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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the Fiscal year ended: June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission file number: 0-21910
CONTINUCARE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
FLORIDA 59-2716023
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
80 SW 8th STREET
SUITE 2350
MIAMI, FLORIDA 33130
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (305) 350-7515
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
COMMON STOCK, AMERICAN STOCK EXCHANGE
$.0001 PAR VALUE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant at October 7, 1999 (computed by reference to
the last reported sale price of the registrant's Common Stock on the American
Stock Exchange on such date): $6,517,563.
Number of shares outstanding of each of the registrant's classes of
Common Stock at October 7, 1999: 14,540,091 shares of Common Stock, $.0001 par
value per share.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's definitive Proxy Statement
pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended,
which will be filed with the Commission subsequent to the date hereof (the
"Proxy Statement"), are incorporated by reference into Part III of this Form
10-K.
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GENERAL
Unless otherwise indicated or the context otherwise requires, all
references in this Form 10-K to "Continucare" or the "Company" includes
Continucare Corporation and its consolidated subsidiaries. The Company disclaims
any intent or obligation to update "forward looking statements." All references
to a Fiscal year are to the Company's fiscal year which ends June 30. As used
herein, Fiscal 2000 refers to fiscal year ending June 30, 2000, Fiscal 1999
refers to fiscal year ending June 30, 1999, Fiscal 1998 refers to fiscal year
ending June 30, 1998 and Fiscal 1997 refers to Fiscal year ending June 30, 1997.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
In connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995 (the "Reform Act"), Continucare is hereby
providing cautionary statements identifying important factors that could cause
the Company's actual results to differ materially from those projected in
forward-looking statements (as such term is defined in the Reform Act) of the
Company made by or on behalf of the Company herein or which are made orally,
whether in presentations, in response to questions or otherwise. Any statements
that express, or involve discussions as to expectations, beliefs, plans,
objectives, assumptions or future events or performance (often, but not always,
through the use of words or phrases such as "will result," "are expected to,"
"will continue," "is anticipated," "plans," "intends," "estimated," "projection"
and "outlook") are not historical facts and may be forward-looking. Accordingly,
such statements, including without limitation, those relating to the Company's
future business, prospects, revenues, working capital, liquidity, capital needs,
interest costs and income, wherever they may appear in this document or in other
statements attributable to the Company, involve estimates, assumptions and
uncertainties which could cause actual results to differ materially from those
expressed in the forward-looking statements. Such uncertainties include, among
others, the following factors:
TROUBLED OPERATING HISTORY
The Company's financial position has changed significantly since June
30, 1998. Throughout Fiscal 1998 and 1999 the Company experienced adverse
business operations, recurring operating losses, negative cash flow from
operations, resulting in a significant working capital deficiency. Furthermore,
as discussed below, the Company was unable to make certain of its scheduled
interest payments. The Company's operating difficulties have in large part been
due to the underperformance of various entities which were acquired in Fiscal
years 1999, 1998 and 1997, the inability to effectively integrate and realize
increased profitability through anticipated economies of scale with these
acquisitions, as well as reductions in reimbursement rates under the Balanced
Budget Act of 1997. In addition, the Company's independent auditors included a
paragraph in their auditors' report on the Company's consolidated financial
statements at June 30, 1999 regarding the substantial doubt about the Company's
ability to continue as a going concern. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Company's
consolidated financial statements and the notes thereto for further discussion.
The continued integration of Continucare's acquired businesses and its
future ability to control costs is important to the Company's ongoing financial
and operational performance. The anticipated benefits from several acquisitions
were not achieved and the operations of these acquired businesses were not
successfully combined with the ongoing operations of the Company in a timely
manner. The process of integrating the acquired businesses caused the
interruption and loss of momentum in the conduct of these businesses and had a
material adverse effect on the Company's operations, financial results and cash
flows. There can be no assurance that the Company will realize any of the
anticipated benefits from its acquisitions. Many of the expenses arising from
the Company's efforts to integrate operations may continue to have a negative
effect on operating results.
Certain of the companies acquired by Continucare have recently or
historically operated at a loss. Other acquired companies have experienced
fluctuations in quarter-to-quarter operating results. In Fiscal 1999 the Company
undertook a business rationalization program (the "Business Rationalization
Program") to divest certain unprofitable operations and to close other
underperforming subsidiary divisions and a financial restructuring program (the
"Financial Restructuring Program") to attempt to strengthen its financial
performance. In
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connection with the implementation of the Business Rationalization Program, the
Company has sold or closed its outpatient rehabilitation division, diagnostic
imaging division and specialty physician practice division; however these
divisions were sold for a loss. Although Continucare in Fiscal 1999, instituted
a series of measures intended to reduce these losses and to operate the acquired
businesses profitably, there can be no assurance that Continucare will reverse
these trends or operate these entities profitably. If there are continuing
operating losses at the acquired companies, Continucare may need additional
capital to fund its business, and there can be no assurance that such additional
capital can be obtained or, if obtained, it will be on terms acceptable to
Continucare.
In the event the Company targets a business to acquire, the Company
will compete with other potential acquirers, some of which may have greater
financial or operational resources than the Company. Consummation of
acquisitions could result in the incurring or assumption by the Company of
additional indebtedness and the issuance of additional equity. The issuance of
shares of the Company's common stock, $0.0001 par value ("Common Stock") for an
acquisition may result in dilution to shareholders.
RISKS OF FINANCIAL LEVERAGE
On April 30, 1999 the Company defaulted on its semi-annual payment of
interest on its Subordinated Notes Payable. On September 29, 1999, the Company
announced that it reached an agreement in principle with the holders of all of
its outstanding Subordinated Notes Payable with regard to a consensual
restructuring (the "Debenture Settlement"), see "Recent Developments - Debt
Restructuring". The Debenture Settlement is expressly conditioned upon the
parties drafting and executing a formal Consent to Supplemental Indenture and
Waiver (the "Waiver"). The Waiver will not be fully effective unless, and until
it is ratified by Continucare's shareholders at a meeting to be held on or
before December 31, 1999 ("Shareholder Approval Date"). While the Company
believes it will execute the Waiver and receive adequate shareholder support,
there can be no assurance to that effect. The inability of the Company to
execute the Waiver and receive adequate shareholder support could have a
material adverse effect on the Company's business and future prospects and could
force the Company to seek bankruptcy protection. Additionally, even if the
Debenture Settlement is concluded, the degree to which Continucare continues to
be leveraged could affect its ability to service its indebtedness, make capital
expenditures, respond to market conditions and extraordinary capital needs, take
advantage of certain business opportunities or obtain additional financing.
Unexpected declines in Continucare's future business, or the inability to obtain
additional financing on terms acceptable to Continucare, if required, could
impair Continucare's ability to meet its debt service obligations or fund
acquisitions and therefore, could have a material adverse effect on the
Company's business and future prospects.
RISKS ASSOCIATED WITH CAPITATED ARRANGEMENTS INCLUDING RISK OF OVER-UTILIZATION
BY MANAGED CARE PATIENTS, RISK OF REDUCTION OF CAPITATED RATES AND REGULATED
RISKS
The Company's provider entities have entered into several managed care
agreements including certain capitated arrangements with managed care
organizations. Under capitated contracts, the health care provider typically
accepts a pre-determined amount for professional services per patient per month
from the managed care payor in exchange for the Company assuming responsibility
for the provision of medical services for each covered individual. Such
contracts pass much of the financial risk of providing care, such as
over-utilization of healthcare services, from the payor to the provider. Because
the Company incurs costs based on the frequency and extent of medical services
provided, but only receives a fixed fee for agreeing to assume responsibility
for the provision of such services, to the extent that the patients covered by
such managed care contracts require more frequent or extensive care than is
anticipated, the Company's operating margins may be reduced and, in certain
cases, the revenue derived from such contracts may be insufficient to cover the
costs of the services provided. In either event, the Company's business,
prospects, financial condition and results of operations may be materially
adversely affected. The Company's future success will depend in part upon its
ability to negotiate contracts with managed care payors on terms favorable to
the Company and upon its effective management of health care costs through
various methods, including competitive pricing and utilization management. The
proliferation of capitated contracts in markets served by the Company could
result in decreased predictability of operating margins. There can be no
assurance that the Company will be able to negotiate satisfactory arrangements
on a capitated basis or that such arrangements will be profitable to the Company
in the future. In addition, in certain jurisdictions,
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capitated agreements in which the provider bears the risk are regulated under
state insurance laws. The degree to which these capitated arrangements are
regulated by insurance laws varies on a state by state basis, and as a result,
the Company may be limited in certain states, such as Florida, in which it may
seek to enter into or arrange capitated agreements for its affiliated physicians
when those capitated contracts involve the assumption of risk. There can be no
guarantee that the state of Florida will continue to maintain the position that
the Company is not regulated as an insurer. See "Dependence on Contracts with
Managed Care Organizations."
DEPENDENCE ON CONTRACTS WITH MANAGED CARE ORGANIZATIONS
The Company's ability to expand is dependent in part on increasing the
number of managed care patients served by its Staff Model clinics, primarily
through negotiating additional and renewing existing contracts with managed care
organizations. The Company's capitated managed care agreement with Foundation
Health Corporation Affiliates ("Foundation") is a ten-year agreement with the
initial term expiring on June 30, 2008, unless terminated earlier for cause. In
the event of termination of the Foundation agreement, the Company must continue
to provide services to a patient with a life-threatening or disabling and
degenerative condition for sixty days as medically necessary. The Company's
capitated managed care agreement with Humana Medical Plans, Inc. ("Humana") is a
ten-year agreement expiring July 31, 2008, unless terminated earlier for cause.
The agreement shall automatically renew for subsequent one-year terms unless
either party provides 180-days written notice of its intent not to renew. In
addition, the Humana agreement may be terminated by the mutual consent of both
parties at any time. Under certain limited circumstances, Humana may immediately
terminate the agreement for cause, otherwise termination for cause shall require
ninety (90) days prior written notice with an opportunity to cure, if possible.
In the event of termination of the Humana agreement, the Company must continue
to provide or arrange for services to any member hospitalized on the date of
termination until the date of discharge or until it has made arrangements for
substitute care. In some cases, Humana may provide 30 days' notice as to an
amendment or modification of the agreements, including but not limited to,
renegotiation of rates, covered benefits and other terms and conditions. The
Company maintains other managed care relationships subject to various negotiated
terms. There can be no assurance that the Company will be able to renew any of
these managed care agreements or, if renewed, that they will contain terms
favorable to the Company and affiliated physicians. The loss of any of these
contracts or significant reductions in capitated reimbursement rates under these
contracts could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Reliance on Key Customers;
Related Party Issues", "Risks Associated with Capitated Arrangements Including
Risk of Over-Utilization by Managed Care Patients, Risk of Reduction of
Capitated Rates and Regulatory Risks," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business Managed Care."
FEE-FOR-SERVICE ARRANGEMENTS
Certain of the Company's physicians who render services on a
fee-for-service basis (as opposed to capitation) typically bill various payors,
such as governmental programs (e.g., Medicare and Medicaid), private insurance
plans and managed care plans, for the health care services provided to their
patients. There can be no assurance that payments under governmental programs or
from other payors will remain at present levels. In addition, payors can deny
reimbursement if they determine that treatment was not performed in accordance
with the cost-effective treatment methods established by such payors or was
experimental or for other reasons. Also, fee-for-service arrangements involve a
credit risk related to uncollectibility of accounts receivable.
RISKS RELATED TO INTANGIBLE ASSETS
In conjunction with the Company's Financial Restructuring Program
approximately $23,800,000 in net intangible assets have been written off as a
result of the sale, dissolution, closing and re-evaluation of certain non or
poorly performing assets. As of June 30, 1999, remaining intangible assets
totaled approximately 83% of Continucare's total assets. Using an amortization
period ranging from 2.5 to 20 years, amortization expense on the Company's
remaining intangible assets will be approximately $2,600,000 per year. Further
acquisitions that result in the recognition of additional intangible assets
would cause amortization expense to further increase. In certain circumstances,
amortization generated by these intangible assets may not be deductible for tax
purposes.
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At the time of or following each acquisition, the Company evaluates
each acquisition and establishes an appropriate amortization period based on the
specific underlying facts and circumstances of each such acquisition. Subsequent
to such initial evaluation, the Company periodically reevaluates such facts and
circumstances to determine if the related intangible asset continues to be
realizable and if the amortization period continues to be appropriate. As the
underlying facts and circumstances subsequent to the date of acquisition can
change, there can be no assurance that the value of such intangible assets will
be realized by the Company. At June 30, 1999, a portion of the net un-amortized
balance of intangible assets acquired was considered to be impaired. As a result
of the determination that approximately $11,700,000 of intangible assets were
impaired, the Company has written off the impaired portion of un-amortized
intangible assets. Any future determination, based on reevaluation of the
underlying facts and circumstances, that a significant impairment has occurred
would require the write-off of the impaired portion of un-amortized intangible
assets, which could have a material effect on Continucare's business and results
of operations.
RELIANCE ON KEY CUSTOMERS; RELATED PARTY ISSUES
In Fiscal 1999, the Company generated approximately 51% of its revenue
from Foundation Health Corporation and approximately 34% of its revenues from
Humana Medical Plan, Inc. In Fiscal 2000, there may be some decrease in the
revenue derived from Foundation as a result of the Company's Business
Rationalization Program, see "Part I, Item I. General, contained elsewhere
herein". The loss of any of these contracts or significant reductions in
reimbursement rates could have a material adverse affect on the Company. See
"Dependence on Contracts with Managed Care Organizations".
Medicare regulations limit cost-based reimbursement for healthcare
charges paid to related parties. A party is considered "related" to a provider
if it is deemed to be under common ownership and/or control with the provider.
One test for determining common control for this purpose is whether the
percentage of the total revenues of the party received from services rendered to
the provider is so high that it effectively constitutes control. Another test is
whether the scope of management services furnished under contract is so broad
that it constitutes control. It is possible that such regulations or the
interpretation thereof could limit the number of management contracts and/or the
fees attributable to such contracts if a particular client of the Company is
deemed "related."
REIMBURSEMENT CONSIDERATIONS
The Company receives reimbursement from the Medicare and Medicaid
programs or payments from insurers, self-funded benefit plans or other
third-party payors. The Medicare and Medicaid programs are subject to statutory
and regulatory changes, retroactive and prospective rate adjustments,
administrative rulings and funding restrictions, any of which could have the
effect of limiting or reducing reimbursement levels. Because a substantial
portion of the services provided by the Company are covered by Medicare, any
changes which limit or reduce Medicare reimbursement levels could have a
material adverse effect on the Company.
Significant changes have been and may be made in the Medicare program,
which could have a material adverse effect on the Company's business, results of
operations, prospects, financial results, financial condition or cash flows. In
addition, legislation has been or may be introduced in the Congress of the
United States which, if enacted, could adversely affect the operations of the
Company by, for example, decreasing reimbursement by third-party payors such as
Medicare or limiting the ability of the Company to maintain or increase the
level of services provided to patients.
Title XVIII of the Social Security Act authorizes Medicare Part A, the
health insurance program that pays for inpatient care for covered persons
(generally, those age 65 and older and the long-term disabled) and Medicare Part
B, a voluntary supplemental medical assistance insurance program. Healthcare
providers may participate in the Medicare program subject to certain conditions
of participation and acceptance of a provider agreement by the Secretary of
Health and Human Services ("HHS"). Only enumerated services, upon satisfaction
of certain criteria, are eligible for Medicare reimbursement. Relative to the
services of the Company's Home Health Agencies ("HHAs") and previously owned or
operated Medicare certified outpatient rehabilitation facilities ("ORFs"),
Comprehensive Outpatient Rehabilitation Facilities ("CORFs"), in the past
Medicare has reimbursed the
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"reasonable costs" for services up to program limits. Medicare-reimbursed costs
are subject to audit, which may result in a decrease in payments the Company has
previously received. Historically, Medicare Part B reimburses the operating cost
component of most hospital outpatient services on a reasonable cost basis,
subject to a 5.8% reduction which the Balanced Budget Act of 1997 (the "Budget
Act"), extended through federal Fiscal year 2000. However, Medicare recently
issued a proposed regulation pursuant to which hospital outpatient services
would be reimbursed on the basis of a prospective payment system ("PPS"). Such a
PPS system is scheduled to be implemented shortly after the year 2000. It is
also impossible to predict the effect a PPS system for these hospital outpatient
services will have on the Company. There can be no assurance that the
established fees will not change in a manner that could adversely affect the
revenues of the Company. See "--The Balanced Budget Act of 1997."
Pursuant to the Medicaid program, the federal government supplements
funds provided by the various states for medical assistance to the medically
indigent. Payment for such medical and health services is made to providers in
an amount determined in accordance with procedures and standards established by
state law under federal guidelines. Significant changes have been and may
continue to be made in the Medicaid program which could have a material adverse
effect on the financial condition, results of operations and cash flows of the
Company.
During certain Fiscal years, the amounts appropriated by state
legislatures for payment of Medicaid claims have not been sufficient to
reimburse providers for services rendered to Medicaid patients. Failure of a
state to pay Medicaid claims on a timely basis may have a material adverse
effect on the Company's cash flow, results of operations and financial
condition.
In 1992, the Medicare program began reimbursing physicians and certain
non-physician professionals such as physical, occupational and speech
therapists, clinical psychologists and clinical social workers, pursuant to a
fee schedule derived using a resource-based relative value scale ("RBRVS").
Reimbursement amounts under the physician fee schedule are subject to periodic
review and adjustment and may affect the Company's revenues to the extent they
are dependent on reimbursement under the fee schedule.
Payments per visit from managed care organizations typically have been
lower than cost-based reimbursement from Medicare and reimbursement from other
payors for nursing and related patient services. In addition, payors and
employer groups are exerting pricing pressure on home health care providers,
resulting in reduced profitability. Such pricing pressures could have a material
adverse effect on the Company's business, results of operations, prospects,
financial results, financial condition or cash flows.
THE BALANCED BUDGET ACT OF 1997
The Balanced Budget Act of 1997 (the "Budget Act") enacted in August
1997 contains numerous provisions related to Medicare and Medicaid
reimbursement. It is unclear whether any or all of these provisions will be
implemented by the Health Care Financing Administration ("HCFA") as scheduled.
The general thrust of the provisions dealing with Medicare and Medicaid
contained in the Budget Act are intended to incentivize providers to deliver
services efficiently at lower costs. The Budget Act also requires the Secretary
of HHS to implement a PPS for home health agency services, and reduces the
amount of Medicare reimbursement for HHA services. Under such a PPS system,
providers will be reimbursed a fixed fee per treatment unit, and a provider
having costs greater than the prospective amount will incur losses. The Company
expects that there will continue to be numerous initiatives on the federal and
state levels for comprehensive reforms affecting the payment for and
availability of healthcare services.
The Budget Act also provides for a PPS for home nursing to be
implemented. Prospective rates determined by the HHS would reflect a 15%
reduction to the cost limits and per-patient limits in place as of September 30,
1999. In the event the implementation deadline is not met, the reduction will be
applied to the reimbursement system then in place. Until PPS takes effect on
October 1, 2000, the Budget Act established an interim payment system ("IPS")
that provides for the lowering of reimbursement limits for home health visits.
For cost reporting periods beginning on or after October 1, 1997,
Medicare-reimbursed home health agencies will have their cost limits determined
as the lesser of (i) actual costs (ii) 105% of median costs of freestanding home
health agencies, or (iii) an agency-specific per-patient cost limit, based on
98% of 1994 costs adjusted for inflation. The
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new IPS cost limits apply to the Company for the cost reporting periods
beginning after October 1997. The failure to implement a PPS for home nursing
services in the next several years could adversely affect the Company and its
growth strategy.
For cost reporting periods beginning on or after October 1, 1997, the
Budget Act requires a home health agency to submit claims for payment for home
health services only on the basis of the geographic location at which the
service was furnished. HCFA has publicly expressed concern that some home health
agencies are billing for services from administrative offices in locations with
higher per-visit cost limitations than the cost limitations in effect in the
geographic location of the home health agency furnishing the service. The
Company is unable to determine the effect of the reimbursement impact resulting
from payments for services based upon geographic location until HCFA finalizes
related regulatory guidance. Any resultant reduction in the Company's cost
limits could have a material adverse effect on the Company's business, financial
condition or results of operations. However, until regulatory guidance is
issued, the effect of such reductions cannot be predicted with any level of
certainty.
Various other provisions of the Budget Act may have an impact on the
Company's business and results of operations. For example, venipuncture will no
longer be a covered skilled nursing home care service unless it is performed in
connection with other skilled nursing services. Additionally, payments will be
frozen for durable medical equipment, excluding orthotic and prosthetic
equipment, and payments for certain reimbursable drugs and biologicals will be
reduced. Beginning with services furnished on or after January 1, 1998, coverage
of home health services is currently being shifted over a period of six years
from Medicare Part A to Medicare Part B except for a maximum of 100 visits
during a spell of illness after a three-day hospitalization initiated within 14
days after discharge or after receiving any covered services in a skilled
nursing facility, each of which will continue to be covered under Medicare Part
A. Another provision of the Budget Act would reduce Medicare reimbursements to
acute care hospitals for non-Medicare patients who are discharged from the
hospital after a very short inpatient stay to the care of a home health agency.
The impact of these reimbursement changes could have a material adverse effect
on the Company's business, financial condition or results of operations.
However, this impact cannot be predicted with any level of certainty at this
time.
