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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------------
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, 1999
[ ] 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)
8605 WESTWOOD CENTER DRIVE, SUITE 400, 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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<S> <C>
Name of Each Exchange
Title of Each Class on Which Registered
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COMMON STOCK, PAR VALUE $.01 PER SHARE Over-The-Counter Bulletin Board
</TABLE>
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 stockholders (based upon the closing price of $ .375 of Common
Stock on the Over-The-Counter Bulletin Board) on December 29, 1999, was
approximately $1,134,747.
As of December 29, 1999, there were 3,788,225 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, currently provides on-site behavioral health services through its
wholly owned subsidiary, MHM Correctional Services Inc. (Correctional Services).
Previously, the Company provided extended care services through its wholly owned
subsidiary, MHM Extended Care Services Inc. (Extended Care Services) and
inpatient psychiatric services through its Hospital Division. The Company formed
Correctional Services in 1997, and in the fourth quarter of 1997 secured
contracts with the Tennessee and Georgia Departments of Correction to provide
behavioral health services on a capitated basis to the inmates of those states'
correctional systems. In the second quarter of 1999, Correctional Services was
awarded a contract to provide similar services to the Broward County, Florida
Correctional Systems, as a subcontractor to Prison Health Services, Inc. who
provides general healthcare services to the Broward facility. During fiscal year
1998, the Company made the determination to focus its strategic growth efforts
on the correctional services market and, during the first quarter of fiscal year
1999, the Company sold most of the operations of its Extended Care Services
subsidiary, which had been operating unprofitably. The sole remaining operation
of the Extended Care Services subsidiary had been a capitated contract to
provide services to Medicaid beneficiaries residing in Georgia nursing homes.
Extended Care Services had been providing these services for the state since
1994 under a contract that expired on June 30, 1997. In April 1999, in a
competitive bid process, a new one-year contract was awarded, with three
successive options to renew this contract for additional terms up to one fiscal
year each. The new contract was awarded to Correctional Services effective May
1, 1999, the beginning date of the new contract. In July 1999, Correctional
Services was awarded a one-year contract to provide professional clinical
staffing to the State of Georgia's Department of Juvenile Justice.
Consistent with its strategy of focusing on the correctional services
market, the Company sold its last two freestanding facilities, Mountain Crest
Behavioral Health Systems, an inpatient psychiatric facility in Fort Collins,
Colorado, in the third quarter of 1998, and Oakview Treatment Center, an
inpatient substance abuse facility in Ellicott City, MD, (which the Company
initially sold in 1996 and which was later reacquired by the Company by
foreclosure), in March 1999. With the sales of the Mountain Crest and Oakview
facilities, the Company no longer owns or operates any inpatient facilities.
Collectively, the sale of certain Extended Care Services operations and the sale
of the Mountain Crest and Oakview facilities is hereafter called the
"Divestiture." See "Item 7, Management's Discussion and Analysis of Financial
Conditions and Results of Operations, RECENT DEVELOPMENTS."
CORRECTIONAL SERVICES, INC.
In fiscal 1997, the Company became aware of opportunities to provide
specialized healthcare services to correctional facilities and formed a wholly
owned subsidiary, MHM Correctional Services Inc. (Correctional Services) to
pursue opportunities in this market niche. In February 1997, Correctional
Services 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, in a competitive bid process, awarded Correctional Services a
three-year contract, with an additional one year extension at the State's
option, to provide statewide, on a capitated basis, mental health
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services to the Tennessee prison system, consisting of approximately 28,000
inmates in 22 facilities. Correctional Services began to provide services under
this contract on July 1, 1997. In September 1997, the Georgia Department of
Corrections, in a competitive bid process, awarded Correctional Services, a
contract with the initial term being the remaining nine months of the
Department's fiscal year, with four additional one year extensions at the option
of the State of Georgia, to provide statewide mental health services, on a
capitated basis, to the Georgia correctional system, consisting of approximately
37,000 inmates in 66 facilities. Correctional Services began to provide services
under this contract on October 1, 1997. In April 1999, Correctional Services was
awarded a contract to provide services to the Broward Correctional Institution
in Florida, under a subcontract with PHS, who provides general healthcare
services to this facility. In April 1999, in a competitive bid process, the
State of Georgia awarded the Company, a new one-year contract, with three
successive options to renew for additional terms up to one fiscal year each, a
capitated mental health care service contract for Medicaid beneficiaries
residing in Georgia nursing homes. Due to the Company's decision to shut down
the Extended Care Services subsidiary, the Company decided to bid the new
contract under Correctional Services effective May 1, 1999.
Outsourcing mental health services within correctional systems is a nascent
industry. The Georgia and Tennessee correctional contracts, serving 65,000
inmates, makes the Company one of the leading 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, as well as to
private companies which provide general medical services to correctional
institutions. Most proposals are submitted pursuant to a competitive bid
process. There can be no assurance that Correctional Services will win other
contracts. Net revenues from Correctional Services contracts approximated 78% of
the Company's total net revenues for fiscal 1999.
The Company believes that there are significant opportunities to grow
Correctional Services based on the size of the market, federal and state
mandates for mental health services to prisoners, and the increasing trend for
state departments of corrections to outsource health services. Accordingly, the
Company has decided to focus its growth efforts on this market. Private
contractors provide services representing approximately 30% of current inmate
healthcare spending in the United States. Privatization of inmate healthcare
services continues to increase due to a growing acceptance of the concept
resulting from past success of privatization efforts and a recognition that
managed care practices are applicable in correctional system settings.
The Company provides mental health services to prison inmates and nursing
home residents under its existing contracts. Under these agreements, the Company
receives monthly payments for services based on the number of participants,
regardless of whether services are actually performed by the Company. This form
of payment is referred to as a captiated-basis contract. The Company believes
that there are several business advantages to its providing health care services
on a capitated basis including lower billing/collection costs, more predictable
cash flows, fewer bad debts, less restrictive government regulations and fewer
billing 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.
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EXTENDED CARE SERVICES INC.
Prior to pursuing a strategy in the corrections market, the Company's
wholly owned subsidiary, MHM Extended Care Services, Inc. (Extended Care
Services) represented a significant portion of the Company's revenues. Primarily
through the Company's acquisitions, by the end of fiscal 1998, the Extended Care
Services subsidiary was providing services to residents of extended care
facilities located in Georgia, Massachusetts, New Jersey, Pennsylvania and
Tennessee. A major component of the business of this subsidiary was a contract
to provide certain capitated mental health care services under the Georgia
Medicaid program to Medicaid beneficiaries residing in nursing homes.
At the end of fiscal year 1998, due to continuing operating losses of
Extended Care Services, the Company decided to divest itself of the unprofitable
operations of this subsidiary. With the exception of its capitated Medicaid
contract in Georgia, in December 1998, all assets and operations of this
subsidiary were sold or discontinued resulting in the virtual liquidation of
Extended Care Services.
Although the Company is effectively out of the extended care services
business, it still remains subject to the regulations of certain governmental
reimbursement programs in which it participated. In this regard, the
reimbursement under Medicare and Medicaid has been made subject to audits by
fiscal intermediaries. These audits could expose the Company to additional
future liabilities.
However in August 1999, Extended Care Services filed a notice of intent to
dissolve in Delaware as provided for by Sections 280 and 281 of the Delaware
General Corporation Laws ("DGCL"). Under these sections, DGCL proscribes
procedures by which the Company can satisfy their duty to the creditors of a
dissolved Delaware corporation. Under guidance of Delaware counsel, the Company
is in the process of following these procedures which will result in the
liquidation of the remaining assets of the Extended Care Services subsidiary and
a resolution of all the liabilities of the subsidiary.
HOSPITAL SERVICES
The sale in April 1998, of the Mountain Crest Behavioral Health Systems
located in Ft. Collins, Colorado, resulted in the total cessation of the
Company's inpatient services business. In March 1999, the Company sold a
hospital, Oakview Treatment Center, property that was reacquired by the Company
in September 1998 in a foreclosure.
Although the Company is effectively out of the inpatient business, it still
remains subject to the regulations of 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 settlements 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
limited access to capital, the Company has been experiencing severe difficulty
generating sufficient cash flows from operations to meet its
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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, 1999, 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 divested
itself of the unprofitable extended care operations which had been conducted by
a subsidiary of the Company, expanded its correctional services business, taken
steps to reduce operating expenses, is attempting to raise additional capital,
and is working to 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.
EMPLOYEES
As of September 30, 1999, the Company has 134 full-time and 22 part-time
employees in the correctional services operations. In addition, as of such date,
the Company had 12 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 also has
relationships with certain healthcare professionals 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 becoming profitable in fiscal 2000,
winning new Correctional Services contracts, the liquidation of the Extended
Care Services subsidiary and resolution of its liabilities, the realization of
future revenues under existing contracts, and maintaining existing borrowing
facilities. 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, that new
Correctional Services contracts will not be secured, the Delaware courts may not
grant the Extended Care Services subsidiary dissolution, existing contracts will
continue, the Company will have adequate cash flow to continue to fund ongoing
operations, and retire debt obligations as they become due, the amount and
timing of receipts of third party settlements, government reimbursement, and
risks associated with industry consolidation and acquisitions and competition.
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ITEM 2. PROPERTIES
Currently, the Company's executive offices are located in Vienna, Virginia
pursuant to a lease expiring in March 2004. Pursuant to such lease, the Company
pays annual rent of approximately $26.00 per square foot on approximately 2,900
square feet, with annual increases in an amount equal to 3% of the prior year's
base rent. In addition to its corporate office, the Company maintains two
regional offices, which require annual lease commitments approximating $55,000
per year. The Company believes that its facilities are adequate to carry on its
business as currently structured.
ITEM 3. LEGAL PROCEEDINGS
The Company is, and may be in the future a party to litigation arising in
the ordinary course of its business. While the Company has no reason to believe
that any pending litigation against it is material, there can be no assurance
that the Company's insurance coverage will be adequate to substantially cover
liabilities arising out of such claims or that any such claims will be covered
by the Company's insurance. Any material litigation, which is not covered by
insurance, may have an adverse effect on the Company's business. Claims against
the Company, regardless of their merit, or outcome, may also have an adverse
effect on the Company's reputation and business.
The Company's subsidiary, MHM Extended Care Services, Inc. has substantial
claims asserted against it in favor of fiscal intermediaries under the Medicare
and Medicaid programs. In some cases, the claims have been asserted against
providers for whom the subsidiary provided management services. The subsidiary
does not have assets sufficient to pay these claims; however, the subsidiary has
contested or has valid defenses to many of the claims.
The subsidiary has instituted dissolution proceedings under the General
Corporation Law of the State of Delaware in part to resolve all of its
outstanding liabilities. The Company has been advised that if it complies with
the statutory requirements for these proceedings, its liabilities fixed and
contingent will be resolved, even absent of full payment to its creditors. At
September 30, 1999, MHM Extended Care Services, Inc. had total assets of $81,000
and total liabilities to external creditors of $1,189,000. Final dissolution
requires approval by the Delaware Court of Chancery which is expected in fiscal
year 2000. Therefore, the Company is of the opinion that the potential for
litigation resulting from these claims is remote.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of MHM Services, Inc. was held on July
8, 1999. The following directors were elected at the meeting. (1) Michael S.
Pinkert, (2) Steven H. Wheeler, (3) William P. Ferretti, (4) John Silverman, (5)
Michael F. Sandler, and (6) Jacob A. Shipon, M.D. No other matter was voted upon
at the meeting.
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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") through
June 16, 1998, and the Over the Counter Bulletin Board ("OTC") thereafter:
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<CAPTION>
HIGH LOW
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Year ended September 30, 1999:
First Quarter $1.156 $.563
Second Quarter .781 .500
Third Quarter .750 .438
Fourth Quarter .719 .438
Year ended September 30, 1998:
First Quarter $1.937 $.375
Second Quarter .937 .312
Third Quarter .937 .500
Fourth Quarter 1.750 .438
</TABLE>
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 9, 1999, there were approximately 1,309 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,
-----------------------------------------------------------------------
1999 1998 1997 1996 1995(1)
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<S> <C> <C> <C> <C> <C>
Net revenues $ 18,388 $ 29,294 $ 20,851 $ 34,670 $ 41,109
Costs and expenses:
Operating 15,128 20,040 14,875 25,765 28,918
General and administrative 4,937 7,539 5,760 9,718 10,085
Provision for bad debts 898 3,326 3,467 6,320 4,467
Depreciation and amortization 252 597 369 1,034 1,603
Gain - sale of freestanding facilities (2) - (2,465) - 4,440 -
Gain - on sale of repossessed property (2) (299) - - - -
Writedown of long-term assets (4) - 430 696 461 2,228
Gain - extended care services operations (3) (301) - - - -
Other (credits) charges:
Equity in earnings of Joint Venture - - - - (835)
Gain on sale of Joint Venture - - - - (3,542)
Interest expense - MEDIQ - 757 1,042 1,097 1,171
Interest expense - other 342 166 93 290 366
Other (income) expense-net (5) (37) - (662) (233) (223)
-------- -------- -------- -------- --------
20,920 30,390 25,640 48,892 44,238
Income (loss) before income tax
expense (benefit), extraordinary item
and cumulative effect of a change in
accounting principle (2,532) (1,096) (4,789) (14,222) (3,129)
Income tax (benefit) expense 39 93 - (308) 894
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Income (loss) before extraordinary item (2,571) (1,189) (4,789) (13,914) (4,023)
Extraordinary item (6) - 9,185 - (463) -
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Net (loss) income $ (2,571) $ 7,996 $ (4,789) $(14,377) $ (4,023)
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Earnings (loss) per share-basic and diluted:
Loss before extraordinary item $ (0.72) $ (0.34) $ (1.40) $ (4.20) $ (1.22)
Extraordinary item - 2.60 - (0.14) -
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(Loss) earnings per share $ (0.72) $ 2.26 $ (1.40) $ (4.34) $ (1.22)
======== ======== ======== ======== ========
Weighted average shares outstanding 3,553 3,528 3,411 3,310 3,310
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BALANCE SHEET DATA (IN THOUSANDS)
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<CAPTION>
SEPTEMBER 30
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1999 1998 1997 1996 1995(1)
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Working capital (deficiency) $ (3,016) $ (2,011) $(11,245) $ 2,566 $ 5,923
Total assets 2,282 7,699 11,414 15,669 30,283
Long term debt, less current maturities 5 176 1,456 257 2,422
Due to MEDIQ, less current maturities (7) - - - 9,967 10,733
Stockholders' (deficit) equity (2,453) (134) (8,270) (3,582) 10,795
</TABLE>
SEE NOTES TO SELECTED CONSOLIDATED FINANCIAL DATA
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Notes to Selected Consolidated Financial Data:
(1) Effective August 1, 1994, the Company formed a joint venture ("Joint
Venture") to combine its contract management business with that of Horizon
Mental Health Services, Inc. ("Horizon"). The Joint Venture, which was
owned 27.5% by the Company and 72.5% by Horizon, managed both companies'
hospital behavioral health care contracts. The operating results of the
contract management business were included in the Company's results of
operations through the commencement of the Joint Venture on August 1, 1994.
