<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT OF 1934
FOR QUARTERLY PERIOD ENDED JUNE 30, 1998
COMMISSION FILE NO. 0-17490
IN HOME HEALTH, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1458213
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
601 CARLSON PARKWAY
SUITE 500
MINNETONKA, MINNESOTA 55305-5214
(Address of principal executive offices)
(Zip Code)
612-449-7500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No
--- ---
As of June 30, 1998, the number of shares outstanding of the registrant's
common stock, $.01 par value was 16,398,781 shares.
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IN HOME HEALTH, INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NO.
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<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets -
June 30, 1998 and September 30, 1997 2-3
Consolidated Statements of Operations -
For the Three and Nine Months Ended June 30,
1998 and 1997 4
Consolidated Statements of Cash Flows -
For the Nine Months Ended June 30, 1998 and 1997 5
Notes to Unaudited Consolidated Financial Statements 6-9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS 10-14
PART II. OTHER INFORMATION 15
</TABLE>
1
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IN HOME HEALTH, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
June 30, 1998 Sept. 30,
(Unaudited) 1997
------------- ---------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 19,658 $ 13,853
Accounts receivable, net of allowances of $1,307 and
$2,029 in June 1998 and September 1997, respectively 14,512 14,125
Prepaid income tax -- 3,907
Deferred income tax 1,419 1,540
Prepaid expenses and other current assets 845 579
-------- --------
Total current assets 36,434 34,004
-------- --------
Property:
Furniture and equipment 9,126 9,621
Computer equipment and software 7,477 7,506
Leasehold improvements 686 727
-------- --------
Total 17,289 17,854
Accumulated depreciation (11,807) (10,501)
-------- --------
Property - net 5,482 7,353
-------- --------
Other Assets:
Accounts receivable, long-term 1,117 2,891
Goodwill, net 5,313 5,432
Other assets 382 544
-------- --------
Total other assets 6,812 8,867
-------- --------
Total Assets $ 48,728 $ 50,224
-------- --------
-------- --------
</TABLE>
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
2
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IN HOME HEALTH, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(AMOUNTS IN THOUSANDS)
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
June 30, 1998 Sept. 30,
(Unaudited) 1997
------------- ---------
<S> <C> <C>
Current Liabilities:
Current maturities of long-term debt $ 302 $ 777
Accounts payable 2,535 4,255
Accounts payable - related party 83 59
Accrued liabilities:
Third party 10,897 6,789
Compensation 3,491 4,034
Insurance 4,824 6,704
Restructuring 843 1,807
Other 495 583
-------- --------
Total current liabilities 23,470 25,008
-------- --------
Long-Term Debt 91 278
Deferred Revenue 82 398
Deferred Rent Payable 207 248
Deferred Income Tax 1,438 1,643
Commitments and Contingencies -- --
Redeemable Convertible Preferred Stock - $1.00 par value,
$20,000 redemption value, authorized 200 shares; issued
and outstanding September 30 - 200 shares -- 19,061
$1.00 par value, $13,000 redemption value, authorized
130 shares; issued and outstanding June 30 - 130 shares 12,536 --
Shareholders' Equity:
Redeemable Convertible Preferred Stock - $1.00 par value,
$7,000 redemption value, authorized 70 shares; issued
and outstanding June 30 - 70 shares 7,000 --
Preferred stock - authorized 800 shares -- --
Common stock - $.01 par value, authorized 40,000 shares;
issued and outstanding June 30 and September 30 -
16,399 shares 164 164
Additional paid-in capital 23,661 23,661
Retained deficit (19,921) (20,237)
-------- --------
Total shareholders' equity 10,904 3,588
-------- --------
Total Liabilities and Shareholders' Equity $ 48,728 $ 50,224
-------- --------
-------- --------
</TABLE>
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
3
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IN HOME HEALTH, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 1998 AND 1997
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30 June 30
------------------- -------------------
