<PAGE>
FORM 10-K/A
Amendment No. 1
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the fiscal year ended June 30, 1994 Commission file number: 0-15088
CONTINENTAL MEDICAL SYSTEMS, INC.
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(Exact name of Registrant as specified in its charter)
Delaware 51-0287965
- ------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
600 Wilson Lane, Post Office Box 715, Mechanicsburg, Pennsylvania 17055
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(Address of principal executive offices)
Registrant's telephone number, including area code: (717) 790-8300
Securities registered Pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
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Common Stock, par value $.01 New York Stock Exchange
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 ((S)229.405 of this chapter) 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. [X]
The aggregate market value (based on the last sale price quoted on the New
York Stock Exchange) of the voting stock held by non-affiliates of the
Registrant as of September 15, 1994 was approximately $350,224,198 (Reference is
made to the statement following Part I, Item 4 of this report for the
assumptions on which this calculation is based.)
The number of shares outstanding of the Registrant's common stock, $.01 par
value, as of September 15, 1994 was 38,380,734.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's 1994 definitive proxy statement (which is
expected to be filed with the Commission not later than 120 days after the
Registrant's 1994 fiscal year) are incorporated by reference into Part III of
this report.
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ITEM 6. SELECTED FINANCIAL DATA.
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<TABLE>
<CAPTION>
Five Year Selected Financial Data
Fiscal Year Ended June 30,
-------------------------------------------------------------------------
1994 1993 1992 1991 1990
<S> <C> <C> <C> <C> <C>
in thousands except per share data
Income Statement Data:
Net Operating Revenue $1,004,839 $901,397 $681,825 $429,921 $291,712
Income (loss) from operations (40,905)/(1)/ 44,187/(2)/ 45,787/(3)/ 27,642 19,051
Net Income (loss) (34,545)/(1)/ 19,519/(2)/ 27,091/(3)/ 18,501 12,701
Income (loss) per common share:
Primary (.92) .51 .73 .63 .48
Fully diluted (.92) .51 .72 .60 .46
Balance Sheet Data:
Total assets 766,742 772,228 475,230 327,796 219,676
Long-term debt, net of current
portion 353,752 382,602 134,835 57,947 92,292
</TABLE>
(1) Reflects a $74,834 special charge related to the impairment of selected
assets of the Company's hospital division, the costs associated with the
consolidation of its contract therapy companies, the losses related to the
termination of certain relationships in the contract therapy business and
certain other costs of the restructuring program. See Note 8 of the
Company's Consolidated Financial Statements which further discuss the
components of, and basis for, the special charge.
(2) Reflects $14,556 of special charges related to the write-down of certain
rehabilitation facility development costs and $2,598 of merger expenses in
connection with the Kron Medical Corporation acquisition and Kron's
subsequent consolidation with CompHealth.
(3) Reflects $1,000 of merger expenses in connection with the CompHealth
acquisition and a one-time charge of $3,319 relating to a terminated merger
agreement.
The selected financial data has been restated to reflect the results of
CompHealth and Kron for the periods prior to their respective acquisitions.
CompHealth and Kron were acquired in business combinations accounted for as
poolings of interests.
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<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
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OF OPERATIONS.
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OVERVIEW
The Company is a diversified provider of comprehensive medical
rehabilitation and physician services. The Company has a significant presence
in each of the rehabilitation industry's three principal sectors - inpatient
rehabilitation care, contract services and outpatient rehabilitation care.
Additionally, the Company is the largest provider of physician locum tenens
services in the United States.
The following table sets forth, for the periods indicated, net operating
revenues for each of the Company's operating groups (in thousands):
<TABLE>
<CAPTION>
Year Ended June 30, Increase (Decrease)
------------------------------- ---------------------
1994 1993 1992 1993-1994 1992-1993
<S> <C> <C> <C> <C> <C>
Net operating revenues:
- ----------------------
Rehabilitation group $ 551,699 $514,224 $388,051 7% 33%
Contract therapy services 343,300 278,652 186,372 23% 50%
Physician services 107,108 108,396 94,905 (1%) 14%
Other 2,732 125 12,497 N/M N/M
---------- -------- -------- ------- -------
$1,004,839 $901,397 $681,825 11% 32%
========== ======== ======== ======= =======
</TABLE>
"Other" revenues referred to in the above table consist principally of
revenues from the Company's new initiatives including SelectRehab, Innovative
Health Alliances and Medical Management Associates. Certain percentage changes
in "Other" are not meaningful (N/M).
Certain reclassifications were made to fiscal 1993 and 1992 net operating
revenues to conform to fiscal 1994 presentations.
The Company's recent growth in net operating revenues has been the result
of expansion of its contract therapy businesses as well as the development of
new rehabilitation hospitals, outpatient clinics and acquisitions of contract
therapy and physician services companies.
In April 1994, the Company sold its 50% interest in the operations of its
Rocky Mountain Rehabilitation Institute, located in Aurora, Colorado, and signed
a definitive agreement to sell by December 31, 1994 the real property comprising
that facility. On June 30, 1994, the Company sold selected assets of its
wholly-owned subsidiary which leased and operated its North Valley
Rehabilitation Hospital, located in Chico, California. In the fourth quarter of
fiscal 1994, the Company also closed or divested twenty-nine of its under
performing outpatient centers.
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<PAGE>
RESULTS OF OPERATIONS
Net Operating Revenues and Income (loss) from Operations
Net operating revenues increased by 11% to $1,004,839,000 for fiscal 1994
from $901,397,000 in fiscal 1993 and increased 32% in fiscal 1993 over fiscal
1992 net operating revenues of $681,825,000. The increase in both periods
resulted from the growth in the Company's existing operations and through the
addition of new rehabilitation hospitals. Additionally, the increase in fiscal
1993 resulted from the acquisition of a contract therapy company in the fourth
quarter of fiscal 1992.
Income (loss) from operations declined to ($40,905,000) for fiscal 1994
from $44,187,000 in fiscal 1993 and decreased in fiscal 1993 from $45,787,000 in
Fiscal 1992. The loss in fiscal 1994 resulted from the special charge,
increases in interest expense, and depreciation and amortization expense, lower
contract respiratory services revenue in the contract therapy services group, a
decline in higher margin specialty care and allied professional days in the
physician services group and increases in certain other operating expenses. The
decrease in income from operations in fiscal 1993 from fiscal 1992 resulted from
the special charge, increased interest expense, and depreciation and
amortization expense, which was offset, in part, by a lower ratio of cost of
services as a percentage of revenue and the effect of merger expenses.
Approximately 42% of the Company's consolidated net operating revenues
during fiscal 1994 was derived from patients covered by the federal government's
Medicare program for the aged and chronically disabled and state Medicaid
programs for the indigent as compared to 41% and 42% for fiscal 1993 and 1992,
respectively. The balance of the Company's net operating revenues was provided
by private pay sources, non-governmental payors, such as commercial insurance
companies, and non-patient related revenues.
Following is a discussion of each of the Company's operating groups.
Certain operating results related to new initiatives and management services
companies have been excluded from the discussion due to their immateriality in
relation to the consolidated results.
Rehabilitation Group:
The following table sets forth, for the periods indicated, net operating
revenues for the rehabilitation group (in thousands):
<TABLE>
<CAPTION>
Year Ended June 30, Increase (Decrease)
-------------------------------- ------------------------
1994 1993 1992 1993-1994 1992-1993
---- ---- ---- --------- ---------
<S> <C> <C> <C> <C> <C>
Net operating revenues:
Rehabilitation group
Hospitals (fiscal year of opening)
Pre-1993 (26 hospitals) $403,785 $424,676 $337,520 (5%) 26%
Fiscal 1993 (6 hospitals) 69,164 29,845 132% N/A
Fiscal 1994 (4 hospitals) 25,327 N/A N/A
Divested facilities (2 hospitals) 24,637 31,150 27,102 (21%) 15%
--------- -------- --------- ----- -----
522,913 485,671 364,622 8% 33%
Other rehab related 28,786 28,553 23,429 1% 22%
--------- -------- --------- ----- -----
Total rehabilitation group $551,699 $514,224 $388,051 7% 33%
======== ======== ======== ===== =====
</TABLE>
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<PAGE>
"Other rehab related" revenues referred to in the above table include
revenues from long-term care operations, Medicare reimbursement of certain home
office costs and certain outpatient operations.
The increases in net operating revenues generated by the rehabilitation
hospital group resulted primarily from new hospital openings. Net operating
revenues generated by the Company's 26 rehabilitation hospitals in operation
during all of fiscal 1994 and 1993 (the "Pre-1993 Hospitals") declined 5% in
fiscal 1994 from the prior year. This decline is principally due to lower costs
which resulted in lower cost based Medicare reimbursement, shorter inpatient
length of stays, and competitive pricing pressures.
As of June 30, 1994, the Company had transitional rehabilitation units,
with a total of 308 beds, in 20 of its rehabilitation hospitals. Transitional
rehabilitation units provide a lower level of care and consequently generate
lower revenues per occupied bed than an acute rehabilitation bed. However,
there are less costs related to providing transitional rehabilitation services.
The Company believes that its transitional rehabilitation 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 percentage of net operating revenues generated by Medicare and Medicaid
patients at the rehabilitation hospitals was 64% in fiscal 1994, and 62% in each
of fiscal 1993 and 1992.
With the pressures to control rising healthcare costs, more services are
being provided on an outpatient basis. Total outpatient treatments in fiscal
1994 increased to 3,025,820 over the 2,448,866 outpatient treatments in fiscal
1993 and 1,635,606 outpatient treatments in fiscal 1992. Outpatient services
represented 16% of the rehabilitation group's net operating revenues in each of
fiscal 1994 and 1993 and 15% in fiscal 1992. While the volume of outpatient
treatments continues to increase, pricing of outpatient services has declined
over the prior year due to several factors including changes in the Company's
marketing strategy and changes in regulatory requirements affecting pricing in
selected states' workers compensation programs.