Among the other changes which the Budget Act is attempting to
accomplish are the following: (i) reducing the amounts which the federal
government will pay for services provided to Medicare and Medicaid beneficiaries
by an estimated $115 billion and $13 billion, respectively over a five-year
period; (ii) reducing payments to hospitals for inpatient and outpatient
services provided to Medicare beneficiaries by an estimated $44 billion over a
five-year period; (iii) establishing the Medicare+Choice Program, which expands
the availability of managed care alternatives to Medicare beneficiaries,
including Medical Savings Accounts; (iv) converting the Medicare reimbursement
of outpatient hospital services from a reasonable cost basis to a PPS; (v)
adjusting the manner in which Medicare calculates the amount of copayments which
are deducted from the Medicare payment to hospitals for outpatient services;
(vi) freezing the Medicare hospital PPS and PPS-exempt hospital and distinct
part unit update for Fiscal year 1998 and 1999, and limiting the level of annual
updates for subsequent years; (vii) reducing various other Medicare payments to
providers; (viii) repealing the federal Boren Amendment, which imposed certain
requirements on the level of reimbursement paid to hospitals for services
rendered to Medicaid beneficiaries; (ix) permitting states to mandate managed
care for Medicaid beneficiaries without the need for federal waivers; (x)
instituting permanent, mandatory exclusion from any federal health care program
for those convicted of three health care-related crimes, and a mandatory 10-year
exclusion for those convicted of two health care-related crimes. Additionally,
the Secretary of HHS will be able to deny entry into Medicare or Medicaid or
deny renewal to any provider or supplier convicted of any felony that the
Secretary deems to be "inconsistent with the best interests" of the program's
beneficiaries; and (xi) creating a new civil monetary penalty for violations of
the Federal Medicare/Medicaid Anti-Fraud and Abuse Amendments to the Social
Securities Act ("Anti-Kickback Law") for cases in which a person contracts with
an excluded provider for the provision of health care items or services where
the person knows or should know that the provider has been excluded from
participation in a federal health care program. Violations will result in
damages three times the remuneration involved, as well as a penalty of $50,000
per violation. There can be no assurance that the Company will not be subject to
the imposition of a fine or other penalty from time to time.
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PROPOSED LEGISLATION
Congress and the State Legislature may propose legislation altering the
financing and delivery of health care services provided by the Company (beyond
the changes made by the Budget Act). There are wide variations among the bills
and their ultimate effect on the Company cannot be determined. Certain proposals
would encourage the growth of managed care networks, extend temporary reductions
in Medicare reimbursement imposed under current law, impose additional costs in
Medicare reimbursement and substantially restructure Medicaid.
ADDITIONAL PAYOR CONSIDERATIONS
Medicare retrospectively audits all reimbursements paid to
participating providers, including those now or previously managed and/or owned
by the Company, cost reports of client hospitals, CORFs, ORFs, and HHAs upon
which Medicare reimbursement for services rendered in the programs managed by
the Company is based. Accordingly, at any time, the Company could be subject to
refund obligations to such clients for prior period cost reports that have not
been audited and settled as of the date hereof.
Certain private insurance companies contract with hospitals and other
providers on an "exclusive" or a "preferred provider" basis and some insurers
have introduced plans known as "preferred provider organizations" ("PPOs").
Under such plans, there may be financial incentives for subscribers to use only
those providers that contract with the plans. Under an exclusive provider plan,
which includes most "health maintenance organizations" ("HMOs"), private payors
limit coverage to those services provided by selected providers. With this
contracting authority, private payors may direct patients away from nonselected
providers by denying coverage for services provided by them.
Most PPOs and HMOs currently pay providers on a discounted
fee-for-service basis or on a discounted fixed rate per day of care. Many health
care providers do not have accurate information about their actual costs of
providing specific types of care, particularly since each patient presents a
different mix of services and lengths of stay. Consequently, the discounts
offered to PPOs and HMOs may result in payments at less than actual costs.
Payors, including Medicare and Medicaid, are attempting to manage
costs, resulting in declining amounts paid or reimbursed to hospitals for the
services provided. As a result, the Company anticipates that the number of
patients served by hospitals on a per diem, episodic or capitated basis will
increase in the future. There can be no assurance that if amounts paid or
reimbursed to HHAs decline, it will not adversely affect the Company.
INCREASED SCRUTINY OF HEALTHCARE INDUSTRY
The healthcare industry has in general been the subject of increased
government and public scrutiny in recent years, which has focused on the
appropriateness of the care provided, referral and marketing practices and other
matters. Increased media and public attention has recently been focused on the
outpatient services industry in particular as a result of allegations of
fraudulent practices related to the nature and duration of patient treatments,
illegal remuneration and certain marketing, admission and billing practices by
certain healthcare providers. The alleged practices have been the subject of
federal and state investigations, as well as other legal proceedings. Healthcare
is a target for investigations because yearly Medicare payments to these types
of services have increased substantially during the past several years. The
Company is unable to predict the effect of a post-payment review on any
Continucare provider or publicity in general about the healthcare services
industry might have on the Company. There can be no assurance that the Company
will not be subject to federal and state review or investigation from time to
time.
Federal and state governments have recently focused significant
attention on healthcare reform intended to control healthcare costs and to
improve access to medical services for uninsured individuals. These proposals
include cutbacks to the Medicare and Medicaid programs and steps to permit
greater flexibility in the administration of Medicaid. See "--Reimbursement
Considerations." It is uncertain at this time what legislation regarding
healthcare reform may ultimately be enacted or whether other changes in the
administration or interpretation of governmental healthcare programs will occur.
There can be no assurance that future healthcare legislation or other changes in
the administration or interpretation of governmental healthcare programs will
not
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have a material adverse effect on the Company's business, results of operations,
prospects, financial results, financial condition or cash flows.
GOVERNMENT REGULATION
The federal government and many states including the state in which the
Company currently operates regulate certain aspects of the healthcare services
provided by programs managed by the Company and other healthcare services
provided by the Company. In particular, the development and operation of
healthcare facilities are subject to federal, state and local licensure and
certification laws. Healthcare facilities are subject to periodic inspection by
governmental and other authorities to assure compliance with the standards
established for continued licensure under state law and certification under the
Medicare and Medicaid programs. Failure to obtain or renew any required
regulatory approvals or licenses could prevent such facility from offering
outpatient services or receiving Medicare, Medicaid or other third party
payments.
The Company is also subject to federal and state laws which govern
financial and other arrangements between healthcare providers. These laws often
prohibit certain direct and indirect payments or fee-splitting arrangements
between healthcare providers that are designed to induce or encourage
overutilization, underutilization or the referral of patients or payor funded
business, or the recommendation of a particular provider for medical products
and services.
Federal "Fraud and Abuse" Laws and Regulations. The Anti-Kickback Law
makes it a criminal felony offense to knowingly and willfully offer, pay,
solicit or receive remuneration in order to induce business for which
reimbursement is provided under the Medicare or Medicaid programs. In addition
to criminal penalties, including fines of up to $25,000 and five (5) years
imprisonment, violations of the Anti-Kickback Law can lead to civil monetary
penalties (which, pursuant to the Budget Act, can amount to as much as $50,000
for each violation, plus up to treble damages, based on the remuneration
illegally offered, paid, received or solicited) and exclusion from Medicare,
Medicaid and certain other state and federal health care programs. The scope of
prohibited payments in the Anti-Kickback Law is broad and includes economic
arrangements involving hospitals, physicians and other health care providers,
including joint ventures, space and equipment rentals, purchases of physician
practices and management and personal services contracts. HHS has published
regulations which describe certain "safe harbor" arrangements that will not be
deemed to constitute violations of the Anti-Kickback Law. The safe harbors
described in the regulations are narrow and do not cover a wide range of
economic relationships which many hospitals, physicians and other health care
providers consider to be legitimate business arrangements not prohibited by the
statute. Because the regulations describe safe harbors and do not purport to
describe comprehensively all lawful or unlawful economic arrangements or other
relationships between health care providers and referral sources, health care
providers having these arrangements or relationships may be required to alter
them in order to ensure compliance with the Anti-Kickback Law.
Management of the Company believes that its contracts with providers,
physicians and other referral sources are in material compliance with the
Anti-Kickback Law and will make every effort to comply with the Anti-Kickback
Law. However, in light of the narrowness of the safe harbor regulations and the
scarcity of case law interpreting the Anti-Kickback Law, there can be no
assurances that the Company will not be alleged to have violated the
Anti-Kickback Law, and if an adverse determination is reached, whether any
sanction imposed would have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
The Office of the Inspector General of the Department of HHS, the
Department of Justice and other federal agencies interpret these fraud and abuse
provisions liberally and enforce them aggressively. Members of Congress have
proposed legislation that would significantly expand the federal government's
involvement in curtailing fraud and abuse and increase the monetary penalties
for violation of these provisions. In addition, some states restrict certain
business relationships between physicians and other providers of health care
services.
The federal government, private insurers and various state enforcement
agencies have increased their scrutiny of provider business practices and
claims, particularly in the areas of home health care and durable medical
equipment in an effort to identify and prosecute parties engaged in fraudulent
and abusive practices. In May 1995, the Clinton Administration instituted
Operation Restore Trust ("ORT"), a health care fraud and abuse
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initiative focusing on nursing homes, home health care agencies and durable
medical equipment companies. ORT, which initially focused on companies located
in California, Florida, Illinois, New York and Texas, the states with the
largest Medicare populations, has been expanded to all 50 states. While the
Company believes that it is in material compliance with such laws, there can be
no assurance that the practices of the Company, if reviewed, would be found to
be in full compliance with such laws, as such laws ultimately may be
interpreted. It is the Company's policy to monitor its compliance with such laws
and to take appropriate actions to ensure such compliance.
State Fraud and Abuse Regulations. Various States also have
anti-kickback laws applicable to licensed healthcare professionals and other
providers and, in some instances, applicable to any person engaged in the
proscribed conduct. For example, Florida enacted "The Patient Brokering Act"
which imposes criminal penalties, including jail terms and fines, for receiving
or paying any commission, bonus, rebate, kickback, or bribe, directly or
indirectly in cash or in kind, or engage in any split-fee arrangement, in any
form whatsoever, to induce the referral of patients or patronage from a
healthcare provider or healthcare facility.
Management of the Company believes that its contracts with providers,
physicians and other referral sources are in material compliance with the State
laws and will make every effort to comply with the State laws. However, there
can be no assurances that the Company will not be alleged to have violated the
State laws, and if an adverse determination is reached, whether any sanction
imposed would have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
Restrictions on Physician Referrals. The federal Anti-Self Referral Law
(the "Stark Law") prohibits certain patient referrals by interested physicians.
Specifically, the Stark Law prohibits a physician, or an immediate family
member, who has a financial relationship with an entity, from referring Medicare
or Medicaid patients with limited exceptions, to that entity for the following
"designated health services", clinical laboratory services, physical therapy
services, occupational therapy services, radiology or other diagnostic services,
durable medical equipment and supplies, radiation therapy services and supplies,
parenteral and enteral nutrients, equipment and supplies, prosthetics, orthotics
and prosthetic devices, home health services, outpatient prescription drugs, and
inpatient and outpatient hospital services. A financial relationship is defined
to include an ownership or investment in, or a compensation relationship with,
an entity. The Stark Law also prohibits an entity receiving a prohibited
referral from billing the Medicare or Medicaid programs for any services
rendered to a patient. The Stark Law contains certain exceptions that protect
parties from liability if the parties comply with all of the requirements of the
applicable exception. The sanctions under the Stark Law include denial and
refund of payments, civil monetary penalties and exclusions from the Medicare
and Medicaid programs.
HHS has proposed regulations further implementing and interpreting the
Stark Law. If adopted as final these regulations will impact the interpretation
and application of the Stark Law. The Company is unable to predict the manner in
which those regulations could impact the Company's current compliance with the
Stark Law.
Management of the Company believes that it is presently in material
compliance with the Stark Law and will make every effort to comply with the
Stark Law. However, in light of the lack of regulatory guidance and the scarcity
of case law interpreting the Stark Law, there can be no assurances that the
Company will not be alleged to have violated the Stark Law, and if an adverse
determination is reached, whether any sanction imposed would have a material
adverse effect on the Company's results of operations, financial condition or
cash flows.
Corporate Practice of Medicine Doctrine. Many states prohibit business
corporations 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 (including Medicare and Medicaid), asset forfeitures and
civil and criminal penalties. These laws vary from state to state, are often
vague and loosely interpreted by the courts and regulatory agencies. The Company
seeks to structure its business arrangements in compliance with these laws and,
from time to time, the Company has sought guidance as to the interpretation of
such laws. There, however, can be no assurance that such laws ultimately will be
interpreted in a manner consistent with the practices of the Company and an
adverse interpretation could have a material adverse effect on the Company's
results of operations, financial condition or cash flows.
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Certificates of Need and Certificates of Exemption. Many states,
including the state in which the Company operates, have procedures for the
orderly and economical development of health care facilities, the avoidance of
unnecessary duplication of such facilities and the promotion of planning for
development of such facilities. Such states require health care facilities to
obtain Certificates of Need ("CONs") or Certificates of Exemption ("COEs")
before initiating projects in excess of a certain threshold for the acquisition
of major medical equipment or other capital expenditures; changing the scope or
operation of a health care facility; establishing or discontinuing a health care
service or facility; increasing, decreasing or redistributing bed capacity;
and/or changing of ownership of a health care facility, among others. Possible
sanctions for violation of any of these statutes and regulations include loss of
licensure or eligibility to participate in reimbursement programs and other
penalties. These laws vary from state to state and are generally administered by
the respective state department of health. The Company seeks to structure its
business operations in compliance with these laws and has sought guidance as to
the interpretation of such laws and the procurement of required CONs and/or
COEs. There can be no assurance, however, that the Company or any of its client
hospitals, or HHAs will be able to obtain required CONs and/or COEs in the
future.
The Company is unable to predict the future course of federal, state or
local legislation or regulation, including Medicare and Medicaid statutes and
regulations. Further changes in the regulatory framework could have a material
adverse effect on the Company's financial condition, results of operations or
cash flows.
GEOGRAPHIC CONCENTRATION
More than 98% of the Company's net revenues in Fiscal 1999 were derived
from the Company's operations in Florida. It is anticipated that in Fiscal 2000
substantially all of the Company's net revenue will be derived from the
Company's operations in Florida. Unless and until the Company's operations
become more diversified geographically (as a result of acquisitions or internal
expansion), adverse economic, regulatory, or other developments in Florida could
have a material adverse effect on the Company's financial condition or results
of operations. The Company has as of Fiscal 1999 closed all operations outside
the State of Florida. In the event that the Company expands its operations into
new geographic markets, the Company will need to establish new relationships
with physicians and other healthcare providers. In addition, the Company will be
required to comply with laws and regulations of states that differ from those in
which the Company currently operates, and may face competitors with greater
knowledge of such local markets. There can be no assurance that the Company will
be able to establish relationships, realize management efficiencies or otherwise
establish a presence in new geographic markets.
DEPENDENCE ON PHYSICIANS
A significant portion of the Company's revenue is derived: (i) from
patient service revenue generated by physicians employed by or under contract
with the Company; and (ii) under managed care contracts held by the Company.
Revenue derived by the Company under capitated managed care contracts depends on
the continued participation of physicians providing medical services to patients
of the managed care companies and independent physicians contracting with the
Company to participate in provider networks which are developed or managed by
the Company. Physicians can typically terminate their agreements to provide
medical services under managed care contracts by providing notice of such
termination to the payor. Termination of these agreements by physicians may
result in termination by the payor of a managed care contract between the
Company and the payor. Any material loss of physicians, whether as a result of
the loss of network physicians or the termination of managed care contracts
resulting from the loss of network physicians or otherwise, could have a
material adverse effect on the Company's business, results of operations,
prospects, financial results, financial condition or cash flows. The Company
competes with general acute care hospitals and other healthcare providers for
the services of medical professionals. Demand for such medical professionals is
high and such professionals often receive competing offers. No assurance can be
given that the Company will be able to continue to recruit and retain a
sufficient number of qualified medical professionals. The inability to
successfully recruit and retain medical professionals could adversely affect the
Company's ability to successfully implement its growth strategy. See "Business
- --Administrative Support Operations."
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COMPETITION
The healthcare industry is highly competitive. Continucare competes
with several national competitors and many regional and national healthcare
companies, some of which have greater resources than Continucare. In addition,
healthcare providers may elect to manage their own outpatient health programs.
Competition is generally based upon reputation, price, the ability to offer
financial and other benefits for the particular provider, and the management
expertise necessary to enable the provider to offer outpatient programs that
provide the full continuum of outpatient services in a quality and
cost-effective manner. The pressure to reduce healthcare expenditures has
emphasized the need to manage the appropriateness of health services provided to
patients. As a result, competitors without management experience covering the
various levels of the continuum of outpatient services may not be able to
compete successfully.
INSURANCE
Continucare carries general liability, comprehensive property damage,
malpractice, workers' compensation, stop-loss and other insurance coverages that
management considers adequate for the protection of Continucare's assets and
operations. There can be no assurance, however, that the coverage limits of such
policies will be adequate to cover losses and expenses for lawsuits brought or
which may be brought against the Company. A successful claim against Continucare
in excess of its insurance coverage could have a material adverse effect on
Continucare.
TECHNOLOGY; YEAR 2000 COMPLIANCE
The Year 2000 Issue is the result of the computer programs being
written using two digits rather than four to define the applicable year. Any of
the Company's computer programs that have time-sensitive software may recognize
a date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations and
patient care, including, among other things, a failure of certain patient care
applications and equipment, a failure of control systems, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities.
Based on a recent and ongoing assessment, the Company determined that
it will be required to modify or replace certain portions of its software,
hardware and patient care equipment so that its systems will function properly
with respect to dates in the year 2000 and thereafter. Affected systems will
include clinical and biomedical instrumentation and equipment used within the
Company for purposes of direct or indirect patient care such as imaging,
laboratory, pharmacy and respiratory devices; cardiology measurement and support
devices; emergency care devices (including monitors, defibrillators, dialysis
equipment and ventilators); and general patient care devices (including
telemetry equipment and intravenous pumps). The Company presently believes that
with modifications to existing software and conversions to new clinical and
biomedical instrumentation and equipment, the Year 2000 Issue will not pose
significant operational problems. However, if such modifications and conversions
are not made, or are not completed timely, the Year 2000 Issue could have a
material impact on the operations of the Company.
The Company has initiated formal communications with all of its
significant suppliers to determine the extent to which the Company's interface
systems are vulnerable to those third parties' failure to remediate their own
Year 2000 Issues. The Company's total Year 2000 project cost and estimates to
complete include the costs and time associated with the impact of third-party
Year 2000 Issues based on presently available information. However, there can be
no guarantee that the systems of other companies on which the Company's systems
rely will be timely converted and would not have an adverse effect on the
Company's systems.
The Company will utilize both internal and external resources to
reprogram, or replace and test the software and patient care equipment for Year
2000 modifications. The Company anticipates completing the Year 2000 project by
December 1, 1999, which is prior to any anticipated impact on its operating
systems. The total cost of the Year 2000 project is estimated at $200,000 and is
being funded through operating cash flows. Of the total projected cost,
approximately $50,000 is attributable to the purchase of new software and
patient care equipment,
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which will be capitalized. The remaining $150,000 will be expensed as incurred
and is not expected to have a material effect on the results of operations.
The costs of the project and the date on which the Company believes it
will complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future events,
including the continued availability of certain resources, third party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved and actual results could differ materially from
those anticipated. Specific factors that might cause material differences
include, but are not limited to, the availability and cost of replacement
equipment and personnel trained in this area, the ability to locate and correct
all relevant computer codes, and similar uncertainties.
UPGRADE OF MANAGEMENT INFORMATION SYSTEMS; TECHNOLOGICAL OBSOLESCENCE
The operations of the Company are heavily dependent on its management
information systems. Implementation of new management information systems and
integration of management information systems in connection with acquisitions
require a transition period during which various functions must be converted or
integrated to the new systems. This conversion and integration process may
entail errors, defects or prolonged downtime, especially at the outset, and such
errors, defects or downtime could have a material adverse effect on the
Company's business, results of operations, prospects, financial results,
financial condition or cash flows.
Both the software and hardware used by the Company in connection with
the services it provides have been subject to rapid technological change.
Although the Company believes that its technology can be upgraded as necessary,
the development of new technologies or refinements of existing technology could
make the Company's existing equipment obsolete. Although the Company is not
currently aware of any pending technological developments that would be likely
to have a material adverse effect on its business, there is no assurance that
such developments will not occur.
* * * * * * *
The Company cautions that the risk factors described above could cause
actual results or outcomes to differ materially from those expressed in any
forward-looking statements of the Company made by or on behalf of the Company.
Any forward-looking statement speaks only as of the date on which such statement
is made, and the Company undertakes no obligation to update any forward-looking
statement or statements to reflect events or circumstances after the date on
which such statement is made or to reflect the occurrences of unanticipated
events. New factors emerge from time to time and it is not possible for
management to predict all of such factors. Further, management cannot assess the
impact of each such factor on the Company's business or the extent to which any
factor, or combination of factors, may cause actual results to differ materially
from those contained in any forward-looking statements
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PART I
ITEM 1. BUSINESS
GENERAL
Continucare, through its Managed Care and Home Health Divisions, is a
provider of outpatient healthcare and home healthcare services exclusively in
the Florida market. The Company's Managed Care Division, through various managed
care agreements and capitated arrangements, is responsible for providing primary
care medical services (the "Primary Care Services") to approximately 40,000
patients. The various managed care agreements and capitated arrangements under
which Continucare provides medical services to its patients require that in
exchange for a predetermined amount, per patient per month, the Company assumes
responsibility to provide and pay for all of its patients' medical needs. The
Company's Home Health Division provides home healthcare services to recovering,
disabled, chronically ill and terminally ill patients in their homes.
Throughout Fiscal 1999 the Company experienced adverse business
operations. To strengthen Continucare financially, since the end of calendar
1998, the Company has undertaken a business rationalization program (the
"Business Rationalization Program") to divest itself of certain unprofitable
operations and to close other underperforming subsidiary divisions and a
financial restructuring program (the "Financial Restructuring Program") to
strengthen its financial performance and financial condition. In connection with
the implementation of its Business Rationalization Program, Continucare has sold
or closed its Outpatient Rehabilitation division, Diagnostic Imaging division
and its Specialty Physician Practices. Although these divisions were sold at a
loss, the divestitures generated net cash proceeds of approximately $5,642,000
(after the payment of transaction costs and other costs such as employee-related
costs). The Business Rationalization Program has assisted management with the
commencement and implementation of its Financial Restructuring Program and has
allowed the Company to focus its resources on a core business model.