1998 1997 1998 1997
------- -------- --------- ---------
<S> <C> <C> <C> <C>
Revenue [net of Medicare reserves of $66,
$13,970, ($4,163), and $14,421 for the
respective periods] $22,904 $ 18,855 $ 77,201 $ 81,815
------- -------- --------- ---------
Operating Expenses:
Direct costs of revenue (primarily payroll
related costs) 12,604 18,001 43,932 52,899
General, administrative and selling expenses 9,726 14,444 31,830 43,328
Restructuring Charge (61) 2,027 (398) 2,027
------- -------- --------- ---------
Total operating expenses 22,269 34,472 75,364 98,254
------- -------- --------- ---------
Income (loss) from operations 635 (15,617) 1,837 (16,439)
------- -------- --------- ---------
Interest:
Interest income 321 183 811 586
Interest expense (20) (51) (57) (203)
------- -------- --------- ---------
Net interest income 301 132 754 383
------- -------- --------- ---------
Income (loss) before income taxes 936 (15,485) 2,591 (16,056)
Income tax benefit -- (1,716) -- (1,780)
------- -------- --------- ---------
Net income (loss) $ 936 $(13,769) $ 2,591 $ (14,276)
------- -------- --------- ---------
------- -------- --------- ---------
Net income (loss) available to common
shareholders $ 287 $(14,443) $ 593 $ (16,297)
------- -------- --------- ---------
------- -------- --------- ---------
Basic and diluted earnings (loss) per share $ .02 $ (.89) $ .04 $ (1.00)
------- -------- --------- ---------
------- -------- --------- ---------
</TABLE>
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
4
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IN HOME HEALTH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED JUNE 30, 1998 AND 1997
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997
-------- -------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income (loss) $ 2,591 $(14,276)
Adjustments:
Depreciation and amortization 2,217 2,435
Accounts receivable 1,387 19,655
Prepaid expenses and other assets 3,634 (2,941)
Accounts payable (1,696) (2,089)
Accounts payable - related party 4,108 (7,992)
Accrued liabilities (3,475) 78
Deferred revenue (316) (316)
Deferred rent payable (41) (68)
Deferred income tax (84) 1,776
-------- -------
Net cash provided (used) by operating activities 8,325 (3,738)
-------- -------
Cash Flows From Investing Activities:
Business acquisitions -- (47)
Acquisition of property (65) (162)
Repayments of advances to officers and employees 7 351
-------- -------
Net cash provided (used) by investing activities (58) 142
-------- -------
Cash Flows From Financing Activities:
Payment of long-term debt (662) (1,195)
Preferred dividends paid (1,800) (1,800)
Repurchase of common stock -- (505)
-------- -------
Net cash used by financing activities (2,462) (3,500)
-------- -------
Cash and Cash Equivalents:
Net increase (decrease) 5,805 (7,096)
Beginning of period 13,853 18,617
-------- -------
End of period $ 19,658 $ 11,521
-------- -------
-------- -------
</TABLE>
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
5
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IN HOME HEALTH, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. FINANCIAL STATEMENTS
In the opinion of management of the Company, the accompanying unaudited
consolidated financial statements contain all adjustments (consisting of only
normal, recurring accruals) necessary to present fairly the financial position
of the Company and its subsidiaries as of June 30, 1998 and the results of
operations for the three and nine months and cash flows for the nine months
ended June 30, 1998 and 1997. The results of operations for any interim period
are not necessarily indicative of the results for the year. These interim
consolidated financial statements should be read in conjunction with the
Company's annual financial statements and related notes in the Company's
Form 10-K.
2. BASIC AND DILUTED EARNINGS PER SHARE
Effective October 1, 1997 the Company adopted Statement of Financial
Accounting Standard No. 128, "Earnings Per Share" (SFAS No. 128). Earnings per
share amounts presented for 1997 have been restated for the adoption of SFAS No.
128. The following table reflects the calculation of basic and diluted earnings
per share for the three months and nine months ended June 30, 1998 and 1997.
