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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A 1
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to ___________
Commission File Number: 1-12238
MHM SERVICES, INC.
(Exact Name of Registrant as Specified in its Charter)
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DELAWARE 52-1223048
(State or Other Jurisdiction of (Identification I.R.S. Employer No.)
Incorporation or Organization)
8000 TOWERS CRESCENT DRIVE, SUITE 810, VIENNA, VIRGINIA 22182
(Address of Principal Executive Offices) (Zip Code)
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Registrant's telephone number, including area code: (703) 749-4600
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
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COMMON STOCK, PAR VALUE $.01 PER SHARE AMERICAN STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act: NONE
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 12 months (or for such shorter period that the Company
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes No X
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
The aggregate market value of the Registrant's common stock held by
nonaffiliates (based upon the closing price of $ .6875 of Common Stock on the
American Stock Exchange) on December 30, 1997, was approximately $1,321,279.
As of December 30, 1997, there were 3,525,848 shares of Common Stock,
par value $.01 per share, of the Registrant outstanding.
DOCUMENTS INCORPORATED BY REFERENCES
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders to be held in 1998 are incorporated by reference into Part III.
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PART I
ITEM 1. BUSINESS
GENERAL
MHM Services, Inc., through its wholly-owned subsidiaries, MHM Extended
Care Services, Inc. ("Extended Care Services Division"), MHM Correctional
Services, Inc. ("Correctional Services Division"), and MHM of Colorado, Inc.
("Hospital Division"), (collectively, the "Company"), offers, arranges for and
manages specialty healthcare services primarily in institutional settings. Since
its founding, the Company's goal has been to offer the highest quality,
cost-effective care in the industry. The Company's Extended Care Services
Division provides specialized medical and behavioral healthcare services to
residents of 870 nursing homes in six states, and provides a wide range of
outpatient behavioral healthcare services to children, adolescents, adults and
families in multiple clinics located in Massachusetts. The Extended Care
Services Division also provides behavioral healthcare services to more than
2,000 Medicaid patients residing in nursing homes under a contract with the
State of Georgia. The Correctional Services Division was formed in fiscal 1997
to provide mental health and other specialized healthcare services to inmates
of correctional systems. In June and September of 1997, the Correctional
Services Division was awarded multi-year contracts with each of the States of
Tennessee and Georgia to provide mental health services to the inmates of such
states' correctional facilities for which the Company is compensated on a
capitation basis. Under these contract awards, the Company currently provides
mental health services to approximately 49,000 inmates in these states. Also,
the Correctional Services Division provides dental services to approximately
5,000 inmates in Delaware under a subcontract with Prison Health Services, Inc.
The Correctional Services Division generated 3 % of the Company's net revenues
in fiscal year 1997. Until April 1996, the Company's Hospital Division operated
seven freestanding psychiatric and substance abuse facilities, which generated
86% of the Company's net revenues for fiscal 1995, and had comprised 77% of the
Company's total assets at the end of fiscal 1995. As a result of the sale of
five of the freestanding facilities in May 1996, and one facility in April
1996, the Hospital Division represented only 67% of net revenues for fiscal
1996 and 31% of net revenues for fiscal 1997. See "Sale of Freestanding
Facilities/Continued Operation of Mountain Crest Hospital."
Historically, the Company's principal businesses were the operation of
freestanding behavioral healthcare facilities and the management of behavioral
healthcare programs under contracts with acute care hospitals. The market for
behavioral healthcare has undergone dramatic changes in recent years. Pressure
on providers to reduce costs has resulted in an increase in the development and
utilization of alternatives to long-term in-patient care, and a decrease in the
utilization of in-patient care and reimbursement rates. With market forces
emphasizing managed care approaches to healthcare, this trend is anticipated to
continue.
In response to these market changes and their adverse impact on the
Company's operating results, significant changes have been made in the structure
of the Company's operations over the past several years. The Company made
significant changes in its operations in 1995, 1996 and 1997, including the sale
of six of the Company's seven freestanding behavioral healthcare facilities (see
"Recent Developments"), so that the Company could focus on its Extended Care
Services Division and Correctional Services Division. The Extended Care Services
Division, which commenced operations in
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the Fall of 1993 has experienced growth through internal development,
principally from one contract with the State of Georgia, and acquisitions.
However, the Company has experienced continuing losses in the Extended Care
Services Division and has made recent changes designed to improve its
profitability and cash flow. The Company formed a Correctional Services Division
in 1997 and in the fourth quarter of 1997 secured contracts with the Tennessee
and Georgia Departments of Correction to provide mental health services on a
capitated basis to the inmates of those states' correctional systems. The
Company is currently seeking additional contract awards in this growing
industry. In fiscal 1997, the Company further refined its strategy to achieve
profitability. The Company is closing or selling extended care operations in
certain states because revenues have not been sufficient to achieve
profitability, and selectively reducing operating and general and administrative
costs and consolidating or outsourcing billing and payroll functions. The
Company's strategic growth efforts are currently focused on its Correctional
Services Division. The Company does not anticipate additional acquisitions in
its Extended Care Services Division for the foreseeable future.
SALE OF FREESTANDING FACILITIES/CONTINUED OPERATION OF MOUNTAIN CREST HOSPITAL
Consistent with the Company's decision to focus on its Extended Care
Services Division, during the first six months of 1996 the Company sold six of
its free-standing hospital facilities. In connection with the sale in April 1996
of the Company's Oakview Treatment Center the Company obtained a waiver from
MEDIQ Incorporated ("MEDIQ") of an event of default provision of a note payable
to MEDIQ (the "MEDIQ Note") relating to the sale of the assets of a significant
subsidiary. In order to obtain the waiver, the Company pledged a note receivable
obtained from the purchaser of such facility with an original principal balance
of $1,875,000 as collateral for the Company's obligations under the MEDIQ Note.
See "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations."
During fiscal 1997, the Company used the remainder of the proceeds from
the sale of five of its free-standing facilities to fund operating losses,
Extended Care Services Division acquisitions and increases in receivables
primarily relating to growth in the Extended Care Services Division. See "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The Company continues to operate Mountain Crest Hospital, a 60-bed
psychiatric hospital located in Fort Collins, Colorado, which also operates
seven alternative care programs for adult, adolescent and geriatric patients,
and serves communities in Colorado. The Company commenced operating this
facility in August 1994 pursuant to a sublease agreement. Mountain Crest
Hospital represented 27% of the Company's net revenue in fiscal 1997, 16% in
fiscal 1996 and 14% in fiscal 1995. See "Item 2. Properties." As a result of
Mountain Crest Hospital's positive contribution to the Company's operating
income, the Company has decided not to actively seek a buyer for its sole
remaining hospital, because it continues to contribute to the Company's
revenues and cash flows. The Company currently leases the Mountain Crest real
estate on which the facility is located but is in the process of seeking
financing to purchase the land and building. The Company believes that this
purchase and financing would have a positive impact on profitability and cash
flow, however, there is no assurance that the Company will be successful in
locating an acceptable financing source for this transaction.
Mountain Crest Hospital is subject to compliance with various federal,
state and local statutes and regulations, including requirements relating to
facility use, licensure and inspection requirements,
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licensing or certification requirements of federal, state and local health
agencies and industry accreditation agencies, such as the Joint Commission on
Accreditation of Healthcare Organizations ("JCAHO"). Mountain Crest Hospital is
JCAHO accredited.
Many states also have statutory requirements, known as certificate of
need laws, intended to avoid the proliferation of unnecessary or under-utilized
healthcare services and facilities by requiring a healthcare facility to obtain
approval prior to offering services or undertaking certain acts. Mountain Crest
Hospital has obtained the necessary certificate of need approval, and the
Company believes it is operating in compliance with the conditions of such
approval. Facilities used for healthcare programs must also comply with
licensing requirements of federal, state and local health agencies, and with the
requirements of municipal building, health and fire codes. In granting and
renewing a facility's license, state health agencies generally consider, among
other factors, the physical condition of the facility, the type of services
offered by the facility, the qualifications of administrative and professional
staff, the quality of professional and other services, and the continuing
compliance of such facility with the laws and regulations applicable to its
operations. Licensing, certificate of need, reimbursement and other applicable
regulations vary by jurisdiction and are subject to change. The Company believes
that the Mountain Crest Hospital is materially in compliance with all applicable
requirements. The Company is not able to predict the impact of future changes in
regulations affecting the industry.
Many healthcare providers receive reimbursement under one or more of
the Medicare or Medicaid programs for behavioral healthcare services. The
Company is reimbursed under such programs for services provided at Mountain
Crest Hospital. In order to receive reimbursement under such programs, each
facility must meet applicable requirements promulgated by the United States
Department of Health and Human Services relating to the type of facility, the
qualifications and requirements of personnel, standards of patient care and
compliance with applicable state and local laws, rules and regulations. The
Company believes that Mountain Crest Hospital, which is currently subject to
such certification, is materially in compliance with all applicable
requirements.
The Medicare prospective payment system uses predetermined
reimbursement rates based upon diagnosis-related groups ("DRGs"). The DRG system
established fixed payment amounts per discharge diagnoses generally provided by
acute care hospitals. Mountain Crest Hospital is currently exempt from the DRG
system. It is possible that, in the future, mental health programs could be
included in the DRG system. The Company is not able to predict the impact, if
any, on its business or operations of such a change in the Medicare
reimbursement system.
Federal law contains certain provisions designed to ensure that
services rendered by healthcare providers to Medicare and Medicaid patients are
medically necessary and meet professionally recognized standards. Those
provisions include a requirement that admissions of Medicare and Medicaid
patients to hospitals must be reviewed in a timely manner to determine medical
necessity. In addition, these provisions state that a hospital may be required
to reimburse the government for the cost of Medicare paid services determined by
a peer review organization to have been medically unnecessary. Mountain Crest
Hospital has quality assurance programs and procedures for utilization review
and retrospective patient care evaluation. Various state and federal laws
regulate the relationships between providers of healthcare services and referral
sources. Among these laws are the Medicare and Medicaid anti-fraud and abuse
provisions (the "Fraud and Abuse Statute"). The Fraud and Abuse Statute
prohibits individuals or entities participating in the Medicare or Medicaid
programs from knowingly and willfully offering, paying, soliciting, or receiving
remuneration in order to induce referrals for items or services
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reimbursed under those programs. The policy objective of this statute is to
ensure that the purpose for a referral is quality of care and not monetary gain
by the referring individual. This prohibition applies to Medicare patients,
Medicaid patients and other beneficiaries of certain federally-funded programs,
and imposes felony criminal penalties and civil sanctions, as well as exclusion
from the Medicare or Medicaid programs, for violations. This provision also sets
forth certain specific exceptions to the general prohibition, and authorizes the
Department of Health and Human Services to promulgate, by regulation, additional
payment practices (known as "safe harbors") which will be immune from
prosecution. In 1991, regulations were issued creating certain "safe harbors"
for relationships between healthcare providers and referral sources. Any
relationship that satisfies the terms of a safe harbor is protected from
criminal prosecution and civil sanctions. Failure to satisfy the requirements of
a safe harbor does not necessarily mean that the relationship is prohibited;
rather, the failure to fit within a safe harbor means the arrangement is not
immune from scrutiny and the possibility of punishment. The Company has
agreements with the physicians who provide professional services at Mountain
Crest Hospital, which generally provide for payments to such persons by the
Company as compensation for their administrative services. The Company believes
that its relationships comply with the Fraud and Abuse Statute provisions and
the safe harbor regulations, and has an on-going compliance monitoring program.
The Omnibus Budget Reconciliation Act of 1993 includes provisions
prohibiting certain physician referrals. These provisions ("Stark II") prohibit
a physician who has a financial relationship with an entity from referring to
that entity for the furnishing of "designated health services" for which payment
would otherwise be made by Medicare or Medicaid. Furthermore, the entity may not
present a claim or bill an individual, third party payor or other entity for
"designated health services" furnished pursuant to such a referral. Inpatient
and outpatient hospital services are specifically included in the definition of
"designated health services."
Although the Fraud and Abuse Statute and Stark II prohibitions apply to
Medicare patients, Medicaid patients and other beneficiaries of certain
federally-funded programs, many state laws extend the prohibition to all payors.
The Company believes its relationships comply with all state and federal
statutes and regulations restricting patient referrals.
There are federal, state and local regulations relating to certain
aspects of the Company's business, including civil commitment of patients to
psychiatric programs and disclosure of information concerning patient
treatments. Many states have adopted "patient bill of rights" regulations which
set forth standards for least restrictive treatment, patient confidentiality,
patient access to mail and telephones, patient access to legal counsel and
requirements that patients be treated with dignity. Moreover, many states have
reporting requirements and procedures. The Company's facility has adopted and
implemented policies and procedures consistent with such regulations.
In recent years, media and public attention has been focused on
allegations of fraudulent practices related to the nature and duration of
patient treatments and related billing practices by certain psychiatric care
providers. These alleged practices have been the subject of federal and state
investigations, as well as legal proceedings. Although not involving the
Company, there is a possibility that such activities and investigations could
have a negative impact on the entire industry. The Company is not able to
determine the extent of such impact, if any, on the Company's business or
operations. Several large companies have suffered financial difficulties
resulting from their psychiatric
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care operations. These companies have been prompted to sell, close or convert to
other uses many facilities throughout the United States.
SALE OF CONTRACT MANAGEMENT BUSINESS
In August 1994, the Company formed a joint venture (Joint Venture) to
combine its contract management business with that of Horizon Mental Health
Services, Inc. (Horizon) of Denton, Texas. The Joint Venture, which was owned
27.5 percent by the Company and 72.5 percent by Horizon, managed both companies'
hospital behavioral health care contracts. The terms of the Joint Venture
provided for the Company's continued ownership of its management contracts and
the assignment to the Joint Venture of the operating responsibilities and
revenues related to such contracts.
In March 1995, Horizon completed its initial public offering, and, in
accordance with the terms of the Joint Venture Agreement, acquired the Company's
interest in the Joint Venture for approximately $9,600,000 (net of related
expenses). The sale resulted in a gain of approximately $500,000 (net of income
taxes of $3,000,000). In connection with the sale, the Company assigned to
Horizon all of its rights and interests in its management contracts, including
related accounts receivable.
MHM was involved in litigation with Horizon involving MHM's right to
certain cash flows as part of the sale of its interest in the Joint Venture. In
May 1997, a court award in the Company's favor was upheld by the Supreme Court
of Delaware, for approximately $459,000. This amount is reported in other income
in 1997.
EXTENDED CARE SERVICES DIVISION
General. The Company's Extended Care Services Division represented
approximately 66% of net revenues for fiscal 1997, 33% for fiscal 1996 and 14%
for fiscal 1995. The increased percentage of revenues generated by this
division resulted from the Company's decision to focus its operations on
opportunities in the Extended Care Services Division primarily as a result of
certain acquisitions completed in 1996 and 1997. Through 1997, the Extended
Care Services Division has not operated profitably overall. Consistent with the
Company's efforts to reduce operating expenses and focus on profitable
operations, the Company is closing or selling extended care operations in
certain states because revenues have not been sufficient to achieve
profitability, and is selectively reducing operating and general and
administrative costs and consolidating or outsourcing billing and payroll
functions. See "Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations." The Company believes that the Extended
Care Services Division can operate profitably in the future by effecting these
improvements; however, there can be no assurance that the Company will be
successful or achieve profitability in its Extended Care Services Division. The
Company's strategic growth efforts are currently focused on its Correctional
Services Division. The Company does not anticipate additional acquisitions in
the Extended Care Services Division for the foreseeable future.
The Company's Extended Care Services Division was formed in October
1993 to pursue opportunities to provide on-site care to nursing home residents
and other patients needing less acute care. In November 1993, the Company
acquired the assets of Atlanta-based ICH Services, L.L.C. (successor to HCI
Services, Inc.), which provided behavioral health and other specialized medical
services to residents of extended care facilities, such as nursing homes,
skilled nursing facilities and
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assisted living facilities. In the fourth quarter of fiscal 1997, the Company
decided to dispose of the Florida and North Carolina operations which were a
core part of the HCI acquisition. See Note 6 of Notes to the Consolidated
Financial Statements and "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations."
The focus of the Company's on-site medical and behavioral healthcare
service programs is to arrange for the provision of clinically-appropriate
cost-effective care to residents of extended care facilities. The aim of the
programs is to maximize the level of functioning and improve the quality of life
of residents, as well as decrease the frequency and duration of in-patient
treatment.
The market for specialized medical and behavioral healthcare services
for residents of extended care facilities has benefited from adoption of the
Omnibus Budget Reconciliation Act ("OBRA") by the Federal government in 1987 (as
amended in 1989, 1992 and 1996). OBRA mandated that all long-term care
facilities make mental health and other specialized medical services, such as
dental, podiatry and optometry, available to their residents in order for the
facility to continue to be certified for Medicare and Medicaid. OBRA also
created the requirement for Pre-Admission Screening and Annual Resident Review
("PASARR") of nursing home residents to evaluate their physical and mental
health prior to admission and annually thereafter. The 1996 OBRA amendments
repealed the annual review of mentally ill and mentally retarded residents of
nursing facilities but required such facilities to promptly notify appropriate
state authorities after a significant change in the physical or mental condition
of a resident who is mentally ill or mentally retarded and mandated that an
assessment review be conducted of the resident after such notification.
In 1994, the Extended Care Services Division began providing mental
health services to Medicaid patients residing in nursing homes in the State of
Georgia under a contract pursuant to the PASARR Program which, through annual
renewals, continues in effect. This program was created by the State of Georgia
to provide a way for extended care facilities to comply with the OBRA mandate.
The contract with the State of Georgia expires in June 1998. The Company
continues to provide services and earn revenues under this program. However,
there can be no assurance that the Company will be successful in its efforts to
secure a follow on contract award. This contract represented 17% of the
Company's net revenues for fiscal 1997. As of September 30, 1997, the Company
provided services under Georgia's PASARR program to approximately 2,400
residents in 317 nursing homes.
In fiscal years 1995 through 1997 the Company pursued a growth
strategy, primarily through acquisitions, to increase its market share and net
revenues in its Extended Care Services Division. By the end of fiscal 1997, the
Company reevaluated this strategy in light of continuing overall losses in the
Extended Care Services Division, lack of capital resources to support further
growth and better alternative growth opportunities in the Correctional Services
Division. Following such evaluation, the Company has determined to focus its
growth efforts on its Correctional Services Division. The Company does not
anticipate additional acquisitions in its Extended Care Services Division for
the foreseeable future.
In 1995, 1996 and 1997, the Company completed several acquisitions in
the Extended Care Services Division which are described below.
Acquisition of SCC/Subsequent Determination to Discontinue Operations.
In July 1995, the Company's Extended Care Services Division acquired certain
assets of Supportive Counseling Care
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("SCC"). SCC, based in Manhattan Beach, California, is a professional
corporation which provided behavioral healthcare services to residents of
approximately 50 extended care facilities. As consideration for the acquired
assets, the Company paid $500,000 in cash and notes. The Company's Extended Care
Services Division also entered into a 40-year management contract to provide
administrative services to SCC.
In November 1996, the Company decided to discontinue the operations of
SCC based upon SCC's continued operating losses and negative cash flow,
resulting in part from significant delays in Medicare reimbursement. The Company
shut down SCC's operations in early December 1996. Certain equipment was
transferred to other offices in the Company. All other SCC assets were written
off as of September 30, 1996. See "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations."
