Item 1. Business - ------- --------
GENERAL
RoTech Medical Corporation ("RoTech" or the "Company") provides comprehensive home health care and primary care physician services, principally to patients in non-urban areas. RoTech operates 631 home health care locations in 36 states. The Company's home health care business provides a diversified range of products and services, with emphasis on home respiratory, home medical equipment and infusion therapies. RoTech has pursued an aggressive acquisition strategy since 1988 which included in fiscal 1997 acquisitions of 174 locations of smaller home health care companies and the opening of 49 new locations. Current industry estimates indicate that approximately half of the nation's home health care industry remains fragmented and is run by either single operators or small, local chains. These smaller providers are RoTech's main competition and main acquisition opportunities. The Company plans to continue to enter new home health care markets through acquisition or start-up as competitive and pricing pressures encourage consolidation and economies of scale.
On October 21, 1997 the shareholders of RoTech approved a merger agreement pursuant to which Integrated Health Services, Inc. acquired RoTech. The merger transaction closed on October 21, 1997. See Item 4.
Recent data suggests that there is a shortage of health care services in non- urban markets. According to the United States Census Bureau, in 1990 non-urban areas of the United States accounted for roughly 25% of the national population, or approximately 62 million people. However, according to the American Medical Association, just 11% of physicians, or approximately 75,000 physicians, practice in non-metropolitan markets. This data indicates that rural markets are underserved, and suggests that there may be opportunities for improvement in access to primary care physicians, as well as specialty services. The Company believes that these needs result in significant opportunities for companies such as RoTech, which can attract, retain and network physicians in non-urban settings while offering ancillary services such as home health care, to become a full-service non-institutional based primary health care provider.
OPERATING AND EXPANSION STRATEGY
RoTech was founded in 1981 to provide home respiratory and home medical equipment products and services to patients in Florida. With its founders' roots in pharmacy and pharmaceutical sales, the Company's marketing directive has always been to provide information to primary care physicians regarding the utilization of home health care techniques, products and services for their patient base. Providing information to these physicians as to disease management leads to earlier identification and treatment of patients, enhancing the patient's quality of life and longevity. The Company has not targeted specialists, as their patients are more acute and since specialists have historically been tied to the hospital systems which results in higher hospitalizations. RoTech's marketing is directed at identifying patients of primary care physicians prior to hospitalization and prior to an acuity level that would require utilizing a specialist.
The Company's strategy is to develop integrated health care delivery systems through the acquisition of smaller local home health care companies in non-urban areas. The Company targets non-urban markets of smaller cities and rural areas, due to the dominance of primary care physicians in these markets, reduced competition and a tendency to care for patients in the home setting. The Company believes that acquisitions of home health care companies will continue to expand the base of relationships with primary care physicians in these markets. Primary care physicians in these markets typically have long-standing relationships with loyal patient bases. These physicians are usually solo practitioners and are the key decision makers in the treatment of their patients. The Company believes that making home health care products and services available to these physicians will result in better, less expensive health care that provides an improved quality of life for the patients and their caregivers in these communities.
SALES AND MARKETING
RoTech believes that the sales and marketing skills of its employees have been instrumental in its growth to date and are critical to its future success. RoTech emphasizes to its employees the importance of patient base growth and retention by providing quality service to physicians and their patients. Approximately 28% of RoTech's employees are actively involved in sales and marketing. The sales representatives employed by the Company
include registered or certified respiratory therapists, registered pharmacists and registered nurses who market all of the Company's services and products and are responsible for maintaining and expanding the Company's relationships with physicians, targeting primary care physicians in non-urban areas.
RoTech provides formal marketing, training, product and service information to all of its technical and sales personnel so they can communicate effectively with physicians about the Company's services and products. These personnel are instructed on methods of serving the physicians by counseling them on new procedures and medical technologies. Each technical and sales person must attend periodic seminars conducted on a Company-wide basis. The Company emphasizes the cross-marketing of all its products to physicians with which its salespeople have already developed professional relationships. The Company believes its marketing approach allows the primary care physician to identify acute and chronic patients earlier in the disease process. Treatment is done at the primary care level and accordingly at less cost than the advanced treatment of the disease by specialists or in a hospital setting.
REIMBURSEMENT FOR SERVICES
A substantial percentage of RoTech's revenue is attributable to third-party payors, including private insurers, Medicare and, to a lesser extent, Medicaid. The Company has substantial expertise at processing claims and continues to create and improve systems to manage third-party reimbursements, to produce clean claims and obtain timely reimbursements by third-party payors. The Company has developed distinct billing and collection departments for Medicare and Medicaid reimbursements and for private insurance company claims which are supported by customized computer systems. These departments work closely with reimbursement officers at branch locations and third-party payors and are responsible for the review of patient coverage, the adequacy and timeliness of documentation and the follow-up with third-party payors to expedite reimbursement payments. Reimbursement from the Medicare program as a percentage of RoTech's total operating revenue approximated 51% for fiscal 1997, 48% for fiscal 1996, 49% for fiscal 1995.
RoTech has achieved increased operating revenue in home respiratory and other medical equipment operations despite increased regulation and corresponding reimbursement reductions. While the increased regulation tends to reduce the amount of reimbursement from government sources for individual cases, the Company believes the continued increased regulation also benefits the Company by reducing the competition from joint ventures and fee revenue sharing arrangements, which the Company has historically avoided.
The Company's levels of operating revenue and profitability of the Company, like those of other health care companies, are affected by the continuing efforts of third-party payors to contain or reduce the costs of health care by lowering reimbursement rates, increasing case management review of services and negotiating reduced contract pricing. Home health care, which is generally less costly to third-party payors than hospital-based care, has benefitted from those cost containment objectives. However, as expenditures in the home health care market continue to grow, initiatives aimed at reducing the costs of health care delivery at non-hospital sites are increasing. Changes in reimbursement policies by third-party payors, or the reduction in or elimination of such reimbursement programs, could have a material adverse impact on the Company's revenues. Various state and federal health reform initiatives may lead to additional changes in reimbursement programs.
