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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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SCHEDULE 14D-9
SOLICITATION/RECOMMENDATION STATEMENT
PURSUANT TO SECTION 14(d)(4) OF THE
SECURITIES EXCHANGE ACT OF 1934
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REGENCY HEALTH SERVICES, INC.
(NAME OF SUBJECT COMPANY)
REGENCY HEALTH SERVICES, INC.
(NAME OF PERSON(s) FILING STATEMENT)
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COMMON STOCK, PAR VALUE $.01 PER SHARE
(TITLE OF CLASS OF SECURITIES)
758934-103
(CUSIP NUMBER OF CLASS SECURITIES)
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DAVID A. GRANT, ESQ.
SENIOR VICE PRESIDENT AND GENERAL COUNSEL
REGENCY HEALTH SERVICES, INC.
2742 DOW AVENUE
TUSTIN, CALIFORNIA 92780
(714) 544-4443
(NAME, ADDRESS AND TELEPHONE NUMBER OF PERSON AUTHORIZED TO RECEIVE NOTICES AND
COMMUNICATIONS ON BEHALF OF THE PERSON(s) FILING STATEMENT)
WITH A COPY TO:
JUDITH R. THOYER, ESQ.
PAUL, WEISS, RIFKIND, WHARTON & GARRISON
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019-6064
(212) 373-3000
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ITEM 1. SECURITY AND SUBJECT COMPANY.
The name of the subject company is Regency Health Services, Inc., a Delaware
corporation (the "Company"). The address of the principal executive offices of
the Company is 2742 Dow Avenue, Tustin, California 92780. The title of the
class of equity securities to which this Solicitation/Recommendation Statement
on Schedule 14D-9 (this "Schedule 14D-9") relates is the common stock, par
value $.01 per share ("Common Stock").
ITEM 2. TENDER OFFER OF THE BIDDER.
This Statement relates to the tender offer (the "Offer") by Sunreg
Acquisition Corp., a Delaware corporation ("Offeror") and a wholly owned
subsidiary of Sun Healthcare Group, Inc., a Delaware corporation ("Sun"), to
purchase all outstanding shares of Common Stock at a price per share of
$22.00, net to the seller in cash, without interest, upon the terms and
subject to the conditions set forth in the Offer to Purchase, dated August 1,
1997 (the "Offer to Purchase") and the related Letter of Transmittal (which
together constitute the "Offer").
The Offer is being made pursuant to an Agreement and Plan of Merger, dated
as of July 26, 1997, among the Company, Sun and Offeror (the "Merger
Agreement"). The Merger Agreement provides, among other things, that as soon
as practicable following the satisfaction or waiver of the conditions set
forth in the Merger Agreement, and unless Sun elects (if such election would
not in any way adversely affect the Company's stockholders or delay the
transactions contemplated by the Merger Agreement) to merge the Company with
and into Sun, Offeror or another subsidiary of Sun, Offeror will be merged
with and into the Company (in any such case, the "Merger") and the Company (or
Sun, Offeror or another subsidiary of Sun, if applicable) will continue as the
surviving corporation (the "Surviving Corporation"). A copy of the Merger
Agreement is filed as Exhibit 2 hereto and is incorporated herein by reference
in its entirety.
As set forth in the Tender Offer Statement on Schedule 14D-1 of Offeror
enclosed herewith, the address of the principal executive offices of Offeror
and Sun is 101 Sun Lane NE, Albuquerque, New Mexico 87109.
ITEM 3. IDENTITY AND BACKGROUND.
(A) Name and Business Address of Person Filing This Statement.
The name and business address of the Company, which is the person filing
this Schedule 14D-9, are set forth in Item 1 above.
(B) (1) Arrangements with Executive Officers, Directors or Affiliates of the
Company.
Certain contracts, agreements, arrangements and understandings between the
Company and certain of its executive officers and directors, together with
certain employee benefit plans of the Company available to them, are described
in Items 11 and 13 of Part III of the Company's Annual Report on Form 10-K for
the year ended December 31, 1996 filed on Form 10-K on March 25, 1997 (the
"Form 10-K"). A copy of the Form 10-K is filed as Exhibit 1 hereto and is
incorporated herein by reference.
It is anticipated that prior to the Effective Time (as defined below), as
contemplated by the Merger Agreement, the Company will amend the employment
agreements of Richard K. Matros, President and Chief Executive Officer of the
Company, and Bruce D. Broussard, Chief Financial Officer of the Company (the
"Executives"), to (i) modify the terms of the noncompete provisions contained
therein so that, except in connection with the ownership and operation of the
Meridian Assets (as defined below), the Executives will not compete with the
Company in certain lines of business for a period of two years following the
termination of such Executive's employment with the Company, and (ii) require
the Company to indemnify the Executives for any excise tax imposed upon the
Executives under Section 4999 of the Internal Revenue Code of 1986, as
amended; provided, that each Executive shall be responsible, and shall not be
indemnified, for the lesser of 20% of such Executive's excise tax, if any, and
$100,000.
It is also anticipated that immediately prior to the Effective Time, as
contemplated by the Merger Agreement, the Company will sell to the Executives,
or entities designated and controlled by the Executives, the stock of Regency
Occupational Medicine Services, Inc., a subsidiary of the Company, which owns
six Meridian
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Neurocare facilities and a Leasehold interest in the Meridian Corporate Office
that it acquired from Regency Rehab Hospitals, Inc., another subsidiary of the
Company (the "Meridian Acquisition"). As provided in the Merger Agreement, the
Executives will consummate the Meridian Acquisition on an "as is, where is"
basis for a cash purchase price of $3,000,000; provided that five days prior
to such sale the chief financial officer of the Company represents to Sun that
as of the date of the Merger Agreement the 12-month trailing EBITDA
(determined on the basis disclosed to Sun prior to the date of the Merger
Agreement) associated with the assets acquired in the Meridian Acquisition is
$1,300,000 or less.
Stockholder Agreement. Sun and Offeror have entered into a Stockholder
Agreement, dated as of July 26, 1997 (the "Stockholder Agreement"), with the
Executives and Smith Management Company and certain of its affiliates, which
includes John W. Adams, the Chairman of the Board of Directors of the Company
(the "Stockholders"). The Stockholders own, in the aggregate, approximately
26% of the issued and outstanding shares of Common Stock. Pursuant to the
Stockholder Agreement, among other things, the Stockholders have agreed to
tender their shares of Common Stock to Offeror pursuant to the terms of the
Offer and not to withdraw any shares of Common Stock so tendered, and to vote
such shares against any other business combination and certain other actions
during the time the Merger Agreement is in effect. The Stockholder Agreement
also provides that notwithstanding the foregoing, the Stockholders (other than
the Executives) will have no obligation to tender their shares of Common
Stock, and such shares so tendered shall, without further act of such
Stockholder, be deemed to be withdrawn from the Offer, prior to October 1,
1997. A copy of the Stockholder Agreement is filed as an exhibit to the Tender
Offer Statement on Schedule 14D-1 of Offeror and is incorporated herein by
reference.
(B) (2) Arrangements with Sun, Offeror and their respective Executive
Officers, Directors or Affiliates.
The Company has entered into the Merger Agreement with Sun and Offeror.
The Merger Agreement
The Offer is being made pursuant to the Merger Agreement.
The following is a summary of certain provisions of the Merger Agreement:
The Merger Agreement provides that, subject to the relevant provisions of
the Delaware General Corporation Law ("Delaware Law"), as soon as practicable
following the satisfaction or waiver of certain conditions set forth in the
Merger Agreement, a certificate of merger with respect to the Merger will be
filed in accordance with Delaware Law and the Merger will be effected. The
Merger will be effective at such time as the certificate of merger is duly
filed with the Secretary of State of the State of Delaware or at a later time
not more than one business day after such filing (the "Effective Time"). In
the Merger, each outstanding share of Common Stock will be converted into the
right to receive the price per share of Common Stock paid in the Offer, in
cash, without any interest thereon (other than shares as to which appraisal
rights are asserted or shares held by Sun, the Company or any of their
respective subsidiaries (as defined in the Merger Agreement)).
The Merger Agreement contains representations and warranties of the parties
that are customary in transactions of this type relating to, among other
things, capitalization, accuracy of SEC filings and financial statements,
absence of undisclosed liabilities, environmental matters, no material adverse
changes, no material litigation, real estate matters, certain regulatory
matters and taxes.
The obligations of the parties to effect the Merger are subject to the
satisfaction or waiver, where permissible, of the following conditions: (i)
the Merger Agreement and the Merger shall have been adopted by the
stockholders of the Company by the requisite vote in accordance with Delaware
Law, if such approval is required by applicable law; (ii) no applicable
domestic law or regulation and no judgment, injunction, order or decree of a
court or governmental agency or authority of competent jurisdiction shall
prohibit or prevent the consummation of the Merger; (iii) Offeror shall have
previously accepted for payment and paid for shares of Common Stock, pursuant
to the Offer; and (iv) any applicable waiting period under the HSR Act will
have expired or been terminated.
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The Company has agreed in the Merger Agreement to take all action necessary
to convene a meeting of its stockholders as promptly as practicable after the
purchase of shares of Common Stock in the Offer to consider and take action
upon the Merger and the Merger Agreement, if such stockholder approval is
required by applicable law to effect the Merger. The Company also has agreed
that its Board of Directors (the "Board") will recommend that stockholders of
the Company approve the Merger and the Merger Agreement and to otherwise use
its best efforts to obtain the necessary approval by the Company's
stockholders to effect the Merger, subject to the Board's fiduciary duty under
applicable law.
Pursuant to the Merger Agreement, immediately prior to the Effective Time,
the unexercisable portion of each outstanding option to purchase shares of
Common Stock will become immediately exercisable in full (by their terms or,
if necessary, by action of the Company), subject to all expiration, lapse,
forfeiture and other terms and conditions thereof, and will be canceled by the
Company, in exchange for the right to receive an amount in cash equal to the
product of (A) the number of shares of Common Stock subject to such stock
option immediately prior to the consummation of the Merger and (B) the excess,
if any, of (1) the price paid for each share of Common Stock in the Offer over
(2) the exercise price per share of Common Stock subject to such stock option.
The Merger Agreement further provides that, following the Effective Time,
the Surviving Corporation will honor certain employment agreements and certain
severance arrangements designed to retain the services of the Company's
employees. Furthermore, Sun has agreed to maintain in effect for a period of
at least six years after the Effective Time the rights to indemnification
currently provided in the Company's Certificate of Incorporation and By-Laws
to the present and former directors, officers and employees of the Company.
Sun also has agreed that the Company will provide for not less than six years
from the Effective Time directors' and officers' liability insurance and
fiduciary liability insurance no less advantageous to the indemnified parties
than that provided by the Company as of the date of the Merger Agreement, to
the extent available at annual premiums during such period not in excess of
150% of the per annum rate of the annual premium currently paid by the Company
for such insurance on the date of the Merger Agreement.
Under the Merger Agreement, the Company and its subsidiaries have agreed to
conduct their business only in the ordinary course, consistent with past
practice, and to use their best efforts to maintain their business
organizations, relationships with third parties and the services of their
present officers and employees. The Company and its subsidiaries have also
agreed to certain restrictions, subject to certain exceptions, on their
ability to (i) propose amendments to or amend their certificates of
incorporation or by-laws; (ii) enter into certain material business
combinations or asset acquisitions; (iii) encumber their properties, assets or
stock; (iv) issue, sell, split, combine, reclassify or acquire shares of their
capital stock or other securities; (v) declare or pay dividends or
distributions on the Common Stock; (vi) enter into, amend or terminate any
material agreement; (vii) incur debt or make loans; (viii) change employee
benefit and compensation arrangements; (ix) change their accounting policies
or procedures; (x) make expenditures or enter into contracts; and (xi) agree
to do any of the foregoing.
The Company also has agreed that neither the Company nor any of its
subsidiaries, nor any of their officers, directors, employees or agents, shall
solicit or encourage any offers, proposals or indications of interest by any
person concerning any merger, sale of assets, sale of shares of capital stock
or similar transactions involving more than 40% of the Common Stock or 40% of
the fair market value of the assets of the Company or its subsidiaries (an
"Acquisition Proposal"). Notwithstanding the foregoing, provided that the
Company and the Board shall have complied with the preceding sentence, then
the Board, if it determines in good faith, after consultation with and the
receipt of advice from, outside counsel, that it is required to do so in order
to discharge properly its fiduciary duties, is not prevented from considering,
negotiating, approving and recommending to the stockholders of the Company an
unsolicited bona fide written Acquisition Proposal (provided that such
Acquisition Proposal is for not less than $23.00 per share of Common Stock and
has no financing contingencies), which the Board determines in good faith
(after consultation with its financial advisors) would result in a transaction
more favorable to the Company's stockholders than the Offer and the Merger (a
"Superior
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Proposal"). The Company has agreed to promptly (not later than 24 hours after
receipt) communicate to Sun the terms of any Acquisition Proposal that it may
receive.
The Merger Agreement provides that the Board of Directors of the Surviving
Corporation will be comprised of the directors and officers of Offeror and
that the Surviving Corporation will adopt the certificate of incorporation and
by-laws of Offeror.
The Merger Agreement also provides that Offeror, upon purchase of shares of
Common Stock pursuant to the Offer, shall be entitled to designate such number
of directors, rounded up to the next whole number, to serve on the Board as
will give the Offeror representation on the Board equal to the product of (i)
the total number of directors on the Board and (ii) the percentage that the
number of shares of Common Stock purchased by Offeror bears to the total
number of shares of Common Stock outstanding, and that the Company shall, upon
request by Offeror, promptly increase the size of the Board and/or exercise
its reasonable best efforts to secure the resignation of such number of
directors as is necessary to enable Offeror's designees to be elected to the
Board.
The Merger Agreement may be terminated and the Merger may be abandoned at
any time prior to the Effective Time, notwithstanding any approval by the
stockholders of the Company, (i) by mutual written consent of the Company,
Offeror and Sun, (ii) by the Company or Sun if the Offer has not been
consummated on or before December 31, 1997 (unless such party's breach causes
the failure to consummate the Offer by such date), (iii) by Sun or the Company
if, as a result of the failure of a condition to the Offer, the Offer has
terminated or expired (unless such party's breach results in the failure of
such condition) without Offeror having purchased any shares of Common Stock in
the Offer, (iv) by the Company or Sun in connection with the Company entering
into, or consummating, a Superior Proposal as described in, and in accordance
with, the third preceding paragraph, provided that the Company has complied
with the provisions of such paragraph and pays the Fee and Expenses described
in the next paragraph, (v) by Sun if the Board or any committee thereof
withdraws or modifies in a manner adverse to Sun the Board's approval or
recommendation of the Offer or the Merger or its adoption of the Merger
Agreement, or approves, or fails to reject within 10 business days, any
Acquisition Proposal, or has resolved to do any of the foregoing, (vi) by the
Company or Sun if any final and nonappealable judgment, order or decree of a
court or governmental agency or authority of competent jurisdiction
permanently restrains, enjoins or prohibits the Offer or the Merger, (vii) by
the Company or Sun if there has been a breach by the other party of any
representation or warranty, which breach, in the case of the Company,
generally must have had, or will have, a material adverse effect on the
Company and its subsidiaries taken as a whole, or a material breach of any
covenant, which has not been or cannot be cured within 20 days of written
notice of such breach, or (viii) by the Company if the Offer has not been
timely commenced by Sun.
The Merger Agreement provides that if (A) it is terminated (i) under the
provisions described in clauses (iv) or (v) of the immediately preceding
paragraph or (ii) under the provisions described in clause (vii) of the
immediately preceding paragraph following a breach by the Company of its
agreement not to solicit or encourage Acquisition Proposals, or (B) it is
terminated and the Company shall have received an Acquisition Proposal at or
prior to, or within 30 days after, the termination of the Merger Agreement
and, within one year after such termination, the Company consummates any
Acquisition Proposal, then, within one business day after such event (or, if
applicable, immediately prior to the effectiveness of the termination of the
Merger Agreement by the Company pursuant to clause (iv) of the immediately
preceding paragraph), the Company will pay to Sun a fee in the amount of
$12,000,000 and reimburse Sun for its actual and documented out-of-pocket
expenses relating to the transactions contemplated by the Merger Agreement not
in excess of $4,000,000 (the "Fee and Expenses").
ITEM 4. THE SOLICITATION OR RECOMMENDATION.
(a) Recommendation of the Board of Directors.
The Board of Directors of the Company has determined that the terms of the
Offer and the Merger are fair to and in the best interests of the Company and
its stockholders and recommends that the stockholders accept the Offer and
tender their shares of Common Stock to Offeror pursuant to the Offer.
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(b) Background of the Offer
Beginning in 1997, the Board and the executive officers of the Company
conducted a strategic review of the Company and considered, among other
things, whether to pursue additional acquisitions, a leveraged buyout
transaction, a sale of the Company, or a financing utilizing the Company's
real estate. The Board, together with certain executive officers of the
Company, held a special board meeting in June, 1997 to review the results of
the ongoing strategic planning. The Board heard a presentation at that meeting
from an investment banking firm about the current trends and the market
environment in the long-term healthcare industry, including a review of, and
the reasons for, the continuing consolidation of companies in the industry.
The Board and the executive officers considered several options, including
maintaining the Company's current operations and continued growth through
acquisitions, a leveraged buy-out of the Company, or a strategic alliance
with, or sale of the Company to, a third party. The group concluded that the
Company either had to make significant acquisitions to continue profitable
growth or be acquired by another company in the industry. The group took into
account that currently the Company does not have the capital to make
significant acquisitions and, at the same time, meet the capital requirements
of its growing business. They determined that it would be in the best interest
of the Company's stockholders if the Company were to be acquired by another
company in the same industry, so that the benefits of the synergies derived
from consolidation could be reflected in the price to be paid for the
Company's Common Stock.
At the June meeting, the President of the Company reported that he had
approached Sun to see if it would be interested in making a proposal to
acquire the Company in a substantially all cash transaction. Sun indicated
that it was not in a position at that time to pursue such a transaction
because it had other matters pending. The Company chose to approach Sun
because it is in the long-term healthcare business and has been recently
acquiring other companies in the industry. The Company believed that Sun's
business would fit in well with the Company's business, which would lead to
potentially significant synergies, and thus Sun could offer an attractive
price. Moreover, in the Company's view, Sun would be in a financial position
to pursue a cash transaction with the Company. Finally, the Company was aware
of Sun's interest in the Company because of prior negotiations between the
parties in early 1995, which negotiations had terminated in March, 1995. The
Board determined to hire an investment banking firm to assist the Company in
its continuing review of strategic alternatives.
In April and May of 1997, the Company gave serious consideration to a
leveraged buy-out transaction in which Smith Management Company, which,
together with its affiliates owns approximately 26% of the Common Stock of the
Company, and of which the Chairman of the Board of the Company, John W. Adams,
is an affiliate, and certain of the executive officers would participate.
However, the Board determined that a leveraged buyout with Smith Management
Company or any other party could not be accomplished at a level that would
obtain a high enough price for the Common Stock and also permit continued
expansion of the Company through acquisitions.
Following the June meeting, the Chairman of the Board, President and Chief
Financial Officer of the Company interviewed several investment banking firms.
The Company subsequently retained Smith Barney to act as its financial advisor
to assist the Company in its continuing strategic review and in negotiating
and evaluating the terms of a possible transaction with Sun or some other
potential buyer. The Company also entered into an engagement with Smith
Management Company to provide additional assistance in connection with
negotiating a potential transaction involving the Company. See Item 5 below.
By July 8, 1997, Sun indicated that it was in a position to discuss a
possible transaction with the Company, but would do so only on an exclusive
basis for a limited period of time. The Company had previously granted to Sun
an exclusive period to pursue a possible transaction during which no
negotiations took place because, as mentioned above, Sun was not then in a
position to pursue such a transaction.
The Company entered into a Confidentiality Agreement on July 8, 1997 with
Sun and provided an exclusive period through July 18, 1997. The Company agreed
that during the exclusive period it would not negotiate with any other party,
nor provide evaluation materials, in connection with a possible transaction,
although the Company was free to pursue a leveraged buy-out transaction. Sun
conducted its due diligence, and arranged for its financing, over the next
three weeks.
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The Company informally extended the exclusivity period until July 25, 1997,
when it was informed that Sun needed additional time to complete its due
diligence and for its Board of Directors to consider whether to proceed with a
transaction. During the initial exclusivity period, by letters dated July 12,
1997 and July 14, 1997, Sun submitted preliminary non-binding indications of
interest, in which it first offered to pursue a transaction at $21 per share
of Common Stock, which was rejected by the Company, and then offered to pursue
a transaction at $22 per share of Common Stock. The letters also indicated a
willingness to investigate the potential benefits (tax and otherwise) of a
mutually acceptable blend of cash and stock consideration. The letters
indicated that Sun's initial financing would be obtained from NationsBank. The
preliminary indications of interest stated that they were subject to
completion of a due diligence review, the receipt of financing for the
transaction, the execution and delivery of a definitive agreement and approval
by the Board of Directors of Sun.
The Board of Directors of the Company met on July 15, 1997 to consider
whether to proceed with a possible transaction with Sun. At that meeting,
Smith Barney reviewed with the Board the financial terms of Sun's $22 per
share proposal and its preliminary analysis of such proposal. After
discussion, the Board determined that the Company should proceed to negotiate
a transaction with Sun. Negotiations took place between the parties, their
counsel and financial advisors on July 17 and 18, as well as during the
following week, focusing primarily on the no solicitation agreement, the
termination fees, the conditions to closing and the terms of a stockholder
agreement. The parties reached substantive agreement on the terms of the
transaction by late Friday, July 25, 1997. The Company was informed that the
Board of Directors of Sun had approved the transaction, subject to completion
of final negotiations, on July 25, 1997.
The Board met on July 26, 1997 to consider the proposed form of the Merger
Agreement with Sun. At this meeting, management and counsel reviewed the
financial and other terms of the proposed Merger Agreement and the Stockholder
Agreement. Smith Barney then reviewed with the Board the financial analyses
performed by Smith Barney in connection with its opinion and orally delivered
the opinion referred to in Item 4(c) below. The Board then approved the Merger
Agreement and the Stockholder Agreement, determined that the Offer and the
Merger are fair to, and in the best interests of, stockholders of the Company,
and recommended that stockholders accept the Offer and tender their shares of
Common Stock to Offeror pursuant to the Offer.
Following the conclusion of the meeting of the Board, the Merger Agreement
and the Stockholders Agreement were finalized. On July 27, 1997, Sun and the
Company issued a joint press release announcing the execution of the Merger
Agreement. A copy of the press release is attached hereto as Exhibit 3 and is
incorporated herein by reference.
(c) Reasons for the Transaction; Factors Considered by the Board
In approving the Merger Agreement, the Stockholder Agreement and the
transactions contemplated thereby and recommending that stockholders of the
Company tender their shares of Common Stock pursuant to the Offer, the Board
considered a number of factors, including:
1. The financial and other terms and conditions of the Offer and the
Merger Agreement;
2. The Board's belief that it obtained the highest immediate value for
its stockholders by entering into a transaction with Sun, which, because of
the synergies that could be created by a combination of the Company with
Sun, could offer the best price for the Company's Common Stock, and by
negotiating on an exclusive basis with Sun, which was Sun's pre-condition
to engaging in the extensive due diligence process that would be required;
3. The oral opinion of Smith Barney rendered to the Board of Directors at
the July 26, 1997 meeting (which opinion was subsequently confirmed by
delivery of a written opinion dated July 26, 1997) to the effect that, as
of such date and based upon and subject to certain matters stated in such
opinion, the $22.00 per share cash consideration to be received by holders
of shares of Common Stock (other than Sun and its
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affiliates) in the Offer and the Merger was fair, from a financial point of
view, to such holders. The full text of Smith Barney's written opinion
dated July 26, 1997, which sets forth the assumptions made, matters
considered and limitations on the review undertaken by Smith Barney, is
attached hereto as Exhibit 4 and is incorporated herein by reference. Smith
Barney's opinion is directed only to the fairness, from a financial point
of view, of the cash consideration to be received in the Offer and the
Merger by holders of shares of Common Stock (other than Sun and its
affiliates) and is not intended to constitute, and does not constitute, a
recommendation as to whether any stockholder should tender shares of Common
Stock pursuant to the Offer. Holders of Common Stock are urged to read such
opinion carefully in its entirety.
4. The historical market prices of, and recent trading activity in, the
shares of Common Stock, particularly the fact that the Offer and the Merger
will enable the stockholders of the Company to realize a premium of
approximately 34.4% over $16 3/8, the closing price of the shares of Common
Stock on July 25, 1997, the last trading day prior to the Board's approval
of the Merger Agreement, and a premium of approximately 79.6% over $12 1/4,
the closing price of the shares of Common Stock on May 30, 1997, the date
the Company first approached Sun regarding its interest in considering an
acquisition of the Company;
5. The possible alternatives to the Offer and the Merger, including,
without limitation, continuing to operate the Company as an independent
entity, and the risks associated therewith, including the ongoing need for
financing for the Company to make significant acquisitions, which the Board
believed would be necessary because of the continuing consolidation in the
long-term health care industry;
6. The fact that the terms of the Merger Agreement shall not prevent the
Board, if it determines in good faith, after consultation with, and receipt
of advice from, outside counsel, that it is required to do so in order to
discharge properly its fiduciary duties, from considering, negotiating and,
subject to payment of the Fee and Expenses, entering into a Superior
Proposal;
7. The likelihood that the Merger would be consummated, including the
fact that the Offer was not conditioned on financing and the Board's
satisfaction that the other conditions, including the condition that the
holders of at least a majority of the principal amount of each of the
Company's 12 1/4% Subordinated Securities due 2003 and of the Company's 9
7/8% Senior Subordinated Securities due 2002 tender their bonds to Sun
pursuant to a tender offer for such securities, would be met;
8. The fact that the proposed Meridian Acquisition (see Item 3(B) above),
was not material to the transaction and did not affect the $22.00 cash
offer from Sun; and
9. The fact that Smith Management Company and certain of its affiliates,
which in the aggregate own approximately 26% of the issued and outstanding
shares of Common Stock, were prepared to tender their shares of Common
Stock in the Offer and enter into the Stockholder Agreement.
The Board did not assign relative weights to the factors or determine that
any factor was of particular importance. Rather, the Board viewed their
position and recommendation as being based on the totality of the information
presented to and considered by it.
ITEM 5. PERSONS RETAINED, EMPLOYED OR TO BE COMPENSATED.
The Company has retained Smith Barney to act as its financial advisor in
connection with the Offer and the Merger. Pursuant to the terms of Smith
Barney's engagement, the Company has agreed to pay Smith Barney for its
services an aggregate financial advisory fee based on a percentage of the
total consideration (including liabilities assumed) payable in connection with
the Offer and the Merger. The fee payable to Smith Barney is currently
estimated to be $4.7 million. The Company also has agreed to reimburse Smith
Barney for reasonable travel and other out-of-pocket expenses, including
reasonable legal fees and expenses, and to indemnify Smith Barney and certain
related parties against certain liabilities, including liabilities under the
federal securities laws, arising out of Smith Barney's engagement. Smith
Barney has in the past provided investment banking services
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to the Company unrelated to the Offer and the Merger, for which services Smith
Barney has received compensation. In the ordinary course of business, Smith
Barney and its affiliates may actively trade or hold the securities of the
Company and Sun for their own account or for the account of customers and,
accordingly, may at any time hold a long or short position in such securities.
In addition, the Company has retained Smith Management Company to provide
financial advice to the Company to assist the Company in negotiating the terms
of the Offer and the Merger. See Item 4(c) above. Upon consummation of the
Offer and the Merger, Smith Management Company will be entitled to a fee of $2
million. The Company has agreed to indemnify Smith Management Company and
certain related parties against certain liabilities, including liabilities
under the federal securities laws, arising out of its engagement.
Neither the Company nor any person acting on its behalf has employed,
retained or compensated any other person to make solicitations or
recommendations to stockholders in connection with the Offer.
ITEM 6. RECENT TRANSACTIONS AND INTENT WITH RESPECT TO SECURITIES.
(a) Except as set forth below, there have been no transactions in the shares
of Common Stock during the past 60 days by the Company or, to the best of the
Company's knowledge, by any executive officer, director, affiliate or
subsidiary of the Company. Foothill Partners L.P. ("Foothill") and Condor
Investments, L.P. ("Condor"), affiliates of John F. Nickoll, a director of the
Company, sold shares of Common Stock as follows:
<TABLE>
<CAPTION>
STOCKHOLDER DATE NUMBER OF SHARES PRICE PER SHARE
- - ----------- ------------- ---------------- ---------------
<S> <C> <C> <C>
Foothill......................... June 10, 1997 2,200 $13.175
Foothill......................... June 11, 1997 25,036 13.015
Foothill......................... June 13, 1997 23,100 13.125
Condor........................... June 10, 1997 2,800 13.175
Condor........................... June 11, 1997 31,864 13.015
Condor........................... June 13, 1997 29,400 13.125
</TABLE>
(b) To the best of the Company's knowledge, each of its executive officers,
directors, affiliates or subsidiaries currently intends to tender, pursuant to
the Offer, any shares of Common Stock beneficially owned individually by such
persons.
ITEM 7. CERTAIN NEGOTIATIONS AND TRANSACTIONS BY THE SUBJECT COMPANY.
(a) Except as set forth in this Schedule 14D-9, the Company is not currently
engaged in any negotiation in response to the Offer, which relates to or would
result in (i) an extraordinary transaction, such as a merger or reorganization
involving the Company or any subsidiary of the Company; (ii) a purchase, sale
or transfer of a material amount of assets by the Company or any subsidiary of
the Company; (iii) a tender offer for or other acquisition of securities by or
of the Company; or (iv) any material change in the present capitalization or
dividend policy of the Company.
(b) Except as described in Item 3(B) and Item 4 above (the provisions of
which are hereby incorporated by reference), there are no transactions, board
resolutions, agreements in principle or signed contracts in response to the
Offer, which relate to or would result in one or more of the matters referred
to in paragraph (a) of this Item 7.
ITEM 8. ADDITIONAL INFORMATION TO BE FURNISHED.
None
ITEM 9. MATERIAL TO BE FILED AS EXHIBITS.
Exhibit 1 Form 10-K of the Company filed on March 25, 1997*
Exhibit 2 Agreement and Plan of Merger dated as of July 26, 1997 among Sun,
Offeror and the Company*
Exhibit 3 Form of Joint Press Release issued by the Company and Sun on July
27, 1997*
Exhibit 4 Opinion of Smith Barney Inc. dated July 26, 1997
- - --------
* Not included in copies mailed to stockholders.
9
<PAGE>
SIGNATURE
After reasonable inquiry and to the best of my knowledge and belief, I
certify that the information set forth in this statement is true, complete and
correct.
/s/ David A. Grant
By: ________________________________
Name: David A. Grant
Title: Senior Vice President and
General Counsel
Dated: August 1, 1997
10
<PAGE>
ANNEX I
INFORMATION STATEMENT PURSUANT TO SECTION 14(F)
OF THE SECURITIES EXCHANGE ACT OF 1934
AND RULE 14F-1 THEREUNDER
GENERAL
This Information Statement is being mailed on or about August 1, 1997 as
part of the Solicitation/Recommendation Statement on Schedule 14D-9 (the
"Schedule 14D-9") of Regency Health Services, Inc. (the "Company") with
respect to the tender offer by Sunreg Acquisition Corp. (the "Offeror") to the
holders of record of the common stock of the Company, par value $.01 per share
("Shares"). Capitalized terms used and not otherwise defined herein shall have
the meaning set forth in the Schedule 14D-9. You are receiving this
Information Statement in connection with the possible election of persons
designated by the Offeror to a majority of the seats on the Board of Directors
of the Company (the "Board"). The Merger Agreement provides that the Offeror,
upon purchase of Shares pursuant to the Offer, shall be entitled to designate
such number of directors (the "Offeror Designees"), rounded up to the next
whole number, to serve on the Board as will give the Offeror representation on
the Board equal to the product of (i) the total number of directors on the
Board and (ii) the percentage that the number of Shares purchased by the
Offeror bears to the total number of Shares outstanding, and that the Company
shall, upon request by the Offeror, promptly increase the size of the Board
and/or exercise its reasonable best efforts to secure the resignation of such
number of directors as is necessary to enable the Offeror Designees to be
elected to the Board. This Information Statement is required by Section 14(f)
of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and
Rule 14f-1 promulgated thereunder.
You are urged to read this Information Statement carefully. You are not,
however, required to take any action.
The Offer to Purchase commenced on August 1, 1997 and is scheduled to expire
at 12:00 midnight, New York City time, on September 15, 1997, at which time,
if all conditions to the Offer have been satisfied or waived, the Offeror will
purchase all of the Shares validly tendered pursuant to the Offer and not
properly withdrawn.
The information contained in this Information Statement concerning the
Offeror and Sun Healthcare Group, Inc. ("Sun") has been furnished to the
Company by Sun and the Company assumes no responsibility for the accuracy,
completeness or fairness of any such information.
At the close of business on July 25, 1997, there were 15,935,300 shares of
Common Stock of the Company issued and outstanding, which is the only class of
securities outstanding having the right to vote for the election of directors
of the Company, each of which entitles its record holder to one vote.
DESIGNEES TO THE COMPANY'S BOARD OF DIRECTORS
The Offeror has informed the Company that it will choose the Offeror
Designees from the directors and executive officers listed in Schedule I to
the Offeror's Offer to Purchase, a copy of which is being mailed to the
Company's stockholders together with the Schedule 14D-9. The Offeror has
informed the Company that each of the directors and executive officers listed
in Schedule I to the Offer to Purchaser has consented to act as a director, if
so designated. The business address of each such person is c/o Sun Healthcare
Group, Inc., 101 Sun Lane, N.E., Albuquerque, NM 87109.
It is expected that the Offeror Designees may assume office at any time
following the purchase by Parent or the Offeror, as applicable, of the
specified minimum number of shares of Common Stock pursuant to the Offer,
which purchase cannot be earlier than September 15, 1997.
11
<PAGE>
DIRECTORS, EXECUTIVE OFFICERS AND AFFILIATES OF THE COMPANY
Certain information regarding (i) the current directors and executive
officers of the Company, (ii) the security ownership of certain beneficial
owners and management of the Company, (iii) certain relationships and
transactions with the Company and (iv) compliance with Section 16(a) of the
Exchange Act is described in Part III of the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1996 filed on Form 10-K on March
25, 1997 (the "Form 10-K"). The Form 10-K is filed as Exhibit 1 to the
Schedule 14D-9 and is incorporated herein by reference.
BOARD MEETINGS AND COMMITTEES
The Board held 10 meetings during fiscal 1996. All of the directors attended
more than 75% of the meetings of the Board.
12
<PAGE>
EXHIBIT 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------------
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the fiscal year ended December 31, 1996.
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from ______ to ______
Commission file number: 1-11144
Regency Health Services, Inc.
(Exact name of Registrant as specified in its charter)
Delaware 33-0210226
(State of incorporation) (I.R.S. Employer Identification No.)
2742 Dow Avenue
Tustin, California 92780
(Address of principal executive offices)
Registrant's telephone number, including area code: (714) 544-4443
Securities registered pursuant to Section 12(b) of the Act:
Title of Securities Name of Exchange on which Registered
Common Stock, $.01 par value 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 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. [ ]
Based on the closing price of $10 5/8 per share on February 28, 1997, the
aggregate market value of the registrant's voting stock held by non-affiliates
was $106,661,000. Solely for purposes of this computation, the registrant's
directors and executive offers have been deemed to be affiliates. Such treatment
is not intended to be, and should not be construed to be, an admission by the
registrant or such directors and officers that any of such persons are
"affiliates," as that term is defined under the Securities Act of 1934.
The number of shares of common stock outstanding as of February 28, 1997 was
15,792,157.
Documents Incorporated by Reference:
Portions of Regency's 1996 Annual Report to Shareholders are incorporated by
reference into Part II of this Form 10-K.
Portions of Regency's Notice of Annual Meeting of Stockholders and Proxy
Statement to be held May 8, 1997 are incorporated by reference into Part III of
this Forms 10-K.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
PART I
ITEM 1 BUSINESS 1
ITEM 2 PROPERTIES 16
ITEM 3 LEGAL PROCEEDINGS 17
ITEM 4 SUBMISSION OF MATTERS
TO A VOTE OF SECURITY HOLDERS 17
PART II
ITEM 5 MARKET FOR REGENCY HEALTH
SERVICES, INC. COMMON STOCK
AND RELATED STOCKHOLDER MATTERS 18
ITEM 6 SELECTED FINANCIAL DATA 18
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS 19
ITEM 8 FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA 30
ITEM 9 CHANGES IN AND DISAGREEMENTS
WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE 55
PART III
ITEM 10 DIRECTORS AND EXECUTIVE
OFFICERS OF REGENCY HEALTH
SERVICES, INC. 56
ITEM 11 EXECUTIVE COMPENSATION 56
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT 56
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS 56
PART IV
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K 57
SIGNATURES 64
</TABLE>
<PAGE>
PART I
ITEM 1. BUSINESS
General
This Annual Report on Form 10-K of Regency Health Services, Inc. ("the
Company" or "Regency") contains statements which constitute "forward looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Such statements appear in a number of places in this Annual Report
including, without limitation, under the headings General, Business Strategy,
Business Units, Manner of Operation, Sources of Payment, Regulation, Competition
and Tax Audits of the Section entitled "Business" and in Management's Discussion
and Analysis of Financial Condition and Results of Operations. Such forward
looking statements include the views, opinions and expectations of the Company,
its officers and directors with respect to the matters there discussed, and as
to the intent, belief and anticipation of such persons expressed in this Annual
Report. Readers are cautioned that any such forward looking statements involve
risks, uncertainties and factors that may impact on the actual results or
activities of the Company. These risks and items are discussed below in greater
detail in the portion of this Annual Report entitled "Factors Which May Affect
the Company".
Regency is a national provider of an array of healthcare services from acute
rehabilitation to home health care. As of February 28, 1997, the Company
delivered care from 116 Company operated inpatient facilities in five states.
These facilities provide a spectrum of services including acute rehabilitation,
neurological care, subacute treatment, basic and intermediate skilled nursing
care, assisted living and ancillary services such as rehabilitation and pharmacy
services. Additionally, the Company provides outpatient rehabilitation through
10 clinics. It also continues to expand its contract rehabilitation therapy,
pharmacy and home health operations. As of February 28, 1997, the Company
provided contract rehabilitation therapy services in 15 states to 63 affiliated
and 116 non-affiliated facilities, pharmacy services in four states to 70
affiliated and 84 non-affiliated facilities and home health care services
through 28 operating locations in California and Ohio.
In order to meet the challenges of healthcare reform, industry consolidation
and other changes, the Company plans to enhance the continuum of care it
provides in defined markets to suit the needs of those markets. The Company
believes adding various inpatient and outpatient services to the continuum,
while expanding the availability of current services like subacute care, will
attract managed care organizations seeking to build relationships with
integrated delivery systems. The Company expects the more diverse services
offered will provide "one stop" shopping for payors and will bring patients into
the Company's delivery system sooner, often either immediately following or in
lieu of invasive treatment. The Company also sees strategic joint operating
relationships with tertiary care institutions, payors and physicians as enabling
it to establish closer ties to the medical community.
Regency was incorporated in Delaware in 1986 and grew rapidly through
acquisitions. In April 1994, Regency merged with Care Enterprises, Inc. ("Care")
in a stock transaction accounted for as a pooling of interests ("the Merger").
The Merger more than doubled the number of facilities and beds operated by the
Company and made the Company a leading provider of long-term and specialty
healthcare services in California. It established a presence for Regency in West
Virginia, Ohio and New Mexico. Additionally, it provided a significant base for
the expansion of both the ancillary services offered by Regency and the home
health care services offered by Care. Following the Merger, management focused
on integrating Regency and Care operations. This included instituting
standardized systems, operating procedures and cost controls. The Company added
several experienced senior officers. Others were replaced, along with a number
of administrators at under-performing facilities. During 1995, the Company
exchanged leasehold interests in three nursing facilities in New Mexico for
leasehold interests in four nursing facilities in Ohio which were operated by
another company; opened a newly constructed facility; and acquired SCRS &
Communicology, Inc. ("SCRS"), a contract rehabilitation therapy company. In
1996, the Company disposed of 7 healthcare facilities in California. It also
acquired 19 healthcare facilities in Tennessee and North Carolina; pharmacy
1
<PAGE>
operations in California, Tennessee and North Carolina, and entered into a joint
venture with a pharmacy in Ohio. To complete the roster of contract
rehabilitation services provided by SCRS, the subsidiary acquired a respiratory
therapy company. In early 1997, the Company acquired four acute rehabilitation
hospitals, six neurological treatment centers and eleven outpatient
rehabilitation clinics in California.
