<PAGE>
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------------
FORM 10-Q
-------------------------------
(Mark One)
X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
-----
Exchange Act of 1934
For the quarterly period ended March 31, 1994
or
Transition Report Pursuant to Section 13 or 15(d) of the Securities
-----
Exchange Act of 1934
Commission file number 0-15088
CONTINENTAL MEDICAL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 51-0287965
(State of incorporation) (I.R.S. Employer Identification No.)
600 Wilson Lane
P.O. Box 715
Mechanicsburg, PA 17055
Telephone Number (717) 790-8300
___________________________________
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 _____
-----
As of April 29, 1994, there were 38,320,207 shares of the Registrant's $.01 par
value Common Stock outstanding.
================================================================================
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Index
Form 10-Q - For the Quarter ended March 31, 1994
- - --------------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page No.
--------
<C> <S> <C>
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets
March 31, 1994 and June 30, 1993...................... 1
Consolidated Statements of Income
Three months and nine months ended March 31, 1994
and 1993.............................................. 2
Consolidated Statement of Stockholders' Equity
Nine months ended March 31, 1994...................... 3
Consolidated Statements of Cash Flows
Nine months ended March 31, 1994 and 1993............. 4-5
Notes to Consolidated Financial Statements............ 6-8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 9-18
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K...................... 19
Signature ..................................................... 20
</TABLE>
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
March 31, 1994 and June 30, 1993
<TABLE>
<CAPTION>
March 31, June 30,
Assets 1994 1993
- - ------------------------------------------------------------------------
(In thousands, except share data)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 50,169 $ 64,444
Accounts receivable,
net of allowance for doubtful
accounts ($15,837, March 31,
1994 and $17,426, June 30, 1993) 249,198 220,122
Other receivables 11,488 10,801
Prepaid income taxes 3,412
Deferred income taxes 9,000 5,062
Prepaid expenses 14,899 14,243
-------- --------
334,754 318,084
-------- --------
Property and equipment, net 286,442 289,822
-------- --------
Other:
Goodwill, net 74,567 58,461
Investments 19,653 16,694
Notes receivable 29,740 29,461
Deferred income taxes 2,847
Deferred costs, new
facilities, net 21,945 28,634
Other assets 31,270 28,225
-------- --------
177,175 164,322
-------- --------
$798,371 $772,228
======== ========
Liabilities and Stockholders' Equity
- - ------------------------------------------------------------------------
Current liabilities:
Current portion of long-term debt $ 3,784 $ 3,809
Current portion of deferred income 899 1,163
Accounts payable 25,193 27,515
Accrued expenses 78,527 64,602
Due to third-party payors 12,972 13,857
Income taxes payable 1,800
-------- --------
123,175 110,946
Long-term debt, net of current portion 374,619 382,602
Deferred income 2,839 3,549
Deferred income taxes 1,500
Other liabilities 2,943 4,005
-------- --------
505,076 501,102
-------- --------
Minority interests 15,239 13,430
-------- --------
Commitments and Contingencies (Note 4)
Stockholders' equity:
Preferred stock, $.01 par;
authorized 10,000,000 shares;
none issued
Common stock, $.01 par; authorized
80,000,000 shares; 37,639,219
shares issued and outstanding,
March 31, 1994 (36,934,546,
June 30, 1993) 376 369
Capital in excess of par 185,009 180,187
Retained earnings 92,671 77,140
-------- --------
278,056 257,696
-------- --------
$798,371 $772,228
======== ========
</TABLE>
See notes to consolidated financial statements.
1
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Consolidated Statements of Income
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
1994 1993 1994 1993
- - --------------------------------------------------------------------------------------------------------------------------
(In thousands, except per share data)
<S> <C> <C> <C> <C>
Net operating revenues $ 252,986 $ 232,305 $ 751,789 $ 660,730
---------- ---------- ---------- ----------
Costs and expenses:
Cost of services 220,472 197,433 649,935 562,288
General and administrative 5,843 4,548 17,699 13,995
Interest expense 9,685 5,855 28,688 14,147
Depreciation and amortization 9,710 7,588 28,486 21,025
---------- ---------- ---------- ---------
245,710 215,424 724,808 611,455
---------- ---------- ---------- ---------
Income from operations 7,276 16,881 26,981 49,275
Other income, principally interest 776 629 2,538 1,941
Merger expenses (2,598) (2,598)
---------- ---------- ---------- ---------
Income before minority interests and
income taxes 8,052 14,912 29,519 48,618
Minority interests (1,042) (1,910) (3,416) (4,818)
---------- ---------- ---------- ---------
Income before income taxes 7,010 13,002 26,103 43,800
Income taxes 2,840 5,238 10,572 16,945
---------- ---------- ---------- ---------
Net income $ 4,170 $ 7,764 $ 15,531 $ 26,855
========== ========== ========== =========
Net income per common share and common
equivalent share (Note 5):
Primary $ .11 $ .20 $ .40 $ .70
========== ========== ========== =========
Fully diluted $ .11 $ .20 $ .40 $ .70
========== ========== ========== =========
Weighted average number of shares outstanding:
Primary 38,519,146 38,015,025 38,181,307 37,913,960
Fully diluted 38,835,178 38,248,670 38,609,729 38,147,605
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Consolidated Statement of Stockholders' Equity
Nine Months Ended March 31, 1994
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Common Stock
------------------- Capital
