-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: keymaster@town.hall.org Originator-Key-Asymmetric: MFkwCgYEVQgBAQICAgADSwAwSAJBALeWW4xDV4i7+b6+UyPn5RtObb1cJ7VkACDq pKb9/DClgTKIm08lCfoilvi9Wl4SODbR1+1waHhiGmeZO8OdgLUCAwEAAQ== MIC-Info: RSA-MD5,RSA, NZ7E7GPsccBTXybi2BJXzyGaAoraTFx4gzBfgVQCcgPhw0RO6fot/hY8smJcwj7w 6RDtumSOlyjP8R58Kc4LAQ== 0000912057-94-003158.txt : 19941004 0000912057-94-003158.hdr.sgml : 19941004 ACCESSION NUMBER: 0000912057-94-003158 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19940630 FILED AS OF DATE: 19940920 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: HALLMARK HEALTHCARE CORP CENTRAL INDEX KEY: 0000765052 STANDARD INDUSTRIAL CLASSIFICATION: 8062 IRS NUMBER: 630817574 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-13991 FILM NUMBER: 94549682 BUSINESS ADDRESS: STREET 1: 300 GALLERIA PKWY STE 650 CITY: ATLANTA STATE: GA ZIP: 30339 BUSINESS PHONE: 4049335500 MAIL ADDRESS: STREET 1: P.O. BOX 723049 CITY: ATLANTA STATE: GA ZIP: 30339 FORMER COMPANY: FORMER CONFORMED NAME: NATIONAL HEALTHCARE INC DATE OF NAME CHANGE: 19920218 10-K 1 10-K - - -------------------------------------------------------------------------------- - - -------------------------------------------------------------------------------- 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 (FEE REQUIRED) FOR THE FISCAL YEAR ENDED JUNE 30, 1994 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NO. 0-13991 --------------------- HALLMARK HEALTHCARE CORPORATION (Exact name of Registrant as specified in its charter) DELAWARE 63-0817574 (State or other jurisdiction (I.R.S. Employer of incorporation or Identification Number) organization)
300 Galleria Parkway, Suite 650, Atlanta, Georgia 30339 (404) 933-5500 (Principal executive offices) ------------------------ Securities registered pursuant to Section 12(g) of the Act: Class A Common Stock, $0.05 par value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, 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 Form 10-K or any amendment to this Form 10-K. (X) The aggregate market value of the Class A Common Stock of the Registrant held by nonaffiliates of the Registrant on August 26, 1994 was $69,864,523. The aggregate market value was determined by reference to the closing price of the stock on such date and excludes for the purpose of this calculation shares held by officers and directors. The number of shares of the Registrant's Common Stock outstanding at August 26, 1994. $0.05 par value Class A common stock -- 3,206,862 $0.05 par value Class B common stock -- 64,102 DOCUMENTS INCORPORATED BY REFERENCE None. - - -------------------------------------------------------------------------------- - - -------------------------------------------------------------------------------- PART I ITEM 1. BUSINESS PROPOSED MERGER Hallmark Healthcare Corporation ("Hallmark" or the "Company") is a party to an Amended and Restated Agreement and Plan of Merger, dated as of June 10, 1994 (the "Merger Agreement"), among Hallmark, Community Health Systems, Inc. and Community Acquisition Corp. Consummation of the merger (the "Merger") contemplated by the Merger Agreement is subject, among other things, to approval of the Merger Agreement by Hallmark's stockholders at a special meeting of stockholders to be held on October 5, 1994. A Joint Proxy Statement/Prospectus relating to the Merger was mailed on September 2, 1994 to Hallmark's stockholders on the record date of the special meeting, August 26, 1994. If the Merger is consummated, each outstanding share of Hallmark's Common Stock will be converted into the right to receive .97 shares of the Common Stock of Community Health Systems, Inc., and each outstanding share of Hallmark's 25% Participating Cumulative Convertible Redeemable Preferred Stock will be converted into the right to receive 5.4 shares of the Common Stock of Community Health Systems, Inc. If the stockholders of Hallmark and the stockholders of Community Health Systems, Inc. approve the Merger and the other conditions to consummation of the Merger are satisfied, Hallmark anticipates that the Merger will become effective on October 5, 1994 or shortly thereafter. GENERAL Hallmark is a hospital management company engaged in the business of providing a broad range of healthcare services primarily to patients in non-urban communities. As of June 30, 1994, Hallmark operated 17 hospitals, with an aggregate capacity of 1,405 licensed beds, 200 of which were used to provide psychiatric services. Hallmark's hospitals are located in non-urban communities in eight states, primarily in the southern United States. Hallmark believes that it is the sole provider of general acute-care hospital services in ten of the 16 communities it serves, because its nearest competitor is at least fifteen miles away or, in one case, there is no competing hospital located in the area Hallmark considers to be its primary market. Of Hallmark's 17 hospitals, 15 are owned and two are leased. Hallmark also manages one acute-care hospital, operates one nursing home facility, owns another nursing home, and, through a majority-owned subsidiary manages pain treatment centers in hospitals owned by other companies. INDUSTRY OVERVIEW The Healthcare Financing Administration ("HCFA") of the United States Department of Health and Human Services estimates that healthcare expenditures in the United States increased to 14% of the gross domestic product in 1992, compared to 13.2% in 1991. Total healthcare expenditures during 1992 are estimated by HCFA at $839 billion. Hospitals, the largest sector in the industry, accounted in 1992 for an estimated $323 billion, or 38.5% of all healthcare expenditures. Although government programs, private insurance companies, managed-care companies and self-insured employers have implemented and will continue to implement various cost-containment measures, healthcare expenditures are expected to continue to increase at a rate in excess of the rate of increase in gross domestic product because of such factors as the aging of the population, increased utilization as health coverage is expanded to include previously uninsured populations, costs of technological advances and general inflation. Cost-containment measures have, in recent years, together with technological advances, resulted in a significant shift from delivery of services on an inpatient basis to outpatient care. Inpatient admissions have declined; and, due to cost-containment pressures and technological advances, lengths of stay have declined even though the typical inpatient is more ill and, accordingly, uses more services than in the past. Most cost-containment measures implemented in recent years by major third-party payors for hospital services include changes in payment methods, increased utilization review and pre-admission 1 certification requirements. The most significant of these is the change in payment methods. The Medicare program has initiated a reimbursement system for hospital operating costs whereby a hospital receives a fixed payment for an inpatient stay based on the patient's diagnosis, without regard to the actual cost of delivery of care to that patient. Certain private insurance companies, managed-care companies and self-insured employers and state Medicaid programs have implemented payment method changes that generally have the same effect as the Medicare diagnosis related groups ("DRG") system. Accordingly, hospitals increasingly bear the risk of not being fully reimbursed for their actual costs; and, in order to maintain profitability, hospitals need to deliver inpatient care efficiently and to control their costs of providing services. On October 27, 1993, President Clinton submitted to Congress proposed comprehensive healthcare reform legislation. Several other comprehensive reform proposals have been and are expected to be introduced in the Congress, and comprehensive alternatives to the Presidents' proposal have recently been introduced by majority leaders in the house and senate. Healthcare reform legislation is also pending in some state legislatures. See "-- Reimbursement and Regulatory Matters." Hallmark cannot predict the effect such reforms may have on its business or its future operations. BUSINESS STRATEGY Hallmark's business strategy is to be the sole or dominant provider of healthcare services in the communities in which its hospitals are located. Hallmark believes this business strategy provides the opportunity to establish and maintain profitable operations in a rapidly changing industry for four reasons. First, its non-urban acute care hospitals face less direct competition from other hospitals than do urban hospitals and generally are the focal point for the delivery of primary and specialty healthcare services in their communities. Furthermore, Hallmark's hospitals generally face less direct competition from specialty healthcare providers, such as outpatient surgery centers, diagnostic centers and rehabilitation, mental health and substance abuse inpatient and outpatient programs. Second, Hallmark's hospitals generally provide primary care services and specialty care services in conjunction with family-practice, internal-medicine and general practice physicians and general surgeons. Hallmark believes the role of physicians and hospitals as complementary providers of primary care services is being and will continue to be enhanced as government, private third-party payors and employers utilize primary care physicians as gatekeepers for specialized healthcare. Third, Hallmark's hospitals, working together with primary care and specialty physicians in the community, may reduce out-migration of community residents seeking primary inpatient and outpatient hospital services and thereby improve hospital operating performance. Fourth, Hallmark's position as the sole or dominant provider of community healthcare services also lowers the competitive pressure to provide expensive but under-utilized specialty services, allowing Hallmark to operate on a cost-effective basis. Hallmark has implemented its business strategy by (i) introducing new specialty services; (ii) emphasizing improved and expanded outpatient services; (iii) recruiting physicians to its communities, which generally have experienced physician shortages; and (iv) assisting physicians in practice management so they can devote more of their efforts to patient care. Each of Hallmark's hospitals formulates individual business objectives designed to meet the healthcare needs of the community it serves and to improve the hospital's operating performance. In recent years Hallmark's ability to incur capital expenditures to enhance inpatient and outpatient services has been limited, due to restrictions in Hallmark's credit agreements and limited access to new capital. New inpatient services that have been established at Hallmark's hospitals, based on local needs, include inpatient psychiatric treatment and substance abuse treatment programs, skilled nursing units, specialized psychiatric treatment programs for geriatric patients, home health services, laparoscopic surgical procedures, and "swing bed" programs, which permit the use of hospital beds as nursing home beds under certain conditions. For example, since July 1, 1991, Hallmark has converted 95 of its licensed beds to geriatric psychiatric services and 23 of its licensed beds to skilled nursing beds. Furthermore in fiscal 1993, one of Hallmark's hospitals qualified as a Medicaid disproportionate share hospital and received significant revenue from the program. Net inpatient revenues on a same- 2 hospital basis increased $14,769,000 and $10,404,000 in 1993 and 1994, respectively, substantially as a result of the addition of such services and payments received under the Medicaid disproportionate share program. Hallmark has increased its outpatient revenues in recent years with the introduction of procedures that are the result of technological advances in the industry, including mobile magnetic resonance imaging equipment, advanced diagnostic imaging, vascular imaging and improvements in ultrasound and mammography. These procedures are designed to enable Hallmark to reduce the out- migration of community residents to tertiary hospitals and, together with other factors, have increased net outpatient revenues on a same-hospital basis approximately $7.2 million and $4.7 million in 1992 and 1993, respectively. Net outpatient revenues in fiscal 1994 was substantially unchanged from fiscal 1993. In fiscal 1994, Hallmark recruited 59 new physicians, including 46 specialty physicians, to 14 of its hospitals. To recruit and retain qualified physicians, Hallmark generally assists recruited physicians in establishing and managing their private practices and provides office space proximate to most of its hospitals to medical staff physicians. At most of its hospitals, Hallmark is developing affiliations with physicians that involve offering combined physician and hospital services to third-party payors and self-insured employers. Hallmark also seeks to maintain a sound relationship with its physicians through its Physician Leadership Council, established in April 1992. The Physician Leadership Council members meet on a periodic basis to discuss common issues with Hallmark's operations management. In addition to recruiting and establishing affiliations with local physicians, some of Hallmark's hospitals seek to improve care and to reduce the extent of patient out-migration by establishing relationships with physicians affiliated with tertiary care hospitals in nearby areas. These relationships enable Hallmark's hospitals and local physicians to provide coordinated care to community residents before and after their treatment at a tertiary care hospital. PATIENT SERVICES Each of Hallmark's hospitals is operated by a wholly-owned subsidiary of Hallmark and provides the inpatient and outpatient medical and surgical services typically available in non-urban hospitals of small to medium size. Such services, which vary by hospital, generally include operating and recovery rooms, intensive care, diagnostic radiology facilities, pharmacies, laboratories, outpatient facilities and emergency departments. Hallmark devotes a total of 200 beds in ten of its hospitals to psychiatric care and provides, in connection with its psychiatric services, inpatient and outpatient treatment programs which include individual therapy, group therapy and occupational and other adjunctive therapies to psychiatric and substance abuse patients. At six of such hospitals, 95 of the psychiatric beds are used to provide psychiatric services to geriatric mental health patients. Hallmark believes that many of its geriatric mental health patients would not otherwise receive mental healthcare and that, after treatment, these patients generally have an improved quality of life. Five of Hallmark's hospitals provide home health services, including, at particular locations, physical therapy, respiratory therapy, medications and other services to patients in their homes. One of Hallmark's hospitals operates a 108-bed nursing home that adjoins the hospital. Six of Hallmark's hospitals have portions of their licensed bed complements designated as "swing beds," which permits the use of these beds as skilled nursing home beds when needed. 3 The following table sets forth certain operating data and net revenues of Hallmark on a same hospital basis, for all hospitals operated at June 30, 1994:
YEARS ENDED JUNE 30, ------------------------------- 1992 1993 1994 --------- --------- --------- Operating Data: Hospitals at year-end (1)..................................... 16 17 17 Licensed beds at year-end..................................... 1,428 1,405 1,405 Average beds in service....................................... 1,229 1,217 1,205 Admissions.................................................... 26,920 27,486 28,911 Patient days.................................................. 141,690 156,616 164,643 Equivalent patient days (2)................................... 204,188 225,356 235,698 Average length of stay (days)................................. 5.3 5.7 5.7 Occupancy rate (3)............................................ 31.6% 35.3% 37.4% Net patient service revenues: Inpatient Services............................................ 66.6% 67.1% 68.6% Outpatient Services........................................... 29.4% 28.6% 26.7% Other Services................................................ 4.0% 4.3% 4.7% --------- --------- --------- Total Services.............................................. 100.0% 100.0% 100.0% --------- --------- --------- --------- --------- --------- - - ------------------------ (1) The number of hospitals increased because of the separate licensing as two hospitals of a facility formerly operated as one hospital. (2) Represents inpatient days adjusted to reflect outpatient utilization. (3) Based on average beds in service. Occupancy based on licensed beds was 27.2%, 30.5% and 32.1% for 1992, 1993 and 1994, respectively.
Occupancy rates at hospital facilities are affected by many factors including, among others, the hospital's relationship with its medical staff, the service area, population size and general economic conditions within the hospital's service area, the level of medical and surgical services offered, outpatient use of hospital services, marketing efforts, treatment availability at competing facilities and types of payor plans available in the area. Generally, Hallmark's hospitals experience a seasonal increase in occupancy during the quarters ending March 31. Declining hospital admissions generally have been an industry-wide trend since the Federal Medicare program began basing hospital operating cost reimbursement on DRGs. This industry-wide trend has had a significant effect on Hallmark's admissions, patient days and occupancy rates. Hallmark believes the average occupancy rates for its hospital facilities in the three-year period were also adversely affected by payor pressures which encourage treatment other than inpatient treatment and the residual effects of the operational and financial difficulties experienced by Hallmark. See "-- History of Hallmark." Such industry-wide trends and payor pressures were offset to some extent in fiscal 1993 and 1994 by the addition of new inpatient programs, principally geriatric psychiatric Medicare programs and by the receipt of disproportionate-share Medicaid revenue. The addition of geriatric psychiatric programs and the increased number of patients under the Medicaid program also had the effect of increasing the average length of stay for fiscal 1993 and fiscal 1994. Although outpatient volume has increased over the period covered, outpatient services as a percentage of net patient service revenues declined in fiscal 1993 and 1994 because inpatient revenue increased more rapidly, primarily as a result of geriatric psychiatric Medicare programs and receipt of disproportionate-share Medicaid revenue. SOURCES OF REVENUE Hallmark receives payment for services rendered to patients from (i) the federal government under the Medicare program; (ii) each of the states in which its facilities are located under the Medicaid or similar programs; and (iii) private insurers, other contractual arrangements and self-pay 4 patients. The following table sets forth, on a same-hospital basis, the approximate percentage of net patient service revenues derived by Hallmark's hospitals from various payment sources for the last three fiscal years:
YEARS ENDED JUNE 30, ------------------------ 1992 1993 1994 ------ ------ ------ Medicare................................................... 44.6% 47.3% 48.7% Medicaid................................................... 10.9% 14.3% 13.7% Private and other (primarily commercial insurance)......... 44.5% 38.4% 37.6% ------ ------ ------ Total.................................................... 100.0% 100.0% 100.0% ------ ------ ------ ------ ------ ------
Increases in the percentage of net patient service revenues from Medicare and Medicaid generally result in increased contractual adjustments and a reduction in net patient service revenues per admission. As a result, Hallmark has designated case managers to maintain efficient utilization of hospital resources, to maintain the delivery of appropriate patient care, to improve the accuracy of diagnosis coding, to review the progression of treatment and to coordinate the education of physicians in coding and billing. In addition, Hallmark seeks to control its operating costs by flexible staffing based on the volume and acuity of patients, making available to its hospitals the option of participating in a large purchasing group, establishing wellness programs for its employees, and continuous evaluation of the cost/benefits of contract services. Hallmark believes the decline in the percentage of revenues from private sources for the three-year period is due to (i) the aging population, which is bringing more patients under the Medicare program, (ii) Hallmark's implementation of geriatric psychiatric Medicare programs, (iii) the receipt of disproportionate share Medicaid revenue, (iv) the industry-wide trend toward the increased use of less expensive outpatient treatment for many services which, in general, are more likely to be used by non-Medicare patients, and (v) increased competition for private patients. See "-- Reimbursement and Regulatory Matters." MANAGED CARE AND MARKETING In the markets in which Hallmark's hospitals are located, "managed care" most often involves negotiated discounts and utilization review procedures between a hospital and self-insured or partially self-insured employers and insurance companies and Medicare and Medicaid cost-containment and utilization review measures. Health maintenance organizations, preferred provider organizations and similar managed care programs, which often establish capitated payment arrangements, have not to date been significant factors in Hallmark's markets. Hallmark believes its hospitals can compete effectively for the type of managed care business that exists in Hallmark's markets by being cost-efficient providers of quality primary care services. As part of Hallmark's efforts to obtain additional managed care revenues, Hallmark intends to make certain capital expenditures to enhance its ability to offer the mix of services desired by these payors. Each hospital has a marketing program based on local needs and opportunities. The programs are designed to establish and enhance relationships with medical staff physicians, with employers and other third-party payors, and with physicians associated with tertiary care hospitals in nearby areas that are utilized by local residents. Physician relationships include recruiting, leasing of medical office building space, practice management and, more recently, affiliating with physicians in offering hospital and physician services to employers and other third-party payors. Relationships with specialty physicians affiliated with tertiary hospitals provide for coordinated care of local residents who are treated both in the community and at a tertiary hospital and are designed to reduce the extent of out-migration of patients from Hallmark's service area. COMPETITION In ten of the communities in which Hallmark's hospitals are located, comprising 58.7% of its available beds, the nearest competitor hospital is at least fifteen miles away or, in one case, there is no 5 competitor hospital in the area Hallmark considers to be its primary market. In such communities, as well as in communities with direct competition, however, Hallmark's facilities face competition from larger regional hospitals or medical centers in the same geographic area to which patients may be referred for treatment of conditions requiring specialized treatment or care or which patients or physicians may prefer for elective admissions. As a response to these competitive pressures, certain of Hallmark's hospitals have agreements with physicians at larger regional hospitals to provide services on a periodic basis to patients in the local community. Seven of Hallmark's hospitals, which represent 41.3% of its available beds, face direct competition from one or more general hospitals in the same community. The competing facilities are operated by major hospital management companies, by government entities supported by tax revenues, or by nonprofit corporations which may be supported by endowments and charitable contributions. Forms of support such as tax revenues, endowments and charitable contributions are generally not available to Hallmark's hospitals. Some of Hallmark's hospitals also face direct competition from specialized facilities (for example, substance abuse, psychiatric or freestanding surgery facilities) or facilities exclusively devoted to specialized populations (for example, military hospitals) in the same or a nearby community. All of Hallmark's hospitals may face competition in the future from newly constructed facilities, particularly in those states not having certificate of need laws as well as from alternative methods of delivering healthcare services. Hallmark's management believes that Hallmark's ability to compete successfully with other hospital facilities is influenced principally by the number and quality of physicians on the hospitals' medical staffs and the hospitals' ability to participate in reimbursement, insurance and managed-care programs. Staff physicians initiate virtually all admissions and many outpatient referrals to acute-care facilities. Although a physician may at any time terminate his or her affiliation with a hospital, Hallmark seeks to attract and retain qualified doctors of varied specializations on its hospital staffs. Hospitals also compete through rate structures and services. Hallmark seeks to encourage its hospital managing directors and facility staffs to evaluate periodically rates and services and to structure charges and services in its facilities to be competitive with those of other local or regional facilities. Hallmark's ability to add services is limited by certificate of need laws, its financial condition and its physicians and employees. EMPLOYEES AND MEDICAL STAFFS As of June 30, 1994, Hallmark had approximately 2,100 full-time and 200 part-time employees, including 32 corporate staff employees whose primary purpose is to assist the administrative staffs of the individual facilities. Approximately 44.8% of these employees were nursing personnel (registered or licensed vocational nurses). Hallmark's employees are not represented by any labor union. Hallmark believes its relations with its employees are generally satisfactory. As of June 30, 1994, approximately 680 physicians were members of the medical staffs of Hallmark's hospitals, of whom fewer than ten were employees of Hallmark. Competition in the recruitment of personnel in the healthcare industry is substantial. Many hospital markets are facing shortages of nursing and professional medical personnel and it is expected that such shortages will continue. REIMBURSEMENT AND REGULATORY MATTERS REIMBURSEMENT. A significant portion of Hallmark's revenues is derived from patients covered by government and private contractual health programs. Payments under these programs are made based on cost, a negotiated rate, or at a predetermined rate based upon the patient's diagnosis, plus, in some programs, capital costs and other factors. Revenues from such government programs are recorded based on established billing rates less allowances and estimated adjustments for patients covered by such programs and are subject to audit and final settlement. 6 The principal sources of Hallmark's contractual payments are Medicare, Medicaid, Blue Cross and private insurance programs (including health maintenance organizations). Medicare is a federal program that provides certain hospital and medical insurance benefits to persons age 65 and over and to some disabled persons. Medicaid is a federal-state medical assistance program administered by the states and provides hospital assistance to certain individuals defined as "medically indigent." Blue Cross is a private healthcare program that provides hospital benefits to subscribers through numerous independent plans varying by state. All of Hallmark's hospitals are certified as providers of Medicare and Medicaid and participate to varying degrees in other reimbursement programs. Amounts received under Medicare, Medicaid, Blue Cross programs and various health maintenance organizations are generally less than the hospital's customary charges for the services covered. Patients are generally not responsible for any difference between customary hospital charges and amounts reimbursed under Medicare, Medicaid and Blue Cross programs or by health maintenance organizations for such services, but are responsible to the extent of any noncovered services, deductibles or co-insurance. Under the Prospective Payment System ("PPS"), Medicare payment for operating costs is made at a predetermined, specific rate for each hospital inpatient based on the patient's diagnosis under the DRG classification system. Currently, all of Hallmark's hospitals are reimbursed through the PPS system for general acute care services. Hallmark's inpatient psychiatric services are not reimbursed through the PPS system. The Medicare program reimburses Hallmark for psychiatric services on a reasonable cost basis, subject to the provisions of the Tax Equity and Fiscal Responsibility Act ("TEFRA"). Under TEFRA, reimbursement for reasonable costs is limited by a hospital's base year costs per discharge, as updated by the Medicare program. In fiscal 1992 to 1994, four of Hallmark's hospitals received supplemental Medicare reimbursement for operating costs due to geographic reclassification adjustments relating to the salaries and wages component of PPS payments. This adjustment is available to certain non-urban hospitals that are located close to urban areas and reflects the effect on such hospitals' salaries and wages expense of proximity to an urban area. In fiscal 1992 to 1994, one of Hallmark's hospitals received supplemental Medicare reimbursement for operating costs due to its qualification as a Medicare dependent hospital. This supplement is paid by Medicare to rural hospitals having less than 100 beds that provide a specific volume of services to Medicare patients. Hallmark cannot predict whether these types of supplemental Medicare reimbursement will be available to hospitals after fiscal 1994. In addition to the Medicare PPS payment described above, certain capital related costs (e.g., interest associated with capital expenditures, depreciation, property taxes and rental payments) were historically reimbursed on a reasonable cost basis subject to certain limitations. Federal legislation reduced reimbursement of such costs to 85% effective October 1, 1988, subject to certain adjustments. In 1991 HCFA issued final regulations that incorporated capital costs into PPS effective for Medicare cost reporting periods beginning on or after October 1, 1991. The incorporation of capital cost into PPS, which does not affect Hallmark's freestanding psychiatric hospital, includes a ten-year transition period. Hallmark has determined that the change in reimbursement method should not have a materially adverse effect on Hallmark's existing operations in the early years. If Hallmark replaces or rebuilds any hospital, such hospital would be subject to limitations in the PPS capital reimbursement methodology, which would result in reimbursement limitations on certain new capital invested in such new or replacement facility. In addition to hospital inpatient and ancillary service payments, the Medicare program provides reimbursement to hospitals for outpatient services. Previously, such services were reimbursed on the basis of 100% of reasonable cost. For cost reporting periods beginning October 1, 1987, Medicare payments for certain outpatient surgery services were reduced to the lower of (i) a percentage of hospital costs, (ii) a percentage of customary charges, or (iii) a prospective payment rate based upon the hospital's historical costs and the rates paid by Medicare for similar procedures performed in freestanding surgical centers. Further limits of Medicare payments for outpatient radiology services became effective October 1, 1988. Radiology and imaging services are paid at the lower of (i) reasonable costs, (ii) customary charges or (iii) a blend of costs and adjusted 7 physician charges. Hallmark's level of reimbursement for outpatient services has decreased as a result of these changes and Hallmark expects its percentage of reimbursed cost for such services to further decrease. The extent of such decrease will be dependent upon the volume of such outpatient services rendered to Medicare program patients. A number of states also utilize a prospective payment system or have established a program to negotiate payment levels at individual hospitals for their state Medicaid programs. Additionally, many states have become more aggressive in obtaining federal matching funds for their Medicaid programs, particularly for "disproportionate share" hospitals. A hospital qualifies as a "disproportionate share" hospital on the basis of the percentage of its patients who are Medicaid or other indigent patients and so qualifies if its percentage of such patients exceeds a percentage level fixed by the applicable state Medicaid program. Eleven of Hallmark's hospitals received "disproportionate-share" revenue in fiscal 1994. Several states have enacted, or plan to enact, a service tax based on a percentage of hospitals' net revenue. Historically, such taxes collected by the states have been subsequently remitted to hospitals through various reimbursement methodologies; however, there is no assurance any such state program will continue to remit such tax revenue to hospitals or that the amounts remitted will approximate the tax paid. In 1991, Congress adopted a law that limits the amounts that state Medicaid programs can pay to "disproportionate-share" hospitals in excess of amounts payable to other hospitals for services to Medicaid patients. Subject to certain exceptions, no more than 12% of total Medicaid spending can be used to provide "disproportionate-share" additional payments to hospitals. These limitations expire in 1996, if Congress adopts certain new maximum Medicaid payment rules by that time. Subject to certain exceptions, the 1991 law also limits a state's share of Medicaid funds that may come from provider taxes. In August 1993, HCFA published final regulations which loosened national and state limits on disproportionate share payments to hospitals by interpreting the statute as setting target percentage goals, rather than as establishing an absolute cap on disproportionate share expenditures. The effect of these regulations was to increase the percentage of the federal government's fiscal year ("FY") 1993 Medicaid expenditures for disproportionate share hospitals from 12% to 13.7%. In recent years, Congress has attempted to control the rising costs of the Medicare and Medicaid programs by a variety of means, including limitations and reductions of payments that otherwise would have been made to providers. In August 1993, Congress enacted the Omnibus Reconciliation Act of 1993 ("OBRA '93") which included reductions in updates to prospective payments to hospitals which would reduce total Medicare payments to hospitals by $21.1 billion from the federal government's FY 1994 through FY 1998 budgets. Reductions in update factors contained in OBRA '93 are: for FY 1995, market basket minus 2.5 percentage points (urban hospitals) and market basket minus one percentage point (rural hospitals); for FY 1995, market basket minus 2.5 percentage points (urban hospitals) and the amount necessary to equalize the rural and other urban standardized amounts (rural hospitals); for FY 1996, for all hospitals, market basket minus two percentage points; for 1997, for all hospitals, market basket minus 0.5 percentage points; for FY 1998, for all hospitals, the percentage increase in the hospital market basket. The hospital market basket is an annual estimate of the increase in price of goods and services purchased by hospitals. For FY 1994, the hospital market basket is 4.3%. Under OBRA '93, 13 of Hallmark's acute-care hospitals are classified as rural hospitals and three are classified as urban hospitals. In addition, OBRA '93 reduced the federal rate for hospital capital expenses by 7.4% for discharges occurring after FY 1993. Outpatient capital reimbursement was reduced by 10% from FY 1996 through 1998. OBRA '93 requires that, in order to qualify for Medicaid reimbursement as a disproportionate share hospital, a hospital must have a Medicaid inpatient utilization rate of at least one percent. For state fiscal years beginning in 1995, disproportionate share hospital payment adjustments to private 8 hospitals are limited to no more than the costs of providing inpatient and outpatient services to Medicaid and uninsured patients, less payments received from Medicaid (other than disproportionate share adjustments) and uninsured patients. OBRA '93 did not have a material adverse effect on Hallmark's fiscal 1994 revenue from the Medicare and Medicaid programs; and Hallmark does not believe that OBRA '93 will have a material adverse effect on its fiscal 1995 revenue from such programs. The OBRA '93 limitation on Medicaid disproportionate share reimbursement has not to date significantly affected Hallmark's hospitals; and the combined effect of the limited increase in Medicare prospective payments and the reduction in the reimbursement rate for capital expenses has resulted in a small increase in the level of Medicare reimbursement. The Medicare and Medicaid programs are subject to statutory and regulatory changes. Also, there are substantial areas subject to administrative rulings, interpretation, governmental funding restrictions and requirements for utilization and quality review. Such matters may significantly reduce payments made under either or both federal programs to Hallmark's hospitals. Because the requirements for certification under Medicare, Medicaid and similar reimbursement programs are subject to change, it may be necessary for Hallmark to make changes in its services, equipment, facilities and personnel to remain qualified for such programs. Although management intends to take all reasonable steps necessary to maintain Hallmark's ability to participate in available reimbursement programs, there can be no assurance that Hallmark will continue to be able to qualify for participation in such programs. Furthermore, annual cost reports required under these programs are subject to audit which may result in significant downward adjustments to the amounts originally estimated to be due Hallmark under these reimbursement programs. These audits often require several years to reach the final determination of amounts earned under the programs. Management believes that adequate provision has been made for retroactive adjustments that might result from such audits. In all states in which Hallmark has facilities, Blue Cross pays hospitals for covered services at their established hospital charges, at a percentage thereof at rates negotiated between Blue Cross and the hospital or at a combination thereof. Other private insurance carriers also reimburse their policyholders or make direct payments to hospitals for covered hospital services at established hospital charges or a percentage thereof. Private payors have increased and are increasing their cost containment measures through the implementation of various procedures including but not limited to pre-admission qualification and utilization review. The privately-insured patient is generally responsible to the hospital for any difference between the insurance proceeds and the total charges. In late 1993, President Clinton submitted to Congress proposed comprehensive healthcare reform legislation. Several other comprehensive reform proposals have been introduced in the Congress, and comprehensive alternatives to the President's proposal have recently been prepared and introduced by the majority leaders in the House and Senate after taking into account the terms of several bills which passed various congressional committees. Debate and a vote on these bills is scheduled for the late summer of 1994, and action on other reform proposals is possible if neither of the major proposals passes. Certain aspects of each proposal offered by the majority leaders, such as reductions in Medicare and Medicaid payments, if adopted, could adversely affect Hallmark's business. In fiscal 1993 and 1994, Hallmark obtained 61.6% and 62.4%, respectively, of its net patient service revenue from the Medicare and Medicaid programs. Other aspects of the proposals by the majority leaders, such as universal health insurance coverage, could have a positive impact on Hallmark's business by reducing the amount of uncompensated care provided by Hallmark's hospitals. No assurance can be given that any reform proposal will be adopted or implemented or that any reform proposal which is ultimately adopted will not have a material adverse effect on Hallmark's financial condition and results of operations. In addition to the federal reform initiatives, state legislatures also have undertaken healthcare reform initiatives independent of federal reform. The States of Maine, Florida, Tennessee, California 9 and Washington have adopted various types of reform legislation. It is not possible at this time to predict what, if any, reforms will be adopted by the states, or when such reforms will be adopted and implemented. No assurance can be given that any such reforms will not have a material adverse effect upon Hallmark's revenues and earnings or upon the demand for Hallmark's services. REGULATION. Hallmark's hospitals and the healthcare industry generally are subject to extensive federal, state and local governmental regulation relating to licensure, conduct of operations, construction of new facilities, expansion of existing facilities and the offering of new services. Failure to comply with applicable laws and regulations could result in, among other things, the imposition of fines, temporary suspension of admission of new patients to the facility or, in extreme circumstances, exclusion from participation in government healthcare reimbursement programs such as Medicare and Medicaid or the revocation of facility licenses. There can be no assurance that future regulatory changes will not have an adverse impact on Hallmark. The federal Anti-Kickback Law prohibits the knowing and willful payment, receipt or offer of remuneration by healthcare providers, such as Hallmark, with respect to any person, including a physician, to induce referrals of patients or in exchange for such referrals. In addition to or in lieu of criminal penalties, an individual or entity can be excluded from participation in the Medicare and Medicaid programs for violation of the Anti-Kickback Law. Hallmark recruits physicians to become members of the medical staffs of its hospitals and to establish private practices in the communities in which Hallmark's hospitals are located. A limited number of the physicians who admit patients to Hallmark's hospitals are employed by Hallmark. Hallmark has entered into various relationships and compensation arrangements in connection with physician recruitment which may be subject to the Anti-Kickback Law. Although Hallmark believes that these arrangements are lawful, no "safe harbor" provisions apply to physician recruitment arrangements not involving physician employment, and evolving interpretations of the Anti-Kickback Law or the adoption of new federal or state laws or regulations could make it necessary for Hallmark to restructure certain of its arrangements. The Office of Inspector General of the Department of Health and Human Services has proposed a "safe harbor" under the Anti-Kickback Law that, if adopted, would provide a "safe harbor" from violation of such law for many of Hallmark's recruiting arrangements with physicians. Hallmark's operations are also subject to a number of state laws regulating relationships and compensation arrangements among healthcare providers. Healthcare facilities must comply with federal, state and local laws related to, among others, the adequacy of medical care, equipment, personnel, operating policies and procedures, fire prevention, rate setting, building codes and environmental protection. Facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with the various standards necessary to maintain licensure and participation in the Medicare and Medicaid programs. Management believes that Hallmark's facilities are in substantial compliance with applicable federal, state, local and independent review body regulations and standards necessary for the operations of such facilities as conducted. In certain instances, governmental or other inspections may result in notification to a facility of certain deficiencies. Failure to correct such deficiencies can result in termination of a facility's Medicare and Medicaid program certification or its operating license. In such instances, Hallmark initiates steps to correct cited deficiencies and to comply with the requirements for maintaining such agreements and licenses. Most of Hallmark's hospitals are accredited by the Joint Commission on Accreditation of Healthcare Organizations. The Joint Commission is a private organization that establishes standards relating to the physical plant, administration, quality of care, and medical staffs of hospitals. Because regulations and standards are subject to interpretation and change, there can be no assurance that Hallmark's facilities will be able to maintain their licenses, certification or accreditation status. Future changes in such legal, regulatory and independent review body requirements could necessitate substantial capital expenditures in order to comply with such requirements and there is no assurance that, if called upon to do so, Hallmark would be able to fund such capital expenditures. 10 Federal law contains numerous provisions designed to insure that services rendered by hospitals to Medicare and Medicaid patients are medically necessary and are of quality which meets professionally recognized standards and to insure that claims for reimbursement under the Medicare and Medicaid programs are properly filed. Among other things, services provided at Hallmark's hospitals are subject to periodic review by Peer Review Organizations ("PRO's"). All hospitals which participate in the Medicare program are subject to review by PRO's. PRO activities include reviews of (i) selected elective admissions, (ii) admissions which occur within seven days of a discharge from a general hospital, (iii) certain transfers of patients from one hospital to another, (iv) validity of diagnostic related group classifications of patients, (v) admissions and services to determine medical necessity and (vi) admissions and services to determine whether quality of care meets professionally recognized standards. PRO's have the authority to recommend to the U.S. Department of Health and Human Services that a provider who is in substantial noncompliance with the medical necessity and quality of care standards of a PRO or who has grossly and flagrantly violated an obligation to render quality care be excluded from participation in the Medicare program or be required to reimburse the federal government for certain payments previously made to the provider under the Medicare program. A hospital is subject to civil monetary penalties if it makes claims for payment for services which were not rendered or were rendered by a person or entity not properly licensed under state law. Except for Louisiana and Texas, all of the states in which Hallmark's healthcare facilities are located have in effect certificate of need or equivalent laws which generally require that the appropriate state agency approve certain acquisitions and determine that a need for additional beds, new services and certain capital expenditures exists prior to additional beds and new services being added, or the proposed capital expenditure (above a specified level) being spent. State approvals often are issued for a specified period of time. Failure to obtain necessary state approval can result in the inability to complete an acquisition, addition or renovation, the imposition of civil or, in some cases, criminal sanctions and the revocation of the facility's license. From time to time, federal and state governments as well as insurers and others have conducted and may conduct inquiries or investigations into businesses in the healthcare industry. Hallmark cannot predict the occurrence or outcome of any such investigations or whether any such investigations would lead to sanctions under existing laws or regulations, changes in, or in the interpretation of, existing laws or regulations or legislation imposing additional regulations on healthcare providers. Hallmark believes that it conducts its business in compliance with applicable laws. LIABILITY INSURANCE Hallmark maintains hospital professional and commercial general liability insurance coverage for occurrences after June 30, 1992 with maximum coverage of $25,000,000, subject to a self-insured retention of $2,000,000 per occurrence and $6,000,000 annual aggregate for hospital professional liability and $1,000,000 per occurrence and $3,000,000 annual aggregate for commercial general liability. Hallmark maintained professional malpractice insurance for certain occurrences prior to February 1988 but is self-insured for all occurrences between February 1988 and June 1992. The liability Hallmark has recorded for losses incurred and claims made is based upon individual case estimates for losses reported, and upon estimates on the basis of past experience for incurred but not reported losses. These estimates are based on actuarial reports obtained annually by Hallmark. Although Hallmark believes that its insurance policies and reserves are adequate, there can be no assurance that its insurance and loss reserves will cover all potential claims that may be asserted against Hallmark. Hallmark is subject to claims and legal actions by patients and others in the ordinary course of business. In management's opinion, the ultimate resolution of such claims will not have a material effect on Hallmark's financial position or results of operations. HISTORY OF HALLMARK Hallmark was incorporated in 1981 under the laws of the State of Delaware. Hallmark began doing business under its present name in fiscal 1992. Prior to that time, it did business under the name National Healthcare, Inc. Hallmark experienced rapid growth from 1981 through late 1986. During this period, Hallmark acquired 32 hospitals having an aggregate of 2,495 licensed beds and 11 eight nursing homes having an aggregate of 515 licensed beds. The expansion was funded primarily with the proceeds of public debt (approximately $28,000,000) and equity offerings (approximately $42,000,000) and borrowings (approximately $120,000,000) from certain banks (the "Banks") totalling approximately $190,000,000. Hallmark experienced financial difficulties as a result of its rapid growth. In January 1987, Hallmark was named as a defendant in a purported class action lawsuit on behalf of certain purchasers of Hallmark's common stock and 14 1/2% Subordinated Debentures due 1997 (the "14 1/2% Debentures"). In November 1987, Hallmark defaulted in the payment of interest on the 14 1/2% Debentures and, in December 1987, defaulted in the payment of principal and interest on its bank credit facility. Hallmark commenced restructuring negotiations with the Banks and settlement negotiations with the plaintiffs in the purported class-action lawsuit in 1987. In December 1987, Hallmark entered into a settlement with the plaintiffs in the class-action lawsuit pursuant to which defendants other than Hallmark paid members of the settlement class approximately $9,925,000 in cash and Hallmark issued approximately 60,000 shares of 25% Participating Cumulative Convertible Redeemable Preferred Stock (the "Preferred Stock") to members of the settlement class. In January 1989, Hallmark and its bank lenders entered into a credit agreement, pursuant to which $112.4 million of principal outstanding under the previous credit facility, together with approximately $21.1 million of unpaid interest and fees, was converted into three series of notes totalling $133.5 million. Also in January 1989, Hallmark's Common Stock was declared ineligible for trading on the NASDAQ automated quotation system. In December 1989, Hallmark consummated a cash tender offer for a portion of the 14 1/2% Debentures. As a result of the tender offer and a private purchase, Hallmark purchased $10,441,000 principal amount of the 14 1/2% Debentures for approximately $902,000. Hallmark consummated an exchange offer for a portion of the remaining 14 1/2% Debentures in June 1990. In the exchange offer, Hallmark exchanged $9,795,000 principal amount of 14 1/2% Debentures for $9,795,000 aggregate principal amount of a new series of debentures, plus cash in the amount of approximately $294,000. During fiscal 1993, Hallmark retired or restructured the balance of the 14 1/2% Debentures. Since June 30, 1987, Hallmark has sold or otherwise disposed of 15 hospitals and six nursing homes. Hallmark applied the cash received from such dispositions to retire or refinance certain indebtedness, including the application of approximately $34.9 million to reduce indebtedness, including $26.1 million of prepayments pursuant to the credit agreement. In May 1991, the Banks agreed to exchange $18.6 million principal amount of indebtedness outstanding pursuant to such credit agreement for approximately 390,000 shares of Hallmark's Class B Common Stock. In May 1993, Hallmark Class A Common Stock was listed for trading on The Nasdaq Stock Market. By June 30, 1993, Hallmark had reduced the principal amount of such indebtedness to $64.2 million. During fiscal 1994, Hallmark completed its financial restructuring with the issuance of its 10 5/8% Senior Subordinated Notes due 2003 (the "Notes"). The net proceeds of the offering were used to repay in full the indebtedness outstanding under Hallmark's formerly outstanding bank credit agreement as well as all of Hallmark's subordinated indebtedness. Hallmark experienced certain operational difficulties during fiscal 1987 through fiscal 1989 as a result of its financial difficulties during such period. The operational difficulties included (i) focus of management attention on the restructuring; (ii) reduction of management and employee morale; and (iii) erosion of support for Hallmark's hospitals by members of their medical staffs. Hallmark believes that its competitors sought to use its financial difficulties as means of attracting physicians and other referral sources. Furthermore, Hallmark believes certain third-party payors were reluctant to enter into agreements with Hallmark's hospitals or otherwise refer patients to Hallmark's hospitals during this period. Hallmark believes that its process of financial restructuring is complete. OTHER Hallmark manages a 230-bed general acute-care hospital owned by an unrelated party under a management agreement that expires in February 1995. Hallmark is also the majority owner of Pain 12 Care, Inc. Pain Care, Inc. operates and develops centers for the treatment of pain. Pain Care, Inc. does not operate any treatment centers in hospitals operated by Hallmark. This business is not material to Hallmark's revenues or earnings. ITEM 2. PROPERTIES FACILITIES The following table sets forth the name, location, type, number of licensed beds and number of beds in service in the hospitals operated by Hallmark at June 30, 1994. The number of licensed beds represent the number of beds permitted in the facility under its state license. The number of beds in service in a hospital is generally less than the number of licensed beds for various reasons, including removal of beds from service due to low occupancy, to permit alternative use of such space, and to permit renovation.
