QUARTERLY REPORT
For the three and six months ended June 30, 2002
CLARENT HOSPITAL CORPORATION
(Successor Company to Paracelsus Healthcare Corporation)
Delaware 95-3565943
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
515 W. Greens Road, Suite 720, Houston, Texas
(Address of principal executive offices)
77067 (281) 774-5100
(Zip Code) (Telephone number, including area code)
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CLARENT HOSPITAL CORPORATION
Quarterly Report
Three and Six Months Ended June 30, 2002
Page
Forward Looking Statements ................................................................................................... 3
Condensed Consolidated Balance Sheets - June 30, 2002 and December 31, 2001 ................ 4
Consolidated Statement of Operations - for the three and six months ended June 30, 2002 ... 5
Consolidated Statement of Cash Flows - for the six months ended June 30, 2002 ................. 6
Notes to Condensed Consolidated Financial Statements ......................................................... 7
Executive Officers .................................................................................................................... 19
Properties .................................................................................................................................. 19
Capitalization ........................................................................................................................... 19
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FORWARD-LOOKING STATEMENTS
Clarent Hospital Corporation (“CHC”) and its subsidiaries, collectively, are herein referred to as the
“Company.” Certain statements herein are "forward-looking statements." Forward-looking statements
involve a number of risks and uncertainties. All statements regarding the Company's expected future
financial position, results of operations, cash flows, liquidity, financing plans, liquidation, debt
repurchases, plans and objectives of management for future operations and words such as "anticipate,"
"believe," "plan," "estimate," "expect," "intend," "may" and other similar expressions are forward-
looking statements. Such forward-looking statements are inherently uncertain, and stockholders must
recognize that actual results may differ materially from the Company's expectations as a result of a
variety of factors. The Company is generally not required to, and does not undertake to, update or revise
its forward-looking statements.
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CLARENT HOSPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
($ in 000's)
Assets June 30, December 31,
2002 2001
Current assets: (Unaudited)
Cash and cash equivalents ............................................................ $ 48,990 $ 151,784
Cash designated for payments under the Amended Plan
(Notes 1 and 6) ....................................................................... 1,498 1,118
Restricted cash ............................................................................. 7,466 8,652
Cash held in escrow - sold hospitals ........................................... 21,225 19,600
Accounts receivable, net .............................................................. 1,017 9,533
Refundable income taxes ............................................................. 6,312 6,312
Assets held for sale (Note 4) ........................................................ -- 220,117
Prepaid expenses and other current assets ................................... 4,377 3,718
Total current assets ............................................................... 90,885 420,834
Other assets .................................................................................... 1,017 1,829
Total assets .................................................................................... $ 91,902 $ 422,663
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ............................................................................ $ 844 $ 7,277
Contractual obligation under HMA Transaction (Note 2) ............. - 170,000
Liabilities related to assets held for sale (Note 4) .......................... - 40,786
Due to government third parties……………… .............................. 6,882 4,200
Deferred gains and other disposition liabilities (Note 2) ................ 29,989 3,361
Other accrued liabilities……………… ........................................... 5,984 18,557
Debt (Note 6) ................................................................................... 19,712 130,000
Total current liabilities ............................................................... 63,411 374,181
Other long-term liabilities (Note 8) .................................................. 4,510 7,592
Commitments and contingencies (Note 8)........................................ - -
Stockholders' equity (Note 1):
Preferred stock, $.01 par value per share, 25,000,000 shares
authorized, none outstanding .................................................... - -
Common stock, $.01 par value per share, 150,000,000 shares
authorized, 6,126,665 shares outstanding ................................ 61 61
Additional paid-in capital ............................................................ 57,899 57,899
Accumulated deficit .................................................................... (33,979) (17,070)
Total stockholders' equity ...................................................... 23,981 40,890
Total liabilities and stockholders' equity ......................................... $ 91,902 $ 422,663
The accompanying notes are an integral part of these consolidated financial statements.
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CLARENT HOSPITAL CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
($ in 000's)
Three Months Six Months
Ended Ended
June 30, 2002 June 30, 2002
General and administrative expenses ............................... $ 1,717 $ 3,739
Interest expense ................................................................ 1,099 4,658
Restructuring charge ........................................................ 225 225
Loss from operations ........................................................ (3,041) (8,622)
Interest and other income ................................................. 743 1,909
Loss before income taxes, discontinued
operations and extraordinary loss ................................ (2,298) (6,713)
Income tax benefit (Note 5) ............................................. -- --
Loss before discontinued operations and
extraordinary loss .......................................................... (2,298) (6,713)
Discontinued operations (Note 4) .................................. (4,121) (2,632)
Extraordinary loss from the early extinguishment of
debt (Note 7) ................................................................ (2,444) (7,564)
Net loss ............................................................................. $ (8,863) $ (16,909)
The accompanying notes are an integral part of these consolidated financial statements.
