- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
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 June 30, 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 August 18, 1999, there were 61,061,709 shares of the Registrant's
$.01 par value Common Stock outstanding, net of treasury shares.
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
<PAGE>
SUN HEALTHCARE GROUP, INC.
Index
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1999
- ------------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page Numbers
------------
<S> <C> <C>
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets
June 30, 1999 and December 31, 1998 ......................... 3-4
Consolidated Statements of Earnings (Losses)
For the three and six months ended June 30, 1999 and 1998 ... 5-6
Consolidated Statements of Comprehensive Income (Losses)
For the three and six months ended June 30, 1999 and 1998 ... 7
Consolidated Statements of Cash Flows
For the six months ended June 30, 1999 and 1998 ............. 8-9
Notes to the Consolidated Financial Statements ..............10-30
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ...............31-54
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ........................................... 55
Item 3. Defaults Upon Senior Securities ............................. 55
Item 5. Other Events ................................................ 55
Item 6. Exhibits and Reports on Form 8-K ............................ 55
Signatures ............................................................ 56
</TABLE>
2
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------- ------------
(In thousands)
<S> <C> <C>
Current assets:
Cash and cash equivalents ...................... $ 27,054 $ 27,504
Accounts receivable, net of allowance for
doubtful accounts of $89,620 as of June 30,
1999, and $79,015 as of December 31, 1998 ... 386,525 538,329
Other receivables .............................. 73,186 48,073
Inventory, net ................................. 48,316 48,862
Prepaids and other assets ...................... 10,571 13,091
Income tax receivables ......................... - 15,874
---------- ----------
Total current assets .......................... 545,652 691,733
---------- ----------
Property and equipment, net .................... 452,364 601,270
Goodwill, net .................................. 514,440 795,945
Notes receivable ............................... 29,587 32,334
Assets held for sale ........................... 184,547 192,447
Other assets, net .............................. 106,201 148,309
Deferred tax assets ............................ - 6,000
---------- ----------
Total assets ............................. $1,832,791 $2,468,038
========== ==========
</TABLE>
(Continued on next page)
3
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------- -------------
(In thousands,
except share date)
<S> <C> <C>
Current liabilities:
Current portion of long-term debt ......................................... $1,310,147 $ 812,621
Current portion of obligations under capital leases ....................... 3,391 3,703
Accounts payable .......................................................... 53,509 94,143
Accrued compensation and benefits ......................................... 105,366 102,091
Accrued interest .......................................................... 60,764 26,095
Accrued self-insurance obligations ........................................ 52,749 54,865
Other accrued liabilities ................................................. 142,693 137,851
----------- -----------
Total current liabilities ............................................ 1,728,619 1,231,369
----------- -----------
Long-term debt, net of current portion ........................................... 273,976 705,653
Obligations under capital leases, net of current portion ......................... 100,089 103,679
Other long-term liabilities ...................................................... 39,716 41,061
----------- -----------
Total liabilities .................................................... 2,142,400 2,081,762
----------- -----------
Commitments and contingencies
Minority interest ................................................................ 6,294 7,517
Company-obligated mandatorily redeemable convertible preferred securities
of a subsidiary trust holding solely 7% convertible junior subordinated
debentures of the Company ................................................. 344,833 345,000
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, 63,261,778
and 61,930,159 shares issued and outstanding as of June 30, 1999
and December 31, 1998, respectively .................................. 630 619
Additional paid-in capital ................................................ 776,124 774,860
Retained deficit .......................................................... (1,397,793) (696,049)
Accumulated other comprehensive income .................................... (4,748) 2,902
----------- -----------
$(625,787) $82,332
----------- -----------
Less:
Unearned compensation ..................................................... 6,853 8,552
Common stock held in treasury, at cost, 2,212,983 and 2,124,868 shares
as of June 30, 1999 and December 31, 1998, respectively .............. 27,378 26,967
Grantor stock trust, at market, 1,638,256 and 1,989,132 shares as of
June 30, 1999 and December 31, 1998, respectively .................... 718 13,054
----------- -----------
Total stockholders' equity (deficit).................................. (660,736) 33,759
----------- -----------
Total liabilities and stockholders' equity (deficit).................. $ 1,832,791 $ 2,468,038
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
4
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (LOSSES)
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months Ended June 30,
------------------------------------
1999 1998
---- ----
(In thousands, except per share data)
<S> <C> <C>
Total net revenues ........................................... $ 600,914 $ 752,392
---------- ----------
Costs and expenses:
Operating ................................................ 608,061 612,256
Corporate general and administrative ..................... 40,257 43,439
Provision for losses on accounts receivable .............. 15,407 13,022
Depreciation and amortization ............................ 22,538 21,519
Interest, net ............................................ 39,006 31,884
Loss on sale of assets ................................... 51,781 7,802
Legal and regulatory matters ............................. 17,131
Financial restructuring costs ............................ 6,046 -
Impairment loss .......................................... 399,963 -
---------- ----------
Total costs and expenses .............................. 1,183,059 747,053
Dividends on convertible preferred securities ................ 6,452 3,771
---------- ----------
Earnings (losses) before income taxes and extraordinary loss.. (588,597) 1,568
Income taxes ................................................. - 815
---------- ----------
Earnings (losses) before extraordinary loss................... (588,597) 753
Extraordinary loss, net of income tax benefit ................ - 10,120
---------- ----------
Net earnings (losses) ........................................ $(588,597) $ (9,367)
========== ==========
Net earnings (losses) per common and common equivalent share
before extraordinary loss:
Basic ................................................. $ (10.06) $ 0.02
========== =========
Diluted ............................................... $ (10.06) $ 0.02
========== =========
Net earnings (losses) per common and common equivalent share:
Basic ................................................. $ (10.06) $ (0.20)
========== =========
Diluted ............................................... $ (10.06) $ (0.20)
========== =========
Weighted average number of common and common equivalent
shares outstanding:
Basic ................................................. 58,499 47,121
========= =========
Diluted ............................................... 58,499 63,466
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (LOSSES)
(Unaudited)
<TABLE>
<CAPTION>
For the Six Months Ended June 30,
------------------------------------
1999 1998
---- ----
(In thousands, except per share data)
<S> <C> <C>
Total net revenues ........................................... $1,273,946 $1,493,882
----------- -----------
Costs and expenses:
Operating ................................................ 1,232,630 1,220,839
Corporate general and administrative ..................... 82,274 82,740
Provision for losses on accounts receivable .............. 29,225 19,036
Depreciation and amortization ............................ 43,985 41,993
Interest, net ............................................ 76,177 67,025
Loss on sale of assets ................................... 63,889 7,802
Legal and regulatory matters ............................. - 17,131
Loss on termination of interest rate swaps ............... 2,488 -
Financial restructuring ................................. 6,046 -
Corporate restructuring costs ............................ 11,428 -
Impairment loss .......................................... 399,962 -
----------- -----------
Total costs and expenses .............................. 1,948,104 1,456,566
Dividends on convertible preferred securities ................ 12,968 3,771
----------- -----------
Earnings (losses) before income taxes, extraordinary loss and
cumulative effect of change in accounting principle......... (687,126) 33,545
Income taxes ................................................. 892 14,405
----------- -----------
Earnings (losses) before extraordinary loss and
cumulative effect of change in accounting principle ....... (688,018) 19,140
Extraordinary loss, net of income tax benefit ................ - 10,120
Cumulative effect of change in accounting principle .......... 13,727 -
----------- -----------
Net earnings (losses) ........................................ $ (701,745) $ 9,020
=========== ===========
Net earnings (losses) per common and common equivalent share
before extraordinary loss and cumulative effect of change
in accounting principle:
Basic ................................................. $ (11.81) $ 0.41
=========== ==========
Diluted ............................................... $ (11.81) $ 0.33
=========== ==========
Net earnings (losses) per common and common equivalent share:
Basic ................................................. $ (12.05) $ 0.19
=========== ==========
Diluted ............................................... $ (12.05) $ 0.16
=========== ==========
Weighted average number of common and common equivalent
shares outstanding:
Basic ................................................. 58,252 47,078
=========== ==========
Diluted ............................................... 58,252 58,036
=========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
6
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSSES)
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months Ended June 30,
------------------------------------
1999 1998
---- ----
(In thousands)
<S> <C> <C>
Net earnings (losses) .................................... $ (588,597) $ (9,367)
Foreign currency translation adjustments, net of tax ..... (1,746) (1,839)
----------- ---------
Comprehensive income (losses) ............................ $ (590,343) $(11,206)
=========== =========
</TABLE>
<TABLE>
<CAPTION>
For the Six Months Ended June 30,
------------------------------------
1999 1998
---- ----
(In thousands)
<S> <C> <C>
Net earnings (losses) .................................... $ (701,745) $ 9,020
Foreign currency translation adjustments, net of tax ..... (7,650) 1,756
----------- --------
Comprehensive income (losses) ............................ $ (709,395) $ 10,776
=========== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
7
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
For the Six Months Ended June 30,
----------------------------------
1999 1998
---- ----
(In thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (losses) ........................................ $ (701,745) $ 9,020
Adjustments to reconcile net earnings (losses) to net cash
provided by (used for) operating activities:
Extraordinary loss ................................... - 10,120
Impairment loss ...................................... 399,962 -
Cumulative effect of change in accounting principle .. 13,727 -
Loss on sale of assets ................................ 63,889 7,802
Depreciation and amortization ......................... 43,985 41,994
Provision for losses on accounts receivable ........... 29,225 19,034
Other, net ............................................ 2,704 3,878
Changes in operating assets and liabilities:
Accounts receivable ................................ 117,753 (138,516)
Other current assets ............................... 28,165 (21,394)
Other current liabilities .......................... (33,788) 56,717
Income taxes payable ............................... 26,769 (11,478)
----------- ---------
Net cash provided by (used for) operating activities (9,354) (22,823)
----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net .................................... (68,680) (63,476)
Acquisitions, net of cash acquired ........................... (2,134) (63,377)
Proceeds from sale and leaseback of property and equipment ... - 16,833
Increase in long-term notes receivable ....................... 2,746 (17,276)
Other assets expenditures .................................... (2,181) (11,384)
----------- ---------
Net cash used for investing activities ............. (70,249) (138,680)
----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings .................................... 123,319 168,976
Long-term debt repayments .................................... (38,377) (331,319)
Conversion of Mediplex 6 1/2% Convertible Subordinated
Debentures due 2003 ........................................ (6,649) -
Net proceeds from issuance of convertible preferred
securities of subsidiary ................................... - 330,342
Net proceeds from issuance of common stock ................... 809 1,231
Purchases of treasury stock .................................. (410) (1,357)
Other financing activities ................................... (1,052) (997)
---------- ---------
Net cash provided by financing activities .......... 77,640 166,876
---------- ---------
Effect of exchange rate on cash and cash equivalents ............ 1,513 (449)
---------- ---------
Net increase (decrease) in cash and cash equivalents ............ (450) 4,924
Cash and cash equivalents at beginning of year .................. 27,504 21,020
---------- ---------
Cash and cash equivalents at end of period ...................... $ 27,054 $ 25,944
========== =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
8
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
For the Six Months Ended June 30,
---------------------------------
1999 1998
---- ----
(In thousands)
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during period for:
Interest net of $1,254 and $1,111 capitalized during the
six months ended June 30, 1999 and 1998, respectively ....... $114,803 $ 42,520
========= =========
Income taxes .................................................. $(30,085) $(20,083)
========= =========
SUPPLEMENTARY SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
The Company's acquisitions during the six months ended
June 30, 1999 and 1998 involved the following:
Fair value of assets acquired ................................. $ 3,184 $549,268
Liabilities assumed ........................................... (1,050) (352,056)
Common stock issued ........................................... - (133,835)
--------- ---------
Cash payments made, net of cash received from others .......... $ 2,134 $ 63,377
========== =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
9
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
In the opinion of management of Sun Healthcare Group, Inc. (the "Company"
or "Sun"), the accompanying interim consolidated financial statements present
fairly the Company's financial position at June 30, 1999 and December 31, 1998,
the consolidated results of its operations for the three and six month periods
ended June 30, 1999 and 1998, and the consolidated statements of cash flows for
the six month periods ended June 30, 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 principle was applied during
the three and six months ended June 30, 1998 are as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
June 30, 1998 June 30, 1998
------------- -------------
<S> <C> <C>
Net earnings (losses) as reported ........... $ (9,367) $ 9,020
========= =======
Pro Forma net earnings (losses) ............. $ (8,329) $ 7,062
========= =======
Net earnings (losses) per common and
common equivalent share as reported:
Basic .................................. $ (0.20) $ 0.19
========= =======
Diluted ................................ $ (0.20) $ 0.16
========= =======
Pro Forma net earnings (losses) per common
and common equivalent share:
Basic .................................. $ (0.18) $ 0.15
========= =======
Diluted ................................ $ (0.13) $ 0.12
========= =======
</TABLE>
10
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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 DEBT AGREEMENTS AND LIQUIDITY
The Company was not in compliance with certain financial covenants
contained in its Senior Credit Facility as of December 31, 1998 and June 30,
1999. Borrowings under the Senior Credit Facility were $745.6 million and $821.3
million at December 31, 1998 and June 30, 1999, respectively. In addition, the
Company failed to make a $19.5 million payment due to the Senior Credit Facility
bank lenders on June 30, 1999. Because of the covenant and payment defaults, the
bank lenders could have required immediate repayment of all amounts outstanding
under the Senior Credit Facility. As a result, the Company has classified all
borrowings under the Senior Credit Facility as current liabilities. The Company
did not have sufficient cash reserves to repay all amounts outstanding under the
Senior Credit Facility at August 18, 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.