BEDS IN SERVICE LICENSED -------------------------- HOSPITAL BEDS ACUTE PSYCHIATRIC TOTAL - - ------------------------------------------------------------ -------- ----- ----------- ----- Woodland Community Hospital (1) Cullman, Alabama 100 80 20 100 Parkway Medical Center Decatur, Alabama 120 94 -- 94 L.V. Stabler Memorial Hospital Greenville, Alabama 74 74 -- 74 Hartselle Medical Center Hartselle, Alabama 150 119 -- 119 Harris Hospital (1) Newport, Arkansas 132 79 17 96 Randolph County Medical Center (1)(2) Pocahontas, Arkansas 50 40 10 50 Doctors Memorial Hospital (2) Bonifay, Florida 34 34 -- 34 Berrien County Hospital (3) Nashville, Georgia 71 61 -- 61 Crossroads Community Hospital (1) Mt. Vernon, Illinois 55 55 -- 55 Byrd Regional Hospital (1) Leesville, Louisiana 70 43 22 65 NorthGate Hospital -- Many Campus Many, Louisiana 68 52 -- 52 NorthGate Hospital -- Pineville Campus (4) Pineville, Louisiana 33 14 19 33 RiverNorth Treatment Center (4) Pineville, Louisiana 66 -- 35 35 Cleveland Community Hospital (1) Cleveland, Tennessee 100 55 30 85 White County Community Hospital Sparta, Tennessee 60 50 10 60 Hill Regional Hospital Hillsboro, Texas 69 47 17 64 Scenic Mountain Medical Center Big Spring, Texas 153 108 20 128 -------- ----- --- ----- Total 1,405 1,005 200 1,205 -------- ----- --- ----- -------- ----- --- ----- - - ------------------------ (1) The number of licensed beds in these facilities includes swing beds which are hospital beds licensed to serve as nursing home beds under certain conditions. (2) These facilities are operated under long-term capitalized leases.
13 (3) Hallmark also operates a 108-bed nursing home that adjoins this hospital. The nursing home is leased under a long-term capitalized lease. (4) These hospitals are separately licensed hospitals located in the same building.
Hallmark owns 15 and leases 12 medical office and clinic buildings. These buildings are generally located adjacent to or proximate to a Hallmark hospital, have an aggregate of approximately 138,000 square feet, and house an aggregate of approximately 200 physicians and other healthcare professionals. Hallmark's corporate offices occupy approximately 15,000 square feet of office space at 300 Galleria Parkway, Suite 650, Atlanta, Georgia. The office space is leased by Hallmark for a term which expires in September, 1996. ITEM 3. LEGAL PROCEEDINGS None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended June 30, 1994. 14 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The following table incorporates high and low sales prices of the Company's Class A common stock after May 17, 1993 as reported by the NASDAQ Stock Market. Prior to May 17, 1993, the Hallmark's stock was not listed on the NASDAQ Stock Market. Accordingly, prices in the following table prior to May 17, 1993 represent high and low bids as reported to and compiled by the National Quotation Bureau by market makers in the Hallmark's Class A common stock. Such bids represent quotations between dealers and do not include retail mark-ups, mark-downs or commissions. Such bids do not necessarily reflect actual transactions and may not reflect transactions not reported to the National Quotation Bureau. All quotations have been adjusted to reflect a 1-for-5 reverse stock split effected in November, 1992.
1994 1993 ---------------- ------------------ FISCAL QUARTER HIGH LOW HIGH LOW - - ------------------- ------- ------- --------- ------- First Quarter $12 1/8 $ 8 1/8 $ 4 17/32 $ 1 1/4 Second Quarter $17 1/2 $ 9 5/8 $ 5 $ 2 1/2 Third Quarter $17 1/4 $11 1/4 $ 4 5/8 $ 2 3/4 Fourth Quarter $21 1/2 $ 9 1/2 $ 8 7/8 $ 3 1/2
There were approximately 800 holders of record in the Hallmark's Class A common stock as of August 26, 1994. The Company has never paid any cash dividends on its common stock and does not anticipate the payment of cash dividends in the foreseeable future. The terms of the Company's note indenture, bank credit agreement and Preferred Stock contain certain covenants which significantly limit and/or restrict Hallmark's ability to declare and pay dividends on its commom stock. 15 ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND STATISTICAL DATA FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA*
YEAR ENDED JUNE 30 ---------------------------------------------- 1990 1991 1992 1993 ---------- ---------- ---------- ---------- (IN THOUSANDS EXCEPT SHARE AND PER SHARE AND STATISTICAL AMOUNTS) Statement of operations: Net patient service revenues............................................ $ 154,966 $ 156,025 $ 164,605 $ 172,521 Other revenues.......................................................... 4,172 5,243 5,400 6,716 ---------- ---------- ---------- ---------- Total revenues...................................................... 159,138 161,268 170,005 179,237 Expenses: Salaries and benefits................................................. 67,234 67,718 72,957 75,641 Supplies and other operating expenses................................. 59,653 61,469 65,380 72,901 Interest (1).......................................................... 15,050 8,565 5,334 3,871 Provision for bad debt................................................ 9,679 11,125 11,775 10,796 Depreciation and amortization......................................... 8,308 8,937 9,426 9,027 Provision (credit) for losses on disposal of certain facilities and restructuring transactions........................................... (4,086) -- (2,133) -- ---------- ---------- ---------- ---------- Income from operations.................................................. 3,300 3,454 7,266 7,001 Gain on sale of hospital facility....................................... -- -- -- 752 ---------- ---------- ---------- ---------- Income before income taxes, extraordinary items and cumulative effect of accounting change...................................................... 3,300 3,454 7,266 7,753 Provision for income taxes.............................................. 346 1,966 3,261 3,303 ---------- ---------- ---------- ---------- Income before extraordinary items and cumulative effect of accounting change................................................................. 2,954 1,488 4,005 4,450 Extraordinary items: Gain on restructure of debt, net of income tax effect................. 3,140 7,294 82 2,017 Credit from utilization of net operating loss carryforwards........... 1,778 5,166 2,682 3,914 ---------- ---------- ---------- ---------- Net income before cumulative effect of accounting change................ 7,872 13,948 6,769 10,381 Cumulative effect of accounting change.................................. -- -- -- -- ---------- ---------- ---------- ---------- Net income.............................................................. 7,872 13,948 6,769 10,381 Accretion of preferred stock redemption requirement..................... 74 223 244 329 ---------- ---------- ---------- ---------- Net income applicable to common stock................................... $ 7,798 $ 13,725 $ 6,525 $ 10,052 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Net income per share: Net income before extraordinary items and cumulative effect of accounting change.................................................... $ .92 $ .44 $ 1.19 $ 1.29 Gain on restructure of debt, net of income tax effect................. .97 2.15 .03 .59 Extraordinary items: Credit from utilization of net operating loss carryforwards........... .55 1.53 .80 1.13 Cumulative effect of accounting change................................ -- -- -- -- ---------- ---------- ---------- ---------- Net income.............................................................. $ 2.44 $ 4.12 $ 2.02 $ 3.01 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Common and Common Equivalent Shares outstanding......................... 3,231,752 3,386,583 3,358,491 3,449,752 Other financial data: EBITDA (2)............................................................ $ 22,572 $ 20,956 $ 19,893 $ 20,651 Capital expenditures.................................................. 7,663 9,075 7,230 6,375 Balance sheet data: Cash and cash equivalents............................................. $ 6,866 $ 7,851 $ 7,749 $ 4,899 Working capital (deficit)............................................. (2,472) 5,248 468 1,383 Property and equipment, net........................................... 117,262 117,648 115,720 108,235 Total assets.......................................................... 173,487 176,950 169,865 159,877 Total debt (3)........................................................ 130,213 104,168 97,731 80,487 Common stockholders' equity (deficit)................................. (26,647) (11,839) (5,200) 4,953 Selected hospital statistics: Number of owned and leased hospitals (end of year).................... 19 18 18 17 Licensed beds (end of year)........................................... 1,570 1,527 1,527 1,405 Average beds in service............................................... 1,567 1,332 1,324 1,232 Admissions (4)........................................................ 40,964 32,976 29,403 27,502 Occupancy rate (4).................................................... 38.3% 36.4% 31.8% 34.8% Patient days (4)...................................................... 219,295 176,906 153,705 156,689 Equivalent patient days (5)........................................... 282,938 238,847 221,334 225,512 *The consolidated financial statements in Item 8 and Management's Discussion and Analysis in Item 7 should be read in conjunction with these tables. 1994 ---------- Statement of operations: Net patient service revenues............................................ $ 182,788 Other revenues.......................................................... 8,756 ---------- Total revenues...................................................... 191,544 Expenses: Salaries and benefits................................................. 83,467 Supplies and other operating expenses................................. 71,706 Interest (1).......................................................... 7,502 Provision for bad debt................................................ 12,713 Depreciation and amortization......................................... 9,428 Provision (credit) for losses on disposal of certain facilities and restructuring transactions........................................... -- ---------- Income from operations.................................................. 6,728 Gain on sale of hospital facility....................................... -- ---------- Income before income taxes, extraordinary items and cumulative effect of accounting change...................................................... 6,728 Provision for income taxes.............................................. 2,826 ---------- Income before extraordinary items and cumulative effect of accounting change................................................................. 3,902 Extraordinary items: Gain on restructure of debt, net of income tax effect................. 19,784 Credit from utilization of net operating loss carryforwards........... -- ---------- Net income before cumulative effect of accounting change................ 23,686 Cumulative effect of accounting change.................................. 805 ---------- Net income.............................................................. 24,491 Accretion of preferred stock redemption requirement..................... 413 ---------- Net income applicable to common stock................................... $ 24,078 ---------- ---------- Net income per share: Net income before extraordinary items and cumulative effect of accounting change.................................................... $ 1.06 Gain on restructure of debt, net of income tax effect................. 5.37 Extraordinary items: Credit from utilization of net operating loss carryforwards........... -- Cumulative effect of accounting change................................ .22 ---------- Net income.............................................................. $ 6.65 ---------- ---------- Common and Common Equivalent Shares outstanding......................... 3,681,410 Other financial data: EBITDA (2)............................................................ $ 23,658 Capital expenditures.................................................. 4,709 Balance sheet data: Cash and cash equivalents............................................. $ 19,757 Working capital (deficit)............................................. 29,541 Property and equipment, net........................................... 104,020 Total assets.......................................................... 173,020 Total debt (3)........................................................ 87,821 Common stockholders' equity (deficit)................................. 31,586 Selected hospital statistics: Number of owned and leased hospitals (end of year).................... 17 Licensed beds (end of year)........................................... 1,405 Average beds in service............................................... 1,205 Admissions (4)........................................................ 28,911 Occupancy rate (4).................................................... 37.4% Patient days (4)...................................................... 164,643 Equivalent patient days (5)........................................... 235,698 *The consolidated financial statements in Item 8 and Management's Discussi conjunction with these tables. - - ---------------------------------- (1) For the fiscal years ended June 30, 1990, 1991, 1992 and 1993, the long-term debt retirements in connection with the Company's financial restructuring were accounted for under SFAS No. 15. The unrecognized gain from such transactions was deferred and is classified on the Company's balance sheet as a deferred restructuring credit. Amortization of the deferred credit had the effect of reducing interest expense by $859,000, $4,162,000, $6,164,000, $6,034,000 and $2,072,000 for the fiscal years ended June 30, 1990, 1991, 1992, 1993 and 1994, respectively. See Note 4 of Notes to Consolidated Financial Statements. (2) Represents earnings before interest expense, income taxes, depreciation and amortization, provisions (credits) for restructuring transactions, gain on sale of healthcare facility and extraordinary items. The Company believes that EBITDA provides useful information regarding the Company's ability to service its debt; however, EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles, and should not be considered as a substitute for net income as an indicator of the Company's operational performance or to cash flow as a measure of liquidity. (3) Includes long-term debt and related accrued interest classified as current at June 30, 1990,1991 and 1992 of $14,906,000, $6,237,000 and $6,940,000, respectively. (4) Includes statistics for six hospital facilities disposed of or held for disposal in 1990, comprised of 516 beds, 36,694 patient days, 6,474 admissions and 45,807 equivalent patient days. (5) Represents inpatient days adjusted to reflect outpatient utilization.
16 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW As of June 30, 1992, Hallmark operated 18 hospitals with an aggregate capacity of 1,527 licensed beds. Hallmark also operated one nursing home and managed one acute-care hospital. During its fiscal year ended June 30, 1993, Hallmark sold two hospitals having an aggregate of 99 licensed beds. Hallmark recognized a gain of $752,000 from the sale of one of the facilities and no gain or loss on the other. For fiscal 1993, the facilities that were sold had total revenues of $974,000 and total expenses of $1,313,000 (excluding interest). For fiscal 1992, the facilities that were sold had total revenues of $12,646,000 and total expenses of $14,616,000 (excluding interest). As a result of such dispositions and the separate licensing as two hospitals of a facility formerly operated as one hospital, the number of hospitals operated by Hallmark at June 30, 1994 was 17. A substantial portion of Hallmark's revenue is derived from the federal Medicare program and state Medicaid programs. These programs have undergone changes in recent years designed to reduce healthcare costs, resulting in pressure on hospitals and other healthcare providers to reduce their costs and limit the provision of services. These changes have had, and future changes in such statutes and regulations may have, an adverse effect on Hallmark. For information concerning the effect of Medicare and Medicaid legislation adopted by Congress in August 1993 on reimbursement under these programs, see "Item 1. Business -- Reimbursement and Regulatory Matters -- Reimbursement." A number of Hallmark's hospitals qualify for "geographic reclassification" or have been qualified as "disproportionate share" or "small dependent" hospitals under the Medicare and/or Medicaid programs. See "Business -- Reimbursement and Regulatory Matters." These hospitals are reimbursed at a more favorable rate than similar hospitals not receiving such designations. On a periodic basis, federal and state regulatory authorities perform reviews of participating hospitals to ensure continued compliance with program requirements and, therefore, qualification for these designations. There can be no assurance that Hallmark will be able to retain these favorable designations in the future for all, or any, of these hospitals, that these programs will continue or that any programs intended to replace such programs will be as financially advantageous to Hallmark as the existing programs. The loss of such designations or programs could have a material adverse effect on Hallmark's operations. In late 1993, President Clinton submitted to Congress proposed comprehensive healthcare reform legislation. Several other comprehensive reform proposals have been introduced in the Congress, and comprehensive alternatives to the President's proposal have recently been prepared and introduced by the majority leaders in the House and Senate after taking into account the terms of several bills which passed various congressional committees. Debate and a vote on these bills is scheduled for late summer 1994, and action on other reform proposals is possible if neither of the major proposals passes. Certain aspects of each proposal offered by the majority leaders, such as reductions in Medicare and Medicaid payments, if adopted, could adversely affect Hallmark's business. In fiscal 1993 and 1994, Hallmark obtained 61.6% and 62.4%, respectively, of its net patient service revenue from the Medicare and Medicaid programs. Other aspects of the proposals by the majority leaders, such as universal health insurance coverage, could have a positive impact on Hallmark's business by reducing the amount of uncompensated care provided by Hallmark's hospitals. No assurance can be given that any reform proposal will be adopted or implemented or that any reform proposal which is ultimately adopted will not have a material adverse effect on Hallmark's financial condition and results of operations. In addition to the federal reform initiatives, state legislatures also have undertaken healthcare reform initiatives independent of federal reform. The States of Maine, Florida, Tennessee, California and Washington have adopted various types of reform legislation. It is not possible at this time to 17 predict what, if any, reforms will be adopted by the states, or when such reforms will be adopted and implemented. No assurance can be given that any such reforms will not have a material adverse effect upon Hallmark's revenues and earnings or upon the demand for Hallmark's services. Hallmark's hospitals have historically operated at low occupancy levels relative to hospitals in more urban environments. Accordingly, Hallmark has sought to manage its operating expenses in such a way as to be a low-cost provider. However, low occupancy levels can significantly impact Hallmark's profitability due to the relatively high fixed-cost component of Hallmark's overall cost structure. Hence, just as the implementation of revenue enhancing programs can significantly improve profitability, any event that decreases revenue can significantly erode Hallmark's financial performance. Despite operating at low occupancy levels, all but one of Hallmark's hospitals generated sufficient revenues to cover their expenses (before interest and allocation of corporate home office overhead) in fiscal 1994. Hallmark's hospital in Cleveland, Tennessee, which had an occupancy rate of 26.7% in fiscal 1994, did not generate sufficient revenues to cover its expenses (before interest and allocation of corporate home office overhead.) Hallmark believes that low occupancy levels are a significant factor contributing to the Cleveland facility's results of operations and that a return to profitability will require continued efforts to minimize operating costs as well as increase occupancy levels at the Cleveland facility. Over the past three years, Hallmark has sought to increase its revenues by qualifying for additional Medicaid reimbursement and by the addition of inpatient and outpatient programs. In fiscal 1992 and 1993, Hallmark added cardiac catheterization service at two hospitals, laparoscopic surgical procedures at seven hospitals, endoscopic carpal tunnel surgery at two hospitals and geriatric psychiatric programs at six of its hospitals. Hallmark also added advanced diagnostic imaging procedures to its outpatient services at one or more of its hospitals in fiscal 1992 and 1993. The benefits of such additional services may not be fully realized, if at all, until future periods. At June 30, 1991, Hallmark's long-term debt and capital lease obligations totalled approximately $104,168,000. At June 30, 1993, Hallmark's long-term debt and capital lease obligations totalled $80,487,000, a reduction of $23,681,000 over the course of two fiscal years. On November 15, 1993, Hallmark completed a registered offering of $80,000,000 principal amount of 10 5/8% Senior Subordinated Notes due 2003. The net proceeds from the offering were approximately $77,600,000, of which approximately $62,100,000 was used to repay Hallmark's then outstanding senior subordinated indebtedness and $10,700,000 to redeem all of Hallmark's outstanding senior subordinated indebtedness (such bank debt and senior subordinated indebtedness are referred to herein collectively as the "Refinanced Debt"). If the Merger is not consummated, the remaining net proceeds will be used for general corporate purposes and to fund certain capital expenditures. At June 30, 1994, Hallmark's long-term debt and capital lease obligations totalled $87,821,000. 18 RESULTS OF OPERATIONS The following table summarizes, for the periods indicated, changes in selected operating indicators. During the periods indicated, Hallmark sold several hospitals, which may have contributed to the percentage changes from period to period. The discussion that follows should be read in conjunction with Hallmark's Consolidated Financial Statements and the notes thereto.
YEAR ENDED JUNE 30, ------------------------------------------ PERCENTAGE INCREASE PERCENTAGE OF TOTAL (DECREASE) IN $ REVENUES FROM PRIOR YEAR ------------------------ --------------- 1992 1993 1994 1993 1994 ------ ------ ------ ------ ------ Total revenues.............................................. 100.0% 100.0% 100.0% 5.4% 6.8% Operating costs: Salaries and benefits..................................... 42.9 42.2 43.6 3.7 10.3 Supplies and other operating expenses..................... 38.5 40.7 37.4 11.5 (1.8) Provision for bad debts................................... 6.9 6.0 6.6 (8.3) 17.8 ------ ------ ------ Total operating costs................................. 88.3 88.9 87.6 6.1 5.3 ------ ------ ------ Operating margin.......................................... 11.7 11.1 12.4 -- 18.9 ------ ------ ------ Capital costs: Interest.................................................. 3.1 2.2 3.9 (27.4) 93.8 Depreciation and amortization............................. 5.6 5.0 5.0 (4.2) 4.5 ------ ------ ------ Total capital costs................................... 8.7 7.2 8.9 (12.6) 31.3 ------ ------ ------ Credit from restructuring transactions and sale of hospital................................................. 1.3 0.4 -- (64.7) (100.0) Income before income taxes and extraordinary items........ 4.3 4.3 3.5 6.7 (13.2) Provision for income taxes................................ 1.9 1.8 1.5 1.3 (14.4) ------ ------ ------ Income before extraordinary items......................... 2.4% 2.5% 2.0% 11.1% (12.3)% ------ ------ ------ ------ ------ ------
The following table sets forth certain operating data for Hallmark on a same-hospital basis, for the periods indicated:
YEAR ENDED JUNE 30, ------------------------------------- 1992(1) 1993(1) 1994(1) ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Hospitals at year end (2)........................................ 16 17 17 Licensed beds at year end........................................ 1,428 1,405 1,405 Average beds in service.......................................... 1,229 1,217 1,205 Net patient services revenues: Inpatient...................................................... $ 100,218 $ 114,987 $ 125,391 Outpatient..................................................... 44,308 48,968 48,858 Other.......................................................... 5,947 7,434 8,539 ----------- ----------- ----------- Total net patient services revenues........................ $ 150,473 $ 171,389 $ 182,788 ----------- ----------- ----------- ----------- ----------- ----------- EBITDA........................................................... $ 21,015 $ 19,992 $ 23,658 Patient days..................................................... 141,690 156,616 164,643 Occupancy rate (3)............................................... 31.6% 35.3% 37.4% Equivalent patient days (4)...................................... 204,188 225,356 235,698 - - ------------------------ (1) Same hospital results exclude operating data for two hospitals sold in 1993. (2) The number of hospitals increased because of the separate licensing as two hospitals of a facility formerly operated as one hospital. (3) Based on average beds in service. (4) Represents inpatient days adjusted to reflect outpatient utilization.
19 FISCAL 1994 COMPARED TO FISCAL 1993 Net patient service revenues, which are total patient service revenues less the provision for contractual and other allowances, increased from $172,521,000 for the year ended June 30, 1993, to $182,788,000 for the year ended June 30, 1994, an increase of $10,267,000, or 6.0%, primarily due to a 5.1% increase in admissions from 27,502 to 28,911 and a 5.1% increase in patient days from 156,689 to 164,643. The increased admissions resulted primarily from the addition of new or expanded services in 1993 including geriatric psychiatric and specialty Medicaid services. Net patient revenues for the years ended June 30, 1993 and 1994 included credits of approximately $2,079,000 and $2,308,000, respectively, from reductions in the provision for contractual allowances primarily as a result of favorable settlements of prior year cost reports with program intermediaries. Other revenues increased from $6,716,000 in fiscal 1993 to $8,756,000 in fiscal 1994, an increase of 30.4%, representing primarily increased revenues from one of Hallmark's majority-owned subsidiaries that operates pain centers in hospitals owned by others. Salaries and benefits increased $7,826,000, or 10.3%, in fiscal 1994 as compared to fiscal 1993. Approximately 60% of the increase is due to an increase in wage rates and benefits. Approximately 20% of the increase is due to the replacement of contract services with full-time and part-time employees. The remaining increase is due to volume increases at Hallmark's hospitals and at its subsidiary which operates pain treatment centers. Interest expense increased $3,631,000 in the year ended June 30, 1994, to $7,502,000. The increase was primarily due to Hallmark's refinancing of its bank debt and subordinated debt in November 1993. Prior to the refinancing, interest expense on Hallmark's debt was significantly reduced by amortization of deferred debt restructuring credits. As a result of the refinancing, the deferred debt restructuring credits were eliminated and from the date of the refinancing forward, interest expense was fully recognized at the effective interest rates of Hallmark's debt. Interest expense was reduced by amortization of deferred debt restructuring credits of $2,072,000 in the year ended June 30, 1994 and by $6,034,000 for the year ended June 30, 1993. Interest expense, excluding amortization of deferred debt restructuring credits, was $9,574,000 in the year ended June 30, 1994 compared with $9,905,000 in 1993. The following supplemental information represents pro forma results of operations assuming the refinancing that occurred in the second quarter of fiscal 1994 had occurred on July 1, 1992.