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CLARENT HOSPITAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
($ in 000's)
Cash Flows from Operating Activities:
Net loss ................................................................................................. $ (16,909)
Adjustments to reconcile net loss to net cash used in operating
activities:
Restructuring charge ......................................................................... 225
Gain on sale of discontinued operations ........................................... (2,905)
Extraordinary loss ............................................................................. 7,564
Changes in operating assets and liabilities - continuing operations (7,288)
Discontinued operations and disposition related costs. .................... (21,047)
Net cash used in operating activities .................................................... (40,360)
Cash Flows from Investing Activities:
Proceeds from sales of discontinued operations .................................. 55,486
Discontinued operations - capital expenditures ................................... (40)
Net cash provided by investing activities............................................. 55,446
Cash Flows from Financing Activities:
Purchase of New Notes ........................................................................ (110,288)
Premium paid on purchase of New Notes ............................................ (7,564)
Discontinued operations - debt payments ............................................ (28)
Net cash used in financing activities .................................................... (117,880)
Decrease in cash and cash equivalents ................................................. (102,794)
Cash and cash equivalents at beginning of period ............................... 151,784
Cash and cash equivalents at end of period ......................................... $ 48,990
Supplemental cash flow information:
Interest paid .......................................................................................... $ 9,413
Supplemental schedule of noncash investing and financing activities:
Debt assumed by purchasers of hospitals ............................................. $ 7,604
The accompanying notes are an integral part of these consolidated financial statements.
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CLARENT HOSPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(UNAUDITED)
NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization - The predecessor to Clarent Hospital Corporation, Paracelsus Healthcare
Corporation (the “Predecessor Company”), was incorporated in November 1980 for the principal
purpose of owning and operating acute care hospitals and related healthcare businesses in
selected markets. On September 15, 2000, the Predecessor Company filed a voluntary petition for
protection under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") with
the United States Bankruptcy Court for the Southern District of Texas (Houston Division) (the
“Bankruptcy Court”) (Case no. 00-38590-H5-11). The bankruptcy filing was limited to the
Predecessor Company and did not include any of the Predecessor Company’s hospital
subsidiaries. On June 28, 2001, (the “Confirmation Date”), the Bankruptcy Court entered an
order (the “Confirmation Order”) confirming the Predecessor Company’s first amended plan of
reorganization, as modified, filed with the Bankruptcy Court on April 18, 2001 (the "Amended
Plan"). On July 9, 2001, the Amended Plan became effective (the “Effective Date”). Also on July
9, 2001, the Predecessor Company merged into a wholly owned subsidiary incorporated in
Delaware and ceased to exist as a separate company. The wholly owned subsidiary emerged
from bankruptcy under the name Clarent Hospital Corporation (“CHC”), a Delaware corporation.
CHC and its subsidiaries are hereafter referred to as the “Company.”
Recent Developments - As of May 2002, the Company has sold all of its former hospitals and
related operations. See Note 2 for a more detailed discussion of these transactions. Accordingly,
it is unlikely that the Company will continue as a going concern. Although the Company’s Board
of Directors has not reached any definitive conclusions as to the ultimate resolution of the
Company’s affairs, it is likely, with shareholder approval, that the Company will cease operations
pursuant to a plan of liquidation. After paying or reserving for all known liabilities and the
projected costs of winding up its corporate affairs, the Company expects to distribute the
remaining net proceeds, if any, to its shareholders. Management is currently evaluating the costs
associated with winding up the Company’s affairs and consequently, what funds, if any, will
ultimately be available for distribution to shareholders in the likely event that a plan of
liquidation is adopted. In addition to cash and cash equivalents, the majority of the Company’s
remaining assets consist primarily of restricted cash, including escrowed funds set aside in
conjunction with the sale of hospitals and related operations, certain retained accounts receivable,
income tax refunds and accrued interest income thereon, prepaid insurance policies, deposits and
discounted notes receivables from prior period dispositions. The net proceeds available for
distribution to shareholders, the timing of such distributions, the tax treatment of the distributions
and the Company’s future financial statement presentation will depend on a number of factors.
These factors include, among others, the realization, if any, of escrowed funds set aside in
conjunction with the sale of the Company’s hospitals and related operations (see Note 2), final
settlement of working capital with certain buyers of the Company’s former hospitals, the timing
of the adoption of a plan of liquidation and the costs and time required to wind up the Company’s
affairs, including severance for certain corporate employees and certain wind down costs
incurred to wrap up the Company’s affairs in the various markets it once served. Final amounts
to be distributed will also be significantly impacted by the resolution of liabilities not assumed by
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the various buyers of the Company and Predecessor Company’s hospitals, including claims for
workers compensation, general and professional liabilities and final settlement of Medicare and
Medicaid cost reports, among others.
As a consequence of the Company’s decision to dispose of substantially all of its
operating assets, the Company implemented a restructuring plan in the fourth quarter of 2001 to
eliminate the majority of its corporate operations and relocate Company records and personnel
necessary to wind down its operations. The Company had four full time employees as of
September 1, 2002, which represents a 88% reduction in corporate staff compared to total
employees at December 31, 2001. The Company relies on a limited number of independent
contractors to assist it with its wind down activities, which consist primarily of the administration
of outstanding legal proceedings against the Company, resolution of pending Medicare/Medicaid
cost report matters, final resolution of disputed claims arising out of the Predecessor Company’s
Chapter 11 bankruptcy filing, the realization of the Company’s remaining assets and disposition
of its remaining obligations, general administrative matters and preparation for potential
liquidation.
