage Healthcare Center, a 110 bed facility in Denton,
Texas
March Stock of Rehab Management Systems, Inc., a multi-state operator of
outpatient rehabilitative clinics and inpatient therapy centers
May Assets of Hospice of the Great Lakes, Inc., an Illinois hospice ser-
vice provider
May Preferred Care, Inc. purchase option deposits in connection with
management agreements
August Stock of J.R. Rehab Associates, Inc., a North Carolina provider of
rehabilitative therapy services to nursing homes, hospitals and oth-
ers
August Assets of Extendicare of Tennessee Inc., a home health provider
August Assets of Edgewater Home Infusion Services Inc., a home infusion
services provider
September Assets of Century Health Services Inc., a home health provider
September Stock of Signature Home Care, Inc., a home health provider
October Stock of First American Health Care of Georgia, Inc., a home health
services provider
Various Litchfield Asset Management, Inc., purchase option deposits in con-
nection with operating leases
November Assets of Mediq Mobile X-Ray Services, Inc., a mobile diagnostic
service provider
November Assets of Total Rehab Services, LLC and Total Rehab Services O2, LLC,
a provider of contract rehabilitative and respiratory services
December Stock, at carryover basis, of Lifeway, Inc., a provider of physician
management and disease management services
Various Contingent purchase price payments on prior acquisition of The Rehab
People in 1994
Various 7 acquisitions, each with total costs of less than $2,000
Various Cash payments of acquisition costs accrued in 1995 and 1996
<CAPTION>
COMMON
CASH STOCK ACCRUED
MONTH PAID ISSUED(1) LIABILITIES TOTAL COST
- ----------- ---------- ----------- ------------- -----------
<S> <C> <C> <C> <C>
January $ 6,900 $ -- $ -- $ 6,900
March 2,000 8,000 2,900 12,900
May -- 8,200 1,000 9,200
May 3,100 7,250 -- 10,350
August 2,100 -- 200 2,300
August 3,411 -- 200 3,611
August 7,974 -- 300 8,274
September 3,992 -- 200 4,192
September 6,447 4,725 2,500 13,672
October 154,084 -- 22,000 176,084
Various 4,018 -- -- 4,018
November 4,942 5,200 5,500 15,642
November 9,173 2,700 1,250 13,123
December 935 (1,440) 275 (230)
Various -- 10,000 -- 10,000
Various 2,566 -- 65 2,631
Various 31,177 -- (31,177) --
-------- -------- ---------- --------
$242,819 $ 44,635 $ 5,213 $292,667
======== ======== ========== ========
</TABLE>
- ----------
(1) Represents shares of IHS common stock as follows: 385,542 shares for RMS,
304,822 shares for Hospice, 305,300 shares for Preferred Care, 196,374
shares for Signature, 203,721 shares for Mediq, 106,559 shares for Total
Rehab, 95,615 shares for Lifeway, and 435,540 shares for The Rehab People.
71
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(2) BUSINESS ACQUISITIONS -(CONTINUED)
The allocation of the total cost of the 1996 acquisitions to the assets
acquired and liabilities assumed is summarized as follows:
<TABLE>
<CAPTION>
PROPERTY,
CURRENT PLANT AND OTHER
ASSETS EQUIPMENT ASSETS
----------- ----------- -----------
<S> <C> <C> <C>
Vintage ................................... $ -- $ 6,900 $ --
Rehab Management Systems (RMS) ............ 1,644 1,021 165
Hospice of the Great Lakes (Hospice) . -- 144 25
Preferred Care ............................ -- 10,350 --
J.R. Rehab ................................ 532 149 --
Extendicare ............................... 2,229 18 --
Edgewater ................................. 1,789 160 1
Century ................................... 5,628 139 202
Signature ................................. 19,938 7,521 99
First American ............................ 44,608 22,438 73,226
Litchfield ................................ -- 4,018 --
Mediq ..................................... 4,518 431 21
Total Rehab ............................... 5,505 128 --
Lifeway ................................... 158 270 70
Rehab People .............................. -- -- --
Other acquisitions ........................ -- 1,863 --
-------- -------- --------
$ 86,549 $ 55,550 $ 73,809
======== ======== ========
<CAPTION>
INTANGIBLE CURRENT LONG-TERM TOTAL
ASSETS LIABILITIES LIABILITIES COST
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
Vintage ................................... $ -- $ -- $ -- $ 6,900
Rehab Management Systems (RMS) ............ 12,832 (1,848) (914) 12,900
Hospice of the Great Lakes (Hospice) . 9,031 -- -- 9,200
Preferred Care ............................ -- -- -- 10,350
J.R. Rehab ................................ 3,159 (1,540) -- 2,300
Extendicare ............................... 1,945 (581) -- 3,611
Edgewater ................................. 7,685 (1,313) (48) 8,274
Century ................................... 12,140 (13,917) -- 4,192
Signature ................................. 21,122 (18,077) (16,931) 13,672
First American ............................ 227,406 (152,095) (39,499) 176,084
Litchfield ................................ -- -- -- 4,018
Mediq ..................................... 15,600 (4,928) -- 15,642
Total Rehab ............................... 11,982 (4,492) -- 13,123
Lifeway ................................... -- (728) -- (230)
Rehab People .............................. 10,000 -- -- 10,000
Other acquisitions ........................ 1,600 (832) -- 2,631
--------- ---------- ---------- ---------
$ 334,502 $ (200,351) $ (57,392) $ 292,667
========= ========== ========== =========
</TABLE>
ACQUISITIONS DURING THE YEAR ENDED DECEMBER 31, 1995
Acquisitions in 1995 and the manner of payment are summarized as follows:
<TABLE>
<CAPTION>
MONTH TRANSACTION DESCRIPTION
- ---------- ---------------------------------------------------------------------
<S> <C>
January Assets of four ancillary service companies
February Assets of ProCare Group, Inc., and its affiliated entities, a home
health service provider in Broward, Dade and Palm Beach counties,
Florida
March Management agreement to manage 34 geriatric care facilities in Texas,
California, Florida, Nevada and Mississippi (known collectively as
the "Preferred Care Facilities")
March Stock of Samaritan Management, Inc., a hospice service provider in
Michigan
March Substantially all the assets of Fidelity Health Care, Inc., a home
healthcare, temporary staffing and infusion services provider in Ohio
June Stock of three ancillary service companies providing mobile x-ray and
electrocardiagram services to long-term care and subacute care
facilities
August Stock of Senior Life Care Enterprises, Inc. ("SLC"), a home health,
supplemental staffing and management service provider
August Stock of Avenel, a 120 bed facility in Plantation, Florida
August Hershey at Woodlands, a 213 bed nursing and personal care facility in
Pennsylvania
November Stock of Governor's Park, a 150 bed facility in Illinois
December Stock of Carrington Pointe, an assisted living facility in
Massachusetts Various Litchfield Asset Management, Inc., purchase
option deposits in con- nection with operating leases
Various 12 acquisitions, each with total costs of less than $2,000
Various Cash payments of acquisition costs accrued in 1994 and 1995
<CAPTION>
COMMON
CASH STOCK ACCRUED
MONTH PAID ISSUED(1) LIABILITIES TOTAL COST
- ---------- ---------- ----------- ------------- -----------
<S> <C> <C> <C> <C>
January $ 3,324 $ 300 $ -- $ 3,624
February 300 3,600 675 4,575
March 10,200 -- -- 10,200
March 5,500 -- 1,000 6,500
March 2,140 -- 350 2,490
June 2,200 -- -- 2,200
August -- 6,000 700 6,700
August 6,360 -- -- 6,360
August 2,100 -- -- 2,100
November 10,035 -- -- 10,035
December 11,800 -- -- 11,800
Various 4,018 -- -- 4,018
Various 8,461 234 1,065 9,760
Various 16,248 -- (16,248) --
------- ------- --------- -------
$82,686 $10,134 $ (12,458) $80,362
======= ======= ========= =======
</TABLE>
- ----------
(1) Represents shares of IHS common stock as follows: 7,935 shares for four
ancillary service companies, 95,062 shares for ProCare, 92,434 shares for
the PCP earnout, and 189,785 shares for SLC.
72
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(2) BUSINESS ACQUISITIONS -(CONTINUED)
The allocation of the total cost of the 1995 acquisitions to the assets
acquired and liabilities assumed is summarized as follows:
<TABLE>
<CAPTION>
PROPERTY,
CURRENT PLANT AND OTHER INTANGIBLE CURRENT LONG-TERM TOTAL
ASSETS EQUIPMENT ASSETS ASSETS LIABILITIES LIABILITIES COST
--------- ----------- ----------- ------------ ------------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Four ancillary service companies ....... $ -- $ 501 $ -- $ 3,155 $ -- $ (32) $ 3,624
ProCare ................................ 57 154 47 4,434 -- (117) 4,575
Preferred Care ......................... -- 10,200 -- -- -- -- 10,200
Samaritan of Michigan .................. 265 -- -- 6,775 (540) -- 6,500
Fidelity ............................... 8 183 -- 2,299 -- -- 2,490
Diagnostics ............................ -- 176 -- 2,458 (434) -- 2,200
Senior Life Care Enterprises (SLC) ..... 4,314 103 (202) 5,638 (1,428) (1,725) 6,700
Avenel ................................. -- 6,360 -- -- -- -- 6,360
Hershey ................................ -- 7,870 -- -- -- (5,770) 2,100
Governor's Park ........................ 832 9,203 -- -- -- -- 10,035
Carrington Pointe ...................... -- 11,800 -- -- -- -- 11,800
Litchfield ............................. -- 4,018 -- -- -- -- 4,018
Other acquisitions ..................... 112 8,748 (140) 8,391 (851) (6,500) 9,760
------- -------- ------- -------- --------- --------- --------
$ 5,588 $ 59,316 $ (295) $ 33,150 $ (3,253) $ (14,144) $ 80,362
======= ======== ======= ======== ========= ========= ========
</TABLE>
Unaudited pro forma combined results of operations of the Company giving
effect to the foregoing acquisitions for the years ended December 31, 1996 and
1997 are presented below. Such pro forma presentation has been prepared assuming
that the acquisitions had been made as of January 1, 1996.
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
-------------------------------
1996 1997
--------------- -------------
<S> <C> <C>
Revenues ................................................................ $ 3,541,385 $3,570,918
Earnings (loss) before extraordinary items and cumulative effect of ac-
counting change ........................................................ 2,305 (4,911)
Earnings (loss) before cumulative effect of accounting change ........... 874 (25,463)
Net earnings (loss) ..................................................... 874 (27,293)
Per common share--basic:
Earnings (loss) before extraordinary items and cumulative effect of
accounting change .................................................... 0.06 (0.11)
Earnings (loss) before cumulative effect of accounting change .......... 0.02 (0.57)
Net earnings (loss) .................................................... 0.02 (0.61)
</TABLE>
The unaudited pro forma results include the historical accounts of the
Company and the historical accounts for the acquired businesses adjusted to
reflect (1) depreciation and amortization of the acquired identifiable tangible
and intangible assets based on the new cost basis of the acquisitions, (2) the
interest expense resulting from the financing of the acquisitions, (3) the new
cost basis for the allocation of corporate overhead expenses and (4) the related
income tax effects. The pro forma results are not necessarily indicative of
actual results which might have occurred had the operations and management teams
of the Company and the acquired companies been combined in prior years.
In connection with its business acquisitions, the Company incurs
transaction costs, costs to exit certain activities and costs to terminate or
relocate certain employees of acquired companies. Liabilities accrued in the
acquisition cost allocations represent direct costs of acquisitions, which
consist primarily of transaction costs for legal, accounting and consulting
fees, of $3,376 in 1995, $16,299 in 1996 and
73
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(2) BUSINESS ACQUISITIONS -(CONTINUED)
$66,440 in 1997, as well as exit costs and employee termination and relocation
costs of $414 in 1995, $20,091 in 1996 and $33,220 in 1997. Accrued acquisition
liabilities for exit costs and employee termination and relocation costs are
recognized in accordance with EITF 95-3, "Recognition Of Liabilities In
Connection With A Purchase Business Combination" and are summarized as follows
for the years ended December 31, 1995, 1996 and 1997:
<TABLE>
<CAPTION>
EMPLOYEE
TERMINATION AND
EXIT RELOCATION
COSTS COSTS TOTAL
----------- ---------------- -----------
<S> <C> <C> <C>
Acquired companies - 1995 .................. $ -- $ 414 $ 414
Payments charged against liability ......... -- (414) (414)
Adjustments recorded to:
Cost of acquisitions ...................... -- -- --
Operations ................................ -- -- --
-------- --------- ---------
Balance at December 31, 1995 ............... -- -- --
-------- --------- ---------
Acquired companies - 1996 .................. 8,203 11,888 20,091
Payments charged against liability ......... (2,326) (6,198) (8,524)
Adjustments recorded to:
Cost of acquisitions ...................... -- (528) (528)
Operations ................................ -- -- --
-------- --------- ---------
Balance at December 31, 1996 ............... 5,877 5,162 11,039
-------- --------- ---------
Acquired companies - 1997 .................. 10,205 23,015 33,220
Payments charged against liability ......... (3,952) (11,346) (15,298)
Adjustments recorded to:
Cost of acquisitions ...................... (1,925) 160 (1,765)
Operations ................................ -- -- --
-------- --------- ---------
Balance at December 31, 1997 ............... $ 10,205 $ 16,991 $ 27,196
======== ========= =========
</TABLE>
The Company has not finalized its plans to exit activities (exit plans) and
to terminate or relocate employees (termination plans) of certain companies
acquired in 1997. Unresolved issues relate primarily to the termination of
certain leases, the closure of certain regional offices and the finalization of
severance and termination arrangements. Accordingly, unresolved issues could
result in additional liabilities for salaries, benefits, rent and other costs,
and related increases to the acquisition cost. These adjustments will be
reported primarily as an increase or decrease in goodwill.
The exit plans at December 31, 1997 consist of the discontinuation of
certain activities of the businesses acquired from HEALTHSOUTH Corporation,
Arcadia Services and Ambulatory Pharmaceutical Services, including estimates for
costs related to the closure of duplicative facilities, lease termination fees
and other exit costs as defined in EITF 95-3. Significant exit activities
relating to the 1997 acquisitions are expected to be completed by December 31,
1998. The exit plans at December 31, 1996 consist primarily of the
discontinuation of certain activities of First American, including estimates for
costs related to the closure of duplicative facilities, lease termination fees
and other exit costs as defined in EITF 95-3. Significant exit activities
relating to the 1996 acquisitions were completed by December 31, 1997.
The termination plans at December 31, 1997 relate primarily to the
following employee groups with the indicated anticipated dates of completion of
termination/relocation: businesses acquired from HEALTHSOUTH Corporation by
December 1998, RoTech and the Lithotripsy Division of Coram by October 1998,
Portable X-Ray Labs by February 1998, Rehab Dynamics by June 1998, Arcadia and
74
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(2) BUSINESS ACQUISITIONS -(CONTINUED)
Ambulatory Pharmaceutical Services by August 1998, and Community Care of America
by September 1998. The termination plans at December 31, 1996 relate primarily
to the following employee groups with the indicated dates of completion of
termination/relocation: First American by October 1997, Mediq and Total Rehab by
November 1997, RMS by March 1997, Signature by September 1997, Hospice of the
Great Lakes by May 1997, and Edgewater by August 1997.
In addition to the accrued acquisition liabilities described above, the
Company allocates the cost of its business acquisitions to the respective assets
acquired and liabilities assumed, including preacquisition contingencies, on the
basis of estimated fair values at the date of acquisition. Often the Company
must await additional information for the resolution or final measurement of
such contingencies during the allocation period, which usually does not exceed
one year from the date of acquisition. Accordingly, the effect of the resolution
or final measurement of preacquisition contingencies during the allocation
period is treated as an acquisition adjustment primarily to the amount of
goodwill recorded. After the allocation period, such resolution or final
measurement is recognized in the determination of net earnings. Preacquisition
contingencies in connection with the Company's business acquisitions primarily
relate to Medicare and Medicaid regulatory compliance matters, claims subject to
intermediary audits, income tax matters and legal proceedings. During the three
years ended December 31, 1997, the Company resolved or completed the final
measurement of certain preacquisition contingencies related to business
acquisitions. Accordingly, the Company adjusted the original allocation of these
businesses by increasing goodwill, decreasing certain third-party payor
settlements receivable, and increasing certain current liabilities. Management
is aware of certain adjustments that might be required with respect to
acquisitions recorded at December 31, 1997; accordingly, the original allocation
could be adjusted to the extent that finalized amounts differ from the
estimates.
(3) PATIENT ACCOUNTS AND THIRD-PARTY PAYOR SETTLEMENTS RECEIVABLE
Patient accounts and third-party payor settlements receivable consist of
the following as of December 31, 1996 and 1997:
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Patient accounts receivable ......................................... $340,803 $726,149
Allowance for doubtful accounts ..................................... 41,527 161,438
-------- --------
299,276 564,711
Third party payor settlements, less allowance for contractual adjust-
ments of $14,979 and $19,827........................................ 27,607 38,721
-------- --------
$326,883 $603,432
======== ========
</TABLE>
Gross patient accounts receivable and third-party payor settlements
receivable from the Federal government (Medicare) were $148,791 and $260,463 at
December 31, 1996 and 1997, respectively. Medicare receivables include pending
requests for exceptions to the Medicare established routine cost limitations for
the reimbursement of costs exceeding these limitations (before related
allowances for contractual adjustments) of $15,640 and $12,803 at December 31,
1996 and 1997, respectively. Amounts receivable from various states (Medicaid)
were $61,675 and $137,707 respectively, at such dates, which relate primarily to
the states of Colorado, Florida, Nebraska, New Mexico, Pennsylvania and Texas.
75
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
(4) INVESTMENTS IN AND ADVANCES TO AFFILIATES
The Company's investments in and advances to affiliates at December 31,
1996 and 1997 are summarized as follows:
<TABLE>
<CAPTION>
1996 1997
--------- ----------
<S> <C> <C>
Investments accounted for by the equity method:
HPC .......................................... $ 8,003 $ --
Tutera ....................................... 7,551 7,737
Speciality ................................... 9,379 6,059
Integrated Living Communities ................ 24,531 --
Other ........................................ 799 4,000
------- -------
50,263 17,796
Other investments:
Capstone Pharmacy Services, Inc. ............. 24,019 --
Other ........................................ 1,765 1,731
------- -------
$76,047 $19,527
======= =======
</TABLE>
Investments in significant unconsolidated affiliates are summarized below.
HPC AMERICA, INC. (HPC)
In September 1995, a wholly owned subsidiary of IHS (Southwood), invested
$8,200 for a 40% interest in HPC America, Inc. ("HPC"), a Delaware corporation
that operates home infusion and home healthcare companies, in addition to owning
physician practices. Subject to certain material transactions requiring the
approval of Southwood, the business was conducted under the direction of the
Chief Executive Officer and President of HPC. Southwood had a right of first
refusal to purchase the remaining 60% interest in HPC at any time through March
1997 and the exclusive right to purchase the remaining 60% interest in HPC for
the six month period beginning March 1997, in each case based upon a multiple of
HPC's earnings. Southwood purchased the remaining 60% interest in HPC (excluding
the physician practices) for $26,127 and sold its 40% interest in HPC's
physician practices in November 1997. (See note 2).
TUTERA HEALTH CARE MANAGEMENT, L.P.
In January, 1993, a wholly-owned subsidiary of IHS, Integrated Health
Services of Missouri, Inc. ("IHSM"), invested $4,650 for a 49% interest in
Tutera Health Care Management, L.P. (the "Partnership" or "Tutera"), a
partnership newly formed to manage and operate approximately 8,000 geriatric
care and assisted retirement beds. Cenill, Inc., a wholly owned subsidiary of
Tutera Group, Inc., is the sole general partner of the Partnership and owns a
51% interest therein. Subject to certain material transactions requiring the
approval of IHSM, the business of the Partnership is conducted by its general
partner. IHSM has the right to become a 51% owner and sole general partner of
the Partnership, or to purchase the general partner's entire interest in the
Partnership, in each case for a price based upon a multiple of the Partnership's
earnings, under the following circumstances: (a) if earnings decline and the
general partner fails to implement operational changes recommended by IHS; (b)
if the general partner discontinues its relationship with the partnership and
the general partner fails to accept IHS' suggested replacement; or (c) if the
general partner defaults on its revolving credit and security agreement with
Continental Bank and fails to pay obligations within 36 months of the default.
