ITEM 1. BUSINESS
GENERAL
Summit Care Corporation (the "Company") principally operates skilled nursing care centers and assisted living centers located in California, Texas and Arizona. The skilled nursing care centers provide subacute, rehabilitative, specialty medical and skilled nursing care. The assisted living centers provide room and board, social and minor medical services in a secure environment and, in selected situations, provide care to early stage Alzheimer's residents. The Company also operates pharmacies which service skilled nursing care centers, assisted living centers and acute hospitals, both affiliated and non-affiliated in Southern California and Texas. In addition, the Company manages subacute care units in acute hospitals. The Company is incorporated under the laws of the State of California.
At June 30, 1997, the Company operated 35 skilled nursing care centers with 4,631 beds. Thirteen centers are in California with 1,515 beds; twenty-one centers are in Texas with 2,966 beds and one center in Arizona with 150 beds. Within its skilled nursing care centers, the Company has established separate units for specialty medical care and subacute: fifteen units are dedicated to Alzheimer's and 35 units for patients requiring services for such complex medical needs as oncology, pulmonary cardiac complications, wounds, respiratory therapy and intensive physical, speech and occupational therapies.
At fiscal year end, the Company operated four assisted living centers with 409 beds in California and opened a fifth center with 66 beds on July 1, 1997. Included in three of the centers are units dedicated to the needs of early stage Alzheimer's residents.
At June 30, 1997, the Company operated two pharmacies in Southern California and through a joint venture, operates one in Texas. The pharmacies provide pharmaceutical products and services to 86 non-affiliated skilled nursing care centers, assisted living centers and acute hospitals located in Southern California and Texas. The pharmacies also provide products and services to the Company's skilled nursing care and assisted living centers. The Company manages subacute units in three acute hospitals.
During fiscal year 1997, the Company opened 261 new beds in two skilled nursing care centers, and on July 1, 1997, opened another 66 new beds in an assisted living center. An existing center in Fresno, California, with 108 beds was expanded to 159 beds in July 1996. This center offers services to Alzheimer's residents in 47 beds and to subacute/skilled nursing residents in 112 beds. In August 1996, 110 beds in a newly constructed skilled nursing care center in Fort Worth, Texas were opened and in June 1997 were increased to 210 beds. The 66 beds opened on July 1, 1997 are in a new assisted living center dedicated to Alzheimer's residents situated on a campus in Orange, California, with a 172-bed skilled nursing care center and an assisted living center with 72 beds.
In addition, construction is in progress to open 47 new beds in a skilled nursing care center currently with 114 beds including 26 Alzheimer's beds. It is presently estimated that the new beds will be open in October 1997.
The growth in the number of centers and beds by acquisition and construction is shown in the following table:
* Centers and beds planned to open in fiscal 1998.
** One center with 88 beds was purchased in July 1996 upon exercise of an option to purchase and another center with 111 beds was purchased in September 1997 upon exercise of an option to purchase.
In April 1994, OrNda HealthCorp ("OrNda") acquired the Company's then majority shareholder, Summit Health, Ltd. ("SHL"). OrNda owned 7.5% Exchangeable Subordinated Notes ("OrNda Notes") exchangeable into all of its equity interest in the Company's common stock, at the option of the holders. In August 1995, OrNda redeemed 100% of the outstanding OrNda Notes in exchange for all of its equity interest in the Company's common stock. OrNda currently has no position in the Company's common stock. In January 1997, OrNda was merged into Tenet Healthcare Corporation ("Tenet").
In December 1995, the Company issued $55 million of Senior Secured Notes ("New Notes") and in July 1996, issued another $15 million of New Notes. The New Notes are payable as follows:
The annual fixed interest rate on each New Note ranges from 7.38% on the earliest maturing New Note to 8.14% on the last New Note to mature and averages 7.8% when weighted. The New Notes are secured by certain real estate in a collateral pool shared, on the basis of dollars committed, with the investors holding the Company's $25 million Senior Secured Notes and the lenders under the Company's $40 million bank line of credit. Proceeds from the New Notes were used to payoff bank debt of $55,000,000, for $12,978,000 in construction of new beds and $2,022,000 for the exercise of a purchase option for a skilled nursing center in July 1996. Concurrent with the issuance of the New Notes, the Company reduced its bank line of credit from $60,000,000 to $40,000,000 at more favorable interest rates and reduced the bank line's repayment period following the revolving commitment from four years to three years.
In December 1996, the Company entered into a limited liability company ("LLC") agreement to operate a pharmacy in Austin, Texas. The purchase price for its 50% membership interest was $1,565,000 in cash. The pharmacy is servicing nursing care centers in Texas operated by either the Company, the other LLC member or non-affiliated nursing center owners.
SUBSEQUENT EVENTS. The Company exercised its purchase option in a lease of a 111-bed skilled nursing care center in Texas in September 1997 for $1,871,000 in cash.
OPERATIONS
The Company provides long-term care services at its skilled nursing care centers, assisted living centers and pharmacies, and manages such services at acute hospitals. Long-term care services provided by the Company are of five types.
SKILLED NURSING CARE. Skilled nursing care is offered in each of the Company's 35 skilled nursing care centers and at the three hospital-based units managed by the Company. Skilled nursing care services consist of round-the-clock care by registered nurses, licensed practical or vocational nurses and certified aides, room and board, special nutritional programs and related medical or other services that may be prescribed by a physician. Each skilled nursing care center has one or more physicians acting as medical director and has agreements with hospitals for the transfer of patients requiring emergency treatment. Each center also has a licensed administrator responsible for all activities in the skilled nursing center and a director of nursing responsible for nursing services.
The Company has a corporate quality assurance department whose licensed nurses, dietitians and medical records technicians supervise services in the skilled nursing care centers. The Company is seeking to become accredited by the Joint Commission on Accreditation of Health Care Organizations in each of its centers. Accreditation has been achieved at the six centers surveyed by the Commission to date and six additional centers are scheduled at this time for survey.
The Company believes education, training and development provide tools that enhance the effectiveness of its employees. The Company's administrators, directors of nursing and department supervisors are trained to recruit employees who meet specific standards. All employees attend a 16-hour general orientation. Administrators and department supervisors receive at least 40 hours of training annually. Other personnel receive twelve hours of training annually, primarily in customer service. Clinical training for licensed nurses, including supervision skills, is conducted by the Company to ensure each licensed nurse meets the skill competency standards. An eight-hour quality improvement program is conducted at each center for employees at all levels in the center on a yearly basis.
REHABILITATIVE CARE. Rehabilitative care is provided in each of the Company's 35 skilled nursing care centers by outside contractors. Rehabilitative care consists of respiratory, physical, speech and occupational therapies and are provided by therapists generally assigned to each center. The Company provides management and oversight of each center's rehabilitative care through the use of corporate therapists and therapy administration.
SUBACUTE AND SPECIALTY MEDICAL SERVICES. The Company continues to focus on extending its specialty and subacute services as a means of increasing revenues and operating margins. Such services are generally reimbursed at rates higher than those for routine skilled nursing care and basic assisted living services. The services allow the Company to treat a greater range of patient acuities, which the Company believes results in increased occupancy at its centers. The Company's goal is to offer care to patients of the highest acuity level permitted by a center's physical plant and employee skill levels. Each skilled nursing care center is certified for participation in the Medicare reimbursement program and contracts with a physician as medical director who has a practice specialty related to the subacute or specialty medical services offered at the center.
The Company provides wound care, hospice care, oncology services, pulmonary cardiac services, infection control, pain management and infusion, enteral nutrition therapy and other specialty medical services in separate units at all of its skilled nursing care centers. Also, the Company operates units for the care of residents in various stages of Alzheimer's. There currently are eighteen Alzheimer's units (fifteen in skilled nursing care centers and three in assisted living centers) with a total of 617 beds and 35 units with 899 beds providing subacute and specialty medical services.
PHARMACEUTICAL PRODUCTS AND SERVICES. The Company provides pharmaceutical products and services through the operation of two pharmacies in Southern California and another in Texas. The pharmacies service 86 non-affiliated skilled nursing care centers, assisted living centers and acute hospitals located in Southern California and Texas, as well as all of the Company's skilled nursing care and assisted living centers. Pharmacists are on call 24 hours a day to ensure the availability of medication whenever it is needed. The pharmacies provide prescription drugs, enteral nutrition therapy services and infusion therapy services, including nutrition, pain management, antibiotic and hydration.