Industry Overview
Healthcare is one of the largest industries in the United States,
representing total expenditures of approximately $884.0 billion or 13.9% of the
1993 gross domestic product, according to the Health Care Financing
Administration ("HCFA"). This 1993 figure represents a 7.8% increase over 1992
expenditures of $820.0 billion recorded by HCFA. Historically, these increases
have outpaced inflation. This is due, in part, to the increased availability and
use of high-technology medicine and to the diverse medical needs of an aging
population.
The post-acute care industry encompasses a broad range of healthcare
services, including basic and intermediate skilled nursing, assisted living,
ambulatory businesses, subacute care, rehabilitation therapy including acute
rehabilitation, home healthcare and pharmacy services provided to patients with
medically complex needs who can be cared for outside of the acute care hospital
environment. The Company's management believes that demand for these services
will increase substantially during the next decade, primarily due to emphasis on
healthcare cost containment and to the growing senior population.
The senior population is growing at a faster rate than the overall population
as a result of the baby boom and advances in medical technology that extend
life. According to the United States Census Bureau ("the Census Bureau"), the
number of individuals in the United States over 64 has grown from approximately
25.6 million in 1980, or approximately 11.3% of the population, to approximately
31.1 million in 1990, or approximately 12.5% of the population. Census Bureau
projections indicate that the number of individuals in this age group is
expected to increase to approximately 34.9 million, to approximately 12.7% of
the population, by the year 2000. Additionally, individuals 85 years of age and
older are one of the fastest growing segments of the population. The Census
Bureau projects that the number of individuals in that age group will increase
from approximately 3.0 million in 1990 to approximately 4.3 million by the year
2000.
Cost containment procedures that encourage reduced lengths of stay in acute
care hospitals are prevalent. In 1983, the federal government changed the
reimbursement for acute care hospitals from a retrospective cost-based system to
a prospective reimbursement system based upon rates established for diagnosis
related groups ("DRGs"). Additionally, many private insurers limit acute care
reimbursement to "reasonable and customary" charges while health maintenance
organizations ("HMOs") and preferred-provider organizations ("PPOs") attempt to
contain costs by negotiating reduced rates for acute care hospital services.
These factors have resulted in reduced lengths of stay in acute care hospitals,
with many patients being discharged to lower level facilities where their
skilled needs can be met more cost-effectively. Accordingly, the Company
believes that the healthcare industry will experience increased demand for post-
acute care. The Company is well positioned to benefit from these developments
due to its expanding capability to provide post-acute and subacute specialty
services. Additionally, industry consolidation is expected to present the
Company with opportunities for growth and expansion of its continuum of care.
Although the Company believes that the demand for the services it provides
will increase over the next decade, it anticipates competition to meet this
demand. In addition, the regulatory framework in which healthcare providers will
operate, including parameters for payment of services, is uncertain. Depending
on the nature of such regulation, the healthcare industry may be subject to
increased pressure to lower operating costs and may face more stringent
requirements regarding reimbursement.
2
<PAGE>
Business Strategy
The Company's strategy is to enhance its position as an integrated delivery
provider recognized for cost-effective, high-quality healthcare services in
selected geographic areas. Implementation of this strategy means adding certain
inpatient and outpatient services along with growing ancillary businesses based
on the needs of the markets where it currently has operations, and involves
certain risks. See "Factors Which May Affect Company". In addition, the Company
plans to develop the information technology infrastructure necessary to support
the cost-effective operation of this integrated delivery system. The fundamental
elements of the Company's strategy include:
. expanding the continuum of care and overall scope of services provided
by the Company through such means as strategic alliances, diversifying
services in inpatient facilities, increasing outpatient ambulatory
business and growth of home healthcare services;
. in-sourcing ancillary services such as pharmacy and rehabilitation
services;
. increasing the Company's marketing of ancillary services to third party
facilities;
. acquiring new businesses to complete the continuum in selected markets
where the Company currently operates;
. engineering operating models and investment in information technology
to reduce administrative and operating costs and develop an integrated
delivery system.
Management believes Regency has certain competitive strengths which support
its strategy. Foremost among these is the Company's market position and
experience operating long-term care facilities in California. The California
market is characterized by a high degree of regulatory oversight and cost
controls imposed by third party payors. With 64% of its revenues in this
environment, the Company has considerable experience controlling operating costs
while continuing to deliver high-quality healthcare. The Company believes it
will be able to utilize this experience as a competitive advantage as it
broadens the continuum of care offered to its patients in existing markets and
expands its ancillary service businesses in new markets. The Company has reduced
revenues from Medi-Cal from 32.3% of total revenues in 1995 to 21.7% (pro-forma
for the acquisition of four acute rehabilitation hospitals, six neurological
care centers and 10 outpatient clinics on January 1, 1997 and the disposition of
six long term care facilities in 1996 and one on January 1, 1997) for 1996.
Expanding the Continuum of Care. A significant component of Regency's growth
strategy is expanding the continuum of care. By increasing its scope of
services, the Company believes that it will attract additional managed care
payors and other insurers as participants in its regional, integrated delivery
systems. Given the current industry consolidation, the Company believes this
strategy is necessary to establish a significant market position in the
geographic areas it has targeted for expansion. Moreover, expanding the
continuum of care should increase business for higher margin ancillary services
and attract greater numbers of patients whose care is reimbursed by other than
government sources.
An important component of this strategy is supplementing current services
offered by the Company. The Company intends to do so through strategic alliances
or by developing new programs. A prime example of a strategic alliance to
reinforce the continuum is the joint venture relationship the Company now enjoys
with two acute medical centers in California. Subacute services also continue to
grow. As of February 28, 1997, 46 of the Company's facilities had subacute
programs in place, up from 42 at the end of 1995. Additionally, the Company
intends to continue to emphasize the growth of its home health care division.
The provision of home health care services complements the Company's facility-
based services and substantially broadens the continuum of care which it is able
to provide. Furthermore, the Company will emphasize the growth in outpatient
services. The Company believes that its ability to package a broad array of
services in this manner is attractive to managed care payors.
3
<PAGE>
Another important industry factor prompting the Company to expand its
continuum is the growing marketing penetration of managed care organizations
both across the nation and in the regions where the Company operates. As managed
care market share increases, it is important for healthcare providers like the
Company to enter into managed care contracts in order to maintain and build
their patient base. In determining which providers to contract with, payors
consider, among other factors, quality of care, range of services, geographic
coverage and the cost-effectiveness of the care. These payors control costs
through stringent utilization review systems, increased use of discounted and
capitated fee arrangements and, when appropriate, directing patients to lower
acuity alternatives along the continuum of patient care. The Company believes
that development of its integrated delivery system in selected regions gives it
the scope of services, quality of care, geographic coverage and cost control
that will enable it to compete more effectively for managed care contracts.
As of January 1, 1997, the Company added 4 acute rehabilitation hospitals, 6
neurological care centers and 10 outpatient clinics to its roster of operations.
With this, it formed a new division, Regency Rehabilitation and Specialty
Services, to mark the significance of rehabilitation services in the strategic
development of the continuum of care.
To implement its strategy, the Company intends to: (i) continue to enhance
the continuum of services it offers; (ii) develop market concentration for its
continuum of inpatient, outpatient and home health services in targeted states
and regions to parallel increasing payor consolidation; (iii) consider strategic
alliances with managed care payors, hospital groups, physicians and other
healthcare providers; (iv) explore acquisitions which could further expand the
services provided by the Company; and (v) upgrade its management information
systems to develop connections between systems and geographic locations which
will assist in integrating financial and clinical data across all business lines
in order to meet the future information needs the managed care environment will
require.
In-Sourcing Patient Services. Regency expects to continue to in-source such
patient services as pharmacy and rehabilitation services. The Company's existing
facilities provide a ready market and could generate additional growth for the
Company's ancillary service businesses. The Company believes that continued in-
sourcing of these services could enhance revenues and solidify its market
position by broadening the base of potential patients from which it is able to
draw and by creating stronger platforms from which it can offer additional
services. Moreover, these types of services should enhance the Company's
profitability by attracting greater numbers of patients who pay directly for
services without the benefit of government assistance programs. Generally, the
profitability of caring for these patients is higher than for patients under
government assistance programs. Historically, the Company has realized higher
profit margins on the ancillary services it is targeting for in-sourcing.
The August 1996 acquisition of Managed Respiratory Care Services by SCRS
enabled the Company to insource additional respiratory therapy rehabilitation
that was previously furnished by non-affiliated providers. During 1996, the
Company acquired Assist A Care pharmacy to expand the growth in the delivery of
pharmacy services in California. The Company expects to complete development of
a hub and satellite network for distribution within its California pharmacy
operations during 1997. The acquisition of Executive Pharmacy provided for the
in-sourcing of pharmacy services to the Company's facilities in Tennessee and
North Carolina and expanded the Company's pharmacy services to non-affiliated
facilities as well. In 1996, a strategic alliance was initiated with Vrable
pharmacy to enable the Company to in-source pharmacy services in Ohio. The
Company believes that continued expansion of the pharmacy network outside of
California and to non-related facilities both in California and in other states
will occur primarily through acquisitions.
Marketing Ancillary Services. In addition to expanding the range of ancillary
services provided directly to its patients, Regency intends to expand the
marketing of its ancillary services to third party facilities. The development
and marketing of ancillary services should enable the Company to serve greater
numbers of higher revenue patients. Expansion of ancillary services marketed to
non-affiliated facilities is an important component of the Company's goal to
increase the quality of its payor mix. Moreover, management believes the
4
<PAGE>
selective acquisition and marketing of ancillary services supports the continued
growth of the Company in targeted market segments and locations and should
produce synergies as the Company expands both the number of facilities it
operates and the continuum of care it provides to its patients.
Expanding Through Acquisition. Regency has grown primarily through the
selective acquisition of new facilities and ancillary service providers. The
Company expects to continue to grow principally through such acquisitions and
the synergies these new facilities and ancillary services may provide. The
Company intends to focus its acquisition and expansion efforts in those markets
where the Company already has a presence that provide an attractive opportunity
for the expansion, geographic and otherwise, of the continuum of care the
Company offers to its patients. By such expansion, the Company intends to
develop a significant market presence, which will enable it to better take
advantage of the opportunities for synergies provided by new acquisitions and to
enhance further the range of services provided to its patients. The Company will
continue to assess the viability of expansion into other areas as economically
attractive acquisitions become available. The Company actively seeks acquisition
opportunities in the ordinary course of its business and is currently reviewing
prospective acquisitions.
Business Units
The Company's business operations consist of four basic units: long-term care
facilities including subacute specialty units, rehabilitation services, pharmacy
services and home healthcare.
Nursing Center Operations. As of February 28, 1997, 103 of the Company's
healthcare facilities are licensed as skilled nursing facilities and provide
skilled nursing care for patients who do not require more extensive treatment at
an acute care hospital. Seven of these facilities and one additional facility
are also approved by the California Department of Health Services to provide
mental health services. The Company's skilled nursing facilities provide 24-hour
nursing care, room and board, social services and activity programs, as well as
special diets and other services that may be specified by a patient's physician.
Patients at these facilities often have been discharged from acute care
hospitals and require substantial medical attention. In some cases, the
facilities also provide assisted living arrangements. In addition to skilled
nursing facilities, the Company operates three facilities for the
developmentally disabled, one of which is also licensed as a skilled nursing
facility and is included above. The Company believes that its substantial
California presence, together with the expansion of its continuum of services
and greater market penetration for its ancillary services, will increase the
Company's ability to obtain contracts and referrals from managed care companies.
For the year ended December 31, 1996, approximately 5.1% of the Company's
revenues were attributable to managed care; management expects this percentage
to increase.
As of February 28, 1997, 25 of the Company's skilled nursing facilities were
accredited by the Joint Commission on Accreditation of Healthcare Organizations
("JCAHO"), an independent organization that reviews facilities and accredits
those that achieve certain standards for quality control and assurance. The
Company has applied for accreditation at additional facilities.
As of February 28, 1997, 46 of the Company's healthcare facilities included
subacute specialty units which serve the needs of patients of all ages who have
medically complex conditions which require ongoing nursing and medical
supervision and access to specialized equipment and services, but do not require
many of the other services provided by acute care hospitals. The Company
increased the number of its facilities containing dedicated subacute units to 46
during 1996 from 42 at the end of 1995. The units provide such services as
respiratory therapy, ventilator care, oncology services, infusion therapy, post-
surgical wound management and care to patients with auto-immune deficiency
syndrome (AIDS). In addition, as of February 28, 1997, the Company provided
specialized services at three of its facilities to patients diagnosed with
Alzheimer's disease. Based upon its experience within the industry and its
knowledge of acute care hospital rates, as disclosed by such institutions,
management believes that it is able to provide subacute care at rates
5
<PAGE>
substantially below the rates typically charged by acute care hospitals for
comparable services and still earn higher average revenues per patient day than
it receives for basic nursing services.
Rehabilitation Services. Ninety-six of the Company's skilled nursing
facilities provide special rehabilitation services including physical, speech,
occupational, and respiratory therapy. These ancillary services are administered
by licensed therapists and rehabilitation aides. Currently, these services are
provided by several contract therapy providers, including SCRS.
The objective of these programs is to help patients achieve their highest
level of functional independence. Rehabilitation services are instrumental in
lowering the overall cost of care by reducing the length of a patient's stay and
improving a patient's quality of life. Specialized management staff oversee
these rehabilitation programs to ensure high-quality service delivery, program
compliance and achievement of maximum outcomes for the patient.
In August 1996, the Company's rehabilitation services subsidiary, SCRS,
acquired Managed Respiratory Care Services, a respiratory therapy provider.
Beyond the services it provides the Company, as of February 28, 1997, SCRS
delivers rehabilitation services at 116 non-affiliated healthcare facilities in
14 states and to home healthcare patients under four contracts with non-
affiliated healthcare providers.
As of January 1, 1997, the Company added four acute rehabilitation hospitals,
six neurological care centers and 10 outpatient clinics to the continuum of
rehabilitation services it offers. The Company believes this enhancement
increases its appeal to managed care payors seeking providers who are able to
effectively manage the cost and quality of care delivered to their patients.
Pharmacy Services. For the past six years, the Company has operated its own
institutional pharmacy, First Class Pharmacy, Inc. In 1996, the Company acquired
or opened four additional pharmacy operations to expand its service to Company-
operated facilities and non-affiliated facilities in California, Ohio, Tennessee
and North Carolina. As of December 31, 1996, the Company's pharmacy operations
provided prescription services and basic pharmaceutical dispensing programs to
68 Company-operated facilities with approximately 7,257 licensed beds and to 84
non-affiliated facilities with approximately 7,428 licensed beds. In addition,
the Company's pharmacy operations provide certain specialty services such as
infusion therapy, enteral nutrition, and urological and ostomy supply programs.
The Company has also developed certain specialty consulting and ancillary
programs to help each facility comply with state and federal regulations.
Additionally, the Company is pursuing development of an automated hub and
satellite network of pharmacy operations within California to reduce the cost of
supplying pharmacy services.
Home Health Services. The Company provides home health care services in
selected areas in California and Ohio through two operating divisions, Care Home
Health and Care At Home. The Company has provided home health care services
since 1983. Care Home Health primarily serves Medicare patients while Care At
Home provides services to private pay, managed care and Medicaid patients. The
services offered include skilled nursing, rehabilitation services, infusion
therapy, ventilator care, care for patients with AIDS, and other specialty
services.
Manner of Operation
Nursing Center Operations. Each healthcare facility operated by the Company
is supervised by a licensed administrator who is responsible for all aspects of
facility operations. A facility administrator typically oversees a director of
nursing, a director of admissions and other department supervisors. The director
of nursing supervises a staff of registered nurses, licensed practical nurses
and nurses' aides. The director of admissions is responsible for developing
local marketing strategies and programs. To supervise the medical management of
patients, the Company also contracts with licensed physicians to act as medical
directors at each facility. The Company's corporate staff provides support to
facility administrators in, among other things, quality improvement, management
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reporting, marketing, management training, legal services, human resources, risk
management, reimbursement, data processing, cash management, and accounting.
The Company has a professional services department which includes field
consultants who represent the corporate philosophy to each professional
discipline providing patient care. The department coordinates the development
and implementation of corporate and administrative policies and procedures and
authors most clinical manuals used in direct patient care. To ensure regulatory
compliance and high-quality clinical services, the department is actively
involved in location-specific and Company-wide quality improvement activities
and education through interdisciplinary consulting services to all of the
Company's operational areas. In 1996, the department introduced a continuous
quality improvement program to the division that is designed to identify
opportunities to improve quality before negative outcomes can occur.
Contract Rehabilitation Therapy Operations. The Company's contract
rehabilitation therapy operations are directed by the senior vice president of
Rehabilitation and managed by two divisional executive vice presidents; one who
oversees field operations, clinical services, corporate support, finance and a
recruiting division known separately as Therapy International and one who
oversees all sales, marketing and the PulsePoint Technologies information
service. Field operations are controlled by divisional vice presidents who
supervise state regional directors and a team of area clinical managers who
typically oversee three to seven facilities each.
Pharmacy Operations. The Company's pharmacy operations are managed by the
senior vice president of Home Health and Pharmacy Operations, who is responsible
for all aspects of home health and pharmacy operations. Each pharmacy is managed
by either a general manager or pharmacy manager, who is a pharmacist, and
supported by a business manager who oversees the billing department staff, a
professional staff of consulting and dispensing pharmacists, nurses and
dietitians, and a support staff of technicians and delivery personnel. The
division corporate staff includes a regional controller, regional vice
presidents of operations, a vice president of business development, a vice
president of acquisitions, and a director of pharmacy support services who
provide financial accounting, management oversight, new program implementation,
acquisitions, marketing, sales support, new business assimilation, and other
management support services to each pharmacy manager.
Home Health Operations. The Company's home health operations are divided
geographically into two regions, each managed by a regional vice president. The
regional vice presidents report to the senior vice president of Home Health and
Pharmacy Services and are supported by regional directors of quality
improvement, consumer education, finance and Infusion. Each of the Medicare
certified agencies is managed by a director of professional services.
Sources of Payment
The Company receives payment for healthcare services from (i) the federally
assisted Medicaid program, (ii) the federal Medicare program, (iii) private
sources, including HMOs and commercial insurance, and (iv) other sources,
including special programs sponsored by local governments and the Veterans
Administration. Because private and Medicare reimbursement rates historically
have been higher than Medicaid reimbursement rates, the Company has targeted the
private-pay market and has worked to make available Medicare-eligible services
in its healthcare facilities. Changes in the mix of the Company's patient
population between Medicaid and a combination of Medicare, private and other
sources can significantly affect profitability. Governmental reimbursement
programs are subject to change, which also can affect profitability.
As of February 28, 1997, 102 of the Company's facilities are certified for
participation in Medicaid. Medicaid is a medical assistance program for the
indigent and is operated by state governments with financial assistance
(approximately 50% of the funds available) from the federal government under a
matching program. Medicaid is subject to federally imposed requirements. Medi-
Cal, California's version of Medicaid, currently provides for reimbursement
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<PAGE>
at established daily rates, as determined by the California Department of Health
Services, based on median costs of nursing facilities, classified by number of
licensed beds and geographic location. Medi-Cal primarily pays for long-term
custodial care for patients who qualify for welfare benefits. In Ohio and West
Virginia Medicaid reimbursement is a prospective cost-based system with an
adjustment factor to account for patient acuity. Medicaid reimbursement is
primarily provided under a prospective cost-based system in Tennessee and in
North Carolina is provided under a system that has both a cost reimbursement
component, subject to limitations, as well as a prospective cost-based
component. Twelve of the Company's home healthcare agencies are eligible to
participate in the Medicare program and all of the Company's home healthcare
agencies are eligible to participate in the Medicaid program.
As of February 28, 1997, 96 of the Company's skilled nursing facilities are
certified for participation in Medicare. Medicare is a health insurance program
operated by the federal government for the aged and certain chronically disabled
individuals. Medicare reimbursement rates for the Company's healthcare
facilities are regulated by the federal government and generally utilize a cost-
based reimbursement system, subject to geographic cost limits. Medicare pays
both the allowed direct costs and allowed overhead costs related to services
provided to patients covered by the Medicare program. Medicare specific rates
are dependent upon the cost and volume of the services provided as calculated on
the cost reports that each facility is required to submit annually to Medicare.
Reimbursement from Medicare is subject to retrospective adjustment to reconcile
payments made to a facility on an interim basis with subsequently determined
allowable costs. Overpayments may be recovered directly from the facility at the
time the adjustment is made or by reducing future payments to the facility or
other facilities operated by the Company.
The Company's cost of care for its Medicare patients sometimes exceeds
regional reimbursement limits established by Medicare. The Company submits
exception requests for its excess costs annually. Exception requests for all
cost report periods through December 31, 1994 have been filed. The Company's
final rates as approved by the Health Care Financing Administration ("HCFA")
represent, on average, approximately 84% of the requested rates as submitted in
the exception requests. During 1994, the Company recognized 50% of the 1994
estimated exception requests anticipated to be received, which represented
revenues of approximately $1,550,000. Commencing January 1, 1995, the Company
recognized 70% of the estimated exception requests anticipated to be received,
which represented revenues of approximately $3,563,000 and $3,001,000 for 1996
and 1995, respectively. Amounts received in respect of exception requests
relating to periods prior to December 31, 1994 will continue to be recorded on
the cash basis. The Company believes that it will be able to recover its excess
costs under any pending exception requests or under any exception requests that
may be submitted in the future; however, there can be no assurance that it will
be able to do so.
The Company has a broad customer base. There are no customers or related
groups of customers that account for a significant portion of the Company's
revenue. The loss of a single customer or group of related customers would not
have a material adverse effect on the operations of the Company taken as a
whole. However, two non-affiliated healthcare providers represented 24% of SCRS
total revenues during 1996. For a detail of revenue by business unit, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Reimbursement rates for HMOs are negotiated by the Company and the
organization. Charges for other private-pay patients are established by the
Company from time to time and are determined by market conditions and costs.
Veterans Administration contracts are generally at negotiated daily rates. The
Company also receives reimbursement, generally at negotiated daily rates,
pursuant to five contracts with county governments relating to certain of the
Company's facilities which provide services to the mentally disordered. These
contracts may be terminated by either party upon 60 days', or less, prior
notice.
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The following table sets forth the Company's percentage of net operating
revenue provided by source of payor for the periods indicated:
<TABLE>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Medicaid 40.6% 39.9% 42.7%
Medicare 29.3 31.9 31.3
Private 11.6 13.6 15.2
Managed care 5.1 5.4 4.6
Other 13.4 9.2 6.2
========= ========= =========
Total 100.0% 100.0% 100.0%
========= ========= =========
</TABLE>
As of February 28, 1997, the Company had in effect agreements with nearly all
major HMOs operating in California to provide skilled nursing care and ancillary
services to patients at its facilities who are enrolled as members in the HMO.
Payment by HMOs for services provided by the Company is based on negotiated
contract rates that vary by HMO. Reimbursement is based upon the level of
patient acuity, irrespective of the actual services provided. Thus, if a patient
requires a greater level of healthcare services than that normally provided a
patient of the agreed acuity level, the Company will not be reimbursed for such
additional services.
Contract Rehabilitation Therapy Services to Non-affiliates. Revenues from
contract rehabilitation services to non-affiliates are generally received
directly from the long-term care facility where the patient being treated
resides, which in turn are paid by Medicare or other payors. These revenues are
included in other sources of revenue. Revenue from contract rehabilitation
therapy services provided to Regency operated facilities are included in the
Medicaid, Medicare and private pay sources of revenues for Regency for each of
the applicable facilities. Charges to non-affiliates, though not directly
regulated, are effectively limited by regulatory reimbursement policies imposed
on the long-term care facilities that receive these therapy services, as well as
competitive market factors.
Pharmacy Services to Non-affiliates. Revenue from the Company's pharmacy
services are derived from the provision of such services to patients at long-
term care facilities not operated by Regency and patients at Regency facilities
billed directly to third-party payors. Regency enters into non-exclusive
contracts with non-affiliated facilities, and personnel at such facilities
submit prescriptions to Regency on behalf of patients at such facilities.
Regency is in most cases paid directly by Medicare, Medicaid or private pay
sources, and not by the long-term care facility. The amounts that can be charged
for prescriptions are often limited by Medicaid regulations.
Home Health Operations. Revenue from the Company's home health operations
come from a variety of payors including the Medicare and Medicaid programs,
commercial insurance, health maintenance organizations, private sources and
special county/state programs. In January 1996, two of the Company's California
home health agencies entered the HCFA "Prospective Pay" pilot program. This is a
three year program under which reimbursement will be determined on an "episode"
basis not on a fee for service (per visit) basis. An "episode" is defined as a
120 day period of home health benefit, inclusive of all necessary services
(including ancillary services).
Related Party Transactions. Medicare regulations that apply to transactions
between related parties, such as Regency and its subsidiaries, are relevant to
the amount of Medicare reimbursement that the Company is entitled to receive for
contract rehabilitation therapy and pharmacy services that it provides to
Regency operated facilities. These Medicare regulations generally require that,
among other things, (i) the Company's rehabilitation therapy and pharmacy
subsidiaries must each be a bona fide separate organization; (ii) a substantial
part of the contract rehabilitation therapy services or pharmacy services, as
the case may be, of the relevant subsidiary must be transacted with non-
affiliated entities, and there is an open, competitive market for the relevant
services; (iii) contract rehabilitation therapy services and pharmacy
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<PAGE>
services, as the case may be, are services that commonly are obtained by long-
term care facilities from other organizations and are not a basic element of
patient care ordinarily furnished directly to patients by such long-term care
facilities; and (iv) the prices charged to the Company's long-term care
facilities by its contract rehabilitation therapy operations subsidiary and
pharmacy operations subsidiaries are in line with the charges for such services
in the open market and no more than the prices charged by its contract
rehabilitation therapy operations subsidiary and pharmacy operations
subsidiaries under comparable circumstances to non-affiliated long-term care
facilities. Regency believes that each of the foregoing requirements are
presently being satisfied with respect to its contract rehabilitation therapy
and pharmacy subsidiaries, and therefore, Regency believes it presently
satisfies the requirements of these regulations. Consequently, it has claimed
and received reimbursement under Medicare for contract rehabilitation therapy
services (since the acquisition of SCRS in July 1995) and pharmacy services
(beginning in January 1996) provided to patients in its own facilities at a
higher rate than if it did not satisfy these requirements. If the Company is
unable to satisfy these regulations, the reimbursement the Company receives for
contract rehabilitation therapy and pharmacy services provided to its own
facilities would be materially adversely affected. If, upon audit by relevant
reimbursement agencies such agencies find that each of these regulations has not
been satisfied, and if, after appeal, such findings are sustained, the Company
could be required to refund some or all of the difference between its cost of
providing these services and the higher amount actually received. While the
Company believes that it has satisfied and will continue to satisfy these
regulations, there can be no assurance that its position would prevail if
contested by relevant reimbursement agencies.
Marketing
Recognizing the growing influence of managed care upon healthcare delivery,
the Company's Marketing and Managed Care departments were combined in 1996. The
integration of these areas allows a synergistic approach to marketing the
Company's services to payors, providers and patients. Long-term strategies and
Company-wide marketing programs are developed by the corporate Marketing &
Managed Care staff. However, primary marketing responsibility rests with field
personnel for each of the Company's business lines.
The Company has developed various marketing and managed care training
programs and manuals for use by staff who are involved in service delivery.
Software programs, statistical data, and field interview responses aid in
development of materials to support marketing efforts. Recognizing that
healthcare decisions are made at the local level by physicians, case managers,
discharge planners, family members and patients, the Company attempts to
identify, develop and maintain relationships with the primary referral sources
in each of the areas it serves. Marketing personnel also research, analyze and
advise the Company concerning opportunities in each of its local market areas.
From this, the Company's marketing staff seeks to develop programs to maximize
occupancy and financial performance in each of the Company's facilities.
Complementing these efforts, Managed Care staff identify and pursue
opportunities to develop relationships with managed care providers.
Quality Management
The Company believes that an essential element of its business strategy is to
focus on the quality of service provided. This depends in large measure on the
existence of a trained and educated work force. The Company views quality
management as a two-pronged system: Continuous Quality Improvement and Total
Quality Management.
In 1996, the Company introduced a Continuous Quality Improvement program into
its long-term care operations. This program places the responsibility for
quality improvement in the hands of those who most greatly impact quality - the
facility staffs. It is a facility-based system of identifying opportunities to
improve quality before negative events can occur. As system weaknesses are
identified, they are resolved through a problem-solving procedure that is based
on Total Quality Management.
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With initial assistance from the Richard Rodgers Consulting Group, the
Company has, since 1993, trained over 9,000 employees in the principles of Total
Quality Management ("TQM"). In addition, certain executive and mid-level
managers have been trained in the use of Statistical Process Control and data
analysis in sound business decision-making.
In implementing its TQM initiative, the Company did not create additional
layers of bureaucracy, but instead developed and communicated to its employees
the simple message that the Company's vision, mission and culture are dedicated
to meeting and exceeding the expectations of its customers.
Because the Company believes that quality planning is an important component
of the strategic planning process and integral to the successful realization of
its strategic objectives, TQM is results-oriented. At all levels of the Company,
rewards are tied to specific agreed-upon result statements that directly support
the Company's strategic objectives. Employee performance is evaluated based upon
achievement of stated quantitative measures. In this way, the Company's focus is
continually directed back to its strategic objectives.
Regulation
The healthcare industry is subject to extensive federal, state and local
statutes and regulations. The regulations include licensure requirements,
reimbursement rules and standards and levels of services of care. Changes in
applicable laws and regulations or new interpretations of existing laws and
regulations could have a material adverse effect on licensure of Company
facilities, eligibility for participation in federal and state programs,
permissible activities, costs of doing business, or the levels of reimbursement
from governmental, private, and other sources. To date such changes have not had
a material adverse effect on the Company's business. However, there can be no
assurance that regulatory authorities will not adopt changes or interpretations
that adversely affect the Company's business.
Licensing. The Company's healthcare facilities and pharmacy services are
subject to licensing requirements by state and local authorities. The Company's
healthcare facilities are licensed by each state's licensing agency. In granting
licenses, an agency considers, among other factors, the physical condition of
the facility, the qualifications of the administrative and nursing staffs, the
quality of care, and compliance with applicable statutes and regulations. The
failure to maintain or renew any required regulatory approvals or licenses could
prevent the Company from offering its existing services or from obtaining
reimbursement.
As of February 28, 1997, 96 of the Company's skilled nursing facilities are
certified for participation in Medicare and 102 of the Company's facilities are
certified for participation in Medicaid. Twelve of the home healthcare agencies
operated by the Company are eligible to participate in the Medicare program and
all of the Companies home healthcare agencies are eligible to participate in the
Medicaid program. The Company, through its subsidiaries, holds licenses to
operate long-term care facilities in California, West Virginia, Ohio, Tennessee
and North Carolina. Ohio does not require that a new license be issued on a
yearly basis. The Company, through its subsidiaries, participates in the
Medicare and Medicaid programs in California, West Virginia, Ohio, Tennessee and
North Carolina.
Most states in which SCRS operates permit a corporation to provide
rehabilitation services provided that the individual therapist is licensed. The
Company's rehabilitation services at facilities not operated by the Company are
offered under the individual license of Sherri L. Medina, the Company's Senior
Vice President-Rehabilitation Services and through the licenses of individual
therapists. In California and Indiana, services are provided either through Ms.
Medina's professional corporation or through a professional corporation of
another employee. The failure by Ms. Medina to maintain her individual license
would prevent the Company from offering such services to other facilities until
a replacement supervising officer were employed.
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<PAGE>
In certain states, statutes require that a state agency approve certain
acquisitions, the addition of beds and services and certain capital
expenditures. Such state approvals generally require implementation of the item
being approved within a specified time period. The failure to obtain the state
approval can result in the inability to make the acquisition, to add the
service, to operate the facility or complete the addition or other change
requested, and can result in the imposition of sanctions or adverse
reimbursement action.
The Omnibus Budget Reconciliation Act of 1987 ("OBRA") was implemented
effective October 1, 1990. Among other things, OBRA eliminated the different
certification standards for "skilled" and "intermediate care" nursing facilities
under the Medicaid program in favor of a single "nursing facility" standard.
OBRA also mandated an increase in the level of services nursing facilities must
provide to participate in Medicare and Medicaid. This change, the cost of which
was partially offset by reimbursement rate increases for Medicaid and an
increase in the routine cost limits under Medicare, thus far has not had a
significant impact on the Company.
Effective July 1, 1995, new regulations under OBRA dealing with enforcement
policies and procedures and a new survey process became operative. These
regulations provide for a variety of penalties for noncompliance with other
substantive regulations and minimum standards of care, including required
preparation and submission of plans of correction, new patient admission
moratoriums, denial of reimbursement, decertification of Medicare reimbursement
eligibility, delicensing, forced facility shutdown and loss of provider status.
While the Company believes that it is in substantial compliance with the current
requirements of OBRA, it is unable to predict how the enforcement regulations
will be implemented, or how future interpretations of current regulations or
future regulations promulgated under OBRA may affect it. In addition, there can
be no assurance that the Company's facilities and the provision of services and
supplies by the Company now or in the future will initially meet or continue to
meet the requirements for participation in Medicare or Medicaid programs.
The Company and its healthcare facilities are subject to routine inspections,
at any time, to monitor compliance with government regulations. Based on such
inspections, the Company receives, from time to time in the ordinary course of
its business, notices of failure to comply with various requirements. The
Company endeavors to take prompt corrective action and, in most cases, the
Company and the reviewing agency agree on remedial steps. The reviewing agency
may take action against a facility, which can include the imposition of fines,
recovery of Medicare payments paid with respect to deficient care, temporary
suspension of admission of new patients to the facility, decertification from
participation in the Medicare or Medicaid programs and, in extreme
circumstances, revocation of the facility's license. In certain circumstances,
failure of compliance at one facility may affect the ability of the Company to
obtain or maintain licenses or approvals under Medicare and Medicaid programs at
other Company facilities.
Reimbursement. Governmental reimbursement programs are subject to statutory
and regulatory changes, administrative rulings and interpretations, government
funding restrictions, and retroactive reimbursement adjustments, all of which
could materially increase or decrease the services covered or the rates paid to
the Company for its services. There have been and the Company expects that there
will continue to be, a number of proposals to limit governmental programs such
as Medicare and Medicaid reimbursement for healthcare services. The Company
cannot predict at this time whether any of these proposals will be adopted or,
if adopted and implemented, what effect such proposals would have on the
Company. There can be no assurance that payments under governmental programs
will remain at levels comparable to present levels or will be sufficient to
cover the cost allocable to patients eligible for reimbursement pursuant to such
programs. In addition, governmental reimbursement programs require strict
compliance with both patient eligibility and acuity requirements, and timely
payment requests. The failure to adhere to these requirements is a basis for
denial of reimbursement or for a required refund, with interest, of any sums
paid by the program.
In addition, the Company's cash flow could be adversely affected by periodic
government program funding delays, shortfalls, or other difficulties, such as
that which occurred in 1995 when the State of California failed to adopt a new
12
<PAGE>
budget prior to the end of the 1994-1995 fiscal year and, as a result, Medi-Cal
delayed reimbursement payments for several weeks. Medi-Cal also delayed payments
and rate increases for several weeks in 1990 and 1991. Medi-Cal has on a number
of recent occasions delayed payments and rate increases, including for several
weeks in each of 1990, 1991 and 1995. The Company has mitigated the effects of
such payment delays by monitoring the related activities of the California
legislature, expediting billings through its electronic billing arrangement and
agreeing with creditors to extend the due date for payables. See Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources." There can be no assurance,
however, that the Company will be able to mitigate the effects of any future
funding delays. During 1996, the Company averaged approximately $8.1 million per
month in cash receipts from the Medi-Cal program.
Antifraud and Self-Referral Regulations. Various Federal and state laws
regulate the relationship between providers of health care services and
physicians or others able to refer medical services, including employment or
service contracts, leases and investment relationships. These laws include the
fraud and abuse provisions of the Medicare and Medicaid and similar state
statutes (the "Fraud and Abuse Laws"), which prohibit the payment, receipt,
solicitation or offering of any direct or indirect remuneration intended to
induce the referral of Medicare and Medicaid patients or for the ordering or
providing of Medicare or Medicaid covered services, items or equipment.
Violations of these provisions may result in civil and criminal penalties and/or
exclusion from participation in the Medicare and Medicaid programs and from
state programs containing similar provisions relating to referrals of privately
insured patients. The United States Department of Health and Human Services
("HHS") has interpreted these provisions broadly to include the payment of
anything of value to influence the referral of Medicare or Medicaid business.
HHS has issued regulations which set forth certain "safe harbors," representing
business relationships and payments that can safely be undertaken without
violation of the Fraud and Abuse Laws. In addition, certain Federal and state
requirements generally prohibit certain providers from referring patients to
certain types of entities in which such provider has an ownership or investment
interest or with which such provider has a compensation arrangement, unless an
exception is available. The Company considers all applicable laws in planning
marketing activities and exercises care in an effort to structure its
arrangements with health care providers to comply with these laws. However,
because there is no procedure for obtaining advisory opinions from government
officials, the Company is unable to provide assurances that all of its existing
or future arrangements will withstand scrutiny under the Fraud and Abuse Laws,
safe harbor regulations or other state or federal legislation or regulations,
nor can it predict the effect of such rules and regulations on these
arrangements in particular or on the Company's operations in general. The
Company systematically reviews its operations on a periodic basis and has
adopted policies intended to ensure that it complies with the Fraud and Abuse
Laws and similar state statutes.
Environmental Regulations. The Company's healthcare operations generate
medical waste that must be disposed of in compliance with Federal, state and
local environmental laws, rules and regulations. The Company's operations are
also subject to compliance with various other environmental laws, rules and
regulations. Such compliance does not, and the Company anticipates that such
compliance will not, materially affect the Company's capital expenditures,
earnings or competitive position.
Competition
The Company, and the healthcare industry in general, faces the challenge of
continuing to provide quality patient care while contending with rising costs,
strong competition for patients and a general reduction of reimbursement rates
by both private and public payors. As both private and public payors reduce the
scope of services which may be reimbursed and reduce reimbursement levels for
covered services, national and state efforts to reform the healthcare system may
further impact reimbursement rates. Changes in medical technology, existing and
future legislation, regulations, contracting innovations and industry
consolidation may require changes in the Company's facilities, equipment,
personnel, rates and/or services in the future.
13
<PAGE>
The Company competes with a variety of other providers of healthcare
services, including other rehabilitation hospitals, other skilled nursing
facilities, other home health providers, hospitals offering long-term care
services and personal care or residential facilities. Competition has become
more intense as alternatives for nursing and rehabilitation patients has
increased. Many hospitals now have skilled nursing units and home health
agencies. Community-based programs such as assisted living and congregate living
centers also compete for residents with the Company's skilled nursing facilities
and congregate living centers. With the movement from `institutional', skilled
nursing facilities to residential living facilities and congregate living
centers, maintaining occupancy rates becomes increasingly difficult.
As of February 28, 1997, the Company operated 83 inpatient facilities
(including 4 acute rehabilitation facilities and 6 neurological care centers)
with 7,521 licensed beds in California. The Company estimates that there are
approximately 1,300 free-standing long-term care facilities with approximately
125,000 licensed beds in California. The Company also operates 33 facilities
with 3,943 beds in West Virginia, Ohio, Tennessee, and North Carolina. The
Company's competitive position varies across statewide and local markets. Some
of the significant factors relating to individuals' selection of the Company's
healthcare facilities include quality of care, reputation, physical appearance,
services offered, family preferences, benefit plan preferences and price. The
Company's facilities and home health agencies operate in communities that are
served by similar entities. Some competing facilities, home health agencies and
pharmacies offer services not offered by the Company. Furthermore, competitors
may benefit from greater financial resources, longer operating histories,
charitable endowments, favorable tax status and other resources not available to
the Company. There can be no assurance that the Company will not encounter
increased competition in the future that would adversely affect the Company's
results of operations.
Contract therapy services, like those offered by SCRS, are provided by other
rehabilitation service companies, many of whom are larger and have greater
resources than the Company. In addition, many of SCRS's existing customers have
begun to develop the capability of directly providing such services, rather than
contracting with other providers for these services.
The long term care pharmacy market is rapidly consolidating and this has
resulted in numerous large institutional pharmacies. These pharmacies are larger
and have greater resources than the Company.
