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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, 2000
[ ] 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)
<TABLE>
<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)
</TABLE>
Registrant's telephone number, including area code: (703) 749-4600
Securities registered pursuant to Section 12(b) of the Act:
<TABLE>
<CAPTION>
Title of Each Class Name of Each Exchange
------------------- on Which Registered
-------------------
<S> <C>
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 $72.00 of common
stock on the Over-the-Counter Bulletin Board) on January 12, 2001, was
approximately $1,026,576.
As of January 12, 2001, there were 30,645 shares of Common Stock, par
value $.01 per share, of the Registrant outstanding.
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PART I
ITEM 1. BUSINESS
GENERAL
We were originally incorporated in Virginia in 1981 and in 1994
reincorporated in Delaware. Since we were formed, we have provided mental health
services, initially in general, substance abuse and psychiatric hospitals and
then in nursing homes and correctional facilities. Today, we principally focus
on the correctional services market.
DESCRIPTION OF BUSINESS
We currently provide mental health services at over 60 correctional
facilities encompassing over 55,000 inmates through statewide contracts with the
Departments of Corrections of the States of Georgia and Tennessee, a subcontract
covering a women's correctional facility in Florida, a subcontract covering a
jail in Mississippi, and contracts with the Departments of Juvenile Justice of
the States of Georgia and Florida. Also, under a contract with the Georgia
Department of Medical Assistance, we provide mental health services to all of
the state's Medicaid patients residing in over 300 nursing homes. By December
1998, we divested ourselves of all our operations we no longer wished to
continue and shifted our business focus to the correctional services market. By
that date we had sold all of our hospital operations and with the limited
exception of our contract in Georgia, discontinued all of our nursing home
operations. Our last inpatient facility had been sold by April 1998. We provide
on-site behavioral health services to the correctional services market through
our subsidiary MHM Correctional Services, Inc. ("Correctional Services"). We
formed Correctional Services in 1997 and in the fourth quarter of 1997 that
entity 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 facilities.
We provide our services under what are known as "capitation"
arrangements. Capitation means we are paid a fixed fee for each inmate eligible
for our services. For that fixed fee, we are required to provide all psychiatric
and psychological services, as well as any psychotropic drugs (i.e., medications
prescribed for mental illness), which are needed by any eligible inmates.
However, we are not responsible for providing inpatient hospitalization that is
provided outside the correctional facilities. In order to limit and control our
risk, the exact level of care we are required to provide for the inmate
population is established by each contract.
In the second quarter of 1999, Correctional Services was awarded a
contract to provide similar services under a capitated arrangement to the
Broward County, Florida correctional systems as a subcontractor to Prison Health
System who provides general healthcare services to the Broward facility.
In July 1999, Correctional Services was awarded a one-year contract to
provide professional mental health staffing to the State of Georgia's Department
of Juvenile Justice on a fee-for-service basis. In February 2000, Correctional
Services was also awarded a three-year contract to provide general medical and
mental health staffing to Career Systems Development Corporation at the Florida
Department of Juvenile Justice's Marion Youth Development Center located in
Ocala, Florida. This contract was awarded on a fee-for-service basis. In July
2000, we were awarded a subcontract to provide mental health staffing for the
Harrison County Jail in Mississippi, a subcontract to provide general medical
and mental health staffing with Career Systems Development Corporation at the
Florida Department of Juvenile Justice's Marion County Intensive Treatment
Facility for the Youth, and a general medical and mental health staffing
contract with the Florida Department of Juvenile Justice's St. John Juvenile
Detention Center and Marion Youth Detention Center.
We provided on-site behavioral services outside the correctional market
through our wholly-owned subsidiary, MHM Extended Care Services, Inc. ("Extended
Care Services"). Extended Care Services had been providing mental health
services to Medicaid residents in nursing homes throughout the State of Georgia
under a contract with the Georgia Department of Medical Assistance that expired
on June 30, 1997. Under this program, Extended Care Services provided mental
health services to 2,400 nursing home patients in the state. These services
consisted of on-site psychiatric and psychological services. The Georgia
Department of Medical Assistance paid Extended Care Services for these services
on a "case rate" basis. This means Extended Care Services was paid a fixed
amount for each patient to whom treatment is provided.
Because Extended Care Services did not have sufficient resources and
because of our decision to discontinue its operations, Extended Care Services
did not seek to effect a renewal of the contract. Since we were aware of the
opportunity, however, and
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because Correctional Services was already operating in Georgia under its
contract with the Georgia Department of Corrections, Correctional Services
sought to procure a contract with the Georgia Department of Medical Assistance.
In May 1999, through a competitive bid process, Correctional Services was
awarded a one-year contract beginning July 1, 1999 with three successive options
to renew this contract for additional terms of up to one year each. On July 1,
2000, this contract was renewed for another year. Between July 1, 1997 and the
time the contract was awarded to Correctional Services, Extended Care Services
continued to provide services to the Georgia Department of Medical Assistance.
When we decided to discontinue the operations of Extended Care Services,
Extended Care Services' outstanding liabilities exceeded its total assets. In
August 1999, Extended Care Services initiated dissolution proceedings under the
Delaware General Corporate Law. By November 30, 2000, these dissolution
proceedings became final. Accordingly, Extended Care Services was dissolved and
its remaining liabilities were discharged.
OUR INDUSTRY
We believe there are significant opportunities for the expansion of our
core business of delivering mental health services to inmates in correctional
facilities. In the United States today there are approximately 6.3 million
adults, or 3.1% of all U.S. residents, under some form of correctional
supervision, including varying levels of incarceration, probation or parole.
According to the U.S. Department of Justice's Bureau of Justice Statistics,
there were 1.9 million more adults under correctional supervision in 1999 than
in 1990. During 1999, the correctional population increased by 2.7%. There are a
number of factors contributing to this increase in incarceration rates including
mandatory sentencing rules coupled with increased conviction rates, an increase
in prison and jail terms for drug-related offenses, longer sentences, and
pressures to reduce or eliminate parole.
All of these inmates have a guaranteed legal right to healthcare. In
fact, in many instances, courts have specifically required the government to
provide such care. As a rule, the healthcare provided to inmates must be of the
same quality and accessibility as in the community at large. In determining
these community standards that set the level of care to which inmates are
entitled, comparison often is made to the level of care available to patients in
state Medicaid programs.
It has been estimated that the cost of providing general healthcare to
inmates in correctional facilities is between $3-5 billion annually. Providers
of healthcare to inmates also estimate that approximately 20% of this cost is
incurred in providing services to the mentally ill. In addition, the Justice
Department's Bureau of Justice statistics estimates that between 1997 and 1998,
there were 283,800 mentally ill offenders being held in the nation's state and
federal prisons and local jails, and an additional 547,800 mentally ill people
on probation in the community. These estimates suggest that the potential market
for mental health services in correctional facilities may be between $600
million to $1 billion per year.
The national problem of addictive diseases is particularly acute in
correctional facilities. The U.S. Department of Justice estimates that 60% of
the total prison population suffers from addiction problems. It is also
estimated that about 14% of the nation's prison inmates and 7% of jail inmates
suffer from other serious mental illnesses. According to a survey by the Federal
Bureau of Justice Statistics, 52% of state prisoners and 34% of federal
prisoners represent they were under the influence of alcohol or drugs at the
time they committed their crimes. However, only 12% of state inmates receive
formal drug treatment while in prison. This is particularly troublesome to
correctional officials in light of a Federal Bureau of Prisons study showing
that 12.1% of inmates who needed but did not receive drug treatment while
incarcerated were re-arrested within six months after release. By comparison,
only 3.3% of such prisoners who did receive drug treatment were re-arrested
within that time period.
As more addicted and mentally ill offenders enter correctional
facilities, correctional officials are increasingly being required to focus on
providing behavioral healthcare to the inmates under their control. One
increasingly major problem for correctional systems is the provision of
psychotropic medications due to the rapidly increasing cost of these drugs. In
addition, the problem of recruiting and hiring qualified mental health
professionals, as well as managing them in programs that provide cost-effective
care, is also becoming increasingly difficult. These and other management and
cost issues surrounding the provision of mental health services have motivated
corrections officials to turn to outside private contractors to assist them. It
is estimated that private providers are presently furnishing only 38% of mental
healthcare services in correctional facilities.
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OUR PLAN FOR GROWTH
We have been experiencing an upsurge of inquiries from state and local
correctional systems that have mental health specific problems and who are
looking for assistance in dealing with them. Many of these correctional systems
solicit offers from the private sector for the provision of inmate healthcare
services by issuing "Requests for Proposals" or "RFPs." Our success in
responding to such RFPs has enabled us to achieve a leading position in the
correctional mental health services market. To achieve greater growth rates, our
strategy is to:
- enter into consulting arrangements with corrections systems which may
lead to larger contracts without requiring RFP procedures;
- expand into other specialty programs such as programs dealing with
substance abuse and self-injurious problems; and
- more aggressively market our services and experience to departments of
corrections before RFPs are issued.
In order to implement this strategy, we have added a new Vice President
for Marketing and Development to lead our marketing staff. We also are seeking
to hire additional full-time marketing personnel. We intend to augment this
staff with part-time consultants located in key markets who are familiar with
the correctional facilities in those markets. Our marketing plans also include
expanding on-site visits, increasing our participation in professional programs,
and developing a national advertising campaign. To support this marketing
effort, we also are developing new lines of consulting products covering
caseload management, pharmacy management, and measurement of the outcomes of
treatment.
Our primary competition for providing mental healthcare to inmates is
established firms that provide healthcare to inmates for physical illnesses.
Some of these companies directly provide mental health services along with
physical medicine and others engage subcontractors to provide mental healthcare.
The three leading inmate healthcare providers are Correctional Medial Services,
Inc., Prison Health Services, Inc., and Wexford Health Services.
We are familiar with most of these providers and in fact have jointly
submitted proposals with these providers on certain contracts to state and local
correctional facilities. For instance, we obtained the contract with the Florida
Department of Corrections for the women's facility in Broward County in a joint
proposal with Prison Health Services, a subsidiary of America Services Group.
EMPLOYEES
As of September 30, 2000, we had 181 full-time and 24 part-time employees
in the correctional services operations. In addition, as of such date, we had 14
employees engaged in corporate and administrative operations.
Our employees include healthcare professionals, such as psychiatrists,
psychologists, social workers, nurses, counselors, occupational and activities
therapists, and employees engaged in corporate finance, marketing,
administration and other support positions. None of the our employees are
covered by a collective bargaining agreement, and we consider our employee
relations to be good. We also have relationships with certain healthcare
professionals pursuant to contracts with each professional establishing
independent contractor relationships.
MAJOR CUSTOMERS
On October 1, 1997, Correctional Services was awarded a multi-year
contract 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. The contract expires on June 30, 2001 but may be extended for
two possible one-year renewal terms. For the year ended September 30, 2000, the
contract accounted for 49% of net revenues. This contract is projected to
provide approximately $12,000,000 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 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 18% of net revenues for the year ended September 30,
2000. This contract is projected to provide approximately $4,100,000 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 revenues under
the contract.
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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, 2000, 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 a one-year
option to renew 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 expired on June 30, 2001; however, the
one-year renewal option was exercised. For the year ended September 30, 2000,
the contract accounted for 11% of net revenues or approximately $2,200,000. The
Company expects that this contract will be renewed 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.
