<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 or 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[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
For the transition period from ______________ to ______________
Commission file number 0-21752
NORTHSTAR HEALTH SERVICES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 25-1697152
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
665 PHILADELPHIA STREET, INDIANA, PENNSYLVANIA 15701
(Address of principal executive offices)
724-349-7500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
----- -----
State the number of shares outstanding of each of the issuer's classes
of common stock, as of the last practicable date:
CLASS OUTSTANDING AS OF May 5, 1998
- -------------------------------------- -----------------------------
Common Stock, par value $.01 per share 5,975,424
Transitional Small Business Disclosure Format (Check one):
YES NO X
----- -----
<PAGE> 2
NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
INDEX PAGE
- ----- ----
Part I - FINANCIAL INFORMATION
<S> <C>
Item 1.
Condensed Consolidated Balance Sheets as of
March 31, 1998 and December 31, 1997 1
Condensed Consolidated Statements of Operations
for the three months ended March 31, 1998 and 1997 3
Condensed Consolidated Statements of Cash Flows
for the three months ended March 31, 1998 and 1997 4
Notes to Condensed Consolidated Financial Statements 5
Item 2.
Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Item 3.
Quantitative and Qualitative Disclosure About Market
Risk Sensitive Instruments 12
Part II - OTHER INFORMATION
Item 1. - Legal Proceedings 13
Item 2. - Changes in Securities and Use of Proceeds 15
Item 3. - Defaults Upon Senior Securities 16
Item 6. - Exhibits and Reports on Form 8-K 17
</TABLE>
<PAGE> 3
Item 1. - Financial Statements
NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Note 1)
(Dollars in Thousands)
<TABLE>
<CAPTION>
A S S E T S March 31, December 31,
----------- 1998 1997
------------------ -------------------
(Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents- $ 243 $ 657
Accounts receivable-
Patients, net of allowances for doubtful accounts of
$1,154 and $1,341, respectively 5,561 5,818
Management fees 312 350
Miscellaneous 322 309
Prepaid expenses and other current assets 142 162
------- -------
Total current assets 6,580 7,296
------- -------
PROPERTY AND EQUIPMENT, net 2,606 2,814
INTANGIBLE ASSETS, net (Note 2) 18,953 19,221
OTHER ASSETS 171 183
------- -------
TOTAL ASSETS $28,310 $29,514
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
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NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Note 1)
(Dollars in Thousands, Except Share Data)
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY March 31, December 31,
------------------------------------ 1998 1997
------------------ -------------------
(Unaudited)
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt (Note 3)
Senior Debt $14,083 $14,083
Thomas Zaucha and Zaucha Family Limited Partnership 3,159 2,932
Other debt 821 1,206
Accounts payable 1,910 2,401
Accrued expenses 7,152 7,476
Contractual obligations to employees 1,046 1,031
------- -------
Total current liabilities 28,171 29,129
------- -------
LONG-TERM DEBT (Note 3)
Thomas Zaucha and Zaucha Family Limited Partnership 1,582 1,757
Other debt 299 282
------- -------
Total long term debt 1,881 2,039
MINORITY INTEREST 239 145
------- -------
Total liabilities 30,291 31,313
------- -------
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share, 1,000,000 shares
authorized, none issued - -
Common stock, par value $.01 per share, 10,000,000 shares authorized;
6,337,988 shares issued at March 31, 1998 and December 31, 1997
63 63
Additional paid-in capital 26,388 26,388
Warrants outstanding 2,392 2,392
Retained deficit (30,371) (30,189)
Less: Treasury stock, 362,564 shares in 1998 and 1997, at cost (453) (453)
------- -------
Total stockholders' equity/(deficit) (1,981) (1,799)
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $28,310 $29,514
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
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<PAGE> 5
NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Note 1)
(Dollars in Thousands, Except Share Data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
---------------------------------------
1998 1997
------------------ -----------------
<S> <C> <C>
REVENUE:
Net patient service revenue $ 7,782 $ 8,637
Management fee revenue 384 545
------------------ -----------------
Total revenue 8,166 9,182
COSTS OF SERVICE 3,729 4,157
------------------ -----------------
Gross profit 4,437 5,025
OPERATING EXPENSES:
Selling, general and administrative expenses 2,969 2,768
Bad debt expense 119 516
Restructuring and other non-recurring expenses (Note 4) 115 1,521
Amortization of intangibles 232 303
Depreciation and amortization 138 149
Management fee expenses 400 710
------------------ -----------------
Total operating expenses 3,973 5,967
------------------ -----------------
OPERATING INCOME/(LOSS) 464 (942)
NON-OPERATING EXPENSES:
Interest expense, net 527 524
Other expense, net (11) (10)
------------------ -----------------
Total non-operating expenses 516 514
------------------ -----------------
LOSS BEFORE INCOME TAXES (52) (1,456)
INCOME TAXES - 65
------------------ -----------------
LOSS BEFORE MINORITY INTEREST (52) (1,521)
MINORITY INTEREST 130 69
------------------ -----------------
NET LOSS $ (182) $ (1,590)
================== =================
NET LOSS PER SHARE (Basic and diluted) $ (0.03) $ (0.27)
================== =================
WEIGHTED AVERAGE NUMBER OF COMMON SHARES AND EQUIVALENTS
5,975,424 5,867,154
================== =================
</TABLE>
The accompanying notes are an integral part of these financial statements.
