<PAGE>
BPH
-------------------
FORM 8-K/A-1
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) October 8, 1997
Sun Healthcare Group, Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in charter)
DELAWARE 001-12040 850410612
- --------------------------------------------------------------------------------
(State or other jurisdiction (Commission (IRS Employer
of incorporation) File Number) Identification No.)
101 Sun Avenue NE, Albuquerque, NM 87109
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (505) 821-3355
NONE
- --------------------------------------------------------------------------------
(Former name or former address, if changed since last report.)
<PAGE>
This report on Form 8-K/A-1 supplements the report on Form 8-K filed with
the Securities and Exchange Commission on October 23, 1997 by Sun Healthcare
Group, Inc., a Delaware corporation (the "Company", "Sun" or the "registrant")
to report its acquisition of all of the stock of Regency Health Services, Inc.,
a Delaware corporation ("Regency").
Items 7. Financial Statements, Pro Forma Financial Information and Exhibits
The following financial information is being filed in order to satisfy the
financial statement requirements for the Form 8-K filed on October 23, 1997.
(a) Financial Statements of Business Acquired
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
AS OF
----------------------------
SEPTEMBER 30, DECEMBER 31,
----------------------------
ASSETS 1997 1996
-------- -------
(In thousands, except share data)
<S> <C> <C>
Current assets:
Cash and cash equivalents $18,435 $22,875
Restricted cash 7,166 4,425
Accounts receivable, net of allowance for
doubtful accounts of $10,240 at September 30,
1997 and $4,723 at December 31, 1996 99,361 80,949
Other receivables 1,528 11,535
Prepaids and other assets 9,538 7,819
Assets held for sale 6,723 6,915
Deferred tax asset 6,897 6,898
-------- --------
Total current assets 149,648 141,416
-------- --------
Property and equipment, net 171,393 135,072
Goodwill, net 62,665 53,753
Other assets, net 26,711 23,335
-------- --------
Total assets $410,417 $353,576
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $5,389 $2,418
Accounts payable 24,777 24,958
Accrued compensation and benefits 33,294 26,253
Workers' compensation accrual 7,166 4,338
Other accrued liabilities 11,557 8,290
Deferred revenue 2,388 2,407
Accrued interest 6,596 5,578
-------- --------
Total current liabilities 91,167 74,242
-------- --------
Long-term debt, net of current portion 223,765 182,490
Other long-term liabilities 10,848 10,878
Deferred income taxes 2,439 5,018
-------- --------
Total liabilities 328,219 272,628
-------- --------
Commitments and Contingencies
Stockholders' equity:
Common stock of $.01 par value, authorized 35,000
shares, 15,887 and 15,919 shares issued and
outstanding at September 30, 1997 and December 31,
1996, respectively, net of 1,008 and 862 shares
held in treasury, respectively 169 168
Additional paid-in capital 52,029 52,031
Retained earnings 30,000 28,749
-------- --------
Total stockholders' equity 82,198 80,948
-------- --------
Total liabilities and stockholders' equity $410,417 $353,576
-------- --------
-------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)
FOR THE
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------------
1997 1996
-------- -------
(In thousands, except per share data)
Total net revenues $490,012 $409,439
-------- --------
Costs and expenses:
Operating 420,797 348,114
Corporate general and administrative 29,574 21,618
Provision for losses on accounts receivable 6,921 1,317
Depreciation and amortization 14,588 11,197
Interest, net 15,388 11,108
-------- --------
Total costs and expenses 487,268 393,354
-------- --------
Earnings before income taxes 2,744 16,085
Income taxes 1,490 6,641
-------- --------
Earnings before extraordinary item 1,254 9,444
Extraordinary item - Loss on extinguishment of
debt, net of applicable income taxes of $812 - (1,193)
-------- --------
Net earnings $1,254 $8,251
-------- --------
-------- --------
See accompanying notes to consolidated financial statements.
3
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
1997 1996
------ ------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $2,051 $8,251
Adjustments to reconcile net earnings to net cash
provided by (used for) operating activities -
Depreciation and amortization 14,588 11,197
Provision for losses on accounts receivable 6,921 1,317
Extraordinary loss on discharge of debt - 2,005
Other, net (3,353) 1,825
Changes in operating assets and liabilities:
Accounts receivable (19,675) (22,762)
Other current assets 10,784 (10,394)
Current and other liabilities 11,367 9,172
------- -------
Net cash provided by operating activities 22,683 611
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net (11,044) (10,969)
Acquisitions, net of cash acquired (48,829) (48,513)
Other assets expenditures 5,781 (1,658)
------- -------
Net cash used for investing activities (54,092) (61,140)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings 49,000 56,143
Long-term debt repayments (15,530) (62,650)
Net proceeds from issuance of common stock 1,441 234
Purchases of treasury stock (1,442) (5,082)
Workers' compensation trust funding (6,500) (10,637)
------- -------
Net cash provided by (used in) financing
activities 26,969 (21,992)
------- -------
Net decrease in cash and cash equivalents (4,440) (82,521)
Cash and cash equivalents at beginning of period 22,875 104,238
------- -------
Cash and cash equivalents at end of period $18,435 $21,717
------- -------
------- -------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during period for:
Interest $14,370 $8,620
------- -------
------- -------
Income taxes $4,125 $3,750
------- -------
------- -------
SUPPLEMENTARY SCHEDULE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
The Company's acquisitions during the nine months
ended September 30, 1997 and 1996, involved
the following:
Fair value of assets acquired $59,599 $54,076
Liabilities assumed (10,770) (5,563)
------- -------
Cash payments made, net of cash received from
others $48,829 $48,513
------- -------
------- -------
4
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
In the opinion of management of Regency Health Services, Inc. (the
"Company" or "Regency"), the accompanying interim consolidated financial
statements present fairly the Company's financial position at September 30,
1997 and December 31, 1996, the consolidated results of its operations for
the three and nine month periods ended September 30, 1997 and 1996, and the
consolidated statements of cash flows for the nine month periods ended
September 30, 1997 and 1996. All adjustments are of a normal and recurring
nature. All material intercompany balances, profits and transactions have
been eliminated. These statements are presented in accordance with the rules
and regulations of the United States Securities and Exchange Commission
("SEC"). Accordingly, they are unaudited, and certain information and
footnote disclosures normally included in the Company's annual consolidated
financial statements have been condensed or omitted, as permitted under the
applicable rules and regulations. Readers of these statements should refer
to the Company's audited consolidated financial statements and notes thereto
for the year ended December 31, 1996, which are included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1996. The results
of operations presented in the accompanying financial statements are not
necessarily representative of operations for an entire year. Certain amounts
have been reclassified in the 1996 financial statements to conform to the
1997 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 and
disclosure of contingent assets or 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.
NEWLY ISSUED PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") has issued Statement of
Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share" which is
effective for both interim and annual reporting periods ending after December
15, 1997. This standard requires restatement of prior interim and annual
earnings per share calculations. SFAS No. 128 replaces fully diluted EPS with
diluted EPS and replaces primary EPS with basic EPS. Basic EPS is computed by
dividing reported earnings by weighted average shares outstanding. Diluted EPS
is computed the same way as fully diluted EPS, except that the calculation now
uses the average share price for the reporting period to compute dilution from
options and warrants under the treasury stock method. The Company will adopt
the new standard in its reporting for the quarter and the year ended December
31, 1997. Management does not believe that adoption of this standard will have
a significant impact on earnings per share.
The FASB has also issued SFAS No. 130, "Reporting Comprehensive Income"
which is effective for fiscal years beginning after December 15, 1997 and
requires restatement of earlier financial statements for comparative purposes.
SFAS No. 130 requires that items meeting the criteria of a component of
comprehensive income, including foreign currency items and unrealized gains and
losses on certain investments in debt and equity securities, be shown in the
financial statements. SFAS No. 130 does not require a specific format for
disclosure of comprehensive income and its components in the financial
statements. Management has not yet determined the effect of SFAS No. 130 on the
consolidated financial statements.
The FASB has also issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and
5
<PAGE>
Related Information." This standard requires that a public business enterprise
report financial and descriptive information about its reportable operating
segments. Operating segments are components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. SFAS No. 131 also requires that all public business
enterprises report information about the revenues derived from the enterprise's
products or services (or groups of similar products and services), about the
countries in which the enterprise earns revenues and holds assets, and about
major customers regardless of whether that information is used in making
operating decisions. However, this Statement does not require an enterprise to
report information that is not prepared for internal use if reporting it would
be impractical. This Statement is effective for financial statements for
periods beginning after December 15, 1997. In the initial year of application,
comparative information for earlier years is required to be restated.
Comparative information for interim periods is not required until the second
year of application. Management has not yet determined the effect, if any, of
SFAS No. 131 on the consolidated financial statements.
2. ACQUISITIONS
Effective January 1, 1997, the Company acquired four acute rehabilitation
hospitals, ten outpatient rehabilitation clinics and six neurological treatment
centers from Horizon/CMS Healthcare Corporation ("CMS"). The purchase price was
$43.0 million, made up of a cash payment of $36.3 million and notes payable
totaling $6.7 million. The Company funded the acquisition with borrowings
against the Amended and Restated Credit Agreement dated December 20, 1996 with
NationsBank of Texas, N.A. as agent for a group of banks (the "NationsBank
Credit Agreement"). Two of the acquired hospitals have joint venture partners
with 30% and 50% interests. Accordingly, the income statement reflects minority
interest related to the joint venture partners' share of the revenues and
expenses of the two hospitals.