Acquisition of Clinic Operations in Massachusetts (MHM Counseling
Services). In December 1995, the Company's Extended Care Services Division
acquired the operations of several behavioral health clinics located in the
metropolitan Boston, Massachusetts area from National Mentor, Inc. As
consideration for the acquired assets, the Company paid $150,000 in cash and
agreed to pay $338,000 in 36 equal monthly installments. At acquisition, the
main clinic in Charlestown, Massachusetts, and the one satellite clinic in
Taunton, Massachusetts, employed approximately 70 behavioral health
professionals, and provided clinical behavioral healthcare services to
approximately 1,400 patients. The Company changed the name of the clinics to MHM
Counseling Services. MHM Counseling Services offers diverse programs designed to
meet the needs of often overlooked and underserved populations: school children,
the mentally impaired and physically disabled, those with chronic medical
illnesses, and older adults. Services can be obtained at a number of convenient
clinic sites across Massachusetts as well as in home-based and outreach
locations, including public schools, nursing homes, vocational centers, day
treatment centers, assisted living facilities, group homes, rehabilitation
hospitals, dialysis centers, and workshops for the developmentally delayed. The
clinics provide scheduling, administration, billing and marketing services.
Acquisition of Extended Care Operations in Massachusetts (Liberty Bay).
Effective as of December 1, 1996, the Company's Extended Care Services Division
acquired, pursuant to an Agreement (the "Liberty Bay Agreement") by and among
the Company, MHM Extended Care Services, Inc., Liberty Bay Colony Health
Services, Inc ("Liberty Bay") and Liberty Management Group, Inc. ("Liberty
Management"), certain assets and contractual rights from Liberty Bay which
constituted Liberty Bay's geropsychiatric management services operations in
Massachusetts. Liberty Bay, a wholly-owned subsidiary of Liberty Management,
provided behavioral healthcare services on a contract basis to residents of
approximately 60 extended care facilities in Massachusetts at the date of
acquisition. The Company combined these operations with MHM Counseling Services
operating under the name "MHM/Bay Colony Counseling Services". See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
As consideration for the purchase, the Company paid Liberty Bay
$150,000 in cash and issued a promissory note in the principal amount of
$150,000 (the "Liberty Bay Note"). The purchase price was primarily allocated to
intangible assets. The Liberty Bay Note provides for quarterly interest payments
at an annual rate of 9% and the payment of the principal amount in one
installment on December 1, 1999. The agreement for the acquisition of Liberty
Bay Colony provides for additional consideration based on cash flows. Amounts
payable are calculated annually for a five-year period at twenty percent
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of the aggregate cash flows from all contracts (net of expenses). The agreement
stipulates limitations on the amount of bad debt expense and regional overhead
which may be charged against cash flow. The agreement also stipulates that the
calculation will be made on a contract by contract basis with no adjustment for
contracts in a loss position, except that in the first annual earnout period a
one time adjustment to regional overhead is made for losses on fifteen specific
contracts. The Company currently estimates that it will be required to make
annual earn out payments of approximately $70,000. However, the actual amount
to be paid will depend upon actual cash flows and may vary significantly from
the Company's current estimate.
Acquisition of Extended Care Operations of Apogee - Effective March 31,
1997, the Extended Care Services Division acquired certain assets and
contractual rights related to the long-term care operations of Apogee, Inc. in
Pennsylvania and Tennessee, consisting of contracts with approximately 275
facilities.
As consideration for the purchase, the Company paid $100,000 in cash,
issued a three-year promissory note in the principal amount of $125,000 and
issued 200,000 shares of common stock of MHM Services, Inc. at $.50 per share.
The purchase price was primarily allocated to intangible assets. The note
provides for interest payments at an interest rate of 7% payable quarterly
(except for the first six months which is payable on September 30, 1997) and
annual principal payments over a three year period. The agreement for the
acquisition of Apogee provides for additional consideration based on net cash
collected as defined in the Apogee purchase agreement. The annual earnout is
payable for a five year period based on 20% of net cash collected. Net cash
collected as defined in the agreement means the actual cash collected reduced
for directly related expenses but not including bad debt allowances, corporate
overhead, amortization of purchase price and depreciation expenses. The Company
incurred a loss from these operations for the period of operation from April 1,
1997 to September 30, 1997 and accordingly estimates that no amount of
additional consideration will be due for the first year. The Company currently
estimates that it will be required to pay approximately $50,000 for each
subsequent year in the five-year period. However, the actual amount to be paid
will depend upon actual future cash flow and may vary significantly from the
Company's current estimate.
Operations of the Extended Care Services Division. In general, the
Company's extended care services are provided under annual contracts with
extended care facilities, which are typically cancelable upon thirty days
notice. The Company schedules provider visits to the facilities and handles
billing and administration. The Company's professionals visit the facilities
either on an as-needed basis or at regularly scheduled intervals. The
obligations of the facility are generally limited to providing space in the
facility for the Company's professionals to meet with residents and assisting
the Company in locating residents who may need care. The Company's Extended Care
Services Division does not receive any compensation from the facility. The
services provided by the Company's professionals are provided only as needed by
the residents. The residents are not required by the facility or the Company to
utilize the Company's professionals.
The healthcare professionals providing services under the Company's
programs are either employees of the Company or render their services on an
independent contract basis pursuant to annual agreements with the Company, which
typically are renewed automatically on an annual basis and cancelable by the
Company upon 60 days notice.
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As of December 15, 1997, the Extended Care Services Division (including
the Georgia PASARR contract) had contracts to arrange for professionals
(employed by or under contract with the Company) to provide mental health
services to residents of 870 extended care facilities in the following states:
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State Number of Facilities
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Georgia 442
Delaware 3
Massachusetts 126
New Jersey 6
Pennsylvania 157
Tennessee 136
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Total 870
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The Extended Care Services Division competes with national, regional
and local companies which provide services to residents of extended care
facilities in a manner similar to that of the Company. In addition, the Company
competes with community-based acute care hospitals which operate programs to
serve the needs of residents of extended care facilities, as well as national
hospital chains which have targeted this market for expansion. The Company also
competes with regional and local behavioral healthcare and other medical
professionals (and their affiliated professional corporations) which provide
services in extended care facilities. Many of the Company's competitors are
larger and have greater financial and other resources than the Company. The
Company believes that competition in this business is primarily on the basis of
quality, range of services and availability of professionals.
The business of the Extended Care Services Division is affected by
federal, state and local laws and regulations concerning, among other matters,
professional licensure and reimbursement. Licensing, reimbursement and other
applicable regulations vary by jurisdiction and are subject to change. The
Company is not able to predict the impact of future changes in regulations
affecting the industry. Certain of the services provided by the Company's
professionals to residents of extended care facilities are reimbursed under the
Medicare and/or Medicaid programs. Accordingly, certain of the Company's
relationships and arrangements are subject to compliance with the Medicare and
Medicaid Fraud and Abuse Statute described above. As mentioned, this statute
sets forth certain specific exceptions to the general prohibition of individuals
or entities participating in the Medicare or Medicaid programs from knowingly
and willfully offering, paying or soliciting or receiving payment in order to
induce referrals for items or services reimbursed under those programs, and
authorizes the Department of Health and Human Services to promulgate, by
regulation, additional payment practices (known as "safe harbors") which will be
immune from prosecution. In 1991, regulations were issued creating certain "safe
harbors" for relationships between healthcare providers and referral sources.
Any relationship that satisfies the terms of a safe harbor is protected from
criminal prosecution and civil sanctions. However, failure to satisfy the
requirements of a safe harbor condition does not necessarily mean that the
relationship is prohibited; rather, the failure to fit within a safe harbor
means the arrangement is not immune from scrutiny and the possibility of
prosecution and sanctions. The Company believes that its
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relationships comply with the Fraud and Abuse Statute as well as all other state
and federal statutes and regulations restricting patient referrals.
Most of the Company's Extended Care Services Division's revenues are
generated through fees paid under Medicare insurance arrangements. The Medicare
benefit has a co-insurance allowable feature which is paid according to a set
fee schedule, plus a "co-insurance" amount which is typically the patient's
responsibility. The co-insurance amount is currently 20% of the allowable for
the services. In many states, this co-payment is covered by the Medicaid program
for eligible individuals, up to the amount stipulated by the Medicare fee
schedule. In the Balanced Budget Act of 1997, Congress increased the states'
flexibility in determining how much to pay for these co-payments. Payment levels
can now be determined by the states' Medicaid Program which could be lower than
the Medicare fee schedule. Although it is unclear when these provisions will
take effect, should states decide to lower their co-pay reimbursement levels,
there would be a material adverse effect on the Company's future Extended Care
Services Division revenues.
Current Medicare regulations do not require a physician to certify the
need for outpatient mental health services for each patient (other than for
partial hospitalization treatment). However, these regulations do require that
such services be part of an established plan of treatment. Some of the fiscal
intermediaries administering the Medicare program in specific geographic regions
require a physician's referral and an established plan of treatment to qualify
for reimbursement for mental health services.
Psychiatrists, psychologists, social workers and nurses are required to
be licensed in the state or states in which they practice. Licensure
requirements are administered by state agencies. The Company's screening process
includes confirmation of necessary licensure, and the Company continually
monitors license status, as well as satisfaction of continuing education and
other related requirements.
In certain states, the employment of psychiatrists, psychologists,
other mental healthcare professionals and other medical professionals by
business corporations is a permissible practice. However, many states, including
some states in which the Company operates, prohibit or otherwise limit business
corporations, such as the Company, from providing behavioral health and other
medical services through the direct employment of psychiatrists, psychologists
and other professionals. In such states, the Company contracts with professional
corporations owned by such professionals, and arranges for the provision of such
services. The Company believes that the operations of the Extended Care Services
Division are structured in compliance with such rules.
CORRECTIONAL SERVICES DIVISION
In fiscal 1997, the Company became aware of opportunities to provide
specialized healthcare services to correctional facilities and formed the MHM
Correctional Services Division to pursue opportunities in this market niche. In
February 1997, the Company began to provide dental services under a contract
with Prison Health Services, Inc. ("PHS") to the 5,000 inmates in the Delaware
correctional system. This contract is for a one-year term and is renewable
annually at the option of PHS. In June 1997, the Tennessee Department of
Corrections awarded the Company a three-year contract to provide statewide
mental health services to the Tennessee prison system, consisting of
approximately 12,000 inmates in 22 facilities, for compensation on a per capita
basis. The Company began to provide services under this contract on July 1,
1997. In September 1997, the Georgia Department of Corrections
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<PAGE> 13
awarded the Company a contract with the initial term being the remaining
nine months of the Department's fiscal year, with four additional one year
extensions at the option of the State of Georgia, to provide statewide mental
health services to the Georgia correctional system, consisting of approximately
37,000 inmates in 40 facilities for compensation on a per capita basis. The
Company began to provide services under this contract on October 1, 1997.
The Georgia and Tennessee correctional contracts make the Company one
of the largest providers of mental health services to inmates in the United
States. The Company is actively pursuing other correctional contract
opportunities. Proposals are submitted pursuant to a competitive bid process,
and there can be no assurance that the Correctional Services Division will win
other contracts. Net revenues from the Correctional Services Division
approximated 3% of the Company's total net revenues for fiscal 1997. However,
such net revenues do not include any revenues from the Company's contract with
the State of Georgia and only three months of revenues from the contract with
the State of Tennessee. Total annual revenues of the Company's three
correctional contracts are estimated to be $10.4 Million.
The Company believes that there are significant opportunities to grow
the Correctional Services Division based on the size of the market, federal and
state mandates for mental health services to prisoners and the increasing trend
for states to outsource mental health services. Accordingly, the Company has
decided to focus its growth efforts on this division. Approximately 30% of
current inmate healthcare spending in the United States is provided by private
contractors. Privatization of inmate healthcare services continues to increase
due to growing acceptance, success of privatization efforts and recognition that
managed care practices are applicable in correctional system settings. In the
past, many states have hired psychologists and other mental health workers on a
contract basis to provide these same services to their inmates. However, the
Internal Revenue Service has recently been threatening to impose payroll tax
requirements on some states which has accelerated the trend to outsource such
services.
The Company believes that there are several advantages to providing
health care services on a capitation basis including lack of billing/collection
costs, more immediate cash flow, fewer bad debts, less government regulations
and fewer compliance issues. At the same time, there are financial risks
associated with entering into capitated arrangements for health care. These
include penetration levels (number of patients treated as a percentage of the
total population), increasing costs and usage of psychotropic medications,
including the introduction of new or improved and more costly medications, and
the availability and cost of labor. If the Company were unable to cover the
costs of these capitated contracts within the agreed upon capitation rates,
significant losses could be incurred. There are also risks unique to providing
health care services in a correctional setting including psychotropic drug use
and abuse and the high degree of litigation which is often present in a
correctional system.
As a result of the Company's continued negative operating results, lack
of cash and availability of capital and a November 1997 unfavorable judgment in
the MEDIQ litigation (See Item 3 - Legal Proceedings), the Company has been
experiencing severe difficulty generating sufficient cash flows from operations
to meet its obligations and sustain its operations. The report of the Company's
independent auditors on the Company's consolidated financial statements as of
and for the year ended September 30, 1997, includes an explanatory paragraph
which states that such conditions raise substantial doubt as to the Company's
ability to continue as a going concern. See "Item 7 - Management's Discussion
and Analysis of Financial Condition and Results of Operations" and Note 2 of
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<PAGE> 14
the Notes to Consolidated Financial Statements. In a continuing effort to
improve this situation for both the immediate future and the long-term, the
Company is continuing its efforts to reduce operating expenses, seek more
profitable business opportunities, finance its working capital requirements,
restructure the MEDIQ debt, raise additional capital and improve its cash flows.
Nevertheless, there can be no assurance that the Company's efforts will result
in positive effects on the Company's financial condition or that the November
1997 unfavorable judgment against the Company in the MEDIQ litigation will not
result in the Company's filing for reorganization under Chapter 11 of the
bankruptcy laws.
EMPLOYEES
As of December 15, 1997, the Company had 158 full-time employees and 87
part-time employees engaged in the operations of the Extended Care Services
Division and 41 full-time employees in the Correctional Services Division and 60
full-time employees and 6 part-time employees engaged in the operations of the
Mountain Crest freestanding facility. In addition, as of such date, the Company
had 11 employees engaged in corporate and administrative operations. In an
effort to help reduce costs, since June 30, 1996, the Company leased its
employees under a contract with Administaff Companies, Inc. ("Administaff").
Under the contract, Administaff and the Company are each responsible for
compliance with specified laws and for specified purposes but also are
considered co-employers for certain other purposes. The Company pays Administaff
a fee based upon a percentage of the Company's gross payroll. The Company and
Administaff agreed to terminate their contract as of January 31, 1998. All
employees covered by the Administaff arrangement will become legal employees of
the Company effective as of that date.
The Company's employees include healthcare professionals, such as
psychiatrists, psychologists, social workers, nurses, counselors and
occupational and activities therapists, and employees engaged in corporate,
finance, marketing, administration and other support positions. None of the
Company's employees are covered by a collective bargaining agreement, and the
Company considers its employee relations to be good. The Company's relationships
with certain healthcare professionals are pursuant to contracts with each
professional establishing independent contractor relationships.
COMPANY HISTORY
The Company was incorporated in 1981 in the Commonwealth of Virginia,
and in October 1994 changed its state of incorporation to Delaware. From 1986 to
August 1993, the Company was a wholly-owned subsidiary of MEDIQ Incorporated
("MEDIQ"). In August 1993, MEDIQ distributed the stock of the Company to MEDIQ's
shareholders.
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<PAGE> 15
FORWARD-LOOKING STATEMENTS
This report includes forward-looking statements based on management's
current plans and expectations relating to the proposed business activities of
the Company, estimates of amounts that are not yet determinable and the proposed
activities of the Company relating to improving its liquidity. Such statements
involve risks and uncertainties which may cause actual future activities and
results of operations to be materially different from that suggested in this
report, including, among others, lack of adequate cash flow to continue to fund
ongoing operations, retire debt obligations as they become due, pay the MEDIQ
Note if the Company's efforts to overturn the MEDIQ judgment are unsuccessful,
the amount and timing of receipt of third party payor settlements, government
reimbursement, risks associated with industry consolidation and acquisitions and
competition.
ITEM 2. PROPERTIES
The Company's executive offices are located in Vienna, Virginia
pursuant to a lease expiring in December 1998. Pursuant to such lease, the
Company pays annual rent of approximately $23 per square foot on approximately
6,600 square feet, with annual increases in an amount equal to 3% of the prior
year's base rent. In connection with the operation of its Extended Care Services
and Correctional Services Divisions, the Company maintains five regional offices
which requires an annual lease commitment of approximately $250,000 per year.
These leases expire from 1999 to 2004. Mountain Crest Hospital is operated
pursuant to a sublease expiring in 2000 and requires base rental payments of
$20,000 monthly and additional rent equal to 6.5% of the net revenues of the
facility and 50% of the facility's excess cash flows (as defined in the lease
agreement). The Company believes that its facilities are adequate to carry on
its business as currently conducted.
ITEM 3. LEGAL PROCEEDINGS
In connection with the spin off of the Company by MEDIQ, its former
corporate parent, on August 31, 1993, the Company executed a five-year $11.5
million note for the balance of unpaid payment obligations imposed on the
Company by MEDIQ and described by MEDIQ as management fees and intercompany
interest.
The Company made the required payments under the note through January
1997. On February 10, 1997, the Company filed a complaint in Superior Court of
New Jersey, Law Division against MEDIQ alleging that the MEDIQ note is invalid
on the grounds that MEDIQ breached its fiduciary obligations in connection with
forcing the Company to execute the MEDIQ note, the MEDIQ note lacks
consideration, the MEDIQ note is unconscionable and it unjustly enriches MEDIQ
at the Company's expense. The Company asked the Court to declare the MEDIQ note
null and void, require MEDIQ to return to the Company all payments MEDIQ has
received under the MEDIQ Note and award the Company compensatory, consequential
and punitive damages. The Company remained current in its payments under the
MEDIQ Note until filing the lawsuit at which time it withheld payments
commencing with the payment due for February 1997 and all subsequent payments.
The Company received notice from MEDIQ by letter dated February 11, 1997,
stating that as a result of the Company's withholding of the February
installment due under the MEDIQ Note, MEDIQ claims to have accelerated all
principal and interest due under the MEDIQ note.
On November 21, 1997, the New Jersey Superior Court, Law Division,
Camden County, entered a summary judgment against the Company and in favor of
MEDIQ. The adverse decision dismissed the Company's suit against MEDIQ and as a
result, judgment has been entered in MEDIQ's favor for the full
15
<PAGE> 16
principal balance and related accrued interest of $11,259,000 and other expenses
of $357,000. The Court also denied the Company's request for a stay in the entry
or execution of judgment.
The Company has filed an appeal with the Appellate Division of the New
Jersey Supreme Court. The Company also has filed a motion in the Appellate
Division seeking summary reversal of the Court's action. If necessary, the
Company will renew with the Appellate Division its request for a stay pending
the appeal. The Company has had communications with MEDIQ concerning settlement,
which communications have been limited to date. If the Company is unable to
obtain a stay on appeal, MEDIQ will be free to commence collection efforts under
the judgment. The Company does not have sufficient funds to pay the MEDIQ
judgment or to collateralize the judgment on appeal. Further, the Company does
not have any readily available source of financing that will permit it to make
such payment, if required to do so. Accordingly, if the MEDIQ judgment is
sustained and MEDIQ seeks to recover its judgment, the Company will be forced to
seek additional sources of debt or equity financing, which is not likely to be
available given the Company's financial condition, or will be required to file
for reorganization under Chapter 11 of the bankruptcy laws.