The Company has guaranteed the debt of the partnership, up to $4,020, which debt
bears interest at prime plus 1 3/4% and matures in October 1998.
76
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(4) INVESTMENTS IN AND ADVANCES TO AFFILIATES-(CONTINUED)
SPECIALITY CARE PLC
In April 1993, a wholly owned subsidiary of IHS (Southwood), acquired a
21.28% interest in the common stock and a 47.64% interest in the 6% cumulative
convertible preferred stock of Speciality Care PLC, an owner and operator of
geriatric care facilities in the United Kingdom. The total cost of the
investment was $748 for the common stock and $2,245 for the preferred stock. The
preferred stock contains certain preferences as to liquidation. In 1994,
Southwood loaned an additional $1,000 to Speciality bearing interest at 9%. In
January 1995 Southwood applied $627 of the loan to pay for additional shares of
common and preferred stock of Speciality subscribed for in November 1994.
In June 1995 the Company loaned an additional $8,575 to Speciality bearing
interest at 12%; this loan was subsequently repaid in August 1995. In addition
the Company invested an additional $4,384 in Speciality. As a result of the
Company's additional investment, the Company has a 21.30% interest in the common
stock and a 63.65% interest in the 6% cumulative convertible preferred stock.
Upon conversion of the preferred stock, the Company will own approximately
31.38% of Speciality (assuming no further issuances). IHS sold its interest in
Speciality in 1998. (See note 23).
INTEGRATED LIVING COMMUNITIES, INC. (ILC)
In November 1995, the Company formed ILC as a wholly-owned subsidiary to
operate the Company's assisted living and other senior housing facilities owned,
leased and managed by the Company. Following formation of ILC, the Company
transferred to ILC as a capital contribution the Company's ownership interests
in three facilities, condominium interests in three facilities and agreements to
manage nine facilities (five of which have subsequently been terminated), and
sublet to ILC two facilities. On October 9, 1996, ILC completed an initial
public offering of its shares at $8.00 per share, in which ILC sold 2,800,000
shares and received aggregate net proceeds of approximately $19,100, and the
Company sold 1,400,000 shares and received aggregate net proceeds of
approximately $10,400. In addition, ILC repaid $7,400 owed to the Company.
Following the offering, the Company owned 2,497,900 shares of ILC common stock,
representing 37.3% of the outstanding ILC common stock, and loaned ILC $3,400.
In the third quarter of 1997, the Company sold its remaining shares in ILC in
connection with the purchase of ILC by Senior Lifestyle Corporation. The Company
recognized a non-recurring gain of $3,914 on the sale, and received full payment
of its loan to ILC.
CAPSTONE PHARMACY SERVICES, INC.
On July 30, 1996, the Company sold its pharmacy division to Capstone
Pharmacy Services, Inc. for a purchase price of $150,000, consisting of cash of
$125,000 and unregistered shares of Capstone common stock having a value of
approximately $25,000. The Company's investment in Capstone common stock
represents less than 8% of the total Capstone shares. Such investment was
recorded at carryover basis of $14,659 and classified as securities available
for sale. An unrealized gain of $9,360 was reflected in stockholders' equity
with respect to such investment, as the current market value of the Capstone
shares at December 31, 1996 was $24,019. The Capstone shares were registered
with the Securities and Exchange Commission in the first fiscal quarter of 1997
and, accordingly, the Company reversed the unrealized gain of $9,360 and
recognized a nonrecurring gain of $7,580.
77
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(4) INVESTMENTS IN AND ADVANCES TO AFFILIATES-(CONTINUED)
The Company's equity in earnings (loss) of affiliates for the years ended
December 31, 1995, 1996 and 1997 is summarized as follows:
<TABLE>
<CAPTION>
1995 1996 1997
---------- --------- ---------
<S> <C> <C> <C>
HPC .................................... $ (185) $ 82 $ 253
Tutera ................................. 960 883 486
Integrated Living Communities .......... -- (241) (440)
Speciality ............................. 668 104 (211)
------ ------ ------
$1,443 $ 828 $ 88
====== ====== ======
</TABLE>
At December 31, 1997 the Company's investment in Tutera exceeded its equity
in the underlying net assets by $3,150, which is being amortized over 15 years.
The Company received cash distributions from its affiliates of $1,012 in 1995,
$830 in 1996 and $245 in 1997. During 1996, the Company's 250,000 common shares
or $2,600 investment in Hearing Health Services, Inc. was repurchased for
approximately $2,600. The Company continues to hold an investment in Hearing
Health Services, Inc. preferred stock.
Selected financial information for the combined affiliates accounted for
under the equity method (excluding HPC and ILC in 1997) is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
-------------- -------------
<S> <C> <C>
Working capital ......... $ 2,007 $ 4,870
Total assets ............ 141,167 46,880
Long-term debt .......... 19,399 14,366
Equity .................. $ 82,707 $24,367
======== =======
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1995 1996 1997
---------- ----------- ----------
<S> <C> <C> <C>
Revenues .................... $64,294 $118,995 $ 38,621
Net earnings (loss) ......... 1,316 1,550 (2,133)
======= ======== ========
</TABLE>
(5) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at December 31, 1996 and 1997 are summarized
as follows:
<TABLE>
<CAPTION>
1996 1997
---------- ------------
<S> <C> <C>
Land .................................................... $ 38,236 $ 43,929
Buildings and improvements .............................. 356,063 638,919
Leasehold improvements and leasehold interests .......... 218,107 248,476
Equipment ............................................... 270,248 442,919
Construction in progress ................................ 67,169 84,623
Pre-construction and pre-acquisition costs .............. 19,603 5,696
-------- ----------
969,426 1,464,562
Less accumulated depreciation and amortization .......... 105,091 145,929
-------- ----------
Net property, plant and equipment ...................... $864,335 $1,318,633
======== ==========
</TABLE>
Included in leasehold improvements and leasehold interests are purchase
option deposits on 89 facilities of $74,131 at December 31, 1996, of which
$29,375 is refundable, and $78,149 at December 31, 1997, of which $33,393 is
refundable.
78
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
(6) INTANGIBLE ASSETS
Intangible assets are summarized as follows at December 31, 1996 and 1997:
<TABLE>
<CAPTION>
1996 1997
----------- -------------
<S> <C> <C>
Intangible assets of businesses acquired, primarily goodwill .......... $570,651 $2,803,325
Deferred financing costs .............................................. 26,842 62,250
-------- ----------
597,493 2,865,575
Less accumulated amortization ......................................... 25,334 50,303
-------- ----------
Net intangible assets ................................................ $572,159 $2,815,272
======== ==========
</TABLE>
The Company amortizes goodwill primarily over 40 years. Management
regularly evaluates whether events or circumstances have occurred that would
indicate an impairment in the value or the life of goodwill. In December 1995,
the Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of." In accordance with the
provisions of SFAS No. 121, if there is an indication that the carrying value of
an asset, including goodwill, is not recoverable, the Company estimates the
projected undiscounted cash flows, excluding interest, of the related business
unit to determine if an impairment loss should be recognized. Such impairment
loss is determined by comparing the carrying amount of the asset, including
goodwill, to its estimated fair value. With its adoption of SFAS 121 in December
1995, the Company performed the impairment analysis at the individual facility
and business unit basis. Prior to the adoption of SFAS 121 the Company performed
the analysis on an entity-wide basis (see note 19).
In addition, in the fourth quarter of 1995 IHS adopted a change in
accounting estimate and wrote-off $25,785 of deferred pre-opening costs (see
note 19). Effective January 1, 1996, the Company changed its accounting method
from deferring and amortizing pre-opening costs of medical specialty units to
recording them as an expense when incurred.
(7) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at December 31, 1996 and 1997 are
summarized as follows:
<TABLE>
<CAPTION>
1996 1997
---------- -----------
<S> <C> <C>
Accounts payable ................................................ $ 69,947 $261,290
Accrued salaries and wages ...................................... 68,058 70,417
Accrued workers' compensation and other claims .................. 19,203 12,490
Accrued interest ................................................ 16,892 33,530
Accrued acquisition liabilities (exit costs and employee termina-
tion and relocation costs) .................................... 5,514 27,196
Accrued transaction costs ....................................... 5,525 40,489
Other accrued expenses .......................................... 155,955 170,555
-------- --------
$341,094 $615,967
======== ========
</TABLE>
79
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
(8) LONG-TERM DEBT
Long-term debt at December 31, 1996 and 1997 is summarized as follows:
<TABLE>
<CAPTION>
1996 1997
----------- ------------
<S> <C> <C>
Revolving credit and term loan facility notes:
Revolving credit loans .................................................................. $342,650 $ 535,000
Term loans .............................................................................. -- 1,150,000
-------- ----------
342,650 1,685,000
10.125% mortgage note payable in monthly installments of $64, including interest, due
August 1997 ............................................................................. 5,502 --
8.094% note payable, due December 2001 ................................................... 9,314 9,205
Prime plus 1.25% note payable (9.75% at December 31, 1997), due December 2000 ............ 8,087 7,954
Mortgages payable in monthly installments of $62, including interest at rates ranging from
9% to 14% ............................................................................... 8,604 7,264
9.75% mortgage note payable in monthly installments of $107, including interest, with
final payment of $13,087 in October 1998................................................. 13,332 13,198
Prime plus 1% (9.5% at December 31, 1997) note payable in monthly installments of $89,
including interest, with final payment in January 2020 .................................. 9,793 9,671
Seller notes, interest rates ranging from 10% to 14%, with final payment of $2,971 in July
2000 .................................................................................... 3,710 3,495
LIBOR plus 1.75% (7.72% at December 31, 1997) mortgage note payable in monthly in-
stallments of $51, including interest, with final payment due December 2000.............. 6,392 6,274
8.8% factored receivables note due December 8, 1998, interest payable monthly ............ 5,000 --
Prime plus 1% note payable due May 1997 .................................................. 1,500 --
12.0% note payable in monthly installments of $153, including interest, with final payment
due May 2000 ............................................................................ 5,130 3,509
Mortgages payable in monthly installments of $89, including interest at rates ranging from
10.09% to 10.64% ........................................................................ -- 8,800
10.89% mortgage note payable in monthly installments of $41, including interest, due April
2015 .................................................................................... -- 3,850
11.50% mortgage note payable in monthly installments of $65, including interest, due
January 2006 ........................................................................... -- 4,981
11.00% mortgage note payable in monthly installments of $216, including interest, due
December 2010 .......................................................................... -- 19,185
11.50% mortgage note payable in monthly installments of $55, including interest, due
January 2006 ........................................................................... -- 4,197
10.95% mortgage note payable in monthly installments of $74, including interest, due
January 2004 ............................................................................ -- 5,240
Obligations under capital leases bearing interest at 9.09% ............................... -- 46,185
11.00% mortgage note payable in monthly installments of $41, including interest, due
December 2006 ......................................................................... -- 2,821
8.60% mortgage note payable in monthly installments of $30, including interest, due July -- 4,032
2034.
Unfavorable lease obligations in connection with business acquisitions ................... -- 10,000
Other .................................................................................... 11,983 22,326
Subordinated debt:
5 3/4% Convertible Senior Subordinated Debentures due January 1, 2001, with
interest payable semi-annually on January 1 and July 1 ................................... 143,750 143,750
6% Convertible Subordinated Debentures due December 31, 2003, with interest payable
semi-annually on January 1 and July 1 ................................................. 115,000 115,000
5 1/4% Convertible Subordinated Debentures due June 1, 2003 of RoTech Medical Corpora-
tion, with interest payable semi-annually on June 1 and December 1 .................... -- 2,164
10 3/4% Senior Subordinated Notes due July 15, 2004, with interest payable semi-annually
on January 15 and July 15 .............................................................. 100,000 107
80
</TABLE>
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(8) LONG-TERM DEBT -(CONTINUED)
<TABLE>
<CAPTION>
1996 1997
------------ ------------
<S> <C> <C>
9 5/8% Senior Subordinated Notes due May 31, 2002, with interest payable semi-annually
on May 31 and November 30 .............................................................. 115,000 25
10 1/4% Senior Subordinated Notes due April 30, 2006, with interest payable semi-annually
on April 30 and October 30 ............................................................ 150,000 150,000
9 1/2% Senior Subordinated Notes due September 15, 2007, with interest payable semi-
annually on March 15 and September 15 ................................................. -- 450,000
9 1/4% Senior Subordinated Notes due January 15, 2008, with interest payable semi-
annually on January 15 and July 15 .................................................... -- 500,000
------- -------
Total subordinated debt ............................................................... 623,750 1,361,046
------- ---------
Total debt ............................................................................... 1,054,747 3,238,233
Less current portion ..................................................................... 16,547 36,081
--------- ---------
Total long-term debt, less current portion .............................................. $1,038,200 $3,202,152
========== ==========
</TABLE>
REVOLVING CREDIT AND TERM LOAN FACILITY
On September 15, 1997, the Company entered into a $1,750,000 revolving
credit and term loan facility with Citibank, N.A., as Administrative Agent, and
certain other lenders (the "New Credit Facility") to replace its existing
$700,000 revolving credit facility. The New Credit Facility consists of a
$750,000 term loan facility (the "Term Facility") and a $1,000,000 revolving
credit facility, including a $100,000 letter of credit subfacility and a $10,000
swing line subfacility (the "Revolving Facility"). The Term Facility, all of
which was borrowed on September 17, 1997, matures on September 30, 2004 and will
be amortized beginning December 31, 1998 as follows: 1998 -- $7,500; each of
1999, 2000, 2001 and 2002 -- $7,500 (payable in equal quarterly installments);
2003 -- $337,500 (payable in equal quarterly installments); and 2004 -- $375,000
(payable in equal quarterly installments). Any unpaid balance will be due on the
maturity date. The Term Facility bears interest at a rate equal to, at the
option of IHS, either (i) in the case of Eurodollar loans, the sum of (x) one
and three-quarters percent or two percent (depending on the ratio of the
Company's Debt (as defined in the New Credit Facility) to earnings before
interest, taxes, depreciation, amortization and rent, pro forma for any
acquisitions or divestitures during the measurement period (the "Debt/EBITDAR
Ratio")) and (y) the interest rate in the London interbank market for loans in
an amount substantially equal to the amount of borrowing and for the period of
borrowing selected by IHS or (ii) the sum of (a) the higher of (1) Citibank,
N.A.'s base rate or (2) one percent plus the latest overnight federal funds rate
plus (b) a margin of one-half percent or three-quarters of one percent
(depending on the Debt/EBITDAR Ratio). The Term Facility can be prepaid at any
time in whole or in part without penalty.
In connection with the December 1997 acquisition of certain businesses from
HEALTHSOUTH Corporation (see note 2), IHS and the lenders under the New Credit
Facility amended the New Credit Facility to provide for an additional $400,000
term loan facility (the "Additional Term Facility") to finance a portion of the
purchase price for the acquisition and to amend certain covenants to permit the
consummation of the acquisition. The Additional Term Facility, which was
borrowed at the closing of the acquisition, will mature on December 31, 2005,
and will be amortized beginning December 31, 1998 as follows: 1998 -- $4,000;
each of 1999, 2000, 2001, 2002 and 2003 -- $4,000 (payable in equal quarterly
installments); 2004 -- $176,000 (payable in equal quarterly installments); and
2005 -- $200,000 (payable in equal quarterly installments). The Additional Term
Facility bears interest at a rate equal to, at the option of IHS, either (i) in
the case of Eurodollar loans, the sum of (x) two and one-quarter percent or two
and one-half percent (depending on the Debt/EBITDAR Ratio) and (y) the interest
rate in the London interbank market for loans in an amount substantially equal
to the amount of borrowing and for the period of borrowing selected by IHS or
(ii) the sum of (a) the higher of (1) Citibank, N.A.'s base
81
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(8) LONG-TERM DEBT -(CONTINUED)
rate or (2) one percent plus the latest overnight federal funds rate plus (b) a
margin of one percent or one and one-quarter percent (depending on the
Debt/EBITDAR Ratio). The Additional Term Facility can be prepaid at any time in
whole or in part without penalty.
The Revolving Facility will reduce to $800,000 on September 30, 2001 and
$500,000 on September 30, 2002, with a final maturity on September 15, 2004;
however, the $100,000 letter of credit subfacility and $10,000 swing line
subfacility will remain at $100,000 and $10,000, respectively, until final
maturity. The Revolving Facility bears interest at a rate equal to, at the
option of IHS, either (i) in the case of Eurodollar loans, the sum of (x)
between three-quarters of one percent and one and three-quarters percent
(depending on the Debt/EBITDAR Ratio) and (y) the interest rate in the London
interbank market for loans in an amount substantially equal to the amount of
borrowing and for the period of borrowing selected by IHS or (ii) the sum of (a)
the higher of (1) Citibank, N.A.'s base rate or (2) one percent plus the latest
overnight federal funds rate plus (b) a margin of between zero percent and
one-half percent (depending on the Debt/EBITDAR Ratio). Amounts repaid under the
Revolving Facility may be reborrowed prior to the maturity date.
The New Credit Facility limits IHS' ability to incur indebtedness or
contingent obligations, to make additional acquisitions, to sell or dispose of
assets, to create or incur liens on assets, to pay dividends, to purchase or
redeem IHS' stock and to merge or consolidate with any other person. In
addition, the New Credit Facility requires that IHS meet certain financial
ratios, and provides the lenders with the right to require the payment of all
amounts outstanding under the facility, and to terminate all commitments under
the facility, if there is a change in control of IHS or if any person other than
Dr. Robert N. Elkins, IHS' Chairman and Chief Executive Officer, or a group
managed by Dr. Elkins, owns more than 40% of IHS' stock. The New Credit Facility
is guaranteed by all of IHS' subsidiaries (other than inactive subsidiaries) and
secured by a pledge of all of the stock of substantially all of IHS'
subsidiaries.
The New Credit Facility replaced the Company's $700,000 revolving credit
facility (the "Prior Credit Facility"). As a result, the Company recorded an
extraordinary loss on extinguishment of debt of approximately $2,384 (net of
related tax benefit of approximately $1,524) in the third quarter of 1997
resulting from the write-off of deferred financing costs of $3,908 related to
the Prior Credit Facility. See note 16.
In May 1996, IHS entered into a $700,000 revolving credit facility,
including a $100,000 letter of credit subfacility, with Citibank, N.A., as
administrative agent, and certain other lenders. The Prior Credit Facility
consisted of a $700,000 revolving loan which reduced to $560,000 on June 30,
2000 and $315,000 on June 30, 2001, with a final maturity on June 30, 2002. The
Prior Credit Facility was guaranteed by IHS' subsidiaries and secured by a
pledge of all of the stock of substantially all of IHS' subsidiaries. Loans
under the Prior Credit Facility bore interest at a rate based on various market
indices similar to those for the New Credit Facility (7.38% at December 31,
1996). On May 15, 1996, IHS borrowed $328,200 under the Prior Credit Facility to
repay amounts outstanding under its $500,000 credit facility. See note 16.
The Company utilizes interest rate swap agreements to manage interest rate
exposure on its floating rate revolving credit and term loan facility. The
principal objective of such contracts is to minimize the risks and/or costs
associated with financial operating activities. Each interest rate swap is
matched as a hedge against existing floating rate debt. The Company does not
hold derivative financial instruments for trading or speculative purposes. At
December 31, 1997, the Company had outstanding $1.05 billion notional amount of
floating to fixed interest rate swap agreements. These swap agreements expire at
various dates through 2004 and effectively convert an aggregate principal amount
of $1.05 billion of variable rate long-term debt into fixed rate borrowings. The
variable interest rates are based on the three month LIBOR rate (5.81% at
December 31, 1997). The weighted average fixed interest rate under these
agreements was 5.89% at December 31, 1997.