On April 1, 1997, the Company acquired HHC Health Group, Inc., a home
health and infusion therapy provider with four locations in California, for $2.3
million, consisting of a cash payment of $1.7 million and a note payable of $.6
million.
On May 1, 1997, the Company acquired Asher Clinic, an outpatient clinic in
California, for $1.7 million in cash.
On May 1, 1997, the Company also acquired Advanced Physical Therapy, Inc.,
which operates three outpatient clinics in California, for $1.7 million,
consisting of a cash payment of $1.4 million and a note payable of $.3 million.
On May 16, 1997, the Company acquired Rainbow Medical LLC, a pharmacy
located in Las Vegas, Nevada for $1.9 million, consisting of $1.2 million in
cash and a note payable of $.7 million.
Effective June 1, 1997, the Company acquired Health Fitness Physical
Therapy, Inc., which operates seven outpatient clinics in California for $1.8
million, consisting of a cash payment of $1.1 million and notes payable of $.7
million.
Effective June 1, 1997, the Company acquired Peachwood Physical Therapy,
Inc., an outpatient clinic in California for $.7 million, $.5 million in cash
and a note payable for $.2 million.
Effective June 1, 1997, the Company acquired Adams & Schmidt Sports
Therapy, which operates four outpatient clinics in California for $1.2 million,
consisting of a cash payment of $.8 million and a note payable for $.4 million.
6
<PAGE>
Effective June 12, 1997, the Company acquired Hospice of the Pacific, a
hospice provider in California for $.4 million in cash.
On July 1, 1997, the Company acquired Pacific Beach Physical Therapy, Inc.,
an outpatient clinic in California, for $.6 million, $.5 million in cash and a
note payable for $.1 million.
Effective August 1, 1997, the Company acquired The Visiting Nurse
Association of Los Angeles, Inc. and The Visiting Nurse Home Services, Inc.,
providers of home health services with seven locations in the Los Angeles area,
in a single transaction. The purchase price was $4.5 million, consisting of
cash payments totaling $3.2 million and a note payable for $1.3 million.
These transactions were accounted for using the purchase method of
accounting under generally accepted accounting principles. Revenues and
expenses are included in the accompanying financial statements subsequent to the
acquisition date.
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 the four acute rehabilitation
hospitals, ten outpatient rehabilitation clinics and six neurological treatment
centers for the nine months ended September 30, 1997 and 1996, as if such
acquisition had been consummated on January 1, 1996. All other acquisitions are
considered immaterial and are not included in the pro forma condensed
consolidated statements of earnings.
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1997 1996
-------- --------
(In thousands, except
per share data)
(Unaudited)
Net operating revenue $490,012 $456,041
Total costs and expenses (including minority
interest) 487,268 439,440
-------- --------
Earnings before provision for income taxes 2,744 16,601
Provision for income taxes 1,490 6,858
-------- --------
Earnings before extraordinary item $ 1,254 $ 9,743
-------- --------
-------- --------
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.
3. DISPOSITIONS
In connection with the 13 facilities identified for disposition by the
Company during the fourth quarter of 1995, the Company disposed of an 81-bed
facility in Pomona, California effective January 1,
7
<PAGE>
1997 for a nominal amount, resulting in a $233,000 charge against the reserve
established for such dispositions.
4. WORKERS' COMPENSATION CLAIMS TRUST
In 1995, the Company established a revocable workers' compensation claims
trust ("Trust") to pre-fund its workers' compensation obligations. The Trust
was funded for fiscal 1995 in March 1996 with approximately $10.6 million from
available cash. In March 1997, the Company pre-funded its fiscal 1996 workers'
compensation obligations with approximately $6.5 million from available cash.
Of the remaining $8.3 million in the Trust at September 30, 1997, $7.2 million
was classified as current restricted cash and $1.1 million was classified as
other long-term assets.
5. NET EARNINGS PER SHARE
Net earnings per common and common equivalent share is based upon the
weighted average number of common shares outstanding during the period plus the
effect of incremental shares of common stock contingently issuable upon exercise
of stock options.
Fully diluted net earnings for the three and nine months ended September
30, 1997 is computed as described above. Fully diluted net earnings for the
three and nine months ended September 30, 1996 is determined on the assumption
that the Convertible Subordinated Debentures were converted as of January 1,
1996. Net earnings is adjusted for the interest on the debentures and the
amortization of underwriting costs related to the debentures, net of tax.
6. SUBSEQUENT EVENTS
On October 8, 1997, the Company sold 6 neurological treatment centers to
members of senior management for $3.0 million in cash.
On October 8, 1997, a wholly-owned subsidiary of the Sun Healthcare, Inc.
("Sun"), an operator of skilled nursing facilities and a provider of related
specialty healthcare services, including rehabilitation therapy and
institutional pharmacy services in the United States, through a tender offer
acquired 98.4% of the capital stock of Regency. The remaining shares were
converted into the right to receive $22.00 in cash per share. Total
consideration for the shares acquired in the tender offer was approximately
$345,200,000.
On October 8, 1997, as part of the financing of the Sun acquisition, 30
facilities were sold in a sale leaseback transaction with proceeds of
approximately $94 million.
On October 9, 1997, a wholly-owned subsidiary of Sun completed a tender
offer for 100%, or $50,000,000, of Regency's 12.25% Junior Subordinated Notes
due 2003 for approximately $61,000,000, and $109,600,000 of the $110,000,000 of
Regency's 9.875% Senior Subordinated Notes due 2002 for approximately
$126,700,000. In addition, Sun repaid Regency's revolving credit facility of
approximately $39,000,000.
8
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Regency Health Services, Inc.:
We have audited the accompanying consolidated balance sheet of Regency
Health Services, Inc. (a Delaware corporation) and subsidiaries as of December
31, 1996 and the related consolidated statements of operations, stockholders'
equity and cash flows for the year then ended. 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 audit.
We conducted our audit 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 audit provides 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 Regency Health
Services, Inc. and subsidiaries as of December 31, 1996, and the results of
their operations and their cash flows for the year then ended, in conformity
with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Orange County, California
February 14, 1997
10
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED BALANCE SHEET
As of December 31, 1996
(In thousands, except par value)
<TABLE>
<CAPTION>
<S> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . $ 22,875
Restricted cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,425
Accounts receivable, net of allowance of $4,723 at December 31, 1996 . . 80,949
Estimated third party settlements. . . . . . . . . . . . . . . . . . . . 10,180
Notes and other receivables. . . . . . . . . . . . . . . . . . . . . . . 1,355
Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . 6,898
Assets held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . 6,915
Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . 7,819
---------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . 141,416
---------
PROPERTY AND EQUIPMENT:
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,207
Buildings and improvements . . . . . . . . . . . . . . . . . . . . . . . 100,120
Leasehold interests -- other . . . . . . . . . . . . . . . . . . . . . . 17,640
Leasehold interests -- related party . . . . . . . . . . . . . . . . . . 1,989
Equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,054
---------
179,010
Less accumulated depreciation and amortization . . . . . . . . . . . . . (43,938)
---------
Total property and equipment . . . . . . . . . . . . . . . . . . . . . 135,072
---------
OTHER ASSETS:
Mortgage notes receivable, net of allowance of $1,352 at
December 31, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,014
Goodwill, net of accumulated amortization of $3,700 at December 31, 1996 . 53,753
Other assets, net of accumulated amortization of $3,736 at
December 31, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,321
---------
Total other assets . . . . . . . . . . . . . . . . . . . . . . . . . . 77,088
---------
$ 353,576
---------
---------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt. . . . . . . . . . . . . . . . . . . . $ 2,418
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,958
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,290
Accrued compensation . . . . . . . . . . . . . . . . . . . . . . . . . . 26,253
Accrued workers' compensation. . . . . . . . . . . . . . . . . . . . . . 4,338
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,407
Accrued interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,578
---------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . 74,242
LONG-TERM DEBT, NET OF CURRENT PORTION . . . . . . . . . . . . . . . . . . 182,490
OTHER LIABILITIES AND NONCURRENT RESERVES. . . . . . . . . . . . . . . . . 10,878
DEFERRED INCOME TAXES. . . . . . . . . . . . . . . . . . . . . . . . . . . 5,018
---------
Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . 272,628
---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; authorized -- 35,000 shares;
15,919 shares issued and outstanding at December 31, 1996,
net of 862 shares held in treasury . . . . . . . . . . . . . . . . . . 168
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . 52,031
Retained earnings. . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,749
---------
Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . . 80,948
---------
$ 353,576
---------
---------
</TABLE>
The accompanying notes are an integral part of this consolidated
balance sheet.