On December 24, 1997, MEDIQ filed a lawsuit in the Superior Court for
the State of Delaware against Michael Pinkert, the Chief Executive Officer and
Chairman of the Board of the Company, alleging, among other things, breach of
fiduciary duty to MEDIQ and demanding judgment in an unspecified amount in
excess of $100,000, plus prejudgment interest, attorneys' fees and costs. Mr.
Pinkert denies the allegations and intends to vigorously defend the action. The
Company's Certificate of Incorporation provides directors and officers of the
Company with certain rights of indemnification for amounts paid in connection
with pending or threatened actions filed against such persons by reason on
acting in such capacities. Such indemnification is payable upon a determination
by the Company's Board of Directors that such person has met the standard for
indemnification. The Company's Board of Directors has not yet considered whether
Mr. Pinkert is entitled to indemnification in connection with the MEDIQ lawsuit
filed in Delaware and accordingly, it is not possible to predict whether the
Company will be obligated to incur expenses as a result of the lawsuit.
In December 1997, the former President and majority stockholder of
Supportive Counseling Care ("SCC") filed a lawsuit against the Company alleging,
among other things, breach of employment contract, employment discrimination,
discrimination under the American With Disabilities Act and wrongful
termination, and seeking unspecified general and compensatory damages, interest,
unspecified punitive damages, attorneys' fees and costs and a declaratory
judgment. The Company is currently in the process of evaluating the merits of
this lawsuit.
The Company is involved in various other legal proceedings incidental
to its business, some of which may be covered by insurance. The Company knows of
no litigation other than described above,, either pending or threatened, which
is likely to have a material adverse effect on the Company's consolidated
financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
quarter ended September 30, 1997.
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<PAGE> 17
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCK HOLDER
MATTERS
MARKET INFORMATION
The following table sets forth, for the periods indicated, the high and
low sales prices for the Company's common stock, par value $.01 per share (the
"Common Stock"), as listed on the American Stock Exchange ("AMEX").
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
Year ended September 30, 1997:
First Quarter $1.063 $.375
Second Quarter .813 .125
Third Quarter .938 .625
Fourth Quarter 1.875 .875
Year ended September 30, 1996:
First Quarter $3.750 $1.750
Second Quarter 2.625 1.000
Third Quarter 1.875 1.250
Fourth Quarter 1.500 .750
</TABLE>
Because of the Company's financial condition and operating results, on
November 26, 1997, the Company received notification from the AMEX that the
Company's common stock will be delisted due to the Company's continuing failure
to meet the AMEX listing guidelines and the acceleration of the MEDIQ Note.
Although the Company has appealed the delisting, there can be no assurance that
the Company will be able to forestall the delisting of the Common Stock by AMEX.
Further, given the Company's financial condition, it is unlikely that the
Company could satisfy the standards for listing on another exchange or Nasdaq.
The delisting of the Common Stock by AMEX would adversely affect the price of
the Company's Common Stock and the ability of the Company's stockholders to sell
their shares.
COMMON STOCKHOLDERS
As of December 30, 1997, there were approximately 1,555 holders of
record of the Company's Common Stock.
DIVIDENDS
The Company has never declared or paid any cash dividends and does not
expect to pay cash dividends for the foreseeable future. The declaration of
dividends in the future will at all times be subject to the sole discretion of
the Company's Board of Directors, and will depend upon the operating results,
capital requirements and financial position, general economic conditions and
other pertinent conditions or restrictions relating to any future financing.
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<PAGE> 18
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial information presented below has
been derived from the audited financial statements of the Company. This data is
qualified in its entirety by reference to, and should be read in conjunction
with the Company's Consolidated Financial Statements and Notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operations, included elsewhere herein.
STATEMENT OF OPERATIONS DATA (IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------------------------------
1997 1996 1995(1) 1994(1) 1993
---------- ---------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Net revenues $ 20,851 $ 34,670 $ 41,109 $ 48,286 $ 46,667
Costs and expenses:
Operating 14,875 25,765 28,918 33,895 31,760
General and administrative 5,760 9,718 10,085 10,644 8,448
Provision for bad debts 3,467 6,320 4,467 2,009 1,444
Depreciation and amortization 369 1,034 1,603 1,617 1,826
Loss - sale of freestanding -- 4,440 -- -- --
facilities (2)
Writedown of long-term assets (3) 696 461 2,228 -- --
Restructuring charges (4) -- -- -- 966 --
Management fees - MEDIQ (6) -- -- -- -- 1,111
Other (credits) charges:
Equity in earnings of Joint Venture -- -- (835) (292) --
Gain on sale of Joint Venture -- -- (3,542) -- --
Interest expense - MEDIQ 1,042 1,097 1,171 932 834
Interest expense - other 93 290 366 389 328
Other (income) expense-net (5) (662) (233) (223) (33) (50)
---------- ---------- ----------- ----------- -----------
Income (loss) before income tax
expense (benefit), extraordinary item
and cumulative effect of a change in
accounting principle (4,789) (14,222) (3,129) (1,841) 966
Income tax (benefit) expense -- (308) 894 (525) 451
Extraordinary item (7) -- (463) -- -- --
Cumulative effect of a change in
accounting principle (8) -- -- -- (732) --
---------- ---------- ----------- ----------- -----------
Net (loss) income $ (4,789) $ (14,377) $ (4,023) $ ( 2,048) $ 515
========== ========== =========== =========== ===========
(Loss) earnings per share $ (1.40) $ (4.34) $ (1.22) $ (.63) $ .17
========== ========== =========== =========== ===========
Weighted average shares outstanding 3,411 3,310 3,310 3,267 2,980
========== ========== =========== =========== ===========
</TABLE>
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<PAGE> 19
BALANCE SHEET DATA
<TABLE>
<CAPTION>
September 30,
----------------------------------------------------------------------------------
1997 1996 1995(1) 1994(1) 1993
(in thousands)
<S> <C> <C> <C> <C> <C>
Working capital $ (11,158) $ 2,566 $ 5,923 $ 485 $ 7,377
Total assets 11,414 15,669 30,283 41,900 37,364
Long term debt, less current maturities 1,456 257 2,422 716 4,532
Due to MEDIQ, less current maturities (9) -- 9,967 10,733 11,500 11,500
Stockholders' (deficit) equity (8,270) (3,582) 10,795 14,818 15,546
</TABLE>
See Notes to Selected Consolidated Financial Data
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<PAGE> 20
Notes to Selected Consolidated Financial Data:
(1) Effective August 1, 1994, the Company formed a joint venture ("Joint
Venture") to combine its contract management business with that of
Horizon Mental Health Services, Inc. ("Horizon"). The Joint Venture,
which was owned 27.5% by the Company and 72.5% by Horizon, managed both
companies' hospital behavioral health care contracts. The operating
results of the contract management business were included in the
Company's results of operations through the commencement of the Joint
Venture on August 1, 1994. On March 20, 1995, Horizon completed its
initial public offering and, in accordance with the terms of the Joint
Venture Agreement, acquired the Company's interest in the Joint Venture
for approximately $9,600,000 (net of related expenses). The sale
resulted in a pre-tax gain of $3,542,000 (approximately $500,000 net of
taxes).
(2) The Company completed the sale of six of its seven freestanding
behavioral health facilities in 1996 and recorded a loss of $4,440,000
consisting primarily of the write off of intangibles related to the
facilities of $3,184,000, loss on the sale of certain property, plant,
and equipment aggregating $319,000, transaction expenses of $568,000,
severance expenses of $349,000, and other expenses of $680,000, offset
by estimated Medicare depreciation recapture income of approximately
$660,000.
(3) In the fourth quarter of 1997, the Company decided to dispose of the
Florida and North Carolina operations of its Extended Care Services
Division and close its Atlanta, Georgia billing office. In connection
with these decisions, the Company determined that goodwill relating to
the acquisition of HCI was permanently impaired and wrote it down to
estimated value resulting in a charge of $696,000. In the fourth
quarter of 1996, the Company wrote off the assets related to the
discontinued operations of SCC including property, plant and equipment
and goodwill resulting in a charge of $461,000. In the fourth quarter
of 1995, the Company determined that the recoverability of certain of
the assets, including property, plant and equipment and goodwill,
related to one of the Company's freestanding facilities, was impaired,
other than temporarily. Accordingly, the carrying value of such assets
was reduced to estimated fair value, resulting in a charge of
$2,228,000.
(4) In connection with the commencement of the Joint Venture, the Company
recorded a restructuring charge of $966,000 related to the downsizing
of its corporate activities.
(5) In May 1997, the Supreme Court of Delaware upheld a lower court award
of $459,000 to the Company from Horizon relating to the rights of the
Company to receive certain cash flows as part of the sale of its
interest in the joint venture to Horizon resulting in additional income
in fiscal 1997.
(6) These management fees represent primarily an allocation of MEDIQ's
claimed overhead, as well as claimed costs to provide services to the
Company. In anticipation of the August 1993 distribution of the
Company's stock to MEDIQ's stockholders, MEDIQ discontinued charging
management fees to the Company effective April 1, 1993. The Company had
continued to obtain certain services from MEDIQ pursuant to a services
agreement which terminated in 1996. Fees for services rendered by MEDIQ
were $30,000, $38,000 and $140,000 in 1997, 1996 and 1995,
respectively, and were included in general and administrative expenses.
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<PAGE> 21
(7) The Company recorded an extraordinary item in the amount of $463,000
consisting primarily of costs related to the early retirement of the
Company's long-term debt and the write-off of associated loan
acquisition costs.
(8) This amount represents the cumulative effect of a change in the
Company's method of accounting for certain preopening costs and certain
costs incurred in securing management contracts.
(9) The Company's long term debt obligations to MEDIQ were reclassified as
a current liability in 1997.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
financial statements, and notes thereto, included elsewhere in this report.
GENERAL
The Company made significant changes in its operations in 1995, 1996
and 1997, including the sale of six of the Company's seven freestanding
behavioral healthcare facilities (see "Recent Developments"), so that the
Company could focus on its Extended Care Services Division and Correctional
Services Division. The Extended Care Services Division, which commenced
operations in the Fall of 1993 has experienced growth through internal
development, principally from one contract with the State of Georgia, and
acquisitions. However, the Company has experienced continuing losses in the
Extended Care Services Division and has made recent changes designed to improve
its profitability and cash flow. The Company formed a Correctional Services
Division in 1997 and in the fourth quarter of 1997 secured contracts with the
Tennessee and Georgia Departments of Correction to provide mental health
services on a capitated basis to the inmates of those states' correctional
systems. The Company is currently seeking additional contract awards in this
growing industry. In fiscal 1997, the Company further refined its strategy to
achieve profitability. The Company is closing or selling extended care
operations in certain states because revenues have not been sufficient to
achieve profitability, and selectively reducing operating and general and
administrative costs and consolidating or outsourcing billing and payroll
functions. The Company's strategic growth efforts are currently focused on its
Correctional Services Division. The Company does not anticipate additional
acquisitions in its Extended Care Services Division for the foreseeable future.
As a result of the Company's continuing negative operating results,
increases in accounts receivable and other factors, the Company has continued to
experience difficulty generating sufficient cash flows from operations to meet
its obligations and sustain its operations. At September 30, 1997, the Company's
current liabilities exceeded its current assets by $11,158,000. The Company's
working capital deficit is primarily due to the classification of the MEDIQ Note
as a current liability. On November 21, 1997, the New Jersey Superior Court, Law
Division, Camden County, entered a judgment against the Company and in favor of
MEDIQ. The adverse decision dismissed the Company's suit against MEDIQ and as a
result, judgment has been entered in MEDIQ's favor for the full principal
balance of the MEDIQ Note and related accrued interest of $11,259,000 and other
expenses of $357,000. The Court also denied the Company's request for a stay in
the entry or execution of judgment.
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<PAGE> 22
The Company has filed an appeal with the Appellate Division of the New
Jersey Supreme Court. The Company also has filed a motion in the Appellate
Division seeking summary reversal of the Court's action. If necessary, the
Company will renew with the Appellate Division its request for a stay pending
the appeal. The Company has had communications with MEDIQ concerning settlement,
which communications have been limited to date. If the Company is unable to
obtain a stay on appeal, MEDIQ will be free to commence collection efforts under
the judgment. The Company does not have sufficient funds to pay the MEDIQ
judgment or to collateralize the judgment on appeal. Further, the Company does
not have any readily available source of financing that will permit it to make
such payment, if required to do so. Accordingly, if the MEDIQ judgment is
sustained and MEDIQ seeks to recover its judgment, the Company will be forced to
seek additional sources of debt or equity financing, which is not likely to be
available given the Company's financial condition, or will be required to file
for reorganization under Chapter 11 of the bankruptcy laws.
The report of the Company's independent auditors on the Company's
audited consolidated financial statements for the fiscal year ended September
30, 1997, includes an explanatory paragraph which states that such conditions
raise substantial doubt as to the Company's ability to continue as a going
concern. In a continuing effort to improve this situation for both the immediate
future and the long-term, the Company is continuing its efforts to reduce
operating expenses, seek more profitable business opportunities, finance its
working capital requirements, restructure the MEDIQ obligation, raise additional
capital and improve its cash flows. Nevertheless, there can be no assurance that
the Company's efforts will result in positive effects on the Company's financial
condition or that the November 1997 unfavorable judgment against the Company in
the MEDIQ litigation will not result in the Company's filing for reorganization
under Chapter 11 of the bankruptcy laws.
RECENT DEVELOPMENTS
The Company incurred aggregate net losses of $23,189,000 for the three
years ended September 30, 1997, and had a stockholders' deficit of $8,270,000 as
of September 30, 1997. The Company is experiencing difficulty in generating
sufficient cash flows to meet its obligations and sustain its operations. At
September 30, 1997, current liabilities exceeded current assets by $11,158,000,
primarily due to the MEDIQ obligation, which is discussed in detail below. See
Note 2 of Notes to Consolidated Financial Statements. The report of the
independent auditors for the fiscal year ended September 30, 1997 includes an
explanatory paragraph which states that such conditions raise substantial doubt
about the Company's ability to continue as a growing concern.
OPERATING STRATEGY. Historically, the Company's principal business was
the operation of freestanding behavioral health-care facilities and the
management of behavioral health-care programs under contracts with acute care
hospitals. The market for behavioral heath-care has undergone dramatic changes
in recent years, resulting in pressure on providers to reduce costs and lower
utilization of in-patient care and reimbursement rates.
In response to these market changes and their adverse impact on the
Company's operating results, the Company has changed its business dramatically
in recent years. In 1996, the Company sold six of its seven freestanding
behavioral health facilities, which had generated approximately 51% of net
revenues for fiscal 1996, deciding to focus on the growth of its Extended Care
Services Division. The Company continues to own one freestanding behavioral
health facility (Mountain Crest), which continues to generate operating cash
flow. The Company currently leases the real estate on which the
22
<PAGE> 23
Mountain Crest facility is located but is seeking financing to purchase the land
and building. There can be no assurance that the Company will be successful in
locating an acceptable source of financing for this transaction.
In fiscal 1996, the Company determined that it would focus its
operating strategy on growth opportunities in its Extended Care Services
Division and other specialty on-site health-care services. During fiscal 1997,
the Company made several acquisitions in its Extended Care Services Division.
See Note 5 of Notes to Consolidated Financial Statements. However, based upon
the Company's liquidity and capital resources, there can be no assurance the
Company will have sufficient resources to be able to continue to expand this
division. Through 1997, the Extended Care Services Division has not operated
profitably overall. Consistent with the Company's efforts to reduce operating
expenses and focus on profitable operations, the Company is closing or selling
extended care operations in certain states where revenues have not been
sufficient to operate on a profitable scale, and is selectively reducing
operating and general and administrative costs and consolidating or outsourcing
billing and payroll functions. See "Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations." The Company believes
that the Extended Care Services Division can operate profitably in the future by
effecting these improvements; however, there can be no assurance that the
Company will be successful or achieve profitability in its Extended Care
Services Division. The Company does not anticipate additional acquisitions in
the Extended Care Services Division in the foreseeable future.
In fiscal 1997, the Company further refined its operating strategy by
forming a Correctional Services Division to provide specialized health services
to inmates in correctional facilities. In fiscal 1997, the Company was awarded
capitated contracts with the States of Tennessee and Georgia to provide mental
health services to inmates in their state correctional facilities. The Company
began performing under these contracts on July 1, 1997 (Tennessee) and October
1, 1997 (Georgia). The Company intends to pursue additional contract
opportunities in the correctional service area, although there can be no
assurance that it will have sufficient resources to do so.
In a continuing effort to improve the Company's financial condition and
operating results for both the immediate future and the longer term, the Company
continues to seek to reduce operating expenses, seek more profitable business
opportunities, finance its working capital requirements, restructure the MEDIQ
obligation, raise additional capital and improve its cash flows. There can be no
assurance the Company's efforts will result in positive effects on the Company's
results of operations or financial condition.
SOURCES OF FINANCING. The Company continues to seek sources of
financing to fund operating costs and expenses. Effective March 11, 1997, the
Company's subsidiary, MHM Extended Care Services, Inc., obtained a revolving
credit facility in an amount up to $4,000,000. The amount eligible for
borrowings on the credit facility is limited based on the amount of the
Company's qualified accounts receivable. In October 1997, the Company borrowed
$500,000 under a line of credit with NationsBank, N.A., which debt is
guaranteed by certain officers and directors of the Company. The line of credit
permits maximum borrowings by the Company of $500,000, and bears interest at a
rate 1/4% below prime rate. As of December 31, 1997, the Company had drawn the
full $500,000. See Note 17 of Notes to Consolidated Financial Statements. As of
September 30, 1997, the Company had cash and cash equivalents available of
$195,000. The Company has continued to experience significant negative cash
flow from operations. Although the
23
<PAGE> 24
Company continues to seek additional sources of debt and equity financing, given
the Company's financial condition it is unlikely that the Company's efforts will
be successful unless the Company is able to significantly reduce its obligation
to MEDIQ. See "Liquidity and Capital Resources."
ACQUISITIONS. Effective as of March 31, 1997, the Company's Extended
Care Services Division acquired certain assets and contractual rights related to
the long-term care operations of Apogee, Inc. in Pennsylvania and Tennessee,
consisting of contracts with approximately 275 facilities. As consideration for
the purchase, the Company paid $100,000 in cash, issued a three-year promissory
note in the principal amount of $125,000 and issued 200,000 shares of common
stock of MHM Services, Inc. at $.50 per share. The purchase price was primarily
allocated to intangible assets. The note provides for interest payments on
September 30, 1997 for the first two quarters and quarterly thereafter at an
annual interest rate of 7% and annual principal payments in the amount of
approximately $41,668. The agreement for the acquisition of Apogee provides for
additional consideration based on net cash collected as defined in the Apogee
purchase agreement. The annual earnout is payable for a five year period based
on 20% of net cash collected. Net cash collected as defined in the agreement
means the actual cash collected reduced for directly related expenses but not
including bad debt allowances, corporate overhead, amortization of purchase
price and depreciation expenses. The Company incurred a loss from these
operations for the period of operations from April 1, 1997 to September 30,
1997 and accordingly estimates that no amount of additional consideration will
be due for the first year. The Company currently estimates that it will be
required to pay approximately $50,000 for each subsequent year in the five-year
period. However, the actual amount to be paid will depend upon actual future
cash flow and may vary significantly from the Company's current estimate.
