<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-10968
MARINER POST-ACUTE NETWORK, INC.
(formerly "Paragon Health Network, Inc.")
(Exact name of registrant as specified in its charter)
DELAWARE 74-2012902
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
ONE RAVINIA DRIVE, SUITE 1500
ATLANTA, GEORGIA 30346
(Address of principal executive offices) (Zip Code)
(678) 443-7000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----------- -----------
There were 43,662,310 shares outstanding of the issuer's only class of common
stock as of July 30, 1998.
<PAGE>
MARINER POST-ACUTE NETWORK, INC.
AND SUBSIDIARIES
FORM 10-Q
TABLE OF CONTENTS
JUNE 30, 1998
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements and Notes.......... 3
Item 2. Management's Discussion and Analysis of Financial.............. 19
Condition and Results of Operations
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.............................................. 30
Item 2. Changes in Securities and Use of Proceeds...................... 33
Item 3. Not applicable
Item 4. Not applicable
Item 5. Other Information.............................................. 33
Item 6. Exhibits and Reports on Form 8-K............................... 33
SIGNATURE PAGE............................................................... 34
<PAGE>
PART 1 FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended June 30, Ended June 30,
------------------------ -------------------------
1998 1997 1998 1997
------------------------ -------------------------
<S> <C> <C> <C> <C>
Net Revenues
Nursing home revenue:
Net patient services $363,220 $187,442 $1,031,599 $555,449
Other 4,300 1,396 9,462 4,096
Non-nursing home revenue:
Pharmacy services 56,739 50,615 163,588 145,874
Therapy services 45,618 44,201 125,877 137,770
Home health, hospital services, and other 24,188 4,779 72,306 10,764
------------ ------------ -------------- ------------
494,065 288,433 1,402,832 853,953
Costs and Expenses:
Salaries and wages 183,898 108,064 522,574 328,461
Employee benefits 41,027 23,786 120,454 74,036
Nursing, dietary and other supplies 21,670 12,932 65,709 39,725
Ancillary services 111,699 58,298 313,349 169,228
General and administrative 50,365 29,813 146,082 88,325
Rent 21,087 10,730 60,229 31,801
Depreciation and amortization 17,787 10,414 51,113 30,480
Provision for bad debts 5,596 5,940 18,995 15,915
Recapitalization, indirect merger and transition costs - - 80,687 -
------------ ------------ -------------- ------------
453,129 259,977 1,379,192 777,971
------------ ------------ -------------- ------------
Income from operations 40,936 28,456 23,640 75,982
Other Income and Expense:
Interest expense 31,564 5,677 83,598 16,302
Interest and dividend income (3,437) (1,189) (8,181) (3,378)
------------ ------------ -------------- ------------
28,127 4,488 75,417 12,924
------------ ------------ -------------- ------------
Income (loss) before income taxes,
equity earnings/minority interest,
and extraordinary loss 12,809 23,968 (51,777) 63,058
Provision (Benefit) for Income Taxes 5,519 10,076 (8,432) 26,445
------------ ------------ -------------- ------------
Income (loss) before equity earnings/
minority interest and extraordinary loss 7,290 13,892 (43,345) 36,613
Equity Earnings/Minority Interest (247) (223) (546) (405)
------------ ------------ -------------- ------------
Income (loss) before extraordinary loss 7,043 13,669 (43,891) 36,208
Extraordinary Loss on Early Extinguishment
of Debt, net of $6,034 Income Tax Benefit - - (11,275) -
------------ ------------ ------------- -----------
Net Income (Loss) $7,043 $13,669 ($55,166) $36,208
=========== =========== ============= ===========
Earnings (Loss) Per Share:
Basic $0.17 $0.23 ($1.26) $0.62
=========== =========== ============= ===========
Diluted $0.17 $0.23 ($1.26) $0.61
=========== =========== ============= ===========
Weighted Average Common
Shares Outstanding:
Basic 42,223 58,643 43,698 58,588
=========== =========== ============= ===========
Diluted 42,588 59,870 43,698 59,815
=========== =========== ============= ===========
The accompanying notes are an integral part of these financial statements.
</TABLE>
3
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share amounts)
<TABLE>
<CAPTION>
June 30, September 30,
ASSETS 1998 1997
------- ------------
(unaudited)
<S> <C> <C>
Current Assets:
Cash and cash equivalents $12,397 $14,355
Receivables, less allowances of $68,948 and $33,138 432,600 211,989
Supplies 32,284 21,237
Deferred income taxes 81,891 24,294
Prepaid expenses and other current assets 31,721 15,354
-------------- ------------
Total current assets 590,893 287,229
Property and Equipment:
Land, buildings and improvements 571,622 378,251
Furniture, fixtures and equipment 183,607 121,698
Leased property under capital leases 12,551 12,551
-------------- ------------
767,780 512,500
Less accumulated depreciation 243,066 210,117
-------------- ------------
524,714 302,383
Goodwill, net 498,607 196,120
Restricted Investments 91,162 51,976
Notes Receivable, net 14,744 11,200
Other Assets 120,106 25,459
-------------- ------------
$1,840,226 $874,367
============== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Notes payable and current maturities of long-term debt $23,481 $43,196
Accounts payable 126,652 46,872
Accrued payroll and related expenses 105,942 66,866
Accrued interest 17,448 2,355
Other accrued expenses 53,641 25,836
-------------- ------------
Total current liabilities 327,164 185,125
Long-Term Debt, net of current maturities 1,279,994 252,763
Long-Term Insurance Reserves 37,953 27,555
Deferred Income Taxes and Other Noncurrent Liabilities 96,386 33,641
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, par value $0.01; 5,000,000 and 4,650,000
shares authorized; none issued - -
Series A - Junior participating preferred stock, par
value $0.01; none and 350,000 shares authorized and
reserved; none issued - -
Common stock, par value $0.01; 75,000,000 shares
authorized; 42,615,787 and 60,803,760 shares issued 426 608
Capital surplus 526,749 226,972
Retained earnings (deficit) (428,625) 164,650
Unrealized gain on securities available-for-sale 179 244
Treasury stock at cost - none and 2,004,444 shares - (17,191)
-------------- ------------
Total stockholders' equity 98,729 375,283
-------------- ------------
$1,840,226 $874,367
============= ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(dollars and shares in thousands)
(unaudited)
<TABLE>
<CAPTION>
Common Stock Retained Unrealized Treasury Stock
----------------- Capital Earnings Gain on ------------------
Shares Amount Surplus (Deficit) Securities Shares Amount Total
------ ------ ----------- ---------- ---------- ------ ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, September 30, 1997 60,804 $608 $226,972 $164,650 $244 2,004 ($17,191) $375,283
Net (loss) (55,166) (55,166)
Issuance of shares to Apollo
Management, L.P. and affiliates 17,778 178 239,822 240,000
Issuance of shares to Professional
Rehabilitation, Inc. 1,147 11 22,575 22,586
Repurchase of shares in connection
with the Recapitalization Merger 54,461 (735,223) (735,223)
Retirement of treasury stock (55,082) (551) (202,060) (538,109) (55,082) 740,720 -
Issuance of shares and options
in exchange for GranCare
common stock and options 17,440 175 238,814 238,989
Funding of options exercised or
canceled under 1992 Employee
Stock Option Plan, net of tax (5,918) (1,350) 11,410 5,492
Funding of employee benefit plans 92 (32) 275 367
Issuance of treasury stock in
exchange for warrants (9) (1) 9 -
Issuance of stock under
various stock option plans,
net of tax 529 5 6,461 6,466
Unrealized loss on
securities available-for-sale (65) (65)
---------- ------ ----------- ------------- ------- ----------- ----------- -----------
Balance, June 30, 1998 42,616 $426 $526,749 ($428,625) $179 - - $98,729
========= ===== ========== ============ ====== ========== ========== ==========
The accompanying notes are an integral part of these financial statements.
</TABLE>
5
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine Months
Ended June 30,
---------------------
1998 1997
---------------------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income (loss) ($55,166) $36,208
Adjustments to reconcile net income (loss) to net cash
(used in) provided by operating activities:
Depreciation and amortization 51,113 30,480
Provision for bad debts 18,995 15,915
Interest accretion on Senior Subordinated
Discount Notes 12,318 -
Income taxes deferred 2,038 (1,152)
Equity earnings/minority interest 546 405
Changes in noncash working capital:
Receivables (43,564) (52,075)
Supplies (8,907) (3,463)
Prepayments and other current assets (9,502) 2,969
Accounts payable (30,181) (9,504)
Accrued expenses and other current liabilities 23,398 (1,999)
Changes in long-term insurance reserves 364 10,279
Other 2,246 (292)
------------ ----------
Net Cash (Used In) Provided By Operating Activities (36,302) 27,771
Cash Flows Used In Investing Activities:
Acquisitions and investments (54,041) (21,988)
Purchases of property and equipment (32,344) (29,643)
Disposals of property, equipment and
other assets 2,252 6,159
Restricted investments 1,736 (25,016)
Net collections on notes receivable 20,622 1,987
Deposits and other (12,639) (50)
------------ ----------
Net Cash Used In Investing Activities (74,414) (68,551)
Cash Flows From Financing Activities:
Issuance of shares to Apollo Management, L.P.
and affiliates 240,000 -
Proceeds from Senior Credit Facility 740,000 -
Proceeds from Senior Subordinated Notes and
Senior Subordinated Discount Notes 448,871 -
Repurchase of shares in connection
with the Recapitalization Merger (735,223) -
Proceeds from long-term debt - 1,502
Net draws under credit line 5,000 39,685
Repayment of long-term debt (565,560) (8,656)
Deferred financing fees (30,178) -
Funding of options under 1992 employee stock
purchase plan, employee benefit plans, and other 5,848 143
------------ ----------
Net Cash Provided By Financing Activities 108,758 32,674
------------ ----------
Decrease in Cash and Cash Equivalents (1,958) (8,106)
Cash and Cash Equivalents, beginning of period 14,355 21,394
------------ ----------
Cash and Cash Equivalents, end of period $12,397 $13,288
=========== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
MARINER POST-ACUTE NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION
Organization
Mariner Post-Acute Network, Inc. (the "Company") changed its name effective
August 1, 1998 from its former name, Paragon Health Network, Inc. ("Paragon"),
following the consummation of the merger (the "Mariner Merger") with Mariner
Health Group, Inc. ("Mariner") on July 31, 1998. See Note 12. The Company was
formed in November 1997 through the recapitalization by merger of Living Centers
of America, Inc. ("LCA") with a newly-formed entity owned by certain affiliates
of Apollo Management, L.P. and certain other investors (the "Recapitalization
Merger"), and the subsequent merger of GranCare, Inc. ("GranCare") with a
wholly-owned subsidiary of LCA (the "GranCare Merger" and collectively with the
Recapitalization Merger, the "Apollo/LCA/GranCare Mergers"). See Notes 2 and 3.
At the time of the GranCare Merger, GranCare operated long-term health care
facilities that provided skilled nursing and residential care services in 15
states, a specialty hospital geriatric services company, and home health
operations. The accompanying condensed consolidated financial statements include
the accounts of the Company and its subsidiaries and all significant
intercompany accounts and transactions have been eliminated.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of the
Company have been prepared in accordance with generally accepted accounting
principles for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission. Accordingly, they do not
include all of the information and notes required by generally accepted
accounting principles for annual financial statements. In the opinion of
management, all adjustments (which include normal recurring adjustments)
considered necessary for a fair presentation have been included. Operating
results for the three and nine months ended June 30, 1998 are not necessarily
indicative of the results that may be expected for the year ended September 30,
1998. These financial statements should be read in conjunction with the audited
consolidated financial statements and notes thereto for the year ended September
30, 1997 included in the Company's Annual Report filed with the Securities and
Exchange Commission on Form 10-K, file No. 1-10968 and the unaudited condensed
consolidated financial statements of GranCare included in the Company's Form 8-
K/A filed January 20, 1998.
Certain prior year amounts have been reclassified to conform with the 1998
presentation.
Recent Accounting Pronouncements
In June 1997 the Financial Accounting Standards Board adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"). SFAS 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements and is effective for fiscal years beginning after December
15, 1997. Reclassification of financial statements for earlier periods provided
for comparative purposes is required.
In June 1997 the Financial Accounting Standards Board adopted Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 requires public
business enterprises to report information about operating segments and related
disclosures about products and services, geographic areas, and major customers.
SFAS 131 is effective for fiscal years beginning after December 15, 1997 and is
applicable to interim periods in the second year of application. Comparative
information for earlier years is required to be restated in the initial year of
application.