11
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
For the year ended December 31, 1996
(In thousands, except per share amount)
NET OPERATING REVENUE. . . . . . . . . . . . . . . . . $558,050
--------
COSTS AND EXPENSES:
Operating expenses . . . . . . . . . . . . . . . . . 453,131
Corporate general and administrative . . . . . . . . 24,292
Rent expense . . . . . . . . . . . . . . . . . . . . 24,956
Depreciation and amortization. . . . . . . . . . . . 15,317
Interest expense . . . . . . . . . . . . . . . . . . 18,060
Restructuring and other non-recurring charges. . . . 11,283
--------
Total costs and expenses . . . . . . . . . . . . . 547,039
--------
INCOME BEFORE PROVISION FOR INCOME TAXES AND
EXTRAORDINARY ITEM . . . . . . . . . . . . . . . . . 11,011
PROVISION FOR INCOME TAXES . . . . . . . . . . . . . . 4,612
--------
INCOME BEFORE EXTRAORDINARY ITEM . . . . . . . . . . . 6,399
EXTRAORDINARY ITEM -- Loss on extinguishment of debt,
net of applicable income taxes of $812 . . . . . . . (1,193)
--------
NET INCOME . . . . . . . . . . . . . . . . . . . . . . $ 5,206
--------
--------
INCOME PER SHARE:
Income before extraordinary item . . . . . . . . . . $ .39
Extraordinary item . . . . . . . . . . . . . . . . . (.07)
--------
Net income per share . . . . . . . . . . . . . . . . $ .32
--------
--------
Weighted average shares of common stock and
equivalents . . . . . . . . . . . . . . . . . . . . 16,476
--------
--------
The accompanying notes are an integral part of this consolidated statement.
12
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the year ended December 31, 1996
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
-------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
------ ------ ---------- -------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995 . . . . . . . . . . . 16,670 $167 $56,679 $23,543 $80,389
Exercise of stock options. . . . . . . . . . 99 1 680 -- 681
Restricted Stock Distribution. . . . . . . . 12 -- 144 -- 144
Charge in lieu of income taxes . . . . . . . -- -- 2,814 -- 2,814
Repurchase of common stock . . . . . . . . . (862) -- (8,286) -- (8,286)
Net income . . . . . . . . . . . . . . . . . -- -- -- 5,206 5,206
------ ---- ------- ------- -------
BALANCE, December 31, 1996 . . . . . . . . . 15,919 $168 $52,031 $28,749 $80,948
------ ---- ------- ------- -------
------ ---- ------- ------- -------
</TABLE>
The accompanying notes are an integral part of this consolidated statement.
13
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
For the year ended December 31, 1996
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,206
--------
Adjustments to reconcile net income to net cash
provided by operating activities:
Extraordinary loss on extinguishment of debt . . . . . . . . 2,005
Depreciation and amortization. . . . . . . . . . . . . . . . 15,317
Deferred income taxes and charge in lieu of taxes. . . . . . (1,317)
Restructuring and other non-recurring charges. . . . . . . . 9,749
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . 122
Change in cash from changes in assets and liabilities,
excluding effects of acquisitions and dispositions:
Accounts receivable. . . . . . . . . . . . . . . . . . . . (28,537)
Estimated third party settlements. . . . . . . . . . . . . (9,380)
Other current assets . . . . . . . . . . . . . . . . . . . (270)
Current and other liabilities. . . . . . . . . . . . . . . 11,308
--------
Net cash provided by operating activities. . . . . . . . . 4,203
--------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . (50,800)
Proceeds from disposition of facilities. . . . . . . . . . . . 3,682
Purchases of property and equipment. . . . . . . . . . . . . . (12,575)
Collection on mortgage notes receivable. . . . . . . . . . . . 695
Changes in other assets, net . . . . . . . . . . . . . . . . . (1,623)
--------
Net cash used in investing activities. . . . . . . . . . . (60,621)
--------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term debt . . . . . . . . . . . . . . . . . . (62,598)
Proceeds from issuance of long-term debt . . . . . . . . . . . 56,143
Workers compensation trust funding . . . . . . . . . . . . . . (10,637)
Purchase of treasury stock . . . . . . . . . . . . . . . . . . (8,286)
Proceeds from exercise of options. . . . . . . . . . . . . . . 433
--------
Net cash used in financing activities. . . . . . . . . . . (24,945)
--------
NET DECREASE IN CASH AND CASH
EQUIVALENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . (81,363)
CASH AND CASH EQUIVALENTS, beginning of period . . . . . . . . . . 104,238
--------
CASH AND CASH EQUIVALENTS, end of period . . . . . . . . . . . . . $ 22,875
--------
--------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the year for interest . . . . . . . . . . . . $ 16,713
--------
--------
Cash paid during the year for income taxes . . . . . . . . . . $ 3,750
--------
--------
The accompanying notes are an integral part of this consolidated statement.
14
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the year ended December 31, 1996:
The Company acquired Assist-A-Care Pharmacy in San Diego, California and
issued a promissory note in the amount of $2.6 million as part of the
purchase price.
The Company issued a promissory note in the amount of $2.2 million in
connection with the acquisition of 18 healthcare facilities in Tennessee
and North Carolina.
The Company acquired Executive Pharmacy and issued a promissory note in the
amount of $763,000.
The accompanying notes are an integral part of this consolidated statement.
15
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
As of December 31, 1996, the Company operated 107 healthcare facilities
with 11,200 licensed beds that provide nursing, rehabilitative, subacute and
other specialized medical services primarily in California and in Ohio, West
Virginia, North Carolina and Tennessee. Through its wholly owned home health
subsidiaries, the Company provides patients with technical medical support at
home such as infusion therapy, ventilator care and respite services. The Company
also provides ancillary services such as rehabilitation programs and
pharmaceutical services at certain of its healthcare facilities as well as at
non-affiliated facilities.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and all of its wholly owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated.
CASH AND CASH EQUIVALENTS
For financial reporting purposes, the Company considers all highly liquid
instruments purchased with a maturity of three months or less to be cash
equivalents.
At December 31, 1996, the Company held personal funds in trust for patients
approximating $1,505,000, which are not reflected on the accompanying balance
sheet.
RESTRICTED CASH
Restricted cash of $4,425,000 at December 31, 1996 represents the portion
of the cash in the Company's pre-funded workers' compensation claims payment
trust expected to be paid during 1997.
ACCOUNTS RECEIVABLE
Accounts receivable are recorded at the net realizable value expected to be
received from federal and state assistance programs or from private sources
including managed care organizations and third party insurers. Receivables from
government agencies represent the only concentrated group of credit risk for the
Company. Management does not believe that there are any credit risks associated
16
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
with these government agencies other than possible funding delays.
Non-government agency receivables consist of receivables from various payors
that are subject to differing economic conditions and do not represent any
concentrated credit risks to the Company. Furthermore, management continually
monitors and adjusts its reserves and allowances associated with these
receivables.
PROPERTY AND EQUIPMENT
At the time of Care Enterprises, Inc.'s (Care) emergence from bankruptcy
on December 31, 1990, property and equipment owned by Care and certain
leasehold interests were adjusted to current fair market value. (Care was
merged with Regency in April, 1994 in a transaction accounted for as a
pooling of interests.) All other property and equipment is recorded at cost.
The assets are depreciated over their estimated useful lives using the
straight-line method as follows:
Buildings and improvements. . . . . . . . . . . . . . 7-40 years
Leasehold interests and improvements. . . . . . . . . Life of leases
Equipment . . . . . . . . . . . . . . . . . . . . . . 5-10 years
Betterments, renewals, and extraordinary repairs that extend the life of
the asset are capitalized; other repairs and maintenance are expensed. The cost
and accumulated depreciation applicable to assets retired are removed from the
accounts and any gain or loss on disposition is recognized in income.
ASSETS HELD FOR SALE
Assets held for sale represents the assets of 13 facilities which the
Company determined to dispose of in 1995. At December 31, 1996, it
represents the assets of the seven remaining facilities which the Company
intends to dispose of during 1997 (see Note 11). Such amounts are carried at
estimated fair value less selling costs.
GOODWILL
The excess of the purchase price over the value of the net assets of the
businesses acquired by the Company is amortized using the straight-line method
over periods ranging from 15 to 22 years. The Company periodically evaluates
the carrying value of goodwill in relation to the operating performance and
future undiscounted cash flows of the underlying business to assess
recoverability. Adjustments are made if the sum of expected future net cash
flows is less than book value of goodwill and other depreciable or amortizable
assets.
ASSET IMPAIRMENT
The carrying values of long-lived assets are reviewed if the facts and
circumstances suggest that an item may be impaired. If this review indicates
that a long-lived asset will not be recoverable, as determined based on the
future undiscounted cash flows of the asset, the Company's carrying value of the
long-lived asset is reduced to fair value.
OTHER LONG-TERM ASSETS
Costs incurred to obtain long-term financing are amortized using the
effective interest method. Costs to initiate and implement subacute specialty
units are amortized on a straight-line basis over 36 months.
DEFERRED REVENUE
Deferred revenue consists of patient billings recorded in advance of
services rendered.
17
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
WORKERS' COMPENSATION
The Company maintains self-insurance programs for workers' compensation for
its nursing facilities in California and Ohio, pharmacy operations, home health
operations and its corporate office employees. For all other operations, the
Company purchases insurance for this risk. The self-insurance liability under
these programs is based on claims filed and actuarial estimates of claims
incurred but not reported. Differences between the amounts accrued and
subsequent settlements are recorded in operations in the year of settlement.
NET OPERATING REVENUE
Revenues are derived from the operation of healthcare facilities, which are
subject to federal and state regulation. Approximately 69.9 percent of
revenues were derived from services provided under federal (Medicare) and state
(Medicaid) medical assistance programs for the year ended December 31, 1996.
Revenues from Medicaid are recorded at the prescribed contract rate. Revenues
from Medicare are recorded based on an estimate of the Company's reimbursable
cost. Limitations on Medicare and Medicaid reimbursement for healthcare
services are continually proposed. Changes in applicable laws and regulations
could have an adverse effect on the levels of reimbursement from governmental,
private, and other sources. These revenues are based, in part, on cost
reimbursement principles and are subject to audit. Provisions for estimated
third-party payor settlements are provided in the period the related services
are rendered. Differences between the amounts accrued and subsequent
settlements are recorded in operations in the year of settlement.
