<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A-1 The following items
were the subject of a
Form 12b-25 and are
included herein:
Items 1 and 2
/X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 30, 1998
or
/ / Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number: 1-12040
SUN HEALTHCARE GROUP, INC.
(Exact name of Registrant as specified in its charter)
Delaware 85-0410612
(State of Incorporation) (I.R.S. Employer Identification No.)
101 Sun Avenue, NE
Albuquerque, New Mexico 87109
(505) 821-3355
(Address and telephone number of Registrant)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding twelve 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 ninety days.
Yes X No
----- -----
As of August 10, 1998, there were 62,293,745 shares of the Registrant's
$.01 par value
Common Stock outstanding, net of treasury shares.
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<PAGE>
SUN HEALTHCARE GROUP, INC.
INDEX
FORM 10-Q/A-1 FOR THE QUARTER ENDED JUNE 30, 1998
- --------------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page Numbers
<S> <C> <C>
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets
June 30, 1998 and December 31, 1997
Consolidated Statements of Earnings
For the three months ended June 30, 1998 and 1997
Consolidated Storts of Earnings for the six months
ended June 30, 1998 & 1997
Consolidated Statements of Cash Flows
For the six months ended June 30, 1998 and 1997
Notes to the Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits and Reports on Form 8-K
Signatures
</TABLE>
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
ASSETS 1998 1997
---------- --------------
(In thousands, except share data)
<S> <C> <C>
Current assets:
Cash and cash equivalents $26,194 $32,684
Accounts receivable, net of allowance for doubtful
accounts of $53,682 as of June 30, 1998, and $42,582
as of December 31, 1997 662,145 554,208
Other receivables 51,169 39,293
Prepaids and other assets 63,484 59,975
Deferred tax asset 23,860 21,100
------------ ------------
Total current assets 826,852 707,260
------------ ------------
Property and equipment, net 835,432 791,117
Goodwill, net 1,057,921 1,046,229
Notes receivable 89,714 76,312
Other assets, net 188,060 184,037
Deferred tax asset 19,771 21,564
------------ ------------
Total assets $3,017,750 $2,826,519
------------ ------------
------------ ------------
</TABLE>
See accompanying notes to consolidated financial statements.
(Continued on next page)
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(Unaudited)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997
------------ ------------
(In thousands, except share data)
<S> <C> <C>
Current liabilities:
Current portion of long-term debt $85,406 $85,461
Current portion of obligations under capital leases 3,500 2,054
Accounts payable 75,386 95,868
Accrued compensation and benefits 102,934 89,639
Accrued interest 27,735 23,666
Accrued self-insurance obligations 57,078 36,354
Other accrued liabilities 128,694 82,899
Income taxes payable 588 -
------------ ------------
Total current liabilities 481,321 415,941
------------ ------------
Long-term debt, net of current portion 1,440,810 1,610,421
Obligations under capital leases, net of current portion 103,257 101,083
Other long-term liabilities 41,829 42,590
Deferred income taxes 6,672 10,906
------------ ------------
Total liabilities 2,073,889 2,180,941
------------ ------------
Minority interest 20,803 20,838
Company-obligated mandatorily redeemable convertible preferred
securities of a subsidiary trust holding solely 7%
convertible junior subordinated debentures of the Company 345,000 --
Stockholders' equity:
Preferred stock 2,786 2,786
Common stock 602 596
Additional paid-in capital 679,665 686,642
Retained earnings (deficit) (38,250) 14,932
Accumulated other comprehensive income 3,552 1,766
------------ ------------
648,355 706,722
------------ ------------
Less:
Unearned compensation 12,055 14,203
Common stock held in treasury 26,931 25,574
Grantor stock trust 31,311 42,205
------------ ------------
Total stockholders' equity 578,058 624,740
------------ ------------
Total liabilities and stockholders' equity $3,017,750 $2,826,519
------------ ------------
------------ ------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (Loss)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
---------------------------------
1998 1997
--------------- ---------------
(In thousands, except share data)
<S> <C> <C>
Total net revenues $826,294 $516,648
--------------- ---------------
Costs and expenses:
Operating 683,022 435,371
Corporate general and administrative 45,493 22,752
Provision for losses on accounts receivable 10,074 3,798
Depreciation and amortization 24,364 15,039
Interest, net 36,536 19,704
Loss on sale of assets 7,802 --
Litigation and investigation costs 30,256 --
Merger expenses 25,560 --
------------- ----------
Total costs and expenses 863,107 496,664
------------- ----------
Dividends on convertible preferred securities of subsidiary 3,771 --
Earnings (loss) before income taxes and extraordinary loss (40,584) 19,984
Income taxes 10,272 9,090
------------- ----------
Earnings (loss) before extraordinary loss (50,856) 10,894
Extraordinary loss from early extinguishment of debt, net
of income tax benefit of $3,709 10,120 --
------------- ----------
Net earnings (loss) ($60,976) $10,894
------------- ----------
------------- ----------
Net earnings (loss) per common and common equivalent share:
Net earning (loss) before extraordinary loss:
Basic ($0.93) $0.21
------------- ----------
------------- ----------
Diluted ($0.93) $0.20
------------- ----------
------------- ----------
Net earnings (loss):
Basic ($1.12) $0.21
------------- ----------
------------- ----------
Diluted ($1.12) $0.20
------------- ----------
------------- ----------
Weighted average number of common and common equivalent
shares outstanding:
Basic 54,534 53,263
------------- ----------
------------- ----------
Diluted 54,534 58,623
------------- ----------
------------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (LOSS)
(Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
--------------------------------
1998 1997
--------------- ------------
(In thousands, except share data)
<S> <C> <C>
Total net revenues $1,637,011 $981,670
------------- ----------
Costs and expenses:
Operating 1,361,972 820,155
Corporate general and administrative 88,345 42,411
Provision for losses on accounts receivable 18,413 8,477
Depreciation and amortization 46,429 28,348
Interest, net 76,133 34,543
Loss on sale of assets 7,802 --
Litigation and investigation costs 30,256 --
Merger expenses 25,560 --
------------- ----------
Total costs and expenses 1,654,910 933,934
------------- ----------
Dividends on convertible preferred securities of subsidiary 3,771 --
Earnings (loss) before income taxes and extraordinary loss (21,670) 47,736
Income taxes 23,862 19,700
------------- ----------
Earnings (loss) before extraordinary loss (45,532) 28,036
Extraordinary loss 10,120 --
------------- ----------
Net earnings (loss) ($55,652) $28,036
------------- ----------
------------- ----------
Net earnings (loss) per common and common equivalent share:
Net earnings (loss) before extraordinary loss
Basic ($0.83) $0.53
------------- ----------
------------- ----------
Diluted ($0.83) $0.51
------------- ----------
------------- ----------
Net earnings (loss)
Basic ($1.02) $0.53
------------- ----------
------------- ----------
Diluted ($1.02) $0.51
------------- ----------
------------- ----------
Weighted average number of common and common equivalent
shares outstanding:
Basic 54,648 53,251
------------- ----------
------------- ----------
Diluted 54,648 58,547
------------- ----------
------------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
-----------------------------
1998 1997
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES: (In thousands)
Net earnings ($55,652) $28,036
Extraordinary loss 10,120 --
Adjustments to reconcile net earnings to net cash provided
by (used for) operating activities -
Depreciation and amortization 46,905 28,348
Provision for losses on accounts receivable 18,412 7,745
Other, net 4,232 2,032
Changes in operating assets and liabilities:
Accounts receivable (148,568) (75,471)
Other current assets (28,020) 11,510
Other current liabilities 95,957 45,657
Income taxes payable (830) 16,803
------------- ----------
Net cash provided by (used for) operating activities (57,444) 64,660
------------- ----------
Cash flows from investing activities:
Capital expenditures, net (70,345) (33,107)
Acquisitions, net of cash acquired (35,381) (183,042)
Proceeds from sale and leaseback of property and equipment 16,833 43,768
Increase in long-term notes receivable (17,275) (37,869)
Other assets expenditures (14,780) 2,089
------------- ----------
Net cash used for investing activities (120,948) (208,161)
------------- ----------
Cash flows from financing activities:
Long-term debt borrowings 172,698 153,597
Long-term debt repayments (331,319) (16,489)
Net proceeds from issuance of convertible preferred
securities of subsidiary 334,171 --
Net proceeds from issuance of common stock 2,617 3,507
Purchases of treasury stock (1,357) --
Other financing activities (4,459) 1,139
------------- ----------
Net cash provided by financing activities 172,351 141,754
------------- ----------
Effect of exchange rate on cash and cash equivalents (449) (1,779)
------------- ----------
Net decrease in cash and cash equivalents (6,490) (3,526)
Cash and cash equivalents at beginning of period 32,684 15,209
------------- ----------
Cash and cash equivalents at end of period $26,194 $11,683
------------- ----------
------------- ----------
See accompanying notes to consolidated financial statements.
(Continued on next page)
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
SIX MONTHS ENDED JUNE 30,
-----------------------------
1998 1997
------------- -------------
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during period for:
Interest net of $1,111 and $964 capitalized
during the six months ending June 30, 1998
and 1997, respectively 75,484 35,213
Income taxes (20,083) (7,283)
SUPPLEMENTARY SCHEDULE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:
The Company's acquisitions during the six months ended
June 30, 1998 and 1997 involved the following:
Fair value of assets acquired 43,903 343,467
Liabilities assumed (6,288) (178,052)
Cash payments made to former APTA shareholders -- 17,817
Fair value of stock and warrants issued (2,235) (190)
------------- ----------
Cash payments made, net of cash received from others $35,380 $183,042
------------- ----------
------------- ----------
</TABLE>
See acompanying notes to consolidated financial statements.
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
In the opinion of management of Sun Healthcare Group, Inc. (the
"Company" or "Sun"), the accompanying interim consolidated financial
statements present fairly the Company's financial position at June 30, 1998
and December 31, 1997, the consolidated results of its operations for the
three and six month periods ended June 30, 1998 and 1997, and the
consolidated statements of cash flows for the six months ended June 30, 1998.
All adjustments are of a normal and recurring nature. These statements are
presented in accordance with the rules and regulations of the United States
Securities and Exchange Commission ("SEC"). Accordingly, they are unaudited,
and certain information and footnote disclosures normally included in the
Company's annual consolidated financial statements have been condensed or
omitted, as permitted under the applicable rules and regulations. Readers of
these statements should refer to the Company's audited consolidated financial
statements and notes thereto for the year ended December 31, 1997, which are
included in the Company's Annual Report on Form 10-K as amended on Form
10-K/A2 for the year ended December 31, 1997. The Company's financial
statements have been restated to reflect the results of operations and
financial position of Retirement Care Associates, Inc. ("RCA") which was
acquired in a business combination accounted for as a pooling of interests
(see Note 2). The results of operations presented in the accompanying
financial statements are not necessarily representative of operations for an
entire year.
ADOPTION OF NEW ACCOUNTING PRONOUNCEMENT
In the first quarter of 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income."
Comprehensive income is defined as the change in equity of a business during
a period from transactions and other events and circumstances from non-owner
sources. Under SFAS 130, the term "comprehensive income" is used to describe
the total of net earnings plus other comprehensive income which, for the
Company, includes foreign currency translation adjustments.
The adoption of SFAS 130 did not impact the calculations of net earnings
or earnings per share, nor did it impact reported assets, liabilities or
total stockholders' equity. It did impact the presentation of stockholders'
equity within the balance sheet and will result in the presentation of
comprehensive income within the annual financial statements, which must be
displayed with the same prominence as other financial statements. Within the
annual financial statements, the Company will report comprehensive income in
the statement of stockholders'equity.
NEWLY ISSUED PRONOUNCEMENTS
On April 3, 1998, the Institute of Certified Public Accountants issued
Statement of Position 98-5, Reporting on the Costs of Start-Up Activities. The
statement requires costs of start-up activities and organization costs to be
expensed as incurred. The statement is effective for financial statements for
fiscal years beginning after December 31, 1998. Initial application will result
in the estimated write-off of
9
<PAGE>
$13.2 million in pre-opening and organizational costs on January 1, 1999,
which will be reported as a cumulative effect of a change in accounting
principle.
In June 1998, a new accounting standard for derivative instruments and
hedging activities was issued. The new standard, which will be effective
January 1, 2000, requires all derivatives to be recognized on the balance
sheet at fair value. Gains or losses from changes in fair value would be
recognized in earnings in the period of change unless the derivative is
designated as hedging instrument. The Company is studying the impact of the
new standard, and is unable to predict at this time the impact on its
financial statements.
