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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A-2
(Mark One)
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/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
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COMMISSION FILE NUMBER 1-12040
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SUN HEALTHCARE GROUP, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 85-0410612
(State of Incorporation) (I.R.S. Employer Identification No.)
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101 SUN AVENUE, NE
ALBUQUERQUE, NEW MEXICO 87109
(505) 821-3355
(Address and telephone number of Registrant)
101 SUN LANE, NE
ALBUQUERQUE, NEW MEXICO 87109
(former address if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
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NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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Common Stock, par value $.01 per New York Stock Exchange
share, and Preferred Stock Purchase
Rights
</TABLE>
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the registrant (1) has filed all reports
required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the registrant's knowledge, in the definitive proxy
statement incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. /X/
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On February 2, 1998, Sun Healthcare Group, Inc. had 49,493,507
outstanding shares of Common Stock, net of treasury shares. Of those,
42,153,925 shares of Common Stock were held by nonaffiliates. The
aggregate market value of such Common Stock held by nonaffiliates,
based on the average of the high and low sales prices of such shares
on the New York Stock Exchange on February 2, 1998, was approximately
$793,000,000.
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GENERAL
Sun Healthcare Group, Inc. ("Sun", the "Company" or the "Registrant") hereby
amends its Annual report on Form 10-K for the fiscal year ended December 31,
1996 by deleting its response to Items 1, 2 and 3 contained in its original
filing and replacing such section with the following sections 1, 2 and 3.
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PART I
ITEM 1. BUSINESS
GENERAL
Sun Healthcare Group, Inc., through its direct and indirect subsidiaries
(collectively referred to herein as "Sun" or the "Company"), is a leading
provider of long-term, subacute and related specialty healthcare services. At
December 31, 1996, the Company operated 160 long-term and subacute care
facilities with 19,321 licensed beds in 19 states in the United States and 75
long-term care facilities with 3,420 registered beds in the United Kingdom. In
addition, the Company provides rehabilitation therapy, respiratory therapy,
temporary therapy staffing services, and pharmaceutical products and services,
to both affiliated and nonaffiliated facilities in the United States, and
outpatient therapy in Canada.
The Company's long-term and subacute care facilities provide a broad range
of healthcare services, including nursing care, subacute care, therapy and other
specialized services such as care to patients with Alzheimer's disease. The
Company's long-term and subacute care facility operations have experienced
significant growth since the Company's inception in 1989. This growth has been
primarily from acquisitions of long-term and subacute care facilities. The
Company believes its long-term and subacute care operations provide it with a
platform for expanding its therapy and pharmaceutical businesses to affiliated
and nonaffiliated long-term and subacute care facilities. In addition, the
Company believes that its expertise in operating long-term and subacute care
facilities enables it to provide its therapy and pharmaceutical services more
effectively and efficiently than providers without such operating expertise.
The Company currently offers physical, occupational and speech therapy
("rehabilitation therapy"), through Sundance Rehabilitation Corporation
("Sundance") and respiratory therapy through Golden Care, Inc. ("Golden Care"),
to patients in affiliated and nonaffiliated long-term and subacute care
facilities. At December 31, 1996, the Company provided therapy services to 911
facilities in 42 states, 759 of which were operated by nonaffiliated parties and
152 of which were affiliated facilities.
Through CareerStaff Unlimited, Inc. ("CareerStaff"), the Company is a
nationwide provider of temporary therapy staffing. CareerStaff provides
therapists skilled in the areas of physical, occupational and speech therapy
primarily to hospitals and nursing home contract service providers. At December
31, 1996, CareerStaff provided temporary therapy staffing services in 36 states.
At December 31, 1996, the Company, through Sunscript Pharmacy Corporation
("Sunscript"), operated 18 pharmacies that provided pharmaceutical products and
services to a total of 437 long-term and subacute care facilities in 21 states,
325 of which were operated by nonaffiliated parties and 112 of which were
affiliated facilities. In addition, the Company operated six pharmacies in the
United Kingdom at December 31, 1996.
INDUSTRY OVERVIEW
The long-term care industry encompasses a broad range of related specialty
healthcare services provided to the elderly and to other patients with medically
complex needs who can be cared for outside of the acute care hospital
environment and generally cannot be efficiently and effectively cared for at
home. Long-term and subacute care facilities offer skilled nursing care, routine
rehabilitation therapy and other support services, primarily to elderly
patients. Long-term and subacute care facilities may also provide a broad range
of specialized healthcare services such as care for patients with Alzheimer's
disease and subacute care. Subacute care includes those services provided to
patients with medically complex conditions who require ongoing medical and
nursing supervision and access to specialized equipment and services, but do not
require many of the other services provided by an acute care hospital. The
Company believes that the demand for the services provided by long-term and
subacute care facilities will increase substantially during the next decade due
primarily to demographic trends, advances in medical technology
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and the impact of cost containment measures by government and private pay
sources. At the same time, government restrictions and high construction and
start-up costs are expected to limit the supply of long-term and subacute care
facilities.
Ancillary services such as therapy and pharmaceutical services increase
long-term and subacute care facility profitability by expanding the range of
services provided at such facilities. Therapy services provided by the Company
primarily consist of rehabilitation and respiratory therapy services.
Pharmaceutical services include dispensing pharmaceuticals for such purposes as
infusion therapy, pain management, antibiotic therapy and parenteral nutrition.
Additional services include providing consultant pharmacists and assistance in
preparation of billing documentation. These ancillary services have
significantly greater operating margins than the margins associated with the
provision of routine services to patients at long-term and subacute care
facilities. Also, the increased use of long-term and subacute care facilities as
alternatives to acute care facilities has greatly increased the demand for such
ancillary services. This trend has created greater markets for the Company's
therapy and pharmacy services to nonaffiliated long-term and subacute care
facilities.
The temporary staffing industry has grown rapidly over the last several
years. Temporary rehabilitation therapy staffing is increasingly becoming a
valuable tool for managing personnel costs and for meeting specialized or
fluctuating employment requirements, particularly as healthcare providers engage
in corporate downsizing. Effective use of temporary personnel enables businesses
to reduce fixed overhead and addresses the growing costs and difficulty of
hiring, training, laying off and redeploying permanent full-time workers.
The long-term care industry in the United Kingdom is currently undergoing
significant change. As a result of demographic trends and recent United Kingdom
legislation and policy, the Company believes there is a growing demand for
long-term care, including more highly specialized and higher quality care. The
Company believes that supply is not keeping pace with demand and that such
demand, along with limited access to capital, is promoting industry
consolidation. These factors are placing significant burdens on small, local
operators, thereby providing, in the Company's view, opportunities for larger,
better-financed long-term care providers such as the Company.
DEMOGRAPHIC TRENDS. The primary consumers of long-term and subacute care
services in the United States and the United Kingdom are persons over 65 years
of age. The Company believes that increases in the number of people in such age
group will continue to result in increased demand for long-term and subacute
care services.
IMPACT OF COST CONTAINMENT MEASURES. In response to rapidly rising
healthcare costs, governmental and private pay sources in the United States have
adopted cost containment measures that have reduced average lengths of hospital
stays. The federal government has acted to curtail increases in healthcare costs
under Medicare by limiting acute care hospital reimbursement for specific
services to predetermined fixed amounts. Under this payment system,
reimbursement for acute care hospital services is based on regional and national
rates established for diagnosis-related groups regardless of length of stay. In
addition, private insurers have begun to limit reimbursement to predetermined
"reasonable charges," while managed care organizations such as health
maintenance organizations ("HMOs") and preferred provider organizations are
attempting to limit hospitalization costs by negotiating discounted rates for
hospital services and by monitoring and reducing hospital utilization. As a
result, average hospital stays have been shortened, with many patients being
discharged despite a continuing need for nursing care. For many of these
patients, home healthcare is not a viable alternative because of the complexity
of medical services and equipment required. Many of the long-term and subacute
care facilities operated by the Company are able to provide these services,
especially rehabilitation and respiratory therapy and pharmaceutical services.
In addition, the facilities that provide these services are able to do so at a
significantly lower cost than acute care hospitals, due to their lower capital
costs, overhead and salary levels.
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LIMITS ON SUPPLY OF LONG-TERM AND SUBACUTE CARE FACILITIES. The
construction of long-term and subacute care facilities and the addition of beds
or services in existing facilities is regulated in most states in which the
Company operates. Many states have implemented health plans that either limit
construction of new long-term and subacute care facilities or limit the number
of long-term beds and thus effectively limit the number of new facilities that
can be constructed. High construction costs and start-up expenses also act to
constrain growth in the number of facilities. See "--Government Regulation" and
"--Competition."