PRODUCTS AND SERVICES
HOME HEALTH CARE PRODUCTS AND SERVICES
HOME RESPIRATORY THERAPY AND EQUIPMENT
RoTech provides a variety of home respiratory therapy products and services on a monthly rental or sale basis. Home respiratory therapy and equipment represented 50%, 42% and 42% of the Company's revenues for the years ended July 1997, 1996 and 1995, respectively. RoTech focuses on serving patients of primary care physicians with chronic pulmonary diseases in their pre-acute stages. Early identification and retention of these patients at the
primary care level reduces the cost of health care and should improve the quality of life of the patients and their families. RoTech also enjoys patient retention post-hospitalization at the patient's or physician's request and does not rely on referrals of patients by hospital discharge planners or case managers. Overall home respiratory market revenues were approximately $1.6 billion in 1993.
The Company's home respiratory care product line includes oxygen concentrators, portable liquid oxygen systems, nebulizers, and ventilator care. Oxygen concentrators extract oxygen from room air and generally provide the least expensive supply of oxygen for patients who require a continuous supply of oxygen, are not ambulatory and who do not require excessive flow rates. Liquid oxygen systems store oxygen under pressure in a liquid form. The liquid oxygen is stored in a stationary unit that can be easily refilled at the patient's home and can be used to fill a portable device that permits greatly enhanced patient mobility. Nebulizers are devices which aerosolize medications, allowing them to be inhaled directly into the patient's lungs. Ventilator therapy is used for the individual that suffers from respiratory failure by mechanically assisting the individual to breathe. The Company provides technicians who deliver and/or install the respiratory care equipment, instruct the patient in its use, refill the high pressure and liquid oxygen systems as necessary and provide continuing maintenance of the equipment.
HOME MEDICAL EQUIPMENT AND SUPPLIES
RoTech provides a full line of equipment and supplies of home medical equipment and supplies for convalescents, including custom pieces required for rehabilitation patients. Home medical equipment and supplies represented 29%, 35%, and 24% of the Company's revenues for the years ended July 31, 1997, 1996 and 1995 respectively. Provision of home medical equipment enables the Company to provide a "one-stop shopping" presence in its non-urban markets, which is required for full patient service satisfaction. These products are provided on a monthly rental or sale basis and include wheelchairs, hospital beds, walkers, patient lifts, orthopedic supplies, catheters, syringes and bathroom aids.
HOME INFUSION THERAPY AND OTHER PHARMACY RELATED PRODUCTS AND SERVICES
Home infusion therapy involves the administration of antibiotics, nutrients or other medications intravenously, intramuscularly, subcutaneously or through a feeding tube. The Company focuses on providing home infusion therapy to patients prior to or in lieu of hospitalization, which generally offers significant cost savings and preferable logistics for patients, their families and caregivers over hospital-based treatments. RoTech believes that its marketing methods of consulting with primary care physicians on home infusion therapies and the continuing evolution of related technological advances should enable further growth of this portion of the business. Focus on the referring primary care physician facilitates the identification of patients requiring sub-acute antibiotic treatments, which constitute 39% of the home infusion therapy market. Home infusion therapies and other pharmacy products accounted for 14%, 16% and 25% of RoTech's revenues for the years ended July 31, 1997, 1996, and 1995, respectively which includes the following types:
Antibiotic Therapy (The majority of the Company's home infusion therapy revenues)--Antibiotic therapy requires the infusion of antibiotic drugs into the patient's bloodstream to treat infections and diseases, such as osteomyelitis (bone infections), bacterial endocarditis (infection of the lining around the heart), wound infections, infections associated with HIV/AIDS, and infections of the kidneys and urinary tract. Antibiotics are generally believed to be more effective when infused directly into the bloodstream than when taken orally. These treatments can be prescribed by primary care physicians, are short-term in nature and recur occasionally.
Enteral Nutrition Therapy--Enteral nutrition therapy is administered to patients who cannot eat as a result of an obstruction to the upper gastrointestinal tract or because they are otherwise unable to be fed orally. As with total parenteral nutrition therapy, enteral nutrition therapy is often administered over a long period.
Pain Management and Chemotherapy--Pain management therapy is the administration of pain controlling drugs to terminally or chronically ill patients and is often administered in conjunction with intravenous chemotherapy. Chemotherapy is the continuous or intermittent intravenous administration of anti-cancer drugs. Chemotherapy generally is administered periodically for several weeks or months.
Total Parenteral Nutrition Therapy--Total parenteral nutrition (TPN) therapy involves the intravenous feeding of nutrients to patients with impaired digestive tracts due to gastrointestinal illnesses or conditions, due to underlying conditions including cancer or HIV/AIDS. TPN is usually longer in duration than other forms of infusion therapy, and can be lifelong.
Other Therapies. Other therapies and services include therapies such as congestive heart failure therapy, hydration therapy and related nursing services.
The Company's home infusion therapy business is dependent in large measure upon physicians continuing to prescribe the administration of drugs and nutrients through intravenous and other infusion methods. Orally administered drugs and alternative drug delivery systems may have an effect upon the demand for certain infusion therapies. The Company can predict neither the ultimate impact of these treatments on the Company's business nor the nature of future medical advances or their eventual impact on the Company's business.
PRIMARY CARE PHYSICIANS' PRACTICES
RoTech has acquired primary care physician practices in the States of Florida and Mississippi. The Company believes that it will be able to increase the profitability of the individual practices through economies of scale and greater efficiencies, and that its centralized billing and reimbursement functions will typically result in lower costs per claim and quicker reimbursement. Physician practices represented 7%, 7% and 9% of the Company's revenues for the years ended July 31, 1997, 1996 and 1995, respectively.