SPECIAL CHARGES
MERGER EXPENSES
In connection with the merger of RCA, the Company charged against the
earnings of the combined company $25.6 million for transaction costs and
integration expenses, including elimination of redundant corporate functions,
severance costs related to the headcount reductions, the write-off of certain
intangibles and property and equipment. At June 30, 1998, liabilities for
approximately $3.3 million in severance and related costs and $15.2 million
for costs remaining on the balance sheet. The Company expects to complete
its consolidation of operations by the end of 1998.
LITIGATION AND INVESTIGATION COSTS
The Company recorded a charge of $30.3 million during the three months
ended June 30, 1998 for professional fees and settlement costs related to
certain legal and regulatory matters. The charge includes amounts provided
for (i) the settlement of shareholder class action litigation against RCA
(see footnote 2) and anticipated costs related to other shareholder actions
against RCA and its former directors, officers and advisors; (ii) the
settlement of a shareholder suit related to the Company's acquisition in 1995
of SunCare (see footnote 5(b)); (iii) anticipated costs related to certain
state regulatory investigations of RCA's operations for matters which
occurred prior to the Company's acquisition of RCA; and (iv) estimated costs
to resolve the ongoing investigation by the Connecticut Department of Social
Services ("DSS") (see footnote 5(a)).
LOSS ON SALE OF ASSETS
The Company recorded a $5.4 million charge in the three months ended
June 30, 1998 from the anticipated sale of five nursing homes in the third
quarter of 1998 and for certain adjustments in the sale price of three
nursing homes sold in 1996. The Company also recorded an additional $2.4
million loss on its anticipated sale of its outpatient rehabilitation clinics
in Canada. In 1997 the Company recorded a $7.0 million loss in order to
reduce the carrying value of its Canadian operations to fair value based on
its estimates of selling value and of costs to sell.
2. ACQUISITIONS
On June 30, 1998, a wholly owned subsidiary of the Company merged with
RCA, an operator of skilled nursing facilities and assisted living centers in
seven states in the southeastern United States. RCA also owned approximately
65% of Contour Medical, Inc. ("Contour"), a national provider of
medical/surgical supplies. Under the amended terms of the merger agreement
the Company issued approximately 7,839,000 shares of its common stock (valued
at $114.6 million based upon the closing price of $14.625 per share as of
June 30, 1998) for all of the outstanding common stock of RCA and certain
redeemable preferred shares of RCA. The Company also issued 298,334 shares of
its Series B Convertible Preferred Stock in exchange for the outstanding
shares of RCA's Series F Preferred Stock, which is convertible into 287,892
shares of Sun common stock valued at $2.8 million at June 30, 1998. In
addition, the Company assumed approximately $170.4 million of indebtedness
excluding $19.8 million of indebtedness eliminated in
10
<PAGE>
consolidation. The merger was accounted for as a pooling of interests, and
accordingly the financial statements have been restated to include the
accounts and operations of RCA for all periods prior to the merger.
On June 30, 1998, the Company also acquired the remaining 35% of
Contour. The Company issued approximately 1,771,000 shares of its common
stock (valued at $25.9 million based upon the closing price of $14.625 per
share as of June 30, 1998) for the remaining outstanding Contour common
stock. The acquisition was accounted for as a purchase and resulted in $66.7
million of additional goodwill.
On November 25, 1997, the Company, RCA and representatives of the
plaintiffs in certain pending class actions against RCA 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 escrowed
on behalf of the defendants the settlement amount into an escrow fund which
is included in other long-term assets as of June 30, 1998. The settlement is
is subject to, among other things, confirmatory discovery, the execution of
definitive documentation and court approval.
Separate results of the operations for the periods presented prior to
the consummation of the merger are as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues:
Sun $753,269 $447,545 $1,494,760 $846,182
RCA 92,138 71,286 176,722 137,723
(less intercompany revenues) (19,114) (2,183) (34,470) (2,235)
-------- -------- ---------- --------
$826,293 $516,648 $1,637,012 $981,670
-------- -------- ---------- --------
-------- -------- ---------- --------
Net earnings (loss):
Sun $(29,514) $17,821 $(11,127) $33,759
RCA (31,463) (6,927) (44,525) (5,723)
-------- -------- ---------- --------
$(60,977) $10,894 $(55,652) $28,036
-------- -------- ---------- --------
-------- -------- ---------- --------
</TABLE>
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 $367.2
million. The total fair value of Regency's assets acquired, including
goodwill of approximately $412.2 million, was approximately $736.6 million,
and liabilities assumed totaled approximately $354.7 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 June 30, 1998,
liabilities for approximately $1.4 million in severance costs and $1.8
million for facility related costs remained on the balance sheet. The
Company expects to complete its consolidation of pharmacies and home health
agencies including the termination of pharmacy, home health service agency
and corporate employees by the end of the third quarter of 1998.
11
<PAGE>
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
proforma results for the three and six months ended June 30, 1997 assume that
the acquisition occurred as of January 1, 1997 (in thousands, except per
share data):
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, 1997 ENDED JUNE 30, 1997
<S> <C> <C>
Net revenues $ 678,923 $ 1,302,477
--------------- --------------
--------------- --------------
Net earnings $ 10,802 $ 27,488
--------------- --------------
--------------- --------------
Net earnings per share:
Basic $ 0.20 $ 0.52
--------------- --------------
--------------- --------------
Diluted $ 0.20 $ 0.50
--------------- --------------
--------------- --------------
</TABLE>
In addition, during the three months ended June 30, 1998, the Company
acquired from various third parties the net ownership of, leasehold rights to
or the management contracts of 3 long-term care facilities in the United
Kingdom. Also during the three months ended June 30, 1998, the Company
acquired 4 pharmacies in the United States. The pro forma impact of these
acquisitions is immaterial.
3. LONG-TERM DEBT AND CONVERTIBLE TRUST ISSUED SECURITIES
In May 1998, the Company issued $345 million of 7% convertible trust
issued preferred securities and $150 million of 9 3/8% Senior Subordinated
Notes due 2008 (yield of 9.425%) (collectively, the "Offerings"). Each
convertible preferred security is convertible into 1.2419 shares of Common
Stock, par value $0.01 per share, of Sun, (equivalent to an initial
conversion price of $20.13 per share of Sun Common Stock). $300 million of
the net proceeds from the Offerings were used by the Company to permanently
repay certain outstanding borrowings under the term loan portion of the
Senior Credit Facility and the remaining $179.1 million of the net proceeds
from the Offerings were used to reduce certain outstanding borrowings under
the revolving credit portion of the Senior Credit Facility (which amounts may
be subsequently reborrowed). As a result of the permanent repayment of
borrowings under the term loan portion of the Company's Senior Credit
Facility, the Company recorded an extraordinary loss of $6.4 million, net of
income tax benefit of $3.7 million.
On May 5, 1998 the Company entered into certain interest rate
transactions with an aggregate notional value of $850 million to minimize the
risks and/or costs associated with certain long-term debt of the Company.
The Company does not otherwise utilize financial instruments for trading or
other speculative purposes. The counterparty to these contractual
arrangements is a major international financial institution with which the
Company has other financial relationships. The Company will be exposed to
credit loss in the event of non-performance by the counterparty. However,
the Company does not anticipate non-performance.
12
<PAGE>
The interest rate swap transactions have been designated as hedges for
accounting purposes. The Company will continue to evaluate this designation
on a periodic basis. The amounts to be paid or received are accrued and are
recognized as an adjustment to interest expense.
Under the interest rate swap transactions, the Company will be a
variable rate payor, effectively converting $550 million of fixed rate debt
and $300 million of variable rate Senior Credit Facility debt, which is based
on U.S. LIBOR, into variable rate debt based on an index of foreign interest
rates. The index of foreign interest rates is based on an equally weighted
average of the interest rates of the LIBOR rates of Germany and Switzerland
and the Bank Bill rate of Australia except that on May 1, 2001 the LIBOR of
the United Kingdom will replace the LIBOR of Switzerland with respect to the
$300 million swap having a maturity date of May 2008. All payments will be
denominated in U.S. dollars. Each interest rate swap includes cap protection
limiting the Company's exposure to interest rate fluctuations. The following
summarizes the terms of the various interest rate swap transactions at May 5,
1998:
<TABLE>
<CAPTION>
NOTIONAL MATURITY INTEREST RATE MAXIMUM INTEREST
AMOUNT DATE RECEIVE PAY (1) RATE PAID
------ ---- ------- ------- ---------
<S> <C> <C> <C> <C>
$300,000,000 5/2003 5.69%(2) 5.53% 7.0%
$300,000,000 5/2008 7.00%(3) 6.35% 7.0% (5/1998-5/2001)
8.5% (5/2001-5/2008)
$250,000,000 7/2002 9.50%(3) 8.95% 9.5% (5/1998-4/2000)
10.5% (4/2000-7/2002)
</TABLE>
(1) An index of foreign interest rates, reset quarterly (see above
description).
(2) U.S. LIBOR, reset quarterly.
(3) Fixed.
4. COMMITMENTS
(a) CONSTRUCTION COMMITMENTS
As of June 30, 1998, the Company had capital commitments of
approximately $15.8 million, including a corporate office building and a
long-term care facility, and various contracts related to improvements to
existing facilities in the United States, and capital commitments of
approximately L0.85 million ($1.4 million as of June 30, 1998) in the United
Kingdom.
(b) FINANCING COMMITMENTS
The Company has advanced $44.3 million and has agreed to advance up to
$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 Senior 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 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. As of June 30, 1998, five assisted living
facilities were under development. Construction was completed on two
facilities during the six months ended June 30, 1998. 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.
13
<PAGE>
5. NET EARNINGS (LOSS) PER SHARE
Basic net earnings 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.
Earnings per share is calculated as follows for the three and six months
ended June 30, (in thousands, except per share data):
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
BASIC:
Net earnings (loss) $(60,977) $10,894 $(55,652) $28,036
--------- ------- --------- -------
--------- ------- --------- -------
Weighted average shares
outstanding 54,534 53,263 54,648 53,251
-------- ------- -------- -------
-------- ------- -------- -------
Earnings (loss) per share:
Net earnings (loss) $(1.12) $0.21 $(1.02) $0.53
--------- ------- --------- -------
--------- ------- --------- -------
DILUTED:
Net earnings used in basic
calculation -- $10,894 -- $28,036
Net income impact of assumed
conversion -- 854 -- 1,709
----- ------- ----- -------
Adjusted net earnings -- $11,748 -- $29,745
----- ------- ----- -------
----- ------- ----- -------
Weighted average shares used
in basic calculation -- 53,263 -- 53,251
14
<PAGE>
Effect of dilutive securities:
Stock options and warrants -- 645 -- 580
Assumed conversion of
convertible debt -- 4,715 -- 4,715
----- ------- ----- -------
Weighted average common and
common equivalent shares
outstanding -- 58,623 -- 58,547
----- ------- ----- -------
----- ------- ----- -------
Earnings per shares:
Net earnings -- $0.20 -- $0.51
----- ------- ----- -------
----- ------- ----- -------
</TABLE>
6. OTHER EVENTS
(a) GOVERNMENT INVESTIGATION
In January 1995, the Company learned that two of its subsidiaries were
the subject of a pending Federal investigation. The investigating agencies
were the United States Department of Health and Human Services' Office of the
Inspector General ("OIG") and the United States Department of Justice.
Although the government never specified the full scope of the investigation,
it focused principally on whether the Company's rehabilitation therapy
subsidiary properly provided and/or billed for unnecessary or unordered
therapy services to residents of skilled nursing facilities; and whether the
Company's long term care subsidiary properly disclosed its relationship with
the Company's rehabilitation therapy subsidiary and properly sought
reimbursement for services provided by that subsidiary.
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. Recently the OIG informed the Company that it had no present
intention of initiating any civil or administrative actions against the
Company or any individuals or seeking monetary damages or other relief with
respect to the issues in the Federal Investigation, and the Civil Division of
the Department of Justice similarly informed the Company that it has
determined not to proceed any further at this time with the Federal
Investigation. No assurance can be given that the government will not
proceed with any investigation at a later time or initiate additional
investigations based on the same or other legal or regulatory concerns.
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. Since 1997, the investigation has also covered
information for the 1995 cost year as well as cost reporting periods prior to
1993. The information under review includes submissions and representations
by the long-term care subsidiary and the Company's chief executive officer.
The evidentiary phase of the hearing has concluded. The Company and the DSS
have had settlement discussions. However, the Company is unable to determine
at this time when the proceedings will be concluded or, if no settlement is
reached, whether the DSS will seek further administrative action or Medicaid
reimbursement sanctions. No assurance can be given that a settlement will in
fact occur or whether any such settlement or other outcome of the
investigation will not have a material adverse effect on the Company's
business, financial condition or results of operations.