ASSISTED LIVING SERVICES. The five assisted living centers operated by the Company are located in California and have 475 beds, with 194 beds in three of the centers dedicated to early stage Alzheimer's. Aside from the Alzheimer's units, assisted living services consist of basic room and board, social activities and assistance with activities of daily living such as dressing and bathing. The Company has purchased vacant land in Texas for future development and operation of assisted living centers.
SOURCE OF REVENUE. The Company's skilled nursing care centers receive payment for health care services from federally assisted Medicaid programs, from the federal Medicare program, from programs operated by preferred provider organizations, health maintenance organizations, the Veterans Administration and directly from patients or their responsible parties or insurers. The assisted living centers receive payment entirely from private individuals, some of whom depend upon supplemental Social Security payments as their primary source of income. The following table sets forth for the Company's skilled nursing care and assisted living centers the approximate percentages of gross revenues (excluding revenues from operation of the pharmacies) derived from the various sources of payment for the period indicated.
Changes in the quality mix between Medicaid and either Medicare, managed care or private pay can significantly affect profitability. Quality mix represents revenues from Medicare, managed care and private pay patients as a percentage of gross revenues excluding pharmacy revenues. Medicare, managed care and private pay patients constitute the most profitable categories and Medicaid patients the least profitable. The Company has consistently maintained a high ratio of Medicare, managed care and private pay patients relative to Medicaid patients; however, no assurance can be given that the Company's quality mix will not change.
Specialty medical, subacute, rehabilitative and pharmacy revenues generally represent the most profitable types of services because the principal payors for such services are Medicare and managed care and, in the case of pharmacy revenues, the skilled nursing care centers. The following tables set forth the approximate percentages of gross revenues and the amounts for these types of revenues:
The pharmacy revenues in the above tables exclude revenues from affiliated skilled nursing care and assisted living centers. While the Company has consistently maintained a high percentage of specialty medical, subacute, rehabilitative and pharmacy revenues relative to total gross revenues, no assurance can be given that these high percentages will not change.
EMPLOYEES. At June 30, 1997, the Company had approximately 4,200 full-time equivalent employees. None of the Company's employees are covered by collective bargaining agreements and the Company considers the relations with its employees to be good. The Company is subject to both federal and state minimum wage and applicable federal and state wage and hour laws and maintains various employee benefit plans.
As a result of increases in the specialty and subacute services provided by the Company (which require greater expenditures for equipment, supplies and independent contractor clinicians than basic nursing services, but which generally yield a higher margin), salaries and related employee benefits as a percentage of operating expenses have decreased during the last three years. Salaries and related employee benefits accounted for approximately 50%, 53% and 56% of the Company's expenses (excluding rental, depreciation and amortization and interest) for fiscal years 1997, 1996 and 1995, respectively.
COMPETITION. The Company operates in a highly competitive industry. The Company's skilled nursing care and assisted living centers are located in communities that also are served by similar centers operated by others. Some competing centers provide services not offered by the Company and some are operated by entities having greater financial and other resources than the Company. In addition, some are operated by non-profit organizations or government agencies supported by endowments, charitable contributions, tax revenues and other sources not available to the Company. Furthermore, cost containment efforts, which encourage more efficient utilization of acute care hospital services, have resulted in decreased hospital occupancy in recent years. As a result, a significant number of acute care hospitals have converted portions of their facilities to other purposes, including specialty and subacute units. In California, Texas and Arizona a certificate of need is no longer required in order to build or expand a nursing center, which is another factor increasing competition. However, in Texas, competition is limited by restrictions on the number of beds that can be enrolled in the Medicaid program. The Company's pharmacies also operate in a highly competitive environment and compete with regional and local pharmacies, medical supply companies and pharmacies operated by other long-term care chains. The Company also may encounter competition in acquiring or developing new centers.
INSURANCE. The Company maintains general and professional, property, casualty, health, directors and officers, automobile, crime, employee's and workers' compensation coverage that the Company believes is adequate. The Company's workers' compensation insurance for its California and Arizona employees is funded by Company payments to a rental captive insurance company. The funds received by the insurance company pay for claims up to $250,000 per claim and for the purchase of reinsurance coverage for amounts in excess of the per claim limit and for annual aggregate claim amounts in excess of audited premiums. Texas employees are covered by a policy for employer's excess and occupational indemnity for risks in excess of $150,000 up to $1,000,000 per occurrence and no annual aggregate stop loss. The Company pays for claims up to $150,000 per occurrence.
The Company's services subject it to liability risk. Malpractice claims may be asserted against the Company if its services are alleged to have resulted in patient injury or other adverse effects, the risk of which is greater for higher acuity patients, such as those treated by the Company's specialty and subacute services, than for traditional long-term care patients. The Company has from time to time been subject to malpractice claims and other litigation in the ordinary course of its business. While the Company believes that the ultimate resolution of all pending legal proceedings will not have a material adverse effect on the Company's business or financial condition, there can be no assurance that future claims will not have such an effect on the Company. Its current policy for general and professional liability coverages is a claims-made policy and has limits of $500,000 per occurrence and $1,000,000 in the aggregate per year and carries a self-insured retention of $100,000 per occurrence and a $600,000 annual aggregate loss limit. In addition, the Company has a claims-made umbrella policy
which provides additional insurance of $8,500,000 per occurrence and $8,500,000 aggregate per year over its primary general and professional policy, its automobile liability policy and its employer liability policy.
Although the Company has not been subject to any judgments or settlements in excess of its insurance limits, there can be no assurance that claims for damages in excess of its coverage limits will not arise in the future.
REGULATION
LICENSURE. The Company's skilled nursing care centers, assisted living centers and pharmacies are subject to various regulatory and licensing requirements of state and local authorities in California, Texas and Arizona. Each skilled nursing care center is licensed by either the California Department of Health Services, the Texas Department of Human Services or the Arizona Department of Health Services, as applicable. Each assisted living center is licensed by the California Department of Social Services and the pharmacies are licensed by the California Board of Pharmacy. All licenses must be renewed annually, and failure to comply with applicable rules, laws and regulations could lead to loss of licenses. In granting, monitoring and renewing licenses, these agencies consider, among other things, the physical condition of the facility, the qualifications of the administrative and nursing staffs, the quality of care and the compliance with applicable laws and regulations. In addition to a variety of state licensing and other laws governing the storage, handling, sale or dispensing of drugs, and the supervising of a duly licensed pharmacist, the pharmacies are subject to federal regulation under the Food, Drug and Cosmetic Act and the Prescription Drug Marketing Act. Moreover, the Company is required to register its pharmacies with the United States Drug Enforcement Administration, and to comply with requirements imposed by that agency with respect to security and reporting of inventories and transactions. Such regulatory and licensing requirements are subject to change, and there can be no assurance that the Company will continue to be able to maintain necessary licenses or that it will not incur substantial costs in doing so. Failure to comply with licensing requirements could result in the loss of the right to payment by Medicare or Medicaid as well as the right to conduct the business of the licensed entity.