YEAR ENDED JUNE 30, ------------------------ 1993 1994 ----------- ----------- (IN THOUSANDS) Total revenues................................................................ $ 179,237 $ 191,544 ----------- ----------- Operating expenses............................................................ 159,338 167,886 Interest expense.............................................................. 10,295 9,986 Depreciation expense.......................................................... 9,027 9,428 ----------- ----------- Total expenses.............................................................. 178,660 187,300 ----------- ----------- Income from operations........................................................ $ 577 $ 4,244 ----------- ----------- ----------- ----------- Income before extraordinary items and cumulative effect of accounting change....................................................................... $ 724 $ 2,459 ----------- ----------- ----------- ----------- Weighted average common and common equivalent shares outstanding.............. 3,450 3,681 ----------- ----------- ----------- ----------- Earnings per share before extraordinary items and cumulative effect of accounting change............................................................ $ 0.21 $ 0.67 ----------- ----------- ----------- -----------
Provision for bad debts increased from $10,796,000 for the year ended June 30, 1993 to $12,713,000 for the year ended June 30, 1994, an increase of $1,917,000, or 17.8%. The increase in the provision for bad debts was primarily due to increased total revenues and increased reserves compared to prior years in self-pay accounts as a result of the volume and aging of self-pay accounts. 20 Management maintains collection practices that recognize the aging and source of payment of patient accounts. Management believes that increased volume, especially as it relates to self-pay accounts, and slower payment patterns generally lead to higher bad debt provisions. Other operating expenses decreased $2,247,000, or 4.5%, for the year ended June 30, 1994 to $47,684,000. The decrease was primarily the result of decreased use of contract services in Hallmark's hospitals partially offset by an increase in volume at Hallmark's hospitals. Other operating expenses for the years ended June 30, 1994 and 1993 were net of reductions of Hallmark's general and professional liability reserves of $1,323,000 and $1,266,000, respectively, based on updated estimates of Hallmark's expected general and professional liability losses. Hallmark reported net income of $24,491,000, or $6.65 per share, for fiscal 1994, compared to net income of $10,381,000, or $3.01 per share, in fiscal 1993. Net income for the year ended June 30, 1994 included a credit of $805,000, or $0.22 per share, related to the cumulative effect of adoption of Statement of Financial Accounting Standards ("SFAS") No. 109 "Accounting for Income Taxes" and an extraordinary gain on restructure of debt of $19,784,000, or $5.37 per share (net of income tax effect of $2,170,000). Net income for fiscal 1993 included extraordinary gains of approximately $2,017,000 (net of income tax effect of $1,344,000), or $0.59 per share, from the restructure or other retirement of $3,463,000 principal amount of the 14 1/2% Subordinated Debentures and $3,914,000, or $1.13 per share, resulting from the utilization of tax net operating loss ("NOL") carryforwards. FISCAL 1993 COMPARED TO FISCAL 1992 Net patient service revenues, which are total patient service revenues less the provision for contractual and other allowances, increased from $164,605,000 in fiscal 1992 to $172,521,000 in fiscal 1993, an increase of $7,916,000, or 4.8%. This increase was primarily due to the addition of new or expanded services, an increase in outpatient revenue and price and reimbursement increases at Hallmark's operating hospitals. The increase was offset in part by the sale of two facilities in fiscal 1993. Other revenues increased from $5,400,000 in fiscal 1992 to $6,716,000 in fiscal 1993, an increase of 24.4%, representing primarily increased revenues from one of Hallmark's majority-owned subsidiaries that operates pain centers in hospitals owned by others. Hallmark's total revenues were $179,237,000 for the year ended June 30, 1993 compared to $170,005,000 in fiscal 1992, or an increase of 5.4%. On a same-hospital basis, net patient service revenues increased $20,916,000, or 13.9% over fiscal 1992. This increase was due primarily to the addition of 95 geriatric psychiatric beds in fiscal 1992 and 1993, which accounted for approximately $11,500,000 of this increase, and a $4,700,000 increase in outpatient revenues. The increase also included $5,900,000 of disproportionate share payments, which represented 3.4% of fiscal 1993 net patient service revenues on a same-hospital basis. Salaries and benefits expense for fiscal 1993 increased $2,684,000, or 3.7%, over fiscal 1992, primarily as a result of increased volume and wage increases. Excluding the effect of the two facilities sold during the year, salaries and benefits increased $8,627,000, or 13.0%, over fiscal 1992, due primarily to the introduction of new services at certain of Hallmark's hospitals and general wage increases. However, salaries and benefits as a percentage of total revenues on a same-hospital basis declined slightly in 1993. Other operating expenses increased $7,383,000 during fiscal 1993, or 17.4% over fiscal 1992, offset in part by the sale of two facilities. Excluding the effect of the sold facilities, other operating expenses increased $12,189,000, or 32.7%. This increase was primarily due to higher utilization of outside contract services and increased fees paid to outside medical specialists. The higher utilization of outside contract services and fees paid to outside medical specialists was primarily the result of an increase in services offered at Hallmark's hospitals and efforts to attract physicians. Interest expense decreased $1,463,000 in fiscal 1993 from $5,334,000 in fiscal 1992. Such decrease was primarily due to a reduction of bank indebtedness during fiscal 1993 and Hallmark's restructuring or other retirement of the 14 1/2% Debentures. Interest expense was also reduced by amortization of deferred debt restructuring credits of $6,034,000 in fiscal 1993 and $6,164,000 in fiscal 1992. 21 Provision for bad debts as a percentage of total revenues decreased from 6.9% in fiscal 1992 to 6.0% for fiscal 1993 primarily as a result of decreased days revenue in accounts receivable and an increase in the percentage of net patient service revenues attributable to Medicare and Medicaid patients. Depreciation and amortization decreased by $401,000 for fiscal 1993 compared to fiscal 1992 primarily due to the sale of two facilities in fiscal 1993. Hallmark reported net income of $10,381,000, or $3.01 per share, for fiscal 1993, compared to net income of $6,769,000, or $2.02 per share, in fiscal 1992. Net income for fiscal 1993 included extraordinary gains of approximately $2,017,000 (net of income tax effect of $1,344,000), or $0.59 per share, from the restructure or other retirement of $3,463,000 principal amount of the 14 1/2% Debentures and $3,914,000, or $1.13 per share, resulting from the utilization of NOL carryforwards. Net income for fiscal 1992 included an extraordinary credit of $2,682,000, or $.80 per share, resulting from the utilization of the NOL carryforwards. Pretax net income before extraordinary items for fiscal 1993 was $7,753,000. Pretax net income before extraordinary items for fiscal 1992 was $7,266,000, including a credit of approximately $2,133,000 related to certain reimbursement items provided in fiscal 1989 in restructuring reserves. TAX MATTERS At June 30, 1994, Hallmark had NOL carryforwards of approximately $24,000,000, which expire in fiscal years 2002 through 2006. If the Merger is not consummated, such NOL carryforwards may be available to offset future taxable income of Hallmark, if any. The Merger will result in an "ownership change" with respect to Hallmark under Section 382 of the Code. As a result, after the Merger, income tax deductions for Hallmark's NOL carryforwards existing at the time of the Merger will be subject to an annual limitation equal to the pre-Merger value of the Hallmark Common Stock and Hallmark Preferred Stock multiplied by the "long-term tax-exempt rate" in effect for the month in which the ownership change occurs (6.01% for ownership changes occurring in June 1994), increased by certain "recognized built-in gains" that are recognized within five years after the Merger. During 1991, Hallmark issued 390,298 shares of Class B common stock in exchange for $18,620,000 of previously outstanding bank debt. Hallmark believes, based on consultation with outside tax and valuation advisors, that the exchange qualified under the stock-for-debt exception to the recognition of income from discharge of indebtedness which is available to insolvent corporations. There can be no assurance, however, that the Internal Revenue Service will not challenge Hallmark's position. If any such challenge by the Internal Revenue Service was sustained, Hallmark's current NOL carryforwards could be reduced by as much as $16,000,000. During the fiscal year 1994, Hallmark adopted SFAS No. 109. SFAS No. 109 requires a change in accounting for income taxes to an asset and liability approach under which deferred tax assets and liabilities are determined based on the difference between the financial accounting and tax accounting basis of assets and liabilities. Deferred tax assets or liabilities at the end of each period are determined using the currently enacted tax rate expected to apply to taxable income in the periods in which the deferred tax asset or liability is expected to be realized. Hallmark recorded a credit of $805,000 to reflect the cumulative effect of adopting such standard. LIQUIDITY AND CAPITAL RESOURCES OPERATIONAL ACTIVITIES. At present, Hallmark satisfies all of its working capital and capital expenditure requirements from cash provided by operations. Payments received by Hallmark from the Medicare and Medicaid programs are Hallmark's single largest source of cash from operations. During fiscal 1994, net revenue derived from the Medicare and Medicaid programs increased by approximately $8,198,000 or 7.9% from the amount derived in fiscal 1993, due primarily to the introduction of geriatric psychiatric services at certain of Hallmark's hospitals in prior years. During the year ended June 30, 1994, cash provided by operations increased $4,465,000, compared to the same period a year earlier, primarily due to increased operating income (excluding 22 interest and depreciation) and decreased interest paid during the period as a result of the semi-annual interest payment terms of the Senior Subordinated Notes, offset in part by a reduction of accounts payable. INVESTMENT ACTIVITIES. Hallmark expended approximately $4,586,000, during fiscal 1994 on capital expenditures. This represented a decrease of $1,789,000, or 28.1%, from fiscal 1993. Capital expenditures during fiscal 1994 consisted primarily of completion of an outpatient surgery center at one facility and equipment purchases at various facilities. Hallmark anticipates that internally generated cash flows and the remaining unused proceeds from the $80,000,000 senior subordinated note offering will be sufficient to fund capital expenditures and working capital requirements through fiscal 1995. FINANCING ACTIVITIES. In fiscal 1994, Hallmark completed the restructuring of the Refinanced Debt upon the issuance of the 10 5/8% Senior Subordinated Notes. Hallmark believes that it increased its operational and financial flexibility by refinancing the Refinanced Debt with the proceeds from the sale of the 10 5/8% Senior Subordinated Notes. Hallmark's debt service requirements during fiscal 1994 were reduced from $13,163,000 to $10,803,000. Furthermore, the covenants contained in the indenture pursuant to which the Senior Subordinated Notes were issued are less restrictive than those previously in effect pursuant to the Refinanced Debt. During the quarter ended March 31, 1994, Hallmark obtained a letter of credit with a commercial bank to secure Hallmark's obligation under one of its capital leases. The lease had previously been secured by a collateral account consisting of approximately $4,100,000 in cash and marketable securities. The collateral account had previously been classified as "Funds held by trustees" in the consolidated balance sheets. Upon obtaining this letter of credit by Hallmark, the collateral account was released as security for the lease and approximately $4,100,000 in cash and marketable securities became available for general corporate purposes. In addition to this letter of credit, Hallmark obtained three letters of credit totalling $2,883,000 in order to satisfy certain security requirements of Hallmark's workers' compensation insurance carrier. All letters of credit are secured by a security interest in Hallmark's self-insurance trust funds in favor of the issuing bank. During the quarter ended December 31, 1993, Hallmark entered into a credit agreement with a financial institution pursuant to which Hallmark may borrow up to $15,000,000 under a working capital facility and up to $10,000,000 under an acquisition facility. Certain conditions must be satisfied prior to Hallmark borrowing under the credit agreement, some of which had not been satisfied as of June 30, 1994. Hallmark anticipates that it will satisfy the remaining conditions to funding under its new credit agreement. INFLATION. The healthcare industry is labor intensive. Wages and other expenses are subject to rapid escalation, especially during periods of inflation and when shortages occur in the marketplace. In addition, suppliers attempt to pass along increases in their costs by charging Hallmark higher prices. In general, Hallmark's revenue increases through price increases or changes in reimbursement levels have not kept up with the cost increases. In light of cost containment measures imposed by government agencies, private insurance companies and managed-care plans, Hallmark is unable to predict its ability to offset or control future cost increases. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information with respect to this item is contained in the Company's consolidated financial statements and financial statement schedules indicated in the index on Page F-1 of this Annual Report on Form 10-K, and is incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 23 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth certain information regarding the directors and executive officers of the Company:
NAME AGE POSITION - - ------------------------------ ----- -------------------------------------------------- James T. McAfee, Jr. 55 Chairman of the Board and Chief Executive Officer Robert M. Thornton, Jr. 45 President, Chief Operating Officer, Chief Financial Officer and Director James E. Martin 62 Director Rolland A. Maxwell 75 Director J. Randolph Seckman 66 Director Kay W. Slayden 59 Director
James T. McAfee, Jr. was elected a Director in September 1987, has been Chief Executive Officer of the Company since September 1987, and has been Chairman of the Board since October 1987. From 1980 to September 1987, Mr. McAfee served as Executive Vice President, Hospital Operations, and as a Director of Charter Medical Corporation. Prior to 1980, Mr. McAfee served as Senior Vice President of Hospital Affiliates International. Robert M. Thornton, Jr. was elected Director in October 1987. Mr. Thornton has been President, Chief Operating Officer and Chief Financial Officer of the Company since November 1993. From January 1987 until November 1993, Mr. Thornton was Executive Vice President, Chief Financial Officer, Treasurer and Secretary of the Company and from November 1986 until January 1987, Mr. Thornton was Senior Vice President and Chief Financial Officer of the Company. From 1981 to November 1986, Mr. Thornton served as Controller and held various corporate finance and accounting positions with Charter Medical Corporation. Prior to 1981, Mr. Thornton was a manager with the accounting firm of Coopers & Lybrand. James E. Martin was elected a Director in October 1991. Dr. Martin was President of Auburn University from 1984 through 1992. Prior to becoming President of Auburn University, Dr. Martin served as President of the University of Arkansas from 1980 to 1984. Dr. Martin also served as a member of the Board of Directors of Charter Medical Corporation from 1981 to 1988. Dr. Martin is currently a consultant to universities and agribusinesses. Rolland A. Maxwell was elected a Director in March 1989. Mr. Maxwell is Chairman of the Board of Directors of John McDaniel Wholesale Supplies, Inc. located in Atlanta, Georgia. Mr. Maxwell previously served as President of Davison's Department Stores (now Macy's Southern division). Mr. Maxwell also previously served as a member of the Board of Directors of Scotty's Inc., a building materials supplier in Winter Haven, Florida from 1974 to 1989, of J.M. Tull Industries, a metal fabrication company in Atlanta, Georgia from 1966 to 1983, of Charter Medical Corporation from 1970 to 1983 and of The Citizens & Southern National Bank in Atlanta, Georgia from 1968 to 1975. J. Randolph Seckman was elected a Director in October 1991. Since 1974, Mr. Seckman has been President of Randy Seckman and Associates, Inc., a financial planning and advisory firm located in Atlanta, Georgia providing services to physicians and executives. Prior to founding Randy Seckman and Associates, Inc., Mr. Seckman served as Vice President of the investment department of Financial Services Corporation, a broker-dealer and registered investment advisor located in Atlanta, Georgia. Kay W. Slayden was elected a Director in March 1989. Mr. Slayden is Vice Chairman of Jackson & Coker, a physician recruiting company in Atlanta, Georgia. From 1986 to 1990, Mr. Slayden was President and Chief Operating Officer of Norrell Health Care and a member of the Board of Directors of Norrell Corporation. From 1982 to 1985, Mr. Slayden was President and Chief Executive Officer of PGA Tour Properties, Inc., and from 1978 to 1980 he was President, Chief Operating Officer and a member of the Board of Directors of Fuqua Industries. From 1980 to 1988, Mr. Slayden served as a member of the Board of Directors of Charter Medical Corporation. 24 The terms of all Directors will expire upon the effectiveness of the Merger. If the merger is not consummated, Director terms will expire as follows: Messrs. Maxwell and Thornton -- 1994, Messrs. McAfee and Slayden -- 1995, and Messrs. Martin and Seckman -- 1996. ITEM 11. EXECUTIVE COMPENSATION The following table sets forth information concerning the compensation paid to James T. McAfee, Jr., the Chief Executive Officer of the Company and Robert M. Thornton, Jr., the Company's only other executive officer: SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ANNUAL COMPENSATION -------------- ALL OTHER -------------------- LTIP COMPENSATION NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) PAYOUTS($)(1) ($)(2) - - -------------------------------------------------- --------- --------- --------- -------------- -------------- James T. McAfee, Jr............................... 1992 405,000 227,813 445,085 -- Chief Executive Officer and 1993 450,000 392,175 153,830 13,102 Chairman of the Board 1994 500,000 468,752 -- 13,406 Robert M. Thornton, Jr............................ 1992 216,000 81,000 245,564 -- President, Chief Operating 1993 237,000 137,697 84,872 1,300 Officer and Chief Financial Officer 1994 297,970 210,320 -- 1,643 - - ------------------------ (1) Represents payments under the Company's 1990 Milestone Bonus Plan, pursuant to which Messrs. McAfee and Thornton were eligible for a cash bonus upon the Company's achievement of certain elements of its financial restructuring. The conditions to payment of such bonuses were satisfied in fiscal 1991, and the bonuses were paid in fiscal 1992 and 1993. (2) Represents term-life insurance premiums paid by the Company.
OPTION GRANTS DURING FISCAL 1994 The following table shows all grants of stock options made to Messrs. McAfee and Thornton during the last fiscal year: OPTION GRANTS TABLE
INDIVIDUAL GRANTS ------------------------------------------- POTENTIAL REALIZABLE VALUE NUMBER OF AT ASSUMED ANNUAL RATES SECURITIES % OF TOTAL OF STOCK PRICE APPRECIATION UNDERLYING OPTIONS FOR OPTION TERM OPTIONS GRANTED TO EXERCISE OR ---------------------------------------- GRANTED EMPLOYEES IN BASE PRICE EXPIRATION NAME (#)(1) FISCAL YEAR ($/SHARE) DATE 5%($) 10%($) - - --------------------------------- ----------- --------------- ------------- ------------------ --------- --------- James T. McAfee, Jr.............. 22,606 17.5% 13.00 November 23, 2003 478,795 762,274 Robert M. Thornton, Jr........... 13,564 10.5% 13.00 November 23, 2003 287,286 457,378 - - ------------------------ (1) The options granted above vest and are exercisable at the rate of 25% of the shares covered by the option on each of the first four anniversary dates of the grant of the option (November 23, 1993).
25 OPTION EXERCISES DURING, AND VALUE OF OPTIONS AT THE END OF, FISCAL 1994 Neither Mr. McAfee nor Mr. Thornton exercised any stock options during fiscal 1994. The following table sets forth certain information regarding the number and value of the unexercised stock options held by Messrs. McAfee and Thornton at June 30, 1994:
VALUE OF UNEXERCISED NUMBER OF SHARES UNDERLYING IN-THE-MONEY OPTIONS UNEXERCISED OPTIONS AT JUNE 30, 1994(1) AT JUNE 30, 1994 ---------------------------- ---------------------------- VALUE OF VALUE OF NUMBER NUMBER EXERCISABLE NON-EXERCISABLE NAME EXERCISABLE NON-EXERCISABLE OPTIONS($) OPTIONS($) - - ----------------------------------------------------- ----------- --------------- ----------- --------------- James T. McAfee, Jr.................................. 84,296 22,606 1,542,617 135,636 Robert M. Thornton, Jr............................... 16,878 13,564 308,867 81,384 - - ------------------------ (1) The value for the in-the-money options was calculated based on the positive spread between the exercise price of such options and the last reported sale price of the Company's Class A Common Stock on June 30, 1994, which was $19.
LONG-TERM INCENTIVE PLAN AWARDS DURING FISCAL 1994 The following table shows all long-term incentive plan awards made to Messrs. McAfee and Thornton during the last fiscal year: LONG-TERM INCENTIVE PLANS -- AWARDS IN LAST FISCAL YEAR
ESTIMATED FUTURE PAYOUTS PERFORMANCE UNDER NON-STOCK NUMBER OF OR OTHER PRICED-BASED PLANS SHARES, PERIOD UNTIL (3)(4) UNITS OR MATURATION -------------------- OTHER RIGHTS OR PAYOUT THRESHOLD MAXIMUM NAME (#)(1) (2) ($) ($) - - -------------------------------------------------------------- ------------ ------------ --------- --------- James T. McAfee, Jr........................................... -- 3 Years 250,000 500,000 Robert M. Thornton, Jr........................................ -- 3 Years 116,490 232,980 - - ------------------------ (1) Participants are not awarded a number of units. Rather, awards are expressed as a percentage of base salary. (2) The performance period until payout of the award began to run on the date that the long-term incentive plan award was granted. In fiscal year 1994, the named executive officers received their award on July 1, 1993 subject to stockholder approval, which was obtained on November 23, 1993. (3) Awards under the plan are based upon two factors, including (i) the achievement of a target debt to total capitalization ratio and (ii) a target return on assets, both as approved by the Compensation Committee and as defined in the plan. (4) In the discretion of the Compensation Committee, payment of vested awards shall be in shares of the Company's Class A Common Stock, cash or a combination of cash and shares of Class A Common Stock, provided that, if any portion of a payment is in cash, cash shall constitute not less than 35% of such payment.
EMPLOYMENT CONTRACTS The Company entered into employment agreements with Messrs. James T. McAfee, Jr. and Robert M. Thornton, Jr., in 1989, which were subsequently amended in 1994 and expire on September 30, 1996 (the "Employment Agreements"). Pursuant to the terms of the Employment Agreements, the employment of Messrs. McAfee and Thornton are terminable by either party to the agreement, in the case of Mr. McAfee, upon six months' prior written notice and, in the case of Mr. Thornton, upon ninety days' prior written notice, provided that such notice is given in the 26 designated notice period. Unless notice is given, the terms of the Employment Agreements automatically extend at the end of their term for an additional term of one year. The Employment Agreements also provide that the Company may terminate the Employment Agreements for "just and substantial cause," as defined therein, but only after the Company provides the executive officer with written notice specifying the cause of such action and grants the executive officer the opportunity to appear before the Board of Directors. Under the terms of the Employment Agreements, Messrs. McAfee and Thornton are entitled to receive base salaries of not less than $500,000 and $320,000, respectively. The Employment Agreements also provide Messrs. McAfee and Thornton with health, accident and dental insurance for the executive officer and his dependents; long-term disability insurance; term life insurance in an amount equal to four times his base annual salary up to $1,500,000 in coverage for Mr. McAfee and three times base annual salary up to $1,000,000 in coverage for Mr. Thornton; an annual executive allowance fund of $20,000 and $15,000 for Messrs. McAfee and Thornton, respectively; and an annual automobile allowance of $20,000 and $15,000 for such officers, respectively. The Employment Agreements also provide for the payment of reasonable initiation fees for business and/or social organizations up to $35,000 and $25,000 for Messrs. McAfee and Thornton, respectively. Under the terms of the Employment Agreements, the Company will indemnify the executive officers from all liability and costs incurred as a consequence of claims resulting from or growing out of such person's status as, or as a result of their having been, a Director and/or officer of the Company. The terms, provisions and conditions of the indemnity are the same as those provided for under the current Certificate of Incorporation and Bylaws of the Company and cannot be changed without the consent of the executive officer affected thereby regardless of any future amendments to such Certificate of Incorporation or Bylaws. The Company's agreement to indemnify the executive officer will survive the termination of the employment contract, regardless of the cause of the termination. The Employment Agreements also provide for the reimbursement of reasonable legal fees and disbursements incurred by the executive officers in connection with enforcement of the Employment Agreements, provided the executive officer prevails in such enforcement proceeding. In addition to the termination provisions outlined above, the Company may terminate the Employment Agreements with Messrs. McAfee and Thornton for any reason upon 90 days' written notice. Mr. McAfee also has the right to terminate the Employment Agreement upon 90 days' written notice if the Board of Directors fails to reappoint him as Chief Executive Officer or Chairman of the Board of the Company, or materially changes his duties and responsibilities under the Employment Agreement. In each case, the Company will provide a severance package to each executive officer, and to Mr. McAfee if he resigns under the circumstances described in the preceding sentence, consisting of monthly severance pay for a period of three years, in the case of Mr. McAfee, and two years, in the case of Mr. Thornton, each payment equal to the highest monthly rate of base salary paid to the executive officer at any time under the Employment Agreement; all unpaid bonuses which have vested, together with that pro rated portion of any bonus for the current fiscal year; restricted shares and stock options which have vested; and other benefits payable thereunder. In the event the executive officer terminates the Employment Agreement during the designated notice period, he shall be entitled to receive all vested bonuses, stock options and restricted stock. Further, the Employment Agreements provide that upon a "Change of Control," as defined below, that occurs prior to September 30, 1996, each such executive officer has the right to terminate his employment under his Employment Agreement (i) by resignation on not less than ninety days' prior written notice given within six calendar months after the occurrence of such Change of Control or (ii) by resignation on not less than ninety days' prior written notice given within eighteen calendar months after such Change of Control, and within six months after the occurrence of any of the following: (a) failure to appoint the officer to the office held by him (and, in the case of Mr. McAfee failure to reappoint him as Chairman of the Board), (b) the making of any material change by the 27 Company in the respective officer's function, duties or responsibilities with the Company which would cause such officer's position to become of less dignity, responsibility, importance or scope or (c) any material breach of such officer's Employment Agreement. For the purposes of the Employment Agreements, a "Change of Control" will be deemed to have occurred if (a) any "Person" (as defined in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended), either alone or in conjunction with its "affiliates" (as defined in Rule 405 of the General Rules and Regulations under the Securities Act of 1933), or other group of persons, corporations, partnerships or other entities who are not affiliates but who are acting in concert with any person, acquire ownership, whether of record or beneficially, of that number of shares of outstanding stock of the Company which would allow such person or entity and/or its affiliates, or others acting in concert, to elect a majority of the Board of Directors of the Company. Under the terms of the Merger Agreement, the Merger, if consummated, would result in a Change of Control under the Employment Agreements and, as such, Messrs. McAfee and Thornton would be entitled to all benefits provided by the Change of Control provisions of their respective Employment Agreements. A Change of Control does not include any acquisition of control (i) by any of the Company's then five most senior officers (as of the date the Employment Agreements were entered into) whether acting alone or in concert with each other, or (ii) pursuant to which such executive officer or former executive officer accepts equity securities of the Company or any entity with or into which the Company is merged or consolidated, or which controls or is controlled by the Company or any such entity except for equity securities received by such person (a) in his capacity as a stockholder and (b) pursuant to stock options and other benefits not materially in excess of those typically available to officers of other publicly held for-profit healthcare companies not subject to a Change of Control. Upon the occurrence of a Change of Control and an election by the executive officer to terminate his employment, the Company shall pay such executive officer or his designee severance pay equal to the highest monthly rate of base salary paid to such executive officer at any time under the Employment Agreement, but not more than $34,166.66 per month for a period of four years in the case of Mr. McAfee or $20,000 per month for a period of three years in the case of Mr. Thornton or, at the election of such executive officer, the Company shall fund a trust by cash or annuity in form and substance satisfactory to the officer in an amount sufficient to permit the trust to make the monthly payments over the prescribed period or any unpaid portion thereof or the Company shall make a lump sum cash payment equal to the sum of the monthly installments without discount to present value, provided, however, such lump sum payment shall not exceed $1,640,000 in the case of Mr. McAfee or $720,000 in the case of Mr. Thornton. Messrs. McAfee and Thornton shall also be entitled to (i) vesting of options to acquire 22,606 shares and 13,564 shares, respectively, of the Company's Class A Common Stock at an exercise price of $13.00 per share pursuant to the 1993 Stock Option Plan, (ii) a pro rated bonus of $93,750 and $48,000, respectively, under the Company's annual bonus plan for the period from July 1, 1994 through September 30, 1994, (iii) a pro rated bonus of $125,000 and $64,000, respectively, under the Company's 1993 Long-Term Incentive Plan for the period from July 1, 1994 through September 30, 1994, (iv) bonuses of $500,000 and $232,980 respectively, due under the Company's 1993 Long-Term Incentive Plan for the year ended June 30, 1994 based on the audited financial statements of the Company without regard to non-recurring costs associated with the Merger, and (v) a payment of $233,570 and $110,760, respectively, in lieu of continuance in any benefit plans of the Company. Payments of base salary shall be offset by any payments made pursuant to any other Company-paid disability or salary continuance program. All such payments and amounts to which Messrs. McAfee and Thornton are entitled are subject to the limitation set forth in Section 280G of the Code, and will be reduced (but not below zero) until no portion of such payments would be subject to the excise tax imposed by Section 4999 of the Code. Under the terms of the Change of Control provisions of the Employment Agreement, approximately $2,593,000 and $1,176,000 will be payable to Messrs. McAfee and Thornton, respectively, including the value of the executive officer's salary, bonus and employment benefits. 28 DIRECTORS' FEES AND COMPENSATION Each Director who is not an employee of the Company, is paid for his services on the Board of Directors: (i) a retainer at the rate of $18,000 per annum; (ii) an additional $1,200 for each Board meeting attended; and (iii) $1,200 per committee meeting attended if not connected with a concurrent Board Meeting or $1,000 per committee meeting attended if connected with a concurrent Board Meeting. The Company also reimburses all of the Directors' company-related and company-approved travel and entertainment expenses, including their expenses in attending meetings of the Board or its Committees. Under the Directors' Stock Option Plan established in 1991, as amended in 1993, each non-employee Director was granted an option in fiscal 1992 to purchase 10,000 shares of the Company's Class A Common Stock and an option in fiscal 1994 to purchase an additional 6,250 shares of the Company's Class A Common Stock. In addition to the above compensation, non-employee members of the Board of Directors of the Company are entitled to receive stipends under the Hallmark Healthcare Corporation Emeritus Director Stipend Plan (the "Emeritus Director Plan") upon retirement from the Board if such persons have served as directors at least 60 months or, in any event, on termination of service as a member of the Board of Directors within one year after a "Change of Control" of the Company. Consummation of the Merger would cause a Change of Control under the terms of the Emeritus Director Plan and would result in the payment of certain benefits provided thereby. The monthly stipends payable under the Emeritus Director Plan are equal to the highest monthly base director's fee paid by the Company to non-employee directors during such former director's period of service as a non-employee director. Such directors are entitled to one monthly payment under the Emeritus Director Plan for each complete month of service as a member of the Board of Directors of the Company. As a result of the Change of Control provisions of the Emeritus Director Plan, four directors of the Company will be entitled to receive monthly payments of $1,500 per director for varying periods. As of September 30, 1994, aggregate payments to the four directors under such provisions total $303,000. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Since November 23, 1993, the Company's executive compensation program has been administered by the Compensation Committee of the Board of Directors. Such committee consists of Messrs. Slayden, Martin and Seckman. Prior to November 23, 1993, the program was administered by the Audit and Compensation Committee, consisting of Messrs. Slayden, Martin, Seckman and Maxwell. See "Item 13. Certain Transactions." ITEM 12. STOCK OWNERSHIP OF PRINCIPAL STOCKHOLDERS AND MANAGEMENT OF HALLMARK The following table sets forth as of August 26, 1994, certain information with respect to ownership of the Company's outstanding Class A Common Stock, by (i) all persons known by the Company to own beneficially more than 5% of the Company's outstanding Class A Common Stock, (ii) each director of the Company and (iii) all directors and executive officers of the Company, as a group.
SHARES OF HALLMARK COMMON STOCK BENEFICIALLY OWNED PERCENT NAME OF BENEFICIAL OWNER (1) OF CLASS - - --------------------------------------------------------------------------- -------------------- ----------- James T. McAfee, Jr. (2)................................................... 381,891 11.6 Robert M. Thornton, Jr. (3)................................................ 78,488 2.4 Kay W. Slayden (4)(5)...................................................... 14,000 * Rolland A. Maxwell (5)..................................................... 4,000 * James E. Martin (5)(6)..................................................... 5,100 * J. Randolph Seckman (5).................................................... 11,000 * All executive officers and directors as a group (6 persons) (7)............ 494,479 14.9 - - ------------------------ * Less than 1%
29 (1) Unless otherwise indicated, the named individual has sole voting and investment power with respect to all shares and the information pertains only to the Company's Class A Common Stock. For each beneficial owner, the number of shares outstanding and the percentage of stock ownership includes the number of common and all common equivalent shares (including options exercisable within 60 days) owned by such individual at August 26, 1994. (2) Includes 84,296 shares which Mr. McAfee has the right to acquire pursuant to options exercisable within 60 days. (3) Includes 1,000 shares owned by Mr. Thornton's spouse, of which Mr. Thornton disclaims beneficial ownership. (4) Includes 10,000 shares based on 2,000 shares of the Company's Preferred Stock owned by Mr. Slayden which are convertible at a ratio of one share of the Company's Preferred Stock into five shares of the Company's Class A Common Stock at any time. (5) Includes 4,000 shares which the named director has the right to acquire pursuant to options exercisable within 60 days. (6) Includes 200 shares owned by Dr. Martin's spouse. (7) Includes 100,296 shares which the members of the group have the right to acquire pursuant to options exercisable within 60 days and includes 10,000 shares based on 2,000 shares of the Company's Preferred Stock owned by Mr. Slayden, which are convertible at a ratio of one share of the Company's Preferred Stock into five shares of the Company's Class A Common Stock at any time.