Shares in excess Retained
issued Amount of par earnings Total
-----------------------------------------------------
(In thousands, except shares issued)
<S> <C> <C> <C> <C> <C>
Balance, July 1, 1993 36,934,546 $369 $180,187 $77,140 $257,696
Stock issued pursuant to:
Employee benefit plans 212,666 2 1,278 1,280
Acquisition agreements 492,007 5 3,544 3,549
Net income for the nine months 15,531 15,531
---------- ---- -------- ------- --------
Balance, March 31, 1994 37,639,219 $376 $185,009 $92,671 $278,056
========== ==== ======== ======= ========
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Nine Months Ended
March 31,
1994 1993
- - --------------------------------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 15,531 $ 26,855
--------- ---------
Adjustments:
Depreciation and amortization 28,486 21,025
Other (222) 4,427
Increase (decrease) in cash from changes in assets and liabilities,
excluding effects of acquisitions and dispositions:
Accounts receivable (28,705) (65,993)
Other assets (7,212) (8,362)
Accounts payable and accrued expenses 10,522 8,017
Other liabilities (2,921) (4,708)
Income taxes 6,557 (4,358)
--------- ---------
Total adjustments 6,505 (49,952)
--------- ---------
Net cash provided by (used in) operating activities 22,036 (23,097)
--------- ---------
Cash flows from investing activities:
Payments pursuant to acquisition agreements, net of cash acquired (14,689) (51,247)
Cash proceeds from sale of property and equipment 13,835
Deferred costs, new facilities (1,839) (10,228)
Acquisition of property and equipment (20,857) (117,965)
Notes receivable (279) (9,226)
Other investing activities (2,975) (8,535)
--------- ---------
Net cash used in investing activities (26,804) (197,201)
--------- ---------
Cash flows from financing activities:
Long-term debt borrowing 88,329 499,292
Long-term debt repayment (97,291) (279,399)
Deferred financing costs (910) (12,006)
Issuance of common stock 1,280 5,923
Capital contributions by minority interests 1,608 502
Dividends of pooled company (183)
Distributions to minority interests (2,523) (1,840)
--------- ---------
Net cash provided by (used in) financing activities (9,507) 212,289
--------- ---------
Decrease in cash and cash equivalents (14,275) (8,009)
Cash and cash equivalents, beginning of period 64,444 35,426
--------- ---------
Cash and cash equivalents, end of period $ 50,169 $ 27,417
========= =========
</TABLE>
4
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Cont'd)
<TABLE>
<CAPTION>
Nine Months Ended
March 31,
1994 1993
- - --------------------------------------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest, net of amounts capitalized ($1,500 and $4,464
in fiscal 1994 and 1993, respectively) $ 31,058 $ 11,128
========= =========
Income taxes $ 4,785 $ 23,082
========= =========
Supplemental schedule of noncash investing and financing activities:
The company issued stock pursuant to various acquisition agreements $ 3,549 $ 3,105
======== =========
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
________________________________________________________________________________
1. Basis of presentation:
In the opinion of the Company, the accompanying interim consolidated financial
statements present fairly the Company's financial position at March 31, 1994,
the results of its operations, and its cash flows for the three and nine month
periods then ended. All adjustments are of a normal and recurring nature.
These statements are presented in accordance with the rules and regulations of
the United States Securities and Exchange Commission ("SEC"). Accordingly, they
are unaudited, and certain information and footnote disclosures normally
included in the Company's annual consolidated financial statements have been
condensed or omitted, as permitted under the applicable rules and regulations.
Readers of these statements should refer to the Company's audited consolidated
financial statements and notes thereto which were presented in the Company's
1993 Annual Report to Stockholders and incorporated by reference in its Form
10-K for the year ended June 30, 1993. The results of operations presented in
the accompanying financial statements are not necessarily representative of
operations for an entire year due to, among other things, new hospital
development, acquisitions, interest rate changes and fluctuations in effective
tax rates. Comparisons to the prior year might also be affected for similar
reasons. Certain items in the fiscal 1993 financial statements have been
reclassified to conform to the classifications in the fiscal 1994 financial
statements.
2. Long-term debt:
On December 31, 1993, the Company amended its credit facility with Citibank,
N.A., as agent for a group of several banks. The amendment extended the
revolving loan period under the facility to December 31, 1996, increased the
commitments under the credit facility from $225,000,000 to $235,000,000 and
amended certain financial covenants.
3. Income taxes:
Effective July 1, 1993, the Company adopted Statement of Financial Accounting
Standards No. 109 (FAS 109), Accounting for Income Taxes. The adoption of FAS
109 changes the Company's method of accounting for income taxes from the
deferred method (APB 11) to an asset and liability approach. Previously the
Company deferred the past tax effects of timing differences between financial
reporting and taxable income. The asset and liability approach requires the
recognition of deferred tax liabilities and assets for the expected future tax
consequences of temporary differences between the carrying amounts and the tax
bases of other assets and liabilities. As permitted by this new accounting
standard, the Company has elected not to restate the financial statements of
prior years. The cumulative effect of adopting FAS 109 was not material; in
addition, there was no effect on pre-tax income for this prospective adoption.