REIMBURSEMENT. The Company's skilled nursing care centers are subject to various requirements for participation in government-sponsored health care funding programs, such as Medicare and Medicaid. To receive Medicare and Medicaid payments, each center must also comply with a number of rules regarding charges and claims procedures, the violation of which can result in denial of reimbursement. Medicare is a health insurance program operated by the federal government for the aged and certain chronically disabled individuals. Medicare utilizes a cost-based reimbursement system for free-standing nursing facilities which, subject to limits fixed for the particular geographic area on the costs for routine services (excluding capital related expenses), reimburses nursing facilities for reasonable direct and indirect allowable costs incurred in providing services (as defined by the program). Effective October 1, 1993, nursing facilities are no longer paid a return on equity under Medicare. Allowable costs normally include administrative and general costs, as well as operating costs and rental, depreciation and interest expenses. Reimbursement is subject to retrospective audit adjustment. An interim rate based upon estimated costs is paid by Medicare during the cost reporting period and a cost settlement is made following an audit of the actual costs as reported in the filed cost report. Such adjustments may result in additional payments being made to the Company or in recoupments from the Company. The Company maintains reserves to cover retroactive audit adjustments. To the extent that the Company's costs exceed certain limits known as the Medicare Routine Cost Limits, the Company may submit exception requests seeking reimbursement for such excess costs from Medicare. To date, the Company has filed three exception requests. Approval has been received on two and the other is subject to the government completing their review of a reopened Medicare cost report for fiscal year 1995. There is no assurance the Company will be able to recover such excess costs under the pending request or any future requests. If the Company files exception requests on a regular basis in the future and fails to recover the excess costs covered by such requests, such failure could adversely affect the Company's financial position and results of operations. In addition, the Company purchases respiratory therapy services and physical therapy services and is subject to payment limits for such therapy services imposed by Medicare. To the extent the Company's actual costs exceed such payment limits, the excess costs will be denied. Occupational therapy and speech therapy services are purchased by the Company from third-party vendors and are not subject to specific Medicare payment limits; however, proposed regulations have been issued which, if adopted, may result in the disallowance of a portion of such costs by the Medicare program in the future. To the extent that costs of therapy services exceed payment limits and are disallowed by Medicare, the Company has contractual arrangements with third-party vendors to recover such costs from the vendors. Medicare will reimburse charges for certain products, such as enteral and parenteral nutrition, provided by a pharmacy directly to Medicare beneficiaries who are not eligible for inpatient services based on a fee screen amount. Finally, under proposed legislation and proposed action by the Health Care Financing Administration, Medicare payments to skilled nursing facilities may be changed from cost reimbursement to a prospective payment system. Under proposals currently being considered, each skilled nursing center would receive the same rate for each day of skilled nursing care, subject to adjustments
for the facility's case mix and the area wage index period. The impact on the Company of payments under a prospective payment system is not known.
Medicaid is a medical assistance program for the indigent, operated by individual states with financial participation by the federal government. California, Texas and Arizona each have Medicaid programs. While the California, Texas and Arizona programs differ in certain respects, all are subject to federally imposed requirements. Approximately 50% of the funds available under the California program, approximately 63% of the funds available under the Texas program and approximately 66% of the funds available under the Arizona program are provided by the federal government under a matching program.
Under Medi-Cal, California currently provides for reimbursement of most routine and ancillary services at free-standing skilled nursing care centers at a flat daily rate, as determined by the California Department of Health Services, based on median costs of skilled nursing care centers, classified by number of beds and geographic location. Under its Medicaid program, Texas currently provides for reimbursement at a flat daily rate, as determined by the Texas Department of Human Services, based on the combination of the mean costs, median costs and appraised value of assets of skilled nursing care centers, classified by the required level of patient care. The Texas legislature has enacted legislation requiring the Department of Human Services to base its Medicaid payments for long-term care on minimum data sets. It is unclear at the present time how the Department will implement changes from the current Texas Index of Level of Effort (TILE) system to use of minimum data sets. Arizona has adopted a managed care approach to providing skilled nursing and other kinds of care to the indigent. Under the Arizona system, beneficiaries enroll in a managed care plan in their area. That managed care plan, which is responsible for providing 90 days of inpatient skilled nursing care, contracts with nursing facilities to provide varying degrees of care, depending upon the needs of the beneficiaries, at negotiated, per diem rates. After the 90 days of skilled nursing care coverage has been exhausted, the beneficiary is enrolled in a county-operated managed care plan, which also pays skilled nursing care centers based on a negotiated per diem rate for each of two levels of service.
California and Texas Medicaid programs reimburse a pharmacy for drugs supplied to patients based on the cost of the drug plus an additional amount which varies depending on the type of drugs supplied.
Effective October 1, 1990, the Omnibus Budget Reconciliation Act of 1987 ("OBRA 87") was implemented. Among other things, it eliminated the different certification standards for "skilled" and "intermediate care" nursing facilities under the Medicare and Medicaid programs in favor of a single "nursing facility" standard. OBRA 87 also mandated an increase in the level of services nursing centers must provide in order to participate in Medicare and Medicaid. This change, the cost of which was partially offset by Medicaid rate increases in California, Texas and Arizona and an increase in the routine cost limits under Medicare, thus far has not had a significant impact on the Company.
OBRA 87 also requires that substantial additional regulations be promulgated, covering, among other things, licensure requirements for administrators, enforcement policies and procedures and the use of restraints and certain drugs. While the Company believes that it is in substantial compliance with the current requirements of OBRA 87, it is unable to predict how future interpretation and enforcement of regulations promulgated under OBRA by the state and federal governments may affect the Company in the future.
Governmental funding for health care programs is subject to statutory and regulatory changes, administrative rulings, interpretations of policy, determinations by intermediaries and governmental funding restrictions, all of which may materially increase or decrease program reimbursement to health care centers. Since 1972, Congress has consistently attempted to curb federal spending on such programs. Recent actions include limitations or freezes on payments to skilled nursing care centers under the Medicare and Medicaid programs. The Company expects that there will continue to be a number of state and federal proposals to limit Medicare and Medicaid reimbursement for health care services. The Company cannot at this time predict whether any of such proposals will be adopted and no assurance can be given that future funding levels of Medicare and Medicaid programs will remain comparable to present levels. Reimbursement limits or other changes in the reimbursement policies as a result of budget cuts or other government action could materially and adversely affect the Company's results of operations. See "Pending Matters That Affect Health Care Operations," discussed below. In addition, in California, the Department of Health Services intends to shift Medi-Cal beneficiaries in selected service areas into managed care plans. If this occurs in the service areas of the Company's centers and if the plans call for covering long-term care, it could have a substantial unfavorable impact on the Company's revenues.
In addition, the Company's cash flow could be materially adversely affected by periodic government program funding delays or budgetary shortfalls. The Company received approximately 9% of its revenues during the fiscal year ended June 30, 1997 from Medi-Cal. Medi-Cal delayed payments for approximately 30 days in 1997 and 1991 and nursing center rate
increases for several months in 1991 and for approximately 30 days in 1992. The Company believes that it will be able to cover any Medi-Cal payment delays that may occur in the future from cash on hand or by borrowing under its $40,000,000 bank line of credit. However, given the percentage of the Company's revenues derived from Medi-Cal, there can be no assurance that rate freezes or future delays in payments from Medi-Cal will not have a material adverse effect on the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
While federal statutes do not provide states with authority to curtail funding of Medicaid reimbursement programs solely due to budget deficiencies, some states nevertheless have curtailed funding for this reason. No assurance can be given that they will not continue to do so or that future funding levels of Medicaid programs will remain comparable to present levels. On June 16, 1990, the United States Supreme Court ruled that health care providers may bring suit in federal court to enforce the Medicaid Act's requirement that the states reimburse skilled nursing care centers at rates adequate to cover the costs of efficiently and economically operated centers. Operators of skilled nursing care centers have used the federal courts to require California and Texas to adequately fund their Medicaid programs.
COMPLIANCE. The Company believes that its centers are in substantial compliance with the various applicable regulatory and licensing requirements of state and local authorities in California, Texas and Arizona, and of the Medicare and Medicaid programs. In the ordinary course of its business, however, the Company from time to time receives notices from state and federal agencies of failure to comply with various requirements. The Company endeavors to take prompt corrective action and, in most cases, the Company and the reviewing agency agree on remedial steps. The reviewing agency may also take action against a center, which can include the imposition of fines, denial of payment for new patients at the center, decertification and loss of participation in the Medicare or Medicaid programs and, in extreme circumstances, revocation of a center's license. In certain circumstances, certain egregious failures to comply by one or more centers with program rules may subject the Company's centers to exclusion from participation in the Medicare and Medicaid programs.
