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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A-1
(Mark One)
/X/ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the fiscal year ended December 31, 1995
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the Transition Period from to .
Commission file number 1-12040
SUN HEALTHCARE GROUP, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 85-0410612
(State of (I.R.S. Employer Identification
Incorporation) No.)
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101 SUN LANE, NE
ALBUQUERQUE, NEW MEXICO 87109
(Address of principal executive offices)
Registrant's telephone number, including area code: (505) 821-3355
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Securities registered pursuant to Section 12(b) of the Act:
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NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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Common Stock, par value $.01 per share, New York Stock Exchange
and Preferred Stock Purchase Rights
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Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required 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 the definitive proxy statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
On March 25, 1996, Sun Healthcare Group, Inc. had 49,037,096 outstanding
shares of Common Stock. Of those, 37,340,102 shares of Common Stock were held by
nonaffiliates. The aggregate market value of such Common Stock held by
nonaffiliates, based on the average of the high and low sales prices of such
shares on the New York Stock Exchange on March 25, 1996, was approximately
$455,080,000.
Documents Incorporated by Reference:
Portions of Sun Healthcare Group, Inc.'s definitive Proxy Statement
for the Annual Meeting of Shareholders held on June 11, 1996
are incorporated by Reference into Part III of this Report.
This Report on Form 10-K/A consists of pages and the index of exhibits is
set forth on page .
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PART I
The Registrant hereby amends the disclosure contained under the caption
"Business" set forth in Part I, Item 1 of the Registrant's Annual Report on Form
10-K for the year ended December 31, 1995. In accordance with Rule 12b-15
promulgated under the Securities Exchange Act of 1934, as amended, the complete
text of Part I, Item 1, as amended, follows.
ITEM 1. BUSINESS
GENERAL
Sun Healthcare Group, Inc. (referred to herein, along with its subsidiaries
and predecessor companies as the "Company") is a provider of high-quality and
cost efficient long-term, subacute and related healthcare services. At December
31, 1995, the Company operated 131 long-term care facilities with 15,921
licensed beds in 16 states and 28 long-term care facilities and 1,437 registered
beds in the United Kingdom. In addition, the Company offers a variety of therapy
services, including rehabilitation therapy and temporary rehabilitation
therapist staffing services, and pharmaceutical products and services, to both
affiliated and nonaffiliated long-term and subacute care facilities.
The Company's long-term and subacute care facilities provide a broad range
of health care services, including nursing care, subacute care, therapy and
other specialized services such as care to patients with Alzheimer's disease.
The Company believes its long-term and subacute care operations provide it with
a platform for expanding its therapy and institutional pharmaceutical services
to affiliated and nonaffiliated long-term and subacute care facilities. In
addition, the Company believes that its expertise in operating long-term and
subacute care facilities enables it to provide its therapy and institutional
pharmaceutical services more effectively and efficiently.
The Company currently offers a variety of therapy services, including
physical, occupational and speech therapy, which commenced operations in 1991,
and through its acquisition of Golden Care, Inc. ("Golden Care") in May 1995,
respiratory therapy, to patients in long-term and subacute care facilities. At
December 31, 1995, the Company provided therapy services to 768 facilities in 41
states, 643 of which are operated by nonaffiliated parties and 125 of which are
affiliated facilities.
Through its acquisition of CareerStaff Unlimited, Inc. ("CareerStaff") in
June 1995, the Company has become a nationwide provider of temporary
rehabilitation therapist staffing. CareerStaff provides licensed therapists
skilled in the areas of physical, occupational and speech therapy primarily to
hospitals and nursing home contract service providers. At December 31, 1995,
CareerStaff had 16 division offices providing temporary rehabilitation therapist
staffing in major metropolitan areas and two division offices specializing in
placements of temporary travelling therapists in smaller cities and rural areas.
In March 1993, the Company commenced its institutional pharmacy business,
and at December 31, 1995, the Company operated 13 regional pharmacies that
provided pharmaceutical products and services to a total of 372 long-term and
subacute care facilities in 17 states, 271 of which are operated by
nonaffiliated parties and 101 of which are affiliated facilities. In 1995, the
Company acquired or opened three new regional pharmacies in three states. For
the year ended December 31, 1995, approximately 78% of the revenues generated by
the Company's institutional pharmacy business were derived from nonaffiliated
parties.
The Company was organized in April 1993, and is the successor to and the
holding company for its wholly-owned subsidiaries, all of which were previously
controlled by Andrew L. Turner, the Company's Chairman of the Board, President
and Chief Executive Officer. The Company, through its wholly-owned subsidiaries,
commenced operations in 1989 with the acquisition of seven long-term care
facility operations with 954 licensed beds in Washington and Connecticut. This
growth was due primarily to acquisitions of long-term and subacute care facility
operations. The Company has expanded its United States long-term and subacute
care operations from 55 facilities with 6,252 licensed beds at December 31, 1993
to 115 facilities with 13,904 licensed beds and 131 facilities with 15,921
licensed beds at December 31, 1994 and 1995, respectively.
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INDUSTRY OVERVIEW
The long-term care industry encompasses a broad range of health care
services provided to the elderly and to other patients with medically complex
needs who can be cared for outside of the acute care hospital environment and
generally cannot be efficiently and effectively cared for at home. Long-term and
subacute care facilities offer skilled nursing care, routine rehabilitation
therapy and other support services, primarily to elderly patients. Long-term and
subacute care facilities may also provide a broad range of specialized health
care services such as care for patients with Alzheimer's disease and subacute
care. Subacute care includes those services provided to patients with medically
complex conditions who require ongoing medical and nursing supervision and
access to specialized equipment and services, but do not require many of the
other services provided by an acute care hospital. The Company believes that the
demand for the services provided by long-term and subacute care facilities will
increase substantially during the next decade due primarily to demographic
trends, advances in medical technology and the impact of cost containment
measures. At the same time, government restrictions and high construction and
start-up costs are expected to limit the supply of long-term and subacute care
facilities.
Ancillary services such as therapy and institutional pharmacy increase
long-term and subacute care facility profitability by expanding the range of
services provided at such facilities. Therapy services provided by the Company
primarily consist of the provision of licensed physical, occupational or speech
therapists, although the Company has recently begun to provide respiratory
therapy services. Institutional pharmacy services include dispensing
pharmaceuticals for such purposes as infusion therapy, pain management,
antibiotic therapy and parenteral nutrition. Additional services include
providing consultant pharmacists and assistance in preparation of billing
documentation. These ancillary services have significantly greater operating
margins than the margins associated with the provision of routine services to
patients at long-term care facilities. Also, the increased use of long-term and
subacute care facilities as alternatives to acute care facilities has greatly
increased the demand for such services. These trends have created greater
markets for the Company's therapy and institutional pharmacy services to
nonaffiliated long-term and subacute care facilities.
The temporary staffing industry has grown rapidly over the last several
years. Temporary rehabilitation therapist staffing is increasingly becoming a
valuable tool for managing personnel costs and for meeting specialized or
fluctuating employment requirements particularly as companies engage in
corporate downsizing. Effective use of temporary personnel enables businesses to
reduce fixed overhead and addresses the growing costs and difficulty of hiring,
laying off and redeploying full-time workers.
The long-term care industry in the United Kingdom is currently undergoing
significant change. As a result of demographic trends and recent United Kingdom
legislation and policy, the Company believes there is a growing demand for
long-term care, including more highly specialized and higher quality care. The
Company believes that supply is not keeping pace with demand and that such
demand, along with limited access to capital, is promoting industry
consolidation. These factors are placing significant burdens on small, local
operators, thereby providing, in the Company's view, opportunities for larger,
better-financed long-term care providers.
DEMOGRAPHIC TRENDS. The primary consumers of long-term and subacute care
services in the United States and the United Kingdom are persons over 65 years
of age. The Company believes that increases in the number of people in such age
group will continue to result in increased demand for long-term and subacute
care services.
IMPACT OF COST CONTAINMENT MEASURES. In response to rapidly rising health
care costs, governmental and private pay sources in the United States have
adopted cost containment measures that have reduced average lengths of hospital
stays. The federal government has acted to curtail increases in health care
costs under Medicare by limiting acute care hospital reimbursement for specific
services to predetermined fixed amounts. Under this payment system,
reimbursement for acute care hospital services is based on regional and national
rates established for diagnosis-related groups regardless of
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length of stay. In addition, private insurers have begun to limit reimbursement
to predetermined "reasonable charges," while managed care organizations such as
health maintenance organizations ("HMOs") and preferred provider organizations
are attempting to limit hospitalization costs by negotiating discounted rates
for hospital services and by monitoring and reducing hospital utilization. As a
result, average hospital stays have been shortened, with many patients being
discharged despite a continuing need for nursing care. For many of these
patients, home health care is not a viable alternative because of the complexity
of medical services and equipment required. Many of the long-term and subacute
care facilities operated by the Company are able to provide these services,
especially rehabilitation therapy, respiratory therapy and institutional
pharmacy services. In addition, the facilities that provide these services are
able to do so at a significantly lower cost than acute care hospitals, due to
their lower capital costs, overhead, and salary levels.
LIMITS ON SUPPLY OF LONG-TERM AND SUBACUTE CARE FACILITIES. The
construction of long-term and subacute care facilities and the addition of beds
or services in existing facilities is regulated in most states in which the
Company operates. Many states have implemented health plans that either limit
construction of new long-term and subacute care facilities or limit the number
of long-term beds and thus effectively limit the number of new facilities that
can be constructed. High construction costs and start-up expenses also act to
constrain growth in the number of facilities. See "-- Government Regulation" and
"-- Competition."
INDUSTRY CONSOLIDATION. Recently, the long-term and subacute care industry
in the United States has been subject to competitive pressures that have
resulted in a trend towards consolidation of smaller, local operators into
larger, more established regional or national operators. Increasing complexity
of medical services provided, growing regulatory and compliance requirements and
increasingly complicated reimbursement systems have resulted in consolidation of
operators who lack the sophisticated management information systems, operating
efficiencies and financial resources to compete effectively.
OPERATING STRATEGY
The Company's long-term operating strategy is to: (i) grow in targeted
health care markets and geographic areas, including internationally, by
selective acquisitions of long-term and subacute care facility operations with
the potential for increased profitability through the utilization of related
services such as rehabilitation and respiratory therapy, institutional pharmacy
and other high margin ancillary services, (ii) increase facility profitability
levels, through aggressive marketing and by offering therapy, subacute care and
other specialized services, thereby improving overall occupancy levels, patient
mix and ancillary revenues, and (iii) expand, through internal growth or
acquisitions, therapy and institutional pharmaceutical services provided
primarily to nonaffiliated long-term and subacute care facilities by utilizing
the Company's experience in operating long-term and subacute care facilities.
This description of the Company's long-term operating strategy is a forward
looking statement, and the Company's ability to successfully execute its
strategy and achieve its strategic goals could be affected by a number of
factors, including the Company's ability to identify and complete suitable
acquisitions, regulatory changes affecting the Company's therapy, institutional
pharmacy and other high margin ancillary services, the outcome of an ongoing
government investigation, and the Company's ability to continue to obtain
outside contracts in its ancillary businesses.
GROWTH THROUGH SELECTIVE ACQUISITIONS AND DEVELOPMENT. A critical component
of the Company's growth strategy has been to acquire long-term and subacute care
facilities and other operations. The Company has in the past expanded, and
intends to continue to expand, through the acquisition of long-term and subacute
care facilities and other operations in health care markets and geographic areas
in which the Company is currently operating or in other areas in which the
Company can acquire a group of facilities around which the Company believes
operational efficiencies can be achieved. The Company believes that
concentrating long-term and subacute care facilities and operations within such
regions reduces corporate overhead and enables the Company to benefit from
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marketing efficiencies. Except for the Company's acquisitions of The Mediplex
Group, Inc. ("Mediplex"), in June 1994, Honorcare Corporation in July 1993,
Exceler Health Care Group PLC ("Exceler") in September 1994, and a 20% interest
in Ashbourne PLC ("Ashbourne") during 1995, the expansion of the Company's
long-term and subacute care operations has generally taken the form of entry
into or assumption of operating leases of long-term and subacute care facilities
that were already in operation. Although the Company intends to continue to
acquire facilities in this fashion, such acquisitions are not expected to
represent a significant percentage of the Company's overall growth.
The Company may, from time to time, selectively consider developing new
health care facilities. The Company is currently developing, or has recently
completed development of, five long-term and subacute care facilities for which
Mediplex had obtained Certificates of Need ("CONs") prior to its acquisition by
the Company. In addition, the Company has commitments with respect to developing
ten additional long-term care facilities in the United Kingdom. The Company also
believes that the most cost-effective and profitable means of expanding its
United Kingdom operations is likely to be through redevelopment of existing
homes and development of new nursing homes. The principal factor leading to
these opportunities is the government-imposed capital spending restrictions that
tend to prevent local authorities from upgrading their existing, under-utilized
residential homes to nursing home standards.
Mediplex is the most significant acquisition undertaken by the Company to
date, and the acquisition of Mediplex allowed the Company to expand its
long-term and subacute care businesses. In addition, in September 1994 the
Company entered the United Kingdom health care market through the acquisition of
a 68% interest in Exceler which, at December 31, 1995, operated 28 long-term
care facilities with 1,437 registered beds in the United Kingdom. On February
15, 1995, the Company acquired the remaining 32% of Exceler, which is now a
wholly-owned subsidiary of the Company. During 1995, the Company acquired a 20%
ownership interest in Ashbourne, a long-term care provider in the United
Kingdom. The Company will continue to evaluate acquisition opportunities outside
of the United States.
Acquisitions present problems of integrating the acquired operations with
existing operations, including the loss of key personnel and institutional
memory of the acquired business, difficulty in integrating corporate,
accounting, financial reporting and management information systems and strain on
existing levels of personnel to operate such acquired businesses. In addition,
certain assumptions regarding the financial condition of the acquired business
may later prove to be incorrect. For example, a significant percentage of the
receivables of the acquired company may ultimately prove to be uncollectible,
which may result in significant write-offs. The Company's net earnings for the
years ended December 31, 1995 and 1994 were adversely impacted by problems
associated with integrating the Mediplex operations, including the write-off of
certain Mediplex receivables from periods prior to the acquisition and an
impairment loss related to the goodwill associated with six of the forty
facilities acquired in the Mediplex acquisition. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations." The Company's
ability to manage its growth effectively will require it to continue to improve
its corporate accounting, financial reporting and management information
systems, and to attract, train, motivate and manage its employees effectively.
There can be no assurance that the Company will be able to successfully
integrate acquired operations; failure to do so effectively and on a timely
basis could have a material adverse effect upon the Company's financial
condition and results of operations.
If the Company is unable to effectively integrate the operations of an
acquired entity with the Company's existing operations, the Company may elect to
divest some or all of the acquired operations. In the second quarter of 1996 the
Company sold its ambulatory surgery subsidiary. The Company's decision to sell
its ambulatory surgery subsidiary was influenced in part by the marketplace's
resistance to the integration of subacute care with ambulatory surgery.
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In addition, the Company has recently acquired two companies, CareerStaff
and Golden Care, that are engaged in lines of business (temporary therapist
staffing and respiratory therapy services, equipment and supplies, respectively)
with which the Company does not have previous operating experience. There can be
no assurance that the Company will develop the systems and operating expertise
to effectively operate these lines of business. Moreover, CareerStaff's growth
has been largely a result of the success of its divisions, which are owned in
part by CareerStaff's division presidents. There is no precedent in the
Company's organization for minority ownership of a subsidiary. There can be no
assurance that Sun will be able to motivate CareerStaff's division presidents to
exhibit the same level of entrepreneurial energy as they did prior to the
CareerStaff merger.
INCREASE FACILITY PROFITABILITY LEVELS. The Company's strategy includes
increasing facility profitability levels through the active marketing of
therapy, institutional pharmacy and other specialized services at long-term and
subacute care facilities because of the higher profitability of these services.
The Company has opened Phoenix Units, which are free-standing dedicated subacute
care units within long-term care facilities, at 39 of its long-term and subacute
care facilities, and at December 31, 1995, the Company provided therapy services
at 125 of its 131 long-term and subacute care facilities in the United States
and provided institutional pharmacy services to 101 of these facilities. As of
December 31, 1995, the Company had established specialized Alzheimer's units in
31 of its 131 facilities in the United States. The Company continually evaluates
the formation of further Alzheimer's units as it acquires additional facilities
or as occupancy rates in existing facilities permit.
EXPAND THERAPY SERVICES AND INSTITUTIONAL PHARMACEUTICAL SERVICES. The
Company intends to expand its provision of specialized ancillary services, such
as rehabilitation or respiratory therapy and institutional pharmaceutical
services, to nonaffiliated long-term and subacute care facilities as well as to
affiliated facilities. These services have significantly greater margins than
the margins associated with routine patient services provided at the Company's
long-term and subacute care facilities. The Company has substantial expertise in
providing such ancillary services. With the exception of the Company's
acquisitions of Golden Care and CareerStaff, the expansion of therapy services
has been promoted primarily through internal development, which is expected to
continue. The Company will continue to consider other therapy related
acquisition opportunities that will allow the Company to diversify and further
expand the range of services that the Company provides.
In the United Kingdom, the Company intends to develop pharmaceutical and
other ancillary businesses to generate additional revenues and profits and to
improve the overall delivery of care at its nursing homes. The Company believes
that it has significant experience and expertise in providing institutional
pharmaceutical and other ancillary services in the United States market, which
the Company believes should assist the Company in its efforts to introduce these
new businesses in the United Kingdom. The Company opened its first regional
pharmacy in the United Kingdom through an acquisition of a small local pharmacy
in the fourth quarter of 1995.
LONG-TERM AND SUBACUTE CARE SERVICES -- UNITED STATES
As of December 31, 1995, the Company owned, leased or managed, directly or
through its subsidiaries, 131 licensed long-term and subacute care facilities
with 15,921 licensed beds located in 16 states. Each long-term and subacute care
facility is located near at least one general acute care hospital, and the
Company has entered into transfer agreements with local hospitals to accept
patients discharged from such hospitals.
BASIC PATIENT AND ANCILLARY SERVICES. The Company's long-term and subacute
care facilities provide inpatient skilled nursing and custodial services as well
as rehabilitative, restorative and transitional medical services. The Company
provides 24-hour nursing care in these facilities by registered nurses, licensed
practical nurses and certified nursing aides. The Company also provides a broad
range of support services including rehabilitation therapy, dietary services,
therapeutic recreational activities, social services, housekeeping and laundry
services and pharmaceutical and medical supplies.
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SPECIALIZED SERVICES. Specialized health care services are those provided
to patients with medically complex needs. These services typically generate
higher profit margins than those associated with the provision of routine
patient services because of the higher reimbursement rates associated with
caring for patients with complex medical conditions. At December 31, 1995, the
Company provided skilled nursing and related medical services and certain
intensive therapy services for Medicare patients at 126 of its 131 long-term and
subacute care facilities. Such services are provided to Medicare patients within
distinct units at these facilities. At December 31, 1995, the Company provided
specialized care for patients with Alzheimer's disease at 31 of its 131
long-term and subacute care facilities under the supervision of specially
trained skilled nursing staff. These facilities also provide therapeutic
recreation and social services personnel. The Company's Alzheimer's program
includes an individually planned activities program, counseling, sensory
stimulation and a family support group.
SUBACUTE CARE. The Company defines subacute care as a minimum of four and
one-half nursing hours and one hour of therapy per patient day. Subacute care
includes those services provided to patients with medically complex conditions
who require ongoing medical and nursing supervision and access to specialized
equipment and services, but do not require many of the other services provided
by an acute care hospital. Services in this category include ventilator and
oxygen care, HIV care, intravenous therapy, complex wound care, traumatic brain
injury care, post-stroke care and hospice care. The Company has the ability to
provide subacute services at most of its long-term care facilities. In addition,
the Company operates 39 Phoenix Units, which are free-standing dedicated
subacute care units within long-term care facilities. The subacute care units
represent, in some cases, a substantial portion of the total beds in the
facility; in other cases, these units represent a smaller portion of overall
facility capacity. The Company has expanded the number of Phoenix Units by
completing the construction of four facilities with subacute care capability in
1995 for which Mediplex had obtained CONs prior to the completion of the
Company's acquisition of Mediplex, and the Company is currently developing
another such facility. The Company plans to expand its provision of subacute
care to other long-term care facilities. The Company believes that there is
significant demand for subacute care and that this sector of the health care
market offers opportunities for growth. By offering a continuum of subacute
health care services, the Company is able to respond to a broad spectrum of
patient clinical needs and payor cost containment objectives.
LONG-TERM CARE SERVICES -- UNITED KINGDOM
As of December 31, 1995, Exceler operated 28 long-term care facilities with
1,437 registered beds in the United Kingdom. In addition, Ashbourne operated 25
long-term care facilities with 2,036 registered beds in the United Kingdom.
Exceler is a long-term care provider in the United Kingdom whose nursing homes
offer a range of long-term care services, primarily nursing care and, more
recently at certain of its homes, specialized services such as day care, care
for the young physically disabled and care for elderly mentally infirm
residents.
BASIC RESIDENT AND ANCILLARY SERVICES. Basic resident services include
those typically provided to residents in nursing homes with respect to
activities of daily living and general medical needs. The Company provides
24-hour nursing and personal care by registered nurses and care assistants in
all of its facilities. The Company also provides a broad range of support
services, including dietary services, therapeutic recreational activities,
social services, housekeeping and laundry services, pharmaceutical and medical
supplies and routine therapy.
SPECIALIZED SERVICES. The Company currently offers various specialized
services at certain of its nursing homes, including day care, care for the young
physically disabled, care for elderly mentally infirm residents and
post-operative care. These services typically generate higher profit margins
than those associated with the provision of routine patient services. Day care
services provide elderly members of the community with facilities focused on
their personal care, recreation and stimulation.
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The care of the young physically disabled involves occupational therapy in
addition to basic services. Certain of the Company's homes provide care for
elderly mentally infirm residents, including those with Alzheimer's disease.
THERAPY SERVICES
The Company has provided therapy services since 1991. These services were
provided by the Company in 41 states as of December 31, 1995. The Company offers
such services to both affiliated and nonaffiliated long-term and subacute care
facilities. These services primarily consist of the provision of licensed
physical, occupational or speech therapists, although the Company has recently
begun to provide respiratory therapy services. These services were provided to
125 affiliated and 643 nonaffiliated long-term and subacute care facilities as
of December 31, 1995. The Company is currently providing rehabilitation therapy
services to all of the Mediplex long-term and subacute care facilities.
TEMPORARY REHABILITATION THERAPIST STAFFING
In June 1995, the Company acquired CareerStaff, which is the only provider
of temporary rehabilitation therapist staffing with a nationwide network of
offices. Founded in 1990, CareerStaff provides licensed therapists skilled in
the areas of physical, occupational and speech therapy primarily to hospitals
and nursing home contract service providers, with a growing emphasis towards
home health care providers. As of December 31, 1995, CareerStaff had on
assignment approximately 1,600 therapists working out of 16 division offices
providing temporary rehabilitation therapist staffing in major metropolitan
areas and two division offices specializing in placements of temporary
travelling therapists in smaller cities and rural areas.
For the years ended December 31, 1995, 1994 and 1993, hospitals represented
approximately 49%, 49% and 51%, respectively, of CareerStaff's revenues, and
nursing home contract service providers represented approximately 23%, 31% and
30%, respectively, of CareerStaff's revenues. Although CareerStaff continues to
derive the majority of its revenues from hospitals and nursing home contract
service providers, CareerStaff's management has observed a trend in its client
base towards subacute providers and home health care agencies.
INSTITUTIONAL PHARMACEUTICAL SERVICES
In March 1993, the Company commenced its institutional pharmacy business
through the purchase of customer contracts and certain related assets from a
pharmacy located in Phoenix, Arizona. Since March 1993, 12 additional regional
pharmacies were opened which service 17 states. At December 31, 1995, the
Company provided pharmaceutical products and services to 372 long-term and
subacute care facilities, 271 of which were operated by nonaffiliated parties.
Included in this total are the acquisitions of all of the outstanding shares of
DanRae Corporation, an institutional pharmacy located in Arizona, in March 1995,
and Nursing Home Consultant Pharmacy, an institutional pharmacy located in South
Carolina, in August 1995. The Company opened its first regional pharmacy in the
United Kingdom through an acquisition of a small local pharmacy in the fourth
quarter of 1995.
Institutional pharmacy services include dispensing pharmaceuticals for such
purposes as infusion therapy, pain management, antibiotic therapy and parenteral
nutrition. Additional services include providing consultant pharmacists and
assistance in preparation of billing documentation. These services are typically
provided to nonaffiliated and affiliated facilities, including subacute and
skilled nursing care facilities, assisted living facilities, group houses,
correctional facilities, mental health facilities and home health care
companies.
The Company intends to pursue opportunities to expand its institutional
pharmacy business through acquisition and internal growth both in the United
States and in the United Kingdom.
AMBULATORY SURGERY
As of December 31, 1995, the Company managed thirteen multi-specialty
ambulatory surgery centers with 40 operating rooms in Connecticut, California,
New Jersey and Pennsylvania. The
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Company has an ownership interest or an option to acquire an ownership interest
in the licensed operator of eight of these centers. All of the facilities are
leased from third parties. During the twelve month period ended December 31,
1995, these thirteen surgical units had been used to perform a total of
approximately 35,000 surgical procedures. In the second quarter of 1996, the
Company sold its ambulatory surgery subsidiary. The Company's decision to sell
its ambulatory surgery subsidiary was influenced in part by the market place's
resistance to the integration of subacute care with ambulatory surgery.
ACQUISITIONS
A critical component of the Company's growth strategy has been to acquire
long-term and subacute care facilities and other operations. Prior to the merger
of Mediplex with a subsidiary of the Company (the "Mediplex Merger"), the
expansion in the Company's long-term and subacute care operations occurred most
frequently by entering into or assuming operating leases of long-term and
subacute care facilities that were already in operation. The Company issued
11,249,544 shares of Common Stock, which had a market value of approximately
$213,741,000 at the date of acquisition, and paid approximately $106,500,000 in
cash, in consideration for the acquisition of Mediplex. Since the Mediplex
Merger, the Company has expanded the divisions in which acquisitions have been
done, with acquisitions in the institutional pharmacy and therapy divisions.
Acquisitions have generally been larger in size and, in most cases, have
utilized stock or a combination of stock and cash. Recent acquisitions include
(i) the acquisition of 100% of the stock of Exceler, a long-term care provider
in the United Kingdom, in September 1994 and February 1995 for an aggregate
purchase price of $17,574,000 in cash plus up to L700,000 ($1,085,000 as of
December 31, 1995) payable in cash on September 30, 1996, and (ii) the
acquisition of the stock of Altis Outpatient Services, Inc., an operator of
ambulatory surgery centers, in January 1995, for 304,902 shares of Common Stock,
which had a market value of approximately $8,000,000 at the date of acquisition,
(iii) the acquisition of the stock of DanRae Corporation, an institutional
pharmacy, in March 1995 for 81,496 shares of Common Stock, which had a market
value of approximately $2,100,000 at the date of acquisition, (iv) the
acquisition of Golden Care, a respiratory therapy company, in May 1995, for
2,106,904 shares of Common Stock and options to purchase an additional 234,100
shares of Common Stock, which had a market value of approximately $40,000,000 at
the date of acquisition, (v) the acquisition of a 20% interest in Ashbourne, a
long-term care provider in the United Kingdom, in the second quarter of 1995,
for approximately $26,000,000 in cash, (vi) the acquisition of CareerStaff, a
provider of temporary therapist staffing, in June 1995, for 6,080,600 shares of
Common Stock, which had a market value of approximately $107,100,000 at the date
of acquisition, (vii) the acquisition of Nursing Home Consultant Pharmacy, an
institutional pharmacy, in August 1995, for 608,800 shares of Common Stock,
which had a market value of approximately $9,400,000 at the date of acquisition,
and (viii) the acquisition of Columbia Health Care, Inc., a Canadian provider of
outpatient rehabilitation therapy services, in November 1995 for approximately
$8,500,000 in cash and warrants to purchase 500,000 shares of common stock at an
exercise price of $15.375 per share. Acquisitions present problems of
integrating the acquired operations into existing operations. See "Operating
Strategy -- Growth through Selective Acquisitions and Development."
Expansion through the use of leases and management agreements permitted the
Company to increase the size of its operations and earnings capacity without
significant capital expenditures, although in certain cases payments have been
required in connection with the restructuring of lease arrangements, and it is
common for a security deposit or a letter of credit to be required at the
inception of a lease term. In addition, in certain cases the Company is required
to expend significant sums immediately following acquisitions to finance such
facilities' operations until payments are received from payor sources for
services rendered by the Company. The Company has also in the past made and
expects to continue to make acquisitions through the use of its own stock as
consideration, thereby avoiding expenditure of cash. Regulatory approval is
generally required in connection with the Company's assumption of operating
responsibility for new facilities.
8
<PAGE>
The Company continually evaluates opportunities to acquire or develop its
health care operations, including but not limited to its therapy and
institutional pharmacy businesses. In evaluating opportunities, management
considers, among other factors, location (including synergies with existing
Company operations), demographics, price, the availability of financing on
acceptable terms (including lease terms and the ability to use Common Stock as
acquisition consideration), the competitive and regulatory environment and the
opportunity to improve performance through the implementation of the Company's
operating strategy.
The Company is continuously discussing with third parties the possible
acquisition of long-term and subacute care facilities and other health care
operations. Such acquisitions are often initiated and completed over a short
period of time. While the Company regularly considers and evaluates
opportunities for expansion and is engaged in discussions with various parties
regarding acquisitions which, if completed, would be material, it does not have
any firm agreements with respect to material acquisitions or expansion.
Potential acquisition candidates generally include companies or facilities in
geographic proximity to facilities operated by the Company, those with similar
operations or those that fit within the Company's operating strategy. In
addition, the Company is actively considering strategic alliances with long-term
care providers outside of the United States, and intends to continue to explore
international acquisitions, particularly in the United Kingdom. The Company
believes that one of its strengths in the past has been its ability to identify
acquisition candidates, and, through capitalizing on operational synergies, to
improve the operating results of these acquired entities. Prior to the Mediplex
Merger, this strategy had been applied in the acquisition and integration of
relatively small numbers of long-term care facilities, and there can be no
assurance that such experience will apply in larger acquisitions, in
acquisitions outside of the United States, or in acquisitions involving new
lines of business. Subject to requirements of Delaware law and the New York
Stock Exchange, the Company stockholders will have no advance opportunity to
evaluate the merits and risks of future acquisitions. There can be no assurance
that any future acquisitions will be completed or that the Company's historical
rate of growth in assets, revenues or net earnings will be sustained.