15
<PAGE>
(b) 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. On May 21, 1998, the Company and
the Plaintiffs agreed to settle the action for $7.4 million. On June 9, 1998,
the Court approved the settlement and entered an order of dismissal.
(c) OTHER INQUIRIES
From time to time, fiscal intermediaries and Medicaid agencies examine
cost reports filed by 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.
6. SUMMARIZED FINANCIAL INFORMATION
The Company acquired The Mediplex Group, Inc. ("Mediplex") on June 23,
1994 and became a co-obligor with Mediplex with respect to the 6 1/2%
Convertible Subordinated Debentures and the 11 3/4% Senior Subordinated Notes
subsequent to the acquisition. Summarized financial information of Mediplex
is provided below (in thousands):
16
<PAGE>
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
---------- ------------
<S> <C> <C>
Current assets $125,089 $108,232
Noncurrent assets 391,224 391,048
Current liabilities 9,945 26,016
Noncurrent liabilities 71,093 72,373
Due to parent 215,455 165,207
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues $150,451 $126,589 $295,082 $247,948
Costs and expenses 137,546 119,664 273,652 235,792
Earnings before intercompany
charges and income taxes 12,905 6,925 21,430 12,156
Intercompany charges (1) 24,830 17,976 49,095 34,331
Earnings (loss) before income
taxes (11,925) (11,051) (27,665) (22,175)
Income taxes (benefit) (5,039) (4,241) (11,802) (8,648)
Net earnings (loss) (6,886) ($6,810) ($15,863) ($13,527)
</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 $12.8
million and $7.9 million for the three months ended June 30, 1998 and 1997,
respectively; and $24.2 million and $15.4 million for the six months ended
June 30, 1998 and 1997, respectively. Royalty fees charged to Mediplex for
the three months ended June 30, 1998 and 1997 for the use of Sun trademarks
were $3.0 million and $1.8 million, respectively; and $5.6 million and $3.5
million for the six months ended June 30, 1998 and 1997, respectively.
Intercompany interest charged to Mediplex for the three months ended June 30,
1998 and 1997 for advances from Sun was $9.0 million and $8.3 million,
respectively; and $19.3 million and $15.4 million for the six months ended
June 30, 1998 and 1997, respectively.
7. SUMMARIZED CONSOLIDATING INFORMATION
In connection with the Company's offering of $250.0 million aggregate
principal amount of 9 1/2% Senior Subordinated Notes due 2007 (the "9 1/2%
Notes") in July 1997, and $150.0 million aggregate principal amount of 9 3/8%
Senior Subordinated Notes due 2008, in May 1998 (the 9 3/8% Notes,
collectively the "Notes"), all direct and indirect subsidiaries of the
Company other than the Company's direct and
17
<PAGE>
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 substantially 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 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 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 the investors.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEET
<TABLE>
<CAPTION>
As of December 31, 1997
Combined Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Elimination Consolidated
---------- --------------- -------------- ----------- ------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents $(1,581) $31,674 $2,591 $- $32,684
Accounts receivable, net - 496,184 58,341 (317) 554,208
Other receivables 11,288 19,591 8,414 - 39,293
Prepaids and other assets 596 52,780 6,599 - 59,975
Deferred tax asset 16,546 4,554 - - 21,100
---------- ----------- ----------- ----------- ----------
Total current assets 26,849 604,783 75,945 (317) 707,260
---------- ----------- ----------- ----------- ----------
Property and equipment, net 30,805 367,503 392,809 - 791,117
Goodwill, net - 876,828 169,401 - 1,046,229
Notes receivable 60,080 2,784 13,448 - 76,312
Other assets, net 701,039 71,011 23,833 (611,846) 184,037
Deferred tax assets 19,077 - 2,487 - 21,564
---------- ----------- ----------- ----------- ----------
Total assets $837,850 $1,922,909 $677,923 $(612,163) $2,826,519
---------- ----------- ----------- ----------- ----------
---------- ----------- ----------- ----------- ----------
Current liabilities:
Current portion of long-term debt $5,000 $41,577 $38,884 $- $85,461
Current portion of obligations under capital
leases 262 1,415 377 - 2,054
Accounts payable 34,031 55,374 6,780 (317) 95,868
Accrued compensation and benefits 21,870 61,144 6,625 - 89,639
Accrued interest payable 16,477 4,448 2,741 - 23,666
Self insurance accrual 369 36,187 (202) - 36,354
Other accrued liabilities 6,028 41,592 35,279 - 82,899
Income taxes payable - - - - -
Deferred income taxes - short term - - - - -
---------- ----------- ----------- ----------- ----------
Total current liabilities 84,037 241,737 90,484 (317) 415,941
---------- ----------- ----------- ----------- ----------
Long-term debt, net of current portion 1,303,377 215,074 91,970 - 1,610,421
Obligations under capital leases, net of
current portion 17 24,284 76,782 - 101,083
Other long-term liabilities - 41,917 673 - 42,590
Deferred tax liabilities (2,480) 1,099 12,287 - 10,906
---------- ----------- ----------- ----------- ----------
Total liabilities 1,384,951 524,111 272,196 317 2,180,941
---------- ----------- ----------- ----------- ----------
Intercompany balances (1,164,154) 1,058,101 113,895 (7,842) -
Minority interest - 4,553 16,285 - 20,838
Total stockholders' equity 617,053 336,144 275,547 (604,004) 624,740
---------- ----------- ----------- ----------- ----------
Total liabilities and
stockholders' equity $837,850 $1,922,909 $677,923 ($612,163) $2,826,519
---------- ----------- ----------- ----------- ----------
---------- ----------- ----------- ----------- ----------
(1) Through various intercompany agreements entered into by the Company,
the Guarantors, and cetain of the non-Guarantor subsidiaries, the
Compnay provides management services, and acts on behalf of the
Guarantors and certain of the non-Guarantors subsidiaries to make
financing available for their operations. The Company charged the
Guarantors for management services totaling $47.4 million and $23.6
million for the periods ended March 31, 1998 and 1997, respectively.
The Company charged non-Guarantor subsidiaries for management services
totaling $0.6 million and $0.3 million for the periods ended March 31,
1998 and 1997, respectively. Intercompany interest charged to the
Guarantors for the periods ended March 31, 1998 and 1997 for advances
from the Company were $37.2 million, and $14.3 million, respectively.
Intercompany interest charged to the non-Guarantor subsidiaries for the
three months ended March 31, 1998 and 1997 for advances from the Company
was $0.8 million and $0.6 million, respectively.
</TABLE>
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEET
As of June 30, 1998
<TABLE>
<CAPTION>
Combined Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Elimination Consolidated
----------- -------------- -------------- ----------- ------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents $ (11,019) $ 32,249 $ 4,963 $ - $ 26,194
Accounts receivable, net - 595,774 68,682 (2,311) 662,145
Other receivables 13,004 29,949 8,216 - 51,169
Prepaids and other assets 4,272 51,973 7,239 - 63,484
Deferred tax asset 18,823 3,700 1,338 - 23,860
----------- ----------- ---------- ----------- ------------
Total current assets 25,080 713,645 90,438 (2,311) 826,852
----------- ----------- ---------- ----------- ------------
Property and equipment, net 47,644 390,876 396,912 - 835,432
Goodwill, net - 882,054 175,867 - 1,057,921
Notes receivable 75,404 862 13,448 - 89,714
Other assets, net 90,546 70,579 26,935 - 188,060
Investment in subsidiaries 553,933 - - (553,933) -
Deferred tax assets 19,771 - - - 19,771
----------- ----------- ---------- ----------- ------------
Total assets $ 812,378 $ 2,058,016 $ 703,600 $(556,244) $ 3,017,750
----------- ----------- ---------- ----------- ------------
----------- ----------- ---------- ----------- ------------
Current liabilities:
Current portion of long-term debt $ 10,000 $ 41,564 $ 33,842 $ - $ 85,406
Current portion of obligations under capital
leases 1,034 2,177 289 - 3,500
Accounts payable 53,273 16,472 7,952 (2,311) 75,386
Accrued compensation and benefits 22,983 66,651 13,300 - 102,934
Accrued interest 19,449 4,842 3,444 - 27,735
Accrued self-insurance obligations 6,463 50,402 213 - 57,078
Other accrued liabilities 26,529 74,018 28,147 - 128,694
Income taxes payable - 588 - - 588
----------- ----------- ---------- ----------- ------------
Total current liabilities 139,731 256,714 87,187 (2,311) 481,321
----------- ----------- ---------- ----------- ------------
Long-term debt, net of current portion 1,136,695 206,410 97,705 - 1,440,810
Obligations under capital leases, net of
current portion 195 26,831 76,232 - 103,257
Other long-term liabilities - 39,551 2,278 - 41,829
Deferred tax liabilities (4,363) 1,099 9,936 - 6,672
----------- ----------- ---------- ----------- ------------
Total liabilities 1,272,258 530,605 273,338 (2,311) 2,073,889
----------- ----------- ---------- ----------- ------------
Intercompany advances (1,382,938) 1,245,394 137,544 - -
Minority interest - 5,257 15,545 - 20,803
Company-obligated manditorily redeemable 345,000 - - - 345,000
convertible preferred securities of a
subsidiary trust holding solely 7%
convertible junior subordinated
debentures of the Company
Total stockholders' equity 578,058 276,760 277,173 (553,933) 578,058
----------- ----------- ---------- ----------- ------------
Total liabilities and stockholders' equity $ 812,378 $ 2,058,016 $ 703,600 $ (556,244) $ 3,017,750
----------- ----------- ---------- ----------- ------------
----------- ----------- ---------- ----------- ------------
</TABLE>
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF EARNINGS
For the Three Months Ended June 30, 1997
<TABLE>
<CAPTION>
Combined Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Elimination Consolidated
--------- -------------- --------------- ----------- -------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Total net revenues $ 372 $437,226 $ 80,995 $(1,945) $516,648
--------- ------------ ----------- ----------- ------------
Costs and expenses:
Operating - 369,271 68,045 (1,945) 435,371
Corporate general and administrative 13,247 6,058 3,447 - 22,752
Provision for losses on accounts - - -
receivable - 3,595 203 - 3,798
Depreciation and amortization 1,157 9,838 4,044 - 15,039
Interest, net 9,118 6,170 4,416 - 19,704
Equity interest in (earnings) loss of - - - -
subsidiaries 4,626 - - (4,626) -
--------- ------------ ----------- ----------- ------------
Total costs and expenses 28,148 394,932 80,155 (6,571) 496,664
--------- ------------ ----------- ----------- ------------
Earnings (loss) before income taxes and
intercompany charges (27,776) 42,294 840 4,626 19,984
Intercompany charges (46,636) 45,718 918 - -
--------- ------------ ----------- ----------- ------------
Earnings (loss) before income taxes 18,860 (3,424) (78) 4,626 19,984
Income taxes 7,966 907 217 - 9,090
--------- ------------ ----------- ----------- ------------
Earnings before extraordinary losses 10,894 (4,331) (295) 4,626 10,894
Extraordinary loss - - - - -
--------- ------------ ----------- ----------- ------------
Net earnings $ 10,894 $ (4,331) $ (295) $ 4,626 $ 10,894
--------- ------------ ----------- ----------- ------------
--------- ------------ ----------- ----------- ------------
</TABLE>
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF EARNINGS
For the Six Months Ended June 30, 1997
<TABLE>
<CAPTION>
Combined Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Elimination Consolidated
---------- -------------- -------------- ------------- --------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Total net revenues $ 1,356 $833,554 $ 150,380 $ (3,620) $ 981,670
------------ -------------- -------------- ------------- --------------
Costs and expenses:
Operating - 696,905 126,870 (3,620) 820,155
Corporate general and administrative 24,891 10,767 6,753 - 42,411
Provision for losses on accounts
receivable - 8,092 385 - 8,477
Depreciation and amortization 2,116 18,610 7,622 - 28,348
Interest, net 16,612 10,524 7,407 - 34,543
Equity interest in (earnings) loss of
subsidiaries (672) - - 672 -
------------ -------------- -------------- ------------- --------------
Total costs and expenses 42,947 744,898 149,037 (2,948) 933,934
------------ -------------- -------------- ------------- --------------
Earnings (loss) before income taxes and
intercompany charges (41,591) 88,656 1,343 (672) 47,736
Intercompany charges (85,498) 83,618 1,880 - -
------------ -------------- -------------- ------------- --------------
Earnings (loss) before income taxes 43,907 5,038 (537) (672) 47,736
Income taxes 15,871 3,464 365 - 19,700
------------ -------------- -------------- ------------- --------------
Net earnings $ 28,036 $ 1,574 $ (902) $ (672) $ 28,036
------------ -------------- -------------- ------------- --------------
------------ -------------- -------------- ------------- --------------
</TABLE>
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF EARNINGS
For the Three Months Ended June 30, 1998
<TABLE>
<CAPTION>
Combined Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Elimination Consolidated