On March 20, 1995, Horizon completed its initial public offering and, in
accordance with the terms of the Joint Venture Agreement, acquired the
Company's interest in the Joint Venture for approximately $9,600,000 (net
of related expenses). The sale resulted in a pre-tax gain of $3,542,000
(approximately $500,000 net of taxes).
(2) The Company completed the sale of six of its seven freestanding behavioral
health facilities in 1996 and recorded a loss of $4,440,000 consisting
primarily of the write off of intangibles related to the facilities of
$3,184,000, loss on the sale of certain property, plant, and equipment
aggregating $319,000, transaction expenses of $568,000, severance expenses
of $349,000, and other expenses of $680,000, offset by estimated Medicare
depreciation recapture income of approximately $660,000. In April 1998, the
Company sold its last inpatient psychiatric hospital operation and reported
a gain on the sale of $2,465,000. In March 1999, the Company sold a
hospital property that was reacquired by the Company in September 1998. The
Company reported a gain of $299,000 on the sale of repossessed property in
March 1999.
(3) In the first quarter of 1999, the Company sold certain assets of its
Extended Care Services subsidiary, which resulted in a gain of $301,000.
(4) In the fourth quarter of 1998, the Company decided to dispose of certain
assets and contractual rights of its Extended Care Services subsidiary. 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 Subsidiary 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.
(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. In
September 1999, the Company completed its negotiations with ICH Services,
LLC (ICH) regarding certain additional consideration payable to ICH as a
result of the Company acquiring certain assets from ICH in November 1993.
The final settlement resulted in the Company paying less consideration than
it had projected. As a final settlement, the Company paid additional
consideration of 250,000 shares of the Company's common stock. The common
stock was issued in September 1999 at its fair value of approximately
$109,000. The gain from the settlement was applied to the remaining balance
of goodwill recorded as of September 30, 1999 from the initial purchase of
the assets. The net gain of $17,000 is reported as other income in fiscal
year 1999.
(6) In 1996, the Company recorded an extraordinary item in the amount of
$463,000 consisting primarily of costs related to the early retirement of
the Company's long-term debt and the write-off of associated
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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) 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.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the audited
consolidated financial statements, and notes thereto, included elsewhere in this
report.
GENERAL
Historically, the Company has provided on-site behavioral health services
through its subsidiaries MHM Correctional Services, Inc. (Correctional Services)
and MHM Extended Care Services, Inc. (Extended Care Services). The Company has
also provided inpatient psychiatric services through its Hospital Division. The
Company made significant changes in its operations over the past several years,
including the divesting all of the Company's seven freestanding behavioral
healthcare facilities. The Company formed Correctional Services in 1997 and in
the fourth quarter of 1997 Correctional Services secured contracts with the
Tennessee and Georgia Departments of Correction to provide behavioral health
services on a capitated basis to the inmates of those states' correctional
systems. In the second quarter of 1999, Correctional Services was awarded a
contract to provide similar services to the Broward County, Florida Correctional
Systems as a subcontractor to Prison Health Services, Inc. who provides general
healthcare services to the Broward facility. During fiscal year 1998, the
Company made the determination to focus its strategic growth efforts on
Correctional Services and, by the first quarter of fiscal year 1999, the Company
sold most of the operations of Extended Care Services, which had been operating
unprofitably (See "Recent Developments"). The sole remaining operation of
Extended Care Services had been a capitated contract to provide services to
Medicaid beneficiaries residing in Georgia nursing homes. Extended Care Services
had been providing these services for the state since 1994 under a contract that
expired on June 30, 1997. In April 1999, in a competitive bid process, a new
one-year contract was awarded, with three successive options to renew this
contract for additional terms up to one fiscal year each. Due to the Company's
decision to shutdown the Extended Care Services subsidiary, the new contract was
bid by Correctional Services effective May 1, 1999. In July 1999, Correctional
Services was awarded a one-year contract to provide professional clinical
staffing to the State of Georgia's Department of Juvenile Justice.
Consistent with its strategy of focusing on Correctional Services, the
Company sold two freestanding facilities, Mountain Crest, an inpatient
psychiatric facility, in the third quarter of 1998, and Oakview, an inpatient
substance abuse facility, (which the Company initially sold in 1996 and later
reacquired through a foreclosure), in March 1999. With the sales of the Mountain
Crest and Oakview facilities, the Company no longer owns or operates any
inpatient facilities. Collectively, the sale of the Extended Care Services
operations and the sale of the Mountain Crest and Oakview facilities are
hereafter called the "Divestiture."
Borrowings coupled with proceeds from the sales of the Company's inpatient
facilities and certain of its extended care operating units have provided the
Company with sufficient cash to fund the Company's working capital needs as the
Company continued to sustain operating losses. At September 30, 1999, the
Company's current liabilities exceeded its current assets by $3,016,000. With
the sale of the unprofitable operations of Extended Care Services, beginning
October 1, 1999, the Company expects that its remaining operations will be
profitable but it recognizes the level of profits may be insufficient to cover
all of the Company's general and administrative expenses. Therefore, continuing
operations will remain
10
<PAGE> 11
dependent upon the Company securing additional contracts in Correctional
Services and obtaining additional working capital. No assurance can be provided
that the Company will be successful in securing additional contracts or
obtaining additional working capital. See, "Liquidity."
The report of the Company's independent auditors on the Company's audited
consolidated financial statements for the fiscal years ended September 30, 1999
and 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.
RECENT DEVELOPMENTS
On 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 Georgia
Department of Medical Assistance. No consideration was received; however, the
Company was relieved of managing the business. The Company recognized a loss on
sale of $4,000 from this transaction in the first quarter fiscal 1999.
On December 31, 1998, the Company entered into an agreement with another
organization to sell certain of the 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 resulted in the Company recording a gain on sale of approximately $290,000
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 Company and the purchaser extended the payments terms of the note
and as of September 30, 1999, $50,000 was still outstanding. The assets acquired
by the purchaser in this transaction secure this note. This transaction resulted
in the Company recording a gain on sale of $15,000 in the first quarter of
fiscal 1999.
On March 8, 1999, the Company received $1,470,000 from the sale of a
hospital property, Oakview Treatment Center that was reacquired by the Company
on September 11, 1998 in a foreclosure. The transaction resulted in the Company
recording a gain on sale of $299,000 during the second quarter of fiscal 1999.
In August 1999, Extended Care Services filed a Certificate of Dissolution
with the State of Delaware's Secretary of State to obtain a discharge of the
subsidiary's debts. Extended Care Services has notified all current and
potential creditors of its planned dissolution to determine the magnitude of
final claims against the subsidiary. After responses have been received from all
current and potential creditors, Extended Care Services will develop a formal
plan of liquidation of the remaining assets of the subsidiary in accordance with
Delaware Law. This plan will be presented to Extended Care Services creditors
for their approval. If an agreement with the creditors cannot be reached, this
plan will then be submitted to the Delaware Court of Chancery for approval. At
September 30, 1999, Extended Care Services had total assets of $81,000 and total
liabilities to external creditors of $1,189,000.
These transactions and current Company efforts are consistent with
management's strategy to improve the Company's profitability through the
divestiture of certain unprofitable operations of Extended Care Services and
focus on the corrections business.
11
<PAGE> 12
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, due to
pressure lowering utilization rates and reimbursement rates for inpatient care.
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 1999, the Company sold all
of its seven freestanding behavioral health facilities, its unprofitable
Extended Care Services operations and decided to focus on the correctional
mental healthcare services market.
In fiscal 1997, the Company formed its Correctional Services subsidiary 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). In April
1999, Correctional Services was awarded a contract to provide similar services
to the Broward County, Florida correctional system as a subcontractor to Prison
Health Services, Inc. who provides general healthcare services to the Broward
facility.
The Company intends to pursue additional contract opportunities with
correctional service providers, although there can be no assurance that it will
have sufficient resources to do so.
SOURCES OF FINANCING
The Company continues to seek sources of financing to fund operating costs
and expenses. In October 1997, the Company borrowed an aggregate of $500,000
under a line of credit with Bank of America (formerly NationsBank), which debt
was guaranteed by Michael S. Pinkert, President and Chief Executive Officer. In
June 1999, the Company, through it subsidiary Correctional Services, increased
this line of credit to a maximum borrowing capacity of $1,300,000. Again, Mr.
Pinkert personally guaranteed the entire line of credit. As of September 30,
1999, the Company had drawn $1,000,000 against this line. See "Item 13: Certain
Relationships and Related Transactions" and Note 11 of Notes to Consolidated
Financial Statements.
As of September 30, 1999, the Company had a working capital deficit of
$3,016,000. 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
There were no acquisitions made by the Company during fiscal year 1999.
OVERVIEW OF REVENUE SOURCES
Correctional Services 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
78%, 37% and 3% of net revenues for the years ended September 30, 1999, 1998 and
1997, respectively. Net revenues in this subsidiary are reported on an accrual
basis at the capitated rate applied to the number of inmates.
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<PAGE> 13
Extended Care Services revenues were generated primarily by billings to
third-party payors based on a fee-for-service provided basis. Also, in certain
instances, the patient was responsible for all or a portion of the services
provided by the subsidiary. The Company recognized 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 adjusted to actual at the time
the payment for the services provided is actually received.
The Company's Extended Care Services subsidiary's revenues represented
approximately 25%, 52%, and 65% of net revenues for the years ended September
30, 1999, 1998, and 1997, 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 states where revenues had not been
sufficient to operate on a profitable scale. The decreased percentage of
revenues in 1999 compared to 1998 resulted from the sale of the remaining
unprofitable extended care operations in December 1998.
The Hospital Division of 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
included Medicaid and other healthcare insurers. The Company had agreements with
third-party payors that provided 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 has made final settlements for prior
reporting periods for all of the six freestanding facilities sold in 1996. The
Company is in the process of negotiating final settlements for prior reporting
periods relating to filed costs reports for the Mountain Crest facility sold in
1998. The Company does not expect final settlements to differ significantly from
amounts reported in the financial statements as of September 30, 1999.
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
(3)%, 11%, and 32% of the Company's net revenues for the years ended September
30, 1999, 1998 and 1997, respectively. Such revenues were significantly affected
by changes in utilization and reimbursement rates. Typically, payments from such
payors were made at amounts less than the amounts charged, based on existing
contractual relationships or reimbursement methodologies. The Company also
received patient service revenues under payment agreements with commercial
insurance carriers, health maintenance organizations, and preferred provider
organizations. The Company recorded net patient service revenues based upon
expected reimbursement. Certain government-sponsored programs pay primarily on a
cost reimbursement basis. The Company was 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. Such adjustments accounted for the
negative revenue percentage in fiscal year 1999.
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<PAGE> 14
<TABLE>
<CAPTION>
RESULTS FROM OPERATION
YEAR ENDED SEPTEMBER 30
------------------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Net revenues 100.0 % 100.0 % 100.0 %
Costs and expenses:
Operating 82.2 68.4 71.4
General and administrative 26.8 25.7 27.7
Provision for bad debts 4.9 11.4 16.6
Depreciation and amortization 1.4 2.0 1.8
Gain - on sale of repossessed property (1.6) - -
Gain - sale of freestanding facilities - (8.5) -
Gain - extended care services operations (1.6) - -
Writedown of long-term assets - 1.5 3.3
Other (credits) charges:
Interest expense - MEDIQ - 2.6 5.0
Interest expense - other 1.9 0.6 0.4
Other (income) expense-net (0.2) - (3.2)
--------- --------- ---------
Loss before income taxes and extraordinary
item (13.8) (3.7) (23.0)
Income tax expense 0.2 0.3 -
--------- --------- ---------
Loss before extraordinary item (14.0) (4.0) (23.0)
Extraordinary item - loss on early
extinguishment of debt - 31.4 -
--------- --------- ---------
Net (loss) income (14.0) % 27.4 % (23.0) %
========= ========= =========
</TABLE>
14
<PAGE> 15
Fiscal Year 1999 Compared to Fiscal Year 1998
Net revenues for the year ended September 30, 1999, were $18,388,000 as
compared to $29,294,000 for the prior year, a decrease of $10,906,000 or 37%,
which reflects the Divesiture of assets in the third quarter of 1998 and in the
first quarter of 1999. Net revenues from Correctional Services were $14,324,000
in 1999 compared to $10,888,000 in 1998. Correctional Services revenues
increased $3,436,000 or 32% due to the new Broward contract that began in April
1999, the renewed Georgia Medicaid contract which commenced in May 1999, and the
Georgia Department of Juvenile Justice contract which began July 1999. Net
revenues from the Extended Care Services were $4,546,000 in 1999 as compared to
$15,326,000 in 1998, a decrease of $10,780,000 or 70%. The portion of the
Extended Care Services operations that were sold in December 1998, accounted for
$9,291,000 of the decrease. The remaining reduction in Extended Care Services
revenues is primarily attributable to renewal of the Georgia Medicaid contract
in the Correctional Services subsidiary effective May 1, 1999. In April 1998,
the Company sold it last freestanding facility, Mountain Crest Hospital. Net
revenues from freestanding facilities were $2,793,000 for 1998. Settlements on
third party cost reports related to the Hospital Division had a negative impact
of $482,000 on net revenues in 1999 as compared to a $287,000 positive impact on
net revenues in 1998.
