<PAGE>
-------------------
FORM 8-K/A-2
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) October 8, 1997
Sun Healthcare Group, Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in charter)
DELAWARE 001-12040 850410612
- --------------------------------------------------------------------------------
(State or other jurisdiction (Commission (IRS Employer
of incorporation) File Number) Identification No.)
101 Sun Avenue NE, Albuquerque, NM 87109
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (505) 821-3355
NONE
- --------------------------------------------------------------------------------
(Former name or former address, if changed since last report.)
<PAGE>
This report on Form 8-K/A-2 supplements the reports on Form 8-K filed
with the Securities and Exchange Commission on October 23, 1997 and December
22, 1997 by Sun Healthcare Group, Inc., a Delaware corporation (the
"Company", "Sun" or the "registrant") to report its acquisition of all of the
stock of Regency Health Services, Inc., a Delaware corporation ("Regency").
Items 7. Financial Statements, Pro Forma Financial Information and Exhibits
The following financial information is being filed in order to satisfy the
financial statement requirements for the Form 8-K filed on October 23, 1997.
(a) Financial Statements of Business Acquired
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
AS OF
----------------------------
SEPTEMBER 30, DECEMBER 31,
----------------------------
ASSETS 1997 1996
-------- -------
(In thousands, except share data)
<S> <C> <C>
Current assets:
Cash and cash equivalents $18,435 $22,875
Restricted cash 7,166 4,425
Accounts receivable, net of allowance for
doubtful accounts of $10,240 at September 30,
1997 and $4,723 at December 31, 1996 93,187 80,949
Other receivables 1,528 11,535
Prepaids and other assets 9,538 7,819
Assets held for sale 6,723 6,915
Deferred tax asset 6,897 6,898
-------- --------
Total current assets 143,474 141,416
-------- --------
Property and equipment, net 171,393 135,072
Goodwill, net 62,665 53,753
Other assets, net 26,711 23,335
-------- --------
Total assets $404,243 $353,576
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $5,389 $2,418
Accounts payable 24,777 24,958
Accrued compensation and benefits 33,294 26,253
Workers' compensation accrual 7,166 4,338
Other accrued liabilities 9,146 8,290
Deferred revenue 2,388 2,407
Accrued interest 6,596 5,578
-------- --------
Total current liabilities 88,756 74,242
-------- --------
Long-term debt, net of current portion 223,765 182,490
Other long-term liabilities 10,848 10,878
Deferred income taxes 2,439 5,018
-------- --------
Total liabilities 325,808 272,628
-------- --------
Commitments and Contingencies
Stockholders' equity:
Common stock of $.01 par value, authorized 35,000
shares, 15,887 and 15,919 shares issued and
outstanding at September 30, 1997 and December 31,
1996, respectively, net of 1,008 and 862 shares
held in treasury, respectively 169 168
Additional paid-in capital 53,471 52,031
Retained earnings 24,795 28,749
-------- --------
Total stockholders' equity 78,435 80,948
-------- --------
Total liabilities and stockholders' equity $404,243 $353,576
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these balance sheets.
2
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF EARNINGS (LOSS)
(UNAUDITED)
FOR THE
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------------
1997 1996
-------- -------
(In thousands, except per share data)
Total net revenues $483,838 $409,439
-------- --------
Costs and expenses:
Operating 420,797 348,114
Corporate general and administrative 29,574 21,618
Provision for losses on accounts receivable 6,921 1,317
Depreciation and amortization 14,588 11,197
Interest, net 15,388 11,108
-------- --------
Total costs and expenses 487,268 393,354
-------- --------
Earnings (loss) before income taxes (3,430) 16,085
Income tax provision(benefit) (918) 6,641
-------- --------
Earnings (loss) before extraordinary item (2,512) 9,444
Extraordinary item - Loss on extinguishment of
debt, net of applicable income taxes of $812 - (1,193)
-------- --------
Net earnings (loss) $(2,512) $8,251
-------- --------
-------- --------
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
1997 1996
------ ------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss) $(2,512) $8,251
Adjustments to reconcile net earnings to net cash
provided by (used for) operating activities -
Depreciation and amortization 14,588 11,197
Provision for losses on accounts receivable 6,921 1,317
Extraordinary loss on discharge of debt - 2,005
Other, net (3,353) 1,825
Changes in operating assets and liabilities:
Accounts receivable (12,238) (22,762)
Other current assets 10,784 (10,394)
Current and other liabilities 8,493 9,172
------- -------
Net cash provided by operating activities 22,683 611
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net (11,044) (10,969)
Acquisitions, net of cash acquired (48,829) (48,513)
Other assets proceeds (expenditures) 5,781 (1,658)
------- -------
Net cash used for investing activities (54,092) (61,140)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings 49,000 56,143
Long-term debt repayments (15,530) (62,650)
Net proceeds from issuance of common stock 1,441 234
Purchases of treasury stock (1,442) (5,082)
Workers' compensation trust funding (6,500) (10,637)
------- -------
Net cash provided by (used in) financing
activities 26,969 (21,992)
------- -------
Net decrease in cash and cash equivalents (4,440) (82,521)
Cash and cash equivalents at beginning of period 22,875 104,238
------- -------
Cash and cash equivalents at end of period $18,435 $21,717
------- -------
------- -------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during period for:
Interest $14,370 $8,620
------- -------
------- -------
Income taxes $4,125 $3,750
------- -------
------- -------
SUPPLEMENTARY SCHEDULE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
The Company's acquisitions during the nine months
ended September 30, 1997 and 1996, involved
the following:
Fair value of assets acquired $59,599 $54,076
Liabilities assumed (10,770) (5,563)
------- -------
Cash payments made, net of cash received from
others $48,829 $48,513
------- -------
------- -------
The accompanying notes are an intergal part of these consolidated financial
statements.
4
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1997
1. BASIS OF PRESENTATION
In the opinion of management of Regency Health Services, Inc. (the
"Company" or "Regency"), the accompanying interim consolidated financial
statements present fairly the Company's financial position at September 30,
1997 and December 31, 1996, the consolidated results of its operations for
the nine month periods ended September 30, 1997 and 1996, and the
consolidated statements of cash flows for the nine month periods ended
September 30, 1997 and 1996. All adjustments are of a normal and recurring
nature. All material intercompany balances, profits and transactions have
been eliminated. These statements are presented in accordance with the rules
and regulations of the United States Securities and Exchange Commission
("SEC"). Accordingly, they are unaudited, and certain information and
footnote disclosures normally included in the Company's annual consolidated
financial statements have been condensed or omitted, as permitted under the
applicable rules and regulations. Readers of these statements should refer
to the Company's audited consolidated financial statements and notes thereto
for the year ended December 31, 1996, which are included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1996. The results
of operations presented in the accompanying financial statements are not
necessarily representative of operations for an entire year. Certain amounts
have been reclassified in the 1996 financial statements to conform to the
1997 presentation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets or liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Sun has restated the historical Regency net revenues for the nine months
ended September 30, 1997, resulting in a reduction to net revenue totalling
$6.2 million. The restatement is a result of Sun's continuing review and
analysis of Regency's balance sheet in connection with the finalization of
the Regency purchase. Based on its review of certain Regency accounts
receivable, Sun believes that the adjustments set forth belong in Regency's
financial statements for the nine months ended September 30, 1997 as the
services were performed prior to September 30, 1997 and the related revenue
recognized during that period was overstated. The adjustments include
reductions to revenues for Medicare routinue cost limit exceptions, certain
billing related to Regency's home health agency and retro-billings to Medicare.
NEWLY ISSUED PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") has issued Statement of
Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share" which is
effective for both interim and annual reporting periods ending after December
15, 1997. This standard requires restatement of prior interim and annual
earnings per share calculations. SFAS No. 128 replaces fully diluted EPS with
diluted EPS and replaces primary EPS with basic EPS. Basic EPS is computed by
dividing reported earnings by weighted average shares outstanding. Diluted EPS
is computed the same way as fully diluted EPS, except that the calculation now
uses the average share price for the reporting period to compute dilution from
options and warrants under the treasury stock method. The Company will adopt
the new standard in its reporting for the quarter and the year ended December
31, 1997. Management does not believe that adoption of this standard will have
a significant impact on earnings per share.
5
<PAGE>
2. ACQUISITIONS
Effective January 1, 1997, the Company acquired four acute rehabilitation
hospitals, ten outpatient rehabilitation clinics and six neurological treatment
centers from Horizon/CMS Healthcare Corporation ("CMS"). The purchase price was
$43.0 million, made up of a cash payment of $36.3 million and notes payable
totaling $6.7 million. The Company funded the acquisition with borrowings
against the Amended and Restated Credit Agreement dated December 20, 1996 with
NationsBank of Texas, N.A. as agent for a group of banks (the "NationsBank
Credit Agreement"). Two of the acquired hospitals have joint venture partners
with 30% and 50% interests. Accordingly, the income statement reflects minority
interest related to the joint venture partners' share of the revenues and
expenses of the two hospitals.
On April 1, 1997, the Company acquired HHC Health Group, Inc., a home
health and infusion therapy provider with four locations in California, for $2.3
million, consisting of a cash payment of $1.7 million and a note payable of $.6
million.
On May 1, 1997, the Company acquired Asher Clinic, an outpatient clinic in
California, for $1.7 million in cash.
On May 1, 1997, the Company also acquired Advanced Physical Therapy, Inc.,
which operates three outpatient clinics in California, for $1.7 million,
consisting of a cash payment of $1.4 million and a note payable of $.3 million.
On May 16, 1997, the Company acquired Rainbow Medical LLC, a pharmacy
located in Las Vegas, Nevada for $1.9 million, consisting of $1.2 million in
cash and a note payable of $.7 million.
Effective June 1, 1997, the Company acquired Health Fitness Physical
Therapy, Inc., which operates seven outpatient clinics in California for $1.8
million, consisting of a cash payment of $1.1 million and notes payable of $.7
million.
Effective June 1, 1997, the Company acquired Peachwood Physical Therapy,
Inc., an outpatient clinic in California for $.7 million, $.5 million in cash
and a note payable for $.2 million.
Effective June 1, 1997, the Company acquired Adams & Schmidt Sports
Therapy, which operates four outpatient clinics in California for $1.2 million,
consisting of a cash payment of $.8 million and a note payable for $.4 million.
6
<PAGE>
Effective June 12, 1997, the Company acquired Hospice of the Pacific, a
hospice provider in California for $.4 million in cash.