As of August 26, 1994, all persons known by the Company to own beneficially more than 5% of the outstanding shares of the Company's Preferred Stock were: (i) Alliance Capital Management Corporation, 1345 Avenue of the Americas, New York, New York 10105-0099, which is the owner of 3,424 shares of the Company's Preferred Stock, representing 10.7% of the voting power of the Company's Preferred Stock; (ii) Kay W. Slayden, a director of the Company, who is the owner of 2,000 shares of the Company's Preferred Stock, representing 6.3% of the voting power of the Company's Preferred Stock and (iii) Executive Life Insurance, 11444 W. Olympic Blvd., West Los Angeles, California 90064, which is the owner of 1,925 shares of the Company's Preferred Stock, representing 6.0% of the voting power of the Company's Preferred Stock. Each of the above holders of the Company's Preferred Stock holds less than one half of one percent of the combined voting power of the Company's Class A Common Stock and the Company's Preferred Stock. On June 10, 1994, the Company entered into a definitive merger agreement with Community Health Systems, Inc. ("Community") under which Community will acquire all of the outstanding shares of the Company's Class A Common Stock, Class B Common Stock and Preferred Stock. The agreement calls for Community to exchange 0.97 shares of its common stock for each share of the Company's Class A and Class B Common Stock and 5.4 shares of its common stock for each share of the Company's Preferred Stock. Consummation of the merger is subject, among other things, to approval by the Company's stockholders at a special meeting to be held on October 5, 1994. See "Item 1. Business -- Proposed Merger". ITEM 13. CERTAIN TRANSACTIONS In fiscal 1994, the Company paid Jackson & Coker, of which Mr. Slayden is Vice Chairman of the Board of Directors, fees and reimbursed expenses totalling approximately $227,000 for services rendered in the recruitment of physicians, including approximately $89,000 for the recruitment of six physicians to four of Hallmark's hospitals, approximately $1,000 for the services of locum tenens physicians, which included compensation to the physicians and brokerage fees, and approximately $137,000 for services in connection with physician searches for which no recruitment has yet occurred. The Company believes that Jackson & Coker is one of the nation's leading physician search firms. The amounts paid to Jackson & Coker during fiscal 1994 by the Company, which were computed at Jackson & Coker's customary rates, were comparable to the rates the Company paid to other physician search firms for similar services during fiscal 1994. 30 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) CONSOLIDATED FINANCIAL STATEMENTS Information with respect to this Item is contained on pages F-1 through F-21 of this Annual Report on Form 10-K, and is specified in detail in the Index on Page F-1. (a)(2) FINANCIAL STATEMENT SCHEDULES Information with respect to this Item is contained on Pages S-1 through S-3 of this Annual Report on Form 10-K, as specified in further detail in the Index on page F-1. Except for those schedules contained on pages S-1 through S-3, all other schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes. (a)(3) EXHIBITS The following exhibits are filed herewith unless otherwise indicated, and exhibits followed by a reference to a note are incorporated by reference:
EXHIBIT NO. DESCRIPTION AND REFERENCE - - ----------- --------------------------------------------------------------------------------------------------------- 2.1 Amended and Restated Agreement and Plan of Merger, dated as of June 10, 1994, by and among Community Health Systems, Inc., Community Acquisition Corp. and the Registrant (Hallmark agrees to furnish supplementally, upon request, a copy of omitted schedules and exhibits.) 3.1 Certificate of Incorporation of Registrant, as amended (9) 3.2 By-laws of Registrant (10) 4.1 Form of Indenture, dated as of November 1, 1993, relating to 10 5/8% Senior Subordinated Notes due 2003 of the Registrant (11) 4.2 Credit Agreement, dated as of December 31, 1993, between the Registrant, as Borrower, and General Electric Capital Corporation, as Lender (12) 10.1 Registration Rights Agreement dated as of January 1, 1989 among the Registrant and the lenders with respect to Class B Non-Voting Common Stock (2) 10.2 Amended Employment Agreement -- James T. McAfee, Jr. 10.3 Second Amendment to Employment Agreement -- James T. McAfee, Jr. 10.4 Amended Employment Agreement -- Robert M. Thornton, Jr. 10.5 Second Amendment to Employment Agreement -- Robert M. Thornton, Jr. 10.6 Mutual Release, dated as of May , 1993, among the Registrant, Stephen L. Phelps, Joseph D. Bohr, Jr. and John F. Schwartz (7) 10.7 Settlement Agreement and Mutual Release, effective July 1, 1993, among First State Insurance Company, the Registrant, Steven L. Phelps, Joseph D. Bohr, Jr., John S. Schwartz, NationsBank of Georgia, N.A., Bank One Texas, N.A., Third National Bank in Nashville, The Bank of New York, and Citicorp North America, Inc. (7) 10.8 Long-Term Stock Incentive Plan -- 1989 (3) 10.9 Long-Term Cash Incentive Plan -- 1990 (3) 10.9a Amendment No. 1 to Long-Term Cash Incentive Plan -- 1990 (8) 10.10 Long-Term Stock Incentive Performance Plan -- 1991 (5)
31
EXHIBIT NO. DESCRIPTION AND REFERENCE - - ----------- --------------------------------------------------------------------------------------------------------- 10.11 Asset Purchase Agreement, dated as of November 25, 1992, between Healthcare of Forsyth, Inc. and Executive Committee of the Baptist Convention of the State of Georgia d/b/a Georgia Baptist Health Care System (6) 10.12 Management Agreement, dated as of January 31, 1990, between Poplar Bluff Physicians Group, Inc. and Registrant (4) 10.13 Lease Agreement, dated as of September 1, 1979, between Randolph County, Arkansas and Randolph County Medical Center, Inc. (7) 10.14 Lease Agreement, dated as of April 1, 1988, between Richard B. Griffin and Berrien Nursing Center Inc. (7) 10.15 Lease Agreement, dated as of August 23, 1984, between Holmes County Hospital Corporation and National Healthcare of Holmes County, Inc. (1) 10.16 Amendment to 1991 Directors' Non-Qualified Stock Option Plan (11) 10.17 1994 Employee Stock Purchase Plan (8) 10.18 1993 Stock Option Plan (8) 10.19 1993 Long-Term Incentive Plan (8) 11.1 Statement re: Computation of Earnings Per Share 21.1 List of Subsidiaries 24.1 Consent of Arthur Andersen LLP - - ------------------------ (1) Filed as an exhibit to the Registrant's Form S-1 Registration Statement No. 2-99387, filed August 2, 1985, as amended by Amendment No. 1 filed September 16, 1985, Amendment No. 2 filed November 1, 1985, and Amendment No. 3 filed November 5, 1985. (2) Filed as an exhibit to the Registrant's Form 10-K for the year ended June 30, 1989, filed September 28, 1989. (3) Filed as an exhibit to the Registrant's Form 10-Q for the quarter ended March 31, 1990, filed May 11, 1990. (4) Filed as an exhibit to the Registrant's Form 8-K filed September 27, 1989. (5) Filed as an exhibit to the Registrant's Form 10-K for the year ended June 30, 1992, filed September 10, 1992. (6) Filed as an Exhibit to Registrant's Form 8, dated February 25, 1993, filed February 26, 1993. (7) Filed as an exhibit to Registrant's Form S-1 Registration Statement No. 33-67958 filed August 26, 1993. (8) Filed as an exhibit to Amendment No. 1 to Registrant's Form S-1 Registration Statement No. 33-67958 filed October 19, 1993. (9) Filed as an exhibit to the Registrant's Form S-8 Registration Statement No. 33-53853 filed May 27, 1994. (10) Filed as an exhibit to the Registrant's Form 10-K for the year ended June 30, 1993, filed September 9, 1993. (11) Filed as an exhibit to the Registrant's Form 10-Q for the quarter ended December 31, 1993, filed February 14, 1994. (12) Filed as an exhibit to the Registrant's Form 10-Q for the quarter ended March 31, 1994, filed May 13, 1994.
(b) Reports on Form 8-K None. 32 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. HALLMARK HEALTHCARE CORPORATION Date: September 16,1994 By: \s\ JAMES T. MCAFEE, JR. -------------------------------------- James T. McAfee, Jr. CHAIRMAN AND CHIEF EXECUTIVE OFFICER Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, in multiple original counterparts, on behalf of the Registrant and in the capacities and on the date indicated: HALLMARK HEALTHCARE CORPORATION
SIGNATURES TITLE DATE - - ------------------------------------------------------ -------------------------------- ----------------------- \s\ JAMES T. MCAFEE, JR. ------------------------------------------- Chairman, Chief Executive September 16, 1994 James T. McAfee, Jr. Officer, and Director President, Chief Operating \s\ ROBERT M. THORNTON, JR. Officer and Chief Financial ------------------------------------------- Officer (Principal Accounting September 16, 1994 Robert M. Thornton, Jr. Officer) \s\ ROLLAND A. MAXWELL ------------------------------------------- Director September 16, 1994 Rolland A. Maxwell ------------------------------------------- Director Kay W. Slayden ------------------------------------------- Director James E. Martin \s\ J. RANDOLPH SECKMAN ------------------------------------------- Director September 16, 1994 J. Randolph Seckman
33 HALLMARK HEALTHCARE CORPORATION INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES The following consolidated financial statements of the Registrant and its subsidiaries are submitted herewith in response to Item 8 and Item 14(a)1: HALLMARK HEALTHCARE CORPORATION AND SUBSIDIARIES
PAGE ----------- Report of independent public accountants.................................................................. F-2 Consolidated balance sheets at June 30, 1993 and 1994..................................................... F-3 Consolidated statements of income for the years ended June 30, 1992, 1993, and 1994....................... F-4 Consolidated statements of redeemable preferred stock and common stockholders' equity for the years ended June 30, 1992, 1993, and 1994............................................................................ F-5 Consolidated statements of cash flows for the years ended June 30, 1992, 1993 and 1994.................... F-6 Notes to consolidated financial statements................................................................ F-7
The following financial statement schedules of the Registrant and its subsidiaries are submitted herewith in response to Item 14(a)2:
PAGE ----------- Schedule V -- Property, plant and equipment............................................................... S-1 Schedule VI -- Accumulated depreciation, depletion and amortization of property, plant and equipment...... S-2 Schedule VIII -- Valuation and qualifying accounts........................................................ S-3
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, are inapplicable or have been disclosed in the notes to consolidated financial statements, and therefore have been omitted. F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and the Stockholders of Hallmark Healthcare Corporation: We have audited the accompanying consolidated balance sheets of Hallmark Healthcare Corporation (a Delaware corporation) and subsidiaries as of June 30, 1993 and 1994, and the related consolidated statements of income, redeemable preferred stock and common stockholders' equity and cash flows for each of the three years in the period ended June 30, 1994. These financial statements and the schedules referred to below 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 financial position of Hallmark Healthcare Corporation and subsidiaries as of June 30, 1993 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1994, in conformity with generally accepted accounting principles. As discussed in Note 9, effective July 1, 1993, the Company changed its method of accounting for income taxes. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in Item 14(a)2 are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Atlanta, Georgia August 12, 1994 F-2 HALLMARK HEALTHCARE CORPORATION CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ASSETS
JUNE 30, ---------------------- 1993 1994 ---------- ---------- Current assets: Cash and cash equivalents............................................................... $ 4,899 $ 19,757 Patient accounts receivable, less allowance for doubtful accounts of $4,135 and $4,083 at June 30, 1993 and 1994, respectively................................................ 19,767 20,396 Other accounts receivable (net)......................................................... 2,212 3,502 Inventories............................................................................. 4,103 4,212 Other current assets.................................................................... 2,301 2,373 Deferred tax asset...................................................................... -- 4,757 ---------- ---------- Total current assets................................................................ 33,282 54,997 Property and equipment: Land and improvements................................................................... 7,277 7,555 Buildings and improvements.............................................................. 98,887 101,798 Equipment............................................................................... 53,296 56,202 Construction in progress................................................................ 2,227 687 ---------- ---------- 161,687 166,242 Less: accumulated depreciation and amortization......................................... (53,452) (62,222) ---------- ---------- Net property and equipment............................................................ 108,235 104,020 Funds held by trustees.................................................................... 13,308 8,172 Other assets.............................................................................. 5,052 5,831 ---------- ---------- Total assets........................................................................ $ 159,877 $ 173,020 ---------- ---------- ---------- ---------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable........................................................................ $ 11,819 $ 9,634 Current portion of long-term debt and capital lease obligations......................... 5,306 247 Accrued payroll, vacation and related taxes............................................. 4,056 3,651 Other accrued liabilities............................................................... 10,718 11,924 ---------- ---------- Total current liabilities........................................................... 31,899 25,456 Long-term debt and capital lease obligations.............................................. 75,181 87,574 Long-term portion of accrued general and professional liability risks..................... 10,795 10,549 Other long-term liabilities............................................................... 6,853 6,899 Deferred income taxes..................................................................... 2,060 9,653 Deferred debt restructuring credits....................................................... 27,041 -- ---------- ---------- Total liabilities................................................................... 153,829 140,131 ---------- ---------- Commitments and contingencies Redeemable preferred stock................................................................ 1,095 1,303 ---------- ---------- Common stockholders' equity: Common stock: Class A, $.05 par value, authorized 25,000,000 shares; issued and outstanding 2,585,457 and 2,982,482 shares at June 30, 1993 and 1994, respectively................................................. 129 149 Class B, $.05 par value, authorized 2,500,000 shares; issued and outstanding 390,298 and 64,102 shares at June 30, 1993 and 1994, respectively............................................................... 19 3 Additional paid-in capital.............................................................. 52,331 54,469 Accumulated deficit..................................................................... (47,526) (23,035) ---------- ---------- Total common stockholders' equity................................................... 4,953 31,586 ---------- ---------- Total liabilities and stockholders' equity.......................................... $ 159,877 $ 173,020 ---------- ---------- ---------- ----------
See accompanying notes. F-3 HALLMARK HEALTHCARE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED JUNE 30, ------------------------------------------- 1992 1993 1994 ------------- ------------- ------------- Net patient service revenues......................................... $ 164,605 $ 172,521 $ 182,788 Other revenues....................................................... 5,400 6,716 8,756 ------------- ------------- ------------- Total revenues................................................. 170,005 179,237 191,544 ------------- ------------- ------------- Expenses: Salaries and benefits.............................................. 72,957 75,641 83,467 Supplies........................................................... 22,832 22,970 24,022 Provision for bad debts............................................ 11,775 10,796 12,713 Other operating expenses........................................... 42,548 49,931 47,684 Interest........................................................... 5,334 3,871 7,502 Depreciation and amortization...................................... 9,426 9,027 9,428 Credit from restructuring transactions............................. (2,133) -- -- ------------- ------------- ------------- Total expenses................................................. 162,739 172,236 184,816 Income from operations............................................. 7,266 7,001 6,728 Gain on sale of healthcare facility................................ -- 752 -- ------------- ------------- ------------- Income before income taxes, extraordinary items and cumulative effect of accounting change....................................... 7,266 7,753 6,728 Provision for income taxes........................................... 3,261 3,303 2,826 Income before extraordinary items and cumulative effect of accounting change............................................. 4,005 4,450 3,902 Extraordinary items: Gain on restructure of debt, net of income tax effect of $42, $1,344 and $2,170 at June 30, 1992, 1993 and 1994, respectively... 82 2,017 19,784 Credit resulting from utilization of net operating loss carryforwards..................................................... 2,682 3,914 -- ------------- ------------- ------------- Income before cumulative effect of accounting change............... $ 6,769 $ 10,381 $ 23,686 Cumulative effect of accounting change............................. -- -- 805 ------------- ------------- ------------- Net income........................................................... $ 6,769 $ 10,381 $ 24,491 Accretion of preferred stock redemption requirement.................. 244 329 413 ------------- ------------- ------------- Net income applicable to common stock................................ $ 6,525 $ 10,052 $ 24,078 ------------- ------------- ------------- ------------- ------------- ------------- Weighted average common and common equivalent shares outstanding..... 3,358,491 3,449,752 3,681,410 ------------- ------------- ------------- Net income per common and common equivalent share: Income before extraordinary items and cumulative effect of accounting change................................................. $ 1.19 $ 1.29 $ 1.06 Extraordinary items: Gain on restructure of debt, net of income tax effect............ .03 .59 5.37 Credit resulting from utilization of net operating loss carryforwards................................................... .80 1.13 -- Cumulative effect of accounting change........................... -- -- 0.22 ------------- ------------- ------------- Net income per common and common equivalent share.................... $ 2.02 $ 3.01 $ 6.65 ------------- ------------- ------------- ------------- ------------- -------------
See accompanying notes. F-4 HALLMARK HEALTHCARE CORPORATION CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND COMMON STOCKHOLDERS' EQUITY (DOLLARS IN THOUSANDS)
COMMON STOCKHOLDERS' EQUITY ------------------------------------------------------------------ REDEEMABLE CLASS A CLASS B PREFERRED STOCK COMMON STOCK COMMON STOCK ------------------ ----------------- ------------------- ADDITIONAL NUMBER OF NUMBER OF NUMBER OF PAID-IN ACCUMULATED SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT --------- ------ --------- ------ --------- ------ ---------- ----------- Balance June 30, 1991................... 45,720 $ 672 2,478,072 $124 390,298 $19 $52,694 $(64,676) Issuance of common stock under employee stock option plans..................... -- -- 20,150 1 -- -- 18 -- Issuance of common stock in exchange for preferred stock........................ (3,739) (95) 18,697 1 -- -- 94 -- Accretion of preferred stock redemption requirement............................ -- 244 -- -- -- -- (244) -- Net income.............................. -- -- -- -- -- -- -- 6,769 --------- ------ --------- ------ --------- ------ ---------- ----------- Balance June 30, 1992................... 41,981 821 2,516,919 126 390,298 19 52,562 (57,907) Issuance of common stock under employee stock option plans..................... -- -- 56,479 2 -- -- 44 -- Issuance of common stock in exchange for preferred stock........................ (2,412) (55) 12,059 1 -- -- 54 -- Accretion of preferred stock redemption requirement............................ -- 329 -- -- -- -- (329) -- Net income.............................. -- -- -- -- -- -- -- 10,381 --------- ------ --------- ------ --------- ------ ---------- ----------- Balance June 30, 1993................... 39,569 1,095 2,585,457 129 390,298 19 52,331 (47,526) Issuance of common stock under employee stock option plans..................... -- -- 38,950 2 -- -- 114 -- Issuance of common stock in exchange for preferred stock........................ (6,382) (204) 31,910 2 -- -- 202 -- Issuance of Class A common stock in exchange for Class B common stock...... -- -- 326,191 16 (326,191) (16) -- -- Accretion of preferred stock redemption requirement............................ -- 413 -- -- -- -- (413) -- Accrual for the issuance of Class A common stock under a long-term incentive plan......................... -- -- -- -- -- -- 1,341 -- Fractional shares retired pursuant to reverse stock split.................... (302) (1) (26) -- (5) -- -- -- Income tax effect of employee stock options and long-term incentive plan... -- -- -- -- -- -- 894 -- Net income.............................. -- -- -- -- -- -- -- 24,491 --------- ------ --------- ------ --------- ------ ---------- ----------- Balance June 30, 1994................... 32,885 $1,303 2,982,482 $149 64,102 $ 3 $54,469 $(23,035) --------- ------ --------- ------ --------- ------ ---------- ----------- --------- ------ --------- ------ --------- ------ ---------- -----------
See accompanying notes. F-5 HALLMARK HEALTHCARE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
YEAR ENDED JUNE 30, --------------------------------- 1992 1993 1994 --------- ---------- ---------- Cash flows from operating activities: Net income................................................................. $ 6,769 $ 10,381 $ 24,491 --------- ---------- ---------- Adjustments to reconcile net income to net cash provided by operating activities: Extraordinary items: Gain on restructure of debt............................................ (82) (2,017) (19,784) Credit resulting from utilization of net operating loss carryforwards......................................................... (2,682) (3,914) -- Cumulative effect of accounting change................................... -- -- (805) Depreciation and amortization............................................ 9,426 9,027 9,428 Provision for deferred taxes............................................. 480 345 2,238 Gain on sale of healthcare facility...................................... -- (752) -- Amortization of deferred debt restructuring credits...................... (6,164) (6,034) (2,072) Change in allowance for doubtful accounts................................ (388) (188) (52) Credit from restructuring transactions................................... (2,133) -- -- Change in assets and liabilities, net of effects of healthcare facilities sold: Patient accounts receivable.............................................. 4,272 (1,797) (1,177) Other accounts receivable................................................ (527) 189 233 Other assets............................................................. 1,351 15 593 Accounts payable......................................................... 153 1,987 (2,185) Accrued interest......................................................... 938 (2,335) 651 Other liabilities........................................................ 3,993 4,492 2,305 --------- ---------- ---------- Total adjustments.................................................. 8,637 (982) (10,627) --------- ---------- ---------- Net cash provided by operating activities................................ 15,406 9,399 13,864 Cash flows from investing activities: Proceeds from sales of healthcare facilities............................. -- 9,336 -- Purchases of property and equipment, net................................. (7,230) (6,375) (4,586) --------- ---------- ---------- Net cash (used in) provided by investing activities...................... (7,230) 2,961 (4,586) --------- ---------- ---------- Cash flows from financing activities: Proceeds from issuance of long-term debt................................. -- -- 80,000 Costs of issuance of long-term debt...................................... -- -- (2,400) Principal payments on long-term debt and capital lease obligations....... (8,278) (15,210) (75,980) Release of funds held by trustees........................................ -- -- 3,960 --------- ---------- ---------- Net cash (used in) provided by financing activities...................... (8,278) (15,210) 5,580 --------- ---------- ---------- (Decrease) Increase in cash and cash equivalents............................. (102) (2,850) 14,858 Cash and cash equivalents at beginning of year............................... 7,851 7,749 4,899 --------- ---------- ---------- Cash and cash equivalents at end of year..................................... $ 7,749 $ 4,899 $ 19,757 --------- ---------- ---------- --------- ---------- ----------
See accompanying notes. F-6 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 1. -- SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES Hallmark Healthcare Corporation (the "Company") is a Delaware corporation which began doing business under its present name during the first quarter of fiscal 1992. The Company is engaged primarily in the ownership and management, through subsidiaries, of hospitals and other healthcare related enterprises. BASIS OF PRESENTATION The consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. INVENTORIES Inventories consist primarily of medical supplies and pharmaceuticals and are stated at the lower of cost (first-in, first-out) or market. PROPERTY AND EQUIPMENT Property and equipment are recorded at historical cost. Expenditures which increase capacity or extend the useful life of an asset are capitalized and depreciated over the remaining estimated useful life of such asset. Maintenance, repairs, and minor replacements are expensed as incurred. Depreciation and amortization are computed at rates estimated by management to amortize the cost of the various assets over the periods of expected use or, in the case of capital leases, over the lives of such leases, if shorter. Depreciation and amortization have been provided on the straight-line method using useful lives ranging from 20 to 45 years for buildings and improvements and 3 to 20 years for equipment. GOODWILL At June 30, 1993 and 1994, the net unamortized balance of consolidated goodwill was $1,262,000 and $865,000, respectively, and is included in the accompanying consolidated balance sheets under the caption "Other assets". These costs are amortized on a straight-line basis over periods ranging from 5 to 40 years. FINANCIAL INSTRUMENTS The Company's financial instruments consist primarily of cash and cash equivalents, patient accounts receivable, other accounts receivable, funds held by trustees, accounts payable, long-term debt and capital lease obligations and redeemable preferred stock. The carrying amounts of cash and cash equivalents, patient accounts receivable, other accounts receivable, and accounts payable approximate their fair value because of the short maturities of those instruments. The carrying amount of funds held by trustees, which consist primarily of short term governmental securities and investment grade commercial paper, approximates the fair value of such funds because of the short maturities of the securities. The carrying amount of the Company's 10 5/8% Senior Subordinated Notes due 2003 (the "Notes") is $80,000,000. The market value of such Notes is approximately $77,100,000 based on the last reported sales price of the Notes on June 30, 1994. The carrying amounts of capital lease obligations approximate their fair value because in management's opinion the carrying amounts of these instruments reflect terms substantially equivalent to prevailing market terms. The carrying F-7 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 1. -- SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES (CONTINUED) value of the Company's redeemable preferred stock is $1,303,000 at June 30, 1994. The market value of such instruments is $3,124,000 based on quoted market prices of the Company's common stock into which the preferred stock is convertible at the holder's option. GENERAL AND PROFESSIONAL LIABILITY The Company is self-insured against a portion of its general and professional liability risks. The reserves for losses within its self-insured retention limits, including loss adjustment expenses, are based on actuarial estimates using the Company's historical claims experience adjusted for current industry trends. The reserve for unpaid claims is adjusted, as such claims mature, to reflect revised actuarial estimates based on actual experience. Of such reserves, $1,300,000 and $1,350,000 at June 30, 1993 and 1994, respectively, are included in the accompanying consolidated balance sheets in "Other accrued liabilities" and represent the estimated amount of claims and loss adjustment expenses to be paid within the following twelve months. The balance of such reserves is classified as "Long-term portion of accrued general and professional liability risks." For the fiscal years ended June 30, 1992, 1993 and 1994, the Company recorded as an expense for self-insurance reserves $896,000, $1,401,000 and $1,197,000, respectively. The Company does not discount its reserves for losses and related expenses to their present value. OTHER ACCRUED LIABILITIES Other accrued liabilities includes amounts related to the Company's self-insured employee group medical coverage of $1,583,000 and $1,472,000 at June 30, 1993 and 1994, respectively. NET PATIENT SERVICE REVENUES The Company's hospitals serve a significant number of patients under government and privately sponsored insurance programs for which payment is made (i) based on cost as defined under the program, (ii) at a predetermined rate based upon the diagnosis, plus, in certain cases, capital costs and other adjustments or (iii) at negotiated rates based on a discount from the Company's usual charges. Net patient service revenues are presented based on established billing rates less allowances and discounts for patients covered by Medicare, Medicaid and other contractual programs. Payments received under these programs are generally less than the established billing rates of the Company's hospitals, and the differences are recorded as contractual allowances or discounts. Such allowances have been deducted from accounts receivable pending final audit and settlement. Provision for contractual allowances and discounts for the fiscal years ended June 30, 1992, 1993 and 1994 were $86,935,000, $94,212,000 and $104,360,000, respectively. In management's opinion, the allowances provided are adequate to cover any liabilities that may result from final settlements. It is the Company's policy to collect compensation for all services performed; however, in the ordinary course of business, the Company renders certain services in its facilities to patients who are financially unable to pay for hospital care, without the expectation of payment and for which the Company does not pursue collection (charity care). The amount of such charity care is not material to the Company's consolidated results of operations. OTHER REVENUES Other revenues include income from non-patient hospital activities such as cafeteria sales, interest income, rental income and other related services as well as revenues from one of the Company's majority-owned subsidiaries that operates pain centers in hospitals owned by others. F-8 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 1. -- SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES (CONTINUED) INCOME TAXES Income taxes are provided by applying the applicable statutory federal and state tax rates to book income before income taxes, adjusted for permanent differences between book and tax income. Deferred income taxes are provided at the enacted marginal rates on the difference between the financial statement and income tax bases of assets and liabilities. Deferred income tax provisions or benefits are based on the change in the deferred tax assets and liabilities from period to period. NOTE 2. -- PROPOSED MERGER On June 10, 1994, the Company entered into a definitive merger agreement with Community Health Systems, Inc. ("Community") under which Community will acquire all of the outstanding shares of the Company's Class A common stock, Class B common stock, and Redeemable preferred stock. The agreement calls for Community to exchange 0.97 shares of its common stock for each share of the Company's Class A and Class B common stock and 5.4 shares of its common stock for each share of the Company's Redeemable preferred stock. The merger is subject to conditions including, but not limited to, the approval of both companies' stockholders and all appropriate regulatory approvals. The Company anticipates that the merger, subject to the satisfaction of those and other conditions, will be consummated in the Company's fiscal year 1995. NOTE 3. -- CHANGE IN OPERATIONS During 1993, the Company divested substantially all of the assets of two subsidiaries that operated a 63 bed hospital in McMinnville, Tennessee and a 36 bed hospital in Cumming, Georgia for approximately $9,400,000 in cash. The Company recognized a gain of $752,000 from the sale of the McMinnville hospital in the quarter ended September 30, 1992. No gain or loss was recognized on the sale of the Cumming hospital. Of the net proceeds of approximately $8,500,000, approximately $7,000,000 was applied as prepayments on amounts outstanding under the former Bank Credit Agreement. The Company utilized the remaining $1,500,000 of the proceeds to acquire a portion of the Company's 14 1/2% Subordinated Debentures (the "14 1/2% Debentures"). The accompanying consolidated statements of income include no revenues and expenses for the McMinnville facility for 1993 and include revenues and expenses for the Cumming facility through November 30, 1992. For the year ended June 30, 1992, the facilities had total revenues of $12,646,000 and total expenses of $14,616,000 (excluding interest). For the year ended June 30, 1993, the facilities had total revenues of $974,000 and total expenses of $1,313,000. F-9 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 4. -- LONG-TERM DEBT Long-term debt consists of the following (in thousands):
JUNE 30, 1993 JUNE 30, 1994 ------------- ------------- Senior Subordinated Notes due November 15, 2003, interest at 10 5/8% per annum payable semi-annually beginning May 15, 1994, redeemable at the Company's option at a redemption price of 105.3125% of principal on or after November 15, 1998, declining to 102.6563% on November 15, 1999 and 100% on November 15, 2000.......... $ -- $ 80,000 Amended and Restated Bank Credit Agreement dated as of January 1, 1989, as amended, ("Bank Credit Agreement").......................................................... 64,244 -- Senior Subordinated Debentures due 1999, interest at 7%............................. 6,238 -- Senior Subordinated Notes due 1999, interest at 7%.................................. 1,098 -- Senior Subordinated Notes due 1993 through 1995, interest at 8% or 9%............... 959 -- Notes collateralized by property and equipment and other indebtedness at various interest rates ranging from 8% to 9% per annum, payable in various amounts through 1999............................................................................... 547 454 ------------- ------------- 73,086 80,454 Less current portion................................................................ (5,206) (97) ------------- ------------- Long-term debt...................................................................... $ 67,880 $ 80,357 ------------- ------------- ------------- -------------
On November 15, 1993, the Company completed a public offering of $80,000,000 principal amount of 10 5/8% Senior Subordinated Notes due 2003. The Notes are senior subordinated obligations of the Company, and, as such, are subordinated to all existing and future senior indebtedness of the Company. The net proceeds from the offering were approximately $77,600,000, of which approximately $62,100,000 was used to repay in full the indebtedness outstanding under the Bank Credit Agreement and approximately $10,700,000 was used to redeem all of the Company's outstanding subordinated indebtedness. The remaining proceeds of approximately $4,800,000 will be used for general corporate purposes. The indenture contains certain covenants which limit or restrict, among other items, (i) additional indebtedness, including subordinated debt; (ii) liens; (iii) issuance of preferred stock by the Company's subsidiaries; (iv) transactions with affiliates; (v) restricted payments, including, but not limited to, cash dividends on the Company's equity securities; (vi) investments and loans; (vii) application of the proceeds of certain asset sales; and (viii) mergers, consolidations and the transfer of substantially all of the assets of the Company to another person, all as defined in the indenture. The Company was in compliance with these covenants at June 30, 1994. The indenture also contains a provision that in the event of a change of control, as defined, the Company shall make an offer to repurchase the Notes at a purchase price equal to 101% of the principal amount thereof, plus accrued interest through the repurchase date. The proposed merger with Community (Note 2), if consummated, would constitute a change of control under the indenture and could result in up to $800,000 in premium payments and the write-off of up to $2,600,000 in deferred loan costs. During the quarter ended December 31, 1993, the Company entered into a credit agreement with a financial institution (the "New Credit Agreement") pursuant to which the Company may borrow up F-10 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 4. -- LONG-TERM DEBT (CONTINUED) to $25,000,000. The New Credit Agreement consists of (i) a working capital facility in the principal amount of up to $15,000,000 and (ii) an acquisition facility in the principal amount of up to $10,000,000 (collectively, the "Facilities"). Borrowings under the working capital facility are secured by an assignment by the Company of its patient accounts receivable to the lender. The Company may not borrow pursuant to the acquisition facility until it is activated by mutual agreement of the Company and the lender, which must be no later than December 31, 1994; the acquisition facility had not been activated as of June 30, 1994. Borrowing capacity under the working capital facility is based on a percentage of the Company's eligible patient accounts receivable, as defined. Certain conditions must be satisfied prior to the Company borrowing under the Facilities, some of which have not yet been satisfied. There was no borrowing availability at June 30, 1994. Interest on the Facilities is payable monthly at a variable rate selected by the Company, which will be either a published rate for thirty day dealer-placed commercial paper, plus 3% or reserve-adjusted one, two or three month LIBOR, plus 3%. The working capital facility terminates on December 31, 1998, at which time the entire unpaid balance under the facility is due. Principal on the acquisition facility is due in twelve monthly installments commencing on December 31, 1997. The Facilities bear an unused line fee of 1/2 of 1% of the average daily unused availability under the Facilities. No unused line fee is charged for the acquisition facility until such line is activated. Under the terms of the New Credit Agreement, the Company is required to meet certain financial covenants, including, among others, a fixed charge coverage ratio, a minimum interest coverage ratio, a minimum net worth level, an accounts receivable turnover ratio and a minimum EBITDA level, as defined. In addition, the New Credit Agreement contains limitations and/or restrictions on acquisitions, investments, capital expenditures, dividends on the Company's equity securities and incurrence of additional indebtedness. The Company was in compliance with these covenants at June 30, 1994. At June 30, 1994, the Company had four outstanding letters of credit totalling $6,858,000 which were issued by a commercial bank and are used to satisfy certain security requirements of the Company's workers' compensation insurance carrier and a lease agreement related to one of the Company's hospitals. To date, there have been no drawings under these letters of credit. During Fiscal years 1990 through 1993, the Company, through a series of transactions, underwent a restructuring of certain of its outstanding indebtedness. The restructuring included modifications to its then outstanding bank debt and the issuance of several series of senior subordinated notes and debentures and payments of cash in exchange for certain of its 14 1/2% Debentures. Pursuant to the provisions of Statement of Financial Accounting Standards ("SFAS") No. 15, "Accounting by Debtors and Creditors for Troubled Debt Restructuring", the Company did not recognize any gain from the modification of its bank debt or from certain transactions in the 14 1/2% Debentures. The unrecognized gain from such transactions was deferred and classified in the accompanying condensed consolidated balance sheets as "Deferred debt restructuring credits". Such credits were amortized as a reduction of interest expense during the period that the restructured debt remained outstanding. During the years ended June 30, 1992, 1993, and 1994, interest expense was reduced by $6,164,000, $6,034,000 and $2,072,000, respectively, as a result of amortization of the deferred credits. During the year ended June 30, 1994, the Company retired all remaining restructured debt and recognized an extraordinary gain of $19,784,000(net of income tax effect of $2,170,000) primarily from the write-off of the remaining balance of the deferred credits. In the course of restructuring its 14 1/2% Debentures, the Company issued $9,895,000 principal amount of 7% Senior Subordinated Debentures due 1999, $1,718,000 principal amount of 9% Senior F-11 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 4. -- LONG-TERM DEBT (CONTINUED) Subordinated Notes due 1993, $800,000 principal amount of 8% Senior Subordinated Notes due 1995, $1,193,000 principal amount of 7% Senior Subordinated Notes due 1999, and paid cash of $8,156,000 in exchange for $30,000,000 of its 14 1/2% Debentures including all accrued interest thereon. Pursuant to such restructuring transactions, the Company recognized an extraordinary gain of approximately $82,000 (net of income tax effect of $42,000) in 1992 and $2,017,000 (net of income tax effect of $1,344,000) in 1993. The following table sets forth the calculation of the extraordinary gain recognized in 1992, 1993 and 1994, respectively (in thousands):