GOVERNMENT REGULATION
The home care industry is subject to extensive government regulation at the federal level through the Medicare program and at the state level through the Medicaid program. Medicare is a federally funded health insurance program which provides health insurance coverage for persons age 65 and older and certain disabled persons, and generally provides reimbursement at specified rates for sales and rentals of specified medical equipment and supplies, provided such equipment and supplies are determined to be medically necessary by the treating physician. Medicaid is a health insurance program administered by state governments which provides reimbursements for health care for certain financially or medically needy persons regardless of age.
The Company is subject to government audits of its Medicare and Medicaid reimbursement claims and has not, to date, experienced any material loss as a result of any such government audits. Under existing federal law, the knowing and willful offer or payment of any remuneration (including any kickback, bribe or rebate) of any kind to another person to induce the referral of Medicare or Medicaid beneficiaries for whom medical supplies and services may be reimbursed by the Medicare or Medicaid programs is prohibited and could subject the parties to such an arrangement to substantial criminal and civil penalties, including exclusion from participation in these programs, for Medicare or Medicaid fraud. The Office of Inspector General of the Department of Health and Human Services ("OIG") has promulgated regulatory "safe harbors" that describe certain practices and business arrangements that comply with Medicare and Medicaid regulations. The OIG and law enforcement authorities have recently increased their investigatory efforts to determine whether various business practices constitute remuneration for, or to induce, referrals. Certain states have also passed statutes and regulations that prohibit payments for referral of patients. These laws vary significantly from state to state. The result of legislative and regulatory efforts is an extra compliance challenge and, therefore, risk. RoTech reached a settlement with the U.S. Attorney for the Middle District of Florida in a civil action related to Medicare claims the government believes it erroneously paid between 1987 and 1989. RoTech remains confident that it was in compliance with all material Medicare and other legal requirements related to this matter. However, in an effort to reduce legal defense costs and to preserve internal resources, RoTech paid $612,500 (approximately $380,000 on an after tax basis) to resolve the matter. These monies represent a repayment of a portion of the estimated disputed claims and related interest over approximately ten years.
The Company received an inquiry from the Medicaid Department of the State of Mississippi and subsequently received two subpoenas from the OIG concerning the Company's 1994 cost report for its Mississippi Rural Health Clinics. The Company is cooperating fully with such inquiries. There has been no statement of issues or particular concerns giving the Company sufficient information to permit the Company to determine the extent of financial exposure, if any. The Company is not aware of any material error in the one year's cost report under inquiry, following consultation with its outside consultant, who also assisted in the preparation and filing of the original report. If any adjustments occur, such would likely relate only to Mississippi physician clinics for 1994. However, medicaid and OIG have the right to audit years subsequent to 1994 and RoTech can not predict the outcome of any such audit.
The types of services and products delivered by the Company, the required quality of such services and products and the manner in which such services and products are delivered and billed are each subject to significant and complex regulations promulgated, interpreted and administered by the appropriate federal or state governmental agency. Although the Company believes that its products, services and procedures comply in all respects with such regulations applicable to reimbursement eligibility, the unavailability of advance formal administrative rulings in most regulated areas subjects the Company to possible subsequent adverse interpretations and rulings which may affect the eligibility of some or all of the Company's services and products for reimbursement. Such an adverse interpretation or ruling could have a substantial adverse impact on the Company's business.
In addition, the Company is required to obtain federal and state licenses and permits relating to the distribution of pharmaceutical products, including a federal Controlled Dangerous Substance Registration Certificate and Florida State Wholesaler License. The Company is required to obtain similar licenses from each state in which it does business.
The Company's acquisitions of primary care physician practices are structured to attempt to comply with federal and state law restrictions on business relationships between the Company and persons who may be in a position to refer patients to the Company for the provision of health care related items or services. Accordingly, the Company endeavors to undertake such acquisitions in a manner where the consideration offered and paid is consistent with fair market value in arms-length transactions and is not determined in a manner that takes into account the volume or value of any referrals or business that might otherwise be generated between the Company and the physician whose practice is to be acquired and for which payment may be made under Medicare or Medicaid. While the Company believes that its acquisitions do not entail any form of unlawful remuneration, there can be no assurances that enforcement authorities will not attempt to construe the consideration exchanged in certain acquisition transactions as entailing unlawful remuneration and to challenge such transactions on such basis.
In many states, the "corporate practice of medicine doctrine" prohibits business corporations from providing, or holding themselves out as providers of, medical care through the employment of physicians. Although the two states in which the Company has acquired practices of primary care physicians, Florida and Mississippi, have not adopted this prohibition, there can be no assurance that either state will not adopt this doctrine in the future. Enforcement of such doctrine could require divestiture of acquired practices or restructuring of physician relationships.
Health care is an area of extensive and dynamic regulatory change. Changes in the law or new interpretations of existing laws can have a dramatic effect on permissible activities, the relative costs associated with doing business, and the amount of reimbursement by government and third-party payors. The Omnibus Budget Reconciliation Act of 1987 ("OBRA 1987") created six categories of durable medical equipment for purposes of reimbursement under the Medicare Part B program. There is a separate fee schedule for each category. OBRA 1987 also controls whether durable medical equipment products will be paid for on a rental or sale basis and established fixed payment rates for oxygen service as well as a 15-month rental ceiling on certain medical equipment. An interim final rule implementing the payment methodology under the fee schedules recently was published in the Federal Register. Payment based on the fee schedules is effective with covered items furnished on or after January 1, 1989. Generally, Medicare pays 80% of the lower of the supplier's actual charge for the item or the fee schedule amount, after adjustment for the annual deductible amount. OBRA 1990 made changes to Medicare Part B reimbursement that were implemented in 1991. The substantive change was the standardization of Medicare rates for certain equipment categories. Laws and regulations often are adopted to regulate new products, services and
industries. The Balanced Budget Act of 1997, enacted in August 1997, reduces the Medicare national payment limits for oxygen and oxygen equipment used in home respiratory therapy by 25% in 1998 and 30% (from 1997 levels) in 1999 and each subsequent year. Approximately 22% of RoTech's total revenues for the year ended July 31, 1997 were derived from the provision of oxygen services to Medicare patients. There can be no assurances that either the states or the federal government will not impose additional regulations upon the Company's activities which might adversely affect the Company's business.