INDUSTRY CONSOLIDATION. Recently, the long-term and subacute care industry
in the United States has been subject to competitive pressures that have
resulted in a trend towards consolidation of smaller, local operators into
larger, more established regional or national operators. Increasing complexity
of medical services provided, growing regulatory and compliance requirements and
increasingly complicated reimbursement systems have resulted in consolidation of
operators who lack the sophisticated management information systems, operating
efficiencies and financial resources to compete efficiently and effectively.
LONG-TERM AND SUBACUTE CARE SERVICES--UNITED STATES
As of December 31, 1996, the Company owned, leased or managed, through its
subsidiaries in the United States, 160 licensed long-term and subacute care
facilities with 19,321 licensed beds located in 19 states. Each long-term and
subacute care facility is located near at least one general acute care hospital,
and the Company has entered into transfer agreements with local hospitals to
accept patients discharged from such hospitals.
BASIC PATIENT AND ANCILLARY SERVICES. The Company's long-term and subacute
care facilities provide inpatient skilled nursing and custodial services as well
as rehabilitative, restorative and transitional medical services. The Company
provides 24-hour nursing care in these facilities by registered nurses, licensed
practical nurses and certified nursing aides. The Company also provides a broad
range of support services including rehabilitation therapy, dietary services,
therapeutic recreational activities, social services, housekeeping and laundry
services and pharmaceutical and medical supplies.
SPECIALIZED SERVICES. Specialized healthcare services are those provided to
patients with medically complex needs. These services typically generate higher
profit margins than those associated with the provision of routine patient
services because of the higher reimbursement rates associated with caring for
patients with complex medical conditions. At December 31, 1996, the Company
provided therapy services for Medicare patients at 155 of its 160 long-term and
subacute care facilities. Such services are provided to Medicare patients within
distinct units at these facilities. At December 31, 1996, the Company provided
specialized care for patients with Alzheimer's disease at 43 of its 160
long-term and subacute care facilities under the supervision of specially
trained skilled nursing staff. These facilities also provide therapeutic
recreation and social services personnel. The Company's Alzheimer's program
includes an individually planned activities program, counseling, sensory
stimulation and a family support group.
SUBACUTE CARE. The Company defines subacute care as a minimum of four and
one-half nursing hours and one hour of therapy per patient day. Subacute care
includes those services provided to patients with medically complex conditions
who require ongoing medical and nursing supervision and access to specialized
equipment and services, but do not require many of the other services provided
by an acute care hospital. Services in this category include ventilator and
oxygen care, HIV care, intravenous therapy, complex wound care, traumatic brain
injury care, post-stroke care and hospice care. The Company has the ability to
provide subacute services at most of its long-term care facilities. In addition,
the Company operates 45 Phoenix Units, which are free-standing dedicated
subacute care units within long-term care facilities. The subacute care units
represent, in some cases, a substantial portion of the total beds in the
facility; in other cases, these units represent a smaller portion of overall
facility capacity. The Company plans to expand its provision of subacute care to
other long-term care facilities. The Company believes that there is significant
demand for subacute care and that this sector of the healthcare market offers
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opportunities for growth. By offering a continuum of subacute healthcare
services, the Company is able to respond to a broad spectrum of patient clinical
needs and payor cost containment objectives.
LONG-TERM CARE SERVICES--UNITED KINGDOM
As of December 31, 1996, the Company, through its wholly owned subsidiary,
Exceler Healthcare Group PLC ("Exceler"), operated 75 long-term care facilities
with 3,420 registered beds in the United Kingdom. During 1995 and 1996, the
Company acquired a 29% ownership interest in Ashbourne PLC ("Ashbourne"), a
long-term care provider in the United Kingdom. The Company acquired the
remaining 71% of Ashbourne in January 1997. At December 31, 1996, Ashbourne
operated 49 long-term care facilities with 3,583 registered beds in the United
Kingdom.
BASIC RESIDENT AND ANCILLARY SERVICES. Basic resident services include
those typically provided to residents in nursing homes with respect to
activities of daily living and general medical needs. The Company provides
24-hour nursing and personal care by registered nurses and care assistants in
all of its facilities. The Company also provides a broad range of support
services, including dietary services, therapeutic recreational activities,
social services, housekeeping and laundry services, pharmaceutical and medical
supplies and routine therapy.
SPECIALIZED SERVICES. The Company currently offers various specialized
services at certain of its nursing homes, including day care, care for the young
physically disabled, care for elderly mentally infirm residents and
post-operative care. These services typically generate higher profit margins
than those associated with the provision of routine patient services. Day care
services provide elderly members of the community with facilities focused on
their personal care, recreation and stimulation. The care of the young
physically disabled involves occupational therapy in addition to basic services.
Certain of the Company's homes provide care for elderly mentally infirm
residents, including those with Alzheimer's disease.
Additional financial information regarding the Company's operations in the
United Kingdom is included in Note 17 to the Company's Consolidated Financial
Statements.
THERAPY SERVICES
The Company provided therapy services in 42 states as of December 31, 1996.
These services primarily consist of rehabilitation and respiratory therapy
services. These services were provided by approximately 6,700 therapists to 152
affiliated and 759 nonaffiliated long-term and subacute care facilities as of
December 31, 1996.
TEMPORARY THERAPY STAFFING
In June 1995, the Company acquired CareerStaff, which is the one of the
largest provider of temporary therapy staffing with a nationwide network of
offices. CareerStaff provides licensed therapists skilled in the areas of
physical, occupational and speech therapy primarily to hospitals and nursing
home contract service providers, with a growing emphasis towards home healthcare
providers. As of December 31, 1996, CareerStaff had on assignment approximately
1,900 therapists working out of 20 offices providing temporary rehabilitation
therapist staffing in major metropolitan areas and 10 offices specializing in
placements of temporary travelling therapists in smaller cities and rural areas.
The Company believes that CareerStaff complements the Company's rehabilitation
therapy services operations by enabling the Company to provide temporary therapy
staffing services for Sun's rehabilitation contracts with both affiliated and
nonaffiliated facilities.
For the years ended December 31, 1996, 1995 and 1994, hospitals represented
approximately 47%, 49% and 49%, respectively, of CareerStaff's revenues, and
nursing home contract service providers represented approximately 22%, 23% and
31%, respectively, of CareerStaff's revenues. Although CareerStaff continues to
derive the majority of its revenues from hospitals and nursing home contract
service providers, an increasing percentage of CareerStaff's revenues has been
derived from home healthcare agencies.
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PHARMACEUTICAL SERVICES
The Company commenced its pharmaceutical business in 1993. At December 31,
1996, the Company operated fifteen pharmacies, three in-house long-term care
pharmacies, one supply distribution center and one pharmaceutical billing and
consulting center which together provided pharmaceutical products and services
to 437 long-term and subacute care facilities in 21 states, 325 of which were
operated by nonaffiliated parties. The Company acquired its first regional
pharmacy in the United Kingdom in the fourth quarter of 1995 and acquired five
additional pharmacies in the United Kingdom during 1996.
Pharmaceutical services include dispensing pharmaceuticals for such purposes
as infusion therapy, pain management, antibiotic therapy and parenteral
nutrition. Additional services include providing consultant pharmacists and
assistance in preparation of billing documentation. These services are typically
provided to nonaffiliated and affiliated facilities, including subacute and
skilled nursing care facilities, assisted living facilities, group houses,
correctional facilities, mental health facilities and home healthcare companies.
The Company intends to pursue opportunities to expand its pharmaceutical
business through acquisitions and internal growth both in the United States and
in the United Kingdom.
ASSISTED LIVING
The Company has committed $47,000,000 to the development of a number of
assisted living facilities which are intended to serve the elderly who do not
need the full-time nursing care provided by long-term and subacute care
facilities but who do need some assistance with the activities of daily living.
See "Item 7--Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
ACQUISITIONS
In February 1997, the Company agreed to acquire Retirement Care Associates,
Inc. ("Retirement Care"), an operator of 107 skilled nursing facilities and
assisted living centers, and its 65% owned subsidiary, Contour Medical, Inc.
("Contour"), a national provider of medical/surgical supplies. In addition, the
Company agreed to acquire the remaining 35% of Contour not presently owned by
Retirement Care. The acquisition of Contour is expected to be accounted for as a
purchase. The Retirement Care and Contour transactions are expected to close in
the second half of 1997. The acquisition of Retirement Care is expected to be
accounted for as a pooling of interests. The agreements call for the Company to
issue 0.6625 shares of common stock in exchange for each outstanding share of
Retirement Care common stock (subject to adjustment as provided in the
agreement) and for the Company to pay $8.50 per share in cash, stock or a
combination of cash and stock (at the election of the Company) for each
outstanding share of Contour common stock not presently owned by Retirement
Care.