The Company did not make its semi-annual interest payments of $7.3 million
on the Company's $150.0 million 9 3/8% Subordinated Notes that was due on May 1,
1999 and of $11.9 million on the Company's $250.0 million 9-1/2% Subordinated
Notes that was due on July 1, 1999. The bank lenders under the Company's Senior
Credit Facility exercised their contractual right blocking the Company from
making these payments. Because the Company did not make these payments, it is in
default under the indentures for the 9 3/8% Subordinated Notes and 9-1/2%
Subordinated Notes and the holders of such Notes could declare all amounts
outstanding under the respective indentures immediately due and payable,
although actual payment would continue to be prohibited by the actions of the
bank lenders. The Company did not have sufficient cash reserves to repay all
amounts outstanding under either of these indentures at August 18, 1999.
The Company is in default of certain Mortgage Notes amounting to $31.9
million and $31.7 million at December 31, 1998 and June 30, 1999, respectively.
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 June
30, 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 June 30, 1999.
As of December 31, 1998 and June 30, 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 August
18, 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. The Company was also in cross default under the terms of leases
for 14 of its long-term care facilities in the United States as of December 31,
1998 and June 30, 1999. The Company has a substantial number of other leases
which may contain similar default or cross default provisions.
11
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The Company and its principal lenders are discussing the terms of an
overall financial restructuring. However, in the event the lenders or lessors
under the agreements and leases described above begin to exercise remedies
against the Company or if the Company makes a determination that it would not be
able to fund its operations outside bankruptcy, the Company will commence a
chapter 11 bankruptcy case under title 11 of the United States Code.
During the second quarter of 1999, the Company recorded financial
restructuring costs of $6.0 million, primarily professional fees, related to the
Company's activities in response to the defaults under the Senior Credit
Facility, the 9 3/8% and 9-1/2% Subordinated Notes.
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.
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 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 and six months ended June 30, 1998 (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
June 30, 1998 June 30, 1998
------------- -------------
<S> <C> <C>
Net revenues $825,417 $1,636,134
Net losses $(22,142) $ (15,350)
Per Share Data:
Net losses per share:
Basic $ (0.41) $ (0.28)
</TABLE>
In addition, during the six months ended June 30, 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
six months ended June 30, 1998, the Company acquired nine pharmacies in the
United States. The pro forma impact of these acquisitions with the exception of
RCA is immaterial.
12
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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 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 included 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
terminated 96 employees at these subsidiaries. As of June 30, 1999, the Company
paid approximately $3.5 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 June 30, 1999, the Company's 1999 restructuring costs reserve
balance was approximately $6.1 million.
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 June 30, 1999,
the Company's 1998 restructuring costs reserve balance was approximately $.9
million and is substantially complete.
5. IMPAIRMENT OF LONG-LIVED ASSETS
The Company periodically evaluates the carrying value of goodwill and any
other related long-lived assets in relation to the future projected cash flows
of the underlying business unit. The assets are considered to be impaired when
the expected future cash flows of the business unit do not exceed the carrying
balances of the goodwill or other long-lived assets. In the second quarter of
1999, the Company recorded a non-cash impairment charge of $400 million related
to the Company's estimate of goodwill and other asset impairment.
During the second quarter of 1999, the Company revised its projections of
future cash flows for its various business units as current operating results
were worse than planned. The significant write-down of goodwill resulted from
the continued adverse impact of PPS on the level of Medicare reimbursement and
occupancy and the demand for the Company's rehabilitation and respiratory
therapy and pharmaceutical and medical supply services (see "Management's
Discussion and Analysis of Financial Condition and Results of Operations Effects
of Changes to Reimbursement"). Additionally, certain of the United Kingdom
facilities have not achieved profitability targets established upon their
acquisition (most of which were acquired in conjunction with Ashbourne).
13
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The following is a summary of the impairment loss by division for the six
months ended June 30, 1998 (in thousands):
Property
and Other
Goodwill Equipment Assets Total
-------- --------- ------ -----
Inpatient Services 188,486 84,156 16,518 289,160
Rehabilitation and
Respiratory Therapy Services 32,190 7,257 11 39,458
Pharmaceuticals and
Medical Supply Services 23,921 2,346 - 26,267
International Operations 16,707 17,641 - 34,348
Other Operations 6,950 1,839 1,940 10,729
6. 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. In 1999, the
Company identified additional inpatient facilities for disposal and revised its
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 and $49.6
million in the second quarter of 1999. In addition, the Company has decided not
to dispose of certain non-core businesses previously recorded in assets held for
sale including the rehabilitation hospitals. The following is a summary of the
carrying amounts and additional loss for the six months ended June 30, 1999
related to the non-core businesses to be disposed of as of June 30, 1999 (in
thousands):
<TABLE>
<CAPTION>
Carrying
Amount Loss
------ ----
<S> <C> <C>
Assisted living facilities ....................... $115,900 $17,832
Other inpatient facilities ....................... 42,814 17,062
Other non-core businesses ........................ 25,833 -
--------- --------
Total ........................................ $184,547 $34,894
========= ========
</TABLE>
Management expects to complete the sales of these businesses during 1999.
In addition, in July of 1999 the Company sold 11 of its long-term care
facilities in the United Kingdom for L24.9 million or $38.6 million and leased
them back under twelve year leases. The transaction resulted in a loss of $16.9
million.
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.
7. 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.
8. COMMITMENTS
(a) CONSTRUCTION COMMITMENTS
The Company had capital commitments, as of June 30, 1999, under various
contracts of approximately $15.6 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.
14
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(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 10).
9. 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 and six months ended June 30, 1999, the Company's stock options and
convertible debentures were anti-dilutive.
Earnings per share is calculated as follows for the three and six months
ended June 30, (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
June 30, June 30,
-------- --------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
BASIC:
Net earnings (losses) before cumulative
effect of change in accounting principle
and extraordinary loss ......................... $(588,597) $ 753 $(688,018) $ 19,140
Earnings per share ............................... $ (10.06) $ .02 $ (11.81) $ .41
--------- -------- --------- --------
Net earnings (losses) ............................ $(588,597) $(9,367) $(701,745) $ 9,020
Earnings (losses) per share ...................... $ (10.06) $ (.20) $ (12.05) $ .19
--------- -------- --------- --------
Weighted average shares outstanding .............. 58,499 47,121 58,252 47,078
DILUTED:
Net earnings (losses) before extraordinary loss .. $(588,597) $ 753 $(688,018) $ 19,140
Earnings (losses) per share before
extraordinary loss ............................. $ (10.06) $ .02 $ (11.81) $ .33
Net earnings (losses)............................. $(588,597) $(9,367) $(701,745) $ 9,020
Earnings (losses) per share ...................... $ (10.06) $ (.20) $ (12.05) $ .16
Weighted average shares used in basic
calculation .................................... 58,499 47,121 58,252 47,078
Effect of dilutive securities:
Stock options and warrants ..................... - 605 - 659
Assumed conversion of convertible debt ......... - 15,740 - 10,299
--------- -------- -------- --------
Weighted average common and common equivalent
shares outstanding ............................. 58,499 63,466 58,252 58,036
========= ======== ======== ========
</TABLE>
15
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
10. 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 AND 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.
The Company and certain of its subsidiaries are defendants in a qui tam
lawsuit brought by a private citizen in the Untied States District Court of the
Central District of California alleging violations of the federal False Claims
Act and a related wrongful termination. The plaintiff alleges that a home health
agency operated by one of the Company's subsidiaries submitted bills for several
years that were improper for various reasons, including bills for patients whose
treatment had not been authorized by their physicians. The government intervened
to the extent that the lawsuit alleges billing without obtaining proper and
timely physician authorization, but declined to intervene in the remainder of
the lawsuit. Although the Company and its subsidiaries intend to vigorously
defend themselves 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 addition, the Department of Health & Human Services (the "HHS") and the
Department of Justice (the "DOJ") periodically investigate matters that have
come to their attention concerning the Company, including cost reporting
matters. To expedite resolution of any outstanding investigations, the Company
has requested that the HHS and the DOJ inform it of any such investigations or
outstanding concerns. In response, the DOJ has informed the Company of a number
of outstanding inquiries, some of which have been prompted by the filing of qui
tam lawsuits that remain under seal. The Company intends to expeditiously
address whatever concerns the HHS and the DOJ may have. 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.
16
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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. On July 21, 1999 the Court issued an order certifying the class,
approving the settlement and dismissing with prejudice 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.
