<PAGE> 1
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
(MARK ONE)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the Fiscal Year Ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
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) (Zip Code)
Registrant's telephone number, including area code: (724) 349-7500
Securities registered pursuant to Section 12(g) of the Act: None
Name of each exchange
Title of each class on which registered
------------------- -------------------
Common Stock-Par Value $.01 Per Share *
* Due to circumstances described herein, the Common Stock was delisted on
May 31, 1996 and is currently quoted on the Over the Counter Bulletin Board.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO_____
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates
of the registrant, based on the closing sale price of such stock as of March 25,
1998 is set forth below:
Aggregate Market Value of the Voting
Class of Stock Stock held by Non-Affiliates
-------------- ----------------------------
Common Stock, $.01 par value $5,437,635
The number of shares of Common Stock outstanding at March 25, 1998: 5,975,424
<TABLE>
<S> <C>
PART OF FORM 10-K INTO WHICH THIS DOCUMENT
DOCUMENTS INCORPORATED BY REFERENCE: IS INCORPORATED:
------------------------------------ ----------------
Selected portions of the 1998 Definitive Proxy Part III, Items 10, 11, 12 and 13
Statement are incorporated by reference in this Report.
</TABLE>
- -------------------------------------------------------------------------------
<PAGE> 2
FORWARD LOOKING STATEMENTS
From time to time, the Company will publish forward looking statements
relating to such matters as anticipated financial performance, business
prospects, and projected plans for and results of its operations. The Private
Securities Litigation Reform Act of 1995 provides a safe harbor for forward
looking statements. In order to comply with the terms of the safe harbor, the
Company notes that 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.
ITEM 1. BUSINESS
In addition to other sections of this document, this Business section
contains the type of forward looking statements and projections discussed above
and must be read in connection with those disclosures.
GENERAL
Northstar Health Services, Inc., a Delaware corporation ("Northstar" or
the "Company"), is a regional provider of physical rehabilitation and other
health care services, including diagnostic testing, in Pennsylvania and adjacent
states, providing services at outpatient rehabilitation clinics and patient care
facilities to patients suffering from physical disabilities. The goals of
physical rehabilitation are to improve a patient's physical strength and range
of motion, reduce pain, prevent injury and restore the ability to perform basic
activities, including communication. The Company believes that physical
rehabilitation improves patient outcomes and shortens a patient's recovery time
and, as a result, has gained increasing recognition by payors as both a
clinically effective and a cost effective means to lower total healthcare
expenses.
Formed in 1991, Northstar has traditionally developed through strategic
alliances and acquisitions. With its merger with Keystone Rehabilitation
Systems, Inc. ("Keystone") in November 1995, the Company greatly expanded its
regional presence and shifted focus from contracted long term care services to
the outpatient rehabilitation therapy business. With the subsequent acquisition
of Penn Vascular Lab in December 1995, the Company had broadened the scope of
its services to include mobile testing and diagnostic services.
During 1996 and 1997, Northstar underwent numerous changes in
leadership and philosophy. On February 6, 1997, Thomas W. Zaucha, the current
and then Chairman of the Board of Directors and Chief Executive Officer of the
Company, commenced a solicitation of Northstar shareholder consents to remove
and replace the other members of the Northstar Board of Directors and effectuate
related changes in Northstar's bylaws (the "Consent Solicitation"). Shortly
thereafter, the Board of Directors terminated Mr. Zaucha's employment with the
Company, though he remained a member of the Board of Directors. On March 24,
1997, Mr. Zaucha delivered executed consents representing the votes of 61% of
the outstanding shares in favor of his proposals and, following confirmation of
the decision by the Delaware Chancery Court on May 8, 1997, Mr. Zaucha resumed
his duties as the Company's Chief Executive Officer.
The ruling of the Delaware Chancery Court was appealed to the Delaware
Supreme Court by three of the Board members removed from office as a result of
the Chancery Courts' decision. On August 1, 1997, a unanimous panel of the
Delaware Supreme Court affirmed the decision of the Delaware Chancery Court
confirming the election of the current Board.
1
<PAGE> 3
Subsequent to the reinstatement of Mr. Zaucha as CEO in May of 1997,
current management reorganized the Company's corporate and subsidiary operations
to better position itself to efficiently manage existing and emerging
opportunities in its primary markets. In connection with the reorganization, the
Company defined three operating subsidiaries:
o KEYSTONE REHABILITATION SYSTEMS, INC. ("Keystone") provides
outpatient rehabilitation, primarily to ambulatory patients at
fifty-seven (57) outpatient sites specializing in orthopaedics,
sports and neurologic rehabilitation. Keystone utilizes physical
therapists, occupational therapists and speech therapists to provide
its services. Keystone also contracts with hospitals, nursing homes,
home health agencies, personal care homes and school districts to
provide physical therapy, occupational therapy, speech language
pathology and athletic training services. Keystone is one of the
largest providers of outpatient rehabilitation services in
Pennsylvania.
o KEYSTONE REHABILITATION MANAGEMENT, INC. ("KRM") provides and
manages interdisciplinary therapy services to long term care and
subacute facilities, as well as hospitals, personal care homes and
home health care agencies on a contract basis. KRM has the ability
to supply experienced management personnel, rehabilitation and
related services to nursing homes and hospitals through contractual
arrangements.
o NORTHSTAR MEDICAL SERVICES, INC. ("NMS") is a subsidiary corporation
that was designed to develop and manage physician practices. To
date, the primary focus of this company has been Penn Vascusonics,
P.C., a radiology practice that provides multiple mobile diagnostic
services including mammography, ultrasound and echocardiography to
physicians, nursing homes and industries. Through this professional
corporation, hospital-quality testing is provided onsite in
physician offices and long term care facilities that provide for an
environment that makes the diagnostic experience less stressful and
more convenient for the patient. Mobile services are provided
through a fleet of customized vans equipped for transporting
equipment to physician office locations. The Company also operates
seven (7) freestanding diagnostic centers in Western Pennsylvania.
This division incurred losses in 1997 that have strained the
resources of the Company. In March 1998, the Company announced that
in keeping with its decision to focus its efforts on its core
rehabilitation business, it has decided to withdraw from the mobile
diagnostic industry.
As of December 31, 1997, the Company had fifty-seven (57) outpatient
rehabilitation clinics, seven (7) freestanding diagnostic testing centers and
thirty (30) contractual agreements with patient care facilities. The Company
continues to strive to expand its presence as a provider of physical
rehabilitation and related services in its geographic marketplace in
Pennsylvania, Ohio and West Virginia.
As will be discussed in the Business Strategy section, the Company will
seek to concentrate its efforts on strengthening operations and increasing
profitability in the outpatient therapy and rehabilitation business, its core
business and primary source of revenue. At the Corporate level, the Company has
expanded certain staff functions to enhance the services provided to operating
subsidiaries in the areas of sales and marketing, provider relations,
recruitment and clinical compliance.
OPERATIONS
OUTPATIENT REHABILITATION CLINICS. As of December 31, 1997, The Company
owned and operated fifty-seven (57) outpatient rehabilitation clinics in
Pennsylvania, Ohio and West Virginia. The Company provides a wide range of
outpatient rehabilitation therapy services to patients who suffer from a variety
of physical ailments including muscular pain, loss of function, injury or
impairment. The Company provides services, prescribed by the patient's
physician, through licensed therapists, therapist assistants, aides and related
personnel, while coordinating the establishment and maintenance of patient
records, billings to third-party payors and management and operations of the
clinics. Northstar leases and purchases equipment for the outpatient clinics
and, although the amount and type of equipment for each
2
<PAGE> 4
clinic may vary, such equipment typically includes whirlpools, electric
stimulation and ultrasound units, exercise machines and hot and cold pack units.
The outpatient rehabilitation clinics are dependent upon patient
referrals from various sources within their communities, including
orthopaedists, internists, neurologists, physiatrists, chiropractors, hospital
discharge planners, community organizations and insurance company case managers.
Referrals also come from non-physician sources, including insurance companies,
managed care organizations, lawyers and employers. The Company's ability to
attract managed care and other third-party payor contracts in multiple locations
is aided by its large share of the geographic market, central billing and
collections services and direct marketing efforts to payors.
CONTRACT REHABILITATION. As of December 31, 1997, the Company had
contractual arrangements with thirty (30) patient care entities that the Company
considers to be of a significant nature based on the level of revenue derived
from these contractual agreements. Under these contracts, the patient care
facility generally furnishes the space for the delivery of rehabilitative
therapy treatments, and the Company provides all other necessary services,
including the appropriate rehabilitation therapies, on-site management, staff
recruitment, continuing education, and quality assurance. The Company provides
services that allow patient care facilities to offer advanced multidisciplinary
therapies that may not be available through their own in-house resources.
Northstar is compensated under such contracts on a fee-for-service basis and
typically collects payment for services directly from the patient care facility,
which in turn receives reimbursement from other third-party payors. Generally,
the Company enters into one-year or renewable contracts that typically can be
cancelled upon a notice of between thirty (30) to ninety (90) days.
INDUSTRY BACKGROUND
The outpatient rehabilitation industry continues to experience
significant consolidation, due primarily to the highly fragmented nature of the
industry and the preference of managed care organizations to contract with
regional providers offering comprehensive, cost-effective programs. In recent
years, due to regulatory considerations, convenience and cost saving measures,
there has been a trend away from hospital based rehabilitation and toward
outpatient rehabilitation services provided in modern, accessible clinics and in
long term care and subacute facilities. Because the population age group aged
fifty-five and older is expected to increase dramatically over the next ten to
fifteen years, this demographic shift will affect those most intensively in need
of rehabilitation services.
Within the rehabilitation sector, the focus for growth is likely to be
in the outpatient segment as the trend toward cost containment continues. Under
the managed care environment, outpatient rehabilitation therapy is chosen as an
alternative to inpatient hospital care primarily as a result of the focus on
reducing patient stays and patient visits. Managed care organizations and
third-party payors are seeking to enter into contract relationships with
rehabilitation providers most capable of delivering a full continuum of care at
the lowest cost without sacrificing the quality or effectiveness of patient care
services. As a result, there has been increased demand for more comprehensive
and sophisticated physical rehabilitation services, particularly for services
already provided by the Company such as work reconditioning, aquatic therapy,
functional capacity evaluations and clinically oriented programs specific to
areas such as women's health, wellness/fitness, headache/TMJ and fibromyalgia.
The Company believes that as the rehabilitation industry continues to
consolidate, it will be necessary to react to industry changes in order to
position the Company to stabilize its operations in its geographic marketplace.
Therefore, the Company will limit its entry into contractual agreements in
patient care facilities and in opening new outpatient centers to those contracts
or locations where a high degree of certainty exists for profitability. As the
outpatient industry achieves more growth resulting from, among other things,
earlier patient discharge from hospitals and other patient care facilities, the
Company believes it can sustain controlled growth by focusing on its core
rehabilitation business while forming strategic alliances with other entities or
providers to capitalize on what it believes are the inherent growth factors of
the rehabilitation industry. They are:
3
<PAGE> 5
o THE EFFECTIVENESS OF PHYSICAL THERAPY. Physical therapy is
recognized by physicians and payors as a cost-effective method to
reduce future healthcare expenses, shorten the recuperation time for
injuries, reduce the likelihood of re-injury, and enable patients to
regain skills necessary to return to independent living or the
workplace. Additionally, physical therapy may assist in containing
healthcare expenses by reducing or eliminating the need for ongoing
inpatient healthcare services and other related costs.
o INCREASING EMPHASIS ON PHYSICAL FITNESS AND THE TREATMENT OF SPORTS
INJURIES. The growing emphasis on wellness, physical fitness,
leisure sports, and conditioning, such as running and aerobics, has
led to increased injuries which require physical therapy and
increased awareness for injury prevention.
o DEMOGRAPHIC SHIFT TOWARD AN AGING POPULATION. The aging population
is expected to increase the demand for rehabilitation services. As a
person ages, he or she becomes more susceptible to both neurologic
and orthopaedic-related ailments, including osteoporosis, which may
result in the type of injury or loss of function which can be aided
by a rehabilitation program that focuses on strengthening and
conditioning. Because the aging population chooses to remain active
well into later years, therapy programs can assist individuals to
sustain enjoyable activities and maintain an active lifestyle.
o EARLIER PATIENT DISCHARGE FROM ACUTE CARE HOSPITALS TO ALTERNATE
SITES. The trends toward earlier patient discharge from acute care
hospitals to subacute sites, from patient care facilities to
outpatient care, and from hospital-based care to clinic-based and
home-based treatment programs, have combined to increase the demand
for all forms of rehabilitation services.
The Company believes that the demand for rehabilitation therapy
services will be favorably affected by the continued recognition of
rehabilitation as both a clinically and a cost-effective method of treating
certain types of disabilities. However, the Company also believes that this
market will be characterized by increased cost containment pressures and the
growing influence of managed care organizations, other third-party payors and
state government mandated workers' compensation programs in the selection of
rehabilitation service providers. In addition, federal and state governments and
other entities, such as managed care organizations and workers' compensation
carriers, increasingly are converging to contain healthcare costs by capping, or
in some cases reducing, the reimbursement rates for rehabilitation services.
Consequently, rehabilitation providers, including Northstar, are addressing this
growing legislative and payor pressure by seeking contract relationships and by
providing services which appeal to the demands of payors, such as work injury
reconditioning, education and prevention and other services which promote
quality care at the lowest possible cost.
Overall, Northstar believes that the rehabilitation industry remains
highly fragmented. Changes within the healthcare environment are leading some
rehabilitation providers, including sole practitioners and owners of small
groups of outpatient rehabilitation clinics to sell such clinics and merge with
larger rehabilitation companies or establish networks of outpatient
rehabilitation clinics within a geographic area.
BUSINESS RISK
The Company is currently experiencing a severe financial crisis that
raises doubts about the ability of the Company to continue as a going concern.
The Company's core businesses are not currently producing operating income
before non-recurring items, nor are they producing sufficient cash flow to
service the Company's outstanding debt or permit the Company to pay all of its
expenses incurred as a result of its recent contest for corporate control. While
the Company has been in negotiations with its principal creditors, including the
holder of its senior secured debt, to effectuate a restructuring of its payment
obligations, it has not heretofore been able to reach such an agreement, and
existing defaults on its payment obligations give the holder of its senior debt
the right to accelerate the Company's payment obligations at any time. In
addition, the Company's shares have been delisted from the Nasdaq National
Market, where they were formerly traded, thus decreasing the Company's access to
additional
4
<PAGE> 6
equity capital. The Company is operating currently based upon the voluntary
forbearance of its principal creditors, the continuation of which cannot be
assured. Moreover, the Company's current financial condition will make it more
difficult, if not impossible, for the Company to attract additional financing,
or for the Company to present itself to possible purchasers as an attractive
acquisition candidate. If the Company is unable to effectuate a business
combination with a financially stronger entity or to raise additional capital
and/or effect a permanent restructuring of its debt, the Company could be
required to file a petition for relief under the provisions of the Bankruptcy
Code, or could have an involuntary petition thereunder filed against it.
BUSINESS STRATEGY
The Company's ability to strengthen its presence as a provider of
rehabilitation services is severely limited by its current financial situation
(See Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations). Therefore, the Company's strategy is to concentrate on
internal mechanisms that do not require significant capital resources to
optimize existing operations. Key elements of the Company's business strategy
are summarized below.
o MAINTAIN REGIONAL PRESENCE. The Company provides both inpatient and
outpatient physical therapy and related services and thus seeks to
position itself as the preferred rehabilitation provider for
physicians, hospitals and managed care organizations and other
referral sources.
o EXPAND REFERRAL SOURCES. The Company seeks to expand the referral
base of the outpatient rehabilitation clinic by aggressively
marketing its rehabilitation services to local and regional referral
sources such as primary care physicians, orthopaedic surgeons,
private industry, insurance companies and managed care
organizations. As part of its strategy, the Company has increased
personnel in sales and marketing and is targeting existing and new
markets in order to gain increased referrals.
o MAXIMIZE PAYOR REIMBURSEMENT. The Company intends to focus attention
on its payor mix in order to maximize its levels of reimbursement
under existing contracts and affiliations with managed care
organizations and other payors such as workers compensation
carriers, insurance companies and third party payors.
o EXPAND CONTRACTS WITH MANAGED CARE ORGANIZATIONS. As managed care
organizations become more prevalent in the marketplace, outpatient
rehabilitation service providers will need to deliver a
comprehensive range of services in a cost effective manner with
multiple locations within a metropolitan area or region. The Company
intends to market its services aggressively to these organizations.
o EXPAND CONTRACTS WITH PATIENT CARE FACILITIES. The Company continues
to seek additional contracts with, as well as expand the range of
services it offers to, long term care and subacute facilities, in
addition to hospitals, schools and home health care agencies.
o INCREASE RANGE OF SERVICES. The Company provides a wide range of
services, including physical, occupational and speech therapies, and
intends to increase its more specialized treatments such as hand
therapy, aquatic therapy, sports therapy, women's health programs,
neurological therapy and incontinence therapy.
o RECRUIT AND RETAIN EXPERIENCED THERAPISTS AND KEY PERSONNEL. The
Company will continue to recruit and develop professional therapists
to staff its facilities and contract obligations and offer
competitive compensation and benefits packages.
o INCREASE EFFICIENCY OF OPERATIONS. The Company maintains centralized
accounting, payroll, accounts receivable/payable and other
administrative functions such as billing and collection. Certain
other functions, including sales and marketing, recruitment,
provider
5
<PAGE> 7
relations and clinical compliance have been centralized to contain
costs and maximize efficiency. The Company has also developed, and is
in the process of implementing, systems designed to enhance
productivity by standardizing and automating certain administrative
functions at the outpatient rehabilitation clinic level.
The Company believes that the success of its future business strategy
and profitability will depend upon several key issues. The Company is aware that
given its limited resources, it must focus its efforts on its core
rehabilitation business and avenues necessary to maximize revenues in its
existing outpatient facilities. In 1998, due to continued losses in the mobile
diagnostic division, the Company decided to withdraw from the mobile diagnostic
business and place the assets for sale. This decision will enable management to
focus its attention on improving profitability and operational efficiency in the
core outpatient rehabilitation services business. In conjunction with this
strategy, the Company realizes the need to control costs and expenses and
subsequently has engaged certain cost containment measures in order to reduce
and/or eliminate unessential costs. These measures include a hiring freeze in
both Regional and Corporate administrative office locations; a reduction of
staffing levels, if appropriate, at all locations; a freeze on capital
expenditures; a freeze on additional administrative office space leases; and the
elimination of any costs not necessary to operations. Management believes that
additional expense reduction measures are also necessary in order to achieve
desired levels of profitability.
In addition to cost containment measures, the Company will attempt to
maximize the performance of its core physical therapy and rehabilitation
business. At the Corporate level, an administrative function that encompasses
sales, marketing, recruitment and provider relations, has been created to
conduct an intense marketing and sales campaign that targets the key referral
sources of the Company in order to attract and expand existing business. The
Company expects much of its future success will rely on its ability to maximize
referrals from physicians, industries and managed care organizations.
Because the Company continues to face severe financial difficulties,
described in more detail in the Management's Discussion and Analysis section,
during 1997 and into 1998, management continued to review its existing business
in order to identify and eliminate unprofitable business units. Consequently,
approximately forty-five (45) contracts for subacute care centers and long term
care facilities were eliminated. In addition, several outpatient facilities in
Pennsylvania, and one (1) in West Virginia, which were unprofitable, were also
closed. The Company believes that by the assessment and elimination of
unprofitable business units, it can protect the core rehabilitation business and
improve its cash position. Overall, the Company realizes that a business
strategy aimed toward maximizing revenues and profitability from existing
operations is necessary to achieve financial results that could ultimately lead
to relisting of its Common Stock on a national market or exchange. However, the
Company does not believe that this will happen in the near future.
Further, as part of its strategy, certain employee incentives
involving stock options or deferred compensation are being implemented to
motivate employees to achieve certain levels of performance, which the Company
anticipates will serve to improve revenues and morale. Most employees of the
Company have been awarded the opportunity to participate in the employee stock
option plans and many have the opportunity to obtain further stock options as
the business of the Company improves.
PATIENT CARE SERVICES
The goals of physical rehabilitation are to improve a
patient's physical strength and range of motion, reduce pain, prevent injury and
restore the patient's ability to perform daily activities as functionally as
possible. The Company utilizes licensed therapists and therapist assistants to
provide physical, occupational and speech therapy to patients with
musculoskeletal injuries, physical disabilities associated with neurological
disorders, and post-surgical rehabilitation. The following is a brief
description of rehabilitation services offered by the Company:
o PHYSICAL THERAPY. Physical therapy is the evaluation and treatment
of physical disabilities designed to improve a patient's physical
strength, range of motion and mobility. Treatments
6
<PAGE> 8
include exercise and the application of modalities such as heat,
cold, water, sound and electricity.
o OCCUPATIONAL THERAPY. Occupational therapy is the evaluation and
treatment of physical and cognitive deficiencies with the goal of
improving self-care, work and leisure skills. Candidates for this
treatment include people who have suffered traumatic injuries, have
disease related disabilities, or who have underdeveloped physical
and cognitive skills. Occupational therapists use a variety of
treatment techniques, including using therapeutic exercises and
activities, designing and fabricating adaptive equipment (such as
splints and custom made handles for utensils) and teaching
compensatory techniques to help these individuals achieve their
potential for independent, productive living.
o SPEECH THERAPY. Speech therapy is the evaluation and treatment of
speech, language, voice and swallowing disorders arising from
strokes, head injuries, degenerative neurological disorders,
developmental deficits, cancer and hearing impairment. Speech
therapists use treatment techniques such as thermal stimulation,
muscle re-education and hearing and/or speech aid through visual
communication devices.
o WORK RECONDITIONING. Work reconditioning is a rehabilitation program
that simulates the specific job activities of an injured worker in
order to prepare the worker to return to work and addresses issues
of productivity, safety, physical tolerances and worker behavior.
The goal is to prepare the patient to work a complete workday safely
and without injury. The Company utilizes a standardized industrial
rehabilitation program at all of its sites to improve both patient
and payor acceptance.
o FUNCTIONAL CAPACITY ASSESSMENT. Functional capacity assessment is
the evaluation of an existing or prospective employee's physical
condition and endurance and of the ability to meet the requirements
of employment. Employers, insurers and other payors may use the
assessment to estimate the extent of rehabilitation treatment needed
or as an objective method of evaluating specific work capacity.
o PAIN MANAGEMENT. Pain management programs are used to assist
patients in the use of compensatory motor patterns and other coping
mechanisms to minimize or eliminate the debilitating effects of
acute and chronic pain.
o PREVENTIVE SERVICES. The Company also provides services designed to
prevent or avoid injuries in the workplace. These preventive
services, which may be performed at an employer's work site, include
programs to teach employees proper body mechanics and techniques and
detailed analysis of specific job activities, such as lifting, with
the goal of educating employees to reduce or prevent workplace
injuries.
MERGERS, ACQUISITIONS AND JOINT VENTURES
Keystone Rehabilitation Systems, Inc. (Keystone)
On November 15, 1995, NSK Merger Corp., a newly-formed subsidiary of
the Company, was merged with and into Keystone (a Pennsylvania corporation)
(the"Merger"). See Note 3 to the Financial Statements.
As consideration for the Merger, the shareholders of Keystone, Thomas
W. Zaucha and Alice L. Zaucha and the Zaucha Family Limited Partnership
(collectively, the "Shareholders"), received, in part, an aggregate of 944,352
shares of Common Stock, par value $.01 per share (the "Common Stock"), of the
Company (the "Stock Consideration"). The Company guaranteed the value of the
Stock Consideration to be at least $5,600,000 through certain periods ending no
later than December 31, 1997. Based on the weighted average trading volume of
the daily closing price per share for the ten consecutive trading days
immediately prior to the third business day prior to the determination date of
December 31, 1997, the
7
<PAGE> 9
Company's Common Stock was valued at $0.96 per share. The Company has a
contractual obligation to fund this shortfall in stock value through a cash
payment equal to the shortfall or, with shareholder approval, through the
issuance of additional shares to the Shareholders in an amount equal to the
shortfall. Based on above formula, 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 Company does not currently have sufficient cash to pay this
obligation or a sufficient number of authorized and unissued common shares
available to meet this entire obligation through the issuance of stock. The
issuance of such 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. Further, such shares would be
included in the calculation of diluted earnings per share except for the fact
that such effect would be anti-dilutive because of the Company's net loss.
The Company also agreed to make additional "earn-out" payments to the
Shareholders of $1,600,000 per year in the event that Keystone's "EBITDA"
exceeds $2,500,000 in any year from 1996 to 2000, inclusive. EBITDA is defined,
generally, to mean Keystone's earnings (including earnings from any internally
generated facility or contract but excluding earnings from any facility or
contract acquired from third parties) before taxes, interest, depreciation and
amortization. In the event an earn-out is not earned and therefore not paid in
any given year, the earn-out will be paid in the next year if EBITDA in such
next year exceeds the greater of $3,200,000 or $2,500,000 plus the amount of the
EBITDA shortfall in such prior year. The Shareholders are to receive an earn-out
of approximately $200,000 for 1995. The calculation for the earn-out amounts for
years 1996 through 2000 includes a reduction in the amount due in the event that
the current liabilities of Keystone at the date of the Merger (other than
permitted capital leases) exceeded $2,000,000. In addition, such earn-out
payments are to be reduced by 50% of such current liabilities up to $2,000,000.
Former management of the Company believed that, based on the results of
operations for 1996 as well as that management's interpretation of the
above-outlined adjustments, the 1996 earn-out computation resulted in no amounts
due to the Shareholders. The current Board of Directors appointed a Special
Committee to review these calculations and the issues in dispute. If the final
earn-out received or paid differs from that calculated by former management, the
change would affect goodwill. The earn-out payments for all years will
accelerate and become due within 90 days after any change in ownership or
control of the Company or a sale of the majority of the assets of the business.
Any additional compensation due to a change in stock price would be additional
purchase price allocated to goodwill. The Company has determined that, based on
the results of operations for 1997, there are no amounts due to the Shareholders
for the 1997 earn-out. As discussed above, if the EBITDA for 1998 exceeds the
greater of $3,200,000 or $2,500,000 plus the amount of the EBITDA shortfall for
1997, the 1997 earn-out will be paid along with the 1998 earn-out.
Penn Vascular Lab, P.C. (PVL)
On November 28, 1995, the Company acquired from PVL (a Pennsylvania
professional corporation) certain assets and the stock of Vascusonics, Inc. (a
Pennsylvania corporation or Vascusonics). See Note 3 to the Financial
Statements. The agreement provided for a management services contract whereby
the Company would provide such services to PVL for a period of two years in
exchange for a fee equal to the excess of collected revenue over the sum of
$75,000 and PVL's business expenses. Although the management services contract
expired on November 28, 1997, it was renewable annually at the mutual agreement
of both parties. The purchase agreement also provided the Company with the
option to purchase the stock of PVL for one dollar under certain circumstances,
during the period one year after the management services contract is terminated.
See Note 21 to the Financial Statements.
The contingent payments, as revised by mutual agreement in January
1997, to the Seller are based upon the Net Collected Revenues, as defined, for
the years ending December 31, 1997 and 1998. If during either of the two years
ending December 31, 1998, the Net Collected Revenues of the businesses acquired
exceeded $3,200,000, then a payment of $37,500 is to be made to the Seller. If
the Collected Revenues were in excess of $3,400,000 and $3,600,000, in each year
then the payment to the physician would be $137,500 and $237,500, respectively.
The Company has determined that under the terms of this calculation, there is no
contingent payment due for the year ending December 31, 1997.
8
<PAGE> 10
In January 1997, the Company reached a settlement agreement with the
Seller of PVL regarding several disputes. In the terms of this agreement, the
Company reduced certain future payments due to the Seller from $100,000 to
$50,000, acquired ownership rights to disputed equipment, and reduced contingent
payment amounts.
Under the purchase agreement, Ultrasonics, Inc. (Ultrasonics) took
ownership of PVL's and Vascusonics' accounts receivable on the date of purchase
just prior to the consummation of the purchase agreement. Also, Ultrasonics
assumed certain leases for equipment used by the Company and entered into new
lease terms with the Company. Ultrasonics is a related party which is owned and
operated by Jeff Bergman. The Company believed that the lease arrangements with
Ultrasonics were for lease rates which were greatly in excess of market rates.
At the date of the merger, Ultrasonics paid off leases which represented a net
liability to PVL of $155,000. However, the lease arrangement with Ultrasonics
obligated the Company to principal payments totaling $1,333,000 over the term of
the leases. The Company treated the excessive lease payments of $1,178,000 as a
disproportionate dividend, and ceased making payments to Ultrasonics in March
1996. In March 1997, Ultrasonics filed suit against the Company as a result of
these disputed lease agreements. In March 1998, the Company reached a settlement
with Jeff Bergman and Ultrasonics over these matters. See Note 21 to the
Financial Statements.
MARKETING OF FACILITIES AND SERVICES
As of December 31, 1997, the Company had a sales and marketing staff of
fifteen (15) responsible for expanding its patient base in outpatient
rehabilitation clinics, subacute and long term care facilities through referrals
by physicians, industries and health maintenance organizations and increasing
the number of contracts with patient care facilities served by the Company
through sales visits, direct and database marketing, advertising and public
relations.
The Company continues to expand its sales and marketing activities at
the local outpatient rehabilitation clinic and at the regional and corporate
levels, targeting hospitals, physicians, industries, insurance companies,
managed care organizations and workers' compensation carriers. The Company
believes that due to increased competition, an emphasis on increased marketing
initiatives are vital to further penetrate target markets, expand into new
territories and increase patient flow.
At the local outpatient rehabilitation clinic level, the facility
directors for each clinic are expected to maintain relationships with existing
referral sources and to establish relationships with new referral sources,
typically physicians, in that clinic's geographic area. Therapists interact with
referral sources on a regular basis in order to maintain personal relationships
and respond to their service needs. The Company believes that being responsive
to the needs of the referral sources will enhance the Company's prospects of
obtaining additional referrals from such sources.
At the regional level (which are groups of related offices and
services), the Company has recognized the value of sales personnel in marketing
to larger regional referral sources (multi-physician practices, industries and
hospital-owned physicians) that may be in a position to refer groups of patients
to the Company's facilities. Sales personnel can arrange for onsite meetings
between facility directors and referral sources and also meet with case
managers, employers and local community groups. Their marketing efforts are
responsible for developing and expanding business relationships with all
referral sources such as insurance companies, managed care organizations, and
industries as well as the physicians targeted by the clinical personnel.
At the corporate level, the Company concentrates on establishing
contracts with multi-regional managed care organizations, insurance companies,
employers and long term care facilities. When appropriate, the Company may
consider service provider alliances in which two or more large rehabilitation
organizations enter into an arrangement such that, collectively, these two
organizations are
9
<PAGE> 11
able to secure a contract with a large referral source. Corporate marketing
programs are effective in establishing links with larger employers and third
party payors.
The Company is aware of the growing importance of managed care
organizations in controlling patient referrals and their demand for high
quality, cost effective care from service providers with a regional presence.
Accordingly, both its corporate and regional sales personnel devote substantial
efforts to building relationships with these organizations. The Company has been
able to secure contracts and establish relationships with such organizations in
the past and believes that its sales and marketing efforts will allow it to
acquire additional contracts from, and establish additional relationships with,
managed care organizations and other referral sources in the future.
COMPETITION
The rehabilitation industry is highly competitive and subject to
continual changes in the manner in which services are delivered and in which
providers are selected. The Company believes the most significant competitive
factors in the rehabilitation market are quality patient care, comprehensive
scope of services offered, treatment, alignment with physicians, outcome
measures, convenience of rehabilitation locations to patients, regional
dominance and the ability to develop and maintain relationships with referral
sources such as physicians, insurance companies, industries, managed care
organizations, lawyers and employers. The Company competes with many national,
local and regional providers of similar rehabilitation and related services,
including the outpatient rehabilitation operations of acute care hospitals,
managed care organizations and other long term care rehabilitation therapy
providers. Many of the Company's competitors have equal or longer histories of
operations and longer term relationships with therapists and referral sources
than the Company and possess greater financial, marketing, human and other
resources than the Company.
The Company also competes with other healthcare companies in acquiring
rehabilitation providers. Several larger national companies with substantially
greater financial resources than the Company have been actively acquiring
rehabilitation providers. Certain of these companies, because of the size of
their stockholders' equity, may not be affected by present or future laws
limiting or prohibiting referrals by stockholders who may be referral sources.
Continued competition in this area may increase the valuation of rehabilitation
providers and limit the Company's ability to make future acquisitions.
The Company also competes for the services of therapists with
hospitals, nursing homes, and other outpatient rehabilitation providers and
physicians' offices. Although the Company has not experienced significant
difficulties in attracting and retaining qualified therapists, it is generally
recognized that the demand for qualified therapists exceeds the supply. This
supply shortage is beginning to abate, and expectations are that in future years
there will be increasing numbers of available therapists. However, there can be
no assurance that the Company will continue to be able to attract or retain
sufficient therapists to meet its needs.
GOVERNMENTAL REGULATION
General. The provision of physical therapy services and reimbursement
for such services is subject to a number of federal, state and local laws,
regulations and rules, some of which are very complex. The various levels of
regulatory activity affect the Company's business activities by controlling its
growth, requiring licensure or certification of its facilities and controlling
the reimbursement to the Company for services provided.
In the majority of states, outpatient rehabilitation facilities do not
require review or approval by state regulators. States with Certificate of Need
(CON) regulations place certain limits on the expansion and acquisition of
healthcare facilities. Therefore, acquisitions or expansion of existing
facilities in these states may require review by state regulators. Presently,
Pennsylvania (in which the majority of the Company's facilities are located)
does not have a CON requirement. Licensure and certification are both regulatory
activities mandated by either state or local agencies or a federal agency.