Operating expenses for the year ended September 30, 1999, were $15,128,000
as compared to $20,040,000 in the prior year, a decrease of $4,912,000 or 25%.
This decrease was attributable primarily to the Divestiture of certain assets in
the third quarter of 1998 and first quarter of 1999. Operating expenses for
Correctional Services were $12,075,000 in 1999 compared to $9,613,000 in 1998.
Correctional Services operating expenses increased $2,462,000 or 26% primarily
due to the new contracts added in 1999. Extended Care Services operating
expenses were $3,053,000 in 1999 as compared to $8,730,000. The decrease of
$5,677,000 or 65% reflects the sale of substantially all of the operation, with
the exception of the Medicaid Georgia contract, in the first quarter of 1999.
The sale of Mountain Crest Hospital in April 1998 and the decrease in wind-up
costs associated with hospitals sold in 1996 accounted for $1,697,000 of the
decrease in operating expenses between 1999 and 1998.
General and administrative expenses for the year ended September 30, 1999,
were $4,937,000 as compared to $7,539,000 in prior year, a decrease of
$2,602,000 or 35%. Again, this decrease was attributable primarily to the
Divestiture of certain assets in the third quarter of 1998 and first quarter of
1999. Correctional Services general and administrative expenses were $825,000 in
1999 as compared to $483,000 in 1998. General and administrative expenses
increased by $342,000 as a result of additional personnel and facility costs
associated with the new contracts secured by the subsidiary in 1999. Extended
Care Services general and administrative expenses were $1,699,000 as compared to
$3,934,000 in 1998. The decrease of $2,235,000 reflects the sale of certain
Extended Care Services operations in fiscal year 1998 and the first quarter of
1999. The sale of Mountain Crest Hospital in April 1998 accounted for $917,000
of the decrease in general and administrative expenses between 1999 and 1998.
Corporate general and administrative expenses were $2,342,000 in 1999 as
compared to $2,238,000 in 1998. The increase in general and administrative
expenses of $104,000 is attributed to increasing development efforts to grow the
correctional services business.
The provision for bad debts for 1999 decreased to $898,000 as compared to
$3,326,000 for 1998. As a percentage of net revenues, the provision for bad
debts was 4.9% in 1999 and 11.4% in 1998. The Divestiture of certain operations
in the third quarter of 1998 and first quarter of 1999 has moved the Company
from having a significant amount of it revenues on a fee-for service basis,
which required substantial bad debt reserves, to a capitated revenue base, which
has fewer collectibility uncertainties. The 1998 bad debt provision related
primarily to the estimated net realizable value of receivables generated in
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<PAGE> 16
the Extended Care Services subsidiary and reserves on receivables remaining
after the sale of the freestanding facilities. The decrease in the bad debt
provision in 1999 reflects an overall reduction in accounts receivable remaining
after the sale of the freestanding facilities and substantially all Extended
Care Services assets.
Depreciation and amortization decreased to $252,000 in 1999 from $597,000
in the prior year due to the sale of certain operations in the third quarter of
1998 and first quarter of 1999.
In March 1999, the Company received $1,470,000 from the sale of a hospital
property that was reacquired by the Company in September 1998 in a foreclosure.
The transaction resulted in the Company recording a gain on the sale of $299,000
in 1999. 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 in 1998.
In December 1998, the Company sold certain assets related to the delivery
of mental health services to residents of extended care facilities in the states
of Pennsylvania, Georgia, Tennessee and Massachusetts. The Company received
consideration of $1,020,000 in these transactions and recorded a gain on these
sales of $301,000 in 1999.
As a result of the settlement between the Company and MEDIQ, it former
parent, in July 1998, there was no interest expense recorded for the note
payable to MEDIQ in 1999 as compared to $757,000 in 1998. Interest expense -
other increased by $176,000 from $166,000 in 1998 to $342,000 in 1999. Increase
in other interest is the result of interest costs related the Extended Care
Services revolving line of credit with HealthCare Financial Partners, the
six-month loan with HealthCare Financial Partners utilized to settle the MEDIQ
note, and the increase in the line of credit with Bank of America (formerly
NationsBank) used to fund current operations
Other income of $37,000 is attributable to $28,000 from interest income
earned on certificates of deposit serving as performance bonds for existing
contracts, $20,000 in other fees paid for an extension of payment terms for a
note due the Company and $5,000 from interest earned on operating cash accounts.
The Company realized a gain of $17,000 from the final settlement with the former
partners of ICH in regards to additional consideration due the partners from the
acquisition of HCI Services, Inc. in 1993. In addition, the Company realized a
$33,000 loss on disposal of certain assets.
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 an extraordinary gain of
$9,185,000 related to early extinguishment of debt.
The net loss in 1999 was $2,571,000 as compared to net income in 1998 of
$7,996,000. Approximately $1,722,000 of the current year loss can be attributed
to the assets and operations sold in the Divestiture. The net income for 1998
was primarily derived from the gain on sale of the Company's last freestanding
hospital and the extraordinary gain on the MEDIQ settlement.
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 Correctional Services in 1998. Net
revenues from the Correctional Services were $10,888,000 in 1998 compared to
$632,000 in 1997. Correctional Services commenced operations in February 1997.
Net revenues from the Extended Care Services 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 during fiscal 1997; Liberty Bay
16
<PAGE> 17
(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 Correctional
Services, 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 in 1997, an increase of $1,779,000 or
31%. Again, this increase was attributable primarily to increased costs in
Correctional Services.
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, the provision for bad
debts was 11.4% in 1998 and 16.6% in 1997. Increased revenues from Correctional
Service have primarily caused this reduction. Because these revenues are paid on
a capitated basis, there are fewer collectibility uncertainties. The 1998 bad
debt provision relates to the estimated net realizable value of receivables
generated in Extended Care Services 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 sale of certain operations in
Extended Care Services.
Depreciation and amortization increased to $597,000 in 1998 from $369,000
in the prior year. The Company reevaluated useful lives and accelerated
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, the Company took a write down of $430,000 of goodwill and
capitalized 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 Bank of America (previously 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 an extraordinary 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 extraordinary gain from the MEDIQ
settlement. The gain from sale of the freestanding hospital and the operation of
the Correctional Services Subsidiary in Georgia and Tennessee generated taxable
income in certain states resulting in an estimated state tax provision of
$93,000 in 1998.
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<PAGE> 18
MAJOR CUSTOMERS
Correctional Services was awarded a multi-year contract (single year with
four optional extension years) with the State of Georgia's Department of
Corrections, 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. For the year ended September 30, 1999, the contract accounted for 49% of
net revenues. This contract is projected to provide approximately $9,100,000 of
annual revenue. The contract is subject to the procurement process of the State
of Georgia, and there is no assurance as to the realization of future revenues
under the contract.
In May 1999, Correctional Services was awarded a one-year capitated
contract, with three successive options to renew this contract for additional
terms up to one fiscal year each, to provide mental health services to
approximately 2,400 Medicaid beneficiaries residing in nursing homes under the
Pre-Admission Screening and Annual Resident Review (PASARR) contract with the
State of Georgia's Department of Medical Assistance. For the year ended
September 30, 1999, the contract accounted for 20% of net revenues. This
contract is projected to provide approximately $4,000,000 of annual revenue. The
contract is subject to the procurement process of the State of Georgia, and
there is no assurance as to the realization of future revenues under the
contract.
Correctional Services was awarded a three-year contract, with an one-year
option to renew at the State's option, 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 and will expire on June
30, 2000. For the year ended September 30, 1999, the contracts accounted for 12%
of net revenues or approximately $2,100,000. The Company expects to renew this
contract at the end of its current term. This contract is subject to the
procurement process of the State of Tennessee, and there is no assurance as to
the realization of future revenues under the contract.
Correctional Services was awarded a three-year contract, with two
additional one year options, as a subcontractor to Prison Health Services, Inc.,
to provide mental health services on a capitated basis to the inmates of Broward
County Correction Institute, Broward County, Florida. This contract began April
1, 1999, and represented 8% of net revenues for the year ended September 30,
1999. This contract is projected to provide approximately $3,200,000 of annual
revenue. Correctional Services, as a subcontractor to Prison Health Services,
Inc., is subject to a 180 day no cause termination of its services by Prison
Health Services, Inc., or a termination of the prime contract by the State of
Florida. There is no assurance as to the realization of future revenue under the
contract.
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, the Company's costs rise proportionately.
The Company has implemented systems to monitor and control increases in
expenses. The Company's capitated contracts with the correctional systems 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
18
<PAGE> 19
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 a relationship with a third-party vendor to provide
electronic billing services for one of its Medicaid contracts in its
Correctional Services subsidiary. The vendor has represented to the Company that
this billing system is Year 2000 compliant. The Company's management has not
performed any reviews over that system, though the vendor is a major supplier of
electronic billing services for the Medicaid program. If their systems were to
fail, the Company would manually prepare and mail their billings to Medicaid for
services rendered.
The Company has outsourced its payroll processing to an independent payroll
company. That vendor has represented to the Company that their payroll
processing system is 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 payroll company would
manually prepare payroll checks for our employees.
The Company's information systems are resident on personal computers.
During fiscal year 1999, the Company spent $13,000 to upgrade its hardware and
software to make these systems Year 2000 compliant. The Company is continuing to
review its systems and plans to spend an additional $10,000 in upgrades to the
system prior to the calendar year end.
LIQUIDITY AND CAPITAL RESOURCES
On September 30, 1999, the Company had cash of $6,000, compared to $54,000
at September 30, 1998. The decrease in available cash is the result of the
Company using cash to fund continued operating losses. As of September 30, 1999,
the Company has a working capital deficit of $3,016,000 as compared to
$2,011,000 as of September 30, 1998. Of the total working capital deficit,
$1,108,000 relates to Extended Care Services subsidiary. As previously
mentioned, this subsidiary recently filed for corporate dissolution under
Delaware law in order to obtain a discharge of its debts.
The Company has funded its operating losses through a combination of the
proceeds derived from the sale of certain operations of its subsidiary operating
units and through borrowed funds. The Company had utilized a revolving credit
facility for its Extended Care Services subsidiary, which was repaid from
collections of accounts receivable remaining from the divested operating units
during the second quarter of 1999. In addition, as of September 30 1999, the
Company has utilized $1,000,000 of a line of credit from Bank of America
(formerly NationsBank) with a maximum borrowing capacity of $1,300,000.
The Company anticipates that it will continue to maintain its borrowing
capacity under the $1,300,000 line of credit, although this cannot be assured.
The line of credit alone, however, will not be sufficient to fund the Company's
working capital needs. The Company realizes that to sustain its operations,
additional correctional service contracts will be required and that even if such
additional contracts are obtained, additional working capital may be necessary
to fund operating expenses until the additional contracts produce contributions
to the Company's cash flow. Therefore, the Company is currently seeking
investment capital for its Correctional Services subsidiary; however, there is
no assurance that the Company will be successful. The Company further recognizes
that it has exhausted its ability to obtain working capital from proceeds
obtained upon the disposition of operating units which are no longer part of the
Company's strategic focus. As the Company seeks to obtain additional contracts
in its Correctional Services subsidiary, it will attempt to continue reducing
its general and administrative expenses. No assurance can be provided, however,
that any of the Company's efforts to improve its current financial condition
will be successful or that the Company will be able to continue in business.
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<PAGE> 20
This report includes forward-looking statements based on management's
current plans and expectations relating to becoming profitable in fiscal 2000,
winning new Correctional Services contracts, the liquidation of the Extended
Care Services subsidiary and resolution of its liabilities, the realization of
future revenues under existing contracts, and maintaining existing borrowing
facilities. 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, that new
Correctional Services contracts will not be secured, Delaware courts may not
grant the Extended Care Services subsidiary dissolution, existing contracts will
not continue, the Company will have adequate cash flow to continue to fund
ongoing operations, and retire debt obligations as they become due, risks
associated with industry consolidation and acquisitions and competition
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<PAGE> 21
ITEM 8 FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S> <C>
Independent Auditors' Report
- 1999 and 1998 22
Consolidated Statements of
Operations -
Three Years Ended
September 30, 1999 23
Consolidated Balance Sheets -
September 30, 1999 and 1998 24
Consolidated Statements of
Stockholders' Deficit -
Three Years Ended
September 30, 1999 25
Consolidated Statements of
Cash Flows -
Three Years Ended 26-
September 30, 1999 27
Notes to Consolidated 28-
Financial Statements 46
Schedule II- Valuation and
Qualifying Accounts and
Reserves 47
</TABLE>
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<PAGE> 22
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, 1999 and 1998, and the related
consolidated statements of operations, stockholders' deficit, and cash flows for
each of the years in the three-year period ended September 30, 1999. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the 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 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, 1999 and 1998, and the results of their
operations and their cash flows for each of the years in the three-year period
ended September 30, 1999, in conformity with generally accepted accounting
principles.
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The supplementary
information included in Schedule II is presented for purposes of additional
analysis and is not a required part of the basic consolidated financial
statements. Such information has been subjected to the auditing procedures
applied in the audits of the basic consolidated financial statements and, in our
opinion, is fairly stated in all material respects in relation to the basic
consolidated financial statements taken as a whole.