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 (CONTINUED)
(UNAUDITED)
11. SUMMARIZED FINANCIAL INFORMATION
The Company acquired The Mediplex Group, Inc. ("Mediplex") on June 23, 1994
and became a co-obligor with Mediplex with respect to the 6.5% Convertible
Subordinated Debentures and the 11.75% Senior Subordinated Notes subsequent to
the acquisition. Summarized financial information of Mediplex is provided below
(in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
-------- -----------
<S> <C> <C>
Current assets ................................... $ 82,265 $113,585
Noncurrent assets ................................ 233,211 225,586
Current liabilities .............................. 3,825 13,165
Noncurrent liabilities ........................... 48,885 69,454
Due to parent .................................... 248,690 206,161
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
June 30, June 30,
-------- --------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues ................................ $112,588 $150,451 $224,023 $295,082
Costs and expenses .......................... 106,127 137,546 215,255 273,652
--------- -------- --------- ---------
Earnings (losses) before intercompany charges,
income taxes and cumulative effect of
change in accounting principle ............ 6,461 12,905 8,768 21,430
Intercompany charges (1) .................... 23,434 24,830 42,201 49,095
--------- -------- --------- ---------
Earnings (losses) before income taxes
and cumulative effect of change in
accounting principle ...................... (16,973) (11,925) (33,433) (27,665)
Income taxes (benefit) ...................... - (5,039) 363 (11,802)
--------- -------- --------- ---------
Net earnings (losses) before cumulative
effect of change in accounting principle .. (16,973) (6,886) (33,796) (15,863)
Cumulative effect of change in accounting
principle ................................. - - 2,520 -
--------- -------- --------- ---------
Net earnings (losses) ....................... $(16,973) $(6,886) $(36,316) $(15,863)
========= ======== ========= =========
</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 $3.8 million and
$12.8 million for the three months ended June 30, 1999 and 1998,
respectively and $7.5 million and $24.2 million for the six months ended
June 30, 1999 and 1998, respectively. Royalty fees charged to Mediplex for
the three months ended June 30, 1999 and 1998 for the use of Sun trademarks
were $1.8 million and $3.0 million, respectively and $3.6 million and $5.6
million for the six months ended June 30, 1999 and 1998, respectively.
Intercompany interest charged to Mediplex for the three months ended June
30, 1999 and 1998 for advances from Sun was $17.8 million and $9.0 million,
respectively and $31.1 million and $19.3 million for the six months ended
June 30, 1999 and 1998, respectively.
18
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
12. 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 June 30, 1999
Total Net Revenues ..... $392,893 $ 58,240 $72,791 $73,551 $58,035 $ (1,002) $(53,594) $600,914
Operating expenses,
corporate general
and administrative
expenses, provision
for losses on
accounts receivable .. 430,679 58,908 68,237 70,883 60,462 28,086 (53,529) 663,726
Depreciation and
amortization ....... 9,062 2,242 2,121 3,715 2,611 2,787 - 22,538
Interest, net .......... 2,253 71 21 3,633 1,959 31,069 - 39,006
Dividend on convertible
preferred securities . - - - - - 6,452 - 6,452
Earnings (losses)
before corporate
allocations .......... (49,101) (2,981) 2,412 (4,680) (6,997) (69,396) (65) (130,808)
Corporate interest
allocation ........... 12,043 3,042 3,117 4,889 2,665 (25,756) - -
Corporate management
fees ................. 18,170 2,361 2,914 732 1,844 (26,021) - -
Regional allocation (235) - - - (52) 287 - -
Net segment earnings
(losses) ............. (79,079) (8,384) (3,619) (10,301) (11,454) (17,906) (65) (130,808)
Intersegment revenues .. 150 30,242 18,115 - 5,136 (49) (53,594) -
Identifiable segment
assets ............... 225,109 80,007 88,734 326,951 206,182 1,548,452 (657,349) 1,818,086
Segment capital
expenditures, net ..... 16,788 1,299 (4,874) 5,083 2,073 8,842 - 29,211
</TABLE>
19
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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 June 30, 1998
Total Net Revenues ..... $502,723 $173,239 $ 54,729 $70,041 $65,671 $ 502 $(114,513) $752,392
Operating expenses,
corporate general
and administrative
expenses, provision
for losses on
accounts receivable .. 458,818 115,200 48,283 63,845 63,589 30,425 (111,442) 668,718
Depreciation and
amortization ....... 8,856 2,317 1,655 5,245 1,261 2,185 - 21,519
Interest, net .......... 890 16 11 4,482 15 26,470 - 31,884
Dividend on convertible
preferred securities . - - - - - 3,771 - 3,771
Earnings (losses)
before corporate
allocations .......... 34,159 55,706 4,780 (3,531) 806 (62,349) (3,071) 26,500
Corporate interest
allocation ........... 12,747 4,057 2,241 6,762 1,947 (27,754) - -
Corporate management
fees ................. 22,160 6,923 2,210 661 1,284 (30,168) (3,070) -
Regional allocation (204) 1,974 - - (2,104) 334 - -
Net segment earnings
(losses) ............. (544) 42,752 329 (10,954) (321) (4,761) (1) 26,500
Intersegment revenues .. 8,869 82,602 15,182 - 7,860 - (114,513) -
Identifiable segment
assets ............... 804,651 266,271 165,360 562,052 226,810 2,179,010 (982,524) 3,221,630
Segment capital
expenditures, net ..... 11,103 5,088 5,012 4,155 965 12,414 - 38,737
</TABLE>
20
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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 Six Months Ended June 30, 1999
Total Net Revenues ..... $855,878 $128,306 $148,612 $145,213 $120,671 $ (1,970) (122,764) $1,273,946
Operating expenses,
corporate general
and administrative
expenses, provision
for losses on
accounts receivable .. 876,527 126,335 142,003 138,446 121,747 59,534 (122,617) 1,341,975
Depreciation and
amortization ....... 17,763 4,381 4,182 7,231 5,229 5,199 - 43,985
Interest, net .......... 4,514 145 42 6,846 4,006 60,624 - 76,177
Dividend on convertible
preferred securities . - - - - - 12,968 - 12,968
Earnings (losses)
before corporate
allocations .......... (42,926) (2,555) 2,385 (7,310) (10,311) (140,295) (147) (201,159)
Corporate interest
allocation ........... 25,625 6,505 6,514 10,011 5,538 (54,193) - -
Corporate management
fees ................. 36,673 5,155 5,920 1,443 3,692 (52,883) - -
Regional allocation (502) - - - (154) 656 - -
Net segment earnings
(losses) ............. (104,722) (14,215) (10,049) (18,764) (19,387) (33,875) (147) (201,159)
Intersegment revenues .. 299 69,012 41,888 - 11,565 - (122,764) -
Identifiable segment
assets ............... 255,109 80,007 88,734 326,951 206,182 1,548,452 (672,644) 1,832,791
Segment capital
expenditures, net ..... 28,150 2,789 (3,387) 7,713 7,769 25,646 - 68,680
</TABLE>
21
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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 Six Months Ended June 30, 1998
Total Net Revenues ..... $992,820 $350,631 $107,606 $136,348 $128,007 $ 834 $(222,364) $1,493,882
Operating expenses,
corporate general
and administrative
expenses, provision
for losses on
accounts receivable .. 912,545 232,921 93,343 123,852 120,499 56,845 (217,388) 1,322,617
Depreciation and
amortization ....... 17,963 4,404 3,162 10,345 2,128 3,991 - 41,993
Interest, net .......... 2,079 14 19 9,064 40 55,809 - 67,025
Dividend on convertible
preferred securities . - - - - - 3,771 - 3,771
Earnings (losses)
before corporate
allocations .......... 60,233 113,292 11,082 (6,913) 5,340 (119,582) (4,976) 58,476
Corporate interest
allocation ........... 24,262 8,020 4,384 13,221 3,429 (53,316) - -
Corporate management
fees ................. 42,809 14,080 4,297 1,286 2,448 (59,944) (4,976) -
Regional allocation .... (241) 1,974 - - (2,206) 473 - -
Net segment earnings
(losses) ............. (6,597) 89,218 2,401 (21,420) 1,669 (6,795) - 58,476
Intersegment revenues .. 14,839 162,149 30,502 - 14,874 - (222,364) -
Identifiable segment
assets ............... 804,651 266,271 165,360 562,052 226,810 2,179,010 (982,524) 3,221,630
Segment capital
expenditures, net ..... 16,670 9,652 3,451 9,655 4,199 19,849 - 63,476
</TABLE>
13. 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.
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.
22
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
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>
23
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEET
As of June 30, 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 ........... $ (6,204) $ 23,237 $ 10,021 $ - $ 27,054
Accounts receivable, net ............ - 338,794 48,429 (698) 386,525
Other receivables ................... 9,257 15,260 48,669 - 73,186
Inventory, net ...................... 12 36,886 11,418 - 48,316
Prepaids and other assets ........... 2,489 7,555 527 - 10,571
Income tax receivable ............... - - - - -
----------- ----------- ----------- ----------- -----------
Total current assets .............. 5,554 421,732 119,064 (698) 545,652
----------- ----------- ----------- ----------- -----------
Property and equipment, net ......... 87,375 135,348 229,641 - 452,364
Goodwill, net ....................... 36 422,127 92,277 - 514,440
Notes receivable .................... 19,231 1,324 9,032 - 29,587
Assets held for sale ................ 4,678 179,869 - - 184,547
Other assets, net ................... 72,704 15,545 17,952 - 106,201
Investment in subsidiaries .......... 571,345 - - (571,345) -
Deferred tax assets.................. - - - - -
----------- ----------- ----------- ----------- -----------
Total assets ...................... $ 760,923 $1,175,945 $ 467,966 $(572,043) $1,832,791
=========== =========== =========== =========== ===========
Current liabilities:
Current portion of long-term debt ... $1,241,422 $ 42,474 $ 26,251 $ - $1,310,147
Current portion of obligations under
capital leases .................... 1,134 2,031 226 - 3,391
Accounts payable .................... 18,380 23,907 11,920 (698) 53,509
Accrued compensation and benefits ... 21,648 71,922 11,796 - 105,366
Accrued interest..................... 53,289 6,663 812 - 60,764
Accrued self insurance obligations .. (12,216) 63,631 1,334 - 52,749
Other accrued liabilities ........... 39,346 73,730 29,617 - 142,693
----------- ----------- ----------- ----------- -----------
Total current liabilities .......... 1,363,003 284,358 81,956 (698) 1,728,619
----------- ----------- ----------- ----------- -----------
Long-term debt, net of current portion . 82,326 140,882 50,768 - 273,976
Obligations under capital leases,
net of current portion ............. - 27,390 72,699 - 100,089
Other long-term liabilities ............ 18 38,248 1,450 - 39,716
----------- ----------- ----------- ----------- -----------
Total liabilities ................. 1,445,347 490,878 206,873 (698) 2,142,400
----------- ----------- ----------- ----------- -----------
Minority interest ...................... - 6,153 141 - 6,294
Company-obligated manditorily redeemable
convertible preferred securities of
a subsidiary trust holding solely
7% convertible junior subordinated
debentures of the Company ........... 344,833 - - - 344,833
Intercompany payables/(receivables) .... (2,536,474) 2,380,446 156,028 - -
Stockholders Equity:
Common stock.......................... 627 (2,370) 2,373 - 630
Preferred stock....................... - - - - -
APIC.................................. 812,249 (311,120) 274,995 - 776,124
Retained earnings..................... 729,290 (1,388,042) (167,696) (571,345) (1,397,793)
Cumulative translation adjustment: - - (4,748) - (4,748)
Less:
Unearned compensation.............. (6,853) - - - (6,853)
Treasury stock..................... (27,378) - - - (27,378)
Grantor trust stock................ (718) - - - (718)
----------- ------------ ----------- ----------- -----------
Total stockholders' equity (deficit).... 1,507,217 (1,701,532) 104,924 (571,345) (660,736)
Total liabilities and
stockholders' equity (deficit)..... $ 760,923 $ 1,175,945 $ 467,966 $(572,043) $1,832,791
=========== ============ =========== =========== ===========
</TABLE>
24
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENT OF EARNINGS (LOSSES)
For the Three Months Ended June 30, 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 .................................. $ (1,002) $515,628 $ 86,288 $ $ 600,914
--------- --------- --------- ---------- ----------
Costs and expenses:
Operating ...................................... - 525,759 82,302 - 608,061
Corporate general and administrative ........... 28,005 7,824 4,428 - 40,257
Provision for loss on accounts receivable ...... - 15,356 51 - 15,407
Depreciation and amoritzation .................. 2,416 16,189 3,933 - 22,538
Interest, net .................................. 30,129 4,900 3,977 - 39,006
Loss on sale of assets ......................... 0 34,895 16,886 - 51,781
Financial restructuring ........................ 6,046 - - - 6,046
Restructuring costs ............................ (14) 14 - - -
Impairment loss ................................ 1,941 359,694 38,328 - 399,963
Loss on interest rate swap ..................... - - - - -
Equity in (earnings) losses of subsidiaries .... 622,641 - - (622,641) -
---------- --------- --------- ---------- -----------
Total costs and expenses .................. 691,164 964,631 149,905 (622,641) 1,183,059
---------- --------- --------- ---------- -----------
Dividends on convertible preferred securities .. 6,452 - - - 6,452
Management fee (income) expense ................ (110,020) 108,815 1,205 - -
---------- --------- --------- ---------- -----------
Earnings (losses) before income taxes........... (588,598) (557,818) (64,822) 622,641 (588,597)
Income taxes.................................... - - - - -