82
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(8) LONG-TERM DEBT -(CONTINUED)
SUBORDINATED DEBT
On September 11, 1997, IHS issued $500,000 aggregate principal amount of
its 9 1/4% Senior Subordinated Notes due 2008 (the "9 1/4% Senior Notes").
Interest on the 9 1/4% Senior Notes is payable semi-annually on January 15 and
July 15. The 9 1/4% Senior Notes are redeemable in whole or in part at the
option of IHS at any time on or after January 15, 2003, at a price, expressed as
a percentage of the principal amount, initially equal to 104.625% and declining
to 100% on January 15, 2006, plus accrued interest thereon. In addition, IHS may
redeem up to $166,667 aggregate principal amount of 9 1/4% Senior Notes at any
time and from time to time prior to January 15, 2001 at a redemption price equal
to 109.25% of the aggregate principal amount thereof, plus accrued interest
thereon, out of the net cash proceeds of one or more Public Equity Offerings (as
defined in the indenture under which the 9 1/4% Senior Notes were issued). IHS
used approximately $321,500 of the net proceeds to repay all amounts outstanding
under the Company's $700,000 revolving credit facility and used the remaining
approximately $164,900 of net proceeds to pay a portion of the purchase price
for the acquisition of the businesses acquired from HEALTHSOUTH and for general
corporate purposes, including working capital.
In May 1997, the Company issued $450,000 aggregate principal amount of its
9 1/2% Senior Subordinated Notes due 2007 (the "9 1/2% Senior Notes"). Interest
on the 9 1/2% Senior Notes is payable semiannually on March 15 and September 15,
commencing September 15, 1997. The 9 1/2% Senior Notes are redeemable for cash
at any time on or after September 15, 2002, at the option of the Company, in
whole or in part, initially at the redemption price equal to 104.75% of
principal amount, declining to 100% of principal amount on September 15, 2005,
plus accrued interest thereon to the date fixed for redemption. In addition, IHS
may redeem up to $150,000 aggregate principal amount of 9 1/2% Senior Notes at
any time and from time to time prior to September 15, 2000 at a redemption price
equal to 108.50% of the aggregate principal amount thereof, plus accrued
interest thereon, out of the net cash proceeds of one or more Public Equity
Offerings (as defined in the indenture under which the 9 1/2% Senior Notes were
issued). The Company used approximately $247,200 of the net proceeds from the
sale of the 9 1/2% Senior Notes to repurchase substantially all of its
outstanding 9 5/8% Senior Subordinated Notes due 2002 and 10 3/4% Senior
Subordinated Notes due 2004 and to pay pre-payment premiums, consent fees and
accrued interest related to the repurchase; the remainder was used to repay a
portion of the balance then outstanding under its revolving credit facility. In
connection with the repurchase, the Company recorded an extraordinary loss of
$18,168 (net of tax). See note 16.
On May 29, 1996, the Company issued $150,000 aggregate principal amount of
its 10 1/4% Senior Subordinated Notes due 2006 (the "10 1/4% Senior Notes").
Interest on the 10 1/4% Senior Notes is payable semi-annually on April 30 and
October 30. The 10 1/4% Senior Notes are redeemable for cash at any time after
April 30, 2001, at IHS' option, in whole or in part, initially at a redemption
price equal to 105.125% of the principal amount, declining to 100% of the
principal amount on April 30, 2004, plus accrued interest thereon to the date
fixed for redemption. Because certain actions were not taken to effect an
exchange offer within specified periods whereby each holder of 10 1/4% Senior
Notes would be offered the opportunity to exchange such notes for new notes
identical in all material respects to the 10 1/4% Senior Notes, except that the
new notes would be registered under the Securities Act, the interest rate on the
10 1/4% Senior Notes increased to 10.5% beginning November 25, 1996, and
continued to increase by 0.25% each 90 days until the exchange offer was
commenced, which occurred on November 26, 1997.
On May 18, 1995, the Company issued $115,000 aggregate principal amount of
its 9 5/8% Senior Subordinated Notes due 2002, Series A (the "9 5/8% Senior
Notes"). Interest on the 9 5/8% Senior Notes is payable semi-annually on May 31
and November 30. The 9 5/8% Senior Notes are not redeemable prior to maturity.
On May 30, 1997, the Company repurchased $114,975 aggregate principal amount of
the 9 5/8% Senior Notes pursuant to a cash tender offer. As a condition of the
Company's obligation to
83
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(8) LONG-TERM DEBT -(CONTINUED)
repurchase tendered 9 5/8% Senior Notes, tendering holders consented to
amendments to the indenture under which the 9 5/8% Senior Notes were issued
which eliminated or modified most of the restrictive covenants previously
contained in such indenture.
On July 7, 1994, the Company issued $100,000 aggregate principal amount of
its 10 3/4% Senior Subordinated Notes due 2004 (the "10 3/4% Senior Notes").
Interest on the 10 3/4% Senior Notes is payable semi-annually on January 15 and
July 15. The 10 3/4% Senior Notes are redeemable in whole or in part at the
option of the Company at any time on or after July 15, 1999, at a price,
expressed as a percentage of the principal amount, initially equal to 105.375%
and declining to 100% on July 15, 2002, plus accrued interest thereon. On May
30, 1997, the Company repurchased $99,893 aggregate principal amount of the 10
3/4% Senior Notes pursuant to a cash tender offer. As a condition of the
Company's obligation to repurchase tendered 10 3/4% Senior Notes, tendering
holders consented to amendments to the indenture under which the 10 3/4% Senior
Notes were issued which eliminated or modified most of the restrictive covenants
previously contained in such indenture.
The Company's $115,000 aggregate principal amount of 6% convertible
subordinated debentures (the "6% Debentures") are due December 31, 2003. The
Company's 5 3/4% convertible senior subordinated debentures (the "5 3/4%
Debentures") in the aggregate principal amount of $143,750 are due January 1,
2001. The $2,164 aggregate principal amount of 5 1/4% convertible subordinated
debentures of RoTech Medical Corporation (the "5 1/4% Debentures") are due June
1, 2003. At any time prior to redemption or final maturity, the 5 3/4%
Debentures, the 6% Debentures and the 5 1/4% Debentures are convertible into
approximately 4,409,509 shares, 3,579,766 shares and 47,865 shares,
respectively, of Common Stock of the Company at $32.60 per share, $32.125 per
share and $45.21 per share, respectively, at the option of the holder, subject
to adjustment upon the occurrence of certain events. The 5 3/4% Debentures, 6%
Debentures and 5 1/4% Debentures are redeemable in whole or in part at the
option of the Company at any time after January 2, 1997, January 1, 1996 and
June 4, 1999, respectively, at initial redemption prices expressed as a
percentage of principal of 103.29%, 104.2% and 103.0%, respectively.
In the event of a change in control of IHS (as defined), each debt holder
may require the Company to repurchase the debt, in whole or in part, at
redemption prices of 100% of the principal amount in the case of the 5 3/4%
Debentures, the 6% Debentures and the 5 1/4% Debentures and 101% of the
principal amount in the case of the 10 3/4% Senior Notes, 9 5/8% Senior Notes,
10 1/4% Senior Notes, 9 1/2% Senior Notes and 9 1/4% Senior Notes.
The indentures under which each of the 10 1/4% Senior Notes, the 9 1/2%
Senior Notes and the 9 1/4% Senior Notes were issued contain certain covenants,
including but not limited to, covenants with respect to the following matters:
(i) limitations on additional indebtedness unless certain coverage ratios are
met; (ii) limitations on other subordinated debt; (iii) limitations on liens;
(iv) limitations on the issuance of preferred stock by IHS' subsidiaries; (v)
limitations on transactions with affiliates; (vi) limitations on certain
payments, including dividends; (vii) application of the proceeds of certain
asset sales; (viii) restrictions on mergers, consolidations and the transfer of
all or substantially all of the assets of IHS to another person; and (ix)
limitations on investments and loans. The indentures under which each of the 10
3/4% Senior Notes and 9 5/8% Senior Notes were issued contain certain limited
covenants, including a covenant with respect to the application of the proceeds
of certain asset sales.
84
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(8) LONG-TERM DEBT -(CONTINUED)
At December 31, 1997, the aggregate maturities of long-term debt for the
five years ending December 31, 2002 and thereafter are as follows:
<TABLE>
<S> <C>
1998 ............... $ 36,081
1999 ............... 30,166
2000 ............... 27,079
2001 ............... 305,639
2002 ............... 315,496
Thereafter ......... 2,523,772
----------
$3,238,233
==========
</TABLE>
Interest capitalized to construction in progress was $5,155 in 1995, $3,800
in 1996 and $3,600 in 1997.
(9) OTHER LONG-TERM LIABILITIES AND CONTINGENCIES RELATED TO FIRST AMERICAN
ACQUISITION
As indicated in note 2, the Company acquired all of the outstanding stock
of First American Health Care of Georgia, Inc. in October 1996. The purchase
price includes contingent payments, certain of which have been determined to be
probable, and the present value thereof is recorded as other long-term
liabilities as of December 31, 1996 and 1997.
Prior to its acquisition by the Company, First American was under
protection of the U.S. Bankruptcy Court, with which it had filed a petition for
reorganization under Chapter 11 of the Bankruptcy Code on February 21, 1996 (the
petition date) following its and its two principal shareholders' convictions on
multiple counts of having made improper Medicare reimbursement claims.
Immediately preceding the Chapter 11 filing, First American and its principal
shareholders had entered into a merger agreement with the Company. In connection
with the bankruptcy proceedings and the establishment and approval of First
American's plan of reorganization, the merger agreement was amended and
confirmed by the Bankruptcy Court on October 4, 1996.
Pursuant to the terms of the First American plan of reorganization and the
amended merger agreement, the purchase price included contingent payments of up
to $155,000. The merger agreement provided that the contingent payments will be
payable (1) if legislation is enacted that changes the Medicare reimbursement
methodology for home health services to a prospectively determined rate
methodology, in whole or in part, or (2) if, in respect to payments contingently
payable for any year through 2003, the percentage increase through 2004 in the
seasonally unadjusted Consumer Price Index for all Urban Consumers for the
Medical Care expenditure category (the "Medical CPI") is less than 8%. If
payable, the contingent payments will be due on February 14 as follows: $10,000
in 2000; $40,000 in 2001; $51,000 in 2002; $39,000 in 2003; and $15,000 in 2004.
The contingent payments would be payable to the Health Care Financing
Administration ("HCFA") for $140,000 and to the former shareholders of First
American for $15,000.
The contingent payments to HCFA, which are due only if the contingent
payments described above become payable, and $95,000 of the cash purchase price
paid by the Company, which was paid to HCFA, are in full settlement of HCFA's
claims made to the Bankruptcy Court related to First American's Medicare
reimbursement claims for all periods prior to the petition date and of any
claims by HCFA related to First American's Medicare reimbursement claims made
after the petition date through December 31, 1996.
The Company has accrued the present value of the payments contingently
payable to HCFA and the former shareholders of First American of $10,000 in 2000
and $40,000 in 2001 at December 31, 1996 and the Company accrued the present
value of the remaining payments at October 1, 1997. The present value of these
payments of $33,851 at December 31, 1996 and $113,042 at December 31, 1997 was
determined using a discount rate of 8% per annum from the dates of probable
payment. The entire
85
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(9) OTHER LONG-TERM LIABILITIES AND CONTINGENCIES RELATED TO FIRST AMERICAN
ACQUISITION -(CONTINUED)
amount is now considered probable because the Balanced Budget Act of 1997,
enacted in August 1997, requires the implementation of a prospective payment
system for home nursing services starting with cost reporting periods beginning
after October 1, 1999. The contingent payments due in 2000 and 2001 were
considered probable at December 31, 1996 because management believed the
anticipated Medical CPI in 1999 and 2000 would probably trigger the required
payments; however, management was unable to predict at the time what the Medical
CPI will be in years subsequent to 2000.
(10) LEASES
The Company has entered into operating leases as lessee of 180 health care
facilities and certain office facilities expiring at various dates through
February 2020. Minimum rent payments due under operating leases in effect at
December 31, 1997 are summarized as follows:
<TABLE>
<S> <C>
1998 ....................... $ 86,643
1999 ....................... 83,524
2000 ....................... 82,883
2001 ....................... 73,557
2002 ....................... 64,388
Subsequent to 2002 ......... 313,897
--------
Total ..................... $704,892
========
</TABLE>
The Company also leases equipment under short-term operating leases having
rentals of approximately $27,656 per year.
The leases of health care facilities provide renewal options for various
terms at fair market rentals at the expiration of the initial term, except for
leases of three facilities which have no renewal options. The Company generally
has the option or right of first refusal to purchase the facilities at fair
market value determined by independent appraisal (or by formula based upon the
cash flow of the facility, as defined) or, with respect to certain leases, at a
fixed price representing the fair market value at the inception of the lease.
Under certain conditions, the Company may be required to exercise the options to
buy the facilities. In connection with 55 leases the Company has paid purchase
option deposits aggregating $57,599 at December 31, 1997, of which $33,393 is
refundable. The Company has also guaranteed approximately $6,600 of indebtedness
of a lessor of one facility.
Minimum rentals are generally subject to adjustment based on the consumer
price index or the annual rate of five year U.S. Treasury securities. Also, the
leases generally provide for contingent rentals, based on gross revenues of the
facilities in excess of base year amounts, and additional rental obligations for
real estate taxes, utilities, insurance and repairs. Contingent rentals were
$2,777 in 1995, $3,565 in 1996 and $2,744 in 1997.
(11) CAPITAL STOCK
The Company is authorized to issue up to 150,000,000 shares of common stock
and 15,000,000 shares of preferred stock. The Board of Directors is authorized
to issue shares of preferred stock in one or more series and to determine and
fix the rights, preferences and privileges of each series, including dividend
rights and preferences, conversion rights, voting rights, redemption rights and
the terms of any sinking fund. The issuance of such preferred stock may have the
effect of delaying, deferring or preventing a change in control of the Company
without further action by the stockholders and may adversely affect the voting
and other rights of the holders of common stock, including the loss of voting
control to others. As of December 31, 1996 and 1997, there were no shares of
preferred stock outstanding.
86
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(11) CAPITAL STOCK -(CONTINUED)
In addition, IHS has designated 750,000 shares of preferred stock as Series
A Junior Participating Cumulative Preferred Stock, $.01 par value per share. The
IHS Stockholders' Rights Plan ("IHS Rights Plan") provides that one preferred
stock purchase right ("Right") will be issued with each share of IHS common
stock prior to the earlier of (a) 10 days following a public announcement that
an individual or group has acquired beneficial ownership of 20% or more of the
outstanding common stock or (b) 10 business days following the commencement of a
tender or exchange offer resulting in the beneficial ownership by a person or
group of 20% or more of the outstanding common stock. When exercisable, each
Right entitles the registered holder to purchase from IHS one one-hundredth of a
share of Series A preferred stock at a price of $135.00 per one one-hundredth of
a share of Series A preferred stock, subject to adjustment.
Series A preferred stock purchasable upon exercise of the Rights will not
be redeemable and is junior to any other series of preferred stock that may be
authorized and issued by IHS. In addition, the Series A preferred stockholders
will be entitled to the following:
o Minimum preferential quarterly dividend payment of $1 per share and an
aggregate dividend of 100 times the dividend declared per share of common
stock;
o Preferential liquidation payment of $100 per share and an aggregate payment of
100 times the payment made per share of common stock;
o 100 votes per share, voting together with common stock;
o In the event of merger, consolidation or other transaction in which common
stock is exchanged, each share of Series A preferred stock will receive 100
times the amount received per share of common stock.
These rights are protected by customary antidilution provisions.
The Company declared a $0.02 per share cash dividend in 1995, 1996 and
1997.
At December 31, 1996 and 1997 the Company had outstanding stock options as
follows:
<TABLE>
<CAPTION>
1996 1997
------------ ------------
<S> <C> <C>
Stock options outstanding pursuant to:
1990 Employee Stock Option Plan ................................... 832,906 486,478
1992 Employee Stock Option Plan ................................... 903,715 740,170
Stock Option Plan for Non-Employee Directors ...................... 200,000 50,000
1994 Stock Incentive Plan ......................................... 2,316,355 1,669,594
Senior Executives' Stock Option Plan .............................. 1,800,000 1,800,000
Stock Option Compensation Plan for Non-Employee Directors ......... 200,000 128,082
1995 Board of Director's Plan ..................................... 300,000 300,000
1996 Employee Stock Option Plan ................................... 1,886,000 2,987,475
RoTech converted options .......................................... -- 1,737,476
Other options ..................................................... 311,123 262,133
--------- ---------
Total stock options outstanding ................................. 8,750,099 10,161,408
========= ==========
</TABLE>
87
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(11) CAPITAL STOCK -(CONTINUED)
The 1990 Employee Stock Option Plan, the 1992 Employee Stock Option Plan
and the 1996 Employee Stock Option Plan provide that options may be granted to
certain employees at a price per share not less than the fair market value at
the date of grant as well as non-qualified options. In 1993, the Company adopted
the Senior Executives' Stock Option Plan and the 1994 Stock Incentive Plan,
which provide for the issuance of options with terms similar to the 1992 plan.
In addition, the Company has adopted two Stock Option Plans for Non-Employee
Directors and a Stock Option Compensation Plan for Non-Employee Directors. The
Board of Directors has authorized the issuance of 14,278,571 shares of Common
Stock under the plans. Such options have been granted with exercise prices equal
to or greater than the estimated fair market value of the common stock on the
date of grant; accordingly, the Company has recorded no compensation expense
related to such grants. The options' maximum term is 10 years. Vesting for the
1990, 1992 and 1994 Employee Stock Option Plans are graded over four to six
years. Vesting for the 1996 Plan is over two to four years. Vesting for the
Directors' plans is one year after the date of grant. Vesting for the Senior
Executives' Plan is generally over three years. In addition, the Company
provides an Employee Stock Purchase Plan whereby employees have the right to
purchase the Company's common stock at 90% of the quoted market price, subject
to certain limitations.
Stock option transactions are summarized as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------------------------ ------------------------ ---------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------------- ---------- ------------- ---------- --------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding-beginning of period 5,879,832 $ 25.98 6,377,554 $ 20.19 8,750,099 $ 20.94
Granted .................................... 1,059,146 28.81 3,096,500 22.14 2,975,272 25.15
Exercised .................................. (340,244) 19.61 (141,382) 14.55 (1,418,968) 19.81
Cancelled .................................. (221,180) 29.63 (582,573) 20.66 (144,995) 21.67
--------- -------- --------- -------- ---------- --------
Options outstanding--end of period ......... 6,377,554 20.19 8,750,099 20.94 10,161,408 22.24
--------- -------- --------- -------- ---------- --------
Options exercisable--end of period ......... 2,731,876 $ 20.15 3,914,843 $ 20.18 5,777,973 $ 22.25
========= ======== ========= ======== ========== ========
</TABLE>
The following summarizes information about stock options outstanding as of
December 31, 1997.