ASSETS HELD FOR SALE
As part of the Mediplex Merger, the Company acquired five facilities and
certain outpatient units providing substance abuse, psychiatric or transitional
living services, as well as three former substance abuse and/or psychiatric
facilities that were closed in 1992 and 1993. In 1994, the Company's Board of
Directors approved a plan of disposition for these facilities. On September 30,
1995, the Company completed the sale of the real estate of five of the operating
psychiatric care and substance abuse treatment facilities and all of the related
outpatient facilities for a purchase price of $39,900,000 consisting of cash and
the assumption of indebtedness secured by one of the facilities. As part of the
sale, the Company provided a five-year $12,500,000 working capital line of
credit for the buyer, which is secured by the accounts receivable of the
facilities being sold and is restricted to a borrowing base determined by the
amount of accounts receivable of the facilities with the buyer. Under the terms
of the working capital line of credit, principal is due in full on September 30,
2000 and interest accrues at either LIBOR plus 2.5% or Prime plus 1.5%. As of
December 31, 1995, $12,500,000 had been advanced on the working capital line of
credit. The Company also subleased two other operating transitional living
facilities and sold the working capital of these facilities to the current
administrator of one of these facilities, who has assumed responsibility for
approximately 60% of the Company's obligations under the present leases and will
pay the Company a total of $13,400,000 over the term of such leases. On May 17,
1995 and August 2, 1995, the Company completed the sale of two of the closed
facilities for $2,000,000 and $2,500,000, respectively. As a result of the terms
of the sales, the Company has retained net liabilites totaling approximately
$10,200,000 and long-term liabilities of approximately $8,600,000 which, as of
December 31, 1995, have been reclassified on the balance sheet. As of December
31, 1995, the Company continues to lease a transitional living facility which
will be purchased and then sold in 1996 and the Company owns an interest in a
substance abuse facility which was closed in 1992.
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In connection with the Mediplex Merger, the Company, directly or through
Mediplex, became responsible for debt obligations that had an outstanding
balance of $82,700,000 at December 31, 1994, which were secured by the Assets
Held for Sale. The Company was required to substitute mortgages or other
financing on certain of its other properties in an amount equal to the debt on
these facilities that was not assumed or refinanced through Meditrust Mortgage
Investments, Inc. ("Meditrust") by the purchaser of these assets. The Company
entered into various sale leaseback transactions with Meditrust to fulfill this
obligation.
REVENUE SOURCES
The Company derives its revenues from a combination of (i) state Medicaid
programs for indigent patients, (ii) the Federal Medicare program for certain
elderly and disabled patients, (iii) private payment sources, which includes
payments for therapy and institutional pharmaceutical services provided to
nonaffiliated long-term and subacute care facilities, (iv) foreign operations in
the United Kingdom and Canada and (v) other miscellaneous sources. Such private
pay sources may themselves derive all or a portion of their revenues from
Medicaid and/or Medicare.
The following table sets forth the percentage of total revenues by payor
source for the Company for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
SOURCES OF REVENUES 1995 1994 1993
- ----------------------------------------------------------------------------- ----------- ----------- -----------
<S> <C> <C> <C>
Medicaid..................................................................... 34% 40% 39%
Medicare..................................................................... 23% 20% 14%
Private pay and other (1).................................................... 41% 39% 47%
Foreign operations........................................................... 2% 1% --
</TABLE>
- ------------
(1) Includes revenues from therapy services, which includes payments for
rehabilitation and respiratory therapy, temporary therapy staffing services
and institutional pharmacy services provided to nonaffiliated long-term and
subacute facilities and not directly charged to Medicaid or Medicare. Such
private pay sources may themselves derive all or a portion of their revenues
from Medicaid and/or Medicare.
UNITED STATES REVENUE SOURCES
The Company's revenues from long-term and subacute care services are
determined by a number of factors, including: (i) the licensed bed capacity of
its facilities, (ii) the occupancy rates of its facilities, (iii) the mix of
patients and the rates of reimbursement among payor categories (Medicaid,
Medicare and private pay and other) and (iv) the extent to which subacute care
and certain ancillary services available in the Company's facilities are
utilized by the patients and paid for by the respective payor sources. The
Company utilizes reimbursement specialists and retains outside reimbursement
consultants to monitor both Medicaid and Medicare regulatory developments and to
assist in compliance with all program requirements with a view to obtaining all
lawful reimbursement.
MEDICAID. The Medicaid program is a program created by the Social Security
Act to benefit indigent persons who are aged, blind or disabled. Payment is made
under state-administered reimbursement programs governed by Federal guidelines.
Although Medicaid programs vary from state to state, typically they provide for
fixed rate payments to health care providers at levels designed to compensate an
efficiently and economically operated facility. Reimbursement rates are
typically determined by the state from "cost reports" filed annually by each
facility, on a prospective or retrospective basis. Under most state Medicaid
programs, individual facilities are reimbursed on a prospective rate system,
subject to retroactive adjustment. Under a prospective system, per diem rates
are established (generally on an annual basis) based upon certain historical
costs of providing services during the prior year, adjusted to reflect factors
such as inflation and any additional services required to be performed.
Retroactive adjustments, if any, are based on a recomputation of the applicable
reimbursement rate following an audit of cost reports. Providers must accept
reimbursement from Medicaid as payment in full for the services rendered. The
provider may not bill the patient for
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services covered by the Medicaid program but may bill the patient for noncovered
services. There can be no assurance that Medicaid reimbursement will be
sufficient to cover actual costs incurred by the Company with respect to
Medicaid services rendered. State Medicaid plans also require that providers
must be subject to governmental audit to ensure the propriety of costs incurred,
which are used as the basis for payments.
Most of the Company's facilities participate in the Medicaid program. The
Company's facilities in Arizona participate in the Arizona Health Care Cost
Containment System Program (the "AHCCCS Program"), which is operated under a
Federal Medicaid waiver. The AHCCCS Program is an alternative to the
conventional Medicaid program. The AHCCCS Program provides Federal financial
assistance for care it provides to needy individuals who would be eligible for
Medicaid in any other state. The AHCCCS Program is designed primarily to secure
health care on a capitated basis under contracts awarded to qualified bidders,
but it also pays some contractors on a fee-for-service basis when capitated
contracts are impractical. The Company negotiates the rates of reimbursement
with the county in which services are provided, on either a capitated or
fee-for-service basis, depending on the county. Under the AHCCCS Program,
nursing facility services are covered for eligible patients of all ages.
Certain states, including Massachusetts, are studying methods for reducing
expenses under their Medicaid programs, which initiatives could have an adverse
effect on applicable Medicaid rates. Connecticut has undertaken a study of
acuity levels and is considering changes in its reimbursement system to take
levels of acuity into account for the reimbursement of nursing costs. The
Company cannot currently determine the potential effect of any such changes. To
date, adjustments from Medicaid audits have not had a material adverse effect on
the Company. The Company believes that it has properly applied the various
payment formulas and that any future adjustments will not be material.
MEDICARE. Medicare is a federally funded and administered health insurance
program that provides coverage for beneficiaries who require certain intensive
rehabilitation therapy services or skilled nursing and certain related medical
services, such as physical, occupational and speech therapy, pharmaceuticals,
medical supplies and ancillary, diagnostic and other necessary services of the
type provided by skilled nursing facilities. Medicare benefits are not available
for patients requiring intermediate and custodial levels of care. In general,
Medicare payments for skilled nursing services and rehabilitative care are based
on allowable costs. With certain exceptions, Medicare pays on an interim basis,
subject to year-end cost settlement. Each facility receives interim payments
during the year. Total incurred costs are later adjusted upward or downward to
reflect actual allowable direct and indirect costs of services based on the
submission of a cost report at the end of each year. If allowable cost is less
than the interim payments, depending on the effective date of the adjustment,
the Company could be required to refund prospectively the excess of amounts it
receives over such allowable costs. If such refund were required to be made, it
would be due shortly following notice from Medicare, and would likely require
the Company to borrow under its Credit Facility. There can be no assurance that
Medicare reimbursement will be sufficient to cover actual costs incurred by the
Company with respect to Medicare services rendered. As of December 31, 1995, 126
of the Company's 131 long-term and subacute care facilities in the United States
(or 96% of such facilities) were certified to receive payment for costs incurred
providing benefits under Medicare.
Medicare reimbursement for services provided in skilled nursing facilities
is based upon the lesser of (i) actual allowable routine and ancillary operating
costs and capital costs or (ii) charges. Facilities that have been in operation
longer than three full cost reporting periods are subject to limits on their
actual routine per diem costs. The routine service cost limits, which are
regionally adjusted for labor costs, are updated annually by HCFA. However,
these limits have been frozen for HCFA's past three fiscal years ended September
30, 1995. The freeze expired on October 1, 1995. Anticipated Medicare payments
and rate adjustments have been delayed as a result of the required change of
fiscal intermediaries from Blue Cross of New Mexico to Blue Cross of Texas. The
announced change has slowed the processing of requests for exceptions to the
Medicare established routine cost limitations
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<PAGE>
for reimbursement ("RCLs"), which in turn has led to delayed revenue
recognition. In addition, the change has led to delays in payments to the
Company resulting in increased borrowings under the Company's revolving credit
facility, thereby causing the Company to incur additional interest expenses.
Hospitals that provide acute care are paid for non-physician services to
Medicare inpatients under the federal prospective payment system ("PPS"), under
which payments are based on standard amounts adjusted for the patient's
diagnosis without regard to the hospital's actual inpatient operating costs.
Medicare payments for inpatient services provided by rehabilitation and
psychiatric hospitals or units and skilled nursing facilities that meet the
requirements to be exempted from the PPS are generally reimbursed on a
reasonable cost basis, subject to certain limits and exceptions. Medicare
payment for most outpatient ancillary services provided in non-acute care
facilities is based upon the lesser of reasonable costs or charges.
Rehabilitation and psychiatric hospitals or units in acute care hospitals
must meet certain eligibility requirements for exclusion from PPS. All of the
Company rehabilitation and psychiatric facilities which are classified as Assets
Held for Sale in the financial statements are exempt from PPS. Rehabilitation
hospitals must show that they provided services to an inpatient population of
whom at least 75% required intensive rehabilitative services for the treatment
of conditions that fell within ten specified categories of injury and disease.
Psychiatric hospitals or units must be primarily engaged in providing
psychiatric services for the diagnosis and treatment of mentally ill patients.
The rehabilitation facilities meeting these requirements are reimbursed by
Medicare for their portion of the actual allowable operating and capital costs
for the first three full cost reporting periods under current or previous
ownership. After this period, the facilities will be subject to limits on their
actual operating costs per discharge. The cost limits were imposed under
regulations adopted under the Tax Equity and Fiscal Responsibility Act of 1982
("TEFRA"). The TEFRA limit is determined based upon actual Medicare allowable
operating costs per discharge incurred in the base year, and is updated annually
by an amount approved by HCFA. The annual payment update reflects changes in the
hospital market basket and budgetary policy. Rehabilitation facilities subject
to TEFRA limits will be reimbursed the lesser of their actual allowable
operating and capital costs or the TEFRA limit plus capital. If a facility's
actual allowable operating costs are less than the TEFRA limit, it will receive
in addition to its actual costs an "incentive" payment which is equivalent to
the lesser of 50% of the difference between the TEFRA amount and actual
operating costs or 5% of the TEFRA amount.
The Company's Golden Care subsidiary derives a significant percentage of its
net revenues and net operating earnings from the provision of respiratory
therapy services and related supplies, equipment and medical gases to
beneficiaries of the Medicare and Medicaid programs who reside in long-term and
subacute care facilities. In general, long-term and subacute care facilities
that contract with an outside provider for the furnishing of respiratory therapy
services are reimbursed under Part A of the Medicare program through the annual
facility cost reporting process. Reimbursement is made under Medicare's
reasonable cost principles, subject to salary equivalency guidelines that
operate as cost limits. Respiratory therapy services furnished under a contract
with an outside provider are Medicare covered services and reimbursable under
Medicare Part A only if furnished by a "transfer hospital" with which the
long-term and subacute care facility has entered into a "transfer agreement."
Golden Care has entered into contracts with a number of transfer hospitals that
participate in the federal Medicare program and the transfer hospitals have
established transfer agreements with a number of skilled nursing facilities.
Pursuant to Golden Care's contracts, the transfer hospitals: (1) rent necessary
respiratory therapy equipment from Golden Care; and (2) receive comprehensive
and specific management services from Golden Care. The transfer hospitals pay
Golden Care monthly rental payments for the equipment, and certain other fees
for the management, administrative and other related services that Golden Care
renders. The long-term or subacute care facility pays the transfer hospital for
the respiratory therapy services rendered by it, and reports the costs in the
annual cost reporting process. Golden Care also receives payment directly under
Part B of the Medicare program for the cost of certain equipment, supplies and
medical gases. Golden Care also has
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<PAGE>
entered in contracts with a number of skilled nursing facilities to provide
necessary medical supplies, medical gases and respiratory therapy equipment,
pursuant to a fee schedule. The skilled nursing facilities pay Golden Care upon
receipt of the medical supplies and medical gases and monthly for the necessary
respiratory therapy equipment.
Current Medicare regulations that apply to transactions between related
parties, such as the Company and its subsidiaries, are relevant to the amount of
Medicare reimbursement that the Company is entitled to receive for the
rehabilitation and respiratory therapy and institutional pharmaceutical services
that it provides to Company-operated facilities. These Medicare regulations
generally require that, among other things, (i) the Company's rehabilitation and
respiratory therapy and institutional pharmacy subsidiaries must each be a bona
fide separate organization; (ii) a substantial part of the rehabilitation and
respiratory therapy services or institutional pharmaceutical services, as the
case may be, of the relevant subsidiary must be transacted with nonaffiliated
entities, and there is an open, competitive market for the relevant services;
(iii) rehabilitation and respiratory therapy services and institutional
pharmaceutical services, as the case may be, are services that commonly are
obtained by long-term and subacute care facilities from other organizations and
are not a basic element of patient care ordinarily furnished directly to
patients by such long-term and subacute care facilities; and (iv) the prices
charged to the Company's long-term and subacute care facilities by its
rehabilitation and respiratory therapy services subsidiaries and institutional
pharmacy subsidiary are in line with the charges for such services in the open
market and no more than the prices charged by its rehabilitation and respiratory
therapy services and institutional pharmacy subsidiaries under comparable
circumstances to nonaffiliated long-term and subacute care facilities. The
Medicare regulations do not indicate a specific level of services that must be
provided to nonaffiliated entities in order to satisfy the "substantial part"
requirement of such regulations. Net revenues from rehabilitation therapy
services provided to nonaffiliated facilities represented 64%, 67% and 74% of
total rehabilitation therapy services net revenues for the twelve months ended
December 31, 1995, 1994 and 1993, respectively. Respiratory therapy services
were not provided to affiliated facilities prior to the acquisition of Golden
Care on May 5, 1995. Respiratory therapy services provided to nonaffiliated
facilities for the period from the date of acquisition of Golden Care on May 5,
1995 to December 31, 1995 represented 64% of total respiratory therapy services
net revenues. Net revenues from institutional pharmacy services provided to
nonaffiliated facilities represented 78%, 81% and 83% of total institutional
pharmacy services revenues for the twelve months ended December 31, 1995, 1994,
and 1993, respectively.
The Company believes that it has satisfied the foregoing Medicare
requirements with respect to its rehabilitation therapy and institutional
pharmacy subsidiaries, and, therefore, is entitled to receive reimbursement for
services provided to the Company-operated facilities at the rates applicable to
services provided to nonaffiliated entities. Consequently, it has claimed and
received reimbursement under Medicare for rehabilitation and respiratory therapy
and institutional pharmaceutical services provided to patients in its own
facilities at a higher rate than if it did not satisfy these requirements. The
Company believes that it has integrated the Mediplex operations, and that it
will integrate the Golden Care operations, so as to remain in compliance with
the regulations. If the Company is unable to satisfy these regulations, the
reimbursement the Company receives for rehabilitation and respiratory therapy
and institutional pharmaceutical services provided to its own facilities would
be materially adversely affected. If, upon audit by relevant reimbursement
agencies, such agencies find that each of these regulations has not been
satisfied, and if, after appeal, such findings are sustained, the Company could
be required to refund some or all of the difference between its cost of
providing these services and the higher amount actually received. While the
Company believes that it has satisfied and will continue to satisfy these
regulations, there can be no assurance that its position would prevail if
contested by relevant reimbursement agencies. The foregoing statements with
respect to the Company's ability to satisfy these regulations are forward
looking and could be affected by a number of factors, including the
interpretations of Medicare regulations by the relevant reimbursement agencies
and the Company's ability to provide services to nonaffiliated facilities.
13
<PAGE>
PRIVATE PAY SOURCES. Private pay revenues include payments from individuals
who pay directly for services without governmental assistance, revenues from
commercial insurers, Blue Cross organizations, HMOs, preferred provider
organizations, workers' compensation programs and other similar payment sources.
Payments from these private pay sources may be charge-based, cost-based or based
on periodically renewable contracts negotiated with these payors. Many
conditions treated by rehabilitation services are covered by liability
insurance, rather than health benefits policies. In such cases, reimbursement
rates are established on a case-by-case basis.
Although the level of charges by the Company to private patients in its
facilities is not subject to the same regulatory control as with Medicaid or
Medicare, its charges are still generally limited to customary and reasonable
charges for such health care services. In addition, many HMOs and other private
payors are under pressure to contain or reduce costs through increasing case
management review of services, lowering reimbursement rates and negotiating
reduced contract pricing.
THERAPY SERVICES TO NONAFFILIATES. Revenues from rehabilitation therapy
services to nonaffiliates are derived from the Company's therapy business which
provides physical, occupational, speech and respiratory therapy, and respiratory
products and supplies, to patients at long-term and subacute care facilities not
operated by the Company. In general, payments for these therapy services are
received directly from the long-term care facilities, which in turn are paid by
Medicare or other payors. Revenues from rehabilitation therapy services provided
to the Company-operated facilities are included in the Medicaid, Medicare and
private pay sources of revenues of the Company. The Company's charges to
nonaffiliates, though not directly regulated, are effectively limited by
regulatory reimbursement policies imposed on the long-term and subacute care
facilities that receive these therapy services, as well as competitive market
factors. The Company's contracts with the nonaffiliated facilities are generally
terminable on 90 days' notice, so that if reimbursement policies changed in such
a way that contract therapy rates owed by such facilities to the Company
exceeded reimbursement paid by Medicare or other payors to such facilities, they
would be able to terminate their contractual relationships with the Company. In
addition, in substantially all instances, the Company may be contractually
required to indemnify the nonaffiliated facility for amounts it has been paid
which are subsequently recouped by Medicare.
CareerStaff revenues are included in the Private and Other category, since
all CareerStaff revenues are derived from billings to facilities served, rather
than directly from Medicare or Medicaid; although Medicare or Medicaid may
reimburse the facilities for the cost of services provided to CareerStaff.
INSTITUTIONAL PHARMACY SERVICES TO NONAFFILIATES. Revenues from the
Company's pharmacy services are derived from the provision of such services to
patients at long-term and subacute care facilities, most of which are not
operated by the Company. The Company enters into non-exclusive contracts with
nonaffiliated facilities, and personnel at such facilities submit prescriptions
to the Company on behalf of patients at such facilities. The Company is in most
cases paid directly by Medicare, Medicaid or private pay sources, and not by the
long-term care facility. The amounts that can be charged for prescriptions are
often limited by Medicaid regulations.
UNITED KINGDOM REVENUE SOURCES
The Company derives its revenues in the United Kingdom from a combination of
(i) DSS income support, (ii) local authority payments and (iii) private payor
sources.
DSS INCOME SUPPORT. The majority of residents in nursing homes in the
United Kingdom are funded by income support payments by the United Kingdom
Department of Social Security (the "DSS"). DSS income support is paid without
any assessment of care need. Under the DSS income support system, if an
individual had less than L8,000 in assets and insufficient income to cover the
cost of home care, that individual is eligible for DSS income support for
nursing home care. A single set of national rates is applied throughout the
United Kingdom (except in London where an additional premium is payable). DSS
income support levels are reviewed annually and generally are increased
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<PAGE>
with United Kingdom inflation rates. Residents receiving income support who
entered homes before April 1993 will continue to have their fees paid until they
die or leave the nursing home. Consequently, the funding changes introduced by
the Community Care Act will take effect gradually as those who receive payments
from the DSS under the pre-April 1993 system are replaced by residents who now
receive local authority funding.
LOCAL AUTHORITY FUNDING. Since implementation of the Community Care Act, if
an individual is assessed by a local authority as requiring nursing home care,
the local authority will place that individual in a nursing home with which it
has contracted (or a home of the individual's choice) and will recover from the
resident any income which he or she may have to cover such costs. In addition,
local authorities may place a charge over a resident's property and recover the
fees for nursing home care from the proceeds of the sale following the death of
the spouse. The local authority is free to contract with any nursing home and
may agree to any fee with the operator of the nursing home. In practice, most
local authorities have used the level of DSS income support payments as a
benchmark against which to set their fees. As a result, local authority rates
are likely to rise in line with DSS income support payments. Some local
authorities, however, have been willing to pay a higher fee for higher
dependency residents or higher quality nursing homes. An individual may choose
to go to a different nursing home than the one offered by the local authority,
provided the extra cost, or "top up," if any, is borne by the individual or by a
third party. Approximately 30% of the Company's residents receiving income
support or local authority funding pay such "top up" payments.
PRIVATE PAYOR SOURCES. Privately funded residents typically pay
approximately 10% more than DSS or local authority-funded residents. The Company
believes that the financial resources of the elderly are projected to increase
in the future. As a result, there is likely to be a decrease in the number of
people who are eligible for local authority funding or DSS income support. The
majority of privately funded residents pay for the cost of nursing home care
with the proceeds from the sale of their home. Health insurance and other
financial products that provide financing for long-term nursing care are in
their infancy in the United Kingdom and it is unlikely that these products will
account for a significant portion of nursing home revenues in the near future.
GOVERNMENT REGULATION
The health care industry is subject to substantial federal, state and local
regulation. The various layers of governmental regulation affect the Company's
business by controlling its growth, requiring licensure or certification of its
facilities, regulating the use of its properties and controlling reimbursement
to the Company for services provided. See "-- Revenue Sources." Licensing,
certification and other applicable governmental regulations vary from
jurisdiction to jurisdiction, are revised periodically, and vary among the
nursing home, therapy and pharmacy operations.
In recent years, an increasing number of legislative proposals have been
introduced or proposed in Congress and in some state legislatures that would
effect major changes in the health care system, either nationally or at the
state level. Among the proposals under consideration are cost controls on
hospitals, insurance market reforms to increase the availability of group health
insurance to small businesses, and requirements that all businesses offer health
insurance coverage to their employees. It is not clear at this time whether any
proposals will be adopted, or, if adopted, what effect, if any, such proposals
would have on the Company's business. There can be no assurance that currently
proposed or future health care legislation or other changes in the
administration or interpretation of governmental health care programs will not
have a material adverse effect on the financial results or operations of the
Company.
In addition, various cost containment measures adopted by governmental and
private pay sources limit the scope and amount of reimbursable health care
expenses and limit increases in reimbursement rates for medical services. In
October 1993, HCFA issued a directive to intermediaries that administer the
Medicare reimbursement policies in the states to review costs incurred by
providers of occupational therapy and speech therapy. Although HCFA has
published salary equivalency guidelines for physical therapy and respiratory
therapy, no such standards exist for occupational therapy
15
<PAGE>
and speech therapy. The directive indicated HCFA's intention to develop salary
equivalency guidelines for occupational and speech therapy. Implementation of
this directive and the development of salary equivalency guidelines could
directly or indirectly limit reimbursement for substantially all of the
Company's rehabilitation therapy services. Reimbursement for such services is
currently evaluated under Medicare's reasonable cost principles. In April and
June 1995, HCFA provided information to intermediaries for their consideration
in determining reasonable costs for occupational and speech therapy. The salary
information set forth in such directives, although not intended to be applied as
absolute limits on reasonable costs, could substantially lower the reimbursement
rates. While the effect of these directives is still uncertain, they may be a
factor considered by such intermediaries in determining reasonable costs, which
could result in a decrease in the Company's revenue or, with respect to
rehabilitation therapy services provided to Company-operated facilities, a
retroactive adjustment of Medicare reimbursement for some prior periods. An
adjustment of reimbursement rates with respect to therapy services provided to
nonaffiliated facilities could result in indemnity claims against the Company,
based on the terms of substantially all of the Company's existing contracts with
such facilities for payments previously made by such facilities to the Company
that are reduced by Medicare in the audit process.
Additional measures are likely to be adopted in the future as Federal and
state governments attempt to control escalating health care costs. Any
reductions in reimbursement levels under Medicaid, Medicare or private payor
programs and any changes in applicable government regulations or interpretations
of existing regulations could significantly affect the Company's profitability.
Furthermore, governmental programs are subject to statutory and regulatory
changes, retroactive rate adjustments to incurred costs, administrative rulings
and government funding restrictions, all of which may materially affect the rate
of payment to facilities and its therapy and institutional pharmacy businesses.
There can be no assurance that payments under government or private payor
programs will remain at levels comparable to present levels or will be adequate
to cover the costs of providing services to patients eligible for assistance
under such programs. Significant decreases in utilization and limits on
reimbursement could have a material adverse effect on the Company's financial
condition and results of operations.
Many of the states in which the Company operates have adopted CON statutes
applicable to the services provided by the Company. Such statutes provide
generally that, prior to the construction of new beds, the addition of new
services or the making of certain capital expenditures exceeding defined levels,
a state agency must determine that a need exists for such proposed activities.
Failure to obtain the necessary state approval can result in the inability to
provide the service, operate the facility or complete the addition or other
change, and can also result in the imposition of sanctions or adverse action in
respect of the facility's license and reimbursement. The Company acquired four
CONs through the Mediplex Merger for construction of four facilities in
Massachusetts, New Jersey and Maryland with a total of 525 licensed beds, which
opened in the first two quarters of 1995. In addition, the Company entered into
an agreement in connection with the Mediplex Merger to acquire one additional
facility in Massachusetts from the entity that has the CON for the facility upon
completion of construction.
Substantially all of the Company's long-term and subacute care facilities in
the United States are licensed under applicable state law. As of December 31,
1995, 126 of the Company's 131 long-term and subacute care facilities in the
United States (or 96% of such facilities) were certified to receive benefits
provided under Medicare, and 128 (or 98% of such facilities) were approved as
providers under Medicaid. Both initial and continuing qualification of a
facility to participate in the Medicaid or Medicare program depends upon many
factors, including accommodations, equipment, services, patient care, safety,
personnel, physical environment and adequate policies, procedures and controls.
In order to participate in the Medicare program, a facility must be licensed and
certified as a provider of skilled nursing services. Effective October 1, 1990,
the Omnibus Budget Reconciliation Act of 1987 eliminated the different
certification standards for "skilled" and "intermediate care" nursing facilities
under the Medicaid program in favor of a single "nursing facility" standard.
This standard
16
<PAGE>
requires, among other things, that the Company have at least one registered
nurse on each day shift and one licensed nurse on each other shift, and
increases training requirements for nurse's aides by requiring a minimum number
of training hours and a certification test before a nurse's aide can commence
work. States continue to be required to certify that nursing facilities provide
"skilled care" in order to obtain Medicare reimbursement. Licensing,
certification and other applicable standards vary from jurisdiction to
jurisdiction and are revised periodically. State agencies survey all long-term
care facilities on a regular basis to determine whether such facilities are in
compliance with the requirements for participation in government sponsored third
party payor programs.
The Company believes that its facilities are in substantial compliance with
the various Medicare and Medicaid regulatory requirements applicable to them.
However, in the ordinary course of its business, the Company receives notices of
deficiencies for failure to comply with various regulatory requirements. The
Company reviews such notices and seeks to take appropriate corrective action. In
most cases, the Company and the reviewing agency will agree upon the measures to
be taken to bring the facility into compliance. In some cases or upon repeat
violations, the reviewing agency has the authority to impose fines, temporarily
suspend admission of new patients to the facility, suspend or decertify from
participation in the Medicare or Medicaid programs and, in extreme
circumstances, revoke a facility's license. These actions would adversely affect
a facility's ability to continue to operate, the ability of the Company to
provide certain services and the facility's eligibility to participate in the
Medicare or Medicaid programs. Additionally, conviction of abusive or fraudulent
behavior with respect to one facility could subject other facilities under
common control or ownership to exclusion from participation in the Medicare and
Medicaid programs.
Certain of the Company's long-term and subacute care facilities in
Louisiana, Texas, Oregon, Washington and Connecticut have received notices in
the past from state agencies that, as a result of certain alleged deficiencies,
the agency was assessing a fine against the Company and/or was taking steps to
decertify the facility from participation in Medicare and Medicaid programs.
However, the deficiencies noted in the Louisiana, Texas, Oregon, Washington and
Connecticut facilities were remedied before any facilities were decertified. To
date none of the Company's facilities has had its license or certification
revoked.
On April 12, 1995, the Company received a notification from the U.S.
Attorney for the District of Connecticut that the U.S. Drug Enforcement
Administration (the "DEA") had alleged that Sunscript Pharmacy Corporation
("Sunscript"), the Company's institutional pharmacy subsidiary, had violated
certain recordkeeping requirements in connection with operations at the
Company's Connecticut pharmacy. The DEA has the authority to impose civil
penalties in connection with these violations. The Company has entered into a
settlement agreement dated May 4, 1995 with the U.S. Attorney with respect to
these allegations, pursuant to which the Company paid a fine, without admission
of misconduct.
Under Massachusetts law, if any person owns, directly and/or indirectly, 5%
or more of the outstanding shares or certain obligations of a health care
provider, then such provider must disclose certain information about such person
to the Massachusetts Department of Public Welfare. If any person owns 10% or
more of the outstanding shares of Mediplex or the Company, then Mediplex or the
Company, as the case may be, may be required to identify such person to the
Massachusetts Department of Public Health and to disclose to the Massachusetts
Rate Setting Commission any transactions between such persons and any facility
operated by Mediplex or the Company, as the case may be, in Massachusetts. Other
states and the U.S. Department of Health and Human Services may have similar
requirements to disclose the names of persons or entities owning more than
certain specified percentages of the outstanding securities of corporations.
Under New York regulations, a corporation may not be licensed to operate certain
health care facilities unless all of its stockholders are specifically
identified, approved individuals or corporations, trusts, partnerships and other
entities owned by such individuals. Therefore, under current New York
regulations, the Company may not be the licensed operator of substance abuse
treatment or mental health facilities in New York, but may own, lease or provide
management services to such facilities. The Company's former psychiatric and
17
<PAGE>
substance abuse facilities in New York were operated by the licensed operator
that operated such facilities prior to the Mediplex Merger, and the operator
continued to operate such facilities after their disposition. See "-- Assets
Held For Sale."
The Company's therapy and institutional pharmacy businesses provide Medicare
and Medicaid covered services and products to long-term and subacute care
facilities under arrangements with both the Company-operated and nonaffiliated
long-term and subacute care facilities. Under these arrangements, the Company's
therapy subsidiary bills and is paid by the long-term and subacute care facility
for the services actually rendered and the details of billing the Medicare and
Medicaid programs are handled directly by the long-term and subacute care
facility. With certain exceptions, the Company's institutional pharmacy
subsidiary bills, and is paid by, Medicare, Medicaid or the private pay source
directly. As a result, the Company's therapy business generally (including
Sundance and CareerStaff) is not Medicare and Medicaid certified and does not
enter into provider agreements with the Medicare and Medicaid programs, but the
Company's institutional pharmacy business does participate in the Medicare and
Medicaid programs.