7
<PAGE>
MARINER POST-ACUTE NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In February 1998 the Financial Accounting Standards Board adopted Statement of
Financial Accounting Standards No. 132, "Employers' Disclosures about Pensions
and Other Postretirement Benefits--an amendment of FASB Statements No. 87, 88,
and 106" ("SFAS 132"). SFAS 132 standardizes disclosure requirements for
pensions and other postretirement benefits, requires additional information on
changes in the benefit obligations and fair values of plan assets, and
eliminates certain existing disclosure requirements. SFAS 132 is effective for
fiscal years beginning after December 15, 1997.
SFAS Nos. 130, 131, and 132 become effective in the Company's fiscal year
ending September 30, 1999. The adoption of these statements is not expected to
have a material impact on the Company's financial statements.
In June 1998 the Financial Accounting Standards Board adopted Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities. SFAS
133 is effective for fiscal years beginning after June 15, 1999. SFAS No. 133
will become effective in the Company's fiscal year ending September 30, 2000.
The adoption of this statement is not expected to have a material impact on the
Company's financial statements.
In March 1998 the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"). SOP 98-1 provides guidance as to whether certain
costs for internal-use software should be capitalized or expensed when incurred.
This SOP is effective for fiscal years beginning after December 15, 1998, but
earlier application is encouraged. The Company does not expect the adoption of
this SOP to have a material impact on its financial statements.
In June 1998 the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities" ("SOP 98-5"). SOP 98-5 provides
guidance on the financial reporting of start-up costs. It requires costs of
start-up activities to be expensed as incurred. This SOP is effective for
fiscal years beginning after December 15, 1998, but earlier application is
encouraged. The Company does not expect the adoption of this SOP to have a
material impact on its financial statements.
NOTE 2. RECAPITALIZATION MERGER
During 1997 the Company entered into the Recapitalization Merger which was
completed effective November 1, 1997. In connection with the Recapitalization
Merger, certain affiliates of Apollo and certain other investors (the "Apollo
Investors") invested $240 million to purchase approximately 17.8 million shares
(adjusted for the three-for-one stock split, see Note 8) of newly issued common
stock of LCA. Concurrent with the Recapitalization Merger, LCA changed its name
to Paragon Health Network, Inc.
On November 4, 1997, the Company sold $275 million of its 9.5% Senior
Subordinated Notes due 2007, at a price of 99.5% of face value and $294 million
of its 10.5% Senior Subordinated Discount Notes due 2007, at a price of 59.6% of
face value (collectively the "Notes"), in a private offering to institutional
investors. Concurrent with the private Notes offering, the Company entered into
a new Senior Credit Facility which is composed of $740 million in Term Loans and
a Revolving Credit Facility which provides for borrowings of up to an additional
$150 million. See Note 7.
8
<PAGE>
MARINER POST-ACUTE NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company used the $240 million invested by the Apollo Investors and the
$1.189 billion of net proceeds provided by the Notes offering and the Term Loans
to (i) purchase approximately 90.5% of the issued and outstanding common stock
of the Company for a per share price of $13.50 (adjusted for the three-for-one
stock split, see Note 8), (ii) to repay substantially all amounts outstanding
under the Company's and under GranCare's (see Note 3 for description of the
GranCare Merger) previous credit facilities and (iii) pay for certain costs
associated with the Apollo/LCA/GranCare Mergers.
NOTE 3. GRANCARE MERGER
Effective November 1, 1997, and subsequent to the Company's recapitalization,
the Company completed the merger acquisition of GranCare pursuant to the terms
of the previously announced GranCare Merger Agreement. In the GranCare Merger
approximately 17.4 million shares (adjusted for the three-for-one stock split,
see Note 8) of the Company's common stock were exchanged for GranCare common
stock and approximately 1.3 million options (adjusted for the three-for-one
stock split, see Note 8) to purchase shares of the Company's common stock were
exchanged for options to purchase GranCare common stock. The Company's total
purchase price of the acquisition was approximately $250.6 million including
legal, consulting and other direct costs. The acquisition was accounted for
under the purchase method of accounting and, accordingly, the results of
GranCare's operations are included in the Company's consolidated financial
statements since the date of acquisition. The assets and liabilities of GranCare
have been recorded at fair market value based on a preliminary purchase price
allocation. The total purchase price has been allocated as follows (in
thousands):
<TABLE>
<S> <C>
Current assets.................................................. $ 260,313
Property and equipment.......................................... 222,283
Goodwill........................................................ 236,149
Restricted investments.......................................... 40,987
Other long-term assets.......................................... 95,959
Current liabilities............................................. (126,601)
Long-term debt.................................................. (369,871)
Other non-current liabilities................................... (108,660)
--------
Total purchase price.......................................... $ 250,559
=========
</TABLE>
At June 30, 1998, a partial adjustment had been made to record GranCare's
property and equipment at fair value, assign a purchase price to unfavorable
operating leases for property and equipment, and assign a value to identifiable
intangible assets. The Company is in the process of finalizing the revaluing of
these items. Goodwill is amortized on a straight-line basis over 30 years. The
Omega Note (see Note 7) assumed by the Company in the GranCare Merger has been
recorded at its fair value. The excess of fair value over the principal amount
of the related mortgage notes, approximately $25 million, has been reflected in
the accompanying balance sheet as other noncurrent liabilities. Such amount is
being amortized using the effective interest method over the expected life of
the note. Amortization, which was approximately $1.1 million and $2.9 million
for the three and nine months ended June 30, 1998, respectively, was recorded as
a reduction to interest expense.
9
<PAGE>
MARINER POST-ACUTE NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 4. RECAPITALIZATION, INDIRECT MERGER AND TRANSITION COSTS
During the quarter ended December 31, 1997, the Company recognized a charge
for recapitalization, indirect merger and transition costs in connection with
the Apollo/LCA/GranCare Mergers. The components of this charge were as follows
(in thousands):
Recapitalization and Indirect Merger Costs:
Change of control and severance............................... $ 20,713
Bridge financing fees ........................................ 8,139
Legal and accounting.......................................... 6,047
Investment banking............................................ 4,616
Other......................................................... 4,962
--------
44,477
Transition Costs:
Retention and employee severance.............................. 13,443
Integration costs............................................. 9,809
Relocation and recruitment.................................... 5,958
Other......................................................... 7,000
--------
36,210
--------
Recapitalization, Indirect Merger and Transition Costs........... $ 80,687
========
Approximately $68.7 million of these costs were paid in the nine months ended
June 30, 1998. The balance is expected to be paid during the fourth quarter of
fiscal year 1998. Amounts unpaid at June 30, 1998 are reflected as other
accrued expenses in the accompanying balance sheet. Also during the three
months ended December 31, 1997, the Company recognized an extraordinary charge
of $11.3 million, net of a $6.0 million income tax benefit, associated with
prepayment penalties incurred on the early extinguishment of debt and the write-
off of certain deferred financing fees in conjunction with the
Apollo/LCA/GranCare Mergers.
NOTE 5. PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma financial information (in thousands, except
per share data) presents the consolidated results of operations of LCA and
GranCare as if the Apollo/LCA/GranCare Mergers had occurred effective October 1,
1997 and 1996, respectively, after giving effect to certain adjustments,
including amortization of goodwill, increased interest expense on debt related
to the Apollo/LCA/GranCare Mergers, and related income tax effects. Such
adjustments exclude a $12.0 million charge, net of a $7.0 million income tax
benefit, for termination fees paid by GranCare to Vitalink Pharmacy Services,
Inc. and Manor Care, Inc. in conjunction with the GranCare Merger. The results
of operations for the three and nine months ended June 30, 1997 include a $30.0
million charge, net of a $6.0 million income tax benefit, recorded by GranCare
in February 1997 in connection with the spin-off of its institutional pharmacy
business. The pro forma financial information is not necessarily indicative of
the results of operations that would have been achieved had the
Apollo/LCA/GranCare Mergers been consummated as of those dates, nor are they
necessarily indicative of future operating results.
10
<PAGE>
MARINER POST-ACUTE NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three Months Nine Months
Ended June 30, Ended June 30,
--------------------- ---------------------
1998 1997 1998 1997
---- ---- ---- ----
Net revenues................... $ 494,065 $ 484,529 $ 1,471,124 $ 1,449,039
========= ========= =========== ===========
Net income (loss) before
extraordinary item.......... $ 7,043 $ 1,789 $ (48,802) $ (16,316)
Extraordinary item............. __ __ (11,275) (4,831)
--------- --------- ------------ ------------
Net income(loss)............... $ 7,043 $ 1,789 $ (60,077) $ (21,147)
========= ========= =========== ===========
Basic Earnings (Loss) Per Share:
Net income (loss) before
extraordinary item....... $ 0.17 $ 0.04 $ (1.18) $ (0.40)
Extraordinary item.......... - - (0.27) (0.12)
--------- --------- ------------ ------------
Net income (loss)........... $ 0.17 $ 0.04 $ (1.45) $ (0.52)
========= ========= ============ ============
Diluted Earnings (Loss)
Per Share:
Net income (loss) before
extraordinary item......... $ 0.17 $ 0.04 $ (1.18) $ (0.40)
Extraordinary item........... - - (0.27) (0.12)
--------- --------- ------------ ------------
Net income (loss)............ $ 0.17 $ 0.04 $ (1.45) $ (0.52)
========= ========= ============ ============
NOTE 6. ACQUISITIONS
On May 1, 1998 the Company completed the acquisition of Professional
Rehabilitation, Inc. and certain affiliated entities for $28.8 million in cash
and $22.6 million in common stock of the Company (1,147,225 shares). South
Carolina-based Professional Rehabilitation, Inc. provides contract physical,
occupational, and speech therapy primarily to skilled nursing facilities in
South Carolina, North Carolina, Georgia, Tennessee, and Alabama. The
transaction was recorded using the purchase method of accounting.
NOTE 7. LONG-TERM DEBT
A summary of total debt as of June 30, 1998 is as follows (in thousands):
Senior Debt:
- ------------
Senior Credit Facility:
Revolving Credit Facility........................ $ 5,000
Term Loans....................................... 740,000
Mortgage notes....................................... 93,469
Obligations under capital leases..................... 5,207
Other notes payable.................................. 1,595
Subordinated Debt:
- ------------------
Senior Subordinated Notes due 2007................... 273,855
Senior Subordinated Discount Notes due 2007.......... 184,349
--------
1,303,475
Less short-term notes payable and current maturities... (23,481)
----------
Total long-term debt.................................... $ 1,279,994
===========
11
<PAGE>
MARINER POST-ACUTE NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Senior Credit Facility. The Senior Credit Facility consists of four
components: a 6 1/2 year term loan facility in an aggregate principal amount of
$240 million (the "Tranche A Term Loan Facility"); a 7 1/2 year term loan
facility in an aggregate principal amount of $250 million (the "Tranche B Term
Loan Facility"); an 8 1/2 year term loan facility in an aggregate principal
amount of $250 million (the "Tranche C Term Loan Facility"); and a 6 1/2 year
revolving credit facility in the maximum amount of $150 million (the "Revolving
Credit Facility"). Loans made under the Tranche A Term Loan Facility ("Tranche A
Term Loans"), the Tranche B Term Loan Facility ("Tranche B Term Loans") and the
Tranche C Term Loan Facility ("Tranche C Term Loans") are collectively referred
to herein as "Term Loans." Advances under the Revolving Credit Facility are
sometimes referred to as "Revolving Loans." The proceeds from borrowings under
the Term Loans were used, along with the proceeds of the Notes offering, to fund
a portion of the Recapitalization Merger, refinance a significant portion of
LCA's and GranCare's pre-merger indebtedness, and to pay costs and expenses
associated with the Apollo/LCA/GranCare Mergers.
The Term Loans will be amortized in quarterly installments totaling $0, $26.5
million, $49.0 million, $51.5 million, $51.5 million, $56.5 million, $186.0
million, $239.0 million and $80.0 million in the fiscal years 1998, 1999, 2000,
2001, 2002, 2003, 2004, 2005 and 2006, respectively. Principal amounts
outstanding under the Revolving Credit Facility will be due and payable in April
2005. As of June 30, 1998, there was $5.0 million borrowed under the Revolving
Credit Facility in addition to approximately $13.7 million letter of credit
issuances.
Interest on outstanding borrowings accrue, at the option of the Company, at
the customary Alternate Base Rate (the "ABR") of The Chase Manhattan Bank
("Chase") or at a reserve adjusted Eurodollar Rate (the "Eurodollar Rate") plus,
in each case, an Applicable Margin. The term "Applicable Margin" means a
percentage that will vary in accordance with a pricing matrix based upon the
respective term loan tenor and the Company's leverage ratio. Through July 1998,
the Applicable Margin for Revolving Loans and Tranche A Term Loans will equal
1.25% for loans based on ABR ("ABR Loans") and 2.25% for loans based on the
Eurodollar Rate ("Eurodollar Loans"); for Tranche B Term Loans, 1.50% in the
case of ABR Loans and 2.50% in the case of Eurodollar Loans; and for Tranche C
Term Loans, 1.75% in the case of ABR Loans and 2.75% in the case of Eurodollar
Loans. The covenants contained in the Senior Credit Facility restrict, among
other things, the ability of the Company to dispose of assets, repay other
indebtedness or amend other debt instruments, pay dividends, and make
acquisitions.