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NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Notes 1 and 2)
(Dollars in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------------
1998 1997
----------------- -----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (182) $ (1,590)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities-
Depreciation and amortization 584 850
Provision for doubtful accounts 119 (154)
Gain on legal settlement - (47)
Interest on discounted obligation 61 57
(Gain)/loss on sale of equipment (7) 2
Provision for increase/(decrease) in contractual obligations to
employees 51 (122)
Minority interest 130 69
Change in current assets and liabilities-
Decrease/(Increase) in receivables 163 (499)
Decrease in other current assets 20 435
(Decrease)/Increase in accounts payable (491) 378
(Decrease)/Increase in accrued expenses (324) 579
----------------- -----------------
Net cash provided/(used) by operating activities 124 (42)
----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of equipment 3 -
Capital expenditures (69) (24)
Deposits, loans and investments 12 3
----------------- -----------------
Net cash used in investing activities (54) (21)
----------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term debt (439) (549)
Distributions to minority interests (36) (76)
Payments of contractual obligations to employees (36) -
Borrowings on long-term debt 27 -
----------------- -----------------
Net cash used in financing activities (484) (625)
----------------- -----------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (414) (688)
CASH AND CASH EQUIVALENTS, beginning balance 657 1,607
----------------- -----------------
CASH AND CASH EQUIVALENTS, ending balance $ 243 $ 919
================= =================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW DATA:
Interest paid $ 410 $ 213
Income taxes paid 10 67
NONCASH INVESTING ACTIVITIES:
Capital lease obligations 28 28
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
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NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
General
These condensed consolidated financial statements of Northstar Health Services,
Inc. (the "Company") are unaudited and reflect all adjustments (consisting only
of normal recurring adjustments) which are, in the opinion of management,
necessary for a fair presentation of the results of operations for the interim
period. These statements should be read in conjunction with the consolidated
financial statements and notes thereto contained in the Company's Form 10-K for
the year ended December 31, 1997.
Management Fees
The Company manages a business on a contract basis that provides mobile
diagnostic services. In conjunction with these contracts, the Company receives
compensation in the form of a monthly management fee. This fee is equal to the
net income or loss of the managed business after the payment of certain
agreed-upon salaries and benefits to certain parties.
Earnings Per Common Share
Earnings per share for the three months ended March 31, 1998 and March 31, 1997
were calculated in accordance with Statement of Financial Accounting Standards
No. 128 (SFAS No. 128), "Earnings per Share", using the weighted average number
of shares outstanding during the period and including the effect of stock
options outstanding. Pursuant to the Company's 1992, 1994, and 1997 Stock Option
plans and certain stock options granted outside of these plans, options for a
total of 14,216 shares of the Company's common stock have been granted and no
options have been exercised for the three months ended March 31, 1998.
The following table reconciles the number of shares utilized in the earnings per
share calculations for the three-month periods ended March 31, 1998 and March
31, 1997 (dollars in thousands):
<TABLE>
<CAPTION>
For the three months ended March 31,
------------------------------------
1998 1997
---- ----
<S> <C> <C>
Basic earnings per share:
Net loss $ (182) $ (1,590)
Average shares outstanding 5,975,424 5,867,154
Loss per share $ (0.03) $ (0.27)
Diluted earnings per share:
Net loss $ (182) $ (1,590)
Average shares outstanding 5,975,424 5,867,154
Shares issuable for Keystone merger - -
Stock warrants - -
Stock options - -
------------- ----------
Diluted average shares outstanding 5,975,424 5,867,154
Loss per share $ (0.03) $ (0.27)
</TABLE>
Options to purchase 967,974 and 891,400 and warrants to purchase 843,500 and
676,000 were outstanding at March 31, 1998, and 1997, respectively, but were not
included in the computation of diluted EPS because the options' exercise price
was greater than the average market price of the common shares and due to the
loss position of the Company for these years. Also, not included in the
calculation of diluted earnings per share were the shares that may be issued to
the Zaucha's in connection with the Keystone merger that are subject to
stockholder approval. See Note 6.