Since December 31, 1998 the Company has not been in compliance with
certain covenants under the terms of its $5,000,000 Credit Facility (the "Credit
Facility") with First Union. During April 1999, the Company used approximately
$4,000,000 of the net proceeds of the sale of its Outpatient Rehabilitation
subsidiary (see "Liquidity and Capital Resources" and Note 1 of the accompanying
Financial Statements) to reduce the outstanding balance of the Credit Facility
to $1,000,000. In connection with the payment, the Company entered into an
amendment to the Credit Facility, which provided, among other things, for the
repayment of the remaining outstanding principal balance of approximately
$1,000,000 to First Union by December 31, 1999. See "Recent Developments - Debt
Restructuring" and Item 7 - "Management's Discussion and Analysis of Financial
Condition and Results of Operations".
On April 30, 1999 the Company defaulted on its semi-annual payment of
interest on its 8% Convertible Subordinated Notes Payable due 2002 (the
"Subordinated Notes Payable"). The Company, in an effort to effect a successful
completion of its Business Rationalization Program and Financial Restructuring,
negotiated a settlement in principle (the "Debenture Settlement") with the
holders of its Subordinated Notes Payable (the "Subordinated Notes Payable
Holders"). See "Recent Developments - Debt Restructuring" and Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
INDUSTRY OVERVIEW
There are three principal industry elements which management believes
have created a substantial opportunity for the Company including: (i) the
continued penetration of the managed care market; (ii) the highly fragmented
nature of the delivery of outpatient services; and (iii) the shift in the
provision of healthcare services from the hospital to lower cost outpatient
locations and the home.
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CONTINUED PENETRATION OF MANAGED CARE. In response to escalating
expenditures in healthcare costs, payors, such as Medicare and managed care
organizations, have increasingly pressured physicians, hospitals and other
providers to contain costs. This pressure has led to the growth of lower cost
outpatient care, and to reduce hospital admissions and lengths of stay. To
further increase efficiency and reduce the incentive to provide unnecessary
healthcare services to patients, payors have developed a reimbursement structure
called capitation. Capitation contracts require the payment to healthcare
providers of a fixed amount per patient for a given patient population, and the
providers assume full responsibility for servicing all of the healthcare
services needs of those patients, regardless of their condition. The Company
believes that low cost providers will succeed in the capitation environment
because such companies have the ability to manage the cost of patient care.
HIGHLY FRAGMENTED MARKET. The highly fragmented nature of the delivery
of outpatient services has created an inefficient healthcare services
environment for patients, payors and providers. Managed care companies and other
payors must negotiate with multiple healthcare services providers, including
physicians, hospitals and ancillary services providers, to provide geographic
coverage to their patients. Physicians who practice alone or in small groups
have experienced difficulty negotiating favorable contracts with managed care
companies and have trouble providing the burdensome documentation required by
such entities. In addition, healthcare service providers may lose control of
patients when they refer them out of their network for additional services that
such providers do not offer. The Company intends to continue affiliating with
physicians who are sole practitioners or who operate in small groups to staff
and expand its network, which should make the Company a provider of choice to
managed care organizations.
SHIFT TOWARD LOW-COST OUTPATIENT TREATMENT. Outpatient treatment has
grown rapidly as a result of: (i) advances in medical technology, which have
facilitated the delivery of healthcare in alternate sites; (ii) demographic
trends, such as an aging population; and (iii) preferences among patients to
receive care in their homes. The Company expects this trend to continue as
managed care companies and healthcare providers continue shifting towards the
lower cost providers.
BUSINESS STRATEGY
The Company intends to leverage the current industry dynamics by: (i)
increasing its managed care revenue; (ii) maintaining its physician network;
(iii) implementing its Staff Model in additional selected strategic markets; and
(iv) maintaining its home care division.
INCREASING MANAGED CARE REVENUE. The Company's core business is
comprised of its established network of Staff Model clinics from which it
provides Primary Care Services to its patients and to the public at large. By
securing additional managed care contracts with the leading managed care
companies in Florida, the Company believes that it will be able to increase its
managed care enrollments. The Company believes that it has been successful in
developing managed care relationships due to its network of quality physicians,
the provision of a range of healthcare services, and its many locations.
MAINTAINING PHYSICIAN NETWORK. The physician network is the platform of
the Company's Independent Practice Association ("IPA"). The Company through its
Business Rationalization Program has greatly reduced the size of its IPA. In an
attempt to better manage the division and the medical cost associated therewith
the Company has reevaluated its IPA business model. The Company, however, may
expand its physician network by: (i) adding physicians to its IPA; and/or (ii)
hiring physicians to work in Company-owned physician practices and clinics.
IMPLEMENTING STAFF MODEL IN SELECTED MARKETS. The Company has
successfully implemented its Staff Model in South and Central Florida, and
intends to selectively expand the model in other appropriate markets, primarily
within Florida, by tailoring its services and facilities to the needs of
individual markets. Currently the Company operated 18 Staff Model clinics in
South and Central Florida.
MAINTAINING HOME CARE DIVISION. During Fiscal 1999 the home health care
industry underwent a major restructuring in response to the federal legislative
enactments of 1997 and 1998 that significantly reduced
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reimbursement for home health services. See - "Cautionary Note Regarding
Forward-Looking Statements"; Reimbursement Considerations"; "The Balance Budget
Act of 1997"; "Proposed Legislation"; "Additional Payor Considerations";
"Increased Scrutiny of Healthcare Industry"; and "Government Legislation". As a
result, many Medicare certified home health agencies have ceased operations
because they are no longer able to generate revenue sufficient to cover costs.
The Company, as a result of the current market conditions, has rationalized its
Home Care Division to a core level that it believes is manageable in the current
regulatory environment.
RECENT DEVELOPMENTS - DEBT RESTRUCTURING
As described above, throughout Fiscal 1999 the Company experienced
adverse business operations. In order to avoid having to seek bankruptcy
protection, and to strengthen itself financially, the Company during the past
Fiscal year undertook a Business Rationalization Program to divest itself of
certain unprofitable operations and close other underperforming subsidiaries and
divisions. In addition the Company undertook a Financial Restructuring Program
designed to strengthen its financial condition.
On April 30, 1999 (the "Default Date") the Company defaulted on its
semi-annual payment of interest on its Subordinated Notes Payable. Within thirty
(30) days of the Default Date, the Company commenced negotiations with an
informal committee of the Subordinated Notes Payable Holders. $45,000,000
in principal balance and $1,800,000 in accrued interest were outstanding as of
the Default Date. On or about July 2, 1999 the Company purchased $4,000,000 face
value of its Subordinated Notes Payable for approximately $200,000, recognizing
a gain on extinguishment of debt of approximately $3,800,000 million.
On September 29, 1999 the Company announced an agreement in principle
with the Subordinated Notes Payable Holders to enter into a settlement and
restructuring agreement with respect to the remaining $41,000,000 principal
balance and approximately $3,300,000 of interest thereon accrued through October
31, 1999. The terms of the proposed Debenture Settlement are as follows: (a)
$31,000,000 of the outstanding principal of the Subordinated Notes Payable will
be converted, on a pro rata basis, into the Company's common stock at a
conversion of $2.00 per share (approximately 15,500,000 shares of capital
stock); (b) all interest accrued on the Subordinated Notes Payable through
October 31, 1999 will be forgiven (approximately $3,300,000); (c) the interest
payment default on the remaining $10,000,000 principal balance of Subordinated
Notes Payable will be waived and the debentures will be reinstated on the
Company's books and records as a performing non-defaulted loan (the "Reinstated
Subordinated Notes Payable"); (d) the Reinstated Subordinated Notes Payable will
bear interest at the rate of 7% per annum commencing November 1, 1999; and (e)
the conversion rate for the Reinstated Subordinated Notes Payable will be
modified as follows:
TERM CONVERSION RATE
- ------------------------------------------------------------------------
Through October 31, 2000......................... $7.25
November 1, 2000 to Maturity..................... $2.00
and (f) the Company will obtain a financially responsible person (the
"Guarantor") to personally guarantee a $3,000,000 bank credit facility (the "New
Credit Facility") for the Company. In consideration for providing the guaranty
the Company will issue to the Guarantor 3,000,000 shares of the Company's
capital stock. The New Credit Facility will replace the Company's existing First
Union Credit Facility and it will additionally be used to finance the Company's
working capital and capital expenditure requirements. The Company has agreed to
convene a meeting of its Shareholders before December 31, 1999 in order to
obtain shareholder approval of the Debenture Settlement.
The successful completion of the proposed Debenture Settlement is
subject to a number of significant risks and uncertainties including, but not
limited to, the need to draft and execute a final settlement agreement with the
Subordinated Notes Payable Holders, the need to consummate the New Credit
Facility, and the need to obtain shareholder ratification of the Debenture
Settlement on or before December 31, 1999. The historical information contained
herein should be considered in the light of the proposed Debenture Settlement,
however, the risks and uncertainties attendant to finally consummating the
settlement should not be ignored.
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CONTINUUM OF CARE
Continucare is a provider of integrated outpatient healthcare. The
Company has established a network of physician practices as the primary
caregiver to its patients and to the public at large and also provides home
health services.
Office and Physician/Health Center Practices. Since commencing its
operations in 1996, the Company has expanded its physician network through
acquisitions of physician practices, employment of new physicians and
affiliations with physicians through the Company's IPA. This physician network
provides a broad platform for the delivery of the Company's continuum of
healthcare services to patients. As of June 30, 1999, the Company operated
eighteen staff model health center clinics, employed or contracted with
approximately 172 physicians all of whom are located in Florida and provided
services to approximately 39,600 patients under capitated managed care
contracts.
The physicians within the Company's network treat patients in
office-based settings as well as health centers. A typical office-based practice
is located in a major metropolitan area, in office space that ranges from 5,000
to 8,000 square feet. The office typically employs or contracts with
approximately two to three physicians. The physicians provide primary care and
specialty care to their patients. A typical health center is located in or near
major metropolitan areas, in space that ranges from 2,500 to 5,000 square feet.
A health center is typically staffed with approximately two physicians, and is
open five days a week.
Home Healthcare. Continucare provides home healthcare services to
recovering, disabled, chronically ill and terminally ill patients in their
homes. Typically, a service care provider (such as a registered nurse, home
health aide, therapist or technician) will visit the patient one or two times a
day or the patient may require around-the-clock care. Treatment may last for
several weeks, several months or the remainder of the patient's life. The
services provided by the Company include skilled nursing, physical therapy,
speech therapy, occupational therapy, medical social services and home health
aide services. Reimbursement for the home health services provided by the
Company include Medicare, Medicaid and managed care.
ADMINISTRATIVE SUPPORT OPERATIONS
Administrative Functions. The Company enhances administrative
operations of its physician practices by providing management functions such as
payor contract negotiations, credentialing assistance, financial reporting, risk
management services, access to lower cost professional liability insurance and
the operation of integrated billing and collection systems. The Company believes
it offers physicians increased negotiating power associated with managing their
practice and fewer administrative burdens, which allows the physician to focus
on providing care to patients.
Employment and Recruiting of Physicians. The Company generally enters
into multiple-year employment agreements with the physicians in the practices
purchased by the Company. These agreements usually provide for base compensation
and benefits and may contain incentive compensation provisions based on quality
indicators. The recruitment process includes interviews and reference checks
incorporating a number of credentialing and competency assurance protocols. The
Company's physicians are generally either board certified or board eligible.
Contract Negotiations. The Company assists its physicians in obtaining
managed care contracts. The Company believes that its experience in negotiating
and managing risk contracts enhance its ability to market the services of its
affiliated physicians to managed care payors and to negotiate favorable terms
from such payors. The managed care contracts are held, managed and administered
by a wholly-owned subsidiary of the Company. The Company also performs quality
assurance and utilization management under each contract on behalf of its
affiliated physicians.
Information Systems. The Company supports freestanding systems for its
physician practices to facilitate patient scheduling, patient management,
billing, collection and provider productivity analysis. Some of the staff
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model health center clinics require upgrades of their information systems in
order to remain technologically competitive. The Company is upgrading
information systems as it becomes necessary. See "Risk Factors -- Upgrade of
Management Information Systems; Technological Obsolescence."
MANAGED CARE
The Company's strategy is to increase enrollment by adding new payor
relationships and new providers to the existing network and by expanding the
network into new geographic areas where the penetration of managed healthcare is
growing. The Company believes new payor and provider relationships are possible
because of its ability to manage the cost of health care without sacrificing
quality. The Company seeks to control one of the "gatekeeping" points of entry
into the managed health care delivery system--the primary care physician's
office--thereby giving the Company a platform for coordinating all aspects of
patient care under global capitation payor contracts.
Contracts with Payors. Contracts with payors generally provide for
terms of one to ten years, may be terminated earlier upon notice for cause or
upon renewal and in some cases without cause. Additionally the contracts are
subject to renegotiation of capitation rates, covered benefits and other terms
and conditions. Pursuant to payor contracts, the physicians provide covered
medical services and receive capitation payments from payors for each enrollee
who selects a Company network physician as his or her primary care physician. To
the extent that patients require more care than is anticipated or require
supplemental medical care that is not otherwise reimbursed by payors, aggregate
capitation payments may be insufficient to cover the costs associated with the
treatment of patients. The Company maintains stop-loss insurance coverage, which
mitigates the effect of occasional high utilization of health care services. If
revenues are insufficient to cover costs or the Company is unable to maintain
stop-loss coverage at favorable rates, the Company's business results of
operations and financial condition could be materially adversely affected. The
loss of significant payor contracts and/or the failure to regain or retain such
payor's patients or the related revenues without entering into new payor
relationships could have a material adverse effect on the Company's business
results of operations and financial condition.
The Company's capitated managed care agreement with Foundation is a
ten-year agreement with the initial term expiring on June 30, 2008, unless
terminated earlier by Foundation for cause. In the event of termination of the
Foundation agreement, the Company must continue to provide services to a patient
with a life-threatening or disabling and degenerative condition for sixty days
as medically necessary. This agreement is automatically renewed for another five
year period unless notice by either party is provided 120 days in advance of the
expiration date. Any negotiation must be completed 90 days prior to the
expiration of the term. Foundation can terminate the agreement with respect to
one or more benefit programs; however, the Company may only terminate the
agreement in its entirety. The Company's capitated managed care agreement with
Humana Medical Plans, Inc. ("Humana") is a ten-year agreement expiring July 31,
2008, unless terminated earlier for cause. The agreement shall automatically
renew for subsequent one-year terms unless either party provides 180-days
written notice of its intent not to renew. In addition, the Humana agreement may
be terminated by the mutual consent of both parties at any time. Under certain
limited circumstances, Humana may immediately terminate the agreement for cause,
otherwise termination for cause shall require ninety (90) days prior written
notice with an opportunity to cure, if possible. In the event of termination of
the Humana agreement, the Company must continue to provide or arrange for
services to any member hospitalized on the date of termination until the date of
discharge or until it has made arrangements for substitute care. In some cases,
Humana may provide 30 days' notice as to an amendment or modification of the
agreements, including but not limited to, renegotiation of rates, covered
benefits and other terms and conditions. The Company maintains other managed
care relationships subject to various negotiated terms. There can be no
assurance that the Company will be able to renew any of these managed care
agreements or, if renewed, that they will contain terms favorable to the Company
and affiliated physicians. The loss of any of these contracts or significant
reductions in capitated reimbursement rates under these contracts could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Risk Factors--Risks Associated with Capitated
Arrangements Including Risk of Over-Utilization by Managed Care Patients, Risk
of Reduction of Capitated Rates and Regulatory Risks," "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and "Business
- --Managed Care."
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Fee-for-Service Arrangements. Certain of the Company's physicians who
render services on a fee-for-service basis (as opposed to capitation) typically
bill various payors, such as governmental programs (e.g., Medicare and
Medicaid), private insurance plans and managed care plans, for the health care
services provided to their patients. There can be no assurance that payments
under governmental programs or from other payors will remain at present levels.
In addition, payors can deny reimbursement if they determine that treatment was
not performed in accordance with the cost-effective treatment methods
established by such payors or was experimental or for other reasons.
COMPLIANCE PROGRAM
The Company has implemented a compliance program to provide ongoing
monitoring and reporting to detect and correct potential regulatory compliance
problems. The program establishes compliance standards and procedures for
employees and agents. The program includes, among other things: (i) written
policies; (ii) in service training for each employee on topics such as insider
trading, anti-kickback laws, Federal False Claims Act and Anti-Self Referral
Act; and (iii) a "hot line" for employees to anonymously report violations.
COMPETITION
The healthcare industry is highly competitive. Continucare competes
with several national competitors and many regional and national healthcare
companies, some of which have greater resources than Continucare. In addition,
healthcare providers may elect to manage their own outpatient health programs.
Competition is generally based upon reputation, price, the ability to offer
financial and other benefits for the particular provider, and the management
expertise necessary to enable the provider to offer outpatient programs that
provide the full continuum of outpatient services in a quality and
cost-effective manner. The pressure to reduce healthcare expenditures has
emphasized the need to manage the appropriateness of health services provided to
patients. As a result, competitors without management experience covering the
various levels of the continuum of outpatient services may not be able to
compete successfully.
GOVERNMENT REGULATION
General. Continucare's business is affected by federal, state and local
laws and regulations concerning healthcare. These laws and regulations impact
the development and operation of outpatient programs and the provision of
healthcare to patients in physicians' offices and in patients' homes. Licensing,
certification, reimbursement and other applicable government regulations vary by
jurisdiction and are subject to periodic revision. Continucare is not able to
predict the content or impact of future changes in laws or regulations affecting
the healthcare industry. See "Risk Factors."
Present and Prospective Federal and State Reimbursement Regulation. The
Company's operations are affected on a day-to-day basis by numerous legislative,
regulatory and industry-imposed operational and financial requirements which are
administered by a variety of federal and state governmental agencies as well as
by self-regulatory associations and commercial medical insurance reimbursement
programs.
HHAs, CORFs and ORFs, including those now or previously managed and/or
owned by Continucare, are subject to numerous licensing, certification and
accreditation requirements. These include, but are not limited to, requirements
relating to Medicare participation and payment, requirements relating to state
licensing agencies, private payors and accreditation organizations. Renewal and
continuance of certain of these licenses, certifications and accreditation are
based upon inspections, surveys, audits, investigations or other review, some of
which may require or include affirmative action or response by Continucare. An
adverse determination could result in a loss, fine or reduction in the scope of
licensure, certification or accreditation or could reduce the payment received
or require the repayment of amounts previously remitted.
Significant changes have been and may be made in the Medicare and
Medicaid programs, which changes could have a material adverse impact on
Continucare's financial condition. In addition, legislation has been or may be
introduced in the Congress of the United States which, if enacted, could
adversely affect the operations of
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Continucare by, for example, decreasing reimbursement by third-party payors such
as Medicare or limiting the ability of Continucare to maintain or increase the
level of services provided to the patients.
Title XVIII of the Social Security Act authorizes Medicare Part A, the
health insurance program that pays for inpatient care for covered persons
(generally, those age 65 and older and the long-term disabled) and Medicare Part
B, a voluntary supplemental medical assistance insurance program. Healthcare
providers may participate in the Medicare program subject to certain conditions
of participation and acceptance of a provider agreement by the federal Secretary
of HHS. Only enumerated services, upon satisfaction of certain criteria, are
eligible for Medicare reimbursement. Relative to the services of Continucare's
now or previously owned, Medicare certified, HHAs, CORFs and ORFs, Medicare
reimburses the "reasonable costs" for services up to program limits. Medicare
reimbursed costs are subject to audit, which may result in either decreases or
increases in payments the Company has previously received.
The Budget Act contains a number of provisions that affect
Continucare's operations. The Budget Act expands the current requirements that
hospitals have a discharge planning process, including information on the
availability of home health services and providers in the area. Each plan must
also identify the entities to whom a patient is referred in which the hospital
has a "disclosable financial interest" or which has such an interest in the
provider. The Budget Act also requires the Secretary of HHS to implement a PPS
for both CORF and outpatient rehabilitation services, and reduces the amount of
Medicare reimbursement for HHA services. Under such a system, providers will be
reimbursed a fixed fee per treatment unit, and a provider having costs greater
than the prospective amount will incur losses. It can not be predicted what
effect, if any, such new PPS will have on the operations of Continucare. The
Budget Act also established per beneficiary caps on certain outpatient
rehabilitation services.
Healthcare Reform. Federal and state governments have recently focused
significant attention on healthcare reform intended to control healthcare costs
and to improve access to medical services for uninsured individuals. These
proposals include cutbacks to the Medicare and Medicaid programs and steps to
permit greater flexibility in the administration of Medicaid. It is uncertain at
this time what legislation on healthcare reform may ultimately be enacted or
whether other changes in the administration or interpretation of governmental
healthcare programs will occur. There can be no assurance that future healthcare
legislation or other changes in the administration or interpretation of
governmental healthcare programs will not have a material adverse effect on
Continucare's business, financial condition or results of operations.
EMPLOYEES
At June 30, 1999, Continucare employed or contracted with approximately
581 individuals of whom 172 are IPA and Staff Model physicians. Continucare has
no collective bargaining agreement with any unions and believes that its overall
relations with its employees are good.
INSURANCE
Continucare carries general liability, comprehensive property damage,
medical malpractice, workers' compensation, stop-loss and other insurance
coverages that management considers adequate for the protection of Continucare's
assets and operations. There can be no assurance, however, that the coverage
limits of such policies will be adequate. A successful claim against Continucare
in excess of its insurance coverage could have a material adverse effect on
Continucare.
SEASONALITY
Approximately 98% of the Company's net revenues in Fiscal 1999 were
derived from the Company's operations in Florida. Florida has historically been
a transient state with the transient factor being directly related to seasonal
climate changes. It is anticipated that in Fiscal 2000 substantially all of the
Company's net revenue will be derived from the Company's operations in Florida.
While there are some seasonal fluctuations to the Company's business, management
does not believe that seasonality will play an adverse role in the future
operations of the Company.
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ITEM 2. PROPERTIES
On or about June 28, 1999, the Company entered into a termination
agreement with the landlord of its former corporate space. Continucare currently
leases approximately 10,000 square feet of space for its corporate offices in
Miami, Florida under a lease expiring in September 2004 with average annual base
lease payments of approximately $200,000. Of the eighteen staff model health
center clinics which the Company operates, five are leased and the other
fourteen staff model health centers are Humana wholly-owned centers. The Humana
wholly-owned center lease arrangements have cancellation options ranging from
thirty (30) days to only cancellation for breach. There can be no assurance,
however, that Humana will not terminate the leases for their wholly-owned
centers. A termination of one or all of the leases for the wholly-owned centers
could have a material adverse effect on Continucare. See "Risk Factors--Risk of
termination of wholly-owned center leases."