Subject in each case to certain exceptions, the following amounts are required
to be applied, as mandatory prepayments, to prepay the Term Loans: (i) 75% of
the net cash proceeds of the sale or issuance of equity by the Company; (ii)
100% of the net cash proceeds of the incurrence of certain indebtedness; (iii)
75% of the net cash proceeds of any sale or other disposition by the Company or
any of its subsidiaries of any assets (excluding the sale of inventory and
obsolete or worn-out property, and subject to a limited exception for
reinvestment of such proceeds within 12 months); and (iv) 75% of excess cash
flow for each fiscal year, which percentage will be reduced to 50% in the event
the Company's leverage ratio as of the last day of such fiscal year is not
greater than 4.50 to 1.00. Mandatory prepayments will be applied pro rata to the
unmatured installments of the Tranche A Term Loans, the Tranche B Term Loans and
the Tranche C Term Loans; provided, however, that as long as any Tranche A Term
Loan remains outstanding, each holder of a Tranche B Term Loan or a Tranche C
Term Loan will have the right to refuse any such mandatory prepayment otherwise
allocable to it, in which case the amount so refused will be applied as an
additional prepayment of the Tranche A Term Loans. The Company will also have
the right to prepay the Senior Credit Facility, in whole or in part, at its
option. Partial prepayments must be in minimum amounts of $1 million and in
increments of $100,000 in excess thereof.
Amounts applied as prepayments of the Revolving Credit Facility may be
reborrowed; amounts prepaid under the Term Loans may not be reborrowed.
12
<PAGE>
MARINER POST-ACUTE NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Senior Subordinated Notes. Also in connection with the Apollo/LCA/GranCare
Mergers, on November 4, 1997 the Company completed a private offering to
institutional investors of $275 million of its 9.5% Senior Subordinated Notes
due 2007, at a price of 99.5% of face value and $294 million of its 10.5% Senior
Subordinated Discount Notes due 2007, at a price of 59.6% of face value
(collectively, the "Notes"). Interest on the Senior Subordinated Notes is
payable semi-annually. Interest on the Senior Subordinated Discount Notes will
accrete until November 1, 2002 at a rate of 10.57% per annum, compounded semi-
annually, and will be cash pay at a rate of 10.5% per annum thereafter. The
Notes will mature on November 1, 2007. The net proceeds from this offering,
along with proceeds from the Senior Credit Facility, were used to fund a portion
of the Recapitalization Merger, refinance a significant portion of LCA's and
GranCare's pre-merger indebtedness, and to pay costs and expenses associated
with the Apollo/LCA/GranCare Mergers.
Other Significant Indebtedness. In connection with the GranCare Merger, the
Company became a party to various agreements between GranCare and Health and
Retirement Properties Trust ("HRPT") and Omega Healthcare Investors, Inc.
("Omega"). HRPT is the holder of a mortgage loan to AMS Properties, Inc. ("AMS
Properties"), a wholly-owned subsidiary of the Company, dated October 1, 1994,
in the aggregate principal amount of $11.5 million (the "HRPT Loan"). The HRPT
Loan is secured, in part, by mortgage and security agreements dated as of March
31, 1995 (collectively, the "HRPT Mortgage") in favor of HRPT and encumbering
two nursing facilities in Wisconsin owned by AMS Properties.
A wholly-owned subsidiary of the Company, Professional Health Care Management,
Inc. ("PHCMI"), is the borrower under a $58.8 million mortgage note executed on
August 14, 1992 (the "Omega Note") in favor of Omega, and under the related
Michigan loan agreement dated as of June 7, 1992 as amended (the "Omega Loan
Agreement"). All $58.8 million was outstanding as of June 30, 1998.
The Omega Note bears interest at a rate which is adjusted annually based on
either (i) changes in the Consumer Price Index or (ii) a percentage of the
change in gross revenues of PHCMI and its subsidiaries from year to year,
divided by 58.8 million, whichever is higher, but in any event subject to a
maximum rate not to exceed 105% of the interest rate in effect for the Omega
Note for the prior calendar year. The current interest rate is 15.0% per annum
which is paid monthly. Additional interest accrues on the outstanding principal
of the Omega Note at the rate of 1% per annum. Such interest is compounded
annually and is due and payable on a pro rata basis at the time of each
principal payment or prepayment. Beginning October 1, 2002, quarterly
amortizing installments of principal in the amount of $1.5 million will also
become due and payable on the first day of each calendar quarter. The entire
outstanding principal amount of the Omega Note is due and payable on August 13,
2007. The Omega Note may be prepaid without penalty during the first 100 days
following August 14, 2002. Payment of the Omega Note after acceleration upon
the occurrence of an event of default will result in a prepayment penalty in the
nature of a "make whole" premium.
The Omega Loan Agreement obligates PHCMI, among other things, to maintain a
minimum tangible net worth of at least $10 million, which may be increased or
decreased under certain circumstances but may not be less than $10 million. The
Company must contribute additional equity to PHCMI, if and when necessary, to
assure that such minimum tangible net worth test is met. PHCMI has satisfied
this test in the past without the contribution of additional equity, and
management believes that it will continue to do so in the future.
NOTE 8. STOCK SPLIT
On November 24, 1997, the Board of Directors of the Company declared a three-
for-one stock split in the form of a stock dividend to stockholders of record as
of December 15, 1997 that was paid on December 30, 1997. In all instances
throughout the financial statements and footnotes, common stock and additional
paid-in capital have been restated to reflect this split.
13
<PAGE>
MARINER POST-ACUTE NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 9. EARNINGS PER SHARE
In February 1997 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS
128 was designed to simplify the standards for computing earnings per share and
increase the comparability of earnings per share data on an international basis.
SFAS 128 replaces the presentation of primary earnings per share with a
presentation of basic earnings per share and requires dual presentation of basic
and diluted earnings per share on the face of the statement of income of all
entities with complex capital structures. The Company adopted SFAS 128 in the
three months ended December 31, 1997 and, accordingly, earnings per share for
all prior periods presented have been restated to conform to the requirements of
this new standard. The following table sets forth the computation of basic and
diluted earnings per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Nine Months
Ended June 30, Ended June 30,
------------------------- --------------------------
1998 1997 1998 1997
---- ---- ---- ----
Numerator for Basic and Diluted Earnings Per Share:
<S> <C> <C> <C> <C>
Net income (loss) before
extraordinary item........................................ $ 7,043 $ 13,669 $ (43,891) $ 36,208
Extraordinary item......................................... -- -- (11,275) --
-------- -------- --------- ---------
Net income (loss).......................................... $ 7,043 $ 13,669 $(55,166) $ 36,208
======== ======== ========= =========
Denominator:
Denominator for basic earnings per share-weighted
average shares........................................ 42,223 58,643 43,698 58,588
Effect of dilutive securities Stock options.............. 365 1,227 -- 1,227
--------- --------- ----------- ----------
Denominator for diluted earnings per share-adjusted
weighted-average shares and assumed conversions....... 42,588 59,870 43,698 59,815
========== ========= ========== ==========
Basic Earnings (Loss) Per Share:
Net income (loss) before extraordinary item............... $ 0.17 $ 0.23 $ (1.00) $ 0.62
Extraordinary item........................................ -- -- (0.26) --
--------- --------- ----------- ----------
Net income (loss) per common share........................ $ 0.17 $ 0.23 $ (1.26) $ 0.62
========== ======== =========== ==========
Diluted Earnings (Loss) Per Share:
Net income (loss) before extraordinary item............... $ 0.17 $ 0.23 $ (1.00) $ 0.61
Extraordinary item........................................ -- -- (0.26) --
--------- --------- ----------- ----------
Net income (loss) per common share........................ $ 0.17 $ 0.23 $ (1.26) $ 0.61
========== ========== ============ ==========
</TABLE>
The effect of dilutive securities for the nine months ended June 30, 1998 has
been excluded because the effect is antidilutive as a result of the net loss for
the period.
NOTE 10. INCOME TAXES
For the nine months ended June 30, 1998, the provision for income taxes was
affected by recapitalization, indirect merger, and transition expenses
associated with the GranCare Merger that are not deductible for income tax
purposes. Excluding the effect of these non-deductible items, the effective
income tax rate for the three and nine months ended June 30, 1998 was
approximately 43.1% and 45.4%, respectively, compared to 42.0% and 41.9%,
respectively, for the same periods in fiscal 1997.
Deferred income taxes reflected in current assets in the accompanying balance
sheets have increased from $24.3 million at September 30, 1997 to $81.9 million
at June 30, 1998. This increase is primarily attributable to deferred taxes
recorded as a result of the GranCare Merger.
14
<PAGE>
MARINER POST-ACUTE NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 11. COMMITMENTS AND CONTINGENCIES
In October 1996 the Company entered into a leasing program, initially totaling
$70.0 million and subsequently increased to $100.0 million, to be used as a
funding mechanism for future assisted living and skilled nursing facility
construction, lease conversions, and other facility acquisitions. The lease is
an unconditional "triple net" lease for a period of seven years with the annual
lease obligation a function of the amount spent by the lessor to acquire or
construct the project, a variable interest rate, and commitment and other fees.
The Company guarantees a minimum of approximately 83% of the residual value of
the leased property and also has an option to purchase the properties at any
time prior to the maturity date at a price sufficient to pay the entire amount
financed, accrued interest, and certain expenses. At June 30, 1998,
approximately $40.4 million of this leasing arrangement was utilized. The
leasing program is accounted for as an operating lease.
As is typical in the healthcare industry, the Company is and will be subject
to claims that its services have resulted in resident injury or other adverse
effects, the risks of which will be greater for higher acuity residents
receiving services from the Company than for other long-term care residents. The
Company is, from time to time, subject to such negligence claims and other
litigation. In addition, resident, visitor, and employee injuries will also
subject the Company to the risk of litigation. From time to time, the Company
and its subsidiaries have been parties to various legal proceedings in the
ordinary course of their respective businesses. In the opinion of management,
except as described below, there are currently no proceedings which,
individually or in the aggregate, if determined adversely to the Company and
after taking into account the insurance coverage maintained by the Company,
would have a material adverse effect on the Company's financial position or
results of operations.
The Company received a letter dated September 5, 1997 from an Assistant United
States Attorney ("AUSA") in the United States Attorney's Office for the Eastern
District of Texas (Beaumont) advising that the office is involved in an
investigation of allegations that services provided at some of the Company's
facilities may violate the Civil False Claims Act. The AUSA informed the Company
that the investigation is the result of a qui tam complaint (which involves a
private citizen requesting the federal government to intervene in an action
because of an alleged violation of a federal statute) filed under seal against
the Company, and the AUSA is investigating the allegations in order to determine
if the United States will intervene in the proceedings. The AUSA has requested
that the Company voluntarily produce a substantial amount of documents,
including medical records of former residents. In November 1997, counsel for
the Company met with the AUSA and the parties engaged in discussions on whether
the voluntary production of former residents' medical records can be
accomplished without violating the residents' rights to privacy and
confidentiality. Based upon the information currently known about the complaint,
the Company believes that given an opportunity to address the allegations, the
AUSA will find intervention by the United States is without merit. In December
1997, the Company advised the AUSA that absent the United States agreeing to
protect the confidentiality of the residents' medical records, and to prevent
unauthorized disclosure of the information requested to non-government
personnel, the Company would not agree to a voluntary production. The Company
has heard nothing further from the AUSA. The Department of Justice attorney
assigned to the case recently invited the Company to reopen discussions directly
with the Department regarding the Company's position on the alleged claims. The
Company will vigorously contest the alleged claims if the complaint is pursued.
15
<PAGE>
MARINER POST-ACUTE NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Department of Justice ("DOJ") has advised the Company that the United
States has declined to intervene in the qui tam complaint filed against The
Brian Center Corporation ("BCC") and one of its subsidiaries, Med-Therapy
Rehabilitation Services, Inc. ("Med-Therapy"), both wholly-owned subsidiaries of
the Company (and of LCA before the Apollo/LCA/GranCare Mergers) in the federal
district court for the Western District of North Carolina. The individual
plaintiff is continuing to pursue the alleged claims that BCC and Med-Therapy
caused certain therapists to make improper therapy record entries with respect
to screening services, and that any claims filed with Medicare for payments
based upon such improper record entries should be viewed as false claims under
the Civil False Claims Act. The Company continues to vigorously contest these
claims. The plaintiff recently filed an amended complaint in response to a court
order on defendants' motion to dismiss which gave plaintiff 20 days to file an
amended complaint or have the original complaint dismissed. The plaintiff filed
an amended complaint which does not raise any new or different allegations. The
Company has filed a motion to dismiss the amended complaint and is awaiting a
decision. No assurance can be given that, if the plaintiff were to prevail in
his claim, the resulting judgment would not have a material adverse effect on
the Company. In connection with the Company's acquisition of BCC, the primary
stockholder (Donald C. Beaver) agreed to indemnify and hold harmless the Company
from and against any and all loss, expense, damage, penalty and liability which
could result from this claim, subject to further adjustment. Mr. Beaver's
indemnity requires any payment to the Company to be in the form of shares of the
Company's common stock.