Additionally, the Company's cost of care for its Medicare patients
sometimes exceeds regional reimbursement limits established by Medicare. The
Company has submitted exception requests for 156 cost reports, covering all cost
report periods through December 31, 1994. To date, final action has been taken
by the Health Care Financing Administration ("HCFA") on 105 exception requests.
The Company's final rates as approved by HCFA represent approximately 84% of the
requested rates as submitted in the exception requests. During 1994, the
Company recognized 50% of the 1994 estimated exception requests anticipated to
be received, which represented revenues of approximately $1,550,000. Commencing
January 1, 1995, the Company recognized 70% of the estimated exception requests
anticipated to be received, which represents revenues of approximately
$3,001,000 and $3,563,000 in 1995 and 1996, respectively. Management believes
that the Company will be able to recover its excess costs under any pending
exception requests or under any exception requests that may be submitted in the
future, however there can be no assurance that it will be able to do so.
STOCK BASED COMPENSATION
Effective January 1, 1996, the Company adopted the disclosure provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 requires
the Company to disclose pro forma net income and earnings per share as if the
fair value based accounting method of SFAS No. 123 had been used to account for
stock based compensation. Those disclosures are included in Note 8.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
18
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. LONG-TERM DEBT
Long-term debt consists of the following as of December 31, 1996 (dollars
in thousands):
Senior Subordinated Notes, interest at 9.875 percent, due October
2002. Interest is payable semi-annually on October 15 and April 15,
commencing April 15, 1996; redeemable beginning
October 15, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . $110,000
Junior Subordinated Notes, interest at 12.25 percent, due July 2003,
interest payable semi-annually on January 15 and July 15, commencing
January 1997; redeemable beginning July 15, 2000 . . . . . . . . . . . 50,000
Industrial revenue bonds ("IRBs"), interest at rates from 4.0 to
8.25 percent, due through September 2012 in varying amounts. . . . . . 9,675
Note payable, collateralized by a deed of trust, interest at
8.75 percent; interest and principal payable monthly through
September 2033 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,697
Note payable, secured, interest at 9.0 percent, interest and principal
payable monthly, balance due November 2013 . . . . . . . . . . . . . . 4,276
Other unsecured indebtedness, interest rates up to 13.0 percent,
payable in varying installments through August 2017. . . . . . . . . . 646
Other secured long-term debt, interest rates up to 10.25 percent,
payable in varying installments through August 2014. . . . . . . . . . 5,614
--------
184,908
Less current portion. . . . . . . . . . . . . . . . . . . . . . . . . . 2,418
--------
$182,490
--------
--------
On June 28, 1996, the Company issued 12.25% Junior Subordinated Notes (the
"Junior Subordinated Notes") in an aggregate amount of $50 million. The Junior
Subordinated Notes will mature on July 15, 2003, unless previously redeemed.
Net proceeds received by the Company totaled approximately $48.4 million and
funded the redemption of the Company's outstanding 6.5% Convertible
19
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. LONG-TERM DEBT (CONTINUED)
Subordinated Debentures due 2003 (the "Convertible Subordinate Debentures") on
July 29, 1996. The Junior Subordinated Notes contain certain covenants, which
are similar to the 9.875% Senior Subordinated Notes ("Subordinated Notes"),
including limitations on the ability of the Company to, among other things, (a)
incur additional indebtedness and issue redeemable preferred stock, (b) sell
equity interests in subsidiaries, (c) make certain restricted payments (as
defined), (d) create liens, and (e) engage in mergers, consolidations or
transfers of substantially all of the assets of the Company to another party.
Effective September 30, 1996, the Company refinanced three of its
Industrial Revenue Bond Issues (IRBs) with an aggregate outstanding principal
balance of $7,560,000 with three new issues of tax exempt IRBs maturing through
September 2012. One of the new issues has a principal balance of $2,830,000 and
bears interest at rates ranging from 4.2% to 6.0% based on the maturity dates of
the individual bonds. The other two IRBs bear interest at a variable rate
initially set at 4.0% which is capped at 12.0%. The refinancing resulted in an
extraordinary loss on extinguishment of debt of $325,000, net of tax resulting
from the write-off of unamortized underwriting costs and payment of a call
premium. The IRBs are secured by irrevocable standby letters of credit issued
against the Company's Amended Credit Agreement.
On December 28, 1995 the Company entered into a revolving credit loan
agreement ("Credit Agreement") with NationsBank of Texas, N.A. as agent for a
group of banks, which provided up to $50 million in revolving line of credit
and letters of credit. No borrowings were drawn on the Credit Agreement
throughout 1996. On December 20. 1996, the Company increased the available
financing to $100 million and revised certain terms and covenants through the
Amended and Restated Credit Agreement ("Amended Credit Agreement").
Borrowings bear interest at either the Base Rate plus up to .50% or the
Adjusted Eurodollar Rate plus .75% to 2.00%, depending on the Company's
Consolidated Adjusted Leverage Ratio, all as defined in the Amended Credit
Agreement. The Amended Credit Agreement has scheduled commitment reductions
of $25 million each on January 2, 1999 and 2000 and expires on January 2,
2001. The Amended Credit Agreement is collateralized by accounts receivable,
all of the common stock of each of the Company's subsidiaries and certain
other current assets of the Company and its subsidiaries. The Amended Credit
Agreement, among other things, (a) requires the Company to maintain certain
financial ratios, and (b) restricts the Company's ability to incur debt and
liens, make investments, pay dividends, purchase treasury stock, prepay or
modify certain debt of the Company, liquidate or dispose of assets, merge
with another corporation, and create or acquire subsidiaries. As of December
31, 1996, $16.2 million of standby letters of credit were issued in
connection with the Company's self-insured workers' compensation programs and
refinanced Industrial Revenue Bonds (discussed above) out of a total
available of $35 million. On January 2, 1997 the Company borrowed $40
million under the Amended Credit Agreement.
On October 12, 1995, the Company issued Subordinated Notes in an aggregate
amount of $110 million. Net proceeds received by the Company totaled
approximately $106.7 million of which approximately $31.5 million was used to
repay the principal and a prepayment penalty on the Company's 8.10% Senior
Secured Notes (which resulted in a loss on extinguishment of debt of
approximately $1.6 million, net of tax) and $47.4 million was used for
acquisitions in 1996 (see Note 10). The Subordinated Notes contain certain
covenants, including limitations on the ability of the Company to, among other
things, (a) incur additional indebtedness and issue preferred stock, (b) sell
equity interests in subsidiaries, (c) make certain restricted payments (as
defined), (d) create liens, and (e) engage in mergers, consolidations or the
transfer of substantially all of the assets of the Company to another party.
20
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. LONG-TERM DEBT (CONTINUED)
On July 29, 1996, the Company completed the redemption of all $48.9 million
of its outstanding Convertible Subordinated Debentures for cash at such amount
from the proceeds of the Junior Subordinated Notes and available cash. The
redemption reduces fully diluted shares by 3.9 million and produces an
extraordinary loss on extinguishment of debt of $868,000, net of tax, resulting
from the write-off of unamortized underwriting costs.
Each of the mortgage notes and certain IRBs are secured by a first deed of
trust on the related facility. Certain IRBs require the maintenance of debt
service reserves funds and all of the IRBs contain affirmative and negative
covenants.
Principal maturities on long-term debt are as follows (in thousands):
YEAR ENDING DECEMBER 31.
------------------------
1997. . . . . . . . . . . . . . . . . . . . . . . $ 2,418
1998. . . . . . . . . . . . . . . . . . . . . . . 3,079
1999. . . . . . . . . . . . . . . . . . . . . . . 497
2000. . . . . . . . . . . . . . . . . . . . . . . 505
2001. . . . . . . . . . . . . . . . . . . . . . . 802
Thereafter. . . . . . . . . . . . . . . . . . . . 177,607
--------
Total . . . . . . . . . . . . . . . . . . . . $184,908
--------
--------
3. INCOME TAXES
The Company and its subsidiaries file consolidated federal and state income
tax returns and account for income taxes under the provisions of SFAS No. 109.
As a result of the Care bankruptcy proceedings, a "change in ownership"
occurred. Prior to the Merger, the Company had substantial net operating loss
carryforwards for tax purposes ("Tax NOL") and income tax credit carryforwards.
In March 1994, the Internal Revenue Service ("IRS") issued final regulations
relative to Tax NOL utilization when a "change in ownership" occurs in
bankruptcy proceedings. These regulations reduced the aggregate Tax NOL
available to the Company but did not limit its annual use.
As a result of the Merger, another "change in ownership" occurred and the
Company's Tax NOL and credit carryforward utilization became subject to a
combined annual limitation of approximately $7.9 million (on a pre-tax basis) in
periods after the Merger.
After considering the adjustments resulting from the IRS examination for
the years 1987 through 1990, the Company has a federal Tax NOL of $2,929,000
and income tax credit carryforwards of $5,503,000 available for use at
December 31, 1996. As a result of Fresh Start Reporting, the tax benefits
realized from the pre-bankruptcy Tax NOL and income tax credit carryforwards
are recorded as an increase in additional paid-in capital and are not
recorded in the statement of operations.