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to a variety of claims and suits that arise from
time to time out of the ordinary course of its business substantially all of
which involve claims related to the alleged malpractice of employed and
contracted medical professionals. In the opinion of the Company's management, no
individual item of litigation or group of similar items of litigation, taking
into account the insurance coverage maintained by the Company and any accounts
for self-insured retention, is likely to have a material adverse effect on the
Company's financial position, results of operations or liquidity.
Two former subsidiaries of the Company are parties to the case of JAMES N.
HOUGH, Plaintiff, v. INTEGRATED HEALTH SERVICES, INC., a Delaware corporation,
and REHAB MANAGEMENT SYSTEMS, INC., a Florida corporation ("RMS"), and
CONTINUCARE REHABILITATION SERVICES, INC., a Florida Corporation. Mr. Hough was
the founder and former Chief Executive Officer and President of RMS. Mr. Hough
sold RMS to Integrated Health Services, Inc., ("IHS"), and entered into an
Employment Agreement (the "Employment Agreement") with IHS. RMS was acquired by
Continucare in February 1998. Mr. Hough is seeking damages from the Employment
Agreement and is alleging breach of contract. His initial demand of $1.1 million
was rejected by the Company and the Company intends to vigorously defend the
claim.
The Company is a party to the case of MANAGED HEALTHCARE SYSTEMS ("MHS") v.
CONTINUCARE CORPORATION & CONTINUCARE HOME HEALTH SERVICES, INC. MHS is
alleging breach of contract and is seeking damages in excess of $1,000,000. The
Company believes the action has little merit and intends to vigorously defend
the claim.
The Company is a party to the case of KAMINE CREDIT CORPORATION ("Kamine")
as assignee of TRI COUNTY HOME HEALTH V. CONTINUCARE CORPORATION. Kamine is
alleging breach of contract and is seeking damages in excess of $5,000,000. The
Company moved to dismiss this motion on February 1, 1999, which motion is still
pending. The Company believes the action has little merit and intends to
vigorously defend the claim.
In connection with the Company's Business Rationalization Program, the
Company has closed or dissolved certain subsidiaries, some of which had pending
claims against them. The Company is also involved in various legal proceedings
incidental to its business that arise from time to time out of the ordinary
course of business--including, but not limited to, claims related to the
alleged malpractice of employed and contracted medical professionals; workers'
compensation claims, and other employee-related matters, and minor disputes with
equipment lessors and other vendors.
In its third quarter report on Form 10-Q for the Fiscal year ended June 30,
1999, the Company disclosed a disagreement with an HMO regarding certain claims
expense information. During the fourth quarter of Fiscal 1999,the Company and
the HMO performed a review of this information for the period through March 31,
1999, and reached an agreement which did not require an adjustment in the
Company's recorded liability to the HMO through such date.
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In the opinion of the Company's management, no individual item of
litigation or group of similar items of litigation, taking into account the
insurance coverage maintained by the Company, is likely to have a material
adverse effect on the company's financial position, results of operation or
liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of the Fiscal year ended June 30, 1999.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
MARKET PRICE
The principal U.S. market in which the Company's Common Stock is traded
is the American Stock Exchange ("AMEX") (symbol: CNU). Prior to the Company's
listing of its Common Stock on AMEX, which occurred on September 11, 1996, such
shares of Common Stock were traded on the NASDAQ Small-Cap Market. The following
table shows the high and low sales prices as reported on NASDAQ, and on AMEX for
the Common Stock for the periods indicated below. These quotations have been
obtained from NASDAQ and AMEX.
PRICE PERIOD HIGH LOW
------------ ---- ---
Fiscal Year 1998
First Quarter $ 8.63 $ 5.00
Second Quarter 7.38 4.75
Third Quarter 6.38 4.75
Fourth Quarter 6.50 4.63
Fiscal Year 1999
First Quarter $ 5.25 $ 2.38
Second Quarter 2.87 1.56
Third Quarter 2.00 .44
Fourth Quarter .75 .19
As of October 7, 1999, there were 114 holders of record of the Common
Stock.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on the Common
Stock and has no present intention to declare or pay cash dividends on the
Common Stock in the foreseeable future but intends to retain earnings, if any,
which it may realize in the foreseeable future, to finance its operations. The
Company is subject to various financial covenants with its lenders that could
limit and/or prohibit the payment of dividends in the future. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations." The
payment of future cash dividends on the Common Stock will be at the discretion
of the Board of Directors and will depend on a number of factors, including
future earnings, capital requirements, the financial condition and prospects of
the Company and any restrictions under credit agreements existing from time to
time. There can be no assurance that the Company will pay any cash dividends on
the Common Stock in the future.
ITEM 6. SELECTED FINANCIAL DATA
Set forth below is selected historical consolidated financial data on
Continucare for the three Fiscal years ended June 30, 1999 and the period from
February 12, 1996 (inception) to June 30, 1996.
The selected historical consolidated financial data for the three
Fiscal years ended June 30, 1999, are derived from the audited consolidated
financial statements of Continucare included herein. The selected historical
consolidated financial data should be read in conjunction with the Company's
consolidated financial statements and related notes included elsewhere herein.
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SELECTED FINANCIAL INFORMATION
FOR THE PERIOD FROM
FEBRUARY 12, 1996
FOR THE YEAR ENDED JUNE 30, (INCEPTION) TO
--------------------------------------------- JUNE 30,
1999 1998 1997 1996
--------------------------------------------- -----------------
OPERATIONS
Revenue
Medical services, net ........................ $ 182,008,710 $ 63,088,911 $ 1,041,793 $ --
Management fees .............................. 518,042 2,495,382 12,874,592 2,507,063
--------------------------------------------- -----------
Subtotal ................................... 182,526,752 65,584,293 13,916,385 2,507,063
Expenses
Medical services ............................. 163,237,820 54,695,446 4,493,195 542,000
Payroll and employee benefits ................ 13,797,555 5,714,653 1,855,000 431,412
Provision for bad debts ...................... 6,196,384 5,778,216 1,818,293 242,664
Professional fees ............................ 1,886,661 1,637,957 1,450,790 203,625
General and administrative ................... 10,198,385 8,435,001 1,176,516 54,430
Writedown of long-lived assets ............... 11,717,073 -- -- --
Depreciation and amortization ................ 5,791,982 3,247,717 208,936 362
--------------------------------------------- -----------
Subtotal ................................... 212,825,860 79,508,990 11,002,730 1,474,493
--------------------------------------------- -----------
(Loss) income from operations ..................... (30,299,108) (13,924,697) 2,913,655 1,032,570
Other income (expense)
Interest income ................................ 138,963 932,397 165,253 --
Interest expense ............................... (5,145,212) (3,007,331) (162,235) (23,204)
Income applicable to minority interest ......... -- -- -- (32,686)
Loss on disposal of subsidiaries ............... (15,361,292) -- -- --
Other .......................................... 24,906 107,696 (9,081) --
--------------------------------------------- -----------
(Loss) income before income taxes and
extraordinary item ............................. (50,641,743) (15,891,935) 2,907,592 976,680
(Benefit) provision for income taxes .............. -- (909,000) 1,200,917 332,071
--------------------------------------------- -----------
(Loss) income before extraordinary item ........... (50,641,743) (14,982,935) 1,706,675 644,609
Extraordinary gain on extinguishment
of debt ........................................ 130,977 -- -- --
--------------------------------------------- -----------
Net (loss) income ................................. $ (50,510,766) $(14,982,935) $ 1,706,675 $ 644,609
============================================= ===========
Basic and diluted (loss) earnings per common share:
(Loss) income before extraordinary item ........ $ (3.50) $ (1.20) $ .16 $ .10
Extraordinary gain on extinguishment of debt .01 -- -- --
--------------------------------------------- -----------
Net (loss) income .............................. $ (3.49) $ (1.20) $ 16 $ .10
============================================= ===========
FINANCIAL POSITION
Total assets ...................................... $ 30,117,620 $.69,486,105 $ 19,851,309 $ 2,864,896
============================================= ===========
Long-term obligations ............................. $ 53,490,787 $ 47,675,061 $ 3,367,106 $ 655,000
============================================= ===========
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Continucare is a provider of outpatient healthcare services in Florida.
The Company provides healthcare services through its network of Staff Model
Clinics, Independent Physician Associations and Home Health division. As a
result of its ability to provide quality healthcare services through
approximately eighteen Staff Model clinics, approximately 139 IPA associated
physicians and two Home Health divisions, the Company has become a preferred
healthcare provider in Florida to some of the nation's largest managed care
organizations, including: (i) Humana for which, as of June 30, 1999, it managed
the care for approximately 18,800 patients on a capitated basis; and (ii)
Foundation, for which, as of June 30, 1999, it managed the care for
approximately 21,000 patients on a capitated basis.
Certain statements included herein which are not statements of
historical fact are intended to be, and are hereby identified as,
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Without limiting the foregoing, the words
"believe," "anticipate," "plan," "expect," "estimate," "intend" and other
similar expressions are intended to identify forward-looking statements. The
Company cautions readers that forward-looking statements involve known and
unknown risks, uncertainties and other factors that may cause the actual
results, performance or achievements of the Company to be materially different
from any future results, performance or achievement expressed or implied by such
forward-looking statements. Such factors include, among others, the following:
the success or failure of the Company in implementing its current business and
operational strategies; the ability of the Company to consummate the Debenture
Settlement on the terms specified in such Debenture Settlement and the timing of
such consummation; the approval of the Debenture Settlement by the Company's
shareholders; the successful implementation of the Company's Business
Rationalization Program and Financial Restructuring Program; the availability,
terms and access to capital and customary trade credit; general economic and
business conditions; competition; changes in the Company's business strategy;
availability, location and terms of new business development; availability and
terms of necessary or desirable financing or refinancing; unexpected costs of
year 2000 compliance or failure by the Company or other entities with which it
does business to achieve compliance; labor relations; the outcome of pending or
yet-to-be instituted legal proceedings; and labor and employee benefit costs.
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RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the consolidated financial statements and notes thereto appearing elsewhere
in this Annual Report. The following tables set forth, for the periods
indicated, the percentage of total revenues represented by certain items in the
Company's Consolidated Statements of Operations.
PERCENT OF REVENUE FOR JUNE 30,
1999 1998 1997
---------------------------
Revenue
Medical services, net ................. 99.7% 96.2% 7.5%
Management fees ....................... 0.3 3.8 92.5
---------------------------
Subtotal ............................ 100.0 100.0 100.0
Expenses
Medical services ...................... 89.4 83.4 32.3
Payroll and employee benefits ......... 7.6 8.7 13.3
Provision for bad debts ............... 3.4 8.8 13.1
Professional fees ..................... 1.0 2.5 10.4
General and administrative ............ 5.6 12.8 8.5
Write down of long-lived assets ....... 6.4 -- --
Depreciation and amortization ......... 3.2 5.0 1.5
---------------------------
Subtotal ............................ 116.6 121.2 79.1
(Loss) income from operations .............. (16.6) (21.2) 20.9
Other income (expense)
Interest income ......................... 0.1 1.4 1.2
Interest expense ........................ (2.8) (4.6) (1.2)
Loss on disposal of subsidiaries ........ (8.5) -- --
Other ................................... -- .2 (0.1)
---------------------------
(Loss) income before income taxes and
extraordinary item ...................... (27.8) (24.2) 20.8
(Benefit) provision for income taxes ....... 0.0 (1.4) 8.6
---------------------------
(Loss) income before extraordinary item .... (27.8) (22.8) 12.2
---------------------------
Extraordinary gain on extinguishment of debt 0.1 -- --
---------------------------
Net (loss) income .......................... (27.7)% (22.8)% 12.2%
===========================
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THE FINANCIAL RESULTS DISCUSSED BELOW RELATED TO THE OPERATION OF CONTINUCARE
FOR THE FISCAL YEAR ENDED JUNE 30, 1999 AS COMPARED TO THE FISCAL YEAR ENDED
JUNE 30, 1998.
Revenue
Total revenues for Fiscal 1999 increased 178% to $182,526,752 from
$65,584,293 in Fiscal 1998. Medical services revenue increased 188% to
$182,008,710 from $63,088,911, respectively. The increase in total and medical
service revenue was principally a result of acquisitions completed in Fiscal
1998 and an increase in the number of patients serviced therefrom. Management
fee revenue decreased 79% to $518,042 from $2,495,382 primarily as a result of
the Company's assignment of its Behavioral Health Management Contracts in the
first quarter of Fiscal 1998.
During Fiscal 1999 the Company disposed of certain underperforming
assets and subsidiaries (the "Rationalized Entities"). During Fiscal 1999 and
1998 total revenue from these Rationalized Entities was approximately
$22,164,000 and $19,581,000 respectively.
Revenue received under the Company's contracts with HMO's amounted to
85% and 57% of medical services revenues in Fiscal 1999 and 1998, respectively.
Revenue received under fee for service arrangements which require the
Company to assume the financial risks relating payor mix and reimbursement rates
accounted for 11% and 33% of medical services revenue in Fiscal 1999 and 1998,
respectively.
Expenses
Medical services expenses in Fiscal 1999 were $163,237,820, or 89% of
total revenue, compared to $54,695,446, or 83% of total revenues, in Fiscal
1998. The increase in medical services expenses as a percentage of total revenue
for Fiscal 1999 resulted from an increase in claims associated with medical
services. During Fiscal 1999 and 1998 Medical services expenses from the
Rationalized Entities were approximately $15,296,000 and $13,815,000,
respectively.
General and administrative expenses for Fiscal 1999 were $10,198,385,
or 6% of revenues, compared to $8,435,001, or 13% of revenues for Fiscal 1998.
The decrease in general and administrative expense as a percent of revenues
resulted from the Company's increase in revenues from its acquisitions during
Fiscal 1998. During Fiscal 1999 and 1998 general and administrative expenses
from the Rationalized Entities was approximately $4,427,000 and $5,318,000,
respectively.
During Fiscal 1999, the Company recorded a loss on disposal of
subsidiaries of $15,361,292 associated with the Company's Business
Rationalization Program. No such charge was recorded in Fiscal 1998.
In accordance with SFAS 121, the Company periodically reviews the
recorded value of its long-lived assets to determine if the future cash flows to
be derived from these assets will be sufficient to recover the remaining
recorded asset values. During the fourth quarter of Fiscal 1999, as a result of
its Business Rationalization Program, the Company recorded a noncash charge of
$11,717,073 related to the write-down of costs in excess of net tangible assets
acquired to estimated realizable values. No such charge was recorded in Fiscal
1998.
The provision for bad debts included approximately $1,500,000 and
$4,800,000 related to notes receivable in Fiscal 1999 and 1998, respectively.
Excluding this amount, bad debt expense was 2.5% of total revenue in Fiscal 1999
versus 1.5% for Fiscal 1998. The increase in bad debt expense as a percentage of
total revenue is primarily attributable to the increase in billings related to
acquisitions made in Fiscal 1998
Depreciation and amortization expense was $5,791,982 in Fiscal 1999 and
$3,247,717 in Fiscal 1998, representing 3% and 5% of total revenues,
respectively. During Fiscal 1999 and 1998 depreciation and amortization from the
Rationalized Entities was approximately $1,596,000 and $1,129,000 respectively.
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Loss from operations for Fiscal 1999 was $30,299,108, or 17% of total
revenues, compared to an operating loss of $13,924,697, or 21% of total
revenues, for Fiscal 1998. Excluding the $11,717,073 writedown of long-lived
assets, the Fiscal 1999 operating loss was $18,582,035, or 10% of total revenue.
Operating loss excluding the writedown of long-lived assets, declined as a
percentage of total revenues due to the implementation of the Business
Rationalization Program, including the sale of underperforming assets.
Interest expense for Fiscal 1999 and Fiscal 1998 was $5,145,212 and
$3,007,331, respectively. The increase in interest expense is primarily
attributable to the Convertible Subordinated Notes Payable, which were
outstanding during all of Fiscal 1999 versus eight months of Fiscal 1998.
The Company's net losses and ongoing operating difficulties raise
substantial doubt about the Company's ability to utilize any related tax
benefits. Accordingly, such amounts have not been recognized for financial
reporting purposes in Fiscal 1999. The Company has net operating loss
carryforwards, which expire in the years 2013 through 2019, of $21,355,000 at
June 30, 1999, for which a valuation allowance has been established for the
entire amount.
Net loss for Fiscal 1999 was $50,510,766 compared to a net loss of
$14,982,935 for Fiscal 1998.
THE FINANCIAL RESULTS DISCUSSED BELOW RELATED TO THE OPERATION OF CONTINUCARE
FOR THE FISCAL YEAR ENDED JUNE 30, 1998 AS COMPARED TO THE FISCAL YEAR ENDED
JUNE 30, 1997.
Revenue
The Company made a number of acquisitions during Fiscal 1998 as it
developed its outpatient services strategy. The substantial increase of
$62,047,118 in medical services revenue during 1998 was a result of these
acquisitions.
Management fee revenue decreased 81% to $2,495,382 for the Fiscal 1998,
from $12,874,592 for Fiscal 1997. The decrease was due to the Company's focus
shifting away from the behavioral health area. In Fiscal 1997, the contracts to
manage and provide staffing and billing services for behavioral health programs
in hospitals and freestanding centers represented approximately 86% of total
revenues. The Company sold its behavioral health management contracts with
freestanding centers and hospitals during the first quarter of Fiscal 1998.
During Fiscal 1998, approximately 33% of the Company's medical services
revenue was derived from fee-for-service arrangements, 57% from capitated
payments from HMOs and 10% from direct contracting with medical providers,
respectively.
Expenses
Medical services of approximately $54,695,446 for Fiscal 1998,
represent the direct cost of providing medical services to patients
($24,668,000) as well as the medical claims incurred by the Company under the
capitated contracts with HMOs ($30,027,000). The costs of the medical services
provided include the salaries and benefits of health professionals providing the
services ($21,088,000), and insurance and other costs necessary to operate the
centers ($3,580,000). Medical claims costs represent the cost of medical
services provided by providers other than the Company but which are to be paid
by the Company for individuals covered by capitated arrangements with HMOs.
Medical services of $4,493,000 for Fiscal 1997 represent the direct cost of
providing medical services to patients, including salaries and benefits of
$4,260,000 and insurance and other costs of $233,000.
Payroll and related benefits for administrative personnel increased by
$3,860,000, or 208%, from $1,855,000 in Fiscal 1997 to $5,715,000 in Fiscal
1998. As a percent of revenue, salary and related benefits fell
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from 13% of total revenue in Fiscal 1997 to 9% in Fiscal 1998. This decrease was
a direct result of the growth from the acquisitions made during 1998.
Provision for bad debts was $5,778,216, or 9% of total revenues, for
the year ended June 30, 1998, as compared to $1,818,293, or 13% of total
revenue, for Fiscal 1997. The dollar amount increase is due primarily to the
increase in the provision for bad debts on notes receivable in Fiscal 1998. The
decrease as a percentage of total revenue is due to the increase in revenue
under capitated managed care contracts.
Professional fees were $1,638,000, or 2% of total revenue, for Fiscal
1998 as compared to $1,451,000, or 10%, of total revenue, for Fiscal 1997. The
decrease as a percentage of revenue was primarily a result of a decrease in
outsourcing costs resulting from the hiring of additional management individuals
in Fiscal 1998.
General and administrative expenses were approximately $8,435,000, or
13% of total revenue, for Fiscal 1998, as compared to $1,177,000, or 8% of total
revenues, for Fiscal 1997. The increase of $7,258,000 was primarily related to
the increased costs attributable to the various primary care practices acquired
during the latter part of Fiscal 1997 in addition to the administrative costs
related to the rehabilitation entities, home health agencies, outpatient primary
care centers and the outpatient radiology and diagnostic imaging services
company acquired during Fiscal 1998.
Depreciation and amortization increased to $3,248,000, or 5% of total
revenue, for Fiscal 1998 as compared to $209,000, or 1% of total revenue, for
Fiscal 1997 primarily as a result of the amortization of costs in excess of net
tangible assets acquired and other intangibles related to the acquisitions noted
above.
Consolidated net interest income (expense) for Fiscal 1998, was
($2,075,000), compared to $3,000, for Fiscal 1997. The increase is due to the
October 30, 1997 issuance of the Convertible Subordinated Notes Payable and
amortization of related deferred financing costs. Interest on the Convertible
Subordinated Notes Payable is payable semiannually beginning April 30, 1998. The
increase in interest expense in Fiscal 1998 was partially offset by an increase
in interest income primarily attributed to the investment of the unused proceeds
of the Convertible Subordinated Notes Payable.
Continucare's consolidated net loss for the year ended June 30, 1998
was approximately $14,983,000 compared to net income for Fiscal 1997 of
approximately $1,707,000 for the reasons discussed above.
LIQUIDITY AND CAPITAL RESOURCES
The Company's financial position has changed significantly since June
30, 1998. Throughout Fiscal 1998 and 1999 the Company experienced adverse
business operations, recurring operating losses, negative cash flow from
operations, resulting in a significant working capital deficiency. Furthermore,
as discussed below, the Company was unable to make certain of its scheduled
interest payments. The Company's operating difficulties have in large part been
due to the underperformance of various entities which were acquired in Fiscal
years 1999, 1998 and 1997, the inability to effectively integrate and realize
increased profitability through anticipated economies of scale with these
acquisitions, as well as reductions in reimbursement rates under the Balanced
Budget Act of 1997. In addition, the Company's independent auditors included a
paragraph in their auditors' report on the Company's consolidated financial
statements at June 30, 1999 regarding the substantial doubt about the Company's
ability to continue as a going concern.
The discussion herein has been prepared assuming that the Company will
continue as a going concern. In order to strengthen itself financially and
remain a going concern, the Company, during the past Fiscal year, began
divesting itself of certain unprofitable operations and disposing of other
underperforming assets as more fully discussed below.
The Company did not make the April 30, 1999 (the "Default Date")
semi-annual payment of interest on its Convertible Subordinated Notes Payable.