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 item of $8,549,000 for the three years
ended September 30, 1999, has an accumulated deficit of $44,678,000 as of
September 30, 1999, has a working capital deficiency of $3,016,000 as of
September 30, 1999, and is experiencing difficulty in generating sufficient cash
flows to meet its obligations and sustaining its operations, as further
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 17, 1999
22
<PAGE> 23
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ -------------
Revenues:
<S> <C> <C> <C>
Net patient service revenue $ 2,207,000 14,864,000 16,986,000
Premium revenue 16,181,000 14,430,000 3,865,000
------------ ------------ -------------
18,388,000 29,294,000 20,851,000
------------ ------------ -------------
Costs and expenses:
Operating 15,128,000 20,040,000 14,875,000
General and administrative 4,937,000 7,539,000 5,760,000
Provision for bad debts 898,000 3,326,000 3,467,000
Depreciation and amortization 252,000 597,000 369,000
Gain on sale of freestanding facilities (note 4) -- (2,465,000) --
Gain on sale of repossessed property (note 4) (299,000) -- --
Writedown of long-term assets (note 6) -- 430,000 696,000
Gain on sale of extended care division assets (301,000) -- --
Other (credits) charges:
Interest expense - MEDIQ (note 11) -- 757,000 1,042,000
Interest expense - other 342,000 166,000 93,000
Other income, net (notes 3 and 5) (37,000) -- (662,000)
------------ ------------ -------------
20,920,000 30,390,000 25,640,000
------------ ------------ -------------
Loss before income taxes and extraordinary item (2,532,000) (1,096,000) (4,789,000)
Income tax expense (note 14) 39,000 93,000 --
------------ ------------ -------------
Loss before extraordinary item (2,571,000) (1,189,000) (4,789,000)
Extraordinary item - gain on early extinguishment
of debt (note 11) -- 9,185,000 --
------------ ------------ -------------
Net income (loss) $(2,571,000) 7,996,000 (4,789,000)
============ ============ =============
Earnings (loss) per share-basic and diluted:
Loss before extraordinary item $ (0.72) (0.34) (1.40)
Extraordinary item -- 2.60 --
------------ ------------ -------------
Net income (loss) $ (0.72) 2.26 (1.40)
============ ============ =============
Weighted average shares outstanding 3,553,000 3,528,000 3,411,000
============ ============ =============
</TABLE>
See accompanying notes to consolidated financial statements
23
<PAGE> 24
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, 1999 and 1998
<TABLE>
<CAPTION>
ASSETS (NOTE 11) 1999 1998
------------- -------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 6,000 54,000
Accounts receivable, less allowances of $337,000
and $4,438,000 in 1999 and 1998, respectively 1,094,000 2,706,000
Prepaid expenses 284,000 134,000
Estimated third-party payor settlements (note 7) 61,000 1,409,000
Repossessed property under contract for sale (note 4) -- 1,172,000
Other current assets (note 8) 269,000 171,000
------------ ------------
Total current assets 1,714,000 5,646,000
Property and equipment, net (note 9) 142,000 335,000
Restricted cash 275,000 526,000
Other intangibles, net of accumulated amortization of $0
and $395,000 in 1999 and 1998, respectively (notes 5 and 6) -- 431,000
Other assets 151,000 223,000
Goodwill, net of accumulated amortization of $0
and $419,000 in 1999 and 1998, respectively (notes 5 and 6) -- 538,000
============ ============
$ 2,282,000 7,699,000
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Cash overdrafts $ 24,000 --
Accounts payable 768,000 425,000
Accrued payroll and related expenses 607,000 830,000
Estimated third-party payor settlements (note 7) 784,000 1,181,000
Other accrued expenses (note 10) 1,085,000 2,054,000
Notes payable (note 11) 187,000 2,069,000
Line of credit (note 11) 1,000,000 500,000
Current maturities of long-term debt (note 11) 275,000 598,000
------------ ------------
Total current liabilities 4,730,000 7,657,000
Long-term debt (note 11) 5,000 176,000
------------ ------------
4,735,000 7,833,000
------------ ------------
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: 3,788,000 and 3,538,000 in 1999 and 1998, respectively) 37,000 35,000
Additional paid-in capital 42,188,000 41,938,000
Accumulated deficit (44,678,000) (42,107,000)
------------ ------------
Total stockholders' deficit (2,453,000) (134,000)
------------ ------------
Commitments and contingencies (note 12)
$ 2,282,000 7,699,000
============ ============
</TABLE>
See accompanying notes to consolidated financial statements
24
<PAGE> 25
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Deficit
Years ended September 30, 1999, 1998, and 1997
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
------------------------------
SHARES PAID-IN ACCUMULATED
ISSUED AMOUNT CAPITAL DEFICIT TOTAL
------------ ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
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 16) -- -- 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)
Issuance of stock warrants in
connection with Line of Credit
(note 16) -- -- 143,000 -- 143,000
Shares issued in connection with
ICH earnout settlement (note 5) 250,000 2,000 107,000 -- 109,000
Net loss -- -- -- (2,571,000) (2,571,000)
------------ ----------- ----------- ----------- -----------
Balance, September 30, 1999 3,788,000 $ 37,000 42,188,000 (44,678,000) (2,453,000)
============ =========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
25
<PAGE> 26
25
<PAGE> 27
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended September 30, 1999, 1998, and 1997
<TABLE>
<CAPTION>
1999 1998 1997
----------- ---------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $(2,571,000) 7,996,000 (4,789,000)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 252,000 597,000 369,000
Issuance of stock warrants 143,000 -- --
Provision for bad debts 898,000 3,326,000 3,467,000
Gain on sale of freestanding facilities -- (2,465,000) --
Gain on sale of extended care operations (301,000) -- --
Gain on sale of repossessed property (299,000) -- --
Gain on early extinguishment of debt -- (9,185,000) --
Loss on disposal of fixed assets 33,000 28,000 --
Writedown of long-term assets -- 430,000 696,000
Increase (decrease) in cash from changes in:
Accounts receivable and estimated third-party
payor settlements, net 1,665,000 (2,997,000) (5,000,000)
Income taxes refundable -- -- 662,000
Prepaid expenses and other (69,000) 141,000 (118,000)
Deferred rent -- (31,000) (198,000)
Accounts payable 343,000 (531,000) 170,000
Accrued payroll and related expenses (223,000) (162,000) 325,000
Accrued expenses - MEDIQ -- 817,000 698,000
Other accrued expenses (632,000) (308,000) 567,000
----------- ----------- -----------
Net cash used in operating activities (761,000) (2,344,000) (3,151,000)
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sale of freestanding facilities and Joint Venture 870,000 3,688,000 --
Proceeds from sale of reprocessed property 1,471,000 -- --
Disposals of extended care services assets 143,000
Capital expenditures for property, plant and equipment (45,000) (23,000) (178,000)
Collections on notes receivable 100,000 -- 190,000
Acquisitions of businesses -- -- (427,000)
Restricted cash 251,000 11,000 (231,000)
Other assets -- 65,000 (82,000)
Other liabilities -- (19,000) (6,000)
----------- ----------- -----------
Net cash provided by (used in) investing
activities 2,790,000 3,722,000 (734,000)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from cash overdrafts 24,000 -- --
Borrowings 3,514,000 12,651,000 4,110,000
Debt repayments (5,615,000) (14,095,000) (3,393,000)
Other -- 12,000 (29,000)
----------- ----------- -----------
Net cash provided by (used in) financing
activities (2,077,000) (1,432,000) 688,000
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents (48,000) (54,000) (3,197,000)
Cash and cash equivalents:
Beginning of year 54,000 108,000 3,305,000
----------- ----------- -----------
End of year $ 6,000 54,000 108,000
=========== =========== ===========
</TABLE>
(Continued)
26
<PAGE> 28
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, continued
Years ended September 30, 1999, 1998, and 1997
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Supplemental disclosure of cash flow information:
Interest paid $ 376,000 292,000 358,000
Income taxes refunded, net of payments -- -- 662,000
=========== =========== ===========
Supplemental disclosure of non-cash investing and financing activities:
Acquisition - portion financed with long-term debt $ -- -- 275,000
Note received from sale of Extended Care Services assets 170,000 -- --
Issuance of stock warrants - to obtain financing from
Bank of America 143,000 -- --
Issuance of stock warrants - to obtain financing
from HCFP -- 128,000 --
Note obtained for insurance premiums 225,000 107,000 --
Issuance of stock - settlement of ICH earnout 109,000 -- --
Issuance of stock - acquisition of Apogee -- -- 100,000
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
27
<PAGE> 29
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) ORGANIZATION
MHM Services, Inc., through its wholly-owned subsidiary, MHM
Correctional Services, Inc. (Correctional Services) is a provider of
mental health services under capitated contract arrangements with
correctional facilities and residents of a long-term care facility.
The Company had provided on-site behavioral mental healthcare services
through its wholly-owned subsidiary, MHM Extended Care Services, Inc.
(Extended Care Services) and inpatient services through its Hospital
Division and MHM of Colorado Inc.
The Company primarily operates in three states. The Company's premium
revenue is derived from three contracts with the state of Georgia, one
contract with the state of Tennessee, and one subcontract with a prime
contractor to the State of Florida. The Company is compensated on the
basis of the number of in-mates or residents in each of the
facilities. The Company's contracts provide for fixed capitation
rates. The terms of each contract vary and can be from one to four
years. Contracts for more than one year have annual renewal options
for mutliple years which are exercisable on mutual agreement between
the Company and the government agency or contractor.
(b) 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.
(c) CASH EQUIVALENTS
Cash equivalents include all liquid investments with remaining
maturities at purchase of three months or less.
(d) ACCOUNTS RECEIVABLE
The Company's account receivable are primarily from Correctional
Services operations for services rendered to residents of correctional
and long-term care facilities. The amounts are due from the states and
the prime contractor with which MHM has contracted. The Company
maintains an allowance for potential losses from uncollectible
accounts.
(e) PROPERTY AND EQUIPMENT
Property 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:
<TABLE>
<S> <C>
Furniture fixtures and equipment 5-8 years
Equipment under capital lease 5-8 years
Leasehold improvements life of lease
</TABLE>
28 (Continued)
<PAGE> 30
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
(f) 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 a medicaid capitation contract with the
State of Georgia. It also includes lockbox accounts restricted to pay
down a revolving credit facility (see note 11).
(g) 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).
(h) 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).
(i) CARRYING VALUE OF LONG-TERM ASSETS
The Company evaluates the carrying value of its long-term assets,
including property and equipment, goodwill and other intangible
assets, based upon current and anticipated undiscounted cash flows,
and recognizes an impairment when it is probable that such estimated
future 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).
(j) 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.
(k) PREMIUM REVENUE RECOGNITION
The Company has agreements with two states and a contractor 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. These capitated payments are earned
and recognized as revenue on a monthly basis.
(l) 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.
(m) EARNINGS (LOSS) PER SHARE
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
29 (Continued)
<PAGE> 31
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
as stock options and warrants are excluded from the earnings (loss)
per share calculation because the effect would be antidilutive.
(n) 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, accrued expenses, notes payable and lines
of credit 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 11) are considered to be equivalent
to their carrying values based upon consideration of borrowings with
similar credit ratings, collateral and maturities.
(o) 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, and the estimated impairment of
goodwill and other intangible assets.
(p) 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.
(q) STOCK OPTION PLAN
The Company accounts for stock-based compensation plans using the
intrinsic value based method of accounting prescribed by APB Opinion
No. 25, Accounting for Stock Issued to Employees; however the Company
discloses the proforma effect on net income as if the fair value based
method of accounting as defined in SFAS No. 123 had been applied.
(r) RECLASSIFICATIONS
Certain amounts in the 1998 financial statements have been
reclassified to conform to the 1999 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 before
extraordinary item of $8,549,000 for the three years ended September 30,
1999, has an accumulated deficit of
30 (Continued)
<PAGE> 32
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
$44,678,000 as of September 30, 1999, and has a stockholders' deficit of
$2,453,000 as of September 30, 1999. As of September 30, 1999, the Company
is in default on one of its notes payable (see note 11) and is experiencing
difficulty in generating sufficient cash flows to meet its other
obligations and to sustain its operations. At September 30, 1999, current
liabilities exceed current assets by $3,016,000. 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 April 1998, the Company sold its one remaining freestanding behavioral
health facility (Mountain Crest). This facility was sold due the
expectation of more profitable opportunities to grow Correctional Services
and other specialty on-site healthcare services.
The Company made several acquisitions in Extended Care Services through
fiscal 1998 (see note 5). However, to date, the subsidiary has operated
unprofitably. As a result, in the first quarter of 1999, the Company sold
substantially all of its Extended Care Services operations and is making
selective reductions in operating and general and administrative costs.
Extended Care Services represented approximately 25 percent of net revenues
for fiscal 1999.
Effective March 11, 1997, Extended Care Services obtained a $4,000,000
revolving credit facility to finance its receivables. Borrowings on the
credit facility were 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 11). In June 1999, the Company increased its borrowing under a
line of credit from $500,000 to $1.3 million.
On August 24, 1999, Extended Care Services notified the state of Delaware
about its intent to dissolve under Section 275 of the General Corporation
Law of the State of Delaware. Subsequent to the filing, Extended Care
Services informed all known and foreseeable creditors about its intent for
dissolution. Extended Care Services has begun preparing a dissolution plan
for which to pay its creditors. Extended Care Services expects its plan of
dissolution will be approved by the Delaware Court of Chancery in fiscal
year 2000. MHM Extended Care Services, Inc. has total assets of $81,000 and
total liabilities to external creditors of $1,189,000 at September 30,
1999. If the plan of dissolution is approved by the Delaware Court of
Chancery, the Company will be relieved of approximately $1,108,000 of
liabilities to external creditors.
