-----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, RvKHrbHo/iUi5j4bk5ue/i/MTHso/3dWOXZ53lyYjMapGrrMSvq4H9N5cDDLHyxw fPU4Xf6TTFi2XzbtyOUrmw== 0000950144-98-004367.txt : 19980410 0000950144-98-004367.hdr.sgml : 19980410 ACCESSION NUMBER: 0000950144-98-004367 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19980409 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: RETIREMENT CARE ASSOCIATES INC /CO/ CENTRAL INDEX KEY: 0000798540 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SKILLED NURSING CARE FACILITIES [8051] IRS NUMBER: 431441789 STATE OF INCORPORATION: CO FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 001-14114 FILM NUMBER: 98590844 BUSINESS ADDRESS: STREET 1: 6000 LAKE FORREST DR STE 200 CITY: ATLANTA STATE: GA ZIP: 30328 BUSINESS PHONE: 4042557500 MAIL ADDRESS: STREET 1: 6000 LAKE FORREST DR STREET 2: STE 200 CITY: ATLANTA STATE: GA ZIP: 30328 10-K/A 1 RETIREMENT CARE ASSOCIATES, INC. 1 U. S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A Amendment No. 2 (Amending Part I - Items 1, 2 and 3, Part II - Item 7, Part III - Item 13 and Part IV - Item 14 and Financial Statements) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the Fiscal Year ended: June 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from: Commission File No. 1-14114 RETIREMENT CARE ASSOCIATES, INC. (Exact Name of Registrant as Specified in its Charter) COLORADO 43-1441789 (State or Other Jurisdiction of (I.R.S. Employer Identi- Incorporation or Organization) fication Number) 6000 Lake Forrest Drive, Suite 200, Atlanta, Georgia 30328 (Address of Principal Executive Offices, Including Zip Code) Registrant's telephone number, including area code: (404) 255-7500 Securities registered pursuant to Section 12(b) of the Act: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED Common Stock, $.0001 Par Value New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: Common Stock $.0001 Par Value 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 Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of September 18, 1997, 14,749,441 shares of common stock were outstanding. The aggregate market value of the common stock of the Registrant held by nonaffiliates on that date was approximately $84,064,500. 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. [ ] Documents incorporated by reference: None. 2 PART II ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. YEAR ENDED JUNE 30, 1997 COMPARED TO YEAR ENDED JUNE 30, 1996 The Company's total revenues for the year ended June 30, 1997 were $253,227,861 compared to $134,011,369 for the year ended June 30, 1996. Management fee revenue decreased from $3,781,433 in the year ended June 30, 1996, to $2,629,329 in the year ended June 30, 1997. The Company leased three long-term care facilities and four assisted living/independent living facilities and purchased two assisted living/independent living facilities during the fiscal year ended June 30, 1997, each of which the Company managed during the fiscal year ended June 30, 1996. All of these facilities were owned and controlled by Messrs. Brogdon and Lane. The Company purchased and leased these facilities to reduce the affiliated receivable due the Company and to increase the number of facilities owned or leased, rather than just managed, by the Company. Included in the Company's management fee revenue is $2,212,500 and $3,472,900 from affiliates during the year ended June 30, 1997 and 1996, respectively. Due to the increased number of facilities owned or leased by the Company, patient service revenue increased from $119,499,849 for the year ended June 30, 1996 to $202,603,841 for the year ended June 30, 1997. The cost of patient services in the amount of $148,520,849 for the year ended June 30, 1997, represent 73% of patient service revenue, as compared to $81,082,972 or 68%, of patient service revenue during the year ended June 30, 1996. The increase in the percentage is attributed to the Company's operation of twenty-one long-term care facilities compared to fourteen assisted living/ independent living facilities in the year end June 30, 1997. The long-term care facilities require more everyday skilled patient services than assisted living/independent living facilities. Additionally, staffing a long-term care facility requires more nursing specialists, therapy services and higher staffing levels as compared to assisted living/independent living facilities. Owning or leasing a facility is distinctly different from managing a facility with respect to operating results and cash flows. For an owned or leased facility, the entire revenue/expense stream of the facility is recorded on the Company's income statement. In case of a management agreement, only the management fee is recorded. The expenses associated with management revenue are somewhat indirect as the infrastructure is already in place to manage the facility. Therefore, the profitability of managing a facility appears more lucrative on a margin basis than that of an owned/leased facility. However, the risk of managing a facility is that the contract generally can be canceled on a relatively short notice, which results in loss of all revenue attributable to the contract. Furthermore, with an owned or leased property the Company benefits from the increase in value of the facility as its performance increases. With a management contract, the owner of the facility maintains the equity value. From a cash flow standpoint, a management contract is more lucrative because the -28- 3 Company does not have to support the ongoing operating cash flow of the facility. The Company owned or leased 35 additional facilities during fiscal year ended June 30, 1997 compared to fiscal year ended June 30, 1996, which resulted in a corresponding increase in net revenues of $36 million during the fiscal year ended June 30, 1997. The number of leased or owned properties at year end are presented in the following table (which does not include managed facilities):
Type Fiscal 1995 Fiscal 1996 Fiscal 1997 Long-Term Care 30 48 69 Assisted Living/Independent Living 8 18 32 Total 38 66 101
CCMC maintains a cash management account where all operating cash funds of the Company's managed facilities are pooled into one bank account and invested daily. Notes and advances due from (to) affiliates consist of advances to facilities, net of advances from facilities, owned by affiliated entities of ($66,989) and $14,316,661 for the fiscal years 1997 and 1996, respectively. For facilities that were in place for the entire year ended June 30, 1996 and June 30, 1997, revenue increased approximately $1 million, or 2%, during the year ended June 30, 1997. For these same facilities, average rates increased approximately 4% while patient-days decreased approximately 2%. Medical supply revenue increased from $9,825,252 during the fiscal year ended June 30, 1996 to $45,500,712 during the fiscal year ended June 30, 1997. These revenues, which are the revenues of Contour, increased primarily due to the acquisition of Ameridyne Corporation on April 1, 1996 and Atlantic Medical Supply Company, Inc. on July 1, 1996. The cost of medical supplies sold during the fiscal year ended June 30, 1996, $5,350,817, represented 54% of the Company's total medical supply revenue for such period, compared to the cost of medical supplies sold during the year ended June 30, 1997, $31,045,671, which represents 68% of the Company's total medical supply revenue for such period. This increase is primarily due to increases in the cost of the goods sold and increased competition in the medical supply industry, which has decreased the sale prices of most products. Other revenues increased from $904,835 for the fiscal year ended June 30, 1996, to $2,463,979 for the fiscal year ended June 30, 1997. Financing fees increased from $150,000 for the fiscal year ended June 30, 1996 to approximately $700,000 for the fiscal year ended June 30, 1997. Financing fees represent fees received by the Company for assisting other companies to obtain financing for facilities. The Company recorded income under the equity method of $240,000 for investments in unconsolidated subsidiaries. The Company also experienced increases in other revenue not related to resident care, such as guest meals and beauty and barber services, due to the increased number of facilities the Company operated. Lease expense increased from $8,442,671 in the year ended June 30, 1996, to $14,117,392 in the year ended June 30, 1997. This increase is primarily attributable to the increased numbers of facilities leased during the year, as well as the full year effect of leased facilities that started during the year ended June 30, 1996. General and administrative expenses for the year ended June 30, 1997 were $46,346,051, representing 18% of total revenues, as compared to $23,192,250 representing 17% of total revenues, for the year ended June 30, 1996. During the year ended June 30, 1997, the Company recorded a $2,982,063 provision for bad debts. The amount of the provision for bad debts was based upon the aging and estimated collectibility of receivables from Medicare, Medicaid and private payors. During the year ended June 30, 1997, the aging of receivables increased compared with the aging of receivables at June 30, 1996. The increase in the allowance for doubtful accounts of Contour reflects an adjustment to the purchase price allocation for Contour's acquisition of Atlantic Medical and its subsidiaries. The adjustment was required to reduce acquired trade receivables, principally due from Medicare and Medicaid, to their net realizable value. During the year ended June 30, 1997, the Company had $673,655 in interest income and financing fees as compared to $1,847,868 in interest income and financing fees for the year ended June 30, 1996. The decrease in interest income is a result of the decreased amount of advances to related parties during the current year. -29- 4 Interest expense increased from $7,948,091 in the year ended June 30, 1996 to $14,111,843 in the year ended June 30, 1997. This increase is primarily attributable to the increased numbers of facilities acquired by the Company during the year, as well as the full year effect of facilities that were acquired by the Company during the year ended June 30, 1996. For the year ended June 30, 1997, the Company incurred benefits for income taxes of $2,343,256 which represents an effective tax benefit rate of 25% as compared to expenses for income taxes of $1,307,091, which represents an effective tax rate of 48% for the year ended June 30, 1996. The net loss of $7,535,810 for the year ended June 30, 1997 is lower than the net income of $1,746,808 for the year ended June 30, 1996, due to the fact that the Company's operations have deteriorated -30- 5 as a result of the pendency of and delays associated with the merger with Sun, including higher-than-normal turnover, costs associated with the integration and operation of the Company's recently-acquired Virginia and North Carolina facilities (including certain regulatory compliance problems), declines in Medicaid rates and occupancy rates during fiscal year 1997 without a corresponding reduction in operating costs, and accounting adjustments related to the restatement of the Company's financial statements. Although difficult to quantify, the Company believes that such staffing concerns led to increases in costs of patient care and selling, general and administrative expenses during fiscal year 1997. Occupancy rates have also impacted the Company's profitability this fiscal year versus fiscal year 1996. Occupancy rates have declined because of the turnover of administrators, social workers, and nurses. With both the expansion of the number of facilities the Company operated during fiscal year 1997 and the higher than normal staff turnover, the Company's existing management staff was spread very thin. Most of the revenue from the management services division of the Company's business is received pursuant to management agreements with entities controlled by Messrs. Brogdon and Lane, two of the Company's officers and directors. These management agreements have three to five year terms, however, they are all subject to termination on 60 days notice, with or without cause, by either the Company or the owners. Therefore, Messrs. Brogdon and Lane have full control over whether or not these management agreements, and thus the management services revenue, continue in the future. These fees represent .87% and 2.82% of the total revenues of the Company for the years ended June 30, 1997 and 1996, respectively. YEAR ENDED JUNE 30, 1996 COMPARED TO YEAR ENDED JUNE 30, 1995 The Company's management has evaluated the potential effect on periods prior to 1996 of certain errors that the Company has corrected in a restatement and reissuance of its 1996 financial statements. Based on such evaluation, the Company's management determined that a restatement of periods prior to 1996 was unnecessary. The following summarizes the principal considerations made by the Company's management in that regard: Allowance for uncollected accounts during 1996. The Company's accounts receivable nearly doubled during 1996, and the mix of such receivables also changed significantly. In 1995, amounts due from Medicare and Medicaid represented approximately 87% of the Company's total accounts receivable, versus 67% in 1996. Further, amounts due from patients increased from approximately $11,000 in 1995 to approximately $3,113,000 in 1996, and the Company's other trade receivables increased from approximately $761,000 in 1995 to approximately $2,595,000 in 1996. The Company's auditors evaluated the Company's position with respect to the allowance in 1995 and concluded that the balance was appropriate for 1995, and nothing was noted that would indicate a misapplication of facts and circumstances during 1995. Nothing would indicate a potential error relating to the allowance for uncollectible accounts. Additional accrual for claims incurred but not reported for self-insured worker's compensation and health care. Until April 1995, the Company had been acquiring commercial insurance, which transferred substantially all risk to a third party insurer. In conjunction with the Company's switch to self-insurance, the Company experienced significant growth during 1996 compared to 1995. During 1996, the Company acquired or leased an additional 28 facilities, a 74% increase in total facilities owned or leased. A similar increase in covered employees can be implied. As a result of the increase in facilities and the rapid increase in covered employees, the reasonable conclusion is that the expenses associated with these increases are properly accounted for in 1996. The Company evaluated what portion of the expenses, if any, would have been properly accrued in 1995 and determined that the amount was immaterial to the 1995 financial statements. Accrual for compensated absences. The Company evaluated what portion of the expenses, if any, would have been properly accrued in 1995 and determined that the amount was immaterial to the 1995 financial statements. -31- 6 Adjustment of previously recorded inventory. This adjustment applies only to the 1996 financial statements. Initially, the Company had erroneously included certain items, such as beds and other insignificant equipment ($200 or less per item), in its physical inventory by facility. The adjustment to inventory represents a correction to the inventory balance to only reflect those items appropriately included as inventory. Adjustment to lease expense. This adjustment represents the amount necessary to increase lease expense to reflect straight line expense for those leases which contained escalation clauses. This adjustment is principally related to 1996 when the Company acquired an additional 28 facilities. The Company evaluated the potential effect on the 1995 financial statements and deemed the expenses to be immaterial to the 1995 financial statements because most of the leases containing escalations were entered into during 1996. The Company's total revenues for the year ended June 30, 1996, were $134,011,369 compared to $79,616,053 for the year ended June 30, 1995. Management fee revenue decreased from $4,169,694 in the year ended June 30, 1995, to $3,781,433 in the year ended June 30, 1996. The Company leased one long-term care facility, purchased three long-term care facilities and purchased two assisted living/independent living facilities during the fiscal year ended June 30, 1996, each of which it managed during the fiscal year ended June 30, 1995. All of these facilities were owned and controlled by Messrs. Brogdon and Lane. The Company purchased and leased these facilities to reduce the affiliated receivable due the Company and to increase the number of facilities owned or leased, rather than just managed, by the Company. Included in the Company's management fee revenue is $3,472,900 and $3,517,500 from affiliates during the years ended June 30, 1996 and 1995, respectively. Due to the increased number of facilities owned or leased by the Company, patient service revenue increased from $69,949,822 for the year ended June 30, 1995 to $119,499,849 for the year ended June 30, 1996. The cost of patient services in the amount of $81,082,972 for the year ended June 30, 1996, represents 68% of patient service revenue, as compared to $47,778,410, or 68%, of patient service revenue during the year ended June 30, 1995. The decrease in the percentage is attributed to an increase in the ratio of assisted living/independent living facilities to long-term care facilities operated during the current year. Assisted living/independent living facilities require less patient services than long-term care facilities. The ratio of long-term care facilities to assisted living/independent living facilities decreased to 2.7 from 3.8 during the year ended June 30, 1996. Owning or leasing a facility is distinctly different from managing a facility with respect to operating results and cash flows. For an owned or leased facility, the entire revenue/expense stream of the facility is recorded on the Company's income statement. In the case of a management agreement, only the management fee is recorded. The expenses associated with management revenue are somewhat indirect as the infrastructure is already in place to manage the facility. Therefore, the profitability of managing a facility appears more lucrative on a margin basis than that of an owned/leased facility. However, the risk of managing a facility is that the contract generally can be canceled on a relatively short notice, which results in loss of all revenue attributable to the contract. Furthermore, with an owned or leased property the Company benefits from the increase in value of the facility as its performance increases. With a management contract, the owner of the facility maintains the equity value. From a cash flow standpoint, a management contract is more lucrative because the Company does not have to support the ongoing operating cash flow of the facility. -32- 7 The Company converted four managed properties to leased properties during the fiscal year ended June 30, 1996, which resulted in an increase in net revenues of $1 million during the fiscal year ended June 30, 1996 compared to the fiscal year ended June 30, 1995. The number of leased or owned properties at year-end are presented in the table below (the table does not included managed facilities):
TYPE FISCAL 1994 FISCAL 1995 FISCAL 1996 ---- ----------- ----------- ----------- Long-term Care 20 30 48 Assisted Living/Independent Living 6 8 18 ----- ----- ------ Total 26 38 66