Various state and federal laws regulate the relationship between providers
of health care services and physicians, including employment or service
contracts, and investment relationships. These laws include the broadly worded
Fraud and Abuse Provisions of the Medicare and Medicaid statutes, which prohibit
various transactions involving Medicare or Medicaid covered patients or
services. Violations of these provisions may result in civil or criminal
penalties for individuals or entities and/or exclusion from participation in the
Medicare and Medicaid programs. The full extent of the application of these
provisions is not presently known. However, the Company believes that it has not
entered into any relationship with physicians or other health care providers
that might be considered to fall within the coverage of the Fraud and Abuse
Provisions and other related state and federal laws. The Company believes that
it will be able to arrange its future business relationships so as to comply
with the Fraud and Abuse Provisions and any safe harbor guidelines issued
pursuant thereto.
All states have adopted a "patient's bill of rights" that sets forth
standards dealing with such issues as using the least restrictive treatment,
patient confidentiality, allowing patient access to the telephone and mail,
allowing the patient to see a lawyer and requiring the patient to be treated
with dignity.
By virtue of the Company's ownership of Exceler and an ownership interest in
Ashbourne, certain of the operations from which the Company may derive income
are subject to national and local regulations in the United Kingdom, including
The Community Care Act 1990 and The Registered Homes Act 1984, as well as
various zoning, health and safety, reimbursement and general corporate
regulations.
In addition, the Company, as an operator of health care facilities, is
subject to various federal, state and local environmental and consumer
protection laws. The Company has been notified by the State of Oregon that it
believes violations of Oregon's consumer protection laws may have occurred at
one of the Company's facilities in Oregon. The Company is engaged in settlement
discussions regarding this matter.
In October 1995 the Connecticut Attorney General publicly disclosed that his
office was investigating certain complaints against the Company and that it
intended to review the allegations presented by, and determine any action to be
taken in response to, such complaints. The Company believes that such
investigation related to certain allegations by the New England Health Care
Employees Union District 1199 ("1199"), which was then engaged in labor
negotiations with the Company. The Company entered into a collective bargaining
agreement with 1199 in November 1995. To date, the Company has not received
notice of any such investigation from the Connecticut Attorney General. If the
State of Connecticut determines to take any action against the Company, such
action and any adverse publicity related to any such investigation could have an
adverse impact on the Company's future results of operations. Based on the facts
currently available, however, the Company is unable to predict whether any such
investigation will be commenced or whether the outcome of any
18
<PAGE>
such investigation will have a material adverse effect on the Company's
financial condition or results of operations. In addition, the Connecticut
Attorney General's office is reviewing certain Medicaid cost reports filed with
the Connecticut Department of Social Services by the Company's long-term care
subsidiary. As a result of such review, the Company's long-term care subsidiary
could be required to reimburse the State of Connecticut for payments previously
received by the Company's long-term care subsidiary. However, the Company does
not believe that this review will have a material adverse effect on the
Company's financial condition or results of operations.
COMPETITION
The Company operates in a highly competitive industry. The nature of
competition varies by location. Its facilities generally operate in communities
that are also served by similar facilities operated by others. Some competing
facilities are located in buildings that are newer than those operated by the
Company and provide services not offered by the Company, and some are operated
by entities having greater financial and other resources and longer operating
histories than the Company. In addition, some facilities are operated by
nonprofit organizations or government agencies supported by endowments,
charitable contributions, tax revenues and other resources not available to the
Company. Some hospitals that either currently provide long-term and subacute
care services or are converting their under-utilized facilities into long-term
and subacute care facilities are also a potential source of competition to the
Company. The Company also competes with other companies in providing
rehabilitation therapy services and pharmaceutical products and services to the
long term care industry and in employing and retaining qualified therapists and
other medical personnel. Many of these competing companies have greater
financial and other resources than the Company.
The Company competes with other facilities based on key competitive factors
such as its reputation for the quality and comprehensiveness of care provided;
the commitment and expertise of its staff; the innovativeness of its treatment
programs; local physician and hospital support; marketing programs; charges for
services; and the physical appearance, location and condition of its facilities.
The range of specialized services, together with the price charged for services,
are also competitive factors in attracting patients from large referral sources.
There is limited, if any, competition in price with respect to Medicaid and
Medicare patients, because revenues for services to such patients are strictly
controlled and based on fixed rates and uniform cost reimbursement principles.
See "-- Revenue Sources."
The Company may also face competition from other facilities, hospitals or
health care companies when it initiates a CON project or seeks to acquire a CON
or a facility covered by an existing CON. CON programs affect the opportunity to
develop or acquire new facilities by creating a regulatory system that can be
used by competitors to delay the implementation of growth strategies. CON laws,
applicable in many of the states in which the Company's facilities are located,
also currently restrict the number of facilities that can compete with the
Company in such states.
EMPLOYEES
As of December 31, 1995, the Company had approximately 27,100 full-time and
regular part-time employees. Of this total, there were approximately 17,300
employees at the long-term and subacute care facilities in the United States,
1,800 employees at the long-term care facilities in the United Kingdom, 4,800
employees involved in providing rehabilitation therapy services in the United
States, 200 employees providing rehabilitation therapy services in Canada, 600
employees at the institutional pharmacy operation, 1,800 employees at
CareerStaff, 100 employees at Golden Care and 500 employees at the corporate and
regional offices. In addition, the Company had approximately 300 full-time and
regular part-time employees at the Ambulatory Surgery Centers. In the second
quarter of 1996, the Company sold its ambulatory surgery subsidiary. Certain of
the Company's employees in Connecticut, Massachusetts and Washington are covered
by collective bargaining contracts. Eight collective bargaining agreements at
six long-term care facilities scheduled to expire in late 1995 were
renegotiated. In addition, employees of three of the Company's facilities
located in Connecticut voted for union
19
<PAGE>
representation in 1995. The Company believes it has satisfactory relationships
with the unions that represent its employees, but it cannot predict the effect
of continued union representation or organizational activities on its future
activities.
Although the Company believes it is able to employ sufficient nurses and
therapists to provide its services, a shortage of health care professional
personnel in any of the geographic areas in which it operates could affect the
Company's ability to recruit and retain qualified employees and could increase
its operating costs. The Company competes with other health care providers for
both professional and service employees and with non-health care providers for
service employees.
INSURANCE
Health care companies are subject to medical professional liability,
personal injury and other liability claims that are customary risks inherent in
the operation of health facilities and are generally covered by insurance. The
Company maintains property, liability and professional liability insurance
policies in amounts and with such coverages and deductibles that are deemed
appropriate by management, based upon historical claims, industry standards and
the nature and risks of its business. The Company also requires that physicians
practicing at its facilities carry medical professional liability insurance to
cover their respective individual professional liabilities.
The Company has self-insured the health care risks of employees who have
elected coverage under the Company-sponsored plans. Workers' compensation
coverage is effected through self-insurance or retrospective/high deductible
insurance policies, except that the Company's long-term and subacute care
subsidiary is a non-subscriber to the workers' compensation program in Texas.
Substantially all of the risk of workers' compensation claims under the high
deductible programs are assumed by the Company and such risks are comparable to
those of an insurance carrier for retrospective policies. The costs of paying
for health care and workers' compensation claims can fluctuate depending on the
type and number of claims in any given period.
20
<PAGE>
The Registrant hereby amends the disclosure contained under the caption
"Selected Financial Data" set forth in Part II, Item 6 of the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1995. In accordance
with Rule 12b-15 promulgated under the Securities Exchange Act of 1934, as
amended, the complete text of Part II, Item 6, as amended, follows.
ITEM 6. SELECTED FINANCIAL DATA
The following Selected Consolidated Financial Data for the years ended
December 31, 1995, 1994, 1993, 1992 and 1991 have been derived from the
Company's Consolidated Financial Statements, which have been restated for the
periods subsequent to December 31, 1991 to include the results of operations for
Golden Care, Inc. and CareerStaff Unlimited, Inc. which were acquired in 1995
and were accounted for as poolings of interest. In addition, the following
Selected Consolidated Financial Data for the years ended December 31, 1995 and
1994 have been restated to reflect the write-off of $23,446,000 of accounts
receivable originally recorded in the fourth quarter of 1995, in the fourth
quarter of 1994 (See Note 2 to the Company's Consolidated Financial Statements).
The financial data set forth below should be read in connection with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1995 1994 1993 1992 1991(1)
---------- ---------- --------- --------- ---------
AS RESTATED
----------------------
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
<S> <C> <C> <C> <C> <C>
Total net revenues................... $1,135,508 $ 673,354 $ 230,815 $ 135,733 $ 70,593
Earnings before pro forma income
taxes and extraordinary loss........ 12,794 36,807 22,710 7,258 1,895
Pro forma earnings (loss) before
extraordinary item (2).............. (20,568) 19,561 13,463 4,373 1,195
Extraordinary item................... (3,413) -- -- -- 36
---------- ---------- --------- --------- ---------
Pro forma net earnings (loss) (2).... $ (23,981) $ 19,561 $ 13,463 $ 4,373 $ 1,231
---------- ---------- --------- --------- ---------
---------- ---------- --------- --------- ---------
Pro forma net earnings (loss) per
common and common equivalent share
(2)(3):
Before extraordinary loss........ $ (0.43) $ 0.61 $ 0.72 $ 0.29
Extraordinary loss............... (0.07) -- -- --
---------- ---------- --------- ---------
Net earnings (loss).............. $ (0.50) $ 0.61 $ 0.72 $ 0.29
---------- ---------- --------- ---------
---------- ---------- --------- ---------
Pro forma weighted average number of
common and common equivalent
shares.............................. 47,419 31,830 18,608 14,902
Working capital.................... $ 237,147 $ 197,150 $ 45,451 $ 2,057 $ 883
Total assets....................... 1,039,869 1,054,223 110,488 27,760 18,484
Long-term debt, net of current
portion........................... 348,460 398,534 11,967 1,365 4,486
Stockholders' equity............... 569,042 550,449 70,361 6,755 1,707
</TABLE>
- ------------------------
(1) Pro forma financial and operating data for 1991 exclude the results of
CareerStaff and Golden Care as the impact of these acquisitions is
insignificant in this year.
(2) There was no provision for Federal or state income taxes in the Company's
consolidated financial statements for certain entities that subsequently
became subsidiaries of the Company that had elected S Corporation status
prior to becoming C corporations. Net earnings (loss) and net earnings
(loss) per share reflect Federal and state income taxes that these entities
would have been subject to and liable for as C Corporations prior to each of
the entities' terminations of their S corporation status.
(3) See Note 15 to the Company's Consolidated Financial Statements for net
earnings (loss) per share information.
21
<PAGE>
The Registrant hereby amends the disclosure contained under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" set forth in Part II, Item 7 of the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1995. In accordance with Rule 12b-15
promulgated under the Securities Exchange Act of 1934, as amended, the complete
text of Part II, Item 7, as amended, follows.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company, which began operations in 1989 with the acquisition of seven
long-term care facility operations, has achieved significant growth through
acquisitions of long-term and subacute care facilities ("facilities") and the
provision of therapy and institutional pharmacy services. The Company's strategy
is to increase profitability through the provision of ancillary services such as
rehabilitation and respiratory therapy and institutional pharmacy to both
affiliated and nonaffiliated facilities. These services have significantly
higher margins than the margins associated with routine services provided to
residents of facilities. The Company's earnings growth historically has resulted
from its acquisition of facilities, expansion of ancillary services through
acquisitions, use of its long-term care operations as a base for expansion of
ancillary services and provision of ancillary services to nonaffiliated
facilities.
The Company's results of operations for the years ended December 31, 1995,
1994 and 1993 reflect the acquisition of facilities, the growth of the Company's
existing facility operations, the expansion of the Company's therapy service
operations and temporary therapy staffing services and the growth of the
Company's institutional pharmacy service operations. On May 5, 1995, the Company
acquired Golden Care, Inc. ("Golden Care"), a provider of respiratory therapy
services to facilities, and on June 21, 1995, the Company acquired CareerStaff
Unlimited, Inc. ("CareerStaff"), a provider of temporary staffing of physical,
occupational and speech therapists to the health care industry. Both
transactions were accounted for as poolings of interest; accordingly, the
Company's financial condition and results of operations for the years ended
December 31, 1995, 1994 and 1993 have been restated to reflect the combined
operations. The Company's merger with The Mediplex Group, Inc. ("Mediplex") was
accounted for as a purchase and accordingly, the Company's financial results
include those of Mediplex since the acquisition of Mediplex in June 1994.
At December 31, 1993, the Company had 55 facilities with 6,252 licensed
beds. During 1994, the Company acquired 60 facilities with 7,652 licensed beds,
including at December 31, 1994, 36 facilities with 5,317 licensed beds through
the Mediplex merger. In 1994, the Company acquired a 68% interest in Exceler
Health Care Group PLC ("Exceler"), a United Kingdom corporation, which as of
December 31, 1994 was operating 18 facilities with 840 registered beds. In 1995,
the Company entered into thirteen transactions relating to the acquisition of
twelve facilities in the United States and eight facilities in the United
Kingdom resulting in an increase of 1,779 licensed beds. In 1995, the Company
developed and opened four facilities in the United States and two in the United
Kingdom with 636 licensed beds. In February 1995, the Company acquired the
remaining 32% interest in Exceler.
The Company's therapy service operations include the provision of physical,
occupational and speech therapy, and the provision of respiratory care and
distribution of related equipment and supplies. The Company's therapy service
business commenced operations in 1991 with the provision of physical,
occupational and speech therapy to facilities operated by the Company and by
nonaffiliated facilities. The Company entered the respiratory therapy service
business through its May 1995 acquisition of Golden Care. Golden Care commenced
operations in 1991. Golden Care provides services to both affiliated and
nonaffiliated facilities. At December 31, 1994, the Company provided its therapy
services to 513 nonaffiliated facilities, an increase of 219 facilities from the
294 nonaffiliated facilities serviced at December 31, 1993. At December 31,
1995, the Company provided its therapy services to 643 nonaffiliated facilities,
an increase of 130 facilities from December 31, 1994.
22
<PAGE>
The Company entered the temporary therapy staffing service business through
its June 1995 acquisition of CareerStaff. CareerStaff commenced operations in
1990 and had 18, 14 and 12 division offices at December 31, 1995, 1994 and 1993,
respectively.
In 1993, the Company began to provide institutional pharmacy services in
Arizona to seven nonaffiliated facilities and four Company operated facilities.
The Company opened institutional regional pharmacies in Hartford, Connecticut,
in Tempe, Arizona and acquired the assets of an institutional regional pharmacy
in Chicago, Illinois in 1993. In 1994, the Company opened additional
institutional regional pharmacies in Connecticut, Massachusetts and Washington
and acquired four additional institutional regional pharmacies in Illinois and
Texas. In 1995, the Company acquired an institutional regional pharmacy in
Arizona and in South Carolina and developed an institutional regional pharmacy
in Massachusetts.
The following table sets forth certain operating data for the Company as of
the dates indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Long-term and Subacute Care Facility Operations
Long-term and subacute care facilities:
Domestic operations....................................... 131 115 55
Foreign operations........................................ 28 18 --
--------- --------- ---------
Total................................................... 159 133 55
--------- --------- ---------
--------- --------- ---------
Licensed beds:
Domestic operations....................................... 15,921 13,904 6,252
Foreign operations........................................ 1,437 840 --
--------- --------- ---------
Total................................................... 17,358 14,744 6,252
--------- --------- ---------
--------- --------- ---------
Therapy Service Contracts:
Nonaffiliated facilities.................................. 643 513 294
Affiliated facilities..................................... 125 108 43
--------- --------- ---------
Total................................................... 768 621 337
--------- --------- ---------
--------- --------- ---------
Temporary Therapy Staffing Service:
Hours billed to nonaffiliates............................. 1,999,092 1,157,535 590,405
Institutional Pharmacy Contracts:
Nonaffiliated facilities.................................. 271 136 48
Affiliated facilities..................................... 101 76 13
--------- --------- ---------
Total................................................... 372 212 61
--------- --------- ---------
--------- --------- ---------
Ambulatory Surgery Centers.................................. 13 6 --
</TABLE>
23
<PAGE>
RESTATEMENT
The Company has restated its financial statements for the years ended
December 31, 1995 and 1994. The restatement is a result of the Company's further
review and analysis of its fourth quarter of 1995 write-off of certain accounts
receivable acquired in its acquisition of Mediplex. Based on its review, the
Company has concluded that $23,446,000 of the Mediplex accounts receivable
written off in the fourth quarter of 1995 should be recognized in the fourth
quarter of 1994 because such accounts receivable were impaired as of the fourth
quarter or earlier and the fourth quarter of 1994 was the quarter in which the
purchase accounting for the Mediplex acquisition was finalized. Accordingly, the
1995 and 1994 financial statements have been restated to reflect the write-off
of $23,446,000 of accounts receivable originally recorded in the fourth quarter
of 1995, in the fourth quarter of 1994. The impact of these adjustments on the
Company's results of operations as originally reported is as follows (in
thousands):
<TABLE>
<CAPTION>
1995 1994
---------------------------- ------------------------
AS REPORTED AS RESTATED AS REPORTED AS RESTATED
------------- ------------- ----------- -----------
<S> <C> <C> <C> <C>
Total Net Revenues....................................... $ 1,135,508 $ 1,135,508 $ 673,354 $ 673,354
Earnings (loss) before pro forma income taxes and
extraordinary loss...................................... (10,652) 12,794 60,253 36,807
Pro forma earnings (loss) before extraordinary item...... (35,105) (20,568) 34,098 19,561
Pro forma net earnings (loss)............................ $ (38,518) $ (23,981) $ 34,098 $ 19,561
------------- ------------- ----------- -----------
------------- ------------- ----------- -----------
Pro forma net earnings (loss) per share:
Primary --
Before extraordinary loss............................ $ (0.74) $ (0.43) $ 1.07 $ 0.61
Extraordinary loss................................... (0.07) (0.07) -- --
------------- ------------- ----------- -----------
Net earnings (loss).................................. $ (0.81) $ (0.50) $ 1.07 $ 0.61
------------- ------------- ----------- -----------
------------- ------------- ----------- -----------
Fully diluted --
Before extraordinary loss............................ $ (0.74) $ (0.43) $ 1.02 $ 0.61
Extraordinary loss................................... (0.07) (0.07) -- --
------------- ------------- ----------- -----------
Net earnings (loss).................................. $ (0.81) $ (0.50) $ 1.02 $ 0.61
------------- ------------- ----------- -----------
------------- ------------- ----------- -----------
</TABLE>
RESULTS OF OPERATIONS
The following table sets forth the amount and percentages of certain
elements of total net revenues for the periods presented (dollars in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
1995 1994 1993
---------------------- --------------------- ---------------------
<S> <C> <C> <C> <C> <C> <C>
Long-term and subacute care
services........................... $ 759,459 67% $ 476,146 71% $ 151,229 65%
Therapy services to nonaffiliates... 170,154 15 106,144 16 49,124 21
Temporary therapy staffing services
to nonaffiliates................... 96,500 9 55,258 8 27,180 12
Institutional pharmacy services to
nonaffiliates...................... 51,409 5 20,427 3 2,034 1
Ambulatory surgery.................. 26,197 2 7,260 1 -- --
Foreign operations.................. 27,072 2 6,196 1 -- --
Management fees and other........... 4,717 -- 1,923 -- 1,248 1
---------- --- --------- --- --------- ---
Total net revenues.............. $1,135,508 100% $ 673,354 100% $ 230,815 100%
---------- --- --------- --- --------- ---
---------- --- --------- --- --------- ---
</TABLE>
Revenues for the long-term and subacute care services include revenues
billed to patients for therapy services and institutional pharmacy services
provided by the Company's affiliated operations. Revenues for therapy services
provided to affiliated facilities were $92,177,000, $45,157,000 and
24
<PAGE>
$12,900,000 for the years ended December 31, 1995, 1994 and 1993, respectively.
Revenues provided to affiliated facilities for institutional pharmacy services
were $14,187,000, $4,900,000 and $403,000 for the years ended December 31, 1995,
1994 and 1993, respectively.
The following table presents the percentage of total net revenues
represented by certain items for the Company for the periods presented:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1995 1994 1993
--------- --------- ---------
AS RESTATED
--------------------
<S> <C> <C> <C>
Total net revenues.................................................... 100% 100% 100%
--------- --- ---
Costs and expenses:
Operating........................................................... 81.9 82.1 84.2
Corporate general and administrative................................ 4.5 4.7 4.6
Provision for losses on accounts receivable......................... 1.3 4.1 0.6
Depreciation and amortization....................................... 2.4 1.8 0.7
Interest, net....................................................... 1.9 1.5 0.1
Conversion expense.................................................. 0.3 0.3 --
Merger expenses..................................................... 0.5 -- --
Strike costs........................................................ 0.4 -- --
Investigation and litigation costs.................................. 0.5 -- --
Impairment loss..................................................... 5.2 -- --
--------- --- ---
Total costs and expenses.......................................... 98.9 94.5 90.2
--------- --- ---
Earnings before pro forma income taxes and extraordinary loss....... 1.1 5.5 9.8
Pro forma income taxes (1).......................................... 2.9 2.6 4.0
--------- --- ---
Pro forma net earnings (loss) before extraordinary loss............. (1.8) 2.9 5.8
Extraordinary loss.................................................. (0.3) -- --
--------- --- ---
Pro forma net earnings (loss)....................................... (2.1)% 2.9% 5.8%
--------- --- ---
--------- --- ---
</TABLE>
- ------------------------
(1) Income taxes for the years ended December 31, 1995, 1994 and 1993 represent
pro forma taxes that the Company would have been subject to and liable for
prior to a reorganization that occurred in April 1993 in which various legal
entities became wholly owned subsidiaries of the Company (the "Sun
Exchange") and also represent pro forma taxes of CareerStaff and Golden Care
prior to their elections to be taxed as C Corporations, which occurred in
June 1994 and May 1995, respectively.
The results of the Company's ambulatory surgery operations and foreign
operations are immaterial to the Company's consolidated results, and therefore
this discussion excludes the Company's ambulatory surgery and foreign
operations. The Company has reached an agreement in principle to sell its
ambulatory surgery subsidiary.
TWELVE MONTHS ENDED DECEMBER 31, 1995 COMPARED TO TWELVE MONTHS ENDED DECEMBER
31, 1994
Total net revenues for the year ended December 31, 1995 increased from the
year ended December 31, 1994 by $462,154,000, a 69% increase, to $1,135,508,000.
Net revenues from long-term and subacute care services, which includes
revenues generated from therapy and institutional pharmaceutical services
provided at the Company's facilities, increased from $476,146,000 for the year
ended December 31, 1994 to $759,459,000 for the year ended December 31, 1995, a
60% increase. Approximately $220,672,000 or 78% of this increase in long-term
and subacute care net revenues is a direct result of the inclusion of a full
year's revenues from 40 facilities which were acquired in the Mediplex merger on
June 23, 1994 including the opening of four additional
25
<PAGE>
facilities in 1995 for which Mediplex had obtained Certificates of Need prior to
the merger. Approximately $41,910,000 or 15% of this increase results from 36
facilities, acquired since December 31, 1993. The remaining net revenue increase
of $20,731,000 is primarily attributable to an increase in revenue per patient
day and an increase in occupancy levels since December 31, 1994 on a same
facility basis for the 55 facilities in operation all of fiscal 1995 and 1994.
The increase in revenue per patient day was a result of payor rate increases and
the Company's focus on expanding its subacute services.
Therapy services net revenues increased 60% from $106,144,000 for the year
ended December 31, 1994 to $170,154,000 for the year ended December 31, 1995,
primarily as a result of the increased services to nonaffiliated facilities from
513 facilities at December 31, 1994 to 643 facilities at December 31, 1995.
Temporary therapy staffing services net revenues increased 75% from
$55,258,000 for the year ended December 31, 1994 to $96,500,000 for the year
December 31, 1995, primarily as a result of the increased service hours billed
to nonaffiliates from 1,157,535 hours in 1994 to 1,999,092 hours in 1995. The
increase in service hours billed is attributable primarily to the expansion of
services at division offices open for over a year and to new offices established
through acquisitions.
Net revenues from institutional pharmaceutical services increased 152% from
$20,427,000 for the year ended December 31, 1994 to $51,409,000 for the year
ended December 31, 1995. The growth in net revenues is primarily the result of
the inclusion of a full year's revenues in institutional pharmacy services
revenues from the opening or acquisition of eight regional pharmacies during
1994 and the opening or acquisition of three regional pharmacies during 1995.
The growth in net revenues is also a result of the increase in services to
nonaffiliated facilities from 136 at December 31, 1994 to 271 at December 31,
1995.
During the second half of 1995, the rate of growth of the Company's earnings
was negatively affected by the following factors:
DELAYED REVENUE RECOGNITION. Anticipated Medicare payments and rate
adjustments were delayed as a result of the required change of fiscal
intermediaries from Blue Cross of New Mexico to Blue Cross of Texas. The
announced change slowed the processing of requests for exceptions to the
Medicare established routine cost limitations for reimbursement, which in
turn led to delayed revenue recognition. In addition, the change led to
delays in receipt of payments resulting in increased borrowings under the
Company's Credit Facility and additional interest expense.
REIMBURSEMENT RATES. In July 1995, the states of Illinois and
Connecticut instituted lower than expected Medicaid reimbursement rates for
long-term care providers. These new rates will remain in effect until June
of 1996. The Company operates eight facilities in Illinois and eighteen
facilities in Connecticut.
GOVERNMENT INVESTIGATION. The Company's rehabilitation therapy
subsidiary is under investigation by the United States Department of Health
and Human Services' Office of Inspector General (the "OIG") (See "Effects
From Changes in Reimbursement"). The Company believes the negative publicity
surrounding the OIG investigation has slowed the Company's success in
obtaining additional outside contracts in its rehabilitation therapy
business, which has resulted in higher than required therapist staffing
levels and has affected the private patient enrollment at certain in-patient
facilities.
In addition, during the third and fourth quarters of 1995, the Company was
negotiating a new labor contract with employees at the Company's eight unionized
facilities in Connecticut who were represented by the Service Employees
International Union ("SEIU"). The Company reached a settlement with the SEIU on
November 2, 1995, and averted a possible labor union strike. However, due to the
additional cost of preparing for a possible labor union strike and negotiating a
settlement, along with the related adverse publicity, the Company temporarily
experienced higher operating costs and a
26
<PAGE>
decline in census at certain facilities in the third and fourth quarters of
1995. The Company recorded a charge in the fourth quarter of certain costs
related to the negotiations and strike preparation (as discussed below).
Operating expenses, which includes rent expense of $73,727,000 and
$43,626,000 for the year ended December 31, 1995 and 1994, respectively, were
$929,493,000 for the year ended December 31, 1995 and $552,662,000 for the year
ended December 31, 1994, an increase of 68%. The increase resulted primarily
from the acquisition and development of 26 facilities and the growth in therapy
and temporary staffing services. Operating expenses as a percentage of net
revenues decreased from 82.1% for the year ended December 31, 1994 to 81.9% for
the year ended December 31, 1995, which can be attributed to the growth in
therapy services, temporary therapy staffing services, institutional
pharmaceutical services and subacute care services, which have higher operating
margins than the margins associated with routine long-term care services. These
gains were partially offset by costs associated with the change in fiscal
intermediaries, lower than expected Medicaid reimbursement rates (as discussed
above) and the negative publicity surrounding the investigation by the OIG.
Corporate general and administrative expenses, which include regional costs
related to the supervision of operations, increased from $31,633,000 for the
year ended December 31, 1994 to $51,468,000 for the year ended December 31,
1995, an increase of 63%. As a percentage of net revenues, corporate general and
administrative expenses were 4.5% and 4.7% for the years ended December 31, 1995
and 1994, respectively.
The provision for losses on accounts receivable was $14,623,000 for the year
ended December 31, 1995, as compared to $27,632,000 for the year ended December
31, 1994. The decrease in the provision reflects the write-off in the fourth
quarter of 1994 of $23,446,000 of Mediplex accounts receivable as discussed
above under "Restatement." In 1995, an additional $7,608,000 of Mediplex
accounts receivable were written-off, of which $3,549,000 represented accounts
receivable existing at the date of acquisition. The additional write-offs of
Mediplex accounts receivable in 1995 were primarily the result of the
difficulties the Company experienced in integrating Mediplex's accounting and
management information systems which hampered collection efforts, changes in
estimates of amounts realizable from third-party payors (see "Effects from
Changes in Reimbursement") and the recognition of losses on balances retained
from the disposition of five of Mediplex's psychiatric care and substance abuse
facilities and related outpatient centers on September 30, 1995 (See "Growth
Through Selective Acquisitions and Development."). The provision for losses on
accounts receivable excluding the write-off of Mediplex accounts receivable in
the fourth quarter of 1994 and the fourth quarter of 1995 described above was
$7,015,000 and $4,186,000 for the years ended December 31, 1995 and 1994,
respectively. As a percentage of net revenues, the provision for losses on
accounts receivable excluding
the write-off of the Mediplex accounts receivable described above remained
constant at 0.6% for the years ended December 31, 1995 and 1994.
The provision for losses on accounts receivable recorded in the fourth
quarter of 1994 attributable to Mediplex accounts receivable represented
approximately 27% of the balances acquired in June 1994 and approximately 3% of
the total consideration paid in the acquisition (including debt assumed). The
portion of the 1994 provision for losses on accounts receivable attributable to
Mediplex accounts receivable existing at the date of acquisition was comprised
of $8,709,000 related to patient balances and $14,737,000 related to third party
payor settlement amounts including Medicare and Medicaid government payors. In
acquiring Mediplex, the Company relied upon Mediplex's public filings with the
Securities and Exchange Commission. After the acquisition, as the integration of
revenue systems of the Company and Mediplex proceeded, the Company determined
that the reserve for uncollectible balances previously set by Mediplex was not
consistent with reserve levels deemed appropriate under the Company's reserve
policies and that additional reserves were required for contractual adjustments
to patient billings. In addition, the Company determined that certain of the
former Mediplex policies regarding accounts receivable from third party payors
were inconsistent with the Company's policies and that certain third party
receivables would not be reimbursed in light of applicable regulatory
determinations. It also became apparent from the Company's review of the
historical
27
<PAGE>
records that the Company would be unable to collect certain accounts.
Accordingly, management determined that certain patient balances acquired in the
acquisition of Mediplex were uncollectible certain third party receivables
recorded by Mediplex prior to the acquisition exceeded final settlements and
certain liabilities existed for amounts claimed in excess of reimbursable
amounts. This resulted in the determination that $23,446,000 of such accounts
receivable existing at the date of the acquisition were impaired as of the
fourth quarter of 1994 or earlier.