5
<PAGE> 8
Reclassifications
Certain reclassifications have been made to prior year financial statements to
conform to the current year presentation.
2. INTANGIBLE ASSETS:
Intangible assets and the related amortization periods consist of the following
(dollars in thousands):
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
----------------- ------------------
<S> <C> <C>
Excess of cost over net assets acquired (40 years) $ 17,481 $ 17,481
Employment agreements (2 to 7 1/2 years) 625 625
Keystone tradename (20 years) 2,500 2,500
Covenant not to compete (5 years) 77 77
Assembled Keystone workforce (5 years) 600 600
Deferred financing and other costs (5 years) 809 809
----------------- ------------------
Gross intangible assets 22,092 22,092
Less- accumulated amortization (3,139) (2,871)
----------------- ------------------
Net intangible assets $ 18,953 $ 19,221
================= ==================
</TABLE>
3. DEBT:
Debt consists of the following (dollars in thousands):
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
---------------- -------------------
<S> <C> <C>
Term loan with Senior Lender $ 6,083 $ 6,083
Revolving line of credit with Senior Lender 2,000 2,000
Acquisition facility with Senior Lender 6,000 6,000
Non-interest bearing term notes to Thomas Zaucha and the Zaucha
Family Limited Partnership 2,625 2,625
Term notes to Thomas Zaucha and the Zaucha Family Limited
Partnership 2,400 2,400
Capital lease obligations with interest rates ranging from 9% to
15.6% 1,089 1,241
Other debt 417 685
----------- -----------
Total long-term debt 20,614 21,034
Less:
Current portion (18,063) (18,221)
Debt discount (670) (774)
----------- -----------
Long-term debt $ 1,881 $ 2,039
=========== ===========
</TABLE>
As of March 31, 1998, the Company has no unused amounts under its existing
credit facilities. During the first quarter of 1998, the Company's weighted
average interest rate was 9.7%.
The Company is currently in default of its obligations under its credit facility
with its Senior Lender, Cerberus Partners, LP. In September 1997, Cerberus
purchased from IBJ Schroder Bank & Trust Company all of the Company's senior
debt amounting to $15.3 million, including principal and accrued interest. The
debt was purchased subject to an existing forbearance agreement that expired at
the end of
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<PAGE> 9
September 1997. The Company had subsequently entered into extensions of the
forbearance agreement directly with Cerberus. The most recent forbearance
agreement extension expired on December 5, 1997. The Company has been operating
under a verbal extension of this agreement since that date. Please refer to the
Liquidity section of Item 2 for further discussion.
4. RESTUCTURING AND NON-RECURRING EXPENSES:
Since 1996, the Company has incurred significant legal, accounting and
consulting expenses arising out of its investigation of apparent wrongdoing on
the part of the management team that controlled Northstar prior to 1996 and the
resulting litigation brought both against and by the Company. It has also
incurred significant expenses related to the proxy solicitation that was
conducted in 1997, and the reorganization of the management and operations of
the Company after the reinstatement of Thomas Zaucha as Chairman and CEO in May
1997. Although the majority of these issues were resolved in 1997, certain
matters are still subject to resolution in 1998. Please refer to Note 6,
Commitments and Contingencies, and to the Legal Proceedings section in Part II
for a discussion of these outstanding matters.
A summary of these unusual and non-recurring expenses is as follows (dollars in
thousands):
<TABLE>
<CAPTION>
For the three months ended
March 31,
--------------------------
1998 1997
---- ----
<S> <C> <C>
Company costs related to proxy solicitation incurred by
former management $ - $ 442
Proxy solicitation cost incurred by Mr. Zaucha - 495
Additional legal and accounting fees - 210
Write off of intangible assets - 169
Litigation and investigation costs 18 102
Corporate restructuring costs 97 103
----- -------
Total $ 115 $ 1,521
----- -------
</TABLE>
5. RELATED-PARTY TRANSACTIONS:
Keystone Acquisition
In connection with the Company's acquisition of Keystone Rehabilitation Systems,
Inc., on November 15, 1995, Mr. Thomas Zaucha, an officer of Northstar, and Mr.