6
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
________________________________________________________________________________
3. Income taxes (continued):
<TABLE>
<CAPTION>
Deferred tax liabilities (assets) were comprised of the following at July 1,
1993 (in thousands):
<S> <C>
Deferred tax liabilities:
Depreciation $ 3,939
Other 1,574
-------
Total 5,513
-------
Deferred tax assets:
Development and pre-opening costs (1,461)
Bad debt reserves (6,448)
Investment valuations (2,353)
Malpractice accrual (1,218)
Health insurance accrual (648)
Deferred revenue (1,691)
Accrued vacation pay (1,564)
Other (2,053)
--------
Total
(17,436)
--------
Valuation allowance for deferred tax assets 671
---------
Excess deferred tax assets over liabilities ($11,252)
=========
</TABLE>
The valuation allowance is the result of the uncertain state tax benefits
resulting from states requiring separate return filings and with no loss
carryover provisions.
On August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 increased the
top corporate tax rate from 34% to 35% effective retroactive to January 1, 1993.
The effects of this tax law change were not material to the Company's net
deferred tax assets and are included in the operating income tax provision.
4. Contingencies:
During the second quarter of fiscal 1994, the Company terminated certain
contractual arrangements in its contract therapy business with certain third
party providers. As a result, the Company is potentially subject to increased
credit risk with regard to the accounts receivable related to the former
arrangements. The Company is currently negotiating with these payors to secure
payment of these receivables. However, the Company is unable to estimate the
ultimate outcome of these negotiations and its subsequent collections. The
receivable net of allowances related to these arrangements at March 31, 1994 is
$15,600,000.
The Company guarantees payment throughout the term of a bond issue to an
economic development authority of amounts due and payable by the owner of a
long-term care facility previously managed by the Company. The outstanding
bonds totalled approximately $6,177,000 at March 31, 1994.
7
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
________________________________________________________________________________
4. Contingencies (continued):
Outstanding letters of credit aggregated approximately $27,149,000 at March 31,
1994.
The Company is subject to legal proceedings and claims which have arisen in the
ordinary course of its business and have not been finally adjudicated, including
without limitation malpractice claims covered under the Company's insurance
policies. In the opinion of management, after consulting with company counsel,
the outcome of these actions will not have a material effect on the financial
position or results of operations of the Company.
5. Earnings per share:
Net income per common and common equivalent share is based upon the weighted
average number of common shares outstanding during the period plus the effect of
common shares contingently issuable, primarily from stock options and
acquisition agreements requiring the issuance of shares contingent on future
earnings.
Fully diluted earnings per share are determined on the assumption that the
7 3/4% convertible subordinated debentures were converted July 1, 1992. Net
income was adjusted for the interest on the debentures, net of the related
income tax benefits.
8
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Form 10-Q -- For the Quarter ended March 31, 1994
________________________________________________________________________________
Overview
The Company's results of operations for the three and nine months ended March
31, 1994 and 1993 reflect the growth of the Company's contract therapy
businesses as well as the development of new inpatient hospitals and outpatient
facilities. This discussion should be read in conjunction with the Management's
Discussion and Analysis of Financial Condition and Results of Operations
presented in the Company's fiscal 1993 Annual Report to Stockholders and
incorporated by reference in its Form 10-K for the fiscal year ended June 30,
1993.
During the nine months ended March 31, 1993, the Company began construction of
three new inpatient rehabilitation hospitals and commenced operations at four
inpatient rehabilitation hospitals adding 227 beds. In addition, the Company
opened 33 outpatient clinics. During the remainder of the fiscal year, the
Company opened two new inpatient rehabilitation hospitals adding 120 beds and
opened 6 outpatient clinics. In February 1993, the Company acquired Kron
Medical Corporation ("Kron"), a physician/locum tenens business. The
acquisition of Kron was accounted for as a pooling of interests, and
accordingly, the Company's financial results have been restated to include the
results of Kron prior to February 1993.
During the nine months ended March 31, 1994, the Company opened three new
inpatient rehabilitation hospitals adding 166 beds and opened 26 outpatient
clinics. In addition, construction began on an inpatient rehabilitation
hospital which will be operated by a joint venture controlled by the Company.
The real estate to this project will be financed by third parties and owned by a
partnership in which the Company has a minority interest. At March 31, 1994,
there were two rehabilitation hospitals, including the previously mentioned
hospital owned through a partnership, with 108 beds under construction.