Depreciation and amortization for the year ended December 31, 1995 totaled
$27,734,000 compared to $11,797,000 for the year ended December 31, 1994, an
increase of 135%. As a percentage of net revenues, depreciation and amortization
expense increased from 1.8% in the year ended December 31, 1994 to 2.4% for the
year ended December 31, 1995. The increases are primarily due to the inclusion
of a full year of amortization of goodwill related to the merger with Mediplex
and the other acquisitions accounted for as purchases and the additional
depreciation of owned facilities acquired through the Mediplex merger and the
acquisition of Exceler.
Net interest expense for the year ended December 31, 1995 totaled
$21,829,000 compared to $10,548,000 for the year ended December 31, 1994, an
increase of 107%. As a percentage of net revenues, interest expense increased
from 1.5% for the year ended December 31, 1994 to 1.9% for the year ended
December 31, 1995. The increase is due to the issuance of the 6% Convertible
Debentures on March 1, 1994, the additional interest expense associated with the
outstanding debt of Mediplex assumed in the Mediplex merger and to increases in
borrowings under the Credit Facility primarily to fund acquisitions, capital
expenditures and the debt tender offer referred to below. In addition, as
previously discussed, the required change in fiscal intermediaries delayed rate
adjustments and payments, resulting in increased borrowings under the Credit
Facility.
The Company incurred a nonrecurring charge of $3,256,000 in connection with
the payment of an inducement fee to effect the conversion in January 1995 of
$39,449,000 of the 6 1/2% Convertible Debentures, and in August 1994, the
Company incurred a similar charge of $2,275,000 related to the conversion of
$24,377,000 of the 6 1/2% Convertible Debentures. In addition in 1995, the
Company recorded an extraordinary charge of $3,413,000, net of the related tax
benefit, in connection with the tender offer, completed in January 1995, for
$78,698,000 principal amount of the 11 3/4% Senior Subordinated Notes.
In connection with the mergers with CareerStaff and Golden Care, the Company
recognized $5,800,000 of transaction related merger costs in the second quarter
of 1995. These included advisor fees and transitional costs related to
consolidating operations.
During 1995, the Company recorded charges and expenses of $4,006,000 related
to averting a strike and negotiating new contracts for certain unionized nursing
homes in Connecticut. The Company has also recorded charges and expenses of
$5,505,000 related to monitoring and responding to the continuing investigation
by the OIG; and legal fees resulting from shareholder litigation. The litigation
charge also includes costs incurred by the Company in its intended debt offering
which was aborted due to the negative publicity resulting from the OIG
investigation. The negative publicity prevented the Company from obtaining an
acceptable interest rate. The charges do not contain any estimated amounts for
settlement of the OIG or shareholder matters. As of December 31, 1995, the
Company had charged $1,316,000 against the investigation and litigation costs
accrual.
The Company periodically evaluates the carrying value of goodwill along with
any other related long-lived assets in relation to the future undiscounted cash
flows of the underlying businesses to assess recoverability. The Company adopted
Statement of Financial Accounting Standards No. 121 (SFAS 121) "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
on December 31, 1995. Under SFAS 121, an impairment loss is recognized if the
sum of the expected long-term cash flows is less than the carrying amount of the
goodwill and other assets being evaluated. The difference between the carrying
amount of the goodwill and other assets being evaluated and the estimated fair
market value of the assets represents the impairment loss. The Company
determines fair value using certain multiples of earnings before interest,
taxes, depreciation
28
<PAGE>
and amortization based on current prices for comparable assets. The impairment
loss, as determined by SFAS 121, of $59,000,000 recorded by the Company
primarily relates to the goodwill associated with six of the forty facilities
acquired in the merger with Mediplex. The impairment loss at these six
facilities was the result of the following circumstances: (i) three facilities
were organized by the Service Employees International Union subsequent to the
acquisition resulting in significantly higher labor costs; (ii) two facilities
experienced significant declines in private pay census and revenues due to, in
one instance, funding reductions in certain programs providing private pay
patients and, in the other instance, the opening of two new facilities by
competitors; and (iii) the remaining facility received lower than expected
Medicaid rates from the State of Connecticut and due to the high acuity of the
patients treated at the facility, reimbursement was not adequate. If the Company
had not elected early adoption of SFAS 121, the impairment loss would have been
based solely on the difference between the assets carrying value and cumulative
long-term cash flows which would have resulted in a loss of $48,900,000. The
operations of the impaired facilities are not material to the consolidated
earnings or cash flows of the Company, and therefore, management does not expect
future operating results of the impaired facilities to have a material adverse
effect on the Company's results of operations or financial condition. However,
the impaired facilities are experiencing marginal or negative cash flows. As
they are leased under long-term operating leases, the Company expects that this
trend will continue until it can implement measures to turn around their
performance or to dispose of the facilities.
Pro forma effective tax rates were 41% for the year ended December 31, 1995,
after excluding the nondeductible conversion fee, the nondeductible portion of
the merger expenses, the nondeductible impairment loss and the deferred tax
charge relating to the conversion of Golden Care from a S to a C corporation
upon merging with the Company as compared to 44% for the year ended December 31,
1994, after excluding the nondeductible conversion fee. The pro forma provision
for income taxes reflects tax expense that would have been recorded if
CareerStaff and Golden Care had been subject to and liable for Federal and state
income taxes as C corporations prior to the terminations of their S corporation
status in June 1994 and May 1995, respectively. The decrease in the effective
tax rate is due to the reduced impact of the nondeductible portion of goodwill
recorded in connection with the Mediplex merger and a more favorable mix of
state income than the prior year.
The pro forma net loss was $23,981,000 for the year ended December 31, 1995
as compared to the pro forma net earnings of $19,561,000 for the year ended
December 31, 1994. Pro forma net earnings before the extraordinary loss for
early extinguishment of debt for the year ended December 31, 1995, excluding the
conversion fee, the merger expenses, the strike and litigation costs, the
impairment loss and the deferred income tax charge relating to Golden Care's
conversion from a S corporation to a C corporation for income tax purposes,
increased 168% to $58,486,000 from pro forma net earnings of $21,836,000 for the
year ended December 31, 1994, excluding the conversion fee of $2,275,000. Pro
forma net earnings before the extraordinary loss for early extinguishment of
debt and excluding the conversion fees, the merger expenses, the strike and
litigation costs, the impairment loss and the deferred tax charge as a
percentage of net revenues were 5.2% as compared to 3.2% for the year ended
December 31, 1995 and 1994, respectively. The increase is primarily due to a
reduction in the provision for losses on accounts receivable (as described
above) in 1995 as compared to 1994 and to the decrease in the effective tax rate
during the year ended December 31, 1995.
TWELVE MONTHS ENDED DECEMBER 31, 1994 COMPARED TO TWELVE MONTHS ENDED DECEMBER
31, 1993
Total net revenues for the year ended December 31, 1994, increased from the
year ended December 31, 1993 by $442,539,000, or 192%, to $673,354,000.
Approximately $205,300,000, or 46% of this increase was due to the addition of
Mediplex's results since the date of acquisition on June 23, 1994.
29
<PAGE>
Net revenues from long-term and subacute care services, which includes
revenues generated from therapy and institutional pharmaceutical services
provided at the Company's facilities, increased from $151,229,000 for the year
ended December 31, 1993 to $476,146,000 for the year ended December 31, 1994, a
215% increase. Approximately $197,351,000, or 61%, of this increase in long-term
and subacute care net revenues is a direct result of the acquisition of 36
facilities in connection with the Mediplex merger, which occurred on June 23,
1994. Approximately $60,238,000, or 19%, of this increase is a result of the
acquisition of 24 other facilities operations since December 31, 1993. The
remaining 20% of the increase in long-term and subacute care services net
revenues is comprised of $16,955,000, which represents an increase in revenue
per patient day and an increase in occupancy levels for the facilities in
operation since December 31, 1992 on a same facility basis, and $50,373,000,
which represents a full year's revenues for facilities acquired in 1993.
The increase in therapy services net revenues from $49,124,000 for the year
ended December 31, 1993 to $106,144,000 for the year ended December 31, 1994, an
increase of 116%, is primarily a result of the increase in the number of
nonaffiliated facilities served from 294 at December 31, 1993 to 513 at December
31, 1994.
The increase in temporary therapy staffing services net revenues from
$27,180,000 for the year ended December 31, 1993 to $55,258,000 for the year
ended December 31, 1994, an increase of 103%, is primarily a result of the
increased service hours billed and an increase in the average hourly rate
billed. The increase in service hours billed is attributable primarily to the
increase in the number of division offices open for over a year and to new
offices established through expansion and acquisition.
Net revenues for the institutional pharmaceutical services business
increased from $2,034,000 for the year ended December 31, 1993 to $20,427,000
for the year ended December 31, 1994. The growth in net revenues results from
providing institutional pharmaceutical services to an additional 88
nonaffiliated facilities since December 31, 1993.
Operating expenses, which includes rent expense of $43,626,000 and
$15,578,000 for the year ended December 31, 1994 and 1993, respectively, were
$552,662,000 for the year ended December 31, 1994 and $194,290,000 for the year
ended December 31, 1993, an increase of 184%. The increase resulted primarily
from the acquisition of 78 facilities since December 31, 1993 and the growth in
therapy services, temporary therapy staffing services and institutional
pharmaceutical services. Operating expenses as a percentage of net revenues
decreased from 84.2% for the year ended December 31, 1993 to 82.1% for the year
ended December 31, 1994, which can be attributed to growth in therapy services,
temporary therapy staffing services, institutional pharmaceutical services and
subacute care services, which have higher operating margins than the margins
associated with routine long-term care services.
Corporate general and administrative expenses increased from $10,675,000 for
the year ended December 31, 1993 to $31,633,000 for the year ended December 31,
1994, an increase of 196%. As a percentage of net revenues, corporate general
and administrative expenses were 4.7% and 4.6% for the year ended December 31,
1994 and 1993, respectively.
The provision for losses on accounts receivable was $27,632,000 for the year
ended December 31, 1994, as compared to $1,265,000 for the year ended December
31, 1993. The increase is primarily due to the write-off of certain Mediplex
accounts receivable which existed at the date of acquisition of Mediplex (as
discussed above in the analysis of the provision for losses on accounts
receivable for the twelve months ended December 31, 1995, compared to the twelve
months ended December 31, 1994) and the growth in net revenues.
Depreciation and amortization expense for the year ended December 31, 1994
totaled $11,797,000 compared to $1,534,0000 for the year ended December 31,
1993. As a percentage of net revenues, depreciation and amortization expense
increased from 0.7% for the year ended December 31, 1993 to 1.8% for the year
ended December 31, 1994. The increases are primarily due to the
30
<PAGE>
amortization on $426,542,000 of goodwill recorded in connection with the
Mediplex merger. Depreciation and amortization expense in 1993 primarily
resulted from the repurchase of stock from National Medical Enterprises, Inc.
and the purchase of Honorcare Corporation ("Honorcare"), both of which occurred
in July 1993.
Net interest expense for the year ended December 31, 1994 totaled
$10,548,000 compared to $341,000 for the year ended December 31, 1993. The
increase was due to the issuance of the 6% Convertible Debentures on March 1,
1994 and the additional interest expense associated with the $338,632,000 of
outstanding Mediplex debt assumed as a result of the Mediplex merger.
The Company incurred a nonrecurring charge of $2,275,000 in connection with
the payment of an inducement fee to effect the conversion in August 1994 of
$24,377,000 of the 6 1/2% Convertible Debentures.
In the second quarter of 1993, the Company was organized and then acquired
its operating entities in the Sun Exchange. Prior to the Sun Exchange, there was
no provision for Federal or state income taxes for certain subsidiaries, since
such subsidiaries elected S corporation status. In addition, effective January
1, 1993, certain C corporations organized in the Sun Exchange adopted Statement
of Financial Accounting Standards No. 109 -- "Accounting for Income Taxes" (FAS
109). Implementation of the new standard resulted in an increase in the deferred
tax liability of approximately $100,000 in the first quarter of 1993. The
Company recorded a $638,000 additional tax provision relative to the recognition
of deferred income taxes upon restructuring of the Company. On June 21, 1995,
the Company acquired CareerStaff and on May 5, 1995, the Company acquired Golden
Care, both accounted for as poolings of interests. A provision for pro forma
taxes has also been included in the Company's Consolidated Financial Statements
to reflect the estimated taxes that would have been incurred if CareerStaff and
Golden Care had been subject to taxation as C corporations prior to the
terminations of their S corporation status in June 1994 and May 1995,
respectively. The pro forma effective tax rate, which reflects the taxes on the
results of operations of the Company on the basis that is required upon
reorganization and termination of S Corporation status, excluding the
nonrecurring charge of $638,000 relating to the Sun Exchange, was 38% for the
year ended December 31, 1993. The pro forma effective tax rate for the year
ended December 31, 1994, excluding the nondeductible conversion fee of
$2,275,000, was 44%. The increase in the effective tax rate is due to the
addition of nondeductible goodwill recorded in connection with the Mediplex
merger, a higher Federal statutory rate and the mix of state income which was
less favorable than the prior year.
Pro forma net earnings for the year ended December 31, 1994, excluding the
conversion fee of $2,275,000, increased 55% to $21,836,000 from pro forma net
earnings of $14,101,000, excluding the charge of $638,000 related to the Sun
Exchange, for the year ended December 31, 1993. Pro forma net earnings as a
percentage of net revenues decreased from 6.1% for the year ended December 31,
1993, excluding the nonrecurring charge of $638,000, to 3.2% for the year ended
December 31, 1994, excluding the conversion fee of $2,275,000, primarily due to
a change in respiratory therapy reimbursement rates in the state of Indiana and
the write-off of certain Mediplex accounts receivable (as discussed above).
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1995, the Company had working capital of $237,147,000,
including cash and cash equivalents of $23,102,000, as compared to working
capital of $197,150,000, including cash and cash equivalents of $78,738,000 at
December 31, 1994. Approximately $55,200,000 of cash and cash equivalents at
December 31, 1994 represented the remaining proceeds from the Company's equity
offering in December 1994 after temporarily paying down its outstanding
borrowings under the Company's Credit Facility. For the year ended December 31,
1995, net cash provided by operations was $6,786,000 compared to net cash used
for operations for the year ended December 31, 1994 of $36,322,000. The net cash
provided by operations for the year ended December 31, 1995 reflects the
Company's growth in net earnings excluding the extraordinary loss, the
conversion expense, the impairment loss and the write-off of certain Mediplex
receivables as discussed above. This was offset
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<PAGE>
by the net cash used for operations to fund an increase in accounts receivable
due to the acquisition or opening of 26 new facilities and the growth in the
therapy and institutional pharmacy services businesses since December 1994. As
previously discussed, Medicare replaced the Company's fiscal intermediary. This
change delayed interim settlement payments and rate adjustments causing a slow
down in Medicare accounts receivable collections. As a result, the Company
increased its borrowings under its Credit Facility. The net cash used for
operations in the year ended December 31, 1994 was used primarily to fund an
increase in accounts receivable related to the acquisition of 78 facilities and
the growth in the therapy and institutional pharmaceutical services businesses
since December 31, 1993. The acquisition of Mediplex contributed $19,876,000 of
this increase. Other significant operating uses of cash for the year ended
December 31, 1995 were payments of $12,150,000 for income taxes and $29,790,000
for accrued interest.
The Company incurred $96,247,000 and $37,862,000 in capital expenditures for
the year ended December 31, 1995 and 1994, respectively. Substantially all such
expenditures during the year ended December 31, 1995 were for the acquisition of
nine facilities in the United States and the United Kingdom, the development and
construction of eleven new facilities in the United States and the United
Kingdom, routine capital expenditures and the construction of two new corporate
office buildings. These expansions were financed through borrowings under the
Company's Credit Facility. The Company has capital expenditure commitments, as
of December 31, 1995, under various contracts, including approximately
$18,500,000 of contracts in the United States and L14,700,000 ($22,700,000 as of
December 31, 1995) of contracts in the United Kingdom, including the
construction and completion of one and ten new facilities in the United States
and United Kingdom, respectively. The $8,132,000 classified as long-term
restricted cash as of December 31, 1995, has been set aside to fund the
completion of a portion of these projects.
In 1995, under five sale and leaseback agreements, the Company sold five of
its facilities for $69,988,000 and leased them back under ten year leases. The
Company has the option to renew the leases for a total lease term of twenty-five
years. The transaction fulfilled the Company's obligation to provide substitute
financing equal to the debt retained by the Company when it sold certain Assets
Held for Sale. Also in 1995, under a sale and leaseback agreement, the Company,
through its United Kingdom subsidiary, sold fifteen of its long-term facilities
for $35,546,000 and leased them back under a twelve year lease. The Company has
the option to renew the leases for a total lease term of thirty years. These
sale and leaseback transactions produced no material gain or loss.
On May 5, 1995 and June 21, 1995, wholly-owned subsidiaries of the Company
merged with and into Golden Care and CareerStaff, respectively. In connection
with the Golden Care merger, the Company issued 2,106,904 shares of common stock
to the former Golden Care stockholders and converted an option to purchase
Golden Care stock for $500,000 into an option to purchase 234,100 shares of the
Company's common stock. In connection with the CareerStaff merger, the Company
issued 6,080,600 shares of common stock to the former CareerStaff stockholders
and assumed and converted outstanding CareerStaff stock options into options to
purchase a total of 302,386 shares of the Company's common stock at prices
ranging from $12.96 to $22.47 per share. CareerStaff had a line of credit of
$15,000,000, of which $2,200,000 was outstanding as of the date of the merger.
The Company repaid and terminated this line of credit on August 1, 1995.
On June 23, 1994, the Company, acquired by merger all of the outstanding
capital stock of Mediplex. The consideration for the Mediplex merger was $11.00
in cash plus 1.28 shares of the Company's common stock for each share of
Mediplex common stock outstanding as of the date of the Mediplex merger (the
"Merger Consideration"). The Company issued 11,249,544 shares of common stock to
the former Mediplex stockholders and paid approximately $106,482,000 in cash to
such holders. Also, in connection with the Mediplex merger, the Company assumed
and converted the outstanding Mediplex stock options into options to purchase a
total of 1,704,500 shares of the Company's common stock.
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<PAGE>
As a result of the acquisition of Mediplex, the Company assumed additional
debt obligations of $338,632,000, which included the following at the date of
the Mediplex merger:
<TABLE>
<S> <C>
Convertible Subordinated Debentures due 2003, interest at
6 1/2% per annum, including unamortized premium of
$13,752,000................................................ $ 100,002,000
Senior Subordinated Notes due 2002, interest at 11 3/4% per
annum, including unamortized premium of $5,525,000......... 90,525,000
Mortgage notes payable and other collateralized notes
payable.................................................... 143,868,000
Other........................................................ 4,237,000
-------------
Total.................................................... $ 338,632,000
-------------
-------------
</TABLE>
In January 1995, the Company and Mediplex completed a Tender Offer for
$78,698,000 of the 11 3/4% Senior Subordinated Notes due 2002 (the "11 3/4%
Notes") at a price of $1,120 per $1,000 principal amount of the 11 3/4% Notes
(the "Tender Offer"). The Company recorded an extraordinary loss, net of related
tax benefits, of $3,413,000 as a result of the extinguishment of debt. The
Tender Offer was financed with the proceeds from the December common stock
offering (see below).
On August 23, 1994, $24,377,000 of the 6 1/2% Convertible Debentures were
converted into 978,136 shares of common stock. Pursuant to the conversion terms
under the indenture relating to the 6 1/2% Convertible Debentures, the Company
paid $8,406,000 in cash to the converting holder. In addition, the Company paid
the accrued interest plus a $2,275,000 conversion fee to the converting holder
to induce conversion. The August 1994 conversion was funded through the use of
available restricted cash balances. In January 1995, an additional $39,449,000
of the 6 1/2% Convertible Debentures were converted. Pursuant to the conversion
terms under the indenture relating to the 6 1/2% Convertible Debentures, the
Company paid $13,603,000 and issued 1,582,905 shares of common stock to the
converting holder. In addition, the Company paid the accrued interest plus a
$3,256,000 conversion fee to the converting holder to induce conversion. The
January 1995 conversion was funded through borrowings under the Credit Facility.
Conversion of the remaining $22,424,000 of outstanding 6 1/2% Convertible
Debentures would require the issuance of an additional 899,771 shares of common
stock and a payment of $7,732,000 in cash pursuant to the conversion terms under
the indenture relating to the 6 1/2% Convertible Debentures.
As part of the Mediplex merger, the Company acquired five facilities and
certain outpatient units providing substance abuse treatment or psychiatric
care, as well as three former substance abuse or psychiatric facilities that
were closed in 1992 and 1993. The Company also acquired three transitional
living facilities that provide community re-entry services to patients suffering
from head trauma and related injuries. In 1994, the Company decided to dispose
of these facilities and developed a plan of disposition that was approved by the
Company's Board of Directors. On September 30, 1995, the Company completed the
sale of the five psychiatric care and substance abuse treatment facilities and
all of the related outpatient facilities for a purchase price of $39,900,000
consisting of cash and the assumption of indebtedness secured by one of the
facilities. As part of the sale, the Company provided a five-year $12,500,000
working capital line of credit for the buyer, which is secured by the accounts
receivable of the facilities sold and is restricted to a borrowing base
determined by the amount of accounts receivable of the facilities upon
completion of the sale. As of December 31, 1995, the Company had advanced
$12,500,000 on the working capital line of credit. The Company also subleased
two other operating transitional living facilities, and sold the working capital
of the two operating facilities to the current administrator of one of these
facilities, who has assumed responsibility for approximately 60% of the
Company's obligations under the present leases and will pay the Company a total
of $13,400,000 over the term of such leases. On May 17, 1995 and August 2, 1995,
the Company completed the sale of two of the closed facilities for $2,000,000
and $2,500,000, respectively. As a result of the terms of the sales, the Company
has retained certain net liabilities totaling approximately $10,200,000 and
long-term liabilities of approximately $8,600,000 which have been
33
<PAGE>
reclassified on the balance sheet. As of December 31, 1995, the Company
continues to lease a transitional living facility which will be purchased and
then sold in 1996 and owns an interest in a substance abuse facility which was
closed in 1992.
In July 1995, the Company entered into a Third Amended and Restated Credit
Agreement (the "Credit Facility") with NationsBank of Texas, N.A. as
Administrative Lender. The Credit Facility provides up to $315,000,000 in a
revolving line of credit and letters of credit. The Credit Facility expires on
July 21, 2000 and is collateralized by a pledge of all of the stock of the
Company's subsidiaries. Borrowings bear interest at either the prevailing prime
rate or the London Interbank Offering Rate ("LIBOR") plus 0.5% to 1.5%,
depending on the Company's consolidated debt to cash flow ratio. The Credit
Facility, among other things, (i) requires the Company to maintain certain
financial ratios, (ii) restricts the Company's ability to incur debt and liens,
make investments, liquidate or dispose of assets, merge with another
corporation, create or acquire subsidiaries, and make acquisitions, and (iii)
restricts the payment of dividends, the acquisition of treasury stock and the
prepayment or modification of certain debt of the Company. Because of the
temporary use of the proceeds from the Company's public offering of its common
stock in December 1994 to reduce borrowings pending completion of the Tender
Offer, there were no outstanding borrowings under the Company's former credit
facility as of December 31, 1994. The Company had $177,600,000 of outstanding
borrowings and $22,165,000 of outstanding standby letters of credit under the
Credit Facility at December 31, 1995. The increase in the outstanding borrowings
as of December 31, 1995 was primarily due to amounts needed to fund the Tender
Offer, the cash consideration paid upon conversion of the 6 1/2% Convertible
Debentures, capital expenditures and acquisitions.
On March 1, 1994, the Company completed an offering of $83,300,000 aggregate
principal amount of 6% Convertible Debentures. The net proceeds of approximately
$80,600,000 from the offering were used to pay part of the cash portion of the
Mediplex merger consideration. In addition, in June 1994 the Company completed
an underwritten public offering of 4,472,420 shares of common stock. The net
proceeds of $83,605,000 were used to pay part of the cash portion of the merger
consideration, the costs associated with the restructuring of Mediplex's
mortgages and leases with Meditrust, expenses of the Mediplex merger, and for
other general corporate purposes. In December 1994, the Company completed an
underwritten public offering of 5,365,000 shares of common stock. The net
proceeds of $111,878,000 were temporarily used to repay outstanding borrowings
under the Company's Credit Facility. The net proceeds were ultimately used to
fund the Tender Offer completed in January 1995.
The Company has $33,135,000 of mortgages with Meditrust as of December 31,
1995, which contain less restrictive covenants than in the Credit Facility and
which include cross default provisions with all of such mortgages and
thirty-five leases also financed by Meditrust. The Company also is the obligor
on an outstanding letter of credit for $4,028,000 as of December 31, 1995 to
guarantee outstanding debt obligations of $3,955,000 as of December 31, 1995 for
a partnership through which the Company acquired a 50% interest. The partnership
owns a long-term care facility which is leased to a third party operator.
In connection with the Mediplex merger, the Company acquired, through
Mediplex, an interest rate hedge swap agreement with a commercial bank, having a
total notional principal amount of $100,000,000 and expiring in 1999. This
agreement called for the payment of variable rate interest by the Company in
return for the assumption by the other contracting party of a fixed rate cost.
For the period beginning June 23, 1994 and ending June 30, 1995, the Company
received a fixed rate of interest of 6.60% and paid interest at the 90 day LIBOR
rate (5.0% for the three months ended October 14, 1994, 5.625% for the three
months ending January 17, 1995, and 6.25% for the three months ended April 12,
1995 and for the period ended June 30, 1995). The Company terminated the
transaction on June 30, 1995 and received cash proceeds of $1,680,000 in
connection with such termination. The resulting gain is being amortized over the
original hedge period as an adjustment to interest expense.
34
<PAGE>
The Company's ongoing capital requirements relate to the costs associated
with its facilities under construction, routine capital expenditures and
potential acquisitions.
The Company believes that its current borrowing capacity under the Credit
Facility and cash from operations will be sufficient to satisfy its working
capital needs, routine capital expenditures, current debt service obligations
and to fund additional potential conversions of 6 1/2% Convertible Debentures.
The Company anticipates that it will fund its construction commitments as well
as its requirements relating to future growth through (i) the available
borrowing capacity under the Credit Facility, (ii) the use of operating leases
and common stock in the future as a means of acquiring facilities and new
operations, (iii) the availability of sale leaseback financing through real
estate investment trusts and other financing sources, and (iv) restricted cash.
However, there can be no assurance that the Company may not require additional
sources of financing in the next twelve months, particularly if it pursues
acquisitions requiring significant cash consideration. Such financing may access
the public securities markets. However, the Company's access to the public
markets may be adversely affected by the status of the OIG Investigation. In
addition, such acquisitions may require approval of the various lenders under
the Company's Credit Facility. If such sources of financing are not available,
the Company may not be able to pursue growth opportunities as actively as it has
in the past, and may be required to alter certain of its operating strategies.
EFFECTS FROM CHANGES IN REIMBURSEMENT
The Company derives a substantial percentage of its total revenues from
Medicare, Medicaid and private insurance. The Company's results of operations
and financial condition may be affected by the revenue reimbursement process,
which in the Company's industry is complex and can involve lengthy delays
between the time that revenue is recognized and the time that reimbursement
amounts are settled. Net revenues realizable under third party payor agreements
are subject to change due to examination and retroactive adjustment by payors
during the settlement process. The Company recognizes revenues from third party
payors and accrues estimated settlement amounts in the period in which the
related services are provided. The Company estimates these settlement balances
by making subjective determinations based on its prior settlement experience.
Differences between the net amounts accrued and subsequent settlements are
recorded in operations at the time of settlement. The majority of third party
payor balances are settled two to three years following the provision of
services. The Company's results of operations and financial condition may also
be affected by the timing of reimbursement payments and rate adjustments from
third party payors. The Company has from time to time experienced delays in
receiving reimbursement from intermediaries.
Various cost containment measures adopted by governmental and private pay
sources have begun to restrict the scope and amount of reimbursable health care
expenses and limit increases in reimbursement rates for medical services. Any
reductions in reimbursement levels under Medicaid, Medicare or private payor
programs and any changes in applicable government regulations or interpretations
of existing regulations could significantly affect the Company's profitability.
Furthermore, government programs are subject to statutory and regulatory
changes, retroactive rate adjustments, administrative rulings and government
funding restrictions, all of which may materially affect the rate of payment to
the Company's facilities and ambulatory surgery centers and its therapy and
institutional pharmacy businesses. There can be no assurance that payments under
governmental or private payor programs will remain at levels comparable to
present levels or will be adequate to cover the costs of providing services to
patients eligible for assistance under such programs. Significant decreases in
utilization and limits on reimbursement could have a material adverse effect on
the Company's results of operations and financial condition including the
possible impairment of certain assets.
In October 1993, the Health Care Financing Administration ("HCFA") issued a
directive to fiscal intermediaries that administer the Medicare reimbursement
policies to review costs incurred by providers of occupational therapy and
speech therapy. Although HCFA has published salary equivalency guidelines for
physical therapy and respiratory therapy, no such standards exist for
35
<PAGE>
occupational therapy and speech therapy. The directive indicated HCFA's intent
to develop salary equivalency guidelines for occupational and speech therapy.
Implementation of this directive and the development of salary equivalency
guidelines could directly or indirectly limit reimbursement for certain of the
Company's rehabilitation therapy services. Reimbursement for such services is
currently evaluated under Medicare's reasonable cost principles. In April and
June 1995, HCFA provided information to intermediaries for their use in
determining reasonable costs for occupational and speech therapy. The salary
information set forth in such directives, although not intended to be applied as
absolute limits of reasonable costs, could substantially lower the reimbursement
rates. While the effect of these directives is still uncertain, they are a
factor considered by such intermediaries in determining reasonable costs, which
could result in a decrease in the Company's revenues or, with respect to
rehabilitation therapy services provided to Company operated facilities, a
retroactive adjustment of Medicare reimbursement for some prior periods. An
adjustment of reimbursement rates with respect to therapy services provided to
nonaffiliated facilities could result in indemnity claims against the Company,
based on the terms of substantially all of the Company's existing contracts with
such facilities, for payments previously made by such facilities to the Company
that are reduced by Medicare in the audit process. The Company derives a
significant percentage of its net earnings from the provision of therapy
services; a change in reimbursement resulting from implementation of this
directive or a reduction in reimbursement rates as a result of a change in
application of reasonable cost guidelines could have a material adverse affect
on the Company's financial condition and results of operations, depending on the
rates adopted and the Company's costs for providing these services.