Zaucha's family limited partnership, have debt and other amounts due directly to
them of $3,919,000 and $1,105,000 as of March 31, 1998, respectively.
In conjunction with the acquisition of Keystone by Northstar, Mr. Zaucha and the
Zaucha Family Limited Partnership were granted certain contingent payments (earn
out payments) based on the financial performance of Keystone during the period
from 1996 to 2000. A Special Committee of the Board of Directors of the Company
has been appointed and is evaluating the earn out calculation for 1996. If an
earn out is determined to be due, the additional consideration would be recorded
as goodwill.
The Company also rents office and clinical space in buildings owned by the
Zaucha Family Limited Partnership and other related entities. Through March 31,
1998, the Company has incurred an expense of $117,590 related to rent due on
these spaces. A Special Committee of the Board of Directors of the Company has
been appointed and is evaluating the fair market lease rates for these
properties.
6. COMMITMENTS AND CONTINGENCIES:
Zaucha Stock Guarantee
The Company guaranteed the value of certain stock issued to Mr. Zaucha and the
Zaucha Family Limited Partnership to be at least $5,600,000 through certain
periods ending no later than December 31, 1997.
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<PAGE> 10
The Company has an obligation to fund the shortfall in stock value through a
cash payment equal to the shortfall or, with shareholder approval, through the
issuance of additional shares in an amount equal to the shortfall. As of the
December 31, 1997 final determination date, the Company was obligated to either
make a cash payment of $4,693,423 or issue approximately 4,888,982 additional
shares of stock.
The Special Committee of the Board has been charged with the authority to
negotiate with the Zaucha's the obligations under the stock guarantee. The
Company presently does not have sufficient cash or authorized shares of Common
Stock to meet its obligations under the guarantee. As disclosed in the Company's
Definitive Proxy Statement filed April 30, 1998, with the Securities and
Exchange Commission, the Special Committee has recommended to the Board that it
seek stockholder approval to issue up to 4,888,982 shares of Common Stock in
order to enable the Company to fully satisfy the obligations of the Company
under the guarantee in stock if deemed appropriate. As the Company does not
currently have enough shares available to fulfill this proposal if it is agreed
to by the shareholders, the Company is also seeking an increase in the number of
authorized shares of common stock. These proposals will be voted on at the
Annual Meeting of Stockholders on June 11, 1998. The issuance of any additional
shares would not affect the purchase price (goodwill) or the statement of
operations, but rather would cause a reclassification of the par value of said
shares to common stock from additional paid-in-capital to the par value of
common stock.
Other
David D. Watson, former President of the Company, has made claims against the
Company in excess of $500,000 in relation to an Employment Agreement and Note.
Negotiations for settlement of these claims have not been successful, and no
legal action has been taken. The Company believes and avers that Mr. Watson has
breached the Employment Agreement, was terminated for cause, and as a result
thereof, the Company has counterclaims against Mr. Watson. The Company has and
will continue to vigorously defend these claims.
7. SUBSEQUENT EVENTS:
In April 1998, the Company announced the implementation of an expense reduction
plan that is expected to reduce operating expenses in excess of $250,000 per
month on an ongoing basis. The full impact of the reductions is not expected to
be realized until the third quarter of 1998 due to the timing of the transition
and implementation of some of the changes.
On May 1, 1998, a hearing was held to determine damages in the Michael J.
Kulmoski, Jr., arbitration case. A decision regarding damages to be awarded to
Kulmoski is expected to be rendered by the end of June 1998. Please refer to the
Legal Proceedings section in Part II for a discussion of this matter.
8
<PAGE> 11
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Information Relating to Forward-Looking Statements
Management's Discussion and Analysis and other sections of this Quarterly Report
include forward-looking statements that reflect the Company's current
expectations relating to such matters as anticipated financial performance,
business prospects, and projected plans for and results of its operations. A
variety of factors could cause the Company's actual results to differ materially
from the anticipated results or other expectations expressed in the Company's
forward looking statements. The risks and uncertainties that may affect the
operations and performance of the Company's business include the following:
changes in regulatory, governmental and payor policies regarding reimbursement;
competition, both directly in terms of other providers of physical therapy and
other services, and the competition for qualified personnel; the outcomes of the
current litigation involving the Company; defaults in borrowing arrangements,
defaults in bank financing, including an inability to comply with various
covenants in connection with such financing; the ability of the Company to have
its Common Stock relisted on a national market or exchange; and the
uncertainties surrounding the healthcare industry in general.