FORWARD-LOOKING STATEMENTS
This reports contains forward-looking statements. Forward-looking
statements relate to future events or our future financial performance. In some
cases, you can identify forward-looking statements by terminology such as "may,"
"will," "should," "expects," "plans," "anticipates," "could," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of these
terms or other similar words. The outcome of the events described in these
forward-looking statements is subject to certain risks. Actual results could
differ materially. The sections entitled "Description of Business",
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" as well as other sections in this report discuss some of the factors
that could contribute to these differences.
ITEM 2. PROPERTIES
Currently, our executive offices are located in Vienna, Virginia pursuant
to a lease expiring in March 2004. Pursuant to such lease, our annual lease
commitment is approximately 2,900 square feet at approximately $26.00 per square
foot, with annual increases in an amount equal to 3% of the prior year's base
rent. In addition to our corporate office, we maintain a regional office in
Atlanta, Georgia and Nashville, Tennessee, which require annual lease
commitments approximating $58,000 per year. We believe that our facilities are
adequate to carry on our business as currently structured.
ITEM 3. LEGAL PROCEEDINGS
We are, and may be in the future a party to litigation arising in the
ordinary course of its business. While we have no reason to believe that any
pending litigation against us is material, there can be no assurance that our
insurance coverage will be adequate to substantially cover liabilities arising
out of such claims or that any such claims will be covered by our insurance. Any
material litigation, which is not covered by insurance, may have an adverse
effect on our business. Claims against us, regardless of their merit, or
outcome, may also have an adverse effect on our reputation and business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of MHM Services, Inc. was held on
August 3, 2000. 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. Also, our stockholders
voted to approve an increase in the number of our common stock shares to be
reserved for our stock option pool from 700 shares to 900 shares. Of the 4,574
shares voting on this matter, 1,987 shares voted for the change, 580 shares
voted against the change, 8 shares abstained from the vote, and 1,999 shares did
not vote on the matter. 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
Our shares of common stock are currently quoted on the OTC Bulletin Board
under the symbol "MHMI.OB." In March 2000, our Board of Directors approved a
plan to declare a 500 to 1 reverse stock split of all issued and outstanding
shares. The record date for the reverse stock split was March 21, 2000. We
purchased all fractional shares resulting from this transaction based on a
pre-split fair market value of $0.45 per share. This value was determined
through a third-party valuation we secured. This reverse stock split resulted in
a reduction in the number of stockholders from approximately 3,000 as of March
21, 2000, to approximately 250 as of September 30, 2000. All share and per share
amounts in the accompanying consolidated financial statements, pro forma
consolidated financial statements, and selected consolidated financial
statements have been retroactively restated to reflect this 500 to 1 reverse
stock split. Prior to the reverse stock split, our shares of common stock were
quoted on the OTC Bulletin Board under the symbol "MHMM". As of September 30,
2000, 15,000,000 shares of common stock are authorized, 7,287 shares are issued
and 7,266 shares are outstanding.
On September 30, 2000, our Board of Directors declared a repricing of all
outstanding stock options to reduce the exercise price to $72.00 per share,
which represents the fair market value of our common stock at September 30,
2000.
On November 20, 2000 we issued 23,779 shares of our common stock through
our Shareholders' Rights Offering (the Offering). Each stockholder, based on a
record date of September 29, 2000, was given the right to purchase four new
shares of our common stock, at $72.00 per share, for each share the stockholder
held on the record date, and the pro rata right to purchase the shares which
other stockholders declined to purchase. We raised approximately $1,621,000, net
of offering expenses. Included within this report are Unaudited Pro Forma
Consolidated Financial Statements to illustrate the effects of the dissolution
of Extended Care Services and the investment capital raised through the Offering
had these events occurred as of October 1, 1999.
Effective November 15, 2000, we granted 2,906 additional stock options to
our employees and Board members in order to offset the dilutive effects of the
Offering to holders of our common stock.
Prior to September 30, 2000, there had been no reported sales of shares
of our common stock since May 3, 2000. Therefore, we used the Offering price as
the market value price of our shares as of date of this report. The following
table sets forth, for the periods indicated, the high and low sales prices of
our common stock, under the symbol "MHMM", as listed on the Over-the-Counter
Bulletin Board ("OTCBB"). The market values have been retroactively adjusted to
reflect the 500-to-1 reverse stock split effected on March 21, 2000:
<TABLE>
<CAPTION>
HIGH LOW
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Year ended September 30, 2000:
First Quarter $ 312.50 $ 187.50
Second Quarter 234.50 93.75
Third Quarter 156.50 93.75
Fourth Quarter - -
Year ended September 30, 1999:
First Quarter $ 578.00 $ 281.50
Second Quarter 390.50 250.00
Third Quarter 375.00 219.00
Fourth Quarter 359.50 219.00
</TABLE>
Market quotations for our shares of common stock reflect inter-dealer
prices, without retail mark-up, markdown or commission, and may not necessarily
represent actual transactions.
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COMMON STOCKHOLDERS
As of September 30, 2000, there were approximately 250 record holders of
the common shares. Such number of record holders was determined from our
stockholder records.
DIVIDEND POLICY
We do not anticipate paying any dividends on any of our common stock in
the foreseeable future. We currently intend to retain all of our earnings, if
any, for use in our business. We may also incur debt in the future, which may
prohibit or restrict the payment of dividends.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial information presented below has been derived
from our audited consolidated financial statements. This data is qualified in
its entirety by reference to, and should be read in conjunction with our
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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CONSOLIDATED STATEMENT OF OPERATIONS DATA (IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------
2000 1999 1998 1997 1996
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net Revenues $ 19,858 18,388 29,294 20,851 34,670
Costs and expenses:
Operating 15,396 15,128 20,040 14,875 25,765
General and administrative 3,999 4,937 7,539 5,760 9,718
Provision for bad debts 181 898 3,326 3,467 6,320
Depreciation and amortization 98 252 597 369 1,034
(Gain) loss on sale of freestanding facilities (note 1) -- (299) (2,465) -- 4,440
Writedown of long-term assets (note 2) -- -- 430 696 461
Gain on sale of extended care services assets (note 3) -- (301) -- -- --
Other (credits) charges:
Interest expense - MEDIQ -- -- 757 1,042 1,097
Interest expense - other 161 342 166 93 290
Other income, net (note 4) (573) (37) -- (662) (233)
------------ ------------ ------------ ------------ ------------
19,262 20,920 30,390 25,640 48,892
------------ ------------ ------------ ------------ ------------
Income (loss) before income taxes and extraordinary item 596 (2,532) (1,096) (4,789) (14,222)
Income tax (benefit) expense (note 8) (3,661) 39 93 -- (308)
------------ ------------ ------------ ------------ ------------
Income (loss) before extraordinary item 4,257 (2,571) (1,189) (4,789) (13,914)
Extraordinary item (note 5) -- -- 9,185 -- (463)
------------ ------------ ------------ ------------ ------------
Net income (loss) $ 4,257 (2,571) 7,996 (4,789) (14,377)
============ ============ ============ ============ ============
Earnings (loss) per share-basic:
Income (loss) before extraordinary item $ 584.19 (376.92) (175.68) (732.37) (2,195.68)
Extraordinary item -- -- 1,357.12 -- (73.06)
------------ ------------ ------------ ------------ ------------
Earnings (loss) per share (note 6) $ 584.19 (376.92) 1,181.44 (732.37) (2,268.74)
============ ============ ============ ============ ============
Weighted average shares outstanding 7,287 6,821 6,768 6,539 6,337
============ ============ ============ ============ ============
Earnings (loss) per share-diluted:
Income (loss) before extraordinary item $ 497.60 (376.92) (175.68) (732.37) (2,195.68)
Extraordinary item -- -- 1,357.12 -- (73.06)
------------ ------------ ------------ ------------ ------------
Earnings (loss) per share (note 6) $ 497.60 (376.92) 1,181.44 (732.37) (2,268.74)
============ ============ ============ ============ ============
Diluted weighted average shares outstanding 8,555 6,821 6,768 6,539 6,337
============ ============ ============ ============ ============
CONSOLIDATED BALANCE SHEET DATA (IN THOUSANDS)
Working capital (deficiency) $ (1,037) $ (3,016) $ (2,011) $ (11,245) $ 2,566
Total assets 6,666 2,282 7,699 11,414 15,669
Long term debt, less current maturities (note 7) 1,400 5 176 1,456 257
Due to MEDIQ, less current maturities - - - - 9,967
Stockholders' equity (deficit) 1,674 (2,453) (134) (8,270) (3,582)
</TABLE>
See Notes to Selected Consolidated Financial Data
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NOTES TO SELECTED CONSOLIDATED FINANCIAL DATA:
(1) We completed the sale of six of our 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,
we sold our last inpatient psychiatric hospital operation and reported a
gain on sale of $2,465,000. In March 1999, we sold a hospital property
that we reacquired in September 1998, and a reported a gain of $299,000
on the sale of this repossessed property.
(2) In the fourth quarter of 1996, we 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 1997, we decided to dispose of the
Florida and North Carolina operations of our Extended Care Services
subsidiary and close our Atlanta, Georgia billing office. In connection
with these decisions, we 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 1998, we decided to dispose of certain assets and contractual rights
of our Extended Care Services subsidiary. In connection with this
decision, we determined that goodwill and other intangibles related to
the prior acquisition of HCI and Apogee operations by Extended Care
Services were permanently impaired and these assets were written down to
an estimated value resulting in a charge of $430,000.
(3) In the first quarter of 1999, we sold certain assets of our Extended Care
Services subsidiary, which resulted in a gain of $301,000.
(4) In May 1997, the Supreme Court of Delaware upheld a lower court award of
$459,000, which we were due from Horizon relating to our rights to
receive certain cash flows as part of the sale of our interest in the
joint venture to Horizon resulting in additional income in fiscal 1997.
In September 1999, we completed negotiations with ICH Services, LLC (ICH)
regarding certain additional consideration payable to ICH as a result of
our acquisition of certain assets from ICH in November 1993. Based on the
final settlement, we paid less consideration than we had projected. As a
final settlement, we paid additional consideration of 500 shares of our
common stock to ICH. 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. In September 2000, as part
of the dissolution process of Extended Care Services, we recorded other
income of $527,000 from the settlement of certain contingent liabilities
related to post-payment reviews of fee-for-service billings in the amount
of $88,000. Prior to settlement, we had recorded reserves of $615,000 for
these contingencies.
(5) In 1996, we recorded an extraordinary loss in the amount of $463,000
consisting primarily of costs related to the early retirement of a
portion of our long-term debt and the write-off of associated loan
acquisition costs. In July 1998, we settled a judgment in the amount of
$11,800,000 for $3,000,000 in cash that was brought against us by our
former parent MEDIQ. As a result of this transaction, the Company
recorded a gain on early extinguishments of debt of $9,185,000.
(6) In 2000, our Board of Directors approved a plan to declare a 500 to 1
reverse stock split of all issued and outstanding shares. The record date
for the reverse stock split was March 21, 2000. We purchased all
fractional shares resulting from this transaction based on a pre-split
fair market value of $0.45 per share. This value was determined through a
third party valuation that we secured. We paid approximately $66,000 for
the purchase of fractional shares. All share and per share amounts in the
selected consolidated financial statements have been retroactively
restated to effect this 500 to 1 reverse stock split. As of September 30,
2000, 15,000,000 shares of common stock are authorized, 7,287 shares are
issued and 7,266 shares are outstanding.
