<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 MARCH 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-10968
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)
(770) 393-0199
(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 41,442,068 shares outstanding of the issuer's only class of common
stock as of April 30, 1998.
<PAGE>
PARAGON HEALTH NETWORK, INC.
AND SUBSIDIARIES
FORM 10-Q
TABLE OF CONTENTS
MARCH 31, 1998
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements and Notes 3
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 2. Changes in Securities and Use of Proceeds 29
Item 3. Not applicable
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 5. Other Information 30
Item 6. Exhibits and Reports on Form 8-K 31
SIGNATURE PAGE 32
<PAGE>
PART 1 FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
PARAGON HEALTH NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended March 31, Ended March 31,
------------------------ ------------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net Revenues
Nursing home revenue:
Net patient services $362,670 $185,323 $668,379 $368,007
Other 3,579 1,363 5,162 2,700
Non-nursing home revenue:
Pharmacy services 55,263 48,656 106,849 95,259
Therapy services 39,371 45,899 80,259 93,569
Home health, hospital services, and other 26,278 4,077 48,118 5,985
-------- -------- -------- --------
487,161 285,318 908,767 565,520
Costs and Expenses:
Salaries and wages 178,655 108,962 338,676 220,397
Employee benefits 43,793 25,974 79,427 50,250
Nursing, dietary and other supplies 23,861 13,314 44,039 26,793
Ancillary services 107,867 56,715 201,650 110,930
General and administrative 74,101 39,880 134,859 79,583
Depreciation and amortization 17,963 10,163 33,326 20,066
Provision for bad debts 4,694 4,466 13,399 9,975
Recapitalization, indirect merger and transition costs - - 80,687 -
-------- -------- -------- --------
450,934 259,474 926,063 517,994
-------- -------- -------- --------
Income (loss) from operations 36,227 25,844 (17,296) 47,526
Other Income and Expense:
Interest expense 30,422 5,501 52,034 10,625
Interest and dividend income (2,460) (1,119) (4,744) (2,189)
-------- -------- -------- --------
27,962 4,382 47,290 8,436
-------- -------- -------- --------
Income (loss) before income taxes,
equity earnings/minority interest,
and extraordinary loss 8,265 21,462 (64,586) 39,090
Provision (Benefit) for Income Taxes 3,748 9,129 (13,951) 16,369
-------- -------- -------- --------
Income (loss) before equity earnings/
minority interest and extraordinary loss 4,517 12,333 (50,635) 22,721
Equity Earnings/Minority Interest (127) (119) (299) (182)
-------- -------- -------- --------
Income (loss) before extraordinary loss 4,390 12,214 (50,934) 22,539
Extraordinary Loss on Early Extinguishment
of Debt, net of $6,034 Income Tax Benefit - - (11,275) -
-------- -------- -------- --------
Net Income (Loss) $4,390 $12,214 ($62,209) $22,539
======== ======== ======== ========
Earnings (Loss) Per Share:
Basic $0.11 $0.21 ($1.40) $0.38
======== ======== ======== ========
Diluted $0.10 $0.21 ($1.40) $0.38
======== ======== ======== ========
Weighted Average Common
Shares Outstanding:
Basic 41,208 58,616 44,434 58,561
======== ======== ======== ========
Diluted 41,826 59,478 44,434 59,423
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
PARAGON HEALTH NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share amounts)
<TABLE>
<CAPTION>
March 31, September 30,
ASSETS 1998 1997
----------- ------------
(unaudited)
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 19,464 $ 14,355
Receivables, less allowances of $71,984 and $33,138 427,910 211,989
Supplies 30,205 21,237
Deferred income taxes 83,421 24,294
Prepaid expenses and other current assets 31,687 15,354
---------- --------
Total current assets 592,687 287,229
Property and Equipment:
Land, buildings and improvements 550,031 378,251
Furniture, fixtures and equipment 169,171 121,698
Leased property under capital leases 12,551 12,551
---------- --------
731,753 512,500
Less accumulated depreciation 229,063 210,117
---------- --------
502,690 302,383
Goodwill, net 468,508 196,120
Restricted Investments 96,241 51,976
Notes Receivable, net 31,482 11,200
Other Assets 88,608 25,459
---------- --------
$1,780,216 $874,367
========== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Notes payable and current maturities of long-term debt $ 17,330 $ 43,196
Accounts payable 128,814 46,872
Accrued payroll and related expenses 88,181 66,866
Accrued interest 30,282 2,355
Other accrued expenses 53,190 25,836
---------- --------
Total current liabilities 317,797 185,125
Long-Term Debt, net of current maturities 1,278,488 252,763
Long-Term Insurance Reserves 42,583 27,555
Deferred Income Taxes and Other Noncurrent Liabilities 70,170 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; 41,389,954 and 60,803,760 shares issued 414 608
Capital surplus 505,085 226,972
Retained earnings (deficit) (435,668) 164,650
Unrealized gain on securities available-for-sale 1,347 244
Treasury stock at cost - none and 2,004,444 shares - (17,191)
---------- --------
Total stockholders' equity 71,178 375,283
---------- --------
$1,780,216 $874,367
========== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
PARAGON HEALTH 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) (62,209) (62,209)
Issuance of shares to Apollo
Management, L.P. and affiliates 17,778 178 239,822 240,000
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 (3,886) (1,350) 11,410 7,524
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 450 4 5,340 5,344
Unrealized gain on
securities available-for-sale 1,103 1,103
------- ----- --------- --------- ------ ------ -------- ---------
BALANCE, MARCH 31, 1998 41,390 $ 414 $ 505,085 $(435,668) $1,347 - - $ 71,178
======= ===== ========= ========= ====== ====== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
PARAGON HEALTH NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six Months
Ended March 31,
-------------------------
1998 1997
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ($62,209) $22,539
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 33,326 20,066
Provision for bad debts 13,399 9,975
Interest accretion on Senior Subordinated
Discount Notes 7,640 -
Income taxes deferred 2,137 (603)
Equity earnings/minority interest 299 182
Changes in noncash working capital:
Receivables (42,201) (43,826)
Supplies (6,828) 122
Prepayments and other current assets (8,268) 2,007
Accounts payable (28,676) (9,799)
Accrued expenses and other current liabilities 20,396 (12,497)
Changes in long-term insurance reserves 4,994 7,360
Other 1,898 (334)
------- -------
NET CASH USED IN OPERATING ACTIVITIES (64,093) (4,808)
CASH FLOWS USED IN INVESTING ACTIVITIES:
Acquisitions and investments (10,831) (15,536)
Purchases of property and equipment (21,934) (21,181)
Disposals of property, equipment and
other assets 2,252 4,928
Restricted investments (2,175) (19,251)
Net collections on notes receivable 1,529 96
Deposits and other (9,238) (1,433)
------- -------
NET CASH USED IN INVESTING ACTIVITIES (40,397) (52,377)
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 - 806
Net draws under credit line 5,500 48,814
Repayment of long-term debt (564,468) (3,560)
Deferred financing fees (30,178) -
Funding of options under 1992 employee stock
purchase plan, employee benefit plans, and other 5,097 82
------- -------
NET CASH PROVIDED BY FINANCING ACTIVITIES 109,599 46,142
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 5,109 (11,043)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 14,355 21,394
------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD $19,464 $10,351
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
PARAGON HEALTH NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION
Organization
Paragon Health Network, Inc. ("Paragon" or the "Company"), formerly known as
Living Centers of America, Inc. ("LCA"), was formed in November 1997 through the
recapitalization by merger of 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 "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 Paragon 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 six months ended March 31, 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.
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.
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.
7
<PAGE>
PARAGON HEALTH NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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"). This SOP 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 31, 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 a Recapitalization Merger Agreement with
Apollo Management, L.P. ("Apollo") and one of its affiliates which was completed
effective November 1, 1997 (the "Recapitalization Merger"). 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 7) 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, Paragon 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, Paragon 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 6.
Paragon 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 7), (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 Mergers.
NOTE 3. GRANCARE MERGER
Effective November 1, 1997, and subsequent to the Company's recapitalization,
Paragon completed the merger acquisition of GranCare pursuant to the terms of
the previously announced GranCare Merger Agreement. In the merger acquisition,
approximately 17.4 million shares (adjusted for the three-for-one stock split,
see Note 7) of Paragon common stock were exchanged for GranCare common stock and
approximately 1.3 million options (adjusted for the three-for-one stock split,
see Note 7) to purchase shares of Paragon 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.................................... 203,075
Goodwill.................................................. 263,690
Restricted investments.................................... 40,987
Other long-term assets.................................... 46,721
Current liabilities....................................... (126,601)
Long-term debt............................................ (369,871)
Other non-current liabilities............................. (67,755)
--------
Total purchase price................................... $250,559
========
</TABLE>
8
<PAGE>
PARAGON HEALTH NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
At March 31, 1998, no 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, nor to assign a value to identifiable
intangible assets, if any. The Company is in the process of revaluing these
items. Goodwill is amortized on a straight-line basis over 30 years. The Omega
Note (see Note 6) assumed by Paragon 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 $1.8 million
for the three and six months ended March 31, 1998, respectively, was recorded as
a reduction to interest expense.