For facilities that were in place for the entire year ended June 30, 1995 and June 30, 1996, revenue increased approximately $3 million, or 5%, during the year ended June 30, 1996. For these same facilities, average rates increased approximately 3% while patient-days increased approximately 2%. During the year ended June 30, 1996, the Company had revenue from medical supply sales of $14,542,421, an approximately $6.2 million increase compared to fiscal year ended June 30, 1995, of which $4,717,169 was intercompany sales which were eliminated in consolidation. These sales reflect the operations of Contour Medical, Inc., of which the Company acquired a majority interest on September 30, 1994. Because the Company acquired Contour on September 30, 1994, only nine months of activity were recorded for fiscal year ended June 30, 1995. Sales for those nine months of $3,617,439 have been annualized and recorded for the year ended June 30, 1995 and comprise $1.2 million of the $6.2 million increase in medical supplies revenue for the fiscal year ended June 30, 1995. Sales for the nine month period following the Contour acquisition have been annualized so as not to distort the net increase in revenues from the fiscal year ended June 30, 1995 to the fiscal year ended June 30, 1996. Moreover, Contour acquired AmeriDyne on March 1, 1996, which contributed $3.6 million of revenue for the fiscal year ended June 30, 1996 (see Contour 6/30/96 10-K, page 16). While AmeriDyne contributed $3.6 million of revenue for the fiscal year ended June 30, 1996 (as set forth correctly in Contour's 6/30/96 10-K), Contour's $4.7 million in sales should not have been labeled intercompany because this amount was not attributable to sales to RCA. The remaining $1.4 million increase in sales increase is attributable to the internal growth of the business. The change in costs of goods sold as a percentage of sales during fiscal year ended June 30, 1996 versus fiscal year ended June 30, 1995 is not meaningful because the method of recording intercompany elimination changed during the fiscal year ended June 30, 1996. During the fiscal year ended June 30, 1995, intercompany sales of $4,995,346 were recorded as an elimination of medical supply revenue and an elimination of routine and ancillary costs. During the fiscal year ended June 30, 1996, intercompany sales of $4,717,169 was recorded as an elimination of medical supply revenue and an elimination of medical supply costs of goods sold. If fiscal year ended June 30, 1996 is treated identically to fiscal year ended June 30, 1995, the costs of goods sold margin would be 107% of sales as compared to 87% of sales during fiscal year ended June 30, 1995. The increase in costs of goods sold margin is primarily attributable to the fact that sales to RCA comprised 32% of Contour's sales during fiscal year ended June 30, 1996 (representing costs without associated revenues), while sales to RCA comprised only 22% of Contour's sales during fiscal year ended June 30, 1995. The Cost of Goods Sold for the year ended June 30, 1996, was $5,773,934. Lease expense increased from $5,769,232 in the year ended June 30, 1995, to $8,442,671 in the year ended June 30, 1996. This increase is primarily attributable to the increased numbers of facilities leased during the year, as well as the full year effect of leased facilities that started during the year ended June 30, 1995. There were ten new facilities leased during the fiscal year ended June 30, 1996. -33- 8 General and administrative expenses for the year ended June 30, 1996, were $23,192,250, representing 17% of total revenues, as compared to $12,769,582 representing 16% of total revenues, for the year ended June 30, 1995. During the year ended June 30, 1996, the Company recorded a $3,423,117 provision for bad debts. The amount of the provision for bad debts was based upon the aging and estimated collectibility of receivables from Medicare, Medicaid and private payors. During the year ended June 30, 1996, the aging of receivables increased compared with the aging of receivables at June 30, 1995. In addition, at June 30, 1996, a larger amount of the receivables was deemed to be uncollectible than at June 30, 1995. As of June 30, 1995, the estimated allowance for bad debts was immaterial to the financial statements and was, therefore, not recorded. The Company's consideration of several factors related to the current accounts receivable balance for fiscal year 1996 resulted in the Company recording a $2.7 million bad debt reserve. The Company considered the overall increase in patient account balances (approximately 80%) resulting from the Company's acquisitions during fiscal year 1996, the deterioration in the aging categories due to untimely collection practices by individual facilities which in several cases resulted in the expiration of allowable time periods to bill accounts, the significant rise in accounts receivable net days, the growth in self-pay balances and the lack of timely write-off of uncollectible accounts throughout the fiscal year. During the year ended June 30, 1996, the Company had $1,847,868 in interest income and financing fees as compared to $658,215 in interest income and financing fees for the year ended June 30, 1995. Financing fees, which totaled $150,000 for the year ended June 30, 1996, represents fees received by the Company for assisting other companies to obtain financing for nursing homes and retirement facilities. The increase in interest income is a result of the increased amount of advances to related parties during the current year. Interest expense increased from $1,179,052 in the year ended June 30, 1995, to $7,948,091 in the year ended June 30, 1996. This increase is primarily attributable to the increased numbers of facilities acquired by the Company during the year, as well as the full year effect of facilities that were acquired by the Company during the year ended June 30, 1995. For the year ended June 30, 1996, the Company incurred expenses for income taxes of $1,307,091, which represents an effective tax rate of 48%, as compared to expenses for income taxes of $3,419,092, which represents an effective tax rate of 40%, for the year ended June 30, 1995. The increase in the effective tax rate is mainly the result of a non-deductible tax penalty of approximately $400,000 which was assessed during the year ended June 30, 1996. The net income of $1,746,808 for the year ended June 30, 1996, is less than the net income of $5,058,503 for the year ended June 30, 1995, due to the provision of an additional allowance for bad debts and increased interest expense because of the larger number of facilities acquired during the most recent fiscal year. Most of the revenue from the management services division of the Company's business is received pursuant to management agreements with entities controlled by Messrs. Brogdon and Lane, two of the Company's officers and directors. These management agreements have three to five year terms; however, they are all subject to termination on 60 days notice, with or without cause, by either the Company or the owners. Therefore, Messrs. Brogdon and Lane have full control over whether or not these management agreements, and thus the management services revenue, continue in the future. These fees represent 2.82% and 5.24% of total revenues of the Company for the years ended June 30, 1996 and 1995, respectively. -34- 9 LIQUIDITY AND CAPITAL RESOURCES At June 30, 1997, the Company had a deficit of $10,489,285 in working capital compared to a $1,496,160 deficit at June 30, 1996. The funds needed to reduce such working capital deficit could be provided by a new line of credit secured by accounts receivable, increased collection efforts on the existing accounts receivable balances, extended payment terms to major vendors and possible refinancing of selected facilities. During the year ended June 30, 1997, cash provided by or (used in) operating activities was ($3,838,000) as compared to $5,549,626 for the year ended June 30, 1996. The $9,387,626 decrease was primarily due to the net loss of $7,535,810 for the year ended June 30, 1997, increases in deferred income taxes of $11,111,558 arising from the carryback of the loss and refunds of estimated tax payments, and increases in accounts receivable of $20,987,667 due to the addition of thirty five facilities for the year ended June 30, 1997. Cash provided by operating activities was primarily attributed to depreciation and amortization of $6,514,713 on the facilities and an increase in accounts payable and accrued expenses of $29,187,587 due to the addition of thirty five facilities for the year ended June 30, 1997. Cash used in investing activities during the year ended June 30, 1997, was $23,581,023. The expenditures primarily related to purchases of property and equipment of 12,734,389 and acquisitions of facilities and a medical supply company of $18,807,777. On August 6, 1996, Contour Medical, Inc., a majority-owned subsidiary of the Company, purchased all of the outstanding stock of Atlantic Medical, a distributor of disposable medical supplies and a provider of third-party billing services to the nursing home and home health care markets. The acquisition was accounted for as a purchase and made retroactively to July 1, 1996. Contour paid $1.4 million in cash and $10.5 million in promissory notes for all of the outstanding stock of Atlantic Medical. The promissory notes bore interest at 7% per annum and were paid in full on January 10, 1997. On October 14, 1996, Winter Haven sold two retirement facilities to the Company at their fair market value, based on an independent appraisal, for a total purchase price of $19,200,000. The facilities were the Jackson Oaks retirement facility in Jackson, Tennessee, which the Company previously leased, and the Cumberland Green retirement facility which the Company previously managed. The purchase prices for these facilities were $12,400,000 and $6,800,000, respectively. These facilities were acquired subject to total bond debt of $7,670,000, resulting $11,530,000 due to Winter Haven, which was applied to eliminate the $11,214,320 owed to the Company by Winter Haven. On September 27, 1996, Gordon Jensen transferred 399,426 shares of the Company's common stock to the Company with a fair market value equal to $3,000,000 in exchange for the cancellation of its debt totalling $2,982,000. The Company subsequently retired these shares. These shares were loaned to Gordon Jensen by Edward E. Lane, Chris Brogdon and Connie Brogdon. Gordon Jensen must repay the debt to Mr. Lane, Mr. Brogdon and Ms. Brogdon with either stock or cash within five years. The advances were due on demand. Cash provided by financing activities during the year ended June 30, 1997, totaled $31,012,336. Sources of cash included proceeds of $9,340,000 from the issuance of 1,000,000 shares of $10.00 Series F Convertible Preferred Stock which were sold in an offering to foreign investors in September, 1996. Holders of the Series F Preferred Stock have no voting rights except as required by law, and have a liquidation preference of $10.00 per share plus 4% per annum from the date of issuance. The shares of Series F Preferred Stock are convertible into shares of common stock at a conversion price of $7.425 or 85% of the average closing bid price for the five trading days prior to the date of conversion, whichever is lower. At the time of conversion, the holder is also entitled to additional shares equal to $10.00 per share of Series F Preferred Stock multiplied by 8% per annum from the date of issuance divided by the applicable conversion price. Sources of cash also included proceeds from stock options and warrants exercised of $1,900,306, and proceeds from long-term debt and lines of credit of $33,919,190. The Company's net borrowing from lines of credit was $9,935,036, with interest rates ranging from prime plus .25% to prime plus 1.25%. Available borrowings at June 30, 1997 was $14,050,000. The Company incurred long-term debt of approximately $24 million, due through 2026, with interest rates ranging from 7.0% to 12.5%. Included in the long-term debt is a $9,750,000 loan with Sun, used to repay the notes payable associated with the Contour acquisition of Atlantic Medical, with interest accruing at rates of 11% and would increase to 15% during any period of default. Principal is due 120 days following the termination of the agreement or merger with Sun. In connection with bond indentures, the Company is required to meet certain covenants, including monthly sinking fund deposits, adequate balances in debt service reserve funds, timely payment of tax obligations and adequate insurance coverage. At June 30, 1997, the Company was in violation of several of these covenants creating a technical default on approximately $51 million of bond indentures. These violations included the failure to make monthly payments to the bond sinking funds for certain of these facilities and inadequate debt service reserves for certain of these facilities. The Company is also delinquent with regard to approximately $1.2 million of property taxes at several facilities. The trustees have not called the bonds in the past for these violations and management does not foresee the bonds being called at this time. -35- 10 All semi-annual interest and principal payments have been made in a timely fashion. Cash used in financing activities primarily consisted of $13,329,520 in payments of long-term debt, $600,000 in redemption of Series AA Preferred Stock, $841,318 in purchases of treasury stock, and $240,000 for dividends on preferred stock. Subsequent to June 30, 1997, the Company obtained an additional note payable from Sun of $5,000,000 for working capital purposes on July 10, 1997. Interest accrues at the rate of 12% and would increase to 16% during any period of default. Principal is due 120 days following the termination of the agreement or merger with Sun. All of the Company's notes receivable and advances to affiliated entities issued during fiscal year 1996 were paid in full during 1997, including interest on the notes receivable at a rate of 12% per annum. Affiliated entities that received notes receivable and advances during 1996 were Gordon Jensen Health Care Association, Inc. ("Gordon Jensen"), Winter Haven Homes, Inc. ("Winter Haven"), Southeastern Cottages, Inc. ("SCI"), National Assistance Bureau, Inc. ("NAB"), Chamber Health Care Society, Inc. ("Chamber") and Senior Care, Inc. ("Senior Care"), all of which are owned or controlled by officers and directors of the Company or family members of such officers and directors, and Sea Breeze Health Care Center ("Sea Breeze"), a wholly-owned subsidiary of the Company. Further, the Company owed such affiliated entities an aggregate of $66,989 as of the fiscal year ended June 30, 1997. At June 30, 1996, the Company had a deficit of $1,496,160 in working capital compared to a surplus of $2,925,302 at June 30, 1995. -36- 11 During the year ended June 30, 1996, cash provided by operating activities was $5,549,626 as compared to $4,208,048 for the year ended June 30, 1995. The $1,341,578 increase was primarily due to net income of $1,746,808 for the year ended June 30, 1996, depreciation and amortization of $3,406,986 on the facilities, provisions for bad debts of $3,423,117 on accounts receivable and increases in accounts payable and accrued expenses of $9,964,620 due to the addition of twenty eight facilities for the year ended June 30, 1996. Cash used in operating activities was primarily due to the increase in accounts receivable of $10,672,485 due to the addition of twenty eight facilities for the year ended June 30, 1996 and increases in inventories of $2,245,194 on the nursing facilities and Contour Medical Supply, Inc. Cash used in investing activities during the year ended June 30, 1996, was $44,981,326. The expenditures primarily related to purchases of property and equipment of $12,490,298 and acquisitions of facilities of $21,938,513. On December 15, 1995, the Company obtained both a sole general and a limited partnership interest, totaling 74.25% interest, in Encore Partners, L.P. in exchange for a capital contribution to Encore of $3.5 million. Encore owns three assisted living/independent living and two long-term care facilities. The acquisition was accounted under the purchase method of accounting. Profits and losses of Encore are allocated 74.25% to the Company and 25.75% to other partners. Available cash, if any, is distributed 74.25% to the Company and 25.75% to the other partners. On February 27, 1996, the Company purchased a thirty six unit assisted living/independent living facility from individuals who are officers and directors of the Company. The Purchase price was $2,000,000 and was financed with $400,000 from the Company and a $1,600,000 mortgage loan from an unrelated third-party real estate investment trust. The Company issued notes receivable and advances to Gordon Jensen, Winter Haven, SCI, NAB, Chamber, Senior Care and Sea Breeze in the aggregate amount of $8,935,677 during the 1996 fiscal year. Gordon Jensen owned one facility, Magnolia Manor, which was constructed and opened in fiscal year 1995 and required construction funding and start-up working capital during fiscal year 1996. This facility's financial condition has improved as resident census has increased. The facility might, however, require additional advances until a stable occupancy level is achieved. Winter Haven owned two facilities which required significant advances to fund working capital and capital improvements during fiscal year 1996. In addition, Renaissance of Titusville, a partnership of which Winter Haven is the sole general partner, required advances during 1996 to fund construction of forty additional units. Renaissance of Titusville has performed poorly historically because of the need for additional units to offset overhead expenses. SCI and NAB each required advances during fiscal year 1996 to fund working capital and capital improvements at Summer's Landing -- Vidalia, SCI's only facility, and Summer's Landing -- Lynn Haven, NAB's only facility. Both of the facilities have historically operated poorly financially due to poor residence census at such facilities. Chamber constructed Parkway Health Care Center, a 120-bed long-term care facility, in 1996, and the Company advanced funds to Chamber for construction, preliminary staffing and planning at the Parkway facility. After Parkway's opening in September 1996, the facility also required additional advances to fund start-up operations. The Company made advances of approximately $80,000 to Senior Care during fiscal year 1996 after the Company's acquisition of the Deerfield Nursing Facility. Senior Care used such advances to satisfy its accounts payable. The Company's Board of Directors believed that such advances were necessary to avoid the possibility of any claims against the Company or its assets by Senior Care's former vendors and suppliers solely by virtue of the Company's succession to the Deerfield Nursing Facility. Any actions involving the Company or its assets could be distracting to management and cause the Company to expend resources in frivolous litigation. The Company purchased Sea Breeze with a low census caused by state imposed sanctions created by quality-of-care issues that arose under its former operators. Sea Breeze, therefore, required significant working capital and capital improvements during fiscal year 1996 to cure such sanctions and allow the admission of new residents. Sea Breeze's financial condition has improved gradually and admissions have increased, but Sea Breeze may require additional working capital until a stable occupancy level is reached. The Company's management fee revenue from its affiliated entities totalled $2,212,500 and $3,472,900 for fiscal years 1997 and 1996, respectively. -37- 12 The Company funded an additional $4,720,047 in restricted bond funds used for debt service reserve requirements, semi-annual principal and interest payments and project funds for facilities under construction or renovation. Cash provided by investment activities was primarily the repayment of a $2,200,000 note receivable from an unrelated third-party. The Company issues advances and notes receivable to affiliated companies controlled by Messrs. Brogdon and Lane to finance working capital deficits and capital expenditures of facilities which are managed by the Company. In the opinion of the Company's Board of