The Company was served with a Petition, Cause No. 97-1500-G, Community
Healthcare Services of America, Inc., v. Rehability Health Services, Inc. and
Living Centers of America, Inc., in the 319th Judicial District Court of Nueces
County, Texas, seeking $5.0 million in damages, filed by Community Health
Services, Inc. ("Community"), in connection with a home health agency management
agreement entered into between Community and a subsidiary of the Company. Such
subsidiary operated a Texas home health agency which Community managed. The
Company is vigorously defending the allegations of Community that the Company
breached the agreement by terminating Community's management services and has
filed a lawsuit against Community for breach of the agreement, Cause No. 97-
03569; Rehability Health Services, Inc. v. Community Healthcare Services, Inc.,
in the 353rd Judicial District Court of Travis County, Texas. The Nueces County
action was transferred to Travis County and the two cases have been consolidated
into Cause No. 97-03569. This matter is currently in the discovery phase.
On June 10, 1997, a GranCare stockholder filed a civil action in state
district court in Harris County, Texas: Howard Gunty, Inc. Profit Sharing Plan
v. Gene E. Burleson, Charles M. Blalack, Antoinette Hubenette, Joel S. Kanter,
Ronald G. Kenny, Robert L. Parker, William G. Petty, Jr., Edward V. Regan, Gary
U. Rolle and GranCare, Inc., No. 97-30762. This complaint alleged, generally,
that the defendants breached their fiduciary duties owed to GranCare's
stockholders by failing to take all reasonable steps necessary to ensure that
GranCare's stockholders receive maximum value for their shares of GranCare
common stock in connection with the GranCare Merger. The plaintiffs sought (i)
an injunction prohibiting the consummation of the GranCare Merger or (ii)
alternatively, if the GranCare Merger were consummated, to have such transaction
rescinded and set aside. In addition, the plaintiffs sought unspecified
compensatory damages, costs and to have the action certified as a class action.
On October 28, 1997, the parties to the aforementioned litigation entered into
an Agreement and Stipulation of Settlement (the "Settlement Agreement") pursuant
to which the plaintiffs agreed to dismiss, with prejudice, all claims against
GranCare in consideration of, among other things, (i) certain additional
disclosure included in the disclosure documents sent to GranCare stockholders in
connection with their approval of the GranCare Merger and (ii) the payment by
GranCare of the fees and expenses of plaintiffs' counsel in an aggregate amount
of no more than $350,000. The effectiveness of the Settlement Agreement is
subject to a number of conditions, including, among others, the entry by the
court of a final judgment approving the terms of the settlement. GranCare
entered into the Settlement Agreement based upon its belief that a speedy
resolution of this dispute was in the best interest of the GranCare stockholders
and in so doing did not in any way admit any wrongdoing or liability in
connection with this matter. On April 6, 1998, the court preliminarily accepted
the Settlement Agreement and ordered that notice of the Settlement Agreement be
mailed to all class members. On July 24, 1998, the court gave final approval to
the settlement and entered judgement dismissing the case with prejudice.
16
<PAGE>
MARINER POST-ACUTE NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
On August 26, 1996, a class action complaint was asserted against GranCare in
the Denver, Colorado District Court, Salas, et al. v. GranCare, Inc., and AMS
Properties, Inc., d/b/a Cedars Health Care Center, Inc. Case No. 96 CV 4449,
asserting five claims for relief, including third-party beneficiary, tortious
interference and negligence per se causes of action arising out of quality of
care issues at a healthcare facility formerly owned by GranCare. On January 20,
1998, plaintiffs requested leave to amend their complaint by adding an
additional class claim for fraud and three new named plaintiffs. The complaint
was amended a second time on February 2, 1998 by adding an additional plaintiff.
At the class certification hearing held on February 20, 1998, plaintiffs again
amended their complaint to clarify that damages for all of the class claims
would be limited to restitution and emotional distress. Pursuant to the Third
Amended Complaint, the class claims were identified as third-party beneficiary
of contract; breach of contract; tortious interference with contract; fraud; and
negligence per se. In addition to the class claims, the named plaintiffs each
asserted claims for promissory estoppel and violation of the Colorado Consumer
Protection Act.
On March 15, 1998, the court entered an order in which it certified a class
action in the matter. The court certified three classes consisting of one
primary class ("Class I") and two subclasses ("Class II" and "Class III").
Class I consists of all people who were residents of Cedars at any time from
September 21, 1993 through February 20, 1998, and is asserting tortious
interference, fraud and negligence per se claims. Class II is comprised of
those members of Class I who were private pay residents and therefore were
individually parties to a contract with Cedars and only asserts the breach of
contract claim. Class III consists of those members of Class I who were either
Medicaid or Medicare residents at Cedars and seeks to recover for breach of the
Medicare or Medicaid provider agreements to which they assert they were third
party beneficiaries.
Although the Cedars plaintiffs agreed to limit the class damages to
restitution and emotional distress, the court has only certified the Classes
with respect to the issue of liability and the various Classes' rights to
restitution. The court determined that emotional distress damages are of such
an individualized and personal nature that the class-wide request for emotional
distress damages was not appropriate for class treatment. Therefore, the class
action will proceed only for purposes of proving liability under the claims and
any corresponding rights to restitution. Upon a finding of liability, if any,
emotional distress damages for any Class member other than the Class
representatives, will be determined in separate trials. The Court's May 8, 1998
case management order outlines the division of claims and trials.
At a status conference on May 7, 1998, plaintiff's counsel orally dismissed
her promissory estoppel claims on behalf of the named plaintiffs. Trial has been
set for six weeks commencing March 15, 1999. The Company intends to vigorously
contest the remaining alleged claims and the certification of the various
Classes.
On May 18, 1998, a class action complaint was asserted against the Company,
certain of its predecessor entities and affiliates and certain other parties in
the Tampa, Florida Circuit Court, Wilson, et al, v. Paragon Health Network,
Inc., et al., case no. 98-03779, asserting 7 claims for relief, including breach
of contract, breach of fiduciary duty, unjust enrichment, violation of Florida
Civil Remedies for Criminal Practices Act, violation of Florida Racketeer and
Corrupt Organization Act, false advertising and common-low conspiracy arising
out of quality of care issues at a health care facility formerly operated by
Brian Center Health and Rehabilitation/Tampa, Inc. and later by a subsidiary of
LCA as a result of the Brian Center Corporation merger. The Company removed this
case to Federal Court on June 10, 1998 and the matter is currently pending in
the United States District Court for the Middle District of Florida, Tampa
division, case no. 98-1205-CIV-T23B. The plaintiffs filed a motion to remand on
June 22, 1998 and the Company filed a motion to dismiss on June 30, 1998. The
Company is currently awaiting the outcome of these motions. The complaint has
only been recently filed and no discovery has been conducted. Accordingly, the
information available to the Company is very limited and the Company is unable
to assess at this point the magnitude of the allegations. The Company intends to
vigorously contest the request for class certification as well as all alleged
claims made.
17
<PAGE>
MARINER POST-ACUTE NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 12. SUBSEQUENT EVENTS
As previously reported, the Company entered into a definitive merger agreement
on April 13, 1998 with Mariner which was executed on July 31, 1998. Under the
terms of the agreement, Mariner shareholders received one share of the Company's
common stock for each Mariner share held. At the time of the Mariner Merger,
Mariner owned, operated and managed freestanding inpatient skilled nursing
facilities, provided rehabilitation program management services to other skilled
nursing facilities and operated outpatient rehabilitation clinics, pharmacies
and home health agencies.
18
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Effective November 1, 1997 the Company completed two merger transactions.
First, pursuant to an agreement and plan of merger among Apollo Management, L.P.
("Apollo Management," and together with certain of its affiliates, "Apollo"),
Apollo LCA Acquisition Corp. (a corporation owned by certain Apollo affiliates
and other investors, "Apollo Sub") and Living Centers of America, Inc. ("LCA"),
Apollo Sub was capitalized with $240 million in cash and was merged with and
into LCA (the "Recapitalization Merger"). In the Recapitalization Merger, LCA
was the surviving corporation and was renamed Paragon Health Network, Inc.
("Paragon" or the "Company"). Second, pursuant to an agreement and plan of
merger among LCA, GranCare, Inc. ("GranCare"), Apollo Management and LCA
Acquisition Sub, Inc., a wholly-owned subsidiary of Paragon ("LCA Sub"),
GranCare merged with LCA Sub with GranCare surviving as a wholly-owned
subsidiary of Paragon (the "GranCare Merger," and collectively with the
Recapitalization Merger, the "Apollo/LCA/GranCare Mergers"). The GranCare Merger
was accounted for under the purchase method of accounting and, accordingly, the
results of GranCare's operations have been included in the Company's
consolidated financial statements since the date of acquisition.
Effective July 31, 1998, the Company acquired Mariner Health Group, Inc.
("Mariner") in a stock for stock merger (the "Mariner Merger") in which (i)
Mariner became a wholly-owned subsidiary of the Company and (ii) the Company
changed its name to Mariner Post-Acute Network, Inc. The results of operations
data contained herein do not include Mariner's operations because the Mariner
Merger occurred subsequent to the quarter ended June 30, 1998.
The Company provides a diverse range of services in the health care continuum
including: (i) post-acute care; (ii) pharmacy, therapy, subacute and other
specialty medical services; and (iii) contract management of specialty medical
programs for acute care hospitals. Post-acute care refers to any care that a
patient receives after discharge from an acute care hospital setting, including
subacute, long-term and specialty medical care. Subacute care refers to complex
medical care and intensive nursing care provided to patients with high acuity
disorders. Long-term care refers to care, typically conducted over an extended
period of time, at a skilled nursing or assisted living facility as well as care
rendered in a patient's home, regardless of whether such care is rendered
following discharge from an acute care hospital. Specialty medical services
refer to any service provided by the Company other than routine skilled nursing
care.
RESULTS OF OPERATIONS
Nursing home revenues are derived from two basic sources: routine services
($267.3 million or 72.7% in the third quarter of fiscal 1998 and $751.2 million
or 72.2% year-to-date in fiscal 1998) and ancillary services ($100.2 million or
27.3% in the third quarter of fiscal 1998 and $289.9 million or 27.8% year-to-
date in fiscal 1998) and are a function of occupancy rates in the long-term care
facilities and the payor mix. Weighted average occupancy, as identified in the
following table, increased by 1.2% and 0.9% over the prior year periods for the
three and nine months ended June 30, 1998, respectively, which included a 0.1%
decline and a 0.2% improvement as a result of the GranCare Merger for the three
and nine months ended June 30, 1998, respectively.
<TABLE>
<CAPTION>
Three Months Nine Months
Ended June 30, Ended June 30,
-------------------- ---------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Weighted average licensed bed count 37,640 22,880 35,871 23,101
Weighted average number of residents 31,502 18,887 30,049 19,142
Weighted average occupancy 83.7% 82.5% 83.8% 82.9%
</TABLE>
19
<PAGE>
Payor mix is the source of payment for the services provided and consists of
private pay, Medicare and Medicaid. Private pay includes revenue from
individuals who pay directly for services without government assistance through
the Medicare and Medicaid programs. Additional sources of private pay include
managed care companies, commercial insurers, health maintenance organizations,
Veteran's Administration contractual payments, and payments for services
provided under contract management programs.
Reimbursement rates from government sponsored programs, such as Medicare and
Medicaid, are strictly regulated and subject to funding appropriations from
federal and state governments. To the extent unfavorable changes in economic
conditions reduce payments under governmental or third-party payor programs, the
Company would be adversely affected. Revenues derived from the Company's non-
nursing home groups are also influenced by payor mix. The table below presents
the approximate percentage of the Company's net revenues derived from the
various sources of payment for the periods indicated:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended June 30, Ended June 30,
-------------------- --------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Private 29.7% 33.3% 28.9% 33.6%
Medicare 31.5% 26.2% 32.5% 25.6%
Medicaid 38.8% 40.5% 38.6% 40.8%
</TABLE>
The percentage of net revenues derived from private pay sources declined in
the three and nine months ended June 30, 1998 primarily as a result of the
GranCare Merger. GranCare has historically had a lower percentage of private
pay revenue than LCA. Excluding GranCare, the percentage of net revenues
derived from private pay and Medicare sources increased to 59.3% for the nine
months ended June 30, 1998 from 59.2% for the nine months ended June 30, 1997,
which was primarily attributable to the growth in the Company's non-nursing home
operations. The net revenues from the non-nursing home operations, which are
primarily generated from private pay and Medicare sources, result in a reduction
of the percentage of net revenues derived from the Medicaid program. In
addition, average reimbursement rates for Medicare patients have increased more
rapidly than for Medicaid residents primarily due to the higher reimbursement
rates associated with the increase in acuity levels. Although cost
reimbursement for Medicare residents generates a higher level of net revenue per
patient day, profitability is not proportionally increased due to the additional
costs associated with the required higher level of care and other services for
such residents. For cost reporting periods beginning on or after July 1, 1998,
the Medicare program will change its method of payment to a fixed per diem rate
under the adopted prospective payment system. See Capital Resources and
Liquidity-Changes in Healthcare Legislation.