Employees
As of February 28, 1997, the Company had approximately 16,170 full-time and
part-time employees. Of these employees, approximately 12,080 were employed at
its healthcare facilities, approximately 850 at its home health agencies,
approximately 240 in its pharmacy operations, approximately 2,680 in
rehabilitation services and approximately 320 at its regional administrative and
corporate offices. Approximately 1,600 of the employees were covered by 12
collective bargaining agreements. The Company believes that it maintains
productive relations with its employees in general and with the 12 collective
bargaining units. The Company is subject to both federal and state minimum wage
and wage and hour laws and maintains various employee benefit plans.
Tax Audits
A State of Ohio income tax audit for the years 1991 through 1994 is ongoing
and a California Franchise Tax Board income tax audit for 1994 is pending.
Although it is not possible to predict with certainty the outcomes of the
audits, in the opinion of the Company, adequate provision for the matters under
review has been made, and the results of the audits are not expected to have a
material adverse effect on the Company's consolidated financial position.
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<PAGE>
Insurance
The Company maintains general and professional liability insurance on a
claims-made basis subject to a $100,000 per occurrence self-insured retention
limited to an aggregate stop loss of $500,000. All-risk property insurance,
including earthquake and flood, is carried for all Company operations.
The Company self-insures its workers' compensation programs for its nursing
facilities in California and Ohio, pharmacy operations, home health operations
and its corporate office employees. For all other operations, the Company
purchases insurance for this risk. The Company is required to maintain standby
letters of credit with the state insurance departments for its self-insurance
workers' compensation programs, which as of December 31, 1996 aggregated
approximately $8.4 million. These letters of credit assure that benefits payable
by the Company to its covered employees (which estimated benefits are reflected
as liabilities on the Company's books and records) are paid when required. The
Company has not defaulted in its workers' compensation benefit payment
obligations since the Company began its self-insurance program in 1983.
Factors Which May Affect Company
The following important factors, among others, in the past have affected and
in the future could affect, the financial results, business strategy, and
business operations of healthcare providers including the Company, and could
materially impact the various forward looking statements contained elsewhere in
this Annual Report. Readers are cautioned to review such forward looking
statements in the context of these factors. A number of these items are
summarized as follows:
Dependence on Reimbursement from Medicare and Medicaid. The Company's
business is dependent upon its ability to obtain and maintain reimbursement from
Medicare and Medicaid. These government-sponsored healthcare programs are highly
regulated and are subject to budgetary and other constraints. In addition, these
government programs have instituted cost-containment measures designed to limit
payments made to healthcare providers. Furthermore, government reimbursement
programs are subject to statutory and regulatory changes, administrative rulings
and interpretations, determinations of intermediaries, government funding
restrictions and retroactive reimbursement adjustments, all of which could
materially increase or decrease the services covered by such programs, the rates
paid to healthcare providers for their services, or the eligibility of providers
to receive reimbursement. In addition, there can be no assurance that the
Company's facilities and the provisions of services by the Company in the future
will continue to meet the requirements for participation in Medicare or Medicaid
programs as presently enacted or as they may be changed.
Governmental Regulation. The long-term care industry is subject to extensive
federal, state and local licensure and certification laws. Long-term care
facilities and home health agencies are subject to annual and routine interim
inspections to monitor compliance with governmental regulations. Certain laws
establish minimum healthcare standards and provide for significant remedies for
non-compliance including fines, refunds of prior payments, new patient admission
moratoriums, federal or state monitoring of operations, and closure of
facilities.
The Company is also subject to federal and state laws that govern financial
and other arrangements involving healthcare providers. These laws often prohibit
certain direct and indirect payments or fee-splitting arrangements between
healthcare providers that are designed to induce or encourage the referral of
patients to, or the recommendation of, a particular provider for medical
products and services. Possible sanctions for violations of any of these or
similar restrictions or prohibitions, include loss of eligibility to participate
in reimbursement programs, as well as civil and criminal penalties. Changes in
interpretation or manner of enforcement of these laws or regulations could
adversely affect the Company.
Dependence on California. A substantial portion of the Company's billings are
to the California Medicaid program, Medi-Cal. California has a less generous and
15
<PAGE>
more heavily regulated healthcare reimbursement system that typically provides
for lower reimbursement rates than do a majority of other states. And,
California historically has enforced its regulations more strictly than most
other jurisdictions. In addition, California has a higher applicable minimum
wage and higher workers' compensation costs than most other states. The Company
may be materially and adversely affected by the failure of Medi-Cal
reimbursement rates to increase in proportion to cost increases, by any
reduction in the levels of reimbursement, or by healthcare reform measures that
substantially increase its operating costs. Further, there have been, and there
are likely to continue to be, strong legislative pressures to avoid increases in
Medi-Cal reimbursement levels and to impose reductions in such payments.
Uncertainty of Litigation. The Company regularly is made a defendant in
lawsuits by or on behalf of patients at one or more of its facilities or to whom
healthcare services were provided seeking to recover for injuries sustained as a
result of alleged errors and omissions. Often these suits also allege that the
injuries resulted from intentional actions or omissions of healthcare personnel
for whom the Company is asserted to have legal responsibility, and consequently
seek awards of punitive damages. The Company also on a regular basis, is sued by
persons claiming that their employment by the Company was improperly terminated,
that they were denied employment or promotions because of their race, creed,
religion, gender, ethnic origin or sexual orientation, or that they suffered
sexual harassment or other tortuous conduct, which suits seek awards of
compensatory, incidental and punitive damages. Although the Company maintains
insurance for its professional errors and omissions, it is not insured for
damages sustained as a result of intentional torts committed, for punitive
damages or for awards of damages in wrongful termination cases. The Company's
financial condition and results of operations could be adversely affected by a
significant award for damages that is not covered by insurance.
ITEM 2. PROPERTIES
The following table sets forth information regarding the healthcare
facilities owned or leased by the Company as of February 28, 1997:
<TABLE>
<CAPTION>
Facilities Beds
----------------------------------------- ------------------------------------------
Owned Leased Managed Total Owned Leased Managed Total
--------- --------- ------------ -------- --------- --------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
California 32 50 1 83 2,098 5,175 248 7,521
Ohio 4 4 -- 8 402 461 -- 863
North Carolina 1 10 -- 11 86 1,278 -- 1,364
Tennessee -- 8 -- 8 -- 1,097 -- 1,097
West Virginia 5 1 -- 6 554 65 -- 619
--------- --------- ------------ -------- --------- --------- ------------ ---------
42 73 1 116 3,140 8,076 248 11,464
========= ========= ============ ======== ========= ========= ============ =========
</TABLE>
Nine of the Company's healthcare facilities are encumbered by deeds of trusts
or mortgages.
The Company's home health subsidiaries, Home Health Services, Inc. and
Americare Homecare, Inc. lease office space aggregating 51,549 square feet for
its 28 home health locations in California and Ohio.
The Company's pharmacy subsidiaries, First Class Pharmacy, Inc. and Assist-A-
Care, Inc. lease approximately 51,934 square feet for its locations in
California, North Carolina and Tennessee.
The Company's rehabilitation subsidiary, South Coast Rehabilitation Services,
Inc. leases an 8,035 square foot office in Aliso Viejo, California.
16
<PAGE>
The Company leases office space aggregating 65,608 square feet for its
corporate and regional offices in California and West Virginia.
The Company also leases space for its outpatient clinics aggregating
approximately 16,500 square feet in California.
In the facilities that are leased, subleased, or managed, the Company's
rights as lessee or sublessee could be subject to termination if the lessor or
sublessor of a facility fails to pay its rent, taxes, loan obligations that are
secured by the facility, if any, or other similar obligations. The Company has
not experienced any such lease terminations, although there can be no assurance
that the Company's rights to operate its leased or subleased facilities will not
be so affected in the future.
The Company's facilities are subject to various governmental zoning and use
restrictions. One of the Company's facilities that provides services for the
mentally disordered is currently operating pursuant to a deemed to be approved
conditional use permit. In July 1992, the facility filed an application for a
conditional use permit and is currently appealing the recent denial of said
application. A mediator has been appointed to monitor this matter. Although
there can be no assurance, the Company believes it will prevail with its appeal
and that the conditional use permit will be renewed.
ITEM 3. LEGAL PROCEEDINGS
In 1995, a class action lawsuit, captioned Standish and Miriam Mallory and
Claire Bauman vs. Regency Health Services, Inc., which had been filed against
the Company in July 1994, was settled for $9,000,000. The Company's portion of
this settlement, together with related legal fees and other costs, resulted in a
pre-tax charge of $3,098,000, which is included in the consolidated statement of
operations for the year ended December 31, 1995.
Additionally, the Company is subject to claims and legal actions by patients
and others in the ordinary course of business. The Company has insurance
policies in varying amounts covering most of the outstanding lawsuits. If a
judgment were awarded in excess of the insurance coverage, the burden would fall
on the Company. The Company does not expect that the ultimate outcome of an
unfavorable judgment in any of the pending legal matters would result in a
material adverse effect on the Company's consolidated financial position or
results of operations. However, there can be no assurances that an unfavorable
judgment in future claims and legal actions would not have a material adverse
effect on the Company's consolidated financial position or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
17
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded under the symbol "RHS" on the New York
Stock Exchange.
The quarterly price range of common stock for 1996 and 1995 are included on
page 47 of the 1996 Regency Annual Report under the caption "Stock Market
Information" and are incorporated herein by reference.
At February 28, 1997, 15,792,157 shares of Company common stock were held of
record by approximately 1,000 stockholders as reported by the Company's transfer
agent.
The Company has not declared or paid cash dividends on common stock since its
inception, and does not currently plan to declare or pay any dividends in the
foreseeable future. Covenants in a note agreement between the Company and its
lenders limit the payment of cash dividends on Company common stock. Among such
restrictions is a provision limiting the payment of dividends and other
restricted payments, as defined, to no more than 50% of consolidated net income
from and after January 1, 1996, on a cumulative basis, plus $5,000,000.
ITEM 6. SELECTED FINANCIAL DATA
On April 4, 1994, Regency and Care completed their merger ("Merger")
accounted for as a pooling-of-interests. Consequently, the historical financial
statements for periods prior to the Merger are restated as though the companies
had been merged since inception. The calculation of income per share for each
period presented prior to the Merger reflects the issuance of .71 of a share of
Regency common stock for each share of common and common equivalent share of
Care common stock.
The following consolidated financial data as of and for the years ended
December 31, 1996, 1995, 1994, 1993 and 1992, have been derived from the
Company's audited Consolidated Financial Statements. The selected consolidated
financial data set forth below should be read in conjunction with Item 7
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and with the Consolidated Financial Statements and the notes thereto
included elsewhere in this Report.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------
1996 (2) 1995 (3) 1994 (4) 1993 1992 (5)
-------- -------- -------- ---- --------
(in thousands except per share data)
<S> <C> <C> <C> <C> <C>
Net operating revenue (1).................... $558,050 $416,093 $377,336 $336,954 $295,340
Income (loss) before extraordinary item...... 6,399 4,454 (800) 11,790 10,419
Net income (loss)............................ 5,206 2,845 (800) 11,742 10,330
Income (loss) per common share before
extraordinary item (fully diluted)........ .39 .27 (.05) .69 .76
Net income (loss) per common share (fully
diluted).................................. .32 .17 (.05) .69 .75
Total assets................................. 353,576 338,942 250,896 242,300 164,403
Total long-term debt......................... 184,908 183,986 101,941 103,245 53,638
- - ------
</TABLE>
(1) In 1994, the Company changed its policy on recognizing revenue from
exception requests filed with the Health Care Financing Administration
("HCFA"). Previously, no revenue was recognized until payment in respect of
the exception request was actually received. In 1994, the Company began
recognizing 50% of the estimated exception requests anticipated to be filed
for the applicable period. In 1995 and 1996, the Company recognized 70% of
the estimated exception requests anticipated to be received for the
applicable period.
18
<PAGE>
(2) In 1996, the Company redeemed all $48.9 million of its outstanding
Convertible Subordinated Debentures resulting in an extraordinary loss on
extinguishment of debt of $1,459,000 ($868,000 net of tax) and refinanced
three of its Industrial Revenue Bond Issues (IRBs) with a principal balance
of $7,560,000 resulting in an extraordinary loss of $546,000 ($325,000 net
of tax). In addition, the Company recorded an $11,283,000 ($6,769,000 net
of tax) charge, primarily related to severance, the write-off of property
which will have no value under the Company's new operating model,
allowances for certain notes and non-patient receivables and a reduction of
the reserve for assets held for sale recorded in 1995.
(3) In 1995, a class action lawsuit, which had been filed against the Company
in July 1994, was settled for $9,000,000. The Company's portion of this
settlement, together with related legal fees and other costs, resulted in a
pre-tax charge of $3,098,000 ($1,921,000 net of tax), which is included in
the consolidated statement of operations for the year ended December 31,
1995. In addition, the Company repaid its $30 million, 8.10% Senior Secured
Notes resulting in costs and a prepayment penalty of $2,681,000 ($1,609,000
net of tax), classified as an extraordinary item and the Company recorded a
$9,000,000 ($8,200,000 net of tax) charge, primarily related to the
disposition of certain facilities (see Note 14 to the Company's
Consolidated Financial Statements).
(4) As required under the pooling-of-interests accounting method, all fees and
expenses related to the Merger and restructuring of the combined companies
were reflected in the Consolidated Statement of Operations of the Company
for the year ended December 31, 1994, resulting in a pre-tax charge of
$14,700,000 ($10,600,000 net of tax), including a reserve for losses
associated with the disposal of duplicate facilities. Additionally, in 1994
the Company recorded a pre-tax charge of approximately $1,600,000 ($975,000
net of tax) related to the closure of a facility damaged by the Northridge,
California earthquake in 1994.
(5) During Care's reorganization period (prior to emergence from bankruptcy
proceedings on December 31, 1990), Care established a reserve for losses on
discontinuance of certain operations. These losses were originally included
as part of an overall provision/(credit) for reorganization items. During
the year ended December 31, 1992, the Company recognized pre-tax gains
resulting from the reversal of reserves for losses on the discontinuance of
certain operations of $461,000 and the reversal of reserves for expenses
and fees resulting from Care's Chapter 11 proceedings of $75,000.
Additionally, in 1992 the Company recognized a gain of $1,000,000 on the
disposal of a nursing facility.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
Overview of Strategic Plan
The healthcare industry continues to change as the government, commercial
payors and healthcare providers like the Company focus on rising healthcare
costs. It is the Company's belief, as well as that of the government and
commercial payors, that the most effective delivery system for reducing costs is
a regionally oriented market based model within the context of the evolving
managed care system. Presently, only 5.1% of the Company's revenues are
generated from managed care payors, however, management and other members of the
industry believe the Medicare system will be adopting a prospective pay system
in the coming years for skilled nursing facilities. Furthermore, the Company
believes more Medicare participants will be entering managed care plans as they
typically offer more services at a fixed price.
Considering the anticipated changes in the industry, the Company believes
19
<PAGE>
that the most successful business strategy in the future will be to provide both
payors and patients, collectively the customers, cost effective delivery of care
with high customer satisfaction. This will mean significant changes in the
current delivery system. The Company believes its future delivery system will
need to have the following components:
o Focus on customers through a fully integrated delivery system which will
allow for "one-stop shopping". This means that the Company will need to
provide multiple low cost services across the continuum of care in each of
the regions in which it provides care. In the future, acquisitions will
focus on completing the continuum of care within the Company's various
regional markets.
o Name recognition as customers must be convinced that the Company provides
consistent service throughout the continuum of care.
o Regionally focus to ensure that diverse services are available in each
market and that those services are integrated rather than the traditional
focus on separate business lines.
o Focus on placing the patient in the most effective setting with the lowest
cost while demonstrating positive outcomes from the delivery of medicine and
care. Basically, the Company will strive to provide high quality service
across the continuum of care at a low cost.
o Focus on a low overhead cost structure. Reengineering to eliminate non-value
added services and investments in information technology will be required in
order to reduce costs and enable the Company to provide consistent,
integrated, low cost services. The investment in information technology will
also provide management critical information in a timely manner to
effectively manage its business in the managed care environment.
During 1996 the Company developed and began to implement its strategic plan
to address these issues. In connection with this plan, the Company acquired four
acute rehabilitation hospitals, ten outpatient rehabilitation clinics and six
neurological treatment centers effective January 1, 1997. The purchase price was
$43.0 million, made up of a cash payment of $36.3 million and notes payable
totaling $6.7 million. This acquisition was one of many steps in the Company's
plan to complete the continuum of care in its various regional markets. The
Company has also hired two individuals with extensive experience in acquisitions
to focus on the acquisition of home health agencies and outpatient clinics,
primarily in our existing nursing operations markets to complete the continuum
of care in those markets.
During 1996, the Company recorded a restructuring and other non-recurring
charge of $11.3 million primarily related to initiatives designed to reengineer
the operating model through which the Company manages its business and lower its
operating costs. Also included in the charge were amounts for consulting and
other obligations for which there is no future benefit, reductions in the assets
held for sale reserve established in 1995, additional reserves for notes and
non-patient receivables and a charge for the impairment of other long-term
assets.
A major component of the reengineering, in terms of importance and cost, will
involve integrating the Company's information systems to allow for the
integrated delivery of patient care across all service lines within the
continuum of care. The Company will therefore be making a significant investment
in information technology over the next five years. This investment will result
in cost savings in the future. The first phase of the investment in information
technology will be investments in the infrastructure such as a communications
network and servers combined with upgrades of the accounts payable software, the
acquisition of Kronos time clocks and other transaction systems, which are
expected to be completed during 1997. The second phase will be the integration
of the various computer systems used by the different divisions of the Company
to allow for a seamless transfer of patient care information across the entire
continuum of care. The integration of the various systems is expected to begin
during 1998.
The Company incurs certain costs and operating inefficiencies in connection
with acquisitions following such acquisition, relating to the integration of
such facility's financial and administrative systems, physical plant and other
aspects of its operations into those of the Company. In addition, the
introduction of a substantial portion of the Company's contract rehabilitation
therapy, pharmacy and other ancillary services to a new operation may take as
long 12 months to fully implement. There can be no assurance that each of the
20
<PAGE>
service providers the Company may acquire will be profitable. In addition, there
can be no assurance that new acquisitions that result in significant integration
costs and inefficiencies will not adversely affect the Company's profitability.
General
In connection with the strategy and acquisitions discussed above, the Company
has created the Regency Rehabilitation and Specialty Services Division which
includes the Acute Rehabilitation Hospitals (and related outpatient clinics and
neurological treatment centers), the Contract Rehabilitation Therapy Operations
and future outpatient clinic acquisitions.
The following table sets forth certain operating data for the Company on the
dates indicated:
<TABLE>
<CAPTION>
February 28, December 31,
1997 1996 1995 1994
<S> <C> <C> <C> <C>
Nursing center operations
Facilities............................ 106 107 94 93
Licensed beds......................... 11,119 11,200 9,178 9,134
Subacute beds......................... 1,108 1,108 1,040 879
Subacute units........................ 46 46 42 35
Regency rehabilitation and specialty services
division
Acute rehabilitation operations
Rehabilitation hospitals.............. 4 -- -- --
Neurological centers.................. 6 -- -- --
Licensed beds......................... 345 -- -- --
Outpatient clinics.................... 10 -- -- --
Contract rehabilitation therapy operations
Non-affiliated facilities served...... 116 114 79 --
Regency operated facilities served.... 63 57 27 --
======= ======= ======= =======
Total................................ 179 171 106 --
======= ======= ======= =======
Pharmacy operations
Non-affiliated facilities served....... 84 84 5 5
Regency operated facilities served..... 70 68 36 34
======= ======= ======= =======
Total................................. 154 152 41 39
======= ======= ======= =======
Home health agencies........................ 28 29 29 28
</TABLE>
Nursing Center Operations
The Company's nursing center operations derive net operating revenue
from the performance of routine and ancillary services at the Company's
facilities. Revenue from routine services is comprised of charges for room and
board and basic nursing services for the care of patients, including those in
the Company's subacute specialty units. Revenue from ancillary services is
comprised of charges for rehabilitative services, subacute specialty services,
and pharmaceutical products and services provided to patients at the Company's
facilities. Nursing center operations derive most of its ancillary services
revenue from Medicare- and HMO-eligible patients. The Company has classified
revenue from nursing center operations as either basic nursing care revenue or
subacute revenue. Basic nursing care revenue includes charges for room and board
21
<PAGE>
for non-Medicare and non-HMO patients. Subacute revenue includes room and board
and basic nursing services for Medicare and HMO patients and revenues from all
ancillary services provided to patients at the Company's facilities.
Effective July 1, 1994, the Company elected to dispose of two healthcare
facilities due to excess capacity in certain markets caused by the Regency and
Care merger (the "Merger") and to dispose of a residential facility operated by
Care (the "Dispositions"). The Company established a $2.7 million reserve in
1994 related to these dispositions, which consisted of a write-down of the
assets to estimated fair value, transaction costs, and a provision for
anticipated operating losses to the time the transactions were completed. These
facilities were disposed of in 1995 and the results of operations of these
facilities since July 1, 1994 are not reflected in the operations of the
Company.
During 1995 the Company exchanged leasehold interests in three healthcare
facilities with 360 beds in New Mexico for leasehold interests in four
healthcare facilities with 461 beds in Ohio previously operated by another
company. In 1995, the Company also opened a newly constructed facility and
disposed of one additional facility.
Effective December 31, 1995, the Company determined to dispose of 13
facilities located in California as part of its strategic plan of diversifying
from California Medicaid. The results of operations of these facilities continue
to be reflected in the Company's financial statements until each disposition is
completed. During 1996 the Company disposed of six of these facilities. On
January 1, 1997 the Company disposed of one additional facility.
Effective February 1, 1996, the Company acquired 18 healthcare facilities
with 2,375 beds in Tennessee and North Carolina, accounted for under the
purchase method of accounting.
Effective April 1, 1996, the Company acquired a healthcare facility with 64
nursing beds and 22 assisted living beds located in Lexington, North Carolina,
accounted for under the purchase method of accounting.
Ancillary Businesses Operations
In July 1995, the Company acquired SCRS & Communicology, Inc. ("SCRS")
accounted for under the purchase method of accounting. SCRS provides
rehabilitation services to Company operated and third party healthcare
facilities in 12 states in the West, Midwest, and Southeast. From July to
December 1995, 79% of SCRS revenues were derived from providing services to non-
affiliated healthcare providers. Two non-affiliated healthcare providers
represented approximately 38% of SCRS total revenues from July to December 1995
and approximately 24% in 1996. In 1996, 70% of SCRS revenues were derived from
providing services to non-affiliated healthcare providers.
The Company's pharmacy operations provide prescription services and basic
pharmaceutical dispensing programs to Company and third party healthcare
facilities. During 1995, 55% of revenues from pharmacy operations were derived
from providing services to non-affiliated healthcare providers and patients at
Regency facilities billed directly to third-party payors. In January and
February of 1996, the Company acquired three additional pharmacy operations
accounted for under the purchase method of accounting. During 1996, 65% of the
revenues of pharmacy operations were derived from providing services to non-
affiliated healthcare providers and patients at Regency facilities billed
directly to third party payors.
The Company's home health operations provide skilled nursing, rehabilitation
and other services in selected areas in California and Ohio. The Company has
positioned its home healthcare capabilities to serve its facilities' home health
needs. During January 1997, two of the home healthcare agencies were
consolidated resulting in a reduction of one agency.
22
<PAGE>
Results of Operations
The following table sets forth the amounts of certain elements of net
operating revenue and the percentage of total net operating revenue for the
periods presented:
<TABLE>
<CAPTION>
Year ended December 31,
1996 1995 1994
---------------------- --------------------- ---------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Basic nursing care................. $285,819 51% $227,243 55% $216,623 58%
Subacute........................... 169,664 31 134,601 32 129,663 34
------------ -------- ----------- -------- ----------- --------
Total nursing center operations 455,483 82 361,844 87 346,286 92
Contract rehabilitation therapy
operations to non-affiliates (1). 42,577 8 12,240 3 -- --
Pharmacy operations to 21,994 4 7,157 2 4,697 1
non-affiliates (2)...............
Home healthcare operations......... 35,302 6 31,792 7 24,456 6
Interest........................... 2,694 -- 3,060 1 1,897 1
============ ======== =========== ======== =========== ========
Total......................... $558,050 100% $416,093 100% $377,336 100%
============ ======== =========== ======== =========== ========
</TABLE>
(1) Net of intercompany billings of $18,004,000 and $3,267,000 for the years
ended December 31, 1996 and 1995, respectively.
(2) Net of intercompany billings of $11,912,000, $5,971,000, and $5,107,000, for
the years ended December 31, 1996, 1995 and 1994, respectively.
The following table sets forth certain operating data for the Company for the
periods presented:
<TABLE>
<CAPTION>
Year ended December 31,
1996 1995 1994
--------- -------- ----------
<S> <C> <C> <C>
Patient Days by Payor:
Medicare........................... 307,313 244,729 239,003
Private/Other...................... 760,992 678,310 708,477
Managed Care....................... 116,508 94,072 72,065
Medicaid........................... 2,476,530 1,905,571 1,926,451
========= ========= ==========
Total........................... 3,661,343 2,922,682 2,945,996
========= ========= ==========
Home Health Visits.................... 253,855 260,526 217,662
Home Health Hours (1)................. 448,717 395,871 --
Revenue Mix:
Medicare........................... 29.3% 31.9% 31.3%
Private/Other...................... 25.0% 22.8% 21.4%
Managed Care....................... 5.1% 5.4% 4.6%
Medicaid........................... 40.6% 39.9% 42.7%
</TABLE>
(1) Information not compiled in 1994.
23
<PAGE>
The following table presents the percentage of net operating revenue
represented by certain items reflected in the Company's Consolidated Statements
of Operations for the periods indicated:
<TABLE>
<CAPTION>
For the year ended December 31,
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Net operating revenue.............................100.0% 100.0% 100.0%
------ ------ ------
Costs and expenses:
Operating expenses............................. 81.2 80.7 81.6
Corporate general and administrative........... 4.4 4.8 5.1
Rent expense................................... 4.5 4.0 4.1
Depreciation and amortization.................. 2.7 2.4 2.5
Interest expense............................... 3.2 2.3 2.1
Merger and restructuring expenses.............. -- -- 3.9
Class action lawsuit settlement................ -- 0.8 --
Restructuring and other non-recurring charges.. 2.0 2.2 0.4
------ ------ ------
Total costs and expenses....... 98.0 97.2 99.7
====== ====== ======
Income before provision for income taxes and
extraordinary item.......................... 2.0% 2.8% 0.3%
====== ====== ======
</TABLE>
Fiscal Year Comparison 1996 to 1995
Net Operating Revenue
The Company's net operating revenue for the fiscal year ended December 31,
1996 ("Fiscal 1996") was $558.1 million compared to $416.1 million for the
fiscal year ended December 31, 1995 ("Fiscal 1995"), an increase of $142.0
million or 34.1%.
Net operating revenue from nursing center operations increased $93.7 million
or 25.9% to $455.5 million from $361.8 million primarily due to revenues of
$78.8 million from the 1996 acquisition of 19 nursing facilities and an increase
in same store revenues (including the impact of sold buildings) of $14.9
million. The increase in same store revenues (excluding sold buildings) was
primarily due to an increase in patient days of 3.9% and an increase in average
rates per patient day of 5.7%, on a same store basis. The increase in
reimbursement rates per patient day of 5.7% was primarily due to providing
services to higher acuity patients, an increase in the Medi-Cal reimbursement
rates beginning in August 1996 and the Company recognizing revenues associated
with the elimination of the Medicare Routine Cost Limit (RCL) inflationary
freeze. The increase in services provided to higher acuity patients is
demonstrated by the shift in payor mix on a same store basis from Medicaid
(43.2% to 42.3%) and private and other (20.4% to 19.5%) to Medicare (30.1% to
31.1%) and managed care (6.2% to 7.0%). The Medi-Cal rate increases in August
1996 resulted in approximately $1.0 million in revenues. The revenue associated
with the elimination of the RCL inflationary freeze totaled $1.5 million.
Net operating revenue from contract rehabilitation therapy operations to non-
affiliates increased $30.3 million or 247.8% in 1996 over 1995 primarily due to
the operations of SCRS being included for the full year in 1996 versus a half
year in 1995 and an increase in the number of non-affiliated facilities served
to 114 in 1996 from 79 in 1995. Net operating revenue from pharmacy operations
to non-affiliates and services to patients in the Company's facilities billed
directly to third parties increased $14.8 million or 207.3% in 1996 over 1995,
primarily due to the acquisitions of Assist-A-Care pharmacy in January 1996 and
Executive Pharmacy in February 1996 (collectively, the "Pharmacy Acquisitions").
Net operating revenue from the pharmacy acquisitions was approximately $12.0
million in 1996. Net operating revenue from home healthcare operations grew $3.5
million or 11.0% in 1996 over 1995 primarily due to an increase in treatment
hours from 395,871 in 1995 to 448,717 in 1996 and an increase in revenue per
visit.
24
<PAGE>
Costs and Expenses
Total costs and expenses increased $142.7 million or 35.3% to $547.0 million
(98.0% of net operating revenue) in 1996 from $404.3 million (97.2% of net
operating revenue) in 1995.
Operating expenses as a percentage of net operating revenue increased from
80.7% in 1995 to 81.2% in 1996. The increase resulted from the incurrence of
increased labor costs in the nursing center operations while reimbursement rates
per patient day for room and board charges remained relatively flat for the
Medi-Cal and Medicare systems during the first and second quarters of 1996. In
addition, the home health agencies participating in the Medicare Prospective Pay
System pilot project beginning in 1996 did not adequately reduce costs at the
outset of this program in the first quarter of 1996. The Company made the
necessary cost reductions during the second and third quarters and realized the
benefits of the Medi-Cal rate increases and the elimination of the RCL freeze
discussed above in the third and fourth quarters. For the fourth quarter of
1996, operating costs as a percentage of revenue were 80.3%.
Corporate general and administrative expense is the corporate overhead and
regional costs related to the supervision of operations. The expense increased
from $19.8 million in 1995 to $24.3 million in 1996 due primarily to the
acquisition of 18 healthcare facilities effective February 1, 1996, the
acquisition of one healthcare facility effective April 1, 1996 and the Pharmacy
Acquisitions (collectively, the "1996 Acquisitions"). However, this expense
decreased as a percentage of revenue from 4.8% in 1995 to 4.4% in 1996. The
decrease as a percentage of revenue is attributed to achieving economies of
scale through acquisition, the reduction of certain corporate office expenses
and same store growth.
Rent expense as a percentage of revenue increased from 4.0% in 1995 to 4.5%
in 1996 primarily due to the assumption of lease obligations from the 1996
Acquisitions.
Depreciation and amortization expense as a percentage of net operating
revenue increased to 2.7% in 1996 from 2.4% in 1995 primarily due to goodwill
amortization related to the purchase of SCRS in July 1995 and the 1996
Acquisitions.
Interest expense increased as a percentage of net operating revenue to 3.2%
in 1996 from 2.3% in 1995 primarily due to the Company issuing the 9 7/8% Senior
Subordinated Notes (the "Senior Subordinated Notes") in October 1995 partially
offset by the repayment of the 8.1% Senior Secured Notes in that month, as well
as the issuance of the 12 (0)% Subordinated Notes in June 1996 partially offset
by the repayment of the 6 (OMEGA)% Convertible Subordinated Debentures in July
1996.
In Fiscal 1995, the Company settled its class action lawsuit resulting in a
pre-tax charge of $3.1 million ($1.9 million net of taxes).
As discussed above, the Company began the transition from development to the
implementation of its strategic plan to achieve lower operating costs and offer
an integrated delivery system during Fiscal 1996. Initiatives associated with
the restructuring include: making a significant investment in information
technology; integrating divisional operations within regional markets;
consolidating and automating the pharmacy operations; reducing the
administrative costs within the home healthcare operations; automating and
streamlining certain functions within the nursing operations; and streamlining
the corporate support structure. As a result of these initiatives, during the
fourth quarter of 1996 the Company recorded a restructuring charge of $6.6
million ($4.0 million after tax). The Company also recorded non-recurring
charges related to consulting fees owed for which there is no future benefit,
the establishment of additional reserves for certain notes and non-patient
receivables, the impairment of certain other long-term assets and a reduction
the assets held for sale reserve established in 1995 in an aggregate amount of
$4.7 million ($2.8 million after tax).
In Fiscal 1996, the Company recorded an extraordinary charge of $1.2 million,
net of tax, resulting from the redemption of all $48.9 million of the
outstanding Convertible Subordinated Debentures and the refinancing of the
25
<PAGE>
Industrial Revenue Bond Issues (IRBs). The redemption of the Convertible
Subordinated Debentures produced an extraordinary loss on extinguishment of debt
of $868,000, net of tax, resulting from the write off of unamortized
underwriting costs and the refinancing of the IRBs resulted in an extraordinary
loss on extinguishment of debt of $325,000 net of tax, resulting from the write
off of unamortized underwriting costs and a call premium paid. In Fiscal 1995,
the Company repaid its $30.0 million Senior Secured Notes, resulting in costs
and a prepayment penalty totaling $2.7 million ($1.6 million net of taxes),
classified as an extraordinary item.
Fiscal Year Comparison 1995 to 1994
Net Operating Revenue
The Company's net operating revenue for Fiscal 1995 was $416.1 million
compared to $377.3 million for the fiscal year ended December 31, 1994 ("Fiscal
1994"), an increase of $38.8 million or 10.3%.
Net operating revenue from nursing operations increased $15.6 million or 4.5%
due to increased levels of reimbursement and a shift in payor mix from Medicaid
to Medicare and managed care, partially offset by a slight decrease in total
patient days. The average increase in reimbursement rates for all payors was
5.3% and was primarily due to providing services to higher acuity patients. The
Company experienced a 0.8% net decrease in total patient days in Fiscal 1995
from Fiscal 1994, consisting of a decrease of 20,880 and 30,167 from Medicaid
and private and other sources, respectively, and an increase of 5,726 and 22,007
from Medicare and managed care, respectively.
Net operating revenue from home health operations grew $7.3 million or 30.0%
in Fiscal 1995 over Fiscal 1994, primarily reflecting additional patient visits.
Pharmacy operations revenues increased $2.5 million or 52.4% in Fiscal 1995 over
Fiscal 1994, primarily as a result of increased pharmacy services provided to
patients serviced in the Company's facilities and billed directly to the
appropriate payors and not the facility. Net operating revenue from contract
rehabilitation therapy operations are a result of the purchase of SCRS in July
1995.
Interest income increased $1.2 million in Fiscal 1995 over Fiscal 1994 due to
investment of proceeds from the issuance of the Senior Subordinated Notes in an
aggregate amount of $110.0 million in October 1995 .
Costs and Expenses
Total costs and expenses for Fiscal 1995 increased $28.2 million, or 7.5%, to
$404.3 million (97.2% of net operating revenue) from $376.1 million (99.7% of
net operating revenue) for Fiscal 1994. This decrease in total costs and
expenses as a percentage of revenues was primarily a result of the merger and
restructuring expenses incurred in Fiscal 1994, partially offset by the class
action lawsuit settlement and the additional disposition of assets charge
recorded in Fiscal 1995. Excluding these non-recurring expenses, total costs and
expenses increased to $392.2 million (94.3% of net operating revenue) in Fiscal
1995 from $359.9 million (95.4% of net operating revenue) in Fiscal 1994,
primarily as a result of providing more services to patients.
Operating expenses as a percentage of net operating revenue decreased to
80.7% for Fiscal 1995, from 81.6% for Fiscal 1994. This decline was primarily
attributable to growth in the Company's higher margin businesses such as
subacute care, contract rehabilitation therapy and pharmacy services in Fiscal
1995.
Corporate general and administrative expense increased $0.4 million, or 2.2%
from Fiscal 1994 to Fiscal 1995, while decreasing as a percentage of net
operating revenue to 4.8% for Fiscal 1995, from 5.1% for Fiscal 1994. The
decrease as a percentage of revenues was attributable to the Company's achieving
12 months of economies of scale in 1995 by eliminating duplicate costs after the
Merger in 1994.
26
<PAGE>
Interest expense as a percentage of net operating revenue increased to 2.3%
in Fiscal 1995 from 2.1% in Fiscal 1994, primarily as a result of the issuance
of the Senior Subordinated Notes in October 1995.
As a result of the Merger, in Fiscal 1994, the Company accrued $14.7 million
($10.6 million net of taxes) of estimated fees and expenses related to the
transaction as required under the pooling-of-interests accounting method. No
comparable fees and expenses were incurred during Fiscal 1995.
In Fiscal 1995, the Company settled its class action lawsuit resulting in a
pre-tax charge of $3.1 million ($1.9 million net of taxes).
In Fiscal 1995, the Company completed the disposition of previously
identified facilities and determined to dispose of an additional 13 nursing
facilities located in California, resulting in an additional pre-tax charge of
$9.0 million ($8.2 million net of taxes). In Fiscal 1994, the Company incurred a
loss of $1.6 million ($1.0 million net of taxes) resulting from closure of one
facility which was substantially damaged in the January 1994 Northridge,
California earthquake, and the abandonment of its leasehold interest.
In Fiscal 1995, the Company repaid its $30.0 million Senior Secured Notes,
resulting in costs and a prepayment penalty totaling $2.7 million ($1.6 million
net of taxes), classified as an extraordinary item.
Liquidity and Capital Resources
Working capital at December 31, 1996 decreased $50.0 million to $67.2 million
(including cash and cash equivalents of $22.9 million) from $117.2 million
(including cash and cash equivalents of $104.2 million) at December 31, 1995.
The decrease was primarily attributable to funding the 1996 Acquisitions
(including funding of working capital), funding of a workers' compensation trust
and the purchase of treasury stock. The Company established a revocable workers'
compensation claims payment trust to pre-fund its workers' compensation
obligations which was funded for Fiscal 1995 in March 1996 with approximately
$10.6 million from available cash. The Company anticipates funding an additional
$5 million to $6 million in March of 1997. During Fiscal 1996, the Company's
receivables increased approximately $29.7 million primarily related to the 1996
Acquisitions and growth in ancillary businesses. The estimated third party
settlements increased by $9.4 million partially due to recording revenue related
to RCL exceptions and the elimination of the RCL inflationary freeze. As of
December 31, 1996 and 1995, the Company had RCL exception request receivables
totaling $8.1 million and $4.5 million, respectively.
The Company's major requirements for liquidity relate to funding working
capital, capital improvements, and debt service obligations. The Company must
also provide funding to cover potential delays, temporary cessations or
interruption in payments by third-party payors due to political or budgetary
constraints. In addition, as part of its strategic plan, the Company anticipates
investing approximately $40 million in information technology over the next five
years. A significant portion of this investment will be financed through
operating leases. Management believes that these liquidity needs can be met from
available cash, internally generated funds and existing borrowing capacity under
the NationsBank credit agreement (discussed below).
The Company's healthcare facilities require capital improvements for
renovations and improvements in physical appearance. Future capital improvements
may be required as a result of routine regulatory inspections. In addition, the
Company is and will continue to invest in improving its information systems. The
Company's capital expenditures for the years ended December 31, 1996 and 1995
were approximately $12.6 million and $14.2 million, respectively. These capital
expenditures have been financed through a combination of internally generated
funds and debt. The Company expects to spend approximately an aggregate of $14.0
million for capital expenditures during 1997 to be financed through borrowings
under the NationsBank credit agreement (discussed below) and funds generated
from operations.
27
<PAGE>
The Company has financed its acquisitions from a combination of borrowings
and funds generated by operations. The Company expects to finance future
acquisitions from a combination of existing cash, the NationsBank credit
agreement (discussed below) and alternative sources such as real estate
investment trusts. Depending on the numbers, size and timing of any such
transactions, the Company may in the future require additional financing in
order to continue to make acquisitions.
During 1996, the Company purchased 862,000 shares of Company common stock at
an average price of $9.56 per share. The transactions, accounted for using the
cost method, reduced stockholders' equity by $8.3 million.
On June 28, 1996 the Company issued 12(0)% Junior Subordinated Notes ("Junior
Subordinated Notes") in an aggregate amount of $50 million. Interest on the
Notes will be payable semi-annually on January 15 and July 15 of each year,
commencing January 15, 1997. The Junior Subordinated Notes will mature on July
15, 2003, unless previously redeemed. Net proceeds received by the Company
totaled approximately $48.4 million and funded the redemption of the Company's
outstanding 6(OMEGA)% Convertible Subordinated Debentures due 2003 on July 29,
1996 (see Note 3 to the Consolidated Financial Statements).
Effective September 30, 1996, the Company refinanced three of its Industrial
Revenue Bond Issues (IRBs) with an aggregate outstanding principal balance of
$7,560,000 with three new issues of tax exempt IRBs maturing through September
2012. One of the new issues bears interest at rates ranging from 4.2% to 6.0%
based on the maturity dates of the individual bonds. The other two IRBs bear
interest at a variable rate initially set at 4.0%, which is capped at 12.0% (see
Note 3 to the Consolidated Financial Statements). The IRBs are now secured by
irrevocable letters of credit rather than mortgages on the specific facilities.