9
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Form 10-Q -- For the Quarter ended March 31, 1994
________________________________________________________________________________
Results of operations
The following table sets forth, for the periods indicated, the relative
percentages of net operating revenues which certain items in the Company's
Consolidated Statements of Income represent.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
1994 1993 1994 1993
- - ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net operating revenues 100.0% 100.0% 100.0% 100.0%
------ ------ ------ ------
Costs and expenses:
Cost of services 87.2 85.0 86.4 85.1
General and administrative 2.3 2.0 2.4 2.1
Interest expense 3.8 2.5 3.8 2.1
Depreciation and amortization 3.8 3.3 3.8 3.2
----- ----- ----- -----
97.1 92.8 96.4 92.5
----- ----- ----- -----
Income from operations 2.9 7.2 3.6 7.5
Other income (expenses):
Income, principally interest .3 .3 .3 .3
Merger expenses (1.1) (.4)
----- ----- ----- -----
Income before minority interests
and income taxes 3.2 6.4 3.9 7.4
Minority interests (.4) (.8) (.4) ( .7)
----- ----- ----- -----
Income before income taxes 2.8 5.6 3.5 6.7
Income taxes 1.1 2.3 1.4 2.6
----- ----- ----- -----
Net income 1.7% 3.3% 2.1% 4.1%
===== ===== ===== =====
</TABLE>
The federal government as well as state governments continue to discuss, propose
and implement various measures to control rising healthcare costs, improve
quality and provide funding for those who currently lack health insurance.
Moreover, within the private sector the healthcare delivery system is
experiencing rapidly changing market conditions primarily attributable to
increased competition and the increased influence of managed care on pricing and
utilization. The Company cannot predict how these regulatory and market changes
will affect future operating results.
10
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Form 10-Q -- For the Quarter ended March 31, 1994
________________________________________________________________________________
Results of Operations (continued)
Net operating revenues:
Net operating revenues for the third quarter of fiscal 1994 increased by 9% to
$252,986,000 from $232,305,000 for the same period of the prior year. During
the nine months ended March 31, 1994, net operating revenues increased 14% to
$751,789,000 from $660,730,000 for the same period in the prior year. The
following table summarizes the net operating revenues for each of the Company's
operating groups (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, Increase March 31, Increase
1994 1993 (Decrease) 1994 1993 (Decrease)
- - -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Rehabilitation group:
Hospitals (Fiscal year of opening):
Pre-1993 (28 hospitals) $107,306 $118,872 (10%) $321,737 $343,014 (6%)
1993 Openings (6 hospitals) 17,552 7,399 137% 51,147 15,491 230%
1994 Openings (3 hospitals) 7,748 N/A N/A 16,458 N/A N/A
-------- -------- -------- --------
132,606 126,271 5% 389,342 358,505 9%
Other rehab related 4,037 3,239 25% 14,037 8,375 68%
-------- -------- -------- --------
Total 136,643 129,510 6% 403,379 366,880 10%
-------- -------- -------- --------
Contract services group:
Physician services 22,165 24,199 (8%) 71,535 75,192 (5%)
Contract therapy 90,349 76,567 18% 265,781 207,276 28%
-------- -------- -------- --------
112,514 100,766 12% 337,316 282,468 19%
-------- -------- -------- --------
Other 3,829 2,029 89% 11,094 11,382 (3%)
-------- -------- -------- --------
$252,986 $232,305 9% $751,789 $660,730 14%
======== ======== ======== ========
</TABLE>
"Other rehab related" revenues referred to in the above table include revenues
from unit management and certain outpatient operations. Both the rehabilitation
hospital group and the contract therapy services offer outpatient rehabilitation
services. "Other" revenues referred to in the above table consist principally
of revenues from long-term care operations at two rehabilitation inpatient
hospitals and Medicare reimbursement of certain home office costs which comprise
general and administrative costs.
11
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Form 10-Q -- For the Quarter ended March 31, 1994
________________________________________________________________________________
Results of Operations (continued)
Rehabilitation hospital group:
The increases in net operating revenues generated by the rehabilitation hospital
group resulted from new hospital openings. Net operating revenues generated by
the Company's 28 rehabilitation hospitals opened prior to fiscal 1993 (the "Pre-
1993 Hospitals") declined 10% and 6% during the three and nine months ended
March 31, 1994, respectively, as compared to the prior year. These declines are
principally due to lower revenue per patient day caused by the conversion of
acute rehabilitation beds to transitional unit beds, lower costs which reduces
cost based Medicare reimbursement, lower inpatient length of stays, and
competitive pricing pressures from Non-Medicare payors. Revenues in fiscal 1994
as compared to fiscal 1993 were also affected by severe weather which occurred
in the third quarter and the benefit of third party payor settlements
reflected in fiscal 1993 revenues.
The Company is a provider to managed care payors in many of its markets.
Managed care programs are designed to encourage more efficient and less costly
utilization of medical services. Additionally, managed care payors are
increasingly involved in negotiating discounted or per diem rates directly with
the Company's rehabilitation hospitals which have adversely affected the revenue
growth and operating margins of the rehabilitation hospital group. The Company
is responding to managed care penetration by reducing costs through several
measures including the introduction of a new acuity based staffing model
within the hospitals, which resulted in a reduction of staff, and a change in
its therapy delivery model. The Company is also establishing cost accounting
systems as well as outcomes documentation and resource consumption information
in order to demonstrate the cost effectiveness of rehabilitation services. The
Company believes this data will be instrumental in its ability to negotiate
with managed care payors.