THIRD QUARTER OF FISCAL 1998 COMPARED TO THIRD QUARTER OF FISCAL 1997. Net
revenues comprising nursing home and non-nursing home operations totaled $494.1
million for the quarter ended June 30, 1998, an increase of $205.7 million or
71.3%, as compared to the same period for fiscal 1997. Nursing home operations
contributed $178.7 million of the increase, which included the acquisition of
GranCare effective November 1, 1997 of $168.4 million, and at the former LCA
facilities, rate increases of $5.3 million and higher ancillary service billings
resulting from the improvement in mix, primarily Medicare, of $7.8 million.
Non-nursing home operations contributed $27.0 million of the increase,
consisting of an increase of $6.2 million for pharmacy services, an increase of
$1.4 million for therapy services, and an increase of $19.4 million from home
health, hospital services, and other. The home health, hospital services and
other revenue increase primarily resulted from the acquisition of GranCare.
Costs and expenses totaled $453.1 million for the quarter ended June 30, 1998,
an increase of $193.2 million or 74.3%, as compared to the same period for
fiscal 1997. The acquisition of GranCare contributed $175.6 million to the
increase in costs. Excluding GranCare, ancillary costs increased by $10.6
million as a result of the increase in ancillary service billings in the nursing
home operations and higher pharmaceutical costs related to the increase in
pharmacy services revenue.
Interest expense totaled $31.6 million for the quarter ended June 30, 1998, an
increase of $25.9 million as compared to the same period for fiscal 1997, which
was primarily a result of the additional debt incurred in conjunction with the
Apollo/LCA/GranCare Mergers.
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The effective income tax rate for the three months ended June 30, 1998 was
approximately 43.1% compared to 42.0% for the same period in 1997. The higher
effective income tax rate reflected the amortization of non-deductible goodwill
associated with the GranCare Merger and the lower pre-tax book income.
FISCAL 1998 YEAR TO DATE COMPARED TO FISCAL 1997 YEAR TO DATE. Net revenues
comprising nursing home and non-nursing home operations totaled $1,402.8 million
for the nine months ended June 30, 1998, an increase of $548.8 million or 64.3%,
as compared to the same period for fiscal 1997. Nursing home operations
contributed $481.5 million of the increase, which included the acquisition of
GranCare effective November 1, 1997 of $458.8 million, and at the former LCA
facilities, rate increases of $17.0 million, higher ancillary service billings
resulting from the improvement in mix, primarily Medicare, of $15.8 million, a
$2.6 million reduction due to a lower average number of residents, and a $4.3
million reduction due to divested facilities. Non-nursing home operations
contributed $67.4 million of the increase, consisting of an increase of $17.7
million for pharmacy services, a decrease of $11.8 million for therapy services,
and an increase of $61.5 million from home health, hospital services, and other.
Home health, hospital services and other revenue increased by $52.5 million as a
result of the GranCare acquisition and $5.2 million from the purchase of two
home health agencies during fiscal year 1997.
Pre-tax recapitalization, indirect merger and transition costs related to the
Apollo/LCA/GranCare Mergers totaled $80.7 million for the nine months ended June
30, 1998. Recapitalization and indirect merger costs included change of control
and severance payments totaling $20.7 million, bridge financing fees of $8.1
million, legal, accounting, and investment banking fees of $10.7 million and
other recapitalization related costs of $5.0 million. Transition costs included
retention and employee severance of $13.4 million, integration and related costs
of $9.8 million and relocation, recruitment, and other transition related costs
of $13.0 million.
Costs and expenses excluding recapitalization, indirect merger, and transition
costs totaled $1,298.5 million for the nine months ended June 30, 1998, an
increase of $520.5 million or 66.9%, as compared to the same period for fiscal
1997. The acquisition of GranCare contributed $485.1 million to the increase in
costs. Excluding GranCare, ancillary, salaries and wages, and general and
administrative costs increased $17.0 million, $6.5 million, and $6.3 million,
respectively. The increase in ancillary costs was the result of higher
ancillary service billings in the nursing home operations and higher
pharmaceutical costs related to the increase in pharmacy services revenue.
Interest expense totaled $83.6 million for the nine months ended June 30,
1998, an increase of $67.3 million as compared to the same period for fiscal
1997, which was primarily a result of the additional debt incurred in
conjunction with the Apollo/LCA/GranCare Mergers.
For the nine months ended June 30, 1998, the provision for income taxes was
affected by recapitalization, indirect merger, and transition expenses that are
not deductible for income tax purposes as well as non-deductible amortization of
goodwill associated with the GranCare Merger. Excluding the effect of these
non-deductible items, the effective income tax rate for the nine months ended
June 30, 1998 was approximately 45.4% compared to 41.9% for the same period in
1997. The effective income tax rate reflected the continuation of previously
existing non-deductible items and the lower pre-tax book income.
For the nine months ended June 30, 1998, the Company recognized an
extraordinary loss of $11.3 million (net of a $6.0 million income tax benefit)
associated with prepayment penalties on the early extinguishment of debt and the
write-off of certain deferred financing fees.
SEASONALITY
The Company's revenues and operating income generally fluctuate from quarter
to quarter. This seasonality is related to a combination of factors which
include the timing of Medicaid rate increases, the number of work days in the
period, and seasonal census cycles.
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IMPACT OF YEAR 2000 ISSUE
The Company completed an assessment of issues related to the Year 2000 and
determined that certain programs would need to be modified or replaced in order
for its financial and human resource information systems to function properly
with respect to dates in the year 2000 and after. The Company determined that
it would replace these systems with new systems that have a total estimated cost
of approximately $8.0 million, primarily for new hardware and software that will
be capitalized. Through June 30, 1998, the Company has capitalized
approximately $4.0 million related to these replacement systems. This project
is expected to be fully implemented by June 1999 which is prior to any
anticipated date-related impact on its operating systems. However, if such
replacement systems are not completed in a timely manner, the Year 2000 issue
could have a material impact on the operations of the Company.
In addition to its financial and human resource systems, the Company has
developed an inventory of critical computer systems and is in the process of
developing and implementing solutions for those systems that are found to have
date-related problems. The Company does not expect the resolution of the Year
2000 issue to have a material impact on the Company's business or financial
condition. However, the Company could be adversely impacted by the Year 2000
issue if its key suppliers and third parties, including governmental agencies
and other third party payors, do not address the issue successfully.
CAPITAL RESOURCES AND LIQUIDITY
Cash and cash equivalents were $12.4 million at June 30, 1998, and working
capital was $263.7 million, an increase of $161.6 million during the nine months
ended June 30, 1998 which included an increase of $133.7 million as a result of
the GranCare Merger. Cash used in operations was $36.3 million which included
approximately $68.7 million in payments for recapitalization, indirect merger,
and transition costs. Excluding the acquisition of accrued expenses in the
GranCare Merger, accrued expenses and other current liabilities increased by
$23.4 million primarily as a result of the remaining accrual for
recapitalization, indirect merger and transition costs which totaled $12.0
million at June 30, 1998. The remaining recapitalization, indirect merger, and
transition costs are expected to be paid during the remainder of fiscal year
1998. Excluding the acquisition of accounts payable in the GranCare Merger,
accounts payable decreased by $30.2 million primarily as a result of the $19.0
million termination fees paid to Vitalink Pharmacy Services, Inc. and Manor
Care, Inc. in consideration of the termination of a non-competition agreement in
conjunction with the GranCare Merger.
Excluding the acquisition of accounts receivable in the GranCare Merger and
other fiscal 1998 acquisitions, accounts receivable increased by $43.6 million
for the nine months ended June 30, 1998. The increase in receivables was
primarily attributable to the timing of collections on Medicare cost reports and
rate adjustments ($7.6 million), revenue increases ($2.9 million) and an
increase in average days outstanding ($18.9 million). The increase in
receivables related to the timing of collection on Medicare cost reports and
rate adjustments is related to fiscal intermediary delays in responding to
requests for interim rate increases and the Company continuing to file Medicare
routine cost limit exception requests. Review by the fiscal intermediary,
approval by the Health Care Financing Administration, and processing for payment
by the intermediaries of a filed routine cost limit exception request generally
takes 12 to 18 months. Management is continuing to monitor trends in the
Company's accounts receivable and is reviewing the Company's collection
procedures.
The Company receives payment for nursing facility services based on rates set
by individual state Medicaid programs. Although payment cycles for these
programs vary, payments generally are made within 30 to 60 days of services
provided. The Federal Medicare program, currently a cost-based reimbursement
program (See "Capital Resources and Liquidity-Changes in Healthcare
Legislation"), pays interim rates, based on estimated costs of services, on a 30
to 45-day basis. Final cost settlements, based on the difference between
audited costs and interim rates, are paid following final cost report audits by
Medicare fiscal intermediaries. Because of the cost report and audit process,
final settlement may not occur until up to 24 months after each facility's
Medicare year end. Additionally, the federal government recently announced that,
in order to stay within Medicare's 1998 budget and performance requirements, it
will reduce the frequency of payment of Medicare claims. Specialty medical
services generally increase the amount of payments received on a delayed basis.
The Company is also moving to a single operating platform for the inpatient
group's accounts receivable. At June 30, 1998, approximately 54% of the former
GranCare facilities had been converted to LCA's field-based accounts receivable
system.
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Cash used in investing activities was $74.4 million in the nine months ended
June 30, 1998, as compared to $68.6 million for the same period in fiscal 1997.
Investing activities for the nine months ended June 30, 1998 included the use of
$28.8 million related to the acquisition of Professional Rehabilitation, Inc.,
$14.1 million related to the acquisition of certain long-term care facilities,
$7.4 million related to various pharmacy acquisitions and $3.4 million to
purchase a previously leased nursing home facility. Deposits and Other
primarily included a deposit to HRPT of $15 million (see "Capital Resources and
Liquidity-Other Significant Indebtedness") reduced by the cash received in the
GranCare Merger. Other investing activities for the nine months ended June 30,
1998 included $32.3 million for routine capital expenditures. Capital
expenditures are expected to be funded by cash from operations or the Revolving
Credit Facility.
Financing activities provided $108.8 million during the nine months ended June
30, 1998. Cash provided by financing activities included $240.0 million from
the issuance of 17.8 million shares of common stock to Apollo and certain other
investors, $740.0 million in proceeds from the Senior Credit Facility, and
$448.9 million in proceeds from the offering of the Notes. Cash of $735.2
million was used to purchase approximately 90.5% of the issued and outstanding
stock of the Company in conjunction with the Recapitalization Merger, $563.3
million to repay substantially all amounts outstanding under the Company's and
GranCare's previous credit facilities, and $30.2 million to pay financing fees
associated with the Senior Credit Facility and the Notes.
Senior Credit Facility. As of June 30, 1998, the Senior Credit Facility
consisted of four components: a 6 1/2 year term loan facility in an aggregate
principal amount of $240 million (the "Tranche A Term Loan Facility"); a 7 1/2
year term loan facility in an aggregate principal amount of $250 million (the
"Tranche B Term Loan Facility"); an 8 1/2 year term loan facility in an
aggregate principal amount of $250 million (the "Tranche C Term Loan Facility");
and a 6 1/2 year revolving credit facility in the maximum amount of $150 million
(the "Revolving Credit Facility"). Loans made under the Tranche A Term Loan
Facility ("Tranche A Term Loans"), the Tranche B Term Loan Facility ("Tranche B
Term Loans") and the Tranche C Term Loan Facility ("Tranche C Term Loans") are
collectively referred to herein as "Term Loans." Advances under the Revolving
Credit Facility are sometimes referred to as "Revolving Loans." The proceeds
from borrowings under the Term Loans were used, along with the proceeds of the
Senior Subordinated Notes offering, to fund a portion of the Recapitalization
Merger, refinance a significant portion of LCA's and GranCare's pre-merger
indebtedness and to pay costs and expenses associated with the
Apollo/LCA/GranCare Mergers.