------------- -------------- -------------- ------------- ------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Total net revenues $ 502 $ 721,322 $ 110,750 $ (6,280) $ 826,294
------------- -------------- -------------- ------------- ------------
Costs and expenses:
Operating - 592,539 96,763 (6,280) 683,022
Corporate general and administrative 28,916 11,971 4,606 - 45,493
Provision for losses on accounts
receivable - 9,787 287 - 10,074
Depreciation and amortization 1,602 17,037 5,725 - 24,364
Interest, net 26,055 6,057 4,424 - 36,536
Loss on sale of assets 2,400 5,402 - - 7,802
Litigation and investigation costs 8,000 22,256 - - 30,256
Merger expenses 10,478 15,082 - - 25,560
Equity interest in (earnings) loss of - - - -
subsidiaries 54,760 - - (54,760) -
------------- -------------- -------------- ------------- ------------
Total costs and expenses 132,211 680,131 111,805 (61,040) 863,107
------------- -------------- -------------- ------------- ------------
Dividends on convertible preferred securities 3,771 - - - 3,771
of subsidiary
------------- -------------- -------------- ------------- ------------
Earnings (loss) before income taxes,
extraordinary loss and intercompany
charges (135,480) 41,191 (1,055) 54,760 (40,584)
Intercompany charges (93,668) 91,877 1,791 - -
------------- -------------- -------------- ------------- ------------
Earnings (loss) before income taxes
and extraordinary loss (41,812) (50,686) (2,846) 54,760 (40,584)
Income taxes 9,045 1,490 (263) - 10,272
------------- -------------- -------------- ------------- ------------
Earnings before extraordinary loss (50,857) (52,176) (2,583) 54,760 (50,856)
Extraordinary loss 10,120 - - - 10,120
------------- -------------- -------------- ------------- ------------
Net earnings (loss) $(60,977) $ (52,176) $ (2,583) $ 54,760 $ (60,976)
------------- -------------- -------------- ------------- ------------
------------- -------------- -------------- ------------- ------------
</TABLE>
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF EARNINGS
For the Six Months Ended June 30, 1998
<TABLE>
<CAPTION>
Combined Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Elimination Consolidated
------------- --------------- --------------- ------------- --------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Total net revenues $ 834 $1,427,670 $216,224 $(7,717) $1,637,011
------------- --------------- --------------- ------------- --------------
Costs and expenses:
Operating - 1,181,220 188,469 (7,717) 1,361,972
Corporate general and administrative 55,633 23,753 8,959 - 88,345
Provision for losses on accounts
receivable - 17,802 611 - 18,413
Depreciation and amortization 3,041 32,151 11,237 - 46,429
Interest, net 55,024 12,107 9,002 - 76,133
Loss on sale of assets 2,400 5,402 - 7,802
Litigation and investigation costs 8,000 22,256 - - 30,256
Merger expenses 10,478 15,082 - - 25,560
Equity interest in (earnings) loss of - -
subsidiaries 67,858 - - (67,858) -
------------- --------------- --------------- ------------- --------------
Total costs and expenses 202,434 1,309,773 218,278 (75,575) 1,654,910
------------- --------------- --------------- ------------- --------------
Dividends on convertible preferred securities 3,771 - - - 3,771
of subsidiary
Intercompany charges (179,767) 176,560 3,207 - -
------------- --------------- --------------- ------------- --------------
Earnings (loss) before income taxes
and extraordinary loss (25,604) (58,663) (5,261) 67,858 (21,670)
Income taxes 19,928 4,436 (502) - 23,862
------------- --------------- --------------- ------------- --------------
Earnings (loss) before extraordinary
Loss (45,532) (63,099) (4,759) 67,858 (45,532)
Extraordinary loss 10,120 - - - 10,120
------------- --------------- --------------- ------------- --------------
Net earnings (loss) $(55,652) $ (63,099) $ (4,759) $67,858 $ (55,652)
------------- --------------- --------------- ------------- --------------
------------- --------------- --------------- ------------- --------------
</TABLE>
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1997
<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) $ 28,036 $ 1,574 $ (902) $ (672) $ 28,036
Adjustments to reconcile net earnings
(loss) to net cash provided by (used
for) operating activities --
Equity in earnings in subsidiaries (672) - - 672 -
Depreciation and amortization 2,115 18,611 7,622 - 28,348
Provision for losses on accounts
receivable - 7,361 385 - 7,745
Other, net 499 1,616 (83) - 2,032
Changes in operating assets and
liabilities:
Accounts receivable - (70,898) (4,573) - (75,471)
Other current assets 11,874 1,667 (2,031) - 11,510
Other current liabilities 9,073 28,983 7,600 - 45,657
Income taxes payable 25,852 (10,039) 990 - 16,803
---------- ---------- ---------- ----------- -----------
Net cash provided by (used for)
operating activities 76,777 (21,125) 9,008 - 64,660
---------- ---------- ---------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net (2,703) (15,938) (14,466) - (33,107)
Acquisitions, net of cash acquired - (35,243) (147,799) - (183,042)
Proceeds from the sale
and leaseback of property and equipment - 30,639 13,129 - 43,768
Increase in long-term note receivable (24,037) (13,832) - - (37,869)
Other assets expenditures (2,080) 10,996 (6,827) - 2,089
---------- ---------- ---------- ----------- -----------
Net cash used for investing activities (28,820) (23,378) (155,963) - (208,161)
---------- ---------- ---------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings 143,629 (5,035) 15,003 - 153,597
Long-term debt repayments (165) (12,633) (3,691) - (16,489)
Purchase of treasury stock - 2,959 - - 2,959
Net proceeds from issuance of common stock 1,677 1,830 - - 3,507
Financing fees paid (758) (846) (216) - (1,820)
Intercompany advances (197,779) 60,534 137,245 - -
---------- ---------- ---------- ----------- -----------
Net cash provided by (used for) financing
activities (53,396) 46,809 148,341 - 141,754
---------- ---------- ---------- ----------- -----------
Effect of exchange rate on cash and cash
equivalents - - (1,779) - (1,779)
---------- ---------- ---------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents (5,439) 2,306 (393) - (3,526)
Cash and cash equivalents at beginning of year 2,226 11,199 1,784 - 15,209
---------- ---------- ---------- ----------- -----------
Cash and cash equivalents at end of period $ (3,213) $ 13,505 $ 1,391 $ - $ 11,683
---------- ---------- ---------- ----------- -----------
---------- ---------- ---------- ----------- -----------
</TABLE>
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1998
<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) $ (55,652) $ (63,099) $ (4,759) $ 67,858 $ (55,652)
Extraordinary loss 10,120 10,120
Adjustments to reconcile net earnings
(loss) to net cash provided by (used
for) operating activities --
Equity in earnings in subsidiaries 67,858 - - (67,858) -
Depreciation and amortization 3,042 32,626 11,237 - 46,905
Provision for losses on accounts
receivable - 17,801 611 - 18,412
Other, net 4,705 (338) (134) - 4,232
Changes in operating assets and
liabilities:
Accounts receivable - (138,179) (10,389) - (148,568)
Other current assets (10,367) (15,615) (2,038) - (28,020)
Other current liabilities 45,329 50,008 620 - 95,957
Income taxes payable 51 368 (1,249) - (830)
--------- --------- --------- ---------- ----------
Net cash provided by (used for)
operating activities 65,085 (116,428) (6,101) - (57,444)
--------- --------- --------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net (19,161) (40,784) (10,400) - (70,345)
Acquisitions, net of cash acquired (16) (33,168) (2,197) - (35,381)
Proceeds from the sale and lease back of
property and equipment - 16,833 - - 16,833
Increase in long-term note receivable (15,324) (1,951) - - (17,275)
Other assets expenditures 1,164 (2,914) (9,358) - (14,780)
--------- --------- --------- ---------- ----------
Net cash used for investing activities (37,009) (61,984) (21,955) - (120,948)
--------- --------- --------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term det borrowings 154,894 10,379 7,425 - 172,698
Long-term det repayments (315,600) (8,427) (7,292) - (331,319)
Net proceeds from issuance 330,343 - - - 330,343
of convertible preferred
securities of subsidiary
Net proceeds from issuance of common stock 3,465 (848) - - 2,617
Purchases of treasury stock (1,357) - - - (1,357)
Financing fees paid (1,120) 489 - - (631)
Intercompany advances (208,137) 177,393 30,744 - -
--------- --------- --------- ---------- ----------
Net cash provided by (used for) financing
activities (37,512) 178,986 30,877 - 172,351
--------- --------- --------- ---------- ----------
Effect of exchange rate on cash and cash
equivalents - - (449) - (449)
--------- --------- --------- ---------- ----------
Net increase (decrease) in cash and cash
equivalents (9,436) 574 2,372 - (6,490)
Cash and cash equivalents at beginning of year (1,581) 31,675 2,590 - 32,684
--------- --------- --------- ---------- ----------
Cash and cash equivalents at end of period $ (11,017) $ 32,249 $ 4,962 $ - $ 26,194
--------- --------- --------- ---------- ----------
--------- --------- --------- ---------- ----------
</TABLE>
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
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, Germany and
Spain.
The Company's earnings growth has historically resulted from the
acquisition of long-term and subacute care 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 ancillary services through acquisitions. Ancillary services,
such as rehabilitation and respiratory therapy services and pharmaceutical
services, have had 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. 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
higher operating margins from the provision of ancillary services were
primarily attributable to favorable reimbursement rates under the Medicare
reimbursement system. However, effective July 1, 1998, Medicare will phase
in a prospective payment system ("PPS") over four years which will provide
reimbursement of all costs including ancillary service and capital-related
costs at a fixed fee. The Company believes that under 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."
On June 30, 1998, a wholly owned subsidiary of the Company merged with
Retirement Care Associates, Inc. ("RCA"), an operator of 98 skilled nursing
facilities and assisted living centers in eight states in the southeastern
United States. RCA also owned approximately 65% of Contour, a national
provider of medical/surgical supplies. The merger was accounted for as a
pooling of interests and accordingly, the financial statements have been
restated to include the accounts and operations of RCA for all periods prior
to the merger. In addition on June 30, 1998, the Company also acquired the
remaining 35% of Contour. The acquisition was accounted for as a purchase.
The Company's results of operations for the three and six months ended
June 30, 1998 and 1997 reflect the acquisition of facilities, the growth of
the Company's existing facility operations, the expansion of the
27
<PAGE>
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 addition, in January 1997, the Company acquired the portion not
previously owned by the Company of Ashbourne PLC ("Ashbourne"), an operator
of 49 nursing and residential support facilities with 3,613 licensed beds in
the United Kingdom.
At June 30, 1998, the Company operated 421 facilities with 48,392
licensed beds in the United States including 98 RCA facilities with 11,235
licensed beds, 155 facilities with 8,731 licensed beds in the United Kingdom,
nine facilities with 1,530 licensed beds in Spain, 13 facilities with 996
licensed beds in Germany and six facilities with 353 licensed beds in
Australia. During the six months ended June 30, 1998, the Company acquired a
net 2 facilities with 228 licensed beds in the United States and one facility
with 58 licensed beds in the United Kingdom. Also, during the six months
ended June 30, 1998, the Company developed and opened two facilities in the
United Kingdom with a total of 156 licensed beds.
At December 31, 1997, the Company operated 419 facilities with 47,890
licensed beds in the United States including 98 RCA facilities with 11,235
licensed beds 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'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 June 30, 1998,
the Company provided its therapy services to 1,449 nonaffiliated facilities,
an increase of 605 facilities from the 844 nonaffiliated facilities serviced
at June 30, 1997.
The Company's temporary therapy service operations, which provide
temporary therapists, had 30 and 27 division offices at June 30, 1998 and
December 31, 1997, respectively. During the six months ended June 30, 1998,
the Company provided a total of 1,323,000 temporary therapy staffing hours to
nonaffiliates, a 3% decrease from the 1,368,966 nonaffiliated temporary
therapy staffing hours provided during the six months ended June 30, 1997.
The Company's pharmaceutical service operations include the provision of
pharmaceuticals, the distribution of related supplies and home care. As of
June 30, 1998, the Company operated 36 regional pharmacies, four in-house
long-term care pharmacies, 14 home health service agencies, and a
pharmaceutical billing and consulting center.