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------ ---------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
PRICES AT 12/31/97 LIFE PRICE AT 12/31/97 PRICE
- ------------------- ------------- ------------- ---------- ------------- -----------
<S> <C> <C> <C> <C> <C>
under $15.......... 108,019 2.57 $ 11.85 68,855 $ 11.49
$15 to $20......... 2,325,762 8.39 19.24 550,607 17.88
$20 to $25......... 6,471,927 7.34 21.47 4,441,411 21.32
over $25........... 1,255,700 9.48 32.87 717,100 32.44
--------- ---- -------- --------- --------
Totals ........... 10,161,408 7.80 $ 22.24 5,777,973 $ 22.25
========== ==== ======== ========= ========
</TABLE>
88
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(11) CAPITAL STOCK -(CONTINUED)
The Company applies APB No. 25 and related interpretations in accounting
for its employee stock options and warrants. Accordingly, no compensation
expense has been recognized in connection with its employee stock options and
warrants. Had compensation expense for the Company's employee stock options and
warrants been determined consistent with SFAS No. 123, the Company's net
earnings (loss) and earnings (loss) per share would have been reduced to the pro
forma amounts indicated below:
<TABLE>
<CAPTION>
1995 1996 1997
--------------------------- ------------------------- ---------------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA AS REPORTED PRO FORMA
------------- ------------- ------------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Net earnings (loss) ................... $ (27,002) $ (44,752) $ 46,334 $ 43,082 $ (33,505) $ (48,994)
Basic earnings (loss) per share ....... (1.26) (2.09) 2.06 1.91 (1.19) (1.73)
Diluted earnings (loss) per share ..... (1.26) (2.09) 1.78 1.68 (1.19) (1.73)
========= ========= ========= ========= ========= =========
</TABLE>
The fair value of the employee options and warrants (including the Employee
Stock Purchase Plan) for purposes of the above pro forma disclosure was
estimated on the date of grant or modification using the Black-Scholes option
pricing model and the following assumptions: a risk-free interest rate of 5.40%
to 6.74% in 1995 and 1996 and 5.80% in 1997, weighted average expected lives of
2 to 9 years for options and 6 months for the Employee Stock Purchase Plan, 0.1%
dividend yield and volatility of 26.3% in 1995 and 1996 and 30.1% in 1997. The
effects of applying SFAS No. 123 in the pro forma net earnings (loss) and
earnings (loss) per share may not be representative of the effects on such pro
forma information for future years. In November 1995, the Board of Directors
authorized a modification to the options outstanding under the Company's option
plans which resulted in the change of the exercise price to $20.875, the market
price on the date of the modification, for certain options with exercise prices
over $21.00. Because no compensation was recognized for the original options,
the modified options are treated as a new grant. Under SFAS 123, compensation
cost of $23,655 in 1995 is recognized immediately for vested options for the
fair value of the new options on the modification date. The effect of this
modification has been included in the pro forma earnings (loss) per share
amounts above. In September 1997, the Board of Directors authorized a
modification to the options outstanding under the Company's option plans which
resulted in a two year acceleration of the options held by senior and executive
vice presidents. Under SFAS 123, compensation cost of $1,229 in 1997 is
recognized immediately for the vested options. The effect of this modification
has been included in the pro forma per share amounts above.
Warrant transactions are summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
1995 PRICE 1996 PRICE 1997 PRICE
------------ ---------- ------------ ---------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Warrants outstanding--beginning of year 497,181 $ 29.28 518,000 $ 31.30 498,000 $ 31.03
Granted to sellers ..................... 65,000 37.95 -- -- 780,000 33.12
Exercised .............................. (44,181) 18.35 -- -- (3,000) 20.00
Cancelled .............................. -- -- (20,000) 38.02 -- --
------- -------- ------- -------- ------- --------
Warrants outstanding--end of year ...... 518,000 $ 31.30 498,000 $ 31.03 1,275,000 $ 32.34
======= ======== ======= ======== ========= ========
</TABLE>
The warrants granted in 1997 consist primarily of warrants granted to
Stephen P. Griggs, the President of RoTech. In connection with the acquisition
of RoTech and as a condition of his five-year employment agreement, Mr. Griggs
was issued warrants to purchase 750,000 shares of IHS Common Stock at a per
share exercise price equal to the average closing sales price of IHS Common
Stock for the 15 business days prior to the acquisition closing date. Such
warrants vest at a rate of 20% per year beginning one year from the acquisition
closing date. The warrants were granted in consideration of future services to
be rendered by Mr. Griggs. As such, the Company applied the guidance provided in
APB Opinion No. 25. Since the exercise price of the warrants was equal, on the
date of grant, to the market value of the stock, no compensation expense was
recognized or deferred
89
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(11) CAPITAL STOCK -(CONTINUED)
In 1995, the Company's Board of Directors authorized the repurchase in the
open market of up to $50,000 of the Company's common stock. The purpose of the
repurchase program was to have available treasury shares of common stock to
satisfy contingent earn-out payments under prior business combinations accounted
for by the purchase method. The repurchases were funded from cash from
operations and drawings under the Company's revolving credit facility. In 1995,
the Company repurchased 400,600 shares of common stock for an aggregate purchase
price of approximately $12,790. No shares were repurchased in 1996. The
repurchase program was discontinued in September 1996. During 1996 the Company
reissued all 400,600 shares in partial satisfaction of earn-out payments.
In 1997, the Company's Board of Directors authorized the repurchase in the
open market of up to $20,000 of the Company's common stock. The purpose of the
repurchase program was to have available treasury shares of common stock to (i)
satisfy contingent earn-out payments under prior business combinations accounted
for by the purchase method, (ii) issue in connection with acquisitions and (iii)
issue upon exercise of outstanding options. The repurchases were funded from
cash from operations and proceeds from the sale of the Company's debt
securities. In 1997, the Company repurchased 548,500 shares of common stock for
an aggregate purchase price of approximately $19,813.
(12) EARNINGS PER SHARE
The Company adopted SFAS No. 128 during the fourth quarter of the year
ended December 31, 1997. SFAS No. 128 establishes revised standards for
computing and presenting earnings per share (EPS) data. It requires dual
presentation of "basic" and "diluted" EPS on the face of the statements of
operations and a reconciliation of the numerators and denominators used in the
basic and diluted EPS calculations. As required by SFAS No. 128, EPS data for
prior periods presented have been restated to conform to the new standard.
Basic EPS is calculated by dividing net earnings (loss) by the weighted
average number of common shares outstanding for the applicable period. Diluted
EPS is calculated after adjusting the numerator and the denominator of the basic
EPS calculation for the effect of all potential dilutive common shares
outstanding during the period. Information related to the calculation of net
earnings per share of common stock is summarized as follows:
<TABLE>
<CAPTION>
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------- --------------- ----------
<S> <C> <C> <C>
For the Year ended December 31, 1996
Basic EPS ................................................. $47,765 22,529,000 $ 2.12
Adjustment for interest on convertible debentures ......... 9,888 -- --
Incremental shares from assumed exercise of dilutive
options and warrants (net of tax benefits related thereto)
and issuance of contingent shares ....................... -- 1,045,310 --
Incremental shares from assumed conversion of the con-
vertible subordinated debentures ........................ -- 7,989,275 --
------- ---------- ------
Diluted EPS ............................................... $57,653 31,563,585 $ 1.83
======= ========== ======
</TABLE>
For the years ended December 31, 1995 and 1997, no exercise of options and
warrants nor conversion of subordinated debentures is assumed since their effect
is antidilutive. The weighted average number of common shares outstanding was
21,463,464 in 1995 and 28,253,218 in 1997.
90
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
(13) INCOME TAXES
The provision for income taxes on earnings before income taxes and
extraordinary items is summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------
1995 1996 1997
------------- ----------- ------------
<S> <C> <C> <C>
Federal .......... $ (13,341) $ 55,577 $ 20,783
State ............ (2,929) 8,138 3,666
--------- -------- ---------
$ (16,270) $ 63,715 $ 24,449
========= ======== =========
Current .......... $ 7,732 $ 21,515 $ 39,042
Deferred ......... (24,002) 42,200 (14,593)
--------- -------- ---------
$ (16,270) $ 63,715 $ 24,449
========= ======== =========
</TABLE>
The amount computed by applying the Federal corporate tax rate of 35% in
1995, 1996 and 1997 to earnings before income taxes and extraordinary items is
summarized as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------------- ----------- -----------
<S> <C> <C> <C>
Income tax computed at statutory rates .................. $ (14,791) $ 39,018 $ 4,664
State income taxes, net of Federal tax benefit .......... (1,904) 5,290 2,383
Amortization of non-deductible intangibles .............. 1,975 2,293 5,568
Basis difference on assets sold ......................... -- 16,136 5,784
Merger costs and other special charges .................. -- -- 6,362
Valuation allowance adjustment .......................... (2,111) (1,353) --
Other ................................................... 561 2,331 (312)
--------- -------- -------
$ (16,270) $ 63,715 $24,449
========= ======== =======
</TABLE>
Deferred income tax (assets) liabilities at December 31, 1996 and 1997 are
as follows:
<TABLE>
<CAPTION>
1996 1997
------------ -----------
<S> <C> <C>
Excess of book over tax basis of assets ......................... $ 109,900 $ 166,520
Deferred pre-opening costs ...................................... 84 --
Insurance reserves .............................................. (10,874) (7,209)
Deferred gain on sale-leaseback ................................. (2,413) (2,040)
Allowance for doubtful accounts ................................. (21,753) (69,787)
Accrued Medicare settlement ..................................... (23,523) (41,330)
Accrued litigation .............................................. (7,354) (5,402)
Accrued vacation ................................................ (4,059) (3,810)
Other accrued expenses not yet deductible for tax ............... (12,729) (37,754)
Pre-acquisition separate company net operating loss carryforwards (4,679) (23,868)
Other ........................................................... (317) 277
--------- ---------
22,283 (24,403)
Valuation allowance ............................................. -- 24,403
--------- ---------
$ 22,283 $ --
========= =========
</TABLE>
The decreases in the valuation allowance for deferred tax assets in 1995
and 1996 are attributable to the utilization of pre-acquisition separate company
net operating loss carryforwards. The Company recorded deferred tax assets in
connection with business acquisitions of $32,093 in 1997, which, net of a
valuation allowance of $24,403 related thereto, has been applied as a reduction
to goodwill. The valuation allowance is necessary because it relates to net
operating loss carryforwards of acquired companies
91
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INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(13) INCOME TAXES-(CONTINUED)
and therefore realization is subject to various limitations under the Internal
Revenue Code. In addition, the Company is still in the process of reviewing the
acquired companies' operations in connection with its integration plans and will
be re-evaluating its assessment of recoverability in 1998 in accordance with
Accounting Principles Board (APB) Opinion No. 16, Business Combinations, and
SFAS No. 38, Accounting for Preacquisition Contingencies of Purchased
Enterprises. Any reduction in the valuation allowance will be recorded as a
reduction of goodwill recorded on such 1997 acquisitions. The pre-acquisition
separate company net operating loss carryforwards expire in years 1998 through
2009.
(14) OTHER COMMITMENTS AND CONTINGENCIES
IHS' contingent liabilities (other than liabilities in respect of
litigation and the First American acquisition) aggregated approximately $86,603
as of December 31, 1997. IHS is obligated to purchase its Greenbriar facility
upon a change in control of IHS. The net price of the facility is approximately
$4,014. IHS has guaranteed approximately $6,600 of the lessor's indebtedness.
IHS is required, upon certain defaults under the lease, to purchase its Orange
Hills facility at a purchase price equal to the greater of $7,130 or the
facility's fair market value. IHS has guaranteed approximately $4,020 owed by
Tutera Group, Inc. and Sunset Plaza Limited Partnership, a partnership
affiliated with a partnership in which IHS has a 49% interest, to Finova Capital
Corporation. IHS has established several irrevocable standby letters of credit
with the Bank of Nova Scotia to secure certain of IHS' self-insured workers'
compensation obligations, health benefits and other obligations. The maximum
obligation was $32,367 at December 31, 1997. In addition, IHS has several surety
bonds in the amount of $32,472 to secure certain of the Company's health
benefits, patient trust funds and other obligations. In addition, with respect
to certain acquired businesses IHS is obligated to make certain contingent
payments if earnings of the acquired business increase or earnings targets are
met. IHS is also obligated under certain circumstances to make contingent
payments of up to $155,000 in respect of IHS' acquisition of First American (see
note 9). In addition, IHS has obligations under operating leases aggregating
approximately $704,892 at December 31, 1997. (See note 10).
IHS leases ten facilities from Meditrust, a publicly-traded real estate
investment trust. With respect to all the facilities leased from Meditrust, IHS
is obligated to pay additional rent in an amount equal to a specified percentage
(generally five percent) of the amount by which the facility's gross revenues
exceed a specified amount (generally based on the facility's gross revenues
during its first year of operation). If an event of default occurs under any
Meditrust lease or any other agreement IHS has with Meditrust, Meditrust has the
right to require IHS to purchase the facility leased from the partnership at a
price equal to the higher of the then current fair market value of the facility
or the original purchase price of the facility paid by Meditrust plus (i) the
cost of certain capital expenditures paid for by Meditrust, (ii) an adjustment
for the increase in the cost of living index since the commencement of the lease
and (iii) all rent then due and payable (all such amounts to be determined
pursuant to the prescribed formula contained in the lease). In addition, each
Meditrust lease provides that a default under any other Meditrust lease or any
other agreement IHS has with Meditrust constitutes a default under such lease.
Upon such default, Meditrust has the right to terminate the leases and to seek
damages based upon lost rent.
The Company maintains a 401(k) plan available to substantially all
employees who have been with the Company for more than six months. In general,
employees may defer up to 20% of their salary subject to the maximum permitted
by law. The Company may make a matching contribution, at its discretion, equal
to a portion of the employee's contribution. Employee and employer contributions
are vested immediately. The Company made a contribution of $351 in 1996 related
to the 1995 plan year and has made no contributions for other years. The Company
also maintains supplemental executive retirement plans for certain of its senior
officers.
92
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
(15) SUPPLEMENTAL CASH FLOW INFORMATION
See note 2 for information concerning significant non-cash investing and
financing activities related to business acquisitions and note 19 for such
information related to non-recurring charges for the years ended December 31,
1995, 1996 and 1997. Other significant non-cash investing and financing
activities are as follows:
o The Company declared cash dividends, which resulted in increases in current
liabilities offset by decreases in retained earnings of $435 in 1995, $471
in 1996 and $814 in 1997.
o The sale of certain non-strategic assets in 1996 resulted in decreases in
net current assets of $449, property of $8,730, other assets of $3,803, an
increase in net current liabilities of $144 and a decrease in long term
debt of $4,008. Total cash received from the sales was $1,293.
o An increase in additional paid-in capital of $7,020 in 1997 resulted from
the exercise of stock options under the Company's various plans, which
increased the Company's current taxes receivable by $7,020.
o An increase in goodwill and other long-term liabilities of $75,000 in 1997
resulted from the Company recording the present value of the remaining
contingent payments to HCFA. (See note 9).
Cash payments for interest were $49,863 in 1995, $56,883 in 1996 and
$104,747 in 1997. Cash payments for income taxes were $27,549 in 1995, $38,193
in 1996 and $24,971 in 1997.
(16) EXTRAORDINARY ITEMS
In the third quarter of 1997, the Company replaced its $700,000 revolving
credit facility with the $1,750,000 revolving credit and term loan facility (see
note 8). This event has been accounted for as an extinguishment of debt and the
Company has recorded a loss on extinguishment of debt of $3,908, relating
primarily to the write-off of deferred financing costs. Such loss, reduced by
the related income tax effect of $1,524, is presented in the statement of
operations as an extraordinary item of $2,384.
In the second quarter of 1997, the Company recorded a pre-tax loss of
$29,782 representing (1) approximately $23,600 of cash payments for pre-payment
premium and tender and consent fees relating to the early extinguishment of debt
resulting from the Company's repurchase pursuant to cash tender offers of
$99,893 principal amount of the Company's $100,000 aggregate principal amount of
outstanding 10 3/4% Senior Subordinated Notes due 2004 and $114,975 of the
Company's $115,000 aggregate principal amount of outstanding 9 5/8% Senior
Subordinated Notes due 2002 and (2) approximately $6,200 relating to the
write-off of deferred financing costs. Such loss, reduced by the related income
tax effect of $11,614, is presented in the statement of operations as an
extraordinary loss of $18,168.
In the second quarter of 1996, the Company replaced its $500,000 revolving
credit and term loan facility with the $700,000 revolving credit facility (see
note 8). This event has been accounted for as an extinguishment of debt and the
Company has recorded a loss on extinguishment of debt of $2,327 relating
primarily to the write-off of deferred financing costs. Such loss, reduced by
the related income tax effect of $896, is presented in the statement of
operations as an extraordinary item of $1,431.
In the second quarter of 1995, the Company replaced its $250,000 revolving
credit and term loan facility with a $500,000 revolving credit and term loan
facility (see note 8). This event has been accounted for as an extinguishment of
debt and the Company has recorded a loss on extinguishment of debt of $826
representing the write-off of deferred financing costs. In the fourth quarter of
1995, the Company incurred prepayment penalties on debt in the amount of $821.
Such losses, reduced by the related income tax effect of $634, is presented in
the statement of operations as an extraordinary item of $1,013.
93
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
(17) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash and cash equivalents, patient accounts
receivable, other current assets, accounts payable and accrued expenses
approximates fair value because of the short-term maturity of these instruments.
The fair value of temporary investments is estimated based on quoted market
prices for these or similar investments. The fair value of third-party payor
settlements receivable is estimated by discounting anticipated cash flows using
estimated market discount rates to reflect the time value of money. The fair
value of the Company's long-term debt is estimated based on current rates
offered to the Company for similar instruments with the same remaining
maturities. Management of the Company believes the carrying amount of the above
financial instruments approximates the estimated fair value. The Company has
investments in unconsolidated affiliates described in note 4, which are untraded
companies and joint ventures. The Company has notes receivable from unaffiliated
individuals and untraded companies totaling $28,102 and $15,524 at December 31,
1996 and 1997, respectively. Also, the Company has purchase option deposits of
$74,131 and $78,149 on 89 leased and managed facilities of which $29,375 and
$33,393 is refundable at December 31, 1996 and 1997, respectively, and has
guaranteed the indebtedness of two of its leased facilities. It is not
practicable to estimate the fair value of these investments, notes and
guarantees since they are not traded, no quoted values are readily available for
similar financial instruments and the Company believes it is not cost-effective
to have valuations performed. However, management believes that there has been
no permanent impairment in the value of such investments and no indication of
probable loss on such guarantees.
(18) RELATED PARTY TRANSACTIONS
In January 1998, IHS began to manage five facilities leased from a real
estate investment trust by an entity equally owned by IHS and an entity
controlled by Timothy Nicholson, a director of the Company. The five facilities
were sold to the real estate investment trust by IHS in January 1998. (See note
23).
In September 1997, the Company acquired through a cash tender offer and
subsequent merger Community Care of America, Inc. ("CCA") for a purchase price
of $4.00 per share, for an aggregate of $34,300. Dr. Robert N. Elkins, chairman,
chief executive officer and president of the Company, was a director of CCA and
beneficially owned approximately 21% of CCA's shares, and John Silverman, a
director and at the time an employee of the Company, was chairman of the board
of directors of CCA. In December 1996, the Company loaned $2,000 to CCA and
received a management agreement and warrants to purchase up to 9.9% of CCA's
common stock at a price of $3.25 per share. The loan bore interest at the annual
rate of interest set forth in the Company's revolving credit agreement plus 2%
and was due on December 27, 1998.
In September 1997, the Company purchased the Naples, Florida residence of
Lawrence P. Cirka, the former President of the Company, for approximately
$4,800. The Company intends to resell the property within the next year.
In December 1997, the Company sold its aircraft to RNE Skyview LLC, a
limited liability company in which Dr. Robert N. Elkins, IHS' chairman, chief
executive officer and president, is the sole member, and simultaneously entered
into a lease agreement for such aircraft with RNE Skyview LLC. No gain or loss
was recorded on the sale.
During 1997 and 1996, the Company loaned Dr. Robert N. Elkins, IHS'
chairman, chief executive officer and president, approximately $13,500 and
$4,700, respectively. Dr. Elkins used the cash proceeds from the loan to
exercise options to purchase 650,000 shares of common stock in 1997, which
shares he continues to hold. In 1996, the cash proceeds were used to purchase
shares of common stock. In addition, the Company has made available loans to
members of senior management in order to purchase stock in the open market
and/or to exercise stock options. Such loans aggregated approximately $4,070 at
December 31, 1997.