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. Managed care payors are increasingly
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 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. The
new staffing model resulted in a reduction of staff and a change in the
hospitals' therapy delivery model. The Company has also established and
continues to refine 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.
Below are selected statistics for the Pre-1993 Hospitals:
<TABLE>
<CAPTION>
%
1994 1993 Change
---- ---- ------
<S> <C> <C> <C>
Occupancy percentage 65.9% 68.0% (3%)
Admissions 19,263 18,101 6%
Average length of stay (days) 22.1 23.7 (7%)
Patient days 423,106 428,044 (1%)
Outpatient treatments 2,325,779 2,074,856 12%
Outpatient % of net revenue 18.2% 17.3% 5%
</TABLE>
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<PAGE>
Occupancy percentage for the Pre-1993 Hospitals for fiscal 1994 was 65.9%
as compared to 68.0% during fiscal 1993. This decline in occupancy percentage
was due to an increase in licensed beds and a lower patient average length of
stay in fiscal 1994. Average length of stay declined, in part, due to cost
controls, case management review and increased efficiencies in treatments.
Average length of stay was also reduced by the increase in the number of
transitional rehabilitation beds which have shorter average lengths of stay.
Certain reimbursement methodologies, including those under the Tax Equity and
Fiscal Responsibility Act ("TEFRA") regulations, applicable to Medicare
reimbursement, make the number of admissions, in addition to occupancy
percentages and average length of stay, important in monitoring the results of
the hospitals as revenue growth becomes increasingly dependent upon patient
volume. As of June 30, 1994, the Company had 15 hospitals subject to TEFRA
regulations. The lower patient average length of stay in fiscal 1994 versus
fiscal 1993 was partially offset by a 6% increase in admissions in fiscal 1994.
The timing of new hospital openings during fiscal 1993 makes a comparison
of occupancy percentages between fiscal 1994 and 1993 for these hospitals not
meaningful. The rehabilitation hospitals opened in fiscal 1993 (the "1993
Hospitals") increased their patient days in fiscal 1994 to 87,857 from 35,644 in
fiscal 1993. During fiscal 1994, the occupancy percentage for the 1993 Hospitals
was 69%. The occupancy percentage for rehabilitation hospitals opened in fiscal
1994 (the "1994 Hospitals") was 42%. The 1994 Hospitals' patient days were
25,112.
Contract Therapy Services:
The increases in net operating revenues generated by contract therapy
services 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 serve over 2,400 facilities.
Approximately 81% of the net operating revenues for fiscal 1994, and 74%
and 66% of the net operating revenues for fiscal 1993 and 1992, respectively,
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 21% for fiscal 1994. This represents an increase
from 17% for fiscal 1993 and 20% for fiscal 1992. 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 an unrelated
Medicare certified provider. As a result of terminating these arrangements, the
Company, in many instances, now provides the same services directly to Medicare
patients.
Physician Services:
The declines in the Company's physician 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 fiscal 1994 declined 20% as compared to the
prior year. This decline was partially offset by the 26% increase in revenues
for the primary care product line during fiscal 1994. The growth in net
operating revenues in fiscal 1993 as compared to fiscal 1992 was due to the
increase in the number of filled days. Filled days were 151,633 and 134,766 in
fiscal 1993 and 1992, respectively.
During fiscal 1994 approximately 51% of net operating revenues was
generated through services to hospitals while 33% involved contracts with
physician groups. The remainder was with managed care programs, clinics and
other sources. In fiscal 1993 and 1992, approximately 48% and 52%,
respectively, of net operating
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<PAGE>
revenues were generated through services to hospitals while 35% in both years
involved contracts with physician groups.
The following table sets forth, for the periods indicated, filled days by
discipline:
<TABLE>
<CAPTION>
Fiscal 1994 Fiscal 1993
--------------------- --------------- %
# of # of Increase
days % days % (Decrease)
---- ----- ---- ----- ----------
<S> <C> <C> <C> <C> <C>
Physicians:
Primary care 47,200 31.7 40,146 26.4 17.6
Specialty care 53,421 35.9 61,520 40.6 (13.2)
Allied professionals 48,302 32.4 49,967 33.0 (3.3)
------- ----- ------- ----- -----
148,923 100.0 151,633 100.0 (1.8)
======= ===== ======= ===== =====
</TABLE>
The decline in specialty care and allied professional days is due to
reduced demand for specialty physicians locum tenens services and additional
competition in local markets. Allied professionals represent approximately 22%
of physician services net operating revenues for the year ended June 30, 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 of this product line. The
Company believes the primary care physician product line has greater growth
prospects than its specialist product line.
The federal government as well as state governments, business and labor
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. The Company is unable to predict what form these
measures will take and as a result cannot estimate how they might affect future
operating results.
Cost of Services
Cost of services for fiscal 1994 totalled $894,488,000 compared to
$787,574,000 for fiscal 1993, an increase of $106,914,000. Cost of services for
fiscal 1992 was $607,737,000. The increases in fiscal 1994 and fiscal 1993 over
the prior year were due primarily to higher salaries, wages and benefits
expenses associated with expansion of the Company's contract therapy businesses,
as well as the development of new rehabilitation hospitals, outpatient clinics
and acquisitions of contract therapy and physician services companies. The
Company's largest component of cost of services is salaries, wages and benefits.
Interest Expense
Interest expense for fiscal 1994 totalled $38,156,000 compared to
$22,747,000 for fiscal 1993, an increase of $15,409,000. Interest expense for
fiscal 1992 was $6,216,000. The increases in fiscal 1994 and fiscal 1993 over
the prior year were due to a higher average outstanding debt balance and a
higher average interest rate resulting from the issuance of $350,000,000 of
senior subordinated notes during fiscal 1993. In addition, interest expense was
impacted by a reduction in the amount of interest capitalized related to new
hospital construction, as the Company had fewer hospitals under construction in
fiscal 1994 than in fiscal 1993 and 1992.
The effects of the interest rate swap agreements on interest expense was to
reduce interest expense by $1,327,000 and $947,000 for fiscal 1994 and 1993,
respectively. There were no interest rate swap agreements in effect during
fiscal 1992. The Company has exposure under the interest rate swap agreements
for fluctuations in short-term interest rates. At June 30, 1994, the Company
would be required to pay approximately $6,300,00 in order to terminate the
interest rate swap and collar agreements, taking into account current interest
rates. This represents an unrealized loss of approximately $6,944,000. The
Company intends to hold these investments until maturity. Additionally, the
Company has exposure to credit loss in the event of nonperformance by the other
party to the interest rate swap agreements. However, the Company does not
anticipate nonperformance by the counterparty.
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<PAGE>
Depreciation and Amortization
Depreciation and amortization as a percentage of net operating revenues
increased for fiscal 1994 to 3.8% from 3.3% and 2.6% in fiscal 1993 and 1992,
respectively. This increase resulted from the depreciation on the new
rehabilitation hospitals which are owned by the Company and an increase in
goodwill amortization resulting from acquisitions.
Merger Expenses
On February 23, 1993, the Company acquired Kron Medical Corporation
("Kron") in a business combination accounted for as a pooling of interests. In
connection with this pooling, the Company incurred $2,598,000 of costs related
to the acquisition and combination of Kron with CompHealth. During fiscal 1992
the Company acquired CompHealth in a business combination accounted for as a
pooling of interests. In connection with this pooling, the Company incurred
$1,000,000 of costs. Additionally, during fiscal 1992, the Company recorded
costs of $3,319,000 related to the termination of a merger agreement.
Special Charge
During the fourth quarter a special pre-tax charge of $74,834,000 was
recorded. The special charge resulted from the approval by the Company's Board
of Directors of several measures to streamline operations and improve
productivity by restructuring the Company into major operating businesses,
flattening the management organization structure, writing down certain assets
and, where appropriate, divesting unproductive assets. The Company began work
on the proposed plan during the fiscal 1994 third quarter as a result of market
changes the Company was experiencing. The special charge comprised several
items including the impairment of selected assets in the Company's
rehabilitation group, the costs associated with the consolidation of its
contract therapy companies, the losses related to the termination of certain
business relationships in the contract therapy business and certain other costs
of the restructuring program.
Approximately $50,244,000 of the charge was associated with the impairment
of assets at eight rehabilitation hospitals, divestiture of two rehabilitation
hospitals, closure of a select group of outpatient locations and miscellaneous
other charges.
Approximately $12,042,000 of the charge was related to the consolidation of
certain contract therapy companies into CMS Therapies and the exit from certain
markets and businesses. This consolidation process involved the closure of
offices, relocation and severance of personnel and the elimination of
duplicative processes.
Approximately $10,800,000 of the charge is related to the writedown of
uncollectible receivables pertaining to the termination of certain business
relationships at the Company's CMS Therapies, Inc. subsidiary. During the second
quarter of fiscal 1994, the Company exited business arrangements in which it
provided therapists to unrelated Medicare certified agencies which in turn
supplied those therapists to non-Medicare certified skilled nursing facilities.
For a variety of business reasons, including, among others, the Healthcare
Financing Administration's announced intentions to increase their review of the
reasonableness of the charges billed by the agencies to the Medicare program,
the Company exited those relationships and, in many instances, began to provide
the same services directly to Medicare patients upon termination of the
contracts with the agencies. Following termination of the contracts, the Company
continued to assess the collectibility of the agency receivables and, due to
deteriorating business relations and declining financial condition of the
agencies, it was determined a write-down of these receivables was required as of
June 30, 1994.
The remainder of the charge, $1,748,000, was to reduce the work force at
the Company's corporate office and provide for transaction costs to execute the
plan.