Effective as of December 1, 1996, the Company's Extended Care Services
Division acquired, pursuant to an agreement (the "Liberty Bay Agreement") by and
among the Company, MHM Extended Care Services, Inc., Liberty Bay Colony Health
Services, Inc. ("Liberty Bay") and Liberty Management Group, Inc. ("Liberty
Management"), certain assets and contractual rights from Liberty Bay which
constitute Liberty Bay's geropsychiatric management services operations in
Massachusetts. The Company has integrated these operations under the name
"MHM/Bay Colony Counseling Services." As a result of this acquisition and the
continued development of MHM/Bay Colony Counseling Services, as of September 30,
1997, the Company served approximately 90 extended care facilities in
Massachusetts.
As consideration for the purchase, the Company paid Liberty Bay
$150,000 in cash and issued a promissory note in the principal amount of
$150,000 (the "Liberty Bay Note"). The purchase price was primarily allocated to
intangible assets. The Liberty Bay Note provides for quarterly interest payments
at an annual rate of nine percent and the payment of the principal amount in one
installment on December 1, 1999. The agreement for the acquisition of Liberty
Bay Colony provides for additional consideration based on cash flows. Amounts
payable are calculated annually for a five year period at twenty percent of the
aggregate cash flows from all contracts (net of expenses). The agreement
stipulates limitations on the amount of bad debt expense and regional overhead
which may be charged against cash flow. The agreement also stipulates that the
calculation will be made on a contract by contract basis with no adjustment for
contracts in a loss position, except that in the first annual earnout period a
one-time adjustment to regional overhead is made for losses on fifteen specific
contracts. The Company currently estimates that it will be required to make
annual earnout payments under the contract of approximately $70,000. However,
the actual amount to be paid will depend upon actual future cash flow and may
vary significantly from the Company's current estimate.
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<PAGE> 25
OVERVIEW OF REVENUE SOURCES
In the Extended Care Services Division, the Company is paid primarily
by third-party payors based on established contractual rates. In certain
instances, the Company also is paid by the patient for all or a portion of the
services. The Company recognizes net revenues from extended care services at the
estimated net realizable amounts from third-party payors, principally state and
federal health insurers (including Medicare and Medicaid) and to a lesser extent
patients, less amounts payable to professionals for the provision of such
services. Estimated amounts recognized by the Company are reconciled at the time
the payment for the services provided is actually received.
The Company's Extended Care Services Division generates revenues from
administrative services for physicians and other healthcare professionals
providing care to residents of extended care facilities. Such revenues
represented approximately 66%, 33% and 14% of total net revenues in 1997, 1996
and 1995, respectively. The increased revenues resulted from the Company's
decision to focus its operations on opportunities in the Extended Care
Services Division primarily as a result of certain acquisitions in 1996 and
1997.
The Company's Correctional Services Division generates revenues from
the provision of specialty health care services to the inmates of correctional
systems primarily at capitated rates based on inmate census. These revenues
represented approximately 3% of total 1997 net revenues. In two of the three
contracts in the Correctional Services Division, the Company is paid by the
state on a monthly basis at contractually agreed-upon rates applied to the
number of inmates in the prison system during the period. Net revenues in this
division are reported on an accrual basis at the capitated rate applied to the
number of inmates.
In the Hospital Division, at the Mountain Crest facility, the Company
is paid at a fixed-rate for services provided based on the allowable cost of
such services. Such payments are generally made by third-party payors,
principally Medicare, but also including Medicaid and other health-care
insurers. The Company has agreements with third-party payors that provide for
payments for patient services at amounts which differ from its established
rates. For Medicare, the Company is reimbursed for cost reimbursable items at a
tentative rate with final settlement determined after submission of annual cost
reports by the Company and audits thereof by the Medicare fiscal intermediary.
The Company is in the process of negotiating final settlements for prior
reporting periods relating to filed costs reports for the six freestanding
facilities sold in 1996. The Company continues to file cost reports for its
Mountain Crest facility.
Patient service revenues from the Company's freestanding facilities
were based on covered charges billed primarily to third party payors, including
Medicare, Medicaid and other government-sponsored programs. These accounted for
31%, 67% and 86% of the Company's total net revenues in 1997, 1996 and 1995,
respectively. Such revenues can be significantly affected by changes in
utilization and reimbursement rates. Typically, payments from such payors are
made at amounts less than the amounts charged, based on existing contractual
relationships or reimbursement methodologies. The Company records net patient
service revenues based upon expected reimbursement. Certain government-sponsored
programs pay primarily on a cost reimbursement basis. The Company is reimbursed
for cost reimbursable items at a tentative rate, with final settlement generally
determined several years after submission of fiscal year cost reports and audits
thereof by the fiscal intermediary. Differences between amounts recorded as
tentative settlements and final audited amounts are reflected as
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<PAGE> 26
adjustments to contractual allowances in the year in which settlement is
determined. The Company also receives patient service revenues under payment
agreements with commercial insurance carriers, health maintenance organizations
and preferred provider organizations.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the
percentage relationship that components of the Company's results of operations
bear to net revenues.
<TABLE>
<CAPTION>
Year Ended September 30,
-----------------------------------------------
1997 1996 1995
------ ------- ------
<S> <C> <C> <C>
Net revenues 100.0% 100.0% 100.0%
Costs and expenses:
Operating 71.4 74.3 70.3
General and administrative 27.7 28.0 24.5
Provision for bad debts 16.6 18.2 10.9
Depreciation and amortization 1.8 3.0 3.9
Loss on sale of freestanding facilities -- 12.8 --
Writedown of long-term assets 3.3 1.3 5.4
Other (credits) charges:
Equity in earnings of Joint Venture -- -- (2.0)
Gain on sale of Joint Venture -- -- (8.6)
Interest expense - MEDIQ 5.0 3.2 2.8
Interest expense - other .4 .8 .9
Other (income) expense - net (3.2) (.6) (.5)
------ ------- ------
Loss before income taxes and extraordinary item (23.0) (41.0) (7.6)
Income tax (benefit) expense -- (.9) 2.2
------ ------- ------
Loss before extraordinary item (23.0) (40.1) (9.8)
------
Extraordinary item - loss on early extinguishment of debt -- (1.3) --
------ ------- ------
Net loss (23.0)% (41.4)% (9.8)%
====== ======= ======
</TABLE>
26
<PAGE> 27
Fiscal Year 1997 Compared to Fiscal Year 1996
Net revenues for the year ended September 30, 1997, were $20,851,000 as
compared to $34,670,000 for the prior year, a decrease of $13,819,000 or 40%,
primarily reflecting the reduction in net revenues due to the 1996 sales of the
Company's freestanding facilities. The Company sold Oakview Treatment Center on
April 5, 1996 and sold five other freestanding facilities on May 31, 1996. The
Company continues to operate one facility, the Mountain Crest facility. As a
result, net revenues from freestanding facilities were $6,482,000 for 1997
compared to $23,255,000 for 1996. Net revenues from the Extended Care Services
Division were $13,737,000 in 1997 as compared to $11,415,000 in 1996, an
increase of 20%. This increase is due principally to the revenues recognized
from two acquisitions made by the Company in its Extended Care Services
Division during fiscal 1996; Liberty Bay (December 1996) and Apogee (March
1997). In the fourth quarter of 1997, the Company decided to dispose of its
extended care operations in Florida and North Carolina. As a result,
approximately $595,000 of net revenues reported in 1997 will not continue in
future years. Net revenues for 1997 also included $632,000 relating to the
Correctional Services Division, which commenced operations in February 1997.
Operating expenses for the year ended September 30, 1997, were
$14,875,000, as compared to $25,765,000 in the prior year, a decrease of
$10,890,000 or 42%. This decrease was attributable primarily to the sale of six
of the Company's seven freestanding behavioral healthcare facilities, offset in
part by increased costs in the Company's Extended Care Services Division and
Correctional Services Division which commenced operations in fiscal 1997.
General and administrative expenses for the year ended September 30,
1997, were $5,760,000 as compared to $9,718,000, a decrease of $3,958,000 or
41%. This decrease was attributable primarily to the sale of six of the
Company's seven freestanding behavioral healthcare facilities, offset by
increases in costs in the Company's Extended Care Services Division and
Correctional Services Division.
The provision for bad debts for 1997 decreased to $3,467,000 as
compared to $6,320,000 for 1996. As a percentage of net revenues, bad debt
expense was 17% in 1997 and 18% in 1996. The 1996 bad debt expense was high due
to the provision for bad debts relating to SCC (See Fiscal Year 1996 Compared to
Fiscal 1995). The 1997 bad debt expense was high due to reserves against
receivables remaining from the sale of freestanding facilities and reserves
against Extended Care Services Division receivables in the Company's Georgia
billing office. In the fourth quarter of 1997, the Company shut down its Georgia
billing office and intends to outsource all of its billing and collection
efforts to minimize further bad debts.
The Company continues to take steps to reduce the operating and general
and administrative costs associated with its Extended Care Services Division,
including consolidation and outsourcing of billing and payroll functions,
closing certain regional offices and disposing of operations in North Carolina
and Florida. However, there can be no assurance that these efforts will not
impact revenue adversely or result in profitable operations.
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<PAGE> 28
Depreciation and amortization decreased to $369,000 in 1997 from
$1,034,000 in the prior year. This decrease of 64% was due to the sale of the
freestanding facilities which had a much higher base of fixed assets than
ongoing operations.
Loss on sale of freestanding facilities were transactions occurring
solely in 1996.
Interest expense - other decreased in 1997 to $93,000 from $290,000 in
1996, a decrease of 68%. This decrease is primarily attributable to the
retirement of debt relating to the freestanding facilities sold in 1996.
Other income for 1997 increased by $429,000 due to the May 1997 award
to the Company of certain cash flows due it from the sale of its interest in the
joint venture to Horizon.
The total net loss for 1997 was $4,789,000 as compared to a loss of
$14,377,000 for 1996. The 1996 loss was higher than 1997 due to operating losses
from the freestanding facilities through the date of sale and the loss from the
sale of freestanding facilities.
Fiscal Year 1996 Compared to Fiscal Year 1995
Net revenues for 1996 were $34,670,000 as compared to $41,109,000 for
the prior year, a decrease of $6,439,000 or 16%, reflecting an increase in net
revenues from the Extended Care Services Division, more than offset by decreased
net revenues from the freestanding facilities. Net revenues from freestanding
facilities were $23,255,000 (including $5,694,000 from Mountain Crest Hospital,
the Company's remaining freestanding facility) in 1996, a decrease of
$12,116,000, or 34%, as compared to the prior year. The decrease in net revenues
resulted primarily from the sale of five of the freestanding facilities on May
31, 1996 and the sale of Oakview Treatment Center on April 5, 1996. Net revenues
from the Extended Care Services Division were $11,415,000 in 1996, as compared
to $5,738,000 in the prior year. This increase is the result of net revenues of
$4,448,000 (as compared to $1,317,000 in 1995) attributable to an acquisition in
July 1995 (SCC) and $1,456,000 attributable to an acquisition in December 1995
(MHM Counseling Services), as well as increased net revenues under a contract
with the State of Georgia to provide mental health services to Medicaid patients
in nursing homes. SCC operations were discontinued in early December 1996. See
provision for bad debts discussion below.
Operating expenses for 1996 were $25,765,000 as compared to $28,918,000
in the prior year. This decrease was attributable to the sale of six of the
Company's seven freestanding behavioral healthcare facilities, offset by
increases in costs associated with the expansion of the Extended Care Services
Division. The level of operating costs of the Extended Care Services Division,
together with the increased provision for bad debts (described below) and
general and administrative expenses, have had an adverse impact on operating
results.
General and administrative expenses for 1996 were $9,718,000 or 28% of
net revenues, as compared to $10,085,000 or 25% of net revenues, in the prior
year. This decrease was attributable to the sale of six of the Company's seven
freestanding behavioral healthcare facilities, offset by increases in costs
associated with the expansion of the Extended Care Services Division. The level
of operating costs of the Extended Care Services Division, together with the
increased provision for bad debts (described below) and general and
administrative expenses, have had an adverse impact on operating results.
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<PAGE> 29
The provision for bad debts for 1996 increased to $6,320,000 as
compared to $4,467,000 in the prior year. The increase in the provision for bad
debts resulted primarily from the operations of SCC (acquired in July 1995)
which are subject to Medicare reimbursement limits, with the remaining charges
billed to the patients or other third party payors. In March 1996, the Company
became aware that SCC's claims, as well as claims submitted by other industry
providers in the region, for reimbursement under the Medicare program were being
subjected to a pre-payment review process by the Medicare fiscal intermediary in
Southern California commencing in April 1996. Under applicable Medicare rules,
therefore, SCC was then required to include specified supporting documentation
with its claims for reimbursement. After the commencement of this prepayment
review, SCC received an increased number of denials and requests for additional
information. In addition, SCC received notice of a proposed suspension of
Medicare payments based upon a review of certain claims by such fiscal
intermediary. Based upon the number of denials, the Company's assessment of
available documentation and knowledge of, and experience with, the appeal
process, the Company increased its provision for bad debts by approximately
$1,000,000 in the third and fourth quarters of fiscal 1996. The allowance for
doubtful accounts represents approximately 90% of the Company's net accounts
receivable balance from SCC's operations as of September 30, 1996. In November
1996, the Company decided to discontinue the operations of SCC based upon SCC's
continued operating losses and negative cash flow, resulting in part from
significant delays in Medicare reimbursement. The Company shut down SCC's
operations in early December 1996. The Company continues to pursue an appeal of
the denied claims. However, there is no assurance that the Company will collect
anything from these claims, and in fiscal 1997, the Company fully reserved the
remaining balance of SCC receivables.
Depreciation and amortization expense for 1996 was $1,034,000 as
compared to $1,603,000 in the prior year. The decrease in depreciation and
amortization expense was attributable to the sale of the six freestanding
facilities.
The Company completed the sale of six of its seven freestanding
behavioral health facilities in 1996 and recorded a loss of $4,440,000
consisting primarily of the write off of intangibles related to the facilities
of $3,184,000, loss on the sale of certain property, plant, and equipment
aggregating $319,000, transaction expenses of $568,000, severance expenses of
$349,000, and other expenses of $680,000, offset by estimated Medicare
depreciation recapture income of approximately $660,000.
In the fourth quarter of 1996, the Company wrote off the assets related
to the discontinued operations of SCC including property, plant and equipment
and intangibles resulting in a charge of $461,000. This compares to a write down
of $2,228,000 in 1995, which related primarily to the assets of one of the
freestanding behavioral health facilities which were reduced to estimated value
based upon an independent appraisal.
Interest expense for 1996 was $1,387,000, as compared to $1,537,000 in
the prior year. The decrease is primarily attributable to the extinguishment of
the working capital line of credit and paydown on the MEDIQ note.
Pretax loss for 1996 before extraordinary item was $14,222,000 as
compared to pretax loss of $3,129,000 in the prior year. The pretax loss for the
current period included a loss of $4,440,000 related to the sale of the
freestanding behavioral health facilities, increases in the bad debt provision
related to SCC reimbursement denials of approximately $1,000,000 and write off
of long-term assets of $461,000 related to the closing of SCC in December 1996.
The prior period included a pretax gain of $3,542,000 on the sale of the
Company's interest in the Joint Venture as well as earnings of $835,000 related
to the
29
<PAGE> 30
Joint Venture offset by the writedown of certain assets of the Company's
freestanding behavioral facilities in the amount of $2,228,000. In addition, the
increase in costs associated with expansion of the Extended Care Services
Division, as well as the increased provision for bad debts, had an adverse
impact on operating results for 1996.
In 1996, the Company recorded an extraordinary item in the amount of
$463,000, consisting primarily of costs related to the early retirement of the
Company's long-term debt and the subsequent write off of associated loan
acquisition costs.
MAJOR CUSTOMER
The Company has two contracts with the State of Georgia. The Extended
Care Services Division provides behavioral healthcare services to more than
2,000 Medicaid patients residing in nursing homes under the Pre-Admission
Screening and Annual Resident Review (PASARR) contract with the State of
Georgia. The PASSAR contract expires June, 1998. In the year ended September 30,
1997, the PASARR contract accounted for 17% of net revenues. MHM Correctional
Services was awarded a multi-year contract (single year with four optional
extension years) with the State of Georgia to provide mental health services to
the inmates of the state's correctional facilities on a capitated basis. This
contract begins on October 1, 1997. This contract is projected to provide
approximately $8 million of annual revenue. Both of these contracts are subject
to the procurement process of the State of Georgia, and there is no assurance as
to the expectation of future revenues earned under these contracts.
IMPACT OF INFLATION
Behavioral health programs are labor intensive. As wages and employee
benefit costs increase during inflationary periods, and outside suppliers pass
cost increases through to the Company, costs rise proportionately. The Company
has implemented systems to monitor and control increases in expenses.
Government-sponsored programs, including Medicare and Medicaid, which represent
a substantial portion of the Company's revenues, and contractual arrangements
with other third party payors, may limit the Company's ability to obtain
corresponding revenue increases. Additionally, the Company's capitated contracts
with the correctional systems of Georgia and Tennessee are subject to an
inflation risk if psychotropic drug costs exceed the contracted increase in the
capitation rate the Company receives.
YEAR 2000 ISSUES
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs that have date sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result in
a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices or engage in similar normal business activities.
Specific application programs which the Company uses and which may be
impacted by this problem include billing related software and the Company's
accounting system. The Company has not yet evaluated the impact of the Year 2000
problem, and therefore there can be no assurance that this issue will not
materially affect future financial results, or cause reported financial
information not to be necessarily indicative of future operating results or
future financial condition. The Company plans to undertake an assessment of the
Year 2000 issue during fiscal 1998.
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<PAGE> 31
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1997, the Company had cash and cash equivalents of
$195,000, compared to $3,305,000 at September 30, 1996. The significant decrease
in available cash is the result of the Company using cash to fund continued
operating losses.
Cash used in operating activities was $3,151,000 for 1997, as compared
to $4,882,000 for the prior year. Cash was primarily used in 1997 to fund a
significant increase of $5,000,000 in accounts receivable and estimated third
party settlements and to fund the provision for bad debts of $3,467,000. The
Company has continued to experience significant operating losses, and is
continuing to seek opportunities to restructure its business to more profitable
lines and to reduce operating expenses. The Company also used $647,000 of cash
to fund investing activities, principally acquisitions in its Extended Care
Services Division ($427,000).
Net cash provided by financing activities in 1997 of $688,000 consisted
primarily of borrowings under the line of credit extended to the Company's
subsidiary by Healthcare Financial Partners. The Company does not presently
anticipate significant capital expenditures during fiscal 1998.
In March 1997, the Company's wholly owned subsidiary, MHM Extended Care
Services, Inc., obtained a revolving credit facility in an amount up to
$4,000,000. The amount eligible for borrowings on the credit facility is limited
based on the amount of the Company's qualified accounts receivable. At September
30, 1997, the Company had outstanding borrowings of $1,122,000 which was
approximately equal to what the Company was eligible to borrow at that date.
Borrowings under the line of credit bear interest at a rate of prime plus 2 and
1/4 percent (10.75% at September 30, 1997). Interest is payable monthly on
outstanding borrowings and the line of credit expires in March, 1999. See Note
10 of Notes to Consolidated Financial Statements.
In October 1997, the Company borrowed $500,000 under a line of credit
with NationsBank, N.A., which debt is guaranteed by certain officers and
directors of the Company. The line of credit permits maximum borrowings by the
Company of $500,000, and bears interest at a rate 1/4% below prime rate. As of
December 31, 1997, the Company had drawn the full $500,000. See Note 17 of Notes
to Consolidated Financial Statements.