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 Mergers. The components of this charge were as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
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
-------
Recapitalization, Indirect Merger and Transition Costs.... 36,210
-------
$80,687
=======
</TABLE>
Approximately $55.3 million of these costs were paid in the six months ended
March 31, 1998. The balance is expected to be paid during the remainder of
fiscal year 1998, primarily in the third quarter. Amounts unpaid at March 31,
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 Mergers.
9
<PAGE>
PARAGON HEALTH NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 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 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 six months ended
March 31, 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 Mergers been consummated as of those dates, nor are they
necessarily indicative of future operating results.
<TABLE>
<CAPTION>
Three Months Six Months
Ended March 31, Ended March 31,
-------------------------- ------------------------
1998 1997 1998 1997
-------- -------- --------- ---------
<S> <C> <C> <C> <C>
Net revenues......................................... $487,161 $487,527 $977,059 $964,510
======== ======== ======== ========
Net income (loss) before extraordinary item.......... $ 4,390 $(21,941) $(56,223) $(18,105)
Extraordinary item................................... -- (4,831) (11,275) (4,831)
-------- -------- -------- --------
Net income(loss)..................................... $ 4,390 $(26,772) $(67,498) $(22,936)
======== ======== ======== ========
Basic Earnings (Loss) Per Share:
Net income (loss) before extraordinary item........ $ 0.11 $ (0.55) $ (1.37) $ (0.45)
Extraordinary item................................. -- (0.12) (0.27) (0.12)
-------- -------- -------- --------
Net income (loss)................................... $ 0.11 $ (0.67) $ (1.64) $ (0.57)
======== ======== ======== ========
Diluted Earnings (Loss) Per Share:
Net income (loss) before extraordinary item........ $ 0.10 $ (0.55) $ (1.37) $ (0.45)
Extraordinary item................................. -- $ (0.12) (0.27) (0.12)
-------- -------- -------- --------
Net income (loss).................................. $ 0.10 $ (0.67) $ (1.64) $ (0.57)
======== ======== ======== ========
</TABLE>
NOTE 6. LONG-TERM DEBT
A summary of total debt as of March 31, 1998 is as follows (in thousands):
<TABLE>
<CAPTION>
Senior Debt:
- ------------
<S> <C>
Senior Credit Facility:
Revolving Credit Facility.................................. $ 5,500
Term Loans................................................. 740,000
Mortgage notes................................................. 93,185
Obligations under capital leases............................... 5,474
Other notes payable............................................ 2,704
Subordinated Debt:
- ------------------
Senior Subordinated Notes due 2007............................. 273,825
Senior Subordinated Discount Notes due 2007.................... 175,130
----------
1,295,818
Less short-term notes payable and current maturities... (17,330)
----------
Total long-term debt............................................. $1,278,488
==========
</TABLE>
10
<PAGE>
PARAGON HEALTH NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Senior Credit Facility. The Senior Credit Facility consists of four
components: a 61/2 year term loan facility in an aggregate principal amount of
$240 million (the "Tranche A Term Loan Facility"); a 71/2 year term loan
facility in an aggregate principal amount of $250 million (the "Tranche B Term
Loan Facility"); an 81/2 year term loan facility in an aggregate principal
amount of $250 million (the "Tranche C Term Loan Facility"); and a 61/2 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 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 March 31, 1998, there was $5.5 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 April 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.
11
<PAGE>
PARAGON HEALTH NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Senior Subordinated Notes. Also in connection with the 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 commencing May 1, 1998.
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 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 March 31, 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.
As substitute collateral for certain divested PHCMI facilities, and as
consideration for granting its consent to such divestiture, Omega required
GranCare to cause a letter of credit in favor of Omega to be issued in the
amount of $9.0 million (the "Omega Letter of Credit"). The Omega Letter of
Credit can be drawn upon following the occurrence of: (i) any event of default
under the Omega Loan documents; (ii) if the Omega Letter of Credit is not
renewed or extended at least 30 days prior to its scheduled expiration date
(currently July 31, 1998); or (iii) if certain representations, warranties or
covenants of PHCMI under the Omega Loan documents are breached and such breaches
are not cured within the prescribed time after notice. Following the Mergers,
the Company caused the Omega Letter of Credit to be replaced with a new standby
letter of credit issued under the Senior Credit Facility.
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.
12
<PAGE>
PARAGON HEALTH NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 7. 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.
NOTE 8. 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 Six Months
Ended March 31, Ended March 31,
--------------------------- --------------------------
1998 1997 1998 1997
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Numerator for Basic and Diluted Earnings Per Share:
Net income (loss) before extraordinary item..... $ 4,390 $12,214 $(50,934) $22,539
Extraordinary item ............................ -- -- (11,275) --
------- ------- -------- -------
Net income (loss)............................... $ 4,390 $12,214 $(62,209) $22,539
======= ======= ======== =======
Denominator:
Denominator for basic earnings per share-weighted
average shares............................. 41,208 58,616 44,434 58,561
Effect of dilutive securities -- Stock
options.................................... 618 862 -- 862
------- ------- -------- -------
Denominator for diluted earnings per share-adjusted
weighted-average shares and assumed
conversions.................................... 41,826 59,478 44,434 59,423
======= ======= ======== =======
Basic Earnings (Loss) Per Share:
Net income (loss) before extraordinary item.... $ 0.11 $ 0.21 $ (1.15) $ 0.38
Extraordinary item............................. -- -- (0.25) --
------- ------- -------- -------
Net income (loss) per common share............. $ 0.11 $ 0.21 $ (1.40) $ 0.38
======= ======= ======== =======
Diluted Earnings (Loss) Per Share:
Net income (loss) before extraordinary item.... $ 0.10 $ 0.21 $ (1.15) $ 0.38
Extraordinary item............................. -- -- (0.25) --
------- ------- -------- -------
Net income (loss) per common share............. $ 0.10 $ 0.21 $ (1.40) $ 0.38
======= ======= ======== =======
</TABLE>
The effect of dilutive securities for the six months ended March 31, 1998 has
been excluded because the effect is antidilutive as a result of the net loss for
the period.
13
<PAGE>
PARAGON HEALTH NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 9. INCOME TAXES
For the three and six months ended March 31, 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
three and six months ended March 31, 1998 was approximately 45.3% and 47.2%,
respectively, compared to 42.5% 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 $83.4 million
at March 31, 1998. This increase is primarily attributable to deferred taxes
recorded as a result of the GranCare Merger.
NOTE 10. 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 March 31, 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 Company will vigorously contest
the alleged claims if the complaint is pursued.
14
<PAGE>
PARAGON HEALTH 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 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 defendants intend to file a motion to dismiss
the amended complaint, which does not raise any new or different allegations.
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. The court has set July 10, 1998 as the hearing
date on which to finally approve the Settlement Agreement.
15
<PAGE>
PARAGON HEALTH 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.
At a status conference on May 7, 1998, the court set the matter for trial for
six weeks commencing January 4, 1999. At the time of this conference,
plaintiff's counsel orally dismissed her promissory estoppel claims on behalf of
the named plaintiffs. The Company intends to vigorously contest the remaining
alleged claims and the certification of the various Classes.
NOTE 11. SUBSEQUENT EVENTS
As previously reported, the Company entered into a definitive merger agreement
on April 13, 1998 with Mariner Health Group, Inc. ("Mariner"). Under the terms
of the agreement, Mariner shareholders will receive one share of Paragon common
stock for each Mariner share held. Each company has also been granted an option
to acquire 19.9% of the other company's common stock under certain events. The
merger is anticipated to close during the third calendar quarter of 1998.
On May 1, 1998 the Company completed the acquisition of Professional
Rehabilitation, Inc. and certain affiliated entities for $27.4 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 will be recorded using the purchase method of accounting.
16
<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 "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.
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
($259.1 million or 70.7% in the second quarter of fiscal 1998 and $483.9 million
or 71.8% year-to-date in fiscal 1998) and ancillary services ($107.1 million or
29.3% in the second quarter of fiscal 1998 and $189.6 million or 28.2% 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 0.8% over the prior year period for both the three
and six months ended March 31, 1998, which included a 0.3% improvement for both
periods as a result of the GranCare Merger.
<TABLE>
<CAPTION>
Three Months Six Months
Ended March 31, Ended March 31,
--------------------------- ---------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Weighted average licensed bed count 37,526 23,098 34,987 23,211
Weighted average number of residents 31,343 19,093 29,323 19,270
Weighted average occupancy 83.5% 82.7% 83.8% 83.0%
</TABLE>
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.
17
<PAGE>
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 Six Months
Ended March 31, Ended March 31,
--------------------------- ---------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Private 27.9% 33.4% 28.3% 33.7%
Medicare 33.9% 26.2% 33.1% 25.3%
Medicaid 38.2% 40.4% 38.6% 41.0%
</TABLE>
The percentage of net revenues derived from private pay sources declined in
the three and six months ended March 31, 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 six months
ended March 31, 1998 from 59.0% for the six months ended March 31, 1997, which
was primarily attributable to the growth in the Company's non-nursing home
operations and an increase in Medicare residents. 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. See Capital Resources and Liquidity-Changes
in Healthcare Legislation.
