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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X ] Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended March 31, 1999
or
[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Commission File Number: 1-12040
SUN HEALTHCARE GROUP, INC.
(Exact name of Registrant as specified in its charter)
Delaware 85-0410612
(State of Incorporation) (I.R.S. Employer
Identification No.)
101 Sun Avenue, NE
Albuquerque, New Mexico 87109
(505) 821-3355
(Address and telephone number of Registrant)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past ninety days.
Yes X No
--- ---
As of May 17, 1999, there were 60,851,089 shares of the Registrant's
$.01 par value Common Stock outstanding, net of treasury shares.
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<PAGE>
SUN HEALTHCARE GROUP, INC.
Index
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 1999
- ------------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page Numbers
------------
<S> <C> <C>
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets
March 31, 1999 and December 31, 1998 ....................3-4
Consolidated Statements of Earnings (Losses)
For the three months ended March 31, 1999 and 1998 ......5
Consolidated Statements of Comprehensive Income (Losses)
For the three months ended March 31, 1999 and 1998 ......6
Consolidated Statements of Cash Flows
For the three months ended March 31, 1999 and 1998 ......7-8
Notes to the Consolidated Financial Statements ..........9-28
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ..........29-49
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ......................................50
Item 6. Exhibits and Reports on Form 8-K .......................50
Signatures .........................................................51
</TABLE>
2
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------- ------------
(In thousands)
<S> <C> <C>
Current assets:
Cash and cash equivalents ...................... $ 47,168 $ 27,504
Accounts receivable, net of allowance for
doubtful accounts of $86,314 as of March 31,
1999, and $79,015 as of December 31, 1998 ... 451,216 538,329
Other receivables .............................. 35,073 48,073
Inventory, net ................................. 50,973 48,862
Prepaids and other assets ...................... 15,536 13,091
Income tax receivables ......................... 14,760 15,874
---------- ----------
Total current assets .......................... 614,726 691,733
---------- ----------
Property and equipment, net .................... 617,482 601,270
Goodwill, net .................................. 804,691 795,945
Notes receivable ............................... 34,377 32,334
Assets held for sale ........................... 178,647 192,447
Other assets, net .............................. 134,992 148,309
Deferred tax assets ............................ -- 6,000
---------- ----------
Total assets ............................. $2,384,915 $2,468,038
========== ==========
</TABLE>
3
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
As of As of
March 31, December 31,
1999 1998
------------- -------------
(In thousands)
<S> <C> <C>
Current liabilities:
Current portion of long-term debt ......................................... $ 85,907 $ 80,914
Credit facility borrowings ................................................ 813,305 731,707
Current portion of obligations under capital leases ....................... 3,798 3,703
Accounts payable .......................................................... 40,174 94,143
Accrued compensation and benefits ......................................... 107,626 102,091
Accrued interest .......................................................... 25,098 26,095
Accrued self-insurance obligations ........................................ 55,293 54,865
Other accrued liabilities ................................................. 146,438 137,851
----------- -----------
Total current liabilities ............................................ 1,277,639 1,231,369
----------- -----------
Long-term debt, net of current portion ........................................... 687,790 705,653
Obligations under capital leases, net of current portion ......................... 101,351 103,679
Other long-term liabilities ...................................................... 40,384 41,061
----------- -----------
Total liabilities .................................................... 2,107,164 2,081,762
----------- -----------
Commitments and contingencies
Minority interest ................................................................ 6,011 7,517
Company-obligated mandatorily redeemable convertible preferred securities
of a subsidiary trust holding solely 7% convertible junior subordinated
debentures of the Company ................................................. 345,000 345,000
Stockholders' equity:
Preferred stock of $.01 par value, authorized 5,000,000 shares, none issued -- --
Common stock of $.01 par value, authorized 155,000,000 shares 62,610,489
and 61,930,159 shares issued and outstanding as of March 31, 1999
and December 31, 1998, respectively .................................. 626 619
Additional paid-in capital ................................................ 775,237 774,860
Retained deficit .......................................................... (809,196) (696,049)
Accumulated other comprehensive income .................................... (3,001) 2,902
----------- -----------
(36,334) 82,332
----------- -----------
Less:
Unearned compensation ..................................................... 7,779 8,552
Common stock held in treasury, at cost, 2,169,443 and 2,124,868 shares
as of March 31, 1999 and December 31, 1998 respectively .............. 27,231 26,967
Grantor stock trust, at market, 1,915,925 and 1,989,132 shares as of
March 31, 1999 and December 31, 1998, respectively ................... 1,916 13,054
----------- -----------
Total stockholders' equity ........................................... (73,260) 33,759
----------- -----------
Total liabilities and stockholders' equity ........................... $ 2,384,915 $ 2,468,038
=========== ===========
The accompanying notes are an integral part of these consolidated balance sheets.
</TABLE>
4
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (LOSSES)
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months Ended March 31,
------------------------------------
1999 1998
---- ----
(In thousands, except per share data)
<S> <C> <C>
Total net revenues ........................................... $ 673,032 $ 741,490
--------- ---------
Costs and expenses:
Operating ................................................ 624,570 608,585
Corporate general and administrative ..................... 42,017 39,301
Provision for losses on accounts receivable .............. 13,818 6,013
Depreciation and amortization ............................ 21,448 20,474
Interest, net ............................................ 37,170 35,140
Loss on sale of assets ................................... 12,106 --
Loss on termination of interest rate swaps ............... 2,488 --
Restructuring costs ...................................... 11,428 --
--------- ---------
Total costs and expenses .............................. 765,045 709,513
Dividends on convertible preferred securities ................ 6,516 --
--------- ---------
Earnings (losses) before income taxes ........................ (98,529) 31,977
Income taxes ................................................. 892 13,590
--------- ---------
Net earnings (losses) before cumulative effect of
change in accounting principle ............................ (99,421) 18,387
--------- ---------
Cumulative effect of change in accounting principle .......... 13,726 --
--------- ---------
Net earnings (losses) ........................................ $(113,147) $ 18,387
========= =========
Net earnings (losses) per common and common equivalent share
before cumulative effect of change in accounting principle:
Basic ................................................. $ (1.73) $ 0.39
========= =========
Diluted ............................................... $ (1.73) $ 0.37
========= =========
Net earnings (losses) per common and common equivalent share:
Basic ................................................. $ (1.96) $ 0.39
========= =========
Diluted ............................................... $ (1.96) $ 0.37
========= =========
Weighted average number of common and common equivalent
shares outstanding:
Basic ................................................. 57,621 46,905
========= =========
Diluted ............................................... 57,621 52,381
========= =========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
5
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSSES)
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months Ended March 31,
------------------------------------
1999 1998
---- ----
(In thousands)
<S> <C> <C>
Net earnings (losses) .................................... $ (113,147) $ 18,387
Foreign currency translation adjustments, net of tax ..... (5,903) 3,625
----------- ---------
Comprehensive income (losses) ............................ $ (119,050) $ 22,012
=========== =========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
6
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months Ended March 31,
------------------------------------
1999 1998
---- ----
(In thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (losses) ........................................ $(113,147) $ 18,387
Adjustments to reconcile net earnings (losses) to net cash
provided by (used for) operating activities:
Cumulative effect of change in accounting principle .. 13,726
Loss on sale of assets ................................ 12,106 --
Depreciation and amortization ......................... 21,448 20,474
Provision for losses on accounts receivable ........... 13,818 6,013
Other, net ............................................ 786 2,086
Changes in operating assets and liabilities:
Accounts receivable ................................ 70,434 (85,499)
Other current assets ............................... 7,813 (21,638)
Other current liabilities .......................... (41,296) 12,252
Income taxes payable ............................... (481) 12,175
---------- ----------
Net cash used for operating activities ............. $ (14,793) $ (35,750)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net .................................... (39,469) (24,829)
Acquisitions, net of cash acquired ........................... (1,225) (7,339)
Increase in long-term notes receivable ....................... (2,043) (6,857)
Other assets expenditures .................................... (1,980) (9,909)
---------- ----------
Net cash used for investing activities ............. (44,717) (48,934)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings .................................... 110,405 88,318
Long-term debt repayments .................................... (27,653) (22,070)
Conversion of Mediplex 6 1/2% Convertible Subordinated
Debentures due 2003 ........................................ (5,840) -
Net proceeds from issuance of common stock ................... 462 543
Purchases of treasury stock .................................. (264) (1,357)
Other financing activities ................................... (283) (255)
---------- ----------
Net cash provided by financing activities .......... 76,827 65,179
---------- ----------
Effect of exchange rate on cash and cash equivalents ............ (2,347) (402)
---------- ----------
Net increase (decrease) in cash and cash equivalents ............ 19,664 (19,907)
Cash and cash equivalents at beginning of year .................. 27,504 21,020
---------- ----------
Cash and cash equivalents at end of period ...................... $ 47,168 $ 1,113
========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
(Continued on next page)
</TABLE>
7
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months Ended March 31,
------------------------------------
1999 1998
---- ----
(In thousands)
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during period for:
Interest net of $439 and $573 capitalized during the
three months ended March 31, 1999 and 1998, respectively .... $ 39,692 $ 43,897
========== =========
Income taxes .................................................. $ 1,373 $ 505
========== =========
SUPPLEMENTARY SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
The Company's acquisitions during the three months ended
March 31, 1999 and 1998 involved the following:
Fair value of assets acquired ................................. $ 2,275 $ 7,438
Liabilities assumed ........................................... (1,050) (99)
---------- ---------
Cash payments made, net of cash received from others .......... $ 1,225 $ 7,339
========== =========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
8
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
In the opinion of management of Sun Healthcare Group, Inc. (the "Company"
or "Sun"), the accompanying interim consolidated financial statements present
fairly the Company's financial position at March 31, 1999 and December 31, 1998,
the consolidated results of its operations for the three month periods ended
March 31, 1999 and 1998, and the consolidated statements of cash flows for the
three month periods ended March 31, 1999 and 1998. All adjustments are of a
normal and recurring nature. These statements are presented in accordance with
the rules and regulations of the United States Securities and Exchange
Commission ("SEC"). Accordingly, they are unaudited, and certain information and
footnote disclosures normally included in the Company's annual consolidated
financial statements have been condensed or omitted, as permitted under the
applicable rules and regulations. Readers of these statements should refer to
the Company's audited consolidated financial statements and notes thereto for
the year ended December 31, 1998, which are included in the Company's Annual
Report on Form 10-K as amended on Form 10-K/A for the year ended December 31,
1998. The results of operations presented in the accompanying financial
statements are not necessarily representative of operations for an entire year.
Certain amounts in the 1998 consolidated financial statements and notes
have been reclassified to conform to the 1999 presentation.
ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS
In 1998, the American Institute of Certified Public Accountants issued
Statement of Position, "Reporting on the Costs of Start-up Activities" ("SOP
98-5"). This statement requires costs of start-up activities and organization
costs to be expensed as incurred. The statement is effective for financial
statements for fiscal years beginning after December 15, 1998. In the first
quarter of 1999, the Company adopted the provisions of SOP 98-5 which resulted
in a cumulative effect of an accounting change pretax charge of $13.7 million.
Pro Forma amounts, assuming the new accounting principal was applied during
the three months ended March 31, 1998 are as follows:
<TABLE>
<CAPTION>
<S> <C>
Net earnings as reported ....................................... $ 18,387
========
Pro Forma net earnings .................................... $ 15,391
========
Net earnings per common and common equivalent share as reported:
Basic ..................................................... $ .39
========
Diluted ................................................... $ .37
========
Pro Forma net earnings per common and common equivalent share:
Basic ..................................................... $ .33
========
Diluted ................................................... $ .29
========
</TABLE>
9
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NEWLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). Under SFAS 133, which will be effective
January 1, 2000, all derivatives are required to be recognized on the balance
sheet at fair value. Gains or losses from changes in fair value would be
recognized in earnings in the period of change unless the derivative is
designated as a hedging instrument. The Company is studying the impact of the
new standard and is unable to predict at this time the impact on its
consolidated financial statements.
2. NON-COMPLIANCE WITH SENIOR CREDIT FACILITY'S FINANCIAL COVENANTS AND
LIQUIDITY
The Company was not in compliance with certain financial covenants
contained in the Senior Credit Facility as of December 31, 1998 and March 31,
1999. Borrowings under the Senior Credit Facility were $745.6 million and $826.8
million at December 31, 1998 and March 31, 1999. On April 29, 1999, the Company
entered into an agreement that waives compliance with the covenants from
December 30, 1998 until May 28, 1999. The terms of the waiver require among
other things that the Company take advantage of the 30-day grace period of the
payment of interest on the Company's $150 million 9 3/8% subordinated notes due
2008, which payment was due May 1, 1999. If the Company does not make the
interest payment by May 31, 1999, the Company would be in default under the
indenture for the 9 3/8% notes, which would cause the Company to be in
cross-default on certain other debt obligations of the Company. The Company
continues to seek an amendment to its Senior Credit Facility agreement that
would bring it into full compliance but cannot predict when or if such an
amendment will be obtained.
Because the Company was not in compliance with certain financial covenants
under the terms of the Senior Credit Facility, the Lenders could have required
immediate repayment of all amounts outstanding under the Senior Credit Facility.
As a result, as of December 31, 1998, the Company classified all borrowings
under the Senior Credit Facility as current liabilities. Although compliance
with the covenants has been waived, the borrowings remain classified as current
liabilities in the accompanying consolidated balance sheet because of the
short-term nature of the waiver. The Company does not have sufficient cash
reserves to repay all amounts outstanding under the Senior Credit Facility at
May 19, 1999. No further amounts may be borrowed under the Senior Credit
Facility. Accordingly, the Company will have to fund all operations, capital
expenditures and regularly scheduled debt service from existing cash reserves
and future net cash flows from operations, if any.
The Company is in default of certain Mortgage Notes amounting to $31.8
million and $31.9 million at December 31, 1998 and March 31, 1999, respectively,
because the Company did not meet its debt service coverage requirement of at
least 1.25 to 1. The Company is attempting to obtain a waiver of the
non-compliance with the financial covenant and to amend these Mortgage Notes'
financial covenants so that the financial covenants will be consistent with the
Company's revised business plan. However, as of May 19, 1999, no agreement to
waive the non-compliance with the financial covenant or to amend the financial
covenants has been reached. Because the Company is in non-compliance with the
terms of certain Mortgage Notes, the holder of these Mortgage Notes could demand
immediate repayment of all amounts due under the mortgages and foreclose on four
facilities. Such amounts are classified as current liabilities as of December
31, 1998 and March 31, 1999.
10
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
If the Company is required to repay the amounts outstanding under the
Senior Credit Facility and the Mortgage Notes, or is unable to fund all
operations, capital expenditures and regularly scheduled debt service, it will
explore a variety of options, including seeking relief under the United States
Bankruptcy Code.
The Company also has other debt arrangements that provide that a default on
any mortgage indenture or instrument which results in the acceleration of
repayment or default in payment of obligations from $0.1 million to in excess of
$20.0 million depending on the terms of the agreement, would allow the creditor
to demand immediate repayment. No acceleration of repayment has occurred and
therefore such borrowings which total $520.9 million are classified as long-term
liabilities as of December 31, 1998 and March 31, 1999.
As of December 31, 1998 and March 31, 1999, the Company was in
non-compliance with certain financial covenants contained in certain master
lease agreements for 96 of its long-term care facilities in the United States
and 33 of its long-term care facilities in the United Kingdom. As a result, the
lessors under these master lease agreements have certain rights, including the
right to require that the Company relinquish the leased facilities. As of May
19, 1999, the lessors had not exercised their rights under their respective
agreements, although there can be no assurance that the lessors will not do so
in the future. Prior to obtaining a waiver of noncompliance with certain
financial covenants in the Senior Credit Facility, the Company was also in cross
default for 14 of its long-term care facilities in the United States as of
December 31, 1998 and March 31, 1999. The aggregate net book value of properties
subject to potential eviction amounted to $54.8 million at December 31, 1998.
The Company has a substantial number of other leases which may contain similar
default or cross default provisions.
3. ACQUISITIONS
On June 30, 1998, the Company acquired Retirement Care Associates, Inc.
("RCA") and approximately 35% of the common stock of Contour Medical, Inc.
("Contour"), collectively referred to as the RCA Acquisition. RCA was an
operator of skilled nursing facilities and assisted living centers in eight
states, primarily in the southeastern United States. Contour was a national
provider of medical and surgical supplies. RCA owned approximately 65% of
Contour prior to the RCA Acquisition. The Company issued approximately 7.6
million shares of its common stock valued at $122.0 million (based upon the
average closing price of the Company's common stock for 20 business days prior
to the acquisition closing date) for all outstanding common stock and certain
redeemable preferred shares of RCA. In addition, the Company issued
approximately 1.9 million shares of its common stock valued at $27.6 million for
the minority interest in Contour's common stock. The Company also issued 298,334
shares of its Series B Convertible preferred stock, which were subsequently
converted into 287,892 shares of Sun common stock, in exchange for the
outstanding shares of RCA's Series F preferred stock. The Company assumed
approximately $170.4 million of RCA indebtedness.