The Company has opened 19 transitional units, with a total of 261 beds, within
its Hospitals since March 31, 1993. Transitional units provide a lower level of
care and consequently generate significantly lower revenues per occupied bed
than an acute rehabilitation bed. However, there are less costs related to
providing the transtional services. The Company believes that its
transitional units will increase its overall inpatient utilization at its
hospitals and expand its continuum of services at various levels of care and
cost, an important factor in dealing with managed care payors. The Company
believes the transitional units enable it to more effectively compete with
other rehabilitation providers, including general acute care hospital based
rehabilitation units, sub-acute units, skilled nursing facilities and other
providers. The Company plans to open additional transitional units in the
future.
Following are selected statistics for the Pre-1993 Hospitals:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
1994 1993 % Change 1994 1993 % Change
- - ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Occupancy percentage 66.8% 69.1% (3%) 64.1% 67.5% (5%)
Admissions 5,389 4,903 10% 15,272 14,634 4%
Average length of stay (days) 21.5 23.4 (8%) 22.0 23.5 (6%)
Patient days 114,328 115,861 (1%) 333,244 344,628 (3%)
Outpatient treatments 627,993 619,518 1% 1,957,163 1,742,016 12%
Outpatient % of net revenue 16.9% 17.3% (2%) 17.9% 16.8% 7%
</TABLE>
12
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Form 10-Q - For the Quarter ended March 31, 1994
________________________________________________________________________________
Results of Operations (continued)
Rehabilitation hospital group (continued):
Occupancy percentage for the Pre-1993 Hospitals for the three months ended March
31, 1994 was 66.8% as compared to 69.1% during the same period in the prior
year. These same facilities' occupancy percentage for the nine months ended
March 31, 1994 was 64.1% as compared to 67.5% during the same period in the
prior year. These declines in occupancy percentage from fiscal 1993 were due to
a lower patient average length of stay in fiscal 1994 - 21.5 days and 22 days
for the three and nine months ended March 31, 1994, respectively, as compared to
23.4 days and 23.5 days for the three and nine months ended March 31, 1993,
respectively. Average length of stay declined, in part, due to cost control,
case management review and efficiencies in treatments as the
Company's hospitals mature. However, due to changes in reimbursement methods,
such as the Tax Equity and Fiscal Responsibility Act ("TEFRA") regulations, the
number of admissions in addition to occupancy percentages and average length of
stay are important in monitoring the results of these hospitals as revenue
growth becomes increasingly dependent upon patient volume. The lower patient
average length of stay in both the three and nine month periods was partially
offset by increases in admissions of 10% and 4% in the three and nine months
ended March 31, 1994, respectively, as compared to the prior period.
The timing of new hospital openings during fiscal 1993 makes a comparison of
occupancy percentages for the three and nine month periods ended March 31, 1994
with the comparable periods in the prior fiscal year for these hospitals not
meaningful. The rehabilitation hospitals opened in fiscal 1993 (the "1993
Hospitals") increased their patient days to 22,957 for the three months ended
March 31, 1994 from 9,397 for the three months ended March 31, 1993. The 1993
Hospitals increased their patient days to 64,315 for the nine months ended March
31, 1994 from 19,140 for the same period of the prior year. The occupancy
percentages for the 1993 Hospitals for the three and nine months ended March 31,
1994 were 73% and 68%, respectively. The occupancy percentages for
rehabilitation hospitals opened in fiscal 1994 (the "1994 Hospitals") were 50%
and 40% for the three and nine months ended March 31, 1994, respectively. The
1994 Hospitals' patient days were 8,019 and 16,016 for the three and nine months
ended March 31, 1994, respectively.
Total outpatient treatments for the rehabilitation hospital group for the three
months ended March 31, 1994 rose to 740,949, a 17% increase over 635,298
provided in the same period of the prior year. For the nine months ended March
31, 1994, outpatient treatments were 2,233,724, a 26% increase over the same
period of the prior year. Outpatient services represented approximately 15% and
16% of the rehabilitation group's net operating revenues for the comparative
three month periods ended March 31, 1994 and 1993, respectively, and 16%
for both the nine months ended March 31, 1994 and 1993. While the
volume of outpatient treatments continue to increase, partially as a result of
shorter inpatient length of stays, pricing of outpatient services has declined
over the prior year due to several factors including changes in the Company's
marketing strategy, regulatory pricing changes in some states, and changes in
selected states' workers compensation programs.
The percentage of net operating revenues generated by Medicare/Medicaid patients
at the rehabilitation hospitals was 65% and 62% for the three months ended March
31, 1994 and 1993, respectively, and 63% and 62% for the nine months ended March
31, 1994 and 1993, respectively.
13
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Form 10-Q - For the Quarter ended March 31, 1994
________________________________________________________________________________
Results of Operations (continued)
Contract services group:
Contract therapy services:
The increases in net operating revenues generated by the contract therapy
companies resulted from same company growth through the addition of new
contracts with both existing and new providers. The net number of facilities
served remained relatively unchanged over the same period in the prior year.
The Company continues to add contracts with new facilities and terminate
business with certain facilities that do not meet the Company's profitability
objectives. The contract therapy companies now serve over 1,900 facilities.