The Senior Credit Facility originally called for Term Loans to be amortized in
quarterly installments totaling $0, $26.5 million, $49.0 million, $51.5 million,
$51.5 million, $56.5 million, $186.0 million, $239.0 million and $80 million in
the fiscal years 1998, 1999, 2000, 2001, 2002, 2003, 2004, 2005 and 2006,
respectively. Principal amounts outstanding under the Revolving Credit Facility
will be due and payable in April 2005. As of June 30, 1998, there was $5.0
million borrowed under the Revolving Credit Facility in addition to
approximately $13.7 million letter of credit issuances.
Effective July 31, 1998, in connection with the consummation of the Mariner
Merger, the Senior Credit Facility was amended to, among other things, increase
the maximum amount available under the Revolving Credit Facility from $150.0
million to $175.0 million, and to provide for an additional $75.0 million of
Tranche A Term Loans, raising the aggregate outstanding amount of Tranche A Term
Loans to $315.0 million. As a result of the increased amount of the Tranche A
Term Loans, amortization of the Term Loans will increase to the following
approximate annual amounts (payable quarterly within each fiscal year): $0,
$33.5 million, $63.0 million, $66.25 million, $66.25 million, $73.0 million,
$194.0 million, $239.0 million and $80.0 million, in fiscal years 1998 through
2006, respectively.
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Interest on outstanding borrowings accrue, at the option of the Company, at
the customary Alternate Base Rate (the "ABR") of The Chase Manhattan Bank
("Chase") or at a reserve adjusted Eurodollar Rate (the "Eurodollar Rate") plus,
in each case, an Applicable Margin. The term "Applicable Margin" means a
percentage that will vary in accordance with a pricing matrix based upon the
respective term loan tenor and the Company's leverage ratio. Through July 1998,
the Applicable Margin for Revolving Loans and Tranche A Term Loans will equal
1.25% for loans based on ABR ("ABR Loans") and 2.25% for loans based on the
Eurodollar Rate ("Eurodollar Loans"); for Tranche B Term Loans, 1.50% in the
case of ABR Loans and 2.50% in the case of Eurodollar Loans; and for Tranche C
Term Loans, 1.75% in the case of ABR Loans and 2.75% in the case of Eurodollar
Loans. The covenants contained in the Senior Credit Facility also, among other
things, restrict the ability of the Company to dispose of assets, repay other
indebtedness or amend other debt instruments, pay dividends, and make
acquisitions. The Company received the consent of the requisite lenders under
the Senior Credit Facility to permit the Mariner Merger, and certain covenants
in the Senior Credit Facility were modified to accommodate the Mariner Merger.
Subject in each case to certain exceptions, the following amounts are required
to be applied, as mandatory prepayments, to prepay the Term Loans: (i) 75% of
the net cash proceeds of the sale or issuance of equity by the Company; (ii)
100% of the net cash proceeds of the incurrence of certain indebtedness; (iii)
75% of the net cash proceeds of any sale or other disposition by the Company or
any of its subsidiaries of any assets (excluding the sale of inventory and
obsolete or worn-out property, and subject to a limited exception for
reinvestment of such proceeds within 12 months); and (iv) 75% of excess cash
flow for each fiscal year, which percentage will be reduced to 50% in the event
the Company's leverage ratio as of the last day of such fiscal year is not
greater than 4.50 to 1.00. Mandatory prepayments will be applied pro rata to the
unmatured installments of the Tranche A Term Loans, the Tranche B Term Loans and
the Tranche C Term Loans; provided, however, that as long as any Tranche A Term
Loans remain outstanding, each holder of a Tranche B Term Loan or a Tranche C
Term Loan will have the right to refuse any such mandatory prepayment otherwise
allocable to it, in which case the amount so refused will be applied as an
additional prepayment of the Tranche A Term Loans. The Company will also have
the right to prepay the Senior Credit Facility, in whole or in part, at its
option. Partial prepayments must be in minimum amounts of $1 million and in
increments of $100,000 in excess thereof.
Amounts applied as prepayments of the Revolving Credit Facility may be
reborrowed; amounts prepaid under the Term Loans may not be reborrowed.
Senior Subordinated Notes. Also in connection with the Apollo/LCA/GranCare
Mergers, on November 4, 1997 the Company completed a private offering to
institutional investors of $275 million of its 9.5% Senior Subordinated Notes
due 2007, at a price of 99.5% of face value and $294 million of its 10.5% Senior
Subordinated Discount Notes due 2007, at a price of 59.6% of face value
(collectively, the "Notes"). Interest on the Senior Subordinated Notes is
payable semi-annually. Interest on the Senior Subordinated Discount Notes will
accrete until November 1, 2002 at a rate of 10.57% per annum, compounded semi-
annually, and will be cash pay at a rate of 10.5% per annum thereafter. The
Notes will mature on November 1, 2007. The net proceeds from this offering,
along with proceeds from the Senior Credit Facility, were used to fund a portion
of the Recapitalization Merger, refinance a significant portion of LCA's and
GranCare's pre-merger indebtedness and to pay costs and expenses associated with
the Apollo/LCA/GranCare Mergers.
Other Significant Indebtedness. In connection with the Apollo/LCA/GranCare
Mergers, the Company became a party to various agreements between GranCare and
Health and Retirement Properties Trust ("HRPT") and Omega Healthcare Investors,
Inc. ("Omega"). HRPT is the holder of a mortgage loan to AMS Properties, Inc.
("AMS Properties"), a wholly- owned subsidiary of the Company, dated October 1,
1994, in the aggregate principal amount of $11.5 million (the "HRPT Loan"). The
HRPT Loan is secured, in part, by mortgage and security agreements dated as of
March 31, 1995 (collectively, the "HRPT Mortgage") in favor of HRPT and
encumbering two nursing facilities in Wisconsin owned by AMS Properties.
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In connection with certain transactions effected in February 1997 by
GranCare's predecessor with Vitalink Pharmacy Services, Inc. ("Vitalink"),
Vitalink (a) paid a consent fee to HRPT in the amount of $10 million, which was
promptly reimbursed by GranCare immediately following the consummation of the
transactions with Vitalink and (b) entered into a limited guaranty (not to
exceed $15 million in the aggregate) of the obligations by GranCare, AMS
Properties and GCIHCC under the HRPT Mortgages, the GCIHCC Lease and the HRPT
Loan (collectively, the "HRPT Obligations") for so long as such obligations
remained outstanding. To support Vitalink's limited guaranty of the foregoing
obligations, GranCare caused an irrevocable letter of credit to be issued to
Vitalink in the event Vitalink made any payments under the limited guaranty (the
"HRPT Letter of Credit").
In connection with obtaining HRPT's consent to the Apollo/LCA/GranCare
Mergers, GranCare and HRPT executed a Restructure and Asset Exchange Agreement
dated October 31, 1997 pursuant to which HRPT and GranCare are in the process of
restructuring their relationship (the "HRPT/GranCare Restructuring"). As a part
of the HRPT/GranCare Restructuring, HRPT consented to the consummation of the
Apollo/LCA/GranCare Mergers and the transactions related thereto, and HRPT
received an unlimited guaranty by the Company and all subsidiaries of the
Company having an ownership interest in AMS and/or GCIHCC (individually, a
"Tenant Entity" and collectively, the "Tenant Entities") which guaranty is
secured by a cash collateral deposit of $15 million, the earned interest on
which is retained by HRPT. The performance by the Tenant Entities of their
respective obligations to HRPT continues to be secured by a pledge of one
million shares of HRPT common stock beneficially owned by GranCare and, as part
of the HRPT/GranCare Restructuring, GranCare agreed to waive the ability to
request a release of such collateral upon the attainment of certain financial
conditions. Accordingly, the Company does not have the ability to sell these
shares to meet any capital requirements. The terms of the leases between HRPT
and the Tenant Entities were extended to January 31, 2013, constituting lease
extensions ranging from 3 to 7 years and the aggregate base rental for all
facilities leased from HRPT (excluding the Exchange Facilities (as defined
below)) increased by $500,000 per year. AMS Properties will also prepay the
$11.5 million HRPT Loan and HRPT will release the HRPT Mortgage upon completion
of a like-kind exchange transaction whereby the Tenant Entities will exchange
(the "Exchange Transaction") five nursing facilities (the two nursing facilities
previously subject to the HRPT Mortgage and three nursing facilities currently
owned by the Company (collectively the "Exchange Facilities")) for four nursing
facilities owned by HRPT. The Company anticipates that the Exchange Transaction
will be completed during the fourth quarter. Following completion of the
Exchange Transaction, the Tenant Entities will lease back the Exchange
Facilities for an aggregate annual rent amount equal to the aggregate rent on
the four HRPT facilities.
In consideration of the HRPT/GranCare Restructuring, the Company paid HRPT a
one time restructuring payment of $10 million. The overall impact of the
HRPT/GranCare Restructuring is not expected to have any material effect on the
Company's operations or cash flows. The Company also paid an aggregate amount of
$19.0 million to Vitalink Pharmacy Services, Inc. ("Vitalink") and Manor Care,
Inc. ("Manor Care") in connection with the settlement of certain litigation
initiated by Vitalink and Manor Care seeking to enjoin the consummation of the
GranCare Merger.
A wholly-owned subsidiary of the Company, Professional Health Care Management,
Inc. ("PHCMI"), is the borrower under a $58.8 million mortgage note executed on
August 14, 1997 (the "Omega Note") in favor of Omega, and under the related
Michigan loan agreement dated as of June 7, 1992 as amended (the "Omega Loan
Agreement"). All $58.8 million was outstanding as of June 30, 1998.
The Omega Note bears interest at a rate which is adjusted annually based on
either (i) changes in the Consumer Price Index or (ii) a percentage of the
change in gross revenues of PHCMI and its subsidiaries from year to year,
divided by 58.8 million, whichever is higher, but in any event subject to a
maximum rate not to exceed 105% of the interest rate in effect for the Omega
Note for the prior calendar year. The current interest rate is 15.0% per annum
which is paid monthly. Additional interest accrues on the outstanding principal
of the Omega Note at the rate of 1% per annum. Such interest is compounded
annually and is due and payable on a pro rata basis at the time of each
principal payment or prepayment. Beginning October 1, 2002, quarterly
amortizing installments of principal in the amount of $1.5 million will also
become due and payable on the first day of each calendar quarter. The entire
outstanding principal amount of the Omega Note is due and payable on August 13,
2007. The Omega Note may be prepaid without penalty during the first 100 days
following August 14, 2002. Payment of the Omega Note after acceleration upon
the occurrence of an event of default will result in a prepayment penalty in the
nature of a "make whole" premium.
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In addition to the interest on the Omega Note described in the preceding
paragraph, and as a condition to obtaining Omega's consent to the February, 1997
transaction between Vitalink and GranCare, PHCMI agreed to pay additional
interest to Omega in the amount of $20,500 per month, through and including July
1, 2002. If the principal balance of the Omega Note for any reason becomes due
and payable prior to that date, there will be added to the indebtedness owed by
PHCMI: (i) the sum of $1.0 million, plus; (ii) interest thereon at 11% per annum
to the prepayment date; less (iii) the amount of such additional interest paid
to Omega prior to the prepayment date.
The Omega Loan Agreement obligates PHCMI, among other things, to maintain a
minimum tangible net worth of at least $10 million, which may be increased or
decreased under certain circumstances but may not be less than $10 million. The
Company must contribute additional equity to PHCMI, if and when necessary, to
assure that such minimum tangible net worth test is met. PHCMI has satisfied
this test in the past without the contribution of additional equity, and
management believes that it will continue to do so in the future.
Mariner Financings
Mariner Senior Credit Facility. Mariner is the borrower under a $460.0
million senior secured revolving loan facility (the "Mariner Senior Credit
Facility"), by and among Mariner, the lenders signatory thereto (the "Mariner
Lenders"), and PNC Bank, National Association, as agent for the Mariner Lenders
(the "Mariner Agent"). As of June 30, 1998, approximately $326.0 million of
loans, and $6.7 million of letters of credit, were outstanding under the Mariner
Senior Credit Facility. The Mariner Senior Credit Facility terminates on
January 3, 2000, and provides for prime rate and Eurodollar - based interest
rate options. The borrowing availability and rate of interest vary depending
upon specified financial ratios, with applicable interest rate margins ranging
between 0% and 0.25% for prime-base borrowings, and between 0.50% and 1.75% for
Eurodollar - based advances. As of July 31, 1998, the applicable margins were
0% for prime-based revolving loans and 1.25% for Eurodollar-based loans. The
Mariner Senior Credit Facility also contains covenants which, among other
things, require Mariner to maintain certain financial ratios and impose certain
limitations or prohibitions on Mariner with respect to the incurrence of
indebtedness, liens and capital leases; the payment of dividends on, and the
redemption or repurchase of, its capital stock; investments and acquisitions,
including acquisition of new facilities; the merger or consolidation of Mariner
with any person or entity; and the disposition of any of Mariner's properties or
assets.