Compliance with the regulatory requirements is monitored by on-site inspections
by various representatives of governmental
10
<PAGE> 12
agencies. Although the Company believes that it is currently in compliance with
applicable laws, regulations and rules, some of such laws, regulations and rules
are broadly written and subject to little or no interpretation by courts or
administrative authorities. Hence, there can be no assurance that a third-party
or governmental agency will not contend that certain aspects of the Company's
operations or procedures are not in compliance with such laws, regulations or
rules or that state agencies or courts would interpret such laws, regulations
and rules in the Company's favor. The sanctions for failure to comply with such
laws, regulations or rules could be denial of the right to conduct business,
significant fines and/or criminal penalties. Additionally, an increase in the
complexity or substantive requirements of such laws, regulations or rules could
have a material adverse effect on the business, financial condition and results
of operations of the Company.
Fraud and Abuse Laws. The Social Security Act and certain provisions of
state law provide civil and criminal penalties for persons who knowingly and
willfully solicit, pay, offer or receive any remuneration, directly or
indirectly, as an inducement to make a referral of a patient for services or
items for which payment may be made under the Medicare programs. Often termed
"fraud and abuse" or "anti-kickback" laws, the provisions have been broadly
interpreted by the courts.
The Officer of Inspector General of the Department of Health and Human
Services ("HHS") has issued regulations specifying certain business arrangements
and payment practices involving providers or other entities, such as the
Company, which will not be considered prohibited activities. Commonly termed
"safe harbor regulations," the regulations set forth certain standards which, if
satisfied, will ensure that the arrangement will not be subject to criminal
prosecution or civil sanctions under the fraud and abuse laws. Failure to
satisfy the safe harbors in and of itself does not render an arrangement
illegal. However, there can be no assurance that enforcement agencies or courts
would determine that the Company is in compliance with the safe harbor
regulations applicable to its current operations.
During 1997, the Company took measures to safeguard its compliance with
governmental rules and regulations by employing a clinical compliance
coordinator at the corporate level who maintains responsibility for identifying,
creating and effecting the appropriate policies with respect to compliance with
the laws.
One principal focus of the fraud and abuse laws has been on
arrangements in which profit distributions are made by a partnership or other
business venture for health-related items or services to persons making
referrals to the venture. Where such arrangements exist, a question is raised as
to whether the profit distributions are illegal payments in exchange for
referrals. Certain safe harbors set forth criteria which, if met, will ensure
that investors in business ventures for health-related items or services will
not be subject to scrutiny under the fraud and abuse laws.
One safe harbor protects profit distributions to investors made by
publicly traded companies with tangible assets of more than $50 million. At
present, the Company does not satisfy the asset threshold for protection under
this safe harbor. Another safe harbor covers investment interests in small
entities. The criteria that must be satisfied for protection under this safe
harbor include, among other things, requirements that no more than 40% of the
investment interests of each class of investment interests in the entity may be
held by persons, or so-called "tainted investors," who are in a position to make
or influence referrals (including hospitals and physicians), furnish items or
services to the entity or otherwise generate business for the entity, and that
no more than 40% of the entity's gross revenues may come from referrals, items,
or services furnished, or business otherwise generated by "tainted investors."
Unless a large percentage of the Company's Common Stock is held by "tainted
investors," investments in the Company should fall within the safe harbor for
investment interests. None of the Company's physical therapy activities are
carried out through partnerships or other investment vehicles which are owned in
whole or in part by hospitals, physicians, or other third parties which make
referrals to, arrange for services by, or recommend the services of such joint
ventures.
The laws involving fraud and abuse and the safe harbor regulations are
currently in a rapid state of development, and it is difficult to provide a
clear analysis of the risks in this area. There can be no
11
<PAGE> 13
assurance that enforcement agencies or courts will determine that any existing
arrangements comply with all applicable laws and regulations.
Stark II. The Omnibus Budget Reconciliation Act of 1993 enacted new
federal anti-referral legislation, more commonly known as "Stark II." Effective
January 1, 1995, Stark II bans referrals by physicians of Medicare patients to
entities for certain designated health services, including physical therapy
services, if a physician or immediate family member has a financial relationship
with the entity providing the service which does not meet any of the exceptions
set forth in Stark II. A financial relationship is generally defined as an
ownership or investment interest in or compensation arrangement with the entity,
subject to certain exceptions. One exception relates to ownership of investment
securities in publicly traded companies that had, at the end of its most recent
fiscal year, or on average during the previous three fiscal years, stockholder
equity exceeding $75 million. At present, the Company does not satisfy the asset
threshold and physicians may not make referrals of Medicare patients to the
Company where the physician or his or her immediate family member holds an
ownership or investment in the Company. Penalties for prohibited referrals
include nonpayment for services rendered pursuant to a prohibited referral,
civil money penalties, and fines and possible exclusion from the Medicare
programs. The Company believes it is currently in compliance with the
requirements of Stark II. However, there can be no assurance that enforcement
agencies or courts will determine that existing arrangements comply with all
applicable laws and regulations.
The Practice of Physical Therapy. The laws and regulations of certain
states restrict the practice of medicine by corporate entities unless such
corporations are professional corporations, with all shareholders being members
of the profession. The continued viability of such restrictions varies among the
states. In many states the applicability of the restrictions has been
significantly reduced. In Pennsylvania, the state in which the majority of the
Company's operations are located, numerous exceptions have substantially eroded
the doctrine. Although the issue is not free from doubt, management does not
believe the doctrine would be applied to the Company's Pennsylvania operations.
The remainder of the Company's operations are in Ohio and West Virginia. Neither
state restricts the corporate practice of physical therapy. If such restrictions
were imposed on the Company, management believes that it could restructure its
operations so as to be in compliance. However, such restructuring could
materially adversely affect the Company and there can be no assurance that a
satisfactory restructuring, under such circumstances, could be accomplished.
Other Legislative and Regulatory Actions. The Pennsylvania legislature
has enacted automobile insurance reforms which became effective in 1991 and
which limit payments to providers for non-emergency services rendered to
patients who suffer injuries as a result of automobile accidents. The
Pennsylvania Legislature also enacted workers' compensation legislation
effective September 1, 1993 which limits payments to providers for services
rendered to patients with work-related injuries. The Pennsylvania Workers'
Compensation Act, among other things, altered the methodology for payment of
healthcare services to persons covered by workers' compensation, limiting
healthcare providers to payment of no greater than 113% of the applicable
governmentally imposed standard fees for medical services as determined
principally under the Medicare program. If such services do not fall under the
Medicare fee structure, the Pennsylvania Department of Labor and Industry
establishes rates, which may not be more than 80% of the prevailing rate for
such services in the area. The law also requires employees to obtain treatment
from designated providers for a specified period of time and contains
restrictions concerning patient referrals, similar to those established in the
Medicare fraud and abuse and Stark II laws, which are designed to prevent fraud
and abuse in the delivery of services to patients covered by workers'
compensation insurance.
REIMBURSEMENT
The healthcare industry is generally experiencing a trend toward cost
containment as private and governmental payors seek to respond to rapidly
escalating healthcare costs. One means of cost containment has been to limit
reimbursement rates by capping or lowering fees or restricting the number of
treatments which will be reimbursed for any given condition. Pennsylvania, as
well as the other states into which the Company anticipates expanding, have fee
schedules which limit the reimbursement rates
12
<PAGE> 14
under workers' compensation programs. Another cost reduction methodology is
increased utilization management by third-party payors through the use of
physician "gatekeepers" and other pre-certification mechanisms to control
utilization of services. The Company expects that legislation and payors' fee
schedules and payment methodologies will continue to limit the reimbursement of
fees for various services and control access to various services, including
rehabilitation services, which may have a material adverse effect on the
business, financial position and results of operations of the Company.
An increasing number of the Company's third-party payors are adopting
prospective payment systems. The Company has signed provider contracts with
managed care organizations, which emphasize utilization control and cost
containment, and the Company's business with these managed care organizations is
expected to increase significantly in the next few years. Managed care
organizations either directly transfer risk to healthcare providers though
capitation payment arrangements or pay for units of service on a steeply
discounted basis. These factors cause significant challenges to all providers,
including the Company.
As a consequence, there can be no assurance that reimbursement for the
Company's services will remain at current levels. The reduction or limitation of
reimbursement levels for the Company's rehabilitation services could have a
material adverse effect on the business, financial condition, and results of
operations of the Company. In addition, such payors are expected to continue to
develop programs designed to control or reduce the cost of healthcare services,
which may have a material adverse effect on the business, financial condition
and results of operations of the Company.
Since January 1, 1996, all direct bill Medicare is being handled
through one of seven certified rehabilitation agencies throughout Pennsylvania,
West Virginia and Ohio. Any clinics providing Medicare services throughout the
Company have been certified as extension sites of one of these agencies. In
addition, patient care facilities that contract with the Company for
rehabilitation therapy services and which bill Medicare directly for
reimbursement of such services also must be certified. The Company believes that
all of its facilities are in compliance with such certification requirements;
however, the loss of the Company's Medicare certification, or the Medicare
certification of a significant number of the patient care facilities with which
the Company contracts could materially adversely affect the Company's ability to
obtain Medicare reimbursement for services.
Rehabilitation services provided in the Company's outpatient
rehabilitation clinics are reimbursed primarily from third-party payors, which
typically take longer to reimburse the Company than Medicare. Reimbursement from
third-party payors is dependent in large part on the Company's timely and
correct submission of claims in accordance with the varying requirements of
different payors. In addition, any future expansion beyond Pennsylvania might
require the Company to seek payment from a larger number of payors, which could
result in longer collection cycles and increased costs of collection.
Most third-party payors, including Highmark Blue Cross/Blue Shield,
compensate the insured or a service provider, such as the Company, for physical,
occupational and speech therapy at fee levels that are determined to be
"reasonable and customary" for such services within a geographic area. The
determination of what is "reasonable and customary" is based on "objective
industry data." Reimbursement based on this criteria may be substantially less
than rates the Company customarily charges and may not cover all of the
Company's costs and expenses. As a result, the Company often will seek the
balance of such claims, if any, as well as the portion of the claims not covered
by third-party payors, directly from the patient. However, certain third-party
payor agreements may prohibit the Company from billing a patient for any amount
by which the Company's fees exceed those allowed by the payor. Therefore,
attempting to collect fees from patients may be uneconomical in light of the
associated costs, or may be prohibited by governmental regulations or
contractual arrangements with third-party payors, and may be unsuccessful.
Additionally, third-party payors could adopt more restrictive reimbursement
schedules, which may affect the Company's profitability.
13
<PAGE> 15
EMPLOYEES
As of December 31, 1997, the Company had 571 employees of whom three
(3) were executive officers of the Company; 245 were licensed therapists or
therapist assistants; and fifteen (15) were involved in marketing and business
development. The Company also has contracts with certain independent physical,
occupational and speech therapists that are utilized by the Company on an as
needed or minimum number of hours per week basis.
None of the Company's employees is represented by a labor union and the
Company is not aware of any activities seeking such organization. The Company
considers it relationships with its employees to be satisfactory.
The Company's business is dependent on its ability to attract and
retain qualified therapists and therapist assistants. The Company employs a
variety of recruiting techniques, including employee referral, personal phone
contact and follow-up, advertising, convention attendance, direct mailing, loan
programs and on-site college recruiting. The Company also maintains
relationships with six local physical therapy colleges and two physical therapy
assistant schools. The ability of the Company to attract and retain qualified
physical, occupational and speech therapists and therapist assistants is crucial
to the Company's operations, and competition for therapists is intense.
Therapists are in short supply and may be attracted to hospitals and other
facilities that may provide predictable locations and work schedules in contrast
to the nature of the Company's services at patient care facilities, which
provide less predictable work schedules and changing locations. Although there
can be no assurance, the Company believes that it is able to compete effectively
for therapists due to its local Pennsylvania presence near several certified
rehabilitation schools, provision for reimbursement for continuing education,
quality reputation and attractive compensation and benefits package. In
addition, the Company believes that its management philosophy appeals to many
therapists because it encourages therapists to manage the operations of their
respective patient care facilities or outpatient rehabilitation clinics on a
semi-autonomous basis, including scheduling, treatment approaches, facility
financial performance, marketing and staff retention. The Company also provides
therapists with career advancement opportunities beyond the individual facility
level. To date, the Company has been able to attract a sufficient number of
physical, occupational and speech therapists, either as employees or as
independent contractors; and although the supply shortage may diminish in future
years, there can be no assurance that this trend will continue. The Company
believes its future success will depend in part on its continued ability to
attract and retain highly skilled employees. If the Company is unable to attract
and retain a sufficient number of qualified therapists to staff all of its
facilities, the Company could be materially adversely affected. The Company
believes its annual turnover rate among therapists compares favorably with that
of its competitors.
In most states, physical, occupational and speech therapists, therapist
assistants, certified occupational therapist assistants ("COTAs") and licensed
technicians must be state licensed clinicians with clinically specific
associate, baccalaureate or masters degrees. All therapists must pass a national
licensure exam administered by the states. A certified physical therapy
assistant provides therapy under the supervision of a physical therapist. In
order to be licensed, physical therapy assistants must have an associate degree
from an approved physical therapy assistant program. In addition, Pennsylvania
requires physical therapy assistants to successfully complete a statewide
written and practical examination. COTAs provide therapy under the supervision
of an occupational therapist. In order to be certified, COTAs must also have an
associate degree and have successfully completed a national certification
examination. Therapists with the Company undergo an initial orientation program
to familiarize themselves with the Company's policies and procedures.
LIABILITY INSURANCE
For the year 1997, the Company maintained professional malpractice
liability insurance up to $5,000,000 per incident and up to $5,000,000 in the
aggregate on all of its professional employees, in addition to coverage for the
customary risks inherent in the operation of healthcare facilities and
businesses in general. In February 1998, the aggregate limit was increased to
$7,000,000. The cost of liability insurance coverage and the availability of
such coverage have varied in recent years with a trend toward higher cost. In an
effort to control the cost associated with such coverage, the Company has
shifted from an occurrence based policy to a claims made policy. While the
Company believes its
14
<PAGE> 16
insurance policies to be adequate in amount and coverage for its current
operations, there can be no assurance that its coverage will, in fact, be or
continue to be available in sufficient amounts and on reasonable terms, or at
all.
ITEM 2. PROPERTIES
As of December 31, 1997, The Company leased approximately 13,000 square
feet as corporate office space at 665 Philadelphia Street, Indiana,
Pennsylvania, 15701, under lease agreements extending through November 15, 2005.
The Company also operated three (3) regional management offices and fifty-seven
(57) outpatient rehabilitation clinics in Pennsylvania, Ohio and West Virginia.
A typical outpatient rehabilitation clinic encompasses 2,000-3,000 square feet
of space and it is leased for an average term of five (5) years. Monthly rental
payments range from approximately $300 to $15,000 per month, depending on the
location, size, and utilities and services provided. Management continually
reviews the size and adequacy of the leased properties and adjustments are made
as office space needs change. Northstar also leased seven (7) fixed diagnostic
sites and one (1) diagnostic management office in Pennsylvania. In addition,
Northstar provided mobile diagnostic services in more than thirty-five (35)
physician offices, which space the Company rents on an hourly basis.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of business, the Company may be subject to
claims and legal actions, from time to time, by patients and others. The Company
does not believe that any such pending actions, if adversely decided, would have
a material adverse effect on its financial condition. (See Item 1, Business
Liability Insurance)
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) and
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.
In response to Northstar's suit against Mark A. DeSimone and the other
defendants, Coregis Insurance Company, a professional liability insurer which
insured DeSimone's former law firm, brought an action in federal court (Coregis
Insurance Co. v. Ogg, Jones Cordes & Ignelzi, C.A. No. 96-2243 W.D. Pa.),
seeking a declaratory judgement that Northstar's claims were not covered by the
defendant's professional liability policy. Although the action named Northstar,
its primary purpose was to determine the obligations of the insurance company.
The main defendant was the law firm which Northstar had sued
15
<PAGE> 17
and which claimed coverage under the professional liability policy in question.
The case was settled as part of the settlement of the Butler action by means of
a $250,000 payment into the Butler settlement fund by the defendant law firm's
professional liability insurer.
In May 1996, a group of approximately 40 Northstar shareholders filed
suit in the state court in California, (Bosco v. Northstar, C.A. No. BC 149867,
Superior Court of California for Los Angeles County), which alleged violations
of various California securities laws and related common law claims. Northstar
and its former Chief Executive Officer, Mark A. DeSimone, and Northstar's former
Chief Financial Officer, Michael J. Kulmoski, Jr. along with the Company's
former auditor, Richard A. Eisner & Co., LLP were named as defendants. This
action was described in the Company's Form 10-K filing for the fiscal year ended
December 31, 1996. In summary, these claims arose out of the false and
misleading statements concerning Northstar and its financial condition which
were disseminated by the individual defendants. In November 1997, the lawsuit
was settled in connection with settlement of the Butler action described above
for the sum of $500,000, which was paid out of the settlement fund created in
the Butler action in December 1997.
In July 1996, Michael Kulmoski, Jr., Northstar's former Chief Financial
Officer and a named defendant in both the shareholder class actions and the
individual action 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. The panel
has scheduled a hearing on the issue of damages for May 1, 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 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.
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.
In February 1997, Thomas W. Zaucha, the current Chairman of the Board
of Directors and Chief Executive Officer of Northstar, commenced a solicitation
of Northstar stockholder consents to remove and replace the other members of the
Northstar Board of Directors which at the time consisted of Messrs. Brody,
Jarrett, Pesci, Smallacombe and Watson (the "Brody Board") and effectuate
related changes in Northstar's bylaws (the "Consent Solicitation"). Shortly
thereafter, the Board of Directors terminated Mr. Zaucha's employment with the
Company, though he remained a member of the Board of Directors. On March 24,
1997, Mr. Zaucha delivered executed consents representing the votes of 61% of
the outstanding shares in favor of his proposals and, following confirmation of
the decision of the Delaware Chancery Court on May 8, 1997, Mr. Zaucha resumed
his duties as the Company's Chief Executive
16
<PAGE> 18
Officer. The ruling of the Delaware Chancery Court was appealed to the Delaware
Supreme Court by three of the Board members removed from office as a result of
the Chancery Courts' decision. On August 1, 1997, a unanimous panel of the
Delaware Supreme Court affirmed the decision of the Delaware Chancery Court
confirming the election of the current Board. The proxy solicitation is
described in greater detail in the Company's report on Form 8-K, dated May 8,
1997.
In January 1997, the Company and Samuel Armfield III, M.D., the seller
in the PVL transaction, reached a settlement in regard to the various claims
that each had against the other, resulting from the acquisition by the Company
of the stock of Vascusonics, Inc. and certain of the assets of Penn Vascular
Labs, P.C.
In January 1997, the Justice Department initiated an action against
Samuel Armfield, III, M.D. for claims amounting to $300,000 in connection with
Dr. Armfield's Medicare billings. Although such claims could be trebled if Dr.
Armfield is convicted, the Company believes that its exposure, through its
dealings with Vascusonics, would aggregate $50,000 to $100,000. In addition, the
Company has recourse against Dr. Armfield for any amounts assessed against the
Company, which the Company plans to aggressively pursue, if necessary.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS
On May 31, 1996, NASDAQ suspended trading in the Company's Common
Stock. Prior to its suspension the Company's Common Stock was traded on the
NASDAQ National Market under the symbol "NSTR". Since the suspension, the
Company's Common Stock is quoted on the Over The Counter Bulletin Board
("OTCBB") under the symbol NSTR. On March 4, 1998 the high and low sales prices
for the Common Stock of the Company as reported by OTCBB were $1.125 and $1.031.
Pursuant to current disclosure guidelines, the following table sets forth the
high and low sales prices for the Common Stock of the Company during the
calendar periods indicated, through December 31, 1997, as reported by NASDAQ and
the OTCBB.
CALENDAR YEAR AND QUARTER HIGH LOW
- ------------------------- ---- ---
1994 First Quarter 10.375 7.875
Second Quarter 9.125 6.750
Third Quarter 8.250 6.250
Fourth Quarter 7.500 4.750
1995 First Quarter 8.500 6.500
Second Quarter 7.625 5.750
Third Quarter 9.625 7.000
Fourth Quarter 7.625 5.375
1996 First Quarter 6.125 2.625
Second Quarter 5.500 1.250
Third Quarter 3.125 1.250
Fourth Quarter 2.000 0.750
1997 First Quarter 3.500 1.187
Second Quarter 3.000 1.500
Third Quarter 3.250 1.625
Fourth Quarter 2.500 0.750
17
<PAGE> 19
As of December 31, 1997, the Company had approximately 1,700 holders of
record, including those who hold in street name, for its Common Stock.
The Company has not paid nor does it expect to pay in the future cash
dividends on its Common Stock.
The Company's Registrar and Transfer Agent for its Common Stock is
Continental Stock Transfer and Trust Company, New York, New York.
ITEM 6. SELECTED FINANCIAL DATA
The information set forth below is provided only for the three years
ended December 31, 1997, 1996 and 1995 because the Company and its independent
public accountants cannot provide such information for any prior years due to
the resignation of its previous auditors.
The following summarizes the activity for fiscal years 1997, 1996 and
1995 (dollars in thousands, except share data):
<TABLE>
<CAPTION>
As of December 31,
--------------------------------------------------------------
BALANCE SHEET DATA: 1997 1996 1995
-------------- -------------- ---------------
<S> <C> <C> <C>
Current Assets $ 7,296 $ 9,446 $ 14,603
Intangible Assets, net 19,221 21,132 23,947
Total Assets 29,514 34,542 43,355
Current Liabilities 29,129 26,265 26,584
Long Term Debt 2,039 4,901 6,288
Total Liabilities 31,313 31,350 32,988
Total Stockholders' Equity (1,799) 3,192 10,367
Twelve Months Ended December 31,
-----------------------------------------------------------------
INCOME STATEMENT DATA 1997 1996 1995
-------------- -------------- ---------------
Net Revenue $ 32,606 $ 37,872 $ 15,771
Gross Profit 16,193 19,083 5,131
Operating Loss (3,941) (5,956) (11,962)
Non-Operating Expenses 2,279 2,226 1,041
Extraordinary Loss - - (274)
Net Loss (5,613) (8,947) (13,101)
Net Loss per Share (Basic
and Diluted) (0.95) (1.44) (3.28)
Weighted Average Number of
Common Shares 5,880,501 6,216,840 3,996,147
Cash Dividends Per Common
Share - - -
</TABLE>
Certain reclassifications have been made to prior year financial statements to
conform with the current year presentation
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
From time to time, the Company will publish forward looking statements
relating to such matters as anticipated financial performance, business
prospects, and projected plans for and results of its operations. The Private
Securities Litigation Reform Act of 1995 provides a safe harbor for forward
looking statements. In order to comply with the terms of the safe harbor, the
Company notes that 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
18
<PAGE> 20
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.
OVERVIEW
The information presented in this Management's Discussion and Analysis is of a
summary nature; please refer to the Financial Statements, including notes, which
are included in this report.
RESULTS OF OPERATIONS
1997 COMPARED TO 1996
Total Revenue
In 1997, the Company's total revenues declined by $5,266,000, or 13.9%,
from $37,872,000 for 1996 to $32,606,000 for 1997. Approximately $2,115,000 of
the decrease was the result of an agreement reached with the former owner of the
Company's subsidiary, NW Rehabilitation Services, Inc., ("NWR") who severed her
relationship with the Company in 1996, and retained the rights to certain of
NWR's contract businesses. The Company also experienced the closure or
termination of certain clinics and contracts that resulted in a decline in net
patient service revenues of approximately $1,858,000. A decline in management
fee revenues of approximately $1,128,000 is attributable to a change in the
reimbursement of certain diagnostic services and the termination of services in
unprofitable areas. The Company entered the sub-acute care business in Illinois
in late 1996. These sub-acute revenues contributed approximately $370,000 in the
1997, compared to $93,000 in 1996. The Company terminated the separate sub-acute
care division of the Company in Illinois in July 1997 due to its poor operating
performance. The Company also opened new outpatient offices and entered into new
contracts that resulted in an increase in net patient service revenues of
$231,000. The remaining decrease in net patient service revenues of $673,000 is
a result of a decline in net reimbursement in continuing operations for the
period as a result of increased managed care penetration in the central and
western Pennsylvania marketplace.
Costs of Service and Gross Profit
Due to the decrease in total revenues, the size of the Company's
workforce also decreased, which contributed to a total decrease in the Company's
costs of service of $2,376,000 from $18,789,000 for 1996 to $16,413,000 for
1997, or 12.6%. As a percentage of net patient service revenue, costs of service
decreased slightly during the year, from 53.6% in 1996 to 53.1% in 1997. As a
result of the decline in total revenue, gross profit declined from $19,083,000
for 1996 to $16,193,000 for 1997. As a percentage of total revenue, gross profit
declined slightly, from 50.4% of revenue for 1996 compared to 49.7% in 1997.
Selling, General and Administrative (SG&A) Expense
Total SG&A expenses for the year declined $1,580,000 from $12,892,000
in 1996 to $11,312,000 in 1997. The 12.3% decrease can be attributed to
increased efficiency and consolidation of the Indiana, PA and Pittsburgh, PA
corporate office functions, a reduction of expenses arising from the NWR
severance agreement, and a reduction of corporate office salary and consulting
expenses resulting from personnel changes made in connection with the
reinstatement of current management as a result of the Consent Solicitation. The
Company is committed to continuing reductions in overhead expenses wherever
possible by continually evaluating all administrative expenses for necessity and
value.
19
<PAGE> 21
Bad Debt Expense
The Company incurred bad debt expense of $2,024,000 or approximately
6.5% of net patient service revenue during the 1997 versus $1,820,000 or
approximately 5.2% for 1996. This increase is the result of a $400,000 bad debt
reserve in the second quarter of 1997 directly attributed to a receivable for a
sub-acute contract in Illinois that has been determined to be uncollectible.
Without this specific reserve, bad debt expense would have been $1,624,000 for
the year, or 5.3% of net patient service revenue, which is comparable to 1996.
Restructuring and Non-Recurring Items
During 1997, certain net costs deemed non-recurring were $2,578,000
compared to $4,969,000 for 1996. A significant portion of the 1997 expense arose
from legal fees and other expenses incurred relating to the Consent Solicitation
initiated by Thomas Zaucha, the Company's current Chief Executive Officer. These
expenses totaled approximately $2,277,000 for 1997, including $527,000 incurred
by the Brody management team. Current management estimates that approximately
$1,250,000 of the total amount of $1,750,000 incurred by Mr. Zaucha in the proxy
contest was the result of additional legal fees necessitated by the hearing in
Delaware in May 1997 and the appeal of that decision in August 1997, due to the
refusal of the Board of Directors and management team led by Steven Brody
(the"Brody Board") to recognize the vote of the shareholders and the decision of
the Delaware court.
In addition, the Company continued to incur higher than normal audit,
legal and other professional fees resulting from continuing reorganization of
the Company, shareholder litigation against the Company, and the Company's
lawsuit against former management. Intangible assets written off for both 1997
and 1996 represented the write off of the remaining employment contracts with
former employees and, in 1997, a reduction in the value of the Keystone
workforce as a result of the termination and attrition of employees who had been
employed by Keystone at the time of the merger in November 1995. These expenses
were offset by a benefit of $2,001,000 in 1997 as the result of legal
settlements and the opinion of legal counsel relating to the settlement of
certain disputes which resulted in the reduction of certain accrued liabilities.
Non-recurring expenses in 1997 without this benefit would have been $4,579,000.
Depreciation and Amortization
Other operating costs include amortization of intangibles arising from
past acquisitions, depreciation and other deferred charges, primarily financing
costs. Amortization of intangibles for 1997 of $1,117,000 declined by $506,000
from the 1996 total, reflecting (1) intangible asset write-offs in 1996, and (2)
completion of the amortization period for certain assets acquired during
previous acquisitions by the Company. The Company expects that amortization of
intangibles will continue to decrease in 1998 as a result of additional
intangible asset write-offs that occurred during 1997.
Interest and Other Non-Operating Expenses
Interest expenses were $2,229,000 for 1997 compared to $2,130,000 for
1996. The increase can be attributed to an increase in the Company's weighted
average interest rate from 1996 to 1997 due to the inability of the Company to
qualify in 1997 for the lower interest rates that were available in the early
part of 1996 with its senior lender, and additional interest due to the Zauchas'
as a result of the Company's inability to make scheduled principal payments in a
timely manner. The Company reported net other non-operating expenses of $50,000
in 1997 compared to net other non-operating expenses of $96,000 in 1996. The
expense for 1996 includes $25,000 for a reduction in the value of an investment
in a partnership.
Income Taxes
The Company has recorded a benefit of $770,000 for 1997 versus an
expense of $471,000 during 1996. The benefit in 1997 is a result of the
amendment of prior year tax returns for loss carrybacks that resulted in
significant federal and state income tax refunds that were received in 1997.
20
<PAGE> 22
As a result of the losses experienced in both 1997 and prior years, the Company
does not anticipate any significant taxable income for federal or state income
tax purposes in 1997 or 1998.
Net Loss:
The net loss for 1997 was $5,613,000 compared to a loss of $8,947,000 for the
same period in 1996.
1996 COMPARED TO 1995
Total Revenue
In 1996, the Company's total revenues increased to $37,872,000 from
$15,771,000 in 1995. Acquired companies, primarily Keystone Rehabilitation
Systems and Penn Vascular Lab, generated approximately $25,439,000 of the
increase, for which a full year's operations were included in 1996 compared to
forty-five days and thirty days, respectively, in 1995. Excluding acquisitions,
net patient service revenue declined by $3,338,000 reflecting extensive
reorganization and the closure or termination of unprofitable clinics and
contracts.
Costs of Service and Gross Profit
The Company's costs of service increased to $18,789,000 in 1996
compared to $10,640,000 in 1995. Of the increase, $10,547,000 arose from
acquired companies, with the remainder of the Company declining by $2,398,000.
As the increase in total cost was proportionately less than the increase in net
revenues, gross profit in 1996 rose by $13,952,000 to $19,083,000 in 1996 (50.4%
of total revenue) compared to $5,131,000 in 1995 (32.5% of total revenue).
Acquired companies accounted for $14,892,000 of the increase in gross profit and
the operations that existed prior to the acquisition declined by $940,000.
Selling, General and Administrative (SG&A) Expenses
Total SG&A expenses increased to $12,892,000 in 1996 compared to
$6,143,000 in 1995. As of percentage of total revenue, SG&A expenses fell from
39.0% in 1995 to 34.0% in 1996. This decrease in the percentage of net revenue
represents increased efficiencies due to the merger with Keystone and
consolidation of the corporate office functions.
Bad Debt Expense
The Company incurred bad debt expense of $1,820,000 or approximately
5.2% of net patient service revenue during 1996 compared to $2,301,000 or
approximately 14.9% in 1995. The 1995 provision was higher than in previous
years and above the industry average due primarily to the Company writing the
historical Northstar patient accounts receivable down to the net collectable
amounts.
Restructuring and Non-Recurring Items
During 1996, certain expenses deemed non-recurring expenses were
$4,969,000, compared to $3,827,000 in 1995. During 1996, these costs consisted
of the following: $751,000 in expenses related to the investigation of the
actions of prior management; $960,000 for the writedown of intangible assets to
actual value; $565,000 in legal costs related to the defense of shareholders
litigation and a plaintiff suit filed against former management; $629,000 in
higher than usual accounting and legal fees as a result of these issues;
$292,000 in restructuring expenses; and, a loss of $1,772,000 for the writeoff
of a note receivable that was collateralized with Common Stock. In 1995, these
costs consisted of a write-down of intangible assets of $3,421,000 and corporate
reorganization costs of $406,000.
21
<PAGE> 23
Depreciation and Amortization Expense
Other operating costs include amortization of intangibles arising from
past acquisitions, depreciation and other deferred charges, primarily finance
costs. Amortization of intangibles for 1996 was $1,623,000 compared to
$1,193,000 for 1995,and depreciation and amortization was $635,000 in 1996
compared to $173,000 in 1995. These increases were due primarily to the impact
of amortization of intangible assets and the depreciation and amortization of
property and equipment recorded in conjunction with the Keystone acquisition in
November 1995.
Interest Expense
Interest expense of $2,130,000 for 1996 represented an increase of
$1,297,000 over 1995, most of which was attributable to increased borrowing
costs arising from debt used to finance acquisitions.
Extraordinary Loss and Income Taxes
The extraordinary loss of $274,000 for 1995 arose from write-offs of
deferred financing costs for the early extinguishment of debt during that year.
The income tax benefit of $236,000 for 1995 was primarily due to refunds arising
from carry-backs of losses to prior years. The Company recorded a tax liability
of $471,000 for 1996 due to anticipated state income and franchise taxes on some
of its profitable subsidiaries.
Net Loss
The net loss for 1996 was $8,947,000 compared to $13,101,000 for 1995.
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 lender 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 is currently
engaged in negotiations with Cerberus to reach a mutually agreeable
restructuring of this debt. In addition, the Company has other obligations,
including obligations incurred in the Keystone merger with the Zaucha's and
professional fees with legal and other professional services firms that it is
currently unable to pay. The Company is attempting to reach payment agreements
with all of these parties; however, there is no assurance that it will be able
to do so on mutually agreeable terms.
During 1997, the cash provided by operations was $1,005,000 versus
$2,481,000 of cash provided by operations during 1996. This change in cash
provided from operations can be attributed to a number of items, but is
primarily the result of a decrease in accounts payable of only $353,000 during
1997 as opposed to a decrease of $1,592,000 during 1996.