Basis of Presentation – The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with Accounting Principles Board Opinion No. 28
“Interim Financial Reporting.” Accordingly, they do not include all of the information and notes
required by generally accepted accounting principles for a complete set of financial statements.
Additionally, the financial statements have been prepared without audit or review by independent
accountants. These financial statements should be read in conjunction with the Company's
audited consolidated financial statements and notes thereto for the year ended December 31,
2001. Management believes that the financial information included herein reflects all
adjustments necessary for a fair presentation of interim results and that all such adjustments are
of a normal and recurring nature. Operating results for the three and six months ended June 30,
2002 are not necessarily indicative of the results that may be expected for the year ending
December 31, 2002.
Certain reclassifications to the prior year condensed consolidated balance sheet have been
made to conform with the current year presentation.
On July 9, 2001, the Effective Date, the Company adopted fresh start reporting in
accordance with the American Institute of Certified Public Accountants’ Statement of Position
90-7 - “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code” (“SOP
90-7”), which resulted in adjustment to the Company’s common stockholders’ equity and the
carrying value of assets and liabilities. For accounting purposes, the inception date for the
reorganized company was deemed to be July 1, 2001.
As a result of the adoption of fresh start reporting, the Company’s post-reorganization
consolidated statement of operations and cashflows have not been prepared on a consistent basis
of accounting with the Predecessor Company’s statements of operations and cashflows.
Accordingly, Predecessor Company consolidated financial statements are not presented herein.
As a consequence of the Company’s decision to exit the hospital management business in
the fourth quarter of 2001, the Company’s hospitals and related operations were classified as
“Assets held for sale” and "Liabilities related to assets held for sale” in the accompanying
condensed consolidated balance sheet, and the results of operations and cash flows for hospital
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and related operations have been classified as discontinued operations in the accompanying
consolidated statements of operations and cash flows. Remaining general and administration
costs and interest have been reported as continuing operations.
Principles of Consolidation - The consolidated financial statements include the accounts
of the Company and its wholly-owned or majority-owned subsidiaries and partnerships. All
significant intercompany accounts and transactions have been eliminated in consolidation.
Investments in affiliates, of which the Company owns more than 20% but not in excess of 50%,
are recorded on the equity method.
Use of Estimates - The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates.
Cash Equivalents - The Company considers highly liquid investments with original
maturities of three months or less to be cash equivalents.
Restricted Cash - The Company had restricted cash of $7.5 million and $8.6 million at
June 30, 2002 and December 31, 2001, respectively. Restricted cash serves primarily as
collateral for outstanding letters of credit. During the third quarter of 2002, a financial institution
terminated a letter of credit in the amount of $850,000 and released the associated cash collateral
to the Company.
Cash Designated for Payments under the Amended Plan - On the Effective Date of the
Amended Plan, all principal and interest outstanding on the Predecessor Company’s 10% Senior
Subordinated Notes (the “Notes”) and allowed general unsecured claims became exchangeable
for (i) 11.5% Senior Notes (due on August 15, 2005) (the “New Notes”) in the aggregate
principal amount of $130.0 million, (ii) a cash payment of $13.4 million, as defined in the
Amended Plan, and (iii) 100.0% of the 6,106,665 shares of new common stock issued by CHC at
the Effective Date under the Amended Plan. As of June 30, 2002, cash designated for payments
under the Amended Plan totaled $1.5 million, which included $600,000 in interest due on New
Notes held in reserve for disputed general unsecured claims still outstanding from the
Predecessor Company’s Chapter 11 bankruptcy proceedings. Such amount is shown as “Cash
Designated for Payments under the Amended Plan” in the accompanying condensed consolidated
balance sheet with an offsetting liability included in other accrued liabilities. Payment of amounts
due under the Amended Plan will occur as disputed general unsecured claims are resolved. On
August 15, 2002, Cash Designated for Payments under the Amended Plan increased to $11.2
million due to the Company’s early redemption of the New Notes. See Note 6 for further
discussion on this matter.
Supplies - All supplies previously classified as assets held for sale have been disposed as
of June 30, 2002.
Property and Equipment - All property and equipment previously classified as assets
held for sale have been disposed as of June 30, 2002.
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Other Long-Term Assets - Other long term assets at June 30, 2002 consisted of deposits
and notes receivable from asset dispositions. The Company regularly reviews the carrying value
of long-term assets records to expense on a current basis any diminution in value based on the
difference between the sum of the future discounted cash flows and net book value.
Net Revenue - Net revenue (see Note 4) includes amounts estimated by management to
be reimbursable by Medicare under the Prospective Payment System and by Medicare and
Medicaid programs under the provisions of cost-reimbursement and other payment formulas.
Payments for services rendered to patients covered by such programs are generally less than
billed charges. Deductions from revenue are made to reduce the charges to these patients to
estimated receipts based on each program's principles of payment/reimbursement. Final
settlements under these programs are subject to administrative review and audit by third parties.