21
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INCOME TAXES (CONTINUED)
The provision for income taxes is as follows for the year ended December
31, 1996 (in thousands):
Current provision:
Federal. . . . . . . . . . . . . . . . . . . $4,950
State. . . . . . . . . . . . . . . . . . . . 1,315
------
6,265
Deferred provision:
Federal. . . . . . . . . . . . . . . . . . . (3,797)
State. . . . . . . . . . . . . . . . . . . . (670)
------
(4,467)
Charge in lieu of income taxes. . . . . . . . . . 2,814
------
$4,612
------
------
A reconciliation of the federal statutory income tax rate with the
Company's effective tax rate for the year ended December 31, 1996 follows:
Federal statutory rate. . . . . . . . . . . . . . 34.0%
State income taxes, net of federal benefit. . . . 6.0
Goodwill amortization . . . . . . . . . . . . . . 3.1
Other, net. . . . . . . . . . . . . . . . . . . . (1.2)
------
41.9%
------
------
22
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INCOME TAXES (CONTINUED)
Deferred income taxes arise from temporary differences in the recognition
of certain expenses for financial and tax reporting purposes. The following is a
summary of these differences and the tax effect of each as of December 31, 1996
(in thousands):
Deferred income tax assets:
Allowance for doubtful accounts................... $ 1,057
Net operating loss carryforward................... 996
Loss contingencies and legal settlements.......... 416
Workers' compensation claims...................... 5,370
Covenant not to compete........................... 901
Disposition of assets charges..................... 4,166
Other reserves.................................... 3,389
Credit carryforwards.............................. 5,519
Other............................................. 243
Valuation allowance............................... (5,207)
----------
Total deferred income tax assets....................... 16,850
----------
Deferred income tax liabilities:
Depreciation...................................... (9,417)
Other............................................. (5,553)
----------
Total deferred income tax liabilities.................. (14,970)
----------
Net deferred income tax asset.......................... $ 1,880
----------
----------
The valuation allowance primarily relates to the net operating loss and
income tax credit carryforwards of the Company for periods prior to its
emergence from bankruptcy. If and when such carryforwards are realized, the
offset will be to additional paid-in capital not to the provision for income
taxes.
4. DEFERRED RENT
Several of the Company's facilities and a home health office are leased
under long-term operating leases that specify scheduled rent increases over the
lease terms. Deferred rent of approximately $986,000, at December 31, 1996, has
been established to recognize the difference between the rent expense paid and
the straight-line recognition of minimum rental expense and is classified in
other liabilities and noncurrent reserves.
5. COMMITMENTS AND CONTINGENCIES
LETTERS OF CREDIT
The Company is contingently liable under letters of credit related to
deposit requirements on its self-insured workers' compensation plans and the
IRBs discussed in Note 2. State regulations require the maintenance of deposits
at specified percentages of estimated future workers' compensation claim
payments that can be satisfied through a combination of cash deposits, surety
bonds and letters of credit. The total amount of letters of credit outstanding
at December 31, 1996, was $16,202,000.
23
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEASES
The Company leases certain facilities and offices under cancelable and
noncancelable agreements expiring at various dates through 2047. The leases are
generally triple-net leases and provide for the Company's payment of property
taxes, insurance, and repairs. Certain leases contain renewal options and rent
escalation clauses. Rent escalation clauses require either fixed increases or
increases tied to the Consumer Price Index ("CPI"). Six leases include purchase
options at fixed or market prices at various dates.
Future minimum lease payments for operating leases at December 31, 1996 are
as follows (in thousands):
YEAR ENDING DECEMBER 31,
------------------------
1997.................................. $ 24,402
1998.................................. 23,005
1999.................................. 22,358
2000.................................. 21,460
2001.................................. 20,127
Thereafter............................ 110,805
---------
$ 222,157
---------
---------
GUARANTEE OF LEASES
The Company is contingently liable for certain operating leases assumed by
the purchasers of the Company's leasehold interests in facilities. With the
exception of a single facility re-entered on October 1, 1994, following the
filing of bankruptcy by the Company's sublessee, which has been operated by the
Company since November 1, 1994, the Company is not aware of any failure on the
part of these purchasers to meet the terms of their obligations, and does not
anticipate any expenditures to be incurred in connection with its guarantees. If
a default were to occur, the Company generally would be able to assume
operations of the facility and use the net revenues thereof to defray the
Company's expenditures on these guarantees.
The following is a schedule of future minimum lease payments at December
31, 1996 for the operating leases for which the Company is contingently liable
(in thousands):
YEAR ENDING DECEMBER 31,
-----------------------
1997.................................. $ 3,165
1998.................................. 1,125
1999.................................. 1,128
2000.................................. 1,136
2001.................................. 1,023
Thereafter............................ 4,617
--------
$ 12,194
--------
--------
LITIGATION
The Company is subject to claims and legal actions by patients and others
in the ordinary course of its business. The Company has insurance policies
related to patient care claims and legal actions. In
24
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
the event judgments were awarded for non-patient care legal actions or in
excess of the insurance coverage for patient care legal actions, the burden
would fall on the Company. The Company does not expect that the ultimate
outcome of an unfavorable judgment in any pending legal matters would result in
a material adverse effect on the Company's consolidated financial position or
results of operations.
EMPLOYMENT AGREEMENTS
At December 31, 1996, the Company had employment agreements with its
president, and certain executive and senior vice presidents, which provide for
annual base salaries in the aggregate of $1,212,000. The agreements expire at
various dates through 1999.
INSURANCE
The Company maintains general and professional liability insurance on a
claims made basis, subject to a $100,000 self-insurance retention. In addition,
all-risk property insurance, including earthquake and flood, is maintained for
all Company locations.
The Company estimates its liability under the above described programs,
including potential legal fees and settlement amounts, with respect to incurred
but not reported claims on a monthly basis, based upon its historical
experience.
6. RELATED PARTY TRANSACTIONS
In February 1988, the Company entered into a 20-year lease with three
five-year option periods for its Heritage (Torrance) facility that is owned by a
former director of the Company. The lease provides for monthly payments,
currently $35,000, which are adjusted annually based on the CPI. Lease expense
for the year ended December 31, 1996, was approximately $419,000.
In June 1990, the Company entered into a ten year lease with four five-year
option periods for its Glendora facility that is directly owned by one former
director and indirectly owned by another director. The lease provides for equal
monthly payments for three years, after which the monthly payment is adjusted
annually based on increases in the CPI. Lease expense for the year ended
December 31, 1996, was approximately $446,000.
The Company leases from Newport Harbor Investments Limited, Inc. ("Newport
Harbor"), a corporation wholly-owned by a former director of the Company, two
nursing facilities located in Beaumont and Riverside, California. The leases
provide for monthly rent payments of $7,083 and $5,142, respectively, subject to
periodic adjustments based on certain increases in the CPI or Medi-Cal
reimbursement rates. The Riverside facility lease contains an option to
purchase the facility for $675,000, subject to adjustment based on increases in
the CPI from March 1992. In 1992, the Company paid Newport Harbor $120,000 as
consideration for the extension of the purchase option on the Riverside facility
for a five-year period. During 1996 the Company exercised the option and
acquired the facility for approximately $700,000, net of the consideration
already paid. Lease expense paid by the Company for the year ended December 31,
1996, was approximately $133,000.
25
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. INCOME PER SHARE
For the year ended December 31, 1996, income per share was calculated
based on the weighted average number of common and common equivalent shares
outstanding during the period of 16,476,000. Fully diluted income per share
for the year ended December 31, 1996 is not presented because the effect of
the assumed conversion of the Convertible Subordinated Debentures was
anti-dilutive.
8. STOCK OPTIONS
Pursuant to the acquisition of Care, Care became a wholly owned subsidiary
of Regency. Stockholders of Care received 0.71 of a share of Regency common
stock for each share of Care common stock outstanding. Pursuant to the Merger,
Regency's stock option plan was amended to increase the number of shares of
Regency common stock available for grant to 1,937,991 shares. This amount does
not include the assumption of the Care stock option plan or share appreciation
rights plan.
The Company has a Director Stock Plan whereby each non-employee director of
the Company receives on July 1 of each year 2,000 restricted shares of Company
Common Stock and options to purchase an additional 6,000 shares of Company
Common Stock. The period of restriction for each award of shares of restricted
stock expires on the last to occur of: the end of the six month period
following the grant date; participant's direct or indirect pecuniary ownership
of shares not subject to restrictions for at least 12 months, provided that the
restrictions shall lapse with respect to one restricted share granted for every
two shares of unrestricted shares; and participants attendance at 75% of the
scheduled board meetings during the 12 month period immediately preceding the
grant date. Any shares which remain restricted when a director's service on the
Company's Board terminates, will be forfeited. The stock options are granted at
fair market value on the date of grant and the participants are entitled to
exercise such options beginning six months and one day after grant and ending
ten years after grant. During the year ended December 31, 1996, the Company
awarded 12,000 shares of restricted stock. At December 31, 1996 restrictions
remained on 12,000 shares of stock. In January 1997, the period of restriction
lapsed on 12,000 shares.