11
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The RCA Acquisition was accounted for as a purchase and resulted in $234.7
million of goodwill. The results of operations of RCA and Contour have been
included in the consolidated statements of earnings (losses) from the
acquisition date. In connection with the purchase, the Company recorded purchase
liabilities including approximately $2.5 million for severance and related costs
and $1.4 million for costs associated with the shut down of certain
administrative facilities. The allocation of the RCA Acquisition purchase price
is preliminary and will be finalized upon the completion of long-lived asset
valuations. In addition, the Company is still evaluating certain obligations of
RCA prior to the acquisition and further adjustments to the preliminary purchase
price allocation may result.
The following unaudited pro forma results assumes that the RCA Acquisition
occurred as of January 1, 1998 and includes its results of operations for the
three months ended March 31, 1998 (in thousands, except per share data):
<TABLE>
<CAPTION>
1998
----
Unaudited
<S> <C>
Net revenues ................................................ $ 810,717
Net earnings ................................................ 6,792
Per Share Data:
Net earnings per share:
Basic .................................................. $.12
Diluted ................................................ $.12
</TABLE>
In addition, during the three months ended March 31, 1998, the Company
acquired from various third parties the net ownership of, leasehold rights to,
or the management contracts of, two long-term care facilities in the United
States and 15 long-term care facilities in the United Kingdom. Also, during the
three months ended March 31, 1998, the Company acquired nine pharmacies in the
United States. The pro forma impact of these acquisitions with the exception of
RCA is immaterial.
4. RESTRUCTURING COSTS
In the first quarter of 1999, the Company initiated a second restructuring
plan focused on further reducing the operating expenses of its United States
operations. Related to the restructuring plan, the Company recorded a first
quarter charge of approximately $11.4. The restructuring plan includes the
termination of 2,900 of its rehabilitation and respiratory therapy services
employees, and 80 of its corporate employees including certain executive
positions. The restructuring plan also included the closure of approximately 23
divisional and regional offices related to the aforementioned operations. In
addition, the plan includes the relocation of the Company's medical supply
subsidiary and temporary therapy services subsidiary to the Company's corporate
headquarters in Albuquerque, New Mexico. As part of the relocation, the Company
will terminate 96 employees of these subsidiaries. As of March 31, 1999, the
Company paid approximately $4.4 million in termination benefits under the 1999
restructuring plan. The 1999 restructuring charge consists of approximately $9.1
million related to employee terminations, approximately $1.4 million related to
lease termination costs and $0.9 million related to asset disposals or
write-offs. As of March 31, 1999, the Company's 1999 restructuring costs reserve
balance was approximately $7.0 million.
12
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In the fourth quarter of 1998, the Company had an initial restructuring
plan and recorded a fourth quarter charge of $4.6 million. As of March 31, 1999,
the Company's 1998 restructuring costs reserve balance was approximately $0.5
million and is substantially complete.
5. ASSETS HELD FOR SALE
Subsequent to December 31, 1998, the Company decided to dispose of several
non-core businesses, including assisted living facilities, rehabilitation
hospitals and other in-patient facilities and other non-core businesses. The
Company recorded a loss of $161.6 million in the fourth quarter of 1998 to
reduce the carrying amount of the non-core businesses identified for disposal to
fair value based on estimates of selling value less costs to sell. The Company
recorded an additional net loss of $10.1 million in the first quarter of 1999
based on revised estimates of selling value less costs to sell. In addition, the
Company has decided not to dispose of certain non-core businesses previously
recorded in assets held for sale. The reversal of $7.0 million of the loss on
disposition was recognized in 1999. The following is a summary of the carrying
amounts and additional loss for the three months ended March 31, 1999 related to
the non-core businesses to be disposed of as of March 31, 1999 (in thousands):
<TABLE>
<CAPTION>
Carrying
Amount Loss
------ ----
<S> <C> <C>
Assisted living facilities ....................... $ 111,848 $ 5,450
Rehabilitation hospitals and other
inpatient facilities ............................ 90,201 (6,290)
Other non-core businesses ........................ 17,882 10,939
--------- ---------
Total ........................................ $ 219,931 $ 10,099
========= =========
</TABLE>
Management expects to complete the sales of these businesses during 1999.
In May 1997, the Company announced its intent to sell and divest of its
outpatient rehabilitation clinics in the United States, as well as Canada. The
carrying amount of the assets held for sale was $243.8 million as of December
31, 1998. The Company completed the sale of the Canadian clinics during the
first quarter of 1999. The Company recorded a loss of $2 million on the sale of
the Canadian clinics. The results of operations of these businesses is not
material.
13
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
6. INTEREST RATE SWAP TRANSACTIONS
In April 1999, the interest rate swap transactions were terminated due
to an event of default relating to the Company's non-compliance with certain
covenants contained in the Senior Credit Facility. The termination resulted in a
$2.5 million pre-tax charge in the first quarter of 1999.
7. COMMITMENTS
(A) CONSTRUCTION COMMITMENTS
The Company had capital commitments, as of March 31, 1999, under various
contracts of approximately $32.1 million in the United States. These include
contractual commitments to improve existing facilities and to develop, construct
and complete a corporate office building and a long-term care facility in the
United States and two long term care facilities in the United Kingdom.
(B) FINANCING COMMITMENTS
The Company has advanced $36.3 million and has agreed to advance up to a
total of $40.0 million, plus an additional $5.0 million to cover accrued
interest due and owing to the Company and other lenders, to a developer of
assisted living facilities to cover 20% of the costs of the development,
construction and operation of assisted living facilities. Advances under the
arrangement are part of the Company's assisted living investment that is
classified as Assets Held for Sale.
(C) LITIGATION
The Company is a party to various legal actions and administrative
proceedings and subject to various claims arising in the ordinary course of
business (see Note 9).
8. NET EARNINGS (LOSSES) PER SHARE
Basic net earnings (losses) per share is based upon the weighted average
number of common shares outstanding during the period.
Diluted net earnings per share in periods of earnings is based upon the
weighted average number of common shares outstanding during the period plus the
number of incremental shares of common stock contingently issuable upon exercise
of stock options and, if dilutive, including the assumption that the Company=s
convertible securities were converted as of the beginning of the period. Net
earnings, if conversion of the securities is assumed, is adjusted for the
interest on the debentures, net of interest related to additional assumed
borrowings to fund the cash consideration on conversion of certain convertible
securities and the related income tax benefits. In periods of losses, diluted
net earnings (losses) per share is based upon the weighted average number of
common shares outstanding during the period. As the Company had a net loss for
the three months ended March 31, 1999, the Company's stock options and
convertible debentures were anti-dilutive.
14
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Earnings per share is calculated as follows for the three months ended
March 31, (in thousands, except per share data):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
BASIC:
Net earnings (losses) before cumulative
effect of change in accounting principle ...... $ (99,421) $18,387
Earnings per share .............................. $ (1.73) $ 0.39
======== =======
Net earnings (losses) ........................... $(113,147) $18,387
Earnings (losses) per share ..................... $ (1.96) $ 0.39
======== =======
Weighted average shares outstanding ............. 57,621 46,905
DILUTED:
Net earnings (losses) before cumulative
effect of change in accounting principle ...... $ (99,421) $18,387
Income impact of assumed conversion ............. - 811
---------- -------
Adjusted net earnings (losses) before cumulative
effect of change in accounting principle ...... $ (99,421) $19,198
Earnings (losses) per share before cumulative
effect of change in accounting principle ...... $ (1.73) $ 0.39
========== =======
Net earnings (losses) ........................... $ (99,421) $18,387
Income impact of assumed conversion ............. - 811
---------- -------
Adjusted net earnings (losses) .................. $ (99,421) $19,198
Earnings (losses) per share ..................... $ (1.96) $ 0.37
========== =======
Weighted average shares used in basic
calculation ................................... 57,621 46,905
Effect of dilutive securities:
Stock options and warrants .................... - 831
Assumed conversion of convertible debt ........ - 4,645
--------- -------
Weighted average common and common equivalent
shares outstanding ............................ 57,621 52,381
========= =======
</TABLE>
9. OTHER EVENTS
(A) LITIGATION
In March, April and May, 1999, class action lawsuits were filed against the
Company and three officers of the Company in the United States District Court
for the District of New Mexico on behalf of purchasers of the Company's common
stock during the class period. These actions have been consolidated as IN RE SUN
HEALTHCARE GROUP, INC. SECURITIES LITIGATION MASTER FILE NO. CIV99-269. The
lawsuits allege, among other things, that the Company did not disclose material
facts concerning the impact that PPS would have on the Company's results of
operations. The lawsuits seek compensatory damages and other relief. Although
the Company intends to vigorously defend itself in this matter, there can be no
assurance that the outcome of this matter will not have a material adverse
effect on the results of operations and financial condition of the Company.
15
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In January 1999, the state of Florida filed criminal charges in the Circuit
Court of the Eighth Judicial Circuit for Alachua County, Florida against three
subsidiaries which were acquired by the Company on June 30, 1998: RCA, Capitol
Care Management Co., Inc. and Gainesville Health Care Center, Inc. All of the
allegations of wrongdoing relate to activities prior to June 30, 1998, the date
of the RCA acquisition. Florida's allegations include violations of certain RICO
laws, abuse or neglect of elderly or disabled persons, grand theft and Medicaid
fraud at a nursing home facility in Florida. Also named as defendants were five
individuals who were involved in the operation of the facility in their
capacities as officers, directors or employees of the defendant entities. If the
defendant entities are convicted, they could be banned from participating in the
Florida Medicaid program. Although the Company's subsidiaries will defend
themselves vigorously in this matter, there can be no assurance that the outcome
of this matter will not have a material adverse effect on the results of
operations and financial condition of the Company.
The Company and certain of its subsidiaries are defendants in two QUI TAM
lawsuits brought by private citizens in the United States District Court for the
Eastern District of California alleging violations of the federal False Claims
Act. The plaintiffs allege that skilled nursing facilities operated by the
subsidiaries and others conspired over the last decade to (i) falsely certify
compliance with regulatory requirements in order to participate in the Medicare
and Medicaid programs, and (ii) falsify records to conceal failures to provide
services in accordance with such regulatory requirements. Although the Company
and its subsidiaries intend to vigorously defend themselves in these matters,
there can be no assurance that the outcome of any one of these matters will not
have a material adverse effect on the results of operations and financial
condition of the Company.
In March 1999, the Company and several of its subsidiaries filed a lawsuit
in the Superior Court of Fulton County in the State of Georgia against certain
individuals who served as directors, officers or employees of Retirement Care
Associates, Inc. ("RCA") prior to the Company's acquisition of RCA, and against
various entities such individuals owned or controlled or with which they have
been affiliated. The lawsuit alleges, among other things, breaches of fiduciary
duties, breaches of contract and conversion. The Company seeks damages in excess
of $30 million and punitive amounts. In May 1999, certain defendants in this
lawsuit filed counterclaims against certain plaintiffs alleging, among other
things, securities fraud, negligent misrepresentation and breach of contract.
Defendants seek damages in an amount to be determined at trial and punitive
amounts.
Between August 25, 1997 and October 24, 1997, 10 class action lawsuits (the
"Actions") were filed in the United States District Court for the Northern
District of Georgia on behalf of persons who purchased RCA Common Stock, naming
RCA and certain of its officers and directors as defendants. The complaints have
overlapping defendants and largely overlapping (although not identical) class
periods. The complaints allege violations of Federal securities laws by the
defendants for disseminating allegedly false and misleading financial statements
for RCA's fiscal year ended June 30, 1996 and its first three quarters of fiscal
year 1997, which the plaintiffs allege materially overstated RCA's
profitability. Generally, each of the Actions seeks unspecified compensatory
damages, prejudgment and postjudgment interest, attorneys' fees and costs and
other equitable and injunctive relief.
On November 25, 1997, RCA, the Company and representatives of the
plaintiffs in the Actions entered into a Memorandum of Understanding ("MOU").
Pursuant to the MOU, the Company paid $9 million into an interest-bearing escrow
account maintained by the Company (the "Escrow Account") to settle the Actions
(the "Settlement"). RCA also agreed to assign coverage under its directors' and
officers' liability insurance policy for these specific claims to the
plaintiffs. The parties have signed the Settlement Agreement and the hearing for
court approval of the settlement is currently scheduled for July 21, 1999. Upon
court approval of the Settlement, all claims by the class that were or could
have been asserted by the plaintiffs against RCA or any of the other defendants
in the Actions will be settled and released, and the Actions will be dismissed
in their entirety with prejudice in exchange for the release of all funds from
the Escrow Account to the Plaintiffs. No assurance can be given that the
Settlement will become final.
16
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company is a party to various other 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
other matters will have a material adverse effect on the financial position or
results of operations of the Company.
(B) OTHER INQUIRIES
From time to time, fiscal intermediaries and Medicaid agencies examine cost
reports filed by predecessor operators of the Company's skilled nursing
facilities. If, as a result of any such examination, it is concluded that
overpayments to a predecessor operator were made, the Company, as the current
operator of such facilities, may be held financially responsible for such
overpayments. At this time the Company is unable to predict the outcome of any
existing or future examinations.
The Company was notified in 1997 by a law firm representing several
national insurance companies that these companies believed that the Company had
engaged in improper billing and other practices in connection with the Company's
delivery of therapy and related services. In response, the Company began
discussions directly with these insurers and hopes to resolve these matters
without litigation; however, the Company is unable at this time to predict
whether it will be able to do so, what the eventual outcome may be or the extent
of its liability, if any, to these insurers.
(C) LEGISLATION, REGULATIONS AND MARKET CONDITIONS
The Company is subject to extensive Federal, state and local government
regulation relating to licensure, conduct of operations, ownership of
facilities, expansion of facilities and services and reimbursement for services.
As such, in the ordinary course of business, the Company's operations are
continuously subject to state and Federal regulatory scrutiny, supervision and
control. Such regulatory scrutiny often includes inquiries, investigations,
examinations, audits, site visits and surveys, some of which may be non-routine.
The Company believes that it is in substantial compliance with the applicable
laws and regulations. However, if the Company is ever found to have engaged in
improper practices, it could be subjected to civil, administrative or criminal
fines, penalties or restitutionary relief.
17
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
10. SUMMARIZED FINANCIAL INFORMATION
The Company acquired The Mediplex Group, Inc. ("Mediplex") on June 23, 1994
and became a co-obligor with Mediplex with respect to the 62% Convertible
Subordinated Debentures and the 11% Senior Subordinated Notes subsequent to the
acquisition. Summarized financial information of Mediplex is provided below (in
thousands):
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
-------- -----------
<S> <C> <C>
Current assets ................................... $ 89,605 $113,585
Noncurrent assets ................................ 221,116 225,586
Current liabilities .............................. 3,129 13,165
Noncurrent liabilities ........................... 51,976 69,454
Due to parent .................................... 224,568 206,161
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------
1999 1998
---- ----
<S> <C> <C>
Net revenues ............................................. $ 111,435 $ 144,631
Costs and expenses ....................................... 109,128 136,106
---------- ----------
Earnings (losses) before intercompany charges,
income taxes and cumulative effect of change
in accounting principle ............................... 2,307 8,525
Intercompany charges (1) ................................. 18,767 24,265
---------- ----------
Earnings (losses) before income taxes and
cumulative effect of change in accounting principle ... (16,460) (15,740)
Income taxes (benefit) ................................... 363 (6,763)
---------- ----------
Net earnings (losses) before cumulative effect of
change in accounting principle ........................ (16,823) (8,977)
---------- ----------
Cumulative effect of change in accounting principle ...... 2,520 -
---------- ----------
Net earnings (losses) .................................... $ (19,343) $ (8,977)
========== ==========
</TABLE>
(1) Through various intercompany agreements entered into by Sun and Mediplex,
Sun provides management services, licenses the use of its trademarks and
acts on behalf of Mediplex to make financing available for its operations.
Sun charged Mediplex for management services totaling $3.7 million and
$11.4 million for the three months ended March 31, 1999 and 1998,
respectively. Royalty fees charged to Mediplex for the three months ended
March 31, 1999 and 1998 for the use of Sun trademarks were $1.7 million and
$2.6 million, respectively. Intercompany interest charged to Mediplex for
the three months ended March 31, 1999 and 1998 for advances from Sun was
$18.8 million and $10.2 million, respectively.
18
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
11. SEGMENT INFORMATION
See Overview in Management's Discussion and Analysis of Financial Condition
and Results of Operations.