Net earnings (losses)...........................$(588,598) $(557,818) $(64,822) $622,641 $(588,597)
========= ========== ========= ========= ==========
</TABLE>
25
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENT OF EARNINGS (LOSSES)
For the Three Months Ended June 30, 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 ...................... $ 502 $ 647,420 $110,750 $ (6,280) $ 752,392
--------- --------- -------- --------- ----------
Costs and expenses:
Operating ............................ - 520,490 98,046 (6,280) 612,256
Corporate general and administrative . 29,825 8,418 5,196 - 43,439
Provision for losses on accounts
receivable ......................... - 12,201 821 - 13,022
Depreciation and amortization......... 1,602 14,192 5,725 - 21,519
Interest, net......................... 26,055 1,405 4,424 - 31,884
Loss on sale of assets ............... 2,400 5,402 - - 7,802
Litigation and investigation costs ... 8,000 9,131 - - 17,131
Merger expenses ...................... - - - - -
Equity interest in (earnings)
loss of subsidiaries ................ 54,760 - - (54,760) -
--------- ---------- -------- --------- ----------
Total costs and expenses......... 122,642 571,239 114,212 (61,040) 747,053
--------- ---------- -------- --------- ----------
Dividends on convertible preferred
securities of subsidiary .............. 3,771 - - - 3,771
-------- ---------- -------- --------- ----------
Earnings before income taxes
and intercompany charges .............. (125,911) 76,181 (3,462) 54,760 1,568
Intercompany charges .................... (93,668) 91,877 1,791 - -
--------- ---------- -------- --------- ----------
Earnings (loss) before income taxes
and extraordinary loss ................ (32,243) (15,696) (5,253) 54,760 1,568
Income taxes............................. (412) 1,490 (263) - 815
--------- ---------- -------- --------- ----------
Earnings before extraordinary loss ...... (31,831) (17,186) (4,990) 54,760 753
Extraordinary loss ...................... 10,120 - - - 10,120
---------- ---------- --------- --------- ----------
Net earnings (loss)...................... $(41,951) $ (17,186) $ (4,990) $ 54,760 $ (9,367)
========== ========== ========= ========= ==========
</TABLE>
26
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENT OF EARNINGS/LOSSES
For the Six Months Ended June 30, 1999
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Combined Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Elimination Consolidated
-------- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Total Revenues....................................... $ (1,970) $1,096,054 $179,862 $ - $1,273,946
--------- ----------- --------- --------- -----------
Costs and expenses:
Operating ...................................... - 1,061,852 170,778 - 1,232,630
Corporate general and administrative ........... 59,535 14,564 8,175 - 82,274
Provision for loss on accounts receivable ...... - 29,055 170 - 29,225
Depreciation and amoritzation .................. 4,482 31,599 7,904 - 43,985
Interest, net .................................. 58,861 9,787 7,529 - 76,177
Loss on sale of assets ......................... 3,009 42,994 17,886 - 63,889
Loss on termination of interest rate swaps ..... 2,488 - - - 2,488
Financial restructuring ........................ 6,046 - - - 6,046
Corporate restructuring costs .................. 3,789 6,374 1,265 - 11,428
Impairment loss ................................ 1,940 359,694 38,328 - 399,962
Equity in (earnings) losses of subsidiaries .... 742,788 - - (742,788) -
Intercompany interest (income) expense ......... (5,031) 5,031 - - -
--------- ---------- --------- --------- ----------
Total costs and expenses .................. 877,907 1,560,950 252,035 (742,788) 1,948,104
--------- ---------- --------- --------- ----------
Dividends on convertible preferred securities .. 12,968 - - - 12,968
Management fee (income) expense ................ (199,689) 196,738 2,951 - -
--------- ---------- --------- --------- ----------
Earnings (losses) before income taxes and
extraordinary loss ........................... (693,156) (661,634) (75,124) 742,788 (687,126)
Income taxes.................................... 5,519 (5,038) 411 - 892
--------- ---------- --------- --------- -----------
Earnings before change in accounting ........... (698,675) (656,596) (75,535) 742,788 (688,018)
Cumulative effect of change in accounting
principles ................................... 3,070 9,351 1,306 - 13,727
---------- ---------- --------- --------- ----------
Net earnings .............................$(701,745) $(665,947) $(76,841) $742,788 $(701,745)
========== ========== ========= ========= ===========
</TABLE>
27
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENT OF EARNINGS (LOSSES)
For the Six Months Ended June 30, 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 ...................... $ 834 $1,284,541 $216,224 $ (7,717) $1,493,882
-------- ---------- -------- --------- ----------
Costs and expenses:
Operating ............................ - 1,038,804 189,752 (7,717) 1,220,839
Corporate general and administrative . 56,542 16,649 9,549 - 82,740
Provision for losses on accounts
receivable ......................... - 17,891 1,145 - 19,036
Depreciation and amortization......... 3,041 27,715 11,237 - 41,993
Interest, net......................... 55,025 2,998 9,002 - 67,025
Loss on sale of assets ............... 2,400 5,402 - - 7,802
Litigation and investigation costs ... 8,000 9,131 - - 17,131
Merger expenses ...................... - - - - -
Equity interest in (earnings)
loss of subsidiaries ................ 67,858 - - (67,858) -
-------- ---------- -------- --------- ----------
Total costs and expenses......... $192,866 $1,118,590 $220,685 $(75,575) $1,456,566
-------- ---------- -------- --------- ----------
Dividends on convertible preferred
securities of subsidiary .............. 3,771 - - - 3,771
-------- ---------- -------- --------- ----------
Earnings before income taxes and
intercompany charges .................. (195,803) 165,951 (4,461) 67,858 33,545
Intercompany charges .................... (179,767) 176,560 3,207 - -
-------- ---------- -------- --------- ----------
Earnings (loss) before income taxes
and extraordinary loss ................ (16,035) (10,609) (7,668) 67,858 33,545
Income taxes............................. 10,471 4,436 (502) - 14,405
-------- ---------- -------- --------- ----------
Earnings before extraordinary loss ...... (26,507) (15,045) (7,166) 67,858 19,140
Extraordinary loss ...................... 10,120 - - - 10,120
-------- ---------- --------- --------- ----------
Net earnings (loss)...................... $ (36,627) $ (15,045) $ (7,166) $ 67,858 $ 9,020
========== ========== ========= ========= ==========
</TABLE>
28
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENT OF CASH FLOWS
For the Six Months Ended June 30, 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 (loss).......................... $(701,745) $ (665,947) $ (76,841) $ 742,788 $(701,745)
Adjustments to reconcile net earnings
(loss) to net cash provided by
(used for) operating activities --
Impairment Loss........................... 1,940 359,694 38,328 - 399,962
Cumulative effect of change in accounting
principle............................... 3,070 9,351 1,306 - 13,727
Loss on sale of assets.................... 3,009 42,994 17,886 63,889
Equity in earnings in subsidiaries........ 742,788 - - (742,788) -
Depreciation and amortization............. 4,482 31,599 7,904 - 43,985
Provision for losses on accounts
receivable.............................. - 29,055 170 - 29,225
Other, net................................ 2,704 - - - 2,704
Changes in operating assets and
liabilities:
Accounts receivable .................. - 111,678 6,075 - 117,753
Other current assets ................. (4,706) 20,632 12,239 - 28,165
Other current liabilities ............ (69,713) 45,306 (9,381) - (33,788)
Income taxes payable ................. 27,659 649 (1,539) - 26,769
--------- ---------- ----------- ---------- ------------
Net cash provided by (used for)
operating activities ................... $ 9,488 $ (14,989) $ (3,853) $ - $ (9,354)
--------- ---------- ----------- ---------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net ................... $ (22,564) $ (34,588) $ (11,528) $ - $ (68,680)
Acquisitions, net of cash acquired .......... - (1,321) (813) - (2,134)
Increase in long-term note receivable ....... 2,769 (633) 610 - 2,746
Other assets expenditures ................... 3,227 (5,782) 374 - (2,181)
---------- ----------- ---------- ---------- ------------
Net cash used for investing activities ... $ (16,568) $ (42,324) $ (11,357) $ - $ (70,249)
---------- ----------- ---------- ---------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings ................... $ 86,056 $ 20,839 $ 16,424 $ - $ 123,319
Long-term debt repayments ................... (10,456) (23,153) (4,768) - (38,377)
Conversion of Mediplex 6 1/2% Convertible
Subordinated Debentures due 2003........... (6,649) - - - (6,649)
Net proceeds from issuance of common stock .. 809 - - - 809
Purchases of treasury stock.................. (410) - - - (410)
Other financing activities .................. (1,052) - - - (1,052)
Intercompany advances ....................... (57,458) 56,458 1,000 - -
---------- ---------- ---------- ---------- ------------
Net cash provided by (used for)
financing activities ................... $ 10,840 $ 54,144 $ 12,656 $ - $ 77,640
--------- ---------- ---------- ---------- ------------
Effect of exchange rate on cash and
cash equivalents ............................ $ - $ - $ 1,513 $ - $ 1,513
--------- ---------- --------- ---------- ------------
Net increase (decrease) in cash and
cash equivalents ............................ $ 3,760 $ (3,169) $ (1,041) $ - $ (450)
Cash and cash equivalents at beginning of year . (9,964) 26,406 11,062 - 27,504
--------- ---------- --------- ---------- -----------
Cash and cash equivalents at end of period ..... $ (6,204) $ 23,237 $ 10,021 $ - $ 27,054
========== ========== ========= ========== ===========
</TABLE>
29
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENT OF CASH FLOWS
For the Six Months Ended June 30, 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 (loss) ......................... $ (36,626) $ (15,046) $ (7,166) $ 67,858 $ 9,020
Extraordinary loss .......................... 10,120 - - - 10,120
Loss on sale of assets ...................... 2,400 5,402 - - 7,802
Adjustments to reconcile net earnings
(losses) to net cash provided by
(used for) operating activities:
Equity in earnings in subsidiaries ....... 67,858 - - (67,858) -
Depreciation and amortization ............ 3,041 27,716 11,237 - 41,994
Provision for losses on accounts
receivable ............................. - 17,889 1,145 - 19,034
Other, net ............................... 4,741 (729) (134) - 3,878
Changes in operating assets and
liabilities:
Accounts receivable .................. - (128,126) (10,390) - (138,516)
Other current assets ................. (10,366) (8,990) (2,038) - (21,394)
Other current liabilities ............ 32,452 21,772 2,493 - 56,717
Income taxes payable ................. (9,406) (823) (1,249) - (11,478)
--------- ---------- --------- --------- -----------
Net cash provided by (used for)
operating activities .................. $ 64,214 $ (80,935) $ (6,102) $ - $ (22,823)
--------- ---------- --------- --------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net ................... $ (19,161) $ (33,915) $ (10,400) $ - $ (63,476)
Acquisitions, net of cash acquired .......... (38,217) (22,964) (2,196) - (63,377)
Proceeds (expenditures) from the sale and
leaseback of property and equipment ....... - 16,833 - - 16,833
Increase in long-term note receivable ....... (15,324) (1,952) - - (17,276)
Other assets expenditures ................... (2,509) 483 (9,358) - (11,384)
---------- ----------- ---------- --------- ------------
Net cash used for investing activities ... $ (75,211) $ (41,515) $ (21,954) $ - $ (138,680)
---------- ----------- ---------- --------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings ................... $ 154,894 $ 6,657 $ 7,425 $ - $ 168,976
Long-term debt repayments ................... (315,600) (8,427) (7,292) - (331,319)
Net proceeds from issuance of convertible
preferred securities of subsidiary ........ 330,342 - - - 330,342
Net proceeds from issuance of common stock .. 3,467 (2,235) (1) - 1,231
Purchase of treasury stock .................. (1,357) - - - (1,357)
Other financing activities .................. (1,120) 123 - - (997)
Intercompany advances ....................... (169,064) 138,320 30,744 - -
--------- ---------- --------- --------- ------------
Net cash provided by (used for)
financing activities ................... $ 1,562 $ 134,438 $ 30,876 $ - $ 166,876
--------- ---------- --------- --------- ------------
Effect of exchange rate on cash and
cash equivalents ............................ $ - $ - $ (449) $ - $ (449)
--------- ---------- --------- --------- ------------
Net increase (decrease) in cash and
cash equivalents ............................ $ (9,435) $ 11,988 $ 2,371 $ - $ 4,924
Cash and cash equivalents at beginning of year . (1,584) 20,012 2,592 - 21,020
--------- ---------- --------- --------- -----------
Cash and cash equivalents at end of period ..... $ (11,019) $ 32,000 $ 4,963 $ - $ 25,944
========== ========== ========= ========= ===========
</TABLE>
30
<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 June 30, 1999, the Company operated 385 inpatient
facilities with 43,343 licensed beds compared to 388 facilities with 44,533
licensed beds at June 30, 1998. Included in the preceding are 42 facilities with
4,798 licensed beds which the Company has announced its intention to divest or
not renew the leases.
