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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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, 1998
[ ] 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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<S> <C>
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:
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Name of Each Exchange
Title of Each Class on Which Registered
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COMMON STOCK, PAR VALUE $.01 PER Over-The-Counter Bulletin
SHARE Board
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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 X No ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of 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
nonaffiliated (based upon the closing price of $ .50 of Common Stock on the
Over-The-Counter Bulletin Board) on December 31, 1998, was approximately
$1,102,073.
As of December 31, 1998, there were 3,538,225 shares of Common Stock,
par value $.01 per share, of the Registrant outstanding.
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PART I
ITEM 1. BUSINESS
GENERAL
MHM Services, Inc. (hereafter, including its subsidiaries, the
"Company") which initially incorporated in 1981 in Virginia and reincorporated
in Delaware in 1994, has provided specialty healthcare services primarily in
institutional settings. Through April 1996, the Company's principal business
was the provision of behavioral healthcare services either in free-standing
hospitals which the Company owned or through the management of behavioral
healthcare programs under contracts with acute care hospitals. As the mental
healthcare market sought less costly alternatives to long-term inpatient
services, in 1993 the Company, principally through its subsidiary, MHM Extended
Care Services, Inc. (the "Extended Care Services Division"), began to provide
specialized medical and behavioral healthcare services primarily to the elderly
in nursing homes and to children, adolescents and adults in clinics located
throughout Massachusetts.
As the Company transitioned its business to the Extended Care Services
Division, within several years, the Company began to appreciate that its
ability to achieve profitable operations through the Extended Care Services
Division was questionable. Therefore, the Company pursued other opportunities.
To this end, starting in the fourth quarter of 1997, the Company, through its
subsidiary MHM Correctional Services, Inc. (the "Correctional Services
Division"), began to provide on a capitated basis mental health care services
to all of the inmate populations of the Tennessee and Georgia Departments of
Correction. The Company is of the opinion that the business associated with
the Correctional Services Division offers the best opportunities, in the short
and long term, to improve the Company's business prospects and achieve
profitable operations.
In order to achieve the shifts in its business strategies, which have
evolved over the past five years, the Company has divested itself of the
business units within the divisions no longer at the core of the Company's
principal business focus. To this end, in fiscal 1998, the Company sold the
last of its seven remaining free-standing facilities it owned. This last sale
occurred on April 17, 1998. In this sale, the Company sold its inpatient
psychiatric operating unit located at Mountain Crest Hospital in Ft. Collins,
Colorado. Immediately prior to this sale, the Company acquired the physical
assets of the hospital which were previously leased to Mountain Crest and then
sold the physical assets along with the operations to Poudre Valley Hospital, a
general hospital also located in Ft. Collins, Colorado. The assets the Company
acquired were purchased for $2,700,000. The entire hospital along with the
psychiatric operations was sold for a cash purchase price of approximately
$6,500,000.
Although the Company determined in fiscal 1998 to divest itself of the
Extended Care Services Division, no transactions occurred within such year.
However, in the first quarter of fiscal 1999, the Company entered into three
agreements, all of which closed in the first quarter of fiscal 1999. See "Item
7, Management's Discussion and Analysis of Financial Conditions and Results of
Operations, RECENT DEVELOPMENTS." As a result of these sales, the Company's
sole remaining operations in the Extended Care Services Division consist of a
capitated Medicaid contract to provide services to Medicaid beneficiaries
residing in Georgia nursing homes.
CORRECTIONAL SERVICES DIVISION
In fiscal 1997, the Company became aware of opportunities to provide
specialized healthcare services to correctional facilities and formed the
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 was for a one-year term. 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 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
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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.
Because outsourcing mental health services within correctional systems
is a nascent industry, the Georgia and Tennessee correctional contracts alone
make the Company, in its opinion, one of the largest providers of mental health
services to inmates in the United States. The Company is also actively pursuing
other correctional contract opportunities through its sales team that markets
directly to federal, state and county correctional programs, and private
companies, which provide general medical services to correctional institutions.
Proposals are submitted pursuant to a competitive bid process. There can be no
assurance that the Correctional Services Division will win other contracts. Net
revenues from the Correctional Services Division approximated 37% of the
Company's total net revenues for fiscal 1998.
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. Private contractors
provide approximately 30% of current inmate healthcare spending in the United
States. 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 for these contract mental health workers. Such a
requirement could accelerate the trend to outsource such services.
The Company believes that there are several advantages to providing
health care services on a capitation basis including lower billing/collection
costs, more predictable cash flow, fewer bad debts, less restrictive 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 utilization levels (number of patients treated as a percentage of
the total population) exceeding projections, 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 providing services under 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 the high degree of litigation that is often
present in a correctional system. To date, the Company has not been a party to
any such litigation.
EXTENDED CARE SERVICES DIVISION
Prior to pursuing a strategy in the corrections market, the Company's
Extended Care Services Division emerged as the primary line of business the
Company determined to pursue. For the three fiscal years ending with September
30, 1997, the Company invoked a growth strategy for the Extended Care Services
Division, primarily through acquisitions, as it sought to increase its market
share. For fiscal 1998, this division generated approximately $15,000,000 of
revenue or 52% of the Company's total revenue.
The purpose of the Extended Care Services Division has been primarily
to provide mental health care professionals primarily to extended care
facilities such as nursing homes. The Company's professionals consist of
employees and independent contractors who provide services generally through
contracts, which are cancelable upon sixty days notice. These professionals
visit the facilities at regularly scheduled intervals or on an as needed basis.
The Company only relies upon the facility for space to render the Company's
services and assistance in locating residents requiring the Company's services.
Billings for the services are made to governmental programs, such as Medicare
and Medicaid, and to the insurers covering the care being provided.
Primarily through the Company's acquisitions, by the end of fiscal
1998, the Extended Care Services Division was providing services to residents
of 738 facilities located in Georgia, Massachusetts, New Jersey, Pennsylvania
and Tennessee. A major component of the business of this division was a
contract to provide certain capitated mental health
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care services under the Georgia Medicaid program to nursing home patients. In
Massachusetts, the Company generally provided mental health care services at
health care clinics to individuals of all ages. However, in 1998, the Company
recognized that its short and long term prospects would be hindered if it
continued to operate the Extended Care Services Division primarily as a result
of the continued losses this division was incurring. Therefore, because of the
Company's need to generate working capital and the losses being incurred in the
Extended Care Services Division, in the first quarter of 1999, the Company sold
its operations in Georgia, other than the capitated Medicaid contract and its
assets and operations in Massachusetts, Pennsylvania, and Tennessee. These
sales along with certain other operations, which were previously discontinued,
resulted in the virtual liquidation of the Extended Care Services Division
other than services provided under services provided the Georgia Medicaid
contract.
The business of the Extended Care Services Division has been affected,
and will continue to be affected so long as the Company continues to operated
the Georgia Medicaid contract, 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. Of all the laws and regulations, those under the
Medicare and Medicaid programs cause the highest level of concern. Under these
programs, providers of services, such as the Company, are subject to audits and
to partial repayments of reimbursements received in prior periods. Also,
companies, which participate in these programs, are subject to the federal
Fraud and Abuse Statute. This statute prohibits individuals or entities which
participate in the Medicare or Medicaid programs from knowingly and willfully
offering, paying, soliciting or receiving payment in order to induce
referrals for items or services reimbursed under these programs. This statute
also authorizes the promulgation of regulations to exempt certain arrangements
from the prohibitions of the statute. In 1991, regulations were issued
creating certain "safe harbors" immunizing certain relationships between health
care providers and referral sources from the scope of the Fraud and Abuse
Statute. Failure to satisfy a safe harbor requirement, however, does not
necessarily mean that a relationship is illegal. Rather, the failure to fit
within a safe harbor means that a particular relationship is not immune from
scrutiny and the possibility of prosecution and sanctions. The Company
believes that it is in compliance with the Fraud and Abuse Statute as well as
other state and federal statutes and regulations restricting patient referrals.
HOSPITAL SERVICES
The sale in April 1998, of the Mountain Crest Hospital located in Ft.
Collins, Colorado, resulted in the total cessation of the Company's inpatient
services business. In fiscal 1996, revenue from hospital services represented
67% of total revenues. By fiscal 1998, this percentage had dropped to 10%.
Although the Company is effectively out of the inpatient business, it
still remains subject to certain governmental reimbursement programs in which
it participated. In this regard, the reimbursement under Medicare and Medicaid
has been made on a cost reimbursement tentative rate basis with final
settlement generally determined several years after submission of fiscal year
cost reports and audits by fiscal intermediaries. These audits could expose
the Company to additional future liabilities.
LIQUIDITY
As a result of the Company's continued negative operating results, and
availability of capital, 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, 1998, 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 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, raise additional capital and improve
its cash flows or find a buyer for the Company. Nevertheless, there can be no
assurance that the Company's efforts will result in positive effects on the
Company's financial condition.
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EMPLOYEES
As of September 30, 1998, the Company had 72 full-time employees and
142 part-time employees engaged in the operations of the Extended Care Services
Division and 43 full-time and 11 part-time employees in the Correctional
Services Division. In addition, as of such date, the Company had 11 employees
engaged in corporate and administrative operations.
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
As noted above, 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.
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 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
Currently, the Company's executive offices are located in Vienna,
Virginia pursuant to a lease expiring in January 1999. 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. On February 1, 1999, the Company's executive
offices will be relocated to McLean, Virginia pursuant to a lease expiring in
November 2000. Pursuant to such lease, the Company will pay annual rent of
approximately $27 per square foot on approximately 3,300 square feet, with
annual increases in an amount equal to 3% of the prior year's base rent. In
connection with its operations, the Company maintains two regional offices,
which require an annual lease commitment of approximately $70,000 per year.
The Company is in the process of relinquishing or terminating other leases it
maintained prior to the divestitures, which have occurred in the Extended Care
Services Division. The Company believes that its facilities are adequate to
carry on its business as currently structured.
ITEM 3. LEGAL PROCEEDINGS
On July 15, 1998, the Company and MEDIQ reached a settlement of
MEDIQ's claim for $11,800,000 against the Company for which MEDIQ had obtained
a judgment against the Company for this dispute. In return for a cash payment
of $3,000,000 by the Company, MEDIQ has vacated its claim, and released the
Company and its affiliates from any and all other liabilities; provided,
however, no bankruptcy proceedings involving the Company occur which result in
MEDIQ repaying all or part of the settlement it received.
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The settlement was funded by a $2,000,000 loan from Health Care
Financial Partners, the Company's principal lender, as well as from the
Company's existing lines of credit. The $2,000,000 is collateralized by
substantially all the assets of the Company. The loan from Health Care
Financial Partners, which has a six month term, carries interest of prime plus
two percent, a two percent commitment fee, and a completion fee of an
additional two percent. In addition, in return for making the loan, Health
Care Financial Partners has been granted warrants for 300,000 shares of common
stock of the Company, priced at $.01 per share and exercisable at any time
before July 15, 2003.
Additionally, Michael S. Pinkert, CEO, has extended his personal
guarantee to Health Care Financial Partners covering $800,000 of the
$2,000,000. In return for his guarantee, Mr. Pinkert has been granted warrants
for 145,000 shares of the Company's stock, at a price of $.50 per share and
exercisable at any time before July 15, 2008.
As a result of the settlement, the Company recognized a one-time gain
of $9,185,000 in the fourth quarter which was reported as an extraordinary
item.
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, 1998.
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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") and the Over
the Counter Bulletin Board ("OTC"):
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HIGH LOW
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Year ended September 30, 1998:
First Quarter $1.937 $.375
Second Quarter .937 .312
Third Quarter .937 .500
Fourth Quarter 1.750 .438
Year ended September 30, 1997:
First Quarter $1.063 $.375
Second Quarter .813 .125
Third Quarter .938 .625
Fourth Quarter 1.875 .875
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On June 9, 1998, the Company was notified that the American Stock Exchange
Executive Committee of the Exchange Board of Governors had denied appeal of the
February 3, 1998 determination by the Exchange to delist the Company stock.
The last day for trading the Company's stock on the American Stock Exchange was
June 16, 1998. Effective June 17, 1998, the Company's stock has been traded on
the Electronic Bulletin Board service under the symbol "MHMM". With respect to
information related to Over-The-Counter Bulletin Board trades, sale price
includes prices between dealers, may not reflect markups, markdowns or
commissions and may not represent the final actual transaction.
COMMON STOCKHOLDERS
As of December 31, 1998, there were approximately 1,480 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.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial information presented below has been
derived from the audited consolidated 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.
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STATEMENT OF OPERATIONS DATA (IN THOUSANDS EXCEPT PER SHARE DATA)
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YEAR ENDED SEPTEMBER 30,
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1998 1997 1996 1995(1) 1994(1)
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Net revenues $ 29,294 $ 20,851 $ 34,670 $ 41,109 $ 48,286
Costs and expenses:
Operating 20,040 14,875 25,765 28,918 33,895
General and administrative 7,539 5,760 9,718 10,085 10,644
Provision for bad debts 3,326 3,467 6,320 4,467 2,009
Depreciation and amortization 597 369 1,034 1,603 1,617
Gain (loss) - sale of freestanding
facilities (2) (2,465) -- 4,440 -- --
Writedown of long-term assets (3) 430 696 461 2,228 --
Restructuring charges (4) -- -- -- -- 966
Other (credits) charges:
Equity in earnings of Joint Venture -- -- -- (835) (292)
Gain on sale of Joint Venture -- -- -- (3,542) --
Interest expense - MEDIQ 757 1,042 1,097 1,171 932
Interest expense - other 166 93 290 366 389
Other (income) expense-net (5) -- (662) (233) (223) (33)
Income (loss) before income tax -------- -------- --------- -------- --------
expense (benefit), extraordinary item
and cumulative effect of a change in
accounting principle (1,096) (4,789) (14,222) (3,129) (1,841)
Income tax (benefit) expense 93 -- (308) 894 (525)
Extraordinary item (6) 9,185 -- (463) -- --
Cumulative effect of a change in
accounting principle (7) -- -- -- -- (732)
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Net (loss) income $ 7,996 $ (4,789) $ (14,377) $ (4,023) $ (2,048)
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(Loss) earnings per share $ 2.26 $ (1.40) $ (4.34) $ (1.22) $ (.63)
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Weighted average shares outstanding 3,528 3,411 3,310 3,310 3,267
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BALANCE SHEET DATA (IN THOUSANDS)
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SEPTEMBER 30,
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1998 1997 1996 1995(1) 1994(1)
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Working capital $ (2,011) $(11,245) $ 2,566 $ 5,923 $ 485
Total assets 7,536 11,414 15,669 30,283 41,900
Long term debt, less current maturities 176 1,456 257 2,422 716
Due to MEDIQ, less current maturities (8) -- -- 9,967 10,733 11,500
Stockholders' (deficit) equity (134) (8,270) (3,582) 10,795 14,818
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SEE NOTES TO SELECTED CONSOLIDATED FINANCIAL DATA
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 $3,000,000 net of taxes).
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(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. In April 1998,
the Company sold its last inpatient psychiatric hospital operation and
reported a gain on the sale of $2,465,000.
(3) In the fourth quarter of 1998, the Company decided to dispose of certain
assets and contractual rights of its Extended Care Services Division. In
connection with this decision, the Company determined that goodwill and
other intangibles related to the acquisition of HCI and Apogee were
permanently impaired and were written down to an estimated value resulting
in a charge of $430,000. 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 partially impaired and was written
down to an 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 Supportive Counseling Care ("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, were 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) 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. In July 1998, the Company and MEDIQ settled the $11,800,000
judgement against the Company for payment of $3,000,000 in cash. As a
result of this transaction, the Company recorded a gain on early
extinguishment of debt of $9,185,000.
(7) 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.
(8) The Company's long term debt obligations to MEDIQ were reclassified as a
current liability in 1997. The MEDIQ obligation was settled in July 1998.
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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, 1997
and 1998, including the sale of all of the Company's seven freestanding
behavioral healthcare facilities (see "Recent Developments"), so that the
Company could focus on its Correctional Services Division and Extended Care
Services Division. 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 industry. 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. In
fiscal 1997, in an effort to improve the financial operations of this division,
the Company closed extended care operations in certain states because revenues
were insufficient to achieve profitability. Despite management's efforts, the
profitability of this division has not improved which has resulted in
management's decision to divest itself of this line of business in favor of
growing the Correctional Services Division.