1992 1993 1994 --------- --------- --------- Principal and accrued interest retired.................................... $ 129 $ 7,600 $ 70,416 Deferred credits retired.................................................. 57 2,312 24,969 --------- --------- --------- Total restructured amounts............................................ 186 9,912 95,385 --------- --------- --------- Cash payments............................................................. 62 5,683 72,831 New debt issued........................................................... -- 800 -- Future interest on new debt issued........................................ -- 68 -- --------- --------- --------- Total consideration................................................... 62 6,551 72,831 --------- --------- --------- Other costs of restructuring.............................................. -- -- 600 --------- --------- --------- Pre-tax gain on debt restructuring........................................ $ 124 $ 3,361 $ 21,954 --------- --------- --------- --------- --------- ---------
The following table sets forth the changes in the balances of the Deferred Debt Restructuring Credits for the fiscal years ended June 30, 1992, 1993 and 1994 (in thousands):
1992 1993 1994 --------- --------- ---------- Beginning Balance................................................... $ 41,498 $ 35,298 $ 27,041 Additions resulting from debt restructuring transactions............ -- 68 -- Additions pursuant to issuance of payment-in-kind notes.............................................................. 21 21 -- Reductions resulting from extinguishment of debt.................... (57) (2,312) (24,969) Amortization credited to interest expense........................... (6,164) (6,034) (2,072) --------- --------- ---------- Ending Balance...................................................... $ 35,298 $ 27,041 $ -- --------- --------- ---------- --------- --------- ----------
Scheduled long-term debt principal payments at June 30, 1994 are as follows (in thousands):
FISCAL YEAR - - ------------------------------------------------------------------------- 1995..................................................................... $ 97 1996..................................................................... 0 1997..................................................................... 0 1998..................................................................... 179 1999..................................................................... 178 Thereafter............................................................... 80,000 --------- $ 80,454 --------- ---------
F-12 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 5. -- LEASES The Company leases certain facilities and equipment under operating and capital lease agreements which expire on various dates and require the Company to pay all maintenance and insurance costs. Rent expense under operating leases was $4,887,000, $4,874,000 and $5,174,000 in fiscal years 1992, 1993, and 1994, respectively. Commitments for property and equipment subject to capital leases and noncancellable operating leases are as follows (in thousands):
JUNE 30, 1994 ---------------------- FISCAL YEAR OPERATING CAPITAL - - ----------------------------------------------------------------------- ----------- --------- 1995................................................................... $ 1,126 $ 1,220 1996................................................................... 693 1,140 1997................................................................... 330 1,130 1998................................................................... 231 1,130 1999................................................................... 103 1,130 Thereafter............................................................. 45 16,689 ----------- --------- Total minimum future lease payments................................ $ 2,528 22,439 ----------- ----------- Less amount representing interest.................................. 15,072 --------- Present value of obligations under capital leases (interest rates range from 9.2% to 15.9%)................................................... 7,367 Less current portion................................................... 150 --------- Long-term capital lease obligations.................................... $ 7,217 --------- ---------
Funds held by trustees include $4,035,000 as of June 30, 1993 of restricted cash held by a trustee as collateral for the Company's obligation under a capital lease for one hospital facility. During 1994, the Company replaced the collateral with a letter of credit issued by a commercial bank in the amount of $3,975,000. Assets capitalized under the above capital leases follow (in thousands):
JUNE 30, -------------------- 1993 1994 --------- --------- Buildings and improvements.............................................. $ 7,815 $ 7,815 Equipment............................................................... 799 921 --------- --------- 8,614 8,736 Less accumulated amortization........................................... (2,229) (2,638) --------- --------- Net assets capitalized under capital leases......................... $ 6,385 $ 6,098 --------- --------- --------- ---------
NOTE 6. -- 25% REDEEMABLE PREFERRED STOCK The Company is authorized to issue 2,500,000 shares of preferred stock (issuable in series) of which it had outstanding at June 30, 1993 and 1994, 39,569 and 32,885 shares, respectively, of $5 par value 25% Participating Cumulative Convertible Redeemable Preferred Stock (the "25% Preferred"). The 25% Preferred has a preference over common stockholders upon liquidation or dissolution of the Company of $125 per share, minus certain dividends if previously paid. Each 25% Preferred share is convertible, at any time, into five shares of Class A common stock, subject to adjustment under certain conditions, and is entitled to annual dividends equal to 25% of defined net income, if any, subject to a F-13 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 6. -- 25% REDEEMABLE PREFERRED STOCK (CONTINUED) maximum annual payment of 10% of liquidation preference, when and if declared by the Board of Directors of the Company out of funds legally available for such dividends. Such dividends are cumulative and subject to certain maximums, limits and other conditions. As of June 30, 1994, the maximum dividend payable to preferred stockholders for fiscal 1994 was $411,000 (10% of liquidation preference). If such dividend is not declared by the Board of Directors of the Company, and it is probable it will not be, then the dividend is cumulative to the extent of 5% of liquidation value ($206,000). The Company's Board of Directors did not declare a dividend at December 31, 1993 (the dividend payment date for fiscal 1993) and therefore such 1993 dividends were cumulative to the extent of 5% of liquidation value ($206,000). In addition, 1990, 1991 and 1992 dividends are cumulative to the extent of 12% of liquidation value ($493,000). To date, dividends are cumulative to the extent of an amount equal to 17% of liquidation preference or $699,000. The holders of the 25% Preferred have voting rights on all matters other than election of Directors. The 25% Preferred is redeemable at any time prior to the required redemption at the Company's option. Based on the current number of shares outstanding, the terms of the 25% Preferred require redemption at a price of $125 per share, minus certain dividends if previously paid, on February 12, 1995 of $548,000, on February 12, 1999 of $2,192,000, and on February 12, 2000 of $1,370,000 (for the remaining shares). No accrual has been made for dividends on the 25% Preferred. The 25% Preferred was recorded at issuance at $9.35 per share and is being accreted to a redemption price of $125 per share through the redemption dates utilizing the interest method. The accretion is charged to retained earnings, if available, or additional paid-in capital. During fiscal 1994, 6,382 shares of the 25% Preferred were converted to 31,910 shares of the Company's Class A common stock. NOTE 7. -- EARNINGS PER SHARE Earnings per share for the years ended June 30, 1992, 1993 and 1994, respectively, are based on the weighted average number of shares of common stock outstanding, adjusted to give effect to common stock equivalents consisting of shares issuable upon conversion of the 25% Preferred (209,905, 197,845, and 164,425 shares, respectively), shares of Class B common stock issued to the Company's Bank Debt Holders pursuant to the Bank Credit Agreement (390,298 shares for each of the two years ended June 30, 1992 and 1993 and 64,102 shares, for the year ended June 30, 1994) and contingently issuable shares pursuant to stock option plans and other contracts (250,951, 294,146, and 489,365 shares, respectively). The number of shares used in the computation was 3,358,491, 3,449,752, and 3,681,410 for 1992, 1993 and 1994, respectively. Net income available to common stockholders has been adjusted for the accretion of the preferred stock redemption requirement applicable to the 25% Preferred. NOTE 8. -- STOCKHOLDERS' EQUITY AND EMPLOYEE STOCK PLANS In November 1992, the Company amended its Amended and Restated Certificate of Incorporation to effect a recapitalization through a one-for-five reverse stock split (the "Reverse Stock Split") pursuant to which on November 10, 1992 (the "Effective Date") every five shares of the Company's 25% Participating Cumulative Convertible Redeemable Preferred Stock, par value $1.00 per share, outstanding on the Effective Date became and are exchangeable for one new share of 25% Preferred and pursuant to which every five shares of the Company's Common Stock, par value $.01 per share, outstanding on the Effective Date became and are exchangeable for one new share of Common Stock F-14 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 8. -- STOCKHOLDERS' EQUITY AND EMPLOYEE STOCK PLANS (CONTINUED) with par value of $.05 per share. The accompanying financial statements, and management's discussion and analysis of results of operations and financial condition, including all share and per share amounts (including, without limitation, all amounts stated as of a specific historical date) and par values have been adjusted to reflect this transaction. In May 1991, the Class B common stock was issued to the holders of the Company's formerly outstanding bank debt in exchange for $18,620,000 principal amount of outstanding bank debt. The Class B stock is non-voting and generally is automatically converted into Class A common stock upon its sale or disposition. The terms of the Company's note indenture and the New Credit Agreement contain certain covenants which significantly limit and/or restrict the Company's ability to declare and pay dividends on its common stock. Under the Long-Term Stock Incentive Plan -- 1989 (the "1989 Plan"), as amended, approximately 708,200 shares of Class A common stock were reserved for issuance from which 195,735 options were outstanding at June 30, 1994. Exercise prices of options outstanding are equal to fair market value of such shares on the dates the options were granted. Options granted to executive officers are fully vested and exercisable at June 30, 1994. Options issued to grantees other than executive officers are exercisable at the rate of 25% per year commencing on the date of grant and expire ten years from the date of grant. The table below summarizes the activity in the Company's 1989 Plan for the years ended June 30, 1992, 1993 and 1994:
1992 1993 1994 --------- --------- --------- Options outstanding at beginning of period........................... 321,816 237,754 224,325 Granted ($3.10 per share in 1992 and prices ranging from $3.73 to $7.00 per share in 1993)............................................ 1,000 60,600 -- Exercised ($0.90 in 1992; $.70 and $.90 per share in 1993; and $.90 to $5.26 per share in 1994)......................................... (20,150) (56,479) (18,390) Canceled............................................................. (64,912) (17,550) (10,200) --------- --------- --------- Outstanding at end of period......................................... 237,754 224,325 195,735 --------- --------- --------- --------- --------- --------- Exercisable at end of period......................................... 175,604 146,925 155,375 --------- --------- --------- --------- --------- ---------
Under the Stock Incentive Performance Plan -- 1991 (the "Performance Plan"), which was instituted in fiscal 1992, 200,000 shares of Class A common stock were reserved for issuance at June 30, 1994. Options for the purchase of 159,525 of such shares were outstanding at June 30, 1994. The exercise price of options outstanding equals fair market value of such shares on the date the options were granted. Options were issued to certain grantees other than executive officers and are exercisable at the rate of 20% per year commencing one year from the date of grant. Such options expire ten years from the date of grant. F-15 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 8. -- STOCKHOLDERS' EQUITY AND EMPLOYEE STOCK PLANS (CONTINUED) The table below summarizes the activity in the Performance Plan for the years ended June 30, 1992, 1993 and 1994:
1992 1993 1994 --------- --------- --------- Outstanding at beginning of period................................... -- 165,605 194,605 Granted (prices ranging from $5.40 to $9.70 per share in 1992; $3.15 to $4.58 per share in 1993 and $8.50 to $16.75 per share in 1994)... 197,205 106,400 40,800 Exercised ($3.15 to $5.40 per share in 1994)......................... -- -- (20,560) Canceled............................................................. (31,600) (77,400) (55,320) --------- --------- --------- Outstanding at end of period......................................... 165,605 194,605 159,525 --------- --------- --------- --------- --------- --------- Exercisable at end of period......................................... -- 21,321 35,242 --------- --------- --------- --------- --------- ---------
Under the 1993 Stock Option Plan, which was instituted in fiscal 1994, 200,000 shares of Class A common stock were reserved for issuance at June 30, 1994. Options for the purchase of 82,939 of such shares were outstanding at June 30, 1994. The exercise price of options outstanding equals fair market value of such shares on the date the options were granted. Options were issued to executive officers and certain other employees of the Company and are exercisable at the rate of 25% per year commencing one year from the date of grant. Such options expire ten years from the date of grant. The table below summarizes the activity in the 1993 Stock Option Plan for the year ended June 30, 1994:
1994 --------- Granted (prices ranging from $12.13 to $13.00 per share)...................................... 88,500 Canceled...................................................................................... (5,561) --------- Outstanding at end of period.................................................................. 82,939 --------- --------- Exercisable at end of period.................................................................. -- --------- ---------
At June 30, 1994, the Company had outstanding options to purchase 25,000 shares at $13.63 per share and 40,000 shares at $5.40 per share. Such options were granted to non-employee directors under the 1991 Directors' Stock Option Plan. The exercise price of options outstanding equals fair market value of such shares on the date the options were granted and the options are exercisable at the rate of 20% per year commencing one year from the date of grant. Such options expire ten years from the date of grant. At June 30, 1994, 16,000 of such options were exercisable. At June 30, 1994, the Company had outstanding options to purchase 20,000 shares of Class A common stock at $7.50 per share. Such options were granted pursuant to a termination agreement with a former executive officer of the Company and expire in August, 1996. The Company has a Long-Term Cash Incentive Plan -- 1990, as amended, for certain executive officers and employees which provided for a cash bonus of approximately $2,036,000 vesting in fiscal 1994 and 1995. During fiscal 1994 the Board of Directors amended the plan providing for a cash bonus of approximately $582,000 and a stock bonus of approximately 176,000 shares of the Company's Class A Common Stock vesting in fiscal 1994 and payable in fiscal 1995. Pursuant to such amendment, an accrual of $1,341,000 for shares to be issued under the amended plan has been credited to Additional paid-in-capital in the accompanying consolidated balance sheet as of June 30, 1994. F-16 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 8. -- STOCKHOLDERS' EQUITY AND EMPLOYEE STOCK PLANS (CONTINUED) During fiscal 1994, the Company adopted the 1993 Long-Term Incentive Plan for certain executive officers and employees which provides for the payment of certain bonuses in cash or a combination of cash and stock in future periods conditional upon the attainment of certain financial goals and continued employment through June 30, 1996. At June 30, 1994, the Company had accrued $1,273,000 under such incentive plan. NOTE 9. -- INCOME TAXES The components of the provision for income taxes follow (in thousands):
YEAR ENDED JUNE 30, ------------------------------- 1992 1993 1994 --------- --------- --------- Current: Federal....................................................... $ 2,559 $ 2,567 $ 193 State.......................................................... 222 391 395 Deferred: Federal...................................................... -- -- 1,969 State......................................................... 480 345 269 --------- --------- --------- Provision for income taxes before extraordinary items.................. 3,261 3,303 2,826 Extraordinary items: Federal and state.................................................... 42 1,344 2,170 Credit resulting from utilization of net operating loss carryforwards......................................................... (2,682) (3,914) -- --------- --------- --------- Total tax provision................................................ $ 621 $ 733 $ 4,996 --------- --------- --------- --------- --------- ---------
A reconciliation between the tax provision computed using the Federal statutory rate and the total tax provision follows (in thousands):
YEAR ENDED JUNE 30, ------------------------------- 1992 1993 1994 --------- --------- --------- Federal income tax provision at statutory rate......................... $ 2,470 $ 2,636 $ 2,288 State income taxes, net of federal benefit............................. 515 548 438 Recognition of differences in the book and tax basis of assets......... 245 216 -- Goodwill amortization.................................................. 84 85 85 Other.................................................................. (53) (182) 15 --------- --------- --------- Provision for income taxes before extraordinary items.................. 3,261 3,303 2,826 Extraordinary items: Gain on restructure of debt.......................................... 42 1,344 2,170 Credit from utilization of net operating loss carryforwards.......... (2,682) (3,914) -- --------- --------- --------- Total tax provision................................................ $ 621 $ 733 $ 4,996 --------- --------- --------- --------- --------- ---------
During the fiscal year 1994, the Company adopted SFAS No. 109, "Accounting for Income Taxes". SFAS No. 109 requires a change in accounting for income taxes to an asset and liability approach under which deferred tax assets and liabilities are determined based on the difference between the financial accounting and tax accounting bases of assets and liabilities. Deferred tax assets or liabilities at the end of each period are determined using the currently enacted tax rate expected to apply to taxable income in the periods in which the deferred tax asset or liability is expected to be realized. The Company recorded a credit of $805,000 to reflect the cumulative effect of adopting such standard. F-17 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 9. -- INCOME TAXES (CONTINUED) The tax effects of temporary differences and loss carryforwards representing deferred tax assets and liabilities at June 30, 1994 were as follows (in thousands):
DEFERRED TAX ASSETS: - - ------------------------------------------------------------------------- Operating loss carryforwards......................................... $ 13,899 General and professional liability risks............................. 4,168 Accrued expenses..................................................... 2,521 Long-term liabilities................................................ 2,802 Other................................................................ 2,267 --------- Total deferred tax assets............................................ 25,657 Valuation allowance.................................................. (11,019) --------- Deferred tax assets after valuation allowance........................ 14,638 --------- DEFERRED TAX LIABILITIES: - - ------------------------------------------------------------------------- Property and depreciation............................................ (13,459) Long-term debt and interest.......................................... (6,075) --------- Total deferred tax liabilities....................................... (19,534) --------- Net deferred tax liabilities......................................... $ (4,896) --------- ---------
The net deferred tax liability is classified as follows in the accompanying June 30, 1994 consolidated balance sheet (in thousands): Current assets..................................................... $ 4,757 Long-term liability................................................ (9,653) --------- $ (4,896) --------- ---------
At June 30, 1994, the Company had tax NOL carryforwards of approximately $24,000,000 which expire in fiscal years 2002 through 2006. Such NOL carryforwards may be available to offset future taxable income of the Company, if any. During 1991, the Company issued 390,298 shares of Class B common stock in exchange for $18,620,000 of bank debt. The Company, based on consultation with outside tax and valuation advisors, believes that the exchange qualified under the stock-for-debt exception to the recognition of income from discharge of indebtedness, which was available to insolvent corporations. There can be no assurance, however, that the Internal Revenue Service will not challenge the Company's position. If any such challenge by the Internal Revenue Service were sustained, the Company's current NOL carryforwards could be reduced by as much as $16,000,000. The Internal Revenue Code (the "Code") contains provisions which limit the use of NOL carryforwards following significant changes in ownership of a corporation's stock. A significant change in ownership generally occurs when persons holding 5% or more of the corporation's stock ("5% shareholders") increase their percentage ownership of such stock, in the aggregate, by more than 50% during any three year period. The Company believes that no significant change in ownership has occurred that would limit the Company's use of the NOL carryforwards described above. However, use of such NOL carryforwards could be limited in the future as a result of, among other things, future F-18 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 9. -- INCOME TAXES (CONTINUED) purchases of the Company's stock by 5% shareholders or the issuance of additional stock (including the issuance of options under the Company's employee benefit plans). The proposed merger with Community (Note 2), if consummated, would constitute a change of control under the Code. NOTE 10. -- COMMITMENTS AND CONTINGENCIES LITIGATION The Company is subject to claims and legal actions by patients and others in the ordinary course of business. The Company believes that such claims will not have a material adverse effect on the Company's financial position or results of operations. The Company is self-insured against a portion of its general and professional liability risks. The liability recorded for losses incurred and claims made is based upon individual case estimates for losses reported and upon estimates on the basis of past experience for incurred but not reported losses. The Company has established and funded a trust fund to pay certain of its general and professional liability losses. The balance of such trust fund was $10,573,000 and $9,522,000 at June 30, 1993 and 1994, respectively. Of such amounts, $1,300,000 and $1,350,000 at June 30, 1993 and 1994, respectively, is classified in the accompanying consolidated balance sheets under the caption "Other current assets" and represents the amount of claims and loss adjustment expenses expected to be paid within the following twelve months. The remaining balance in such trust fund is classified as "Funds held by trustees". Such self-insurance funds have been pledged as collateral for four letters of credit issued by a commercial bank totalling $6,858,000. OTHER CONTINGENCIES The Company has employment agreements with two executive officers which provide for certain payments and benefits, including accelerated vesting of unvested stock options and bonus payments, in the event of a "change in control" of the Company, as defined. Change in control is generally defined as the acquisition of that number of shares of the outstanding stock which would allow such acquiring entity or a concerted group of entities to elect a majority of the Company's Board of Directors. The employment agreements for two executive officers were approved by the Board of Directors in 1989 and subsequently amended in 1994. Pursuant to their terms, the agreements currently are for terms which expire on September 30, 1996. Absent notice within designated periods, such agreements automatically renew for additional one year terms. The maximum contingent liability under the agreements is approximately $2,700,000. The proposed merger with Community (Note 2), if consummated, would constitute a change of control under the employment agreements. NOTE 11. -- SUPPLEMENTAL INFORMATION TO CONSOLIDATED STATEMENTS OF CASH FLOWS The Company paid $9,796,000, $10,691,000, and $7,923,000 in interest on various obligations in the fiscal years ended June 30, 1992, 1993, and 1994, respectively. The Company paid $458,000, $458,000, and $620,000, in income taxes in the fiscal years ended June 30, 1992, 1993, and 1994, respectively. F-19 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 12. -- QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
FISCAL 1994 QUARTERS ENDED ------------------------------------------------ SEPTEMBER 30 DECEMBER 31 MARCH 31 JUNE 30 ------------ ------------ --------- --------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Total revenues................................................ $ 47,328 $ 47,936 $ 48,805 $ 47,475 Income before income taxes, extraordinary items and cumulative effect of accounting change.................................. 2,168 1,100 2,649 811 Income before extraordinary items and cumulative effect of accounting change............................................ 1,257 638 1,536 471 Extraordinary gain on restructure of debt, net of income tax effect of $2,170............................................. -- 19,784 -- -- Cumulative effect of accounting change........................ 805 -- -- -- ------------ ------------ --------- --------- Net income................................................ $ 2,062 $ 20,422 $ 1,536 $ 471 ------------ ------------ --------- --------- ------------ ------------ --------- --------- Net income per common and common equivalent share (1) Income before extraordinary items and cumulative effect of accounting change............................................ $ 0.34 $ 0.17 $ 0.42 $ 0.13 Extraordinary gain on restructure of debt, net of income tax effect....................................................... -- 5.26 -- -- Cumulative effect of accounting change........................ 0.21 -- -- -- ------------ ------------ --------- --------- Net income per common and common equivalent share......... $ 0.55 $ 5.43 $ 0.42 $ 0.13 ------------ ------------ --------- --------- ------------ ------------ --------- --------- Weighted average common and common equivalent shares outstanding.................................................. 3,728 3,760 3,676 3,684 ------------ ------------ --------- --------- ------------ ------------ --------- --------- - - ------------------------ (1) The sum of per share amounts does not equal the annual per share amount due to quarterly fluctuations in weighted average common and common equivalent shares outstanding.
During the quarters ended September 30, 1993, December 31, 1993, March 31, 1994, and June 30, 1994, the Company recognized credits of $65,000, $347,000, $549,000, and $1,347,000, respectively, from reductions to contractual reserves primarily as a result of estimate changes and favorable settlements of prior year cost reports with program intermediaries. Such amounts are reflected in the accompanying consolidated statements of income as adjustments to net patient service revenues. F-20 HALLMARK HEALTHCARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED JUNE 30, 1994 NOTE 12. -- QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (CONTINUED) During the third quarter of fiscal 1994, the Company recognized a credit of $1,323,000 due to a reduction in the Company's general and professional liability reserves based on updated estimates of the Company's expected general and professional liability losses.
FISCAL 1993 QUARTERS ENDED ------------------------------------------------ SEPTEMBER 30 DECEMBER 31 MARCH 31 JUNE 30 ------------ ------------ --------- --------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Total revenues................................................ $ 41,581 $ 43,572 $ 47,216 $ 46,868 Income before income taxes and extraordinary items........................................................ 544 1,159 3,826 2,224 Income before extraordinary items............................. 211 573 2,341 1,325 Extraordinary items: Gain on restructure of debt, net of income tax effect of $253, $549 and $542, respectively.......................... -- 490 1,066 461 Credit resulting from utilization of net operating loss carryforward............................................... 243 646 1,826 1,199 ------------ ------------ --------- --------- Net income................................................ $ 454 $ 1,709 $ 5,233 $ 2,985 ------------ ------------ --------- --------- ------------ ------------ --------- --------- Net income per common and common equivalent share (1) Income before extraordinary items............................. $ .07 $ .17 $ .70 $ .38 Extraordinary items: Gain on restructure of debt, net of income tax effect....... -- .15 .32 .13 Credit resulting from utilization of net operating loss carryforward............................................... .07 .19 .54 .35 ------------ ------------ --------- --------- Net income per common and common equivalent share......... $ .14 $ .51 $ 1.56 $ .86 ------------ ------------ --------- --------- ------------ ------------ --------- --------- Weighted average common and common equivalent shares outstanding.................................................. 3,343 3,346 3,350 3,453 ------------ ------------ --------- --------- ------------ ------------ --------- --------- - - ------------------------ (1) The sum of per share amounts does not equal the annual per share amount due to quarterly fluctuations in weighted average common and common equivalent shares outstanding.
During the quarters ended September 30, 1992, December 31, 1992, March 31, 1993, and June 30, 1993, the Company recognized credits (charges) of $458,000, $499,000, $1,135,000, and ($13,000), respectively, from reductions to (increases in) contractual reserves primarily as a result of estimate changes and favorable settlements of prior year cost reports with program intermediaries. Such amounts are reflected in the accompanying consolidated statements of income as adjustments to net patient service revenues. During the third quarter of fiscal 1993, the Company recognized a credit of $1,266,000 due to a reduction in the Company's general and professional liability reserves based on updated estimates of the Company's expected general and professional liability losses. F-21 SCHEDULE V HALLMARK HEALTHCARE CORPORATION PROPERTY, PLANT AND EQUIPMENT JUNE 30, 1992, 1993, AND 1994 (DOLLARS IN THOUSANDS)
BALANCE BALANCE JUNE 30, ADDITIONS OTHER JUNE 30, 1991 AT COST RETIREMENTS CHANGES(1) 1992 ----------- ----------- ----------- ----------- ----------- Land and improvements............................. $ 7,828 $ 24 $ 15 $ 85 $ 7,922 Buildings and improvements........................ 104,135 894 171 288 105,146 Equipment......................................... 51,078 4,648 426 166 55,466 Construction in progress.......................... 568 1,763 -- (539) 1,792 ----------- ----------- ----------- ----------- ----------- $ 163,609 $ 7,329 $ 612 $ -- $ 170,326 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE BALANCE JUNE 30, ADDITIONS OTHER JUNE 30, 1992 AT COST RETIREMENTS CHANGES(1) 1993 ----------- ----------- ----------- ----------- ----------- Land and improvements............................. $ 7,922 $ 21 $ 666 $ -- $ 7,277 Buildings and improvements........................ 105,146 515 8,460 1,686 98,887 Equipment......................................... 55,466 2,561 5,434 703 53,296 Construction in progress.......................... 1,792 3,314 490 (2,389) 2,227 ----------- ----------- ----------- ----------- ----------- $ 170,326 $ 6,411 $ 15,050 $ -- $ 161,687 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE BALANCE JUNE 30, ADDITIONS OTHER JUNE 30, 1993 AT COST RETIREMENTS CHANGES(1) 1994 ----------- ----------- ----------- ----------- ----------- Land and improvements............................. $ 7,277 $ 231 $ -- $ 47 $ 7,555 Buildings and improvements........................ 98,887 380 2 2,533 101,798 Equipment......................................... 53,296 2,538 152 520 56,202 Construction in progress.......................... 2,227 1,560 -- (3,100) 687 ----------- ----------- ----------- ----------- ----------- $ 161,687 $ 4,709 $ 154 $ -- $ 166,242 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- - - ------------------------ (1) Other changes represent transfers during the year between construction in progress and other property, plant and equipment categories.
S-1 SCHEDULE VI HALLMARK HEALTHCARE CORPORATION ACCUMULATED DEPRECIATION, DEPLETION, AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT JUNE 30, 1992, 1993, AND 1994 (DOLLARS IN THOUSANDS)
ADDITIONS BALANCE CHARGED TO BALANCE JUNE 30, COSTS AND OTHER JUNE 30, 1991 EXPENSES RETIREMENTS CHANGES 1992 --------- ----------- ----------- ----------- --------- Land improvements...................................... $ 1,009 $ 212 $ -- $ -- $ 1,221 Buildings and improvements............................. 24,549 3,375 118 (8) 27,798 Equipment.............................................. 20,403 5,429 253 8 25,587 --------- ----------- ----------- ----------- --------- $ 45,961 $ 9,016 $ 371 $ -- $ 54,606 --------- ----------- ----------- ----------- --------- --------- ----------- ----------- ----------- ---------
ADDITIONS BALANCE CHARGED TO BALANCE JUNE 30, COSTS AND OTHER JUNE 30, 1992 EXPENSES RETIREMENTS CHANGES 1993 --------- ----------- ----------- ----------- --------- Land improvements...................................... $ 1,221 $ 302 $ 140 $ -- $ 1,383 Buildings and improvements............................. 27,798 3,131 6,692 -- 24,237 Equipment.............................................. 25,587 5,053 2,808 -- 27,832 --------- ----------- ----------- ----------- --------- $ 54,606 $ 8,486 $ 9,640 $ -- $ 53,452 --------- ----------- ----------- ----------- --------- --------- ----------- ----------- ----------- ---------
ADDITIONS BALANCE CHARGED TO BALANCE JUNE 30, COSTS AND OTHER JUNE 30, 1993 EXPENSES RETIREMENTS CHANGES 1994 --------- ----------- ----------- ----------- --------- Land improvements...................................... $ 1,383 $ 264 $ -- $ -- $ 1,647 Buildings and improvements............................. 24,237 2,768 8 -- 26,997 Equipment.............................................. 27,832 5,821 75 -- 33,578 --------- ----------- ----------- ----------- --------- $ 53,452 $ 8,853 $ 83 $ -- $ 62,222 --------- ----------- ----------- ----------- --------- --------- ----------- ----------- ----------- ---------
S-2 SCHEDULE VIII HALLMARK HEALTHCARE CORPORATION VALUATION AND QUALIFYING ACCOUNTS JUNE 30, 1992, 1993, AND 1994 (DOLLARS IN THOUSANDS)
ADDITIONS BALANCE CHARGED TO DEDUCTIONS BALANCE JUNE 30, COSTS AND CHARGED TO DEDUCTIONS JUNE 30, 1991 EXPENSES OTHER ACCOUNTS (1) 1992 --------- ----------- -------------- ------------- --------- Allowance for doubtful accounts................. $ 4,495 $ 11,775 $ -- $ 12,163 $ 4,107 --------- ----------- -------------- ------------- --------- --------- ----------- -------------- ------------- ---------
ADDITIONS BALANCE CHARGED TO DEDUCTIONS BALANCE JUNE 30, COSTS AND CHARGED TO DEDUCTIONS JUNE 30, 1992 EXPENSES OTHER ACCOUNTS (1) 1993 --------- ----------- -------------- ------------- --------- Allowance for doubtful accounts................. $ 4,107 $ 10,796 $ -- $ 10,768 $ 4,135 --------- ----------- -------------- ------------- --------- --------- ----------- -------------- ------------- ---------
ADDITIONS BALANCE CHARGED TO DEDUCTIONS BALANCE JUNE 30, COSTS AND CHARGED TO DEDUCTIONS JUNE 30, 1993 EXPENSES OTHER ACCOUNTS (1) 1994 --------- ----------- -------------- ------------- --------- Allowance for doubtful accounts................. $ 4,135 $ 12,713 $ -- $ 12,765 $ 4,083 --------- ----------- -------------- ------------- --------- --------- ----------- -------------- ------------- --------- - - ------------------------ (1) To write off uncollectible amounts.