Political, economic and regulatory influences are subjecting the health care industry in the United States to fundamental change. Although Congress has failed to pass comprehensive health care reform legislation thus far, the Company anticipates that Congress and state legislatures will continue to review and assess alternative health care delivery and payment systems and may in the future propose and adopt legislation effecting fundamental changes in the health care delivery system. Further, each area of medical care is subject to scrutiny and revision as to the amount of reimbursement which is reasonable. Any reduction in reimbursement in those goods and services provided by the Company would have a direct effect on gross revenues of the Company. Legislative debate is expected to continue in the future, and the Company cannot predict what impact the adoption of any federal or state health care reform measures or future private sector reform may have on its industry or business.
Pursuant to federal legislation (commonly known as "Stark II") enacted as part of The Omnibus Budget Reconciliation Act of 1993, and effective January 1, 1995, physicians are prohibited from making referrals to entities in which they (or immediate family members) have an investment interest or compensation arrangement, where such referral is for any "designated health service" covered by Medicare/Medicaid, including parenteral and enteral nutrients, equipment and supplies, and home health services. Ownership by a physician of investment securities in a publicly-held corporation with stockholders' equity exceeding $75 million at the end of the corporation's most recent fiscal year or on average during the previous three fiscal years is exempt from the investment prohibition if the securities are traded on the New York, American or a regional stock exchange, or The Nasdaq National Market. Exemptions from the compensation arrangement prohibition include (i) amounts paid by an employer to a physician pursuant to a bona fide employment relationship meeting specified requirements, including payments being unrelated to referrals and consistent with the fair market value of the services provided and (ii) other personal service arrangements if certain requirements are met, including that compensation be paid over the term of a written agreement with a term of one year or more, be set in advance, not exceed fair market value, and be unrelated to referrals. While RoTech intends to structure its acquisitions and operations to comply with Stark II, there can be no assurance that future interpretations of that law will not require structural and organizational modifications of the Company's existing relationships with physicians, nor can assurance be given that present or future relationships between the Company and physicians will be found to be in compliance with such law.
Competition
The home healthcare market is highly competitive and is divided among a large number of providers, some of which are national providers but most of which are either regional or local providers. RoTech believes that the primary competitive factors in this market are the ability of a company to provide prompt and reliable service, the expertise and availability of personnel, the range of products and services offered and, to a limited extent, the price of the product or service. RoTech's current and potential competitors include several national providers which have significantly greater financial and other resources than RoTech. There can be no assurance that RoTech will not encounter increased competition which could adversely affect its business, results of operations or financial condition.
RoTech also competes with other home healthcare companies for acquisitions and managed care contracts (deriving approximately 5% of its revenues from managed care contracts). There can be no assurance that additional acquisitions can be made and managed care contracts can be obtained on favorable terms or at all.
INSURANCE
In recent years, participants in the health care market have become subject to an increasing number of malpractice and product liability lawsuits, many of which involve large claims and significant defense costs. As a result of the liability risks inherent in the Company's lines of business, including the risk of liability due to the negligence of physicians or other health care professionals employed by or otherwise under contract to the Company, the Company maintains liability insurance intended to cover such claims. There can be no assurance that the coverage limits of the Company's insurance policies will be adequate, or that the Company can obtain liability insurance in the future on acceptable terms or at all.
The Company currently has in force various liability insurance policies, with total coverage limits of $26 million per occurrence and in the aggregate annually. These policies contain various levels of deductibles and self-insured retentions. They provide the Company protection against claims alleging bodily injury or property damage arising out of the Company's operations, including home health care, but excluding the Company's employed physicians. The Company has in force, with respect to physicians employed by the Company, individual professional liability insurance policies, with coverage limits ranging from $250,000 per occurrence to $1 million per occurrence, and ranging from $750,000 in the aggregate annually to $3 million in the aggregate annually. The Company's insurance policies are subject to annual renewal.
ITEM 2.
ITEM 2. PROPERTIES - -------------------
The Company leases all of its offices and facilities. The Company's corporate headquarters is currently located in a 25,300 square foot warehouse/office building located at 4506 L.B. McLeod Road, Suite F, Orlando, Florida 32811, leased by the Company for a 5 year period ending September 30, 2000 at a current rate of $3.40 per square foot with utilities, taxes and insurance being the financial responsibility of the Company.
In addition to its corporate headquarters, the Company leases office facilities for its 613 locations. These facilities are primarily used for general office work and the dispatching of registered respiratory therapists, registered nurses, registered pharmacists and delivery personnel.
The Company's office facilities vary in size from approximately 200 to 6,000 square feet. The total space leased for these offices is approximately 1.5 million square feet at an average price of $8.11 per square foot. All of such office space is leased pursuant to operating leases.