On July 1, 1997, the Company acquired Pacific Beach Physical Therapy, Inc.,
an outpatient clinic in California, for $.6 million, $.5 million in cash and a
note payable for $.1 million.
Effective August 1, 1997, the Company acquired The Visiting Nurse
Association of Los Angeles, Inc. and The Visiting Nurse Home Services, Inc.,
providers of home health services with seven locations in the Los Angeles area,
in a single transaction. The purchase price was $4.5 million, consisting of
cash payments totaling $3.2 million and a note payable for $1.3 million.
These transactions were accounted for using the purchase method of
accounting under generally accepted accounting principles. Revenues and
expenses are included in the accompanying financial statements subsequent to the
acquisition date.
The following unaudited pro forma condensed consolidated statements of
earnings present the summarized consolidated results of operations of the
Company after giving effect to the acquisition of the four acute rehabilitation
hospitals, ten outpatient rehabilitation clinics and six neurological treatment
centers for the nine months ended September 30, 1997 and 1996, as if such
acquisition had been consummated on January 1, 1996. All other acquisitions are
considered immaterial and are not included in the pro forma condensed
consolidated statements of earnings.
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1997 1996
-------- --------
(In thousands, except
per share data)
(Unaudited)
Net operating revenue $483,838 $456,041
Total costs and expenses (including minority
interest) 487,268 439,440
-------- --------
Earnings before provision for income taxes (3,430) 16,601
Provision for income taxes (918) 6,858
-------- --------
Earnings before extraordinary item $ (2,512) $ 9,743
-------- --------
-------- --------
The pro forma results are presented for informational purposes only and are
not necessarily indicative of what results of operations actually would have
been had such acquisitions been consummated at the beginning of such period or
of future operations or results.
3. DISPOSITIONS
In connection with the 13 facilities identified for disposition by the
Company during the fourth quarter of 1995, the Company disposed of an 81-bed
facility in Pomona, California effective January 1,
7
<PAGE>
1997 for a nominal amount, resulting in a $233,000 charge against the reserve
established for such dispositions.
4. WORKERS' COMPENSATION CLAIMS TRUST
In 1995, the Company established a revocable workers' compensation claims
trust ("Trust") to pre-fund its workers' compensation obligations. The Trust
was funded for fiscal 1995 in March 1996 with approximately $10.6 million from
available cash. In March 1997, the Company pre-funded its fiscal 1996 workers'
compensation obligations with approximately $6.5 million from available cash.
Of the remaining $8.3 million in the Trust at September 30, 1997, $7.2 million
was classified as current restricted cash and $1.1 million was classified as
other long-term assets.
5. NET EARNINGS PER SHARE
Net earnings per common and common equivalent share is based upon the
weighted average number of common shares outstanding during the period plus the
effect of incremental shares of common stock contingently issuable upon exercise
of stock options.
Fully diluted net earnings for the three and nine months ended September
30, 1997 is computed as described above. Fully diluted net earnings for the
three and nine months ended September 30, 1996 is determined on the assumption
that the Convertible Subordinated Debentures were converted as of January 1,
1996. Net earnings is adjusted for the interest on the debentures and the
amortization of underwriting costs related to the debentures, net of tax.
6. SUBSEQUENT EVENTS
On October 8, 1997, the Company sold 6 neurological treatment centers to
members of senior management for $3.0 million in cash.
On October 8, 1997, a wholly-owned subsidiary of the Sun Healthcare, Inc.
("Sun"), an operator of skilled nursing facilities and a provider of related
specialty healthcare services, including rehabilitation therapy and
institutional pharmacy services in the United States, through a tender offer
acquired 98.4% of the capital stock of Regency. The remaining shares were
converted into the right to receive $22.00 in cash per share. Total
consideration for the shares acquired in the tender offer was approximately
$345,200,000.
On October 8, 1997, as part of the financing of the Sun acquisition, 30
facilities were sold in a sale leaseback transaction with proceeds of
approximately $83.6 million.
On October 9, 1997, a wholly-owned subsidiary of Sun completed a tender
offer for 100%, or $50,000,000, of Regency's 12.25% Junior Subordinated Notes
due 2003 for approximately $61,000,000, and $109,600,000 of the $110,000,000 of
Regency's 9.875% Senior Subordinated Notes due 2002 for approximately
$126,700,000. In addition, Sun repaid Regency's revolving credit facility of
approximately $39,000,000.
8
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Regency Health Services, Inc.:
We have audited the accompanying consolidated balance sheet of Regency
Health Services, Inc. (a Delaware corporation) and subsidiaries as of December
31, 1996 and the related consolidated statements of operations, stockholders'
equity and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Regency Health
Services, Inc. and subsidiaries as of December 31, 1996, and the results of
their operations and their cash flows for the year then ended, in conformity
with generally accepted accounting principles.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Orange County, California
February 14, 1997
9
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED BALANCE SHEET
As of December 31, 1996
(In thousands, except par value)
<TABLE>
<CAPTION>
<S> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . $ 22,875
Restricted cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,425
Accounts receivable, net of allowance of $4,723 at December 31, 1996 . . 80,949
Estimated third party settlements. . . . . . . . . . . . . . . . . . . . 10,180
Notes and other receivables. . . . . . . . . . . . . . . . . . . . . . . 1,355
Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . 6,898
Assets held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . 6,915
Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . 7,819
---------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . 141,416
---------
PROPERTY AND EQUIPMENT:
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,207
Buildings and improvements . . . . . . . . . . . . . . . . . . . . . . . 100,120
Leasehold interests -- other . . . . . . . . . . . . . . . . . . . . . . 17,640
Leasehold interests -- related party . . . . . . . . . . . . . . . . . . 1,989
Equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,054
---------
179,010
Less accumulated depreciation and amortization . . . . . . . . . . . . . (43,938)
---------
Total property and equipment . . . . . . . . . . . . . . . . . . . . . 135,072
---------
OTHER ASSETS:
Mortgage notes receivable, net of allowance of $1,352 at
December 31, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,014
Goodwill, net of accumulated amortization of $3,700 at December 31, 1996 . 53,753
Other assets, net of accumulated amortization of $3,736 at
December 31, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,321
---------
Total other assets . . . . . . . . . . . . . . . . . . . . . . . . . . 77,088
---------
$ 353,576
---------
---------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt. . . . . . . . . . . . . . . . . . . . $ 2,418
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,958
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,290
Accrued compensation . . . . . . . . . . . . . . . . . . . . . . . . . . 26,253
Accrued workers' compensation. . . . . . . . . . . . . . . . . . . . . . 4,338
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,407
Accrued interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,578
---------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . 74,242
LONG-TERM DEBT, NET OF CURRENT PORTION . . . . . . . . . . . . . . . . . . 182,490
OTHER LIABILITIES AND NONCURRENT RESERVES. . . . . . . . . . . . . . . . . 10,878
DEFERRED INCOME TAXES. . . . . . . . . . . . . . . . . . . . . . . . . . . 5,018
---------
Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . 272,628
---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; authorized -- 35,000 shares;
15,919 shares issued and outstanding at December 31, 1996,
net of 862 shares held in treasury . . . . . . . . . . . . . . . . . . 168
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . 52,031
Retained earnings. . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,749
---------
Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . . 80,948
---------
$ 353,576
---------
---------
</TABLE>
The accompanying notes are an integral part of this consolidated
financial statement.
11
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
For the year ended December 31, 1996
(In thousands, except per share amount)
NET OPERATING REVENUE. . . . . . . . . . . . . . . . . $558,050
--------
COSTS AND EXPENSES:
Operating expenses . . . . . . . . . . . . . . . . . 453,131
Corporate general and administrative . . . . . . . . 24,292
Rent expense . . . . . . . . . . . . . . . . . . . . 24,956
Depreciation and amortization. . . . . . . . . . . . 15,317
Interest expense . . . . . . . . . . . . . . . . . . 18,060
Restructuring and other non-recurring charges. . . . 11,283
--------
Total costs and expenses . . . . . . . . . . . . . 547,039
--------
INCOME BEFORE PROVISION FOR INCOME TAXES AND
EXTRAORDINARY ITEM . . . . . . . . . . . . . . . . . 11,011
PROVISION FOR INCOME TAXES . . . . . . . . . . . . . . 4,612
--------
INCOME BEFORE EXTRAORDINARY ITEM . . . . . . . . . . . 6,399
EXTRAORDINARY ITEM -- Loss on extinguishment of debt,
net of applicable income taxes of $812 . . . . . . . (1,193)
--------
NET INCOME . . . . . . . . . . . . . . . . . . . . . . $ 5,206
--------
--------
INCOME PER SHARE:
Income before extraordinary item . . . . . . . . . . $ .39
Extraordinary item . . . . . . . . . . . . . . . . . (.07)
--------
Net income per share . . . . . . . . . . . . . . . . $ .32
--------
--------
Weighted average shares of common stock and
equivalents . . . . . . . . . . . . . . . . . . . . 16,476
--------
--------
The accompanying notes are an integral part of this consolidated statement.
12
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the year ended December 31, 1996
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
-------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
------ ------ ---------- -------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995 . . . . . . . . . . . 16,670 $167 $56,679 $23,543 $80,389
Exercise of stock options. . . . . . . . . . 99 1 680 -- 681
Restricted Stock Distribution. . . . . . . . 12 -- 144 -- 144
Charge in lieu of income taxes . . . . . . . -- -- 2,814 -- 2,814
Repurchase of common stock . . . . . . . . . (862) -- (8,286) -- (8,286)
Net income . . . . . . . . . . . . . . . . . -- -- -- 5,206 5,206
------ ---- ------- ------- -------
BALANCE, December 31, 1996 . . . . . . . . . 15,919 $168 $52,031 $28,749 $80,948
------ ---- ------- ------- -------
------ ---- ------- ------- -------
</TABLE>
The accompanying notes are an integral part of this consolidated statement.