Results of Operations
Three Months Ended March 31, 1998 and 1997
Total revenue
During the first quarter of 1998, the Company's total revenues declined by
$1,016,000, or 11.1%, from $9,182,000 for the first quarter of 1997 to
$8,166,000 for the first quarter of 1998. Revenues decreased approximately
$1,262,000 as the result of the closure or termination of certain clinics and
contracts. A decline in management fee revenues of approximately $161,000 is
attributable to the termination of services in unprofitable areas and a change
in the reimbursement of certain diagnostic services. The Company opened new
outpatient offices and entered into new contracts that resulted in an increase
in net patient service revenues of $196,000. Net patient service revenue from
continuing operations increased $211,000 as a result of the Company's expanded
sales and marketing efforts that contributed to an increase in the number of
patient referrals in the first quarter of 1998 and due to a revision in the
Company's fee schedule effective February 1, 1998, that positively affected net
reimbursement from certain payors.
Costs of service and Gross profit
Due to the decrease in total revenues, the Company's costs of service also
decreased $428,000 from $4,157,000 for the first quarter of 1997 to $3,729,000
for 1998, or 10.3%. However, as a percentage of net patient service revenue,
costs of service remained relatively constant, decreasing slightly from 48.1% in
the first quarter of 1997 to 47.9% in the first quarter of 1998. As a result of
the decline in total revenue, gross profit declined $588,000, from $5,025,000
(54.7% of total revenue) for the first quarter of 1997 to $4,437,000 (54.3% of
total revenue) for 1998.
Selling, general and administrative expense
Total selling, general and administrative expenses for the first quarter
increased $201,000 from $2,768,000 in 1997 to $2,969,000 in 1998. The 7.26%
increase can be attributed to the expansion of corporate services in the areas
of sales, marketing, provider relations, recruitment, and regional management
that has contributed to revenues in continuing operations.
9
<PAGE> 12
Bad debt expense
The Company incurred bad debt expense of $119,000 or approximately 1.5% of net
patient service revenue during the first quarter of 1998 versus $516,000 or
approximately 6.0% during the first quarter of 1997. The decrease in bad debt
expense was accomplished through increased billing efficiency and the use of a
more aggressive collection agency in 1998 that has increased the rate of bad
debt recoveries.
Restructuring and non-recurring expense
The Company continued to incur additional legal and other professional fees
resulting from the continuing reorganization of the Company and litigation both
against and on behalf of the Company in various matters. During the first
quarter of 1998, the expenses deemed non-recurring were $115,000.
Depreciation and amortization
Other operating costs include amortization of intangibles arising from past
acquisitions, depreciation and other deferred charges, primarily finance costs.
Amortization of intangibles for the first quarter of 1998 of $232,000 declined
by $71,000 from the 1997 total, reflecting (1) intangible asset write-offs that
occurred after the first quarter of 1997 and (2) completion of the amortization
period for certain assets acquired during previous acquisitions by the Company.
Interest and other non-operating expenses
Interest expenses were $527,000 for the first quarter of 1998 compared to
$524,000 for 1997. The Company reported net non-operating income of $11,000 in
the first quarter of 1998 compared to $10,000 in the first quarter of 1997.
Income taxes
The Company has not recorded a tax provision during the first quarter of 1998.
As a result of the losses experienced in 1997 and prior years, as well as to
date in 1998, the Company does not anticipate any significant taxable income for
federal or state income tax purposes.
Net loss
The net loss for the first quarter of 1998 was $181,000 compared to a loss of
$1,590,000 for the same period in 1997. This improvement is due primarily to the
decrease in the amount of restructuring and other non-recurring expenses from
the first quarter of 1997 to the first quarter of 1998.
Liquidity and Capital Resources
The Company is currently in default of its obligations under the credit facility
with Cerberus Partners, LP. Failure to reach an agreement with this senior
creditor relative to a restructuring of the Company's outstanding debt
obligations would likely result in acceleration of the loan and a filing of a
petition for relief under the Federal Bankruptcy Code. The Company had come to a
verbal agreement on restructured payment terms and covenants in March 1998;
however, since that time, the Company has been unable to finalize a written
restructuring of this debt. The Company has continued to comply with the terms
of the last forbearance agreement, and has made monthly payments to Cerberus
that approximate the monthly interest expense on the loan.
During the three months ended March 31, 1998, the Company provided $124,000
versus $42,000 of cash used by operations during the first three months of 1997.