<TABLE>
<CAPTION>
(in thousands, except per share amounts)
THREE MONTHS NINE MONTHS
------------ -----------
1998 1997 1998 1997
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
EARNINGS PER SHARE:
Net income (loss) $ 936 $ (13,769) $ 2,591 $ (14,276)
Dividends on preferred stock (600) (600) (1,800) (1,800)
Preferred stock accretion (49) (74) (198) (221)
-------- --------- -------- ---------
Income (loss) available to
common shareholders $ 287 $ (14,443) $ 593 $ (16,297)
-------- --------- -------- ---------
-------- --------- -------- ---------
Weighted average shares outstanding 16,399 16,311 16,399 16,349
-------- --------- -------- ---------
-------- --------- -------- ---------
Income (loss) per share-basic and diluted $ .02 $ (.89) $ .04 $ (1.00)
-------- --------- -------- ---------
-------- --------- -------- ---------
</TABLE>
Options to purchase 1,070,666 shares of common stock were outstanding at
June 30, 1998. These options were not included in the computation of diluted
earnings per share because the options' exercise price was greater than the
average market price of the common shares. Options to purchase 1,283,291 shares
of common stock were outstanding at June 30, 1997, and were not included in the
computation of diluted earnings per share due to the loss in the period.
Redeemable convertible preferred stock was issued to ManorCare Health Services,
Inc. in October 1995. As of April 13, 1998, 130,000 preferred shares may be
redeemed in cash at the option of the holder or the Company on and after the
fifth anniversary of their issuance, while 70,000 shares can be redeemed only at
the option of the Company on and after the fifth anniversary. The redeemable
preferred shares have voting rights on an as-if converted basis, and are
initially convertible into 10 million common shares at an initial conversion
price of $2.00 per share. A private warrant was issued in October 1995 to
ManorCare Health Services, Inc. to purchase 6 million shares of common stock at
$3.75 per share and expires in October 1998. The impact of the redeemable
convertible preferred
6
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stock and the warrant on diluted earnings per share would be anti-dilutive and
therefore, they have been excluded.
3. RESTRUCTURING CHARGE
During the third and fourth quarters of fiscal 1997, the Company recorded
$2,027,000 and $449,000, respectively, in restructuring charges as a result of
the implementation of a plan to restructure its field operations and reduce the
Company's cost structure. The charge includes $1,820,000 of costs associated
with lease costs and related equipment write-offs associated with the closing of
eight pharmacies, the consolidation of seven sites in multi-site markets, the
relocation of eight other sites to more economical locations and $361,000 of
severance costs related to administrative staff reductions.
Total expenditures related to facilities consolidation were $566,000 during
the nine months ended June 30, 1998. As of June 30, 1998, $843,000 of costs,
comprised of lease costs and related equipment write-offs associated with
vacated sites, remain to be paid out and are included in other current
liabilities. The restructuring plan is expected to be substantially complete by
the end of fiscal 1998.
4. COMMITMENTS AND CONTINGENCIES
Approximately 56% and 55% of revenue for the nine months ended June 30,
1998 and 1997, respectively, was derived from services provided to Medicare
beneficiaries. Payments for reimbursable services are made by the Medicare
program based on reimbursable costs incurred in rendering the services.
Medicare makes interim payments as services are rendered, and the Company files
cost reports on an annual basis which are subject to audit and retroactive
adjustment by Medicare. The Company reports revenue only for those costs that
it believes are probable (as defined in Statement of Financial Accounting
Standards No. 5) of recovery under the applicable Medicare statutes and
regulations and reports its accounts receivable balances at net realizable
value. The Company utilizes an extensive system of internal controls to attempt
to ensure such proper reporting of revenues. The Company employs personnel with
significant Medicare reimbursement experience to prepare its cost reports and to
monitor its operations on an ongoing basis to identify and seek to minimize
those costs which are not reimbursed. As a part of its system of internal
controls, the Company uses a detailed analysis process in calculating its
Medicare revenue at the time services are rendered. This process considers the
nature and amounts of the disputed costs (as described in more detail below)
along with several authoritative, legal and historical sources of information
including:
* Applicable statutes and regulations, such as those contained in the Title
XVIII of the Social Security Act, particularly Sec. 1861 (V) (1) (A)
"Reasonable Cost" and 42 C.F.R. 413.9 "Cost Related to Patient Care",
Health Care Financing Administration ("HCFA") Publication 11 "Health
Insurance Manual", applicable sections of HCFA Publication 15-1 "Provider
Reimbursement Manual" and intermediary letters and program memoranda issued
by HCFA.