ANTI-KICKBACK LAWS. The Company is also subject to federal and state laws which govern financial and other arrangements between health care providers. Federal law, as well as the law in California, Texas and Arizona and other states, prohibits direct or indirect payments in some cases or fee-splitting arrangements between health care providers that are designed to induce or encourage the referral of patients to, or the recommendation of, a particular provider for medical products and services. These laws include the federal "Anti-kickback law" which prohibits, among other things, the offer, payment, solicitation or receipt of any form of remuneration in return for, or to induce, the referral of Medicare and Medicaid patients. A wide array of relationships and arrangements, including ownership interests in a company by persons who refer or are in a position to refer patients, as well as personal service agreements have, under certain circumstances, been alleged or have been found to violate these provisions. Certain arrangements, such as the provision of services for less than fair market value compensation, may also violate such laws. Because of the law's broad reach, the federal government has published regulations, known commonly as "safe harbors," which set forth the requirements under which certain relationships will not be considered to violate the law. One of these safe harbors protects investment interests in certain large publicly traded entities which meet certain requirements regarding the marketing of their securities and the payment of returns on the investment. A second safe harbor protects payments for management services which are set in advance at a fair market rate and which do not vary with the value or volume of services referred, so long as there is a written contract which meets certain requirements. A safe harbor for discounts, which focuses primarily on appropriate disclosure, is also available. A violation of the federal Anti-kickback law and similar state law could result in the loss of eligibility to participate in Medicare or Medicaid, or in criminal penalties.
In addition, the federal government and some states restrict certain business relationships between physicians and other providers of health care services. OBRA 93 contained provisions which greatly expanded the then existing federal prohibition on physician referrals to entities with which a physician has a financial relationship. Effective January 1, 1995, OBRA 93 has prohibited any physician with a financial relationship (defined as a direct or indirect ownership or investment interest or compensation arrangement) with an entity from making a referral for a Medicare or Medicaid (along with certain other federal payment programs) "designated health service" to that entity, and prohibits that entity from billing for such services. "Designated health services" do not include skilled nursing services, but do include many services which nursing facilities provide to their patients including therapy and enteral and parenteral nutrition. In addition, exceptions exist for physician ownership in publicly traded companies which at the end of a company's most recent fiscal year end or on average during the past three years have shareholder equity exceeding $75,000,000 and for the payment of fair market compensation for the provision of personal services, so long as various requirements are met.
California also has a state statute which limits the ability of physicians to refer patients for certain specified services to an entity with which it has a financial interest which includes most ownership or compensation arrangements. A broad exception applies for referrals to certain licensed providers, including nursing centers. Many states, including California, prohibit business corporations and other persons or entities not licensed to practice medicine from providing, or holding themselves out as a provider of, medical care. Possible sanctions for violation of any of these restrictions or prohibitions include loss of licensure or eligibility to participate in reimbursement programs and civil and criminal penalties. These laws, their construction and level of enforcement, vary from state to state.
Each of the Company's skilled nursing care centers has at least one medical director who is a licensed physician. The medical directors may from time to time refer their patients to the Company's centers in their independent professional judgment. The physician anti-referral restrictions and prohibitions could, among other things, require the Company to modify its contractual arrangements with its medical directors or prohibit its medical directors from referring patients to the Company. From time to time, the Company has sought guidance as to the interpretation of these laws, and believes that such arrangements are consistent with legal requirements. However, there can be no assurance that such laws will ultimately be interpreted in a manner consistent with the practices of the Company.
ENVIRONMENTAL REGULATION. The Company is also subject to a wide variety of federal, state and local environmental and occupational health and safety laws and regulations. Among the types of regulatory requirements faced by health care providers are: air and water quality control requirements; waste management requirements; specific regulatory requirements applicable to asbestos, polychlorinated biphenyls, and radioactive substances; requirements for providing notice to employees and members of the public about hazardous materials and wastes; and certain other requirements.
In its role as owner and/or operator of properties or centers, the Company may be subject to liability for investigating and remedying any hazardous substances that have come to be located on the property, including any such substances that may have migrated off, or emitted, discharged, leaked, escaped or been transported from, the property. Ancillary to the Company's operations are, in various combinations, the handling, use, storage, transportation, disposal and/or discharge of hazardous, infectious, toxic, radioactive, flammable and other hazardous materials, wastes, pollutants or contaminants. Such activities may result in damage to individuals, property or the environment; may interrupt operations and/or increase their costs; may result in legal liability, damages, injunctions or fines; may result in investigations, administrative proceedings, penalties or other governmental agency actions; and may not be covered by insurance. There can be no assurance that the Company will not encounter such risks in the future, and such risks may result in material adverse consequences to the operations or financial condition of the Company.
PENDING MATTERS THAT AFFECT HEALTH CARE OPERATIONS. In recent years, an increasing number of legislative proposals have been introduced in Congress and various state legislatures that would affect major reforms of the health care system. Among the proposals under consideration are insurance market reforms to increase the availability of group health insurance to small businesses, requirements that all businesses offer health insurance coverage to their employees, the provision of federal tax credits to individuals for the purchase of health insurance and the creation of a single government health insurance plan that would cover all citizens. Governors of several states have sought congressional assistance to allow states more flexibility in determining Medicaid payment methods and rates, including payment rates for skilled nursing care. If Congress adopts legislation granting states the power to determine Medicaid payment methods and rates, it could have a substantial adverse impact on the Company. A portion of such Medicare and Medicaid reductions would likely reduce the level of payments received by skilled nursing facilities and could adversely impact revenues received by the Company under the Medicare and Medicaid Programs. Until final legislation is adopted implementing the budget agreement, the scope of such proposed reductions on skilled nursing care centers is unclear. Any reduction in federal Medicaid expenditures would likely result in reductions in state Medicaid expenditures because Medicaid is jointly funded by the federal and state governments. In California, the Department of Health Services has established plans to enroll many Medi-Cal recipients in managed care plans. These plans have the option of covering long-term care in addition to other services, which could materially adversely affect the Company's revenues. Changes in the reimbursement levels under Medicare or Medicaid and changes in applicable governmental regulations could materially adversely affect the Company's results of operations. It is uncertain at this time what health care reform legislation will ultimately be enacted and implemented or whether other changes in the administration or interpretation of the governmental health care programs will occur. There can be no assurance that future health care legislation or other changes in the administration or interpretation of governmental health care programs, if enacted, will not have a material adverse effect on the results of operations of the Company.
In August 1996, federal legislation was signed into law that increased minimum wages from $4.25 per hour to $4.75 per hour on October 1, 1996 and to $5.15 per hour on September 1, 1997. An initiative statute entitled "Minimum Wage
Increase" was adopted in California by the voters on November 5, 1996. The initiative statute increased the then current minimum wages of $4.25 per hour to $5.00 per hour on March 1, 1997 and which will increase to $5.75 per hour on March 1, 1998 for all industries. The initiative statute affects minimum wages for California employees only. The Company believes that these wage increases will not have a material adverse effect on the Company's operations.
The growth in health care spending has caused the private sector, Medicare and state Medicaid programs, to reshape the financing of health care services for their beneficiaries. One of the most significant changes to the financing of health care services which the Company anticipates is the shift to managed care. The federal Medicare program, state Medicaid programs and private insurers are anticipated to place greater reliance on managed care alternatives in the future. Providers are generally willing to discount charges for services to managed care plan patients because managed care plans can direct (or strongly influence) the flow of patients. The Company believes that while it is likely that it will service an increasing proportion of managed care enrollees in the future at payment rates which may not be as favorable as those presently in effect, the expansion of managed care may also increase the volume of patients served.
ITEM 2.
ITEM 2. PROPERTIES
EXISTING FACILITIES
As of September 16, 1997, the Company owns or leases 35 skilled nursing care and five assisted living centers. In addition, the Company owns its corporate headquarters and leases space in buildings at which it operates its pharmacy business, located in Pasadena and Yorba Linda, California. The following table sets forth certain information concerning the skilled nursing care centers and assisted living centers currently operated by the Company.
(1) The Company's leases for its Sharon and Palm Grove centers require that Tenet guarantee the Company's obligations under each lease.
(2) Leased with options to purchase ranging from July 1998 to February 2005.
(3) Subleased to the Company by Tenet.
(4) Building owned by the Company with real property held under a ground lease extending to June 2030.
(5) Center opened July 1, 1997.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to malpractice claims and other litigation in the ordinary course of business. In the opinion of its management, the ultimate resolution of all pending legal proceedings will not have a material adverse effect on the Company's business or financial condition.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during the fourth quarter of its fiscal year ended June 30, 1997.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers, who are not also directors are:
David G. Schumacher, Jr., has been President and Chief Operating Officer of Summit Care Corporation since January 1, 1997 and previously served as Sr. Vice President - Operations and Chief Operating Officer from January 1, 1996. Prior to joining Summit, Mr. Schumacher was the Vice President of Operations at Arbor Health Care Company. He also spent ten years in various operations capacities at Manor Care.