Additional significant acquisitions include (i) the acquisition of the
remaining 71% interest in Ashbourne, a long-term care provider in the United
Kingdom, during the first quarter of 1997 for L67,300,000 ($110,100,000) in
cash, which followed the Company's acquisition of a 29% ownership interest in
Ashbourne during 1996 and 1995 for approximately $36,048,000 in cash, (ii) the
acquisition of APTA Healthcare ("APTA") on December 15, 1996 for L13,733,000
($23,545,000 as of December 31, 1996), (iii) the acquisition of CareerStaff, a
provider of temporary therapy staffing, in June 1995, for 6,080,600 shares of
Common Stock, which had a market value of approximately $107,100,000 at the date
of acquisition, (iv) the acquisition of Golden Care, a respiratory therapy
company, in May 1995, for 2,106,904 shares of Common Stock and options to
purchase an additional 234,100 shares of Common Stock, which had a market value
of approximately $40,000,000 at the date of acquisition, (v) the acquisition of
100% of the stock of Exceler, a long-term care provider in the United Kingdom,
in September 1994 and February 1995 for an aggregate purchase price of
$18,640,000 in cash and (vi) the acquisition of Columbia Health Care, Inc., a
Canadian provider of outpatient rehabilitation therapy services, in November
1995 for
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approximately $8,500,000 in cash and warrants to purchase 500,000 shares of
common stock at an exercise price of $15.375 per share. Acquisitions present
problems of integrating the acquired operations into existing operations.
Expansion through the use of leases and management agreements has permitted
the Company to increase the size of its operations and earnings capacity without
significant capital expenditures, although in certain cases payments have been
required in connection with the restructuring of lease arrangements, and it is
common for a security deposit or a letter of credit to be required at the
inception of a lease term. In addition, in certain cases the Company is required
to expend significant sums immediately following acquisitions to finance such
facilities' operations until payments are received from payor sources for
services rendered by the Company. The Company has also in the past made and
expects to continue to make acquisitions through the use of its own stock as
consideration, thereby avoiding expenditure of cash. Regulatory approval is
generally required in connection with the Company's assumption of operating
responsibility for new facilities.
The Company continually evaluates opportunities to acquire or develop its
healthcare operations, including but not limited to its therapy and
pharmaceutical businesses. In evaluating opportunities, management considers,
among other factors, location (including synergies with existing Company
operations), demographics, price, the availability of financing on acceptable
terms (including lease terms and the ability to use Common Stock as acquisition
consideration), the competitive and regulatory environment and the opportunity
to improve performance through the implementation of the Company's operating
strategy.
The Company is continuously discussing with third parties the possible
acquisition of long-term and subacute care facilities and other healthcare
operations. Such acquisitions are often initiated and completed over a short
period of time. While the Company regularly considers and evaluates
opportunities for expansion and is engaged in discussions with various parties
regarding acquisitions which, if completed, would be material, it does not have
any firm agreements with respect to material acquisitions or expansion except
for the Company's acquisition of RCA and Contour as previously discussed.
Potential acquisition candidates generally include companies or facilities in
geographic proximity to facilities operated by the Company, those with similar
operations or those that fit within the Company's operating strategy. In
addition, the Company intends to continue to explore international acquisitions,
particularly in Europe. Subject to the requirements of Delaware law and the New
York Stock Exchange, the Company's stockholders will have no advance opportunity
to evaluate the merits and risks of future acquisitions. There can be no
assurance that any future acquisitions will be completed or that the Company's
historical rate of growth in assets, revenues or net earnings will be sustained.
Acquisitions present problems of integrating the acquired operations with
existing operations, including the loss of key personnel and institutional
memory of the acquired business, difficulty in integrating corporate,
accounting, financial reporting and management information systems and strain on
existing levels of personnel to operate such acquired businesses. In addition,
certain assumptions regarding the financial condition of an acquired business
may later prove to be incorrect. For example, a significant percentage of the
receivables of the acquired company may ultimately prove to be uncollectible,
which may result in significant write-offs. The Company's net earnings for the
years ended December 31, 1995 and 1994 were adversely impacted by problems
associated with integrating the operations of The Mediplex Group, Inc.
("Mediplex"), which was acquired by the Company in June 1994, including the
write-off during 1995 and 1994 of certain Mediplex receivables from periods
prior to the acquisition and an impairment loss during 1995 related to the
goodwill associated with six of the forty facilities acquired in the Mediplex
acquisition. In addition, net earnings for the year ended December 31, 1996 were
adversely affected by certain negative revenue adjustments and write-offs of
certain accounts receivables associated with Mediplex. These adjustments were
primarily the result of changes in accounting estimates based on events
occurring in 1996. Mediplex is the most significant acquisition undertaken by
the Company to date, and the acquisition of Mediplex allowed the Company to
expand its long-term and subacute care businesses. See
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"Item 7--Management's Discussion and Analysis of Financial Condition and Results
of Operations." The Company's ability to manage its growth effectively will
require it to continue to improve its corporate accounting, financial reporting
and management information systems, and to attract, train, motivate and manage
its employees effectively. There can be no assurance that the Company will be
able to successfully integrate acquired operations or to successfully manage any
growth; failure to do so effectively and on a timely basis could have a material
adverse effect upon the Company's financial condition and results of operations.
If the Company is unable to effectively integrate the operations of an
acquired entity with the Company's existing operations, the Company may elect to
divest some or all of the acquired operations. In the second quarter of 1996 the
Company sold its ambulatory surgery subsidiary. The Company's decision to sell
its ambulatory surgery subsidiary was influenced in part by the marketplace's
resistance to the integration of subacute care with ambulatory surgery.
REVENUE SOURCES
The Company derives its revenues from a combination of (i) state Medicaid
programs for indigent patients, (ii) the Federal Medicare program for certain
elderly and disabled patients, (iii) private payment sources, which includes
payments for therapy and pharmaceutical services provided to nonaffiliated long-
term and subacute care facilities, (iv) foreign operations in the United Kingdom
and Canada and (v) other miscellaneous sources. Such private pay sources may
themselves derive all or a portion of their revenues from Medicaid and/or
Medicare.
The following table sets forth the percentage of total revenues by payor
source for the Company for the periods indicated:
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YEAR ENDED
DECEMBER 31,
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SOURCES OF REVENUES 1996 1995 1994
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Medicaid...................................................... 31% 34% 40%
Medicare...................................................... 23 23 20
Private pay and other (1)..................................... 41 41 39
Foreign operations............................................ 5 2 1
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(1) Includes revenues from therapy services, which includes payments for
rehabilitation and respiratory therapy, temporary therapy staffing services
and pharmaceutical services provided to nonaffiliated long-term and subacute
facilities and not directly charged to Medicaid or Medicare. Such private
pay sources may themselves derive all or a portion of their revenues from
Medicaid and/or Medicare.
UNITED STATES REVENUE SOURCES
The Company's revenues from long-term and subacute care services are
determined by a number of factors, including: (i) the licensed bed capacity of
its facilities, (ii) the occupancy rates of its facilities, (iii) the mix of
patients and the rates of reimbursement among payor categories (Medicaid,
Medicare and private pay and other) and (iv) the extent to which subacute care
and certain ancillary services available in the Company's facilities are
utilized by the patients and paid for by the respective payor sources. The
Company utilizes reimbursement specialists and retains outside reimbursement
consultants to monitor both Medicaid and Medicare regulatory developments and to
assist in compliance with all program requirements with a view to obtaining all
lawful reimbursement.
MEDICAID. The Medicaid program is a program created by the Social Security
Act to benefit indigent persons who are aged, blind or disabled. Payment is made
under state-administered reimbursement programs governed by Federal guidelines.
Although Medicaid programs vary from state to state, typically they provide for
fixed rate payments to healthcare providers at levels designed to compensate an
efficiently
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and economically operated facility. Reimbursement rates are typically determined
by the state from "cost reports" filed annually by each facility, on a
prospective or retrospective basis. Under most state Medicaid programs,
individual facilities are reimbursed on a prospective rate system, subject to
retroactive adjustment. Under a prospective system, per diem rates are
established (generally on an annual basis) based upon certain historical costs
of providing services during the prior year, adjusted to reflect factors such as
inflation and any additional services required to be performed. Retroactive
adjustments, if any, are based on a recomputation of the applicable
reimbursement rate following an audit of cost reports. Providers must accept
reimbursement from Medicaid as payment in full for the services rendered. The
provider may not bill the patient for services covered by the Medicaid program
but may bill the patient for noncovered services. There can be no assurance that
Medicaid reimbursement will be sufficient to cover actual costs incurred by the
Company with respect to Medicaid services rendered. State Medicaid plans also
require that providers must be subject to governmental audit to ensure the
propriety of costs incurred, which are used as the basis for payments.