Settlements under reimbursement agreements with third-party payers are estimated and recorded
in the period the related services are rendered. Laws and regulations governing the Medicare and
Medicaid programs are complex and subject to interpretation. As a result, there is at least a
reasonable possibility that recorded estimates will change by a material amount. The estimated
reimbursement amounts are adjusted in subsequent periods as cost reports are prepared and filed
and as final settlements are determined (in relation to certain government programs, primarily
Medicare, this is generally referred to as the "cost report" filing and settlement process).
The Company believes that it is in compliance with all applicable laws and regulations
and is not aware of any material pending or threatened investigations against the Company
involving allegations of potential wrongdoing. 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, Medicaid, Tricare and other
government programs.
In the ordinary course of business, the Company’s hospitals rendered services free of
charge to patients who are financially unable to pay for hospital care. The value of these services
rendered were not material to the Company's consolidated results of operations.
Income Taxes - The Company records its income taxes under the liability method. Under
this method, deferred income tax assets and liabilities are recognized for the tax consequences of
temporary differences by applying enacted statutory tax rates applicable to future years to
differences between the financial statement carrying amounts and the tax bases of existing assets
and liabilities.
Common Stock - The Company had 6,126,665 shares of common stock outstanding at
June 30, 2002, of which 405,369 were held in reserve pending resolution of disputed general
unsecured claims arising out of the Predecessor Company’s Chapter 11 bankruptcy proceedings.
In the third quarter of 2002, 58,665 of such shares became available for distribution pursuant to
the resolution of certain prior disputed general unsecured claims. The Company does not have
any options, warrants or other dilutive securities outstanding. In October 2001, the Company’s
four outside directors received a common stock grant of 15,000 shares each with 5,000 shares
vesting immediately and the remaining 10,000 shares vesting annually in increments of 5,000
shares each in July 2002 and July 2003. Pursuant to such grant, 20,000 shares of common stock
were issued in July 2002. The Company amortizes the stock grants over the period services are
rendered based on the estimated fair value of the common stock at the date of grant. No
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executive officers of the Company own CHC common stock.
Comprehensive Loss - Comprehensive loss equals reported loss.
NOTE 2 . DISPOSITIONS
In November 2001, the Company executed two separate definitive agreements to sell the
assets of the 107 licensed bed facility Westwood Medical Center in Midland, Texas to an
unaffiliated party (the “Midland Transaction”) and the stock of four subsidiaries that own or lease
four hospitals with 507 licensed beds to Health Management Associates, Inc. (the “HMA
Transaction”). On December 14, 2001, a majority of the Company’s registered shareholders
gave their consent to the HMA Transaction, and retroactively, the Midland Transaction, and
authorized the Company to proceed with the sale of its remaining hospitals provided that the
terms ultimately negotiated were at least as favorable as those described by management. Notice
of such consent was subsequently provided to the Company’s remaining shareholders. The
Midland Transaction closed on November 30, 2001. The HMA Transaction was funded by the
buyer on December 31, 2001 and consummated effective January 1, 2002.
The sales price for the Midland Transaction, which included the sale of net working
capital, consisted of $29.5 million in cash and the assumption of $52,000 in long term capital
lease obligations. Cash proceeds of $1.6 million will be held in an escrow account for 18 months
as sole recourse for all indemnity obligations of the Company, as defined in the asset purchase
agreement. The 2001 gain on the Midland Transaction is subject to further adjustment pending
final settlement of net working capital conveyed as part of the transaction, which the Company
expects to occur by the end of 2002. The Company’s calculation of net working capital indicates
that an additional $355,000 is due to the buyer, which the Company has fully accrued in
"Deferred gains and other disposition liabilities" in the accompanying condensed consolidated
balance sheet. However, the buyer has given notice of its objection to the Company’s calculation
and has asserted that the Company owes it approximately $1.2 million, due primarily to the
buyer’s assessment of the collectability of certain patient accounts receivable. Discussions are
ongoing with the buyer, and the parties have retained a third party accounting firm to assist in
resolving this matter. The Company can provide no assurance as to the ultimate outcome or the
impact any resolution of the disputed amounts may have on the Company’s statement of
operations, financial position or cash flows. Final settlement of working capital is not expected
to have any impact on escrowed funds.
With respect to the HMA Transaction, the Company sold the stock of four subsidiary
corporations owning or leasing four acute care hospitals: 117 bed Lancaster Community Hospital
in Lancaster, California; 129 bed Santa Rosa Medical Center in Milton, Florida; 85 bed Fentress
County General Hospital in Jamestown, Tennessee; and 176 bed The Medical Center of
Mesquite in Mesquite, Texas. The sales price, which included the sale of net working capital,
consisted of $170.0 million in cash and the assumption of $4.1 million in long term capital lease
obligations. The sales price is subject to further adjustment for final settlement of net working
capital. The Company’s calculation of net working capital conveyed at December 31, 2001
indicates that an additional $726,000 is due from the buyer. However, the buyer has given notice
of its objection to the Company’s calculation and has asserted that the Company owes it
approximately $9.3 million, due primarily to the buyer’s assessment of the collectability of
certain patient accounts receivable and government third party receivables. Discussions are
ongoing with the buyer, and the parties have retained a third party accounting firm to assist in
11
resolving this matter. The Company can provide no assurance as to the ultimate outcome or the
impact any resolution of the disputed amounts may have on the Company’s statement of
operations, financial position or cash flows.