28
<PAGE>
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, Germany 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 June 30, 1998, 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>
JUNE 30, DECEMBER 31, 1997
-------------------- -----------------
1998 1997
------ ------
<S> <C> <C> <C>
Long-term and Subacute Care Facility Operations:
Long-term and subacute care facilities
(including managed facilities):
Domestic operations 398 258 396
Foreign operations 183 133 162
------ ------ ------
Total 581 391 558
------ ------ ------
Licensed beds (including managed facilities):
Domestic operations 45,785 30,632 45,283
Foreign operations 11,610 7,632 10,448
------ ------ ------
Total 57,395 38,264 55,731
------ ------ ------
------ ------ ------
Assisted Living Facility Operations:
Assisted living facilities
Domestic 23 23 23
Foreign -- -- --
------ ------ ------
Total 23 23 23
------ ------ ------
------ ------ ------
Licensed beds
Domestic 2,607 2,607 2,607
Foreign -- -- --
------ ------ ------
Total 2,607 2,607 2,607
------ ------ ------
------ ------ ------
Therapy Service Operations:
Nonaffiliated facilities served 1,449 844 1,278
Affiliated facilities served 296 168 287
------ ------ ------
Total 1,745 1,012 1,565
------ ------ ------
------ ------ ------
Temporary Therapy Staffing Service Operations:
Hours billed to nonaffiliates (in thousands)
Three months ended June 30 646 698 --
Six months ended June 30 1,323 1,369
Twelve months ended December 31 -- -- 2,893
29
<PAGE>
Pharmaceutical Operations:
Nonaffiliated facilities served 628 394 546
Affiliated facilities served 248 143 255
------ ------ ------
Total 876 537 801
------ ------ ------
------ ------ ------
</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>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ----------------------------
1998 1997 1998 1997
------------ ---------- ------------ ------------
<S> <C> <C> <C> <C>
Long-term and subacute
care services $561,316 68% $325,308 63% $1,102,697 67% $611,785 62%
Assisted living facilities 8,222 1 7,638 1 17,258 1 15,072 2
Therapy services to
nonaffiliates 82,739 10 64,021 12 175,522 11 129,393 13
Foreign operations 70,042 8 48,317 9 136,348 8 86,090 9
Temporary therapy staffing
services to nonaffiliates 31,628 4 34,292 7 67,154 4 67,237 7
Pharmaceutical services to
nonaffiliates 65,767 8 35,002 7 126,686 8 67,539 7
Management fees and other 6,580 1 2,070 1 11,346 1 4,554 -
-------- --- -------- --- ---------- --- -------- ---
Total net revenues $826,294 100% $516,648 100% $1,637,011 100% $981,670 100%
-------- --- -------- --- ---------- --- -------- ---
-------- --- -------- --- ---------- --- -------- ---
</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
domestic affiliated facilities were $94.9 million and $41.2 million
for the three months ended June 30, 1998 and 1997, respectively; and
$184.6 million and $75.3 million for the six months ended June 30,
1998 and 1997, respectively. Revenues provided to domestic affiliated
facilities for pharmaceutical services were $22.4 million and $5.0
million for the three months ended June 30, 1998 and 1997, respectively; and
$42.9 million and $22.4 million for the six months ended June 30, 1998
and 1997, respectively.
30
<PAGE>
The following table presents the percentage of total net revenues
represented by certain items for the Company for the periods presented:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------- ------------------
1998 1997 1998 1997
------ ------- ------ ------
<S> <C> <C> <C> <C>
Total net revenues 100.0% 100.0% 100.0% 100.0%
Costs and expenses:
Operating 82.7 84.3 83.2 81.4
Corporate general and
administrative 5.5 4.4 5.4 6.5
Provision for losses on
accounts receivable 1.2 0.7 1.1 0.9
Depreciation and amortization 2.9 2.9 2.8 2.9
Interest, net 4.4 3.8 4.7 3.5
Merger expenses 3.1 - 1.6 -
Litigation and investigation costs 3.6 - 1.8 -
Loss on sale of assets 1.0 - 0.4 -
----- ----- ----- -----
Total costs and expenses 104.4 96.1 101 95.2
----- ----- ----- -----
Dividends on Convertible Preferred
Securities of subsidiary 0.5 - 0.3 0.0
Earnings (loss) before income taxes
and extraordinary loss (4.9) 3.9 (1.3) 4.9
Income taxes 1.2 1.8 1.5 2.0
----- ----- ----- -----
Earnings (loss) before extraordinary
loss (6.1) 2.1 (2.8) 2.9
Extraordinary loss from early
extinguishment of debt, net of
income taxes 1.2 - 0.6 -
----- ----- ----- -----
Net earnings (7.3%) 2.1% (3.4%) 2.9%
----- ----- ----- -----
----- ----- ----- -----
</TABLE>
THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997
Total net revenues for the three months ended June 30, 1998 increased
60% from approximately $516.6 million for the three months ended June 30,
1997 to approximately $826.3 million. Approximately $20.9 million of the
increase relates to RCA.
Excluding RCA, 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
22
<PAGE>
$272.6 million for the three months ended June 30, 1997 to $487.3 million for
the three months ended June 30, 1998, a 79% increase. Approximately $137.0
million or 63% of this increase results from the 110 leased or owned
facilities acquired from Regency in October 1997 and approximately $53.0
million or 25% of this increase resulted from an additional 60 leased or
owned facilities acquired or opened since December 31, 1996. The acquisition
of Regency occurred in October 1997 and net revenues include the results of
operations since the date of acquisition. The remaining net revenues increase
of $24.7 million, after giving effect to a decrease in net revenues of
approximately $3.9 million relating to four facilities sold during 1997 and
six facilities sold during 1998, is primarily attributable to an increase in
revenue per patient day on a same facility basis for the 138 leased or owned
facilities in operation for all of 1997 and 1998. The increase in revenue per
patient day was a result of payor rate increases and the expansion of the
Company's subacute services.
RCA's net revenues from long-term care facilities which includes
revenues generated from therapy and pharmaceutical services provided at RCA's
facilities, increased from $52.7 million for the three months ended June 30,
1997 to $69.6 million for the three months ended June 30, 1998.
Approximately $10.5 million of the increase is due to increased occupancy and
an increase in revenue per patient day on a same-store basis for the 51
leased or owned facilities in operation for all of 1997 and 1998. The
remaining increase is primarily attributable to the 24 leased or owned
facilities acquired or opened since December 31, 1996.
RCA's net revenues from assisted living facilities increased from $7.6
million for the three months ended June 30, 1997 to $8.2 million for the
three months ended June 30, 1998. The increase is primarily related to an
increase in occupancy at the 23 facilities, all of which have been open
since December 31, 1996.
Net revenues from therapy services to nonaffiliated facilities increased
42% from $64.0 million for the three months ended June 30, 1997 to $82.7
million for the three months ended June 30, 1998, primarily as a result of an
increase in the number of nonaffiliated facilities served from 844 facilities
at June 30, 1997 to 1,449 facilities at June 30, 1998.
Net revenues from foreign operations increased 45% from $48.3 million
for the three months ended June 30, 1997 to $70.0 million for the three
months ended June 30, 1998. Approximately $7.1 million or 33% of this
increase was the result of increased net revenues from the nursing home
operations in the United Kingdom. Approximately $13.1 million or 60% of this
total increase is the result of the Company's acquisitions of nursing homes
in Germany, Australia and Spain during 1997.
Net revenues from pharmaceutical services to nonaffiliated facilities,
excluding RCA's medical supply subsidiary, Contour, increased 143% from $24.1
million for the three months ended June 30, 1997 to $58.6 million for the
three months ended June 30, 1998. Approximately $21.2 million or 61% 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, the remaining net
revenues increase was primarily the result of the increase in nonaffiliated
facilities served as a result of additional acquisitions during 1997.
Contour's net revenues to nonaffiliated facilities increased 31% from $10.9
million for the three months ended June 30, 1997 to $14.3 million for the
three months ended June 30, 1998. The increase is primarily due to the
opening of two distribution centers since June 30, 1997.
Excluding RCA, operating expenses, which includes rent expense of $58.4
million and $33.0 million for the three months ended June 30, 1998 and 1997,
respectively, increased 66% from
23
<PAGE>
approximately $366.9 million for the three months ended June 30, 1997 to
approximately $608.7 million for the three months ended June 30, 1998. The
increase resulted primarily from the net increase of 130 leased or owned
facilities since June 30, 1997 and the growth in therapy and pharmaceutical
services. Operating expenses as a percentage of net revenues decreased from
82% for the three months ended June 30, 1997 to 81% for the three months
ended June 30, 1998. RCA's operating expenses, which includes rent expense
of $5.3 million and $4.4 million for the three months ended June 30, 1998 and
1997, respectively, increased from $70.7 million for the three months ended
June 30, 1997 to $93.5 million for the three months ended June 30, 1998, a
32% increase. The increase resulted primarily from the net increase of 24
leased or owned facilities since January 1, 1997 and the growth in Contour.
Excluding RCA, corporate general and administrative expenses, which
include regional costs related to the supervision of operations, increased
100% from $21.0 million for the three months ended June 30, 1997 to $41.9
million for the three months ended June 30, 1998. As a percentage of net
revenues, corporate general and administrative expenses increased from 4.7%
for the three months ended June 30, 1997 to 5.6% for the three months ended
June 30, 1998. The increase was primarily due to an increase in costs
relating to the expansion of the Company's corporate infrastructure to
support newly acquired domestic operations including the acquisition of
Regency and RCA, and implementation of new business strategies. RCA's
corporate general and administrative expenses were $1.8 million and $3.5
million for the three months ended June 30, 1997 and 1998, respectively. The
Company expects that these costs should be substantially eliminated by the
end of the third quarter when the integration of RCA's corporate office is
expected to be completed.
Excluding RCA, the provision for losses on accounts receivable increased
129% from $3.6 million for the three months ended June 30, 1997 to $8.2
million for the three months ended June 30, 1998. As a percentage of net
revenues, provision for losses on accounts receivable increased from 0.8% for
the three months ended June 30, 1997 to 1.1% for the three months ended June
30, 1998. RCA's provision for losses on accounts receivable was $0.2 million
and $1.9 million for the three months ended June 30, 1997 and 1998,
respectively.
Excluding RCA, depreciation and amortization increased 69% from $12.7
million for the three months ended June 30, 1997 to $21.5 million for the six
months ended June 30, 1998. As a percentage of net revenues, depreciation and
amortization expense increased from 2.8% for the three months ended June 30,
1997 as compared to 2.9% for the three months ended June 30, 1998. RCA's
depreciation and amortization expense increased from $2.3 million for the
three months ended June 30, 1997 to $2.8 million for the three months ended
June 30, 1998. As a percentage of net revenues, RCA's depreciation and
amortization expense decreased from 3.2% for the three months ended June 30,
1997 to 3.1% for the three months ended June 30, 1998.
Excluding RCA, net interest expense increased 125% from $14.2 million
for the three months ended June 30, 1997 to $31.9 million for the three
months ended June 30, 1998. As a percentage of net revenues, interest expense
increased from 3.2% for the three months ended June 30, 1997 to 4.2% for the
three months ended June 30, 1998. The increase was related to (i) an increase
in the Company's weighted average interest rate resulting from the Company's
issuance of $250 million of 9 1/2% Notes in July 1997 and the Company's
issuance of $150 million of 9 3/8% Notes in May 1998, (ii) higher interest
rates and borrowing costs under the Company's Senior Credit Facility as
compared to the old credit facility that was retired in October 1997, (iii)
an increase in borrowings under the Company's Senior Credit Facility
associated with various acquisitions during 1997 and 1998 including Regency
and Ashbourne and various acquisitions in Spain, Germany and Australia and
(iv) offset partially by the Company's hedging strategy
24
<PAGE>
(see "Liquidity and Capital Resources"). Interest expense for RCA was $4.7
million and $5.5 million for the three months ended June 30, 1998 and 1997,
respectively.
In connection with the merger of RCA, the Company recorded merger
expenses of $25.5 million for transaction costs and integration expenses,
including elimination of redundant corporate functions, severance costs
related to the headcount reductions, the write-off of certain intangibles and
property and equipment.
The Company recorded a charge for litigation and investigation costs of
$30.3 million during the three months ended June 30, 1998 for professional
fees and settlement costs related to certain legal and regulatory matters.