Proceeds from the sales of the Company's inpatient facilities and
substantially all of its Extended Care Services operations have provided
the Company with sufficient cash to fund the Company's working capital
needs as the Company continues to sustain operating losses. With the sale
of the unprofitable operations of Extended Care Services in 1999, the
Company expects that its remaining operations will be profitable, but it
recognizes the level of profits may be insufficient to cover all of the
Company's general and administrative expenses. Therefore, continuing
operations will remain dependent upon the Company securing additional
contracts in Correctional Services and obtaining additional working
capital. 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.
(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
31 (Continued)
<PAGE> 33
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
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
collateralized by the real property sold. On July 31, 1998, due to lack of
payment on the promissory notes, the Company declared the notes to be in
default. As a result, the Company reacquired Oakview Treatment Center in a
foreclosure sale on 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 entered into an agreement to resell the property in fiscal
1998. The sale was settled on March 8, 1999 and resulted in a gain of
approximately $299,000 in fiscal 1999.
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
in fiscal 1998.
(5) ACQUISITIONS
(a) HCI SERVICES
In November 1993, Extended Care Services 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.
32 (Continued)
<PAGE> 34
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
On December 16, 1998, Extended Care Services entered into an agreement
with another organization to divest substantially all 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.
On September 9, 1999, the Company negotiated a final settlement with
the former partners of ICH to pay the additional consideration with
250,000 shares of the Company's common stock. The common stock was
issued in September 1999 at its fair value of approximately $109,000.
At the time of settlement, substantially all the assets previously
acquired had been sold. Therefore, the effect of this settlement
resulted in a reversal of amounts previously accrued totaling
$337,000, a write down of remaining goodwill totaling $209,000, and
the remainder credited to other income, net.
(b) MHM COUNSELING SERVICES
In December 1995, Extended Care Services 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.
(c) LIBERTY BAY
Effective as of December 1, 1996, Extended Care Services 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. Extended Care Services 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, Extended Care Services 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. Extended Care Services
obtained an extention of the payment of the principal amount of the
note to December 31, 2000. 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 expensed annually by
the Company and totaled approximately $0 and $37,000 for years
beginning December 1, 1998 and 1997, respectively.
On December 31, 1998, Extended Care Services entered into an agreement
with another organization to sell certain of the 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 resulted in a gain on
sale of approximately $290,000 in fiscal 1999.
33 (Continued)
<PAGE> 35
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
(d) APOGEE
Effective as of March 31, 1997, Extended Care Services 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 Extended Care Services paid
$100,000 in cash, issued a three year promissory note in the principal
amount of $125,000, and the Company 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. Extended Care Services 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 additional consideration
for the years beginning March 31, 1997 or 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. The sale resulted in a
loss of $4,000 which was recognized in fiscal 1999. Losses of
approximately $176,000 consisting of the write down of related
intangibles were recognized in fiscal 1998.
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, 1999. The assets acquired by the purchaser in
this transaction secure this note. This transaction resulted in a gain
on the sale of approximately $15,000 in fiscal 1999.
(6) WRITEDOWN OF LONG-TERM ASSETS
In September 1997, the Company decided to dispose of the Florida and North
Carolina operations of Extended Care Services 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 additional assets
and contractual rights related to the Extended Care Services. 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.
34 (Continued)
<PAGE> 36
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
HCI Services and Apogee collectively represent revenues of $2,919,000,
$5,028,000, and $4,771,000, respectively. HCI Services and Apogee
collectively represent net losses of $371,000, $1,205,000 and $2,645,000
for the years ended September 30, 1999, 1998 and 1997 respectively.
As a result of sales of assets related to Extended Care Services described
above and in note 4, the Company has no ongoing revenues from those
operations. Had these sales of assets taken place at the beginning of
fiscal year 1999, the Company's total revenues for the year ended September
30, 1999 would have been approximately $15,895,000. Similarly, the
Company's net loss for the year ended September 30, 1999 would have been
approximately $804,000 and its loss per share (basic and diluted) would
have been approximately $(.23).
(7) THIRD-PARTY PAYORS
The Company had agreements with third-party payors that provided for
payments for patient services at amounts that differed from its established
rates. The Company is in the process of negotiating final settlements for
prior reporting periods relating to filed cost reports for a freestanding
behavioral health facility sold in 1998.
Tentative and final settlements with all third-party payors for prior cost
reporting periods have resulted in adjustments to decrease net patient
service revenue by approximately $1,056,000 for 1999 and increase net
patient service revenue by $762,000 and for 1998 $965,000 and 1997,
respectively.
A summary of the payment arrangements that the Company had with major
third-party payors relating to operations which have all been sold as of
September 30, 1999, is as follows:
(a) 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.
(b) 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.
(c) 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.
35 (Continued)
<PAGE> 37
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
(8) OTHER CURRENT ASSETS
Other current assets includes the following:
<TABLE>
<CAPTION>
1999 1998
----------- ---------
<S> <C> <C>
Deposit $ 75,000 --
Pharmaceutical supplies 173,000 163,000
Other current assets 21,000 8,000
----------- ---------
$ 269,000 171,000
=========== =========
</TABLE>
(9) PROPERTY AND EQUIPMENT
Property and equipment includes the following:
<TABLE>
<CAPTION>
1999 1998
----------- ---------
<S> <C> <C>
Leasehold and improvements $ 23,000 21,000
Furniture, fixtures, and equipment 761,000 968,000
Equipment under capital lease 187,000 323,000
----------- ---------
971,000 1,312,000
Less accumulated depreciation (829,000) (977,000)
----------- ---------
$ 142,000 335,000
=========== =========
</TABLE>
Depreciation expense related to property and equipment was $120,000,
$191,000, and $185,000 for 1999, 1998, and 1997, respectively.
(10) OTHER ACCRUED EXPENSES
Other accrued expenses includes the following:
<TABLE>
<CAPTION>
1999 1998
---------- ---------
<S> <C> <C>
Accrued refunds $ 6,000 166,000
Accrued professional fees 330,000 665,000
Accrued pharmaceutical costs 491,000 284,000
Accrued miscellaneous taxes 106,000 184,000
Other accrued expenses 152,000 755,000
---------- ---------
$1,085,000 2,054,000
========== =========
</TABLE>
36 (Continued)
<PAGE> 38
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
(11) LONG-TERM DEBT
(a) 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 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 was collateralized by substantially
all the assets of the Company, had a six month term which expired in
January 1999, carried interest at prime plus two percent, required a
two percent commitment fee, and a completion fee of an additional two
percent.
37 (Continued)
<PAGE> 39
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
(b) REVOLVING CREDIT FACILITY
Effective March 11, 1997, Extended Care Services entered into a
$4,000,000 revolving credit facility with HealthCare Financial
Partners. The facility bore interest at prime plus 2.25 percent, was
secured by accounts receivable, and expired in March 1999. The loan
was also secured by the stock of the Company's subsidiary, Extended
Care Services. The amount of credit available fluctuated based on the
amount of qualified accounts receivable. As of September 30, 1999 and
1998, the Company had $0 and $344,000 outstanding under this facility,
respectively.
(c) LINE OF CREDIT
In October 1997, the Company borrowed an aggregate of $500,000 under a
line of credit with Bank of America, which debt was guaranteed by
Michael S. Pinkert, President and Chief Executive Officer, William P.
Ferretti, Director and Lee Calligaro former Vice President and General
Council of the Company. The line of credit permitted maximum
borrowings by the Company of $500,000 and was originally due on March
31, 2000.
In June 1999, the Company increased this line of credit to a maximum
borrowing capacity of $1,300,000 with a commitment fee of .5 percent.
The line of credit is due in May 2000 and bears interest at the
Eurodollar rate plus 2.6 percent, per annum (weighted-average interest
rate of 9.9 percent at September 30, 1999). As of September 30, 1999,
the Company had drawn $1,000,000 against this line.
Mr. Pinkert personally guaranteed the entire line of credit. For his
guaranty, the Company granted, in June 1999, 90,000 warrants to
purchase stock of the Company at $.10 per share. William Ferretti,
John Silverman, Jacob Shipon, directors of the Company, and Lee
Calligaro, have indemnified Mr. Pinkert on his guarantee in the extent
of $550,000. For their indemnifications, the Company granted to each
indemnitor on a pro rata basis based on their individual
indemnification, a total of 99,000 warrants to purchase stock of the
Company at $.10 per share. As a fee to the guarantor and idemnitors
for the ongoing risks represented by the guarantee and indemnification
obligations, for each month during which the guarantee and
indemnification obligations are outstanding, warrants for the number
of shares as are equal in value (at a price of $.10 per share) to one
and one-half percent of the average loan balance which is outstanding
during the month will be issued. Expenses totaling approximately
$84,000 were recorded in 1999 as a result of the issuance of these
warrants.
Also in June 1999, Mr. Pinkert, Mr. Ferretti, and Mr. Calligaro,
guarantor and idemnitors of the original line of credit of $500,000,
who earned warrants of 105,394, 35,126, and 35,126, respectively,
during the period that the original obligation was outstanding, were
granted a reduction in the warrant exercise price of these warrants to
$.10 per share to purchase Company stock. Expense totaling
approximately $59,000 was recorded in 1999 for the reduction in the
warrant exercise price.
(d) TERM LOANS AND CAPITAL LEASE OBLIGATIONS
At September 30, 1999 and 1998, term loans totaling $192,000 and
$339,000, 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 Mentor totaling $47,000
at September 30, 1999, is in technical default for nonpayment of
principal due to the dissolution of Extended Care Services and
therefore is classified as a current liability in the consolidated
financial statements.
38 (Continued)
<PAGE> 40
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
Capital lease obligations totaling $21,000 and $72,000 at September
30, 1999 and 1998, respectively, are payable in monthly installments
including interest at rates ranging from 9 percent to 13 percent
through January 2001 and are collateralized by certain assets with a
net book value of $40,000 and $76,000, respectively.
(e) NOTES PAYABLE
At September 30, 1999 and 1998, the Company had promissory notes
outstanding totaling $187,000 and $69,000, respectively. The notes
were issued to insurance underwriters to finance the purchase of
certain insurance policies. The notes are being repaid in monthly
installments with interest of 8 percent and are due in 2000. The notes
are secured by prepaid insurance premiums which are classified as
prepaid expenses in the accompanying consolidated balance sheets.
Scheduled maturities of all long-term debt are as follows:
<TABLE>
<CAPTION>
YEAR ENDING SEPTEMBER 30
<S> <C>
2000 $ 275,000
2001 5,000
----------
$ 280,000
==========
</TABLE>
(12) COMMITMENTS AND CONTINGENCIES
(a) 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:
<TABLE>
<CAPTION>
YEAR ENDING SEPTEMBER 30
<S> <C>
2000 $ 168,000
2001 173,000
2002 169,000
2003 155,000
2004 81,000
----------
Total future minimum lease payments $ 746,000
==========
</TABLE>
Lease expense was $357,000, $938,000, and $1,496,000 for 1999, 1998,
and 1997, respectively.
(b) 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 position.
39 (Continued)
<PAGE> 41
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
(c) CONTINGENCIES
On March 2, 1998, the Company was notified that a claim for refund of
certain Medicare payments is being made against Supportive Counseling
Centers (SCC) to which a subsidiary of Extended Care Services
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
reimbursements paid to SCC prior to any involvement of Extended Care
Services 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.
On November 23, 1998, the Company received a notice from the
Massachusetts Peer Review Organization, Inc. (MassPro), that MHM
Counseling Services, through a clinic located in Taunton,
Massachusetts, owned by Extended Care Services, 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 of payments made in 1997 to
MHM Counseling Services for services provided to 25 Medicaid
recipients at the Taunton facility, MHM Counseling Services was
requested to repay the Massachusetts Medical Assistance Program an
extrapolated amount of approximately $215,000. The Company has
appealed this determination, but has not received a report of the
results of this appeal. On June 3, 1999, MHM Counseling Services
received another notice from MassPro, that the counseling service
clinic located in Cambridge, 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 Mass Pro's audit of payments made in 1997 to
MHM Counseling Services for services provided to 26 Medicaid
recipients at the Cambridge facility, MHM Counseling Services was
requested to repay the Massachusetts Medical Assistance Program an
extrapolated amount of approximately $1,019,000. The Company has
vigorously appealed these findings with the State.
In reference to the above claims, it is the Company's position that
extrapolating the results from a limited sample from a review of a
subset of certain professionals is not valid when applied to a group
of other professionals. Furthermore, the samples selected were not
based on a statistically valid sampling methodology. Therefore, in the
Company's view, extrapolation is not appropriate. Based upon the
Company's review of claims audited by MassPro the Company believes it
will prevail in reducing the amount of repayment requested and is
vigorously appealing the initial findings by MassPro. At September 30,
1999, the Company has reserved approximately $615,000 and believes
this amount is sufficient to cover any potential settlements with
MassPro. It is reasonably possible that any potential settlement will
differ from the amounts reserved.
On July 14, 1999, the Company became aware that a notice of a
post-payment review of claims processed in 1998 from the CIGNA
HealthCare Medicare Administration (CIGNA), was sent to Psychiatric
Specialty Group, the (Practice). MHM Extended Care Services Inc.
managed the Practice in 1998. The notice indicated that there were
certain deficiencies in the medical records of fifteen beneficiaries'
records reviewed and indicated an overpayment of $4,100. As a result,
CIGNA is now proceeding to perform a statistically valid random sample
audit. The Practice is required to immediately repay the overpayment
of $4,100 identified in the audit and such repayment has been reserved
in the Company's consolidated financial statements at September 30,
1999. The Company does not believe its ultimate liability will exceed
the amount reserved.
40 (Continued)
<PAGE> 42
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
(d) 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 occurred
during the policy period. The coverage per occurrence is $1,000,000
with a $3,000,000 aggregate.