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 June
30, 1999 the Company's rehabilitation and respiratory therapy services segment
provided services to 1,500 facilities in 45 states, 1,047 of which were operated
by nonaffiliated parties compared to 1,745 facilities as of June 30, 1998, 1,376
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 927
long term and sub-acute care facilities, including 586 nonaffiliated facilities,
as of June 30, 1999 through its 43 pharmacies and 1 pharmaceutical billing and
consulting center. At June 30, 1998, pharmaceutical products and services were
provided to approximately 868 facilities, including 561 nonaffiliated
facilities. The Company's medical supply subsidiary provided products to over
2,702 affiliated and nonaffiliated facilities as of June 30, 1999.
INTERNATIONAL OPERATIONS: This segment consists of long-term care
facilities in the United Kingdom, Spain and Germany, and acute care hospitals in
Australia. This segment also provides pharmaceutical services in the United
Kingdom, Germany and Spain, and medical supplies in Australia. At June 30, 1999,
the Company operated 148 inpatient facilities with 8,370 licensed beds in the
United Kingdom; 11 inpatient facilities with 1,604 beds in Spain; 16 facilities
with 1,122 licensed beds in Germany and 5 hospitals with 338 licensed beds in
Australia compared to 155 facilities with 8,731 licensed beds in the United
Kingdom; 9 facilities with 1,530 licensed beds in Spain; 13 facilities with 996
licensed beds in Germany; and 6 hospitals with 353 licensed beds in Australia as
of June 30, 1998.
31
<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
and nursing staffing services, assisted living services, home health and
hospice, software development and other ancillary services. The Company's
temporary therapy service operations provided approximately 539,381 temporary
therapy staffing hours to nonaffiliates for the six months ended June 30, 1999
compared to 1,323,882 hours for the six months ended June 30, 1998. The assisted
living subsidiary operated 29 assisted living facilities with 3,549 beds in the
United States as of June 30, 1999 compared to 32 assisted living facilities with
976 beds in the United States as of June 30, 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 August 13, 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, the use of its long-term
and subacute care operations as a base for expansion of certain of its ancillary
services, the 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 were primarily attributable to favorable reimbursement rates
under the Medicare cost-based 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 provides for 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 implementation of PPS at the
Company's 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 first quarter of 1999, the Company
experienced a significant and rapid decline in the demand for its ancillary
services from its nonaffiliated customers following the implementation of PPS.
This reduced demand continued during the second quarter of 1999. See "Effects
from Changes in Reimbursement."
32
<PAGE>
The following table sets forth certain operating data for the Company as of
the dates indicated:
<TABLE>
<CAPTION>
June 30, December 31,
-------- ------------
1999 1998 1998
---- ---- ----
<S> <C> <C> <C>
Inpatient Services:
Facilities ...................................... 385 388 397
Licensed beds ................................... 43,343 44,533 44,941
Rehabilitation and Respiratory Therapy Services:
Nonaffiliated facilities served ................. 1,047 1,376 1,294
Affiliated facilities served .................... 453 369 421
----- ----- -----
Total ........................................ 1,500 1,745 1,715
===== ===== =====
Pharmaceutical and Medical Supply Services:
Nonaffiliated facilities served ................. 586 561 584
Affiliated facilities served .................... 341 307 346
---- ----- -----
Total ........................................ 927 868 930
==== ====== ======
International Operations:
Facilities:
United Kingdom ................................ 148 155 155
Other foreign ................................. 32 28 31
---- ----- ------
Total ........................................ 180 183 186
==== ===== ======
Licensed Beds:
United Kingdom ................................ 8,370 8,731 8,705
Other foreign ................................. 3,064 2,879 3,048
----- ----- ------
Total ........................................ 11,434 11,610 11,753
====== ====== ======
</TABLE>
33
<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 Six Months Ended
------------------ ----------------
June 30, June 30,
-------- --------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Inpatient Services .............. $392,893 $502,723 $ 855,878 $ 992,820
Rehabilitation and
Respiratory Therapy Services... 58,240 173,239 128,306 350,631
Pharmaceutical and
Medical Supply Services........ 72,791 54,729 148,612 107,606
International Operations......... 73,551 70,041 145,213 136,348
Other Operations................. 58,035 65,671 120,671 128,007
Corporate ....................... (1,002) 502 (1,970) 834
Intersegment Eliminations........ (53,594) (114,513) (122,764) (222,364)
--------- -------- ---------- ----------
Total Net Revenues $600,914 $752,392 $1,273,946 $1,493,882
========= ======== ========== ==========
</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 $31.3 million and $82.6
million for the three months ended June 30, 1999 and 1998, respectively and
$70.0 million and $162.1 million for the six months ended June 30, 1999 and
1998, respectively. Revenues for pharmaceutical and medical supply services
provided to domestic affiliated facilities were $19.5 million and $15.2 million
for the three months ended June 30, 1999 and 1998, respectively and $43.2
million and $30.5 million for the six months ended June 30, 1999 and 1998,
respectively. Revenues for services provided by other non-reportable segments to
affiliated facilities were $5.3 million and $7.9 million for the three months
ended June 30, 1999 and 1998, respectively and $11.7 million and $14.9 million
for the six months ended June 30, 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 Six Months Ended
------------------ ----------------
June 30, June 30,
-------- --------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Inpatient Services .............. $(49,101) $34,159 $ (42,926) $ 60,233
Rehabilitation and
Respiratory Therapy Services... (2,981) 55,706 (2,555) 113,292
Pharmaceutical and
Medical Supply Services........ 2,412 4,780 2,385 11,082
International Operations......... (4,680) (3,531) (7,310) (6,913)
Other Operations................. (6,997) 806 (10,311) 5,340
Earnings (Losses) before income
taxes and corporate allocation. (61,347) 91,920 (60,717) 183,034
Corporate ....................... (69,396) (62,349) (140,295) (119,582)
Intersegment Eliminations........ (65) (3,071) (147) (4,976)
---------- -------- ---------- ----------
Net Segment Earnings (Losses). $(130,808) $26,500 $(201,159) $ 58,476
========== ======== ========== ==========
</TABLE>
34
<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.
THREE MONTHS ENDED JUNE 30, 1999 COMPARED TO THREE MONTHS ENDED JUNE 30, 1998
INPATIENT SERVICES
Net revenues, which include revenues generated from therapy and
pharmaceutical services provided at the Inpatient Services facilities, decreased
approximately $109.8 million from $502.7 million for the three months ended June
30, 1998 to $392.9 million for the three months ended June 30, 1999, a 21.8%
decrease. Net revenues were negatively impacted in the second quarter of 1999 by
certain changes in accounting estimates for third party settlements. In the
second quarter of 1999, the Company recorded negative revenue adjustments
totaling approximately $66.3 million. The adjustments included $12.2 million for
the projected settlement of 1998 facility costs reports based on the Company's
filing of its 1998 cost reports with its fiscal intermediary in the second
quarter and $6.7 million of revenue adjustments related to the results of
certain Medicare and Medicaid cost report audits. In addition, the negative
revenue adjustments included reserves of $47.4 million for certain Medicare cost
reimbursements, primarily requests for exceptions to the Medicare established
routine cost limitations, which have been delayed pending review by the Health
Care Financing Administration. Historically, such reimbursement was
formula-based and approval was ordinarily given upon confirmation of the
calculation by the Company's Medicare fiscal intermediary. Revenue was
recognized when a reasonable estimate of the amount receivable was determined.
Due to the pending review, the Company believes it can no longer make a
reasonable estimate of the amount receivable and accordingly has reserved the
amount outstanding. Excluding the negative revenue adjustments and $52.5 million
of net revenues from the 67 facilities acquired in the RCA acquisition on June
30, 1998, net revenues declined $96.1 million or 19%. 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 45% (see "Effects of Changes in
Reimbursement").
Operating expenses, which include rent expense of $52.1 million and $49.1
million for the three months ended June 30, 1999 and 1998, respectively,
decreased 6.4% from $448.0 million for the three months ended June 30, 1998 to
$415.9 million for the three months ended June 30, 1999. After considering $49.2
million of operating expenses related to the facilities acquired in the RCA
acquisition, operating expenses decreased $81.3 million or 18.1%. 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 and the
negative revenue adjustments, increased from 89.1% for the three months ended
June 30, 1998 to 90.6% for the three months ended June 30, 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.