Management believes that its office and warehouse facilities are suitable and adequate for its planned needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS - --------------------------
The Company is from time to time involved in various legal proceedings. Although the Company does not believe that any currently pending proceeding will materially and adversely affect the Company, there can be no assurance that any current or future proceeding will not have a material adverse affect on the Company's financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------
On October 21, 1997 a special meeting of shareholders was held. At that meeting, shareholders approved a proposal to approve and adopt the Agreement and Plan of Merger dated July 6, 1997 between the Company and Integrated Health Services, Inc. ("IHS"). As a result of this approval, the Company became a wholly-owned subsidiary of IHS on October 21, 1997. Each outstanding share of RoTech Common Stock was converted into the right to receive and each report to acquire a share of RoTech Common Stock was converted into the right to purchase, .5806 of a share of common stock of IHS.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholder - -------------------------------------------------------------------------- Matters - -------
On October 21, 1997 a special meeting of shareholders was held. At that meeting, shareholders approved a proposal to approve and adopt the Agreement and Plan of Merger dated July 6, 1997 between the Company and Integrated Health Services, Inc. ("IHS"). As a result of this approval, the Company became a wholly-owned subsidiary of IHS on October 21, 1997 (the "Merger"). Each outstanding share of RoTech Common Stock was converted into the right to receive and each report to acquire a share of RoTech Common Stock was converted into the right to purchase, .5806 of a share of common stock of IHS. As a result, RoTech's Common Stock is no longer publicly traded.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA - --------------------------------
The information required by this item is set forth under the heading "Selected Consolidated Financial Data" on Page 22 of the Company's Annual Report to the Shareholders for the fiscal year ended July 31, 1997, and is hereby incorporated by reference.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - -------------------------------------------------------------------------------- OF OPERATION - ------------
Statements in this Annual Report on Form 10-K concerning the Company's business outlook or future economic performance; anticipated profitability, revenues, expenses or other financial items; and product line growth, together with other statements that are not historical facts, are "forward-looking statements" as that term is defined under Federal Securities Laws. Forward-looking statements are subject stated in such statements. Such risks, uncertainties and factors include, but are not limited to, the Company's substantial indebtedness, growth strategy, capital requirements and recent acquisitions as well as competition, government regulation, general economic conditions and the other risks detailed in the Company's filings with the Securities and Exchange Commission, including this Annual Report on Form 10-K.
RESULTS OF OPERATIONS
The following table presents the percentage of certain items relative to total operating revenue:
FOR THE FISCAL YEARS ENDED JULY 31, 1997 AND 1996
Operating revenue increased 61% to $423 million for the fiscal year ended July 31, 1997 ("fiscal 1997") from $263 million for the fiscal year ended July 31, 1996 ("fiscal 1996"). The increase in operating revenue is attributable to acquisitions and expanded product and service lines in existing areas of operation. Revenue from acquisitions in fiscal 1997 totaled $59 million. During fiscal 1997, the Company added 174 home care locations and operated 589 home care locations in 35 states as of July 31, 1997. The Company continues to employ a single sales force to maintain and develop both the home respiratory therapy, other medical equipment, home infusion therapy and other pharmacy related lines of business.
Operating revenue from home respiratory therapy and equipment increased 92% to $211.3 million for fiscal 1997 from $110.1 million for fiscal 1996. Operating revenue from home medical equipment and supplies increased 33% to $122.6 million for fiscal 1997 from $92.1 million for fiscal 1996. The increases in these two product lines were due mainly to increases in patient bases throughout the Company's locations and increased marketing efforts in certain locations acquired during fiscal year 1997 and 1996. The majority of the Company's acquisitions are of businesses that operate primarily in these two product lines.
Operating revenue from home infusion therapy and pharmacy related services increased 43% to $59.2 million for fiscal 1997 from $41.5 million for fiscal 1996. The Company anticipated growth in this line of business to continue as the Company expands its service areas.
Operating revenue from physician and other services increased 53% to $29.6 million for fiscal 1997, from $19.4 million for fiscal 1996. The Company currently owns 24 physician practices and employs 29 primary care physicians. These practices are clustered in two rural marketplaces. The Company anticipated growth in this line of business to continue yet decline as a percentage of operating revenue as the Company continues to acquire home health care operations.
Cost of revenue as a percentage of operating revenue decreased to 25.0% for fiscal 1997 from 27.0% for fiscal 1996 due to changes in the product mix in the last year resulting from mid-year fiscal 1996 and fiscal 1997 acquisitions. Selling, general and administrative expenses as a percentage of operating revenue increased to 49.4% for fiscal 1997 from 48.4% for fiscal 1996 due to an increase in bad debt expense. Changes in the Company's mix of business also affect these categories. For example, physician practices have no cost of revenue and all expenses are of a selling, general and administrative nature.
Depreciation and amortization expense increased 66% to $44.0 million for fiscal 1997 from $26.5 million for fiscal 1996. Depreciation and amortization expense as a percentage of operating revenue was 10.4% for fiscal 1997 and 10.1% for fiscal 1996. The dollar increase was attributable to the Company's purchase of fixed and intangible assets resulting from various acquisitions and the fixed assets needed for the increased rentals of equipment. All acquisitions in fiscal 1997 were accounted for by the purchase method.
Interest expense, net of interest income, increased to $13.6 million for fiscal 1997 from $5.2 million for fiscal 1996. This increase resulted from the Company borrowing monies to fund certain acquisitions along with the issuance of the Convertible Subordinated Debentures on June 1, 1996.
Income tax expense was provided at a 39.1% effective rate, compared to 37.5% the prior fiscal 1996.
Net income for fiscal 1997 was $30.8 million, a 50% increase over the $20.6 million for fiscal year 1996. Net income per share on a fully diluted basis increased 37% to $1.12 for fiscal 1997 compared to $0.82 for fiscal 1995. The weighted average number of shares on a fully diluted basis increased 23% to 30.9 million at July 31, 1997 from 25.2 million at July 31, 1996, primarily as a result of shares issued in conjunction with certain acquisitions.