<TABLE>
<CAPTION>
Rehabilitation
and
Respiratory Pharmaceutical
Inpatient Therapy and Medical International Other Intersegment
Services Services Supply Services Operations Operations Corporate Eliminations Consolidated
-----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
For the Three Months Ended March 31, 1998
Total Net Revenues ..... $485,177 $177,393 $52,877 $66,306 $67,256 $ 332 $(107,851) $741,490
Operating expenses,
corporate general
and administrative
expenses, provision
for losses on
accounts receivable .. 449,196 117,720 45,057 60,005 61,396 26,471 (105,946) 653,899
Depreciation and
amortization ....... 8,917 2,087 1,506 5,099 1,060 1,805 - 20,474
Interest, net .......... 1,174 (2) 8 4,582 40 29,338 - 35,140
Earnings (losses)
before corporate
allocations .......... 25,890 57,588 6,306 (3,380) 4,760 (57,282) (1,905) 31,977
Corporate interest
allocation ........... 11,302 3,963 2,114 6,459 1,768 (25,606) - -
Corporate management
fees ................. 20,365 7,156 2,087 624 1,305 (29,632) (1,905) -
Net segment earnings
(losses) ............. (5,777) 46,469 2,105 (10,463) 1,687 (2,044) - 31,977
Intersegment revenues .. 5,969 79,547 15,220 - 7,115 - (107,851) -
Identifiable segment
assets ............... 652,892 253,216 98,502 552,890 102,992 1,802,275 (774,781) 2,687,986
Segment capital
expenditures, net ..... 6,660 4,441 793 5,500 - 7,435 - 24,829
</TABLE>
19
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
<TABLE>
<CAPTION>
Rehabilitation
and
Respiratory Pharmaceutical
Inpatient Therapy and Medical International Other Intersegment
Services Services Supply Services Operations Operations Corporate Eliminations Consolidated
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
For the Three Months Ended March 31, 1999
Total Net Revenues ...... $461,105 $70,066 $75,822 $71,664 $64,514 $ (968) $(69,171) $673,032
Operating expenses,
corporate general and
administrative expenses,
provision for losses on
accounts receivable ... 447,201 67,426 73,766 67,560 63,075 30,548 (69,171) 680,405
Depreciation and
amortization .......... 8,464 2,140 2,072 3,514 2,751 2,507 - 21,448
Interest, net ........... 2,260 74 21 3,214 2,047 29,554 - 37,170
Dividend on convertible
preferred securities ... - - - - - 6,516 - 6,516
Earnings (losses)
before corporate
allocations ........... 3,180 426 (37) (2,624) (3,359) (70,093) (72,507)
Corporate interest
allocation ............ 13,517 3,463 3,398 5,122 2,904 (28,404) - -
Corporate management
fees .................. 18,140 2,795 3,007 711 1,902 (26,555) - -
Net segment earnings
(losses) .............. (28,477) (5,832) (6,442) (8,457) (8,165) (15,134) - (72,507)
Intersegment revenues ... 150 38,770 23,774 - 6,428 49 (69,171) -
Identifiable segment
assets ................ 727,417 205,866 131,072 448,701 284,509 1,631,676 (1,044,326) 2,384,915
Segment capital
expenditures, net .... 12,366 2,413 1,692 (2,630) 4,221 16,147 - 39,469
</TABLE>
12. SUMMARIZED CONSOLIDATING INFORMATION
In connection with the Company's offering of the 9 1/2% Notes in July 1997
and the 9 3/8% Notes in May, 1998 all direct and indirect subsidiaries of the
Company other than the Company's direct and indirect foreign subsidiaries,
CareerStaff and its direct and indirect subsidiaries, and certain other
immaterial subsidiaries of the Company (the "Guarantors") have, jointly and
severally, unconditionally guaranteed the 9 1/2% Notes and 9 3/8% Notes. These
guarantees are subordinated to all existing and future senior debt and
guarantees of the Guarantors and are unsecured.
The Company conducts all of its business through and derives virtually all
of its income from its subsidiaries. Therefore, the Company's ability to make
required payments with respect to its indebtedness (including the 9 1/2% Notes
and the 9 3/8% Notes) and other obligations depends on the financial results and
condition of its subsidiaries and its ability to receive funds from its
subsidiaries. There are no restrictions on the ability of any of the Company's
subsidiaries to transfer funds to the Company, except as provided by appropriate
law.
20
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Pursuant to Rule 3-10 of Regulation S-X, the following summarized
consolidating information is for the Company, the wholly-owned Guarantors, and
the Company's non-Guarantor subsidiaries with respect to the 9 1/2% Notes and
the 9 3/8% Notes. This summarized financial information has been prepared from
the books and records maintained by the Company, the Guarantors and the
non-Guarantor subsidiaries. The summarized financial information may not
necessarily be indicative of results of operations or financial position had the
Guarantors or non-Guarantor subsidiaries operated as independent entities. The
separate financial statements of the Guarantors are not presented because
management has determined they would not be material to investors.
21
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONSOLIDATING BALANCE SHEET
As of December 31, 1998
(In thousands)
<TABLE>
<CAPTION>
Combined Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Elimination Consolidated
------- ------------ ------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents ........... $ (9,964) $ 26,406 $ 11,062 $ - $ 27,504
Accounts receivable, net ............ 311 485,293 60,313 (7,588) 538,329
Other receivables ................... 14,304 17,600 16,169 - 48,073
Inventory, net ...................... 13 39,640 9,209 - 48,862
Prepaids and other assets ........... 2,651 9,151 1,289 - 13,091
Income tax receivable ............... 15,874 - - - 15,874
----------- ----------- ----------- ----------- -----------
Total current assets .............. 23,189 578,090 98,042 (7,588) 691,733
----------- ----------- ----------- ----------- -----------
Property and equipment, net ......... 66,341 228,732 306,197 - 601,270
Goodwill, net ....................... - 669,785 126,160 - 795,945
Notes receivable .................... 21,999 693 9,642 - 32,334
Assets held for sale ................ - 192,447 - - 192,447
Other assets, net ................... 75,710 50,287 22,312 - 148,309
Investment in subsidiaries .......... (904) - - 904 -
Deferred tax assets ................. 6,000 - - - 6,000
----------- ----------- ----------- ----------- -----------
Total assets ...................... $ 192,335 $ 1,720,034 $ 562,353 $ (6,684) $ 2,468,038
=========== =========== =========== ============ ===========
Current liabilities:
Current portion of long-term debt ... $ 728,032 $ 57,212 $ 27,377 $ - 812,621
Current portion of obligations under
capital leases .................... 1,134 2,333 236 - 3,703
Accounts payable .................... 63,170 17,192 21,369 (7,588) 94,143
Accrued compensation and benefits ... 19,160 69,510 13,421 - 102,091
Accrued interest payable ............ 19,616 5,957 522 - 26,095
Accrued self insurance obligations .. (2,713) 56,241 1,337 - 54,865
Other accrued liabilities ........... 23,699 77,128 37,024 - 137,851
----------- ----------- ----------- ----------- -----------
Total current liabilities .......... 852,098 285,573 101,286 (7,588) 1,231,369
----------- ----------- ----------- ----------- -----------
Long-term debt, net of current portion . 502,822 162,061 40,770 - 705,653
Obligations under capital leases,
net of current portion ............. - 27,731 75,948 - 103,679
Other long-term liabilities ............ - 39,123 1,938 - 41,061
----------- ----------- ----------- ----------- -----------
Total liabilities ................. 1,354,920 514,488 219,942 (7,588) 2,081,762
----------- ----------- ----------- ----------- -----------
Intercompany payables/(receivables) .... (1,541,344) 1,398,795 142,549 - -
Minority interest ...................... - 6,118 1,399 - 7,517
Company-obligated manditorily redeemable
convertible preferred securities of
a subsidiary trust holding solely
7% convertible junior subordinated
debentures of the Company ........... 345,000 - - - 345,000
Total stockholders' equity ............. 33,759 (199,367) 198,463 904 33,759
----------- ----------- ----------- ----------- -----------
Total liabilities and
stockholders' equity ............. $ 192,335 $ 1,720,034 $ 562,353 $ (6,684) $ 2,468,038
=========== =========== =========== ============ ===========
</TABLE>
22
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONSOLIDATING BALANCE SHEET
As of March 31, 1999
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Combined Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Elimination Consolidated
------- ------------ ------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents ........... $ (7,093) $ 43,547 $ 10,714 $ - $ 47,168
Accounts receivable, net ............ - 399,683 51,533 - 451,216
Other receivables ................... 7,124 9,353 18,596 - 35,073
Inventory, net ...................... 12 41,080 9,881 - 50,973
Prepaids and other assets ........... 5,755 8,131 1,650 - 15,536
Income tax receivable ............... 14,760 - - - 14,760
----------- ----------- ----------- ----------- -----------
Total current assets .............. 20,558 501,794 92,374 - 614,726
----------- ----------- ----------- ----------- -----------
Property and equipment, net ......... 80,992 237,988 298,502 - 617,482
Goodwill, net ....................... - 690,079 114,612 - 804,691
Notes receivable .................... 23,780 1,241 9,356 - 34,377
Assets held for sale ................ - 178,647 - - 178,647
Other assets, net ................... 98,153 18,820 18,019 - 134,992
Investment in subsidiaries .......... 439,745 (439,745) - - -
----------- ----------- ----------- ----------- -----------
Total assets ...................... $ 663,228 $1,888,824 $ 532,863 $ - $2,384,915
=========== =========== =========== =========== ===========
Current liabilities:
Current portion of long-term debt ... $ 15,386 $ 44,828 $ 25,693 $ - $ 85,907
Current facility borrowings ......... 813,305 813,305
Current portion of obligations under
capital leases .................... 1,134 2,438 226 - 3,798
Accounts payable .................... 28,555 (8,873) 20,492 - 40,174
Accrued compensation and benefits ... 3,073 89,897 14,656 - 107,626
Accrued interest payable ............ 18,022 6,190 886 - 25,098
Accrued self insurance obligations .. (10,793) 65,319 767 - 55,293
Other accrued liabilities ........... 20,665 87,425 38,348 - 146,438
----------- ----------- ----------- ----------- -----------
Total current liabilities .......... 889,347 287,224 101,068 $ - $1,277,639
----------- ----------- ----------- ----------- -----------
Long-term debt, net of current portion . $ 501,002 $ 140,590 $ 46,198 $ - $ 687,790
Obligations under capital leases,
net of current portion ............. - 27,437 73,914 - 101,351
Other long-term liabilities ............ - 38,842 1,542 - 40,384
----------- ----------- ----------- ----------- -----------
Total liabilities ................. $1,390,349 $ 494,093 $ 222,722 $ - $2,107,164
----------- ----------- ----------- ----------- -----------
Intercompany payables/(receivables) .... $ (906,385) $1,698,403 $ 141,077 $(933,095) $ -
Minority interest ...................... - 5,844 167 - 6,011
Company-obligated manditorily redeemable
convertible preferred securities of
a subsidiary trust holding solely
7% convertible junior subordinated
debentures of the Company ........... 345,000 - - - 345,000
Total stockholders' equity ............. $ (165,736) $(1,009,516) $ 168,897 $ 933,095 $ (73,260)
----------- ------------ ----------- ----------- -----------
Total liabilities and
stockholders' equity .............. $ 663,228 $ 1,188,824 $ 532,863 $ - $2,384,915
=========== ============ =========== =========== ===========
</TABLE>
23
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONSOLIDATING STATEMENT OF EARNINGS (LOSSES)
As of March 31, 1998
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Combined Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Elimination Consolidated
------- ------------ ------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Total net revenues ...................... $ 332 $637,121 $105,474 $(1,437) $741,490
------- -------- -------- -------- --------
Costs and expenses:
Operating ............................ - 518,316 91,706 (1,437) 608,585
Corporate general and administrative . 26,717 8,231 4,353 - 39,301
Provision for losses on accounts
receivable ......................... - 5,690 323 - 6,013
Depreciation and amortization......... 1,439 13,523 5,512 - 20,474
Interest, net......................... 28,969 1,593 4,578 - 35,140
Equity interest in (earnings)
loss of subsidiaries ................ 36 - - (36) -
--------- ---------- ---------- --------- ---------
Total costs and expenses......... $ 57,161 $547,353 $106,472 $(1,473) $709,513
--------- ---------- ---------- --------- ---------
Earnings (loss) before income taxes
and intercompany charges .............. (56,829) 89,768 (998) 36 31,977
Intercompany charges..................... (86,099) 84,683 1,416 - -
---------- --------- --------- --------- ---------
Earnings (loss) before income taxes...... 29,270 5,085 (2,414) 36 31,977
Income taxes............................. 10,883 2,946 (239) - 13,590
---------- --------- ---------- --------- ---------
Net earnings (losses).................... $ 18,387 $ 2,139 $ (2,175) $ 36 $ 18,387
========== ========= =========== ========= ===========
</TABLE>
24
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONSOLIDATING STATEMENT OF EARNINGS (LOSSES)
As of March 31, 1999
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Combined Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Elimination Consolidated
------- ------------ ------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Total net revenues ...................... $ (968) $ 580,426 $ 93,574 - $ 673,032
Costs and expenses:
Operating ............................ - 536,092 88,476 - 624,568
Corporate general and administrative . 31,530 6,740 3,747 - 42,017
Provision for losses on accounts
receivable ......................... - 13,699 119 - 13,818
Depreciation and amortization......... 2,066 15,411 3,971 - 21,448
Interest, net......................... 28,732 4,886 3,552 - 37,170
Loss on sale of assets................ 3,007 8,099 1,000 - 12,106
Restructuring costs................... 3,805 6,359 1,265 - 11,429
Loss on interest rate swap............ 2,488 - - - 2,488
Equity in (earnings) losses of
subsidiary.......................... 120,147 - - (120,147) -
Intercompany interest (income)
expense............................. (5,031) 5,031 - - -
---------- ---------- ---------- ----------- ----------
Total costs and expenses ........ $ 186,744 $ 596,317 $ 102,130 $ (120,147) $ 765,044
---------- ---------- ---------- ----------- ----------
Operating income......................... $(187,712) (15,891) (8,556) 120,147 (92,012)
Dividend convertible preferred
securities............................. 6,516 - - - 6,516
Management fee (income) expense.......... (89,669) 87,923 1,746 - -
Earnings (loss) before income taxes
and extraordinary losses............... (104,559) (103,814) (10,302) 120,147 (98,528)
Income taxes............................. 5,519 (5,038) 411 - 892
Earnings before change in accounting..... (110,078) (98,776) (10,713) 120,147 (99,420)
Cumulative effect of change in
accounting principle................... 3,069 9,352 1,306 - 13,727
---------- ---------- ---------- ----------- ----------
Net earnings (losses)............... $(113,147) $(108,128) $ (12,019) $ 120,147 $(113,147)
========== ========= ========== ========== ==========
</TABLE>
25
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONSOLIDATING STATEMENT OF CASH FLOWS
As of March 31, 1998
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Combined Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Elimination Consolidated
------- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (losses) ....................... $ 18,387 $ 2,139 $ (2,175) $ 36 $ 18,387
Adjustments to reconcile net earnings
(losses) to net cash provided by
(used for) operating activities --
Equity in earnings in subsidiaries ....... 36 - - (36) -
Depreciation and amortization ............ 1,439 13,523 5,512 - 20,474
Provision for losses on accounts
receivable ............................. - 5,690 323 - 6,013
Other, net ............................... 2,494 (358) (50) - 2,086
Changes in operating assets and
liabilities:
Accounts receivable .................. - (75,249) (10,250) - (85,499)
Other current assets ................. (7,481) (11,469) (2,688) - (21,638)
Other current liabilities ............ 10,428 (1,515) 3,339 - 12,252
Income taxes payable ................. 10,754 1,400 21 - 12,175
--------- ---------- --------- --------- ----------
Net cash provided by (used for)
operating activities.................... 36,057 (65,839) (5,968) - (35,750)
--------- ---------- --------- --------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net ................... (7,245) (11,861) (5,723) - (24,829)
Acquisitions, net of cash acquired .......... - (1,502) (5,837) - (7,339)
Increase in long-term note receivable ....... (7,344) 487 - - (6,857)
Other assets expenditures ................... (8,929) (1,384) 404 - (9,909)
---------- ---------- --------- --------- ----------
Net cash used for investing activities ... (23,518) (14,260) (11,156) - (48,934)
---------- ---------- --------- --------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings ................... 86,521 58 1,739 - 88,318
Long-term debt repayments ................... (8,396) (6,626) (7,048) - (22,070)
Net proceeds from issuance of common stock .. 543 - - - 543
Purchase of treasury stock .................. (1,357) - - - (1,357)
Financing fees paid ......................... (403) 148 - - (255)
Intercompany advances ....................... (100,731) 76,302 24,429 - -
--------- ---------- --------- --------- ----------
Net cash provided by (used for)
financing activities ................... (23,823) 69,882 19,120 - 65,179
--------- ---------- --------- --------- ----------
Effect of exchange rate on cash and
cash equivalents ............................ - - (402) - (402)
--------- ---------- --------- --------- -----------
Net increase (decrease) in cash and
cash equivalents ............................ (11,284) (10,217) 1,594 - (19,907)
Cash and cash equivalents at beginning of year . (1,581) 20,010 2,591 - 21,020
--------- ---------- --------- --------- -----------
Cash and cash equivalents at end of period ..... $(12,865) $ 9,793 $ 4,185 $ - $ 1,113
========= ========== ========= ========= ===========
</TABLE>
26
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONSOLIDATING STATEMENT OF CASH FLOWS
As of March 31, 1999
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Combined Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Elimination Consolidated
------- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (losses) ....................... $(113,147) $ (108,128) $ (12,019) $ 120,147 $(113,147)
Adjustments to reconcile net earnings
(losses) to net cash provided by
(used for) operating activities --
Equity in earnings in subsidiaries ....... 120,147 - - (120,147) -
Cumulative effect ........................ 3,069 9,351 1,306 - 13,726
Loss on sale of assets ................... 3,007 8,099 1,000 12,106
Depreciation and amortization ............ 2,066 15,411 3,971 - 21,448
Provision for losses on accounts
receivable ............................. - 13,699 119 - 13,818
Other, net ............................... 786 - - - 786
Changes in operating assets and
liabilities:
Accounts receivable .................. 1,811 59,843 8,780 - 70,434
Other current assets ................. 3,060 1,293 3,460 - 7,813
Other current liabilities ............ (61,264) 16,897 3,071 - (41,296)
Income taxes payable ................. (481) - - - (481)
Net cash provided by (used for) --------- ---------- ---------- ---------- ------------
operating activities ................... $ (40,946) $ 16,465 $ 9,688 $ - $ (14,793)
--------- ---------- ---------- ---------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net ................... $ (16,096) $ (17,163) $ (6,210) $ - $ (39,469)
Acquisitions, net of cash acquired .......... - (1,901) 676 - (1,225)
Increase in long-term note receivable ....... 1,779 (4,108) 286 - (2,043)
Other assets expenditures ................... (6,177) (96) 4,293 - (1,980)
---------- ----------- ---------- --------- ------------
Net cash used for investing activities ... $ (20,494) $ (23,268) $ (955) $ - $ (44,717)
---------- ----------- ---------- --------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings ................... $ 103,351 $ (2,333) $ 9,387 $ - $ 110,405
Long-term debt repayments ................... (4,511) (20,093) (3,049) - (27,653)
Conversion of Mediplex 6 1/2% Convertible
Subordinated Debentures due 2003 .......... - (5,840) - - (5,840)
Net proceeds from issuance of common stock .. 462 - - - 462
Purchases of treasury stock ................. (264) - - - (264)
Other financing activities .................. 394 (281) (396) - (283)
Intercompany advances ....................... (35,121) 52,491 (17,370) - -
--------- ---------- --------- --------- ------------
Net cash provided by (used for)
financing activities ................... $ 64,311 $ 23,944 $ (11,428) $ - $ 76,827
--------- ---------- --------- --------- ------------
Effect of exchange rate on cash and
cash equivalents ............................ $ - $ - $ 2,347 $ - $ 2,347
--------- ---------- --------- --------- ------------
Net increase (decrease) in cash and
cash equivalents ............................ $ 2,871 $ 17,141 $ (348) $ - $ 19,664
Cash and cash equivalents at beginning of year . (9,964) 26,406 11,062 - 27,504
--------- ---------- --------- --------- -----------
Cash and cash equivalents at end of period ..... $ (7,093) $ 43,547 $ 10,714 $ - $ 47,168
========== ========== ========= ========= ===========
</TABLE>
27
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(UNAUDITED)
28
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Sun Healthcare Group, Inc., through its direct and indirect subsidiaries
(collectively referred to as "Sun" or the "Company"), is a leading provider of
high quality and cost efficient long-term, subacute and related specialty
healthcare services in the United States and the United Kingdom. The Company
also has operations in Spain, Germany and Australia. The Company operates
through four principal business segments:
INPATIENT SERVICES: This segment provides, among other services, 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, licenses practical nurses and certified
nursing assistants. At March 31, 1999, the Company operated 397 inpatient
facilities with 44,930 licensed beds compared to 310 facilities with 35,759
licensed beds at March 31, 1998. Included in the preceding are 16 facilities
with 1,927 licensed beds which the Company has announced its intention to divest
or not renew leases on certain facilities.