As of June 30, 1999, the Company had $45,000,000 principal amount outstanding
under the Convertible Subordinated Notes Payable and accrued and unpaid interest
of approximately $2,400,000 The amount of interest due as of April 30, 1999 was
$1,800,000. Within thirty (30) days of the Default Date, the Company commenced
negotiations with an informal committee of the holders of the Convertible
Subordinated Notes Payable to restructure a portion of the debt and related
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interest in exchange for common stock and to obtain terms on the remaining
portion of the debt that are more favorable to the Company. On or about July 2,
1999 the Company purchased $4,000,000 face value of its Convertible Subordinated
Notes Payable for approximately $200,000, recognizing a pre-tax gain on
extinguishment of debt of approximately $3,800,000. The Company funded the
purchase of the Convertible Subordinated Notes Payable from working capital. On
September 29, 1999 the Company announced an agreement in principle with the
holders of the Convertible Subordinated Notes Payable to enter into a settlement
and restructuring agreement with respect to the remaining $41,000,000 principal
balance and approximately $3,300,000 of interest thereon accrued through October
31, 1999. Also, see Item 1 "Recent Developments - Debt Restructuring" and Note 6
of the Company's Consolidated Financial Statements.
In August 1998, the Company entered into the Credit Facility with First
Union Bank. The Credit Facility provided for a $5,000,000 Acquisition Facility
and a $5,000,000 Revolving Loan. The Company borrowed the entire $5,000,000
Acquisition Facility to fund acquisitions. The Company never utilized the
Revolving Loan. Since December 31, 1998 the Company has not been in compliance
with the terms and conditions of the Acquisition Facility. During April 1999,
the Company used approximately $4,000,000 of the net proceeds from the sale of
certain of the Rationalized Entities to reduce the outstanding balance of the
Credit Facility. In connection with the payment, the Company entered into an
amendment to the Credit Facility, which provided, among other things, for the
repayment of the remaining outstanding principal balance of approximately
$1,000,000 by December 31, 1999.
For the twelve months ended June 30, 1999, the Company incurred a net
loss of $50,510,766 and the net cash used in operating activities was $1,372,681
primarily as a result of the net loss, offset by (i) non-cash operating items,
including depreciation and amortization, provision for bad debt, loss on sale of
subsidiary and write-down of long-lived assets, and (ii) increase in medical
claims payable. For the twelve months ended June 30, 1999, net cash provided by
investing activities was $250,508. Net cash used in financing activities for the
twelve months ended June 30, 1999 was a $3,128,474, comprised primarily of the
$5,000,000 borrowed under the Credit Facility, partially offset by repayment of
$4,000,000 on the Credit Facility and approximately $3,500,000 on other debts.
Also, see Note 7 to the Company's Consolidated Financial Statements.
The Company's working capital deficit was approximately $60,200,000 at
June 30, 1999, which includes the reclassification of $45,000,000 of Convertible
Notes to current liabilities due to the Company's default on the April 30, 1999
interest payment, compared to working capital of approximately $11,124,000 at
June 30, 1998.
During the twelve months ended June 30, 1999, capital expenditures
amounted to approximately $750,000.
The Company continues to take steps to improve its cash flow and
profitability through the implementation of its Business Rationalization Program
and Financial Restructuring Program by: (1) divesting of its non-profitable
business units; (2) reducing personnel levels; (3) negotiating with the
Subordinated Notes Payable Holders; and (4) negotiating with its HMOs. While the
Company believes that these measures will improve its cash flow and
profitability, there can be no assurances that it will be able to implement any
of the above steps and, if implemented, the steps will improve the Company's
cash flow and profitability sufficiently to fund its operations and satisfy its
obligations as they become due.
If there are continuing operating losses, Continucare may need
additional capital to fund its business, and there can be no assurance that such
additional capital can be obtained or, if obtained, that it will be on terms
acceptable to Continucare. The incurring or assumption by the Company of
additional indebtedness could result in the issuance of additional equity and/or
debt which could have a dilutive effect on shareholders and a significant effect
on the Company's operations.
In addition to the Company's liquidity difficulties, the Company is
experiencing administrative difficulties, including the loss of key personnel.
Also, the Company has fallen below the continued listing requirements of the
American Stock Exchange and there can be no assurance that the listing will be
continued.
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IMPACT OF YEAR 2000
The Year 2000 Issue is the result of the computer programs being
written using two digits rather than four to define the applicable year. Any of
the Company's computer programs that have time-sensitive software may recognize
a date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations and
patient care, including, among other things, a failure of certain patient care
applications and equipment, a failure of control systems, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities.
Based on a recent and ongoing assessment, the Company determined that
it will be required to modify or replace certain portions of its software,
hardware and patient care equipment so that its systems will function properly
with respect to dates in the year 2000 and thereafter. Affected systems will
include clinical and biomedical instrumentation and equipment used within the
Company for purposes of direct or indirect patient care such as imaging,
laboratory, pharmacy and respiratory devices; cardiology measurement and support
devices; emergency care devices (including monitors, defibrillators, dialysis
equipment and ventilators); and general patient care devices (including
telemetry equipment and intravenous pumps). The Company presently believes that
with modifications to existing software and conversions to new clinical and
biomedical instrumentation and equipment, the Year 2000 Issue will not pose
significant operational problems. However, if such modifications and conversions
are not made, or are not completed timely, the Year 2000 Issue could have a
material impact on the operations of the Company.
The Company has initiated formal communications with all of its
significant suppliers to determine the extent to which the Company's interface
systems are vulnerable to those third parties' failure to remediate their own
Year 2000 Issues. The Company's total Year 2000 project cost and estimates to
complete include the costs and time associated with the impact of third-party
Year 2000 Issues based on presently available information. However, there can be
no guarantee that the systems of other companies on which the Company's systems
rely will be timely converted and would not have an adverse effect on the
Company's systems.
The Company will utilize both internal and external resources to
reprogram, or replace and test the software and patient care equipment for Year
2000 modifications. The Company anticipates completing the Year 2000 project by
December 1, 1999, which is prior to any anticipated impact on its operating
systems. The total cost of the Year 2000 project is estimated at $200,000 and is
being funded through operating cash flows. Of the total projected cost,
approximately $50,000 is attributable to the purchase of new software and
patient care equipment, which will be capitalized. The remaining $150,000 will
be expensed as incurred and is not expected to have a material effect on the
results of operations.
The costs of the project and the date on which the Company believes it
will complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future events,
including the continued availability of certain resources, third party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved and actual results could differ materially from
those anticipated. Specific factors that might cause material differences
include, but are not limited to, the availability and cost of replacement
equipment and personnel trained in this area, the ability to locate and correct
all relevant computer codes, and similar uncertainties.
The operations of the Company are heavily dependent on its management
information systems. Implementation of new management information systems and
integration of management information systems in connection with acquisitions
require a transition period during which various functions must be converted or
integrated to the new systems. This conversion and integration process may
entail errors, defects or prolonged downtime, especially at the outset, and such
errors, defects or downtime could have a material adverse effect on the
Company's business, results of operations, prospects, financial results,
financial condition or cash flows.
Both the software and hardware used by the Company in connection with
the services it provides have been subject to rapid technological change.
Although the Company believes that its technology can be upgraded as necessary,
the development of new technologies or refinements of existing technology could
make the Company's existing equipment obsolete. Although the Company is not
currently aware of any pending technological
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developments that would be likely to have a material adverse effect on its
business, there is no assurance that such developments will not occur.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
At June 30, 1999, the Company had only cash equivalents, invested in
high grade, very short-term securities, which are not typically subject to
material market risk. The Company has outstanding loans at fixed rates. For
loans with fixed interest rates, a hypothetical 10% change in interest rates
would have no impact on the Company's future earnings and cash flows related to
these instruments. A hypothetical 10% change in interest rates would have an
immaterial impact on the fair value of these instruments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted in a separate section of this
report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The accounting firm of Deloitte & Touche LLP ("Deloitte & Touche")
represented pre-merger Continucare as its independent accountants during the
period from February 12, 1996 (inception) to June 30, 1996 and was appointed as
the Company's independent accountants by the Board of Directors for fiscal year
1997. Deolitte & Touche was dismissed by the Company's Board of Directors on May
6,1998. During the period for which Deloitte & Touche was the Company's
independent auditors, there were no disagreements between the Company and
Deloitte & Touche on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements, if
not resolved to the satisfaction of Deloitte & Touche, would have caused it to
make reference to the subject matter of the disagreement in connection with its
reports. Deloitte & Touche's reports on the financial statements of the Company
for the period from inception to June 30, 1996, and the year ended June 30,
1997, did not contain an adverse opinion or disclaimer of opinion, and were not
qualified or modified as to uncertainty, audit scope or accounting principles.
The Company's Board of Directors appointed Ernst & Young LLP as the
Company's independent accountants for Fiscal 1998 and 1999. There have been no
reported disagreements on any matter of accounting principles or practice or
financial statement disclosure at any time during the period that operations
have been audited by Ernst & Young LLP.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information with respect to directors and executive officers of the
Company is incorporated by reference to the registrant's Proxy Statement to be
filed with the Securities and Exchange Commission pursuant to Regulation 14A not
later than 120 days after the end of the Fiscal year covered by this report.
ITEM 11. EXECUTIVE COMPENSATION
The information required in response to this item is incorporated by
reference to the registrant's Proxy Statement to be filed with the Securities
and Exchange Commission pursuant to Regulation 14A not later than 120 days after
the end of the Fiscal year covered by this report.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required in response to this item is incorporated by
reference to the registrant's Proxy Statement to be filed with the Securities
and Exchange Commission pursuant to Regulation 14A not later than 120 days after
the end of the Fiscal year covered by this report.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required in response to this item is incorporated by
reference to the registrant's Proxy Statement to be filed with the Securities
and Exchange Commission pursuant to Regulation 14A not later than 120 days after
the end of the Fiscal year covered by this report.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements
Reference is made to the Index set forth on Page F-1 of this Annual
Report on Form 10-K.
(a)(2) Financial Statement Schedules
All schedules have been omitted because they are inapplicable or the
information is provided in the consolidated financial statements,
including the notes hereto.
(a)(3) Exhibits
3.1 Restated Articles of Incorporation of Company, as amended. (4)
3.2 Restated Bylaws of Company. (4)
4.1 Form of certificate evidencing shares of Common Stock. (4)
4.2 Indenture, dated as of October 30, 1997, between the Company and American Stock
Transfer & Trust Company, as Trustee, relating to 8% Convertible Subordinated
Notes due 2002. (9)
4.3 Registration Rights Agreement, dated as of October 30, 1997, by and between the
Company and Loewenbaum & Company Incorporated. (9)
4.4 Continucare Corporation Amended and Restated 1995 Stock Option Plan (11)
10.1 Employment Agreement between the Company and Charles M. Fernandez dated as of
September 11, 1996. (2)
10.2 Employment Agreement between the Company and Susan Tarbe dated as of September 23,
1996. (3)
10.3 Agreement and Plan of Merger by and among Continucare Corporation, Zanart
Entertainment Incorporated and Zanart Subsidiary, Inc. dated August 9, 1996. (1)
10.4 Stock Purchase Agreement dated April 10, 1997 by and among Continucare
Corporation, Continucare Physician Practice Management, Inc., AARDS, Inc. and
Sheridan Healthcorp. Inc. (6)
10.5 Stock Purchase Agreement dated April 10, 1997 by and among Continucare
Corporation, Continucare Physician Practice Management, Inc., Rosenbaum, Weitz &
Ritter, Inc. and Sheridan Healthcorp, Inc. (6)
10.6 Stock Purchase Agreement dated April 10, 1997 by and among Continucare
Corporation, Continucare Medical Management, Inc., Arthritis & Rheumatic Disease
Specialties, Inc. and Sheridan Healthcare, Inc. (6)
10.7 Acquisition Facility ($3,000,000), Revolving Credit Facility ($2,000,000) and
Security Agreement among Continucare Corporation, Borrower and First Union
National Bank of Florida, dated November 14, 1996, as amended on March 4, 1997.
(7)
10.8 Lease Agreement, dated as of the 29th day of August 1996, between Miami Tower
Associates Limited Partnership and Continucare Corporation, as amended. (8)
10.9 Physician Employment Agreement, dated as of the 10th day of April, 1997, by and
between Arthritis and Rheumatic Disease Specialties, Inc. and Norman Gaylis, M.D.
(8)
10.10 First Amendment, dated as of the 17th day of September, 1997, to Employment
Agreement, dated August 23, 1996, between the Company and Susan Tarbe. (8)
10.11 Employment Agreement, dated as of the 20th day of October, 1997, by and between
Continucare Corporation and Joseph P. Abood. (8)
10.12 Placement Agreement, dated as of October 27, 1997, between the Company and
Loewenbaum & Company Incorporated (the "Placement Agent"). (9)
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10.13 Purchase Agreement, dated as of September 4, 1997, by and among Continucare
Corporation, Continucare Physician Practice Management, Inc., a wholly owned
subsidiary of Continucare Corporation, DHG Enterprises, Inc. f/k/a Doctor's Health
Group, Inc. and Doctor's Health Partnership, Inc., both Florida corporations, and
Claudio Alvarez and Yvonne Alvarez. (10)
10.14 Stock Purchase Agreement, dated as of February 13, 1998, by and among Continucare
Corporation, Continucare Rehabilitation Services, Inc., Integrated Health
Services, Inc., Rehab Management Systems, Inc., IntegraCare, Inc. and J.R. Rehab
Associates, Inc. (12)
10.15 Asset Purchase Agreement, dated as of April 7, 1998, by and among: (i) SPI Managed
Care, Inc., SPI Managed Care of Hillsborough County, Inc., SPI Managed Care of
Broward, Inc., Broward Managed Care, Inc., each a Florida corporation; (ii) First
Medical Corporation, a Delaware corporation and First Medical Group, Inc., a
Delaware corporation; and (iii) CNU Acquisition Corporation, a Florida
corporation. (13) and (15)
10.16 Asset Purchase Agreement, dated as of August 18, 1998, by and among: (i) Caremed
Health Systems, Inc.; (ii) Caremed Medical Management, Inc.; Caremed Health
Administrators, Inc., each a Florida corporation; and (iii) Continucare Managed
Care, Inc., a Florida corporation. (16)
10.17 Asset Purchase Agreement, dated April 7, 1999, by and among: (i) Kessler
Rehabilitation of Florida, Inc., a Florida Corporation; Rehab Management Systems,
Inc., a Florida Corporation; Continucare Occmed Services, Inc., a Florida
Corporation; and Continucare Corporation, a Florida Corporation. (17)
10.18 Second Amendment To Acquisition Facility, revolving Credit Facility and Security
Agreement among Continucare Corporation, Borrower and First Union National Bank of
Florida, dated April 7, 1999 (19) (Exhibit 10.18 ).
10.19 Lease Termination Agreement as of the 28th day of June 1999, between NOP 100 2nd
Street Tower, LLC (Assignee in interest of Miami Tower Associates Limited
Partnership) and Continucare Corporation. (19) (Exhibit 10.19 )
21.1 Subsidiaries of the Company. (19) (Exhibit 21.1 )
23.1 Consent of Ernst & Young LLP (19) (Exhibit 23.1 )
23.2 Consent of Deloitte & Touche LLP (19) (Exhibit 23.2 )
27.1 Financial Data Schedule (19) (Exhibit 27.1 )
99.1 Notification of failure to make the April 30, 1999 semi-annual payment of interest
on its 8% Convertible Subordinated Notes Payable due 2002. (18)
Documents incorporated by reference to the indicated exhibit to the following
filings by the Company under the Securities Act of 1933, as amended, or the
Securities Exchange Act of 1934.
(1) Current Report Form 8-K dated August 9, 1996.
(2) Form 10-KSB filed with the Commission on September 30, 1996.
(3) Form 10-KSB filed with the Commission on October 21, 1996.
(4) Post Effective Amendment No. 1 to the Registration Statement
on SB-2 on Form S-3 Registration Statement filed on October
29, 1996.
(5) Form 8-K/A filed with the Commission on December 3, 1996.
(6) Form 8-K filed with the Commission on April 25, 1997.
(7) Form 10-KSB for the fiscal year ended June 30, 1997, filed
with the Commission on September 29, 1997.
(8) Form 10-KSB/A for the fiscal year ended June 30, 1997, filed
with the Commission on October 28, 1997.
(9) Form 8-K dated October 30, 1997 and filed with the Commission
on November 13, 1997.
(10) Form 8-K dated October 31, 1997 and filed with the Commission
on November 13, 1997.
(11) Schedule 14A dated December 26, 1997 and filed with the
Commission on December 30, 1997.
(12) Form 8-K dated February 13, 1998 and filed with the Commission
on February 26, 1997.
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(13) Form 8-K dated April 14, 1998 and filed with the Commission on
April 27, 1998.
(14) Form 8-K dated May 6, 1998 and filed with the Commission on
May 11, 1998.
(15) Form 8-K/A dated May 11, 1998 and filed with the Commission on
May 15, 1998.
(16) Form 8-K dated and filed with the Commission on September 2,
1998.
(17) Form 8-K dated April 21, 1999 and filed with the Commission on
April 23, 1999.
(18) Form 8-K dated April 30, 1999 and filed with the Commission on
May 3, 1999.
(19) Filed herewith.
(b) Reports on Form 8-K
There were two reports on Form 8-K filed with the Securities and
Exchange commission ("SEC") in the fourth quarter of Fiscal 1999. Form
8-K was filed on April 23, 1999 regarding the sale of substantially all
of the assets of Rehab Management Systems, Inc., a Florida Corporation
to Kessler Rehabilitation of Florida, Inc., a Florida Corporation. Form
8-K was filed on May 3, 1999 regarding the Company's failure to make
the April 30, 1999 semi-annual payment of interest on its Subordinated
Notes Payable.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CONTINUCARE CORPORATION
By: /s/ CHARLES M. FERNANDEZ
------------------------------------------------
Charles M. Fernandez
Chairman of the Board, Chief Executive Officer, and
President
Dated: October 13, 1999
Pursuant to the requirements of Section 13 or 15(d) 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.
SIGNATURE TITLE DATE
/s/CHARLES M. FERNANDEZ Chairman of the Board, Chief October 13, 1999
- ------------------------------------ Executive Officer and President
Charles M. Fernandez (principal executive officer,
principal financial officer and
principal accounting officer)
/s/PHILLIP FROST, M.D. Vice Chairman of the Board October 13, 1999
- ------------------------------------
Phillip Frost, M.D.
/s/Neil Flanzraich Director October 13, 1999
- ------------------------------------
Neil Flanzraich
/s/Spencer J. Angel Executive Vice President, Chief October 13, 1999
- ------------------------------------ Operating Officer and Director
Spencer Angel
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INDEX TO FINANCIAL STATEMENTS
PAGE
Report of Independent Certified Public Accountants........................................ F-2
Independent Auditors' Report.............................................................. F-3
Consolidated Balance Sheets as of June 30, 1999 and 1998.................................. F-4
Consolidated Statements of Operations for the years ended June 30, 1999, 1998
and 1997............................................................................. F-5
Consolidated Statements of Shareholders' (Deficit) Equity for the years ended
June 30, 1999, 1998 and 1997........................................................... F-6
Consolidated Statements of Cash Flows for the years ended June 30, 1999, 1998
and 1997............................................................................. F-7
Notes to Consolidated Financial Statements................................................ F-9
F-1
39
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Continucare Corporation and Subsidiaries:
We have audited the accompanying consolidated balance sheets of
Continucare Corporation and subsidiaries as of June 30, 1999 and 1998, and the
related consolidated statements of operations, shareholders' equity (deficit)
and cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the 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 financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Continucare Corporation and subsidiaries at June 30, 1999 and 1998 and the
consolidated results of their operations and their cash flows for the years then
ended in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared
assuming that Continucare Corporation and subsidiaries will continue as a going
concern. As more fully described in Note 1, the Company has incurred recurring
operating losses and has a working capital deficiency. In addition, the Company
has not complied with certain covenants of loan agreements with lenders. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regards to these matters are also described
in Note 1. The consolidated financial statements do not include any adjustments
to reflect the possible future effects on the recoverability and classification
of assets or the amounts and classification of liabilities that may result from
the outcome of this uncertainty.