Current Medicare regulations that apply to transactions between related
parties, such as the Company's subsidiaries, are relevant to the amount of
Medicare reimbursement that the Company is entitled to receive for the
rehabilitation and respiratory therapy and institutional pharmaceutical services
that it provides to Company operated facilities. These Medicare regulations
require that, among other things, a substantial part of the rehabilitation and
respiratory therapy services or institutional pharmaceutical services, as the
case may be, of the relevant subsidiary be transacted with nonaffiliated
entities in order for the Company to receive reimbursement for services provided
to Company operated facilities at the rates applicable to services provided to
nonaffiliated entities. The Medicare regulations do not indicate a specific
level of services that must be provided to nonaffiliated entities in order to
satisfy the "substantial part" requirement of such regulations. Net revenues
from rehabilitation therapy services provided to nonaffiliated facilities
represented 64%, 67% and 74% of total rehabilitation services net revenues for
the year ended December 31, 1995, 1994 and 1993, respectively. The Company's
respiratory therapy operations did not provide services to nonaffiliated
facilities prior to the acquisition of Golden Care on May 5, 1995. Respiratory
therapy services provided to nonaffiliated facilities represented 64% of total
respiratory therapy services net revenues for the period from the date of
acquisition of Golden Care on May 5, 1995 to December 31, 1995. Net revenues
from institutional pharmacy services provided to nonaffiliated facilities
represented 78%, 81% and 83% of total institutional pharmacy services revenues
for the years ended December 31, 1995, 1994 and 1993, respectively. The Company
believes that it satisfies the requirements of these regulations regarding
nonaffiliated business. Consequently, it has claimed and received reimbursements
under Medicare for rehabilitation and respiratory therapy and institutional
pharmaceutical services provided to patients in its own facilities at a higher
rate than if it did not satisfy these requirements. If the Company is unable to
satisfy these regulations, the reimbursement that the Company receives for
rehabilitation and respiratory therapy and institutional pharmaceutical services
provided to its own facilities would be materially and adversely affected. If,
upon audit by relevant reimbursement agencies, such agencies find that these
regulations have not been satisfied, and if, after appeal, such findings are
sustained, the Company could be required to refund some or all of the difference
between its cost of providing these services and the higher amount actually
received. While the Company believes that it has satisfied and will continue to
satisfy these regulations, there can be no assurance that its position would
prevail if contested by relevant reimbursement agencies. The foregoing
statements with respect to the Company's ability to satisfy these regulations
are forward looking and could
36
<PAGE>
be affected by a number of factors, including the interpretation of Medicare
regulations by the relevant reimbursement agencies and the Company's ability to
provide services to nonaffiliated facilities.
The Company's subsidiaries, including those which provide subacute and
long-term care, rehabilitation and respiratory therapy and institutional
pharmaceutical services, are engaged in industries which are extensively
regulated. As such in the ordinary course of business, the operations of these
subsidiaries are continuously subject to state and Federal regulatory scrutiny,
supervision and control. Such regulatory scrutiny often includes inquiries,
investigations, examinations, audits, site visits and surveys, some of which may
be non-routine.
In addition to being subject to the direct regulatory oversight of state and
Federal regulatory agencies, these industries are frequently subject to the
regulatory supervision of fiscal intermediaries. Fiscal intermediaries are
agents of HCFA who interpret and implement applicable laws and regulations and
make decisions about the appropriate reimbursement to be paid under Medicare and
Medicaid. The Company's subsidiaries are subject to the oversight of several
different intermediaries. Those different intermediaries have taken varying
interpretations of the applicable laws and regulations. The lack of uniformity
in the interpretation and implementation of such laws and regulations reflects
in part the fact that the statutory standards are subject to interpretation and
the manuals which are published and utilized by HCFA and the intermediaries in
performing their regulatory functions are often not sufficiently specific to
provide clear guidance in the areas which are the subject of regulatory
scrutiny.
It is the policy of the Company to comply with all applicable laws and
regulations, and the Company believes that its subsidiaries are in substantial
compliance with all material laws and regulations which are applicable to their
businesses. However, given the extent to which the interpretation and
implementation of applicable laws and regulations varies and the lack of clear
guidance in the areas which are the subject of regulatory scrutiny, there can be
no assurance that the business activities of the Company's subsidiaries will not
from time to time become the subject of regulatory scrutiny, or that such
scrutiny will not result in interpretations of applicable laws or regulations by
government regulators or intermediaries which differ materially from those taken
by the Company's subsidiaries.
The Company's rehabilitation therapy subsidiary is under investigation by
the OIG. The allegations underlying the investigation have not been fully
disclosed to the Company, and the OIG is still in the process of collecting
additional information. The Company believes that the investigation includes a
review of whether the Company's rehabilitation therapy subsidiary has engaged in
improper practices, including the provision of, and billing for, concurrent
therapy services and unnecessary or unordered services to residents of skilled
nursing facilities. In addition, the Company's rehabilitation therapy subsidiary
provides therapy services to, among others, the Company's long-term care
subsidiary. The Company understands that the OIG is also reviewing claims filed
by its long-term care subsidiary with respect to the services. The Company has
cooperated and continues to cooperate with the investigation. If there have been
improper practices or the investigation is broader in scope, depending on the
nature and extent of such impropriety, the investigation could result in the
imposition of civil, administrative, or criminal fines, penalties, or
restitutionary relief, and may have a negative impact on the Company. The
negative publicity surrounding the OIG investigation has slowed the Company's
success in obtaining additional outside contracts in the rehabilitation therapy
business, which has resulted in higher than required therapist staffing levels
and has affected the private patient enrollment in certain in-patient
facilities. The Company is unable to determine at this time when the
investigation is to be concluded, however, based on the facts currently
available, it does not believe that the outcome of the OIG investigation will
have a material adverse effect on the Company's financial condition or results
of operations. The foregoing statements with respect to the outcome of the OIG
investigation are forward looking and could be affected by a number of factors,
including the actual scope of the OIG investigation, the OIG's factual findings
and the OIG's interpretation of Federal statutes and regulations.
37
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LITIGATION
Prior to the Company's acquisition of CareerStaff, a holder of CareerStaff's
common stock has filed a lawsuit (the "CareerStaff Litigation") as a purported
class action against CareerStaff and the directors of CareerStaff alleging
breach of fiduciary duty in entering into a merger agreement with the Company
and against the Company alleging that the Company aided and abetted the alleged
breach of fiduciary duty by the CareerStaff directors. In February 1996, the
plaintiff filed a status report with the court stating that the plaintiff
intended to file a stipulation of dismissal without prejudice. The Company
believes that the CareerStaff Litigation is without merit; however, there can be
no assurance that the CareerStaff Litigation will not have an impact on the
Company's accounting for the merger.
On June 30, 1995, two civil class action complaints were filed against the
Company and certain of its current and former directors and officers in the
United States District Court for the District of New Mexico. Two more
complaints, based on the same underlying events, were filed on August 30, 1995.
On October 6 and October 10, 1995, two additional complaints were filed, also
based on the same underlying events. These six complaints were consolidated by a
court order dated November 27, 1995, and an amended class action complaint,
captioned IN RE SUN HEALTHCARE GROUP, INC. LITIGATION (the "Complaint") was
filed in the United States District Court for the District of New Mexico on
January 26, 1996. The Complaint was purportedly brought on behalf of all persons
who either exchanged their shares of common stock of CareerStaff for shares of
the Company's common stock pursuant to a merger agreement between CareerStaff
and the Company, or who purchased shares of the Company's common stock between
October 26, 1994 and June 27, 1995. The Complaint alleges that defendants
misrepresented or failed to disclose material facts about the OIG investigation
and about the Company's operations and financial results, which plaintiffs
contend artificially inflated the price of the Company's securities.
On or about January 23, 1996, two of the Golden Care selling stockholders
filed a lawsuit (the "Golden Care Litigation") against the Company and certain
of its officers and directors in the United States District Court for the
Southern District of Indiana. Plaintiffs allege, among other things, that the
Company did not disclose material facts concerning the OIG investigation and
that the Company's financial results were misstated. The Complaint purports to
state claims, INTER ALIA, under federal and state securities laws and for breach
of contract, including a breach of the registration rights agreement pursuant to
which the Company agreed to register the shares being registered for resale by
such Golden Care selling stockholders. The Company believes that the Golden Care
Litigation is without merit; however, there can be no assurance that the Golden
Care Litigation will not have an impact on the Company's accounting for the
merger.
On September 8, 1995, a derivative action was filed in the United States
District Court for the District of New Mexico, captioned BRICKELL PARTNERS V.
TURNER, ET AL. The complaint was not served on any defendant. On June 19, 1996,
an amended complaint alleging breach of fiduciary duty by certain current and
former of the Company's directors and officers based on substantially the same
events as those set forth in the above described securities class actions was
filed and subsequently served on the defendants.
The Company has reviewed the allegations in the complaints, believes them to
be without merit, and intends to defend itself vigorously. Relief sought in
these actions is unspecified. The Company believes the shareholder actions will
not have a material adverse impact on its results of operations or financial
condition. The foregoing statements with respect to the possible outcomes of the
CareerStaff Litigation, the Golden Care Litigation and the shareholder actions
are forward looking and could be affected by a number of factors, including
judicial interpretations of applicable law, the uncertainties and risks inherent
in any litigation, particularly a jury trial, the existence, scope and number of
any subsequently-filed complaints, and the scope of insurance coverage. In
addition, the outcome of the shareholder actions could be affected by the
outcome of the OIG investigation and all factors that could affect that outcome.
38
<PAGE>
EFFECTS OF INFLATION
Health care costs have been rising and are expected to continue to rise at a
rate higher than that anticipated for consumer goods as a whole. The Company's
operations could be adversely affected if it experiences significant delays in
receiving reimbursement rate increases from Medicaid and Medicare sources for
its labor and other costs.
The Registrant hereby amends the disclosure contained under the caption
"Financial Statements and Supplementary Data" set forth in Part II, Item 8 of
the Registrant's Annual Report on Form 10-K for the year ended December 31,
1995. In accordance with Rule 12b-15 promulgated under the Securities Exchange
Act of 1934, as amended, the complete text of Part II, Item 8, as amended,
follows.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information with respect to Item 8 is contained in the Company's
consolidated financial statements and financial statement schedules and are set
forth herein beginning on Page F-1.
39
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements and Financial Statement Schedules
(i) Financial Statements
Report of Independent Public Accountants
Consolidated Balance Sheets as of December 31, 1995 and 1994
Consolidated Statements of Earnings (Loss) for the years ended
December 31, 1995, 1994 and 1993
Consolidated Statements of Stockholders' Equity as of December 31,
1995, 1994 and 1993
Consolidated Statements of Cash Flows for the years ended December
31, 1995, 1994 and 1993
Notes to Consolidated Financial Statements
(ii) Financial Statement Schedules
Schedule II Valuation and Qualifying Accounts for the years ended
December 31, 1995, 1994 and 1993
(All other financial statement schedules required by Rule 5-04 of Regulation S-X
are not applicable or the required information is included in the audited
financial statements.)
(b) Reports on Form 8-K.
None
(c) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------- ---------------------------------------------------------------------------------------------------
<S> <C>
2.1(1) Preincorporation Agreement dated as of April 13, 1993, between Sun and Andrew L. Turner, Nora L.
Turner and Elizabeth L. Keefer, as Trustee of Turner's Children's Trust No. 3
2.2(2)(7) Agreement and Plan of Merger dated January 27, 1994, by and among Sun, Sun Acquisition Corporation,
The Mediplex Group, Inc., Abraham D. Gosman and Andrew L. Turner, as amended. Filed without
schedules attached.
Exhibit A: Form of Mediplex Legal Opinion
Exhibit B: Form of Sun Legal Opinion
Exhibit C: Letter dated January 19, 1994 between NationsBank of Texas, N.A. and Sun Healthcare
Group, Inc., with Annex A
Exhibit D: Consent Agreement dated January 27, 1994 by and between Meditrust Mortgage
Investments, Inc. and Sun Healthcare Group, Inc., with Annex A
Exhibit E: Sun Guaranty
2.3(2) Asset Sale Agreement dated January 27, 1994 by and among Mediplex, Abraham D. Gosman and Sun
Exhibit A: Assets Being Purchased
Exhibit B: Non-Competition Agreement
</TABLE>
40
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------- ---------------------------------------------------------------------------------------------------
<S> <C>
Exhibit C: Lock-Up Letter
2.4(1) Plan of Reorganization and Merger Agreement by and between Honorcare Corporation, Don A. Karchmer,
Thomas E. Stewart, John E. Bingaman and James W. Campbell, Sun and Sunrise
2.5(12) Merger Agreement dated as of February 20, 1995 between DanRae Corporation, Daniel and Rae Jacob,
Sun and Sunscript Pharmacy Corporation
2.6(15) Agreement and Plan of Merger dated as of April 27, 1995 by and between Golden Care, Inc., Golden
Acquisition Corporation and Sun
2.7(15) First Amendment to Agreement and Plan of Merger dated as of May 4, 1995 by and between Golden Care,
Inc., Golden Acquisition Corporation and Sun
2.8(16) Agreement and Plan of Merger dated March 30, 1995 by and between Sun, Sun Acquisition Corporation
and CareerStaff Unlimited, Inc.
2.9(16) First Amendment to Agreement and Plan of Merger dated April 7, 1995 by and between Sun, Sun
Acquisition Corporation and CareerStaff Unlimited, Inc.
2.10(15) Second Amendment to Agreement and Plan of Merger dated May 11, 1995 by and between Sun, Sun
Acquisition Corporation and CareerStaff Unlimited, Inc.
2.11(13) Plan of Reorganization and Merger dated August 15, 1995 by and among Nursing Home Consultant
Pharmacy, Inc., T. Edward Childress, III, John P. O'Brien, Jr., Sun and Sunscript Pharmacy
Corporation
2.12(13) Share Purchase Agreement dated as of November 30, 1995 among Sun, Columbia Health Care Inc. and the
Vendors named therein. Schedule 14: Form of Warrant
2.13(12) Merger Agreement dated January 27, 1995 between Anesthesia Services Medical Group Inc., Altis
Outpatient Services, Inc., Sun and Medical Management & Development Corporation
2.14(10) Investment and Shareholders' Agreement between Sun Healthcare Group, Inc., Sun Healthcare Group
International Ltd., Exceler Health Care Group PLC, Guernroy Limited, John Ernest Moreton, The
Alexanders and the Optionholders relating to Exceler Health Care Group PLC, dated September 7, 1994
3.1(1) Certificate of Incorporation of Sun
3.2(1)(9) Bylaws of Sun, as amended
3.3(6) Certificate of Amendment to Certificate of Incorporation of Sun dated June 23, 1994
3.4(21) Certificate of Amendment to Certificate of Incorporation of Sun dated April 15, 1993
4.1(3) Fiscal Agency Agreement dated as of March 1, 1994 between Sun and NationsBank of Texas, N.A., as
Fiscal Agent
4.2(6) Amended and Restated Indenture, dated October 1, 1994, among Sun, The Mediplex Group, Inc. and
Fleet Bank of Massachusetts, N.A. as Trustee
4.3(6) Amended and Restated First Supplemental Indenture to Amended and Restated Indenture, dated October
1, 1994, among Sun, The Mediplex Group, Inc. and Fleet Bank of Massachusetts, N.A. as Trustee
(6 1/2% Convertible Subordinated Debentures due 2003)
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------- ---------------------------------------------------------------------------------------------------
<S> <C>
4.4(17) Form of Rights Agreement, dated as of June 2, 1995, between Sun and Boatmen's Trust Company, which
includes the form of Certificate of Designations for the Series A Preferred Stock as Exhibit A, the
form of Right Certificate as Exhibit B and the form of Summary of Preferred Stock Purchase Rights
as Exhibit C.
4.5(18) First Amendment to Rights Agreement, dated as of August 11, 1995, amending the Rights Agreement,
dated as of June 2, 1995, between Sun and Boatmen's Trust Company
10.1(1) Sun 1993 Combined Incentive and Nonqualified Stock Option Plan
10.2(1) Sun 1993 Directors Stock Option Plan
10.3(1) Lease Agreement for Menlo Park Healthcare Center dated as of November 1, 1991, between Oregon
Associates Limited Partnership ("Lessor") and Sunrise ("Lessee")
10.4(1) Sublease Agreement for Hillside Living Center d/b/a Hillside Healthcare Center dated as of March 1,
1992, between Elite Care Corporation ("Sublessor") and Turner Enterprises, Inc. ("Sublessee")
(Lease attached as Exhibit)
10.5(1) Sublease Agreement for Crown Manor Living Center d/b/a Crown Manor Healthcare Center dated as of
March 1, 1992, between Elite Care Corporation ("Sublessor") and Turner Enterprises, Inc.
("Sublessee") (Lease attached as Exhibit)
10.6(1) Sublease Agreement for Colonial Manor Living Center d/b/a Colonial Manor Healthcare Center dated as
of March 1, 1992, between Elite Care Corporation ("Sublessor") and Turner Enterprises, Inc.
("Sublessee") (Lease attached as Exhibit)
10.7(1) Sublease Agreement for Douglas Living Center d/b/a Douglas Healthcare Center dated as of March 1,
1992, between Elite Care Corporation ("Sublessor") and Turner Enterprises, Inc. ("Sublessee")
(Lease attached as Exhibit)
10.8(1) Lease Agreement for Whispering Pines Care Center and Valley Rehabilitation Center dated as of
October 1, 1991, between Belle Mountain Associates Limited Partnership ("Lessor") and Sunrise
("Lessee")
10.9(1) Lease Agreement for Columbia View Nursing Home dated as of June 30, 1992, between Columbia
Associates Limited Partnership ("Lessor") and Turner Enterprises, Inc. ("Lessee")
10.10(1) Lease Agreement for Adams House Healthcare Center dated as of October 1, 1992, between Adams
Connecticut Associates Limited Partnership ("Lessor") and Turner Enterprises, Inc. ("Lessee")
10.11(1) Sublease, Assumption and Consent Agreement for Coronado Care Center dated as of May 31, 1990, among
Phoenix Nursing Home Limited Partnership ("Lessor"), Horizon Healthcare Corporation
("Lessee/Sublessor") and Sunrise ("Sublessee") pursuant to a Lease dated December 18, 1987 between
Lessor and Lessee (Lease attached as Exhibit)
10.12(4) Lease Agreement for the Coronado Care Center addition, dated as of August 30, 1991, by and between
Phoenix Nursing Home Limited Partnership II ("Lessor") and Sunrise ("Lessee")
10.13(1) Lease Agreement for Bayside Health and Rehabilitation Center dated as of July 26, 1991, between
Bellingham Associates Limited Partnership ("Lessor") and Sunrise ("Lessee")
</TABLE>
42
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------- ---------------------------------------------------------------------------------------------------
<S> <C>
10.14(1) Sublease, Assumption and Consent Agreement for Blue Mountain Convalescent Center dated as of
December 31, 1988, among Washington Associates ("Lessor"), Horizon Healthcare Corporation
("Lessee/Sublessor") and Sunrise ("Sublessee") pursuant to a Lease Agreement dated January 1, 1987,
between Lessor and Lessee (Lease attached as Exhibit)
10.15(1) Sublease, Assumption and Consent Agreement for Laurelwood Care Center dated as of December 31,
1988, among Belle Mountain Associates ("Lessor"), Horizon Healthcare Corporation
("Lessee/Sublessor") and Sunrise ("Sublessee") pursuant to a Lease dated December 1, 1987 between
Lessor and Lessee (Lease attached as Exhibit)
10.16(1) Lease Agreement for East Mesa Care Center dated as of September 30, 1990, between East Mesa
Associates Limited Partnership ("Lessor") and Sunrise ("Lessee")
10.17(1) Lease Agreement for Mercer Island Care Center dated as of July, 1991, among Mercer View
Convalescent Center, Tenants-in-Common ("Lessor"), Sunrise ("Lessee") and Andrew L. Turner and Nora
Turner, husband and wife ("Guarantor")
10.18(1) Assignment and Assumption of Lease with Consent of Lessor for Torrington Extend-A-Care Center dated
as of November 1, 1990, between Beverly Enterprises-Connecticut, Inc. ("Assignor/ Lessee"), Turner
Enterprises, Inc. ("Assignee"), Andrew L. Turner and Nora Turner ("Guarantors"), Harvey J. Angell
and Zev Karkomi ("Special Guarantors") and Beverly Investment Properties, Inc. ("Lessor") (Lease
attached)
10.19(1) Assignment and Assumption of Lease with Consent of Lessor for Danbury Pavilion Health Care d/b/a
Heritage Heights Care Center dated as of November 1, 1990, by and among Beverly
Enterprises-Connecticut, Inc. ("Assignor/Lessee"), Turner Enterprises, Inc. ("Assignee"), Andrew L.
Turner and Nora Turner ("Guarantors") and TOR Associates ("Lessor") pursuant to a lease dated March
1, 1986, between lessor and assignor (Lease attached as Exhibit)
10.20(1) Lease Agreement for Park Villa Convalescent Center dated as of April 1, 1993, between LTC
Properties, Inc. ("Lessor") and Sunrise ("Lessee")
10.21(1) Lease Agreement for San Juan Care Center and Burton Care Center dated as of October 31, 1992, by
and between Zev Karkomi and Jerold Ruskin (collectively, the "Lessors") and Sunrise ("Lessee")
10.22(4) Lease Agreement dated as of July 13, 1993, by and between Angelina Associates ("Lessor") and
Honorcare Corporation ("Lessee"), with Assignment Agreement dated as of July 13, 1993 by and
between Honorcare Corporation ("Assignor") and Sun Healthcare Corporation ("Assignee") (Angelina
Facility)
10.23(4) Lease Agreement dated as of August 31, 1986, by and between Karan Associates ("Lessee") and
Campbell Care of Wylie, Inc., Assignment of Lease dated November 20, 1989 by and between Campbell
Care of Wylie, Inc. and Honorcare Corporation ("Lessee"), with First Lease Addendum dated August
31, 1986, Second Addendum dated January 9, 1987, Third Addendum dated November 30, 1989 and Fourth
Addendum dated July 12, 1993, and Assignment Agreement dated as of July 13, 1993, by and between
Honorcare Corporation ("Assignor") and Sun Healthcare Corporation ("Assignee") (Hillcrest Manor
Nursing Center)
</TABLE>
43
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------- ---------------------------------------------------------------------------------------------------
<S> <C>
10.24(4) Lease Agreement dated as of July 13, 1993, by and between July Associates IV ("Lessor") and
Honorcare Corporation ("Lessee"), with Assignment Agreement dated as of July 13, 1993, by and
between Honorcare Corporation ("Assignor") and Sun Healthcare Corporation ("Assignee") (Park Plaza)
10.25(4) Lease Agreement dated as of July 13, 1993, by and between Angelina Associates ("Lessor") and
Honorcare Corporation ("Lessee"), with Assignment Agreement dated as of July 13, 1993, by and
between Honorcare Corporation ("Assignor") and Sun Healthcare Corporation ("Assignee") (Wells)
10.26(4) Lease Agreement dated as of July 13, 1993, by and between Angelina Associates ("Lessor") and
Honorcare Corporation ("Lessee"), with Assignment Agreement dated as of July 13, 1993, by and
between Honorcare Corporation ("Assignor") and Sun Healthcare Corporation ("Assignee") (Pineywood)
10.27(4) Lease Agreement dated as of July 13, 1993, by and between Golden Age Associates ("Lessor") and
Honorcare Corporation ("Lessee") (Golden Age)
10.28(4) Lease Agreement dated as of July 13, 1993, by and between July Associates III ("Lessor") and
Honorcare Corporation ("Lessee") (High Plains)
10.29(4) Form of Management Agreement between GF/Massachusetts, Inc. and Sunrise
10.30(5) Lease Agreement dated as of December 6, 1993, by and between Massachusetts Nursing Homes Limited
Partnership ("Lessor") and Sunrise ("Lessee")
10.31(5) Lease Agreement dated October 1993, by and between Salem Associates, Ltd. ("Lessor") and Sunrise
("Lessee") (Doctors Nursing Home)
10.32(4) Lease Assignment and Transfer of Operations Agreement dated as of December 30, 1993, by and between
HEA of New Mexico, Inc. and Sunrise (Lease attached) (Country Life Manor)
10.33(1) Agreement dated April 16, 1993 among National Medical Enterprises, Inc., Sunrise, Sundance
Rehabilitation Corporation, Turner Enterprises, Inc., Sunscript Pharmacy Corporation, Sun, Andrew
L. Turner, Nora Turner and the Turner Children's Trust
10.34(1) Tax Indemnity Agreement between Sun, Sundance Rehabilitation Corporation, Turner Enterprises, Inc.
and Andrew L. Turner and Nora L. Turner
10.35(1) Indemnity Agreement between Sun and each of Sun's Directors
10.36(1) Employment Agreement between Sun and Andrew L. Turner
10.37(1) Agreement as of May 5, 1993, between Sundance Rehabilitation Corporation and Andrew L. Turner
10.38(4) Lease Agreement dated as of January 1, 1994, by and between October Associates ("Lessor") and
Sunrise ("Lessee") (Stanton Nursing Home)
10.39(4) Lease Agreement dated as of January 1, 1994, by and between Whitewright Associates ("Lessor") and
Sunrise ("Lessee") (Campbell Care of Whitewright)
10.40(4) Lease Agreement dated as of January 1, 1994, by and between October Associates ("Lessor") and
Sunrise ("Lessee") (Valley Mills Care Center)
10.41(4) Lease Agreement dated as of January 1, 1994, by and between October Associates ("Lessor") and
Sunrise ("Lessee") (Moody Care Center)
</TABLE>
44
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------- ---------------------------------------------------------------------------------------------------
<S> <C>
10.42(4) Management and Operations Transfer Agreement dated as of March 11, 1994, by and between Sunscript
Pharmacy Corporation and Mediscript, Inc.
10.43(4) Employment Agreement between Sun and John E. Bingaman
10.44(8) Therapy Services Agreement dated as of April 13, 1994 by and between Sundance Rehabilitation
Corporation and Mediplex
10.45(7) Lease Agreement dated as of April 26, 1994, by and between Sumner Nursing Home, L.L.C. and Sunrise
10.46(8) Lease Agreement dated as of September 22, 1993, as amended, between Carlinville Associates and
Sunrise Healthcare Corporation
10.47(8) Lease Agreement dated as of July 30, 1993 between Zev Karkomi, Thunderbird Associated Limited
Partnership and Sunrise Healthcare Corporation
10.48(6) Lease Agreement by and between Bellingham II Associates Limited Partnership and Sunrise Healthcare
Corporation, dated May 31, 1994
10.49(6) Amendment and Restatement of Loan Agreement [Brookline] by and between Mediplex of Massachusetts,
Inc. and Meditrust Mortgage Investments, Inc., dated June 23, 1994
10.50(6) Amendment and Restatement of Loan Agreement [Columbus] by and between Mediplex Rehabilitation of
Massachusetts, Inc. and Meditrust Mortgage Investments, Inc., dated June 23, 1994
10.51(6) Loan Agreement [Denver] by and between Mediplex of Colorado, Inc. and Valley View Psychiatric
Services, Inc. and Meditrust Mortgage Investments, Inc., dated June 23, 1994
10.52(6) Loan Agreement [Holliswood] by and between Mediplex of New York, Inc. and Meditrust Mortgage
Investments, Inc., dated June 23, 1994
10.53(6) Amendment and Restatement of Facility Lease Agreement [Lenox Hill] -- Meditrust of Lynn, Inc. and
Mediplex Rehabilitation of Massachusetts, Inc., dated June 23, 1994
10.54(6) Amendment and Restatement of Facility Lease Agreement [Northampton] -- New England Finance
Corporation and Mediplex Rehabilitation of Massachusetts, Inc., dated June 23, 1994
10.55(6) Amendment and Restatement of Facility Lease Agreement [Woodcrest] -- Meditrust and Mediplex of New
Jersey, Inc., dated June 23, 1994
10.56(6) Amendment and Restatement of Facility Lease Agreement [Westport] -- Meditrust and Mediplex of
Connecticut, Inc., dated June 23, 1994
10.57(6) Amendment and Restatement of Facility Lease Agreement [Newton] -- Meditrust and Mediplex of
Massachusetts, Inc., dated June 23, 1994
10.58(6) Amendment and Restatement of Facility Lease Agreement [Wilmington] -- Meditrust and Mediplex of
Massachusetts, Inc,, dated June 23, 1994
10.59(6) Loan Agreement [Arms Acres] by and between Mediplex of New York, Inc. and Meditrust Mortgage
Investments, Inc., dated June 23, 1994
10.60(6) Loan Agreement [Conifer Park] -- Mediplex of New York, Inc. and Meditrust Mortgage Investments,
Inc., dated June 23, 1994
</TABLE>
45
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------- ---------------------------------------------------------------------------------------------------
<S> <C>
10.61(6) Amendment and Restatement of Facility Lease Agreement [Stamford] by and between G-WZ of Stamford,
Inc. and Meditrust Mortgage Investments, Inc., dated June 23, 1994
10.62(6) Amendment and Restatement of Facility Lease Agreement [Cheshire] -- Meditrust and Mediplex of
Connecticut, Inc., dated June 23, 1994
10.63(6) Amendment and Restatement of Facility Lease Agreement [East Longmeadow] -- Meditrust and Quality
Nursing Care of Massachusetts, Inc., dated June 23, 1994
10.64(6) Amendment and Restatement of Facility Lease Agreement [Wethersfield] -- Meditrust and Mediplex of
Connecticut, Inc., dated June 23, 1994
10.65(6) Amendment and Restatement of Facility Lease Agreement [Danbury] -- Meditrust and Mediplex of
Connecticut, Inc., dated June 23, 1994
10.66(6) Amendment and Restatement of Facility Lease Agreement [Manatee] -- Meditrust and Manatee Springs
Nursing Center, Inc., dated June 23, 1994
10.67(6) Amendment and Restatement of Facility Lease Agreement [Camden] -- Plaza Medical Nursing Facility
and P.M.N.F. Management, Inc., dated June 23, 1994
10.68(6) Facility Lease Agreement [Washington] -- Pacific Finance Corporation and Sunrise Healthcare
Corporation, dated June 23, 1994
10.69(6) Amendment and Restatement of Facility Lease Agreement [Darien] -- New England Finance Corporation
and Mediplex of Connecticut, Inc., dated June 23, 1994
10.70(6) Amendment and Restatement of Facility Lease Agreement [Randolph] -- Meditrust and Mediplex of
Massachusetts, Inc., dated June 23, 1994
10.71(6) Amendment and Restatement of Facility Lease Agreement [Peabody] -- Meditrust and Mediplex of
Massachusetts, Inc., dated June 23, 1994
10.72(6) Amendment and Restatement of Facility Lease Agreement [Newington] -- Meditrust and Mediplex of
Connecticut, Inc., dated June 23, 1994
10.73(6) Amendment and Restatement of Facility Lease Agreement [Beverly] -- Meditrust and Mediplex of
Massachusetts, Inc., dated June 23, 1994
10.74(6) Facility Lease Agreement [Weymouth] -- Meditrust of Massachusetts, Inc. and Mediplex of
Massachusetts, Inc., dated June 23, 1994
10.75(6) Amendment and Restatement of Facility Lease Agreement [Lexington] -- Meditrust and Mediplex of
Massachusetts, Inc., dated June 23, 1994
10.76(6) Amendment and Restatement of Facility Lease Agreement [Michigan] -- Meditrust Tri-States, Inc. and
Mediplex of Ohio, Inc., dated June 23, 1994
10.77(6) Amendment and Restatement of Facility Lease Agreement [Christian Hill] -- Meditrust of
Massachusetts, Inc. and Mediplex Rehabilitation of Massachusetts, Inc., dated June 23, 1994
10.78(6) Amendment and Restatement of Facility Lease Agreement [Arkansas] -- Meditrust of Benton, Inc. and
Mediplex Management of Texas, Inc., dated June 23, 1994
10.79(6) Amendment and Restatement of Facility Lease Agreement [Holyoke] -- Meditrust of Massachusetts, Inc.
and Mediplex Rehabilitation of Massachusetts, Inc., dated June 23, 1994
</TABLE>
46
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------- ---------------------------------------------------------------------------------------------------
<S> <C>
10.80(6) Amendment and Restatement of Facility Lease Agreement [Cortland] -- Meditrust of New York, Inc. and
Community Re-entry Services of Cortland, Inc., dated June 23, 1994
10.81(6) Amendment and Restatement of Facility Lease Agreement [Southern Connecticut], dated June 23, 1994,
between New England Finance Corporation and Mediplex of Connecticut, Inc.