In Fiscal 1996, the Company recorded an extraordinary charge of $1.2 million
resulting from the redemption of all $48.9 million of the outstanding
Convertible Subordinated Debentures and the refinancing of the IRBs. The
redemption of the Convertible Subordinated Debentures produced an extraordinary
loss on extinguishment of debt of $868,000, net of tax, resulting from the write
off of unamortized underwriting costs and the refinancing of the IRBs resulted
in an extraordinary loss on extinguishment of debt of $325,000 net of tax,
resulting from the write off of unamortized underwriting costs and a call
premium paid.
On December 28, 1995 the Company entered into a revolving credit loan
agreement ("Credit Agreement") with NationsBank of Texas, N.A. as agent for a
group of banks, which provided up to $50 million in a revolving line of credit
and letters of credit. No borrowings were drawn on the Credit Agreement at
December 31, 1995 and throughout 1996. On December 20, 1996, the Company
increased the available financing to $100 million and revised certain terms and
covenants through the Amended and Restated Credit Agreement ("Amended Credit
Agreement"). Borrowings bear interest at either the Base Rate plus up to .50% or
the Adjusted Eurodollar Rate plus .75% to 2.00%, depending on the Company's
Consolidated Adjusted Leverage Ratio, all as defined in the Amended Credit
Agreement. The Amended Credit Agreement has scheduled commitment reductions of
$25 million each on January 2, 1999 and 2000 and expires on January 2, 2001. The
Amended Credit Agreement is collateralized by accounts receivable, all of the
common stock of each of the Company's subsidiaries and certain other current
assets of the Company and its subsidiaries. The Amended Credit Agreement, among
other things, (a) requires the Company to maintain certain financial ratios, and
(b) restricts the Company's ability to incur debt and liens, make investments,
pay dividends, purchase treasury stock, prepay or modify certain debt of the
Company, liquidate or dispose of assets, merge with another corporation, and
create or acquire subsidiaries. As of December 31, 1996, $16.2 million of
standby letters of credit were issued in connection with the Company's self-
insured workers' compensation programs and refinanced Industrial Revenue Bonds
(discussed above) out of a total available of $35 million. On January 2, 1997
the Company borrowed $40 million under the Amended Credit Agreement principally
to fund the acquisition of four acute rehabilitation hospitals, ten outpatient
rehabilitation clinics and six neurological treatment centers for $36.3 million
in cash and notes payable totaling $6.7 million.
28
<PAGE>
In October 1995, the Company issued the Subordinated Notes in an aggregate
amount of $110 million. Interest on the Subordinated Notes will be payable semi-
annually commencing April 15, 1996. The Subordinated Notes mature on October 15,
2002, unless previously redeemed. The net proceeds to the Company were
approximately $106.7 million, of which approximately $31.5 million were used to
repay the principal and prepayment penalty on the 8.1% Senior Secured Notes and
$47.4 million was used for acquisitions subsequent to December 31, 1995 (see
Notes 3 and 13 to the Company's Consolidated Financial Statements).
Seasonality
The Company's income from operations before fixed charges generally
fluctuates from quarter to quarter. The fluctuation is related to several
factors: the timing of Medicaid rate increases, seasonal census cycles, and the
number of calendar days in a given quarter. As a result, the Company's income
from operations before fixed charges tends to be higher in its third and fourth
quarters when compared to the first and second quarters.
Impact of Inflation
The healthcare industry is labor intensive. Wages and other labor costs are
especially sensitive to inflation. Increases in wages and other labor costs as a
result of inflation, or increases in federal or state minimum wages without a
corresponding increase in Medicare and Medicaid reimbursement rates, could
adversely impact the Company.
Reimbursement
The majority of the Company's net operating revenue is derived from services
provided under the Medicare and Medicaid programs. Numerous proposals relating
to healthcare reform have been or may be introduced in the United States
Congress, state legislatures or by governmental agencies who regulate the
Medicare and Medicaid programs. It is uncertain what reform will ultimately be
enacted by the federal government, any state government or governmental agencies
and therefore, the Company cannot predict at this time the impact on the Company
of any proposed reforms.
As discussed above, the Company provides contract rehabilitation and pharmacy
services to both Regency operated and non-affiliated facilities. Under current
Medicare regulations, reimbursement for these services provided to Medicare
eligible patients in Regency facilities is based upon the related entity's cost
to provide the services unless a significant portion of the related entity's
revenues are derived from non-affiliated facilities. If a significant portion of
the related entity's revenues are derived from non-affiliated facilities,
Medicare will reimburse the facility's cost, which includes a profit paid to the
related entity. During 1995 and prior years, the Company was reimbursed by
Medicare based on its pharmacy operation costs on billings to Regency
facilities, as it did not meet the significant portion criteria. After the
acquisition of Assist-A-Care Pharmacy and Executive Pharmacy in 1996, the
Company believes it meets the significant portion criteria and is recording a
profit on billings for pharmacy services provided to Medicare eligible patients
in Regency facilities. The Company believes it meets the significant portion
criteria for its contract rehabilitation therapy operations provided by SCRS,
and therefore has recorded a profit on billings to Regency facilities since the
acquisition of SCRS. Medicare regulations do not define a "significant portion,"
therefore, the Company's and Medicare's interpretations could differ, which
could result in retroactive adjustments related to the profit on billings to
Regency facilities for pharmacy and contract rehabilitation services.
In the federal budget deficit reduction bill, various reimbursement rules and
regulations were adopted by the federal government that pertain to the Company.
The changes to regulations promulgated under OBRA, some of which expand the
remedies available to enforce regulations mandating minimum healthcare
standards, may have an adverse effect on the Company's operations. The Company
is unable to predict the particular effect on the Company until the manner in
which these regulations are implemented becomes known.
29
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements and Supplementary Data
Report of Independent Public Accountants.............................. 31
Consolidated Balance Sheets as of December 31, 1996 and 1995.......... 32
Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1995 and 1994................................... 34
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1996, 1995 and 1994................................... 35
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995 and 1994................................... 36
Notes to Consolidated Financial Statements............................ 38
30
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Regency Health Services, Inc.:
We have audited the accompanying consolidated balance sheets of REGENCY
HEALTH SERVICES, INC. (a Delaware corporation) and subsidiaries as of December
31, 1996 and 1995 and the related consolidated statements of operations,
stockholders' equity and cash flows for the three years in the period ended
December 31, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Regency Health Services, Inc.
and subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index of
financial statements is presented for purposes of complying with the Securities
and Exchange Commission's rules and is not a required part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in our audits of the basic financial statements and, in our
opinion, fairly states in all material respects, the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
Orange County, California
February 14, 1997 ARTHUR ANDERSEN LLP
31
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS
<TABLE>
<CAPTION>
December 31,
1996 1995
---- ----
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents........................................... $ 22,875 $104,238
Restricted cash..................................................... 4,425 --
Accounts receivable, net of allowances of $4,723 and $3,757 at
December 31, 1996 and 1995, respectively.......................... 80,949 51,203
Estimated third party settlements................................... 10,180 800
Notes and other receivables......................................... 1,355 2,182
Deferred income taxes............................................... 6,898 5,447
Assets held for sale................................................ 6,915 8,970
Other current assets................................................ 7,819 6,396
--------- ---------
Total current assets........................................ 141,416 179,236
--------- ---------
PROPERTY AND EQUIPMENT:
Land................................................................ 21,207 21,249
Buildings and improvements.......................................... 100,120 96,396
Leasehold interests - other......................................... 17,640 17,556
Leasehold interests - related party................................. 1,989 2,075
Equipment........................................................... 38,054 24,610
--------- ---------
179,010 161,886
Less accumulated depreciation and amortization...................... (43,938) (34,679)
--------- ---------
Total property and equipment................................ 135,072 127,207
--------- ---------
OTHER ASSETS:
Mortgage notes receivable, net of allowances of $1,352 and $951 at
December 31, 1996 and 1995, respectively......................... 1,014 5,163
Goodwill, net of accumulated amortization of $3,700 and $563 at
December 31, 1996 and 1995, respectively......................... 53,753 13,621
Other assets, net of accumulated amortization of $3,736 and $2,206
at December 31, 1996 and 1995, respectively...................... 22,321 13,715
--------- ---------
Total other assets.......................................... 77,088 32,499
========= =========
$353,576 $338,942
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
32
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED BALANCE SHEETS (Continued)
(In thousands, except par value)
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
December 31,
1996 1995
---- ----
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt................................... $ 2,418 $ 4,371
Accounts payable.................................................... 24,958 22,285
Accrued expenses.................................................... 8,290 5,946
Accrued compensation................................................ 26,253 18,051
Accrued workers' compensation....................................... 4,338 5,377
Deferred revenue.................................................... 2,407 1,743
Accrued interest.................................................... 5,578 4,231
--------- ---------
Total current liabilities................................... 74,242 62,004
LONG-TERM DEBT, NET OF CURRENT PORTION................................. 182,490 179,615
OTHER LIABILITIES AND NONCURRENT RESERVES.............................. 10,878 8,988
DEFERRED INCOME TAXES.................................................. 5,018 7,946
--------- ---------
Total liabilities........................................... 272,628 258,553
--------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; authorized - 35,000 shares;
15,919 and 16,670 shares issued and outstanding at December 31,
1996 and 1995, respectively, net of 862 shares held in treasury
in 1996.......................................................... 168 167
Additional paid-in capital.......................................... 52,031 56,679
Retained earnings................................................... 28,749 23,543
--------- ---------
Total stockholders' equity.................................. 80,948 80,389
========= =========
$353,576 $338,942
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
33
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
NET OPERATING REVENUE..................................... $558,050 $416,093 $377,336
------------ ------------- ------------
COSTS AND EXPENSES:
Operating expenses..................................... 453,131 335,849 307,807
Corporate general and administrative................... 24,292 19,811 19,392
Rent expense........................................... 24,956 16,767 15,555
Depreciation and amortization.......................... 15,317 10,122 9,295
Interest expense....................................... 18,060 9,676 7,844
Merger and restructuring expenses...................... -- -- 14,650
Class action lawsuit settlement........................ -- 3,098 --
Restructuring and other non-recurring charges.......... 11,283 9,000 1,600
------------ ------------ -----------
Total costs and expenses............................ 547,039 404,323 376,143
------------ ------------ -----------
INCOME BEFORE PROVISION FOR INCOME TAXES AND EXTRAORDINARY
ITEM................................................... 11,011 11,770 1,193
PROVISION FOR INCOME TAXES................................ 4,612 7,316 1,993
----------- ----------- ----------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM 6,399 4,454 (800)
EXTRAORDINARY ITEM - Loss on extinguishment of debt, net of
applicable income taxes of $812 and $1,072 in 1996 and
1995, respectively..................................... (1,193) (1,609) --
----------- ----------- ----------
NET INCOME (LOSS)......................................... $ 5,206 $ 2,845 $ (800)
=========== =========== ==========
INCOME (LOSS) PER SHARE:
Income (loss) before extraordinary item................... $ .39 $ .27 $ (.05)
Extraordinary item........................................ (.07) (.10) --
------------ ------------ -----------
Net income (loss) per share............................... $ .32 $ .17 $ (.05)
============ ============ ===========
Weighted average shares of common stock and equivalents... 16,476 16,654 16,545
============ ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
34
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Additional
Common Stock Paid-In Retained
Shares Amount Capital Earnings Total
------ ------ -------- -------- -----
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1993................. 16,220 $162 $45,355 $21,498 $67,015
Exercise of stock options............... 95 1 475 -- 476
Conversion of Convertible Subordinated
Debentures........................... 87 1 1,031 -- 1,032
Charge in lieu of income taxes (1994)... -- -- 2,636 -- 2,636
Retroactive charge in lieu of income
taxes (1993)......................... -- -- 2,608 -- 2,608
Net loss................................ -- -- -- (800) (800)
------- ----- -------- -------- --------
BALANCE, December 31, 1994................. 16,402 164 52,105 20,698 72,967
Exercise of stock options............... 211 2 1,254 -- 1,256
Exercise of share appreciation rights... 55 1 614 -- 615
Conversion of Convertible Subordinated
Debentures........................... 2 -- 20 -- 20
Charge in lieu of income taxes.......... -- -- 2,686 -- 2,686
Net income.............................. -- -- -- 2,845 2,845
------- ----- -------- -------- --------
BALANCE, December 31, 1995................. 16,670 167 56,679 23,543 80,389
Exercise of stock options.............. 99 1 680 -- 681
Restricted Stock Distribution........... 12 -- 144 -- 144
Charge in lieu of income taxes.......... -- -- 2,814 -- 2,814
Repurchase of common stock ............. (862) -- (8,286) -- (8,286)
Net income ............................. -- -- -- 5,206 5,206
------- ----- -------- -------- --------
BALANCE, December 31, 1996................. 15,919 $168 $52,031 $28,749 $80,948
======= ===== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
35
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).......................................... $ 5,206 $ 2,845 $ (800)
----------- ------------ -----------
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Extraordinary loss on extinguishment of debt............ 2,005 2,681 --
Depreciation and amortization........................... 15,317 10,122 9,295
Deferred income taxes and charge in lieu of taxes....... (1,317) 4,506 408
Restructuring and other non-recurring charges........... 9,749 9,000 6,052
Other, net.............................................. 122 649 (94)
Change in cash from changes in assets and liabilities,
excluding effects of acquisitions and dispositions:
Accounts receivable................................... (28,537) 1,481 (4,640)
Estimated third party settlements..................... (9,380) (3,569) 1,645
Other current assets.................................. (270) 6,748 (1,582)
Current and other liabilities......................... 11,308 (4,003) 814
----------- ------------ -----------
Net cash provided by operating activities............. 4,203 30,460 11,098
----------- ------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions............................................... (50,800) (13,225) --
Proceeds from disposition of facilities.................... 3,682 -- 2,239
Purchases of property and equipment........................ (12,575) (14,223) (12,576)
Collection on mortgage notes receivable.................... 695 349 410
Changes in other assets, net............................... (1,623) (1,278) (2,585)
----------- ------------ -----------
Net cash used in investing activities................. (60,621) (28,377) (12,512)
----------- ------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term debt................................. (62,598) (31,940) (2,705)
Proceeds from issuance of long-term debt................... 56,143 107,162 2,996
Workers compensation trust funding......................... (10,637) -- --
Purchase of treasury stock................................. (8,286) -- --
Proceeds from exercise of options.......................... 433 1,256 476
----------- ------------ -----------
Net cash provided by (used in) financing activities... (24,945) 76,478 767
----------- ------------ -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.......... (81,363) 78,561 (647)
CASH AND CASH EQUIVALENTS, beginning of period................ 104,238 25,677 26,324
----------- ------------ -----------
CASH AND CASH EQUIVALENTS, end of period...................... $ 22,875 $104,238 $25,677
=========== ============ ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest..................... $ 16,713 $ 8,334 $ 6,788
=========== ============ ===========
Cash paid during the year for income taxes................. $ 3,750 $ 2,152 $ 2,651
=========== ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
36
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the year ended December 31, 1996:
The Company acquired Assist-A-Care Pharmacy in San Diego,
California and issued a promissory note in the amount of $2.6
million as part of the purchase price.
The Company issued a promissory note in the amount of $2.2 million
in connection with the acquisition of 18 healthcare facilities in
Tennessee and North Carolina.
The Company acquired Executive Pharmacy and issued a promissory
note in the amount of $763,000.
During the year ended December 31, 1995:
$20,000 of the Company's Convertible Subordinated Debentures were
converted into 1,616 shares of common stock.
The Company issued a promissory note of $3,400,000 in connection
with the acquisition of SCRS and Communicology, Inc.
During the year ended December 31, 1994:
$1,076,000 of the Company's Convertible Subordinated Debentures
were converted into 86,946 shares of common stock. Unamortized
debenture fees of $44,000 were offset against additional paid-in
capital.
The accompanying notes are an integral part of these consolidated statements.
37
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. MERGER AND BASIS OF PRESENTATION
On April 4, 1994, Regency Health Services, Inc. ("Regency" or the
"Company") and Care Enterprises, Inc. ("Care") completed the merger (the
"Merger"). Pursuant to the Agreement and Plan of Merger, dated as of December
20, 1993, as amended, Care Merger Sub, Inc., a wholly owned subsidiary of
Regency, was merged with and into Care, and Care became a wholly owned
subsidiary of Regency. Each share of common stock of Care was converted into
0.71 of a share of common stock of Regency. Approximately 9,400,000 shares of
common stock were issued in this transaction. At the time of the Merger, Regency
operated 43 healthcare facilities with 4,215 licensed beds and Care operated 51
healthcare facilities with 5,040 licensed beds.
The Merger qualified as a pooling-of-interests transaction under
generally accepted accounting principles. The pooling-of-interests method of
accounting is intended to present as a single interest two or more common
stockholder interests that were previously independent. The pooling-of-interests
method of accounting assumes that the combining companies have been merged from
inception. Consequently, the historical financial statements for periods prior
to the consummation of the combination are restated as though the companies had
been merged since inception. The calculation of income per share for 1994
presented reflects the issuance of .71 of a share of Regency Common Stock for
each share of common and common equivalent share of Care Common Stock. The
restated financial statements are adjusted to conform the accounting policies of
the separate companies.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business As of December 31, 1996, the Company operated 107
healthcare facilities with 11,200 licensed beds that provide nursing,
rehabilitative, subacute and other specialized medical services primarily in
California and in Ohio, West Virginia, North Carolina and Tennessee. Through its
wholly owned home health subsidiaries, the Company provides patients with
technical medical support at home such as infusion therapy, ventilator care and
respite services. The Company also provides ancillary services such as
rehabilitation programs and pharmaceutical services at certain of its healthcare
facilities as well as at non-affiliated facilities.
Principles of Consolidation The consolidated financial statements
include the accounts of the Company and all of its wholly owned subsidiaries.
All significant intercompany accounts and transactions have been eliminated.
Cash and Cash Equivalents For financial reporting purposes, the Company
considers all highly liquid instruments purchased with a maturity of three
months or less to be cash equivalents.
At December 31, 1996 and 1995, the Company held personal funds in trust
for patients approximating $1,505,000 and $690,000, respectively, which are not
reflected on the accompanying balance sheets.
Restricted Cash Restricted cash of $4,425,000 at December 31, 1996
represents the portion of the cash in the Company's pre-funded workers'
compensation claims payment trust expected to be paid during 1997.
Accounts Receivable Accounts receivable are recorded at the net
38
<PAGE>
realizable value expected to be received from federal and state assistance
programs or from private sources including managed care organizations and third
party insurers. Receivables from government agencies represent the only
concentrated group of credit risk for the Company. Management does not believe
that there are any credit risks associated with these government agencies other
than possible funding delays. Non-government agency receivables consist of
receivables from various payors that are subject to differing economic
conditions and do not represent any concentrated credit risks to the Company.
Furthermore, management continually monitors and adjusts its reserves and
allowances associated with these receivables.
Property and Equipment At the time of Care's emergence from bankruptcy
on December 31, 1990, property and equipment owned by Care and certain leasehold
interests were adjusted to current fair market value. All other property and
equipment is recorded at cost. The assets are depreciated over their estimated
useful lives using the straight-line method as follows:
Buildings and improvements....................................... 7-40 years
Leasehold interests and improvements............................. Life of leases
Equipment........................................................ 5-10 years
Betterments, renewals, and extraordinary repairs that extend the life
of the asset are capitalized; other repairs and maintenance are expensed. The
cost and accumulated depreciation applicable to assets retired are removed from
the accounts and any gain or loss on disposition is recognized in income.
Assets Held for Sale During 1995, the Company adopted Statement of
Financial Accounting Standards ("SFAS") No. 121 "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The adoption
of SFAS No. 121 did not have a material effect on the Company's financial
statements. At December 31, 1995, assets held for sale represents the assets of
13 facilities which the Company determined to dispose of in 1995. At December
31, 1996, it represents the assets of the seven remaining facilities which the
Company intends to dispose of during 1997 (see Note 14). Such amounts are
carried at estimated fair value less selling costs.
Goodwill The excess of the purchase price over the value of the net
assets of the businesses acquired by the Company is amortized using the
straight-line method over periods ranging from 15 to 22 years. The Company
periodically evaluates the carrying value of goodwill in relation to the
operating performance and future undiscounted cash flows of the underlying
business to assess recoverability. Adjustments are made if the sum of expected
future net cash flows is less than book value of goodwill and other depreciable
or amortizable assets.
Asset Impairment The carrying values of long-lived 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.
Other Long-Term Assets Costs incurred to obtain long-term financing are
amortized using the effective interest method. Costs to initiate and implement
subacute specialty units are amortized on a straight-line basis over 36 months.
Deferred Revenue Deferred revenue consists of patient billings recorded
in advance of services rendered.
Workers' Compensation The Company maintains self-insurance programs for
workers' compensation for its nursing facilities in California and Ohio,
pharmacy operations, home health operations and its corporate office employees.
For all other operations, the Company purchases insurance for this risk. The
self-insurance liability under these programs is based on claims filed and
actuarial estimates of claims incurred but not reported. Differences between the
amounts accrued and subsequent settlements are recorded in operations in the
year of settlement.
39
<PAGE>
Net Operating Revenue Revenues are derived from the operation of
healthcare facilities, which are subject to federal and state regulation.
Approximately 69.9%, 71.8%, and 74.0%, percent of revenues were derived from
services provided under federal (Medicare) and state (Medicaid) medical
assistance programs for the years ended December 31, 1996, 1995 and 1994,
respectively. Revenues from Medicaid are recorded at the prescribed contract
rate. Revenues from Medicare are recorded based on an estimate of the Company's
reimbursable cost. Limitations on Medicare and Medicaid reimbursement for
healthcare services are continually proposed. Changes in applicable laws and
regulations could have an adverse effect on the levels of reimbursement from
governmental, private, and other sources. These revenues are based, in part, on
cost reimbursement principles and are subject to audit. Provisions for estimated
third-party payor settlements are provided in the period the related services
are rendered. Differences between the amounts accrued and subsequent settlements
are recorded in operations in the year of settlement.
Additionally, the Company's cost of care for its Medicare patients
sometimes exceeds regional reimbursement limits established by Medicare. The
Company has submitted exception requests for 156 cost reports, covering all cost
report periods through December 31, 1994. To date, final action has been taken
by the Health Care Financing Administration ("HCFA") on 105 exception requests.
The Company's final rates as approved by HCFA represent approximately 84% of the
requested rates as submitted in the exception requests. During 1994, the Company
recognized 50% of the 1994 estimated exception requests anticipated to be
received, which represented revenues of approximately $1,550,000. Commencing
January 1, 1995, the Company recognized 70% of the estimated exception requests
anticipated to be received, which represents revenues of approximately
$3,563,000 and $3,001,000 in 1996 and 1995, respectively. Management believes
that the Company will be able to recover its excess costs under any pending
exception requests or under any exception requests that may be submitted in the
future, however there can be no assurance that it will be able to do so.
Stock Based Compensation. Effective January 1, 1996, the Company
adopted the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation." SFAS No. 123 requires the Company to disclose proforma net income
and earnings per share as if the fair value based accounting method of SFAS No.
123 had been used to account for stock based compensation. These disclosures are
included in Note 9.
Use of Estimates The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Corporate General and Administrative Expenses During 1995, the Company
changed its classification of general and administrative expenses. Previously,
the Company classified all corporate overhead, regional costs related to the
supervision of operations, the administrative costs at the Company's facilities,
pharmacies, and home care operations as administrative and general expenses. The
Company now classifies corporate overhead and the regional costs related to the
supervision of operations as corporate general and administrative expenses. All
other costs which relate to the daily operations have been classified as
operating expenses for the periods presented. These costs in 1994 have been
reclassified to conform to the 1996 and 1995 presentation.
Financial Statement Presentation Estimated third party settlements
classified in accounts receivable, other assets and other liabilities and non-
current reserves in the 1995 financial statements have been reclassified to
estimated third party settlements in current assets to conform to the 1996
presentation. Certain other amounts have been reclassified in the 1995 and 1994
financial statements to conform to the 1996 presentation.
40
<PAGE>
3. LONG-TERM DEBT
Long-term debt consists of the following (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
1996 1995
---- ----
<S> <C> <C>
Senior Subordinated Notes, interest at 9.875 percent, due October 2002. Interest
is payable semi-annually on October 15 and April 15, commencing
April 15, 1996; redeemable beginning October 15, 1999.................... $110,000 $110,000
Junior Subordinated Notes, interest at 12.25 percent, due July 2003, interest
payable semi-annually on January 15 and July 15, commencing January 1997;
redeemable beginning July 15, 2000....................................... 50,000 --
Industrial revenue bonds ("IRBs"), interest at rates from 4.0 to 8.25
percent, due through September 2012 in varying amounts................... 9,675 9,800
Note payable, collateralized by a deed of trust, interest at 8.75 percent;
interest and principal payable monthly through September 2033............ 4,697 4,714
Note payable, secured, interest at 9.0 percent, interest and principal
payable monthly, balance due November 2013............................... 4,276 4,308
Convertible Subordinated Debentures, interest at 6.5 percent, due March 2003,
redeemed in 1996......................................................... -- 48,904
Note payable, interest at 6.0 percent. Interest payable quarterly commencing
October 1, 1995; fully repaid in 1996.................................... -- 3,400
Other unsecured indebtedness, interest rates up to 13.0 percent, payable in
varying installments through August 2017................................. 646 1,014
Other secured long-term debt, interest rates up to 10.25 percent, payable in
varying installments through August 2014................................. 5,614 1,846
------------ -------------
184,908 183,986
Less current portion........................................................ 2,418 4,371
------------ -------------
$182,490 $179,615
============ =============
</TABLE>
On June 28, 1996, the Company issued 12.25% Junior Subordinated Notes
(the "Junior Subordinated Notes") in an aggregate amount of $50 million. The
Junior Subordinated Notes will mature on July 15, 2003, unless previously
redeemed. Net proceeds received by the Company totaled approximately $48.4
million and funded the redemption of the Company's outstanding 6.5% Convertible
Subordinated Debentures due 2003 (the "Convertible Subordinated Debentures") on
July 29, 1996. The Junior Subordinated Notes contain certain covenants, which
are similar to the 9.875% Senior Subordinated Notes ("Subordinated Notes"),
including limitations on the ability of the Company to, among other things, (a)
incur additional indebtedness and issue redeemable preferred stock, (b) sell
equity interests in subsidiaries, (c) make certain restricted payments (as
defined), (d) create liens, and (e) engage in mergers, consolidations or
transfers of substantially all of the assets of the Company to another party.
Effective September 30, 1996, the Company refinanced three of its
Industrial Revenue Bond Issues (IRBs) with an aggregate outstanding principal
balance of $7,560,000 with three new issues of tax exempt IRBs maturing through
September 2012. One of the new issues has a principal balance of $2,830,000 and
bears interest at rates ranging from 4.2% to 6.0% based on the maturity dates of
the individual bonds. The other two IRBs bear interest at a variable rate
initially set at 4.0% which is capped at 12.0%. The refinancing resulted in an
extraordinary loss on extinguishment of debt of $325,000, net of tax resulting
from the write-off of unamortized underwriting costs and payment of a call
premium. The IRBs are secured by irrevocable standby letters of credit issued
against the Company's Amended Credit Agreement.
On December 28, 1995 the Company entered into a revolving credit loan
agreement ("Credit Agreement") with NationsBank of Texas, N.A. as agent for a
group of banks, which provided up to $50 million in a revolving line of credit
and letters of credit. No borrowings were drawn on the Credit Agreement at
41
<PAGE>
December 31, 1995 and throughout 1996. On December 20, 1996, the Company
increased the available financing to $100 million and revised certain terms and
covenants through the Amended and Restated Credit Agreement ("Amended Credit
Agreement"). Borrowings bear interest at either the Base Rate plus up to .50% or
the Adjusted Eurodollar Rate plus .75% to 2.00%, depending on the Company's
Consolidated Adjusted Leverage Ratio, all as defined in the Amended Credit
Agreement. The Amended Credit Agreement has scheduled commitment reductions of
$25 million each on January 2, 1999 and 2000 and expires on January 2, 2001. The
Amended Credit Agreement is collateralized by accounts receivable, all of the
common stock of each of the Company's subsidiaries and certain other current
assets of the Company and its subsidiaries. The Amended Credit Agreement, among
other things, (a) requires the Company to maintain certain financial ratios, and
(b) restricts the Company's ability to incur debt and liens, make investments,
pay dividends, purchase treasury stock, prepay or modify certain debt of the
Company, liquidate or dispose of assets, merge with another corporation, and
create or acquire subsidiaries. As of December 31, 1996, $16.2 million of
standby letters of credit were issued in connection with the Company's self-
insured workers' compensation programs and refinanced Industrial Revenue Bonds
(discussed above) out of a total available of $35 million. On January 2, 1997
the Company borrowed $40 million under the Amended Credit Agreement.
On October 12, 1995, the Company issued Subordinated Notes in an
aggregate amount of $110 million. Net proceeds received by the Company totaled
approximately $106.7 million of which approximately $31.5 million was used to
repay the principal and a prepayment penalty on the Company's 8.10% Senior
Secured Notes (which resulted in a loss on extinguishment of debt of
approximately $1.6 million, net of tax) and $47.4 million was used for
acquisitions in 1996 (see Note 13). The Subordinated Notes contain certain
covenants, including limitations on the ability of the Company to, among other
things, (a) incur additional indebtedness and issue preferred stock, (b) sell
equity interests in subsidiaries, (c) make certain restricted payments (as
defined), (d) create liens, and (e) engage in mergers, consolidations or the
transfer of substantially all of the assets of the Company to another party.
In March 1993, the Company issued $50,000,000 aggregate principal
amount of its Convertible Subordinated Debentures resulting in net proceeds to
the Company of approximately $47,800,000. During the years ended December 31,
1995 and 1994, $20,000 and $1,076,000 of the Convertible Subordinated Debentures
were converted into 1,616 and 86,946 shares of common stock, respectively. On
July 29, 1996, the Company completed the redemption of all $48.9 million of its
outstanding Convertible Subordinated Debentures for cash at such amount from the
proceeds of the Junior Subordinated Notes and available cash. The redemption
reduces fully diluted shares by 3.9 million and produces an extraordinary loss
on extinguishment of debt of $868,000, net of tax, resulting from the write-off
of unamortized underwriting costs.
Each of the mortgage notes and certain IRBs are secured by a first deed
of trust on the related facility. Certain IRBs require the maintenance of debt
service reserve funds and all of the IRBs contain affirmative and negative
covenants.
Principal maturities on long-term debt are as follows (in thousands):
<TABLE>
<CAPTION>
Year Ending December 31,
<S> <C>
1997................................................................ $ 2,418
1998................................................................ 3,079
1999................................................................ 497
2000................................................................ 505
2001................................................................ 802
Thereafter.......................................................... 177,607
----------
Total............................................................... $184,908
==========
</TABLE>
42
<PAGE>
4. INCOME TAXES
The Company and its subsidiaries file consolidated federal and state
income tax returns and account for income taxes under the provisions of SFAS No.
109.
As a result of the Care bankruptcy proceedings, a "change in ownership"
occurred. Prior to the Merger, the Company had substantial net operating loss
carryforwards for tax purposes ("Tax NOL") and income tax credit carryforwards.
In March 1994, the Internal Revenue Service ("IRS") issued final regulations
relative to Tax NOL utilization when a "change in ownership" occurs in
bankruptcy proceedings. These regulations reduced the aggregate Tax NOL
available to the Company but did not limit its annual use.
As a result of the Merger, another "change in ownership" occurred and
the Company's Tax NOL and credit carryforward utilization became subject to a
combined annual limitation of approximately $7.9 million (on a pre-tax basis) in
periods after the Merger.
After considering the adjustments resulting from the IRS examination
for the years 1987 through 1990, the Company has a federal Tax NOL of $2,929,000
and income tax credit carryforwards of $5,503,000 available for use at December
31, 1996. As a result of Fresh Start Reporting, the tax benefits realized from
the pre-bankruptcy Tax NOL and income tax credit carryforwards are recorded as
an increase in additional paid-in capital and are not recorded in the statement
of operations.
The provision for income taxes is as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Current provision:
Federal........................... $4,950 $ 722 $ 597
State............................. 1,315 1,016 988
--------- -------- ----------
6,265 1,738 1,585
Deferred provision:
Federal........................... (3,797) 2,459 (1,971)
State............................. (670) 433 (257)
--------- -------- ----------
(4,467) 2,892 (2,228)
Charge in lieu of income taxes....... 2,814 2,686 2,636
========= ======== ==========
$4,612 $7,316 $ 1,993
========= ======== ==========
</TABLE>
A reconciliation of the federal statutory income tax rate with the
Company's effective tax rate follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Federal statutory rate...................... 34.0% 34.0% 34.0%
State income taxes, net of federal benefit.. 6.0 6.0 6.0
Disposition of assets charges............... -- 19.6 --
Other non-deductible items.................. -- -- 21.4
Non-deductible merger related expenses...... -- -- 101.4
Goodwill amortization....................... 3.1 1.7 4.4
Other, net.................................. (1.2) 0.8 --
====== ===== =====
41.9% 62.1% 167.2%
===== ===== ======
</TABLE>
43
<PAGE>
Deferred income taxes arise from temporary differences in the
recognition of certain expenses for financial and tax reporting purposes. The
following is a summary of these differences and the tax effect of each (in
thousands):
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Deferred income tax assets:
Allowance for doubtful accounts................. $ 1,057 $ 1,054
Net operating loss carryforward................. 996 3,789
Loss contingencies and legal settlements........ 416 734
Workers' compensation claims.................... 5,370 4,827
Covenant not to compete......................... 901 --
Disposition of assets charges................... 4,166 2,844
Accrued interest................................ -- 598
Other reserves.................................. 3,389 1,035
Credit carryforwards............................ 5,519 4,883
Other........................................... 243 613
Valuation allowance............................. (5,207) (10,100)
--------- --------
Total deferred income tax assets................... 16,850 10,277
--------- --------
Deferred income tax liabilities:
Depreciation.................................... (9,417) (9,109)
Other........................................... (5,553) (3,667)
--------- --------
Total deferred income tax liabilities.............. (14,970) (12,776)
--------- --------
Net deferred income tax asset (liability).......... $ 1,880 $ (2,499)
========= ========
</TABLE>
The valuation allowance primarily relates to the net operating loss and
income tax credit carryforwards of the Company for periods prior to its
emergence from bankruptcy. If and when such carryforwards are realized, the
offset will be to additional paid-in capital not to the provision for income
taxes.
5. DEFERRED RENT
Several of the Company's facilities and a home health office are leased
under long-term operating leases that specify scheduled rent increases over the
lease terms. Deferred rent of approximately $986,000 and $932,000, at December
31, 1996 and 1995, respectively, has been established to recognize the
difference between the rent expense paid and the straight-line recognition of
minimum rental expense and is classified in other liabilities and noncurrent
reserves.
6. COMMITMENTS AND CONTINGENCIES
Letters of Credit
The Company is contingently liable under letters of credit related to
deposit requirements on its self-insured workers' compensation plans and the
IRBs discussed in Note 3. State regulations require the maintenance of deposits
at specified percentages of estimated future workers' compensation claim
payments that can be satisfied through a combination of cash deposits, surety
bonds and letters of credit. The total amount of letters of credit outstanding
at December 31, 1996 and 1995, were $16,202,000 and $16,050,000, respectively.
At December 31, 1995, the letters of credit were collateralized by cash. The
cash collateral was subsequently released in connection with the Company's
Credit Agreement discussed in Note 3.
44
<PAGE>
Leases
The Company leases certain facilities and offices under cancelable and
noncancelable agreements expiring at various dates through 2047. The leases are
generally triple-net leases and provide for the Company's payment of property
taxes, insurance, and repairs. Certain leases contain renewal options and rent
escalation clauses. Rent escalation clauses require either fixed increases or
increases tied to the Consumer Price Index ("CPI"). Six leases include purchase
options at fixed or market prices at various dates.
Future minimum lease payments for operating leases at December 31, 1996
are as follows (in thousands):
<TABLE>
<CAPTION>
Year Ending December 31,
<S> <C>
1997......................................... $ 24,402
1998......................................... 23,005
1999......................................... 22,358
2000......................................... 21,460
2001......................................... 20,127
Thereafter................................... 110,805
==========
$222,157
==========
</TABLE>
Guarantee of Leases
The Company is contingently liable for certain operating leases assumed
by the purchasers of the Company's leasehold interests in facilities. With the
exception of a single facility re-entered on October 1, 1994, following the
filing of bankruptcy by the Company's sublessee, which has been operated by the
Company since November 1, 1994, the Company is not aware of any failure on the
part of these purchasers to meet the terms of their obligations, and does not
anticipate any expenditures to be incurred in connection with its guarantees. If
a default were to occur, the Company generally would be able to assume
operations of the facility and use the net revenues thereof to defray the
Company's expenditures on these guarantees.
The following is a schedule of future minimum lease payments at
December 31, 1996 for the operating leases for which the Company is contingently
liable (in thousands):
<TABLE>
<CAPTION>
Year Ending December 31,
<S> <C>
1997......................................... $ 3,165
1998......................................... 1,125
1999......................................... 1,128
2000......................................... 1,136
2001......................................... 1,023
Thereafter................................... 4,617
=========
$12,194
=========
</TABLE>
Litigation
In 1995, a class action lawsuit, which had been filed against the
Company in July 1994, was settled for $9,000,000. The Company's portion of this
settlement, together with related legal fees and other costs, resulted in a pre-
tax charge of $3,098,000, which is included in the consolidated statement of
operations for the year ended December 31, 1995.
The Company is subject to claims and legal actions by patients and
others in the ordinary course of its business. The Company has insurance
policies related to patient care claims and legal actions. In the event
judgments were awarded for non-patient care legal actions or in excess of the
insurance coverage for patient care legal actions, the burden would fall on the
Company. The Company does not expect that the ultimate outcome of an unfavorable
judgment in any pending legal matters would result in a material adverse effect
on the Company's consolidated financial position or results of operations.
45
<PAGE>
Employment Agreements
At December 31, 1996, the Company had employment agreements with its
president, and certain executive and senior vice presidents, which provide for
annual base salaries in the aggregate of $1,212,000. The agreements expire at
various dates through 1999.
Insurance
The Company maintains general and professional liability insurance on a
claims made basis, subject to a $100,000 self-insurance retention. In addition,
all-risk property insurance, including earthquake and flood, is maintained for
all Company locations.
The Company estimates its liability under the above described programs,
including potential legal fees and settlement amounts, with respect to incurred
but not reported claims on a monthly basis, based upon its historical
experience.
7. RELATED PARTY TRANSACTIONS
In February 1988, the Company entered into a 20-year lease with three five-
year option periods for its Heritage (Torrance) facility that is owned by a
former director of the Company. The lease provides for monthly payments,
currently $35,000, which are adjusted annually based on the CPI. Lease expense
for the years ended December 31, 1996, 1995 and 1994, was approximately
$419,000, $415,000, and $409,000, respectively.
In June 1990, the Company entered into a ten year lease with four five-
year option periods for its Glendora facility that is directly owned by one
former director and indirectly owned by another director. The lease provides for
equal monthly payments for three years, after which the monthly payment is
adjusted annually based on increases in the CPI. Lease expense for the years
ended December 31, 1996, 1995 and 1994, was approximately $446,000, $437,000,
and $420,000, respectively.
The Company leases from Newport Harbor Investments Limited, Inc. ("Newport
Harbor"), a corporation wholly-owned by a former director of the Company, two
nursing facilities located in Beaumont and Riverside, California. The leases
provide for monthly rent payments of $7,083 and $5,142, respectively, subject to
periodic adjustments based on certain increases in the CPI or Medi-Cal
reimbursement rates. The Riverside facility lease contains an option to purchase
the facility for $675,000, subject to adjustment based on increases in the CPI
from March 1992. In 1992, the Company paid Newport Harbor $120,000 as
consideration for the extension of the purchase option on the Riverside facility
for a five-year period. During 1996 the Company exercised the option and
acquired the facility for approximately $700,000, net of the consideration
already paid. Lease expense paid by the Company for the years ended December 31,
1996, 1995 and 1994, was approximately $133,000, $147,000 and $147,000,
respectively.
The Company had a 26% interest in a pharmacy partnership formed in April
1992, which provided products and services to several healthcare facilities
operated by the Company. For the year ended December 31, 1994 these purchases
totaled approximately $7,525,000. In August 1994, the Company sold its interest
in the pharmacy partnership to the other partner. The Company received its net
equity in the partnership plus $200,000 for goodwill. The total cash received by
the Company was $2,239,000.