13
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
For the year ended December 31, 1996
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,206
--------
Adjustments to reconcile net income to net cash
provided by operating activities:
Extraordinary loss on extinguishment of debt . . . . . . . . 2,005
Depreciation and amortization. . . . . . . . . . . . . . . . 15,317
Deferred income taxes and charge in lieu of taxes. . . . . . (1,317)
Restructuring and other non-recurring charges. . . . . . . . 9,749
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . 122
Change in cash from changes in assets and liabilities,
excluding effects of acquisitions and dispositions:
Accounts receivable. . . . . . . . . . . . . . . . . . . . (28,537)
Estimated third party settlements. . . . . . . . . . . . . (9,380)
Other current assets . . . . . . . . . . . . . . . . . . . (270)
Current and other liabilities. . . . . . . . . . . . . . . 11,308
--------
Net cash provided by operating activities. . . . . . . . . 4,203
--------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . (50,800)
Proceeds from disposition of facilities. . . . . . . . . . . . 3,682
Purchases of property and equipment. . . . . . . . . . . . . . (12,575)
Collection on mortgage notes receivable. . . . . . . . . . . . 695
Changes in other assets, net . . . . . . . . . . . . . . . . . (1,623)
--------
Net cash used in investing activities. . . . . . . . . . . (60,621)
--------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term debt . . . . . . . . . . . . . . . . . . (62,598)
Proceeds from issuance of long-term debt . . . . . . . . . . . 56,143
Workers compensation trust funding . . . . . . . . . . . . . . (10,637)
Purchase of treasury stock . . . . . . . . . . . . . . . . . . (8,286)
Proceeds from exercise of options. . . . . . . . . . . . . . . 433
--------
Net cash used in financing activities. . . . . . . . . . . (24,945)
--------
NET DECREASE IN CASH AND CASH
EQUIVALENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . (81,363)
CASH AND CASH EQUIVALENTS, beginning of period . . . . . . . . . . 104,238
--------
CASH AND CASH EQUIVALENTS, end of period . . . . . . . . . . . . . $ 22,875
--------
--------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the year for interest . . . . . . . . . . . . $ 16,713
--------
--------
Cash paid during the year for income taxes . . . . . . . . . . $ 3,750
--------
--------
The accompanying notes are an integral part of this consolidated statement.
14
<PAGE>
REGENCY HEALTH SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the year ended December 31, 1996:
The Company acquired Assist-A-Care Pharmacy in San Diego, California and
issued a promissory note in the amount of $2.6 million as part of the
purchase price.
The Company issued a promissory note in the amount of $2.2 million in
connection with the acquisition of 18 healthcare facilities in Tennessee
and North Carolina.
The Company acquired Executive Pharmacy and issued a promissory note in the
amount of $763,000.
The accompanying notes are an integral part of this consolidated statement.
15
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
As of December 31, 1996, the Company operated 107 healthcare facilities
with 11,200 licensed beds that provide nursing, rehabilitative, subacute and
other specialized medical services primarily in California and in Ohio, West
Virginia, North Carolina and Tennessee. Through its wholly owned home health
subsidiaries, the Company provides patients with technical medical support at
home such as infusion therapy, ventilator care and respite services. The Company
also provides ancillary services such as rehabilitation programs and
pharmaceutical services at certain of its healthcare facilities as well as at
non-affiliated facilities.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and all of its wholly owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated.
CASH AND CASH EQUIVALENTS
For financial reporting purposes, the Company considers all highly liquid
instruments purchased with a maturity of three months or less to be cash
equivalents.
At December 31, 1996, the Company held personal funds in trust for patients
approximating $1,505,000, which are not reflected on the accompanying balance
sheet.
RESTRICTED CASH
Restricted cash of $4,425,000 at December 31, 1996 represents the portion
of the cash in the Company's pre-funded workers' compensation claims payment
trust expected to be paid during 1997.
ACCOUNTS RECEIVABLE
Accounts receivable are recorded at the net realizable value expected to be
received from federal and state assistance programs or from private sources
including managed care organizations and third party insurers. Receivables from
government agencies represent the only concentrated group of credit risk for the
Company. Management does not believe that there are any credit risks associated
16
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
with these government agencies other than possible funding delays.
Non-government agency receivables consist of receivables from various payors
that are subject to differing economic conditions and do not represent any
concentrated credit risks to the Company. Furthermore, management continually
monitors and adjusts its reserves and allowances associated with these
receivables.
PROPERTY AND EQUIPMENT
At the time of Care Enterprises, Inc.'s (Care) emergence from bankruptcy
on December 31, 1990, property and equipment owned by Care and certain
leasehold interests were adjusted to current fair market value. (Care was
merged with Regency in April, 1994 in a transaction accounted for as a
pooling of interests.) All other property and equipment is recorded at cost.
The assets are depreciated over their estimated useful lives using the
straight-line method as follows:
Buildings and improvements. . . . . . . . . . . . . . 7-40 years
Leasehold interests and improvements. . . . . . . . . Life of leases
Equipment . . . . . . . . . . . . . . . . . . . . . . 5-10 years
Betterments, renewals, and extraordinary repairs that extend the life of
the asset are capitalized; other repairs and maintenance are expensed. The cost
and accumulated depreciation applicable to assets retired are removed from the
accounts and any gain or loss on disposition is recognized in income.
ASSETS HELD FOR SALE
Assets held for sale represents the assets of 13 facilities which the
Company determined to dispose of in 1995. At December 31, 1996, it
represents the assets of the seven remaining facilities which the Company
intends to dispose of during 1997 (see Note 11). Such amounts are carried at
estimated fair value less selling costs.
GOODWILL
The excess of the purchase price over the value of the net assets of the
businesses acquired by the Company is amortized using the straight-line method
over periods ranging from 15 to 22 years. The Company periodically evaluates
the carrying value of goodwill in relation to the operating performance and
future undiscounted cash flows of the underlying business to assess
recoverability. Adjustments are made if the sum of expected future net cash
flows is less than book value of goodwill and other depreciable or amortizable
assets.
ASSET IMPAIRMENT
The carrying values of long-lived assets are reviewed if the facts and
circumstances suggest that an item may be impaired. If this review indicates
that a long-lived asset will not be recoverable, as determined based on the
future undiscounted cash flows of the asset, the Company's carrying value of the
long-lived asset is reduced to fair value.
OTHER LONG-TERM ASSETS
Costs incurred to obtain long-term financing are amortized using the
effective interest method. Costs to initiate and implement subacute specialty
units are amortized on a straight-line basis over 36 months.
DEFERRED REVENUE
Deferred revenue consists of patient billings recorded in advance of
services rendered.
17
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
WORKERS' COMPENSATION
The Company maintains self-insurance programs for workers' compensation for
its nursing facilities in California and Ohio, pharmacy operations, home health
operations and its corporate office employees. For all other operations, the
Company purchases insurance for this risk. The self-insurance liability under
these programs is based on claims filed and actuarial estimates of claims
incurred but not reported. Differences between the amounts accrued and
subsequent settlements are recorded in operations in the year of settlement.
NET OPERATING REVENUE
Revenues are derived from the operation of healthcare facilities, which are
subject to federal and state regulation. Approximately 69.9 percent of
revenues were derived from services provided under federal (Medicare) and state
(Medicaid) medical assistance programs for the year ended December 31, 1996.
Revenues from Medicaid are recorded at the prescribed contract rate. Revenues
from Medicare are recorded based on an estimate of the Company's reimbursable
cost. Limitations on Medicare and Medicaid reimbursement for healthcare
services are continually proposed. Changes in applicable laws and regulations
could have an adverse effect on the levels of reimbursement from governmental,
private, and other sources. These revenues are based, in part, on cost
reimbursement principles and are subject to audit. Provisions for estimated
third-party payor settlements are provided in the period the related services
are rendered. Differences between the amounts accrued and subsequent
settlements are recorded in operations in the year of settlement.
Additionally, the Company's cost of care for its Medicare patients
sometimes exceeds regional reimbursement limits established by Medicare. The
Company has submitted exception requests for 156 cost reports, covering all cost
report periods through December 31, 1994. To date, final action has been taken
by the Health Care Financing Administration ("HCFA") on 105 exception requests.
The Company's final rates as approved by HCFA represent approximately 84% of the
requested rates as submitted in the exception requests. During 1994, the
Company recognized 50% of the 1994 estimated exception requests anticipated to
be received, which represented revenues of approximately $1,550,000. Commencing
January 1, 1995, the Company recognized 70% of the estimated exception requests
anticipated to be received, which represents revenues of approximately
$3,001,000 and $3,563,000 in 1995 and 1996, respectively. Management believes
that the Company will be able to recover its excess costs under any pending
exception requests or under any exception requests that may be submitted in the
future, however there can be no assurance that it will be able to do so.
STOCK BASED COMPENSATION
Effective January 1, 1996, the Company adopted the disclosure provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 requires
the Company to disclose pro forma net income and earnings per share as if the
fair value based accounting method of SFAS No. 123 had been used to account for
stock based compensation. Those disclosures are included in Note 8.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
18
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. LONG-TERM DEBT
Long-term debt consists of the following as of December 31, 1996 (dollars
in thousands):
Senior Subordinated Notes, interest at 9.875 percent, due October
2002. Interest is payable semi-annually on October 15 and April 15,
commencing April 15, 1996; redeemable beginning
October 15, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . $110,000
Junior Subordinated Notes, interest at 12.25 percent, due July 2003,
interest payable semi-annually on January 15 and July 15, commencing
January 1997; redeemable beginning July 15, 2000 . . . . . . . . . . . 50,000
Industrial revenue bonds ("IRBs"), interest at rates from 4.0 to
8.25 percent, due through September 2012 in varying amounts. . . . . . 9,675
Note payable, collateralized by a deed of trust, interest at
8.75 percent; interest and principal payable monthly through
September 2033 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,697
Note payable, secured, interest at 9.0 percent, interest and principal
payable monthly, balance due November 2013 . . . . . . . . . . . . . . 4,276
Other unsecured indebtedness, interest rates up to 13.0 percent,
payable in varying installments through August 2017. . . . . . . . . . 646
Other secured long-term debt, interest rates up to 10.25 percent,
payable in varying installments through August 2014. . . . . . . . . . 5,614
--------
184,908
Less current portion. . . . . . . . . . . . . . . . . . . . . . . . . . 2,418
--------
$182,490
--------
--------
On June 28, 1996, the Company issued 12.25% Junior Subordinated Notes (the
"Junior Subordinated Notes") in an aggregate amount of $50 million. The Junior
Subordinated Notes will mature on July 15, 2003, unless previously redeemed.