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, 1998, the
Company's current liabilities exceeded its current assets by $2,011,000. The
Company's working capital deficit is primarily due to the classification as
current liabilities of a $2,000,000 loan with HealthCare Financial Partners,
the Company's principal lender, as well as the Company's existing line of
credit with NationsBank of $500,000. The loan from HealthCare Financial
Partners and the NationsBank line of credit were used to fund a $3,000,000 cash
payment to MEDIQ as final settlement of a judgement of $11,800,000 brought
against the Company by MEDIQ. This settlement was reached in July 1998.
The report of the Company's independent auditors on the Company's audited
consolidated financial statements for the fiscal year ended September 30, 1998,
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, 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.
RECENT DEVELOPMENTS
In 1996 the Company sold Oakview Treatment Center to Glass Mental Health
Foundation for $50,000 in cash and two promissory notes totaling $2,150,000.
Due to lack of payment on the promissory notes, the Company declared the notes
in default and foreclosed on the property in September 1998. The property is
subject to a junior lien held by the Internal Revenue Service (IRS). On
November 6, 1998, the Company entered into an agreement with an investor to
purchase the real property for an amount that will substantially cover the
amount of notes receivable outstanding.
Effective December 16, 1998, the Company entered into an agreement to
divest certain assets related to the delivery of mental health services to
patients of extended care facilities in the States of Tennessee and Georgia,
except those provided under the Company's Medicaid contract with the State of
10
<PAGE> 11
Georgia Department of Medical Assistance. No consideration was received;
however, the Company was relieved of managing the business. Losses of
approximately $251,000 consisting of the write down of related intangible
assets were recognized in fiscal 1998 in anticipation of this transaction.
On December 31, 1998, the Company entered into an agreement with another
organization to sell certain assets initially acquired from National
Mentor, Inc., Liberty Bay Colony Health Services, Inc. (Liberty Bay) and
Liberty Management Group, Inc. (Liberty Management) related to the delivery of
outpatient mental health services and services to patients of extended care
facilities in the State of Massachusetts. These assets were sold for $850,000,
which will result in a gain on sale of approximately $200,000 to be recorded by
the Company in the first quarter of fiscal 1999.
On December 31, 1998, the Company entered into an agreement to sell
certain assets related to the delivery of mental health services to patients of
extended care facilities in the State of Pennsylvania. The total consideration
for this transaction was $170,000 of which $20,000 was paid at closing and the
remaining $150,000 was in the form of a promissory note payable, in its
entirety, on March 30, 1999. The assets acquired by the purchaser in this
transaction secure this note. This transaction will result in a gain on sale of
approximately $25,000 to be recorded by the Company in the first quarter of
fiscal 1999.
These transactions and current Company efforts are consistent with
management's strategy to improve the Company's profitability through the
divestiture of certain extended care services and focus upon the corrections
business.
OPERATING STRATEGY
Historically, the Company's principal business was 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, resulting
in pressure on providers to reduce both costs, by lowering utilization of
inpatient 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. Beginning in 1996 and concluding in 1998, the Company sold all
of its seven freestanding behavioral health facilities, deciding to focus on
the growth of its Extended Care Services Division and then its Corrections
Services Division.
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 healthcare services. During fiscal 1997, the Company
made several acquisitions in its Extended Care Services Division. See Note 5 of
Notes to Consolidated Financial Statements. Through 1998, the Extended Care
Services Division has not operated profitably despite the Company's efforts to
reduce operating expenses and focus on profitable operations. These efforts
included the Company closing or selling, in 1997, extended care operations in
certain states where revenues have not been sufficient to operate on a
profitable scale, and selectively reducing operating, general and
administrative costs and consolidating or outsourcing billing and payroll
functions. Notwithstanding these changes, the Company determined that the
Extended Care Services Division will not operate profitably in the future and
decided to divest itself of the division.
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.
11
<PAGE> 12
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 and again in July 1998, 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 2.6% over the EuroDollar
rate. As of September 30, 1998, the Company had drawn the full $500,000. In
July 1998, the Company borrowed $2,000,000 from HealthCare Financial Partners,
which has a six-month term and an interest rate of prime plus 2%. In
consideration of the loan, the Company granted HealthCare Financial Partners
five year warrants for 300,000 shares exercisable at $.01 per share. Michael S.
Pinkert, President and CEO, has guaranteed $800,000 of the loan with HealthCare
Financial Partners. For his guaranty, the Company granted Mr. Pinkert 145,000
ten year warrants exercisable at $.50 per share. See Note 14 of Notes to
Consolidated Financial Statements. As of September 30, 1998, the Company had
cash and cash equivalents available of $54,000. 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. No
assurance can be provided that the Company's efforts will be successful.
ACQUISITIONS
Effective 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, as such term is defined in the Apogee Agreement, commencing
March 31, 1997. Such additional consideration is calculated annually by the
Company and did not result in a liability for the year beginning March 31,
1997. As of September 30, 1998 the Company does not anticipate any liability
for the year beginning March 31, 1998 or thereafter.
Effective 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, 1998, the Company served approximately 115 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 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 of the
aggregate cash flows from all contracts (net of expenses). The agreement
stipulates limitations on the
12
<PAGE> 13
amount of bad debt expense and regional overhead that 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. Such
additional consideration is calculated, paid, and expensed, annually by the
Company and totaled approximately $37,000 and $3,000 for years beginning
December 1, 1997 and 1996, respectively. The payment for December 1, 1998 was
estimated at $40,000. After December 1, 1998, given the recent sale of the
Liberty Bay business, no future earn-out liability will exist except for
certain modest amounts from receivable collections occurring after the sale.
OVERVIEW OF REVENUE SOURCES
In the Extended Care Services Division, the Company is paid primarily by
third-party payors based on fee-for-service basis. 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). 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 has generated revenues from
clinical services for physicians and other healthcare professionals providing
care to residents of extended care facilities. Such revenues represented
approximately 52%, 66%, and 33% of total net revenues in 1998, 1997 and 1996,
respectively. The decreased percentage of revenues in 1998 compared to 1997
resulted from the Company's decision in 1997 to close certain extended care
operations in certain states where revenues had not been sufficient to operate
on a profitable scale and from the increased revenues generated from the
Correctional Services Division.
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 37% of total 1998 net revenues. The Company is based
under its Correction Service contracts on a monthly basis. 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 the Company was primarily paid at a fixed-rate for
services provided based on the allowable cost of such services. Such payments
were generally made by third-party payors, principally Medicare, but also
including Medicaid and other health-care insurers. The Company had agreements
with third-party payors that provide for payments for patient services at
amounts that differ from its established rates. For Medicare, the Company was
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 two of the six freestanding facilities sold in 1996
and its Mountain Crest facility sold in 1998.
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
10%, 31%, and 67% of the Company's total net revenues in 1998, 1997 and 1996,
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 adjustments to contractual allowances in the year in which
settlement is determined. The Company also receives patient service revenues
under
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<PAGE> 14
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,
------------------------------------------
1998 1997 1996
------------ ------------ -----------
<S> <C> <C> <C>
Net revenues 100.0% 100.0% 100.0%
Costs and expenses:
Operating 68.4 71.4 74.3
General and administrative 25.7 27.7 28.0
Provision for bad debts 11.4 16.6 18.2
Depreciation and amortization 2.0 1.8 3.0
(Gain) loss on sale of freestanding facilities (8.4) -- 12.8
Writedown of long-term assets 1.5 3.3 1.3
Other (credits) charges:
Interest expense - MEDIQ 2.6 5.0 3.2
Interest expense - other .6 .4 .8
Other (income) expense - net --- (3.2) (.6)
-------- ------- -------
Loss before income taxes and extraordinary item (3.7) (23.0) (41.0)
Income tax (benefit) expense .3 --- (.9)
-------- ------- -------
Loss before extraordinary item (4.0) (23.0) (40.1)
Extraordinary item - loss on early extinguishment of debt 31.4 --- ( 1.3)
-------- ------- -------
Net Income (Loss) 27.4% (23.0)% (41.4)%
======== ======= =======
</TABLE>
Fiscal Year 1998 Compared to Fiscal Year 1997
Net revenues for the year ended September 30, 1998, were $29,294,000 as
compared to $20,851,000 for the prior year, an increase of $8,443,000 or 40%,
primarily reflecting the revenue growth from the Correctional Services Division
in 1998. Net revenues from the Correctional Services Division were $10,888,000
in 1998 compared to $632,000 in 1997. The Correctional Services Division
commenced operations in February 1997. Net revenues from the Extended Care
Services Division were $15,326,000 in 1998 as compared to $13,737,000 in 1997,
an increase of $1,589,000 or 12%. This increase is due principally to the
revenues related to two acquisitions made by the Company in its Extended Care
Services Division during fiscal 1997; Liberty Bay (December 1996) and Apogee
(March 1997). In April 1998, the Company sold it last freestanding facility,
Mountain Crest Hospital. As a result, net revenues from freestanding facilities
were $2,793,000 for 1998 compared to $6,482,000 for 1997. Net revenues from
favorable settlements on third-party costs reports were $762,000 in 1998.
Operating expenses for the year ended September 30, 1998, were $20,040,000,
as compared to $14,875,000 in the prior year, an increase of $5,165,000 or 35%.
This increase was attributable primarily to increased costs in the Correctional
Services Division, which commenced operations in fiscal 1997.
General and administrative expenses for the year ended September 30, 1998,
were $7,539,000 as compared to $5,760,000, an increase of $1,779,000 or 31%.
Again, this increase was attributable primarily to increased costs in the
Correctional Services Division.
The provision for bad debts for 1998 decreased to $3,326,000 as compared to
$3,467,000 for 1997. As a percentage of net revenues, bad debt expense was 11%
in 1998 and 17% in 1997. Increased revenues from the Correctional Service's
Division primarily caused this reduction. Because these revenues
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<PAGE> 15
are paid on a capitated basis, there are no bad debts associated with these
revenues. The 1998 bad debt provision relates to the estimated net realizable
value of receivables generated in the Extended Care Services Division and
reserves on receivables remaining after the sale of the freestanding
facilities. The decline for the 1998 bad debt provision reflects an overall
reduction in accounts receivable remaining after the sale of the freestanding
facilities and the Extended Care Services Division.
Depreciation and amortization increased to $597,000 in 1998 from $369,000
in the prior year. The Company accelerated its amortization of goodwill and
other intangibles related to the Liberty and Apogee acquisitions, beginning
October 1, 1997. Amortization costs in 1998 were $406,000 as compared to
$184,000 in 1997.
In preparation for the divestiture of certain operations of the Extended
Care Services Division, the Company took a write down of $430,000 of goodwill
and capitialized start-up costs from its acquisition of the extended care
operations of Apogee and HCI.
In April 1998, the Company sold its last remaining freestanding psychiatric
hospital operation, Mountain Crest Hospital in Fort Collins, Colorado for a
cash price of approximately $6,500,000. As a result of the transaction, the
Company reported a one-time gain of $2,465,000.
Interest expense - other increased in 1998 to $166,000 from $93,000 in
1997, an increase of 78%. This increase is primarily caused by interest costs
for the revolving line of credit with HealthCare Financial Partners, the line
of credit with NationsBank and the six-month loan with HealthCare Financial
Partners.
In July 1998, in return for a $3,000,000 payment, the Company and MEDIQ
settled the $11,800,000 judgement MEDIQ had obtained against the Company. As a
result of this settlement, the Company recognized a one-time gain of $9,185,000
related to early extinguishment of debt.
Net income for 1998 was $7,996,000 as compared to a net loss for 1997 of
$4,789,000. The net income for 1998 was primarily derived from the sale of the
Company's last freestanding hospital and the recorded gain from the MEDIQ
settlement. The gain from sale of the freestanding hospital and the operation
of the Correctional Services Division in Georgia and Tennessee generated
taxable income in certain states resulting in an estimated state tax provision
of $93,000 in 1998.
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 inpatient facilities. The Company sold Oakview Treatment
Center on April 5, 1996, and sold five other freestanding facilities on May 31,
1996. The Company continued 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 related to two acquisitions made by the Company in its Extended
Care Services Division during fiscal 1997; 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 were not
generated in fiscal 1998. 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.
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<PAGE> 16
General and administrative expenses for the year ended September 30, 1997,
were $5,760,000 as compared to $9,718,000 in fiscal 1996, 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 from
$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 Supportive Counseling Care (SCC). The 1997
bad debt expense was high due to reserves against receivables remaining after
the sale of freestanding facilities and bad debt 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
outsourced all of its billing and collection efforts to minimize further bad
debts.
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 depreciable fixed assets than
ongoing operations.
Loss on sale of freestanding facilities was from 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
recorded from the sale of freestanding facilities.
MAJOR CUSTOMER
The Company has two contracts with the State of Georgia. The Extended Care
Services Division provides behavioral healthcare services to approximately
2,400 Medicaid patients residing in nursing homes under the Pre-Admission
Screening and Annual Resident Review (PASARR) contract with the State of
Georgia, the so-called Georgia Medicaid contract. The PASSAR contract expires
June 1999. For the year ended September 30, 1998, the PASARR contract
accounted for 12% 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 began on
October 1, 1997. This contract is projected to provide approximately $9,000,000
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.
MHM Correctional Services was awarded a three-year contract with the State
of Tennessee to provide mental health services to the inmates of the state's
correctional facilities on a capitated basis. This contract began on July 1,
1997. This contract is projected to provide approximately $2,000,000 of annual
revenue. This contract is subject to the procurement process of the State of
Tennessee, and there is no assurance as to the expectation of future revenues
earned under these contracts.
16
<PAGE> 17
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 that the Company uses and which this issue
may impact include billing related software and payroll. The Company's Chief
Financial Officer is in charge of investigating the potential impact of the
Year 2000 issue. The Company has not completed its evaluation of the impact of
the Year 2000 issue, and therefore, there can be no assurance that this issue
will not materially affect future financial results, or cause reported
financial information to be necessarily indicative of future operating results
or future financial condition.
The Company has a material relationship with a third-party vendor that
performs billing and collections on behalf of the Extended Care Services
Division. The vendor has represented to the Company that this billing system
is Year 2000 compliant. In fiscal 1998, the Company's management did not
perform a formal review of this system because of the anticipated divestiture
of the Extended Care Services Division in fiscal year 1999 thus, eliminating
the need to continue the vendor's service.
The Company has outsourced its payroll processing to an independent payroll
company. That vendor has represented to the Company that their payroll
processing systems are year 2000 compliant. The Company's management has not
performed any reviews over that system, though the vendor is a major supplier
of payroll services. If their systems were to fail, the Company would manually
prepare payroll for its employees.
The Company's information systems are resident on personal computers. The
Company plans to take the appropriate steps to make these systems Year 2000
compliant during fiscal 1999. The costs of addressing the Company's year 2000
issues have not been estimated.
LIQUIDITY AND CAPITAL RESOURCES
On September 30, 1998, the Company had cash and cash equivalents of
$54,000, compared to $108,000 at September 30, 1997. The decrease in available
cash is the result of the Company using cash to fund continued operating
losses.
Cash used in operating activities was $2,344,000 for 1998, as compared to
$3,151,000 for the prior year. Cash was primarily used in 1998 to reduce debt
and fund operating losses. 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.
17
<PAGE> 18
Net cash provided by investing activities in 1998 of $3,722,000 was
primarily from the sale of the Company's last freestanding facility, Mountain
Crest Hospital.
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, 1998, the Company had outstanding borrowings of $344,000 which
was approximately equal to what the Company was eligible to borrow at that
date. See Note 10 of Notes to Consolidated Financial Statements.
In July 1998 and 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 2.6% above the EuroDollar
rate. As of September 30, 1998, the Company had drawn the full $500,000. See
Note 10 of Notes to Consolidated Financial Statements.
In July 1998, the Company settled its dispute with MEDIQ Inc. The Company
funded the $3,000,000 settlement payment to MEDIQ by fully drawing on the
NationsBank line of credit in the amount of, $500,000, drawing on a portion of
the revolving line of credit with HealthCare Financial Partners, amounting to
$275,000, and receiving a loan from HealthCare Financial Partners of
$2,000,000. The Company's Directors and Officers liability insurance paid the
remaining $225,000 of this settlement.
The loan from HealthCare Financial Partners has a six-month term and an
interest rate of prime plus 2%. In consideration of the loan, the Company
granted HealthCare Financial Partners five year warrants for 300,000 shares of
stock exercisable at $.01 per share. Michael S. Pinkert has also guaranteed
$800,000 of the $2,000,000 HealthCare Financial Partners loan. For his
guaranty, the Company granted Mr. Pinkert ten year warrants for 145,000 share
of stock excerisable at $.50 per share. See Note 10 of Notes to Consolidated
Financial Statements.
The Company expects to repay the $2,000,000 loan with HealthCare Financial
Partners and the $500,000 line of credit with NationsBank from the proceeds of
the sale of real property owned by the Company and proceeds from cost report
settlements outstanding from the sale of the freestanding hospital facilities
in 1996.