This change in cash provided from operations is primarily the result of a
decrease in the net loss from $1,590,000 during the first three months of 1997
to $182,000 during the same period in 1998 that allowed the Company to reduce
the amount of its outstanding liabilities and the increased efficiency in
accounts receivable in the first three months of 1998 that resulted in decreased
receivables and an improvement in the provision for doubtful accounts.
10
<PAGE> 13
The net cash used in investing activities increased from $21,000 in the first
three months of 1997 to $54,000 in the first three months of 1998 resulting
primarily from an increase in expenditures for capital equipment in 1998.
During the first three months of 1997, the Company made debt principal payments
of $549,000 which were primarily scheduled debt and lease payments as well as
payments on debt to former owners and managers of the Company. This amount
decreased to $439,000 for the first three months of 1998 due to the final
payment of certain debt after the first quarter of 1997. In addition, during the
first quarter of 1998, the Company paid approximately $36,000 to minority
interest holders in companies controlled by Northstar and $36,000 under
contractual obligations with certain employees. During the first three months of
1998, the Company made no additional material borrowings under any debt
arrangements.
Summary
The Company is presently experiencing a severe liquidity crisis as a result of
the significant expenses incurred related to the contest for corporate control
in 1997; the investigation and litigation expenses arising out of certain
actions taken by the Company's pre-1996 management; continuing operating losses;
and prior obligations to buy out profit-sharing interests in several of the
Company's key clinics. As a result of these circumstances, the Company's access
to the capital and debt markets has been severely impaired. If it is unable to
raise additional capital and/or effect a permanent restructuring of the terms of
its outstanding long-term debt obligations in the foreseeable future, the
Company could be required to file a petition for relief under the provisions of
the Bankruptcy Code.
In response to these developments, the Company has focused its efforts on
improving the performance of its core physical therapy and rehabilitation
businesses. To this end, the Company has announced its decision to withdraw from
the mobile diagnostic industry so that management can focus on the core
rehabilitation business. The Company has also announced the implementation of an
expense reduction plan that is expected to reduce operating expenses in excess
of $250,000 per month on an ongoing basis. The full impact of the reductions is
not expected to be realized until the third quarter of 1998 due to the timing of
the transition and implementation of some of the changes The Company's Chairman
has indicated that he will not demand immediate reimbursement of all expenses
due to him in connection with the 1997 proxy fight, and he is currently
negotiating with the Special Committee of the Board a restructuring of other
components of his debt and stock guarantees of which the Company is currently in
default.
There can be no assurance that the Company will be successful in raising
additional equity or other capital, or that it will be in a position to do so on
terms that will not dilute the equity interest of the Company's existing
stockholders. The Company is not currently eligible to utilize Form S-3 to
register offerings of securities under the Securities Act of 1933, and its
shares are not currently listed on either the NASDAQ National Market or the
NASDAQ Small Cap Market. These circumstances could adversely affect the
Company's ability to attract additional equity capital.
11
<PAGE> 14
Item - 3. Quantitative and Qualitative Disclosure About Market Risk Sensitive
Instruments
The Company currently does not invest excess funds in derivative financial
instruments or other market risk sensitive instruments for the purpose of
managing its foreign currency exchange rate risk or for any other purpose.
12
<PAGE> 15
Part II - OTHER INFORMATION
Item 1. - Legal Proceedings
Shareholder Suits and Related Litigation
In November, 1997, a comprehensive settlement of a number of shareholder
lawsuits filed in 1996 and consolidated into one action in federal court in the
Western District of Pennsylvania (Butler v. Northstar, No. 96-701 W.D. Pa) was
given final approval by the court. The lawsuit alleged violations of federal
securities laws by the Company and certain of its former officers and directors,
and an alleged scheme to disseminate false and misleading information regarding
the Company. This action was described in the Company's Form 10-K filing for the
fiscal year ended December 31, 1996. In December 1997, with no party having
appealed the order approving the settlement, the decision became final. The
settlement agreement which was approved by the court, created a settlement fund
of $6.45 million, of which $5.75 million, less expenses and legal counsel fees,
will be paid to those Northstar shareholders who submitted proofs of claim by
December 27, 1997, which the court approves as valid claims. The Company
contributed $100,000 to the $6.45 million settlement fund; the insurer on the
Company's directors and officers' liability policy contributed the $1.0 million
limits of coverage of that policy; and the $5.35 million balance in the fund was
contributed by other defendants.
In September 1996, the Company filed an action in federal court in Pittsburgh,
seeking to recover damages from Northstar's former Chief Executive Officer and
various Northstar related-parties and others (Northstar v. DeSimone, C.A. No.