SECOND QUARTER OF FISCAL 1998 COMPARED TO SECOND QUARTER OF FISCAL 1997. Net
revenues comprising nursing home and non-nursing home operations totaled $487.2
million for the quarter ended March 31, 1998, an increase of $201.9 million or
70.7 %, as compared to the same period for fiscal 1997. Nursing home operations
contributed $179.6 million of the increase, which included the acquisition of
GranCare effective November 1, 1997 of $173.2 million, and at the former LCA
facilities, rate increases of $4.6 million, higher ancillary service billings
resulting from the improvement in mix, primarily Medicare, of $4.1 million, and
a $1.6 million reduction due to divested facilities. Non-nursing home operations
contributed $22.3 million of the increase, consisting of an increase of $6.6
million for pharmacy services, a decrease of $6.5 million for therapy services,
and an increase of $22.2 million from home health, hospital services, and other.
Home health, hospital services and other revenue increased by $21.7 million as a
result of the GranCare acquisition.
Costs and expenses totaled $450.9 million for the quarter ended March 31,
1998, an increase of $191.5 million or 73.8%, as compared to the same period for
fiscal 1997. The acquisition of GranCare contributed $185.5 million to the
increase in costs. Excluding GranCare, ancillary costs increased by $4.6 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. Excluding GranCare, bad debt expense decreased by $0.7 million
primarily due to a $2.5 million reduction for therapy operations which was
partially offset by bad debt expense in the prior year period being reduced by
$1.1 million as a result of the collection of a note receivable that was
substantially reserved. The reduction in bad debt expense at therapy operations
over the prior year period was a result of a reduction in average days
outstanding.
Interest expense totaled $30.4 million for the quarter ended March 31, 1998,
an increase of $24.9 million as compared to the same period for fiscal 1997,
which was primarily a result of the additional debt incurred in conjunction with
the Mergers.
The effective income tax rate for the three months ended March 31, 1998 was
approximately 45.3% compared to 42.5% 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.
18
<PAGE>
FISCAL 1998 YEAR TO DATE COMPARED TO FISCAL 1997 YEAR TO DATE. Net revenues
comprising nursing home and non-nursing home operations totaled $908.8 million
for the six months ended March 31, 1998, an increase of $343.2 million or 60.7%,
as compared to the same period for fiscal 1997. Nursing home operations
contributed $302.8 million of the increase, which included the acquisition of
GranCare effective November 1, 1997 of $288.9 million, and at the former LCA
facilities, rate increases of $11.7 million, higher ancillary service billings
resulting from the improvement in mix, primarily Medicare, of $8.0 million, a
$2.0 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 $40.4 million of the increase, consisting of an increase of $11.6
million for pharmacy services, a decrease of $13.3 million for therapy services,
and an increase of $42.1 million from home health, hospital services, and other.
Home health, hospital services and other revenue increased by $36.9 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
Mergers totaled $80.7 million for the six months ended March 31, 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 $845.4 million for the six months ended March 31, 1998, an
increase of $327.4 million or 63.2%, as compared to the same period for fiscal
1997. The acquisition of GranCare contributed $309.3 million to the increase in
costs. Excluding GranCare, ancillary and general and administrative costs
increased $7.5 and $5.5 million, respectively. The increase in ancillary costs
is the result of higher ancillary service billings in the nursing home
operations and higher pharmaceutical costs related to the increase in pharmacy
services revenue. Excluding GranCare, bad debt expense increased by $1.8 million
primarily due to bad debt expense in the prior year period being reduced by $1.1
million as a result of the collection of a note receivable that was
substantially reserved.
Interest expense totaled $52.0 million for the six months ended March 31,
1998, an increase of $41.4 million as compared to the same period for fiscal
1997, which was primarily a result of the additional debt incurred in
conjunction with the Mergers.
For the six months ended March 31, 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 six months ended
March 31, 1998 was approximately 47.2% 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 six months ended March 31, 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 March 31, 1998, the Company has capitalized
approximately $3.1 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 $19.5 million at March 31, 1998, and working
capital was $274.5 million, an increase of $172.8 million during the six months
ended March 31, 1998 which included an increase of $133.7 million as a result of
the GranCare Merger. Cash used in operations was $64.1 million which included
approximately $55.3 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
$20.4 million primarily as a result of the remaining accrual for
recapitalization, indirect merger and transition costs which totaled $25.4
million at March 31, 1998. The remaining recapitalization, indirect merger, and
transition costs are expected to be paid during the remainder of fiscal year
1998, primarily during the third quarter. Excluding the acquisition of accounts
payable in the GranCare Merger, accounts payable decreased by $28.7 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,
accounts receivable increased by $42.2 million for the six months ended March
31, 1998. The increase in receivables was primarily attributable to the timing
of collections on Medicare cost reports and rate adjustments ($14.9 million),
revenue increases ($15.6 million) and an increase in average days outstanding
($6.4 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 post-acute care
division accounts receivable. At March 31, 1998, approximately 52% 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 $40.4 million in the six months ended
March 31, 1998, as compared to $52.4 million for the same period in fiscal 1997.
Investing activities for the six months ended March 31, 1998 included $3.4
million to purchase a previously leased facility and $7.4 million related to
various pharmacy acquisitions. 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 six months ended March 31, 1998 included $21.9
million for routine capital expenditures. Capital expenditures are expected to
be funded by cash from operations or the Revolving Credit Facility.
Financing activities provided $109.6 million during the six months ended March
31, 1998. Cash provided by financing activities included $240.0 million from
the issuance of 17.8 million shares of 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 Senior Subordinated Notes and Senior
Subordinated Discount 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 Senior Subordinated Notes.
Senior Credit Facility. The Senior Credit Facility consists of four
components: a 61/2 year term loan facility in an aggregate principal amount of
$240 million (the "Tranche A Term Loan Facility"); a 71/2 year term loan
facility in an aggregate principal amount of $250 million (the "Tranche B Term
Loan Facility"); an 81/2 year term loan facility in an aggregate principal
amount of $250 million (the "Tranche C Term Loan Facility"); and a 61/2 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 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 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 March 31, 1998, there was $5.5 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 April 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 is currently seeking, and expects to receive, a
waiver of certain covenants in the Senior Credit Facility with respect to the
announced merger between the Company and Mariner Health Group, Inc. (see
"Merger").
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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 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 commencing May 1, 1998.
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 Mergers.
Other Significant Indebtedness. In connection with the 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.
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").
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In connection with obtaining HRPT's consent to the 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 Mergers and the
transactions related thereto. In addition, Vitalink's guaranty of the HRPT
Obligations was released and the HRPT Letter of Credit was terminated and
replaced with 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 by June 1998. 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 March 31, 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.
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 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.
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As substitute collateral for certain divested PHCMI facilities, and as
consideration for granting its consent to such divestiture, Omega required
GranCare to cause a letter of credit in favor of Omega to be issued in the
amount of $9.0 million (the "Omega Letter of Credit"). The Omega Letter of
Credit can be drawn upon following the occurrence of: (i) any event of default
under the Omega Note documents; (ii) if the Omega Letter of Credit is not
renewed or extended at least 30 days prior to its scheduled expiration date
(currently July 31, 1998); or (iii) if certain representations, warranties or
covenants of PHCMI under the Omega Note documents are breached and such breaches
are not cured within the prescribed time after notice. Following the Mergers,
the Company caused the Omega Letter of Credit to be replaced with a new standby
letter of credit issued under the Senior Credit Facility.
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.
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 billion and $13 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, 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.
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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 will have 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 for
fiscal year 1998 are approximately $187 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 will be
approximately $60 million of which $30 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 March 31, 1998 approximately $40.4 million of this leasing
arrangement was utilized. The leasing program is accounted for as an operating
lease.
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
million, of which $130.8 million was available after considering $13.7 million
in outstanding letters of credit and the $5.5 million borrowed at March 31,
1998. The Company's future operating performance and ability to service or
refinance the 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.
MERGER
As previously reported, the Company entered into a definitive merger agreement
on April 13, 1998 with Mariner Health Group, Inc. ("Mariner"). Under the terms
of the agreement, Mariner shareholders will receive one share of Paragon common
stock for each Mariner share held. Each company has also been granted an option
to acquire 19.9% of the other company's common stock under certain events. The
merger is anticipated to close during the third calendar quarter of 1998.
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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.
(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 and LCA.
26
<PAGE>
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
Company will vigorously contest the alleged claims if the complaint is
pursued.
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 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 defendants intend to
file a motion to dismiss the amended complaint, which does not raise
any new or different allegations. 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.
27
<PAGE>
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.
The court has set July 10, 1998 as the hearing date on which to
finally approve the Settlement Agreement.
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.
28
<PAGE>
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.