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 all of its freestanding facilities,
has taken steps to reduce operating expenses, is attempting to raise additional
capital, and is working to improve its cash flows. See "Recent Developments."
With respect to its efforts to reduce operating expenses, in 1997 the Company
ceased providing extended care services in the States of North Carolina and
Florida, and made a decision to sell, and has sold, substantially all of its
Extended Care Services Division in the first quarter of fiscal 1999. 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 operating losses and raise additional working capital. 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
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.
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<PAGE> 19
This report includes forward-looking statements based on management's
current plans and expectations, relating to 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, and the need to manage
growth.
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<PAGE> 20
ITEM 8 FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report 21
- 1998 and 1997
Independent Auditors' Report - 22
1996
Consolidated Statements of
Operations -
Three Years Ended 23
September 30, 1998
Consolidated Balance Sheets -
September 30, 1998 and 1997 24
Consolidated Statements of
Stockholders' Deficit -
Three Years Ended 25
September 30, 1998
Consolidated Statements of
Cash Flows -
Three Years Ended September 26-
30, 1998 27
Notes to Consolidated 28-
Financial Statements 50
Schedule II- Valuation and
Qualifying Accounts and
Reserves 51
</TABLE>
20
<PAGE> 21
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
MHM Services, Inc.:
We have audited the accompanying consolidated balance sheets of MHM Services,
Inc. and subsidiaries as of September 30, 1998 and 1997, and the related
consolidated statements of operations, stockholders' deficit, and cash flows
for the years then ended. Our audits 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 audits. The accompanying consolidated financial statements of MHM
Services, Inc. as of September 30, 1996, 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 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 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 audits provide a
reasonable basis for our opinion.
In our opinion, the 1998 and 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, 1998 and 1997, and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles. Also, in our
opinion, the financial statement schedule for 1998 and 1997, 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 losses before extraordinary items of $19,892,000 for the three years
ended September 30, 1998, has a working capital deficiency of $2,011,000 as of
September 30, 1998 and is experiencing difficulty in generating sufficient cash
flows to meet its obligations and sustaining its operations, as discussed in
Note 2 to the consolidated financial statements. 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.
KPMG LLP
McLean, Virginia
December 31, 1998
21
<PAGE> 22
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
MHM Services, Inc.
Vienna, Virginia
We have audited the accompanying consolidated statements of operations,
stockholders' deficit, and cash flows of MHM Services, Inc. and subsidiaries
for the year ended September 30, 1996. Our audit also included the financial
statement schedule for the year 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 audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the results of operations and cash flows of MHM Services,
Inc. and subsidiaries for the year ended September 30, 1996 in conformity with
generally accepted accounting principles. Also, in our opinion, the financial
statement schedule for the year 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 the three years ended September 30,
1996 and has stockholders' deficency of 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
22
<PAGE> 23
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended September 30, 1998, 1997, and 1996
<TABLE>
<CAPTION>
1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Net patient service revenue $ 14,864,000 16,986,000 31,400,000
Premium revenue 14,430,000 3,865,000 3,270,000
- ------------------------------------------------------------------------------------------------------------------------------
29,294,000 20,851,000 34,670,000
- ------------------------------------------------------------------------------------------------------------------------------
Costs and expenses:
Operating 20,040,000 14,875,000 25,765,000
General and administrative 7,539,000 5,760,000 9,718,000
Provision for bad debts 3,326,000 3,467,000 6,320,000
Depreciation and amortization 597,000 369,000 1,034,000
(Gain) loss on sale of freestanding facilities (note 4) (2,465,000) - 4,440,000
Writedown of long-term assets (note 6) 430,000 696,000 461,000
Other (credits) charges:
Interest expense - MEDIQ (note 10) 757,000 1,042,000 1,097,000
Interest expense - other 166,000 93,000 290,000
Other income, net (note 3) - (662,000) (233,000)
- ------------------------------------------------------------------------------------------------------------------------------
30,390,000 25,640,000 48,892,000
- ------------------------------------------------------------------------------------------------------------------------------
Loss before income taxes and extraordinary item (1,096,000) (4,789,000) (14,222,000)
Income tax (benefit) expense (note 12) 93,000 - (308,000)
- ------------------------------------------------------------------------------------------------------------------------------
Loss before extraordinary item (1,189,000) (4,789,000) (13,914,000)
Extraordinary item - gain (loss) on early extinguishment
of debt (note 10) 9,185,000 - (463,000)
- ------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 7,996,000 (4,789,000) (14,377,000)
- ------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) per share-basic and diluted:
Loss before extraordinary item $ (0.34) (1.40) (4.20)
Extraordinary item 2.60 - (.14)
- ------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 2.26 (1.40) (4.34)
- ------------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding 3,528,000 3,411,000 3,310,000
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
(Continued)
23
<PAGE> 24
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, 1998 and 1997
<TABLE>
<CAPTION>
=================================================================================================================================
ASSETS (NOTE 10) 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 54,000 108,000
Accounts receivable, less allowances of $4,438,000 and $5,514,000
in 1998 and 1997, respectively 2,706,000 4,491,000
Prepaid expenses 134,000 ,000
Estimated third-party payor settlements (note 7) 1,409,000 103,000
Repossessed property under contract for sale (note 4) 1,172,000 1,910,000
Other current assets 8,000 133,000
- ---------------------------------------------------------------------------------------------------------------------------------
Total current assets 5,483,000 6,964,000
Property, plant, and equipment, net (note 8) 335,000 531,000
Restricted cash 526,000 537,000
Notes receivable, net (note 4) - 1,039,000
Other intangibles, net of accumulated amortization of $395,000
and $144,000 in 1998 and 1997, respectively (notes 5 and 6) 431,000 873,000
Deferred rent - 416,000
Other assets 223,000 288,000
Goodwill, net of accumulated amortization of $419,000 and $266,000
in 1998 and 1997, respectively (notes 5 and 6) 538,000 766,000
- ---------------------------------------------------------------------------------------------------------------------------------
$ 7,536,000 11,414,000
- ---------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
- ---------------------------------------------------------------------------------------------------------------------------------
Current liabilities:
Accounts payable $ 444,000 975,000
Accrued payroll and related expenses 746,000 908,000
Accrued expenses - MEDIQ (note 10) - 1,019,000
Estimated third-party payor settlements (note 7) 967,000 2,187,000
Other accrued expenses (note 9) 2,258,000 2,400,000
Note payable (note 10) 2,000,000 -
Line of credit (note 10) 500,000 -
Current maturities of long-term debt (note 10) 579,000 10,720,000
- ---------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 7,494,000 18,209,000
Long-term debt (note 10) 176,000 1,456,000
Other liabilities - 19,000
- ---------------------------------------------------------------------------------------------------------------------------------
7,670,000 19,684,000
- ---------------------------------------------------------------------------------------------------------------------------------
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:
3,538,000 and 3,513,000 in 1998 and 1997, respectively) 35,000 35,000
Additional paid-in capital 41,938,000 41,798,000
Accumulated deficit (42,107,000) (50,103,000)
- ---------------------------------------------------------------------------------------------------------------------------------
Total stockholders' deficit (134,000) (8,270,000)
- ---------------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies (note 11)
$ 7,536,000 11,414,000
=================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
(Continued)
24
<PAGE> 25
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Deficit
Years ended September 30, 1998, 1997, and 1996
<TABLE>
<CAPTION>
===============================================================================================================================
Common stock
-------------------------- Additional
Shares paid-in Accumulated
issued Amount capital deficit Total
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
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)
Exercise of stock options 25,000 - 12,000 - 12,000
Issuance of stock warrants in connection
With Mediq settlement (note 14) - - 128,000 - 128,000
Net income - - - 7,996,000 7,996,000
- --------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1998 3,538,000 $ 35,000 41,938,000 (42,107,000) (134,000)
================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
(Continued)
25
<PAGE> 26
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended September 30, 1998, 1997, and 1996
<TABLE>
<CAPTION>
1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 7,996,000 (4,789,000) (14,377,000)
Adjustments to reconcile net income (loss) to net cash used in operating
activities:
Depreciation and amortization 597,000 369,000 1,034,000
Provision for bad debts 3,326,000 3,467,000 6,320,000
Provision (benefit) for deferred income taxes - - 500,000
(Gain) loss on sale of freestanding facilities (2,465,000) - 4,440,000
Gain on early extinguishment of debt (9,185,000) - -
Loss on disposal of fixed assets 28,000 - -
Writedown of long-term assets 430,000 696,000 461,000
Increase (decrease) in cash from changes in:
Accounts receivable and estimated third-party payor
settlements, net (2,997,000) (5,000,000) (723,000)
Income taxes refundable - 662,000 (662,000)
Prepaid expenses and other 141,000 (118,000) 10,000
Deferred rent (31,000) (198,000) (52,000)
Accounts payable (531,000) 170,000 (867,000)
Accrued payroll and related expenses (162,000) 325,000 (283,000)
Accrued expenses - MEDIQ 817,000 698,000 (56,000)
Other accrued expenses (380,000) 567,000 (627,000)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (2,344,000) (3,151,000) (4,882,000)
- --------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from sale of freestanding facilities and Joint Venture 3,688,000 - 9,099,000
Capital expenditures for property, plant and equipment (23,000) (178,000) (273,000)
Collections on notes receivable - 190,000 -
Acquisitions of businesses - (427,000) (150,000)
Deferred costs - - 69,000
Restricted cash 11,000 (231,000) (306,000)
Other assets 65,000 (82,000) (30,000)
Other liabilities (19,000) (6,000) (6,000)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 3,722,000 (734,000) 8,403,000
- --------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Borrowings 12,651,000 4,110,000 -
Debt repayments (14,095,000) (3,393,000) (3,280,000)
Other 12,000 (29,000) (20,000)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (1,432,000) 688,000 (3,300,000)
- --------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (54,000) (3,197,000) 221,000
Cash and cash equivalents:
Beginning of year 108,000 3,305,000 3,084,000
- --------------------------------------------------------------------------------------------------------------------------------
End of year $ 54,000 108,000 3,305,000
================================================================================================================================
</TABLE>
(Continued)
26
<PAGE> 27
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
<TABLE>
<CAPTION>
1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------------------
<S> <S> <C> <C>
Supplemental disclosure of cash flow information:
Interest paid $ 292,000 358,000 1,398,000
Income taxes refunded, net of payments - 662,000 71,000
- --------------------------------------------------------------------------------------------------------------------------------
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
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 warrants - to obtain financing from HCFP 128,000 - -
Issuance of stock - acquisition of Apogee - 100,000 -
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
(Continued)
27
<PAGE> 28
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1998, 1997, and 1996
- --------------------------------------------------------------------------------
(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), is a provider of on-site specialty
health care services. The Company provides subacute medical and
behavioral health services to residents of long-term care facilities as
well as to inmates of state correctional facilities. The Company
primarily operates in four states. The Company's premium revenue is
derived from two contracts with the state of Georgia and one contract
with the state of Tennessee.
CONSOLIDATION
The accompanying consolidated financial statements include the accounts
of MHM Services, Inc. and its subsidiaries. All significant
inter-company 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 Extended Care Services
Division are due from its patients (primarily in Massachusetts,
Pennsylvania, Tennessee and Georgia) and other third-party payors,
primarily Medicare (50 percent), Medicaid (20 percent), Blue Cross (5
percent) and various commercial insurance companies and other (20
percent). The Company's accounts receivable from its Correctional
Services Division (5 percent) are due from the states with which MHM
has contracted. The Company maintains an allowance for potential losses
from uncollectible accounts.
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
Leasehold improvements life of lease
(Continued)
28
<PAGE> 29
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(1) CONTINUED
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. It also includes lockbox accounts restricted to pay down a
certain revolving credit facility (see note 10).
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 three to five years (see note 6).
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 three to five 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).
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.
(Continued)
29
<PAGE> 30
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(1) CONTINUED
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
amounts of charity care provided, at established rates, were $14,000,
$12,000, and $682,000 for 1998, 1997, and 1996, 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.
EARNINGS (LOSS) PER SHARE
The Company adopted SFAS No. 128 (Statement 128), Earnings Per Share,
in 1998. Under this statement, earnings (loss) per common share is
computed by dividing net income (loss) by the weighted average number
of common shares outstanding during the year. Common stock equivalents
such as stock options and warrants are excluded from the earnings
(loss) per share calculation because the effect would be antidilutive.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of cash and cash equivalents, restricted cash, accounts
receivable, estimated third-party payor settlements receivable and
payable, 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).
(Continued)
30
<PAGE> 31
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(1) CONTINUED
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 most 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 and other
intangible assets.
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment date.
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 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.
(Continued)
31
<PAGE> 32
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(1) CONTINUED
RECLASSIFICATIONS
Certain items in the prior years' financial statements have been
reclassified to conform to the 1998 presentation.
(2) LIQUIDITY
The accompanying consolidated financial statements have been prepared
on a going concern basis that 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 $11,170,000 for the three years ended September 30, 1998, has
an accumulated deficit of $42,107,000 as of September 30, 1998, and has
a stockholders' deficit of $134,000 as of September 30, 1998. As of
September 30, 1998, the Company is in default on one of its notes
payable (see note 10) and is experiencing difficulty in generating
sufficient cash flows to meet its other obligations and to sustain its
operations. At September 30, 1998, current liabilities exceed current
assets by $2,011,000. 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 May 1996, the Company sold six of its seven freestanding behavioral
health facilities that 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 sold its one remaining freestanding behavioral health facility
(Mountain Crest) on April 17, 1998. Mountain Crest represented
approximately 10 percent of net revenues for fiscal 1998.
The Company has made several acquisitions in its Extended Care Services
Division through fiscal 1997 (see note 5). However, to date, this
division has operated unprofitably overall. As a result, 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.
Effective March 11, 1997, the Extended Care Services Division obtained
a $4,000,000 revolving credit facility to finance its receivables.
Borrowings on the credit facility are limited to qualified accounts
receivable. Also, the Company borrowed $500,000 in October 1997 and
again in July 1998 on a line of credit guaranteed by certain officers
and directors of the Company. In July 1998, the Company borrowed
$2,000,000 to finance a settlement with MEDIQ (note 10).
(Continued)
32
<PAGE> 33
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(2) CONTINUED
In a continuing effort to improve the Company's financial condition for
both the immediate future and the long term, the Company is seeking
more profitable business opportunities through its Correctional
Services Division while divesting of its Extended Care Services
Division. Also, the Company is continuing its efforts to finance its
working capital requirements, 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.
(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 interest in
its management contracts, including related accounts receivable.
The Company was involved in litigation with Horizon involving the
Company's right to certain cash flows as part of the sale of its
interest in the Joint Venture. In May 1997, the Supreme Court of
Delaware upheld a court award in the Company's favor 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 was
equal to the net book value of the Oakview Treatment Center immediately
prior to the sale. The notes were collaterialized by the real property
sold. On July 31, 1998, due to lack of payment on the promissory notes,
MHM declared the notes to be in default. As a result, the Company
reacquired Oakview Treatment Center in a foreclosure sale on
(Continued)
33
<PAGE> 34
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(4) CONTINUED
September 11, 1998. The property was reacquired subject to a junior
lien held by the Internal Revenue Service (IRS). At September 30,1998,
the notes receivable due from the purchaser totaled $1,172,000 and are
reported as repossessed property in the accompanying balance sheets.
The Company has entered into an agreement to resell the property at an
amount that will substantially cover the amount of notes receivable
outstanding. Any sale of the property is contingent upon IRS approval
up until the IRS's right of redemption expires on January 11, 1999.
On May 31, 1996, the Company sold certain assets, consisting
principally of five of its freestanding behavioral healthcare
facilities, to Behavioral Healthcare Corporation (BHC), 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 these six 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.
The Company sold its last freestanding behavioral health facility,
Mountain Crest Hospital, on April 17, 1998. The hospital operations,
together with certain assets previously leased by the Hospital, were
sold to Poudre Valley Hospital for a cash purchase price of
approximately $6,500,000. In connection with the sale to Poudre Valley,
the Company acquired the previously leased assets for a purchase price
of $2,700,000. As a result of this sale, the Company reported a pretax
gain of approximately $2,400,000.
(Continued)
34
<PAGE> 35
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(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 provided behavioral
health and other specialized medical services under annual contracts
with extended care facilities. The operating results are included in
the Company's consolidated 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. The Company estimates that the amount
payable under the terms of the original agreement approximates $337,000
which has been accrued and expensed as of September 30, 1998, 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.