35
<PAGE>
Corporate general and administrative expenses, which include regional costs
related to the supervision of operations, were $7.8 million and $8.2 million for
the three months ended June 30, 1999 and 1998, respectively. Excluding the
effect of the negative revenue adjustments, as a percentage of net revenues,
corporate general and administrative expenses were 1.7% and 1.6% for the three
months ended June 30, 1999 and 1998, respectively.
Provision for losses on accounts receivable increased 159.3% from $2.7
million for the three months ended June 30, 1998 to $7.0 million for the three
months ended June 30, 1999. As a percentage of net revenues, provision for
losses on accounts receivable increased from 0.5% for the three months ended
June 30, 1998 to 1.2% for the three months ended June 30, 1999. The change was
primarily due to increased aging of certain accounts receivable.
Depreciation and amortization increased 2.3% from $8.9 million for the
three months ended June 30, 1998 to $9.1 million for the three months ended June
30, 1999. Excluding the effect of the negative revenue adjustments, as a
percentage of net revenues, depreciation and amortization expense increased from
1.8% for the three months ended June 30, 1998 to 2.0% for the three months ended
June 30, 1999. The increase primarily relates to increased amortization for RCA
goodwill.
Net interest expense increased 153% from $0.9 million for the three months
ended June 30, 1998 to $2.3 million for the three months ended June 30, 1999.
Excluding the effect of the negative revenue adjustments, as a percentage of net
revenues, interest expense increased from 0.2% for the three months ended June
30, 1998 to 0.5% for the three months ended June 30, 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
66.4% from $173.2 million for the three months ended June 30, 1998 to $58.2
million for the three months ended June 30, 1999. Revenues from services
provided to affiliated facilities decreased from $82.6 million for the three
months ended June 30, 1998 to $30.2 million for the three months ended June 30,
1999, a decrease of 63.4%. Revenues from services provided to nonaffiliated
facilities decreased approximately $62.6 million, or 69.1%, from $90.6 million
for the three months ended June 30, 1998 to $28.0 million for the three months
ended June 30, 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").
Operating expenses decreased 52.4% from $112.1 million for the three months
ended June 30, 1998 to $53.4 million for the three months ended June 30, 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. Operating expenses as a percentage of net
revenue increased from 64.7% for the three months ended June 30, 1998 to 91.6%
for the three months ended June 30, 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.
36
<PAGE>
Provision for losses on accounts receivable increased 77.8% from $3.1
million for the three months ended June 30, 1998 to $5.5 million for the three
months ended June 30, 1999. As a percentage of net revenues, provision for
losses on accounts receivable increased from 1.8% for the three months ended
June 30, 1998 to 9.5% for the three months ended June 30, 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 was $2.2 million and $2.3 million for the
three months ended June 30, 1999 and 1998, respectively. As a percentage of net
revenues, depreciation and amortization expense increased from 1.3% for the
three months ended June 30, 1998 to 3.8% for the three months ended June 30,
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 33%
from $54.7 million for the three months ended June 30, 1998 to $72.8 for the
three months ended June 30, 1999. The increase is primarily due to the company's
medical supply operations acquired in connection with the RCA acquisition in
June 1998.
Operating expenses increased 50.4% from $44.8 million for the three months
ended June 30, 1998 to $67.4 million for the three months ended June 30, 1999.
The increase is primarily related to the Company's medical supply operations.
Operating expenses as a percentage of revenue increased from 81.8% for the three
months ended June 30, 1998 to 92.6% for the three months ended June 30, 1999.
This increase is a result of the acquisition of Contour, which has higher
operating costs than the Company's pharmacy services operation and downward
pricing pressure as a result of decreased reimbursement under PPS.
Provision for losses on accounts receivable decreased from $3.5 million for
the three months ended June 30, 1998 to $0.8 million for the three months ended
June 30, 1999. As a percentage of net revenues, the provision for losses on
accounts receivable decreased from 6.3% for the three months ended June 30, 1998
to 1.1% for the three months ended June 30, 1999. This decrease is the result of
improved collections for certain aged accounts receivable.
Depreciation and amortization increased 23.5% from $1.7 million for the
three months ended June 30, 1998 to $2.1 million for the three months ended June
30, 1999. As a percentage of net revenues, depreciation and amortization expense
was 2.9% and 3.0% for the three months ended June 30, 1999 and 1998,
respectively.
INTERNATIONAL OPERATIONS
Revenues from international operations excluding the effect of the
disposition of the Canadian operations, increased $8.0 million, or 12.3%, from
$65.5 million for the three months ended June 30, 1998 to $73.6 million for the
three months ended June 30, 1999. Approximately $4.4 million of this increase
was provided by growth in pharmaceutical supply operations in the United Kingdom
and Australia. The remaining increase was primarily the result of facility
additions and occupancy increases at inpatient services in the United Kingdom,
Spain and Germany.
Operating expenses excluding the effect of the disposition of the Canadian
operations, which include rent expense of $7.5 million and $9.3 million for the
three months ended June 30, 1998 and 1999, respectively, increased approximately
18.3% from $56.4 million for the three months ended June 30, 1998 to $66.7
million for the three months ended June 30, 1999. As a percentage of revenues,
operating expenses increased from 86.1% for the three months ended June 30, 1998
to 90.7% for the three months ended June 30, 1999. The increase is primarily
attributable to increased temporary staffing costs in the U.K. due to a nursing
shortage and increases in rent expense in the U.K. primarily a result of the
sale-leaseback of 32 facilities completed October 1998.
37
<PAGE>
Corporate general and administrative expenses excluding the effect of the
disposition of the Canadian operations were $4.2 million and $3.0 million for
the three months ended June 30, 1999 and 1998, respectively. As a percentage of
revenues, corporate, general and administrative expenses increased from 4.6% for
the three months ended June 30, 1998 to 5.7% for the three months ended June 30,
1999. The increase is primarily due to the expansion of the international
infrastructure to support future growth, as well as implementation of new
business strategies.
Depreciation and amortization for international operations decreased 29.2%
from $5.2 million for the three months ended June 30, 1998 to $3.7 million for
the three months ended June 30, 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 and the sale-leaseback of 32 facilities
completed in October 1998.
OTHER NONREPORTABLE SEGMENTS AND CORPORATE GENERAL AND ADMINISTRATIVE
DEPARTMENTS
Nonreportable segments include temporary therapy and nursing staffing, home
health, assisted living, software development and other ancillary services.
Revenues from other nonreportable segments decreased 11.7% from $65.7 million
for the three months ended June 30, 1998 to $58.0 million for the three months
ended June 30, 1999. Operating expenses increased 1.6% from $57.0 million for
the three months ended June 30, 1998 to $57.9 for the three months ended June
30, 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 related to acquisitions in the Company's home
health, assisted living, disease state management, laboratory and radiology
subsidiaries 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 decreased 1.1% from $28.0 million for the three months ended June 30,
1998 to $27.7 million at June 30, 1999. As a percentage of consolidated net
revenues of $668.2 million and $752.4 million for the three months ended June 30
1999 and 1998, respectively, corporate general and administrative expenses not
directly attributed to segments increased from 3.7% to 4.6%. Although costs
declined, corporate general and administrative costs as a percentage of
consolidated net revenues increased due to the Company's net revenue
deterioration as a result of PPS.
NET INTEREST EXPENSE
Net interest expense not directly attributed to segments increased 17.4%
from $26.5 million for the three months ended June 30, 1998 to $31.1 million for
the three months ended June 30, 1999. As a percentage of consolidated net
revenues, interest expense increased from 3.5% for the three months ended June
30, 1998 to 5.2% for the three months ended June 30, 1999. The increase was
related to (i) an increase in the Company's weighted average interest rate
resulting from the issuance of the Company's $150 million of 9 3/8% Notes in May
1998, (ii) higher interest rates and borrowing costs related to the Company's
Senior Credit Facility as a result of non-compliance with certain financial
covenants under the Senior Credit Facility, 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.
38
<PAGE>
OTHER SPECIAL AND NON-RECURRING CHARGES
Financial Restructuring
During the second quarter of 1999, the Company recorded financial
restructuring costs of $6.0 million, primarily professional fees, related to the
Company's activities in response to the defaults under the Senior Credit
Facility, the 9 3/8% Subordinated Notes and the 9-1/2% Subordinated Notes (see
"Liquidity and Capital Resources").
Loss on Sale of Assets
A net non-cash charge of approximately $34.9 million was recorded due to
the anticipated and/or completed termination of certain facility lease
agreements and 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 $16.9 million related to
the sale-leaseback of 11 facilities in the United Kingdom which was completed in
July of 1999. See footnote 6 in the accompanying Consolidated Financial
Statements.
Impairment of Goodwill and Other Long-Lived Assets
The Company periodically evaluates the carrying value of goodwill and any
other related long-lived assets in relation to the future projected cash flows
of the underlying business unit. The assets are considered to be impaired when
the expected future cash flows of the business unit do not exceed the carrying
balances of the goodwill or other long-lived assets. The Company recorded a
non-cash impairment charge of $400.0 million related to the Company's estimate
of goodwill and other asset impairment. The charge included approximately $289.2
million related to 187 of its inpatient facilities segment, $39.5 million
related to its rehabilitation and respiratory therapy services segment, $26.2
million related to its pharmaceuticals and medical supply services, $33.7
million related to the certain inpatient facilities in the United Kingdom, and
$.6 million related to seven pharmacies in its pharmaceutical and medical supply
services segment in the United Kingdom and approximately $10.8 million related
to other operations.
The significant write-down of goodwill resulted from the continued adverse
impact of PPS on the level of Medicare reimbursement and the demand for the
Company's rehabilitation and respiratory therapy and pharmaceutical and medical
supply services (see "Effects of Changes to Reimbursement"). Additionally,
certain of the United Kingdom facilities have not achieved profitability targets
established upon their acquisition (most of which were acquired in conjunction
with Ashbourne).
In the three months ended June 30, 1999, the Company increased its
valuation allowance for the deferred tax assets resulting from its net operating
losses 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 for U.K. deferred tax assets resulting from its net
operating losses which may not be realizable.
Legal and Regulatory Matters
In the second quarter of 1998, the company recorded charges for litigation
and investigation costs of approximately $17.1 million for professional fees and
settlement costs related to certain legal and regulatory matters. The charge
includes (i) approximately $8.0 million for the settlement of a shareholder suit
related to the Company's acquisition of SunCare in 1995; (ii) approximately $8.2
million for estimated costs to resolve the investigation by the Connecticut
Department of Social Services ("DDS") (see "Regulation"); and (iii)
approximately $0.9 million provided for certain monetary penalties (see
"Regulation") and general legal costs of its inpatient services segment.
Extraordinary Loss
In the second quarter of 1998, the Company recorded an extraordinary loss
of $10.1 million, net of income tax benefit of $3.7 million. Approximately $10.2
million of the gross loss relates to the permanent pay-down of $300 million of
the term loan portion of the Company's Senior Credit Facility. The remaining
$3.7 million of the gross loss relates to the retirement of $5.0 million of
Contour convertible debentures which were purchased by the Company.