At a status conference on May 7, 1998, the court set the matter for
trial for six weeks commencing January 4, 1999. At the time of this
conference, plaintiff's counsel orally dismissed her promissory
estoppel claims on behalf of the named plaintiffs. The Company
intends to vigorously contest the remaining alleged claims and the
certification of the various Classes.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
As part of their compensation package, the Company's outside
directors receive $25,000 in annual compensation, one-half of which is
paid in shares of the Company's common stock. In addition, non-
employee director committee chairmen receive an additional $5,000
annually in Company common stock. The number of shares of stock
granted is determined by dividing the cash amount by the closing price
of the Company's common stock on the date of the annual meeting.
Accordingly, on February 19, 1998, the Company made the following
grants of unregistered common stock to its non-employee directors
under the exemptions from registration provided by Section 4(2) of the
Securities Act of 1933, as amended, and the regulations promulgated
thereunder:
<TABLE>
<CAPTION>
Shares
Granted
--------------
<S> <C>
Donald C. Beaver 641
Laurence M. Berg 641
Gene E. Burleson 641
Peter P. Copses (committee chairman) 897
Jay M. Gellert 641
Joel S. Kanter 641
John H. Kissick 641
Baltej S. Maini, M.D. (committee chairman) 897
William G. Petty, Jr. 641
Robert L. Rosen (committee chairman) 897
</TABLE>
The closing price of the Company's common stock on the grant date
was $19.50.
29
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of stockholders of the Company was held on
February 19, 1998 in Atlanta, Georgia. At that time the following
directors were elected (the votes cast for and withheld for each
director are summarized below):
<TABLE>
<CAPTION>
Votes Votes
For Withheld
-------------- --------------
<S> <C> <C>
Donald C. Beaver 38,889,465 60,594
Laurence M. Berg 38,891,535 58,524
Gene E. Burleson 38,891,526 58,533
Peter P. Copses 38,891,535 59,163
Jay M. Gellert 38,891,535 58,524
Joel S. Kanter 38,891,535 58,524
John H. Kissick 38,891,505 58,554
Baltej S. Maini, M.D. 38,891,535 58,524
William G. Petty, Jr. 38,891,535 58,524
Keith B. Pitts 38,890,896 59,163
Robert L. Rosen 38,891,535 58,524
</TABLE>
The following matters were also voted on at the annual meeting (the
votes cast for, against, and abstentions for each matter are
summarized below):
<TABLE>
<CAPTION>
Votes Votes
For Against Abstentions
-------------- -------------- --------------
<S> <C> <C> <C>
Approval of the Paragon Incentive Compensation Plan 30,185,085 674,571 27,774
Approval of the Paragon Long-Term Incentive Plan 28,881,804 1,978,620 26,976
Approval of the Paragon Employee Stock Purchase Plan 30,050,505 811,476 25,419
</TABLE>
ITEM 5. OTHER INFORMATION
On January 8, 1998, Paragon Rehabilitation, Inc. ("PRI") filed a
complaint alleging that the Company's use of the name "Paragon" has
caused and is likely to cause confusion as to the affiliation of the
Company and PRI and that, therefore, the Company's use of "Paragon"
violates PRI's trade name and service mark. Because the Company
intends to change its name in connection with the Mariner merger, the
Company believes that it will be able to reach an accommodation with
PRI.
30
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
(a) Exhibit Index
Exhibit
Number
------
<S> <C>
2.1 Agreement and Plan of Merger among Paragon Health Network, Inc.,
Mariner Health Group, Inc., and Paragon Acquisition Sub, Inc.
(filed as Exhibit 2.1 to the Registrant's Form 8-K dated April 13,
1998 and incorporated herein by reference).
10.1 Employment Agreement between Paragon Health Network, Inc. and
Robert V. Napier
27.1 Financial Data Schedule
27.2 Restated Financial Data Schedule
27.3 Restated Financial Data Schedule
99.1 Parent Stock Option Agreement dated as of April 13, 1998, by and
between Paragon Health Network, Inc. and Mariner Health Group, Inc.
(filed as Exhibit 99.1 to the Registrant's Form 8-K dated April 13,
1998 and incorporated herein by reference).
99.2 Company Stock Option Agreement dated as of April 13, 1998, by and
between Mariner Health Group, Inc. and Paragon Health Network, Inc.
(filed as Exhibit 99.2 to the Registrant's Form 8-K dated April 13,
1998 and incorporated herein by reference).
99.3 Parent Voting Agreement dated as of April 13, 1998, by and among
Mariner Health Group, Inc. and certain stockholders of Paragon
Health Network, Inc. (filed as Exhibit 99.3 to the Registrant's
Form 8-K dated April 13, 1998 and incorporated herein by reference).
99.4 Company Voting Agreement dated as of April 13, 1998, by and among
Paragon Health Network, Inc. and certain stockholders of Mariner
Health Group, Inc. (filed as Exhibit 99.4 to the Registrant's Form
8-K dated April 13, 1998 and incorporated herein by reference).
</TABLE>
(b) Reports on Form 8-K
On January 20, 1998 the Company filed Form 8-K/A updating the Pro
Forma Condensed Consolidated Financial Statements incorporated by
reference into Form 8-K filed November 4, 1997 to the Registrant's
fiscal year ended September 30, 1997.
On April 23, 1998 the Company filed Form 8-K announcing the
execution of the Agreement and Plan of Merger by and between Paragon
Health Network, Inc., Mariner Health Group, Inc., and Paragon
Acquisition Sub, Inc.
31
<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.
May 11, 1998
PARAGON HEALTH 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
32
<PAGE>
EMPLOYMENT AGREEMENT
Employment Agreement dated as of February 12, 1998 between Robert V.
Napier (the "Executive") and Paragon Health Network, Inc., a Delaware
corporation (the "Company").
WHEREAS, the Company desires to employ the Executive as a Senior Vice
President and Chief Information Officer, and the Executive desires to accept
such employment, for the term and upon the other conditions hereinafter set
forth; and
WHEREAS, as a condition of entering into this Agreement, the Executive
agrees to waive the Executive's rights, if any, against the Company and any
predecessor company (including GranCare, Inc.) under (i) any employment
agreement and (ii) any other plan, arrangement or agreement of any kind that
provides any form of severance payments; and
WHEREAS, the parties desire to enter into this Agreement setting forth the
terms and conditions of the employment relationship of the Executive with the
Company;
NOW, THEREFORE, the parties agree as follows:
1. Employment The Company hereby employs the Executive, and the Executive
----------
hereby accepts employment with the Company, upon the terms and subject to the
conditions set forth herein.
2. Term This Agreement shall commence on the date hereof (the "Effective
----
Date") and continue for the two-year period (the "Term") terminating on the
second anniversary of the Effective Date, or upon the Executive's earlier death,
disability or other termination of employment pursuant to Section 11; provided,
however, that commencing on the second anniversary of the Effective Date and on
each anniversary thereafter, the Term shall automatically be extended for one
additional year unless, not later than 90 days prior to any such anniversary,
either party hereto shall have notified the other party hereto in writing that
such extension shall not take effect.
3. Position. During the Term, the Executive shall serve as Senior Vice
--------
President and Chief Information Officer of the Company or in such other
executive position in the Company as the Executive shall approve.
4. Duties and Reporting Relationship. During the Term, the Executive
---------------------------------
shall, on a full time basis, use his skills and render services to the best of
his abilities in supervising and conducting the operations of the Company and
shall not engage in any other business activities except with the prior written
approval of the Board of Directors of the Company (the "Board") or its duly
authorized designee. The Executive shall also perform such other executive and
administrative duties (not inconsistent with the position of Senior Vice
President and Chief Information Officer) as the Executive may reasonably be
expected to be capable of performing on behalf of the Company, as may from time
to time be authorized or directed by the Board. The
<PAGE>
Executive agrees to be employed by the Company in all such capacities for the
Term, subject to all the covenants and conditions hereinafter set forth.
5. Place of Performance. The Executive shall perform his duties and
--------------------
conduct his business at the principal executive offices of the Company, except
for required travel on the Company's business.
6. Salary and Annual Bonus.
-----------------------
(a) Base Salary. The Executive's base salary hereunder shall be
-----------
$270,000.00 a year, payable monthly and prorated for any partial
year of employment. The Board shall review such base salary at
least annually and make such adjustment from time to time as it
may deem advisable, but the base salary shall not at any time be
less than $270,000.00 a year.
(b) Annual Bonus. The Company shall provide the Executive with an
------------
opportunity to earn upon achievement of target performance, an
annual bonus equal to fifty percent (50%) of his base salary (the
"Target Bonus"), with a minimum bonus of between fifty percent
(50%) of Target Bonus upon achievement of threshold performance
and an opportunity to earn up to one hundred fifty percent (150%)
of the Target Bonus for performance in excess of the targets.
7. Vacation, Holidays and Sick Leave. During the Term, the Executive
---------------------------------
shall be entitled to paid vacation, paid holidays and sick leave in accordance
with the Company's standard policies for its senior vice presidents.
8. Business Expenses. The Executive shall be reimbursed for all ordinary
-----------------
and necessary business expenses incurred by him in connection with his
employment upon timely submission by the Executive of receipts and other
documentation as required by the Internal Revenue Code and in conformance with
the Company's normal procedures.