S-3 EX-2.1 2 EXHIBIT 2.1 APPENDIX A AMENDED AND RESTATED AGREEMENT AND PLAN OF MERGER AMENDED AND RESTATED AGREEMENT AND PLAN OF MERGER (this "Agreement"), dated as of June 10, 1994, by and among COMMUNITY HEALTH SYSTEMS, INC., a Delaware corporation ("CHS"), COMMUNITY ACQUISITION CORP., a Delaware corporation and a wholly-owned subsidiary of CHS ("Merger Sub"), and HALLMARK HEALTHCARE CORPORATION, a Delaware corporation ("Hallmark"). RECITALS A. CHS, Merger Sub and Hallmark are parties to that certain Agreement and Plan of Merger, dated as of June 10, 1994, and desire to amend such Agreement and Plan of Merger, and to restate such agreement in its entirety as amended. B. The Boards of Directors of CHS and Hallmark each have determined that a business combination between CHS and Hallmark is in the best interests of their respective companies and stockholders and, accordingly, have agreed to effect the merger provided for herein upon the terms and subject to the conditions set forth herein. C. For federal income tax purposes, it is intended that the merger provided for herein shall qualify as a reorganization within the meaning of Section 368 of the Internal Revenue Code of 1986, as amended (the "Code"), and, for financial accounting purposes, shall be accounted for as a "pooling of interests." D. CHS and Hallmark have each received a fairness opinion as more fully described herein. E. CHS, Merger Sub and Hallmark desire to make certain representations, warranties and agreements in connection with the merger. NOW THEREFORE, in consideration of the foregoing, and of the representations, warranties, covenants and agreements contained herein, the parties hereto hereby agree as follows: ARTICLE 1 1. THE MERGER. 1.1. THE MERGER. Subject to the terms and conditions of this Agreement, at the Effective Time (as defined in Section 1.3), Hallmark shall be merged with and into Merger Sub (the "Merger") in accordance with this Agreement and the separate corporate existence of Hallmark shall thereupon cease. Merger Sub shall be the surviving corporation in the Merger (sometimes hereinafter referred to as the "Surviving Corporation"). The Merger shall have the effects specified in the Delaware General Corporation Law (the "DGCL"). 1.2. THE CLOSING. Subject to the terms and conditions of this Agreement, the closing of the Merger (the "Closing") shall take place (a) at the offices of McGlinchey Stafford Lang, A Law Corporation, 643 Magazine Street, New Orleans, Louisiana, at 10:00 a.m., local time, on the first business day immediately following the day on which the last to be fulfilled or waived of the conditions set forth in Article 8 shall be fulfilled or waived in accordance herewith or (b) at such other time, date or place as CHS and Hallmark may agree. The date on which the Closing occurs is hereinafter referred to as the "Closing Date." 1.3. EFFECTIVE TIME. If all the conditions to the Merger set forth in Article 8 shall have been fulfilled or waived in accordance herewith and this Agreement shall not have been terminated as provided in Article 9, the parties hereto shall cause a Certificate of Merger meeting the requirements of Section 251 of the DGCL to be properly executed and filed in accordance with such Section on the A-1 Closing Date. The Merger shall become effective at the time of filing of the Certificate of Merger with the Secretary of State of the State of Delaware in accordance with the DGCL or at such later time which the parties hereto shall have agreed upon and designated in such filing as the effective time of the Merger (the "Effective Time"). ARTICLE 2 2. CERTIFICATE OF INCORPORATION AND BYLAWS OF THE SURVIVING CORPORATION. 2.1. CERTIFICATE OF INCORPORATION. The Certificate of Incorporation of Merger Sub in effect immediately prior to the Effective Time shall be the Certificate of Incorporation of the Surviving Corporation, until duly amended in accordance with applicable law. 2.2. BYLAWS. The Bylaws of Merger Sub in effect immediately prior to the Effective Time shall be the Bylaws of the Surviving Corporation, until duly amended in accordance with applicable law. ARTICLE 3 3. DIRECTORS AND OFFICERS OF THE SURVIVING CORPORATION. 3.1. DIRECTORS. The directors of Merger Sub immediately prior to the Effective Time shall be the directors of the Surviving Corporation as of the Effective Time. 3.2. OFFICERS. The officers of Merger Sub immediately prior to the Effective Time shall be the officers of the Surviving Corporation as of the Effective Time. ARTICLE 4 4. CONVERSION OF HALLMARK STOCK. 4.1. CONVERSION OF HALLMARK STOCK. (a) At the Effective Time, each share of the Common Stock, $.01 par value, of Merger Sub outstanding immediately prior to the Effective Time shall remain outstanding and shall represent one share of Common Stock, $.01 par value, of the Surviving Corporation. (b) At the Effective Time, each share of Class A Common Stock, $.05 par value, of Hallmark and each share of Class B Common Stock, $.05 par value, of Hallmark (collectively, "Hallmark Common Stock"), issued and outstanding immediately prior to the Effective Time shall, by virtue of the Merger and without any action on the part of the holder thereof, be converted into the right to receive .97 shares of Common Stock, $.01 par value ("CHS Common Stock"), of CHS (the "Exchange Ratio"). (c) At the Effective Time, each share of 25% Participating Cumulative Convertible Redeemable Preferred Stock, $5 par value ("Redeemable Preferred Stock"), of Hallmark issued and outstanding immediately prior to the Effective Time (other than those with respect to which the holder thereof has perfected appraisal rights under the DGCL and has not subsequently lost, withdrawn or forfeited such rights) shall, by virtue of the Merger and without any action on the part of the holder thereof, be converted into the right to receive 5.4 shares of CHS Common Stock (the "Preferred Exchange Ratio"). (d) As a result of the Merger and without any action on the part of the holder thereof, all shares of Hallmark Common Stock and all shares of Redeemable Preferred Stock shall cease to be outstanding and shall be canceled and retired and shall cease to exist, and each holder of a certificate (a "Certificate") representing any shares of Hallmark Common Stock or any shares of Redeemable Preferred Stock shall thereafter cease to have any rights with respect to such shares of Hallmark Common Stock or Redeemable Preferred Stock, except the right to receive, without interest, the CHS Common Stock and cash for fractional shares of CHS Common Stock in accordance with Sections 4.1(b), 4.1(c) and 4.2(e) upon the surrender of such Certificate. A-2 (e) Each share of Hallmark Common Stock and Redeemable Preferred Stock issued and held in Hallmark's treasury at the Effective Time shall, by virtue of the Merger, cease to be outstanding and shall be canceled and retired without payment of any consideration therefor. (f) All options (individually, a "Hallmark Option" and collectively, the "Hallmark Options") outstanding immediately prior to the Effective Time under Hallmark's 1993 Stock Option Plan, Long-Term Stock Incentive Plan -- 1989, Stock Incentive Performance Plan -- 1991 and 1991 Directors' Stock Option Plan, as amended (collectively, the "Hallmark Stock Option Plans"), and options set forth in the Hallmark Disclosure Letter shall remain outstanding following the Effective Time. At the Effective Time, such Hallmark Options shall, by virtue of the Merger and without any further action on the part of Hallmark or the holder of any such Hallmark Options, be assumed by CHS in such manner that CHS (i) is a corporation "assuming a stock option in a transaction to which Section 424(a) applied" within the meaning of Section 424 of the Internal Revenue Code of 1986, as amended (the "Code"), or (ii) to the extent that Section 424 of the Code does not apply to any such Hallmark Options, would be such a corporation were Section 424 applicable to such option. Each Hallmark Option assumed by CHS shall be exercisable upon the same terms and conditions as under the applicable Hallmark Stock Option Plan and the applicable option agreement issued thereunder, except that (i) each such Hallmark Option shall be exercisable for that whole number of shares of CHS Common Stock (to the nearest whole share) into which the number of shares of Hallmark Common Stock subject to such Hallmark Option immediately prior to the Effective Time would be converted under this Section 4.1, and (ii) the option price per share of CHS Common Stock shall be an amount equal to the option price per share of Hallmark Common Stock subject to such Hallmark Option in effect immediately prior to the Effective Time divided by the Exchange Ratio (the price per share, as so determined, being rounded down to the nearest full cent). Within ten days after the Closing Date, CHS shall notify each holder of an option under the Hallmark Stock Option Plans of the assumption of such options by CHS and the revisions to the options effected thereby. No payment shall be made for fractional interests. From and after the date of this Agreement, no additional options shall be granted by Hallmark or its Subsidiaries under the Hallmark Stock Option Plans or otherwise. 4.2. EXCHANGE OF CERTIFICATES REPRESENTING HALLMARK COMMON STOCK AND REDEEMABLE PREFERRED STOCK. (a) As of the Effective Time, CHS shall deposit, or shall cause to be deposited, with CHS's Transfer Agent, as exchange agent (the "Exchange Agent"), for the benefit of the holders of shares of Hallmark Common Stock and Redeemable Preferred Stock, for exchange in accordance with this Article 4, certificates representing the shares of CHS Common Stock and cash in lieu of fractional shares (such cash and certificates for shares of CHS Common Stock being hereinafter referred to as the "Exchange Fund") to be issued pursuant to Section 4.1 and paid pursuant to this Section 4.2 in exchange for outstanding shares of Hallmark Common Stock and Redeemable Preferred Stock. (b) Promptly after the Effective Time, CHS shall cause the Exchange Agent to mail to each holder of record of a Certificate or Certificates (other than those representing Redeemable Preferred Stock with respect to which the holder thereof has perfected appraisal rights under the DGCL and has not subsequently lost, withdrawn or forfeited such rights) (i) a letter of transmittal which shall specify that delivery shall be effected, and risk of loss and title to the Certificates shall pass, only upon delivery of the Certificates to the Exchange Agent and shall be in such form and have such other provisions as CHS may reasonably specify and (ii) instructions for use in effecting the surrender of the Certificates in exchange for certificates representing shares of CHS Common Stock and cash in lieu of fractional shares. Upon surrender of a Certificate for cancellation to the Exchange Agent together with such letter of transmittal, duly executed and completed in accordance with the instructions thereto, the holder of such Certificate shall be entitled to receive in exchange therefor (x) a certificate representing that number of whole shares of CHS Common Stock and (y) a check representing the amount of cash in lieu of fractional shares, if any, which such holder has the right to receive in respect of the Certificate surrendered pursuant to Section 4.1(b) or Section 4.1(c), after giving effect to any required withholding tax, and the Certificate so surrendered shall forthwith be canceled. No interest will be A-3 paid or accrued on the value of any CHS Common Stock or cash payable to holders of Certificates. In the event of a transfer of ownership of Hallmark Common Stock or Redeemable Preferred Stock which is not registered in the transfer records of Hallmark, a certificate representing the proper number of shares of CHS Common Stock, together with a check for the cash to be paid in lieu of fractional shares, may be issued to such a transferee if the Certificate representing such Hallmark Common Stock or Redeemable Preferred Stock is presented to the Exchange Agent, accompanied by all documents required to evidence and effect such transfer and to evidence that any applicable stock transfer taxes have been paid. (c) Notwithstanding any other provisions of this Agreement, no dividends on CHS Common Stock shall be paid with respect to any shares of Hallmark Common Stock or Redeemable Preferred Stock represented by a Certificate until such Certificate is surrendered for exchange as provided herein. Subject to the effect of applicable laws, following surrender of any such Certificate, there shall be paid to the holder of the certificates representing whole shares of CHS Common Stock issued in exchange therefor, without interest, (i) at the time of such surrender, the amount of dividends or other distributions with a record date after the Effective Time theretofore payable with respect to such whole shares of CHS Common Stock and not paid, less the amount of any withholding taxes which may be required thereon, and (ii) at the appropriate payment date, the amount of dividends or other distributions with a record date after the Effective Time but prior to surrender and a payment date subsequent to surrender payable with respect to such whole shares of CHS Common Stock, less the amount of any withholding taxes which may be required thereon. (d) At or after the Effective Time, there shall be no transfers on the stock transfer books of Hallmark of the shares of Hallmark Common Stock or Redeemable Preferred Stock which were outstanding immediately prior to the Effective Time. If, after the Effective Time, Certificates are presented to the Surviving Corporation, they shall be canceled and exchanged for certificates for shares of CHS Common Stock and cash in lieu of fractional shares, if any, deliverable in respect thereof pursuant to this Agreement in accordance with the procedures set forth in this Article 4. Certificates surrendered for exchange by any person constituting an "affiliate" of Hallmark for purposes of Rule 145(c) under the Securities Act of 1933 (the "Securities Act") shall not be exchanged until CHS has received a written agreement from such person as provided in Section 7.10. (e) No fractional shares of CHS Common Stock shall be issued pursuant hereto. In lieu of the issuance of any fractional share of CHS Common Stock pursuant to Section 4.1(b) or Section 4.1(c), cash adjustments will be paid to holders in respect of any fractional share of CHS Common Stock that would otherwise be issuable, and the amount of such cash adjustment shall be equal to such fractional proportion of the "Average Price" of a share of CHS Common Stock. The "Average Price" of a share of CHS Common Stock shall be the average of the closing sales prices thereof as reported on The NASDAQ Stock Market ("NASDAQ") or on such other principal exchange on which the CHS Common Stock is listed (as reported by The Wall Street Journal or, if not reported thereby, by another authoritative source) over the ten business days immediately preceding the Closing Date. (f) Any portion of the Exchange Fund (including the proceeds of any investments thereof and any shares of CHS Common Stock) that remains unclaimed by the former stockholders of Hallmark one year after the Effective Time shall be delivered to the Surviving Corporation. Any former stockholders of Hallmark who have not theretofore complied with this Article 4 shall thereafter look only to the Surviving Corporation for payment in respect of their shares, in any event without any interest thereon. (g) None of CHS, Hallmark, the Exchange Agent or any other person shall be liable to any former holder of shares of Hallmark Common Stock or Redeemable Preferred Stock for any amount properly delivered to a public official pursuant to applicable abandoned property, escheat or similar laws. (h) In the event any Certificate shall have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming such Certificate to be lost, stolen or destroyed and, if A-4 required by the Surviving Corporation, the posting by such person of a bond in such reasonable amount as the Surviving Corporation may direct as indemnity against any claim that may be made against it with respect to such Certificate, the Exchange Agent will issue in exchange for such lost, stolen or destroyed Certificate the shares of CHS Common Stock and cash in lieu of fractional shares, and unpaid dividends and distributions on shares of CHS Common Stock as provided in Section 4.2(c), deliverable in respect thereof pursuant to this Agreement. 4.3. ADJUSTMENT OF EXCHANGE RATIO. In the event that, subsequent to the date of this Agreement but prior to the Effective Time, Hallmark or CHS changes the number of shares of Hallmark Common Stock, Redeemable Preferred Stock or CHS Common Stock, respectively, issued and outstanding as a result of a stock split, reverse stock split, stock dividend, recapitalization or other similar transaction, the Exchange Ratio or the Preferred Exchange Ratio, as the case may be, shall be appropriately adjusted. ARTICLE 5 5. REPRESENTATIONS AND WARRANTIES OF HALLMARK. Except as set forth in the disclosure letter delivered at or prior to the execution hereof to CHS (the "Hallmark Disclosure Letter"), Hallmark represents and warrants to CHS as of the date of this Agreement as follows: 5.1. EXISTENCE; GOOD STANDING; CORPORATE AUTHORITY; COMPLIANCE WITH LAW. Hallmark is a corporation duly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation. Hallmark is duly licensed or qualified to do business as a foreign corporation and is in good standing under the laws of any other state of the United States in which the character of the properties owned or leased by it therein or in which the transaction of its business makes such qualification necessary, except where the failure to be so qualified would not have a material adverse effect on the business, results of operations or financial condition of Hallmark and its Subsidiaries (as defined in Section 10.14) taken as a whole (a "Hallmark Material Adverse Effect"). Hallmark has all requisite corporate power and authority to own, operate and lease its properties and carry on its business as now conducted. Each of Hallmark's Significant Subsidiaries (as defined in Section 10.14 hereof) is a corporation or partnership duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation or organization, has the corporate or partnership power and authority to own its properties and to carry on its business as it is now being conducted, and is duly qualified to do business and is in good standing in each jurisdiction in which the ownership of its property or the conduct of its business requires such qualification, except for jurisdictions in which such failure to be so qualified or to be in good standing would not have a Hallmark Material Adverse Effect. Neither Hallmark nor any of its Subsidiaries is in violation of any order of any court, governmental authority or arbitration board or tribunal, or any law, ordinance, governmental rule or regulation to which Hallmark or any Hallmark Subsidiary or any of their respective properties or assets is subject, where such violation would have a Hallmark Material Adverse Effect. Hallmark and its Subsidiaries have obtained all licenses, permits and other authorizations and have taken all action required by applicable law or governmental regulations in connection with their business as now conducted, where the failure to obtain any such item or to take any such action would have a Hallmark Material Adverse Effect. The copies of Hallmark's Certificate of Incorporation and Bylaws previously delivered to CHS are true and correct. 5.2. AUTHORIZATION, VALIDITY AND EFFECT OF AGREEMENTS. Hallmark has the requisite corporate power and authority to execute and deliver this Agreement and all agreements and documents contemplated hereby. Subject only to the approval of this Agreement and the transactions contemplated hereby by the holders of a majority of the combined voting power of the then outstanding shares of Hallmark Common Stock and Redeemable Preferred Stock voting together as a single class (the "Requisite Hallmark Approval"), the consummation by Hallmark of the transactions contemplated hereby has been duly authorized by all requisite corporate action. Subject to obtaining the A-5 Requisite Hallmark Approval, this Agreement constitutes, and all agreements and documents contemplated hereby (when executed and delivered pursuant hereto) will constitute, the valid and legally binding obligations of Hallmark, to the extent it is a party thereto, enforceable in accordance with their respective terms, subject to applicable bankruptcy, insolvency, moratorium or other similar laws relating to creditors' rights and general principles of equity. 5.3. CAPITALIZATION. The authorized capital stock of Hallmark consists of 25,000,000 shares of Hallmark Common Stock, which may be issued and outstanding as either Class A Common Stock or Class B Common Stock and 2,500,000 shares of Preferred Stock, of which 60,000 shares have been designated as Redeemable Preferred Stock and 2,440,000 shares of Preferred Stock are authorized having a par value of $1.00 per share. As of June 10, 1994 there were 2,982,178 shares of Class A Common Stock issued and outstanding, 64,102 shares of Class B Common Stock issued and outstanding, and 32,966 shares of Redeemable Preferred Stock issued and outstanding. Since such date, no additional shares of capital stock of Hallmark have been issued, except (i) upon exercise of options outstanding pursuant to the Hallmark Stock Option Plans, (ii) upon conversion of Class B Common Stock into Class A Common Stock and (iii) upon conversion of Redeemable Preferred Stock into Class A Common Stock. Hallmark has no outstanding bonds, debentures, notes or other obligations the holders of which have the right to vote (or which are convertible into or exercisable for securities having the right to vote) with the stockholders of Hallmark on any matters. All such issued and outstanding shares of Hallmark Common Stock and Redeemable Preferred Stock are duly authorized, validly issued, fully paid, nonassessable and free of preemptive rights. Other than as contemplated by this Agreement or as set forth above, and except for the issuance by Hallmark prior to the Effective Time of up to 176,000 shares of Hallmark Common Stock pursuant to the Long Term Cash Incentive Plan-1990, there are not at the date of this Agreement any existing options, warrants, calls, subscriptions, convertible securities, or other rights, agreements or commitments which obligate Hallmark or any of its Subsidiaries to issue, transfer or sell any shares of capital stock of Hallmark or any of its Subsidiaries. After the Effective Time, the Surviving Corporation will have no obligation to issue, transfer or sell any shares of capital stock of Hallmark or the Surviving Corporation pursuant to any Hallmark Benefit Plan (as defined in Section 5.11). 5.4. SUBSIDIARIES. Each of the outstanding shares of capital stock of each of Hallmark's Subsidiaries is duly authorized, validly issued, fully paid and nonassessable, and is owned, directly or indirectly, by Hallmark free and clear of all liens, pledges, security interests, claims or other encumbrances other than liens imposed by local law which are not material. The Hallmark Disclosure Letter includes the following information for each Subsidiary of Hallmark: (i) its name and jurisdiction of incorporation or organization; (ii) its authorized capital stock or share capital; (iii) the number of issued and outstanding shares of capital stock or share capital; and (iv) the number of shares of such capital stock owned by Hallmark or any of its Subsidiaries. 5.5. OTHER INTERESTS. Except for interests in the Hallmark Subsidiaries, neither Hallmark nor any Hallmark Subsidiary owns directly or indirectly any interest or investment (whether equity or debt) in any corporation, partnership, joint venture, business, trust or entity (other than investments in short-term investment securities). 5.6. NO VIOLATION. Neither the execution and delivery by Hallmark of this Agreement nor the consummation by Hallmark of the transactions contemplated hereby in accordance with the terms hereof, will (i) conflict with or result in a breach of any provisions of the Certificate of Incorporation or Bylaws of Hallmark; (ii) except as disclosed in the Hallmark Reports (as defined in Section 5.7) result in a breach or violation of, a default under, or the triggering of any payment or other material obligations pursuant to, or accelerate vesting under, any of its existing Hallmark Stock Option Plans, or any grant or award made under any of the foregoing other than accelerated vesting of outstanding options under stock option agreements and employment agreements, in existence on the date hereof, with certain employees of Hallmark by reason of, in whole or in part, the consummation of the Merger, (iii) violate, or conflict with, or result in a breach of any provision of, or constitute a default (or an event which, with notice or lapse of time or both, would constitute a default) under, or result in the A-6 termination or in a right of termination or cancellation of, or accelerate the performance required by, or result in the creation of any lien, security interest, charge or encumbrance upon any of the material properties of Hallmark or its Subsidiaries under, or result in being declared void, voidable, or without further binding effect, any of the terms, conditions or provisions of any note, bond, mortgage, indenture, deed of trust or any material license, franchise, permit, lease, contract, agreement or other instrument, commitment or obligation to which Hallmark or any of its Subsidiaries is a party, or by which Hallmark or any of its Subsidiaries or any of their properties is bound or affected, except for any of the foregoing matters which would not have a Hallmark Material Adverse Effect; or (iv) other than the filings provided for in Article 1, certain federal, state and local regulatory filings, filings required under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act"), the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the Securities Act or applicable state securities and "Blue Sky" laws or filings in connection with the maintenance of qualification to do business in other jurisdictions (collectively, the "Regulatory Filings"), require any material consent, approval or authorization of, or declaration, filing or registration with, any domestic governmental or regulatory authority, the failure to obtain or make which would have a Hallmark Material Adverse Effect. 5.7. SEC DOCUMENTS. Hallmark has delivered to CHS each registration statement, report, proxy statement or information statement prepared by it since December 31, 1991, including, without limitation, (i) its Annual Report on Form 10-K for the year ended June 30, 1993, (ii) its Quarterly Reports on Form 10-Q for the periods ended September 30 and December 31, 1993, and March 31, 1994, and (iii) its Proxy Statement for the Annual Meeting of Stockholders held November 23, 1993, each in the form (including exhibits and any amendments thereto) filed with the Securities and Exchange Commission (the "SEC") (collectively, the "Hallmark Reports"). As of their respective dates, the Hallmark Reports (i) were prepared in all material respects in accordance with the applicable requirements of the Securities Act, the Exchange Act, and the rules and regulations thereunder and (ii) did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements made therein, in the light of the circumstances under which they were made, not misleading. Each of the consolidated balance sheets of Hallmark included in or incorporated by reference into the Hallmark Reports (including the related notes and schedules) fairly presents the consolidated financial position of Hallmark and the Hallmark Subsidiaries as of its date and each of the consolidated statements of income, shareholders' equity and cash flows of Hallmark included in or incorporated by reference into the Hallmark Reports (including any related notes and schedules) fairly presents the results of operations, shareholders' equity or cash flows, as the case may be, of Hallmark and the Hallmark Subsidiaries, for the periods set forth therein (subject, in the case of unaudited statements, to exceptions to generally accepted accounting principles as permitted by SEC rules with respect to unaudited quarterly financial statements) in each case in accordance with generally accepted accounting principles consistently applied during the periods involved, except as may be noted therein. Except as and to the extent set forth on the consolidated balance sheet of Hallmark and the Hallmark Subsidiaries at March 31, 1994, including all notes thereto, or as set forth in the Hallmark Reports, neither Hallmark nor any of the Hallmark Subsidiaries has any material liabilities or obligations of any nature (whether accrued, absolute, contingent or otherwise) that would be required to be reflected on, or reserved against in, a balance sheet of Hallmark or in the notes thereto, prepared in accordance with generally accepted accounting principles consistently applied, except liabilities arising in the ordinary course of business since such date. 5.8. LITIGATION. Except as disclosed in the Hallmark Reports filed with the SEC prior to the date hereof, there are no claims, actions, suits, proceedings, arbitrations or investigations pending against Hallmark or the Hallmark Subsidiaries or, to the actual knowledge of the executive officers of Hallmark, threatened against Hallmark or the Hallmark Subsidiaries, at law or in equity, or before or by any federal or state commission, board, bureau, agency or instrumentality, that are reasonably likely to have a Hallmark Material Adverse Effect, nor does any executive officer of Hallmark have actual knowledge of any facts or circumstances that such executive officer believes would be likely to form the basis for any such claims, actions, suits, proceedings, arbitrations or investigations. A-7 5.9. ABSENCE OF CERTAIN CHANGES. Except as disclosed in the Hallmark Reports filed with the SEC prior to the date hereof, since June 30, 1993, Hallmark has conducted its business only in the ordinary course of such business and there has not been (i) any Hallmark Material Adverse Effect; (ii) any declaration, setting aside or payment of any dividend or other distribution with respect to its capital stock; or (iii) any material change in its accounting principles, practices or methods. 5.10. TAXES. Hallmark and each of its Subsidiaries (i) have timely filed all material federal, state and foreign tax returns required to be filed by any of them prior to the date of this Agreement or requests for extension have been timely filed and any such request shall have been granted and not expired and all such returns are complete in all material respects, (ii) have paid or accrued all taxes shown to be due and payable on such returns, and (iii) have properly accrued all such taxes for such periods subsequent to the periods covered by such returns, and (iv) have not had any federal income tax returns audited by the Internal Revenue Service (the "IRS"). 5.11. EMPLOYEE BENEFIT PLANS. All employee benefit plans and other benefit arrangements covering employees of Hallmark and the Hallmark Subsidiaries (the "Hallmark Benefit Plans") are listed in the Hallmark Disclosure Letter, except Hallmark Benefit Plans which are not material. True and complete copies of the Hallmark Benefit Plans have been made available to CHS. To the extent applicable, the Hallmark Benefit Plans comply, in all material respects, with the requirements of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and the Code, and any Hallmark Benefit Plan intended to be qualified under Section 401(a) of the Code has been determined by the IRS to be so qualified. No Hallmark employee benefit plan covered by Title IV of ERISA or Section 412 of the Code is now, or ever was, to the actual knowledge of the executive officers of Hallmark, maintained by Hallmark or any Hallmark Subsidiary, or any predecessors thereof. No Hallmark Benefit Plan nor Hallmark has incurred any liability or penalty under Section 4975 of the Code or Sections 502(i) or 502(l) of ERISA. Each Hallmark Benefit Plan has been maintained and administered in all material respects in compliance with its terms and with ERISA and the Code to the extent applicable thereto. The Hallmark Benefit Plans are, except by reason of possible non-compliance with Section 402(b) of ERISA, terminable by Hallmark. To the actual knowledge of the executive officers of Hallmark, there are no pending or anticipated material claims against or otherwise involving any of the Hallmark Benefit Plans and no suit, action or other litigation (excluding claims for benefits incurred in the ordinary course of Hallmark Benefit Plan activities) has been brought against or with respect to any such Hallmark Benefit Plan, except for any of the foregoing which would not have a Hallmark Material Adverse Effect. All contributions required to be made as of the date hereof to the Hallmark Benefit Plans have been made or provided for. Since September 25, 1980, neither Hallmark nor any entity under "common control" with Hallmark within the meaning of ERISA Section 4001 has contributed to, or been required to contribute to, any "multi-employer plan" (as defined in Section 3(37) and 4001(a)(3) of ERISA). Hallmark does not maintain or contribute to any plan or arrangement which provides or has any liability (except as may be required by law) to provide life insurance, medical or other employee welfare benefits to any employee or former employee upon his retirement or termination of employment and Hallmark has never represented, promised or contracted (whether in oral or written form) to or with any employee or former employee that such benefits would be provided. Except as disclosed in the Hallmark Reports, the execution of, and performance of the transactions contemplated in, this Agreement will not (either alone or upon the occurrence of any additional or subsequent events) constitute an event under any benefit plan, policy, arrangement or agreement or any trust or loan that will or may result in any payment (whether of severance pay or otherwise), acceleration, forgiveness of indebtedness, vesting, distribution, increase in benefits or obligations to fund benefits with respect to any employee. 5.12. LABOR MATTERS. Neither Hallmark nor any of its Subsidiaries is a party to, or bound by, any collective bargaining agreement, contract or other agreement or understanding with a labor union or labor organization. There is no unfair labor practice or labor arbitration proceeding pending or, to the actual knowledge of the executive officers of Hallmark, threatened against Hallmark or its Subsidiaries relating to their business, except for any such proceeding which would not have a A-8 Hallmark Material Adverse Effect. To the actual knowledge of the executive officers of Hallmark, there are no organizational efforts with respect to the formation of a collective bargaining unit presently being made or threatened involving employees of Hallmark or any of its Subsidiaries. 5.13. POOLING OF INTERESTS. To the actual knowledge of the executive officers of Hallmark, Hallmark has not taken or failed to take any action which would prevent the accounting for the Merger as a pooling of interests in accordance with Accounting Principles Board Opinion No. 16, the interpretative releases issued pursuant thereto, and the pronouncements of the SEC. 5.14. NO BROKERS. Hallmark has not entered into any contract, arrangement or understanding with any person or firm which may result in the obligation of Hallmark or CHS to pay any finder's fees, brokerage or agent's commission or other like payments in connection with the negotiations leading to this Agreement or the consummation of the transactions contemplated hereby, except that Hallmark has retained Mabon Securities Corp. as its financial advisor, the arrangements with which have been disclosed in writing to CHS prior to the date hereof. Other than the foregoing arrangements, Hallmark is not aware of any claim for payment of any finder's fees, brokerage or agent's commissions or other like payments in connection with the negotiations leading to this Agreement or the consummation of the transactions contemplated hereby. 5.15. CHS STOCK OWNERSHIP. Neither Hallmark nor any of its Subsidiaries owns any shares of CHS Common Stock or other securities convertible into CHS Common Stock. 5.16. AGREEMENTS. (a) Neither Hallmark nor any of its Subsidiaries is a party to: (i) any agreement, contract or commitment containing any covenant limiting the freedom of Hallmark or any of its Subsidiaries to engage in any line of business or to compete with any person in any line of business permitted by its or their Certificate of Incorporation or by applicable law; (ii) any written agreement, order or decree of or with any federal or state regulatory agency except those listed in the Hallmark Disclosure Letter; or (iii) any obligation of guaranty or indemnity, except as provided in Section 5.11, obligations of Subsidiaries guaranteed by Hallmark, and income guarantees provided to recruit healthcare professionals. (b) All material agreements, contracts or commitments (except those entered into in the ordinary course of business) to which Hallmark or any of its Subsidiaries is a party or which affects its or their business, operations or assets are listed in the Hallmark Reports. Neither Hallmark nor any of its Subsidiaries has in any material respect breached, nor is there any pending or threatened claim that it or any of its Subsidiaries has materially breached, any of the terms or conditions of any such agreements, contracts or commitments. 5.17. TITLE TO ASSETS. (a) On March 31, 1994, Hallmark and each of its Subsidiaries had and, except with respect to assets disposed of for adequate consideration in the ordinary course of business since such date, now has, good and merchantable title to all real property and good and merchantable title to all other material properties and assets reflected on the consolidated balance sheet of Hallmark as of such date, and has good and merchantable title to all real property and good and merchantable title to all other material properties and assets acquired since such date, in each case free and clear of all mortgages, liens, pledges, restrictions, security interests, charges and encumbrances of any nature except for (i) mortgages and encumbrances which secure indebtedness which is properly reflected in the aforesaid balance sheet; (ii) liens for taxes accrued but not yet payable; (iii) liens arising as a matter of law in the ordinary course of business with respect to obligations incurred after the date of the aforesaid balance sheet, provided that the obligations secured by such liens are not delinquent or are being contested in good faith; (iv) such imperfections of title and encumbrances, if any, as do not materially detract from the value or materially interfere with the present use of any of such properties or assets or the pending sale of any of such owned properties or assets; and (v) capital leases, if any, A-9 with third parties for fair and adequate consideration. Hallmark and each of its Subsidiaries own, or have valid leasehold interests in, all material properties and assets used in the conduct of their business. Any real property and other material assets held under lease by Hallmark or any of its Subsidiaries are held under valid, subsisting and enforceable leases with such exceptions as are not material and do not interfere with the use made or proposed to be made by Hallmark or any of its Subsidiaries of such property. (b) With respect to each lease of any real property or a material amount of personal property to which Hallmark or any of its Subsidiaries is a party, and except for leases as lessor or sublessor to healthcare professionals, (i) such lease is in full force and effect in accordance with its terms; (ii) all rents and other monetary amounts that have become due and payable thereunder have been paid; (iii) there exists no default, or event, occurrence, condition or act, which with the giving of notice, the lapse of time or the happening of any further event, occurrence, condition or act would become a default under such lease; and (iv) the Merger will not constitute a breach under, or cause a termination of, such lease. Notwithstanding anything to the contrary herein, Hallmark shall have the right to supplement the Hallmark Disclosure Letter on or before 5:00 p.m., Eastern Daylight Time, Monday, June 13, 1994, to report exceptions to the representation and warranty contained in this Section 5.17(b)(iv). (c) Neither Hallmark nor any of its Subsidiaries has any legal obligation, absolute or contingent, to any other person to sell or otherwise dispose of any substantial part of its assets; or to sell or dispose of any of its assets except in the ordinary course of business consistent with past practices. 5.18. INSURANCE POLICIES. Hallmark and each of its Subsidiaries maintain in force insurance policies and bonds in such amounts and against such liabilities and hazards as are considered by it to be reasonable. A complete list of all such insurance policies is contained in the Hallmark Disclosure Letter. Neither Hallmark nor any of its Subsidiaries is now liable, nor will it or any of them become liable, for any material retroactive premium adjustment not recorded on its books or otherwise provided for. All policies are valid and enforceable and in full force and effect, and neither Hallmark nor any of its Subsidiaries has received any notice of a material premium increase or cancellation with respect to any of its insurance policies or bonds. Within the last three years, neither Hallmark nor any of its Subsidiaries has been refused any basic insurance coverage sought or applied for, and Hallmark has no reason to believe that its existing insurance coverage cannot be renewed as and when same shall expire, upon terms and conditions standard in the market at the time renewal is sought. 5.19. ENVIRONMENTAL MATTERS. (a) (i) Hallmark and each of its Subsidiaries have obtained all material permits, licenses and other authorizations that are required to be obtained by it in connection with the operation of its businesses and ownership of its properties (collectively, the "Hallmark Subject Properties") under any applicable Environmental Law Requirements, as hereinafter defined, except for such matters as would not have a Hallmark Material Adverse Effect; (ii) Hallmark and each of its Subsidiaries are in compliance in all respects with all terms and conditions of such permits, licenses and authorizations and with all applicable Environmental Law Requirements, except for such matters as would not have a Hallmark Material Adverse Effect; (iii) There are no past or present events, conditions, circumstances, activities or plans by Hallmark or any of its Subsidiaries related in any manner to Hallmark or any of its Subsidiaries or the Hallmark Subject Properties that did or would violate or prevent compliance or continued compliance with any of the Environmental Law Requirements or give rise to any Environmental Liability, as hereinafter defined, except for such matters as would not have a Hallmark Material Adverse Effect; (iv) There is no civil, criminal or administrative action, suit, demand, claim, order, judgment, hearing, notice or demand letter, notice of violation, investigation or proceeding pending or to the A-10 actual knowledge of any executive officer of Hallmark threatened by any person against Hallmark or any of its Subsidiaries, or any prior owner of any of the Hallmark Subject Properties and relating to any of the Hallmark Subject Properties, and relating in any way to any Environmental Law Requirement or seeking to impose any Environmental Liability, except for such matters as would not have a Hallmark Material Adverse Effect; and (v) Neither Hallmark nor any of its Subsidiaries is subject to or responsible for any Environmental Liability which is not set forth and adequately reserved against on the March 31, 1994 consolidated balance sheet of Hallmark. (b) "Environmental Law Requirement" shall mean any court order or decree or current law or current ordinance, rule or regulation, notice, plan or demand letter relating to pollution or protection of the environment, including those relating to emissions, discharges, releases, or threatened releases of pollutants, contaminants, chemicals or industrial, toxic or hazardous substances or wastes into the environment (including without limitation, ambient air, surface water, ground water or land) or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes. (c) "Environmental Liability" shall mean (i) any liability or obligation arising under any Environmental Law Requirement that has resulted in or is reasonably likely to result in a Hallmark Material Adverse Effect, or (ii) any liability or obligation under any other current theory of law or equity (including, without limitation, any liability for personal injury, property damage or remediation) that results from, or is based upon or related to, the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling, or the emission, discharge, release or threatened release into the environment, of any pollutant, contaminant, chemical, or industrial, toxic or hazardous substance or waste, which liability or obligation has resulted in or is reasonably likely to result in a Hallmark Material Adverse Effect. 