At June 30, 1994, $18,794,000 is included within accrued liabilities to
complete the plan associated with certain components of the special charge. The
components of this accrual are more fully described in the notes to the
Company's financial statements.
The Company estimates that the reorganization plan, when fully implemented,
will reduce or eliminate approximately $5,500,000 of costs and expenses
annually, including approximately $2,500,000 of savings related to consolidation
and reorganization of the contract therapy companies, $1,500,000 related to
depreciation associated with facility write-downs and $1,500,000 related to
other savings associated with the elimination of unprofitable operations.
During the fourth quarter of fiscal 1993 the Company recorded a pre-tax
charge of $14,556,000 related principally to the write-off of deferred costs for
approximately 30 abandoned rehabilitation hospital development projects on which
construction had not started. The decision to abandon certain projects and
pursue less capital intensive growth than in the past was a result of changes in
the Company's rehabilitation hospital development strategy in response to
changes in various healthcare delivery markets. Prior to fiscal 1994, the
Company deferred certain costs incurred to obtain government approvals and other
expenses related to the development of rehabilitation hospitals. Based on a
historical high rate of completion, costs of developing a project were charged
to operations only when it was probable that the project would be abandoned. As
a result of its change in development strategy, the Company changed its
accounting for development costs. Ongoing hospital development costs are now
expensed until that time when it is probable that construction will commence.
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<PAGE>
Minority Interests
Minority interests in net income decreased for the year ended June 30, 1994
to $4,730,000 from $6,663,000 in fiscal 1993. This decline is primarily due to
lower earnings during fiscal 1994 at the Company's joint ventured rehabilitation
hospitals. In fiscal 1993, minority interests in income decreased $108,000 from
$6,771,000 in fiscal 1992. This decrease reflects the Company's July 1992
acquisition of the minority interests in its Communi-Care/Pro-Rehab subsidiary
and was offset by an increase in the number of joint venture companies operating
rehab hospitals.
Income Taxes
Income taxes as a percentage of income (loss) before income taxes were
(18)%, 44% and 35% respectively for fiscal 1994, 1993 and 1992. These
percentages reflect the restatements for the poolings of interests with Kron in
fiscal 1993 and CompHealth in fiscal 1992. Both of these entities were S-
Corporations prior to the merger and made no provision for income taxes. The
pro forma effective tax rate, including Kron and CompHealth taxed at statutory
rates prior to their acquisition dates, was (18)%, 45%, and 38% in fiscal 1994,
1993 and 1992. The significant increase in the pro forma effective tax rate
from fiscal 1992 to fiscal 1993 results from the loss of various state tax
deductions due to one-time charges, the effect of certain transaction-related
pooling expenses which are not tax deductible, an increase in non-deductible
goodwill costs and a more unfavorable mix of state income. The tax benefit in
fiscal 1994 resulted from a pre-tax loss caused by the special charge and was
offset by certain non-deductible components of the special charge, prior year
tax assessments and a higher effective state tax rate.
Adoption of New Accounting Principles
Effective July 1, 1993 the Company adopted Financial Accounting Standards
Board Statement No. 109 "Accounting for Income Taxes" which changed the method
of accounting for income taxes for the Company in fiscal 1994. The statement
requires an asset and liability approach for accounting and reporting income
taxes. Under this approach, deferred taxes are based on future tax consequences
of events that have been recognized on the Company's financial statements or tax
return. Accordingly, deferred taxes are adjusted for changes in tax rates when
enacted. Under the prior rules, deferred taxes were provided based on their
relationship with pre-tax income at the tax rates in effect when the deferral
occurs and are not adjusted for changes in those rates. The cumulative effect
of this statement was not material.
In fiscal 1993 the Company adopted the provisions of Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." Upon issuance of this statement, the Company reviewed the
provisions of the new statement and concluded that the statement compelled the
write-down to fair value of a long term care investment being held to maturity
as a result of the impairment of the investment using a discounted cash flow
analysis. Prior to the issuance of this statement, the asset was carried at
historical cost which is expected to be recovered upon maturity. The Company
recognized an after tax cumulative effect of $3,204,000 in adopting this
statement.
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<PAGE>
CAPITAL RESOURCES AND LIQUIDITY
For the year ended June 30, 1994, operating activities provided $50,708,000
of cash as compared with $6,789,000 in fiscal 1993, and $12,981,000 in fiscal
1992. 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 cash flow increase
relates principally to the slowdown of capital intensive hospital development
projects. Investing activities, primarily development, construction and
acquisition activities, resulted in uses of cash of $30,368,000 during fiscal
1994 as compared with $217,276,000 in fiscal 1993 and $96,407,000 in fiscal
1992. Available cash was primarily used to fund the cash requirements for
fiscal 1994. Cash inflows of $23,060,000 resulted from the sale of real estate
and equipment of one rehabilitation hospital under construction and the sale of
the operations of two rehabilitation hospitals and other miscellaneous assets.
The Company's current ratio was 2.07:1 at June 30, 1994 compared to 2.90:1 at
June 30, 1993. This decrease reflects the accrual of $18,794,000 related to the
special charge as well as an increase in the amounts due to third-party payors.
See the Consolidated Statements of Cash Flows for a detailed analysis of the
components of cash flow.
Long-term debt outstanding at June 30, 1994 totalled $357,765,000,
including $4,013,000 which represents the current portion of long-term debt.
The Company's percentage ratio of long-term debt to total capitalization both at
June 30, 1994 and 1993 was 60% The Company's credit facility provides up to
$235,000,000 in a revolving line of credit, of which up to $45,000,000 is
available in the form of letters of credit. At June 30, 1994, there were no
borrowings and approximately $30,006,000 of letters of credit were outstanding
under the credit facility. The credit facility provides for a revolving loan
period through December 31, 1996 and the subsequent conversion of the revolving
loan into a four-year term loan. The Company has pledged its ownership
interests in certain of its operating subsidiaries as collateral under the
facility. The Company is also subject to certain financial and other covenants,
including, without limitation, restrictions on the amount of other indebtedness
it may incur and a prohibition on paying cash dividends.
On August 17, 1992, the Company issued $200,000,000 of 10 7/8% Senior
Subordinated Notes due 2002 ("10 7/8% Notes"). The 10 7/8% Notes were sold at
99.25% of their principal amount. On March 16, 1993 the Company issued
$150,000,000 of 10 3/8% Senior Subordinated Notes due 2003 ("10 3/8 Notes").
The 10 3/8% Notes were sold at 99.22% of their principal amount. The 10 7/8%
Notes are subject to redemption at any time on or after August 15, 1997, at the
option of the Company at specified redemption prices plus accrued interest. The
10 3/8% Notes are subject to redemption at any time on or after April 1, 1998,
at the option of the Company at specified redemption prices plus accrued
interest. The Company used the aggregate net proceeds of the 10 7/8% Notes and
10 3/8% Notes (collectively, the "Notes") to repay all indebtedness outstanding
under the credit facility at the time of each such sale (approximately
$277,000,000 in the aggregate for both issuances) and the remainder for general
corporate purposes including the construction and acquisition of rehabilitation
hospitals. Under the terms of the indentures for the Notes, the Company's
ability to incur additional indebtedness, provide guarantees and pay cash
dividends is limited under certain circumstances.
The Company's ongoing capital requirements relate principally to routine
capital expenditures, future development projects, potential acquisitions and
growth of its contract therapy and physician services companies. The Company
constructed fewer free-standing rehabilitation hospitals during fiscal 1994 than
in prior years. The Company currently estimates that its fiscal 1995 capital
requirements will consist of capital maintenance and improvements at existing
facilities in the normal course of business and will be funded through the
Company's operating cash flow or its credit facility. Pursuant to contingent
deferred payment provisions of certain acquisition agreements, the Company
estimates that approximately $17,000,000 in cash and the Company's common stock
may be required to be paid to the sellers of the acquired companies through
fiscal 1997, based upon the earnings of the acquired companies.
-25-
<PAGE>
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 consideration. Management believes that current sources of capital are
sufficient to meet the needs of the Company's business for fiscal 1995 and for
the foreseeable future. Liquidity on a short-term basis will be provided
internally from the Company's operating cash flow and externally from its bank
credit facility. At June 30, 1994 the Company had $204,994,000 of unused
borrowing capacity (subject to applicable covenants which may limit borrowing
capacity) under its credit facility, of which $14,994,000 is available in the
form of letters of credit.
The Company recorded in fiscal 1994, a special charge of $74,834,000 which
included a restructuring of certain elements of its business. The Company
expects that the net cash effect of this charge will be minimal.
In October 1992, the Company acquired 97% interests in the partnerships
which owned the real estate of its Aurora, Colorado, Plano, Texas and Webster,
Texas rehabilitation hospitals. The aggregate purchase price was $39,000,000.
These hospitals commenced operations in June 1989, March 1991 and October 1991,
respectively, and had been operated by the Company under long-term operating
leases with third parties prior to their acquisitions. In October 1992, the
Company acquired the condominium interest which comprises its San Diego
rehabilitation hospital. The purchase price for the condominium interest was
$25,200,000. The hospital commenced operations in April 1992 and had been
operated by the Company under an interim operating lease prior to its
acquisition. These acquisitions were financed with long-term debt borrowings.
The Company has agreed to lend up to $3,000,000 for working capital through
August 31, 2000 to the purchaser of certain of its long-term care facilities.
On August 31, 2000, the outstanding working capital loan balance will be
converted into a term loan payable in quarterly installments over a four-year
period. As of June 30, 1994, $900,000 has been provided pursuant to this
commitment.
