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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A-2
(Mark One)
/X/ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 1-12040
SUN HEALTHCARE GROUP, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 85-0410612
(State of Incorporation) (I.R.S. Employer Identification No.)
</TABLE>
101 SUN AVENUE NE
ALBUQUERQUE, NEW MEXICO 87109
(505) 821-3355
(Address and telephone number of Registrant)
Securities registered pursuant to Section 12(b) of the Act:
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<S> <C>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Stock, par value $.01 per share, and New York Stock Exchange
Preferred Stock Purchase Rights
</TABLE>
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in the definitive proxy statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
On March 27, 1998, Sun Healthcare Group, Inc. had 49,594,627 outstanding
shares of Common Stock, net of treasury stock. Of those, 42,254,045 shares of
Common Stock were held by nonaffiliates. The aggregate market value of such
Common Stock held by nonaffiliates, based on the average of the high and low
sales prices of such shares on the New York Stock Exchange on March 27, 1998,
was approximately $788,302,027.
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Sun Healthcare Group, Inc. ("Sun", the "Company" or the "Registrant") hereby
amends its Annual Report on Form 10-K for the fiscal year ended December 31,
1997 by deleting its responses on Items 6 and 7 contained in its original filing
and Item 14 contained in its amended filing and replacing such sections with the
following:
ITEM 6. SELECTED FINANCIAL DATA
The following Selected Consolidated Financial Data for the years ended
December 31, 1997, 1996, 1995, 1994 and 1993 have been derived from the
Company's Consolidated Financial Statements. The financial data set forth below
should be read in connection with "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations" and with the Company's
Consolidated Financial Statements and related notes thereto.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
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<S> <C> <C> <C> <C> <C>
1997(1) 1996(2) 1995(3)(4)(5) 1994(3) 1993(3)
------------ ------------ ------------ ---------- ----------
<CAPTION>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Total net revenues............................ $ 2,010,820 $ 1,316,308 $1,135,508 $ 673,354 $ 230,815
Earnings before income taxes and extraordinary
loss........................................ 95,882 52,466 12,794 36,807 22,710
Earnings (loss) before extraordinary loss..... 54,729 21,536 (20,568) 19,561 13,463
Extraordinary loss............................ 19,928 -- 3,413 -- --
------------ ------------ ------------ ---------- ----------
Net earnings (loss)..................... $ 34,801 $ 21,536 $ (23,981) $ 19,561 $ 13,463
------------ ------------ ------------ ---------- ----------
------------ ------------ ------------ ---------- ----------
Net earnings (loss) per common and common
equivalent share(6):
Net earnings (loss) before extraordinary
loss:
Basic..................................... $ 1.18 $ 0.46 $ (0.43) $ 0.63 $ 0.73
Diluted................................... $ 1.12 $ 0.46 $ (0.43) $ 0.61 $ 0.72
Net earnings:
Basic....................................... $ 0.75 $ 0.46 $ (0.51) $ 0.63 $ 0.73
Diluted..................................... $ 0.74 $ 0.46 $ (0.51) $ 0.61 $ 0.72
Weighted average number of common and common
equivalent shares:
Basic....................................... 46,329 46,360 47,419 31,038 18,374
Diluted..................................... 51,851 46,868 47,419 31,830 18,608
Working capital............................... $ 307,025 $ 211,582 $ 237,147 $ 197,150 $ 45,451
Total assets.................................. 2,579,236 1,229,426 1,042,503 1,054,223 110,488
Long-term debt, net of current portion........ 1,567,971 483,453 348,460 398,534 11,967
Stockholders' equity.......................... 617,053 572,137 569,042 550,449 70,361
</TABLE>
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(1) Results for the year ended December 31, 1997 include a charge of $7.0
million recognized by the Company in order to reduce the carrying value of
the Canadian operations to fair value based on revised estimates of selling
value and of costs to sell. In addition, in 1997, the Company recorded an
extraordinary charge of $17.9 million, net of the related tax benefit, in
connection with the Company's purchase of Regency's 12.25% Junior
Subordinated Notes due 2003 and of Regency's 9.875% Senior Subordinated
Notes due 2002 and an extraordinary charge of $2.1 million, net of the
related tax benefit, related to the refinancing of the Company's credit
facility.
(2) Results for the year ended December 31, 1996 include a $24.0 million charge
recognized by the Company to settle certain of the lawsuits brought by
shareholders and, as a reduction of this
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settlement charge, $9.0 million which was received from the Company's
director and officer liability insurance carrier in connection with the
settlement (see Note 15 to the Consolidated Financial Statements). In
addition, in 1996, the Company recorded additional expenses of $4.3 million
related to monitoring and responding to the continuing investigation by the
United States Department of Health and Human Services' Office of Inspector
General ("OIG") and to responding to the remaining shareholder litigation
related to the announcement of the OIG investigation. The charges do not
contain any estimated amounts for settlement of the OIG investigation or
remaining shareholder litigation matters.
(3) Results for the year ended December 31, 1995 and prior years represent pro
forma amounts to include pro forma taxes of CareerStaff and Golden Care
prior to their conversions to be taxed as C corporations, which occurred in
June 1994 and May 1995, respectively.
(4) Results for the year ended December 31, 1995 include a charge of $3.3
million in connection with the payment of an inducement fee to effect the
conversion in January 1995 of $39.4 million of the 6 1/2% Convertible
Subordinated Debentures and an extraordinary charge of $3.4 million, net of
the related tax benefit, in connection with the tender offer of the 11 3/4%
Senior Subordinated Notes. (See Note 6 to the Consolidated Financial
Statements).
(5) Also included in results for the year ended December 31, 1995 is $5.8
million of transaction-related merger costs incurred in connection with the
merger of the Company with CareerStaff and Golden Care (see Note 2 to the
Consolidated Financial Statements), a $59.0 million impairment loss recorded
by the Company which primarily relates to goodwill associated with six of
the forty facilities acquired in the acquisition of Mediplex (see Note 1(g))
to the Consolidated Financial Statements), $4.0 million related to averting
a strike and negotiating new contracts for certain unionized homes in
Connecticut, and a charge of $5.5 million related to monitoring and
responding to the investigation by the OIG and legal fees resulting from the
shareholder litigation.
(6) See Note 1(o) to the Company's Consolidated Financial Statements for net
earnings (loss) per share information. Also, pro forma net earnings per
share data for the year ended December 31, 1993 is calculated based upon the
number of shares of the Company's common stock issued upon the formation of
Sun Healthcare Group, Inc. on April 15, 1993, which placed under the control
of a single corporation all of the Company's operations and the appropriate
weighted average number of shares of the Company's common stock for common
stock transactions of the Company subsequent to the Company's
preincorporation agreement dated as of April 13, 1993, and also include the
appropriate weighted average number of shares of the Company's common stock
for common stock transactions of CareerStaff and Golden Care for the year
ended December 31, 1993.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company, through its direct and indirect subsidiaries (hereinafter
collectively referred to as the "Company"), is a provider of long-term, subacute
and related specialty healthcare services, including rehabilitation and
respiratory therapy services and pharmaceutical services. Long-term care and
subacute care services and outpatient therapy services are provided through
affiliated facilities. Therapy services and pharmaceutical services are provided
by the Company in both affiliated and nonaffiliated facilities located in the
United States. The Company also provides long-term care services in the United
Kingdom, Spain and Germany and acute care services in Australia and
pharmaceutical services in the United Kingdom and Spain.
The Company's earnings growth has historically resulted from the acquisition
of long-term and subacute care facilities ("facilities"), use of its long-term
and subacute care operations as a base for expansion of its ancillary services,
provision of ancillary services to nonaffiliated facilities and expansion of
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ancillary services through acquisitions. Under the current Medicare
reimbursement system, ancillary services, such as rehabilitation and respiratory
therapy services and pharmaceutical services, have significantly higher
operating margins than the margins associated with the provision of routine
services to patients at long-term and subacute care facilities and accordingly
have provided more than half of the Company's operating profits. The higher
operating margins from the provision of ancillary services are primarily
attributable to more favorable reimbursement rates. In addition, a substantial
portion of the Company's consolidated interest expense was attributable to the
Company's long-term and sub-acute services and its foreign operations due to the
capital intensive nature of these businesses and to related acquisitions. The
Company believes that when Medicare implements a prospective payment system
("PPS") for long-term and subacute care services it may be better able than some
of its competitors to respond to the new PPS environment because it provides
more types of ancillary services in-house and to nonaffiliated facilities than
many of its competitors. There can be no assurance that the Company will be able
to maintain its margins or that its margins will not decrease and that PPS will
not have a material adverse effect on the Company's financial condition or
results of operations. See "Effects from Changes in Reimbursement."
The Company's results of operations for the years ended December 31, 1997,
1996 and 1995 reflect the acquisition of facilities, the growth of the Company's
existing facility operations, the expansion of the Company's therapy service
operations and temporary therapy staffing services, and the growth of the
Company's pharmaceutical service operations.
In October 1997, the Company acquired Regency Health Services, Inc.
("Regency"), an operator of skilled nursing facilities and a diversified
provider of rehabilitation therapy, pharmacy and home health services. At the
date of acquisition, Regency operated 111 long-term care facilities (including
one managed facility) in the United States and provided rehabilitation therapy
and pharmacy services to both affiliated and nonaffiliated facilities.
In February 1997, the Company agreed to acquire Retirement Care Associates,
Inc. ("Retirement Care"), an operator of approximately 106 skilled nursing
facilities and assisted living centers, and its 65% owned subsidiary, Contour
Medical, Inc. ("Contour"), a national provider of medical/surgical supplies. In
addition, the Company agreed to acquire the remaining 35% of Contour not
presently owned by Retirement Care. The acquisition of Retirement Care is
expected to be accounted for as a pooling of interests and the acquisition of
the minority interest of Contour is expected to be accounted for as a purchase.
These transactions are expected to close in the second quarter of 1998.
In January 1997, the Company acquired the portion not previously owned by
the Company of Ashbourne PLC, which as of the date of acquisition, operated 49
nursing and residential support facilities in the United Kingdom.
At December 31, 1997, the Company operated 321 facilities with 36,655
licensed beds in the United States and 137 facilities with 7,837 licensed beds
in the United Kingdom, 8 facilities with 1,328 licensed beds in Spain, 11
facilities with 930 licensed beds in Germany and 6 facilities with 353 licensed
beds in Australia. In addition to Regency and Ashbourne, during 1997, the
Company acquired 54 facilities in the United States and 9 facilities in the
United Kingdom, resulting in a total increase of 6,399 and 476 licensed beds in
the United States and United Kingdom, respectively. Also, in 1997 the Company
developed and opened one facility in the United States and 9 facilities in the
United Kingdom with a total of 154 and 604 licensed beds in the United States
and United Kingdom, respectively. The Company also acquired 38% of the equity of
Alpha Healthcare Limited, an operator of ten acute care facilities in Australia.
At December 31, 1996, the Company operated 160 facilities with 19,321
licensed beds in the United States and 75 facilities with 3,420 licensed beds in
the United Kingdom. During 1996, the Company acquired APTA Healthcare PLC
("APTA") which operated 32 facilities with 1,264 licensed beds in the United
Kingdom. In addition to APTA during 1996, the Company acquired 32 facilities in
the United States and 11 facilities in the United Kingdom, resulting in a total
increase of 3,874 and 486 licensed beds
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in the United States and United Kingdom, respectively. In addition, in 1996 the
Company developed and opened four facilities in the United Kingdom with 230
licensed beds.
At December 31, 1995, the Company operated 131 facilities with 15,921
licensed beds in the United States and 28 facilities with 1,437 licensed beds in
the United Kingdom.
The Company's therapy service operations include the provision of physical,
occupational and speech therapy, the provision of respiratory care, the
provision of additional ancillary healthcare services, such as dentistry, and
the distribution of related equipment and supplies. As of December 31, 1997, the
Company provided its therapy services to 1,278 nonaffiliated facilities, an
increase of 519 facilities from the 759 nonaffiliated facilities serviced at
December 31, 1996.
The Company's temporary therapy service operations which provide temporary
therapists, had 27, 20, and 18 division offices at December 31, 1997, 1996 and
1995, respectively. During the year ended December 31, 1997, the Company
provided a total of 2,817,000 temporary therapy staffing hours to nonaffiliates,
an increase of 415,000 hours from the 2,402,000 nonaffiliated temporary therapy
staffing hours provided during the year ended December 31, 1996.
The Company's pharmaceutical service operations include the provision of
pharmaceuticals, the distribution of related supplies and home care. As of
December 31, 1997, the Company operated 34 regional pharmacies, four in-house
long-term care pharmacies, 14 home health service agencies, and a pharmaceutical
billing and consulting center.
The Company's foreign operations, in addition to the nursing home facilities
in the United Kingdom, Spain and Germany and acute care facilities in Australia,
include the provision of pharmaceutical services in the United Kingdom and Spain
and outpatient therapy services in Canada. During 1997, the Company announced
its intention to sell and divest itself of its outpatient therapy service
operations in Canada, as well as in the United States. As of December 31, 1997,
the Company operated 19 pharmacies and one supply distribution center in the
United Kingdom and one pharmacy in Spain.
The following table sets forth certain operating data for the Company as of
the dates indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Long-term and Subacute Care Facility Operations
Long-term and subacute care facilities (including managed facilities):
Domestic operations.............................................................. 321 160 131
Foreign operations............................................................... 162 75 28
--------- --------- ---------
Total.......................................................................... 483 235 159
--------- --------- ---------
--------- --------- ---------
Licensed beds (including managed facilities):
Domestic operations.............................................................. 36,655 19,321 15,921
Foreign operations............................................................... 10,448 3,420 1,437
--------- --------- ---------
Total.......................................................................... 47,103 22,741 17,358
--------- --------- ---------
--------- --------- ---------
Therapy Service Operations:
Nonaffiliated facilities served.................................................. 1,278 759 643
Affiliated facilities served..................................................... 287 152 125
--------- --------- ---------
Total.......................................................................... 1,565 911 768
--------- --------- ---------
--------- --------- ---------
Temporary Therapy Staffing Service Operations:
Hours billed to nonaffiliates (in thousands)..................................... 2,817 2,402 1,999
--------- --------- ---------
--------- --------- ---------
</TABLE>
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<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
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<S> <C> <C> <C>
Pharmaceutical Operations:
Nonaffiliated facilities served.................................................. 546 325 271
Affiliated facilities served..................................................... 255 112 101
--------- --------- ---------
Total.......................................................................... 801 437 372
--------- --------- ---------
--------- --------- ---------
</TABLE>
RESULTS OF OPERATIONS
The following table sets forth the amount and percentages of certain
elements of total net revenues for the periods presented (dollars in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
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1997 1996 1995
----------------------- ----------------------- -----------------------
<S> <C> <C> <C> <C> <C> <C>
Long-term and subacute care services.............. $ 1,237,746 62% $ 826,780 63% $ 759,459 67%
Therapy services to nonaffiliates................. 301,301 15 220,592 17 170,154 15
Foreign operations................................ 198,154 10 60,985 4 27,072 2
Temporary therapy staffing services to
nonaffiliates................................... 138,556 7 116,818 9 96,500 9
Pharmaceutical services to nonaffiliates.......... 123,411 6 70,673 5 51,409 5
Ambulatory surgery................................ -- -- 11,857 1 26,197 2
Management fees and other......................... 11,652 -- 8,603 1 4,717 --
------------ --- ------------ --- ------------ ---
Total net revenues.............................. $ 2,010,820 100% $ 1,316,308 100% $ 1,135,508 100%
------------ --- ------------ --- ------------ ---
------------ --- ------------ --- ------------ ---
</TABLE>
Revenues for long-term and subacute care services include revenues billed to
patients for therapy and pharmaceutical services provided by the Company's
affiliated operations. Revenues for therapy services provided to affiliated
facilities were $180.9 million, $113.9 million and $92.2 million for the years
ended December 31, 1997, 1996 and 1995, respectively. Revenues provided to
domestic affiliated facilities for pharmaceutical services were $32.7 million,
$19.5 million and $14.2 million for the years ended December 31, 1997, 1996 and
1995, respectively.
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The following table presents the percentage of total net revenues
represented by certain items for the Company for the periods presented:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Total net revenues..................................................... 100% 100% 100%
--- --- ---
Costs and expense:
Operating............................................................ 82.7 84.2 81.9
Corporate general and administrative................................. 4.9 4.7 4.5
Provision for losses on accounts receivable.......................... 0.8 1.1 1.3
Depreciation and amortization........................................ 2.8 2.6 2.4
Interest, net........................................................ 3.7 2.0 1.9
Loss on sale of Canadian operations.................................. 0.3 -- --
Conversion expense................................................... -- -- 0.3
Merger expenses...................................................... -- -- 0.5
Strike costs......................................................... -- -- 0.4
Investigation and litigation costs................................... -- 1.5 0.5
Impairment loss...................................................... -- -- 5.2
--- --- ---
Total costs and expenses........................................... 95.2 96.1 98.9
--- --- ---
Earnings before income taxes and extraordinary loss.................... 4.8 3.9 1.1
Income taxes(1)........................................................ 2.1 2.3 2.9
--- --- ---
Net earnings (loss) before extraordinary loss(1)....................... 2.7 1.6 (1.8)
Extraordinary loss..................................................... 1.0 -- 0.3
--- --- ---
Net earnings (loss)(1)................................................. 1.7% 1.6% (2.1)%
--- --- ---
--- --- ---
</TABLE>
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(1) Results for the year ended December 31, 1995 represents pro forma amounts to
include pro forma taxes of SunCare prior to its conversion to be taxed as a
C Corporation, which occurred in May 1995.
The results of the Company's ambulatory surgery operations are immaterial to
the Company's consolidated results and, therefore, this discussion excludes the
Company's ambulatory surgery operations. The Company sold its ambulatory surgery
subsidiary in the second quarter of 1996.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Total net revenues for the year ended December 31, 1997 increased 53% from
$1,316 million for the year ended December 31, 1996 to $2,011 million.
Net revenues from long-term and subacute care services, which includes
revenues generated from therapy and pharmaceutical services provided at the
Company's facilities, increased from $826.8 million for the year ended December
31, 1996 to $1,237.7 million for the year ended December 31, 1997, a 50%
increase. Net revenues from long-term and subacute care services were negatively
impacted in 1997 and 1996 by certain changes in accounting estimates for
third-party settlements (see "Effects from Changes in Reimbursement" and Note 1
to the Consolidated Financial Statements for information regarding the Company's
revenue recognition policy). In the fourth quarter of 1997, the Company recorded
negative revenue adjustments totaling approximately $15 million resulting from
changes in accounting estimates primarily based on new information arising from
the settlement in late 1997 of substantially all of the Company's facility cost
reports for 1994 and 1995. This charge also includes an estimate for projected
settlements in 1996 based on prior years' settlements. The $15 million of
negative revenue adjustments represents approximately 2% of total Medicare
revenues recognized in the periods settled and 1996. Historically, fiscal
intermediaries have settled the Company's facility cost reports during the
latter half of the year.
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In addition, the extinguishment of certain Regency debt during the fourth
quarter of 1997, resulted in an increase in certain reimbursable costs from
Medicare. As a result, the Company recognized $4.0 million of revenues from
Medicare of which $3.5 million was for long-term and subacute care services.
In the fourth quarter of 1996, the Company recorded negative revenue
adjustments totalling approximately $23.0 million resulting from changes in
accounting estimates of amounts realizable from third-party payors. These
changes in accounting estimates primarily arose out of the cost reporting
settlement process in the latter part of 1996, including the settlement of
outstanding Medicare cost reports and the results of Medicare and Medicaid cost
report audits. Approximately $19.4 million of the adjustments related to changes
in estimates out of the settlement of prior years' cost reports including $11.1
million of adjustments from the Company's Mediplex facilities.
Giving effect to the adjustments in 1997 and 1996 (discussed above), net
revenues from long-term and subacute care services increased 50% from $826.8
million for the year ended December 31, 1996 to $1,237.7 million for the year
ended December 31, 1997. Approximately $126.8 million or 31% of this increase
results from the 110 leased or owned facilities acquired from Regency and
approximately $206.4 million or 50% of this increase resulted from an additional
79 leased or owned facilities acquired or opened since December 31, 1995. The
acquisition of Regency occurred in October 1997 and net revenues include the
results of operations since the date of acquisition. The remaining net revenue
increase of $89.2 million, after giving effect to a decrease in net revenues of
approximately $11.4 million relating to three facilities sold during 1996 and
four facilities sold during 1997, is primarily attributable to an increase in
revenue per patient day on a same facility basis for the 123 leased or owned
facilities in operation for all of 1996 and 1997. The increase in revenue per
patient day was a result of payor rate increases and the expansion of the
Company's subacute services.
Net revenues from therapy services to nonaffiliated facilities increased 37%
from $220.6 million for the year ended December 31, 1996 to $301.3 million for
the year ended December 31, 1997 primarily as a result of an increase in the
number of nonaffiliated facilities served from 759 facilities at December 31,
1996 to 1,278 facilities at December 31, 1997. This increase includes 46
nonaffiliated facilities and approximately $10.2 million in net revenues from
therapy services provided to Retirement Care facilities primarily in the latter
half of 1997.
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Net revenues from foreign operations increased 225% from $61.0 million for
the year ended December 31, 1996 to $198.1 million for the year ended December
31, 1997. Approximately $111.1 million or 81% of this increase was the result of
increased net revenues from the nursing home operations in the United Kingdom.
The increase relating to the nursing home operations in the United Kingdom was
primarily the result of the Company's acquisitions of Ashbourne in January 1997
and APTA in December 1996, which when combined, added approximately $94.0
million or 85% of the increase in net revenues from the nursing home operations
in the United Kingdom during the year ended December 31, 1997. Approximately
$15.1 million or 11% of the total increase was the result of increased net
revenues from the pharmacy operations which was primarily the result of 18
pharmacies and a supply distribution center acquired or opened since December
31, 1995 in the United Kingdom. The remaining increase in net revenues is
attributable to the Company's acquisitions of nursing homes in Spain, acute care
facilities in Australia, and increased revenues from the Company's outpatient
clinics in Canada. As previously discussed, the Company has announced its
intention to sell and divest itself of its outpatient therapy service operations
in Canada.
Net revenues from temporary therapy staffing services to nonaffiliated
facilities increased 19% from $116.8 million for the year ended December 31,
1996 to $138.6 million for the year ended December 31, 1997 primarily as a
result of an increase in service hours billed to nonaffiliates from 2,402,000
hours in the year ended December 31, 1996 to 2,817,000 hours in the year ended
December 31, 1997. The increase in service hours billed was primarily
attributable to acquisitions during 1997 and 1996.
Net revenues from pharmaceutical services to nonaffiliated facilities
increased 75% from $70.7 million for the year ended December 31, 1996 to $123.4
million for the year ended December 31, 1997. Approximately $24.9 million or 47%
of the increase in net revenues was the result of the addition of 10 pharmacies
and 14 home health agencies acquired from Regency. In addition, net revenues
increased by $22.0 million primarily as a result of the increase in
nonaffiliated facilities served as a result of additional acquisitions during
1997 and 1996.
Operating expenses, which includes rent expense of $143.9 million and $91.7
million for the year ended December 31, 1997 and 1996, respectively, increased
50% from $1,107.8 million for the year ended December 31, 1996 to $1,662.8
million for the year ended December 31, 1997. The increase resulted primarily
from the net increase of 62 leased or owned facilities during various times
during the year ended December 31, 1996 and 257 leased or owned facilities
during the year ended December 31, 1997 and the growth in therapy and temporary
therapy staffing services. Operating expenses as a percentage of net revenues
decreased from 84.2% for the year ended December 31, 1996 to 82.7% for the year
ended December 31, 1997. The decrease in operating expenses as a percentage of
net revenues was primarily due to the acquisitions of Ashbourne and APTA whose
facility leases are primarily capital leases and therefore include interest and
depreciation expense instead of rent expense. The decrease is offset by lower
operating margins in the United Kingdom as occupancy rates in the United Kingdom
have been negatively impacted by an excess number of available beds in the
United Kingdom. In addition, since December 31, 1995, the Company has opened 20
long-term care facilities in the United Kingdom which has also negatively
impacted occupancy as well as operating margins.
Corporate general and administrative expenses, which include regional costs
related to the supervision of operations, increased 58% from $62.1 million for
the year ended December 31, 1996 to $98.2 million for the year ended December
31, 1997. As a percentage of net revenues, corporate general and administrative
expenses increased from 4.7% for the year ended December 31, 1996 to 4.9% for
the year ended December 31, 1997. The increase was primarily due to an increase
in costs relating to the expansion of the Company's corporate infrastructure to
support the development of the Company's foreign operations, newly acquired
domestic operations including the acquisition of Regency, and implementation of
new business strategies.
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The provision for losses on accounts receivable increased 5% from $15.0
million for the year ended December 31, 1996 to $15.8 million for the year ended
December 31, 1997. As a percentage of net revenues, provision for losses on
accounts receivable decreased from 1.1% for the year ended December 31, 1996 to
0.8% for the year ended December 31, 1997. In 1996, the Company experienced
higher than expected write-offs of patient accounts receivable primarily at its
Mediplex facilities acquired in June 1994 and recorded an additional provision
for losses on accounts receivable of approximately $6.6 million. In addition,
beginning in mid 1996, the Company increased its accounts receivable reserve in
response to a slowdown in collections from nonaffiliated facilities for therapy
services due to delays in payment by the nonaffiliated facilities' Medicare
fiscal intermediaries (see "Liquidity and Capital Resources").
Depreciation and amortization increased 67% from $33.8 million for the year
ended December 31, 1996 to $56.6 million for the year ended December 31, 1997.
As a percentage of net revenues, depreciation and amortization expense increased
from 2.6% for the year ended December 31, 1996 to 2.8% for the year ended
December 31, 1997, respectively. The increase is primarily due to the assets
acquired by the Company, including goodwill, of Regency acquired during the
fourth quarter of 1997, of Ashbourne acquired during the first quarter of 1997
and of APTA acquired during the fourth quarter of 1996.
Net interest expense increased 188% from $25.9 million for the year ended
December 31, 1996 to $74.5 million for the year ended December 31, 1997. As a
percentage of net revenues, interest expense increased from 2.0% for the year
ended December 31, 1996 to 3.7% for the year ended December 31, 1997. The
increase was related to (i) an increase in borrowing costs resulting from the
Company's issuance of $250 million of 9 1/2% Senior Subordinated Notes due 2007
in July of 1997, and (ii) an increase in borrowings and borrowing costs under
the Company's credit facility associated with acquisitions during 1996 and 1997
including Regency, Ashbourne and APTA. The increase was also due to interest
expense related to capital leases assumed by the Company as part of the
Company's acquisitions of Ashbourne and APTA.
In 1997, the Company recorded a charge totaling $7.0 million in order to
reduce the carrying value of the Canadian operations to fair value based on
revised estimates of selling value and of costs to sell.
In 1997, the Company recorded an extraordinary charge of $17.9 million net
of the related tax benefit, in connection with the Company's purchase of
Regency's 12.25% Junior Subordinated Notes due 2003 and of Regency's 9.875%
Senior Subordinated Notes due 2002 and an extraordinary charge of $2.1 million,
net of the related tax benefit, related to the refinancing of the Company's
credit facility.