Approximately 79% of the net operating revenues in both the three and nine
months ended March 31, 1994, and 73% of the net operating revenues in both the
three and nine months ended March 31, 1993, were generated through the provision
of therapist services to skilled nursing facilities, while the remainder was
generated by therapy services to hospitals, schools, clinics and other
institutions.
The percentage of net operating revenues generated from direct services to
Medicare/Medicaid patients was 20% for both the three and nine months ended
March 31, 1994. This represents an increase from 17% for both the three and
nine months ended March 31, 1993. The principal reason for the increases in
fiscal 1994 is the Company's decision to terminate its contractual arrangements
with certain third party providers. Under these arrangements, the Company
provided therapy services to Medicare patients through a certified intermediary.
As a result of terminating these arrangements, the Company, in many instances,
now provides the same services directly to Medicare patients.
During the three months ended March 31, 1994, the group's earnings have declined
compared to the prior year, primarily due to lower contract respiratory
services revenues as a result of changes in reimbursement in the state of
Indiana in December 1993. Earnings for the group for the nine months ended
March 31, 1994 were impacted, in addition to the above, by lower productivity
per therapist, partially as a result of turnover and the consolidation of two
of the Company's contract services companies, and severe weather which
affected the group's outpatient volume.
Physician/locum tenens services:
The declines in the Company's physician/locum tenens services net operating
revenues were a result of reduced demand and pricing pressures in the specialist
product line of the Company's physician/locum tenens services. Net operating
revenues for the specialist product line for the three months ended March 31,
1994 declined 20% as compared to the same quarter of the prior year and declined
16% for the nine months ended March 31, 1994 as compared to the same period of
the prior year. This decline was partially offset by the 25% and 26% increase
in revenues for the primary care product line during the three and nine months
ended March 31, 1994, respectively.
14
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Form 10-Q - For the Quarter ended March 31, 1994
________________________________________________________________________________
Results of Operations (continued)
Contract services group (continued):
Physician/locum tenens services (continued):
The following tables set forth filled days by discipline:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1994 1993
- - --------------------------------------------------------------------------------
Number Number Increase
of days % of days % (decrease)
<S> <C> <C> <C> <C> <C>
Physicians:
Primary care 12,108 44.4 10,292 33.8 17.6%
Specialty care 12,028 44.1 14,458 47.4 (16.8%)
Allied professionals 3,131 11.5 5,737 18.8 (45.4%)
------ ----- ------ -----
27,267 100.0 30,487 100.0 (10.6%)
====== ===== ====== =====
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended
March 31,
1994 1993
- - --------------------------------------------------------------------------------
Number Number Increase
of days % of days % (decrease)
<S> <C> <C> <C> <C> <C>
Physicians:
Primary care 35,370 40.0 29,459 30.7 20.1%
Specialty care 39,837 45.1 46,625 48.7 (14.6%)
Allied professionals 13,188 14.9 19,750 20.6 (33.2%)
------ ----- ------ -----
88,395 100.0 95,834 100.0 (7.8%)
====== ===== ====== =====
</TABLE>
The decline in specialty care and allied professional days is due to reduced
demand as a result of the uncertainty regarding healthcare reform, de-emphasis
of specialty physician programs and reimbursement and additional competition
in local markets. Allied professionals represent approximately 9% of
physician/locum tenens services net operating revenues for the three months
ended March 31, 1994 and 11% for the nine months ended March 31, 1994. The
increase in primary care filled days and its relative increase as a percentage
of total filled days reflects the increased demand for primary care physicians
and the Company's increased emphasis on this product line. The Company
believes the primary care physician product line has greater growth prospects
than its specialist product line.
15
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Form 10-Q - For the Quarter ended March 31, 1994
________________________________________________________________________________
Results of Operations (continued)
Costs and expenses:
Cost of services increased to $220,472,000 for the three months ended March 31,
1994, a 12% increase over the cost of services for the three months ended March
31, 1993 of $197,433,000. For the nine months ended March 31, 1994, cost of
services was $649,935,000, an increase of 16% over $562,288,000 for the same
period of the prior year. This increase is attributable to the opening of new
rehabilitation hospitals and outpatient clinics, and expansion of businesses
within the contract services group. Cost of services as a percentage of net
operating revenues increased from 85.0% for the three months ended March 31,
1993 to 87.2% for the three months ended March 31, 1994. For the nine months
ended March 31, 1994, the percentage was 86.4%, an increase from 85.1% for the
comparable period in the prior year. The increases in cost of services as a
percentage of net operating revenues are due to lower net revenues generated by
the Company's Pre-1993 rehabilitation hospitals; within contract therapy
business, the decline in per therapist productivity, pricing pressures
principally within the Company's respiratory therapy services, and the
elimination of certain contractual arrangements with third party providers; and
the declines in the physician services/locum tenens specialist line revenues and
filled days.
General and administrative expenses increased in the third quarter of fiscal
1994 and the nine months then ended as compared to the comparable periods in
fiscal 1993 in total dollars and as a percentage of net operating revenues.
This is due to increased staffing to support the operating groups and a
redeployment of the Company's resources formerly involved with the development
of hospitals as a result of changes in the Company's development strategy.