8. INCOME (LOSS) PER SHARE
For the years ended December 31, 1996, 1995 and 1994, income (loss) per
share was calculated based on the weighted average number of common and common
equivalent shares outstanding during the periods of 16,476,000, 16,654,000, and
16,545,000, respectively. Fully diluted income (loss) per share for the years
ended December 31, 1996, 1995 and 1994 is not presented because the effect of
the assumed conversion of the Convertible Subordinated Debentures was anti-
dilutive.
46
<PAGE>
The 1994 income per share calculation does not include the shares reserved
for issuance in connection with the Company's Share Appreciation Rights Plan,
which provides for settlement of the rights in cash or stock. Through December
31, 1994, all Share Appreciation Rights that had been settled were settled for
cash. During 1995, the Board of Directors settled all remaining outstanding
rights and issued shares which are included in the weighted average share
calculation for 1996 and 1995. (See Note 10.)
9. STOCK OPTIONS
Pursuant to the Merger, Care became a wholly owned subsidiary of Regency.
Stockholders of Care received 0.71 of a share of Regency common stock for each
share of Care common stock outstanding. Pursuant to the Merger, Regency's stock
option plan was amended to increase the number of shares of Regency common stock
available for grant to 1,937,991 shares. This amount does not include the
assumption of the Care stock option plan or share appreciation rights plan.
The Company has a Director Stock Plan whereby each non-employee director of
the Company receives on July 1 of each year 2,000 restricted shares of Company
Common Stock and options to purchase an additional 6,000 shares of Company
Common Stock. The period of restriction for each award of shares of restricted
stock expires on the last to occur of: the end of the six month period following
the grant date; participant's direct or indirect pecuniary ownership of shares
not subject to restrictions for at least 12 months, provided that the
restrictions shall lapse with respect to one restricted share granted for every
two shares of unrestricted shares; and participants attendance at 75% of the
scheduled board meetings during the 12 month period immediately preceding the
grant date. Any shares which remain restricted when a director's service on the
Company's Board terminates, will be forfeited. The stock options are granted at
fair market value on the date of grant and the participants are entitled to
exercise such options beginning six months and one day after grant and ending
ten years after grant. During the years ended December 31, 1996, 1995 and 1994,
the Company awarded 12,000, 14,000, and 12,000 shares of restricted stock,
respectively, and during the year ended December 31, 1994, 6,000 shares of
restricted stock were forfeited. At December 31, 1996 restrictions remained on
12,000 shares of stock. In January 1997, the period of restriction lapsed on
12,000 shares.
The following is a summary of options granted pursuant to Regency's
Employee and Director stock option plans (such amounts do not include restricted
stock awards):
<TABLE>
<CAPTION>
For the year ended December 31,
1996 1995 1994
-------------------------- --------------------------- ----------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Options
outstanding at
the beginning
of the year... 1,226,214 $11.94 1,773,436 $12.37 659,058 $5.63
Granted....... 911,000 10.34 262,641 11.42 1,461,015 15.08
Exercised..... (99,491) 4.28 (210,004) 5.90 (94,736) 5.27
Canceled...... (288,612) 13.28 (599,859) 15.11 (251,901) 13.28
========== ====== ========= ====== ========= ======
Options
outstanding at
the end of the
year.......... 1,749,111 $11.32 1,226,214 $11.94 1,773,436 $12.37
========== ====== ========= ====== ========= ======
Options
Exercisable... 493,008 527,284 701,563
========== ========= =========
</TABLE>
47
<PAGE>
During 1996, 1995 and 1994, no compensation cost was recognized related to
the above stock options. The following outlines the significant assumptions used
to calculate the fair value information presented utilizing the Black-Scholes
Single Option approach with ratable amortization.
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Risk-free interest rate.................................... 5.90% 6.14%
Expected life.............................................. 7.65 6.50
Expected volatility........................................ 41% 41%
Expected dividends......................................... - -
Weighted average grant date fair value of options granted.. $5.61 $5.95
</TABLE>
A detail of the options outstanding and exercisable as of December 31, 1996
is presented below:
<TABLE>
<CAPTION>
Options outstanding Options exercisable
- - -------------------------------------------------------------------------- ------------------------------
Weighted
average Weighted Weighted
remaining average average
Range of exercise Number contractual exercise Number exercise
prices outstanding life in years price exercisable price
- - ----------------- ----------- ------------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
$3.17 - $6.98 105,561 .84 $ 3.95 100,235 $ 3.94
9.15 - 10.75 821,112 8.83 10.04 86,796 10.15
11.00 - 12.88 389,000 8.72 11.69 71,250 11.68
15.00 - 15.38 433,438 7.34 15.22 234,727 15.21
- - --------------- --------- ---- ------ ------- ------
$3.17 - $15.38 1,749,111 7.96 $11.32 493,008 $11.52
=============== ========= ==== ====== ======= ======
</TABLE>
As the Company has adopted the disclosure requirement of SFAS No. 123, the
following table shows pro-forma net income and earnings per share as if the fair
value based accounting method had been used to account for stock-based
compensation cost.
<TABLE>
<CAPTION>
(in thousands, except earnings per share) 1996 1995
---- ----
<S> <C> <C>
Net income as reported...................... $5,206 $2,845
Pro forma compensation expense.............. (774) (235)
====== ======
Pro forma net income........................ $4,432 $2,610
====== ======
Pro forma earnings per share................ $.27 $.16
====== ======
</TABLE>
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts. At December 31, 1996, 2,123,897 shares of common
stock have been reserved for issuance under the Company's stock option plans.
10. SHARE APPRECIATION RIGHTS PLAN
In January 1991, Care's Board of Directors adopted a Share Appreciation
Rights Plan (the "SAR Plan"), which provided for the award of up to 710,000
units to certain key executives. The SAR Plan was amended by the Care Board of
Directors and stockholders in May 1992, and assumed by Regency at the time of
the Merger.
The SAR Plan provides that upon award, 25% of the units vest on each of the
first four anniversaries of the award date and vested units must be exercised
before the fifth anniversary of the award. All outstanding units fully vested on
January 1, 1995. Upon exercise, the awardee is entitled to receive the
difference between the base value and the market value on the
48
<PAGE>
date the units are exercised, in cash or stock, at the Company's option. During
1995, the Company discontinued the SAR Plan and settled all outstanding units
for $1,628,000 cash and 55,310 shares. This resulted in a charge to income of
$534,000 during 1995.
The following is a summary of the SAR Plan (as adjusted by the Exchange
Ratio due to the Merger):
<TABLE>
<CAPTION>
Year ended December 31,
1995 1994
---- ----
<S> <C> <C>
Units outstanding at beginning of the year...... 236,430 236,430
Granted......................................... -- --
Settled......................................... (236,430) --
Canceled........................................ -- --
======= =======
Units outstanding at end of the year............ -- 236,430
======= =======
Units exercisable at end of the year............ -- 177,322
======= =======
Unit price of outstanding units................. -- $1.41
======= =======
Unit price of settled units..................... $1.41 --
======= =======
</TABLE>
11. RETIREMENT SAVINGS PLAN
Regency sponsors an employee retirement savings plan under Section 401(k)
of the Internal Revenue Code. All employees who are regularly scheduled to work
20 hours or more per week, and complete 90 days of service are eligible to
participate. Participants can contribute, on a pre-tax basis, up to 15% of their
earnings to the plan (subject to certain limitations), for which the Company
matched 15% of the first 3% of contributions made for persons with less than
three years of service and 25% of the first 5% for all others. The Company's
contributions are subject to a four-year vesting period. Matching contributions
made by the Company for the years ended December 31, 1996, 1995 and 1994 were
approximately $697,000, $471,000, and $279,000, respectively.
12. MERGER AND RESTRUCTURING EXPENSES
All fees and expenses related to the Merger and to the consolidation and
restructuring of the combining companies during the year ended December 31,
1994, were expensed as required under the pooling-of-interests accounting
method.
49
<PAGE>
The following is a summary of the merger and restructuring expenses,
separated into cash and non-cash items (in thousands):
<TABLE>
<CAPTION>
Cash Non-Cash Total
---- -------- -----
<S> <C> <C> <C>
Severance..................................................... $ 4,394 $ -- $ 4,394
Management information, accounting,
and operational integration................................ 2,373 -- 2,373
Investment banking fees....................................... 1,400 -- 1,400
Value of assets written off................................... -- 777 777
Legal fees.................................................... 612 -- 612
Mailing and printing costs.................................... 501 -- 501
Merger bonuses................................................ 500 -- 500
Accounting fees............................................... 440 -- 440
Former Care director and officer liability insurance.......... 550 -- 550
Miscellaneous................................................. 453 -- 453
------- ------ -------
11,223 777 12,000
------- ------ -------
Duplicate facility disposals:
Operating losses........................................... 581 -- 581
Value of assets written off................................ -- 1,569 1,569
Loss on disposals.......................................... 500 -- 500
------- ------ -------
1,081 1,569 2,650
======= ====== =======
Total......................................................... $12,304 $2,346 $14,650
======= ====== =======
</TABLE>
As of December 31, 1994, the remaining accrual relating to merger and
restructuring expenses was $4,452,000 including cash and non-cash items of
$2,800,000 and $1,700,000, respectively. The remaining accrual consisted of a
provision for duplicate facility disposals of $2.3 million, severance costs of
$1.5 million, investment banking fees of $126,000, and other costs totaling
$545,000. All remaining costs were utilized during 1995. (See Note 14.)
13. ACQUISITIONS
Effective January 2, 1996, the Company completed the acquisition of the
assets of Assist-A-Care, a pharmacy located in San Diego, California. The
purchase price was $5.8 million, composed of $3.2 million cash and a $2.6
million note payable.
Effective February 1, 1996, the Company acquired leasehold interests in 18
health care facilities in Tennessee and North Carolina with 2,375 beds from
Liberty Healthcare Limited Partnership ("Liberty") through an asset purchase for
$39.3 million cash and a note payable for $2.2 million. The Company also
acquired Executive Pharmacy (consisting of one pharmacy in North Carolina and
one in Tennessee) with a $763,000 note payable and an enteral feeding business
for $1.5 million cash from businesses affiliated with Liberty. In addition, the
Company paid $400,000 cash for the inventory of Liberty. A portion of the
purchase was funded with notes payable, which may be reduced as a result of
certain seller liabilities and audit adjustments. Escrow accounts established at
the time of purchase were funded with $2.96 million for payment on the notes
payable and are included in other assets on the accompanying consolidated
balance sheet as of December 31, 1996.
On April 1, 1996, the Company completed the acquisition of the assets of
Buena Vista Nursing Center ("Buena Vista"), a health care facility with 64
skilled nursing beds and 22 assisted living beds, located in Lexington, North
Carolina. The purchase price was $2.875 million, consisting of $2.675 million in
cash and a $200,000 note payable. Payment of the note is dependent upon Buena
Vista attaining certain financial targets.
50
<PAGE>
On July 6, 1995, the Company acquired all of the stock of SCRS &
Communicology, Inc. ("SCRS") for a total purchase price of $13.5 million, of
which $3.4 million is represented by a promissory note which was paid in January
1996. SCRS provides contract rehabilitation services to Company operated and
third party healthcare facilities.
All acquisitions during 1995 and 1996 were accounted for under the
purchase method of accounting
The following unaudited pro forma condensed consolidated statements of
earnings present the summarized consolidated results of operations of the
Company after giving effect to the acquisitions of Liberty and Liberty-
affiliated businesses for the years ended December 31, 1996 and 1995, as if such
acquisitions had been consummated on January 1, 1995 (in thousands, except per
share data):
<TABLE>
<CAPTION>
Year ended
December 31,
------------------
1996 1995
---- ----
(Unaudited)
<S> <C> <C>
Net operating revenue............................... $564,856 $495,690
Total costs and expenses............................ 553,264 483,020
------- --------
Income before provision for income taxes............ 11,592 12,670
Provision for income taxes.......................... 4,856 7,676
-------- --------
Net income before extraordinary item................ $ 6,736 $ 4,994
======== ========
Income before extraordinary item per common share... $ 0.41 $ 0.30
======== ========
</TABLE>
The pro forma results are presented for informational purposes only and
are not necessarily indicative of what results of operations actually would have
been had such acquisitions been consummated at the beginning of such period or
of future operations or results. The effect of the other acquisitions is
immaterial.
14. RESTRUCTURING AND OTHER NON-RECURRING CHARGES
During 1996 the Company developed a comprehensive strategic plan
impacting all of its operating divisions. In connection with this strategic plan
the Company has undertaken initiatives designed to reengineer the operating
model through which it manages its business. This reengineering effort is
focused on identifying and implementing the most effective and efficient model
for managing the delivery of products and services to the Company's patients on
a local market by market basis. The plan includes consolidating and automating
the Pharmacy operations, consolidating the Home Health operations, automating
and streamlining certain functions in the nursing center operations, and
streamlining the corporate support structure. Through this process the Company
identified approximately 350 non-direct patient care positions across all
divisions, including the Corporate Office, which will be eliminated. Of the
positions identified, approximately 30 were eliminated during 1996. The Company
began the implementation phase of this plan during the fourth quarter of 1996.
Additionally, the Company has identified the implementation of
significant management information system (MIS) enhancements as a critical
component of its overall strategic plan. Implementing these MIS initiatives will
be an integral part of the realization of an effective and efficient management
model, through which the Company can monitor its patients, from both a cost and
a clinical perspective, seamlessly throughout the continuum of care and across
all divisions of the Company. Furthermore, these MIS initiatives will provide
management with complete patient information within each local market, which is
vital in the managed care environment of today and in the future. This
implementation is expected to continue during 1997 and into 1998. Several of the
51
<PAGE>
Company's current management information systems will be replaced in connection
with the MIS initiatives. The Company has also identified certain impaired
property and equipment and intangible assets and future contractual obligations
that will have no value to the Company under the new operating model due to
obsolescence, consolidation of locations, and streamlining of processes.
Accordingly, the Company has written off certain long-term assets and accrued
certain obligations, including obligations related to leases.
The Company has evaluated the reserve established in 1995 for the
disposition of 13 facilities located in California discussed below and
allowances established for certain notes and other non-patient receivables.
Based on the actual sale of six of the 13 facilities, and the estimated sales
prices for the remaining seven facilities, the Company has reduced the reserve
for the disposition of 13 facilities as of December 31, 1996. Earnings before
income taxes for the remaining seven facilities were $940,000, $765,000 and
$316,000 for 1996, 1995 and 1994, respectively. In addition, an allowance was
established for certain notes and non-patient receivables that arose in prior
years, which were not collected as anticipated by the Company and certain long-
term assets were written down to net realizable value.
The following summarizes the impact of the above items on the Company's
results of operations for 1996:
<TABLE>
<CAPTION>
Non-
Restructuring recurring Total
------------- ---------- ------------
<S> <C> <C> <C>
MIS and other property and equipment written off
$2,057,000 $2,320,000 $ 4,377,000
Goodwill and other assets written off........... 2,300,000 1,255,000 3,555,000
Future lease and other obligations.............. 325,000 1,891,000 2,216,000
Severance (including $711,000 paid during 1996).
1,377,000 -- 1,377,000
Allowance for notes and other receivables....... -- 1,010,000 1,010,000
Reengineering costs incurred.................... 511,000 -- 511,000
Reduction of reserve for assets held for sale... -- (1,763,000) (1,763,000)
---------- ---------- -----------
$6,570,000 $4,713,000 $11,283,000
========== ========== ===========
</TABLE>
In 1995, the Company determined to dispose of 13 facilities located in
California. In addition, during 1995 the Company completed the disposition of
duplicate facilities identified during 1994 as part of the merger and
restructuring costs, the Simi Valley healthcare facility damaged in the Southern
California (Northridge) earthquake and one other facility, and exchanged
leasehold interests in three nursing centers in New Mexico for leasehold
interest in four nursing centers in Ohio. These transactions resulted in a net
charge of $9,000,000 during 1995. This charge was based upon management's best
estimates of the amounts expected to be estimated fair value less selling costs.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments at
December 31, 1996 are as follows (in thousands):
<TABLE>
<CAPTION>
Carrying
Amount Fair Value
-------- ----------
<S> <C> <C>
Cash and cash equivalents.................. $ 22,875 $ 22,875
======== ========
Mortgage notes receivable.................. $ 1,937 $ 1,937
======== ========
Long-term debt, including current portion.. $184,908 $190,139
======== ========
</TABLE>
52
<PAGE>
The carrying amount approximates fair value for cash and cash
equivalents because of the short maturity of these instruments. The fair value
of mortgage notes receivable was estimated based on the present value of future
cash flows using current rates the Company could obtain on notes with similar
characteristics and maturities. The fair value for the Company's long-term debt
was estimated based on the quoted market prices for the same or similar issues
or on the present value of future cash flows using current rates the Company
could obtain on debt with similar characteristics and maturities.
16. SUBSEQUENT EVENTS
Effective January 1, 1997, the Company acquired four acute
rehabilitation hospitals, eleven outpatient rehabilitation clinics and six
neurological treatment centers from Horizon/CMS Healthcare Corporation ("CMS").
The purchase price was $43.0 million, made up of a cash payment of $36.3 million
and notes payable totaling $6.7 million.
17. QUARTERLY FINANCIAL DATA (UNAUDITED):
<TABLE>
<CAPTION>
Year Ended December 31, 1996
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------- ------- ------- ------- -----
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Net operating revenue.............. $129,963 $137,632 $144,103 $146,352 $558,050
======== ======== ======== ======== ========
Income (loss) before extraordinary
item............................ $ 2,737 $ 3,065 $ 3,641 $ (3,044) $ 6,399
======== ======== ======== ======== ========
Net income (loss).................. $ 2,737 $ 3,065 $ 2,448 $ (3,044) $ 5,206
======== ======== ======== ======== ========
Income (loss) per share - Primary:
Income (loss) before
extraordinary item........... $ .16 $ .19 $ .22 $ (.19) $ .39
======== ======== ======== ======== ========
Net income (loss)............... $ .16 $ .19 $ .15 $ (.19) $ .32
======== ======== ======== ======== ========
Income (loss) per share -
Fully Diluted:
Income (loss) before
extraordinary item........... $ .16 $ .18 $ .22 $ (.19) $ .39
======== ======== ======== ======== ========
Net income (loss)............... $ .16 $ .18 $ .15 $ (.19) $ .32
======== ======== ======== ======== ========
</TABLE>
Effective January 2, 1996, the Company completed the acquisition of the
assets of Assist-A-Care, a pharmacy located in San Diego, California. The
purchase price was $5.8 million, composed of $3.2 million in cash and a $2.6
million note payable.
Effective February 1, 1996, the Company acquired leasehold interests in
18 health care facilities in Tennessee and North Carolina with 2,375 beds from
Liberty Healthcare Limited Partnership ("Liberty") through an asset purchase for
$39.3 million cash and a note payable for $2.2 million. The Company also
acquired Executive Pharmacy (consisting of one pharmacy in North Carolina and
one in Tennessee) with a $763,000 note payable and an enteral feeding business
for $1.5 million cash from businesses affiliated with Liberty. In addition, the
Company paid $400,000 cash for the inventory of Liberty.
53
<PAGE>
On April 1, 1996, the Company completed the acquisition of the assets
of Buena Vista Nursing Center in Lexington, North Carolina. The purchase price
was $2.875 million, consisting of $2.675 million in cash and a note payable for
$200,000.
On July 29, 1996, the Company completed the redemption of all $48.9
million of its outstanding Convertible Subordinated Debentures for cash at such
amount. The redemption reduces fully diluted shares by 3.9 million shares and
results in an extraordinary loss on extinguishment of debt of $868,000, net of
tax, resulting from the write-off of unamortized underwriting costs.
Effective September 30, 1996, the Company refinanced three of its IRBs
with an aggregate outstanding principal balance of $7,560,000 with three new
issues of tax exempt IRBs. The refinancing resulted in an extraordinary loss on
extinguishment of debt of $325,000, net of tax, resulting from the write-off of
unamortized underwriting costs and a call premium paid.
During the fourth quarter of 1996, the Company recorded an $11.3
million charge related to restructuring and other non-recurring items as
discussed in Note 14.
<TABLE>
<CAPTION>
Year Ended December 31, 1995
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------- ------- ------- ------- -----
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Net operating revenue.............. $97,548 $99,766 $107,492 $111,287 $416,093
======= ======= ======== ======== ========
Income (loss) before extraordinary
item............................ $ 3,087 $ 1,780 $ 4,042 $ (4,455) $ 4,454
======= ======= ======== ======== ========
Net income (loss).................. $ 3,087 $ 1,780 $ 4,042 $ (6,064) $ 2,845
======= ======= ======== ======== ========
Income (loss) per share - Primary:
Income (loss) before
extraordinary item........... $ .19 $ .11 $ .24 $ (.27) $ .27
======= ======= ======== ======== ========
Net income (loss)............... $ .19 $ .11 $ .24 $ (.36) $ .17
======= ======= ======== ======== ========
Income (loss) per share -
Fully Diluted:
Income (loss) before
extraordinary item........... $ .18 $ .11 $ .22 $ (.27) $ .27
======= ======= ======== ======== ========
Net income (loss)............... $ .18 $ .11 $ .22 $ (.36) $ .17
======== ======= ======== ======== ========
</TABLE>
Effective July 6, 1995, the Company acquired all of the stock of SCRS &
Communicology, Inc. ("SCRS") for a total purchase price of $13.5 million, of
which $3.4 million is represented by a promissory note which was paid in January
1996. The acquisition was accounted for under the purchase method of accounting.
SCRS provides rehabilitation services to Company operated and third party
healthcare facilities.
54
<PAGE>
In May 1995, a class action lawsuit which had been filed against the
Company in July 1994, was settled for $9,000,000. The Company's portion of this
settlement, together with related legal fees and other costs, resulted in a pre-
tax charge of $3,098,000, which is included in the consolidated statement of
operations for the quarter ended June 30, 1995.
In October 1995, the Company repaid its $30 million, 8.10% Senior
Secured Notes resulting in costs and prepayment penalties of $2,681,000
($1,609,000 net of tax), classified as an extraordinary item in the quarter
ended December 31, 1995.
In December 1995, the Company recorded a $9,000,000 charge, primarily
related to the disposition of certain facilities (See Note 14).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
55
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item for the Company's directors and
executive officers will be contained in Regency's Notice of Annual Meeting of
Stockholders and Proxy Statement, pursuant to Regulation 14A, to be filed with
the Securities and Exchange Commission on or before April 14, 1997, and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item will be contained in Regency's Notice
of Annual Meeting of Stockholders and Proxy Statement, pursuant to Regulation
14A, to be filed with the Securities and Exchange Commission on or before April
14, 1997, and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item will be contained in Regency's Notice
of Annual Meeting of Stockholders and Proxy Statement, pursuant to Regulation
14A, to be filed with the Securities and Exchange Commission on or before April
14, 1997 and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item will be contained in Regency's Notice
of Annual Meeting of Stockholders and Proxy Statement, pursuant to Regulation
14A, to be filed with the Securities and Exchange Commission on or before April
14, 1997, and is incorporated herein by reference.
56
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following are filed as part of this Report.
(a)(1) FINANCIAL STATEMENTS
Report of Independent Public Accountants.......................... 31
Consolidated Balance Sheets as of December 31, 1996 and 1995...... 32
Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1995 and 1994................................ 34
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1996, 1995 and 1994.......................... 35
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995 and 1994................................ 36
Notes to Consolidated Financial Statements........................ 38
(a)(2) FINANCIAL STATEMENT SCHEDULES
Schedule II - Valuation and Qualifying Accounts
All other Financial Statement schedules have been omitted from this
Item 14(a)(2) because they are not applicable or not required or because the
information is included elsewhere in the financial statements or the notes
thereto.
<TABLE>
<CAPTION>
(a)(3) EXHIBITS
Number Description
<C> <S>
3.1 Restated Certificate of Incorporation of the Company. (7)
3.2 Restated Bylaws of the Company, and Amendment thereto dated
June 8, 1995 (11).
4.1 Restated Certificate of Incorporation and Restated Bylaws
filed as Exhibits 3.1 and 3.2. (7)(11)
4.2 Specimen of Common Stock Certificate. (1)
4.3 Indenture, dated as of October 12, 1995, for 9-7/8% Senior
Subordinated Notes due 2002, among Registrant, the
Subsidiary Guarantors named therein and U.S. Trust Company
of California, N.A., as Trustee. (originally filed as
Exhibit number 4.4) (12)
4.4 Form of 9 7/8% Senior Subordinated Note due 2003 of Regency
Health Services, Inc. (included in Exhibit 4.3)
4.5 Second Amended and Restated Registration Rights Agreement,
dated as of January 31, 1994, among Regency Health Services,
Inc., Care Enterprises, Inc. and the stockholders named
therein. (originally filed as Exhibit number 4.7) (7)
</TABLE>
57
<PAGE>
<TABLE>
<C> <S>
4.6* Registrant's Long-Term Incentive Plan. (originally filed as
Exhibit number 4.8) (4)
4.7* Amendment to Regency Health Services, Inc. Long-Term
Incentive Plan. (originally filed as Exhibit number 4.9)(7)
4.8* Regency Health Services, Inc. Director Stock Plan.
(originally filed as Exhibit number 4.10) (4)
4.9* Indenture, dated as of June 28, 1996, between Regency Health
Services, Inc. As Issuer, the Guarantors named therein and
U.S. Trust Company of California, N.A., as Trustee.
(originally filed as Exhibit number 4.11) (16)
4.10* Form of 12-1/4% Subordinated Note due 2003 of Regency Health
Services, Inc. (included in Exhibit 4.9). (originally filed
as Exhibit number 4.12) (16)
10.1* Registrant's 401 (K) Employee Retirement Savings Plan.
(originally filed as Exhibit number 10.1) (1)
10.2* Form of Indemnity Agreement between the Registrant and its
Directors. (originally filed as Exhibit number 10.3) (1)
10.3 Master Contract for Non-Public, Non-Secretarian School
Agency Services, dated September 16, 1991, between Regency
High School and Long Beach Unified School District.
(originally filed as Exhibit number 10.4) (1)
10.4 Mental Health Services Agreement for adolescent center for
1993, 1994 and 1995, between the County of Los Angeles,
Department of Mental Health and Harbor View, formerly Harbor
View Rehabilitation Center. (originally filed as Exhibit
number 10.5) (2)
10.5 Building Loan Agreement, dated November 20, 1992, by and
between Carmichael Convalescent Hospital and PFC
Corporation. (originally filed as Exhibit number 10.6) (3)
10.6 Security Agreement, dated as of November 20, 1992, between
Carmichael Convalescent Hospital and PFC Corporation.
(originally filed as Exhibit number 10.7) (3)
10.7* Employment Agreement between Regency Health Services, Inc.
and Richard K. Matros dated April 4, 1994. (originally filed
as Exhibit number 10.10) (7)
10.8* Letter agreement between the Registrant and Cecil Mays
(originally filed as Exhibit number 10.14) (9)
10.9* Employment agreement between Regency Health Services, Inc.
and Stephen W. Carlton dated January 9, 1995. (originally
filed as Exhibit number 10.17) (10)
10.10* Indemnification Agreement dated January 1, 1994, between the
Company and Brad L. Kerby. (originally filed as Exhibit
number 10.18) (10)
</TABLE>
58
<PAGE>
<TABLE>
<C> <S>
10.11 Stock Purchase Agreement dated as of July 5, 1995 among the
Company, Sherri Medina, Jamison Ashby, Daniel Larson and
Vivra Incorporated. (originally filed as Exhibit number
10.19) (11)
10.12 Promissory Note dated as of July 6, 1995 by the Company in
favor of Vivra Incorporated. (originally filed as Exhibit
number 10.20) (11)
10.13 Indemnification Escrow Agreement dated as of July 6, 1995
among the Company, Vivra Incorporated, SCRS & Communicology,
Inc., of Ohio and Mellon Bank, N.A. (originally filed as
Exhibit number 10.21) (11)
10.14 Form of Non-Competition and Non-Disclosure Agreement dated
as of July 6, 1995 between the Company and each of Sherri
Medina, Jamison Ashby and Daniel Larson. (originally filed
as Exhibit number 10.22) (11)
10.15 Non-Competition and Non-Disclosure Agreement dated as of
July 6, 1995 between the Company and Vivra Incorporated.
(originally filed as Exhibit number 10.23) (11)
10.16 Inducement Agreement dated as of July 6, 1995 among the
Company, Sherri Medina and SCRS & Communicology, Inc., of
Ohio. (originally filed as Exhibit number 10.24) (11)
10.17 Management Services Agreement dated January 1, 1995 between
SCRS & Communicology, Inc., of Ohio and SCRS &
Communicology, Inc. (originally filed as Exhibit number
10.25) (11)
10.18* Employment Agreement dated as of July 6, 1995 between the
Company and Sherri Medina. (originally filed as Exhibit
number 10.26) (11)
10.19* Employment Agreement dated as of June 8, 1995 between the
Company and David A. Grant. (originally filed as Exhibit
number 10.27) (11)
10.20* Severance Agreement and Release of Claims dated as of March
31, 1995 between the Company and Brad L. Kerby. (originally
filed as Exhibit number 10.29) (11)
10.21* Credit Agreement, dated as of December 28,1995, among
Registrant, the financial institutions listed therein as
Lenders, Nations Bank Capital Markets, Inc., as Arranger and
NationsBank of Texas, N.A., as Agent. (originally filed as
Exhibit number 10.31) (13)
10.22* Settlement Agreement and Release of All Claims dated as of
October 18, 1995 between the Company and James R. Wodach
(originally filed as Exhibit number 10.32) (14)
10.23* Employment Agreement dated as of December 15, 1995 between
the Company and Bruce D. Broussard (originally filed as
Exhibit number 10.33) (14)
10.24 Non-Qualified Stock Option Agreement between Regency Health
Services, Inc. and Richard K. Matros dated January 2, 1996.
10.25 Non-Qualified Stock Option Agreement between Regency Health
Services, Inc. and Bruce D. Broussard dated January 2, 1996.
</TABLE>
59
<PAGE>
<TABLE>
<C> <S>
10.26* Severance Letter Agreement dated as of February 22, 1996
between the Company and Barbara Garner (originally filed as
Exhibit number 10.34) (14)
10.27 Purchase and Sale Agreement, dated as of January 12, 1996,
between Registrant and Liberty Healthcare Limited
Partnership and Liberty Assisted Living Centers Limited
Partnership. (originally filed as Exhibit number 10.35)(15)
10.28 Stock Purchase and Sale Agreement dated February 1, 1996,
between First Class Pharmacy, Inc., a wholly-owned
subsidiary of the Registrant, and the owners of Common Stock
of Executive Pharmacy Services, Inc. (originally filed as
Exhibit number 10.36) (15)
10.29 Purchase and Sale Agreement - Fresno, dated as of November
19, 1996, between Regency Rehab Hospitals, Inc., a wholly-
owned subsidiary of the Registrant and Continental Medical
Systems, Inc. (originally filed as Exhibit number 2.1) (17)
10.30 Purchase and Sale Agreement - Kentfield, dated as of
November 19, 1996 between Regency Rehab Hospitals, Inc., a
wholly-owned subsidiary of the Registrant and Kentfield
Hospital Corporation. (originally filed as Exhibit number
2.2) (17)
10.31 Stock Purchase and Sale Agreement - Rehabworks of
California, dated as of November 19, 1996, between Regency
Rehab Hospitals, Inc., a wholly-owned subsidiary of the
Registrant and CMS Therapies, Inc. (originally filed as
Exhibit number 2.3) (17)
10.32 Purchase and Sale Agreement - San Bernardino, dated as of
November 19, 1996, between Regency Rehab Hospitals, Inc., a
wholly-owned subsidiary of the Registrant and Continental
Medical Systems, Inc. (originally filed as Exhibit number
2.4) (17)
10.33 Purchase and Sale Agreement - San Bernardino Real Estate,
dated as of November 19, 1996, between Regency Rehab
Properties, Inc., a wholly-owned subsidiary of the
Registrant and Rehab Concepts Corp. (originally filed as
Exhibit number 2.5) (17)
10.34 Purchase and Sale Agreement - San Diego, dated as of
November 19, 1996, between Regency Rehab Hospitals, Inc., a
wholly-owned subsidiary of the Registrant and San Diego
Rehab Limited Partnership. (originally filed as Exhibit
number 2.6) (17)
10.35 Purchase and Sale Agreement - San Diego Real Estate, dated
as of November 19, 1996, between Regency Rehab Properties,
Inc., a wholly-owned subsidiary of the Registrant and San
Diego Health Associates Limited Partnership. (originally
filed as Exhibit number 2.7) (17)
10.36 Purchase and Sale Agreement - Western Neurologic Residential
Centers, dated as of November 10, 1996, between Regency
Rehab Hospitals, Inc., a wholly-owned subsidiary of the
Registrant and Western Neurologic Residential Centers.
(originally filed as Exhibit number 2.8) (17)
</TABLE>
60
<PAGE>
<TABLE>
<C> <S>
10.37 First Amendment to Purchase and Sale Agreement - Western
Neurologic Residential Centers, Dated as of November 19,
1996, between Regency Rehab Hospitals, Inc., a wholly-owned
subsidiary of the Registrant and Western Neurologic
Residential Centers. (originally filed as Exhibit number
2.9) (17)
10.38 Regional Office Agreement, dated November 19, 1996, between
Regency Rehab Hospitals, Inc., a wholly-owned subsidiary of
the Registrant and Continental Medical Systems, Inc.
(originally filed as Exhibit number 2.10)(17)
10.39 Amended and Restated Credit Agreement dated as of December
20, 1996 among Regency Health Services, Inc., as borrower,
the Lenders listed, Nationsbanc Capital Markets, Inc., as
arranger, and Nationsbank of Texas, N.A., as agent.
(originally filed as Exhibit number 2.11) (17)
10.40 Amendment and confirmation of Collateral Account Agreement,
Company Pledge Agreement and Company Security Agreement.
(originally filed as Exhibit number 2.12) (17)
10.41 Amendment and Confirmation of Subsidiary Guaranty,
Subsidiary Pledge Agreement and Subsidiary Security
Agreement. (originally filed as Exhibit number 2.13) (17)
10.42 Asset Purchase Agreement among Managed Respiratory Care
Services, Inc. (MRCS), and Arizona corporation, Jean Mathews
and Joe Salazar (the sole stockholders, directors and
officers of MRCS) and SCRS & Communicology, Inc. of Ohio, a
wholly owned subsidiary of the Registrant.
10.43 Financing Agreement by and between the City of Beckley, West
Virginia and Beckley Health Care Corp. ("Beckley Financing
Agreement"), a wholly owned subsidiary of the Registrant,
dated as of September 1, 1996.
10.44 Indenture of Trust relating to $2,830,000 Nursing Facility
Refunding Revenue Bonds, Series 1996 by and between The City
of Beckley, West Virginia and One Valley Bank, National
Association, as Trustee, dated as of September 1, 1996
issued in connection with the Beckley Financing Agreement.
10.45 Financing Agreement by and between the Board of
Commissioners of the County of Perry, Ohio, by and on behalf
of the County of Perry, Ohio and New Lexington Health Care
Corp. ("New Lexington Financing Agreement"), a wholly owned
subsidiary of the Registrant, dated as of September 1, 1996.
10.46 Indenture of Trust relating to $2,545,000 Nursing Facility
Refunding Revenue Bonds, Series 1996 by and between County
of Perry, Ohio and SunTrust Bank, Central Florida, National
Association, as Trustee, dated as of September 1, 1996
issued in connection with the New Lexington Financing
Agreement.
10.47 Financing Agreement by and between the County Commission of
Harrison County by and on behalf of Harrison County, West
Virginia and Salem Health Care Corp. ("Salem Financing
Agreement"), a wholly owned subsidiary of the Registrant,
dated as of September 1, 1996.
10.48 Indenture of Trust relating to $2,185,000 Nursing Facility
Refunding Revenue Bonds, Series 1996 by and between the
County Commission of Harrison County by and on behalf of
Harrison County, West Virginia and One Valley Bank, National
Association, as Trustee, dated as of September 1, 1996
issued in connection with the Salem Financing Agreement.
13 1996 Annual Report to Security Holders
21 List of Subsidiaries of the Registrant
</TABLE>
61
<PAGE>
23 Consent of Independent Public Accountants
27 Financial Data Schedule
* Management or compensatory plan, contract or arrangement
(1) Incorporated by reference to Regency Health Services, Inc.'s Registration
Statement on Form S-1 (No. 33-45591).
(2) Incorporated by reference to Regency Health Services, Inc.'s 1992 Annual
Report on Form 10-K (File No. 1-11144).
(3) Incorporated by reference to Regency Health Services, Inc.'s Registration
Statement on Form S-1 (No. 33-53590).
(4) Incorporated by reference to Regency Health Services, Inc.'s 1993 Proxy
Statement dated December 10, 1993 (File No. 1-11144).
(5) Incorporated by reference to Regency Health Services, Inc.'s 1993 Annual
Report on Form 10-K (File No. 1-11144).
(6) Incorporated by reference to Regency Health Services, Inc.'s Report on Form
10-Q for the Quarter Ended September 30, 1993 (File No. 1-11144).
(7) Incorporated by reference to Regency Health Services, Inc.'s and Care
Enterprises, Inc.'s Joint Proxy Statement dated March 7, 1994.
(8) Incorporated by reference to Care Enterprises, Inc.'s 1993 Annual Report on
Form 10-K (File No. 1-9310).
(9) Incorporated by reference to Regency Health Services, Inc.'s Transition
Report on Form 10-K (File No. 1-11144).
(10) Incorporated by reference to Regency Health Services, Inc.'s 1994 Annual
Report on Form 10-K (File No. 1-11144).
(11) Incorporated by reference to Regency Health Services, Inc.'s Report on Form
10-Q for the Quarter Ended June 30, 1995 (File No. 1-11144).
(12) Incorporated by reference to Regency Health Services, Inc.'s Report on Form
8-K dated August 24, 1995 (File No. 1-11144).
(13) Incorporated by reference to Regency Health Services, Inc.'s Report on Form
8-K dated December 28, 1995 (File No. 1-11144).
(14) Incorporated by reference to Regency Health Services, Inc.'s 1995 Annual
Report on Form 10-K (File No. 1-11144).
(15) Incorporated by reference to Regency Health Services, Inc.'s Report on Form
8-K dated February 15, 1996 (File No. 1-11144).
(16) Incorporated by reference to Regency Health Services, Inc.'s Report on Form
10-Q for the Quarter Ended June 30, 1996 (File No. 1-11144).
(17) Incorporated by reference to Regency Health Services, Inc.'s Report on Form
8-K dated January 15, 1997.
(b) REPORTS ON FORM 8-K
None.
62
<PAGE>
SCHEDULE II
REGENCY HEALTH SERVICES, INC.
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
Balance Charged Charged
at to to Balance
Beginning Costs & Other at End
Description of Period Expenses Accounts Deductions of Period
----------- --------- --------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C>
FOR THE YEAR ENDED
DECEMBER 31, 1996
Allowance for doubtful
accounts............. $3,757 $2,890 $410 (a) $2,334 $4,723
Allowance for mortgage
loan losses.......... 951 689 -- 288 1,352
------ ------ ----- ------ ------
$4,708 $3,579 $410 $2,622 $6,075
====== ====== ===== ====== ======
FOR THE YEAR ENDED
DECEMBER 31, 1995
Allowance for doubtful
accounts............. $4,189 $1,922 $734 (b) $3,088 $3,757
Allowance for mortgage
loan losses.......... 951 -- -- -- 951
------ ------ ----- ------ ------
$5,140 $1,922 $734 $3,088 $4,708
====== ====== ===== ====== ======
FOR THE YEAR ENDED
DECEMBER 31, 1994
Allowance for doubtful
accounts............. $2,970 $1,344 $687 (c) $ 812 $4,189
Allowance for mortgage
loan losses.......... 1,664 -- -- 713 951
------ ------ ---- ------ ------
$4,634 $1,344 $687 $1,525 $5,140
====== ====== ==== ====== ======
</TABLE>
(a) Includes (i) Executive Pharmacy acquired reserves and (ii) recoveries
(b) Includes (i) the reclassification of accruals established in 1994 for
receivables related to duplicate facility disposals, (ii) SCRS acquired
reserves, and (iii) recoveries
(c) Reclassification of reserve established against note received by Care
63
<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 report to be signed on
its behalf by the undersigned, thereunto duly authorized.
REGENCY HEALTH SERVICES, INC.