The Company also expended less money on investing activities in 1997
versus that expended during 1996. The net cash used in investing activities
declined from $349,000 in 1996 to $304,000 in 1997 resulting primarily from the
repayment to the Company of deposits and loans.
The Company also had a significant change in its cash used in financing
activities. During 1996, the Company had a net usage of $6,255,000 during the
year. This total was used to:
o Pay $5,100,000 of a note due to Thomas Zaucha and the Zaucha Family
Limited Partnership as a result of the Keystone acquisition; and
o Make payments of approximately $1,566,000 that were used to amortize long
term debt and other obligations of the Company.
The net figure presented above also includes a $400,000 cash inflow during
the first quarter of 1996 resulting from a direct borrowing on the Company's
line of credit with its senior creditor.
22
<PAGE> 24
During 1997, the Company made net debt payments of $1,041,000, which
were primarily scheduled debt and lease payments as well as to pay debts owed to
former owners and managers of the Company. In addition, the Company paid
approximately $202,000 to minority interest holders in companies controlled by
Northstar and $665,000 under contractual obligations with certain employees.
During 1997, 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 expenses 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 forseeable 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 terminated its
separate sub-acute care division in Illinois which had incurred significant
operating losses and experienced a high rate of uncollectible receivables, and
has focused its efforts on improving the performance of it's core physical
therapy and rehabilitation businesses. To this end, the Company has formed a
corporate administrative function that encompasses sales, marketing,
recruitment, provider relations, managed care services and clinical compliance
to support the day-to-day operations of all subsidiaries of the Company. The
Company has also announced it's decision to withdraw from the mobile diagnostic
industry so that management can focus on the core rehabilitation business. The
Company is also continuing to review all expenses in an effort to reduce costs
wherever possible. The expenses associated with the Company's 1997 proxy fight
have ended, and the Company's Chairman has indicated that he will not demand
immediate reimbursement of all expenses due to him in connection therewith.
While the Company is currently in default of its obligations under its Credit
Agreement, it has been actively engaged in negotiations with Cerberus that the
Company expects will lead to the execution of a permanent restructuring of its
debt.
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 significantly 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
(SFAS No. 130), the objective of which is to report and disclose a measure
("comprehensive income") of all changes in equity of a company that result from
transactions with owners. SFAS No. 130 is effective for financial statements
issued for periods beginning after December 15, 1997. The Company will adopt
SFAS No. 130 in 1998.
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131, "Disclosure about Segments of an
Enterprise and Related Information" (SFAS No. 131), which requires use of the
"management approach" model for segment reporting. The management approach model
is based on the way company management organizes segments within the Company for
making operating decisions and assessing performance. Reportable segments are
based on products and services, geography, legal structure, management
structure, or any other manner in which management disaggregates a company. SFAS
No. 131 is effective for financial statements issued for periods beginning after
December 15, 1997. The Company will adopt SFAS No. 131 in 1998.
23
<PAGE> 25
In February 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 132, "Employers' Disclosures
about Pension and Other Postretirement Benefits" (SFAS No. 132), which revises
employers' disclosures about pension and other postretirement benefit plans.
SFAS No. 132 is effective for financial statements issued for periods beginning
after December 15, 1997. The Company will adopt SFAS No.
132 in 1998.
YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written
using two digits rather than four digits to define the applicable year. Computer
programs that have date-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.
Based on a recent assessment, the Company has determined that it will
not be required to replace significant portions of its software in order for its
computer systems to properly utilize dates beyond December 31, 1999. The Company
presently believes that if any modifications are required, they will be
insignificant in scope and cost.
The Company has initiated formal communications with its significant
payors and vendors to determine the extent to which the Company is vulnerable to
those third parties' failure to remediate their own Year 2000 Issue. Currently,
the Company does not believe the failure of such third parties to remediate
their own Year 2000 Issue will have a material adverse effect on the Company.
There can be no guarantee, however, that the systems of other companies on which
the Company's systems rely will be timely converted, or that failure to convert
by another company, or a conversion that is incompatible with the Company's
systems, would not have a material adverse effect on the Company.
To the extent that the Company's computer systems need to be modified
to remediate any Year 2000 Issue, the Company plans to complete such remediation
by December 31, 1998. The Company's assessment of its Year 2000 Issue is based
on management's best estimates, which were derived utilizing assumptions of
future events, including the continued availability of certain resources, third
party modification plans and other factors. There can be no guarantee that
management's assessment that the Company's Year 2000 Issue is insignificant is
correct.
ITEM 7A. 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
This information is set forth as exhibits beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
In March 1996, the Company's auditors, KPMG Peat Marwick ("KPMG"), who
had been appointed in late 1995, resigned prior to completing an audit of
Northstar, citing concerns related to the management of the Company that had
been in place prior to the merger with Keystone in November 1995. KPMG advised
the Company that (1) internal controls were not sufficient for preparation of
reliable financial statements; (2) information had come to their attention which
made them unwilling to rely on management's representations and unwilling to be
associated with the financial statements prepared by management; and (3) the
scope of the audit should be expanded significantly, and that information had
come to their attention that, if further investigated, might materially impact
the fairness or reliability of previously issued financial statements. As a
result, the Company's Form 10-K for the year ended
24
<PAGE> 26
December 31, 1995 was not filed timely. The Company retained Arthur
Andersen LLP as its auditors, and Arthur Andersen completed the audit of the
Company for the years ended December 31, 1997, 1996 and 1995. (See Note 1 to the
Financial Statements)
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Identification of Directors
The information required by this item is set forth under the caption
"Directors and Executive Officers of the Company" in definitive Proxy Statement
for the 1998 Annual Meeting of Shareholders (the "definitive Proxy Statement")
to be filed pursuant to Regulation 14A and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is set forth under the caption
"Executive Compensation" in definitive Proxy Statement to be filed pursuant to
Regulation 14A and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is set forth under the caption
"Security Ownership and Certain Beneficial Ownership" in definitive Proxy
Statement to be filed pursuant to Regulation 14A and is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is set forth under the caption
"Certain Relationships and Related Transactions" in definitive Proxy Statement
to be filed pursuant to Regulation 14A and is incorporated herein by reference.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
A) 1. FINANCIAL STATEMENTS
The financial statements, together with the report thereon of the
Company's independent accountants, are included in this report on the pages
listed below.
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Public Accountants F-1
Consolidated Balance Sheets
as of December 31, 1997and 1996 F-2
Consolidated Statements of Operations
for the years ended December 31, 1997, 1996 and 1995 F-4
Consolidated Statements of Stockholders' Equity
for the years ended December 31, 1997, 1996 and 1995 F-5
Consolidated Statements of Cash Flows
for the years ended December 31, 1997, 1996 and 1995 F-7
Notes to Consolidated Financial Statements F-9
Schedule II - Valuation and Qualifying Accounts
for the years ended December 31, 1997, 1996 and 1995 F-34
Report of Independent Public Accountants
On Financial Statement Schedule F-35
</TABLE>
25
<PAGE> 27
2. EXHIBITS
(B) REPORTS ON FORM 8-K
99 The Company filed a Form 8-K report dated February 21, 1997. The item
listed was Item 5, Other Events; Item 7(c), Exhibits.
The Company filed a Form 8-K report dated May 8, 1997. The item listed
was Item 1, Changes in Control of Registrant; Item 7(c), Exhibits. This
exhibit, previously filed on May 15, 1997 with the Company's 10-Q
Quarterly Report, is hereby incorporated by reference.
The Company filed a Form 8-K report dated August 1, 1997. The items
listed were Item 1, Changes in Control of Registrant; Item 5, Other
Events and Item 7(c), Exhibits. This exhibit, previously filed on
August 14, 1997 with the Company's 10-Q Quarterly Report, is
incorporated by reference.
The Company filed a Form 8-K report dated August 14, 1997. The items
listed were Item 5, Other Events and Item 7(c), Exhibits. This exhibit,
previously filed on November 14, 1997 with the Company's 10-Q Quarterly
Report, is incorporated by reference.
The Company filed a Form 8-K report dated September 10, 1997. The items
listed were Item 5, Other Events and Item 7(c), Exhibits. This exhibit,
previously filed on November 14, 1997 with the Company's 10-Q Quarterly
Report, is incorporated by reference.
(C) 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-K.
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
10.1 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. signed May 31, 1996, filed as an exhibit to
the Company's Annual Report on Form 10-K for the Fiscal Year ended
December 31, 1996, is incorporated by reference.
10.3 Forbearance Agreement between Northstar Health Services, Inc. and IBJ
Schroder Bank & Trust Co., dated August 18, 1997.
10.4 Extension Supplement between Northstar Health Services, Inc. and IBJ
Schroder Bank & Trust Co. dated August 29, 1997.
26
<PAGE> 28
10.5 Extension Supplement between Northstar Health Services, Inc., Cerberus
Partners, LLP and IBJ Schroder Bank & Trust Co. dated October 1, 1997.
10.6 Extension Supplement between Northstar Health Services, Inc., Cerberus
Partners, LLP and IBJ Schroder Bank & Trust Co. dated November 12,
1997.
10.7 Assignment and Acceptance Agreement between Northstar Health Services,
Inc. and Cerberus Partners, LP, dated September 8, 1997.
10.8 Advisory Agreement between Northstar Health Services, Inc. and
Commonwealth Associates dated June 9, 1997.
10.9 Robert J. Smallacombe Independent Consultant Contract with Northstar
signed January 20, 1997, filed as an exhibit to the Company's Annual
Report on Form 10-K for the Fiscal Year ended December 31, 1996, is
incorporated by reference.
10.10 Employment Agreement between Northstar Health Services, Inc. and David
D. Watson, filed as an exhibit to the Company's Annual Report on Form
10-K for the Fiscal Year ended December 31, 1996, is incorporated by
reference.
16.1 KPMG Peat Marwick Letter of Resignation dated March 25, 1996, filed as
an exhibit to the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1996, is incorporated by reference.
20.1 Termination and Mutual Release Agreement between Northstar Health
Services, Inc. and John A. Lombardi, dated November 4, 1997.
20.2 Settlement Agreement and Mutual Release Agreement between Northstar
Health Services, Inc. and Steven N. Brody, dated November 24, 1997.
21 SUBSIDIARIES OF THE REGISTRANT
27 Financial Data Schedule
27
<PAGE> 29
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, on the 31st day of
March, 1998.
NORTHSTAR HEALTH SERVICES, INC.
By: /s/ Thomas W. Zaucha
-------------------------------
Thomas W. Zaucha, Chairman, CEO,
President and Director
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Lisa S. Guarino Executive Vice President, Chief Financial March 31, 1998
- ---------------------------- Officer and Treasurer
(Principal Accounting and Financial Officer)
/s/ Lawrence F. Jindra, MD Director March 31, 1998
- ----------------------------
/s/ James H. McElwain Director March 31, 1998
- ----------------------------
/s/ Mark G. Mykityshyn Director March 31, 1998
- ----------------------------
/s/ Roger J. Reschini Director March 31, 1998
- ----------------------------
/s/ David B. White Director March 31, 1998
- ----------------------------
</TABLE>
28
<PAGE> 30
Item 14. - Exhibits, Financial Statement Schedules, and Reports on Form 8-K
a) 1. Financial Statements
The financial statements, together with the report thereon of the Company's
independent accountants, are included in this report on the pages listed below.
<TABLE>
<CAPTION>
Financial Statements Page
- -------------------- ----
<S> <C>
Report of Independent Public Accountants F-1
Consolidated Balance Sheets
as of December 31, 1997 and 1996 F-2
Consolidated Statements of Operations
for the years ended December 31, 1997, 1996 and 1995 F-4
Consolidated Statements of Stockholders' Equity
for the years ended December 31, 1997, 1996 and 1995 F-5
Consolidated Statements of Cash Flows
for the years ended December 31, 1997, 1996 and 1995 F-7
Notes to Consolidated Financial Statements F-9
Schedule II - Valuation and Qualifying Accounts
for the years ended December 31, 1997, 1996 and 1995 F-34
Report of Independent Public Accountants
on Financial Statement Schedule F-35
</TABLE>
<PAGE> 31
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Northstar Health Services, Inc.:
We have audited the accompanying consolidated balance sheets of Northstar
Health Services, Inc, (a Delaware corporation and the Company) and Subsidiaries
as of December 31, 1997 and 1996 and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Northstar
Health Services, Inc. and Subsidiaries at December 31, 1997 and 1996, and the
results of its operations and its cash flows for the three years then ended, in
conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 7 to the
consolidated financial statements, the Company has suffered significant losses
from operations, has a net capital deficiency, has not paid all creditors on a
timely basis and is not meeting its contractual obligations with regard to debt
principal and interest payments and certain financial covenants which the lender
has not waived. These matters raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 7. The financial statements do not include
any adjustments relating to the recoverability and classification of asset
carrying amounts or the amount and classification of liabilities that might
result should the Company be unable to continue as a going concern.
Arthur Andersen LLP
Pittsburgh, Pennsylvania,
March 23, 1998
F-1
<PAGE> 32
NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (NOTE 1)
(Dollars in Thousands)
<TABLE>
<CAPTION>
A S S E T S December 31, December 31,
----------- 1997 1996
------------ -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 657 $ 1,607
Accounts receivable-
Patients, net of allowances for doubtful accounts of
$ 1,341 and $ 2,015, respectively 5,818 6,098
Management fees 501 766
Miscellaneous 158 244
Prepaid expenses and other current assets 162 731
------- -------
Total current assets 7,296 9,446
------- -------
PROPERTY AND EQUIPMENT, net (Notes 5, 6 and 10) 2,814 3,682
INTANGIBLE ASSETS, net (Note 4) 19,221 21,132
OTHER ASSETS 183 282
------- -------
TOTAL ASSETS $29,514 $34,542
======= =======
</TABLE>
The accompanying notes are an integral part of these
financial statements.
F-2
<PAGE> 33
NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (NOTE 1)
(Dollars in Thousands, Except Share Data)
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY December 31, December 31,
------------------------------------ 1997 1996
------------ ------------
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt (Notes 6, 7, 10, and 12)
Senior Debt $ 14,083 $ 14,083
Thomas Zaucha and Zaucha Family Limited Partnership 2,932 1,285
Other debt 1,206 1,893
Accounts payable 2,401 2,048
Accrued expenses (Note 8) 7,476 5,323
Contractual obligations to employees (Note 16) 1,031 1,633
-------- --------
Total current liabilities 29,129 26,265
-------- --------
LONG-TERM DEBT (Notes 6, 7, 10, and 12)
Thomas Zaucha and Zaucha Family Limited Partnership 1,757 3,183
Other debt 282 1,718
-------- --------
Total long term debt 2,039 4,901
MINORITY INTEREST (Note 3) 145 184
-------- --------
Total liabilities 31,313 31,350
-------- --------
STOCKHOLDERS' EQUITY (Notes 3, 6, 9, 12 and 13) 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 and 6,229,718 shares issued at December 31, 1997 and
1996, respectively 63 62
Additional paid-in capital 26,388 26,208
Warrants outstanding 2,392 1,951
Retained deficit (30,189) (24,576)
Less: Treasury stock, 362,564 shares in 1997 and 1996, at cost (453) (453)
-------- --------
Total stockholders' (deficit)/ equity (1,799) 3,192
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 29,514 $ 34,542
======== ========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
F-3
<PAGE> 34
NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (NOTE 1)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Dollars in Thousands, Except Share Data)
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
REVENUE:
Net patient service revenue $ 30,903 $ 35,041 $ 15,424
Management fee revenue 1,703 2,831 347
---------- ---------- ----------
Total revenue 32,606 37,872 15,771
COSTS OF SERVICE 16,413 18,789 10,640
---------- ---------- ----------
Gross profit 16,193 19,083 5,131
OPERATING EXPENSES:
Selling, general and administrative expenses 11,312 12,892 6,143
Bad debt expense 2,024 1,820 2,301
Restructuring and other non-recurring items (Note 9) 2,578 4,969 3,827
Impairment of long-lived assets (Note 4) -- -- 3,050
Amortization of intangibles (Note 4) 1,117 1,623 1,193
Depreciation and amortization 561 635 173
Management fee expenses 2,542 3,100 406
---------- ---------- ----------
Total operating expenses 20,134 25,039 17,093
---------- ---------- ----------
OPERATING LOSS (3,941) (5,956) (11,962)
NON-OPERATING EXPENSES:
Interest expense, net 2,229 2,130 833
Other expense, net 50 96 208
---------- ---------- ----------
Total non-operating expenses 2,279 2,226 1,041
---------- ---------- ----------
LOSS BEFORE INCOME TAXES (6,220) (8,182) (13,003)
INCOME TAXES (Note 14) (770) 471 (236)
---------- ---------- ----------
LOSS BEFORE MINORITY INTEREST AND EXTRAORDINARY LOSS (5,450) (8,653) (12,767)
MINORITY INTEREST 163 294 60
---------- ---------- ----------
LOSS BEFORE EXTRAORDINARY LOSS (5,613) (8,947) (12,827)
EXTRAORDINARY LOSS -- -- (274)
---------- ---------- ----------
NET LOSS $ (5,613) $ (8,947) $ (13,101)
========== ========== ==========
EARNINGS PER SHARE:
Basic and diluted earnings:
Loss before extraordinary loss $ (0.95) $ (1.44) $ (3.21)
Extraordinary loss -- -- (0.07)
========== ========== ==========
Net Loss Per Share $ (0.95) $ (1.44) $ (3.28)
========== ========== ==========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES AND EQUIVALENTS (Basic
and Diluted) 5,880,501 6,216,840 3,996,147
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
F-4
<PAGE> 35
NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (NOTE 1)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Dollars in Thousands)
<TABLE>
<CAPTION>
Common Stock Common Shares Issuable Additional
--------------------- ---------------------- Paid-in Warrants
Shares Issue Amount Shares Amount Capital Oustanding
------------ ------ ------ ------ ------- ----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1994,
as restated 2,600,000 $26 20,378 $ 127 $ 5,705 $ 342
Issuance of Common Stock in
secondary offering 2,012,500 20 -- -- 10,678 --
Issuance of stock for
acquisitions (Note 3) 200,591 2 -- -- 1,678 --
Shares issuable for
acquisitions (Note 3) -- -- 944,352 5,591 -- --
Issuance of shares issuable 20,378 -- (20,378) (127) 127 --
Issuance of Common Stock in
exchange for salary reduction 30,000 -- -- -- 198 --
Interest accrued -- -- -- -- -- --
Warrants issued in connection
with bank financing -- -- -- -- -- 703
Issuance of warrants for
consulting services -- -- -- -- -- 220
Issuance of warrants to
Underwriter -- -- -- -- (686) 686
Compensatory stock options
issued -- -- -- -- 358 --
Disproportionate dividend (Note 3) -- -- -- -- -- --
Reclassification of note
receivable for new collateralization
by Common Stock -- -- -- -- -- --
Issuance of common shares and
collateralized note receivable
(Note 3) 362,564 4 -- -- 2,146 --
Exercise of stock options 59,333 1 -- -- 422 --
Net Loss -- -- -- -- -- --
--------- --- -------- ------- -------- ------
BALANCE, December 31, 1995 5,285,366 53 944,352 5,591 20,626 1,951
Issuance of shares issuable
(Note 3) 944,352 9 (944,352) (5,591) 5,582 --
Receipt of Common Stock as
Treasury stock through
surrender of a note
receivable (Note 3) -- -- -- -- -- --
Write off of uncollectible
notes receivable -- -- -- -- -- --
Net Loss -- -- -- -- -- --
--------- --- -------- ------- -------- ------
BALANCE, December 31, 1996 6,229,718 62 -- -- 26,208 1,951
Issuance of Common Stock 108,270 1 -- -- 180 --
Issuance of warrants for
consulting services -- -- -- -- -- 441
Net Loss -- -- -- -- -- --
--------- --- -------- ------- -------- ------
BALANCE, December 31, 1997 6,337,988 $63 -- -- $ 26,388 $2,392
========= === ======== ======= ======== ======
</TABLE>
The accompanying notes are an integral part of these
financial statements.
F-5
<PAGE> 36
NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (NOTE 1)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Dollars in Thousands)
<TABLE>
<CAPTION>
Treasury Stock
Retained --------------- Notes
(Deficit) Shares Amount Receivable Total
--------- ------ ------ ---------- -----
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1994, as
restated $ (1,350) -- -- $ (30) $ 4,820
Issuance of Common Stock in
secondary offering -- -- -- -- 10,698
Issuance of stock for
acquisitions (Note 3) -- -- -- -- 1,680
Shares issuable for
acquisitions (Note 3) -- -- -- -- 5,591
Issuance of shares issuable -- -- -- -- --
Issuance of Common Stock in
exchange for salary reduction -- -- -- -- 198
Interest accrued -- -- -- (7) (7)
Warrants issued in connection with
bank financing -- -- -- -- 703
Issuance of warrants for
consulting services -- -- -- -- 220
Issuance of warrants to
Underwriter -- -- -- -- --
Compensatory stock options issued -- -- -- -- 358
Disproportionate dividend (Note 3) (1,178) -- -- -- (1,178)
Reclassification of note receivable
for new collateralization by
Common Stock -- -- -- (38) (38)
Issuance of common shares and
collateralized note receivable
(Note 3) -- -- -- (2,150) --
Exercise of stock options -- -- -- -- 423
Net Loss (13,101) -- -- -- (13,101)
-------- ------- ---- ------- --------
BALANCE, December 31, 1995 (15,629) -- -- (2,225) 10,367
Issuance of shares issuable
(Note 3) -- -- -- -- --
Receipt of Common Stock as
treasury stock through
surrender of a note
receivable (Note 3) -- 362,564 453 2,150 1,697
Write off of uncollectible
notes receivable -- -- -- 75 75
Net Loss (8,947) -- -- -- (8,947)
-------- ------- ---- ------- --------
BALANCE, December 31, 1996 (24,576) 362,564 453 -- 3,192
Issuance of Common Stock -- -- -- -- 181
Issuance of warrants for
consulting services -- -- -- -- 441
Net Loss (5,613) -- -- -- (5,613)
-------- ------- ---- ------- --------
BALANCE, December 31, 1997 $(30,189) 362,564 $453 $ -- $ (1,799)
======== ======= ==== ======= ========
</TABLE>
The accompanying notes are an integral part of these
financial statements
F-6
<PAGE> 37
NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (NOTES 1 AND 2)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Dollars in Thousands)
<TABLE>
<CAPTION>
CASH FLOWS FROM OPERATING ACTIVITIES: 1997 1996 1995
------- ------- --------
<S> <C> <C> <C>
Net loss $(5,613) $(8,947) $(13,101)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities-
Depreciation and amortization 3,255 4,293 1,781
Impairment of long-lived assets -- -- 3,050
Loss on early extinguishment of debt -- -- 274
Legal settlements (2,001) -- --
Provision for doubtful accounts 2,020 1,820 2,301
Loss on note receivable collateralized by common stock -- 1,772 --
Loss on write off of investment -- 25 --
Interest on discounted obligation 223 241 --
Deferred income taxes -- -- (128)
Loss on sale of equipment 66 47 16
Provision for increase in contractual obligations to employees 63 262 --
Compensation expense related to options and warrants 441 113 570
Minority interest 163 294 61
Change in current assets and liabilities-
(Increase)/decrease in receivables (1,392) (912) 36
Decrease/(increase) in other current assets 569 126 (218)
Increase/(decrease) in accounts payable 353 1,592 (212)
Increase in accrued expenses 2,858 1,755 789
------- ------- --------
Net cash provided/(used) by operating activities 1,005 2,481 (4,781)
------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions, net of cash acquired -- (10) (13,124)
Earn-out payments on prior period acquisitions -- -- (617)
Capital expenditures (434) (345) (420)
Deposits, loans and investments 99 (12) (33)
Other investing activities -- -- (668)
Proceeds from sale of equipment 31 18 3
------- ------- --------
Net cash used in investing activities (304) (349) (14,859)
------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of Common Stock 181 -- 10,699
Payments on long-term debt (1,041) (1,566) (15,695)
Debt issuance and organization costs -- -- (729)
Payment of acquisition note to Thomas Zaucha -- (5,100) --
Stock options exercised -- -- 457
Payments of contractual obligations to employees (665) (79) --
Distributions to minority interests (202) (226) (57)
Borrowings on long-term debt 76 716 30,045
------- ------- --------
Net cash (used)/provided by financing activities (1,651) (6,255) 24,720
------- ------- --------
NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS (950) (4,123) 5,080
CASH AND CASH EQUIVALENTS, beginning balance 1,607 5,730 650
------- ------- --------
CASH AND CASH EQUIVALENTS, end balance $ 657 $ 1,607 $ 5,730
======= ======= ========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
F-7
<PAGE> 38
NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (NOTES 1 AND 2)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Dollars in Thousands)
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW DATA:
Interest paid $1,520 $821 $1,018
Income taxes paid 41 216 494
NONCASH INVESTING ACTIVITIES:
Capital lease obligations $ 43 $395 $1,467
Issuance of stock for acquisition -- -- 1,680
Shares issuable for acquisition -- -- 5,591
Issue warrants to bank as debt related -- -- 703
Issue note receivable and related common shares collateralizing note -- -- 2,150
Issuance of Common Stock in exchange for salary reduction -- -- 198
Issuance of Common Stock warrants for services 441 -- 886
Notes payable issued in connection with the acquisitions -- -- 9,618
Treasury stock received through surrender of note receivable collateral -- 453 --
</TABLE>
The accompanying notes are an integral part of these
financial statements.
F-8
<PAGE> 39
NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS ORGANIZATION AND SIGNIFICANT EVENTS:
Nature of Operations
Northstar Health Services, Inc. (Northstar or the Company) is a regional
provider of physical rehabilitation and other health care services, including
diagnostic testing, in Pennsylvania and adjacent states, providing services at
outpatient rehabilitation clinics and patient care facilities to patients
suffering from physical disabilities. The goals of rehabilitation therapy are to
improve a patient's physical strength and range of motion, reduce pain, prevent
injury and restore the ability to perform basic activities, including
communication. The Company provides these services primarily through outpatient
rehabilitation clinics and under contractual arrangements with other patient
care facilities, such as nursing homes and hospitals. The term "Company" means,
unless otherwise indicated, the Company and its subsidiaries and their
respective predecessors.
Trading of Common Shares
On May 18, 1995, the Securities and Exchange Commission (the Commission)
declared effective a registration statement on Form SB-2 originally filed by the
Company on March 31, 1995. The registration statement registered with the
Commission, among other things, the offer and sale of 1,750,000 shares of Common
Stock (the Public Offering). A closing on the Public Offering was held on May
26, 1995. On June 8 and June 15, 1995, the underwriters of the Public offering
exercised their over-allotment option to purchase an aggregate of 262,500 shares
of Common Stock. The net proceeds of approximately $10,000,000 from the Public
Offering, and the exercise of the over-allotment option, were used to finance
acquisitions, repay certain of the Company's short-term indebtedness, pay
certain expenses of the Company's Public Offering not paid at closing and for
other general corporate purposes, including working capital.
The Company's Common Stock was traded on the NASDAQ National Market
beginning June 3, 1993 under the symbol "NSTR". After some of the events
outlined below occurred, trading of the Company's Common Stock was halted by the
NASDAQ National Market on May 31, 1996.
Resignation of Auditors and Immediate Board Changes
In March 1996, the Company's auditors, KPMG Peat Marwick (KPMG), who had
been appointed in late 1995, resigned prior to completing an audit of Northstar.
Soon after KPMG's resignation, the Company's former Chairman of the Board, Mark
A. DeSimone was asked to resign from the Company's Board of Directors along with
one independent director. Certain members of management were also relieved from
their duties. Concurrently, Thomas W. Zaucha was appointed as Chairman of the
Board and an independent member of the Board of Directors was appointed to
investigate certain allegations of improprieties.
Stockholders' Suits
Following the resignation of KPMG, while the Company was conducting its
investigation and before the Company filed its suit as discussed below, the
Company was named in suits filed by groups of stockholders. See Note 20 for a
discussion of the settlement of this litigation.
Company's Suit
Based upon the investigation completed by special independent legal
counsel, the Board of Directors voted to pursue legal actions against the
Company's former Chairman of the Board; certain former employees; the
predecessor auditors of the Company (for years prior to 1995), Richard A. Eisner
& Company; and certain other individuals and entities who were allegedly
involved in improper actions and diversion of funds to other entities. A
complaint was filed in the Western District of Pennsylvania United States
District Court on September 12, 1996. See Note 20 for a further discussion of
the settlement of this litigation.
Consent Solicitation
In February 1997, Thomas W. Zaucha, the current and then Chairman of the
Board of Directors and Chief Executive Officer of the Company, commenced a
solicitation of Northstar shareholder consents to remove and replace the other
members of the Northstar Board of Directors and effectuate related changes in
Northstar's bylaws (the "Consent Solicitation"). Shortly thereafter, the Board
of Directors terminated Mr. Zaucha's employment with the
F-9
<PAGE> 40
Company, though he remained a member of the Board of Directors. On March 24,
1997, Mr. Zaucha delivered executed consents representing the votes of 61% of
the outstanding shares in favor of his proposals and, following confirmation of
the decision by the Delaware Chancery Court on May 8, 1997, Mr. Zaucha resumed
his duties as the Company's Chief Executive Officer.
The ruling of the Delaware Chancery Court was appealed to the Delaware
Supreme Court by three of the Board members removed from office as a result of
the Chancery Courts' decision. On August 1, 1997, a unanimous panel of the
Delaware Supreme Court affirmed the decision of the Delaware Chancery Court
confirming the election of the current Board. See Note 9 regarding related legal
costs.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company,
its wholly-owned subsidiaries, and its interests in partnerships and joint
venture arrangements only for the period subsequent to their acquisition. All
significant intercompany balances and transactions have been eliminated. The
Company uses the equity method of accounting for less than majority-owned
entities.
Basis of Presentation
The Company maintains its accounts on the accrual basis of accounting. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Reclassifications
Certain reclassifications have been made to prior year financial statements
to conform with the current year presentation.
Industry Risks
The healthcare industry in the United States continues to experience
significant change even without passage of comprehensive legislative reform at
the federal level. The primary force for change in today's competitive
marketplace continues to be the consolidation and increased efficiency in
healthcare delivery and financing.
An increasing number of the Company's third-party payors are adopting
prospective payment systems. The Company has signed provider contracts with
managed care organizations, which emphasize utilization control and cost
containment, and the Company's business with these managed care organizations is
expected to increase significantly in the next few years. Managed care
organizations either directly transfer risk to healthcare providers through
capitation payment arrangements or pay for units of service on a steeply
discounted basis. These factors cause significant challenges to all providers,
including the Company.
Net Patient Service Revenue
The Company has agreements with certain third-party payors that provide for
payments to the Company at amounts different from its established fee schedules.
Services rendered to Medicare program beneficiaries are paid based on a
cost reimbursement methodology subject to cost limitations. The Company is
reimbursed for services at a tentative interim rate with final settlement
determined after submission of annual cost reports by the Company and audits
thereof by the Medicare fiscal intermediary. The Company's Medicare cost reports
have been audited with final settlements determined by the Medicare fiscal
intermediary through December 31, 1995 for all providers. Any normal recurring
types of changes arising from audit or settlement after the close of the fiscal
year are reflected in subsequent years' net patient service revenue.
The Company has also entered into payment agreements with certain
commercial insurance carriers, health maintenance organizations and preferred
provider organizations. The basis for payment to the Company under these
agreements includes prospectively determined rates and discounts from
established charges. Certain of these
F-10
<PAGE> 41
contracts provide capitation terms whereby the Company receives a sum of money
per covered member within the certain insurance plan and in return the Company
agrees to provide all of the rehabilitation and certain diagnostic testing which
is deemed medically necessary for these plan members. In addition to the
payments from the insurance organizations, the Company may, depending on the
coverage circumstances, collect co-payment amounts directly from patients for
each event of service.
The Company grants credit without collateral to its patients, most of whom
are local residents and are insured under third-party payor agreements. The mix
of gross receivables from patients and third-party payors at December 31, 1997
and 1996, was as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Workers' compensation 30% 31%
Other third-party payors 24 20
Blue Cross, Blue Shield & related managed care products 21 16
Contracts with nursing homes and other such providers 12 15
Medicare 10 14
Self-pay patients 3 3
Medicaid -- 1
=== ===
100% 100%
=== ===
</TABLE>
The healthcare industry is subject to numerous laws and regulations of
federal, state and local governments. These laws and regulations include, but
are not necessarily limited to, matters such as licensure, accreditation,
requirements of government healthcare program participation, reimbursement for
patient services, and Medicare and Medicaid fraud and abuse. Recently,
government activity has increased with respect to investigations and allegations
concerning possible violations of fraud and abuse statutes and regulations by
healthcare providers. Violations of these laws and regulations could result in
expulsion from government healthcare programs together with imposition of
significant fines and penalties, as well as significant repayments for patient
services previously billed. Management believes that the Company is in
compliance with fraud and abuse as well as other government laws and
regulations. While the Company is not aware of any current violations,
compliance with such laws and regulations can be subject to future government
review and interpretation as well as regulatory actions unknown or unasserted at
this time.
Management Fees
The Company manages, on a contract basis, a mobile diagnostics business.
Also, during a portion of 1996 and 1997, the Company managed a physician
practice, which was discontinued in June 1997. 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. The
management fees and related expenses are presented in the Revenue and Operating
Expenses sections of the Consolidated Statements of Operations.
Insurance
The Company presently insures against malpractice with independent
third-party insurers utilizing claims-made policies, and workers' compensation
risks with independent third-party insurers or state Workers' Compensation
insurance funds, where required.