9. Pension and Welfare Benefits. During the Term, the Executive shall be
----------------------------
eligible to participate fully in all health benefits, insurance programs,
pension and retirement plans and other employee benefit and compensation
arrangements available to vice presidents of the Company generally.
10. Stock Options The Company, pursuant to the terms of its stock option
-------------
plan, may grant to the Executive, stock options to purchase a number of shares
of common stock.
11. Termination of Employment.
-------------------------
(a) General. The Executive's employment hereunder may be terminated
-------
without any breach of this Agreement only under the following
circumstances.
2
<PAGE>
(b) Death or Disability.
-------------------
(i) The Executive's employment hereunder shall automatically
terminate upon the death of the Executive.
(ii) If, as a result of the Executive's incapacity due to
physical or mental illness, the Executive is unable to
perform the essential functions of his job for any one
hundred eighty (180) days (whether or not consecutive)
during any eighteen (18) month period, and no reasonable
accommodation can be made that will allow Executive to
perform his essential functions, the Company may terminate
the Executive's employment hereunder for any such incapacity
(a "Disability").
(c) Termination by the Company. The Company may terminate the
--------------------------
Executive's employment hereunder at any time, whether or not for
Cause. For purposes of this Agreement, "Cause" shall mean (i)
the failure or refusal by the Executive to perform his duties
hereunder (other than any such failure resulting from the
Executive's incapacity due to physical or mental illness), which
has not ceased within ten (10) days after a written demand for
substantial performance is delivered to the Executive by the
Company, which demand identifies the manner in which the Company
believes that the Executive has not performed such duties, (ii)
the engaging by the Executive in willful misconduct or an act of
moral turpitude which is materially injurious to the Company,
monetarily or otherwise (including, but not limited to, conduct
which violates Section 15 hereof) or (iii) the conviction of the
Executive of, or the entering of a plea of nolo contendere by,
the Executive with respect to, a felony.
(d) Termination by the Executive. The Executive shall be entitled to
----------------------------
terminate his employment hereunder (A) for Good Reason, (B) if
his health should become impaired to an extent that makes his
continued performance of his duties hereunder hazardous to his
physical or mental health, provided that the Executive shall
have furnished the Company with a written statement from a
qualified doctor to such effect and provided, further, that, at
the Company's request, the Executive shall submit to an
examination by a doctor selected by the Company and such doctor
shall have concurred in the conclusion of the Executive's doctor
or (C) without the Executive's express written consent, any
failure by the Company to comply with any material provision of
this Agreement, which failure has not been cured within ten (10)
days after notice of such noncompliance has been given by the
Executive to the Company. For purposes of this Agreement, "Good
Reason" shall mean the occurrence following a Change in Control
during the term of this Agreement, of any one of the following
acts by the Company, or failures by the Company to act, unless,
in the case of any act or failure to act described below, such
3
<PAGE>
act or failure to act is corrected prior to the Date of
Termination specified in the Notice of Termination given in
respect thereof:
(i) any material diminution in the Executive's authorities or
responsibilities (including reporting responsibilities)
which were in effect immediately prior to the Change in
Control or from his status, title, position or
responsibilities (including reporting responsibilities)
which were in effect following a Change in Control pursuant
to the Executive's consent to accept any such change; the
assignment to him of any duties or work responsibilities
which are inconsistent with such status, title, position or
work responsibilities; or any removal of the Executive
from, or failure to reappoint or reelect him to any of such
positions, except if any such changes are because of
Disability, retirement, death or Cause;
(ii) a reduction by the Company in the Executive's base salary
or Target Bonus as in effect on the date hereof or as the
same may be increased from time to time except for across-
the-board salary reductions similarly affecting all senior
executives of the Company and all senior executives of any
Person (as defined in Section 11(h)(i) below) in control of
the Company provided in no event shall any such reduction
reduce the Executive's base salary below $270,000.00;
(iii) the relocation of the Executive's office at which he is to
perform his duties, to a location more than fifty (50)
miles from the location at which the Executive performed
his duties prior to the Change in Control, except for
required travel on the Company's business to an extent
substantially consistent with his business travel
obligations prior to the Change in Control;
(iv) the failure by the Company, without the Executive's
consent, to pay to the Executive any portion of the
Executive's current compensation;
(v) the failure by the Company to continue to provide the
Executive with benefits substantially similar in value to
the Executive in the aggregate to those enjoyed by the
Executive under any of the Company's pension, life
insurance, medical, health and accident, or disability
plans in which the Executive was participating immediately
prior to the Change in Control, unless the Executive
participates after the Change in Control in other
comparable benefit plans generally available to senior
executives of the Company and senior executives of any
Person in control of the Company;
4
<PAGE>
(vi) any purported termination of the Executive's employment
which is not effected pursuant to a Notice of Termination
satisfying the requirements of Section 11(f) below; for
purposes of this Agreement, no such purported termination
shall be effective.
The Executive's continued employment for 6 months following any act or failure
to act constituting Good Reason hereunder without the delivery of a Notice of
Termination shall constitute consent to, and a waiver of rights with respect to,
such act or failure to act.
(e) Voluntary Resignation. Should the Executive wish to resign from
---------------------
his position with the Company or terminate his employment for
other than Good Reason during the Term, the Executive shall give
sixty (60) days written notice to the Company ("Notice Period"),
setting forth the reasons and specifying the date as of which
his resignation is to become effective. During the Notice
Period, the Executive shall cooperate fully with the Company in
achieving a smooth transition of the Executive's duties and
responsibilities to such person(s) as may be designated by the
Company. The Company reserves the right to accelerate the Date
of Termination by giving the Executive notice and payment of
amounts due to the Executive under Section 6(a) and, to the
extent applicable, Section 6(b) for the balance of the Notice
Period. The Company's obligation to continue to employ the
Executive or to continue payment of the amounts described in the
preceding sentence shall cease immediately if: (1) the Executive
has not satisfied his obligations to cooperate fully with a
smooth transition or (2) the Company has grounds to terminate
the Executive's employment immediately for Cause.
(f) Notice of Termination. Any purported termination of the
---------------------
Executive's employment by the Company or by the Executive shall
be communicated by written Notice of Termination to the other
party hereto in accordance with Section 19. "Notice of
Termination" shall mean a notice that shall indicate the
specific termination provision in this Agreement relied upon and
shall set forth in reasonable detail the facts and circumstances
claimed to provide a basis for termination of the Executive's
employment under the provision so indicated.
(g) Date of Termination. "Date of Termination" shall mean (i) if the
-------------------
Executive's employment is terminated because of death, the date
of the Executive's death, (ii) if the Executive's employment is
terminated for Disability, the date Notice of Termination is
given, (iii) if the Executive's employment is terminated
pursuant to Subsection (c), (d) or (e) hereof or for any other
reason (other than death or Disability), the date specified in
the Notice of Termination which shall not be less than sixty
(60) days from the date such Notice of Termination is given.
5
<PAGE>
(h) Change in Control. For purposes of this Agreement, a Change in
-----------------
Control of the Company shall have occurred if
(i) any "Person" (as defined in Section 3(a)(9) of the
Securities Exchange Act of 1934 (the "Exchange Act") as
modified and used in Sections 13(d) and 14(d) of the
Exchange Act (other than (1) the Company or any of its
subsidiaries, (2) any trustee or other fiduciary holding
securities under an employee benefit plan of the Company or
any of its subsidiaries, (3) an underwriter temporarily
holding securities pursuant to an offering of such
securities, (4) any corporation owned, directly or
indirectly, by the stockholders of the Company in
substantially the same proportions as their ownership of
the Company's common stock or (5) Apollo Management, LP,
any of its affiliates and any investments funds managed by
it (collectively, "Apollo"), is or becomes the "beneficial
owner" (as defined in Rule 13d-3 under the Exchange Act),
directly or indirectly, of securities of the Company
representing more than 50% of the combined voting power of
the Company's then outstanding voting securities;
(ii) during any period of not more than two (2) consecutive
years, not including any period prior to the date of this
Agreement, individuals who at the beginning of such period
constitute the Board, and any new director (other than a
director designated by a person (other than Apollo) who has
entered into an agreement with the Company to effect a
transaction described in clause (i), (iii), or (iv) of this
Section 1l(h)) whose election by the Board or nomination
for election by the Company's stockholders was (A) made
pursuant to the Stockholders Agreement affecting the
Company dated November 4, 1997 or (B) approved by a vote of
at least two-thirds (2/3) of the directors then still in
office who either were directors at the beginning of the
period or whose election or nomination for election was
previously so approved, cease for any reason to constitute
at least a majority thereof;
(iii) the stockholders of the Company approve a merger or
consolidation of the Company with any other corporation,
other than both (A) a merger or consolidation which would
result in the voting securities of the Company outstanding
immediately prior thereto continuing to represent (either
by remaining outstanding or by being converted into voting
securities of the surviving or parent entity) 50% or more
of the combined voting power of the voting securities of
the Company or such surviving or parent entity outstanding
immediately after such merger or consolidation or (B) a
merger or consolidation in which no person acquires 50% or
more of the combined voting power of the Company's then
outstanding securities; or
6
<PAGE>
(iv) the stockholders of the Company approve a plan of complete
liquidation of the Company or an agreement for the sale or
disposition by the Company of all or substantially all of
the Company's assets (or any transaction having a similar
effect) other than such a sale or disposition to Apollo.