(13) CONCENTRATION OF CREDIT RISK
Approximately 78 percent, 37 percent, and 3 percent of the Companies
revenues for the years ended September 30, 1999, 1998, and 1997,
respectively, relates to amounts earned under five contracts to provide
mental health services to correctional and long-term care facilities in
three states. Contracts with revenues exceeding 10 percent of the Company's
total consolidated revenues were as follows:
<TABLE>
<CAPTION>
Years ended September 30,
-----------------------------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Georgia Department of Corrections 49% 29% 2%
Tennessee Department of Corrections 12% 7% 1%
</TABLE>
The Company's accounts receivable are primarily from Correctional Services
for services rendered to the states and a prime contractor with which MHM
has contracted. Accounts receivable under these contracts with an
outstanding balance of 10 percent or greater at September 30, 1999, are as
follows:
<TABLE>
<CAPTION>
September 30, 1999
------------------
<S> <C>
Georgia Department of Medical Assistance 31%
Prison Health Services 16%
Tennessee Department of Corrections 48%
</TABLE>
41 (Continued)
<PAGE> 43
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
(14) INCOME TAXES
Income tax (benefit) expense consists of the following:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ---------- -----------
<S> <C> <C> <C>
Current:
Federal $ -- -- --
State 39,000 93,000 --
----------- ---------- -----------
39,000 93,000 --
----------- ---------- -----------
Deferred:
Federal -- -- --
State -- -- --
----------- ---------- -----------
-- -- --
----------- ---------- -----------
Total income tax (benefit)
expense $ 39,000 93,000 --
=========== ========== ===========
</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>
1999 1998 1997
----------- --------- -----------
<S> <C> <C> <C>
Statutory expense (benefit) $ (862,000) (386,000) (1,676,000)
State income tax (benefit) expense (89,000) 93,000 (71,000)
Increase in valuation allowance 1,052,000 383,000 1,668,000
Goodwill amortization -- -- 5,000
Other items, net (62,000) 3,000 74,000
----------- --------- -----------
Total income tax (benefit)
expense $ 39,000 93,000 --
=========== ========= ===========
</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.
42 (Continued)
<PAGE> 44
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
Significant components of deferred tax assets and liabilities follow:
<TABLE>
<CAPTION>
1999 1998
-------------- ------------
<S> <C> <C>
Assets: $
Allowance for doubtful accounts 130,000 1,709,000
Net operating loss carryforwards 4,885,000 1,716,000
Writedown of long-term assets -- 434,000
Other 58,000 105,000
-------------- ------------
5,073,000 3,964,000
Valuation allowance (4,964,000) (3,912,000)
-------------- ------------
109,000 52,000
Liabilities - prepaid expenses 109,000 52,000
-------------- ------------
Net deferred tax asset $ -- --
============== ============
</TABLE>
At September 30, 1999, for income tax purposes, the Company had federal
operating loss carry-forwards of approximately $11,900,000 expiring through
2019. 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 an increase of $1,052,000 in 1999 and
an increase of $383,000 in 1998.
(15) RELATED-PARTY TRANSACTIONS
(a) INTEREST EXPENSE - MEDIQ
The Company incurred interest expense related to the note payable to
MEDIQ of $0, $757,000, and $1,042,000 in 1999, 1998, and 1997,
respectively.
(b) SERVICES AGREEMENT - MEDIQ
From April 1, 1993 through September 30, 1996, the Company 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 $30,000 for
fiscal 1997, and are included in general and administrative expenses.
(16) STOCK OPTIONS AND WARRANTS
(a) 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 450,000 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
43 (Continued)
<PAGE> 45
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
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, 1999, options to acquire
201,000 shares of stock were exercisable under the Stock Option Plan
and options to acquire 16,000 shares of stock were exercisable under
the Directors' Stock Option Plan. Exercise prices of stock options
granted represent fair market value of the common stock at date of
grant, or for the re-priced options, at January 30, 1997.
The Company applies APB Opinion No. 25 in accounting for its stock
option plan for options granted to employees and directors and,
accordingly, no compensation expense 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>
YEARS ENDED SEPTEMBER 30,
1999 1998 1997
---------- ------------ ------------
<S> <C> <C> <C>
Net income (loss):
As reported $ (2,571,000) 7,996,000 (4,789,000)
Pro forma (2,607,000) 7,961,000 (4,808,000)
Income (loss) per common share:
As reported (.72) 2.26 (1.40)
Pro forma $ (.74) 2.25 (1.41)
</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 1999, 1998
and 1997, respectively: dividend yield of 0 percent (all years);
expected volatility 116.85, 126.51 and 132.79 percent; risk-free
interest rate of 4.98, 5.66 and 6.46 percent; and expected lives of 3
years for options granted in 1999 and 8 years for options granted in
1998 and 1997.
44 (Continued)
<PAGE> 46
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
A summary of the status of the Company's stock options as of September
30, 1999, 1998, and 1997, and changes during the years ended on those
dates is presented below:
<TABLE>
<CAPTION>
1999 1998 1997
---------------------------- ---------------------------- ---------------------------
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 382,200 $ 0.76 $ 359,400 $ 0.72 $ 259,600 $ 3.28
Granted 112,500 0.62 95,100 0.84 165,000 0.98
Exercised -- -- (24,800) 0.50 (3,000) 0.50
Forfeited (47,500) 0.79 (47,500) 0.74 (62,200) 1.48
---------- ----------- ---------- -------------- ---------- ---------
Outstanding at end of year 447,200 0.72 382,200 0.76 359,400 0.72
---------- ----------- ---------- -------------- ---------- ---------
Options exercisable at
end of year 217,000 0.65 181,900 0.59 176,400 0.50
Weighted-average fair value
of options granted
during the year $ 0.44 $ 0.79 $ 0.93
========== ========== ==========
</TABLE>
The following table summarizes information about stock options outstanding at
September 30, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISEABLE
-------------------------------------------------------------------------------- -------------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE REMAINING EXERCISE EXERCISE
PRICES NUMBER CONTRACTUAL LIFE PRICE NUMBER PRICE
------------- ------- ---------------- --------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
$0.50 - $0.75 340,700 6.70 $ 0.57 174,800 $ 0.52
1.00 - 1.50 106,500 7.91 1.23 42,200 1.22
------------- ------- ---------------- --------- -------- ----------
$0.50 - $1.75 447,200 7.01 $ 0.72 217,000 $ 0.65
============= ======= ================ ========= ======== ==========
</TABLE>
(b) 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
11). 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.
45 (Continued)
<PAGE> 47
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1999, 1998, and 1997
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 Bank of America line of credit
(see note 11). 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 in fiscal 1998, as
to the exercise price exceeded the stock's fair value on each date of
grant.
In June 1999, the Company increased the line of credit to $1,300,000.
In exchange for guarantees and indemnifications by officers and
directors as described in note 11, the Company repriced 175,600
warrants previously granted to these individuals from an exercise
price of $1.51 per share to $.10 per share of the Company's stock.
Expense totaling approximately $59,000 was recorded in 1999 for the
reduction in warrant exercise price. The Company also granted these
individuals a total of 249,000 warrants for shares of the Company's
stock at $.10 per share. These warrants do not expire and are
immediately exercisable. Expense totaling approximately $84,000 was
recorded in 1999 for the issuance of these warrants.
At September 30, 1999, the Company had a total of 869,700 warrants
outstanding with exercise prices ranging from $0.01 to $0.50 and
remaining lives ranging from 4 to 10 years.
(17) 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, 1999, 1998, and 1997, the Company's contributions
were $29,000, $44,000, and $38,000, respectively.
(18) FOURTH-QUARTER RESULTS (UNAUDITED)
The Company experienced net income of approximately $116,000 in the fourth
quarter of 1999 as a result of increased revenues from Correctional
Services contracts, reduction in operating expenses and general and
administrative expenses from the wind down of operations sold in Extended
Care Services.
46
<PAGE> 48
SCHEDULE II
MHM SERVICES, INC. AND SUBSIDIARIES
Valuation and Qualifying Accounts and Reserves
Years ended September 30, 1999, 1998, and 1997
<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, 1999:
Allowance for doubtful accounts $ 4,438,000 898,000 4,999,000 337,000
Year ended September 30, 1998:
Allowance for doubtful accounts $ 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
================ ============== ============== ===============
</TABLE>
* Approximately $650,000 of the 1998 deduction is related to the sale of
Mountain Crest receivables in the sale described in note 4.
47
<PAGE> 49
ITEM 10. DIRECTORS AND EXCUTIVE OFFICERS OF THE REGISTRANT.
<TABLE>
<CAPTION>
NAME AGE POSITIONS WITH THE COMPANY
- ---- ---- --------------------------
<S> <C> <C>
Michael S. Pinkert 58 President, Chief Executive Officer and
Director
John L. Silverman (1) 58 Director
William P. Ferretti (1)(2) 56 Director
Michael F. Sandler (1)(2) 54 Director
Jacob A. Shipon(3) 60 Director
Steven H. Wheeler 37 Executive Vice President - Operations and Director
Cleveland E. Slade 44 Vice President and Chief Financial Officer
Robert W. May 39 Vice President - Development
</TABLE>
(1) Member of the Compensation and Stock Option Committee
(2) Member of the Audit Committee
(3) Became a Director February 1999
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 February 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.
48
<PAGE> 50
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., a court
reporting firm. 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 Company had been a wholly owned subsidiary
of MEDIQ. Mr. Sandler previously served the Company as a Director from August
1993 until January 1997.
Dr. Jacob A Shipon, a family physician for over 30 years, became a Director
of the Company in February 1999. Dr. Shipon was formerly Vice Chairman of MEDIQ,
Inc.
Steven H. Wheeler joined the Company in May 1994 and has served as Vice
President-Operations since December 1997. Prior thereto, he served as Vice
President - Integrated Delivery Systems. Before joining the Company, Mr. Wheeler
was Director of Business Development/Operations for Florida Psychiatric Group
from April 1993 to February 1994, General Manager, Psych Options, Inc. from
March 1992 to April 1993, and Regional Director of Operations, Merit Behavioral
Care Corporation (formerly American Biodyne) from May 1990 to February 1992.
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.
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.
49
<PAGE> 51
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 1999 (collectively "Named
Executive Officers")
<TABLE>
<CAPTION>
(2) (1)
ANNUAL LONG TERM
NAME AND COMPENSATION $ COMPENSATION ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS STOCK OPTIONS COMPENSATION $
------------------ ---- ------ ----- -------------- -------------
<S> <C> <C> <C> <C> <C>
MICHAEL S. PINKERT 1999 150,000 368,966 7,478
President & CEO 1998 237,000 16,927
1997 253,293 60,000 18,493
STEVEN H. WHEELER 1999 115,000 30,000 7,200
Executive VP of 1998 121,687 10,000 8,937
Operations & Director 1997 124,202 30,000 7,422
CLEVELAND E. SLADE 1999 110,000 30,000 7,200
Vice President & CFO 1998
1997
ROBERT W. MAY 1999 90,000 42,605 30,000
VP of Development 1998
1997
</TABLE>
1. Amounts reported represent the total of automobile allowances and
Company contributions to the 401(k) plan.
2. Amounts reported include compensation associated with warrants issued
to these employees in return for their line of credit guarantee (See
Item 13 - Certain relationships and related Transactions)
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
$10,000 for their services in such capacities. In 1993 the Company adopted a
Stock Option Plan for Non-Employee Directors. All options granted under this
plan vest 20% at date of grant with the remaining 80% vesting ratably over four
years. Options granted expire ten years from the date of original grant. Mr.
Ferretti was granted 12,500 options when he became a Director in August 1996.
Mr. Silverman was
50
<PAGE> 52
granted 12,500 options when he became a Director in February 1998, Mr. Sandler
was granted 12,500 options when he became a Director in August 1998 and Dr.
Shipon was granted 12,500 options when he became a Director in February 1999.
Stock Options Granted
The following table summarizes stock options granted during fiscal 1999 to
the Company's Named Executive Officers.
<TABLE>
<CAPTION>
Potential Realizable
Value at Assumed
Annual Rates of Stock
Individual Grants Price Appreciation for
Option Term (1)
- ------------------------------------------------------------------------------------ ----------------------------------
Percent of Total Exercise
Options Granted or Base
Options to Employees in Price Expiration
Name Granted (2) Fiscal Year ($/Share) Date 5% 10%
- ---- ----------- ----------- --------- ---- --- ----
<S> <C> <C> <C> <C> <C> <C>
Steven H. Wheeler 30,000 30.0% $0.62 04/07/09 $12,000 $30,000
Robert W. May 30,000 30.0% $0.62 04/07/09 $12,000 $30,000
Cleveland E. Slade 30,000 30.0% $0.62 04/07/09 $12,000 $30,000
</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, 1999
value of the exercisable and unexercisable options held by each of the Named
Executive Officers. No stock options were exercised during fiscal 1999 by any of
the Named Executive Officers.
<TABLE>
<CAPTION>
Value of Unexercised
Total Number of In-The-Money Options
Unexercised Options At Year End
Shares
Acquired Value
On Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
<S> <C> <C> <C> <C> <C> <C>
Michael Pinkert - - 110,800 31,200 - -
Steven Wheeler - - 22,000 58,000 - -
Robert May - - 9,800 49,200 - -
Robert May - - 4,000 46,000 - -
</TABLE>
51
<PAGE> 53
The value of the unexercised in-the-money options does not reflect executory
costs or the impact of federal or state income taxes and may be impacted by
subsequent changes in the market price of the Company's stock.
Board Compensation Committee Report on Executive Compensation
Historically, the Company's Board of Directors, through the advice of its
Compensation Committee, has determined compensation arrangements for the
Company's executive officers by reference to a survey of compensation trends by
position among hospital management companies. An independent management
compensation consultant prepared this survey. For the fiscal year ended
September 30, 1999, the Compensation Committee did not actively meet since the
Company was without resources to pay substantial bonuses and the performance of
the Company would not give merit to any bonus under the Incentive Compensation
Program the Company has employed.