Date: March 24, 1997 By /s/ Richard K. Matros
-------------------------
Richard K. Matros
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Name and Signature Title Date
By /s/ Richard K. Matros President and Chief March 24, 1997
----------------------------- Executive Officer(Principal
Richard K. Matros executive officer)
By /s/ Bruce D. Broussard Executive Vice President, March 24, 1997
----------------------------- and Chief Financial Officer
Bruce D. Broussard (Principal financial and
accounting officer)
By /s/ John W. Adams Chairman of the Board March 24, 1997
----------------------------- of Directors
John W. Adams
By /s/ Gregory S. Anderson Director March 24, 1997
-----------------------------
Gregory S. Anderson
By /s/ Tony Astorga Director March 24, 1997
-----------------------------
Tony Astorga
By /s/ Robert G. Coo Director March 24, 1997
-----------------------------
Robert G. Coo
By /s/ Richard K. Matros Director March 24, 1997
-----------------------------
Richard K. Matros
By /s/ John F. Nickoll Director March 24, 1997
-----------------------------
John F. Nickoll
By /s/ Arthur J. Pasmas Director March 24, 1997
-----------------------------
Arthur J. Pasmas
64
<PAGE>
Exhibit 2
CONFORMED COPY
================================================================================
AGREEMENT AND PLAN OF MERGER
by and among
SUN HEALTHCARE GROUP, INC.,
SUNREG ACQUISITION CORP.
and
REGENCY HEALTH SERVICES, INC.
------------------
DATED AS OF JULY 26, 1997
------------------
================================================================================
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
ARTICLE 1 THE OFFER...................................................... 2
Section 1.1 The Offer................................................ 2
Section 1.2 Company Actions.......................................... 4
ARTICLE 2 THE MERGER..................................................... 5
Section 2.1 The Merger............................................... 5
Section 2.2 Closing; Effective Time.................................. 5
Section 2.3 Certificate of Incorporation............................. 6
Section 2.4 By-laws.................................................. 6
Section 2.5 Directors and Officers................................... 6
ARTICLE 3 EFFECT OF THE MERGER ON THE CAPITAL STOCK OF THE CONSTITUENT
CORPORATION; EXCHANGE OF CERTIFICATES.......................... 6
Section 3.1 Effect on Capital Stock.................................. 6
Section 3.2 Exchange of Common Stock................................. 7
Section 3.3 No Liability............................................. 8
Section 3.4 Certain Adjustments...................................... 8
ARTICLE 4 REPRESENTATIONS AND WARRANTIES OF THE COMPANY.................. 9
Section 4.1 Organization............................................. 9
Section 4.2 Capitalization........................................... 9
Section 4.3 Subsidiaries............................................. 10
Section 4.4 Authorization; Binding Agreement......................... 10
Section 4.5 Noncontravention......................................... 10
Section 4.6 Governmental Approvals................................... 11
Section 4.7 SEC Filings; Financial Statements........................ 11
Section 4.8 Information Supplied..................................... 12
Section 4.9 Absence of Certain Changes or Events..................... 12
Section 4.10 Finders and Investment Bankers; Transaction Expenses..... 13
Section 4.11 Voting Requirement....................................... 13
Section 4.12 Litigation............................................... 13
Section 4.13 Taxes.................................................... 13
Section 4.14 Permits; Compliance with Laws............................ 14
Section 4.15 Title to Properties...................................... 15
Section 4.16 State Takeover Statutes.................................. 15
Section 4.17 Employee Benefit Plans................................... 16
Section 4.18 Insurance................................................ 17
Section 4.19 Environmental Matters.................................... 17
Section 4.20 Opinion of Financial Advisor............................. 18
Section 4.21 Intellectual Property.................................... 18
</TABLE>
i
<PAGE>
<TABLE>
<S> <C> <C>
ARTICLE 5 REPRESENTATIONS AND WARRANTIES OF PARENT AND MERGER SUB........ 19
Section 5.1 Organization............................................. 19
Section 5.2 Authorization; Binding Agreement......................... 19
Section 5.3 Noncontravention......................................... 19
Section 5.4 Governmental Approvals................................... 19
Section 5.5 Information Supplied..................................... 20
Section 5.6 Financing................................................ 20
Section 5.7 Regulatory Approval...................................... 20
Section 5.8 Compliance with Laws..................................... 21
Section 5.9 Litigation............................................... 21
ARTICLE 6 COVENANTS...................................................... 21
Section 6.1 Conduct of Business of the Company....................... 21
Section 6.2 Stockholder Approval; Proxy Statement.................... 23
Section 6.3 Access and Information................................... 24
Section 6.4 No Solicitation.......................................... 24
Section 6.5 Reasonable Efforts; Additional Actions................... 25
Section 6.6 Notification of Certain Matters.......................... 26
Section 6.7 Public Announcements..................................... 27
Section 6.8 Indemnification and Insurance............................ 27
Section 6.9 Directors................................................ 28
Section 6.10 Employee Matters......................................... 28
Section 6.11 Consummation of Merger................................... 29
Section 6.12 Debt Offers/Consent Solicitations........................ 30
ARTICLE 7 CONDITIONS..................................................... 30
Section 7.1 Conditions to Each Party's Obligations................... 30
ARTICLE 8 TERMINATION.................................................... 31
Section 8.1 Termination.............................................. 31
Section 8.2 Procedure for and Effect of Termination.................. 32
Section 8.3 Fees and Expenses........................................ 32
</TABLE>
ii
<PAGE>
<TABLE>
<S> <C> <C>
ARTICLE 9 MISCELLANEOUS................................................ 33
Section 9.1 Certain Definitions................................... 33
Section 9.2 Amendment and Modification............................ 33
Section 9.3 Waiver of Compliance; Consents........................ 34
Section 9.4 Survival.............................................. 34
Section 9.5 Notices............................................... 34
Section 9.6 Assignment............................................ 35
Section 9.7 GOVERNING LAW......................................... 35
Section 9.8 Counterparts.......................................... 35
Section 9.9 Interpretation........................................ 36
Section 9.10 Entire Agreement...................................... 36
Section 9.11 No Third Party Beneficiaries.......................... 36
Section 9.12 Obligations of Parent................................. 36
EXHIBIT A - CONDITIONS OF THE OFFER
</TABLE>
iii
<PAGE>
AGREEMENT AND PLAN OF MERGER
AGREEMENT AND PLAN OF MERGER, dated as of July 26, 1997 (the
"Agreement"), by and among SUN HEALTHCARE GROUP, INC., a Delaware corporation
---------
("Parent"), SUNREG ACQUISITION CORP., a Delaware corporation and a wholly owned
------
subsidiary of the Parent ("Merger Sub"), and REGENCY HEALTH SERVICES, INC., a
----------
Delaware corporation (the "Company"). Merger Sub and the Company are sometimes
-------
collectively referred to herein as the "Constituent Corporations."
------------------------
WHEREAS, the respective Boards of Directors of Parent, Merger Sub and
the Company have each determined that it is advisable and in the best interests
of their respective stockholders for Parent to acquire the Company on the terms
and subject to the conditions set forth in this Agreement;
WHEREAS, in furtherance of such acquisition, Parent proposes to cause
Merger Sub to make a tender offer (as it may be amended from time to time as
permitted under this Agreement, the "Offer") to purchase all the issued and
-----
outstanding shares ("Shares") of Common Stock, par value $.01 per share, of the
------
Company (the "Common Stock"), at a price per share of Common Stock of $22.00 net
------------
to the seller in cash, upon the terms and subject to the conditions set forth in
this Agreement; and the Board of Directors of the Company has approved the Offer
and the Merger (as hereinafter defined) and is recommending that the Company's
stockholders accept the Offer;
WHEREAS, concurrently with the execution of this Agreement and as an
inducement to Parent to enter into this Agreement, Parent, Merger Sub and
certain stockholders of the Company are entering into a Stockholder Agreement
(the "Stockholder Agreement") pursuant to which such stockholders have, among
---------------------
other things, agreed to tender all such stockholders' shares of Common Stock to
Merger Sub at the price per Share paid in the Offer, upon the terms and subject
to the conditions set forth in the Stockholder Agreement; and the Stockholder
Agreement has been approved by the Board of Directors of the Company;
WHEREAS, Parent, Merger Sub and the Company desire to make certain
representations, warranties, covenants and agreements in connection with the
Offer and the Merger and also to prescribe various conditions to the Offer and
the Merger.
NOW THEREFORE, in consideration of the representations, warranties,
covenants and agreements contained herein, and intending to be legally bound
hereby, the parties hereto agree as follows:
1
<PAGE>
ARTICLE 1
THE OFFER
Section 1.1 The Offer.
---------
(a) Subject to the provisions of this Agreement, as promptly as
practicable but in no event later than the fifth business day from and including
the date of the public announcement of this Agreement, Merger Sub shall, and
Parent shall cause Merger Sub to, commence the Offer. The obligation of Merger
Sub to, and of Parent to cause Merger Sub to, commence the Offer and accept for
payment, and pay for, any shares of Common Stock tendered pursuant to the Offer
shall be subject only to the conditions set forth in Exhibit A (any of which may
be waived by Merger Sub in its sole discretion, provided that, without the
consent of the Company, Merger Sub shall not waive the Minimum Condition (as
defined in Exhibit A)) and to the terms and conditions of this Agreement.
Merger Sub may at any time transfer or assign to one or more corporations
directly or indirectly wholly owned by Parent the right to purchase all or any
portion of the Shares tendered pursuant to the Offer, but no such assignment
shall relieve Parent or Merger Sub of its obligations hereunder. Merger Sub
expressly reserves the right to modify the terms of the Offer, except that,
without the consent of the Company, Merger Sub shall not (i) reduce the number
of shares of Common Stock subject to the Offer, (ii) reduce the price per share
of Common Stock to be paid pursuant to the Offer (except pursuant to Section
3.4), (iii) modify or add to the conditions set forth in Exhibit A, (iv) except
as provided in the remainder of this Section 1.1, extend the Offer, (v) change
the form of consideration payable in the Offer (other than by increasing the
cash offer price) or (vi) amend or modify any term of the Offer in any manner
adverse to any of the Company's stockholders. The initial expiration date shall
be September 15, 1997. Notwithstanding the foregoing, Merger Sub may, without
the consent of the Company, but subject to the Company's right to terminate this
Agreement pursuant to Section 8.1(b)(ii), (i) extend the Offer, if at the
scheduled expiration date of the Offer any of the conditions to Merger Sub's
obligation to purchase shares of Common Stock shall not be satisfied, until such
time as such conditions are satisfied or waived or (ii) extend the Offer for any
period required by any rule, regulation, interpretation or position of the
Securities and Exchange Commission (the "SEC") or the staff thereof applicable
---
to the Offer or in order to obtain any material regulatory approval applicable
to the Offer. Merger Sub agrees that: (A) in the event it would otherwise be
entitled to terminate the Offer at any scheduled expiration thereof due to the
failure of one or more of the conditions set forth in the first sentence of the
introductory paragraph or paragraphs (a) or (g) of Exhibit A to be satisfied or
waived, it shall give the Company notice thereof and, at the request of the
Company, if such conditions are reasonably likely to be satisfied during the
requested extension period, extend the Offer until the earlier of (1) such time
as such condition is, or conditions are, satisfied or waived and (2) the date
chosen by the Company, which shall not be later than (x) December 31, 1997 or
(y) the date on which the Company reasonably believes all such conditions will
be satisfied (it being understood that the Company shall not be entitled to make
such request if it is then in breach of this Agreement, and that nothing in this
Section 1.1 shall modify Parent's and Merger Sub's right to terminate this
Agreement in the event that the Company is in breach hereof or the conditions
specified in paragraphs (d) or (e) of Annex A are applicable); provided that if
--------
any such condition is not satisfied by the date so chosen by the Company, the
Company may request
2
<PAGE>
and Merger Sub shall make further extensions of the Offer in accordance with
the terms of this Section 1.1(a); and (B) in the event that Merger Sub would
otherwise be entitled to terminate the Offer at any scheduled expiration date
thereof due solely to the failure of the Minimum Condition to be satisfied, it
shall, at the request of the Company, extend the Offer for such period as may be
requested by the Company not to exceed ten business days from such scheduled
expiration date. Subject to the terms and conditions of the Offer and this
Agreement, Merger Sub shall, and Parent shall cause Merger Sub to, pay for all
shares of Common Stock validly tendered and not withdrawn pursuant to the Offer
that Merger Sub becomes obligated to purchase pursuant to the Offer immediately
after the expiration of the Offer; provided, however, that notwithstanding the
-------- -------
foregoing Parent may, in its sole discretion, extend the expiration date of the
Offer for a period not to exceed ten business days and in no event ending after
December 31, 1997, if Parent reasonably believes that as a result of such
extension 90% or more of the Shares will be tendered in the Offer. If, at any
scheduled expiration date prior to October 1, 1997, there shall have been
tendered, and not withdrawn, fewer than 90% of the Shares, then Merger Sub
shall, at the request of the Company, extend the Offer for such number of days
(up to 20 calendar days) as the Company may request. No such request shall be
made by the Company if, in its sole judgment, it concludes that the Merger could
be consummated on or prior to October 6, 1997.
(b) On the date of commencement of the Offer, Parent and Merger Sub
shall file with the SEC a Tender Offer Statement on Schedule 14D-1 with respect
to the Offer, which shall contain an offer to purchase and a related letter of
transmittal and summary advertisement (such Schedule 14D-1 and the documents and
exhibits included therein pursuant to which the Offer will be made, together
with any supplements or amendments thereto, the "Offer Documents"). The Offer
---------------
Documents shall comply as to form in all material respects with the requirements
of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the
------------
rules and regulations promulgated thereunder and the Offer Documents on the date
first published, sent or given to the Company's stockholders, shall not contain
any untrue statement of a material fact or omit to state any material fact
required to be stated therein or necessary in order to make the statements
therein, in light of the circumstances under which they were made, not
misleading, except that no representation is made by Parent or Merger Sub with
respect to information supplied by the Company in writing for inclusion in the
Offer Documents. Each of Parent, Merger Sub and the Company agrees promptly to
correct any information provided by it for use in the Offer Documents if and to
the extent that such information shall have become false or misleading in any
material respect, and each of Parent and Merger Sub further agrees to take all
steps necessary to amend or supplement the Offer Documents and to cause the
Offer Documents as so amended or supplemented to be filed with the SEC and to be
disseminated to the Company's stockholders, in each case as and to the extent
required by applicable Federal securities laws. The Company and its counsel
shall be given a reasonable opportunity to review the Offer Documents and all
amendments and supplements thereto prior to their filing with the SEC or
dissemination to stockholders of the Company. Parent and Merger Sub agree to
provide the Company and its counsel any comments Parent, Merger Sub or their
counsel may receive from the SEC or its staff with respect to the Offer
Documents promptly after the receipt of such comments.
3
<PAGE>
(c) Parent shall contribute to Merger Sub on a timely basis the funds
necessary to purchase any shares of Common Stock that Merger Sub becomes
obligated to purchase pursuant to the Offer and to perform any of its other
obligations pursuant to this Agreement.
Section 1.2 Company Actions.
---------------
(a) The Company hereby approves of and consents to the Offer and
represents that the Board of Directors of the Company, at a meeting duly called
and held on July 26, 1997, unanimously adopted resolutions approving this
Agreement and the Stockholder Agreement and the transactions contemplated hereby
and thereby, including, the Offer and the Merger, determining that the terms of
the Offer and the Merger are fair to, and in the best interests of, the
Company's stockholders and recommending that the Company's stockholders accept
the Offer and tender their shares pursuant to the Offer and approve and adopt
this Agreement. The Company has been advised by each of its directors and
executive officers that each such person intends to tender all shares of Common
Stock owned individually by such person pursuant to the Offer.
(b) Promptly following the filing of the Offer Documents with the SEC,
the Company shall file with the SEC a Solicitation/Recommendation Statement on
Schedule 14D-9 with respect to the Offer (such Schedule 14D-9, as amended from
time to time, the "Schedule 14D-9") containing the recommendation described in
--------------
Section 1.2(a) and shall mail the Schedule 14D-9 to the stockholders of the
Company; provided that the Company shall not be required to include such
--------
recommendation in the Schedule 14D-9 if the Company receives a bona fide written
Acquisition Proposal (as defined in Section 6.4) from any person or group, the
receipt of which was not related to a breach of Section 6.4, (i) that the Board
of Directors of the Company determines in its good faith judgment, after
consultation with the Company's financial advisor, is a Superior Proposal (as
defined in Section 6.4) and (ii) as a result of which, the Board determines in
good faith, after consultation with, and receipt of advice from, the Company's
outside counsel, that it would constitute a breach of the Board's fiduciary duty
under applicable law to so include such recommendation. The Schedule 14D-9
shall comply as to form in all material respects with the requirements of the
Exchange Act and the rules and regulations promulgated thereunder and, on the
date filed with the SEC and on the date first published, sent or given to the
Company's stockholders, shall not contain any untrue statement of a material
fact or omit to state any material fact required to be stated therein or
necessary in order to make the statements therein, in light of the circumstances
under which they were made, not misleading, except that no representation is
made by the Company with respect to information supplied by Parent or Merger Sub
in writing for inclusion in the Schedule 14D-9. Each of the Company, Parent and
Merger Sub agrees promptly to correct any information provided by it for use in
the Schedule 14D-9 if and to the extent that such information shall have become
false or misleading in any material respect, and the Company further agrees to
take all steps necessary to amend or supplement the Schedule 14D-9 and to cause
the Schedule 14D-9 as so amended or supplemented to be filed with the SEC and
disseminated to the Company's stockholders, in each case as and to the extent
required by applicable Federal securities laws. Parent and its counsel shall be
given a reasonable opportunity to review the Schedule 14D-9 and all amendments
and supplements thereto prior to their filing with the SEC or dissemination to
stockholders of the
4
<PAGE>
Company. The Company agrees to provide Parent and its counsel in writing with
any comments the Company or its counsel may receive from the SEC or its staff
with respect to the Schedule 14D-9 promptly upon the receipt of such comments.
(c) In connection with the Offer, the Company shall cause its transfer
agent to furnish Merger Sub promptly with mailing labels containing the names
and addresses of the record holders of Common Stock as of a recent date and of
those persons becoming record holders subsequent to such date, together with
copies of all lists of stockholders, security position listings and computer
files and all other information in the Company's possession or control regarding
the beneficial owners of Common Stock, and shall furnish to Merger Sub such
information and assistance (including updated lists of stockholders, security
position listings and computer files) as Parent may reasonably request in
communicating the Offer to the Company's stockholders. Subject to the
requirements of applicable law, and except for such steps as are necessary to
disseminate the Offer Documents and any other documents necessary to consummate
the Merger, Parent and Merger Sub shall hold in confidence the information
contained in any such labels, listings and files, will use such information only
in connection with the Offer and the Merger and, if this Agreement shall be
terminated, will, upon request, deliver to the Company all copies (in all forms)
of such information then in their possession or control.
ARTICLE 2
THE MERGER
Section 2.1 The Merger. Subject to the last two sentences of this
----------
Section 2.1, upon the terms and subject to the conditions of this Agreement, at
the Effective Time (as defined in Section 2.2) and in accordance with the
General Corporation Law of the State of Delaware (the "DGCL"), Merger Sub shall
----
be merged with and into the Company, which shall be the surviving corporation in
the Merger (the "Surviving Corporation"). At the Effective Time, the separate
---------------------
existence of Merger Sub shall cease and the other effects of the Merger shall be
as set forth in Section 259 of the DGCL. At the election of Parent, if such
election would not in any manner adversely affect the Company's stockholders or
delay the transactions contemplated hereby, (i) any direct or indirect wholly
owned subsidiary (as defined in Section 9.1(e)) of Parent may be substituted for
and assume all of the rights and obligations of Merger Sub as a constituent
corporation in the Merger or (ii) the Company may be merged with and into Merger
Sub or Parent with Merger Sub or Parent, respectively, continuing as the
Surviving Corporation with the effects set forth above. In either such event,
the parties agree to execute an appropriate amendment to this Agreement in order
to reflect the foregoing.
Section 2.2 Closing; Effective Time. Subject to the provisions of
-----------------------
Article 7, the closing of the Merger (the "Closing") shall take place in New
-------
York City at the offices of Brobeck, Phleger & Harrison LLP, as soon as
practicable but in no event later than 10:00 a.m. New York City time on the
second business day after the date on which each of the conditions set forth in
Article 7 have been satisfied or waived by the party or parties entitled to the
benefit of such conditions, or at such other place, at such other time or on
such other date as Parent, Merger Sub and the Company may mutually agree. The
date on which the Closing actually
5
<PAGE>
occurs is hereinafter referred to as the "Closing Date." At the Closing,
------------
Parent, Merger Sub and the Company shall cause a certificate of merger (the
"Certificate of Merger") to be executed and filed with the Secretary of State of
- - ----------------------
the State of Delaware in accordance with the DGCL. The Merger shall become
effective as of the date and time of such filing, or such other time within one
business day of such filing as Merger Sub and the Company shall agree to be set
forth in the Certificate of Merger (the "Effective Time").
--------------
Section 2.3 Certificate of Incorporation. The certificate of
----------------------------
incorporation of Merger Sub, as in effect immediately prior to the Effective
Time, shall become, from and after the Effective Time, the certificate of
incorporation of the Surviving Corporation, until thereafter altered, amended or
repealed as provided therein and in accordance with applicable law.
Section 2.4 By-laws. The by-laws of Merger Sub, as in effect
-------
immediately prior to the Effective Time, shall become, from and after the
Effective Time, the by-laws of the Surviving Corporation, until thereafter
altered, amended or repealed as provided therein and in accordance with
applicable law.
Section 2.5 Directors and Officers. The directors and officers of
----------------------
Merger Sub immediately prior to the Effective Time shall become, from and after
the Effective Time, the directors and officers of the Surviving Corporation,
until their respective successors are duly elected or appointed and qualify or
their earlier resignation or removal.
ARTICLE 3
EFFECT OF THE MERGER ON THE CAPITAL STOCK OF THE
CONSTITUENT CORPORATION; EXCHANGE OF CERTIFICATES
Section 3.1 Effect on Capital Stock. As of the Effective Time, by
-----------------------
virtue of the Merger and without any action on the part of the holder of any
shares of Common Stock or any shares of capital stock of Merger Sub:
(a) Capital Stock of Merger Sub. Each share of the capital
---------------------------
stock of Merger Sub issued and outstanding immediately prior to the Effective
Time shall be converted into and become one fully paid and nonassessable share
of common stock, par value $0.01 per share, of the Surviving Corporation.
(b) Treasury Stock and Parent-Owned Stock. Each share of
-------------------------------------
Common Stock that is owned by the Company or any subsidiary of the Company
("Treasury Shares") and each share of Common Stock that is owned by Parent,
---------------
Merger Sub or any other subsidiary of Parent ("Parent Shares") shall
-------------
automatically be canceled and retired and shall cease to exist, and no
consideration shall be delivered in exchange therefor.
(c) Conversion of Common Stock. Subject to Section 3.1(e),
--------------------------
each issued and outstanding share of Common Stock (other than shares to be
canceled in accordance with Section 3.1(b)) shall be converted into the right to
receive from the Surviving Corporation
6
<PAGE>
in cash, without interest, the price paid for each share of Common Stock in the
Offer (the "Merger Consideration"). As of the Effective Time, all shares of the
--------------------
Common Stock shall no longer be outstanding and shall automatically be canceled
and retired and shall cease to exist, and each holder of a certificate
representing any such shares of Common Stock shall cease to have any rights with
respect thereto, except the right to receive the Merger Consideration, without
interest.
(d) Options. Immediately prior to the Effective Time, the
-------
unexercisable portion of each outstanding option (a "Company Stock Option") to
--------------------
purchase shares of Common Stock, shall become immediately exercisable in full
(by their terms or, if necessary, by action of the Company), subject to all
expiration, lapse, forfeiture and other terms and conditions thereof. The
Company shall take all action necessary so that each Company Stock Option (and
any rights thereunder) outstanding immediately prior to the Effective Time shall
be canceled immediately prior to the Effective Time in exchange for the right to
receive an amount in cash equal to the product of (A) the number of shares of
Common Stock subject to such Company Stock Option immediately prior to the
Effective Time (after giving effect to the first sentence of this Section
3.1(d)) and (B) the excess, if any, of (1) the Merger Consideration over (2) the
per share exercise price of such Company Stock Option, to be delivered by the
Surviving Corporation immediately following the Effective Time.
(e) Dissenting Shares. Notwithstanding anything in this Agreement to
-----------------
the contrary, each share of Common Stock that is issued and outstanding
immediately prior to the Effective Time and that is held by a stockholder who
has available to it, and who has properly exercised and perfected, appraisal
rights under Section 262 of the DGCL (the "Dissenting Shares"), shall not be
-----------------
converted into or exchangeable for the right to receive the Merger
Consideration, but shall be entitled to receive such consideration as shall be
determined pursuant to Section 262 of the DGCL; provided, however, that if such
-------- -------
holder shall have failed to perfect or shall have effectively withdrawn or lost
the right to appraisal and payment under the DGCL, each share of Common Stock of
such holder shall thereupon be deemed to have been converted into and to have
become exchangeable for, as of the Effective Time, the right to receive the
Merger Consideration, without any interest thereon, in accordance with Section
3.1(a), and such shares shall no longer be Dissenting Shares. The Company shall
give Parent (i) prompt notice of any demands for fair value for shares of Common
Stock received by the Company and (ii) the opportunity to participate in and
direct all negotiations and proceedings with respect to any such demands. The
Company shall not, without the prior written consent of Parent, make any payment
with respect to, or settle, offer to settle or otherwise negotiate, any such
demands.
Section 3.2 Exchange of Common Stock.
------------------------
(a) From time to time, on or before the Effective Time, in the event
fewer than 80% of the then outstanding Shares are tendered and not withdrawn
pursuant to the Offer, Parent shall cause to be deposited in trust with a bank
or trust company designated by Parent and satisfactory to the Company (the
"Paying Agent") cash, cash equivalents or a combination thereof in amounts and
- - -------------
at the times necessary for the prompt payment of the Merger Consideration upon
surrender of certificates representing Shares as part of the Merger pursuant
7
<PAGE>
to Section 3.1 (it being understood that any and all interest earned on funds
made available to the Paying Agent pursuant to this Agreement and not used to
pay Merger Consideration shall be turned over to Parent).
(b) Promptly after the Effective Time, the Paying Agent (which, for
the purposes of this subsection (b), may be Parent) shall mail to each holder of
record of a certificate or certificates that immediately prior to the Effective
Time represented outstanding shares of Common Stock that were converted into the
right to receive the Merger Consideration pursuant to Section 3.1 (the
"Certificates") a form letter of transmittal (which shall specify that delivery
- - -------------
shall be effected, and risk of loss and title to the Certificates shall pass,
only upon proper delivery of the Certificates to the Paying Agent) and
instructions for use in effecting the surrender of the Certificates for payment
therefor. Upon surrender by such holder to the Paying Agent of a Certificate,
together with such letter of transmittal duly executed, the holder of such
Certificate shall be entitled to receive in exchange therefor, cash in an amount
equal to the product of the number of shares of Common Stock represented by such
Certificate multiplied by the Merger Consideration, and such Certificate shall
forthwith be canceled. No interest will be paid or accrued on the cash payable
upon the surrender of the Certificates. If the payment is to be made to a
person other than the person in whose name a Certificate surrendered is
registered, it shall be a condition of payment that (a) the Certificate so
surrendered shall be properly endorsed or otherwise in proper form for transfer
and (b) the person requesting such payment shall pay any transfer or other taxes
required by reason of the payment to a person other than the registered holder
of the Certificate surrendered or establish to the satisfaction of the Surviving
Corporation that such tax has been paid or is not applicable. Until surrendered
in accordance with the provisions of this Section 3.2, each Certificate shall
represent for all purposes whatsoever only the right to receive the Merger
Consideration in cash multiplied by the number of shares evidenced by such
Certificate, without any interest thereon.
(c) After the Effective Time there shall be no transfers on the stock
transfer books of the Surviving Corporation of the shares of Common Stock that
were outstanding immediately prior to the Effective Time. If, after the
Effective Time, Certificates are presented to the Surviving Corporation for
transfer or for any other reason, they shall be canceled and exchanged for cash
as provided in this Article 3, except as otherwise provided by law.
Section 3.3 No Liability. None of Parent, Merger Sub, the Company or
------------
the Paying Agent shall be liable to any person in respect of any cash from the
Payment Fund delivered to a public official pursuant to any applicable abandoned
property, escheat or similar law.
Section 3.4 Certain Adjustments. If between the date of this Agreement
-------------------
and the time of the Majority Acquisition (as defined below), the outstanding
shares of Common Stock shall be changed into a different number of shares by
reason of any reclassification, recapitalization, split-up, combination or
exchange of shares, or any dividend payable in stock or other securities shall
be declared thereon with a record date within such period, or the number of
shares of Common Stock on a fully diluted basis is in excess of that specified
in Section 4.2 (regardless of whether such excess is a result of an additional
issuance of Common Stock or a
8
<PAGE>
correction to such Section) (excluding, however, changes in such number on a
fully diluted basis caused solely by a change in the price of the Common Stock
and by the exercise of Company Stock Options outstanding on the date of this
Agreement), then Parent may unilaterally cause the Merger Consideration and the
per share price to be paid in the Offer to be adjusted accordingly to provide to
the holders of Common Stock the same aggregate economic effect as contemplated
by this Agreement prior to such reclassification, recapitalization, split-up,
combination, exchange, dividend or increase.
ARTICLE 4
REPRESENTATIONS AND WARRANTIES
OF THE COMPANY
The Company represents and warrants to Parent and Merger Sub as follows:
Section 4.1 Organization. The Company and each of its subsidiaries is
------------
duly organized and validly existing under the laws of the jurisdiction of its
incorporation or organization and has all requisite power and authority to own,
lease and operate its properties and to carry on its business as now being
conducted. The Company and each of its subsidiaries are duly qualified to do
business and in good standing in its jurisdiction of organization and in each
jurisdiction in which the property owned, leased or operated by it or the nature
of the business conducted by it makes such qualification necessary, except for
such failures to be so duly qualified and in good standing that, individually or
in the aggregate, will not have a Material Adverse Effect (as defined in Section
9.1(c)) with respect to the Company. The Company has previously delivered or
made available to Parent correct and complete copies of the certificates of
incorporation and by-laws (or equivalent governing instruments), as currently in
effect, of the Company and each of its subsidiaries.
Section 4.2 Capitalization. The authorized capital stock of the
--------------
Company is as disclosed in the SEC Filings (as defined in Section 4.7). At the
close of business on July 25, 1997, (a) 15,935,300 shares of Common Stock were
issued and outstanding, and (b) 1,801,859 shares of Common Stock were reserved
for issuance upon exercise of Company Stock Options. All issued and outstanding
shares of Common Stock have been duly authorized and are validly issued, fully
paid, nonassessable and free of preemptive rights. Except as set forth in this
Section 4.2 and on Schedule 4.2, as of the date of this Agreement, there are no
outstanding securities, options, warrants, calls, rights, commitments,
agreements, arrangements or undertakings of any kind to which the Company or any
of its subsidiaries is a party or by which any of them is bound (i) obligating
the Company or any of its subsidiaries to issue, deliver, sell, transfer,
repurchase, redeem or otherwise acquire or vote, or cause to be issued,
delivered, sold, transferred, repurchased, redeemed or otherwise acquired or
voted, any shares of capital stock or other voting securities of the Company or
of any of its subsidiaries, (ii) restricting the transfer of Common Stock or
(iii) obligating the Company or any of its subsidiaries to issue, grant, extend
or enter into any such security, option, warrant, call, right, commitment,
agreement, arrangement or undertaking. The Company is not aware of any voting
trust, stockholder agreement or other similar arrangement relating to any shares
of Common Stock. Schedule 4.2
9
<PAGE>
sets forth a complete and correct list as of the date hereof of (w) the number
of options and warrants to purchase Common Stock outstanding and the number of
shares of Common Stock issuable thereunder, (x) the exercise price of each such
outstanding stock option and warrant, (y) the vesting schedule of each such
outstanding stock option (it being understood that all such stock options shall
become exercisable pursuant to Section 3.1(d)) and (z) the grantee or holder of
each such option and warrant. All shares of Common Stock subject to issuance as
aforesaid, upon issuance prior to the Effective Time on the terms and conditions
specified in the instruments pursuant to which they are issuable, will be duly
authorized, validly issued, fully paid and nonassessable. Except as is set
forth on Schedule 4.2, there are no material outstanding contractual obligations
of the Company to provide funds to, or make any material investment (in the form
of a loan, capital contribution or otherwise) in, any Company subsidiary or any
other person.
Section 4.3 Subsidiaries. All of the outstanding shares of capital
------------
stock of each of the Company's subsidiaries that are owned by the Company or any
other subsidiary of the Company (collectively, the "Subsidiary Shares") have
-----------------
been duly authorized and are validly issued, fully paid and nonassessable and
free of preemptive rights. Except as set forth on Schedule 4.3, all of the
Subsidiary Shares are owned by the Company free and clear of all liens, claims,
charges, encumbrances or security interests (collectively, "Liens") with respect
-----
thereto.
Section 4.4 Authorization; Binding Agreement. The Company has the full
--------------------------------
corporate power and authority to execute and deliver this Agreement and, subject
to adoption of this Agreement by the stockholders of the Company in accordance
with the DGCL, the certificate of incorporation and by-laws of the Company, to
consummate the transactions contemplated hereby. The execution and delivery of
this Agreement and the consummation of the transactions contemplated hereby have
been duly and validly authorized by all necessary corporate action on the part
of the Company, subject to the adoption of this Agreement by the stockholders of
the Company in accordance with the DGCL and the certificate of incorporation and
by-laws of the Company. This Agreement has been duly and validly executed and
delivered by the Company and, subject to the adoption of this Agreement by the
stockholders of the Company in accordance with the DGCL and the certificate of
incorporation and by-laws of the Company, constitutes a legal, valid and binding
agreement of the Company, enforceable against the Company in accordance with its
terms except as may be limited by (a) bankruptcy, insolvency, reorganization or
other laws now or hereafter in effect relating to creditors' rights generally
and (b) general principles of equity (regardless of whether enforceability is
considered in a proceeding at law or in equity).
Section 4.5 Noncontravention. Neither the execution and delivery of
----------------
this Agreement nor the consummation of the transactions contemplated hereby or
thereby will (a) conflict with or result in any breach of any provision of the
certificate of incorporation or by-laws (or equivalent governing instruments) of
the Company or any of its subsidiaries, (b) except as set forth on Schedule 4.5
and in connection with the Consent Solicitations (as defined below), require any
consent, approval or notice under, or conflict with or result in a violation or
breach of, or constitute (with or without notice or lapse of time or both) a
default (or give rise to any right of termination, cancellation or acceleration)
under, any of the terms, conditions or provisions of any note, bond, mortgage,
indenture, lease, agreement or other
10
<PAGE>
instrument or obligation (collectively, "Contracts and Other Agreements") to
------------------------------
which the Company or any of its subsidiaries is a party or by which any of them
or any material portion of their properties or assets may be bound or (c)
subject to the approvals, filings and consents referred to in Section 4.6,
violate any order, judgment, writ, injunction, determination, award, decree,
law, statute, rule or regulation (collectively, "Legal Requirements") applicable
------------------
to the Company or any of its subsidiaries or any material portion of their
properties or assets; provided that no representation or warranty is made (i) in
--------
the foregoing clauses (b) or (c) or with respect to matters that, individually
or in the aggregate, will not (i) have a Material Adverse Effect with respect to
the Company or (ii) materially delay the transactions contemplated by this
Agreement.
Section 4.6 Governmental Approvals. No consent, approval or
----------------------
authorization of or declaration or filing with any foreign, federal, state,
municipal or other governmental department, commission, board, bureau, agency or
instrumentality (each, a "Governmental Entity") on the part of the Company or
-------------------
any of its subsidiaries that has not been obtained or made is required in
connection with the execution or delivery by the Company of this Agreement or
the consummation by the Company of the transactions contemplated hereby, other
than (a) the filing of the Certificate of Merger with the Secretary of State of
the State of Delaware, (b) filings and other applicable requirements under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR
---
Act"), and the Exchange Act, (c) the filing of appropriate documents with the
- - ---
relevant authorities of states other than Delaware in which the Company or any
of its subsidiaries is authorized to do business, (d) such filings as may be
required in connection with any state or local tax which is attributable to the
beneficial ownership of the Company's or its subsidiaries, real property, if
any, (e) such filings and consents as may be required under any environmental,
health or safety law or regulation, or any health care licensure laws,
reimbursement authorities and their agents, certificate of need laws and other
health care laws and regulations, pertaining to any notification, disclosure or
required approval required by the Merger or the transactions contemplated by
this Agreement, (f) such filings as may be required by any applicable state
securities or "blue sky" laws or state takeover laws, and (g) consents,
approvals, authorizations, declarations or filings that, if not obtained or
made, will not, individually or in the aggregate, result in a Material Adverse
Effect with respect to the Company or a material delay in the transactions
contemplated by this Agreement or the Stockholder Agreement.
Section 4.7 SEC Filings; Financial Statements. The Company has made
---------------------------------
all filings required to be made under the Exchange Act with the SEC since
December 31, 1996 (the "SEC Filings"). As of their respective dates, the SEC
-----------
Filings complied as to form in all material respects with the requirements of
the Securities Act of 1933, as amended (the "Securities Act"), or the Exchange
--------------
Act, as the case may be, and the rules and regulations of the SEC promulgated
thereunder applicable to such SEC Filings, and the SEC Filings did not contain
any untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements therein, in
light of the circumstances under which they were made, not misleading. The
financial statements set forth in the SEC Filings comply as to form in all
material respects with applicable accounting requirements and the published
rules and regulations of the SEC promulgated under the Securities Act or the
Exchange Act, as the case may be, and have been prepared in accordance with
generally accepted accounting principles applied on a consistent basis during
the periods involved (except
11
<PAGE>
as may be indicated in the notes to such financial statements) and fairly
present in all material respects the consolidated financial position of the
Company and its subsidiaries at the respective dates thereof and the
consolidated results of operations and cash flows for the respective periods
then ended (subject, in the case of unaudited interim financial statements, to
exceptions permitted by Form 10-Q under the Exchange Act and to normal year-end
adjustments). As of March 31, 1997, neither the Company nor any of its
subsidiaries had, and since such date neither the Company nor any of its
subsidiaries has incurred, any liabilities of any nature, whether accrued,
absolute, contingent or otherwise, whether due or to become due that are
required to be recorded or reflected on a consolidated balance sheet of the
Company under generally accepted accounting principles, except as reflected or
reserved against or disclosed in the financial statements of the Company
included in the SEC Filings or set forth on Schedule 4.7.
Section 4.8 Information Supplied. None of the information supplied or
--------------------
to be supplied by the Company for inclusion or incorporation by reference in (i)
the Offer Documents, (ii) the Schedule 14D-9, (iii) if applicable, the proxy
statement relating to the adoption of this agreement by the Company's
stockholders (the "Proxy Statement") or (iv) the information to be filed by the
---------------
Company in connection with the Offer pursuant to Rule 14f-1 promulgated under
the Exchange Act (the "Information Statement"), will, in the case of the Offer
---------------------
Documents and the Schedule 14D-9 and the Information Statement, at the
respective times the Offer Documents, the Schedule 14D-9 and the Information
Statement are filed with the SEC or first published, sent or given to the
holders, or, in the case of the Proxy Statement, at the date the Proxy Statement
is first mailed to the Company's stockholders or at the time of the meeting of
the Company's stockholders held to vote on approval and adoption of this
Agreement, contain any untrue statement of a material fact or omit to state any
material fact required to be stated therein or necessary in order to make the
statements therein, in light of the circumstances under which they are made, not
misleading, except that no representation or warranty is made by the Company
with respect to statements made or incorporated by reference therein based on
information supplied by Parent or Merger Sub in writing specifically for
inclusion or incorporation by reference therein. The Schedule 14D-9, the Proxy
Statement and the Information Statement will comply as to form in all material
respects with the requirements of the Exchange Act and the rules and regulations
thereunder, except that no representation or warranty is made by the Company
with respect to statements made or incorporated by reference therein based on
information supplied by Parent or Merger Sub in writing specifically for
inclusion or incorporation by reference therein or as set forth in any of
Parent's SEC Filings.
