-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, F5k0LyQNnNIypGAabWiinIFQKsA3ASYD2onVrzgXmclpFncgWCj5ECXwz5UKfi5W JX7ZkMwXRt41yWpX3ENlng== 0001005477-00-004310.txt : 20000525 0001005477-00-004310.hdr.sgml : 20000525 ACCESSION NUMBER: 0001005477-00-004310 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 20000524 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LEXINGTON HEALTHCARE GROUP INC CENTRAL INDEX KEY: 0001026348 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SKILLED NURSING CARE FACILITIES [8051] IRS NUMBER: 061468252 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-22261 FILM NUMBER: 643024 BUSINESS ADDRESS: STREET 1: 1557 NEW BRITAIN AVE CITY: FARMINGTON STATE: CT ZIP: 06032 BUSINESS PHONE: 8606742700 MAIL ADDRESS: STREET 1: 1557 NEW BRITAIN AVE CITY: FARMINGTON STATE: CT ZIP: 06032 10-K/A 1 FORM 10-K/A Item 8. Financial Statements and Supplementary Data Index to Consolidated Financial Statements Reports of Independent Certified Public Accountants on Consolidated Financial Statements as of June 30, 1999 and 1998 and for the Years Ended June 30, 1999, 1998 and 1997 Financial Statements: Consolidated Balance Sheets June 30, 1999 and 1998 Consolidated Statements of Operations Years Ended June 30, 1999, 1998 and 1997 Consolidated Statements of Changes in Stockholders' Equity Years Ended June 30, 1999, 1998 and 1997 Consolidated Statements of Cash Flows, Years Ended June 30, 1999, 1998 and 1997 Notes to Consolidated Financial Statements DISANTO BERTOLINE & COMPANY, P.C. 628 Hebron Avenue, Building #3 Glastonbury, CT 06033 INDEPENDENT AUDITORS' REPORT To the Board of Directors of Lexington Healthcare Group, Inc. Farmington, Connecticut We have audited the accompanying consolidated balance sheets of Lexington Healthcare Group, Inc. and subsidiaries as of June 30, 1999 and 1998, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the years ended June 30, 1999, 1998 and 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Lexington Healthcare Group, Inc. and subsidiaries as of June 30, 1999 and 1998, and the results of their operations and their cash flows for the years ended June 30, 1999, 1998 and 1997 in conformity with generally accepted accounting principles. DISANTO BERTOLINE & COMPANY, P.C. Glastonbury, Connecticut September 24, 1999 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JUNE 30, 1999 AND 1998
1999 1998 ASSETS ----------- ----------- CURRENT ASSETS Cash and cash equivalents $ 3,675,000 $ 831,000 Accounts receivable - net of allowance for doubtful accounts of $848,000 and $346,000 for 1999 and 1998, respectively 16,092,000 10,848,000 Estimated third-party payor settlements-Medicare -- 197,000 Note receivable-related party -- 595,000 Inventories 1,058,000 777,000 Prepaid and other current assets 1,031,000 533,000 ----------- ----------- Total current assets 21,856,000 13,781,000 PROPERTY, EQUIPMENT & LEASEHOLD IMPROVEMENTS, net 4,147,000 3,370,000 OTHER ASSETS Security deposits - related parties 2,337,000 2,337,000 Residents' funds 403,000 206,000 Goodwill, net of accumulated amortization of $358,000 and $190,000 for 1999 and 1998, respectively 3,013,000 3,181,000 Deferred tax asset 35,000 35,000 Bed licenses - net of accumulated amortization of $232,000 and $116,000 for 1999 and 1998, respectively 1,510,000 1,626,000 Operating subsidy receivable (less current portion of $104,000) 555,000 701,000 Other assets, net 427,000 376,000 ----------- ----------- 8,280,000 8,462,000 ----------- ----------- $34,283,000 $25,613,000 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Notes payable (current portion) $ 3,748,000 $ 313,000 Due to SunBridge - purchased receivables 2,582,000 -- Accounts payable and accrued expenses 13,473,000 8,532,000 Estimated third-party payor settlements-Medicaid 922,000 1,686,000 Estimated third-party payor settlements-Medicare 17,000 -- Capital leases payable (current portion) 119,000 85,000 Income taxes payable 40,000 91,000 ----------- ----------- Total current liabilities 20,901,000 10,707,000 OTHER LIABILITIES Notes payable (less current portion) 7,415,000 7,132,000 Capital leases payable (less current portion) 353,000 292,000 Residents' funds payable 403,000 206,000 Deferred rent 314,000 364,000 Other liabilities 120,000 -- ----------- ----------- 8,605,000 7,994,000 ----------- ----------- Total liabilities 29,506,000 18,701,000 ----------- ----------- COMMITMENTS AND CONTINGENCIES (Note N) MINORITY INTERESTS 545,000 529,000 STOCKHOLDERS' EQUITY Common stock, par value $.01 per share, authorized 15,000,000 shares 41,000 41,000 Additional paid-in capital 6,126,000 6,126,000 Note receivable - related party (574,000) -- Retained earnings (deficit) (1,361,000) 216,000 ----------- ----------- Total stockholders' equity 4,232,000 6,383,000 =========== =========== $34,283,000 $25,613,000 =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 1999, 1998 AND 1997
1999 1998 1997 ------------ ------------ ------------ REVENUES Net patient service revenue $ 58,867,000 $ 57,610,000 $ 35,536,000 Management fee revenue 17,620,000 225,000 279,000 Other revenue 405,000 417,000 85,000 ------------ ------------ ------------ Total revenues 76,892,000 58,252,000 35,900,000 EXPENSES Facility operating expenses: Salaries and benefits 57,109,000 42,823,000 26,979,000 Food, medical and other supplies 7,778,000 4,077,000 2,689,000 Other operating expenses 8,845,000 8,685,000 5,113,000 Corporate, general and administrative expenses 2,953,000 1,871,000 1,282,000 Interest expense 1,040,000 792,000 178,000 ------------ ------------ ------------ Total expenses 77,725,000 58,248,000 36,241,000 ------------ ------------ ------------ Income (loss) from operations (833,000) 4,000 (341,000) OTHER INCOME (EXPENSE) Provision for lawsuit settlement (539,000) -- -- Gain on sale of bed licenses -- 280,000 -- ------------ ------------ ------------ Income (loss) before income taxes and minority interest (1,372,000) 284,000 (341,000) PROVISION FOR (BENEFIT FROM) INCOME TAXES 15,000 30,000 (66,000) MINORITY INTEREST IN INCOME OF CONSOLIDATED JOINT VENTURES (190,000) (224,000) -- ------------ ------------ ------------ Net income (loss) $ (1,577,000) $ 30,000 $ (275,000) ============ ============ ============ Basic earnings (loss) per common share $ (0.38) $ 0.01 $ (0.10) ============ ============ ============ Weighted average number of common shares outstanding 4,125,000 4,125,000 2,724,000 ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements. LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED JUNE 30, 1999, 1998 AND 1997
Common Stock ------------------------- Additional Note Rec. Number Paid-in Related Retained of Shares Amount Capital Party Earnings TOTAL ----------- ----------- ----------- ----------- ----------- ----------- Balance, June 30, 1996 2,462,000 $ 25,000 $ 1,000 $ -- $ 461,000 $ 487,000 Issuance of common stock for legal services rendered 130,000 1,000 59,000 -- -- 60,000 Issuance of common stock in connection with the acquisition of BALZ 300,000 3,000 1,497,000 -- -- 1,500,000 Issuance of common stock in connection with the acquisition of PRN 108,000 1,000 539,000 -- -- 540,000 Issuance of common stock and warrants in connection with initial public offering, net of issuance costs of $1,734,000 1,125,000 11,000 4,072,000 -- -- 4,083,000 Net loss -- -- -- -- (275,000) (275,000) ----------- ----------- ----------- ----------- ----------- ----------- Balance, June 30, 1997 4,125,000 41,000 6,168,000 -- 186,000 6,395,000 Additional costs of issuance -- -- (42,000) -- -- (42,000) Net income -- -- -- -- 30,000 30,000 ----------- ----------- ----------- ----------- ----------- ----------- Balance, June 30, 1998 4,125,000 41,000 6,126,000 -- 216,000 6,383,000 Net loss -- -- -- -- (1,577,000) (1,577,000) Reclassification of note receivable - related party -- -- -- (574,000) -- (574,000) ----------- ----------- ----------- ----------- ----------- ----------- Balance, June 30, 1999 4,125,000 $ 41,000 $ 6,126,000 $ (574,000) $(1,361,000) $ 4,232,000 =========== =========== =========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED JUNE 30, 1999, 1998 AND 1997