Cash proceeds of $18.0 million from the HMA transaction will be held in an escrow
account for 24 months as sole recourse for all indemnity obligations of the Company. The term
of the escrow can be extended under certain circumstances. At the end of 24 months, the escrow
agent will disburse to the Company all remaining funds except to the extent that certain
qualifying claims remain between the buyer and the Company, in which case certain amounts
may be retained by the escrow agent beyond the 24 month period until such matters are fully and
finally resolved pursuant to the provisions of the purchase and escrow agreements. No amounts
have been disbursed from the escrow account.
The $18.0 million in escrowed funds set aside as part of the HMA Transaction represents
an arm’s length, negotiated liability for all known, unknown and potential claims to which the
Company is subject under its indemnification obligation under the HMA Transaction, and as
such, represents a contingent gain. The recognition of this contingent gain will be deferred until
the termination of the escrow agreement and the release of any remaining escrowed funds to the
Company, less any known and probable liabilities to which the Company may still be subject as a
result of the HMA Transaction. The $18.0 million in escrowed funds have been recorded as
“Cash held in escrow - sold hospitals” at June 30, 2002 with an offsetting deferred gain of the
same amount included in “Deferred gain and other disposition liabilities” in the accompanying
condensed consolidated balance sheet.
Given the significant difference between the Company and buyer’s calculation of net
working capital conveyed at December 31, 2001, the Company has deferred recognition of any
gain on the HMA Transaction until the disputed amounts have been resolved. Final settlement of
working capital is not expected to have any impact on escrowed funds.
On December 13, 2001, the Company executed a definitive agreement to sell the assets of
the 191 licensed bed BayCoast Medical Center, in Baytown, Texas to an unaffiliated party (the
“Baytown Transaction”) for $13.5 million in cash proceeds, inclusive of certain components of
working capital. Cash proceeds of $625,000 will be held in an escrow account for a period of up
to 24 months, subject to adjustment after the first 18 months, as sole recourse for all indemnity
obligations of the Company, as defined in the asset purchase agreement. At the end of 18 months,
the escrow agent will disburse to the Company all remaining funds except to the extent that
certain qualifying claims remain between the buyer and the Company, in which case certain
amounts may be retained by the escrow agent beyond the 18 month period until such matters are
fully and finally resolved pursuant to the provisions of the asset purchase and escrow agreements.
The transaction closed on January 31, 2002. On February 20, 2002 the Company entered into a
definitive agreement to sell its medical office buildings in Baytown, Texas for $2.0 million. The
transaction closed on April 30, 2002. The Company recognized an aggregate gain of
approximately $520,000 on the disposition of its Baytown, Texas operations.
On December 18, 2001, the Company executed a definitive agreement to sell the assets of
the 218 licensed bed Heartland Health System, in Fargo, North Dakota (“HHS”) to an
unaffiliated party for $34.0 million in net cash proceeds, inclusive of certain components of
working capital. Net cash proceeds reflect $1.4 million paid a minority partner for certain assets
sold in the transaction. Cash proceeds of $1.0 million will be held in an escrow account for 18
12
months as sole recourse for all indemnity obligations of the Company, as defined in the asset
purchase agreement. At the end of 18 months, the escrow agent will disburse to the Company all
remaining funds except to the extent that certain qualifying claims remain between the buyer and
the Company, in which case certain amounts may be retained by the escrow agent beyond the 18
month period until such matters are fully and finally resolved pursuant to the provisions of the
asset purchase and escrow agreements. Approximately $2.0 million of cash proceeds were used
to fund the Company’s remaining obligation under a settlement agreement with respect to two
lawsuits alleging certain violations of Federal and North Dakota wage and hour laws. The
lawsuits were settled on September 7, 2001. The transaction closed on January 31, 2002. Also
on January 22, 2002, the Company assigned its 49% interest in a Fargo, North Dakota durable
medical equipment partnership in exchange for $2.2 million in cash. The Company recognized
an aggregate gain of approximately $2.6 million on the disposition of its Fargo, North Dakota
operations.
The Midland and HMA Transactions constituted a change of control under the indenture
agreement for the New Notes (See Note 7).