Net proceeds received by the Company totaled approximately $48.4 million and
funded the redemption of the Company's outstanding 6.5% Convertible
19
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. LONG-TERM DEBT (CONTINUED)
Subordinated Debentures due 2003 (the "Convertible Subordinate Debentures") on
July 29, 1996. The Junior Subordinated Notes contain certain covenants, which
are similar to the 9.875% Senior Subordinated Notes ("Subordinated Notes"),
including limitations on the ability of the Company to, among other things, (a)
incur additional indebtedness and issue redeemable preferred stock, (b) sell
equity interests in subsidiaries, (c) make certain restricted payments (as
defined), (d) create liens, and (e) engage in mergers, consolidations or
transfers of substantially all of the assets of the Company to another party.
Effective September 30, 1996, the Company refinanced three of its
Industrial Revenue Bond Issues (IRBs) with an aggregate outstanding principal
balance of $7,560,000 with three new issues of tax exempt IRBs maturing through
September 2012. One of the new issues has a principal balance of $2,830,000 and
bears interest at rates ranging from 4.2% to 6.0% based on the maturity dates of
the individual bonds. The other two IRBs bear interest at a variable rate
initially set at 4.0% which is capped at 12.0%. The refinancing resulted in an
extraordinary loss on extinguishment of debt of $325,000, net of tax resulting
from the write-off of unamortized underwriting costs and payment of a call
premium. The IRBs are secured by irrevocable standby letters of credit issued
against the Company's Amended Credit Agreement.
On December 28, 1995 the Company entered into a revolving credit loan
agreement ("Credit Agreement") with NationsBank of Texas, N.A. as agent for a
group of banks, which provided up to $50 million in revolving line of credit
and letters of credit. No borrowings were drawn on the Credit Agreement
throughout 1996. On December 20. 1996, the Company increased the available
financing to $100 million and revised certain terms and covenants through the
Amended and Restated Credit Agreement ("Amended Credit Agreement").
Borrowings bear interest at either the Base Rate plus up to .50% or the
Adjusted Eurodollar Rate plus .75% to 2.00%, depending on the Company's
Consolidated Adjusted Leverage Ratio, all as defined in the Amended Credit
Agreement. The Amended Credit Agreement has scheduled commitment reductions
of $25 million each on January 2, 1999 and 2000 and expires on January 2,
2001. The Amended Credit Agreement is collateralized by accounts receivable,
all of the common stock of each of the Company's subsidiaries and certain
other current assets of the Company and its subsidiaries. The Amended Credit
Agreement, among other things, (a) requires the Company to maintain certain
financial ratios, and (b) restricts the Company's ability to incur debt and
liens, make investments, pay dividends, purchase treasury stock, prepay or
modify certain debt of the Company, liquidate or dispose of assets, merge
with another corporation, and create or acquire subsidiaries. As of December
31, 1996, $16.2 million of standby letters of credit were issued in
connection with the Company's self-insured workers' compensation programs and
refinanced Industrial Revenue Bonds (discussed above) out of a total
available of $35 million. On January 2, 1997 the Company borrowed $40
million under the Amended Credit Agreement.
On October 12, 1995, the Company issued Subordinated Notes in an aggregate
amount of $110 million. Net proceeds received by the Company totaled
approximately $106.7 million of which approximately $31.5 million was used to
repay the principal and a prepayment penalty on the Company's 8.10% Senior
Secured Notes (which resulted in a loss on extinguishment of debt of
approximately $1.6 million, net of tax) and $47.4 million was used for
acquisitions in 1996 (see Note 10). The Subordinated Notes contain certain
covenants, including limitations on the ability of the Company to, among other
things, (a) incur additional indebtedness and issue preferred stock, (b) sell
equity interests in subsidiaries, (c) make certain restricted payments (as
defined), (d) create liens, and (e) engage in mergers, consolidations or the
transfer of substantially all of the assets of the Company to another party.
20
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. LONG-TERM DEBT (CONTINUED)
On July 29, 1996, the Company completed the redemption of all $48.9 million
of its outstanding Convertible Subordinated Debentures for cash at such amount
from the proceeds of the Junior Subordinated Notes and available cash. The
redemption reduces fully diluted shares by 3.9 million and produces an
extraordinary loss on extinguishment of debt of $868,000, net of tax, resulting
from the write-off of unamortized underwriting costs.
Each of the mortgage notes and certain IRBs are secured by a first deed of
trust on the related facility. Certain IRBs require the maintenance of debt
service reserves funds and all of the IRBs contain affirmative and negative
covenants.
Principal maturities on long-term debt are as follows (in thousands):
YEAR ENDING DECEMBER 31.
------------------------
1997. . . . . . . . . . . . . . . . . . . . . . . $ 2,418
1998. . . . . . . . . . . . . . . . . . . . . . . 3,079
1999. . . . . . . . . . . . . . . . . . . . . . . 497
2000. . . . . . . . . . . . . . . . . . . . . . . 505
2001. . . . . . . . . . . . . . . . . . . . . . . 802
Thereafter. . . . . . . . . . . . . . . . . . . . 177,607
--------
Total . . . . . . . . . . . . . . . . . . . . $184,908
--------
--------
3. INCOME TAXES
The Company and its subsidiaries file consolidated federal and state income
tax returns and account for income taxes under the provisions of SFAS No. 109.
As a result of the Care bankruptcy proceedings, a "change in ownership"
occurred. Prior to the Merger, the Company had substantial net operating loss
carryforwards for tax purposes ("Tax NOL") and income tax credit carryforwards.
In March 1994, the Internal Revenue Service ("IRS") issued final regulations
relative to Tax NOL utilization when a "change in ownership" occurs in
bankruptcy proceedings. These regulations reduced the aggregate Tax NOL
available to the Company but did not limit its annual use.
As a result of the Merger, another "change in ownership" occurred and the
Company's Tax NOL and credit carryforward utilization became subject to a
combined annual limitation of approximately $7.9 million (on a pre-tax basis) in
periods after the Merger.
After considering the adjustments resulting from the IRS examination for
the years 1987 through 1990, the Company has a federal Tax NOL of $2,929,000
and income tax credit carryforwards of $5,503,000 available for use at
December 31, 1996. As a result of Fresh Start Reporting, the tax benefits
realized from the pre-bankruptcy Tax NOL and income tax credit carryforwards
are recorded as an increase in additional paid-in capital and are not
recorded in the statement of operations.
21
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INCOME TAXES (CONTINUED)
The provision for income taxes is as follows for the year ended December
31, 1996 (in thousands):
Current provision:
Federal. . . . . . . . . . . . . . . . . . . $4,950
State. . . . . . . . . . . . . . . . . . . . 1,315
------
6,265
Deferred provision:
Federal. . . . . . . . . . . . . . . . . . . (3,797)
State. . . . . . . . . . . . . . . . . . . . (670)
------
(4,467)
Charge in lieu of income taxes. . . . . . . . . . 2,814
------
$4,612
------
------
A reconciliation of the federal statutory income tax rate with the
Company's effective tax rate for the year ended December 31, 1996 follows:
Federal statutory rate. . . . . . . . . . . . . . 34.0%
State income taxes, net of federal benefit. . . . 6.0
Goodwill amortization . . . . . . . . . . . . . . 3.1
Other, net. . . . . . . . . . . . . . . . . . . . (1.2)
------
41.9%
------
------
22
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INCOME TAXES (CONTINUED)
Deferred income taxes arise from temporary differences in the recognition
of certain expenses for financial and tax reporting purposes. The following is a
summary of these differences and the tax effect of each as of December 31, 1996
(in thousands):
Deferred income tax assets:
Allowance for doubtful accounts................... $ 1,057
Net operating loss carryforward................... 996
Loss contingencies and legal settlements.......... 416
Workers' compensation claims...................... 5,370
Covenant not to compete........................... 901
Disposition of assets charges..................... 4,166
Other reserves.................................... 3,389
Credit carryforwards.............................. 5,519
Other............................................. 243
Valuation allowance............................... (5,207)
----------
Total deferred income tax assets....................... 16,850
----------
Deferred income tax liabilities:
Depreciation...................................... (9,417)
Other............................................. (5,553)
----------
Total deferred income tax liabilities.................. (14,970)
----------
Net deferred income tax asset.......................... $ 1,880
----------
----------
The valuation allowance primarily relates to the net operating loss and
income tax credit carryforwards of the Company for periods prior to its
emergence from bankruptcy. If and when such carryforwards are realized, the
offset will be to additional paid-in capital not to the provision for income
taxes.
4. DEFERRED RENT
Several of the Company's facilities and a home health office are leased
under long-term operating leases that specify scheduled rent increases over the
lease terms. Deferred rent of approximately $986,000, at December 31, 1996, has
been established to recognize the difference between the rent expense paid and
the straight-line recognition of minimum rental expense and is classified in
other liabilities and noncurrent reserves.
5. COMMITMENTS AND CONTINGENCIES
LETTERS OF CREDIT
The Company is contingently liable under letters of credit related to
deposit requirements on its self-insured workers' compensation plans and the
IRBs discussed in Note 2. State regulations require the maintenance of deposits
at specified percentages of estimated future workers' compensation claim
payments that can be satisfied through a combination of cash deposits, surety
bonds and letters of credit. The total amount of letters of credit outstanding
at December 31, 1996, was $16,202,000.
23
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEASES
The Company leases certain facilities and offices under cancelable and
noncancelable agreements expiring at various dates through 2047. The leases are
generally triple-net leases and provide for the Company's payment of property
taxes, insurance, and repairs. Certain leases contain renewal options and rent
escalation clauses. Rent escalation clauses require either fixed increases or
increases tied to the Consumer Price Index ("CPI"). Six leases include purchase
options at fixed or market prices at various dates.
Future minimum lease payments for operating leases at December 31, 1996 are
as follows (in thousands):
YEAR ENDING DECEMBER 31,
------------------------
1997.................................. $ 24,402
1998.................................. 23,005
1999.................................. 22,358
2000.................................. 21,460
2001.................................. 20,127
Thereafter............................ 110,805
---------
$ 222,157
---------
---------
GUARANTEE OF LEASES
The Company is contingently liable for certain operating leases assumed by
the purchasers of the Company's leasehold interests in facilities. With the
exception of a single facility re-entered on October 1, 1994, following the
filing of bankruptcy by the Company's sublessee, which has been operated by the
Company since November 1, 1994, the Company is not aware of any failure on the
part of these purchasers to meet the terms of their obligations, and does not
anticipate any expenditures to be incurred in connection with its guarantees. If
a default were to occur, the Company generally would be able to assume
operations of the facility and use the net revenues thereof to defray the
Company's expenditures on these guarantees.