(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.
(8) The valuation allowance on deferred tax assets was reduced by $3,753,000
in 2000 based upon management's projections and estimates that the tax
attributes will be fully utilized.
9
<PAGE> 10
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
We prepared the following Unaudited Pro Forma Consolidated Statement of
Operations for the year ended September 30, 2000 and Unaudited Pro Forma
Consolidated Balance Sheet as of September 30, 2000 to illustrate the effects of
the dissolution of our wholly owned subsidiary, Extended Care Services, and the
closing of our Shareholders' Rights Offering. The Unaudited Pro Forma
Consolidated Financial Statements are presented as if these transactions had
occurred as of October 1, 1999.
We believe that the assumptions used in preparing the Unaudited Pro Forma
Consolidated Financial Statements provide a reasonable basis for presenting the
significant effects directly attributable to the dissolution of Extended Care
Services and the Shareholders' Rights Offering. The Unaudited Pro Forma
Consolidated Financial Statements do not purport to represent what our results
of operations would actually have been if these transactions had in fact
occurred on October 1, 1999, or to project our results of operations for any
future period. These statements should be read in connection with, and are
qualified by reference to, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial statements
and related notes included elsewhere in this report.
10
<PAGE> 11
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED SEPTEMBER 30, 2000
(IN THOUSANDS, EXCEPT SHARES OUTSTANDING AND PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA PRO FORMA
2000 ADJUSTMENTS 2000
----------------- -------------- -----------------
<S> <C> <C> <C>
Revenues $ 19,858 -- 19,858
----------------- -------------- -----------------
Costs and expenses:
Operating 15,396 -- 15,396
General and administrative 3,999 -- 3,999
Provision for bad debts 181 -- 181
Depreciation and amortization 98 -- 98
Other (credits) charges:
Interest expense 161 (116) (3) 45
Other income, net (573) -- (573)
----------------- -------------- -----------------
19,262 (116) 19,146
----------------- -------------- -----------------
Income before gain on dissolution and
income taxes 596 116 712
Gain on dissolution of Extended Care Services -- 261 (1) 261
----------------- -------------- -----------------
Income before income taxes 596 377 973
Income tax expense (benefit) (3,661) 133 (3) (3,528)
----------------- -------------- -----------------
Net income $ 4,257 244 4,501
================= ============== =================
Earnings per common share:
Basic $ 584.19 144.89
================= =================
Diluted 497.60 139.20
================= =================
Weighted average shares outstanding:
Basic 7,287 23,779 (2) 31,066
================= ============== =================
Diluted 8,555 23,779 (2) 32,334
================= ============== =================
</TABLE>
See Notes to Pro Forma Consolidated Financial Statements
11
<PAGE> 12
PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2000
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA PRO FORMA
ASSETS 2000 ADJUSTMENTS 2000
--------------- ------------ ---------------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents $ 211 169 (1) (2) (3) 380
Accounts receivable, net 1,479 -- 1,479
Prepaid expenses 347 (10)(1) 337
Other current assets 267 (91)(2) 176
Deferred income taxes 251 10 (3) 261
--------------- -------- ---------------
Total current assets 2,555 78 2,633
Property and equipment, net 85 -- 85
Restricted cash 275 -- 275
Other assets 106 -- 106
Deferred income taxes 3,645 (130)(3) 3,515
--------------- -------- ---------------
$ 6,666 (52) 6,614
=============== ======== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 454 (91)(3) 363
Accrued payroll and related expenses 977 -- 977
Estimated third-party payor settlements 106 (88)(1) 18
Other accrued expenses 1,675 (273)(1) (3) 1,402
Notes payable and current maturities of long-term debt 237 (62)(1) 175
Deferred income taxes 143 (3)(3) 140
--------------- -------- ---------------
Total current liabilities 3,592 (517) 3,075
Long-term debt 1,400 (1,400)(2) --
--------------- -------- ---------------
4,992 (1,917) 3,075
--------------- -------- ---------------
Stockholders' equity:
Preferred stock ($0.01 par value per share; 5,000,000 -- -- --
shares authorized at September 30, 2000 actual and
pro forma; no shares issued and outstanding at
September 30, 2000 actual and proforma)
Common stock ($0.01 par value per share; 15,000,000 -- -- --
shares authorized at September 30, 2000 actual and
pro forma; 7,287 and 31,066 shares issued at
September 30, 2000 actual and proforma; 7,266 and
31,045 shares outstanding at September 30, 2000
actual and pro forma)
Additional paid-in capital 42,100 1,621 (3) 43,721
Accumulated deficit (40,421) 244 (1) (3) (40,177)
Treasury stock (5) -- (5)
--------------- -------- ---------------
Total stockholders' equity 1,674 1,865 3,539
--------------- -------- ---------------
$ 6,666 (52) 6,614
=============== ======== ===============
</TABLE>
See Notes to Pro Forma Consolidated Financial Statements
12
<PAGE> 13
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS:
(1) Reflects the write-off of approximately $439,000 in liabilities and
$178,000 in assets related to the dissolution of Extended Care
Services, resulting in a gain on dissolution of approximately $261,000.
(2) Reflects the allocation of estimated net proceeds of approximately $1.6
million from the sale of 23,779 shares of common stock through our
Shareholders' Rights Offering ("Offering").
(3) Reflects the application of the net proceeds from our Offering to pay off
amounts outstanding under our credit facility and accrued liabilities
associated with the Offering. Interest expense of $116,000 from the
senior credit facility has been eliminated as if the facility had been
paid off as of October 1, 1999. The tax impact of the proforma interest
expense adjustment has also been reflected.
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.
RECENT DEVELOPMENTS
On August 25, 1999, Extended Care Services filed a Certificate of
Dissolution with the Secretary of State of the State of Delaware. It was
Extended Care Services' intent to dissolve under Section 280 and 281 of the
Delaware General Corporate Law ("DGCL"). Subsequent to the filing, Extended Care
Services informed all known and foreseeable creditors about its intent to
dissolve and prepared a dissolution plan for which to pay its outstanding
creditors.
Certain contingent claims were sought against Extended Care Services.
Most of these claims were the result of refunds for certain Medicaid payments
made to Extended Care Services in prior years. These claims were based on audits
performed by third-party fiscal intermediaries on behalf of the state. Extended
Care Services settled certain claims brought against it in order to finalize
its plan of dissolution to present to the Delaware Court of Chancery, which
resulted in other income of approximately $527,000 for the year ended September
30, 2000.
On October 30, 2000, the Delaware Court of Chancery approved Extended
Care Services' dissolution plan to distribute its remaining total assets of
approximately $178,000 on a pro-rata basis, to its external creditors. The
dissolution of Extended Care Services became effective on November 30, 2000,
which was the first business day after which creditors could file an appeal of
the final order and judgment issued by the Delaware Court of Chancery. Please
refer to the Pro Forma Consolidated Financial Statements within this report to
review the potential effect this transaction would have had on our September 30,
2000 financial statements if this event had occurred as of October 1, 1999.
On November 20, 2000, as a result of a Shareholders' Rights Offering, we
raised approximately $1,621,000, net of offering expenses, through the issuance
of 23,779 shares of our common stock at $72.00 per share to our existing
stockholders. We used $1,300,000 of the proceeds from this offering and $100,000
from operations to liquidate our promissory note with Bank of America. The
remaining proceeds will be used as working capital. See the Pro Forma
Consolidated Financial Statements within this report to review the potential
effect this transaction would have had on our September 30, 2000 financial
statements if this event had occurred as of October 1, 1999.
13
<PAGE> 14
SOURCES OF FINANCING
We had executed a promissory note with the Bank of America that had a
$1.8 million maximum borrowing capacity, which was personally guaranteed by our
Chief Executive Officer and one of our Directors. See Note 10 of Notes to
Consolidated Financial Statements. This promissory note provides for a variable
rate of interest based on the Eurodollar rate plus 2.6% and may expose us to
certain interest rate risk resulting from changes in the Eurodollar rate, which
we believe will have no significant impact to us. At September 30, 2000, we had
drawn $1.4 million against the note.
On November 20, 2000, we issued 23,779 shares of our common stock to our
existing stockholders of record as of September 29, 2000, at $72.00 per share.
Each stockholder, as of the record date, was allotted the right to purchase four
new shares of our common stock for each share that they held. In addition, each
stockholder was allowed to purchase additional shares from the shares allotted
to other stockholders who did not choose to participate in the offering. We
raised $1,621,000, net of offering expenses, from this offering, which was used
to liquidate the outstanding promissory note with Bank of America. The remaining
proceeds are expected to be used for working capital needs.
OVERVIEW OF REVENUE SOURCES
Correctional Services generates revenues from the provision of specialty
health care services to the inmates of correctional systems primarily under
capitated rates based on inmate census. These revenues represented approximately
100%, 78% and 37% of net revenues for the fiscal years ended September 30, 2000,
1999 and 1998, respectively. Net revenues in this subsidiary are reported on an
accrual basis at the capitated rate applied to the number of inmates regardless
of the services provided.
While it was operational, Extended Care Services' revenues were generated
primarily by billings to third-party payors based on a fee-for-service 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 due 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.
Extended Care Services' revenues represented approximately 0%, 25%, and
52% of net revenues for the fiscal years ended September 30, 2000, 1999 and
1998, respectively. The decreased percentage of revenues in 2000, 1999 and 1998,
reflects the effect of the sale of the remaining unprofitable extended care
operations in December 1998 and our focus in growing our business in the
correctional services market.
While it was operational, our hospital division's revenues were primarily
generated from payments at a fixed-rate for services provided based on the
allowable cost of such services. Such payments were generally made by a
third-party, principally Medicare, but also included Medicaid and other
healthcare insurers. We had agreements with these third-party payors that
provided for payments for patient services at amounts that differed from our
established rates. For Medicare, we were reimbursed for cost reimbursable items
at a tentative rate with final settlement determined after we submitted an
annual cost report and an audit was completed by the Medicare fiscal
intermediary. We have made final settlements for prior reporting periods for all
of the freestanding facilities sold. The hospital division's revenues
represented approximately 0%, (3)% and 11% of our revenues for the years ended
September 30, 2000, 1999 and 1998, respectively.
14
<PAGE> 15
The following table describes our results of operations as a percentage
of net revenues for the periods presented:
RESULTS FROM OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30
---------------------------------------------
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Net revenues 100.0 % 100.0 % 100.0 %
Costs and expenses:
Operating 77.5 82.2 68.4
General and administrative 20.1 26.8 25.7
Provision for bad debts 0.9 4.9 11.4
Depreciation and amortization 0.5 1.4 2.0
Gain - 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
Other (credits) charges:
Interest expense - MEDIQ - - 2.6
Interest expense - other 0.9 1.9 0.6
Other income-net (2.9) (0.2) -
------------- ------------- -------------
Income (loss) before income taxes and extraordinary item 3.0 (13.8) (3.7)
Income tax (benefit) expense (18.4) 0.2 0.3
------------- ------------- -------------
Income (loss) before extraordinary item 21.4 (14.0) (4.0)
Extraordinary item - gain on early extinguishment of debt - - 31.4
------------- ------------- -------------
Net income (loss) 21.4 % (14.0) % 27.4 %
============= ============= =============
</TABLE>
FISCAL YEAR 2000 COMPARED TO FISCAL YEAR 1999
Net revenues for the year ended September 30, 2000, were $19,858,000 as
compared to $18,388,000 for the prior year, an increase of $1,470,000 or 8%.