Cash and Cash Equivalents
All cash equivalents are stated at cost, which approximates market. The
Company considers all highly liquid investments purchased with a maturity of
three months or less when purchased to be cash equivalents.
Property and Equipment
The Company's property and equipment are stated at cost and are depreciated
using the straight-line method over the estimated useful lives of the assets or
the term of the lease, as appropriate. Most non-leased depreciable assets have
estimated useful lives in the range of five to seven years.
Upon disposal of property items, the asset and related accumulated
depreciation accounts are relieved of the amounts recorded therein for such
items, and any resulting gain or loss is reflected in income.
F-11
<PAGE> 42
Deferred Costs
Debt issuance costs are amortized over the term of the debt. Such costs are
included in intangibles.
Intangible Assets
Intangible assets consist of the excess of cost over net assets of acquired
organizations (goodwill), non-compete and employment agreements with certain key
employees of organizations which have been acquired, the Keystone tradename and
assembled workforce and other intangibles consisting of primarily deferred
financing costs.
In March 1995, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." This accounting pronouncement requires that long-lived assets and
identifiable intangibles to be held and used by an entity are to be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of the assets may not be recoverable.
The Company chose early adoption of this accounting pronouncement as of
December 31, 1995. In accordance therewith, as of December 31, 1995, the then
current management believed that certain actions of the DeSimone management team
led to the litigation discussed in Note 1, and other circumstances occurred that
indicated that the remaining balance of intangible assets may not be
recoverable. Thus, as these factors have indicated that intangible assets should
be evaluated for possible impairment, the Company has used an estimate of the
related operations' undiscounted cash flows over the remaining life of the
various intangible assets in measuring whether these intangible assets are
recoverable. The Company's evaluations have resulted in adjustments to goodwill,
non-compete and employment agreements. See Note 4.
Treasury Stock
The Company may periodically repurchase its own stock as a result of a
specific transaction or as part of an organized repurchase plan. The Company
accounts for such stock repurchases on the cost basis and records the stock
value as a contra-equity line item on its financial statements. Treasury Stock
was received in December 1996 as a result of a surrender of 362,564 shares of
Common Stock in connection with a certain note receivable. See Note 3.
Earnings Per Common Share
During the fourth quarter of 1997, the Company adopted SFAS No. 128,
"Earnings Per Share". Under SFAS No. 128, earnings per share are classified as
basic earnings per share and diluted earnings per share. Basic earnings per
share includes only the weighted average common shares outstanding. Diluted
earnings per share includes the weighted average common shares outstanding and
any dilutive common stock equivalent shares in the calculation. All prior
periods have been restated to reflect this adoption. Treasury shares are treated
as retired for earnings per share purposes.
As discussed in Note 3, additional shares are potentially issuable to the
Shareholders as defined therein. These additional shares were also excluded from
the diluted earnings per share calculations as the Company has not determined if
these shares will be issued and due to their antidilutive effect.
The following table reflects the calculation of earnings per share under
SFAS No. 128:
<TABLE>
<CAPTION>
For the year ended December 31,
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Basic earnings per share:
Net loss $(5,613) $(8,947) $(13,101)
Average shares outstanding 5,880,501 6,216,840 3,996,147
Loss per share $(0.95) $(1.44) $(3.28)
Diluted earnings per share:
Net loss $(5,613) $(8,947) $(13,101)
Average shares outstanding 5,880,501 6,216,840 3,996,147
Shares issuable for Keystone merger -- -- --
Stock warrants -- -- --
Stock options -- -- --
----------- ----------- -----------
Diluted average shares outstanding 5,880,501 6,216,840 3,996,147
Loss per share $(0.95) $(1.44) $(3.28)
</TABLE>
F-12
<PAGE> 43
Options to purchase 1,187,758, 681,200, and 581,980 were outstanding at
December 31, 1997, 1996 and 1995, 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.
3. MERGERS, ACQUISITIONS AND JOINT VENTURE AGREEMENTS:
Keystone Rehabilitation Systems, Inc. (Keystone)
On November 15, 1995, NSK Merger Corp., a newly-formed subsidiary of the
Company, was merged with and into Keystone (a Pennsylvania corporation). Prior
to this merger (the "Merger"), Keystone was the largest privately held
rehabilitation company in Pennsylvania, providing services in physical,
occupational and speech therapy, including sports rehabilitation and work
hardening in outpatient clinics, as well as in patient care facilities, located
throughout Pennsylvania and in New York, Ohio and West Virginia.
As consideration for the Merger, the shareholders of Keystone, Thomas W.
Zaucha and Alice L. Zaucha and the Zaucha Family Limited Partnership
(collectively, the "Shareholders"), received the following: (a) $2,500,000 in
cash; (b) a Time Note due January 3, 1996, in the aggregate principal amount of
$5,100,000; (c) a five-year, interest free Term Note in the aggregate principal
amount of $2,625,000; (d) the agreement by the Company to issue, on January 3,
1996, a three-year, 6% Term Note in the aggregate principal amount of $2,400,000
(the Three-Year Note); and (e) the agreement by the Company to issue to the
Shareholders, on January 3, 1996, an aggregate of 944,352 shares of Common
Stock, par value $.01 per share (the "Common Stock"), of the Company (the "Stock
Consideration"). The debt issued in this acquisition was discounted using
current market rates. See Note 6.
In connection with the Merger, the Company (i) guaranteed the value of the
Stock Consideration to be at least $5,600,000 through certain periods ending no
later than December 31, 1997; (ii) agreed to seek necessary stockholder approval
to allow the Three-Year Note to be converted into Common Stock at the conversion
price of $5.93 per share and to pay any guaranteed amount in additional shares
of Northstar Common Stock based on the trading price of the Common Stock at the
time of issuance; and (iii) issued a five-year interest-free note to David D.
Watson, Keystone's Chief Operating Officer and Executive Vice President, in the
aggregate principal amount of $375,000, in release of any interest Mr. Watson
might have had in Keystone. Similar to the debt in the preceding paragraph, this
obligation to Mr. Watson was discounted using the Company's current borrowing
rate.
As discussed above, a stock price of $5.93 per share was guaranteed to the
Shareholders for periods ending not later than December 31, 1997. Based on the
weighted average trading volume of the daily closing price per share for the ten
consecutive trading days immediately prior to the third business day prior to
the determination date of December 31, 1997, the Company's Common Stock was
valued at $0.96 per share. The Company has a contractual obligation to fund this
shortfall in stock value through a cash payment equal to the shortfall or, with
shareholder approval, through the issuance of additional shares to the
Shareholders in an amount equal to the shortfall. Based on above formula, 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 Company does not
currently have sufficient cash to pay this obligation or a sufficient number of
authorized and unissued common shares available to meet this entire obligation
through the issuance of stock. The issuance of such 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. Further, such
shares would be included in the calculation of diluted earnings per share except
for the fact that such effect would be anti-dilutive because of the Company's
net loss.
The Company also agreed to make additional "earn-out" payments to the
Shareholders of $1,600,000 per year in the event that Keystone's "EBITDA"
exceeds $2,500,000 in any year from 1996 to 2000, inclusive. EBITDA is defined,
generally, to mean Keystone's earnings (including earnings from any internally
generated facility or contract but excluding earnings from any facility or
contract acquired from third parties) before taxes, interest, depreciation and
amortization. In the event an earn-out is not earned and therefore not paid in
any given year, the earn-out will be paid in the next year if EBITDA in such
next year exceeds the greater of $3,200,000 or $2,500,000 plus the amount of the
EBITDA shortfall in such prior year. The Shareholders are to receive an earn-out
of approximately $200,000 for 1995. The calculation for the earn-out amounts for
years 1996 through 2000 includes a reduction in the amount due in the event that
the current liabilities of Keystone at the date of the Merger (other than
permitted capital leases) exceeded $2,000,000. In addition, such earn-out
payments are to be reduced by 50% of such current liabilities up to $2,000,000.
Former management of the Company believed that, based on the results of
operations for 1996 as well as that management's interpretation of the
above-outlined adjustments, the 1996 earn-out computation resulted in no amounts
due to the Shareholders. The current Board of Directors appointed a Special
Committee to review these calculations and the issues in dispute. If the final
earn-out received or paid differs from that calculated by former
F-13
<PAGE> 44
management, the change would affect goodwill. The earn-out payments for all
years will accelerate and become due within 90 days after any change in
ownership or control of the Company or a sale of the majority of the assets of
the business. Any additional compensation due to a change in stock price would
be additional purchase price allocated to goodwill. The Company has determined
that, based on the results of operations for 1997, there are no amounts due to
the Shareholders for the 1997 earn-out. As discussed above, if the EBITDA for
1998 exceeds the greater of $3,200,000 or $2,500,000 plus the amount of the
EBITDA shortfall for 1997, the 1997 earn-out will be paid along with the 1998
earn-out.
The consideration for the Merger was determined by arms-length negotiations
among the various parties. In connection with this Merger, the Company paid fees
of approximately $145,000 to Commonwealth Associates and the Company paid cash
of $450,000 and issued 150,000 shares of Common Stock with a market value of
$937,500 to Commercial Financial Corporation. See Note 12.
At the effective time of the Merger, the Company paid $2,500,000 in cash to
the Shareholders and deposited $5,100,000 in a cash collateral account with a
bank to support a letter of credit securing the Company's obligation to pay the
Shareholders $5,100,000 on January 3, 1996. This obligation was paid on its due
date. The Company borrowed $3,500,000 of such amounts under the $6,500,000
acquisition line portion of its then existing $16,000,000 credit facility with
IBJ Schroder Bank and Trust Company. The remainder of the funds required at the
effective time of the Merger were provided from working capital.
Immediately prior to the Merger and in accordance with the Merger
Agreement, Keystone transferred to the Zaucha Family Limited Partnership, of
which Thomas W. Zaucha is a general partner, all of the real estate owned by
Keystone for approximately $5,200,000, the independently appraised value of the
assets involved. These funds were used to pay off real estate and other debt
owed to a bank by Keystone. In connection with the Merger, the parcels of such
real estate used in Keystone's business were then leased to Keystone. See Note
12 for discussion of these rental payments.
As part of the Merger, certain of the executive officers of Keystone
entered into employment agreements with and became executive officers of the
Company. See Note 15.
In connection with the Merger, the purchase price was allocated to the
assets acquired and liabilities assumed as follows based on an appraisal
<TABLE>
<CAPTION>
<S> <C>
(dollars in thousands):
Excess of cost over acquired net assets $ 9,895
Keystone tradename 2,500
Assembled workforce 1,000
Employment agreements 1,000
Cash 266
Accounts receivable 5,328
Other current assets 591
Property and equipment 2,291
Other assets 163
Accounts payable (294)
Other current liabilities (3,123)
Loans payable (1,271)
Minority interest (112)
========
$ 18,234
========
</TABLE>
The operating results for the year ended December 31, 1995, are discussed
below assuming the acquisition of Keystone had been effective as of January 1,
1995. The pro forma information is, however, not necessarily indicative of the
combined results of operations as they might have been for the year ended
December 31, 1995. The pro forma amounts give effect to, among other things,
depreciation and amortization on the revalued assets acquired and imputed
interest on the debt incurred at the average interest rate actually incurred by
the Company during the period indicated.
Assuming that Keystone had been acquired on January 1, 1995, the unaudited
pro forma operating results of the Company for the year ended December 31, 1995
would have approximated the following: total revenue would have been
$35,741,000; the net loss would have been $12,890,000; and the loss per common
share would have been $2.67.
F-14
<PAGE> 45
Penn Vascular Lab, P.C. (PVL)
On November 28, 1995, the Company acquired from PVL (a Pennsylvania
professional corporation) certain assets and the stock of Vascusonics, Inc. (a
Pennsylvania corporation or Vascusonics). The agreement provided for a
management services contract whereby the Company would provide such services to
PVL for a period of two years in exchange for a fee equal to the excess of
collected revenue over the sum of $75,000 and PVL's business expenses. Although
the management services contract expired on November 28, 1997, it was renewable
annually at the mutual agreement of both parties. The purchase agreement also
provided the Company with the option to purchase the stock of PVL for one dollar
under certain circumstances, during the period one year after the management
services contract is terminated. See Note 21.
As consideration for the above-mentioned items, the Company (a) paid
$50,000 to the Seller upon the consummation of the agreement; (b) loaned
$2,150,000 to the Seller in exchange for a note; (c) provided the Seller with
shares of Northstar Common Stock with a fair market value equivalent of
$2,150,000 on the date of the acquisition; (d) promised to pay $100,000 to the
Seller in twelve equal non-interest bearing installment payments beginning in
December 1996; and (e) promised to pay certain contingent payments to the
Seller. The non-interest bearing note to the Seller was discounted using a
market rate of interest. See Note 6. Additionally, in exchange for the loan and
the Common Stock the Seller agreed to pay back to Northstar the lesser of
$2,150,000 or the proceeds from the sale of the Common Stock. The aforementioned
Northstar stock was pledged by the Seller as collateral for the note.
The contingent payments, as revised by mutual agreement in January 1997, to
the Seller are based upon the Net Collected Revenues, as defined, for the years
ending December 31, 1997 and 1998. If during either of the two years ending
December 31, 1998, the Net Collected Revenues of the businesses acquired
exceeded $3,200,000, then a payment of $37,500 is to be made to the Seller. If
the Collected Revenues were in excess of $3,400,000 and $3,600,000, in each year
then the payment to the physician would be $137,500 and $237,500, respectively.
The Company has determined that under the terms of this calculation, there is no
contingent payment due for the year ending December 31, 1997.
During 1996, the Seller returned to the Company the shares of Common Stock
which were issued in conjunction with the acquisition and the note receivable
which was collateralized with those shares. As of the date of the stock
surrender, the value of the stock collateral had decreased to $1.25 per share.
Accordingly, the Company included in its 1996 consolidated statement of
operations the effect of the reduction in collateral value.
In January 1997, the Company reached a settlement agreement with the Seller
of PVL regarding several disputes. In the terms of this agreement, the Company
reduced certain future payments due to the Seller from $100,000 to $50,000,
acquired ownership rights to disputed equipment, and reduced contingent payment
amounts.
The Company borrowed $2,500,000 under the $6,500,000 acquisition portion of
its then existing $16,000,000 credit facility with IBJ Schroder Bank and Trust
Company. These borrowings financed the $2,150,000 promissory note to the Seller
and a $350,000 broker fee. Under the purchase agreement, Ultrasonics, Inc.
(Ultrasonics) took ownership of PVL's and Vascusonics' accounts receivable on
the date of purchase just prior to the consummation of the purchase agreement.
Also, Ultrasonics assumed certain leases for equipment used by the Company and
entered into new lease terms with the Company. Ultrasonics is a related party
which is owned and operated by Jeff Bergman. See Note 21.
The Company believed that the lease arrangements with Ultrasonics were for
lease rates which were greatly in excess of market rates. At the date of the
merger, Ultrasonics paid off leases which represented a net liability to PVL of
$155,000. However, the lease arrangement with Ultrasonics obligated the Company
to principal payments totaling $1,333,000 over the term of the leases. The
Company treated the excessive lease payments of $1,178,000 as a disproportionate
dividend, and ceased making payments to Ultrasonics in March 1996. In March
1997, Ultrasonics filed suit against the Company as a result of these disputed
lease agreements. In March 1998, the Company reached a settlement with Jeff
Bergman and Ultrasonics over these matters. See Note 21.
In connection with the PVL acquisition, the Company paid a brokerage fee of
$350,000 to Mr. James P. Shields. Mr. Shields is a cousin of Mr. DeSimone, the
former Chairman of the Board of Directors of the Company. Additionally, in
connection with the above mentioned management services contract, the Company
provided shares of Common Stock with a fair market value of approximately
$300,000 to Mr. Shields in consideration for him to renegotiate his employment
agreement with the Company so as to include duties with respect to both PVL and
Vascusonics. The term of this management contract was for a period of seven
years and compensation consisted of a management fee of 12% of the gross
collections. Prior to this revised contract, Mr. Shields received compensation
F-15
<PAGE> 46
equal to 5% of gross collections. In March 1996, the Company canceled Mr.
Shield's contract and severed his relationship with the Company. See Note 12.
The Company expensed during 1995 the amounts paid and shares issued to Mr.
Shields in connection with the above mentioned brokerage fee and re-negotiation
of his employment contract. The Company has also expensed $50,000 paid to
Commonwealth Associates in connection with this acquisition.
Joint Venture Activities
Prior to 1995 the Company formed a joint venture with CDL Medical
Technologies, Inc. (CDL) to provide mobile diagnostic services, including
cardiac services in Western Pennsylvania. The Company acquired a 51% interest in
the venture for a note of $55,000.
4. INTANGIBLE ASSETS:
Intangible Assets and the related amortization periods consist of the
following (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
1997 1996
-------- --------
<S> <C> <C>
Excess of cost over net assets acquired (40 years) $ 17,481 $ 17,481
Employment agreements (2 to 71/2 years) 625 2,660
Keystone tradename (20 years) 2,500 2,500
Covenant not to compete (5 years) 77 1,258
Assembled Keystone workforce (5 years) 600 1,000
Deferred financing and other costs (5 years) 809 861
-------- --------
$ 22,092 $ 25,760
Less accumulated amortization (2,871) (4,628)
-------- --------
Intangible assets $ 19,221 $ 21,132
======== ========
</TABLE>
As discussed in Note 2, the Company has chosen to adopt SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" as of December 31, 1995. In accordance therewith, as of December
31, 1995, the Company believed that certain actions of the DeSimone management
team that lead to the litigation discussed in Notes 1 and 20, and other
circumstances have occurred that indicated that the remaining balance of
intangible assets may not be recoverable. Thus, as these factors have indicated
that intangible assets should be evaluated for possible impairment, the Company
has used an estimate of the related operations' undiscounted cash flows over the
remaining life of the various intangible assets in measuring whether these
assets are recoverable.
The Company's evaluations resulted in adjustments to decrease goodwill and
non-compete and employment agreements as follows as of December 31, 1995:
<TABLE>
<CAPTION>
<S> <C>
Goodwill $2,940,795
Non-compete 32,334
Employment agreements 76,661
----------
Total $3,049,790
==========
</TABLE>
As of December 31, 1996, management of the Company did not believe that any
of the remaining intangible assets were impaired. As of December 31, 1997,
management evaluated the remaining intangibles that resulted in adjustments to
decrease the Assembled Keystone workforce in the amount of $400,000, net of
accumulated amortization to date. On a going-forward basis, the Company will
continue to evaluate whether later events and circumstances have occurred that
indicate the remaining estimated useful life of goodwill may warrant revision or
that the remaining balance of intangible assets may not be recoverable. When
factors indicate that intangible assets should be evaluated for possible
impairment, the Company will use an estimate of the related operation's
undiscounted cash flow over the remaining life of the goodwill in measuring
whether the goodwill or other intangible asset is recoverable. Any subsequent
asset impairment will be accounted for as a charge to the operating expenses of
the Company.
F-16
<PAGE> 47
5. PROPERTY AND EQUIPMENT:
Property and equipment consists of the following (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
1997 1996
------- -------
<S> <C> <C>
Vehicles $ 301 $ 342
Clinical equipment 1,720 1,875
Furniture and fixtures 890 991
Leased medical equipment 1,934 1,885
Leasehold improvements 780 709
------- -------
Total cost basis $ 5,625 $ 5,802
Less accumulated depreciation (2,811) (2,120)
------- -------
Property and equipment - net $ 2,814 $ 3,682
======= =======
</TABLE>
6. DEBT:
Debt consists of the following (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
1997 1996
-------- --------
<S> <C> <C>
Term loan with senior lender due in 60 monthly graduated payments, plus
interest at a Base Rate plus 1.5% in 1997 and 1996
(Note 7) $ 6,083 6,083
Revolving line of credit with senior lender, due on demand
and no later than 10/20/00, interest payable monthly a Base
Rate plus 1.5% in 1997 and 1996 (Note 7) 2,000 2,000
Acquisition facility with senior lender, due in equal monthly
installments beginning 4/30/97 at a Base Rate plus 2% in
1997 and 1996 (Note 7) 6,000 6,000
Non-interest bearing term notes to Thomas Zaucha and the
Zaucha Family Limited Partnership, approximately $85,000
due on 11/15/97 and then approximately $210,000 due
quarterly until 11/15/00 (interest imputed at 9%) 2,625 2,625
Term notes to Thomas Zaucha and the Zaucha Family
Limited Partnership, due in equal quarterly installments
beginning on 9/30/96 of $200,000, 6% stated interest
rate (interest imputed at 9%) 2,400 2,400
Capital lease obligations with interest rates ranging from
9% to 15.6% 1,241 3,059
Other debt 685 1,157
-------- --------
Total long-term debt $ 21,034 $ 23,324
Less:
Current portion (18,221) (17,261)
Debt discount (774) (1,162)
-------- --------
Long-term debt $ 2,039 $ 4,901
======== ========
</TABLE>
The Company's weighted average interest rate was 10.4% and 9.9% for 1997
and 1996, respectively.
Med-Bill Financing
On September 1, 1995, a $4,500,000 term note was refinanced by the Integra
facility, described below, and all amounts due were paid in full. At the time of
the early extinguishment of debt, the Company recognized the remaining
unamortized debt issuance cost of $175,000 as an extraordinary loss. See Note
12.
Integra Facility
On June 29, 1995, the Company accepted a commitment letter from Integra
Bank (Integra facility) for a
F-17
<PAGE> 48
$6,500,000 credit facility, consisting of a $4,500,000 term loan and a
$2,000,000 revolving line of credit. The proceeds of the term loan were used to
consolidate the Company's existing loan obligations to Med-Bill. The proceeds of
the revolving credit facility provided working capital as needed. In addition,
the former President and Chief Executive Officer of the Company, Mark A.
DeSimone, personally guaranteed the loan. Mr. DeSimone received a 5% guarantee
fee totaling $325,000. The credit facility closed in August 1995. At the time of
this early extinguishment of debt, the Company recognized the remaining
unamortized debt issuance costs of approximately $100,000 as an extraordinary
loss.
IBJ Schroder and Cerberus Partners Facility
On October 20, 1995, the Company closed on a credit facility with IBJ
Schroder Bank and Trust Company (IBJ). The facility consisted of a $6,500,000
term loan to refinance existing obligations, a $3,000,000 revolving line of
credit to fund operations and a $6,500,000 acquisition facility to fund the
Company's existing and future acquisition activity (collectively, the IBJ
Facility). The total facility had a final maturity of five years from the date
of closing. The term loan was funded in full at closing and was used to repay an
existing bank credit facility. The term loan was to be repaid through 60 monthly
payments beginning at $83,333 and ending at $133,337 with interest at either the
LIBOR rate plus 300 basis points or a Base Rate, as defined, plus 1.5%, subject
to the terms and conditions of the credit agreement. Repayment terms required
the revolving line of credit to be paid in full five years from closing, and
interest accrued thereon at either LIBOR rate plus 300 basis points or the Base
Rate plus 1.5% subject to the terms and conditions of the credit agreement. The
repayment terms on the acquisition facility were $142,857 per month beginning
April 30, 1997, and for a period of 42 months at either the LIBOR rate plus 350
basis points or the Base Rate plus 2.0% subject to the terms and conditions of
the credit agreement. The IBJ facility was secured by a first priority lien on
substantially all of the assets of the Company. In addition, the credit
agreement had various financial compliance covenants with which the Company must
comply, including certain ratios and free cash flow requirements. See Note 7.
Fees paid in connection with the IBJ facility consisted of a 1.25% commitment
fee paid at closing, 0.5% unused revolving line of credit fee and a 0.5% unused
acquisition facility fee, subject to the terms and conditions of a credit
agreement.
In addition, the Company issued to IBJ certain warrants (the "IBJ
Warrants"). The IBJ Warrants may be exercised to purchase up to 240,000 shares
of the Company's Common Stock at an exercise price of $6.76 per share until
October 20, 2000. The IBJ Warrants and the Shares underlying the IBJ Warrants
have been registered. The fair market value of the IBJ Warrants on the date of
issuance, October 20, 1995, was $703,000.The Company accounted for the IBJ
Warrants as a debt discount and is amortizing the fair market value of these
warrants on a straight-line basis over the 60 months life of the IBJ Facility.
As of December 31, 1996, the term loan portion of this facility had been
drawn down in full, the remaining $1,000,000 of the original revolving line of
credit balance was canceled, and $6,000,000 of the acquisition facility had been
used and the remaining $500,000 had been terminated by the bank. See Note 7.
In September 1997, Cerberus Partners, LP, (Cerberus) a diversified
financial securities firm that invests in publicly traded and private debt
issues of both large and middle market companies, purchased from IBJ all of the
Company's senior debt amounting to $15.3 million, including principal and
accrued interest. The debt was purchased subject to the existing Credit
Agreement and forbearance agreement and extensions thereof. The Company executed
an Assignment and Acceptance Agreement and consented to the transfer of the IBJ
Warrants to Cerberus in connection with this matter. The Company is currently
negotiating an amended and restated agreement that provides for repayment
through 48 monthly graduated payments beginning February 1, 1999, plus interest
monthly beginning January 1998 at the Base Rate plus 1.5%., and revised
financial and other covenant provisions. A closing date on this agreement has
not been determined at this time.
At December 31, 1997, the scheduled aggregate annual maturities of
long-term debt are as follows (dollars in thousands):
<TABLE>
<CAPTION>
<S> <C> <C>
1998 $18,221
1999 1,753
2000 1,022
2001 27
2002 11
-------
Total $21,034
=======
</TABLE>
F-18
<PAGE> 49
7. COVENANTS UNDER CREDIT AGREEMENT:
Current management does not believe that the Company was ever in compliance
with the covenants of the IBJ Facility. During 1996, the Company entered into
two forbearance agreements with IBJ regarding the events of default on the IBJ
Facility. Under the terms of these forbearance agreements, IBJ agreed not to
institute the default rate of interest on the notes and also agreed not to force
the Company into accelerated payment. The second forbearance agreement expired
on December 31, 1996. On August 18, 1997, current management of the Company
entered into a new forbearance agreement with IBJ that expired on August 31,
1997, and was subsequently extended through December 5, 1997. From December 5,
the Company has been operating under a verbal extension of the forbearance
agreement with Cerberus.
The financial covenants, among other restrictions of the IBJ Facility for
fiscal year 1995 do not permit (a) the ratio of Consolidated Current Assets to
Consolidated Current Liabilities, as defined, at any time to be less than 1.75
to 1.00; (b) Consolidated EBITDA for the twelve months ended December 31, 1995,
to be less than $3,300,000; (c) the Consolidated Net Worth at any time to be
less than the sum of (i) $18,000,000, (ii) 80% of Consolidated Net Income on a
cumulative basis (without deduction for any losses) for the period commencing on
October 1, 1995 and ending on the last day of the Determination Period most
recently ended and (iii) the Net Proceeds of any sale or other disposition of
any equity securities by the Borrower, (d) the ratio, for any Determination
Period ending on the last day of any calendar month during any period set forth,
including the three months ended December 31, 1995, of (i) Consolidated EBITA
for such Determination Period minus Capital Expenditures made during such
Determination Period to (ii) Consolidated Fixed Charges for such Determination
Period, to be less than the ratio set forth of 1.20 and (e) (i) with respect to
any Determination Period, the aggregate principal amount of all Acquisition
Loans and Term Loans outstanding on the last day of such Determination Period
plus the aggregate Revolving Credit Commitments as of the last day of such
Determination Period to exceed the Free Cash Flow of the Borrower and its
consolidated Subsidiaries for such Determination Period multiplied by 3.25, and
(ii) the sum of Consolidated Indebtedness as of the last day of such
Determination Period and the aggregate Available RC Commitment as of the last
day of such Determination Period to exceed the Free Cash Flow of the Borrower
and its consolidated Subsidiaries for such Determination Period multiplied by
3.75. Similar covenants were applicable to fiscal year 1996 and 1997, and are
stated in the agreement for subsequent fiscal years.
The non-financial covenants of the IBJ Facility included but were not
limited to the Company furnishing (a) annual audited financial statements within
90 days to IBJ without a "going concern" opinion and (b) quarterly financial
data within 45 days of a quarter-end.
Effective May 31, 1996, the Company entered into a forbearance agreement
with IBJ Schroder regarding certain events of default on the IBJ facility. IBJ
agreed to forbear on the default events in the event that the Company complied
with certain additional covenants regarding cash receipts and disbursements,
levels of cash collections, and amount of service revenues. Some of the
covenants in the loan agreement may have changed in conjunction with the
negotiation of the forbearance agreement. In addition, there are numerous
reporting requirements of the Company to IBJ regarding these covenants. As of
December 31, 1996, the then current management of the Company believed that it
had substantially complied with all of these covenants. In conjunction with the
forbearance agreements, IBJ and the Company agreed to convert all Eurodollar
based loans to Base Rate loans. As of December 31, 1996, the interest rate on
all outstanding borrowing was denominated in the Base Rate.
On August 18, 1997, the current management of the Company entered into a
Forbearance Agreement with IBJ that terminated August 31, 1997. After the
purchase of the debt by Cerberus, the Company entered into extensions of this
agreement through December 5, 1997. Since that date, the Company has operated
under a verbal extension of the Forbearance Agreement while negotiations on an
amended credit agreement are taking place. As the Company is still in default on
the original credit facility and has not received any waivers regarding events
of non-compliance, all indebtedness due to Cerberus at December 31, 1997, is
still classified as current in the accompanying consolidated balance sheet.
Other indebtedness did not contain cross-default provisions and long-term
portions thereof have not been classified as current.
During the last three years the Company has suffered significant losses
from operations of $3.9 million, $6.0 million and $12.0 million for the years
ended December 31, 1997, 1996 and 1995, respectively. As of December 31, 1997
the Company has a net capital deficiency of $1.8 million. Additionally, the
Company has not paid all creditors on a timely basis and is not meeting its
contractual obligations with regard to debt principal and interest payments and
certain financial covenants which the lender has not waived. These matters raise
substantial doubt about the Company's ability to continue as a going concern.
These financial statements do not include any adjustments relating to the
recoverability and classification of asset carrying amounts or the amount and
classification of liabilities that might result should the Company be unable to
continue as a going concern.
F-19
<PAGE> 50
Management has focused its efforts in three main areas: reducing costs in
order to improve operating income, resolving outstanding litigation and
renegotiating payment arrangements with lenders and creditors. During the year
ended December 31, 1997 operational improvements were made and the most
significant litigation facing the Company was settled. During 1998 management is
continuing their efforts to obtain operational performance improvements and is
working with their senior and subordinated debt lenders and other creditors to
extend payment terms and amend credit agreements to conform to the Company's
present structure and circumstances.
If the Company is unable to effectuate a business combination with a
financially stronger entity or to raise additional capital and/or effect a
permanent restructuring of its debt, the Company could be required to file a
petition for relief under the provisions of the Bankruptcy Code, or could have
an involuntary petition thereunder filed against it.
8. ACCRUED EXPENSES:
Accrued expenses consist of the following (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
-----------------
1997 1996
------ ------
<S> <C> <C>
Payroll, including payroll taxes and deductions $1,359 $1,867
Reimbursement of proxy solicitation costs to Thomas Zaucha 1,613 0
Accrued interest 1,459 1,180
Other 3,045 2,276
------ ------
Total accrued expenses $7,476 $5,323
====== ======
</TABLE>
9. RESTRUCTURING AND NON-RECURRING ITEMS:
During 1997 and 1996, following the resignation of KPMG as its independent
public accountants, the Company incurred professional fees in connection with
the ensuing independent investigation, shareholder litigation and suit against
the parties allegedly responsible for the wrong doings against the Company and
its shareholders. The professional fees in connection with these actions are
anticipated to continue until all of the legal matters are resolved.
Additionally, given the situations discussed above, the Company's fiscal year
1995 audit fees were higher than would otherwise be incurred.
Because of the actions of the DeSimone management group, the Company has
been faced with recording certain transactions which are unusual in nature and
are not expected to be recurring in future years. These transactions include,
but are not limited to, the recognition of losses on notes receivable
collateralized with Common Stock, payments to potentially related parties for
acquisition-related functions which cannot be capitalized as part of purchase
price under APB No. 16, and other unusual compensation arrangements offered to
certain former employees.
In addition, significant expenses were incurred as a result of the Consent
Solicitation described in Note 1. All expenses related to this action have been
expensed in 1997. The Company has agreed to reimburse Mr. Zaucha for the costs
incurred. As of December 31, 1997, unpaid professional fees in this matter are
approximately $1,613,000. See Note 8.
A summary of these unusual and non-recurring items are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------ ------
<S> <C> <C> <C>
Company costs related to proxy solicitation incurred by $ 527 $ -- $ --
Brody management
Proxy solicitation costs incurred by Mr. Zaucha 1,750 -- --
Legal and accounting fees 693 629 --
Litigation costs 558 565 --
Loss on notes receivable collateralized with Common Stock -- 1,772 --
Write off of intangible assets 707 960 3,421
Corporate restructuring costs 344 292 406
Professional fees related to investigation -- 751 --
Ultrasonics and management services legal settlements (2,001) -- --
------- ------ ------
Total $ 2,578 $4,969 $3,827
======= ====== ======
</TABLE>
The Company realized a benefit of $1,418,751 for the write-off of lease
obligations as the result of the settlement of the Ultrasonics/Jeff Bergman
suit. (See Note 21). The Company has also recorded a benefit of $581,933 for the
write-off of accruals related to the management services agreement with James
Shields that are no longer considered, in management's or legal counsel's
opinion, to be due.