The following is a schedule of future minimum lease payments at December
31, 1996 for the operating leases for which the Company is contingently liable
(in thousands):
YEAR ENDING DECEMBER 31,
-----------------------
1997.................................. $ 3,165
1998.................................. 1,125
1999.................................. 1,128
2000.................................. 1,136
2001.................................. 1,023
Thereafter............................ 4,617
--------
$ 12,194
--------
--------
LITIGATION
The Company is subject to claims and legal actions by patients and others
in the ordinary course of its business. The Company has insurance policies
related to patient care claims and legal actions. In
24
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
the event judgments were awarded for non-patient care legal actions or in
excess of the insurance coverage for patient care legal actions, the burden
would fall on the Company. The Company does not expect that the ultimate
outcome of an unfavorable judgment in any pending legal matters would result in
a material adverse effect on the Company's consolidated financial position or
results of operations.
EMPLOYMENT AGREEMENTS
At December 31, 1996, the Company had employment agreements with its
president, and certain executive and senior vice presidents, which provide for
annual base salaries in the aggregate of $1,212,000. The agreements expire at
various dates through 1999.
INSURANCE
The Company maintains general and professional liability insurance on a
claims made basis, subject to a $100,000 self-insurance retention. In addition,
all-risk property insurance, including earthquake and flood, is maintained for
all Company locations.
The Company estimates its liability under the above described programs,
including potential legal fees and settlement amounts, with respect to incurred
but not reported claims on a monthly basis, based upon its historical
experience.
6. RELATED PARTY TRANSACTIONS
In February 1988, the Company entered into a 20-year lease with three
five-year option periods for its Heritage (Torrance) facility that is owned by a
former director of the Company. The lease provides for monthly payments,
currently $35,000, which are adjusted annually based on the CPI. Lease expense
for the year ended December 31, 1996, was approximately $419,000.
In June 1990, the Company entered into a ten year lease with four five-year
option periods for its Glendora facility that is directly owned by one former
director and indirectly owned by another director. The lease provides for equal
monthly payments for three years, after which the monthly payment is adjusted
annually based on increases in the CPI. Lease expense for the year ended
December 31, 1996, was approximately $446,000.
The Company leases from Newport Harbor Investments Limited, Inc. ("Newport
Harbor"), a corporation wholly-owned by a former director of the Company, two
nursing facilities located in Beaumont and Riverside, California. The leases
provide for monthly rent payments of $7,083 and $5,142, respectively, subject to
periodic adjustments based on certain increases in the CPI or Medi-Cal
reimbursement rates. The Riverside facility lease contains an option to
purchase the facility for $675,000, subject to adjustment based on increases in
the CPI from March 1992. In 1992, the Company paid Newport Harbor $120,000 as
consideration for the extension of the purchase option on the Riverside facility
for a five-year period. During 1996 the Company exercised the option and
acquired the facility for approximately $700,000, net of the consideration
already paid. Lease expense paid by the Company for the year ended December 31,
1996, was approximately $133,000.
25
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. INCOME PER SHARE
For the year ended December 31, 1996, income per share was calculated
based on the weighted average number of common and common equivalent shares
outstanding during the period of 16,476,000. Fully diluted income per share
for the year ended December 31, 1996 is not presented because the effect of
the assumed conversion of the Convertible Subordinated Debentures was
anti-dilutive.
8. STOCK OPTIONS
Pursuant to the acquisition of Care, Care became a wholly owned subsidiary
of Regency. Stockholders of Care received 0.71 of a share of Regency common
stock for each share of Care common stock outstanding. Pursuant to the Merger,
Regency's stock option plan was amended to increase the number of shares of
Regency common stock available for grant to 1,937,991 shares. This amount does
not include the assumption of the Care stock option plan or share appreciation
rights plan.
The Company has a Director Stock Plan whereby each non-employee director of
the Company receives on July 1 of each year 2,000 restricted shares of Company
Common Stock and options to purchase an additional 6,000 shares of Company
Common Stock. The period of restriction for each award of shares of restricted
stock expires on the last to occur of: the end of the six month period
following the grant date; participant's direct or indirect pecuniary ownership
of shares not subject to restrictions for at least 12 months, provided that the
restrictions shall lapse with respect to one restricted share granted for every
two shares of unrestricted shares; and participants attendance at 75% of the
scheduled board meetings during the 12 month period immediately preceding the
grant date. Any shares which remain restricted when a director's service on the
Company's Board terminates, will be forfeited. The stock options are granted at
fair market value on the date of grant and the participants are entitled to
exercise such options beginning six months and one day after grant and ending
ten years after grant. During the year ended December 31, 1996, the Company
awarded 12,000 shares of restricted stock. At December 31, 1996 restrictions
remained on 12,000 shares of stock. In January 1997, the period of restriction
lapsed on 12,000 shares.
26
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTIONS (CONTINUED)
The following is a summary of options granted pursuant to Regency's
Employee and Director stock option plans during the year ended December 31, 1996
(such amounts do not include restricted stock awards):
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
--------- ---------
Options outstanding at the
beginning of the year . . . . . . . . 1,226,214 $11.94
Granted. . . . . . . . . . . . . . . . 911,000 10.34
Exercised. . . . . . . . . . . . . . . (99,491) 4.28
Canceled . . . . . . . . . . . . . . . (288,612) 13.28
--------- ---------
--------- ---------
Options outstanding at the end of
the year. . . . . . . . . . . . . . . 1,749,111 $11.32
--------- ---------
--------- ---------
Options Exercisable. . . . . . . . . . 493,008
---------
---------
During 1996, no compensation cost was recognized related to the above stock
options. The following outlines the significant assumptions used to calculate
the fair value information presented utilizing the Black-Scholes Single Option
approach with ratable amortization.
Risk-free interest rate. . . . . . . . . . . . . . . . . . . . . 5.90%
Expected life. . . . . . . . . . . . . . . . . . . . . . . . . . 7.65
Expected volatility. . . . . . . . . . . . . . . . . . . . . . . 41%
Expected dividends . . . . . . . . . . . . . . . . . . . . . . . --
Weighted average grant date fair value of options granted. . . . $5.61
A detail of the options outstanding and exercisable as of December 31, 1996 is
presented below:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------------------- -------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE IN YEARS PRICE EXERCISABLE PRICE
----------------- ----------- ------------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 3.17 - $ 6.98 105,561 .84 $ 3.95 100,235 $ 3.94
9.15 - 10.75 821,112 8.83 10.04 86,796 10.15
11.00 - 12.88 389,000 8.72 11.69 71,250 11.68
15.00 - 15.38 433,438 7.34 15.22 234,727 15.21
----------------- --------- ---- ------ ------- ------
$ 3.17 - $15.38 1,749,111 7.96 $11.32 493,008 $11.52
----------------- --------- ---- ------ ------- ------
----------------- --------- ---- ------ ------- ------
</TABLE>
27
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTIONS
As the Company has adopted the disclosure requirement of SFAS No. 123,
the following table shows pro forma net income and earnings per share as if
the fair value based accounting method had been used to account for
stock-based compensation cost for the year ended December 31, 1996 (In
thousands, except earnings per share).
Net income as reported................................. $5,206
Pro forma compensation expense......................... (774)
------
------
Pro forma net income................................... $4,432
------
------
Pro forma earnings per share........................... $ .27
------
------
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts. At December 31, 1996, 2,123,897 shares of common
stock have been reserved for issuance under the Company's stock option plans.
28
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. RETIREMENT SAVINGS PLAN
Regency sponsors an employee retirement savings plan under Section 401(k)
of the Internal Revenue Code. All employees who are regularly scheduled to work
20 hours or more per week, and complete 90 days of service are eligible to
participate. Participants can contribute, on a pre-tax basis, up to 15% of
their earnings to the plan (subject to certain limitations), for which the
Company matched 15% of the first 3% of contributions made for persons with less
than three years of service and 25% of the first 5% for all others. The
Company's contributions are subject to a four-year vesting period. Matching
contributions made by the Company for the year ended December 31, 1996 were
approximately $697,000.
10. ACQUISITIONS
Effective January 2, 1996, the Company completed the acquisition of the
assets of Assist-A-Care, a pharmacy located in San Diego, California. The
purchase price was $5.8 million, composed of $3.2 million cash and a $2.6
million note payable.
29
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. ACQUISITIONS (CONTINUED)
Effective February 1, 1996, the Company acquired leasehold interests in
18 health care facilities in Tennessee and North Carolina with 2,375 beds
from Liberty Healthcare Limited Partnership ("Liberty") through an asset
purchase for $39.3 million cash and a note payable for $2.2 million. The
Company also acquired Executive Pharmacy (consisting of one pharmacy in North
Carolina and one in Tennessee) with a $763,000 note payable and an enteral
feeding business for $1.5 million cash from businesses affiliated with
Liberty. In addition, the Company paid $400,000 cash for the inventory of
Liberty. A portion of the purchase was funded with notes payable, which may
be reduced as a result of certain seller liabilities and audit adjustments.
Escrow accounts established at the time of purchase were funded with $2.96
million for payment on the notes payable and are included in other assets on
the accompanying consolidated balance sheet as of December 31, 1996.
On April 1, 1996, the Company completed the acquisition of the assets of
Buena Vista Nursing Center ("Buena Vista"), a health care facility with 64
skilled nursing beds and 22 assisted living beds, located in Lexington, North
Carolina. The purchase price was $2.875 million, consisting of $2.675 million
in cash and a $200,000 note payable. Payment of the note is dependent upon
Buena Vista attaining certain financial targets.
On July 6, 1995, the Company acquired all of the stock of SCRS &
Communicology, Inc. ("SCRS") for a total purchase price of $13.5 million, of
which $3.4 million is represented by a promissory note which was paid in January
1996. SCRS provides contract rehabilitation services to Company operated and
third party healthcare facilities.
All acquisitions during 1996 were accounted for under the purchase method
of accounting.