In June 1994, the Company obtained consents from its bondholders and
amended its credit facility to permit purchases of its Senior Subordinated Notes
in the open market. During the first two months of fiscal 1995, the Company
purchased approximately $26,835,000 of its Senior Subordinated Notes utilizing
its operating cash flow. The Company anticipates that it will employ operating
cash flow in new growth opportunities within its core businesses and to
selectively retire long-term debt.
-26-
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
-------------------------------------------
Continental Medical Systems, Inc. and Subsidiaries
Financial Statements
June 30, 1994 and 1993 and 1992
-27-
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
June 30, 1994 and 1993
<TABLE>
<CAPTION>
Assets 1994 1993
- ----------------------------------------------------------------------------------------------------------------------
(In thousands, except share data)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 54,862 $ 64,444
Accounts receivable, net of allowance for doubtful accounts
($16,685 June 30, 1994; $17,426 June 30, 1993) 232,198 220,122
Other receivables 10,778 10,801
Prepaid expenses 13,720 14,243
Prepaid income taxes 4,319 3,412
Deferred income taxes 5,610 5,062
----------- ----------
Total current assets 321,487 318,084
----------- ----------
Property and equipment, net (Note 3) 252,023 289,822
----------- ----------
Goodwill, net (Note 2) 72,613 58,461
Investments, principally affiliates 21,804 16,694
Notes receivable (Note 14) 31,454 29,461
Deferred income taxes 14,357 2,847
Deferred costs, new facilities, net (Notes 4 and 8) 20,885 28,634
Other assets 32,119 28,225
----------- ----------
193,232 164,322
----------- ----------
$ 766,742 $ 772,228
=========== ==========
<CAPTION>
Liabilities and Stockholders' Equity
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Current liabilities:
Current portion of long-term debt (Note 6) $ 4,013 $ 3,809
Accounts payable 28,615 27,515
Accrued expenses (Note 5) 97,780 64,602
Due to third-party payors 24,676 13,857
----------- ----------
Total current liabilities 155,084 109,783
Long-term debt, net of current portion (Note 6) 353,752 382,602
Other liabilities 7,391 8,717
----------- ----------
Total liabilities 516,227 501,102
----------- ----------
Minority interests 14,963 13,430
----------- ----------
Commitments and contingencies (Notes 2 and 7)
Stockholders' equity:
Preferred stock, $.01 par; authorized 10,000,000 shares; none issued
Common stock, $.01 par; authorized 80,000,000 shares; 38,359,245
issued and outstanding, June 30, 1994 (36,934,546 June 30, 1993)
(Note 16) 384 369
Capital in excess of par 192,573 180,187
Retained earnings (Note 6) 42,595 77,140
----------- ----------
235,552 257,696
----------- ----------
$ 766,742 $ 772,228
=========== ==========
</TABLE>
See notes to consolidated financial statements.
-28-
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Consolidated Statements of Operations
Years ended June 30, 1994, 1993 and 1992
<TABLE>
<CAPTION>
1994 1993 1992
- ----------------------------------------------------------------------------------------------------------------------------------
(In thousands, except share data)
<S> <C> <C> <C>
Net operating revenues $ 1,004,839 $ 901,397 $ 681,825
------------- ------------- -------------
Costs and expenses:
Cost of services 894,488 787,574 607,737
Interest expense 38,156 22,747 6,216
Depreciation and amortization 38,266 29,735 17,766
Merger expenses (Note 9) 2,598 4,319
Special charge (Note 8) 74,834 14,556
------------- ------------- -------------
1,045,744 857,210 636,038
------------- ------------- -------------
Income (loss) from operations (40,905) 44,187 45,787
Other income, principally interest 3,442 2,762 2,936
------------- ------------- -------------
Income (loss) before minority interests, income taxes
and cumulative effect of accounting change (37,463) 46,949 48,723
Minority interests (4,730) (6,663) (6,771)
------------- ------------- -------------
Income (loss) before income taxes and cumulative effect
of accounting change (42,193) 40,286 41,952
Income taxes (Note 10) (7,648) 17,563 14,861
------------- ------------- -------------
Income (loss) before cumulative effect of accounting change (34,545) 22,723 27,091
Cumulative effect of accounting change (Note 11) (3,204)
------------- ------------- -------------
Net income (loss) $ (34,545) $ 19,519 $ 27,091
============= ============= =============
Income (loss) per common share and common
equivalent share (Note 17):
Primary:
Income (loss) before cumulative effect of accounting change $ (.92) $ .59 $ .73
Cumulative effect of accounting change (.08)
------------- ------------- -------------
Net income (loss) $ (.92) $ .51 $ .73
============= ============= =============
Fully diluted:
Income (loss) before cumulative effect of accounting change $ (.92) $ .59 $ .72
Cumulative effect of accounting change (.08)
------------- ------------- -------------
Net income (loss) $ (.92) $ .51 $ .72
============= ============= =============
Weighted average number of shares outstanding:
Primary: 37,662,519 38,050,513 37,169,328
Fully diluted: 37,662,519 38,289,537 37,402,973
</TABLE>
See notes to consolidated financial statements.
-29-
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
Years ended June 30, 1994, 1993 and 1992
<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> <C> <C>
Balance, June 30, 1991 34,733,028 $ 348 $ 154,819 $ 32,524 $ 187,691
Stock issued pursuant to:
Employee benefit plans 632,684 6 7,223 7,229
Acquisition agreements 194,500 2 3,785 3,787
Distributions of pooled companies (1,811) (1,811)
Net income for the year 27,091 27,091
---------- ------- ------------ ------------ ------------
Balance, June 30, 1992 35,560,212 356 165,827 57,804 223,987
Stock issued pursuant to:
Employee benefit plans 1,196,859 11 11,260 11,271
Acquisition agreements 177,475 2 3,100 3,102
Distributions of pooled companies (183) (183)
Net income for the year 19,519 19,519
---------- ------- ------------ ------------ ------------
Balance, June 30, 1993 36,934,546 369 180,187 77,140 257,696
Stock issued pursuant to:
Employee benefit plans 285,192 3 1,842 1,845
Acquisition agreements 1,139,507 12 10,544 10,556
Net loss for the year (34,545) (34,545)
---------- ------- ------------ ------------ ------------
Balance, June 30, 1994 38,359,245 $ 384 $ 192,573 $ 42,595 $ 235,552
========== ======= ============ ============ ============
</TABLE>
See notes to consolidated financial statements.
-30-
<PAGE>
Continental Medical Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years ended June 30, 1994, 1993 and 1992
<TABLE>
<CAPTION>
1994 1993 1992
- ----------------------------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (34,545) $ 19,519 $ 27,091
---------- --------- ---------
Adjustments:
Depreciation and amortization 38,266 29,735 17,766
Other 1,028 5,867 4,639
Special charge 74,834 14,556
Cumulative effect of accounting change, net of taxes 3,204
Increase (decrease) in cash from changes in assets and liabilities,
excluding effects of acquisitions and dispositions:
Accounts receivable (27,174) (69,961) (53,751)
Other assets (9,497) (2,997) (9,260)
Accounts payable and accrued expenses 13,853 19,855 23,294
Other liabilities 5,542 (1,670) 321
Income taxes (11,599) (11,319) 2,881
---------- --------- ---------
Total adjustments 85,253 (12,730) (14,110)
---------- --------- ---------
Net cash provided by operating activities 50,708 6,789 12,981
---------- --------- ---------
Cash flows from investing activities:
Payments pursuant to acquisition agreements, net of cash acquired (16,363) (57,303) (10,664)
Cash proceeds from sale of property and equipment 23,060
Deferred costs, new facilities (3,527) (13,526) (17,699)
Acquisition of property and equipment (26,416) (131,185) (72,176)
Notes receivable (1,993) (6,938) 2,444
Other investing activities (5,129) (8,324) 1,688
---------- --------- ---------
Net cash used in investing activities (30,368) (217,276) (96,407)
---------- --------- ---------
Cash flows from financing activities:
Long-term debt borrowings 88,054 528,290 80,454
Long-term debt repayments (118,061) (280,772) (7,263)
Deferred financing costs (893) (12,306) (1,142)
Issuance of common stock 1,733 6,375 4,131
Capital contributions by minority interests 2,388 555 1,136
Dividends of pooled companies (183) (1,811)
Distributions to minority interests (3,143) (2,454) (1,905)
---------- --------- ---------
Net cash provided by (used in) financing activities (29,922) 239,505 73,600
---------- --------- ---------
Net increase (decrease) in cash and cash equivalents (9,582) 29,018 (9,826)
Cash and cash equivalents, beginning of year 64,444 35,426 45,252
---------- --------- ---------
Cash and cash equivalents, end of year $ 54,862 $ 64,444 $ 35,426
========== ========= =========
</TABLE>
See notes to consolidated financial statements.
-31-
<PAGE>
1. Summary of Significant Accounting Policies:
Principles of consolidation:
The consolidated financial statements include the Company and its 50% or
greater owned subsidiaries which the Company controls. All significant
intercompany accounts and transactions have been eliminated.
Investments in affiliates in which the Company owns 20% or more and limited
partnerships are carried, primarily, on the equity basis which approximates the
Company's equity in their underlying net book value. Other investments are
stated at cost.
Cash equivalents:
The Company considers all highly liquid investments with maturities of
three months or less when purchased to be cash equivalents. Cash equivalents are
stated at cost.
Accounts receivable:
The Company receives payment for services rendered from the federal and
state governments under the Medicare and Medicaid programs and private pay
payors including third-party insurers, workers' compensation plans and
healthcare providers. The following table summarizes the percent of net accounts
receivable from all payors as of June 30, 1994 and 1993 respectively:
<TABLE>
<CAPTION>
1994 1993
---- ----
<S> <C> <C>
Government 39% 35%
Private 61% 65%
---- ----
100% 100%
==== ====
</TABLE>
Management does not believe that there are any credit risks associated with
receivables from governmental agencies. Private and other receivables consist of
receivables from a large number of payors, involved in diverse activities,
subject to differing economic conditions, and do not represent any concentrated
credit risks to the Company. Management continually monitors and adjusts its
reserves and allowances associated with these receivables.