This increase is the result of our continued efforts to grow our business and
obtain new correctional services contracts. Net revenues from Correctional
Services were $19,858,000 in 2000 as compared to $14,324,000 in 1999, an
increase of $5,534,000 or 39%. Net revenues from the dissolved Extended Care
Services operations were $0 in 2000 as compared to $4,546,000 in 1999.
Settlements on third party cost reports related to our hospital division had a
negative impact of $482,000 on net revenues in 1999.
Operating expenses for the fiscal year ended September 30, 2000, were
$15,396,000 as compared to $15,128,000 for the prior year, an increase of
$268,000 or 2%. Correctional Services operating expenses were $15,396,000 as
compared to $12,075,000, an increase of $3,321,000 or 28% primarily due to new
contracts added during the year. Operating expenses related to the dissolved
Extended Care Services operations were $0 in 2000 as compared to $3,053,000 in
1999.
General and administrative expenses for the year ended September 30,
2000, were $3,999,000 as compared to $4,937,000 for the prior year, a decrease
of $938,000 or 19%. This decrease is primarily attributed to the divesture of
certain assets of the dissolved Extended Care Services operations in 1999.
Correctional Services' general and administrative expenses were $1,391,000 in
2000 as compared to $896,000 in 1999, an increase of $495,000 or 55% primarily
due to new contracts added during the year as well as marketing costs incurred
in 2000 to grow our business. General and administrative expenses for the
dissolved Extended Care Services operations were $36,000 in 2000 as compared to
$1,699,000 in 1999. Costs incurred in 2000 from Extended Care Services were
attributed to the wind down of costs associated with the assets sold in 1999.
Corporate general and administrative expenses were $2,572,000 as compared to
$2,342,000 in 1999, a $230,000 increase or 10% attributed to cost of living
increases in our administrative personnel costs and an increase in franchise tax
expense.
Our provision for bad debts for 2000 decreased to $181,000 as compared to
$898,000 for 1999. As a percentage of net revenues, the provision for bad debts
was 0.9% in 2000 and 4.9% in 1999, respectively. The divestiture of certain
operations of
15
<PAGE> 16
Extended Care Services during the first quarter of 1999 has changed our
operations from having a significant amount of our revenues on a fee-for-service
basis, which required substantial bad debt reserves, to capitated revenue
arrangements, which have fewer collectibility uncertainties. Our 2000 bad debt
provision primarily represents our best estimate of potential uncollectible
revenues for clients we serve in our PASARR program, who may not obtain the
Medicaid coverage required to reimburse us for certain services we have provided
and a provision for potential uncollectible revenues from our correctional
fee-for-service business.
Depreciation and amortization decreased to $98,000 in 2000 from $252,000
in the prior year due to the sale of certain Extended Care Services operations
during the first quarter of 1999.
Interest expense was $161,000 in 2000 as compared to $342,000 in 1999.
Interest expense in 2000 is primarily from the promissory note with Bank of
America, which we used to fund operations. In 1999, in addition to the
promissory note, we incurred interest expense associated with a revolving line
of credit used to fund Extended Care Services' operations, and a six-month loan
with Heller Financial, formerly known as Healthcare Financial Partners, which
was used to settle a note with MEDIQ.
We recorded other income of $573,000 in 2000 related to the following
transactions. In September 2000, as part of the dissolution of Extended Care
Services, in return for an $88,000 payment, we settled a contingent liability
associated with post-payment reviews of certain fee-for-service billings, which
had been reserved for $615,000. As a result of this settlement, we recognized
other income of $527,000 in 2000. We recorded income of $80,000 from bad debt
recoveries on Extended Care Services' accounts receivable, which had been
previously written off as bad debts. We recorded interest income of $36,000 from
outstanding certificates of deposit held to secure performance bonds for
existing contracts. We had a gain on sale on certain assets of $8,000 and we
received income tax refunds of $41,000. We recorded a loss of $119,000 from the
final settlement of Medicare cost reports of Mountain Crest Hospital, which was
sold in April 1998, and certain legal settlements associated with Extended Care
Services.
Other income in 1999 was $37,000 of which $28,000 resulted from interest
income earned on outstanding certificates of deposit held to secure performance
bonds for existing contracts, $20,000 in other fees paid for an extension of
payment terms for a note due to us and $5,000 from interest earned on operating
cash accounts. We realized a gain of $17,000 from the final settlement with the
former partners of ICH in regards to additional consideration due to the
partners from the acquisition of HCI Services, Inc. in 1993. In addition, we
realized a loss of $33,000 from the disposal of certain assets.
We recognized a tax benefit of $3,661,000 in 2000 as a result of reducing
the valuation allowance on our deferred tax assets due to our projections and
estimates that the tax attributes will be fully utilized. We recognized a
provision of income taxes of $39,000 in 1999.
We are reporting net income of $4,257,000 in 2000 as compared to a net
loss of $2,571,000 in 1999. Approximately $3,753,000 of 2000 net income was
attributed to the recognition of a tax benefit as a result of reducing our
valuation allowance on deferred tax assets during 2000. Approximately $1,722,000
of our 1999 net loss was attributed to the divesture of Mountain Crest Hospital,
Oakview Hospital and the sale of certain assets of Extended Care Services.
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 divestiture 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 contracts that began in April, May
and July of 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, we sold our 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 our 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 Extended Care Services' operations with the exception of the Medicaid
Georgia contract. The sale of Mountain Crest Hospital in April 1998 and the
decrease in wind-up costs associated with hospitals sold in 1996 accounted
16
<PAGE> 17
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 $896,000 in
1999 as compared to $483,000 in 1998. General and administrative expenses
increased by $413,000 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 changed our operation
from having a significant amount of our 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 the
Extended Care Services subsidiary and reserves on receivables remaining after
the sale of our 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, we received $1,470,000 from the sale of a hospital
property that we reacquired in September 1998 in a foreclosure. As a result of
this transaction, we recorded a gain on the sale of $299,000 in 1999. In April
1998, we sold our 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, we reported a one-time
gain of $2,465,000 in 1998.
In December 1998, we 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. We received consideration of
$1,020,000 for these transactions and recorded a gain on these sales of $301,000
in 1999.
As a result of a settlement between MEDIQ, our former parent, and us in
July 1998, there was no interest expense recorded for the note payable to MEDIQ
in 1999 as compared to $757,000 in 1998. Other interest expense increased by
$176,000 from $166,000 in 1998 to $342,000 in 1999. The increase in other
interest expense was the result of interest costs related to the MHM 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 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 to us and $5,000 from interest earned on operating cash accounts. We
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, we realized a $33,000 loss on
disposal of certain assets.
In July 1998, in return for a $3,000,000 payment, we settled an
$11,800,000 judgment, brought against us by MEDIQ, our former parent. As a
result of this settlement, we 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 our 1999 net loss can be attributed to
the assets and operations sold in the sale of Mountain Crest Hospital and
Oakview Hospital, as well as the sale of Extended Care Services' operations. The
net income for 1998 was primarily derived from the gain on sale of our last
freestanding hospital and the extraordinary gain on the MEDIQ settlement.
17
<PAGE> 18
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have funded operating losses through a combination of
the proceeds derived from the sale of certain operations of our subsidiaries'
operating units and through borrowed funds. As of September 30, 2000 we had
stockholders' equity of $1,674,000 and a working capital deficit of $1,037,000.
On October 30, 2000, the Delaware Court of Chancery approved Extended
Care Services' dissolution plan to distribute its total remaining assets of
approximately $178,000 on a pro-rata basis, to its external creditors. Extended
Care Services' external liabilities were $439,000 as of September 30, 2000.
Please refer to the Pro Forma Consolidated Financial Statements within this
report to review the potential effect this transaction would have had on our
September 30, 2000 financial statements if this event had occurred as of October
1, 1999.
On November 20, 2000, as a result of a Shareholders' Rights Offering, we
raised approximately $1,621,000, net of offering expenses, through the issuance
of 23,779 shares of our common stock at $72.00 per share to our existing
stockholders. We used a portion of the proceeds from this offering to liquidate
our promissory note with Bank of America. The remaining proceeds will be used as
working capital. See the Pro Forma Consolidated Financial Statements within this
report to review the potential effect this transaction would have had on our
September 30, 2000 financial statements if this event had occurred as of October
1, 1999.
As a result of the dissolution of Extended Care Services and investment
capital raised through a Shareholders' Rights Offering, we have been able to
reduce our working capital deficit. We believe our future operating results
will produce additional working capital, which we intend to use to obtain
additional contracts to provide mental health services in correctional
facilities.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In March 2000, the Financial Accounting Standard Board (FASB) issued FASB
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation. Under FASB Interpretation No. 44, if the exercise price of a fixed
stock option award is reduced, the award shall be accounted for as variable from
the date of modification to the date the award is exercised, forfeited, or
expires unexercised. Under variable accounting, compensation cost is measured at
each reporting period as the sum of the following:
a. The intrinsic value of the award (if any) at the original measurement
date
b. The intrinsic value of the variable award that exceeds the lesser of
the intrinsic value of the original award (1) at the original
measurement date or (2) immediately prior to the modification.
The Company accounts for stock-based compensation for all modified awards in
accordance with FASB Interpretation No. 44.
IMPACT OF INFLATION
Behavioral health programs are labor intensive. As wages and employee
benefit costs increase during inflationary periods, our outside suppliers may
pass cost increases through to us, and our costs may rise proportionately. We
have implemented systems to monitor and control increases in expenses. Our
capitated contracts with the correctional systems may limit our ability to
obtain corresponding revenue increases. Additionally, our capitated contracts
with the correctional systems of Georgia and Tennessee and the subcontracts with
Prison Health Systems and Career Development Systems are subject to an inflation
risk if psychotropic drug costs exceed the contracted increase in the capitation
rate we receive.
18
<PAGE> 19
ITEM 8 FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report 20
- 2000 and 1999
Consolidated Statements of
Operations -
Three Years Ended 21
September 30, 2000
Consolidated Balance Sheets -
September 30, 2000 and 1999 22
Consolidated Statements of
Stockholders' Equity (Deficit) -
Three Years Ended 23
September 30, 2000
Consolidated Statements of 24-
Cash Flows - 25
Three Years Ended September
30, 2000
Notes to Consolidated 26-
Financial Statements 43
Schedule II - Valuation and 44
Qualifying Accounts and
Reserves
</TABLE>
19
<PAGE> 20
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 (the Company), as of September 30, 2000 and 1999, and the
related consolidated statements of operations, stockholders' equity (deficit),
and cash flows for each of the years in the three-year period ended September
30, 2000. 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 auditing standards generally accepted
in the United States of America. 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.