96-1695, W.D. Pa.). This action was described in the Company's Form 10-K filing
for the fiscal year ended December 31, 1996. Since then, in connection with the
settlement of the Butler class action, Northstar has settled its claims against
its former Chief Executive Officer for the sum of $600,000 which was then
contributed to the settlement fund created in the Butler action. Since that
settlement, Northstar has also agreed to settle its claims against another
related-party and his affiliated companies (the Bergman defendants) that results
in mutual releases and no payments to either party. That settlement is in the
process of being documented. Northstar's claims against the two remaining sets
of defendants (the Shields and Horoszko defendants) are being prosecuted
vigorously.
Claim for Breach of Employment Agreement
In July 1996, Michael Kulmoski, Jr. ("Kulmoski"), Northstar's former Chief
Financial Officer and a named defendant in the shareholder class actions
described above, filed a demand for arbitration against Northstar (Kulmoski v.
Northstar, American Arbitration Assn., No. 55-116-0106-96-CEW). In his demand
for arbitration, Kulmoski, whose employment with Northstar was terminated in the
summer of 1996, alleges breach of his employment agreement by Northstar and
related claims, including a claim for indemnification under Northstar's by-laws
in suits filed against him by Northstar shareholders. Kulmoski later agreed,
however, to sever the issue of his right to indemnification from this proceeding
to be decided by the courts as an ancillary issue in the Butler case. An
arbitration hearing was held on November 6 and 7, 1997 on the issue of liability
only, post-hearing briefs were submitted in mid-February 1998. On March 20,
1998, an arbitration panel decided that the record does not support the
conclusion that Kulmoski's employment had been terminated for "cause" as defined
in his employment agreement. A hearing on the issue of damages was held on May
1, 1998. Post-hearing briefs on the various damages issues are due on May 19,
1998, and a decision is expected to be rendered by the arbitration panel before
the end of June 1998.
In October 1997, in accordance with his agreement to have the issue of his right
to indemnification for counsel fees and expenses incurred in his defense of the
shareholder actions filed against him in the Butler and Bosco cases, Michael
Kulmoski, Jr., filed a petition for such fees and expenses in the Butler case in
which he sought an award of $69,244.02. (Kulmoski Fee Petition in Butler v.
Northstar, C.A. No. 96-709, W.D. Pa.) Although Northstar had raised an issue
whether Kulmoski was entitled to indemnification under its by-laws under the
circumstances of these cases, in an effort to resolve this matter, Northstar
agreed to confine its objections to the amount of the counsel fees and expenses
claimed in the petition. In an opinion and order dated December 16, 1997, the
court agreed with
13
<PAGE> 16
Northstar's objections and awarded Kulmoski $22,050.77 in counsel fees and
expenses. Notwithstanding Kulmoski's agreement to submit this issue to the judge
for final resolution, he has appealed the court's decision to the United States
Court of Appeals for the Third Circuit.
Claim on Lease Agreements
In March 1997, Ultrasonics, Inc. confessed judgement against two subsidiaries of
the Company, and filed a lawsuit against the Company itself in the Court of
Common Pleas of Allegheny County, Pennsylvania for alleged non-performance under
two lease agreements with the Company. In addition to challenging the legality
and enforceability of these lease agreements as fraudulent in the RICO action
described above, the Company filed an Answer and Counterclaim against
Ultrasonics for fraud. As part of Northstar's settlement of its claims against
the Bergman defendants described above, Ultrasonics, Inc., will file praecipes
to mark the judgements entered against the two subsidiaries of the Company
satisfied in full, and the parties will each file a praecipe to settle and
discontinue their respective claims in the lawsuit Ultrasonics, Inc., filed
against the Company.
14
<PAGE> 17
Item 2. - Changes in Securities and Use of Proceeds
Chapter 1, Title 8, Section 170 of the Delaware Corporation Law provides that
the directors of every corporation may declare and pay dividends either out of
surplus or, in the event that there is no surplus, out of net profits for the
fiscal year in which the dividend is declared and/or the preceding fiscal year.
Since the Company has not had surplus during the past fiscal year and does not
have surplus during the first quarter of fiscal year 1998, and has experienced
net losses during the past fiscal year and continues to experience net losses
during the first quarter of fiscal year 1998, under Delaware corporate law, the
Company cannot declare and pay dividends on its Common Stock.
In addition, the Company is prohibited from declaring any dividend, other than
dividends payable solely in common stock, on any shares of any class of stock
under the terms of the Company's Credit Agreement with Cerberus Partners, LP.