* Administrative decisions and rulings on related issues by the Department of
Health and Human Services' Provider Reimbursement Review Board ("PRRB") and
Administrative Law Judges.
* Judicial decisions from Federal District Courts on relevant cases.
* Consultation with independent industry experts such as Medicare cost
reimbursement consultants.
* Opinions of outside legal counsel who specialize in dealing with Medicare
reimbursement issues.
* Historical knowledge gained internally from past Medicare audits.
Meetings and other communication with Medicare Intermediaries, the Blue
Cross Association and HCFA.
7
<PAGE>
This detailed analysis process is updated on a quarterly basis, taking
into account any new information (such as decisions relating to the Company's
disputed costs, and administrative and judicial decisions relating to similar
issues) that may affect the determination of the net realizable value of
accounts receivable or of liabilities to repay amounts received for disputed
costs. Results of this detailed analysis process are extrapolated to other
unaudited cost reporting years, including operations that have not yet been
audited by Medicare, to estimate the gross amount of reimbursement that would be
affected. The Company, through this ongoing control and monitoring process,
provides a reserve (by means of a revenue reduction) for any costs incurred
which the Company believes are not probable of recovery. This reserve is
reported as a reduction of accounts receivable for disputed costs for which the
Company may not ultimately receive payment. The Company also reports as a
liability disputed costs for which it has received payment, but which may have
to be returned to Medicare. Accordingly, the Company believes that its accounts
receivable are stated at net realizable value, and that it has recorded all
probable liabilities for repayment of disputed costs.
Over the years, Medicare auditors employed by the Medicare fiscal
intermediaries have, in connection with their retrospective audit process, taken
certain positions with respect to certain types of costs, claiming that they are
not reimbursable and thus not recoverable by the Company from the Medicare
program. These positions are based on interpretations promulgated after the
period covered by the cost reports and applied retroactively, on interpretations
of cost reimbursement principles that are contrary to the Company's
interpretations, or on what the Company believes to be misapplications of
specific reimbursement principles, that could not have been foreseen at the time
services were rendered and revenue recorded. These positions taken by Medicare
fiscal intermediaries are usually determined from Medicare's Notices of Program
Reimbursement ("NPR"), which typically are not received until two to three years
after the services are rendered. In those situations where the Company decides
to not challenge an NPR finding, any revenue relating to these costs, as well as
the extrapolated impact, if any, on other open cost reporting years, if not
written off or provided for earlier, is written off as a revenue reduction at
that time. The results of all NPRs are included in the analysis process in
calculating net Medicare revenue as described above.
In cases where the Company disagrees with the positions taken by the
Medicare fiscal intermediaries' auditors and HCFA, it vigorously pursues such
matters through administrative and legal channels. The normal Medicare
administrative appeal process may take several years to resolve these types of
disputes. The Company has established a reserve for the portion of these costs
not considered probable of recovery. As additional costs are incurred, the
Company is increasing the reserve to cover such additional costs that are not
considered probable of recovery. Since the reserves have been established, the
Company has continued to review whether the level is appropriate.
The Company had NPRs challenging $6.6 million as of June 30, 1998. There is an
additional $2.1 million of costs at June 30, 1998 related to open cost reporting
years that are similar to the costs that have been challenged on NPRs. The
Company has settled with HCFA to recover $4.6 million (see below) of the $6.6
million withheld through June 30, 1998. Together these amounts ($6.6 million
plus $2.1 million minus $4.6 million) comprise a total of $4.1 million that the
Company considers to be disputed costs. The cost categories in dispute are the
cost of physical therapists employed by the Company and certain other branch and
corporate expenses. The settlements were primarily related to certain personnel
costs relating to the Company's community liaison position and pharmacy
expenses. As a result of such settlements, the amount in dispute with respect to
NPRs received and anticipated has been reduced by $15.1 million and the Medicare
reserve has been reduced by $13.4 million.
In June 1998, the Company received a favorable ruling from the U.S.