As more fully discussed in footnote 17, on October 30, 2000, the Delaware Court
of Chancery approved Extended Care Services' dissolution plan to distribute its
total remaining assets, on a pro-rata basis, to its external creditors. The
dissolution of Extended Care Services became effective on November 30, 2000.
Also, as more fully discussed in footnote 17, on November 20, 2000, the Company
raised $1,621,000, net of offering expenses, in investment capital as a result
of a Shareholders' Rights Offering.
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, 2000 and 1999, and the results of their
operations and their cash flows for each of the years in the three-year period
ended September 30, 2000, in conformity with accounting principles generally
accepted in the United States of America.
/s/ KPMG LLP
January 10, 2001
20
<PAGE> 21
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended September 30, 2000, 1999 and 1998
<TABLE>
<CAPTION>
2000 1999 1998
------------ ------------ ------------
<S> <C> <C> <C>
Net revenues (note 12) $19,858,000 18,388,000 29,294,000
------------ ------------ ------------
Costs and expenses:
Operating 15,396,000 15,128,000 20,040,000
General and administrative 3,999,000 4,937,000 7,539,000
Provision for bad debts 181,000 898,000 3,326,000
Depreciation and amortization 98,000 252,000 597,000
Gain on sale of freestanding facilities (note 3) -- (299,000) (2,465,000)
Writedown of long-term assets (note 5) -- -- 430,000
Gain on sale of extended care division assets
(note 4) -- (301,000) --
Other (credits) charges:
Interest expense - MEDIQ (note 10) -- -- 757,000
Interest expense - other 161,000 342,000 166,000
Other income, net (notes 2, 4 and 6) (573,000) (37,000) --
------------ ------------ ------------
19,262,000 20,920,000 30,390,000
------------ ------------ ------------
Income (loss) before income taxes and extraordinary
item 596,000 (2,532,000) (1,096,000)
Income tax expense (benefit)(note 13) (3,661,000) 39,000 93,000
------------ ------------ ------------
Income (loss) before extraordinary item 4,257,000 (2,571,000) (1,189,000)
Extraordinary item (note 10) -- -- 9,185,000
------------ ------------ ------------
Net income (loss) $ 4,257,000 (2,571,000) 7,996,000
============ ============ ============
Earnings (loss) per common share-basic:
Income (loss) before extraordinary item $ 584.19 (376.92) (175.68)
Extraordinary item -- -- 1,357.12
------------ ------------ ------------
Net income (loss) $ 584.19 (376.92) 1,181.44
============ ============ ============
Weighted average shares outstanding 7,287 6,821 6,768
============ ============ ============
Earnings (loss) per common share-diluted:
Income (loss) before extraordinary item $ 497.60 (376.92) (175.68)
Extraordinary item -- -- 1,357.12
------------ ------------ ------------
Net income (loss) $ 497.60 (376.92) 1,181.44
============ ============ ============
Diluted weighted average shares outstanding 8,555 6,821 6,768
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
21
<PAGE> 22
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, 2000 and 1999
<TABLE>
<CAPTION>
ASSETS 2000 1999
------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 211,000 6,000
Accounts receivable, less allowances of $111,000
and $337,000 in 2000 and 1999, respectively (note 12) 1,479,000 1,094,000
Prepaid expenses (note 10) 347,000 284,000
Estimated third-party payor settlements (note 6) -- 61,000
Other current assets (note 7) 267,000 269,000
Deferred income taxes (note 13) 251,000 --
------------ ------------
Total current assets 2,555,000 1,714,000
Property and equipment, net (note 8) 85,000 142,000
Restricted cash 275,000 275,000
Other assets 106,000 151,000
Deferred income taxes (note 13) 3,645,000 --
------------ ------------
$ 6,666,000 2,282,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Cash overdrafts $ -- 24,000
Accounts payable 454,000 618,000
Accrued payroll and related expenses 977,000 607,000
Estimated third-party payor settlements (note 6) 106,000 784,000
Other accrued expenses (note 9) 1,675,000 1,235,000
Notes payable (note 10) 170,000 187,000
Line of credit (note 10) -- 1,000,000
Current maturities of long-term debt (note 10) 67,000 275,000
Deferred income taxes (note 13) 143,000 --
------------ ------------
Total current liabilities 3,592,000 4,730,000
Long-term debt (note 10) 1,400,000 5,000
------------ ------------
4,992,000 4,735,000
------------ ------------
Stockholders' equity (deficit) (note 14):
Preferred stock ($0.01 par value; 5,000,000 shares authorized;
no shares issued and outstanding) -- --
Common stock ($0.01 par value; 15,000,000 shares authorized;
7,287 shares issued at September 30, 2000 and 1999; 7,266 and
7,287 shares outstanding at September 30, 2000 and 1999,
respectively) -- --
Additional paid-in capital 42,100,000 42,225,000
Accumulated deficit (40,421,000) (44,678,000)
Treasury stock, 21 common shares at September 30, 2000, at cost (5,000) --
------------ ------------
Total stockholders' equity (deficit) (note 17) 1,674,000 (2,453,000)
------------ ------------
Commitments and contingencies (note 11)
$ 6,666,000 2,282,000
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE> 23
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity (Deficit)
Years ended September 30, 2000, 1999 and 1998
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
--------------------- PAID-IN ACCUMULATED TREASURY
SHARES AMOUNT CAPITAL DEFICIT STOCK TOTAL
----------- -------- ------------ ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, September 30, 1997 6,743 $ -- 41,833,000 (50,103,000) -- (8,270,000)
Exercise of stock options 50 -- 12,000 -- -- 12,000
Issuance of stock warrants in
connection with MEDIQ
settlement (note 14) -- -- 128,000 -- -- 128,000
Net income -- -- -- 7,996,000 -- 7,996,000
----------- -------- ------------ ------------- ------------ -------------
Balance, September 30, 1998 6,793 -- 41,973,000 (42,107,000) -- (134,000)
Issuance of stock warrants in
connection with line of credit
(note 10) -- -- 143,000 -- -- 143,000
Shares issued in connection with
ICH earnout settlement (note 4) 494 -- 109,000 -- -- 109,000
Net loss -- -- -- (2,571,000) -- (2,571,000)
----------- -------- ------------ ------------- ------------ -------------
Balance, September 30, 1999 7,287 -- 42,225,000 (44,678,000) -- (2,453,000)
Issuance of stock warrants in
connection with line of credit
(note 10) -- -- 69,000 -- -- 69,000
Purchase of fractional shares
from reverse stock split (note 14) -- -- (66,000) -- -- (66,000)
Repurchase of stock warrants
issued in connection with
MEDIQ settlement (note 14) -- -- (128,000) -- -- (128,000)
Purchase of treasury stock (note 14) (21) -- -- -- (5,000) (5,000)
Net income -- -- -- 4,257,000 -- 4,257,000
---------------------------------- ------------- ------------ -----------
Balance, September 30, 2000 7,266 $ -- 42,100,000 (40,421,000) (5,000) 1,674,000
=========== ======== ============ ============= ============ =============
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE> 24
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended September 30, 2000, 1999 and 1998
<TABLE>
<CAPTION>
2000 1999 1998
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 4,257,000 (2,571,000) 7,996,000
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 98,000 252,000 597,000
Issuance of stock warrants 69,000 143,000 --
Provision for bad debts 172,000 898,000 3,326,000
Gain on sale of freestanding facilities -- (299,000) (2,465,000)
Gain on sale of extended care operations -- (301,000) --
Gain on early extinguishment of debt -- -- (9,185,000)
Gain on sale of investments (13,000) -- --
Gain on third-party settlement (note 2) (527,000) -- --
Loss on disposal of assets 5,000 33,000 28,000
Writedown of long-term assets -- -- 430,000
Increase (decrease) in cash from changes in:
Accounts receivable and estimated third-party
payor settlements, net (687,000) 1,665,000 (2,997,000)
Prepaid expenses and other assets 125,000 (69,000) 141,000
Deferred rent -- -- (31,000)
Accounts payable (164,000) 193,000 (531,000)
Accrued payroll and related expenses 370,000 (223,000) (162,000)
Accrued expenses - MEDIQ -- -- 817,000
Other accrued expenses 349,000 (482,000) (308,000)
Deferred taxes (3,753,000) -- --
---------- ----------- -----------
Net cash provided by (used in) operating activities 301,000 (761,000) (2,344,000)
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sale of extended care division, freestanding
facilities and joint venture -- 2,341,000 3,688,000
Proceeds from sale of investments 50,000 -- --
Disposal of extended care services assets -- 143,000 --
Capital expenditures for property and equipment (46,000) (45,000) (23,000)
Collections on notes receivable 40,000 100,000 --
Change in restricted cash -- 251,000 11,000
Other assets -- -- 65,000
Other liabilities -- -- (19,000)
----------- ----------- -----------
Net cash provided by investing activities 44,000 2,790,000 3,722,000
---------- ----------- -----------
Cash flows from financing activities:
Change in cash overdrafts (24,000) 24,000 --
Borrowings 500,000 3,514,000 12,651,000
Debt repayments (508,000) (5,615,000) (14,095,000)
Purchase of treasury stock (5,000) -- --
Cash payout for fractional shares (66,000) -- --
Repurchase of stock warrants (37,000) -- --
Other -- -- 12,000
----------- ----------- -----------
Net cash used in financing activities (140,000) (2,077,000) (1,432,000)
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents 205,000 (48,000) (54,000)
Cash and cash equivalents:
Beginning of year 6,000 54,000 108,000
----------- ----------- -----------
End of year $ 211,000 6,000 54,000
=========== =========== ===========
(Continued)
</TABLE>
24
<PAGE> 25
MHM SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended September 30, 2000, 1999 and 1998
<TABLE>
<CAPTION>
2000 1999 1998
-------- -------- --------
<S> <C> <C> <C>
Supplemental disclosure of cash flow information:
Interest paid $151,000 376,000 292,000
Income taxes paid 83,000 -- --
======== ======== ========
Supplemental disclosure of non-cash investing and financing activities:
Note obtained for insurance premiums $178,000 225,000 107,000
Note received from sale of Extended Care Services assets -- 170,000 --
Issuance of stock warrants - to obtain financing from HCFP -- -- 128,000
Issuance of stock - settlement of ICH earnout -- 109,000 --
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE> 26
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) ORGANIZATION AND BUSINESS DESCRIPTION
MHM Services, Inc. (the Company), through its wholly-owned
subsidiary, MHM Correctional Services, Inc. (Correctional
Services) is a provider of mental health services to prison
inmates and long-term care residents under capitated contract
arrangements with state correctional and other governmental
agencies. The Company formerly 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 four states. The Company's net
revenues are derived primarily from three contracts with the
state of Georgia, one contract with the state of Tennessee, and
one subcontract with a prime contractor in the states of Florida
and Mississippi. The Company is compensated based on the number
of inmates 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. Currently, the
Company's contracts expire at various dates through March 31,
2004. Contracts for more than one year have annual renewal
options for multiple years, which are exercisable on mutual
agreement between the Company and the government agency or
contractor. Most of the contracts are subject to termination for
convenience by either party. Management of the Company is not
aware of any circumstances that would cause an agency to
terminate an existing agreement.
(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 accounts receivable are primarily for services
rendered to residents of correctional and long-term care
facilities. The amounts are due from the state agencies and the
prime contractors with which the Company has contracted. The
Company maintains an allowance for potential losses from
uncollectible accounts.