26
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTIONS (CONTINUED)
The following is a summary of options granted pursuant to Regency's
Employee and Director stock option plans during the year ended December 31, 1996
(such amounts do not include restricted stock awards):
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
--------- ---------
Options outstanding at the
beginning of the year . . . . . . . . 1,226,214 $11.94
Granted. . . . . . . . . . . . . . . . 911,000 10.34
Exercised. . . . . . . . . . . . . . . (99,491) 4.28
Canceled . . . . . . . . . . . . . . . (288,612) 13.28
--------- ---------
--------- ---------
Options outstanding at the end of
the year. . . . . . . . . . . . . . . 1,749,111 $11.32
--------- ---------
--------- ---------
Options Exercisable. . . . . . . . . . 493,008
---------
---------
During 1996, no compensation cost was recognized related to the above stock
options. The following outlines the significant assumptions used to calculate
the fair value information presented utilizing the Black-Scholes Single Option
approach with ratable amortization.
Risk-free interest rate. . . . . . . . . . . . . . . . . . . . . 5.90%
Expected life. . . . . . . . . . . . . . . . . . . . . . . . . . 7.65
Expected volatility. . . . . . . . . . . . . . . . . . . . . . . 41%
Expected dividends . . . . . . . . . . . . . . . . . . . . . . . --
Weighted average grant date fair value of options granted. . . . $5.61
A detail of the options outstanding and exercisable as of December 31, 1996 is
presented below:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------------------- -------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE IN YEARS PRICE EXERCISABLE PRICE
----------------- ----------- ------------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 3.17 - $ 6.98 105,561 .84 $ 3.95 100,235 $ 3.94
9.15 - 10.75 821,112 8.83 10.04 86,796 10.15
11.00 - 12.88 389,000 8.72 11.69 71,250 11.68
15.00 - 15.38 433,438 7.34 15.22 234,727 15.21
----------------- --------- ---- ------ ------- ------
$ 3.17 - $15.38 1,749,111 7.96 $11.32 493,008 $11.52
----------------- --------- ---- ------ ------- ------
----------------- --------- ---- ------ ------- ------
</TABLE>
27
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTIONS
As the Company has adopted the disclosure requirement of SFAS No. 123,
the following table shows pro forma net income and earnings per share as if
the fair value based accounting method had been used to account for
stock-based compensation cost for the year ended December 31, 1996 (In
thousands, except earnings per share).
Net income as reported................................. $5,206
Pro forma compensation expense......................... (774)
------
------
Pro forma net income................................... $4,432
------
------
Pro forma earnings per share........................... $ .27
------
------
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts. At December 31, 1996, 2,123,897 shares of common
stock have been reserved for issuance under the Company's stock option plans.
28
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. RETIREMENT SAVINGS PLAN
Regency sponsors an employee retirement savings plan under Section 401(k)
of the Internal Revenue Code. All employees who are regularly scheduled to work
20 hours or more per week, and complete 90 days of service are eligible to
participate. Participants can contribute, on a pre-tax basis, up to 15% of
their earnings to the plan (subject to certain limitations), for which the
Company matched 15% of the first 3% of contributions made for persons with less
than three years of service and 25% of the first 5% for all others. The
Company's contributions are subject to a four-year vesting period. Matching
contributions made by the Company for the year ended December 31, 1996 were
approximately $697,000.
10. ACQUISITIONS
Effective January 2, 1996, the Company completed the acquisition of the
assets of Assist-A-Care, a pharmacy located in San Diego, California. The
purchase price was $5.8 million, composed of $3.2 million cash and a $2.6
million note payable.
29
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. ACQUISITIONS (CONTINUED)
Effective February 1, 1996, the Company acquired leasehold interests in
18 health care facilities in Tennessee and North Carolina with 2,375 beds
from Liberty Healthcare Limited Partnership ("Liberty") through an asset
purchase for $39.3 million cash and a note payable for $2.2 million. The
Company also acquired Executive Pharmacy (consisting of one pharmacy in North
Carolina and one in Tennessee) with a $763,000 note payable and an enteral
feeding business for $1.5 million cash from businesses affiliated with
Liberty. In addition, the Company paid $400,000 cash for the inventory of
Liberty. A portion of the purchase was funded with notes payable, which may
be reduced as a result of certain seller liabilities and audit adjustments.
Escrow accounts established at the time of purchase were funded with $2.96
million for payment on the notes payable and are included in other assets on
the accompanying consolidated balance sheet as of December 31, 1996.
On April 1, 1996, the Company completed the acquisition of the assets of
Buena Vista Nursing Center ("Buena Vista"), a health care facility with 64
skilled nursing beds and 22 assisted living beds, located in Lexington, North
Carolina. The purchase price was $2.875 million, consisting of $2.675 million
in cash and a $200,000 note payable. Payment of the note is dependent upon
Buena Vista attaining certain financial targets.
On July 6, 1995, the Company acquired all of the stock of SCRS &
Communicology, Inc. ("SCRS") for a total purchase price of $13.5 million, of
which $3.4 million is represented by a promissory note which was paid in January
1996. SCRS provides contract rehabilitation services to Company operated and
third party healthcare facilities.
All acquisitions during 1996 were accounted for under the purchase method
of accounting.
The following unaudited pro forma condensed consolidated statement of
earnings present the summarized consolidated results of operations of the
Company after giving effect to the acquisitions of Liberty and
Liberty-affiliated businesses for the year ended December 31, 1996, as if
such acquisitions had been consummated on January 1, 1996 (in thousands,
except per share data):
(Unaudited)
Net operating revenue.................................. $564,856
Total costs and expenses............................... 553,264
---------
Income before provision for income taxes............... 11,592
Provision for income taxes............................. 4,856
---------
Net income before extraordinary item .................. $ 6,736
---------
---------
Income before extraordinary item per common share...... $ 0.41
---------
---------
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 effect of the other acquisitions is
immaterial.
11. RESTRUCTURING AND OTHER NON-RECURRING CHARGES
During 1996 the Company developed a comprehensive strategic plan impacting
all of its operating divisions. In connection with this strategic plan the
Company has undertaken initiatives designed to reengineer the operating model
through which it manages its business. This reengineering effort is focused on
identifying and implementing the most effective and efficient model for managing
the delivery of products and services to the Company's patients on a local
market basis. The
30
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. RESTRUCTURING AND OTHER NON-RECURRING CHARGES (CONTINUED)
plan includes consolidating and automating the Pharmacy operations,
consolidating the Home Health operations, automating and streamlining certain
functions in the nursing center operations, and streamlining the corporate
support structure. Through this process the Company identified approximately
350 non-direct patient care positions across all divisions, including the
Corporate Office, which will be eliminated. Of the positions identified,
approximately 30 were eliminated during 1996. The Company began the
implementation phase of this plan during the fourth quarter of 1996.
Additionally, the Company has identified the implementation of
significant management information system (MIS) enhancements as a critical
component of its overall strategic plan. Implementing these MIS initiatives
will be an integral part of the realization of an effective and efficient
management model, through which the Company can monitor its patients, from
both a cost and a clinical perspective, seamlessly throughout the continuum
of care and across all divisions of the Company. Furthermore, these MIS
initiatives will provide management with complete patient information within
each local market, which is vital in the managed care environment of today
and in the future. This implementation is expected to continue during 1997
and into 1998. Several of the Company's current management information
systems will be replaced in connection with the MIS initiatives. The Company
has also identified certain impaired property and equipment and intangible
assets and future contractual obligations that will have no value to the
Company under the new operating model due to obsolescence, consolidation of
locations, and streamlining of processes. Accordingly, the Company has
written off certain long-term assets and accrued certain obligations related
to leases.
The Company has evaluated the reserve established in 1995 for the
disposition of 13 facilities located in California discussed below and
allowances established for certain notes and other non-patient receivables.
Based on the actual sale of six of the 13 facilities, and the estimated sales
prices for the remaining seven facilities, the Company has reduced the
reserve for the disposition of 13 facilities of December 31, 1996. Earnings
before income taxes for the remaining seven facilities were $940,000 for the
year ended December 31, 1996. In addition, an allowance was established for
certain notes and non-patient receivables that arose in prior years, which
were not collected as anticipated by the Company and certain long-term assets
were written down to net realizable value.
The following summarizes the impact of the above items on the Company's
results of operations for 1996:
<TABLE>
<CAPTION>
RESTRUCTURING NON-RECURRING TOTAL
------------- ------------- ------------
<S> <C> <C> <C>
MIS and other property and
equipment written off................. $ 2,057,000 $ 2,320,000 $ 4,377,000
Goodwill and other assets written off... 2,300,000 1,255,000 3,555,000
Future lease and other obligations...... 325,000 1,891,000 2,216,000
Severance (including $711,000 paid
during 1996).......................... 1,377,000 -- 1,377,000
Allowance for notes and other
receivables........................... -- 1,010,000 1,010,000
Reengineering costs incurred............ 511,000 -- 511,000
Reduction of reserve for assets
held for sale......................... -- (1,763,000) (1,763,000)
------------- ------------- ------------
$ 6,570,000 $ 4,713,000 $11,283,000
------------- ------------- ------------
------------- ------------- ------------
</TABLE>
31
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. RESTRUCTURING AND OTHER NON-RECURRING CHARGES (CONTINUED)
In 1995, the Company determined to dispose of 13 facilities located in
California. In addition, during 1995 the Company completed the disposition of
duplicate facilities identified during 1994 as part of the merger and
restructuring costs, the Simi Valley healthcare facility damaged in the Southern
California (Northridge) earthquake and one other facility, and exchanged
leasehold interests in three nursing centers in New Mexico for leasehold
interest in four nursing centers in Ohio. These transactions resulted in a net
charge of $9,000,000 during 1995. This charge was based upon management's best
estimates of the amounts expected to be realized on the disposition of those
facilities with carrying amounts in excess of estimated fair value less selling
costs.
12. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments at
December 31, 1996 are as follows (in thousands):
CARRYING AMOUNT FAIR VALUE
--------------- ----------
Cash and cash equivalents.................... $ 22,875 $ 22,875
---------- ----------
---------- ----------
Mortgage notes receivable.................... $ 1,937 $ 1,937
---------- ----------
---------- ----------
Long-term debt, including current portion.... $ 184,908 $ 190,139
---------- ----------
---------- ----------
The carrying amount approximates fair value for cash and cash equivalents
because of the short maturity of these instruments. The fair value of
mortgage notes receivable was estimated based on the present value of future
cash flows using current rates the Company could obtain on notes with similar
characteristics and maturities. The fair value for the Company's long-term
debt was estimated based on the quoted market prices for the same or similar
issues or on the present value of future cash flows using current rates the
Company could obtain on debt with similar characteristics and maturities.
13. SUBSEQUENT EVENTS
Effective January 1, 1997, the Company acquired four acute rehabilitation
hospitals, eleven outpatient rehabilitation clinics and six neurological
treatment centers from Horizon/CMS Healthcare Corporation ("CMS"). The
purchase price was $43.0 million, made up of a cash payment of $36.3 million
and notes payable totaling $6.7 million.
32
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. QUARTERLY FINANCIAL DATA (UNAUDITED):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
-------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTAL
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Net operating revenue $ 129,963 $ 137,632 $ 144,103 $ 146,352 $ 558,050
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Income (loss) before extraordinary item $ 2,737 $ 3,065 $ 3,641 $ (3.044) $ 6,399
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net income (loss) $ 2,737 $ 3,065 $ 2,448 $ (3,044) $ 5,206
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Income (loss) per share -- Primary:
Income (loss) before extraordinary
item $ .16 $ .19 $ .22 $ (.19) $ .39
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net income (loss) $ .16 $ .19 $ .15 $ (.19) $ .32
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Income (loss) per share -- Fully Diluted:
Income (loss) before extraordinary
item $ .16 $ .18 $ .22 $ (.19) $ .39
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net income (loss) $ .16 $ .18 $ .15 $ (.19) $ .32
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
Effective January 2, 1996, the Company completed the acquisition of the
assets of Assist-A-Care, a pharmacy located in San Diego, California. The
purchase price was $5.8 million, composed of $3.2 million in cash and a $2.6
million note payable.
Effective February 1, 1996, the Company acquired leasehold interests in
18 health care facilities in Tennessee and North Carolina with 2,375 beds
from Liberty Healthcare Limited Partnership ("Liberty") through an asset
purchase for $39.3 million cash and a note payable for $2.2 million. The
Company also acquired Executive Pharmacy (consisting of one pharmacy in North
Carolina and one in Tennessee) with a $763,000 note payable and an enteral
feeding business for $1.5 million cash from businesses affiliated with
Liberty. In addition, the Company paid $400,000 cash for the inventory of
Liberty.
On April 1, 1996, the Company completed the acquisition of the assets of
Buena Vista Nursing Center in Lexington, North Carolina. The purchase price
was $2.875 million, consisting of $2.675 million in cash and a note payable
for $200,000.
On July 29, 1996, the Company completed the redemption of all $48.9 million
of its outstanding Convertible Subordinated Debentures for cash at such amount.
The redemption reduces fully diluted shares by $3.9 million shares and results
in an extraordinary loss on extinguishment of debt of $868,000, net of tax,
resulting from the write-off of unamortized underwriting costs.
Effective September 30, 1996, the Company refinanced three of its IRBs with
an aggregate outstanding principal balance of $7,560,000 with three new issues
of tax exempt IRBs. The refinancing resulted in an extraordinary loss on
extinguishment of debt of $325,000, net of tax, resulting from the write-off of
unamortized underwriting costs and a call premium paid.
33
<PAGE>
(b) Pro Forma Financial Information
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
The following Unaudited Pro Forma Combined Balance Sheet as of September
30, 1997 and the Unaudited Pro Forma Combined Statements of Earnings for the
nine months ended September 30, 1997 and the year ended December 31, 1996
give effect to the acquisition of Regency by the registrant (the "Regency
Acquisition") as if the Regency Acquisition had occurred on September 30,
1997 for the Unaudited Pro Forma Combined Balance Sheet and January 1, 1996
for the Unaudited Pro Forma Combined Statements of Earnings.
The pro forma adjustments are based upon currently available information
and upon certain assumptions that Sun's management believes are reasonable.
Sun accounted for the Regency Acquisition as a purchase of Regency by Sun.
Regency's assets and liabilities were recorded at their initial estimated
fair market values as of the date of the Regency Acquisition.
The adjustments included in the Unaudited Pro Forma Combined Financial
Statements represent Sun's preliminary determination of these adjustments
based upon available information. There can be no assurance that the actual
adjustments will not differ significantly from the pro forma adjustments
reflected in the Unaudited Pro Forma Combined Financial Statements.
The Unaudited Pro Forma Combined Financial Statements are not necessarily
indicative of the financial position or either future results of operations
or results that might have been achieved if the foregoing transaction had
been consummated as of the indicated dates. The Unaudited Pro Forma Combined
Financial Statements should be read in conjunction with the historical
consolidated financial statements of Sun and Regency, together with the
related notes thereto.
The Unaudited Pro Forma Combined Statements of Earnings do not reflect
the integration costs related to the Regency Acquisition or the benefits or
cost savings anticipated to result from the Regency Acquisition.
34
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES AND
REGENCY HEALTH SERVICES, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
AS OF SEPTEMBER 30, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
REGENCY SUN &
ACQUISITION REGENCY
SUN REGENCY ADJUSTMENTS COMBINED
--------- --------- ----------- ----------
<S> <C> <C> <C> <C>
Cash and cash equivalents............................................. $ 2,418 $ 18,435 -- $ 20,853
Restricted cash....................................................... 1,666 7,166 -- 8,832
Accounts receivable, net.............................................. 379,011 99,361 (5,500)(m) 469,872
(3,000)(n)
Other receivables..................................................... 17,844 1,528 19,372
Prepaids and other assets............................................. 28,984 16,261 -- 45,245
Deferred tax asset.................................................... 331 6,897 2,394 9,622
--------- --------- ----------- ---------
Total current assets.............................................. 430,254 149,648 (6,106) 573,796
--------- --------- ----------- ---------
Property & equipment, net............................................. 546,456 171,393 (2,867)(c) 714,982
Goodwill, net......................................................... 566,367 62,665 367,121(d) 933,488
(62,665)(e)
Other assets, net..................................................... 168,649 26,711 (15,860)(f) 202,206
27,000(g)
(3,559)(b)
(735)(p)
Deferred tax asset.................................................... 702 -- 27,676(h) 34,572
6,194(r)
--------- --------- ----------- ---------
Total assets...................................................... $1,712,428 $ 410,417 $ 336,199 $2,459,044
--------- --------- ----------- ---------
--------- --------- ----------- ---------
Current portion of long-term debt..................................... $ 42,180 $ 5,389 -- $ 47,569
Accounts payable and
accrued expenses.................................................... 152,030 85,778 (1,388)(b) 251,505
2,800(o)
8,485(p)
3,800(q)
--------- --------- ----------- ---------
Total current liabilities......................................... 194,210 91,167 13,697 299,074
--------- --------- ----------- ---------
Long-term debt, net of current portion................................ 861,245 223,765 394,202(g) 1,490,998
(147,637)(g)
147,637(g)
3,500(k)
8,286(l)
Other long-term liabilities........................................... 12,994 10,848 -- 23,842
Deferred income taxes................................................. 11,799 2,439 -- 14,238
--------- --------- ----------- ---------
Total liabilities................................................. 1,080,248 328,219 419,685 1,828,152
--------- --------- ----------- ---------
Minority interest................................................. 2,328 -- -- 2,328
Redeemable convertible
preferred stock..................................................... -- -- -- --
Preferred stock....................................................... -- -- -- --
Common stock.......................................................... 516 169 (169)(i) 516
Additional paid-in-capital............................................ 639,687 52,029 (52,029)(i) 639,687
Retained earnings..................................................... 75,492 30,000 (29,117)(i) 74,204
(2,171)(b)
Cumulative translation adjustment..................................... (444) -- -- (444)
--------- --------- ----------- ---------
715,251 82,198 (83,486) 713,963
--------- --------- ----------- ---------
Less:
Unearned compensation............................................... 14,816 14,816
Common stock held in treasury, at cost.............................. 25,574 -- -- 25,574
Employee benefit trust,
at market......................................................... 45,009 -- -- 45,009
--------- --------- ---------- ----------
Total stockholders' equity........................................ 629,852 82,198 (83,486) 628,564
--------- --------- ----------- ---------
Total liabilities and stockholders' equity........................ $1,712,428 $ 410,417 $ 336,199 $2,459,044
--------- --------- ----------- ---------
--------- --------- ----------- ---------
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
35
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES AND