On December 16, 1998, the Company entered into an agreement with
another organization to divest certain of the assets acquired from ICH
related to the delivery of mental health services to patients of
extended care facilities in the state of Georgia. No consideration was
received; however, the Company was relieved of managing the business.
Losses of approximately $75,000 consisting of the writedown of related
intangible assets were recognized in fiscal 1998 in anticipation of
this transaction. The Company's PASARR contract with the State of
Georgia Department of Medical Assistance was not a part of this
transaction.
(Continued)
35
<PAGE> 36
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(5) CONTINUED
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).
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 and
relocated the Charlestown clinic to Cambridge. 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 115 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, paid, and
(Continued)
36
<PAGE> 37
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(5) CONTINUED
expensed annually by the Company and totaled approximately $37,000 and
$3,000 for years beginning December 1, 1997 and 1996, respectively.
On December 31, 1998, the Company entered into an agreement with
another organization to sell certain assets acquired from
National Mentor, Inc., Liberty Bay and Liberty Management related to
the delivery of outpatient mental health services and services to
patients of extended care facilities in the state of Massachusetts.
These assets were sold for $850,000, which will result in a gain on
sale of approximately $200,000 to be recorded by the Company in the
first quarter of fiscal 1999.
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 263 facilities.
The operating results are included in the Company's consolidated
results of operations from the date of acquisition.
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 and did not result
in a liability for the year beginning March 31, 1997. As of September
30, 1998 the Company does not anticipate a liability for the year
beginning March 31, 1998.
On December 16, 1998, the Company entered into an agreement with
another organization to divest certain assets related to the delivery
of mental health services to patients of extended care facilities in
the state of Tennessee. No consideration was received; however, the
Company was relieved of managing the business. Losses of approximately
$176,000 consisting of the write down of related intangibles were
recognized in fiscal 1998 in anticipation of this transaction.
On December 31, 1998, the Company entered into an agreement with
another organization to sell certain assets related to the delivery of
mental health services to patients of extended care facilities in the
state of Pennsylvania. The total consideration for this transaction was
$170,000 of which $20,000 was paid at closing and the remaining
$150,000 was in the form of a promissory note payable, in its entirety,
on March 30,
(Continued)
37
<PAGE> 38
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(5) CONTINUED
1999. The assets acquired by the purchaser in this transaction secure
this note. This transaction will result in a gain on the sale of
approximately $25,000 to be recorded by the Company in the first
quarter of fiscal 1999.
(6) WRITEDOWN OF LONG-TERM ASSETS
In November 1996, the Company decided that its SCC operation was to be
discontinued because of continuing losses. The Company shut down
operations in December 1996. As a result, the carrying value of all
other assets related to SCC, primarily intangible assets were written
down 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 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 resulting in a charge of $696,000 in the year ended
September 30, 1997.
In September 1998, the Company decided to sell certain assets and
contractual rights related to the Extended Care Services Division. In
connection with this decision, the Company determined that the
recoverability of remaining goodwill and other intangible assets
relating to a portion of the HCI Services and Apogee acquisitions (note
5) was permanently impaired. As a result, the carrying value of
goodwill and other intangibles relating to these operations were
written down resulting in a charge of $430,000 in the year ended
September 30, 1998.
HCI Services and Apogee collectively represent revenues of $5,028,000,
$4,771,000 and $5,510,000 and net losses of $1,205,000, $2,645,000 and
$539,000 for the years ended September 30, 1998, 1997, and 1996
respectively.
As a result of sales of assets related to the Extended Care Division
and the Company's last free-standing facility described above and in
note 4, the Company will have virtually no ongoing revenues from those
operations. Had these sales of assets taken place at the beginning of
fiscal year 1998, the Company's total revenues for the year ended
September 30, 1998 would have been approximately $15,000,000.
Similarly, the Company's loss before extraordinary item for the year
ended September 30, 1998 would have been approximately $1,300,000 and
its loss per share before extraordinary item (basic and diluted) would
have been approximately $(.38).
(Continued)
38
<PAGE> 39
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 that 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 two of the six freestanding behavioral health facilities sold in
1996, as well as for the remaining facility sold in 1998.
Tentative and final settlements with all third-party payors for prior
cost reporting periods have resulted in adjustments to increase net
patient service revenue by approximately $762,000 and $965,000 for 1998
and 1997, respectively.
A summary of the payment arrangements with major third-party payors
follows.
MEDICARE
Inpatient non-acute 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.
EXTENDED CARE SERVICES
Professional services provided to residents of extended care facilities
are paid primarily on a fee-for-service basis. Medicare is the primary
payor for such services. The Company is reimbursed based on fee
schedules and is subject to prepayment and retroactive reviews of
medical necessity conducted by the intermediary.
(Continued)
39
<PAGE> 40
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(8) PROPERTY, PLANT, AND EQUIPMENT
Property, plant and equipment includes the following:
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
Leasehold improvements $ 21,000 29,000
Furniture, fixtures, and equipment 968,000 994,000
Equipment under capital lease 323,000 323,000
- -----------------------------------------------------------------------------------------------
1,312,000 1,346,000
Less accumulated depreciation and amortization 977,000 815,000
- -----------------------------------------------------------------------------------------------
$ 335,000 531,000
- -----------------------------------------------------------------------------------------------
</TABLE>
Depreciation and amortization expense related to property, plant, and
equipment was $191,000, $185,000, and $735,000 for 1998, 1997, and
1996, respectively.
(9) OTHER ACCRUED EXPENSES
Other accrued expenses includes the following:
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
Accrued rent $ - 255,000
Accrued refunds 166,000 218,000
Accrued professional fees 665,000 860,000
Accrued miscellaneous taxes 184,000 254,000
Other accrued expenses 1,243,000 813,000
- -----------------------------------------------------------------------------------------------
$ 2,258,000 2,400,000
- -----------------------------------------------------------------------------------------------
</TABLE>
(10) LONG-TERM DEBT
MEDIQ
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 bore interest at a rate of prime plus
1.5 percent, 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
(Continued)
40
<PAGE> 41
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(10) CONTINUED
representing the contractually required principal payments for October
1996 through January 1997, were 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 of 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. For fiscal year
ended September 30, 1997, the outstanding amount owed by the Company
under the MEDIQ Note ($10,478,000) was classified as a current
liability. Additionally, the Company had accrued interest payable under
the terms of the note of $777,000 and other accrued expenses of
$242,000 as of September 30, 1997.
On November 21, 1997, a Judge of the New Jersey Superior Court, Law
Division, Camden County, entered a summary judgement against the
Company and in favor of MEDIQ. The adverse decision dismissed the
Company's suit against MEDIQ and as a result, judgement was entered in
MEDIQ's favor for the full principal balances and related accrued
interest. The Law Division also denied the Company's request for a stay
in the entry of execution of the judgement.
On July 15, 1998, the Company and MEDIQ settled the $11,800,000
judgement against the Company. In return for a cash payment of
$3,000,000 by the Company, MEDIQ has vacated its claim, and released
the Company and its affiliates from any and all other liabilities;
provided, however, no bankruptcy proceedings involving the Company
occur which result in MEDIQ repaying all or part of the settlement
amount it received. The settlement resulted in an extraordinary gain
for fiscal 1998 of approximately $9,185,000.
A $2,000,000 note obtained from HealthCare Financial Partners as well
as draws on the Company's existing line of credit funded the
settlement. The $2,000,000 note is collateralized by substantially all
the assets of the Company, has a six month term expiring in January
1999, carries interest of prime plus two percent, a two percent
(Continued)
41
<PAGE> 42
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(10) CONTINUED
commitment fee, and a completion fee of an additional two percent. The
weighted-average interest rate is 10.42 percent as of September 30,
1998.
REVOLVING CREDIT FACILITY
Effective March 11, 1997, MHM Extended Care Services, Inc. entered into
a $4,000,000 revolving credit facility with 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, 1998 and 1997, the Company had $344,000 and $1,122,000 outstanding
under this facility, respectively. The weighted-average interest rate
is 10.75 percent as of September 30, 1998 and 1997.
LINE OF CREDIT
On October 1, 1997, the Company secured a line of credit with
NationsBank, N.A. that permits maximum borrowings by the Company of
$500,000, with a commitment fee of .5 percent and bears interest at the
Eurodollar Rate plus 2.6 percent, per annum. Certain members of senior
management and a Board member personally guaranteed payment of the line
to include the liability costs, and expenses. For their guarantee the
Company granted the guarantors a security interest in and lien on all
real and personal, tangible or intangible property of the Company. As
of September 30, 1998, the Company had $500,000 outstanding under this
line of credit. The weighted-average interest rate was 7.16 percent.
The line of credit expires in March 1999.
TERM LOANS AND CAPITAL LEASE OBLIGATIONS
At September 30, 1998 and 1997, term loans totaling $339,000 and
$450,000, 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). The note to Apogee totaling $125,000 at
September 30, 1998, is in default for nonpayment of principal and
therefore is classified as a current liability in the consolidated
financial statements.
Capital lease obligations totaling $72,000 and $126,000 at September
30, 1998 and 1997, 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 $76,000 and $115,000, respectively.
(Continued)
42
<PAGE> 43
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(10) CONTINUED
OTHER EARLY EXTINGUISHMENT OF DEBT
In 1996, the Company recorded an extraordinary item in the amount of
$463,000 consisting primarily of costs related to the early
extinguishment of the Company's long-term debt and the write off of
associated loan acquisition costs.
Scheduled maturities of all long-term debt are as follows:
<TABLE>
<CAPTION>
Year ending September 30
- -------------------------------------------------------------------
<S> <C>
1999 $ 579,000
2000 166,000
2001 8,000
2002 2,000
- -------------------------------------------------------------------
$ 755,000
- -------------------------------------------------------------------
</TABLE>
(11) COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases certain equipment and office facilities under
non-cancelable operating leases. The future minimum lease payments
required under operating leases are as follows:
Lease expense was $938,000, $1,496,000, and $1,433,000 for 1998, 1997,
and 1996, respectively.
<TABLE>
<CAPTION>
Year ending September 30
- -------------------------------------------------------------------
<S> <C>
1999 $ 355,000
2000 257,000
2001 246,000
2002 200,000
2003 184,000
Thereafter 77,000
- -------------------------------------------------------------------
Total future minimum lease payments $ 1,319,000
- -------------------------------------------------------------------
</TABLE>
(Continued)
43
<PAGE> 44
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(11) CONTINUED
The Company is currently negotiating a new lease for its Corporate
Office. The Company expects this new lease to commence February 1,
1999.
LITIGATION
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, either pending or threatened, which is likely
to have a material adverse effect on the Company's consolidated
financial statements.
CONTINGENCIES
On November 23, 1998, the Company received a notice from the
Massachusetts Peer Review Organization, Inc. (MassPro), that the
Company's counseling clinic located in Taunton, Massachusetts had
failed to comply with certain regulations, rules, standards and
statutes applicable to providers participating in the Massachusetts
Medical Assistance Program. As a result of MassPro's audit, the Company
was requested to repay the Massachusetts Medical Assistance Program
$215,000. The Company has thirty days to appeal this determination.
Although the Company believes it will prevail in reducing the amount of
repayment requested, the full amount of this potential liability has
been recorded in the consolidated financial statements at September 30,
1998.
MassPro performed a similar audit in April 1998 on the Company's clinic
located in Cambridge, Massachusetts. The Company has not received any
correspondence from MassPro on the results of this audit. The Company
does not believe the results of this audit will have a material
financial impact on the Company's operations.
The Company has been notified that a claim for refund of certain
Medicare payments is being made against SCC to which a subsidiary of
the Company previously provided management services. The claim is being
asserted by the Medicare fiscal intermediary which was responsible for
processing and paying SCC's claims for Medicare payments, and arises
from post payment review by the fiscal intermediary. The claim, which
seeks approximately $1,700,000 in refunds, relates to Medicare
reimbursement paid to the group prior to any involvement of the
Company's subsidiary as well as during the period in which management
services were provided to SCC. No claim has been asserted against the
Company or its subsidiary, and the Company does not believe that it has
any liability with respect to the claims made against SCC.
MALPRACTICE INSURANCE
The Company has a general and professional liability policy that is
written on a claims-made basis with a five year prepaid extended
reporting period. This means coverage is extended for events reported
sixty months after the policy ends, as long as the event
(Continued)
44
<PAGE> 45
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(11) CONTINUED
occurred during the policy period. The coverage per occurrence is
$1,000,000 with a $3,000,000 aggregate.
(12) INCOME TAXES
Income tax (benefit) expense consists of the following:
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ - - (662,000)
State 93,000 - (146,000)
- -----------------------------------------------------------------------------------------------------------------
93,000 - (808,000)
- -----------------------------------------------------------------------------------------------------------------
Deferred:
Federal - - 500,000
State - - -
- -----------------------------------------------------------------------------------------------------------------
- - 500,000
- -----------------------------------------------------------------------------------------------------------------
Total income tax (benefit) expense $ 93,000 - (308,000)
- -----------------------------------------------------------------------------------------------------------------
</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>
1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory expense (benefit) $ (386,000) (1,676,000) (4,888,000)
State income taxes, net of federal (benefit) tax 93,000 (71,000) (96,000)
Valuation allowance 383,000 1,668,000 4,658,000
Goodwill amortization - 5,000 18,000
Other items-net 3,000 74,000 -
- ------------------------------------------------------------------------------------------------------------------------------------
Total income tax (benefit) expense $ 93,000 - (308,000)
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The reconciliation presented above reflects tax expense from income
(loss) before extraordinary items. For 1998, the MEDIQ extraordinary
gain of $9,185,000 does not result in any tax expense. This is due to
the extraordinary gain qualifying for income exclusion under Internal
Revenue Code (IRC) Section 108 and utilization of net operating loss
carry-forwards.
(Continued)
45
<PAGE> 46
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(12) CONTINUED
Significant components of deferred tax assets and liabilities follow:
<TABLE>
<CAPTION>
1998 1997
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Allowance for doubful acounts $ 1,709,000 $ 2,256,000
Net operating loss carryforwards 1,504,000 4,318,000
Writedown of long-term assets 434,000 268,000
Other 105,000 191,000
Valuation allowance (3,700,000) (6,958,000)
- ------------------------------------------------------------------------------------------
52,000 75,000
- ------------------------------------------------------------------------------------------
Liabilities:
Prepaid expenses 52,000 39,000
Depreciation and amoritzation - 36,000
- ------------------------------------------------------------------------------------------
52,000 75,000
- ------------------------------------------------------------------------------------------
Net deferred tax asset $ - -
- ------------------------------------------------------------------------------------------
</TABLE>
At September 30, 1998, for income tax purposes, the Company had federal
operating loss carry-forwards of approximately $3,907,000 and, state
net operating loss carry-forwards of approximately $12,334,000 expiring
through 2012. The income exclusion under IRC Section 108 causes a
reduction in tax attributes; thus net operating loss carry-forwards are
reduced accordingly. The change in valuation allowance was a reduction
of $3,258,000 in 1998 and an increase of $1,668,000 in 1997.
(13) RELATED-PARTY TRANSACTIONS
ACCRUED EXPENSES - MEDIQ
As of September 30, 1997, 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. As of September
30, 1998, there were no accrued expenses payable to MEDIQ.
(Continued)
46
<PAGE> 47
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(13) CONTINUED
INTEREST EXPENSE - MEDIQ
The Company incurred interest expense related to the note payable to
MEDIQ of $757,000, $1,042,000, and $1,097,000 in 1998, 1997, and 1996
respectively.
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 service agreement
terminated in 1996. Fees for such services, were $0, $30,000, and
$38,000 for 1998, 1997, and 1996, 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, and 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 OPTIONS AND WARRANTS
OPTIONS
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. Under the Stock Option Plan
for Non-Employee Directors there is no limitation of the Company's
common stock that may be subject to stock options granted. 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, 1998, options to acquire 174,400 shares of
stock were exercisable under the Stock Option Plan and options to
acquire 7,500 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
re-priced options, at January 30, 1997.
(Continued)
47
<PAGE> 48
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(14) CONTINUED
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 for stock options has been
recognized in the consolidated 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 income
(loss) would have been decreased (increased) to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income (loss):
As reported $ 7,996,000 (4,789,000) (14,377,000)
Pro forma 7,961,000 (4,808,000) (14,391,000)
Income (loss) per common share:
As reported $ 2.26 (1.40) (4.34)
Pro forma 2.25 (1.41) (4.35)
- ------------------------------------------------------------------------------------------
</TABLE>
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 1998, 1997
and 1996, respectively: dividend yield of 0 percent (all years);
expected volatility 126.51, 132.79 and 140.19 percent; risk-free
interest rate of 5.66, 6.46 and 6.90 percent; and expected lives of 8
years (all years).