Mariner's obligations under the Mariner Senior Credit Facility are
collateralized by a pledge of the stock of substantially all of its subsidiaries
and are guaranteed by substantially all of its subsidiaries. In addition, the
Mariner Senior Credit Facility is collateralized by mortgages on certain
inpatient facilities of Mariner and its subsidiaries, by leasehold mortgages on
certain inpatient facilities leased by Mariner or its subsidiaries, and by
security interests in certain other property and assets of Mariner and its
subsidiaries. As the owner of 100% of the capital stock of Mariner, the Company
has pledged such capital stock to Chase as additional collateral to secure the
Company's obligations in connection with the Senior Credit Facility and the
Synthetic Lease (as the latter term is defined herein below under the caption,
"Other Factors Affecting Liquidity and Capital Resources").
Mariner and its subsidiaries are treated as unrestricted subsidiaries under
the Senior Credit Facility. Unlike subsidiaries of the Company other than
Mariner and its subsidiaries (the "Non-Mariner Subsidiaries"), Mariner and its
subsidiaries neither guarantee the Company's obligations under the Senior Credit
Facility nor pledge their assets to secure such obligations. Correspondingly,
the Company and the Non-Mariner Subsidiaries do not guarantee or assume any
obligations under the Mariner Senior Credit Facility. Mariner and its
subsidiaries are not subject to the covenants contained in the Senior Credit
Facility, and the covenants contained in the Mariner Senior Credit Facility are
not binding on the Company and the Non-Mariner Subsidiaries. Mariner and the
Mariner subsidiaries are obligated to continue to comply with the covenants
contained in the Mariner Senior Credit Facility without taking into account the
revenues, expenses, net income, assets or liabilities of the Company and the
Non-Mariner Subsidiaries. The converse is true with respect to the Company,
which (together with its Non-Mariner Subsidiaries) must continue to comply with
the covenants contained in its Senior Credit Facility without taking into
account the revenues, expenses, net income, assets or liabilities of Mariner and
its subsidiaries.
Mariner Senior Subordinated Notes. Mariner is also the issuer of certain 9-
1/2% Senior Subordinated Notes due 2006 (the "Mariner Notes") which were issued
pursuant to that certain Indenture dated as of April 4, 1996 (the "Mariner
Indenture") with Mariner as issuer and State Street Bank and Trust Company as
trustee, and are outstanding in the aggregate principal amount of $150.0
million.
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As a consequence of the Mariner Merger and the resulting change of control at
Mariner, the holders of the Mariner Notes (the "Mariner Bondholders") have the
right under the Mariner Indenture to put their Mariner Notes back to Mariner for
repurchase (the "Change of Control Purchase") as a consequence of the
consummation of the Mariner Merger. The Change of Control Purchase must be
concluded within ninety (90) days after the effective time of the Mariner
Merger, and will be at a price equal to 101% of the outstanding principal amount
of any Mariner Notes that are put to Mariner.
Mariner has the right to borrow up to $25.0 million under the Mariner Senior
Credit Facility to pay the purchase price of any Mariner Notes tendered pursuant
to the Change of Control Purchase. Mariner has also received a commitment from
Salomon Brothers Holding Company Inc. and Salomon Brothers Inc. for a senior
subordinated bridge loan facility in the maximum amount of $151.5 million to
provide additional liquidity to pay the purchase price of any Mariner Notes so
tendered. The Bridge Loan Commitment expires on September 30, 1998.
Accordingly, Mariner anticipates having sufficient funds available to it to
satisfy its obligation to purchase any and all Mariner Notes that are tendered
pursuant to the Change of Control Purchase.
Other Mariner Indebtedness. As of June 30, 1998, Mariner and its subsidiaries
had approximately $64.9 million of facility-specific mortgage and other term
loan indebtedness outstanding and $71.7 million in capital lease obligations.
Changes in Healthcare Legislation. The Balanced Budget Act enacted in August
1997 (the "Balanced Budget Act"), contains numerous changes to the Medicare and
Medicaid programs with the intent of slowing the growth of payments under these
programs by $115.0 billion and $13.0 billion, respectively, over the next five
years. Approximately 50% of the savings will be achieved through a reduction in
the growth of payments to providers and physicians.
The Balanced Budget Act amended the Medicare program by revising the payment
system for skilled nursing services. Currently, nursing homes are reimbursed by
the Medicare program based on the actual costs of services provided. However,
the Balanced Budget Act requires the establishment of a prospective payment
system ("PPS") for nursing homes for cost reporting periods beginning on or
after July 1, 1998. Under PPS, nursing homes will receive a fixed per diem rate
for each of their patients which, during the first three years, will be based on
a blend of facility specific rates and Federal acuity adjusted rates.
Thereafter, the per diem rates will be based solely on Federal acuity adjusted
rates. Subsumed in this per diem rate will be ancillary services, such as
pharmacy and rehabilitation services, which historically have been provided to
many of the Company's nursing facilities by the Company's pharmacy and therapy
subsidiaries.
The Balanced Budget Act also requires the establishment of an interim payment
system for home health services for cost reporting periods beginning on or after
October 1, 1997. The interim payment system continues per visit limits and
establishes new per beneficiary annual cost limits. A permanent prospective
payment system for home health services will be established by October 1, 1999.
On May 5, 1998, the Health Care Financing Administration released the nursing
home PPS rates that will be in effect from July 1, 1998 through September 30,
1999. The Company is not able to predict at this time what effect the PPS
system will have on its nursing home, home health, pharmacy, rehabilitation and
hospital services businesses. The Company is evaluating the new regulations and
believes that while PPS may initially result in more intense price competition
and lower margins among ancillary service providers (including the Company's
pharmacy, therapy, and hospital services subsidiaries), PPS will also provide
opportunities to efficiently operated low cost providers who can achieve
economies of scale.
The Balanced Budget Act also repealed the Boren Amendment ("Boren"), which had
required state Medicaid programs to reimburse nursing facilities for the costs
that are incurred by efficiently and economically operated providers in order to
meet quality and safety standards. Because of the repeal of Boren, states now
have considerable flexibility in establishing Medicaid payment rates. In
addition, Boren provided a dispute resolution mechanism whereby providers could
challenge Medicaid rates set by the various states, the repeal of which will now
make it more difficult to challenge these rates in the future. The Company is
not able to predict whether any states will adopt changes in their Medicaid
reimbursement programs, or, if adopted and implemented, what effect such
initiatives would have on the Company.
27
<PAGE>
On January 30, 1998, the Health Care Financing Administration issued its new
salary equivalency guidelines which change Medicare reimbursement rates for
contracted therapy services. Under salary equivalency, the Company is
reimbursed for contracted therapy services based on the time spent on the
premises by the contract therapist times a fixed rate, depending on the service
provided. While the new rates for physical therapy represent an increase over
what the Company previously received for such services, the new rates for
occupational therapy and speech language pathology represent decreases from what
the Company previously received. The salary equivalency guidelines will remain
in effect until the facility at which such services are provided, including the
Company's facilities and other facilities serviced by the Company's therapy
subsidiaries, start billing under PPS. The Company believes that while salary
equivalency had a slight adverse effect on its therapy revenue, the Company does
not believe that salary equivalency will have a material adverse effect on the
Company's consolidated revenues.
Other Factors Affecting Liquidity and Capital Resources. In addition to
principal and interest payments on its long-term indebtedness, the Company has
significant rent obligations relating to its leased facilities. The Company's
estimated principal payments, cash interest payments, and rent obligations
(including Mariner) for fiscal year 1998 are approximately $198.0 million.
The Company's operations require capital expenditures for renovations of
existing facilities in order to continue to meet regulatory requirements, to
upgrade facilities for the treatment of subacute patients and to accommodate the
addition of specialty medical services, and to improve the physical appearance
of its facilities for marketing purposes. The Company estimates that total
capital expenditures for the year ending September 30, 1998 (excluding Mariner)
will be approximately $60.0 million of which $30.0 million represents
maintenance capital expenditures.
In addition to the Senior Credit Facility, the Company has a lease arrangement
providing for up to $100.0 million to be used as a funding mechanism for future
assisted living and skilled nursing facility construction, lease conversions,
and other facility acquisitions (the "Synthetic Lease"). This leasing program
allows the Company to complete these projects without committing significant
financing resources. The lease is an unconditional "triple net" lease for a
period of seven years with the annual lease obligation a function of the amount
spent by the lessor to acquire or construct the project, a variable interest
rate, and commitment and other fees. The Company guarantees a minimum of
approximately 83% of the residual value of the leased property and also has an
option to purchase the properties at any time prior to the maturity date at a
price sufficient to pay the entire amount financed, accrued interest, and
certain expenses. At June 30, 1998 approximately $40.4 million of this leasing
arrangement was utilized. The leasing program is accounted for as an operating
lease. The Company also received the consent of the requisite lenders under the
Synthetic Lease transaction to permit the Mariner Merger, and certain covenants
in the Synthetic Lease documents were modified to accommodate the Mariner
Merger.
The Company currently maintains two captive insurance subsidiaries to provide
for reinsurance obligations under workers' compensation, general and
professional liability, and automobile liability. These obligations are funded
with long-term, fixed income investments which are not available to satisfy
other obligations of the Company.
The Company believes that the cash flow generated from its operations, the
Company's cash and cash equivalents, together with amounts available under the
Senior Credit Facility, should be sufficient to fund its debt service
requirements, working capital needs, anticipated capital expenditures and other
operating expenses. The Revolving Credit Facility will provide the Company with
revolving loans in an aggregate principal amount at any time not to exceed
$150.0 million, of which $131.3 million was available after considering $13.7
million in outstanding letters of credit and the $5.0 million borrowed at June
30, 1998. (As indicated above, effective July 31, 1998, availability under the
Revolving Credit Facility was increased to $175.0 million.) In addition, the
Mariner Senior Credit Facility will provide Mariner with revolving loans up to
$460.0 million, of which approximately $127.3 million was available as June 30,
1998, after taking into account the $326.0 million in revolving loans and $6.7
million of letters of credit outstanding as of such date. The Company's future
operating performance and ability to service or refinance the Notes, the Mariner
Senior Credit Facility and the Mariner Notes and to extend or refinance the
Senior Credit Facility will be subject to future economic conditions and to
financial, business and other factors, many of which are beyond the Company's
control.
28
<PAGE>
MERGER
As previously reported, the Company entered into a definitive merger agreement
on April 13, 1998 with Mariner which was executed on July 31, 1998. Under the
terms of the agreement, Mariner shareholders received one share of Paragon
common stock for each Mariner share held. At the time of the Mariner Merger,
Mariner owned, operated and managed freestanding inpatient skilled nursing
facilities, provided rehabilitation program management services to other skilled
nursing facilities and operated outpatient rehabilitation clinics, pharmacies
and home health agencies.
CAUTIONARY STATEMENTS
Information provided herein by the Company contains, and from time to time the
Company may disseminate materials and make statements which may contain,
"forward-looking" information as that term is defined by the Private Securities
Litigation Reform Act of 1995 (the "Act"). In particular, "Management's
Discussion and Analysis of Financial Condition and Results of Operation Capital
Resources and Liquidity" contains information concerning the ability of the
Company to service its debt obligations and other financial commitments as they
come due and the effect of changes in healthcare legislation and regulation. The
aforementioned forward looking statements, as well as other forward looking
statements made herein, are qualified in their entirety by these cautionary
statements, which are being made pursuant to the provisions of the Act and with
the intention of obtaining the benefits of the "safe harbor" provisions of the
Act.
The Company cautions investors that any forward-looking statements made by the
Company are not guarantees of future performance and that actual results may
differ materially from those in the forward-looking statements as a result of
various factors, including, but not limited to, the following:
(i) In recent years, an increasing number of legislative proposals have
been introduced, proposed, and in some cases adopted, by Congress and
in some state legislatures which would effect major changes in the
healthcare system. However, the Company cannot predict the form of
future healthcare reform legislation which may be proposed or adopted
by Congress or by state legislatures. Accordingly, the Company is
unable to assess the effect of any such legislation on its business.
There can be no assurance that any such legislation will not have a
material adverse impact on the future growth, revenues and net income
of the Company.
(ii) The Company derives substantial portions of its revenues from third-
party payors, including government reimbursement programs such as
Medicare and Medicaid, and some portions of its revenues from non-
governmental sources, such as commercial insurance companies, health
maintenance organizations and other charge-based contracted payment
sources. Both government and non government payors have undertaken
cost-containment measures designed to limit payments to healthcare
providers, such as PPS. There can be no assurance that payments under
governmental and non-governmental payor programs will be sufficient to
cover the costs allocable to patients eligible for reimbursement. The
Company cannot predict whether or what proposals or cost-containment
measures will be adopted or, if adopted and implemented, what effect,
if any, such proposals might have on the operations of the Company. As
stated above, the Company is currently evaluating the effect of the
recently announced PPS rates on its business.