REGENCY HEALTH SERVICES, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF EARNINGS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SUN REGENCY SUN &
FINANCE SUN ACQUISITION REGENCY
SUN TRANSACTION ADJUSTED REGENCY ADJUSTMENTS COMBINED
--------- ----------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Total net revenues............................ $1,332,354 $ -- $1,332,354 $ 490,012 $ -- $1,822,366
---------- ---------- ---------- --------- ----------- ----------
Costs and expenses:
Operating................................... 1,091,249 -- 1,091,249 421,043 -- 1,512,292
Corporate general and administrative........ 63,189 -- 63,189 29,574 -- 92,763
Provision for losses on receivables......... 10,736 -- 10,736 6,921 -- 17,657
Depreciation and amortization............... 37,332 -- 37,332 14,588 6,930 (d) 54,334
(2,581)(e)
(1,935)(f)
Interest, net............................... 42,670 (9,141)(a) 46,250 15,388 30,834 (g) 90,578
-- 12,721 (a) (11,899)(g)
10,005 (g)
Minority interest........................... -- -- -- (246) -- (246)
--------- ----------- --------- --------- ----------- ----------
Total costs and expenses.................. 1,245,176 3,580 1,248,756 487,268 31,354 1,767,378
--------- ----------- --------- --------- ----------- ----------
Earnings before income taxes.................. 87,178 (3,580) 83,598 2,744 (31,354) 54,988
Income taxes.................................. 33,999 (1,396)(j) 32,603 1,490 (9,625)(j) 24,468
--------- ----------- --------- --------- ----------- ----------
Net earnings................................ $ 53,179 $ (2,184) $ 50,995 $ 1,254 $ (21,729) $ 30,520
--------- ----------- --------- --------- ----------- ----------
--------- ----------- --------- --------- ----------- ----------
Net Earnings per common and common equivalent
share:
Primary................................... $ 1.13 $ 0.65
--------- ---------
--------- ---------
Fully diluted............................. $ 1.07 $ 0.64
--------- ---------
--------- ---------
Weighted average number of common and common
equivalent shares outstanding:
Primary................................... 46,973 46,973
--------- ---------
--------- ---------
Fully diluted............................. 52,053 52,053
--------- ---------
--------- ---------
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
36
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES AND
REGENCY HEALTH SERVICES, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SUN REGENCY SUN &
FINANCE SUN ACQUISITION REGENCY
SUN TRANSACTION ADJUSTED REGENCY ADJUSTMENTS COMBINED
--------- ----------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Total net revenues............................ $1,316,308 $ -- $1,316,308 $ 558,050 $ -- $1,874,358
--------- ---------- ---------- --------- ---------- ----------
Costs and expenses:
Operating................................... 1,107,821 -- 1,107,821 438,958 -- 1,546,779
Corporate general and administrative........ 62,085 -- 62,085 60,531 -- 122,616
Provision for losses on receivables......... 14,970 -- 14,970 2,890 -- 17,860
Depreciation and amortization............... 33,817 -- 33,817 15,317 9,240(d) 52,650
(3,099)(e)
(2,625)(f)
Interest, net............................... 25,899 (13,955)(a) 36,434 18,060 38,736(g) 92,668
-- 24,490(a) (562)(g)
Restructuring charge........................ -- -- -- 11,283 -- 11,283
Investigation and litigation costs.......... 19,250 -- 19,250 -- -- 19,250
--------- ---------- --------- --------- ---------- ---------
Total costs and expenses.................. 1,263,842 10,535 1,274,377 547,039 41,690 1,863,106
--------- ---------- --------- --------- ---------- ---------
Earnings before income taxes.................. 52,466 (10,535) 41,931 11,011 (41,690) 11,252
Income taxes.................................. 30,930 (4,109)(j) 26,821 4,612 (12,788)(j) 18,645
--------- ---------- --------- --------- ---------- ---------
Net earnings (loss)......................... $ 21,536 $ (6,426) $ 15,110 $ 6,399 $ (28,902) $ (7,393)
--------- ---------- --------- --------- ---------- ---------
--------- ---------- --------- --------- ----------- ---------
Net earnings (loss) per common and common
equivalent shares:.......................... $ 0.46 $ (0.16)
--------- ---------
--------- ---------
Weighted average number of common and common
equivalent shares outstanding:.............. 46,840 46,840
--------- ---------
--------- ---------
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
37
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES AND
REGENCY HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
The immediately preceding unaudited pro forma combined balance sheet as of
September 30, 1997 gives effect to the Regency Acquisition as if it had occurred
on September 30, 1997. The immediately preceding unaudited pro forma combined
statements of earnings for the nine months ended September 30, 1997 and for the
year ended December 31, 1996 give effect to the issuance by Sun of $250 million
of its 9 1/2% Senior Notes due 2007 (the "Notes") and the Regency Acquisition as
if these transactions occurred on January 1, 1996. In connection with the
Regency Acquisition, Sun replaced its existing credit facility (the "Old Credit
Facility") with a $1.2 billion credit facility (the "New Credit Facility").
Sun retired certain indebtedness of Regency near the time of the Regency
Acquisition. Sun expects to record an extraordinary charge of approximately
$19,702,000 (net of income tax benefit) in connection with the retirement of
this Regency indebtedness. The unaudited pro forma combined financial statements
do not reflect this transaction.
(a) In connection with the issuance of the Notes, Sun capitalized the related
debt issuance costs and used net proceeds from the Notes to repay borrowings
under its Old Credit Facility. The Old Credit Facility's interest expense,
which accrued interest at variable rates that averaged 7.1% and 6.8% for the
nine months ended September 30, 1997 and for the year ended December 31,
1996, respectively, is replaced by interest expense incurred under the
Notes. The debt issuance costs associated with the Notes will be amortized
using the effective interest method over the term of the Notes.
(b) Represents the write-off of Sun's deferred financing costs related to the
Old Credit Facility. In connection with the write-off of such debt issuance
costs, Sun expects to record an extraordinary charge in the fourth quarter
of 1997 of approximately $2,171,000, which is net of related income tax
benefits of $1,388,000.
(c) Represents the writedown of certain information system development costs
that were recorded on Regency's balance sheet at September 30, 1997; the
development plan associated with such costs is not expected to be utilized
by Sun.
(d) Represents the excess of the Regency purchase price (including an estimate
of the transaction costs) over the fair market value of the net assets
acquired. This intangible asset will be amortized using the straight-line
method over a period of 40 years.
(e) Represents the elimination of Regency's historical goodwill balance in
connection with the purchase price allocation.
(f) Reflects the revaluation of certain intangible assets in connection with the
Regency Acquisition. The amortization associated with such intangible assets
recorded in Regency's historical statements of earnings has been eliminated.
(g) Represents borrowings under the New Credit Facility that were used (i) to
acquire the capital stock of Regency; (ii) to fund the debt issuance costs
associated with the New Credit Facility; and (iii) to repay the amounts
outstanding prior to the Regency Acquisition under Sun's Old Credit Facility
and Regency's revolving credit facility. The interest expense incurred under
the Old Credit Facility and Regency's revolving credit facility is replaced
by interest expense incurred under the New Credit Facility; such borrowings
under the New Credit Facility were assumed to accrue interest at the rate of
8.6% and 8.2% for the nine months ended September 30, 1997 and for the year
ended December 31, 1996, respectively.
(h) Represents the deferred tax asset generated by the write-off of certain of
Regency's fixed and intangible assets.
(i) Reflects the elimination of Regency's historical stockholders' equity
balance in connection with the purchase price allocation.
(j) Represents the income tax benefit associated with the additional expenses
presented.
(k) Represents severance payments for certain Regency employees terminated
at the date of acquisition that were funded through borrowings under
the New Credit Facility.
(l) Represents the investment banking fees related to the acquisition that
were funded through borrowings under the New Credit Facility.
(m) Reflects the establishment of reserves for potential adjustments by
third-party payors for amounts billed prior to the acquisition.
(n) Reflects a reduction in Regency's accounts receivable balance to
conform with Sun's revenue recognition policy regarding requests for
additional reimbursement of costs based on exceptions to the Medicare
established routine cost limitations for reimbursement.
(o) Reflects the termination benefits and transitional costs to be paid to
certain former Regency employees.
(p) Represents transactional costs and expenditures to integrate Regency's
operations into Sun.
(q) Reflects the writedown to fair market value of certain Regency assets.
(r) Reflects the deferred tax assets which arose as a result of the
adjustments made above.
38
<PAGE>
(c) Exhibit No. Description
2.1 Agreement and Plan of Merger, dated as of July 26,
1997, among Sun Healthcare Group, Inc., Sunreg
Acquisition Corp. and Regency Health Services, Inc.
(the "Agreement and Plan of Merger"). (included in the
registrant's Current Report on Form 8-K as filed by the
registrant on October 23, 1997)
23.01 Consent of Arthur Andersen LLP, Independent Auditors
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Dated: December 22, 1997 By: /s/ Robert D. Woltil
-------------------------
Name: Robert D. Woltil
Title: Chief Financial Officer
<PAGE>
INDEX OF EXHIBITS
2.1 Agreement and Plan of Merger dated July 26, 1997, among Sun Healthcare
Group, Inc., Sunreg Acquisition Corp. and Regency Health Services Inc.
(the "Agreement and Plan of Merger") (included in the registrant's
Current Report on Form 8-K as filed by the registrant on October 23,
1997).
23.01 Consent of Arthur Andersen LLP, Independent Auditors
<PAGE>
Exhibit 23.01
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report on the Regency Health Services, Inc. December 31, 1996 financial
statements included in this Form 8-K, into Sun Healthcare Group, Inc.'s
previously filed Registration Statement File Nos. 33-80540, 33-93692,
333-3058 and 333-38583.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Orange County, California
December 19, 1997