(Continued)
26
<PAGE> 27
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
(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>
<CAPTION>
<S> <C>
Furniture, fixtures, and equipment 5-8 years
Equipment, under capital lease 5-8 years
Leasehold improvements life of lease
</TABLE>
(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.
(g) CARRYING VALUE OF LONG-TERM ASSETS
The Company evaluates the carrying value of its long-term 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
assets. Measurement of the amount of impairment, if any, is
based upon the difference between the carrying value and fair
value (see note 5).
(h) REVENUE RECOGNITION
The Company has agreements with state correctional and other
governmental agencies and a contractor to provide mental health
services to prison inmates and long-term care 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.
During 1999 and 1998, net revenues also include fee-for-service
revenues from patients and third-party payors for inpatient and
on-site mental health services. Retroactive adjustments under
reimbursement agreements with third-party payors 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.
(i) CONTRACT ACQUISITION COSTS
Contract acquisition costs are expensed as incurred.
(j) 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.
(Continued)
27
<PAGE> 28
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
(k) EARNINGS (LOSS) PER SHARE
Historical
Basic earnings (loss) per common share is computed by dividing
net income (loss) by the weighted average number of common
shares outstanding and diluted earnings per common share is
computed using the weighted average number of common shares
outstanding and dilutive stock warrants under the treasury stock
method.
The following table reconciles the weighted average common
shares used in the basic earnings per common share calculation
and the weighted average common shares and common share
equivalents used in the diluted earnings per common share
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------------------------------------
2000 1999 1998
----------------- --------------- -------------
<S> <C> <C> <C>
Weighted average common shares (basic) 7,287 6,821 6,768
Stock warrant equivalent shares 1,268 -- --
----------------- --------------- -------------
Weighted average common shares and
common share equivalents (diluted) 8,555 6,821 6,768
================= =============== =============
</TABLE>
The Company had securities outstanding that could potentially
dilute basic earnings per share in the future, but were excluded
from the loss per share calculation for the years ended September
30, 1999 and 1998, because the effect would be anti-dilutive.
These securities outstanding consisted of 1,479 and 1,032 stock
warrant equivalent shares at September 30, 1999 and 1998,
respectively.
Pro Forma (unaudited)
Pro forma earnings per share for the year ended September 30,
2000, is computed using the weighted average number of common
shares outstanding, including the pro forma effects of the
issuance of new shares upon the closing of the Company's
Shareholders' Rights Offering (see note 17), as if such event
occurred on October 1, 1999. The resulting pro forma adjustment
includes an increase in the weighted average shares used to
compute the basic and diluted earnings per share of 23,779 shares
for the year ended September 30, 2000.
A reconciliation of shares used in the pro forma calculation is as
follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
2000
-----------------
<S> <C>
Shares used in computing basic earnings per share 7,287
Adjustment to reflect the issuance of new shares (unaudited) 23,779
-----------------
Shares used in computing pro forma basic earnings per share
(unaudited) 31,066
=================
Shares used in computing diluted earnings per share 8,555
Adjustment to reflect issuance of new shares (unaudited) 23,779
-----------------
Shares used in computing diluted pro forma earnings per share
(unaudited) 32,334
=================
</TABLE>
(Continued)
28
<PAGE> 29
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
(l) 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 payroll and
related expenses, other accrued expenses, capital lease
obligations, notes payable and lines of credit are equivalent to
their carrying value because of the short-term maturity of those
instruments. The fair value of the Company's long-term debt (see
note 10) is considered to be equivalent to its carrying value
based upon consideration of borrowings with similar credit
ratings, collateral and maturities.
(m) 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 affect the reported amounts of net 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 and estimates of assets and liabilities due
from/to third-party payors.
(n) 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.
(o) STOCK OPTION PLAN
The Company accounts for stock-based compensation in accordance
with the provisions of Accounting Principles Board ("APB")
Opinion No. 25, Accounting for Stock Issued to Employees (APB
25), and related interpretations, and complies with the
disclosure provisions of SFAS No. 123, Accounting for
Stock-Based Compensation. Under APB 25, compensation expense is
based on the difference, if any, on the date of grant, between
the fair value of the Company's stock and the exercise price.
Effective September 30, 2000, the Board of Directors declared a
repricing of all stock options outstanding by lowering the
exercise price to the fair market value of the Company's stock
as of September 30, 2000 (see note 14). Upon the declaration of
the repricing of all outstanding stock options, the Company
accounts for stock-based compensation for all modified awards in
accordance with Financial Accounting Standards Board (FASB)
Interpretation No. 44, Accounting for Certain Transactions
involving Stock Compensation. Under FASB Interpretation No. 44,
if the exercise price of a fixed stock option award is reduced,
the award shall be
(Continued)
29
<PAGE> 30
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
accounted for as variable from the date of modification to the
date the award is exercised, forfeited, or expires unexercised.
Under variable accounting, compensation cost is measured at each
reporting period as the sum of the following:
1. The intrinsic value of the award (if any) at the
original measurement date, plus
2. The intrinsic value of the variable award that exceeds
the lesser of the intrinsic value of the original award
(a) at the original measurement date or (b) immediately
prior to the modification.
(p) RECLASSIFICATIONS
Certain amounts in the 1999 financial statements have been
reclassified to conform to the 2000 presentation.
(2) DISSOLUTION OF EXTENDED CARE SERVICES
On August 25, 1999, Extended Care Services filed a Certificate of
Dissolution with the Secretary of State of the State of Delaware.
Subsequent to the filing, Extended Care Services informed all known and
foreseeable creditors about its intent to dissolve and prepared a
dissolution plan for which to pay its outstanding creditors.
As part of the dissolution process of Extended Care Services, the
Company obtained a final settlement with a third-party payor relating
included in other income to post payment reviews of fee-for-service
billings that resulted in a gain of $527,000 included in other income
for the year ended September 30, 2000.
On October 30, 2000, the Delaware Court of Chancery approved Extended
Care Services' dissolution plan to distribute its remaining total assets
of approximately $178,000, on a pro-rata basis, to its external
creditors. The dissolution of Extended Care Services became effective on
November 30, 2000, which was the first business day after which
creditors could file an appeal of the final order and judgment issued by
the Delaware Court of Chancery. The pro forma financial results of this
subsequent event are described in Note 17.
(3) 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 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
(Continued)
30
<PAGE> 31
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
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
$2,465,000 in fiscal 1998.
(4) ACQUISITIONS AND DIVESTITURES
(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 purchase price consisted of 660
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.
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 500 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) 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 integrated the Liberty Bay
operations with MHM Counseling Services and the combined
operations from the date of acquisition operated under the name
"MHM/Bay Colony Counseling Services."
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 note provides for quarterly
interest payments at an annual rate of nine percent and the
payment of the principal amount in one installment on December
1, 1999. Extended Care Services obtained an extension of the
payment of the principal amount of the note to December 31,
2000.
On December 31, 1998, Extended Care Services entered into an
agreement with another organization to sell certain of the
assets related to the delivery of outpatient mental health
(Continued)
31
<PAGE> 32
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
services and services to patients of extended care facilities in
the state of Massachusetts. These assets were sold for $850,000,
and resulted in a gain on sale of approximately $290,000 in
fiscal 1999.
(c) 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.
As consideration for the purchase, 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 400 shares
of common stock of MHM Services, Inc. at $250 per share. 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 seven percent and annual principal
payments.
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 that 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.
(5) WRITEDOWN OF LONG-TERM ASSETS
In September 1998, the Company decided to sell certain additional assets
and contractual rights related to Extended Care Services as described in
note 4. 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 was
permanently impaired. As a result, the carrying value of goodwill and
other intangibles relating to these operations was written down
resulting in a charge of $430,000 in the year ended September 30, 1998.
(6) 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 has negotiated final settlements with all
third-party payors for all reporting periods.
Final settlements with third-party payors for prior cost reporting
periods resulted in an increase to other income of $599,000 for the year
ended September 30, 2000. Tentative and final settlements with
third-party payors for prior cost reporting periods and post payment
reviews of fee-for-service billings have resulted in adjustments to
decrease net revenues by approximately $1,056,000 for the year ended
September 30, 1999, and increase net revenues by $762,000 for the year
ended September 30, 1998.
(Continued)
32
<PAGE> 33
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
Payment arrangements that the Company had with major third-party payors
relating to operations which have all been sold as of September 30, 1999
included cost reimbursement, prospectively determined rates per
discharge, prospectively determined daily rates, and discounted
fee-for-service.
(7) OTHER CURRENT ASSETS
Other current assets includes the following:
<TABLE>
<CAPTION>
2000 1999
-------------- --------------
<S> <C> <C>
Deposits $ 163,000 248,000
Capitalized offering costs (note 14) 91,000 --
Other current assets 13,000 21,000
-------------- --------------
$ 267,000 269,000
============== ==============
</TABLE>
(8) PROPERTY AND EQUIPMENT
Property and equipment includes the following:
<TABLE>
<CAPTION>
2000 1999
--------- ---------
<S> <C> <C>
Leasehold improvements $ 5,000 23,000
Furniture, fixtures, and equipment 790,000 761,000
Equipment under capital lease 187,000 187,000
--------- ---------
982,000 971,000
Less accumulated depreciation (897,000) (829,000)
--------- ---------
$ 85,000 142,000
========= =========
</TABLE>
Depreciation expense related to property and equipment was $98,000,
$120,000, and $191,000 for fiscal 2000, 1999, and 1998, respectively.
(9) OTHER ACCRUED EXPENSES
Other accrued expenses includes the following:
<TABLE>
<CAPTION>
2000 1999
-------------- --------------
<S> <C> <C>
Accrued professional fees $ 336,000 330,000
Accrued pharmaceutical costs 724,000 491,000
Accrued miscellaneous taxes 89,000 106,000
Other accrued expenses 526,000 308,000
-------------- --------------
$ 1,675,000 1,235,000
============== ==============
</TABLE>
(Continued)
33
<PAGE> 34
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
(10) LONG-TERM DEBT
(a) PROMISSORY NOTE
In October 1997, the Company borrowed an aggregate of $500,000
under a line credit with Bank of America. Michael S. Pinkert,
Chairman and Chief Executive Officer, personally guaranteed the
debt. William Ferretti, Director, and Lee Calligaro, former Vice
President and General Counsel of the Company, each indemnified
Mr. Pinkert on his guarantee to the extent of $100,000. In
conjunction with the personal guarantee and indemnifications,
the Company awarded Mr. Pinkert, Mr. Ferretti, and Mr.
Calligaro, warrants of 108, 36, and 36, respectively, to
purchase the Company's common stock at an exercise price of $755
per share. In addition, for each month there was an outstanding
balance on the line of credit, the Company issued additional
warrants to purchase shares of the Company's common stock at
$755 per share. The Company granted warrants equal to one-half
percent of the average loan balance that was outstanding at the
end of each month, based on the guarantor's and indemnitors'
pro-rata share. The line of credit was originally due on March
31, 2000.
In fiscal 1999, a reduction of the warrant exercise price to $50
was made to Mr. Pinkert, Mr. Ferretti, and Mr. Calligaro,
guarantor and indemnitors of the line of credit, who earned
warrants of 210, 70, and 70, respectively, during the period
that the obligation was outstanding. The Company recorded
$59,000 of expense in fiscal 1999 for the reduction in the
warrant exercise price.