1999 1998 1997 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $(1,577,000) $ 30,000 $ (275,000) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 817,000 569,000 110,000 Provision for doubtful accounts 502,000 166,000 105,000 Minority interest in income of consolidated joint ventures 190,000 224,000 -- Legal expenses pursuant to stock issuance -- -- 60,000 Benefit from deferred taxes -- -- (97,000) Loss on disposal of assets -- 27,000 -- Gain on sale of bed licenses -- (280,000) -- Decrease in deferred rent (50,000) (52,000) (52,000) Changes in operating assets and liabilities: Increase in accounts payable and accrued expenses 4,941,000 752,000 1,099,000 Due to SunBridge - purchased receivables 2,582,000 -- -- Decrease in due to related parties, net -- -- (291,000) (Increase) decrease in other assets (51,000) (417,000) 85,000 (Decrease) increase in income taxes payable (51,000) (113,000) 204,000 Increase in inventories (281,000) (274,000) (240,000) (Decrease) increase in estimated third-party payor settlements--Medicaid and Medicare, net (550,000) 1,444,000 46,000 Increase in prepaid and other current assets (601,000) (115,000) (341,000) (Increase) decrease in accounts and operating subsidy receivable (5,600,000) (3,046,000) 282,000 ----------- ----------- ----------- Net cash provided by (used in) operating activities 271,000 (1,085,000) 695,000 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Repayments of note receivable - related party 120,000 787,000 -- Proceeds from sale of bed licenses -- 1,550,000 -- Cash paid for businesses acquired -- -- (1,434,000) Increase in security deposits - related parties -- (55,000) -- Increase in goodwill on purchase of subsidiary -- (75,000) -- Disbursements on note receivable - related party (99,000) (1,092,000) (162,000) Acquisition of property, equipment and leasehold improvements (583,000) (681,000) (285,000) ----------- ----------- ----------- Net cash provided by (used in) investing activities (562,000) 434,000 (1,881,000) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from line of credit, net 3,431,000 -- -- Proceeds of short term borrowings and Beverly receivables -- 400,000 500,000 Proceeds from mortgage note -- 231,000 -- Proceeds from issuance of common stock, net -- -- 4,083,000 Decrease in deferred registration costs -- -- 198,000 Proceeds of notes payable to officers -- -- 100,000 Repayment of notes payable to officers -- (29,000) (110,000) Stock registration costs -- (42,000) -- Repayment of short-term borrowing -- (200,000) (2,763,000) Minority investment (distribution) in consolidated joint ventures (54,000) 305,000 -- Repayments of mortgage and term notes payable (120,000) (88,000) -- Repayments of capital lease obligations (122,000) (95,000) (34,000) ----------- ----------- ----------- Net cash provided by financing activities 3,135,000 482,000 1,974,000 ----------- ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,844,000 (169,000) 788,000 CASH AND CASH EQUIVALENTS, beginning of year 831,000 1,000,000 212,000 ----------- ----------- ----------- CASH AND CASH EQUIVALENTS, end of year $ 3,675,000 $ 831,000 $ 1,000,000 =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) FOR THE YEARS ENDED JUNE 30, 1999, 1998 AND 1997
1999 1998 1997 ----------- ----------- ----------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash payments for: Interest $ 1,040,000 $ 789,000 $ 176,000 Income taxes 9,000 145,000 -- Non-cash investing and financing activities: Certain assets acquired through assumption of mortgage note payable $ 392,000 $ 6,863,000 $ -- Equipment and leasehold improvements acquired through assumption of notes payable and capital leases 232,000 555,000 -- Common stock issued in connection with legal services recorded as cost of issuance -- -- 60,000 Offset of note payable - officers/stockholders against note receivable - related party -- -- 266,000 Details of businesses acquired was as follows: Fair value of assets acquired $ -- $ -- $ 4,788,000 Liabilities assumed -- -- 1,314,000 ----------- ----------- ----------- Purchase price, net of cash received -- -- 3,474,000 Common stock issued for acquired businesses -- -- (2,040,000) ----------- ----------- ----------- Net cash paid for acquired businesses $ -- $ -- $ 1,434,000 =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE A - SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Lexington Healthcare Group, Inc. and all of its wholly-owned subsidiaries: Balz Medical Services, Inc. ("BALZ"), Professional Relief Nurses, Inc. ("PRN" ), Lexington Highgreen Holding, Inc. and Lexicore Rehab Services, L.L.C. (Lexicore) (collectively, the "Company") as well as the accounts of a joint venture controlled by the Company, Lexicon Pharmacy Services, L.L.C. All material intercompany balances and transactions have been eliminated in consolidation. As of January 1, 1999, the Company acquired the remaining 50% membership interest of Lexicore for a nominal amount plus $120,000 of residual payments which are payable based on the occurrence of certain future events. The acquisition of Lexicore has been accounted for using the purchase method of accounting and, accordingly, the purchase price has been allocated to the assets purchased and liabilities assumed based on their fair value on the date of acquisition. The Company has not recorded any goodwill in connection with this purchase. Henceforth, the Company has accounted for Lexicore as a wholly-owned subsidiary and minority interest has been adjusted accordingly. NATURE OF OPERATIONS The Company is a long-term and subacute care provider, which operates six and manages an additional four nursing home facilities at June 30, 1999 with a total of 1,302 beds licensed by the State of Connecticut. The Company also provides medical supplies and durable medical equipment to nursing homes, provides physical, occupational and speech therapy and other services to qualified health care facilities, and provides health care services in the homes of its patients. JOINT VENTURE The Company has a 70% interest in Lexicon Pharmacy Services, L.L.C. ("Lexicon"), a Delaware limited liability company, which was formed on October 31, 1997 to provide institutional pharmacy services to qualified health care facilities and the patients residing therein. The limited liability company agreement provides for Lexicon to continue until November 1, 2002, with earlier termination possible in the event of exercise by a member of an option to terminate or the occurrence of certain other events specified in the agreement. The agreement also stipulates that members are not personally liable for any debts or losses of Lexicon beyond their respective capital contribution and that no member shall be permitted or required to make any additional capital contributions, except as specifically provided in the agreement. Page F-1 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE A - SIGNIFICANT ACCOUNTING POLICIES (Continued) JOINT VENTURE (Continued) For financial reporting purposes, the assets, liabilities and earnings of this joint venture have been included in the Company's consolidated financial statements. The other member's interest in the joint venture has been recorded as minority interest. USE OF ESTIMATES The preparation of consolidated 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. REVENUE RECOGNITION PATIENT SERVICE REVENUE Revenues are recognized at the time the service is provided to the patient. A substantial amount of the Company's revenues are billed to third party payors, i.e., Medicaid, Medicare and others under the provisions of reimbursement formulas and regulations in effect. Patient service revenue is reported at the estimated net realizable amount from residents, third-party payors, and others for services rendered. Revenue received under cost reimbursement agreements is subject to audit and retroactive adjustment by third-party payors. Provisions for estimated adjustments have been reflected in patient service revenue. Differences between estimated adjustments and final settlements are recorded in the year of settlement. MANAGEMENT FEES As consideration for services provided under an interim management agreement with SunBridge Healthcare Corporation (see Note B), the Company is entitled to retain the excess of any revenues earned in the delivery of patient services over the expenses incurred during the term and will be responsible for any excess of expenses incurred over revenues earned in the operation of the facilities during the term. Such revenues have been classified as management fee revenue in the accompanying consolidated statement of operations. The Company recognizes other management fees as they are earned and accrues related fees payable to subcontractors as they are incurred. Page F-2 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE A - SIGNIFICANT ACCOUNTING POLICIES (Continued) CASH EQUIVALENTS For the purpose of the consolidated statements of cash flows, the Company defines cash equivalents as highly liquid instruments with an original maturity of three months or less. The Company had cash equivalents of $1,172,000 at June 30, 1999 and $141,000 at June 30, 1998, consisting of overnight investments. INVENTORIES Inventories consisting of food, chemicals and supplies are valued at the lower of cost or market, with cost determined on a first-in, first-out (FIFO) basis. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS Property, equipment and leasehold improvements are stated at cost. Depreciation is provided on a straight-line basis over the estimated useful lives of the property and equipment. Leasehold improvements are amortized over the remaining period of the respective leases or the estimated useful lives of the improvement, whichever is shorter. Maintenance, repairs and minor renovations are charged to operations as incurred. Expenditures which substantially increase the useful lives of the related assets are capitalized. RESIDENTS' FUNDS Residents' funds represent cash balances which have been deposited into a separate bank account and are restricted for the use of the residents. INCOME TAXES The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. RECLASSIFICATIONS Certain reclassifications have been made to the prior year consolidated financial statements to conform to the current year presentation. Page F-3 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE A - SIGNIFICANT ACCOUNTING POLICIES (Continued) RECENT ACCOUNTING STANDARDS IMPAIRMENT OF LONG-LIVED ASSETS In fiscal 1997, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", which requires a company to review the carrying value of long-lived assets and certain intangibles for impairment when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Management believes that the adoption of SFAS No. 121 will not have a material adverse effect on the Company's consolidated financial statements. STOCK BASED COMPENSATION In fiscal 1997, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation", which establishes a fair value based method of accounting for an employee stock option or similar equity instrument. SFAS No. 123 gives entities a choice of recognizing related compensation expense by adopting the new fair value method or to continue to measure compensation using the intrinsic value approach under Accounting Principles Board (APB) Opinion No. 25, the former standard. If the former standard for measurement is elected, SFAS No. 123 requires supplemental disclosure to show the effects of using the new measurement criteria. The Company intends to continue using the measurement prescribed by APB Opinion No. 25 and accordingly, this pronouncement will not affect the Company's consolidated financial position or results of operations. EARNINGS PER COMMON SHARE The Company has adopted Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share". The objective of SFAS No. 128 is to simplify the standards for computing earnings per share (EPS) and make them comparable to international EPS standards. It replaces the presentation of primary and fully-diluted EPS with a presentation of basic and diluted EPS. All prior period EPS data presented has been restated to conform with the provisions of this statement. Dilutive earnings per share has not been presented as the potentially dilutive stock options are anti-dilutive. Page F-4 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE A - SIGNIFICANT ACCOUNTING POLICIES (Continued) RECENT ACCOUNTING STANDARDS (Continued) COMPREHENSIVE INCOME In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income," which established standards for reporting and display of comprehensive income, its components and accumulated balances. Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners. The Company has no material components of other comprehensive income (loss) and, accordingly, the Company's comprehensive income (loss) is the same as its net income (loss) for all years presented. SEGMENT REPORTING In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments of an Enterprise and Related Information," which changes the way public companies report financial and descriptive information about their operating segments. The Company provides health care services and many other closely related ancillary services to its patients and residents. All of these services fall within one reportable segment as defined in SFAS No. 131. NOTE B - REORGANIZATION, PUBLIC STOCK OFFERING AND ACQUISITIONS REORGANIZATION AND PUBLIC STOCK OFFERING Lexington Healthcare Group, Inc. was incorporated in 1996. It completed an initial public offering of its common stock in May, 1997 during which 1,125,000 shares of common stock at $5 per share and 1,940,625 common stock warrants at $.10 per warrant were issued resulting in net proceeds to the Company of $4.1 million. Upon completion of this offering, the Company became the successor to Lexington Health Care Group, LLC, a limited liability company ("LLC"), and the members of LLC exchanged their membership interests in LLC for 2,462,000 shares of the Company's common stock representing a combined 59.7% ownership of the Company. LLC was formed on March 8, 1995 and commenced operations on July 1, 1995. The business combination was accounted for as a reorganization of entities under common control, in a manner similar to a pooling of interests, using LLC's historical cost basis. Accordingly, the accompanying consolidated