10.82(6) Amendment and Restatement of Facility Lease Agreement [Southbury], dated June 23, 1994, between New
England Finance Corporation and Mediplex of Connecticut, Inc.
10.83(6) Facility Lease Agreement [Bowling Green], dated June 23, 1994, between Meditrust of Kentucky, Inc.
and Mediplex of Kentucky, Inc.
10.84(6) Facility Lease Agreement [Milford], dated June 23, 1994, between Meditrust of Connecticut, Inc. and
Mediplex of Connecticut, Inc.
10.85(19) Third Amended and Restated Credit Agreement among Sun, The Mediplex Group Inc., Certain Lenders and
NationsBank of Texas, N.A., dated July 21, 1995
10.86(6) Lease and Security Agreement by and between Nationwide Health Properties, Inc. and Sunrise
Healthcare Corporation, dated September 1, 1994
10.87(6) Lease Agreement by and between Sumner Hills L.L.C. and Sunrise Healthcare Corporation, dated
September 9, 1994
10.88(6) Termination of Employment Agreement and Consulting Agreement by and between Sun Healthcare Group
and John E. Bingaman
10.89(11) Purchase Agreement between Belle Mountain Associates Limited Partnership and Sunrise Healthcare
Corporation for facility in the State of Washington Corporation, Daniel and Rae Jacob, Sun and
Sunscript Pharmacy Corporation.
10.90(14) Deed of Amendment and Instrument relating to Exceler Health Care Group Plc dated February 15, 1995
10.91(14) Amendments to Sun 1993 Combined Incentive and Nonqualified Stock Option Plan
10.92(14) First Amendment to Sun 1992 Director Stock Option Plan
10.93(20) Lease Agreement for Wheeler Care Center, dated as of July 24, 1995, by and between Wheeler
Healthcare Associates, L.L.C., a Texas limited liability company ("Lessor") and Sunrise Healthcare
Corporation ("Lessee").
10.94(20) Agreement with Respect to and Second Amendment of Lease Agreement, dated as of September 1, 1995,
by and between Massachusetts Nursing Homes Limited Partnership ("Lessor") and Sunrise Healthcare
Corporation ("Lessee").
10.95(20) Third Amendment of Lease Agreement, dated as of September 1, 1995, by and between Massachusetts
Nursing Homes Limited Partnership ("Lessor") and Sunrise Healthcare Corporation ("Lessee").
10.96(20) Lease Agreement for Clifton Care Center, dated as of September 13, 1995, between Missouri
Associates ("Lessor") and Sunrise Healthcare Corporation ("Lessee").
10.97(20) Facility Lease Agreement, dated as of September 30, 1995, by and between Meditrust of
Massachusetts, Inc. ("Lessor") and New Bedford Nursing Center, Inc. ("Lessee") (Guaranty of Sun
attached as Exhibit).
</TABLE>
47
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------- ---------------------------------------------------------------------------------------------------
<S> <C>
10.98(20) Facility Sublease Agreement, dated as of September 30, 1995, by and between Meditrust of New
Jersey, Inc., as Sublessor, and West Jersey/Mediplex Rehabilitation Limited Partnership (Guaranty
of Sun attached as Exhibit).
10.99(20) Facility Lease Agreement, dated as of September 30, 1995, by and between Meditrust of
Massachusetts, Inc. ("Lessor") and Mediplex of Massachusetts, Inc. ("Lessee") (Guaranty of Sun
attached as Exhibit).
10.100(20) Facility Lease Agreement, dated as of September 30, 1995, by and between Meditrust of
Massachusetts, Inc. ("Lessor") and Sundance Rehabilitation Corporation ("Lessee") (Guaranty of Sun
attached as Exhibit).
10.101(20) Facility Lease Agreement, dated as of September 30, 1995, by and between Meditrust of
Massachusetts, Inc. ("Lessor") and Mediplex of Concord, Inc. ("Lessee") (Guaranty of Sun attached
as Exhibit).
10.102(20) Indemnity Agreement (New Bedford), dated as of September 30, 1995, by and among New Bedford Nursing
Center, Inc. ("Seller"), Sun and Meditrust of Massachusetts, Inc. ("Buyer").
10.103(20) Indemnity Agreement (Marlton), dated as of September 30, 1995, by and among West Jersey/Mediplex
Rehabilitation Limited Partnership, as Assignor, Sun and Meditrust of New Jersey, Inc., as
Assignee.
10.104(20) Indemnity Agreement (Concord), dated as of September 30, 1995, by and among Mediplex of
Massachusetts, Inc. ("Seller"), and Meditrust of Massachusetts, Inc. ("Buyer").
10.105(20) Indemnity Agreement (Concord-1B), dated as of September 30, 1995, by and among Sundance
Rehabilitation Corporation ("Seller"), Sun and Meditrust of Massachusetts, Inc. ("Buyer").
10.106(20) Indemnity Agreement (Concord -- 2A & 2B), dated as of September 30, 1995, by and among Mediplex of
Concord, Inc. ("Seller"), Sun and Meditrust of Massachusetts, Inc. ("Buyer").
10.107(20) Indemnity Agreement (Oradell), dated as of September 30, 1995, by and among Bergen Eldercare, Inc.
("Seller"), Sun and Meditrust of New Jersey, Inc. ("Buyer").
10.108(21) Sun 1995 Non-Employee Directors' Stock Option Plan
10.109(21) Sun Employee Stock Purchase Plan
10.110(21) Sun 1996 Combined Incentive and Nonqualified Stock Option Plan
10.111(21) Second Amendment to Third Amended and Restated Credit Agreement among Sun, The Mediplex Group Inc.,
Certain Lenders and NationsBank of Texas, N.A., dated January 22, 1996
10.112(21) Third Amendment to Third Amended and Restated Credit Agreement among Sun, The Mediplex Group Inc.,
Certain Lenders and NationsBank of Texas, N.A., dated March 21, 1996
10.113(21) Omnibus Amendment to Loan Agreements, dated as of March 28, 1996, by and between certain
subsidiaries of The Mediplex Group, Inc. and certain subsidiaries of Sun.
</TABLE>
48
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------- ---------------------------------------------------------------------------------------------------
<S> <C>
10.114(21) Omnibus Amendment to Facility Lease Agreements, dated as of March 28, 1996, by and between certain
subsidiaries of The Mediplex Group, Inc. and certain subsidiary of Sun.
11.1 Computation of earnings per share
21.1(21) Subsidiaries of the Registrant
23.1 Consent of Arthur Andersen LLP
23.2 Consent of Coopers & Lybrand L.L.P.
23.3 Consent of Ernst & Young LLP
</TABLE>
- ------------
(1) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-62670) on Form S-1.
(2) Incorporated by reference from exhibits to the Company's Form 8-K dated
January 27, 1994.
(3) Incorporated by reference from exhibits to the Company's Form 8-K dated
March 11, 1994.
(4) Incorporated by reference from exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1993.
(5) Incorporated by reference from exhibits to the Company's Form 10-Q/A-1 for
the quarter ended September 30, 1993.
(6) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended September 30, 1994.
(7) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-77522) on Form S-1.
(8) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-77272) on Form S-4.
(9) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-77870) on Form S-1.
(10) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-82296) on Form S-1.
(11) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-85194) on Form S-1.
(12) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-90248) on Form S-1.
(13) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-96240) on Form S-3.
(14) Incorporated by reference from exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1994.
(15) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended March 31, 1995.
(16) Incorporated by reference to the Company's Form 8-K filed April 12, 1995.
(17) Incorporated by reference from exhibits to the Company's Form 8-A filed
June 6, 1995.
(18) Incorporated by reference from exhibits to the Company's Form 8-A/A-1 filed
August 17, 1995.
49
<PAGE>
(19) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended June 30, 1995.
(20) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended September 30, 1995.
(21) Incorporated by reference from exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1995.
50
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SUN HEALTHCARE GROUP, INC.
By /s/ ANDREW L. TURNER
------------------------------------
Andrew L. Turner
President and Chief Executive
Officer
Date: August 5, 1996
51
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of
Sun Healthcare Group, Inc:
We have audited the accompanying consolidated balance sheets of SUN
HEALTHCARE GROUP, INC. (a Delaware corporation) AND SUBSIDIARIES (Note 1) as of
December 31, 1995 and 1994, as restated (Note 2), and the related consolidated
statements of earnings (loss), stockholders' equity and cash flows for each of
the three years in the period ended December 31, 1995. 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 did not audit the financial statements of CareerStaff Unlimited,
Inc. ("CareerStaff") nor Golden Care, Inc. ("Golden Care"), companies acquired
during 1995 in transactions accounted for as poolings-of-interests, as discussed
in Notes 1 and 4. Such statements are included in the consolidated financial
statements of Sun Healthcare Group, Inc. and subsidiaries and reflect total
assets and net revenues constituting 1.94 and 10.40 percent, respectively in
1994, and net revenues constituting 17.04 percent in 1993 of the related
consolidated totals. These statements were audited by other auditors whose
reports have been furnished to us and our opinion, insofar as it relates to
amounts included for CareerStaff and Golden Care, is based solely upon the
reports of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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 and the reports of other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the reports of the other auditors,
the financial statements referred to above present fairly, in all material
respects, the financial position of Sun Healthcare Group, Inc. and subsidiaries
as of December 31, 1995 and 1994, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1995, in
conformity with generally accepted accounting principles.
Our audits and the audits of other auditors were made for the purpose of
forming an opinion on the basic financial statements taken as a whole. The
schedule listed in the index of financial statements is presented for purposes
of complying with the Securities and Exchange Commission's rules and is not 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, based on our audits and the reports of the other auditors,
fairly states in all material respects the financial data required to be set
fourth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Albuquerque, New Mexico
July 25, 1996
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
CareerStaff Unlimited, Inc.
We have audited the consolidated balance sheet of CareerStaff Unlimited,
Inc. and subsidiaries as of December 31, 1994 and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
two years in the period ended December 31, 1994 (not presented separately
herein). 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 CareerStaff
Unlimited, Inc. and subsidiaries at December 31, 1994, and the consolidated
results of their operations and their cash flows for each of the two years in
the period ended December 31, 1994, in conformity with generally accepted
accounting principles.
ERNST & YOUNG LLP
Houston, Texas
March 8, 1995,
except for Note 16, as to which
the date is March 30, 1995
F-2
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Golden Care, Inc.
We have audited the balance sheet of Golden Care, Inc. as of December 31,
1994, and the related statements of income, changes in stockholders' equity, and
cash flows for each of the two years in the period ended December 31, 1994.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Golden Care, Inc. as of
December 31, 1994, and the related statements of income, changes in
stockholders' equity, and cash flows for each of the two years in the period
ended December 31, 1994, in conformity with generally accepted accounting
principles.
COOPERS & LYBRAND L. L. P.
Indianapolis, Indiana
March 22, 1995
F-3
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1995 1994
------------- -------------
<S> <C> <C>
AS RESTATED
-------------
<CAPTION>
(IN THOUSANDS, EXCEPT SHARE
DATA)
<S> <C> <C>
Current assets:
Cash and cash equivalents......................................................... $ 23,102 $ 78,738
Restricted cash................................................................... 1,914 1,792
Accounts receivable, net of allowance for doubtful accounts of $11,035 and $9,508
in 1995 and 1994, respectively................................................... 236,797 160,705
Other receivables................................................................. 29,976 17,609
Prepaids and other assets......................................................... 18,300 13,422
Deferred tax asset................................................................ 27,098 17,863
------------- -------------
Total current assets............................................................ 337,187 290,129
------------- -------------
Property and equipment, net......................................................... 201,132 197,407
Restricted cash..................................................................... 8,132 19,836
Assets held for sale, net........................................................... -- 14,962
Goodwill, net....................................................................... 421,660 457,936
Other assets, net................................................................... 62,856 25,537
Deferred tax asset.................................................................. 8,902 48,416
------------- -------------
Total assets.................................................................... $ 1,039,869 $ 1,054,223
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt................................................. $ 10,417 $ 18,374
Accounts payable.................................................................. 33,000 18,172
Accrued compensation and benefits................................................. 23,742 31,626
Workers' compensation accrual..................................................... 6,339 2,517
Other accrued liabilities......................................................... 23,210 15,805
Accrued interest.................................................................. 3,332 6,485
------------- -------------
Total current liabilities....................................................... 100,040 92,979
------------- -------------
Long-term debt, net of current portion.............................................. 348,460 398,534
Other long-term liabilities......................................................... 17,052 9,442
------------- -------------
Total liabilities............................................................... 465,552 500,955
------------- -------------
Minority interest................................................................... 5,275 2,819
Commitments and contingencies
Stockholders' equity:
Preferred stock of $.01 par value, authorized 5,000,000 shares, none issued....... -- --
Common stock of $.01 par value, authorized 100,000,000 shares, 47,916,367 and
45,021,219 shares issued and outstanding at December 31, 1995 and 1994,
respectively..................................................................... 479 450
Additional paid-in capital........................................................ 568,054 521,614
Retained earnings................................................................. 777 28,165
Cumulative translation adjustment................................................. (268) 220
------------- -------------
Total stockholders' equity...................................................... 569,042 550,449
------------- -------------
Total liabilities and stockholders' equity...................................... $ 1,039,869 $ 1,054,223
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (LOSS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1995 1994 1993
------------- ------------- -------------
<S> <C> <C> <C>
AS RESTATED
----------------------------
<CAPTION>
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
Total net revenues................................................... $ 1,135,508 $ 673,354 $ 230,815
------------- ------------- -------------
Costs and expenses:
Operating.......................................................... 929,493 552,662 194,290
Corporate general and administrative............................... 51,468 31,633 10,675
Provision for losses on accounts receivable........................ 14,623 27,632 1,265
Depreciation and amortization...................................... 27,734 11,797 1,534
Interest, net...................................................... 21,829 10,548 341
Conversion expense................................................. 3,256 2,275 --
Merger expenses.................................................... 5,800 -- --
Strike costs....................................................... 4,006 -- --
Investigation and litigation costs................................. 5,505 -- --
Impairment loss.................................................... 59,000 -- --
------------- ------------- -------------
Total costs and expenses....................................... 1,122,714 636,547 208,105
------------- ------------- -------------
Earnings before income taxes and extraordinary loss.................. 12,794 36,807 22,710
Income taxes......................................................... 33,132 14,688 5,246
------------- ------------- -------------
Net earnings (loss) before extraordinary loss...................... (20,338) 22,119 17,464
Extraordinary loss from early extinguishment of debt, net of income
tax benefit of $2,372............................................... (3,413) -- --
------------- ------------- -------------
Net earnings (loss)................................................ $ (23,751) $ 22,119 $ 17,464
------------- ------------- -------------
------------- ------------- -------------
Pro forma data:
Historical earnings before income taxes and extraordinary loss..... $ 12,794 $ 36,807 $ 22,710
Pro forma income taxes............................................. 33,362 17,246 9,247
------------- ------------- -------------
Pro forma net earnings (loss) before extraordinary loss............ (20,568) 19,561 13,463
Extraordinary loss................................................. (3,413) -- --
------------- ------------- -------------
Pro forma net earnings (loss)...................................... $ (23,981) $ 19,561 $ 13,463
------------- ------------- -------------
------------- ------------- -------------
Pro forma net earnings (loss) per common and common equivalent share:
Pro forma net earnings (loss) before extraordinary loss.......... $ (0.43) $ 0.61 $ 0.72
Extraordinary loss............................................... (0.07) -- --
------------- ------------- -------------
Pro forma net earnings (loss).................................... $ (0.50) $ 0.61 $ 0.72
------------- ------------- -------------
------------- ------------- -------------
Pro forma weighted average number of common and common equivalent
shares outstanding.................................................. 47,418,700 31,829,904 18,607,681
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1995 1994 1993
------------ ------------ ----------
<S> <C> <C> <C>
AS RESTATED
--------------------------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss).................................................... $ (23,751) $ 22,119 $ 17,464
Adjustments to reconcile net earnings (loss) to net cash provided by
(used for) operating activities -
Extraordinary loss................................................... 5,785 -- --
Conversion expense................................................... 3,256 2,275 --
Depreciation and amortization........................................ 27,734 11,797 1,534
Provision for losses on accounts receivable.......................... 14,623 27,632 1,265
Impairment loss...................................................... 59,000 -- --
Other................................................................ (2,220) (908) 493
Accounts receivable.................................................. (90,887) (76,929) (25,707)
Other current assets................................................. 970 (4,521) (8,409)
Other current liabilities............................................ (6,334) (10,029) 6,879
Income taxes payable................................................. 18,610 (7,758) 3,352
------------ ------------ ----------
Net cash provided by (used for) operating activities............... 6,786 (36,322) (3,129)
------------ ------------ ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................................... (96,247) (37,862) (7,076)
Transfer of restricted cash............................................ -- 16,054 --
Acquisitions, net of cash acquired..................................... (25,417) (128,378) (7,584)
Purchase of minority interest in Ashbourne PLC......................... (25,874) -- --
Proceeds from operations and sale of assets held for sale.............. 36,878 (2,186) --
Proceeds from sale and leaseback of property and equipment............. 105,534 -- --
Other assets expenditures.............................................. (22,648) (3,507) (3,340)
------------ ------------ ----------
Net cash used for investing activities............................. (27,774) (155,879) (18,000)
------------ ------------ ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings.............................................. 185,299 145,055 11,065
Long-term debt repayments.............................................. (115,730) (88,163) (8,555)
Transfer of restricted cash............................................ -- 667 --
Repurchase of 11 3/4% Senior Subordinated Notes due 2002............... (89,370) -- --
Conversion of Mediplex 6 1/2% Convertible Subordinated Debentures due
2003.................................................................. (16,859) (10,681) --
Net proceeds from issuance of common stock............................. 2,976 216,608 46,838
Purchase and retirement of common stock................................ -- -- (8,020)
Other financing activities............................................. (1,429) -- --
Distribution of prior S corporation earnings........................... (333) (8,889) (5,271)
------------ ------------ ----------
Net cash provided by (used for) financing activities............... (35,446) 254,597 36,057
------------ ------------ ----------
Effect of exchange rate on cash and cash equivalents..................... 798 -- --
------------ ------------ ----------
Net increase (decrease) in cash and cash equivalents..................... (55,636) 62,396 14,928
------------ ------------ ----------
Cash and cash equivalents at beginning of year........................... 78,738 16,342 1,414
------------ ------------ ----------
Cash and cash equivalents at end of year................................. $ 23,102 $ 78,738 $ 16,342
------------ ------------ ----------
------------ ------------ ----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL CUMULATIVE
----------------------- PAID-IN RETAINED TRANSLATION
SHARES AMOUNT CAPITAL EARNINGS ADJUSTMENT TOTAL
---------- ----------- -------------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT SHARE DATA)
Balance at December 31, 1992............ 5,999,563 $ 79 $ 711 $ 7,442 -- $ 8,232
Increase in common stock outstanding in
connection with the formation of Sun
Healthcare Group, Inc., including
540,000 shares issued to the minority
stockholder of Sunrise................. 8,979,000 69 7,308 -- -- 7,377
Reclassification of retained earnings as
additional paid-in capital to reflect
the change in tax status of Turner and
Sundance............................... -- -- 7,927 (7,927) -- --
Common stock offerings.................. 5,750,423 58 46,780 -- -- 46,838
Common stock issued in connection with
the Honorcare acquisition.............. 590,909 6 6,494 -- -- 6,500
Repurchase and retirement of common
stock.................................. (540,000) (5) (8,015) -- -- (8,020)
Issuance of common stock for employee
benefits............................... 285,919 3 392 -- -- 395
Distribution of prior S corporation
earnings............................... -- -- (3,900) (4,525) -- (8,425)
Net earnings............................ -- -- -- 17,464 -- 17,464
---------- ----- -------------- ----------- ----------- ---------
Balance at December 31, 1993............ 21,065,814 210 57,697 12,454 -- 70,361
---------- ----- -------------- ----------- ----------- ---------
Distribution of prior S corporation
earnings............................... -- -- 218 (5,954) -- (5,736)
Reclassification of retained earnings as
additional paid-in capital to reflect
change in tax status of CareerStaff.... -- -- 454 (454) -- --
Common stock offerings.................. 10,662,020 107 205,402 -- -- 205,509
Common stock issued pursuant to the
Mediplex merger and related
transactions........................... 11,249,544 112 213,629 -- -- 213,741
Common stock issued in connection with
other acquisitions..................... 14,186 -- 150 -- -- 150
Additional consideration recorded for
the excess of the fair value over the
exercise price of the Mediplex stock
options assumed in connection with the
merger................................. -- -- 14,473 -- -- 14,473
Issuance of common stock for employee
benefits............................... 1,051,519 11 11,088 -- -- 11,099
Conversion of 6 1/2% Convertible
Subordinated Debentures due 2003....... 978,136 10 18,503 -- -- 18,513
Cumulative translation adjustment....... -- -- -- -- 220 220
Net earnings (as restated).............. -- -- -- 22,119 -- 22,119
---------- ----- -------------- ----------- ----------- ---------
Balance at December 31, 1994 (as
restated).............................. 45,021,219 450 521,614 28,165 220 550,449
---------- ----- -------------- ----------- ----------- ---------
Distribution of prior S corporation
earnings............................... -- -- -- (333) -- (333)
Reclassification of retained earnings as
additional paid-in capital to reflect
the change in tax status of Golden
Care, Inc.............................. -- -- 3,908 (3,908) -- --
Common stock issued in connection with
immaterial poolings.................... 690,296 7 174 604 -- 785
Common stock issued in connection with
other acquisitions..................... 338,768 3 8,231 -- -- 8,234
Additional consideration recorded for
the fair value of warrants issued in
connection with the Columbia
acquisition............................ -- -- 1,095 -- -- 1,095
Issuance of common stock for employee
benefits............................... 283,179 3 2,973 -- -- 2,976
Conversion of 6 1/2% Convertible
Subordinated Debentures due 2003....... 1,582,905 16 30,059 -- -- 30,075
Cumulative translation adjustment....... -- -- -- -- (488) (488)
Net loss (as restated).................. -- -- -- (23,751) -- (23,751)
---------- ----- -------------- ----------- ----------- ---------
Balance at December 31, 1995............ 47,916,367 $ 479 $ 568,054 $ 777 $ (268) $ 569,042
---------- ----- -------------- ----------- ----------- ---------
---------- ----- -------------- ----------- ----------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND NATURE OF PRESENTATION
Sun Healthcare Group, Inc. ("the Company" or "Sun") was formed on April 15,
1993, as a holding company to combine, under the control of a single
corporation, the operations of Sunrise Healthcare Corporation ("Sunrise"),
Turner Enterprises, Inc. ("Turner"), Sundance Rehabilitation Corporation
("Sundance"), and Sunscript Pharmacy Corporation ("Sunscript"), which were under
the majority control of a single stockholder. Effective January 1, 1994, Turner
was merged into Sunrise.
During 1993, the stockholders of the Company, except National Medical
Enterprises, Inc., ("NME") entered into an agreement (the "Preincorporation
Agreement") with the Company. The Preincorporation Agreement provided for the
transfer to the Company of the ownership of Sunrise, Turner, Sundance, and
Sunscript in exchange for common shares of the Company. A separate agreement was
entered into among the Company, Sunrise, Turner, Sundance, Sunscript and other
stockholders of these corporations and NME that provided for NME to exchange its
shares of common stock in Sunrise (the only one of these entities in which it
owned stock) for shares of the Company. A total of 9,000,000 common shares of
the Company with $.01 par value were issued in connection with these agreements
to replace the original 21,000 outstanding common shares. The exchange of the
original shares was recorded by the Company at historical book value. A total of
540,000 shares valued at $8,020,000 with a net book value of $643,000 were
repurchased from NME and accounted for at fair market value under the purchase
method of accounting whereby goodwill of $7,377,000 was recorded. In addition,
retained earnings of Turner and Sundance totaling $7,927,000 was reclassified to
additional paid-in capital in connection with the change to C corporation status
(see Notes 9 and 10).
On May 5, 1995, a subsidiary of the Company merged with Golden Care, Inc.
("Golden Care") and on June 21, 1995, a subsidiary of the Company merged with
CareerStaff Unlimited, Inc. ("CareerStaff"). Both transactions were accounted
for as pooling of interests; accordingly, the Company's consolidated financial
statements for all periods presented prior to the combination have been restated
to reflect the combined operations (see Note 4). Certain immaterial poolings
occurred in 1995 for which prior periods financial statements were not restated.
(2) RESTATEMENT OF FINANCIAL STATEMENTS
The Company has restated its financial statements for the years ended
December 31, 1995 and 1994. The restatement is a result of the Company's further
review and analysis of its fourth quarter of 1995 write-off of certain accounts
receivable acquired in its merger with Mediplex. Based on its review, the
Company has concluded that $23,446,000 of the Mediplex accounts receivable
written off in the fourth quarter of 1995 should have been recognized in the
fourth quarter of 1994 because such accounts receivable were impaired as of that
date or earlier and the fourth quarter of 1994 was the quarter in which the
purchase accounting for the Mediplex acquisition was finalized. Accordingly, the
1995 and 1994 financial statements have been restated to reflect the write-off
of $23,446,000 of
F-8
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) RESTATEMENT OF FINANCIAL STATEMENTS (CONTINUED)
accounts receivable, originally recorded in the fourth quarter of 1995, in the
fourth quarter of 1994. The impact of these adjustments on the Company's results
of operations as originally reported is as follows (in thousands):
<TABLE>
<CAPTION>
1995 1994
---------------------------- ------------------------
AS REPORTED AS RESTATED AS REPORTED AS RESTATED
------------- ------------- ----------- -----------
<S> <C> <C> <C> <C>
Total net revenues....................................... $ 1,135,508 $ 1,135,508 $ 673,354 $ 673,354
Earnings (loss) before pro forma income taxes and
extraordinary loss...................................... (10,652) 12,794 60,253 36,807
Pro forma earnings (loss) before extraordinary item...... (35,105) (20,568) 34,098 19,561
Pro forma net earnings (loss)............................ $ (38,518) $ (23,981) $ 34,098 $ 19,561
------------- ------------- ----------- -----------
------------- ------------- ----------- -----------
Pro forma net earnings (loss) per share:
Primary --
Before extraordinary loss............................ $ (0.74) $ (0.43) $ 1.07 $ 0.61
Extraordinary loss................................... (0.07) (0.07) -- --
------------- ------------- ----------- -----------
Net earnings......................................... $ (0.81) $ (0.50) $ 1.07 $ 0.61
------------- ------------- ----------- -----------
------------- ------------- ----------- -----------
Fully diluted --
Before extraordinary loss............................ $ (0.74) $ (0.43) $ 1.02 $ 0.61
Extraordinary loss................................... (0.07) (0.07) -- --
------------- ------------- ----------- -----------
Net earnings......................................... $ (0.81) $ (0.50) $ 1.02 $ 0.61
------------- ------------- ----------- -----------
------------- ------------- ----------- -----------
</TABLE>
(3) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES
(a) NATURE OF BUSINESS
The Company is a provider of long-term, subacute and related specialty
health care services including rehabilitation and respiratory therapy services
and pharmacy services through the Company's and through other nonaffiliated
long-term and subacute facilities located in the United States. The Company also
provides long-term care and pharmacy services in the United Kingdom and
outpatient rehabilitation therapy services in Canada.
(b) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its greater than 50% owned subsidiaries that the Company controls.
Investments in affiliates, which are included in other assets, in which the
Company owns 20% to 50% are carried on the equity method. Investments in
companies owned less than 20% are carried at cost. All significant intercompany
accounts and transactions have been eliminated in consolidation.
(c) CASH EQUIVALENTS
The Company considers all highly liquid, unrestricted investments with
original maturities of three months or less to be cash equivalents. Cash
equivalents are stated at cost.
(d) NET REVENUES
Net revenues consist of patient revenues, contract therapy services
revenues, temporary therapy staffing services revenues and institutional
pharmaceutical services revenues. Net revenues are recognized as services are
provided. Net patient revenues are recorded net of provisions for discount
arrangements with commercial payors and contractual allowances with third party
payors, primarily Medicare and Medicaid. Net revenues realizable under third
party payor agreements are subject to
F-9
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING
POLICIES (CONTINUED)
change due to examination and retroactive adjustment. Estimated third party
payor settlements are recorded in the period the related services are rendered.
Differences between the net amounts accrued and subsequent settlements are
recorded in operations at the time of settlement, of which the majority is
settled in two to three years.
The Company has submitted to the Health Care Financing Administration
("HCFA") various requests for exceptions to the Medicare established routine
cost limitations for reimbursement ("RCLs"). These exceptions are permitted
under the Medicare regulations to allow providers to treat higher acuity
patients. Included in net revenues are amounts related to exceptions to the RCLs
of $8,862,000 and $103,000 for the years ended December 31, 1995 and 1994,
respectively. These amounts are net of adjustments to record management's
estimate of amounts that will ultimately be approved by HCFA. Accounts
receivable include requests for exceptions to the RCLs, including accounts
receivable acquired in the merger with Mediplex, of $11,115,000 and $2,887,000
at December 31, 1995 and 1994, respectively. As of December 31, 1995, the
Company has submitted twenty-six exception requests and has received approval on
eleven exception requests. Amounts realizable are subject to final settlement of
the respective cost reports.
(e) ACCOUNTS RECEIVABLE
The Company receives payment for services rendered from Federal and state
governments under the Medicare and Medicaid programs and private pay payors,
including third party insurers, workers' compensation plans and healthcare
providers. The following table summarizes the percent of accounts receivable by
payor category as of December 31 as restated:
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
Government..................................................... 51% 57%
Private and other.............................................. 49 43
--- ---
100% 100%
--- ---
--- ---
</TABLE>
Management does not believe that there are any credit risks associated with
receivables from governmental agencies. Private and other receivables consist of
receivables from a large number of payors involved in diverse activities and
subject to differing economic conditions, which do not represent any
concentrated credit risks to the Company.
(f) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Major renewals or improvements
are capitalized, whereas ordinary maintenance and repairs are expensed as
incurred. Depreciation and amortization is computed using the straight-line
method over the estimated useful lives of the assets as follows: buildings and
improvements -- 5 to 40 years; leasehold improvements -- the shorter of the
estimated useful lives of the assets or the life of the lease; equipment -- 3 to
15 years.