(i) Return of Property. When the Executive ceases to be employed by
------------------
the Company, the Executive will promptly surrender to the
Company all Company property, including without limitation, all
records and other documents obtained by him or entrusted to him
during the course of his employment with the Company provided,
however, that the Executive may retain copies of such documents
as necessary for the Executive's personal records for federal
income tax purposes.
12. Compensation During Disability; Death or Upon Termination.
---------------------------------------------------------
(a) During any period that the Executive fails to perform his duties
hereunder as a result of incapacity due to physical or mental
illness ("Disability Period"), the Executive shall continue to
receive his base salary at the rate then in effect for such
period until his employment is terminated pursuant to Section
1l(b)(ii) hereof, provided that payments so made to the
Executive during the Disability Period shall be reduced by the
sum of the amounts, if any, payable to the Executive with
respect to such period under disability benefit plans of the
Company or under the Social Security disability insurance
program, and which amounts were not previously applied to reduce
any such payment.
(b) If the Executive's employment is terminated by his death or
Disability, the Company shall pay (i) any base salary due to the
Executive under Section 6(a) through the date of such
termination and (ii) an amount equal to the Target Bonus he
would have received for the fiscal year that ends on or
immediately after the Date of Termination, assuming the Company
achieved the lowest target level for which a bonus is paid under
the plan described in Section 6(b), prorated for the period
beginning on the first day of the fiscal year in which occurs
the Date of Termination through the Date of Termination. In
addition, if the Executive's employment is terminated by his
death, the Company shall continue to pay to his estate his
salary for an additional six months at the rate then in effect.
(c) If the Executive's employment is terminated by the Company for
Cause or by the Executive for other than Good Reason, the
7
<PAGE>
Company shall pay the Executive his base salary through the Date
of Termination at the rate in effect at the time Notice of
Termination is given, and the Company shall have no further
obligations to the Executive under this Agreement.
(d) If following a Change in Control (A) the Company terminates the
Executive's employment without Cause, or (B) the Executive
terminates his employment for Good Reason, then
(i) the Company shall pay the Executive his base salary
through the Date of Termination at the rate in effect at
the time Notice of Termination is given and all other
unpaid amounts, if any, to which the Executive is entitled
as of the Date of Termination under any compensation plan
or program of the Company, at the time such payments are
due;
(ii) in lieu of any further salary payments to the Executive
for periods subsequent to the Date of Termination, the
Company shall pay as liquidated damages to the Executive
an aggregate amount equal to the product of (A) the sum of
(1) the Executive's base salary at the rate in effect of
the Date of Termination and (2) the average of the annual
bonuses actually paid to the Executive by the Company with
respect to the two (2) fiscal years which immediately
precede the year of the Term which the Date of Termination
occurs provided if there was bonus or bonuses paid to the
--------
Executive with respect only to one fiscal year that
immediately precedes the year within the Term in which the
Date of Termination occurs, then such single year's bonus
or bonuses shall be utilized in the calculation pursuant
to this clause (2), provided, further, that for purposes
-----------------
of this Agreement, if the Date of Termination occurs
before the end of the first fiscal year that ends after
the Effective Date, the amount of the bonus paid by the
Company to the Executive shall be deemed to be the Target
Bonus and (B) the number two (2);
(iii) the Company shall pay the Executive an amount equal to the
prorated Target Bonus that would have been paid for the
period beginning on the first day of the fiscal year in
which the Date of Termination occurs;
(iv) the Company shall continue coverage for the Executive, on
the same terms and conditions as would be applicable if
the Executive were an active Employee, under the Company's
life insurance, medical, health and similar welfare
benefit plans (other then group disability benefits) for a
period of twenty-four (24) months. Benefits otherwise
receivable by the Executive pursuant to this Section
12(d)(iv) shall be reduced to the extent comparable
benefits are actually received by the Executive from a
subsequent employer during the period during which the
Company is required to provide such benefits, and the
Executive shall report any such benefits actually received
by him to the Company; and
8
<PAGE>
(v) the payments provided for in this Section 12(d) (other
than Section 12(d)(iv)) shall be made not later than the
thirtieth (30th) day following the Date of Termination,
provided, however, that if the amounts of such payments,
and the limitation on such payments set forth in Section
16 hereof, cannot be finally determined on or before such
day, the Company shall pay to the Executive on such day an
estimate, as determined in good faith by the Company, of
the minimum amount of such payments to which the Executive
is clearly entitled and shall pay the remainder of such
payments (together with interest at the rate provided in
section 1274(b)(2)(B) of the Code (as defined in Section
16)) as soon as the amount thereof can be determined but
in no event later than the sixtieth (60th) day after the
Date of Termination. In the event that the amount of the
estimated payments exceeds the amount determined by the
Company within six (6) months after payment to have been
due, such excess shall constitute a loan by the Company to
the Executive, payable no later than the thirtieth (30th)
business day after demand by the Company (together with
interest at the rate provided in section 1274(b)(2)(B) of
the Code). At the time that payments are made under this
Section 12(d), the Company shall provide the Executive
with a written statement setting forth the manner in which
such payments were calculated and the basis for such
calculations including, without limitation, any opinions
or other advice the Company has received from outside
counsel, auditors or consultants (and any such opinions or
advice which are in writing shall be attached to the
statement).
(vi) If the Executive continues to be employed by the Company
for one (1) year after a Change of Control and has not by
such time given Notice of Termination for Good Reason, the
Executive will have waived his right to exercise his
rights under Section 12(d) hereof with respect to any act
or failure to act which constitutes Good Reason.
(e) If the Executive terminates his employment under clause (C) of
Section 11(d) hereof or, prior to any Change of Control, the
Company terminates the Executive's employment without Cause,
then
(i) the Company shall pay the Executive his base salary
through the Date of Termination at the rate in effect at
the time Notice of Termination is given and all other
unpaid amounts, if any, to which the Executive is entitled
as of the Date of
9
<PAGE>
Termination under any compensation plan or program of the
Company, at the time such payments are due;
(ii) the Company shall pay to the Executive the greater of
either (A) the remaining amount of base salary owed for the
Term; or (B) an aggregate amount equal to the sum of (1)
nine (9) months of the Executive's base salary at the rate
in effect as of the Date of Termination plus (2) one (1)
additional month of the Executive's base salary at such
rate for each full year of service beyond the first
anniversary of this Agreement, not to exceed eighteen (18)
months of base salary payments; such amount to be paid in
substantially equal monthly installments during the period
commencing with the month immediately following the month
in which the Date of Termination occurs or in a lump sum
payment, as decided by the Company;
(iii) the Company shall pay the Executive his Target Bonus
prorated for the period beginning on the first day of the
fiscal year in which occurs the Date of Termination through
the Date of Termination;
(iv) the Company shall continue coverage for the Executive, on
the same terms and conditions as would be applicable if the
Executive were an active employee, under the Company's life
insurance, medical, health, and similar welfare benefit
plans (other then group disability) for a period not to
exceed the number of months the Executive will be paid
under Section 12(e)(ii) beginning on the Date of
Termination;
(v) benefits otherwise receivable by the Executive pursuant to
clause (iv) of this Section 12(e) shall be reduced to the
extent comparable benefits are actually received by the
Executive from a subsequent employer during the period
which the Company is required to provide such benefits, and
the Executive shall report any such benefits actually
received by him to the Company;
(vi) the payments made to the Executive under Section 12(e)
hereof will be reduced by the amount of payments provided
for by any subsequent employer of the executive for a
position obtained after the Date of Termination.
(f) If the Executive experiences a termination under Section 12(d)
or 12(e) hereof, until the Executive finds another full-time
position or for 6 months, whichever is earlier, the Company
shall provide the Executive with professional outplacement
services of the Executive's choosing and shall reimburse the
10
<PAGE>
Executive documented incidental outplacement expenses directly
related to the Executive's job search such as resume mailing,
interview trips, and clerical support, subject to a maximum cost
of $10,000 for such outplacement services and incidental
expenses. The Executive's choice of professional outplacement
services is subject to the Company's reasonable prior approval.
If the Company has not approved or disapproved of the
Executive's choice within ten (10) business days of receiving
notice of such choice, the Company will be deemed to have given
is approval. Any approval by the Company will be in writing and
will state the basis for such disapproval. The Executive will
not be entitled to receive cash or lieu of the professional
outplacement services provided pursuant to this Section.
(g) If the Executive shall terminate his employment under clause (B)
of Sections 11(d) or 11(e) hereof, the Company shall pay the
Executive his base salary through the Date of Termination at the
rate in effect at the time Notice of Termination is given, and
the Company shall have no further obligations to the Executive
under this Agreement.