Derwin L. Williams was appointed Vice President - Finance and Chief Financial Officer of the Company on July 1, 1993, Treasurer on May 10, 1994 and Senior Vice President - Finance on December 8, 1995. Previously he has served in the same position at three other nursing home companies: Hallmark Health Service, Inc. from November 1989 to February 1992; Care Enterprises from April 1980 to August 1987; and Flagg Industries, Inc. from June 1978 to March 1980. Mr. Williams has also served in various capacities specializing in Medicare reimbursement for the Company in 1992 and 1993 and for Beverly Enterprises in 1988 and 1989. He is also a certified public accountant.
Michael H. Martel was appointed Senior Vice President - Marketing in March 1995. Prior to joining Summit, Mr. Martel was Vice President - Marketing for Arbor Health Care Company from August 1992 to March 1995. Mr. Martel served as Regional Director of Marketing for the acute care rehabilitation division of National Medical Enterprises from April 1988 to August 1992.
John L. Farber was appointed Vice President - Controller, Chief Accounting Officer and Secretary on June 2, 1997. Prior to joining Summit, Mr. Farber was Vice President of Finance at FHP Insurance Company and Director of Finance at FHP International Corporation from September 1990 to May 1997. Mr. Farber also served in financial executive positions in two other companies from September 1979 to August 1990. He is also a certified public accountant.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the NASDAQ Stock Market under the symbol SUMC. On September 11, 1997, the Company had approximately 1,600 shareholders of record.
The table below sets forth high and low bid prices as reported by the National Association of Securities Dealers, Inc. High and low bid prices reflect inter-dealer prices, without retail markup, markdown or commissions, and may not necessarily represent actual transactions.
No dividends have been paid or are expected to be paid in the foreseeable future on the Company's common stock, as the Company's Board of Directors intends to retain earnings for the use in its business. The Company is restricted from the payment of dividends (other than dividends payable in common stock) or to acquire its common stock by its bank line of credit agreement and senior secured note agreements to the extent that such payments exceed $5,000,000 plus 50% of the Company's net income after June 30, 1995.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The following table summarizes certain selected financial data of the Company and should be read in conjunction with the related Consolidated Financial Statements of the Company and accompanying Notes to Consolidated Financial Statements:
(1) Earnings per share are based on the weighted average number of shares of common stock outstanding and common stock equivalents arising from stock options, which were 6,818,247 for the year ended June 30, 1997; 6,895,661 for the year ended June 30, 1996; 6,837,991 for the year ended June 30, 1995; 5,156,780 for the year ended June 30, 1994 and 5,028,936 for the year ended June 30, 1993. The effect of common stock equivalents arising from stock options on the computation of earnings per share is not significant.
(2) Does not include 66 beds opened on July 1, 1997 specializing in Alzheimer's patients.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS)
TWELVE MONTHS ENDED JUNE 30, 1997 COMPARED TO TWELVE MONTHS ENDED JUNE 30, 1996
Net revenues increased $21,865 or 12.4% from $176,062 in fiscal 1996 to $197,927 in fiscal 1997. The increase occurred due to the following:
The special charge to Medicare revenues reflect the result of adjustments proposed by Medicare in connection with an audit of fiscal 1995, which would have an effect on revenues for that fiscal year, fiscal 1996 and fiscal 1997. Average occupancy was 84.8% in the fiscal year ended June 30, 1997 compared to 85.9% in the fiscal year ended June 30, 1996. Excluding newly constructed beds, the average occupancy was 87.0% in the fiscal year ended June 30, 1997 and 86.4% in the fiscal year ended June 30, 1996. The Company's quality mix (revenues from Medicare, managed care and private pay patients as a percentage of gross revenues excluding pharmacy revenues) was 69.6% in the fiscal year ended June 30, 1997 and 66.7% in the fiscal year ended June 30, 1996.
Expenses, consisting of salaries and benefits, supplies, purchased services, provision for doubtful accounts and other expenses as a percent of net revenues, before the effect of the special charge, increased from 84.6% of net revenues in the fiscal year ended June 30, 1996 to 88.0% in the fiscal year ended June 30, 1997. Total salaries and employee related benefits were 43.9% of net revenues, before the effect of the special charge, in the fiscal year ended June 30, 1997 compared to 44.4% of net revenues in the fiscal year ended June 30, 1996. Purchases of rehabilitative and other specialty services were 25.3% of net revenues, before the effect of the special charge, in the fiscal year ended June 30, 1997 compared to 21.6% of net revenues in the fiscal year ended June 30, 1996. Expenses increased $30,580 or 20.5% from $148,929 in the fiscal year ended June 30, 1996 to $179,509 in the fiscal year ended June 30, 1997 for the following reasons:
Income before rental, depreciation and amortization and interest expense, net of interest income, decreased $8,715 or 32.1% from $27,133 in the fiscal year ended June 30, 1996 to $18,418 in the fiscal year ended June 30, 1997 and was 9.3% of net revenues in the fiscal year ended June 30, 1997 (and 12.0% of net revenues before the special charge to revenues) compared to 15.4% in the fiscal year ended June 30, 1996.
Rental, depreciation and amortization and interest expense, net of interest income, increased by $2,858 or 18.6% from $15,372 in the fiscal year ended June 30, 1996 to $18,230 in the fiscal year ended June 30, 1997. The increase was primarily due to depreciation of additions to property and equipment and interest expense related to higher long-term debt.
The Company's effective tax rate was 63.3% of income in the fiscal year ended June 30, 1997 compared to 37.9% of income in the fiscal year ended June 30, 1996. The increase in the effective tax rate was primarily due to
certain permanent differences between book income and taxable income. Net income was $69 for the fiscal year ended June 30, 1997, a decrease of $7,240 or 99.1% from $7,309 for the fiscal year ended June 30, 1996.
TWELVE MONTHS ENDED JUNE 30, 1996 COMPARED TO TWELVE MONTHS ENDED JUNE 30, 1995
Net revenues increased $39,036 or 28.5% from $137,026 in fiscal 1995 to $176,062 in the fiscal year 1996. The increase occurred due to the following:
Average occupancy was 85.9% in the fiscal years ended June 30, 1996 and 1995, and new beds were opened in both fiscal years. Excluding acquisitions and newly constructed beds, the average occupancy was 88.4% in the fiscal year ended June 30, 1996 and 89.0% in the fiscal year ended June 30, 1995. The Company's quality mix (revenues from Medicare, managed care and private pay patients as a percentage of gross revenues excluding pharmacy revenues) was 66.7% in the fiscal year ended June 30, 1996 and 63.1% in the fiscal year ended June 30, 1995.
Expenses, consisting of salaries and benefits, supplies, purchased services, provision for doubtful accounts and other as a percent of net revenues increased from 82.0% of net revenues in the fiscal year ended June 30, 1995 to 84.6% in the fiscal year ended June 30, 1996. Total salaries and employee related benefits were 44.4% of net revenues in the fiscal year ended June 30, 1996 compared to 46.1% of net revenues in the fiscal year ended June 30, 1995. Expenses increased $36,552 or 32.5% from $112,377 in the fiscal year ended June 30, 1995 to $148,929 in the fiscal year ended June 30, 1996 for the following reasons:
Income before rental, depreciation and amortization and interest expense, net of interest income, increased $2,484 or 10.1% from $24,649 in the fiscal year ended June 30, 1995 to $27,133 in the fiscal year ended June 30, 1996 and was 15.4% of net revenues in the fiscal year ended June 30, 1996 compared to 18.0% in the fiscal year ended June 30, 1995.
Rental, depreciation and amortization and interest expense, net of interest income, increased by $3,221 or 26.5% from $12,151 in the fiscal year ended June 30, 1995 to $15,372 in the fiscal year ended June 30, 1996. Substantially all of this increase was due to depreciation and amortization, rent and interest expense related to acquisitions and newly constructed beds in fiscal years 1995 and 1996.