Directors, these advances represent a good use of the Company's funds because they enable such affiliated companies to develop their properties, increase census revenue and increase the fair market value of the facilities, which gives the Company greater assurances that the facilities will continue to pay management fees to the Company. Further, as census revenues increase, management fees payable to the Company will likewise increase. In addition, as properties mature and develop, they may be acquired by the Company with a portion of the purchase price payable through the cancellation of advances and notes receivable due the Company. Cash provided by financing activities during the year ended June 30, 1996, totaled $34,269,880. Sources of cash included proceeds of $9,300,000 from the issuance of 1,000,000 shares of $10.00 Series E Convertible Preferred Stock which were sold in an offering to foreign investors in April, 1996. Holders of the Series E Preferred Stock have no voting rights except as required by law, and have a liquidation preference of $10.00 per share plus 4% per annum from the date of issuance. The shares of Series E Preferred Stock are convertible into shares of common stock at a conversion price of $11.55 or 85% of the average closing bid price for the five trading days prior to the date of conversion, whichever is lower (but no lower than $5.00). At the time of conversion, the holder is also entitled to additional shares equal to $10.00 per share of Series E Preferred Stock multiplied by 8% annum from the date of issuance divided by the applicable conversion price. Sources of cash also included proceeds from stock options and warrants exercised of $559,593, and proceeds from long-term debt and lines of credit of $35,329,244. The Company's net borrowing from lines of credit was $3,556,535, with interest rates ranging from prime plus .25% to prime plus 1.25%. Available borrowings at June 30, 1996 was $5,075,000. The Company incurred long-term debt of approximately $31 million, due through 2025, with interest rates ranging from 6.75% to 11.28%. In connection with bond indentures, the Company is required to meet certain covenants, including monthly sinking fund deposits, adequate balances in debt service reserve funds, timely payment of tax obligations and adequate insurance coverage. At June 30, 1996, the Company was in violation of several of these covenants creating a technical default on approximately $14 million of bond indentures. These violations included the failure to make monthly payments to the bond sinking funds for certain of these facilities and inadequate debt service reserves for certain of these facilities. The Company is also delinquent with regard to approximately $800,000 of property taxes at several facilities. The trustees have not called the bonds in the past for these violations and management does not foresee the bonds being called at this time. All semi-annual interest and principal payments have been made in a timely fashion. Cash used in financing activities primarily consisted of $9,443,626 in payments of long-term debt, $600,000 in redemption of Series AA Preferred Stock, $274,040 in purchases of treasury stock, and $270,000 for dividends on preferred stock. During the year ended June 30, 1995, cash provided by operating activities -38- 13 was $4,208,048 as compared to $1,523,311 for the year ended June 30, 1994. The $2,684,737 increase was primarily due to the increased net income for the year ended June 30, 1995. Cash used in investing activities during the year ended June 30, 1995, was $(10,644,726). The expenditures primarily related to purchases of property and equipment of $6,079,610, purchases of bonds receivable of $4,487,936, increases in investments and advances to The Atrium Ltd. of $2,985,833 and advances to affiliates of $1,742,147 due to capital expenditures and working capital deficits of the affiliates. These were partially offset by the proceeds from a sale-leaseback transaction of $4,500,000. At June 30, 1995, advances to affiliates had increased to $7,328,222 from $5,605,250 at June 30, 1994, due to additional capital expenditures and working capital deficits of the affiliates. Cash provided by financing activities during the year ended June 30, 1995, totalled $10,683,801. Sources of cash included capital investment by minority shareholders of a subsidiary of $1,729,469, net borrowings under lines of credit of $1,745,316 and proceeds from long-term debt of $9,564,670. Cash used in financing activities primarily consisted of $2,130,654 in payments of long-term debt and $225,000 for dividends on preferred stock. Management's objective is to acquire only those facilities it believes will be able to generate sufficient revenue to pay all operating costs, management fees, lease payments or debt service, and still return a 3% to 4% cash flow. Management believes that the Company's cash flow from operations, together with lines of credit and the sale of securities described below, will be sufficient to meet the Company's liquidity needs for the current year. The Company maintains various lines of credit with interest rates ranging from prime plus .25% to prime plus 1.25%. At June 30, 1997, the Company had approximately $4,115,000 in unused credit available under such lines. On September 30, 1994, the Company purchased a majority of the stock of Contour Medical, Inc. in exchange for shares of the Company's common stock and preferred stock. The Company is obligated to redeem the preferred stock issued in the transaction over the five years for $3,000,000 in cash. $600,000 was paid on September 30, 1996 pursuant to this obligation. Management intends to fund these redemptions from cash flow generated from operations. In the event the merger with Sun does not take place, management's plans include a complete reorganization of operations of the Company and Contour. With respect to the Company, this reorganization plan would include new personnel to implement increased census and develop and implement ancillary businesses (e.g., pharmacy and therapy). A comprehensive plan is being developed to implement these changes, if necessary. The personnel for this plan have been identified and could be immediately available. The funds needed to implement this plan would be provided from a new line of credit, sale and lease-back transactions for certain identified properties of the Company, as well as refinancing of other of the Company's targeted facilities. The Company believes that its long-term liquidity needs will generally be met by income from operations. If necessary, the Company believes that it can obtain an extension of its current line of credit and/or other lines of credit from commercial sources. Except as described above, the Company is not aware of any trends, demands, commitments or understandings that would impact its liquidity. The Company intends to use long-term debt financing in connection with the purchase of additional assisted living/independent living and long-term care facilities on terms which can be paid out of the cash flow generated by the property. -39- 14 The Company intends to continue to lease or purchase additional retirement care and/or nursing home facilities in the future. IMPACT OF INFLATION AND PENDING FEDERAL HEALTH CARE LEGISLATION Management does not expect inflation to have a material impact on the Company's revenues or income in the foreseeable future so long as inflation remains below the 9% level. The Company's business is labor intensive and wages and other labor costs are sensitive to inflation. Management believes that any increases in labor costs in its management services segment can be offset over the long term by increasing the management fees. With respect to the operations segment, approximately 52% of the Company's net patient service revenue is received from state Medicaid programs. The two states which make Medicaid payments to the Company have inflation factors built into the rates which they will pay. Georgia's inflation factor is nine percent and Tennessee's inflation is eleven percent. Therefore, increases in operating costs due to inflation should be covered by increased Medicaid reimbursements. Management is uncertain what the final impact will be of pending federal health care reform packages since the legislation has not been finalized. However, based on information which has been released to the public thus far, Management doesn't believe that there will be cuts in reimbursements paid to nursing homes. Legislative and regulatory action, at the state and federal level, has resulted in continuing changes in the Medicare and Medicaid reimbursement programs. The changes have limited payment increases under these programs. Also, the timing of payments made under the Medicare and Medicaid programs are subject to regulatory action and governmental budgetary constraints. Within the statutory framework of the Medicare and Medicaid programs, there are substantial areas subject to administrative rulings and interpretations which may further affect payments made under these programs. Further, the federal and state governments may reduce the funds available under those programs in the future or require more stringent utilization and quality review of health care facilities. ACCOUNTING PRONOUNCEMENT The Financial Accounting Standard Board has adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS No. 115). The Company has adopted this standard in fiscal 1995. In management's opinion, adopting SFAS No. 115 did not materially affect the Company's financial statements for the year ended June 30, 1995. -40- 15 PART III ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The Company has agreements to provide management and accounting services for nursing homes and personal care facilities which are owned or controlled by entities which are owned or controlled by Officers, Directors and principal shareholders of the Company. As of October 1, 1997, the Company had agreements to manage two facilities owned or controlled by Winter Haven Homes, Inc. ("Winter Haven"); one facility owned or controlled by Gordon Jensen Health Care Associates, Inc. ("Gordon Jensen"); two facilities owned or controlled by National Assistance Bureau, Inc. ("NAB"); one facility owned by Southeastern Cottages, Inc. ("SCI"); and two facilities owned by Chamber Health Care Society, Inc. ("Chamber"). The Company previously managed a facility owned by Senior Care, Inc. ("Senior Care"). Winter Haven is owned by a corporation which is owned 50% by Edward E. Lane, an Officer and Director of the Company, and 50% by -41- 16 Connie Brogdon, the wife of an Officer and Director of the Company. Gordon Jensen is a non-profit corporation of which Edward E. Lane is President. NAB is also a non-profit corporation of which Edward E. Lane is President and Chris Brogdon is Secretary/Treasurer. Chamber and Senior Care are non-profit corporations. Edward E. Lane is President and a director of Chamber. SCI is a corporation owned 50% by Chris Brogdon and 50% by Edward E. Lane. The agreements to provide management and accounting services to the affiliated entities are for periods of three to five years but are cancelable upon 60 days' notice by either party. The agreements provide for monthly fees ranging from $2,000 to $28,000 per facility and expire at various times between 1999 to 2002. During the fiscal year ended June 30, 1997, these agreements resulted in revenue to the Company of $2,212,500. The Company currently manages eight facilities owned or controlled by affiliates of the Company, and as part of its duties, the Company also manages the cash and pays the bills for the facilities. In doing so, the Company maintains a cash management system where the deposits of all properties are swept into an investment account daily. The Company is not obligated by its management agreements with such affiliates to advance working capital to such affiliated entities, but the Company has and will continue to advance such working capital to such affiliated entities when necessary. At June 30, 1996, aggregate amounts were due from the following entities: Winter Haven - $8,887,833; Gordon Jensen - $2,982,975; SCI - $679,144; NAB - $1,326,391; Chamber - $336,857; Senior Care - $84,095; and other affiliates - $19,366. Subsequent to June 30, 1996, entities controlled by Winter Haven assumed the liabilities of NAB, SCI, Chamber and Senior Care.
Monthly Management Management Management Fee Payable at Agreement Renewal "Facility Fee June 30, 1997 Expiration Provisions -------- ---------- -------------- ---------- ---------- Midway Health Care Center 24,000 24,000 12/00 Three year automatic unless cancelled Summers Landing - Vidalia 2,000 2,000 06/01 No renewal provision New Beginnings Health & Rehabilitation 28,000 28,000 12/00 Three year automatic unless cancelled Summers Landing - Lynn Haven 2,000 2,000 01/99 One year automatic unless cancelled Renaissance of Sanford 15,000 15,000 07/02 No renewal provision Marshall C. Voss Health Care 14,000 14,000 07/01 Three year automatic unless cancelled Parkway Health & Rehabilitation 4,000 4,000 03/00 No renewal provision Sea Breeze Health Care 12,000 12,000 07/00 Three year automatic unless cancelled"
On October 14, 1996, Winter Haven sold two retirement facilities to the Company for their fair value, based on an independent appraisal, for a total purchase price of $19,200,000. These include the Jackson Oaks retirement facility in Jackson, Tennessee, which the Company previously leased, and the Cumberland Green retirement facility which the Company previously managed. The purchase prices for these facilities were $12,400,000 and $6,800,000, respectively. These facilities were acquired subject to total bond debt of $7,670,000, resulting in $11,530,000 due to Winter Haven, which was applied to eliminate the $11,214,320 owed to the Company by Winter Haven. On September 27, 1996, Gordon Jensen transferred 399,426 shares of the Company's Common Stock to the Company with a fair market value of $3,000,000 in exchange for the cancellation of its debt totaling $2,982,000. The Company subsequently retired these shares. These shares were loaned to Gordon Jensen by Edward E. Lane, Chris Brogdon and Connie Brogdon. Gordon Jensen must repay the debt to Mr. Lane, Mr. Brogdon and Mrs. Brogdon with either stock or cash within five years. In February 1996, the Company purchased a 36-unit retirement facility known as Summers Landing-Cordele, from Gordon Jensen. The purchase price for the facility was $2,000,000, $400,000 of which was paid in cash by the Company and the balance of which was financed through a $1,600,000 mortgage loan from an unrelated third party real estate investment trust. -42- 17 In May 1996, the Company leased the 60-bed Lake Forest Health Care Center from a partnership controlled by Winter Haven. The lease is for a period of 10 years at $25,000 per month. On June 30, 1996, the Company leased the 158-unit Jackson Oaks retirement facility from Winter Haven for a period of 15 years. The Company paid Winter Haven $50,000 per month under this lease. As noted above, Winter Haven subsequently sold this facility to the Company in October 1996 to retire a portion of its debt to the Company. On September 1, 1996, the Company leased the 58-unit Summer's Landing- Douglas facility from Gordon Jensen. The Company paid $300,000 to Gordon Jensen on execution of the lease and is paying the debt service on an existing mortgage -43- 18 each month during the first year. During year two, there will be an additional payment of $500 per month; in year three - $750 per month; in year four - $1,000 per month; and in year five (and any extension of the lease) - $1,250 per month. The lease is for an initial term of five years, but the Company may extend the lease for additional terms of five years each. As of June 30, 1997, the Company has paid a total of $260,000 in lease payments for such facility. The Company has guaranteed the debts of two facilities owned by Winter Haven totaling approximately $6,000,000. The Company has management agreements on these facilities which expire in 2000. On September 30, 1996, the Company leased the 101-unit (with 28 additional units under construction) retirement facility known as The Renaissance - Titusville in Titusville, Florida from a partnership controlled by Winter Haven for a period of 10 years. The Company has the right to extend the lease for an additional five year term. The Company paid Winter Haven $1,500,000 on execution of the lease, and will pay monthly rent equal to 1.1 times the debt service requirements on the facility. For the purposes of this calculation, the principal debt will not exceed $6,000,000. As of June 30, 1997, the Company has paid a total of $387,000 in lease payments for such facility. During the year ended June 30, 1997, the Company entered into leases on eight facilities with Retirement Group, L.L.C., the owner of these facilities. Retirement Group, L.L.C. is owned 41.1% by an entity controlled by Edward E. Lane; 41.8% by Chris Brogdon and his wife, Connie Brogdon; 10.0% by Winter Haven Homes; 3.5% by Darrell C. Tucker; and 3.6% by James J. Andrews, an officer of a subsidiary of the Company. Each of these leases are for an initial term of ten (10) years, with the Company having the right to extend each lease for an initial five (5) year term. The amount of the rent payment under each lease is equal to 110% of the principal and interest that Retirement Group, L.L.C. is required to pay to the lenders of the respective properties. During the fiscal year ended June 30, 1997, $1,355,217 was paid to Retirement Group, L.L.C. under these leases. All lease terms with affiliated entities of the Company are comparable to terms that could be obtained in an arms' length negotiation with independent third parties. As of June 30, 1997, the Company has guaranteed debt in the amount of approximately $30,000,000 related to eight facilities owned by affiliates and leased by the Company. The debt is collateralized by such facilities, bears interest at rates ranging from approximately 10% to 11.5% and matures at various times through 2007. -44- 19 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) 1. FINANCIAL STATEMENTS. The following financial statements are filed as part of this report:
Page(s) Independent Auditors' Report................................... F-1 Report of Independent Certified Public Accountants............. F-2 Consolidated Balance Sheets as of June 30, 1997 and 1996....... F-3 - F-4 Consolidated Statements of Income for the years ended June 30, 1997, 1996 and 1995................................. F-5 Consolidated Statements of Shareholders' Equity for the years ended June 30, 1997, 1996 and 1995..................... F-6 - F-7 Consolidated Statements of Cash Flows for the years ended June 30, 1997, 1996 and 1995................................. F-8 - F-9 Notes to Financial Statements.................................. F-10 - F-28
(a) 2. FINANCIAL STATEMENT SCHEDULES. All schedules have been omitted, as the required information is inapplicable or the information is presented in the financial statements or the notes thereto. (a) 3. Exhibits:
EXHIBIT NO. DESCRIPTION LOCATION 2.1 Agreement and Plan of Incorporated by reference Merger and Reorganization to Exhibit 2.1 to the Company's dated February 17, 1997, Current Report on Form 8-K among Sun Healthcare Group, dated February 17, 1997 Peach Acquisition Corporation 2.2 Amendment No. 1 to the Agree- Incorporated by reference ment and Plan of Merger and to Exhibit 2.1 to the Company's Reorganization dated as of Current Report on Form 8-K February 17, 1997, among Sun dated May 23, 1997 Healthcare Group, Inc., Peach Acquisition Corporation and Retirement Care Associates, Inc. 2.3 Amendment No. 2 to the Agree- Incorporated by reference ment and Plan of Merger and to Exhibit 2.1 to the Company's Reorganization dated as of Current Report on Form 8-K February 17, 1997, among Sun dated August 21, 1997 Healthcare Group, Inc., Peach Acquisition Corporation and Retirement Care Associates, Inc.