39
<PAGE>
CONSOLIDATED RESULTS OF OPERATIONS
Income tax expense for the three months ended June 30, 1999 was $.1 million
compared to $.8 million for the three months ended June 30, 1998. In the three
months ended June 30, 1999, the Company increased its valuation allowance for
the deferred tax assets resulting from its net operating losses 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 for U.K.
deferred tax assets resulting from its net operating losses which may not be
realizable.
The net loss for the three months ended June 30, 1999 was $588.6 million
compared to a net loss of $9.4 million for the three months ended June 30, 1998.
Before considering the negative revenue adjustments, the impairment loss, the
loss on sale of assets, the financial restructuring costs, the loss before
income taxes for the three months ended June 30, 1999 was $64.5 million compared
to earnings before income taxes excluding the effect of the litigation and
investigation costs and the loss on sale of assets of $26.5 million for the
three months ended June 30, 1998.
SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 1998
INPATIENT SERVICES
Net revenues, which include revenues generated from therapy and
pharmaceutical services provided at the Inpatient Services facilities, decreased
approximately $136.9 million from $992.8 million for the six months ended June
30, 1998 to $855.9 million for the six months ended June 30, 1999, a 13.8%
decrease. Net revenues were negatively impacted in the second quarter of 1999 by
certain changes in accounting estimates for third party settlements. In the
second quarter of 1999, the Company recorded negative revenue adjustments
totaling approximately $66.3 million. The adjustments included $12.2 million for
the projected settlement of 1998 facility costs reports based on the Company's
filing of its 1998 cost reports with its fiscal intermediary in the second
quarter and $6.7 million of revenue adjustments related to the results of
certain Medicare and Medicaid cost report audits. In addition, the negative
revenue adjustments included reserves of $47.4 million for certain Medicare cost
reimbursements, primarily requests for exceptions to the Medicare established
routine cost limitations, which have been delayed pending review by the Health
Care Financing Administration. Historically, such reimbursement was formula
based and approval given ordinarily upon confirmation of the calculation by the
Company's Medicare fiscal intermediary. Revenue was recognized when a reasonable
estimate of the amount receivable was determined. Due to the pending review, the
Company believes it can no longer make a reasonable estimate of the amount
receivable and accordingly has reserved the amount outstanding. Excluding the
negative revenue adjustments and $110.4 million of net revenues from the 67
facilities acquired in the RCA acquisition on June 30, 1998, net revenues
declined $247.3 million or 24.9%. This decrease is primarily the result of the
reduced Medicare rates received under PPS in the first half of 1999. Excluding
the effect of the RCA acquisition on Medicare revenues, average Medicare rates
declined by 36% (see "Effects of Changes in Reimbursement").
Operating expenses, which include rent expense of $105.4 million and $95.8
million for the six months ended June 30, 1999 and 1998, respectively, decreased
4.5% from $892.3 million for the six months ended June 30, 1998 to $851.8
million for the six months ended June 30, 1999. After considering $105.7 million
of operating expenses related to the facilities acquired in the RCA acquisition,
operating expenses decreased $146.2 million or 16.4%. 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 and the
negative revenue adjustments, increased from 89.9% for the six months ended June
30, 1998 to 100.1% for the six months ended June 30, 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 $16.3 million and $16.0
million for the six months ended June 30, 1999 and 1998, respectively. Excluding
the negative revenue adjustments, as a percentage of net revenues, corporate
general and administrative expenses were 1.7% for the six months ended June 30,
1999 and 1998.
40
<PAGE>
Provision for losses on accounts receivable increased 179.5% from $3.9
million for the six months ended June 30, 1998 to $10.9 million for the six
months ended June 30, 1999. Excluding the negative revenue adjustments, as a
percentage of net revenues, provision for losses on accounts receivable
increased from 0.4% for the six months ended June 30, 1998 to 1.2% for the six
months ended June 30, 1999. The change was primarily due to increased aging of
certain accounts receivable.
Depreciation and amortization decreased 1% from $18.0 million for the six
months ended June 30, 1998 to $17.8 million for the six months ended June 30,
1999. Excluding the negative revenue adjustments, as a percentage of net
revenues, depreciation and amortization expense was 1.9% and 1.8% for the six
months ended June 30, 1999 and 1998, respectively.
Net interest expense increased 114.3% from $2.1 million for the six months
ended June 30, 1998 to $4.5 million for the six months ended June 30, 1999.
Excluding the negative revenue adjustments, as a percentage of net revenues,
interest expense increased from 0.2% for the six months ended June 30, 1998 to
0.5% for the six months ended June 30, 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
63.4% from $350.6 million for the six months ended June 30, 1998 to $128.3
million for the six months ended June 30, 1999. Revenues from services provided
to affiliated facilities decreased from $162.1 million for the six months ended
June 30, 1998 to $69.0 million for the six months ended June 30, 1999, a
decrease of 57.4%. Revenues from services provided to nonaffiliated facilities
decreased approximately $129.2 million, or 68.5%, from $188.5 million for the
six months ended June 30, 1998 to $59.3 million for the six months ended June
30, 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").
Operating expenses decreased 47.5% from $225.8 million for the six months
ended June 30, 1998 to $118.5 million for the six months ended June 30, 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 64.4% for the six months ended June 30, 1998 to 92.3% for the six
months ended June 30, 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 increased 11.3% from $7.1
million for the six months ended June 30, 1998 to $7.9 million for the six
months ended June 30, 1999. As a percentage of net revenues, provision for
losses on accounts receivable increased from 2.0% for the six months ended June
30, 1998 to 6.1% for the six months ended June 30, 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 was $4.4 million and $4.3 million for the six
months ended June 30, 1999 and 1998, respectively. As a percentage of net
revenues, depreciation and amortization expense increased from 1.2% for the six
months ended June 30, 1998 to 3.3% for the six months ended June 30, 1999,
respectively. The increase is primarily a result of increased equipment costs.
41
<PAGE>
PHARMACEUTICAL AND MEDICAL SUPPLY OPERATIONS
Net revenues from pharmaceutical and medical supply services increased
38.1% from $107.6 million for the six months ended June 30, 1998 to $148.6 for
the six months ended June 30, 1999. Approximately $36.6 million of this increase
is a result of the company's acquisition of Contour in connection with the RCA
acquisition in June 1998.
Operating expenses increased 50.1% from $89.7 million for the six months
ended June 30, 1998 to $134.6 million for the six months ended June 30, 1999.
The increase is primarily related to the Company's medical supply operations.
Operating expenses as a percentage of revenue increased from 83.4% for the six
months ended June 30, 1998 to 90.6% for the six months ended June 30, 1999. This
increase is primarily a result of the acquisition of Contour, which has higher
operating costs than the Company's pharmacy services operation and downward
pricing pressure as a result, of decreased reimbursement under PPS.
Provision for losses on accounts receivable decreased from $7.4 million for
the six months ended June 30, 1998 to $3.6 million for the six months ended June
30, 1999. As a percentage of net revenues, the provision for losses on accounts
receivable increased from 3.4% for the six months ended June 30, 1998 to 5.0%
for the six months ended June 30, 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 31.2% from $3.2 million for the six
months ended June 30, 1998 to $4.2 million for the six months ended June 30,
1999. As a percentage of net revenues, depreciation and amortization expense was
2.9% and 2.8% for the six months ended June 30, 1999 and 1998, respectively.
INTERNATIONAL OPERATIONS
Revenues from international operations excluding the effect of the
disposition of the Canadian operations, increased $17.6 million, or 13.8%, from
$127.6 million for the six months ended June 30, 1998 to $145.2 million for the
six months ended June 30, 1999. Approximately $4.6 million of this increase was
provided by U.K. inpatient services whose net revenues increased from $89.3
million for the six months ended June 30, 1998 to $93.9 million for the six
months ended June 30, 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
79.9% for the six months ended June 30, 1998 to 81.1% for the six months ended
June 30, 1999. Approximately $5.2 million of the increase was provided by the
growth in pharmaceutical supply operations in Australia. The remaining increase
was primarily the result of facility additions and occupancy increases at
inpatient services in Spain and Germany.
Operating expenses, excluding the effect of the disposition of the Canadian
operations, which include rent expense of $15.0 million and $19.0 million for
the six months ended June 30, 1998 and 1999, respectively, increased
approximately 26.9% from $103.6 million for the six months ended June 30, 1998
to $131.5 million for the six months ended June 30, 1999. As a percentage of
revenues, operating expenses increased from 81.2% for the six months ended June
30, 1998 to 90.5% for the six months ended June 30, 1999. The increase is
primarily attributable to increased temporary staffing costs in the U.K. 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 30.2%
from $10.3 million for the six months ended June 30, 1998 to $7.2 million for
the six months ended June 30, 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.
42
<PAGE>
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 5.7% from $128.0 million for the six
months ended June 30, 1998 to $120.7 million for the six months ended June 30,
1999. Operating expenses increased 4.2% from $111.7 million for the six months
ended June 30, 1998 to $116.4 for the six month periods ended June 30, 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 related to acquisitions in the Company's home health, assisted living,
disease state management, laboratory and radiology subsidiaries 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 4.2% from $54.8 million for the six months ended June 30,
1998 to $57.1 million at June 30, 1999. As a percentage of consolidated net
revenues of $1.27 billion and $1.50 billion for the six months ended June 30
1999 and 1998, respectively, corporate general and administrative expenses not
directly attributed to segments increased from 3.7% to 4.5%. This increase was
primarily due to the Company's net revenue deterioration as a result of PPS.
Net interest expense not directly attributed to segments increased 8.6%
from $55.8 million for the six months ended June 30, 1998 to $60.6 million for
the six months ended June 30, 1999. As a percentage of consolidated net
revenues, interest expense increased from 3.7% for the six months ended June 30,
1998 to 4.8% for the six months ended June 30, 1999. The increase was related to
(i) an increase in the Company's weighted average interest rate resulting from
the 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 a result
of non-compliance under certain financial covenants under the Senior Credit
Facility, 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
Loss on Sale of Assets
A net non-cash charge of approximately $44.9 million was recorded due to
the anticipated and/or completed termination of certain facility lease
agreements and 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 $16.9 million related to
the sale-leaseback of 11 facilities in the United Kingdom which was completed in
July of 1999. The Company also recorded a loss of approximately $2.0 million on
the sale of its Canadian operations. See footnote 6 in the accompanying
Consolidated Financial Statements.
43
<PAGE>
Corporate 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").
Financial Restructuring
During the second quarter of 1999, the Company recorded financial
restructuring costs of $6.0 million, primarily professional fees, related to the
Company's activities in response to the defaults under the Senior Credit
Facility, the 9 3/8% Subordinated Notes and the 9-1/2% Subordinated Notes (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 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.
Impairment Loss
The Company recorded an impairment loss of $400.0 million in the second
quarter of 1999 (see discussion for Three Months Ended June 30, 1999 Compared to
Three Months Ended June 30, 1998).
Legal and Regulatory Matters
In the second quarter of 1998, the Company recorded charges for litigation
and investigation costs of approximately $17.1 million for professional fees and
settlement costs related to certain legal and regulatory matters (see discussion
for Three Months Ended June 30, 1999 Compared to Three Months Ended June 30,
1998).
Extraordinary Loss
In the second quarter of 1998, the Company recorded an extraordinary loss
of $10.1 million, net of income tax benefit of $3.7 million (see discussion for
the Three Months Ended June 30, 1999 Compared to Three Months Ended June 30,
1998).