In 1996, the Company reached an agreement in principle to settle certain of
the class-action lawsuits brought by shareholders for $24.0 million and
recognized, as a reduction of the settlement cost, a $9.0 million claim from its
director and officer liability insurance carrier. Although the Company funded
the settlement payment in 1996, the Company did not receive payment from its
insurance carrier until March 1997. In addition, in 1996 the Company accrued
additional charges and expenses of $4.3 million related to monitoring and
responding to the continuing investigation by the U.S. Department of Health and
Human Services' Office of Inspector General ("OIG") and responding to the
remaining shareholder litigation filed after the announcement of the OIG
investigation. The charges do not contain any estimated amounts for settlement
of the OIG investigation or remaining shareholder litigation matters (see
"Effects from Changes in Reimbursement" and "Litigation").
The Company's effective tax rate was 40% for the year ended December 31,
1997 after excluding the loss on the sale of the Canadian operations and was 41%
for the year ended December 31, 1996 after excluding the investigation and
litigation charge. The decrease in the effective tax rate was due to a more
favorable mix of state income in the United States than in the prior year. The
effective tax rate is expected to increase during 1998 primarily due to a less
favorable mix of state income in the United States and the increased amount of
nondeductible goodwill resulting primarily from the acquisition of Regency.
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Net earnings were $34.8 million for the year ended December 31, 1997 as
compared to net earnings of $21.5 million for the year ended December 31, 1996.
Net earnings were $54.7 million for the year ended December 31, 1997 before the
extraordinary loss, as compared to net earnings of $21.5 million for the year
ended December 31, 1996. As a percentage of net revenues, net earnings before
the extraordinary loss were 2.7% for the year ended December 31, 1997 and 1.6%
for the year ended December 31, 1996. Net earnings before the extraordinary loss
and the loss on sale of the Canadian operations for the year ended December 31,
1997 were $61.7 million or 3.1% as a percentage of net revenues and net earnings
before the investigation and litigation costs for the year ended December 31,
1996 were $42.4 million, or 3.2% as a percentage of net revenues. The margin
decrease was primarily due to the increased costs and lower margins from the
Company's nursing home operations in the United Kingdom, including the borrowing
costs associated with acquisitions in the United Kingdom (discussed above).
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Total net revenues for the year ended December 31, 1996 increased 16% from
$1,135 million for the year ended December 31, 1995 to $1,316 million.
Net revenues from long-term and subacute care facilities were negatively
impacted by certain changes in accounting estimates for third party settlements
(as discussed above). After considering these adjustments, net revenues
increased 9% from $759.5 million for the year ended December 31, 1995 to $826.8
million for the year ended December 31, 1996. Approximately $82.6 million of
this increase resulted from 18 leased or owned facilities acquired during the
year ended December 31, 1996 and 16 facilities acquired or opened at various
times during the year ended December 31, 1995. Net revenues for facilities
opened before January 1, 1995 decreased $15.3 million due to the negative
revenue adjustments previously discussed and the sale of three of these
facilities during 1996. The sold facilities contributed $17.7 million to the
decrease.
Net revenues from therapy services to nonaffiliated facilities increased 30%
from $170.1 million for the year ended December 31, 1995, to $220.6 million for
the year ended December 31, 1996 primarily as a result of an increase in the
number of nonaffiliated facilities served from 643 facilities at December 31,
1995 to 759 facilities at December 31, 1996.
Net revenues from temporary therapy staffing services to nonaffiliated
facilities increased 21% from $96.5 million for the year ended December 31, 1995
to $116.8 million for the year ended December 31, 1996 primarily as a result of
an increase in service hours billed to nonaffiliates from 1,999,000 hours in
1995 to 2,402,000 hours in 1996. The increase in service hours billed was
primarily attributable to the increase of services at division offices open for
over one year and to new offices established through acquisitions.
Net revenues from pharmaceutical services to nonaffiliated facilities
increased 37% from $51.4 million for the year ended December 31, 1995 to $70.7
million for the year ended December 31, 1996. The growth in net revenues was
primarily a result of the increase in the number of nonaffiliated facilities
served from 271 at December 31, 1995 to 325 at December 31, 1996. The increase
in nonaffiliated facilities served was the result of the opening and acquisition
of pharmacies during 1996 and 1995 and the increase in the number of
nonaffiliated facilities served by pharmacies open prior to January 1, 1995.
Net revenues from foreign operations increased 125% from $27.1 million for
the year ended December 31, 1995 to $61.0 million for the year ended December
31, 1996. Net revenue growth of $18.0 million was attributable to the
acquisition of Columbia, a provider of outpatient rehabilitation therapy in
Canada, during November 1995. The remaining net revenue increase of $15.9
million was attributable to the 47 facilities acquired or opened in the United
Kingdom during the year ended December 31, 1996 and the 10 facilities acquired
or opened in the United Kingdom during the year ended December 31, 1995.
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Operating expenses, which includes rent expense of $91.7 million and $73.7
million for the years ended December 31, 1996 and 1995, respectively, increased
19% from $929.5 million for the year ended December 31, 1995 to $1,107.8 million
for the year ended December 31, 1996. The increase resulted primarily from the
net increase of 62 leased or owned facilities during the year ended December 31,
1996 and 26 leased or owned facilities during the year ended December 31, 1995
and the growth in therapy and temporary therapy staffing services. Operating
expenses as a percentage of net revenues increased from 81.9% for the year ended
December 31, 1995 to 84.2% for the year ended December 31, 1996. This increase
was primarily attributable to negative revenue adjustments recorded by the
Company during the fourth quarter of 1996 (as discussed above). In addition, the
increase can also be attributed to newly developed facilities opened during 1996
and 1995, which, during the start-up period, have experienced lower operating
margins as the Company implements its operating strategies, and to increased
operating costs without a corresponding increase in billing rates due to
competitive pressures. Seasonal declines in therapist productivity during the
holiday season in the fourth quarter also contributed to the decrease. The
Company's operating costs during the holiday season remained relatively constant
despite temporary revenue reductions due to the reduced number of business days
during the fourth quarter in 1996 as compared to 1995.
Corporate general and administrative expenses, which include regional costs
related to the supervision of operations, increased 21% from $51.5 million for
the year ended December 31, 1995 to $62.1 million for the year ended December
31, 1996. As a percentage of net revenues, corporate general and administrative
expenses increased from 4.5% for the year ended December 31, 1995 to 4.7% for
the year ended December 31, 1996. The increase was primarily due to expansion of
the Company's corporate infrastructure to support the operations of fourteen
facilities in California for which the Company entered into a management
agreement during the third quarter of 1996. The increase was also due to an
increase in costs relating to the expansion of the Company's corporate
infrastructure to support the developing foreign operations and implementation
of new business strategies.
The provision for losses on accounts receivable increased 3% from $14.6
million for the year ended December 31, 1995 to $15.0 million for the year ended
December 31, 1996. As a percentage of net revenues, provision for losses on
accounts receivable decreased from 1.3% for the year ended December 31, 1995 to
1.1% for the year ended December 31, 1996. In 1995, $7.6 million of Mediplex
accounts receivable were written-off, of which $3.5 million represented accounts
receivable existing at the date of the acquisition of Mediplex. The write-offs
of Mediplex accounts receivable in 1995 were primarily the result of the
difficulties the Company experienced in integrating Mediplex's accounting and
management information systems which hampered collection efforts, changes in
estimates of amounts realizable from third-party payors (see "Effects from
Changes in Reimbursement") and the recognition of losses on balances retained
from the disposition of five of Mediplex's psychiatric care and substance abuse
facilities and related outpatient centers on September 30, 1995. In 1996, the
Company continued to experience higher than expected write-offs of patient
accounts receivable primarily at its Mediplex facilities and recorded an
additional provision for losses on accounts receivable of approximately $6.6
million. In addition, beginning in mid 1996, the Company increased its accounts
receivable reserve in response to a slowdown in collections from nonaffiliated
facilities for therapy services due to delays in payment by the nonaffiliated
facilities' Medicare fiscal intermediaries (see "Liquidity and Capital
Resources").
Depreciation and amortization increased 22% from $27.7 million for the year
ended December 31, 1995 to $33.8 million for the year ended December 31, 1996.
As a percentage of net revenues, depreciation and amortization expense remained
relatively constant at 2.6% and 2.4% for the years ended December 31, 1996 and
1995, respectively.
Net interest expense increased 19% from $21.8 million for the year ended
December 31, 1995 to $25.9 million for the year ended December 31, 1996. The
increase is primarily related to borrowings associated with the repurchase of
2,030,116 shares of the Company's outstanding common stock and purchase of a
9.9% interest in OmniCell Technologies, Inc. ("OmniCell"). Each of these
purchases was
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financed by borrowings under the Company's revolving credit facility. As a
percentage of net revenues, interest expense remained relatively constant at
2.0% and 1.9% for the years ended December 31, 1996 and 1995, respectively.
In 1996, the Company reached an agreement in principle to settle certain of
the class-action lawsuits brought by shareholders for $24.0 million and
recognized, as a reduction of the settlement cost, a $9.0 million claim from its
director and officer liability insurance carrier. In addition, in 1996 the
Company accrued additional charges and expenses of $4.3 million related to
monitoring and responding to the continuing investigation by the OIG and
responding to the remaining shareholder litigation filed after the announcement
of the OIG investigation. In 1995, the Company also recorded charges and
expenses of $5.5 million related to monitoring and responding to the continuing
investigation by the OIG and legal fees resulting from shareholder litigation.
The 1995 charges also included costs incurred by the Company in connection with
financing activities which were not concluded due to negative publicity
resulting from the OIG investigation. The charges do not contain any estimated
amounts for settlement of the OIG investigation or remaining shareholder
litigation matters (see "Effects from Changes in Reimbursement" and
"Litigation").
The Company incurred a nonrecurring charge of $3.3 million in connection
with the payment of an inducement fee to effect the conversion in January 1995
of $39.4 million of the 6 1/2% Convertible Debentures. In addition, in 1995 the
Company recorded an extraordinary charge of $3.4 million, net of the related tax
benefit, in connection with the tender offer, completed in January 1995, for
$78.7 million principal amount of the 11 3/4% Senior Subordinated Notes. No
similar charges were recorded during 1996.
In connection with the mergers with CareerStaff and SunCare, formerly known
as Golden Care, the Company recognized $5.8 million of transaction related
merger costs in the second quarter of 1995. These included advisor fees and
transitional costs related to consolidating operations. No similar charges were
recorded during 1996.
During 1995, the Company recorded charges and expenses of $4.0 million
related to averting a strike and negotiating new contracts for certain unionized
nursing homes in Connecticut. No similar charges were recorded during 1996.
The Company periodically evaluates the carrying value of goodwill along with
any other related long-lived assets in relation to the future undiscounted cash
flows of the underlying businesses to assess recoverability. The Company adopted
Statement of Financial Accounting Standards No. 121 (SFAS 121) "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
on December 31, 1995. Under SFAS 121, an impairment loss is recognized if the
sum of the expected long-term cash flows is less than the carrying amount of the
goodwill and other assets being evaluated. The difference between the carrying
amount of the goodwill and other assets being evaluated and the estimated fair
market value of the assets represents the impairment loss. The Company
determines fair value using certain multiples of earnings before interest,
taxes, depreciation and amortization based on current prices for comparable
assets. The impairment loss, as determined in accordance with SFAS 121, of $59.0
million recorded by the Company primarily relates to the goodwill associated
with six of the forty facilities acquired in the Mediplex acquisition. The
impairment loss at these six facilities was the result of the following
circumstances: (i) three facilities were organized by the Service Employees
International Union subsequent to the acquisition resulting in significantly
higher labor costs; (ii) two facilities experienced significant declines in
private pay census and revenues due to, in one instance, funding reductions in
certain programs providing private pay patients and, in the other instance, the
opening of two new facilities by competitors; and (iii) the remaining facility
received lower than expected Medicaid rates from the State of Connecticut and
due to the high acuity of the patients treated at the facility, reimbursement
was not adequate. If the Company had not elected early adoption of SFAS 121, the
impairment loss would have been based solely on the difference between the
assets carrying value and cumulative long-term cash flows which would have
resulted in a loss of $48.9 million. The operations of the impaired facilities
are not
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material to the consolidated earnings or cash flows of the Company, and
therefore, management does not expect future operating results of the impaired
facilities to have a material adverse effect on the Company's financial
condition or results of operations.
The Company's effective tax rate was 41% for the year ended December 31,
1996 after excluding the investigation and litigation charge, and was unchanged
from the pro forma effective tax rate for the year ended December 31, 1995 after
excluding the conversion fee, the merger expenses, the impairment loss and the
deferred tax charge relating to the conversion of SunCare from a S corporation
to a C corporation upon merging with the Company. The pro forma provision for
income taxes for the year ended December 31, 1995 reflects tax expense that
would have been recorded if SunCare had been subject to and liable for Federal
and state income taxes as a C corporation prior to the termination of its S
corporation status in May 1995.
Net earnings were $21.5 million for the year ended December 31, 1996 as
compared to a pro forma net loss of $24.0 million for the year ended December
31, 1995. Net earnings decreased 26% from net earnings of $53.6 million before
the extraordinary loss for early extinguishment of debt, the conversion fee, the
merger expenses, the strike, the investigation and litigation costs, the
impairment loss, and the deferred tax charge (the "extraordinary or unusual
charges") for the year ended December 31, 1995 to $42.4 million for the year
ended December 31, 1996 before the investigation and litigation charge. As a
percentage of net revenues, net earnings were 3.2% for the year ended December
31, 1996 before the investigation and litigation charge, as compared to 4.7% for
the year ended December 31, 1995 before the extraordinary or unusual charges.
The decrease was primarily due to the revenue adjustments recorded by the
Company's long-term and subacute care services (discussed above).
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had working capital of $307.0 million,
including cash and cash equivalents of $21.0 million, as compared to working
capital of $211.6 million, including cash and cash equivalents of $14.9 million
at December 31, 1996. For the year ended December 31, 1997, net cash provided by
operations was $21.7 million compared to net cash provided by operations for the
year ended December 31, 1996 of $26.8 million. The net cash provided by
operations for the year ended December 31, 1997 reflects the Company's growth in
net earnings, receipt of $9.0 million from the Company's director and officer
liability insurance carrier and timing of certain obligations of the Company.
This was offset by an increase in the net cash used for operations to fund an
increase in accounts receivable.
The Company's accounts receivable have increased since December 31, 1996.
Accounts receivable increased in part because of the growth in the Company's
inpatient, therapy and pharmaceutical services businesses since December 31,
1996. The growth in accounts receivable is also attributable to timing of
third-party reimbursement payments received by the Company subsequent to
year-end and settlement of prior year cost reports during late 1997. In
addition, fiscal intermediaries of long-term care facilities acquired by the
Company are changed to the Company's fiscal intermediary resulting in temporary
delays in timing of third-party payments. The Company is in the process of
changing fiscal intermediaries related to facilities acquired from Regency and
other acquisitions which occurred during the latter half of 1997. This process
could result in delays in receiving reimbursement from third-party payors.
Accounts receivable for therapy services have also increased in part because
the ability of nonaffiliated facilities to provide timely payments has been
impacted by their receipt of payments from fiscal intermediaries which, in some
instances, have been delayed due to the fiscal intermediaries conducting reviews
of facilities' therapy claims.
Accounts receivable also increased during the year ended December 31, 1997
due to the increased number of filings for requests for additional reimbursement
of costs based on exceptions to the Medicare established routine cost
limitations for reimbursement ("RCLs") for which payment has been delayed
pending settlement of the respective cost reports. These exceptions are
permitted under the Medicare regulations to reimburse providers for the costs of
treating higher acuity patients than are routinely seen in
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a long-term care facility. Included in net revenues are amounts related to
exceptions to the RCLs of $16.6 million, $12.3 million, and $8.9 million for the
years ended December 31, 1997, 1996 and 1995, respectively. These amounts
represent management's estimate, based on its prior experience with the Medicare
program's regulations and the Company's records of services provided, of amounts
that will ultimately be approved and paid by its fiscal intermediaries. Accounts
receivable include requests for exceptions to the RCLs of $28.8 million and
$19.1 million as of December 31, 1997 and 1996, respectively including $11.4
million of RCL's related to facilities acquired from Regency as of December 31,
1997. Amounts realizable are subject to final settlement of the respective cost
reports and no assurance can be given that management's estimate will be
accurate upon such final settlement. Under PPS, facilities will still be
required to file Medicare cost reports, however since Medicare will pay nursing
facilities on a fixed fee per patient day (as described below) from the time PPS
becomes effective, the Company's revenues will no longer be tied to such
settlement process. (See "Effects from Changes in Reimbursement").
Other significant operating uses of cash for the year ended December 31,
1997 were payments of $70.8 million for interest and net payments totaling $8.6
million for income taxes.
In May 1997, the Company received court approval of the $24.0 million
settlement of certain class-action shareholder lawsuits captioned IN RE SUN
HEALTHCARE GROUP, INC. LITIGATION which amount was previously paid during the
fourth quarter of 1996. The plaintiffs alleged that the Company and certain
current and former directors and officers misrepresented or failed to disclose
material facts about the OIG investigation and about the Company's operations
and financial results. The Company received $9.0 million during March 1997 from
its director and officer liability insurance carrier for its claims submitted in
connection with the settlement. In addition, the Company accrued additional
charges and expenses of $4.3 million in 1996 and $5.5 million in 1995 related to
monitoring and responding to the continuing OIG investigation and responding to
the shareholder litigation matters. The charges do not contain any estimated
amounts for settlement of the OIG investigation or remaining shareholder
litigation matters (see "Effects from Changes in Reimbursement" and
"Litigation"). As of December 31, 1997, an accrual of $3.0 million related to
the previously recorded charges and expenses remained.
The Company incurred $103.2 million and $76.2 million in capital
expenditures during the years ended December 31, 1997 and 1996, respectively.
Substantially all such expenditures during the year ended December 31, 1997
related to the Company's long-term and subacute care facility operations and
were for the continued development and construction of one facility in the
United States, twelve new facilities in the United Kingdom, and routine capital
expenditures. These routine capital expenditures include expenditures to
refurbish existing and recently acquired facilities. These capital expenditures
were financed through borrowings under the Company's Credit Facility (as defined
below). The Company had capital expenditure commitments, as of December 31,
1997, under various contracts, including approximately $25.9 million in the
United States and L1.0 million ($1.6 million as of December 31, 1997) in the
United Kingdom. These include contractual commitments to improve existing
facilities and to develop, construct and complete a corporate office building
and a long-term care facility in the United States and two long-term care
facilities in the United Kingdom.
The Company paid $564.1 million and $75.6 million for acquisitions during
the years ended December 31, 1997 and 1996, respectively. This includes
approximately $269.3 million, $114.7 million and $19.3 million of net cash paid
by the Company during the year ended December 31, 1997 to acquire Regency,
Ashbourne and APTA, respectively. These acquisitions and the acquisitions
described below were funded by borrowings under the Company's Credit Facility.
The acquisition of Regency was also financed by approximately $83.6 million of
net proceeds received from the sale and leaseback of 30 facilities owned by
Regency prior to its acquisition by the Company.
In July 1997, the Company acquired a majority interest in Eurosar, S.A., a
privately owned operator of eight nursing homes in Spain. In August 1997, the
Company acquired 38% of the equity of Alpha Healthcare Limited, a publicly held
acute care provider in Australia. In addition, in November 1997, the Company
acquired from Moran Health Care Pty Ltd. a majority interest in six hospitals in
Australia. In
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December 1997, the Company acquired a majority interest in Heim-Plan
Unternehmensgruppe, an operator of 11 nursing homes in Germany.
In addition, in April 1997, the Company acquired the lease rights of 13
long-term care facilities which had previously been managed by the Company since
the third quarter of 1996 for a purchase price of $12.6 million, including the
assumption of $10.7 million in long-term debt. The Company has also extended
financing of approximately $14.8 million to the former owners of these
facilities. Also during the year ended December 31, 1997, the Company acquired
the operations of nine domestic long-term care and assisted living facilities
for approximately $12.0 million in addition to the assumption of all the
facilities' leases. In connection with this acquisition, the Company agreed to
provide financing of $5.8 million to the owner of the nine facilities for
expansion of certain of the facilities of which $3.1 million had been advanced
as of December 31, 1997.
In total, during the year ended December 31, 1997, the Company acquired a
total net ownership of, the leasehold rights to, or the management of 161
long-term care facilities in the United States including 111 facilities acquired
in the acquisition of Regency, 62 long-term care facilities in the United
Kingdom, including 49 facilities acquired in the acquisition of Ashbourne, 8
long-term care facilities in Spain, 11 long-term care facilities in Germany and
6 acute care facilities in Australia. The Company also acquired or opened a
total net 20 pharmacies in the United States and 13 pharmacies in the United
Kingdom.
The Company agreed in February 1997 to acquire Retirement Care Associates,
Inc. ("Retirement Care"), an operator of skilled nursing facilities and assisted
living centers. Retirement Care also owns (and the Company would acquire)
approximately 65% of Contour Medical, Inc. ("Contour"), a national provider of
medical/surgical supplies. The amended terms of the merger (the "RCA Merger")
provide for a purchase price of approximately $152.1 million in the Company's
common stock (based upon the closing price of the Company's common stock as of
March 22, 1998) and the assumption of approximately $192.9 million of
indebtedness including $19.8 million of indebtedness which will be eliminated in
consolidation (based on Retirement Care's December 31, 1997 balance sheet).
Specifically, the agreement, as amended, calls for the Company to issue shares
of common stock having a value equal to $10.00 in exchange for each outstanding
share of Retirement Care's common stock (subject to a 10% collar centered on a
$22.00 share price for the Company's common stock). The Company expects that the
RCA Merger will be accounted for as a pooling of interests. The Company has also
agreed to acquire the remaining 35% of Contour not presently owned by Retirement
Care for approximately $35 million, payable in the Company's common stock or
cash, at the option of the Company (the "Contour Merger"). The Contour Merger
will be accounted for as a purchase.
Based upon a review of Retirement Care's, Contour's and the Company's
publicly available historical financial statements, the RCA and Contour Mergers
would have had a dilutive impact on the Company's reported earnings per share
for the year ended December 31, 1997. There can be no assurance that the future
combined results will not continue to be dilutive.
Costs to be incurred in connection with the mergers of Retirement Care and
Contour are expected to be significant and will be charged against earnings of
the combined company. The charge is currently estimated to be approximately $30
million for transaction costs and integration expenses, including elimination of
redundant corporate functions, severance costs related to headcount reductions,
the write-off of certain intangibles and property and equipment and the
settlement of certain class action lawsuits (described below). Approximately $25
million of these estimated charges are expected to be charged to operations in
the fiscal quarter in which the RCA Merger is consummated. Approximately $5
million of the estimated charges relating to the integration expenses are
expected to be expensed as incurred as these costs will benefit future combined
operations. These amounts are preliminary estimates only and are, therefore,
subject to change. In addition, there can be no assurance that the Company will
not incur additional charges in subsequent quarters to reflect costs associated
with the RCA Merger and the Contour Merger. As of December 31, 1997, the Company
has incurred approximately $2.8 million in transaction costs (as described
above).
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On January 10, 1997, the Company loaned Retirement Care $9.8 million in
order to enable Retirement Care to cause the repayment of certain indebtedness
incurred by Contour in connection with Contour's acquisition of Atlantic Medical
Supply Company, Inc. ("Atlantic") on August 6, 1996. On July 10, 1997, the
Company and Retirement Care amended the terms of the loan to: (i) increase the
applicable interest rate by 2.0%; (ii) extend the maturity date to 120 days
after the termination of the Retirement Care Merger Agreement; and (iii) replace
the collateral securing the loan with a second lien on all of Retirement Care's
accounts receivable. Consistent with Retirement Care's bank line of credit, the
loan is unconditionally and irrevocably guaranteed by certain officers of
Retirement Care. On July 10, 1997, the Company also agreed to loan Retirement
Care an additional $5.0 million which is also secured by a second lien on all of
Retirement Care's accounts receivable and is unconditionally and irrevocably
guaranteed by certain officers of Retirement Care. The interest receivable
related to the promissory notes was $1.0 million as of December 31, 1997. As of
December 31, 1997, Retirement Care owed the Company an additional $12.4 million
in the form of unsecured trade receivables in respect to ancillary and
management services provided by the Company.
On November 25, 1997, the Company, Retirement Care and representatives of
the plaintiffs in certain pending class actions against Retirement Care and its
management reached an agreement in principle to settle these class actions for
$9.0 million. In connection with the agreement in principle, the Company has
escrowed on behalf of the defendants the settlement amount into an escrow fund
which is included in Other Assets as of December 31, 1997. The settlement is
contingent upon the closing of the RCA Merger and is subject to, among other
things, confirmatory discovery, the execution of definitive documentation and
court approval.
On October 9, 1997, the Company purchased 100%, or $50.0 million, of
Regency's 12.25% Junior Subordinated Notes due 2003 for approximately $60.1
million plus interest, and $109.6 million of the $110.0 million of Regency's
9.875% Senior Subordinated Notes due 2002 for approximately $122.0 million plus
interest. As a result of the repurchase of the debt, the Company recorded an
extraordinary loss of $17.9 million, net of the related tax benefit, in the
fourth quarter of 1997. In addition, the Company paid down Regency's revolving
credit facility of $39.0 million. These transactions were funded by borrowings
under the Company's Credit Facility. As of the date of acquisition, and prior to
the tender, Regency had approximately $229.5 million of outstanding
indebtedness.
In December 1997, the Company purchased from a third party $5.0 million
aggregate principal amount of 9% Contour convertible debentures which are
convertible into one million shares of Contour common stock, for an aggregate
price of $8.4 million in cash.
The Company conducts business outside of the United States, in the United
Kingdom, Spain, Australia, Germany and Canada. The foreign operations accounted
for 10%, 4% and 2% of the Company's total net revenues during the year ended
December 31, 1997, 1996 and 1995, respectively, and 13% of the Company's
consolidated total assets as of December 31, 1997. The Company's financial
condition and results of operations are subject to foreign exchange risk.
Because of the Company's foreign growth strategies, the Company does not expect
to repatriate funds invested overseas and, therefore, foreign currency
transaction exposure is not normally hedged. Exceptional planned foreign
currency cash flow requirements, such as acquisitions overseas, are hedged
selectively to prevent fluctuations in the anticipated foreign currency value.
Changes in the net worth of the Company's foreign subsidiaries arising from
currency fluctuations are accumulated in the translation adjustments component
of stockholders' equity.
During the year ended December 31, 1997, the Company sold five of its
long-term and subacute care facilities in the United States for approximately
$31.2 million in cash and approximately $5.6 million in assumption of debt and
leased them back under fourteen-year leases. Also, during the year ended
December 31, 1997, the Company, through its United Kingdom subsidiary, sold 27
of its long-term care facilities for approximately $49.3 million and leased them
back under twelve-year leases.