-45- 20 3.1 Articles of Incor- Incorporated by reference poration, as amended to Exhibit No. 3.1 to the Company's Form S-18 Regis- tration Statement No. 33-7666-D 3.2 Bylaws, as amended Incorporation by reference to Exhibit No. 3.2 to the Company's Form S-18 Regis- tration Statement No. 33-7666-D 3.3 Articles of Amendment Incorporated by reference to Articles of Incor- to Exhibit 3.3 to the poration Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993 3.4 Statements Establish- Incorporated by reference ing Series A and Series to Exhibit 3.4 to the D Convertible Preferred Company's Annual Report on Stock Form 10-K for the fiscal year ended June 30, 1994 3.5 Articles of Amendment to Incorporated by reference Articles of Incorporation to Exhibit 3.5 to the (Series AA Convertible Company's Annual Report on Preferred Stock) Form 10-K for the fiscal year ended June 30, 1994 3.6 Articles of Amendment to Incorporated by reference Incorporation (Series E to Exhibit 3.6 to the Convertible Preferred Company's Annual Report on Stock) Form 10-K for the fiscal year ended June 30, 1996 3.7 Articles of Amendment to Incorporated by reference Articles of Incorporation to Exhibit 3.7 to the (Series F Convertible Pre- Company's Annual Report on ferred Stock) and Certif- Form 10-K for the fiscal icate of Correction to year ended June 30, 1996 same 10.1 Employment Agreement Incorporated by reference with Darrell C. Tucker to Exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1996 10.2 Management and Marketing * Agreement with Affiliates 10.3 Nursing Home Management * Agreements with Affiliates 10.4 Lease Agreements with * Affiliates
-46- 21 10.5 Loan Agreement between Incorporated by reference Residential Care Facilities to Exhibit 10.1 to the for the Elderly Authority of Company's Current Report the City of Dublin and the on Form 8-K dated February 3, Company 1994 10.6 Deed to Secured Debt and Incorporated by reference Security between Residen- to Exhibit 10.2 to the tial Care Facilities for Company's Current Report the Elderly Authority of on Form 8-K dated February 3, the City of Dublin and 1994 the Company 10.7 Trust Indenture between Incorporated by reference Residential Care Facili- to Exhibit 10.3 to the ties for the Elderly Company's Current Report Authority of the City of on Form 8-K dated February 3, Dublin and the Sentinel 1994 Trust Company 10.8 Loan Agreement between Incorporated by reference Highlands County (Florida) to Exhibit 10.2 to the Industrial Development Company's Current Report Authority and the Company on Form 8-K dated March 3, 1994 10.9 Trust Indenture between Incorporated by reference Highlands County (Florida) to Exhibit 10.3 to the Industrial Development Company's Current Report Authority and the Company on Form 8-K dated March 3, 1994 10.10 Asset Purchase Agreement Incorporated by reference between the Company and to Exhibit 10.1 to the Springdale Convalescent Company's Current Report Center of Atlanta, Ltd., et on Form 8-K dated April 29, al., and Springdale Conva- 1994 lescent Center Purchase Agreement between the Company and Bartow River L.L.C. 10.11 Promissory Note from the Incorporated by reference Company to Winter Haven to Exhibit 10.46 to the Homes Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1994 10.12 Promissory Note from the Incorporated by reference Company to Tiffany Indus- to Exhibit 10.3 to the tries, Inc. Company's Current Report on Form 8-K dated April 29, 1994
-47- 22 10.13 Loan Agreement with Cave Incorporated by reference Spring Housing Develop- to Exhibit 10.57 to the ment Corporation Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1994 10.14 Trust Indenture between Incorporated by reference Cave Spring Housing to Exhibit 10.58 to the Development Corporation Company's Annual Report and Sentinel Trust Company on Form 10-K for the fiscal year ended June 30, 1994 10.15 Transfer and Assignment of Incorporated by reference to Loan Asset and Forbearance to Exhibit 10.67 to the Agreement with R. Wayne Company's Annual Report Lowe, et al. on Form 10-K for the fiscal year ended June 30, 1994 10.16 Promissory Note from South- Incorporated by reference eastern Cottages, Inc. and to Exhibit 10.67 to the related Mortgage and Company's Registration Security Agreement Statement on Form S-1 File No. 33-85886 10.17 Promissory Note from Gordon Incorporated by reference Jensen Health Care, Inc. to Exhibit 10.68 to the and related Deed to Secure Company's Registration Debt Statement on Form S-1 File No. 33-85886 10.18 Promissory Note from Incorporated by reference Renaissance Retirement, to Exhibit 10.69 to the Ltd. and related Mortgage Company's Registration and Security Agreement Statement on Form S-1 File No. 33-85886 10.19 Promissory Note from Incorporated by reference Retirement Village of to Exhibit 10.70 to the Jackson, Ltd. and related Company's Registration Deed of Trust Statement on Form S-1 File No. 33-85886 10.20 Promissory Note from Incorporated by reference Hendersonville Retirement to Exhibit 10.71 to the Village, Ltd. and related Company's Registration Deed of Trust Statement on Form S-1 File No. 33-85886 10.21 Agreement and Amendment Incorporated by reference to Agreement with The to Exhibit 10.77 to the Atrium of Jacksonville, Company's Annual Report Ltd. and Assignment to on Form 10-K for the fiscal the Company year ended June 30, 1994 10.22 Guaranties and Stock Pledge Incorporated by reference and Maintenance Agreements to Exhibit 10.80 to the with Edward E. Lane and Company's Registration Connie B. Brogdon Statement on Form S-1 File No. 33-85886
-48- 23 10.23 Dearfield Nursing Home Incorporated by reference Purchase Agreement to Exhibit 10.1 to the Com- pany's Report on Form 8-K dated April 28, 1995 10.24 Loan Agreement Incorporated by reference to Exhibit 10.2 to the Com- pany's Report on Form 8-K dated April 28, 1995 10.25 Promissory Note Secured by Incorporated by reference Security Deed to Exhibit 10.3 to the Com- pany's Report on Form 8-K dated April 28, 1995 10.26 Security Agreement Incorporated by reference to Exhibit 10.4 to the Com- pany's Report on Form 8-K dated April 28, 1995 10.27 Deed to Secure Debt, Incorporated by reference Security Agreement, to Exhibit 10.5 to the Com- Assignment of Rents and pany's Report on Form 8-K Filing for Dearfield dated April 28, 1995 Nursing Home 10.28 Edwinola Retirement Incorporated by reference Community Purchase Agree- to Exhibit 10.93 to the ment Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1995 10.29 Loan Agreement between Incorporated by reference Dade City, Florida and to Exhibit 10.94 to the the Company Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1995 10.30 Promissory Note from The Incorporated by reference Atrium Nursing Home, Inc. to Exhibit 10.95 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1995 10.31 Promissory Note from Incorporated by reference Hendersonville Retirement to Exhibit 10.96 to the Village, Ltd. Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1995 10.32 Second Amendment to Incorporated by reference Agreement with The Atrium to Exhibit 10.97 to the of Jacksonville, Ltd. Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1995
-49- 24 10.33 Promissory Note from Incorporated by reference National Assistance to Exhibit 10.98 to the Bureau Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1995 10.34 Letter Agreement with Incorporated by reference R. Wayne Lowe, et al., to Exhibit 10.99 to the Amending Forebearance Company's Annual Report on Agreement Form 10-K for the fiscal year ended June 30, 1995 10.35 Hillview Nursing Home Incorporated by reference Purchase Agreement to Exhibit 10.100 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1995 10.36 Crestwood Nursing Home Incorporated by reference Purchase Agreement and to Exhibit 10.101 to the Lease Assignment Agree- Company's Annual Report on ment Form 10-K for the fiscal year ended June 30, 1995 10.37 Florida Retirement Villa Incorporated by reference Purchase Agreement to Exhibit 10.102 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1995 10.38 Loan Agreement dated Incorporated by reference September 29, 1995, with to Exhibit 10.103 to the LTC Properties, Inc. Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1995 10.39 Form of Promissory Note * ($5,000,000) by Retirement Management Corporation and Capitol Care Management Company, Inc. to Sun Healthcare Group, Inc. dated July 10, 1997 10.40 Form of Subsidiary * Guaranty dated July 10, 1997 10.41 Form of Subsidiary Pledge * Agreement dated July 10, 1997 10.42 Form of Security Agreement * by Retirement Care Associates, Inc. dated July 10, 1997 10.43 Form of Security Agreement * by Capitol Care Management company, Inc. in favor of Sun Healthcare Group, Inc. dated July 10, 1997 10.44 Form of Subsidiary Security * Agreement dated July 10, 1997 10.45 Form of Subsidiary * Guaranty dated July 10, 1997 10.46 Form of Pledge Agreement by * Capitol Care Management Corporation in favor of Sun Healthcare Group, Inc. dated July 10, 1997 10.47 Form of Security Agreement * by Retirement Management Corporation in favor of Sun Healthcare Group, Inc. dated July 10, 1997
-50- 25 10.48 Form of Amended and Restated * Promissory Note ($9,750,000) by Retirement Management Corporation and Capitol Care Management Company, Inc. to Sun Healthcare Group, Inc. dated as of July 10, 1997 10.49 Form of Pledge of Agreement * by Retirement Management Corporation in favor of Sun Healthcare Group, Inc. dated as of July 10, 1997 10.50 Form of Amended and Restated * Pledge Agreement by Retirement Care Associates, Inc. in favor of Sun Healthcare Group, Inc. dated as of July 10, 1997 10.51 Form of Agreement to Provide * Management Services to Long Term Care Facilities dated July 15, 1997 16 Letter re Change in Incorporated by reference Certifying Accountant to Exhibit 16.1 to the Company's Current Report on Form 8-K/A dated as of August 14, 1997 21 Subsidiaries of the * Registrant 23.1 Consent of Cherry, Bekaert & * Holland, L.L.P. 23.2 Consent of BDO Seidman, LLP * 27 Financial Data Schedule *
- -------------------- * Previously filed (b) REPORTS ON FORM 8-K. The Company filed one Report on Form 8-K during the last quarter of the period covered by this Report as follows: The Company filed a Report on Form 8-K dated May 27, 1997, reporting information under Item 5 - Other Events and Item 7 - Financial Statements, Pro Forma Financial Information and Exhibits, reporting an amendment to the Company's Agreement and Plan of Merger with Sun Healthcare Group, Inc. -51- 26 REPORT OF CHERRY, BEKEART & HOLLAND INDEPENDENT AUDITORS' REPORT Board of Directors and Shareholders of Retirement Care Associates, Inc. We have audited the accompanying consolidated balance sheets of Retirement Care Associates, Inc. and subsidiaries as of June 30, 1997 and 1996 and the related consolidated statements of income, shareholders' equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsiblity is to express an opinion on these financial statements based on our audits. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Retirement Care Associates, Inc. and subsidiaries as of June 30, 1997 and 1996 and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. As described in Note 6 to the consolidated financial statements, the Company changed its method of accounting for certain costs in inventory. /s/ Cherry, Bekaert & Holland, L.L.P. CHERRY, BEKAERT & HOLLAND, L.L.P. Greensboro, North Carolina October 10, 1997 F-1 27 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors and Shareholders of Retirement Care Associates, Inc. We have audited the accompanying consolidated statements of income, shareholders' equity and cash flows of Retirement Care Associates, Inc. and Subsidiaries for the year ended June 30, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Retirement Care Associates, Inc. and Subsidiaries for the year ended June 30, 1995, in conformity with generally accepted accounting principles. /s/ BDO Seidman, LLP BDO SEIDMAN, LLP Atlanta, Georgia October 9, 1995, except for Note 1 which is as of May 1, 1996 F-2 28 FINANCIAL STATEMENTS Retirement Care Associates, Inc. & Subsidiaries Consolidated Balance Sheets June 30, 1997 and 1996
1997 1996 Assets: Current Assets Cash and cash equivalents $ 3,637,878 $ 45,365 Accounts receivable, net 40,391,377 18,845,780 Inventories 7,255,289 3,998,991 Note and accrued interest receivable 75,000 613,750 Deferred tax asset 4,408,733 2,008,430 Income tax receivable 4,065,431 -- Restricted bond funds 3,068,276 2,342,565 Prepaid expenses and other assets 2,009,467 1,623,679 Total current assets 64,911,451 29,478,560 Property and equipment, net of accumulated depreciation 150,492,221 111,420,486 Marketable equity securities -- 33,645 Investment in unconsolidated affiliates 734,514 496,800 Deferred lease and loan costs 13,065,759 7,665,891 Goodwill, net of accumulated amortization 16,357,532 6,636,675 Notes and advances due from non-affiliates 1,421,405 1,372,247 Notes and advances due from affiliates 1,411,379 14,316,661 Restricted bond funds 3,689,969 3,514,969 Other assets 3,286,736 2,556,353 Total assets $255,370,966 $177,492,287
The accompanying notes are an integral part of the consolidated financial statements F-3 29 Retirement Care Associates, Inc. & Subsidiaries Consolidated Balance Sheets June 30, 1997 and 1996
1997 1996 Liabilities and Shareholders' Equity Current liabilities: Lines of credit $ 9,935,036 $ 3,556,535 Current maturities of long-term debt 11,454,059 2,220,491 Loans Payable to Affiliates 1,478,368 -- Accounts payable 34,076,015 10,115,347 Accrued expenses 18,417,258 11,316,030 Income taxes payable -- 3,726,317 Deferred gain 40,000 40,000 Total current liabilities 75,400,736 30,974,720 Deferred gain 181,370 371,370 Deferred income taxes 1,098,929 277,000 Long-term debt, less current 141,674,131 108,481,040 Minority interest 4,520,953 4,122,039 Commitments and contingencies Redeemable convertible preferred stock 1,800,000 2,400,000 Shareholders' equity Common stock, $.0001; 300,000,000 shares authorized; 14,489,888 and 12,145,875 shares issued, respectively 1,450 1,214 Preferred stock 3,250,000 8,712,003 Additional paid-in capital 43,799,617 27,025,901 Retained earnings (deficit) (16,356,220) (4,752,880) Treasury stock, at cost -- (120,120) 30,694,847 30,866,118 $ 255,370,966 $ 177,492,287
The accompanying notes are an integral part of the consolidated financial statements. F-4 30 Retirement Care Associates, Inc. & Subsidiaries Consolidated Statements of Income For the years ended June 30, 1997, 1996 and 1995
1997 1996 1995 Revenues: Net patient service revenue 202,603,841 $ 119,499,849 $ 69,949,822 Medical supply revenue 45,500,712 9,825,252 3,617,439 Management fee revenue: From affiliates 2,212,500 3,472,900 3,517,500 From others 446,829 308,533 652,194 Other revenue 2,463,979 904,835 1,879,098 Total revenues 253,227,861 134,011,369 79,616,053 Expenses: Cost of patient services 148,520,849 80,815,511 47,778,410 Cost of medical supplies sold 31,045,671 5,350,817 3,153,430 Lease expense 14,117,392 8,442,671 5,769,232 General and administrative 46,346,051 23,192,250 12,769,582 Depreciation and amortization 6,514,713 3,406,986 1,128,183 Provision for bad debts 2,982,063 3,423,117 -- Total expenses 249,526,739 124,631,352 70,598,837 Operating income 3,701,122 9,380,017 9,017,216 Other income (expense): Interest income 673,655 1,847,868 658,215 Interest expense (14,111,843) (7,948,091) (1)179,052 Income before minority interest, income taxes, extraordinary item and cumulative effect of change in accounting principle (9,737,066) 3,279,794 8,496,379 Minority interest 348,000 (597,895) (18,784) Income before income taxes, extraordinary item and cumulative effect of change in accounting principle (9,389,066) 2,681,899 8,477,595 Income taxes (2,343,256) 1,307,091 3,419,092 Income before extraordinary item and cumulative effect of change in accounting principle (7,045,810) 1,374,808 5,058,503 Extraordinary Charge - loss on extinguishment of debt, net of tax benefit of $300,000 490,000 -- -- Cumulative effect of change in accounting principle, net of income taxes of $228,000 -- 372,000 -- Net income (loss) (7,535,810) $ 1,746,808 $ 5,058,503 Preferred stock dividends 2,236,777 2,266,777 225,000 Income (loss) applicable to common stock $ (9,772,587) $ (519,969) $ 4,833,503 Income (loss) per common and common equivalent share: Income (loss) before extraordinary item and cumulative effect of change in accounting principle $ (0.68) $ (.08) $ 0.38 Extraordinary Charge-loss on extinguishment of debt (.03) -- -- Cumulative effect of change in accounting principle -- 0.03 -- Net income (loss) (.71) (.05) 0.38 Weighted average shares outstanding 13,709,590 11,324,755 12,616,835
The accompanying notes are an integral part of the consolidated financial statements. F-5 31 Retirement Care Associates, Inc. & Subsidiaries Consolidated Statements of Shareholders' Equity For the Years Ended June 30, 1997, 1996 and 1995