The Company's effective tax rate was 37.9% of income in the fiscal year ended June 30, 1996 and 39.9% of income in the fiscal year ended June 30, 1995. Net income after taxes decreased $202 or 2.7% from $7,511 in the fiscal year ended June 30, 1995 to $7,309 in the fiscal year ended June 30, 1996.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1997, the Company had $3,994 in cash and cash equivalents and working capital of $12,648. For the fiscal year ended June 30, 1997, the Company's cash and cash equivalents increased by $1,336.
Net cash provided by operating activities increased $11,149 from $6,866 for the fiscal year ended June 30, 1996 to $18,015 for the fiscal year ended June 30, 1997. Net cash provided by operating activities, plus proceeds of $15,000 in new long-term debt (see description below) were used principally for capital expenditures of $24,075 for new and existing centers, the net reduction of loans outstanding on the line of credit of $1,000, the purchase of a lease option for $2,022, and the acquisition of a 50% interest in a limited liability company for $1,565.
Accounts receivable, less allowance for doubtful accounts, increased $5,819 due to increased total revenues in the fiscal year ended June 30, 1997 compared to the prior year, primarily in Medicare and managed care revenues. At June 30, 1997, the Company's average accounts receivable days outstanding were 41, compared to 39 at June 30, 1996.
For the fiscal year ended June 30, 1997, the Company added $24,075 to its property and equipment. These additions were primarily for the completion of a 210 bed skilled nursing facility in Fort Worth, Texas or $2,300, construction of a 66 bed assisted living center in Orange, California, or $3,525, and the renovation of buildings and replacement of furniture and equipment at the remaining centers and the pharmacies, or $18,250.
These additions to property and equipment were primarily financed with funds from $15,000 of Senior Secured Notes issued in July 1996 and with cash generated from operations. The $15,000 funding represents the second and last issuance of the $70,000 Senior Secured Notes. The initial funding of $55,000 occurred in December 1995.
The Company believes that it has sufficient cash flow from its existing operations and from its bank line of credit to service long-term debt due within one year of $6,997 (the Company intends to borrow this amount against its bank line of credit which has a revolver extending to September 30, 1998 followed by a three-year payment period), to make normal recurring capital replacements, additions and improvements to existing centers of approximately $9,100 planned for the next 12 months, to develop properties costing approximately $3,000 over the next 12 months, to purchase a 111-bed center for $1,871 in accordance with a purchase option in a lease and to meet other long-term working capital needs and obligations. The loans outstanding on the line of credit at June 30, 1997 were $5,000. The Company expects, on a selective basis, to pursue expansion of its existing centers and the acquisition or development of additional centers in markets where demographics and competitive factors are favorable.
IMPACT OF INFLATION
The health care industry is labor intensive. Wages and other expenses increase more rapidly during periods of inflation and when shortages in the labor market occur. In addition, suppliers pass along rising costs in the form of higher prices. Increases in reimbursement rates under Medicaid generally lag behind actual cost increases, so that the Company may have difficulty covering them in a timely fashion.
RECENT ACCOUNTING PRONOUNCEMENTS
In October 1995, Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), was issued which, if elected, would require companies to use a new fair value method of valuing stock-based compensation plans. The Company has elected to continue following present accounting rules under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" which uses an intrinsic value method and often results in no compensation expense. In accordance with SFAS 123, the Company has provided in the notes to the accompanying financial statements pro forma disclosure of what net income and earnings per share would have been had the new fair value method been used.
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"), which is effective for fiscal years ending after December 15, 1997, including interim periods. Earlier adoption is not permitted. However, an entity is permitted to disclose pro forma earnings per share amounts computed under SFAS 128 in the notes to the financial statements in periods prior to adoption. The statement requires restatement of all prior-period earnings per share data presented after the effective date. SFAS 128 specifies the computation, presentation, and disclosure requirements for earnings per share and is substantially similar to the standard recently issued by the International Accounting Standards Committee entitled "International Accounting Standards, Earnings per Share." The Company plans to adopt SFAS 128 in fiscal year 1998 and has not determined the impact of adoption.
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"), which is effective for fiscal years ending after December 15, 1997. SFAS 131 establishes standards for the way that public enterprises report information about operating segments in annual financial statements. It also requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. Under existing accounting standards, the Company has reported its operations as one line of business because substantially all of its revenues have been derived from its skilled nursing care centers and assisted living centers and closely related ancillary services. The Company is presently evaluating the new standard in order to determine its effect, if any, on the way the Company might report its operations in the future.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT AUDITORS
The Board of Directors Summit Care Corporation
We have audited the accompanying consolidated balance sheets of Summit Care Corporation and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended June 30, 1997. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Summit Care Corporation at June 30, 1997 and 1996, and the consolidated results of its operations and cash flows for each of the three years in the period ended June 30, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Los Angeles, California August 22, 1997
SUMMIT CARE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
See accompanying notes
SUMMIT CARE CORPORATION CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
See accompanying notes
SUMMIT CARE CORPORATION CONSOLIDATED BALANCE SHEETS (CONTINUED) (DOLLARS IN THOUSANDS)
See accompanying notes
SUMMIT CARE CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS) THREE YEARS ENDED JUNE 30, 1997
See accompanying notes
SUMMIT CARE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
See accompanying notes
SUMMIT CARE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (DOLLARS IN THOUSANDS)
See accompanying notes
SUMMIT CARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED JUNE 30, 1997 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS. Summit Care Corporation ("Company" or "SCC") provides a variety of health care services primarily to the elderly through the operation of subacute, skilled nursing, Alzheimer's and assisted living units in skilled nursing care centers and assisted living centers in California, Texas and Arizona. These services include nursing care, lodging, food and certain specialty medical services, including rehabilitation care, infusion therapy and other ancillary services. The Company also provides specialty pharmaceutical and infusion therapy services to other long-term care providers. In April 1994, OrNda HealthCorp ("OrNda") acquired the Company's then majority shareholder, Summit Health Ltd. ("SHL"). OrNda's 7.5% Exchangeable Subordinated Notes ("OrNda Notes") were exchangeable into its equity interest in the Company's common stock, at the option of the holders. OrNda redeemed 100% of the outstanding OrNda Notes in exchange for its equity interest in the Company's common stock in August 1995. OrNda currently has no position in the Company's common stock. In January 1997, OrNda was merged into Tenet Healthcare Corporation ("Tenet").
BASIS OF CONSOLIDATION. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated.
USE OF ESTIMATES. The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
INVENTORIES. Inventories are stated at the lower of cost (first-in, first-out method) or market.
REVENUES. Approximately 72 percent, 70 percent and 68 percent of the Company's revenues in the years ended June 30, 1997, 1996 and 1995 were derived from funds under federal and state medical assistance programs, the continuation of which are dependent upon governmental policies. These revenues are based, in certain cases, upon cost reimbursement principles and are subject to audit. Revenues are recorded on an accrual basis as services are performed at their estimated net realizable value. Differences between final settlement and estimated net realizable value accrued in prior years are reported as adjustments to the current year's net revenues. These adjustments decreased net revenues by $4,892 in fiscal 1997. A significant portion of the Company's skilled nursing care center revenues is derived from government sponsored health care programs such as Medicare and Medicaid. These programs are highly regulated and are subject to budgetary and other constraints. While the Company's cash flow could be adversely affected by periodic government program funding delays or shortfalls, management does not believe there are any significant credit risks associated with these government programs.
PROPERTY AND EQUIPMENT. Depreciation and amortization (straight-line method) is based on the estimated useful lives of the individual assets as follows:
Buildings and improvements 15-40 years Leasehold improvements Shorter of lease term or estimated useful life Furniture and equipment 3-20 years
Amortization of capital leases is included in depreciation and amortization expense. For leasehold improvements, where the Company has acquired the right of first refusal to purchase or to renew the lease, amortization is based on the lesser of the estimated useful lives and the period covered by the right.
INTANGIBLE ASSETS. Goodwill of $2,321, less accumulated amortization of $182, is included in other assets at June 30, 1997 and is amortized over 35 years using the straight-line method.