District Court in the case involving physical therapist costs. The Court ruled
that the Secretary's application of contractor
8
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physical therapist salary equivalency guidelines to the Company's employee
physical therapists is contrary to law. The Court's decision is a result of the
Company's appeal to an October 1997 decision of the Secretary when, for the
second time, she ruled that the contractor salary equivalency guidelines were
applicable to the Company's employee physical therapists. The Secretary has 60
days from the date of the decision to appeal.
As of June 30, 1998, the Company, based on its analysis process, believes
that recovery of $2,958,000 of total disputed costs (including the extrapolated
impact) may not be probable and, accordingly, has established reserves which
totaled that amount as of June 30, 1998. Total accounts receivable (net of
reserves) due from Medicare at June 30, 1998 were $7,757,000, including the
receivables (net of reserves) for disputed costs of $1,117,000. As of June 30,
1998, the Company had received $10,897,000 in payments from Medicare for which
Medicare may seek repayment and accordingly, such a potential liability for
repayments is recorded as Accrued Liabilities - Third Party. The Company
believes it is probable that it has not incurred any other liability to repay
disputed costs. In view of the expectation that resolution of the disputed costs
will not likely be accomplished within the next twelve months, related net
receivables of $1,117,000 as of June 30, 1998 have been classified as a
non-current asset.
5. INCOME TAXES
At September 30, 1997, the Company had federal operating loss carryforwards of
$11,000,000 which will expire in 2012. Management believes it is more likely
than not that certain of these net operating loss carryforwards and other
temporary differences may expire unused and, accordingly, has established a
valuation allowance against them. During the nine months ended June 30, 1998,
income tax expense of $1,100,000 was offset by utilizing a portion of the net
operating loss carryforwards.
6. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 131 "Disclosures about Segments of an
Enterprise and Related Information" which is effective for fiscal years
beginning after December 15, 1997. The Company has not determined the impact of
adoption of the standard.
9
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ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information which management
believes is relevant to an assessment and understanding of the Company's level
of operation and financial condition. This discussion should be read with the
consolidated financial statements appearing in Item 1.
RESULTS OF OPERATIONS
Revenue for the three and nine months ended June 30, 1998 increased 21% and
decreased 6%, respectively, over the same periods in the prior year. Revenue
for the prior year periods included increases to Medicare reserves totaling
$13,970,000. Excluding these reserve increases, revenue for the three and nine
month periods decreased $9,921,000 (30%) and $18,584,000 (19%), respectively.
This decrease in revenue resulted principally from a cost reduction program
management implemented in fiscal 1997 and lower Medicare payments under the new
per-beneficiary cost limits which were announced April 1, 1998 but made
effective retroactive to October 1, 1997. Visit Division revenue decreased 4%
while Extended Hours, Infusion and Hospice Division revenue decreased 8% from
the prior year.
The Balanced Budget Act of 1997 calls for the implementation on October 1,
1999, of a new Prospective Payment System (PPS) for Medicare payments for home
health services. Until PPS is implemented, the Balanced Budget Act established
an Interim Payment System (IPS), effective October 1, 1997, that reimburses home
health agencies the lesser of: (1) actual, reasonable costs, (2) per-visit cost
limits, or (3) newly implemented per-beneficiary cost limits. The IPS program
was announced April 1, 1998, but given effect retroactively to October 1, 1997.
The new per-beneficiary cost limits, together with the per-visit cost limits to
which the Company is accustomed, have caused a $5.5 million reduction in the
Company's year-to-date revenue. The Company initiated a series of cost reduction
programs, care delivery process improvements, and revenue growth actions in
response to IPS. The full impact of the initiatives has not yet been realized,
but the Company made significant progress during the three months ended June 30,
1998, with a revenue reduction of $1.0 million compared to $4.5 million for the
six months ended March 31, 1998.
Direct costs decreased $5,397,000 (30%) and $8,967,000 (17%) for the
three and nine month periods ended June 30, 1998, respectively, compared to the
prior year periods. These reductions were principally the result of the
Company's cost reduction program. Direct costs, as a percent of revenue, were
55% and 57% for the three and nine months ended June 30, 1998 versus 95% and 65%
for the same periods of the previous year. This decrease was primarily due to
the Medicare revenue reserve recorded last year.