Property and equipment and depreciation:
Property and equipment are stated at the lower of cost or net realizable
value. Depreciation is being provided on the straight-line method primarily over
the estimated useful lives of the assets as follows:
Buildings and improvements 30 to 40 years
Furniture and equipment 3 to 20 years
Accelerated methods and shorter lives are used for income tax purposes.
Goodwill:
Goodwill is being amortized using the straight-line method over 15 to 40
years. Accumulated amortization is $8,220,000 and $5,787,000 on June 30, 1994
and 1993, respectively.
-32-
<PAGE>
Deferred costs, new facilities:
Hospital development costs are expensed until it is probable that
construction will commence. For completed facilities owned by third parties and
leased by the Company, deferred costs are amortized over the lease term,
principally 10 years. For internally developed and owned facilities, these costs
become part of the fixed asset and are amortized over its estimated useful life.
Start-up expenses ("pre-opening costs") incurred prior to the opening of
new facilities are capitalized and amortized on a straight-line basis over
periods of 24 to 60 months upon the commencement of operations. Pre-opening
costs consist of all costs relating to a specific new operating facility which
are incurred in the period prior to admitting patients.
Asset impairment:
The carrying value of long-lived assets including identifiable intangibles
and goodwill related to those assets are reviewed if the facts and circumstances
suggest that an item may be impaired. If this review indicates that a long-lived
asset will not be recoverable, as determined based on the future undiscounted
cash flows of the asset, the Company's carrying value of the long-lived asset is
reduced to fair value.
Due to third-party payors:
Due to third-party payors represents the difference between amounts
received under interim payment plans from third-party payors for services
rendered and amounts estimated to be reimbursed by those third-party payors upon
settlement of cost reports.
Net operating revenues:
Revenues consist of patient revenue and contract therapy and physician
services revenue. Revenues are recognized as services are rendered.
Patient revenue includes amounts estimated to be reimbursable by third-
party payors under the provisions of cost reimbursement formulas in effect.
Final determination of amounts earned is subject to review by third-party payors
and their agents. Any adjustments which may result at the time of settlement are
not expected to be material. Differences between estimated provisions and final
settlements are recorded in operations in the year finalized.
Contract therapy and physician services revenues represent revenues from
services provided by therapists and other healthcare professionals to healthcare
facilities and other institutions.
Income taxes:
The Company files a consolidated federal income tax return with all 80% or
more owned subsidiaries. Separate federal returns are filed for subsidiaries
owned less than 80%. Effective July 1, 1993, the Company adopted Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes. See Note
10.
Restatement and reclassification:
Certain items in the fiscal 1993 and 1992 consolidated financial statements
have been reclassified to conform to the classifications used in the fiscal 1994
consolidated financial statements.
-33-
<PAGE>
2. Acquisitions:
On March 31, 1994, the Company acquired all of the outstanding stock of
Medical Management Associates, Inc. ("MMA"), for $1,500,000 in cash relating to
certain non-compete agreements and 647,500 shares of the Company's common stock.
The acquisition was accounted for by the purchase method of accounting. In
addition, certain costs of approximately $162,000 related to the transaction
were capitalized into the acquisition cost. Pursuant to the acquisition
agreement, additional shares of the Company's common stock may be issued over
the next three years, subject to the achievement of certain pre-tax earnings
levels.
On February 23, 1993, the Company acquired all of the outstanding stock of
Kron Medical Corporation ("Kron") in exchange for 1,268,331 shares of the
Company's common stock. The acquisition was accounted for as a pooling of
interests, and, accordingly, the Company's financial statements have been
restated to include the results of Kron for all periods presented. The effect
of the Kron acquisition on the consolidated results of operations of the Company
for the periods prior to the combination is immaterial.
On November 4, 1991, the Company acquired all of the outstanding stock of
CompHealth, Inc. ("CompHealth") in exchange for 3,007,890 shares of the
Company's common stock. CompHealth offers contract staffing services by
physicians and other allied health professionals. The acquisition was accounted
for as a pooling of interests and, accordingly, the Company's financial
statements have been restated to include the results of CompHealth for all
periods presented.
Prior to their respective mergers, Kron and CompHealth (the "pooled
companies") were treated as S-Corporations for federal and, with some exceptions
in the case of CompHealth, for state tax purposes. Therefore, no provision for
income taxes was made except for those states where CompHealth did not qualify
for S-Corporation status. Prior to their respective mergers, the pooled
companies made regular cash dividend distributions to their shareholders, in
part, to offset tax liabilities which accrued directly to their shareholders.
Distributions for fiscal 1993 and 1992 were $183,000 and $1,811,000,
respectively.
During fiscal 1993 and 1992, the Company acquired the entities, described
below, which were accounted for by the purchase method of accounting. The pro
forma effects of the acquisitions on the consolidated results of operations of
the Company for the periods prior to the acquisition dates are not material.
Prior to fiscal 1992, the Company acquired 80% of the outstanding stock of
Communi-Care/ProRehab, Inc. ("Communi-Care") and on July 1, 1992 acquired the
remaining 20% of the outstanding stock. The initial purchase price was
approximately $5,654,000, paid in cash and the Company's common stock. The
purchase price for the remaining 20% of the outstanding stock was approximately
$4,831,000, paid in cash and the Company's common stock. As additional purchase
price under the purchase agreement, cash and common stock totalling $8,589,000,
$2,504,000 and $2,639,000 was paid during fiscal 1994, 1993 and 1992,
respectively. Additional cash and common stock may be paid over the next two
years as additional purchase price, subject to adjustment based upon future
earnings.
On May 28, 1992 the Company acquired all the outstanding stock of Advanced
Care Medicine, Inc. ("AcMed") which provides respiratory therapy in long-term
care settings. The initial purchase price was approximately $3,100,000 paid in
cash and the Company's common stock. As additional purchase price under the
purchase agreement, cash and common stock totalling $960,000 was paid in fiscal
1993 and additional contingent payments may be paid based on earnings levels
through December 1996. Additionally, the Company paid the former AcMed
stockholders $2,000,000 in cash and the Company's common stock in consideration
for certain non-compete agreements.
-34-
<PAGE>
On October 19, 1992 the Company acquired a majority ownership in three
partnerships which owned the real estate of three of the Company's
rehabilitation hospitals for $39,000,000. The hospitals had been operated by
the Company under long-term operating leases prior to their acquisition. On
October 28, 1992, the Company acquired a condominium interest which comprises
another of its rehabilitation hospitals for $25,200,000. The hospital had been
operated under an interim operating lease prior to the acquisition.
During fiscal 1994 and 1993, the Company acquired various other outpatient
and contract rehabilitation services providers for $7,339,000 and $10,785,000,
respectively. The Company paid the former owners of these businesses $940,000
and $1,529,000, respectively, in consideration for certain non-compete
agreements.
Pursuant to other acquisitions consummated prior to 1992, cash and common
stock totaling $1,920,000, $2,162,000 and $2,937,000 was paid during fiscal
1994, 1993 and 1992, respectively.
Contingent payments estimated under all of the Company's acquisition
agreements approximate $17,000,000 and may be paid in cash and the Company's
common stock through fiscal 1997. These amounts are subject to adjustment based
upon the achievement of certain earnings levels.
3. Property and Equipment:
Property and equipment comprise the following (in thousands):
<TABLE>
<CAPTION>
June 30,
--------------
1994 1993
-------- --------
<S> <C> <C>
Land $ 24,448 $ 15,426
Buildings and improvements 189,349 185,999
Furniture and equipment 87,079 74,035
Construction in progress 2,487 47,650
-------- --------
303,363 323,110
Less: accumulated depreciation 51,340 33,288
-------- --------
$252,023 $289,822
======== ========
</TABLE>
4. Deferred Costs, New Facilities:
Deferred costs, new facilities comprise the following (in thousands):
<TABLE>
<CAPTION>
June 30,
--------------
1994 1993
-------- --------
<S> <C> <C>
Deferred development costs $ 4,705 $ 7,028
Pre-opening costs 50,706 46,784
------- -------
55,411 53,812
Less: accumulated amortization 34,526 25,178
------- -------
$20,885 $28,634
======= =======
</TABLE>
-35-
<PAGE>
5. Accrued Expenses:
Accrued expenses comprise the following (in thousands):
<TABLE>
<CAPTION>
June 30,
--------------
1994 1993
-------- --------
<S> <C> <C>
Salaries, wages and benefits $44,269 $37,215
Interest 12,136 13,133
Accrual for special charge 18,794
Other 22,581 14,254
------- -------
$97,780 $64,602
======= =======
</TABLE>
6. Long-term Debt:
Long-term debt comprises the following (in thousands, except interest
rates):
<TABLE>
<CAPTION>
June 30, 1994
-----------------------------------------------------
Current Long-term
Rate Portion Portion Maturity
---- ------- ---------- --------
<S> <C> <C> <C> <C>
10 7/8% Senior Subordinated Notes (b) 10 7/8% $200,000 2002
10 3/8% Senior Subordinated Notes (b) 10 3/8% 150,000 2003
Convertible subordinated debenture (c) 7 3/4% 2,000 2012
Notes, other (d) 5% to 14% $4,013 5,157 1994-2000
Unamortized discount (2,405)
------ ---------
4,013 354,752
Less: note receivable on convertible
debenture 1,000
------ --------
$4,013 $353,752
====== ========
</TABLE>
<TABLE>
<CAPTION>
June 30, 1993
-----------------------------------------------------
Current Long-term
Rate Portion Portion Maturity
---- ------- ---------- --------
<S> <C> <C> <C> <C>
Revolving line of credit (a) (a) $ 27,000 1996-1999
10 7/8% Senior Subordinated Notes (b) 10 7/8% 200,000 2002
10 3/8% Senior Subordinated Notes (b) 10 3/8% 150,000 2003
Convertible subordinated debenture (c) 7 3/4% 2,000 2012
Prime + 1 1/2%
Notes, other (d) to 16.3% $3,809 7,175 1994-1999
Unamortized discount (2,573)
------ ---------
Less: note receivable on convertible 3,809 383,602
debenture
1,000
------ --------
$3,809 $382,602
====== ========
</TABLE>
Annual maturities for the next five years are as follows: 1995, $4,013,000;
1996, $2,858,000; 1997, $1,220,000; 1998, $838,000; and 1999, $13,000.