F-20
<PAGE> 51
10. LEASES:
The Company has entered into various non-cancelable operating leases
expiring at various dates through December 31, 2002 for office and medical
equipment, vehicles and office space at its headquarters and certain
rehabilitation centers. During the years ended December 31, 1997 and 1996,
rental expense included in the statement of operations was $3,001,000 and
$3,345,000, respectively. As discussed in Note 12, the Company leases certain
properties from a related party.
Future minimum lease commitments for all non-cancelable leases as of
December 31, 1997 are as follows (dollars in thousands):
<TABLE>
<CAPTION>
Operating
Year Ending December 31, Leases
------------------------ ---------
<S> <C> <C>
1998 $ 2,559
1999 1,918
2000 1,657
2001 1,300
2002 959
Thereafter 2,175
-------
Total Payments $10,568
=======
</TABLE>
11. EMPLOYEE BENEFIT PLANS:
The Company has a deferred compensation plan for its employees pursuant to
Section 401(k) of the Internal Revenue Code of 1986, as amended (the "Northstar
Plan"). This plan provides for certain matching of employee contributions up to
prescribed limits of 10% of the employee contribution. Keystone also had a
deferred compensation plan for its employees pursuant to Section 401(k) of the
Internal Revenue Code of 1986, as amended (the "Keystone Plan"). The Keystone
Plan provides for certain matching of employee contributions equal to 50% of
participants' contributions up to three hundred dollars per year. The Keystone
plan also provides that Keystone may make discretionary contributions; however,
no such contributions were made during the forty-five days ended December 31,
1995 or in 1996 or 1997.
During 1997, 1996 and 1995 the Company made contributions to the Plans of
approximately $62,000, $26,000 and $86,000, respectively.
12. RELATED-PARTY TRANSACTIONS:
The current management of the Company does not adopt or affirm any related
party disclosures made in prior financial statements or public filings. The
transactions disclosed below are based on management's knowledge at this point
in time.
Transactions Directly With Mr. Mark DeSimone
During the year ended December 31, 1995, Mr. DeSimone reimbursed the
Company for $220,000 of expenses. During 1995 he also paid 7% interest of
$29,000 to the Company on this obligation. Conversely, the Company repaid a loan
of $162,000 to Mr. DeSimone on May 30, 1995 along with 8% per annum interest of
$6,000.
As of July 18, 1995, in consideration for Mr. DeSimone entering into an
extended non-compete agreement with the Company, fixing his compensation over
the term of the agreement and for returning to the Company options covering
250,000 shares of Common Stock, the Company amended, restated and replaced Mr.
DeSimone's previous employment agreement. In addition to annual compensation and
certain benefits, Mr. DeSimone received 30,000 shares of Common Stock with a
fair market value of $198,000, a one-time bonus of $175,000 and the repayment of
a personal loan to PNC Bank in the amount of $150,000. In connection with this
loan repayment, for each year Mr. DeSimone remained as an employee or consultant
to the Company, the Company agreed to waive repayment by Mr. DeSimone to the
Company of one-seventh of this loan satisfaction.
In September 1995, the Company received approximately $253,000 from Mr.
DeSimone for payment of third party receivables that the Company had recorded.
In February 1996, Mr. DeSimone terminated his employment with the Company
but continued to work as a consultant to the Company. His employment contract
was changed to a consulting arrangement with similar terms.
F-21
<PAGE> 52
The Company paid him $47,000 under the terms of this agreement during 1996. In
March 1996, Mr. DeSimone resigned from the Board of Directors and the Company
terminated its relationship with him.
As discussed in Note 6, Mr. DeSimone personally guaranteed the Integra
facility and received a 5% guarantee fee totaling $325,000.
Mr. DeSimone was a director of SMT Health Services, Inc. ("SMT") during
1995. Mr. DeSimone also had a 5-year consulting arrangement with SMT from which
he received $75,000 for consulting services. Mr. DeSimone sold his consulting
business to the Company prior to 1995. Current management believes that these
and possibly other fees for consulting services should have been remitted to the
Company and sought to recover such fees in the legal action described in Note
20.
Transactions With Med-Bill Corporation, Inc., Med Consulting and Med-Stat, Inc.
Med-Bill Corporation, Inc. ("Med-Bill"), which is a company located in
Western Pennsylvania, was a related party. Mr. James P. Shields, a cousin of Mr.
DeSimone was an officer and the sole owner of Med-Bill. Additionally, Mr.
DeSimone and his wife, Leslie M. DeSimone, were believed to be associated with
Med-Bill and had the principal financial interests in Med-Bill. Likewise, Med
Consulting and Med-Stat, Inc. were believed to have relationships similar to
that of Med-Bill.
In 1994, the Company agreed to pay Med-Bill a financing fee of $250,000 in
connection with a loan to the Company. On May 29, 1995, the Company paid the
final installment of $150,000 toward the aforementioned financing fee.
Prior to 1995, Med-Bill purchased certain obligations of the Company
totaling $930,000. This obligation was paid in full during 1995. No interest was
paid on this note.
In the first quarter of 1995, the Company loaned Med-Bill and Medconsulting
$41,000 and $25,000, respectively, pursuant to a demand note that bears interest
at the rate of 9% per annum. At December 31, 1995, these amounts were deemed
uncollectible and were written-off.
On July 1, 1995, the Company entered into a lease agreement with Med-Stat,
Inc. for two pieces of ultrasound equipment in the amount of $225,000 and paid a
deposit of $30,000. On August 31, 1995, the lease was bought-out by a reduction
in amounts due from Med-Bill of $167,500. The Company believed that the
equipment leased/purchased may have been used and may not have been acquired at
fair market value.
White Oak Diagnostics Systems ("White Oak")
In November 1993, the Company acquired an interest in White Oak from
Northern Diagnostics Services, Inc. ("Northern Diagnostics"), an entity which
was purportedly owned by Mr. James Shields.
In connection with the acquisition, the Company agreed to make certain
contingent payments to either Northern Diagnostics or Med-Bill if gross
collected revenues exceeded $400,000 for 1995. The 1995 revenues exceeded the
aforementioned threshold and a contingent payment was made to Med-Bill during
the year of $85,000. Given the related party nature of the transaction, this
payment was treated as a disproportionate dividend as the Company was required
to record its investment in White Oak at the same basis as that of the related
parties' investment in White Oak.
Northern Diagnostics acquired White Oak from a group of physicians. In
August 1995, White Oak made payments to the former physician owners of
approximately $150,000. The Company believes that these payments by White Oak
represented amounts due to these physicians by Northern Diagnostics for the
acquisition.
On May 30, 1995, the Company paid $350,000 to Med-Bill to satisfy amounts
recorded as due Med-Bill.
PVL Acquisition
In connection with the purchase of PVL and Vascusonics, the Company
transferred to Ultrasonics, Inc. ("Ultrasonics"), all the receivables of PVL and
Vascusonics as of December 1, 1995, with a value as stated in the acquisition
agreement of $350,000 for no known consideration. Ultrasonics is a related party
and is owned by Mr. James Shields and/or Mr. Jeff D. Bergman, the CEO and
Chairman of the Board of SMT.
The purchase agreement stated that certain equipment lease obligations
would be transferred to
F-22
<PAGE> 53
Ultrasonics. White Oak and Vascusonics then agreed to sublease the equipment
from Ultrasonics such that the Sellers would have no future liability under the
leases. Also, White Oak and the Company jointly and severally indemnified the
Sellers from and against any liability resulting from the failure of Ultrasonics
to discharge all obligations to the lessors after the date of the sale. The
Company is not aware of any consideration received from Ultrasonics in exchange
for the lease contracts, which management believes yielded lease payments to
Ultrasonics which were in excess of fair market value for the leased equipment,
or issuance of the previously mentioned indemnification.
During 1996, the Company paid $53,341 in lease payments. Further, although
the lessor paid approximately $155,000 for the equipment which it leased to the
Company, the Company was scheduled to make lease payments totaling approximately
$1,333,000. After March 1996, the Company refused to pay any further amounts
under this contract, believing the payments to be excessive. The resulting
litigation and resolution of such is described in Note 21.
As discussed in Note 3, in connection with this acquisition, the Company
paid a brokerage fee of $350,000 to Mr. James Shields.
Shields Management Agreement
Throughout 1995, the Company paid fees to Mr. James Shields or Med-Bill in
connection with certain management services that he provided at White Oak.
Additionally, upon the acquisition of PVL, Mr. Shields began providing such
services at PVL. In total, management fees of approximately $270,000 were paid
to Mr. Shields/Med-Bill during 1995. As of December 31, 1995, the Company had
approximately $37,000 due to Mr. Shields or Med-Bill. The Company severed its
relationship with Mr. Shields during the first quarter of 1996. See Note 3 for
information relating to the financial incentives provided to Mr. Shields to
renegotiate his employment contract with the Company to terms more favorable to
Mr. Shields.
During 1996, the Company paid Mr. Shields $59,106 under the terms of this
contract. After March 1996, the Company refused to pay any further amounts under
this contract, believing the payments to be excessive. The Company is vigorously
contesting this obligation, which is described in more detail in Note 21.
Keystone Acquisition
As part of the acquisition of Keystone, the Company paid cash of $450,000
and issued 150,000 shares of Common Stock with a market value of $937,500 to
Commercial Financial Corporation ("CFC") for services rendered. CFC is
wholly-owned by Nichlaus P. Horoczko who is a personal friend and business
associate of Mr. DeSimone. CFC is believed by the Company to be a related party.
Additionally, the Company had made certain guarantees to CFC that the
aforementioned shares would be able to be sold with net proceeds of at least
$937,500. These costs were expensed during 1995.
The Company believes that these shares of Common Stock were sold on
February 12, 1996 for approximately $840,000. In the opinion of management, as
Mr. Horoczko did not perform any services of value, he was not entitled to the
common shares discussed above or any additional compensation thereon. Mr.
Horoczko is a defendant in the Company's suit as discussed in Notes 1 and 20.
In connection with the Keystone acquisition, Mr. Thomas Zaucha and Mr.
David Watson, who both sold interests in the former Keystone, and are now or
were officers with Northstar, have gross debt and other amounts due directly to
them of $3,919,000 and $262,500, respectively, as of December 31, 1997 and
$3,919,000 and $293,750 as of December 31, 1996. In addition, Mr. Zaucha's
Family Limited Partnership is due $1,105,000 as of December 31, 1997 and 1996.
See Note 6.
As required under the Merger Agreement, immediately prior to the merger,
Keystone sold, at fair market value determined by a third party appraisal, all
of the real estate previously owned by Keystone to the Zaucha Family Limited
Partnership, of which Mr. Zaucha, is a general partner, and a related entity, in
return for a payment of $5,215,568. The parcels of such real estate used in
Keystone's business were then leased to Keystone. The Board of Directors, when
led by Steven Brody, one of the directors removed from office as a result of the
Consent Solicitation (see Note 1), alleged that these leasing arrangements,
which were negotiated when Mr. Brody was acting as a consultant to Mr. Zaucha in
the merger of Keystone with Northstar, were in excess of fair market value. A
Special Committee of the current Board of Directors of the Company has been
appointed and is evaluating the fair market lease rates for these properties.
The leases are for a period of either five or ten years, and commenced
November 15, 1995. Lease
F-23
<PAGE> 54
payments were $470,360 for 1997 and 1996 and $59,000 for 1995. Future minimum
lease payments under these leases, which are also disclosed within Note 10, are
as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
1998 $470,360
1999 470,360
2000 478,854
2001 536,629
2002 534,837
Thereafter 1,542,842
----------
Total $4,033,882
==========
</TABLE>
The Company also uses, on an as needed basis, the services of Impulse
Development Corporation, a company controlled by Thomas Zaucha, primarily for
leasehold improvement construction. Subsequent to the Consent Solicitation and
the reinstatement of Thomas Zaucha as Chairman and CEO, the current Board of
Directors solicited bids for these construction services from other companies,
and Impulse submitted the lowest bid. Payments to Impulse totaled $ 80,404,
$86,320 and $9,156 in 1997, 1996 and 1995, respectively.
Transactions with Board Members
In 1996, Brody Associates, a consulting firm wholly-owned by Steven Brody,
one of the Directors removed from office as a result of the Consent Solicitation
(see Note 1), was retained to perform a variety of consulting services for the
Company related to its investigation of former management and related to the
corporate restructuring of the Company. The Company paid $148,103 in 1997 and
$223,795 in 1996 to Brody Associates for these services and related business
expenses. The agreement was terminated as a result of the Consent Solicitation
described in Note 1. The Company entered into a settlement and release agreement
with Steven Brody and Brody Associates in November 1997 that provided for, among
other things, a payment of approximately $26,000 in outstanding consulting bills
with Brody Associates. At December 31, 1997, the Company had a remaining
liability to Brody Associates of $10,000. See Note 13 for stock option activity.
In 1996, the Company retained Executive Advisory Group, Ltd., whose sole
owner is Robert Smallacombe, one of the Directors removed from office as a
result of the Consent Solicitation (see Note1), to serve as a management
consultant and to aid in the corporate restructuring. For these services and
related business expenses, the Company paid $ 53,179 in 1997 and $189,503 in
1996 to Executive Advisory Group, Ltd. In addition, in February 1997, after the
Brody Board removed Thomas Zaucha from office as Chairman and CEO, Smallacombe
was appointed the new CEO and his existing consulting agreement was converted
into an employment contract. The Company paid $65,708 in salary and expenses in
1997 under this employment agreement. This contract was terminated for cause as
a result of the Consent Solicitation (see Note 1). As of December 31, 1997, the
Company is disputing any obligation to Smallacombe under the terminated
employment agreement. See Note 13 for option activity. See Note 21.
In conjunction with the investigation of former management, the Company
retained Plowman, Speigel & Lewis, P.C. in order to assist in understanding
certain corporate governance and securities litigation issues. Charles Jarrett,
Jr., one of the directors removed from office as a result of the Consent
Solicitation, is also a member of that firm. During 1996, but prior to Mr.
Jarrett's appointment to the Board of Directors, the Company paid to Plowman,
Speigel & Lewis, P.C. $32,548 for professional services rendered.
As discussed in Note 16, the Company has certain contractual obligations
due to employees. One such employee is the wife of Mr. Watson, a former officer
and director of the Company. Mrs. Watson's funds provided to the Company were
$126,354 as of December 31, 1996. In August 1997, Mrs. Watson exercised the
buyout provision of her employment contract and terminated her relationship with
the Company. See Note 16.
The Company obtains it's professional and general liability insurance
through The Reschini Agency, Inc., a company owned by Roger Reschini, a member
of the current Board of Directors. Policy premiums through this company totaled
approximately $214,000 and $184,000 in 1997 and 1996, respectively, with the
agency earning a commission on these premiums of approximately $25,000 and
$22,000 in 1997 and 1996, respectively. During 1997, the Company entered into a
simultaneous transaction with the Reschini Agency whereby the Company paid
approximately $180,000 for insurance premiums and the Reschini Agency purchased
108,270 shares of the newly issued Company Common Stock at a per share price of
$1.66 per share, which represents the average of the previous five days closing
stock prices.
F-24
<PAGE> 55
The Company had transactions involving Thomas Zaucha and related parties as
discussed in Notes 3 and earlier in Note 12. The Company also conducted
transactions with Mark DeSimone and related parties as discussed earlier in Note
12.
OTHER
During 1995, the Company paid $13,500 to Ogg Jones DeSimone & Igneizi, a
law firm in which Mr. DeSimone was a partner, purportedly for rent.
13. STOCK OPTIONS AND WARRANTS:
Stock Options
The Company adopted a stock option plan in 1992 (the "1992 Plan"), a 1994
stock option plan for non-employee directors (the "1994 Plan") and a 1997 stock
option plan (the "1997 Plan"), collectively (the "Plans"). As permitted, the
Company accounts for these plans under APB Opinion No. 25, which does not
normally require recognition of compensation expense. Had compensation cost been
determined consistent with FASB Statement No. 123, the Company's pro forma net
loss and loss per share would have been:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net Loss As Reported $(5,613) $(8,947) $(13,101)
Pro Forma $(7,003) $(9,652) $(14,298)
Basic loss Per Share As Reported $ (0.95) $ (1.44) $ (3.28)
Pro Forma $ (1.19) $ (1.55) $ (3.58)
</TABLE>
Because the Statement No. 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
The activity regarding the 1992, 1994, 1997 and Independent Plans is as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
Wt. Avg. Wt. Avg. Wt. Avg.
Shares Ex Price Shares Ex Price Shares Ex Price
------ -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 681,200 $4.12 581,980 $5.97 774,080 $6.72
Granted 921,933 2.06 330,000 2.27 300,000 5.54
Exercised -- -- -- -- 74,000 5.33
Expired/canceled (415,375) 4.09 (230,780) 6.16 (418,100) 7.15
Outstanding at end of year 1,187,758 2.53 681,200 4.12 581,980 5.98
Exerciseable at end of year 1,187,758 2.53 681,200 4.12 581,980 5.98
Wt. Avg. fair value of options
granted $1.90 $2.67 $5.03
</TABLE>
The fair value of the option grants as outlined above for the 1992, 1994,
1997 and Independent Plans is estimated using the Black-Scholes option pricing
model with the following assumptions: life of the options ranging from 3 to 5
years; an assumed risk free rate of interest ranging from 5.04% to 6.73%; an
expected dividend yield of 0%, consistent with the Company's policy; expected
volatility of 168% for the grants during 1997, 173% for grants during 1996 and
118% volatility for 1995.
A total of 1,800,000 shares is authorized and has been reserved for
issuance under the Plans: 650,000 for the 1992 Plan, 150,000 for the 1994 Plan,
and 1,000,000 for the 1997 Plan. Options may be either "incentive stock options"
within the meaning of Section 422 of the United States Internal Revenue Code of
1986, or non-qualified options. The Plans are administered by the Compensation
and Nominating Committee of the Board of Directors who determine among other
things, those individuals who shall receive options, the time period during
which the options may be partially or fully exercised, the number of shares of
Common Stock that may be purchased under each option, and the option exercise
price.
F-25
<PAGE> 56
The following summarizes the activity under the 1992 Plan:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996 December 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Options-
Outstanding at beginning of year 418,700 544,480 594,080
Granted 393,350 85,000 285,000
Exercised -- -- 24,000
Expired/Canceled (247,875) (210,780) (310,600)
Outstanding at end of year 564,275 418,700 544,480
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996 December 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Options price share ranges
Outstanding at beginning of year $1.50 - 7.88 $5.00 - 7.88 $5.25 - 7.88
Granted $1.625 - 2.3125 $1.50 - 2.00 $5.00 - 7.00
Options exercisable at end of year 564,175 418,700 544,480
Exercisable option price ranges $1.50 - 7.88 $1.50 - 7.88 $5.00 - 7.88
Options available for grant at end of 85,825 231,300 105,520
year
</TABLE>
Under the 1992 plan, on October 6, 1997, the Compensation and Nominating
Committee awarded stock option grants to 533 Company employees to purchase
365,850 shares of Common Stock at $2.31 per share (the fair market value on the
date of grant). Eligible employees included those who were employed on or before
October 1, 1997 and who were still with the Company on January 1, 1998. These
options collectively expire on October 6, 2002. In addition, the Company's Chief
Financial Officer received an option to purchase 15,000 shares of Common Stock
at an exercise price of $2.00 per share pursuant to an employment contract dated
September 1, 1997. The plan also has participants who received stock options
that were awarded prior to the Northstar/Keystone merger, those of whom are
still employed with the Company.
The stock option information presented herein represents current
management's belief of the transactions which have occurred. Certain
reclassifications of prior year information have been made to reflect current
management's belief and available information. Due to the dilutive effect of
options, this change has no impact on earnings per share. To date, 24,000
options have been exercised under the 1992 Stock Option Plan.
The following summarizes the activity under the 1994 Plan:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996 December 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Options-
Outstanding at beginning of year 17,500 37,500 30,000
Granted 37,500 -- 15,000
Exercised -- -- --
Expired/Canceled (17,500) (20,000) (7,500)
Outstanding at end of year 37,500 17,500 37,500
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996 December 31, 1995
----------------- ----------------- -----------------
Options price share ranges
<S> <C> <C> <C>
Outstanding at beginning of year $6.125 - 7.3125 $6.125 - 7.3125 $7.31 - 7.31
Granted $2.375 - 2.375 $ -- $6.125 - 6.875
Options exercisable at end of year 37,500 17,500 37,500
Exercisable option price ranges $2.375 - 2.375 $6.125 - 7.3125 $6.125 - 7.31
Options available for grant at
end of year 112,500 132,500 112,500
</TABLE>
Under the 1994 Plan, on March 24, 1997, the five non-employee members of
the Board of Directors each received an option to purchase 7,500 shares of
Common Stock at an exercise price of $2.375 per share with an expiration date of
March 24, 2007. The option prices represented fair market value at the dates of
grant. During 1997, options for 7,500 shares were cancelled pursuant to a
settlement agreement with a former director. Options totaling 10,000 shares
belonging to a former director expired in March 1997.
F-26
<PAGE> 57
The following summarizes the activity under the 1997 Plan:
<TABLE>
<CAPTION>
December 31, 1997
-----------------
<S> <C>
Options-
Outstanding at beginning of year --
Granted 253,583
Exercised --
Expired/Canceled --
Outstanding at end of year 253,583
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997
-----------------
<S> <C>
Option price share ranges
Outstanding at beginning of year --
Granted $1.5625 - 1.875
Options exercisable at end of year 253,583
Exercisable option price ranges $1.5625 - 1.875
Options available for grant at end of year 746,417
</TABLE>
The 1997 stock option plan received shareholder approval at the annual
meeting of stockholders in September 1997. The plan authorizes 1,000,000 shares
to be reserved for issuance under the plan. The 1997 plan is intended as an
incentive and to encourage stock ownership by officers, certain key employees,
consultants and directors of the Company. Several members of management
personnel were subsequently awarded stock options by the Compensation and
Nominating Committee pursuant to employment agreements entered into in the
fourth quarter of 1997. In addition, upon re-election to the Board in September
1997, the five non-employee directors and the Corporate Secretary each received
an option to purchase 25,000 shares of Common Stock at an exercise price of
$1.687, which was the fair market value of the grant date of September 11, 1997.
Beginning in 1994, the Company entered into contracts or agreements with
Directors or officers which bound the Company to provide stock option grants
outside of the existing plans, which have been categorized into an Independent
Plan (the "Independent Plan"). Options granted under this category typically
involve terms which differ from the existing stock option plans of the Company,
namely in the amount of the options granted, the length of the options and the
individuals or groups of individuals to which they are granted. The following
summarizes the activity under the Independent Plan:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996 December 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Options-
Outstanding at beginning of year 245,000 -- 150,000
Granted 237,500 245,000 --
Exercised -- -- 50,000
Expired/Canceled (150,000) -- (100,000)
Outstanding at end of year 332,500 245,000 --
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996 December 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Options price share ranges
Outstanding at beginning of year $ 0.75 - 5.25 -- $5.25 - 5.25
Granted $1.25 - 2.375 $ 0.75 - 5.25 --
Options exercisable at end of year 332,500 245,000 --
Exercisable option price ranges $0.75 - 5.25 $ 0.75 - 5.25 --
</TABLE>
The terms of these grants during 1997 are as follows: (a) On March 24, 1997
the five non-employee members of the Board of Directors each received an option
to purchase 17,500 shares of Common Stock at an exercise price of $2.375 per
share that expires March 24, 2002. These options were in addition to the options
awarded under the 1994 Director's plan and comprised the 25,000 options given to
Directors upon appointment to the Board in March, 1997; (b) Pursuant to a
separation and settlement agreement with a former executive officer, the Company
awarded an option to purchase 10,000 shares of Common Stock; (c) As part of a
mutual release and settlement agreement with a former director, Steven N. Brody,
the Company set forth an option to purchase 40,000 shares of Common Stock in
exchange for other compensation and consideration which resulted in the
cancellation of 25,000 previously issued options; (d) The Board of Directors
approved that Michael S. Delaney, Secretary and Officer receive an option to
purchase 25,000 shares of Common Stock at an exercise price of $2.375
F-27
<PAGE> 58
on March 24, 1997; (e) During 1997 options to purchase 25,000 shares of Common
Stock were granted to former directors who were removed form their respective
positions with the Company on March 24, 1997. Such options (for the former
directors) expire in March 1998.
Stock Warrants
Since the Company's initial public offering of Common Stock in June 1993,
the Company had numerous occasions to issue warrants to underwriters, their
lenders and other organizations.
In connection with the Public Offering for underwriting services provided,
the Company issued 87,500 warrants to Pennsylvania Merchant Group, 70,000
warrants to Commonwealth Associates and 17,500 warrants to Andreas V. Bello on
May 18, 1995, for the purchase of its Common Stock at $8.29 per share. These
warrants are exercisable over a four-year period commencing on May 18, 1996. The
total fair value of these 175,000 warrants on the grant date was approximately
$686,000 as determined through a calculation using the Black-Scholes model. The
value of these warrants has been accounted for as a deduction of the Offering
proceeds through a reduction in additional paid-in capital.
On June 13, 1995, the Company issued 110,000 warrants to US Equity Capital
Corp. for the purchase of its Common Stock at $5.63 per share as compensation
for consulting services. These warrants are exercisable over a three-year period
ending on June 13, 1998. The fair value of these warrants on the grant date
based upon a Black-Scholes model calculation was approximately $220,000 and has
been expensed in the accompanying consolidated statement of operations.
On June 9, 1997, the Company issued 100,000 warrants to Commonwealth
Associates for the purchase of its Common Stock at $2.55 per share as
compensation for advisory services. The Company also reset the exercise price of
the 70,000 warrants issued on May 18, 1995 to Commonwealth Associates and 17,500
warrants to Andres V. Bello to $2.55 per share. The fair value of these warrants
on the grant date based upon a Black-Scholes model calculation was approximately
$185,000 and $161,875, respectively. In addition, on July 23, 1997, the Company
issued 25,000 warrants to Stephen Booke and Gerald Amato, both of Booke &
Company, for investor relations consulting services. The fair value for each of
these warrants on the grant date based upon a Black-Scholes model calculation
was approximately $47,000.
The following summarizes the Company's warrant activity:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996 December 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Warrants-
Outstanding at beginning of year 693,500 693,500 168,500
Granted 237,500 -- 525,000
Exercised -- -- --
Expired/Canceled (87,500) -- --
-------- ------- -------
Outstanding at end of year 843,500 693,500 693,500
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996 December 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Warrant price per share ranges
Outstanding at beginning of year $5.50 - 6.29 $5.50 - 6.25 $5.50 - 6.25
Granted during the year $2.55 -- $5.63 - 8.29
Warrants exercisable at end of year 843,500 693,500 518,500
Exercisable warrant price ranges $2.55 - 8.29 $5.50 - 8.29 $5.50 - 6.25
</TABLE>
14. INCOME TAXES:
The provision (benefit) for income taxes consisted of the following (in
thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Current:
Federal $ (770) $(2,472) $(2,105)
State -- (337) 111
Deferred:
Federal (1,461) 26 (2,596)
State (150) 9 (587)
Valuation allowance 1,611 3,245 4,941
------- ------- -------
$ (770) $ 471 $ (236)
======= ======= =======
</TABLE>
F-28
<PAGE> 59
The reconciliation between income taxes computed by applying the statutory
U.S. federal income tax rate to the loss before income taxes and the actual
benefit for income taxes is as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Income tax at U.S. federal statutory rate $(2,115) $(2,782) $(4,421)
State income taxes, net of federal income tax benefit (150) (69) (768)
Permanent differences (117) 764 260
Valuation allowance 1,612 2,558 4,693
------- ------- -------
$ (770) $ 471 $ (236)
======= ======= =======
</TABLE>
The Company had $9,395,000 in deferred tax assets at December 31, 1997, due
primarily to timing differences resulting from provisions for doubtful accounts
receivable, net book value of fixed and intangible assets, certain reserves and
net operating loss carryforwards. The Company had approximately $11,173,000 of
federal net operating losses and approximately $13,840,000 of state net
operating losses at December 31, 1997, which expire in varying amounts between
1999 and 2010.
A valuation allowance has been recorded to reduce deferred tax assets
because the Company believes, based on the weight of available evidence, it is
more likely than not that all of the deferred tax assets may not be realized.
15. EMPLOYMENT AGREEMENTS:
During March 1996, the Company terminated Mr. DeSimone's employment
agreement. In accordance with the aforementioned agreement, Mr. DeSimone was to
receive six months salary after termination. The Company has not paid, and
pursuant to a settlement agreement, will not pay any termination salary to Mr.
DeSimone. See Note 20 for additional discussion of this settlement.
On April 30, 1996, one of the former owners of an acquired business
terminated her employment agreement with the Company due to a change in control
clause in the employee's contract. A new contract was negotiated with the same
salary; however, the new agreement ended approximately six months prior to the
initial contract. The Company and this employee later agreed to terminate this
employee's contract as a result of operational difficulties. The Company is
currently in dispute with this individual over issues related to this
separation.
In July 1996, the Company terminated a former officer who had been on
suspension pending the outcome of the Board of Director's independent
investigation. The Company is currently involved in arbitration with this former
employee. See Note 20 for additional discussion of this matter.
In September 1996, the Company's then, and now current, chief financial
officer left the employment of the Company to pursue other interests as part of
a negotiated settlement. An employment contract was entered into with a new
chief financial officer; however, this contract was terminated in May 1997 as a
result of the outcome of the Consent Solicitation discussed in Note 1, and a
settlement was reached with this former employee in November 1997. The Company
rehired the previous chief financial officer in September 1997 under a new
employment contract.
In May 1997, the Company's Chief Executive Officer, who was also one of the
Board members removed by the Consent Solicitation, was terminated for cause. The
Company is currently involved in a dispute with this former employee, as the
Company does not believe that it has any obligation for any further payments
under these employment contracts. See Note 21.
In July 1997, the Company's former President, who was also one of the Board
members removed by the Consent Solicitation, was terminated for cause. The
Company is currently involved in a dispute with this former employee, as the
Company does not believe that it has any obligation for any further payments
under this employee's employment contract. The Company also believes that this
employee is still bound by and has violated the terms of the non-compete
provision in this contract.
F-29
<PAGE> 60
The Company has entered into employment agreements, expiring from 1998
through 2002, with certain of its officers and other key employees. The minimum
annual payments required under these agreements are as follows (dollars in
thousands):
<TABLE>
<CAPTION>
<S> <C> <C>
1998 $1,568
1999 944
2000 782
2001 543
2002 559
------
Total $4,396
======
</TABLE>
Included in the above figures are employment agreement obligations to
facility directors who have also provided working capital funds to the Company
as discussed in Note 16. The employment agreements for these employees do not
have a fixed termination date. As such, the payments to those individuals of
approximately $480,000 annually will continue indefinitely beyond 2002.
Between October 29 and November 1, 1997, pursuant to employment contracts
entered into with certain key management personnel, the Company granted options
to purchase a total of 97,500 shares of Common Stock for amounts of shares
ranging from 2,500 to 25,000, at an exercise price of $1.875. The options were
granted at the fair market value on the date of grant. In addition, certain
employees also were entitled to additional options based on performance as
outlined in the agreements. Subsequently, the Company granted approximately
6,000 options to purchase Common Stock during the fourth quarter at exercise
prices based upon an average of the closing price of the Company's stock for the
five days preceding the date of grant. These contracts provide for quarterly
option grants based upon the financial performance of certain operating units of
the business. Such grants are made on the filing date of the Company's financial
data with the Securities and Exchange Commission.
The employment contracts of various members of management include change in
control provisions whereby said employees would receive a maximum of six months
base salary. Change in control provisions include, acquisition by third parties,
mergers, consolidation, sale of more than 50% of assets, any person or group
becoming the beneficial owner of more than 30% of the stock of the Company, or
if Thomas W. Zaucha no longer serves as the CEO or Chairman.
In addition to the aforementioned employment agreements, the Company had a
management agreement with Mr. James Shields to perform services within certain
business operations of the Company. The agreement, before any extension, expires
on November 29, 2002. Mr. Shield's compensation was to be a fee of 12% of the
gross collections of the operations that he managed. See Note 12.
16. CONTRACTUAL OBLIGATIONS TO EMPLOYEES:
Prior to the acquisition of Keystone, certain former partners of Keystone
and clinicians executed employment agreements with Keystone. These contracts
required the employees to provide funds to Keystone as part of their incentive
compensation arrangements. In return these employees received incentive
compensation equivalent to 25% of the net income for their facilities for each
month. As of December 31, 1997 and 1996, the balance of the funds provided to
Keystone was $352,065 and $952,000, respectively.
As provided for within these agreements, the change in controlling interest
in Keystone enables these employees to terminate the contracts and be entitled
to either the funds they provided to Keystone or two times the most recent
twelve months of pre-commission net income of the facility that they operate.
During 1997, six of these employees exercised their buyout option resulting in
an obligation of $904,312. Four of these employees were paid in full in 1997,
with a remaining unpaid liability of $237,000 as of December 31, 1997, which is
being paid pursuant to payment schedules arranged with the remaining two
employees. As of December 31, 1997 and 1996, the calculated maximum amounts due
to the remaining employees under these agreements, including the $237,000
discussed above, is $1,031,331 and $1,633,000, respectively. See Note 12.
F-30
<PAGE> 61
17. FAIR VALUE OF FINANCIAL INSTRUMENTS:
The carrying amounts and estimated fair values of the Company's financial
instruments as of December 31, 1997 and 1996, are as follows (dollars in
thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
Carrying Amount Fair Value Carrying Amount Fair Value
--------------- ---------- --------------- ----------
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 657 $ 657 $ 1,607 $ 1,607
Long-term debt, including
current portion 19,786 19,786 19,103 19,103
</TABLE>
The following methods and assumptions were used by the Company in
estimating the fair value of each class of financial instruments for which it is
practicable to estimate that value. Fair value is defined as the amount at which
the instrument could be exchanged in a transaction between willing parties.