Most of the Company's facilities participate in the Medicaid program. The
Company's facilities in Arizona participate in the Arizona Health Care Cost
Containment System Program (the "AHCCCS Program"), which is operated under a
Federal Medicaid waiver. The AHCCCS Program is an alternative to the
conventional Medicaid program. The AHCCCS Program provides Federal financial
assistance for care it provides to needy individuals who would be eligible for
Medicaid in any other state. The AHCCCS Program is designed primarily to secure
healthcare on a capitated basis under contracts awarded to qualified bidders,
but it also pays some contractors on a fee-for-service basis when capitated
contracts are impractical. The Company negotiates the rates of reimbursement
with the county in which services are provided, on either a capitated or
fee-for-service basis, depending on the county. Under the AHCCCS Program,
nursing facility services are covered for eligible patients of all ages.
Certain states, including Massachusetts, are studying methods for reducing
expenses under their Medicaid programs, which initiatives could have an adverse
effect on applicable Medicaid rates. Connecticut has undertaken a study of
acuity levels and is considering changes in its reimbursement system to take
levels of acuity into account for the reimbursement of nursing costs. The
Company cannot currently determine the potential effect of any such changes.
MEDICARE. Medicare is a federally funded and administered health insurance
program that provides coverage for beneficiaries who require certain intensive
rehabilitation therapy services or skilled nursing and certain related medical
services, such as rehabilitation therapy, pharmaceuticals, medical supplies and
ancillary, diagnostic and other necessary services of the type provided by
skilled nursing facilities. Medicare inpatient benefits are not available for
patients requiring intermediate and custodial levels of care. In general,
Medicare payments for skilled nursing services and rehabilitative care are based
on allowable costs. With certain exceptions, Medicare pays on an interim basis,
subject to year-end cost settlement. Each facility receives interim payments
during the year. Total incurred costs are later adjusted upward or downward to
reflect actual allowable direct and indirect costs of services based on the
submission of a cost report at the end of each year. If allowable cost is less
than the interim payments, depending on the effective date of the adjustment,
the Company could be required to refund prospectively the excess of amounts it
receives over such allowable costs. If such refund were required to be made, it
would be due shortly following notice from Medicare, and would likely require
the Company to borrow under its revolving credit facility. There can be no
assurance that Medicare reimbursement will be sufficient to cover actual costs
incurred by the Company with respect to Medicare services rendered. As of
December 31, 1996, 155 of the Company's 160 long-term and subacute care
facilities in the United States (or 97% of such facilities) were certified to
receive payment for costs incurred while providing benefits covered under
Medicare.
Medicare reimbursement for services provided in skilled nursing facilities
is based upon the lesser of (i) actual allowable routine and ancillary operating
costs and capital costs or (ii) charges. Facilities that have been in operation
longer than three full cost reporting periods are subject to limits on their
actual
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routine per diem costs. The routine service cost limits, which are regionally
adjusted for labor costs, are required to be updated annually by HCFA. However,
these limits were frozen by HCFA for its past three fiscal years ended September
30, 1995. The freeze expired on October 1, 1995. However, no new cost limits
have been published.
Hospitals that provide acute care are paid for non-physician services to
Medicare inpatients under the federal prospective payment system ("PPS"), under
which payments are based on standard amounts adjusted for the patient's
diagnosis without regard to the hospital's actual inpatient operating costs.
Medicare payments for inpatient services provided by rehabilitation and
psychiatric hospitals or units that meet the requirements to be exempted from
the PPS are generally reimbursed on a reasonable cost basis, subject to certain
limits and exceptions. Medicare payment for most outpatient ancillary services
provided in non-acute care facilities is based upon the lesser of reasonable
costs or charges.
Rehabilitation hospitals or units in acute care hospitals must meet certain
eligibility requirements for exclusion from PPS. Rehabilitation hospitals must
show that they provided services to an inpatient population of whom at least 75%
required intensive rehabilitative services for the treatment of conditions that
fell within ten specified categories of injury and disease. The rehabilitation
facilities meeting these requirements are reimbursed by Medicare for their
portion of the actual allowable operating and capital costs for the first three
full cost reporting periods under current or previous ownership. After this
period, the facilities will be subject to limits on their actual operating costs
per discharge. The cost limits were imposed under regulations adopted under the
Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"). The TEFRA limit is
determined based upon actual Medicare allowable operating costs per discharge
incurred in a base year, and is updated annually by an amount approved by HCFA.
The annual payment update reflects changes in the hospital market basket and
budgetary policy. Rehabilitation facilities subject to TEFRA limits will be
reimbursed the lesser of their actual allowable operating and capital costs or
the TEFRA limit plus capital costs. If a facility's actual allowable operating
costs are less than the TEFRA limit, it will receive in addition to its actual
costs an "incentive" payment which is equivalent to the lesser of 50% of the
difference between the TEFRA amount and actual operating costs or 5% of the
TEFRA amount.
The Company's respiratory therapy subsidiary derives a significant
percentage of its net revenues and net operating earnings from the provision of
respiratory therapy services and related supplies, equipment and medical gases
to beneficiaries of the Medicare and Medicaid programs who reside in long-term
and subacute care facilities. In general, long-term and subacute care facilities
that contract with an outside provider for the furnishing of respiratory therapy
services are reimbursed under Part A of the Medicare program through the annual
facility cost reporting process. Reimbursement is made under Medicare's
reasonable cost principles, subject to salary equivalency guidelines that
operate as cost limits. Respiratory therapy services furnished under a contract
with an outside provider are Medicare covered services and reimbursable under
Medicare Part A only if furnished by a "transfer hospital" with which the
long-term and subacute care facility has entered into a "transfer agreement."
Golden Care has entered into contracts with a number of hospitals that
participate in the Federal Medicare program and the hospitals have established
transfer agreements with a number of skilled nursing facilities. Pursuant to
Golden Care's contract, the hospitals rent necessary respiratory therapy
equipment from Golden Care and receive comprehensive and specific management
services from Golden Care. The hospitals pay Golden Care monthly rental payments
for the equipment, and certain other fees for the management, administrative and
other related services that Golden Care renders. Golden Care also has entered
into contracts with a number of skilled nursing facilities to provide necessary
medical supplies, medical gases and respiratory therapy equipment, pursuant to a
fee schedule. The skilled nursing facilities pay Golden Care upon receipt of the
medical supplies and medical gases and monthly for the necessary respiratory
therapy equipment.
Current Medicare regulations that apply to transactions between related
parties, such as the Company's subsidiaries, are relevant to the amount of
Medicare reimbursement that the Company is entitled to receive for the
rehabilitation and respiratory therapy and pharmaceutical services that it
provides to
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affiliated facilities. These related party regulations require that, among other
things, (i) the Company's rehabilitation and respiratory and pharmaceutical
subsidiaries must each be a bona fide separate organization; (ii) a substantial
part of the rehabilitation and respiratory therapy services or pharmaceutical
services, as the case may be, of the relevant subsidiary must be transacted with
nonaffiliated entities, and there is an open, competitive market for the
relevant services; (iii) rehabilitation and respiratory therapy services and
pharmaceutical services, as the case may be, are services that commonly are
obtained by long-term and subacute care facilities from other organizations and
are not a basic element of patient care ordinarily furnished directly to
patients by such long-term and subacute care facilities; and (iv) the prices
charged to the Company's long-term and subacute care facilities by its
rehabilitation and respiratory therapy services subsidiaries and pharmaceutical
subsidiary are in line with the charges for such services in the open market and
no more than the prices charged by its rehabilitation and respiratory therapy
services and pharmaceutical subsidiaries under comparable circumstances to
nonaffiliated long-term and subacute care facilities. The related party
regulations do not indicate a specific level of services that must be provided
to nonaffiliated entities in order to satisfy the "substantial part" requirement
of such regulations. In instances where the issue has been litigated by others,
no consistent standard has emerged as to the appropriate threshold necessary to
satisfy the "substantial portion" requirement.
Net revenues from rehabilitation therapy services provided to nonaffiliated
facilities represented 66%, 64% and 67% of total rehabilitation services net
revenues for the years ended December 31, 1996, 1995 and 1994, respectively.