The Company capitalizes certain costs associated with developing and
acquiring health care facilities and related outpatient programs. Capitalized
costs include direct incremental investigation, negotiation, development,
acquisition and preconstruction costs; indirect and general expenses related to
such activities are expensed as incurred. Preconstruction costs include the
direct costs of securing control of the development site, obtaining the
requisite certificate of need and other approvals, as well as the direct costs
of preparing for actual development and construction. The capitalized costs are
transferred to construction in progress and depreciable asset categories as
construction is begun and completed, respectively. The Company capitalizes
interest directly related to the development and construction of new facilities
as a cost of the related asset.
F-10
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING
POLICIES (CONTINUED)
(g) ASSETS HELD FOR SALE
Assets held for sale represent the assets of four psychiatric facilities,
four substance abuse treatment facilities, certain outpatient clinics and three
transitional living facilities acquired in connection with the Company's merger
with Mediplex which, excluding a closed substance abuse facility and a
transitional living facility, were sold during 1995 (see Notes 4 and 6).
(h) GOODWILL/IMPAIRMENT LOSS
The excess of the purchase price over the fair value of the net assets of
the businesses acquired by the Company is amortized using the straight-line
method over periods ranging from 20 to 40 years. Accumulated amortization of
such costs was $18,721,000, $6,291,000 and $437,000 as of December 31, 1995,
1994 and 1993, respectively.
The Company periodically evaluates the carrying value of goodwill along with
any other related long-lived assets in relation to the future undiscounted cash
flows of the underlying businesses to assess recoverability. The Company adopted
Statement of Financial Accounting Standards No. 121 (SFAS 121) "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
on December 31, 1995. Under SFAS 121, an impairment loss is recognized if the
sum of the expected long-term cash flows is less than the carrying amount of the
goodwill and other assets being evaluated. The difference between the carrying
amount of the goodwill and other assets being evaluated and the estimated fair
market value of the assets represents the impairment loss. The Company
determines fair value using certain multiples of earnings before interest,
taxes, depreciation and amortization based on current prices for comparable
assets. The impairment loss, as determined by SFAS 121, of $59,000,000 recorded
by the Company primarily relates to the goodwill associated with six of the
forty facilities acquired in the merger with Mediplex. The impairment loss at
these six facilities was the result of the following circumstances: (i) three
facilities were organized by the Service Employees International Union
subsequent to the acquisition resulting in significantly higher labor costs;
(ii) two facilities experienced significant declines in private pay census and
revenues due to, in one instance, funding reductions in certain programs
providing private pay patients and, in the other instance, the opening of two
new facilities by competitors; and (iii) the remaining facility received lower
than expected Medicaid rates from the State of Connecticut and due to the high
acuity of the patients treated at the facility, reimbursement was not adequate.
If the Company had not elected early adoption of SFAS 121, the impairment loss
would have been based solely on the difference between the assets carrying value
and cumulative long-term cash flows which would have resulted in a loss of
$48,900,000. The operations of the impaired facilities are not material to the
consolidated earnings or cash flows of the Company, and therefore, management
does not expect future operating results of the impaired facilities to have a
material adverse effect on the Company's results of operations or financial
condition. However, the impaired facilities are experiencing marginal or
negative cash flows. As they are leased under long-term operating leases, the
Company expects that this trend will continue until it can implement measures to
turn around their performance or to dispose of the facilities.
(i) OTHER ASSETS
Costs incurred in obtaining debt financing are amortized as interest expense
over the terms of the related indebtedness. The Company amortizes preopening
costs (start-up costs related to new facilities, specialty units within a
facility, new rehabilitation regions and pharmacies) over a period ranging from
one year (for costs not reimbursed by third party payors) to five years (for
costs reimbursed by third party payors, including the Medicare and Medicaid
programs).
F-11
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING
POLICIES (CONTINUED)
(j) WORKERS' COMPENSATION INSURANCE
Workers' compensation coverage is effected through self-insurance or
retrospective and high deductible insurance policies and other hybrid policies
which vary by the states in which the Company operates. Provisions for estimated
settlements are provided in the period of the related coverage. Differences
between the amounts accrued and subsequent settlements are recorded in
operations in the year of settlement.
(k) INCOME TAXES
Income tax expense (benefit) is based on reported earnings before income
taxes. Deferred income taxes reflect the impact of temporary differences between
the amount of assets and liabilities recognized for financial reporting purposes
and such amounts recognized for tax purposes.
Prior to converting to C corporations, Turner, Sundance, CareerStaff and
Golden Care had elected S corporation status whereby income taxes are paid by
the stockholders rather than by the entities. Accordingly, there is no provision
for income taxes in the financial statements for these entities to the extent
such income or loss was includable by the stockholders in their personal income
tax returns (see Note 10).
(l) FOREIGN CURRENCY TRANSLATION
The financial position and results of operations of the Company's foreign
subsidiaries are measured using local currency as the functional currency.
Assets and liabilities of these subsidiaries are translated at the exchange rate
in effect at each year end. Income statement accounts are translated at the
average rate of exchange prevailing during the year. Translation adjustments
arising from differences in exchange rates from period to period are included in
the accumulated foreign currency translation adjustment account in stockholders'
equity.
(m) STRIKE AND INVESTIGATION AND LITIGATION COSTS
During the fourth quarter of 1995, the Company recorded charges and expenses
of $4,006,000 related to averting a strike and negotiating new contracts for
certain unionized nursing homes in Connecticut. The Company also recorded
charges and expenses of $5,505,000 related to monitoring and responding to the
continuing investigation by the U.S. Department of Health and Human Services'
Office of the Inspector General ("OIG") and legal fees resulting from
shareholder litigation (see Note 16). The litigation charge also includes costs
incurred by the Company in its intended debt offering which was aborted due to
the negative publicity resulting from the OIG investigation. The negative
publicity prevented the Company from obtaining an acceptable interest rate.
(n) FINANCIAL STATEMENT PREPARATION AND PRESENTATION
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, the
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.
Certain amounts in the 1994 and 1993 consolidated financial statements and
notes have been reclassified to conform to the 1995 presentation.
(4) ACQUISITIONS
On June 21, 1995, a wholly-owned subsidiary of the Company merged with and
into CareerStaff. CareerStaff provides temporary staffing of physical,
occupational, and speech therapists to the health care industry. Under the terms
of the merger agreement, the Company issued 6,080,600 shares of its
F-12
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) ACQUISITIONS (CONTINUED)
common stock in exchange for all the outstanding common stock of CareerStaff.
The merger was accounted for as a pooling of interests, and accordingly, the
Company's financial statements have been restated to include the accounts and
operations of CareerStaff for periods prior to the merger.
On May 5, 1995, a wholly-owned subsidiary of the Company merged with and
into Golden Care. Golden Care provides respiratory therapy services to long-term
and subacute care facilities. Under the terms of the merger agreement, the
Company issued 2,106,904 shares of its common stock in exchange for all of the
outstanding common stock of Golden Care. In connection with the merger, Golden
Care terminated its S corporation status and recorded a deferred income tax
provision of $1,487,000. The merger was accounted for as a pooling of interests,
and accordingly, the Company's financial statements have been restated to
include the accounts and operations of Golden Care for periods prior to the
merger.
In connection with the mergers of the Company with CareerStaff and Golden
Care, the Company recognized $5,800,000 of merger costs. These costs include
transaction costs and advisory fees and transitional costs related to
consolidating operations.
Separate results of the combining entities for periods prior to combination
are as follows, except as described in Note (1) (in thousands):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------
1995 (1) 1994 1993
------------- ----------- -----------
<S> <C> <C> <C>
AS RESTATED
--------------------------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C>
Net Revenues:
Sun.......................................................... $ 1,086,985 $ 603,337 $ 191,495
CareerStaff.................................................. 45,116 55,258 27,180
Golden Care.................................................. 4,022 14,759 12,140
Less: Intercompany revenues.................................. (615) -- --
------------- ----------- -----------
$ 1,135,508 $ 673,354 $ 230,815
------------- ----------- -----------
------------- ----------- -----------
Net Earnings (Loss):
Sun.......................................................... $ (26,644) $ 13,859 $ 10,428
CareerStaff.................................................. 2,319 3,881 1,065
Golden Care.................................................. 574 4,379 5,971
------------- ----------- -----------
$ (23,751) $ 22,119 $ 17,464
------------- ----------- -----------
------------- ----------- -----------
Pro Forma Net Earnings (Loss) (see Note 9):
Sun.......................................................... $ (26,644) $ 13,859 $ 9,168
CareerStaff.................................................. 2,319 3,094 659
Golden Care.................................................. 344 2,608 3,636
------------- ----------- -----------
$ (23,981) $ 19,561 $ 13,463
------------- ----------- -----------
------------- ----------- -----------
</TABLE>
- ------------------------
(1) Sun results for the twelve months ended December 31, 1995 include the
results of CareerStaff and Golden Care and the elimination of the
intercompany revenues for the period following the consummation of each of
the mergers.
F-13
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) ACQUISITIONS (CONTINUED)
In May and June of 1995, the Company acquired a total minority interest of
20% in Ashbourne PLC, an operator of nursing homes in the United Kingdom, for
$25,874,000. On the date of acquisition, the Company's investment exceeded the
underlying equity in net assets by approximately $13,700,000.
On November 30, 1995, the Company acquired 75% of the common stock of
Columbia Health Care, Inc. ("Columbia") stock for $8,500,000. The Company has
agreed to purchase the remaining shares in three to five years based on a
multiple of Columbia's earnings. In addition, the Company issued warrants to
purchase 500,000 shares of the Company's common stock with an exercise price of
$15.375 per share to former owners of Columbia which had a value of $1,095,000
at the date of acquisition. As of December 31, 1995, the warrants were
exercisable and expire in approximately four years. The Columbia acquisition was
accounted for as a purchase. The effects of the Ashbourne PLC and the Columbia
acquisitions, individually and in the aggregate, are immaterial to the results
of the Company, and therefore pro forma information is not provided.
On June 23, 1994, the Company, through a wholly-owned subsidiary, acquired
by merger all of the outstanding capital stock of Mediplex, which as of June 23,
1994 provided long-term and subacute health care services to patients through 36
inpatient facilities, six ambulatory surgery centers and related outpatient
programs. Pursuant to the merger, the Company issued 11,249,544 shares of the
Company's common stock and paid approximately $106,482,000 in cash to the
stockholders of Mediplex. The merger was accounted for as a purchase and
accordingly, the results of Mediplex's operations have been included in the
Company's consolidated financial statements from the date of acquisition. The
fair market value of assets acquired, including goodwill of $426,542,000, was
$761,548,000 and liabilities assumed totaled $397,560,000.
Concurrent with the execution of the Mediplex merger agreement between the
Company and Mediplex, the Company entered into a restructuring agreement (the
"Meditrust Restructuring") with Meditrust, a health care real estate investment
trust that is Mediplex's principal landlord and lender, to obtain the consent of
Meditrust to the Mediplex merger as required under the terms of the existing
leases and mortgages between Mediplex and Meditrust. Pursuant to the Meditrust
Restructuring, the Company entered into a guaranty agreement relating to all
leases and loans with Meditrust, restructured the terms of all existing leases
and entered into new leases for certain facilities, restructured certain
Mediplex debt arrangements, purchased three facilities for $115,000,000 of which
$41,000,000 was paid in cash and $74,000,000 was financed through mortgages,
received $11,000,000 pursuant to a mortgage entered into on a rehabilitation
hospital and received $41,570,000 through four sale leaseback transactions.
Also, concurrent with the Mediplex merger, certain Mediplex assets were sold to
and certain Mediplex liabilities were assumed by the former Chairman of the
Board, Chief Executive Officer and principal stockholder of Mediplex. The
consideration received by the Company for these assets was $23,486,000 in cash
and 1,137,683 shares of the Company's common stock. These related transactions
were included in the purchase accounting for the Mediplex merger.
As a result of the Mediplex merger, the Company acquired four psychiatric
facilities, four substance abuse treatment facilities, certain outpatient
clinics and three transitional living facilities, including three former
substance abuse or psychiatric care facilities which had been closed by Mediplex
in 1992 and 1993 (See Note 6). In recent years, these facilities have
experienced declines in revenues and occupancy rates. In addition, certain of
these facilities are not in geographic areas consistent with the Company's
regional management structure. In view of the operating trends and the Company's
desire to focus on its primary lines of business, management decided to dispose
of these facilities and units and developed a plan of disposition, which was
approved by the Board of Directors in the third quarter of 1994. Accordingly, in
connection with the Mediplex merger, these assets were
F-14
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) ACQUISITIONS (CONTINUED)
recorded at their estimated net realizable value and additional goodwill of
approximately $16,000,000 has been recorded to provide for the estimated costs
related to the disposal and operating results during the holding period.
On September 2, 1994, the Company, through its wholly owned subsidiary, Sun
Healthcare Group International Ltd. ("SHGI"), acquired for approximately
$12,400,000, a 68% interest in Exceler Health Care Group PLC ("Exceler"), an
English corporation that at December 31, 1995 operated 28 nursing homes with
1,437 registered beds throughout the United Kingdom. Simultaneously, Exceler
acquired all of the outstanding shares of Forest Health Care Limited ("Forest")
for approximately $7,100,000. The acquisition was accounted for by the purchase
method of accounting. The sellers of Forest received an additional $2,400,000
during 1995 as required under the terms of the purchase agreement. In February
1995, the Company purchased the remaining 32% interest in Exceler for
approximately $4,700,000 in cash and deferred purchase payments if certain
earnings targets for Exceler are achieved, of which $474,000 was paid in 1995,
and up to L700,000 ($1,085,000 as of December 31, 1995) is payable on September
30, 1996. Amounts paid pursuant to the terms of the purchase agreement will be
recorded as additional costs in excess of the net assets of the acquired
companies.
In July 1993, the Company acquired Honorcare, which at the date of
acquisition, operated 14 long-term care facilities. The purchase consideration
was payable in $6,500,000 cash and 590,909 shares of common stock of the Company
valued at $6,500,000. This acquisition was accounted for under the purchase
method of accounting and resulted in goodwill of $13,000,000. Seven of these
long-term care facilities were operated under management agreements which the
Company converted to operating leases after the acquisition during 1993 and
1994, for consideration of a $672,000 note payable from the Company and the
Company's assumption of assets and liabilities of certain of these facilities.
The following unaudited pro forma condensed consolidated statements of
earnings present the summarized consolidated results of operations of the
Company after giving effect to the acquisition of Mediplex for the year ended
December 31, 1994, as if such acquisition had been consummated on January 1,
1994 as restated (in thousands, except per share data):
<TABLE>
<S> <C>
Total net revenues....................................................... $ 846,500
Total costs and expenses................................................. 801,165
---------
Earnings before income taxes............................................. 45,335
Pro forma income taxes................................................... 21,397
---------
Pro forma net earnings................................................... $ 23,938
---------
---------
Pro forma net earnings per common and common equivalent share............ $ .60
---------
---------
</TABLE>
The pro forma results are presented for informational purposes only and are
not necessarily indicative of what results of operations actually would have
been had such acquisitions been consummated at the beginning of such period or
of future operations or results. The effects of the other acquisitions are
immaterial.
F-15
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1995 1994
----------- -----------
<S> <C> <C>
Land.......................................................................... $ 12,358 $ 14,042
Buildings and improvements.................................................... 79,868 93,021
Leasehold improvements........................................................ 33,433 14,395
Equipment..................................................................... 55,031 35,678
Construction in progress...................................................... 37,353 47,116
----------- -----------
Total..................................................................... 218,043 204,252
Less accumulated depreciation and amortization................................ (16,911) (6,845)
----------- -----------
Total property and equipment, net......................................... $ 201,132 $ 197,407
----------- -----------
----------- -----------
</TABLE>
On September 30, 1995, under five sale and leaseback agreements, the Company
sold five of its long-term and subacute care facilities for $69,988,000 and
leased them back under ten year leases. Also in 1995, under sale and leaseback
agreements, the Company, through its United Kingdom subsidiary, sold fifteen of
its long-term care facilities for $35,546,000 and leased them back under a
twelve year lease. These transactions produced no material gain or loss.
(6) ASSETS HELD FOR SALE
As discussed in Notes 2 and 3, as a result of the Mediplex merger, the
Company acquired certain facilities providing psychiatric, substance abuse and
transitional living services. On September 30, 1995, the Company completed the
sale of five of the operating psychiatric care and substance abuse treatment
facilities and all of the related outpatient facilities for a sales price of
$39,900,000 consisting of cash and the assumption of indebtedness secured by one
of the facilities. As part of the sale, the Company provided a five-year
$12,500,000 working capital line of credit to the buyer, which is secured by the
accounts receivable of the facilities sold and is restricted to a borrowing base
determined by the amount of accounts receivable of the facilities. Under the
terms of the working capital line of credit, principal is due in full on
September 30, 2000 and interest accrues at either LIBOR plus 2.5% or Prime plus
1.5%. As of December 31, 1995, $12,500,000 had been advanced on the working
capital line of credit. The Company also subleased two other operating
transitional living facilities and sold the working capital of these facilities
to the current administrator of one of these facilities, who has assumed
responsibility for approximately 60% of the Company's obligations under the
present leases and will pay the Company a total of $13,400,000 over the term of
such leases. On May 17, 1995 and August 2, 1995, the Company completed the sale
of two of the closed facilities for $2,000,000 and $2,500,000, respectively. As
a result of the terms of the sales, the Company has retained net liabilities
totaling approximately $10,200,000 and long-term liabilities of approximately
$8,600,000 which, as of December 31, 1995, have been reclassified from Assets
Held for Sale, net to the natural classifications on the balance sheet. As of
December 31, 1995, the Company continues to lease a transitional living facility
which will be purchased and then sold in 1996, and the Company owns an interest
in a substance abuse facility which was closed in 1992.
F-16
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) ASSETS HELD FOR SALE (CONTINUED)
The results of operations of these facilities including the gain on the sale
of certain facilities, were as follows (in thousands):
<TABLE>
<CAPTION>
PERIOD JUNE 24,
YEAR ENDED 1994 THROUGH
DECEMBER 31, 1995 DECEMBER 31, 1994
----------------- -------------------
<S> <C> <C>
Net revenues.................................................... $ 63,236 $ 38,281
-------- --------
-------- --------
Loss from operations before income taxes........................ 3,527 1,936
Income tax benefit.............................................. 1,425 762
-------- --------
Loss from assets held for sale.................................. $ 2,102 $ 1,174
-------- --------
-------- --------
</TABLE>
(7) LONG-TERM DEBT
Long-term debt consists of the following (dollars in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1995 1994
----------- -----------
<S> <C> <C>
Revolving Line of Credit (see below).................................................... $ 177,600 $ --
Convertible Subordinated Debentures due 2004, interest at 6% per annum.................. 83,300 83,300
Convertible Subordinated Debentures due 2003, interest at 6 1/2% per annum, includes
unamortized premium of $3,142 and $10,793 as of December 31, 1995 and 1994,
respectively........................................................................... 25,566 72,666
Senior Subordinated Notes due 2002, interest at 11 3/4% per annum, includes unamortized
premium of $131 and $5,353 as of December 31, 1995 and 1994, respectively.............. 6,292 90,333
Mortgage notes payable due at various dates through 2005, interest at rates from 10.5%
to 14.0%, collateralized by various facilities......................................... 35,375 113,332
Mortgage notes payable due in pound sterling and at various dates through 2017, interest
at 2.5% to 4% plus the FHBR rate ("Finance House Base Rate"), collateralized by various
facilities in the United Kingdom....................................................... 10,332 19,908
Industrial Revenue Bonds due 2015, interest rate at 5.5% as of December 31, 1994,
collateralized by a psychiatric hospital............................................... -- 8,920
Industrial Revenue Bonds due 2016, interest rate at 10.25% as of December 31, 1995,
collateralized by a rehabilitation hospital............................................ 4,060 4,165
Notes payable to a bank due 1996, payable in pound sterling with interest at a rate of
3% plus the FHBR rate, collateralized by the assets of various facilities.............. 4,582 11,153
Notes payable to a bank due 1998, interest at prime rate less .25%, collateralized by
the assets of the ambulatory surgery centers........................................... 5,096 6,741
Obligations under capital lease agreements, imputed interest at rates ranging from 5.4%
to 11.5%; due through 1999, collateralized by leased equipment......................... 2,937 2,104
Other long-term debt.................................................................... 3,737 4,286
----------- -----------
Total long-term debt.................................................................... 358,877 416,908
Less current portion.................................................................... (10,417) (18,374)
----------- -----------
Long-term debt, net of current portion.................................................. $ 348,460 $ 398,534
----------- -----------
----------- -----------
</TABLE>
F-17
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) LONG-TERM DEBT (CONTINUED)
Annual maturities for the next five years at December 31, 1995, are as
follows (in thousands):
<TABLE>
<S> <C>
1996..................................................... $ 10,417
1997..................................................... 7,915
1998..................................................... 5,200
1999..................................................... 1,747
2000..................................................... 179,219
Thereafter............................................... 154,379
---------
$ 358,877
---------
---------
</TABLE>
In July 1995, the Company entered into a Third Amended and Restated Credit
Agreement (the "Credit Facility") with NationsBank of Texas, N.A. as
administrative lender. The Credit Facility provides up to $315,000,000 in a
revolving line of credit and letters of credit. The Credit Facility expires on
July 21, 2000 and is collateralized by a pledge of all stock of the Company's
subsidiaries. Borrowings bear interest at either the prevailing prime rate or
the LIBOR rate plus 0.5% to 1.5% depending on the Company's consolidated debt to
cash flow ratio. The Credit Facility, among other things, (i) requires the
Company to maintain certain financial ratios, (ii) restricts the Company's
ability to incur debt and liens, make investments, liquidate or dispose of
assets, merge with another corporation, create or acquire subsidiaries, and make
acquisitions, and (iii) restricts the payment of dividends, the acquisition of
treasury stock and the prepayment or modification of certain debt of the
Company. Because of the temporary use of the proceeds from the Company's public
offering of its common stock in December 1994 to reduce borrowings pending
completion of the tender offer, there were no outstanding borrowings under the
former Credit Facility as of December 31, 1994. The Company had $177,600,000 of
outstanding borrowings and $22,165,000 of outstanding standby letters of credit
under the Credit Facility at December 31, 1995.
On March 1, 1994, the Company issued $83,300,000 aggregate principal amount
of 6% Convertible Subordinated Debentures due 2004 (the "6% Debentures") which
are convertible into shares of the Company's common stock at a conversion price
of $21.84 per share, subject to adjustment under certain conditions. The Company
received net proceeds of approximately $80,600,000 from the offering. Part of
the net proceeds was used to pay a portion of the cash consideration of the
Mediplex merger. The 6% Debentures are redeemable by the Company at par, in
whole or in part, after March 1, 1997.
Holders of the 6 1/2% Convertible Subordinated Debentures due 2003 (the
"6 1/2% Debentures") are entitled under the indenture to receive the Mediplex
merger consideration in respect of each share of Mediplex common stock into
which the 6 1/2% Debentures would have been convertible at the time of the
Mediplex merger. The Company has agreed to be a co-obligor of the 6 1/2%
Debentures. In January 1995, $39,449,000 of the 6 1/2% Debentures were
converted. Pursuant to the conversion terms under the indenture, the Company
paid $13,603,000 and issued 1,582,905 shares of the Company's common stock to
the converting holder. In addition, the Company paid accrued interest plus a
conversion fee of $3,256,000 to the converting holder, which was expensed in the
first quarter of 1995, to induce conversion. In August 1994, $24,377,000 of the
6 1/2% Debentures were converted into 978,136 shares of the Company's common
stock. Pursuant to the conversion terms under the indentures, the Company paid
$8,406,000 to the converting holder. In addition, the Company paid accrued
interest plus a conversion fee of $2,275,000 to the converting holder to induce
conversion, which was expensed in the third quarter of 1994. Conversion of the
remaining $22,424,000 of outstanding 6 1/2%
F-18
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) LONG-TERM DEBT (CONTINUED)
Debentures would require the issuance of an additional 899,771 shares of the
Company's common stock and a payment of $7,732,000 in cash pursuant to the
conversion terms under the indenture relating to the 6 1/2% Debentures.
In January 1995, the Company completed a tender offer for $78,698,000 of the
11 3/4% Senior Subordinated Notes due 2002 (the "11 3/4% Notes") at a price of
$1,120 per $1,000 of principal amount of the notes. The Company recorded an
extraordinary loss, net of related tax benefits, of $3,413,000 as a result of
the extinguishment of such debt. Concurrent with the tender offer, the Company
deleted by amendment certain covenants contained in the original indenture that
restricted the Company from fully integrating Mediplex into its operations. In
addition, the amendments modified certain provisions relating to mergers and
consolidations and events of default. In conjunction with the amendments, the
Company became a co-obligor on the 11 3/4% Notes.
The Company has $33,135,000 of mortgages with Meditrust as of December 31,
1995, which contain less restrictive covenants than in the Credit Facility and
which include cross default provisions with all of such mortgages and leases
also financed by Meditrust. The Company also is the obligor on an outstanding
letter of credit with a bank of $4,028,000 as of December 31, 1995 to guarantee
outstanding debt obligations of $3,955,000 as of December 31, 1995 for a
partnership through which the Company acquired a 50% interest. The partnership
owns a long-term care facility which is leased to a third party operator.
In connection with the Mediplex merger, the Company acquired, through
Mediplex, an interest rate hedge swap agreement with a commercial bank, having a
total notional principal amount of $100,000,000 and expiring in 1999. This
agreement called for the payment of variable rate interest by the Company in
return for the assumption by the other contracting party of a fixed rate cost.
For the period beginning June 23, 1994 and ending June 30, 1995, the Company
received a fixed rate of interest of 6.60% and paid interest at the 90 day LIBOR
rate (5.0% for the three months ended October 14, 1994, 5.625% for the three
months ended January 17, 1995, and 6.25% for the three months ended April 12,
1995 and for the period ended June 30, 1995). The Company terminated the
transaction on June 30, 1995 and received cash proceeds of $1,680,000 in
connection with such termination. The resulting gain is being amortized over the
original hedge period as an adjustment to interest expense.
(8) COMMITMENTS AND CONTINGENCIES
(a) LEASE COMMITMENTS
The Company has various non-cancelable operating leases for facilities with
initial lease terms generally ranging from 6 to 20 years and renewal options of
5 to 40 years. Certain of the lease agreements provide for payment escalations
coincident with increases in certain economic indices.
Future minimum lease payments under non-cancelable operating leases at
December 31, 1995, are as follows (in thousands):
<TABLE>
<S> <C>
1996..................................................... $ 75,039
1997..................................................... 76,432
1998..................................................... 76,331
1999..................................................... 77,252
2000..................................................... 77,798
Thereafter............................................... 414,587
---------
$ 797,439
---------
---------
</TABLE>
F-19
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) COMMITMENTS AND CONTINGENCIES (CONTINUED)
Several leases contain contingent rental provisions based on operating
results. Rent expense totaled $73,727,000, $43,626,000 and $15,578,000 in 1995,
1994 and 1993, respectively, including contingent rentals of approximately
$182,000, $254,000 and $101,000 during 1995, 1994 and 1993, respectively.
The Company leases or subleases 52 facilities from affiliates of two
directors of the Company as of December 31, 1995, which is included in the
information above. The aggregate lease expense for these facilities was
approximately $13,800,000, $12,800,000 and $8,300,000 in 1995, 1994 and 1993,
respectively. Future minimum lease commitments related to these facilities total
approximately $137,600,000 at December 31, 1995. The Company's management
believes the terms of all of the foregoing leases are as favorable to the
Company as those that could have been obtained from nonrelated parties.
(b) CONSTRUCTION COMMITMENTS
The Company has capital expenditure commitments, as of December 31, 1995,
under various contracts, including approximately $18,500,000 of contracts in the
United States and L14,700,000 ($22,700,000 as of December 31, 1995) of contracts
in the United Kingdom, including the construction and completion of one and ten
new long-term and subacute care facilities in the United States and United
Kingdom, respectively. The $8,132,000 classified as long-term restricted cash as
of December 31, 1995, has been set aside to fund the completion of a portion of
these projects.
(c) LITIGATION
The Company is a party to various legal actions and administrative
proceedings and subject to various claims arising in the ordinary course of
business. The Company does not believe that the ultimate disposition of these
matters will have a material adverse effect on the financial position or results
of operations of the Company (see Notes 3 and 16).
(9) INCOME TAXES
Income tax expense (benefit) on earnings (loss) before extraordinary loss
consists of the following (in thousands):
<TABLE>
<CAPTION>
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
AS RESTATED
--------------------
Current:
Federal............................................................. $ (212) $ 16,829 $ 1,916
State............................................................... (102) 3,362 632
--------- --------- ---------
(314) 20,191 2,548
--------- --------- ---------
Deferred:
Federal............................................................. 27,744 (4,894) 2,368
State............................................................... 5,702 (609) 330
--------- --------- ---------
33,446 (5,503) 2,698
--------- --------- ---------
Total............................................................. $ 33,132 $ 14,688 $ 5,246
--------- --------- ---------
--------- --------- ---------
</TABLE>
Foreign income taxes were immaterial.
F-20
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) INCOME TAXES (CONTINUED)
Actual tax expense (benefit) differs from the "expected" tax expense
(benefit) on earnings (loss) before extraordinary loss, computed by applying the
U.S. Federal corporate income tax rate of 35% in 1995 and 1994, and 34% in 1993,
to pretax net earnings (loss) of the Company as follows (in thousands):
<TABLE>
<CAPTION>
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
AS RESTATED
--------------------
Computed "expected" tax expense (benefit)............................ $ 4,478 $ 12,882 $ 7,721
Adjustments in income taxes resulting from:
Amortization of goodwill........................................... 3,235 1,492 --
Impairment loss.................................................... 15,452 -- --
Increase in valuation allowance.................................... 3,038 -- --
Conversion fee..................................................... 1,139 796 --
Merger expenses.................................................... 1,199 -- --
S corporation earnings not taxable to the Company (at Federal
rates)............................................................ (230) (2,251) (3,863)
State income tax expense, net of Federal income tax benefit........ 3,332 1,730 635
Recognition of deferred income taxes for former S corporations..... 1,487 -- 638
Other.............................................................. 2 39 115
--------- --------- ---------
$ 33,132 $ 14,688 $ 5,246
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-21
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) INCOME TAXES (CONTINUED)
Deferred tax assets (liabilities) were comprised of the following (in
thousands):
<TABLE>
<CAPTION>
1995 1994
---------- -----------
<S> <C> <C>
AS RESTATED
-----------
Deferred tax assets:
Provision for losses on accounts receivable........................................ $ 14,851 $ 13,977
Accrued liabilities................................................................ 8,788 6,975
Property and equipment............................................................. 10,650 27,064
Intangible assets.................................................................. 8,190 20,105
Carryforward of deductions limited by Internal Revenue Code Section 382............ 6,380 6,250
Long-term debt premium............................................................. 51 2,085
Write-down of assets held for sale and reserve for estimated costs of disposal and
future operating losses........................................................... 7,989 14,511
Deferred income.................................................................... 2,771 --
Alternative minimum tax credit..................................................... 899 --
Other.............................................................................. 212 --
---------- -----------
Total gross deferred tax asset..................................................... 60,781 90,967
Less valuation allowance:
Federal........................................................................ (18,526) (16,006)
State.......................................................................... (2,512) (1,994)
---------- -----------
Total valuation allowance........................................................ (21,038) (18,000)
Deferred tax asset................................................................... 39,743 72,967
---------- -----------
Deferred tax liabilities:
Golden Care change in its method of accounting for income taxes from cash to
accrual basis..................................................................... (1,109) --
Revenues related to third party settlements........................................ -- (2,326)
Property and equipment attributable to United Kingdom operations................... (2,634) (4,362)
---------- -----------
Total gross deferred tax liability................................................... (3,743) (6,688)
---------- -----------
Deferred tax asset, net.............................................................. $ 36,000 $ 66,279
---------- -----------
---------- -----------
</TABLE>
$18,000,000 of the valuation allowance was recorded in connection with
deferred tax assets acquired in the Mediplex merger. Accordingly, any tax
benefits recognized in future periods attributable to this portion of the
valuation allowance will be allocated to reduce goodwill. The $3,038,000
increase in the valuation allowance relates to uncertainties in the realization
of tax deductible intangibles included in the impairment loss (see Note 3(H)).