General, administrative and selling expenses for the three months and nine
months ended June 30, 1998 decreased $4,718,000 (33%) and $11,498,000 (27%),
respectively, compared to the same periods of the previous year. These
reductions were principally the result of the Company's cost reduction program.
General, administrative and selling expenses for the three and nine months ended
June 30, 1998 as a percent of revenues were 42% and 41%, versus 77% and 53% for
the same periods of the
10
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previous year. This decrease was attributable to the decrease in costs
associated with the Company's restructuring plan and the Medicare revenue
reserve recorded last year.
Net interest income for the three and nine months ended June 30, 1998
was $301,000 and $754,000 versus $132,000 and $383,000 for the same periods of
the previous year. The increases in net interest income was principally
attributable to higher average cash balances resulting from improved cash flow
from operations and reductions in interest expense due to reduction of long-term
debt.
Net income for the three and nine months ended June 30, 1998 was $936,000 and
$2,591,000 compared to net loss of $13,769,000 and $14,276,000 for the same
periods of the previous year. The net income improvement is primarily due to
the $13,970,000 Medicare revenue reserve and the $2,027,000 restructuring charge
recorded in the previous year. Net income available to common shareholders was
$287,000 and $593,000 for the three and nine months ended June 30, 1998,
compared to a loss of $14,443,000 and $16,297,000 for the same periods of the
previous year. The difference between net income and net income available to
common shareholders is primarily the result of the preferred stock dividend
payable to ManorCare Health Services, Inc. for its $20 million preferred stock
investment in In Home Health. Basic and diluted earnings per share were $.02
and $.04 compared to a loss of $.89 and $1.00 per share last year.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents increased $5,805,000 to $19,658,000
at June 30, 1998 from $13,853,000 at September 30, 1997. Net cash provided from
operating activities for the nine months ended June 30, 1998 was $8,325,000. The
increase in operating cash provided by operating activities includes $3.9
million of income tax refunds received relating to fiscal 1997 net operating
loss carrybacks.
Approximately 56% and 55% of revenue for the nine months ended June 30,
1998 and 1997, respectively, was derived from services provided to Medicare
beneficiaries. Payments for reimbursable services are made by the Medicare
program based on reimbursable costs incurred in rendering the services.
Medicare makes interim payments as services are rendered, and the Company files
cost reports on an annual basis which are subject to audit and retroactive
adjustment by Medicare. The Company reports revenue only for those costs that
it believes are probable (as defined in Statement of Financial Accounting
Standards No. 5) of recovery under the applicable Medicare statutes and
regulations and reports its accounts receivable balances at net realizable
value. The Company utilizes an extensive system of internal controls to attempt
to ensure such proper reporting of revenues. The Company employs personnel with
significant Medicare reimbursement experience to prepare its cost reports and to
monitor its operations on an ongoing basis to identify and seek to minimize
those costs which are not reimbursed. As a part of its system of internal
controls, the Company uses a detailed analysis process in calculating its
Medicare revenue at the time services are rendered. This process considers the
nature and amounts of the disputed costs (as described in more detail below)
along with several authoritative, legal and historical sources of information
including:
* Applicable statutes and regulations, such as those contained in the Title
XVIII of the Social Security Act, particularly Sec. 1861 (V) (1) (A)
"Reasonable Cost" and 42 C.F.R. 413.9 "Cost Related to Patient Care",
Health Care Financing Administration ("HCFA") Publication 11 "Health
Insurance
11
<PAGE>
Manual", applicable sections of HCFA Publication 15-1 "Provider
Reimbursement Manual" and intermediary letters and program memoranda issued
by HCFA.
* Administrative decisions and rulings on related issues by the Department of
Health and Human Services' Provider Reimbursement Review Board ("PRRB") and
Administrative Law Judges.
* Judicial decisions from Federal District Courts on relevant cases.
* Consultation with independent industry experts such as Medicare cost
reimbursement consultants.
* Opinions of outside legal counsel who specialize in dealing with Medicare
reimbursement issues.
* Historical knowledge gained internally from past Medicare audits.
* Meetings and other communication with Medicare Intermediaries, the Blue
Cross Association and HCFA.