CASH AND CASH EQUIVALENTS
The carrying amount reported in the balance for cash and cash equivalents
approximates their fair value.
LONG-TERM DEBT
The fair value of long-term debt is estimated based on the quoted market
prices for the same or similar issues or on the current rates offered to the
Company for debt of the same remaining maturities.
18. SIGNIFICANT CUSTOMERS:
Although net patient service revenue is generated by performing procedures
or services for the ultimate patients, who are referred for care through their
physician, the Company receives most of its revenues through payments made by
certain governmental programs, private insurers such as Blue Cross and Blue
Shield of Western Pennsylvania or organizations such as nursing homes.
Additionally, the Company receives management fees for certain entities for
which it performs certain management services.
19. COMMITMENTS AND CONTINGENCIES:
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. See Notes 3 and 15. 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.
20. LITIGATION:
In the ordinary course of business, the Company may be subject to claims
and legal actions, from time to time, by patients and others. The Company does
not believe that any such pending actions, if adversely decided, would have a
material adverse effect on its financial condition.
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 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. 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.
F-31
<PAGE> 62
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.). 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) and 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.
In response to Northstar's suit against Mark A. DeSimone and the other
defendants, Coregis Insurance Company, a professional liability insurer which
insured DeSimone's former law firm, brought an action in federal court (Coregis
Insurance Co. v. Ogg, Jones Cordes & Ignelzi, C.A. No. 96-2243 W.D. Pa.) seeking
a declaratory judgement that Northstar's claims were not covered by the
defendant's professional liability policy. Although the action named Northstar,
its primary purpose was to determine the obligations of the insurance company.
The main defendant was the law firm which Northstar had sued and which claimed
coverage under the professional liability policy in question. The case was
settled as part of the settlement of the Butler action by means of a $250,000
payment into the Butler settlement fund by the defendant law firm's professional
liability insurer.
In May 1996, a group of approximately 40 Northstar shareholders filed suit
in the state court in California, (Bosco v. Northstar, C.A. No. BC 149867,
Superior Court of California for Los Angeles County), which alleged violations
of various California securities laws and related common law claims. Northstar
and its former Chief Executive Officer, Mark A. DeSimone, and Northstar's former
Chief Financial Officer, Michael J. Kulmoski, Jr. along with the Company's
former auditor, Richard A. Eisner & Co., LLP were named as defendants. In
summary, these claims arose out of the false and misleading statements
concerning Northstar and its financial condition, which were disseminated by the
individual defendants. In November 1997, the lawsuit was settled in connection
with settlement of the Butler action described above for the sum of $500,000,
which was paid out of the settlement fund created in the Bulter action in
December 1997.
In July 1996, Michael Kulmoski, Jr., Northstar's former Chief Financial
Officer and a named defendant in both the shareholder class actions and the
individual action 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. The panel
has scheduled a hearing on the issue of damages for May 1, 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 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.
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.
In February 1997, Thomas W. Zaucha, the current Chairman of the Board of
Directors and Chief Executive Officer of Northstar, commenced a solicitation of
Northstar stockholder consents to remove and replace the other members of the
Northstar Board of Directors which at the time consisted of Messrs. Brody,
Jarrett, Pesci, Smallacombe and Watson (the "Brody Board") and effectuate
related changes in Northstar's bylaws (the "Consent Solicitation"). Shortly
thereafter, the Board of Directors terminated Mr. Zaucha's employment with the
Company,
F-32
<PAGE> 63
though he remained a member of the Board of Directors. On March 24, 1997, Mr.
Zaucha delivered executed consents representing the votes of 61% of the
outstanding shares in favor of his proposals and, following confirmation of the
decision of the Delaware Chancery Court on May 8, 1997, Mr. Zaucha resumed his
duties as the Company's Chief Executive Officer. The ruling of the Delaware
Chancery Court was appealed to the Delaware Supreme Court by three of the Board
members removed from office as a result of the Chancery Courts' decision. On
August 1, 1997, a unanimous panel of the Delaware Supreme Court affirmed the
decision of the Delaware Chancery Court confirming the election of the current
Board.
In January 1997, the Company and Samuel Armfield III, M.D., reached a
settlement in regard to the various claims that each had against the other,
resulting from the acquisition by the Company of the stock of Vascusonics, Inc.
and certain of the assets of Penn Vascular Labs, P.C.
In January 1997, the Justice Department initiated an action against Samuel
Armfield, III, M.D. for claims amounting to $300,000 in connection with Dr.
Armfield's Medicare billings. Although such claims could be trebled if Dr.
Armfield is convicted, the Company believes that its exposure, through its
dealings with Vascusonics, would aggregate $50,000 to $100,000. In addition, the
Company has recourse against Dr. Armfield for any amounts assessed against the
Company, which the Company plans to aggressively pursue, if necessary.
21. SUBSEQUENT EVENTS
In March 1998, the Company reached a settlement in principle with
Ultrasonics, Inc. and Jeff Bergman, that results in mutual releases and no
payments to either party. The paperwork in this matter is expected to be
completed in the near future. See Note 20.
In March 1998, the Company its decision to withdraw from the mobile
diagnostic business. In November 1995, the Company acquired certain assets from
Penn Vascular Lab, P.C. and the stock of Vascusonics, Inc. (Note 3). This
division has incurred losses in 1997 that have strained the resources of the
Company. This decision will allow the Company to focus its efforts on its core
rehabilitation business.
In March 1998, Robert J. Smallacombe, a former director, consultant and
employee of the Company filed a Writ of Summons against the Company and other
related parties. Mr. Smallacombe was terminated for cause in May 1997. See Note
15. Mr. Smallacombe believes he is entitled to the balance of his employment
contract and certain stock options that may or may not have been granted. The
Company believes that it has counterclaims against Mr. Smallacombe, and intends
to vigorously defend itself against these claims.
As discussed in Note 20, an arbitration panel decided that the record does
not support the conclusion that Michael Kulmuski, Jr.'s employment had been
terminated for "cause" as defined in his employment agreement.
F-33
<PAGE> 64
Schedule II
NORTHSTAR HEALTH SERVICES, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
FOR YEARS ENDING DECEMBER 31, 1997, 1996 AND 1995
(Dollars in Thousands)
<TABLE>
<CAPTION>
Balance at Charged to Balance at
Beginning of Costs and Deductions from End of
Period Expenses Recoveries Reserve (1) Other Period
------------ ----------- ---------- --------------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Year ended December 31,
1995 - Allowance for
doubtful accounts $ 141 2,301 -- (715) 1,791(2) $3,518
Year ended December 31,
1996 - Allowance for
doubtful accounts(3) $ 3,518 1,820 -- (3,323) -- $2,015
Year ended December 31,
1997 - Allowance for
doubtful accounts $ 2,015 2,024 -- (2,698) -- $1,341
</TABLE>
(1) Represents uncollected accounts charged against the allowance account.
(2) Represents allowance for doubtful accounts acquired through acquisition.
(3) Certain reclassifications have been made to conform with the current year
presentation.
F-34
<PAGE> 65
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULE
To Northstar Health Services, Inc.:
We have audited in accordance with generally accepted auditing standards,
the financial statements included in Northstar Health Services, Inc.'s Form
10-K, and have issued our report thereon dated March 23, 1998. Our audit was
made for the purpose of forming an opinion on those statements taken as a whole.
The schedule listed in the index in Item 14(a) of this Form 10-K is the
responsibility of the Company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
Arthur Andersen LLP
Pittsburgh, Pennsylvania
March 23, 1998
F-35
<PAGE> 1
Exhibit 4.1
1997 STOCK OPTION PLAN
Purpose
The Company's 1997 Stock Option Plan, which is attached hereto as EXHIBIT
A, is intended as an incentive and to encourage stock ownership by officers,
consultants, directors and certain other key employees of the Company and its
subsidiaries in order to increase their proprietary interest in the Company's
success and to encourage them to remain in the employ or service of the Company.
Administration
The 1997 Stock Option Plan is administered by the Compensation Committee
(the "Committee"), which is appointed by the Board of Directors, as described in
the Plan. The Committee, subject to the provisions of the 1997 Stock Option
Plan, in its sole discretion, may grant options under the Plan, and has the
power to construe the Plan, to determine all questions thereunder and to adopt
and amend such rules and regulations for the administration of the 1997 Stock
Option Plan as it may deem desirable.
Eligibility, Grant of Options
Pursuant to the 1997 Stock Option Plan, key persons of the Company and its
subsidiaries who have been selected by the Committee as participants are
eligible to receive stock options. In addition, under the 1997 Stock Option
Plan, certain directors of the Company who are not employees of the Company may
be eligible to receive limited stock options pursuant to a formula grant to be
determined and instituted at the discretion of the Committee.
Options granted under the 1997 Stock Option Plan may be "incentive stock
options" ("ISOs"), within the meaning of Section 422 of the Internal Revenue
Code of 1986, as amended (the "Code"), or nonqualified stock options ("NQSOs");
provided, however, that ISOs may only be granted to participants who are also
employees of the Company and its subsidiaries. The exercise price of the options
will be determined by the Committee when the options are granted, subject to a
minimum price in the case of ISOs of the Fair Market Value (as defined in the
1997 Stock Option Plan) of the Common Stock on the date of grant and a minimum
price in the case of NQSOs of 85% of the Fair Market Value of the Common Stock
on the date of grant. Options vest and become exercisable as determined by the
Committee. The option exercise price may be paid in cash, by check, by delivery
to the Company shares of Common Stock already owned by the option holder for at
least six months, or by such other method as the Committee may permit from time
to time.
Amount of Shares
The aggregate number of shares of Common Stock that may be issued pursuant
to a stock option under the 1997 Stock Option Plan may not exceed 1,000,000. The
maximum number of shares which may be subject to options in any calendar year to
an option holder shall not exceed 100,000 shares.
Effect of Change in Control of the Company
In the event of a Change in Control (as defined in the 1997 Stock Option
Plan) of the Company, all options will become immediately vested and
exercisable.
-9-
<PAGE> 2
Term of Options
No options may be granted under the 1997 Stock Option Plan after September
11, 2007.
Market Value
The market value of the Common Stock as determined by the closing price of
July 15, 1997 was $3.00 per share.
Federal Tax Consequences
Set forth below is a brief description of the federal income tax
consequences applicable to ISOs and NQSOs granted under the 1997 Stock Option
Plan.
ISOs
No taxable income is realized by the optionee upon the grant or exercise of
an ISO. If Common Stock is issued to an optionee pursuant to the exercise of an
ISO, and if no disqualifying disposition of such shares is made by such optionee
within two years after the date of grant or within one year after the transfer
of such shares to such optionee, then (1) upon sale of such shares, any amount
realized in excess of the option price will be taxed to such optionee as a
long-term capital gain and any loss sustained will be a long-term capital loss,
and (2) no deduction will be allowed to the optionee's employer for federal
income tax purposes.
If the Common Stock acquired upon the exercise of an ISO is disposed of
prior to the expiration of either holding period described above, generally (1)
the optionee will realize ordinary income in the year of disposition in an
amount equal to the excess (if any) of the fair market value of such shares at
exercise (or, if less, the amount realized on the disposition of such shares)
over the option price paid for such shares, and (2) the optionee's employer will
be entitled to deduct such amount for federal income tax purposes if the amount
represents an ordinary and necessary business expense. Any further gain (or
loss) realized by the optionee will be taxed as short-term or long-term capital
gain (or loss), as the case may be, and will not result in any deduction by the
employer.
Subject to certain exceptions for disability or death, if an ISO is
exercised more than three months following termination of employment, the
exercise of the option will generally be taxed as the exercise of an NQSO.
For purposes of determining whether an optionee is subject to any
alternative minimum tax liability, an optionee who exercises an ISO generally
would be required to increase his or her alternative minimum taxable income, and
compute the tax basis in the stock so acquired, in the same manner as if the
optionee had exercised an NQSO. Each optionee is potentially subject to the
alternative minimum tax. In substance, a taxpayer is required to pay the higher
of his/her alternative minimum tax liability or his/her "regular" income tax
liability. As a result, a taxpayer has to determine his/her potential liability
under the alternative minimum tax.
-10-
<PAGE> 3
In general, for purposes of the alternative minimum tax, the exercise of an
ISO will be treated essentially as if it were the exercise of an NQSO. As a
result, the rules of Section 83 of the Code relating to transfers of property,
including restricted property, will apply in determining the optionee's
alternative minimum taxable income. Consequently, an optionee exercising an ISO
with respect to unrestricted Common Stock will have income, for purposes of
determining the base for the application of the alternative minimum tax, in an
amount equal to the spread between the option price for the shares and the fair
market value of the shares on the date of exercise.
NQSOs
With respect to NQSOs: (1) no income is realized by the optionee at the
time the Option is granted; (2) generally, at exercise, ordinary income is
realized by the optionee in an amount equal to the difference between the option
price paid for the shares and the fair market value of the shares, if
unrestricted, on the date of exercise, and the optionee's employer is generally
entitled to a tax deduction in the same amount subject to applicable tax
withholding requirements; and (3) at sale, appreciation (or depreciation) after
the date of exercise is treated as either short-term or long-term capital gain
(or loss) depending on how long the shares have been held.
Section 162(m) Deductibility Limitation
Section 162(m) of the Code provides that the deduction by a publicly-held
corporation for compensation paid in a taxable year to the chief executive
officer and the four other most highly compensated executive officers of the
corporation is limited to $1 million per each individual officer. For purposes
of Section 162(m) of the Code, compensation which is performance-based is not
counted as subject to the deductibility limitation. Income pursuant to options
granted is intended to be fully deductible by the Company, by qualifying such
income as performance-based compensation and, therefore, exempt from the
limitations of Section 162(m) of the Code.
The foregoing summary with respect to Federal income taxation does not
purport to be complete and reference is made to the applicable provisions of the
Code.
-11-
<PAGE> 1
Exhibit 10.3
EXECUTION COPY
FORBEARANCE AGREEMENT
FORBEARANCE AGREEMENT, dated as of August 18, 1997 (this "Forbearance
Agreement"), among
(i) NORTHSTAR HEALTH SERVICES, INC., a Delaware corporation (the
"Borrower"),
(ii) NORTHSTAR MEDICAL SERVICES, INC., f/k/a NSHS HOLDINGS, INC., a
Delaware corporation; DIRECT PROVIDER NETWORK, INC., f/k/a NORTHSTAR HS
HOLDINGS, INC., a Delaware corporation; NSHS SERVICES, INC., a Delaware
corporation; NORTHSTAR HEALTH CONSULTING, INC., a Delaware corporation;
ABILITY PLUS REHABILITATION MANAGEMENT COMPANY, f/k/a NSHS CARDIAC
HOLDINGS, INC., a Delaware corporation; NORTHSTAR DIAGNOSTIC SERVICES,
INC., f/k/a NORTHSTAR NUCLEAR SERVICES, INC., a Delaware corporation;
KEYSTONE REHABILITATION SYSTEMS, INC., a Pennsylvania corporation; KEYSTONE
REHABILITATION MANAGEMENT, INC., a Pennsylvania corporation; and
VASCUSONICS, INC., a Pennsylvania corporation (collectively, together with
the New Guarantors referred to below, the "Subsidiary Guarantors"); and
(iii) IBJ SCHRODER BANK & TRUST COMPANY ("IBJS");
in respect of the Credit Agreement referred to below.
WITNESSETH:
WHEREAS, the Borrower, the lenders parties thereto (the "Lenders") and
IBJS, as Agent (in such capacity, the "Agent") have entered into that certain
Credit Agreement dated as of October 20, 1995 (as amended, the "Credit
Agreement") and the Borrower has entered into certain other Credit Documents (as
defined in the Credit Agreement); and
WHEREAS, the Subsidiary Guarantors are parties to that certain Subsidiaries
Guarantee dated as of October 20, 1995 (as amended, supplemented or otherwise
modified, the "Subsidiaries Guarantee") to the Agent for the benefit of the
Lenders and have entered into certain other Credit Documents; and
WHEREAS, certain Events of Default (as defined in the Credit Agreement)
exist under the Credit Agreement; and
WHEREAS, the Agent and the Lenders are unwilling to waive the Events of
Default that currently exist; and
<PAGE> 2
WHEREAS, notwithstanding the foregoing, subject to the terms and conditions
hereof, the Agent and the Lenders are willing, through August 31, 1997, to
forbear in certain respects in the enforcement of the remedies set forth in the
Credit Documents as set forth herein; provided, that the rights of the Agent
and the Lenders are not otherwise waived or impaired.
NOW, THEREFORE, in consideration of the premises, the mutual covenants
contained herein and for other valuable consideration, the receipt and adequacy
of which are hereby acknowledged, the Borrower, the Subsidiary Guarantors, the
Agent and the Lenders hereby agree as follows:
1. Definitions. Capitalized terms used and not otherwise defined herein
shall have the meanings ascribed thereto in the Credit Agreement.
2. Acknowledgments.
(a) The Borrower acknowledges that, as of June 30, 1997, it is
indebted to the Lenders (i) pursuant to the Term Loan and the Term Note, in the
amount of $6,083,335 (the "Existing Term Loan Principal"); (ii) pursuant to the
Revolving Credit Loans and the Revolving Credit Note, in the amount of
$2,000,000 (the "Existing Revolving Credit Principal"); (iii) pursuant to the
Acquisition Loans and the Acquisition Note, in the amount of $6,000,000 (the
"Existing Acquisition Loan Principal"); (iv) accrued but unpaid interest on the
Existing Term Loan Principal, Existing Revolving Credit Principal and Existing
Interest"), and (v) accrued but unpaid fees in the amount of $1,176.48
("Existing Fees") (collectively, the Existing Term Loan Principal, the Existing
Revolving Credit Principal, the Existing Acquisition Principal, the Existing
Interest and the Existing Fees, the "Outstanding Indebtedness").
(b) The Borrower acknowledges the effectiveness and continuing validity
of the Credit Agreement (including, without limitation, Section 12.5 thereof)
and of each Credit Document to which it is a party.
(c) The Borrower acknowledges that one or more Events of Default have
occurred and are continuing and that, pursuant to Section 10 of the Credit
Agreement, the Agent is presently entitled, with the consent of the Lenders, to
terminate the Commitments and to declare the Outstanding Indebtedness and the
other amounts owing under the Credit Agreement to be due and payable.
(d) The Borrower acknowledges the cancellation of (i) the unused
portion of the Acquisition Credit Commitment and (ii) of the Revolving Credit
Commitment, in each case prior to the date hereof. The Revolving Credit
Commitment is subject to reinstatement at the sole option of the Lenders.
-2-
<PAGE> 3
(e) Each Subsidiary Guarantor acknowledges the effectiveness and
continuing validity of the Subsidiaries Guarantee and of each Credit Document to
which it is a party.
(f) Each Subsidiary Guarantor acknowledges the existence and amount of
the Outstanding Indebtedness and its liability therefor pursuant to the terms of
the Subsidiaries Guarantee.
(g) Each Subsidiary Guarantor expressly acknowledges and consents to
this Forbearance Agreement and to the terms hereof, such Forbearance Agreement
and terms to be without prejudice to such Subsidiary Guarantor's liability
pursuant to the Subsidiaries Guarantee and the other Credit Documents to which
it is a party.
(h) Each of the Borrower, each Subsidiary Guarantor, and each of Thomas
W. Zaucha, Alice L. Zaucha and the Zaucha Family Limited Partnership
(collectively, the "Zaucha Parties"), hereby ratifies and acknowledges all of
the terms and conditions of the letter agreement, dated April 8, 1997, between
IBJ Schroder Bank & Trust Company and the Zaucha Parties (the "First
Pre-Negotiation Letter"), the Borrower and each Subsidiary Guarantor hereby
represent and warrant that all corporate action on its part necessary for such
ratification has been taken and is in full force and effect, and such terms and
conditions of the First Pre-Negotiation Letter are hereby incorporated by
reference as if such terms and conditions were set forth herein in full.
(i) The Company hereby ratifies and acknowledges all of the terms and
conditions of the letter agreement, dated May 21, 1997, between the Company and
IBJS (the "Second Pre-Negotiation Letter"), and the Company hereby represents
and warrants that all corporate action on its part necessary for such
ratification has been taken and is in full force and effect, and such terms and
conditions of the Second Pre-Negotiation Letter are hereby incorporated by
reference as if such terms and conditions were set forth herein in full.
(j) The Borrower and its Subsidiaries hereby acknowledge and agree
that, without the consent of the Agent and the Lenders as provided in the Credit
Agreement and in the Subordination Agreement, dated as of October 15, 1995, by
and among the Subordinated Creditors parties thereto, the Company and the Agent,
as amended by an Amendment and Supplement, dated as of November 15, 1995
(designating the Zaucha Parties and David Watson as New Subordinated Creditors),
no payments shall be made to Zaucha Parties in respect of debt owing to the
Zaucha Parties subject to the Subordination Agreement except in strict
conformity with the terms of the Subordination Agreement, notwithstanding that
any payments may have heretofore been permitted to be made to the Zaucha Parties
in respect of such debt.
3. Forbearance; Deferral of Principal; Interest Rate.
(a) Subject to the terms and conditions set forth herein, the Agent and the
Lenders hereby agree that none of them shall, prior to the Forbearance
Termination Date,
-3-
<PAGE> 4
exercise any of the remedies set forth in the Credit Agreement or in any of the
other Credit Documents.
(b) Subject to the terms and conditions set forth herein, the Agent and the
Lenders hereby agree that the unpaid principal installments of the Term Loan
which were due or became due prior to the date hereof, and each principal
installment of the Term Loan that shall become due and payable from the date
hereof to the Forbearance Termination Date, together with accrued interest on
the Outstanding Indebtedness shall be deferred until, and shall be due on, the
Forbearance Termination Date.
(c) Subject to the terms and conditions set forth herein, the Agent and the
Lenders hereby waive the imposition of interest at the Default Rate as provided
in Section 5.5(c) of the Credit Agreement prior to the Forbearance Termination
Date and the Agent, the Lenders agree that interest shall accrue on all unpaid
Obligations for the period from the date of the Credit Agreement to but
excluding the Forbearance Termination Date at the rates provided for such
Obligations in Section 5.5(a) or (b) (or, if no such rate is so provided, at the
rate provided for Revolving Credit Loans which are Base Rate Loans in Section
5.5(b)).
(d) For so long as this Forbearance Agreement shall remain in effect or a
Default shall have occurred and be continuing, none of the Loans may be
maintained as Eurodollar Loans.
4. Termination. This Forbearance Agreement shall terminate on August 31,
1997, unless earlier terminated upon the occurrence of a Forbearance Event of
Default (any such date, the "Forbearance Termination Date"). The Forbearance
Termination Date may be extended from time to time by the execution and delivery
by the Agent and the Borrower of an extension supplement substantially in the
form of Exhibit A hereto and appropriately completed (an "Extension
Supplement"). The Lender shall have no obligation to extend the Forbearance
Termination Date pursuant to any Extension Supplement, and the Agent's agreement
to permit any such extension shall be subject to the sole discretion of the
Agent.
5. Representations and Warranties. In order to induce the Lenders to enter
into this Forbearance Agreement, the Borrower and each Subsidiary Guarantor
hereby represents and warrants to the Agent and to each Lender that:
(a) Subject to Section 5(b) of this Forbearance Agreement, each of the
representations and warranties made by the Borrower and each of the
Subsidiary Guarantors in each Credit Document to which it is a party is
true and correct in all material respects as of the date hereof.
(b) The representations and warranties made by the Borrower in the
Credit Agreement are qualified to the extent set forth on the Supplemental
Disclosure Schedule attached as Schedule 1 hereto.
-4-
<PAGE> 5
(c) The Borrower has no intention of commencing bankruptcy, insolvency
or similar proceedings prior to August 31, 1997 and has no intention of
commencing such proceedings thereafter if mutually acceptable agreements
can be reached among the Borrower and its principal creditors and
shareholders.
(d) Attached to this Forbearance Agreement as Exhibit B is a true and
complete description of any and all mergers, name changes, asset
dispositions (whether by dividend or otherwise) or similar transactions to
reorganize the corporate or capital structure of the Borrower and its
Subsidiaries which are currently contemplated by the Borrower or any
Subsidiaries or which have occurred since October 20, 1995 (the "Corporate
Structure Transactions").
6. Conditions Precedent to Effectiveness of Forbearance Agreement. This
Forbearance Agreement shall not become effective unless and until:
(a) the Agent has received this Agreement, executed and delivered by a
duly authorized officer of the Borrower and each Subsidiary Guarantor;
(b) [intentionally omitted];
(c) the Agent has received evidence satisfactory to the Agent that the
Pre-Negotiation Letter has been ratified by the Board of Directors of the
Borrower;
(d) the Agent has received the executed legal opinion of Wilikie Farr
& Gallagher, counsel to the Borrower and the Subsidiary Guarantors,
covering such matters incident to the transactions contemplated by this
Forbearance Agreement as the Agent may reasonably require;
(e) the Borrower shall have taken (at the Borrower's expense) all
actions necessary or desirable to perfect or to continue perfected the
security interests of the Agent and the Lenders in all of the property of
the Borrower and its Subsidiaries after giving effect to the Corporate
Structure Transactions (including, without limitation, delivery of stock
certificates and stock powers to the Agent, execution, delivery and filing
of financing statements under the Uniform Commercial Code of any
jurisdiction, execution and delivery of any amendments or supplements to
any Credit Documents, and any other filings, recordations or notices as the
Agent may request); and
(f) the Agent has received such other documents and information as the
Agent may reasonably require, which documents and information shall be
satisfactory to the Agent in its sole discretion.
7. Covenants. The agreement of the Agent and the Lenders to forbear from
exercising remedies as set forth in Section 3 hereof is expressly conditioned
upon the Borrower's continued compliance with the following:
-5-
<PAGE> 6
(a) The Borrower shall continue to comply with the affirmative covenants
set forth in Section 8 of the Credit Agreement (other than Section 8.3 thereof);
provided that the monthly financial statements required to be delivered pursuant
to Section 8.1(c) of the Credit Agreement within 30 days following the last day
of each month may, with respect to the last month of each fiscal quarter, be
delivered within 45 days following the last day of each such month.
(b) The Borrower shall furnish to the Agent:
(i) weekly reports of actual cash receipts and disbursements ("Weekly
Cash Flow Reports") no later than Thursday of the next succeeding week,
each such Weekly Cash Flow Report to be in the format currently being
provided to the Agent; and
(ii) monthly reports of actual cash receipts and disbursements for
each month, each period of three months ended on such month and
year-to-date ("Monthly Cash Flow Reports") and the Company's "Monthly
Profit and Loss Statement (Consolidated by Cost Center)" and "Detail
Consolidated Profit and Loss Statement", in each case no later than the
fifteenth day of the next succeeding month, and in the format currently
being provided to the Agent (including all schedules thereto currently
being provided to the Agent);
each of such Weekly Cash Flow Reports and Monthly Cash Flow Reports (including
schedules thereto) to be certified as correct and complete by a Responsible
Officer of the Borrower and to be provided both in hard copy form and an
electronic form reasonably satisfactory to the Agent.
(d) Collections for each successive four-week period ending on a Friday
shall be no less than $2,500,000.
(e) Cash disbursements for each successive four-week period ended on a
Friday, excluding cash disbursements during such period for shareholder
lawsuits, shall not exceed the sum of collections for such period and the amount
of cash balances on the first day of such period. Except as provided in the
immediately prior sentence, without the prior consent of the Lenders, the
Borrower and each of its Subsidiaries agrees that it shall not pay, or commit to
pay, or undertake any transaction which would result in or require the payment
of, any cash disbursement that would be unusual or extraordinary or outside the
ordinary course of business, such determination to be made by reference both to
the business of the Borrower and its Subsidiaries as presently conducted and by
reference to the business plan, budget and projections delivered pursuant to
Section 7(k).
(f) Amounts invoiced by the Borrower and its Subsidiaries on or prior to
the tenth day of each month for the prior month shall be no less than
$3,000,000.
(g) The Borrower shall provide full disclosure to the Agent of all proposed
settlements of any material litigation involving the Borrower.
-6-
<PAGE> 7
(h) The Borrower shall promptly provide such additional financial and other
information, including, without limitation, payment plans for significant
creditors not yet negotiated or known as of the date hereof, certified copies of
corporate proceedings of the Borrower and any of its Subsidiaries, certified
copies of management communications and communications from certified public
accountants engaged by the Borrower or any of its Subsidiaries from time to
time, certified copies of all notices from or other communications with the
Securities and Exchange Commission, the National Association of Securities
Dealers, any stock exchange or similar organization and other Governmental
Authorities, and such other information as the Agent or the Lenders may from
time to time request. Without limitation of the foregoing, the Borrower shall
deliver to the Agent promptly, copies of all reports filed by the Borrower or
any Subsidiary with the Securities and Exchange Commission on the EDGAR system.
(j) The Borrower shall, not later than September 30, 1997, provide to the
Agent and each Lender a business plan and projected financial statements of the
Borrower and its Subsidiaries for the period from July 1, 1997 to June 30, 1998
(the "Plan Period"), which business plan and projected financial statements
shall be in form and substance reasonably acceptable to the Agent and the
Lenders.
(1) The Borrower shall pay:
(i) to Cadwalader, Wickersham & Taft, an amount equal to $5,000 per
week on account of legal fees and disbursements previously invoiced;
(ii) to the Agent for the account of the Lenders, an amount for each
month listed in the table below set forth opposite such month below,
payable in the equal bimonthly installments set forth below on the 10th day
and the 25th day of each of such months:
<TABLE>
<CAPTION>
Monthly Bi-Monthly
Month Amount Installment
----- ------ -----------
<S> <C> <C>
June 1997 $130,000 $65,000
July 1997 130,000 65,000
August 1997 130,000 65,000
</TABLE>
in each case on account of accrued and unpaid interest on the outstanding
Loans;
(iii) to the Agent for the account of the Lenders, concurrently with
the delivery to the Agent of each Weekly Cash Plow Report, an amount equal
to the excess, if any, of (A) collections for such week over (B) the sum of
cash disbursements for such week (including cash disbursements pursuant to
Section 6(l)(i) and (ii) hereof) and an amount of cash to be retained from
such collections determined by the Borrower in light of reasonably
anticipated cash needs and consistent with maintaining prudent,
non-excessive reserves (such excess, "Excess Cash"), which Excess Cash
shall be applied by the Agent and
-7-
<PAGE> 8
the Lenders to the payment of accrued and unpaid interest on the
outstanding Loans, until all such accrued and unpaid interest has been
paid in full; and
(iv) notwithstanding the provisions of Section 5.4(b) of the
Credit Agreement and Section 7(l)(iii) hereof, to the Agent for the
account of the Lenders, a percentage to be negotiated between the
Borrower and the Lenders of net proceeds of any extraordinary
transactions, including, without limitation, transactions of the type
described in Section 5.4(b) of the Credit Agreement.
If the Forbearance Termination Date is extended pursuant to an Extension
Supplement, unless modified pursuant to such Extension Supplement the
payments set forth in this Section 7(1) shall continue during the term of
such extension of the Forbearance Termination Date, in the same amounts and
at the same periodicity, as set forth for the initial term of this
Forbearance Agreement in this Section 7(1).
8. Events of Default.
(a) The agreement of the Agent and the Lenders to make Forbearance
Revolving Credit Loans and to forbear from exercising remedies pursuant to
Section 3 hereof shall immediately terminate and be of no further force and
effect upon the occurrence of any of the following (each, a "Forbearance Event
of Default"):
(i) the occurrence of one or more Defaults or Events of Default
under any of Subsections 10(c), (d), (f), (h), (i), (j) and (1) of the
Credit Agreement (other than a Default or Event of Default arising
solely from a breach of the Borrower's obligations under Section 9.1,
9.13 (to the extent applicable to Withdrawal Payments) or 9.20 of the
Credit Agreement); or
(ii) any representation or warranty made or deemed made by the
Borrower or any Subsidiary Guarantor in Section 5 hereof or elsewhere
herein or which is contained in any certificate, document or financial
or other statement created and/or delivered at any time under or in
connection with this Forbearance Agreement or on or subsequent to the
date hereof under or in connection with any other Credit Document
shall prove to have been incorrect in any material respect on or as of
the date made or deemed made; or
(iii) the Borrower or any Subsidiary shall default in the
observance or performance of any agreement contained in Section 7; or
(iv) Withdrawal Payments shall be paid in excess of (A) with
respect to lump sum payments, $550,000 in the aggregate, and (B) with
respect to any other payments to any Person entitled to receive
Withdrawal Payments, an amount in excess of the amounts currently
being paid to such Person as "Employment Commission EA Payments" (such
amounts to be paid no more frequently than such Employment
Commission EA Payments and to be payable only to Persons who
continue to operate a clinic of the Company); or
-8-
<PAGE> 9
(v) the Agent or the Lenders shall in their sole discretion
determine that an adverse change has occurred in the finances or
business operations of the Borrower or the Subsidiary Guarantors; or
(vi) (x) the Agent or the Lenders shall in their sole discretion
determine that any litigation, investigation or proceeding relating to
the Borrower or any Subsidiary thereof or any present or former
Affiliate of any thereof, any actual or proposed solicitation of
proxies or consents from any holders of any securities issued by the
Borrower or any of its Subsidiaries or similar action, or any change
or development in or in respect of any of the foregoing (including,
without limitation, any settlement thereof), could have an adverse
effect on the business, operations, properties, condition (financial
or otherwise) or prospects of the Borrower or any Subsidiary thereof
or on the rights or remedies of the Agent or the Lenders under any of
the Credit Documents, or (y) any settlement of any of the foregoing
shall be entered into on terms and conditions that are not acceptable
to the Agent or any Lender in their sole discretion, or (z) the
litigation currently pending in the Federal District Court for the
Western District of Pennsylvania captioned "Michael Butler et al. vs.