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The Company has advanced $32.8 million and expects to lend up to a total of
$47.0 million under a revolving subordinated credit agreement ("Financing
Facility") to a developer of assisted living facilities for the development,
construction and operation of assisted living facilities. Any advances under the
Financing Facility have been and are expected to be funded by borrowings under
the Company's Credit Facility (as defined below) and will be subject to certain
conditions, including the approval of each project by the Company. The developer
has obtained a commitment for mortgage financing to fund 50% of the cost of each
project. The Company's advances under the Financing Facility are subordinate to
the mortgage financing. The Financing Facility with respect to each facility
bears interest at 9% or 13% depending on the percentage of completion of the
facility under construction. All amounts advanced are due in full on November 1,
2001. The advances to the developer totaled approximately $32.8 million and $9.0
million at December 31, 1997 and 1996. As of December 31, 1997, five assisted
living facilities were under development. Construction was completed on one
facility in 1997. In addition, the Company has entered into a purchase option
agreement with the developer whereby the Company will pay the developer $50,000
for each option to purchase any of the facilities. The option will grant the
Company the right to purchase any of the facilities, after a specified time
period, at the greater of the estimated fair market value of the property or the
total amount invested by the developer.
At December 31, 1997, the Company had, on a consolidated basis, $1.6 billion
of outstanding indebtedness including capital lease obligations, including
$975.1 million of indebtedness under its $1.2 billion Credit Facility (as
discussed below). The Company also had $40.2 million of outstanding standby
letters of credit under its Credit Facility as of December 31, 1997.
On July 8, 1997, the Company issued $250 million aggregate principal amount
of 9 1/2% Senior Subordinated Notes due 2007 (the "9 1/2% Notes"). The net
proceeds from the sale of approximately $243 million were used to reduce
outstanding borrowings under the Company's Credit Facility. The 9 1/2% Notes,
which are subject to customary terms and covenants, are redeemable by the
Company at a premium, in whole or in part, after July 1, 2002.
On October 8, 1997 the Company entered into a Credit Agreement with certain
lenders, certain co-agents, and NationsBank of Texas, N.A. as administrative
lender to replace the Company's old revolving credit facility. On November 12,
1997, the Company entered into a First Amendment to Credit Agreement (the
"Credit Facility"). The Credit Facility provides for borrowings by the Company
of up to $1.2 billion consisting of $500 million in a revolving credit facility
which borrowings bear interest at the prevailing prime rate plus 0% to 1% or the
LIBOR rate plus.75% to 2.50%, and $700 million in term loans which bear interest
at the prevailing prime rate plus 0% to 1.5% or the LIBOR rate plus .75% to
3.0%. The revolving credit facility matures in November 2003 and the term loans
begin amortization in March 1998 and reach final maturity in November 2005. In
connection with this refinancing, the Company recorded an extraordinary loss of
$2.1 million, net of related tax benefit, in the fourth quarter of 1997. The
Credit Facility, among other things, (i) requires the Company to maintain
certain financial ratios, (ii) restricts the Company's ability to incur debt and
liens, make investments, liquidate or dispose of assets, merge with another
corporation, create or acquire subsidiaries, and make acquisitions, and (iii)
prohibits the payment of dividends, the acquisition of treasury stock and the
prepayment or modification of certain debts of the Company. The Credit Facility
is collateralized by a pledge of the stock of the majority of the Company's
subsidiaries. As of December 31, 1997, the Company had borrowings of $275.1
million outstanding under the revolving credit facility, $700.0 million
outstanding in term loans, and $40.2 million of outstanding standby letters of
credit under the credit facility. As of December 31, 1997, up to $184.7 million
is available under the credit facility.
Scheduled aggregate principal payments of the Company's long-term debt for
the next five years as of December 31, 1997 are as follows: $56.8 million in
1998, $33.4 million in 1999, $40.6 million in 2000, $49.4 million in 2001, $65.6
million in 2002, and $1.3 billion thereafter. Based on the Company's interest
rates, foreign currency exchange rates, and outstanding borrowings as of
December 31, 1997, aggregate interest payments related to the Company's
long-term debt for the next five years are expected to be
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approximately: $137 million in 1998, $134 million in 1999, $131 million in 2000,
$127 million in 2001, and $122 million in 2002. The amounts of scheduled
principal and interest payments related to the Company's long-term debt are
subject to changes which may be significant, in outstanding borrowings, interest
rates and foreign currency exchange rates.
The Company's ongoing capital requirements relate to, among other things,
the costs associated with its facilities under construction, routine capital
expenditures, advances under the Financing Facility, potential acquisitions and
implementation of growth strategies.
The Company believes that its current borrowing capacity under its Credit
Facility and cash from operations will be sufficient to satisfy its working
capital needs, capital commitments related to its facilities under construction,
routine capital expenditures, advances under the Financing Facility, current
debt service obligations (including the aforementioned principal and interest
payments) and to fund potential conversions of 6 1/2% Convertible Debentures.
The Company is currently evaluating several financing alternatives, which
include the issuance of debt and/or equity. The Company anticipates that it will
fund its construction commitments as well as its requirements relating to future
growth through (i) the available borrowing capacity under its Credit Facility,
(ii) the use of operating leases and debt or equity related securities in the
future as a means of acquiring facilities and new operations, (iii) the
availability of sale and leaseback financing through real estate investment
trusts and other financing sources and (iv) the sale of debt or equity
securities in the public or private capital markets. There can be no assurance
that the Company will seek or obtain additional sources of financing in the next
twelve months. In addition, such additional financing, if any, may be subject to
certain restrictions including mandatory prepayment provisions in the Credit
Facility or otherwise require approval of various lenders under the Company's
Credit Facility. In November 1997 and in March 1998, the Company amended its
shelf registration statement on Form S-3 to, among other things, increase the
amount of securities which may be sold thereunder to $1 billion, which sales are
subject to the registration statement being declared effective by the Securities
and Exchange Commission. In the event the Company offers securities thereunder,
the Company may be required to repay indebtedness under the Credit Facility. If
such sources of financing are not available, the Company may not be able to
pursue growth opportunities as actively as it has in the past, and may be
required to alter certain of its operating strategies.
EFFECTS FROM CHANGES IN REIMBURSEMENT
The Company derives a substantial percentage of its total revenues from
Medicare, Medicaid and private insurance. The Company's financial condition and
results of operations may be affected by the revenue reimbursement process,
which is complex and can involve lengthy delays between the recognition of
revenue and the time reimbursement amounts are settled. Net revenues realizable
under third-party payor agreements are subject to change due to examination and
retroactive adjustment by payors during the settlement process. Payors may
disallow in whole or in part requests for reimbursement based on determinations
that certain costs are not reimbursable or reasonable or because additional
supporting documentation is necessary. The Company recognizes revenues from
third-party payors and accrues estimated settlement amounts in the period in
which the related services are provided. The Company estimates these settlement
balances by making determinations based on its prior settlement experience and
its understanding of the applicable reimbursement rules and regulations. The
majority of third-party payor balances are settled two to three years following
the provision of services. The Company has experienced differences between the
net amounts accrued and subsequent settlements, which differences are recorded
in operations at the time of settlement. For example, in the fourth quarter of
1997, the Company recorded negative revenue adjustments totalling approximately
$15.0 million resulting from changes in accounting estimates of amounts
realizable from third-party payors. These changes in accounting estimates
primarily arose out of the settlement in late 1997 of certain facility cost
reports for 1994 and 1995 and also include estimated charges for projected
settlements in 1996.
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Accounts receivable have also increased in part because the ability of
nonaffiliated facilities to provide timely payments has been impacted by their
receipt of payments from fiscal intermediaries which, in some instances, have
been delayed due to the fiscal intermediaries conducting reviews of facilities'
therapy claims.
The Company's results of operations would be materially and adversely
affected if the amounts actually received from third-party payors in any
reporting period differs materially from the amounts accrued in prior periods.
The Company's financial condition and results of operations may also be affected
by the timing of reimbursement payments and rate adjustments from third-party
payors. The Company has from time to time experienced delays in receiving final
settlement and reimbursement from government agencies.
Various cost containment measures adopted by governmental and private pay
sources have begun to restrict the scope and amount of reimbursable healthcare
expenses and limit increases in reimbursement rates for medical services. Any
reductions in reimbursement levels under Medicaid, Medicare or private payor
programs and any changes in applicable government regulations or interpretations
of existing regulations could significantly affect the Company's profitability.
Furthermore, government programs are subject to statutory and regulatory
changes, retroactive rate adjustments, administrative rulings and government
funding restrictions, all of which may materially affect the rate of payment to
the Company's facilities and its therapy and pharmaceutical businesses. There
can be no assurance that payments under governmental or private payor programs
will remain at levels comparable to present levels or will be adequate to cover
the costs of providing services to patients eligible for assistance under such
programs. Significant decreases in utilization, changes in reimbursement,
including salary equivalency and PPS, could have a material adverse effect on
the Company's financial condition and results of operations, including the
possible impairment of certain assets.
In the Balanced Budget Act of 1997 ("BBA"), Congress passed numerous changes
to the reimbursement policies applicable to exempt hospital services, skilled
nursing, therapy and other ancillary services.
The BBA generally provides for a phase-in of a prospective payment system
for skilled nursing facilities over a four year period, effective for the
Company's facilities on January 1, 1999. Under PPS, Medicare will pay skilled
nursing facilities a fixed fee per patient day based on the acuity level of the
patient to cover all post-hospital extended care routine service costs (i.e.
Medicare Part A patients), including ancillary and capital related costs for
beneficiaries receiving skilled services. The per diem rate will also cover
substantially all items and services furnished during a covered stay for which
reimbursement is currently made separately under Medicare. Such services are
currently reimbursed on a "pass through" basis. During the phase-in, payments
will be based on a blend of the facility's historical costs and a federally
established per diem rate. Since, among other things, the federally established
per diem rates have not been finalized, it is unclear what impact PPS will have
on the Company. There can be no assurance that PPS will not have a material
adverse effect on the results of operations and financial condition of the
Company.
The Company's revenues from its inpatient facilities will be significantly
affected by the size of the federally established per diem rate. There can be no
assurance that the per diem rate will not be less than the amount the Company's
inpatient facilities currently receive for treating the patients currently in
its care. Moreover, since the Company treats a greater percentage of higher
acuity patient than many nursing homes, the Company may also be adversely
impacted if the federal per diem rates for higher acuity patients does not
adequately compensate the Company for the additional expenses and risks for
caring for such patients. As a result, there can be no assurance that the
Company's financial condition and results of operations will not be materially
and adversely affected.
The Company is responding to the implementation of PPS by establishing
SunSolution-Registered Trademark-. SunSolution will offer to provide ancillary
services for a fixed fee to nonaffiliated facilities. There can be no assurance
that there will be a market for the SunSolution products and services or whether
a change in the demand
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for the Company's services following the imposition of PPS will not adversely
affect the Company's revenues. Even if SunSolution is successful, no assurance
can be given that the costs of providing the contracted for services will be
less than the fixed fee received by the Company for such services. Given the
relative profitability of Sun's ancillary services, there can be no assurance
that the Company's margins and ultimately the Company's results of operations
and financial condition will not be materially and adversely affected.
In addition, for all Medicare patients not receiving post-hospital extended
care services (i.e. Medicare Part B patients), effective July 1, 1998,
reimbursement for ancillary services, including rehabilitation therapy, medical
supplies, pharmacy, temporary staffing for rehabilitation therapy, and other
ancillary services, will be made pursuant to yet-to-be developed fee schedules.
In addition, effective January 1, 1999, there will be an annual per beneficiary
cap of $1,500 on reimbursement for outpatient physical therapy and speech
therapy and an annual per beneficiary cap of $1,500 on reimbursement for
occupational therapy. Facilities will be permitted to bill patients directly for
services rendered in excess of these caps; provided however, there can be no
assurance as to whether the Company will receive any payments in excess of these
caps. There can be no assurance whether such yet-to-be developed fee schedules
or caps will not have a material adverse effect on the Company.
The Company's growth strategy relies heavily on the acquisition of long-term
and subacute care facilities. Regardless of the legal form of the acquisition,
the Medicare and Medicaid Programs often require that the Company assume certain
obligations relating to the reimbursement paid to the former operators of the
facilities acquired by the Company. From time to time, fiscal intermediaries and
Medicaid agencies examine cost reports filed by such predecessor operators. The
Company is currently the subject of several such examinations. If, as a result
of any such examinations, it is concluded that overpayments to a predecessor
operator were made, the Company, as the current operator of such facilities, may
be held financially responsible for such overpayments. At this time the Company
is unable to predict the outcome of any existing or future examinations.
Reimbursement for therapy services is currently evaluated under Medicare's
reasonable cost principles. Under current law, the reasonable costs for physical
therapy and respiratory services may not exceed an amount equal to the salary
that would reasonably have been paid to a therapist for providing the services
(together with certain additional costs) within each geographical area. Salary
equivalency guidelines are the amounts published by the Health Care Financing
Administration ("HCFA") which reflect the prevailing salary, fringe benefit and
expense factors as determined by HCFA. HCFA then uses the salary equivalency
guidelines to determine the reimbursement rates for physical therapy and
respiratory therapy costs. Although salary equivalency guidelines will no longer
be effective following the implementation of PPS and fee schedule reimbursement,
HCFA has published new salary equivalency guidelines.
On January 30, 1998, HCFA revised salary equivalency guidelines for
respiratory therapy and physical therapy, and for the first time published new
salary equivalency guidelines for speech therapy and occupational therapy. HCFA
has indicated that the new salary equivalency guidelines would apply to all
services rendered on or after April 1, 1998. Implementation of these guidelines
will increase reimbursement rates for respiratory therapy and physical therapy,
but reduce reimbursement rates for speech therapy and occupational therapy. The
implementation of these new guidelines in the middle of a facility's fiscal year
may be contrary to HCFA's own regulations, and a request has been submitted to
HCFA to clarify the implementation schedule. If implemented, the effect of the
changes could have a material adverse impact on the Company's results of
operations. The salary equivalency guidelines rates will have no continuing
impact on reimbursement for therapy services rendered to a Medicare patient
receiving post-hospital extended care services following the commencement of
PPS, because under PPS, therapy services will be bundled into each facility's
per diem reimbursement from Medicare. In addition, the salary equivalency
guidelines will have no continuing impact on therapy services rendered to all
other Medicare patients after the institution of fee schedule reimbursement for
therapy services, which the BBA provides will be effective on July 1, 1998.
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Additionally, if the proposed guidelines are adopted, it could have an
adverse effect on the cash flow of the facilities to whom the Company provides
services, thereby potentially adversely affecting the collectibility of amounts
owed to the Company.
In 1995, and periodically since then, HCFA has provided information to
intermediaries for use in determining reasonable costs for occupational and
speech therapy. This information, although not intended to impose limits on such
costs, suggests that fiscal intermediaries should carefully review costs which
appear to be in excess of what a "prudent buyer" would pay for those services.
While the effect of these directives is still uncertain, they are a factor
considered by such intermediaries in evaluating the reasonableness of amounts
paid by providers for the services of the Company's rehabilitation therapy
subsidiary. When salary equivalency guidelines, PPS and fee schedules are
implemented, reimbursement for these services will no longer be on a "pass
through" basis and the HCFA directives and reasonable cost guidelines discussed
in this paragraph will become moot as to services rendered after their
effectiveness. In addition, some intermediaries require facilities to justify
the cost of contract therapists versus employed therapists as an aspect of the
"prudent buyer" analysis. With respect to rehabilitation therapy services
provided to affiliated facilities, a retroactive adjustment of Medicare
reimbursement could be made for some prior periods. With respect to
nonaffiliated facilities, an adjustment of reimbursement rates for therapy
services could result in indemnity claims against the Company, based on the
terms of substantially all of the Company's existing contracts with such
facilities, for payments previously made by such facilities to the Company that
are reduced by Medicare in the audit process. Any change in reimbursement rates
resulting from implementation of the HCFA directives or a reduction in
reimbursement as a result of a change in application of reasonable cost
guidelines could have a material adverse effect on the Company's financial
condition and results of operations (depending on the rates adopted) and
customers' ability to pay for prior and continuing services. When PPS with
respect to Medicare Part A (effective for the Company's facilities on January 1,
1999) and fee schedules with respect to Medicare Part B (effective July 1, 1998)
are implemented, the Company's facilities' reimbursement will no longer be
affected by salary equivalency guidelines and the cost reporting settlement
process for services rendered after their effectiveness.
Current Medicare regulations that apply to transactions between related
parties, such as the Company's subsidiaries, are relevant to the amount of
Medicare reimbursement that the Company is entitled to receive for the
rehabilitation and respiratory therapy and pharmaceutical services that it
provides to Company-operated facilities. These related party regulations require
that, among other things, a substantial part of the rehabilitation and
respiratory therapy services or pharmaceutical services, as the case may be, of
the relevant subsidiary be transacted with nonaffiliated entities in order for
the Company to receive reimbursement for services provided to Company-operated
facilities at the rates applicable to services provided to nonaffiliated
entities. The related party regulations do not indicate a specific level of
services that must be provided to nonaffiliated entities in order to satisfy the
"substantial part" requirement of such regulations. In instances where this
issue has been litigated by others, no consistent standard has emerged as to the
appropriate threshold necessary to satisfy the "substantial part" requirement.
The Company's net revenues from rehabilitation therapy services, including
net revenues from temporary therapy staffing services, provided to nonaffiliated
facilities represented 70%, 71% and 74% of total rehabilitation and temporary
therapy staffing services net revenues for the years ended December 31, 1997,
1996 and 1995, respectively. Respiratory therapy services provided to
nonaffiliated facilities represented 63%, 58%, and 55% of total respiratory
therapy services net revenues for the years ended December 31, 1997, 1996 and
the period from the date of acquisition of SunCare on May 5, 1995 to December
31, 1995, respectively. The Company's respiratory therapy operations did not
provide services to affiliated facilities prior to the acquisition of SunCare on
May 5, 1995. Net revenues from pharmaceutical services billed to nonaffiliated
facilities represented 79%, 78% and 78% of total pharmaceutical services
revenues for the years ended December 31, 1997, 1996 and 1995, respectively. The
Company believes that it satisfies the requirements of these regulations
regarding nonaffiliated business. Consequently, it has
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claimed and received reimbursement under Medicare for rehabilitation and
respiratory therapy and pharmaceutical services provided to patients in its own
facilities at a higher rate than if it did not satisfy these requirements. If
the Company were deemed to not have satisfied these regulations, the
reimbursement that the Company receives for rehabilitation and respiratory
therapy and pharmaceutical services provided to its own facilities would be
significantly reduced, as a result of which the Company's financial condition
and results of operations would be materially and adversely affected. If, upon
audit by Federal or state reimbursement agencies, such agencies find that these
regulations have not been satisfied, and if, after appeal, such findings are
sustained, the Company could be required to refund some or all of the difference
between its cost of providing these services to any entity found to be subject
to the related party regulations and the higher amount actually received. While
the Company believes that it has satisfied and will continue to satisfy these
regulations, there can be no assurance that its position would prevail if
contested by relevant reimbursement agencies. The foregoing statements with
respect to the Company's ability to satisfy these regulations are forward
looking and could be affected by a number of factors, including the
interpretation of Medicare regulations by Federal or state reimbursement
agencies and the Company's ability to provide services to nonaffiliated
facilities. When the salary equivalency guidelines, PPS and the fee schedules
are implemented, the Medicare impact of the related party rule will be
significantly reduced.
REGULATION
The Company's subsidiaries, including those which provide subacute and
long-term care, rehabilitation and respiratory therapy and pharmaceutical
services, are engaged in industries which are extensively regulated. As such, in
the ordinary course of business, the operations of these subsidiaries are
continuously subject to state and Federal regulatory scrutiny, supervision and
control. Such regulatory scrutiny often includes inquiries, investigations,
examinations, audits, site visits and surveys, some of which may be non-routine.
The Company is currently the subject of several such investigations.
In addition to being subject to the direct regulatory oversight of state and
Federal regulatory agencies, these industries are frequently subject to the
regulatory supervision of fiscal intermediaries. Fiscal intermediaries are
agents of HCFA who interpret and implement applicable laws and regulations and
make decisions about the appropriate reimbursement to be paid under Medicare and
Medicaid. The Company's subsidiaries are subject to the oversight of several
different intermediaries. Those different intermediaries have taken varying
interpretations of the applicable laws and regulations. The lack of uniformity
in the interpretation and implementation of such laws and regulations reflects
in part the fact that the statutory standards are subject to interpretation and
the manuals which are published and utilized by HCFA and the intermediaries in
performing their regulatory functions are often not sufficiently specific to
provide clear guidance in the areas which are the subject of regulatory
scrutiny.
It is the policy of the Company to comply with all applicable laws and
regulations, and the Company believes that its subsidiaries are in substantial
compliance with all material laws and regulations which are applicable to their
businesses. However, given the extent to which the interpretation and
implementation of applicable laws and regulations vary and the lack of clear
guidance in many of the areas which are the subject of regulatory scrutiny,
there can be no assurance that the business activities of the Company's
subsidiaries will not from time to time become the subject of regulatory
scrutiny, or that such scrutiny will not result in interpretations of applicable
laws or regulations by government regulators or intermediaries which differ
materially from those taken by the Company's subsidiaries. In addition, if the
Company is ever found to have engaged in improper practices, it could be subject
to civil, administrative or criminal fines, penalties or restitutionary relief.
In January 1995, the Company learned that it was the subject of a pending
Federal investigation. The investigating agencies are the United States
Department of Health and Human Services' Office of Inspector General ("OIG") and
the United States Department of Justice. At this time, the Company does
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not know the full scope of the investigation. However, the Company currently
believes that the investigation is focused principally on whether the Company
provided and billed for unnecessary or unordered therapy services to residents
of skilled nursing facilities and whether the Company adequately documented the
therapy services which it provided.
In July 1997, the Criminal Division of the U.S. Department of Justice
informed the Company that it had completed its investigation of the Company, and
that it would not initiate any actions against the Company or any individuals.
The investigation by the Civil Division of the Department of Justice and the OIG
is still proceeding. The government continues to collect information, and the
Company continues to cooperate with the investigators. The Company and the
government have had preliminary discussions, and the Company expects to have
continuing discussions, regarding a possible settlement of the investigation.
The Company is unable to determine at this time when the investigation will
be concluded, how large a monetary settlement the government may seek, the
nature of any other remedies that may be sought by the government, whether or
when a settlement will in fact occur or whether any such settlement or any other
outcome of the investigation will have a material adverse effect on the
Company's financial condition or results of operations. The foregoing statements
with respect to the outcome of the investigation are forward-looking and could
be affected by a number of factors, including the actual scope of the
investigation, the government's factual findings and the interpretation of
Federal statutes and regulations by the government and federal courts and
whether any such factual findings could serve as a basis for proceedings by
other governmental authorities. From time to time the negative publicity
surrounding the investigation has in the past adversely affected the private pay
enrollment in certain inpatient facilities and slowed the Company's success in
obtaining additional outside contracts in the rehabilitation therapy business,
which resulted in higher than required therapist staffing levels. Negative
publicity in the future could have a similar effect.
In 1996, the Connecticut Attorney General's office and the Connecticut
Department of Social Services ("DSS") began an investigation and initiated a
hearing in order to determine whether the Company's long-term care subsidiary
submitted false and misleading fiscal information on its 1993 and 1994 Medicaid
cost reports. In 1997, the DSS began an investigation of information submitted
for the 1995 cost year as well as cost reporting periods prior to 1993. The
evidentiary phase of the hearing has concluded, but the proceedings are still in
progress and the Company is unable to determine at this time when the
investigation will be concluded or whether the evidence will warrant further
administrative action or Medicaid reimbursement sanctions by DSS. However, based
on the Company's current understanding of the investigation, the Company does
not believe the investigation will have a material adverse effect on the
Company's financial condition or results of operations. The foregoing statement
with regard to the outcome of this investigation is forward-looking and could be
affected by a number of factors, including factual findings and the
interpretation of applicable laws and regulations by the Attorney General and
the DSS and whether any such factual findings could serve as a basis for
proceedings by other governmental authorities in Connecticut or elsewhere.
Pursuant to the Health Insurance Portability and Accountability Act of 1996,
Congress has provided additional funding to Medicare and Medicaid enforcement
units to investigate potential cases of reimbursement abuse in the health care
services industry. The Act also sets guidelines to encourage federal, state, and
local law enforcement agencies to share general information and to coordinate
specific law enforcement activities including conducting investigations, audits,
evaluations, and inspections relating to the delivery of and payment for health
care. From time to time enforcement agencies conduct audits, inspections and
investigations with respect to the reimbursement activities of the subsidiaries
of the Company. The Company is currently the subject of several such
investigations. It is the Company's practice to cooperate fully in such matters.
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LITIGATION
On or about January 23, 1996, two former stockholders of SunCare, John
Brennan and Susan Bird, filed a lawsuit (the "SunCare Litigation") against the
Company and certain of its officers and directors in the United States District
Court for the Southern District of Indiana. Plaintiffs allege, among other
things, that the Company did not disclose material facts concerning the
investigation by the OIG and that the Company's financial results were
misstated. The complaints purport to state claims, INTER ALIA, under Federal and
state securities laws and for breach of contract, including a breach of a
registration rights agreement pursuant to which the Company agreed to register
the shares of the Company's common stock issued to such former stockholders of
SunCare in the acquisition. Plaintiffs purport to seek recision, unspecified
compensatory damages, punitive damages and other relief. The trial is currently
scheduled to begin in the Summer of 1998.
The Company believes the SunCare Litigation will not have a material adverse
impact on its financial condition or results of operations, although the
unfavorable resolution of this action in any reporting period could have a
material adverse impact on the Company's results of operations for that period.
The foregoing statements with respect to the possible outcome of the SunCare
Litigation are forward-looking and could be affected by a number of factors,
including judicial interpretations of applicable law, the uncertainties and risk
inherent in any litigation, particularly a jury trial, the existence and scope
of any subsequently filed complaints, the scope of insurance coverage, and the
outcome of the OIG investigation and all factors that could affect that outcome.
On September 8, 1995, a derivative action was filed by Brickell Partners
against certain of the Company's current and former directors and officers in
the United States District Court for the District of New Mexico, captioned
BRICKELL PARTNERS V. TURNER, ET AL. The complaint was not served on any
defendant. On June 19, 1996, an amended complaint alleging breach of fiduciary
duty by certain of the Company's current and former directors and officers was
filed and subsequently served on the defendants. On August 5, 1996, the District
Court dismissed this action without prejudice for failure to serve the
defendants within the required time period. The plaintiffs filed a new
complaint, alleging the same claims, on August 19, 1996. In December 1997, the
Company and the plaintiffs reached an agreement in principle to settle the
action for an immaterial amount. The settlement is subject to definitive
documentation and court approval.
The Company was notified in 1997 by a law firm representing several national
insurance companies that these companies believed that the Company had engaged
in improper billing and other practices in connection with the Company's
delivery of therapy and related services. In response, the Company began
discussions directly with these insurers and hopes to resolve these matters
without litigation; however, the Company is unable at this time to predict
whether it will be able to do so, what the eventual outcome may be or the extent
of its liability, if any, to these insurers.
YEAR 2000 ISSUE
In common with users of computers around the world, the Company is
investigating if and to what extent the date change from 1999 to 2000 may affect
its networks and systems. The Company has established and implemented a program
designed to minimize the impact of the transition to the year 2000 on the
Company and its customers by seeking to cause the Company's key networks and
systems and the networks and systems of its vendors to be year 2000 compliant
before December 31, 1999. The Company expects to incur internal staff costs,
external consulting costs, and other expenses related to infrastructure and
facility enhancement necessary to prepare the systems for the year 2000.