Respiratory therapy services provided to nonaffiliated facilities represented
55% and 64% of total respiratory therapy services net revenues for the year
ended December 31, 1996 and the period from the date of acquisition of Golden
Care on May 5, 1995 to December 31, 1995, respectively. The Company's
respiratory therapy operations did not provide services to affiliated facilities
prior to the acquisition of Golden Care on May 5, 1995. Net revenues from
pharmaceutical services billed to nonaffiliated facilities represented 78%, 78%
and 81% of total pharmaceutical services revenues for the years ended December
31, 1996, 1995 and 1994. The Company believes that it satisfies the requirements
of the related party regulations regarding nonaffiliated business. Consequently,
it has claimed and received reimbursement under Medicare for rehabilitation and
respiratory therapy and pharmaceutical services provided to patients in its own
facilities at a higher rate than if it did not satisfy these requirements. If
the Company were deemed not to have satisfied these regulations, the
reimbursement that the Company receives for rehabilitation and respiratory
therapy and pharmaceutical services provided to its own facilities would be
materially and adversely affected. If, upon audit by Federal or state
reimbursement agencies, such agencies find that these regulations have not been
satisfied, and if, after appeal, such findings are sustained, the Company could
be required to refund some or all of the difference between its cost of
providing these services and the higher amount actually received. While the
Company believes that it has satisfied and will continue to satisfy these
regulations, there can be no assurance that its position would prevail if
contested by relevant reimbursement agencies. The Company believes that it will
be able to integrate the Retirement Care operations so as to remain in
compliance with these regulations; however, in order to so comply the Company
may be required to restrict the number of Retirement Care facilities to which
the Company provides therapy and pharmacy services. The foregoing statements
with respect to the Company's ability to satisfy these regulations are forward
looking and could be affected by a number of factors, including the
interpretation of Medicare regulations by Federal or state reimbursement
agencies and the Company's ability to provide services to nonaffiliated
facilities.
PRIVATE PAY SOURCES. Private pay revenues include payments from individuals
who pay directly for services without governmental assistance, revenues from
nonaffiliated facilities, served by the Company's ancillary therapy and pharmacy
operations, commercial insurers, Blue Cross organizations, HMOs, preferred
provider organizations, workers' compensation programs and other similar payment
sources. Payments from these private pay sources may be charge-based, cost-based
or based on periodically renewable contracts negotiated with these payors. Some
medical conditions treated with rehabilitation therapy services are covered by
liability insurance, rather than health benefits policies. In such cases,
reimbursement rates are established on a case-by-case basis.
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Although the level of charges by the Company to private patients in its
facilities is not subject to the same regulatory control as with Medicaid or
Medicare, its charges are still generally limited to customary and reasonable
charges for such healthcare services. In addition, many managed care
organizations and other non-governmental payors are under pressure to contain or
reduce costs through increasing case management review of services, lowering
reimbursement rates and negotiating reduced contract pricing.
THERAPY SERVICES TO NONAFFILIATES. Revenues from therapy services to
nonaffiliates are derived from the Company's therapy business which provides
rehabilitation and respiratory therapy, and respiratory products and supplies,
to patients at long-term and subacute care facilities not operated by the
Company. In general, payments for these therapy services are received directly
from the long-term care facilities, which in turn are paid by Medicare or other
payors. Revenues from therapy services provided to affiliated facilities are
included in the Medicaid, Medicare and private pay sources of revenues of the
Company. The Company's charges to nonaffiliates, though not directly regulated,
are effectively limited by regulatory reimbursement policies imposed on the
long-term and subacute care facilities that receive these therapy services, as
well as competitive market factors. The Company's contracts with the
nonaffiliated facilities are generally terminable on 30 to 60 days' notice, so
that if reimbursement policies changed in such a way that contract therapy rates
owed by such facilities to the Company exceeded reimbursement paid by Medicare
or other payors to such facilities, they would be able to terminate their
contractual relationships with the Company. In addition, in substantially all
instances, the Company may be contractually required to indemnify the
nonaffiliated facility for amounts it has been paid which are subsequently
disallowed by Medicare.
CareerStaff revenues are included in the Private and Other category, since
all CareerStaff revenues are derived from billings to facilities served, rather
than directly from Medicare or Medicaid; although Medicare or Medicaid may
reimburse the facilities for the cost of services provided to CareerStaff.
PHARMACEUTICAL SERVICES TO NONAFFILIATES. Revenues from the Company's
pharmaceutical services are derived from the provision of such services to
patients at long-term and subacute care facilities, most of which are not
operated by the Company. The Company enters into non-exclusive contracts with
nonaffiliated facilities, and personnel at such facilities submit prescriptions
to the Company on behalf of patients at such facilities. The Company is in most
cases paid directly by Medicare, Medicaid or private pay sources, and not by the
long-term care facility. The amounts that can be charged for prescriptions are
often limited by Medicaid regulations.
UNITED KINGDOM REVENUE SOURCES
The Company derives its revenues in the United Kingdom from a combination of
(i) income support payments by the United Kingdom Department of Social Security
(the "DSS"), (ii) local authority payments and (iii) private payor sources.
DSS INCOME SUPPORT. The majority of residents in nursing homes in the
United Kingdom are funded by income support payments by the DSS. DSS income
support is paid without any assessment of care need. Under the DSS income
support system, if an individual had less than L8,000 in assets and insufficient
income to cover the cost of home care, that individual is eligible for DSS
income support for nursing home care. A single set of national rates is applied
throughout the United Kingdom (except in London where an additional premium is
payable). DSS income support levels are reviewed annually and generally are
increased with United Kingdom inflation rates. Residents receiving income
support who entered homes before April 1993 will continue to have their fees
paid until they die or leave the nursing home. Consequently, the funding changes
introduced by the Community Care Act will take effect gradually as those who
receive payments from the DSS under the pre-April 1993 system are replaced by
residents who now receive local authority funding.
LOCAL AUTHORITY FUNDING. Since implementation of the Community Care Act, if
an individual is assessed by a local authority as requiring nursing home care,
the local authority will place that individual in a nursing home with which it
has contracted (or a home of the individual's choice) and will recover from
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the resident any income which he or she may have to cover such costs. In
addition, local authorities may place a charge over a resident's property and
recover the fees for nursing home care from the proceeds of the sale following
the death of the spouse. The local authority is free to contract with any
nursing home and may agree to any fee with the operator of the nursing home. In
practice, most local authorities have used the level of DSS income support
payments as a benchmark against which to set their fees. As a result, local
authority rates are likely to rise in line with DSS income support payments.
Some local authorities, however, have been willing to pay a higher fee for
higher dependency residents or higher quality nursing homes. An individual may
choose to go to a different nursing home than the one offered by the local
authority, provided the extra cost, or "top up," if any, is borne by the
individual or by a third party. Approximately 30% of the Company's residents
receiving income support or local authority funding pay such "top up" payments.
PRIVATE PAYOR SOURCES. Privately funded residents typically pay
approximately 10% more than DSS or local authority-funded residents. The Company
believes that the financial resources of the elderly are projected to increase
in the future. As a result, there is likely to be a decrease in the number of
people who are eligible for local authority funding or DSS income support. The
majority of privately funded residents pay for the cost of nursing home care
with the proceeds from the sale of their home. Health insurance and other
financial products that provide financing for long-term nursing care are in
their infancy in the United Kingdom and it is unlikely that these products will
account for a significant portion of nursing home revenues in the near future.
GOVERNMENT REGULATION
The healthcare industry is subject to substantial federal, state and local
regulation. The various layers of governmental regulation affect the Company's
business by controlling its growth, requiring licensure or certification of its
facilities, regulating the use of its properties and controlling reimbursement
to the Company for services provided. See "Revenue Sources." Licensing,
certification and other applicable governmental regulations vary from
jurisdiction to jurisdiction, are revised periodically, and vary among the
nursing home, therapy and pharmacy operations.
In recent years, an increasing number of legislative proposals have been
introduced or proposed in Congress and in some state legislatures that would
effect major changes in the healthcare system, either nationally or at the state
level. Among the proposals under consideration are cost controls on hospitals,
insurance market reforms to increase the availability of group health insurance
to small businesses, and requirements that all businesses offer health insurance
coverage to their employees. It is not clear at this time whether any proposals
will be adopted, or, if adopted, what effect, if any, such proposals would have
on the Company's business. There can be no assurance that currently proposed or
future healthcare legislation or other changes in the administration or
interpretation of governmental healthcare programs will not have a material
adverse effect on the financial results or operations of the Company.
In 1993, the Health Care Financing Administration ("HCFA") issued a
directive to fiscal intermediaries that administer the Medicare reimbursement
policies to review costs incurred by providers of occupational therapy and
speech therapy provided by contract suppliers such as the Company's
rehabilitation therapy subsidiary. Although HCFA has published salary
equivalency guidelines for contract physical therapy and respiratory therapy,
guidelines for occupational therapy and speech therapy have not yet been
published in final form. Implementation of speech and occupational salary
equivalency guidelines in accord with draft proposals of HCFA could directly or
indirectly limit reimbursement for certain of the Company's occupational and
speech therapy services. Reimbursement for such services is currently evaluated
under Medicare's reasonable cost principles.