ERNST & YOUNG LLP
Miami, Florida
October 6, 1999
F-2
40
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Continucare Corporation and Subsidiaries:
We have audited the accompanying consolidated statement of operations
of Continucare Corporation and subsidiaries (the "Company") for the year ended
June 30, 1997 and the related consolidated statement of shareholders' equity and
cash flows for the year ended June 30, 1997. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the results of operations of the Company and
its cash flows for the year ended June 30, 1997 in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Miami, Florida
September 23, 1997
F-3
41
CONTINUCARE CORPORATION
CONSOLIDATED BALANCE SHEETS
JUNE 30,
ASSETS 1999 1998
-------------------------------
Current assets
Cash and cash equivalents ..................................................... $ 3,185,077 $ 7,435,724
Accounts receivable, net of allowance for doubtful accounts of $5,752,000 and
$2,071,000, respectively .................................................... 302,166 9,009,462
Other receivables ............................................................. 266,057 1,091,744
Prepaid expenses and other current assets ..................................... 298,899 595,086
Income taxes receivable ....................................................... -- 1,800,000
-------------------------------
Total current assets ........................................................ 4,052,199 19,932,016
Notes receivable, net of allowance for doubtful accounts of $7,051,000 and
$5,510,000, respectively ...................................................... -- 1,644,420
Equipment, furniture and leasehold improvements, net ............................. 1,098,289 5,496,025
Cost in excess of net tangible assets acquired, net of accumulated amortization of
$3,837,000 and $2,252,000 respectively ........................................ 22,346,156 38,621,561
Deferred financing costs, net of accumulated amortization of $1,203,000 and
$400,000, respectively ........................................................ 2,551,811 3,373,999
Other assets, net ................................................................ 69,165 418,084
-------------------------------
Total assets ................................................................ $ 30,117,620 $ 69,486,105
===============================
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current liabilities
Accounts payable .............................................................. $ 842,442 $ 816,844
Accrued expenses .............................................................. 2,358,346 2,593,493
Accrued salaries and benefits ................................................. 1,856,140 2,629,660
Medical claims payable ........................................................ 4,825,081 966,251
Convertible subordinated notes payable ........................................ 45,000,000 --
Current portion of long-term debt ............................................. 6,857,946 850,000
Accrued interest payable ...................................................... 2,400,022 623,556
Current portion of capital lease obligations .................................. 112,652 328,295
-------------------------------
Total current liabilities ................................................... 64,252,629 8,808,099
Deferred tax liability ........................................................... -- 954,894
Capital lease obligations, less current portion .................................. 123,436 496,766
Convertible subordinated notes payable ........................................... -- 46,000,000
Long-term debt, less current portion ............................................. 1,396,753 --
-------------------------------
Total liabilities ........................................................... 65,772,818 56,259,759
Commitments and contingencies
Shareholders' (deficit) equity
Common stock, $0.0001 par value: 100,000,000 shares authorized; 17,536,283
shares issued and 14,540,091 shares outstanding at June 30, 1999; and
16,661,283 shares
issued and 13,731,283 shares outstanding at June 30, 1998 ................... 1,455 1,374
Additional paid-in capital .................................................... 32,910,465 31,099,303
Accumulated deficit ........................................................... (63,142,417) (12,631,651)
Treasury stock (2,996,192 shares at June 30, 1999 and 2,930,000 shares at
June 30, 1998) .............................................................. (5,424,701) (5,242,680)
-------------------------------
Total shareholders' (deficit) equity ........................................ (35,655,198) 13,226,346
-------------------------------
Total liabilities and shareholders' (deficit) equity ........................ $ 30,117,620 $ 69,486,105
===============================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-4
42
CONTINUCARE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED JUNE 30,
1999 1998 1997
------------- ------------ ------------
Revenue
Medical services, net ............................... $ 182,008,710 $ 63,088,911 $ 1,041,793
Management fees ..................................... 518,042 2,495,382 12,874,592
------------- ------------ ------------
Subtotal .......................................... 182,526,752 65,584,293 13,916,385
Expenses
Medical services .................................... 163,237,820 54,695,446 4,493,195
Payroll and employee benefits ....................... 13,797,555 5,714,653 1,855,000
Provision for bad debts ............................. 6,196,384 5,778,216 1,818,293
Professional fees ................................... 1,886,661 1,637,957 1,450,790
General and administrative .......................... 10,198,385 8,435,001 1,176,516
Write down of long-lived assets ..................... 11,717,073 -- --
Depreciation and amortization ....................... 5,791,982 3,247,717 208,936
------------- ------------ ------------
Subtotal .......................................... 212,825,860 79,508,990 11,002,730
------------- ------------ ------------
(Loss) income from operations ............................ (30,299,108) (13,924,697) 2,913,655
Other income (expense)
Interest income ....................................... 138,963 932,397 165,253
Interest expense ...................................... (5,145,212) (3,007,331) (162,235)
Loss on disposal of subsidiaries ...................... (15,361,292) -- --
Other ................................................. 24,906 107,696 (9,081)
------------- ------------ ------------
(Loss) income before income taxes and extraordinary item . (50,641,743) (15,891,935) 2,907,592
(Benefit) provision for income taxes ..................... -- (909,000) 1,200,917
------------- ------------ ------------
(Loss) income before extraordinary items ................. (50,641,743) (14,982,935) 1,706,675
Extraordinary gain on extinguishment of debt ............. 130,977 -- --
------------- ------------ ------------
Net (loss) income ........................................ $ (50,510,766) $(14,982,935) $ 1,706,675
============= ============ ============
Basic and diluted (loss) earnings per common share:
(Loss) income before extraordinary item ............... $ (3.50) $ (1.20) $ .16
Extraordinary gain on extinguishment of debt .......... .01 -- --
------------- ------------ ------------
Net (loss) income ..................................... $ (3.49) $ (1.20) $ .16
============= ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-5
43
CONTINUCARE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIT) EQUITY
RETAINED TOTAL
ADDITIONAL EARNINGS SHAREHOLDERS'
COMMON PAID-IN (ACCUMULATED TREASURY EQUITY
STOCK CAPITAL DEFICIT) STOCK (DEFICIT)
------------------------------------------------------------------------
Balance at July 1, 1996 ................. $ 667 $ 763,202 $ 644,609 $ -- $ 1,408,478
Issuance of stock related to private
placement, net of costs .............. 330 6,499,670 -- -- 6,500,000
Issuance of stock/merger with Zanart, net
of merger costs ...................... 290 1,845,428 -- -- 1,845,718
Exercise of stock warrants .............. 91 5,441,584 -- -- 5,441,675
Buyout of minority interest
in subsidiary ........................ 4 -- -- -- 4
Repurchase of stock ..................... (293) -- -- (2,284,330) (2,284,623)
Net income .............................. -- -- 1,706,675 -- 1,706,675
----------------------------------------------------------------------
Balance at June 30, 1997 ................ 1,089 14,549,884 2,351,284 (2,284,330) 14,617,927
Issuance of stock related to Doctors .... 25 2,311,294 -- -- 2,311,319
Health Group
Issuance of stock related to other ...... 8 401,277 -- -- 401,285
acquisitions
Issuance of stock related to private
placement, net of costs .............. 225 10,574,775 -- -- 10,575,000
Exercise of stock warrants and options .. 27 1,101,973 -- -- 1,102,000
Settlement of former shareholder claim .. -- 1,385,100 -- (2,958,350) (1,573,250)
Issuance of stock warrants .............. -- 775,000 -- -- 775,000
Net loss ................................ -- -- (14,982,935) -- (14,982,935)
----------------------------------------------------------------------
Balance at June 30, 1998 ................ 1,374 31,099,303 (12,631,651) (5,242,680) 13,226,346
Receipt of stock in settlement of ....... (7) -- -- (182,021) (182,028)
receivable
Issuance of stock for settlement of
former shareholder claim ............. 30 (30) -- -- --
Issuance of stock related to ZAG
agreement ............................ 58 1,811,192 -- -- 1,811,250
Net loss ................................ -- -- (50,510,766) -- (50,510,766)
----------------------------------------------------------------------
Balance at June 30, 1999 ................ $ 1,455 $ 32,910,465 $(63,142,417) $(5,424,701) $(35,655,198)
======================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-6
44
CONTINUCARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30,
1999 1998 1997
------------ ------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) income .................................................. $(50,510,766) $(14,982,935) $ 1,706,675
Adjustments to reconcile net (loss) income to cash used in
operating activities:
Depreciation and amortization, including amortization of
deferred loan costs .......................................... 6,705,221 3,648,581 208,936
Provision for bad debts ......................................... 4,656,384 1,953,013 1,818,293
Write down of long-lived assets ................................. 11,717,073 -- --
Loss on purchase of minority interest ........................... -- -- 9,081
Income applicable to minority interest .......................... -- -- 162,235
Provision for notes receivable .................................. 1,540,000 3,825,219 --
Loss on treasury stock transaction .............................. -- 426,750 --
Loss on disposal of subsidiaries ................................ 15,361,292 -- --
Amortization of discount on notes payable ....................... 254,531 -- --
Gain on early extinguishment of debt ............................ (130,977) -- --
Compensation expense on exercise of warrants .................... -- 212,500 --
Changes in assets and liabilities, excluding the effect of
acquisitions and disposals:
Decrease (increase) in accounts receivable ...................... 3,044,990 (3,615,007) (2,031,859)
Decrease (increase) in prepaid expenses and other current assets 191,644 127,467 (368,373)
Decrease (increase) in other receivables ........................ (221,092) (2,891,744) (5,000,000)
Decrease in income tax receivable ............................... 1,800,000 -- --
Increase in intangible assets ................................... 75,674 -- (249,063)
Decrease (increase) in other assets ............................. 24,141 (206,662) (499,402)
Decrease (increase) in deferred tax asset, net .................. -- 505,699 (450,824)
(Decrease) increase in accounts payable and accrued expenses .... (1,516,093) 2,311,647 813,681
Increase in medical claims payable .............................. 3,858,831 -- --
Increase in accrued interest payable ............................ 1,776,466 586,261 14,134
(Decrease) increase in income and other taxes payable ........... -- (693,709) 199,179
---------- ------------ -----------
Net cash used in operating activities ................................. (1,372,681) (8,792,920) (3,667,307)
---------- ------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash proceeds from disposal of subsidiaries ........................ 5,642,216 -- --
Cash paid for acquisitions ......................................... (4,640,000) (37,972,997) (3,342,500)
Property and equipment additions ................................... (751,708) (1,006,706) (536,091)
---------- ------------ -----------
Net cash provided by (used in) investing activities ................... 250,508 (38,979,703) (3,878,591)
---------- ------------ -----------
(Continued on next page).
F-7
45
CONTINUCARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEAR ENDED JUNE 30,
1999 1998 1997
----------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments to redeem Convertible Subordinated Notes ........... $ (720,000) $ (2,000,000) $ (2,284,623)
Issuance of common stock to purchase minority interest ...... -- -- (204,000)
Principal repayments under capital lease obligation ......... (247,619) (254,233) (27,105)
Proceeds received from private placement of common stock .... -- 10,575,000 6,600,000
Payments on acquisition notes ............................... (1,475,000) (892,500) --
Costs incurred associated with Convertible Subordinated Notes -- (3,000,000) --
Proceeds from acceleration of Series A Warrants ............. -- -- 5,441,675
Proceeds from Convertible Subordinated Notes ................ -- 46,000,000 --
Proceeds from Term and Revolving Notes ...................... 5,000,000 2,500,000 2,500,000
Costs incurred associated with Term and Revolving Notes ..... (161,051) -- --
Proceeds from issuance of common stock ...................... -- 889,500 1,970,715
Repayment of loan from HCMP ................................. -- -- (55,250)
Repayment of Term and Revolving Notes ....................... (3,935,745) (5,000,000) --
Repayments to Medicare per agreement ........................ (1,736,579) -- --
Costs incurred associated with Private Placement and Merger . -- -- (225,000)
Proceeds from note repayment ................................ 147,520 -- --
Repayment of shareholder note ............................... -- (599,000) --
----------- ------------ ------------
Net cash (used in) provided by financing activities ............ (3,128,474) 48,218,767 13,716,412
----------- ------------ ------------
Net (decrease) increase in cash and cash equivalents ........... (4,250,647) 446,144 6,170,514
Cash and cash equivalents at beginning of fiscal year .......... 7,435,724 6,989,580 819,066
----------- ------------ ------------
Cash and cash equivalents at end of fiscal year ................ $ 3,185,077 $ 7,435,724 $ 6,989,580
=========== ============ ============
SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Cash paid for income taxes ..................................... $ -- $ 1,528,445 $ 1,457,000
=========== ============ ============
Cash paid for interest ......................................... $ 2,125,895 $ 2,021,070 $ 86,348
=========== ============ ============
Notes payable issued for acquisitions .......................... $ 5,819,411 $ -- $ --
=========== ============ ============
Receipt of stock in settlement of receivable ................... $ 182,028 $ $ --
=========== ============ ============
Stock issued in ZAG agreement .................................. $ 1,811,250 $ -- $ --
=========== ============ ============
Purchase of furniture and fixtures with proceeds of
capital lease obligation .................................... $ -- $ -- $ 252,712
=========== ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-8
46
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - GENERAL
Continucare Corporation ("Continucare" or the "Company") is a provider of
integrated outpatient healthcare and home healthcare services primarily in
Florida. Continucare's predecessor, Zanart Entertainment, Incorporated
("Zanart") was incorporated in 1986. On August 9, 1996, a subsidiary of Zanart
merged into Continucare Corporation (the "Merger"), which was incorporated on
February 1, 1996 as a Florida Corporation ("Old Continucare"). As a result of
the Merger, the shareholders of Old Continucare became shareholders of Zanart,
and Zanart changed its name to Continucare Corporation. As of June 30, 1999 the
Company operated, owned and/or managed: (i) eighteen Staff Model clinics in
South and Central Florida; an Independent Practice Association with 139
physicians; and two Home Health agencies.
Throughout fiscal 1998 and 1999 the Company experienced adverse business
operations, recurring operating losses, negative cash flow from operations, and
a significant working capital deficiency developed. Furthermore, as discussed
below and further in Note 6, the Company was unable to make the interest payment
due April 30, 1999 on the 8% Convertible Subordinated Notes Payable due 2002
(the "Notes"). The Company's operating difficulties have in large part been due
to the underperformance of various entities which were acquired in fiscal years
1999, 1998 and 1997, the inability to effectively integrate and realize
increased profitability through anticipated economies of scale with these
acquisitions, as well as reductions in reimbursement rates under the Balanced
Budget Act of 1997.
The financial statements of the Company have been prepared assuming that the
Company will continue as a going concern. In order to strengthen itself
financially and remain a going concern, the Company, during the past fiscal
year, began divesting itself of certain unprofitable operations and disposing of
other underperforming assets as more fully disclosed in Note 3. On April 30,
1999 (the "Default Date") the Company defaulted on its semi-annual payment of
interest on the Notes. On September 29, 1999 the Company announced an agreement
in principle with the holders of the Notes to enter into a settlement and
restructuring agreement with respect to the remaining $41,000,000 principal
balance and approximately $3,300,000 of interest thereon accrued through October
31, 1999 (the "Debenture Settlement") (see Note 6). The successful completion of
the proposed Debenture Settlement is subject to a number of significant risks
and uncertainties including, but not limited to, the need to draft and execute a
final settlement agreement with the holders of the Notes, the need to enter into
a new credit facility, and the need to obtain shareholder ratification of the
Debenture Settlement prior to December 31, 1999.
To strengthen Continucare financially, since the end of calendar 1998, the
Company has undertaken a business rationalization program (the "Business
Rationalization Program") to divest itself of certain unprofitable operations
and to close other underperforming subsidiary divisions and a financial
restructuring program (the "Financial Restructuring Program") to strengthen its
financial condition and performance. In connection with the implementation of
its Business Rationalization Program, Continucare has sold or closed its
Outpatient Rehabilitation subsidiary and Diagnostic Imaging subsidiary. These
divestitures generated net cash proceeds of approximately $5,642,000 (after the
payment of transaction costs and other costs). The Business Rationalization
Program has assisted management with the commencement and implementation of its
Financial Restructuring Program and has allowed the Company to focus its
resources on a core business model. While the Company believes that the Business
Rationalization Program and Financial Restructuring Program will improve its
cash flow and profitability, there can be no assurance that it will be able to
continue implementing any of the necessary programs and, if implemented, that
the programs will improve the Company's cash flow and profitability sufficiently
to fund its operations and satisfy its obligations as they become due.
F-9
47
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents--The Company defines cash and cash equivalents as
those highly-liquid investments purchased with an original maturity of three
months or less.
Deposits in banks may exceed the amount of insurance provided on such deposits.
The Company performs reviews of the credit worthiness of its depository banks.
The Company has not experienced any losses on its deposits of cash.
Accounts Receivable--Accounts receivable result primarily from medical services
provided to patients on a fee-for-service basis and on a capitated basis and
from hospitals where the Company provides medical services. Fee-for-service
amounts are paid by government sponsored health care programs (primarily
Medicare and Medicaid), insurance companies, self-insured employers and
patients.
Accounts receivable include an allowance for contractual adjustments, charity
and other adjustments. Contractual adjustments result from differences between
the rates charged for the service performed and amounts reimbursed under
government sponsored health care programs and insurance contracts. Charity and
other adjustments represent services provided to patients for which fees are not
expected to be collected at the time the service is provided.
Equipment, Furniture and Leasehold Improvements--Equipment, furniture and
leasehold improvements are stated at cost. Depreciation is computed using the
straight line method over the estimated useful lives of the related assets,
which range from three to five years. Leasehold improvements are amortized over
the underlying assets' useful lives or the term of the lease, whichever is
shorter. Repairs and maintenance costs are expensed as incurred. Improvements
and replacements are capitalized.
Costs In Excess Of Net Tangible Assets Acquired--Costs in excess of net tangible
assets acquired are stated net of accumulated amortization and are amortized on
a straight-line basis over periods ranging from 2.5 to 20 years. The Company
periodically evaluates the recovery of the carrying amount of costs in excess of
net tangible assets acquired by determining if a permanent impairment has
occurred. Indicators of a permanent impairment include duplication of resources
resulting from acquisitions, instances in which the estimated undiscounted cash
flows of the entity are less than the remaining unamortized balance of the
underlying intangible assets and other factors. The Company believes that
certain of its costs in excess of net tangible assets acquired--primarily those
related to its Independent Practice Association ("IPA") and one of its Home
Health divisions, $9,200,000 and $2,200,000 respectively--have been impaired
based upon recent and anticipated significant cash flow deficiencies.
Accordingly, these assets were written off during 1999.
Deferred Financing Costs--Expenses in connection with the Company's issuance of
the 8% Convertible Subordinated Notes due 2002 (see Note 6) have been deferred
and are being amortized using the interest method over the life of the notes.
Fair Value of Financial Instruments--The estimated fair values of financial
instruments have been determined by the Company using available market
information and appropriate valuation methods. Considerable judgment is required
in interpreting market data to develop the estimates of fair value. Accordingly,
the estimates presented herein are not necessarily indicative of the amounts the
Company could realize in a current market exchange. The use of different market
assumptions and/or estimation methods may have a material effect on the
estimated fair value amounts. The Company has used the following market
assumptions and/or estimation methods:
F-10
48
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Cash and cash equivalents, accounts receivable, accounts payable and
accrued expenses--The carrying values approximate fair value due to the
relatively short maturity of the respective instruments.
Convertible subordinated notes payable--The fair value at June 30, 1999
approximates $2,360,000 based on the proposed terms of the Debenture
Settlement (see Note 6) and at June 30, 1998 the carrying value
approximated fair value based on the terms of the notes.
Long-term debt and capital lease obligations--The carrying value at
June 30, 1999 approximates fair value based on the terms of the
obligations. The Company has imputed interest on non-interest bearing
debt using an incremental borrowing rate of 8%.
Accounting for Stock-Based Compensation--The Company has elected to follow
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25") and related Interpretations in accounting for its employee
stock options because the alternative fair value accounting provided for under
Financial Accounting Standards Board (FASB) Statement No. 123, "Accounting for
Stock-Based Compensation" ("Statement 123"), requires use of option valuation
models that were not developed for use in valuing employee stock options. Under
APB 25, when the exercise price of the Company's employee stock options equals
or exceeds the market price of the underlying stock on the date of grant, no
compensation expense is recognized (see Note 11).
Earnings per Share--Basic earnings per share is computed by dividing the net
income or loss by the weighted average common shares outstanding for the period.
Diluted earnings per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity.
Business Segments--The Company adopted SFAS 131, "Disclosures about Segments of
an Enterprise and Related Information" during fiscal 1999. The Company has
concluded that it operates in one segment of business, that of managing the
provision of outpatient health care and health care related services, primarily
in the State of Florida.
Revenue--The Company's health care providers provide service to patients on
either a fee for service arrangement or under a fixed monthly fee arrangement
with HMOs or through contracts directly with the payor. Revenue is recorded in
the period services are rendered as determined by the respective contract.
Management fee revenue represents fees received by the Company to manage
outpatient facilities owned by third parties.
Fee for service arrangements (11% and 33% of medical services net revenue in
fiscal 1999 and 1998, respectively) require the Company to assume the financial
risks relating to payor mix and reimbursement rates. The Company receives
reimbursement for these services under either the Medicare or Medicaid programs
or payments from the individual, insurers, self-funded benefit plans or
third-party payors. The Company is paid based upon established charges, the cost
of providing services, predetermined rates per diagnosis, or discounts from
established charges. Revenue is recorded as an estimated amount, net of
contractual allowances. These accounts, which are unsecured, have longer
collection periods than capitated fee contracts and require the Company to bear
the credit risk of uninsured individuals.
F-11
49
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Under the Company's contracts with Humana Medical Plans, Inc. ("Humana") and
Foundation Health Corporation ("Foundation", and together with Humana, the
"HMOs"), the Company receives a fixed, monthly fee from the HMOs for each
covered life in exchange for assuming responsibility for the provision of
medical services. Total medical services net revenue related to Foundation
approximated 51% and 38% for fiscal 1999 and 1998, respectively. Total medical
services net revenue relating to Humana approximated 34% and 19% for fiscal 1999
and 1998, respectively. To the extent that patients require more frequent or
expensive care than was anticipated by the Company, revenue to the Company under
a contract may be insufficient to cover the costs of care provided.
When it is probable that expected future health care costs and maintenance costs
under a contract or group of existing contracts will exceed anticipated
capitated revenue on those contracts, the Company recognizes losses on its
prepaid healthcare services with HMOs.
Approximately 4% and 10% of the Company's medical services net revenue in fiscal
1999 and 1998, respectively, is earned through contracts, which are directly
between the payor (i.e., hospital), and the Company. These contracts provide for
payments to the Company based upon a fixed percentage of the hospital's charges
related to the services provided by the Company to patients of the hospital.
Certain of the Company's services are paid based on a reasonable cost
methodology. The Company is reimbursed for cost reimbursable items at a
tentative rate with final settlement determined after submission of annual cost
reports and audits thereof by the payor. Changes in the estimated settlements
recorded by the Company may be adjusted in future periods as final settlements
are determined.
Revenue from the Medicare and Medicaid programs, accounted for approximately 4%,
50% and 69% of the Company's net patient service revenue for the years ended
June 30, 1999, 1998 and 1997, respectively. Laws and regulations governing the
Medicare and Medicaid programs are complex and subject to interpretation. The
Company believes that it is in compliance with all applicable laws and
regulations and is not aware of any pending or threatened investigations
involving allegations of potential wrongdoing. While no such regulatory
inquiries have been made, compliance with such laws and regulations can be
subject to future government review and interpretation as well as significant
regulatory action including fines, penalties, and exclusion from the Medicare
and Medicaid programs.
Medical Service Expense--The Company contracts with or employs various health
care providers to provide medical services to its patients. Primary care
physicians are compensated on either a salary or capitation basis. For patients
enrolled under capitated managed care contracts, the cost of specialty services
are paid on either a fee for service, per diem or capitation basis.