Although the total cost to the Company of achieving year 2000 compliant systems
is not expected to be material to the Company's operations or financial
condition, there can be no assurance that the costs will be as expected or that
this program will be successful or that the date change from 1999 to 2000 will
not materially adversely affect the Company's business, financial condition and
results of operations. The ability of third parties with
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which the Company transacts business to adequately address their year 2000
issues is outside the Company's control. Although the Company will seek
alternative vendors, where its current vendors are unwilling or unable to become
year 2000 compliant in a timely manner, there can be no assurance that the
Company's operations will not be materially adversely affected by the ability of
third parties dealing with the Company, including Medicare and Medicaid, to also
manage the effect of the year 2000 date change.
EFFECTS OF INFLATION
Healthcare costs have been rising and are expected to continue to rise at a
rate higher than that anticipated for consumer goods as a whole. The Company's
operations could be adversely affected if it experiences significant delays in
receiving reimbursement rate increases from Medicaid and Medicare sources for
its labor and other costs.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements and Financial Statement Schedules
(i) Financial Statements:
Report of Independent Public Accountants
Consolidated Balance Sheets for the years ended December 31, 1997 and
1996
Consolidated Statements of Earnings (Loss) for the years ended
December 31, 1997, 1996 and 1995
Consolidated Statements of Stockholders' Equity as of December 31,
1997, 1996 and 1995
Consolidated Statements of Cash Flows for the years ended December
31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements
(ii) Financial Statement Schedules:
Report of Independent Public Accountants
Schedule II Valuation and Qualifying Accounts for the years ended
December 31, 1997, 1996 and 1995
(All other financial statement schedules required by Rule 5-04 of Regulation
S-X are not applicable or the required information is included in the audited
financial statements.)
(b) Reports on Form 8-K
Report dated October 23, 1997 reporting the acquisition of Regency
Health Services, Inc. ("Regency").
Report dated December 3, 1997 reporting (i) the amendment to the
Agreement and Plan of Merger and Reorganization, dated as of February 17,
1997, as amended by Amendment No. 1 thereto dated as of May 27, 1997 and by
Amendment No. 2 thereto dated as of August 21, 1997, by and among Sun,
Retirement Care Associates, Inc., a Colorado corporation and a wholly-owned
subsidiary of Sun ("RCA Merger Sub"), pursuant to which RCA Merger Sub will
be merged with and into RCA; (ii) an amendment to the Agreement and Plan of
Merger and Reorganization, dated as of February 17, 1997 as amended by
Amendment No. 1 thereto dated as of August 21, 1997, by and among Sun,
Contour Medical, Inc., a Nevada corporation ("Contour"), and Nectarine
Acquisition corporation, a Nevada corporation and wholly-owned subsidiary of
Sun ("Contour Merger Sub"), pursuant to which Contour Merger Sub will be
merged with and into Contour; (iii) an amendment to the Stockholders Stock
Option and Proxy Agreement, dated as of February 17, 1997, by and among Sun
and certain principal stockholders of RCA; and (iv) an amendment to the
Stockholders Stock Option and Proxy Agreement, dated as of February 17, 1997
by and among Sun and RCA, as principal stockholder of Contour.
Report dated December 22, 1997 supplementing the Form 8-K filed by the
Company on October 23, 1997 and including (i) the consolidated financial
statements of Regency and (ii) unaudited pro forma combined financial
statements of Regency and Sun.
25
<PAGE>
(c) Exhibits
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
- ---------------- ------------------------------------------------------------------------------------------------
<C> <S>
2.1(1) Preincorporation Agreement dated as of April 13, 1993 between Sun and Andrew L. Turner, Nora L.
Turner and Elizabeth L. Keefer, as Trustee of Turner's Children's Trust No. 3
2.2(16) Agreement and Plan of Merger and Reorganization, dated as of February 17, 1997 among Sun, Peach
Acquisition Corporation and Retirement Care Associates, Inc.
2.3(16) Agreement and Plan of Merger and Reorganization, dated as of February 17, 1997 among Sun,
Nectarine Acquisition Corporation and Contour Medical, Inc.
2.4(21) Amendment No. 1 to the Agreement and Plan of Merger and Reorganization dated as of February 17,
1997 among Sun, Retirement Care Associates, Inc. and Peach Acquisition Corporation
2.5(22) Amendment No. 2 to the Agreement and Plan of Merger and Reorganization dated as of February
17,1997 among Sun, Retirement Care Associates, Inc. and Peach Acquisition Corporation
2.6(22) Amendment No. 1 to the Agreement and Plan of Merger and Reorganization dated as of February 17,
1997 among Sun, Contour Medical, Inc. and Nectarine Acquisition Corporation
2.7(23) Amendment No. 3 to the Agreement and Plan of Merger and Reorganization dated as of February 17,
1997 among Sun, Retirement Care Associates, Inc. and Peach Acquisition Corporation
2.8(23) Amendment No. 2 to the Agreement and Plan of Merger and Reorganization dated as of February 17,
1997 among Sun, Contour Medical, Inc. and Nectarine Acquisition Corporation
2.9(20) Agreement and Plan of Merger, dated as of July 26, 1997, among Sun, Sunreg Acquisition Corp. and
Regency Health Services, Inc.
2.10(25) Amendment No. 4 to the Agreement and Plan of Merger and Reorganization dated as of February 17,
1997 among Sun, Retirement Care Associates, Inc. and Peach Acquisition Corporation
2.11(25) Amendment No. 3 to the Agreement and Plan of Merger and Reorganization dated as of February 17,
1997 among Sun, Contour Medical, Inc. and Nectarine Acquisition Corporation
3.1(1)(5)(13) Certificate of Incorporation of Sun, as amended
3.2(1)(8) Bylaws of Sun, as amended
4.1(2) Fiscal Agency Agreement dated as of March 1, 1994 between Sun and NationsBank of Texas, N.A., as
Fiscal Agent
4.2(5) Amended and Restated Indenture, dated October 1, 1994, among Sun, The Mediplex Group, Inc. and
Fleet Bank of Massachusetts, N.A. as Trustee (6% Convertible Subordinated Debentures due 2004)
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
- ---------------- ------------------------------------------------------------------------------------------------
<C> <S>
4.3(5) Amended and Restated First Supplemental Indenture to Amended and Restated Indenture, dated
October 1, 1994, among Sun, The Mediplex Group, Inc. and Fleet Bank of Massachusetts, N.A. as
Trustee (6 1/2% Convertible Subordinated Debentures due 2003)
4.4(10) Form of Rights Agreement, dated as of June 2, 1995, between Sun and Boatmen's Trust Company,
which includes the form of Certificate of Designations for the Series A Preferred Stock as
Exhibit A, the form of Right Certificate as Exhibit B and the form of Summary of Preferred
Stock Purchase Rights as Exhibit C.
4.5(11) First Amendment to Rights Agreement, dated as of August 11, 1995, amending the Rights Agreement,
dated as of June 2, 1995, between Sun and Boatmen's Trust Company
4.6(24) Indenture dated July 8, 1997, related to the 9 1/2% Senior Subordinated Notes due 2007 by and
between Sun, the Guarantors named therein, and First Trust National Association
10.1(3) Lease Agreement dated as of August 31, 1986, by and between Karan Associates ("Lessee") and
Campbell Care of Wylie, Inc., Assignment of Lease dated November 20, 1989 by and between
Campbell Care of Wylie, Inc. and Honorcare Corporation ("Lessee"), with First Lease Addendum
dated August 31, 1986, Second Addendum dated January 9, 1987, Third Addendum dated November
30, 1989 and Fourth Addendum dated July 12, 1993, and Assignment Agreement dated as of July
13, 1993, by and between Honorcare Corporation ("Assignor") and Sun Healthcare Corporation
("Assignee") (Hillcrest Manor Nursing Center)
10.2(13) Lease Agreement for West Magic Care Center dated as of August 1, 1987, between Skyview
Associates ("Lessor") and Don Bybee and A. Keith Holloway ("Lessee")
10.3(1) Lease Agreement for East Mesa Care Center dated as of September 30, 1990, between East Mesa
Associates Limited Partnership ("Lessor") and SunRise ("Lessee")
10.4(1) Assignment and Assumption of Lease with Consent of Lessor for Torrington Extend-A-Care Center
dated as of November 1, 1990, between Beverly Enterprises Connecticut, Inc.
("Assignor/Lessee"), Turner Enterprises, Inc. ("Assignee"), Andrew L. Turner and Nora Turner
("Guarantors"), Harvey J. Angell and Zev Karkomi ("Special Guarantors") and Beverly Investment
Properties, Inc. ("Lessor") (Lease attached)
10.5(1) Lease Agreement for Mercer Island Care Center dated as of July, 1991, among Mercer View
Convalescent Center, Tenants-in-Common ("Lessor"), SunRise ("Lessee") and Andrew L. Turner and
Nora Turner, husband and wife ("Guarantor")
10.6(1) Lease Agreement for Bayside Health and Rehabilitation Center dated as of July 26, 1991, between
Bellingham Associates Limited Partnership ("Lessor") and SunRise ("Lessee")
10.7(1) Lease Agreement for Menlo Park Healthcare Center dated as of November 1, 1991, between Oregon
Associates Limited Partnership ("Lessor") and SunRise ("Lessee")
10.8(1) Sublease Agreement for Hillside Living Center d/b/a Hillside Healthcare Center dated as of March
1, 1992, between Elite Care Corporation ("Sublessor") and Turner Enterprises, Inc.
("Sublessee") (Lease attached as Exhibit)
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
- ---------------- ------------------------------------------------------------------------------------------------
<C> <S>
10.9(1) Sublease Agreement for Crown Manor Living Center d/b/a Crown Manor Healthcare Center dated as of
March 1, 1992, between Elite Care Corporation ("Sublessor") and Turner Enterprises, Inc.
("Sublessee") (Lease attached as Exhibit)
10.10(1) Sublease Agreement for Colonial Manor Living Center d/b/a Colonial Manor Healthcare Center dated
as of March 1, 1992, between Elite Care Corporation ("Sublessor") and Turner Enterprises, Inc.
("Sublessee") (Lease attached as Exhibit)
10.11(1) Sublease Agreement for Douglas Living Center d/b/a Douglas Healthcare Center dated as of March
1, 1992, between Elite Care Corporation ("Sublessor") and Turner Enterprises, Inc.
("Sublessee") (Lease attached as Exhibit)
10.12(1) Lease Agreement for Columbia View Nursing Home dated as of June 30, 1992, between Columbia
Associates Limited Partnership ("Lessor") and Turner Enterprises, Inc. ("Lessee")
10.13(1) Lease Agreement for Adams House Healthcare Center dated as of October 1, 1992, between Adams
Connecticut Associates Limited Partnership ("Lessor") and Turner Enterprises, Inc. ("Lessee")
10.14(1) Lease Agreement for San Juan Care Center and Burton Care Center dated as of October 31, 1992, by
and between Zev Karkomi and Jerold Ruskin (collectively, the "Lessors") and SunRise ("Lessee")
10.15(3) Lease Agreement dated as of July 13, 1993, by and between Angelina Associates ("Lessor") and
Honorcare Corporation ("Lessee"), with Assignment Agreement dated as of July 13, 1993 by and
between Honorcare Corporation ("Assignor") and Sun Healthcare Corporation ("Assignee")
(Angelina Facility)
10.16(3) Lease Agreement dated as of July 13, 1993, by and between July Associates IV ("Lessor") and
Honorcare Corporation ("Lessee"), with Assignment Agreement dated as of July 13, 1993, by and
between Honorcare Corporation ("Assignor") and Sun Healthcare Corporation ("Assignee") (Park
Plaza)
10.17(3) Lease Agreement dated as of July 13, 1993, by and between Angelina Associates ("Lessor") and
Honorcare Corporation ("Lessee"), with Assignment Agreement dated as of July 13, 1993, by and
between Honorcare Corporation ("Assignor") and Sun Healthcare Corporation ("Assignee") (Wells)
10.18(3) Lease Agreement dated as of July 13, 1993, by and between Angelina Associates ("Lessor") and
Honorcare Corporation ("Lessee"), with Assignment Agreement dated as of July 13, 1993, by and
between Honorcare Corporation ("Assignor") and Sun Healthcare Corporation ("Assignee")
(Pineywood)
10.19(3) Lease Agreement dated as of July 13, 1993, by and between Golden Age Associates ("Lessor") and
Honorcare Corporation ("Lessee") (Golden Age)
10.20(3) Lease Agreement dated as of July 13, 1993, by and between July Associates III ("Lessor") and
Honorcare Corporation ("Lessee") (High Plains)
10.21(7) Lease Agreement dated as of July 30, 1993 between Zev Karkomi, Thunderbird Associated Limited
Partnership and SunRise Healthcare Corporation
10.22(7) Lease Agreement dated as of September 22, 1993, as amended, between Carlinville Associates and
SunRise Healthcare Corporation
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
- ---------------- ------------------------------------------------------------------------------------------------
<C> <S>
10.23(4) Lease Agreement dated October 1993, by and between Salem Associates, Ltd. ("Lessor") and SunRise
("Lessee") (Doctors Nursing Home)
10.24(4) Lease Agreement dated as of December 6, 1993, by and between Massachusetts Nursing Homes Limited
Partnership ("Lessor") and SunRise ("Lessee")
10.25(3) Lease Assignment and Transfer of Operations Agreement dated as of December 30, 1993, by and
between HEA of New Mexico, Inc. and SunRise (Lease attached) (Country Life Manor)
10.26(3) Lease Agreement dated as of January 1, 1994, by and between October Associates ("Lessor") and
SunRise ("Lessee") (Stanton Nursing Home)
10.27(3) Lease Agreement dated as of January 1, 1994, by and between Whitewright Associates ("Lessor")
and SunRise ("Lessee") (Campbell Care of Whitewright)
10.28(3) Lease Agreement dated as of January 1, 1994, by and between October Associates ("Lessor") and
SunRise ("Lessee") (Valley Mills Care Center)
10.29(3) Lease Agreement dated as of January 1, 1994, by and between October Associates ("Lessor") and
SunRise ("Lessee") (Moody Care Center)
10.30(6) Lease Agreement dated as of April 26, 1994, by and between Sumner Nursing Home, L.L.C. and
SunRise
10.31(5) Lease Agreement by and between Bellingham II Associates Limited Partnership and SunRise
Healthcare Corporation, dated May 31, 1994
10.32(12) Lease Agreement for Wheeler Care Center, dated as of July 24, 1995, by and between Wheeler
Healthcare Associates, L.L.C., a Texas limited liability company ("Lessor") and SunRise
Healthcare Corporation ("Lessee").
10.33(12) Agreement with Respect to and Second Amendment of Lease Agreement, dated as of September 1,
1995, by and between Massachusetts Nursing Homes Limited Partnership ("Lessor") and SunRise
Healthcare Corporation ("Lessee").
10.34(12) Third Amendment of Lease Agreement, dated as of September 1, 1995, by and between Massachusetts
Nursing Homes Limited Partnership ("Lessor") and SunRise Healthcare Corporation ("Lessee").
10.35(12) Lease Agreement for Clifton Care Center, dated as of September 13, 1995, between Missouri
Associates ("Lessor") and SunRise Healthcare Corporation ("Lessee").
10.36(17) Lease Agreement for Heritage Heights dated as of March 1, 1996, by and between Tor Associates
("Lessor") and SunRise Healthcare Corporation ("Lessee").
10.37(15) Second Amendment to Lease, dated as of June 1, 1996, by and between East Mesa Associates Limited
Partnership ("Lesser") and SunRise Healthcare Corporation ("Lessee").
10.38(14) Lease Agreement dated July 1, 1996 between Oak/Jones, Inc. and SunRise Healthcare Corporation
for Oaks Health & Rehabilitation Center.
10.39(14) Lease Agreement dated July 1, 1996 between Oak/Jones, Inc. and SunRise Healthcare Corporation
for Jones Health & Rehabilitation Center.
10.40(15) Sub-Sublease Agreement, dated as of August 22, 1996, by and between Yuba Nursing Homes, Inc.
("Lessor") and SunRise Healthcare Corporation ("Lessee").
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
- ---------------- ------------------------------------------------------------------------------------------------
<C> <S>
10.41(17) Lease Agreement for Casa del Sol Nursing Home dated as of November 26, 1996, by and between
Raton Property Limited Company ("Lessor") and SunRise Healthcare Corporation ("Lessee").
10.42(17) Lease Agreement for Blue Mountain Convalescent Center dated as of November 30, 1996, by and
between Washington Associates ("Lessor") and SunRise Healthcare Corporation ("Lessee").
10.43(17) Lease Agreement for Payette Lakes Care Center dated as of November 30, 1996, by and between
Idaho Associates L.L.C. ("Lessor") and SunRise Healthcare Corporation ("Lessee").
10.44(17) Lease Agreement for Valley Rehabilitation and Living Center dated as of November 30, 1996, by
and between Idaho Associates L.L.C. ("Lessor") and SunRise Healthcare Corporation ("Lessee").
10.45(17) Unconditional Guaranty of Lease dated as of November 30, 1996 given by Sun Healthcare Group,
Inc. ("Guarantor") to Idaho Associates, L.L.C. ("Lessor") relating to Magic Valley Manor.
10.46(17) Unconditional Guaranty of Lease dated as of November 30, 1996 given by Sun Healthcare Group,
Inc. ("Guarantor") to Idaho Associates, L.L.C. ("Lessor") relating to Valley Rehabilitation
and Living Center.
10.47(3) Form of Management Agreement between GF/Massachusetts, Inc. and SunRise
10.48(5) Amendment and Restatement of Loan Agreement [Brookline] by and between Mediplex of
Massachusetts, Inc. and Meditrust Mortgage Investments, Inc., dated June 23, 1994
10.49(5) Amendment and Restatement of Loan Agreement [Columbus] by and between Mediplex Rehabilitation of
Massachusetts, Inc. and Meditrust Mortgage Investments, Inc., dated June 23, 1994
10.50(5) Loan Agreement [Denver] by and between Mediplex of Colorado, Inc. and Valley View Psychiatric
Services, Inc. and Meditrust Mortgage Investments, Inc., dated June 23, 1994
10.51(13) Omnibus Amendment to Loan Agreements, dated as of March 28, 1996, by and between certain
subsidiaries of The Mediplex Group, Inc. and certain subsidiaries of Sun
10.52(19) Credit Agreement among Sun, certain lenders, certain co-agents, and NationsBank of Texas, N.A.,
as Administrative Lender, dated October 8, 1997
10.53(19) Form of First Amendment to Credit Agreement dated October 8, 1997 among Sun, certain lenders,
certain co-agents, and NationsBank of Texas, N.A., as Administrative Lender, to be dated as of
November 12, 1997
10.54(9) First Amendment to Sun 1992 Director Stock Option Plan
10.55(1) Sun 1993 Combined Incentive and Nonqualified Stock Option Plan
10.56(1) Sun 1993 Directors Stock Option Plan
10.57(9) Amendments to Sun 1993 Combined Incentive and Nonqualified Stock Option Plan
10.58(13) Sun 1995 Non-Employee Directors' Stock Option Plan
</TABLE>
30
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
- ---------------- ------------------------------------------------------------------------------------------------
<C> <S>
10.59(13) Sun Employee Stock Purchase Plan
10.60(13) 1996 Combined Incentive and Nonqualified Stock Option Plan
10.61(1) Tax Indemnity Agreement between Sun, SunDance Rehabilitation Corporation, Turner Enterprises,
Inc. and Andrew L. Turner and Nora L. Turner
10.62(1) Form of Indemnity Agreement between Sun and each of Sun's Directors before July 3, 1996
10.63(25) Form of Indemnity Agreement between Sun and each of Sun's Directors from and after July 3, 1996
10.64(1) Employment Agreement between Sun and Andrew L. Turner
10.65(1) Agreement as of May 5, 1993, between SunDance Rehabilitation Corporation and Andrew L. Turner
10.66(3) Employment Agreement between Sun and John E. Bingaman
10.67(5) Termination of Employment Agreement and Consulting Agreement by and between Sun Healthcare Group
and John E. Bingaman
10.68(17) Severance Agreement between Sun and Andrew L. Turner dated January 1, 1997
10.69(17) Form of Severance Agreement entered into between Sun and its President, Chief Financial Officer
and Senior Vice Presidents
10.70(18) Sun 1997 Non-Employee Directors' Stock Plan
10.71(18) Sun 1997 Stock Incentive Plan
10.72(18) Lease Agreement for Casa Loma Convalescent Center dated as of February 24, 1997 by and between
Idaho Associates, LLC ("Lessor") and SunRise Healthcare Corporation ("Lessee")
10.73(19) Lease Agreement for Evergreen Nursing and Convalescent Centre dated as of June 5, 1997, between
Effingham Associates, L.L.C. ("Lessor") and SunRise Healthcare Corporation ("Lessee")
21* Subsidiaries of the Registrant
23 Consent of Arthur Andersen LLP
27.1 Financial Data Schedule--1997
27.2 Financial Data Schedule--1996
</TABLE>
- ------------------------
* Previously filed.
(1) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-62670) on Form S-1.
(2) Incorporated by reference from exhibits to the Company's Form 8-K dated
March 11, 1994.
(3) Incorporated by reference from exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1993.
(4) Incorporated by reference from exhibits to the Company's Form 10-Q/A-1 for
the quarter ended September 30, 1993.
31
<PAGE>
(5) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended September 30, 1994.
(6) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-77522) on Form S-1.
(7) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-77272) on Form S-4.
(8) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-77870) on Form S-1.
(9) Incorporated by reference from exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1994.
(10) Incorporated by reference from exhibits to the Company's Form 8-A filed
June 6, 1995.
(11) Incorporated by reference from exhibits to the Company's Form 8-A/A-1 filed
August 17, 1995.
(12) Incorporated by reference from exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1995.
(13) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended March 31, 1996.
(14) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended June 30, 1996.
(15) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended September 30, 1996.
(16) Incorporated by reference from exhibits to the Company's Form 8-K dated
February 17, 1997.
(17) Incorporated by reference from exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1996.
(18) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended March 31, 1997.
(19) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended September 30, 1997
(20) Incorporated by reference from exhibits to the Company's Form 8-K dated
October 8, 1997.
(21) Incorporated by reference from exhibits to the Company's Form 8-K dated May
27, 1997.
(22) Incorporated by reference from exhibits to the Company's Form 8-K dated
August 21, 1997.
(23) Incorporated by reference from exhibits to the Company's Form 8-K dated
November 25, 1997.
(24) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended June 30, 1997.
(25) Incorporated by reference from exhibits to the Company's Form 8-K dated
April 3, 1998.
32
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
SUN HEALTHCARE GROUP, INC.
By: /s/ ROBERT D. WOLTIL
-----------------------------------------
Robert D. Woltil
CHIEF FINANCIAL OFFICER
May 21, 1998
</TABLE>
33
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of
Sun Healthcare Group, Inc.:
We have audited the accompanying consolidated balance sheets of Sun
Healthcare Group, Inc. (a Delaware corporation) and subsidiaries as of December
31, 1997 and 1996, and the related consolidated statements of earnings (loss),
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Sun Healthcare Group, Inc.