Sundance entered into an agreement with its majority stockholder effective
May 5, 1993, whereby Sundance agreed to change its method of accounting for
income tax purposes from the cash basis to the accrual basis pending approval by
the Internal Revenue Service (IRS). In connection therewith, Sundance approved
future distributions to the majority stockholder out of its prior accumulated S
corporation earnings in an amount sufficient to cover certain of his tax
obligations, which the Company estimated would be approximately $3,900,000 and
which was charged to additional paid-in capital in 1993. In 1994, the Company
determined that the obligation under this agreement was $3,682,000 and the
difference of $218,000 was included as an adjustment to additional paid-in
capital in 1994. Such distributions totaled $2,936,000 and $746,000 during 1994
and 1993, respectively.
F-22
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) INCOME TAXES (CONTINUED)
Upon merging with the Company on May 5, 1995, Golden Care terminated its S
Corporation status for Federal and state income tax purposes. In connection with
this termination, the Company recorded a deferred income tax provision and
liability of $1,487,000.
(10) PRO FORMA INCOME TAXES -- (UNAUDITED)
For financial reporting purposes, a pro forma provision for income taxes has
been reflected in the consolidated statements of earnings to present taxes on
the results of operations of Turner and Sundance for the period from January 1,
1993 to April 15, 1993, CareerStaff for the period from January 1, 1994 through
June 22, 1994 and the year ended December 31, 1993, and Golden Care for the
period January 1, 1995 through May 5, 1995 and for the years ended December 31,
1994 and 1993 on the basis that is required upon their change in tax status from
S corporation to C corporation. These amounts ($230,000, $2,558,000 and
$4,001,000 in 1995, 1994 and 1993, respectively) are equal to the required
Federal and state income tax provisions that would have been recorded if these
entities had not elected S corporation status and were subject to and liable for
Federal and state income taxes as C corporations prior to each of the companies'
termination of their S corporation status. CareerStaff terminated its S
corporation status for Federal and state income tax purposes on June 22, 1994.
Golden Care terminated its S corporation status upon merging with the Company on
May 5, 1995. In connection with Golden Care's termination of its S Corporation
status, the Company recorded a deferred income tax provision and liability of
$1,487,000 in the second quarter of 1995. The Company distributed a total of
$333,000, $8,889,000 and $5,271,000 in 1995, 1994 and 1993, respectively, of
prior S corporation earnings to stockholders for certain of these tax
obligations.
(11) SUPPLEMENTARY INFORMATION RELATING TO STATEMENTS OF CASH FLOWS
Supplementary information for the consolidated statements of cash flows is
set forth below (in thousands):
<TABLE>
<CAPTION>
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Cash paid during the period for:
Interest, net of $2,839, $3,705 and $38 capitalized in 1995, 1994
and 1993, respectively............................................. $ 26,951 $ 10,942 $ 516
Income taxes........................................................ 12,150 22,446 1,894
</TABLE>
Supplemental schedule of non-cash investing activities:
The Company's acquisitions during 1995, the Company's merger with
Mediplex on June 23, 1994, the related transactions and other acquisitions
during 1994 and the Company's acquisition of Honorcare during 1993 and other
related transactions and acquisitions involved the following (in thousands):
<TABLE>
<CAPTION>
1995 1994 1993
--------- ------------ ---------
<S> <C> <C> <C>
Fair value of assets acquired...................................... $ 43,825 $ 785,694 $ 14,084
Liabilities assumed................................................ (9,079) (443,575) --
Fair value of stock issued (Note 3)................................ (9,329) (213,741) (6,500)
--------- ------------ ---------
Cash payments made, net of cash received from others............... $ 25,417 $ 128,378 $ 7,584
--------- ------------ ---------
--------- ------------ ---------
</TABLE>
In January 1995, the Company issued 1,582,905 shares of its common stock
upon the conversion of $39,449,000 principal amount of 6 1/2% Debentures and in
August 1994, the Company issued 978,136 shares of its common stock upon the
conversion of $24,377,000 principal amount of 6 1/2% Debentures (see Note 7).
F-23
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments at December
31, 1995 and 1994 are as follows (in thousands):
<TABLE>
<CAPTION>
1995 1994
-------------------------- --------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Cash and cash equivalents....................... $ 23,102 $ 23,102 $ 78,738 $ 78,738
Long-term debt, including current portion....... (358,877) (352,843) (416,908) (465,830)
Interest rate swap and cap agreements........... -- -- (808) (3,180)
</TABLE>
The cash and cash equivalents carrying amount approximates fair value
because of the short maturity of these instruments. The fair value of the
Company's long-term debt was 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. The fair value of the interest rate swap and
cap agreements are the estimated amounts that the Company would receive or pay
to terminate the swap agreements, taking into account current interest rates.
The interest rate swap and cap agreements were terminated on June 30, 1995 (see
Note 7).
(13) CAPITAL STOCK
(a) SALE OF COMMON SHARES -- SUN
In connection with the Company's merger with Mediplex, the Company issued
4,472,420 shares of its common stock in a public offering resulting in net
proceeds of $83,605,000. In December 1994, the Company completed a public stock
offering of 5,365,000 shares of its common stock resulting in net proceeds of
$111,878,000. In July 1993, the Company completed an initial public stock
offering of 4,700,000 of its common shares resulting in net proceeds of
$46,432,000. In connection therewith, the Company acquired Honorcare (see Note
4) and repurchased and retired the 540,000 shares of its common stock issued to
NME (see Note 1) for cash of $8,020,000.
SALE OF COMMON SHARES -- CAREERSTAFF
Prior to the Company's merger with CareerStaff, CareerStaff in June 1994
completed an initial public stock offering of 824,600 equivalent shares of Sun's
common stock resulting in net proceeds of approximately $9,526,000. In 1993 and
1992, CareerStaff completed private placements of 1,050,423 and 943,643
equivalent shares of Sun common stock resulting in net proceeds of $406,000 and
$443,000, respectively.
(b) STOCK OPTION PLANS
STOCK INCENTIVE PLAN
During 1993, the Company adopted the Company's 1993 Combined Incentive and
Nonqualified Stock Option Plan (the "Stock Incentive Plan"). The Plan reserves
3,000,000 shares of the Company's common stock for grant and authorizes the
Board of Directors or a committee appointed by the Board of Directors to
administer the plan and to grant to certain employees, officers, and consultants
of the Company's incentive stock options or nonqualified stock options at an
exercise price not less than the fair market value per share of the Company's
common stock at the date of grant. Each option grant under the Stock Incentive
Plan becomes fully exercisable three years after the date of grant and expires
ten years from the date of grant. As of December 31, 1995, there were options
outstanding under the Stock Incentive Plan to purchase 2,800,457 shares of
common stock with exercise prices ranging from $9.50 to $24.00 per share.
F-24
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) CAPITAL STOCK (CONTINUED)
DIRECTOR STOCK OPTION PLAN
During 1993, the Company adopted the Director Stock Option Plan (the
"Original Director Stock Plan"). Under the Original Director Stock Plan, each
nonemployee director serving as a director at the time of the Company's initial
public offering received at the time of the initial public offering an initial
grant of options for 20,000 shares and annual grants in January 1994, 1995 and
1996 of options for 7,500 shares, with an exercise price equal to the initial
public offering price of $11.00 per share. At December 31, 1995, options to
purchase 66,500 shares of common stock were outstanding and exercisable under
the Original Director Stock Plan with an exercise price of $11.00 per share. No
options will be granted under the Original Director Stock Plan after January
1996. All options to nonemployee directors are nonqualified stock options and
become fully exercisable one year after the date the option is granted, but only
if the director attends at least 75% of the total board and committee meetings
for the calendar year in which the option was granted.
During 1995, the Company adopted a new Nonemployee Director Stock Option
Plan ("Director Stock Plan") to supersede the Original Director Stock Plan which
restricted stock option grants to only those nonemployee directors who were
serving as directors at the time of the Company's initial public offering in
1993. Under the new Director Stock Plan, each person who is a nonemployee
director is granted an option to purchase 5,000 shares of common stock on the
date such person first becomes a nonemployee director. On each subsequent
anniversary of the initial option grant such person will receive an option to
purchase 1,000 shares of common stock. Each option is a nonqualified stock
option and is granted at an exercise price equal to the fair market value of the
Company's common stock at the date of grant. Each option becomes exercisable
after two years in quarterly increments per year and expires ten years from the
date of grant. As of December 31, 1995, there were options outstanding to
purchase a total of 15,000 shares of common stock outstanding under the new
Director Stock Plan at exercise prices ranging from $9.50 to $15.75 per share. A
total of 200,000 shares of the Company's common stock have been reserved for
issuance under the new Director Stock Plan. All options granted under the new
Director Stock Plan have been made subject to defeasance if the Company's
stockholders do not approve the Director Stock Plan at the Company's annual
meeting of stockholders in 1996.
MEDIPLEX OPTION PLANS
In connection with the Mediplex merger, the Company assumed and converted
the outstanding Mediplex stock options under existing plans into options to
purchase a total of 1,704,500 shares of the Company's common stock with exercise
prices ranging from $6.75 to $18.50. As of December 31, 1995, options to
purchase 623,182 shares of common stock, of which 419,085 were exercisable, were
outstanding with exercise prices ranging from $7.75 to $17.63. The difference
between the fair market value of the Company's common stock at the date of the
merger and the exercise price of the assumed options was accounted for as
additional consideration in the merger. The fair market value approximated the
intrinsic value of the Company's common stock and the difference between the two
valuations had the intrinsic value been used would not have been material to net
earnings or to net equity as of the date of the merger.
CAREERSTAFF OPTION PLANS
In connection with the CareerStaff merger, the Company assumed and converted
the outstanding CareerStaff stock options granted in 1995 and 1994 under
existing plans into options to purchase a total of 302,386 shares of the
Company's common stock with exercise prices ranging from $12.96 to $22.47. As of
December 31, 1995, all of the outstanding options to purchase a total of 142,386
shares of the Company's common stock were exercisable.
F-25
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) CAPITAL STOCK (CONTINUED)
The following is a summary of the stock options under the Stock Incentive
Plan, the Director Stock Option Plans and the assumed Mediplex and CareerStaff
Option Plans:
<TABLE>
<CAPTION>
EXERCISE PRICE PER
SHARES SHARE
------------ -------------------
<S> <C> <C>
Balance at December 31, 1992......................................... -- --
Granted............................................................ 819,000 $11.00- $15.75
Cancelled.......................................................... (82,000) 11.00- 15.75
------------ -------------------
Balance at December 31, 1993......................................... 737,000 11.00- 15.75
Granted............................................................ 1,885,976 11.00- 22.50
Options assumed in connection with the Mediplex Merger............. 1,704,500 6.75- 18.50
Exercised.......................................................... (1,051,519) 6.75- 12.63
Cancelled.......................................................... (268,782) 11.00- 19.00
------------ -------------------
Balance at December 31, 1994......................................... 3,007,175 7.75- 22.50
Granted............................................................ 1,530,673 9.50- 24.00
Exercised.......................................................... (283,179) 9.25- 23.25
Cancelled.......................................................... (607,144) 9.50- 24.00
------------ -------------------
Balance at December 31, 1995......................................... 3,647,525 $ 7.75- $24.00
------------ -------------------
------------ -------------------
</TABLE>
At December 31, 1995, options to purchase 627,971 common shares were
exercisable.
OPTIONS ISSUED IN CONNECTION WITH THE GOLDEN CARE MERGER
The Company issued options to purchase a total of 234,100 shares of the
Company's common stock with a total exercise price of $500,000 as part of the
consideration in the Company's merger with Golden Care. These options represent
10% of the total shares of the Company's common stock issued in connection with
the Golden Care merger. These options replaced options granted to an employee in
1994 under an employment agreement in which former Golden Care stockholders
granted an option to an employee to acquire 10% of their holdings. All such
options vested as of the date of the merger.
(14) PREFERRED STOCK PURCHASE RIGHTS
On June 2, 1995, the Board of Directors declared a dividend of one preferred
stock purchase right ("Right") for each outstanding share of common stock of the
Company for stockholders of record on June 15, 1995 and for all future issuances
of common stock. The Rights are currently not exercisable or transferable apart
from the common stock and have no voting rights. Each Right entitles the
registered holder to purchase from the Company one one-hundredth of a share of
Series A Preferred Stock, par value $0.01 per share. The Rights become
exercisable ten business days following the date a person or group of affiliated
persons acquires 15% or more of the Company's common stock, or announces a
tender or exchange offer which would result in the beneficial ownership by a
person or group of affiliated person of 15% or more of the outstanding Company's
common stock. The Rights also become exercisable if any person, who is the
beneficial owner of 15% or more of the Company's common stock as of the date of
record, acquires an additional 1% or more of the outstanding Company's common
stock. The Rights may be redeemed by the Company at a price of $.001 per Right
before their expiration on June 2, 2005.
In the event that the Company is acquired in a merger or other business
combination or certain other events occur, provision shall be made so that each
holder of a Right, excluding the Rights beneficially owned by the acquiring
persons, shall have the right to receive, upon exercise thereof at
F-26
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(14) PREFERRED STOCK PURCHASE RIGHTS (CONTINUED)
the then current exercise price, that number of shares of common stock of the
surviving company which at the time of such transaction will have a market value
of two times the exercise price of the Right.
(15) PRO FORMA NET EARNINGS (LOSS) PER SHARE
Pro forma net earnings (loss) per common and common equivalent share for the
year ended December 31, 1995 and 1994 is based upon the weighted average number
of common shares outstanding during the period including the common stock
transactions of CareerStaff and Golden Care plus the effect, if dilutive, of
incremental shares of common stock contingently issuable in respect of stock
options. Pro forma fully diluted net earnings per share for certain of the
quarters during the years ended December 31, 1995 and 1994 is determined on the
assumption that the 6% Debentures and the 6 1/2% Debentures were converted as of
the dates of issuance and acquisition on March 1, 1994, and June 23, 1994,
respectively. Net earnings is adjusted for the interest on the debentures, net
of interest related to additional assumed borrowings to fund the cash
consideration on conversion of the 6 1/2% Debentures and the related income tax
benefits.
Pro forma net earnings per share for the year ended December 31, 1993, is
calculated based upon the number of shares of the Company's common stock issued
upon the formation of Sun Healthcare Group, Inc. on April 15, 1993, which placed
under the control of a single corporation all of the Company's operations and
the appropriate weighted average number of shares of the Company's common stock
for common stock transactions of the Company subsequent to the Preincorporation
Agreement and also include the appropriate weighted average number of shares of
the Company's common stock for common stock transactions of CareerStaff and
Golden Care for the year ended December 31, 1993.
(16) OTHER EVENTS
(a) GOVERNMENT INVESTIGATION
The Company's rehabilitation therapy subsidiary is under investigation by
the OIG. The allegations underlying the investigation have not been fully
disclosed to the Company, and the OIG is still in the process of collecting
additional information. The Company believes that the investigation includes a
review of whether the Company's rehabilitation therapy subsidiary has engaged in
improper practices, including the provision of, and billing for, concurrent
therapy services and unnecessary or unordered services to residents of skilled
nursing facilities. In addition, the Company's rehabilitation therapy subsidiary
provides therapy services to, among others, the Company's long-term care
subsidiary. The Company understands that the OIG is also reviewing claims filed
by its long-term care subsidiary with respect to the services. The Company has
cooperated and continues to cooperate with the investigation. If there have been
improper practices or the investigation is broader in scope, depending on the
nature and extent of such impropriety, the investigation could result in the
imposition of civil, administrative, or criminal fines, penalties, or
restitutionary relief, and may have a negative impact on the Company. The
Company is unable to determine at this time when the investigation is to be
concluded, however, based on the facts currently available, it does not believe
that the outcome of the OIG investigation will have a material adverse effect on
the Company's results of operations or financial condition.
(b) LITIGATION
A holder of CareerStaff's common stock has filed a lawsuit (the "CareerStaff
Litigation") as a purported class action against CareerStaff and the directors
of CareerStaff alleging breach of fiduciary duty in entering into a merger
agreement with the Company and against the Company alleging that the Company
aided and abetted the alleged breach of fiduciary duty by the CareerStaff
directors. In
F-27
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(16) OTHER EVENTS (CONTINUED)
February 1996, the plaintiff filed a status report with the court stating that
the plaintiff intends to file a stipulation of dismissal without prejudice. The
Company believes that the CareerStaff Litigation is without merit; however,
there can be no assurance that the CareerStaff Litigation will not have an
impact on the Company's accounting for the merger.
On June 30, 1995, two civil class-action complaints were filed against the
Company and certain of its current and former directors and officers in the
United States District Court for the District of New Mexico. Two more
complaints, based on the same underlying events, were filed on August 30, 1995.
On October 6 and October 10, 1995, two additional complaints were filed, also
based on the same underlying events. These six complaints were consolidated by a
court order dated November 27, 1995, and an amended class action complaint,
captioned IN RE SUN HEALTHCARE GROUP, INC. LITIGATION (the "Complaint"), was
filed in the United States District Court for the District of New Mexico on
January 26, 1996. The Complaint was purportedly brought on behalf of all persons
who either exchanged their shares of common stock of CareerStaff for shares of
Sun common stock pursuant to a merger agreement between CareerStaff and the
Company, or who purchased shares of Sun common stock between October 26, 1994
and June 27, 1995. The Complaint alleges that defendants misrepresented or
failed to disclose material facts about the OIG investigation and about the
Company's operations and financial results, which plaintiffs contend
artificially inflated the price of the Company's securities.
On or about January 23, 1996, two of the Golden Care selling stockholders
filed a lawsuit (the "Golden Care Litigation") against the Company and certain
of its officers and directors in the United States District Court for the
Southern District of Indiana. Plaintiffs allege, among other things, that the
Company did not disclose material facts concerning the OIG investigation and
that the Company's financial results were misstated. The Complaint purports to
state claims, INTER ALIA, under federal and state securities laws and for breach
of contract, including a breach of the registration rights agreement pursuant to
which Sun agreed to register the shares for resale by such Golden Care selling
stockholders. The Company believes that the Golden Care Litigation is without
merit; however, there can be no assurance that the Golden Care Litigation will
not have an impact on the Company's accounting for the merger.
On September 8, 1995, derivative action was filed in the United States
District Court for the District of New Mexico, captioned BRICKELL PARTNERS V.
TURNER, ET AL. The complaint was not served on any defendant. On June 19, 1996,
an amended complaint alleging breach of fiduciary duty by certain current and
former of the Company's directors and officers based on substantially the same
events as those set forth in the above described securities class actions was
filed and subsequently served on the defendants.
The Company has reviewed the allegations in the complaints, believes them to
be without merit, and intends to defend itself vigorously. Relief sought in the
action is unspecified. The Company believes the shareholder actions will not
have a material adverse impact on its results of operations or financial
condition.
F-28
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(17) SUMMARIZED FINANCIAL INFORMATION
The Company acquired Mediplex on June 23, 1994 and became a co-obligor with
Mediplex with respect to the 6 1/2% Debentures and the 11 3/4% Debentures
subsequent to the acquisition (see Notes 4 and 7). Summarized financial
information of Mediplex, after giving effect to the restatement discussed in
Note 2, is provided below (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1995 1994
----------- -----------
<S> <C> <C>
AS RESTATED
------------------------
Current assets............................................................. $ 130,794 $ 112,831
Noncurrent assets.......................................................... 461,592 634,173
Current Liabilities........................................................ 34,823 41,146
Noncurrent Liabilities..................................................... 91,150 302,806
Due to Parent.............................................................. 168,222 48,817
</TABLE>
The results of operations of Mediplex subsequent to the date of acquisition
by Sun are labeled "Company", and the financial position and results of
operations of Mediplex for the period prior to the acquisition by Sun are
labeled "Predecessor."
<TABLE>
<CAPTION>
COMPANY
JUNE 24, 1994 COMPANY
COMPANY TO JANUARY 1, 1994
YEAR ENDED DECEMBER 31, TO
DECEMBER 31, 1995 1994 JUNE 23, 1994
----------------- --------------- -----------------
<S> <C> <C> <C>
AS RESTATED
----------------------------------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Net revenues.............................................. $ 448,254 $ 205,300 $ 221,640
----------------- --------------- -----------------
Costs and expenses........................................ 432,730 217,572 208,455
Impairment loss........................................... 52,621 -- --
----------------- --------------- -----------------
Earnings (loss) before intercompany charges, income taxes
and extraordinary loss................................... (37,097) (12,272) 13,185
Intercompany charges (1).................................. 39,205 -- --
----------------- --------------- -----------------
Earnings (loss) before income taxes and extraordinary
loss..................................................... (76,302) (12,272) 13,185
Income taxes (benefit).................................... (7,432) (8,909) 3,645
----------------- --------------- -----------------
Net earnings (loss) before extraordinary loss......... (68,870) (3,363) 9,540
Extraordinary loss, net of income tax benefit............. (3,413) -- --
----------------- --------------- -----------------
Net earnings (loss)................................... $ (72,283) $ (3,363) $ 9,540
----------------- --------------- -----------------
----------------- --------------- -----------------
</TABLE>
- ------------------------
(1) Through various intercompany agreements entered into by Sun and Mediplex,
Sun provides management services, licenses the use of its trademarks and
acts on behalf of Mediplex to make financing available for its operations.
Sun charged Mediplex for management services totaling $20,478,000 for the
year ended December 31, 1995. On September 30, 1995, Sun and Mediplex
finalized licensing agreements and financing agreements which were effective
January 1, 1995. Royalty fees charged to Mediplex for the year ended
December 31, 1995, for the use of Sun trademarks were $4,725,000.
Intercompany interest charged to Mediplex for the year ended December 31,
1995, for advances from Sun was $14,002,000. During 1994, Sun did not charge
Mediplex for these same services.
F-29
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(18) QUARTERLY FINANCIAL DATA (UNAUDITED)
The Company's unaudited consolidated quarterly financial information follows
(in thousands, except per share data):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995
--------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER (2)
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Total net revenues............................................ $ 256,734 $ 278,980 $ 289,273 $ 310,521
Earnings (loss) before income taxes and extraordinary loss.... 20,013 19,306 27,359 (53,884)
Net earnings (loss) before extraordinary loss................. 10,826 8,741 16,415 (56,320)
Net earnings (loss) before extraordinary loss (1)............. 10,541 8,796 16,415 (56,320)
Extraordinary loss............................................ (3,413) -- -- --
----------- ----------- ----------- -----------
Net earnings (loss) (1)................................... $ 7,128 $ 8,796 $ 16,415 $ (56,320)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Net earnings (loss) per share
Fully diluted (1)(3)
Net earnings (loss) per share before extraordinary loss
(1)(3)................................................... $ 0.21 $ 0.18 $ 0.33 $ (1.18)
Extraordinary loss (3).................................... (0.06) -- -- --
----------- ----------- ----------- -----------
Net earnings (loss) (1)(3).............................. $ 0.15 $ 0.18 $ 0.33 $ (1.18)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
<CAPTION>
YEAR ENDED DECEMBER 31, 1994
--------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER (2)
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Total net revenues............................................ $ 95,404 $ 118,627 $ 222,315 $ 237,008
Earnings (loss) before income taxes........................... 7,327 9,408 20,307 (235)
Net earnings (loss)........................................... 5,383 6,532 11,027 (823)
Pro forma net earnings (loss) (1)............................. $ 4,464 $ 5,683 $ 10,521 $ (1,107)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Pro forma net earnings (loss) per share
Fully diluted (1)(3)........................................ $ 0.21 $ 0.23 $ 0.25 $ (0.03)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
- ------------------------
(1) A provision for pro forma income taxes has been reflected in the
consolidated quarterly financial information for periods in which certain
entities were not subject to Federal and state income taxes (See Note 10).
(2) Amounts have been restated (See Note 2).
(3) Earnings per share are computed independently for each of the quarters
presented (See Note 15).
(19) SUBSEQUENT EVENTS
On February 21, 1996, the Company announced that the Company had reached an
agreement in principle for the sale of SunSurgery Corporation, its ambulatory
surgery subsidiary.
On February 23, 1996, the Company announced that its Board of Directors
approved a common stock repurchase program to acquire up to $25,000,000 of its
outstanding common stock.
F-30
<PAGE>
SCHEDULE II
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COLUMN C
----------------------------
COLUMN B ADDITIONS COLUMN E
----------- ---------------------------- COLUMN D -----------
COLUMN A BALANCE AT CHARGED TO CHARGED TO ---------- BALANCE AT
- ------------------------------------------------ BEGINNING COSTS AND OTHER ACCOUNTS DEDUCTIONS END OF
DESCRIPTION OF PERIOD EXPENSES DESCRIBE (1) DESCRIBE PERIOD
- ------------------------------------------------ ----------- ----------- --------------- ---------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1995:
As restated
Allowance for doubtful accounts............... $ 9,508 $ 14,623 $ 743 $ (13,839) $ 11,035
----------- ----------- ------- ---------- -----------
----------- ----------- ------- ---------- -----------
Year ended December 31, 1994:
As restated
Allowance for doubtful accounts............... $ 1,129 $ 27,632 $ 5,934 $ (25,187) $ 9,508
----------- ----------- ------- ---------- -----------
----------- ----------- ------- ---------- -----------
Year ended December 31, 1993:
Allowance for doubtful accounts............... $ 726 $ 1,265 -- $ (862) $ 1,129
----------- ----------- ------- ---------- -----------
----------- ----------- ------- ---------- -----------
</TABLE>
- ------------------------
(1) Represents the allowance for doubtful accounts of acquired entities at the
date of acquisition.
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
PAGE IN
SEQUENTIALLY
EXHIBIT NUMBERED COPY
--------------------------------------------------------------------------------------- -----------------------
<S> <C> <C>
11.1 Computation of earnings per share
23.1 Consent of Arthur Andersen LLP
23.2 Consent of Coopers & Lybrand L.L.P.
23.3 Consent of Ernst & Young LLP
</TABLE>
<PAGE>
EXHIBIT 11.1
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF EARNINGS (LOSS) PER SHARE
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1995 1994 1993
--------- --------- -----------
<S> <C> <C> <C>
AS RESTATED
--------------------
<CAPTION>
(IN THOUSANDS,
EXCEPT SHARE DATA)
<S> <C> <C> <C>
Shares outstanding at beginning of period........................................... 45,021 21,066 14,979(1)
Weighted average shares issued pursuant to:
Common stock offering............................................................. -- 3,325 3,395
Acquisition agreements............................................................ 694 5,887 --
Employee benefit plans............................................................ 182 412 --
Conversion of 6 1/2% Convertible Subordinated Debentures due 2003................. 1,522 348 --
Dilutive effect of outstanding stock options........................................ -- 792 234
--------- --------- -----------
Weighted average number of common and common equivalent shares outstanding.......... 47,419 31,830 18,608
--------- --------- -----------
--------- --------- -----------
Net earnings (loss) before extraordinary loss on early extinguishment of debt (2)... $ (20,568) $ 19,561 $ 13,463
Extraordinary loss.................................................................. (3,413) -- --
--------- --------- -----------
Net earnings (loss) (2)............................................................. $ (23,981) $ 19,561 $ 13,463
--------- --------- -----------
--------- --------- -----------
Net earnings (loss) before extraordinary loss per common and common equivalent share
(2)................................................................................ $ (0.43) $ 0.61 $ 0.72
Extraordinary loss.................................................................. (0.07) -- --
--------- --------- -----------
Net earnings (loss) per common and common equivalent share (2)...................... $ (0.50) $ 0.61 $ 0.72
--------- --------- -----------
--------- --------- -----------
</TABLE>
- ------------------------------
(1) Shares outstanding at beginning of period is based upon 9,000,000 shares of
the Company's common stock subsequently issued upon the formation of Sun
Healthcare Group, Inc. on April 15, 1993 which placed under the control of
single corporation all of the Company's operations and include the
appropriate weighted average shares of CareerStaff Unlimited, Inc.
("CareerStaff") and Golden Care, Inc. ("Golden Care").
(2) For financial reporting purposes, a pro forma provision for income taxes
has been reflected in the computation of earnings (loss) per share to
present taxes on the results of operations of CareerStaff for the twelve
months ended December 31, 1993 and for the period from January 1, 1994 to
June 22, 1994 and of Golden Care for the twelve months ended December 31,
1994 and 1993, and for the period from January 1, 1995 to May 5, 1995, as
if these entities had not elected S corporation status and were subject to
and liable for Federal and state income taxes prior to each of the
companies termination of their S corporation status. CareerStaff terminated
its S corporation status on June 22, 1994. Golden Care terminated its S
corporation status for Federal and state income tax purposes upon merging
with the Company on May 5, 1995.
<PAGE>
[LETTERHEAD]
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference of our reports included in this Form 10-K/A-1, into Sun Healthcare
Group, Inc.'s previously filed Registration Statements on Form S-8
(No. 33-80540, No. 33-93692 and No. 333-03058).
ARTHUR ANDERSEN LLP
Albuquerque, New Mexico
August 2, 1996
<PAGE>
[LETTERHEAD]
EXHIBIT 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
We consent to the incorporation of our report dated March 22, 1995, with
respect to the financial statements of Golden Care, Inc. included in this
Annual Report on Form 10-K/A-1 into filed Registration Statements of Sun
Healthcare Group, Inc. on Form S-8 (No. 33-80540, No. 33-93692 and
No. 333-03058).
COOPERS & LYBRAND L.L.P.
Indianapolis, Indiana
August 5, 1996
<PAGE>
[LETTERHEAD]
EXHIBIT 23.3
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 No. 33-80540, Form S-8 No. 33-93692, and Form S-8 No. 333-03058) of
Sun Healthcare Group, Inc. of our report dated March 8, 1995, except for
Note 16 which is dated March 30, 1995, with respect to the consolidated
financial statements of CareerStaff Unlimited, Inc. included in the Annual
Report (Form 10-K/A-1) of Sun Healthcare Group, Inc. for the year ended
December 31, 1995.
ERNST & YOUNG LLP
Houston, Texas
August 5, 1996