The cost of health care services provided or contracted for is accrued in the
period in which it is provided. In addition, the Company provides for claims
incurred but not yet reported based on past experience together with current
factors. Estimates are adjusted as changes in these factors occur and such
adjustments are reported in the year of determination. Although considerable
variability is inherent in such estimates, management believes that the amounts
accrued are adequate.
Reinsurance (stop-loss insurance)--Reinsurance premiums are reported as health
care cost which are included in medical service expense in the accompanying
statements of operations, and reinsurance recoveries are reported as a reduction
of related health care costs.
F-12
50
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Principles of Consolidation--The consolidated financial statements include the
accounts of the Company, its wholly-owned subsidiaries, and all entities in
which the Company has a greater than 50% voting interest. All significant
intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates. Changes in the estimates are charged or credited to operations as the
estimates are revised.
Reclassifications--Certain prior year amounts have been reclassified to conform
with the current year presentation.
NOTE 3 - BUSINESS COMBINATIONS AND DISPOSALS
Physician Practices
On April 10, 1997, the Company, through Continucare Physician Practice
Management, Inc., a wholly-owned subsidiary, acquired all of the outstanding
stock of certain arthritis rehabilitation centers and affiliated physician
practices. The acquisitions included the purchase of AARDS, INC., a Florida
corporation formerly known as Norman B. Gaylis, M.D., Inc., of Rosenbaum, Weitz
& Ritter, Inc., a Florida corporation, and of Arthritis & Rheumatic Disease
Specialties, Inc., a Florida corporation, from Sheridan Healthcare, Inc.
(collectively "AARDS") The aggregate purchase price was approximately
$3,300,000. As a result of the acquisitions, purchase price in excess of the
fair value of the net tangible assets acquired of approximately $2,149,000 was
recorded and was being amortized over a weighted average life of 14 years. The
consolidated financial statements include the accounts of these acquisitions
from the date of the acquisitions.
In connection with the purchase of AARDS, the Company entered into a management
agreement with ZAG Group, Inc. ("ZAG"), an entity controlled by the principals
of AARDS. The management agreement, among other things, provided for ZAG to
perform certain services in exchange for specified compensation. In addition,
the Company entered into a put/call agreement with ZAG, which allowed each of
the parties to require the other party, after a two-year period, to either sell
or purchase all the issued and outstanding capital stock of ZAG for a specified
price to be paid in a combination of cash and common stock of the Company. In
August 1998, the Company paid approximately $2,000,000 to ZAG in connection with
the cancellation of the put/call agreement of which $115,000 was paid in cash
and the remaining $1,885,000 was paid by issuing 575,000 shares of the Company's
common stock with a fair market value of approximately $1,600,000 million. In
the event that the common stock issued does not have an aggregate fair market
value of approximately $1,885,000 on October 15, 1999, the contract stipulates
that the Company shall pay additional cash consideration or issue additional
shares of its common stock so that the aggregate value of the stock issued is
approximately $1,885,000. The management agreement was terminated upon the
cancellation of the put/call agreement. The total amount paid in connection with
the cancellation of the put/call agreement was included in cost in excess of
tangible assets acquired on the accompanying balance sheet and was being
amortized over a weighted average life of 14 years. Based on the current market
price of the Company's common stock, additional consideration of approximately
$1,600,000 in cash or approximately 2,352,000 shares of the Company's common
stock would have to be issued.
F-13
51
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 - BUSINESS COMBINATIONS AND DISPOSALS (CONTINUED)
On March 12, 1999, the Company ceased all operations of these practices. The
Company recorded a loss on disposal of approximately $4,200,000 which consisted
principally of losses on tangible assets sold or disposed of plus write-off of
the goodwill associated with the operations, including the costs in excess of
tangible assets acquired associated with the cancellation of the ZAG put/call
agreement.
Home Health Services
On September 19, 1997, the Company acquired the stock of Maxicare, Inc.
("Maxicare"), a Florida based home health agency for $4,200,000 including
approximately $900,000 of liabilities assumed. In addition, $300,000 of
additional purchase price is contingent upon maintaining various performance
criteria and, if earned, would be due in equal installments in September 1999
and 1998. Management and the former owner are still evaluating whether or not
the performance criteria have been met. The acquisition is being accounted for
under the purchase method of accounting. The purchase price in excess of the
fair value of the net tangible assets acquired was approximately $3,048,000 and
is being amortized using the straight-line method over a weighted average life
of 18 years. The consolidated financial statements include the accounts of
Maxicare since the date of acquisition. As discussed in Note 1, during fiscal
1999 management determined that the intangible assets associated with Maxicare
were impaired.
Radiology Services
On December 1, 1997, the Company acquired the assets of Beacon Healthcare Group
for $2,200,000 in cash and 83,000 shares of the Company's common stock with a
value of $490,000. The purchase price in excess of the fair value of the net
tangible assets acquired was approximately $2,000,000 and has been amortized
using the straight-line method over a weighted average life of 17 years. On
December 27, 1998, the Company sold the stock of the diagnostic imaging services
subsidiary (the "Subsidiary") for a cash purchase price of $120,000. Prior to
the sale, the Subsidiary conveyed through dividends all of the accounts
receivable of the Subsidiary to the Company. All obligations existing on the
date of sale remained the obligations of the Company. As a result of this
transaction, the Company recorded a loss on disposal of approximately
$4,152,000, including a write off of approximately $1,800,000 of costs in excess
of the net assets acquired, and an accrual for operating leases not assumed by
the buyer which expire through 2007 of approximately $1,000,000.
Rehabilitation Management Services
On February 13, 1998, the Company acquired the stock of Rehab Management
Systems, Inc., IntegraCare, Inc. and J.R. Rehab Associates, Inc., collectively
referred to as "RMS", for a total purchase price of approximately $10,500,000,
including acquisition costs of approximately $500,000. RMS operates numerous
rehabilitation clinics in the States of Florida, Georgia, Alabama, North
Carolina and South Carolina as a Medicare and Medicaid provider of outpatient
rehabilitation services. The acquisition was accounted for under the purchase
method of accounting. The purchase price in excess of the fair value of the net
tangible assets acquired was approximately $6,160,000 and was being amortized
using the straight-line method over a weighted average life of 15 years. On
April 8, 1999, the Company sold substantially all the assets of RMS to Kessler
Rehabilitation of Florida, Inc. ("Kessler") for $5,500,000 in cash and the
assumption of certain liabilities. The Company recorded a loss on sale of
approximately $6,800,000, including the write off of the unamortized costs in
excess of net assets acquired of approximately $5,700,000. The consolidated
financial statements included the accounts of RMS from the date of purchase to
the date of sale. A member of the Company's Board of Directors at the time of
the sale is also a director of Kessler.
F-14
52
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 - BUSINESS COMBINATIONS AND DISPOSALS (CONTINUED)
Managed Care Services
On October 31, 1997, the Company purchased the assets of DHG Enterprises, Inc.
and Doctors Health Partnership, Inc. (collectively, "Doctors Health Group"), a
company that provides healthcare services at outpatient centers through managed
care contracts. The total purchase price for the acquisition was approximately
$16,000,000, including acquisition costs of approximately $1,052,000. Of this
amount, $1,700,000 was paid in common stock of the Company (242,098 shares),
approximately $13,700,000 was paid in cash and warrants to purchase 200,000
shares of the Company's common stock with an estimated fair market value of
$600,000 were issued. The warrants have an exercise price of $7.25 per share for
a period of 5 years. The acquisition is being accounted for under the purchase
method of accounting. The purchase price in excess of the fair value of the net
tangible assets acquired was approximately $15,478,000 and is being amortized
using the straight-line method over a weighted average life of 15 years. The
consolidated financial statements include the accounts of Doctors Health Group
from the purchase date.
On January 1, 1998, the Company acquired certain of the assets of Medical
Services Organization, Inc. ("MSO") for a total purchase price of $4,260,000.
MSO provides healthcare services at outpatient centers through capitated managed
care contracts. The Company paid $2,560,000 in cash and entered into a note
payable totaling $1,700,000. The acquisition is being accounted for under the
purchase method of accounting. The purchase price in excess of the fair value of
the net tangible assets acquired was approximately $4,260,000 and is being
amortized using the straight-line method over 10 years. The amortization period
is based on the remaining life of the contract acquired. The note is payable in
six equal monthly installments beginning May 1, 1998. At June 30, 1999 the note
had been paid in full. In addition, the Company is obligated to pay the owners
of MSO an additional purchase price up to a maximum amount of $25,000,000 based
on the annualized net revenues of the acquired contract for the twelve month
period ended December 31, 1998, as adjusted under the terms of the acquisition
agreement with the former owner of MSO, times a multiple of 4.25. The additional
purchase price, if any, may be paid entirely in Common Stock of the Company;
however the Company may, at its discretion, pay 50% of the additional purchase
price in cash. Based on the performance of the contract for that period, the
Company has not paid or accrued for any additional purchase price. Furthermore,
as discussed in Note 1, Management has determined that the intangible assets of
MSO are impaired. The consolidated financial statements include the accounts of
MSO since the date of purchase.
On April 14, 1998, the Company purchased the assets of SPI Managed Care, Inc.,
SPI Managed Care of Hillsborough County, Inc., SPI Managed Care of Broward,
Inc., and Broward Managed Care, Inc., collectively "SPI". SPI provides
healthcare services at outpatient centers through capitated managed care
contracts. The total purchase price for the acquisition was approximately
$6,750,000. The acquisition is being accounted for under the purchase method of
accounting. The purchase price in excess of the fair value of the net tangible
assets acquired was approximately $6,416,000 and is being amortized using the
straight-line method over a weighted average life of 15 years. The consolidated
financial statements include the accounts of SPI from the purchase date.
In August 1998, the Company purchased the contracts of CareMed Inc. ("CareMed"),
a managed care healthcare company which owns or has agreements with
approximately 30 physician practices. The total purchase price was approximately
$6,700,000, of which $4,200,000 was paid at closing and the remaining balance is
payable in equal monthly installments over the ensuing 24 months. The entire
purchase was in excess of the net tangible assets acquired and it was being
amortized over 10 years. As discussed in Note 1, Management has determined that
the intangible assets associated with this operation were impaired. The
consolidated financial statements included the accounts of CareMed since the
acquisition date.
F-15
53
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 - BUSINESS COMBINATIONS AND DISPOSAL (CONTINUED)
Other
On December 31, 1996 (the "Effective Date"), the Company purchased the 25%
minority interest in a 75% owned subsidiary for 40,000 shares of Continucare
common stock, $0.0001 par value, having a market value of $204,000 on the
Effective Date. Such amount was offset against a receivable due from the
minority shareholder. As a result, the minority interest on Continucare's
consolidated balance sheet, approximately $195,000 as of the Effective Date, was
eliminated and a loss on the purchase of minority interest of approximately
$9,000 was recorded.
The following unaudited pro forma data summarize the results of operations for
the periods indicated as if the above transactions had been completed at the
beginning of the year preceding the respective transaction dates. The pro forma
data gives effect to actual operating results prior to the transactions and
adjustments to depreciation, interest expense, goodwill amortization and income
taxes. These pro forma amounts do not purport to be indicative of the results
that would have actually been obtained if the transactions had occurred at an
earlier date or that may be obtained in the future. Included in expenses for the
year ended June 30, 1999, are impairment charges of $11,717,073 due to the
write-down of certain intangible assets related to continuing subsidiaries,
while the loss on disposals of $15,361,289 has been excluded in the pro forma
amounts below.
YEAR ENDED JUNE 30,
1999 1998 1997
------------ ------------ -----------
(Unaudited)
Total revenues .............................. $161,039,157 $ 90,185,985 $79,441,279
============ ============ ===========
Net loss..................................... $(27,571,235) $(10,688,205) $ (707,096)
============ ============ ===========
Basic and diluted loss per
common share .............................. $ (1.91) $ (0.85) $ (.07)
============ ============ ===========
NOTE 4 - NOTES RECEIVABLE
In the first quarter of fiscal 1998, the Company assigned the accounts
receivable related to its behavioral health programs and assigned its behavioral
health management contracts to third parties in exchange for notes receivable in
the aggregate amount of $7,800,000. The Company recorded no gain or loss on the
assignment since the amount received approximated the net book value of the
assets assigned. The notes receivable are to be paid over a five year term with
interest to accrue at 9% per annum. The notes receivable are secured by all the
assets of the behavioral health business.
During fiscal 1998, the Company determined that these notes receivable were
impaired and increased its allowance for doubtful accounts against these notes
receivable by approximately $3,800,000. Of this amount, approximately $1,500,000
was recorded in the fourth quarter. The Company did not recognize any interest
income on these notes in fiscal 1998 or 1999. During fiscal 1999, the Company
determined that these notes had been further impaired and increased its
allowance for doubtful accounts by approximately $1,500,000. The balance of the
notes at June 30, 1999, net of the allowance, is $0. The Company will apply all
payments to principal with interest being recognized on a cash basis after all
principal has been paid.
F-16
54
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 - NOTES RECEIVABLE (CONTINUED)
During fiscal 1999 the Company accepted $29,700 in cash and 66,192 shares of the
Company's common stock in full satisfaction of a $340,000 receivable from a
former employee of the Company and a promissory note due from the same former
employee of $46,750. The shares were valued at $2.75 per share and are included
in Treasury Stock at June 30, 1999.
NOTE 5 - EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS
Equipment, furniture and leasehold improvements are summarized as follows:
JUNE 30, ESTIMATED
---------------------------- USEFUL LIVES
1999 1998 (IN YEARS)
----------- ----------- ------------
Furniture, fixtures and equipment ......... $ 1,995,740 $ 8,727,597 3-5
Furniture and equipment under capital lease 252,712 252,712 5
Vehicles .................................. -- 68,515 5
Leasehold improvements .................... 145,887 827,654 5
----------- -----------
2,394,339 9,876,478
Less accumulated depreciation ............. (1,296,050) (4,380,453)
----------- -----------
$ 1,098,289 $ 5,496,025
=========== ===========
Depreciation expense for the years ended June 30, 1999, 1998 and 1997 was
$1,481,439, $969,007 and $157,749, respectively. Accumulated amortization for
furniture and fixtures under capital lease agreements was $117,948 at June 30,
1999.
In connection with its acquisitions, the Company entered into various
noncancellable leases for certain furniture and equipment that are classified as
capital leases. The leases are payable over 5 years and the Company has used
incremental borrowing rates ranging from 9% to 35% per annum. In addition, the
Company entered into capital leases during fiscal 1999 which, in conjunction
with its various business disposals (see Note 3), were canceled or transferred
to the purchasers of those businesses.
Future minimum lease payments under all capital leases are as follows:
For the year ending June 30,
2000 .................................................... $129,932
2001 .................................................... 90,402
2002 .................................................... 37,660
2003 .................................................... 1,256
2004 .................................................... --
--------
259,250
Less amount representing imputed interest ............... 23,162
--------
Present value of obligation under capital lease ......... 236,088
Less current portion .................................... 112,652
--------
Long-term capital lease obligation ...................... $123,436
========
F-17
55
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 - CONVERTIBLE SUBORDINATED NOTES PAYABLE
On October 30, 1997, the Company issued $46,000,000 of 8% Convertible
Subordinated Notes Payable due 2002 (the "Notes"). As previously discussed in
Note 1, the Company defaulted on its April 30, 1999 semi-annual payment of
interest on the Notes.
On August 12, 1998, the Company redeemed $1,000,000 of the Notes and recorded an
extraordinary gain on retirement of debt of $130,977. The Company used cash from
operations to redeem the Notes. On July 2, 1999, the Company redeemed an
additional $4,000,000 of the Notes as described in more detail in the following
paragraphs. Also, as described in the following paragraphs, subsequent to June
30, 1999, the Company reached an agreement in principle with the remaining Note
holders which will modify the terms of the Notes. At the time the Notes were
issued, interest on the Notes was payable semiannually beginning April 30, 1998.
The Notes could be converted into shares of common stock of the Company at a
conversion price of $7.25 per share at any time after 60 days following the date
of initial issuance which is adjusted upon the occurrence of certain events. In
addition, the Notes are redeemable, in whole or in part, at the option of the
Company at any time on or after October 31, 2000, at the redemption prices
(expressed as a percentage of the principal amount) set forth below for the
12-month period beginning October 31 of the years indicated:
2000 ............................... 104.00%
2001 ............................... 102.00%
and thereafter at 100% of principal amount, together with accrued interest to
the redemption date.
The Notes were not registered under the Securities Act of 1933, as amended (the
"Securities Act") and could not be offered or sold without registration or an
applicable exemption from the registration requirements. A registration
statement covering resales of the Notes became effective on January 8, 1998. As
a result, holders of Notes who are identified in the registration statement may
make resales of the Notes, as described in the registration statement, without
any volume limitations or other constraints normally applicable to sales of
"restricted securities."
As described in the notes to these financial statements, throughout fiscal 1999
the Company experienced adverse business operations. In order to avoid having to
seek bankruptcy protection, and to strengthen itself financially, the Company
during the past fiscal year undertook a Business Rationalization Program by
divesting itself of certain unprofitable operations and by closing other
underperforming subsidiary divisions. In addition, the Company undertook a
Financial Restructuring Program designed to strengthen its financial condition
(See Note 1).
On April 30, 1999 (the "Default Date"), the Company defaulted on its semi-annual
payment of interest on the Notes. Within thirty (30) days of the Default Date,
the Company commenced negotiations with an informal committee of the holders of
the Notes. On the default date, the outstanding principal balance of the Notes
was $45,000,000 and the related accrued interest was approximately $1,800,000.
On July 2, 1999 the Company purchased $4,000,000 face value of the Notes for
approximately $200,000. The resulting pre-tax gain on extinguishment of debt of
approximately $3,800,000 was recognized on July 2, 1999.
On September 29, 1999 the Company announced an agreement in principle with the
holders of the Notes to enter into a settlement and restructuring agreement with
respect to the remaining $41,000,000 principal balance and approximately
$3,300,000 of interest thereon accruing through October 31, 1999 (the "Debenture
Settlement"). The terms of the proposed Debenture Settlement are as follows: (a)
$31,000,000 of the outstanding principal of the Notes will be converted, on a
pro rata basis, into the Company's common stock at a conversion rate of $2.00
per share (approximately 15,500,000 shares of capital stock); (b) all interest
accrued on the
F-18
56
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 - CONVERTIBLE SUBORDINATED NOTES PAYABLE (CONTINUED)
Notes through October 31, 1999 will be forgiven (approximately $3,300,000); (c)
the interest payment default on the remaining $10,000,000 principal balance of
the Notes will be waived and the debentures will be reinstated on the Company's
books and records as a performing non-defaulted loan (the "Reinstated
Subordinated Debentures"); (d) the Reinstated Subordinated Debentures will bear
interest at the rate of 7% per annum commencing November 1, 1999; and (e) the
conversion rate for the Reinstated Subordinated Debentures will be modified as
follows:
TERM CONVERSION RATE
- -------------------------------------------------------------------
Through October 31, 2000......................... $7.25
November 1, 2000 to Maturity..................... $2.00
and (f) the Company will obtain a financially responsible person (the
"Guarantor") to personally guaranty a $3,000,000 bank credit facility (the "New
Credit Facility") for the Company. In consideration for providing the guaranty
the Company will issue to the Guarantor 3,000,000 shares of the Company's common
stock. The New Credit Facility will replace the Company's existing bank Credit
Facility and it will additionally be used to finance the Company's working
capital and capital expenditure requirements
The Company has agreed to convene a meeting of its Shareholders before December
31, 1999 in order to obtain shareholder approval of the Debenture Settlement.
The successful completion of the proposed Debenture Settlement is subject to a
number of significant risks and uncertainties including, but not limited to, the
need to draft and execute a final settlement agreement with the Note holders,
the need to consummate the New Credit Facility, and the need to obtain
shareholder ratification of the Debenture Settlement prior to December 31, 1999.
NOTE 7 - LONG-TERM DEBT
The following long-term debt was outstanding as of June 30, 1999 and 1998.
1999 1998
-----------------------
Contract Modification Note........................... $3,644,337 $ --
Acquisition Note..................................... 1,804,605 850,000
Credit Facility...................................... 1,064,255 --
Other Outstanding Notes.............................. 1,741,502 --
-----------------------
8,254,699 850,000
Less Current Portion................................. 6,857,946 850,000
-----------------------
Long-Term............................................ $1,396,753 $ --
=======================
Contract Modification Note--Effective August 1, 1998, the Company entered into
two amendments to its professional provider agreements with an HMO. The
amendments, among other things, extended the term of the original agreement from
six to ten years and increased the percentage of Medicare premiums received by
the
F-19
57
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7 - LONG-TERM DEBT (CONTINUED)
Company effective January 1, 1999. In exchange for the amendments, the Company
signed a $4.0 million non interest bearing promissory note (the "Note") with the
HMO of which $1,000,000 will be paid over the 12 months commencing January 1999
and the remaining $3,000,000 over the ensuing 24 months. The note was recorded
net of imputed interest. None of the payments required under the Note have been
paid. The total amount in arrears is $365,647 at June 30, 1999. As the Company
is not in compliance with the terms of the Note, the outstanding balance has
been classified as current in the accompanying consolidated balance sheet. The
$4,000,000 cost, net of imputed interest calculated at 8%, or approximately
$500,000, is included in other intangible assets on the accompanying
consolidated balance sheet and is being amortized over 9.6 years, the remaining
term of the contract.
Acquisition Note--In August 1998, the Company, through its Continucare Managed
Care Subsidiary, purchased professional provider contracts with approximately 30
physicians from an unrelated entity. The total purchase price was approximately
$6,700,000 of which $4,200,000 was paid in cash at closing and the remaining
$2,500,000 is payable in equal monthly installments over the ensuing 24 months.
The note is noninterest bearing. The Company has imputed interest at 8%. The
Company has repaid $625,000 of the note and is in arrears for $416,667 at June
30, 1999. Since the Company is not in compliance with the terms of the purchase
agreement, the outstanding balance has been classified as current in the
accompanying consolidated balance sheet. The purchase price was included in
other intangible assets on the accompanying consolidated balance sheet and was
being amortized over 10 years, the term of the contracts. However, later in
fiscal 1999 management determined that these assets were impaired, as discussed
in Note 1, and the unamortized balance was written-off.