FOR THE FISCAL YEARS ENDED JULY 31, 1996 AND 1995
Operating revenue increased 96% to $263.0 million for the fiscal year ended July 31, 1996 ("fiscal 1996") from $134.1 million for the fiscal year ended July 31, 1995 ("fiscal 1995"). The increase in operating revenue is attributable to acquisitions and expanded product and service lines in existing areas of operation. During fiscal 1996, the Company added 165 home care locations and operated 366 home care locations in 28 states as of July 31, 1996. The Company continues to employ a single sales force to maintain and develop both the home respiratory therapy, other medical equipment, home infusion therapy and other pharmacy related lines of business.
Operating revenue from home respiratory therapy and equipment increased 95% to $110.1 million for fiscal 1996 from $56.5 million for fiscal 1995. Operating revenue from home medical equipment and supplies increased 185% to $92.1 million for fiscal 1996 from $32.3 million for fiscal 1995. The increases in these two product lines were due mainly to increases in patient bases throughout the Company's locations and increased marketing efforts in certain locations acquired during fiscal year 1995 and 1996. The majority of the Company's acquisitions are of businesses that operate primarily in these two product lines.
Operating revenue from home infusion therapy and pharmacy related services increased 24% to $41.5 million for fiscal 1996 from $33.6 million for fiscal 1995.
Operating revenue from physician practices increased 65% to $19.4 million for fiscal 1996, from $11.7 million for fiscal 1995. The Company currently owns 24 physician practices and employs 29 primary care physicians. These practices are clustered in two rural marketplaces.
Cost of revenue as a percentage of operating revenue decreased to 27.0% for fiscal 1996 from 27.1% for fiscal 1995 due to changes in the product mix in the last year resulting from mid-year fiscal 1995 and fiscal 1996 acquisitions. Selling, general and administrative expenses as a percentage of operating revenue reduced to 48.4% for fiscal 1996 from 49.6% for fiscal 1995, as the revenue base has grown faster than the Company's costs. Changes in the Company's mix of business also affect these categories. For example, physician practices have no cost of revenue and all expenses are of a selling, general and administrative nature.
Depreciation and amortization expense increased 177% to $26.5 million for fiscal 1996 from $9.6 million for fiscal 1995. Depreciation and amortization expense as a percentage of operating revenue was 10.1% for fiscal 1996 and 7.1% for fiscal 1995. The dollar increase was attributable to the Company's purchase of fixed and intangible assets resulting from various acquisitions and the fixed assets needed for the increased rentals of equipment. All acquisitions in fiscal 1996 were accounted for by the purchase method for acquisitions.
Interest expense, net of interest income, increased to $5.2 million for fiscal 1996 from $835,000 for fiscal 1995. This increase resulted from the Company borrowing monies to fund certain acquisitions along with the issuance of the convertible subordinated debentures on June 1, 1996.
Income tax expense was provided at a 37.5% effective rate, compared to 37.2% the prior fiscal 1995.
Net income for fiscal 1996 was $20.6 million, a 56.4% increase over the $13.1 million for fiscal year 1995. Net income per share on a fully diluted basis increased 30.2% to $0.82 for fiscal 1996 compared to $0.63 for fiscal 1995. The weighted average number of shares on a fully diluted basis increased 20.1% to 25.2 million at July 31, 1996 from 21.0 million at July 31, 1995, primarily as a result of the May 1995 public stock offering and shares issued in conjunction with certain acquisitions.
LIQUIDITY AND CAPITAL RESOURCES
At July 31, 1997, total current assets were $152.1 million and total current liabilities were $212.0 million, resulting in a working capital deficit of $59.8 million. This deficit results from the classification of the Company's line of credit as a current liability. The Company's current ratio was 0.72 to 1 at July 31, 1997 compared to 1.47 to 1 at July 31, 1996. Net trade accounts receivable increased $28.9 million in fiscal 1997, or 35%. This increase is attributable to acquisitions of the net assets of many home health care companies during the year and the 61% increase in operating revenue over the prior year. The Company's days revenue outstanding on net accounts receivable decreased to 81 days at July 31, 1997 from 92 days at July 31, 1996. Acquired receivables remaining outstanding account for approximately 11 days revenue outstanding at July 31, 1997 compared to 16 days revenue outstanding at July 31, 1996.
Current liabilities increased $135.5 million in fiscal 1997, as an additional $129 million was borrowed on the syndicated bank line of credit. The balance of the change was due to income taxes payable.
During fiscal 1997, the Company generated cash of $70 million from operating activities primarily as a result of net income of $30.8 million along with non-cash expenses of $73 million. Advances on the syndicated bank line of credit were utilized to fund acquisitions and internal expansion. During fiscal 1997, the Company spent $137 million to acquire various home health care companies and $56 million to purchase property and equipment, primarily rental equipment, for operational needs. The Company has been financing its revenue growth and increased working capital requirements with positive net cash provided by operating activities and short-term borrowings.
On June 1, 1996, the Company issued $110 million aggregate principal amount of 5 1/4% convertible subordinated debentures ("debentures"). Upon receipt, the proceeds were used to reduce the syndicated bank line of credit. The debentures are due 2003 with interest payable on June 1 and December 1, commencing December 1, 1996. The debentures do not provide for a sinking fund. The Debentures were converted into Common Stock of the Company at any time after the 60/th/ day following the date of original issuance of the debentures and at or before maturity at a conversion price of $26.25 per share, subject to adjustment in certain events, plus accrued interest. As a result of the Merger, the debentures are converted into IHS Common Stock at a conversion price of $45.21 per share, subject to adjustments in certain circumstances. The Debentures are redeemable at the option of the Company, in whole or in part, but not before June 4, 1999. The Company's ability to repurchase the Debentures is dependent upon the Company's having sufficient funds and may be limited by the terms of the Company's senior indebtedness or the subordination provisions of the related indenture.