(h) The Executive shall not be required to mitigate the amount of
any payment provided for in this Section 12 by seeking other
employment or otherwise, and, except as provided in Sections
12(e) hereof, the amount of any payment or benefit provided for
in this Section 12 shall not be reduced by any compensation
earned by the Executive as the result of employment by another
employer or by retirement benefits.
(i) Release. Prior to making any payment pursuant to Sections
-------
12(d)(iii) and 12(d)(iv) or Sections 12(e)(ii) and 12(e)(iii),
whichever is applicable, the Company shall have the right to
require the Executive to sign, and the Executive hereby agrees
to sign, an agreement to be bound by the terms of Section 15 of
this Agreement and a waiver of all claims the Executive
may have (including any claims under the Age Discrimination in
Employment Act), and the Company may withhold payment of such
amount until the period during which the Executive may revoke
such waiver (normally seven days) has elapsed.
13. Representations and Covenants.
-----------------------------
(a) The Company represents and warrants that this Agreement has been
authorized by all necessary corporate action of the Company and
is a valid and binding agreement of the Company enforceable
against it in accordance with its terms.
(b) The Executive represents and warrants that he is not a party to
any agreement or instrument which would prevent him from
entering into or performing his duties in any way under this
Agreement. The Executive agrees and covenants that he will
11
<PAGE>
obtain, and submit to, such physical examinations as may be
necessary to facilitate the Company obtaining an insurance
policy for its benefit insuring the life of the Executive.
14. Successors: Binding Agreement.
-----------------------------
(a) The Company will require any successor (whether direct or
indirect, by purchase, merger, consolidation or otherwise) to
all or substantially all of the business and/or assets of the
Company to expressly assume and agree to perform this Agreement
in the same manner and to the same extent that the Company would
be required to perform it if no such succession had taken place.
(b) This Agreement is a personal contract and the rights and
interests of the Executive hereunder may not be sold,
transferred, assigned, pledged, encumbered, or hypothecated by
him, except as otherwise expressly permitted by the provisions
of this Agreement. This Agreement shall inure to the benefit of
and be enforceable by the Executive and his personal or legal
representatives, executors, administrators, successors, heirs,
distributees, devisees and legatees. If the Executive should die
while any amount would still be payable to him hereunder had the
Executive continued to live, all such amounts, unless otherwise
provided herein, shall be paid in accordance with the terms of
this Agreement to his devisee, legatee or other designee or, if
there is no such designee, to his estate.
15. Confidentiality and Non-Competition Covenants.
---------------------------------------------
(a) The Executive covenants and agrees that he will not at any time
during or at any time after the end of the Term, directly or
indirectly, use for his own account, or disclose to any person,
firm or corporation, other than authorized officers, directors
and employees of the Company or its subsidiaries, Confidential
Information (as hereinafter defined) that is treated as trade
secrets by the Company and will not at any time during or for a
period equal to the number of payments which are being made
under Section 12(e) hereof directly or indirectly, use for his
own account, or disclose to any person, firm or corporation,
other than authorized officers, directors and employees of the
Company or its subsidiaries, any other Confidential Information.
As used herein, "Confidential Information" of the Company means
information of any kind, nature or description which is
disclosed to or otherwise known to the Executive as a direct or
indirect consequence of his association with the Company, which
information is not generally known to the public or in the
business in which the Company is engaged or which information
relates to specific investment opportunities within the scope of
the Company's business which were considered by the Executive or
the Company during the term of this Agreement. Confidential
12
<PAGE>
Information that is treated as confidential trade secrets by the
Company shall include, but not be limited to, strategic
operating plans and budgets, policy and procedure manuals,
computer programs, financial forms and information, patient or
resident lists and accounts, supplier information, accounting
forms and procedures, personnel policies, information pertaining
to the salaries, positions and performance reviews of the
Company's employees, information on the methods of the Company's
operations, research and data developed by or for the benefit of
the Company and information relating to revenues, costs, profits
and the financial condition of the Company. During the Term and
for a period of two years following the termination of the
Executive's employment, the Executive shall not induce any
employee of the Company or its subsidiaries to terminate his or
her employment by the Company or its subsidiaries in order to
obtain employment by any person, firm or corporation affiliated
with the Executive.
(b) The Executive covenants and agrees that any information,
materials, ideas, discoveries, techniques or programs developed
or discovered by the Executive in connection with the
performance of his duties hereunder shall remain the sole and
exclusive property of the Company and, to the extent it
constitutes Confidential Information, shall be subject to the
covenants contained in the preceding paragraph.
(c) The Executive covenants and agrees that during the Term and, if
the Executive's employment is terminated by the Executive for
other than Good Reason, for a period of two (2) years following
the termination of the Executive's employment, the Executive
shall not, directly or indirectly, own an interest in, operate,
join, control, or participate as a partner, director, principal,
officer, or agent of, enter into the employment of, or act as a
consultant to, in any case in which he has control or
supervision over a significant portion of any entity (i) whose
principal business is the operation of one or more skilled
nursing facilities or (ii) which operates a skilled nursing
business that is material in relation to the Company's
comparable business and (iii) in either case, which derives at
least 10% of its skilled nursing facility revenue from
facilities which are located within 35 miles of centers or
facilities operated by the Company. Notwithstanding anything
herein to the contrary, the foregoing provisions of this Section
15(c) shall not prevent the Executive from acquiring securities
representing not more than 5% of the outstanding voting
securities of any publicly held corporation.
(d) Without limiting the right of the Company to pursue all other
legal and equitable remedies available for violation by the
Executive of the covenants contained in this Section 15, it is
expressly agreed by the Executive and the Company that such
13
<PAGE>
other remedies cannot fully compensate the Company for any such
violation and that the Company shall be entitled to injunctive
relief, without the necessity of proving actual monetary loss,
to prevent any such violation or any continuing violation
thereof. Each party intends and agrees that if in any action
before any court or agency legally empowered to enforce the
covenants contained in this Section 15, any term, restriction,
covenant or promise contained herein is found to be unreasonable
and accordingly unenforceable, then such term, restriction,
covenant or promise shall be deemed modified to the extent
necessary to make it enforceable by such court or agency. The
covenants contained in Section 15 shall survive the conclusion
of the Executive's employment by the Company.
16. Prohibition on Parachute Payments.
---------------------------------
(a) Notwithstanding any other provisions of this Agreement, any
payment or benefit received or to be received by the Executive
in connection with a Change in Control of the Company or the
termination of the Executive's employment (whether pursuant to
the terms of this Agreement or any other plan, arrangement or
agreement with the Company, any person whose actions result in a
Change in Control or any Person affiliated with the Company or
such Person) (all such payments and benefits, including, without
limitation, base salary and bonus payments, being hereinafter
called "Total Payments") would not be deductible (in whole or in
part), by the Company, an affiliate or any Person making such
payment or providing such benefit as a result of section 280G of
the Internal Revenue Code of 1986, as amended (the "Code"),
then, to the extent necessary to make such portion of the Total
Payments deductible (and after taking into account any reduction
in the Total Payments provided by reason of section 280G of the
Code in such other plan, arrangement or agreement), (A) such
cash payments shall first be reduced (if necessary, to zero),
and (B) all other non-cash payments by the Company to the
Executive shall next be reduced (if necessary, to zero). For
purposes of this limitation (i) no portion of the Total Payments
the receipt or enjoyment of which the Executive shall have
effectively waived in writing prior to the Date of Termination
shall be taken into account, (ii) no portion of the Total
Payments shall be taken into account which in the opinion of tax
counsel selected by the Company's independent auditors and
reasonably acceptable to the Executive does not constitute a
"parachute payment" within the meaning of section 280G(b)(2) of
the Code, including by reason of section 280G(b)(4)(A) of the
Code, (iii) such payments shall be reduced only to the extent
necessary so that the Total Payments (other than those referred
to in clauses (i) or (ii)) in their entirety constitute
reasonable compensation for services actually rendered within
the meaning of section 280G(b)(4)(B) of the Code or are
otherwise not subject to disallowance as deductions, in the
opinion of the tax counsel referred to in clause (ii); and (iv)
14
<PAGE>
the value of any non-cash benefit or any deferred payment or
benefit included in the Total Payments shall be determined by
the Company's independent auditors in accordance with the
principles of sections 280G(d)(3) and (4) of the Code.
(b) If it is established pursuant to a final determination of a
court or an Internal Revenue Service proceeding that,
notwithstanding the good faith of the Executive and the Company
in applying the terms of this Section 16, the aggregate
"parachute payments" paid to or for the Executive's benefit are
in an amount that would result in any portion of such "parachute
payments" not being deductible by reason of section 280G of the
Code, then the Executive shall have an obligation to pay the
Company upon demand an amount equal to the sum of (i) the excess
of the aggregate "parachute payments" paid to or for the
Executive's benefit over the aggregate "parachute payments" that
could have been paid to or for the Executive's benefit without
any portion of such "parachute payments" not being deductible by
reason of section 280G of the Code; and (ii) interest on the
amount set forth in clause (i) of this sentence at the rate
provided in section 1274(b)(2)(B) of the Code from the date of
the Executive's receipt of such excess until the date of such
payment.