Bank Note--In August 1998, the Company entered into a credit facility (the
"Credit Facility") with a bank which provides for a $5,000,000 Acquisition
Facility and a $5,000,000 Revolving Loan. Under the terms of the Credit
Facility, the Company may elect the interest rate to be either the bank's prime
rate or the London InterBank Offered Rate plus 250 basis points. Interest only
on each acquisition advance under the Acquisition Facility is payable monthly in
arrears for the first six months. Interest only on the Revolving Loan advances
is payable quarterly in arrears. Commencing six months from the date of each
acquisition advance, the acquisition advance shall be repayable in equal monthly
amortization payments, based upon a five year amortization. The Company borrowed
the entire $5,000,000 Acquisition Facility to fund acquisitions. In all events,
the Revolving Loan matures and all unpaid principal and interest is due in full
on August 31, 2001. The Company never utilized the Revolving Loan. During April
1999, the Company used approximately $4,000,000 of the net proceeds of the sale
of its rehabilitative subsidiaries to reduce the outstanding balance of the
Credit Facility. In connection with the payment, the Company entered into an
amendment to the Credit Facility, which provided, among other things, for the
repayment of the remaining outstanding principal balance of approximately
$1,000,000 to the Bank by December 31, 1999. The Company continues to not be in
compliance with certain non-monetary covenants under the Credit Facility and
therefore, the total amount outstanding has been classified as a current
liability in the consolidated balance sheet. The Credit Facility is secured by
substantially all of the assets of the Company and contains restrictive
covenants which, among other things, require the Company to maintain certain
financial ratios, limits the incurring of additional debt, limits the payment of
dividends and limits the amount of capital expenditures.
Other Outstanding Notes--In conjunction with the operation of its Home Health
Divisions the Company has entered into five (5) repayment agreements (the
"Repayment Agreements") with a governmental agency. These Repayments Agreements
derive from various overpayments received by the Company for expenses that were
expected to be generated in conjunction with Home Health patient care
activities. Three of the four non interest bearing Repayment Agreements have a
maturity date in the last calendar quarter of 2003. The fourth non interest
bearing Repayment Agreements has a maturity date in the first quarter of 2004.
One of the five Repayment Agreements has an interest rate of 13.50% and has a
maturity date in the first quarter of 2004.
F-20
58
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8 - EARNINGS PER SHARE
The following table sets forth share and common share equivalents used in the
computation of basic and diluted earnings per share:
YEAR ENDED JUNE 30,
1999 1998 1997
------------ ------------ -----------
Numerator for basic and dilutive earnings per share
(Loss) income before extraordinary items ....... $(50,641,743) $(14,982,935) $ 1,706,675
Extraordinary gain on extinguishment of debt ... 130,977 -- --
------------ ------------ -----------
Net (loss) income .............................. $(50,510,766) $(14,982,935) $ 1,706,675
============ ============ ===========
Denominator
Denominator for basic (loss) earnings per
share-weighted average shares ................. 14,451,493 12,517,503 10,406,089
Effects of dilutive securities
Employee stock options .......................... -- -- 275,214
------------ ------------ -----------
Denominator for diluted (loss) earnings per
share-adjusted weighted average shares and
assumed conversions ........................... 14,451,493 12,517,503 10,681,303
============ ============ ===========
For additional disclosure regarding the employee stock options and warrants see
Note 11.
Basic and diluted loss per share for fiscal 1999 and 1998 are the same because
the effect of common stock equivalents is antidilutive.
Options and warrants to purchase 1,138,500, 1,388,500, and 180,000 shares of the
Company's Common Stock were outstanding at June 30, 1999, 1998, and 1997,
respectively, but were not included in the computation of diluted earnings per
share because the effect would be antidilutive.
NOTE 9 - RELATED PARTY TRANSACTIONS
For the year ended June 30, 1997, the Company provided certain management
services to five facilities owned by two shareholders of Continucare, in return
for a management fee based on Continucare's estimated cost of providing such
services. The management fee charged was calculated based on the ratio of
patient volume represented by the five facilities to total patient volume
managed by Continucare, applied to certain of Continucare's expenses that were
related to the provision of such services. The resulting management fee was
recorded by Continucare as a reduction of the respective financial statement
expense line items. For the fiscal year ended June 30, 1997, management fees
related to this agreement were approximately $878,000. In April 1997, this
agreement was terminated through a termination and settlement agreement entered
into between Continucare and the shareholders (the "Termination and Settlement
Agreement").
In addition, during the year ended June 30, 1997, Continucare had contracted
with a company owned, in part, by two shareholders to provide certain managerial
and administrative services to and on behalf of Continucare at cost. For the
year ended June 30, 1997, total expenses incurred by the Company for these
services totaled approximately $314,000 and are recorded in the appropriate
expense categories in the consolidated statements of operations. This agreement
was also terminated through the Termination and Settlement Agreement.
F-21
59
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9 - RELATED PARTY TRANSACTIONS (CONTINUED)
During the fiscal year ended June 30, 1997, the Company was obligated under a
note to a company owned by certain shareholders of the Company at that time. In
April 1997, the Health Care Management Partners, Inc. (HCMP) Note was settled as
part of the Termination and Settlement Agreement.
During the fiscal year ended June 30, 1998, the Company incurred expenses of
$200,000 for consulting services provided by a corporation in which one of its
shareholders is an executive officer of the Company. On September 18, 1998, the
Company purchased the corporation for $115,000 in cash and 575,000 shares with a
fair market value of approximately $1,600,000 of the Company's restricted common
stock. Additional consideration is contingently due to the former owners based
on the price of the Company's common stock at October 15, 1999 as described
further in Note 3.
The Company rents various medical facilities and equipment from corporations
owned by physician employees of the Company. General and administrative expenses
for fiscal years ended June 30, 1999, 1998 and 1997 included $186,000, $305,000
and $89,000, respectively, under these lease agreements.
During fiscal years ended June 30, 1999 and 1998, the Company earned $ 379,442
and $381,000 in management fees from an entity whose executive officer was a
director of the Company. At June 30, 1999, receivables totaling $760,442 are
included in accounts receivable for these services and have been fully reserved.
NOTE 10 - SETTLEMENT OF FORMER SHAREHOLDER CLAIM
In July 1997, the Company received a demand for arbitration relating to a claim
by a former shareholder of a predecessor of the Company alleging securities
fraud in connection with the redemption of his shares. Pursuant to a settlement
agreement entered into on June 12, 1998, the Company paid $2,000,000 in cash and
on July 12, 1998 issued 300,000 shares of common stock (with a fair market value
of $1,385,000) in settlement of this claim. The Company reflected this
transaction at June 30, 1998 as an increase in treasury stock of $2,958,000 and
legal settlement expense of $426,000, which was reflected as general and
administrative expense in the fiscal 1998 consolidated statement of operations.
The increase in treasury stock results in recording the treasury stock acquired
at its fair market value at the redemption date.
NOTE 11 - STOCK OPTION PLAN AND WARRANTS
In January 1998, the Company's shareholders approved an amendment to the
Company's Amended and Restated 1995 Stock Option Plan (the "Stock Option Plan")
covering employees of the Company to increase the authorized shares for issuance
upon the exercise of stock options from 1,200,000 to 1,750,000.
Under the terms of the Stock Option Plan, the exercise price for options granted
is required to be at least the fair market value of the Company's common stock
on the date of grant and expire 10 years after the date of the grant.
Pro forma information regarding net income and earnings per share is required by
FASB No. 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement. 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 1999,
1998 and 1997, respectively: risk-free interest rates of 5.25%, 5.5% and 6.32%;
dividend yields of 0%; volatility factors of the expected market price of the
Company's common stock of 82.5%, 66.4% and 63.6%, and a weighted-average
expected life of the options of 10, 10 and 3 years.
F-22
60
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11 - STOCK OPTION PLAN AND WARRANTS (CONTINUED)
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, 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 its employee 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 Company's pro
forma information follows:
YEAR ENDED JUNE 30,
1999 1998 1997
------------- ------------- ----------
Pro forma net (loss) income ....................... $ (52,046,336) $ (17,730,428) $ 647,745
Basic pro forma net (loss) income per share ....... (3.60) (1.42) .06
Diluted pro forma net (loss) income per share ..... $ (3.60) $ (1.42) $ .06
The following table summarizes information related to the Company's stock option
activity for the years ended June 30, 1999, 1998 and 1997:
YEAR ENDED JUNE 30,
1999 1998 1997
---------------------- --------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE
OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE
---------------------- --------------------- --------------------
Outstanding at beginning of the year 1,388,500 $5.45 376,400 $6.26 100,000 $5.46
Granted ............................ 562,500 5.90 1,238,000 5.53 276,400 6.54
Exercised .......................... -- -- (17,000) 6.00 -- --
Forfeited .......................... (812,500) $5.58 (208,900) $7.19 -- $ --
--------- --------- ---------
Outstanding at end of the year ..... 1,138,500 1,388,500 376,400
========= ========= =========
Exercisable at end of the year ..... 847,085 727,171 266,400
========= ========= =========
Weighted average fair value of
options granted during the year .. $ 4.18 $ 4.10 $ 3.98
========== ========== =========
Stock options outstanding as of July 1, 1996 relate to options issued prior to
the Zanart Merger.
F-23
61
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11 - STOCK OPTION PLAN AND WARRANTS (CONTINUED)
The following table summarizes information about the options outstanding at June
30, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
RANGE ---------------------------------------------------------------------------------------------
OF WEIGHTED AVERAGE
EXERCISE OUTSTANDING AT REMAINING WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
PRICES JUNE 30, 1999 CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
---------------------------------------------------------------------------------------------------------------
$5.00-$7.25 1,138,500 8.53 $5.58 847,085 $5.60
In connection with the sale of the Notes (see Note 6), the Company issued
warrants to purchase 200,000 shares of the Company's common stock with exercise
prices ranging from $8.00 to $12.50 per share as a placement fee. The fair
market value of the warrants at date of issuance was $775,000. This amount is
being amortized, using the interest method, over the life of the Notes. During
fiscal 1997, approximately $5,440,000 was received by the Company pursuant to
the exercise of certain warrants which had been issued prior to the Company's
merger with Zanart. During fiscal 1998,warrants to purchase 250,000 shares of
common stock at $3.15 per share were exercised. The Company has 760,000 warrants
outstanding at June 30, 1999 which are exercisable through December 31, 2007,
with exercise prices ranging from $7.25 to $12.50 per share.
Shares of common stock have been reserved for future issuance at June 30, 1999
as follows:
Convertible subordinated notes............................... 6,206,897
Warrants..................................................... 760,000
Stock Options................................................ 1,138,500
---------
Total 8,105,397
=========
NOTE 12 - INCOME TAXES
The Company accounts for income taxes under FASB Statement No. 109, "Accounting
for Income Taxes". Deferred income tax assets and liabilities are determined
based upon differences between the financial reporting and tax bases of assets
and liabilities and are measured using the enacted tax rates and laws that will
be in effect when the differences are expected to reverse.
The components of the provision for income taxes for the years ended June 30,
1999, 1998 and 1997 are as follows:
YEAR ENDED JUNE 30,
1999 1998 1997
----------------------------------------------
Current income taxes:
Federal ................................ $ -- $(1,448,000) $ 1,410,318
State .................................. -- 33,000 241,423
----------------------------------------------
Total current ........................ -- (1,415,000) 1,651,741
----------------------------------------------
Deferred income taxes:
Federal ................................ -- 435,000 (398,752)
State .................................. -- 71,000 (52,072)
----------------------------------------------
Total deferred ....................... -- 506,000 (450,824)
----------------------------------------------
Total (benefit) provision for income taxes $ -- $ (909,000) $ 1,200,917
==============================================
F-24
62
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12 - INCOME TAXES (CONTINUED)
Deferred income taxes reflect the net effect of temporary differences between
the carrying amount of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. The tax effects of temporary
differences that give rise to deferred tax assets and deferred tax liabilities
are as follows:
JUNE 30,
1999 1998 1997
--------------------------------------------
Deferred tax assets:
Bad debt and notes receivable reserve ......... $ 4,065,794 $ 2,610,363 $ 712,418
Depreciable/amortizable assets ................ 762,486 845,133 26,010
Alternative minimum tax credit ................ 111,973 111,973 --
Other ......................................... 454,379 302,544 --
Impairment charge ............................. 3,540,577 -- --
Net operating loss carryforward ............... 8,036,027 1,208,747 --
--------------------------------------------
Deferred tax assets ........................... 16,971,236 5,078,760 738,428
Deferred tax liabilities:
Depreciation and amortization ................. -- (337,034) --
Change in tax accounting method ............... -- -- (197,770)
Specifically identified intangibles ........... -- (954,894) --
Other ......................................... (23,126) (23,126) (34,959)
Valuation allowance ........................... (16,948,110) (4,718,600) --
--------------------------------------------
Deferred tax liabilities ...................... (16,971,236) (6,033,654) (232,729)
--------------------------------------------
Net deferred tax (liability) asset ............... $ -- $ (954,894) $ 505,699
============================================
SFAS No. 109 requires a valuation allowance to reduce the deferred tax assets
reported if, based on the weight of the evidence, it is more likely than not
that some portion or all of the deferred tax assets will not be realized. At
June 30, 1997, management believed it was more likely than not that the tax
benefit associated with certain temporary differences would be recognized. After
consideration of all the evidence, both positive and negative, management
determined that a valuation allowance of $16,948,110 and $4,718,600 is necessary
at June 30, 1999 and 1998, respectively, to reduce the deferred tax assets to
the amount that will more than likely not be realized. The change in the
valuation allowance for the current period is $12,229,510. At June 30, 1999, the
Company had available net operating loss carryforwards of $21,355,000, which
expire in 2013 through 2019.
A reconciliation of the statutory federal income tax rate with the Company's
effective income tax rate for the years ended June 30, 1999, 1998 and 1997 is as
follows:
1999 1998 1997
----------------------------------
Statutory federal rate.................................. (34.0)% (34.0)% 34.0%
State income taxes, net of federal income tax benefit... (2.6) (3.6) 4.1
Goodwill and other non-deductible items................. 10.1 1.0 0.4
Change in valuation allowance........................... 24.2 28.5 --
Other................................................... 2.3 2.4 0.7
---------------------------------
Effective (benefit) tax rate 0% (5.7)% 39.2%
=================================
F-25
63
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13 - EMPLOYEE BENEFIT PLAN
As of January 1, 1997, the Company adopted a tax qualified employee savings and
retirement plan covering the Company's eligible employees. The Continucare
Corporation 401(k) Profit Sharing Plan and Trust (the "401(k) Plan") was amended
and restated on July 1, 1998. The 401(k) Plan is intended to qualify under
Section 401 of the Internal Revenue Code (the "Code") and contains a feature
described in Code Section 401(k) under which a participant may elect to have his
or her compensation reduced by up to 16% (subject to IRS limits) and have that
amount contributed to the 401(k) Plan. On February 1, 1999, the Internal Revenue
Service issued a favorable determination letter for the 401(k) Plan.
Under the 401(k) Plan, new employees who are at least eighteen (18) years of age
are eligible to participate in the 401(k) Plan after 90 days of service.
Eligible employees may elect to reduce their compensation by the lesser of 16%
of their annual compensation or the statutorily prescribed annual limit of
$10,000 (for 1999) and have the reduced amount contributed to the 401(k) Plan.
The Company may, at its discretion, make a matching contribution and a
non-elective contribution to the 401(k) Plan. Such matching contributions were
$51,512 for the year ending June 30, 1998. There were no matching contributions
for the years ending June 30, 1997 or 1999. Participants in the 401(k) Plan do
not begin to vest in the employer contribution until the end of two years of
service, with full vesting achieved after five years of service.
Under the 401(k) Plan, each participant directs the investment of his or her
401(k) Plan account from among the 401(k) Plan's many options. During fiscal
1999, the 401(k) Plan underwent an integration and conversion process by which:
(i) certain 401(k) plans of subsidiaries purchased through past acquisitions
were merged into the 401(k) Plan; and (ii) the 401(k) Plan's valuation system
was converted from a quarterly to a daily valuation.
NOTE 14 - COMMITMENTS AND CONTINGENCIES
Employment Agreements--The Company maintains employment agreements with certain
officers and key executives expiring at various dates through July 2001. In
addition, one employment agreement provides for one additional year term for
each year of service by the executive. The agreements provide for annual base
salaries in the aggregate of approximately $1,300,000, annual increases, bonuses
and stock option grants. The employment agreements with certain officers also
provide that in the event of a change in control of the Company, as defined
therein, each officer is entitled to an acceleration of the remainder of the
officer's term and the automatic vesting of any unvested stock options.
Insurance--The Company maintains policies for general and professional liability
insurance jointly with each of the providers. Coverage under the policies is
$1,000,000 per incident and $3,000,000 in the aggregate. It is the Company's
intention to renew such coverage on an on-going basis.
F-26
64
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Leases--The Company leases office space and equipment under various
non-cancelable operating leases. Rent expense under such operating leases was
$4,520,866, $2,426,416 and $357,339 for the years ended June 30, 1999, 1998 and
1997 respectively. Future annual minimum payments under such leases as of June
30, 1999 are as follows:
For the fiscal year ending June 30,
2000........................................ $ 910,425
2001........................................ 411,916
2002........................................ 349,151
2003........................................ 276,768
2004........................................ 180,525
-----------
Total.................................... $ 2,128,785
===========
Concentrations of Revenues - For the years ended June 30, 1999 and 1998, the
Company generated approximately 31% and 36% respectively of total revenues from
Foundation Health Corporation Affiliates. Humana Medical Plans, Inc. accounted
for an additional 48% and 17%, respectively, of total revenues in fiscal 1999.
For the year ended June 30, 1997, the Company generated approximately 68.0% of
total revenues from Community Mental Health Centers owned by two individuals.
Additionally, during the same period, approximately 10.5% of total revenues were
derived from a certain hospital chain. No other facility and/or chain accounted
for 10% or more of the Company's total revenues.
The Company is a party to the case of JAMES N. HOUGH, Plaintiff, v. INTEGRATED
HEALTH SERVICES, INC., a Delaware corporation, and REHAB MANAGEMENT SYSTEMS,
INC., a Florida corporation ("RMS"), and CONTINUCARE REHABILITATION SERVICES,
INC., a Florida Corporation. Mr. Hough was the founder and former Chief
Executive Officer and President of RMS. Mr. Hough sold RMS to Integrated Health
Services, Inc., ("HIS"), and entered into an Employment Agreement (the
"Employment Agreement") with HIS. RMS was acquired by Continucare in February
1998. Mr. Hough is seeking damages from the Employment Agreement and is alleging
breach of contract. His initial demand of $1,100,000 was rejected by the Company
and the Company intends to vigorously defend the claim.
The Company is a party to the case of MANAGED HEALTHCARE SYSTEMS ("MHS") v.
CONTINUCARE CORPORATION & CONTINUCARE HOME HEALTH SERVICES, INC. MHS is
alleging breach of contract and is seeking damages in excess of $1,000,000. The
Company believes the action has little merit and intends to vigorously defend
the claim.
The Company is a party to the case of KAMINE CREDIT CORPORATION ("Kamine") as
assignee of TRI COUNTY HOME HEALTH V. CONTINUCARE CORPORATION. Kamine is
alleging breach of contract and is seeking damages in excess of $5,000,000. The
Company moved to dismiss this motion on February 1, 1999, which motion is still
pending. The Company believes the action has little merit and intends to
vigorously defend the claim.
In connection with the Company's Business Rationalization Program, the Company
has closed or dissolved certain subsidiaries, some of which had pending claims
against them. The Company is also involved in various other legal proceedings
incidental to its business that arise from time to time out of the ordinary
course of business--including, but not limited to, claims related to the
alleged malpractice of employed and contracted medical
F-27
65
CONTINUCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
professionals, workers' compensation claims and other employee-related matters,
and minor disputes with equipment lessors and other vendors.
In its third quarter report on Form 10-Q for the fiscal year ended June 30,
1999, the Company disclosed a disagreement with an HMO regarding certain claims
expense information. During the fourth quarter of 1999, the Company and the HMO
performed a review of this information for the period through March 31, 1999,
and reached an agreement which did not require an adjustment in the Company's
recorded liability to the HMO through such date.
In the opinion of the Company's management, no individual item of litigation or
group of similar items of litigation, taking into account the insurance coverage
maintained by the Company, is likely to have a material adverse effect on the
Company's financial position, results of operations or liquidity.
NOTE 15 - VALUATION AND QUALIFYING ACCOUNTS
Activity in the Company's Valuation and Qualifying Accounts consists of the
following:
YEAR ENDED JUNE 30,
1999 1998 1997
-----------------------------------------------
Allowance for doubtful accounts related to accounts receivable:
Balance at beginning of period............................... $ 2,071,000 $ 1,061,000 $ 147,000
Provision for doubtful accounts.............................. 4,655,000 1,010,000 1,818,000
Write-offs of uncollectible accounts receivable.............. (974,000) -- (904,000)
-----------------------------------------------
Balance at end of period..................................... $ 5,752,000 $ 2,071,000 $ 1,061,000
===============================================
Allowance for doubtful accounts related to notes receivable:
Balance at beginning of period............................... $ 5,510,000 $ 742,000 $ 742,000
Provision for doubtful accounts.............................. 1,541,000 4,768,000 --
Write-offs of uncollectible notes receivable................. -- -- --
-----------------------------------------------
Balance at end of period..................................... $ 7,051,000 $ 5,510,000 $ 742,000
===============================================
Tax valuation allowance for deferred tax assets:
Balance at beginning of period............................... $ 4,718,600 $ -- $ --
Additions, charged to cost and expenses...................... 12,229,510 4,718,600 --
Deductions................................................... -- -- --
-----------------------------------------------
Balance at end of period..................................... $ 16,948,110 $ 4,718,600 $ --
===============================================
F-28
66
EXHIBIT INDEX
Exhibit Description
------- -----------------------------------------
10.18 Second Amendment to Acquisition Facility.
10.19 Lease Termination Agreement.
21.1 Subsidiaries of the Company.
23.1 Consent of Ernst & Young LLP
23.2 Consent of Deloitte & Touche LLP.
27.1 Financial Data Schedule.