As of July 31, 1997, the Company had a syndicated bank line of credit of $300 million, with approximately $113.5 million available for future borrowing, as of September 16, 1997. The syndicated bank line of credit carries a negative pledge on all Company assets, is payable on demand and provides for interest rates, at the Company's election, of LIBOR plus .75%. The syndicated bank line of credit requires compliance by the Company with certain financial and negative covenants, including a restriction on dividends. As of July 31, 1997, the Company was in compliance with all covenants contained in the credit facility. In connection with the Merger, the credit facility was paid in full and terminated. Management believes that its credit capacity and cash flow from operations, will be sufficient for the Company's projected growth in the near future.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------
Financial Statements: - ---------------------
The information required by this item is set forth on page 1 through 20 in the Company's Annual Report to Shareholders for the fiscal year ended July 31, 1997, and is hereby incorporated by reference.
Selected Quarterly Consolidated Financial Data: - -----------------------------------------------
The supplementary financial information is set forth on page __ on the Company's Annual Report to Shareholders for the fiscal year ended July 31, 1997, and is hereby incorporated by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ----------------------------------------------------------------------- FINANCIAL DISCLOSURE - --------------------
Not Applicable
PART III --------
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------
As of July 31, 1997, the following were directors of the Company:
The company has established an Executive Committee consisting of William P. Kennedy, Stephen P. Griggs and William A. Walker, II; a Stock Option Plan Committee consisting of William A. Walker II, a Compensation Committee consisting of William A. Walker II and Leonard E. Williams; an Audit Committee consisting of William A. Walker II, Leonard E. Williams and Jack T. Weaver, D.O. and a Nominating Committee consisting of William A. Walker II and Leonard E. Williams. During the company's fiscal year ended July 31, 1997, its Audit Committee held two (2) meetings and each committee member attended such meeting. Also, during the Company's fiscal year ended July 31, 1997, the Company's Board of Directors held four meetings, and a quorum of directors was present at each meeting.
The following persons are executive officers (but not directors) of the Company:
On October 21, 1997, the shareholders of the Company approved a merger with Integrated Health Services, Inc. see Item 4. As a result, the following are the executive officers and directors of RoTech Medical Corporation as of October 21, 1997:
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION - --------------------------------
The following table sets forth the annual and long-term compensation for the Company's Chief Executive Officer at July 31, 1997 and the only executive officers at July 31,1997 whose aggregate salary and bonus compensation exceeded $100,000, as well as the total compensation paid to each individual for the Company's previous two fiscal years:
See "Item 13. Certain Relationships and Related Transactions" for information with respect to payments to companies wholly or partially owned by Mssrs. Griggs and Kennedy.
In connection with and as a condition to the Merger, Mr. Griggs will enter into a five-year agreement with RoTech whereby he will serve as President of RoTech at a base salary of $500,000 per annum. Under his employment agreement, Mr. Griggs will receive a $500,000 bonus in each year in which RoTech's net income contribution to IHS equals or exceeds specified targets, with an additional bonus determined by IHS to be paid if the net income contribution target is exceeded. In addition, in connection with the Merger Mr. Griggs will receive a one-time cash sign-on bonus of $3.5 million, payable at Closing, and be issued warrants to purchase 750,000 shares of IHS Common Stock on the NYSE for the 15 business days prior to the Closing Date (subject to acceleration upon Mr. Grigg's death or the occurrence of a change in control of IHS). Pursuant to a related agreement, RoTech will also be obligated to pay to Mr. Griggs the amount of any excise tax payable by him under Section 4999 of the Code (or any corresponding provisions of state or local tax law) as a result of any payments to him pursuant to his employment agreement or in connection with the Merger, as well as the income tax and excise tax on such additional compensation such that, after the payment of income and excise taxes, Mr. Griggs is in the same economic position in which he would have been if the provisions of Section 4999 of the Code (or any corresponding provisions of state of local tax) had not been applicable.
On October 21, 1997, the shareholders of the Company approved a merger with Integrated Health Services, Inc. whereby each share of common stock and each stock option was converted to .5806 shares of IHS stock. Therefore, further information regarding executive stock options is considered not applicable.
1996 Key Employee Stock Option Plan
On April 1, 1996, the Board of Directors adopted a non-qualified stock option plan under the name "1996 Key Employee Stock Option Plan". The provisions of this plan are identical to the 1993 stock option plan, except that the total number of shares subject to the 1996 plan, post stock split, is 1,000,000 shares. The 1996 Key Employee Stock Option Plan is intended to not qualify as an "Incentive Stock Option Plan" as that term is described in the Federal Internal Revenue Code of 1986, as amended.
Key Man Life Insurance
The Company currently maintains a split dollar key life insurance policy on the life of Mr. Kennedy in the face amount of $10,000,000. The beneficiaries of the policy are Mr. & Mrs. Kennedy's designated heirs pursuant to an irrevocable trust established by Mr. Kennedy. The company shall have the unqualified right to receive a portion of the death benefit equal to the greater of the total amount of premiums paid by the Company or the cash surrender value of the policy reduced by any outstanding indebtedness on the policy.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------
As of October 21, 1997, RoTech was acquired by Integrated Health Services, Inc. and all shares of RoTech common stock were converted to .5806 of Integrated Health Services, Inc. common stock. All shares of RoTech Common Stock are now owned by IHS.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------
The Company leases office space in a building located at 942 S.E. 17th Street, Ocala, Florida, a building in which Mr. Kennedy owns an undivided one-half interest. Such lease is a month-to month lease providing for monthly rental payments of approximately $1,500. Aggregate payments made by the Company under such lease during fiscal 1997 were approximately $18,000.
The Company purchased approximately $711,000 of products from companies owned by Mr. Kennedy in fiscal 1997. Companies owned by Mr. Kennedy purchased approximately $11,000 of products from the Company.
A & C Business Services, Inc., a Florida corporation, of which Mr. Kennedy is the sole shareholder, provides certain business services to the Company. The cost of such services to the Company during fiscal year 1996 amounted to approximately $203,000.