As of September 30, 1997, the Company had cash and cash equivalents of
$195,000. The Company has continued to experience significant negative cash flow
from operations. Although the Company continues to seek additional sources of
debt and equity financing, given the Company's financial condition it is
unlikely that the Company's efforts will be successful unless the Company is
able to significantly reduce its obligations to MEDIQ.
On February 10, 1997, the Company filed a complaint in Superior Court
of New Jersey - Law Division against MEDIQ Incorporated ("MEDIQ") alleging that
the note that was executed in connection with the distribution of the Company's
stock to MEDIQ's stockholders (the "MEDIQ Note") is invalid on the grounds that
MEDIQ breached its fiduciary obligations to the Company in connection with
forcing the Company to execute the MEDIQ Note, the MEDIQ Note lacks
consideration, the MEDIQ Note is unconscionable and it unjustly enriches MEDIQ
at the Company's expense. The Company asked the Court to declare the MEDIQ Note
null and void, require MEDIQ to return to the Company all payments MEDIQ has
received under the MEDIQ Note and award the Company compensatory, consequential
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<PAGE> 32
and punitive damages. The Company remained current in its payments under the
MEDIQ Note until filing the lawsuit at which time it withheld payments
commencing with the payment due for February 1997 and all subsequent payments.
By letter dated February 11, 1997, the Company received notice from MEDIQ that,
as a result of the Company's failure to make the February installment under the
MEDIQ Note, MEDIQ accelerated all principal and interest due under the MEDIQ
Note.
On November 21, 1997, the New Jersey Superior Court, Law Division,
Camden County, entered a summary judgment against the Company and in favor of
MEDIQ. The adverse decision dismissed the Company's suit against MEDIQ and as a
result, judgment has been entered in MEDIQ's favor for the full principal
balance and related accrued interest of $11,259,000 and other expenses of
$357,000. The Court also denied the Company's request for a stay in the entry
or execution of judgment.
The Company has filed an appeal with the Appellate Division of the New
Jersey Supreme Court. The Company also has filed a motion in the Appellate
Division seeking summary reversal of the Court's action. If necessary, the
Company will renew with the Appellate Division its request for a stay
pending the appeal. The Company has had communications with MEDIQ concerning
settlement, which communications have been limited to date. If the Company is
unable to obtain a stay from the Appellate Division, MEDIQ will be free to
commence collection efforts under the judgment. The Company does not have
sufficient funds to pay the MEDIQ judgment or to collateralize the judgment on
appeal. Further, the Company does not have any readily available source of
financing that will permit it to make such payment, if required to do so.
Accordingly, if the MEDIQ judgment is sustained and MEDIQ seeks to recover its
judgment, the Company will be forced to seek additional sources of debt or
equity financing, which is not likely to be available given the Company's
financial condition, or will be required to file for reorganization under
Chapter 11 of the bankruptcy laws.
Cash flows from operations are not sufficient to permit payment of the
MEDIQ judgment or repayment of the MEDIQ Note. As of September 30, 1997, the
Company's current liabilities exceeded its current assets by $11,158,000. At
such date, current liabilities include $11,497,000 due to MEDIQ, representing
the MEDIQ Note, accrued interest thereon and other accrued expenses related to
the obligation. In addition, as reflected in the financial statements of the
Company for the fiscal year ended September 30, 1997, and the report of the
Company's independent auditors thereon, the Company has been experiencing
difficulty generating sufficient cash flows to meet its obligations and sustain
its operations and, as a result, may not be able to meet its other obligations.
MEDIQ has pledged the MEDIQ Note as collateral for certain of its indebtedness
to a third party unaffiliated with MEDIQ or the Company. In the event of default
by MEDIQ on such indebtedness, such third party would obtain all of MEDIQ's
rights under the MEDIQ Note, including the right to the payment of principal and
interest as and when due in accordance with the terms of the MEDIQ Note.
As a result of the Company's continued negative operating results and
reduced collections of accounts receivable from certain government-funded
payors, as well as other administrative delays by third party payors, the
Company has been experiencing difficulty generating sufficient cash flows from
operations to meet its obligations and sustain its operations. In an effort to
improve this situation, the Company sold most of its freestanding facilities and
is taking steps to reduce operating expense, attempting to raise additional
capital, and working to improve its cash flows. See "Recent Developments." With
respect to its efforts to reduce operating expenses, the Company recently
decided to close extended care services provided in the States of North Carolina
and Florida, and may close or sell additional operations in its Extended Care
Services Division. The Company also recently closed a billing office in Georgia.
See "Recent Developments." The Company's liquidity could also be improved by:
(i) the collection of additional outstanding receivables (ii) significant
reductions in overhead; and (iii) obtaining additional capital and/or financing
sources. However, to date the
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<PAGE> 33
Company's efforts to improve liquidity through these means have not been
successful. There can be no assurance that any of such events will occur or, if
they do occur, that the impact on cash flows will be sufficient to enable the
Company to continue its operations. In the event that the Company is unable to
enhance its liquidity, the Company may be required to renegotiate the terms of
its financial obligations, significantly curtail its level of operations or
otherwise significantly reduce operating expenses. The Company has had
discussions with potential investors with the objective of raising additional
capital. To date, such efforts have been unsuccessful. The Company believes that
it will be unable to obtain additional capital without first obtaining
modifications to its financial obligations to MEDIQ. If the Company is not
successful in its appeal of the MEDIQ judgment or negotiating restructured terms
with MEDIQ, it may be forced to file for reorganization under Chapter 11 of the
bankruptcy laws.
As described above, the Company had $195,000 of available cash at
September 30, 1997, is fully drawn on its line of credit with Healthcare
Financial Partners and also fully drawn on its line of credit with NationsBank.
As discussed above, the Company intends to continue to pursue opportunities to
reduce operating expenses, increase its profitable activities and obtain
additional financing in an effort to improve its liquidity, financial condition
and results of operations. However, there can be no assurance that the Company
will be able to implement all or any of these strategies or, if implemented,
that such strategies will be successful. The Company does not believe that it
will be able to secure additional financing unless it is successful in obtaining
significant modifications to its obligations to MEDIQ. The Company is currently
not able to pay the MEDIQ judgment entered in November of 1997, or to post a
bond to secure the judgment pending the Company's appeal. If the Company is not
successful in obtaining modification of its obligations to MEDIQ and is not able
to secure additional financing, the Company currently anticipates that it will
be forced to file for reorganization under the bankruptcy laws.
This report includes forward-looking statements based on management's
current plans and expectations, relating to, among other matters, the MEDIQ
litigation, the proposed business activities of the Company, and the proposed
activities of the Company relating to improving its liquidity. Such statements
involve risks and uncertainties which may cause actual future activities and
results of operations to be materially different from that suggested in this
report, including, among others, the use of available cash resources to fund
continued operating losses, the risks associated with industry consolidation and
acquisitions, the need to manage growth and the outcome of the MEDIQ litigation.
33
<PAGE> 34
ITEM 8 FINANCIAL STATEMENTS
Independent Auditors' Report - 1997 35
Independent Auditors' Report - 1996 and 1995 36
Consolidated Statements of Operations -
Three Years Ended September 30, 1997 37
Consolidated Balance sheets -
September 30, 1997 and 1996 38
Consolidated Statements of Stockholders' Deficit -
Three Years Ended September 30, 1997 39
Consolidated Statements of Cash Flows -
Three Years Ended September 30, 1997 40-41
Notes to Consolidated Financial Statements 42-65
34
<PAGE> 35
Independent Auditors' Report
Board of Directors and Stockholders
MHM Services, Inc.:
We have audited the accompanying consolidated balance sheet of MHM Services,
Inc. and subsidiaries as of September 30, 1997, and the related consolidated
statements of operations, stockholders' deficit, and cash flows for the year
then ended. Our audit also included the financial statement schedule listed in
the Index at Item 14. These consolidated financial statements and the financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on the consolidated financial statements
and the financial statement schedule based on our audit. The accompanying
consolidated financial statements of MHM Services, Inc. as of September 30, 1996
and 1995, were audited by other auditors whose report thereon dated December 30,
1996, expressed an unqualified opinion with an explanatory paragraph describing
an uncertainty about the Company's ability to continue as a going concern.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the consolidated financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the 1997 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of MHM
Services, Inc. and subsidiaries as of September 30, 1997, and the results of
their operations and their cash flows for the year then ended in conformity with
generally accepted accounting principles. Also, in our opinion, the financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. The Company has incurred
aggregated net losses of $23,189,000 for the three years ended September 30,
1997, has a stockholders' deficit of $8,270,000 as of September 30, 1997 and is
experiencing difficulty in generating sufficient cash flows to meet its
obligations and sustain its operations, as discussed in Note 2 to the
consolidated financial statements. The Company is also involved in litigation
regarding debt of approximately $12 million. A judgment has been entered against
the Company for the full amount. The Company plans to file an appeal, however,
if they do not prevail and the lender pursues collection, the Company may be
required to file for reorganization under Chapter 11 of the bankruptcy laws (see
Note 10). Such conditions raise substantial doubt as to the Company's ability to
continue as a going concern. Management's plans concerning these matters are
also described in Note 2 to the consolidated financial statements. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
McLean, Virginia
November 26, 1997
35
<PAGE> 36
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
MHM Services, Inc.
Vienna, Virginia
We have audited the accompanying consolidated balance sheet of MHM Services,
Inc. and subsidiaries as of September 30, 1996, and the related consolidated
statements of operations, stockholders' deficit, and cash flows for each of the
two years in the period ended September 30, 1996. Our audits also included the
financial statement schedule for the two years ended September 30, 1996 listed
in the Index at Item 14. These financial statements and the financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statements and the
financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of MHM Services, Inc. and
subsidiaries as of September 30, 1996, and the results of their operations and
their cash flows for each of the two years in the period ended September 30,
1996 in conformity with generally accepted accounting principles. Also, in
our opinion, the financial statement schedule for the two years ended September
30, 1996, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. The Company has incurred
aggregated net losses of $20,448,000 for three years ended September 30, 1996
and has a stockholders' deficiency of $3,582,000 as of September 30, 1996 and
is experiencing difficulty in generating sufficient cash flows to meet its
obligations and sustain its operations. Such conditions raise substantial doubt
as to the Company's ability to continue as a going concern. The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Washington, D.C.
December 30, 1996
<PAGE> 37
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended September 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
=======================================================================================================
1997 1996 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Net patient service revenue $ 16,986,000 31,400,000 38,442,000
Premium revenue 3,865,000 3,270,000 2,667,000
- ------------------------------------------------------------------------------------------------------
20,851,000 34,670,000 41,109,000
- ------------------------------------------------------------------------------------------------------
Costs and expenses:
Operating 14,875,000 25,765,000 28,918,000
General and administrative 5,760,000 9,718,000 10,085,000
Provision for bad debts 3,467,000 6,320,000 4,467,000
Depreciation and amortization 369,000 1,034,000 1,603,000
Loss on sale of freestanding facilities (note 4) - 4,440,000 -
Writedown of long-term assets (note 6) 696,000 461,000 2,228,000
Other (credits) charges:
Equity in earnings of Joint Venture (note 3) - - (835,000)
Gain on sale of Joint Venture (note 3) - - (3,542,000)
Interest expense - MEDIQ (note 13) 1,042,000 1,097,000 1,171,000
Interest expense - other 93,000 290,000 366,000
Other income - net (note 3) (662,000) (233,000) (223,000)
- ------------------------------------------------------------------------------------------------------
25,640,000 48,892,000 44,238,000
- ------------------------------------------------------------------------------------------------------
Loss before income taxes and extraordinary item (4,789,000) (14,222,000) (3,129,000)
Income tax (benefit) expense (note 12) - (308,000) 894,000
- ------------------------------------------------------------------------------------------------------
Loss before extraordinary item (4,789,000) (13,914,000) (4,023,000)
Extraordinary item - loss on early extinguishment
of debt (note 10) - (463,000) -
- ------------------------------------------------------------------------------------------------------
Net loss $ (4,789,000) (14,377,000) (4,023,000)
- ------------------------------------------------------------------------------------------------------
Loss per share:
Loss before extraordinary item $ (1.40) (4.20) (1.22)
Extraordinary item - (.14) -
- ------------------------------------------------------------------------------------------------------
Net loss $ (1.40) (4.34) (1.22)
- ------------------------------------------------------------------------------------------------------
Weighted average shares outstanding 3,411,000 3,310,000 3,310,000
- ------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
37
<PAGE> 38
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, 1997 and 1996
<TABLE>
<CAPTION>
==============================================================================================================================
ASSETS 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 195,000 3,305,000
Accounts receivable, less allowances of $5,514,000 and $4,404,000 in 1997 and 1996,
respectively (note 10) 4,491,000 4,565,000
Prepaid expenses 103,000 237,000
Income taxes refundable - 662,000
Estimated third-party payor settlements (note 7) 1,910,000 2,616,000
Other current assets 352,000 183,000
- ------------------------------------------------------------------------------------------------------------------------------
Total current assets 7,051,000 11,568,000
Property, plant, and equipment, net (note 8) 531,000 538,000
Restricted cash 450,000 306,000
Notes receivable, net (note 4) 1,039,000 1,229,000
Other intangibles, net of accumulated amortization
of $247,000 and $104,000 in 1997 and 1996, respectively 873,000 230,000
Deferred rent 416,000 218,000
Other assets 288,000 205,000
Goodwill, net of accumulated amortization of $297,000 and $188,000 in 1997 and 1996,
respectively (notes 5 and 6) 766,000 1,375,000
- ------------------------------------------------------------------------------------------------------------------------------
$ 11,414,000 15,669,000
==============================================================================================================================
LIABILITIES AND STOCKHOLDERS' DEFICIT
- ------------------------------------------------------------------------------------------------------------------------------
Current liabilities:
Accounts payable $ 975,000 805,000
Accrued payroll and related expenses 908,000 583,000
Accrued expenses - MEDIQ (note 13) 1,019,000 321,000
Estimated third-party payor settlements (note 7) 2,187,000 4,500,000
Other accrued expenses (note 9) 2,400,000 1,833,000
Current maturities of long-term debt (note 10) 10,720,000 960,000
- ------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 18,209,000 9,002,000
Long-term debt (note 10):
MEDIQ - 9,967,000
Other 1,456,000 257,000
Other liabilities 19,000 25,000
- ------------------------------------------------------------------------------------------------------------------------------
19,684,000 19,251,000
- ------------------------------------------------------------------------------------------------------------------------------
Stockholders' deficit:
Preferred stock ($.01 par value; authorized: 5,000,000; issued and outstanding: none) - -
Common stock ($.01 par value; authorized: 15,000,000; issued and
outstanding: 3,513,000 and 3,310,000 in 1997 and 1996, respectively) 35,000 33,000
Additional paid-in capital 41,798,000 41,699,000
Accumulated deficit (50,103,000) (45,314,000)
- ------------------------------------------------------------------------------------------------------------------------------
Total stockholders' deficit (8,270,000) (3,582,000)
- ------------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies (note 11)
$ 11,414,000 15,669,000
==============================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
38
<PAGE> 39
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Deficit
Years ended September 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
===========================================================================================================================
Common stock
--------------------------- Additional
Shares paid-in Accumulated
issued Amount capital deficit Total
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, September 30, 1994 3,310,000 $ 33,000 41,699,000 (26,914,000) 14,818,000
Net loss - - - (4,023,000) (4,023,000)
- ---------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1995 3,310,000 33,000 41,699,000 (30,937,000) 10,795,000
Net loss - - - (14,377,000) (14,377,000)
- ---------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1996 3,310,000 33,000 41,699,000 (45,314,000) (3,582,000)
Issuance of common stock in connection
with Apogee acquisition (note 5) 200,000 2,000 98,000 - 100,000
Exercise of stock options 3,000 - 1,000 - 1,000
Net loss - - - (4,789,000) (4,789,000)
- ---------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1997 3,513,000 $ 35,000 41,798,000 (50,103,000) (8,270,000)
===========================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
39
<PAGE> 40
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended September 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
==================================================================================================================================
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (4,789,000) (14,377,000) (4,023,000)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 369,000 1,034,000 1,603,000
Provision for bad debts 3,467,000 6,320,000 4,467,000
Provision (benefit) for deferred income taxes - 500,000 (215,000)
Loss on sale of freestanding facilities - 4,440,000 -
Undistributed earnings from Joint Venture - - (835,000)
Gain on sale of Joint Venture - - (3,542,000)
Writedown of long-term assets 696,000 461,000 2,228,000
Other - - 57,000
Increase (decrease) from changes in:
Accounts receivable and estimated third-party settlements, net (5,000,000) (723,000) (2,596,000)
Income taxes refundable 662,000 (662,000) -
Prepaid and other assets (118,000) 10,000 969,000
Deferred rent (198,000) (52,000) (166,000)
Accounts payable 170,000 (867,000) (514,000)
Accrued payroll and related expenses 325,000 (283,000) 118,000
Accrued expenses - MEDIQ 698,000 (56,000) (616,000)
Other accrued expenses 567,000 (554,000) (271,000)
Income taxes payable - (73,000) 988,000
- ----------------------------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (3,151,000) (4,882,000) (2,348,000)
- ----------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from sale of freestanding facilities and Joint Venture - 9,099,000 9,609,000
Capital expenditures for property, plant and equipment (178,000) (273,000) (631,000)
Distributions from Joint Venture - - 1,000,000
Collections on notes receivable 190,000 - -
Acquisitions of businesses (427,000) (150,000) (100,000)
Deferred costs - 69,000 -
Restricted cash (144,000) (306,000) -
Other assets (82,000) (30,000) -
Other liabilities (6,000) (6,000) (589,000)
- ----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (647,000) 8,403,000 9,289,000
- ----------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Borrowings 4,110,000 - 1,679,000
Debt repayments (3,393,000) (3,280,000) (6,271,000)
Other (29,000) (20,000) -
- ----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 688,000 (3,300,000) (4,592,000)
- ----------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (3,110,000) 221,000 2,349,000
Cash and cash equivalents:
Beginning of year 3,305,000 3,084,000 735,000
- ----------------------------------------------------------------------------------------------------------------------------------
End of year $ 195,000 3,305,000 3,084,000
- ----------------------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Interest paid $ 358,000 1,398,000 1,577,000
Income taxes (refunded) paid, net (662,000) (71,000) 121,000
==================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
40
<PAGE> 41
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
<TABLE>
<CAPTION>
==================================================================================================================================
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Supplemental disclosure of non-cash investing and financing activities:
Property and equipment and other assets financed with capital leases
and long-term debt $ - 63,000 487,000
Acquisition - portion financed with long-term debt 275,000 338,000 -
Notes received from sale of freestanding facility - 1,400,000 -
Liabilities assumed - BHC - 1,160,000 -
Issuance of stock - acquisition of Apogee 100,000 - -
==================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
41
<PAGE> 42
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1997, 1996 and 1995
================================================================================
(1) Organization and Summary of Significant Accounting Policies
Organization
MHM Services, Inc., through its wholly-owned subsidiaries, MHM Extended Care
Services, Inc. (Extended Care Services Division), MHM Correctional Services,
Inc. (Correctional Services Division), and MHM of Colorado, Inc., (collectively
the Company), offers, arranges for and manages specialty healthcare services
primarily in institutional settings. Since its founding, the Company's goal has
been to offer the highest quality, cost-effective care in the industry.
In October 1986, the Company was acquired by MEDIQ Incorporated (MEDIQ).
Effective August 31, 1993, MEDIQ distributed to its shareholders the shares of
the Company's common stock.
Consolidation
The accompanying consolidated financial statements include the accounts of MHM
Services, Inc. and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
Cash Equivalents
Cash equivalents include all liquid investments with purchased maturities of
three months or less.