INSURANCE COVERAGE. The Company self insures for certain levels of workers' compensation and general and professional liability coverage. The Company utilizes a captive insurance company for the purpose of providing reinsurance coverage for workers' compensation claims filed by its California and Arizona employees in excess of a $250,000 self insurance retention per occurrence and not subject to an annual aggregate limit. The Company has elected under Texas law to decline to participate in the Texas workers' compensation insurance program and maintains employer's excess and occupational indemnity insurance on claims subject to a $150,000 self insurance retention per occurrence with no annual aggregate limit. The Company maintains general and professional liability insurance on a claims made basis, subject to a $100,000 self insurance retention per occurrence and $600,000 on an annual aggregate basis.
Under both self insurance programs, the Company estimates its liability, including potential legal fees and settlement amounts, based on claims filed and estimates of claims incurred but not reported, utilizing historical experience on an undiscounted basis. Differences between the amounts accrued and subsequent settlements are recorded in operations in the year of settlement.
EARNINGS PER SHARE. Earnings per share is based on the weighted average number of shares of common stock outstanding and common stock equivalents arising from stock options which were 6,818,247 for the year ended June 30, 1997, 6,895,661 for the year ended June 30, 1996 and 6,837,991 for the year ended June 30, 1995. The effect of common stock equivalents arising from stock options on the computation of earnings per share is not significant.
CASH AND CASH EQUIVALENTS. Cash and cash equivalents include highly liquid investments with an original maturity of three months or less. The Company places its temporary cash investments with high credit quality financial institutions.
CASH MANAGEMENT. The Company utilizes a centralized cash management system. Payable to bank represents checks outstanding.
ACCOUNTING FOR THE IMPAIRMENT AND DISPOSAL OF LONG-LIVED ASSETS. Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121"), requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. SFAS 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company believes, based on current circumstances, that there are no indicators of impairment to its long-lived assets, and the Company presently has no expectations for disposing of any long-lived assets.
RECENT ACCOUNTING PRONOUNCEMENTS. In October 1995, Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), was issued which, if elected, would require companies to use a new fair value method of valuing stock-based compensation plans. The Company has elected to continue following present accounting rules under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" which uses an intrinsic value method and often results in no compensation expense. In accordance with SFAS 123, the Company has provided pro forma disclosure of what net income and earnings per share would have been had the new fair value method been used (see Note 10).
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"), which is effective for fiscal years ending after December 15, 1997, including interim periods. Earlier adoption is not permitted. However, an entity is permitted to disclose pro forma earnings per share amounts computed under SFAS 128 in the notes to the financial statements in periods prior to adoption. The statement requires restatement of all prior-period earnings per share data presented after the effective date. SFAS 128 specifies the computation, presentation, and disclosure requirements for earnings per share and is substantially similar to the standard recently issued by the International Accounting Standards Committee entitled "International Accounting Standards, Earnings per Share." The Company plans to adopt SFAS 128 in fiscal year 1998 and has not determined the impact of adoption.
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"), which is effective for fiscal years ending after December 15, 1997. SFAS 131 establishes standards for the way that public enterprises report information about operating segments in annual financial statements. It also requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. Under existing accounting standards, the Company has reported its operations as one line of business because substantially all of its revenues have been derived from its skilled nursing care centers and assisted living centers and closely related ancillary services. The Company is presently evaluating the new standard in order to determine its effect, if any, on the way the Company might report its operations in the future.
RECLASSIFICATIONS. Certain amounts have been reclassified to conform with 1997 presentations.
2. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating its fair market value disclosures.
CASH AND CASH EQUIVALENTS. The carrying amount reported in the balance sheet for cash and cash equivalents approximates its fair value.
NOTES RECEIVABLE (INCLUDING CURRENT PORTION). The carrying amount, before the allowance for doubtful accounts, is $8,434. The fair value of $8,400 is estimated using discounted cash flow analyses, based on interest rates currently being offered for notes with similar terms to borrowers of similar credit quality.
LONG-TERM DEBT (INCLUDING CURRENT PORTION). The carrying value of $121,452 of long-term debt is based on the original face value (issue amount). The fair value of $120,300 is estimated based on the present value of the underlying cash flows discounted at the Company's incremental borrowing rate.
3. MATERIAL TRANSACTIONS WITH RELATED ENTITIES
TENET HEALTHCARE CORPORATION, ORNDA HEALTHCORP AND SUMMIT HEALTH LTD. The Company had an agreement with Tenet/OrNda, which expired in March 1997, under which the Company leased a portion of its corporate office space to OrNda and shared the cost of building services with OrNda. The agreement also required OrNda to provide tax accounting to the Company. The Company's rental income from OrNda for the space exceeded the payments to OrNda for services by $31 for the year ended June 30, 1997. For the years ended June 30, 1996 and 1995, payments to OrNda for services exceeded rental income for the space by $50 and $23, respectively. The Company believes that the amount reimbursed for the services provided and the rental income received are reasonable. The agreement also indemnified the Company against any liability arising from its divestiture of facilities, the net assets of which were purchased by SHL during the year ended June 30, 1992. The provisions of the indemnification survive the termination of the agreement. Certain provisions of this agreement were terminated or amended as a result of the redemption on August 28, 1995 by OrNda of 100% of the OrNda Notes in exchange for the Company's common stock (see Note 1).
In January 1994, the Company entered into a ten-year sub-lease of a nursing care center with SHL. The Company believes the monthly lease payments of $37 are reasonable for the market area. Lease payments to Tenet, OrNda and SHL were $450 for each of the years ended June 30, 1997, 1996 and 1995.
At June 30, 1997, the net amount due from Tenet for transactions between the Company and Tenet was $918 and is included in Other Current Assets (see Note 5).
4. ACQUISITIONS AND CONSTRUCTION ACTIVITY
FISCAL YEAR 1997. In August 1996, the Company opened a 110-bed skilled nursing care center in Fort Worth, Texas, and in June 1997, opened another 100 beds at the same site. Total cost of construction including the original purchase price (see this Note, Fiscal Year 1995) was $12,012. On July 1, 1997, the Company opened a 66-bed assisted living center in Orange, California, dedicated to Alzheimer's and other patients with dementia. Total cost of construction, which constituted renovation of an existing building on a campus with a 172-bed skilled nursing center and a 72-bed assisted living center, was $3,525. Cost of construction completed in the year ended June 30, 1997 was financed with funds from $15 million of Senior Secured Notes ("Notes") issued in July 1996 and with cash generated from operations. The Notes represented the second and last issuance of $70 million of Notes. The first issuance of $55 million occurred in December 1995.
In July 1996, the Company exercised a purchase option in its lease of a 88-bed skilled nursing care center in Rockport, Texas. The purchase price of $2,022 was financed with funds from the Notes.
In December 1996, the Company entered into a limited liability company ("LLC") agreement to operate a pharmacy in Austin, Texas. The purchase price for its 50% membership interest was $1,565 in cash. The pharmacy services nursing centers in Texas operated by either the Company, the other LLC member or non-affiliated nursing center owners. The Company accounts for its investment in the LLC under the equity method of accounting. The Company's equity in earnings of the LLC was insignificant during fiscal year 1997.
In June 1997, the Company purchased 10 acres of vacant land in Longview, Texas for $648 in cash. The land will be used for new services which will complement the 174-bed skilled nursing center currently owned and operated by the Company.
FISCAL YEAR 1996. On January 8, 1996, the Company opened a 108-bed skilled nursing care center in Fresno, California, and in August 1996, opened another 51 beds at the same site. Total cost of construction including the original purchase price was $14,024. In March 1996, the Company added 20 licensed beds to one of its two skilled nursing care centers in Beaumont, Texas, increasing the center's total beds to 148. Total cost of construction was $785. In June 1996, the Company also added 54 beds to its skilled nursing care center in Longview, Texas, increasing the total beds to 182. Total cost of construction was $1,860. Cost of construction completed in the year ended June 30, 1996 was financed with funds from Notes issued in December 1995 and draws against the Company's bank line of credit (see Note 6).
FISCAL YEAR 1995. On September 1, 1994, the Company purchased a 220-bed skilled nursing care center in White Settlement (Fort Worth), Texas, for $11,925 in cash and a four-acre site for $1,500 in cash for construction of a 210-bed skilled nursing care center located in Fort Worth, Texas, which began in May 1995.