94
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(18) RELATED PARTY TRANSACTIONS -(CONTINUED)
In November 1996, the Company purchased LifeWay, Inc. ("LifeWay"), a
disease management company in Miami, Florida for approximately $900 through the
issuance of 38,502 shares of common stock. Prior to the purchase, IHS owned
approximately 10% of LifeWay and Dr. Robert N. Elkins, IHS' chairman, chief
executive officer and president, beneficially owned approximately 65%. IHS also
issued 48,129 shares of Common Stock to Dr. Elkins in payment of outstanding
loans of $1,125 from Dr. Elkins to LifeWay and 8,984 shares in partial payment
of a bonus to a stockholder of LifeWay.
In October 1996, the Company loaned $3,445 to ILC, which loan was repaid in
1997. Dr. Robert N. Elkins, chairman, chief executive officer and president of
the Company, was chairman of the board of directors of ILC and Lawrence P.
Cirka, at the time president and chief operating officer of the Company, was a
director of ILC.
In April 1993, a wholly-owned subsidiary of the Company acquired a 21.28%
interest in the common stock and a 47.64% interest in the 6% cumulative
preferred stock of Speciality Care PLC, an owner and operator of geriatric care
facilities in the United Kingdom. Robert N. Elkins, chairman of the board, chief
executive officer and president of the Company, was a director of Speciality
Care PLC until its sale in February 1998, and Timothy Nicholson, a director of
the Company, was chairman and managing director of Speciality Care PLC until its
sale in February 1998. Mr. Nicholson was formerly executive vice president of
the Company. In 1995 the Company invested an additional $4,384 in Speciality
Care PLC. As a result of the Company's additional investment, the Company had a
21.3% interest in the Common Stock and a 63.65% interest in the 6% cumulative
convertible preferred stock at December 31, 1997. The Company's equity in
Speciality Care PLC was $6,059 at December 31, 1997 (see notes 4 and 23).
(19) LOSS ON IMPAIRMENT OF LONG-LIVED ASSETS AND OTHER NON-RECURRING CHARGES
<TABLE>
<CAPTION>
1995 1996 1997
---------- ------------ -----------
<S> <C> <C> <C>
Loss on impairment of long-lived assets -- nursing and assisted living
facilities ............................................................ $ 83,321 $ -- $ --
Write-off of deferred pre-opening costs in connection with change in ac-
counting estimate ..................................................... 25,785 -- --
Loss on management contract terminations:
Nursing facilities .................................................... 21,915 7,825 3,700
Home health ........................................................... -- -- 8,199
IntegraCare merger costs ................................................ 1,939 -- --
Gain on sale of pharmacy division ....................................... -- (34,298) (7,580)
Loss (gain) on sale of Integrated Living Communities, Inc. .............. -- 8,497 (3,914)
Loss on closure of redundant operations:
Home health ........................................................... -- 3,519 1,387
Rehabilitation ........................................................ -- -- 2,929
Termination of Coram merger and related settlement costs ................ -- -- 27,555
Termination payments in connection with RoTech acquisition .............. -- -- 4,750
Write-down to net realizable value of assets to be sold:
Physician practice and outpatient clinic operations ................... -- -- 58,912
Nursing facilities .................................................... -- -- 2,500
Termination of other business activities:
International investment and development activities ................... -- -- 5,490
Pre-acquisition activities ............................................ -- -- 4,500
Purchase options on nursing facilities ................................ -- -- 6,268
National purchasing contract .......................................... -- -- 5,742
Other ................................................................... -- -- 12,604
-------- --------- --------
$132,960 $ (14,457) $133,042
======== ========= ========
</TABLE>
In the fourth quarter of 1995, the Company, as well as industry analysts,
believed that Medicare and Medicaid reform was imminent. Both the House and
Senate balanced budget proposals proposed a
95
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(19) LOSS ON IMPAIRMENT OF LONG-LIVED ASSETS AND OTHER NON-RECURRING CHARGES
- -(CONTINUED)
reduction in future growth in Medicare and Medicaid spending from 10% a year to
approximately 4-6% a year. While Medicare and Medicaid reform had been discussed
prior to the fourth quarter, the Company came to believe that a future reduction
in the growth of Medicare and Medicaid spending was now virtually a certainty.
Such reforms include, in the near term, a continued freeze in the Medicare
routine cost limit ("RCL"), followed by reduced increases in later years, more
stringent documentation requirements for Medicare RCL exception requests,
reduction in the growth in Medicaid reimbursement in most states, as well as
salary equivalency in rehabilitative services and, in the longer term (2-3
years), a switch to a prospective payment system for home care and nursing
homes, and repeal of the "Boren Amendment", which requires that states pay
hospitals "reasonable and adequate" rates. The Company estimated the effect of
the aforementioned reforms on each nursing and subacute facility, as well as on
its rehabilitative services, respiratory therapy, home care, mobile diagnostic
and pharmacy divisions by reducing (or in some cases increasing) the future
revenues and expense growth rates for the impact of each of the aforementioned
factors. Accordingly, these events and circumstances triggered the early
adoption of Statement of Financial Accounting Standards No. 121 in the fourth
quarter of 1995. In accordance with SFAS No. 121, the Company estimated the
future cash flows expected to result from those assets to be held and used.
In estimating the future cash flows for determining whether an asset is
impaired, and if expected future cash flows used in measuring assets are
impaired, the Company grouped its assets at the lowest level for which there are
identifiable cash flows independent of other groups of assets. These levels were
each of the individual nursing/subacute facilities, and each of the home health,
rehabilitative therapy, respiratory therapy, pharmacy and mobile diagnostics
divisions. The results of comparing future undiscounted cash flows to historical
carrying value were that 12 individual nursing facilities and one assisted
living facility were identified for an impairment charge. None of the remaining
facilities or business units were identified since only those facilities or
business units where the carrying value exceeded the undiscounted cash flows are
considered impaired. The business units having significant goodwill were not
identified for an impairment charge because projected undiscounted cash flows
were sufficient to recover goodwill over the remainder of the 40 year estimated
useful life. Prior to adoption of SFAS 121, the Company evaluated impairment on
the entity level. Such an evaluation yielded no impairment as of September 30,
1995.
After determining the facilities eligible for an impairment charge, the
Company determined the estimated fair value of such facilities. Also, the
Company obtained valuation estimates prepared by independent appraisers or had
received offers from potential buyers on 6 of the 12 facilities identified for
impairment, comprising 72% of the total charge. Such valuation estimates were
obtained to corroborate the Company's estimate of value. The excess carrying
value of goodwill, buildings and improvements, leasehold improvements and
equipment above the fair value was $83,321 (of which $1,533 represented goodwill
and $81,788 represented property and equipment), which was included in the
statement of operations for 1995 as loss on impairment of long-lived assets.
In connection with the adoption of SFAS No. 121 described above, the
Company adopted a change in accounting estimate to write-off in 1995 all
deferred pre-opening costs of MSUs. This change was made in recognition of the
circumstances, discussed above, which raised doubt about and thereby triggered
the assessment of recoverability of long-lived assets in 1995. These
circumstances also raised doubt as to the estimated future benefit and
recoverability of deferred pre-opening costs, resulting in the Company's
decision to write-off $25,785 of deferred pre-opening costs. In connection with
the change in accounting estimate regarding the future benefits and
recoverability of deferred pre-opening costs, the Company has changed its
accounting method beginning in 1996 from deferring and amortizing pre-opening
costs to recording them as an expense when incurred. The effect of this change
in 1996 was to decrease amortization expense by approximately $3,900 and to
increase operating expenses by approximately $3,900.
96
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(19) LOSS ON IMPAIRMENT OF LONG-LIVED ASSETS AND OTHER NON-RECURRING CHARGES
- -(CONTINUED)
During the fourth quarter of 1995, the Company terminated the Crestwood
management contract, a 10 year contract entered into in January 1994 to manage
23 long-term care and psychiatric facilities in California owned by Crestwood
Hospital. The terms of the contract required the payment of a management fee to
IHS and a preferred return to the Crestwood owners. IHS terminated the
management contract with Crestwood Hospital due primarily to changes in
California Medicaid rates which no longer provided sufficient cash flow at the
facilities to support both IHS' management fee and the preferred return to the
owners. As a result, the Company incurred a $21,915 loss on the termination of
this contract. Such loss consists of the write-off of $8,496 of management fees,
$11,097 of loans made to Crestwood Hospital and the owners of Crestwood, as well
as the interest thereon, and $2,322 of contract acquisition costs.
During the third quarter of 1995, the Company merged with IntegraCare, Inc.
in a transaction accounted for as a pooling of interests. In connection with
this transaction, the Company incurred merger costs of $1,939 for accounting,
legal, and other costs. These costs are included as an other non-recurring
charge on the statement of operations.
On July 30, 1996, the Company sold its pharmacy division to Capstone
Pharmacy Services, Inc. ("Capstone") for a purchase price of $150,000,
consisting of cash of $125,000 and unregistered shares of Capstone common stock
having a value of approximately $25,000. The Company had determined that its
ownership of pharmacy operations is not critical to the development and
implementation of its post-acute care network strategy. As a result of the sale,
the Company recorded a $34,298 pre-tax gain ($298 gain after income taxes).
Because IHS's investment in the pharmacy division had a very small tax basis,
the taxable gain on the sale significantly exceeded the gain for financial
reporting purposes, thereby resulting in a disproportionately higher income tax
provision related to the sale (see note 4). The Capstone common stock received
in the sale was recorded at its carryover cost of $14,659. During the first
quarter of 1997, the Company recorded the remaining gain of $7,580 on its
investment in the Capstone shares when such shares were registered. Previously,
such gain was accounted for as an unrealized gain on available for sale
securities.
On October 9, 1996, ILC, a wholly owned subsidiary of IHS, completed an
initial public offering of ILC common stock. The Company had determined that the
direct operation of assisted-living communities is not required for its
post-acute care network strategy. In connection with the ILC offering the
Company sold 1,400,000 of ILC common stock and recorded a $8,497 loss. Following
the offering, the Company continued to own 2,497,900 shares of ILC Common Stock,
representing 37.3% of the outstanding ILC common stock (see note 4). In the
third quarter of 1997, the Company sold its remaining interest in ILC. The sale
resulted in a non-recurring gain of $3,914.
The Company's strategy is to expand its home health care services to take
advantage of health care payors' increasing focus on having healthcare provided
in the lowest-cost setting possible and patients' desires to be treated at home.
As a result, during the fourth quarter of 1996, the Company acquired First
American Health Care of Georgia Inc. ("First American"), a provider of home
health services in 21 states, principally Alabama, California, Florida, Georgia,
Michigan, Pennsylvania and Tennessee. In addition, the Company has acquired
other home care companies during 1994, 1995 and 1996. In the fourth quarter of
1996, the Company recorded a $3,519 non-recurring charge resulting from the
closure of certain redundant home care agencies in those markets where First
American presently provides home health services.
In connection with the acquisition of First American, the Company
terminated the All Seasons management contract, a 10 year contract entered into
in September 1994 to manage six geriatric care facilities in Washington State.
As a result of the lack of synergies with First American home care agencies, as
well as changes to the reimbursement environment within the state of Washington,
the
97
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(19) LOSS ON IMPAIRMENT OF LONG-LIVED ASSETS AND OTHER NON-RECURRING CHARGES
-(CONTINUED)
Company believed it was in its best interest to terminate such contract. As a
result, the Company incurred a $7,825 loss on the termination. Such loss
consists of the write-off of $3,803 of management fees and $4,022 of loans made
to All Seasons.
On October 19, 1996, the Company and Coram Healthcare Corporation ("Coram")
entered into a definitive agreement and plan of merger (the "Merger Agreement")
providing for the merger of a wholly-owned subsidiary of IHS into Coram, with
Coram becoming a wholly-owned subsidiary of IHS. Under the terms of the Merger
Agreement, holders of Coram common stock were to receive for each share of Coram
common stock 0.2111 of a share of the Company's common stock, and IHS would have
assumed approximately $375,000 of indebtedness. On April 4, 1997, IHS notified
Coram that it had exercised its rights to terminate the Merger Agreement. IHS
also terminated the March 30, 1997 letter amendment, setting forth proposed
revisions to the terms of the merger (which included a reduction in the exchange
ratio to 0.15 of a share of IHS common stock for each share of Coram common
stock), prior to the revisions becoming effective at the close of business on
April 4, 1997. On May 5, 1997, IHS and Coram entered into a settlement agreement
pursuant to which the Company paid Coram $21,000 in full settlement of all
claims Coram might have against IHS pursuant to the Merger Agreement, which the
Company recognized as a non-recurring charge in the second quarter. In addition,
during the first quarter the Company incurred a non-recurring charge of $6,555
relating to accounting, legal and other costs related to the merger.
In September 1997, the Company recorded a non-recurring charge of $4,750
resulting from termination payments in connection with its fourth quarter merger
with RoTech Medical Corporation.
In connection with the consummation of certain recent acquisitions, IHS has
incurred costs to discontinue or dispose of certain activities previously
performed by the Company. In addition, the Company has elected to exit certain
activities acquired over the past several years that are no longer considered a
part of core operations. Such businesses include physician practices, outpatient
clinics, selected nursing facilities in non-strategic markets and international
investment and development activities.
The Company is presently entertaining offers for the sale of its physician
practices, outpatient clinics and certain nursing facilities. The write down to
net realizable value is based upon these offers. The remaining portion of the
charge relates to the exit of international operations, termination of a
national purchasing contract and the write-off of purchase option deposits on
certain managed facilities.
At this time, a formal plan of restructuring measures is currently being
formulated with respect to certain recent acquisitions; however, it is not
practicable at this time to estimate the nature, timing or total cost of the
various potential restructuring measures or to assess the likelihood that
particular restructuring measures will be implemented. Therefore, no provision
for the cost of such restructuring measures has been included in the financial
statements. Management's decision with respect to the nature and timing of any
restructuring measures may require that non-recurring charges, potentially
significant, be recorded in IHS' statements of operations in subsequent periods.
In the fourth quarter of 1997, IHS recorded a $3,700 charge to exit 11
California nursing facilities under management. The components of this charge
were to writeoff the following assets: a $602 management fee receivable, a
$2,250 purchase option deposit, a $550 cash advance for capital improvements and
other working capital requirements of the owner, and $298 in deferred
acquisition costs.
In the fourth quarter of 1997, the Company also recorded an $8,199 charge
to exit a home health management contract. The components of this charge were to
writeoff the following assets: a $769 management fee receivable, a $3,200 cash
advance for capital improvements and other working capital, a $1,000 loan to the
home health company, and $3,230 of unamortized value assigned to the management
contract at the acquisition date.
98
<PAGE>
INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(19) LOSS ON IMPAIRMENT OF LONG-LIVED ASSETS AND OTHER NON-RECURRING CHARGES
-(CONTINUED)
In the fourth quarter of 1997, the Company incurred other costs of $12,604,
which included: (i) $1,300 in termination and severance costs associated with
the sale of outpatient and physician practices, (ii) $1,100 in lease termination
costs associated with the sale of outpatient and physician practices, (iii)
$3,800 in investments and loans related to other start-up joint ventures, (iv)
$3,500 in obsolete information systems for acquisitions completed prior to 1997,
(v) $975 prior owner litigation settlements subsequent to one year after
acquisition date, (vi) $970 in lease termination costs associated with the
closing of six mobile diagnostic locations in non-strategic markets, and (vii)
$959 in other miscellaneous charges.
(20) CUMULATIVE EFFECT OF ACCOUNTING CHANGE
In November 1997, the Emerging Issues Task Force ("EITF") reached consensus
on Issue 97-13 concerning costs of projects that combine business process
reengineering and information technology transformation. EITF Issue 97-13 now
requires that certain costs of business process reengineering and information
technology projects be expensed as incurred. These costs include costs related
to the formulation, evaluation and selection of alternative software, costs of
the determination of needed technology, certain data conversion costs, training
costs and post-implementation application maintenance and support costs. In
accordance with EITF Issue 97-13, the unamortized balance of these costs of
$3,000 has been written-off in the fourth quarter of 1997 and reported as the
cumulative effect of a change in accounting principle (net of income taxes of
$1,170) of $1,830.
(21) CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES
The following information is provided in accordance with the AICPA
Statement of Position No. 94-6, "Disclosure of Certain Significant Risks and
Uncertainties."
The Company's strategy is to use geriatric care facilities as a platform to
provide a wide variety of post-acute medical and rehabilitative services more
typically delivered in the acute care hospital setting and to use home
healthcare to provide those medical and rehabilitative services which do not
require 24-hour monitoring. Post-acute care includes subacute care, outpatient
and home care, inpatient and outpatient rehabilitation, diagnostic, respiratory
therapy and pharmacy services. The Company's post-acute health care system is
intended to provide continuity of care for its patients following discharge from
acute care hospitals. The Company also manages such operations for other owners
for a fee, which is generally based on a percentage of the gross revenue. The
Company and others in the health care business are subject to certain inherent
risks, including the following:
o Substantial dependence on revenues derived from reimbursement by the
Federal Medicare and state Medicaid programs;
o Ability to obtain per diem rates approvals for costs which exceed the
Federal Medicare established per diem rates;
o Government regulations, government budgetary constraints and proposed
legislative and regulatory changes; and
o Lawsuits alleging malpractice and related claims.
Such inherent risks require the use of certain management estimates in the
preparation of the Company's financial statements and it is reasonably possible
that a change in such estimates may occur.
The Company receives payment for a significant portion of services rendered
to patients from the Federal government under Medicare and from the states in
which its facilities and/or services are provided, are located under Medicaid.
Revenue derived from Medicare and various state Medicaid reimbursement programs
represented 49.3% and 17.1%, respectively, of the Company's revenue for the year
ended December 31, 1997, and the Company's operations are subject to a variety
of other Federal, state
99
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INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(21) CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES -(CONTINUED)
and local regulatory requirements. Failure to maintain required regulatory
approvals and licenses and/or changes in such regulatory requirements could have
a significant adverse effect on the Company. Changes in Federal and state
reimbursement funding mechanisms, related government budgetary constraints and
differences between final settlements and estimate settlements receivable under
Medicare and Medicaid retrospective reimbursement programs, which are subject to
audit and retroactive adjustment, could have a significant adverse effect on the
Company. The Company's cost of care for its MSU patients generally exceeds
regional reimbursement limits established under Medicare. The success of the
Company's MSU strategy will depend in part on its ability to obtain per diem
rate approvals for costs which exceed the Medicare established per diem rate
limits and by obtaining waivers of these limitations.
The Company is subject to malpractice and related claims, which arise in
the normal course of business and which could have a significant effect on the
Company. As a result, the Company maintains occurrence basis professional and
general liability insurance with coverage and deductibles which management
believes to be appropriate.
The Company is also subject to workers' compensation and employee health
benefit claims, which are primarily self-insured; however, the Company does
maintain certain stop-loss and other insurance coverage which management
believes to be appropriate. Provisions for estimated settlements relating to the
workers' compensation and health benefit plans are provided in the period of the
related claim on a case by case basis plus an amount for incurred but not
reported claims. Differences between the amounts accrued and subsequent
settlements are recorded in operations in the period of settlement.
The Company believes that adequate provision for the aforementioned items
has been made in the accompanying consolidated financial statements and that
their ultimate resolution will not have a material effect on the consolidated
financial statements.
Since its inception, the Company has grown through acquisitions, and
realization of acquisition costs, including intangible assets of businesses
acquired, is dependent initially upon the consummation of the acquisitions and
subsequently upon the Company's ability to successfully integrate and manage
acquired operations. Also, the Company's development of post-acute care networks
is dependent upon successfully effecting economics of scale, the recruitment of
skilled personnel and the expansion of services and related revenues.
(22) SEGMENT REPORTING
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information. SFAS No. 131 establishes standards for the
way public business enterprises are to report information about operating
segments in annual financial statements and requires those enterprises to report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers.