The charge includes amounts provided for (i) the settlement of shareholder
class action litigation against RCA (see "Litigation") and anticipated costs
related to other shareholder actions against RCA and its former directors,
officers and advisors; (ii) the settlement of a shareholder suit related to
the Company's acquisition in 1995 of SunCare (see "Litigation"); (iii)
anticipated costs related to certain state regulatory investigations of RCA's
operations for matters which occurred prior to the Company's acquisition of
RCA; and (iv) estimated costs to resolve the ongoing investigation by the
Connecticut Department of Social Services ("DSS") (see "Regulation").
The Company recognized a $7.8 million loss on sale of assets in the
three months ended June 30, 1998. Approximately $5.2 million relates to the
anticipated sale of five nursing homes in the third quarter of 1998 and for
certain adjustments to the sale price of three nursing homes sold in 1996.
Approximately $2.4 million relates to additional losses on the Company's
anticipated sale of its outpatient rehabilitation clinics in Canada. The
Company recorded a $7.0 million loss in 1997 in order to reduce the carrying
value of its Canadian operations to fair value based on its estimates of
selling value and of costs to sell.
Excluding RCA and the loss on sale of assets, litigation and
investigation costs and the merger expense (collectively the "Special
Charges"), the Company's effective tax rate was 42.8% for the three months
ended June 30, 1998 and was 39.0% for the three months ended June 30, 1997.
The increase in the effective tax rate was primarily due to a less favorable
mix of state income in the United States and the increased amount of
nondeductible goodwill amortization expense resulting primarily from the
acquisition of Regency. RCA recorded a tax benefit of $2.3 million for the
three months ended June 30, 1997 on its loss of $6.9 million, but did not
record any benefit for the three months ended June 30, 1998 on its loss of
$14.2 million due to uncertainty regarding the realization of the tax
benefit.
In the three months ended June 30, 1998, the Company recorded an
extraordinary loss of $10.1 million, net of income tax benefit of $3.7
million. Approximately $10.2 million of the gross loss relates to the
permanent pay-down of $300 million of the term loan portion of the Company's
credit facility. The remaining $3.7 million of the gross loss relates to the
retirement of $5.0 million of Contour convertible debentures which were
purchased by the Company.
Excluding RCA, the Special Charges and the extraordinary loss, net
earnings increased 20% from $17.8 million for the three months ended June 30,
1997 to $21.3 million for the three months ended June 30, 1998. As a
percentage of net revenues, net earnings before income taxes, excluding RCA,
the Special Charges and the extraordinary loss, decreased from 6.5% for the
three months ended June 30, 1997 to 4.9% for the three months ended June 30,
1998. The margin decrease was primarily due to increased borrowings and
borrowing costs, and increased corporate and general administrative expenses.
RCA incurred net losses of $6.9 million and $14.2 million for the three
months ended June 30, 1997 and 1998. The
25
<PAGE>
primary reason for the increased net loss was RCA's inability to recognize a
tax benefit on its net operating losses.
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
Total net revenues for the six months ended June 30, 1998 increased 67%
from $981.7 million for the six months ended June 30, 1997 to $1.64 billion.
Approximately $39 million of the increase relates to RCA.
Excluding RCA, 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 $511.9 million for the
six months ended June 30, 1997 to $972.5 million for the six months ended
June 30, 1998, a 90% increase. Approximately $273.1 million or 61% of this
increase results from 110 leased or owned facilities acquired from Regency in
October 1997 and approximately $129.5 million or 29% of this increase
resulted from an additional 60 facilities acquired or opened since December
31, 1996. The remaining net revenue increase of $56.9 million, after giving
effect to a decrease in net revenues of approximately $9.0 million relating
to six facilities sold during 1998 and four facilities sold during 1997, is
primarily attributable to an increase in revenue per patient day and an
increase in occupancy levels since December 31, 1997 on a same facility basis
for the 138 leased or owned facilities in operation all fiscal year 1997 and
the six months ended June 30, 1998. The increase in revenue per patient day
was a result of payor rate increases and the expansion of the Company's
subacute services.
RCA's net revenues from long-term care facilities which includes
revenues generated from therapy and pharmaceutical services provided at RCA's
facilities, increased from $99.9 million for the six months ended June 30,
1997 to $131.8 million for the six months ended June 30, 1998. Approximately
$12.1 million of the increase is due to an increase in revenue per patient
day on a same-store basis for the 51 leased or owned facilities in operation
for all of 1997 and 1998. The remaining increase is primarily attributable
to the 24 leased or owned facilities acquired or opened since December 31,
1996.
RCA's net revenues from assisted living facilities increased from $15.1
million for the six months ended June 30, 1997 to $17.3 million for the six
months ended June 30, 1998. The increase is primarily related to an increase
in revenue per patient day at the 23 facilities, all of which have been
open since December 31, 1996.
Net revenues from therapy services to nonaffiliated facilities increased
49% from $131.6 million for the six months ended June 30, 1997 to $195.9
million for the six months ended June 30, 1998 primarily as a result of an
increase in the number of nonaffiliated facilities served from 844 facilities
at June 30, 1997 to 1,449 facilities at June 30, 1998.
Net revenues from foreign operations increased 58% from $86.1 million
for the six months ended June 30, 1997 to $136.3 million for the six months
ended June 30, 1998. Approximately $19.9 million or 40% 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 during January 1997, which added approximately $6.4 million of net
revenues during the six months ended June 30, 1998. Approximately $26.3
million or 52% of this total increase is the result of the Company's
acquisitions of nursing homes in Germany, Spain and Australia during 1997.
26
<PAGE>
Net revenues from temporary therapy staffing services to nonaffiliated
facilities remained constant at $67.2 million for the six months ended June 30,
1997 and for the six months ended June 30, 1998.
Net revenues from pharmaceutical services, excluding RCA's medical
supply subsidiary, Contour, to nonaffiliated facilities increased 148% from
$44.9 million for the six months ended June 30, 1997 to $111.5 million for
the six months ended June 30, 1998. The growth in net revenues was primarily
a result of the increase in the number of nonaffiliated facilities served
from 394 at June 30, 1997 to 628 at June 30, 1998. The increase in
nonaffiliated facilities served was the result of the opening and acquisition
of pharmacies during 1997 and 1996 and the increase in the number of
nonaffiliated facilities served by pharmacies open prior to January 1, 1996.
Contour's net revenues to nonaffiliated facilities increased 21.6% from $22.7
million for the six months ended June 30, 1997 to $27.6 million for the six
months ended June 30, 1998. The increase is primarily due to the opening of
two distribution centers since June 30, 1997.
Excluding RCA, operating expenses, which includes rent expense of $113.5
million and $60.7 million for the six months ended June 30, 1998 and 1997,
respectively, increased 76% from $694.8 million for the six months ended June
30, 1997 to $1.2 billion for the six months ended June 30, 1998. The
increase resulted primarily from the net increase of 130 leased or owned
facilities since June 30, 1997 and the growth in therapy and pharmacy
services. Operating expenses as a percentage of net revenues decreased from
82% for the six months ended June 30, 1997 to 81% for the six months ended
June 30, 1998. RCA's operating expenses, which includes rent expense of $10.5
million and $8.1 million for the six months ended June 30, 1998 and 1997,
respectively, increased from $127.6 million for the six months ended June 30,
1997 to $179.2 million for the six months ended June 30, 1998, a 40%
increase. The increase resulted primarily from the net increase of 24 leased
or owned facilities since January 1, 1997 and the growth in Contour.
Excluding RCA, corporate general and administrative expenses, which
include regional costs related to the supervision of operations, increased
106% from $39.4 million for the six months ended June 30, 1997 to $81.2
million for the six months ended June 30, 1998. As a percentage of net
revenues, corporate general and administrative expenses increased from 4.7%
for the six months ended June 30, 1997 to 5.4% for the six months ended June
30, 1998. The increase was primarily due to an increase in costs relating to
the expansion of the Company's corporate infrastructure to support newly
acquired domestic operations including the acquisition of Regency and RCA,
and implementation of new business strategies. RCA's corporate general and
administrative expenses were $2.9 million and $7.1 million for the six
months ended June 30, 1997 and 1998, respectively. The Company expects that
these costs should be substantially eliminated by the end of the third
quarter when the integration of RCA's corporate office is expected to be
completed.
Excluding RCA, the provision for losses on accounts receivable increased
109% from $6.8 million for the six months ended June 30, 1997 to $14.2
million for the six months ended June 30, 1998. As a percentage of net
revenues, provision for losses on accounts receivable increased from 0.8% for
the six months ended June 30, 1997 to 1% for the six months ended June 30,
1998. RCA's provision for losses on accounts receivable was $1.7 million and
$4.2 million for the six months ended June 30, 1997 and 1998, respectively.
Excluding RCA, depreciation and amortization increased 73% from $24.3
million for the six months ended June 30, 1997 to $42.0 million for the six
months ended June 30, 1998. As a percentage of net revenues, depreciation
and amortization expense decreased from 2.9% for the six months ended June
30, 1997 to 2.8% for the six months ended June 30, 1998, respectively.
RCA's depreciation and
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<PAGE>
amortization expense increased from $4.0 million for the six months ended
June 30, 1997 to $4.4 million for the six months ended June 30, 1998. As a
percentage of net revenues, depreciation and amortization expense remained
constant at 2.9% for the six months ended June 30, 1997 and the six months
ended June 30, 1998.
Excluding RCA, net interest expense increased 163% from $25.5 million
for the six months ended June 30, 1997 to $67.0 million for the six months
ended June 30, 1998. As a percentage of net revenues, interest expense
increased from 3.0% for six months ended June 30, 1997 to 4.5% for the six
months ended June 30, 1998. The increase was related to (i) an increase in
the Company's weighted average interest rate resulting from the Company's
issuance of $250 million of 9 1/2% Notes in July 1997 and the Company's
issuance of $150 million of 9 3/8% Notes in May 1998, (ii) higher interest
rates and borrowing costs under the Company's Senior Credit Facility as
compared to the old credit facility that was retired in October 1997, (iii)
an increase in borrowings under the Company's Senior Credit Facility associated
with various acquisitions during 1997 and 1998 including Regency and Ashbourne
and various acquisitions in Spain, Germany and Australia and (iv) offset
partially by the Company's hedging strategy (see "Liquidity and Capital
Resources"). Interest expense for RCA was $9.1 million for the six months
ended June 30, 1998 and 1997, respectively.
In connection with the merger of RCA, the Company recorded company
merger expenses of $25.5 million for transaction costs and integration
expenses, including elimination of redundant corporate functions, severance
costs related to the headcount reductions, the write-off of certain
intangibles and property and equipment.
The Company recorded a charge for litigation and investigation costs of
$30.3 million during the six months ended June 30, 1998 for professional
fees and settlement costs related to certain legal and regulatory matters
(see discussion for Three Months Ended June 30, 1998 Compared to Three Months
Ended June 30, 1997).
The Company recognized a $7.4 million loss on sale of assets in the
six months ended June 30, 1998 (see discussion for Three Months Ended June
30, 1998 Compared to Three Months Ended June 30, 1997).
Excluding RCA and the loss on sale of assets, litigation and
investigation costs and the merger expenses (collectively the "Special
Charges"), the Company's effective tax rate was 42.7% for the six months
ended June 30, 1998 and was 39% for the six months ended June 30, 1997. The
increase in the effective tax rate was due to a less favorable mix of state
income in the United States than in the prior year and the increased amount
of non-deductible goodwill amortization expense resulting primarily from the
acquisition of Regency. RCA recorded a tax benefit of $1.9 million for the
six months ended June 30, 1997, but did not record any benefit for the six
months ended June 30, 1998 on its loss of $23.9 million due to uncertainty
regarding the realization of the tax benefit.
In the six months ended June 30, 1998, the Company recorded an
extraordinary loss of $10.1 million net of income tax benefit of $3.7 million
(see discussion for Three Months Ended June 30, 1998 Compared to Three Months
Ended June 30, 1997).
Excluding RCA, the Special Charges and the extraordinary loss, net
earnings were $39.7 million for the six months ended June 30, 1998 as
compared to net earnings of $33.8 million for the six months ended June 30,
1997. As a percentage of net revenues, net earnings decreased from 4.0% for
the six
28
<PAGE>
months ended June 30, 1997 to 2.7% for the six months ended June 30, 1998.
The margin decrease was primarily due to the increased borrowings and
borrowing costs and increased corporate and general administrative expenses.
RCA incurred net losses of $5.7 million and $27.3 million for the six months
ended June 30, 1997 and 1998, respectively.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1998, the Company had working capital of $345.5 million,
including cash and cash equivalents of $26.2 million, as compared to working
capital of $291.3 million, including cash and cash equivalents of $32.7
million at December 31, 1997. For the six months ended June 30, 1998, net
cash used for operations was $59.8 million compared to net cash provided by
operations for the six months ended June 30, 1997 of $64.7 million. The net
cash used for operations for the six months ended June 30, 1998 reflects an
increase in the net cash used to fund an increase in accounts receivable.