REHABILITATION AND RESPIRATORY THERAPY SERVICES: This segment provides,
among other services, physical, occupational, speech and respiratory therapy
services to affiliated and nonaffiliated skilled nursing facilities. As of March
31, 1999 the Company's rehabilitation and respiratory therapy services segment
provided services to 1,620 facilities in 44 states, 1,237 of which were operated
by nonaffiliated parties compared to 1,676 facilities as of March 31, 1998,
1,316 of which were nonaffiliated.
PHARMACEUTICAL AND MEDICAL SUPPLY SERVICES: This segment is comprised of an
institutional pharmaceutical subsidiary and a medical supply subsidiary. The
pharmaceutical subsidiary provides pharmaceutical products primarily to long
term and subacute care facilities for such purposes as infusion therapy, pain
management, antibiotic therapy and parenteral nutrition as well as providing
consultant pharmacist services. The medical supply subsidiary primarily provides
medical supplies to long-term care and sub-acute care facilities. The Company's
pharmaceutical subsidiary provided pharmaceutical products and services to 955
long term and sub-acute care facilities, including 592 nonaffiliated facilities,
as of March 31, 1999 through its 39 pharmacies and 2 pharmaceutical billing and
consulting centers. At March 31, 1998 pharmaceutical products and services were
provided to approximately 840 facilities including 554 nonaffiliated facilities.
The Company's medical supply subsidiary provided products to over 2,070
affiliated and nonaffiliated facilities as of March 31, 1999.
INTERNATIONAL OPERATIONS: This segment consists of long-term care
facilities in the United Kingdom, Spain and Germany as well as acute care
hospitals in Australia. This segment also provides pharmaceutical services in
the United Kingdom, Germany and Spain and medical supplies in Australia. At
March 31, 1999, the Company operated 155 inpatient facilities with 8,705
licensed beds in the United Kingdom; 10 inpatient facilities with 1,604 beds in
Spain; 16 facilities with 1,122 licensed beds in Germany and 5 hospitals with
309 licensed beds in Australia compared to 152 facilities with 8,517 licensed
beds in the United Kingdom; 8 facilities with 1,328 licensed beds in Spain; 11
facilities with 934 licensed beds in Germany; and 6 hospitals with 353 licensed
beds in Australia as of March 31, 1998.
29
<PAGE>
The Company's international operations also included outpatient therapy
service operations in Canada which were included in assets held for sale. The
Company completed the sale of its Canadian operations in the first quarter of
1999. The loss on sale was $12.1 million.
OTHER OPERATIONS
The Company's other operations include temporary therapy services, assisted
living services, home health and hospice, software development and other
ancillary services. The Company's temporary therapy service operations provided
approximately 290,417 temporary therapy staffing hours to nonaffiliates for the
three months ended March 31, 1999 compared to 678,041 hours for the three months
ended March 31, 1998. The assisted living subsidiary operated 32 assisted living
facilities with 3,450 beds in the United States as of March 31, 1999 compared to
8 assisted living facilities with 729 beds in the United States as of March 31,
1998. The Company has announced that it is planning to divest itself of its
assisted living facilities. No agreements have been entered into for the sale of
these assets held for sale as of May 19, 1999.
On June 30, 1998, a wholly owned subsidiary of the Company acquired
Retirement Care Associates, Inc. ("RCA"), an operator of 98 skilled nursing
facilities and assisted living centers in eight states primarily in the
southeastern United States. RCA also owned approximately 65% of Contour Medical,
Inc. ("Contour"), a national provider of medical/surgical supplies. The Company
also acquired the remaining 35% of Contour on June 30, 1998. Both the RCA merger
and the Contour acquisition were accounted for as purchases.
The Company's earnings growth has historically resulted from the
acquisition of long-term and subacute care facilities, use of its long-term and
subacute care operations as a base for expansion of certain its ancillary
services, provision of ancillary services to nonaffiliated facilities and
expansion of ancillary services through acquisitions. Ancillary services, such
as rehabilitation and respiratory therapy services and pharmaceutical and
medical supply services, have had significantly higher operating margins than
the margins associated with the provision of routine services to patients at
long-term and subacute care facilities and accordingly have historically
provided more than half of the Company's operating profits. In addition, a
substantial portion of the Company's consolidated interest expense was
attributable to the Company's long-term and subacute services and its foreign
operations due to the capital intensive nature of these businesses and to
related acquisitions. The higher operating margins from the provision of
ancillary services have been primarily attributable to favorable reimbursement
rates under the Medicare reimbursement system. However, effective July 1, 1998,
Medicare began a four year phase in of a prospective payment system ("PPS") for
Part A patients which will provide reimbursement of all costs including
ancillary service and capital-related costs at a fixed fee. A small percentage
of the long-term and subacute care industry transitioned to PPS on July 1, 1998,
including the Company's facilities that were acquired in the RCA Acquisition.
The vast majority of the industry transitioned to PPS on January 1, 1999. The
Company's average per diem rates under PPS are less than the amounts received
under cost based reimbursement. The Company's RCA facilities results were
negatively impacted by the implementation of PPS. The implementation of PPS at
the Company's remaining facilities resulted in a significant decline in Medicare
revenues. In addition, as a result of the industry-wide reductions in Medicare
reimbursement, the Company's nonaffiliated ancillary service customers have
significantly reduced their usage of such services. In the fourth quarter of
1998, the Company experienced a significant and rapid decline in the demand for
its ancillary services as its nonaffiliated customers prepared for the
implementation of PPS. This negative trend continued during the first quarter of
1999. See "Effects from Changes in Reimbursement."
30
<PAGE>
The following table sets forth certain operating data for the Company as of
the dates indicated:
<TABLE>
<CAPTION>
March 31, December 31,
--------- ------------
1999 1998 1998
---- ---- ----
<S> <C> <C> <C>
Inpatient Services:
Facilities .................................................. 397 310 397
Licensed beds ............................................... 44,930 35,759 44,941
Rehabilitation and Respiratory Therapy Service
Operations:
Nonaffiliated facilities served ............................. 1,237 1,316 1,294
Affiliated facilities served ................................ 383 360 421
----- ----- -----
Total .................................................... 1,620 1,676 1,715
===== ===== =====
Pharmaceutical and Medical Supply Services:
Nonaffiliated facilities served ............................. 592 554 584
Affiliated facilities served ................................ 363 286 346
---- ----- -----
Total .................................................... 955 840 930
==== ====== ======
International Operations:
Facilities
United Kingdom ............................................ 155 152 155
Other foreign ............................................. 31 25 31
---- ----- ------
Total .................................................... 186 177 186
==== ===== ======
Licensed beds
United Kingdom ............................................ 8,705 8,517 8,705
Other foreign ............................................. 3,035 2,615 3,048
----- ----- ------
Total .................................................... 11,740 11,132 11,753
====== ====== ======
</TABLE>
31
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the amount of certain elements of total net
revenues for the periods presented (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended
------------------
March 31,
---------
1999 1998
---- ----
<S> <C> <C>
Inpatient Services ..................................$461,105 $485,175
Rehabilitation and Respiratory Therapy Services ..... 70,066 177,393
Pharmaceutical and Medical Supply Services .......... 75,822 52,877
International Operations ............................ 71,664 66,306
Other Operations .................................... 64,514 67,258
Corporate ........................................... (968) 332
Intersegment Eliminations ........................... (69,171) (107,851)
-------- ---------
Total net revenues .............................$673,032 $741,490
========= =========
</TABLE>
Inpatient facilities revenues for long-term care, subacute care and
assisted living services include revenues billed to patients for therapy and
pharmaceutical services and medical supplies provided by the Company's
affiliated operations. Revenues for rehabilitation and respiratory therapy
services provided to domestic affiliated facilities were $38.8 million and $79.5
million for the three months ended March 31, 1999 and 1998, respectively.
Revenues for pharmaceutical and medical supply services provided to domestic
affiliated facilities were $23.8 million and $15.2 million for the three months
ended March 31, 1999 and 1998, respectively. Revenues for services provided by
other non-reportable segments to affiliated facilities were $6.4 million and
$7.1 million for the three months ended March 31, 1999 and 1998, respectively.
The following table sets forth the amount of net segment earnings (losses)
for the periods presented (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended
------------------
March 31,
---------
1999 1998
---- ----
<S> <C> <C>
Inpatient Services ..................................$ 3,180 $25,890
Rehabilitation and Respiratory Therapy Services ..... 426 57,588
Pharmaceutical and Medical Supply Services .......... (37) 6,306
International Operations ............................ (2,624) (3,380)
Other Operations .................................... (3,359) 4,760
--------- --------
Earnings (losses) before income taxes, corporate
allocation of interest and management fees ......... (2,414) 91,164
Corporate ........................................... (70,093) (57,282)
Intersegment Eliminations ........................... ( - ) ( 1,905)
--------- --------
Net Segment Earnings (losses) ..................$(72,507) $31,977
========= ========
</TABLE>
32
<PAGE>
Corporate expenses include amounts for interest and corporate general and
overhead expenses. The Company allocates these to its segments through
management fees and intercompany interest charges. Management fees are assessed
based on segment net revenues. Interest is charged based upon average net asset
balances at rates determined by management, and is intended to be consistent
with the rates incurred under the Company's Senior Credit Facility.
The following table presents the percentage of total net revenues
represented by certain items for the Company for the periods presented:
<TABLE>
<CAPTION>
Three Months Ended
------------------
March 31,
---------
1999 1998
---- ----
<S> <C> <C>
Total net revenues ..................................100.00% 100.00%
------- -------
Costs and expenses:
Operating ...................................... 92.8% 82.1%
Corporate general and administrative ........... 6.2% 5.3%
Provision for loss on accounts receivable ...... 2.1% 0.8%
Depreciation and amoritzation .................. 3.2% 2.8%
Interest, net .................................. 5.5% 4.7%
Loss on sale of assets ......................... 1.8% -
Loss on termination of interest rate swaps ..... 0.4% -
Restructuring costs ............................ 1.7% -
------- -------
Total costs and expenses ..................113.7% 95.7%
Dividends on convertible preferred securities .. 1.0% -
------- -------
Earnings (losses) before income tax and
cumulative effect of change in accounting
principle ....................................(14.7%) 4.3%
Income taxes.................................... 0.1% 1.8%
------ -------
Net earnings (losses) before cumulative
effect of change in accounting principle .....(14.8%) 2.5%
Cumulative effect of change in accounting
principle .................................... 2.0% -
------- -------
Net earnings (losses) ...............................(16.8%) 2.5%
======= =======
</TABLE>
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31, 1998
INPATIENT SERVICES
Net revenues, which include revenues generated from therapy and
pharmaceutical services provided at the Inpatient Services facilities, decreased
approximately $24.1 million from $485.2 million for the three months ended March
31, 1998 to $461.1 million for the three months ended March 31, 1999, a 5%
decrease. After considering $57.7 million of net revenues from the 75 facilities
acquired in the RCA acquisition on June 30, 1998, net revenues declined $73.7
million or 15.4%. This decrease is primarily the result of the reduced Medicare
rates received under PPS in the first quarter of 1999. Excluding the effect of
the RCA acquisition on Medicare revenues, average Medicare rates declined by 35%
(see "Effects of Changes in Reimbursement").
33
<PAGE>
Operating expenses, which include rent expense of $52.9 million and $45.8
million for the three months ended March 31, 1999 and 1998, respectively,
decreased 1.1% from $439.9 million for the three months ended March 31, 1998 to
$435.2 million for the three months ended March 31, 1999. After considering
$50.8 million of operating expenses related to the facilities acquired in the
RCA acquisition, operating expenses decreased $55.5 million or 12.6%. The
decrease resulted primarily from cost restructuring in response to PPS,
including reduced ancillary service costs from affiliated providers. Operating
expenses as a percentage of net revenues excluding the effect of the RCA
acquisition, increased from 90.7% for the three months ended March 31, 1998 to
95.3% for the three months ended March 31, 1999. The increase in operating
expenses as a percentage of revenue is primarily due to decreased Medicare
revenue as a result of the implementation of PPS at the Company's facilities
without a corresponding decline in the level of service provided to Medicare
patients.
Corporate general and administrative expenses, which include regional
costs, related to the supervision of operations, were $8.2 million and $8.1
million for the three months ended March 31, 1999 and 1998, respectively. As a
percentage of net revenues, corporate general and administrative expenses
remained constant at 1.7% for the three months ended March 31, 1999 and 1998.