A summary of the status of the Company's stock options as of September
30, 1998, 1997, and 1996, and changes during the years ended on those
dates is presented below:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------- ------------------------- --------------------------
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 359,400 $ 0.72 259,600 $ 3.28 269,600 $ 3.68
Granted 95,100 0.84 165,000 0.98 61,500 1.99
Exercised (24,800) 0.50 (3,000) 0.50 - -
Forfeited (47,500) 0.74 (62,200) 1.48 (71,500) 3.68
- ---------------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 382,200 0.76 359,400 0.72 259,600 3.28
- ---------------------------------------------------------------------------------------------------------------------------------
Options exercisable at end of year 181,900 0.59 176,400 0.50 161,500 3.62
- ---------------------------------------------------------------------------------------------------------------------------------
Weighted-average fair value
of options granted
during the year $ 0.79 $ 0.93 $ 1.83
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(Continued)
48
<PAGE> 49
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(14) CONTINUED
The following table summarizes information about stock options
outstanding at September 30, 1998:
<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>
$0.50 - $0.75 265,700 6.70 $ 0.55 160,000 0.51
1.00 - 1.50 111,500 8.90 1.23 21,900 1.22
1.75 5,000 9.81 1.75 - -
- ----------------------------------------------------------------------------------------------------------
$0.50 - $1.75 382,200 7.39 0.76 181,900 0.59
- ----------------------------------------------------------------------------------------------------------
</TABLE>
WARRANTS
On July 15, 1998, the Company issued warrants to purchase 300,000
shares of common stock at $.01 per share to HealthCare Financial
Partners (HCFP), in exchange for HCFP granting the Company a $2,000,000
note payable used to fund the MEDIQ settlement (see note 10). The
warrants are immediately exercisable and will expire on July 15, 2003.
This resulted in an expense of $128,000 that served to reduce the MEDIQ
gain.
On July 15, 1998, the Company issued warrants to purchase 145,000
shares of common stock at $.50 per share (which exceeded the current
fair value of each share) to the Company's Chief Executive Officer in
exchange for an $800,000 personal guarantee on the $2,000,000 note
payable to HCFP. The warrants are immediately exercisable and will
expire on July 15, 2008. No expense was attributed to this grant.
On October 1, 1997, the Company issued warrants to purchase 90,000
shares of common stock at $1.51 per share to certain members of the
Company's senior management and a certain Board member in exchange for
personal guarantees on the $500,000 NationsBank, N.A. line of credit
(see note 10). In addition, for each month there was an outstanding
balance on the line of credit, the Company issued additional warrants
to purchase shares of common stock at $1.51 per share. As a result,
during fiscal 1998, an additional 45,900 warrants were granted. All of
the warrants are immediately exercisable and have no expiration period.
No expense was attributed to these grants, as to the exercise price
exceeded the stock's fair value on each date of grant.
(Continued)
49
<PAGE> 50
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(15) RETIREMENT PLAN
The Company has a 401(k) plan (the Plan). Employees, who are age 21 or
older, are eligible to join the Plan upon completion of six months of
service. 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 1.5 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, 1998, 1997, and 1996,
the Company's contributions were $44,000 $38,000, and $70,000,
respectively.
(16) FOURTH-QUARTER RESULTS
The fourth quarter income of approximately $7,024,000 resulted
primarily from the $9,185,000 extraordinary gain on the early
extinguishment of the MEDIQ liability. Excluding the extraordinary
gain, the Company would have experienced a net loss of approximately
$2,161,000, which exceeded prior quarterly reported losses due to
several fourth quarter adjustments such as the following: write down of
goodwill and other intangible assets due to a decision to divest the
Extended Care Services Division ($251,000), an increase in the
allowance for doubtful accounts related to the Extended Care Services
Division ($750,000), an increase in the liability due to ICH ($179,000)
(see note 5), and a liability recorded in connection with a contingency
($215,000) (see note 11). Also, during the fourth quarter, an
adjustment related to changes in estimated third-party payor
settlements occurred, effectively increasing net patient service
revenue by $486,000.
(17) NEW FINANCIAL ACCOUNTING STANDARDS
The Financial Accounting Standards Board has issued SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information
that 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.
- --------------------------------------------------------------------------------
(Continued)
50
<PAGE> 51
SCHEDULE II
MHM SERVICES, INC. AND SUBSIDIARIES
Valuation and Qualifying Accounts and Reserves
Years ended September 30, 1998, 1997, and 1996
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
Balance at Charged to Balance at
beginning of costs and end
period expenses Deductions of period
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Year ended September 30, 1998:
Allowance for doubtful accounts(1) $ 5,514,000 3,326,000 4,402,000 4,438,000
Year ended September 30, 1997:
Allowance for doubtful accounts $ 4,404,000 3,467,000 2,357,000 5,514,000
Year ended September 30, 1996:
Allowance for doubtful accounts $ 1,299,000 6,320,000 3,215,000 4,404,000
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Approximately $650,000 of the 1998 deduction is related
to the sale of Mountain Crest receivables in the sale
described in note 4.
51
<PAGE> 52
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 LLP was engaged as its new independent accountant to
audit the Registrant's consolidated financial statements for the fiscal year
ending September 30, 1998 and 1997.
The independent accountants' report 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
LLP since the date of their engagement.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
<TABLE>
<CAPTION>
NAME AGE POSITIONS WITH THE COMPANY
- ---- --- --------------------------
<S> <C> <C>
Michael S. Pinkert 57 President, Chief Executive Officer and
Director
John L. Silverman (1)(2) 57 Director
William P. Ferretti (2)(3) 53 Director
Michael F. Sandler (3)(4) 53 Director
Steven H. Wheeler 36 Executive Vice President - Operations and
Director
Cleveland E. Slade 43 Vice President and Chief Financial Officer
Robert W. May 38 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
(4) Became a Director August 1998
52
<PAGE> 53
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.
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) and Vitas
Healthcare Corporation (provider of hospice services) and a general partner of
the Mid-Atlantic Venture Fund -II (venture capital firm).
Michael F. Sandler has been a Director of the Company since August 1998.
Mr. Sandler is President and Chief Exexutive Officer of VeriText L.L.C.
Previously, Mr. Sandler held the position Senior Vice President-Finance and
Chief Executive Officer and was on the Board of Directors of MEDIQ, Inc. From
1986 to 1993 the Registrant had been a wholly owned subsidiary of MEDIQ. Mr.
Sandler previously served the Registrant as a Director from August 1993 until
January 1997.
Steven H. Wheeler joined the Company in May 1994 and has served as Vice
President-Operations since December 1997. Prior to this promotion, 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.
Cleveland E. Slade has been Vice President and Chief Financial Officer
since July 1998. Previously, Mr. Slade served as Vice President of Finance,
Chief Financial Officer and Secretary of Sheppard Pratt Foundation from February
1997 to June 1998. Mr. Slade served as Regional Controller and the Corporate
Controller for the Company from September 1994 to January 1997.
53
<PAGE> 54
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. Officers are elected
annually by the Board and serve at the discretion of the Board of Directors.
54
<PAGE> 55
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 1998 (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 1998 237,000 - - 16,927
President & Chief 1997 253,293 - 60,000 18,493
Executive Officer 1996 297,000 - - 5,537
-
Steven H. Wheeler 1998 121,687 - 10,000 8,937
Executive Vice 1997 124,202 - 30,000 7,422
President-Operations 1996 105,000 - - 6,588
And Director
Lee Calligaro 1998 110,000 - - 7,200
Vice President- 1997 - - - -
General Counsel 1996 - - - -
</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
$10,000 for their services in such capacities. In 1993 the Company adopted a
Stock Option Plan for Non-Employee Directors. All options granted under this
plan vest 20% at date of grant with the remaining 80% vesting ratably over four
years. Options granted expire ten years from the date of original grant. On
January 30, 1997, the Company granted 10,000 options to William Ferretti and
10,000 options to Kenneth A. Kessler, M.D. In February 1998, Dr. Kessler
resigned as a Director and all nonvested options were terminated. Additionally
Messrs. Silverman and Freedman were granted 12,500 options each at the time they
became Directors in January 1998 and Mr. Sandler was granted 12,500 options when
he became a Director in August 1998.
55
<PAGE> 56
Stock Options Granted
The following table summarizes stock options granted during fiscal 1998
to the Company's Named Executive Officers.
<TABLE>
<CAPTION>
Potential Realizable
Value at Assumed Annual
Rates of Stock Price
Individual Grants Appreciation for Option
Term (1)
--------------------------------------------------------------------------------------- ----------------------------------
Percent of Total
Options Granted to Exercise or
Options Employees in Base Price Expiration
Name Granted (2) Fiscal Year ($/Share) Date 5% 10%
---- ----------- ----------- --------- ---- -- ---
<S> <C> <C> <C> <C> <C> <C>
Steven H. Wheeler 10,000 17.4% $0.62 12/18/07 $3,075 $7,423
Robert May 2,000 3.5% $1.50 10/29/07 $1,488 $3,592
Robert May 7,000 12.2% $0.62 12/18/07 $2,152 $5,196
Cleveland E. Slade 20,000 35.0% $0.68 05/07/08 $6,745 $16,282
</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.
Aggregated Option and Fiscal Year-End Option Value Table
The following sets forth information concerning the September 30, 1998
value of the exercisable and unexercisable options held by each of the Named
Executive Officers. No stock options were exercised during fiscal 1998 by any of
the Named Executive Officers.
<TABLE>
<CAPTION>
Value of Unexercised
Total Number of In-The-Money Options
Un exercised Options At Year End
Shares
Aquired Value
On Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
<S> <C> <C> <C> <C> <C> <C>
Michael Pinkert - - 100,400 41,600 $53,100 -
Steve Wheeler - - 12,000 38,000 $ 4,130 $9,420
Lee Calligaro - - 4,000 16,000 $ 2,360 $9,440
Robert May - - 4,000 25,000 $ 590 $5,650
Cleveland E. Slade - - - 20,000 - $8,200
</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.
56
<PAGE> 57
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.
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.
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. In 1998 Mr. Pinkert accepted a
voluntary reduction in salary to help improve the Company's cash flow. There was
no consideration for this reduction.
The Company has an incentive compensation program that 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 1998, 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.
57
<PAGE> 58
During fiscal 1998 the Company awarded options for 20,000 shares to
Cleveland E. Slade at the time he joined the Company as Vice President and Chief
Financial Officer. The Company awarded options for 9,000 shares to Robert May
for his achievements in improving operations.
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)
Michael S. Sandler (2)
(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. 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. Upon rejoining the Board of Director in August 1998, he has
been reappointed to 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.
STOCK PERFORMANCE CHART
The following chart compares the cumulative total shareholder return on
the Company's Common Stock for fiscal years 1994 through 1998 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 9/30/98
<S> <C> <C> <C> <C> <C> <C>
MHM Services, Inc. 100 68 85 18 32 26
Peer Group 100 143 129 134 175 29
S&P 600 100 99 125 145 198 168
</TABLE>
58
<PAGE> 59
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of November 30, 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 Named Executive Officer and by all directors and officers of the Company as
a group.
<TABLE>
<CAPTION>
Name Number of % of Class
Shares(1) Outstanding (2)
<S> <C> <C>
Bessie G. Rotko (3) 920,811 26.0%
Michael S. Pinkert 567,803 (4) (5) 16.0%
William P. Ferretti 44,661 (4) 1.3%
Steven H. Wheeler 19,885 (4) (5) *
John L. Silverman 2,500 (4) *
Michael Sandler 2,500 (4) *
Cleveland E. Slade 0 (4) *
Lee Calligaro 40,646 (4) 1.1%
HealthCare Financial Partners 300,000 (7) 8.5%
Apogee, Inc. 200,000 (6) 5.7%
All Executive Officers and Directors as a Group 684,795 19.4%
</TABLE>
* 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.
(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 Provident National Bank, c/o Robert
Tropp, 1600 Market Street, Philadelphia, PA 19103.
(4) Includes options exercisable currently or within the next 60 days
including Mr. Pinkert - 100,400, Mr. Ferretti - 1,130 , Mr.
Wheeler - 17,000 ,Mr. Silverman - 2,500 , Mr. Sandler - 2,500 and
Mr. Calligaro 8,000 and warrants issued including Mr. Pinkert -
238,474, Mr. Ferretti - 31,154 and Mr. Calligaro - 31,154.
(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.
(7) Represents warrants issued to HealthCare Financial Partners as
additional consideration for the $2,000,000 loan the Company used
as a part of the MEDIQ settlement. The address of HealthCare
Financial Partners is 2 Wisconsin Circle, 4th Floor, Chevy Chase,
MD 20815.
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); except that Messrs.
Ferretti and Wheeler each inadvertently filed a Form 4 late, which forms have
been subsequently filed.
59
<PAGE> 60
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 guaranteed 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
granted 90,000 warrants to purchase common stock of the Company at a price of
$1.51 per share. The warrants were issued as follows, Mr. Pinkert - 54,000
shares, Messrs. Ferretti and Calligaro 18,000 shares each. In addition, warrants
are granted each month following that there is a balance outstanding on the
loan. Additional warrants granted through November 30, 1998, were Mr. Pinkert -
33,514, Messrs. Ferretti and Calligaro 11,168 each. The total warrants
outstanding at November 30, 1998 were 590,850.
In funding the MEDIQ settlement, the Company secured a loan for
$2,000,000 from its principle lender HealthCare Financial Partners in July 1998.
The loan from HealthCare Financial Partners has a six-month term and an interest
rate of prime plus 2.6% above the Eurodollar rate. As a condition of granting
the loan, HealthCare Financial Partners required Michael S. Pinkert to guarantee
$800,000 of the $2,000,000 loan. For his guaranty, the Company granted Mr.
Pinkert ten year warrants for 145,000 share of stock exercisable at $.50 per
share.
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statement Schedules are set forth on pages 23 to 27 of
this report
(b) Reports on Form 8-K
The Company filed a voluntary report on Form 8-K on September 29,
1998, announcing the appointment of Michael F. Sandler to the
Board of Directors replacing Richard S. Freedman, who resigned
from the Board. Mr. Freedman gave no reason for his resignation.
(c) Exhibits are listed in the Exhibit Index which is on page 62 of
this Form 10-K and which is incorporated by reference herein.
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<PAGE> 61
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C>
3.1 Restated Articles of Incorporation of MHM Services, Inc. (1)
3.2 Amended By-laws of MHM Services, Inc. (2)
4.1 Specimen certificate (3)
4.2 Common Stock Purchase Warrant Agreement between the Company
and Health Care Financial Partners, Inc. dated July 15, 1998 (4)
4.3 Registration Rights Agreement between the Company and Health
Care Financial Partners, Inc. dated July 15, 1998 (4)
4.4 Registration Rights Agreement between the Company and
Michael S. Pinkert dated July 15, 1998
4.5 Common Stock Purchase Warrant Agreement between the Company
and Michael S. Pinkert dated July 15, 1998 (4)
10.1 1993 Stock Option Plan (5)
10.2 1993 Non-Employee Directors' Stock Option Plan (5)
10.3 1993 Bonus Plan (3)
10.4 1996 Non-Employee Directors' Stock Option Plan (6)
10.5 Amendment to 1993 Stock Option Plan (6)
10.6 Sublease Agreement between the Company and Stanley Martin
Companies, Inc. dated June 1996 (7)
10.7 Contract with Tennessee Department of Corrections (8)
10.8 Consent to Assignment of Contract with Tennessee
Department of Corrections (8)
10.9 Contract with Georgia Department of Corrections (8)
</TABLE>
61
<PAGE> 62
<TABLE>
<S> <C>
10.10 Purchase Agreement with Apogee, Inc. (8)
10.11 Settlement Agreement among MHM Services, Inc., Oakview
Limited Partnership, Columbia Health Associated Limited
Partnership, Michael S. Pinkert and MEDIQ, Incorporated
dated July 15, 1998 (4)
10.12 Promissory Note of MHM Services, Inc., MHM Extended Care
Services, Inc., MHM of Colorado, Inc., Oakview Limited
Partnership and Columbia Health Associated Limited
Partnership to Michael S. Pinkert dated July 15, 1998 (4)
10.13 Credit and Security Agreement among MHM Services, Inc.;
MHM Correctional Services, Inc., MHM Extended Care Services,
Inc. MHM of Colorado, Inc., Oakview Limited Partnership,
Columbia Health Associated Limited Partnership, Michael
S. Pinkert and Health Care Financial Partners Funding II, Inc.
dated July 15, 1998 (4)
10.14 $2,000,000 Promissory Note of MHM Services, Inc., MHM Extended
Care Services, Inc., MHM of Colorado, Inc., Oakview Limited
Partnership, Columbia Health Associated Limited Partnership
to HealthCare Financial Partners Funding II, Inc. dated
July 15, 1998 (9)
21 Subsidiaries of MHM Services, Inc. (9)
23 Consents of KPMG LLP and Deloitte & Touche LLP (9)
27 Financial Data Schedule (9)
</TABLE>
- ----------------
(1) Incorporated by reference to the Registrant's Form 8-K/A dated May 15,
1996
(2) Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended September 30, 1995
(3) Incorporated by reference to the Registrant's Form 10 filed August 13,
1993
(4) Incorporated by reference to the Registrant's Form 10-Q for the quarter
ended June 30, 1998
(5) Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended September 30, 1993
(6) Incorporated by reference to the Registrant's 1996 Annual Meeting Proxy
Statement
(7) Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended September 30, 1996
(8) Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended September 30, 1997
(9) Filed herewith
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<PAGE> 63
7.1 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.