L&G of Orlando, Inc., a Florida corporation, of which Mr. Griggs is a shareholder, provides certain business services to the Company. The cost of such services to the Company during fiscal year 1997 amounted to approximately $301,000.
Mr. Walker, the former Secretary and a former Director of the Company, is a shareholder, director, assistant secretary, assistant treasurer and a member of the Executive Committee of Winderweedle, Haines, Ward & Woodman, P.A. ("WHWW"), a law firm with offices in Winter Park and Orlando, Florida. This law firm is general counsel to the Company and each of its subsidiaries and was paid approximately $362,000 in fiscal 1997. WHWW entered into a stock option agreement ("Agreement") with the Company on July 1, 1995. The Agreement grants WHWW the unassignable and non-transferable right and option to purchase from the Company up to, but not exceeding in the aggregate, 20,000 shares of the Company's common stock, par value $.0002, at an option price of $13.88. Any options not exercised on or before June 30, 2000 terminate on such date and are null and void.
As a result of the Merger, the options represent the right to purchase 11,612 shares of IHS Common Stock at $23.91 per share and 11,612 shares of IHS Common Stock at $33.59 per share.
In the opinion of management, each of the foregoing transactions with officers, directors, principal shareholders or affiliates were on terms no less favorable to the Company than terms available from persons not affiliated with the Company. The terms of any future transactions with officers, directors, principal shareholders or affiliates will be no less favorable to the Company than those which could be obtained from unaffiliated parties, and any future transactions with affiliated parties, including loans to Company officers, will be approved by a majority of the independent and disinterested members of the Company's Board of Directors.
PART IV -------
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - --------------------------------------------------------------------------
(a) Documents filed as part of this report:
1. Financial Statements: The audited consolidated balance -------------------- sheets of the Registrant and subsidiaries as of July 31, 1997 and July 31, 1996, and the related consolidated statements of income, changes in stockholders' equity and cash flows of the Registrant and subsidiaries for the three fiscal years ended July 31, 1997, are set forth on pages 1 through 20 of the Registrant's Annual Report to Shareholders for the fiscal year ended July 31, 1997, which statements are incorporated in this report by reference.
2. Financial Statement Schedules. The following Financial Statement ----------------------------- Schedule for the fiscal years ended July 31, 1997, 1996, and 1995 is set forth under the heading "Financial Statement Schedule" on page 21 of the Company's Annual Report to Shareholders for the fiscal year ended July 31, 1997 and is hereby incorporated by reference.
Schedule II Valuation and Qualifying Accounts for the fiscal years ended July 31, 1997, 1996 and 1995
All other schedules are omitted because they are not required, are not applicable, or the required information is included in the Consolidated Financial Statements or notes thereto.
(a) 3. Exhibits. The exhibits filed as a part of this Report are listed in -------- the attached Index to Exhibits.
(b) Reports on Form 8-K filed in the fourth quarter of fiscal 1997. --------------------------------------------------------------
Current Report on Form 8-K dated May 28, 1997 reporting the settlement with the U.S. Attorney for the Middle District of Florida in a civil action relating to Medicare claims the United States Government believes it erroneously paid between 1987 and 1989;
Current Report on Form 8-K dated July 6, 1997 reporting the execution of the Merger Agreement; and
Current Report on 8-K dated September 17, 1997 reporting earnings for the fourth quarter and year ended July 31, 1997; and
Current Report on 8-K dated October 21, 1997 reporting the completion of the merger with Integrated Health Services.
Index to Exhibits
Except as otherwise indicated, the following Exhibits are incorporated by reference as a part of this Report on Form 10-K:
4.1 Form of Stock Certificate. (Incorporated by reference to Exhibit 4.1 to the Company's Registration Statement No. 33-8711 of Form S-1.)
4.2 Indenture dated as of June 1, 1996, between the Company and PNC Bank, Kentucky, Inc. (Incorporated by reference to Exhibit 4.1 to the Company's Registration Statement No. 333-10915 on Form S-3).
10.1 Form of Registrant's 1986 Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10.5 to the Company's Registration Statement No. 33-8711 of Form S-1.)
10.2 Amended and Restated Revolving Credit and Line of Credit Agreement, dated June 4, 1996, by and among RoTech Medical Corporation, and SunTrust Bank, Central Florida, National Association, individually as an Agent, Nationsbank of Florida, N.A., NBD Bank, PNC Bank, Kentucky, Inc., Barnett Bank of Central Florida, N.A. and Cooperatieve to be Centrale Raiffeisen-Boerenleenbank B.A., "Rabobank Nederland", New York Branch, filed herewith.
10.3 Form of Registrant's Incentive Compensation Plan (Incorporated by reference to Exhibit 10.3 to the Company's Registration Statement No. 33-41097 of Form S-2.)
10.4 Form of Registrant's Restricted Stock Plan for Non-Employee Directors (Incorporated by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 1992.)
10.5 Form of Registrant's July 9, 1993 Stock Option Plan, (Incorporated by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 1994.)
10.6 Form of Registrant's Amended Restricted Stock Plan for Non-Employee Directors (Incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 1995.)
10.7 RoTech Medical Corporation 1996 Key Employee Stock Option Plan (Incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 1996.)
11.0 Computation of Earnings Per Share (Incorporated by reference to Exhibit 11.0 to the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 1996.)
13.1 Annual report to security holders, filed herewith.
22.1 Subsidiaries of Registrant (Incorporated by reference to Exhibit 22.1 to the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 1996.)
Joint Proxy Statement of Integrated Health Services, Inc. and RoTech Medical Corporation for the Special Meeting of Shareholders to be held on October 21, 1997.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, RoTech Medical Corporation has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
ROTECH MEDICAL CORPORATION, a Florida corporation
By: /s/ Stephen P. Griggs ----------------------- Stephen P. Griggs, President
Date:
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.