-36-
<PAGE>
(a) The Company is party to a credit facility with Citibank, N.A., as
agent for a group of several banks (the "Facility"). The Facility provides up
to $235,000,000 in a revolving line of credit, of which up to $45,000,000 is
available in the form of letters of credit. The Facility provides for a
revolving loan period through December 31, 1996 and the subsequent conversion of
the revolving loan into a term loan. At June 30, 1994, $30,006,000 of letters
of credit were outstanding. The Company has pledged its ownership interests in
certain of its operating subsidiaries as collateral under the Facility.
At the Company's option, the interest rate on any loan under the Facility
will be based on the London Interbank Offered Rate (LIBOR) or a base rate as
specified in the agreement as adjusted for a margin. There were no borrowings
under the facility at June 30, 1994. At June 30, 1993, the weighted average
interest rate for all borrowings under the facility was 5.17%. Under the terms
of the Facility, the Company must, among other things, maintain certain
financial covenants. The Company is also limited in the amount of other
indebtedness it may incur and may not declare or pay cash dividends.
(b) On August 17, 1992, the Company issued its 10 7/8% Senior Subordinated
Notes due 2002 ("10 7/8% Notes") in the amount of $200,000,000 in a public
offering in which the Company received net proceeds of $192,500,000. The
10 7/8% Notes were priced at 99.25%, to yield 11% annually to maturity. On
March 16, 1993 the Company issued its 10 3/8% Senior Subordinated Notes due 2003
("10 3/8% Notes") in the amount of $150,000,000 in a private placement in which
the Company received net proceeds of $144,586,000. The 10 3/8% Notes were priced
at 99.22% to yield 10 1/2% annually to maturity. The 10 3/8% Notes were
subsequently registered in a registered exchange offer. Of the difference
between the face amount of each issue of the Notes and the net proceeds of the
offerings, $2,664,000 represented original issue discount. The remaining
$10,250,000 represented various issuance costs and is recorded within other
assets and is amortized over the life of the notes. The 10 7/8% Notes are
subject to redemption at any time on or after August 15, 1997 at the option of
the Company at specified redemption prices plus accrued interest. The 10 3/8%
Notes are subject to redemption at any time on or after April 1, 1998, at the
option of the Company at specified redemption prices plus accrued interest. The
indentures for the Notes contain certain covenants which include a limitation on
the Company's ability to incur additional indebtedness, provide guarantees and
pay cash dividends.
(c) In November 1987, a 7 3/4% convertible subordinated debenture was sold
to the Company's Chairman and Chief Executive Officer. This $2,000,000
debenture is convertible into shares of common stock at a conversion price of
$8.56 per share. Simultaneously, the Company loaned the Chairman and Chief
Executive Officer $2,000,000 to purchase the debenture. The loan is evidenced
by a promissory note bearing interest at 7 3/4%, payable on the maturity date of
the debenture or earlier to the extent that he converts or sells the debenture.
At June 30, 1994, $1,000,000 is outstanding on the note.
(d) These notes, primarily related to capitalized leases, require periodic
payments of principal and interest through maturity.
In order to reduce the impact of changes in interest rates on its long-term
debt, the Company, during fiscal 1994 and 1993, entered into four, seven year,
interest rate swap agreements with notional amounts of $25,000,000 each which
mature in 1999 and 2000 where the Company receives yields of between 5.16% and
6.65% and pays a six month LIBOR yield. These interest rate swap agreements are
subject to one year counter swap agreements where the Company receives a six
month LIBOR yield and pays a yield of between 3.62% and 4.08%. The Company has
limited its exposure under each interest rate swap agreement for interest rate
increases through the purchase of interest rate caps which impose limits of
between 5.25% and 8.00% which expire in 1996 and 1997. The differential to be
paid or received is accrued as interest rate changes and is recognized over the
life of the agreements. The counterparty to the interest rate swap agreements
and interest rate cap agreements is a large international financial institution.
While the
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<PAGE>
Company may be exposed to losses in the event of nonperformance, it does not
anticipate nonperformance under the agreements.
7. Commitments and Contingencies:
Leases:
The Company leases 18 of its rehabilitation hospitals under non-cancelable
operating leases. These leases have terms of ten to fifteen years.
Future minimum lease payments under all non-cancelable operating leases as
of June 30, 1994, are as follows (in thousands):
<TABLE>
<S> <C>
1995 $ 47,600
1996 44,541
1997 40,465
1998 36,213
1999 28,867
Thereafter 67,775
--------
$265,461
========
</TABLE>
Substantially all of the above leases have optional renewal terms based
upon fair market rentals at the time of renewal. Certain facility operating
leases require contingent lease payments based upon net patient revenues.
Total rental expense under operating leases for 1994, 1993 and 1992 was
$62,686,000, $64,648,000 and $56,014,000, respectively. The rental expense for
1994, 1993 and 1992 included contingent payments of $5,138,000, $6,982,000 and
$6,066,000, respectively.
Other:
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 total approximately $6,177,000 at June 30, 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, which
include malpractice claims covered under the Company's insurance policy. In the
opinion of management, the outcome of these actions will not have a material
effect on the financial position or results of operations of the Company.
8. Special Charge and Change in Accounting Principle:
During the fourth quarter a special pre-tax charge of $74,834,000 was
recorded. The special charge resulted from the approval by the Company's Board
of Directors of several measures to streamline operations and improve
productivity by restructuring the Company into major operating businesses,
flattening the management organization structure, writing down certain assets
and, where appropriate, divesting of unproductive assets. The Company began
working on the proposed plan during the fiscal 1994 third quarter as a result of
market changes the Company was experiencing. The special charge comprised
several items including the impairment of selected assets in the Company's
hospital division, the costs associated with the consolidation of its contract
therapy
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<PAGE>
companies, the losses related to the termination of certain business
relationships in the contract therapy business and certain other costs of the
restructuring program.
At June 30, 1994, $18,794,000 represents the balance of the special charge,
(excluding the write down of assets which are reflected as a reduction of the
related asset account), which is included within accrued liabilities. The
components of the special charge are as follows (in thousands):
<TABLE>
<S> <C> <C> <C>
Original Fiscal 1994 Balance
Provision Activity June 30, 1994
--------- ----------- -------------
Impairment of assets
Consolidation and restructuring $50,244 $(41,406) $ 8,838
Employee and other costs 22,842 (13,807) 9,035
1,748 ( 827) 921
------- -------- -------
$74,834 $(56,040) $18,794
======= ======== =======
</TABLE>
Approximately $50,244,000 of the special charge was associated with the
impairment of assets at eight rehabilitation hospitals, divestiture of two
rehabilitation hospitals, closure of a select group of outpatient locations and
miscellaneous other charges.
The impaired assets were identified in accordance with the Company's policy
and based upon a review of the facts and circumstances related to the assets and
a determination that the assets would not be recoverable, as determined based
upon the future undiscounted cash flows resulting from the assets. The
impairment loss was measured as the difference between the carrying amount of
the assets and their fair value as determined by independent appraisals.
Approximately $12,042,000 of the charge is related to the consolidation of
certain contract therapy companies into CMS Therapies and the exit from certain
markets and businesses. This consolidation process involved the closure of
offices, relocation and severance of personnel and elimination of duplicative
processes.
Approximately $10,800,000 of the charge is related to the writedown of
uncollectible receivables pertaining to the termination of certain business
relationships at the Company's CMS Therapies, Inc. subsidiary. During the second
quarter of fiscal 1994, the Company exited business arrangements in which it
provided therapists to unrelated Medicare certified agencies which in turn
supplied those therapists to non-Medicare certified skilled nursing facilities.
For a variety of business reasons, including, among others, the Healthcare
Financing Administration's announced intentions to increase their review of the
reasonableness of the charges billed by the agencies to the Medicare program,
the Company exited those relationships and, in many instances, began to provide
the same services directly to Medicare patients upon termination of the
contracts with the agencies. Following termination of the contracts, the Company
continued to assess the collectibility of the agency receivables and, due to
deteriorating business relations and declining financial condition of the
agencies, it was determined a write-down of these receivables was required as of
June 30, 1994.
The remainder of the charge, $1,748,000, was to reduce the work force at
the Company's corporate office and provide for transaction costs to execute the
plan.
During the fourth quarter of fiscal 1993 the Company recorded a pre-tax
charge of $14,556,000 related principally to the write-off of deferred costs for
approximately 30 abandoned rehabilitation hospital development projects for
which construction had not started. The decision to write-down or abandon
certain projects and pursue less capital-intensive growth than in the past, was
a result of changes in the Company's rehabilitation hospital development
strategy in response to changes in various healthcare delivery markets.
Previously, the Company had deferred certain costs incurred to obtain government
approvals and other expenses related to the development of rehabilitation
hospitals. Based on a historical high rate of completion, costs of developing a
project were charged to operations only when it was determined that the project
would be abandoned.