financial statements for periods prior to the reorganization reflect the accounts and operations of LLC and adjustment has been made to give effect to the reorganization resulting in the restatement of certain stockholders' equity accounts. Page F-5 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE B - REORGANIZATION, PUBLIC STOCK OFFERING AND ACQUISITIONS (Continued) ACQUISITIONS - BALZ AND PRN The Company acquired in May 1997, simultaneously with the closing of the public offering, all of the common stock of BALZ and PRN. Prior to acquisition, the members of LLC owned 44% and 25% of BALZ and PRN, respectively. The Company acquired all of the common stock of BALZ in exchange for 300,000 shares of common stock of the Company which were valued at $1,500,000 based on the price of the public offering. The purchase price of PRN consisted of $1,620,000 payable in cash and the exchange of 108,000 shares of common stock of the Company which were valued at $540,000 based on the price of the public offering. Furthermore, prior to the acquisition, PRN distributed 100% of its net book value to its former stockholders; this book value was approximately $392,000. Certain adjustments have been made during the year ended June 30, 1998 to record $76,000 of additional liabilities assumed as a direct result of the purchase. The acquisitions of BALZ and PRN have been accounted for using the purchase method of accounting and, accordingly, the purchase price has been allocated to the assets purchased and the liabilities assumed based upon their fair values at date of acquisition. The excess of the purchase price over the fair value of the net assets acquired was $3,371,000 and has been recorded as goodwill, which is being amortized on a straight-line basis over 20 years. The amount of goodwill amortization was $168,000, $170,000 and $20,000 for the years ended June 30, 1999, 1998 and 1997, respectively. The purchase price was allocated as follows: BALZ PRN ---- --- Working capital, other than cash $516,000 $268,000 Property and equipment 80,000 71,000 Other assets -- 38,000 Goodwill 1,135,000 2,236,000 Other liabilities (315,000) (555,000) ----------- ----------- Purchase price, net of cash received $1,416,000 $2,058,000 =========== =========== Page F-6 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE B - REORGANIZATION, PUBLIC STOCK OFFERING AND ACQUISITIONS (Continued) ACQUISITIONS - GREENWOOD AND HIGHLAND NURSING HOMES On July 1, 1997, Lexington Highgreen Holding, Inc. (a wholly-owned subsidiary of Lexington Healthcare Group, Inc.) purchased substantially all of the assets of two skilled nursing facilities, Greenwood Health Center and Highland Acres Extend-a-Care Center from Beverly Enterprises, Inc. ("Beverly"). These facilities are located in Hartford and Winsted, CT and at the time of purchase had 240 and 75 licensed beds, respectively. The Company is presently operating 225 beds, has returned the license on 40 beds to the State of Connecticut and, in November 1997, sold the remaining license on 50 beds to an unrelated party for $1,550,000 in cash resulting in a gain of $280,000 which is reflected as other income in the accompanying consolidated statement of operations. All real estate, property, fixed and operating assets of the nursing homes were acquired (with the exception of certain proprietary computer hardware and systems) for a purchase price of approximately $6.8 million which was financed by a mortgage on the real estate from Nationwide Health Properties, Inc., the previous lessor to Beverly. Beverly has agreed to pay a $2.5 million operating subsidy to the Company over five years, bringing the net cost of the transaction to the Company to $4.3 million. The acquisition has been accounted for using the purchase method of accounting and, accordingly, the purchase price has been allocated to the assets purchased based on their fair values at the date of acquisition. The Company has not recorded any goodwill in connection with this purchase but has allocated $1,742,000 of the purchase price to bed licenses, which is being amortized over 15 years. The amount of bed license amortization was $116,000 in each of the years ended June 30, 1999 and 1998. The operating results of these acquired nursing homes have been included in the consolidated statement of operations from the date of acquisition. On the basis of a pro forma consolidation of the results of operations as if the acquisition of these nursing homes had taken place at the beginning of fiscal year 1997 (based on a representative period of time, a one-year period ending June 30, 1997 for the Company and the available one-year period ending December 31, 1996 for the nursing homes acquired), consolidated net revenues would have been $50.2 million for fiscal 1997. Page F-7 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE B - REORGANIZATION, PUBLIC STOCK OFFERING AND ACQUISITIONS (Continued) ACQUISITIONS - GREENWOOD AND HIGHLAND NURSING HOMES (Continued) Consolidated pro forma net loss would have been $(189,000) for fiscal 1997 and pro forma loss per share would have been $(.07) for fiscal 1997. Such pro forma amounts reflect the operating results produced by Beverly, as adjusted to reflect the purchased costs of assets acquired and the elimination of liabilities which were not assumed, as well as to reflect known changes being made in the operations of these nursing homes, i.e., increased revenues from rate and census increases and decreases in costs as a result of wage rate and benefit reductions negotiated, along with other changes reflective of reduced bed operations. However, the resulting pro forma amounts are not necessarily indicative of what the actual consolidated results of operations might have been had the acquisitions been effective at the beginning of fiscal 1997. MANAGEMENT OF SUN HOMES AND SUBSEQUENT ACQUISITION OF ADAMS AND HERITAGE On November 1, 1998 the Company began providing management services for four skilled nursing facilities in Connecticut under an interim Management Agreement with SunBridge Healthcare Corporation ("SunBridge"), a New Mexico corporation and nation-wide healthcare provider. As consideration for the services provided under this Management Agreement, the Company is entitled to retain the excess of any revenues earned in the delivery of patient services over the expenses incurred during the term and will be responsible for any excess of expenses incurred over revenues earned in the operation of the facilities during the term. Under the terms of the agreement SunBridge retained responsibility for all building lease costs. In addition, the Company purchased substantially all of SunBridge's accounts receivable for these facilities. As of June 30, 1999, the balance owed is presented as "Due to SunBridge - purchased receivables" in the accompanying consolidated balance sheet. As a result of this agreement, the Company earned management fees of $17,394,000 and incurred costs and expenses of $17,004,000 during the year ended June 30, 1999. Subsequent to the end of its fiscal year, the Company finalized agreements to acquire the operations of two of the managed facilities, Adams House and Heritage Heights, effective September 1, 1999. Initially the buildings will be leased with an option to purchase. These facilities are located in Torrington and Danbury, CT and have a total of 240 skilled nursing beds. Management contracts covering the two other SunBridge facilities with a total of 239 skilled nursing beds were