Preferred Stock Common Stock Series A Series E Series F Shares Amount Balance June 30, 1994 $ 364,083 $ -- $ -- 9,526,166 $ 952 Issuance of common stock upon conversion of Series A preferred stock (364,083) -- -- 69,508 7 Issuance of common stock upon conversion of Series D preferred stock -- -- -- 125,000 12 Issuance of common stock upon Contour Medical, Inc. acquisition -- -- -- 105,000 11 Stock dividend, 5% -- -- -- 491,409 49 Balance June 30, 1995 $ -- $ -- $ -- 10,317,083 $ 1,031 Issuance of Series E preferred stock -- 9,300,000 -- -- -- Issuance of common stock upon conversion of Series E preferred stock -- (534,750) -- 54,516 5 Imputed dividend on Series E preferred stock -- (1,996,777) -- -- -- Amortization of imputed Series E Preferred stock dividend -- (1,943,530) -- -- -- Treasury stock purchased -- -- -- -- -- Retirement of treasury stock -- -- -- (15,500) (2) Stock issued in exchange for cancellation of warrants and stock warrants exercised -- -- -- 1,198,894 120 Stock options exercised -- -- -- 22,076 2 Preferred stock, 10% dividend -- -- -- -- -- Stock dividend, 5% -- -- -- 568,806 58 Balance June 30, 1996 $ -- $ 8,712,003 $ -- 12,145,875 $ 1,214 Issuance of Series F preferred stock -- -- 9,340,000 -- -- Amortization of imputed Series E preferred stock dividend -- 53,247 -- -- -- Issuance of common stock upon conversion of Series E preferred stock -- (8,765,250) -- 1,318,533 132 Imputed dividend on Series F preferred stock -- (1,996,777) -- -- -- Amortization of imputed Series F preferred stock dividend -- 1,996,777 -- -- -- Issuance of common stock upon conversion of Series F preferred stock -- -- (6,090,000) 1,148,698 115 Treasury stock purchased Retirement of treasury stock -- -- -- (520,272) (52) Stock issued in exchange for Cancellation of warrants and new stock warrants exercised -- -- -- 144,872 15 Stock options exercised -- -- -- 252,182 26 Preferred stock, 10% dividend -- -- -- -- -- Balance June 30, 1997 $ -- $ -- $ 3,250,000 14,489,888 $ 1,450
The accompanying notes are an integral part of the consolidated financial statements. F-6 32 Retirement Care Associates, Inc. & Subsidiaries Consolidated Statements of Shareholders' Equity For the Years Ended June 30, 1997, 1996 and 1995
Retained Paid-In Earnings Treasury Capital (Deficit) Stock Balance June 30, 1994 $ 12,391,673 $ 643,043 $ -- Issuance of common stock upon conversion of Series A preferred stock 364,076 -- -- Issuance of common stock upon conversion of Series D preferred stock 499,989 -- -- Issuance of common stock upon Contour Medical, Inc. acquisition 999,988 -- -- Preferred stock, 10% dividend -- (225,000) -- Stock dividend, 5% 4,299,951 (4,300,000) -- Net income -- 5,058,503 -- Balance June 30, 1995 $ 18,555,677 $ 1,176,546 $ -- Issuance of Series E preferred stock -- -- -- Issuance of common stock upon conversion of Series E preferred stock 534,743 -- -- Imputed dividend on Series E preferred stock 1,996,777 -- -- Amortization of imputed Series E preferred stock dividend (1,943,530) -- -- Treasury stock purchased -- -- (274,040) Retirement of treasury stock -- (153,918) 153,920 Stock issued in exchange for cancellation of warrants and stock warrants exercised 473,673 -- -- Stock options exercised 156,303 -- -- Preferred stock, 10% dividend -- (270,000) -- Stock dividend, 5% 7,252,258 (7,252,316) -- Net income -- 1,746,808 -- Balance June 30, 1996 $ 27,025,901 $ (4,752,880) $ (120,120) Issuance of Series F preferred stock -- -- -- Amortization of imputed Series E Preferred stock dividend 53,247 -- -- Issuance of common stock upon conversion of Series E preferred stock 8,768,297 -- -- Imputed dividend on Series F preferred stock 1,996,777 -- -- Amortization of imputed Series F preferred stock dividend (1,996,777) -- -- Issuance of common stock upon conversion of Series F preferred stock 6,086,446 -- Treasury stock purchased -- -- (3,707,410) Retirement of treasury stock -- (3,827,530) 3,827,530 Stock issued in exchange for Cancellation of warrants and new stock warrants exercised 70,966 -- -- Stock options exercised 1,901,254 -- -- Preferred stock, 10% dividend -- (240,000) -- Net income -- (7,535,810) -- Balance June 30, 1997 $ 43,799,617 $(16,356,220) $ --
The accompanying notes are an integral part of the consolidated financial statements. F-7 33 Retirement Care Associates, Inc. & Subsidiaries Consolidated Statements of Cash Flows For the Years Ended June 30, 1997, 1996 and 1995
1997 1996 1995 Cash flows from operating activities Net income (loss) $ (7,535,810) $ 1,746,808 $ 5,058,503 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Gain on sale of assets (608,423) -- -- Depreciation and amortization 6,514,713 3,406,986 1,128,183 Loss on sale of marketable securities -- 29,085 -- Cumulative effect of change in accounting principles -- (372,000) -- Amortization of deferred gain (40,000) (40,000) (40,000) Provision for bad debt 2,982,063 3,423,117 -- Equity in income from investees -- 146,800 -- Minority interest (348,000) 597,895 18,784 Deferred income taxes (11,111,558) (1,297,613) 261,092 Changes in assets and liabilities net of effects of acquisitions Accounts receivable (20,987,667) (10,672,485) (6,012,900) Inventories (960,447) (2,245,194) (996,139) Prepaid expenses and other assets (970,008) 703,690 (642,013) Accrued interest receivable 38,750 157,917 (196,667) Accounts payable and accrued expenses 29,187,587 9,964,620 6,608,148 Deferred lease and loan costs -- -- (978,943) Net cash provided by (used in) operating activities (3,838,800) 5,549,626 4,208,048 Cash flows from investing activities: Purchases of property and equipment (12,734,389) (12,490,298) (6,079,610) Proceeds from sale leaseback transaction -- -- 4,500,000 Proceed from repayment of notes receivable 13,500,000 2,200,000 -- Issuance of notes receivable and advances to affiliates and non-affiliates (143,876) (8,935,677) (1,742,147) Purchase of bonds receivable -- -- (4,487,936) Investments in unconsolidated affiliates (237,714) 3,787,635 (3,335,833) Restricted bond funds (900,711) (4,720,047) (17,317) Proceed from sale of fixed assets 3,350,000 -- -- Cash acquired in acquisition of Contour Medical, Inc. -- -- 73,254 Decrease in marketable equity securities -- -- 444,863 Proceed from sale of marketable equity securities 33,645 36,780 -- Goodwill paid in acquisitions (2,109,852) (2,327,736) -- Acquisitions, net of cash required (18,807,777) (21,938,513) -- Payment of deferred lease costs (5,530,349) (593,470) -- Net cash used in investing activities $(23,581,023) $(44,981,326) $(10,644,726)
The accompanying notes are an integral part of the consolidated financial statements. F-8 34 Retirement Care Associates, Inc. & Subsidiaries Consolidated Statements of Cash Flows (continued) For the Years Ended June 30, 1997, 1996 and 1995
1997 1996 1995 Cash flows from financing activities Capital investment by minority shareholders of subsidiary $ -- $ 2,088,492 $ 1,729,469 Redemption of preferred stock (600,000) (600,000) -- Purchase of treasury stock (841,318) (274,040) -- Dividends on preferred stock (240,000) (270,000) (225,000) Proceeds from issuance of preferred stock 9,340,000 9,300,000 -- Proceeds from stock options and warrants exercised 1,900,306 559,593 -- Proceeds from long-term debt and net borrowings under line of credit 33,919,190 35,329,244 11,309,986 Payments on long-term debt (13,329,520) (9,443,626) (2,130,654) Payments on deferred loan costs (614,690) (2,419,783) -- Proceeds from L/P to affiliates 1,478,368 -- -- Net cash provided by financing activities 31,012,336 34,269,880 10,683,801 Net increase (decrease) in cash and cash equivalents 3,592,513 (5,161,820) 4,247,123 Cash and cash equivalents, beginning of year 45,365 5,207,185 960,062 Cash and cash equivalents, end of year $ 3,637,878 $ 45,365 $ 5,207,185
The accompanying notes are an integral part of the consolidated financial statements. F-9 35 RETIREMENT CARE ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 1997 and 1996 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: NATURE OF BUSINESS AND BASIS OF PRESENTATION Retirement Care Associates, Inc. ("RCA" or the "Company") operates 101 leased and owned nursing and retirement facilities in the Southeast United States and manages, for both related and unaffiliated third parties, an additional 9 nursing and retirement facilities. The Company also owns a majority interest in Contour Medical, Inc. ("Contour") whose principal operations consist of distributing medical supplies to healthcare facilities. PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, as well as its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. CASH AND CASH EQUIVALENTS For purposes of financial statement presentation, the Company considers all highly liquid investments with maturities of three months or less at issuance to be cash equivalents. INVENTORIES Inventories, consisting mainly of medical supplies, are valued at the lower of cost (first-in, first-out) or market. ALLOWANCE FOR POSSIBLE LOAN LOSSES The Company periodically reviews the adequacy of the allowance for possible loan losses on affiliate notes receivable by considering various factors, among others, such as the fair value of the underlying facility collateral in excess of prior and senior liens, the periodic results of operations of the underlying collateral, the fair value of other collateral or guarantees pledged as security for the notes receivable, and the Company's ability to foreclose, if necessary, against prior and senior liens to protect the collateral value. During 1996, the Company adopted Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" (SFAS No. 114). All affiliated notes receivable were liquidated subsequent to June 30, 1996 (see Note 19). PROPERTY, EQUIPMENT AND DEPRECIATION Property and equipment are recorded at cost less accumulated depreciation. Depreciation, which includes amortization of assets under capital leases, is computed using the straight-line method over the estimated useful lives of the related assets (five to thirty years). Maintenance and repairs are charged to expense as incurred. Upon sale, retirement or other disposition of these assets the cost and the related accumulated depreciation are removed from the respective accounts and any gain or loss on the disposition is included in income. INVESTMENT IN UNCONSOLIDATED AFFILIATES During the year ended June 30, 1995, the Company acquired a 35% interest in In-House Rehab, Inc. ("In-House"), a therapy service company, for $350,000. The F-10 36 Company accounts for its investment in In-House on the equity method. The Company's share of In-House's net income was $327,714 and $146,800 for the years ended June 30, 1997 and 1996, respectively. DEFERRED LEASE AND LOAN COSTS Deferred lease and loan costs, consisting of lease acquisition fees paid to lessors and loan commitment fees and related expenditures, are amortized over the respective terms of the lease or loan using the interest method. The related amortization of the lease and loan cost is recorded as lease and interest expense, respectively. RESTRICTED BOND FUNDS Restricted bond funds relate to the debt service requirements of RCA's outstanding bond obligations. RCA has several industrial revenue bonds, housing development mortgage revenue bonds and municipal revenue bonds, which relate to the restricted bond funds. Current restricted bond funds include principal and interest funds which are used for payment of principal and interest on or before the dates required by the trust indenture. Non-current restricted bond funds include debt service reserve funds (used for payment of principal and interest when principal and interest funds are insufficient) and project funds (used for payment of construction, improvement and equipment costs at facilities under construction). GOODWILL Goodwill arises in connection with business combinations accounted for as purchases where the purchase price exceeds the fair value of the net assets of the acquired businesses. Goodwill is amortized on a straight-line basis over 15 years. The carrying value of goodwill is reviewed if the facts and circumstances suggest that it may be impaired. Any permanent impairment would be recognized by a charge against earnings. Accumulated amortization of goodwill approximated $719,000 and $233,000 as of June 30, 1997 and 1996, respectively. ASSESSMENT OF LONG-LIVED ASSETS Effective July 1, 1996, the Company adopted FAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. The Company periodically reviews the carrying values of its long-lived assets (primarily property and equipment and intangible assets) whenever events or circumstances provide evidence that suggests that the carrying amount of long-lived assets may not be recovered. If this review indicates that the long-lived assets may not be recoverable, the Company reviews the expected undiscounted future net operating cash flows from its facilities, as well as valuations obtained in connection with various refinancings. Any permanent impairment of value is recognized as a charge against earnings in the statement of income. As of June 30, 1997, the Company does not believe there is any indication that the amortization period of its long-lived assets needs to be adjusted. DEFERRED GAIN Deferred gain on a sale-leaseback transaction is recorded at cost and is amortized into income on a straight-line basis over 10 years, the life of the lease. The related amortization is recorded as a reduction of lease expense. STOCK DIVIDENDS During January 1995 and April 1996, the Company declared 5% stock dividends which were payable on February 15, 1995 and May 15, 1996, respectively, to shareholders of record on February 15, 1995 and May 1, 1996, respectively. All common stock information presented has been retroactively restated to reflect these stock F-11 37 dividends. NET PATIENT SERVICE REVENUE Net patient service revenue is derived primarily from services to retirement center residents and nursing home patients. Retirement center residents typically pay rent in advance of the month for which it is due. Nursing home patients are predominately beneficiaries of the Medicare and Medicaid programs. The Medicare program reimburses nursing homes on the basis of allowable costs, subject to certain limits. Payments are received throughout the year at amounts estimated to approximate costs. Following year end, cost reports are filed with the Medicare program and final settlements are made. Provisions for Medicare settlements are provided in the financial statements in the period the related services are rendered. Differences between amounts accrued and final settlements are reported in the year of settlement. State Medicaid programs pay nursing homes primarily on a per diem basis with no retroactive settlement. Revenues from services to Medicaid patients are recorded at payment rates established by the various state programs in the period services are rendered. There has been, and the Company expects that there will continue to be, a number of proposals to limit Medicare and Medicaid payments for long-term and rehabilitative services. The Company cannot predict at this time whether any of these proposals will be accepted or, if adopted and implemented, what effect such proposals would have on the Company. TAXES ON INCOME Deferred income taxes are recognized for the tax consequences of temporary differences between the financial reporting bases and the tax bases of the Company's assets and liabilities. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable for the period and the change during the period in deferred tax assets and liabilities. NET INCOME PER SHARE Net income per share is computed on the basis of net income applicable to common stock and the weighted average number of common and common equivalent shares outstanding during each year, retroactively adjusted to give effect to the stock dividends. Shares used in the calculation consist of the weighted average number of shares actually outstanding as well as the weighted average number of common share equivalents which include dilutive convertible preferred stock, stock options and warrants. Common stock equivalents for the years ended June 30, 1997 and 1996 have not been included since the effect would be antidilutive. Shares used in the calculation for the year ended June 30, 1995 consisted of the weighted average number of shares actually outstanding (10,798,292), as well as, the weighted average number of common share equivalents (1,818,543) which include dilutive stock options and warrants. 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 and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. The Financial Accounting Standards Board released SFAS No. 123, "Accounting for F-12 38 Stock Based Compensation." SFAS No. 123 encourages, but does not require, companies to recognize compensation expense based on the fair value of grants of stock, stock options, and other equity investments to employees. Although expense recognition for employee stock-based compensation is not mandatory, SFAS No. 123 requires that companies not adopting must disclose pro forma net income and earnings per share. The Company will continue to apply the prior accounting rules and make pro forma disclosures. RECLASSIFICATIONS Certain 1995 amounts have been reclassified to conform with the 1997 and 1996 presentations. 