and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Albuquerque, New Mexico
February 24, 1998
F-1
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------
1997 1996
------------ ------------
(IN THOUSANDS,
EXCEPT SHARE DATA)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................................... $ 21,020 $ 14,880
Accounts receivable, net of allowance for doubtful accounts of $34,433 and $16,877
as of December 31, 1997 and 1996, respectively.................................... 523,161 282,268
Other receivables................................................................... 33,550 33,430
Prepaids and other assets........................................................... 38,440 19,854
Deferred tax assets................................................................. 16,546 12,716
------------ ------------
Total current assets.............................................................. 632,717 363,148
------------ ------------
Property and equipment, net......................................................... 631,102 305,720
Goodwill, net....................................................................... 1,030,893 432,505
Notes receivable.................................................................... 91,062 21,733
Other assets........................................................................ 171,898 93,323
Deferred tax assets................................................................. 21,564 12,997
------------ ------------
Total assets...................................................................... $ 2,579,236 $ 1,229,426
------------ ------------
------------ ------------
</TABLE>
(Continued on next page)
F-2
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------
1997 1996
------------ ------------
(IN THOUSANDS,
EXCEPT SHARE DATA)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt................................................... $ 56,817 $ 27,701
Current portion of obligations under capital leases................................. 2,054 1,281
Accounts payable.................................................................... 61,873 39,180
Accrued compensation and benefits................................................... 78,960 29,718
Accrued interest.................................................................... 20,451 4,426
Accrued self-insurance obligations.................................................. 34,354 12,079
Payable to APTA shareholders........................................................ -- 23,545
Other accrued liabilities........................................................... 71,183 13,636
------------ ------------
Total current liabilities......................................................... 325,692 151,566
------------ ------------
Long-term debt, net of current portion................................................ 1,488,861 460,501
Obligations under capital leases, net of current portion.............................. 79,110 22,952
Other long-term liabilities........................................................... 42,428 14,813
Deferred tax liabilities.............................................................. 9,807 4,760
------------ ------------
Total liabilities................................................................. 1,945,898 654,592
------------ ------------
Minority interest..................................................................... 16,285 2,697
Commitments and contingencies......................................................... -- --
Stockholders' equity:
Preferred stock of $.01 par value, authorized 5,000,000 shares, none issued......... -- --
Common stock of $.01 par value, authorized 100,000,000 shares, 51,697,914 and
51,142,729 shares issued and outstanding as of December 31, 1997 and 1996,
respectively...................................................................... 517 511
Additional paid-in capital.......................................................... 639,637 611,434
Retained earnings................................................................... 57,114 22,313
Cumulative translation adjustment................................................... 1,766 3,718
------------ ------------
699,034 637,976
------------ ------------
Less:
Unearned compensation............................................................. 14,203 --
Common stock held in treasury, at cost, 2,053,207 and 2,030,116 shares as of
December 31, 1997 and 1996, respectively........................................ 25,574 25,069
Grantor stock trust, at market, 2,178,315 and 3,019,993 shares as of December 31,
1997 and 1996, respectively..................................................... 42,204 40,770
------------ ------------
Total stockholders' equity........................................................ 617,053 572,137
------------ ------------
Total liabilities and stockholders' equity........................................ $ 2,579,236 $ 1,229,426
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (LOSS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
Total net revenues...................................................... $ 2,010,820 $ 1,316,308 $ 1,135,508
------------ ------------ ------------
Costs and expenses:
Operating............................................................. 1,662,818 1,107,821 929,493
Corporate general and administrative.................................. 98,169 62,085 51,468
Provision for losses on accounts receivable........................... 15,839 14,970 14,623
Depreciation and amortization......................................... 56,630 33,817 27,734
Interest, net......................................................... 74,482 25,899 21,829
Loss on sale of Canadian operations................................... 7,000 -- --
Conversion expense.................................................... -- -- 3,256
Merger expenses....................................................... -- -- 5,800
Strike costs.......................................................... -- -- 4,006
Investigation and litigation costs.................................... -- 19,250 5,505
Impairment loss....................................................... -- -- 59,000
------------ ------------ ------------
Total costs and expenses............................................ 1,914,938 1,263,842 1,122,714
------------ ------------ ------------
Earnings before income taxes and extraordinary loss..................... 95,882 52,466 12,794
Income taxes............................................................ 41,153 30,930 33,132
------------ ------------ ------------
Net earnings (loss) before extraordinary loss......................... 54,729 21,536 (20,338)
Extraordinary loss from early extinguishment of debt, net of income tax
benefit of $9,815 and $2,372 in 1997 and 1995, respectively........... 19,928 -- 3,413
------------ ------------ ------------
Net earnings (loss)................................................... $ 34,801 $ 21,536 $ (23,751)
------------ ------------ ------------
------------ ------------ ------------
Net earnings (loss) per common and common equivalent share:
Net earnings (loss) before extraordinary loss:
Basic............................................................... $ 1.18 $ 0.46 $ (0.43)
------------ ------------ ------------
------------ ------------ ------------
Diluted............................................................. $ 1.12 $ 0.46 $ (0.43)
------------ ------------ ------------
------------ ------------ ------------
Net earnings (loss):
Basic............................................................... $ 0.75 $ 0.46 $ (0.51)
------------ ------------ ------------
------------ ------------ ------------
Diluted............................................................. $ 0.74 $ 0.46 $ (0.51)
------------ ------------ ------------
------------ ------------ ------------
Weighted average number of common and common equivalent shares
outstanding:
Basic............................................................... 46,329 46,360 47,419
------------ ------------ ------------
------------ ------------ ------------
Diluted............................................................. 51,851 46,868 47,419
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
1997 1996 1995
--------------------- --------------------- ---------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- ---------- --------- ---------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
COMMON STOCK
Issued and outstanding at beginning of year..... 51,143 $ 511 47,916 $ 479 45,021 $ 450
Issuance of common stock for employee
benefits...................................... 487 5 106 1 283 3
Conversion of 6 1/2% Convertible Subordinated
Debentures due 2003........................... 68 1 -- -- 1,583 16
Issuance of common stock in connection with
establishment of the Grantor Stock Trust...... -- -- 3,050 30 -- --
Common stock issued in connection with
acquisitions.................................. -- -- 71 1 339 3
Common stock issued in connection with
immaterial poolings........................... -- -- -- -- 690 7
--------- ---------- --------- ---------- --------- ----------
Issued and outstanding at end of year........... 51,698 517 51,143 511 47,916 479
--------- ---------- --------- ---------- --------- ----------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year.................... 611,434 568,054 521,614
Issuance of common stock for employee
benefits...................................... 5,518 1,206 2,973
Tax benefit of stock options exercised.......... 1,741 99 --
Conversion of 6 1/2% Convertible Subordinated
Debentures due 2003........................... 1,109 -- 30,059
Consideration recorded for the fair value of
warrants issued in connection with
acquisitions.................................. 191 -- 1,095
Adjustment to market value of common stock held
by the Grantor Stock Trust.................... 19,644 3,445 --
Issuance of common stock in connection with the
establishment of the Grantor Stock Trust...... -- 37,670 --
Common stock issued in connection with
acquisitions.................................. -- 960 174
Common stock issued in connection with
immaterial poolings........................... -- -- 8,231
Reclassification of retained earnings as
additional paid-in capital to reflect the
change in tax status of Golden Care, Inc...... -- -- 3,908
--------- ---------- --------- ---------- --------- ----------
Additional paid-in capital at end of year....... 639,637 611,434 568,054
--------- ---------- --------- ---------- --------- ----------
RETAINED EARNINGS
Balance at beginning of year.................... 22,313 777 28,165
Net earnings (loss)............................. 34,801 21,536 (23,751)
</TABLE>
(continued on next page)
F-5
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
1997 1996 1995
--------------------- --------------------- ---------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- ---------- --------- ---------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Distribution of prior S corporation earnings.... -- -- (333)
Reclassification of retained earnings as
additional paid-in capital to reflect the
change in tax status of Golden Care, Inc...... -- -- (3,908)
Common stock issued in connection with
immaterial poolings........................... -- -- 604
--------- ---------- --------- ---------- --------- ----------
Retained earnings at end of year................ 57,114 22,313 777
--------- ---------- --------- ---------- --------- ----------
CUMULATIVE TRANSLATION ADJUSTMENT
Balance at beginning of year.................... 3,718 (268) 220
Aggregate translation adjustment................ (1,952) 3,986 (488)
--------- ---------- --------- ---------- --------- ----------
Cumulative translation at end of year........... 1,766 3,718 (268)
--------- ---------- --------- ---------- --------- ----------
Total........................................... 51,698 699,034 51,143 637,976 47,916 569,042
--------- ---------- --------- ---------- --------- ----------
UNEARNED COMPENSATION
Balance at beginning of year.................... -- -- --
Issuance of shares of restricted common stock... (17,458) -- --
Amortization of stock issued under restricted
stock option plan............................. 3,255 -- --
--------- ---------- --------- ---------- --------- ----------
Unearned compensation at end of year............ (14,203) -- --
--------- ---------- --------- ---------- --------- ----------
COMMON STOCK IN TREASURY
Balance at beginning of year.................... (25,069) -- --
Acquired at cost................................ (505) (25,069) --
--------- ---------- --------- ---------- --------- ----------
Common stock in treasury at end of year......... (25,574) (25,069) --
GRANTOR STOCK TRUST
Balance at beginning of year.................... (40,770) -- --
Issuance of common stock in connection with
establishment of the Grantor Stock Trust...... -- (37,700) --
Issuance of common stock from the Grantor Stock
Trust......................................... 752 375 --
Issuance of shares of restricted common stock... 17,458 -- --
Adjustment to market value of common stock held
by the Grantor Stock Trust.................... (19,644) (3,445) --
--------- ---------- --------- ---------- --------- ----------
Grantor stock trust at end of year.............. (42,204) (40,770) --
--------- ---------- --------- ---------- --------- ----------
Total stockholders' equity...................... 51,698 $ 617,053 51,143 $ 572,137 47,916 $ 569,042
--------- ---------- --------- ---------- --------- ----------
--------- ---------- --------- ---------- --------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
----------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss)....................................................... $ 34,801 $ 21,536 $ (23,751)
Adjustments to reconcile net earnings (loss) to net cash provided by
operating activities--
Extraordinary loss...................................................... 29,743 -- 5,785
Loss on sale of Canadian operations..................................... 7,000 -- --
Conversion expense...................................................... -- -- 3,256
Litigation settlement................................................... -- (4,750) --
Depreciation and amortization........................................... 56,630 33,817 27,734
Provision for losses on accounts receivable............................. 15,839 14,970 14,623
Impairment loss......................................................... -- -- 59,000
Other, net.............................................................. 3,312 (2,032) (2,220)
Changes in operating assets and liabilities:
Accounts receivable................................................... (164,966) (57,059) (90,887)
Other current assets.................................................. (6,323) (6,696) 970
Other current liabilities............................................. 24,228 3,262 (6,334)
Income taxes payable.................................................. 21,469 23,764 18,610
----------- ---------- ----------
Net cash provided by operating activities............................. 21,733 26,812 6,786
----------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net................................................. (103,162) (76,223) (73,497)
Acquisitions, net of cash acquired........................................ (564,134) (75,579) (74,041)
Purchase of minority interest in OmniCell Technologies, Inc............... -- (25,332) --
Net proceeds from sale of SunSurgery Corporation.......................... -- 24,828 --
Proceeds (expenditures) from operations and sale of assets
held for sale........................................................... -- (3,810) 36,878
Proceeds from sale and leaseback of property and equipment................ 80,457 34,603 105,534
Increase in long-term note receivables.................................... (57,431) (8,665) (12,479)
Other assets expenditures................................................. (35,851) (12,011) (10,169)
----------- ---------- ----------
Net cash used for investing activities................................ (680,121) (142,189) (27,774)
----------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings................................................. 1,837,062 137,155 185,299
Long-term debt repayments................................................. (966,024) (4,273) (115,730)
Repurchase of 12.25% Junior Subordinated Notes and 9.875% Senior
Subordinated Notes...................................................... (182,070) -- --
Repurchase of 11 3/4% Senior Subordinated Notes........................... -- -- (89,370)
Conversion of 6 1/2% Convertible Subordinated Debentures.................. -- -- (16,859)
Net proceeds from issuance of common stock................................ 6,275 1,582 2,976
Purchases of treasury stock............................................... (505) (25,069) --
Financing fees paid....................................................... (33,411) (1,776) (1,762)
----------- ---------- ----------
Net cash provided by (used for) financing activities.................. 661,327 107,619 (35,446)
----------- ---------- ----------
Effect of exchange rate on cash and cash equivalents........................ 3,201 (464) 798
----------- ---------- ----------
Net increase (decrease) in cash and cash equivalents........................ 6,140 (8,222) (55,636)
Cash and cash equivalents at beginning of year.............................. 14,880 23,102 78,738
----------- ---------- ----------
Cash and cash equivalents at end of year.................................... $ 21,020 $ 14,880 $ 23,102
----------- ---------- ----------
----------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES
(a) NATURE OF BUSINESS
Sun Healthcare Group, Inc., through its direct and indirect subsidiaries
(hereinafter collectively referred to as "Sun" or the "Company"), is a provider
of long-term, subacute and related specialty healthcare services including
rehabilitation and respiratory therapy services and pharmaceutical services.
Long-term and subacute care and outpatient therapy services are provided through
Company-operated facilities. Therapy services and pharmaceutical services are
provided both in Company-operated and in other nonaffiliated facilities located
in the United States. The Company also provides long-term care services in the
United Kingdom, Spain and Germany and acute care services in Australia,
pharmaceutical services in the United Kingdom and Spain, and outpatient
rehabilitation therapy services in Canada.
(b) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its greater than 50% owned subsidiaries. Investments in affiliates, in which
the Company owns 20% to 50%, are carried on the equity method. Investments in
companies owned less than 20% are carried at cost. All significant intercompany
accounts and transactions have been eliminated in consolidation.
(c) CASH EQUIVALENTS
The Company considers all highly liquid, unrestricted investments with
original maturities of three months or less to be cash equivalents. Cash
equivalents are stated at cost.
(d) NET REVENUES
Net revenues consist of long-term and subacute care revenues, therapy
services revenues, temporary therapy staffing services revenues and
pharmaceutical services revenues. Net revenues are recognized as services are
provided. Net revenues are recorded net of provisions for discount arrangements
with commercial payors and contractual allowances with third-party payors,
primarily Medicare and Medicaid. Net revenues realizable under third-party payor
agreements are subject to change due to examination and retroactive adjustment.
Estimated third-party payor settlements are recorded in the period the related
services are rendered. The methods of making such estimates are reviewed
frequently, and differences between the net amounts accrued and subsequent
settlements or estimates of expected settlements are reflected in current
earnings.
The Company has submitted to the Health Care Financing Administration
("HCFA") various requests for exceptions to the Medicare established routine
cost limitations for reimbursement ("RCLs"). These exceptions are permitted
under the Medicare regulations to allow providers to treat higher acuity
patients. Included in net revenues are amounts related to exceptions to the RCLs
of $16.6 million, $12.3 million and $8.9 million for the years ended December
31, 1997, 1996 and 1995 respectively. These amounts are net of adjustments to
record management's estimate, based on its prior experience with the Medicare
program's regulations and the Company's records of service provided, of amounts
that will ultimately be approved by HCFA. Accounts receivable include requests
for exceptions to the RCLs of $28.8 million, and $19.1 million at December 31,
1997 and 1996, respectively. Amounts realizable are subject to final settlement
of the respective cost reports. Differences between the net amounts accrued and
subsequent settlements or estimates of expected settlements are recorded in
operations at the time of settlement.
F-8
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES
(CONTINUED)
(e) ACCOUNTS RECEIVABLE
The Company receives payment for services rendered from Federal and state
governments under the Medicare and Medicaid programs and private pay payors,
including third party insurers, workers' compensation plans, healthcare
providers and individuals. The following table summarizes the percent of
accounts receivable by payor category as of December 31:
<TABLE>
<CAPTION>
1997 1996
----- -----
<S> <C> <C>
Government...................................................................... 49% 44%
Private and other............................................................... 51 56
--- ---
100% 100%
--- ---
--- ---
</TABLE>
Management does not believe that there are any credit risks associated with
receivables from governmental agencies. Private and other receivables consist of
receivables from a large number of payors involved in diverse activities and
subject to differing economic conditions, which management believes do not
represent any concentrated credit risks to the Company. In certain instances,
the collection of amounts from healthcare providers for therapy services has
slowed because payment is primarily dependent upon such facilities' receipt of
payment from fiscal intermediaries. In addition, fiscal intermediaries of
long-term care facilities acquired by the Company are changed to the Company's
fiscal intermediary resulting in temporary delays in timing of third-party
payments.
(f) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Major renewals or improvements
are capitalized, whereas ordinary maintenance and repairs are expensed as
incurred. Depreciation and amortization is computed using the straight-line
method over the estimated useful lives of the assets as follows: buildings and
improvements--5 to 40 years; leasehold improvements--the shorter of the
estimated useful lives of the assets or the life of the lease; equipment--3 to
20 years. Amortization of property and equipment held under capital leases is
included in depreciation and amortization expense.
The Company capitalizes certain costs associated with developing and
acquiring healthcare facilities and related outpatient programs. Capitalized
costs include site investigation, negotiation, development, acquisition and
preconstruction costs; indirect and general expenses related to such activities
are expensed as incurred. Preconstruction costs include the direct costs of
securing control of the development site, obtaining the requisite certificate of
need and other approvals, as well as the direct costs of preparing for actual
development and construction. The capitalized costs are transferred to
construction in progress and depreciable asset categories as construction is
begun and completed, respectively. The Company capitalizes interest directly
related to the development and construction of new facilities as a cost of the
related asset.
(g) GOODWILL/IMPAIRMENT LOSS
The excess of the purchase price over the fair value of the net assets of
the businesses acquired by the Company is amortized using the straight-line
method over periods ranging from 20 to 40 years. Accumulated amortization of
such costs was $47.9 million and $28.9 million as of December 31, 1997 and 1996,
respectively.
F-9
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES
(CONTINUED)
The Company periodically evaluates the carrying value of goodwill along with
any other related long-lived assets in relation to the future undiscounted cash
flows of the underlying businesses to assess recoverability. The Company adopted
Statement of Financial Accounting Standards No. 121 (SFAS 121) "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
on December 31, 1995. Under SFAS 121, an impairment loss is recognized if the
sum of the expected long-term cash flows is less than the carrying amount of the
goodwill and other assets being evaluated. The difference between the carrying
amount of the goodwill and other assets being evaluated and the estimated fair
market value of the assets represents the impairment loss. The Company
determines fair value using certain multiples of earnings before interest,
taxes, depreciation and amortization based on current prices for comparable
assets.
The impairment loss, as determined in accordance with SFAS 121, of $59.0
million recorded by the Company in 1995 primarily relates to the goodwill
associated with six of the forty facilities acquired in the Mediplex
acquisition. The impairment loss at these six facilities was the result of the
following circumstances: (i) three facilities were organized by the Service
Employees International Union subsequent to the acquisition resulting in
significantly higher labor costs; (ii) two facilities experienced significant
declines in private pay census and revenues due to, in one instance, funding
reductions in certain programs providing private pay patients and, in the other
instance, the opening of two new facilities by competitors; and (iii) the
remaining facility received lower than expected Medicaid rates from the State of
Connecticut and due to the high acuity of the patients treated at the facility,
reimbursement was not adequate. If the Company had not elected early adoption of
SFAS 121 during 1995, the impairment loss would have been based solely on the
difference between the assets carrying value and cumulative long-term cash flows
which would have resulted in a loss of $48.9 million.
(h) OTHER ASSETS
Costs incurred in obtaining debt financing are amortized as interest expense
over the terms of the related indebtedness. The Company amortizes preopening
costs (start-up costs related to new facilities, specialty units within a
facility, new rehabilitation regions and pharmacies) over a period ranging from
one year (for costs not reimbursed by third-party payors) to five years (for
costs reimbursed by third-party payors, including the Medicare and Medicaid
programs). Other assets also includes equity and cost-based investments (see
Note 2).
(i) ACCRUED SELF-INSURANCE OBLIGATIONS
It is the policy of the Company to self-insure for certain insurable risks
including general and professional liability, workers' compensation, and certain
employee benefits through the use of self-insurance or retrospective and high
deductible insurance policies and other hybrid policies which vary by the states
in which the Company operates. Provisions for estimated settlements, including
incurred but not reported losses, are provided in the period of the related
coverage. These provisions are based on internal evaluations of the merits of
individual claims and the reserves assigned by the Company's independent
insurance carriers. The methods of making such estimates and establishing the
resulting accrued liabilities are reviewed frequently, and any adjustments
resulting therefrom are reflected in current earnings. Claims are paid over
varying periods, which generally range from one to five years. Accrued
liabilities for future claims are not discounted.
F-10
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES
(CONTINUED)
(j) INVESTIGATION AND LITIGATION COSTS
In 1996, the Company reached an agreement in principle to settle certain
class-action lawsuits brought by shareholders for $24.0 million and recognized,
as a reduction of the settlement cost, a $9.0 million claim from its director
and officer liability insurance carrier for its claim submitted in connection
with the settlement. In addition, in 1996 the Company recorded additional
charges and expenses of $4.3 million related to monitoring and responding to the
continuing investigation by the U.S. Department of Health and Human Services'
Office of Inspector General ("OIG") and responding to the remaining shareholder
litigation filed after the announcement of the OIG investigation. In 1995, the
Company recorded charges and expenses of $5.5 million related to monitoring and
responding to the continuing OIG investigation and legal fees resulting from
shareholder litigation (see Note 14). The 1995 charges also included costs
incurred by the Company in connection with financing activities which were not
concluded due to negative publicity resulting from the OIG investigation. The
charges do not contain any estimated amounts for settlement of the OIG
investigation or remaining shareholder litigation matters.
(k) STRIKE COSTS
During 1995, the Company recorded charges and expenses of $4.0 million
related to averting a strike and negotiating new contracts for certain unionized
nursing homes in Connecticut.
(l) INCOME TAXES
Income tax expense is based on reported earnings before income taxes.
Deferred income taxes reflect the impact of temporary differences between the
amount of assets and liabilities recognized for financial reporting purposes and
such amounts recognized for tax purposes.
Prior to converting to a C corporation, SunCare, formerly known as Golden
Care, had elected S corporation status whereby income taxes are paid by the
stockholders rather than by the entity. Accordingly, there is a pro forma
provision of $230,000 in 1995 for income taxes for this entity equal to the
Federal and state income tax provisions that would have been recorded if this
entity had been a C corporation for all of 1995 (see Note 2).
(m) CUMULATIVE TRANSLATION ADJUSTMENT
The financial position and results of operations of the Company's foreign
subsidiaries are measured using local currency as the functional currency.
Assets and liabilities of these subsidiaries are translated at the exchange rate
in effect at each year end. Statement of earnings accounts are translated at the
average rate of exchange prevailing during the year. Translation adjustments
arising from differences in exchange rates from period to period are included in
the cumulative translation adjustment account in stockholders' equity.
(n) STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related Interpretations. Accordingly,
compensation cost for stock options is measured as the excess, if any, of the
quoted market price of the Company's stock at the date of the grant over the
amount an employee must pay to acquire the stock. Statement of Financial
Accounting Standards No. 123 "Accounting for Stock-
F-11
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES
(CONTINUED)
Based Compensation" ("SFAS 123") was issued in 1995 and the Company has adopted
the disclosure requirements of SFAS 123 (see Note 11).
(o) NET EARNINGS (LOSS) PER SHARE
Basic net earnings (loss) per share is based upon the weighted average
number of common shares outstanding during the period.
Diluted net earnings per share in periods of earnings is based upon the
weighted average number of common shares outstanding during the period plus the
number of incremental shares of common stock contingently issuable upon exercise
of stock options and, if dilutive, including the assumption that the Company's
convertible debentures were converted as of the beginning of the period. Net
earnings, if conversion of the debentures is assumed, is adjusted for the
interest on the debentures, net of interest related to additional assumed
borrowings to fund the cash consideration on conversion of certain convertible
debentures and the related income tax benefits. In periods of loss, diluted net
earnings per share is based upon the weighted average number of common shares
outstanding during the period. See Note 12 for calculation of earnings per share
data for the years ended December 31, 1997, 1996 and 1995.
The Company adopted Statement of Financial Accounting Standards No. 128
"Earnings per Share" ("SFAS 128") in 1997. All prior period earnings per common
share data have been restated to conform to the provisions of this statement.
(p) FINANCIAL STATEMENT PREPARATION AND PRESENTATION
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Certain amounts in the 1996 and 1995 consolidated financial statements and
notes have been reclassified to conform to the 1997 presentation.
(2) MERGERS AND ACQUISITIONS
In October 1997, the Company acquired the capital stock of Regency Health
Services, Inc. ("Regency"), an operator of skilled nursing facilities and a
provider of related specialty healthcare services, including rehabilitation
therapy, pharmacy and home health services in the United States. Total
consideration for the shares acquired was approximately $350.6 million. The
total fair value of Regency's assets acquired, including goodwill of
approximately $422.6 million, was approximately $661.9 million, and liabilities
assumed totaled approximately $370.4 million. Recorded purchase liabilities
included approximately $11.2 million for severance and related costs and $2.0
million for costs associated with the shut down of certain acquired pharmacies
and home health service agencies that will be consolidated with the Company's
existing facilities. At December 31, 1997, liabilities for approximately $2.8
million in severance costs and $2.0 million for facility related costs remained
on the balance sheet. The Company expects to complete its termination of
pharmacy, home health service agency and corporate employees and consolidation
of pharmacies and home health service agencies by mid-1998.
On October 9, 1997, the Company, completed a tender offer for 100%, or $50.0
million, of Regency's 12.25% Junior Subordinated Notes due 2003 for
approximately $60.1 million plus accrued interest, and
F-12
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(2) MERGERS AND ACQUISITIONS (CONTINUED)
$109.6 million of the $110.0 million of Regency's 9.875% Senior Subordinated
Notes due 2002 for approximately $122.0 million plus accrued interest. As a
result of the repurchase of this debt, the Company recorded an extraordinary
loss of $17.9 million, net of the related tax benefit, in the fourth quarter of
1997. In addition, the Company repaid Regency's revolving credit facility of
approximately $39.0 million. In addition, the extinguishment of certain Regency
debt during the fourth quarter of 1997 resulted in an increase in certain
reimbursable costs from Medicare. As a result, the Company recognized $4.0
million of revenues from Medicare during 1997.
The acquisition of Regency, including certain transaction costs, and the
tender offer for its debt, described above, were financed by borrowings under
the Company's Credit Facility (as described below) and approximately $83.6
million of net proceeds received from the sale and leaseback of 30 facilities
owned by Regency prior to its acquisition by the Company.
The acquisition of Regency was accounted for as a purchase and the operating
results of Regency have been included in the consolidated statements of earnings
from the date of acquisition. The following unaudited pro forma results assume
that the acquisition occurred as of January 1, 1996 (in thousands, except per
share data):
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Net revenues.................................................... $ 2,494,658 $ 1,874,358
Earnings before extraordinary items............................. 31,908 (817)
Net earnings (loss)............................................. 11,980 (2,010)
Net earnings per share:
Basic....................................................... 0.26 (0.04)
Diluted..................................................... 0.25 (0.04)
</TABLE>
The allocation of the purchase price of Regency is preliminary and will be
finalized upon completion of asset valuations. In addition, the Company is still
evaluating certain obligations of Regency prior to the merger and further
adjustments to the preliminary purchase price allocation may result.
The Company agreed in February 1997, to acquire Retirement Care Associates,
Inc. ("Retirement Care"), an operator of skilled nursing facilities and assisted
living centers. Retirement Care also owns (and the Company would acquire)
approximately 65% of Contour Medical, Inc. ("Contour"), a national provider of
medical/surgical supplies. The amended terms of the merger (the "RCA Merger")
provide for a purchase price of approximately $156.3 million in common stock
(based upon the closing price of the Company's common stock as of December 31,
1997) and the assumption of approximately $192.9 million of indebtedness
including $19.8 million of indebtedness which will be eliminated in
consolidation (based on Retirement Care's December 31, 1997 balance sheet).
Specifically, the agreements, as amended, call for the Company to issue shares
of common stock having a value equal to $10.00 in exchange for each outstanding
share of Retirement Care's common stock (subject to a 10% collar centered on a
$22.00 share price for the Company's common stock). The Company expects that the
RCA Merger will be accounted for as a pooling of interests. The Company has also
agreed to acquire the remaining 35% of Contour not presently owned by Retirement
Care for approximately $35 million, payable in common stock or cash, at the
option of the Company (the "Contour Merger"). The Contour Merger will be
accounted for as a purchase.
Costs to be incurred in connection with the mergers of Retirement Care and
Contour are expected to be significant and will be charged against earnings of
the combined company. The charge is currently estimated to be approximately $30
million for transaction costs and integration expenses, including
F-13
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(2) MERGERS AND ACQUISITIONS (CONTINUED)
elimination of redundant corporate functions, severance costs related to
headcount reductions, write-off of certain intangibles and property and
equipment and the settlement of certain class action lawsuits (described below).
Approximately $25 million of these estimated charges are expected to be charged
to operations in the fiscal quarter in which the merger with Retirement Care is
consummated. Approximately $5 million of the estimated charges relating to the
integration expenses are expected to be expensed as incurred as these costs will
benefit future combined operations. These amounts are preliminary estimates only
and are, therefore, subject to change. In addition, there can be no assurance
that the Company will not incur additional charges in subsequent quarters to
reflect costs associated with the RCA Merger and the Contour Merger.
On January 10, 1997, the Company loaned Retirement Care $9.8 million in
order to enable Retirement Care to cause the repayment of certain indebtedness
incurred by Contour in connection with Contour's acquisition of Atlantic Medical
Supply Company, Inc. ("Atlantic") on August 6, 1996. On July 10, 1997, the
Company and Retirement Care amended the terms of the loan to: (i) increase the
applicable interest rate by 2.0%; (ii) extend the maturity date to 120 days
after the termination of the Retirement Care Merger Agreement; and (iii) replace
the collateral securing the loan with a second lien on all of Retirement Care's
accounts receivable. Consistent with Retirement Care's bank line of credit, the
loan is unconditionally and irrevocably guaranteed by certain officers of
Retirement Care. On July 10, 1997, the Company also agreed to loan Retirement
Care an additional $5.0 million which is also secured by a second lien on all of
Retirement Care's accounts receivable and is unconditionally and irrevocably
guaranteed by certain officers of Retirement Care. The interest receivable
related to the promissory notes was $1.0 million as of December 31, 1997. As of
December 31, 1997, Retirement Care owed the Company an additional $12.4 million
in the form of unsecured trade receivables in respect to ancillary and
management services provided by the Company.
In December 1997, the Company purchased from a third party $5.0 million
aggregate principal amount of 9% Contour convertible debentures which are
convertible into one million shares of Contour common stock, for an aggregate
purchase price of $8.4 million in cash.
On November 25, 1997 the Company, Retirement Care and representatives of the
plaintiffs in certain pending class actions against Retirement Care and its
management reached an agreement in principle to settle these class actions for
$9.0 million. In connection with the agreement in principle, the Company has
escrowed on behalf of the defendants the settlement amount into an escrow fund
which is included in Other Assets as of December 31, 1997. The settlement is
contingent upon the closing of the RCA Merger and is subject to, among other
things, confirmatory discovery, the execution of definitive documentation and
court approval.