terminated as of August 31, 1999 and the operations of those facilities were returned to SunBridge. Page F-8 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE C - FINANCIAL INSTRUMENTS CONCENTRATIONS OF CREDIT RISK The Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents, residents' funds, accounts receivable, note receivable-related party, security deposits-related parties, and operating subsidy receivable. Cash and cash equivalents and residents' funds The Company places its cash deposits with high credit-quality institutions and such deposits exceeded federal depository insurance limits by approximately $3,066,000 at June 30, 1999. However, the Company has not experienced any losses in this area and management believes its cash deposits are not subject to significant credit risk. Accounts receivable The Company grants credit without collateral to its patients, all of whom are residents of local communities in the State of Connecticut in which the Company's facilities are located, and most of whom are insured under third-party payor agreements. Management provides ongoing credit evaluations of its residents and has provided for potential credit losses through direct write-offs and such write-offs have been within management's expectations. Industry experience indicates that, after such direct write-offs have been made, potential credit losses are considered minimal, therefore only a negligible allowance for doubtful accounts is considered necessary by management. The mix of receivables from patients, third-party payors and others as of June 30, 1999, 1998 and 1997 is as follows: 1999 1998 1997 ---- ---- ---- Medicare and Medicaid 68% 71% 80% Private insurance and other nongovernment agencies 26 25 10 Other 6 4 10 --- --- --- 100% 100% 100% ==== ==== ==== Note receivable-related party This amount is controlled by an officer and director of the Company and is collateralized. Subsequent to year end, the Company seized the collateral as settlement of the obligations (see Note F). Page F-9 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE C - FINANCIAL INSTRUMENTS (Continued) CONCENTRATIONS OF CREDIT RISK (Continued) Operating subsidy receivable This amount is due from Beverly, a provider of health care services throughout the United States, in connection with the Company's purchase of the assets of two nursing homes (see Note B). The receivable is unsecured, but Beverly has made all required payments in a timely manner, and management believes it is not subject to significant credit risk. Security deposits - related parties This amount is controlled by entities related to the Company by common ownership (see Note I); accordingly, management believes it represents negligible credit risk. FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards (SFAS) No. 107, Fair Value of Financial Instruments, requires disclosure of the fair value of financial instruments for which the determination of fair value is practicable. SFAS No. 107 defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The carrying amounts of the Company's financial instruments approximate their fair values as outlined below: Cash and cash equivalents, residents' funds, accounts receivable and accounts and accrued expenses payable: The carrying amounts approximate their fair values because of the short maturity of those instruments. Notes payable and obligations under capital leases: The carrying amounts approximate fair value because the interest rates on the notes or leases approximate the Company's current borrowing rate. Management has determined that it is not practicable to estimate the fair value of the note receivable - related party, security deposits - related parties, and operating subsidy receivable due to the lack of marketability of these financial instruments. The Company's financial instruments are held for other than trading purposes. Page F-10 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE D - THIRD-PARTY REVENUE ADJUSTMENTS AND SETTLEMENTS The Company has recorded reductions in patient service revenue of $443,000, $699,000 and $45,000 during the years ended June 30, 1999, 1998 and 1997, respectively, in connection with adjustments of previously recorded estimated settlements as shown below: Year ended June 30, ------------------- 1999 1998 1997 ---- ---- ---- Medicare $(402,000) $(115,000) $(45,000) Medicaid (41,000) (584,000) -- --------------------------------------- $(443,000) $(699,000) $(45,000) ========= ========= ======== As of June 30, 1999 and 1998 the Company had recorded the following amounts as receivable and payable in connection with estimated Medicare and Medicaid settlements: 1999 1998 ---- ---- Receivable -- $197,000 Payable $939,000 1,686,000 Such amounts represent management's best estimates of the amounts expected to be realized or that may be due and are based on anticipated results of ongoing negotiations, interpretation of applicable regulations and other assumptions. It is reasonably possible that the amounts the Company will ultimately realize or be obligated to pay could differ materially in the near term. NOTE E - PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS Property, equipment and leasehold improvements consist of the following: June 30, June 30, 1999 1998 ----------------------- Land and land improvements $ 359,000 $ 321,000 Building and building improvements 1,803,000 1,486,000 Equipment 1,734,000 1,339,000 Leasehold improvements 1,059,000 608,000 ---------- ---------- 4,955,000 3,754,000 Less: accumulated depreciation and amortization 808,000 384,000 ---------- ---------- $4,147,000 $3,370,000 ========== ========== Depreciation and amortization expense totaled $430,000, 267,000, and $90,000 for the years ended June 30, 1999, 1998, and 1997, respectively. Page F-11 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE F - NOTE RECEIVABLE--RELATED PARTY At June 30, 1997, the Company had a $290,000 note receivable due from an entity in which an officer and director of the Company has a controlling ownership interest. During the year ended June 30, 1998, $23,000 was charged for management fees and costs, interest of $26,000 accumulated, an additional $286,000 was advanced and $30,000 was repaid; the balance due at June 30, 1998 was $595,000. In July 1998 an additional $50,000 was advanced and interest of $4,000 accumulated, making the balance due $649,000 at July 31, 1998. During September 1998, the $649,000 balance was converted into an 8% interest-bearing promissory note due from the officer requiring monthly installments of $15,000 and a balloon payment of the remaining balance due May 31, 1999. As security for the note, the officer pledged 600,000 of his shares of the Company's common stock. Based on the above, the note receivable was classified as a current asset in the accompanying consolidated balance sheet at June 30, 1998. Monthly payments totaling $120,000 were made during the year ended June 30, 1999, however, the balloon payment was not made at May 31, 1999. In July, the officer stated he would be unable to make the balloon payment and the Company, pursuant to Board of Director's approval, defaulted the note and seized the collateral of 600,000 shares in satisfaction of the note and interest due. The 600,000 shares had a market bid price of $731,000 at the time of their surrender and the note and accumulated interest had a carrying value of $574,000. The Company's Board of Directors considers the difference between the market price and carrying value of the