This program 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
In addition, it has been the policy of the Committee to utilize stock
options to provide a link between compensation and the market performance of the
Company's stock, and to focus attention of management on the enhancement of
shareholder value. As a general rule the options are subject to ratable vesting
over a five-year period.
During fiscal 1999 the Company awarded options for 30,000 shares to Steven
H. Wheeler, and options for 30,000 shares to Cleveland E. Slade for their
respective achievements in improving operations. Robert May was awarded bonuses
totaling approximately $43,000, and options for 30,000 shares for his role in
securing the subcontract with Prison Health Services, Inc., the State of
Georgia's Medicaid contract, and the contract with the State of Georgia's
Department of Juvenile Justice.
52
<PAGE> 54
STOCK PERFORMANCE CHART
The following chart compares the cumulative total shareholder return on the
Company's Common Stock for fiscal years 1994 through 1999 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.
Comparison of 60 month Cumulative Total Return* Among MHM Services Inc.
the S&P 600 Value Index and Peer Group
<TABLE>
<CAPTION>
Cumulative Total Return
-----------------------------------------------------------
9/94 9/95 9/96 9/97 9/98 9/99
<S> <C> <C> <C> <C> <C> <C>
MHM SERVICES, INC. 100 126 26 48 40 15
PEER GROUP 100 99 116 153 37 23
S & P SMALLCAP 600 100 126 146 199 169 198
</TABLE>
53
<PAGE> 55
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
AMONG MHM SERVICES, INC., THE S & P SMALLCAP 600 INDEX
AND A PEER GROUP
* $100 INVESTED ON 9/30/94 IN STOCK OR INDEX - INCLUDING REINVESTMENT OF
DIVIDENDS.
FISCAL YEAR ENDING SEPTEMBER 30.
54
<PAGE> 56
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of November 30, 1999, 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>
Michael S. Pinkert 719,960 (4) (5) 15.9%
Michael J. Rotko 537,811 11.9%
Jacob & Judith Shipon 499,097 (3) 11.0%
Bernard Korman 234,319 (3) 5.2%
William P. Ferretti 165,484 (4) 3.7%
Steven H. Wheeler 24,710 (4) (5) *
John L. Silverman 40,572 (4) *
Robert W. May 10,200 (4) *
Carla M. Skolnick 2,320 (4) *
Michael Sandler 5,000 (4) *
Cleveland E. Slade 4,000 (4) *
HealthCare Financial Partners 300,000 (6) 6.6%
All Executive Officer and Directors as a Group 1,471,343 32.5%
</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) In May 1999, 892,742 of the Company's shares originally held in
the Bernard B Rotko Trust for Bessie G. Rotko, who is the lifetime
income beneficiary of the trust, was distributed equally to
Michael J. Rotko and Judith M. Shipon who have voting and
investment power with respect to transferred shares held.
(4) Includes options exercisable currently or within the next 60 days,
following September 30, 1999, including Mr. Pinkert - 110,800, Dr.
Shipon - 2,500, Mr. Ferretti - 3,623, Mr. Wheeler - 22,000, Mr.
Silverman - 5,000, Mr. May - 9,800, Mrs. Skolnick - 2,300, Mr.
Sandler - 5,000 and Mr. Slade - 4,000. Includes warrants
exercisable currently or within the next 60 days, following
September 30, 1999, including Mr. Pinkert - 368,966, Dr. Shipon -
35,572, Mr. Ferretti - 70,698 and Mr. Silverman - 35,572.
(5) Includes shares held in retirement accounts
(6) 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.
55
<PAGE> 57
Beneficial Ownership Reporting Compliance
To the best of the Company's knowledge, all Directors and Executive
Officers timely filed all forms required by Section 16(a)
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In October 1997, the Company obtained an unsecured $500,000 line of credit
from Bank of America (formerly 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, former
Vice President and General counsel of the Company 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 and
indemnification, 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, Mr. Ferretti and Calligaro 18,000 shares each. In
addition, warrants were granted each month subsequently as a result of the
outstanding balance on the loan. Additional warrants granted through May 31,
1999 prior to the refinancing on the line of credit, were Mr. Pinkert - 51,394,
Mr. Ferretti and Mr. Calligaro 17,126 each.
In June 1999, the Company renegotiated the line of credit to a maximum
borrowing capacity of $1,300,000. Mr. Pinkert personally guaranteed this new
line of credit. For his guaranty, the Company granted 90,000 warrants to
purchase stock of the Company at $.10 per share. William P. Ferretti, John
Silverman, Jacob Shipon, and Lee Calligaro have indemnified Mr. Pinkert on his
guarantee to the extent of $550,000. For their indemnifications, the Company
granted to each indemnitor on a prorata basis according to their individual
indemnification, a total of 99,000 warrants to purchase stock of the Company at
$.10 per share. As a fee to the guarantor and indemnitors for the ongoing risks
represented by the guarantee and indemnification obligations, for each month
during which the guarantee and indemnification obligations are outstanding,
warrants for the number of shares as are equal in value (at a price of $.10 per
share) to one and one-half percent of the average loan balance which is
outstanding during the month will be issued. Also, Mr. Pinkert, Mr. Ferretti,
and Mr. Calligaro, guarantor and indemnitors of the original line of credit of
$500,000, who earned warrants of 105,394, 35,126, and 35,126, respectively,
during the period that this obligation was outstanding, were granted a reduction
in their warrant exercise purchase price to $.10 per share to purchase Company
stock with previously earned warrants. Additional warrants granted through
September 30, 1999, were Mr. Pinkert - 28,572, Mr. Ferretti - 8,572, Mr.
Silverman - 8,572, Dr. Shipon - 8,572 and Mr. Calligaro 5,716 each. .
In funding the MEDIQ settlement, the Company secured a loan for $2,000,000
from its principal lender HealthCare Financial Partners in July 1998. The loan
from HealthCare Financial
56
<PAGE> 58
Partners had 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.
The total warrants outstanding at September 30, 1999 were 869,700.
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statement Schedules are set forth on pages 22 to 26 of this
report
(b) Reports on Form 8-K
The Company filed a report on Form 8-K on March 16, 1999, announcing
the sale of certain assets of its Extended Care Services Subsidiary.
(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.
57
<PAGE> 59
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
- ----------- -----------
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)
4.6 Credit, Security, and Guarantee Agreement between the Company
and Michael S. Pinkert, William P. Ferretti, Jacob S. Shipon,
M.D, John L. Silverman, and Lee Calligaro dated July 8, 1999.
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)
10.7 Contract with Tennessee Department of Corrections (8)
58
<PAGE> 60
<TABLE>
<S> <C>
10.8 Consent to Assignment of Contract with Tennessee Department of
Corrections (8)
10.9 Contract with Georgia Department of Corrections (8)
10.10 Asset Purchase agreement by and between Paradigm Health
Services, Inc. and MHM Extended Care Services, Inc. (10)
10.11 Interim Management Agreement by and between Paradigm Health
Services, Inc. and MHM Extended Care Services, Inc. (10)
10.12 Assets Purchase Agreement by and among Arbour Elder Services,
Inc., d/b/a Arbour Seniorcare and MHM Extended Care Services,
Inc. and MHM Services, Inc. (10)
10.13 Assets Purchase Agreement by and between BHG of Pennsylvania,
LLC and MHM Extended Care Services, Inc. (10)
1.14 Interim Management Agreement by and between BHG of
Pennsylvania, LLC and MHM Extended Care Services, Inc. (10)
10.15 Term Promissory Note of BHG of Pennsylvania, LLC, issued to MHM
Extended Care Services, Inc. (10)
10.16 Guaranty Agreement be and among Integrated health Options, LLC,
BHG, Inc. and Illiana Behavioral management, Inc., for the
benefit of MHM Extended Care Services, Inc. (10)
21 Subsidiaries of MHM Services, Inc. (9)
23 Consents of KPMG 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
(10) Incorporated by reference to the Registrant's Form 8-K/A dated March 16,
1999
59
<PAGE> 61
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.
Dated December 29, 1999 MHM Services, Inc.
By: /s/ MICHAEL S. PINKERT
-----------------------------------
Michael S. Pinkert
President, Chief Executive Officer
and Director
/s/ STEVEN H. WHEELER
---------------------------------
Steven H. Wheeler
Executive Vice President - Operations
and Director
/s/ CLEVELAND E. SLADE
---------------------------------
Cleveland E. Slade
Vice President - Finance and
Chief Financial Officer
/s/ JOHN L. SILVERMAN
---------------------------------
John L. Silverman
Director
/s/ WILLIAM P. FERRETTI
---------------------------------
William P. Ferretti
Director
/s/ MICHAEL F. SANDLER
---------------------------------
Michael F. Sandler
Director
/s/ DR. JACOB SHIPON
---------------------------------
Dr. Jacob Shipon
Director
60
<PAGE> 1
EXHIBIT 4.6
CREDIT, SECURITY, AND GUARANTEE AGREEMENT
This Agreement is made this 8 day of July, 1999, by and among MHM
Correctional Services, Inc. ("Borrower"), MHM Services, Inc. ("MHM"), Michael S.
and Eleanor Pinkert ("the Pinkerts", and William P. Ferretti, Jacob S. Shipon,
M.D., John L. Silverman, and Lee Calligaro (the latter four individuals
sometimes referred to as "Indemnitors"). MHM Extended Care Services, Inc. joins
solely to guarantee performance hereof by its corporate affiliates.
WHEREAS, Borrower, a wholly-owned subsidiary of MHM, is in need of
additional working capital because of increases in its business and of
additional business opportunities available to it; and
WHEREAS, MHM currently has a revolving line of credit with NationsBank,
N.A. (the "Bank") in the amount of $500,000 (the "Original Line"); and
WHEREAS, in order to make the needed additional working capital available
to Borrower, it has been determined to substitute Borrower for MHM under the
Original Line and to negotiate with Bank an increase in the Line on behalf of
Borrower up to a maximum loan amount (including the Original Line) of $1.05
million (the "Revised Line");
WHEREAS, the Pinkerts have issued their personal guarantee of the
Original Line to the Bank; and Lee Calligaro and William P. Ferretti each have
indemnified and agreed to hold harmless the Pinkerts from a pro rata portion of
any liability the Pinkerts might incur as a result of guaranteeing the Original
Line (collectively, the "Original Guarantees" and the "Original Guarantors").
<PAGE> 2
WHEREAS, in return for undertaking the obligations described in the
preceding paragraph, the Original Guarantors were granted certain Warrants to
purchase stock of MHM ("Original Warrants") which, as of June 30, 1999, were in
the following amounts:
<TABLE>
<CAPTION>
ORIGINAL GUARANTORS ORIGINAL WARRANTS
------------------- -----------------
<S> <C>
Pinkert 105,394
Ferretti 35,126
Calligaro 35,126
</TABLE>
WHEREAS, the Bank will require further and additional guarantees in order
to allow substitution of Borrower as borrower under the Line and to increase the
borrowings available under the Line to $1.05 million; and
WHEREAS, the Pinkerts are willing to allow substitution of Borrower for
MHM as borrower under the Line and to increase their Guarantee by guaranteeing
repayment by the Borrower to the Bank of the Revised Line up to a maximum of
$1.05 million;
WHEREAS, Calligaro and Ferretti are willing to maintain the
indemnification obligations undertaken by them in connection with the Original
Line and to allow substitution of Borrower as borrower under that portion of the
Line representing the Original Line, and John L. Silverman, Jacob A. Shipon,
M.D., and Ferretti are willing to undertake indemnification obligations to the
Pinkerts as to a portion of the additional liabilities the Pinkerts might incur
as a result of the increase by the Pinkerts of their Guarantee;
NOW THEREFORE, in return for good and valuable consideration, receipt and
adequacy of which is hereby acknowledged (which consideration includes without
limitation the expected benefits of the Revised Line to Borrower as a subsidiary
of MHM in which all the individual parties are stockholders) and in order to
induce the Pinkerts to issue the Bank Guarantee
2
<PAGE> 3
and the Indemnitors to undertake the Indemnification Obligations described
below, it hereby is agreed as follows:
1. REVISED LINE: Subject to the approval of Bank, Borrower will be
substituted for MHM as borrower under the Line, and the Line will be increased
to permit borrowings by Borrower of a total up to $1.05 million.
2. GUARANTEE: Subject to the terms and conditions of this Agreement,
the Pinkerts agree to increase their personal Guarantee to the Bank by
guaranteeing repayment by Borrower of amounts borrowed from Bank under the
Revised Line up to a total principal amount (including the Original Line) not to
exceed $1.05 million, plus interest, costs, and other expenses incurred by Bank
in connection with the Revised Line (the "Bank Guarantee"). Such guarantee
increase may be by way of issuance of a new guarantee replacing the Original
Guarantee or by issuance of another guarantee in addition to the Original
Guarantee, as the Bank and the Pinkerts may agree and in a form acceptable to
the Bank and the Pinkerts.