Provision for losses on accounts receivable increased 232% from $1.2
million for the three months ended March 31, 1998 to $3.8 million for the three
months ended March 31, 1999. As a percentage of net revenues, provision for
losses on accounts receivable increased from 0.2% for the three months ended
March 31, 1998 to 0.8% for the three months ended March 31, 1999. The change was
primarily due to increased aging of certain accounts receivable.
Depreciation and amortization decreased 5.1% from $8.9 million for the
three months ended March 31, 1998 to $8.5 million for the three months ended
March 31, 1999. As a percentage of net revenues, depreciation and amortization
expense remained constant at 1.8% for the three months ended March 31, 1999 and
1998.
Net interest expense increased 92.5% from $1.2 million for the three months
ended March 31, 1998 to $2.3 million for the three months ended March 31, 1999.
As a percentage of net revenues, interest expense increased from .02% for the
three months ended March 31, 1998 to 0.5% for the three months ended March 31,
1999. The increase is primarily a result of certain facility specific debt
assumed in the RCA acquisition.
REHABILITATION AND RESPIRATORY THERAPY SERVICES
Net revenues from rehabilitation and respiratory therapy services decreased
60.5% from $177.4 million for the three months ended March 31, 1998 to $70.1
million for the three months ended March 31, 1999. Revenues from services
provided to affiliated facilities decreased from $79.5 million for the three
months ended March 31, 1998 to $38.8 million for the three months ended March
31, 1999, a decrease of 51.3%. Revenues from services provided to nonaffiliated
facilities decreased approximately $66.6 million, or 68%, from $97.8 million for
the three months ended March 31, 1998 to $31.3 million for the three months
ended March 31, 1999. The decrease is a result of the industry's transition to
PPS and the resulting decline in demand for the Company's therapy services. In
addition to the decline in demand for the Company's therapy services, market
rates for these services have declined significantly. This decline is attributed
to downward pricing pressure as a result of an excess supply of therapy service
providers due to the industry's restructuring in response to decreased
reimbursement under PPS (see "Effects of Changes in Reimbursement").
34
<PAGE>
Operating expenses decreased 42.7% from $113.7 million for the three months
ended March 31, 1998 to $65.1 million for the three months ended March 31, 1999.
The decrease resulted primarily from the decline in the demand for the Company's
therapy services resulting in a reduction in the number of therapists employed
by the Company's therapy services (see "Other Special and Non-Recurring Charges
- - Restructuring Costs"). Operating expenses as a percentage of total revenue
increased from 64.1% for the three months ended March 31, 1998 to 92.9% for the
three months ended March 31, 1999. This increase is attributable to downward
pricing pressure as a result of the excess supply of therapy service providers
due to the industry's restructuring in response to the decreased reimbursement
under PPS.
Provision for losses on accounts receivable decreased 42.3% from $4.0
million for the three months ended March 31, 1998 to $2.3 million for the three
months ended March 31, 1999. As a percentage of net revenues, provision for
losses on accounts receivable increased from 2.2% for the three months ended
March 31, 1998 to 3.3% for the three months ended March 31, 1999. The increase
is a result of increased reserves recorded due to the impact of PPS, which for
certain nonaffiliated customers has negatively affected their cash flows,
adversely affecting the collectibility of amounts due to the Company.
Depreciation and amortization remained constant at $2.1 million for the
three months ended March 31, 1999 and 1998. As a percentage of net revenues,
depreciation and amortization expense increased from 1.2% for the three months
ended March 31, 1998 to 3.0% for the three months ended March 31, 1999,
respectively. The increase is primarily a result of increased equipment costs.
PHARMACEUTICAL AND MEDICAL SUPPLY OPERATIONS
Net revenues from pharmaceutical and medical supply services increased
43.3% from $52.9 million for the three months ended March 31, 1998 to $75.8 for
the three months ended March 31, 1999. Approximately $17.2 million of this
increase is a result of the company's medical supply operations acquired in
connection with the RCA acquisition in June 1998. The remaining increase is
primarily a result of the addition of four pharmacies since March 31, 1998.
Operating expenses increased 49.6% from $44.6 million for the three months
ended March 31, 1998 to $67.1 million for the three months ended March 31, 1999.
The increase is primarily related to the Company's medical supply operations and
the additional four pharmacies that opened in 1998. Operating expenses as a
percentage of revenue increased from 85.0% for the three months ended March 31,
1998 to 88.6% for the three months ended March 31, 1999. This increase is
primarily a result of the acquisition of Contour, which has higher operating
costs than the Company's pharmacy services operation. Excluding Contour,
operating expenses as a percentage of revenue was 86.3%.
35
<PAGE>
Provision for losses on accounts receivable increased from $0.1 million for
the three months ended March 31, 1998 to $6.6 million for the three months ended
March 31, 1999. As a percentage of net revenues, the provision for losses on
accounts receivable increased from 0.2% for the three months ended March 31,
1998 to 8.7% for the three months ended March 31, 1999. This increase is a
result of the effect PPS has had on nonaffiliated customers' cash flow (as
discussed above under Rehabilitation and Respiratory Therapy Services).
Depreciation and amortization increased 37.6% from $1.5 million for the
three months ended March 31, 1998 to $2.1 million for the three months ended
March 31, 1999. As a percentage of net revenues, depreciation and amortization
expense was 2.7% and 2.8% for the three months ended March 31, 1999 and 1998,
respectively.
INTERNATIONAL OPERATIONS
Revenues from international operations excluding the effect of the
disposition of the Canadian operations, increased $9.6 million, or 15.4%, from
$62.1 million for the three months ended March 31, 1998 to $71.7 million for the
three months ended March 31, 1999. Approximately $4.0 million of this increase
was provided by U.K. inpatient services whose net revenues increased from $42.8
million for the three months ended March 31, 1998 to $46.8 million for the three
months ended March 31, 1999. The increase in U.K. revenues is due to the
addition of four facilities during 1998 as well as an increase in occupancy
rates from 77.8% for the three months ended March 31, 1998 to 78.8% for the
three months ended March 31, 1999. The remaining increase was primarily the
result of facility additions and occupancy increases at inpatient services in
Spain, Germany and Australia.
Operating expenses, which include rent expense of $6.4 million and $9.7
million for the three months ended March 31, 1998 and 1999, respectively,
increased approximately 14.3% from $56.6 million for the three months ended
March 31, 1998 to $64.8 million for the three months ended March 31, 1999. As a
percentage of revenues, operating expenses increased from 85.5% for the three
months ended March 31, 1998 to 90.4% for the three months ended March 31, 1999.
The increase is primarily attributable to increased temporary staffing costs due
to a nursing shortage and increases in rent expense primarily a result of the
sale-leaseback of 32 facilities completed October 1998.
Depreciation and amortization for international operations decreased 31.1%
from $5.1 million for the three months ended March 31, 1998 to $3.2 million for
the three months ended March 31, 1999. The decrease is primarily a result of the
write-off in the fourth quarter of 1998 of goodwill and certain other long-lived
assets pursuant to Statement of Financial Accounting Standards No.
121 - Impairment of Long-Lived Assets.
OTHER NONREPORTABLE SEGMENTS AND CORPORATE GENERAL AND ADMINISTRATIVE
DEPARTMENTS
Nonreportable segments include temporary therapy staffing, home health,
assisted living, software development and other ancillary services. Revenues
from other nonreportable segments decreased 4.1% from $67.3 million for the
three months ended March 31, 1998 to $64.5 million for the three months ended
March 31, 1999. Operating expenses increased 1.8% from $59.3 million for the
three months ended March 31, 1998 to $60.3 for the three month periods ended
March 31, 1999. Total revenues and operating expenses for nonreportable segments
represent less than 10% of the consolidated Company's results. Growth in
revenues and operating expenses relates primarily to acquisitions in the
Company's home health, assisted living, disease state management, laboratory and
radiology subsidiaries. These increases were offset by significant declines in
revenues and operating expenses in the Company's temporary therapy staffing
subsidiary which was adversely affected by the long term care industry's
transition to PPS. Operating results were also negatively impacted by expenses
related to software development costs incurred by the Company's subsidiary, Sun
Healthcare Systems. These costs are being expensed in accordance with Statement
of Financial Accounting Standards No. 86: Accounting for Costs of Computer
Software to be Sold, Leased or Otherwise Marketed. Development of the Company's
products are not expected to reach the stage under which capitalization is
permitted until late 1999 or 2000.
Corporate general and administrative costs not directly attributed to
segments increased 15.4% from $26.5 million for the three months ended March 31,
1998 to $30.5 million at March 31, 1999. As a percentage of consolidated net
revenues of $741.5 million and $673.0 million for the three months ended March
31, 1999 and 1998, respectively, corporate general and administrative expenses
not directly attributed to segments increased from 3.6% to 4.5%. This increase
was primarily due to an increase in costs relating to the expansion of the
Company's corporate infrastructure to support newly acquired domestic operations
including Regency and RCA, as well as implementation of new business strategies.
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Net interest expense not directly attributed to segments increased 1.0%
from $29.3 million for the three months ended March 31, 1998 to $29.5 million
for the three months ended March 31, 1999. As a percentage of consolidated net
revenues, interest expense increased from 4.0% for the three months ended March
31, 1998 to 4.4% for the three months ended March 31, 1999. The increase was
related to (i) an increase in the Company's weighted average interest rate
resulting from the issuance of $250 million of 9 1/2% Notes in July 1997 and the
Company's issuance of $150 million of 9 3/8% Notes in May 1998, (ii) higher
interest rates and borrowing costs under the Company's Senior Credit Facility as
compared to the previous credit facility that was retired in October 1997, and
(iii) an increase in borrowings under the Company's Senior Credit Facility
principally related to various acquisitions during 1998.
DIVIDENDS ON CONVERTIBLE PREFERRED STOCK
In May 1998, the Company issued $345 million of 7% Convertible Trust Issued
Preferred Securities.
OTHER SPECIAL AND NON-RECURRING CHARGES
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
In 1998, the American Institute of Certified Public Accountants issued
Statement of Position, "Reporting on the Costs of Start-up Activities" ("SOP
98-5"). This statement requires costs of start-up activities and organization
costs to be expensed as incurred. The statement is effective for financial
statements for fiscal years beginning after December 15, 1998. In the first
quarter of 1999, the Company adopted the provisions of SOP 98-5 which resulted
in a cumulative effect of an accounting change pretax charge of $13.7 million.
OTHER LONG-LIVED ASSETS
LOSS ON SALE OF ASSETS
A net non-cash charge of approximately $10.1 million was recorded to
further reduce the carrying amount of certain assets that the Company determined
were not integral to its core business operations. In addition, the Company
recorded a loss of approximately $2 million on the sale of its Canadian
operations. See footnote 5.
RESTRUCTURING COSTS
In response to the industry changes mandated by PPS the Company recorded a
charge of approximately $11.4 million for the three months ended March 31, 1999
predominately related to restructuring its operations in order to more closely
align the inpatient services, rehabilitation and respiratory therapy services,
and pharmaceutical and medical supply services divisions (see "Liquidity and
Capital Resources").
LOSS ON TERMINATION OF INTEREST RATE SWAPS
In April 1999, the interest rate swap transactions were terminated due to
an event of default relating to the Company's with certain covenants contained
in the Senior Credit Facility. The termination resulted in a $2.5 million
pre-tax charge in the first quarter of 1999.
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CONSOLIDATED RESULTS OF OPERATIONS
Income tax expense for the three months ended March 31, 1999 was $0.9
million compared to $13.6 million for the three months ended March 31, 1998. In
the three months ended March 31, 1999, the Company increased its valuation
allowance by $33.5 million for deferred tax assets which may not be realized as
a result of the adverse effect of the new operating environment under PPS. Also,
in 1999 the Company established a valuation allowance of $1.5 million for U.K.
deferred tax assets, which may not be realizable.
The net loss for the three months ended March 31, 1999 was $113.1 million
compared to net earnings of $18.4 million for the three months ended March 31,
1998. Before considering the loss on sale of assets, the restructuring costs and
the loss on termination of interest rate swaps, the loss before income taxes for
the three months ended March 31, 1999 was $72.4 million compared to earnings
before income taxes of $31.9 million for the three months ended March 31, 1998.
The loss in the first quarter of 1999 was due to the implementation of PPS and
its resulting adverse impact on the demand for ancillary services.
LIQUIDITY AND CAPITAL RESOURCES
The Company was not in compliance with certain financial covenants
contained in the Senior Credit Facility as of December 31, 1998 and March 31,
1999. On April 29, 1999, the Company entered into an agreement that waives
compliance with the covenants from December 30, 1998 until May 28, 1999. The
terms of the waiver require among other things that the Company take advantage
of the 30-day grace period of the payment of interest on the Company's $150
million 9 3/8% subordinated notes due 2008, which payment was due May 1, 1999.
If the Company does not make the interest payment by May 31, 1999, the Company
would be in default under the indenture for the 9 3/8% notes, which would cause
the Company to be in cross-default on certain other debt obligations of the
Company. The Company continues to seek an amendment to its Senior Credit
Facility agreement that would bring it into full compliance but cannot predict
when or if such an amendment will be obtained.
Because the Company was not in compliance with certain financial covenants
under the terms of the Senior Credit Facility, the Lenders could have required
immediate repayment of all amounts outstanding under the Senior Credit Facility.
As a result, as of December 31, 1998, the Company classified all borrowings
under the Senior Credit Facility as current liabilities. Although compliance
with the covenants has been waived, the borrowings remain classified as current
liabilities in the accompanying consolidated balance sheets because of the
short-term nature of the waiver.
As a result, at March 31, 1999, the Company had a working capital deficit
of $662.9 million including cash and cash equivalents of $47.2 million, as
compared to a working capital deficit of $539.6 million, including cash and cash
equivalents of $27.5 million at December 31, 1998. Without classification of the
amounts under the Senior Credit Facility as current, the Company would have
positive working capital of $150.4 million as of March 31, 1999. The Company
does not have sufficient cash reserves to repay all amounts outstanding under
the Senior Credit Facility at May 19, 1999.
The Company is in default of certain Mortgage Notes amounting to $31.8
million and $31.9 million at March 31, 1999 and December 31, 1998, respectively,
because the Company did not meet its debt service coverage requirement of at
least 1.25 to 1. The Company is attempting to obtain a waiver of the
non-compliance with the financial covenant and to amend these Mortgage Notes'
financial covenants so that the financial covenants will be consistent with the
Company's revised business plan. However, as of May 19, 1999, no agreement to
waive the non-compliance with the financial covenant or to amend the financial
covenants has been reached. Because the Company is in non-compliance with the
terms of these Mortgage Notes, the holder of the Mortgage Notes could demand
immediate repayment of all amounts due under the mortgages and foreclose on four
facilities. Such amounts are classified as current liabilities as of December
31, 1998 and March 31, 1999.
The Company also has other debt arrangements that provide that a default on
any mortgage indenture or instrument which results in the acceleration of
repayment or default in payment of obligations from $0.1 million to in excess of
$20.0 million depending on the terms of the agreement, would allow the creditor
to demand immediate repayment. No acceleration of repayment has occurred and
therefore such borrowings which total $520.9 million are classified as long-term
liabilities as of December 31, 1998 and March 31, 1999.
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As of December 31, 1998 and March 31, 1999, the Company was in
non-compliance with certain financial covenants contained in certain master
lease agreements for 96 of its long-term care facilities in the United States
and 33 of its long-term care facilities in the United Kingdom. As a result, the
lessors under these master lease agreements have certain rights, including the
right to require that the Company relinquish the leased facilities. As of May
19, 1999, the lessors had not exercised their rights under their respective
agreements, although there can be no assurance that the lessors will not do so
in the future. Prior to obtaining a waiver of the non-compliance with certain
financial covenants in the Senior Credit Facility, the Company was also in cross
default for 14 of its long-term care facilities in the United States as of
December 31, 1998 and March 31, 1999. The aggregate net book value of properties
subject to potential eviction amounted to $54.8 million at December 31, 1998.
The Company has a substantial number of other leases which may contain similar
default or cross default provisions.
For the three months ended March 31, 1999, net cash used for operations was
$14.4 million compared to net cash used by operations for the three months ended
March 31, 1998 of $35.8 million. The net cash used for operations for the three
months ended March 31, 1999 reflects the significant losses incurred (as
discussed in "Results of Operations" above).
The Company's accounts receivable have increased since December 31, 1998.
Accounts receivable increased in part because of the growth in the Company's
inpatient, therapy and pharmaceutical services businesses since December 31,
1998. RCA and Contour represent $72.0 million of the gross increase. The
implementation of PPS for certain nonaffiliated ancillary service customers has
negatively affected their cash flows thereby adversely affecting the
collectibility of amounts due to the Company. Other nonaffiliated ancillary
service customers, due to the transition to PPS, have slowed, reduced or stopped
payment for service in anticipation of the adverse effect PPS would have on
their cash flow. As a result, accounts receivable from nonaffiliated customers
has increased, and the Company has increased its provision for doubtful accounts
in the first quarter of 1999. Also, accounts receivable for therapy services
have increased in part because the ability of nonaffiliated facilities to
provide timely payment has been impacted by their receipt of payments from
fiscal intermediaries which, in some instances, have been delayed due, in part,
to the fiscal intermediaries conducting reviews of facilities' therapy claims.