This detailed analysis process is updated on a quarterly basis, taking into
account any new information (such as decisions relating to the Company's
disputed costs, and administrative and judicial decisions relating to similar
issues) that may affect the determination of the net realizable value of
accounts receivable or of liabilities to repay amounts received for disputed
costs. Results of this detailed analysis process are extrapolated to other
unaudited cost reporting years, including operations that have not yet been
audited by Medicare, to estimate the gross amount of reimbursement that would be
affected. The Company, through this ongoing control and monitoring process,
provides a reserve (by means of a revenue reduction) for any costs incurred
which the Company believes are not probable of recovery. This reserve is
reported as a reduction of accounts receivable for disputed costs for which the
Company may not ultimately receive payment. The Company also reports as a
liability disputed costs for which it has received payment, but which may have
to be returned to Medicare. Accordingly, the Company believes that its accounts
receivable are stated at net realizable value, and that it has recorded all
probable liabilities for repayment of disputed costs.
Over the years, Medicare auditors employed by the Medicare fiscal
intermediaries have, in connection with their retrospective audit process, taken
certain positions with respect to certain types of costs, claiming that they are
not reimbursable and thus not recoverable by the Company from the Medicare
program. These positions are based on interpretations promulgated after the
period covered by the cost reports and applied retroactively, on interpretations
of cost reimbursement principles that are contrary to the Company's
interpretations, or on what the Company believes to be misapplications of
specific reimbursement principles, that could not have been foreseen at the time
services were rendered and revenue recorded. These positions taken by Medicare
fiscal intermediaries are usually determined from Medicare's Notices of Program
Reimbursement ("NPR"), which typically are not received until two to three years
after the services are rendered. In those situations where the Company decides
to not challenge an NPR finding, any revenue relating to these costs, as well as
the extrapolated impact, if any, on other open cost reporting years, if not
written off or provided for earlier, is written off as a revenue reduction at
that time. The results of all NPRs are included in the analysis process in
calculating net Medicare revenue as described above.
In cases where the Company disagrees with the positions taken by the
Medicare fiscal intermediaries' auditors and HCFA, it vigorously pursues such
matters through administrative and legal channels. The normal Medicare
administrative appeal process may take several years to resolve these types of
disputes. The Company has established a reserve for the portion of these costs
not considered probable of recovery. As additional costs are incurred, the
Company is increasing the reserve to cover such additional costs that are not
considered probable of recovery. Since the reserves have been established, the
Company has continued to review whether the level is appropriate.
12
<PAGE>
The Company had NPRs challenging $6.6 million as of June 30, 1998. There is an
additional $2.1 million of costs at June 30, 1998 related to open cost reporting
years that are similar to the costs that have been challenged on NPRs. The
Company has settled with HCFA to recover $4.6 million (see below) of the $6.6
million withheld through June 30, 1998. Together these amounts ($6.6 million
plus $2.1 million minus $4.6 million) comprise a total of $4.1 million that the
Company considers to be disputed costs. The cost categories in dispute are the
cost of physical therapists employed by the Company and certain other branch and
corporate expenses. The settlements were primarily related to certain personnel
costs relating to the Company's community liaison position and pharmacy
expenses. As a result of such settlements, the amount in dispute with respect to
NPRs received and anticipated has been reduced by $15.1 million and the Medicare
reserve has been reduced by $13.4 million.
In June 1998, the Company received a favorable ruling from the U.S.
District Court in the case involving physical therapist costs. The Court ruled
that the Secretary's application of contractor physical therapist salary
equivalency guidelines to the Company's employee physical therapists is contrary
to law. The Court's decision is a result of the Company's appeal to an October
1997 decision of the Secretary when, for the second time, she ruled that the
contractor salary equivalency guidelines were applicable to the Company's
employee physical therapists. The Secretary has 60 days from the date of the
decision to appeal.