In 1995, and periodically since then, HCFA has provided information to
intermediaries for their use in determining reasonable costs for occupational
and speech therapy. The information set forth in such directives, although not
intended to impose limits on reasonable costs for speech therapy and
occupational therapy, suggests that fiscal intermediaries should carefully
review costs which appear to be in excess of
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what a "prudent buyer" would pay for those services. While the effect of these
directives is still uncertain, they are a factor considered by such
intermediaries in evaluating the reasonableness of amounts paid by providers for
the services of the Company's rehabilitation therapy subsidiary. These
directives will become obsolete for cost reporting periods beginning after
salary equivalency guidelines for all therapies are finalized. In addition, some
intermediaries also require facilities to justify the cost of contract
therapists versus employed therapists as an aspect of the "prudent buyer"
analysis. Accordingly, the "prudent buyer" analyses could result in lower
reimbursement rates and a corresponding decrease in net revenues of the Company.
With respect to rehabilitation therapy services provided to affiliated
facilities, a retroactive adjustment of Medicare reimbursement could be made for
some prior periods. An adjustment of reimbursement rates with respect to therapy
services provided to nonaffiliated facilities could result in indemnity claims
against the Company, based on the terms of substantially all of the Company's
existing contracts with such facilities, for payments previously made by such
facilities to the Company that are reduced by Medicare in the audit process. The
Company derives a significant percentage of its net earnings from the provision
of therapy services; a change in reimbursement rates resulting from
implementation of this directive or a reduction in reimbursement as a result of
a change in application of reasonable cost guidelines could have a material
adverse affect on the Company's financial condition and results of operations,
depending on the rates adopted and the Company's costs for providing these
services.
Additional measures are likely to be adopted in the future as Federal and
state governments attempt to control escalating healthcare costs. Any reductions
in reimbursement levels under Medicaid, Medicare or private payor programs and
any changes in applicable government regulations or interpretations of programs
are subject to statutory and regulatory changes, retroactive rate adjustments to
incurred costs, administrative rulings and government funding restrictions, all
of which may materially affect the rate of payment to facilities and the
Company's therapy and pharmaceutical businesses. There can be no assurance that
payments under government or private payor programs will remain at levels
comparable to present levels or will be adequate to cover the costs of providing
services to patients eligible for assistance under such programs. Significant
decreases in utilization of therapy services and limits on reimbursement for
therapy services could have a material adverse effect on the Company's financial
condition and results of operations.
Many of the states in which the Company operates have adopted CON statutes
applicable to the services provided by the Company. Such statues provide
generally that, prior to the construction of new beds, the addition of new
services or the making of certain capital expenditures exceeding defined levels,
a state agency must determine that a need exists for such proposed activities.
Failure to obtain the necessary state approval can result in the inability to
provide the service, operate the facility or complete the addition or other
change, and can also result in the imposition of sanctions or adverse action in
respect of the facility's license and reimbursement.
All of the Company's long-term and subacute care facilities in the United
States are licensed under applicable state law where licensure is required. As
of December 31, 1996, 155 of the Company's 160 long-term and subacute care
facilities in the United States (or 97% of such facilities) were certified to
receive benefits provided under Medicare, and 157 (or 99% of such facilities)
were approved as providers under Medicaid. Both initial and continuing
qualification of a facility to participate in the Medicaid or Medicare program
depend upon many factors, including accommodations, equipment, services, patient
care, safety, personnel, physical environment and adequate policies, procedures
and controls. In order to participate in the Medicare program, a facility must
be licensed and certified as a provider of skilled nursing services. Effective
October 1, 1990, the Omnibus Budget Reconciliation Act of 1987 eliminated the
different certification standards for "skilled" and "intermediate care" nursing
facilities under the Medicaid program in favor of a single "nursing facility"
standard. This standard requires, among other things, that the Company have at
least one registered nurse on each day shift and one licensed nurse on each
other shift, and increases training requirements for nurse's aides by requiring
a minimum number of training hours and a certification test before a nurse's
aide can commence work. States continue to be required to certify that nursing
facilities provide "skilled care" in order to obtain Medicare reimbursement.
Licensing,
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certification and other applicable standards vary from jurisdiction to
jurisdiction and are revised periodically. State agencies survey all long-term
care facilities on a regular basis to determine whether such facilities are in
compliance with the requirements for participation in government sponsored third
party payor programs.
The Company believes that its facilities are in substantial compliance with
the various Medicare and Medicaid regulatory requirements of certification.
However, in the ordinary course of its business, the Company receives notices of
deficiencies for failure to comply with various regulatory requirements. The
Company reviews such notices and seeks to take appropriate corrective action. In
most cases, the Company and the reviewing agency will agree upon the measures to
be taken to bring the facility into compliance. In some cases or upon repeat
violations, the reviewing agency has the authority to impose fines, temporarily
suspend admission of new patients to the facility, suspend or decertify from
participation in the Medicare or Medicaid programs and, in extreme
circumstances, revoke a facility's license. These actions would adversely affect
a facility's ability to continue to operate, the ability of the Company to
provide certain services and the facility's eligibility to participate in the
Medicare or Medicaid programs.
Certain of the Company's long-term and subacute care facilities have
received notices in the past from state agencies that, as a result of certain
alleged deficiencies, the agencies were assessing fines or were taking steps to
decertify the facility from participation in Medicare and Medicaid programs.
However, the deficiencies were remedied before any facilities were decertified.
To date, none of the Company's facilities has had its license or certification
revoked.
The Company's therapy and pharmaceutical businesses provide Medicare and
Medicaid covered services and products to long-term and subacute care facilities
under arrangements with both affiliated and nonaffiliated long-term and subacute
care facilities. Under these arrangements, the Company's therapy subsidiary
bills and is paid by the long-term and subacute care facility for the services
actually rendered and the details of billing the Medicare and Medicaid programs
are handled directly by the long-term and subacute care facility. With certain
exceptions, the Company's pharmaceutical subsidiary bills, and is paid by,
Medicare, Medicaid or the private pay source directly. As a result, the
Company's therapy business generally (including Sundance and CareerStaff) is not
Medicare and Medicaid certified and does not enter into provider agreements with
the Medicare and Medicaid programs, but the Company's pharmaceutical business
does participate in the Medicare and Medicaid programs.
Various state and federal laws regulate the relationship between providers
of healthcare services and physicians, including employment or service
contracts, and investment relationships. These laws include the broadly worded
Fraud and Abuse Provisions of the Medicare and Medicaid statutes, which prohibit
various transactions involving Medicare or Medicaid covered patients or
services. Violations of these provisions may result in civil or criminal
penalties for individuals or entities and/or exclusion from participation in the
Medicare and Medicaid programs. For example, conviction of abusive or fraudulent
behavior with respect to one facility could subject other facilities under
common control or ownership to exclusion from participation in the Medicare and
Medicaid programs. For example, conviction of abusive or fraudulent behavior
with respect to one facility could subject other facilities under common control
or ownership to exclusion from participation in the Medicare and Medicaid
programs. The full extent of the application of these provisions is not
presently known. However, the Company believes that it has not entered into any
relationship with physicians or other healthcare providers that might be
considered to fall within the coverage of the Fraud and Abuse Provisions and
other related state and federal laws. The Company believes that it will be able
to arrange its future business relationships so as to comply with the Fraud and
Abuse Provisions or any safe harbor guidelines issued pursuant thereto.
All states have adopted a "patient's bill of rights" that sets forth
standards dealing with such issues as using the least restrictive treatment,
patient confidentiality, allowing patient access to the telephone and mail,
allowing the patient to see a lawyer and requiring the patient to be treated
with dignity. In addition, the Company, as an operator of health care
facilities, is subject to various federal, state and local consumer protection
laws.
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By virtue of the Company's ownership of Exceler and APTA and an ownership
interest in Ashbourne, certain of the operations from which the Company may
derive income are subject to national and local regulations in the United
Kingdom, including The Community Care Act 1990 and The Registered Homes Act
1984, as well as various zoning, health and safety, reimbursement and general
corporate regulations.
The Company also is subject to federal, state and local laws, regulations
and ordinances that govern activities or operations that may have adverse
environmental effects (such as the generation, handling, storage and disposal of
medical and hazardous wastes) or impose liability for the costs of remediation
of contaminated property in certain circumstances without regard to fault. The
Company could incur liability under such laws for the activities of former
operators of facilities acquired by the Company. Certain of the Company's
operations routinely involve the handling of medical wastes, some of which are
or may become regulated as hazardous substances. The Company has not incurred,
and does not expect to incur, any significant expenditures or liabilities for
environmental matters. As a result, the Company believes that its environmental
obligations will not materially affect the Company.