Other significant operating uses of cash for the three months ended March
31, 1999 were $39.7 million for net interest payments and $1.4 million for
income taxes.
The Company believes that its existing cash reserves ($55.6 million at May
18, 1999) and the successful execution of its operational and financial recovery
plan will provide sufficient cash for its operations, capital expenditures and
regularly scheduled debt service throughout 1999. The projected cash balance
during 1999 would not be adequate if the Company were required to repay the
balance outstanding under the Senior Credit Facility or certain Mortgage Notes.
No assurance can be given that the Company will have sufficient cash for
operations, capital expenditures and regularly scheduled debt service throughout
1999. Further, no assurance can be given that the Company will be successful in
negotiating waivers and amendments to the Senior Credit Facility and certain
Mortgage Notes or that the Company will be able to meet any amended financial
covenants prospectively. If the Company is unable to generate sufficient cash
flow from its operations or successfully negotiate an amendment of the Senior
Credit Facility, it would explore a variety of other options, including but not
limited to other sources of financing, additional asset dispositions, or relief
under the United States Bankruptcy code.
As a result of the Company's recent financial results, the New York Stock
Exchange (the "Exchange") has notified the Company that the Company does not
currently meet the Exchange's quantitative continued listing criteria. At the
request of the Exchange, the Company intends to submit to the Exchange a written
proposal regarding the appropriateness of the continued listing of the Company's
common stock. No assurance can be given that the Exchange will continue to list
the Company's common stock.
In response to the significant losses experienced in the fourth quarter of
1998 which have continued in the first quarter of 1999, the Company has
developed an operational and financial recovery plan that is intended to restore
the Company's profitability in the new operating environment under PPS, although
no assurance can be given that the plan will be successful.
39
<PAGE>
The Company incurred $31.5 million in capital expenditures during the three
months ended March 31, 1999. Expenditures related primarily to the construction
of a corporate office building and to the Company's long-term care, subacute
care and assisted living facility operations including the construction of three
new facilities in the United States and three new facilities in the United
Kingdom as well as routine capital expenditures. The Company had capital
expenditure commitments as of March 31, 1999, under various contracts of $32.1
million in the United States. These include contractual commitments to improve
existing facilities and to develop, construct and complete a corporate office
building.
On June 30, 1998, a wholly owned subsidiary of the Company merged with RCA,
an operator of skilled nursing facilities and assisted living centers in eight
states principally in the southeastern United States. RCA also owned
approximately 65% of Contour, a national provider of medical/surgical supplies.
Under the amended terms of the merger agreement, the Company issued
approximately 7.6 million shares of its common stock (valued at $122.0 million
based upon the average closing price of the Company's common stock for 20
business days prior to the acquisition closing date, which was $16.03) for all
outstanding common stock of RCA and certain redeemable preferred shares of RCA.
The Company also issued 298,334 shares of its Series B Convertible Preferred
Stock in exchange for the outstanding shares of RCA's Series F Preferred Stock,
which were subsequently converted into 287,892 shares of Sun common stock valued
at $2.8 million at June 30, 1998. As of December 31, 1998, all the Series B
Shares have been converted into Sun common stock. In addition, the Company
assumed approximately $170.4 million of RCA indebtedness. The merger was
accounted for as a purchase and resulted in $234.7 million of goodwill.
On June 30, 1998, the Company also acquired the remaining 35% of Contour.
The Company issued approximately 1.9 million shares of its common stock (valued
at approximately $27.6 million) for the remaining outstanding Contour common
stock. The acquisition was accounted for as a purchase and resulted in $23.4
million of additional goodwill.
In connection with the RCA Merger, the Company recorded purchase
liabilities including $24.7 million for severance and related costs and $1.4
million for costs associated with the shutdown of certain administrative
facilities.
In the fourth quarter of 1998, the Company implemented an initial
restructuring plan and recorded a fourth quarter charge of $4.6 million. As of
March 31, 1999, the Company's 1998 restructuring costs reserve balance was
approximately $0.5 million and is substantially complete.
In the first quarter of 1999, the Company initiated a second restructuring
plan focused on further reducing the operating expenses of its United States
operations. Related to the restructuring plan, the Company recorded a first
quarter charge of approximately $11.4. The restructuring plan included the
termination of 2,900 of its rehabilitation and respiratory therapy services
employees, and 80 of its corporate employees including certain executive
positions. The restructuring plan also included the closure of approximately 23
divisional and regional offices related to the aforementioned operations. In
addition, the plan includes the relocation of the Company's medical supply
subsidiary and temporary therapy services subsidiary to the Company's corporate
headquarters in Albuquerque, New Mexico. As part of the relocation, the Company
will terminate 96 employees of these subsidiaries. As of March 31, 1999, the
Company paid approximately $4.4 million in termination benefits under the 1999
restructuring plan. The 1999 restructuring charge consists of approximately $9.1
million related to employee terminations, approximately 1.4 million related to
lease termination costs and $0.8 million related to asset disposals or
write-offs. As of March 31, 1999, the Company's 1999 restructuring costs reserve
balance was approximately $6.9 million.
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The Company also conducts business in the United Kingdom, Spain, Australia
and Germany. International operations accounted for 11% and 9% the Company's
total net revenues during the three months ended March 31, 1999 and 1998
respectively, and 18% of the Company's consolidated total assets as of March 31,
1999. The Company's financial condition and results of operations are subject to
foreign exchange risk. Exceptional planned foreign currency cash flow
requirements, such as acquisitions overseas, are hedged selectively to prevent
fluctuations in the anticipated foreign currency value. Changes in the net worth
of the Company's foreign subsidiaries arising from currency fluctuations are
reflected in the accumulated other comprehensive income component of
stockholders' equity.
Subsequent to December 31, 1998, the Company decided to dispose of several
non-core businesses including assisted living facilities, rehabilitation
hospitals and other non-core businesses. The Company recorded a loss of $161.6
million before unrecorded gains in the fourth quarter of 1998 to reduce the
carrying amount of these businesses identified for disposal to fair value based
on estimates of selling value and of costs to sell. The Company recorded a loss
of $10.1 million for the three months ended March 31, 1999 to further reduce the
carrying value based on current sale negotiations and market conditions. In
addition, the Company has decided not to dispose of certain non-core businesses
previously recorded in assets held for sale. The reversal of $7.0 of the loss on
disposition was recognized in 1999. The aggregate carrying amount of these
businesses is approximately $219.9 million at March 31, 1999. The Company
expects net proceeds including cash related to those operations with unrecorded
gains of $93.4 million after the reduction of related debt of approximately
$108.3 million. Under the terms of the Senior Credit Facility such proceeds are
required to be used to permanently reduce outstanding borrowings under the
Senior Credit Facility.
In May 1997, the Company announced its intent to sell and divest of its
outpatient rehabilitation clinics in the United States as well as Canada. The
carrying amount of the assets held for sale was $22.5 million as of December 31,
1998. The Company completed the sales of the Canadian clinics during the first
quarter of 1999 which resulted in an additional loss on sale of $2.1 million.
The results of operations of these businesses is not material.
Under the terms of an Amended and Restated subordinated Loan Agreement (the
"Subordinated Loan"), the Company has advanced $36.3 million and has agreed to
advance up to a total of $40 million, plus an additional $5 million to cover
accrued interest due and owing to the Company and other lenders, to a developer
of assisted living facilities to cover 20% of the costs of the development,
construction and operation of assisted living facilities. Advances are subject
to certain conditions, including the approval of each project by the Company.
Advances under the Subordinated Loan are part of the assets related to the
Company's assisted living facilities which the Company intends to divest (as
discussed above).
At March 31, 1999, the Company had on a consolidated basis, $1.7 billion of
outstanding indebtedness including capital lease obligations and $826.8 million
of indebtedness under its Senior Credit Facility. The Company also had
$42.6 million of outstanding standby letters of credit under its Senior Credit
Facility as of March 31, 1999.
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In May 1998, the Company issued $345 million of 7% Convertible Trust Issued
Preferred Securities (the "CTIPS") and $150 million of 9 3/8% Senior
Subordinated Notes due 2008 (yield of 9.425%) (collectively the "Offerings").
Each convertible preferred security is convertible into 1.2419 shares of Sun
common stock, par value $0.01 per share, of Sun (equivalent to an initial
conversion price of $20.13 per share of Sun common stock). Of the net proceeds,
$300 million from the Offerings were used by the Company to permanently repay
certain outstanding borrowings under the term loan portion of the Senior Credit
Facility and the remainder of the net proceeds from the Offerings were used to
reduce certain outstanding borrowings under the revolving credit portion of the
Company's Senior Credit Facility. On April 14, 1999, the Company announced that
it was exercising its right to defer the dividend payment, scheduled for May 1,
1999, on the CTIPS.
On May 5, 1998, the Company entered into certain interest rate transactions
with an aggregate notional value of $850 million to minimize the risks and/or
costs associated with certain long-term debt of the Company. On April 9, 1999,
the interest rate swap transactions were terminated due to an event of default
relating to the Company's non-compliance with certain covenants contained in the
Senior Credit Facility. The termination resulted in a pre-tax loss of $2.5
million in the first quarter of 1999. The Company does not otherwise utilize
financial instruments for trading or other speculative purposes. The interest
rate swap transactions were designated as hedges for accounting purposes.
EFFECTS FROM CHANGES IN REIMBURSEMENT
The Company derives a substantial percentage of its total revenues from
Medicare, Medicaid and private insurance. The Company's financial condition and
results of operations may be affected by the revenue reimbursement process,
which is complex and can involve lengthy delays between the recognition of
revenue and the time reimbursement amounts are settled. Net revenues realizable
under third-party payor agreements are subject to change due to examination and
retroactive adjustment by payors during the settlement process. Payors may
disallow in whole or in part requests for reimbursement based on determinations
that certain costs are not reimbursable or reasonable or because additional
supporting documentation is necessary. The Company recognizes revenues from
third-party payors and accrues estimated settlement amounts in the period in
which the related services are provided. The Company estimates these settlement
balances by making determinations based on its prior settlement experience and
its understanding of the manner in which the third-party payors will interpret
the applicable reimbursement rules and regulations. The majority of third-party
payor balances are settled two to three years following the provision of
services.
The Company has historically experienced differences between the net
amounts accrued and subsequent settlements, which differences are recorded in
operations at the time of settlement. For example, in the fourth quarter of
1998, the Company recorded negative revenue adjustments totalling $34.7 million
primarily for the projected settlement of 1997 facility cost reports which were
not settled as of December 31, 1998 and the projected settlement of the 1998
cost reports based on historical information. Accounts receivable have also been
negatively impacted in part because the ability of nonaffiliated facilities to
provide timely payments has been impacted by their receipt of payments from
fiscal intermediaries which, in some instances, have been delayed due to the
fiscal intermediaries conducting reviews of facilities' therapy claims.
The implementation of PPS for certain nonaffiliated ancillary service
customers has negatively affected their cash flows, which has adversely affected
the collectibility of amounts due to the Company. As a result, accounts
receivable for nonaffiliated customers has increased, and the Company has
increased its provision for doubtful accounts in the first quarter of 1999.
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The Company's results of operations could be materially and adversely
affected if the amounts actually received from third-party payors in any
reporting period differed materially from the amounts accrued in prior periods.
The Company's financial condition and results of operations may also be affected
by the timing of reimbursement payments and rate adjustments from third-party
payors. The Company has from time to time experienced delays in receiving final
settlement and reimbursement from government agencies.
Various cost containment measures adopted by governmental and private pay
sources restrict the scope and amount of reimbursable healthcare expenses and
limit increases in reimbursement rates for medical services. Any reductions in
reimbursement levels under Medicaid, Medicare or private payor programs and any
changes in applicable government regulations or interpretations of existing
regulations could significantly affect the Company's profitability. Furthermore,
government programs are subject to statutory and regulatory changes, retroactive
rate adjustments, administrative rulings and government funding restrictions,
all of which may materially affect the rate of payment to the Company's
facilities and its therapy and pharmaceutical services businesses. There can be
no assurance that payments under governmental or private payor programs will
remain at levels comparable to present levels or will be adequate to cover the
costs of providing services to patients eligible for assistance under such
programs. Significant decreases in utilization and changes in reimbursement
could have a material adverse effect on the Company's financial condition and
results of operations, including the possible impairment of certain assets.
In the Balanced Budget Act of 1997 ("BBA"), Congress passed numerous
changes to the reimbursement policies applicable to exempt hospital services,
skilled nursing, therapy and other ancillary services. The BBA mandates the
implementation of a prospective payment system for skilled nursing facilities.
PPS became effective on July 1, 1998 for the Company's facilities that it
acquired with RCA and on January 1, 1999 for the remainder of its facilities.
Under PPS, Medicare pays skilled nursing facilities a fixed fee per patient per
day based on the acuity level of the patient to cover all post-hospital extended
care routine service costs (i.e. Medicare Part A patients), including ancillary
and capital related costs for beneficiaries receiving skilled services. Prior to
the implementation of PPS, the costs of many of such services were reimbursed on
a "pass through" basis. During the first three years of the PPS phase-in,
payments will generally be based on a blend of the facility's historical costs
based on 1995 cost data and a federally established per diem rate. Although it
is unclear what the long-term impact of PPS will be, the transition to PPS
negatively impacted the Company's earnings for the quarters ended September 30,
1998, December 31, 1998, and March 31, 1999. There can be no assurance that PPS
will not have a long-term material adverse effect on the results of operations
and financial condition of the Company.
The Company's revenues from its inpatient facilities have been
significantly affected by the federally established PPS per diem rate. The
Company's experience has been that the average per diem reimbursement rate is
less than the amount the Company's inpatient facilities received on a daily
basis under cost-based reimbursement. In response, the Company has taken various
actions to reduce its costs. Moreover, since the Company treats a greater
percentage of higher acuity patients than many nursing homes, the Company has
also been adversely impacted because federal per diem rates for higher acuity
patients do not adequately compensate the Company for the additional expenses
and risks for caring for such patients. There can be no assurance that PPS will
not have a long-term material adverse effect on the Company's financial
condition and results of operations.
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In addition, the implementation of PPS has resulted in a greater than
expected decline in demand for the Company's therapy and pharmaceutical
services. For instance, the nursing home industry has responded to the lower
reimbursement levels under PPS by, among other things, seeking lower acuity
residents who need less ancillary services and by providing therapy services
in-house, which has resulted in a significant decline in the demand for the
Company's therapy services. Prior to the implementation of PPS, Sun's ancillary
services, such as rehabilitation and respiratory therapy services and
pharmaceutical services, had significantly higher operating margins than the
margins associated with Sun's long-term and subacute care facilities and
accordingly such services provided most of Sun's operating profits. Although the
Company has taken and continues to take actions to reduce its costs of providing
ancillary services, there can be no assurance that the Company will be able to
maintain its prior profit margins on its ancillary services.
The Company's response to the implementation of PPS includes the
establishment of SunSolution. SunSolution provides ancillary services for a
fixed fee to nonaffiliated facilities. As of April 19, 1999, SunSolution has
secured fewer contracts with nonaffiliated facilities than projected and the
average revenue per contract was significantly less than the Company projected.
There can be no assurance that the Company will develop a market for the
SunSolution products and services. Even if there is a market for SunSolution's
services, no assurance can be given that the costs of providing the contracted
services will be less than the fixed fee received by the Company for such
services. Given the importance of the profitability of Sun's ancillary services,
there can be no assurance that PPS will not have a long-term material adverse
effect on the Company's margins and ultimately the Company's results of
operations and financial condition.
Effective January 1, 1999, for all nursing home patients not receiving
post-hospital extended care services (i.e., Medicare Part B patients), Medicare
reimbursement for ancillary services, including rehabilitation therapy, medical
supplies, pharmacy and other ancillary services, will be made to the skilled
nursing facility pursuant to fee schedules published on November 2, 1998. In
addition, effective January 1, 1999, there is an annual per beneficiary cap of
$1,500 on Medicare reimbursement for outpatient physical therapy and speech
therapy and an annual per beneficiary cap of $1,500 on Medicare reimbursement
for occupational therapy. Facilities will be permitted to bill patients directly
for services rendered in excess of these caps; however, there can be no
assurance that the Company will receive any payment in excess of these caps.
There can also be no assurance that such fee schedules and caps will not have a
material adverse effect on the Company.