As of June 30, 1998, the Company, based on its analysis process, believes
that recovery of $2,958,000 of total disputed costs (including the extrapolated
impact) may not be probable and, accordingly, has established reserves which
totaled that amount as of June 30, 1998. Total accounts receivable (net of
reserves) due from Medicare at June 30, 1998 were $7,757,000, including the
receivables (net of reserves) for disputed costs of $1,117,000. As of June 30,
1998, the Company had received $10,897,000 in payments from Medicare for which
Medicare may seek repayment and accordingly, such a potential liability for
repayments is recorded as Accrued Liabilities - Third Party. The Company
believes it is probable that it has not incurred any other liability to repay
disputed costs. In view of the expectation that resolution of the disputed costs
will not likely be accomplished within the next twelve months, related net
receivables of $1,117,000 as of June 30, 1998 have been classified as a
non-current asset.
The Company has letter of credit facilities from a commercial bank totaling
$2,583,390. These credit facilities are collateralized by secured investments
and will expire on December 15, 1998.
Management believes cash provided by operations and existing cash balances
are sufficient to meet the Company's financial requirements for the foreseeable
future.
FORWARD LOOKING INFORMATION
Statements included in this Form 10-Q that are not historical or current
facts are "forward-looking statements" made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995 and are
subject to certain risks and uncertainties that could cause actual results to
differ materially. The Company's ability to succeed in the future is dependent
upon government regulation, third party reimbursement, competition and factors
affecting the health care industry in general. The Company's future results of
operations and financial condition will be affected by factors such as (i)
proposed changes to the Medicare reimbursement system from a retrospective
cost-based system to a prospective payment system, (ii) settlements which may be
reached with the Department of Health and Human Services regarding cost reports,
and (iii) its ability to establish and maintain close working
13
<PAGE>
relationships with referral sources, including payors, hospitals, physicians and
other health care professionals. As a result of these developments, the Company
is not able to conclude that it is more likely than not that it will be able to
generate future earnings which will allow it to utilize its NOLs and,
accordingly, has established a valuation allowance against the NOLs. Please
refer to our Form 10-K for the fiscal year ended September 30, 1997 for a more
thorough discussion of forward looking information.
14
<PAGE>
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS - None.
ITEM 2 - CHANGE IN SECURITIES - On April 13, 1998, the Company entered into a
Preferred Stock Modification Agreement with ManorCare Health Services,
Inc. ("ManorCare") the holder of all 200,000 outstanding shares of the
Company's Series A Preferred Stock. Under the Agreement, ManorCare
agreed, with respect to 70,000 shares (the "Modified Shares") of the
Series A Preferred Stock, to waive the right to give notice on or
after October 24, 2000 requiring the Company to redeem the Modified
Shares. ManorCare also agreed that any transferee of the Modified
Shares would be required to agree to the same limitation.
The effect of the Agreement is to permit the Company to present the
Modified Shares in the Shareholders' Equity portion of its balance
sheet, while the remainder of the Preferred Stock continues to be
presented as a "mezzanine item" between the Liabilities and
Shareholders' Equity sections of the balance sheet.
The reason for the Agreement was to allow the Company to meet the
requirements for continued listing of its common stock on the NASDAQ
National Market. The Company also provided an undertaking to the
NASDAQ Stock Market, Inc. ("NASDAQ") that the Company will not
voluntarily redeem any of its Preferred Stock if the redemption would
cause the Company's net tangible assets, as defined by NASDAQ, to be
less than $5,000,000, unless NASDAQ otherwise consents. Based on the
Agreement and the undertaking described above, the Company believes
that its common stock will continue to be listed for trading on the
NASDAQ National Market.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES - None.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - None.
ITEM 5 - OTHER INFORMATION - None.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits -
Exhibit 27 - Financial Data Schedule.
(b) Reports on Form 8-K - A report on Form 8-K was filed April 14,
1998 containing disclosure pursuant to Item 5 of Form 8-K. See ITEM 2
above.
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Form 10-Q report to be signed on its behalf by
the undersigned thereunto duly authorized.
In Home Health, Inc.
-------------------------------
Registrant
Date: July 22, 1998 /s/Wolfgang von Maack
-------------------------------
Wolfgang von Maack
Chief Executive Officer
Date: July 22, 1998 /s/Robert J. Hoffman, Jr.
-------------------------------
Robert J. Hoffman, Jr.
Acting Chief Financial Officer
16
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