As a result of the change in development strategy, the Company changed its
accounting for development costs. Hospital development costs are expensed until
that time when it is probable that construction will commence.
9. Merger Expenses:
Costs of $2,598,000 related to the merger with Kron and Kron's subsequent
consolidation with the Company's other physician services company, CompHealth,
were charged to expense in the third quarter of fiscal 1993.
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<PAGE>
Costs of $1,000,000 related to the merger with CompHealth were charged to
expense in the second quarter of fiscal 1992. In the fourth quarter of fiscal
1992, the Company incurred expenses of $3,319,000 related to the termination of
a merger agreement.
10. 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. Under the
deferred method, tax expense was based on items of income and expense that were
reported in different years in the financial statements and tax returns, and
were measured at the rate in effect in the year the difference originated.
Under FAS 109 the deferred tax assets and liabilities are measured using the tax
rates and laws that will be in effect when the differences are expected to be
realized or settled. As permitted, the Company has elected not to restate the
financial statements of prior years. The cumulative effect of adopting FAS 109
was not material and has been included in the operating income tax provision.
There was no effect on pre-tax income for this prospective adoption.
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 and made certain other tax law changes. The effects of these tax law
changes were not material and have been included in the operating income tax
provision.
At June 30, 1994, the Company has an estimated $2,800,000 capital loss
carryforward as a result of certain restructuring transactions. The loss is
only available to offset future capital gain income and will expire in fiscal
1999.
Deferred tax liabilities (assets) were comprised of the following at June
30, 1994 (in thousands):
<TABLE>
<S> <C>
Depreciation and amortization $ 10,441
Other 3,973
---------
Total deferred tax liabilities 14,414
---------
Special charges (20,511)
Bad debt reserves (2,888)
Other non-deductible accruals (7,673)
Tax carryforward items (1,889)
Other (3,220)
---------
Total deferred tax assets (36,181)
---------
Valuation allowance 1,800
---------
Excess of deferred tax assets over liabilities $(19,967)
=========
Deferred Tax Balance Sheet Classification:
Current $ (5,610)
Noncurrent (14,357)
---------
Total $(19,967)
=========
</TABLE>
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<PAGE>
The valuation allowance is the result of: (1) The uncertain state tax
benefits resulting from states requiring separate return filings or with no or
limited loss carryover provisions; and (2) limitations on the Company's ability
to absorb the estimated $2,800,000 capital loss in the five year carryforward
period. The valuation allowance increased by approximately $900,000 during
fiscal 1994 primarily as a result of the capital loss limitation.
Income taxes comprise the following (in thousands):
<TABLE>
Liability
Method Deferred Method
------- ---------------
1994 1993 1992
---- ---- ----
<S> <C> <C> <C>
Current:
Federal $ 4,513 $19,180 $14,698
State and local 1,306 3,641 3,293
Deferred:
Federal (11,360) (3,681) (1,769)
State and local (1,103) (214) 78
Less:
Minority interest (1,004) (1,363) (1,439)
------- ------- -------
$(7,648) $17,563 $14,861
======= ======= =======
</TABLE>
A reconciliation of the statutory federal income tax rates with the
effective income tax rate is as follows:
<TABLE>
Liability
Method Deferred Method
------- ---------------
1994 1993 1992
---- ---- ----
<S> <C> <C> <C>
Federal income tax at statutory rates (35.0%) 34.0% 34.0%
State income taxes, net of federal tax
benefit (.1%) 6.9% 4.4%
Amortization of goodwill 1.4% 1.5% .8%
Merger costs 1.2% .2%
Assessments 6.9%
Adjustment for inclusion of pooled
companies (Note 2) (.8%) (2.6%)
Special charge 4.1%
Capital loss valuation allowance 2.3%
Other 2.3% .8% (1.4%)
------- ------ -----
(18.1%) 43.6% 35.4%
======= ====== =====
</TABLE>
The components of the provision for deferred income taxes for fiscal years
1993 and 1992 are as follows (in thousands):
<TABLE>
1993 1992
------- -------
<S> <C> <C>
Conversion from cash basis of accounting $ (267) $ (454)
Depreciation 1,094 790
Deferred costs (3,228) (53)
Bad debts (1,038) (119)
Accrued expenses and other (456) (1,855)
------- -------
$(3,895) $(1,691)
======= =======
</TABLE>
-41-
<PAGE>
11. Adoption of New Accounting Principle:
In fiscal 1993 the Company adopted the provisions of Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities". Upon issuance of this statement, the Company reviewed the
provisions of the new statement and concluded that the statement compelled the
write-down to fair value of a long term care investment being held to maturity
as a result of the impairment of the investment using a discounted cash flow
analysis. Prior to the issuance of this statement, the asset was carried at
historical cost which is expected to be recovered upon maturity. In applying
this statement, the Company recognized a $5,000,000 write-down to fair value of
the long-term care investment. The cumulative effect of this change in
accounting principle, on an after-tax basis, was $3,204,000 or $.08 per share on
a fully diluted basis.
12. Consolidated Statements of Cash Flow:
Supplementary information for the consolidated statements of cash flows is
set forth below (in thousands):
<TABLE>
1994 1993 1992
---- ---- ----
<S> <C> <C> <C>
Cash paid during the year for:
Interest, net of amounts
capitalized ($1,615, $5,918 and $1,226
in 1994, 1993 and 1992, respectively) $39,202 $10,356 $ 5,252
======= ======= =======
Income taxes $ 4,955 $27,819 $11,200
======= ======= =======
The sales of long-term care facilities
resulted in the following:
Assets disposed of
$15,344
Liabilities assumed by buyer =======
Notes received from buyers
$2,995
12,349
------
$15,344
=======
</TABLE>
In fiscal 1992, the Company purchased 100% of the capital stock of AcMed
for $5,100,000 in cash and the Company's common stock. In fiscal 1994, the
Company purchased 100% of the capital stock of MMA for $8,668,000 in cash and
the Company's common stock.
<TABLE>
(in thousands):
MMA AcMed
----- -----
<S> <C> <C>
Fair value of assets acquired $9,525 $7,424
Less:
Cash payments (1,662) (3,200)
Fair value of stock issued (7,006) (1,900)
-------- --------
Liabilities assumed
$ 857 $2,324
======= =======
</TABLE>
In fiscal 1993, the Company purchased the 20% minority interest of Communi-
Care for $3,941,000 in cash and $890,000 in stock, plus future payments based on
earnings.
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<PAGE>
13. Fair Value of Financial Instruments:
The estimated fair values of the Company's financial instruments at June
30, 1994 are as follows (in thousands):
<TABLE>
Carrying Fair
Amount Value
-------- -----
<S> <C> <C>
Cash and cash equivalents $54,862 $54,862
Notes Receivable $31,165 $30,643
Investments $11,367
Long-term debt $354,272 $339,927
Interest rate swap agreements / interest rate
collar agreements $644 $(6,300)
</TABLE>
Cash and cash equivalents' carrying amount approximates fair value because
of the short maturity of these instruments. The fair value of notes receivable
was estimated by discounting the future cash flows using current rates available
to similar borrowers under similar circumstances. It is not practicable to
estimate the fair value of the Company's investments, which comprise certain
short-term and equity investments because of the lack of a quoted market price,
and the inability to estimate fair value without incurring excessive costs. The
$11,367,000 carrying amount at June 30, 1994 represents the original cost of the
investments, which management believes it not impaired. The fair value of the
Company's long-term debt, excluding capital leases, was estimated based on the
quoted market prices for the same or similar issues or on the current rates
offered to the Company for debt of the same remaining maturities. The fair
values of interest rate swaps and interest rate collars are the estimated
amounts that the Company would receive or pay to terminate the swap agreements,
taking into account current interest rates.
14. Disposition of Long-term Care Facilities:
On March 31, 1992, the Company sold substantially all of the property and
equipment of two of its long-term care facilities to Renaissance Healthcare
Corporation ("RHC"), a long-term care company owned and operated by former
management employees of the Company. The aggregate sales price was
approximately $9,700,000 and was financed through installment sales agreements.
In addition, the Company sold all of the outstanding stock of another facility
to RHC for approximately $2,600,000 financed through a promissory note. There
were no gains or losses on the sales. As part of the transactions, the Company
increased a previously agreed upon working capital loan commitment to $3,000,000
and extended its payment terms.
The Company has notes receivable and other investments, related to its
divestiture of its free-standing long-term care facilities totaling $22,078,000
including notes receivable of $16,765,000 from RHC. Repayment of those amounts
are dependent upon the cash flows of the individual companies. Collateral on
certain notes receivable and investments aggregating $4,129,000 consists of
first or second mortgages, personal guarantees and pledges of certain other
assets. Certain notes receivable from RHC aggregating $13,265,000 reflect
future installment sales obligations under which the Company holds title to the
sold assets until all payments are made.
All notes receivable bear interest at 5% to 12% and require future
principal payments of approximately $547,000 in 1995, $3,742,000 in 1996,
$1,015,000 in 1997, $683,000 in 1998, $661,000 in 1999, and $25,353,000
thereafter. The current portion of these long-term notes are included in other
receivables in the consolidated balance sheets.
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<PAGE>
15. Related Party Transactions:
The Company has been party to various contracts with Commercial
Construction Company, Inc. ("CCI") for the construction of new rehabilitation
hospitals to be owned and operated by the Company. CCI is wholly owned by the
son of the Company's Chairman and Chief Executive Officer and brother of the
President of the Company. In addition, the Company purchases other development
and maintenance services, equipment, furniture and supplies for its
rehabilitation hospitals through CCI and its affiliates. In fiscal 1994, 1993
and 1992, the Company made payments aggregating approximately $16,950,000,
$75,220,000 and $14,994,000, respectively, to CCI and its affiliates. Of these
payments, $7,189,000, $66,204,000, and $12,470,000 were recorded in Property and
Equipment for fiscal 1994, 1993 and 1992, respectively, and $9,761,000,
$9,016,000 and $2,524,000 were charged to Cost of Services for fiscal 1994,
1993, and 1992 respectively. As of June 30, 1994, commitments under outstanding
contracts with CCI and its affiliates were $7,273,000 plus reimbursement of
certain personnel costs.