15
<PAGE> 18
Item 3. - Defaults Upon Senior Securities
The Company is currently in default of its financial and other covenants and
payment obligations under its Credit Agreement with Cerberus Partners, LP. As of
the date of the filing of this report, the Company is in arrears on its
principal obligations in the amount of $3,990,000 and accrued interest in the
amount of approximately $1,162,000. Please refer to the Liquidity and Capital
Resources and Summary sections of the Management's Discussion and Analysis (Part
I, Item 2).
16
<PAGE> 19
Item 6. - Exhibits and Reports on Form 8-K
(a) Exhibits Required by Item 601 of Regulation S-K
The following exhibits required by Item 601 of Regulation S-K are set
forth in the following list and are filed either by incorporation or by
reference from previous filings with the Securities and Exchange
Commission or by attachment to this Form 10-Q.
3.1 Articles of Incorporation of Northstar Health Services, Inc., as filed
in the state of Delaware, filed as an exhibit to the Company's Annual
Report on Form 10-K for fiscal year ended December 31, 1996, is
incorporated by reference.
3.2 Bylaws of Northstar Health Services, Inc., filed as an exhibit to the
Company's 10-Q Quarterly Report dated August 14, 1997, is incorporated
by reference.
4.1 1997 Stock Option Plan, filed as an exhibit to the Company's Annual
Report on Form 10-K for fiscal year ended December 31, 1997, is
incorporated by reference.
4.2 1994 Stock Option Plan for Non-Employee Directors, filed as an exhibit
to the Company's Annual Report on Form 10-K for fiscal year ended
December 31, 1996, is incorporated by reference.
4.3 1992 Stock Option Plan, as amended, filed as an exhibit to the
Company's Annual Report on Form 10-K for fiscal year ended December 31,
1996, is incorporated by reference.
10.1 Employment Agreement dated November 15, 1995, between Northstar Health
Services, Inc. and Thomas W. Zaucha, filed as an exhibit to the
Company's Form 8-K dated November 15, 1995, is incorporated by
reference.
10.2 Employment Agreement dated September 1, 1997, between Northstar Health
Services, Inc. and Lisa S. Guarino, filed as an exhibit to the
Company's 10-Q Quarterly Report dated November 14, 1997, is
incorporated by reference.
10.2 Forbearance Agreement between Northstar Health Services, Inc. and IBJ
Schroder Bank & Trust Co., filed as an exhibit to the Company's Annual
Report on Form 10-K for fiscal year ended December 31, 1997, dated
August 18, 1997, is incorporated by reference.
10.3 Extension Supplement between Northstar Health Services, Inc. and IBJ
Schroder Bank & Trust Co., filed as an exhibit to the Company's Annual
Report on Form 10-K for fiscal year ended December 31, 1997, dated
August 29, 1997, is incorporated by reference.
10.4 Extension Supplement between Northstar Health Services, Inc., Cerberus
Partners, LLP and IBJ Schroder Bank & Trust Co., filed as an exhibit to
the Company's Annual Report on Form 10-K for fiscal year ended December
31, 1997, dated October 1, 1997, is incorporated by reference.
10.5 Extension Supplement between Northstar Health Services, Inc., Cerberus
Partners, LLP and IBJ Schroder Bank & Trust Co., filed as an exhibit to
the Company's Annual Report on Form 10-K for fiscal year ended December
31, 1997, dated November 12, 1997, is incorporated by reference.
10.6 Assignment and Acceptance Agreement between Northstar Health Services,
Inc. and Cerberus Partners, LP, filed as an exhibit to the Company's
Annual Report on Form 10-K for fiscal year ended December 31, 1997,
dated September 8, 1997, is incorporated by reference.
10.7 Advisory Agreement between Northstar Health Services, Inc. and
Commonwealth Associates, filed as an exhibit to the Company's Annual
Report on Form 10-K for fiscal year ended December 31, 1997, dated June
9, 1997, is incorporated by reference.
17
<PAGE> 20
27 Financial Data Schedule
(b) Reports on Form 8-K
None
18
<PAGE> 21
SIGNATURES
In accordance with the requirements 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.
Northstar Health Services, Inc.
(Registrant)
By: /s/ THOMAS W. ZAUCHA
-----------------------
Thomas W. Zaucha
Chairman of the Board, President and Chief Executive Officer
(Principal Executive Officer)
Date: May 8, 1998
By: /s/ LISA S. GUARINO
-----------------------
Lisa S. Guarino, CPA
Executive Vice President and Chief Financial Officer
(Principal Accounting and Financial Officer)
Date: May 8, 1998
19
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