On January 30, 1997, the Company acquired all of the capital stock not
previously owned by the Company of Ashbourne PLC ("Ashbourne") which as of the
date of acquisition provided healthcare services to patients through 49 nursing
facilities in the United Kingdom. Pursuant to the acquisition, the Company paid
approximately L67.3 million ($110.1 million as of the respective dates of
payment) for the portion of Ashbourne totaling 70.8% not previously owned by the
Company. The Company had previously acquired a 9% minority interest for $10.2
million in 1996 and a 20% minority interest for $25.9 million in 1995. The
acquisition was accounted for as a purchase and Ashbourne's results of
operations have been included in the Company's financial statements from the
date of acquisition on January 30, 1997. The total fair value of 100% of
Ashbourne's assets acquired, including goodwill of approximately $61.3 million,
was approximately $300.0 million and liabilities assumed totaled approximately
$147.7 million.
F-14
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(2) MERGERS AND ACQUISITIONS (CONTINUED)
In July 1997, the Company acquired a majority interest in Eurosar, S.A.
("Eurosar"), a privately owned operator of eight nursing homes in Spain. In
August 1997, the Company acquired 38% of the equity of Alpha Healthcare Limited,
a publicly held acute care provider in Australia. In addition, in November 1997,
Sun acquired from Moran Healthcare Group Pty Ltd. ("Moran") a majority interest
in six hospitals in Australia. In December 1997, the Company acquired a majority
interest in Heim-Plan Unternehmensgruppe ("Heim-Plan"), an operator of 11
nursing homes in Germany.
On December 15, 1996, the Company acquired all of the capital stock of APTA
Healthcare PLC ("APTA"), which provided healthcare services to patients through
32 nursing facilities in the United Kingdom. The Company paid cash totaling
approximately L11.3 million ($19.3 million as of the respective dates of
payment) to former stockholders of APTA and issued notes with a maturity not to
exceed five years, totaling approximately L2.5 million ($4.0 million as of
December 31, 1997) to the remaining stockholders of APTA who elected not to
receive cash as consideration. The fair market value of assets acquired,
including goodwill of $17.9 million, was $72.7 million and liabilities assumed
totaled $49.2 million. Also in 1996, the Company purchased a 9.9% investment in
OmniCell Technologies, Inc. ("OmniCell") for $25.3 million.
On June 21, 1995, the Company merged with and into CareerStaff Unlimited,
Inc. ("CareerStaff"). CareerStaff provides temporary staffing of physical,
occupational and speech therapists to the healthcare industry. Under the terms
of the merger agreement, the Company issued 6,080,600 shares of its common stock
in exchange for all the outstanding common stock of CareerStaff. The merger was
accounted for as a pooling of interests and, accordingly, the Company's
financial statements have been restated to include the accounts and operations
of CareerStaff for periods prior to the merger.
On May 5, 1995, the Company merged with and into SunCare. SunCare provides
respiratory therapy services to long-term and subacute care facilities. Under
the terms of the merger agreement, the Company issued 2,106,904 shares of its
common stock in exchange for all of the outstanding common stock of SunCare. In
connection with the merger, SunCare terminated its S corporation status and
recorded a deferred income tax provision of $1.5 million. The merger was
accounted for as a pooling of interests and, accordingly, the Company's
financial statements have been restated to include the accounts and operations
of SunCare for periods prior to the merger.
In connection with the mergers of the Company with CareerStaff and SunCare,
the Company recognized $5.8 million of merger costs. These costs include
transaction costs and advisory fees and transitional costs related to
consolidating operations.
Between 1995 and 1997, the Company acquired 80% of the common stock of
Columbia Health Care Inc. ("Columbia"), a provider of outpatient rehabilitation
therapy services in Canada, for $8.5 million. In addition, the Company issued
warrants to former owners of Columbia to purchase 500,000 shares of the
Company's common stock with an exercise price of $15.375 per share which had a
value of $1.1 million at the date of acquisition. As of December 31, 1997, the
warrants were exercisable and, if unexercised, will expire in approximately four
years. The Columbia acquisition was accounted for as a purchase.
The effects of the Company's acquisitions during 1997, 1996 and 1995,
excluding Regency, individually and in the aggregate, are immaterial to the
results of the Company and, therefore, pro forma information is not provided.
F-15
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(3) DISPOSITION
In May 1997, the Company announced its intent to sell and divest itself of
its outpatient rehabilitation clinics in the United States, as well as in
Canada. The sale of the United States operations is expected to close in the
first half of 1998, and to result in no material gain or loss. The Company
recorded a $7.0 million loss in 1997 in order to reduce the carrying value of
the Canadian operations to fair value based on revised estimates of selling
value and of costs to sell. The results of operations of these businesses are
immaterial.
In June 1996, the Company completed the sale of all of the outstanding stock
of SunSurgery Corporation, its ambulatory surgery subsidiary, for approximately
$27.9 million in cash and the assumption of $5.6 million in debt by the buyer.
As of the date of sale, SunSurgery Corporation had approximately $3.1 million in
cash which was retained by the buyer. The sale resulted in no material gain or
loss to the Company.
(4) PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31 (in
thousands):
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Land.................................................................. $ 64,280 $ 21,983
Buildings and improvements............................................ 368,350 148,530
Leasehold improvements................................................ 64,826 52,630
Equipment............................................................. 142,837 76,812
Construction in progress.............................................. 45,314 34,097
---------- ----------
Total............................................................... 685,607 334,052
Less accumulated depreciation and amortization........................ (54,505) (28,332)
---------- ----------
Property and equipment, net......................................... $ 631,102 $ 305,720
---------- ----------
---------- ----------
</TABLE>
In 1997, the Company sold five of its long-term and subacute care facilities
in the United States for approximately $31.2 million in cash and approximately
$5.6 million in assumption of debt and leased them back under fourteen year
leases. Also in 1997, the Company sold 27 of its long-term care facilities in
the United Kingdom for approximately $49.3 million and leased them back under
twelve-year leases. These transactions produced no material gain or loss.
During 1996, the Company sold three of its long-term and subacute care
facilities for $11.9 million including the assumption of debt totaling $3.2
million and leased them back under fifteen year leases. Also during 1996, the
Company sold ten of its long-term care facilities in the United Kingdom for
$25.8 million and leased them back under twelve year leases. These transactions
produced no material gain or loss.
In 1995, the Company sold five of its long-term and subacute care facilities
for $70.0 million and leased them back under ten year leases. Also in 1995, the
Company sold fifteen of its long-term care facilities in the United Kingdom for
$35.5 million and leased them back under twelve year leases. These transactions
produced no material gain or loss.
F-16
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(5) ASSETS HELD FOR SALE
As a result of the acquisition of the Mediplex Group, Inc. ("Mediplex") in
1994, the Company acquired certain facilities providing psychiatric, substance
abuse and transitional living services. On September 30, 1995, the Company sold
five of the operating psychiatric care and substance abuse treatment facilities,
all of the related outpatient facilities and a transitional living facility for
a sales price of $39.9 million consisting of cash and the assumption of
indebtedness secured by one of the facilities. The sale of the transitional
living facility was completed in 1996 at a net cost to the Company of $3.8
million. As part of the sale, the Company provided a five-year $12.5 million
working capital line of credit to the buyer, which is secured by the accounts
receivable of the facilities sold and is restricted to a borrowing base
determined by the amount of accounts receivable of the facilities. Under the
terms of the working capital line of credit, principal is due in full on
September 30, 2000 and interest accrues at either LIBOR plus 2.5% or Prime plus
1.5%. As of December 31, 1997, $12.5 million had been advanced on the working
capital line of credit. In 1995, the Company subleased two operating
transitional living facilities and sold the working capital of these facilities
to the current administrator of one of these facilities, who has assumed
responsibility for approximately 60% of the Company's obligations under the
present leases and will pay the Company a total of $13.4 million over the term
of such leases. Also in 1995, the Company completed the sale of two of the
closed facilities for $2.0 million and $2.5 million, respectively. As of
December 31, 1997, the Company continues to own an interest in a substance abuse
facility which was closed in 1992.
F-17
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(6) LONG-TERM DEBT
Long-term debt consists of the following as of December 31 (dollars in
thousands):
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Revolving Credit Facility (see below)................................................. $ 275,075 $ 279,300
Credit Facility Term Loans (see below)................................................ 700,000 --
Senior Subordinated Notes due 2007, interest at 9 1/2% per annum...................... 250,000 --
Convertible Subordinated Debentures due 2004, interest at 6% per annum................ 83,300 83,300
Convertible Subordinated Debentures due 2003, interest at 6 1/2% per annum, includes
unamortized premium of $2,314 and $2,728 as of December 31, 1997 and 1996,
respectively........................................................................ 23,029 25,137
Senior Subordinated Notes due 2002, interest at 11 3/4% per annum, includes
unamortized premium of $122 and $126 as of December 31, 1997 and 1996,
respectively........................................................................ 6,283 6,287
Mortgage notes payable due at various dates through 2005, interest at rates from 8.5%
to 14%, collateralized by various facilities........................................ 45,285 38,939
Mortgage notes payable in Spanish pesetas and due at various dates through 2017,
interest at rates from 5.6% to 13.3%, collateralized by various facilities in
Spain............................................................................... 13,498 --
Mortgage notes payable in pound sterling and due at various dates through 2017,
interest at rates from 2.5% to 4% plus the FHBR rate ("Finance House Base Rate"),
collateralized by various facilities in the United Kingdom.......................... 8,904 31,543
Mortgage notes payable in German marks and due at various dates through 2022, interest
at rates from 8.5% to 9%, collateralized by various facilities in Germany........... 7,778 --
Revolving lines of credit with a bank due at various dates through 2001, payable in
pound sterling, interest at rates from 8.7% to 9% plus the FHBR rate, collateralized
by the assets of various facilities................................................. 90,473 20,309
Other long-term debt.................................................................. 42,053 3,387
------------ ------------
Total long-term debt................................................................ 1,545,678 488,202
Less current portion.................................................................. (56,817) (27,701)
------------ ------------
Long-term debt, net of current portion.............................................. $ 1,488,861 $ 460,501
------------ ------------
------------ ------------
</TABLE>
Annual maturities for the next five years as of December 31, 1997 are as
follows (in thousands):
<TABLE>
<S> <C>
1998........................................................ $ 56,817
1999........................................................ 33,351
2000........................................................ 40,565
2001........................................................ 49,357
2002........................................................ 65,583
Thereafter.................................................. 1,300,005
------------
$ 1,545,678
------------
------------
</TABLE>
F-18
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(6) LONG-TERM DEBT (CONTINUED)
On July 8, 1997, the Company issued $250 million aggregate principal amount
of 9 1/2% Senior Subordinated Notes due 2007 (the "9 1/2% Notes"). The net
proceeds from the sale, approximately $243 million, were used to reduce
outstanding borrowings under the Company's credit facility. The 9 1/2% Notes,
which are subject to customary terms and covenants, are redeemable by the
Company at a premium, in whole or in part, after July 1, 2002.
On October 8, 1997, the Company entered into a Credit Agreement with certain
lenders, certain co-agents, and NationsBank of Texas, N.A. as administrative
lender to replace the Company's old revolving credit facility. On November 12,
1997, the Company entered into a First Amendment to Credit Agreement (the
"Credit Facility"). The Credit Facility provides for borrowings by the Company
of up to $1.2 billion consisting of $500 million in a revolving credit facility
which borrowings bear interest at the prevailing prime rate plus 0% to 1% or the
LIBOR rate plus .75% to 2.50%, and $700 million in term loans which bear
interest at the prevailing prime rate plus 0% to 1.5% or the LIBOR rate plus
.75% to 3.0%. One month LIBOR was 5.7% as of December 31, 1997. The revolving
credit facility matures in November 2003 and the term loans begin amortization
in March 1998 and reach final maturity in November 2005. In connection with this
refinancing, the Company recorded an extraordinary loss of $2.1 million, net of
the related tax benefit, in the fourth quarter of 1997. The Credit Facility,
among other things, (i) requires the Company to maintain certain financial
ratios, (ii) restricts the Company's ability to incur debt and liens, make
investments, liquidate or dispose of assets, merge with another corporation,
create or acquire subsidiaries, and make acquisitions, and (iii) prohibits the
payment of dividends, the acquisition of treasury stock and the prepayment or
modification of certain debts of the Company. The Credit Facility is
collateralized by a pledge of the stock of the majority of the Company's
subsidiaries. The Company had borrowings of $275.1 million outstanding under the
revolving Credit Facility, $700.0 million outstanding in term loans, and $40.2
million of outstanding standby letters of credit under the Credit Facility as of
December 31, 1997.
Holders of the 6 1/2% Convertible Subordinated Debentures due 2003 (the
"6 1/2% Debentures") are entitled under the indenture to receive the Mediplex
acquisition consideration in respect of each share of Mediplex common stock into
which the 6 1/2% Debentures would have been convertible at the time of the
acquisition of Mediplex. The Company has agreed to be a co-obligor of the 6 1/2%
Debentures. In January 1995, $39.4 million of the 6 1/2% Debentures were
converted. Pursuant to the conversion terms under the indenture, the Company
paid $13.6 million and issued 1,582,905 shares of the Company's common stock to
the converting holder. In addition, the Company paid accrued interest plus a
conversion fee of $3.3 million to the converting holder, which was expensed in
the first quarter of 1995, to induce conversion. Conversion of the remaining
$20.7 million of outstanding 6 1/2% Debentures would require the issuance of an
additional 831,197 shares of the Company's common stock and a payment of $7.1
million in cash pursuant to the conversion terms under the indenture relating to
the 6 1/2% Debentures.
In January 1995, the Company completed a tender offer for $78.7 million of
the 11 3/4% Senior Subordinated Notes due 2002 (the "11 3/4% Notes") at a price
of $1,120 per $1,000 of principal amount of the notes. The Company recorded an
extraordinary loss, net of the related tax benefit, of $3.4 million as a result
of the extinguishment of such debt. Concurrent with the tender offer, the
Company deleted by amendment certain covenants contained in the original
indenture that restricted the Company from fully integrating Mediplex into its
operations. In addition, the amendments modified certain provisions relating to
mergers and consolidations and events of default. In conjunction with the
amendments, the Company became a co-obligor on the 11 3/4% Notes.
F-19
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(6) LONG-TERM DEBT (CONTINUED)
In 1994, the Company issued $83.3 million aggregate principal amount of 6%
Convertible Subordinated Debentures due 2004 which are convertible into shares
of the Company's common stock at a conversion price of $21.84 or 3,814,102
shares of the Company's common stock.
The Company has $32.3 million of mortgages with Meditrust as of December 31,
1997 which contain less restrictive covenants than the Credit Facility and which
include cross default provisions with all of such mortgages and leases also
financed by Meditrust. The Company also is the obligor on an outstanding letter
of credit with a bank of $3.8 million as of December 31, 1997 to guarantee
outstanding debt obligations for a partnership through which the Company
acquired a 50% interest. The partnership owns a long-term care facility which is
leased to a third-party operator.
(7) COMMITMENTS AND CONTINGENCIES
(a) LEASE COMMITMENTS
The Company has various noncancelable operating leases for facilities with
initial lease terms generally ranging from 5 to 23 years and renewal options of
5 to 40 years. Certain of the lease agreements provide for payment escalations
coincident with increases in certain economic indices.
The Company has various facilities and equipment under capital lease
agreements. Property and equipment, net includes the following amounts for
assets held under capital leases as of December 31 (in thousands):
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Land..................................................................... $ 7,282 $ 2,154
Building and improvements................................................ 65,536 19,383
Equipment................................................................ 6,409 3,912
--------- ---------
Total.................................................................. 79,227 25,449
Less accumulated depreciation............................................ (5,208) (785)
--------- ---------
Property and equipment, net............................................ $ 74,019 $ 24,664
--------- ---------
--------- ---------
</TABLE>
Future minimum lease payments under noncancelable leases as of December 31,
1997 are as follows (in thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
----------- -----------
<S> <C> <C>
1998................................................................ $ 9,237 $ 122,921
1999................................................................ 8,785 122,468
2000................................................................ 8,588 121,514
2001................................................................ 8,809 115,709
2002................................................................ 8,425 113,291
Thereafter.......................................................... 263,536 730,958
----------- -----------
Total minimum lease payments...................................... 307,380 $ 1,326,861
-----------
-----------
Less amount representing interest................................... (226,216)
-----------
Present value of net minimum lease payments under capital
leases.......................................................... $ 81,164
-----------
-----------
</TABLE>
F-20
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(7) COMMITMENTS AND CONTINGENCIES (CONTINUED)
Rent expense under operating leases totaled $143.9 million, $91.7 million,
and $73.7 million in 1997, 1996 and 1995, respectively.
The Company leases or subleases 63 facilities from affiliates of two
directors of the Company as of December 31, 1997, which is included in the
information above. The aggregate lease expense for these facilities was
approximately $20.2 million, $16.7 million, and $13.8 million in 1997, 1996 and
1995, respectively. Future minimum lease commitments related to these facilities
total approximately $177.3 million at December 31, 1997. The Company's
management believes the terms of all of the foregoing leases are as favorable to
the Company as those that could have been obtained from nonrelated parties.
(b) CONSTRUCTION COMMITMENTS
The Company had capital commitments, as of December 31, 1997, under various
contracts, including approximately $25.9 million in the United States and L1.0
million ($1.6 million as of December 31, 1997) in the United Kingdom. These
include contractual commitments to improve existing facilities and to develop,
construct and complete a corporate office building and a long-term care facility
in the United States and two long-term care facilities in the United Kingdom.
(c) FINANCING COMMITMENTS
The Company has advanced $32.8 million and expects to lend up to a total of
$47.0 million under a revolving subordinated credit agreement ("Financing
Facility") to a developer of assisted living facilities for the development,
construction and operation of assisted living facilities. Any advances under the
Financing Facility have been and are expected to be funded by borrowings under
the Company's credit facility and will be subject to certain conditions,
including the approval of each project by the Company. The developer has
obtained a commitment for mortgage financing to fund 50% of the cost of each
project. The Company's advances under the Financing Facility are subordinate to
the mortgage financing. The Financing Facility with respect to each assisted
living facility bears interest at 9% or 13% depending on the percentage of
completion of the facility under construction. All amounts advanced are due in
full on November 1, 2001. The advances to the developer totaled approximately
$32.8 million and $9.0 million at December 31, 1997 and 1996, respectively. As
of December 31, 1997, five assisted living facilities were under development.
Construction was completed on one facility in 1997. In addition, the Company has
entered into a purchase option agreement with the developer whereby the Company
will pay the developer $50,000 for each option to purchase any of the
facilities. The option will grant the Company the right to purchase the
facility, after a specified time period, at the greater of the estimated fair
market value of the property or the total amount invested by the developer.
(d) LITIGATION
The Company is a party to various legal actions and administrative
proceedings and subject to various claims arising in the ordinary course of
business (see Notes 1(j) and 14).
F-21
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(8) INCOME TAXES
Income tax expense (benefit) on earnings (loss) before extraordinary loss
consists of the following for the year ended December 31 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Current:
Federal.................................................... $ 18,441 $ 12,790 $ (212)
State...................................................... 5,918 4,835 (102)
--------- --------- ---------
24,359 17,625 (314)
--------- --------- ---------
Deferred:
Federal.................................................... 13,604 11,037 27,744
State...................................................... 3,190 2,268 5,702
--------- --------- ---------
16,794 13,305 33,446
--------- --------- ---------
Total.................................................... $ 41,153 $ 30,930 $ 33,132
--------- --------- ---------
--------- --------- ---------
</TABLE>
Actual tax expense differs from the "expected" tax expense on earnings
before extraordinary loss, computed by applying the U.S. Federal corporate
income tax rate of 35% to earnings before income taxes and extraordinary loss of
the Company as follows for the year ended December 31 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Computed "expected" tax expense.................................................. $ 33,559 $ 18,363 $ 4,478
Adjustments in income taxes resulting from:
Amortization of goodwill....................................................... 3,765 3,045 3,235
Impairment loss................................................................ -- -- 15,452
Increase in valuation allowance................................................ 2,450 7,615 3,038
Conversion fee................................................................. -- -- 1,139
Merger expenses................................................................ -- -- 1,199
S corporation earnings not taxable to the Company (at Federal rates)........... -- -- (230)
State income tax expense, net of Federal income tax benefit.................... 3,041 4,617 3,332
Loss on sale of subsidiary stock............................................... -- (2,458) --
Recognition of deferred income taxes for former S corporations................. -- -- 1,487
Other.......................................................................... (1,662) (252) 2
--------- --------- ---------
$ 41,153 $ 30,930 $ 33,132
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-22
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(8) INCOME TAXES (CONTINUED)
Deferred tax assets (liabilities) were comprised of the following as of
December 31 (in thousands):
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Deferred tax assets:
Accounts receivable..................................................................... $ -- $ 8,045
Accrued liabilities..................................................................... 22,057 3,629
Property and equipment.................................................................. -- 3,270
Intangible assets....................................................................... 18,175 8,154
Carryforward of deductions limited by Internal Revenue Code Section 382................. 6,250 9,222
Write-down of assets held for sale and reserve for estimated costs of disposal and
future operating losses............................................................... 6,513 5,714
Deferred income......................................................................... 2,840 2,275
Shareholder settlement.................................................................. 1,051 7,571
Alternative minimum tax credit.......................................................... 3,453 425
Jobs credit carryforwards............................................................... 3,477 --
Capital loss carryforwards.............................................................. 4,023 1,573
State net operating loss carryforwards.................................................. 7,313 5,156
United Kingdom trading loss carryforwards............................................... 7,895 --
Other................................................................................... 2,676 523
---------- ----------
85,723 55,557
---------- ----------
Less valuation allowance:
Federal................................................................................. (31,195) (24,843)
State................................................................................... (5,115) (3,810)
---------- ----------
(36,310) (28,653)
---------- ----------
Total deferred tax assets................................................................. 49,413 26,904
---------- ----------
Deferred tax liabilities:
Property and equipment attributable to United Kingdom operations........................ (15,234) (4,760)
Property and equipment attributable to United States operations......................... (989) --
Accounts receivable..................................................................... (1,527) --
Partnership investments................................................................. (522) --
Changes in certain subsidiaries' methods of accounting for income taxes from cash to
accrual basis......................................................................... (370) (1,191)
Other................................................................................... (2,468) --
---------- ----------
(21,110) (5,951)
---------- ----------
Deferred tax asset, net................................................................... $ 28,303 $ 20,953
---------- ----------
---------- ----------
</TABLE>
Various subsidiaries have state net operating loss ("NOL") carryforwards
totaling $138.1 million with expiration dates through the year 2012. In
addition, the Company has capital loss carryforwards of approximately $11.0
million of which $4.0 million will expire in 2001 and $7.0 million will expire
in 2003. United Kingdom trading loss carryforwards of $25.5 million and the
alternative minimum tax credit carryforwards of $3.5 million have no expiration
dates. The $3.5 million of jobs tax credit carryforwards will
F-23
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(8) INCOME TAXES (CONTINUED)
expire beginning in 2007. Because there is a risk that certain of these NOL and
capital loss carryforwards may expire unutilized, a valuation allowance has been
established against them.
In connection with the deferred tax assets acquired in the acquisition of
Mediplex, the Company recorded an $18.0 million valuation allowance. The Company
recorded a $5.2 million valuation allowance in the current year related to the
deferred tax assets acquired in the acquisition of Regency. Accordingly, any tax
benefits recognized in future periods attributable to these portions of the
valuation allowance will be allocated to reduce goodwill. The additional $2.5
million increase in the valuation allowance in 1997 relates to the realizability
of capital loss carryforwards.
Upon merging with the Company on May 5, 1995, SunCare terminated its S
Corporation status for Federal and state income tax purposes. In connection with
this termination, the Company recorded a deferred income tax provision and
liability of $1.5 million.
(9) SUPPLEMENTARY INFORMATION RELATING TO STATEMENTS OF CASH FLOWS
Supplementary information for the consolidated statements of cash flows is
set forth below for the year ended December 31 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Cash paid during the year ended December 31 for:
Interest, net of $2,023, $2,472 and $2,839 capitalized
during 1997, 1996 and 1995, respectively................. $ 68,814 $ 26,821 $ 26,951
Income taxes............................................... 8,553 7,608 12,150
</TABLE>
The Company's acquisitions during 1997, 1996 and 1995 involved the following
for the year ended December 31 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------ ---------- ---------
<S> <C> <C> <C>
Fair value of assets acquired............................ $ 1,159,012 $ 145,652 $ 66,575
Liabilities assumed...................................... (613,988) (55,741) (9,079)
Cash payments or payables to former APTA shareholders.... 19,300 (23,545) --
Fair value of stock and warrants issued.................. (190) (961) (9,329)
------------ ---------- ---------
Cash payments made, net of cash received from others..... $ 564,134 $ 65,405 $ 48,167
------------ ---------- ---------
------------ ---------- ---------
</TABLE>
In January 1995, the Company issued 1,582,905 shares of its common stock
upon the conversion of $39.4 million principal amount of 6 1/2% Debentures (see
Note 6).
F-24
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(10) FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments as of
December 31 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
-------------------------- ----------------------
<S> <C> <C> <C> <C>
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------------ ------------ ---------- ----------
Cash and cash equivalents.................................... $ 21,020 $ 21,020 $ 14,880 $ 14,880
Long-term debt and capital lease obligations including
current portion............................................ 1,626,842 1,640,814 512,435 510,400
</TABLE>
The cash and cash equivalents carrying amount approximates fair value
because of the short maturity of these instruments. The fair value of the
Company's long-term debt was estimated based on the quoted market prices for the
same or similar issues or on the current rates offered to the Company for debt
of the same remaining maturities.
(11) CAPITAL STOCK
(a) COMMON STOCK REPURCHASE
In the first quarter of 1996, the Company repurchased 2,030,116 shares of
its outstanding common stock at a cost, including commissions, of $25.1 million.
In 1997, the Company repurchased 23,091 shares of its outstanding common stock
at a cost of $.5 million.
(b) STOCK OPTION PLANS
STOCK INCENTIVE PLANS
The Company has stock incentive plans for certain employees, officers, and
consultants of the Company. Awards made under the plans may be in the form of
stock options, stock appreciation rights, stock awards, performance share
awards, or other stock-based awards. The Board of Directors or a committee
appointed by the Board of Directors determines the vesting schedule and the
option price which is generally not to be less than the fair market value per
share of the Company's common stock at the date of grant. Options granted prior
to March 1996 generally vest at the end of three years and expire ten years from
the date of grant. Options granted during and after March 1996 generally vest
ratably over three years and expire ten years from the date of grant. At
December 31, 1997, options for 3,123,124 shares were outstanding, options for
1,051,260 shares were vested and 3,589,500 shares were available for future
grants under the stock incentive plans for officers, certain employees, and
consultants. Exercise prices of outstanding options to purchase shares of the
Company's common stock range from $9.50 to $24.00. During the year ended
December 31, 1997, the Company awarded an aggregate of 783,000 shares of
restricted stock to ten senior executives which will be expensed over the
vesting period. As of December 31, 1997, 106,800 of the restricted shares have
vested and the remainder vest ratably over four to five years.