Accounts Receivable
The Company's accounts receivable from its freestanding facility and Extended
Care Services Division are due from its patients and other third-party payors,
primarily Medicare (56 percent), Medicaid (18 percent), Blue Cross (3 percent)
and various commercial insurance companies and other (23 percent). The Company's
accounts receivable from its Correctional Services Division are due from the
states which MHM has contracted. The Company grants credit without requiring
collateral to support these receivables. The Company maintains an allowance for
potential losses from uncollectible accounts.
(Continued)
42
<PAGE> 43
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(1) Continued
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Capital leases are recorded at
the present value of future lease payments. The Company provides for
depreciation and amortization on a straight-line basis as follows:
Buildings and improvements 30 years
Furniture, fixtures and equipment 5-8 years
Equipment under capital lease 5-8 years
Goodwill
Goodwill represents the excess of the purchase price over the fair value of net
assets acquired and is amortized on a straight-line basis over twenty years (see
note 6).
Carrying Value of Long-Term Assets
At September 30, 1996, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed of. The Company evaluates the carrying
value of long-term assets, including property, plant, and equipment, goodwill
and other intangible assets, based upon current and anticipated net income and
undiscounted cash flows, and recognizes an impairment when it is probable that
such estimated future net income and/or cash flows will be less than the
carrying value of the asset. Measurement of the amount of impairment, if any, is
based upon the difference between carrying value and fair value (see note 6).
Restricted Cash
Restricted cash consists of certificates of deposit which secure performance
bonds obtained as required by a correctional contract with the state of
Tennessee and an extended care contract with the state of Georgia.
Other Intangible Assets
Other intangible assets consist primarily of contractual rights and covenants
not to compete. These assets are amortized on a straight-line basis over ten to
twenty years.
(Continued)
43
<PAGE> 44
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(1) Continued
Patient Service Revenue Recognition
Net patient service revenues are reported at the estimated net realizable
amounts from patients and third-party payors for services rendered, including
estimated retroactive adjustments under reimbursement agreements with
third-party payors. Retroactive adjustments are accrued on an estimated basis in
the period in which the related services are rendered and adjusted in future
periods as final settlements are determined.
Premium Revenue Recognition
The Company has agreements with two states to provide mental health services to
prison inmates and nursing home residents. Under these agreements, the Company
receives monthly capitated payments based on the number of participants,
regardless of services actually performed by the Company.
Charity Care
The Company has a policy of providing charity care at its behavioral health
facilities to patients who are unable to pay. Such patients are identified based
on financial information obtained from the patient and subsequent analysis.
Since the Company does not expect payment, estimated charges for charity care
are not included in revenues. The amount of charity care provided, at
established rates, was $12,000, $682,000, and $1,081,000 for 1997, 1996, and
1995, respectively.
Malpractice Insurance Coverage
Medical malpractice claims are covered by a medical malpractice insurance
policy, which is a claims made policy with a prepaid five year extended
reporting period included.
Loss Per Share
Loss per share is computed using the weighted average number of shares
outstanding during the year. Stock options have not been included because their
effect would be antidilutive.
(Continued)
44
<PAGE> 45
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(1) Continued
Fair Value of Financial Instruments
The fair value of cash and cash equivalents, accounts receivable, third-party
payor settlements, accounts payable and accrued expenses are equivalent to their
carrying value because of the short-term maturity of those instruments. The fair
values of the Company's long-term debt (see note 10) are considered to be
equivalent to their carrying values based upon consideration of borrowings with
similar credit ratings, collateral and maturities. The fair value of the
Company's notes receivable is equivalent to its carrying value which was
estimated at net realizable value (see note 4).
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements.
Estimates also effect the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The more
significant estimates include the allowance for potential losses from
uncollectible accounts receivable, estimates of assets and liabilities due
from/to third-party payors, the estimated net realizable value of notes
receivable, and the estimated impairment of goodwill.
Income Taxes
Income taxes are accounted for in accordance with Financial Accounting Standards
Board Statement No. 109 (Statement 109). Under the asset and liability method of
Statement 109, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that are expected to apply
to taxable income in the years in which those temporary differences are expected
to be recovered or settled.
Stock Option Plan
Prior to October 1, 1996, the Company accounted for its stock option plan in
accordance with the provisions of Accounting Principles Board (APB) Opinion No.
25, Accounting for Stock Issued
(Continued)
45
<PAGE> 46
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(1) Continued
to Employees, and related interpretations. As such, compensation expense would
be recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. On October 1, 1996, the Company
adopted SFAS No. 123, Accounting for Stock-Based Compensation, which permits
entities to recognize as expense over the vesting period the fair value of all
stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows
entities to continue to apply the provisions of APB Opinion No. 25 and provide
pro forma net income and pro forma earnings per share disclosures for employee
stock option grants made in 1996 and future years as if the fair-value-based
method defined in SFAS No. 123 had been applied. The Company has elected to
continue to apply the provisions of APB Opinion No. 25 and provide the pro forma
disclosure provisions of SFAS No. 123.
Reclassifications
Certain items in the prior years' financial statements have been reclassified to
conform with the 1997 presentation.
(2) Liquidity
The accompanying consolidated financial statements have been prepared on a going
concern basis which contemplates the continuation of operations, realization of
assets and liquidation of liabilities in the ordinary course of business. The
Company has incurred aggregated net losses of $23,189,000 for the three years
ended September 30, 1997, and has a stockholders' deficit of $8,270,000 as of
September 30, 1997. The Company is experiencing difficulty in generating
sufficient cash flows to meet its obligations and sustain its operations. At
September 30, 1997, current liabilities exceed current assets by $11,158,000
primarily due to the MEDIQ litigation as discussed in note 10. As further
discussed in note 10, on November 21, 1997, a judge of the New Jersey superior
court entered a judgment against the Company in favor of MEDIQ. Such conditions
raise substantial doubt about the Company's ability to continue as a going
concern. The consolidated financial statements do not include any adjustments
that might result should the Company be unable to continue as a going concern.
In 1996, the Company sold six of its seven freestanding behavioral health
facilities which represented approximately 51 percent of net revenues for fiscal
1996. These facilities were sold due to the expectation of more profitable
opportunities to grow the Extended Care Services Division and other specialty
on-site healthcare services. The Company continues to own one freestanding
behavioral health facility (Mountain Crest). The Company currently leases the
Mountain Crest real estate on which the facility is located but is in the
process of seeking
(Continued)
46
<PAGE> 47
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(2) Continued
financing to purchase the land and building. The Company believes that this
purchase and financing will have a positive impact on profitability and cash
flow, however, there is no assurance that the Company will be successful in
locating an acceptable financing source for this transaction.
The Company has made several acquisitions in its Extended Care Services Division
(see note 5). However, to date, this division has operated unprofitably overall.
The Company is in the process of closing or selling extended care operations in
states where revenues have not been sufficient to operate profitably, as well as
making selective reductions in operating and general and administrative costs
and consolidating or outsourcing billing and payroll functions. The Company
believes that these changes will improve the profitability of the Extended Care
Services Division.
Effective March 11, 1997, MHM Extended Care Services, Inc. obtained a $4,000,000
revolving credit facility to finance its receivables. Borrowings on the credit
facility are limited to qualified accounts receivable. As discussed in note 17,
the Company borrowed $500,000 in October 1997 on a line of credit guaranteed by
certain officers and directors of the Company.
The Company has been awarded capitated contracts with the states of Tennessee
and Georgia to provide mental health services to the inmates in their state
correctional facilities. These contracts began on July 1, 1997 and October 1,
1997, respectively and are expected to generate approximately $10.4 million of
revenues per year and operate profitably, however profitability of these
contracts cannot be assured. The Company is pursuing additional correctional
services contract opportunities.
In a continuing effort to improve the Company's financial condition for both the
immediate future and the long term, the Company is continuing its efforts to
reduce operating expenses, seek more profitable business opportunities, finance
its working capital requirements, restructure the MEDIQ debt, raise additional
capital and improve its cash flows. Nevertheless, there can be no assurance that
the Company's efforts will result in positive effects on the Company's financial
condition or that the November 1997 unfavorable summary judgment against the
Company in the MEDIQ litigation will not result in the Company's filing for
reorganization under Chapter 11 of the bankruptcy laws.
(Continued)
47
<PAGE> 48
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(3) Joint Venture
In August 1994, the Company formed a joint venture (Joint Venture) to combine
its contract management business with that of Horizon Mental Health Services,
Inc. (Horizon) of Denton, Texas. The Joint Venture, which was owned 27.5 percent
by the Company and 72.5 percent by Horizon, managed both companies' hospital
behavioral health care contracts. The terms of the Joint Venture provided for
the Company's continued ownership of its management contracts and the assignment
to the Joint Venture of the operating responsibilities and revenues related to
such contracts.
In March 1995, Horizon completed its initial public offering, and, in accordance
with the terms of the Joint Venture Agreement, acquired the Company's interest
in the Joint Venture for approximately $9,600,000 (net of related expenses). The
sale resulted in a gain of approximately $500,000 (net of income taxes of
$3,000,000). In connection with the sale, the Company assigned to Horizon all of
its rights and interests in its management contracts, including related accounts
receivable.
MHM was involved in litigation with Horizon involving MHM's right to certain
cash flows as part of the sale of its interest in the Joint Venture. In May
1997, a court award in the Company's favor was upheld by the Supreme Court of
Delaware, for approximately $459,000. This amount is reported in other income in
1997.
(4) Sale of Freestanding Facilities
On April 5, 1996, the Company sold Oakview Treatment Center to a non-profit
corporation affiliated with a privately-owned operator of two psychiatric
hospitals for $50,000 in cash and $2,150,000, evidenced by two promissory notes
payable to the Company. For financial statement purposes, the notes were
recorded using the cost recovery method of accounting at an estimated net
realizable value of $1,400,000. This value was equal to the net book value of
the Oakview Treatment Center immediately prior to the sale. The notes are
payable in monthly installments of principal and interest (at prime) based on a
15-year amortization, with the remaining principal due in five years (or earlier
under certain circumstances). In connection with obtaining a waiver from MEDIQ
of an event of default provision of the MEDIQ Note relating to the sale of the
assets of a significant subsidiary, the Company pledged one of the notes
receivable
(Continued)
48
<PAGE> 49
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(with an original principal balance of $1,875,000) as collateral for the
Company's obligations under the MEDIQ Note (see note 10).
On May 31, 1996, the Company sold certain assets, consisting principally of five
of its freestanding behavioral healthcare facilities, to Behavioral Healthcare
Corporation, pursuant to an Asset Purchase Agreement (the BHC Agreement), dated
as of January 24, 1996, and amended as of April 11, 1996, by and between the
Company and BHC (the BHC Sale). The facilities were sold to BHC for
approximately $10,209,000, consisting of $9,049,000 in cash and $1,160,000 in
assumed liabilities of the freestanding facilities (reflecting post-closing
adjustments by both parties).
The Company used a portion of the proceeds from the BHC Sale for (i) the
repayment of the principal amount outstanding under the Company's revolving
credit facility ($2,515,000, including related early termination fees of
$174,000); (ii) the extinguishment of a portion of the indebtedness not assumed
by BHC at the closing of the sale ($692,000, including early termination fees of
$139,000), which consisted primarily of indebtedness secured by certain of the
assets (particularly a facility and certain equipment) acquired by BHC; and
(iii) the funding of the Company's obligation to complete repairs to two of the
freestanding facilities sold to BHC in the amount of $284,000. During 1997, the
Company used the remainder of the proceeds to fund operating losses, Extended
Care Services Division acquisitions and increases in receivables primarily
relating to growth in the Extended Care Services Division.
The pretax loss on the sale of six of its seven freestanding behavioral health
facilities in 1996 was $4,440,000 consisting primarily of the write off of
intangibles related to the facilities of $3,184,000, loss on the sale of certain
property, plant, and equipment aggregating $319,000, transaction expenses of
$568,000, severance expenses of $349,000, and other expenses of $680,000, offset
by estimated Medicare depreciation recapture income of approximately $660,000.
(5) Acquisitions
HCI Services
In November 1993, the Company acquired substantially all of the assets and
assumed certain liabilities of Atlanta-based ICH Services, L.L.C. (ICH)
(successor to HCI Services, Inc.), which provides behavioral health and other
specialized medical services under annual contracts with extended care
facilities. The operating results are included in the Company's consolidated
(Continued)
49
<PAGE> 50
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(5) Continued
results of operations from the date of acquisition. The purchase price consisted
of 330,000 shares of the Company's common stock, as well as certain additional
consideration payable, in cash or additional shares of the Company's common
stock at the option of the former ICH members, after the third anniversary of
the acquisition (November 18, 1996) in an amount equal to approximately 20
percent of the appraised fair market value of the acquired operations.
To date, neither the Company nor ICH has requested an appraisal of the acquired
operations as provided for in the purchase agreement. Both parties have
negotiated to modify the terms of the additional consideration without reaching
any definitive agreements. The progress of future negotiations is uncertain.
If no agreement is reached, the Company will be required to comply with the
terms of the original agreement. The Company believes that the value of the
acquired assets has significantly declined since the acquisition date based on
prior and ongoing operational losses as well as increasing regulatory and
economic pressures inherent in the extended care services business. Therefore
the Company believes that it will be able to meet its obligation to fund the
additional consideration, and the amount estimated to be payable under the terms
of the original agreement of $158,000 has been accrued as of September 30, 1997,
in the consolidated financial statements. However, if an appraisal results in a
value significantly in excess of the Company's expectation and ICH members
demand payment in cash, the Company could be forced into a bankruptcy filing as
a result of insufficient funding. In any event, the issuance of additional stock
to satisfy the Company's obligation could have a dilutive effect on the
Company's outstanding common stockholders.
Supportive Counseling Care
In July 1995, the Company acquired certain assets of Supportive Counseling Care
(SCC) of Manhattan Beach, California, a provider of behavioral healthcare
services to extended care facilities, for $500,000, and entered into a 40 year
management contract to provide administrative services to SCC. The operating
results of the acquired business are included in the Company's consolidated
results of operations from the date of acquisition.
This business was discontinued in December 1996 (see note 6).
(Continued)
50
<PAGE> 51
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(5) Continued
MHM Counseling Services
In December 1995, the Company's Extended Care Services Division acquired the
behavioral healthcare clinic operations of National Mentor, Inc. located in
Charlestown and Taunton, Massachusetts. The Company changed the name of the
clinics to MHM Counseling Services. The purchase price included cash of $150,000
and a $338,000 term loan payable in 36 monthly installments. The purchase price
was allocated primarily to intangible assets. The operating results of the
acquired business are included in the Company's consolidated results of
operations from the date of acquisition.
Liberty Bay
Effective as of December 1, 1996, the Company's Extended Care Services Division
acquired, pursuant to an Agreement (the Liberty Bay Agreement) by and among the
Company, MHM Extended Care Services, Inc., Liberty Bay Colony Health Services,
Inc. (Liberty Bay) and Liberty Management Group, Inc. (Liberty Management),
certain assets and contractual rights from Liberty Bay which constituted Liberty
Bay's geropsychiatric management services operations in Massachusetts. The
Company has integrated these operations with MHM Counseling Services and the
combined operations from the date of acquisition operate under the name "MHM/Bay
Colony Counseling Services", and, as a result of the acquisition and continued
development, serve approximately 90 extended care facilities.
As consideration for the purchase, the Company paid Liberty Bay $150,000 in cash
and issued a promissory note in the principal amount of $150,000. The purchase
price was primarily allocated to intangible assets. The note provides for
quarterly interest payments at an annual rate of 9 percent and the payment of
the principal amount in one installment on December 1, 1999. The Company also
agreed to pay Liberty Bay additional consideration consisting of 20 percent of
"cash flow" (as such term is defined in the Liberty Bay Agreement) from the
acquired contracts over the five year period commencing December 1, 1996. Such
additional consideration is calculated annually by the Company.
Apogee
Effective as of March 31, 1997, the Company's Extended Care Services Division
acquired certain assets and contractual rights related to the long-term care
operations of Apogee, Inc. in Pennsylvania and Tennessee, consisting of
contracts with approximately 275 facilities. The operating results are included
in the Company's consolidated results of operations from the date of
acquisition.
(Continued)
51
<PAGE> 52
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(5) Continued
As consideration for the purchase, the Company paid $100,000 in cash, issued a
three year promissory note in the principal amount of $125,000, and issued
200,000 shares of common stock of MHM Services, Inc. at $.50 per share. The
purchase price was primarily allocated to intangible assets. The note provides
for interest payments six months after the closing date for the first two
quarters and quarterly thereafter at an annual interest rate of 7 percent and
annual principal payments. The Company also agreed to pay Apogee additional
consideration consisting of 20 percent of "net cash collected" (as such term is
defined in the Apogee Agreement) from the acquired operations over a five year
period commencing March 31, 1997. Such additional consideration is calculated
annually by the Company.
(6) Writedown of Long-Term Assets
In fiscal 1995, the Company determined that the recoverability of certain of the
assets, including property, plant and equipment and goodwill, related to one of
the Company's freestanding behavioral health facilities was impaired, other than
temporarily. Accordingly, the carrying value of such assets was reduced to the
estimated fair value, resulting in a charge of $2,228,000 based upon an
independent appraisal.
In November 1996, the Company decided that its SCC operation was to be
discontinued because of its continuing losses. The Company shut down operations
in early December 1996. As a result, the carrying value of all other assets
related to SCC, primarily intangibles, have been written off resulting in a
charge of $461,000 in the year ended September 30, 1996.
In September 1997, the Company decided to dispose of the Florida and North
Carolina operations of its Extended Care Services Division and close its
Atlanta, Georgia billing office. In connection with these decisions, the Company
determined that the recoverability of goodwill relating to the HCI acquisition
(note 5) was permanently impaired. The Company evaluated the carrying value of
goodwill based on discounted cash flow analysis and estimated disposal values.
As a result, the carrying value of goodwill and other intangibles relating to
these operations were written down by $696,000.
(Continued)
52
<PAGE> 53
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(7) Third-Party Payors
The Company has agreements with third-party payors that provide for payments for
patient services at amounts which differ from its established rates. The Company
is in the process of negotiating final settlements for prior reporting periods
relating to filed cost reports for the six freestanding behavioral health
facilities sold in 1996. The Company continues to file cost reports for its
Mountain Crest facility.
During 1997, tentative and final settlements with all third-party payors for
cost reporting periods prior to 1997 have resulted in an adjustment to increase
net patient service revenue by approximately $965,000.
A summary of the payment arrangements with major third party payors follows.
Medicare
Inpatient nonacute services, certain outpatient services and defined capital
costs related to Medicare beneficiaries are paid primarily on a cost
reimbursement basis. The Company is reimbursed for cost reimbursable items at a
tentative rate with final settlement determined after submission of annual cost
reports by the Company and audits thereof by the Medicare fiscal intermediary.
Other Third-Party Payors
The Company has also entered into payment agreements with certain commercial
insurance carriers, health maintenance organizations and preferred provider
organizations. The basis for payment to the Company under these agreements
includes prospectively determined rates per discharge, discounts from
established charges and prospectively determined daily rates. Services rendered
to Blue Cross subscribers are paid based upon the provisions of individual plans
and include payment of predetermined rates or a percentage of charges.