<TABLE>
<S> <C>
Dated January 14, 1999 MHM SERVICES, INC.
By: /s/ Michael Pinkert
---------------------------------
Chief Executive Officer, President
And Director
/s/ Steven H. Wheeler
----------------------------------
Executive Vice President-Operations
And Director
/s/ Cleveland E. Slade
-----------------------------------
Vice President - Finance
Chief Financial Officer
/s/ John L. Silverman
------------------------------------
Director
/s/ William P. Ferretti
-------------------------------------
Director
/s/ Michael F. Sandler
------------------------------------
Director
</TABLE>
63
<PAGE> 1
SECURED BRIDGE NOTE
$2,000,000.00 July 15, 1998
FOR VALUE RECEIVED, and intending to be legally bound, the undersigned,
MHM SERVICES, INC., a Delaware corporation ("MHM"), MHM CORRECTIONAL SERVICES,
INC., a Delaware corporation ("MCS"), MHM OF COLORADO, INC., a Delaware
corporation ("MOC"), MHM EXTENDED CARE SERVICES, INC., a Delaware corporation
("Extended"), OAKVIEW LIMITED PARTNERSHIP, a Maryland limited partnership
("Oakview"), and COLUMBIA HEALTH ASSOCIATES LIMITED, a Maryland limited
partnership ("Columbia" and collectively with Oakview and the MHM entities,
"Borrower"), jointly and severally, promise to pay, in lawful money of the
United States, to the order of HCFP FUNDING II, INC., a Delaware corporation,
its successors and assigns ("Lender"), the principal sum of TWO MILLION AND
NO/100 DOLLARS ($2,000,000.00), or so much of such sum as shall have been
advanced by Lender (the "Principal Sum") in accordance with the terms of this
Secured Bridge Note (the "Note"), together with interest and other fees as
further set forth in this Note, to be paid in accordance with the terms set
forth below.
1. Principal and Interest.
a. If not sooner repaid, Borrower promises to pay to Lender the
entire Principal Sum on January 15, 1999 (the "Maturity Date").
b. In addition to the repayment of the Principal Sum, Borrower
promises to pay to Lender interest on the Principal Sum on a monthly basis from
the date of this Note until the Maturity Date. Interest shall be at a
fluctuating rate per annum (on the basis of the actual number of days elapsed
over a year of 360 days) equal to the Prime Rate plus two percent (Prime plus
2.0%) (the "Base Rate"), provided that after an Event of Default the rate shall
be equal to the Base Rate plus five percent (5%) (the "Default Interest Rate").
For purposes of the foregoing, the term "Prime Rate" means that rate of
interest designated as such by Fleet National Bank of Connecticut, N.A. (the
"Bank"), or any successor to the Bank, as the same may from time to time
fluctuate. If the Bank ceases to designate such a base lending rate, Lender
shall reasonably select an alternate, nationally recognized commercial bank as
the designator of such interest rate. Accrued interest shall be payable monthly
in arrears on the last Business Day (as defined below) of each month from July
31, 1998 and continuing through and including the Maturity Date. After
maturity, and until the entire Principal Sum plus any other amount due and
unpaid shall be paid in full, without limiting any of Lender's other rights and
remedies, all outstanding amounts of the Principal Sum shall bear interest,
payable on demand, at the Default Interest Rate, but in no event shall the
interest payable exceed the maximum lawful rate.
1
<PAGE> 2
c. If interest due under this Note is not paid when due, then
Lender may request that the due and unpaid interest be paid from excess
collections under the working capital line of credit made available to the
borrower under the Loan Agreement (as defined below in Section 4(a)(vii).
d. Repayment of all obligations under this Note is secured by,
among other things, the following:
(i) All of Borrower's rights to payment under that certain
Cost Settlement Report more particularly described on Schedule 1(d) (the "Cost
Settlement");
(ii) That certain Assignment of Deed of Trust Notes as
Collateral from Oakview and Columbia to Lender of even date with this Note (the
"Purchase Note Assignment"), assigning Borrower's rights under (A) that certain
Purchase Money Note No. 1 made by Glass Mental Health Foundation, Inc., a
not-for-profit Maryland corporation ("Glass"), in favor of Oakview and Columbia,
dated as of April 5, 1996, in the original principal amount of One Million Eight
Hundred Seventy-Five Thousand and No/100 Dollars ($1,875,000) ("Purchase Note
1"), and (B) that certain Purchase Money Note No. 2 made by Glass, in favor of
Oakview and Columbia, dated as of April 5, 1996, in the original principal
amount of Two Hundred Seventy-Five Thousand and No/100 Dollars ($275,000.00)
("Purchase Note 2");
(iii) That certain Collateral Assignment of Security Agreement
from Oakview and Columbia to Lender of even date with this Note (the "Security
Agreement Assignment") of Borrower's rights under that certain Security
Agreement made by Glass in favor of Oakview and Columbia, dated as of April 5,
1996 (the "Security Agreement"); and
(iv) That certain Collateral Assignment of Deed of Trust from
Oakview and Columbia to Lender of even date with this Note (the "Deed of Trust
Assignment") of Borrower's rights under that certain first priority Purchase
Money Deed of Trust and Security Agreement dated as of April 5, 1996 (the "Glass
Deed of Trust") executed by Glass in favor of Oakview and Columbia, encumbering
that certain real property at 3100 North Ridge Road, Ellicott City, Howard
County, Maryland (the "Real Property").
2. Fees. In consideration for the extension of credit by Lender as
evidenced by this Note, Borrower shall pay to Lender (i) a Commitment Fee in the
amount of Forty Thousand and No/100 Dollars ($40,000.00), which shall be paid to
Lender through a deduction from the amount to be advanced at the time of the
loan evidenced by this Note; and (ii) a Completion Fee in the amount of Forty
Thousand and No/l00 Dollars ($40,000.00), which shall be due and payable on the
earlier of the Maturity Date or the date on which Borrower pays in full all
principal and interest under this Note.
2
<PAGE> 3
3. Additional Payments. Borrower further promises to pay to Lender,
immediately upon demand, any and all other sums and charges that may at the time
become due and payable under this Note, and all reasonable costs and
disbursements in connection with the preparation of this Note, and in the
collection of any payments due under this Note and in any action, suit or
proceeding to protect, sustain or enforce the rights and remedies of Lender
under this Note.
4. Conditions to Borrowing; Prepayment.
a. Subject to the terms and conditions of this Note, Lender shall
make available to Borrower the Principal Sum, in immediately available funds,
not later than 12:00 Noon (Eastern time) on the Business Day on which the
following conditions precedent are satisfied:
(i) Borrower shall have executed and delivered to Lender
this Note, the Purchase Note Assignment, the Security Agreement Assignment, the
Deed of Trust Assignment, the Common Stock Purchase Warrant made by MHM in favor
of Health Care Financial Partners, Inc., the parent of Lender ("HCFP"), of even
date with this Note (the "Warrant"), the Registration Rights Agreement made by
and between MHM and HCFP, of even date with this Note (the "Registration Rights
Agreement"), and all other documents, certificates and agreements reasonably
requested by Lender and duly executed or delivered in connection with this
transaction;
(ii) Borrower shall have caused to be executed by Michael S.
Pinkert, president of Borrower, that certain Secured Unconditional Guaranty of
Payment and Performance in favor of Lender and of even date with this Note (the
"Guaranty") (this Note, the Purchase Note Assignment, the Security Agreement
Assignment, the Deed of Trust Assignment, the Warrant, the Registration Rights
Agreement, the Guaranty and all such other documents related to the loan, as
amended from time to time, are sometimes collectively referred to in this
Secured Note as the "Loan Documents");
(iii) Borrower shall have delivered to Lender originals of
Purchase Note 1, Purchase Note 2, the Security Agreement and the Glass Deed of
Trust (which are sometimes collectively referred to as the "Glass Documents"),
or an Affidavit of Lost Instrument, in a form acceptable to Lender in its sole
discretion, executed under oath by an officer of Congress Financial Corporation;
(iv) Borrower shall have delivered or caused to be delivered
to Lender a settlement agreement by and between Borrower and Mediq Incorporated
(collectively with any of its subsidiaries or affiliates, "MEDIQ") relating to
the dismissal of all actions pending between Borrower and MEDIQ and as more
particularly described on Schedule 4(a) (collectively, the "MEDIQ Litigation"),
and all other documents necessary to effectuate the dismissal of the MEDIQ
Litigation and/or the satisfaction of all judgments that MEDIQ may have against
Borrower in connection with the MEDIQ Litigation (collectively, the "MEDIQ
3
<PAGE> 4
Judgment"), which documents shall have been executed by all parties and shall be
in form ready for filing with the appropriate courts and any other applicable
authorities:
(v) Borrower shall have delivered or caused to be delivered
to Lender that certain Promissory Note made by Borrower in favor of MEDIQ, which
has been marked as "Settled and Paid", along with UCC-3 Termination Statements,
signed by MEDIQ and any other necessary party, evidencing the release by MEDIQ
of all liens against any of Borrower's assets;
(vi) No Event of Default under this Note and no material
breach under any other Loan Documents, shall have occurred and be continuing;
(vii) No Event of Default shall have occurred under that
certain Loan and Security Agreement by and between Extended and MOC, as
borrower, and HCFP Funding, Inc., an affiliate of Lender ("Funding"), as lender,
dated as of March 11, 1997, as amended on September 24, 1997 and as it may be
amended, modified, restated or replaced from time to time (the "Loan
Agreement");
(viii) All warranties contained in this Note, the other Loan
Documents or otherwise made in writing in connection with this transaction by or
on behalf of Borrower or any party to any Loan Document shall be true and
correct in all material respects;
(ix) Lender shall have received Uniform Commercial Code
("UCC"), judgment and tax lien searches with the Secretary of State and local
filing offices of each jurisdiction where Borrower maintains a place of
business, which searches yield results consistent with the representations and
warranties contained in this Note; and
(x) Borrower shall have used its best efforts to provide an
endorsement in favor of Lender on Borrower's current title insurance policy that
insures the interest of Borrower and its successors and assigns in the Real
Property.
b. Borrower hereby irrevocably authorizes Lender to disburse the
proceeds of the requested advance by wire transfer to such bank account as may
be designated by MHM from time to time or elsewhere if pursuant to written
direction from MHM.
c. Lender shall enter all advances of the Principal Sum as debits
to a loan account in the name of Borrower and shall also record as credits in
the loan account all payments made by Borrower and all proceeds of Collateral
that are indefeasibly paid to Lender, and may record in the loan account, in
accordance with customary accounting practice, other debits and credits,
including interest and all charges and expenses properly chargeable to Borrower,
with respect to the extension of credit contemplated by this Note.
4
<PAGE> 5
d. Lender will account to Borrower monthly with a statement of
advances, charges and payments made pursuant to this Note, and the account
rendered by Lender shall be deemed final, binding and conclusive upon Borrower
absent manifest error.
e. All amounts received by Borrower relating to the Cost
Settlement shall be immediately applied as a mandatory prepayment of principal
under this Note.
f. All amounts received by Borrower as net proceeds on the sale of
the Real Property shall be immediately applied as a mandatory prepayment of
principal under this Note.
g. All amounts due under this Note shall become immediately due
and payable upon the termination of the Loan Agreement.
h. Borrower may prepay all or any part of the Principal Sum
outstanding, without penalty, together with all interest accrued on the
Principal Sum and all other sums that are payable pursuant to this Note.
5. Payment Office. The Principal Sum, the interest on the Principal
Sum, and any other amounts payable under this Note are payable in lawful money
of the United States of America at the office of Lender, at 2 Wisconsin Circle,
Fourth Floor, Chevy Chase, Maryland 20815, Attention: Ethan D. Leder, President
or at such other place as Lender may specify in writing to Borrower. Any payment
by other than immediately available funds shall be subject to collection.
Interest shall continue to accrue until the funds by which payment is made are
available to Lender for its use. Any payment stated to be due on a day on which
banks in Maryland are required or permitted to be closed for business shall be
due and payable on the next business day (each such day, a "Business Day") and
such extension of time shall be included in the computation of interest in
connection with such payment.
6. No Presentment; Acceleration. On the Maturity Date or upon the
occurrence of an Event of Default (as defined in Section 12 below), the
outstanding Principal Sum, accrued and unpaid interest on the Principal Sum, and
all other sums owed by Borrower to Lender in connection with this Note or the
other Loan Documents shall immediately become due and payable. Borrower hereby
expressly waives any presentment for payment, demand for payment, notice of
nonpayment or dishonor, protest and notice of protest of any kind.
7. Security Agreement.
a. This Note shall constitute a security agreement as that term is
used in the UCC and Borrower hereby grants to Lender, in order to secure
Borrower's obligations under this Note, a security interest in the following
(collectively, the "Collateral"):
5
<PAGE> 6
(i) All of Borrower's now-owned and hereafter acquired or
arising Accounts, accounts receivable and rights to payment of every kind and
description, and all of Borrower's contract rights, chattel paper, documents and
instruments with respect thereto, and all of Borrower's rights, remedies,
security and liens, in, to and in respect of the Accounts, including, without
limitation, rights of stoppage in transit, replevin, repossession and
reclamation and other rights and remedies of an unpaid vendor, lienor or secured
party, guaranties or other contracts of suretyship with respect to the Accounts,
deposits or other security for the obligation of any obligor, and credit and
other insurance (for purposes of this Note, "Account" means any right to payment
for goods sold or leased or services rendered, whether or not evidenced by an
instrument or chattel paper, and whether or not earned by performance,
including, without limitation, the right to payment of management fees);
(ii) All moneys, securities and other property and the
proceeds thereof, now or hereafter held or received by, in transit to, in
possession of, or under the control of Lender or a bailee or Affiliate (as
defined in Section 11(j) below) of Lender, from or for Borrower, whether for
safekeeping, pledge, custody, transmission, collection or otherwise, and all of
Borrower's deposits (general or special), balances, sums and credits with Lender
at any time existing;
(iii) All of Borrower's right, title and interest in, to and
in respect of all goods relating to, or which by sale have resulted in,
Accounts, including, without limitation, all goods described in invoices or
other documents or instruments with respect to, or otherwise representing or
evidencing, any Account, and all returned, reclaimed or repossessed goods;
(iv) All of Borrower's now or hereafter acquired deposit
accounts into which Accounts are deposited, including the Lockbox Account (for
purposes of this Note, "Lockbox Account" means an account maintained by Debtor
at Bank One Arizona, N.A. (or a successor financial institution), into which all
collections of Accounts are paid directly);
(v) All of Borrower's now owned and hereafter acquired or
arising general intangibles and other property of every kind and description
with respect to, evidencing or relating to its Accounts, accounts receivable and
other rights to payment, including, but not limited to, all existing and future
customer lists, choses in action, claims, books, records, ledger cards,
contracts, licenses, formulae, tax and other types of refunds, returned and
unearned insurance premiums, rights and claims under insurance policies, and
computer programs, information, software, records, and data, as the same relates
to the Accounts;
(vi) All of Borrower's other general intangibles (including,
without limitation, any proceeds from insurance policies after payment of prior
interests), patents, unpatented inventions, trade secrets, copyrights, contract
rights, goodwill, literary rights, rights to performance, rights under licenses,
choses-in-action, claims, information contained in computer media (such as data
bases, source and object codes, and information therein), things in action,
trademarks and trademarks applied for (together with the goodwill associated
therewith) and
6
<PAGE> 7
derivatives thereof, trade names, including the right to make, use, and vend
goods utilizing any of the foregoing, and permits, licenses, certifications,
authorizations and approvals, and the rights of Borrower thereunder, issued by
any governmental, regulatory, or private authority, agency, or entity whether
now owned or hereafter acquired, together with all cash and non-cash proceeds
and products thereof;
(vii) All of Borrower's now owned or hereafter acquired
inventory of every description which is held by Borrower for sale or lease or is
furnished by Borrower under any contract of service or is held by Borrower as
raw materials, work in process or materials used or consumed in a business,
wherever located, and as the same may now and hereafter from time to time be
constituted, together with all cash and non-cash proceeds and products thereof;
(viii) All of Borrower's now owned or hereafter acquired
machinery, equipment, computer equipment, tools, tooling, furniture, fixtures,
goods, supplies, materials, work in process, whether now owned or hereafter
acquired, together with all additions, parts, fittings, accessories, special
tools, attachments, and accessions now and hereafter affixed thereto and/or used
in connection therewith, all replacements thereof and substitutions therefor,
and all cash and non-cash proceeds and products thereof;
(ix) The proceeds of the Cost Settlement;
(x) Purchase Note 1, Purchase Note 2, the Security
Agreement, and the Glass Deed of Trust; and
(xi) The proceeds (including, without limitation, insurance
proceeds) of all of the foregoing.