The following unaudited pro forma condensed consolidated statement of
earnings present the summarized consolidated results of operations of the
Company after giving effect to the acquisitions of Liberty and
Liberty-affiliated businesses for the year ended December 31, 1996, as if
such acquisitions had been consummated on January 1, 1996 (in thousands,
except per share data):
(Unaudited)
Net operating revenue.................................. $564,856
Total costs and expenses............................... 553,264
---------
Income before provision for income taxes............... 11,592
Provision for income taxes............................. 4,856
---------
Net income before extraordinary item .................. $ 6,736
---------
---------
Income before extraordinary item per common share...... $ 0.41
---------
---------
The pro forma results are presented for informational purposes only and are
not necessarily indicative of what results of operations actually would have
been had such acquisitions been consummated at the beginning of such period or
of future operations or results. The effect of the other acquisitions is
immaterial.
11. RESTRUCTURING AND OTHER NON-RECURRING CHARGES
During 1996 the Company developed a comprehensive strategic plan impacting
all of its operating divisions. In connection with this strategic plan the
Company has undertaken initiatives designed to reengineer the operating model
through which it manages its business. This reengineering effort is focused on
identifying and implementing the most effective and efficient model for managing
the delivery of products and services to the Company's patients on a local
market basis. The
30
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. RESTRUCTURING AND OTHER NON-RECURRING CHARGES (CONTINUED)
plan includes consolidating and automating the Pharmacy operations,
consolidating the Home Health operations, automating and streamlining certain
functions in the nursing center operations, and streamlining the corporate
support structure. Through this process the Company identified approximately
350 non-direct patient care positions across all divisions, including the
Corporate Office, which will be eliminated. Of the positions identified,
approximately 30 were eliminated during 1996. The Company began the
implementation phase of this plan during the fourth quarter of 1996.
Additionally, the Company has identified the implementation of
significant management information system (MIS) enhancements as a critical
component of its overall strategic plan. Implementing these MIS initiatives
will be an integral part of the realization of an effective and efficient
management model, through which the Company can monitor its patients, from
both a cost and a clinical perspective, seamlessly throughout the continuum
of care and across all divisions of the Company. Furthermore, these MIS
initiatives will provide management with complete patient information within
each local market, which is vital in the managed care environment of today
and in the future. This implementation is expected to continue during 1997
and into 1998. Several of the Company's current management information
systems will be replaced in connection with the MIS initiatives. The Company
has also identified certain impaired property and equipment and intangible
assets and future contractual obligations that will have no value to the
Company under the new operating model due to obsolescence, consolidation of
locations, and streamlining of processes. Accordingly, the Company has
written off certain long-term assets and accrued certain obligations related
to leases.
The Company has evaluated the reserve established in 1995 for the
disposition of 13 facilities located in California discussed below and
allowances established for certain notes and other non-patient receivables.
Based on the actual sale of six of the 13 facilities, and the estimated sales
prices for the remaining seven facilities, the Company has reduced the
reserve for the disposition of 13 facilities of December 31, 1996. Earnings
before income taxes for the remaining seven facilities were $940,000 for the
year ended December 31, 1996. In addition, an allowance was established for
certain notes and non-patient receivables that arose in prior years, which
were not collected as anticipated by the Company and certain long-term assets
were written down to net realizable value.
The following summarizes the impact of the above items on the Company's
results of operations for 1996:
<TABLE>
<CAPTION>
RESTRUCTURING NON-RECURRING TOTAL
------------- ------------- ------------
<S> <C> <C> <C>
MIS and other property and
equipment written off................. $ 2,057,000 $ 2,320,000 $ 4,377,000
Goodwill and other assets written off... 2,300,000 1,255,000 3,555,000
Future lease and other obligations...... 325,000 1,891,000 2,216,000
Severance (including $711,000 paid
during 1996).......................... 1,377,000 -- 1,377,000
Allowance for notes and other
receivables........................... -- 1,010,000 1,010,000
Reengineering costs incurred............ 511,000 -- 511,000
Reduction of reserve for assets
held for sale......................... -- (1,763,000) (1,763,000)
------------- ------------- ------------
$ 6,570,000 $ 4,713,000 $11,283,000
------------- ------------- ------------
------------- ------------- ------------
</TABLE>
31
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. RESTRUCTURING AND OTHER NON-RECURRING CHARGES (CONTINUED)
In 1995, the Company determined to dispose of 13 facilities located in
California. In addition, during 1995 the Company completed the disposition of
duplicate facilities identified during 1994 as part of the merger and
restructuring costs, the Simi Valley healthcare facility damaged in the Southern
California (Northridge) earthquake and one other facility, and exchanged
leasehold interests in three nursing centers in New Mexico for leasehold
interest in four nursing centers in Ohio. These transactions resulted in a net
charge of $9,000,000 during 1995. This charge was based upon management's best
estimates of the amounts expected to be realized on the disposition of those
facilities with carrying amounts in excess of estimated fair value less selling
costs.
12. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments at
December 31, 1996 are as follows (in thousands):
CARRYING AMOUNT FAIR VALUE
--------------- ----------
Cash and cash equivalents.................... $ 22,875 $ 22,875
---------- ----------
---------- ----------
Mortgage notes receivable.................... $ 1,937 $ 1,937
---------- ----------
---------- ----------
Long-term debt, including current portion.... $ 184,908 $ 190,139
---------- ----------
---------- ----------
The carrying amount approximates fair value for cash and cash equivalents
because of the short maturity of these instruments. The fair value of
mortgage notes receivable was estimated based on the present value of future
cash flows using current rates the Company could obtain on notes with similar
characteristics and maturities. The fair value for the Company's long-term
debt was estimated based on the quoted market prices for the same or similar
issues or on the present value of future cash flows using current rates the
Company could obtain on debt with similar characteristics and maturities.
13. SUBSEQUENT EVENTS
Effective January 1, 1997, the Company acquired four acute rehabilitation
hospitals, eleven outpatient rehabilitation clinics and six neurological
treatment centers from Horizon/CMS Healthcare Corporation ("CMS"). The
purchase price was $43.0 million, made up of a cash payment of $36.3 million
and notes payable totaling $6.7 million.
32
<PAGE>
REGENCY HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. QUARTERLY FINANCIAL DATA (UNAUDITED):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
-------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTAL
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Net operating revenue $ 129,963 $ 137,632 $ 144,103 $ 146,352 $ 558,050
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Income (loss) before extraordinary item $ 2,737 $ 3,065 $ 3,641 $ (3.044) $ 6,399
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net income (loss) $ 2,737 $ 3,065 $ 2,448 $ (3,044) $ 5,206
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Income (loss) per share -- Primary:
Income (loss) before extraordinary
item $ .16 $ .19 $ .22 $ (.19) $ .39
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net income (loss) $ .16 $ .19 $ .15 $ (.19) $ .32
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Income (loss) per share -- Fully Diluted:
Income (loss) before extraordinary
item $ .16 $ .18 $ .22 $ (.19) $ .39
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net income (loss) $ .16 $ .18 $ .15 $ (.19) $ .32
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
Effective January 2, 1996, the Company completed the acquisition of the
assets of Assist-A-Care, a pharmacy located in San Diego, California. The
purchase price was $5.8 million, composed of $3.2 million in cash and a $2.6
million note payable.
Effective February 1, 1996, the Company acquired leasehold interests in
18 health care facilities in Tennessee and North Carolina with 2,375 beds
from Liberty Healthcare Limited Partnership ("Liberty") through an asset
purchase for $39.3 million cash and a note payable for $2.2 million. The
Company also acquired Executive Pharmacy (consisting of one pharmacy in North
Carolina and one in Tennessee) with a $763,000 note payable and an enteral
feeding business for $1.5 million cash from businesses affiliated with
Liberty. In addition, the Company paid $400,000 cash for the inventory of
Liberty.
On April 1, 1996, the Company completed the acquisition of the assets of
Buena Vista Nursing Center in Lexington, North Carolina. The purchase price
was $2.875 million, consisting of $2.675 million in cash and a note payable
for $200,000.
On July 29, 1996, the Company completed the redemption of all $48.9 million
of its outstanding Convertible Subordinated Debentures for cash at such amount.
The redemption reduces fully diluted shares by $3.9 million shares and results
in an extraordinary loss on extinguishment of debt of $868,000, net of tax,
resulting from the write-off of unamortized underwriting costs.
Effective September 30, 1996, the Company refinanced three of its IRBs with
an aggregate outstanding principal balance of $7,560,000 with three new issues
of tax exempt IRBs. The refinancing resulted in an extraordinary loss on
extinguishment of debt of $325,000, net of tax, resulting from the write-off of
unamortized underwriting costs and a call premium paid.
33
<PAGE>
(b) Pro Forma Financial Information
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
The following Unaudited Pro Forma Combined Balance Sheet as of September
30, 1997 and the Unaudited Pro Forma Combined Statements of Earnings for the
nine months ended September 30, 1997 and the year ended December 31, 1996
give effect to the acquisition of Regency by the registrant (the "Regency
Acquisition") as if the Regency Acquisition had occurred on September 30,
1997 for the Unaudited Pro Forma Combined Balance Sheet and January 1, 1996
for the Unaudited Pro Forma Combined Statements of Earnings.
The pro forma adjustments are based upon currently available information
and upon certain assumptions that Sun's management believes are reasonable.
Sun accounted for the Regency Acquisition as a purchase of Regency by Sun.
Regency's assets and liabilities were recorded at their initial estimated
fair market values as of the date of the Regency Acquisition.
The adjustments included in the Unaudited Pro Forma Combined Financial
Statements represent Sun's preliminary determination of these adjustments
based upon available information. There can be no assurance that the actual
adjustments will not differ significantly from the pro forma adjustments
reflected in the Unaudited Pro Forma Combined Financial Statements.
The Unaudited Pro Forma Combined Financial Statements are not necessarily
indicative of the financial position or either future results of operations
or results that might have been achieved if the foregoing transaction had
been consummated as of the indicated dates. The Unaudited Pro Forma Combined
Financial Statements should be read in conjunction with the historical
consolidated financial statements of Sun and Regency, together with the
related notes thereto.
The Unaudited Pro Forma Combined Statements of Earnings do not reflect
the integration costs related to the Regency Acquisition or the benefits or
cost savings anticipated to result from the Regency Acquisition.