On February 15, 2002, the Company entered into a definitive agreement to sell the stock
of Paracelsus Macon County Medical Center, Inc. d/b/a Flint River Community Hospital, in
Montezuma, Georgia to an unaffiliated party for the assumption of $2.9 million in capital lease
obligations. The transaction closed on March 21, 2002. There are no indemnity obligations or
escrow requirements for this transaction; however, the sales price is subject to further adjustment
for final settlement of net working capital. The Company’s calculation of net working capital
conveyed at March 21, 2002 is not materially different from initial estimates contemplated in the
stock purchase agreement; however, the buyer has given notice of its objection to the Company’s
calculation and has asserted that the Company owes it approximately $3.0 million, due primarily
to litigation arising after the sale of the stock of the subsidiary and the buyer’s objection to the
Company’s classification of certain government third party payables as long term. Discussions
are ongoing with the buyer. Given the significant difference between the Company and buyer’s
calculation of net working capital, the Company has deferred recognition of any gain on the
transaction until the disputed amounts have been resolved. The Company can provide no
assurance as to the ultimate outcome or the impact any resolution of the disputed amounts may
have on the Company’s statement of operations, financial position or cash flows
On February 25, 2002, the Company entered into a definitive agreement to sell the stock
of Paracelsus Clay County Hospital, Inc. d/b/a Cumberland River Hospital, in Celina, Tennessee
to an unaffiliated party for $1.7 million in cash and the assumption of $131,000 in long term
capital lease obligations. No escrow for indemnity obligations or final working capital
settlement are required under this agreement. The transaction closed on May 14, 2002. The
Company recognized a loss of $512,000 on this transaction.
In June 2002, the Company received $2.0 million in full settlement of a note receivable
and other outstanding issues arising from a Predecessor Company disposition. Net proceeds
received exceeded the value of the note recorded on the Company’s books pursuant to its
application of Fresh Start Reporting in 2001, resulting in the recognition of a $295,000 gain in
the second quarter of 2002.
The sales price for each transaction described herein was arrived at through an arm’s
length negotiation. The Company estimates of gain/loss on the above transactions are based on
13
its best estimates for all known and probable costs directly attributable to the transactions.
However, the reported gain/loss for each transaction is subject to further adjustment pending
resolution of ongoing discussions with vendors and other parties regarding contract terminations,
finalization of net working capital settlements, where applicable, and the finalization of certain
other costs necessary to wind down the Company’s operations in its former markets. The
Company did not recognize any gain with respect to the $3.2 million in escrowed funds set aside
as part of the Midland Transaction and the disposition of the Company’s operations in Fargo,
North Dakota, and Baytown, Texas. The recognition of any gain associated with these escrowed
funds will be deferred until the termination of the escrow agreements and the release of any
remaining escrowed funds to the Company. Although the Company is not currently aware of any
claims that may be asserted against the escrowed funds, there can be no assurance as to what
amount, if any, of the $3.2 million in escrowed funds will ultimately be realized by the Company
upon the expiration of the escrow agreements. The $3.2 million in escrowed funds have been
recorded as “Cash held in escrow - sold hospitals” at June 30, 2002 with an offsetting deferred
gain of an equal amount included in “Deferred gain and other disposition liabilities” in the
accompanying condensed consolidated balance sheet. No amounts have been distributed from
the escrow accounts.
NOTE 3. RESTRUCTURING CHARGE
The Company recorded a restructuring charge of $225,000 in the second quarter of 2002
to accrue for additional costs associated with the Company’s previously announced reduction of
corporate overhead. Such charge was in addition to the $3.9 million charge recorded in the
fourth quarter of 2001, and consists primarily of an increase in severance costs resulting from the
appointment of Robert M. Starling as President and Chief Liquidating Officer and the
appointment of Frank A. Uribie as Executive Vice President and General Counsel effective June
1, 2002. As of June 30, 2002, the Company has paid $2.1 million in severance to former
corporate employees.
NOTE 4 . DISCONTINUED OPERATIONS
As a consequence of the Company’s decision to exit the hospital management business in
the fourth quarter of 2001, the Company’s hospitals and related operations were reclassified as
either “Assets held for sale” or “Liabilities related to assets held for sale” in the accompanying
condensed consolidated balance sheet, and the results of operations and cash flows for such
hospitals and related operations have been reclassified as “Discontinued operations” in the
accompanying consolidated statements of operations and cash flows. General and administrative
costs and interest expense have been reported as continuing operations.
The Company has retained significant, unfunded liabilities for open cost reports under the
Medicare and Medicaid programs, workers compensation and general and professional liabilities,
among others, with respect to the asset sale transactions discussed in Note 2 and certain prior
period dispositions. Given the Company’s disposition of all of its hospitals and related
operations and the likelihood that it will, with shareholder approval, cease operations pursuant to
a plan of liquidation, management intends to expedite the resolution of these matters whenever
possible so long as it is in the best interest of the Company’s stockholders to do so. It should be
noted that reimbursement for services under the Medicare or Medicaid programs are remitted
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directly to the hospitals that provided such services, and the Company generally must rely on the
buyers of those hospitals to (i) assist in the conduct and resolution of cost report audits and (ii)
remit to the Company any funds received from prior period cost reports. The Company intends to
vigorously pursue all amounts due it under the Medicare and Medicaid programs or from the
buyers of its former facilities so long as it is cost effective to do so. For three months ending
June 30, 2002, the Company accrued an additional $2.1 million in contractual allowances for
revisions to estimated obligations related to open cost reports under the Medicare and Medicaid
programs. Such charges are recorded as a deduction to net revenue in the period in which
amounts become known or estimable, which resulted in a negative charge to net revenue for the
three months ended June 30, 2002.