In June 1999, the Company increased the line of credit to a
maximum borrowing capacity of $1,300,000 with a commitment fee
of 0.5 percent. The due date on the line of credit was extended
to May 31, 2000. Mr. Pinkert personally guaranteed the entire
line of credit. For his guaranty in June 1999, the Company
granted an additional 180 warrants at $50 per share. Mr.
Ferretti, John Silverman, Dr. Jacob Shipon, directors of the
Company, and Mr. Calligaro, indemnified Mr. Pinkert on his
guarantee to 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 198 warrants at
$50 per share. The Company also granted warrants equal to
one-half percent of the average loan balance that is outstanding
at the end of each month, based on the guarantor's and
indemnitors' pro-rata share, at an exercise price of $50 per
share.
Effective May 31, 2000, the Company converted its line of credit
of $1,300,000 to a promissory note due on May 31, 2002. Interest
rate is at the Eurodollar rate plus 2.6 percent per annum,
(weighted-average interest rate of 8.8 percent for the year
ended September 30, 2000). The note has a revolving feature that
allows the Company to borrow, repay, and re-borrow up to the
maximum aggregate amount. On July 13, 2000, with no changes in
the original terms, the Company increased the borrowing capacity
on the note to $1,800,000 of which the Company had drawn
$1,400,000 as of September 30, 2000.
Mr. Pinkert and Dr. Shipon have personally guaranteed this note
in the amounts of $1,300,000 and $500,000, respectively. For
their guarantees, the Company granted Mr. Pinkert an additional
180 warrants and Dr. Shipon 126 warrants to purchase stock of
the Company at $50 per share. As compensation to Mr. Pinkert and
Dr. Shipon for the ongoing risks represented by their
guarantees, the Company grants warrants at one and one-half
percent of the average note balance that is outstanding at the
end of each month, based on the guarantors' pro-rata share, at
an exercise price of $50 per share.
(Continued)
34
<PAGE> 35
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
(b) TERM LOANS AND CAPITAL LEASE OBLIGATIONS
At September 30, 2000 and 1999, the Company had term loans and a
capital lease obligation outstanding totaling $67,000 and
$213,000, respectively. The various term loans relate to the
Apogee, Liberty Bay, and MHM Counseling acquisitions, which bear
interest at rates ranging from seven percent to nine percent
(see note 4). Effective November 30, 2000, outstanding
obligations from these term loans have been settled as part of
the dissolution process of Extended Care Services (see notes 2
and 17).
The capital lease obligations are payable in monthly
installments including interest at rates ranging from nine
percent to thirteen percent through January 2001 and are
collateralized by certain assets with a net book value of $0 and
$40,000 at September 30, 2000 and 1999, respectively.
The note to Mentor totaling $47,000 at September 30, 2000, is
technically in default for nonpayment of principal and therefore
is classified as a current liability in the consolidated
financial statements. The note was paid on December 8, 2000,
from the remaining assets of Extended Care Services as part of
the dissolution process.
(c) NOTES PAYABLE
At September 30, 2000 and 1999, the Company had promissory notes
outstanding totaling $170,000 and $187,000, 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 payable by July 1, 2001. 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>
2001 $ 67,000
2002 1,400,000
--------------
$ 1,467,000
==============
</TABLE>
(d) 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.
On July 15, 1998, the Company and MEDIQ settled an $11,800,000
judgment against the Company for repayment of this debt in
return for a cash payment of $3,000,000 by the Company. MEDIQ
released the Company and its affiliates from any and all other
liabilities. The settlement resulted in an extraordinary gain
for fiscal 1998 of approximately $9,185,000.
(Continued)
35
<PAGE> 36
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
(11) COMMITMENTS AND CONTINGENCIES
(a) LEASES
The Company leases certain equipment and office facilities under
non-cancelable operating leases. The future minimum lease
payments under all non-cancelable operating leases as of
September 30, 2000 are:
<TABLE>
<S> <C>
2001 $ 173,000
2002 169,000
2003 155,000
2004 81,000
--------------
Total future minimum lease payments $ 578,000
==============
</TABLE>
Rent expense under all operating leases was approximately
$211,000, $357,000, and 938,000 for the years ended September
30, 2000, 1999 and 1998, 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.
(c) 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 per year.
(12) CONCENTRATION OF CREDIT RISK
The Company generates revenues based on fee-for-service arrangements as
well as from capitated contract arrangements with state correctional and
other governmental agencies. Net revenues generated under its
fee-for-service arrangements approximated $918,000, $2,207,000, and
$14,864,000 for the years ended September 30, 2000, 1999, and 1998,
respectively. Revenues generated from the Company's capitated contract
arrangements approximated $18,940,000, $16,181,000, and $14,430,000 for
the years ended September 30, 2000, 1999, and 1998, respectively.
(Continued)
36
<PAGE> 37
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
Approximately 98 percent, 89 percent, and 48 percent of the Company's
revenues for the years ended September 30, 2000, 1999, and 1998,
respectively, relates to amounts earned under four contracts to provide
mental health services to residents of correctional and long-term care
facilities. Contracts with revenues exceeding 10 percent of the
Company's total consolidated revenues were as follows:
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
----------------------------------------
2000 1999 1998
-------------- ------------ ----------
<S> <C> <C> <C>
Georgia Department of Corrections 49% 49% 29%
Georgia Department of Medical Assistance 20% 20% 12%
Tennessee Department of Corrections 11% 12% 7%
Florida Department of Corrections 18% 8% 0%
</TABLE>
The Company's accounts receivable are for services rendered to the state
correctional and other governmental agencies and a prime contractor with
which MHM has a capitated contract arrangement. Accounts receivable
under these contracts with an outstanding balance of 10 percent of total
accounts receivable or greater at September 30, 2000, are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000
----------------------
<S> <C>
Prison Health Services 38%
Georgia Department of Medical Assistance 18%
Tennessee Department of Corrections 24%
</TABLE>
(13) INCOME TAXES
Income tax (benefit) expense consists of the following:
<TABLE>
<CAPTION>
2000 1999 1998
------------- ------------- -------------
<S> <C> <C> <C>
Current:
Federal $ 4,000 -- --
State 88,000 39,000 93,000
------------- ------------- -------------
92,000 39,000 93,000
------------- ------------- -------------
Deferred:
Federal (3,315,000) -- --
State (438,000) -- --
------------- ------------- -------------
(3,753,000) -- --
------------- ------------- -------------
Total income tax (benefit)
expense $ (3,661,000) 39,000 93,000
============= ============= =============
</TABLE>
(Continued)
37
<PAGE> 38
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
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>
2000 1999 1998
------------- ------------- -------------
<S> <C> <C> <C>
Statutory expense (benefit) $ 203,000 (862,000) (386,000)
State income tax (benefit) expense 58,000 (89,000) 93,000
Increase (decrease) in valuation allowance (4,046,000) 1,052,000 383,000
Other items, net 124,000 (62,000) 3,000
------------- ------------- -------------
Total income tax (benefit)
expense $ (3,661,000) 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.
Significant components of deferred tax assets and liabilities follow:
<TABLE>
<CAPTION>
2000 1999
-------------- --------------
<S> <C> <C>
Assets:
Allowance for doubtful accounts $ 39,000 130,000
Net operating loss carryforwards 3,645,000 4,885,000
Accrued vacation and bonuses 196,000 --
Other 16,000 58,000
-------------- --------------
3,896,000 5,073,000
Valuation allowance -- (4,964,000)
-------------- --------------
3,896,000 109,000
Liabilities - prepaid expenses 143,000 109,000
-------------- --------------
Net deferred tax asset $ 3,753,000 --
============== ==============
</TABLE>
At September 30, 2000, for income tax purposes, the Company had federal
operating loss carry-forwards of approximately $10,851,000 expiring
through 2019. The change in valuation allowance was a decrease of
$4,964,000 in 2000 of which $918,000 relates to an expired net operating
loss and an increase of $1,052,000 in 1999. The valuation allowance was
reduced in 2000 based upon management's projections and estimates that
the tax attributes will be fully utilized. Losses could be subject to
loss limitations under various provisions of the IRC.
(Continued)
38
<PAGE> 39
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
(14) STOCKHOLDERS' EQUITY (DEFICIT)
(a) COMMON STOCK
The Company's Certificate of Incorporation authorizes the issuance
of 15,000,000 shares of common stock, with a par value of $0.01
per share. On March 21, 2000, the Board of Directors approved plan
to declare a 500 to 1 reverse stock split of all issued and
outstanding shares. The record date for the reverse stock split
was March 21, 2000. The Company purchased all fractional shares
resulting from this transaction based on a pre-split fair market
value of $0.45 per share, totaling approximately $66,000.
The number of authorized shares and the par value of common stock
were not affected by the reverse stock split. The effect of the
reverse stock split has been retroactively reflected in the
consolidated balance sheets and consolidated statements of
stockholders' deficit for all periods presented. All references to
the number of common shares and per share amounts elsewhere in the
consolidated financial statements and related footnotes have been
restated as appropriate to reflect the effect of the reverse split
for all periods presented.
(b) TREASURY STOCK
On September 27, 2000, the Company repurchased 21 shares of common
stock at a cost of approximately $5,000. These shares were
repurchased from the Company's 401(k) Plan. The repurchased shares
were recorded at cost and resulted in an increase in the Company's
stockholders' deficit.
(c) OPTIONS
The Company has a Stock Option Plan (Stock Option Plan) under
which 900 shares of the Company's common stock have been reserved
for future stock option grants to employees of the Company. As of
September 30, 2000 and 1999, 808 and 799 options, respectively,
were outstanding under the Stock Option Plan. Options outstanding
under the Stock Option Plan vest at 20 percent each year and may
not be granted for a term in excess of ten years from the date of
grant.
The Company also has a Stock Option Plan for Non-Employee
Directors (the Directors' Stock Option Plan). Options authorized
under the Directors' Stock Option Plan totaled 1,101 and 955 as of
September 30, 2000 and 1999, respectively. As of September 30,
2000 and 1999, 95 options were outstanding under the Directors'
Stock Option Plan. Options granted under the Directors' Stock
Option Plan vest 20 percent immediately, with the remaining
options vesting over a four-year period.
Effective November 15, 2000, the Board of Directors amended the
authorized number of options reserved under the Stock Option Plan
and Directors' Stock Option Plan to equal a combined total of 15
percent of total outstanding shares of the Company, after taking
into effect the impact of the Shareholders' Rights Offering,
subject to final approval at the Annual Stockholders' Meeting. As
of November 15, 2000, a total of 4,656 options were authorized
under these plans.
On September 30, 2000, the Board declared a repricing of all
outstanding options to reduce the exercise price to $72 per share,
which represents the fair market value of the Company's common
stock at September 30, 2000.