(iii)The Company is subject to extensive federal, state and local
regulations governing licensure, conduct of operations at existing
facilities, construction of new facilities, purchase or lease of
existing facilities, addition of new services, certain capital
expenditures, cost-containment and reimbursement for services
rendered. The failure to obtain or renew required regulatory approvals
or licenses, the delicensing of facilities owned, leased or operated
by the Company or the disqualification of the Company from
participation in certain federal and state reimbursement programs
could have a material adverse effect upon the operations of the
Company.
29
<PAGE>
(iv) There can be no assurance that the Company will be able to continue
its substantial growth or be able to fully implement its business
strategies for its post-acute care, pharmaceutical services,
rehabilitation services, or hospital services divisions or that
management will be able to successfully integrate the operations of
GranCare, LCA, and Mariner.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As is typical in the healthcare industry, the Company is and will be
subject to claims that its services have resulted in resident injury
or other adverse effects, the risks of which will be greater for
higher acuity residents receiving services from the Company than for
other long-term care residents. The Company is, from time to time,
subject to such negligence claims and other litigation. In addition,
resident, visitor, and employee injuries will also subject the Company
to the risk of litigation. From time to time, the Company and its
subsidiaries have been parties to various legal proceedings in the
ordinary course of their respective business. In the opinion of
management, except as described below, there are currently no
proceedings which, individually or in the aggregate, if determined
adversely to the Company and after taking into account the insurance
coverage maintained by the Company, would have a material adverse
effect on the Company's financial position or results of operations.
The Company received a letter dated September 5, 1997 from an
Assistant United States Attorney ("AUSA") in the United States
Attorney's Office for the Eastern District of Texas (Beaumont)
advising that the office is involved in an investigation of
allegations that services provided at some of the Company's facilities
may violate the Civil False Claims Act. The AUSA informed the Company
that the investigation is the result of a qui tam complaint (which
involves a private citizen requesting the federal government to
intervene in an action because of an alleged violation of a federal
statute) filed under seal against the Company, and the AUSA is
investigating the allegations in order to determine if the United
States will intervene in the proceedings. The AUSA has requested that
the Company voluntarily produce a substantial amount of documents,
including medical records of former residents. In November 1997,
counsel for the Company met with the AUSA and the parties engaged in
discussions on whether the voluntary production of former residents'
medical records can be accomplished without violating the residents'
rights to privacy and confidentiality. Based upon the information
currently known about the complaint, the Company believes that given
an opportunity to address the allegations, the AUSA will find
intervention by the United States is without merit. In December 1997,
the Company advised the AUSA that absent the United States agreeing to
protect the confidentiality of the residents' medical records, and to
prevent unauthorized disclosure of the information requested to non-
government personnel, the Company would not agree to a voluntary
production. The Company has heard nothing further from the AUSA. The
Department of Justice attorney assigned to the case recently invited
the Company to reopen discussions directly with the Department
regarding the Company's position on the alleged claims. The Company
will vigorously contest the alleged claims if the complaint is
pursued.
30
<PAGE>
The Department of Justice ("DOJ") has advised the Company that the
United States has declined to intervene in the qui tam complaint filed
against The Brian Center Corporation ("BCC") and one of its
subsidiaries, Med-Therapy Rehabilitation Services, Inc. ("Med-
Therapy"), both wholly-owned subsidiaries of the Company (and of LCA
before the Apollo/LCA/GranCare Mergers) in the federal district court
for the Western District of North Carolina. The individual plaintiff
is continuing to pursue the alleged claims that BCC and Med-Therapy
caused certain therapists to make improper therapy record entries with
respect to screening services, and that any claims filed with Medicare
for payments based upon such improper record entries should be viewed
as false claims under the Civil False Claims Act. The Company
continues to vigorously contest these claims. The plaintiff recently
filed an amended complaint in response to a court order on defendants'
motion to dismiss which gave plaintiff 20 days to file an amended
complaint or have the original complaint dismissed. The plaintiff
filed an amended complaint which does not raise any new or different
allegations. The Company has filed a motion to dismiss the amended
complaint and is awaiting a decision. No assurance can be given that,
if the plaintiff were to prevail in his claim, the resulting judgment
would not have a material adverse effect on the Company. In connection
with the Company's acquisition of BCC, the primary stockholder (Donald
C. Beaver) agreed to indemnify and hold harmless the Company from and
against any and all loss, expense, damage, penalty and liability which
could result from this claim, subject to further adjustment. Mr.
Beaver's indemnity requires any payment to the Company to be in the
form of shares of the Company's common stock.
The Company was served with a Petition, Cause No. 97-1500-G,
Community Healthcare Services of America, Inc., v. Rehability Health
Services, Inc. and Living Centers of America, Inc., in the 319th
Judicial District Court of Nueces County, Texas, seeking $5.0 million
in damages, filed by Community Health Services, Inc. ("Community"), in
connection with a home health agency management agreement entered into
between Community and a subsidiary of the Company. Such subsidiary
operated a Texas home health agency which Community managed. The
Company is vigorously defending the allegations of Community that the
Company breached the agreement by terminating Community's management
services and has filed a lawsuit against Community for breach of the
agreement, Cause No. 97-03569; Rehability Health Services, Inc. v.
Community Healthcare Services, Inc., in the 353rd Judicial District
Court of Travis County, Texas. The Nueces County action was
transferred to Travis County and the two cases have been consolidated
into Cause No. 97-03569. This matter is currently in the discovery
phase.
On June 10, 1997, a GranCare stockholder filed a civil action in
state district court in Harris County, Texas: Howard Gunty, Inc.
Profit Sharing Plan v. Gene E. Burleson, Charles M. Blalack,
Antoinette Hubenette, Joel S. Kanter, Ronald G. Kenny, Robert L.
Parker, William G. Petty, Jr., Edward V. Regan, Gary U. Rolle and
GranCare, Inc., No. 97-30762. This complaint alleged, generally, that
the defendants breached their fiduciary duties owed to GranCare's
stockholders by failing to take all reasonable steps necessary to
ensure that GranCare's stockholders receive maximum value for their
shares of GranCare common stock in connection with the GranCare
Merger. The plaintiffs sought (i) an injunction prohibiting the
consummation of the GranCare Merger or (ii) alternatively, if the
GranCare Merger were consummated, to have such transaction rescinded
and set aside. In addition, the plaintiffs sought unspecified
compensatory damages, costs and to have the action certified as a
class action.
31
<PAGE>
On October 28, 1997, the parties to the aforementioned litigation
entered into an Agreement and Stipulation of Settlement (the
"Settlement Agreement") pursuant to which the plaintiffs agreed to
dismiss, with prejudice, all claims against GranCare in consideration
of, among other things, (i) certain additional disclosure included in
the disclosure documents sent to GranCare stockholders in connection
with their approval of the GranCare Merger and (ii) the payment by
GranCare of the fees and expenses of plaintiffs' counsel in an
aggregate amount of no more than $350,000. The effectiveness of the
Settlement Agreement is subject to a number of conditions, including,
among others, the entry by the court of a final judgment approving the
terms of the settlement. GranCare entered into the Settlement
Agreement based upon its belief that a speedy resolution of this
dispute was in the best interest of the GranCare stockholders and in
so doing did not in any way admit any wrongdoing or liability in
connection with this matter. On April 6, 1998, the court
preliminarily accepted the Settlement Agreement and ordered that
notice of the Settlement Agreement be mailed to all class members. On
July 24, 1998, the court gave final approval to the settlement and
entered judgement dismissing the case with prejudice.
On August 26, 1996, a class action complaint was asserted against
GranCare in the Denver, Colorado District Court, Salas, et al. v.
GranCare, Inc., and AMS Properties, Inc., d/b/a Cedars Health Care
Center, Inc. Case No. 96 CV 4449, asserting five claims for relief,
including third-party beneficiary, tortious interference and
negligence per se causes of action arising out of quality of care
issues at a healthcare facility formerly owned by GranCare. On
January 20, 1998, plaintiffs requested leave to amend their complaint
by adding an additional class claim for fraud and three new named
plaintiffs. The complaint was amended a second time on February 2,
1998 by adding an additional plaintiff. At the class certification
hearing held on February 20, 1998, plaintiffs again amended their
complaint to clarify that damages for all of the class claims would be
limited to restitution and emotional distress. Pursuant to the Third
Amended Complaint, the class claims were identified as third-party
beneficiary of contract; breach of contract; tortious interference
with contract; fraud; and negligence per se. In addition to the class
claims, the named plaintiffs each asserted claims for promissory
estoppel and violation of the Colorado Consumer Protection Act.
On March 15, 1998, the court entered an order in which it certified
a class action in the matter. The court certified three classes
consisting of one primary class ("Class I") and two subclasses ("Class
II" and "Class III"). Class I consists of all people who were
residents of Cedars at any time from September 21, 1993 through
February 20, 1998, and is asserting tortious interference, fraud and
negligence per se claims. Class II is comprised of those members of
Class I who were private pay residents and therefore were individually
parties to a contract with Cedars and only asserts the breach of
contract claim. Class III consists of those members of Class I who
were either Medicaid or Medicare residents at Cedars and seeks to
recover for breach of the Medicare or Medicaid provider agreements to
which they assert they were third party beneficiaries.
Although the Cedars plaintiffs agreed to limit the class damages to
restitution and emotional distress, the court has only certified the
Classes with respect to the issue of liability and the various
Classes' rights to restitution. The court determined that emotional
distress damages are of such an individualized and personal nature
that the class-wide request for emotional distress damages was not
appropriate for class treatment. Therefore, the class action will
proceed only for purposes of proving liability under the claims and
any corresponding rights to restitution. Upon a finding of liability,
if any, emotional distress damages for any Class member other than the
Class representatives, will be determined in separate trials. The
Court's May 8, 1998 case management order outlined the division of
claims and trials.
At a status conference on May 7, 1998, plaintiff's counsel orally
dismissed her promissory estoppel claims on behalf of the named
plaintiffs. Trial has been set for six weeks commencing March 15,
1999. The Company intends to vigorously contest the remaining alleged
claims and the certification of the various Classes.
32
<PAGE>
On May 18, 1998, a class action complaint was asserted against the
Company, certain of its predecessor entities and affiliates and
certain other parties in the Tampa, Florida Circuit Court, Wilson, et
al. v. Paragon Health Network, Inc., et al., case no. 98-03779,
asserting 7 claims for relief, including breach of contract, breach of
fiduciary duty, unjust enrichment, violation of Florida Civil Remedies
for Criminal Practices Act, violation of Florida Racketeer and Corrupt
Organization Act, false advertising and common-low conspiracy arising
out of quality of care issues at a health care facility formerly
operated by Brian Center Health and Rehabilitation/Tampa, Inc. and
later by a subsidiary of LCA as a result of the Brian Center
Corporation merger. The Company removed this case to Federal Court on
June 10, 1998 and the matter is currently pending in the United States
District Court for the Middle District of Florida, Tampa division,
case no. 98-1205-CIV-T23B. The plaintiffs filed a motion to remand on
June 22, 1998 and the Company filed a motion to dismiss on June 30,
1998. The Company is currently awaiting the outcome of these motions.
The complaint has only been recently filed and no discovery has been
conducted. Accordingly, the information available to the Company is
very limited and the Company is unable to assess at this point the
magnitude of the allegations. The Company intends to vigorously
contest the request for class certification as well as all alleged
claims made.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In connection with the acquisition of Professional Rehability, Inc.
and certain affiliated companies, on May 1, 1998 the Company issued
1,147,225 shares of its common stock (the "Shares") as part of the
consideration. The Shares were issued pursuant to the exemption from
registration contained in Rule 506 of Regulation D promulgated under
the Securities Act of 1933, as amended. The issuance of the Shares
falls within this exemption because (i) the value of the Shares at the
time of the issuance was approximately $22.6 million; (ii) the Shares
were issued to one accredited investor; (iii) the Shares were not
offered in a general solicitation or general advertising; and (iv) the
resale of the Shares was properly restricted.
ITEM 5. OTHER INFORMATION
On July 31, 1998, the Company acquired Mariner Health Group, Inc. by
merger, as previously disclosed in the Company's public filings with
the Securities and Exchange Commission.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index
Exhibit
Number
-------
27.1 Financial Data Schedule
(b) Reports on Form 8-K
On August 11, 1998 the Company filed Form 8-K announcing the
completion of the acquisition by merger of Mariner Health Group, Inc.
on July 31, 1998.
33
<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.
August 13, 1998
MARINER POST-ACUTE NETWORK, INC.
(Registrant)
By: /s/ Charles B. Carden
----------------------------------
Charles B. Carden
Executive Vice President and
Chief Financial Officer
By: /s/ Ronald W. Fleming
---------------------------------
Ronald W. Fleming
Vice President, Controller,
and Chief Accounting Officer
34
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