The following table summarizes net revenue and pre-tax losses for discontinued
operations for the three and six months ended June 30, 2002 ($ in 000’s). All assets and
liabilities previously classified as held for sale have been disposed as of June 30, 2002:
Three Months Six Months
Ended Ended
June 30, 2002 June 30, 2002
Net revenue $ (1,792) $ 10,456
Discontinued operations before income taxes:
Loss from discontinued operations $ (3,866) $ (5,537)
Gain (loss) on sale of discontinued operations (255) 2,905
$ (4,121) $ (2,632)
NOTE 5 . INCOME TAXES
The benefit for income taxes recorded for the three and six months ended June 30, 2002
was offset in full by the recognition of a valuation allowance to fully reserve net deferred tax
assets resulting from operating losses. As a result of the Company’s decision to dispose of all of
its hospitals and related operations, the realization of the tax assets may be substantially and
permanently impaired. The future realization of the deductible temporary differences and net
operating loss carryforwards depends on the existence of sufficient taxable income within the
carryforward period. Since it is unlikely that NOLs will be fully utilized, a valuation allowance
has been placed on the deferred tax assets.
NOTE 6. CASH DESIGNATED FOR PAYMENTS UNDER THE AMENDED PLAN
As of June 30, 2002, cash designated for payments under the Amended Plan totaled $1.5
million, which included $600,000 in interest due on New Notes held in reserve for disputed
general unsecured claims arising out of the Predecessor Company’s Chapter 11 Bankruptcy
proceedings. Such amount is shown as “Cash Designated for Payments under the Amended
Plan” in the accompanying condensed consolidated balance sheet with an offsetting liability
included in other accrued liabilities. Payment of amounts due under the Amended Plan will occur
as disputed general unsecured claims are resolved. At June 30, 2002, approximately $8.6 million
of the New Notes and 405,369 shares of common stock were held in reserve pending resolution
of such disputed general unsecured claims. However, on August 15, 2002, the Company
exercised its rights under the indenture of the New Notes (the “Indenture”) to redeem all New
Notes outstanding on August 15, 2002 at 105.75% of the principal amount plus accrued and
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unpaid interest due thereon. Such redemption included the $8.6 million in New Notes held in
reserve. As a result of this redemption, approximately $11.2 million in cash is being held in
reserve as of September 20, 2002, which resulted from the principal amount of the $8.6 million
New Notes previously held in reserve, accrued interest due thereon through the date of
redemption, a redemption premium equal to 5.75% of New Note principal value, and remaining
cash payments due under the Amended Plan. Approximately $1.6 million of such funds and
58,665 shares of common stock will be distributed pursuant to the resolution of certain prior
disputed general unsecured claims. At September 20, 2002, three disputed general unsecured
claims aggregating approximately $4.0 million remain outstanding. The Company is currently
unable to estimate at what amount, if any, such claims will be allowed. Once such claims are
resolved, the holders of these allowed claims will be entitled to a pro rata share of (i) cash
payments required under the Amended plan, (ii) a cash payment equal to the value of the New
Notes the holders would have otherwise received prior to the redemption, interest due thereon
through the date of redemption, a 5.75% redemption premium and (iii) common stock. The
amount of funds and common stock received by such holders will be calculated based on the
value of their allowed general unsecured claim relative to the total Predecessor Company allowed
general unsecured claims approved as part of the Predecessor Company’s Chapter 11 bankruptcy
proceedings. After such distribution is made, all remaining funds will be redistributed to all
holders of allowed general unsecured claims on a pro rata basis. The Company estimates that
approximately $8.0 million and 300,000 shares of common stock will be available for
redistribution to holders of all Predecessor Company allowed general unsecured claims at the
conclusion of this process.
NOTE 7. DEBT
At June 30, 2002, the Company had $19.7 million principal amount of New Notes
(11.5% Senior Notes) outstanding. The New Notes paid interest semi-annually each February
15th and August 15th and were due on August 15, 2005. Approximately $8.6 million in New
Notes were held in reserve at June 30, 2002 pending resolution of disputed general unsecured
claims arising out of the Predecessor Company’s Chapter 11 bankruptcy proceedings (See Note
6). On May 13, 2002, the Company’s Board of Directors approved the exercise of the Company’s
optional redemption rights under the Indenture to purchase any and all New Notes that remained
outstanding on August 15, 2002 at 105.75% of the principal amount plus accrued and unpaid
interest due thereon. Accordingly, on June 28, 2002, the Company gave notice to the Indenture
Trustee to redeem all New Notes still outstanding by August 15, 2002. On August 15, 2002, the
Company redeemed and discharged in full the $19.7 million principal amount of New Notes then
outstanding for an aggregate cash payment of $22.0 million, which included a 5.75% redemption
premium and accrued interest through the date of redemption. Upon redemption of the New
Notes, the Company satisfied all obligations under the Indenture.