This was offset by the Company's growth in net earnings before special charges
and timing of payment of certain obligations of the Company.
The Company's accounts receivable have increased since December 31,
1997. Accounts receivable increased in part because of the growth in the
Company's inpatient, therapy and pharmaceutical services businesses since
December 31, 1997. The growth in accounts receivable is also attributable to
the fact that when long-term care facilities are acquired by the Company, the
fiscal intermediaries are changed to the Company's fiscal intermediary
resulting in temporary delays in timing of third-party payments. The Company
has completed the transition for Regency and expects the temporary delays to
end in the third quarter.
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.
Other significant operating uses of cash for the six months ended June
30, 1998 were payments of $76.6 million for interest and net payments
totaling $20.1 million for income taxes.
The Company incurred $71.4 million in capital expenditures during the
six months ended June 30, 1998. Substantially all such expenditures during
the six months ended June 30, 1998 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, two 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 Senior Credit Facility. The Company had capital expenditure
commitments, as of June 30, 1998, under various contracts, including
approximately $15.8 million in the United States and L0.85 million ($1.4
million as of June 30, 1998) 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.
The Company paid approximately a net of $35.4 million in cash for
acquisitions during the six months ended June 30, 1998. These acquisitions
were funded by borrowings under the Company's Senior Credit Facility.
29
<PAGE>
On June 30, 1998, a wholly owned subsidiary of the Company merged with
RCA, an operator of skilled nursing facilities and assisted living centers in
seven states in the southeastern United States. RCA also owned approximately
65% of Contour Medical, Inc. ("Contour"), a national provider of
medical/surgical supplies. Under the amended terms of the merger agreement
the Company issued approximately 7,839,000 shares of its common stock (valued
at $114.6 million based upon the closing price of $14.625 per share as of
June 30, 1998) for all of the outstanding common stock of RCA and certain
redeemable preferred shares of RCA. The Company also issued 298,334 shares
of its Series B Convertible Preferred Stock in exchange for the outstanding
shares of RCA's Series F Preferred Stock, which is convertible into 279,279
shares of Sun common stock valued at $2.8 million at June 30, 1998. In
addition, the Company assumed approximately $170.4. million of indebtedness
excluding $19.8 million of indebtedness eliminated in consolidation. The
merger was accounted for as a pooling of interests and accordingly, the
financial statements have been restated to include the accounts and
operations of RCA for all periods prior to the merger.
On June 30, 1998, the Company also acquired the remaining 35% of
Contour. The Company issued approximately 1,771,000 shares of its common
stock (valued at approximately $25.9 million based upon the closing price of
$14.625 per share as of June 30, 1998) for the remaining outstanding Contour
common stock. The acquisition was accounted for as a purchase.
On November 25, 1997, the Company, RCA and representatives of the
plaintiffs in certain pending class actions against RCA 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 escrowed
on behalf of the defendants the settlement amount into an escrow fund which
is included in other long-term assets as of June 30, 1998. The settlement is
subject to, among other things, confirmatory discovery, the execution of
definitive documentation and court approval.
In connection with the merger of RCA, the Company charged against the
earnings of the combined company $25.6 million for transaction costs and
integration expenses, including elimination of redundant corporate functions,
severance costs related to the headcount reductions, the write-off of certain
intangibles and property and equipment. At June 30, 1998, liabilities for
approximately $3.3 million in severance and related costs and $15.2 million
for costs remaining on the balance sheet. The Company expects to complete
its consolidation of operations by the end of 1998.
The Company conducts business outside of the United States, in the
United Kingdom, Spain, Australia, Germany and Canada. The foreign operations
accounted for 9% and 11% of the Company's total net revenues during the three
months ended June 30, 1998 and 1997, respectively, and 21% of the Company's
consolidated total assets as of June 30, 1998. 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 reflected in the accumulated other
comprehensive income component of stockholders' equity.
30
<PAGE>
The Company has advanced $44.3 million and has agreed to advance up to
$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 Senior 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 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. As of June 30, 1998, five assisted living
facilities were under development. Construction was completed on two
facilities during the six months ended June 30, 1998. 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 June 30, 1998, the Company had, on a consolidated basis, $1.6 billion
of outstanding indebtedness including capital lease obligations, including
$714.8 million of indebtedness under its $1.2 billion Senior Credit Facility.
The Company also had $50.9 million of outstanding standby letters of credit
under its Senior Credit Facility as of June 30, 1998.
In May 1998, the Company issued $345 million of 7% convertible trust
issued preferred securities and $150 million of 9 3/8% Senior Subordinated
Notes due 2008 (yield of 9.425%) (collectively the "Offerings"). Each
convertible preferred security is convertible into 1.2419 shares of common
stock, par value $0.01 per share, of Sun, (equivalent to an initial
conversion price of $20.13 per share of Sun common stock). $300 million of
the net proceeds from the Offerings were used by the Company to permanently
repay certain outstanding borrowings under the term loan portion of the
Senior Credit Facility and the remainder of the net proceeds from the
Offerings were used to reduce certain outstanding borrowings under the
revolving credit portion of the Senior Credit Facility (which amounts may be
subsequently reborrowed).
On May 5, 1998 the Company entered into certain interest rate
transactions with an aggregate notional value of $850 million to minimize the
risks and/or costs associated with certain long-term debt of the Company.
The Company does not otherwise utilize financial instruments for trading or
other speculative purposes. The counterparty to these contractual
arrangements is a major international financial institution with which the
Company has other financial relationships. The Company will be exposed to
credit loss in the event of non-performance by the counterparty. However,
the Company does not anticipate non-performance.
The interest rate swap transactions have been designated as hedges for
accounting purposes. The Company will continue to evaluate this designation
on a periodic basis. The amounts to be paid or received are accrued and are
recognized as an adjustment to interest expense.
Under the interest rate swap transactions, the Company will be a
variable rate payor, effectively converting $550 million of fixed rate debt
and $300 million of variable rate Senior Credit Facility debt, which is based
on U.S. LIBOR, into variable rate debt based on an index of foreign interest
rates. The index of foreign interest rates is based on an equally weighted
average of the interest rates of Germany and
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<PAGE>
Switzerland and the Bank Bill rate of Australia except that on May 1, 2001
the LIBOR of the United Kingdom will replace the LIBOR of Switzerland with
respect to the $300 million swap having a maturity date of May 2008. All
payments will be denominated in U.S. dollars. Each interest rate swap
includes cap protection limiting the Company's exposure to interest rate
fluctuations. The following summarizes the terms of the various interest
rate swap transactions at May 5, 1998:
<TABLE>
<CAPTION>
Notional Maturity Interest Rate Maximum Interest
Amount Date Receive Pay (1) Rate Paid
-------- ------ -------- ------ -------------
<S> <C> <C> <C> <C>
$300,000,000 5/2003 5.69%(2) 5.53% 7.0%
$300,000,000 5/2008 7.00%(3) 6.35% 7.0% (5/1998-5/2001)
8.5% (5/2001-5/2008)
$250,000,000 7/2002 9.50%(3) 8.95% 9.5% (5/1998-4/2000)
10.5% (4/2000-7/2002)
</TABLE>
(1) An index of foreign interest rates, reset quarterly (see above
description).
(2) U.S. LIBOR, reset quarterly.
(3) Fixed.
The Company's hedging strategy in entering into the interest rate swap
transactions is to obtain the benefit of less costly variable rate debt while
capping its overall exposure to interest rate fluctuations. The Company
believes that an index of foreign interest rates lessens the volatility of
interest rate fluctuations. However, no assurance can be given that such a
strategy will lower the volatility of interest rate fluctuations or reduce
the cost of capital.
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
Senior Credit Facility, the net proceeds from the Offerings 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 and to fund potential conversions of 6 1/2% Convertible
Debentures. The Company anticipates that it will fund its construction
commitments as well as its requirements relating to future growth through (i)
the available borrowing capacity under its Senior 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 Senior
Credit Facility or otherwise require approval of various lenders under the
Company's Senior Credit Facility. The Company has on file with the Securities
and Exchange Commission a shelf registration statement on Form S-3 which,
among other things, provides for the sale of up to $1.0 billion of securities
which sales are subject to the registration statement being declared
effective by the Securities and Exchange Commission. If such additional
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.
NEWLY ISSUED PRONOUNCEMENTS
On April 3, 1998, the Institute of Certified Public Accountants issued
Statement of Position 98-5, Reporting on the Costs of Start-Up Activities.
The statement requires costs of start-up activities and organization costs to
be expensed as incurred. The statement is effective for financial statements
for fiscal years beginning after December 31, 1998. Initial application will
result in the estimated write-off of $13.2 million in pre-opening and
organizational costs on January 1, 1999, which will be reported as a
cumulative effect of a change in accounting principle.
In June 1998, a new accounting standard for derivative instruments and
hedging activities was issued. The new standard, which will be effective
January 1, 2000, requires all derivatives to be recognized on the balance
sheet at fair value. Gains or losses from changes in fair value would be
recognized in earnings in the period of change unless the derivative is
designated as a hedging instrument. The Company is studying the impact of the
new standard, and is unable to predict at this time the impact on its
financial statements.
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<PAGE>
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 totaling 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.
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 financial condition and results of operations would be
materially and adversely affected if the amounts actually received from
third-party payors in any reporting period differed 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 (the "BBA"), Congress passed numerous
changes to the reimbursement policies applicable to exempt hospital services,
skilled nursing, therapy and other ancillary
33
<PAGE>
services. The BBA generally provides for a phase-in of a prospective
payment system for skilled nursing facilities over a four year period. PPS
will become effective for the Company's facilities on January 1, 1999, other
than the facilities acquired with RCA for which PPS became effective July 1,
1998. 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. Interim final regulations, including the federal
per diem rate, were published on May 12, 1998. 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 patients 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. 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 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), reimbursement for
ancillary services, including rehabilitation therapy, medical supplies,
pharmacy, temporary staffing for rehabilitation therapy, and other ancillary
services, will be made pursuant to fee schedules which were to be effective
July 1, 1998 but which are not yet published. 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; however, there can be no assurance that the
Company will receive any payments in excess of these caps. There also can be
no assurance that 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
34
<PAGE>
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
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 services. Although salary equivalency guidelines will no longer be
effective following the implementation of PPS for Part A and fee schedule
reimbursement for Part B, 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 10, 1998. Implementation of
these guidelines has increased reimbursement rates for respiratory therapy
and physical therapy, but effectively reduced reimbursement rates for speech
therapy and occupational therapy. 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 were to be effective as early as July 1, 1998 but which have not yet
been published.
Additionally, the salary equivalency guidelines adopted 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
35
<PAGE>
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, other than the facilities acquired with RCA for which PPS became
effective July 1, 1998) and fee schedules with respect to Medicare Part B
(which were to be effective July 1, 1998 but which have not yet been
published for all services) 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 60%, 70% and 74% of total
rehabilitation and temporary therapy staffing services net revenues for the
three months ended June 30, 1998 and the years ended December 31, 1997 and
1996, respectively. Respiratory therapy services provided to nonaffiliated
facilities represented 56%, 63% and 55% of total respiratory therapy services
net revenues for the three months ended June 30, 1998 and the years ended
December 31, 1997 and 1996, respectively. Net revenues from pharmaceutical
services billed to nonaffiliated facilities represented 79%, 79% and 78% of
total pharmaceutical services revenues for the three months ended June 30,
1998 and the years ended December 31, 1997 and 1996, respectively. The
Company believes that it satisfies the requirements of these regulations
regarding nonaffiliated business. Consequently, it has 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.
36
<PAGE>
The OIG has announced an intention to conduct a national medical review
that will assess the medical necessity of physical and occupational therapy
services provided to skilled nursing facility patients. The OIG has indicated
the results of the review will be used to quantify overpayments for therapy
services and to develop baseline data that can be used to asses the impact of
the BBA. The company is unable to determine what if any impact this review
might have on the company, including its prospective payment rates.
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's subsidiaries are 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 a provider is ever found to have engaged in
improper practices, it could be subject to civil, administrative or criminal
fines, penalties or restitutionary relief, and reimbursement authorities
could also seek the suspension or exclusion of the provider or individuals
from participation in their programs.