Section 4.9 Absence of Certain Changes or Events. Except as disclosed
------------------------------------
in the SEC Filings or on Schedule 4.9, since March 31, 1997, the Company and its
subsidiaries have conducted their respective businesses in the ordinary course
consistent with past practice and as of the date hereof there has not been (i)
any condition, event or occurrence that, individually or in the aggregate, has
resulted in a Material Adverse Effect with respect to the Company (without
regard, however, to changes in conditions generally applicable to the long-term
care industry or general economic conditions), (ii) any declaration, setting
aside or payment of any dividend or other distribution (whether in cash, stock
or property) with respect to any of the Company's capital stock, (iii) any
split, combination or reclassification of any of its capital stock or any
issuance or the authorization of any issuance of any other securities in respect
of, in lieu of or in substitution for shares of its capital stock, (iv) except
as reflected on Schedule 4.2 and except
12
<PAGE>
as disclosed in this Agreement, (x) any granting by the Company or any of its
subsidiaries to any executive officer or other key employee of the Company or
any of its subsidiaries of any increase in compensation, except as required
under employment agreements in effect as of July 1, 1997 (true and correct
copies of which have been provided to Parent), or (y) any granting by the
Company or any of its subsidiaries to any such executive officer of any increase
in severance or termination pay, except as was required under any employment,
severance or termination agreements in effect as of July 1, 1997 (true and
correct copies of which have been provided to Parent) as the same may be amended
consistent with terms described on Schedule 6.10(c), (v) any damage, destruction
or loss, whether or not covered by insurance, that has had or will have a
Material Adverse Effect with respect to the Company or (vi) except insofar as
may have been disclosed in the SEC Filings or required by a change in generally
accepted accounting principles and set forth on Schedule 4.9, any change in
accounting methods, principles or practices except as required by generally
accepted accounting principles.
Section 4.10 Finders and Investment Bankers; Transaction Expenses.
----------------------------------------------------
Neither the Company nor any of its officers or directors has employed any
investment banker, business consultant, financial advisor, broker or finder in
connection with the transactions contemplated by this Agreement, except for
Smith Barney Inc. ("Smith Barney") and Smith Management Company ("SMC"), or
------------ ---
incurred any liability for any investment banking, business consultancy,
financial advisory, brokerage or finders' fees or commissions in connection with
the transactions contemplated hereby, except for fees payable to Smith Barney
and SMC (as reflected in agreements between such firms and the Company, copies
of which have been delivered to Parent).
Section 4.11 Voting Requirement. The affirmative vote of the holders
------------------
of a majority of the outstanding shares of Common Stock in favor of adoption of
this Agreement and the Merger is the only vote of the holders of any class or
series of the Company's capital stock necessary to approve this Agreement and
the transactions contemplated hereby under any applicable law, rule or
regulation or pursuant to the requirements of the Company's certificate of
incorporation or by-laws.
Section 4.12 Litigation. Except as disclosed in the SEC Filings or on
----------
Schedule 4.12, there is no suit, action, proceeding or investigation pending or,
to the knowledge of the Company, overtly threatened against the Company or any
of its subsidiaries that, individually or in the aggregate, will have a Material
Adverse Effect with respect to the Company, nor is there any judgment, decree,
injunction, rule or order of any Governmental Entity or arbitrator outstanding
against the Company or any of its subsidiaries having any such effect.
Section 4.13 Taxes. The Company has filed all material tax returns
-----
required to be filed by it and has paid, or has set up an adequate reserve for
the payment of, all taxes required to be paid as shown on such returns, and the
most recent financial statements contained in the SEC Filings reflect an
adequate reserve for all taxes payable by the Company accrued through the date
of such financial statements. The unpaid taxes, including any contingent tax
liabilities and net deferred tax liabilities, of the Company which have accrued
as of the date of the most recent financial statements contained in the SEC
Filings do not materially exceed the
13
<PAGE>
reserve for accrued tax liability set forth or included in such financial
statements. Except as disclosed in Schedule 4.13, no federal, state or local
audits, examinations or other administrative proceedings have been commenced or,
to the Company's knowledge, are pending with regard to any taxes or tax returns
of the Company or any of its subsidiaries which such audit, if determined
adversely, will have a Material Adverse Effect with respect to the Company. No
agreements have been made by the Company for the extension of time or the waiver
of the statute of limitations for the assessment or payment of any federal,
state or local taxes. Neither the Company nor any of its subsidiaries is or has
been a United States real property holding company within the meaning of Section
897(c)(2) of the Internal Revenue Code of 1986, as amended (the "Code").
----
Section 4.14 Permits; Compliance with Laws.
-----------------------------
(a) The Company and the Company subsidiaries have (i) all franchises,
grants, authorizations, licenses, establishment registrations, product listings,
permits, easements, variances, exceptions, consents, certificates,
identification and registration numbers, approvals and orders of any
Governmental Entity necessary for the Company or any Company subsidiary to own,
lease and operate its properties or to produce, store, distribute and market its
products or otherwise to carry on its business as it is now being conducted and
(ii) agreements and certifications from all Federal, state, foreign and local
governmental agencies and accrediting and certifying organizations having
jurisdiction over such facility or facilities that are required to operate the
facility or facilities in the manner in which it or they are currently operated
and receive reimbursement for care provided to patients covered under the
Federal Medicare program ("Medicare"), any applicable state Medicaid program
--------
("Medicaid") or any comparable foreign medical reimbursement program (all the
--------
matters referred to in clauses (i) and (ii) collectively, the "Company
-------
Permits"), except where the failure to have, or the suspension or cancellation
- - -------
of, any of the Company Permits will not have, individually or in the aggregate,
a Material Adverse Effect with respect to the Company, and no suspension or
cancellation of any of the Company Permits is pending or, to the knowledge of
the Company, threatened, except where the failure to have, or the suspension or
cancellation of, any of the Company Permits will not have, individually or in
the aggregate, a Material Adverse Effect with respect to the Company. Without
limiting the generality of the foregoing, except as set forth in Schedule
4.14(a), all of the Company's facilities are certified for participation or
enrollment in the Medicare program and the Medicaid programs for states in which
the Company has facilities, have current and valid provider contracts with the
Medicare program and the Medicaid programs for states in which the Company has
facilities and are in substantial compliance with the conditions of
participation of such programs. Neither the Company nor any Company subsidiary
is in conflict with, or in default or violation of, (A) any law applicable to
the Company or any Company subsidiary or by which any property or asset of the
Company or any Company subsidiary is bound or affected or (B) any Company
Permits, except in the case of clauses (A) and (B) for any such conflicts,
defaults or violations that will not have, individually or in the aggregate, a
Material Adverse Effect with respect to the Company. Neither the Company nor
any Company subsidiary has received notice from the regulatory authorities that
enforce the statutory or regulatory provisions in respect of either the Medicare
or the Medicaid program of any pending or threatened investigations or surveys,
and no such investigations or surveys are pending or, to the knowledge of the
Company, threatened or imminent. Schedule 4.14(a) sets
14
<PAGE>
forth, as of the date of this Agreement, all actions, proceedings,
investigations or surveys pending or, to the knowledge of the Company,
threatened against the Company or any Company subsidiary that could reasonably
be expected to result in (i) the loss or revocation of a Company Permit
necessary to operate one or more facilities or for a facility to receive
reimbursement under the Medicare or Medicaid programs or (ii) the suspension or
cancellation of any other Company Permit, except, in the case of clauses (i) and
(ii), any such Company Permit where such suspension or cancellation will not
have, individually or in the aggregate, a Material Adverse Effect with respect
to the Company.
(b) The Company and each Company subsidiary, as appropriate, is an
approved participating provider in and under all third party payment programs
from which it receives revenues. No action or investigation is pending, or to
the knowledge of the Company, threatened to suspend, limit, terminate,
condition, or revoke the status of the Company or any Company subsidiary as a
provider in any such program, and neither the Company nor any Company subsidiary
has been provided written notice by any third party payor of its intention to
suspend, limit, terminate, revoke, condition or fail to renew in whole or in
part or decrease the amounts payable under any arrangement with the Company or
such Company subsidiary as a provider, which action, investigation, proceeding,
suspension, limitation, termination, revocation, conditioning or failure to
renew will have, individually or in the aggregate, a Material Adverse Effect
with respect to the Company.
(c) Neither the Company nor any Company subsidiary is delinquent with
respect to the filing of any claims, cost reports or annual filings required to
be filed to secure payments for services rendered by them under any third-party
payment program from which they receive or expect to receive revenues,
including, without limitation, Medicare and Medicaid, except where such
delinquency will not individually or in the aggregate have a Material Adverse
Effect with respect to the Company. Except as indicated in its financial
statements included in the SEC Filings, the Company or each Company subsidiary,
as applicable, has paid, or caused to be paid, all refunds, discounts,
adjustments, or amounts owing that have become due to such third party payors
pursuant to such claims, reports or filings and, to the knowledge of the
Company, there are no material changes required to be made to any cost reports,
claims or filings made by it for any period or of any deficiency in any such
claim, report, or filing, except for changes and deficiencies that in the
aggregate will not have a Material Adverse Effect with respect to the Company.
Section 4.15 Title to Properties. The Company and its subsidiaries
-------------------
have good, valid and marketable title to the properties and assets reflected on
the most recent consolidated balance sheet included in the SEC Filings (the
"Balance Sheet") (other than properties and assets disposed of in the ordinary
-------------
course of business since the date of the Balance Sheet, and all such properties
and assets are free and clear of any Liens, except as described in the SEC
Filings and the financial statements included therein or on Schedule 4.3 or
4.15, liens for current taxes not yet due and other than Liens or title
imperfections that will not have a Material Adverse Effect with respect to the
Company.
Section 4.16 State Takeover Statutes. The Board of Directors of the
-----------------------
Company has approved the Offer, the Merger, this Agreement, the Stockholder
Agreement, the pledge,
15
<PAGE>
if any, of Shares by Merger Sub to a provider of financing for the Offer to
Parent or Merger Sub and the exercise of remedies after the Majority Acquisition
with regard to any such pledged Shares and such approval is sufficient to render
inapplicable to the Offer, the Merger, this Agreement, the Stockholder
Agreement, the pledge, if any, of Shares by Merger Sub to a provider of
financing for the Offer to Parent or Merger Sub and the exercise of remedies
after the Majority Acquisition with regard to any such pledged Shares and the
transactions contemplated by this Agreement and the Stockholder Agreement, the
provisions of Section 203 of the DGCL.
Section 4.17 Employee Benefit Plans.
----------------------
(a) The Company and each of its subsidiaries have complied, and
currently are in compliance, in all material respects with the applicable
provisions of the Employee Retirement Income Security Act of 1974, as amended
("ERISA") and the Code with respect to each employee benefit plan (as defined
-----
under Section 3(3) of ERISA) maintained by the Company or any of its
subsidiaries (each, a "Plan"). There has been no prohibited transaction (within
----
the meaning of Section 406 of ERISA or Section 4975 of the Code) with respect to
any Plan.
(b) Each of the Plans that is intended to qualify under Section 401(a)
of the Code does so qualify and is exempt from taxation pursuant to Section
501(a) of the Code. The Company has no Plans which are employee pension benefit
plans (within the meaning of Section 3(2)(A) of ERISA).
(c) Neither the Company nor any of its subsidiaries has maintained,
adopted or established, contributed or been required to contribute to, or
otherwise participated in or been required to participate in, any employee
benefit plan or other program or arrangement subject to Title IV of ERISA
(including, without limitation, a "multi-employer plan" (as defined in Section
3(37) of ERISA) and a defined benefit plan (as defined in Section 3(35) of
ERISA)).
(d) No Plan provides benefits, including, without limitation, death,
health or medical benefits (whether or not insured), with respect to current or
former employees of the Company beyond their retirement or other termination of
service with the Company (other than (i) coverage mandated by applicable law,
(ii) deferred compensation benefits accrued as liabilities on the books of the
Company, or (iii) benefits the full cost of which is borne by the current or
former employee (or his beneficiary)).
(e) The Company has made available to Parent (i) copies of all
employment agreements with officers of the Company; (ii) copies of all
agreements with consultants who are individuals obligating the Company to make
annual cash payments in an amount exceeding $100,000 and which are not
terminable on less than 60 days' notice without penalty; (iii) copies of all
plans, programs, agreements and other arrangements of the Company with or
relating to its employees which contain change of control provisions; and (iv)
the various forms of employment agreement, if any, of the Company for its non-
executive employees.
16
<PAGE>
(f) To the Company's knowledge, the Company and the Company
subsidiaries are in compliance with the requirements of the Americans With
Disabilities Act and the health care continuation and notice provisions of the
Consolidated Omnibus Budget Reconciliation Act of 1985.
(g) The Company and the Company subsidiaries are in compliance with
the requirements of the Workers Adjustment and Retraining Notification Act
("WARN") and have no liabilities pursuant to WARN.
----
(h) Except as set forth on Schedule 4.17(h), neither the Company nor
any Company subsidiary is a party to any collective bargaining or other labor
union contract applicable to persons employed by the Company or any Company
subsidiary and no collective bargaining agreement is being negotiated by the
Company or any Company subsidiary. As of the date of this Agreement, there is
no labor dispute, strike or work stoppage against the Company or any Company
subsidiary pending or, to the knowledge of the Company, threatened which may
interfere with the respective business activities of the Company or any Company
subsidiary. As of the date of this Agreement, to the knowledge of the Company,
none of the Company, any Company subsidiary, or any of their respective
representatives or employees has committed any unfair labor practice in
connection with the operation of the respective businesses of the Company or any
Company subsidiary, and there is no charge or complaint against the Company or
any Company subsidiary by the National Labor Relations Board or any comparable
governmental entity pending or threatened in writing, except where such unfair
labor practice, charge or complaint will not have a Material Adverse Effect with
respect to the Company.
Section 4.18 Insurance. The Company maintains, and has maintained,
---------
without interruption, during the past three years, policies or binders of
insurance covering such risks, and events, including personal injury, property
damage and general liability, in amounts the Company reasonably believes
adequate for its business and operations.
Section 4.19 Environmental Matters.
---------------------
(a) Except as set forth in the SEC Filings, (i) the assets,
properties, businesses and operations of the Company and its subsidiaries are
and have been in compliance with applicable Environmental Laws (as defined
below), except for such non-compliance which has not had and will not have a
Material Adverse Effect with respect to the Company); (ii) the Company and its
subsidiaries have obtained and, as currently operating, are in compliance with
all Company Permits necessary under any Environmental Law for the conduct of the
business and operations of the Company and its subsidiaries in the manner now
conducted except for such non-compliance which has not had and will not have a
Material Adverse Effect with respect to the Company; (iii) all Hazardous
Substances generated at or in connection with the real properties and operation
of the Company have been transported and otherwise handled, treated and disposed
of in compliance with all applicable Environmental Laws and in a manner that
does not result in liability under Environmental Laws, except for noncompliance
or liability which has not had and will not have a Material Adverse Effect with
respect to the Company, (iv) no Hazardous Substances have been disposed of or
otherwise released, handled or stored by the Company on the real properties on
which the Company's business is conducted or elsewhere in
17
<PAGE>
violation of applicable Environmental Laws or in a manner that would result in
liability under applicable Environmental Laws which will have a Material Adverse
Effect with respect to the Company and (v) neither the Company nor any of its
subsidiaries nor any of their respective assets, properties, businesses or
operations has received or is subject to any outstanding order, decree,
judgment, complaint, agreement, claim, citation, notice, or to the knowledge of
the Company, any investigation, inquiry or proceeding indicating that the
Company or any of its subsidiaries is or may be (a) liable for a violation of
any Environmental Law or (b) liable for any Environmental Liabilities and Costs
(including, without limitation, any such Environmental Liabilities or Costs
incurred in connection with being designated as a "potentially responsible
party" pursuant to the Comprehensive Environmental Response, Compensation and
Liability Act or any analogous state law (any such designation of the Company
being set forth on Schedule 4.19)), where such liabilities, individually or in
the aggregate, will have a Material Adverse Effect with respect to the Company.
(b) For purposes of this Agreement, the terms below shall have the
following meanings:
"Environmental Law" means any law (including, without limitation, common
-----------------
law), regulation, ordinance, guideline, code, decree, judgment, order, permit or
authorization or other legally enforceable requirement of any Governmental
Authority relating to worker or public safety and the indoor and outdoor
environment, including, without limitation, pollution, contamination, Hazardous
Substances, cleanup, regulation and protection of the air, water or soils in the
indoor or outdoor environment; and
"Environmental Liabilities and Costs" means all damages, penalties,
-----------------------------------
obligations or clean-up costs assessed or levied pursuant to any Environmental
Law;
"Hazardous Substances" means petroleum products, asbestos, radioactive
--------------------
material, or hazardous or toxic substances or wastes as defined or regulated
under any Environmental Law.
Section 4.20 Opinion of Financial Advisor. The Board of Directors of
----------------------------
the Company has received the opinion of Smith Barney, dated the date of this
Agreement, to the effect that, as of the date of this Agreement, the cash
consideration to be received in the Offer and the Merger by the holders of
Common Stock (other than Parent and its affiliates) is fair, from a financial
point of view, to such holders, and a complete and correct signed copy of such
opinion will be delivered to Parent after receipt thereof by the Company.
Section 4.21 Intellectual Property. The Company neither owns nor
---------------------
licenses any intellectual property (including, without limitation, patents,
copyrights, trademarks or know-how) the absence of which will have a Material
Adverse Effect with respect to the Company.
18
<PAGE>
ARTICLE 5
REPRESENTATIONS AND WARRANTIES
OF PARENT AND MERGER SUB
Parent and Merger Sub represent and warrant to the Company as follows:
Section 5.1 Organization. Each of Parent and Merger Sub is a
------------
corporation duly organized, validly existing and in good standing under the laws
of the jurisdiction of its incorporation. Merger Sub is a newly formed, wholly
owned subsidiary of the Parent and, except for activities incident to the
acquisition of the Company, Merger Sub has not engaged in any business
activities of any type or kind whatsoever.
Section 5.2 Authorization; Binding Agreement. Each of Parent and
--------------------------------
Merger Sub has the full corporate power and authority to execute and deliver
this Agreement and to consummate the transactions contemplated hereby. The
execution and delivery of this Agreement and the consummation of the
transactions contemplated hereby have been duly and validly authorized by all
necessary corporate action on the part of each of Parent and Merger Sub. This
Agreement has been duly and validly executed and delivered by each of Parent and
Merger Sub and constitutes a legal, valid and binding agreement of each of
Parent and Merger Sub, enforceable against each of them in accordance with its
terms except as may be limited by (a) bankruptcy, insolvency, reorganization or
other laws now or hereafter in effect relating to creditors' rights generally
and (b) general principles of equity (regardless of whether enforceability is
considered in a proceeding at law or in equity).
Section 5.3 Noncontravention. Neither the execution and delivery of
----------------
this Agreement nor the consummation of the transactions contemplated hereby will
(a) conflict with or result in any breach of any provision of the certificate of
incorporation or by-laws of Parent or Merger Sub, (b) require any consent,
approval or notice under or conflict with or result in a violation or breach of,
or constitute (with or without notice or lapse of time or both) a default (or
give rise to any right of termination, cancellation or acceleration) under, any
of the terms, conditions or provisions of any Contracts and Other Agreements to
which Parent or Merger Sub is a party or by which either of them or any material
portion of their properties or assets may be bound or (c) subject to the matters
referred to in clauses (a), (b) and (c) of Section 5.4 below, violate any Legal
Requirements applicable to Parent or Merger Sub or any material portion of their
properties or assets; provided that no representation or warranty is made in the
--------
foregoing clauses (b) and (c) with respect to matters that, individually or in
the aggregate, will neither materially delay the transactions contemplated
hereby nor have a Material Adverse Effect with respect to Parent.
Section 5.4 Governmental Approvals. No consent, approval or
----------------------
authorization of, or declaration or filing with, any Governmental Entity on the
part of either Parent or Merger Sub that has not been obtained or made is
required in connection with the execution or delivery by Parent or Merger Sub of
this Agreement or the consummation by Parent or Merger Sub of the transactions
contemplated hereby, other than (a) the filing of the Certificate of Merger with
the Secretary of State of the State of Delaware, (b) filings under the HSR Act,
the Exchange Act
19
<PAGE>
and as set forth on Schedule 5.4, (c) the filing of appropriate documents with
the relevant authorities of states other than Delaware in which Parent or any of
its subsidiaries is authorized to do business, (d) such filings as may be
required in connection with any state or local tax which is attributable to the
beneficial ownership of Parent's or its subsidiaries' real property, if any, (e)
such filings and consents as may be required under any environmental, health or
safety law or regulation, or any health care licensure laws, reimbursement
authorities and their agents, certificate of need laws and other health care
laws and regulations, pertaining to any notification, disclosure or required
approval required by the Merger or the transactions contemplated by this
Agreement, (f) such filings as may be required by any applicable state
securities or "blue sky" laws or state takeover laws and (g) consents,
approvals, authorizations, declarations or filings that, if not obtained or
made, will neither, individually or in the aggregate, materially delay the
transactions contemplated hereby nor have a Material Adverse Effect with respect
to Parent.
Section 5.5 Information Supplied. None of the information supplied or
--------------------
to be supplied in writing by Parent or Merger Sub specifically for inclusion or
incorporation by reference in the Offer Documents, the Schedule 14D-9, the
Information Statement, or, if applicable, the Proxy Statement will, in the case
of the Offer Documents, the Schedule 14D-9 and the Information Statement, at the
respective times the Offer Documents, the Schedule 14D-9 and the Information
Statement are filed with the SEC or first published, sent or given to the
holders, or, in the case of the Proxy Statement, at the date the Proxy Statement
is first mailed to the Company's stockholders or at the time of the meeting of
the Company's stockholders held to vote on approval and adoption of this
Agreement, contain any untrue statement of a material fact or omit to state any
material fact required to be stated therein or necessary in order to make the
statements therein, in light of the circumstances under which they are made, not
misleading. The Offer Documents will comply as to form in all material respects
with the requirements of the Exchange Act and the rules and regulations
promulgated thereunder, except that no representation or warranty is made by
Parent or Merger Sub with respect to statements made or incorporated by
reference therein based on information supplied in writing by the Company
specifically for inclusion or incorporation by reference therein.
Section 5.6 Financing. After giving effect to borrowings under
---------
Parent's financing commitments, Merger Sub will have sufficient funds available
to purchase all the outstanding shares on a fully diluted basis of Common Stock
pursuant to the Offer and the Merger, to satisfy its obligations under Section
3.1(d), to refinance all indebtedness that will or may become due as a result of
the consummation of the Offer or the Merger, to comply with Section 10.1 of each
of the Indentures (as defined in Section 6.12) and to pay all fees and expenses
incurred by it or disclosed pursuant to Section 4.10 related to the transactions
contemplated by this Agreement.
Section 5.7 Regulatory Approval. Parent is not aware of any existing
-------------------
impediment to the approval of the transactions contemplated hereby by any
Governmental Authority whose approval is required to consummate the transactions
contemplated hereby.
20
<PAGE>
Section 5.8 Compliance with Laws. Except as set forth in Parent's SEC
--------------------
Filings, neither Parent nor any of its subsidiaries is in conflict with, or in
default or violation of, any law, rule, regulation, order, judgment or decree
applicable to Parent or any subsidiary or by which any property or asset of
Parent or any subsidiary is bound or affected, except for any such conflicts,
defaults or violations that will not in the aggregate materially delay the
transactions contemplated hereby. Except as set forth in Parent's SEC Filings,
Parent and its subsidiaries have all permits, licenses, authorizations,
consents, approvals and franchises from governmental agencies required to
conduct their businesses as now being conducted (the "Parent Permits"), except
--------------
for such permits, licenses, authorizations, consents, approvals and franchises
the absence of which would not in the aggregate materially delay the
transactions contemplated hereby. Except as set forth in the Parent's SEC
Filings, Parent and its subsidiaries are in compliance with the terms of the
Parent Permits, except where the failure so to comply would not in the aggregate
materially delay the transactions contemplated hereby.
Section 5.9 Litigation. Except as disclosed in Parent's Filings, there
----------
is no suit, action, proceeding or investigation pending or, to the knowledge of
Parent, overtly threatened in writing against Parent or any of its subsidiaries
that, individually or in the aggregate, will materially delay the transactions
contemplated hereby, nor is there any judgment, decree, injunction, rule or
order of any Governmental Entity or arbitrator outstanding against Parent or any
of its subsidiaries having any such effect.
ARTICLE 6
COVENANTS
Section 6.1 Conduct of Business of the Company. Except as contemplated
----------------------------------
by this Agreement, during the period commencing on the date hereof and ending at
the Effective Time, the Company shall, and shall cause each of its subsidiaries
to, conduct its operations according to its ordinary course of business
consistent with past practice, and the Company shall, and shall cause each of
its subsidiaries to, use all reasonable efforts to preserve intact its business
organization and to maintain satisfactory relationships with its customers,
suppliers, employees and others having material business relationships with it.
Without limiting the generality of the foregoing, and except as otherwise
expressly provided in this Agreement, prior to the Effective Time, neither the
Company nor any or its subsidiaries will, without the prior written consent of
the Parent:
(a) amend or propose to amend its certificate of incorporation or
by-laws;
(b) authorize for issuance, issue, sell, pledge, deliver or agree
or commit to issue, sell, pledge or deliver (whether through the issuance or
granting of any options, warrants, calls, subscriptions, stock appreciation
rights or other rights or other agreements) any capital stock of any class or
any securities convertible into or exchangeable for shares of capital stock of
any class of the Company, or any other ownership interest (including stock
appreciation
21
<PAGE>
rights or phantom stock) other than shares of Common Stock issuable upon
exercise of Company Stock Options outstanding on the date of this Agreement;
(c) split, combine or reclassify any shares of Common Stock or
declare, pay or set aside for payment any dividend or other distribution in
respect of any Common Stock, or redeem, purchase or otherwise acquire any shares
of Common Stock or any other securities of the Company or any rights, warrants
or options to acquire any such shares of other securities;
(d) enter into any other agreements, commitments or contracts that are
material to the Company and its subsidiaries taken as a whole or otherwise make
any material change that is adverse to the Company in (i) any existing
agreement, commitment or arrangement that is material to the Company and its
subsidiaries taken as a whole or (ii) the conduct of the business or operations
of the Company and its subsidiaries;
(e) sell, pledge, dispose of or encumber any assets of the Company or
any of its subsidiaries (except for (i) sales of assets in the ordinary course
of business and in a manner consistent with past practice, (ii) dispositions of
obsolete or worthless assets, (iii) the dispositions described on, and pursuant
to the terms described in, Schedule 6.1(e) and (iv) the sale of the assets on
Schedule 6.1(e) hereto (the "Meridian Assets") on an "as is, where is," basis to
---------------
the individuals named thereon for a cash purchase price of $3,000,000 without
recourse to the Company if, and only if, five days prior to such sale the chief
financial officer of the Company shall have certified in writing to Parent that
as of the date of this Agreement the twelve months trailing EBITDA (determined
on the basis disclosed to Parent prior to the date of this Agreement) associated
with such assets is $1,300,000 or less;
(f) (i) acquire (by merger, consolidation, or acquisition of stock or
assets) any corporation, partnership or other business organization or division
thereof, except for the acquisitions described on Schedule 6.1(f); (ii) incur
any indebtedness for borrowed money (other than pursuant to the Company's credit
facilities as in effect on the date of this Agreement) or issue any debt
securities or assume, guarantee or endorse or otherwise as an accommodation
become responsible for, the obligations of any person, or make any loans or
advances; (iii) enter into or amend any material contract or agreement other
than in the ordinary course of business or enter into any management contract
for a facility not cancelable without penalty within 30 days of notice; (iv)
authorize or make any capital expenditures or purchase of fixed assets which
are, in the aggregate, in excess of $7,400,000 (exclusive of management
information systems expenditures as described in the proviso hereto) for the
Company and its subsidiaries, taken as a whole; provided, however, the Company
-------- -------
will give Parent prior notice of the making or the firm commitment of capital
expenditure or lease payment in any calendar quarter relating to management
information systems equipment with a fair market value greater than $1,000,000;
or (v) terminate any material contract or amend any of its material terms (other
than amendments to existing credit arrangements designed to remedy defaults
thereunder);
(g) increase the compensation payable or to become payable to its
officers or employees, or grant any severance or termination pay to, or, except
as set forth on
22
<PAGE>
Schedule 6.10(c), enter into any employment or severance agreement with any
director, officer or other employee of the Company or any of its subsidiaries;
(h) take any action, other than as required by GAAP, to change
accounting policies or procedures or cash maintenance policies or procedures
(including, without limitation, procedures with respect to revenue recognition,
capitalization of development costs, payments of accounts payable and collection
of accounts receivable);
(i) make any material Tax election inconsistent with past practices or
settle or compromise any material federal, state, local or foreign tax liability
or agree to an extension of a statute of limitations for any assessment of
federal income tax or material state corporate income or franchise tax, except
to the extent the amount of any such settlement has been reserved for on the
Company's most recent SEC Filings;
(j) pay, discharge, settle, or satisfy any lawsuits, claims,
liabilities or obligations (absolute, accrued, asserted or unasserted,
contingent or otherwise), other than the payment, discharge or satisfaction in
the ordinary course of business and consistent with past practice of liabilities
reflected or reserved against in the financial statements of the Company or
incurred in the ordinary course of business and consistent with past practice;
(k) except as may be required by law, take any action to establish,
adopt or enter into, or to terminate or amend any Plan;
(l) (i) permit any increase in the number of employees of the Company
employed by the Company on the date hereof other than pursuant to an employee
plan to be agreed to by the Company and Parent as promptly as practicable after
the date hereof acting reasonably and in good faith or (ii) terminate any
employees of the Company identified on Schedule 6.10(c) other than for Cause (as
defined below);
(m) enter into any contract or arrangement with any affiliate of the
Company (other than subsidiaries of the Company); or
(n) agree, commit or arrange to do any of the foregoing.
Section 6.2 Stockholder Approval; Proxy Statement. Following the
-------------------------------------
purchase of shares of Common Stock pursuant to the Offer, if required by
applicable law in order to consummate the Merger, the Company shall take all
action necessary in accordance with applicable law to convene a meeting of its
stockholders as promptly as practicable to consider and vote upon this Agreement
and the transactions contemplated hereby. The Company shall, through its Board
of Directors (the "Board"), recommend that the Company's stockholders vote in
-----
favor of the adoption of this Agreement and the transactions contemplated
hereby, subject to the Board's fiduciary duty under applicable law. As soon as
practicable following the purchase of shares of Common Stock pursuant to the
Offer, the Company shall prepare and file with the SEC under the Exchange Act
the Proxy Statement and shall use its reasonable best efforts to cause the Proxy
Statement to be mailed to stockholders of the Company as promptly as practicable
after such filing. At the meeting of the Company's stockholders, the Parent
shall
23
<PAGE>
cause all Parent Shares to be voted in favor of the adoption of this Agreement
and the transactions contemplated hereby.
Section 6.3 Access and Information. Between the date of this Agreement
----------------------
and the Effective Time, the Company shall, and shall cause its subsidiaries to,
afford the Parent and its authorized representatives (including its accountants,
financial advisors and legal counsel) reasonable access during normal business
hours to all of the properties, personnel, Contracts and Other Agreements, books
and records of the Company and its subsidiaries and shall promptly deliver or
make available to the Parent (a) a copy of each report, schedule and other
document filed by the Company pursuant to the requirements of Federal or state
securities laws and (b) all other information concerning the business,
properties, assets and personnel of the Company and its subsidiaries as the
Parent may from time to time reasonably request. The terms of the
Confidentiality Agreement dated July 8, 1997 (the "Confidentiality Agreement")
-------------------------
between the Company and the Parent) are incorporated herein by reference and
shall remain in full force and effect.
Section 6.4 No Solicitation.
---------------
(a) The Company shall not, directly or indirectly, through any
officer, director, employee, representative or agent of the Company or any of
its subsidiaries, solicit or encourage (including by way of furnishing
information) the initiation of any inquiries or proposals regarding an
Alternative Transaction (as defined below) (any of the foregoing inquiries or
proposals being referred to herein as an "Acquisition Proposal"). Provided that
--------------------
the Company and the Board shall have complied with the first sentence of this
Section 6.4(a), nothing contained in this Section 6.4(a) or any other provision
of this Agreement shall prevent the Board if it determines in good faith, after
consultation with, and the receipt of advice from, outside counsel, that it is
required to do so in order to discharge properly its fiduciary duties, from
considering, negotiating, approving and recommending to the stockholders of the
Company an unsolicited bona fide written Acquisition Proposal (provided that
--------
such Acquisition Proposal is for not less than $23.00 per Share and has no
financing contingencies) which the Board of Directors of the Company determines
in good faith (after consultation with its financial advisors) would result in a
transaction more favorable to the Company's stockholders than the transaction
contemplated by this Agreement (any Acquisition Proposal meeting such criteria,
including those specified in the immediately preceding parenthetical proviso,
being referred to herein as a "Superior Proposal"). Nothing herein shall
-----------------
prohibit the Company from complying with Rules 14d-9 and 14e-2 under the
Exchange Act with respect to any other tender offers.
(b) The Company shall promptly, but in no event later than 24 hours,
notify Parent after receipt of any Acquisition Proposal or any request for
nonpublic information relating to the Company or any of its subsidiaries in
connection with an Acquisition Proposal or for access to the properties, books
or records of the Company or any subsidiary by any person or entity that informs
the Board that it is considering making, or has made, an Acquisition Proposal.
Such notice to Parent shall be made orally and in writing and shall indicate in
reasonable detail the identity of the offeror and the terms and conditions of
such proposal, inquiry or contact.
24
<PAGE>
(c) If the Board receives a request for material nonpublic information
by a party who makes an unsolicited bona fide Acquisition Proposal and the Board
determines that such proposal, if consummated pursuant to its terms would be a
Superior Proposal, then, and only in such case, the Company may, subject to the
execution of a confidentiality agreement substantially similar to that then in
effect between the Company and Parent, provide such party with access to
information regarding the Company.
(d) The Company shall immediately cease and cause to be terminated any
existing discussions or negotiations with any parties (other than Parent and
Merger Sub) conducted heretofore with respect to any of the foregoing. The
Company agrees not to release any third party from any confidentiality or
standstill agreement to which the Company is a party.
(e) The Company shall ensure that the officers, directors and
employees of the Company and its subsidiaries and any investment banker or other
advisor or representative retained by the Company are aware of the restrictions
described in this Section; and shall be responsible for any breach of this
Section 6.4 by such bankers, advisors and representatives.
Section 6.5 Reasonable Efforts; Additional Actions.
--------------------------------------
(a) Upon the terms and subject to the conditions of this Agreement,
each of the parties hereto shall use all reasonable efforts to take, or cause to
be taken, all action, and to do or cause to be done, and to assist and cooperate
with the other parties in doing, all things necessary, proper or advisable to
consummate and make effective as promptly as practicable the transactions
contemplated by this Agreement, including using all reasonable efforts to (i)
obtain all consents, amendments to or waivers under the terms of any of the
Company's contractual arrangements required by the transactions contemplated by
this Agreement, (ii) effect promptly all necessary or appropriate registrations
and filings with Governmental Entities, including, without limitation, filings
and submissions pursuant to the HSR Act, the Exchange Act, the DGCL and state
and Federal licensing authorities, (iii) defend any lawsuits or other legal
proceedings, whether judicial or administrative, challenging this Agreement or
the consummation of the transactions contemplated hereby and (iv) fulfill or
cause the fulfillment of the conditions to Closing set forth in Article 7. In
connection with and without limiting the foregoing, the Company and its Board of
Directors shall (x) take all action necessary to ensure that no state takeover
statute or similar statute or regulation (including, without limitation, Section
203 of the DGCL) is or becomes applicable to the Offer, the Merger, this
Agreement or any of the other transactions contemplated by this Agreement and
(y) if any state takeover statute or similar statute or regulation becomes
applicable to the Offer, the Merger, this Agreement, the Stockholder Agreement
or any other transaction contemplated by this Agreement or the Stockholder
Agreement, take all action necessary to ensure that the Offer, the Merger and
the other transactions contemplated by this Agreement and the Stockholder
Agreement may be consummated as promptly as practicable on the terms
contemplated by this Agreement and the Stockholder Agreement and otherwise to
minimize the effect of such statute or regulation on the Offer, the Merger, this
Agreement, the Stockholder Agreement and the other transactions contemplated by
this Agreement and the Stockholder Agreement. Notwithstanding the foregoing,
the Board of Directors of the Company shall not be prohibited from taking any
action expressly permitted by the terms of this Agreement.
25
<PAGE>
(b) If, at any time after the Effective Time, the Surviving
Corporation shall determine or be advised that any deeds, bills of sale,
assignments, assurances or any other actions or things are necessary or
desirable to vest, perfect or confirm of record or otherwise in the Surviving
Corporation the right, title or interest in, to or under any of the rights,
properties or assets of either of the Constituent Corporations acquired or to be
acquired by the Surviving Corporation as a result of, or in connection with, the
Merger or otherwise to carry out this Agreement, the officers and directors of
the Surviving Corporation shall be authorized to execute and deliver, in the
name and on behalf of each of the Constituent Corporations or otherwise, all
such deeds, bills of sale, assignments and assurances and to take and do, in the
name and on behalf of each of the Constituent Corporations or otherwise, all
such other actions and things as may be necessary or desirable to vest, perfect
or confirm any and all right, title and interest in, to and under such rights,
properties or assets in the Surviving Corporation or otherwise to carry out this
Agreement.
(c) In furtherance and without limiting the above provisions, each of
the Company and Parent shall as promptly as practicable following the execution
and delivery of this Agreement file with the United States Federal Trade
Commission (the "FTC") and the United States Department of Justice ("DOJ") the
--- ---
notification and report form, if any, required for the transactions contemplated
hereby (using reasonable best efforts to make such filings within ten business
days after the date hereof) and any supplemental information requested in
connection therewith pursuant to the HSR Act. Any such notification and report
form and supplemental information shall be in substantial compliance with the
requirements of the HSR Act. Each of the Company and Parent shall furnish to
the other such necessary information and reasonable assistance as the other may
request in connection with its preparation of any filing or submission which is
necessary under the HSR Act. The Company and Parent shall keep each other
apprised of the status of any communications with, and any inquiries or requests
for additional information from, the FTC and the DOJ and shall comply promptly
with any such inquiry or request. Each of Parent and the Company shall use all
reasonable efforts to obtain any clearance required under the HSR Act for, and
to provide assistance to the other in any antitrust proceedings related to, the
consummation of the transactions contemplated by this Agreement.
(d) Each of Parent and the Company agrees to cause to be filed as
promptly as practicable all other applications and notices ("Applications")
------------
required to be filed with Governmental Authorities in order to consummate the
Offer and the Merger (using reasonable best efforts to make such filings within
ten business days after the date hereof), and to pursue diligently the approval
of such Applications.
(e) The Company shall use all reasonable efforts to cause its present
and past, if any, independent auditors to consent to the inclusion or
incorporation by reference of the Company's historical financial statements any
registration statement or proxy statement of Parent, to the extent such consents
are required by applicable law or regulation.
Section 6.6 Notification of Certain Matters. The Company shall give
-------------------------------
notice to Parent, and Parent and Merger Sub shall give notice to the Company,
promptly upon becoming aware of (a) any occurrence, or failure to occur, of any
event, which occurrence or
26
<PAGE>
failure to occur has caused or will cause any representation or warranty in this
Agreement to be untrue or inaccurate in any material respect at any time after
the date hereof and prior to the Effective Time and (b) any material failure on
its part to comply with or satisfy any covenant, condition or agreement to be
complied with or satisfied by it hereunder; provided that the delivery of any
--------
notice pursuant to this Section 6.6 shall not limit or otherwise affect the
remedies available hereunder to the party receiving such notice.
Section 6.7 Public Announcements. The initial press release or
--------------------
releases with respect to the transactions contemplated by this Agreement shall
be in the form agreed to by Parent and the Company. Thereafter, for as long as
this Agreement is in effect, Parent and Merger Sub, on the one hand, and the
Company, on the other hand, shall not, and shall cause their subsidiaries and
affiliates not to, issue or cause the publication of any press release or any
other announcement with respect to the Offer, the Merger, this Agreement or the
other transactions contemplated hereby without the consent of the other (which
shall not be unreasonably withheld or delayed), except where such release or
announcement is required by applicable law or pursuant to any listing agreement
with, or the rules or regulations of, any securities exchange or any other
regulatory requirement.
Section 6.8 Indemnification and Insurance.
-----------------------------
(a) Parent agrees that all rights to indemnification existing in favor
of the present or former directors, officers, and employees of the Company (as
such) or any of its subsidiaries or present or former directors of the Company
or any of its subsidiaries serving or who served at the Company's or any of its
subsidiaries' request as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust, employee benefit plan or other
enterprise, as provided in the Company's certificate of incorporation or by-
laws, or the articles of incorporation, by-laws or similar organizational
documents of any of the Company's subsidiaries and the indemnification
agreements with such present and former directors, officers and employees as in
effect as of the date hereof (true and correct copies of which have been
provided to Parent) with respect to matters occurring at or prior to the
Effective Time shall survive the Merger and shall continue in full force and
effect and without modification (other than modifications following the Merger
which would enlarge the indemnification rights) for a period of not less than
six years, and the Surviving Corporation shall comply fully with its obligations
hereunder and thereunder.