17. Entire Agreement. This Agreement contains all the understandings
----------------
between the parties hereto pertaining to the matters referred to herein, and on
the Effective Date shall supersede all undertakings and agreements, whether oral
or in writing, previously entered into by them with respect thereto. The
Executive represents that, in executing this Agreement, he does not rely and has
not relied upon any representation or statement not set forth herein made by the
Company with regard to the subject matter, bases or effect of this Agreement or
otherwise.
18. Amendment or Modification. Waiver. No provision of this Agreement may
---------------------------------
be amended or waived unless such amendment or waiver is agreed to in writing,
signed by the Executive and by a duly authorized officer of the Company. No
waiver by any party hereto of any breach by another party hereto of any
condition or provision of this Agreement to be performed by such other party
shall be deemed a waiver of a similar or dissimilar condition or provision at
the same time, any prior time or any subsequent time.
19. Notices. Any notice to be given hereunder shall be in writing and
-------
shall be deemed given when delivered personally, sent by courier or telecopy or
registered or certified mail, postage prepaid, return receipt requested,
addressed to the party concerned at the address indicated below or to such other
address as such party may subsequently give notice of hereunder in writing:
To Executive at: Robert V. Napier
8528 Elk Run Drive
Clarkston, Michigan 48348
To the Company at: Paragon Health Network, Inc.
One Ravinia Drive, Suite 1500
15
<PAGE>
Atlanta, Georgia 30346
Any notice delivered personally or by courier under this Section 19
shall be deemed given on the date delivered and any notice sent by telecopy or
registered or certified mail, postage prepaid, return receipt requested, shall
be deemed given on the date telecopied or mailed.
20. Severability. If any provision of this Agreement or the application of
------------
any such provision to any party or circumstances shall be determined by any
court of competent jurisdiction to be invalid and unenforceable to any extent,
the remainder of this Agreement or the application of such provision to such
person or circumstances other than those to which it is so determined to be
invalid and unenforceable, shall not be affected thereby, and each provision
hereof shall be validated and shall be enforced to the fullest extent permitted
by law.
21. Survivorship. The respective rights and obligations of the parties
------------
hereunder shall survive any termination of this Agreement to the extent
necessary to the intended preservation of such rights and obligations.
22. Governing Law: Attorney's Fees.
------------------------------
(a) This Agreement will be governed by and construed in accordance
with the laws of the State of Georgia, without regard to its
conflicts of laws principles.
(b) The prevailing party in any dispute arising out of this
Agreement shall be entitled to be paid its reasonable attorney's
fees incurred in connection with such dispute from the other
party to such dispute.
23. Dispute Resolution. The Executive and the Company shall not initiate
------------------
legal proceedings relating in any way to this Agreement or to the Executive's
employment or termination from employment with the Company until thirty (30)
days after the party against whom the claim is made ("respondent") receives
written notice from the claiming party of the specific nature of any purported
claims and the amount of any purported damages attributable to each such claim.
The Executive and the Company further agree that if respondent submits the
claiming party's claim to the CPR Institute for Dispute Resolution,
JAMS/Endispute, or other local dispute resolution service for nonbinding
mediation prior to the expiration of such thirty (30) day period, the claiming
party may not institute arbitration or other legal proceedings against
respondent until the earlier of: (a) the completion of good-faith mediation
efforts or (b) 90 days after the date on which the respondent received written
notice of the claimant's claim(s); provided, however, that nothing in this
Section 23 shall prohibit the Company from pursuing injunctive or other
equitable relief against the Executive prior to, contemporaneous with, or
subsequent to invoking or participating in these dispute resolution processes.
The Company shall pay the cost of the mediator.
16
<PAGE>
24. Headings. All descriptive headings of sections and paragraphs in this
--------
Agreement are intended solely for convenience, and no provision of this
Agreement is to be construed by reference to the heading of any section or
paragraph.
25. Withholdings. All payments to the Executive under this Agreement
------------
shall be reduced by all applicable withholding required by federal, state or
local tax laws.
26. Counterparts. This Agreement may be executed in counterparts, each of
------------
which shall be deemed an original, but all of which together shall constitute
one and the same instrument.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the date first above written.
PARAGON HEALTH NETWORK, INC.
BY: /s/ Susan Thomas Whittle
--------------------------------------
NAME: Susan Thomas Whittle
--------------------------------------
TITLE: Senior Vice President and General Counsel
------------------------------------------
EXECUTIVE
/s/ Robert V. Napier
--------------------------------------------
Robert V. Napier
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-END> MAR-31-1998
<CASH> 19,464
<SECURITIES> 0
<RECEIVABLES> 499,894
<ALLOWANCES> 71,984
<INVENTORY> 30,205
<CURRENT-ASSETS> 592,687
<PP&E> 731,753
<DEPRECIATION> 229,063
<TOTAL-ASSETS> 1,780,216
<CURRENT-LIABILITIES> 317,797
<BONDS> 1,278,488
0
0
<COMMON> 414
<OTHER-SE> 70,764
<TOTAL-LIABILITY-AND-EQUITY> 1,780,216
<SALES> 908,767
<TOTAL-REVENUES> 908,767
<CGS> 0
<TOTAL-COSTS> 926,063
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 47,290
<INCOME-PRETAX> (64,586)
<INCOME-TAX> (13,951)
<INCOME-CONTINUING> (50,934)
<DISCONTINUED> 0
<EXTRAORDINARY> (11,275)
<CHANGES> 0
<NET-INCOME> 0
<EPS-PRIMARY> (1.40)<F1>
<EPS-DILUTED> (1.40)
<FN>
<F1>EPS-Primary reflects EPS-Basic
</FN>
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR YEAR
<FISCAL-YEAR-END> SEP-30-1997 SEP-30-1996 SEP-30-1995
<PERIOD-END> SEP-30-1997 SEP-30-1996 SEP-30-1995
<CASH> 14,355 21,394 17,886
<SECURITIES> 0 0 0
<RECEIVABLES> 245,127 209,745 168,469
<ALLOWANCES> 33,138 17,405 16,500
<INVENTORY> 21,237 16,582 13,264
<CURRENT-ASSETS> 287,229 269,439 226,852
<PP&E> 512,500 476,051 463,186
<DEPRECIATION> 210,117 186,333 169,815
<TOTAL-ASSETS> 874,367 809,612 730,708
<CURRENT-LIABILITIES> 185,125 168,348 192,221
<BONDS> 252,763 262,702 181,929
0 0 0
0 0 0
<COMMON> 608 608 608
<OTHER-SE> 374,675 328,707 302,988
<TOTAL-LIABILITY-AND-EQUITY> 874,367 809,612 730,708
<SALES> 1,140,288 1,114,491 893,869
<TOTAL-REVENUES> 1,140,288 1,114,491 893,869
<CGS> 0 0 0
<TOTAL-COSTS> 1,045,180 1,024,935 836,864
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 16,852 12,461 10,817
<INCOME-PRETAX> 78,256 77,095 46,188
<INCOME-TAX> 33,604 33,759 21,750
<INCOME-CONTINUING> 43,917 43,180 24,234
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 0 0 0
<EPS-PRIMARY> 0.75 0.72 0.43<F1>
<EPS-DILUTED> 0.73 0.71 0.42
<FN>
<F1>EPS-Primary reflects EPS-Basic
</FN>
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 9-MOS 6-MOS 3-MOS
<FISCAL-YEAR-END> SEP-30-1997 SEP-30-1997 SEP-30-1997
<PERIOD-END> JUN-30-1997 MAR-31-1997 DEC-31-1996
<CASH> 13,288 10,351 21,322
<SECURITIES> 0 0 0
<RECEIVABLES> 266,602 261,461 261,444
<ALLOWANCES> 36,731 33,894 29,600
<INVENTORY> 20,395 16,743 16,005
<CURRENT-ASSETS> 296,853 289,575 306,103
<PP&E> 504,607 495,817 488,891
<DEPRECIATION> 205,187 198,804 193,491
<TOTAL-ASSETS> 881,557 866,260 861,382
<CURRENT-LIABILITIES> 142,268 142,469 172,723
<BONDS> 309,467 311,233 295,270
0 0 0
0 0 0
<COMMON> 608 608 608
<OTHER-SE> 366,210 352,201 339,309
<TOTAL-LIABILITY-AND-EQUITY> 881,557 866,260 861,382
<SALES> 853,953 565,520 280,202
<TOTAL-REVENUES> 853,953 565,520 280,202
<CGS> 0 0 0
<TOTAL-COSTS> 777,971 517,994 258,520
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 12,924 8,436 4,054
<INCOME-PRETAX> 63,058 39,090 17,628
<INCOME-TAX> 26,445 16,369 7,240
<INCOME-CONTINUING> 36,208 22,539 10,325
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 0 0 0
<EPS-PRIMARY> 0.62 0.38 0.18<F1>
<EPS-DILUTED> 0.61 0.38 0.18
<FN>
<F1>EPS-Primary reflects EPS-Basic
</FN>
</TABLE>