IHS has chosen to early adopt SFAS No. 131 in 1997. As of December 31,
1997, IHS has two primary operating segments: the nursing facilities services
segment and the home health services segment. No other individual business
segment is individually in excess of the 10% thresholds of SFAS No. 131. IHS
management analyzes its business on a contribution margin basis before corporate
and fixed costs (interest, depreciation and amortization, rent and non-recurring
items):
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INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(22) SEGMENT REPORTING -(CONTINUED)
<TABLE>
<CAPTION>
HOME HEALTH NURSING FACILITIES
SEGMENT AND OTHER CONSOLIDATED
------------ -------------------- -------------
<S> <C> <C> <C>
Revenues .................... $ 705,033 1,288,164 1,993,197
Operating Expenses .......... $ 667,997 811,009 1,479,006
---------- --------- ---------
Contribution Margin ......... $ 37,036 477,155 514,191
Total Assets ................ $1,637,561 3,425,583 5,063,144
</TABLE>
Since there is no inter-segment revenue or receivables, a reconciliation to
consolidated operations is not presented. Additionally, because the acquisition
of First American Home Care did not occur until October 1996, the Home Health
Nursing division did not represent a segment exceeding the 10% thresholds of
SFAS No. 131 in 1996 and segment reporting is therefore not presented. Revenue
derived from Medicare and various state Medicaid reimbursement programs
represented 49.3% and 17.1%, respectively, of the Company's total revenue for
the year ended December 31, 1997 and the Company's operations are subject to a
variety of other federal, state, and local regulatory requirements as discussed
more fully in note 20. The Company does not evaluate its operations on a
geographic basis.
(23) SUBSEQUENT EVENTS
In January 1998, the Company acquired Paragon Rehabilitative Services Inc.,
a contract rehabilitation company in Ohio. The total purchase price was
approximately $10,777.
In January 1998, the Company acquired the assets of nine respiratory
companies. The total purchase price of these respiratory companies was
approximately $9,370.
In February 1998, the Company entered into an agreement with Mapleton
Enterprises to lease a 100 bed skilled nursing facility in Montana.
In February 1998, the Company acquired twelve respiratory companies. The
total purchase price of these respiratory companies was approximately $18,904.
In March 1998, the Company entered into an agreement with Carrolton
Management Company to lease seven skilled nursing facilities having a total of
816 beds.
In March 1998, the Company acquired two respiratory companies. The total
purchase price of the two companies was approximately $1,825.
The Company has reached a definitive agreement to purchase a company
operating 44 skilled nursing facilities having a total of 5,622 beds. The
approximate purchase price of these facilities is $70,350. In addition, the
Company has reached agreements in principle to purchase a lithotripsy company
for approximately $10,500 and 15 respiratory companies for approximately
$42,359. There can be no assurance that any of these pending acquisitions will
be consummated on the proposed terms, different terms, or at all.
In January 1998, the Company sold five long-term care facilities to Omega
Healthcare Investors, Inc. for $44,500, which facilities were leased back by
Lyric Health Care LLC ("LLC"), a newly formed subsidiary of IHS, at an annual
rent of approximately $4,500. The Company recorded a $2.5 million loss on the
sale of these facilities in 1997. IHS also entered into management and franchise
agreements with LLC. The management and franchise agreements' initial terms are
13 years with two renewal options of 13 years each. The base management fee is
3% of gross revenues, subject to increase if gross revenues exceed $350,000. In
addition, the agreement provides for an incentive management fee equal to 70% of
annual net cash flow (as defined in the management agreement). The duties of IHS
as manager include
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INTEGRATED HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(23) SUBSEQUENT EVENTS -(CONTINUED)
the following: accounting, legal, human resources, operations, materials and
facilities management and regulatory compliance. The annual franchise fee is 1%
of gross revenues, which grants LLC the authority to use the Company's trade
names and proprietary materials.
In a related transaction, TFN Healthcare Investors, Inc. ("TFN") purchased
a 50% interest in LLC for $1,000 and IHS' interest in LLC was reduced to 50%.
The LLC will dissolve on December 31, 2047 unless extended for an additional 12
months. On February 1, 1998 LLC also entered into a five year employment
agreement with Timothy F. Nicholson, the principal stockholder of TFN and a
director of the Company. Pursuant to LLC's operating agreement, Mr. Nicholson
will serve as Managing Director of LLC and will have the day-to-day authority
for the management and operation of LLC and will initiate policy proposals for
business plans, acquisitions, employment policy, approval of budgets, adoption
of insurance programs, additional service offerings, financing strategy,
ancillary service usage, change in material terms of any lease and
adoption/amendment of employee health, benefit and compensation plans. As a
result of the aforementioned transactions, IHS will account for its investment
in Lyric using the equity method of accounting since IHS no longer controls
Lyric.
In February 1998 Speciality Care, PLC was acquired by Craegmoor Healthcare
Company Limited, an owner and operator of residential nursing homes in the
United Kingdom. Craegmoor operates 65 nursing homes with 3,106 beds, including
the 24 homes with 1,142 beds owned by Speciality Care. The stockholders of
Speciality Care received 10% of the oustanding ordinary shares of Craegmoor; as
a result of its ownership of Speciality Care, IHS owns approximately 5.3% of the
outstanding ordinary shares of Craegmoor Healthcare.
(24) RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Standards No. 130, Reporting Comprehensive Income. SFAS No. 130
establishes standards for reporting and display of comprehensive income and its
components in a full set of general purpose financial statements. SFAS No. 130
was issued to address concerns over the practice of reporting elements of
comprehensive income directly in equity. SFAS No 130 is effective for both
interim and annual periods beginning in 1998. Comparative financial statements
provided for earlier periods are required to be reclassified to reflect the
provisions of this Statement. Also, the FASB recently issued Statement of
Financial Standards No. 132, Employers' Disclosure About Pensions and Other Post
Retirement Benefits. SFAS No. 132 revises employers' disclosures about pension
and other post retirement benefit plans, and it is effective in 1998. It is
anticipated that SFAS No. 130 and SFAS No. 132 will have no material effect on
current or future financial statements of the Company.
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INTEGRATED HEALTH SERVICES, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1996 1997
-------------- -------------- -------------
<S> <C> <C> <C>
Allowance for doubtful accounts:
Balance at beginning of period .............................. $ 16,630 $ 18,128 $ 41,527
Provisions for bad debts .................................... 19,359 29,913 41,356
Acquired companies .......................................... 993 10,932 107,078
Accounts receivable written-off (net of recoveries) ......... (18,854) (17,446) (28,523)
--------- --------- ---------
$ 18,128 $ 41,527 $ 161,438
========= ========= =========
</TABLE>
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTOR
The section entitled "Proposal No. 1--Elections of Directors" in the
Company's Proxy Statement for the Annual Meeting of stockholders is incorporated
herein by reference.
EXECUTIVE OFFICERS
See "Part I--Item 1. Executive Officers of the Company."
ITEM 11. EXECUTIVE COMPENSATION
The section entitled "Executive Compensation" in the Company's Proxy
Statement for the Annual Meeting of Stockholders is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section entitled "Beneficial Ownership of Common Stock" in the
Company's Proxy Statement for the Annual Meeting of Stockholders is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The section entitled "Executive Compensation--Compensation Committee
Interlocks and Insider Participation" in the Company's Proxy Statement for the
Annual Meeting of Stockholders is incorporated herein by reference.
In April 1993, the Company purchased units, consisting of Preference Shares
and Class B Ordinary Shares, of Speciality Care PLC ("Speciality"), a United
Kingdom company formed by Mr. Nicholson to acquire Burley Healthcare PLC. The
Company paid approximately $2,993,000 for the units, which initially represented
(on a pre-dilution basis) approximately 25% of the voting equity of Speciality.
The Company purchased units at the same price and on the same terms as the
purchase by other outside, unaffiliated investors, including Nash & Sells, an
independent English venture capital firm. Speciality was prohibited from
undertaking certain major corporate actions, including refinancings and the sale
of Speciality, without the consent of the Company and the other outside,
unaffiliated investors. Entities controlled by Mr. Nicholson and Dr. Elkins paid
approximately $1,505,950 for Class A Ordinary Shares, which initially
represented approximately 50.1% of the voting equity of Speciality, although Dr.
Elkins gave Mr. Nicholson a proxy over the shares Dr. Elkins controlled. Mr.
Nicholson served as Chairman and Managing Director of Speciality. In addition, a
limited partnership in which a subsidiary of the Company was the general partner
and executive officers and certain directors of the Company were limited
partners (the "Company Partnership") paid approximately $585,000 for units
consisting of Preference Shares and Class B Ordinary Shares initially
representing approximately 3.5% of the voting equity of Speciality; this
purchase was at the same purchase price and on the same terms as the Company's
purchase. As a result of Dr. Elkins' and Mr. Nicholson's interest in the
transaction, a committee of directors consisting of then disinterested members
of the Board of Directors of the Company was established to review the
transaction.
In October 1994, the Company made a $1 million loan to Speciality for
purposes of acquiring a healthcare facility. The loan accrued interest at 9%,
was payable on demand, and was secured by substantially all the assets of
Speciality. In November 1994, the Company subscribed for an additional 100,000
Class B Ordinary Shares and 300,000 Preference Shares of Speciality at a price
of \P1 per share, the same price paid by Nash, Sells & Partners Ltd., which
purchase price was paid through cancellation
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<PAGE>
of the loan. The foregoing transactions with Speciality were approved by the
disinterested members of the Board of Directors. The Company agreed to allow a
bank to take a first lien on the aforementioned nursing facility and to have its
lien become a second lien on the same property.
In June 1995 the Company loaned Speciality \P5.9 million, which loan was
repaid in August 1995 upon the completion of the reorganization of Speciality.
In August 1995, the Company, together with other investors of Speciality,
completed a reorganization of the share capital of Speciality. The Company
purchased 4,773,846 Convertible Preference Shares from Speciality at a
subscription price of \P1 per share. Speciality redeemed 1,800,000 Preference
Shares owned by the Company at a price of \P1 per Share. The 525,000 Class B
Ordinary Shares owned by the Company were redesignated and converted into
387,187 Ordinary Shares of 10p each of Speciality. In addition, certain
investors, including entities controlled by Mr. Nicholson, purchased the shares
owned by the Company Partnership for $1,504,990 (including accrued dividends).
As a result of the reorganization, the Company owned 63.65% of the Convertible
Preference Shares and 21.3% of the Ordinary Shares of Speciality (31.38% of the
outstanding Ordinary Shares assuming no further issuances and conversion of the
Convertible Preference Shares). Speciality also repaid \P752,741 owed to Mr.
Nicholson. The reorganization of Speciality was approved by the Board of
Directors of the Company upon the recommendation of a special committee of
disinterested directors appointed by the Board, which had obtained a fairness
opinion and advice from independent legal counsel. Under the Articles of
Association of Speciality, the Company had the right to nominate two directors;
Dr. Elkins and Mr. Cirka were the Company's nominees.
In July 1995, Dr. Elkins sold a portion of his Speciality shares to an
entity controlled by Mr. Nicholson and contributed the remainder of his
Speciality shares to a limited partnership (the "Speciality Partnership"). The
general partners of the Speciality Partnership consisted of a limited
partnership controlled by Dr. Elkins and a corporation the sole stockholders of
which were Mr. Nicholson and his wife; however, the partnership agreement of
such limited partnership granted to the general partner controlled by Mr.
Nicholson all voting and dispositive power with respect to the Speciality shares
owned by the partnership. In September 1997 the Speciality Partnership was
dissolved and the Speciality shares owned by it were distributed to the entity
controlled by Mr. Nicholson.
In February 1998 Speciality was acquired by Craegmoor Healthcare Company
Limited, an owner and operator of residential nursing homes in the United
Kingdom. Craegmoor Healthcare operates 65 nursing homes with 3,106 beds,
including the 24 homes with 1,142 beds owned by Speciality. The stockholders of
Speciality received 10% of the outstanding ordinary shares of Craegmoor
Healthcare having a value at the date of closing of approximately $20.8 million;
as a result of their ownership of Speciality, the Company owns approximately
5.3% of the outstanding ordinary shares of Craegmoor Healthcare and the entity
controlled by Mr. Nicholson owns approximately 1.2% of the outstanding ordinary
shares of Craegmoor Healthcare.
During fiscal year 1997 the Company's Symphony Rehabilitation Services and
Symphony Pharmacy Services divisions received payments from Community Care of
America, Inc. ("CCA") of approximately $2,029,000 and $176,000, respectively,
for rehabilitation and pharmacy services, respectively, provided to CCA's
patients. These divisions provided similar services to a number of unrelated
companies at similar rates in 1997. Dr. Elkins was a director and Mr. Silverman
was Chairman of the Board of CCA. Dr. Elkins beneficially owned 21.1% of the
outstanding shares of CCA and the Company owned warrants to purchase
approximately 14.9% of CCA.
In December 1996, the Company entered into a management agreement with CCA
pursuant to which the Company agreed to supervise, manage and operate the
financial, accounting, MIS, reimbursement and ancillary services contract
functions for CCA (the "Services") from January 1, 1997 to December 31, 2001.
The Company was to receive a management fee as follows: (a) for 1997, an amount
equal to the lesser of (i) two percent (2%) of CCA's gross revenues (as
defined), subject to increase under certain circumstances, or (ii) twice the
amount of CCA's total direct and indirect costs in performing the Services for
the period July 1, 1996 to December 31, 1996 ("Owners' Cost"); and (b) for 1998
and thereafter, the lesser of (i) two percent (2%) of CCA's gross revenues,
subject to increase under certain circumstances, or (ii) a percentage of CCA's
gross revenues determined by dividing the Owners'
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Cost by CCA's gross revenues for the period July 1, 1996 to December 31, 1996.
The management fee was payable monthly, but CCA could elect to defer all or a
portion of the fee until May 31, 1998. Thereafter, the management fee could be
deferred only to the extent funds are not available after paying debt service
and other expenses. Any management fee not paid was accrued and bore interest.
Management fees due IHS from CCA from January 1, 1997 until the Company's
acquisition of CCA on September 25, 1997 aggregated approximately $2.2 million,
all of which was deferred.
In connection with the management agreement, the Company made available to
CCA a revolving credit facility pursuant to which CCA could borrow up to $5.0
million for additional working capital until December 27, 1998. Borrowings under
this line of credit bore interest at a rate equal to the annual rate set forth
in the Company's revolving credit agreement with Citibank, N.A. plus 2% per
annum. In connection therewith, CCA issued to the Company warrants to purchase
an aggregate of 752,182 shares of CCA's common stock, one-half of which were
exercisable at $3.22 per share (the average of the high and low trading price of
CCA's common stock on January 14 and 15, 1997) for a two-year period and the
remaining one-half of which were exercisable at $6.44 per share for a five-year
period. CCA granted the Company registration rights relating to the shares
underlying the warrants. In July 1997 the Company made available to CCA an
additional $5.0 million revolving credit facility pursuant to which CCA could
borrow up to $5.0 million for additional working capital until July 18, 1999.
Borrowings under this line of credit bore interest at a rate equal to the annual
rate set forth in the Company's revolving credit agreement with Citibank, N.A.
plus 4% per annum. Borrowings under the two facilities were subordinated to
CCA's borrowings from unaffiliated third-party lenders. At the time of the
Company's acquisition of CCA, CCA had borrowed an aggregate of $10.0 million
under these facilities.
In April 1997, the Company guaranteed CCA's loan and lease obligations to
Health and Retirement Properties Trust, which aggregated approximately $10
million at March 31, 1997, and a $4.8 million overadvance made by Daiwa
Healthco-2 LLC to CCA. In connection with these guarantees, CCA issued to the
Company warrants to purchase 379,900 shares of CCA common stock at a purchase
price of $1.937 per share for a period of five years. CCA granted the Company
registration rights relating to the shares underlying the warrants.
In September 1997, the Company acquired CCA through a cash tender offer and
subsequent merger for a purchase price of $4.00 per share. As a result of the
transaction, Dr. Elkins and Messrs. Silverman and Cirka received $3,384,940,
$32,332 and $44,556, respectively. Certain other executive officers of the
Company owned shares of CCA which they purchased at prices higher than $4.00;
consequently, they lost money on the transaction.
In November 1995 the Company formed Integrated Living Communities, Inc.
("ILC") as a wholly-owned subsidiary of the Company to operate the assisted
living and other senior housing facilities owned, leased and managed by the
Company. Following ILC's formation, the Company transferred to ILC as a capital
contribution its ownership interest in three facilities, condominium interests
in three facilities, and agreements to manage nine facilities (five of which
were subsequently cancelled). In addition, the Company sublet two facilities to
ILC. Through October 9, 1996, the Company provided all of ILC's required
financial, legal, accounting, human resources and information systems services,
for which it received a flat fee of 6% of ILC's total revenues, and satisfied
all of ILC's capital requirements in excess of internally generated funds
through a $75 million revolving credit facility. The Company estimates that the
cost to ILC of obtaining these services from third parties would have been
significantly higher than the fee charged by the Company. The Company provided
certain building maintenance, housekeeping, emergency call and residence meal
services at certain of ILC's facilities.
On October 9, 1996, ILC completed an initial public offering of its common
stock to the public at a price of $8.00 per share. The Company sold 1,400,000
shares of ILC common stock in the offering, for which it received aggregate net
proceeds of approximately $10.4 million. In addition, ILC used approximately
$7.4 million of the proceeds from the offering to repay outstanding indebtedness
to the Company. Following the closing of the offering, ILC borrowed an
additional $3.4 million from the Company (the "November Loan"). The loan bore
interest at the rate of 14% per annum, was to be repaid in 24 equal monthly
installments of principal plus interest beginning December 2, 1996 and was
subordinated
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to ILC's revolving credit facility with Nationsbank. In April 1997 IHS and ILC
amended the November Loan to modify the payment schedule and provide for an
interest rate of 12%. The November Loan matured in November 1998 and was
subordinated to ILC's revolving credit facility with Nationsbank. In April 1997
IHS and ILC also entered into a $5.0 million revolving credit facility.
Borrowings under this facility bore interest at a rate per annum of 12%, and the
facility matured in April 1998. This facility was subordinated to ILC's
revolving credit facility with Nationsbank. Robert N. Elkins, the Company's
Chairman of the Board and Chief Executive Officer, served as Chairman of the
Board of ILC. Lawrence P. Cirka, the former President and a former director of
the Company, was a director of ILC. Messrs. Elkins and Cirka were granted
options to purchase 235,000 shares and 98,000 shares, respectively, of ILC
common stock at a purchase price of $8.00 per share, equal to the initial public
offering price, in June 1996. These options became exercisable in three equal
annual installments, commencing June 10, 1997, although they would become
immediately exercisable under certain circumstances generally related to a
change in control of ILC or Dr. Elkins or Mr. Cirka, as the case may be, ceasing
to be a director of ILC. In July 1997, an unrelated third party purchased all
the outstanding stock of ILC, including the Company's remaining 37.3% interest,
for $11.00 per share. All options granted to Dr. Elkins and Mr. Cirka became
immediately exercisable.
In November 1996, Mr. Nicholson entered into a consulting agreement with
ILC. Pursuant to the agreement, which was effective June 1, 1996 and terminated
upon the sale of ILC in July 1997, Mr. Nicholson advised ILC with respect to its
acquisition and development activities. Mr. Nicholson received an annual
consulting fee of $250,000, as well as negotiated brokerage commissions on
certain transactions. Mr. Nicholson did not receive any commissions from ILC.
During 1997 the Law Offices of Robert A. Mitchell, a director of the
Company, performed legal services for the Company for which such firm received
$194,450.
On December 12, 1997, the Company entered into an Aircraft Lease Agreement
(the "Lease") with RNE Skyview, LLC ("Skyview"), which is wholly owned by Dr.