In January 1995, the Company learned that two of its subsidiaries were
the subject of a Federal investigation (the "Federal Investigation"). The
agencies investigating the Company were the OIG and the United States
Department of Justice. Although the government never specified the full
scope of the Federal Investigation, it focused on whether the Company's
rehabilitation therapy subsidiary properly provided and/or billed for
concurrent therapy services; whether that subsidiary provided and billed for
unnecessary
37
<PAGE>
or unordered therapy services to residents of skilled nursing facilities; and
whether the Company's long-term care subsidiary properly disclosed its
relationship with the Company's rehabilitation therapy subsidiary and
properly sought reimbursement for services provided by that subsidiary. The
Company cooperated extensively in the Federal Investigation, and met on
numerous occasions with the investigating agencies to address these issues.
During 1997 and 1998, discussions with the government focused on the issue of
unnecessary or excessive therapy services.
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. Recently the OIG informed the Company that it had no present
intention of initiating any civil or administrative actions against the
Company or any individuals or seeking monetary damages or other relief with
respect to the issues in the Federal Investigation, and the Civil Division of
the Department of Justice similarly informed the Company that it has
determined not to proceed any further at this time with the Federal
Investigation. No assurance can be given that the government will not
proceed with any investigation at a later time or initiate additional
investigations based on the same or other legal or regulatory concerns.
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. Since 1997, the investigation has also covered
information for the 1995 cost year as well as cost reporting periods prior to
1993. The information under review includes submissions and representations
by the long-term care subsidiary and the Company's chief executive officer.
The evidentiary phase of the hearing has concluded. The Company and the DSS
have had settlement discussions. However, the Company is unable to determine
at this time when the proceedings will be concluded or, if no settlement is
reached, whether the DSS will seek further administrative action or Medicaid
reimbursement sanctions. No assurance can be given that a settlement will in
fact occur or whether any such settlement or other outcome of the
investigation will not have a material adverse effect on the Company's
business, financial condition or results of operations.
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's
subsidiaries are currently the subject of several such investigations. It is
the Company's practice to cooperate fully in such matters.
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
38
<PAGE>
issued to such former stockholders of SunCare in the acquisition. On May 21,
1998, the Company and the Plaintiffs agreed to settle the action for $7.4
million. On June 9, 1998, the Court approved the settlement and entered an
order of dismissal.
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.
Between August 25, 1997 and October 24, 1997, ten putative class action
lawsuits (the "Actions") were filed in the United States District Court for
the Northern District of Georgia on behalf of persons who purchased RCA
Common Stock, naming RCA and certain of its officers and directors as
defendants. The complaints have overlapping defendants and largely
overlapping (although not identical) class periods. The complaints allege
violations of Federal securities laws by the defendants for disseminating
allegedly false and misleading financial statements for RCA's fiscal year
ended June 30, 1996 and its first three quarters of fiscal year 1997, which
the plaintiffs allege materially overstated RCA's profitability. Generally,
each of the Actions seeks unspecified compensatory damages, pre-judgment and
post-judgment interest, attorneys' fees and costs and other equitable and
injunctive relief.
On November 25, 1997, RCA, the Company and representatives of the
plaintiffs entered into a Memorandum of Understanding ("MOU"). Pursuant to
the MOU, the Company paid $9 million into an interest-bearing escrow account
maintained by the Company (the "Escrow Account") to settle the Actions (the
"Settlement"). RCA also agreed to assign coverage under its directors' and
officers' liability insurance policy for these specific claims to the
plaintiffs. The Settlement is contingent upon confirmatory discovery and is
subject to the execution of definitive documentation and court approval.
Upon satisfaction of the conditions precedent to the Settlement, all claims
by the class that were or could have been asserted by the plaintiffs against
RCA or any of the other defendants in the Actions will be settled and
released, and the Actions will be dismissed in their entirety with prejudice
in exchange for the release of all funds from the Escrow Account to the
Plaintiffs. Plaintiffs commenced their confirmatory discovery in July 1998.
No assurance can be given that the Settlement will become final. There can
be no assurance that additional actions will not be filed against RCA and its
officers and directors. However, the Actions are styled as class actions, and
should the Settlement become final, any additional class actions would be
precluded, although individual plaintiffs may opt out of the Settlement.
YEAR 2000 RISK
In common with users of computers around the world, Sun is investigating
if and to what extent the date change from 1999 to 2000 may affect its
networks and systems. Sun 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 Sun of achieving year 2000 compliant systems is not expected to
be material to Sun'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 Sun's business, financial condition and results of
operations. The ability of third parties with which Sun transacts business to
adequately address their year 2000 issues is outside Sun's control. Although
Sun 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 Sun's business, financial condition and results of operations
will not be materially adversely affected by the ability of third parties
dealing with Sun, including Medicare and Medicaid, to also manage the effect
of the year 2000 date change.
39
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information with respect to this item is found in Management's Discussion
and Analysis of Financial Condition and Results of Operations and is
incorporated herein by reference.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) Not applicable.
(b) Not applicable.
(c) 1. On May 4, 1998, Sun Financing I, a statutory business trust formed
under the laws of the State of Delaware and a wholly owned subsidiary
of the Company, completed a private placement of $13.8 million 7%
Convertible Trust Issued Preferred Securities ("Convertible Preferred
Securities") for an aggregate offering price of $345.0 million. The
initial purchasers of the Convertible Preferred Securities were Bear,
Stearns & Co., Inc., Donaldson, Lufkin & Jenrette Securities
Corporation, J.P. Morgan & Co., NationsBanc Montgomery Securities LLC
and Schroder & Co., Inc. The aggregate fees paid to the initial
purchasers were approximately $10.4 million. The Convertible
Preferred Securities were offered to qualified institutional buyers in
reliance on Rule 144A under the Securities Act of 1933, as amended
(the "Securities Act"), and to a limited number of institutional
accredited investors under Rule 501(a)(1), (2), (3) or (7) under the
Securities Act. Each Convertible Preferred Security is convertible at
the option of the holder into 1.2419 shares of the Company's common
stock (equivalent to a conversion price of $20.13 per share of Company
common stock). The proceeds from the offering of Convertible
Preferred Securities were used by the Company to repay outstanding
borrowings under the term loan portion of the Company's credit
facility and to reduce borrowings under the revolving credit portion
of the Company's credit facility.
2. On May 14, 1998, the Company issued 124,382 shares of its common stock
in the Company's acquisition of Pacific Health Care, Inc. The shares
were valued at $2.2 million. The shares were issued in reliance on
Section 4(2) of the Securities Act.
3. On May 14, 1998, the company issued approximately $2.9 million of
convertible promissory notes (the "Convertible Notes") in connection
with the Company's acquisition of certain assets of Portbridge, Inc.
The Convertible Notes are convertible into a maximum of 179,991 shares
of the Company's common stock (equivalent to a conversion price of
approximately $16.48 per share). The Convertible Notes were issued in
reliance on Section 4(2) of the Securities Act.
4. On June 12, 1998, the Company issued 212,120 shares of its common
stock in the Company's acquisition of OMC Home Healthcare, Inc. and
Advantage Health Services, Inc. The shares were valued at $3.5
million. The shares were issued in reliance on Section 4(2) of the
Securities Act.
(d) Not applicable.
40
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) A special meeting of the Company's Stockholders was held June 30, 1998.
(b) Not applicable.
(c) The matters voted at the meeting and the results were as follows:
1. The approval and adoption of the Agreement and Plan of Merger and
Reorganization, dated as of February 17, 1997, as amended by
Amendments No. 1, 2, 3 and 4 thereto, among the Company, Retirement
Care Associates, Inc. and Peach Acquisition Corporation (the "RCA
Merger Agreement") and the merger of Peach Acquisition Corporation
with and into Retirement Care Associates, Inc. (the "RCA Merger")
pursuant to the RCA Merger Agreement and the issuance of Company's
Common Stock and Series B Convertible Preferred Stock pursuant to the
RCA Merger.
<TABLE>
<CAPTION>
For Against Abstain Non-Vote
----- ------- ------- --------
<S> <C> <C> <C>
25,067,398 2,459,889 226,514 9,907,912
</TABLE>
2. The approval and adoption of the Agreement and Plan of Merger and
Reorganization, dated as of February 17, 1997, as amended by
Amendments No. 1, 2 and 3 thereto, among the Company, Contour Medical,
Inc. and Nectarine Acquisition Corporation (the "Contour Merger
Agreement") and the merger of Nectarine Acquisition Corporation with
and into Contour Medical, Inc. (the "Contour Merger") pursuant to the
Contour Merger Agreement and the issuance of Company's Common Stock
pursuant to the Contour Merger.
<TABLE>
<CAPTION>
For Against Abstain Non-Vote
----- ------- ------- --------
<S> <C> <C> <C>
25,075,338 2,467,836 210,628 9,908,912
</TABLE>
3. The approval of amendment to the Company's Certificate of
Incorporation to increase the number of authorized shares of the
Company's Common Stock from 100,000,000 to 150,000,000.
<TABLE>
<CAPTION>
For Against Abstain Non-Vote
----- ------- ------- --------
<S> <C> <C> <C>
37,052,393 473,267 137,052 0
</TABLE>
(d) Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(3.1) Certificate of Incorporation, as amended, of the Company.*
(4.1) Certificate of Designations of Series A Preferred Stock of the
Company.*
(4.2) Certificate of Designations of Series B Convertible Preferred
Stock of the Company.*
(27.1) Financial Data Schedule (included herein).
41
<PAGE>
*Previously filed
(b) Reports on Form 8-K
Report dated April 3, 1998 and filed April 10, 1998 reporting 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 May
27, 1997, by Amendment No. 2 thereto dated as of August 21, 1997 and by
Amendment No. 3 thereto dated as of November 27, 1997, by and among the
Company, Retirement Care Associates, Inc. and Peach Acquisition
Corporation.
Report dated April 14, 1998 and filed April 16, 1998 reporting that the
Company has commenced marketing two private placements of its securities.
The Company and Sun Financing I, a Delaware statutory business trust and
subsidiary of the Company, will offer $300 million ($345 million if the
initial purchasers' overallotment is exercised in full) of convertible
trust issued preferred securities and the Company will offer $125 million
of Senior Subordinated Notes due 2008.
Report dated October 8, 1997 and filed April 16,1 998 reporting the
financial statements of Regency Health Services, Inc.
Report dated April 29, 1998 and filed April 29, 1998 reporting the pricing
of two private placements of $150 million of Senior Subordinated Notes due
2008 and $345 million of convertible trust issued preferred securities.
Report dated May 5, 1995 and filed May 15, 1998 to delete and replace
exhibit 23.1, Consent of Accountant.
Report dated March 31, 1998 and filed on June 25, 1998 to include
Summarized Consolidating Information for the Company and the Company's
guarantor and non-guarantor subsidiaries with respect to the Company's
9 1/2% Senior Subordinated Notes due 2007 and 9% Senior Subordinated Notes
due 2008 as of and for the three months ended March 31, 1998.
Report dated June 30, 1998 and filed on July 21, 1998 reporting the
acquisition of Retirement Care Associates, Inc. and Contour Medical, Inc.
42
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SUN HEALTHCARE GROUP, INC.
Date: August 19, 1998 By: /s/ Robert D. Woltil *
----------------------------
Robert D. Woltil
Chief Financial Officer
*Signing on the behalf of the Registrant and as principal financial officer.
43
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE SUN HEALTHCARE GROUP, INC. JUNE 30, 1998 FORM 10-Q AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 6-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> JUN-30-1998 JUN-30-1997
<CASH> 26,194 0
<SECURITIES> 0 0
<RECEIVABLES> 715,827 0
<ALLOWANCES> 53,682 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 826,852 0
<PP&E> 835,432 0
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 3,017,750 0
<CURRENT-LIABILITIES> 481,321 0
<BONDS> 1,544,067 0
0 0
2,786 0
<COMMON> 602 0
<OTHER-SE> 574,670 0
<TOTAL-LIABILITY-AND-EQUITY> 3,017,750 0
<SALES> 0 0
<TOTAL-REVENUES> 826,294 516,648
<CGS> 0 0
<TOTAL-COSTS> 863,107 496,664
<OTHER-EXPENSES> 3,771 0
<LOSS-PROVISION> 10,074 3,798
<INTEREST-EXPENSE> 36,536 19,704
<INCOME-PRETAX> (40,584) 19,984
<INCOME-TAX> 10,272 9,090
<INCOME-CONTINUING> (50,856) 10,894
<DISCONTINUED> 0 0
<EXTRAORDINARY> 10,120 0
<CHANGES> 0 0
<NET-INCOME> (60,976) 10,894
<EPS-PRIMARY> (0.93) 0.21
<EPS-DILUTED> (0.93) 0.20
</TABLE>