DIRECTOR STOCK INCENTIVE PLANS
The Company has stock incentive plans for nonemployee directors, which
provide for the grant of nonqualified options, stock appreciation rights, stock
awards, performance share awards, or other stock-
F-25
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(11) CAPITAL STOCK (CONTINUED)
based awards. Beginning in 1997, all nonemployee directors will receive an
annual grant of options for 4,000 shares at a price not less than fair market
value of the Company's common stock at the date of grant and an annual grant of
2,000 restricted stock awards. All awards vest ratably over three years and
stock option awards expire ten years after the date of grant. Exercise prices of
outstanding options to purchase shares of common stock range from $9.50 to
$21.88. Nonemployee directors have the option of electing to receive a portion
of their annual board compensation in the form of restricted stock awards which
vest in quarterly increments over one year. During the year ended December 31,
1997, the Company awarded an aggregate of 15,080 shares of restricted stock to
nonemployee directors which will be expensed over the vesting period. As of
December 31, 1997, 770 of the restricted shares are vested and the remainder
vest ratably over one to three years. As of December 31, 1997, options for
110,500 shares were outstanding, options for 67,000 shares have vested and
360,920 shares were available for future grant under the stock incentive plans
for nonemployee directors.
The following is a summary of the status of the Company's Stock Incentive
Plans, the Director Stock Incentive Plans and assumed option plans from
acquisitions as of December 31, 1997, 1996 and 1995, and changes during the
years ending on those dates is presented below (shares in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-------------------------- -------------------------- --------------------------
<S> <C> <C> <C> <C> <C> <C>
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
----------- ------------- ----------- ------------- ----------- -------------
Outstanding at beginning of year......... 3,348 $ 15.91 3,648 $ 16.12 3,007 $ 15.79
Granted
Price equals fair value................ 814 18.06 441 13.74 1,508 16.82
Price is less than fair value.......... -- -- 15 11.00 23 11.00
Exercised................................ (487) 11.25 (106) 11.09 (283) 12.78
Cancelled................................ (336) 17.28 (650) 16.54 (607) 17.07
----- ----- -----
Outstanding at year-end.................. 3,339 16.90 3,348 15.91 3,648 16.12
----- ----- -----
----- ----- -----
Options exercisable at year-end.......... 1,210 17.25 796 11.53 628 11.62
----- ----- -----
----- ----- -----
Options available for future grant....... 3,950 3,022 330
----- ----- -----
----- ----- -----
Weighted average fair value of options
granted during the year................ $ 5.89 $ 5.41 $ 7.04
----- ----- -----
----- ----- -----
</TABLE>
The fair value of each option granted in 1997, 1996 and 1995 is estimated at
the date of grant using the Black-Scholes option pricing model with the
following weighted-average assumptions:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Expected Life (in years).............................................. 4 4 4
Risk-free Interest Rate............................................... 6.26% 5.37% 6.22%
Expected Volatility................................................... 42% 41% 41%
Dividend Yield........................................................ -- -- --
</TABLE>
F-26
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(11) CAPITAL STOCK (CONTINUED)
Had compensation cost for the Company's 1997, 1996 and 1995 option grants
been determined consistent with SFAS 123 (see Note 1(n)) which establishes fair
value as the measurement basis for stock-based awards, the Company's net
earnings and net earnings per share for 1997, 1996 and 1995 would approximate
the pro forma amounts below (in thousands, except per share data):
<TABLE>
<CAPTION>
1997 1996 1995
------------------------ ------------------------ ------------------------
<S> <C> <C> <C> <C> <C> <C>
AS REPORTED PRO FORMA AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- ----------- ----------- ----------- ----------- -----------
Net earnings (loss)................. $ 34,801 $ 32,804 $ 21,536 $ 19,548 $ (23,751) $ (25,229)
Net earnings (loss) per share:
Basic............................. $ 0.75 $ 0.71 $ 0.46 $ 0.42 $ (0.51) $ (0.53)
Diluted........................... $ 0.74 $ 0.70 $ 0.46 $ 0.42 $ (0.51) $ (0.53)
</TABLE>
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts. SFAS 123 does not apply to options granted prior
to 1995, and additional option grants in future years are anticipated.
The following table summarizes information about stock options outstanding
as of December 31, 1997 (shares in thousands):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- ----------------------------
<S> <C> <C> <C> <C> <C>
WEIGHTED WEIGHTED
WEIGHTED AVERAGE AVERAGE AVERAGE
NUMBER REMAINING EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICE OUTSTANDING CONTRACTUAL LIFE PRICE OUTSTANDING PRICE
- -------------------------------------- ------------- ------------------- ------------- ------------- -------------
$ 7.75 - $10.13....................... 376 7.55 $ 9.45 34 $ 8.99
11.00 - 15.84....................... 1,090 7.66 13.60 395 12.35
16.07 - 19.00....................... 834 6.81 18.31 459 18.87
20.50 - 24.00....................... 1,039 8.05 21.92 322 21.78
----- --- ------ ----- ------
3,339 7.56 16.90 1,210 17.25
----- -----
----- -----
</TABLE>
OPTIONS ISSUED IN CONNECTION WITH THE SUNCARE MERGER
During 1995, the Company issued options to purchase a total of 234,100
shares of the Company's common stock with a total exercise price of $.5 million
as part of the consideration in the Company's merger with SunCare. These options
represent 10% of the total shares of the Company's common stock issued in
connection with the SunCare merger. These options replaced options granted to an
employee in 1994 under an employment agreement in which former SunCare
stockholders granted an option to an employee to acquire 10% of their holdings.
All such options vested as of the date of the merger.
(c) GRANTOR STOCK TRUST
In the first quarter of 1996, the Company sold 3,050,000 newly issued shares
of the Company's common stock to a newly established Grantor Stock Trust
("Trust") for approximately $37.7 million. The Trust was created to fund future
obligations under certain of the Company's benefit plans, including, but not
limited to, stock option plans, a stock purchase plan, health insurance plans
and employee compensation. The sale of the shares to the Trust was recorded as
an increase in stockholders' equity with a
F-27
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(11) CAPITAL STOCK (CONTINUED)
corresponding reduction for the value of the shares held by the Trust. As stock
is released from the Trust to satisfy certain employee compensation and benefit
plans, the number and the related fair value of shares held by the Trust is
reduced and stockholders' equity correspondingly increases in accordance with
SOP 93-6. As of December 31, 1997, the Trust held 2,178,315 shares of the
Company's common stock.
The Trust delivered to the Company a promissory note for approximately $37.7
million. The cash portion of the purchase price of approximately $31,000
represents the par value of the shares of the Company's common stock sold to the
Trust. Amounts owed by the Trust will be repaid periodically with cash received
from the Company or will be forgiven by the Company thereby enabling the release
of shares from the Trust to satisfy the Company's obligations for certain
employee compensation and benefit plans.
(12) EARNINGS PER SHARE
Earnings per share is calculated as follows for the year ended December 31
(in thousands, except per share data):
<TABLE>
<CAPTION>
1997 1996 1995(1)
--------- --------- ---------
<S> <C> <C> <C>
BASIC:
Net earnings (loss) before extraordinary loss................................... $ 54,729 $ 21,536 $ (20,568)
Net earnings (loss)............................................................. 34,801 21,536 (23,981)
Weighted average shares outstanding............................................. 46,329 46,360 47,419
Earnings (loss) per share:
Net earnings (loss) before extraordinary loss................................. $ 1.18 $ 0.46 $ (0.43)
Net earnings (loss)........................................................... $ 0.75 $ 0.46 $ (0.51)
DILUTED:
Net earnings (loss) before extraordinary loss used in basic calculation......... $ 54,729 $ 21,536 $ (20,568)
Income impact of assumed conversions............................................ 3,410 -- --
--------- --------- ---------
Adjusted net earnings (loss) before extraordinary loss.......................... 58,139 21,536 (20,568)
Extraordinary loss.............................................................. 19,928 -- 3,413
--------- --------- ---------
Net earnings (loss)............................................................. $ 38,211 $ 21,536 $ (23,981)
--------- --------- ---------
--------- --------- ---------
Weighted average shares used in basic calculation............................... 46,329 46,360 47,419
Effect of dilutive securities:
Stock options and warrants.................................................... 832 508 --
Assumed conversion of convertible debt........................................ 4,690 -- --
--------- --------- ---------
Weighted average common and common equivalent shares outstanding................ 51,851 46,868 47,419
--------- --------- ---------
--------- --------- ---------
Earnings (loss) per share:
Net earnings (loss) before extraordinary loss................................. $ 1.12 $ 0.46 $ (0.43)
Net earnings (loss)........................................................... $ 0.74 $ 0.46 $ (0.51)
</TABLE>
- ------------------------
(1) Results for the year ended December 31, 1995 represent pro forma amounts to
include pro forma taxes of SunCare prior to its conversion to be taxed as a
C Corporation, which occurred in May 1995 (See Note 1(l).
F-28
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(13) PREFERRED STOCK PURCHASE RIGHTS
On June 2, 1995, the Board of Directors declared a dividend of one preferred
stock purchase right ("Right") for each outstanding share of common stock of the
Company for stockholders of record on June 15, 1995 and for all future issuances
of common stock. The Rights are currently not exercisable or transferable apart
from the common stock and have no voting rights. Each Right entitles the
registered holder to purchase from the Company one one-hundredth of a share of
Series A Preferred Stock, par value $0.01 per share. The Rights become
exercisable ten business days following the date a person or group of affiliated
persons acquires 15% or more of the Company's common stock, or announces a
tender or exchange offer which would result in the beneficial ownership by a
person or group of affiliated persons of 15% or more of the outstanding
Company's common stock. The Rights also become exercisable if any person, who is
the beneficial owner of 15% or more of the Company's common stock as of the date
of record, acquires an additional 1% or more of the outstanding Company's common
stock. The Rights may be redeemed by the Company at a price of $.001 per Right
before their expiration on June 2, 2005.
In the event that the Company is acquired in a merger or other business
combination or certain other events occur, provision shall be made so that each
holder of a Right, excluding the Rights beneficially owned by the acquiring
persons, shall have the right to receive, upon exercise thereof at the then
current exercise price, that number of shares of common stock of the surviving
company which at the time of such transaction will have a market value of two
times the exercise price of the Right.
(14) OTHER EVENTS
(a) GOVERNMENT INVESTIGATION
In January 1995, the Company learned that it was the subject of a pending
Federal investigation. The investigating agencies are the United States
Department of Health and Human Services' Office of Inspector General ("OIG") and
the United States Department of Justice. At this time, the Company does not know
the full scope of the investigation. However, the Company currently believes
that the investigation is focused principally on whether the Company provided
and billed for unnecessary or unordered therapy services to residents of skilled
nursing facilities and whether the Company adequately documented the therapy
services which it provided.
In July 1997, the Criminal Division of the U.S. Department of Justice
informed the Company that it had completed its investigation of the Company, and
that it would not initiate any actions against the Company or any individuals.
The Investigation by the Civil Division of the Department of Justice and the OIG
is still proceeding. The government continues to collect information, and the
Company continues to cooperate with the investigators. The Company and the
government have had preliminary discussions, and the Company expects to have
continuing discussions, regarding a possible settlement of the investigation.
The Company is unable to determine at this time when the investigation will
be concluded, how large a monetary settlement the government may seek, the
nature of any other remedies that may be sought by the government, whether or
when a settlement will in fact occur or whether any such settlement or any other
outcome of the investigation will have a material adverse effect on the
Company's financial condition or results of operations. From time to time the
negative publicity surrounding the investigation has in the past adversely
affected the private pay enrollment in certain inpatient facilities and slowed
the Company's success in obtaining additional outside contracts in the
rehabilitation therapy business, which resulted in higher than required
therapist staffing levels. Negative publicity in the future could have a similar
effect.
F-29
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(14) OTHER EVENTS (CONTINUED)
(b) LITIGATION
Prior to the Company's acquisition of CareerStaff, a holder of CareerStaff's
common stock filed a lawsuit (the "CareerStaff Litigation") as a purported class
action against CareerStaff and the directors of CareerStaff alleging breach of
fiduciary duty in entering into a merger agreement with the Company and against
the Company alleging that the Company aided and abetted the alleged breach of
fiduciary duty by the CareerStaff directors. The CareerStaff Litigation was
voluntarily dismissed without prejudice on May 8, 1996.
On June 30, 1995, two civil class-action complaints were filed against the
Company and certain of its current and former directors and officers in the
United States District Court for the District of New Mexico. Two more
complaints, based on the same underlying events, were filed on August 30, 1995.
On October 6 and October 10, 1995, two additional complaints were filed, also
based on the same underlying events. These six complaints were consolidated by a
court order dated November 27, 1995 and an amended class action complaint,
captioned IN RE SUN HEALTHCARE GROUP, INC. LITIGATION (the "Complaint"), was
filed in the United States District Court for the District of New Mexico on
January 26, 1996. The Complaint was purportedly brought on behalf of all persons
who either purchased shares of the Company's common stock between October 26,
1994 and June 27, 1995, or who exchanged their shares of common stock of
CareerStaff for shares of the Company's common stock pursuant to merger
agreement between CareerStaff and the Company. The Complaints allege that
defendants misrepresented or failed to disclose material facts about the OIG
investigation and about the Company's operations and financial results, which
plaintiffs contend artificially inflated the price of the Company's securities.
In May 1997, the Company received court approval of the $24.0 million
settlement of certain class-action shareholder lawsuits which was previously
paid in the fourth quarter of 1996. The Company received $9.0 million during
March 1997, from its director and officer liability insurance carrier for its
claim submitted in connection with the settlement.
On or about January 23, 1996, two former stockholders of SunCare, John
Brennan and Susan Bird, filed a lawsuit (the "SunCare Litigation") against the
Company and certain of its officers and directors in the United States District
Court for the Southern District of Indiana. Plaintiffs allege, among other
things, that the Company did not disclose material facts concerning the
investigation by the OIG and that the Company's financial results were
misstated. The complaints purport to state claims, INTER ALIA, under Federal and
state securities laws and for breach of contract, including a breach of a
registration rights agreement pursuant to which the Company agreed to register
the shares of the Company's common stock issued to such former stockholders of
SunCare in the acquisition. Plaintiffs purport to seek recision, unspecified
compensatory damages, punitive damages and other relief. The trial is currently
scheduled to start in the summer of 1998.
The Company believes the SunCare Litigation will not have a material adverse
impact on its financial condition or results of operations, although the
unfavorable resolution of this action in any reporting period could have a
material adverse impact on the Company's results of operations for that period.
On September 8, 1995, a derivative action was filed by Brickell Partners
against certain of the Company's current and former directors and officers in
the United States District court for the district of New Mexico, captioned
BRICKELL PARTNERS V. TURNER, ET AL. The complaint was not served on any
defendant. On June 19, 1996, an amended complaint alleging breach of fiduciary
duty by certain of the Company's
F-30
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(14) OTHER EVENTS (CONTINUED)
current and former directors and officers was filed and subsequently served on
the defendants. On August 5, 1996, the District Court dismissed this action
without prejudice for failure to serve the defendants within the required time
period. The plaintiffs filed a new complaint, alleging the same claims, on
August 19, 1996. In December 1997, the Company and the plaintiffs reached an
agreement in principle to settle the action for an immaterial amount. The
settlement is subject to definitive documentation and court approval.
(c) OTHER INQUIRIES
From time to time, fiscal intermediaries and Medicaid agencies examine cost
reports filed by such predecessor operators. The Company is currently the
subject of several such examinations. If, as a result of any such examination,
it is concluded that overpayments to a predecessor operator were made, the
Company, as the current operator of such facilities, may be held financially
responsible for such overpayments. At this time the Company is unable to predict
the outcome of any existing or future examinations.
The Company was notified in 1997 by a law firm representing several national
insurance companies that these companies believed that the Company had engaged
in improper billing and other practices in connection with the Company's
delivery of therapy and related services. In response, the Company began
discussions directly with these insurers and hopes to resolve these matters
without litigation; however, the Company is unable at this time to predict
whether it will be able to do so, what the eventual outcome may be or the extent
of its liability, if any, to these insurers.
(d) LEGISLATION, REGULATIONS AND MARKET CONDITIONS
The Company is subject to extensive Federal, state and local government
regulation relating to licensure, conduct of operations, ownership of
facilities, expansion of facilities and services and reimbursement for services.
As such, in the ordinary course of business, the Company's operations are
continuously subject to state and Federal regulatory scrutiny, supervision and
control. Such regulatory scrutiny often includes inquiries, investigations,
examinations, audits, site visits and surveys, some of which may be non-routine.
The Company believes that it is in substantial compliance with the applicable
laws and regulations. However, if the Company is ever found to have engaged in
improper practices, it could be subjected to civil, administrative or criminal
fines, penalties or restitutionary relief.
F-31
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(15) SUMMARIZED FINANCIAL INFORMATION
The Company acquired Mediplex on June 23, 1994 and became a co-obligor with
Mediplex with respect to the 6 1/2% Debentures and the 11 3/4% Debentures
subsequent to the acquisition. Summarized financial information of Mediplex is
provided below (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
<S> <C> <C>
1997 1996
----------- -----------
Current assets.................................... $ 108,232 $ 103,629
Noncurrent assets................................. 391,048 429,555
Current liabilities............................... 26,016 21,904
Noncurrent liabilities............................ 72,373 83,370
Due to parent..................................... 165,207 152,447
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
<S> <C> <C> <C>
1997 1996 1995
---------- ---------- ----------
Net revenues................................................................. $ 507,750 $ 457,748 $ 448,254
---------- ---------- ----------
Costs and expenses........................................................... 486,541 438,799 436,930
Impairment loss.............................................................. -- -- 52,621
---------- ---------- ----------
Earnings (loss) before intercompany charges, income taxes and extraordinary
loss....................................................................... 21,209 18,949 (41,297)
Intercompany charges(1)...................................................... 78,957 50,133 35,005
---------- ---------- ----------
Earnings (loss) before income taxes and extraordinary loss................... (57,748) (31,184) (76,302)
Income tax benefit........................................................... (18,326) (9,757) (7,432)
---------- ---------- ----------
Net loss before extraordinary loss........................................... (39,422) (21,427) (68,870)
Extraordinary loss, net of income tax benefit................................ -- -- 3,413
---------- ---------- ----------
Net loss..................................................................... $ (39,422) $ (21,427) $ (72,283)
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
- ------------------------
(1) Through various intercompany agreements entered into by Sun and Mediplex,
Sun provides management services, licenses the use of its trademarks and
acts on behalf of Mediplex to make financing available for its operations.
Sun charged Mediplex for management services totaling $32.3 million, $29.0
million and $20.5 million for the years ended December 31, 1997, 1996 and
1995, respectively. Royalty fees charged to Mediplex for the years ended
December 31, 1997, 1996 and 1995, for the use of Sun trademarks were $7.4
million, $6.7 million and $4.7 million, respectively. Intercompany interest
charged to Mediplex for the years ended December 31, 1997, 1996 and 1995,
for advances from Sun was $39.3 million, $14.4 million and $9.8 million,
respectively.
F-32
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(16) QUARTERLY FINANCIAL DATA (UNAUDITED)
The Company's unaudited consolidated quarterly financial information follows
(in thousands, except per share data)(1)(2):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
-----------------------------------------------
<S> <C> <C> <C> <C>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER(3)
---------- ---------- ---------- -----------
Total net revenues............................................... $ 398,636 $ 447,545 $ 486,172 $ 678,466
Earnings before income taxes and extraordinary loss.............. 26,127 29,214 31,836 8,704
Net earnings before extraordinary loss........................... 15,937 17,821 19,420 1,551
Extraordinary loss............................................... -- -- -- 19,928
---------- ---------- ---------- -----------
Net earnings (loss).............................................. 15,937 17,821 19,420 (18,377)
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------
Net earnings (loss) per common and common equivalent share:
Net earnings before extraordinary loss:
Basic.......................................................... 0.35 0.39 0.42 0.03
Diluted........................................................ 0.33 0.36 0.39 0.03
Net earnings (loss):
Basic.......................................................... 0.35 0.39 0.42 (0.39)
Diluted........................................................ 0.33 0.36 0.39 (0.39)
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
------------------------------------------------
<S> <C> <C> <C> <C>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER(4) QUARTER(5)
---------- ---------- ----------- -----------
Total net revenues............................................... $ 320,291 $ 325,452 $ 340,508 $ 330,057
Earnings (loss) before income taxes.............................. 25,565 27,276 4,231 (4,606)
Net earnings (loss).............................................. 15,339 16,366 (5,562) (4,607)
Net earnings (loss) per share:
Basic.......................................................... 0.32 0.36 (0.12) (0.10)
Diluted........................................................ 0.31 0.34 (0.12) (0.10)
</TABLE>
- ------------------------
(1) The Company adopted SFAS 128 "Earnings per Share" in 1997. All prior period
earnings per common share data have been restated to conform to the
provisions of this statement.
(2) Earnings per share are computed independently for each of the quarters
presented and therefore may not sum to the totals for the year (See Note
1(o)).
(3) The fourth quarter of 1997 includes a charge of $7.0 million recognized by
the Company in order to reduce the carrying value of the Canadian operations
to fair value based on revised estimates of selling value and of costs to
sell. In addition, in 1997, the Company recorded an extraordinary charge of
$17.9 million, net of the related tax benefit, in connection with the
Company's purchase of Regency's 12.25% Junior Subordinated Notes due 2003
and of Regency's 9.875% Senior Subordinated Notes due 2002 and an
extraordinary charge of $2.1 million, net of the related tax benefit,
related to the refinancing of the Company's credit facility.
F-33
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(16) QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
(4) The third quarter of 1996 includes a $24.0 million charge to settle certain
of the lawsuits brought by shareholders (see Note 14).
(5) The fourth quarter of 1996 includes a net $4.8 million benefit which
consists of $9.0 million the Company received from its director and officers
liability insurance carrier in 1997 and a $4.3 million charge related to
continuing litigations and investigation costs (see Note 14).
(17) GEOGRAPHIC SEGMENT INFORMATION
The Company operates predominantly in the long-term care segment of the
healthcare industry. The Company is a provider of long-term, subacute and
related ancillary care services to nursing home patients. In addition to the
services provided in the United States, the Company provides services in the
United Kingdom, Spain, Germany, Australia and Canada.
A summary of the Company's operations by geographic area is presented below
(in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
------------------------------------------------------
<S> <C> <C> <C> <C>
UNITED
STATES UNITED KINGDOM OTHER CONSOLIDATED
------------ --------------- --------- ------------
Net revenues............................................. $1,812,666 $ 168,306 $ 29,848 $2,010,820
Operating profits........................................ 168,745 8,275 (6,656) 170,364
Interest expense, net.................................... 74,482
------------
Consolidated earnings before income taxes and
extraordinary loss..................................... 95,882
------------
------------
Total assets............................................. 2,249,795 259,665 69,776 2,579,236
Capital expenditures..................................... 51,931 52,370 1,835 106,136
Depreciation and amortization............................ 41,121 13,142 2,367 56,630
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
------------------------------------------------------
<S> <C> <C> <C> <C>
UNITED
STATES UNITED KINGDOM OTHER CONSOLIDATED
------------ --------------- --------- ------------
Net revenues............................................. $1,255,323 $ 42,156 $ 18,829 $1,316,308
Operating profits........................................ 74,894 2,179 (382) 76,691
Equity in earnings of Ashbourne.......................... -- -- -- 1,674
Interest expense, net.................................... -- -- -- 25,899
------------
Consolidated earnings before income taxes................ 52,466
------------
------------
Total assets............................................. 1,033,804 168,578 27,044 1,229,426
Capital expenditures..................................... 56,962 18,699 562 76,223
Depreciation and amortization............................ 30,436 1,851 1,530 33,817
</TABLE>
F-34
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(18) SUMMARIZED CONSOLIDATING INFORMATION
In connection with the Company's offering of $250,000,000 aggregate
principal amount of 9 1/2% Senior Subordinated Notes due 2007 (the "9 1/2%
Notes") in July 1997, all direct and indirect subsidiaries of the Company other
than the Company's direct and indirect foreign subsidiaries, CareerStaff and its
direct and indirect subsidiaries, and certain other immaterial subsidiaries of
the Company (the "Guarantors") have, jointly and severally, unconditionally
guaranteed the Notes. These guarantees are subordinated to all existing and
future senior debt and guarantees of the Guarantors and are unsecured.
The Company conducts all of its business through and derives virtually all
of its income from its subsidiaries. Therefore, the Company's ability to make
required payments with respect to its indebtedness (including the 9 1/2% Notes)
and other obligations depends on the financial results and condition of its
subsidiaries and its ability to receive funds from its subsidiaries. There are
no restrictions on the ability of any of the Company's subsidiaries to transfer
funds to the Company, except as provided by appropriate law.
Pursuant to Rule 3-10 of Regulation S-X, the following summarized
consolidating information is for the Company, the wholly-owned Guarantors, and
the Company's non-Guarantor subsidiaries with respect to the 9 1/2% Notes. This
summarized financial information has been prepared from the books and records
maintained by the Company, the Guarantors and the non-Guarantor subsidiaries.
The summarized financial information may not necessarily be indicative of
results of operations or financial position had the Guarantors or non-Guarantor
subsidiaries operated as independent entities. The separate financial statements
of the Guarantors are not presented because management has determined they would
not be material to investors.