Interest expense for the three months ended March 31, 1994 totalled $9,685,000
compared to $5,855,000 for the three months ended March 31, 1993, an increase of
$3,830,000. For the nine months ended March 31, 1994, interest expense totalled
$28,688,000, an increase of $14,541,000 from the nine months ended March 31,
1993. The increases in fiscal 1994 are due to a higher average outstanding debt
balance and a higher average interest rate resulting from the issuance of
$150,000,000 of senior subordinated notes in March 1993. In addition, interest
expense was impacted by a reduction in the amount of interest capitalized
related to new hospital construction, as the Company has fewer hospitals under
construction in fiscal 1994. For the three and nine month periods ended March
31, 1994, interest costs of $273,000 and $1,500,000, respectively, related to
the rehabilitation hospitals under construction were capitalized. For both the
three and nine months ending March 31, 1993, interest costs of $1,656,000 and
$4,464,000 were capitalized, respectively.
Depreciation and amortization as a percentage of net operating revenues
increased in both the three and nine months ended March 31, 1994. This increase
resulted from the depreciation on the new rehabilitation hospitals which are
owned rather than leased by the Company and an increase in goodwill amortization
resulting from acquisitions.
16
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Form 10-Q - For the Quarter ended March 31, 1994
________________________________________________________________________________
Results of Operations (continued)
Minority Interests:
Minority interests in net income decreased for both the three and nine months
ended March 31, 1994. This decline is primarily due to declining earnings at
the Company's joint ventured rehabilitation hospitals primarily within
California.
Income Taxes:
Effective July 1, 1993, the Company adopted Financial Accounting Standards Board
Statement No. 109, "Accounting for Income Taxes." See note 3 of the Notes to
Consolidated Financial Statements for a description of the Statement and its
implementation.
Income taxes as a percentage of income before income taxes were 40.5% for both
the three and nine months ended March 31, 1994 and 40.3% and 38.7% for the three
and nine months ended March 31, 1993, respectively. The rates for fiscal 1993
reflect the restatement for Kron, which as an S-Corporation prior to its
acquisition made no provision for income taxes. The pro forma effective rates
including Kron taxed at statutory rates prior to its acquisition were 40.6%
and 39.6% for the three and nine months ended March 31, 1993, respectively.
The increase in the effective rate was due to an increase in non-deductible
goodwill costs, the mix of state income which was not as favorable as in the
prior fiscal years and the impact of the Omnibus Budget Reconciliation Act of
1993.
Capital Resources and Liquidity
For the nine months ended March 31, 1994, operating activities provided
$22,036,000 of cash. In the past, the Company has utilized cash from operations
to fund the working capital of new hospital openings as well as the expansion
of certain contract therapy and physician services companies. The increase in
operating cash is primarily due to the slowdown of new hospital openings.
Other elements of operating cash flow included an increase in accounts
receivable caused primarily by the Company's increased revenue from the new
rehabilitation hospitals opened in fiscal 1994 and 1993 and growth in
consolidated days sales outstanding. Days sales outstanding at March 31, 1994
were 93 days versus 89 days at June 30, 1993. The increase in consolidated
days sales outstanding is primarily due to an increase in amounts due from the
federal government's Medicare program under interim payment plans. Investing
activities, primarily development, construction and acquisition activities,
resulted in uses of cash of $26,804,000 during the nine months ended March 31,
1994. Available cash was primarily used to fund these cash requirements. See
the Consolidated Statements of Cash Flows for a detailed analysis of the
components of cash flow.
Long-term debt outstanding at March 31, 1994 totalled $378,403,000 including
$3,784,000 which represents the current portion of long-term debt. During the
nine months ended March 31, 1994, the Company repaid a net $8,962,000 of its
long-term debt. The Company's Credit Facility was amended on December 31, 1993,
to provide up to $235,000,000 in a revolving line of credit, of which up to
$35,000,000 is available in the form of letters of credit. At March 31, 1994,
approximately $20,000,000 of borrowing, and $27,149,000 of letters of credit,
were outstanding under the Credit Facility. The amendment also extended the
revolving loan period to December 31, 1996 and amended certain financial
covenants. See footnote 6 to the Notes to the Consolidated Financial Statements
for the year ended June 30, 1993 for further explanation of long-term debt.
17
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Form 10-Q - For the Quarter ended March 31, 1994
________________________________________________________________________________
Capital Resources and Liquidity (continued)
During the second quarter of fiscal 1994, the Company terminated certain
contractual arrangements in its contract therapy business with certain third
party providers. As a result, the Company is potentially subject to increased
credit risk with regard to the accounts receivable related to the former
arrangements. The Company is currently negotiating with these payors to secure
payment of these receivables. However, the Company is unable to estimate the
ultimate outcome of these negotiations and its subsequent collection. The
receivable net of allowances related to these arrangements at March 31, 1994 is
$15,600,000.
The Company's ongoing capital requirements relate principally to routine capital
expenditures, costs associated with its rehabilitation hospitals under
construction, future development projects, potential acquisitions and growth of
its contract services companies. The Company's commitments under various
construction agreements were not material at March 31, 1994. The Company will
construct fewer freestanding rehabilitation hospitals during fiscal 1994 than in
prior years. In addition, capital may be required to make contingent payments
required in connection with the Company's previous acquisitions and for working
capital needs.