2. BUSINESS ACQUISITIONS: ENCORE On December 15, 1995, the Company obtained both a sole general and a limited partnership interest, totaling a 74.25% interest, in Encore Partners, L.P. ("Encore") in exchange for a capital contribution to Encore of $3.5 million. Encore owns three retirement facilities, totaling 527 beds, and two nursing homes, totaling 157 beds. The acquisition was accounted under the purchase method of accounting. The consolidated financial statements include the results of operations since the date of acquisition. Profits and losses of Encore are allocated 74.25% to the Company and 25.75% to other partners. Available cash, if any, is distributed 74.25% to the Company and 25.75% to the other partners. ATRIUM During the year ended June 30, 1995, Winter Haven Homes, Inc. ("Winter Haven"),an affiliated entity, assigned to the Company its rights under an agreement between Atrium and Winter Haven. The agreement granted Winter Haven the right to acquire up to a 75% ownership interest in Atrium in exchange for and upon meeting certain performance requirements. In addition to the assignment, Winter Haven and the Company entered into a separate Compensation Agreement requiring the Company to pay Winter Haven an amount equal to 25% of the appraised values of Atrium upon each transfer of a 25% interest in Atrium to the Company. Through June 30, 1996, the payment of each 25% interest in Atrium was reflected as an increase in Investment in Unconsolidated Affiliates and a decrease in Notes and Advances Due From Affiliates in the accompanying financial statements. At June 30, 1995, a 50% interest in Atrium had been transferred to the Company at a carrying value of $1,913,000 plus advances made by the Company to Atrium of $2,149,060. This investment was accounted for under the equity method. In May 1996, the Company obtained an additional 25% interest for $1,230,000, bringing the total investment to $3,143,000 plus advances made by the Company to Atrium of $2,602,942, and the total ownership interest to 75%. Effective May 1996, the accounts of Atrium have been consolidated with those of the Company. The minority partners of Atrium are allocated 25% of the profits and losses and 25% of available cash flow, if any, is distributed to the minority partners. ATLANTIC MEDICAL On August 6, 1996, Contour acquired all of the outstanding stock of Atlantic Medical Supply Company, Inc. ("Atlantic Medical"), a distributor of disposable medical supplies and a provider of third-party billing services to the nursing home and home health care markets. The acquisition was accounted for as a purchase and made retroactively to July 1, 1996. Contour paid $1.4 million in cash and $10.5 million in promissory notes for all of the outstanding stock of F-13 39 Atlantic Medical. The purchase price exceeded fair value of the net assets acquired by approximately $1.3 million. The resulting goodwill is being amortized on the straight-line method over forty years. The consolidated financial statements include the results of operation of Atlantic Medical subsequent to June 30, 1996. The promissory notes bore interest at 7% per annum and were due in full on January 10, 1997. In the event of a default in the payment of the promissory notes, they were convertible into shares of common stock of RCA. On January 10, 1997, Contour retired all outstanding notes due to sellers of Atlantic Medical in the aggregate principal amount of $10,850,000, along with accrued interest. The retirement of these notes was funded by a loan of $9,750,000 from the Company, with the balance funded from Contour's existing line of credit with Barnett Bank. The loan from the Company was evidenced by a convertible promissory note bearing interest at 9% per annum and payable upon demand. This note was convertible into 1,950,000 shares of Contour's Common Stock, and on January 10, 1997, the Company exercised this conversion right. OTHER During the year ended June 30, 1996, the Company purchased a number of other facilities. Such purchases included both nursing and retirement facilities. The data related to these purchases is as follows:
1996 Number of Facilities Purchased: Nursing 7 Retirement 3 Total 10 Cost of acquired facilities: Cash paid $ 223,000 Debt incurred 19,811,000 Total $20,034,000
The cost of the facilities acquired during 1996 exceeded the fair value of net assets acquired by approximately $2,660,000. The excess is being amortized over a 20-year period. The Company typically obtains financing in excess of the purchase price paid for acquired facilities. The excess funds are used to cover certain closing costs associated with the transactions with any residual amounts retained by the Company. The acquisitions referred to above have been accounted for using the purchase method of accounting. The operating results of those acquired facilities have been included in the consolidated statement of operations from the date of acquisition. The following table presents unaudited pro forma results of operations data as if the acquisitions described above had occurred on July 1, 1995. The pro forma amounts are provided for information purposes only. It is based on historic information and does not necessarily reflect the actual results that would have occurred, nor is it necessarily indicative of future results of operations of the combined enterprise.
For the year ended June 30, (Unaudited) 1997 1996 Revenues $254,410,713 $158,534,082 Net income (7,537,686) 1,798,053 Net income (loss) per share (.71) (.04)
The pro forma information includes adjustments for interest expense that would have been incurred to finance the acquisitions, additional depreciation based on the fair market value of the facilities and other adjustments, together with related income tax effects. The pro forma financial information is not F-14 40 necessarily indicative of the results of operations as they would have been had the transactions been effected on the assumed dates. 3. RELATED PARTY TRANSACTIONS: The Company provides management and administrative services for eight facilities in addition to leasing twelve facilities, all owned by affiliates. These affiliates are owned and controlled by two individuals who are officers and directors of the Company. The management and administrative services to affiliate facilities are provided pursuant to agreements which have three to five year terms and are cancelable with sixty days written notice by either party. The agreements provided for monthly fees ranging from $2,000 to $28,000 per facility and expire through 2002. Revenue from these management services totaled $2,212,500, $3,472,900 and $3,517,500 for the years ended June 30, 1997, 1996 and 1995, respectively. CCMC maintains a cash management account where all operating cash funds of the managed facilities are pooled into one bank account and invested daily. Notes and advances due from (to) affiliates consist of advances to facilities, net of advances from facilities, owned by the following affiliated entities:
June 30, 1997 1996 Gordon Jensen Health Care Association, Inc. $(1,019,474) $2,982,975 Winter Haven Homes, Inc. (458,894) 8,887,833 Southeastern Cottages, Inc. 295,642 679,144 National Assistance Bureau, Inc. 149,815 1,326,391 Chamber Health Care Society, Inc. 964,240 336,857 Senior Care, Inc. 1,682 84,095 Other Affiliates - 19,366 (66,989) $14,316,661 Less current portion (payable) (1,478,368) - Noncurrent receivable $ 1,411,379 $14,316,661
The above amounts receivable from affiliates as of June 10, 1996 were satisfied during the acquisition by the Company of two facilities from related parties and the return of approximately 400,000 shares of Company stock held by Gordon Jensen to the Company treasury, discussed in following paragraphs. These notes required quarterly interest payments at 8% per annum. The notes were collateralized by second mortgages on facilities owned by affiliates, and certain notes were guaranteed by the principals of Winter Haven, who are shareholders of the Company. The amounts receivable from and payable to affiliates as of June 30, 1997 were unsecured. The amounts receivable of $1,411,379 are noncurrent. The amounts payable of $1,478,368 are current and payable upon demand. The Company's exposure to credit loss in the event of nonperformance by its related parties totaled $1,411,379 and $14,316,661 as of June 30, 1997 and 1996, respectively. FACILITY ACQUISITIONS FROM AFFILIATES On February 27, 1996, the Company purchased a 36-unit retirement facility from an affiliate. The purchase price was $2,000,000 and was financed with $400,000 from the Company and a $1,600,000 mortgage loan from an unrelated third-party real estate investment trust. On May 5, 1996, the Company entered into a lease agreement with an affiliate to rent a 60-unit nursing home. Terms of the agreement are ten years at $300,000 per year beginning on June 1, 1996. The total lease payments in 1996 were $25,000. F-15 41 On October 14, 1996, the Company acquired two retirement facilities from related parties, individuals who control the Company and its affiliates, for their fair value, based on independent appraisals, totaling $19,200,000. The facilities were subject to bond debt of $7,670,000. The remaining balance due from the Company was $11,530,000. For the purpose of this transaction, Winter Haven had assumed the amounts due to the Company in the amount of $2,426,487, from Southeastern Cottages, Inc., National Assistance Bureau, Inc., Chamber Health Care Society, Inc. and Senior Care, Inc. which, in combination with the amount of $8,887,833 previously due from Winter Haven to the Company, totaled $11,314,320. As part of the exchange agreement, the Company and Winter Haven agreed to offset the Company's debt incurred of $11,530,000 with the Company's receivable of $11,314,320. FACILITIES LEASED FROM AFFILIATES During the years ended June 30, 1997 and 1996, the Company leased nursing homes and retirement homes from affiliates. In 1996, one facility was leased with an annual rental of $300,000, expiring in 2006 with one ten-year renewal. In 1997, a total of eleven facilities were leased with annual rentals ranging from approximately $290,000 to $850,000, expiration dates through 2007, and renewal periods of five to ten years. The annual rentals of the ten leases acquired in 1997 are based upon 110% of the outstanding debt balance, so the future annual rentals are expected to decline during the lease terms. ADDITIONAL TRANSACTIONS On September 27, 1996, Gordon Jensen Health Care Association, Inc. (Gordon Jensen) returned approximately 400,000 shares of stock in the Company which had a fair market value of $3,000,000 in payment of Gordon Jensen's debt of $2,982,000 due to the Company. The retirement of these shares reduced stockholders' equity of the Company by $3,000,000. In 1997, the Company received a guarantee fee of $500,000 for guarantee of Contour's $10,500,000 note payable which arose in connection with its acquisition of Atlantic Medical. As payment, the Company received 100,000 shares of Contour common stock. Contour's note payable was paid off in January, 1997 and the guarantee was released. As of June 30, 1997 the Company had guaranteed debt in the amount of approximately $30,000,000 related to eight facilities of affiliates which the Company leases or manages. The debt is collateralized by the facilities, bears interest ranging from approximately 10% to 11.5% with due dates through 2007. The Company was paid fees of $150,000 by affiliates in connection with locating financing for three facilities in 1996. These fees were included in interest income on the accompanying statements of income. The Company has service and consulting agreements whereby In-House provides to facilities therapy and case management for a fixed monthly fee plus a charge per treatment unit provided. In 1997, the Company purchased approximately $5,129,000 or 77% of the total sales of In-House, and the Company's account payable to In-House of $1,528,000 was 49% of the total accounts receivable of In-House. For 1996, total sales and accounts receivable of In-House related to the Company. 4. ACCOUNTS RECEIVABLE: Patient accounts receivable and net patient service revenue include amounts estimated by management to be payable by Medicaid and Medicare under the provisions of payment formulas in effect. Medicaid and Medicare programs accounted for approximately 72% and 68% of net patient service revenue during 1997 and 1996, respectively. The Company grants credit without collateral to its patients most of whom are local residents of the respective nursing home and retirement facilities and are insured under third-party payor agreements. The mix of receivables from patients and third party payors is as follows:
June 30, 1997 1996 Medicaid $17,452,025 $10,644,368 Medicare 9,728,258 4,304,368 Other third-party payors 1,084,008 1,598,816 Patients 12,315,451 3,113,145 Trade receivables - Contour 7,811,635 2,595,083 48,391,377 22,255,780 Allowance for doubtful accounts 8,000,000 3,410,000 $40,391,377 $18,845,780
F-16 42 In the opinion of management, any differences between the net revenue recorded and final determination will not materially affect the consolidated financial statements. The activity in the allowance for doubtful accounts is as follows:
June 30, 1997 1996 1995 Beginning of Period $3,410,000 $ -- $ -- Provision 2,982,063 3,423,117 -- Other Additions-Contour 1,995,386 -- -- Write Offs (387,449) (13,117) -- End of Period $8,000,000 $3,410,000 --
The increase in the allowance for doubtful accounts of Contour reflects an adjustment to the purchase price allocation for Contour's acquisition of Atlantic Medical and its subsidiaries. The adjustment was required to reduce acquired trade receivables, principally due from Medicare and Medicaid, to their net realizable value. 5. NOTE RECEIVABLE: On February 7, 1996, the Company loaned $500,000 to an unaffiliated company. The note, plus interest at 9% per annum, was due on February 7, 1997 and was collateralized by a first lien on a 38-bed nursing home in Atlanta, Georgia. This note was paid in full with interest on May 15, 1997. 6. CHANGE IN ACCOUNTING FOR SUPPLIES INVENTORY: During the year ended June 30, 1996, the Company changed its method of accounting for facility supplies inventory from expensing when purchased to capitalizing and expensing as used. The Company believes that this change is preferable in the circumstances because it more closely matches inventory costs with net patient service revenue. In connection with the capitalization of facility supplies inventory at June 30, 1996, the Company recorded additional inventory and reduced supplies expense by approximately $1.0 million, of which approximately $600,000 related to inventory on hand as of June 30, 1995. Accordingly, the cumulative effect of this change in accounting principle on beginning retained earnings has been shown, net of tax, as a separate component of the statement of operations for the year ended June 30, 1996. Although the cumulative effect on retained earnings at June 30, 1995 resulting from the change can be determined, the pro forma effects of retroactive application cannot be computed for individual prior periods. Accordingly, net income and income per common share computed on a pro forma basis have not been presented for the years ended June 30, 1995 and 1994. 7. PROPERTY AND EQUIPMENT: Property and equipment consisted of the following:
Estimated Useful Lives 1997 1996 Land - $ 8,330,565 $ 7,184,001 Buildings 30 107,901,652 83,281,050 Equipment 5-10 16,115,893 12,179,912 Leasehold improvements 5-10 3,373,755 2,193,228 Buildings and equipment under capital leases 5-30 18,642,560 8,111,801 154,364,425 112,949,992 Less accumulated depreciation 13,897,697 8,518,084 140,466,728 104,431,908 Construction in progress 10,025,493 6,988,578 Net property and equipment $150,492,221 111,420,486
Construction in progress, consisting of the development of four facilities, includes approximately $607,000 and $605,000 of capitalized interest costs as of June 30, 1997 and 1996, respectively. The total contract price of construction in progress was approximately $13,500,000 for the year ended June 30, 1997. Substantially all property and equipment is pledged as collateral for long-term debt. F-17 43 8. DEFERRED LEASE AND LOAN COST: In connection with the execution of certain lease transactions and financing of acquisitions, the Company incurred lease and loan commitment fees, which are included in deferred lease and loan costs in the accompanying balance sheets, as follows:
June 30, 1997 1996 Lease cost: Affiliated $ 2,000,000 $ 500,000 Non-affiliated 5,831,968 1,801,619 Loan cost: Affiliated 410,000 410,000 Non-affiliated 6,414,978 5,800,288 14,656,946 8,511,907 Less accumulated amortization 1,591,187 846,016 Net deferred lease and loan cost 13,065,759 $7,665,891