5.20. INTELLECTUAL PROPERTY. Hallmark and each of its Subsidiaries owns or has the legal right to use all trademarks, trade names, service marks, software and other intellectual property that is material to the conduct of its or their respective business. 5.21. OPINION OF FINANCIAL ADVISOR. Hallmark has received the opinion of Mabon Securities Corp., to the effect that, as of the date hereof, the consideration to be received by the holders of Hallmark Common Stock pursuant to Section 4.1(b) is fair from a financial point of view. 5.22. LICENSES AND PERMITS. All of Hallmark's hospitals and other health care facilities have all necessary licenses, permits, and authorizations required to lawfully conduct their respective businesses as presently conducted, including but not limited to all material licenses, certificates of need, permits, certifications, provider and other third-party payor contracts and regulatory authorizations required for the hospitals to operate as they currently operate and in accordance with all applicable laws, rules, regulations, ordinances, or orders of any governmental authority, and (a) no such license, permit, or authorization is subject to revocation or forfeiture by virtue of any existing circumstance, (b) there is no pending or threatened proceeding to modify in any material respect or revoke any material license, permit, or authorization, and (c) no such license, permit, or authorization is subject to any outstanding order, decree, judgment, stipulation, or known investigation that would materially affect such license, permit, or authorization. All of Hallmark's hospitals and other health care facilities have obtained accreditation by the Joint Commission on Accreditation of Healthcare Organizations for the Hospital. 5.23. MEDICARE/MEDICAID COST REPORTS. Neither Hallmark nor any of its Subsidiaries has filed any required terminating Medicare cost report on any facility which Hallmark or any of its Subsidiaries has sold or no longer operates, for which it has not received a Notice of Program Reimbursement. Neither Hallmark nor any of its Subsidiaries has received any Notice of Program Reimbursement (or similar document for Medicaid) with respect to any such facility's cost reports, including cost reports A-11 for those facilities it has sold or no longer operates, which requires a material refund to the government agency responsible for the Medicare or Medicaid program and which either (a) has not been paid or (b) is not reflected as a liability in the consolidated balance sheet of Hallmark and its Subsidiaries at March 31, 1994. 5.24. COMPLIANCE WITH MEDICARE/MEDICAID PROGRAMS. Hallmark and its Subsidiaries have filed all cost and other reports required to be filed in connection with all state and federal Medicare and Medicaid programs due on or before the date hereof, which are complete and correct in all material respects, subject to adjustment upon audit. There are no claims, actions, payment reviews or appeals pending or threatened before any commission, board or agency, including, without limitation, any intermediary or carrier, the Administrator of the Health Care Financing Administration, or any state agency, with respect to any Medicare or Medicaid claims filed by Hallmark or any of its Subsidiaries on or before the date hereof, which would have a Hallmark Material Adverse Effect or materially adversely affect any of its hospitals, the operation or utility thereof, or the consummation of the transactions contemplated hereby, except as set forth on the Hallmark Disclosure Letter (and except for appeals of items that are fully reserved in the Hallmark Reports) and no validation review or program integrity review related to Hallmark, or any of its hospitals or Subsidiaries has been conducted since January 1, 1991 by any commission, board or agency in connection with the Medicare or Medicaid program, and to the actual knowledge of the executive officers of Hallmark, no such reviews are scheduled, pending or threatened against or affecting Hallmark, any of its hospitals or Subsidiaries. ARTICLE 6 6. REPRESENTATIONS AND WARRANTIES OF CHS AND MERGER SUB. Except as set forth in the disclosure letter delivered at or prior to the execution hereof to Hallmark (the "CHS Disclosure Letter"), CHS and Merger Sub represent and warrant to Hallmark as of the date of this Agreement as follows: 6.1. EXISTENCE; GOOD STANDING; CORPORATE AUTHORITY; COMPLIANCE WITH LAW. Each of CHS and Merger Sub is a corporation duly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation. CHS is duly licensed or qualified to do business as a foreign corporation and is in good standing under the laws of any other state of the United States in which the character of the properties owned or leased by it therein or in which the transaction of its business makes such qualification necessary, except where the failure to be so qualified would not have a material adverse effect on the business, results of operations or financial condition of CHS and its Subsidiaries taken as a whole (a "CHS Material Adverse Effect"). CHS has all requisite corporate power and authority to own, operate and lease its properties and carry on its business as now conducted. Each of CHS's Significant Subsidiaries is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation, has the corporate power and authority to own its properties and to carry on its business as it is now being conducted, and is duly qualified to do business and is in good standing in each jurisdiction in which the ownership of its property or the conduct of its business requires such qualification, except for jurisdictions in which such failure to be so qualified or to be in good standing would not have a CHS Material Adverse Effect. Neither CHS nor any CHS Subsidiary or any of their respective properties or assets is in violation of any order of any court, governmental authority or arbitration board or tribunal, or any law, ordinance, governmental rule or regulation to which CHS or any of its Subsidiaries is subject, where such violation would have a CHS Material Adverse Effect. CHS and its Subsidiaries have obtained all licenses, permits and other authorizations and have taken all actions required by applicable law or governmental regulations in connection with their business as now conducted, where the failure to obtain any such item or to take any such action would have a CHS Material Adverse Effect. The copies of CHS's Certificate of Incorporation and Bylaws previously delivered to Hallmark are true and correct. A-12 6.2. AUTHORIZATION, VALIDITY AND EFFECT OF AGREEMENTS. Each of CHS and Merger Sub has the requisite corporate power and authority to execute and deliver this Agreement and all agreements and documents contemplated hereby. Subject only to the approval of this Agreement and the transactions contemplated hereby by the holders of a majority of the outstanding shares of CHS Common Stock and by the holders of a majority of the outstanding shares of Common Stock, $.01 par value, of Merger Sub (the "Requisite CHS Approval"), the consummation by CHS and Merger Sub of the transactions contemplated hereby has been duly authorized by all requisite corporate action. Subject to obtaining the Requisite CHS Approval, this Agreement constitutes, and all agreements and documents contemplated hereby (when executed and delivered pursuant hereto) will constitute, the valid and legally binding obligations of each of CHS and Merger Sub, to the extent it is a party thereto, enforceable in accordance with their respective terms, subject to applicable bankruptcy, insolvency, moratorium or other similar laws relating to creditors' rights and general principles of equity. 6.3. CAPITALIZATION. The authorized capital stock of CHS consists of 30,000,000 shares of CHS Common Stock, and 5,000,000 shares of preferred stock, $.01 par value (the "CHS Preferred Stock"). As of May 31, 1994 there were 11,436,496 shares of CHS Common Stock issued and outstanding, and no shares of CHS Preferred Stock issued and outstanding. Since such date, no additional shares of capital stock of CHS have been issued, except pursuant to the exercise of options outstanding under CHS stock option and employee stock purchase plans (collectively, the "CHS Stock Option Plans"). CHS has no outstanding bonds, debentures, notes or other obligations the holders of which have the right to vote (or which are convertible into or exercisable for securities having the right to vote) with the stockholders of CHS on any matter. All such issued and outstanding shares of CHS Common Stock and CHS Preferred Stock are duly authorized, validly issued, fully paid, nonassessable and free of preemptive rights. Other than as contemplated by this Agreement or set forth in the CHS Disclosure Letter, there are not at the date of this Agreement any existing options, warrants, calls, subscriptions, convertible securities, or other rights, agreements or commitments which obligate CHS or any of its Subsidiaries to issue, transfer or sell any shares of capital stock of CHS or any of its Subsidiaries. 6.4. SUBSIDIARIES. (a) Each of the outstanding shares of capital stock of each of CHS's Subsidiaries is duly authorized, validly issued, fully paid and nonassessable, and is owned, directly or indirectly, by CHS free and clear of all liens, pledges, security interests, claims or other encumbrances other than liens imposed by local law which are not material. The following information for each Subsidiary of CHS has been previously provided to Hallmark: (i) its name and jurisdiction of incorporation or organization; (ii) its authorized capital stock or share capital; (iii) the number of issued and outstanding shares of capital stock or share capital; and (iv) the number of shares of such capital stock owned by CHS or any of its Subsidiaries. (b) The authorized capital stock of Merger Sub consists, or will consist prior to the Closing, of 10,000 shares of Common Stock, $.01 par value, all of which shares are, or will be prior to the Closing, issued and outstanding and owned by CHS. Merger Sub has not engaged in any activities other than in connection with the transactions contemplated by this Agreement. 6.5. OTHER INTERESTS. Except for interests in the CHS Subsidiaries, neither CHS nor any CHS Subsidiary owns directly or indirectly any interest or investment (whether equity or debt) in any corporation, partnership, joint venture, business, trust or entity (other than investments in short-term investment securities). 6.6. NO VIOLATION. Neither the execution and delivery by CHS and Merger Sub of this Agreement nor the consummation by CHS and Merger Sub of the transactions contemplated hereby in accordance with the terms hereof, will (i) conflict with or result in a breach of any provisions of the Certificate of Incorporation or Bylaws of CHS or Merger Sub; (ii) except as disclosed in the CHS Reports, result in a breach or violation of, a default under, or the triggering of any payment or other material obligations pursuant to, or accelerate vesting under, any of the CHS Stock Option Plans, or any grant or award made under any of the foregoing, (iii) violate, or conflict with, or result in a breach of any provision of, or constitute a default (or an event which, with notice or lapse of time or both, A-13 would constitute a default) under, or result in the termination or in a right of termination or cancellation of, or accelerate the performance required by, or result in the creation of any lien, security interest, charge or encumbrance upon any of the material properties of CHS or its Subsidiaries under, or result in being declared void, voidable, or without further binding effect, any of the terms, conditions or provisions of any note, bond, mortgage, indenture, deed of trust or any material license, franchise, permit, lease, contract, agreement or other instrument, commitment or obligation to which CHS or any of its Subsidiaries is a party, or by which CHS or any of its Subsidiaries or any of their properties is bound or affected, except for any of the foregoing matters which would not have a CHS Material Adverse Effect; or (iv) other than the Regulatory Filings, require any material consent, approval or authorization of, or declaration, filing or registration with, any domestic governmental or regulatory authority, the failure to obtain or make which would have a CHS Material Adverse Effect. 6.7. SEC DOCUMENTS. CHS has delivered to Hallmark each registration statement, report, proxy statement or information statement prepared by it since December 31, 1991, including, without limitation, (i) its Annual Report on Form 10-K for the year ended December 31, 1993, (ii) its Quarterly Report on Form 10-Q for the period ended March 31, 1994, and (iii) its Proxy Statement for the Annual Meeting of Stockholders held April 28, 1994, each in the form (including exhibits and any amendments thereto) filed with the SEC (collectively, the "CHS Reports"). As of their respective dates, the CHS Reports (i) were prepared in all material respects in accordance with the applicable requirements of the Securities Act, the Exchange Act, and the rules and regulations thereunder and (ii) did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements made therein, in the light of the circumstances under which they were made, not misleading. Each of the consolidated balance sheets of CHS included in or incorporated by reference into the CHS Reports (including the related notes and schedules) fairly presents the consolidated financial position of CHS and the CHS Subsidiaries as of its date and each of the consolidated statements of income, retained earnings and cash flows included in or incorporated by reference into the CHS Reports (including any related notes and schedules) fairly presents the results of operations, retained earnings or cash flows, as the case may be, of CHS and the CHS Subsidiaries, for the periods set forth therein (subject, in the case of unaudited statements, to exceptions to generally accepted accounting principles as permitted by SEC rules with respect to unaudited quarterly financial statements), in each case in accordance with generally accepted accounting principles consistently applied during the periods involved, except as may be noted therein. Except as and to the extent set forth on the consolidated balance sheet of CHS and the CHS Subsidiaries at March 31, 1994, including all notes thereto, or as set forth in the CHS Reports, neither CHS nor any of the CHS Subsidiaries has any material liabilities or obligations of any nature (whether accrued, absolute, contingent or otherwise) that would be required to be reflected on, or reserved against in, a balance sheet of CHS or in the notes thereto, prepared in accordance with generally accepted accounting principles consistently applied, except liabilities arising in the ordinary course of business since such respective dates. 6.8. LITIGATION. Except as disclosed in the CHS Reports filed with the SEC prior to the date hereof, there are no claims, actions, suits, proceedings, arbitrations or investigations pending against CHS or the CHS Subsidiaries or, to the actual knowledge of the executive officers of CHS, threatened against CHS or the CHS Subsidiaries, at law or in equity, or before or by any federal or state commission, board, bureau, agency or instrumentality, that are reasonably likely to have a CHS Material Adverse Effect, nor does any executive officer of CHS have actual knowledge of any facts or circumstances that such executive officer believes would be likely to form the basis for any such claims, actions, suits, proceedings, arbitrations or investigations. 6.9. ABSENCE OF CERTAIN CHANGES. Except as disclosed in the CHS Reports filed with the SEC prior to the date hereof, since December 31, 1993, CHS has conducted its business only in the ordinary course of such business and there has not been (i) any CHS Material Adverse Effect; (ii) any declaration, setting aside or payment of any dividend or other distribution with respect to its capital stock; or (iii) any material change in its accounting principles, practices or methods. A-14 6.10. POOLING OF INTERESTS. To the actual knowledge of the executive officers of CHS, CHS has not taken or failed to take any action which would prevent the accounting for the Merger as a pooling of interests in accordance with Accounting Principles Board Opinion No. 16, the interpretative releases issued pursuant thereto, and the pronouncements of the SEC. 6.11. NO BROKERS. CHS has not entered into any contract, arrangement or understanding with any person or firm which may result in the obligation of Hallmark or CHS to pay any finder's fees, brokerage or agent's commissions or other like payments in connection with the negotiations leading to this Agreement or the consummation of the transactions contemplated hereby, except that CHS has retained Lehman Brothers as its financial advisor, the arrangements with which have been disclosed in writing to Hallmark prior to the date hereof. Other than the foregoing arrangements, CHS is not aware of any claim for payment of any finder's fees, brokerage or agent's commissions or other like payments in connection with the negotiations leading to this Agreement or the consummation of the transactions contemplated hereby. 6.12. CHS COMMON STOCK. The issuance and delivery by CHS of shares of CHS Common Stock in connection with the Merger and this Agreement have been duly and validly authorized by all necessary corporate action on the part of CHS except for the approval of its stockholders contemplated by this Agreement. The shares of CHS Common Stock to be issued in connection with the Merger and this Agreement, when issued in accordance with the terms of this Agreement, will be validly issued, fully paid and nonassessable. 6.13. OPINION OF FINANCIAL ADVISOR. CHS has received the opinion of Lehman Brothers, to the effect that, as of the date hereof, the consideration to be paid by CHS in the Merger to the holders of Hallmark Common Stock and the holders of Redeemable Preferred Stock pursuant to Section 4.1(b) and Section 4.1(c), respectively, is fair to CHS from a financial point of view. 6.14. TAXES. CHS and each of its Subsidiaries (i) have timely filed all material federal, state and foreign tax returns required to be filed by any of them prior to the date of this Agreement or requests for extension have been timely filed and any such request shall have been granted and not expired and all such returns are complete in all material respects, (ii) have paid or accrued all taxes shown to be due and payable on such returns, and (iii) have properly accrued all such taxes for such periods subsequent to the periods covered by such returns, and (iv) have "open" years for federal income tax returns only as set forth in the CHS Disclosure Letter. 6.15. EMPLOYEE BENEFIT PLANS. All employee benefit plans and other benefit arrangements covering employees of CHS and the CHS Subsidiaries (the "CHS Benefit Plans") are listed in the CHS Disclosure Letter, except CHS Benefit Plans which are not material. True and complete copies of the CHS Benefit Plans have been made available to Hallmark. To the extent applicable, the CHS Benefit Plans comply, in all material respects, with the requirements of ERISA, and the Code, and any CHS Benefit Plan intended to be qualified under Section 401(a) of the Code has been determined by the IRS to be so qualified. No CHS employee benefit plan covered by Title IV of ERISA or Section 412 of the Code is now, or ever was, to the actual knowledge of the executive officers of CHS, maintained by CHS or any CHS Subsidiary, or any predecessors thereof. No CHS Benefit Plan nor CHS has incurred any liability or penalty under Section 4975 of the Code or Sections 502(i) or 502(l) of ERISA. Each CHS Benefit Plan has been maintained and administered in all material respects in compliance with its terms and with ERISA and the Code to the extent applicable thereto. The CHS Benefit Plans are, except by reason of possible non-compliance with Section 402(b) of ERISA, terminable by CHS. To the actual knowledge of the executive officers of CHS, there are no pending or anticipated material claims against or otherwise involving any of the CHS Benefit Plans and no suit, action or other litigation (excluding claims for benefits incurred in the ordinary course of CHS Benefit Plan activities) has been brought against or with respect to any such CHS Benefit Plan, except for any of the foregoing which would not have a CHS Material Adverse Effect. All contributions required to be made as of the date hereof to the CHS Benefit Plans have been made or provided for. Since September 25, 1980, neither CHS nor any entity under "common control" with CHS within the meaning of ERISA Section 4001 A-15 has contributed to, or been required to contribute to, any "multi-employer plan". CHS does not maintain or contribute to any plan or arrangement which provides or has any liability (except as may be required by law) to provide life insurance, medical or other employee welfare benefits to any employee or former employee upon his retirement or termination of employment and CHS has never represented, promised or contracted (whether in oral or written form) to or with any employee or former employee that such benefits would be provided. Except as disclosed in the CHS Reports, the execution of, and performance of the transactions contemplated in, this Agreement will not (either alone or upon the occurrence of any additional or subsequent events) constitute an event under any benefit plan, policy, arrangement or agreement or any trust or loan that will or may result in any payment (whether of severance pay or otherwise), acceleration, forgiveness of indebtedness, vesting, distribution, increase in benefits or obligations to fund benefits with respect to any employee. 6.16. LABOR MATTERS. Neither CHS nor any of its Subsidiaries is a party to, or bound by, any collective bargaining agreement, contract or other agreement or understanding with a labor union or labor organization. There is no unfair labor practice or labor arbitration proceeding pending or, to the actual knowledge of the executive officers of CHS, threatened against CHS or its Subsidiaries relating to their business, except for any such proceeding which would not have a CHS Material Adverse Effect. To the actual knowledge of the executive officers of CHS, there are no organizational efforts with respect to the formation of a collective bargaining unit presently being made or threatened involving employees of CHS or any of its Subsidiaries. 6.17. AGREEMENTS. (a) Neither CHS nor any of its Subsidiaries is a party to: (i) any agreement, contract or commitment containing any covenant limiting the freedom of CHS or any of its Subsidiaries to engage in any line of business or to compete with any person in any line of business permitted by its or their Certificate of Incorporation or by applicable law; (ii) any written agreement, order or decree of or with any federal or state regulatory agency except those listed in the CHS Disclosure Letter; or (iii) any obligation of guaranty or indemnity, except as provided in Section 6.15, obligations of Subsidiaries guaranteed by CHS, and income guarantees provided to recruit healthcare professionals. (b) All material agreements, contracts or commitments (except those entered into in the ordinary course of business) to which CHS or any of its Subsidiaries is a party or which affects its or their business, operations or assets are listed in the CHS Reports. Neither CHS nor any of its Subsidiaries has in any material respect breached, nor is there any pending or threatened claim that it or any of its Subsidiaries has materially breached, any of the terms or conditions of any such agreements, contracts or commitments. 6.18. TITLE TO ASSETS. (a) On March 31, 1994, CHS and each of its Subsidiaries had and, except with respect to assets disposed of for adequate consideration in the ordinary course of business since such date, now has, good and merchantable title to all real property and good and merchantable title to all other material properties and assets reflected on the consolidated balance sheet of CHS as of such date, and has good and merchantable title to all real property and good and merchantable title to all other material properties and assets acquired since such date, in each case free and clear of all mortgages, liens, pledges, restrictions, security interests, charges and encumbrances of any nature except for (i) mortgages and encumbrances which secure indebtedness which is properly reflected in the aforesaid balance sheet; (ii) liens for taxes accrued but not yet payable; (iii) liens arising as a matter of law in the ordinary course of business with respect to obligations incurred after the date of the aforesaid balance sheet, provided that the obligations secured by such liens are not delinquent or are being contested in good faith; (iv) such imperfections of title and encumbrances, if any, as do not materially detract from the value or materially interfere with the present use of any of such properties or assets or the pending sale of any of such owned properties or assets; and (v) capital leases, if any, with third parties for fair and adequate consideration. CHS and each of its Subsidiaries own, or have A-16 valid leasehold interests in, all material properties and assets used in the conduct of their business. Any real property and other material assets held under lease by CHS or any of its Subsidiaries are held under valid, subsisting and enforceable leases with such exceptions as are not material and do not interfere with the use made or proposed to be made by CHS or any of its Subsidiaries of such property. (b) With respect to each lease of any real property or a material amount of personal property to which CHS or any of its Subsidiaries is a party, and except for leases as lessor or sublessor to healthcare professionals, (i) such lease is in full force and effect in accordance with its terms; (ii) all rents and other monetary amounts that have become due and payable thereunder have been paid; (iii) there exists no default, or event, occurrence, condition or act, which with the giving of notice, the lapse of time or the happening of any further event, occurrence, condition or act would become a default under such lease; and (iv) the Merger will not constitute a breach under, or cause a termination of, such lease. (c) Neither CHS nor any of its Subsidiaries has any legal obligation, absolute or contingent, to any other person to sell or otherwise dispose of any substantial part of its assets; or to sell or dispose of any of its assets except in the ordinary course of business consistent with past practices. 6.19. INSURANCE POLICIES. CHS and each of its Subsidiaries maintain in force insurance policies and bonds in such amounts and against such liabilities and hazards as are considered by it to be reasonable. A complete list of all such insurance policies is contained in the CHS Disclosure Letter. Neither CHS nor any of its Subsidiaries is now liable, nor will it or any of them become liable, for any material retroactive premium adjustment not recorded on its books or otherwise provided for. All policies are valid and enforceable and in full force and effect, and neither CHS nor any of its Subsidiaries has received any notice of a material premium increase or cancellation with respect to any of its insurance policies or bonds. Within the last three years, neither CHS nor any of its Subsidiaries has been refused any basic insurance coverage sought or applied for, and CHS has no reason to believe that its existing insurance coverage cannot be renewed as and when same shall expire, upon terms and conditions standard in the market at the time renewal is sought. 6.20. ENVIRONMENTAL MATTERS. (a) CHS and each of its Subsidiaries have obtained all material permits, licenses and other authorizations that are required to be obtained by it in connection with the operation of its businesses and ownership of its properties (collectively, the "CHS Subject Properties") under any applicable Environmental Law Requirements, except for such matters as would not have a CHS Material Adverse Effect; (b) CHS and each of its Subsidiaries are in compliance in all respects with all terms and conditions of such permits, licenses and authorizations and with all applicable Environmental Law Requirements, except for such matters as would not have a CHS Material Adverse Effect; (c) There are no past or present events, conditions, circumstances, activities or plans by CHS or any of its Subsidiaries related in any manner to CHS or any of its Subsidiaries or the CHS Subject Properties that did or would, in any respect, violate or prevent compliance or continued compliance with any of the Environmental Law Requirements or give rise to any Environmental Liability, except for such matters as would not have a CHS Material Adverse Effect; (d) There is no civil, criminal or administrative action, suit, demand, claim, order, judgment, hearing, notice or demand letter, notice of violation, investigation or proceeding pending or to the actual knowledge of any executive officer of CHS or any of its Subsidiaries threatened by any person against CHS, or any prior owner of any of the CHS Subject Properties and relating to any of the CHS Subject Properties, and relating in any way to any Environmental Law Requirement or seeking to impose any Environmental Liability, except for such matters as would not have a CHS Material Adverse Effect; and A-17 (e) Neither CHS nor any of its Subsidiaries is subject to or responsible for any Environmental Liability which is not set forth and adequately reserved against on the March 31, 1994 consolidated balance sheet of CHS. 6.21. INTELLECTUAL PROPERTY. CHS and each of its Subsidiaries owns or has the legal right to use all trademarks, trade names, service marks, software and other intellectual property that is material to the conduct of its or their respective business. 6.22. LICENSES AND PERMITS. All of CHS's hospitals and other health care facilities have all necessary licenses, permits, and authorizations required to lawfully conduct their respective businesses as presently conducted, including but not limited to all material licenses, certificates of need, permits, certifications, provider and other third-party payor contracts and regulatory authorizations required for the hospitals to operate as they currently operate and in accordance with all applicable laws, rules, regulations, ordinances, or orders of any governmental authority, and (a) no such license, permit, or authorization is subject to revocation or forfeiture by virtue of any existing circumstance, (b) there is no pending or threatened proceeding to modify in any material respect or revoke any material license, permit, or authorization, and (c) no such license, permit, or authorization is subject to any outstanding order, decree, judgment, stipulation, or known investigation that would materially affect such license, permit, or authorization. All of CHS's hospitals and other health care facilities have obtained accreditation by the Joint Commission on Accreditation of Healthcare Organizations for the Hospital, other than Pinellas Community Hospital. 6.23. MEDICARE/MEDICAID COST REPORTS. Neither CHS nor any of its Subsidiaries has filed any required terminating Medicare cost report on any facility which CHS or any of its Subsidiaries has sold or no longer operates, for which it has not received a Notice of Program Reimbursement. Neither CHS nor any of its Subsidiaries has received any Notice of Program Reimbursement (or similar document for Medicaid) with respect to any of its facility's cost reports, including cost reports for those facilities it has sold or no longer operates, which requires a material refund to the government agency responsible for the Medicare or Medicaid program and which either (a) has not been paid or (b) is not reflected as a liability in the consolidated balance sheet of CHS and its Subsidiaries at March 31, 1994. 6.24. COMPLIANCE WITH MEDICARE/MEDICAID PROGRAMS. CHS and its Subsidiaries have filed all cost and other reports required to be filed in connection with all state and federal Medicare and Medicaid programs due on or before the date hereof, which are complete and correct in all material respects, subject to adjustment upon audit. There are no claims, actions, payment reviews or appeals pending or threatened before any commission, board or agency, including, without limitation, any intermediary or carrier, the Administrator of the Health Care Financing Administration, or any state agency, with respect to any Medicare or Medicaid claims filed by CHS or any of its Subsidiaries on or before the date hereof, which would have a CHS Material Adverse Effect or materially adversely effect, any of its hospitals, the operation or utility thereof, or the consummation of the transactions contemplated hereby, except as set forth on the CHS Disclosure Letter (and except for appeals of items that are fully reserved in the CHS Reports) and no validation review or program integrity review related to CHS, or any of its hospitals or Subsidiaries has been conducted since January 1, 1991 by any commission, board or agency in connection with the Medicare or Medicaid program, and to the actual knowledge of the executive officers of CHS, no such reviews are scheduled, pending or threatened against or affecting CHS, any of its hospitals or Subsidiaries. ARTICLE 7 7. COVENANTS. 7.1. ACQUISITION PROPOSALS. Prior to the Effective Time, Hallmark agrees (a) that neither it nor any of its Subsidiaries shall, and Hallmark shall direct and use its best efforts to cause its respective officers, directors, employees, agents and representatives (including, without limitation, any investment banker, attorney or accountant retained by it or any of its Subsidiaries) not to, initiate, solicit or encourage, directly or indirectly, any inquiries or the making or implementation of any proposal or A-18 offer (including, without limitation, any proposal or offer to its stockholders) with respect to a merger, acquisition, consolidation or similar transaction involving, or any purchase of all or any significant portion of the assets or equity securities of, Hallmark or any of its Significant Subsidiaries (any such proposal or offer being hereinafter referred to as an "Acquisition Proposal") or engage in any negotiations concerning, or provide any confidential information or data to, or have any discussions with, any person relating to an Acquisition Proposal, or otherwise facilitate any effort or attempt to make or implement an Acquisition Proposal; (b) that it will immediately cease and cause to be terminated any existing activities, discussions or negotiations with any parties conducted heretofore with respect to any of the foregoing and Hallmark will take the necessary steps to inform the individuals or entities referred to above of the obligations undertaken in this Section 7.1; and (c) that it will notify CHS immediately of the identity of the potential acquiror and the terms of such person's or entity's proposal if any such inquiries or proposals are received by, any such information is requested from, or any such negotiations or discussions are sought to be initiated or continued with, it; provided, however, that nothing contained in this Section 7.1 shall prohibit the Board of Directors of Hallmark from (i) furnishing information to or entering into discussions or negotiations with, any person or entity that makes an unsolicited written proposal to acquire Hallmark pursuant to a merger, consolidation, share exchange, purchase of a substantial portion of the assets, business combination or other similar transaction, if, and only to the extent that, (A) the Board of Directors of Hallmark determines in good faith that such action is required for the Board of Directors to comply with its fiduciary duties to stockholders (B) prior to furnishing such information to, or entering into discussions or negotiations with, such person or entity, Hallmark provides written notice to CHS to the effect that it is furnishing information to, or entering into discussions or negotiations with, such person or entity, and (C) subject to any confidentiality agreement with such person or entity (which Hallmark determined in good faith was required to be executed in order for the Board of Directors to comply with its fiduciary duties to stockholders), Hallmark keeps CHS informed of the status of any such discussions or negotiations; and (ii) to the extent applicable, complying with Rule 14e-2 promulgated under the Exchange Act with regard to an Acquisition Proposal. Nothing in this Section 7.1 shall (x) permit Hallmark to terminate this Agreement (except as specifically provided in Article 9 hereof), (y) permit Hallmark to enter into any agreement with respect to an Acquisition Proposal during the term of this Agreement (it being agreed that during the term of this Agreement, Hallmark shall not enter into any agreement with any person that provides for, or in any way facilitates, an Acquisition Proposal (other than a confidentiality agreement in customary form)), or (z) affect any other obligation of any party under this Agreement. 7.2. CONDUCT OF BUSINESS. (a) Prior to the Effective Time, except as set forth in the Hallmark Disclosure Letter or as contemplated by any other provision of this Agreement, unless CHS has consented in writing thereto, Hallmark: (i) Shall, and shall cause each of its Subsidiaries to, conduct its operations according to its usual, regular and ordinary course in substantially the same manner as heretofore conducted; (ii) Shall use its best efforts, and shall cause each of its Subsidiaries to use its best efforts, to preserve intact its business organizations and goodwill, keep available the services of its officers and employees and maintain satisfactory relationships with those persons having business relationships with it; (iii) Shall confer on a bi-weekly basis with one or more representatives of CHS to report on operational matters and performance, and any proposal to acquire any business, hospital, physician practice or other material assets, or to engage in any other material transaction; (iv) Shall not amend its Certificate of Incorporation or Bylaws; (v) Shall promptly notify CHS of any material emergency or other material change in the condition (financial or otherwise), business, properties, assets, liabilities, prospects or the normal course of its businesses or in the operation of its properties, any material litigation or material governmental complaints, investigations or hearings (or communications indicating that the A-19 same may be contemplated), or the occurrence of any event, circumstance or transaction that would constitute a breach of any representation or warranty contained herein as if such representation or warranty was being made as of the date of such event, circumstance or transaction; (vi) Shall promptly deliver to CHS true and correct copies of any report, statement or schedule filed with the SEC subsequent to the date of this Agreement, any internal monthly operating report(s) prepared for or delivered to Hallmark's Board of Directors and the monthly consolidating financial statements for Hallmark and its Subsidiaries for and as of each month end subsequent to the date of this Agreement; (vii) Shall not (A) except pursuant to the exercise of options, warrants, conversion rights and other contractual rights existing on the date hereof and disclosed pursuant to this Agreement, issue any shares of its capital stock, effect any stock split or otherwise change its capitalization as it existed on the date hereof, (B) grant, confer or award any option, warrant, conversion right or other right not existing on the date hereof to acquire any shares of its capital stock, (C) increase any compensation or enter into or amend any employment agreement with any of its present or future officers or directors, except for normal increases consistent with past practices and the payment of cash bonuses to officers pursuant to and consistent with existing plans or programs, or (D) adopt any new employee benefit plan (including any stock option, stock benefit or stock purchase plan) or amend any existing employee benefit plan in any material respect; (viii) Shall not (A) declare, set aside or pay any dividend or make any other distribution or payment with respect to any shares of its capital stock or (B) except in connection with the use of shares of capital stock to pay the exercise price or tax withholding in connection with stock-based employee benefit plans of Hallmark, directly or indirectly redeem, purchase or otherwise acquire any shares of its capital stock or capital stock of any of its Subsidiaries, or make any commitment for any such action; and (ix) Shall not, and shall not permit any of its Subsidiaries to sell, lease or otherwise dispose of any of its assets (including capital stock of Subsidiaries) which are material, individually or in the aggregate, except in the ordinary course of business. (b) Prior to the Effective Time, except as set forth in the CHS Disclosure Letter or as contemplated by any other provision of this Agreement, unless Hallmark has consented in writing thereto, CHS: (i) Shall, and shall cause each of its Subsidiaries to, conduct its operations according to its usual, regular and ordinary course in substantially the same manner as heretofore conducted; (ii) Shall use its best efforts, and shall cause each of its Subsidiaries to use its best efforts, to preserve intact its business organizations and goodwill, keep available the services of its officers and employees and maintain satisfactory relationships with those persons having business relationships with it; (iii) Shall promptly notify CHS of any material emergency or other material change in the condition (financial or otherwise), business, properties, assets, liabilities, prospects or the normal course of its businesses or in the operation of its properties, any material litigation or material governmental complaints, investigations or hearings (or communications indicating that the same may be contemplated), or the occurrence of any event, circumstance or transaction that would constitute a breach of any representation or warranty contained herein as if such representation or warranty was being made as of the date of such event, circumstance or transaction; (iv) Shall not amend its Certificate of Incorporation to affect its capitalization; (v) Shall promptly deliver to CHS true and correct copies of any report, statement or schedule filed with the SEC subsequent to the date of this Agreement and its internal consolidated monthly operating statements for each month end subsequent to the date of this Agreement; A-20 (vi) Shall not declare, set aside or pay any dividend or make any other distribution or payment with respect to any shares of its capital stock; and (vii) Shall not, and shall not permit any of its Subsidiaries to sell, lease or otherwise dispose of any of its assets (including capital stock of Subsidiaries) which are material, individually or in the aggregate, except in the ordinary course of business. 