Borrower shall, at Borrower's expense, perform all acts and execute
all documents requested by Lender at any time to evidence, perfect, maintain and
enforce Lender's security interest and the priority of Lender's security
interest in the Collateral. Upon Lender's request, at any time and from time to
time, Borrower shall, at Borrower's sole cost and expense, execute and deliver
to Lender one or more financing statements (in form and substance satisfactory
to Lender) pursuant to the UCC and, where permitted by law, Borrower hereby
authorizes Lender to execute and file one or more financing statements signed
only by Lender. Notwithstanding anything to the contrary contained in this Note,
Borrower and Lender agree that Lender is, and shall be deemed to be, the
"secured party" as that term is defined in the UCC and elsewhere with respect to
personal property.
b. In addition to all other rights, options, and remedies granted
to Lender under this Note, upon the occurrence of an Event of Default, Lender
may exercise all other rights granted to it under this Note and all rights under
the Uniform Commercial Code in effect in the
7
<PAGE> 8
applicable jurisdiction(s) and under any other applicable law, and exercise the
following rights and remedies (which list is given by way of example and is not
intended to be an exhaustive list of all such rights and remedies):
(i) The right to take possession of, send notices regarding,
and collect directly the Collateral, with or without judicial process, and to
exercise all rights and remedies available to Lender with respect to the
Collateral under the Uniform Commercial Code in effect in the jurisdiction(s) in
which such Collateral is located;
(ii) The right to (by its own means or with judicial
assistance) enter any of Borrower's premises and take possession of the
Collateral, or render it unusable, or dispose of the Collateral on such premises
in compliance with subsection (c) below, without any liability for rent,
storage, utilities, or other sums, and Borrower shall not resist or interfere
with such action;
(iii) The right to require Borrower at Borrower's expense to
assemble all or any part of the Collateral and make it available to Lender at
any place designated by Lender; and
(iv) The right to relinquish or abandon any Collateral or any
security interest therein.
c. Borrower agrees that a notice received by it at least five (5)
days before the time of any intended public sale, or the time after which any
private sale or other disposition of the Collateral is to be made, shall be
deemed to be reasonable notice of such sale or other disposition. If permitted
by applicable law, any perishable Collateral that threatens to decline rapidly
in value or that is sold on a recognized market may be sold immediately by
Lender without prior notice to Borrower. At any sale or disposition of
Collateral, Lender may (to the extent permitted by applicable law) purchase all
or any part of the Collateral, free from any right of redemption by Borrower,
which right is hereby waived and released. Borrower covenants and agrees not to
interfere with or impose any obstacle to Lender's exercise of its rights and
remedies with respect to the Collateral following an Event of Default.
d. Lender shall have the right to proceed against all or any
portion of the Collateral to satisfy the liabilities and obligations of Borrower
to Lender in any order. All rights and remedies granted Lender under this Note
and under any agreement referred to in this Note, or otherwise available at law
or in equity, shall be deemed concurrent and cumulative, and not alternative
remedies, and Lender may proceed with any number of remedies at the same time
until the Principal Sum, all interest, costs, expenses and other charges due
under, and all other existing and future liabilities and obligations of Borrower
to Lender under, this Note are satisfied
8
<PAGE> 9
in full. The exercise of any one right or remedy shall not be deemed a waiver or
release of any other right or remedy, and Lender, upon the occurrence of an
Event of Default, may proceed against Borrower, and/or the Collateral, at any
time, under any agreement, with any available remedy and in any order.
8. Use of Funds. Borrower covenants and agrees that the loan of the
Principal Sum, or any portion of the Principal Sum, shall be used to settle
the MEDIQ Litigation.
9. Representations. Each entity constituting Borrower hereby warrants
and represents to Lender that:
a. It is either (i) a corporation that has been duly organized and
is validly existing, and in good standing under the laws of its state of
incorporation and is in good standing as a foreign corporation in each
jurisdiction in which the character of the properties owned or leased by it or
the nature of its business makes such qualification necessary, and has the
necessary corporate power and authority to own its assets and transact the
business in which it is engaged, and has obtained all certificates, licenses and
qualifications required under all laws, regulations, ordinances, or orders of
public authorities necessary for the ownership and operation of all of its
properties and transaction of all of its business; or (ii) a limited partnership
for which MHM serves as the general partner, has been duly formed and is validly
existing, and in good standing under the laws of its state of formation and is
in good standing as a foreign limited partnership in each jurisdiction in which
the character of the properties owned or leased by it or the nature of its
business makes such qualification necessary, and has the necessary power and
authority to own its assets and transact the business in which it is engaged,
and has obtained all certificates, licenses and qualifications required under
all laws, regulations, ordinances, or orders of public authorities necessary for
the ownership and operation of all of its properties and transaction of all of
its business
b. Borrower has full power and authority to enter into, execute,
and deliver this Note and to perform its obligations under this Note and the
other Loan Documents, all of which have been duly authorized by all necessary
action of its directors or the directors of its general partner. This Note
constitutes a valid and binding obligation of Borrower, enforceable in
accordance with its terms.
c. The execution, delivery or performance of or under this Note
will not violate or conflict with any law, rule, regulation, order, judgment,
indenture, instrument, or agreement by which Borrower or Borrower's properties
or assets are bound or affect, or conflict or be inconsistent with, or result in
any breach of, any of the terms, covenants or provisions of, or constitute a
default under, or result in the creation or imposition of any lien, security
interest, charge or other encumbrance upon any of the properties or assets of
Borrower, pursuant to the
9
<PAGE> 10
terms of any indenture, mortgage, deed of trust, agreement or other instrument
to which Borrower is a party or by which Borrower's properties or assets may be
bound or to which they may be subject other than a lien, security interest,
charge or other encumbrance in favor of Lender.
d. Other than the MEDIQ Litigation or as disclosed on Schedule
9(d), there are no actions, suits or other proceedings pending, including,
without limitation, any condemnation proceeding, or to the knowledge of Borrower
threatened, against or adversely affecting Borrower's properties or assets or
the validity or enforceability of this Note or the other Loan Documents.
Borrower is not in default with respect to any order, writ, injunction, decree
or demand of any court or governmental authority. Other than as disclosed on
Schedule 9(d), there is no litigation or proceeding, including, without
limitation, any condemnation proceeding, pending or, to the knowledge of
Borrower, threatened against or affecting Borrower's properties or assets, or
any circumstances existing which would in any manner materially adversely affect
Borrower's properties or assets, or the validity or ability of Borrower to
perform any obligations under this Note or the other Loan Documents.
e. The financial statements of Borrower previously delivered to
Lender are true, correct and complete and fairly present the financial condition
of Borrower as of the date presented. No material adverse change in the
financial condition of Borrower has occurred since the date of such financial
statements of Borrower delivered to Lender.
f. Other than those rights of MEDIQ relating to the MEDIQ
Litigation which will be released simultaneously with the closing of the Loan,
Borrower is the sole owner of all right, title and interest in and to all of the
Collateral, free and clear of any lien, security interest, charge or
encumbrance, other than a lien, security interest, charge or other encumbrance
in favor of Lender, and Borrower has the full right, power, and authority to
convey, transfer, and grant the security title and security interest in the
Collateral granted to the Lender.
g. The outstanding balances of Purchase Note 1 and Purchase Note
2, respectively, are as set forth on Schedule 9(g).
10. Affirmative Covenants.
Borrower covenants and agrees that until this Note shall be repaid
in full:
a. Financial Statements. Borrower will furnish to Lender (i)
monthly, quarterly and annual profit and loss statements, balance sheets, and
cash flow reports; (ii) internally prepared annual financial statements for
Borrower within sixty (60) days after the end of Borrower's fiscal years; and
(iii) promptly upon receipt thereof, copies of any reports submitted to Borrower
by independent accountants in connection with any interim audit of the books of
Borrower and copies of each management control letter provided to Borrower by
independent accountants.
10
<PAGE> 11
b. Existence, Good Standing, and Compliance with Laws. Borrower
will do or cause to be done all things necessary to obtain and keep in full
force and effect all corporate or partnership existence, as applicable, rights,
licenses, privileges, and franchises of Borrower necessary to the ownership of
its property or the conduct of its business, and comply with all applicable
present and future laws, ordinances, rules, regulations, orders and decrees of
any governmental authority having or claiming jurisdiction over Borrower.
c. Taxes and Charges. Borrower will timely file all tax reports
and pay and discharge all taxes, assessments and governmental charges or levies
imposed upon Borrower, or its income or profits or upon its properties or any
part thereof, before the same shall be in default and prior to the date on which
penalties attach thereto, as well as all lawful claims for labor, material,
supplies or otherwise which, if unpaid, might become a lien or charge upon the
properties or any part thereof of Borrower; provided, however, that Borrower
shall not be required to pay and discharge or cause to be paid and discharged
any such tax, assessment, charge, levy or claim so long as the validity or
amount thereof shall be contested in good faith and by appropriate proceedings
by Borrower, and Borrower shall have set aside on their books adequate reserve
therefor; and provided further, that such deferment of payment is permissible
only so long as Borrower's title to, and its right to use, the Collateral is not
adversely affected thereby and Lender's lien and priority on the Collateral are
not adversely affected, altered or impaired thereby.
d. Insurance. Borrower will carry adequate public liability and
professional liability insurance with responsible companies satisfactory to
Lender in such amounts and against such risks as is customarily maintained by
similar businesses and by owners of similar property in the same general area.
e. Maintenance of Property. Borrower will maintain, keep and
preserve all of the Note Collateral in good repair, working order and condition
and from time to time make all necessary and proper repairs, renewals,
replacements, betterments and improvements thereto, so that the business carried
on in connection therewith may be properly and advantageously conducted at all
times.
f. Litigation and Other Proceedings. Borrower shall give prompt
notice to Lender of any litigation, arbitration, or other proceeding before any
court or governmental authority against or affecting Borrower if the amount
claimed is not fully insured and is more than $10,000.00.
g. Licensure; Medicare/Medicaid Cost Reports. Borrower will
maintain all certificates of need, provider numbers and licenses necessary to
conduct its business as presently conducted, and take any steps required to
comply with any such new or additional requirements that may be imposed on
providers of medical products and services. If required, all Medicaid/Medicare
cost reports will be properly filed.
11
<PAGE> 12
h. Visits and Inspections. Borrower agrees to permit
representatives of Lender, from time to time, as often as may be reasonably
requested, but only during normal business hours, to visit and inspect the
properties of Borrower, and to inspect, audit and make extracts from its books
and records, and discuss with its officers, its employees and its independent
accountants, Borrower's business, assets, liabilities, financial condition,
business prospects and results of operations.
i. Further Assurances. Borrower will defend its title to the
Collateral against all persons and will, upon request of the Lender, (i) furnish
such further assurances of title as may be required by the Lender, (ii) deliver
and execute or cause to be delivered and executed, in form and content
satisfactory to the Lender, any financing statements, notices, certificates of
title, and other documents and pay the cost of filing or recording the same in
all public offices deemed necessary by the Lender, as well as any recordation,
documentary, or transfer tax required by law to be paid in connection with such
filing or recording, and (iii) do such other acts as the Lender may reasonably
request in order to perfect, preserve, maintain, or continue the perfection of
the Lender's security interest in the Collateral and/or its priority.
j. Dismissal of MEDIQ Litigation. Within one (1) Business Day
after the Closing, Borrower shall make, or shall cause to be made, all necessary
filings with the Court to evidence the dismissal, with prejudice, of the MEDIQ
Litigation.
k. Institution of Foreclosure Proceedings. Within two (2) Business
Days following Lender's written request, Borrower shall instruct its counsel
immediately to file a foreclosure action in the Circuit Court of Howard County,
Maryland seeking foreclosure of the Glass Deed of Trust.
11. Negative Covenants.
Borrower covenants and agrees that until this Note shall be repaid
in full:
a. Borrowing. Borrower will not create, incur, assume or suffer to
exist any liability for borrowed money except: (i) indebtedness to Lender; (ii)
indebtedness of Borrower secured by mortgages, encumbrances or liens expressly
permitted by Lender; (iii) accounts payable to trade creditors and current
operating expenses (other than for borrowed money) which are not aged more than
one hundred twenty (120) days from the billing date or more than thirty (30)
days from the due date, in each case incurred in the ordinary course of business
and paid within such time period, unless the same are being contested in good
faith and by appropriate and lawful proceedings, and Borrower shall have set
aside such reserves, if any, with respect thereto as are required by GAAP and
deemed adequate by Borrower and its independent accountants; and (iv) borrowings
incurred in the ordinary course of its business and not exceeding $10,000.00
12
<PAGE> 13
in the aggregate outstanding at any one time. Borrower will not make
prepayments on any existing or future indebtedness for borrowed money in excess
of $10,000.00 to any third person or entity (other than Lender, to the extent
permitted by this Note or any subsequent agreement between Borrower and
Lender).
b. Liens and Encumbrances. Borrower will not create, incur, assume
or suffer to exist any mortgage, pledge, lien or other encumbrance of any kind
(including the charge upon property purchased under a conditional sale or other
title retention agreement) upon, or any security interest in, any of the
Collateral, whether now owned or hereafter acquired. Notwithstanding the
foregoing, Borrower may grant to Michael S. Pinkert a security interest,
subordinated in all respects to Lender's liens, in all of the Collateral except
Purchase Note 1, Purchase Note 2 and the Glass Deed of Trust.
c. Loans. Borrower will not make loans or advances to any third
person or entity, other than (i) trade credit extended in the ordinary course of
its business, and (ii) advances for business travel and similar temporary
advances in the ordinary course of business to officers, members, directors, and
employees without the prior written consent of Lender.
d. Contingent Liabilities. Borrower will not assume, guarantee,
endorse, contingently agree to purchase or otherwise become liable upon the
obligation of any third person or entity, except by the endorsement of
negotiable instruments for deposit or collection or similar transactions in the
ordinary course of business.
e. Joint Ventures. Borrower will not invest directly or indirectly
in any joint venture for any purpose without the prior written consent of
Lender.
f. Merger, Acquisition, or Sale of Assets. Borrower will not enter
into any merger or consolidation with or acquire all or substantially all of the
assets of any Person, and will not sell, lease, or otherwise dispose of any of
its assets except in the ordinary course of its business without the prior
written consent of Lender.
g. Sale and Leaseback. Borrower will not, directly or indirectly,
enter into any arrangement whereby Borrower sells or transfers all or any part
of its assets and thereupon and within one year thereafter rents or leases the
assets so sold or transferred without the prior written consent of Lender.
h. Distributions. Borrower will not make, declare or pay dividends
or distributions.
i. Subsidiaries. Borrower does not have, and will not form, any
subsidiary with assets valued over $20,000.00, or make any equity investment in
or any loan in the nature of an equity investment to, any other person, without
the prior written consent of Lender.
13
<PAGE> 14
j. Transactions with Affiliates and Subsidiaries. Borrower will
not enter into any transaction, including without limitation the purchase, sale,
or exchange of property, or the lending or giving of funds to any Affiliate or
subsidiary, except in the ordinary course of business and pursuant to the
reasonable requirements of Borrower's business and upon terms substantially the
same and no less favorable to Borrower as it would obtain in a comparable arm's
length transaction with any Person not an Affiliate or subsidiary, and so long
as the transaction is not otherwise prohibited under this Note. For purposes of
the foregoing, the term "Affiliate" means, with respect to a specified Person,
any Person directly or indirectly controlling, controlled by, or under common
control with the specified Person, including without limitation their
stockholders, members and any Affiliates of the specified Person. A Person shall
be deemed to control a corporation, limited liability company or other entity if
the Person possesses, directly or indirectly, the power to direct or cause the
direction of the management and business of the corporation or other entity,
whether through the ownership of voting securities, by contract, or otherwise.