9. SHAREHOLDERS' EQUITY: STOCK PURCHASE WARRANTS During the year ended June 30, 1997, the Company issued warrants to an investment banker and consultants to purchase 250,000 shares of its common stock at prices ranging from $6.96875 to $9.25 per share. The warrants were exercisable at varying dates through June 1999. None of the warrants were exercised during the year ended June 30, 1997. The Company has issued Class A warrants in connection with a private offering and Class B and Class C warrants in connection with an offer to Class A warrant holders to convert their warrants. The Class A and Class C warrants are exercisable at $1.00 per warrant, the Class B warrants are exercisable at $6.00 per warrant. At any time during the period the warrants are exercisable, the Company may redeem the warrants at $.05 per warrant upon 45 days written notice in the event certain listing and registration requirements are achieved, and the closing bid price of the common stock exceeds $7.00 per share for the Class A and Class C Warrants, and $10.00 per share for the Class B Warrants, for 20 of 30 consecutive trading days. During the year ended June 30, 1997, Class A Warrants were exercised to purchase approximately 136,180 shares of common stock and Class C Warrants were exercised to purchase approximately 8,692 shares of common stock. As of June 30, 1997, there were Class A warrants outstanding which entitle the holders to purchase 101,581 shares of common stock, Class B warrants outstanding which entitle the holders to purchase 426,432 shares of common stock and Class C Warrants outstanding which entitle the holders to purchase 186,956 shares of common stock. STOCK OPTIONS Stock option plans In October 1995 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." This new standard defines a fair value based method of accounting for an employee stock option or similar equity instrument. This statement 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 Principals 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. This statement is effective for the Company's 1997 fiscal year. The Company intends to continue using the measurement practices prescribed by APB Opinion No. 25, and accordingly, this pronouncement will not affect the Company's financial position or results of operations. In December 1993, the Company adopted the 1993 Stock Option Plan (the "Plan"). A total of 1,682,625 shares of the Company's common stock have been reserved for F-18 44 issuance under the Plan. Under the Plan, options are granted at an exercise price of not less than 100% of the fair market value of the shares on the date of grant. Certain options are exercisable immediately, while others are subject to vesting provisions as specified by the Board of Directors on the date of grant. Each option grant under the Plan automatically expires ten years after the date of grant or at such earlier time as may be determined by the Board of Directors. The following is a summary of stock option activity and related information for the years ended June 30:
1997 1996 1995 Weighted Avg. Weighted Avg. Weighted Avg. Options Exercise Price Options Exercise Price Options Exercise Price Outstanding: Beginning 1,498,368 $6.77 1,066,818 $5.24 882,110 $4.74 Granted 364,025 $7.44 489,300 $9.90 239,138 $7.42 Exercised (246,973) $4.59 (22,076) $4.65 - - Canceled (30,810) $4.65 (35,674) $5.36 (54,430) $6.67 End of year 1,584,610 $5.40 1,498,368 $6.77 1,066,818 $5.24 Exercisable: End of year 1,584,610 $5.40 1,498,368 $6.77 1,066,818 $5.24 Weighted average fair value of options granted during the year: $6.72 $7.56 $5.82
Exercise prices for options outstanding as of June 30, 1997 ranged from $4.65 to $10.24. The weighted average remaining contractual life of those options is 7.35 years. Because the Company has adopted the disclosure-only provisions of SFAS No. 123, no compensation cost has been recognized for the stock option plans. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant date of the awards consistent with the provisions of SFAS No. 123, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:
1997 1996 Net income (loss) as reported $(7,535,810) 1,746,808 Net loss - pro forma net (8,908,810) (513,192) Loss per share - as reported (.71) (.05) Loss per share - pro forma (.81) (.25)
The fair value of each option grant is estimated on the date of grant using Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 1996 and 1995; dividend yield of 0%, expected volatility of 66%, risk-free interest rates of 6.0% for 1997 and 5.4% for 1996 and expected lives of four years for 1996 options and five years for 1995 options. PREFERRED STOCK As of June 30, 1997, the Company has authorized 40,000,000 shares of preferred stock and has designated the following series of preferred stock: - - SERIES AA REDEEMABLE CONVERTIBLE PREFERRED STOCK 300,000 shares of Series AA Redeemable Convertible Preferred Stock are authorized. These shares were issued in connection with the acquisition of a majority interest in Contour. Holders of the Series AA Redeemable Convertible Preferred Stock are entitled to receive cumulative dividends of $1.00 per share (10%) annually, and are convertible into common stock at any time at the rate of F-19 45 5.5125 shares of common stock for each six shares of Series AA Redeemable Convertible Preferred Stock. Each share is entitled to one vote and has a preferred rate of $10.00 per share upon voluntary or involuntary liquidation, dissolution, or winding up of affairs of the Company. The Company may redeem shares of Series AA Redeemable Convertible Preferred Stock, in whole or in part, at any time at its option at a price of $10.00 per share plus any unpaid dividends (the "Redemption Price"). In addition, to the extent that such funds are legally available, the Company is required to redeem, at the Redemption Price, at least 20% of each holder's initial number of shares of Series AA Redeemable Convertible Preferred Stock by September 30, 1995; 40% by September 30, 1996; 60% by September 30, 1997; 80% by September 30, 1998; and 100% by September 30, 1999. In the event that a holder of Series AA Redeemable Convertible Preferred Stock shall have converted a portion of his shares into common stock, such converted shares shall be counted toward the redemption requirement and shall be deemed redeemed for the purposes of the mandatory redemption requirement. In addition, in the event that the Company fails to pay any dividend on the Series AA Redeemable Convertible Preferred Stock within 30 days of the due date, the Company is required to redeem all of the outstanding Series AA Redeemable Convertible Preferred Stock. During the year ended June 30, 1996, the Company redeemed 60,000 shares of Series A Redeemable Preferred Stock. - - SERIES A CONVERTIBLE PREFERRED STOCK 2,000,000 shares of Series A Convertible Preferred Stock, par value $.10 per share, are authorized. Each share is entitled to 10 votes and has a preference rate of $.01 per share with no dividend rights. 750,000 shares of Series A Preferred Stock were issued in connection with a 1992 acquisition transaction between the Company and Capitol Care Management Company, Inc. The preferred shares were converted into common stock in 1994 and 1995. - - SERIES C CONVERTIBLE PREFERRED STOCK 1,000,000 shares of Series C Convertible Preferred Stock are authorized. Each share is entitled to one vote per share and had a preference rate of $1.00 per share with no dividend rights. The shares of Series C Convertible Preferred Stock were converted in 1994 into common stock. - - SERIES E CONVERTIBLE PREFERRED STOCK 1,000,000 shares of Series E Convertible Preferred Stock (the "Series E") are authorized. These share were sold in an offering to foreign investors in April 1996 at $10.00 per share. Holders of the Series E have no voting rights except as required by law, and have liquidation preference of $10.00 per share plus 4% per annum from the date of issuance. The shares of Series E are convertible into shares of common stock at a conversion price of $11.55 or 85% of the average closing bid price for the five trading days prior to the date of conversion, whichever is lower (but no lower than $5.00). At the option of the holder of the Series E shares, 50% of the shares can be converted to common shares after 45 days from the date of issuance with the remaining 50% available for conversion after 75 days from the date of issuance. At the time of conversion the holder is also entitled to additional shares equal to $10.00 per share of Series E multiplied by 8% per annum form the date of issuance divided by the applicable conversion price. The Company has accounted for the Series E in accordance with Emerging Issues Task Force Consensus D-60. As a result, at the date of issuance, $1,996,777 of the proceeds were considered imputed dividends and allocated to additional paid-in capital. This amount was recognized as preferred dividends over the period from the date of issuance to the earliest date of conversion permitted by the terms of the Series E. At June 30, 1997, the entire amount of the imputed preferred dividends had been recognized. During the year ended June 30, 1997, the remaining 942,500 Series E shares were converted into 1,318,533 shares of common stock. - - SERIES F CONVERTIBLE PREFERRED STOCK 1,000,000 shares of Series F Convertible Preferred Stock (the "Series F") are authorized. These share were sold in an offering to foreign investors in April 1996 at $10.00 per share. Holders of the Series E have no voting rights except as required by law, and have liquidation preference of $10.00 per share plus 4% per annum form the date of issuance. The shares of Series F are convertible into shares of common stock at a conversion price of $7.425 or 85% of the average closing bid price for the five trading days prior to the date of conversion, whichever is lower. At the option of the holder of the Series F shares, one-third of the shares can be converted to common shares after 60 days from the date of issuance, one-third of the shares after 90 days from the date of issuance, and the remaining one-third after 120 days from the date of issuance. At the time of conversion the holder is also entitled to additional shares equal to $10.00 per share of Series F multiplied by 8% per annum form the date of issuance divided by the applicable conversion price. F-20 46 The Company has accounted for the Series F in accordance with Emerging Issues Task Force Consensus D-60. As a result, at the date of issuance, $1,996,777 of the proceeds were considered imputed dividends and allocated to additional paid-in capital. This amount was recognized as preferred dividends over the period from the date of issuance to the earliest date of conversion permitted by the terms of the Series F. At June 30, 1997, the entire amount of the imputed preferred dividends had been recognized. During the year ended June 30, 1997, 651,666 Series F shares were converted into 1,148,698 shares of common stock. F-21 47 TREASURY STOCK During the year ended June 30, 1997, the Company purchased and retired 520,326 shares of its common stock at an aggregate cost of $3,923,222. 10. LONG-TERM DEBT: Long-term debt at June 30, 1997 and 1996 is summarized as follows:
1997 1996 Non-affiliates: Notes payable to a real estate investment trust ("REIT") $ 40,700,380 $ 39,623,938 Industrial development revenue bonds 22,615,000 20,060,000 Municipal revenue bonds 26,265,000 18,170,000 Housing development mortgage revenue bonds 25,795,000 21,750,000 Notes payable to banks (8.5% or prime plus 1% to 10% due through 2003) 15,780,008 3,049,012 Capitalized lease obligations 21,972,802 8,048,581 153,128,190 110,701,531 Less current maturities 11,454,059 2,220,491 $141,674,131 $108,481,040
Future maturities of debt and capital lease obligations are as follows:
Capital Year Lease Debt Total 1998 $ 2,408,701 $ 11,980,406 $ 14,389,107 1999 2,416,138 2,538,317 4,954,455 2000 2,423,272 2,963,682 5,386,954 2001 2,430,508 3,455,739 5,886,247 2002 2,437,846 3,552,304 5,990,150 Thereafter 36,798,942 106,664,940 143,463,882 Total 48,915,407 131,155,388 180,070,795 Less amount representing imputed interest at 11% to 12% 26,942,605 - 26,942,605 Total obligations $ 21,972,802 $131,155,388 $153,128,190
The notes payable to the REIT consist of mortgage notes on sixteen facilities. Principal amounts are amortized over a 25-year period with monthly installments payable through 2006. Interest ranges on these notes from 9.75% to 11.28% and increases annually at rates ranging from 0.1% to 0.25%. The notes are collateralized by property and equipment of the sixteen facilities. The industrial development revenue bonds consist of bonds on two facilities: a retirement community located in San Destin, Florida and Atrium, a nursing and retirement community located in Jacksonville, Florida. The San Destin facility serves as collateral for $11,925,000 of bonds payable to the Walton County Industrial Development Authority. Principal payments range from $150,000 to $1,300,000 annually through 2019 and interest accrues at 10.5%. The Atrium facility serves as collateral for three City of Jacksonville Industrial Development Revenue Refunding bonds totaling $10,690,000. Principal payments F-22 48 range from $65,000 to $375,000 annually through 2024, $6,060,000 due in 2011, and interest accrues at rates ranging from 6.5% to 11.5%. The housing development mortgage revenue bonds include approximately $18,525,000 of bond debt assumed by the Company in connection with the acquisition of Encore. The bond debt, which is collateralized by property and equipment of five facilities, includes Okaloosa County, Florida Retirement Rental Housing Revenue Series A bonds totaling $7,925,000 with semi-annual interest payments at 10.75% due in 2003 and Ohio Rental Housing Revenue Series A bonds totaling $9,800,000 with semi-annual interest at 10.38% due in 2009. The remainder of the housing development mortgage revenue bonds consist of bonds totaling $8,070,000 collateralized by three facilities with interest ranging from 7% to 11.0% with maturities through 2026. The housing development mortgage revenue bonds require annual principal payments ranging from $150,000 to $2,000,000. The municipal revenue bonds, which are collateralized by property and equipment of seven facilities and require annual principal payments ranging from $370,000 to $1,635,000, consist of the following: Dade City, Florida Series A and B bonds totaling $6,395,000, with principal payments due through 2025 and interest ranging from 6.75% to 8%. Highland County Series A and B bonds totaling $4,230,000, with principal payments due through 2024 and interest ranging from 6.5% to 8.5%. City of Dublin Series A and B bonds totaling $2,740,000, with principal payments due through 2024 and interest ranging from 8.5% to 10.5% Rome-Floyd County Development Authority Revenue Series A and B bonds totaling $2,655,000, with principal payments due through 2011 and interest rates ranging from 7.5% to 10%. Americus-Sumter Series A and B bonds totaling $1,900,000, with principal payments due through 2026 and interest rates ranging from 8.0% to 10.25%. Houston County Series A and B bonds totaling $5,650,000 with principal payments due through 2026 and interest rates ranging from 7% to 8.4%. Sumner, TN Series A and B bonds totaling $2,695,000 with principal payments due through 2010 and interest rates ranging from 10.5% to 12.5%. The Company recorded an extraordinary charge of $490,000, net of income tax benefit of $300,000, associated with the early extinguishment of approximately $9.2 million of long-term debt on the Company's retirement facility located in Destin, Florida. In connection with the bond indentures, the Company is required to meet certain covenants, including monthly sinking fund deposits, adequate balances in debt service reserve funds, timely payment of tax obligations and adequate insurance coverage. At June 30, 1997 and 1996, the Company was in default under several of these covenants including the failure to make monthly payments to the bond sinking funds for certain of these facilities and inadequate debt service reserves for certain of the facilities. The Company is also delinquent with regard to the payment of property taxes at several facilities. The bond indentures underlie industrial development revenue bonds, municipal revenue bonds and housing development mortgage bonds that, together, totalled approximately $51,300,000 at June 30, 1997. The following table includes the bonds that were in default as of June 30, 1997:
AMOUNT BOND TRUSTEE OUTSTANDING ---- -------------- ----------- Jacksonville Series 1996....................... Sentinel Trust $ 8,735,000 Jacksonville Series 1994....................... Sentinel Trust 1,955,000 Dublin, Georgia IDA Series A and B............. Sentinel Trust 2,740,000 Highland County IDA Series A and B............. Sentinel Trust 4,230,000 Cave Springs 1994.............................. Sentinel Trust 1,650,000 Dade City, Florida............................. Sentinel Trust 6,395,000 Rome-Floyd 1996 Series A and B................. Sentinel Trust 2,655,000 Walton County.................................. Sentinel Trust 11,925,000 Americus-Sumpter PDA Series A and B............ Sentinel Trust 1,900,000 Cave Springs 1996.............................. Sentinel Trust 1,555,000 Jackson, Tennessee 1993........................ Sentinel Trust 1,600,000 Jackson, Tennessee 1989........................ Sentinel Trust 3,265,000 Sumner, Tennessee 1989 Series A and B.......... Sentinel Trust 2,695,000 -------------- ----------- TOTAL:............................... $51,300,000