The Company acquired on October 1, 1994 the leasehold interest in six skilled nursing care centers and the real and personal property of a seventh with a combined total of 783 beds located in various communities in Texas for $30,938, including goodwill of $2,321. The purchase price consists of (i) $11,470 in cash (of which $8,541 was funded under the Company's bank line of credit), (ii) a $2,814 promissory note ($3,000 less a $186 discount) at 9% interest (7% contract rate) fully amortized in seven years and (iii) a $16,654 capital lease obligation assumed by the Company. The leases on the six centers range from eight to twenty-one years, include purchase options, the first exercisable in July 1996, and the last exercisable in February 2005, and have combined monthly payments of $159.
On December 1, 1994, the Company acquired four skilled nursing care centers in three communities in East Texas with a combined total of 548 beds for $27,000 in cash and, in a separate transaction, the leasehold interest in a 119-bed skilled nursing care center located in Big Spring, Texas, for $800 in cash. Both transactions were funded under the Company's bank line of credit.
The Company's acquisitions have been accounted for as purchases and, accordingly, the results of operations of the acquired centers have been included in the consolidated statement of income since the date of acquisition.
The Company completed in May 1995 an addition of 74 beds to a 76-bed nursing care center which is operated under a ten-year sub-lease with OrNda (see Note 3).
5. OTHER CURRENT ASSETS
Other current assets as of June 30 consist of the following:
6. LONG-TERM DEBT
Long-term debt consists of the following:
Future maturities of long-term debt (including capital lease obligations) are as follows: years ending June 30, 1998 - $-0-; 1999 - $8,699; 2000 - $13,788; 2001 - $17,187; 2002 - $10,904, and thereafter - $70,874.
In December 1995, the Company amended its secured bank line of credit which reduced the commitment from $60,000 to $40,000, converted accounts receivable from collateral to a negative pledge, extended the revolver to September 30, 1997 (the revolver has been subsequently extended to September 30, 1998) and reduced the period of the term loan upon termination of the revolver from four to three years. The interest rate is variable and at the Company's option, will equal either the bank prime rate or the Eurodollar rate plus a margin (reduced by the amendment) that varies depending on the ratio of certain senior debt to earnings before certain interest, taxes, depreciation and amortization. At June 30, 1997, credit line loans outstanding were $5,000 which was used to finance the construction described in Note 4. At June 30, 1997, the Company classified $6,997 of current debt maturities as long-term debt based on its intent and ability to refinance these obligations under the bank line of credit.
The bank line of credit loan agreement and the two senior secured note agreements contain covenants that include requirements to comply with certain financial tests and ratios and restrict the ability of the Company to incur additional indebtedness. Also, the Company is restricted by the agreements from the payment of dividends (other than dividends payable in common stock) or to acquire its common stock to the extent that such payments exceed $5,000 plus 50% of the Company's net income after June 30, 1995. The Company currently is meeting all financial tests and ratios.
Interest expense was $10,296, $8,701 and $6,033 in fiscal years 1997, 1996 and 1995, respectively, of which $1,678, $1,605 and $759 in 1997, 1996 and 1995 were capitalized as part of the ongoing construction projects. Interest payments were $10,124, $7,874 and $5,712 in fiscal years 1997, 1996 and 1995, respectively.
7. INCOME TAXES
The provision for income taxes consists of the following:
Deferred income taxes result from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements and represent differences between income for tax purposes and income for financial statement purposes in future years. Temporary differences are primarily attributable to reporting for income tax purposes the excess of tax over book depreciation, bad debts and vacation benefits. The current deferred tax assets are included in other current assets (see Note 5). Significant components of the Company's deferred tax liabilities and assets as of June 30 are as follows:
A reconciliation of the provision for income taxes with the amount computed using the federal statutory rate is as follows:
The increase in the effective tax rate was primarily due to certain permanent differences between book income and taxable income. Total income tax payments during fiscal years 1997, 1996 and 1995 were $1,828, $3,904 and $4,876, respectively.
8. LEASES
The Company leases certain of its centers, equipment and its pharmacy space under both noncancellable operating leases and capital leases. The leases generally provide for payment of property taxes, insurance and repairs, and have rent escalation clauses based upon the consumer price index or annual per bed adjustments.
All capital leases contain purchase options, and the accompanying balance sheet and following table have been prepared assuming such options will be exercised (see Note 11). Some leases contain various renewal options and extend up to the year 2030. Property and equipment includes the following amounts for leases which have been capitalized:
The future minimum rental payments under noncancellable operating leases and capital leases (including purchase options when expected to be exercised) that have initial or remaining lease terms in excess of one year as of June 30, 1997, are as follows:
9. CONTINGENCIES
The Company is subject to malpractice claims and other litigation arising in the ordinary course of business. In the opinion of management, any liability beyond amounts covered by insurance and the ultimate resolution of all pending legal proceedings will not have a material adverse effect on the Company's financial position or results of operations.
10. STOCK OPTION PLAN
Effective July 1, 1991, the Company adopted a stock option plan authorizing the issuance of 250,000 shares of common stock. The plan was amended on December 9, 1994 and again on December 8, 1995 to increase the authorized shares to 1,400,000. Options may be granted to key employees and directors of the Company. Options granted to employees may be either incentive stock options or nonstatutory options. Only non-qualified options may be granted to non-employee directors. Options granted to non-employee directors are granted automatically pursuant to a formula grant provision contained in the plan. The option price per share for incentive stock options shall not be less than 85% of the fair market value at the date of the grant. The terms of each option and the increments in which each is exercisable are determined by a committee appointed by the Board of Directors. No option may be exercised after ten years from the date of the grant and no option may be granted under the plan after June 30, 2001.
The following summarizes activity in the stock option plan:
The weighted average fair value per share of options granted during the year was $6.72 and $10.14 for fiscal years 1997 and 1996, respectively. The exercise prices for options outstanding at June 30, 1997 ranged from $10.50 to $22.50. The weighted average remaining contractual life of these options is approximately 8 years.
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) which uses an intrinsic value method and, because the exercise price of the Company's stock options equals the market price of the underlying stock on the date of grant, results in no compensation expense. However, pro forma information regarding net income and earnings per share is required by Statement of Financial Accounting Standards No. 123, "Accounting and Disclosure of Stock-Based Compensation" (SFAS 123), and, in the following disclosure, has been determined as if the Company had accounted for its stock options under the fair value method of SFAS 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for the years ended June 30, 1997 and 1996, respectively: risk-free interest rates of 6.4% and 5.5%; dividend yields of zero percent for both years; volatility factors of the expected market price of the Company's common stock of 48.4% and 46.8%; and a weighted average expected life of the options of 5 years.
Because the Company's stock options have characteristics significantly different from those options used in the Black-Scholes option pricing model, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of the Company's stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The effects of providing pro forma disclosure are not likely to be representative of the effects on reported net income for future years. The Company's pro forma information follows for the years ended June 30, 1997 and 1996:
11. SUBSEQUENT EVENT
In September 1997, the Company exercised a purchase option in its lease of a 111-bed skilled nursing care center in La Grange, Texas. The purchase option price of $1,871 was financed by a draw on the Company's bank line of credit (see Note 6).
12. UNAUDITED QUARTERLY INFORMATION
Following is a summary of unaudited quarterly results of operations from the years ended June 30, 1997 and 1996:
See accompanying notes
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
The information required by Part III of Form 10-K (Items 10 through 13) is set forth in the Company's definitive proxy statement for its Annual Meeting of Shareholders to be held on December 11, 1997, which will be filed with the Commission pursuant to Regulation 14A within 120 days of the Company's last fiscal year, and such information is incorporated herein by reference. See also "Executive Officers of the Registrant" in Part I of this report for certain information concerning the Company's executive officers who are not also directors of the Company.
PART IV
All other schedules are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the Company's consolidated financial statements and notes thereto.
(3) Exhibits
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SUMMIT CARE CORPORATION
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:
SUMMIT CARE CORPORATION SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN THOUSANDS)
(1) Recoveries of amounts written off. (2) Write-offs of uncollectible accounts.
SUMMIT CARE CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED JUNE 30, 1997
EXHIBIT INDEX
SUMMIT CARE CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED JUNE 30, 1997
EXHIBIT INDEX
SUMMIT CARE CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED JUNE 30, 1997
EXHIBIT INDEX