The Company's growth strategy has relied heavily on the acquisition of
long-term and subacute care facilities. Regardless of the legal form of the
acquisition, the Medicare and Medicaid programs often require that the Company
assume certain obligations relating to the reimbursement paid to the former
operators of the facilities acquired by the Company. From time to time, fiscal
intermediaries and Medicaid agencies examine cost reports filed by such
predecessor operators. The Company is currently the subject of several such
examinations. If, as a result of any such examinations, it is concluded that
overpayments to a predecessor operator were made, the Company, as the current
operator of such facilities, may be held financially responsible for such
overpayments. At this time the Company is unable to predict the outcome of any
examinations.
Prior to the implementation of PPS, reimbursement for therapy services was
evaluated under Medicare's reasonable cost principles. In 1995, and periodically
since then, HCFA provided information to fiscal intermediaries for use in
determining reasonable costs for occupational and speech therapy. This
information, although not intended to impose limits on such costs, suggested
that fiscal intermediaries should carefully review costs which appear to be in
excess of what a "prudent buyer" would pay for those services. While the effect
of these directives is still uncertain, they are a factor considered by such
intermediaries in evaluating the reasonableness of amounts paid by providers for
the services of the Company's rehabilitation therapy subsidiary for fiscal years
prior to the implementation of PPS. Because PPS payments and fee schedules have
become the methods of reimbursement for these services, HCFA directives and
reasonable cost guidelines discussed in this paragraph have no impact on the
Company as to services rendered after January 1, 1999. A retroactive adjustment
of Medicare reimbursement could, however, be made for some prior periods. With
respect to nonaffiliated facilities, an adjustment of reimbursement rates for
therapy services could result in indemnity claims against the Company, based on
the terms of substantially all of the Company's existing contracts with such
facilities, for payments previously made by such facilities to the Company that
are reduced by Medicare in the audit process.
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Medicare regulations address transactions between related parties, such as
between the Company's subsidiaries that operate skilled nursing facilities and
subsidiaries which provide ancillary services. For periods prior to the
effective date of PPS, these regulations are relevant to the amount of Medicare
reimbursement that the Company's skilled nursing facilities are entitled to
receive for certain rehabilitation and respiratory therapy and pharmaceutical
services provided by the Company's ancillary service subsidiaries. An exception
to the related party regulations is available provided that, among other things,
a substantial part of the services of the relevant subsidiary supplier be
transacted with nonaffiliated entities. When that exception applies, the skilled
nursing facility may receive reimbursement for services provided by the
Company's ancillary service subsidiaries at the rates applicable to services
provided to nonaffiliated entities. The related party regulations do not
indicate a specific level of services that must be provided to nonaffiliated
entities in order to satisfy the "substantial part" requirement of this
exception. In instances where this issue has been litigated by others, no
consistent standard has emerged as to the appropriate threshold necessary to
satisfy the "substantial part" requirement.
The Company's net revenues from rehabilitation therapy services, including
net revenues from temporary therapy staffing services, provided to nonaffiliated
facilities represented 56%, 70% and 71% of total rehabilitation and temporary
therapy staffing services net revenues for the years ended December 31, 1998,
1997 and 1996, respectively. Respiratory therapy services provided to
nonaffiliated facilities represented 46%, 63% and 58% of total respiratory
therapy services net revenues for the years ended December 31, 1998, 1997 and
1996, respectively. Net revenues from pharmaceutical services billed to
nonaffiliated facilities represented 70%, 79% and 78% of total pharmaceutical
services revenues for the years ended December 31, 1998, 1997 and 1996,
respectively. The Company considers RCA a nonaffiliated entity for all periods
prior to its acquisition. The Company believes that it satisfies the
requirements of the exception to the 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 fair market value, rather than at Company
cost, which would have applied if it did not satisfy the exception. If the
Company were deemed to not have satisfied these regulations, the reimbursement
that the Company receives for rehabilitation and respiratory therapy and
pharmaceutical services provided to its own facilities would be significantly
reduced, as a result of which the Company's financial condition and results of
operations would be materially and adversely affected. If, upon audit by Federal
or state reimbursement agencies, such agencies find that the exception has not
been satisfied, and if, after appeal, such findings are sustained, the Company
could be required to refund some or all of the difference between its cost of
providing these services to any entity found to be subject to the related party
regulations and the fair market value amount actually received. While the
Company believes that it has satisfied these regulations, there can be no
assurance that its position would prevail if contested by relevant reimbursement
agencies. The foregoing statements with respect to the Company's ability 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. The implementation of PPS and the fee schedules has
significantly reduced the Medicare reimbursement impact of the related party
rule.
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The office of the Inspector General of the U.S. Department of Health and
Human Services ("OIG") has begun to conduct a national medical audit that will
assess the medical necessity of physical and occupational therapy services
provided to skilled nursing facility patients. Generally, the OIG has indicated
the results of the audit will be used to quantify overpayments for therapy
services in facilities audited and to develop baseline data that can be used to
assess the impact of the BBA. The Company is unable to determine what if any
impact this audit might have on the Company.
REGULATION
The Company's subsidiaries, including those that provide subacute and
long-term care, rehabilitation and respiratory therapy and pharmaceutical
services, are engaged in industries that are extensively regulated. As such, in
the ordinary course of business, the operations of these subsidiaries are
continuously subject to state and federal regulatory scrutiny, supervision and
control. Such regulatory scrutiny often includes inquiries, investigations,
examinations, audits, site visits and surveys, some of which may be non-routine.
The Company's subsidiaries are currently the subject of several such
investigations. In addition to being subject to the direct regulatory oversight
of state and federal regulatory agencies, these industries are frequently
subject to the regulatory supervision of fiscal intermediaries.
If a provider is ever found by a court of competent jurisdiction to have
engaged in improper practices, it could be subject to civil, administrative, or
criminal fines, penalties or restitutionary relief, and reimbursement
authorities could also seek the suspension or exclusion of the provider or
individuals from participation in their program. If a facility is decertified,
the facility will not be reimbursed by the Federal government for caring for
residents that are covered by Medicare and Medicaid, and the facility would be
forced to care for such residents without being reimbursed or to transfer such
residents. The Company currently has several facilities that are the subject of
decertification efforts by HCFA, which the Company is contesting.
Decertification could cause material adverse financial and operational effects
on individual facilities.
It is the policy of the Company to comply with all applicable laws and
regulations. However, given the extent to which the interpretation and
implementation of applicable laws and regulations vary and the lack of clear
guidance in many of the areas which are the subject of regulatory scrutiny,
there can be no assurance that the business activities of the Company's
subsidiaries will not from time to time become the subject of regulatory
scrutiny, or that such scrutiny will not result in interpretations of applicable
laws or regulations by government regulators or intermediaries which differ
materially from those taken by the Company's subsidiaries.
Pursuant to Health Insurance Portability and Accountability Act of 1996,
Congress has provided additional funding to Medicare and Medicaid enforcement
units to investigate potential cases of reimbursement abuse in the health care
services industry. The Act also sets guidelines to encourage federal, state, and
local law enforcement agencies to share general information and to coordinate
specific law enforcement activities including conducting investigations, audits,
evaluations, and inspections relating to the delivery of and payment for health
care. From time to time enforcement agencies conduct audits, inspections and
investigations with respect to the reimbursement activities of the subsidiaries
of the Company. The Company's subsidiaries are currently the subject of several
such investigations. It is the Company's practice to cooperate fully in such
matters.
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LITIGATION
In March, April and May, 1999, class action lawsuits were filed against the
Company and three officers of the Company in the United States District Court
for the District of New Mexico on behalf of purchasers of the Company's common
stock during the class period. These actions have been consolidated as IN RE SUN
HEALTHCARE GROUP, INC. SECURITIES LITIGATION MASTER FILE NO. CIV99-269. The
lawsuits allege, among other things, that the Company did not disclose material
facts concerning the impact that PPS would have on the Company's results of
operations. The lawsuits seek compensatory damages and other relief. Although
the Company intends to vigorously defend itself in this matter, there can be no
assurance that the outcome of this matter will not have a material adverse
effect on the results of operations and financial condition of the Company.
In January 1999, the state of Florida filed criminal charges in the Circuit
Court of the Eighth Judicial Circuit for Alachua County, Florida against three
subsidiaries which were acquired by the Company on June 30, 1998: RCA, Capitol
Care Management Co., Inc. and Gainesville Health Care Center, Inc. All of the
allegations of wrongdoing relate to activities prior to June 30, 1998, the date
of the RCA acquisition. Florida's allegations include violations of certain RICO
laws, abuse or neglect of elderly or disabled persons, grand theft and Medicaid
fraud at a nursing home facility in Florida. Also named as defendants were five
individuals who were involved in the operation of the facility in their
capacities as officers, directors or employees of the defendant entities. If the
defendant entities are convicted, they could be banned from participating in the
Florida Medicaid program. Although the Company's subsidiaries will defend
themselves vigorously in this matter, there can be no assurance that the outcome
of this matter will not have a material adverse effect on the results of
operations and financial condition of the Company.
The Company and certain of its subsidiaries are defendants in two QUI TAM
lawsuits brought by private citizens in the United States District Court for the
Eastern District of California alleging violations of the federal False Claims
Act. The plaintiffs allege that skilled nursing facilities operated by the
subsidiaries and others conspired over the last decade to (i) falsely certify
compliance with regulatory requirements in order to participate in the Medicare
and Medicaid programs, and (ii) falsify records to conceal failures to provide
services in accordance with such regulatory requirements. Although the Company
and its subsidiaries intend to vigorously defend themselves in these matters,
there can be no assurance that the outcome of any one of these matters will not
have a material adverse effect on the results of operations and financial
condition of the Company.
In March 1999, the Company and several of its subsidiaries filed a lawsuit
in the Superior Court of Fulton County in the State of Georgia against certain
individuals who served as directors, officers or employees of Retirement Care
Associates, Inc. ("RCA") prior to the Company's acquisition of RCA, and against
various entities such individuals owned or controlled or with which they have
been affiliated. The lawsuit alleges, among other things, breaches of fiduciary
duties, breaches of contract and conversion. The Company seeks damages in excess
of $30 million and punitive amounts. In May 1999, certain defendants in this
lawsuit filed counterclaims against certain plaintiffs alleging, among other
things, securities fraud, negligent misrepresentation and breach of contract.
Defendants seek damages in an amount to be determined at trial and punitive
amounts.
Between August 25, 1997 and October 24, 1997, 10 class action lawsuits (the
"Actions") were filed in the United States District Court for the Northern
District of Georgia on behalf of persons who purchased RCA Common Stock, naming
RCA and certain of its officers and directors as defendants. The complaints have
overlapping defendants and largely overlapping (although not identical) class
periods. The complaints allege violations of Federal securities laws by the
defendants for disseminating allegedly false and misleading financial statements
for RCA's fiscal year ended June 30, 1996 and its first three quarters of fiscal
year 1997, which the plaintiffs allege materially overstated RCA's
profitability. Generally, each of the Actions seeks unspecified compensatory
damages, prejudgment and postjudgment interest, attorneys' fees and costs and
other equitable and injunctive relief.
On November 25, 1997, RCA, the Company and representatives of the
plaintiffs in the Actions entered into a Memorandum of Understanding ("MOU").
Pursuant to the MOU, the Company paid $9 million into an interest-bearing escrow
account maintained by the Company (the "Escrow Account") to settle the Actions
(the "Settlement"). RCA also agreed to assign coverage under its directors' and
officers' liability insurance policy for these specific claims to the
plaintiffs. The parties have signed the Settlement Agreement and the hearing for
court approval of the settlement is currently scheduled for July 21, 1999. Upon
court approval of the Settlement, all claims by the class that were or could
have been asserted by the plaintiffs against RCA or any of the other defendants
in the Actions will be settled and released, and the Actions will be dismissed
in their entirety with prejudice in exchange for the release of all funds from
the Escrow Account to the Plaintiffs. No assurance can be given that the
Settlement will become final.
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In 1997, the Company was notified by a law firm representing several
national insurance companies that these companies believed that the Company had
engaged in improper billing and other practices in connection with the Company's
delivery of therapy and related services. In response, the Company began
discussions directly with these insurers and hopes to resolve these matters
without litigation; however, the Company is unable at this time to predict
whether it will be able to do so, what the eventual outcome may be or the extent
of its liability, if any, to these insurers.
The Company is a party to various other 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
other matters will have a material adverse effect on the financial position or
results of operations of the Company.
YEAR 2000 RISK
STATE OF READINESS. The Company has implemented a process to address its
Year 2000 compliance issues. The process includes (i) an inventory and
assessment of the compliance of the essential systems and equipment of the
Company and of critical suppliers, customers and other third parties, (ii) the
remediation of non-compliant systems and equipment, and (iii) contingency
planning. The Company has completed its inventory and assessment of its
information technology ("IT") systems and equipment and non-IT systems and
equipment (embedded technology) and approximately 90% of its inventory and
assessment of the systems and equipment of critical suppliers, customers and
other third parties.
With respect to the Year 2000 compliance of critical third parties, the
Company derives a substantial portion of its revenues from the Medicare and
Medicaid programs. Congress' General Accounting Office concluded in 1998 that it
is highly unlikely that all Medicare systems will be compliant on time to ensure
the delivery of uninterrupted benefits and services into the Year 2000.
The Company has completed approximately 90% of the remediation process for
critical IT and non-IT systems and equipment. The Company has also completed
approximately 80% of contingency planning in the event that essential systems
and equipment fail to be Year 2000 compliant. The Company is planning to be Year
2000 compliant for all its essential systems and equipment by the fourth quarter
of 1999, although there can be no assurance that it will achieve its objective
by such date or by January 1, 2000 or that such potential non-compliance will
not have a material adverse effect on the Company's business, financial
condition or results of operations. In addition, there can be no assurance that
all of the Company's critical suppliers, customers and other third parties will
be Year 2000 compliant by January 1, 2000, or that such potential non-compliance
will not have a material adverse effect on the Company's business financial
condition or results of operations.
COSTS. The Company currently estimates that its aggregate costs directly
related to Year 2000 compliance efforts will be approximately $12 million, of
which approximately $2.5 million has been spent through March 31, 1999. Of these
costs, the Company estimates that approximately $3 million will be spent to
repair systems and equipment and $9 million will be spent to replace systems and
equipment. The Company's Year 2000 efforts are ongoing and its overall plan and
cost estimations will continue to evolve as new information becomes available.
The Company's analysis of its Year 2000 issues is based in part on information
from third party suppliers and customers; there can be no assurance that such
information is accurate or complete.
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RISKS. The failure of the Company or third parties to be fully Year 2000
compliant for essential systems and equipment by January 1, 2000 could result in
interruptions of normal business work operations. The Company's potential risks
include (i) the inability to deliver critical care, resulting in death or
personal injury of residents of the Company's facilities and in non-affiliated
facilities, (ii) the delayed receipt of reimbursement from the Federal or State
governments, private payors, or intermediaries, (iii) the failure of security
systems, elevators, heating systems or other operational systems and equipment,
resulting in death or personal injury of residents of the Company's facilities
and (iv) the inability to receive critical equipment and supplies from vendors.
Each of these events could have a material adverse affect on the Company's
business, results of operations and financial condition.
CONTINGENCY PLANS. The Company has completed approximately 80% of its
contingency plan for Year 2000-related issues. These plans include, but are not
limited to, identification of alternate supplies, alternate electronic processes
and alternate manual systems. The company is planning to have contingency plans
completed for essential systems and equipment by July 1, 1999; however, there
can be no assurance that it will meet this objective by such date or by January
1, 2000.
FORWARD-LOOKING STATEMENTS. The Year 2000 disclosure set forth above
contains forward-looking statements. Specifically, such statements are contained
in sentences including the words "plans," "expects" or "anticipates." Such
forward-looking statements are subject to inherent risks and uncertainties that
may cause actual results to differ materially from those contemplated by the
forward-looking statements. Factors that may cause actual results to differ
materially from those contemplated by the forward-looking statements include
availability and cost of personnel trained in this area, and the failure of
third parties to (i) respond to the Company's inquiries as to whether the
systems and equipment supplied to the Company are compliant and (ii) adequately
remediate Year 2000 issues. The Company could experience material adverse
affects to its business, results of operations, and financial condition if it is
unable to identify and remediate all non-compliant essential systems and
equipment on the time schedule currently planned.
YEAR 2000 INFORMATION AND READINESS DISCLOSURE ACT. The Year 2000
disclosure set forth above is intended to be a "year 2000 statement" as such
term is defined in the Year 2000 Information and Readiness Disclosure Act of
1998 (the "Year 2000 Act") and, to the extent such disclosure relates to year
2000 processing of the Company or to products or services offered by the
Company, is also intended to be a "Year 2000 readiness disclosure" as such term
is defined in the Year 2000 Act.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information with respect to this item is found in "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Litigation" and
is incorporated by reference herein.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(10.1) Limited Waiver and Agreement, dated as of April 27, 1999, to
Credit Agreement among Sun, certain lenders, certain co-agents,
and NationsBank of Texas, as Administrative Lender.