Northstar Health Services, Inc. et al." shall fail to be settled on
terms and conditions satisfactory to the Agent and the Lenders on or
prior to September 30, 1997; or
(vii) (x) Any Person or "group" (within the meaning of Section
13(d) or 14(d) of the Securities Exchange Act of 1934, as amended)
other than the Zaucha Parties (A) shall have acquired beneficial
ownership of 30% or more of any outstanding class of Capital Stock
having ordinary voting power in the election of directors of the
Borrower or (B) shall obtain the power (whether or not exercised) to
elect a majority of the Borrower's directors or (ii) the Board of
Directors of the Borrower shall not consist of a majority of
Continuing Directors; for purposes of this Agreement, "Continuing
Directors" shall mean the directors of the Borrower on the Forbearance
Effective Date and each other director, if such other director's
nomination for election to the Board of Directors of the Borrower is
recommended by a majority of the then Continuing Directors; or
(ix) an Event of Default shall occur under Section 10(g) of the Credit
Agreement, or the Company shall incur liabilities (including in respect of a
compliance audit) relating to a 401(k) Plan (one such liability which is more
fully described on the Supplemental Disclosure Schedule), together aggregating
in excess of $150,000.
(b) Upon the occurrence of a Forbearance Event of Default on or as of any
date, the Forbearance Termination Date shall be deemed to occur on said date.
9. Absence of Waiver. The parties hereto agree that the agreements set
forth in Sections 2 and 3 hereof shall not be deemed to:
(a) be a consent to, or waiver of, any Default or Event of Default;
-9-
<PAGE> 10
(b) except as expressly set forth herein; modify or limit any other
term or condition of the Credit Agreement or any other Credit Document;
(c) impose upon any Lender or the Agent any obligation, express or
implied, to consent to any amendment or further modification of the Credit
Agreement or other Credit Documents, including, without limitation, any
further extension of the Revolving Credit Commitment; or
(d) prejudice any right or remedy that the Agent or the Lenders may now
have or may in the future have under the Credit Agreement or under or in
connection with the other Credit Documents or any instrument or agreement
referred to therein including, without limitation, any right or remedy
resulting from any Default or Event of Default.
10. Miscellaneous.
(a) Section headings used in this Forbearance Agreement are for
convenience of reference only and shall not affect the construction of this
Forbearance Agreement.
(b) This Forbearance Agreement may be executed by one or more of the
parties hereto by facsimile or in any number of separate counterparts and all of
said counterparts taken together shall be deemed to constitute one and the same
instrument.
(c) This Forbearance Agreement and the rights and obligations of the
parties under this Forbearance Agreement shall be governed by, and construed and
interpreted in accordance with, the law of the State of New York, without giving
effect to conflicts of laws principles.
(d) All obligations of the Borrower and each Subsidiary Guarantor and
all rights of the Agent and the Lenders that are expressed herein shall be in
addition to and not in limitation of those provided by applicable law.
(e) This Forbearance Agreement, the Credit Agreement and the other
Credit Documents represent the agreement of the Borrower, the Agent and the
Lenders with respect to the subject matter hereof, and there are no promises,
undertakings, representations or warranties by the Agent or any Lender relative
to subject matter hereof not expressly set forth or referred to herein or in the
other Credit Documents.
(f) Whenever possible, each provision of this Forbearance Agreement
shall be interpreted in such manner as to be effective and valid under
applicable law; but if any provision of this Forbearance Agreement shall be
prohibited by or invalid under applicable law, such provision shall be
ineffective to the extent of such prohibition or invalidity, without
invalidating the remainder of such provision of such provision or the remaining
provisions of this Forbearance Agreement.
-10-
<PAGE> 11
(g) THE BORROWER AND EACH SUBSIDIARY GUARANTOR HEREBY IRREVOCABLY AND
UNCONDITIONALLY:
(A) SUBMITS FOR ITSELF AND ITS PROPERTY IN ANY LEGAL ACTION OR
PROCEEDING RELATING TO THIS FORBEARANCE AGREEMENT AND THE OTHER CREDIT
DOCUMENTS TO WHICH IT IS A PARTY, OR FOR RECOGNITION AND ENFORCEMENT
OF ANY JUDGMENT IN RESPECT THEREOF, TO THE NON-EXCLUSIVE GENERAL
JURISDICTION OF THE COURTS OF THE STATE OF NEW YORK, THE COURTS OF THE
UNITED STATES OF AMERICA FOR THE SOUTHERN DISTRICT OF NEW YORK, AND
APPELLATE COURTS FROM ANY THEREOF;
(B) CONSENTS THAT ANY SUCH ACTION OR PROCEEDING MAY BE BROUGHT IN
SUCH COURTS AND WAIVES ANY OBJECTION THAT IT MAY NOW OR HEREAFTER HAVE
TO THE VENUE OF ANY SUCH ACTION OR PROCEEDING IN ANY SUCH COURT OR
THAT SUCH ACTION OR PROCEEDING WAS BROUGHT IN AN INCONVENIENT COURT
AND AGREES NOT TO PLEAD OR CLAIM THE SAME;
(C) AGREES THAT SERVICE OF PROCESS IN ANY SUCH ACTION OR
PROCEEDING MAY BE EFFECTED BY MAILING A COPY THEREOF BY REGISTERED OR
CERTIFIED MAIL (OR ANY SUBSTANTIALLY SIMILAR FORM OF MAIL), POSTAGE
PREPAID, TO THE BORROWER AT ITS ADDRESS SET FORTH IN SECTION 12.2 OF
THE CREDIT AGREEMENT AND TO EACH SUBSIDIARY GUARANTOR AT ITS ADDRESS
SET FORTH BELOW ITS SIGNATURE ON THE SUBSIDIARIES GUARANTEE, OR AT
SUCH OTHER ADDRESS OF WHICH THE AGENT SHALL HAVE BEEN NOTIFIED
PURSUANT THERETO;
(D) AGREES THAT NOTHING HEREIN SHALL AFFECT THE RIGHT TO EFFECT
SERVICE OF PROCESS IN ANY OTHER MANNER PERMITTED BY LAW OR SHALL
LIMIT THE RIGHT TO SUE IN ANY OTHER JURISDICTION; AND
(E) WAIVES, TO THE MAXIMUM EXTENT NOT PROHIBITED BY LAW, ANY
RIGHT IT MAY HAVE TO CLAIM OR RECOVER IN ANY LEGAL ACTION OR
PROCEEDING REFERRED TO IN THIS SECTION ANY SPECIAL, EXEMPLARY,
PUNITIVE OR CONSEQUENTIAL DAMAGES.
(h) EACH OF THE BORROWER, THE SUBSIDIARY GUARANTORS, THE LENDERS AND THE
AGENT HEREBY IRREVOCABLY AND UNCONDITIONALLY WAIVES TRIAL BY JURY IN ANY LEGAL
ACTION OR PROCEEDING RELATING TO THIS FORBEARANCE AGREEMENT AND ANY
-11-
<PAGE> 12
OTHER CREDIT DOCUMENT TO WHICH IT Is A PARTY AND FOR ANY
COUNTERCLAIM THEREIN.
(i) This Forbearance Agreement shall be deemed a "Credit Document" for
purposes of the Credit Agreement and the other Credit Documents.
(j) This Forbearance Agreement constitutes the entire agreement among the
parties with respect to the subject matter hereof and supersedes all prior and
contemporaneous oral or written agreements with respect to the subject matter
hereof.
(k) The Borrower and each Subsidiary Guarantor hereby acknowledges that:
(i) it has been advised by counsel in the negotiation, execution
and delivery of this Forbearance Agreement;
(ii) neither the Agent nor any Lender has any fiduciary
relationship to the Borrower or any Subsidiary Guarantor, and the
relationship between the Agent and the Lenders, on the one hand, and
the Borrower and the Subsidiary Guarantors, on the other, is solely
that of creditor and debtor; and
(iii) no joint venture exists among the lenders or among the
Borrower, the Subsidiary Guarantors and the Lenders.
[SIGNATURE PAGES FOLLOW]
-12-
<PAGE> 13
Forbearance Agreement
dated as of August 18, 1997
IN WITNESS WHEREOF, the parties hereto have caused this Forbearance
Agreement to be duly executed and delivered as of the day and year first above
written.
IBJ SCHRODER BANK & TRUST COMPANY,
as Agent and as a Lender
By /s/ DANIEL H. CASHER
------------------------------
Name: Daniel H. Casher
Title: Vice President
NORTHSTAR HEALTH SERVICES, INC.
By
------------------------------
Name:
Title:
NORTHSTAR MEDICAL SERVICES, INC.,
f/k/a NSHS HOLDINGS, INC.
By
------------------------------
Name:
Title:
DIRECT PROVIDER NEWWORK, INC.; f/k/a
NORTHSTAR HS HOLDINGS, INC.
By
------------------------------
Name:
Title:
-13-
<PAGE> 14
Forbearance Agreement
dated as of August 18, 1997
IN WITNESS WHEREOF, the parties hereto have caused this Forbearance
Agreement to be duly executed and delivered as of the day and year first above
written.
IBJ SCHRODER BANK & TRUST COMPANY,
as Agent and as a Lender
By
------------------------------
Name:
Title:
NORTHSTAR HEALTH SERVICES, INC.
By /s/ THOMAS W. ZAUCHA
------------------------------
Name: Thomas W. Zaucha
Title: Chairman & CEO
NORTHSTAR MEDICAL SERVICES. INC.,
f/k/a NSHS HOLDINGS, INC;
By /s/ THOMAS W. ZAUCHA
------------------------------
Name: Thomas W. Zaucha
Title:
DIRECT PROVIDER NETWORK, INC.; f/k/a
NORTHSTAR HS HOLDINGS, INC.
By /s/ THOMAS W. ZAUCHA
------------------------------
Name: Thomas W. Zaucha
Title:
-13-
<PAGE> 15
Forbearance Agreement
dated as of August 18, 1997
NSHS SERVICES, INC.
By /s/ THOMAS W. ZAUCHA
------------------------------
Name: Thomas W. Zaucha
Title:
NORTHSTAR HEALTH
CONSULTING, INC.
By /s/ THOMAS W. ZAUCHA
------------------------------
Name: Thomas W. Zaucha
Title:
ABILITY PLUS REHABILITATION
MANAGEMENT COMPANY, f/k/a
NSHS CARDIAC HOLDINGS, INC.
By /s/ THOMAS W. ZAUCHA
------------------------------
Name: Thomas W. Zaucha
Title:
NORTHSTAR DIAGNOSTIC
SERVICES, INC., f/k/a
NORTHSTAR NUCLEAR SERVICES, INC.
By /s/ THOMAS W. ZAUCHA
------------------------------
Name: Thomas W. Zaucha
Title:
-14-
<PAGE> 16
Forbearance Agreement
dated as of August 18, 1997
KEYSTONE REHABILITATION SYSTEMS,
INC.
By /s/ THOMAS W. ZAUCHA
------------------------------
Name: Thomas W. Zaucha
Title:
KEYSTONE REHABILITATION
MANAGEMENT, INC.
By /s/ THOMAS W. ZAUCHA
------------------------------
Name: Thomas W. Zaucha
Title:
VASCUSONICS, INC.
By /s/ THOMAS W. ZAUCHA
------------------------------
Name: Thomas W. Zaucha
Title:
-15-
<PAGE> 1
Exhibit 10.4
EXTENSION SUPPLEMENT
EXTENSION SUPPLEMENT, dated as of August 29, 1997 (this "Supplement"),
between Northstar Health Services, Inc., a Delaware corporation (the
"Borrower"), and IBJ Schroder Bank & Trust Company (the "Agent").
WITNESSETH
WHEREAS, the Agent and the Borrower are parties to that certain Forbearance
Agreement, dated as of August 18, 1997 (as amended, supplemented or otherwise
modified prior to the date hereof, the "Forbearance Agreement"); and
WHEREAS, the Forbearance Agreement shall by its terms terminate on the
Forbearance Termination Date referenced therein (the "Old Forbearance
Termination Date"); and
WHEREAS, the Borrower has requested that the Old Forbearance Termination
Date be extended as contemplated by Section 4 of the Forbearance Agreement, and
the Agent is willing to agree to such extension but only on the terms and
subject to the conditions set forth herein;
NOW, THEREFORE, in consideration of the premises and for other valuable
consideration, the receipt and adequacy of which are hereby acknowledged, the
Borrower and the Agent hereby agree as follows:
1. Definitions. Terms defined in or by reference in the Forbearance
Agreement are used herein as therein defined.
2. Forbearance Termination Date. The Forbearance Termination Date is hereby
extended to September 30, 1997 (the "New Forbearance Termination Date").
3. Effectiveness. This Supplement shall become effective upon receipt by
the Agent of evidence satisfactory to the Agent that this Supplement has been
executed and delivered by the Borrower and the Agent.
4. Representations and Warranties. To induce the Agent to enter into this
Supplement, the Borrower hereby represents and warrants to the Agent and the
Lenders that, after giving effect to the extension of the Forbearance
Termination Date and the other modifications to the Forbearance Agreement
provided for herein, the representations and warranties contained in the
Forbearance Agreement will be true and correct in all material respects as if
made on and as of the date hereof and that no Forbearance Event of Default will
have occurred and be continuing.
<PAGE> 2
5. No Other Modifications. Except as expressly modified hereby, the
Forbearance Agreement shall remain in full force and effect in accordance with
its terms, without any waiver, amendment or modification of any provision
thereof.
6. Counterparts. This Supplement may be executed by one or more of the
parties hereto on any number of separate counterparts and all of said
counterparts taken together shall be deemed to constitute one and the same
instrument.
7. Applicable Law. THIS SUPPLEMENT SHALL BE GOVERNED BY, AND CONSTRUED AND
INTERPRETED IN ACCORDANCE WITH, THE LAW OF THE STATE OF NEW YORK.
[SIGNATURE PAGE FOLLOWS]
-2-
<PAGE> 3
Extension Supplement
dated as of August 29, 1997
IN WITNESS WHEREOF, the parties hereto have caused this Supplement to be
duly executed and delivered as of the day and year first above written.
IBJ SCHRODER BANK & TRUST COMPANY,
as Agent
By
---------------------------------
Name:
Title:
NORTHSTAR HEALTH SERVICES, INC.
By /s/ THOMAS W. ZAUCHA
---------------------------------
Name: Thomas W. Zaucha
Title: Chairman, President & CEO
-3-
<PAGE> 1
Exhibit 10.5
SECOND EXTENSION SUPPLEMENT
EXTENSION SUPPLEMENT, dated as of October 1, 1997 (this "Supplement"),
between Northstar Health Services Inc., a Delaware corporation (the
"Borrower"), Cerberus Partners, LLP (the "Lender"), and IEJ Schroder Bank &
Trust Company (the "Agent").
WITNESSETH
WHEREAS, the Agent and the Borrower are parties to that certain
Forbearance Agreement, dated as of August 18, 1997 (as amended, supplemented or
otherwise modified prior to the date hereof, the "Forbearance Agreement"); and
WHEREAS, the Forbearance Agreement shall terminate on the Forbearance
Termination Date referenced in the Extension Supplement to the Forbearance
Agreement dated August 29, 1997 (the "Old Forbearance Termination Date"); and
WHEREAS, the Borrower has requested that the Old Forbearance Termination
Date be further extended as contemplated by Section 4 of the Forbearance
Agreement, and both the Agent and the Lender is willing to agree to such
extension but only on the terms and subject to the conditions set forth herein;
NOW THEREFORE, in consideration of the premises and for other valuable
consideration, the receipt and adequacy of which are hereby acknowledged, the
parties hereto hereby agree as follows:
1. Definitions. Terms defined in or by reference in the Forbearance
Agreement are used herein as therein defined.
2. Forbearance Termination Date. The Forbearance Termination date is
hereby extended to October 8, 1997 (the "New Forbearance Termination Date").
3. Effectiveness. This Supplement shall become effective upon receipt by
the Lender of evidence satisfactory to the Agent that this Supplement has been
executed and delivered by the Borrower and the Lender.
4. Representations and Warranties. To induce the Lender and the Agent to
enter into this Supplement, the Borrower hereby represents and warrants to the
Agent and the Lender that, after giving effect to the extension of the
Forbearance Termination Date and the other modifications to the Forbearance
Agreement provided for herein, the representations and warranties contained in
the Forbearance Agreement will be true and correct in all material respects as
if made on and as of the date hereof and that no Forbearance Event of Default
will have occurred and be continuing.
<PAGE> 2
5. No Other Modifications. Except as expressly modified hereby, the
Forbearance Agreement shall remain in full force and effect in accordance with
its terms, without any waiver, amendment or modification of any provision
thereof.
6. Counterparts. This Supplement may be executed by one or more of the
parties hereto on any number of separate counterparts. Such counterparts, taken
together, shall be deemed to constitute one and the same instrument.
7. Applicable Law. THIS SUPPLEMENT SHALL BE GOVERNED BY, AND CONSTRUED AND
INTERPRETED IN ACCORDANCE WITH, THE LAW OF THE STATE OF NEW YORK.
IN WITNESS WHEREOF, the parties hereto have caused this Supplement to be
duly executed and delivered as of the day and year first above written.
CERBERUS PARTNERS, LLP
As Lender
BY: /s/ JOYCE C. JOHNSON-MILLER
----------------------------------
Name: Joyce C. Johnson-Miller
Title: Managing Director
IBJ SCHRODER BANK & TRUST COMPANY
As Agent
BY: __________________________________
Name:
Title:
NORTHSTAR HEALTH SERVICES, INC.
BY: /s/ THOMAS W. ZAUCHA
----------------------------------
Name: Thomas W. Zaucha
Title: CEO
-2-
<PAGE> 1
Exhibit 10.6
THIRD EXTENSION SUPPLEMENT
EXTENSION SUPPLEMENT, dated as of November 12, 1997 (this "Supplement"),
between Northstar Health Services, Inc., a Delaware corporation (the
"Borrower"), Cerberus Partners, LLP (the "Lender"), and IBJ Schroder Bank &
Trust Company (the "Agent").
WITNESSETH
WHEREAS, the Agent and the Borrower are parties to that certain
Forbearance Agreement, dated as of August 18, 1997 (as amended by a Second
Extension Supplement dated as of October 1, 1997, the "Forbearance Agreement"),
and
WHEREAS, the Forbearance Agreement terminated on October 8, 1997, the
Forbearance Termination Date referenced in the Second Extension Supplement to
the Forbearance Agreement dated as of October 1, 1997 (the "Old Forbearance
Termination Date"); and
WHEREAS, the Borrower has requested that the Old Forbearance Termination
Date be further extended as permitted by Section 4 of the Forbearance
Agreement, and both the Agent and the Lender are willing to agree to such
extension but only on the terms and subject to the conditions set forth herein;
NOW THEREFORE, in consideration of the premises and for other valuable
consideration, the receipt and adequacy of which are hereby acknowledged, the
parties hereto hereby agree as follows:
1. Definitions. Terms defined in or by reference in the Forbearance
Agreement are used herein as therein defined.
2. Forbearance Termination Date. The Forbearance Termination Date is
hereby extended to December 5, 1997 (the "New Forbearance Termination Date").
3. Effectiveness. This Supplement shall become effective upon receipt by
the Lender of evidence satisfactory to the Lender that this Supplement has been
executed and delivered by it, the Agent, and the Borrower.
4. Acknowledgment. The Borrower acknowledges that, as of November 10,
1997, it is indebted to the Lender in the aggregate amount of $15,237,325.72,
including principal, interest and fees, such amount is presently past due and
payable, and not subject to any defenses, offsets or counterclaims. Interest
and expenses continue to accrue beyond November 10, 1997 in respect of the
Borrower's indebtedness.
5. Business Plan. To induce the Lender to enter into this Supplement, the
Borrower hereby agrees to provide the Lender with a business plan approved by
the Borrower's Board of Directors and
<PAGE> 2
its Executive Committee, in form and substance acceptable to the Lender in its
sole discretion, not later than November 21, 1997. Failure by the Borrower to
provide such Business Plan to the Lender by November 21, 1997, shall constitute
a Forbearance Event of Default under the Forbearance Agreement.
6. Effecting of Corporate Structure Transactions. As additional inducement
for the Lender to enter into this Supplement, the Borrower hereby agrees to
cause all of the stock certificates evidencing corporate ownership of the
Borrower and its Affiliates not heretofore pledged and delivered to the Lender,
to be pledged and delivered to the Lender, in form and substance satisfactory
to the Lender, not later than November 20, 1997. In addition, the Borrower will
provide the Lender with an updated Collateral Certificate for itself and its
Affiliates, in form and substance satisfactory to the Lender, not later than
November 21, 1997. Failure to comply with either of the foregoing shall
constitute a Forbearance Event of Default.
7. Restriction On Settlement of Claims. As additional inducement for the
Lender to enter into this Supplement, the Borrower hereby agrees that it will
not settle any claims asserted against the Borrower or any of its Affiliates
without the prior written consent of the Lender; provided, however, that such
entities may settle claims arising in the ordinary course of their business
without the need to obtain the Lender's prior written consent.
8. Representations and Warranties. To induce the Lender and the Agent to
enter into this Supplement, the Borrower hereby represents and warrants to the
Agent and the Lender, on behalf of itself and the Subsidiary Guarantors that,
after giving effect to the extension of the Forbearance Termination Date as set
forth herein and compliance with the provisions of paragraph 6 herein, the
representations and warranties contained in the Forbearance Agreement will be
true and correct in all material respects as if made on and as of the date
hereof and that no Forbearance Event of Default will have occurred and be
continuing.
9. No Other Modifications. Except as expressly modified hereby, the
Forbearance Agreement shall remain in full force and effect in accordance with
its terms, without any waiver, amendment or modification of any provision
thereof.
10. Counterparts. This Supplement may be executed by one or more of the
parties hereto on any number of separate counterparts. Such counterparts, taken
together, shall be deemed to constitute one and the same instrument.
-2-
<PAGE> 3
11. Applicable Law. THIS SUPPLEMENT SHALL BE GOVERNED BY, AND CONSTRUED
AND INTERPRETED IN ACCORDANCE WITH, THE LAW OF THE STATE OF NEW YORK.
IN WITNESS WHEREOF, the parties hereto have caused this Supplement to be
duly executed and delivered as of the day and year first above written.
CERBERUS PARTNERS, LLP
As Lender
BY: /s/ JOYCE C. JOHNSON-MILLER
---------------------------------
Name: Joyce C. Johnson-Miller
Title: Managing Director
IBJ SCHRODER BANK & TRUST COMPANY
As Agent
BY: _____________________________
Name:
Title:
NORTHSTAR HEALTH SERVICES, INC.
BY: /s/ THOMAS W. ZAUCHA
---------------------------------
Name: Thomas W. Zaucha
Title: Chairman, President & CEO
-3-
<PAGE> 1
Exhibit 10.7
[EXECUTION COPY]
ASSIGNMENT AND ACCEPTANCE
Reference is made to the Credit Agreement, dated as of October 20, 1995
(the "Credit Agreement") among Northstar Health Services, Inc., a Delaware
corporation (the "Borrower"), the lenders which are or may become parties to the
Credit Agreement (the "Lenders") and IBJ Schroder Bank & Trust Company, as agent
for the Lenders (in such capacity, the "Agent"). Terms defined in the Credit
Agreement and not otherwise defined herein are used herein with the meanings so
defined.
IBJ Schroder Bank & Trust Company (the "Assignor") and Cerberus
Partners, L.P. (the "Assignee") agree as follows:
1. The Assignor hereby irrevocably sells and assigns to the Assignee
without recourse to the Assignor, and the Assignee hereby irrevocably purchases
and assumes from the Assignor without recourse to the Assignor, as of the
Effective Date (as defined below), all of the Assignor's interest (the "Assigned
Interest") in and to the Assignor's rights and obligations under the Credit
Agreement as are set forth on Schedule I (individually, an "Assigned Facility";
collectively, the "Assigned Facilities"), in a principal amount for each
Assigned Facility as set forth on Schedule 1.
2. The Assignor (a) makes no representation or warranty and assumes no
responsibility with respect to any statements, warranties or representations
made in or in connection with the Credit Agreement or the execution, legality,
validity, enforceability, genuineness, sufficiency or value of the Credit
Agreement, any other Credit Documents or any other instrument or document
furnished pursuant thereto, other than that it has not created any adverse claim
upon the interest being assigned by it hereunder and that such interest is free
and clear of any such adverse claim; (b) makes no representation or warranty and
assumes no responsibility with respect to the financial condition of the
Borrower or any Subsidiary or any obligor of any of their respective obligations
under the Credit Agreement or any other Credit Documents or any other instrument
or document furnished pursuant hereto or thereto; and (c) attaches the Note(s)
held by it evidencing the Assigned Facilities and requests that the Agent
exchange such Note(s) for a new Note or Notes payable to the Assignee (and, if
the Assignor is retaining any portion of its rights and obligations under the
Credit Documents, to the Assignor) in the amounts which reflect the assignment
being made hereby.
3. The Assignee (a) represents and warrants that it is legally authorized
to enter into this Assignment and Acceptance; (b) confirms that it has received
a copy of the Credit Agreement, together with copies of the financial statements
delivered pursuant to Section 6.1 thereof and such other documents and
information as it has deemed appropriate to make its own credit analysis and
decision to enter into this Assignment and Acceptance; (c) agrees that it will,
<PAGE> 2
independently and without reliance upon the Assignor, the Agent or any other
Lender and based on such documents and information as it shall deem appropriate
at the time, continue to make its own credit decisions in taking or not taking
action under the Credit Agreement, the other Loan Documents or any other
instrument or document furnished pursuant hereto and thereto; (d) appoints and
authorizes the Agent to take such action as agent on its behalf and to exercise
such powers and discretion under the Credit Agreement, the other Credit
Documents or any other instrument or document furnished pursuant hereto or
thereto as are delegated to the Agent by the terms thereof, together with such
powers as are incidental thereto; and (e) agrees that it will be bound by the
provisions of the Credit Agreement and will perform in accordance with its terms
all the obligations which by the terms of the Credit Agreement are required to
be performed by it as a Lender including, if it is organized under the laws of a
jurisdiction outside the United States, its obligation pursuant to subsection 5.
12(b) of the Credit Agreement.
4. The effective date of this Assignment and Acceptance shall be September
8, 1997 (the "Effective Date"). Following the execution of this Assignment and
Acceptance, it will be delivered to the Agent for acceptance by it and recording
by the Agent pursuant to Section 12.6(c) of the Credit Agreement, effective as
of the Effective Date (which shall not, unless otherwise agreed to by the Agent,
be earlier than five Business Days after the date of such acceptance and
recording by the Agent).
5. Upon such acceptance and recording, from and after the Effective Date,
the Agent shall make all payments in respect of the Assigned Interest (including
payments of principal, interest, fees and other amounts) to the Assignee whether
such amounts have accrued prior to the Effective Date or accrue subsequent to
the Effective Date. The Assignor and the Assignee shall make all appropriate
adjustments in payments by the Agent for periods prior to the Effective Date or
with respect to the making of this assignment directly between themselves.
6. From and after the Effective Date, (a) the Assignee shall be party to
the Credit Agreement and, to the extent provided in this Assignment and
Acceptance, have the rights and obligations of a Lender thereunder and under the
other Credit Documents and shall be bound by the provisions thereof and (b) the
Assignor shall, to the extent provided in this Assignment and Acceptance,
relinquish its rights and be released from its obligations under the Credit
Agreement.
7. This Assignment and Acceptance shall be governed by and construed in
accordance with the laws of the State of New York.
IN WITNESS WHEREOF, the parties hereto have caused this Assignment and
Acceptance to be executed as of the date first above written by their respective
duly authorized officers on Schedule I hereto.
-2-
<PAGE> 3
Schedule 1
to Assignment and Acceptance
Relating to the Credit Agreement, Dated as of October 20, 1995
Among
Northstar Health Services, Inc.,
the Lenders Named Therein
and
IBJ Schroder Bank & Trust Company, as Agent for the Lenders
(in such capacity, the "Agent")
-----------------------------------------
Name of Assignor: IBJ Schroder Bank & Trust Company
Name of Assignee: Cerberus Partners, L.P.
Effective Date of Assignment: September 8, 1997
Credit Principal Commitment
Facility Assigned Amount Assigned Percentage Assigned
- ----------------- --------------- -------------------
Revolving Credit $2,000,000.00 100%
Term Loan $6,083,335.00 100%
Acquisition Term Loan $6,000,000.00 100%
IBJ SCHRODER BANK
& TRUST COMPANY CERBERUS PARTNERS, L.P.
By: /s/ DAVID H. CASHON By: /s/ JOYCE C. JOHNSON-MILLER
----------------------------- ----------------------------
Name: David H. Cashon Name: Joyce C. Johnson-Miller
Title: Vice President Title: Managing Director
Accepted: Consented to:
IBJ SCHRODER BANK NORTHSTAR HEALTH SERVICES, INC.
& TRUST COMPANY, as Agent
By: /s/ DAVID H. CASHON By:
----------------------------- ----------------------------
Name: David H. Cashon Name:
Title: Vice President Title:
-3-
<PAGE> 1
Exhibit 10.8
[LOGO] 733 THIRD AVENUE, NEW YORK, NY 10017 212 297-5600
Commonwealth Associates
INVESTMENT BANKING
Northstar Health Services, Inc.
The Atrium
665 Philadelphia Street
Indiana, PA 15701 June 9, 1997
Gentlemen,
This letter, when executed by the parties hereto, will constitute an
agreement between Northstar Health Services, Inc. ("Northstar" or "the Company")
and Commonwealth Associates ("Commonwealth"), pursuant to which the Company
agrees to retain Commonwealth and Commonwealth agrees to be retained by the
Company under the following terms and conditions:
1. The Company hereby retains Commonwealth to perform advisory services
related to corporate finance, capital raising, capital restructuring and
mergers and acquisitions, and Commonwealth hereby accepts such retention
for a term commencing on the date hereof and ending on December 31, 1997
(other than with respect to its retention under paragraphs 3(i) and (ii)
below), with automatic extensions thereto unless thereafter terminated by
either party with a minimum of 60 days prior written notice to the other.
In this regard, and subject to the terms set forth below, Commonwealth
specifically shall furnish to the Company advice and recommendations with
respect to (i) the restructuring of the Company's senior indebtedness to
IBJ Schroder Bank and Trust Co., including its possible acquisition or
pay-out by another lending institution; (ii) the restructuring of the
Company's junior indebtedness to Thomas W. Zaucha and his family
partnership; (iii) the manner and timing of public or private offerings of
Northstar's securities; and (iv) any inquiries received or to be made by
the Company with respect to possible sales, mergers, acquisitions or
business combinations.
2. As compensation for the services described in paragraph 1 above the Company
shall issue to Commonwealth, at the execution hereof, as an initial
non-refundable retainer fee, five year warrants, in a form designated by
Commonwealth and acceptable to the Company, to purchase up to 100,000
shares of the Company's Common Stock, at a strike price equal to 120% of
the average closing bid price of the Company's Common Stock for the five
preceding business days. As additional compensation the Company shall pay
monthly non-refundable cash retainer payments of $6,500 payable on the
first day of each month starting on July 1, 1997. In addition, the exercise
price of the 87,500 warrants to purchase
1
<PAGE> 2
shares of the Company's Common Stock issued to Commonwealth Associates and
certain of its directors, officers, and employees in connection with the
Company's public offering of Common Stock in May 1995 shall be reset to the
same exercise price as above. Commonwealth also shall receive from the
Company the following incentive compensation:
(i) Upon successful completion of the restructuring of the Company's
senior indebtedness a cash fee equal to 1.5% of the principal amount
restructured; and
(ii) Upon successful completion of the restructuring of the Company's
junior indebtedness a cash fee equal to .5% of the principal amount
restructured. However, should Commonwealth Associates arrange or
provide services in connection with a third party financing, a cash
fee equal to 1.5% of the principal amount shall be due and payable at
the closing of such financing.
3. (i) In the event that the Company engages in a sale to or a merger or
combination with another entity having an actual or implied value of
greater than $10 million (value being defined as the sum of all
consideration to be exchanged or offered to Northstar and/or its
shareholders, including but not limited to cash, securities,
assumption of debt and deferred and/or contingent payments),
Commonwealth shall act as the Company's investment banker in any such
transaction and shall receive the following cash fees upon its
closing:
o 1.5% of the value of the transaction up to and including $50
million;
o 1.125% of any value in excess of $50 million up to and
including $100 million; and
o 0.75% of any value in excess of $100 million.
(ii) In the event that the Company engages in an acquisition or the
purchase of assets of another company having an actual or implied
value of greater than $10 million, Commonwealth shall act as the
Company's investment banker in any such transaction and shall receive
the following cash fees upon its closing:
o 2.25% of the first $25 million value of the transaction;
o 1.5% of the second $25 million value of the transaction; and
o 0.75% of any value in excess of $50 million.
Commonwealth's rights under these paragraphs 3(i) and (ii) shall survive
the expiry of this agreement by a period of nine months.
4. In the event that the Company engages in a transaction or transactions to
issue its securities (whether publicly or privately), Commonwealth shall
have the right of first negotiation to lead-manage or co-manage any such
transaction on terms and conditions to be mutually agreed with the Company.
2
<PAGE> 3
5. The Company will reimburse Commonwealth, monthly in arrears, for
Commonwealth's reasonable expenses incurred in the performance of its
duties and Commonwealth shall account for such expenses to the Company
setting forth in reasonable detail the amount and reason for such cost or
expense.