Elkins. Pursuant to the Lease, the Company has agreed to lease one aircraft from
Skyview for seven years, commencing on December 12, 1997 and terminating on
December 12, 2004, with automatic one-year extensions unless either party
notifies the other in writing six months prior to termination. Under the Lease,
the Company has agreed to pay Skyview a commercially reasonable base rent, which
shall be no less than $89,675.81 per month and $1,076,109.72 per year. The
Company must also pay additional rent of $2,150 per block hour for any month in
which the number of block hours flown is more than 42 hours. The Company is
responsible for all maintenance and operation expenses of the aircraft during
the term of the Lease. The Lease provides that Dr. Elkins shall have exclusive
first use of the aircraft throughout the term of the Lease, even if Dr. Elkins
is terminated as an employee of the Company for any reason, including, without
limitation, as a result of a change of control of the Company (as defined in the
Company's credit facility). The Lease further provides that in the event of the
termination of Dr. Elkins' employment with the Company, including, without
limitation, as a result of a change of control of the Company, the members of
the aircraft's cockpit crew shall become employees of Skyview; however, the
salaries, expenses and benefits of such crew members shall be a cost and expense
of the Company throughout the term of the Lease. Dr. Elkins is obligated to
reimburse the Company for its out-of-pocket costs associated with use of the
aircraft if, at any time during the term of the Lease, Dr. Elkins uses the
aircraft for his own personal use. In connection with the Lease, Skyview
purchased the Gulfstream II airplane then owned by the Company for its fair
market value of $5.082 million, which aircraft was traded in at its fair market
value in partial payment of the $8.9 million purchase price for the aircraft
purchased by Skyview. The Company recognized no gain or loss on the sale of the
aircraft to Skyview. The Lease and the aircraft are subject to a security
interest in favor of BTM Capital Corporation securing a loan in the amount of
$9,177,159 made to Skyview, which represents the cash purchase price paid for
the aircraft purchased from the Company and the cash portion of the purchase
price for the new aircraft, plus approximately $275,000 to cover work orders and
closing costs. Dr. Elkins has also pledged all of his membership interests in
Skyview to secure such loan. The base rent paid by the Company under the lease
equals Skyview's monthly and annual debt service costs on the loan from BTM
Capital Corporation.
Pursuant to a Relocation Agreement dated as of August 5, 1997 between Mr.
Cirka and the Company, the Company purchased Mr. Cirka's Florida residence and
Mr. Cirka agreed to perform substan-
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tially all of his duties for the Company at its Owings Mills, Maryland
headquarters beginning on May 1, 1998. Mr. Cirka had previously performed his
duties for the Company at the Company's Naples, Florida, office. The Company
paid Mr. Cirka a total of $4,823,774 for his Florida residence (including
furniture and improvements), including approximately $579,000 for real estate
taxes, closing costs and reimbursement of relocation expenses, and agreed to
allow Mr. Cirka to rent such Florida residence on a month-to-month basis until
May 1, 1998. In addition, the Company has granted Mr. Cirka a right of first
refusal through March 31, 1999 to match any third-party offer on the residence
which is acceptable to the Company. Mr. Cirka and the Company have agreed that
if Mr. Cirka does not exercise his option to repurchase the residence and the
Company sells the residence for less than $4,823,774 to a third party, the
difference between $4,823,774 and the sale price will be deducted from Mr.
Cirka's bonus. The Company believes that the current fair market value of Mr.
Cirka's Florida residence is approximately $4.2 million to $4.5 million.
In March 1998 Mr. Cirka ceased to be an officer and director of the
Company. The Company is treating Mr. Cirka as if his employment was terminated
without cause (as such term is defined in his employment agreement). As a
result, Mr. Cirka is entitled to a payment of five times the sum of (a) his
salary and (b) the highest of (i) his salary in 1998, (ii) his bonus in 1997 or
(iii) his bonus in 1996. In addition, all stock option and other equity-based
rights became fully vested and Mr. Cirka is entitled to receive certain benefits
for five years after termination.
In January 1998, the Company sold five long-term care facilities to Omega
Healthcare Investors, Inc. ("Omega") for $44,500,000, which facilities were
leased back by Lyric Health Care LLC ("Lyric"), a newly formed subsidiary of the
Company, at an annual rent of approximately $4,500,000. The Company also entered
into management and franchise agreements with Lyric, which agreements have
initial terms of 13 years with two renewal options of 13 years each. The base
management fee is 3% of gross revenues, subject to increase if gross revenues
exceed $350,000,000. In addition, the management agreement provides for an
incentive management fee equal to 70% of annual net cash flow (as defined in the
management agreement). The duties of the Company as manager include the
following: accounting, legal, human resources, operations, materials and
facilities management and regulatory compliance. The annual franchise fee is 1%
of gross revenues, which grants Lyric the authority to use the Company's trade
names and proprietary materials. In a related transaction, TFN Healthcare
Investors, Inc., an entity in which Mr. Nicholson is the principal stockholder
("TFN Healthcare"), purchased a 50% membership interest in Lyric for $1,000,000
and the Company's interest in Lyric was reduced to 50%. Lyric will dissolve on
December 31, 2047 unless extended for an additional 12 months. In addition, in
March 1998 the Company sold an additional five long-term care facilities to
Omega for approximately $50,500,000, which facilities were leased back to Lyric
at an annual rent of approximately $4,949,000. IHS is managing these facilities
for Lyric pursuant to the above-described agreements.
In February 1998, Mr. Nicholson entered into an employment agreement with
Lyric pursuant to which Mr. Nicholson serves as Managing Director of Lyric,
having day-to-day authority for the management and operation of Lyric. Mr.
Nicholson receives a base salary of $250,000, which may be increased from time
to time with the Company's approval and shall be increased to $275,000, $300,000
and $350,000 upon Lyric achieving annual fiscal year revenues of $150 million,
$250 million and $450 million, respectively. Mr. Nicholson will also receive
benefits similar to those provided to the Company's executive officers. The
agreement has an initial term through December 31, 2002, subject to automatic
one year extensions thereafter unless the Company or Mr. Nicholson elects not to
extend. The agreement may be terminated by Lyric for Cause or by Mr. Nicholson
for Good Reason. Upon termination by Lyric without Cause or by Mr. Nicholson for
Good Reason, Mr. Nicholson will be entitled to a severance payment equal to one
year's salary plus the average of his last two annual bonuses, payable 50%
within 10 days of termination and 50% monthly in 12 equal installments unless
such termination occurs within one year following a change of control of the
Company or the Company and TFN Healthcare cease to own in aggregate 50% of
Lyric, in which case the entire severance payment shall be made in one lump sum.
If Mr. Nicholson resigns within 30 days after TFN Healthcare's interest in Lyric
is diluted below 33 1/3% and TFN Healthcare sells its interest in Lyric, then
Mr. Nicholson will be entitled to severance in an amount equal to up to three
times his annual salary. The employment agreement contains confidentiality and
non-compete provisions. For purposes of the agreement, "Cause" means (i) Mr.
Nicholson
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materially fails to perform his duties, (ii) Mr. Nicholson materially breaches
his confidentiality or non-compete covenants, (iii) Mr. Nicholson is convicted
of any felony or any misdemeanor involving moral turpitude, or commits larceny,
embezzlement or theft of Lyric's tangible or intangible property, or (iv) TFN
Healthcare disposes of more than 50% of its interest in Lyric, and "Good Reason"
is defined as (i) a material breach of the agreement by Lyric, (ii) a change of
control of the Company (similar to the change of control definition contained in
Dr. Elkins' employment agreement (see "Executive Compensation--Employment
Agreements")), (iii) the Company and TFN Healthcare no longer own in aggregate
50% of Lyric or (iv) TFN Healthcare's interest in Lyric is diluted below 33 1/3%
and TFN Healthcare sells its interest in Lyric.
In April 1998 the Company reached an agreement in principle to sell 44
facilities to Monarch Properties, Inc., a newly-formed real estate investment
trust ("Monarch"), for an aggregate purchase price of approximately $371
million. It is currently contemplated that Monarch will lease 42 of these 44
facilities to Lyric, and that Lyric will engage the Company to manage the
facilities pursuant to the arrangements described above. The transactions with
Monarch and Lyric are subject to completion of definitive documentation and
completion of Monarch's initial public offering, and there can be no assurance
that the transaction will be completed on these terms, on different terms or at
all. Dr. Elkins is Chairman of the Board of Directors of Monarch, and it is
currently contemplated that he will beneficially own between five and ten
percent of Monarch following completion of Monarch's public offering.
As of June 5, 1995, Asia Care, Inc., a wholly-owned subsidiary of the
Company ("Asia Care"), entered into an employment agreement with John L.
Silverman, subsequently amended, pursuant to which Mr. Silverman served as Chief
Executive Officer and President of Asia Care, with responsibility for pursuing
business opportunities and establishing Asia Care's business in Asia. In 1997
Mr. Silverman received salary of $202,277 plus a cash bonus of $60,000. The
Company had guaranteed the payment of Mr. Silverman's salary and bonus. Mr.
Silverman had the right to purchase 10% of the outstanding stock of Asia Care at
fair market value at any time during the term of the agreement and for a period
of six months after termination or expiration of the employment agreement. The
agreement, which had a term of three years, was terminated effective December
31, 1997 and Asia Care ceased operations. In connection with the termination of
the agreement, the Company paid Mr. Silverman $202,227 as consideration for his
12 month non-compete and non-solicitation agreement, and reimbursed certain
expenses, including the cost of Mr. Silverman and his wife relocating to the
United States.
The Company from time to time makes loans available to its senior
executives in order to allow such persons to purchase stock, primarily through
the exercise of options, finance the purchase or construction of a residence, or
satisfy other personal obligations. In the absence of such loans, these
executives would be obligated in most cases either to forego such activities or
sell shares of Common Stock beneficially owned by them to finance such
activities. The Company also believes that making such loans available to its
executive officers helps attract and retain highly qualified management
personnel.
At March 1, 1998, the Company had three outstanding loans to Robert N.
Elkins, the Company's Chairman and Chief Executive Officer, aggregating
$19,944,095. One loan, in the original principal amount of $4,690,527 ("Loan
A"), was used primarily to purchase shares of the Company's Common Stock, bears
interest at a rate per annum equal to the higher of 7.5% or the Company's cost
of borrowing under its bank credit facility and is due December 19, 2001. The
principal amount of Loan A, which is unsecured, is due in five annual
installments beginning December 19, 1997; however, repayment of the first
installment of principal of $281,432 was forgiven in 1997. The largest amount of
indebtedness outstanding under Loan A during fiscal 1997 was $4,690,527. During
1997 Dr. Elkins paid no interest to the Company in respect of Loan A. The second
loan is in the original principal amount of $13,447,000 ("Loan B"). Loan B,
which was used to exercise options, bears interest at 6.8% per annum, is due
October 1, 2002 and is unsecured. The largest amount of indebtedness outstanding
under Loan B during fiscal 1997 was $13,447,000. Dr. Elkins must prepay Loan B
with the proceeds (less broker's commissions and taxes) resulting from the sale
by him of up to 650,000 shares of the Company's Common Stock. Loan B provides
that upon the occurrence of any change of control of the Company or the
termination of Dr. Elkins' employment with the Company by death, for permanent
disability, by Dr. Elkins for Good Reason or by the Company without Cause (as
such terms are defined in Dr. Elkins' employment
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agreement), any amounts outstanding and not then due under Loan B shall be
automatically and immediately discharged. Pursuant to the Supplemental Agreement
entered into between the Company and Dr. Elkins, Dr. Elkins is entitled to
receive bonuses on each October 1 from 1998 to 2002 in amounts sufficient to
enable him to repay the principal of and interest on Loan B less the amount of
his salary and bonus for the prior calendar year in excess of $500,000. The
Supplemental Agreement also provides that upon the occurrence of any change of
control of the Company or the termination of Dr. Elkins' employment with the
Company by death, for permanent disability, by Dr. Elkins for Good Reason or by
the Company without Cause (as such terms are defined in Dr. Elkins' employment
agreement), any amounts outstanding under Loan A shall be automatically and
immediately discharged. The third loan, which was made in January 1998, is in
the original principal amount of $2,088,000 ("Loan C"). Loan C, which was used
to exercise options, bears interest at 6.8% per annum, is due January 28, 2003
and is unsecured. Dr. Elkins must prepay Loan C with the proceeds (less broker's
commissions and taxes) resulting from the sale by him of the first 100,000
shares of Common Stock after the earlier to occur of (i) repayment in full of
Loan B or (ii) the sale of 650,000 shares of Common Stock and the use of the
proceeds therefrom to repay a portion of Loan B. Dr. Elkins continues to own the
shares of Common Stock acquired upon the exercise of options using the Loan B
and Loan C proceeds. Dr. Elkins has indicated to the Company that he intends to
use all salary and bonus in excess of $500,000 received by him in 1998, net of
taxes, to repay these loans.
At March 1, 1998, the Company had outstanding loans to Lawrence P. Cirka,
the former President and a former director of the Company, aggregating
$1,886,058. One loan, in the original principal amount of $1,474,530, was used
primarily to purchase shares of the Company's Common Stock, bears interest at
the higher of 7.5% or the Company's cost of borrowing under its bank credit
facility and is due December 19, 2001. The principal amount of the loan is due
in five annual installments beginning December 19, 1997 and is unsecured. In
December 1997, the Company loaned Mr. Cirka $500,000, which he used for personal
purposes. This loan bears interest at the rate of 8%, is unsecured, and is due
in 10 equal annual installments beginning December 10, 1998, although the
Company has the right to accelerate the maturity if Mr. Cirka leaves the
Company's employ for any reason. The loan provides that if Mr. Cirka's
employment is terminated within one year after the occurrence of any change of
control of the Company, any amounts outstanding under the loan shall be
automatically and immediately forgiven as of the last day of employment. The
largest amount of indebtedness outstanding during fiscal 1997 was $1,974,530.
During 1997 Mr. Cirka paid $85,139 in interest to the Company and made all
required principal repayments, aggregating $88,472, in respect of these loans.
At March 1, 1998, the Company had outstanding loans to C. Taylor Pickett,
the Company's Executive Vice President -- Chief Financial Officer, of $506,963.
One loan, made in November 1997 in the principal amount of $500,000, bears
interest at 6.8%, is unsecured and is due on November 13, 2002. The second loan,
made in March 1996 in the principal amount of $6,963, bears interest at 9% and
is unsecured. The largest amount of indebtedness outstanding during fiscal 1997
was $506,963. The proceeds of these loans were used primarily to purchase shares
of the Company's Common Stock.
At March 1, 1998, the Company had outstanding loans to Anthony R. Masso,
the Company's Executive Vice President -- Managed Care, aggregating $125,000.
One such loan, made in July 1996 in the principal amount of $75,000, bears
interest at 7.9%, is secured by Mr. Masso's home and is due on July 31, 1999.
The second loan, made in August 1994 in the principal amount of $50,000, bears
interest at 4%, is unsecured and is due January 1, 1999. The largest amount of
indebtedness outstanding during fiscal 1997 was $125,000. The proceeds of the
loans were used primarily to finance the purchase of a house.
At March 1, 1998, the Company had outstanding loans to Brian K. Davidson,
the Company's Executive Vice President -- Development, aggregating $907,650. One
such loan, made in August 1997 in the principal amount of $500,000, bears
interest at 8%, is unsecured and is due December 31, 1998. The second loan, made
in April 1997 in the principal amount of $407,650, bears interest at 9%, is
secured by two homes and other collateral, and is due April 3, 2000. The largest
amount of indebtedness outstanding during fiscal 1997 was $907,650. The proceeds
of the loans were used to finance the purchase of a house and for personal
purposes.
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At March 1, 1998, the Company had outstanding loans to W. Bradley Bennett,
the Company's Executive Vice President -- Chief Accounting Officer, aggregating
$231,000. Two such loans in the aggregate principal amount of $181,000 are
unsecured and bear interest at 9%; $125,000, which was loaned in April 1997, is
due April 4, 1998 and the remainder, which was loaned in August 1995, is due
December 31, 1998; the third loan, made in August 1997 in the principal amount
of $50,000, bears interest at 7.5%, is unsecured and is due August 6, 1998. The
largest amount of indebtedness outstanding during fiscal 1997 was $231,000. The
proceeds of the loans were used primarily to finance the purchase of a house.
At March 1, 1998, the Company had outstanding loans to Marshall A. Elkins,
the Company's Executive Vice President and General Counsel, of $894,000. One
such loan, made in March 1998 in the principal amount of $850,000, bears
interest at 6.8%, is unsecured and is due October 1, 2002. The second loan, made
in April 1993 in the principal amount of $44,000, bears interest at 7%, is
unsecured and is due on demand. The largest amount of indebtedness outstanding
during fiscal 1997 was $44,000. The proceeds of the loans were used for personal
purposes.
At March 1, 1998, the Company had outstanding loans to Marc B. Levin, the
Company's Executive Vice President -- Investor Relations, aggregating $967,738.
Two such loans, in the aggregate principal amount of $908,000, are unsecured and
bear interest at 8%; $58,000, which was loaned in June 1997, is due June 25,
2000 and the remainder, which was loaned in October 1997, is due December 31,
2000; two additional loans, one made in May 1995 in the principal amount of
$27,000 and the other made in December 1996 in the principal amount of $12,738,
are unsecured and bear interest at 9%. A fifth loan, made in May 1994 in the
principal amount of $20,000, bears interest at 7.5%, is unsecured, and is due
May 13, 2000. The largest amount of indebtedness outstanding during fiscal 1997
was $967,738. The proceeds of the loans were used for personal purposes.
At March 1, 1998, the Company had outstanding loans to C. Christian Winkle,
the Company's Executive Vice President -- Chief Operating Officer, aggregating
$610,000. One such loan, made in November 1997 in the principal amount of
$600,000, bears interest at 8%, is unsecured and is due November 18, 2000; the
second loan, made in September 1996 in the principal amount of $10,000, bears
interest at 9% and is unsecured. The largest amount of indebtedness outstanding
during fiscal 1997 was $610,000. The proceeds of the loans were primarily used
to finance the construction of a house.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements and Financial Statement Schedules
(1) and (2) See "Index to Consolidated Financial Statements and
Supplemental Schedules" at Item 8 of this Annual Report on Form 10-K.
(3) The following exhibits are filed or incorporated by reference as part
of this Annual Report (Exhibit Nos. 10.27, 10.28, 10.29, 10.30, 10.31, 10.32,
10.33, 10.34, 10.35, 10.36, 10.37, 10.38, 10.39, 10.40, 10.41, 10.42, 10.43,
10.44, 10.45, 10.46, 10.47, 10.48, 10.49, 10.50, 10.51, 10.52, 10.53, 10.74 and
10.76 are management contracts, compensatory plans or arrangements):
2.1 -- Agreement and Plan of Merger, dated as of July 6, 1997, among
Integrated Health Services, Inc., IHS Acquisition XXIV, Inc.
and RoTech Medical Corporation. (1)
2.2 -- Agreement and Plan of Merger, dated as of August 1, 1997, among
Integrated Health Services, Inc., IHS Acquisition XXVI, Inc. and
Community Care of America, Inc. (2)
2.3 -- Purchase and Sale Agreement, entered into as of November 3, 1997,
between HEALTHSOUTH Corporation, Horizon/CMS Healthcare
Corporation and Integrated Health Services, Inc. (3)
3.1 -- Third Restated Certificate of Incorporation, as amended. (4)
3.2 -- Amendment to the Third Restated Certificate of Incorporation,
dated May 26, 1995. (5)
3.3 -- Certificate of Designation of Series A Junior Participating
Cumulative Preferred Stock (6)
3.4 -- By-laws, as amended. (7)
4.1 -- Indenture, dated as of December 1, 1992, between Integrated
Health Services, Inc. and Signet Trust Company, as Trustee,
relating to the Company's 6% Convertible Subordinated Debentures.