COMPETITION
The Company operates in a highly competitive industry. The nature of
competition varies by location. Its facilities generally operate in communities
that are also served by similar facilities operated by others. Some competing
facilities are located in buildings that are newer than those operated by the
Company and provide services not offered by the Company, and some are operated
by entities having greater financial and other resources and longer operating
histories than the Company. In addition, some facilities are operated by
nonprofit organizations or government agencies supported by endowments,
charitable contributions, tax revenues and other resources not available to the
Company. Some hospitals that either currently provide long-term and subacute
care services or are converting their under-utilized facilities into long-term
and subacute care facilities are also a potential source of competition to the
Company. The Company also competes with other companies in providing
rehabilitation therapy services and pharmaceutical products and services to the
long term care industry and in employing and retaining qualified therapists and
other medical personnel. Many of these competing companies have greater
financial and other resources than the Company.
The Company competes with other facilities based on key competitive factors
such as its reputation for the quality and comprehensiveness of care provided;
the commitment and expertise of its staff; the innovativeness of its treatment
programs; local physician and hospital support; marketing programs; charges for
services; and the physical appearance, location and condition of its facilities.
The range of specialized services, together with the price charged for services,
are also competitive factors in attracting patients from large referral sources.
There is limited, if any, competition in price with respect to Medicaid and
Medicare patients, because revenues for services to such patients are strictly
controlled and based on fixed rates and uniform cost reimbursement principles.
See "Revenue Sources."
The Company may also face competition from other facilities, hospitals or
healthcare companies when it initiates a CON project or seeks to acquire a CON
or a facility covered by an existing CON. CON programs affect the opportunity to
develop or acquire new facilities by creating a regulatory system that can be
used by competitors to delay the implementation of growth strategies. CON laws,
applicable in many of the states in which the Company's facilities are located,
also currently restrict the number of facilities that can compete with the
Company in such states.
EMPLOYEES
As of December 31, 1996, the Company had approximately 35,900 full-time and
part-time employees. Of this total, there were approximately 22,400 employees at
the long-term and subacute care facilities in the United States, 2,500 employees
at the long-term care facilities in the United Kingdom, 6,400 employees involved
in providing rehabilitation therapy services in the United States, 300 employees
providing rehabilitation therapy services in Canada, 700 employees at the
pharmaceutical operations in the United
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States, 2,200 employees in the temporary therapy staffing business, 700
employees of hospitals who are managed by the Company and provide respiratory
therapy services and 700 employees at the corporate and regional offices.
Certain of the Company's employees in Connecticut, Massachusetts, California,
Washington and New Mexico are covered by collective bargaining contracts. The
Company believes it has satisfactory relationships with the unions that
represent its employees, but it cannot predict the effect of continued union
representation or organizational activities on its future activities.
Although the Company believes it is able to employ sufficient nurses and
therapists to provide its services, a shortage of healthcare professional
personnel in any of the geographic areas in which it operates could affect the
Company's ability to recruit and retain qualified employees and could increase
its operating costs. The Company competes with other healthcare providers for
both professional and service employees and with non-healthcare providers for
service employees.
INSURANCE
Healthcare companies are subject to medical professional liability, personal
injury and other liability claims that are customary risks inherent in the
operation of health facilities and are generally covered by insurance. The
Company maintains property, liability and professional liability insurance
policies in amounts and with such coverages and deductibles that are deemed
appropriate by management, based upon historical claims, industry standards and
the nature and risks of its business. The Company also requires that physicians
practicing at its facilities carry medical professional liability insurance to
cover their respective individual professional liabilities.
The Company has self-insured the healthcare risks of employees who have
elected coverage under the Company-sponsored plans. Workers' compensation
coverage is effected through self-insurance, retrospective or high-deductible
insurance policies or other hybrid policies which vary by the states in which
the Company operates except that the Company's long-term and subacute care
subsidiary is a non-subscriber to the workers' compensation program in Texas.
The costs of paying for healthcare and workers' compensation claims can
fluctuate depending on the type and number of claims in any given period.
ITEM 2. PROPERTIES
FACILITIES. Most of the Company's long-term and subacute care facilities
are subject to long-term operating leases, subleases, or management agreements.
The Company considers its properties to be in good operating condition and
suitable for the purposes for which they are being used. The Company's
facilities that are leased are subject to long-term operating leases or
subleases, the terms of which range from 6 to 23 years, and require the Company,
among other things, to fund all applicable capital expenditures, taxes,
insurance and maintenance costs. The Company's rights as lessee or sublessee
could be subject to termination upon a foreclosure by the underlying mortgage
lender or termination by the lessor. The annual rent payable under each of the
leases generally increases based on a fixed percentage (generally 2 to 3%) and,
in some instances, based on increases in revenues or income and reimbursement
rates or number of occupied beds. Many of the leases contain renewal options to
extend the term for between 5 to 40 consecutive years. Thirty-four of the
Company's facilities are leased from Meditrust. The Meditrust leases generally
provide for a fixed annual 2.5% increase over the prior year's rent and have
initial terms expiring between 2004 and 2008 with renewal options for five
consecutive five year terms. The Meditrust leases contain cross-default
provisions, so that a default under any one of the Meditrust leases may trigger
a default under all mortgages and leases financed by Meditrust. Seventeen of the
Company's long-term and subacute care facilities are subject to management
agreements, which generally provide the Company with management fees based on a
percentage of the revenues of the managed facility and may also include a fixed
fee component.
At December 31, 1996, the Company had an aggregate of $32,712,000 of
outstanding mortgages with Meditrust which contain cross-default provisions with
all of such mortgages and leases also financed by Meditrust.
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<PAGE>
The Company believes that the aggregate occupancy percentages for all of its
facilities were 90%, 92% and 91% in the United States and 88%, 89% and 86% in
the United Kingdom for the years ended December 31, 1994, 1995 and 1996,
respectively. However, the Company believes that occupancy percentages, either
individually or in the aggregate, should not be relied upon alone to determine
the profitability of a facility. Other factors include, among other things, the
sources of payment, terms of reimbursement and the acuity level for each of the
patients in such facilities. The Company also believes there is not a consistent
industry standard as to how occupancy is measured and that the information may
not be comparable among long-term care providers. See "Business" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Effects from Changes in Reimbursement." The Company computes average
occupancy percentages by dividing the total number of beds sold by the total
number of licensed beds available for use during the periods indicated.
FACILITIES IN THE UNITED STATES. The following table sets forth certain
information concerning the long-term and subacute care facilities owned, leased
or managed by the Company in the United States as of December 31, 1996. Unless
otherwise indicated, all facilities listed below are leased by the Company.
<TABLE>
<CAPTION>
NUMBER OF NUMBER OF
STATE FACILITIES LICENSED BEDS (1)
- ------------------------------------------------- ---------- -----------------
<S> <C> <C>
Massachusetts (2)................................ 35 4,574
Texas............................................ 22 2,705
Washington (3)................................... 21 1,924
California (4)................................... 17 2,185
Connecticut (5).................................. 15 2,159
Arizona.......................................... 10 1,527
Illinois......................................... 9 980
Idaho (6)........................................ 9 813
New Jersey (7)................................... 5 766
New Mexico....................................... 4 277
Florida (3)...................................... 3 390
Oklahoma......................................... 2 135
Oregon........................................... 2 195
Colorado (3)..................................... 1 117
Kentucky......................................... 1 55
Louisiana........................................ 1 177
Maryland......................................... 1 170
Indiana.......................................... 1 95
Iowa............................................. 1 77
--- ------
160 19,321
--- ------
--- ------
</TABLE>
- ------------------------
(1) "Licensed Beds" refers to the number of beds for which a license has been
issued, which may vary in some instances from licensed beds available for
use.
(2) Includes three facilities owned and two facilities managed by the Company.
(3) Includes one facility owned by the Company.
(4) Includes fourteen facilities managed by the Company.
(5) Includes one facility managed by the Company and is the holder by assignment
of an opion to acquire this facility.
(6) Includes three facilities owned by the Company.
(7) Includes one facility managed by the Company.
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<PAGE>
See "Item 13--Certain Relationships and Related Transactions" for a
description of certain relationships between the Company and certain of its
executive officers and directors with respect to leases for certain of the above
facilities in the United States.
FACILITIES IN THE UNITED KINGDOM. The following table sets forth certain
information concerning the long-term care facilities owned or leased by the
Company as of December 31, 1996. Unless otherwise indicated, all facilities
listed below are leased by the Company.