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.
CONSOLIDATED RESULTS OF OPERATIONS
Income tax expense for the six months ended June 30, 1999 was $0.8 million
compared to $14.4 million for the six months ended June 30, 1998. In the six
months ended June 30, 1999, the Company increased its valuation allowance for
the deferred tax assets resulting from its net operating losses 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 for U.K.
deferred tax assets resulting from its net operating losses which may not be
realizable.
The net loss for the six months ended June 30, 1999 was $701 million
compared to net earnings of $9.0 million for the six months ended June 30, 1998.
Before considering negative revenue adjustments, the loss on sale of assets, the
restructuring costs, the loss on termination of interest rate swaps, and the
cumulative effect of change in accounting principle, the loss before income
taxes for the six months ended June 30, 1999 was $267.2 million compared to
earnings before the legal and regulatory charge, the loss on sale of assets and
income taxes of $58.5 million for the six months ended June 30, 1998.
44
<PAGE>
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 June 30,
1999. Borrowings under the Senior Credit Facility were $745.6 million and $820.9
million at December 31, 1998 and June 30, 1999, respectively. In addition, the
Company failed to make a $19.5 million payment due to the Senior Credit Facility
bank lenders on June 30, 1999. Because of the covenant and payment defaults, the
bank lenders could have required immediate repayment of all amounts outstanding
under the Senior Credit Facility. As a result, the Company has classified all
borrowings under the Senior Credit Facility as current liabilities. The Company
did not have sufficient cash reserves to repay all amounts outstanding under the
Senior Credit Facility at August 18, 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.
The Company did not make its semi-annual interest payments of $7.3 on the
Company's $150.0 million 9 3/8% Subordinated Notes that was due on May 1, 1999
and of $11.9 million on the Company's $250.0 million 9-1/2% Subordinated Notes
that was due on July 1, 1999. The bank lenders under the Company's Senior Credit
Facility exercised their contractual right blocking the Company from making
these payments. Because the Company did not make these payments, it is in
default under the indentures for the 9 3/8% Subordinated Notes and 9-1/2%
Subordinated Notes and the holders of such Notes could demand all amounts
outstanding under the respective indentures immediately due and payable,
although actual payment would continue to be prohibited by the actions of the
bank lenders. The Company did not have sufficient cash reserves to repay all
amounts outstanding under either of these indentures at August 18, 1999.
The Company is in default of certain Mortgage Notes amounting to $31.9
million and $31.7 million at December 31, 1998 and June 30, 1999, respectively,
because the Company did not meet its debt service coverage. 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 June 30, 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 June 30, 1999.
As of December 31, 1998 and June 30, 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 August
18, 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. The Company was also in cross default under the terms of leases
for 14 of its long-term care facilities in the United States as of December 31,
1998 and June 30, 1999. The aggregate net book value of properties subject lease
defaults 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.
The Company and its principal lenders are discussing the terms of an
overall financial restructuring. However, in the event the lenders or lessors
under the agreements and leases described above begin to exercise remedies
against the Company or if the Company makes a determination that it would not be
able to fund its operations outside bankruptcy, the Company will commence a
chapter 11 bankruptcy case under title 11 of the United States Code.
For the six months ended June 30, 1999, net cash used for operations was
$9.4 million compared to net cash used by operations for the six months ended
June 30, 1998 of $22.8 million. The net cash used for operations for the six
months ended June 30, 1999 reflects the significant losses incurred (as
discussed in "Results of Operations" above) and the receipt of certain income
tax refunds of $30.1 million.
Other significant operating uses of cash for the six months ended June 30,
1999 were $42.9 million for net interest refunds and $28.7 million for income
tax refunds.
The Company's cash reserves at August 18, 1999 were $52.4 million.
45
<PAGE>
In response to the significant losses experienced in the fourth quarter of
1998 which have continued in the second 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.
As a result of the Company's recent financial results, on June 29, 1999 the
New York Stock Exchange (the "Exchange") suspended the trading in the common
stock of the Company. The suspension was the result of the Company falling below
the Exchange's continued listing criteria relating to the Company's (i) net
tangible assets available to common stock (less than $12 million) and (ii)
average net income after rates for the past three years (less than $600,000).
The Exchange has applied to the Securities and Exchange Commission to delist the
Company's common stock. As of August 13, 1999 the Company's common stock was
trading on the Over-the-Counter Bulletin Board under the symbol "SHGE".
The Company incurred $68.7 million in capital expenditures during the six
months ended June 30, 1999. Expenditures related primarily to the construction
of a corporate office building as well as expenditures related to the Company's
long-term care, subacute care and assisted living facility operations including
the construction of two new facilities in the United States and two new
facilities in the United Kingdom as well as routine capital expenditures. The
Company had capital expenditure commitments as of June 30, 1999, under various
contracts of $15.6 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
June 30, 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
terminated 96 employees of these subsidiaries. As of June 30, 1999, the Company
paid approximately $3.5 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 June 30, 1999, the Company's 1999 restructuring costs reserve
balance was approximately $6.1 million.
46
<PAGE>
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 11.4% and 9.1% for the six months ended June 30, 1999 and 1998,
respectively, and 17.8% of the Company's consolidated total assets as of June
30, 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 44.9 million for the six months ended June 30, 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 including the rehabilitation
hospitals. The aggregate carrying amount of these businesses is approximately
$184.5 million at June 30, 1999. 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 June 30, 1999, the Company had on a consolidated basis, $1.7 billion of
outstanding indebtedness including capital lease obligations and $820.9 million
of indebtedness under its Senior Credit Facility. The Company also had $41.4
million of outstanding standby letters of credit under its Senior Credit
Facility as of June 30, 1999.
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 was 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 was 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.
47
<PAGE>
EFFECTS FROM CHANGES IN REIMBURSEMENT
The Company derives a substantial percentage of its total revenues from
Medicare, Medicaid and private insurance. The Company's financial condition and
results of operations may be affected by the revenue reimbursement process,
which is complex and can involve lengthy delays between the recognition of
revenue and the time reimbursement amounts are settled. Net revenues realizable
under third-party payor agreements are subject to change due to examination and
retroactive adjustment by payors during the settlement process. Payors may
disallow in whole or in part requests for reimbursement based on determinations
that certain costs are not reimbursable or reasonable or because additional
supporting documentation is necessary. The Company recognizes revenues from
third-party payors and accrues estimated settlement amounts in the period in
which the related services are provided. The Company estimates these settlement
balances by making determinations based on its prior settlement experience and
its understanding of the 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. In the
second quarter, The Health Care Financing Administration has informed the
Company that all outstanding cost report settlements due to the Company's
nursing facilities, which was approximately $69.0 as of June 30, 1999, will be
delayed pending resolution of outstanding audit issues and certain inquiries
initiated by the U.S. Department of Justice. The Company is unable to predict
when the outstanding audit issues and inquiries will be resolved. No assurance
can be given that the resolution of the outstanding audit issues and inquiries
will not result in a material adverse effect on the results of operations and
financial condition of the Company.
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. 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.
48
<PAGE>
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 to date. 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 prior to the implementation of PPS,
the Company treated a greater percentage of higher acuity patients than many
nursing homes, the Company was 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.
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.
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.
49
<PAGE>
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.
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.
50
<PAGE>
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 two 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.
51
<PAGE>
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 and 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.
The Company and certain of its subsidiaries are defendants in a qui tam
lawsuit brought by a private citizen in the Untied States District Court of the
Central District of California alleging violations of the federal False Claims
Act and a related wrongful termination. The plaintiff alleges that a home health
agency operated by one of the Company's subsidiaries submitted bills for several
years that were improper for various reasons, including bills for patients whose
treatment had not been authorized by their physicians. The government intervened
to the extent that the lawsuit alleges billing without obtaining proper and
timely physician authorization, but declined to intervene in the remainder of
the lawsuit. Although the Company and its subsidiaries intend to vigorously
defend themselves 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 addition, the Department of Health & Human Services (the "HHS") and the
Department of Justice (the "DOJ") periodically investigate matters that have
come to their attention concerning the Company, including cost reporting
matters. To expedite resolution of any outstanding investigations, the Company
has requested that the HHS and the DOJ inform it of any such investigations or
outstanding concerns. In response, the DOJ has informed the Company of a number
of outstanding inquiries, some of which have been prompted by the filing of qui
tam lawsuits that remain under seal. The Company intends to expeditiously
address whatever concerns the HHS and the DOJ may have. 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.
52
<PAGE>
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. On July 21, 1999 the Court issued an order certifying the class,
approving the settlement and dismissing with prejudice 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.
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 for each of its
information technology ("IT") systems and equipment, non-IT systems and
equipment (embedded technology) and 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. There can be no assurance that all Medicare systems will be
compliant on time to ensure the delivery of uninterrupted benefits and services
into the Year 2000.
53
<PAGE>
The Company has completed approximately 95% of the remediation process for
critical IT and non-IT systems and equipment. The Company has also completed
approximately 95% 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 $10 million, of
which approximately $7.7 million has been spent through June 30, 1999. Of these
costs, the Company estimates that approximately $7 million will be spent to
repair systems and equipment, and $2 million will be spent to replace systems
and equipment and $1 million will be spend on activities related to contingency
planning. 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.
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 95% 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 October 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.
54
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information with respect to this item is found in "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Litigation" and
is incorporated by reference herein.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Information with respect to this item is found in "Notes to Consolidated
Financial Statements - Note 2 - Non-Compliance with Debt Agreements and
Liquidity."
ITEM 5. OTHER EVENTS
Effective July 15, 1999, Zev Karkomi resigned from the Board of Directors
of the Company. His letter of resignation stated that his company required all
of his attention.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(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.
Report dated May 31, 1999 and filed June 9, 1999 reporting that the waiver
of covenant defaults under the Company's bank agreement expired and that
the bank lenders exercised their right to prohibit the Company from making
the semi-annual interest payment on the Company's 9 3/8% Subordinated
Notes.
55
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SUN HEALTHCARE GROUP, INC.
Date: August 19, 1999 By: /s/ Robert D. Woltil *
-------------------------
Robert D. Woltil
Chief Financial Officer
*Signing on the behalf of the Registrant and as principal financial
officer.
56
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE SUN HEALTHCARE GROUP, INC. JUNE 30, 1999 FORM 10-Q AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 27,054
<SECURITIES> 0
<RECEIVABLES> 476,145
<ALLOWANCES> 89,620
<INVENTORY> 48,316
<CURRENT-ASSETS> 545,652
<PP&E> 452,364
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,832,791
<CURRENT-LIABILITIES> 1,728,619
<BONDS> 0
0
0
<COMMON> 630
<OTHER-SE> (661,366)
<TOTAL-LIABILITY-AND-EQUITY> 1,832,791
<SALES> 0
<TOTAL-REVENUES> 1,273,946
<CGS> 0
<TOTAL-COSTS> 1,948,104
<OTHER-EXPENSES> 12,968
<LOSS-PROVISION> 29,225
<INTEREST-EXPENSE> 76,177
<INCOME-PRETAX> (687,126)
<INCOME-TAX> 892
<INCOME-CONTINUING> (688,018)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (13,727)
<NET-INCOME> (701,745)
<EPS-BASIC> (12.05)
<EPS-DILUTED> (12.05)
</TABLE>