6. All obligations of Commonwealth contained herein shall be subject to
Commonwealth's reasonable availability for such performance, in view of the
nature of the requested service and the amount of notice received.
Commonwealth shall devote time and effort to the performance of its duties
hereunder as Commonwealth shall determine is reasonably necessary for such
performance. Commonwealth may look to others for information, investment
recommendations, economic advice and/or research, upon which to base its
advice to the Company hereunder, as it shall deem appropriate. The Company
shall furnish to Commonwealth all information relevant to the performance
by Commonwealth. In the event that the Company fails to furnish any such
material or information when reasonably requested by Commonwealth and thus
prevents or impedes Commonwealth's performance hereunder, any inability of
Commonwealth to perform shall not be a breach of its obligations
7. Commonwealth will hold, and will use its commercially reasonable efforts to
cause its officers, directors, employees, consultants, advisors, and agents
to hold in confidence any confidential information which the Company
provides to Commonwealth pursuant to this Agreement. Commonwealth may
disclose such information to its officers, directors, employees,
consultants, advisors, and agents, in connection with the services to be
rendered as contemplated by this Agreement, so long as such persons are
informed by Commonwealth of the confidential nature of such information and
are directed by Commonwealth to treat such information confidentially in
accordance herewith. Notwithstanding the forgoing, Commonwealth shall not
be required to maintain confidentiality with respect to information (i)
which is or becomes part of the public domain; (ii) of which Commonwealth
had independent knowledge prior to disclosure to it by the Company; (iii)
which comes into the possession of Commonwealth in the normal and routine
course of its own business from and through independent non-confidential
sources; or (iv) which is required to be disclosed by Commonwealth by
governmental requirements. If Commonwealth is requested or required (by
oral questions, interrogatories, requests of information document
subpoenas, civil investigative demands, or similar process) to disclose any
confidential information supplied to it by the Company, or its
representatives. Commonwealth shall, unless prohibited by law, promptly
notify the Company of such request(s) so that the Company may seek an
appropriate protective order.
8. The Company agrees to the indemnification and other agreements set forth in
the Indemnification Agreement attached hereto, the provisions of which are
incorporated herein reference and shall survive the termination,
expiration per supercession of this Agreement.
3
<PAGE> 4
9. This Agreement may not be transferred, assigned or delegated by any of the
parties hereto without the prior written consent of the other party hereto.
10. Any notice hereunder shall be sent to the Company and to Commonwealth at
their respective addresses set forth above. Any notice shall be given by
hand delivery, facsimile transmission or overnight delivery or courier
service, against receipt thereof, and shall be deemed to have been given
when received. Either party may designate any other address to which notice
shall be given, by giving written notice to the other of such change of
address.
11. This Agreement has been made in the State of New York and shall be
construed and governed in accordance with the laws as thereof without
giving effect to principles governing conflicts of law.
12. This Agreement contains the entire agreement between the parties and, may
not be altered or modified, except in writing and signed by each party.
13. In the event any dispute exists hereunder, the prevailing party shall be
able to recover form the other party its legal fees and expenses in
addition to any other recovery in such litigation or arbitration. The
parties hereto agree to arbitrate any such dispute hereunder in New York
City, State of New York (site of Commonwealth's primary office) in
accordance with the standards of the AAA.
If you are in agreement with the foregoing, please execute two copies of
this letter in the space provide below and return them undersigned.
Yours sincerely,
COMMONWEALTH ASSOCIATES
/s/ MICHAEL R. LYALL /s/ ANDRES V. BELLO
------------------------ -------------------
Michael R. Lyall Andres V. Bello
Senior Managing Director Managing Director
[Signature page follows)
4
<PAGE> 5
By: Commonwealth Associates Management, Inc
as General Partner
By: /s/ BASIL ASCIUTTO
- -----------------------------------------
Title: C.O.O.
Name: Basil Asciutto
Agreed to and accepted as of this date
NORTHSTAR HEALTH SERVICES, INC.
By: /s/ THOMAS W. ZAUCHA
- -----------------------------------------
Name: Thomas W. Zaucha
Title: Chairman & Chief Executive Officer
5
<PAGE> 6
NORTHSTAR HEALTH SERVICES, INC.
THE ATRIUM
665 PHILADELPHIA STREET
INDIANA, PA 15701
Commonwealth Associates June 9, 1997
733 Third Avenue
New York, NY 10017
Gentlemen:
This letter will confirm that we have engaged Commonwealth Associates, to
advise and assist us in connection with the matters referred to in our letter
agreement June 9, 1997 (the "Engagement Letter"). In consideration of your
agreement (the "Agreement") to act on our behalf in connection with such
matters, we agree to indemnify and hold harmless you and your affiliates and you
and your respective officers, directors, employees and agents and each other
person, if any, controlling you or any of your affiliates (you and each such
other person being an "Indemnified Person") from and against any losses, claims,
damages or liabilities related to, arising out of or in connection with the
engagement (the "Engagement") under the Engagement Letter, and will reimburse
each Indemnified Person for all expenses (including, to the extent set forth
below, reasonable fees and expenses of counsel) as they are incurred in
connection with investigating, preparing, pursuing or defending any action,
claim, suit, investigation or proceeding related to, arising out of or in
connection with the Engagement, whether or not pending or threatened and whether
or not any Indemnified Person is a party. Promptly after receipt by an
Indemnified Person of the commencement of any such action, such Indemnified
Person will, if a claim in respect thereof is to be made against us hereunder,
notify us of the commencement thereof; but the failure to so notify us will not
relieve us from liability except to the extent of actual prejudice caused
thereby. Upon such notification, we shall be entitled to participate in the
action and, upon notice thereof to the Indemnified Person, to assume the defense
thereof with counsel of our choice reasonably satisfactory to you who may,
except in the case of manifest conflict, be counsel to us and other parties
similarly situated, whereupon we will not be liable to such Indemnified Party
for any legal or other expenses subsequently incurred by such Indemnified Person
in connection with the defense thereof other than reasonable costs of
investigation. We will not, however, be responsible for any losses, claims,
damages or liabilities (or expenses relating thereto) that are finally
judicially determined to have resulted from the bad faith or gross negligence of
any Indemnified Person. We also agree that no Indemnified Person shall have any
liability, (whether direct or indirect, in contract or tort or otherwise), to us
for or in connection with the Engagement, except for any such liability for
losses, claims, damages or liabilities incurred by us that are finally
judicially determined to have resulted from gross negligence or recklessness of
such Indemnified Person.
We will not, without your prior written consent, settle, compromise,
consent to the entry of any judgment in or otherwise seek to terminate any
action, claim, suit or
6
<PAGE> 7
proceeding in respect of which indemnification may be sought hereunder (whether
or not any Indemnified Person is a party thereto) unless such settlement,
compromise, consent or termination includes a release of each Indemnified Person
from any liabilities arising out of such action, claim, suit or proceeding. No
Indemnified Person seeking indemnification, reimbursement or contribution under
this agreement will, without our prior written consent, settle, compromise,
consent to the entry of any judgment in or otherwise seek to terminate any
action, claim, suit, investigation or proceeding referred to in the preceding
paragraph.
If the indemnification provided for in the first paragraph of this
agreement is judicially determined to be unavailable (other than in accordance
with the third sentence of the first paragraph hereof) to an Indemnified Person
in respect of any losses, claims, damages or liabilities referred to herein,
then, in lieu of indemnifying such Indemnified Person hereunder, we shall
contribute to the amount paid or payable by such Indemnified Person as a result
of such losses, claims, damages or liabilities (and expenses relating thereto)
(i) in such proportion as is appropriate to reflect the relative benefits to
you, on the one hand, and us, on the other hand, of the Engagement or (ii) if
the allocation provided by clause (i) above is not available, in such proportion
as is appropriate to reflect not only the relative benefits referred to in such
clause (i) but also the relative fault of each of you and us, as well as any
other relevant equitable considerations; provided, however, in no event shall
your aggregate contribution to the amount paid or payable exceed the aggregate
amount of cash fees actually received by you under the Engagement Letter. For
the purposes of this Agreement, the relative benefits to us and you of the
Engagement shall be deemed to be in the same proportion as: (a) the total value
paid or contemplated to be paid or received or contemplated to be received by us
or our shareholders, as the case may be, in the transaction or transactions by
you that are the subject of the Engagement, whether or not any such transaction
is consummated, bears to (b) the cash fees paid or to be paid to you under the
Engagement Letter in respect of such transaction or transactions.
The provisions of this Agreement shall apply to the Engagement and any
modification thereof and shall remain in full force and effect regardless of
any termination or the completion of your services under the Engagement Letter.
This Agreement and the Engagement Letter shall be governed by and construed
in accordance with the laws of the State of New York applicable to contracts
executed in and to be performed in that state.
Very truly yours,
Northstar Health Services, Inc.,
/s/ THOMAS W. ZAUCHA
-----------------------------------
Thomas W. Zaucha
Chairman & Chief Executive Officer
7
<PAGE> 1
Exhibit 20.1
TERMINATION AGREEMENT AND GENERAL RELEASE
THIS TERMINATION AGREEMENT AND GENERAL RELEASE is made and entered into on
the 4th day of November, 1997, by and between JOHN A. LOMBARDI (hereinafter
"Employee") and NORTHSTAR HEALTH SERVICES, INC. (hereinafter "Company").
RECITALS:
WHEREAS, the Employee and Company are parties to an Employment Agreement
dated September 16, 1996 (the "Original Employment Agreement"), pursuant to
which, among other things, the Company employed Employee as the Executive
Vice-President, Chief Financial Officer and Treasurer of the Company; and
WHEREAS, the Employee and Company are also parties to an Employment
Agreement dated March 13, 1997 (the "Subsequent Employment Agreement"), pursuant
to which, among other things, the Company employed Employee as Executive
Vice-President, Chief Financial Officer and Treasurer of the Company; and
WHEREAS, Employee and Company are desirous of entering into an Agreement
defining the terms of Employee's voluntary termination from the Company's
employment (hereinafter "termination") and certain related terms.
NOW THEREFORE, in consideration of the mutual promises hereinafter set
forth and intending to be legally bound, Employee and the Company agree as
follows:
1. Employee's termination shall be effective as of the 10th day of May,
1997. Employee shall have all rights as defined in the Company's established
benefit plans and policies applicable to an individual employee in his position
who voluntarily terminates his employment.
2. As a further, special separation award, the Company has agreed to pay
Employee the gross amount of $35,000.00, less usual deductions, in consideration
of the undertakings of Employee described herein, but without any admission of
contractual or other legal liability whatsoever to Employee in respect to or in
any way related to his employment, including his recruitment, hire, terms and
conditions of employment, benefits and termination, payable as follows:
The sum of $15,000.00, less usual deductions, upon the signing of this
Agreement (the check will be drafted through the Company payroll system,
dated November 7, 1997, and delivered at the time of the signing of this
<PAGE> 2
Agreement), the receipt of which is hereby acknowledged by Employee; and
The sum of $2,500.00, less usual deductions, payable by Company to Employee
on the following Company payroll dates: November 21, 1997; December 5,
1997; December 19, 1997; January 2, 1998; January 16, 1998; January 30,
1998; February 13, 1998; and February 27, 1998.
3. The Company and Employee agree to terminate all stock options in any and
all agreements between the Company and the Employee, verbal or otherwise,
including the stock options granted in the Employment Agreement of September 16,
1996, Exhibit "A", Section 2, described as follows:
On September 16, 1996, Employee was granted, under the 1992 Stock Option
Plan, stock options for 25,000 shares of the Company's Common Stock. Such
options have an exercise price equal to the fair market value (as defined
in the 1992 Stock Option Plan) as of September 16, 1996. Employee
acknowledges that in accordance with said Plan, if the Employee's
relationship with the Company or affiliated corporation ceases for any
reason other than termination for death or total disability (and unless by
its terms the option provides otherwise), the Employee may exercise, for a
3-month period following cessation, only that portion of the Employee's
option which was exercisable at the time of cessation. The Company does not
waive this limitation.
Employee was also granted stock options to purchase 50,000 shares of the
Company's Common Stock at $2.00. Such option shares are not exercisable
until Company's Common Stock has traded in excess of $5.93 for at least ten
(10) consecutive trading days. Employee acknowledges that these stock
options must be exercised within twelve (12) months of termination. The
Company does not waive this limitation.
The Company and Employee agree that the Employee shall be granted, under
the Out of Plan Plan, 10,000 shares of the Company's Common Stock in
connection with the execution of this Termination Agreement and General
Release. Such options shall be vested immediately, shall have an exercise
price of $2.00, and shall terminate at 11:59 p.m. on December 31, 1998.
4. Employee agrees to maintain strict confidentiality with respect to the
terms of this Agreement and to refrain from advising any current or former
employees of the Company or others not needing to know such terms.
5. The Employee and Company hereby agree that the above-mentioned
Subsequent Employment Agreement was and is null and void ab initio, and had,
has, and shall have no legal force and effect.
<PAGE> 3
6. Except for the payments due Employee by company as set forth in this
Agreement, Employee does, for himself, his heirs, executors and assigns, hereby
forever releases and discharges the Company, its divisions, subsidiaries,
affiliates, officers, directors, employees, representatives, successors,
assigns, and agents from any and all claims, demands, actions, suits, damages,
fees, costs, and other obligations or liabilities of any kind, whether now known
or unknown, prior to and including this date, relating to any and all losses,
injuries, and other damages incurred by Employee, in respect to or in any way
related to his recruitment, hire, terms and conditions of employment, benefits
of employment, or termination, which are or could have been complained of under
any federal, state or local law, statute, ordinance, regulation or order.
Employee also expressly waives all present and future employment rights with the
Company or any affiliate organization of the Company. Employee represents and
warrants that he has not assigned any such claim or authorized any person or
entity to assert such claim on his behalf.
7. Company does, for itself, its successors and assigns, hereby forever
releases and discharges the Employee, his heirs and assigns, from any and all
claims, demands, actions, suits, damages, fees, costs, and other obligations or
liabilities of any kind, whether now known or unknown, prior to and including
this date, relating to any and all losses, injuries, and other damages incurred
by Company, in respect to or in any way related to Employee's employment, or
termination, which are or could have been complained of under any federal, state
or local law, statute, ordinance, regulation or order. Company also expressly
waives all present and future employment rights with the Employee.
8. Employee hereby agrees and recognizes that his employment relationship
with Company has been permanently and irrevocably severed and that Company does
not have any obligation, contractual or otherwise, to hire, re-hire, or
re-employ him in the future.
9. Employee agrees and acknowledges that the Agreement by Company described
herein, and the settlement and termination of any claims against Employer as set
forth herein, are not and shall not be construed to be an admission of any
violation of any federal, state or local statute or regulation, or of any duty
owed by Company to Employee.
10. Employee covenants and agrees that he shall not engage in any
communications which shall disparage Company or unlawfully interfere with its
existing or prospective business relationships. Employee agrees, further, that
he shall make himself available and cooperate with Company in any reasonable
manner in connection with any matters including, but not limited to, litigation
now pending or which may arise in the future which Employee was involved in or
which relate to Employee's term of employment with the Company. If requests are
made after the salary continuation period, reasonable compensation may be
considered if time requirements are significant.
<PAGE> 4
11. Employee hereby certifies that he has read the terms of this
Termination Agreement and General Release, that he has had an opportunity to
discuss it with his attorneys, and that he understands its terms and effects.
Employee acknowledges, further, that he is executing this Termination Agreement
and General Release of his own volition, with a full understanding of its terms
and effects, and with the intention of releasing all claims in exchange for the
consideration described in this Termination Agreement and General Release, which
he acknowledges is adequate and satisfactory to him. Neither Company nor its
agents, representatives, or attorneys have made any representation to him
concerning the terms and effects of this Termination Agreement and General
Release other than those contained herein. Employee further agrees, covenants
and promises that he will not communicate or disclose the terms or amount of
this Termination Agreement and General Release to any person other than members
of his immediate family, his attorney, his accountant, or such other person(s)
to whom disclosure may be necessary to implement and/or enforce this Agreement
or to otherwise conduct personal business.
INTENDING TO BE LEGALLY BOUND, Employee and Company execute this
Termination Agreement and General Release this 5th day of November, 1997.
WITNESS: EMPLOYEE:
/s/ PAUL A. MANION /s/ JOHN A. LOMBARDI (SEAL)
- ----------------------- ---------------------------
JOHN A. LOMBARDI
COMPANY:
ATTEST: NORTHSTAR HEALTH SERVICES, INC.
/s/ JAMES J. ?????????? BY: /s/ THOMAS W. ZAUCHA
- ----------------------- --------------------------
Assistant Secretary THOMAS W. ZAUCHA, CEO
(SEAL)
<PAGE> 5
ABSOLUTE GUARANTEE OF PAYMENT
OF OBLIGATION
FOR VALUE RECEIVED, I, THOMAS W. ZAUCHA, of 100 Lafayette Circle, Indiana,
Pennsylvania, 15701, absolutely guarantee payment to JOHN A. LOMDARDI of the
special separation award indebtedness due John A. Lombardi as set forth in
paragraph 2 of the Termination Agreement and General Release dated the 4th
day of November, 1997, by and between John A. Lombardi, "Employee", and
Northstar Health Services, Inc., "Company". If Northstar Health Services, Inc.
defaults in the payments, less usual deductions, payable by Company to Employee
as set forth in paragraph 2 of the Termination Agreement and General Release, I
will pay John A. Lombardi the unpaid balance thereon on demand.
DATED: November 5, 1997
/s/ THOMAS W. ZAUCHA (SEAL)
-----------------------------
Thomas W. Zaucha
<PAGE> 1
Exhibit 20.2
SETTLEMENT AGREEMENT AND MUTUAL RELEASE
This Settlement Agreement and Mutual Release is entered into this 24th day of
November, 1997, by and between STEVEN N. BRODY and STEVEN N. BRODY ASSOCIATES
("Brody Associates")
A
N
D
NORTHSTAR HEALTH SERVICES, INC. ("Northstar"), THOMAS W. ZAUCHA and ALICE L.
ZAUCHA (the "Zauchas") and the ZAUCHA FAMILY LIMITED PARTNERSHIP (the
"Partnership"):
WHEREAS, Northstar, a Delaware corporation, is a regional provider of
physical, occupational and speech therapy;
WHEREAS, Steven N. Brody and/or Brody Associates served as consultant
and/or director of Northstar from January 1, 1996 to May 9, 1997;
WHEREAS, Thomas W. Zaucha is the Chairman, President, CEO and a
shareholder of Northstar;
WHEREAS, Alice L. Zaucha is a shareholder of Northstar;
WHEREAS, Steven N. Brody purchased 50,000 shares of Northstar common stock
from the Zauchas by agreement dated February, 1996, as follows: (i) 25,000
shares for aggregate cash payment of $148,250.00, or $5.93 per share; and (ii)
25,000 shares pursuant to delivery by Steven N. Brody to the Zauchas of a
promissory note in the principal amount of $100,000.00;
WHEREAS, the Zauchas were the holders of the Northstar shares transferred
from Thomas W. and Alice L. Zaucha to Steven N. Brody;
WHEREAS, Steven N. Brody and Brody Associates have asserted certain claims
against Northstar and Thomas W. Zaucha;
WHEREAS, Northstar, the Zauchas and the Partnership have asserted certain
claims against Steven N. Brody and Brody Associates;
WHEREAS, Steven N. Brody, Brody Associates, Northstar, the Zauchas and the
Partnership now wish to resolve any disputes which may exist between them.
<PAGE> 2
NOW, THEREFORE, for and in consideration of the mutual promises and
covenants set forth below, and intending to be legally bound, Steven N. Brody,
Brody Associates, Northstar, the Zauchas and the Partnership hereby agree as
follows:
1. The foregoing recitals are incorporated herein by reference.
2. Steven N. Brody and Brody Associates, on behalf of themselves and their
agents, attorneys, heirs, executors, administrators, officers, directors,
employees, parents, subsidiaries, affiliates, successors and assigns, do hereby
release, remise, acquit, satisfy and forever discharge the Zauchas, Northstar
and the Partnership and his, hers and their agents, attorneys, heirs,
executors, administrators, officers, directors, employees, parents,
subsidiaries, affiliates, successors and assigns, from any and all actions,
causes of action, suits, debts, accounts, liability, damages, attorney's fees,
claims, counterclaims, accounts, covenants, controversies, agreements,
promises, judgments and demands whatsoever, whether arising in contract or in
tort, arising from all claims, liquidated or unliquidated, contingent or fixed,
determined or undetermined, known or unknown, foreseen or unforeseen, at law
or in equity which Steven N. Brody or Brody Associates or any of their
successors or assigns, or any one or more of them, has had, now has or may have
against the Zauchas, Northstar and the Partnership for, upon or by reason of
any matter, cause or thing whatsoever arising from the parties' relationship
and the termination thereof, including without limitation the claims related to
the service of Steven N. Brody and/or Brody Associates as consultant and/or
director of Northstar.
3. The Zauchas, Northstar and the Partnership, on behalf of themselves,
and their agents, attorneys, heirs, executors, administrators, officers,
directors, employees, parents, subsidiaries, affiliates, successors and
assigns, do hereby release, remise, acquit, satisfy and forever discharge
Steven N. Brody and Brody Associates and their agents, attorneys, heirs,
executors, administrators, officers, directors, employees, parents,
subsidiaries, affiliates, successors and assigns from any and all actions,
causes of action, suits, debts, accounts, liability, damages, attorney's fees,
claims, counterclaims, accounts, covenants, controversies, agreements,
promises, judgments and demands whatsoever, whether arising in contract or in
tort, arising from all claims, liquidated or unliquidated, contingent or fixed,
determined or undetermined, known or unknown, foreseen or unforeseen, at law or
in equity which the Zauchas, Northstar or the Partnership, or any of their
successors or assigns, or any one or more of them, have had, now have or may
have against Steven N. Brody and Brody Associates for, upon or by reason of any
matter, cause or thing whatsoever arising from the parties' relationship and
the termination thereof.
4. Northstar agrees:
(a) to pay to Steven N. Brody $26,190.00 as follows:
(i) $10,000.00 upon the execution of this Agreement;
(ii) $6,190.00 on or before January 1, 1998;
-2-
<PAGE> 3
(iii) $5,000.00 on or before February 1, 1998; and
(iv) $5,000.00 on or before March 1, 1998;
(b) to issue to Steven N. Brody within thirty (30) days of the date of
this Agreement options to purchase 40,000 shares of common stock of
Northstar at a price of $1.25 per share, said options to vest
immediately upon issuance and to be exercised within thirty (30)
months of the date of their issuance, pursuant to the terms of the
Non-Qualified Stock Option Agreement for Steven N. Brody attached to
this Agreement as Exhibit A;
(c) to take all steps reasonably necessary to facilitate the transfer of
the shares held by Steven N. Brody including removing any restrictions
which exist on the transfer of the Northstar common stock (other than
the stock to be transferred pursuant to Paragraph 5 below) currently
owned by Steven N. Brody and providing such legal opinions as are
required by the transfer agent to permit the transfer of the shares by
Steven N. Brody;
(d) to indemnify Steven N. Brody and Brody Associates against all losses,
damages, costs and expenses which Steven N. Brody and/or Brody
Associates may suffer through or arising from any and all claims,
demands or suits allegedly based upon any statement, action or failure
to act of Steven N. Brody, Brody Associates, or any other individual
or entity relating to the service of Steven N. Brody and/or Brody
Associates as consultant and/or director or officer of Northstar.
5. Steven N. Brody shall transfer to the Zauchas, jointly, 25,000 shares of
Northstar common stock.
6. The Zauchas shall forgive and/or mark as satisfied the $100,000.00
promissory note delivered to them by Steven N. Brody in February 1996 pursuant
to the purchase of 25,000 shares of Northstar common stock.
7. Thomas W. Zaucha personally guarantees the timely payment from
Northstar to Steven N. Brody of the amounts described in Paragraphs
4(a)(ii)-(iv) of this Agreement, and agrees to pay such amounts to Steven N.
Brody if Northstar fails to make any payment in the amount or by the date set
forth in those paragraphs.
8. The transfer of shares from Steven N. Brody to the Zauchas pursuant to
Paragraph 5 above shall not preclude Steven N. Brody from filing a claim in the
action styled as Butler, et al. v. Northstar Health Services, Inc., et al., and
docketed in the United States District Court for the Western District of
Pennsylvania at civil action number 96-701, with respect to those shares or from
receiving the proceeds of the settlement of the action attributable to those
shares.
-3-
<PAGE> 4
9. This Agreement does not constitute an admission of fault or liability
by Steven N. Brody and Brody Associates or the Zauchas, Northstar and the
Partnership.
10. This Agreement shall be governed by and construed in accordance with
Pennsylvania law.
11. The parties agree that the terms and conditions of this Agreement
constitute the full and complete understandings, agreements, promises of the
parties and that there are no oral or written understandings, agreements,
promises or inducements made or offered other than those set forth herein. This
Agreement can only be modified by a subsequent writing signed by both parties.
12. In the event of a breach of this Agreement, the prevailing party shall
be entitled to payment of its reasonable attorney's fees and costs.
13. This Agreement may be executed in counterparts, each of which shall be
deemed an original, and such original counterparts shall together constitute
but one and the same agreement.
WITNESS the due execution hereof on the date above written:
WITNESS:
/s/ PAUL H. TITUS /s/ STEVEN N. BRODY
- ----------------------- --------------------------
Paul H. Titus Steven N. Brody
WITNESS:
/s/ PAUL H. TITUS /s/ STEVEN N. BRODY
- ----------------------- --------------------------
Paul H. Titus Steven N. Brody on behalf of
Steven N. Brody Associates
ATTEST: NORTHSTAR HEALTH SERVICES, INC.
/s/ MICHAEL S. DILANEY BY: /s/ THOMAS W. ZAUCHA
- ----------------------- ----------------------
Michael S. Dilaney Thomas W. Zaucha
TITLE: Chairman, President & CEO
-4-
<PAGE> 5
WITNESS:
/s/ MICHAEL S. DILANEY /s/ THOMAS W. ZAUCHA
- --------------------------- --------------------------
Michael S. Dilaney Thomas W. Zaucha
WITNESS:
/s/ MICHAEL S. DILANEY /s/ ALICE L. ZAUCHA
- --------------------------- --------------------------
Michael S. Dilaney Alice L. Zaucha
WITNESS: ZAUCHA FAMILY LIMITED
PARTNERSHIP
/s/ MICHAEL S. DILANEY BY: /s/ THOMAS W. ZAUCHA
- --------------------------- --------------------------
Michael S. Dilaney Thomas W. Zaucha
TITLE: General Partner
-5-
<PAGE> 1
Exhibit 21
SUBSIDIARIES OF THE REGISTRANT
Northstar Health Services, Inc., a Delaware Corporation, has the subsidiaries
listed below. All are wholly owned. Northstar Health Services, Inc. has no
parent.
State of Incorporation
----------------------
Keystone Rehabilitation Systems, Inc. Pennsylvania
Northstar Medical Services, Inc. Delaware
NSHS Services, Inc. Delaware
Ability Plus Rehabilitation Management Company Delaware
Direct Provider Network, Inc. Delaware
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 657
<SECURITIES> 0
<RECEIVABLES> 6,477
<ALLOWANCES> 1,341
<INVENTORY> 0
<CURRENT-ASSETS> 7,296
<PP&E> 2,814
<DEPRECIATION> 2,811
<TOTAL-ASSETS> 29,514
<CURRENT-LIABILITIES> 29,129
<BONDS> 2,039
0
0
<COMMON> 63
<OTHER-SE> (1,862)
<TOTAL-LIABILITY-AND-EQUITY> 29,514
<SALES> 32,606
<TOTAL-REVENUES> 32,606
<CGS> 16,413
<TOTAL-COSTS> 19,516
<OTHER-EXPENSES> 50
<LOSS-PROVISION> 2,024
<INTEREST-EXPENSE> 2,229
<INCOME-PRETAX> (6,220)
<INCOME-TAX> (770)
<INCOME-CONTINUING> (5,450)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,613)
<EPS-PRIMARY> (0.95)
<EPS-DILUTED> (0.95)
</TABLE>
<PAGE> 1
Exhibit 99
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
-------------------------------
Date of Report (Date of earlier event reported) January 16, 1997
NORTHSTAR HEALTH SERVICES, INC.
------------------------------------------------------
(Exact name or registrant as specified in its charter)
DELAWARE 0-21752 25-1697152
- ------------------------------ ------------------------ ------------------
(State of other (Commission File Number) (IRS Employer
jurisdiction of incorporation) Identification No.)
750 HOLIDAY DRIVE, FOSTER PLAZA 9, PITTSBURGH, PENNSYLVANIA 15220
------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (412) 920-1730
-----------------------
- --------------------------------------------------------------------------------
(Former name or former address, if changes since last report)
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 and (2) has been subject to such filing requirements for
the past 90 days. Yes No X
----- -----
Item 1. Change in Control of Registrant.
Not applicable.
Item 2. Acquisition or Disposition of Assets.
Not applicable.
Item 3. Bankruptcy or Receivership.
Not Applicable.
Item 4. Changes in Registrant's Certifying Accountant.
Not applicable.
Item 5. Other Events.
<PAGE> 2
On February 13, 1997, the Board of Directors of Northstar Health Services,
Inc., released a statement in response to SEC filings seeking control of the
Board of Directors filed by Thomas Zaucha, entities he controls, and
Commonwealth Associates, an investment banking firm, formerly and perhaps
currently, closely associated with former Chairman, Mark DeSimone.
Item 6. Resignation of Registrant's Directors.
Not applicable.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits.
(a) Financial Statements and Business Acquired.
Not applicable.
(b) Pro Forma Financial Information.
Not applicable.
(c) Exhibits - Press Release
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned hereunto duly authorized.
NORTHSTAR HEALTH SERVICES, INC.
By: /s/ Robert J. Smallacombe
----------------------------
Robert J. Smallacombe, CEO
DATED: February 21, 1997
<PAGE> 3
Northstar Health Services Inc. Press Release
For more information contact: Melissa M. Krantz
The Krantz Group, Inc.
(212)891-7235
For Immediate Release
Northstar Health Services, Inc.
Board of Directors Responds to 14A Filing
(Indiana, Pennsylvania) -- February 13, 1997 -- The Board of Directors of
Northstar Health Services, Inc., released the following statement in response to
SEC filings seeking control of the Board of Directors of Northstar filed by
Thomas Zaucha, entities he controls, and Commonwealth Associates, an investment
banking firm, formerly and perhaps currently, closely associated with former
Chairman, Mark DeSimone:
"This action by the Zaucha-Commonwealth group is absurd at this time. Under
direction of this board, Northstar Health Services is in the best position it
has been in some time: it is close to settling its litigation with shareholders;
it is working successfully on its bank financing; it has successfully
restructured its operations; and the 1995 and 1996 audits and annual reports are
approaching completion -- all without the assistance of Mr. Zaucha. This proxy
fight is an attempt to return the Company to its prior suspect management.
Specifically, the history, conduct and motivation of this group are, at a
minimum, suspect and clearly not in the best interests of Northstar or its
shareholders:
1) Commonwealth Associates' apparent collaboration with Mr. Zaucha's
"committee" represents an attempt by them to avoid rectifying their serious
conflicts of interest which have plagued Northstar and are being corrected
by the new Board of Directors. Mr. Zaucha and Commonwealth Associates, his
representative, had responsibility for the due diligence that was supposed
to have been done with respect to Northstar in 1995. Both failed to
properly examine the self-dealing transactions of Mark DeSimone that has
led up to the resignation of the Company's auditors in March 1996. In fact,
before being hired by Mr. Zaucha to pursue his proxy fight, Commonwealth
Associates (which was paid over $1,800,000 in 1995 for purported services
to Northstar, including due diligence) was fired by the Board of Northstar
for its refusal to cooperate with the Company's representatives and its
continuing secret discussions and relationship with Mr. DeSimone following
disclosure of his defalcations. Prior to that dismissal, Commonwealth
Associates was identified by the Company's independent investigators as the
prime subject of further investigation and a potential defendant in the
racketeering act claims filed by the Company against Mr. DeSimone and
others.
Further, Commonwealth was subpoenaed on November 21, 1996 and directed to
provide documents pertinent to that racketeering case on December 22, 1996.
To date, Commonwealth has not provided a single one of those documents and
the Company is in the process of requesting that they be held in contempt
of court.
2) Mr. Zaucha persistently acts in his own interest with little regard for his
responsibility to shareholders of Northstar. Mr. Zaucha has refused to
renegotiate terms of leases on real estate which he owns directly or
controls and which were leased to Northstar through supposed "arms length"
negotiations with Mr. DeSimone. An investigation recently revealed that
rents paid by the Company to Zaucha-related entities are at least twice the
local rental rates for office space, as a result of sweetheart deals with
Mr. DeSimone.
3) In his latest efforts to exploit the Company, Mr. Zaucha sought to obtain
approximately $115,000 inappropriately from the Company by requisitions for
payment of tax refunds to which the Company is legally entitled. Mr. Zaucha
was not entitled to such payment.
In conclusion, the Board of Directors believes that it is in the best interest
of the shareholders to support the Board of Directors so that they can stay on
their successful course to ensure shareholder value and continued vitality. Any
change in corporate governance at this time would be a disruption of the
progress this Board has made. The last thing Northstar's stockholders need is a
return to the conflicts of interest of prior management."
Northstar Health Services, Inc. is a leading regional provider of
rehabilitation therapy, mobile diagnostics, subacute contracted care and related
services at outpatient rehabilitation clinics and by contact to other health
care facilities in Pennsylvania, Ohio, Illinois and West Virginia.
# # # #