(Continued)
53
<PAGE> 54
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(8) Property, Plant and Equipment
<TABLE>
<CAPTION>
1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C>
Buildings and improvements $ 29,000 18,000
Furniture, fixtures and equipment 994,000 836,000
Equipment under capital lease 323,000 314,000
- ------------------------------------------------------------------------------
1,346,000 1,168,000
Less accumulated depreciation and amortization 815,000 630,000
- ------------------------------------------------------------------------------
$ 531,000 538,000
==============================================================================
</TABLE>
Depreciation and amortization expense related to property, plant and equipment
was $185,000, $735,000, and $1,272,000 for 1997, 1996 and 1995, respectively.
(9) Other Accrued Expenses
Other accrued expenses includes the following:
<TABLE>
<CAPTION>
1997 1996
- -------------------------------------------------------------
<S> <C> <C>
Accrued rent $ 255,000 218,000
Accrued refunds 218,000 345,000
Accrued professional fees 860,000 677,000
Accrued miscellaneous taxes 254,000 223,000
Other accrued expense 813,000 370,000
- -------------------------------------------------------------
$ 2,400,000 1,833,000
=============================================================
</TABLE>
(10) Long-Term Debt
MEDIQ Note
(Continued)
54
<PAGE> 55
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(10) Continued
In connection with the spin-off of the Company by MEDIQ, its former corporate
parent, on August 31, 1993, the Company executed a five-year note (the MEDIQ
Note) for the balance of unpaid payment obligations imposed on the Company by
MEDIQ and described by MEDIQ as management fees and intercompany interest. The
original principal amount of the MEDIQ Note was $11,500,000 which bears
interest at a rate of prime plus 1.5 percent (10 percent at September 30,
1997), with monthly payments of interest only through September 1995 and then
monthly principal and interest payments for the following three years
(principal payments of $767,000 were made in 1996, and additional principal
payments of $256,000 representing the contractually required principal payments
for October 1996 through January 1997, have been made as of September 30,
1997), based on a fifteen year amortization period, with the balance due on
August 31, 1998.
The Company filed a complaint on February 10, 1997 in Superior Court of New
Jersey, Law Division against MEDIQ alleging that the MEDIQ Note is invalid on
the grounds that MEDIQ breached its fiduciary obligations in connection with
forcing the Company to execute the MEDIQ Note, the MEDIQ Note lacks
consideration, the MEDIQ Note is unconscionable and it unjustly enriches MEDIQ
at the Company's expense. The case was then transferred by the Court to Camden,
New Jersey. The Company asked the Court to declare the MEDIQ Note null and void,
require MEDIQ to return to the Company all payments MEDIQ has received under the
MEDIQ Note and award the Company compensatory, consequential and punitive
damages. The Company remained current in its payments under the MEDIQ Note until
filing the lawsuit at which time it withheld payments commencing with the
payment due for February 1997 and all subsequent payments. The Company received
notice from MEDIQ by letter dated February 11, 1997 stating, that as a result of
the Company's withholding of the February installment due under the MEDIQ Note,
MEDIQ claims to have accelerated all principal and interest due under the MEDIQ
Note. Consequently, the outstanding amounts owed by the Company under the MEDIQ
Note ($10,478,000) have been classified as a current liability. Additionally,
the Company has accrued interest payable under the terms of the note through
September 30, 1997 of $777,000 and other accrued expenses of $242,000.
On November 21, 1997, a Judge of the New Jersey Superior Court, Law Division,
Camden County, entered a summary judgment against the Company and in favor of
MEDIQ. The adverse decision dismissed the Company's suit against MEDIQ and as a
result, judgment has been entered in MEDIQ's favor for the full principal
balance and related accrued interest. The
(Continued)
55
<PAGE> 56
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(10) Continued
Law Division also denied the Company's request for a stay in the entry or
execution of judgment.
The Company has filed an appeal with the Appellate Division of the New
Jersey Supreme Court. The Company also has filed a motion in the Appellate
Division seeking reversal of the Court's action. If necessary, the Company will
renew with the Appellate Division its request for a stay pending the appeal.
The Company has had communications with MEDIQ concerning settlement, which
communications have been limited to date. If the Company is unable to obtain a
stay, MEDIQ will be free to commence collection efforts under the judgment to
be entered for the outstanding principal, accrued interest and other accrued
expenses. The Company does not have sufficient funds to pay the judgment or to
collateralize the judgment on appeal. Further, the Company does not have any
readily available source of financing that will permit it to make such payment
if required to do so. Accordingly, if the MEDIQ judgment is sustained and MEDIQ
seeks to recover its judgment, the Company will be forced to seek additional
sources of debt or equity financing, which is not likely to be available given
the Company's financial condition, or will be required to file for
reorganization under Chapter 11 of the bankruptcy laws.
Revolving Credit Facility
Effective August 14, 1995, the Company entered into a $5,000,000 revolving
credit facility with a commercial lender. The facility, which bore interest at
prime plus 2 percent, was secured by accounts receivable from the freestanding
behavioral health facilities and property plant and equipment at two of the
freestanding behavioral health facilities. In 1996, the Company repaid the
outstanding balance of the revolving credit facility with proceeds from the sale
of the freestanding behavioral health facilities.
Effective March 11, 1997, MHM Extended Care Services, Inc. entered into a
$4,000,000 revolving credit facility with an affiliate of Bethesda,
Maryland-based commercial lender Healthcare Financial Partners. The facility,
which bears interest at prime plus 2.25 percent, is secured by accounts
receivable and expires in March 1999. The loan is also secured by the stock of
the Company's subsidiary, MHM Extended Care Services, Inc. The amount of credit
available fluctuates based on the amount of qualified accounts receivable. As of
September 30, 1997, the Company had $1,122,000 outstanding under this facility.
The weighted average interest rate is 10.75 percent as of September 30, 1997.
(Continued)
56
<PAGE> 57
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(10) Continued
Term Loans and Capital Lease Obligations
At September 30, 1997 and 1996, term loans totaling $450,000 and $289,000,
respectively, represent various notes payable relating to the Apogee, Liberty
Bay, and MHM Counseling acquisitions which bear interest at rates ranging from 7
percent to 9 percent and terms through March 2000 (see note 5).
Capital lease obligations totaling $126,000 and $162,000 at September 30, 1997
and 1996, respectively, are payable in monthly installments including interest
at rates ranging from 9 percent to 13 percent and terms through January 2001 and
are collateralized by certain assets with a net book value of $115,000 and
$143,000, respectively.
Early Retirement of Debt
In 1996, the Company recorded an extraordinary item in the amount of $463,000,
consisting primarily of costs related to the early retirement of the Company's
long-term debt and the write off of associated loan acquisition costs.
Scheduled maturities of long-term debt (including the MEDIQ Note) are as
follows:
<TABLE>
<CAPTION>
Year ending September 30
- -------------------------------------------------------------
<S> <C>
1998 $ 10,720,000
1999 1,238,000
2000 208,000
2001 8,000
2002 2,000
- -------------------------------------------------------------
$ 12,176,000
=============================================================
</TABLE>
(11) Commitments and Contingencies
Leases
The Company leases certain equipment and office facilities under noncancelable
operating leases. The future minimum lease payments required under operating
leases are as follows:
(Continued)
57
<PAGE> 58
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(11) Continued
<TABLE>
<CAPTION>
Year ending September 30
- ---------------------------------------------------------
<S> <C>
1998 $ 1,148,000
1999 850,000
2000 673,000
2001 329,000
2002 200,000
Thereafter 260,000
- ---------------------------------------------------------
Total future minimum lease payments $ 3,460,000
- ---------------------------------------------------------
</TABLE>
Lease expense was $1,496,000, $1,433,000, and $2,053,000 for 1997, 1996 and
1995, respectively. The terms of the lease for the Company's Mountain Crest
facility, expiring in December 2000, require additional rent based upon 6.5
percent of the net revenues of the facility and 50 percent of excess cash flow
(as defined in the lease agreement).
Litigation
The Company is involved in various other legal proceedings incidental to its
business, some of which may be covered by insurance. With the exception of the
MEDIQ litigation, the Company knows of no other litigation, either pending or
threatened, which is likely to have a material adverse effect on the Company's
consolidated financial statements.
(12) Income Taxes
Income tax (benefit) expense consists of the following:
(Continued)
58
<PAGE> 59
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(12) Continued
<TABLE>
<CAPTION>
1997 1996 1995
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ - (662,000) 670,000
State - (146,000) 439,000
- ---------------------------------------------------------------------------------------
- (808,000) 1,109,000
- ---------------------------------------------------------------------------------------
Deferred:
Federal - 500,000 (200,000)
State - - (15,000)
- ---------------------------------------------------------------------------------------
- 500,000 (215,000)
- ---------------------------------------------------------------------------------------
Total income tax (benefit) expense $ - (308,000) 894,000
- ---------------------------------------------------------------------------------------
</TABLE>
The differences between the effective income tax (benefit) expense and the
income tax (benefit) expense computed using the U.S. federal income tax rate are
as follows:
<TABLE>
<CAPTION>
1997 1996 1995
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory benefit $ (1,676,000) (4,888,000) (1,064,000)
State income taxes, net of federal (benefit) tax (71,000) (96,000) 280,000
Valuation reserve 1,668,000 4,658,000 -
Effect of disposition of Joint Venture - - 1,206,000
Writedown of long-term assets - - 300,000
Goodwill amortization 5,000 18,000 65,000
Other items - net 74,000 - 107,000
- ------------------------------------------------------------------------------------------
Income tax (benefit) expense $ - (308,000) 894,000
- ------------------------------------------------------------------------------------------
</TABLE>
(Continued)
59
<PAGE> 60
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(12) Continued
Significant components of deferred tax assets and liabilities follows:
<TABLE>
<CAPTION>
1997 1996
- --------------------------------------------------------------------
<S> <C> <C>
Assets:
Allowance for doubtful accounts $ 2,256,000 1,136,000
Capital loss carryforward - 832,000
Net operating loss carryforwards 4,318,000 3,195,000
Writedown of long-term assets 268,000 157,000
Other 191,000 112,000
Valuation allowance (6,958,000) (5,290,000)
- --------------------------------------------------------------------
75,000 142,000
- --------------------------------------------------------------------
Liabilities:
Prepaid expenses 39,000 77,000
Depreciation and amortization 36,000 34,000
Other - 31,000
- --------------------------------------------------------------------
75,000 142,000
- --------------------------------------------------------------------
Net deferred tax asset $ - -
- --------------------------------------------------------------------
</TABLE>
At September 30, 1997, for income tax purposes, the Company had federal and
state net operating loss carryforwards of approximately $11,216,000 and
$18,316,000, respectively, expiring through 2012. The change in valuation
allowance was $1,668,000 in 1997 and $4,658,000 in 1996.
(13) Related-Party Transactions
Accrued Expenses - MEDIQ
Amounts payable to MEDIQ include accrued interest payable of $777,000 and other
accrued expenses of $242,000 primarily representing unpaid federal taxes for the
period in which the Company was included in MEDIQ's consolidated federal tax
return and expenses incurred by MEDIQ on behalf of the Company.
Interest Expense MEDIQ
The Company incurred interest expense related to the note payable to MEDIQ of
$1,042,000, $1,097,000, and $1,171,000 in 1997, 1996, and 1995, respectively.
(Continued)
60
<PAGE> 61
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(13) Continued
Services Agreement - MEDIQ
Since April 1, 1993, the Company has obtained certain legal, accounting, tax and
risk management services from MEDIQ at prescribed rates pursuant to a services
agreement. The services agreement terminated in 1996. Fees for such services
were $30,000, $38,000, and $140,000 for 1997, 1996, and 1995, respectively, and
are included in general and administrative expenses.
Tax Allocation/Sharing Agreement
Pursuant to a tax allocation/sharing agreement, the Company will reimburse MEDIQ
for any future tax assessments against MEDIQ resulting from the Company's
operations, the Company will be reimbursed by MEDIQ for any future tax benefit
derived by MEDIQ resulting from the Company's operations and the Company will be
indemnified for certain tax liabilities, in each case, for periods during which
the Company had been a member of MEDIQ's consolidated group.
(14) Stock Option Plans
The company has a Stock Option Plan (the Stock Option Plan) and a Stock Option
Plan for Non-Employee Directors (the Directors' Stock Option Plan). Under the
Stock Option Plan, up to 350,000 shares of the Company's common stock may be
subject to stock options granted to officers and key employees of the Company.
Options vest at 20 percent each year and may not be granted for a term in excess
of ten years from the date of grant. On January 30, 1997, all outstanding
options, which totaled 233,600, were re-priced at an exercise price of $.50. As
of September 30, 1997, options to acquire 162,400 shares of stock were
exercisable under the Stock Option Plan and options to acquire 14,000 shares of
stock were exercisable under the Directors' Stock Option Plan. Exercise prices
of stock options granted represent fair market value of the common stock at date
of grant, or for the repriced options, at January 30, 1997.
The Company applies APB Opinion No. 25 in accounting for its stock option plan
for options granted to employees and directors and accordingly, no compensation
expense has been recognized in the financial statements. Had the Company
determined compensation expense based on the fair value at the grant date for
its stock options under SFAS No. 123, the Company's net loss would have been
increased to the pro forma amounts indicated below:
(Continued)
61
<PAGE> 62
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(14) Continued
<TABLE>
<CAPTION>
1997 1996
- --------------------------------------------------------------
<S> <C> <C>
Net loss:
As reported $ (4,789,000) $ (14,377,000)
Pro forma (4,808,000) (14,391,000)
Loss per common share:
As reported $ (1.40) $ (4.34)
Pro forma (1.41) (4.35)
- --------------------------------------------------------------
</TABLE>
Proforma net losses reflect compensation expense under SFAS No. 123 only for
options granted in 1997 and 1996. Therefore, the full impact of calculating
compensation expense for stock options under SFAS No. 123 is not reflected in
the proforma net loss amounts presented above because compensation expense is
reflected over the options' vesting period and compensation expense for options
granted prior to October 1, 1995 is not considered.
The fair value of each option is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions generally used for grants in 1997 and 1996, respectively: dividend
yield of 0 percent (both years), expected volatility of 132.79 and 140.19
percent, risk free interest rate of 6.46 and 6.9 percent, and expected lives of
8 years.
A summary of the status of the Company's stock options as of September 30, 1997,
1996 and 1995, and changes during the years ended on those dates is presented
below:
<TABLE>
<CAPTION>
1997 1996 1995
--------------------- ----------------------- -----------------------
Weighted- Weighted- Weighted-
average average average
exercise exercise exercise
Shares price Shares price Shares price
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year 259,600 $3.28 269,600 $3.68 264,600 $3.86
Granted 165,000 0.98 61,500 1.99 64,000 3.00
Exercised (3,000) 0.50 - - - -
Forfeited (62,200) 1.48 (71,500) 3.68 (59,000) 3.72
- ------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 359,400 0.72 259,600 3.28 269,600 3.68
- ------------------------------------------------------------------------------------------------------------------
Options exerciseable at
year end 176,400 0.50 161,500 3.62 124,800 3.87
- ------------------------------------------------------------------------------------------------------------------
Weighted-average fair value
of options granted
during the year $0.93 $1.83 $2.88
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(Continued)
62
<PAGE> 63
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(14) Continued
The following table summarizes information about stock options outstanding at
September 30, 1997:
<TABLE>
<CAPTION>
Options outstanding Options exercisable
------------------------------------------- ---------------------
Weighted-average Weighted- Weighted-
remaining average average
Exercise contractual exercise exercise
prices Number life price Number price
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$.50 254,400 7.05 $.50 176,400 $.50
1.25 105,000 9.77 1.25 - -
- ---------------------------------------------------------------------------------------------
$.50 - 1.25 359,400 7.84 $ .72 176,400 $.50
- ---------------------------------------------------------------------------------------------
</TABLE>
(15) Retirement Plan
The Company has a 401(k) plan (the Plan). Employees are eligible to join the
Plan upon completion of six months of service during which they have worked a
minimum of 1,000 hours and are age 21 or older. The Plan provides that the
Company will make a matching contribution equal to $0.50 for each $1.00
contributed by a participant not to exceed 3 percent of a participant's
compensation. The Company's matching contribution is made in cash to be used to
purchase shares of common stock of the Company for the accounts of the
participants. For the years ended September 30, 1997, 1996, and 1995, the
Company's contributions were $38,000, $70,000, and $81,000, respectively.
(16) Fourth-Quarter Results
The fourth quarter loss of approximately $2,400,000 exceeded prior quarterly
reported losses for several reasons including the following: writing down of HCI
goodwill and other intangibles ($696,000) due to the decision to dispose of most
of these operations (note 5), reserving the remaining accounts receivable of
$510,000 related to the facilities sold in 1996 due to the significant drop off
in collections in the fourth quarter, and reaching an agreement to pay a former
employee a total of $150,000. In addition, the Company reduced its liability to
third-party payors by about $965,000, which was primarily offset by additional
reserves for accounts receivable.
(Continued)
63
<PAGE> 64
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(17) Subsequent Events
In October 1997, the Company borrowed $500,000 from NationsBank on an unsecured
line of credit. The line of credit bears interest at 1/4 below prime rate and is
due for renewal in April 1998. Three officers and directors of the Company
personally guaranteed the line of credit and in consideration thereof will be
awarded common stock warrants based on the amounts outstanding on the loan.
On November 25, 1997, the Company received notification from the American Stock
Exchange (AMEX) that the Company's shares will be delisted due to the Company's
continuing failure to meet their listing guidelines and the adverse judgment
concerning the MEDIQ note. The Company has appealed this decision to the AMEX.
Failure to be listed on the AMEX may adversely affect the price of the Company's
common stock and the ability of the Company's stockholders to sell their shares.
(Continued)
64
<PAGE> 65
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(18) New Financial Accounting Standards
The Financial Accounting Standards Board has issued SFAS No. 128, Earnings per
Share, which will require the Company to change its method of calculating EPS.
SFAS No. 128 simplifies the computation of EPS by replacing the presentation of
primary EPS with a presentation of basic EPS. Basic EPS is calculated by
dividing income available to common stockholders by the weighted average number
of common shares outstanding during the period. Options, warrants, and other
potentially dilutive securities are excluded from the calculation of basic EPS.
Diluted EPS, which has not changed significantly from the current calculation of
fully diluted EPS, includes the options, warrants and other potentially dilutive
securities that are excluded from basic EPS. In accordance with the provisions
of SFAS No. 128, the Company will adopt this new standard for the year ending
September 30, 1998. Had the Company adopted the new standard for the year ended
September 30, 1997, (early adoption is specifically prohibited) the results
would have been the same as the loss per share amount reflected in the
accompanying consolidated statement of operations.
The Financial Accounting Standards Board has also issued SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information which will
require the Company to report certain information about operating segments. In
accordance with the provisions of SFAS No. 131, the Company will adopt this new
standard for the year ending September 30, 1999. The adoption of this standard
will not have a material effect on the financial position or results of
operations of the Company.
65
<PAGE> 66
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On May 1, 1997, the Registrant discharged Deloitte & Touche LLP as
the Company's independent accountant to audit the Registrant's consolidated
financial statements. KPMG Peat Marwick LLP was engaged as its new independent
accountant to audit the Registrant's consolidated financial statements for the
fiscal year ending September 30, 1997.
The independent accountants' reported dated December 30, 1996 on the
consolidated financial statements for the fiscal years ended September 30, 1996
and 1995 contained no qualification or modification as to audit scope or
accounting principles, nor any disclaimer of opinion; however, for each of the
years it included an explanatory paragraph relating to the Company's ability to
continue as a going concern. The decision to change accountants was recommended
by management and approved by the Board of Directors.