34
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES AND
REGENCY HEALTH SERVICES, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
AS OF SEPTEMBER 30, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
REGENCY SUN &
ACQUISITION REGENCY
SUN REGENCY ADJUSTMENTS COMBINED
--------- --------- ----------- ----------
<S> <C> <C> <C> <C>
Cash and cash equivalents............................................. $ 2,418 $ 18,435 -- $ 20,853
Restricted cash....................................................... 1,666 7,166 -- 8,832
Accounts receivable, net.............................................. 379,011 93,187 -- 472,198
Other receivables..................................................... 17,844 1,528 -- 19,372
Prepaids and other assets............................................. 28,984 16,261 -- 45,245
Deferred tax asset.................................................... 331 6,897 -- 7,228
--------- --------- ----------- ---------
Total current assets.............................................. 430,254 143,474 -- 573,728
--------- --------- ----------- ---------
Property & equipment, net............................................. 546,456 171,393 (23,126)(a) 694,723
Goodwill, net......................................................... 566,367 62,665 415,752 (b) 982,119
(62,665)(b)
Other assets, net..................................................... 168,649 26,711 (19,180)(c) 195,066
27,000 (d)
(3,559)(e)
(4,555)(f)
Deferred tax asset.................................................... 702 -- 25,122 (g) 25,824
--------- --------- ----------- ---------
Total assets...................................................... $1,712,428 $ 404,243 $ 354,789 $2,471,460
--------- --------- ----------- ---------
--------- --------- ----------- ---------
Current portion of long-term debt..................................... $ 42,180 $ 5,389 -- $ 47,569
Accounts payable and
accrued expenses.................................................... 152,030 83,367 (1,388)(e) 261,511
10,532 (h)
22,129 (f)
1,471 (i)
(8,806)(f)
2,176 (i)
--------- --------- ----------- ---------
Total current liabilities......................................... 194,210 88,756 26,114 309,080
--------- --------- ----------- ---------
Long-term debt, net of current portion................................ 861,245 223,765 556,565 1,493,938
(147,637)(d)
Other long-term liabilities........................................... 12,994 10,848 12,294 (k) 36,136
Deferred income taxes................................................. 11,799 2,439 -- 14,238
--------- --------- ----------- ---------
Total liabilities................................................. 1,080,248 325,808 447,336 1,853,392
--------- --------- ----------- ---------
Minority interest................................................. 2,328 -- -- 2,328
Redeemable convertible
preferred stock..................................................... -- -- -- --
Preferred stock....................................................... -- -- -- --
Common stock.......................................................... 516 169 (169)(l) 516
Additional paid-in-capital............................................ 639,687 53,471 (53,471)(l) 639,687
Retained earnings..................................................... 75,492 24,795 (18,858)(l) 61,380
(17,878)(f)
(2,171)(e)
Cumulative translation adjustment..................................... (444) -- -- (444)
--------- --------- ----------- ---------
715,251 78,435 (92,547) 701,139
--------- --------- ----------- ---------
Less:
Unearned compensation............................................... 14,816 -- -- 14,816
Common stock held in treasury, at cost.............................. 25,574 -- -- 25,574
Employee benefit trust,
at market......................................................... 45,009 -- -- 45,009
--------- --------- ---------- ----------
Total stockholders' equity........................................ 629,852 78,435 (92,547) 615,740
--------- --------- ----------- ---------
Total liabilities and stockholders' equity........................ $1,712,428 $ 404,243 $ 354,789 $2,471,460
--------- --------- ----------- ---------
--------- --------- ----------- ---------
</TABLE>
The accompanying notes are an integral part of this unaudited pro forma
combined balance sheet
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES AND
REGENCY HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA COMBINED BALANCE SHEET
The immediately preceding unaudited pro forma combined balance sheet as of
September 30, 1997 gives effect to the Regency Acquisition as if it had
occurred on September 30, 1997. In connection with the Regency Acquisition,
Sun replaced its existing credit facility (the ""Old Credit Facility'') with
a $1.2 billion credit facility (the ""New Credit Facility'').
(a) Reflects the write-down to fair market value of certain Regency property
and equipment due to the closure of Regency's corporate office, the
closure of certain Regency pharmacy facilities and the sale of certain
former Regency facilities. The reduction to Regency's historical value
was recorded for the following asset groups: $9,607,000 to buildings;
$7,325,000 to equipment; and $6,194,000 to construction in progress.
(b) The following table details the allocation of the Regency purchase price:
<TABLE>
<S> <C>
Regency purchase price $ 367,260,000
Acquisition costs 14,668,000
--------------
Adjusted purchase price 381,928,000
Less: Regency historical net book value excluding
goodwill, net of $62,665,000 13,359,000
--------------
Excess to be allocated $ 368,569,000
--------------
--------------
Allocation of excess purchase price:
Write-off of certain Regency historical
intangible assets (see (c)) $ (19,180,000)
Involuntary employee termination
benefits (see (h)) (10,532,000)
Leasehold interest valuation (see (k)) (12,294,000)
Write down of certain Regency assets
to fair market value (see (a)) (23,126,000)
Lease termination fees and reserve for
future minimum lease payments (see (i)) (1,471,000)
Other (2,176,000)
Deferred tax assets resulting from
adjustments made above 25,122,000
Goodwill 412,226,000
--------------
Excess to be allocated $ 368,569,000
--------------
--------------
</TABLE>
The allocation of the purchase price of Regency is preliminary and will
be finalized upon completion of asset valuations. In addition, Sun is
still evaluating certain obligations of Regency prior to the acquisition
and further adjustments to the preliminary purchase price may result.
Based on analysis performed to date, Sun does not expect that the
finalization of the purchase price allocation will result in a material
adjustment to its financial position. Sun is continuing to analyze the
balance sheet of Regency as of September 30, 1997. Certain adjustments
may be recorded to properly state the net assets acquired in the Regency
Acquisition. Sun does not expect that the impact of any future
adjustments to Regency's September 30, 1997 balance sheet will be
significant to its financial position, although such adjustments may be
significant to Regency's results of operations for the nine months ended
September 30, 1997.
The goodwill will be amortized using the straight-line method over a period
of 40 years. Regency's historical goodwill at September 30, 1997 was
$71,573,000. Regency assigned useful lives ranging from 15 to 22 years to
its goodwill.
(c) Represents the write-down to fair market value of leasehold interests,
covenants-not-to-compete, deferred financing costs and other
intangible assets in connection with the Regency purchase price
allocation. Regency's historical balance sheet included these
intangible assets which were determined by Sun to provide no future
benefit and therefore were written-off in the purchase price
allocation.
(d) In connection with the Regency Acquisition, the following amounts
were paid out through borrowings under the New Credit Facility:
<TABLE>
<S> <C>
Regency purchase price $ 367,260,000
Retire Sun Old Credit Facility 108,637,000
Retire Regency revolving credit facility 39,000,000
Payment of New Credit Facility Committment fee 27,000,000
Payment of Regency acuisition costs 14,668,000
----------------
Borrowings under the New Credit Facility $ 556,565,000
----------------
----------------
</TABLE>
(e) Represents the write-off of Sun's deferred financing costs related to the
Old Credit Facility. In connection with the write-off of such debt
issuance costs, Sun expects to record an extraordinary charge in the fourth
quarter of 1997 of approximately $2,171,000, which is net of related income
tax benefits of $1,388,000.
(f) Sun retired the following indebtedness of Regency on October 9, 1997:
<TABLE>
<S> <C>
Senior Subordinated Notes, interest at 9.875%, due October 2002
("Senior Notes")................................................ $110,000,000
Junior Subordinated Notes, interest at 12.25%, due July 2003
("Junior Notes")................................................ 50,000,000
------------
Subtotal....................................................... $160,000,000
------------
------------
</TABLE>
The transaction resulted in an extraordinary loss, net of income tax
benefit, of $17,878,000. This extraordinary loss was calculated as follows:
<TABLE>
<S> <C>
Prepayment premiums................................................ $21,122,000
Unamortized deferred financing costs............................... 4,555,000
Transaction costs.................................................. 1,007,000
------------
26,684,000
Income tax benefit............................................... 8,806,000
------------
$17,878,000
------------
------------
</TABLE>
(g) Represents the deferred tax asset generated by the write-off of certain of
Regency's fixed and intangible assets. Sun believes that this deferred tax
asset is fully realizable.
(h) Represents the involuntary employee termination benefits to be paid
to certain former Regency employees and payments made to certain
former executives of Regency under pre-existing change of control
agreements. Regency's corporate office and it's long-term care and
pharmacy division management functions were eliminated in connection
with the Regency Acquisition. The termination of former Regency
employees is expected to be completed no later than the second
quarter of 1998.
(i) Represents lease termination fees and reserves for future minimum
lease payments. The lease termination fees relate to Regency's
corporate headquarters and certain Regency facilities that are
expected to be shut-down in March 1998 and June 1998, respectively.
The reserve for future minimum lease payments relate to Regency
leased pharmacy facilities and related properties whereby a
significant portion of the buildings are not needed for future
operations.
(j) Represents deposits and other assets of Regency which have been
determined by Sun to provide no future benefit.
(k) Represents the amount recognized for unfavorable Regency leases
assumed by Sun in the Regency Acquisition.
(l) Reflects the elimination of Regency's historical stockholders' equity
balance in connection with the purchase price allocation.
35
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES AND
REGENCY HEALTH SERVICES, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF EARNINGS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SUN REGENCY SUN &
FINANCE SUN ACQUISITION REGENCY
SUN TRANSACTION ADJUSTED REGENCY ADJUSTMENTS COMBINED
--------- ----------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Total net revenues............................ $1,332,354 $ -- $1,332,354 $ 483,838 $ -- $1,816,192
---------- ---------- ---------- --------- ----------- ----------
Costs and expenses:
Operating................................... 1,091,249 -- 1,091,249 421,043 (1,537)(bb) 1,510,755
Corporate general and administrative........ 63,189 -- 63,189 29,574 -- 92,763
Provision for losses on receivables......... 10,736 -- 10,736 6,921 -- 17,657
Depreciation and amortization............... 37,332 -- 37,332 14,588 7,729 (cc) 54,206
(2,581)(dd)
(1,935)(ee)
(927)(ff)
Interest, net............................... 42,670 (9,141)(aa) 46,250 15,388 39,502 (gg) 89,241
12,721 (aa) (11,899)(hh)
Minority interest........................... -- -- -- (246) -- (246)
--------- ----------- --------- --------- ----------- ----------
Total costs and expenses.................. 1,245,176 3,580 1,248,756 487,268 28,352 1,764,376
--------- ----------- --------- --------- ----------- ----------
Earnings (loss) before income taxes........... 87,178 (3,580) 83,598 (3,430) (28,352) 51,816
Income taxes.................................. 33,999 (1,396)(ii) 32,603 (918) (8,043)(ii) 23,642
--------- ----------- --------- --------- ----------- ----------
Net earnings (loss)......................... $ 53,179 $ (2,184) $ 50,995 $ (2,512) $ (20,309) $ 28,174
--------- ----------- --------- --------- ----------- ----------
--------- ----------- --------- --------- ----------- ----------
Net Earnings per common and common equivalent
share:
Primary................................... $ 1.13 $ .60
--------- ---------
--------- ---------
Fully diluted............................. $ 1.07 $ .59
--------- ---------
--------- ---------
Weighted average number of common and common
equivalent shares outstanding:
Primary................................... 46,973 46,973
--------- ---------
--------- ---------
Fully diluted............................. 52,053 52,053
--------- ---------
--------- ---------
</TABLE>
The accompanying notes are an integral part of this unaudited pro forma
combined financial statement.