(8)
4.2 -- Form of 6% Debenture (included in 4.1). (8)
4.3 -- Indenture, dated as of December 15, 1993, from Integrated Health
Services, Inc., as Issuer, to The Bank of New York (as successor
in interest) to NationsBank of Virginia, N.A., as Trustee,
relating to the Company's 5 3/4% Convertible Senior Subordinated
Debentures due 2001. (9)
4.4 -- Form of 5 3/4% Debenture (included in 4.3) (9)
4.5 -- Registration Rights Agreement, dated as of December 17, 1993,
between Integrated Health Services, Inc. and Smith Barney
Shearson Inc. relating to the Company's 5 3/4% Convertible Senior
Subordinated Debentures due 2001. (9)
4.6 -- Supplemental Indenture dated as of September 15, 1994 between
Integrated Health Services, Inc. and The Bank of New York (as
successor in interest) to NationsBank of Virginia N.A. (10)
4.7 -- Amended and Restated Supplemental Indenture, dated as of May 15,
1997, between Integrated Health Services, Inc. and Signet Trust
Company, Inc., as Trustee, relating to the Company's 10 3/4%
Senior Subordinated Notes due 2004. (11)
4.8 -- Form of Note (included in 4.7). (11)
4.9 -- Second Amended and Restated Supplemental Indenture, dated as of
May 15, 1997, from Integrated Health Service, Inc. to Signet
Trust Company, as trustee, relating to the Company's 9 5/8%
Senior Subordinated Notes due 2002 and 9 5/8% Senior Subordinated
Notes due 2002, Series A. (11)
4.10 -- Form of 9 5/8% Senior Subordinated Notes (included in 4.9). (11)
4.11 -- Indenture, dated as of May 15, 1996 between the Company and
Signet Trust Company, as Trustee. (12)
4.12 -- Form of 10 1/4% Senior Subordinated Notes (included in 4.11).
(12)
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4.13 -- Indenture, dated as of May 30, 1997, between Integrated Health
Services, Inc. and First Union National Bank of Virginia, as
Trustee, relating to the Company's 9 1/2% Senior Subordinated
Notes due 2007. (11)
4.14 -- Form of 9 1/2% Senior Subordinated Note (included in 4.13). (11)
4.15 -- Indenture, dated as of September 11, 1997, between Integrated
Health Services, Inc. and First Union National Bank of Virginia,
as Trustee, relating to the Company's 9 1/4% Senior Subordinated
Notes due 2008. (13)
4.16 -- Form of 9 1/4% Senior Subordinated Note (included in 4.15). (13)
4.17 -- Indenture, dated as of June 1, 1996, between RoTech Medical
Corporation and PNC Bank, Kentucky, Inc., as Trustee, relating to
RoTech's 5 1/4% Convertible Subordinated Debentures due 2003.
(14)
4.18 -- Form of 5 1/4% Convertible Subordinated Debentures (included in
4.17). (14)
10.1 -- Letter dated March 28, 1991 from Integrated Health Services of
Brentwood, Inc., Integrated Health Services, Inc., Alpine Manor,
Inc., Briarcliff Nursing Home, Inc., Cambridge Group, Inc.,
Integrated Health Services of Riverbend, Inc., Integrated Health
Services of Cliff Manor, Inc., Integrated Health Group, Elm Creek
of IHS, Inc., Spring Creek of IHS, Inc., Carriage-By-The-Lake of
IHS, Inc. and Firelands of IHS, Inc. to Meditrust Mortgage
Investments, Inc. (15)
10.2 -- Loan and Security Agreement dated as of May 1, 1990 by and
between Sovran Bank/ Central South and Integrated of Amarillo,
Inc. (15)
10.3 -- Amended and Restated Promissory Note dated April 8, 1991 made by
Integrated of Amarillo, Inc. in favor of Sovran Bank/Tennessee in
the aggregate principal amount of $ 300,000. (15)
10.4 -- Construction Loan Agreement dated November, 1990 by and between
First National Bank of Vicksburg and River City Limited
Partnership. (15)
10.5 -- Guaranty and Suretyship Agreement, dated as of January 1, 1992,
between Integrated Health Services, Inc. and Nationsbank of
Tennessee. (15)
10.6 -- Deed of Trust Note from Integrated Health Services at Alexandria,
Inc. to Oakwood Living Centers of Virginia, Inc., dated June 4,
1993. (16)
10.7 -- Loan Agreement dated as of December 30, 1993, by and among
Integrated Health Services at Colorado Springs, Inc. as Borrower,
Integrated Health Services, Inc., as Guarantor, and Bell Atlantic
Tricon Leasing Corp. (9)
10.8 -- Promissory Note, dated December 30, 1993 made by Integrated
Health Services at Colorado Springs, Inc. in favor of Bell
Atlantic Tricon Leasing Corp. (9)
10.9 -- Guaranty Agreement, dated as of December 30, 1993, made by
Integrated Health Services, Inc. in favor of Bell Atlantic Tricon
Leasing Corp. (9)
10.10 -- Credit Agreement, dated as of May 15, 1996, as amended, by and
among Integrated Health Services, the lenders named therein, and
Citibank, N.A., as administrative agent. (11)
10.11 -- Amendment No. 3 to Revolving Credit Agreement, dated as of May
15, 1996, as amended, among Integrated Health Services, Inc.,
Citibank N.A., as administrative agent thereunder and the other
financial institutions party thereto. (17)
10.12 -- Guaranty by Integrated Health Services, Inc. dated December 16,
1993 to IFIDA Healthcare Group, Ltd., Morris Manor Associates,
Plymouth House Health Care Center, Inc., Chateau Associates,
Broomall Associates, Lake Ariel Associates, Winthrop House
Associates, Limited Partnership, Mill Hill Associates, Limited
Partnership, Hillcrest Associates and Kent Associates, L.P. (8)
10.13 -- Loan Agreement, dated December 20, 1993, by and between
Integrated Health Services at Central Florida, Inc. and
Southtrust Bank of Alabama, National Association. (9)
10.14 -- Mortgage and Security Agreement, dated December 20, 1993, between
Integrated Health Services of Central Florida, Inc. and
Southtrust Bank of Alabama, National Association. (18)
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10.15 -- Guaranty Agreement, dated December 20, 1993, by Integrated Health
Services, Inc. in favor of Southtrust Bank of Alabama, National
Association. (18)
10.16 -- Assignment and Pledge of Deposit Account, dated December 20,
1993, from Integrated Health Services at Central Florida, Inc. in
favor of Southtrust Bank of Alabama, National Association. (18)
10.17 -- Amended and Restated Purchase Option, dated as of October 1,
1992, by and between Integrated Health Services of Green Briar,
Inc. and Skilled Rehabilitative Services, Inc. (8)
10.18 -- Receivables Purchase Agreement, dated as of September 30, 1992,
by and between Skilled Rehabilitative Services, Inc. and
Integrated Health Services of Green Briar, Inc. (8)
10.19 -- Promissory Note, dated October 1, 1992, made by Integrated Health
Services of Green Briar, Inc. to the order of Skilled
Rehabilitative Services, Inc. (8)
10.20 -- Letter dated February 18, 1994, to IFIDA Health Care Group, Ltd.
from Integrated Health Services, Inc. (18)
10.21 -- Facilities Agreement dated as of August 31, 1994 by and among
Litchfield Asset Management Corp., Integrated Health Services of
Lester, Inc and Integrated Health Services, Inc. (19)
10.22 -- First Amendment to Facilities Agreement, dated as of September
30, 1997, among Litchfield Investment Company, L.L.C., Integrated
Health Services of Lester, Inc. and Integrated Health Services,
Inc. (7)
10.23 -- Purchase Option Agreement dated as of August 31, 1994 between
Litchfield Asset Management Corp. and Integrated Health Services
of Lester, Inc. As permitted by the instructions of Item 601 of
Regulation S-K, the 42 additional Purchase Option Agreements
between subsidiaries of Integrated Health Services, Inc. and
Litchfield Asset Management Corp. have been omitted because each
such agreement is substantially identical in all material
respects to the aforementioned Purchase Option. (19)
10.24 -- Guaranty dated as of August 31, 1994 by Integrated Health
Services, Inc. for the benefit of Litchfield Asset Management
Corp. (19)
10.25 -- Warrant to Purchase Shares of Common Stock of Integrated Health
Services, Inc. dated as of August 31, 1994 issued to Litchfield
Asset Management Corp. (19)
10.26 -- Participation Agreement dated as of August 31, 1994 between
Litchfield Asset Management Corp. and Integrated Health Services
of Lester, Inc. (19)
10.27 -- Form of Indemnity Agreement. (15)
10.28 -- Integrated Health Services, Inc. Equity Incentive Plan, as
amended. (20)
10.29 -- Integrated Health Services, Inc. 1990 Employee Stock Option Plan,
as amended. (20)
10.30 -- Integrated Health Services, Inc. 1992 Stock Option Plan (20)
10.31 -- Integrated Health Services, Inc. Employee Stock Purchase Plan
(20)
10.32 -- Senior Executives' Stock Option Plan. (21)
10.33 -- Cash Bonus Replacement Plan (22)
10.34 -- Integrated Health Services, Inc. Stock Option Plan for New
Non-Employee Directors, as amended. (23)
10.35 -- Integrated Health Services, Inc. Stock Option Compensation Plan
for Non-Employee Directors, as amended. (23)
10.36 -- Integrated Health Services, Inc. 1995 Stock Option Plan for
Non-Employee Directors. (23)
10.37 -- Stock Option Agreement, dated as of November 27, 1995, by and
between Integrated Health Services, Inc. and John Silverman. (23)
10.38 -- Integrated Health Services, Inc. 1994 Stock Incentive Plan, as
amended. (23)
10.39 -- 1996 Stock Incentive Plan of Integrated Health Services, Inc., as
amended. (7)
10.40 -- 1998 Stock Compensation Plan. (7)
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10.41 -- Integrated Health Services, Inc. Amended and Restated Key
Employee Supplemental Executive Retirement Plan ("Plan A"). (7)
10.42 -- Integrated Health Services, Inc. Supplemental Executive
Retirement Plan ("Plan B") (24)
10.43 -- Integrated Health Services, Inc. Supplemental Deferred
Compensation Plan ("Plan Z") (24)
10.44 -- Employment Agreement dated January 1, 1994 between Integrated
Health Services, Inc. and Robert N. Elkins. (25)
10.45 -- Amendment No. 1 to Employment Agreement dated as of January 1,
1995 between Integrated Health Services, Inc. and Robert N.
Elkins. (25)
10.46 -- Amendment No. 2 to Employment Agreement, effective as of November
18, 1997, between Integrated Health Services, Inc. and Robert N.
Elkins. (7)
10.47 -- Supplemental Agreement, effective as of November 18, 1997, by and
between Integrated Health Services, Inc. and Robert N. Elkins.
(7)
10.48 -- Promissory Note, dated September 29, 1997, made by Robert N.
Elkins in favor of Integrated Health Services, Inc. (7)
10.49 -- Employment Agreement dated as of January 1, 1994 between
Integrated Health Services, Inc. and Lawrence P. Cirka. (25)
10.50 -- Amendment to Employment Agreement dated as of January 1, 1995
between Integrated Health Services, Inc. and Lawrence P. Cirka.
(25)
10.51 -- Relocation Agreement, dated as of August 5, 1997, between
Integrated Health Services, Inc. and Lawrence P. Cirka. (7)
10.52 -- Employment Agreement dated as of October 1, 1996 between
Integrated Health Services, Inc. and C. Christian Winkle.(26)
10.53 -- Employment Agreement, dated as of October 21, 1997, between
RoTech Medical Corporation and Stephen Griggs. (7)
10.54 -- Revolving Credit and Security Agreements, dated as of December
30, 1992, between Integrated Health Services, Inc. and Morgan
Hill Health Care Investors, Inc. (27)
10.55 -- Purchase Option and Right of First Refusal Agreement, dated
January 20, 1993, among Integrated Health Services of Missouri,
Inc., Dominic F. Tutera, Joseph C. Tutera, and Michael J. Tutera.
(27)
10.56 -- Purchase Option and Right of First Refusal Agreement dated
January 20, 1993, between Integrated Health Services of Missouri,
Inc. and Dominic F. Tutera. (27)
10.57 -- Revolving Credit and Security Agreement dated January 20, 1993,
between Integrated Health Services of Missouri, Inc. and Cenill,
Inc. (27)
10.58 -- Guaranty dated July 1, 1992 made by Integrated Health Services,
Inc. (27)
10.59 -- Guaranty dated September 15, 1992 made by Integrated Health
Services, Inc. (27)
10.60 -- Aircraft Lease Agreement between RNE Skyview LLC and Integrated
Health Services, Inc., dated as of December 12, 1997. (7)
10.61 -- Assignment Agreement dated May 28, 1993 among Square D Company,
Integrated Health Services, Inc., Manekin at Owings Mills I
Limited Partnership, and McDonough School, Inc. (16)
10.62 -- Assignment dated June 1, 1993 among Integrated Health Services,
Inc., Rouse-Teachers Properties, Inc., Rouse Office Management,
Inc. and Square D Company. (16)
10.63 -- Investment Agreement for Speciality Care PLC dated July 26, 1995.
(24)
10.64 -- Credit Amendment, dated as of September 15, 1997, by and among
Integrated Health Services, Inc., the lenders named therein, and
Citibank, N.A., as administrative agent. (28)
10.65 -- Amendment No. 1 dated as of December 1, 1997, to the Revolving
Credit and Term Loan Agreement among Integrated Health Services,
Inc., the lenders parties to the Credit Agree- ment and Citbank,
N.A., as administrative agent for the lenders. (29)
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10.66 -- Settlement Agreement and Mutual Release, made and entered into as
of Monday, May 5, 1997, by and between Integrated Health
Services, Inc. and Coram Healthcare Corporation.(17)
10.67 -- Purchase Agreement, dated as of January 13, 1998, between Omega
Healthcare Investors, Inc. and Gainesville Health Care Center,
Inc., Rest Haven Nursing Center (Chestnut Hill), Inc., Rikad
Properties, Inc., Integrated Management-Governor's Park, Inc. and
Lyric Health Care LLC and Lyric Health Care Holdings, Inc. (7)
10.68 -- Master Franchise Agreement, dated as of January 13, 1998, between
Integrated Health Services Franchising Co., Inc. and Lyric Health
Care LLC. (7)
10.69 -- Master Management Agreement, dated as of January 13, 1998,
between Lyric Health Care LLC and IHS Facility Management, Inc.
(7)
10.70 -- Indemnity Agreement, dated as of January 13, 1998 by and between
Integrated Health Services, Inc. and Omega Healthcare Investors,
Inc. (7)
10.71 -- Master Lease, dated as of January 13, 1998, between Omega
Healthcare Investors, Inc. and Lyric Health Care Holdings, Inc.
(7)
10.72 -- Amended and Restated Operating Agreement of Lyric Health Care
LLC, dated as of February 1, 1998, by and between Integrated
Health Services, Inc. and TFN Healthcare Investors, LLC. (7)
10.73 -- Employment Agreement, effective as of February 1, 1998, by and
between Lyric Health Care LLC and Timothy F. Nicholson. (7)
10.74 -- Warrant to purchase shares issued to Shephen Griggs. (7)
10.75 -- Share Acquisition Agreement relating to Speciality Care Limited.
(7)
10.76 -- Employment Agreement dated as of June 1, 1994 between Integrated
Health Services, Inc. and Anthony Masso. (26)
21 -- Subsidiaries of Registrant. (7)
23.1 -- Consent of KPMG Peat Marwick LLP.
27 -- Financial Data Schedule. (7)
- ----------
(1) Incorporated herein by reference to the Company's Current Report on Form
8-K dated July 6, 1997.
(2) Incorporated herein by reference to the Company's Tender Offer Statement on
Schedule 14D-1 filed with the Securities and Exchange Commission on August
7, 1997.
(3) Incorporated herein by reference to the Company's Current Report on Form
8-K dated November 3, 1997.
(4) Incorporated by reference to the Company's Registration Statement on Form
S-3, Nos 33-77754, effective June 29, 1994.
(5) Incorporated by reference to the Company's Registration Statement on Form
S-4, No. 33-94130, effective September 15, 1995.
(6) Incorporated by reference to the Company's Current Report on Form 8-K dated
September 27, 1995.
(7) Filed with the Company's Annual Report on Form 10-K for the year ended
December 31, 1997.
(8) Incorporated by reference to the Company's Registration Statement on Form
S-3, No. 33-54458, effective December 9, 1992.
(9) Incorporated by reference to the Company's Registration Statement on Form
S-3, No. 33-76322, effective June 29, 1994.
(10) Incorporated by reference to the Company's Registration Statement on Form
S-3, No. 33-81378, effective September 21, 1994.
(11) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the period ended June 30, 1997.
(12) Incorporated by reference to the Company's Quarterly Report on From 10-Q
for the period ended June 30, 1994.
(13) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the period ended September 30, 1997.
(14) Incorporated by reference to RoTech Medical Corporation's Registration
Statement on Form S-3, No. 333-10915, effective September 10, 1996.
(15) Incorporated by reference to the Company's Registration Statement on Form
S-1, No. 33-39339, effective April 25, 1991.
(16) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the period ended June 30, 1993.
(17) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the period ended March 31, 1997.
(18) Incorporated by reference the Company's Annual Report on Form 10-K for the
year ended December 31, 1993.
(19) Incorporated by reference to the Company's Current Report on Form 8-K dated
August 31, 1994.
116
<PAGE>
(20) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the period ended June 30, 1992.
(21) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the period ended March 31, 1994.
(22) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the period ended June 30, 1995.
(23) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the period ended September 30, 1996.
(24) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 1995.
(25) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the period ended March 31, 1996.
(26) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 1996.
(27) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 1992.
(28) Incorporated by reference from the Company's Current Report on 8-K dated
September 15, as amended.
(29) Incorporated by reference to the Company's Current Report on Form 8-K,
dated December 31, 1993.
(b) Reports on Form 8-K
(1) Current Report on Form 8-K dated October 21, 1997, as amended,
reporting the Company's acquisition of RoTech Medical Corporation.
(2) Current Report on Form 8-K dated November 3, 1997, as amended,
reporting the Company's agreement to purchase 139 owned, leased or managed
long-term care facilities, 12 specialty hospitals and certain other
businesses from HEALTHSOUTH Corporation.
(3) Current Report on Form 8-K dated December 31, 1997, as amended,
reporting the acquisition of 139 owned, leased or managed long-term care
facilities, 12 specialty hospitals and certain other businesses from
HEALTHSOUTH Corporation;
(c) Exhibits
See (a) (3) above.
(d) Financial Statement Schedules
See "Index to Consolidated Financial Statements and Supplemental
Schedule" at Item 8 of this Annual Report on Form 10-K. Schedules not
included herein are omitted because they are not applicable or the
required information appears in the Consolidated Financial Statements
or notes thereto.
117
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
INTEGRATED HEALTH SERVICES, INC.
(Registrant)
By: /s/ C. Taylor Pickett
------------------------------------
C. Taylor Pickett
May 28, 1998 Executive Vice President--
Chief Financial Officer
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to incorporation by reference in the registration statements
(Nos. 33-44648, 33-44649, 33-44650, 33-44651, 33-44653, 33-53914, 33-53912,
33-53916, 33-86684, 33-97190, 333-01432, 333-28289, 333-28293, 333-28317,
333-28321 and 333-47853) on Form S-8 and (Nos. 33-66126, 33-68302, 33-77380,
33-81378, 33-87890, 33-98764, 333-4053, 333-12685, 333-31121, 333-35577,
333-35851, 333-41973 and 333-42169) on Forms S-3 or S-4 of Integrated Health
Services, Inc. of our report dated March 25, 1998, relating to the consolidated
balance sheets of Integrated Health Services, Inc. and subsidiaries as of
December 31, 1996 and 1997 and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1997 and the related schedule, which report
appears in the December 31, 1997 annual report on Form 10-K of Integrated Health
Services, Inc., as amended by Form 10-K/A filed on May 29, 1998.
Our report refers to changes in accounting methods, in 1995, to adopt
Statement of Financial Accounting Standards No. 121 relating to impairment of
long-lived assets and, in 1996, from deferring and amortizing pre-opening costs
of medical specialty units to recording them as expenses when incurred.
KPMG PEAT MARWICK LLP
Baltimore, Maryland
May 29, 1998