note receivable of $157,000 to be a reasonable and fair discount for the shares received. Based on the above, the Company has presented the balance of the note receivable as a reduction of stockholders' equity in the accompanying consolidated balance sheet as of June 30, 1999. Page F-12 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE G - NOTES PAYABLE Notes payable consist of the following: June 30, June 30, 1999 1998 ------------------------- 10% mortgage note secured by property and equipment of two nursing homes; due in 2022, with monthly installments of approximately $68,000 $ 7,342,000 $ 7,028,000 10% bank line of credit -- 200,000 Line of credit at prime plus 2%, (8.75% at June 30, 1999) secured by accounts receivable and other assets 3,631,000 -- 9.45% equipment term notes; due in 2003 with monthly installments of $2,200 84,000 102,000 8.75% equipment term note payable to a bank; due in 2003 with monthly installments of approximately $2,000 80,000 97,000 Vehicle term notes; due in 2001 with monthly installments of $1,000 26,000 18,000 ----------- ----------- 11,163,000 7,445,000 Less: current portion 3,748,000 313,000 ----------- ----------- $ 7,415,000 $ 7,132,000 =========== =========== In July 1997, the Company financed the purchase of two nursing homes with a $6.8 million mortgage note payable to Nationwide Health Properties, Inc. Nationwide has agreed to finance up to $2 million in improvements to the nursing homes made in connection with change of ownership requirements. Through June 30, 1999, $623,000 has been advanced for such improvements and is included in the mortgage obligation above. In addition, the Company is required to maintain a debt service reserve of $360,000 which, as of June 30, 1999, is fully funded and is included in other assets in the accompanying consolidated balance sheets. In December 1998, the Company entered into a financing agreement with a healthcare lender for a line of credit of up to $4.5 million, which is secured by its accounts receivable and certain other assets. This line of credit replaced the 10% $2,000,000 bank line of credit shown above. At June 30, 1999 the Company was not in compliance with two covenants of this loan agreement, but has obtained a waiver of compliance for those specific requirements existing at June 30, 1999. Page F-13 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE G - NOTES PAYABLE (Continued) Aggregate principal maturities of notes payable in succeeding years are as follows: Year ending June 30: 2000 $ 3,748,000 2001 165,000 2002 155,000 2003 157,000 2004 129,000 Subsequent to 2004 6,809,000 ----------- $11,163,000 =========== NOTE H - ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consist of the following: June 30, June 30, 1999 1998 --------------------------- Accounts payable $ 7,730,000 $ 5,534,000 Accrued payroll and payroll taxes 4,118,000 2,310,000 Other accrued expenses 1,625,000 688,000 ----------- ----------- $13,473,000 $ 8,532,000 =========== =========== NOTE I - LEASE COMMITMENTS CAPITAL LEASES The following is an analysis of leased property under capital leases by major class at June 30, 1999: Equipment $579,000 Less: accumulated amortization 157,000 -------- $422,000 ======== Amortization expense relative to leased property under capital leases totaled $80,000, $47,000, and $29,000 for the years ended June 30, 1999, 1998 and 1997 respectively, and is included in depreciation and amortization expense disclosed in Note E. Page F-14 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE I - LEASE COMMITMENTS (Continued) CAPITAL LEASES (Continued) The following is a schedule by years of future minimum lease payments under capital leases, together with the present value of the net minimum lease payments: Year ending June 30: 2000 $178,000 2001 148,000 2002 146,000 2003 101,000 2004 22,000 -------- Total minimum lease payments 595,000 Less: amount representing interest 123,000 -------- $472,000 ======== RELATED PARTY OPERATING LEASES The Company leases four of its nursing homes facilities (including certain equipment) under an operating lease with a partnership related through common ownership. The Company is responsible for property taxes, maintenance, insurance, etc. under the lease. The lease agreement, as amended, commenced on July 1, 1995 and is for a ten-year period, with four five-year renewal options at specified rents. In addition, the Company leases its corporate office space from an entity related through common ownership under an operating lease which expires in February 2013 and has two five-year renewal options with rent at then market rates. Further, the Company leases office and warehouse space from a limited liability company related through common ownership under an operating lease which expires January 31, 2002. Future minimum lease payments required under these related party lease obligations, net of sublease rentals are as follows: Year ending June 30: 2000 $ 2,679,000 2001 2,680,000 2002 2,687,000 2003 2,674,000 2004 2,687,000 Thereafter 3,832,000 ---------- $17,239,000 =========== Rent expense charged to operations under these related party operating leases aggregated $2,653,000, 2,538,000 and $2,488,000 for the years ended June 30, 1999, 1998, and 1997, respectively. Page F-15 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE I - LEASE COMMITMENTS (Continued) RELATED PARTY OPERATING LEASES (Continued) The Company has deposited with the related partnership, in connection with the nursing home facilities lease, a non-interest bearing security deposit of approximately $2.3 million as of June 30, 1999 and 1998. Such security deposit is comprised of a payment of approximately $1.3 million made by the Company on the related partnership's behalf and payments of $1 million representing excess rent which was paid to the related partnership prior to the retroactive reduction of periodic rent payments. The Company has also deposited, in connection with its corporate office lease, a non-interest bearing security deposit of approximately $55,000 as of June 30, 1999 and 1998. Deferred rent payable represents the excess of rent expense determined on a straight-line basis over amounts paid to date pursuant to the lease with the related partnership. OTHER OPERATING LEASES The Company's PRN subsidiary has other operating leases which expire in various years through 2001. Rent expense charged to operations under such leases totaled approximately $82,000, $78,000 and $9,000 for the years ended June 30, 1999, 1998 and 1997, respectively. Future minimum lease payments required under these other operating leases are as follows: Year ending June 30: 2000 $39,000 2001 3,000 ------- $42,000 ======= NOTE J - STOCKHOLDERS' EQUITY WARRANTS In connection with the public offering, the Company has issued warrants to purchase 1,940,625 shares of Company's common stock at $6 per share, subject to adjustment in certain circumstances, which may be exercised at any time after May 14, 1998 through May 13, 2003. The warrants are subject to redemption by the Company at any time after May 14, 1998 at a price of $.05 per warrant provided that the closing price of the Company's common stock has equaled or exceeded $10 per share for a period of twenty consecutive trading days. In April 1999, the Company issued to an investment banking firm warrants to purchase 250,000 shares of the Company's common stock. The warrants vest and are exercisable as follows: Date Number of warrants Exercise price ---- ------------------ -------------- April 1, 1999 125,000 $1.00 September 25, 1999 125,000 1.50 None of the above warrants have been exercised. Page F-16 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE J - STOCKHOLDERS' EQUITY (Continued) STOCK OPTION PLAN The Company has reserved 450,000 shares of its common stock for issuance pursuant to stock options which may be granted pursuant to the Company's 1997 Stock Option Plan. The Plan provides for grants to employees, consultants and directors of the Company. Subject to the provisions of the Plan, the Board has the authority to determine the individuals to whom the stock options are to be granted, the number of shares to be covered by each option, the exercise price, the type of option, the option period, the restrictions, if any, on the exercise of the option, the terms for the payment of the option price and other terms and conditions. During the year ended June 30, 1998, the Company issued options to purchase 302,000 shares of its common stock to directors and employees at exercise prices ranging from $2.625 to $3.062 based on the market value at date of grant. The Board of Directors re-priced these outstanding options in November 1998 at $.87 based on the current market value. Such options vest at a rate of one-third per year and are fully vested on the fourth anniversary of their issuance. The options expire December 16, 2003 and March 17, 2004 depending on their date of issuance. During the year ended June 30, 1999 33,000 options were cancelled when the employees to whom they were issued terminated their employment. Through June 30, 1999 no options have been exercised. The Company has adopted Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation". In accordance with the provisions of SFAS No. 123, the Company applies APB Opinion No. 25 in accounting for its stock option plans and, accordingly, does not recognize compensation cost at the grant date. If the Company had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by SFAS No. 123, net income and income per share would have been adjusted to the pro forma amounts indicated below: The fair value of each option grant is estimated on the date of grant with the following assumptions: Expected dividend yield 0% Expected volatility 41% Risk-free interest rate 9% Expected life of options 72 months
Year ended June 30, 1999 Year ended June 30, 1998 ------------------------- ------------------------ As reported Pro forma As reported Pro forma ----------- --------- ----------- --------- Net income (loss) $(1,577,000) $(1,794,000) $30,000 $(21,000) ============ ============ ======= ========= Basic earnings (loss) per common share $(.38) $(.43) $.01 $(.01) ====== ====== ==== ======
Page F-17 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE J - STOCKHOLDERS' EQUITY (Continued) PREFERRED STOCK The Company is authorized to issue 1,000,000 shares of preferred stock, $.01 per value, with such rights, preferences and designations and to be issued in such series as determined by the Board of Directors. As of June 30, 1999, the Company has issued no preferred stock. NOTE K - OTHER MANAGEMENT FEES The Company had managed a nursing home owned by an entity in which an officer and director of the Company has a controlling interest (see Note F); revenues earned in connection with this agreement were $18,000 and $72,000 for the years ended June 30, 1998 and 1997, respectively. The contract ended as of September 30, 1997. Also during the years ended June 30, 1999 and 1998 medical supplies, pharmacy products, and therapy services were provided to this entity by Balz, Lexicon and Lexicore. A total of $17,000 and $92,000 was charged for these products and services during the years ended June 30, 1999 and 1998, respectively; there was a balance due to the Company of $109,000 at June 30, 1999. The Company also manages a second home which is an unrelated entity under a contract which extends through July 31, 1999 and generates an annual management fee of approximately $207,000. The Company subcontracts the management of this facility at an annual cost of approximately $188,000. NOTE L - INCOME TAXES The components of the provision for (benefit from) income taxes for the years ended June 30, 1999, 1998 and 1997 are as follows: 1999 1998 1997 ---- ---- ---- Current: Federal $ -- $ -- $(11,000) State 15,000 30,000 42,000 ------- -------- -------- 15,000 30,000 31,000 ------- -------- -------- Deferred: Federal -- -- (97,000) State -- -- -- ------- -------- -------- -- -- (97,000) ------- -------- -------- $15,000 $30,000 $(66,000) ======= ======== ======== Page F-18 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE L - INCOME TAXES (Continued) Certain of the entities included in the consolidated financial statements were separate taxpayers for tax purposes for the first ten months of fiscal 1997. The income tax expense for all prior periods was recorded on an entity by entity basis as of May 14, 1997. Effective May 15, 1997, the entities became members of a consolidated group for tax purposes. The significant components of the deferred tax provision for 1999, 1998 and 1997 are as follows: 1999 1998 1997 ---- ---- ---- Net operating loss $(143,000) $ (84,000) $ -- Bad debt reserve (154,000) (52,000) (80,000) Property and equipment 28,000 27,000 (14,000) Organizational costs (32,000) 31,000 (24,000) Deferred rent 21,000 21,000 (172,000) Accrued expenses (262,000) (118,000) (266,000) Deferred revenue (1,000) 599,000 -- Valuation allowance 543,000 (424,000) 459,000 --------- --------- --------- $ -- $ -- $ (97,000) ========= ========= ========= The components of the net deferred tax asset and liability as of June 30, 1999 and 1998 were as follows: Deferred tax assets (liabilities) 1999 1998 - --------------------------------- ---- ---- Net operating losses $ 227,000 $ 84,000 Bad debt reserve 286,000 132,000 Property and equipment (41,000) (13,000) Organizational costs 25,000 (7,000) Deferred rent 130,000 151,000 Accrued expenses 646,000 384,000 Deferred revenue (660,000) (661,000) Valuation allowance (578,000) (35,000) --------- --------- Net deferred tax asset $ 35,000 $ 35,000 ========= ========= Page F-19 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE L - INCOME TAXES (Continued) The Company has recorded a valuation allowance of $578,000 and $35,000 at June 30, 1999 and 1998, respectively, to reflect the estimated amount of deferred tax assets. A valuation allowance is required if it is more likely than not that some or all of the deferred tax assets will not be realized in future years. The net change in the valuation allowance for deferred tax assets was an increase of $543,000 for the year ended June 30, 1999, a decrease of $424,000 for the year ended June 30, 1998 and an increase of a $459,000 for the year ended June 30, 1997. The principal reasons for the difference between the statutory federal income tax rate and the effective rate are as follows: 1999 1998 1997 ---- ---- ---- Statutory federal income tax rate (34.0%) 34.0% (34.0%) State taxes, net of federal benefits 1.2 7.0 8.8 Goodwill amortization 5.0 20.2 2.2 Minority interest adjustment (4.5) (26.8) -- Purchase accounting adjustments and change in tax status -- -- 3.6 Bad debt expense 8.8 -- -- Accrued expenses 11.7 -- -- Other adjustments 16.5 (1.5) -- Valuation allowance (3.7) (22.3) -- ----- ----- ----- 1.0% 10.6% (19.4%) ===== ===== ===== NOTE M - RISKS AND UNCERTAINTIES LABOR CONCENTRATION/PENSION CONTRIBUTION As of June 30, 1999, approximately 63% of the Company's employees