The Company has historically expanded its business, in part, through selective
acquisitions and intends to pursue additional acquisition opportunities from
time to time. It is anticipated that future acquisitions will be funded through
the issuance of capital stock and payment of cash and other considerations.
Management believes that current sources of liquidity are sufficient to meet the
needs of the Company's business for fiscal 1994. Liquidity on a short-term
basis will be provided internally from the Company's operating cash flow and
externally from its Credit Facility. At March 31, 1994 the Company had
$187,851,000 of unused borrowing capacity (subject to applicable covenants which
may limit borrowing capacity) under its Credit Facility, of which $7,851,000 is
available in the form of letters of credit. Additionally, the Company believes
it has the capacity to obtain additional debt and equity financing to supplement
its operating cash flow in order to meet the Company's needs beyond those
anticipated in fiscal 1994.
The Company announced on February 1, 1994, that it is currently refining its
business plan, which could include a restructuring of certain elements of its
business. The Company plans to complete its plan and announce it during the
latter half of the fourth quarter. The Company is unable at the present time to
predict the impact this will have, if any, on its operating results and its
liquidity.
On May 10, 1994 the Company announced that it has sold its fifty percent
interest in the operations of its Rocky Mountain Rehabilitation Institute,
located in Aurora, Colorado, and signed a definitive agreement to sell later
this year the real property comprising that facility. The sale is to the
Company's former joint venture partner in the Rocky Mountain facility, HealthOne
of Denver, Colorado. In a separate transaction, the Company has signed a
definitive agreement to sell the assets of its wholly-owned subsidiary which
leases and operates its North Valley Rehabilitation Hospital, located in Chico,
California, to Chico Community Hospital. The sale of the North Valley facility
is expected to be completed by no later than June 30 and is subject to customary
closing conditions.
18
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Form 10-Q - For the Quarter ended March 31, 1994
________________________________________________________________________________
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(11) Computation of earnings per share
(b) Reports on Form 8-K
(1) The Company's Reports on Form 8-K filed during the quarter for which
this report is filed were reported on the Company's Form 10-Q for the
quarterly period ended December 31, 1993, filed with the Commission on
February 14, 1994.
19
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Signature
Form 10-Q - For the Quarter ended March 31, 1994
________________________________________________________________________________
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CONTINENTAL MEDICAL SYSTEMS, INC.
Date: May 13, 1994 By: /S/ Dennis L. Lehman
--------------------------
Dennis L. Lehman
Senior Vice-President - Finance
and Chief Financial Officer
Signing on the behalf of the registrant and
as principal financial officer.
20
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Document Page
- - ------ -------- ----
<C> <S> <C>
11. Computation of earnings per share
</TABLE>
<PAGE>
Exhibit 11
Continental Medical Systems, Inc. and Subsidiaries
Computation of Earnings per Share
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
1994 1993 (1) 1994 1993 (1)
------------------- ------------------
(In thousands, except per share data)
<S> <C> <C> <C> <C>
Primary:
Shares outstanding at beginning of
period 37,550 36,800 36,935 35,560
Weighted average shares issued
pursuant to:
Employee benefit plans 74 7 146 506
Acquisition agreements 22 307 125
Dilutive effect of outstanding stock
options 494 574 338 1,081
Contingent shares issuable pursuant
to acquisition agreements 401 612 455 641
------- ------- ------- -------
Weighted average number of shares
and equivalent shares outstanding 38,519 38,015 38,181 37,913
======= ======= ======= =======
Net income $ 4,170 $ 7,764 $15,531 $26,855
Additional goodwill amortization
from contingent shares issuable
pursuant to acquisition agreements (44) (44) (132) (138)
------- ------- ------- -------
Adjusted net income used in primary
calculation $ 4,126 $ 7,720 $15,399 $26,717
======= ======= ======= =======
Net income per share and equivalent
share $0.11 $0.20 $0.40 $0.70
======= ======= ======= =======
Fully Diluted:
Weighted average number of shares
and equivalent shares used in
primary calculation 38,519 38,015 38,181 37,913
Additional dilutive effect of stock
options 113
Additional dilutive effect of
contingent shares issuable
pursuant to acquisition agreements 82 82
Assumed conversion of dilutive
convertible debentures 234 234 234 234
------- ------- ------- -------
Fully diluted weighted average
number of shares and equivalent
shares outstanding 38,835 38,249 38,610 38,147
======= ======= ======= =======
Net income used in primary
calculation $ 4,126 $ 7,720 $15,399 $26,717
Adjustment for interest expense, net
of related income tax benefits 23 39 69 116
------- ------- ------- -------
Adjusted net income used in fully
diluted calculation $ 4,149 $ 7,759 $15,468 $26,833
======= ======= ======= =======
Fully diluted net income per share
and equivalent share $0.11 $0.20 $0.40 $0.70
======= ======= ======= =======
</TABLE>
(1) On February 23, 1993, CMS acquired Kron in a business combination accounted
for as a pooling of interests. Accordingly, all share data at the beginning
of the period has been restated to include the shares issued in the
combination, and all financial results have been restated to include the
financial results of Kron prior to February 23, 1993.