(27.1) Financial Data Schedule
(b) Reports on Form 8-K
Report dated April 5, 1999 and filed April 13, 1999 reporting that the
Company's acquisition of Retirement Care Associates, Inc. would be
accounted for as a purchase rather than a pooling of interests as a result
of the Company's decision to divest certain of its non-core businesses and
based on discussions with the SEC and the Company's accountants.
Report dated March 31, 1999 and filed April 15, 1999 reporting that the
Company filed its Form 10-K for the year ended December 31, 1998 with
certain sections omitted, and that an amendment would be filed to include
the omitted sections.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SUN HEALTHCARE GROUP, INC.
Date: May 20, 1999 By: /s/ Robert D. Woltil *
-------------------------
Robert D. Woltil
Chief Financial Officer
*Signing on the behalf of the Registrant and as principal financial
officer.
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EXHIBIT 10.1
LIMITED WAIVER AND AGREEMENT
This LIMITED WAIVER AND AGREEMENT, dated as of April 27, 1999 (this
"Agreement"), is entered into by and among SUN HEALTHCARE GROUP, INC., a
Delaware corporation ("Borrower"), the entities listed on the signature pages
hereto as Guarantors (collectively, "Guarantors"), the entities listed on the
signature pages hereto as Lenders (collectively, "Lenders"), the Co-Agents
listed on the signature pages hereto as Co-Agents (collectively, the
"Co-Agents"), and NATIONSBANK, N.A. (successor by merger to NationsBank of
Texas, N.A.), as Administrative Agent (in said capacity, the "Administrative
Agent").
This Agreement is made with reference to that certain Credit Agreement
dated as of October 8, 1997, by and among Borrower, Lenders, Co-Agents and
Administrative Agent, as amended by that certain First Amendment to Credit
Agreement, dated as of November 12, 1997, that certain Second Amendment to
Credit Agreement, dated as of March 27, 1998, that certain Third Amendment to
Credit Agreement, dated as of May 29, 1998 and that certain Fourth Amendment to
Credit Agreement, dated as of October 30, 1998 (as amended, the "Credit
Agreement"). Capitalized terms used herein without definition shall have the
same meanings herein as set forth in the Credit Agreement.
WHEREAS, the Lenders have extended Advances and made other extensions of
credit to Borrower and Guarantors have guaranteed the Obligations pursuant to
the Subsidiary Guaranties; and
WHEREAS, Borrower has failed to comply with certain covenants and other
provisions set forth in the Credit Agreement (the "Designated Covenants") as set
forth on Schedule A attached hereto (the "Scheduled Defaults"), and
WHEREAS, Borrower has requested that Lenders agree to waive the Scheduled
Defaults as of December 30, 1998 and Lenders have agreed to do so for a limited
period of time, and only to the extent and on the terms set forth expressly
below.
NOW, THEREFORE, in consideration of the covenants, conditions and
agreements hereinafter set forth, and for other good and valuable consideration,
the receipt and adequacy of which are all hereby acknowledged, the Borrower, the
Guarantors, the Lenders, the Co-Agents and Administrative Agent covenant and
agree as follows:
I. ACKNOWLEDGEMENTS; REPRESENTATIONS; ADDITIONAL AGREEMENTS.
A. Each of Borrower and the Guarantors acknowledges and agrees that the
terms of the Loan Documents are the valid and binding obligations of Borrower
and the Guarantors, as the case may be, enforceable in accordance with their
terms and are not subject to any claims, offsets, defenses or counterclaims.
B. Each of Borrower and the Guarantors acknowledges and agrees that the
Scheduled Defaults have occurred and are continuing and, absent the waivers and
amendments contained herein, such Scheduled Defaults would constitute Events of
Defaults that would entitle Lenders to declare the Obligations immediately due
and payable and to take action to collect the Obligations.
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C. Borrower represents that, except for the Scheduled Defaults, (i) no
Defaults or Events of Default have occurred or are continuing and (ii) the
representations and warranties made in the Loan Documents are true and correct
in all material respects as of the date hereof as though made at and as of the
date hereof, except for (x) such representations and warranties that relate to a
particular date or which fail to be true and correct as a result of events or
occurrences permitted under the Loan Documents, and (y) such matters as are set
forth in the Borrower's Report on Form 10-K for the fiscal year ended December
31, 1998, including amendments on Form 10-KA, as filed with the Securities and
Exchange Commission through April 23, 1999.
D. Borrower will deliver the following information to Administrative Agent:
1. Notice by facsimile immediately, and in any event on the same day if
received by noon Albuquerque time and by the next day if received
after noon Albuquerque time, of any communication (whether oral or
written), notice or legal process from or on behalf of a holder of or
representative of (including, without limitation, a trustee) any
Subordinated Debt, Sun Financing Preferred Securities, or other debt
in a principal amount in excess of $10,000,000 on which Borrower or
any of its Subsidiaries is obligated, together with a copy of any such
written notice or communication received by Borrower; provided,
however, that Borrower shall not be required to provide notice of
communications with holders of Borrower's debt requesting information
concerning Borrower's financial or operating status or intentions
concerning payment of the holder's debt, which communication does not
involve an indenture trustee or counsel and in which the holder or
representative of such debt does not discuss the formation of a formal
or informal committee of debt holders, acceleration or any other
action to enforce remedies.
2. Promptly upon receipt or availability, (i) monthly financial
statements (including a balance sheet and statement of cash flows) in
the form provided to management, (ii) weekly cash flow projections for
the following three month period in the form provided to management,
(iii) notice of any assertion that the obligor (or any agent thereof)
on any Medicaid or Medicare account receivable asserts that it has a
claim against Borrower or any of its Subsidiaries or intends to assert
a right of setoff or recoupment (or similar payment), involving in
excess of $10,000,000 in the aggregate, together with a copy of any
written notice or communication related thereto and (iv) other reports
or information as may be reasonably requested by Administrative Agent.
Borrower shall deliver the monthly financial statements referenced in
clause (i) of this Section for January through March 1999 to
Administrative Agent no later than May 7, 1999.
E. Borrower and its Restricted Subsidiaries shall deliver to Administrative
Agent weekly statements of the cash position of the Borrower and its Restricted
Subsidiaries showing balances and locations of accounts.
F. Borrower, Guarantors and Lenders agree that, notwithstanding Sections
7.4(a) or 2.5(c) of the Credit Agreement, during the time that the waiver set
forth in Section II hereof is in effect (the "Waiver Period"), Borrower and
Guarantors shall not be entitled to retain the Net Cash Proceeds of any assets
sold, leased, transferred or disposed of as permitted by Section 7.4(a)(viii) of
the Credit Agreement and all such proceeds shall be applied to the Term Loan
Advances as set forth in Section 2.5(c)(i) of the Credit Agreement. Borrower,
Guarantors and Lenders further agree that notwithstanding anything in any Loan
Documents to the contrary, during the Waiver Period, Borrower and Guarantors
shall promptly deliver to Administrative Agent for application to the Advances
in the case of cash proceeds, or to secure the Obligations in the case of
proceeds other than cash, all proceeds of the note executed by Liberty
Healthcare Management Group, Inc. pledged to the Lenders.
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G. Notwithstanding Section 11.6 of the Credit Agreement, during the Waiver
Period, Borrower's prior consent shall not be required for sale by a Lender of a
Participation or the assignment by a Lender of its rights and obligations under
the Credit Agreement and the Loan Documents.
H. Borrower and Guarantors acknowledge that pursuant to Section 11.2 of the
Credit Agreement they are obligated to reimburse the reasonable out-of-pocket
expenses of the Lenders, including the working group of Lenders, incurred in
connection with this Agreement, a possible amendment to the Credit Agreement and
related matters.
II. WAIVER; ADVANCES.
A. Subject to the terms hereof and in reliance on the representations and
warranties of the Borrower herein contained, Lenders, Administrative Agent and
Co-Agents hereby waive the Scheduled Defaults from December 30, 1998 until the
earlier of (x) 5:00 p.m. E.D.T. on May 28, 1999 and (y) the date upon which any
of the Conditions set forth in Section III hereof is not satisfied or ceases to
continue to be satisfied (the earlier of clauses (x) and (y) being referred to
as the "Waiver Termination Date")). The Credit Agreement is hereby amended, (x)
effective as of December 30, 1998, to excuse compliance solely through the
Waiver Termination Date with the Designated Covenants solely to the extent of
the Scheduled Defaults; and (y) on the Waiver Termination Date, to reinstitute
all Designated Covenants and to require Borrower's compliance with such
Designated Covenants including compliance with such Designated Covenants for the
fiscal quarters ended December 31, 1998 and March 31, 1999.
B. Borrower is not authorized to receive any Revolving Credit Advances that
would increase the amount of the Revolving Credit Advances outstanding as of the
date hereof and Borrower is not authorized to have issued any Letters of Credit
that would increase the Reimbursement Obligations from the amount outstanding as
of the date hereof. Borrower will not request any such Revolving Credit Advances
or the issuance of any such Letters of Credit. Prior to the Waiver Termination
Date, Borrower may reborrow Revolving Credit Advances repaid after the date
hereof and may designate outstanding Advances as Base Rate Advances or LIBOR
Advances, and the applicable Interest Period for any LIBOR Advances, in each
case in accordance with the terms of the Credit Agreement.
III. CONDITIONS.
The waiver set forth in Section II hereof is subject to the satisfaction
and continuation of the following conditions (the "Conditions").
A. No Default or Event of Default other than a Scheduled Default shall
occur.
B. Neither Borrower nor any Subsidiaries shall have made or set apart any
payment on account of any Subordinated Debt, including, without limitation,
payment of interest, principal, conversion, redemption or defeasance of any
Subordinated Debt other than payment (in an amount not to exceed $1,050,000 in
the aggregate) on conversion of the Convertible Bonds.
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C. Neither Sun Financing, Borrower nor any of Borrower's Subsidiaries shall
declare any Dividends or pay any Dividends in respect of the Sun Financing
Preferred Securities.
D. Neither any holder of any Subordinated Debt nor any trustee for any
Subordinated Debt shall have accelerated any such debt or commenced any
collection proceeding in respect thereto.
E. Borrower shall have satisfied and be in compliance with each term and
condition of this Agreement.
F. No event or circumstance shall hereafter occur, or shall have heretofore
occurred but is hereafter discovered by Lenders, that has a Material Adverse
Effect, regardless of whether such event or circumstance would constitute an
Event of Default.
IV. RESERVATION OF RIGHTS.
A. Without limiting the generality of the provisions in Section 11.11 of
the Credit Agreement, the waiver and amendment set forth above in Section II
shall be limited precisely as written and relates solely to the Scheduled
Defaults during the Waiver Period in the manner and to the extent above set
forth, and nothing in this Agreement shall be deemed to:
1. Constitute a waiver of compliance by Borrower with respect to the
Designated Covenants in any other instance or any other term,
provision or condition of the Credit Agreement or any other instrument
or agreement referred to therein; or
2. Prejudice any right or remedy that Administrative Agent, the Co-Agents
or any Lender may now have (except to the extent such right or remedy
was based upon the Scheduled Defaults that will not exist during the
Waiver Period upon giving effect to this Agreement) or may have in the
future under or in connection with the Credit Agreement or any other
instrument or agreement referred to therein.
Except as expressly set forth herein, the terms, provisions and conditions
of the Credit Agreement and the other Loan Documents shall remain in full force
and effect and in all other respects are hereby ratified and confirmed.
B. Without limiting the generality of the foregoing, Borrower and
Subsidiaries will not claim that any prior action or course of conduct by
Administrative Agent, Co-Agents or any of the Lenders constitutes an agreement
or obligation to continue such action or course of conduct in the future.
Borrower and Subsidiaries acknowledge that Administrative Agent, Co-Agents and
Lenders have made no commitment as to how the Scheduled Defaults will be
resolved upon the Waiver Termination Date.
C. Borrower, Guarantors, Administrative Agent, Co-Agents and Lenders may,
from time to time, engage in negotiations concerning the Obligations which may
be lengthy and complex. None of Administrative Agent, Co-Agents or the Lenders
shall have any obligation to modify, amend and/or restructure the Obligations or
any of the Loan Documents in connection with such negotiations or otherwise.
Each of Administrative Agent, Co-Agents and the Lenders may terminate such
negotiations at any time, in its sole discretion, with or without notice, and
without liability of any kind. None of Administrative Agent, Co-Agents or the
Lenders shall have any obligation or liability by virtue of the commencement,
prosecution or termination of negotiations concerning any possible amendment.
None of Administrative Agent, Co-Agents or the Lenders shall waive any rights or
incur any liability by negotiation nor by the passage of time associated
therewith.
4
<PAGE>
D. Subject only to the terms of this Agreement, and subject to any
applicable notice, grace or cure periods, Administrative Agent, Co-Agents and
Lenders may exercise any right or remedy available to them pursuant to the Loan
Documents or by applicable law or in equity during the Waiver Period, including,
without limitation, as the result of a Default or Event of Default other than a
Scheduled Default, and nothing herein shall operate to restrict, inhibit or
prohibit Administrative Agent, Co-Agents or the Lenders from exercising any such
right or remedy or from the prosecution or continued prosecution of any action
or proceeding in furtherance of the foregoing.
E. The Loan Documents are in full force and effect, and shall remain in
full force and effect, unless and until an agreement modifying the Loan
Documents is executed and delivered by the applicable parties, and then only to
the extent such an agreement actually modifies such Loan Documents.
F. At any time on or after the Waiver Termination Date, Administrative
Agent, Co-Agents and the Lenders shall be entitled to exercise all their rights
and remedies (including rights and remedies based on the Scheduled Defaults),
whether under the Loan Documents or at law or in equity, without further notice
or demand.
V. CONDITIONS TO EFFECTIVENESS.
This Agreement shall be effective upon the satisfaction of the following
conditions:
A. Administrative Agent shall have received counterparts of this Agreement
executed by the Determining Lenders;
B. Administrative Agent shall have received counterparts of this Agreement
executed by Borrower and acknowledged by each Guarantor;
C. Administrative Agent shall have received, in form and substance
satisfactory to Administrative Agent and its counsel, such other documents,
certificates and instruments as Administrative Agent shall require;
D. Borrower shall have paid all fees and expenses billed through the date
hereof owing to Administrative Agent and Lenders, including without limitation,
fees and expenses of counsel to Administrative Agent;
Borrower shall have paid to O'Melveny & Myers LLP, counsel to
Administrative Agent, a retainer in the amount of $250,000, and to
PricewaterhouseCoopers LLP, financial advisors to Administrative Agent, a
retainer in the amount of $250,000, in each case to be applied to future amounts
owing under Section 11.2 of the Credit Agreement so that Borrower need not make
additional payments under Section 11.2 of the Credit Agreement until such
retainers have been exhausted, and which retainers shall be in addition to
Borrower's obligation to pay amounts owing to Administrative Agent billed
through the date hereof, as required by Section V.D above; and
Borrower shall have delivered evidence satisfactory to Administrative Agent
and its counsel that Borrower has exercised its right to extend the interest
payment on the Borrower Subordinated Debentures due on May 1, 1999.
VI. GUARANTORS' ACKNOWLEDGEMENT.
A. By signing below, each of the Guarantors: (a) acknowledges, consents and
agrees to the execution, delivery and performance by Borrower of this Agreement,
and (b) acknowledges and agrees that its obligations with respect to its
Subsidiary Guaranty or any other Loan Documents executed by it are (i) not
released, diminished, waived, modified, impaired or affected in any manner by
this Agreement, (ii) hereby ratified and confirmed, and (iii) not subject to any
claims, offsets, defenses or counterclaims.
B. By signing below, each Guarantor acknowledges and agrees that (i)
notwithstanding the conditions to effectiveness set forth in this Agreement,
such Guarantor is not required by the terms of any Subsidiary Guaranty or any
other Loan Document to consent to the terms of this Agreement and (ii) nothing
in this Agreement or any of the Loan Documents shall be deemed to require the
consent of such Guarantor to any future amendments to or modifications of or
waivers with respect to the Credit Agreement, or shall diminish or release such
Guarantor's guarantee of the Obligations if such consent is not obtained.
5
<PAGE>
VII. OTHER MATTERS.
A. ENTIRE AGREEMENT. THE CREDIT AGREEMENT, AS AFFECTED BY THIS AGREEMENT,
AND THE OTHER LOAN DOCUMENTS REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES
AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT
ORAL AGREEMENTS BETWEEN THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS
BETWEEN THE PARTIES.
B. This Agreement shall be governed by, and interpreted in accordance with
Texas law without regard to principles of conflicts of law.
C. This Agreement may be executed in any number of counterparts and by
different parties hereto in separate counterparts, each of which when so
executed and delivered shall be deemed to be an original and all which taken
together shall constitute but one and the same instrument.
D. Section headings in this Agreement are included herein for convenience
of reference only and shall not constitute a part of this Agreement for any
other purpose.
[signature pages omitted]
6
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