For purposes of the foregoing definition the term "Person" means an individual,
partnership, corporation, trust, joint venture, joint stock company, limited
liability company, association, unincorporated organization, governmental
authority, or any other entity.
k. Contracts and Agreements. Borrower will not become or be a
party to any contract or agreement which would materially breach this Note, or
materially breach any other material instrument, agreement, or document to which
Borrower is a party or by which it is or may be bound.
l. Truth of Statements and Certificates. Borrower will not furnish
to Lender any certificate or other document that contains any untrue statement
of a material fact or that omits to state a material fact necessary to make it
not misleading in light of the circumstances under which it was furnished.
12. Events of Default. The following events are each an "Event of
Default" under this Note:
a. Borrower fails to make any payment of principal when due or
fails to make any payment of interest, fees or other amounts owed to or for the
account of Lender under this Note and such payment remains unpaid for five (5)
days after the date that such payment is due; or
b. Borrower has made any representations or warranties in this
Note, the Loan Documents, any financial statement delivered to Lender or
otherwise in connection with this Note or the related transaction that contains
any untrue statement of a material fact or omits a material fact necessary to
make the statements contained in this Note or in such document or financial
statement not misleading; or
14
<PAGE> 15
c. Borrower shall fail to perform or observe, or cause to be
performed or observed, any other term, obligation, covenant, condition or
agreement contained in this Note or the other Loan Documents, and any such
failure shall have continued for a period of ten (10) days after written notice
of such failure; or
d. Borrower shall (i) apply for, or consent in writing to, the
appointment of a receiver, trustee or liquidator; or (ii) file a voluntary
petition seeking relief under the Bankruptcy Code, or be unable, or admit in
writing Borrower's inability, to pay their debts as they become due; or (iii)
make a general assignment for the benefit of creditors; or (iv) file a petition
or an answer seeking reorganization or an arrangement or a readjustment of debt
with creditors, apply for, take advantage, permit or suffer to exist the
commencement of any insolvency, bankruptcy, suspension of payments,
reorganization, debt arrangement, liquidation, dissolution or similar event,
under the law of the United States or of any state in which Borrower is a
resident; or (v) file an answer admitting the material allegations of a petition
filed against Borrower in any such bankruptcy, reorganization or insolvency case
or proceeding or (vi) take any action authorizing, or in furtherance of, any of
the foregoing; or
e. (i) an involuntary case is commenced against Borrower and the
petition is not contested within ten (10) days or is not dismissed within sixty
(60) days after the commencement of the case or (ii) an order, judgment or
decree shall be entered by any court of competent jurisdiction on the
application of a creditor adjudicating Borrower bankrupt or insolvent, or
appointing a receiver, trustee or liquidator of Borrower or of all or
substantially all of the assets of Borrower and the order, judgment or decree
shall continue unstayed and in effect for a period of sixty (60) days or shall
not be discharged within ten (10) days after the expiration of any stay of such
order, judgment, or decree; or
f. Any obligation of Borrower for the payment of borrowed money in
excess of $10,000.00 is not paid when due or within any applicable grace
period, or such obligation becomes or is declared to be due and payable before
the expressed maturity of the obligation, or there shall have occurred an event
that, with the giving of notice or lapse of time, or both, would cause any such
obligation to become, or allow any such obligation to be declared to be, due
and payable; or
g. One or more final judgments against Borrower or attachments
against its property in excess of $10,000.00 and not fully and unconditionally
covered by insurance shall be rendered by a court of record and shall remain
unpaid, unstayed on appeal, undischarged, unbonded and undismissed for a period
of twenty (20) days; or
h. Borrower ceases any material portion of its business operations
as currently conducted; or
15
<PAGE> 16
i. There shall occur a material adverse change in the financial
condition or business prospects of Borrower, or Lender in good faith shall deem
itself insecure as a result of acts or events bearing upon the financial
condition of Borrower or the ability of Borrower to repay this Note, which
change shall have continued unremedied for a period of ten (10) days after
written notice from Lender; or
j. Borrower shall fail to comply strictly with the terms of
Section 10(j) and/or Section 10(k) of this Note; or
k. An Event of Default shall occur under the Loan Agreement.
13. Lender's Rights.
a. Upon the occurrence of an Event of Default, Lender may, in
addition to its rights and remedies set forth in Section 7 above, proceed, to
the extent permitted by law, to protect and enforce its rights either by suit in
equity or by action at law, or both, whether for the specific performance of any
covenant, condition or agreement contained in this Note or in aid of the
exercise of any power granted in this Note, or proceed to enforce the payment of
this Note or to enforce any other legal or equitable right of Lender. No right
or remedy in this Note or the other Loan Documents or in other agreement or
instrument to the benefit of Lender is intended to be exclusive of any other
right or remedy, and each and every such right or remedy shall be cumulative and
shall be in addition to every other right and remedy given under this Note or
now or hereafter existing at law or in equity or by statute or otherwise.
Without limiting the generality of the foregoing, if the outstanding Principal
Sum, or any of the other obligations of Borrower to Lender shall not be paid
when due, Lender shall not be required to resort to any particular security,
right or remedy or to proceed in any particular order of priority, and Lender
shall have the right at any time and from time to time, in any commercially
reasonable manner and in any order, to enforce its security interests with
respect to the Collateral, liens, rights and remedies, or any of them, as it
deems appropriate in the circumstances, and apply the proceeds of any Collateral
to such obligations of Borrower as it determines in its sole discretion.
b. If an Event of Default has occurred as provided above and
Borrower has not paid the all amounts outstanding, including all principal,
together with interest accrued on such amounts, upon demand by Lender, then
Borrower shall pay to Lender interest on such outstanding amounts at a rate per
annum equal to the Default Interest Rate from the date such outstanding amounts
are due until the date this Note is paid in full. Borrower promises to pay all
costs of collection, including reasonable attorneys' fees, if this Note is
referred to an attorney for collection after the Event of Default.
14. No Defenses. Borrower's obligations under this Note shall not be
subject to any set-off, counterclaim or defense to payment that Borrower now has
or may have in the future.
16
<PAGE> 17
15. No Waiver. No failure or delay on the part of Lender in exercising
any right, power or privilege under this Note or the other Loan Documents nor
any course of dealing between Borrower and Lender, shall operate as a waiver of
the right, power or privilege, nor shall a single or partial exercise of any
right. power or privilege preclude any other or further exercise of, or the
exercise of any other, right, power or privilege.
16. Writing Required. No modification or waiver of any provisions of
this Note or any other Loan Documents, and no consent to any departure by
Borrower, shall in any event be effective, without respect to any course of
dealing between the parties, unless the modification or waiver shall be in a
writing executed by Lender and then such waiver or consent shall be effective
only in the specific instance and for the purpose for which given. No notice to
or demand on Borrower in any case shall thereby entitle Borrower to any other or
further notice or demand in the same, similar or other circumstances.
17. Usury Limitation. Notwithstanding anything contained to the
contrary in this Note, Lender shall never be entitled to receive, collect or
apply as interest any amount in excess of the maximum rate of interest permitted
to be charged by applicable law. If Lender receives, collects or applies as
interest any such excess, the amount that would be excessive interest shall be
applied to the reduction of the Principal Sum; and if the Principal Sum is paid
in full, any remaining excess shall be paid to Borrower. In determining whether
or not the interest paid or payable in any specific case exceeds the highest
lawful rate, Lender and Borrower shall to the maximum extent permitted under
applicable law: (i) characterize any non-principal payment as an expense, fee or
premium rather than as interest; and (ii) "spread" the total amount of interest
throughout the entire term of the obligation so that the interest rate is deemed
to have been uniform throughout the entire term.
18. Notices. Any notice or demand given under this Note shall be given
by delivering it, sending by telecopier (with a confirming copy by regular
mail), or by mailing it by certified or registered mail, postage prepaid, return
receipt requested, or sent by prepaid overnight courier service addressed to
Borrower at MHM Extended Care Services, Inc., 8000 Towers Crescent Drive, Suite
810, Vienna, Virginia 22182, Attention: Mr. Darren Brady, Telephone: (703)
749-4651, Telecopier: (703) 749-4604. Any notice to be given to Lender under
this Note shall be given by personally delivering it, sending it by telecopier
(with a confirming copy by regular mail), mailing it by certified or registered
mail, return receipt requested, or sending it by prepaid overnight courier
service, addressed to Lender at: 2 Wisconsin Circle, Fourth Floor, Chevy Chase,
Maryland 20815 Attention: Ethan D. Leder, President: Telephone: (301) 961-1640,
Telecopier: (301) 664-9860, or at such other place as Lender may specify in
writing to Borrower. Each party may designate a change of address by notice to
the other given in accordance with this Section 18 at least fifteen (15) days
before such change of address is to become effective. A notice given under this
Note shall be deemed received upon receipt if it is personally delivered or sent
by telecopier, five (5) days after it is deposited in the U.S. mail if it is
sent by regular mail, or on the next Business Day after delivery to the
overnight courier service, if it is sent by overnight courier service.
17
<PAGE> 18
19. Section Headings. The headings of the several paragraphs of this
Note are inserted solely for convenience of reference and are not a part of and
are not intended to govern, limit or aid in the construction of any term or
provision.
20. Severability. Any provision contained in this Note that is
prohibited or unenforceable in any respect in any jurisdiction shall, as to
such jurisdiction be ineffective to the extent of such prohibition or
unenforceability without invalidating the remaining provisions hereof and any
such prohibition or unenforceability in any jurisdiction shall not invalidate
or render unenforceable such provision in any other jurisdiction.
21. Survival of Terms. All covenants, agreements, representations and
warranties made in this Note or in any financial statements delivered pursuant
to this Note shall survive Borrower's execution and delivery of this Note to
Lender and shall continue in full force and effect so long as this Note or any
other obligation under this Note shall be outstanding and unpaid or any other
obligation of Borrower to Lender or its affiliates under this Note shall remain
unperformed.
22. GOVERNING LAW; CONSENT TO JURISDICTION. THIS NOTE IS TO BE GOVERNED
BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF MARYLAND WITHOUT
RESPECT TO ANY OTHERWISE APPLICABLE CONFLICTS-OF-LAWS PRINCIPLES, BOTH AS TO
INTERPRETATION AND PERFORMANCE, AND THE PARTIES EXPRESSLY CONSENT AND AGREE TO
THE NON-EXCLUSIVE JURISDICTION OF THE COURTS OF THE STATE OF MARYLAND AND THE
UNITED STATES DISTRICT COURT FOR THE DISTRICT OF MARYLAND AND TO THE LAYING OF
VENUE IN MARYLAND, WAIVING ALL CLAIMS OR DEFENSES BASED ON LACK OF PERSONAL
JURISDICTION, IMPROPER VENUE, INCONVENIENT FORUM OR THE LIKE. BORROWER HEREBY
CONSENTS TO SERVICE OF PROCESS BY MAILING A COPY OF THE SUMMONS TO BORROWER, BY
CERTIFIED OR REGISTERED MAIL, POSTAGE PREPAID, TO BORROWER'S ADDRESS SET FORTH
IN SECTION 18 ABOVE. BORROWER FURTHER WAIVES ANY CLAIM FOR CONSEQUENTIAL DAMAGES
IN RESPECT OF ANY ACTION TAKEN OR OMITTED TO BE TAKEN BY LENDER IN GOOD FAITH.
23. WAIVER OF TRIAL BY JURY. EACH OF BORROWER AND LENDER HEREBY (A)
COVENANTS AND AGREES NOT TO ELECT A TRIAL BY JURY OF ANY ISSUES TRIABLE OF RIGHT
BY A JURY, AND (B) WAIVES ANY RIGHT TO TRIAL BY JURY FULLY TO THE EXTENT THAT
ANY SUCH RIGHT SHALL NOW HEREAFTER EXIST. THIS WAIVER OF RIGHT TO TRIAL BY JURY
IS SEPARATELY GIVEN, KNOWINGLY AND VOLUNTARILY, BY EACH OF BORROWER AND LENDER,
AND THIS WAIVER IS INTENDED TO ENCOMPASS INDIVIDUALLY EACH INSTANCE AND EACH
ISSUE AS TO WHICH THE RIGHT TO A JURY TRIAL WOULD OTHERWISE ACCRUE. EACH PARTY
IS HEREBY
18
<PAGE> 19
AUTHORIZED AND REQUESTED TO SUBMIT THIS NOTE TO ANY COURT HAVING JURISDICTION
OVER THE SUBJECT MATTER AND THE PARTIES TO THIS NOTE, SO AS TO SERVE AS
CONCLUSIVE EVIDENCE OF THE FOREGOING WAIVER OF THE RIGHT TO JURY TRIAL. FURTHER,
EACH OF BORROWER AND LENDER HEREBY CERTIFIES THAT NO REPRESENTATIVE OR AGENT OF
THE OTHER PARTY HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT SUCH OTHER PARTY
WILL NOT SEEK TO ENFORCE THIS WAIVER OF RIGHT TO JURY TRIAL PROVISION.
[SIGNATURES ON FOLLOWING PAGE]
19
<PAGE> 20
IN WITNESS WHEREOF, the undersigned has executed this Secured Bridge Note
as of the day and year first above written.
BORROWER:
MHM SERVICES, INC.
a Delaware corporation
By: /S/ M.S. PINKERT
--------------------------------
Name: M.S. Pinkert
Title: President
MHM CORRECTIONAL SERVICES, INC.
a Delaware corporation
By: /S/ M.S. PINKERT
--------------------------------
Name:
Title:
MHM OF COLORADO, INC.
a Delaware corporation
By: /S/ M.S. PINKERT
--------------------------------
Name:
Title:
MHM EXTENDED CARE SERVICES, INC.
a Delaware corporation
By: /S/ M.S. PINKERT
--------------------------------
Name:
Title:
20
<PAGE> 21
COLUMBIA HEALTH ASSOCIATES LIMITED
a Maryland limited partnership
By: MHM SERVICES, INC.
a Delaware corporation
Its General Partner
By: /S/ M.S. PINKERT
--------------------------------
Name: M.S. Pinkert
Title: President
OAKVIEW LIMITED PARTNERSHIP
a Maryland limited partnership
By: MHM SERVICES, INC.
a Delaware corporation
Its General Partner
By: /S/ [SIGNATURE]
--------------------------------
Name:
Title:
21
<PAGE> 1
EXHIBIT 21
Subsidiaries of MHM Services, Inc.
MHM Extended Care Services, Inc.
MHM Correctional Services, Inc.
MHM of Colorado, Inc.
<PAGE> 1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
MHM Services, Inc.:
We consent to incorporation by reference in the registration statement (No.
333-09147) on Form S-8 of MHM Services, Inc. of our report dated December 31,
1998, on the consolidated balance sheets of MHM Services, Inc. and subsidiaries
as of September 30, 1998 and 1997, and the related consolidated statements of
operations, stockholders' deficit, and cash flows for the years then ended, and
the related schedule, which report appears in the September 30, 1998 annual
report on Form 10-K of MHM Services, Inc.
Our report dated December 31, 1998, contains an explanatory paragraph that
states that the Company has suffered recurring losses from operations, has a
working capital deficiency, 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 and financial statement
schedule do not include any adjustments that might result from the outcome of
that uncertainty.
KPMG LLP
McLean, Virginia
January 14, 1999
<PAGE> 2
Exhibit No. 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
333-09147 of MHM Services, Inc. on Form S-8 of our report dated December 30,
1996, appearing in this Annual Report on Form 10-K of MHM Services, Inc. for
the year ended September 30, 1998.
/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Washington, D.C.
January 6, 1999
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<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-END> SEP-30-1998
<CASH> 54
<SECURITIES> 0
<RECEIVABLES> 7,144
<ALLOWANCES> (4,438)
<INVENTORY> 0
<CURRENT-ASSETS> 5,483
<PP&E> 1,312
<DEPRECIATION> (977)
<TOTAL-ASSETS> 7,536
<CURRENT-LIABILITIES> 4,415
<BONDS> 3,079
0
0
<COMMON> 35
<OTHER-SE> (169)
<TOTAL-LIABILITY-AND-EQUITY> 7,536
<SALES> 0
<TOTAL-REVENUES> 31,759
<CGS> 0
<TOTAL-COSTS> 28,606
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 3,326
<INTEREST-EXPENSE> 923
<INCOME-PRETAX> (1,096)
<INCOME-TAX> 93
<INCOME-CONTINUING> (1,189)
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