The HMA and Midland Transactions resulted in the disposition of substantially all of the
Company’s operating assets, which constituted a change of control under the Indenture for the
New Notes. Upon the occurrence of a change of control, holders of the New Notes had the right
to require the Company to repurchase the New Notes at a purchase price in cash equal to 101%
of the aggregate principal amount plus accrued and unpaid interest to the date of purchase, up to
the amount of available funds. Accordingly, on January 30, 2002, the Company commenced a
Change of Control Offer for any and all of the $130.0 million principal amount of the New Notes
for a cash purchase price equal to 101% of the principal amount plus accrued and unpaid interest
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due thereon. The Change of Control Offer ended on March 15, 2002, and resulted in the
repurchase of $2.3 million principal of the New Notes plus accrued interest due thereon and a 1%
change of control premium.
During the second quarter, the Company’s management executed several transactions
retiring certain of the New Notes, believing that it was in the best interest of the Company’s
stockholders for the Company to retire the New Notes at the earliest possible date and at the
lowest possible cost. Consequently, with the approval of the Board of Directors, the Company
repurchased an aggregate of $108.0 million principal amount of New Notes as of June 30, 2002
pursuant to privately negotiated transactions initiated by a small number of institutions that held
large blocks of New Notes. The Company paid total cash consideration of $117.3 million, which
included a premium and accrued and unpaid interest through the date of purchase.
As of June 30, 2002, the Company had $6.6 million in cash collateralized letters of credit
outstanding under an agreement with Bank One N.A. Additionally, at June 30, 2002, the
Company had another $850,000 letter of credit outstanding with a different bank that was
terminated in the third quarter of 2002 with the associated cash collateral released to the
Company.
Due to cross default provisions, a $2.9 million capital lease obligation of a former
hospital subsidiary was in default as a consequence of the Predecessor Company’s Chapter 11
bankruptcy proceedings. In March 2002, the Company sold the stock in the subsidiary that is
obligated under the capital lease and the buyer assumed the capital lease. The Company is still a
guarantor of the capital lease obligation; however, the buyer of the subsidiary stock has agreed to
use its best efforts to refinance, refund or otherwise discharge the obligation within twelve
months of its purchase of the subsidiary stock, and if successful, fully release and discharge the
Company from its lease guaranty agreement. If the buyer fails to discharge the Company’s lease
guaranty obligation within twelve months of its purchase of the subsidiary stock, the buyer shall
pay the Company $350,000.
As of September 30, 2002, the Company has no debt outstanding or credit arrangements
in place other than the aforementioned cash collateralized letters of credit.
NOTE 8. COMMITMENTS AND CONTINGENCIES
Litigation – The Company is subject to claims and legal actions by patients and others in
the ordinary course of business, as described below.
Professional and Liability Risks - The Company is subject to claims and suits in the
ordinary course of business, including those arising from the care and treatment provided at its
former facilities. The Company maintains insurance and, where appropriate, reserves with
respect to the possible liability arising from such claims. The Company is self-insured for the
first $1.0 million per occurrence of general and professional liability claims. Excess insurance
amounts up to $50.0 million were covered by third party insurance carriers through 2001.
Beginning January 1, 2002, the Company obtained new insurance coverage with limits up to
$21.0 million. The Company accrues an estimated liability for its uninsured exposure and self-
insured retention based on historical loss patterns and actuarial projections.
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The Company believes that it has appropriately established loss reserves as required
under generally accepted accounting principles.
Medicare and Medicaid - Within the statutory framework of the Medicare and Medicaid
programs, there are substantial areas subject to administrative rulings, interpretations and
discretion that may affect payments made under these programs. Funds received from these
programs are subject to audit. These audits can result in retroactive adjustments of such
payments. It often takes many years to make a final determination about the amounts earned
under the programs because of audits by the program representatives, providers' rights of appeal
and the application of numerous technical reimbursement provisions. Management believes that
adequate provisions have been made for such adjustments. There can be no assurance that future
audits will not result in material retroactive adjustments.
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SUPPLEMENTAL INFORMATION
EXECUTIVE OFFICERS
On May 31, 2002, Robert L. Smith was terminated without cause as Chief Executive
Officer of the Company and on June 7, 2002 Lawrence Humphrey was terminated without cause
as Chief Financial Officer of the Company, both as a result of the disposition of all of the
Company’s hospitals and related operations. Mr. Smith remains a member of the Company’s
Board of Directors.
Effective June 1, 2002 the board appointed Robert M. Starling, President and Chief
Liquidating Officer and appointed Frank A. Uribie, Executive Vice President and General
Counsel.
PROPERTIES
As of June 30, 2002, the Company has disposed of all of its hospital operations.
CAPITALIZATION
AS OF SEPTEMBER 30, 2002
Amount
Title of Class Amount Authorized Outstanding
Common stock 150,000,000 6,146,665 (1)
Par value $0.01 per
share
Preferred stock 25,000,000 0
Par value $0.01 per
share
11 1/2% Senior Notes $130,000,000 $0
due 2005
(1) Includes 405,369 shares of common stock held in reserve pending resolution of Predecessor
Company disputed general unsecured claims arising out of its Chapter 11 bankruptcy
proceedings.
The Company’s transfer agent and registrar is as follows:
Mellon Investor Services LLC
Ridgefield Park, New Jersey
www.melloninvestor.com
800-756-3353
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