were covered by ten separate collective bargaining agreements with New England Health Care Employees Union, District 1199/SEIU, AFL-CIO ("Union") two of which expire in November, 2000 (representing 14% of the Company's employees) and another eight of which expire on March 15, 2001. These employees participate in Union pension plans to which the Company contributes an amount stipulated in each collective bargaining agreement. For the years ended June 30, 1999, 1998 and 1997, contributions were approximately $1,458,000, 842,000 and $572,000, respectively. Page F-20 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE M - RISKS AND UNCERTAINTIES (Continued) LABOR CONCENTRATION/PENSION CONTRIBUTION (Continued) During the year ended June 30, 1999, the Company implemented a new defined-contribution pension plan for non-union employees to which the Company will contribute 4% of employee compensation annually; investments in the plan will be directed by the participants. In connection therewith the Company has recorded pension expense of $236,000 for the year ended June 30, 1999. PATIENT SERVICE REVENUE Approximately 85%, 82% and 86% of net patient service revenue was derived under federal and state third-party reimbursement programs in 1999, 1998 and 1997, respectively. These revenues are based, in part, on cost reimbursement principles and are subject to audit and retroactive adjustment by the respective third-party fiscal intermediaries. The general trend in the nursing home industry is lower private pay utilization due to liberal asset transfer rules and the degree of financial planning that takes place by the general public. The Company's ability to maintain the current level of private pay utilization and thereby reduce reliance on third-party reimbursement is uncertain due to the economic and regulatory environment in which all Connecticut nursing homes operate. Effective for the year ended June 30, 1999, the Company began receiving its nursing home Medicare reimbursement under a new per diem system known as the prospective payment system. This new system entirely changes the way the Company is paid for Medicare Part A services. The Company's success under this acuity-based system is largely dependent on managing patient utilization of clinical resources. The Company's ability to maintain its current level of Medicare reimbursement is uncertain. MALPRACTICE INSURANCE The Company maintains malpractice insurance coverage on an occurrence basis. It is the intention of the Company to maintain such coverage on an occurrence basis in ensuing years. As of June 30, 1999, no known malpractice claims have been asserted against the Company which, either individually or in the aggregate, are in excess of insurance coverage. Page F-21 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE N - COMMITMENTS AND CONTINGENCIES EMPLOYMENT AGREEMENTS The Company has employment agreements with three of its executive officers which became effective upon consummation of the public offering. The agreements provide that such individuals shall devote substantially all of their working time and attention to the business of the Company and contain certain non-compete provisions. The agreements have an initial term of five years and are automatically renewable for successive one-year periods unless either the Company or the employee elects not to renew his or her employment. The CEO's agreement provides for a $250,000 annual salary, with cost of living increases and a bonus equal to 1% of the Company's net income before taxes. The President's employment agreement is identical except that the salary is $175,000 annually. The agreement with the president of BALZ provides for a base annual salary of $100,000, subject to five percent annual increases, plus a bonus of 3.75% of BALZ's net profits before taxes. YEAR 2000 The Company is continuing work on resolving the potential impact of the year 2000 on the ability of its computerized information systems to accurately process information that may be date-sensitive. Any of the Company's programs that recognize a date using "00" as the year 1900 rather than the year 2000 could result in errors or system failures. The Company utilizes a number of computer programs across its entire operation, however it primarily uses licensed software products, with a significant portion of processes and transactions centralized in only a few third party vendor packages. Certain of those packages were acquired in recent years and are Year 2000 compliant. Management has made plans to complete the conversion of remaining programs before the end of the calendar year. The Company currently believes that costs of addressing this issue will not have a material adverse impact on the Company's financial position. However, if the Company and third parties upon which it relies are unable to address this issue in a timely manner, it could result in a material financial risk to the Company. In order to assure that this does not occur, the Company plans to devote all resources required to resolve any significant Year 2000 issues in a timely manner. Page F-22 LEXINGTON HEALTHCARE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999, 1998 AND 1997 NOTE N - COMMITMENTS AND CONTINGENCIES (Continued) LAWSUIT SETTLEMENT AND CONTINGENCIES The former President and Administrator of Professional Relief Nurses, Inc. (PRN), the Company's home care subsidiary, initiated a lawsuit against Lexington Healthcare Group, Inc., PRN, and Jack Friedler, the Company's Chairman and CEO, in connection with her termination in July 1998. In September 1999 the Company reached a settlement in principle to avoid the expenses of protracted litigation. The Company has recorded a provision for lawsuit settlement of $539,000 in the accompanying consolidated statement of operations for the year ended June 30, 1999. The Company has funded a $350,000 cash bond as of June 30, 1999 which is included in prepaid and other current assets in the accompanying consolidated balance sheet. The Company is also involved in other legal proceedings and is subject to certain lawsuits and claims in the ordinary course of its business. Although the ultimate effect of these matters is often difficult to predict, management believes that their resolution will not have a material adverse effect on the Company's consolidated financial statements. NOTE O - SUBSEQUENT EVENT (unaudited) In October 1999, Federal officials (the "government") seized records and documents from the Company and subpoenaed current and former employees to provide testimony in connection with a grand jury investigation being conducted by the Office of the U.S. Attorney. The Company and certain members of senior management have been named as targets of the government's investigation. However, the government has not provided the Company with any documentation from which it may determine the nature and scope of the investigation. The Company is cooperating fully with the government investigation, has provided all requested records and information, and management is confident that the Company has not committed any wrongdoings. In addition, the Company has established an independent committee of the Board of Directors to supervise its own internal investigation. The ultimate outcome of this uncertainty cannot presently be determined. Accordingly, no provision for any liability that may result has been made in the accompanying consolidated financial statements. Page F-23 -----END PRIVACY-ENHANCED MESSAGE-----