(b) For a period of not less than six years after the Effective Time,
the Surviving Corporation shall maintain officers' and directors' liability
insurance and fiduciary liability insurance covering the persons described in
paragraph (a) of this Section 6.8 (whether or not they are entitled to
indemnification thereunder) who are currently covered by the Company's existing
officers' and directors' or fiduciary liability insurance policies on terms no
less advantageous to such indemnified parties than such existing insurance;
provided, however, that in no event shall Parent be required to expend in any
- - -------- -------
one year an amount in excess of 150% of the annual premiums currently paid by
the Company for such insurance.
(c) This Section 6.8, which shall survive the consummation of the
Merger at the Effective Time and shall continue for the periods specified
herein, is intended to
27
<PAGE>
benefit the Company, the Surviving Corporation, and any person or entity
referenced in this Section 6.8 or indemnified hereunder each of whom may enforce
the provisions of this Section 6.8 (whether or not parties to this Agreement).
Section 6.9 Directors. Promptly upon the acceptance for payment of,
---------
and payment for, such number of shares of Common Stock by Merger Sub pursuant to
the Offer as satisfies the Minimum Condition (the "Majority Acquisition"), and
--------------------
from time to time thereafter, Merger Sub shall be entitled to designate such
number of directors on the Board of Directors of the Company, rounded up to the
next greatest whole number, subject to compliance with Section 14(f) of the
Exchange Act, as shall represent a percentage of the Board of Directors equal to
the percentage of the outstanding shares of Common Stock owned by Merger Sub;
provided that, from the Majority Acquisition until the Effective Time, at least
- - --------
two persons who are directors of the Company on the date hereof shall be
directors of the Company (the "Continuing Directors"); and provided further
-------------------- --- -------- -------
that, if the number of Continuing Directors shall be reduced below two for any
reason whatsoever, any remaining Continuing Directors shall be entitled to
designate a person to fill such vacancy as a Continuing Director for purposes of
this Agreement or, if no Continuing Directors then remain, the other directors
shall designate two persons to fill such vacancies who shall not be officers,
directors, stockholders or affiliates of Parent, Merger Sub or the Company, and
such persons shall be deemed to be Continuing Directors for purposes of this
Agreement. The Company and its Board of Directors shall, at such time, take all
such action needed to cause Merger Sub's designees to be appointed to the
Company's Board of Directors. Subject to applicable law, the Company shall take
all action requested by Parent necessary to effect any such election, including
mailing to its stockholders the Information Statement containing the information
required by Section 14(f) of the Exchange Act and Rule 14f-1 promulgated
thereunder not later than ten days prior to the scheduled expiration date of the
Offer, and the Company agrees to make such mailing with the mailing of the
Schedule 14D-9 (provided that Merger Sub shall have provided to the Company on a
timely basis all information required to be included in the Information
Statement with respect to Merger Sub's designees). At such times, the Company
will also cause (i) each committee of the Board of Directors, (ii) if requested
by Merger Sub, the board of directors of each of the Company's subsidiaries and
(iii) if requested by Merger Sub, each committee of such board to include
persons designated by Merger Sub constituting the same percentage of each such
committee or board as Merger Sub's designees are of the Board. The Company
shall, upon request by Merger Sub, promptly increase the size of the Board or
exercise its best efforts to secure the resignations of such number of directors
as is necessary to enable Merger Sub designees to be elected to the Board and
shall cause Merger Sub's designees to be so elected.
Section 6.10 Employee Matters.
----------------
(a) Parent agrees to cause the Surviving Corporation to comply in all
respects with the change of control provisions of the employment agreements of
each of the persons identified in Schedule 6.10(a) (the "Executives"). Without
----------
limiting the foregoing, all amounts payable upon such change in control shall be
paid in cash immediately following the Majority Acquisition, excluding payments
with respect to Company Stock Options which shall be paid as provided in Section
3.1(d).
28
<PAGE>
(b) (A) Parent agrees to pay or to cause the Surviving Corporation to
pay, in either case upon the terms and subject to the conditions set forth in
this Section 6.10(b), to each of the employees of the Company identified on
Schedule 6.10(b) (the "Affected Employees") an amount (the "Accrued Bonus
------------------ -------------
Payment") equal to such Affected Employee's annual bonus (which amount is set
- - -------
forth opposite such Affected Employee's name on Schedule 6.10(b) under the
heading "Stakeholder Bonus 1997") multiplied by a fraction, the numerator of
which is the number of days that have elapsed from December 31, 1996 (or the
date of hire of the Affected Employee, if later) until the earlier to occur of
the dates set forth in clauses (B)(i) and (B)(ii) hereof and the denominator of
which is 365; provided, that if any such Affected Employee (other than the
--------
persons referred to in Section 6.10(a)) voluntarily terminates his or her
employment other than for Good Reason to Terminate (as defined below), or dies
or becomes disabled, or is terminated for Cause prior to December 31, 1997, the
Surviving Corporation shall not be obligated to make such payment with respect
to such Affected Employee.
(B) Payment of each Affected Employee's Accrued Bonus Payment
shall be payable within two weeks after the earlier to occur of (i) the
termination following the purchase of shares of Common Stock pursuant to the
Offer of such Affected Employee's employment (other than for Cause, disability,
death or termination by such Affected Employee without Good Reason to Terminate)
and (ii) December 31, 1997, if the Affected Employee is employed by the
Surviving Corporation or any of its subsidiaries at such time.
(c) Parent, Merger Sub and the Company agree to comply with the terms,
policies and procedures specified on Schedule 6.10(c).
(d) For purposes of this Section 6.10, "Cause" means conviction of a
-----
felony or a crime involving personal dishonesty or theft or misappropriation of
the property of the Surviving Corporation or its subsidiaries; and "Good Reason
-----------
to Terminate" shall be deemed to occur if Parent, the Surviving Corporation or
- - ------------
any of their subsidiaries or affiliates shall (i) take any action which
substantially reduces an Affected Employee's title, duties, responsibilities,
salary, or, unless such change affects all employees of the Surviving
Corporation or its subsidiaries at a comparable level of seniority and
responsibility, benefits, or (ii) require the Affected Employee to relocate
permanently in excess of 35 miles from the Affected Employees' primary place of
business.
(e) Notwithstanding anything to the contrary contained herein or in
any other document, agreement or instrument, if any person is terminated by the
Company (other than for Cause) following the purchase of shares of Common Stock
pursuant to the Offer but prior to the Effective Time, all Company Stock Options
held by any such person shall be treated as provided in Section 3.1(d) hereof.
Section 6.11 Consummation of Merger. Parent agrees that, subject to
----------------------
the satisfaction of the conditions set forth in Section 7.1, in the event ninety
percent or more of the Shares are tendered pursuant to the Offer, it will unless
precluded by applicable law cause Merger Sub to consummate the Merger as soon as
practicable, but in no event later than five business days after the expiration
of the Offer.
29
<PAGE>
Section 6.12 Debt Offers/Consent Solicitations. Subject to the
---------------------------------
provisions of this Agreement, Merger Sub shall, and Parent shall cause Merger
Sub to, commence (i) a tender offer (the "Junior Tender Offer") to purchase all
-------------------
of the principal amount of, and a consent solicitation (the "Junior Consent
--------------
Solicitation") to the holders of, the Company's 12 1/4% Subordinated Securities
- - ------------
due 2003 (the "Junior Securities") upon the terms and subject to the conditions
-----------------
set forth in Schedule 6.12 and (ii) a tender offer (the "Senior Tender Offer"
-------------------
and, together with the Junior Tender Offer, the "Debt Offers") to purchase all
-----------
of the principal amount of, and a consent solicitation (the "Senior Consent
--------------
Solicitation" and, together with the Junior Consent Solicitation, the "Consent
- - ------------ -------
Solicitations") to the holders of, the Company's 9 7/8% Senior Subordinated
- - -------------
Securities due 2002 (the "Senior Securities" and, together with the Junior
-----------------
Securities, the "Securities") upon the terms and subject to the conditions set
----------
forth in Schedule 6.12. The obligations of Merger Sub to, and of Parent to
cause Merger Sub to, (i) commence the Debt Offers and the Consent Solicitations,
(ii) accept for payment, and pay for, any Securities tendered pursuant to the
Debt Offers and (iii) effect amendments to the terms of the respective
indentures governing the Junior Securities and the Senior Securities (the
"Junior Indenture" and the "Senior Indenture", respectively, and together the
---------------- ----------------
"Indentures") by means of consents obtained pursuant to the Consent
----------
Solicitations, shall be subject only to the conditions set forth in Schedule
6.12 (any of which may be waived by Merger Sub in its sole discretion). Parent
shall contribute to Merger Sub on a timely basis the funds necessary to purchase
any Securities that Merger Sub becomes obligated to purchase pursuant to the
Debt Offers. The Company shall make all reasonable efforts to assist and
cooperate with Merger Sub in conducting the Debt Offers and the Consent
Solicitations.
ARTICLE 7
CONDITIONS
Section 7.1 Conditions to Each Party's Obligations. The respective
--------------------------------------
obligations of each party to effect the Merger shall be subject to the
fulfillment at or prior to the Effective Time of the following conditions:
(a) If required by applicable law, the Merger shall have been
approved by holders of Common Stock as required by such applicable law;
(b) No Legal Requirements shall have been enacted, entered,
promulgated or enforced by any court or Governmental Entity that prohibits or
prevents the consummation of the Merger;
(c) Merger Sub shall have previously accepted for payment and
paid for Shares pursuant to the Offer; and
(d) Any waiting period applicable to the Merger under the HSR
Act shall have expired or been terminated.
30
<PAGE>
ARTICLE 8
TERMINATION
Section 8.1 Termination. This Agreement may be terminated and the
-----------
Merger contemplated hereby may be abandoned at any time prior to the Effective
Time, whether before or after adoption by the stockholders of the Company:
(a) By the mutual written consent of Parent, Merger Sub and the
Company (but only by action of the Continuing Directors after the purchase of
Common Stock pursuant to the Offer);
(b) By Parent, Merger Sub or the Company (but only by action of
the Continuing Directors after the purchase of Common Stock pursuant to the
Offer):
(i) if a court of competent jurisdiction or other
Governmental Entity shall have issued an order or taken any other action
permanently restraining, enjoining or otherwise prohibiting the Offer or
the Merger and such order or other action shall have become final and
nonappealable; or
(ii) (x) as a result of the failure, occurrence or
existence of any of the conditions set forth in Exhibit A (1) Merger Sub
shall have failed to commence the Offer within five business days following
the date of this Agreement or (2) the Offer shall have terminated or
expired in accordance with its terms without Merger Sub having accepted for
payment any shares of Common Stock pursuant to the Offer or (y) Merger Sub
shall not have accepted for payment any shares of Common Stock pursuant to
the Offer by December 31, 1997; provided, however, that the right to
-------- -------
terminate this Agreement pursuant to this Section 8.1(b)(ii) shall not be
available to any party whose failure to perform any of its obligations
under this Agreement results in the failure, occurrence or existence of any
such condition;
(c) By the Company in connection with the entering into, or
consummation of, a Superior Proposal in accordance with Section 6.4, provided
that it has complied with all provisions thereof, including the notice
provisions therein, and that it complies with applicable requirements relating
to the payment (including the timing of any payment) of the Expenses and the
Fee;
(d) By Parent or Merger Sub prior to the purchase of Shares of
Common Stock pursuant to the Offer in the event of a breach by the Company of
any representation, warranty, covenant or other agreement contained in this
Agreement, which (A) would give rise to the failure of a condition set forth in
paragraph (d) or (e) of Exhibit A, and (B) has not been or cannot be cured
within 20 days after the giving of written notice to the Company;
(e) By the Company, if Parent or Merger Sub shall have breached
in any material respect any of their respective representations, warranties,
covenants or other
31
<PAGE>
agreements contained in this Agreement, which failure to perform has not been
cured within 20 days after the giving of written notice to Parent or Merger Sub;
or
(f) by Parent or Merger Sub if either Parent or Merger Sub is
entitled to terminate the Offer as a result of the occurrence of any event set
forth in paragraph (c) of Exhibit A.
Section 8.2 Procedure for and Effect of Termination. In the event that
---------------------------------------
this Agreement is terminated and the Merger is abandoned by the Parent or the
Merger Sub, on the one hand, or by the Company, on the other hand, pursuant to
Section 8.1, written notice of such termination and abandonment shall forthwith
be given to the other parties and this Agreement shall terminate and the Merger
shall be abandoned without any further action. If this Agreement is terminated
as provided herein, no party hereto shall have any liability or further
obligation to any other party under the terms of this Agreement except with
respect to the willful breach by any party hereto and except that the provisions
of this Section 8.2, the final sentence of Section 6.3, Section 8.3 and Article
9 shall survive the termination of this Agreement.
Section 8.3 Fees and Expenses. (a) Except as set forth in this Section
-----------------
8.3, all fees and expenses incurred in connection with this Agreement and the
transactions contemplated hereby shall be paid by the party incurring such
expenses, whether or not the Merger is consummated.
(b) The Company shall pay Parent a fee of $12,000,000 (the
"Fee"), and reimburse Parent for actual and documented out-of-pocket expenses of
---
Parent relating to the transactions contemplated by this Agreement (including,
but not limited to, fees and expenses of Parent's counsel) not in excess of
$4,000,000 ("Expenses"), in the event that:
--------
(i) this Agreement is terminated (x) by Parent pursuant
to Section 8.1(f) or (y) by the Company pursuant to Section
8.1(c);
(ii) this Agreement is terminated by Parent pursuant to
Section 8.1(d) after a breach of Section 6.4 by the Company; or
(iii) (A) the Company shall have received an Acquisition
Proposal at or prior to, or within 30 days after, the termination
of this Agreement and (B) an Alternative Transaction is
consummated on or prior to the one-year anniversary of the
termination of this Agreement.
(c) As used herein, "Alternative Transaction" means (i) a
-----------------------
transaction pursuant to which any person (or group of persons) other than Parent
or its affiliates (a "Third Party") acquires more than 40% of the outstanding
-----------
Shares, whether from the Company or pursuant to a tender offer or exchange offer
or otherwise, (ii) a merger or other business combination involving the Company
pursuant to which any Third Party acquires more than 40% of the outstanding
equity securities of the Company or the entity surviving such merger or business
combination or (iii) any other transaction pursuant to which any Third Party
acquires control of assets (including for this purpose the outstanding equity
securities of subsidiaries of
32
<PAGE>
the Company, and the entity surviving any merger or business combination
including any of them) of the Company and its subsidiaries having a fair market
value equal to more than 40% of the fair market value of all the assets of the
Company and its subsidiaries, taken as a whole, immediately prior to such
transaction; provided, however, that the term Alternative Transaction shall not
-------- -------
include any acquisition of securities by a broker dealer in connection with a
bona fide public offering of such securities.
(d) The Fee and Expenses payable pursuant to Section 8.3(b) shall be
paid upon the earlier of (i) immediately prior to the termination of this
Agreement by the Company pursuant to Section 8.1(c) and (ii) within one business
day after the first to occur of the events described in Section 8.3(b)(i)(x),
(ii) and (iii).
ARTICLE 9
MISCELLANEOUS
Section 9.1 Certain Definitions. For purposes of this Agreement, the
-------------------
following terms shall have the meanings ascribed to them in this Section 9.1(a):
(a) "affiliate," with respect to any person, shall mean any person
---------
controlling, controlled by or under common control with such person;
(b) "knowledge," with respect to the Company, shall mean the actual
---------
knowledge of any executive officer or director of the Company;
(c) "Material Adverse Effect," with respect to any person, shall mean
-----------------------
a material adverse effect on the business, assets, properties, financial
condition or results of operations of such person and its subsidiaries taken as
a whole;
(d) "person" shall mean and include an individual, a partnership, a
------
joint venture, a limited liability company, a corporation, a trust, an
unincorporated organization and a government or any department or agency
thereof; and
(e) "subsidiary," with respect to any person, shall mean any
----------
corporation 50% or more of the outstanding voting power of which, or any
partnership, joint venture, limited liability company or other entity 50% or
more of the total equity interest of which, is directly or indirectly owned by
such person. For purposes of this Agreement, all references to "subsidiaries"
of a person shall be deemed to mean "subsidiary" if such person has only one
subsidiary.
Section 9.2 Amendment and Modification. Subject to applicable law,
--------------------------
this Agreement may be amended, modified or supplemented only by a written
agreement signed by each of the parties hereto at any time prior to the
Effective Time with respect to any of the terms contained herein; provided,
--------
however, that after this Agreement is adopted by the Company's stockholders
- - -------
pursuant to Section 6.2, no such amendment or modification shall
33
<PAGE>
(a) alter or change the amount or kind of the consideration to be delivered to
the stockholders of the Company, (b) alter or change any term of the certificate
of incorporation of the Surviving Corporation or (c) alter or change any of the
terms or conditions of this Agreement if such alteration or change would
adversely affect the stockholders of the Company. If Merger Sub's designees are
appointed or elected to the Board of Directors of the Company as provided in
Section 6.10, after the acceptance for payment of shares of the Common Stock
pursuant to the Offer and prior to the Effective Time, the affirmative vote of a
majority of the Continuing Directors of the Company shall be required for the
Company to take action to (i) amend or terminate this Agreement, (ii) exercise
or waive any of the Company's rights or remedies under this Agreement, (iii)
extend the time for performance of Parent's and Merger Sub's respective
obligations under this Agreement, (iv) take any action to amend or otherwise
modify the Company's certificate of incorporation or by-laws or (v) take any
action that would adversely affect the rights of the holders of Common Stock or
the holders of Company Stock Options with respect to the transactions
contemplated hereby.
Section 9.3 Waiver of Compliance; Consents. Any failure of Parent or
------------------------------
Merger Sub, on the one hand, or the Company, on the other hand, to comply with
any obligation, covenant, agreement or condition herein may, subject to Section
9.2, be waived by Parent, Merger Sub or the Company, respectively, only by a
written instrument signed by the party granting such waiver, but such waiver or
failure to insist upon strict compliance with such obligation, covenant,
agreement or condition shall not operate as a waiver of, or estoppel with
respect to, any subsequent or other failure. Whenever this Agreement requires
or permits consent by or on behalf of any party hereto, such consent shall be
given in writing in a manner consistent with the requirements for a waiver of
compliance as set forth in this Section 9.3 and in Section 9.2. Notwithstanding
anything herein to the contrary, if Merger Sub accepts Shares for payment prior
to October 1, 1997, Parent and Merger Sub shall not be obligated to, and shall
not, consummate the Merger (subject to the other terms and conditions hereof)
until October 2, 1997.
Section 9.4 Survival. The respective representations and warranties of
--------
Parent, Merger Sub and the Company contained herein shall not survive the
Closing hereunder.
Section 9.5 Notices. All notices and other communications hereunder
-------
shall be in writing and shall be deemed to have been duly given when delivered
in person or by telecopier (with a confirmed receipt thereof), and on the next
business day when sent by overnight courier service, to the parties at the
following addresses (or at such other address for a party as shall be specified
by like notice):
(a) if to Parent or Merger Sub, to:
Sun Healthcare Group, Inc.
101 Sun Lane NE
Albuquerque, New Mexico 87109
Attention: General Counsel
Telecopier: (505) 822-0747
34
<PAGE>
with a copy to:
Brobeck, Phleger & Harrison LLP
One Market
Spear Street Tower
San Francisco, California 94105
Attention: Michael J. Kennedy
Telecopier: (415) 442-1010
(b) if to the Company, to:
Regency Health Services, Inc.
2742 Dow Avenue
Tustin, California 92780
Attention: General Counsel
Telecopier: (714) 544-4413
with a copy to:
Paul, Weiss, Rifkind,
Wharton & Garrison
1285 Avenue of the Americas
New York, New York 10019-6064
Attention: Judith R. Thoyer
Telecopier: (212) 757-3990
Section 9.6 Assignment. This Agreement and all of the provisions
----------
hereof shall be binding upon and inure to the benefit of the parties hereto and
their respective successors and permitted assigns, but neither this Agreement
nor any of the rights, interests or obligations hereunder shall be assigned by
any of the parties hereto without the prior written consent of the other
parties, except that Parent and Merger Sub may assign all or any of their rights
hereunder to any affiliate provided that no such assignment shall relieve the
assigning party of its obligations hereunder.
Section 9.7 GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND
-------------
CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF DELAWARE APPLICABLE TO
AGREEMENTS MADE AND TO BE PERFORMED ENTIRELY WITHIN SUCH STATE, WITHOUT REGARD
TO THE CHOICE OF LAW PRINCIPLES THEREOF.
Section 9.8 Counterparts. This Agreement may be executed and delivered
------------
(including by facsimile transmission) in one or more counterparts, each of which
shall be deemed an original, but all of which together shall constitute one and
the same instrument.
35
<PAGE>
Section 9.9 Interpretation. The article and section headings contained
--------------
in this Agreement are solely for the purpose of reference, are not part of the
agreement of the parties and shall not in any way affect the meaning or
interpretation of this Agreement.
Section 9.10 Entire Agreement. This Agreement (including the
----------------
schedules, exhibits, documents or instruments referred to herein) and the
Confidentiality Agreement embody the entire agreement and understanding of the
parties hereto in respect of the subject matter hereof and thereof and supersede
all prior agreements and understandings, both written and oral, among the
parties, or between any of them, with respect to the subject matter hereof and
thereof.
Section 9.11 No Third Party Beneficiaries. Except as expressly
----------------------------
provided in Section 6.8, this Agreement is not intended to, and does not, create
any rights or benefits of any party other than the parties hereto.
Section 9.12 Obligations of Parent. Wherever this Agreement requires
---------------------
Merger Sub to take any action, such requirement shall be deemed to include an
undertaking on the part of Parent to cause Merger Sub to take such action.
36
<PAGE>
IN WITNESS WHEREOF, Parent, Merger Sub and the Company have caused this
Agreement to be signed by their respective duly authorized officers as of the
date first above written.
SUN HEALTHCARE GROUP, INC.
By /s/ Robert D. Woltil
--------------------------------------------
Name: Robert D. Woltil
Title: Senior Vice President for Financial
Services and Chief Financial Officer
SUNREG ACQUISITION CORP.
By /s/ Robert D. Woltil
--------------------------------------------
Name: Robert D. Woltil
Title: Vice President
REGENCY HEALTH SERVICES, INC.
By /s/ Richard K. Matros
--------------------------------------------
Name: Richard K. Matros
Title: President and Chief Executive
Officer
<PAGE>
EXHIBIT A
CONDITIONS OF THE OFFER
-----------------------
Notwithstanding any other term of the Offer or this Agreement, Merger Sub
shall not be required to accept for payment or, subject to any applicable rules
and regulations of the SEC, including Rule 14e-1(c) under the Exchange Act
(relating to Merger Sub's obligation to pay for or return tendered shares of
Common Stock after the termination or withdrawal of the Offer), to pay for any
shares of Common Stock tendered pursuant to the Offer unless, (i) there shall
have been validly tendered and not properly withdrawn prior to the expiration of
the Offer such number of shares of Common Stock which would constitute a
majority of the outstanding shares of Common Stock on a fully-diluted basis on
the date of purchase (the "Minimum Condition") ("on a fully-diluted basis"
-----------------
means, as of the date of the purchase of shares of Common Stock pursuant to the
Offer, the number of shares of Common Stock outstanding, together with all
shares of Common Stock issuable pursuant to options, convertible securities and
any other rights to acquire Shares) and (ii) any waiting period under the HSR
Act or applicable state regulatory statutes or regulations applicable to the
purchase of shares of Common Stock pursuant to the Offer shall have expired or
been terminated. Furthermore, notwithstanding any other term of the Offer or
this Agreement, Merger Sub shall not be required to accept for payment or,
subject as aforesaid, to pay for any shares of Common Stock not theretofore
accepted for payment or paid for, and (subject to Sections 1.1(a) and 6.5(a) of
this Agreement) may terminate the Offer if, at any time on or after the date of
this Agreement and before the acceptance of such shares for payment or the
payment therefor, any of the following conditions exists:
(a) there shall be pending by any Governmental Entity or other person any
suit, action or proceeding (i) challenging the acquisition by Parent or Merger
Sub of any shares of Common Stock under the Offer, seeking to restrain or
prohibit the making or consummation of the Offer or the Merger or the
performance of any of the other transactions contemplated by this Agreement or
the Stockholder Agreement or seeking to obtain from the Company, Parent or
Merger Sub any damages that are material in relation to the Company and its
subsidiaries taken as a whole, (ii) seeking to prohibit or limit the ownership
or operation by the Company, Parent or any of their respective subsidiaries of a
material portion of the business or assets of the Company and its subsidiaries,
taken as a whole, or Parent and its subsidiaries, taken as a whole, or to compel
the Company or Parent to dispose of or hold separate any material portion of the
business or assets of the Company and its subsidiaries, taken as a whole, or
Parent and its subsidiaries, taken as a whole, as a result of the Offer, the
Merger or any of the other transactions contemplated by this Agreement or the
Stockholder Agreement, (iii) seeking to impose material limitations on the
ability of Parent or Merger Sub to acquire or hold, or exercise full rights of
ownership of, any shares of Common Stock accepted for payment pursuant to the
Offer, including, without limitation, the right to vote such Common Stock on all
matters properly presented to the stockholders of the Company, (iv) seeking to
prohibit Parent or any of its subsidiaries from effectively controlling in any
material respect the business or operations of the Company and its subsidiaries,
taken as a whole or (v) which otherwise is reasonably likely to have a Material
Adverse Effect with respect to the Company;
A-1
<PAGE>
(b) there shall be any statute, rule, regulation, legislation, judgment,
order or injunction enacted, entered, enforced, promulgated, or deemed
applicable to the Offer or the Merger, or any other action shall be taken by any
Governmental Entity, other than the application to the Offer or the Merger of
applicable waiting periods under the HSR Act which, in any case, is reasonably
likely to result, directly or indirectly, in any of the consequences referred to
in clauses (i) through (v) of paragraph (a) above;
(c) (i) the Board or any committee thereof shall have withdrawn or modified
in a manner adverse to Parent or Merger Sub its approval or recommendation of
the Offer or the Merger or its adoption of this Agreement, or approved or failed
to reject within 10 business days, any Acquisition Proposal, (ii) the Company
shall have entered into any agreement with respect to any Superior Proposal in
accordance with Section 6.4 of this Agreement or (iii) the Board or any
committee thereof shall have resolved to take any of the foregoing actions;
(d) any of the representations and warranties of the Company set forth in
this Agreement that are qualified as to materiality shall not be true and
correct or any such representations and warranties that are not so qualified
shall not be true and correct in any material respect, in each case at the date
of this Agreement and, in the case of representations and warranties other than
those made specifically as of the date of this Agreement, at the scheduled or
extended expiration of the Offer;
(e) the Company shall have failed to perform in any material respect any
obligation or to comply in any material respect with any agreement or covenant
of the Company to be performed or complied with by it under this Agreement;
(f) this Agreement shall have been terminated in accordance with its terms or
the Offer shall have been terminated with the consent of the Company;
(g) (i) less than a majority in principal amount of either of the Securities
shall have been tendered and not withdrawn pursuant to the Debt Offers or (ii)
consents shall have been obtained in the Consent Solicitations from holders
(other than the Company and its Affiliates (as such term is defined in the
applicable Indenture)) of less than a majority in principal amount as of the
applicable record date of either of the Securities;
(h) there shall have occurred (i) any general suspension of, or limitation of
prices for, trading on the NYSE, AMEX, Nasdaq National Market, (ii) any
declaration of banking moratorium or suspension or payment in respect of banks
in the United States, (iii) any general limitation by a Government Entity on, or
any other event that would limit, the extension of credit by banks or other
lending institutions, (iv) any commencement of war, armed hostilities or other
international or national calamity directly or indirectly involving the United
States having a significant adverse effect on the functionality of financial
markets in the United States or (v) in the case of any of the foregoing,
existing at time of the commencement of the Offer, a material acceleration or
worsening thereof which, in the reasonable judgment of Merger Sub in any case
and regardless of circumstances, makes it inadvisable to proceed with such
acceptance for payment or payment.
A-2
<PAGE>
The foregoing conditions are for the sole benefit of Merger Sub and Parent
and may, subject to the terms of this Agreement, be waived by Merger Sub and
Parent in whole or in part at any time and from time to time in their sole
discretion. The failure by Parent, or Merger Sub at any time to exercise any of
the foregoing rights shall not be deemed a waiver of any such right, the waiver
of any such right with respect to particular facts and circumstances shall not
be deemed a waiver with respect to any other facts and circumstances and each
such right shall be deemed an ongoing right that may be asserted at any time and
from time to time.
A-3
<PAGE>
Exhibit 3
[LOGO OF SUN HEALTHCARE GROUP, INC. APPEARS HERE]
Contacts: Phyllis Goodman (media)
Marjorie Goldstein (investors)
505-821-3355
101 SUN LANE, NE
ALBUQUERQUE, NEW MEXICO 87109
SUN HEALTHCARE GROUP TO ACQUIRE REGENCY HEALTH SERVICES
FOR $589 MILLION
Transaction Will Move Sun to Top-Three Ranking
Among U.S. Long-Term Care Providers
Albuquerque, N.M., and Tustin, Calif., July 27, 1997 -- Sun Heathcare Group,
Inc. (NYSE:SHG) and Regency Health Services, Inc. (NYSE:RHS) announced today
that the companies have signed a definitive agreement under which Sun will
acquire all of the outstanding shares of Regency for $22 per share, or
approximately $369 million in cash. In addition, approximately $220 million of
Regency debt will be assumed or refinanced, putting the value of the total
transaction at approximately $589 million. Regency is an operator of skilled
nursing facilities and a diversified provider of rehabilitation therapy,
institutional pharmacy and home health services.
Regency presently operates 116 inpatient facilities (including 46 with
subacute specialty units), 26 outpatient rehabilitation therapy clinics, and
eight institutional pharmacies. Regency currently has rehabilitation therapy
contracts with 202 facilities and pharmacy contracts with 164 facilities.
Regency's projected total revenues for 1997 are approximately $670 million.
Pursuant to the merger agreement, which was unanimously approved by each of
Sun's and Regency's board of directors, Sun will commence a tender offer for all
of the outstanding shares of Regency within five business days. Upon completion
of the tender offer, the merger agreement provides that shares of Regency not
tendered will be acquired in a merger at the same price per share in cash. Smith
Management Company and its affiliates, Regency's largest shareholder group, have
agreed to tender their shares, which constitute 25 percent of Regency's common
stock pursuant to the tender offer. In addition, certain officers and directors
have agreed to tender their shares.
Sun has obtained a long-term financing commitment of approximately $1
billion through
<PAGE>
2
NationsBank of Texas, N.A., the lead lender in Sun's existing credit facility,
to provide financing for the Regency acquisition, satisfy outstanding credit
facility obligations and provide for ongoing working capital needs. Depending
on market conditions, Sun subsequently plans to replace a portion of the
NationsBank financing through a combination of equity and debt offerings.
The merger will be accounted for on a purchase accounting basis. The
offer is subject to the tender of at least a majority of Regency's shares on a
fully diluted basis, the consent of a majority of Regency's existing
subordinated debt holders, and other customary conditions including required
government approvals. The offer is not subject to Sun's arranging for financing
as a condition for closing.
Sun expects to complete the merger with Regency during the fourth quarter
of 1997, and expects the transaction to be accretive in 1998. No changes will
be made to Sun's board of directors and no significant changes are expected to
be made to Sun's senior management.
Upon completion of the Regency acquisition, and Sun's pending acquisition
of Retirement Care Associates, Inc., Sun will operate 510 long-term care
facilities in the United States and the United Kingdom, with a total of 49,141
beds, and 47 assisted living facilities, with 4,583 units. Considering both
acquisitions, Sun expects annualized revenues in excess of $3 billion in 1998,
and will employ more than 72,000 people in the United States and the United
Kingdom.
Sun expects to realize significant business synergies for the acquisition
of Regency, including the following:
1. Sun's assimilation of Regency's corporate operations is expected to
result in a significant reduction in combined general and
administrative expense.
2. The addition of Regency's 116 inpatient facilities provides immediate
opportunities to expand Sun's pharmacy, medical supply, therapy and
ancillary service businesses.
3. Sun expects to leverage its infrastructure and management expertise
to achieve enhanced efficiencies and improved operational performance
in Regency's contract therapy business.
4. The combination of Sun's and Regency's pharmacy businesses will create
<PAGE>
3
significant economies of scale and operating efficiencies.
Andrew L. Turner, Sun's chairman and chief executive officer, said, "The
acquisition of Regency will significantly increase our facility operations and
revenues and substantially improve our administrative efficiency. By every
important objective measure -- facility operations, revenues or contracts -- Sun
will become one of the three largest providers of long-term care services in the
country."
John W. Adams, president of Smith Management Company and chairman of
Regency, stated, "We are supportive of the transaction completely, which is
demonstrated by the commitment to tender our shares."
Richard K. Matros, president and chief executive officer of Regency, noted,
"The addition of Regency's dedicated and skilled employees to Sun's operations,
combined with the size, strength and market presence of the newly created
entity, will enhance the company's ability to succeed in the dynamic environment
of the evolving long-term care industry."
Sun has engaged Schroder & Co., Inc. as financial advisor for the
transaction; Regency has engaged Smith Barney.
Headquartered in Albuquerque, N.M., Sun is a diversified international
long-term care provider. Sun companies operate long-term care facilities and
pharmacy services across the United States and in the United Kingdom. Sun
subsidiaries also provide therapy services in the United States, fulfill the
medical supply needs of nursing homes, and offer a comprehensive array of
ancillary services for the healthcare industry.
Regency, a national healthcare provider with headquarters in Tustin,
Calif., offers acute rehabilitation, subacute care, skilled nursing,
neurological care and other specialized long-term care and outpatient services.
The company has licensed beds in California, Ohio, West Virginia, North
Carolina and Tennessee, and home health services in 23 locations in two states.
It also offers contract rehabilitation therapy services and institutional
pharmacy services.
Except for historical information, all other matters in this press release
are forward-looking statements that involve risks and uncertainties including,
but not limited to, those detailed from time to time in the company's SEC
filings, which include Sun's and Regency's annual reports on Form 10-K for the
fiscal year ended December 31, 1996.
##
<PAGE>
4
- - --------------------------------------------------------------------------------
STATISTICAL SUMMARY
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Sun Retirement Regency COMBINED
Healthcare Care Health
Group Associates Services
and
Contour
Medical
- - ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Long-term care facilities 311 83 116 510
- - ------------------------------------------------------------------------------------------------
Long-term care beds 29,122 8,526 11,493 49,141
- - ------------------------------------------------------------------------------------------------
Assisted living facilities 5 42 0 47
- - ------------------------------------------------------------------------------------------------
Assisted living units 514 4,069 0 4,583
- - ------------------------------------------------------------------------------------------------
Facilities served through 1,012 83* 202 1,297
therapy contracts
- - ------------------------------------------------------------------------------------------------
Facilities served through 537 125* 164 826
pharmacy contracts
- - ------------------------------------------------------------------------------------------------
Facilities served through 183* 1,400 116* 1,699
medical supply contracts
- - ------------------------------------------------------------------------------------------------
Acute hospital specialty supply contracts 0 550 0 550
- - ------------------------------------------------------------------------------------------------
Outpatient rehabilitation clinics 43 0 26 69
- - ------------------------------------------------------------------------------------------------
Home health service locations 0 0 23 23
- - ------------------------------------------------------------------------------------------------
Total employees 48,500 7,700 16,000 72,200
- - ------------------------------------------------------------------------------------------------
*Expected synergies
</TABLE>
<PAGE>
EXHIBIT 4
SMITH BARNEY
- - ---------------------------------
A Member of TravelersGroup [LOGO]
212-816-6000
July 26, 1997
The Board of Directors
Regency Health Services, Inc.
2742 Dow Avenue
Tustin, California 92680
Members of the Board:
You have requested our opinion as to the fairness, from a financial point of
view, to the holders of the common stock of Regency Health Services, Inc.
("Regency") of the consideration to be received by such holders pursuant to the
terms and subject to the conditions set forth in the Agreement and Plan of
Merger, dated as of July 26, 1997 (the "Merger Agreement"), by and among Sun
Healthcare Group, Inc. ("Sun Healthcare"), Sunreg Acquisition Corp., a wholly
owned subsidiary of Sun Healthcare ("Merger Sub"), and Regency. As more fully
described in the Merger Agreement, (i) Sun Healthcare will cause Merger Sub to
commence a tender offer to purchase all outstanding shares of the common stock,
par value $0.01 per share, of Regency (the "Regency Common Stock") at a purchase
price of $22.00 per share, net to the seller in cash (the "Tender Offer") and
(ii) subsequent to the Tender Offer, Merger Sub will be merged with and into
Regency (the "Merger" and, together with the Tender Offer, the "Transaction")
and each outstanding share of Regency Common Stock not previously tendered will
be converted into the right to receive $22.00 in cash.
In arriving at our opinion, we reviewed the Merger Agreement and held
discussions with certain senior officers, directors and other representatives
and advisors of Regency and certain senior officers and other representatives of
Sun Healthcare concerning the business, operations and prospects of Regency. We
examined certain publicly available business and financial information relating
to Regency as well as certain financial forecasts and other information and data
for Regency which were provided to or otherwise discussed with us by the
management of Regency. We reviewed the financial terms of the Merger as set
forth in the Merger Agreement in relation to, among other things: current and
historical market prices and trading volumes of Regency Common Stock; the
historical and projected earnings and other operating data of Regency; and the
capitalization and financial condition of Regency. We considered, to the extent
publicly available, the financial terms of certain other similar transactions
recently effected which we considered relevant in evaluating the Merger and
analyzed certain financial, stock market and other publicly available
information relating to the businesses of other companies whose operations we
considered relevant in evaluating those of Regency. In addition to the
foregoing, we conducted such other analyses and examinations and considered such
other financial, economic and market criteria as we deemed appropriate in
arriving at our opinion.
In rendering our opinion, we have assumed and relied, without independent
verification, upon the accuracy and completeness of all financial and other
information and data publicly available or furnished to or otherwise reviewed by
or discussed with us. With respect to financial forecasts and other information
and data provided to or otherwise reviewed by or discussed with us, we have been
advised by the management of Regency that such forecasts and other information
and data were reasonably prepared on bases reflecting the best currently
available estimates and judgments of the management of Regency as to the future
financial performance of Regency. We have not made or been provided with an
independent evaluation or appraisal of the assets or liabilities (contingent or
<PAGE>
The Board of Directors
Regency Health Services, Inc.
July 26, 1997
Page 2
otherwise) of Regency nor have we made any physical inspection of the properties
or assets of Regency. In connection with our engagement, we were not requested
to, and did not, solicit third party indications of interest in a possible
acquisition of Regency. Our opinion is necessarily based upon information
available to us, and financial, stock market and other conditions and
circumstances existing and disclosed to us, as of the date hereof.
Smith Barney has been engaged to render financial advisory services to Regency
in connection with the proposed Transaction and will receive a fee for such
services, a significant portion of which is contingent upon the consummation of
the Transaction. We also will receive a fee upon the delivery of this opinion.
In the ordinary course of our business, we and our affiliates may actively trade
or hold the securities of Regency for our own account or for the account of our
customers and, accordingly, may at any time hold a long or short position in
such securities. We have in the past provided investment banking services to
Regency unrelated to the proposed Transaction, for which services we have
received compensation. In addition, we and our affiliates (including Travelers
Group Inc. and its affiliates) may maintain relationships with Regency and Sun
Healthcare.
Our advisory services and the opinion expressed herein are provided for the
information of the Board of Directors of Regency in its evaluation of the
proposed Transaction, and our opinion is not intended to be and does not
constitute a recommendation to any stockholder as to whether or not such
stockholder should tender shares of Regency Common Stock in the Tender Offer or
how such stockholder should vote on the proposed Merger. Our opinion may not be
published or otherwise used or referred to, nor shall any public reference to
Smith Barney be made, without our prior written consent; provided, that this
opinion letter may be included in its entirety in the
Solicitation/Recommendation Statement of Regency relating to the proposed
Transaction.
Based upon and subject to the foregoing, our experience as investment bankers,
our work as described above and other factors we deemed relevant, we are of the
opinion that, as of the date hereof, the cash consideration to be received in
the Transaction by the holders of Regency Common Stock (other than Sun
Healthcare and its affiliates) is fair, from a financial point of view, to such
holders.
Very truly yours,
/s/ Smith Barney Inc.
SMITH BARNEY INC.