During fiscal years 1996 and 1995 and subsequent interim periods of
1997, there have been no disagreements with Deloitte & Touche, LLP on any
matter of accounting principles or practices which if not resolved to their
satisfaction would have resulted in a reference to the subject matter in the
independent accountants' report. Similarly, there have been no such
disagreements with KPMG Peat Marwick LLP since the date of their engagement.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
<TABLE>
<CAPTION>
NAME AGE POSITIONS WITH THE COMPANY
- ---- --- --------------------------
<S> <C> <C>
Michael S. Pinkert 56 President, Chief Executive Officer and
Director
John L. Silverman (1)(2) 56 Director
Richard Freedman (1)(3) 44 Director
William P. Ferretti (2)(3) 54 Director
Steven H. Wheeler 34 Executive Vice President - Operations and
Director
Lee Calligaro 55 Vice President and General Counsel
Robert W. May 37 Vice President - Development
</TABLE>
- -----------------
(1) Became a Director February 1998
(2) Member of the Compensation and Stock Option Committee
(3) Member of the Audit Committee
Mr. Pinkert has been President, Chief Executive Officer and a Director
of the Company since he founded it in 1981. He was formerly Vice President of
Psychiatric Institutes of America ("PIA") from 1979 to 1981. Prior to joining
PIA, he was Vice President of Charter Medical Corporation from 1976 to 1977
where he was responsible for international marketing. He also worked in
conjunction with Charter and PIA from 1974 to 1975 in establishing a hospital
management company in Iran. Mr. Pinkert has worked in the health care
management and consulting industry for over 30 years.
John L. Silverman became a Director of the Company in January 1998.
Mr. Silverman is currently an independent consultant to the healthcare
industry. For the past three years, he served as the Chief Executive Officer of
AsiaCare, Inc., a southeast Asian healthcare investment company. From 1990 to
August 1997, he was the Vice President and Chief Financial Officer of Chi
Systems, Inc., a healthcare consulting company. Mr. Silverman is currently a
Director of Integrated Health Services, Inc. and Superior Consultant Holding
Corporation and several private companies.
66
<PAGE> 67
Richard Freedman became a Director of the Company in February 1998.
Mr. Freedman is currently an independent investor. In 1992 Mr. Freedman was a
founder of Prism Health Group, Inc., and served as Executive Vice President and
General Counsel until 1997. From 1990 to 1992 he served as Executive Vice
President of Oakwook Living Centers, Inc.
William P. Ferretti has been a Director of the Company since August
1996. Mr. Ferretti has been Chief Executive Officer of Medstar Television, Inc.
(producer and syndicator of televised medical news) since 1982 and also is a
Director of U.S. Physicians, Inc. (physician practice management services) and
Vitas Healthcare Corporation (provider of hospice services) and a general
partner of the NEPA Venture Fund -II (venture capital firm).
Steven H. Wheeler joined the Company in May 1994 and has served as
Vice President-Operations since December 1997. Prior thereto, he served as Vice
President - Integrated Delivery Systems. Before joining the Company, Mr.
Wheeler was Director of Business Development/Operations for Florida Psychiatric
Group from April 1993 to February 1994, General Manager, Psych Options, Inc.
from March 1992 to April 1993, and Regional Director of Operations, Merit
Behavioral Care Corporation (formerly American Biodyne) from May 1990 to
February 1992.
Lee Calligaro is General Counsel, Vice President and Assistant
Secretary. He joined the Company on February 1, 1997. Previously, Mr. Calligaro
served as Vice President and General Counsel for United Psychiatric Group,
Washington, D.C. an operator of psychiatric hospitals and other mental
healthcare programs, from June 1994 to February 1997. Mr. Calligaro was a
senior partner in the law firm of Calligaro and Mutryn, P.C. from June 1986 to
June 1994, with an emphasis in healthcare law.
Robert May has been an employee of the Company for four years and was
promoted in December 1997 to Vice President of Development. Previously, he
served in other managerial positions with the Company including Regional Vice
President and Director of the PASARR program. Prior to joining the Company, Mr.
May was Vice President/Administrator, Tallahassee Memorial Regional Medical
Center, Psychiatric Center, Tallahassee, Florida.
Directors are elected annually to serve until the next annual meeting
and until the election and qualification of their successors. Subsequent to the
last stockholders' meeting, Kenneth A. Kessler, M.D. resigned from the Board of
Directors (February 1998). Officers are elected annually by the Board and serve
at the discretion of the Board of Directors.
67
<PAGE> 68
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth certain information regarding
compensation paid during each of the last three fiscal years to the Company's
Chief Executive Officer and the Company's other most highly compensated
executive officers whose annual compensation exceeded $100,000 in fiscal 1997
(collectively "Named Executive Officers")
<TABLE>
<CAPTION>
Annual Compensation Long Term
Name and ------------------- Compensation All Other
Principal Position Year Salary $ Bonus $ Stock Options (#) Compensation $ (1)
------------------ ---- -------- ------- ----------------- ------------------
<S> <C> <C> <C> <C> <C>
Michael S. Pinkert 1997 253,293 - 60,000 18,483
President & Chief 1996 297,000 - - 5,237
Executive Officer 1995 297,000 - - 5,290
Steven H. Wheeler 1997 124,202 - 30,000 7,442
Vice President- 1996 105,000 - - 6,588
Operations 1995 95,000 - 10,000 5,000
</TABLE>
- -----------------
1. Amounts reported represent the total of automobile allowances and
Company contributions to the 401(k) plan.
Compensation of Directors
Directors who are employees of the Company receive no additional
compensation for their services as Directors or as members of committees of the
Board of Directors. Non-employee Directors receive an annual Director's fee of
$10,000 for their services in such capacities. In 1993 the Company adopted a
Stock Option Plan for Non-Employee Directors. All options granted under this
plan vest 20% at date of grant with the remaining 80% vesting ratably over four
years subject to a director continuing to serve on the Board. Options granted
expire ten years from the date of original grant. On January 30, 1997, the
Company granted 10,000 options to William Ferretti and 10,000 options to
Kenneth A. Kessler, M.D. In February 1998, Dr. Kessler resigned as a Director
and all nonvested options were terminated. Additionally Messrs. Silverman and
Freedman were granted 12,500 options each at the time they became Directors in
January 1998.
68
<PAGE> 69
Stock Options Granted
The following table summarizes stock options granted during fiscal
1997 to the Company's Named Executive Officers.
<TABLE>
<CAPTION>
Potential Realizable
Value at Assumed
Annual Rates of Stock
Individual Grants Price Appreciation for
Option Term (1)
- -------------------------------------------------------------------------------- ---------------------------------
Percent of Total
Options Granted Exercise or
Options to Employees in Base Price Expiration
Name Granted (2) Fiscal Year ($/Share) Date 5% 10%
---- ----------- ----------- --------- ---- -- ---
<S> <C> <C> <C> <C> <C> <C>
Michael S. Pinkert 60,000 41.4% 1.25 7/8/07 47,170 119,530
Steven H. Wheeler 5,000 3.4% .50 1/30/07 1,570 3,985
25,000 17.2% 1.25 7/8/07 19,655 49,800
</TABLE>
- --------------
1. The information in these columns illustrates the value that might be
realized upon exercise of the options assuming the specified compound
rates of appreciation of the Company's common stock from its value as of
the date of the grant over the term of the options. The potential
realizable value columns are based on the total amount of options
granted. However, the total amount may not become exercisable (see Note
2). In addition, the amounts reflected do not take into account amounts
required to be paid for federal or state income taxes. The amounts also
do not reflect the effect of option provisions regarding termination of
the option following termination of employment or nontransferability
requirements. These amounts were calculated based on requirement of the
Securities and Exchange Commission and do not necessarily reflect the
Company's estimate of future stock price growth.
2. The options indicated become exercisable in 20% installments over a five
year period commencing on the first anniversary of the grant date.
Report on Repricing of Options
As of January 30, 1997, all outstanding options for the Company's
stock were repriced to reflect market pricing. Following is a summary of option
repricing for the Company's Named Executive Officers:
<TABLE>
<CAPTION>
Number of Market Price Exercise Length of Original
Securities of Stock at Price at Time New Option Remaining
Underlying Time of of Repricing Exercise at Date of
Name Date Options Repriced Repricing ($) ($) Price ($) Repricing
----------- ------ ------------------ --------------- ------------- --------- -------------------
<S> <C> <C> <C> <C> <C> <C>
Michael S. Pinkert 1/30/97 90,000 $.50 $3.75 $.50 80 months
Steve Wheeler 1/30/97 10,000 $.50 $3.00 $.50 93 months
</TABLE>
See the Report of the Compensation Committee for further discussion of the
reasons for the option repricing and the basis for the repricing.
69
<PAGE> 70
Aggregated Option and Fiscal Year-End Option Value Table
The following sets forth information concerning the September 30, 1997
value of the exercisable and unexercisable options held by each of the Named
Executive Officers. No stock options were exercised during fiscal 1997 by any
of the Named Executive Officers.
<TABLE>
<CAPTION>
Total Number of Unexercised Value of Unexercised In-The-
Options # Money Options at Year End $
Shares ----------------------------- ------------------------------
Acquired on Value
Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
----------- ---------- ----------- -------------- ------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Michael S. Pinkert - - 90,000 60,000 $78,750 $7,500
Steve Wheeler - - 4,000 36,000 $3,500 $12,750
</TABLE>
The value of the unexercised in-the-money options does not reflect executory
costs or the impact of federal or state income taxes and may be impacted by
subsequent changes in the market price of the Company's stock.
Board Compensation Committee Report on Executive Compensation
Compensation arrangements for the Company's executive officers are
determined by the Company's Board of Directors by reference to a survey of
compensation trends by position among hospital management companies. This
survey was prepared by an independent management compensation consultant. The
Company's base compensation levels have averaged at the median for the
industry, with incentive compensation, if any, enabling the Company's executive
officers to receive additional compensation if the Company's financial
objectives are attained. The companies surveyed included some of, but are not
limited to, the companies represented in the peer group index in the
performance graph following this report. This survey was used as a basis for
comparison because it included a broad spectrum of hospital management
companies, including the Company. Since August 1993, the Compensation and Stock
Option Committee (the "Committee") has reviewed compensation levels of the
Company's employees and determined guidelines for the future, including
incentive compensation. The Committee is also authorized to grant stock options
to officers and key employees of the Company pursuant to the Company's 1993
Stock Option Plan, and to determine the terms of such options.
It is the policy of the Committee, and the Board of Directors, as a
whole, that a significant portion of the annual compensation of the Company's
Chief Executive Officer and other executive officers should be directly linked
to the Company's performance, as well as each individual's contribution. The
Company's compensation programs are designed to provide competitive financial
rewards for successfully meeting the Company's strategic and operating
objectives, with the purposes of retaining personnel and supporting a
performance-oriented environment.
70
<PAGE> 71
The compensation of the Company's Chief Executive Officer and other
executive officers is comprised of base salary, as well as cash and stock
incentives based on annual and long-term results of the Company. Increases in
base salary, if any, will be based on individual performance, level of
responsibilities and the Company's overall performance.
In January 1997 the Board of Directors approved the repricing of all
outstanding stock options previously awarded to employees and directors to
reflect current market conditions for the Company's common stock. The
Compensation Committee made the decision to reprice the options based on their
belief that the decline in the Company's stock price since the original grants
was significant enough such that the outstanding options no longer provided
sufficient incentive to its employees. Consideration was given to the financial
difficulties experienced by the Company, the risks assumed by the employees in
light of these financial difficulties and the level of incentives deemed
appropriate to retain employees.
Changes in Mr. Pinkert's compensation, if any, would be determined by
the Committee based upon its subjective analysis of his performance and the
Company's overall performance. In 1997 Mr. Pinkert accepted a voluntary
reduction in salary to help improve the Company's cash flow. In consideration
of this reduction, he received stock options for an additional 60,000 shares
based on a survey prepared by an independent management compensation consultant
reporting to the Compensation Committee.
The Company has an incentive compensation program which rewards the
Company's executive officers based upon the Committee's subjective
determination concerning individual performance and the Company's achievement
of its internal financial objectives. Executive officers become entitled to
receive a percentage of the bonus potential based upon the percentage
achievement of the Company's internal projected operating profit. Bonuses to be
paid, if any, are determined based upon the amount by which the Company exceeds
its projected operating profit and the allocation of a bonus pool among the
plan participants. The bonus pool is based upon the amount by which the Company
exceeds its projected operating profit, and can range from 25% to 100% of the
amount over the Company's projected operating profit. Allocation factors
include salary levels and individual performance evaluations. Through this
plan, a significant portion of each executive officer's annual total
compensation is placed at risk in order to provide an incentive toward
sustained high performance. For fiscal 1997, the Company did not meet its
projected financial goals and, as a result, the Company's executive officers
did not receive any bonus payments under this plan.
In addition, it has been the policy of the Committee to utilize stock
options to provide a link between compensation and the market performance of
the Company's stock, and to focus attention of management on the enhancement of
shareholder value. As a general rule the options are subject to ratable vesting
over a five year period.
During fiscal 1997 the Company awarded options for 20,000 shares to
Lee Calligaro at the time he joined the Company as Vice President and General
Counsel. The Compensation Committee believes that such options were
commensurate with his experience and abilities and representative of market
compensation for similar positions in similar companies. The Company
71
<PAGE> 72
also awarded options for a total of 20,000 shares to Robert May who was
promoted to Vice President of Development. Such awards were commensurate with
the Company's development in the Correctional Services Division of the Company
where Mr. May was instrumental in the Company winning long term contracts with
the Tennessee and Georgia Departments of Correction. If the Company's executive
officers create additional value for the Company's shareholders, evidenced by
increases in the Company's stock price, the Company's executive officers will
also benefit through appreciation of the potential value of outstanding stock
options. The Committee believes that the long-term nature of stock options also
encourages executive officers to remain in the employ of the Company.
Compensation and Stock Option Committee
William P. Ferretti
Kenneth Kessler (1)
H. Scott Miller (2)
Michael S. Sandler (3)
(1) Dr. Kessler resigned from the Board of Directors in February 1998 and at
that time ceased to be a member of the Compensation and Stock Option
Committee.
(2) Mr. Miller resigned from the Board of Directors in January 1997 and at
that time ceased to be a member of the Compensation and Stock Option
Committee.
(3) Mr. Sandler resigned from the Board of Directors in January 1997 and at
that time ceased to be a member of the Compensation and Stock Option
Committee.
Compensation Committee Interlocks and Insider Participation
Dr. Kenneth A. Kessler served on the Compensation Committee of the
Board of Directors prior to his resignation from the Board in February 1998.
During Dr. Kessler's tenure on the Compensation Committee, Michael S. Pinkert
served on the Board of Directors of American Psych Systems, Inc., a corporation
for which Dr. Kessler serves as Chief Executive Officer and Chairman.
72
<PAGE> 73
STOCK PERFORMANCE CHART
The following chart compares the cumulative total shareholder return
on the Company's Common Stock for fiscal years 1993 through 1997 with the S&P
600 (small cap companies) and an index of peer companies selected by the
Company, consisting of: Vencor Inc., Comprehensive Care Corp., Magellan Health
Services, Inc. (formerly Charter Medical Corp.), PMR Corporation and Ramsay
Health Care, Inc.
<TABLE>
<CAPTION>
Comparison of 60 month Cumulative Total Return* Among MHM Services, Inc.,
the S&P 600 Value Index and a Peer Group
--------------------------------------------------------------------------------------------
9/30/93 9/30/94 9/30/95 9/30/96 9/30/97
<S> <C> <C> <C> <C> <C> <C>
MHM Services, Inc. MHM 100 68 85 18 32
Peer Group Peer1 100 107 108 179 185
S&P 600 S&P 600 100 102 126 136 190
</TABLE>
*$100 Invested on September 30, 1993 in Stock or Index - Including
Reinvestment of Dividends
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of May 31, 1998, the beneficial
ownership of shares of the Company's Common Stock par value $.01 per share by
each person known to the Company to be the owner of in excess of five percent
of the Company's outstanding shares of common stock, each director of the
Company, each executive officer and by all directors and officers of the
Company as a group.
<TABLE>
<CAPTION>
Number of % of Class
Name Shares(1) Outstanding (2)
<S> <C> <C>
Bessie G. Rotko (3) 906,798 25.7%
Michael S. Pinkert 400,527 (4) (5) 10.8%
William P. Ferretti 108,203 (4) 3.0%
Steve Wheeler 14,710 (4) (5) *
John L. Silverman 2,500 (4) *
Richard Freedman 2,500 (4) *
Lee Calligaro 53,317 (4) 1.5%
Robert W. May 4,000 (4) *
Apogee, Inc. 200,000 (6) 5.7%
All Executive Officers and Directors as a
Group 585,757 15.5%
</TABLE>
15 * Represents less than one percent
(1) Except as otherwise indicated below, all shares are expected
to be beneficially owned, and sole investment and voting
power is expected to be held, by the person named.
73
<PAGE> 74
(2) All percentages are rounded to the nearest tenth, and are based
upon the number of shares outstanding, including, as appropriate,
the shares referred to in the notes below.
(3) Mrs. Rotko is the lifetime income beneficiary of a trust. The
Trustees, Bessie G. Rotko, Michael J. Rotko, Judith M. Shipon,
Lionel Felzer and Provident National Bank, share voting and
investment power with respect to the shares held in the trust.
The address of the trustees is c/o Lionel E. Felzer, MEDIQ
Incorporated, One MEDIQ Plaza, Pennsauken, NJ 08110
(4) Includes options exercisable within the next 60 days including
Mr. Pinkert - 102,000; Mr. Ferretti - 9,500; Mr. Wheeler -
12,000; Mr. Calligaro - 4,000 and Mr. May - 4,000. Also includes
warrants issuable as follows: Mr. Pinkert - 72,614; Mr. Ferretti
- 24,203; and Mr. Calligaro - 24,203.
(5) Includes shares held in retirement accounts
(6) Represents shares issued to Apogee, Inc in connection with
acquisition of assets for Company's Extended Care Services
Division during fiscal 1997. The address of Apogee, Inc. is 1060
First Avenue, Suite 410, King of Prussia, PA 19406.
Beneficial Ownership Reporting Compliance
To the best of the Company's knowledge, all Directors and Executive
Officers timely filed all forms required by Section 16(a).
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In October 1997, the Company obtained an unsecured $500,000 line of
credit from NationsBank. This line of credit was required in order to meet the
cash demands of the Company, and there were no other reasonable sources for
financing. Michael S. Pinkert personally gauranteed and collateralized the line
of credit. William P. Ferretti and Lee Calligaro personally guaranteed the
payment of the line of credit to NationsBank up to $100,000 each. In
consideration of the risks assumed in connection with the guarantee, the
Company agreed to issue 90,000 warrants to purchase common stock of the Company
at a price of $1.51 per share. The warrants were issuable as follows, Mr.
Pinkert - 54,000 shares, Messrs. Ferretti and Calligaro 18,000 shares each. In
addition, warrants are issuable for each month that there is a balance
outstanding on the loan. Additional warrants issuable through May 31, 1998,
were Mr. Pinkert - 18,614, Messrs. Ferretti and Calligaro 6,203 each. The total
warrants outstanding at May 31, 1998 were 121,020.
74
<PAGE> 75
SIGNATURES
Pursuant to requirements of Section 13 or 15(d) of the Securities Exchange Act
of 1934, the Registrant had duly caused this report to be signed on its behalf
by the undersigned, hereunto duly authorized.
Dated July 7, 1998 MHM SERVICES, INC.
By: /s/ Michael Pinkert
-------------------------------
Chief Operating and Financial
Officer and Director
/s/ Steven H. Wheeler
-------------------------------
Vice President, Operations and
Director
/s/ William P. Ferretti
-------------------------------
Director