The Company generally has a grace period of 30 days to cure defaults after receipt of written notification from the bond trustee, and no such written notification has been received. The Company believes that it is probable that, upon receipt of such written notification, the Company could cure such defaults within the 30 day grace period. The trustees have not called the bonds in the past for these defaults and management does not foresee the bonds being called at this time. All semi-annual interest and principal payments have been made in a timely fashion. 11. LINES OF CREDIT: The Company maintains various lines of credit with interest rates ranging from prime plus .25% to prime plus 1.25%. Available borrowings under the lines of credit totaled $14,050,000 and $5,075,000 for the years ended June 30, 1997 and 1996, respectively. Total borrowings against the lines of credit were $9,935,036 and $3,556,535 at June 30, 1997 and 1996, respectively. 12. COMMITMENTS AND CONTINGENCIES: OPERATING LEASES The Company leases nursing homes and retirement care facilities from unaffiliated entities (in addition to leasing eleven nursing and retirement facilities from affiliated entities. (see Note 3). The lease agreements commenced on various dates with terms extending through February 2016. The Company has options to extend most of the leases for an additional five to ten years. The Company also leases certain facilities under agreements classified as capital leases. These agreements include purchase options exercisable at the Company's discretion during, or at the end of, each of the lease terms. The capital lease agreements commenced on various dates with terms extending through October 2008. Included in the above agreements are seven leases whereby a sale to the lessor F-23 49 preceded the lease agreement ("sale/leaseback transaction"). The Company has accounted for six of these sale/leaseback transactions as sales with no gains or losses recognized on the transactions. The remaining sale/leaseback transaction was capitalized and included a deferred gain of $381,370 to be amortized over the term of the lease. Future minimum payments, by year and in the aggregate, under noncancelable operating leases with initial or remaining terms of one year or more consist of the following at June 30, 1997:
Year Amount 1998 $ 19,484,267 1999 19,264,153 2000 19,243,829 2001 19,159,033 2002 18,710,901 Future years 119,850,928 Total $215,713,111
The Company's rental expense under operating leases for nursing homes and retirement care facilities amounted to approximately $13,200,000, $6,040,000 and $5,750,000 for the years ended June 30, 1997, 1996 and 1995, respectively. The Company leases office space under a noncancelable operating lease which expires in October 2000. At June 30, 1997, minimum future rental payments under the noncancelable lease were as follows:
Year Amount 1998 $325,455 1999 341,683 2000 358,673 2001 120,509
Total amounts paid for rental of office facilities totaled approximately $306,000, $317,000, and $60,000 for the years ended June 30, 1997, 1996 and 1995, respectively. OTHER The Company has guaranteed 20% to 100%, or approximately $9,000,000, of debt on six facilities owned by unaffiliated entities that are currently operated by the Company under operating leases. The Company is involved in legal proceedings arising in the ordinary course of business. In addition, the Company is in dispute with the Internal Revenue Service ("IRS") concerning the application of certain income and payroll tax liabilities and payments. The IRS contends that the Company is delinquent in the payment of certain taxes and has assessed taxes, penalties and interest in connection with the alleged underpayment of approximately $1.2 million. The Company contends that the IRS has misapplied payments between income and payroll taxes and between the Company and its affiliates. Based on the opinion of counsel handling the matter that it is unlikely that a settlement of the dispute would require a payment materially greater than $400,000 plus interest, the Company has estimated and accrued in the accompanying financial statements $400,000 for ultimate settlement of this matter. The Company has filed lawsuits against the IRS related to this matter. In the opinion of management, the ultimate resolution of pending legal proceedings and the IRS dispute will not have a material effect on the Company's financial positions or results of operations. F-24 50 13. INCOME TAXES: The components of the provision for income taxes were as follows:
Year ended June 30, 1997 1996 1995 Current: Federal $(1,097,110) $2,671,891 $2,659,000 State (240,648) 501,600 499,000 (1,337,758) 3,173,491 3,158,000 Deferred (benefit): Federal (846,568) (1,571,500) 221,928 State (158,930) (294,900) 39,164 $(1,005,498) (1,866,400) 261,092 Total income tax provision $(2,343,256) $1,307,091 $3,419,092
The income tax provisions (benefit) included in the consolidated statements of income are as follows:
1997 1996 1995 Income before extraordinary item and cumulative effect of change in accounting principle $(2,343,256) $1,307,091 $3,419,092 Cumulative effect of change in accounting principle - 228,000 - Extraordinary Item (300,000) - - (2,643,256) $1,535,091 $3,419,092
Deferred income taxes are provided to reflect temporary differences between financial and income tax bases of assets and liabilities. The sources of the temporary differences and their effect on the net deferred taxes at June 30, 1997 and 1996 are as follows:
1997 1996 Current deferred taxes: Deferred tax assets: Workers' compensation accrual $1,936,000 $1,062,900 Provision for losses on accounts receivable 2,039,200 811,300 Health insurance accrual 227,800 227,800 Net operating loss 444,500 355,100 Total current deferred tax asset 4,647,500 2,457,100 Less valuation allowance (444,500) (355,100) 4,203,000 2,102,000 Deferred tax liability - other (137,569) (93,570) Net current deferred tax asset 4,065,431 $2,008,430 Noncurrent deferred taxes: Deferred tax asset - deferred gain 276,700 $ 276,700 Deferred tax liabilities: Property and equipment 673,900 352,600 Deferred lease cost 568,200 201,100 Other 133,529 - Net noncurrent deferred tax liability $1,098,929 $ 277,000
The provision for income taxes for the year ended June 30, 1996 and 1995 varies from the amount determined by applying the Federal statutory rate to pretax income as a result of the following:
1997 1996 Income tax expense (benefit) at federal statutory rate (3,310,600) $1,115,130 Nondeductible tax penalties 305,800 417,700 State income taxes, net of federal tax benefit (192,000) 331,100 Other, net 668,801 (556,839) $(2,527,999) $1,307,091
The primary difference between the actual income tax rate of approximately 40% for the year ended June 30, 1995 and the Federal income tax rate of 34% is the F-25 51 amount paid for state income taxes. 14. FAIR VALUES OF FINANCIAL INSTRUMENTS AND INVESTMENTS: The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments. CASH AND CASH EQUIVALENTS The carrying amount reported in the balance sheet for cash and cash equivalents approximates fair value because of the short maturity of these instruments. MARKETABLE EQUITY SECURITIES The carrying amount reported in the balance sheet for marketable equity securities approximates fair value. All marketable equity securities are classified as "available for sale" for accounting purposes and, therefore, are carried at fair value with unrealized gains and losses recorded directly in equity. There were no significant unrealized gains or losses at June 30, 1996. NOTES RECEIVABLE The carrying amount approximates fair value for the notes receivable based on the fair value being estimated as the net present value of cash flows that would be received on the notes over the remaining notes' terms using the current market interest rates rather than stated interest rates. SHORT- AND LONG-TERM DEBT The fair value of all debt has been estimated based on the present value of expected cash flows related to existing borrowings discounted at rates currently available to the Company for debt with similar terms and remaining maturities. The cost basis and estimated fair values of the Company's financial instruments at June 30 are as follows:
June 30, 1997 Carrying Fair Amount Value Financial assets: Cash and cash equivalents $ 3,637,878 $ 3,637,878 Financial liabilities: Short-term debt 21,389,095 21,389,095 Long-term debt 141,674,131 128,718,000
June 30, 1996 Carrying Fair Amount Value Financial assets: Cash and cash equivalents $ 45,365 $ 45,365 Marketable equity securities 33,645 33,645 Financial liabilities: Short-term debt 5,777,026 5,777,026 Long-term debt 108,481,040 112,338,000
As of June 30, 1995, the carrying amount of all financial instruments approximated fair value. F-26 52 15. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: As described in Note 2, the Company acquired certain businesses during 1997. The fair value of the assets acquired was $30,411,391 and the fair value of the liabilities assumed was $11,603,614, which resulted in net cash payments of $18,807,777. As described in Note 2, the Company acquired certain businesses during 1996. The fair value of assets acquired was $69,826,951 and the fair value of liabilities assumed was $47,888,438, which resulted in net cash payments of $21,938,513. During 1997, the Company entered into approximately $14,000,000 of capital lease agreements. Contour acquired Atlantic Medical Supply Company, Inc. and sold CFI with noncash transactions of $16,073,970 and $624,252, respectively. Cash paid for interest during the years ended June 30, 1997, 1996 and 1995 was $13,851,484, $6,561,954, and $1,172,883, respectively. Cash paid for income taxes during the years ended June 30, 1997, 1996 and 1995 was $3,265,632, $3,561,089, and $829,292, respectively. Dividends on preferred stock of $15,000 and $1,996,777 were accrued but not paid at June 30, 1996. Dividends on preferred stock of $1,966,777 were accrued but not paid at June 30, 1997. During 1997 and 1996, approximately $13,730,000 and $8,112,000, respectively, of lease assets and obligations were capitalized. 16. ACCRUED EXPENSES: Accrued expenses consisted of the following as of June 30:
1997 1996 Payroll and payroll taxes $ 5,808,124 $ 3,587,217 Interest 2,129,164 1,868,805 Workers Compensation 5,275,000 2,975,000 Other 5,204,970 2,885,008 Total $18,417,258 $11,316,030
17. EMPLOYEE RETIREMENT PLAN: During the year ended June 30, 1996, the company established a defined contribution retirement plan. Employees qualify for the plan upon the completion of three months of service with the Company and reaching the age of twenty-one. Company contributions to the plan represent a matching percentage of certain employee contributions. The matching percentage is subject to management's discretion based upon consolidated financial performance. For the years ended June 30, 1997 and 1996, the Company has not made any contributions to the plan. 18. BUSINESS SEGMENT INFORMATION: Retirement Care Associates; Inc. and Subsidiaries is a long-term health care provider which engages in two distinct business segments. The Retirement Care Associates entity operates and manages nursing homes and retirement facilities throughout the Southeast. As of June 30, 1997, approximately 11,100 beds were owned or operated by this entity. The Contour entity manufacturers a full line of orthopedic care and F-27 53 rehabilitation products and distributes them to nursing facilities throughout the Southeast. The Contour entity was acquired in 1995. The following represents business segment information for the years ended June 30, 1997, 1996 and 1995.
1997 1996 1995 Operating revenues: Retirement Care Associates $204,612,388 $124,951,954 $76,656,829 Contour Medical 48,615,473 9,059,415 2,959,224 253,227,861 $134,011,369 $79,616,053 Depreciation and amortization expense: Retirement Care Associates $ 5,653,472 $ 2,806,637 $ 1,051,842 Contour Medical 861,241 600,349 76,341 $ 6,514,713 $ 3,406,986 $ 1,128,183 Identifiable assets: Retirement Care Associates $227,984,979 $165,094,536 $72,644,179 Contour Medical 27,385,987 12,397,751 7,613,367 $255,370,966 $177,492,287 $80,257,546 Capital expenditures: Retirement Care Associates $ 11,764,903 $ 11,741,135 $ 5,763,553 Contour Medical 969,486 749,163 316,057 $ 12,734,389 $ 12,490,298 $ 6,079,610 Operating Income Retirement Care Associates $ 3,006,819 $ 8,540,815 $ 8,865,388 Contour Medical 694,303 839,202 151,820 $ 3,701,122 $ 9,380,017 $ 9,017,208
19. SUBSEQUENT EVENTS The board of directors of RCA has unanimously approved and adopted the Agreement and Plan of Merger and reorganization, dated as of February 17, 1997, as amended by Amendment No. 1 thereto dated as of May 27, 1997, and also amended by Amendment No. 2 thereto dated as of August 21, 1997, with Sun Healthcare Group, Inc. ("Sun"). The proposed RCA merger is contingent upon, among other things, the approval of the holders of the requisite number of shares of Sun Common Stock and RCA Capital Stock, which is described in a Joint Proxy Statement/Prospectus/Information Statement. The proposed RCA Merger will be consummated as soon as practicable after such approvals are obtained and the other conditions to the RCA Merger are satisfied or waived. The Company renewed debt of $9,750,000 and obtained $5,000,000 of additional debt with Sun Healthcare Group, Inc. on July 10, 1997. Interest accrues at rates ranging from 11% to 12% and would increase from 15% to 16% during any period of default. Principal is due 120 days following the termination of the agreement or merger with Sun. Subsequent to June 30, 1997, the Company became obligated on approximately $2,500,000 bonds to construct a twenty-five unit addition to its Jackson, Tennessee facility. 20. ADJUSTMENTS TO 1996 FINANCIAL STATEMENTS As discussed in Note 19, on February 17, 1997, following a series of meetings and negotiations, the company agreed to be acquired by Sun Healthcare Group, Inc. (Sun) through an exchange of shares of Sun for shares of the Company. During due diligence procedures associated with the transaction, certain adjustments to previously issued financial statements were discovered to be required. Those adjustments, together with additional amounts, have been applied to the financial statements for the year ended June 30, 1996 as restatements and corrections as follows: F-28 54
Additional provision for uncollectible accounts $1,705,000 Additional accrual for claims incurred, but not reported for self-insured worker's compen- sation and health care 3,400,000 Accrual for compensated absences 300,000 Adjustment of previously recorded inventory 809,219 Adjustment to lease expense 530,000 6,744,219 Less: Adjustment to income taxes (2,921,219) Decrease in net income $3,823,000 Decrease in net income per share $ .34
21. LIQUIDITY During the period ending June 30, 1997, the Company experienced a significant net operating loss and at the same time a decline in liquidity, resulting from the operating loss and a heightened level of investment in new facilities. Management believes that the operating loss is the result of a decline in the overall census of residents and patients in the Company's facilities, together with losses at Contour Medical, Inc. resulting from costs of consolidation of subsidiaries acquired during the period. Closing of the merger of the Company with Sun as discussed in Note 19 will provide access to additional sources of liquidity as the Company's facility proceed through a combination of new admissions to nursing facilities and set-up of retirement facilities. In the event the merger does not take place, management's plans include a complete reorganization of operations of the nursing home segment, assisted living segment and Contour Medical, Inc. This reorganization plan would include new personnel to implement increased census, develop and implement ancillary business (i.e., pharmacy, therapy, etc.) which would be beneficial from an operations point of view as well as increase profits for the Company. A comprehensive plan is being developed to implement these changes if necessary. The personnel for this plan have been identified and could be brought on board quickly. The funds to implement this plan would be provided from a new line of credit, sale and lease-back transactions for certain identified properties of the Company as well as refinancing of other Company targeted facilities. F-29 55 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. RETIREMENT CARE ASSOCIATES, INC. Dated: April 8, 1998 By: /s/ Darrell C. Tucker --------------------------------- Darrell C. Tucker, Treasurer -----END PRIVACY-ENHANCED MESSAGE-----