3. INDEMNIFICATION: Subject to the terms and conditions of this
Agreement, Indemnitors hereby agree, severally and not jointly, and each up to
the maximum total principal amount set forth next to their names below, to
indemnify and hold harmless the Pinkerts for any liability for repayment of
principal amounts, and for a proportionate share of the associated costs or
expenses (including without limitation, interest paid or interest foregone and
attorney fees) incurred by the Pinkerts as a result of their issuance of the
Bank Guarantee (the "Indemnification Obligations"). The Indemnification
Obligations include by reference as though fully set forth herein all terms and
conditions set forth in the Guarantee issued by the Pinkerts to the Bank in
connection with the Revised Line so that the indemnification liabilities of
Indemnitors to the Pinkerts shall conform to the liabilities the Indemnitors
would have assumed had they themselves
3
<PAGE> 4
been parties to the Bank Guarantee (but limited in amount, pro rata, to the
amounts set forth beside the name of each):
<TABLE>
<CAPTION>
INDEMNITY
INDEMNITOR OBLIGATIONS
---------- -----------
<S> <C>
Ferretti $150K
Calligaro $100K
Silverman $150K
Shipon $150K
</TABLE>
4. GUARANTEE AND INDEMNIFICATION FEES: In consideration of the
issuance of the Bank Guarantee by the Pinkerts pursuant to paragraph 2, above,
and of the assumption of the Indemnification Obligations by the Indemnitors
pursuant to paragraph 3, above, MHM hereby agrees to issue Warrants to the
Pinkerts and to the Indemnitors for the purchase of stock in MHM at a price of
$.10 (ten cents) per share, in the following amounts:
(a) Initiation Fee: as a fee for initiation of the Bank Guarantee
and of the Indemnification Obligations:
<TABLE>
<CAPTION>
GUARANTORS/INDEMNITORS INITIATION WARRANTS
---------------------- -------------------
<S> <C>
Pinkerts 90,000
Ferretti 27,000
Calligaro 18,000
Silverman 27,000
Shipon 27,000
</TABLE>
(b) Continuation Fee: As a fee for the ongoing risks represented
by the Bank Guarantee and the Indemnification Obligations, for each month
during which the Bank Guarantee and Indemnification Obligations are
outstanding, Warrants for the number of shares as are equal in value (at
a price of $.10 (ten cents) per share)
4
<PAGE> 5
to one and one-half percent of the average loan balance which is
outstanding during the month and which is subject to the Bank Guarantee
and the Indemnification Obligations. Such Warrants shall be prorated
among the individual parties in proportion to the loan amounts set forth
next to the name of each in column 1 below, such that if the full Loan
amount of $1.05 million were outstanding during a given month each of the
individual parties hereto would receive for that month the number of
warrants set forth next to the name of each under column 2:
<TABLE>
<CAPTION>
1. 2.
GUARANTORS/ GUARANTEE/INDEMNITY ADDITIONAL
INDEMNITORS OBLIGATIONS WARRANTS/MONTH
----------- ----------- --------------
<S> <C> <C>
Pinkerts $500K (portion not indemnified) 7,500
Ferretti $150K 2,250
Calligaro $100K 1,500
Silverman $150K 2,250
Shipon $150K 2,250
</TABLE>
The Warrants to be issued pursuant to this paragraph 4 shall be in the
form attached as Exhibit A.
5. ORIGINAL WARRANTS: It is understood that the issuance of Warrants
pursuant to this Agreement shall be in addition to the Original Warrants
described in the fifth "Whereas Clause," above, to which each of the
shareholders identified in said clause previously has become entitled as a
result of the Original Guarantee, which entitlement is hereby confirmed and
ratified. Further provided, however, that the Original Warrants hereby are
amended to provide that the price per share at which stock of Borrower may be
purchased under the Original Warrants shall be $.10 (ten cents) per share. It is
hereby acknowledged that issuance of Warrants as a Continuation Fee pursuant to
paragraph 4(b) above shall be in lieu of and substitute for any similar
5
<PAGE> 6
or additional warrants which otherwise might have become issuable hereafter
pursuant to the Original Guarantee.
6. OBLIGATIONS OF BORROWER AND MHM TO GUARANTORS AND INDEMNITORS:
(a) Borrower and MHM acknowledge that Guarantor and Indemnitors
have undertaken the obligations set out in this Agreement as an
accommodation to Borrower and MHM, at considerable personal financial
risk. Accordingly, and in further consideration of the agreements of
Guarantor and Indemnitors herein, Borrower and MHM agree to indemnify and
hold harmless Guarantor and Indemnitors from any and all loss, expenses,
fees, costs, claims, demands, and liabilities of any kind (including
without limitation, payments of interests and fees, appraisal and audit
expenses, letter of credit fees, bank fees or charges, and attorney's
fees) in any way arising from or related to this Agreement or the
performance or nonperformance of the undertakings set forth herein, it
being the intent of the parties that Guarantor and Indemnitors shall not
incur or bear any unreimbursed cost or expense, and shall not undertake
any unreimbursed liability by reason of their agreement as set forth
herein. The indemnification granted hereby shall survive both payment in
full of all obligations hereunder and termination of this Agreement.
(b) Borrower and MHM agree that they will not consent to or enter
into any modification or amendment of the Revised Line or seek any waiver
in connection with therewith, without the prior written consent of
Grantors and Indemnitors. Borrower and MHM will give Grantors and
Indemnitors prompt written notice of any default or any other notice in
connection with the Revised
6
<PAGE> 7
Line received or sent by Borrower or MHM or on its behalf of either,
together with a complete copy of such notice. The Pinkerts hereby agree
that they will promptly furnish to Indemnitors copies of any notices or
communications received by them from Bank in connection with the Bank
Guarantee or the Revised Line.
(c) As security for the obligations of Borrower and MHM under this
Agreement, including the obligation to repay to Guarantors and
Indemnitors any payments made pursuant to the Bank Guarantee or the
Indemnification Obligations, Borrower and MHM hereby grant to Guarantor
and Indemnitor a lien and security interest in all of the accounts
receivable of Borrower and MHM, whether existing now or hereafter
created. Such lien and security interest shall be of the first priority,
superior to all other liens, security interests, claims, or interests
whatsoever. Upon the request of the Guarantor or any Indemnitor, Borrower
and MHM will execute and deliver any and all documents, agreements,
instruments, and other writings (including but not limited to executed
Forms UCC 1) necessary or appropriate to create and perfect the security
interest created hereby. Borrower and MHM further agree that, in the
event of any Guarantee or Indemnity Payment, the Guarantors and
Indemnitors shall be entitled, upon satisfaction of the Borrowers'
obligations to Bank under Revised Line, to be subrogated to all rights of
Bank against Borrower and MHM and to all collateral security or
guarantees or rights of offset held by Bank for payment and performance
of Borrower's or MHM's obligations under the Revised Line.
7
<PAGE> 8
(d) Release of Guarantor and Indemnitors. Borrower and MHM release
Guarantor and Indemnitors from any claims for loss or damage resulting
from any acts, omissions, or conduct of any kind by Guarantors or
Indemnitors.
7. ADDITIONAL UNDERTAKINGS
(a) MHM Services, Inc. and MHM Extended Care Services, Inc.,
hereby each guarantee to Guarantor and Indemnitors the full performance
by Borrower of all its obligations hereunder.
(b) No Other Borrowings. Without the written consent of Guarantor
and Indemnitors, granted or withheld in their sole discretion, Borrower
and MHM covenant and agree that they will not create, incur, assume or
suffer to exist any indebtedness, or any mortgages, liens, pledges, or
encumbrances on its property except: (i) the line of credit for up to
$1.05 Million with NationsBank which is the subject to this Agreement;
and (ii) accounts payable to trade creditors and current operating
expenses 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. Borrower and MHM will not make
prepayments on any existing or further indebtedness other than on amounts
subject to the Bank Guarantee.
8
<PAGE> 9
8. MISCELLANEOUS
(a) Conditions Precedent. The obligations of Guarantor and
Indemnitors hereunder shall be subject to approval and ratification of
this Agreement by the Board of Directors of Borrower and of MHM.
(b) Entire Agreement; Amendments. This Agreement constitutes the
full and entire understanding and agreement among the parties with regard
to the subject matter and supersedes all prior written or oral
agreements, understandings, representations and warranties made with
respect thereto. No amendment, supplement or modification of this
Agreement nor any waiver of any provision thereof shall be made except in
writing executed by the party against whom enforcement is sought.
(c) No Waiver; Cumulative Rights. No waiver by any party hereto of
any one or more default by the other party in the performance of any of
the provisions of this Agreement shall operate or be construed as a
waiver of any further default or defaults, whether of a like or different
nature. No failure or delay on the part of any party in exercising any
right, power or remedy hereunder shall operate as a waiver thereof, no
shall any single or partial exercise of any such right, power or remedy
preclude any other or further exercise thereof or the exercise of any
other right, power or remedy. The remedies provided for herein are
cumulative and are not exclusive of any remedies that may be available to
any party hereto at law, in equity or otherwise.
(d) Notices. Any notice or other communication required or
permitted hereunder shall be in writing and personally delivered, mailed
by registered or
9
<PAGE> 10
certified mail (return receipt requested and postage prepaid), sent by
telecopier (with a confirmation copy sent by regular mail), or sent by
prepaid overnight courier service, and addressed to the relevant party as
its address set forth below, or at such other address as such party may,
by written notice, designate as its address for purposes of notice
hereunder:
<TABLE>
<S> <C>
MHM Services, Inc. Lee Calligaro
MHM Correctional Services, Inc. 3818 Klingle Place, N.W.
MHM Extended Care Services, Inc. Washington, D.C. 20016
Each at:
8605 Westwood Center Drive
Suite 200 John L. Silverman
Vienna, VA 22182 4872 Reservoir Road, N.W.
Washington, D.C. 20007
Michael S. and Eleanor Pinkert
705 Potomac Knoll Drive
McLean, VA 22102 Jacob A. Shipon, M..D.
1115 Devon Road
William P. Ferretti Rydal, Pa 19046
C/o MedStar Communications, Inc.
5920 Hamilton Boulevard
Allentown, PA 18106
</TABLE>
If mailed, notice shall be deemed to be given five (5) days after being
sent. If sent by personal delivery or telecopier, notice shall be deemed to be
given when delivered, and if sent by prepaid courier, notice shall be deemed to
be on the next Business Day following deposit with the courier.
(e) Severability. If any term, covenant or condition of this
Agreement, or the application of such term, covenant or condition to any
party or circumstances shall be found by a court of competent
jurisdiction to be, to any extent, invalid or
10
<PAGE> 11
unenforceable, the remainder of this Agreement and the application of
such term, covenant, or condition to parties or circumstances other than
those as to which it is held invalid or unenforceable, shall not be
affected thereby, and each term, covenant or condition shall be valid and
enforceable to the fullest extent permitted by law. Upon determination
that any such term is invalid, illegal or unenforceable, the parties
hereto shall amend this Agreement so as to effect the original intent of
the parties as closely as possible in an acceptable manner.
(f) Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be deemed an original, but all of which
together shall constitute but one instrument.
(g) Third Parties. No rights are intended to be created hereunder
for the benefit of any third party donee, creditor, or incidental
beneficiary.
(h) Choice of Law; Consent to Jurisdiction. This Agreement and the
obligations thereby created shall be governed by, and construed in
accordance with, the laws of the Commonwealth of Virginia, without regard
to any otherwise applicable principles of conflicts of laws. If any
action arising out of this agreement or the note is commenced by
Guarantor or Indemnitors in the Commonwealth of Virginia or federal court
located in the Commonwealth of Virginia, Borrower and MHM hereby consent
to the jurisdiction of any such court in any such action and to the
laying of venue in the Commonwealth of Virginia. Any process in any such
action shall be duly served if mailed by registered mail, postage
prepaid, to the Borrower and MHM at their addresses set forth above.
11
<PAGE> 12
IN WITNESS WHREOF, the parties hereto have each executed and delivered
this Agreement as of July 8, 1999.
MHM SERVICES, INC.
By: /s/ MICHAEL S. PINKERT
----------------------------------
Michael S. Pinkert
President
MHM CORRECTIONAL SERVICES, INC.
(BORROWER)
By: /s/ MICHAEL S. PINKERT
----------------------------------
Michael S. Pinkert
President
MHM EXTENDED CARE SERVICES, INC.
(as to paragraph 7(a))
By: /s/ MICHAEL S. PINKERT
----------------------------------
Michael S. Pinkert
President
/s/ MICHAEL S. PINKERT
---------------------------------------
Michael S. Pinkert
/s/ ELEANOR PINKERT
---------------------------------------
Eleanor Pinkert
/s/ WILLIAM P. FERRETTI
---------------------------------------
William P. Ferretti
/s/ LEE CALLIGARO
---------------------------------------
Lee Calligaro
/s/ JOHN L. SILVERMAN
---------------------------------------
John L. Silverman
/s/ DR. JACOB SHIPON
---------------------------------------
Jacob A. Shipon, M.D.
12
<PAGE> 1
EXHIBIT 21
Subsidiaries of MHM Services, Inc.
MHM Extended Care Services, Inc.
MHM Correctional Services, Inc.
MHM of Colorado, Inc.
<PAGE> 1
EXHIBIT 23
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 17,
1999, on the consolidated balance sheets of MHM Services, Inc. and subsidiaries
as of September 30, 1999 and 1998, and the related consolidated statements of
operations, stockholders' deficit, and cash flows for each of the years in the
three-year period ended September 30, 1999, and the related schedule, which
report appears in the September 30, 1999 annual report on Form 10-K of MHM
Services, Inc.
Our report dated December 17, 1999, contains an explanatory paragraph that
states that the Company has suffered recurring losses from operations, has an
accumulated deficit, has a working capital deficiency, 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 and financial statement schedule do not include any adjustments that
might result from the outcome of that uncertainty.
KPMG LLP
McLean, Virginia
December 29, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> SEP-30-1999
<CASH> 6
<SECURITIES> 0
<RECEIVABLES> 1,431
<ALLOWANCES> (337)
<INVENTORY> 0
<CURRENT-ASSETS> 1,714
<PP&E> 971
<DEPRECIATION> (829)
<TOTAL-ASSETS> 2,282
<CURRENT-LIABILITIES> 4,730
<BONDS> 0
0
0
<COMMON> 37
<OTHER-SE> (2,453)
<TOTAL-LIABILITY-AND-EQUITY> 2,282
<SALES> 0
<TOTAL-REVENUES> 18,388
<CGS> 0
<TOTAL-COSTS> 20,317
<OTHER-EXPENSES> (637)
<LOSS-PROVISION> 898
<INTEREST-EXPENSE> 342
<INCOME-PRETAX> (2,532)
<INCOME-TAX> 39
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,571)
<EPS-BASIC> (0.72)
<EPS-DILUTED> (0.72)
</TABLE>