36
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES AND
REGENCY HEALTH SERVICES, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SUN REGENCY SUN &
FINANCE SUN ACQUISITION REGENCY
SUN(jj) TRANSACTION ADJUSTED REGENCY ADJUSTMENTS COMBINED
--------- ----------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Total net revenues............................ $1,316,308 $ -- $1,316,308 $ 558,050 $ -- $1,874,358
--------- ---------- ---------- --------- ---------- ----------
Costs and expenses:
Operating................................... 1,107,821 -- 1,107,821 438,958 (2,049)(bb) 1,544,730
Corporate general and administrative........ 62,085 -- 62,085 60,531 -- 122,616
Provision for losses on receivables......... 14,970 -- 14,970 2,890 -- 17,860
Depreciation and amortization............... 33,817 -- 33,817 15,317 10,306 (cc) 52,480
(3,099)(dd)
(2,625)(ee)
(1,236)(ff)
Interest, net............................... 25,899 (13,955)(aa) 36,434 18,060 46,623 (gg) 100,555
24,490(aa) (562)(hh)
Restructuring charge........................ -- -- -- 11,283 -- 11,283
Investigation and litigation costs.......... 19,250 -- 19,250 -- -- 19,250
--------- ---------- --------- --------- ---------- ---------
Total costs and expenses.................. 1,263,842 10,535 1,274,377 547,039 47,358 1,868,774
--------- ---------- --------- --------- ---------- ---------
Earnings before income taxes.................. 52,466 (10,535) 41,931 11,011 (47,358) 5,584
Income taxes.................................. 30,930 (4,109)(ii) 26,821 4,612 (14,450)(ii) 16,983
--------- ---------- --------- --------- ---------- ---------
Net earnings (loss)......................... $ 21,536 $ (6,426) $ 15,110 $ 6,399 $ (32,908) $ (11,399)
--------- ---------- --------- --------- ---------- ---------
--------- ---------- --------- --------- ---------- ---------
Net earnings (loss) per common and common
equivalent shares:.......................... $ 0.46 $ (.24)
--------- ---------
--------- ---------
Weighted average number of common and common
equivalent shares outstanding:.............. 46,840 46,840
--------- ---------
--------- ---------
</TABLE>
The accompanying notes are an integral part of this unaudited pro forma
combined financial statement.
37
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES AND
REGENCY HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA COMBINED STATEMENTS OF EARNINGS
The immediately preceding unaudited pro forma combined statements of earnings
for the nine months ended September 30, 1997 and for the year ended December
31, 1996 give effect to the issuance by Sun of $250 million of its 9 1/2%
Senior Notes due 2007 (the "Notes") and the Regency Acquisition as if these
transactions occurred on January 1, 1996.
(aa) In connection with the issuance of the Notes in July 1997, Sun
capitalized related debt issuance costs and used the net proceeds of
$242.6 million to repay borrowings under its Old Credit Facility.
Interest expense up to July 1997, associated with $242.6 million of
borrowings under the Old Credit Facility, is eliminated in the
accompanying unaudited pro forma combined statements of earnings. The
average variable interest rate for Old Credit Facility borrowings was
7.1%. The Notes interest expense of $12,721,000 and $24,490,000 for the
nine months ended September 30, 1997 and the year ended December 31,
1996, respectively, includes amortization of debt issuance costs using
the effective interest method over the ten-year term of the Notes of
$384,000 and $740,000, respectively.
(bb) Represents the amortization of the unfavorable lease reserve
established in connection with the Regency purchase price allocation.
See footnote (k) to the Unaudited Pro Forma Combined Balance Sheet as
of September 30, 1997.
(cc) As presented in footnote (b) to the Unaudited Pro Forma Combined
Balance Sheet as of September 30, 1997, the Regency acquisition
goodwill is $415,752,000 and has an estimated useful life of 40 years.
The amortization charge is calculated using the straight-line method.
(dd) Represents the elimination of Regency's historical goodwill
amortization expense.
(ee) Represents the elimination of Regency's historical intangible asset
amortization for the intangible assets written down in connection
with the Regency purchase price allocation. The intangible asset
write-down is presented in footnote (c) to he Unaudited Pro Forma
Combined Balance Sheet as of September 30, 1997.
(ff) Represents the elimination of the depreciation expense resulting from
the write-down of certain Regency assets to fair market value (see (a)
in the Unaudited Pro Forma Combined Balance Sheet as of September 30,
1997).
(gg) Represents interest expense recognized on borrowings under the New
Credit Facility for the following purposes:
<TABLE>
<CAPTION>
<S> <C>
Regency purchase price $ 367,260,000
Retire Sun Old Credit Facility 108,637,000
Retire Regency revolving credit facility 39,000,000
Payment of New Credit Facility Commitment fee 27,000,000
Payment of Regency acquisition costs 14,668,000
Payment of involuntary termination benefits 10,532,000
-------------
Borrowings under the New Credit Facility $ 567,097,000
-------------
-------------
</TABLE>
Pro forma interest expense on borrowings under the New Credit Facility
is computed using a weighted average interest rate of 8.6%, which is
based on the LIBOR at March 31, 1998 of 5.7% plus applicable margins as
stated in the New Credit Facility and includes deferred financing cost
amortization of $3,116,000 and $4,154,000 for the nine months ended
September 30, 1997 and the year ended December 31, 1996, respectively.
(hh) Represents the elimination of historical interest expense related to (i)
Sun's Old Credit Facility and (ii) Regency's line of credit. A portion of
Sun's Old Credit Facility interest expense has been eliminated in
connection with the pro forma adjustment for the Notes above. In the nine
months ended September 30, 1997 and the year ended December 31, 1996,
Sun's average outstanding balance under the Old Credit Facility after
giving effect to the pro forma repayment attributable to the proceeds of
the Notes was $108.6 million and zero, respectfully. The average balance
outstanding on Regency's line of credit was $39.0 million and zero for
the nine months ended September 30, 1997 and the year ended December 31,
1996, respectively. The weighted average interest rate for the nine
months ended September 30, 1997 for the Sun and Regency credit facilities
was 7.1% and 7.5%, respectively.
(ii) Represents the income tax benefit associated with the additional expenses
presented using an assumed 39% blended statutory tax rate in effect during
the periods and calculated as follows (dollar amounts in thousands):
<TABLE>
<CAPTION>
REGENCY
SUN FINANCE ACQUISITION
TRANSACTION ADJUSTMENTS
----------- -----------
<S> <C> <C>
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997:
Earnings (loss) before income taxes................................ $ (3,580) $ (28,352)
Add back non-deductible goodwill amortization...................... n/a 7,729
----------- -----------
(3,580) (20,623)
Blended statutory income tax rate.................................. x 39% x 39%
----------- -----------
Income tax benefit................................................. $ (1,396) $ (8,043)
----------- -----------
----------- -----------
FOR THE YEAR ENDED DECEMBER 31, 1996:
Earnings (loss) before income taxes................................ $ (10,535) $ (47,358)
Add back non-deductible goodwill amortization...................... n/a 10,306
----------- -----------
(10,535) (37,052)
Blended statutory income tax rate.................................. x 39% x 39%
----------- -----------
Income tax benefit................................................. $ (4,109) $ (14,450)
----------- -----------
----------- -----------
</TABLE>
(jj) Results for the year ended December 31, 1996 include a $24,000,000 charge
recognized by Sun to settle certain of the lawsuits brought by shareholders
and, as a reduction of this settlement charge, $9,000,000 which was received
from Sun's director and officer liability insurance carrier in connection
with the settlement (see Note (14) to Sun's Consolidated Financial
Statements for the year ended December 31, 1996). In addition, in 1996 Sun
recorded additional expenses of $4,250,000 related to monitoring and
responding to the continuing investigation by the United States Department
of Health and Human Services' Office of Inspector General ("OIG") and to
responding to the remaining shareholder litigation related to the
announcement of the OIG investigation. The charge does not contain any
estimated amounts for settlement of the OIG investigation or remaining
shareholder litigation matters. Also in 1996, Sun recorded an additional
provision for losses on accounts receivable of $6,550,000, related primarily
to its Mediplex facilities (see "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included in Sun's Annual
Report on Form 10-K for the year ended December 31, 1996).
38
<PAGE>
(c) Exhibit No. Description
2.1 Agreement and Plan of Merger, dated as of July 26,
1997, among Sun Healthcare Group, Inc., Sunreg
Acquisition Corp. and Regency Health Services, Inc.
(the "Agreement and Plan of Merger"). (included in the
registrant's Current Report on Form 8-K as filed by the
registrant on October 23, 1997)
23.01 Consent of Arthur Andersen LLP, Independent Public
Accountants
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Dated: April 15, 1998 By: /s/ William C. Warrick
-------------------------
Name: William C. Warrick
Title: Vice President,
Corporate Controller
<PAGE>
INDEX OF EXHIBITS
2.1 Agreement and Plan of Merger dated July 26, 1997, among Sun Healthcare
Group, Inc., Sunreg Acquisition Corp. and Regency Health Services Inc.
(the "Agreement and Plan of Merger") (included in the registrant's
Current Report on Form 8-K as filed by the registrant on October 23,
1997).
23.01 Consent of Arthur Andersen LLP, Independent Public Accountants
<PAGE>
Exhibit 23.01
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the inclusion of
our report on the Regency Health Services, Inc. December 31, 1996 financial
statements included in this Form 8-K, into Sun Healthcare Group, Inc.'s
previously filed Registration Statement File Nos. 33-80540, 33-93692,
333-3058 and 333-38583.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Orange County, California
April 14, 1998