<TABLE>
<CAPTION>
NUMBER OF
NUMBER OF REGISTERED
COUNTY FACILITIES BEDS(1)
- ------------------------------------------------- ---------- -----------------
<S> <C> <C>
Nottinghamshire (2).............................. 12 459
West Midlands (3)................................ 12 542
Leicestershire (4)............................... 5 219
Derbyshire (4)................................... 4 176
Merseyside (5)................................... 4 226
Tyne and Wear (6)................................ 4 188
Berkshire (7).................................... 3 112
Greater Manchester (4)........................... 3 115
London (6)....................................... 3 175
Owent............................................ 3 119
Staffordshire (5)................................ 3 154
Clwyd (4)........................................ 2 89
Londonderry...................................... 2 96
South Yorkshire (5).............................. 2 143
Armagh (5)....................................... 1 41
Cambridgeshire (5)............................... 1 19
Cheshire (5)..................................... 1 40
Down............................................. 1 40
Essex (5)........................................ 1 50
Humberside....................................... 1 86
Midglamoargan.................................... 1 60
Newry............................................ 1 39
Norfolk (5)...................................... 1 13
Shropshire....................................... 1 65
Suffolk (5)...................................... 1 15
Warwickshire (5)................................. 1 35
West Yorkshire................................... 1 104
--
-----
75 3,420
--
--
-----
-----
</TABLE>
- ------------------------
(1) "Registered Beds" refers to the number of beds for which a register has been
issued, which may vary in some instances from registered beds available for
use.
(2) Includes four facilities owned by the Company.
(3) Includes ten facilities owned by the Company.
(4) Includes two facilities owned by the Company.
(5) Includes one facility owned by the Company.
(6) Includes three facilities owned by the Company.
(7) Includes two facilities owned and one facility managed by the Company.
18
<PAGE>
CONSTRUCTION OF HEALTHCARE FACILITIES IN THE UNITED KINGDOM. The Company
intends to complete construction of seven facilities in the United Kingdom
through its wholly owned subsidiary Sun Healthcare Group International, Ltd. The
aggregate number of beds for these seven projects is 992 and the estimated
aggregate capital cost of these seven facilities is approximately L7,300,000
($12,500,000) as of December 31, 1996.
PHARMACEUTICAL SERVICES. As of December 31, 1996, the Company operated
fifteen pharmacies and three in-house long-term care pharmacies in 21 states,
six pharmacies in the United Kingdom, one supply distribution center and one
pharmaceutical billing and consulting center.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to various legal actions and administrative
proceedings and is subject to various claims arising in the ordinary course of
business. The Company does not believe that the ultimate disposition of these
matters will have a material adverse effect on the financial position or results
of operations of the Company.
Prior to the Company's acquisition of CareerStaff, a holder of CareerStaff's
common stock filed a lawsuit (the "CareerStaff Litigation") as a purported class
action against CareerStaff and the directors of CareerStaff alleging breach of
fiduciary duty in entering into a merger agreement with the Company and against
the Company alleging that the Company aided and abetted the alleged breach of
fiduciary duty by the CareerStaff directors. The CareerStaff Litigation was
voluntarily dismissed without prejudice on May 8, 1996.
On June 30, 1995, two civil class action complaints were filed against the
Company and certain of its current and former directors and officers in the
United States District Court for the District of New Mexico. Two more
complaints, based on the same underlying events, were filed on August 30, 1995.
On October 6 and October 10, 1995, two additional complaints were filed, also
based on the same underlying events. These six complaints were consolidated by a
court order dated November 27, 1995 and an amended class action complaint,
captioned IN RE SUN HEALTHCARE GROUP, INC. LITIGATION (the "Complaint"), was
filed in the United States District Court for the District of New Mexico on
January 26, 1996. The Complaint was purportedly brought on behalf of all persons
who either purchased shares of the Company's common stock between October 26,
1994 and June 27, 1995, or who exchanged their shares of common stock of
CareerStaff for shares of the Company's common stock pursuant to a merger
agreement between CareerStaff and the Company. The Complaint alleges that
defendants misrepresented or failed to disclose material facts about the United
States Department of Health and Human Services' Office of Inspector General
("OIG") investigation and about the Company's operations and financial results,
which plaintiffs contend artificially inflated the price of the Company's
securities.
In October 1996, the Company reached an agreement in principle to settle
these class action lawsuits for $24,000,000 which the Company funded in the
fourth quarter of 1996. The settlement is subject to the execution of definitive
documentation and court approval. The Company received $9,000,000 from its
directors and officers liability insurance carrier for its claim submitted in
connection with the settlement in March 1997.
On or about January 23, 1996, two former stockholders of Golden Care, John
Brennan and Susan Bird, filed a lawsuit (the "Golden Care Litigation") against
the Company and certain of its officers and directors in the United States
District Court for the Southern District of Indiana. Plaintiffs allege, among
other things, that the Company did not disclose material facts concerning the
investigation by the OIG and that the Company's financial results were
misstated. The Complaint purports to state claims, INTER ALIA, under Federal and
state securities laws and for breach of contract, including a breach of the
registration rights agreement pursuant to which the Company agreed to register
the shares being registered for resale by such former Golden Care stockholders.
Plaintiffs purport to seek recission, unspecified compensatory damages, punitive
damages and other relief. By Order dated October 11, 1996, the court granted in
part
19
<PAGE>
and denied in part defendants' motion to dismiss. There can be no assurance that
the Golden Care Litigation will not have an impact on the Company's accounting
for the merger.
On September 8, 1995, a derivative action was filed by Brickell Partners
against certain of the Company's current and former directors and officers in
the United States District Court for the District of New Mexico, captioned
BRICKELL PARTNERS V. TURNER, ET AL. The complaint was not served on any
defendant. On June 19, 1996, an amended complaint alleging breach of fiduciary
duty by certain current and former of the Company's directors and officers based
on substantially the same events as those set forth in the above described
securities class actions was filed and subsequently served on the defendants. On
August 5, 1996, the District Court dismissed this action without prejudice for
failure to serve the defendants within the required time period. Brickell
Partners filed a new complaint, alleging the same claims, on August 19, 1996.
Defendants have moved to dismiss the new complaint.
The Company believes the Golden Care Litigation and the derivative action
will not have a material adverse impact on its financial condition or results of
operations, although the unfavorable resolution of any of these actions in any
reporting period could have a material adverse impact on the Company's results
of operations for that period. The foregoing statements with respect to the
possible outcomes of the Golden Care Litigation and the derivative action are
forward looking and could be affected by a number of factors, including judicial
interpretations of applicable law, the uncertainties and risks inherent in any
litigation, particularly a jury trial, the existence, scope and number of any
subsequently filed complaints, the scope of insurance coverage, and the outcome
of the OIG investigation and all factors that could affect that outcome.
In January 1995, the Company learned that it was the subject of a pending
Federal investigation. The investigating agencies are the United States
Department of Health and Human Services' Office of Inspector General and the
United States Department of Justice. The government is still in the process of
collecting information. The Company has cooperated and continues to cooperate
with the investigation.
At this time, the Company understands that the investigation includes a
review of whether the Company's rehabilitation therapy subsidiary properly
provided and/or billed for concurrent therapy services and whether it provided
unnecessary or unordered services to residents of skilled nursing facilities.
The Company understands that the investigation also includes a review of whether
its long-term care subsidiary properly disclosed its relationship with the
Company's rehabilitation therapy subsidiary and properly sought reimbursement
for services provided by that subsidiary.
The Company is unable to determine at this time when the investigation will
be concluded or what its precise scope might be. If there have been improper
practices or the investigation is broader in scope than the Company currently
understands it to be, depending on the nature and extent of such impropriety,
the investigation could result in the imposition of civil, administrative, or
criminal fines, penalties, or restitutionary relief, and may have a negative
impact on the Company. From time to time the negative publicity surrounding the
investigation has slowed the Company's success in obtaining additional outside
contracts in the rehabilitation therapy business, which has resulted in higher
than required therapist staffing levels, and has affected the private pay
enrollment in certain inpatient facilities. Based on its current understanding
of the investigation, however, the Company does not believe that the outcome of
the investigation will have a material adverse effect on the Company's financial
condition or results of operations. The foregoing statements with respect to the
outcome of the investigation are forward looking and could be affected by a
number of factors, including the actual scope of the investigation, the
government's factual findings and the interpretation of Federal statutes and
regulations by the government and Federal courts.
In 1996, the Connecticut Attorney General's office and the Connecticut
Department of Social Services ("DSS") began investigating whether Medicaid cost
reports for 1993 and 1994 submitted to the DSS by the Company's long-term care
subsidiary contained false and misleading fiscal information. Based on its
current understanding of the investigation, the Company believes the
investigation will not have a material adverse effect on the Company's financial
condition or results of operations. The foregoing statement with regard to the
outcome of this investigation is forward looking and could be affected by a
number of factors, including the factual findings and interpretation of
applicable laws and regulations by the Attorney General and the DSS.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, hereunto duly authorized.
SUN HEALTHCARE GROUP, INC.
By: /s/ Mark G. Wimer
-----------------------------------------
Mark G. Wimer
PRESIDENT AND CHIEF
OPERATING OFFICER
FEBRUARY 2, 1998