(Continued)
39
<PAGE> 40
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
The Company applies APB Opinion No. 25 in accounting for its stock
option plans 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,
2000 1999 1998
------------- -------------- -------------
<S> <C> <C> <C>
Net income (loss):
As reported $ 4,257,000 (2,571,000) 7,996,000
Pro forma 4,213,000 (2,607,000) 7,961,000
Earnings (loss) per common share-basic:
As reported $ 584.19 (376.92) 1,181.44
Pro forma 578.15 (382.20) 1,176.27
Earnings (loss) per common share-diluted
As reported $ 497.60 (376.92) 1,181.44
Pro forma 492.46 (382.20) 1,176.27
</TABLE>
The fair value of each option is estimated on the date of grant
using the Black-Scholes option pricing model. For all options that
were re-priced as of September 30, 2000, the modified awards were
considered an exchange of the original award for a new award. As a
result, all options outstanding at September 30, 2000 were
re-valued under the Black-Scholes option pricing model as of
September 30, 2000. The weighted-average assumptions generally
used for grants were:
<TABLE>
<CAPTION>
2000 1999 1998
-------------- -------------- --------------
<S> <C> <C> <C>
Expected volatility 107.56% 116.85% 126.51%
Dividend yield 0% 0% 0%
Risk free interest rate 5.97% 4.98% 5.66%
Expected life 3 years 3 years 8 years
</TABLE>
(Continued)
40
<PAGE> 41
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
A summary of the status of the Company's stock options as of
September 30, 2000, 1999 and 1998, and changes during the years
ended on those dates is presented below:
<TABLE>
<CAPTION>
2000 1999 1998
-------------------- ------------------- -------------------
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 894 $ 360 764 380 719 $ 360
Granted 941 72 225 310 190 420
Exercised -- -- -- -- (50) 250
Forfeited (932) 356 (95) 395 (95) 370
--------- --------- --------- --------- -------- ---------
Outstanding at end of year 903 72 894 360 764 380
--------- --------- --------- --------- -------- ---------
Options exercisable at
end of year 562 72 434 325 363 295
Weighted-average fair value
of options granted
during the year $ 49 $ 220 $ 395
========= ========= ========
</TABLE>
The weighted average remaining contractual life of all outstanding
options is 7.10 years at September 30, 2000.
(d) WARRANTS
On July 15, 1998, the Company issued warrants to purchase 600
shares of common stock at $5 per share to Heller Healthcare
Finance Inc., formerly known as Healthcare Financial Partners
(HCFP), in exchange for HCFP granting the Company a $2,000,000
note payable used to fund the MEDIQ settlement (see note 10). The
warrants were immediately exercisable and had a scheduled
expiration date on July 15, 2003. The issuance of the warrants
resulted in an expense of $128,000 in 1998 that served to reduce
the MEDIQ gain. On September 8, 2000, the Company repurchased
these warrants from Heller Healthcare Finance, Inc., for
approximately $142,000 of which $37,000 was paid in cash during
fiscal 2000 and the remainder will be paid in fiscal 2001. The
Company retired the warrants from circulation.
As part of the ongoing risk incurred by the Company's senior
management and certain Board members for their personal guarantees
and indemnification of the Company's outstanding debt (see note
10), the Company has issued warrants totaling 759, 578 and 272 for
the years ended September 30, 2000, 1999 and 1998, respectively.
These warrants are immediately exercisable. The Company has
expensed $69,000, $143,000 and $0 for the years ended September
30, 2000, 1999 and 1998, respectively, as a result of the issuance
of these warrants.
None of the outstanding warrants issued have been exercised as of
September 30, 2000. Total outstanding warrants were 1,900, 1,739
and 1,161 as of September 30, 2000, 1999 and 1998, respectively.
Warrants outstanding as of September 30, 2000, have an exercise
price ranging from $50 to $250 per share, with a remaining life of
7 to 10 years.
(Continued)
41
<PAGE> 42
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
(15) RETIREMENT PLAN
The Company has a 401(k) plan (the Plan). Employees, who are age 21 or
older, are eligible to join the Plan upon completion of six months of
service. The Plan provides that the Company will make a matching
contribution equal to $0.50 for each $1.00 contributed by a participant
not to exceed 1.5 percent of a participant's compensation. The Company's
matching contribution is made in cash to be distributed among the funds
elected by the participants. For the years ended September 30, 2000, 1999
and 1998, the Company's contributions were $7,000, $29,000, and $44,000,
respectively.
(16) FOURTH-QUARTER RESULTS (UNAUDITED)
The Company experienced net income of approximately $3,896,000 in the
fourth quarter of fiscal 2000 partly as a result of the favorable
settlement of certain contingent liabilities related to post payment
reviews of fee-for-service billings in Extended Care Services. The
settlement resulted in a gain of $527,000 which was recorded in other
income the fourth quarter of fiscal 2000. In addition, in the fourth
quarter of fiscal 2000, the Company reduced the valuation allowance on
its deferred tax assets (see note 13).
The Company's unaudited quarterly financial information is as follows:
<TABLE>
<CAPTION>
BASIC INCOME DILUTED INCOME
TOTAL NET NET INCOME (LOSS) (LOSS)
REVENUES (LOSS) PER SHARE PER SHARE
------------ ------------- --------------- -----------------
<S> <C> <C> <C> <C>
Quarter ended:
September 30, 2000 5,389,000 3,896,000 534.65 495.17
June 30, 2000 5,046,000 26,000 3.57 3.02
March 30, 2000 4,739,000 179,000 24.56 20.14
December 30, 1999 4,684,000 156,000 21.41 17.45
Quarter ended:
September 30, 1999 4,664,000 116,000 16.13 13.44
June 30, 1999 4,451,000 (504,000) (74.19) (74.19)
March 30, 1999 3,932,000 (1,511,000) (222.43) (222.43)
December 30, 1998 5,869,000 (673,000) (99.07) (99.07)
</TABLE>
Earnings (loss) per share was calculated for each three month and the
twelve month period on a stand alone basis. As a result, the sum of the
earnings (loss) per share for the four quarters does not equal the
earnings (loss) per share for the twelve months.
(17) SUBSEQUENT EVENTS (UNAUDITED)
(a) DISSOLUTION OF EXTENDED CARE SERVICES
As discussed in note 2, the dissolution of Extended Care Services
became effective on November 30, 2000. As of September 30, 2000,
Extended Care Services' assets were $178,000 and its outstanding
liabilities were $439,000. On December 8, 2000, Extended Care
Services
(Continued)
42
<PAGE> 43
MHM SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2000, 1999 and 1998
paid all existing creditors as noted per the terms of its Plan of
Liquidation and Dissolution to resolve all of its outstanding
liabilities. As such, a net gain on dissolution of $261,000 will
be recorded in first quarter of fiscal 2001.
(b) SHAREHOLDERS' RIGHTS OFFERING
On November 20, 2000, the Company raised $1,621,000, net of
offering expenses, in investment capital as a result of a
Shareholders' Rights Offering (the Offering). Each stockholder,
based on a record date of September 29, 2000, was given the right
to purchase four new shares of the Company's common stock for each
share of common stock the stockholder held on the record date, and
the pro-rata right to purchase shares which other stockholders
declined to purchase. As a result of the Offering, the Company
issued 23,779 shares of common stock at $72 per share on November
20, 2000. The Company had approximately $91,000 of capitalized
legal and other costs associated with the Offering which are
included in current assets in the consolidated balance sheets as
of September 30, 2000. Effective November 22, 2000 the Company
used $1,300,000 of the proceeds of the Offering to liquidate the
promissory note with Bank of America. Effective November 15, 2000,
the Company granted 2,906 stock options to its employees and Board
members in order to offset the dilutive effects of the Offering to
option holders.
Had the dissolution of Extended Care Services and the Offering
occurred as of October 1, 1999, current assets would have
increased by $78,000, total liabilities would have decreased by
$1,917,000, and stockholders' equity would have increased by
$1,865,000, resulting in stockholders' equity of $3,539,000 as of
September 30, 2000. In addition, the Company would have reported
net income of $4,501,000 for the year ended September 30, 2000,
its earnings per share - basic would have been $144.89 and its
earnings per share - diluted would have been $139.20.
43
<PAGE> 44
SCHEDULE II
MHM SERVICES, INC. AND SUBSIDIARIES
Valuation and Qualifying Accounts and Reserves
Years ended September 30, 2000, 1999, and 1998
<TABLE>
<CAPTION>
Balance At Charge To Balance At
Beginning Of Costs And End Of
Period Expenses Deductions Period
<S> <C> <C> <C> <C>
Year ended September 30, 2000:
Allowance for doubtful accounts $ 337,000 181,000 407,000 111,000
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
============== ============== ============== ===============
</TABLE>
*Approximately $272,000 of the 2000 deduction is related to the write off of
receivables related to the sale of certain operating units of Extended Care
Services described in note 4 to the consolidated financial statements. The
Company recorded other income of $80,000 during 2000 related to recoveries of
Extended Care Services' accounts receivable which had been previously written
off as bad debt.
*Approximately $650,000 of the 1998 deduction is related to the sale of Mountain
Crest Hospital receivables in the sale described in note 3 to the
consolidated financial statements.
44
<PAGE> 45
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 concerning our directors and
executive officers is hereby incorporated by reference to our definitive proxy
statement for our 2001 annual meeting of stockholders that will be filed
pursuant to Regulation 14A by January 28, 2001.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 concerning executive
compensation is incorporated by reference to our definitive proxy statement for
our 2001 annual meeting of stockholders that will be filed pursuant to
Regulation 14A by January 28, 2001.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 concerning the security
ownership of certain beneficial owners and management is incorporated by
reference to our definitive proxy statement for our 2001 annual meeting of
stockholders that will be filed pursuant to Regulation 14A by January 28, 2001.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item 13 concerning certain transactions
is incorporated by reference to our definitive proxy statement for our 2001
annual meeting of stockholders that will be filed pursuant to regulation 14A by
January 28, 2001.
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statement Schedules are set forth on pages 20 to 44 of this
report
(b) Form 8-K filed on November 2, 2000 is incorporated by reference herein.
(c) Exhibits are listed in the Exhibit Index which is on page 46 of this
Form 10-K and which is incorporated by reference herein.
45
<PAGE> 46
\
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
3.1 Restated Articles of Incorporation of MHM Services, Inc. (1)
3.2 Amended By-laws of MHM Services, Inc. (2)
4.1 Specimen certificate (3)
4.2 Registration Rights Agreement between the Company and Michael S. Pinkert dated July 15, 1998 (4)
4.3 Common Stock Purchase Warrant Agreement between the Company and Michael S. Pinkert dated July 15, 1998 (4)
10.1 1993 Stock Option Plan (5)
10.2 1993 Non-Employee Directors' Stock Option Plan (5)
10.3 1996 Non-Employee Directors' Stock Option Plan (6)
10.4 Amendment to 1993 Stock Option Plan (6)
21 Subsidiaries of MHM Services, Inc. (9)
23 Consents of KPMG LLP (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
46
<PAGE> 47
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 January12, 2000 MHM Services, Inc.
By: /s/ MICHAEL S. PINKERT
---------------------------------
Michael S. Pinkert
Chairman, Chief Executive Officer
and Director
/s/ STEVEN H. WHEELER
---------------------------------
Steven H. Wheeler
President , Chief Operating Officer
and Director
/s/ CLEVELAND E. SLADE
---------------------------------
Cleveland E. Slade
Vice President, Chief Financial Officer
and Secretary
/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/ JACOB SHIPON, M.D.
---------------------------------
Dr. Jacob Shipon
Director
47