16. Stock Options:
Under various Company stock option plans, shares of common stock have been
reserved for issuance to officers, key employees and directors. The following
summary covers options under these plans as adjusted for the three-for-two stock
split paid November 15, 1991:
<TABLE>
Fiscal Year
----------------------------------------
1994 1993 1992
---------- ---------- -----------
<S> <C> <C> <C>
Shares under options at beginning of
period 5,441,563 6,469,567 2,843,190
Options granted during the period 1,135,003 3,633,932 4,252,031
Options canceled or terminated (364,571) (3,465,812) (25,099)
Options exercised:
1994 ($5.25 to $7.33) (206,125)
1993 ($.18 to $13.00) (1,196,124)
1992 ($5.25 to $13.00) (600,555)
--------- --------- ---------
Shares under option, end of period 6,005,870 5,441,563 6,469,567
Shares available for future grants 2,733,698 2,004,877 180,866
Shares reserved --------- --------- ---------
8,739,568 7,446,440 6,650,433
========= ========= =========
Options exercisable 2,054,179 1,502,507 1,745,552
========= ========= =========
</TABLE>
The Company has the following stock compensation plans at June 30, 1994:
The 1986 Stock Option Plan (1986 Plan), the 1989 Non-Qualified Stock Option
Agreement, the 1989 Non-Employee Directors' Stock Option Plan, the 1992 CEO
Stock Option Plan (1992 Plan), the 1993 Non-Qualified Stock Option Plan (1993
Plan), and the 1994 Stock Option Plan (1994 Plan). Options outstanding at June
30, 1994 are at prices ranging from $5.25 to $21.84 per share, the fair market
value of the stock at the date of grant. Accordingly, no compensation expense
has been recorded for these awards. Options become exercisable in four to seven
annual installments commencing on the first anniversary of the date of grant,
and expire between November 1994 and August 2003, five to ten years from the
date of grant.
In August 1993, the Board of Directors approved adoption of the 1994 Plan
which authorized options of 1,500,000 shares. No options were granted under the
Plan as of June 30, 1994.
In May 1993, the Board of Directors approved adoption of the 1993 Plan
which authorized options of 1,000,000 shares. Officers and directors of the
Company are not eligible to receive options under the 1993 Stock Option Plan.
In May 1993, the Company's Board of Directors granted options, exercisable
at the market price on the date of grant ($11 per share), to substantially all
employees holding outstanding options with exercise prices higher than such
current market price. The number of shares subject to the options granted to
each employee was equal in number to the shares covered by options previously
granted to such employee at higher exercise prices. The new
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<PAGE>
options were granted to each employee conditioned on such employee's agreement
to cancel their previously granted options for an equal number of shares at the
higher exercise prices. The term, vesting rate and other provisions of the new
options were otherwise identical to the options canceled. As a result, options
on 3,339,187 shares with exercise prices per share ranging from $13 to $22.88
per share were canceled and the same number of new options were granted at an
exercise price of $11 per share.
During fiscal 1993, the Company loaned its Chairman and Chief Executive
Officer $4,548,000 for the exercise of stock options and the payment of the
resulting income taxes, and loaned its President $530,000 for the payment of
income taxes resulting from the exercise of stock options. The tax loans were
authorized under the 1986 Plan, and the remaining loan was authorized by the
Company's Board of Directors. The loans are repayable upon demand with interest
payable monthly at the IRS' Applicable Federal Rate, adjusted semi-annually on
January 1, and July 1.
17. Net Income (Loss) Per Share:
Net income (loss) per common share and common equivalent share is based
upon the weighted average number of common shares outstanding during the period
plus the dilutive 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 on July 1, 1991. Net
income was adjusted for the interest on the debentures, net of the related
income tax benefits.
18. Shareholders' Rights Plan:
On March 11, 1991, the Company declared a distribution of Preferred Stock
Purchase Rights ("Rights") to holders of the Company's common stock and
authorized the issuance of additional Rights for common stock issued after that
date. The Company may redeem the Rights at $.001 per right at any time until
they become exercisable.
The rights become exercisable only if (with certain exceptions and
limitations) a person or group attempts to obtain beneficial ownership of 20% or
more of the Company's common stock or is determined to be an "adverse person" by
the Board of Directors. Each Right, if and when it becomes exercisable, may be
exchanged for 1/1000th of a share of Series A Junior Participating Preferred
Stock, at an exercise price of $85, subject to adjustment.
In certain actual or potential takeover situations if the Rights have not
been redeemed, Rights holders will be entitled to purchase common stock or other
securities or property of the Company or an acquiring company.
19. Subsequent Event
In June 1994, the Company obtained consents from its bondholders and
amended its credit facility to permit purchases of its Senior Subordinated Notes
in the open market. During the first two months of fiscal 1995, the Company
purchased approximately $26,835,000 of its Senior Subordinated Notes in a series
of open market purchases utilizing its operating cash flow.
-45-
<PAGE>
20. Quarterly Results of Operations (unaudited):
The following is a summary of the unaudited quarterly results of operations
for (in thousands, except per share data):
<TABLE>
<CAPTION>
Fiscal Year 1994
---------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net operating revenues $249,762 $249,041 $252,986 $253,050
Income (loss) before income taxes 12,727 6,366 7,010 (68,296) (a)
Net income (loss) 7,573 3,788 4,170 (50,076) (a)
Income (loss) per share $ .20 $ .10 $ .11 $ (1.31)
<CAPTION>
Fiscal Year 1993
---------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net operating revenues $209,889 $218,536 $232,305 $240,667
Income before income taxes and
cumulative effect of accounting
change 14,676 16,122 13,002(b) (3,514)(c)
Income before cumulative effect
of accounting change 9,095 9,996 7,764(b) (4,132)(c)
Net income 9,095 9,996 7,764(b) (7,336)(c)
Income per share:
Income before cumulative
effect of accounting change $.24 $.26 $.20 $(.11)
Cumulative effect of
accounting change ---- ---- ---- (.08)
-----
Net income $.24 $.26 $.20 $(.19)
==== ==== ==== ======
</TABLE>
(a) Includes $74,834 pre-tax special charge related to the impairment of
selected assets of the Company's hospital division, the costs associated
with the consolidation of its contract therapy companies, the losses related
to the termination of certain relationships in the contract therapy business
and certain other costs of the restructuring program.
(b) Includes $2,598 of pre-tax merger expense related to the Kron acquisition
and its subsequent consolidation with CompHealth.
(c) Includes $14,556 pre-tax special charge related to the write-down of certain
rehabilitation facility development costs.
-46-
<PAGE>
Report of Independent Auditors
The Board of Directors and Stockholders of
Continental Medical Systems, Inc.
We have audited the consolidated balance sheet of Continental Medical Systems,
Inc. and subsidiaries as of June 30, 1994, and the related consolidated
statements of operations, stockholders' equity, and cash flows for the year then
ended. Our audit also included the financial statement schedules listed in the
Index at Item 14(a). These financial statements and schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedules based on our audit. The
consolidated financial statements of Continental Medical Systems, Inc. and
subsidiaries for each of the two years in the period ended June 30, 1993 were
audited by other auditors whose report dated August 10, 1993 on those statements
included an explanatory paragraph that described the change in the Company's
method of accounting for development costs and the adoption of the provisions of
Statement of Financial Accounting Standards No. 115 discussed in Notes 8 and 11
to the consolidated financial statements.
We conducted our audit 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 and schedules. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement and
schedule presentation. We believe that our audit provides a reasonable basis for
our opinion.
In our opinion, the 1994 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Continental
Medical Systems, Inc. and subsidiaries at June 30, 1994, and the consolidated
results of their operations and their cash flows for the year then ended in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedules, when considered in relation to the
basic financial statements taken as a whole, present fairly in all material
respects the information set forth therein.
As discussed in Note 10 to the consolidated financial statements, in fiscal 1994
the Company changed its method of accounting for income taxes.
Ernst & Young LLP
Harrisburg, Pennsylvania
August 9, 1994
<PAGE>
Report of Independent Accountants
To the Board of Directors
of Continental Medical Systems, Inc.
In our opinion, the consolidated financial statements listed in the accompanying
index, present fairly, in all material respects, the financial position, results
of operations and cash flows of Continental Medical Systems, Inc. and its
subsidiaries as of and for each of the two years in the period ended June 30,
1993, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above. We have not audited the consolidated financial statements of Continental
Medical Systems, Inc. for any period subsequent to June 30, 1993.
As discussed in Notes 8 and 11 to the consolidated financial statements, in
fiscal 1993 the Company changed its method of accounting for development costs
and adopted the provisions of Statement of Financial Accounting Standards
No. 115.
Our audits of the consolidated financial statements referred to above also
included an audit of the related financial statement schedules. In our opinion,
these financial statement schedules present fairly, in all material respects,
the information set forth therein when read in conjunction with the related
consolidated financial statements.
Price Waterhouse
Philadelphia, PA
August 10, 1993
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Amendment No. 1 to be
signed on its behalf by the undersigned, thereunto duly authorized.
CONTINENTAL MEDICAL SYSTEMS, INC.
June 1, 1995 By:/s/ Dennis L. Lehman
------------------------------------
Dennis L. Lehman, Senior Vice
President-Finance and Chief Financial
Officer (Principal financial and
accounting officer)