F-35
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(18) SUMMARIZED CONSOLIDATING INFORMATION (CONTINUED)
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
------------ ----------- -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Current assets:
Cash and cash equivalents............... $ (1,581) $ 20,010 $ 2,591 $ -- $ 21,020
Accounts receivable, net................ -- 465,137 58,341 (317) 523,161
Other receivables....................... 11,288 13,848 8,414 -- 33,550
Prepaids and other assets............... 596 31,245 6,599 -- 38,440
Deferred tax assets..................... 16,546 -- -- -- 16,546
------------ ----------- -------------- ----------- ------------
Total current assets.................. 26,849 530,240 75,945 (317) 632,717
------------ ----------- -------------- ----------- ------------
Property and equipment, net............. 30,805 207,488 392,809 -- 631,102
Goodwill, net........................... -- 861,492 169,401 -- 1,030,893
Notes receivable........................ 60,080 17,534 13,448 -- 91,062
Other assets, net....................... 89,193 58,872 23,833 -- 171,898
Investment in subsidiaries.............. 611,846 -- -- (611,846) --
Deferred tax assets..................... 19,077 -- 2,487 -- 21,564
------------ ----------- -------------- ----------- ------------
Total assets.......................... $ 837,850 $1,675,626 $ 677,923 $(612,163) $2,579,236
------------ ----------- -------------- ----------- ------------
------------ ----------- -------------- ----------- ------------
Current liabilities:
Current portion of long-term debt....... $ 5,000 $ 12,933 $ 38,884 $ -- $ 56,817
Current portion of obligations under
capital leases........................ 262 1,415 377 -- 2,054
Accounts payable........................ 34,031 21,379 6,780 (317) 61,873
Accrued compensation and benefits....... 21,870 50,465 6,625 -- 78,960
Accrued interest........................ 16,477 1,233 2,741 -- 20,451
Accrued self-insurance obligations...... 369 34,187 (202) -- 34,354
Other accrued liabilities............... 6,028 29,876 35,279 -- 71,183
------------ ----------- -------------- ----------- ------------
Total current liabilities............. 84,037 151,488 90,484 (317) 325,692
------------ ----------- -------------- ----------- ------------
Long-term debt, net of current portion.... 1,303,377 93,514 91,970 -- 1,488,861
Obligations under capital leases, net of
current portion......................... 17 2,311 76,782 -- 79,110
Other long-term liabilities............... -- 41,755 673 -- 42,428
Deferred tax liabilities.................. (2,480) -- 12,287 -- 9,807
------------ ----------- -------------- ----------- ------------
Total liabilities..................... 1,384,951 289,068 272,196 (317) 1,945,898
------------ ----------- -------------- ----------- ------------
Intercompany payables/(receivables)....... (1,164,154) 1,058,101 113,895 (7,842) --
Minority interest......................... -- -- 16,285 -- 16,285
Total stockholders' equity................ 617,053 328,457 275,547 (604,004) 617,053
------------ ----------- -------------- ----------- ------------
Total liabilities and stockholders'
equity.............................. $ 837,850 $1,675,626 $ 677,923 $(612,163) $2,579,236
------------ ----------- -------------- ----------- ------------
------------ ----------- -------------- ----------- ------------
</TABLE>
F-36
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(18) SUMMARIZED CONSOLIDATING INFORMATION (CONTINUED)
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 1996
<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
--------- ----------- -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Current assets:
Cash and cash equivalents.................. $ 2,226 $ 10,870 $ 1,784 $ -- $ 14,880
Accounts receivable, net................... -- 254,659 28,376 (767) 282,268
Other receivables.......................... 28,343 4,263 824 -- 33,430
Prepaids and other assets.................. 691 17,512 1,651 -- 19,854
Deferred tax assets........................ 12,716 -- -- -- 12,716
--------- ----------- -------------- ----------- ------------
Total current assets..................... 43,976 287,304 32,635 (767) 363,148
--------- ----------- -------------- ----------- ------------
Property and equipment, net................ 48,072 145,157 112,491 -- 305,720
Goodwill, net.............................. -- 363,934 68,571 -- 432,505
Notes receivable........................... 21,687 46 -- -- 21,733
Other assets, net.......................... 34,361 54,118 4,844 -- 93,323
Investment in subsidiaries................. 426,898 -- -- (426,898) --
Deferred tax assets........................ 12,997 -- -- -- 12,997
--------- ----------- -------------- ----------- ------------
Total assets............................. $ 587,991 $ 850,559 $ 218,541 $(427,665) $1,229,426
--------- ----------- -------------- ----------- ------------
--------- ----------- -------------- ----------- ------------
Current liabilities:
Current portion of long-term debt.......... $ -- $ 2,092 $ 25,609 $ -- $ 27,701
Current portion of obligations under
capital leases........................... 289 635 357 -- 1,281
Accounts payable........................... 26,407 3,822 9,718 (767) 39,180
Accrued compensation and benefits.......... 11,203 14,918 3,597 -- 29,718
Accrued interest........................... 3,538 822 66 -- 4,426
Payable to APTA shareholders............... -- -- 23,545 -- 23,545
Accrued self-insurance obligations......... (748) 12,990 (163) -- 12,079
Other accrued liabilities.................. 5,186 6,653 1,797 -- 13,636
--------- ----------- -------------- ----------- ------------
Total current liabilities................ 45,875 41,932 64,526 (767) 151,566
--------- ----------- -------------- ----------- ------------
Long-term debt, net of current portion....... 362,601 70,768 27,132 -- 460,501
Obligations under capital leases, net of
current portion............................ 279 1,387 21,286 -- 22,952
Other long-term liabilities.................. -- 13,716 1,097 -- 14,813
Deferred tax liabilities..................... -- -- 4,760 -- 4,760
--------- ----------- -------------- ----------- ------------
Total liabilities........................ 408,755 127,803 118,801 (767) 654,592
--------- ----------- -------------- ----------- ------------
Intercompany payables/(receivables).......... (392,901) 372,771 20,130 -- --
Minority interest............................ -- -- 2,697 -- 2,697
Total stockholders' equity................... 572,137 349,985 76,913 (426,898) 572,137
--------- ----------- -------------- ----------- ------------
Total liabilities and stockholders'
equity................................. $ 587,991 $ 850,559 $ 218,541 $(427,665) $1,229,426
--------- ----------- -------------- ----------- ------------
--------- ----------- -------------- ----------- ------------
</TABLE>
F-37
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(18) SUMMARIZED CONSOLIDATING INFORMATION (CONTINUED)
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
----------- ------------ -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Total net revenues......................... $ 2,337 $ 1,671,369 $ 337,114 $ -- $2,010,820
----------- ------------ -------------- ----------- ------------
Costs and expenses:
Operating................................ -- 1,376,767 286,051 -- 1,662,818
Corporate general and administrative..... 61,687 22,643 13,839 -- 98,169
Provision for losses on accounts
receivable............................. (750) 15,733 856 -- 15,839
Depreciation and amortization............ 4,574 35,301 16,755 -- 56,630
Interest, net............................ 52,244 5,646 16,592 -- 74,482
Loss on sale of Canadian operations...... 7,000 -- -- -- 7,000
Equity interest in (earnings) loss of
subsidiaries........................... 22,925 -- -- (22,925) --
----------- ------------ -------------- ----------- ------------
Total costs and expenses............... 147,680 1,456,090 334,093 (22,925) 1,914,938
----------- ------------ -------------- ----------- ------------
Earnings (loss) before income taxes and
intercompany charges..................... (145,343) 215,279 3,021 22,925 95,882
Intercompany charges(1).................... (221,738) 217,578 4,160 -- --
----------- ------------ -------------- ----------- ------------
Earnings (loss) before income taxes........ 76,395 (2,299) (1,139) 22,925 95,882
Income taxes............................... 39,544 935 674 -- 41,153
----------- ------------ -------------- ----------- ------------
Earnings (loss) before extraordinary
loss..................................... 36,851 (3,234) (1,813) 22,925 54,729
Extraordinary loss......................... 2,050 17,878 -- -- 19,928
----------- ------------ -------------- ----------- ------------
Net earnings (loss)........................ $ 34,801 $ (21,112) $ (1,813) $ 22,925 $ 34,801
----------- ------------ -------------- ----------- ------------
----------- ------------ -------------- ----------- ------------
</TABLE>
F-38
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(18) SUMMARIZED CONSOLIDATING INFORMATION (CONTINUED)
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
----------- ------------ -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Total net revenues......................... $ 2,373 $ 1,140,879 $ 178,906 $ (5,850) $1,316,308
----------- ------------ -------------- ----------- ------------
Costs and expenses:
Operating................................ -- 957,831 155,840 (5,850) 1,107,821
Corporate general and administrative..... 40,769 14,224 7,092 -- 62,085
Provision for losses on accounts
receivable............................. -- 14,699 271 -- 14,970
Depreciation and amortization............ 3,614 25,911 4,292 -- 33,817
Interest, net............................ 20,770 4,160 969 -- 25,899
Investigation and litigation costs....... 19,250 -- -- -- 19,250
Equity interest in (earnings) loss of
subsidiaries........................... (6,757) -- -- 6,757 --
----------- ------------ -------------- ----------- ------------
Total costs and expenses............... 77,646 1,016,825 168,464 907 1,263,842
----------- ------------ -------------- ----------- ------------
Earnings (loss) before income taxes and
intercompany charges..................... (75,273) 124,054 10,442 (6,757) 52,466
Intercompany charges(1).................... (115,085) 113,361 1,724 -- --
----------- ------------ -------------- ----------- ------------
Earnings (loss) before income taxes........ 39,812 10,693 8,718 (6,757) 52,466
Income taxes............................... 18,276 8,338 4,316 -- 30,930
----------- ------------ -------------- ----------- ------------
Net earnings (loss)........................ $ 21,536 $ 2,355 $ 4,402 $ (6,757) $ 21,536
----------- ------------ -------------- ----------- ------------
----------- ------------ -------------- ----------- ------------
</TABLE>
F-39
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(18) SUMMARIZED CONSOLIDATING INFORMATION (CONTINUED)
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 1995
<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
---------- ------------ -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Total net revenues.......................... $ 1,032 $ 1,010,904 $ 126,235 $ (2,663) $1,135,508
---------- ------------ -------------- ----------- ------------
Costs and expenses:
Operating................................. -- 826,538 105,618 (2,663) 929,493
Corporate general and administrative...... 32,807 13,388 5,273 -- 51,468
Provision for losses on accounts
receivable.............................. -- 14,632 (9) -- 14,623
Depreciation and amortization............. 1,646 23,545 2,543 -- 27,734
Interest, net............................. 8,138 11,075 2,616 -- 21,829
Conversion expense........................ -- 3,256 -- -- 3,256
Merger expenses........................... 5,800 -- -- -- 5,800
Strike costs.............................. -- 4,006 -- -- 4,006
Investigation and litigation costs........ 5,505 -- -- -- 5,505
Impairment loss........................... -- 59,000 -- -- 59,000
Equity interest in (earnings) loss of
subsidiaries............................ 39,465 -- -- (39,465) --
---------- ------------ -------------- ----------- ------------
Total costs and expenses................ 93,361 955,440 116,041 (42,128) 1,122,714
---------- ------------ -------------- ----------- ------------
Earnings (loss) before extraordinary loss,
income taxes and intercompany charges..... (92,329) 55,464 10,194 39,465 12,794
Intercompany charges(1)..................... (74,103) 74,103 -- -- --
---------- ------------ -------------- ----------- ------------
Earnings (loss) before extraordinary loss
and income taxes.......................... (18,226) (18,639) 10,194 39,465 12,794
Income taxes(2)............................. 5,525 22,973 4,634 -- 33,132
---------- ------------ -------------- ----------- ------------
Earnings (loss) before extraordinary loss... (23,751) (41,612) 5,560 39,465 (20,338)
Extraordinary loss from early extinguishment
of debt................................... -- (3,413) -- -- (3,413)
---------- ------------ -------------- ----------- ------------
Net earnings (loss)......................... $ (23,751) $ (45,025) $ 5,560 $ 39,465 $ (23,751)
---------- ------------ -------------- ----------- ------------
---------- ------------ -------------- ----------- ------------
</TABLE>
F-40
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(18) SUMMARIZED CONSOLIDATING INFORMATION (CONTINUED)
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
----------- ----------- -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss).............................. $ 34,801 $ (21,112) $ (1,813) $ 22,925 $ 34,801
Adjustments to reconcile net earnings (loss) to
net cash provided by (used for) operating
activities--
Equity in earnings of subsidiaries............. 22,925 -- -- (22,925) --
Extraordinary loss............................. 3,059 26,684 -- -- 29,743
Loss on Sale of Canadian operations............ 7,000 -- -- -- 7,000
Depreciation and amortization.................. 4,574 35,301 16,755 -- 56,630
Provision for losses on accounts receivable.... -- 14,983 856 -- 15,839
Other, net..................................... 5,353 (1,697) (344) -- 3,312
Changes in operating assets and liabilities:
Accounts receivable.......................... -- (143,875) (21,091) -- (164,966)
Other current assets......................... 10,960 (8,939) (8,344) -- (6,323)
Other current liabilities.................... 38,152 (22,303) 8,379 -- 24,228
Income taxes payable......................... 30,654 (7,861) (1,324) -- 21,469
----------- ----------- -------------- ----------- ------------
Net cash provided by (used for) operating
activities..................................... 157,478 (128,819) (6,926) -- 21,733
----------- ----------- -------------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net........................ (2,900) (47,893) (52,369) -- (103,162)
Acquisitions, net of cash acquired............... -- (346,054) (218,080) -- (564,134)
Proceeds (expenditures) from the sale and
leaseback of property and equipment............ -- 31,179 49,278 -- 80,457
Increase in long-term notes receivables.......... (38,392) (5,590) (13,449) -- (57,431)
Other asset expenditures......................... (24,489) (16,285) 4,923 -- (35,851)
----------- ----------- -------------- ----------- ------------
Net cash used for investing activities......... (65,781) (384,643) (229,697) -- (680,121)
----------- ----------- -------------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings........................ 1,793,711 4,508 38,843 -- 1,837,062
Long-term debt repayments........................ (847,114) (53,035) (65,875) -- (966,024)
Repurchase of certain Regency debt............... -- (182,070) -- -- (182,070)
Net proceeds from issuance of common stock....... 6,275 -- -- -- 6,275
Purchases of treasury stock...................... (505) -- -- -- (505)
Other financing activities....................... (33,369) -- (42) -- (33,411)
Intercompany advances............................ (1,014,502) 753,199 261,303 -- --
----------- ----------- -------------- ----------- ------------
Net cash provided by (used for) financing
activities................................... (95,504) 522,602 234,229 -- 661,327
----------- ----------- -------------- ----------- ------------
Effect of exchange rate on cash and cash
equivalents...................................... -- -- 3,201 -- 3,201
----------- ----------- -------------- ----------- ------------
Net increase (decrease) in cash and cash
equivalents...................................... (3,807) 9,140 807 -- 6,140
Cash and cash equivalents at beginning of period... 2,226 10,870 1,784 -- 14,880
----------- ----------- -------------- ----------- ------------
Cash and cash equivalents at end of period......... $ (1,581) $ 20,010 $ 2,591 $ -- $ 21,020
----------- ----------- -------------- ----------- ------------
----------- ----------- -------------- ----------- ------------
</TABLE>
F-41
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(18) SUMMARIZED CONSOLIDATING INFORMATION (CONTINUED)
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
----------- ----------- -------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss)................................ $ 21,536 $ 2,355 $ 4,402 $ (6,757) $ 21,536
Adjustments to reconcile net earnings (loss) to net
cash provided by (used for) operating
activities--
Equity in earnings of subsidiaries............... (6,757) -- -- 6,757 --
Depreciation and amortization.................... 3,614 25,911 4,292 -- 33,817
Provision for losses on accounts receivable...... -- 14,699 271 -- 14,970
Litigation settlement............................ (4,750) -- -- -- (4,750)
Other, net....................................... 668 (2,927) 227 -- (2,032)
Changes in operating assets and liabilities:
Accounts receivable............................ -- (50,266) (6,793) -- (57,059)
Other current assets........................... (5,964) (1,782) 1,050 -- (6,696)
Other current liabilities...................... 8,824 (6,344) 782 -- 3,262
Income taxes payable........................... 22,422 (620) 1,962 -- 23,764
----------- ----------- -------------- ----------- ------------
Net cash provided by (used for) operating
activities....................................... 39,593 (18,974) 6,193 -- 26,812
----------- ----------- -------------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net.......................... (11,292) (23,410) (41,521) -- (76,223)
Acquisitions, net of cash acquired................. -- (28,779) (46,800) -- (75,579)
Investment in OmniCell Technologies, Inc........... (25,332) -- -- -- (25,332)
Net proceeds from sale of SunSurgery Corporation... -- 24,828 -- -- 24,828
Proceeds from operations and sale of assets held
for sale......................................... -- (3,810) -- -- (3,810)
Proceeds (expenditures) from the sale and leaseback
of property and equipment........................ -- 8,766 25,837 -- 34,603
Increase in long-term notes receivables............ (9,188) 523 -- -- (8,665)
Other asset expenditures........................... (2,426) (4,678) (4,907) -- (12,011)
----------- ----------- -------------- ----------- ------------
Net cash used for investing activities........... (48,238) (26,560) (67,391) -- (142,189)
----------- ----------- -------------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings.......................... 101,678 955 34,522 -- 137,155
Long-term debt repayments.......................... (255) (2,110) (1,908) -- (4,273)
Net proceeds from issuance of common stock......... 1,582 -- -- -- 1,582
Purchases of treasury stock........................ (25,069) -- -- -- (25,069)
Other financing activities......................... (1,835) 11 48 -- (1,776)
Intercompany advances.............................. (58,583) 29,957 28,626 -- --
----------- ----------- -------------- ----------- ------------
Net cash provided by (used for) financing
activities..................................... 17,518 28,813 61,288 -- 107,619
----------- ----------- -------------- ----------- ------------
Effect of exchange rate on cash and cash
equivalents...................................... -- -- (464) -- (464)
----------- ----------- -------------- ----------- ------------
Net increase (decrease) in cash and cash
equivalents...................................... 8,873 (16,721) (374) -- (8,222)
Cash and cash equivalents at beginning of period... (6,647) 27,591 2,158 -- 23,102
----------- ----------- -------------- ----------- ------------
Cash and cash equivalents at end of period......... $ 2,226 $ 10,870 $ 1,784 $ -- $ 14,880
----------- ----------- -------------- ----------- ------------
----------- ----------- -------------- ----------- ------------
</TABLE>
F-42
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(18) SUMMARIZED CONSOLIDATING INFORMATION (CONTINUED)
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1995
<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
---------- ----------- -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss)....................... $ (23,751) $ (45,025) $ 5,560 $ 39,465 $ (23,751)
Adjustments to reconcile net earnings
(loss) to net cash provided by (used
for) operating activities--
Equity in loss of subsidiaries.......... 39,465 -- -- (39,465) --
Extraordinary loss...................... -- 5,785 -- -- 5,785
Conversion expense...................... -- 3,256 -- -- 3,256
Depreciation and amortization........... 1,646 23,545 2,543 -- 27,734
Provision for losses on accounts
receivable............................ -- 14,632 (9) -- 14,623
Impairment loss......................... -- 59,000 -- -- 59,000
Other, net.............................. -- (2,220) -- -- (2,220)
Changes in operating assets and
liabilities:
Accounts receivable................... -- (85,381) (5,506) -- (90,887)
Other current assets.................. (1,651) 2,511 110 -- 970
Other current liabilities............. 4,543 (14,672) 3,795 -- (6,334)
Income taxes payable.................. 8,396 9,530 684 -- 18,610
---------- ----------- -------------- ----------- ------------
Net cash provided by (used for) operating
activities.............................. 28,648 (29,039) 7,177 -- 6,786
---------- ----------- -------------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net................. (22,811) (15,393) (35,293) -- (73,497)
Acquisitions, net of cash acquired........ (9,638) 1,513 (65,916) -- (74,041)
Proceeds from operations and sale of
assets held for sale.................... -- 36,878 -- -- 36,878
Proceeds from the sale and leaseback of
property and equipment.................. -- 69,988 35,546 -- 105,534
Increase in long-term notes receivables... (12,500) 21 -- -- (12,479)
Other assets expenditures................. (4,074) (7,519) 1,424 -- (10,169)
---------- ----------- -------------- ----------- ------------
Net cash provided by (used for)
investing activities.................. (49,023) 85,488 (64,239) -- (27,774)
---------- ----------- -------------- ----------- ------------
</TABLE>
F-43
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(18) SUMMARIZED CONSOLIDATING INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
---------- ----------- -------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings................. 177,029 3,634 4,636 -- 185,299
Long-term debt repayments................. (537) (94,017) (21,176) -- (115,730)
Repurchase of 11.75% Senior Subordinated
Notes due 2002.......................... -- (89,370) -- -- (89,370)
Conversion of Convertible Subordinated
Debentures due 2003..................... -- (16,859) -- -- (16,859)
Net proceeds from issuance of common
stock................................... 2,976 -- -- -- 2,976
Other financing activities................ (1,179) (472) (111) -- (1,762)
Intercompany advances..................... (213,653) 145,351 68,302 -- --
---------- ----------- -------------- ----------- ------------
Net cash provided by (used for)
financing activities.................. (35,364) (51,733) 51,651 -- (35,446)
---------- ----------- -------------- ----------- ------------
Effect of exchange rate on cash and cash
equivalents............................... -- -- 798 -- 798
---------- ----------- -------------- ----------- ------------
Net increase (decrease) in cash and cash
equivalents............................... (55,739) 4,716 (4,613) -- (55,636)
Cash and cash equivalents at beginning of
period.................................... 49,092 22,875 6,771 -- 78,738
---------- ----------- -------------- ----------- ------------
Cash and cash equivalents at end of
period.................................... $ (6,647) $ 27,591 $ 2,158 $ -- $ 23,102
---------- ----------- -------------- ----------- ------------
---------- ----------- -------------- ----------- ------------
</TABLE>
Through various intercompany agreements entered into by the Company, the
Guarantors and certain of the non-Guarantor subsidiaries, Sun provides
management services, and acts on behalf of the Guarantors and certain of the
non-Guarantor subsidiaries to make financing available for their operations. The
Company charged the Guarantors for management services totaling $75.7 million,
$82.7 million and $58.3 million for the years ended December 31, 1997, 1996 and
1995, respectively. The Company charged the non-Guarantor subsidiaries for
management services totaling $1.5 million and $1.2 million for the years ended
December 31, 1997 and 1996, respectively. Intercompany interest charged to the
Guarantors for the years ended December 31, 1997, 1996 and 1995 for advances
from the Company were $141.8 million, $30.6 million and $15.8 million,
respectively. Intercompany interest charged to the non-Guarantor subsidiaries
for the years ended December 31, 1997 and 1996 for advances from the Company was
$2.7 million and $.6 million, respectively.
F-44
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of
Sun Healthcare Group, Inc.:
We have audited in accordance with generally accepted auditing standards the
consolidated financial statements of Sun Healthcare Group, Inc. and subsidiaries
in this Form 10-K and have issued our report thereon dated February 24, 1998.
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The schedule listed as Item
14(a)(ii) in the index of financial statements is the responsibility of the
Company's management and is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in our audits of the basic consolidated financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
consolidated financial statements taken as a whole.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Albuquerque, New Mexico
February 24, 1998
F-45
<PAGE>
SCHEDULE II
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COLUMN C
---------------------------
COLUMN B ADDITIONS COLUMN E
----------- --------------------------- COLUMN D -----------
COLUMN A BALANCE AT CHARGED TO CHARGED TO ----------- BALANCE AT
- ------------------------------------------------ BEGINNING COSTS AND OTHER ACCOUNTS DEDUCTIONS END OF
DESCRIPTION OF PERIOD EXPENSES DESCRIBE(1) DESCRIBE PERIOD
- ------------------------------------------------ ----------- ----------- -------------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997:
Allowance for doubtful accounts................. $ 16,877 $ 15,839 $ 10,241 $ (8,524) $ 34,433
----------- ----------- ------- ----------- -----------
----------- ----------- ------- ----------- -----------
Year ended December 31, 1996:
Allowance for doubtful accounts................. $ 11,035 $ 14,970 $ 1,394 $ (10,522) $ 16,877
----------- ----------- ------- ----------- -----------
----------- ----------- ------- ----------- -----------
Year ended December 31, 1995:
Allowance for doubtful accounts................. $ 9,508 $ 14,623 $ 743 $ (13,839) $ 11,035
----------- ----------- ------- ----------- -----------
----------- ----------- ------- ----------- -----------
</TABLE>
- ------------------------
(1) Represents the allowance for doubtful accounts of acquired entities at the
date of acquisition.
F-46
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference of our reports dated February 24, 1998 included in this Form 10-K/A-2
into the Sun Healthcare Group, Inc. and Subsidiaries previously filed
Registration Statements on Form S-8 (No. 33-80540, No. 33-93692, No. 333-03058
and No. 333-38583).
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Albuquerque, New Mexico
May 20, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SUN
HEALTHCARE GROUP, INC., 1997 DECEMBER 31 FORM 10-K, MARCH 31 FORM 10-Q, JUNE 30
FORM 10-Q, SEPTEMBER 30 FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS YEAR
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997 DEC-31-1997
<PERIOD-START> JAN-01-1997 JAN-01-1997 JAN-01-1997 JAN-01-1997
<PERIOD-END> MAR-31-1997 JUN-30-1997 SEP-30-1997 DEC-31-1997
<CASH> 24,866 8,045 2,418 21,120
<SECURITIES> 0 0 0 0
<RECEIVABLES> 329,244 348,086 400,102 559,781
<ALLOWANCES> 17,220 19,509 21,091 34,433
<INVENTORY> 0 0 0 0
<CURRENT-ASSETS> 394,403 406,743 430,254 632,717
<PP&E> 542,349 544,211 546,456 685,607
<DEPRECIATION> 0 0 0 54,505
<TOTAL-ASSETS> 1,537,082 1,604,187 1,712,428 2,579,236
<CURRENT-LIABILITIES> 168,342 195,693 194,210 325,692
<BONDS> 754,253 772,021 861,245 1,567,971
0 0 0 0
0 0 0 0
<COMMON> 512 513 516 517
<OTHER-SE> 584,821 607,863 629,336 616,536
<TOTAL-LIABILITY-AND-EQUITY> 1,537,082 1,604,187 1,712,428 2,579,236
<SALES> 0 0 0 0
<TOTAL-REVENUES> 398,636 846,181 1,332,354 2,010,820
<CGS> 0 0 0 0
<TOTAL-COSTS> 327,903 694,787 1,091,249 1,662,818
<OTHER-EXPENSES> 0 0 0 0
<LOSS-PROVISION> 3,194 6,773 10,736 15,839
<INTEREST-EXPENSE> 11,324 25,486 42,670 74,482
<INCOME-PRETAX> 26,127 55,342 87,178 95,882
<INCOME-TAX> 10,190 21,583 33,999 41,153
<INCOME-CONTINUING> 15,937 33,759 53,179 54,729
<DISCONTINUED> 0 0 0 0
<EXTRAORDINARY> 0 0 0 19,928
<CHANGES> 0 0 0 0
<NET-INCOME> 15,937 33,759 53,179 34,801
<EPS-PRIMARY> 0.35 0.73 1.15 0.75
<EPS-DILUTED> 0.33 0.69 1.08 0.74
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SUN
HEALTHCARE GROUP, INC. 1996 DECEMBER 31 FORM 10-K, MARCH 31 FORM 10-Q, JUNE 30
FORM 10-Q, SEPTEMBER 30 FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS YEAR
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996
<PERIOD-START> JAN-01-1996 JAN-01-1996 JAN-01-1996 JAN-01-1996
<PERIOD-END> MAR-31-1996 JUN-30-1996 SEP-30-1996 DEC-31-1996
<CASH> 17,096 9,415 21,420 14,880
<SECURITIES> 0 0 0 0
<RECEIVABLES> 266,752 279,336 280,289 299,145
<ALLOWANCES> 10,000 9,759 13,873 16,877
<INVENTORY> 0 0 0 0
<CURRENT-ASSETS> 341,880 325,321 346,330 363,148
<PP&E> 226,627 101,324 227,518 334,052
<DEPRECIATION> 0 0 0 28,332
<TOTAL-ASSETS> 1,069,921 1,077,023 1,099,728 1,229,426
<CURRENT-LIABILITIES> 100,370 101,324 124,300 151,566
<BONDS> 388,859 379,724 384,869 483,453
0 0 0 0
0 0 0 0
<COMMON> 511 511 512 511
<OTHER-SE> 559,041 577,148 572,514 571,626
<TOTAL-LIABILITY-AND-EQUITY> 1,069,921 1,077,023 1,099,728 1,229,426
<SALES> 0 0 0 0
<TOTAL-REVENUES> 320,291 645,744 986,251 1,316,308
<CGS> 0 0 0 0
<TOTAL-COSTS> 264,629 531,862 811,210 1,107,821
<OTHER-EXPENSES> 0 0 0 0
<LOSS-PROVISION> 1,220 2,463 4,967 14,970
<INTEREST-EXPENSE> 6,426 12,911 18,987 25,899
<INCOME-PRETAX> 25,565 52,842 57,072 52,466
<INCOME-TAX> 10,226 21,137 30,929 30,930
<INCOME-CONTINUING> 15,339 31,705 26,143 21,536
<DISCONTINUED> 0 0 0 0
<EXTRAORDINARY> 0 0 0 0
<CHANGES> 0 0 0 0
<NET-INCOME> 15,339 31,705 26,143 21,536
<EPS-PRIMARY> 0.32 0.68 0.56 0.46
<EPS-DILUTED> 0.31 0.64 0.56 0.46
</TABLE>