7.3. MEETINGS OF STOCKHOLDERS. Each of CHS and Hallmark will take all action necessary in accordance with applicable law and its Certificate of Incorporation and Bylaws to convene a meeting of its stockholders as promptly as practicable to consider and vote upon the approval of this Agreement and the transactions contemplated hereby. The Board of Directors of each of CHS and Hallmark shall recommend such approval and CHS and Hallmark shall each take all lawful action to solicit such approval; including, without limitation, timely mailing the Proxy Statement/Prospectus (as defined in Section 7.7); provided, however, that such recommendation or solicitation is subject to any action taken by, or upon authority of, the Board of Directors of CHS or Hallmark, as the case may be, in the exercise of its good faith judgment as to its fiduciary duties to its stockholders. CHS and Hallmark shall coordinate and cooperate with respect to the timing of such meetings and shall use their best efforts to hold such meetings on the same day. It shall be a condition to CHS's obligation to mail the Proxy Statement/ Prospectus that CHS shall have received (a) an opinion of Lehman Brothers, dated the date of the Proxy Statement/Prospectus, to the effect that, as of the date thereof, the consideration to be paid by CHS pursuant to the Merger is fair to CHS from a financial point of view and (b) a "comfort" letter from Arthur Andersen & Co., independent public accountants for Hallmark, dated the date of the Proxy Statement/Prospectus, with respect to the financial statements of Hallmark included in the Proxy Statement/Prospectus, substantially in the form described in Section 8.3(c). It shall be a condition to Hallmark's obligation to mail the Proxy Statement/Prospectus that Hallmark shall have received (a) an opinion of Mabon Securities Corp., dated the date of the Proxy Statement/ Prospectus, to the effect that, as of the date thereof, the consideration to be received by the holders of Hallmark Common Stock and the holders of Redeemable Preferred Stock pursuant to Section 4.1(b) and Section 4.1(c), respectively, is fair to such stockholders from a financial point of view and (b) a "comfort" letter from Arthur Andersen & Co., independent public accountants for CHS, dated the date of the Proxy Statement/Prospectus, with respect to the financial statements of CHS included in the Proxy Statement/Prospectus, substantially in the form described in Section 8.2(c). 7.4. FILINGS; OTHER ACTION. Subject to the terms and conditions herein provided, Hallmark and CHS shall: (a) promptly make their respective filings and thereafter make any other required submissions under the HSR Act with respect to the Merger; (b) use their best efforts to cooperate with one another in (i) determining which filings are required to be made prior to the Effective Time with, and which consents, approvals, permits or authorizations are required to be obtained prior to the Effective Time from, governmental or regulatory authorities of the United States, the several states and foreign jurisdictions in connection with the execution and delivery of this Agreement and the consummation of the transactions contemplated hereby and (ii) timely making all such filings and timely seeking all such consents, approvals, permits or authorizations; and (c) use their best efforts to take, or cause to be taken, all other action and do, or cause to be done, all other things necessary, proper or appropriate to consummate and make effective the transactions contemplated by this Agreement. If at any time after the Effective Time, any further action is necessary or desirable to carry out the purpose of this Agreement, the proper officers and directors of CHS and Hallmark shall take all such necessary action. 7.5. INSPECTION OF RECORDS. From the date hereof to the Effective Time, each party hereto shall allow all designated officers, attorneys, accountants and other representatives of the other parties access at all reasonable times to the records (except patient medical records) and files, correspondence, audits and properties, as well as to all information relating to commitments, contracts, titles and financial position, or otherwise pertaining to the business and affairs, of such party and its Subsidiaries. A-21 7.6. PUBLICITY. The initial press release relating to this Agreement shall be a joint press release and thereafter Hallmark and CHS shall, subject to their respective legal obligations (including requirements of stock exchanges and other similar regulatory bodies), consult with each other, and use reasonable efforts to agree upon the text of any press release, before issuing any such press release or otherwise making public statements with respect to the transactions contemplated hereby and in making any filings with any federal or state governmental or regulatory agency or with any national securities exchange with respect thereto. 7.7. REGISTRATION STATEMENT. CHS and Hallmark shall cooperate and promptly prepare and CHS shall file with the SEC as soon as practicable a Registration Statement on Form S-4 (the "Form S-4") under the Securities Act, with respect to the CHS Common Stock issuable in the Merger, a portion of which Registration Statement shall also serve as the joint proxy statement with respect to the meetings of the stockholders of Hallmark and of CHS in connection with the Merger (the "Proxy Statement/Prospectus"). The respective parties will cause the Proxy Statement/Prospectus and the Form S-4 to comply as to form in all material respects with the applicable provisions of the Securities Act, the Exchange Act and the rules and regulations thereunder. CHS shall use all reasonable efforts, and Hallmark will cooperate with CHS, to have the Form S-4 declared effective by the SEC as promptly as practicable. CHS shall use its best efforts to obtain, prior to the effective date of the Form S-4, all necessary state securities law or "Blue Sky" permits or approvals required to carry out the transactions contemplated by this Agreement. CHS agrees that the Proxy Statement/Prospectus and each amendment or supplement thereto at the time of mailing thereof and at the time of the respective meetings of stockholders of CHS and Hallmark, or, in the case of the Form S-4 and each amendment or supplement thereto, at the time it is filed or becomes effective, will not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; provided, however that the foregoing shall not apply to the extent that any such untrue statement of a material fact or omission to state a material fact was made by CHS in reliance upon and in conformity with information concerning Hallmark furnished to CHS by Hallmark or its officers, directors, or other agents or affiliates specifically for use in the Proxy Statement/ Prospectus. Hallmark agrees that the information provided by it for inclusion in the Proxy Statement/Prospectus and each amendment or supplement thereto, at the time of mailing thereof and at the time of the respective meetings of stockholders of CHS and Hallmark, or, in the case of information provided by Hallmark for inclusion in the Form S-4 or any amendment or supplement thereto, at the time it is filed or becomes effective, will not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. CHS will advise Hallmark, promptly after it receives notice thereof, of the time when the Form S-4 has become effective or any supplement or amendment has been filed, the issuance of any stop order, the suspension of the qualification of the CHS Common Stock issuable in connection with the Merger for offering or sale in any jurisdiction, or any request by the SEC for amendment of the Proxy Statement/Prospectus or the Form S-4 or comments thereon and responses thereto or requests by the SEC for additional information. 7.8. LISTING APPLICATION. CHS shall promptly prepare and submit to NASDAQ or such other national securities exchange on which the CHS Common Stock is listed a listing application covering the shares of CHS Common Stock issuable in the Merger, and shall use its best efforts to obtain, prior to the Effective Time, approval for the listing of such CHS Common Stock for trading on its National Market System. 7.9. FURTHER ACTION. Each party hereto shall, subject to the fulfillment at or before the Effective Time of each of the conditions of performance set forth herein or the waiver thereof, perform such further acts and execute such documents as may be reasonably required to effect the Merger. A-22 7.10. AGREEMENTS BY AFFILIATED STOCKHOLDERS. (a) At least 30 days prior to the Closing Date, Hallmark shall deliver to CHS a list of names and addresses of those persons who were or are anticipated to be, in Hallmark's reasonable judgment, at the time the Merger is submitted to a vote of the stockholders of Hallmark, "affiliates" (each such person, an "Affiliate") of Hallmark within the meaning of Rule 145 of the rules and regulations promulgated under the Securities Act ("Rule 145"). Hallmark shall provide CHS such information and documents as CHS shall reasonably request for purposes of reviewing such list. Hallmark shall use all reasonable efforts to deliver or cause to be delivered to CHS, prior to the Closing Date, from each of the Affiliates of Hallmark identified in the foregoing list, an Affiliate Letter in the form attached hereto as Exhibit A. CHS shall be entitled to place legends as specified in such Affiliate Letters on the certificates evidencing any CHS Common Stock to be received by such Affiliates pursuant to the terms of this Agreement, and to issue appropriate stock transfer instructions to the transfer agent for the CHS Common Stock, consistent with the terms of such Letters. (b) At least 30 days prior to the Closing Date, CHS shall deliver to Hallmark a list of names and addresses of those persons who were or are anticipated to be, in CHS's reasonable judgment, at the time the Merger is submitted to a vote of the stockholders of CHS, Affiliates of CHS within the meaning of Rule 145. CHS shall provide Hallmark such information and documents as Hallmark shall reasonably request for purposes of reviewing such list. CHS shall use all reasonable efforts to deliver or cause to be delivered to Hallmark prior to the Closing Date, from each of the Affiliates of CHS identified in the foregoing list, an Affiliate Letter in the form attached hereto as Exhibit B. 7.11. EXPENSES. Whether or not the Merger is consummated, all costs and expenses incurred in connection with this Agreement and the transactions contemplated hereby shall be paid by the party incurring such expenses except as set forth in Section 9.5 hereof and except that (a) the filing fee in connection with the HSR Act filing, (b) the filing fee in connection with the filing of the Form S-4 or Proxy Statement/Prospectus with the SEC, (c) the filing fees and counsel fees and expenses incurred by CHS in connection with obtaining the necessary state securities or "Blue Sky" law permits and approvals, (d) the expenses incurred in connection with printing and mailing the Form S-4 and the Proxy Statement/Prospectus, and (e) any expenses incurred to perform environmental assessments or surveys of real property owned or leased by Hallmark, shall be shared equally by Hallmark and CHS. 7.12. INDEMNIFICATION AND INSURANCE. (a) From and after the Effective Time, Surviving Corporation shall indemnify, defend and hold harmless to the same extent provided under the Certificate of Incorporation and/or Bylaws of CHS as such documents were in effect on the date of this Agreement, each person who as of the date immediately prior to the Effective Time was an officer or director of Hallmark or any Subsidiary thereof (individually, an "Indemnified Party" and collectively, the "Indemnified Parties"), against all losses, claims, damages, liabilities, costs or expenses (including reasonable attorneys' fees) based upon or arising from his acts or omissions as an officer or director of Hallmark; provided, however, that the indemnification provided herein shall not apply to any claim against an Indemnified Person if such Indemnified Person had actual knowledge of the existence of the claim and failed to make a good faith effort to require Hallmark to notify its existing directors and officers liability insurance carriers of the existence of such claim prior to the Closing Date; provided, however, that the immediately preceding clause shall not preclude the advancement of expenses in accordance with the Certificate of Incorporation and/or Bylaws of CHS, subject to an Indemnified Party's obligation to repay such advances if it shall ultimately be determined that he is not entitled to be indemnified by CHS. (b) For a period of five years after the Effective Time, the Surviving Corporation shall not amend the provisions of its Certificate of Incorporation and Bylaws providing for exculpation of director and officer liability and indemnification, as such documents were in effect on the date of this Agreement, in any respect that would diminish or otherwise jeopardize the Indemnified Parties' rights of indemnification thereunder, unless required by law or by the Surviving Corporation's then existing directors and officers liability insurance carriers. A-23 (c) For a period of five years after the Effective Time, CHS shall cause to be maintained director and officer liability insurance in an amount equal to or greater than $15,000,000 covering any of the Indemnified Parties. (d) CHS shall pay all expenses, including reasonable attorneys' fees, that may be incurred by any Indemnified Parties in enforcing the indemnity and other obligations provided for in this Section 7.12. (e) Each Indemnified Party hereby releases, effective at the Effective Time of the Merger, CHS and the Surviving Corporation from any obligation that either of them may have (including any obligation as successor to Hallmark) to indemnify such Indemnified Party for acts taken by such Indemnified Party as an officer and/or director and/or employee of Hallmark and/or any of its Subsidiaries, except to the extent set forth in this Section 7.12. 7.13. CERTAIN BENEFITS. (a) From and after the Effective Time, subject to applicable law, and except as contemplated hereby with respect to the Hallmark Stock Option Plans and the termination of Hallmark's 1993 Long-Term Incentive Plan and 1990 Long-Term Cash Incentive Plan for Non-Executive Officers and Other Key Employees (Fiscal 1993 Awards), CHS and its Subsidiaries will honor in accordance with their terms, all Hallmark Benefit Plans listed in the Hallmark Disclosure Letter; provided, however, that nothing herein shall preclude any change effected on a prospective basis in any such Hallmark Benefit Plan that is permitted pursuant to the following sentence of this Section 7.13. For a period of not less than one year following the Effective Time, subject to applicable law, CHS and its Subsidiaries will provide benefits (or cash compensation in lieu of such benefits), other than severance arrangements, to Hallmark employees who become employees of CHS and its Subsidiaries which will under the aforesaid Hallmark Benefit Plans or under the CHS Benefit Plans or any combination thereof (it being expressly acknowledged that different Hallmark employees may be covered under different combinations of benefit plans and arrangements at any given time); provided that CHS shall have the right to revise coverage under the CHS Benefit Plans during the one-year period as long as such revisions do not cause a material reduction in the Hallmark employees' overall benefits packages on an aggregate basis as compared to coverage provided under the aforesaid Hallmark Benefit Plans on the Closing Date. With respect to the CHS Benefit Plans, CHS and the Surviving Corporation shall grant all Hallmark employees from and after the Effective Time credit for all service with Hallmark and its affiliates and predecessors prior to the Effective Time for all purposes for which such service was recognized by Hallmark. To the extent CHS Benefit Plans provide medical or dental welfare benefits after the Effective Time, such plans shall allow a credit for all employee service for Hallmark and its affiliates for any preexisting conditions and shall provide that any expenses incurred on or before the Effective Time shall be taken into account under CHS Benefit Plans for purposes of satisfying applicable deductible, coinsurance and maximum out-of-pocket provisions. (b) CHS agrees to employ at the Effective Time all employees of Hallmark and its Subsidiaries who are employed on the Closing Date on terms consistent with Hallmark's current employment practices and at comparable levels of compensation and positions. Such employment shall be at will and CHS shall be under no obligation to continue to employ any individuals. (c) For purposes of this Section 7.13, the term "employees" shall mean all current employees of Hallmark and its Subsidiaries (including those on lay-off, disability or leave of absence, paid or unpaid). 7.14. POOLING; REORGANIZATION. From and after the date hereof and until the Effective Time, neither CHS nor Hallmark nor any of their respective subsidiaries or other affiliates shall (i) knowingly take any action, or knowingly fail to take any action, that would jeopardize the treatment of the Merger as a "pooling of interests" for accounting purposes; (ii) knowingly take any action, or knowingly fail to take any action, that would jeopardize qualification of the Merger as a reorganization within the meaning of Section 368(a) of the Code; or (iii) enter into any contract, agreement, commitment or arrangement with respect to either of the foregoing. Following the Effective Time, A-24 CHS shall use its best efforts to conduct its business in a manner that would not jeopardize the characterization of the Merger as a "pooling of interests" for accounting purposes and as a reorganization within the meaning of Section 368(a) of the Code. 7.15. GOVERNANCE. CHS's Board of Directors shall take all action necessary to cause the directors comprising the full Board of Directors of CHS at the Effective Time to be comprised of eight directors, consisting of all of the current directors of CHS (the "CHS Designees") and Messrs. James McAfee and Kay Sladen (the "Hallmark Designees"). If, prior to the Effective Time, any of the CHS Designees or the Hallmark Designees shall decline or be unable to serve as a director, Hallmark (if such person was a Hallmark Designee) or CHS (if such person was a CHS Designee) shall designate another person to serve in such person's stead, which person shall be reasonably acceptable to the non-designating party. 7.16. STOCKHOLDER COMMITMENTS. Simultaneously with the execution of this Agreement, each of the executive officers and directors of Hallmark shall execute and deliver to CHS a Stockholder's Commitment in the form attached hereto as Exhibit C. 7.17. RESTRUCTURING OF MERGER. Upon the mutual agreement of CHS and Hallmark, the Merger shall be restructured in the form of a reverse triangular merger of Merger Sub into Hallmark, with Hallmark being the surviving corporation. In such event, this Agreement shall be deemed appropriately modified to reflect such form of merger. ARTICLE 8 8. CONDITIONS. 8.1. CONDITIONS TO EACH PARTY'S OBLIGATION TO EFFECT THE MERGER. The respective obligation of each party to effect the Merger shall be subject to the fulfillment at or prior to the Closing Date of the following conditions: (a) This Agreement and the transactions contemplated hereby shall have been approved in the manner required by applicable law or by applicable regulations of any stock exchange or other regulatory body by the holders of the issued and outstanding shares of capital stock of Hallmark and CHS entitled to vote thereon. (b) The waiting period applicable to the consummation of the Merger under the HSR Act shall have expired or been terminated. (c) Neither of the parties hereto shall be subject to any order or injunction of a court of competent jurisdiction which prohibits the consummation of the transactions contemplated by this Agreement. In the event any such order or injunction shall have been issued, each party agrees to use its reasonable efforts to have any such injunction lifted. (d) The Form S-4 shall have become effective and no stop order with respect thereto shall be in effect. (e) CHS and Hallmark shall have received from Arthur Andersen & Co. an opinion that the Merger will be treated as a "pooling of interests" under applicable accounting standards. (f) All consents, authorizations, orders and approvals of (or filings or registrations with) any governmental commission, board or other regulatory body required in connection with the execution, delivery and performance of this Agreement shall have been obtained or made, except for filings in connection with the Merger and any other documents required to be filed after the Effective Time and except where the failure to have obtained or made any such consent, authorization, order, approval, filing or registration would not have a material adverse effect on the business of CHS and Hallmark (and their respective Subsidiaries), taken as a whole, following the Effective Time. A-25 8.2. CONDITIONS TO OBLIGATION OF HALLMARK TO EFFECT THE MERGER. The obligation of Hallmark to effect the Merger shall be subject to the fulfillment at or prior to the Closing Date of the following conditions: (a) CHS shall have performed its agreements contained in this Agreement required to be performed on or prior to the Closing Date and the representations and warranties of CHS and Merger Sub contained in this Agreement and in any document delivered in connection herewith shall be true and correct as of the Closing Date, and Hallmark shall have received a certificate of the Chairman and President of CHS, dated the Closing Date, certifying to such effect; provided however, that notwithstanding anything herein to the contrary, this Section 8.2(a) shall be deemed to have been satisfied even if such representations or warranties are not true and correct, unless the failure of any of the representations or warranties to be so true and correct would have or would be reasonably likely to have a CHS Material Adverse Effect. (b) Hallmark shall have received the opinion of King and Spalding, dated the Closing Date, to the effect that the Merger will be treated for Federal income tax purposes as a reorganization within the meaning of Section 368(a) of the Code, and that the conversion in the Merger of Hallmark Common Stock and Redeemable Preferred Stock into CHS Common Stock will not result in gain or loss to the holders thereof. (c) Hallmark shall have received a "comfort" letter from Arthur Andersen & Co., of the kind contemplated by the Statement of Auditing Standards with respect to Letters to Underwriters promulgated by the American Institute of Certified Public Accountants (the "AICPA Statement"), dated the Closing Date, in form and substance reasonably satisfactory to Hallmark, in connection with the procedures undertaken by them with respect to the financial statements of CHS and its Subsidiaries contained in the Form S-4, and the other matters contemplated by the AICPA Statement and customarily included in comfort letters relating to transactions similar to the Merger. (d) From the date of this Agreement through the Effective Time, there shall not have occurred any change in the financial condition, business or operations of CHS and its Subsidiaries, taken as a whole, that would have or would be reasonably likely to have a CHS Material Adverse Effect other than any such change that affects both Hallmark and CHS in a substantially similar manner; provided, however, that any determination with respect to the occurrence of a CHS Material Adverse Effect shall exclude the effect of expenses incurred by CHS in connection with this Agreement. (e) Hallmark shall have received an opinion from McGlinchey Stafford Lang, A Law Corporation, special counsel to CHS, dated as of the Closing Date, in form and substance reasonably satisfactory to Hallmark. 8.3. CONDITIONS TO OBLIGATION OF CHS AND MERGER SUB TO EFFECT THE MERGER. The obligations of CHS and Merger Sub to effect the Merger shall be subject to the fulfillment at or prior to the Closing Date of the following conditions: (a) Hallmark shall have performed its agreements contained in this Agreement required to be performed on or prior to the Closing Date and the representations and warranties of Hallmark contained in this Agreement and in any document delivered in connection herewith shall be true and correct as of the Closing Date, and CHS shall have received a certificate of the Chairman and President of Hallmark, dated the Closing Date, certifying to such effect; provided, however, that notwithstanding anything herein to the contrary, this Section 8.3(a) shall be deemed to have been satisfied even if such representations or warranties are not true and correct, unless the failure of any of the representations or warranties to be so true and correct would have or would be reasonably likely to have a Hallmark Material Adverse Effect. (b) CHS shall have received the opinion of McGlinchey Stafford Lang, A Law Corporation, special counsel to CHS, dated the Closing Date, to the effect that the Merger will be treated for A-26 Federal income tax purposes as a reorganization within the meaning of Section 368(a) of the Code, and that CHS and Hallmark will each be a party to that reorganization within the meaning of Section 368(b) of the Code. (c) CHS shall have received a "comfort" letter from Arthur Andersen & Co., of the kind contemplated by the AICPA Statement, dated the Closing Date, in form and substance reasonably satisfactory to CHS, in connection with the procedures undertaken by them with respect to the financial statements and other financial information of Hallmark and its Subsidiaries contained in the Form S-4 and the other matters contemplated by the AICPA Statement and customarily included in comfort letters relating to transactions similar to the Merger. (d) From the date of this Agreement through the Effective Time, there shall not have occurred any change in the financial condition, business or operations of Hallmark and its Subsidiaries, taken as whole, that would have or would be reasonably likely to have a Hallmark Material Adverse Effect, other than any such change that affects both Hallmark and CHS in a substantially similar manner; provided, however, that any determination with respect to the occurrence of a Hallmark Material Adverse Effect shall exclude the effect of expenses incurred by Hallmark in connection with this Agreement. (e) CHS and Merger Sub shall have received an opinion from King & Spalding, special counsel to Hallmark, dated as of the Closing Date, in form and substance reasonably satisfactory to CHS and Merger Sub. (f) CHS shall have received from not less than 75% by value of the participants in Hallmark's 1993 Long-Term Incentive Plan an executed Consent to the termination of such plan in the form attached hereto as Exhibit D. ARTICLE 9 9. TERMINATION. 9.1. TERMINATION BY MUTUAL CONSENT. This Agreement may be terminated and the Merger may be abandoned at any time prior to the Effective Time, before or after the approval of this Agreement by the stockholders of Hallmark or CHS, by the mutual consent of CHS and Hallmark. 9.2. TERMINATION BY EITHER CHS OR HALLMARK. This Agreement may be terminated and the Merger may be abandoned by action of the Board of Directors of either CHS or Hallmark if (a) the Merger shall not have been consummated by December 31, 1994, or (b) the approval of Hallmark's stockholders required by Section 8.1(a) shall not have been obtained at a meeting duly convened therefor or at any adjournment thereof, or (c) the approval of CHS' stockholders required by Section 8.1(a) shall not have been obtained at a meeting duly convened therefor or at any adjournment thereof, or (d) a United States federal or state court of competent jurisdiction or United States federal or state governmental, regulatory or administrative agency or commission shall have issued an order, decree or ruling or taken any other action permanently restraining, enjoining or otherwise prohibiting the transactions contemplated by this Agreement and such order, decree, ruling or other action shall have become final and nonappealable; provided, that the party seeking to terminate this Agreement pursuant to this clause (d) shall have used all reasonable efforts to remove such injunction, order or decree; and further provided, in the case of a termination pursuant to clause (a) above, that the terminating party shall not have breached in any material respect its obligations under this Agreement in a manner that shall have proximately contributed to the occurrence of the failure referred to in said clause. 9.3. TERMINATION BY HALLMARK. This Agreement may be terminated and the Merger may be abandoned at any time prior to the Effective Time, before or after the adoption and approval by the stockholders of Hallmark referred to in Section 8.1(a), by action of the Board of Directors of Hallmark, if (a) in the exercise of its good faith judgment as to its fiduciary duties to its stockholders the Board of Directors of Hallmark shall have failed to recommend or shall have withdrawn or modified its A-27 recommendation or approval of the transactions contemplated by this Agreement, or (b) there has been a breach by CHS or Merger Sub of any representation or warranty contained in this Agreement which would have or would be reasonably likely to have a CHS Material Adverse Effect, or (c) there has been a material breach of any of the covenants or agreements set forth in this Agreement on the part of CHS, which breach is not curable or, if curable, is not cured within 30 days after written notice of such breach is given by Hallmark to CHS or (d) there has been a breach by CHS of its covenant in Section 7.3 hereof to recommend approval of this Agreement and the transactions contemplated thereby. 9.4. TERMINATION BY CHS. This Agreement may be terminated and the Merger may be abandoned at any time prior to the Effective Time, before or after the adoption and approval by the stockholders of CHS referred to in Section 8.1(a), by action of the Board of Directors of CHS, if (a) there has been a breach by Hallmark of any representation or warranty contained in this Agreement which would have or would be reasonably likely to have a Hallmark Material Adverse Effect; or (b) there has been a material breach of any of the covenants or agreements set forth in this Agreement on the part of Hallmark, which breach is not curable or, if curable, is not cured within 30 days after written notice of such breach is given by CHS to Hallmark; or (c) another entity, person, or group (as defined in Section 13(d)(3) of the Exchange Act) commences a public offer to acquire at least 990,136 shares of Hallmark Common Stock at a price per share in excess of $23.00 per share and, in fact, acquires pursuant to said offer or otherwise at least 990,136 shares of Hallmark Common Stock or it shall have been publicly disclosed or CHS shall have learned that any entity, person, or group shall have acquired at least 990,136 shares of Hallmark Common Stock, or shall have been granted any option or right, conditional or otherwise, to acquire at least 990,136 shares of Hallmark Common Stock; or (d) Hallmark enters into an agreement providing for a business combination whereby Hallmark, or at least 990,136 shares of Hallmark Common Stock, or all or substantially all of Hallmark's assets are to be acquired by, or Hallmark is to be consolidated with, a person or entity other than CHS or a Subsidiary or affiliate of CHS; or (e) there has been a material breach by Hallmark of any of the covenants contained in Section 7.1 hereof or a breach of such Section resulting in an Acquisition Proposal, or a breach of its covenant in Section 7.3 hereof to recommend approval of this Agreement and the transactions contemplated thereby. 9.5. EFFECT OF TERMINATION AND ABANDONMENT. (a) If (i) Hallmark terminates this Agreement pursuant to Section 9.3(a), or (ii) CHS terminates this Agreement pursuant to Sections 9.4(c), 9.4(d), or 9.4(e), and as of the date of such termination, (x) there has been no breach by CHS of a representation or warranty which would have or would be reasonably likely to have a CHS Material Adverse Effect, or (y) there has been no material breach of any of the covenants or agreements set forth in this Agreement on the part of CHS, then immediately, but in any event not later than five business days after such termination, Hallmark shall pay to CHS an amount in cash equal to $8,000,000, plus actual out of pocket expenses incurred by CHS and Merger Sub in connection with the transactions contemplated hereby (including but not limited to fees and disbursements of counsel, fees and expenses of investment bankers, accountants and lenders, and printing costs) in an amount not exceeding $1,500,000 (collectively, the "CHS Fee"). (b) If (i) Hallmark terminates this Agreement pursuant to Section 9.3(b), or (ii) CHS terminates this Agreement pursuant to Section 9.4(a), then immediately, but in any event not later than five business days after such termination, the non-terminating party shall pay to the terminating party an amount equal to such terminating party's actual out of pocket expenses incurred by the terminating party in connection with the transactions contemplated hereby (including but not limited to fees and disbursements of counsel, fees and expenses of investment bankers, accountants and lenders, and printing costs) in an amount not exceeding $2,000,000 (the "Termination Fee"); provided, however, that the Termination Fee shall not be payable if, as of the date of such termination, (x) there has been a breach by the terminating party of a representation or warranty which would have or would be A-28 reasonably likely to have, a CHS Material Adverse Effect or Hallmark Material Adverse Effect, as the case may be, or (y) there has been a material breach of any of the covenants or agreements set forth in this Agreement on the part of the terminating party. (c) In the event of termination of this Agreement and the abandonment of the Merger pursuant to this Article 9, all obligations of the parties hereto shall terminate, except the obligations of the parties pursuant to this Section 9.5 and Section 7.11 and except for the provisions of Sections 10.3, 10.4, 10.6, 10.8, 10.9, 10.12, 10.13 and 10.14. In the event of termination of this Agreement pursuant to Sections 9.3 or 9.4, nothing herein shall prejudice the ability of the non-breaching party from seeking damages from any other party for any breach of this Agreement, including without limitation, attorneys' fees and the right to pursue any remedy at law or in equity unless such non-breaching party has received the Termination Fee, in which event, such fee shall constitute liquidated damages and the non-breaching party shall have no right to pursue any other remedy; and provided further, that in the event CHS has received the CHS Fee, it shall not (i) assert or pursue in any manner, directly or indirectly, any claim or cause of action based in whole or in part upon alleged tortious or other interference with rights under this Agreement against any entity or person submitting an Acquisition Proposal or (ii) assert or pursue in any manner, directly or indirectly, any claim or cause of action against Hallmark or any of its officers or directors based in whole or in part upon its or their receipt, consideration, recommendation, or approval of an Acquisition Proposal or Hallmark's exercise of its right of termination under Section 9.3(a). Notwithstanding the foregoing, in the event either party is required to file suit to seek any such fee, and it ultimately succeeds on the merits, it shall be entitled to all expenses, including attorneys' fees, which it has incurred in enforcing its rights hereunder. 9.6. EXTENSION; WAIVER. At any time prior to the Effective Time, any party hereto, by action taken by its Board of Directors, may, to the extent legally allowed, (a) extend the time for the performance of any of the obligations or other acts of the other parties hereto, (b) waive any inaccuracies in the representations and warranties made to such party contained herein or in any document delivered pursuant hereto and (c) waive compliance with any of the agreements or conditions for the benefit of such party contained herein. Any agreement on the part of a party hereto to any such extension or waiver shall be valid only if set forth in an instrument in writing signed on behalf of such party. ARTICLE 10 10. GENERAL PROVISIONS. 10.1. NONSURVIVAL OF REPRESENTATIONS, WARRANTIES AND AGREEMENTS. All representations, warranties and agreements in this Agreement or in any instrument delivered pursuant to this Agreement shall be deemed to the extent expressly provided herein to be conditions to the Merger and shall not survive the Merger, provided, however, that the agreements contained in Article 4 and in Sections 7.12, 7.13, 7.14 and 7.15 and this Article 10, and the agreements delivered pursuant to this Agreement shall survive the Merger. 10.2. NOTICES. Any notice required to be given hereunder shall be sufficient if in writing, and sent by facsimile transmission and by courier service (with proof of service), hand delivery or certified or registered mail (return receipt requested and first-class postage prepaid), addressed as follows: If to CHS or Merger Sub: If to Hallmark: 3707 FM 1960 West, Suite 500 300 Galleria Parkway, Suite 650 Houston, TX 77068 Atlanta, GA 30339 Attn: E. Thomas Chaney Attn: Robert M. Thornton, Jr. President President
A-29 With a copy to: With a copy to: McGlinchey Stafford Lang King & Spalding 2777 Stemmons Freeway, Ste. 925 191 Peachtree Street Dallas, Texas 75207 Atlanta, Georgia 30303 Attn: Alan Jacobs, Esq. Attn: Robert Miller, Esq.
or to such other address as any party shall specify by written notice so given, and such notice shall be deemed to have been delivered as of the date so telecommunicated, personally delivered or mailed. 10.3. ASSIGNMENT; BINDING EFFECT; BENEFIT. Neither this Agreement nor any of the rights, interests or obligations hereunder shall be assigned by any of the parties hereto (whether by operation of law or otherwise) without the prior written consent of the other parties. Subject to the preceding sentence, this Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and assigns. Notwithstanding anything contained in this Agreement to the contrary, except for the provisions of Article 4 and Sections 7.12 and 7.13, nothing in this Agreement, expressed or implied, is intended to confer on any person other than the parties hereto or their respective heirs, successors, executors, administrators and assigns any rights, remedies, obligations or liabilities under or by reason of this Agreement. 10.4. ENTIRE AGREEMENT. This Agreement, the Exhibits, the Hallmark Disclosure Letter, the CHS Disclosure Letter, the Confidentiality Agreement, dated April 12, 1994, between Hallmark and CHS and any documents delivered by the parties in connection herewith constitute the entire agreement among the parties with respect to the subject matter hereof and supersede all prior agreements and understandings among the parties with respect hereto. No addition to or modification of any provision of this Agreement shall be binding upon any party hereto unless made in writing and signed by all parties hereto. 10.5. AMENDMENT. This Agreement may be amended by the parties hereto, by action taken by their respective Boards of Directors, at any time before or after approval of matters presented in connection with the Merger by the stockholders of Hallmark and CHS, but after any such stockholder approval, no amendment shall be made which by law requires the further approval of stockholders without obtaining such further approval. This Agreement may not be amended except by an instrument in writing signed on behalf of each of the parties hereto. 10.6. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware without regard to its rules of conflict of laws. Each of Hallmark and CHS hereby irrevocably and unconditionally consents to submit to the exclusive jurisdiction of the courts of the State of Delaware and of the United States of America located in the State of Delaware (the "Delaware Courts") for any litigation arising out of or relating to this Agreement and the transactions contemplated hereby (and agrees not to commence any litigation relating thereto except in such courts), waives any objection to the laying of venue of any such litigation in the Delaware Courts and agrees not to plead or claim in any Delaware Court that such litigation brought therein has been brought in an inconvenient forum. 10.7. COUNTERPARTS. This Agreement may be executed by the parties hereto in separate counterparts, each of which when so executed and delivered shall be an original, but all such counterparts shall together constitute one and the same instrument. Each counterpart may consist of a number of copies hereof each signed by less than all, but together signed by all of the parties hereto. 10.8. HEADINGS. Headings of the Articles and Sections of this Agreement are for the convenience of the parties only, and shall be given no substantive or interpretive effect whatsoever. 10.9. INTERPRETATION. In this Agreement, unless the context otherwise requires, words describing the singular number shall include the plural and vice versa, and words denoting any gender shall include all genders and words denoting natural persons shall include corporations and partnerships and vice versa. A-30 10.10. WAIVERS. Except as provided in this Agreement, no action taken pursuant to this Agreement, including, without limitation, any investigation by or on behalf of any party, shall be deemed to constitute a waiver by the party taking such action of compliance with any representations, warranties, covenants or agreements contained in this Agreement. The waiver by any party hereto of a breach of any provision hereunder shall not operate or be construed as a waiver of any prior or subsequent breach of the same or any other provision hereunder. 10.11. INCORPORATION OF EXHIBITS. The Hallmark Disclosure Letter, the CHS Disclosure Letter and all Exhibits attached hereto and referred to herein are hereby incorporated herein and made a part hereof for all purposes as if fully set forth herein. 10.12. SEVERABILITY. Any term or provision of this Agreement which is invalid or unenforceable in any jurisdiction shall, as to that jurisdiction, be ineffective to the extent of such invalidity or unenforceability without rendering invalid or unenforceable the remaining terms and provisions of this Agreement or affecting the validity or enforceability of any of the terms or provisions of this Agreement in any other jurisdiction. If any provision of this Agreement is so broad as to be unenforceable, the provision shall be interpreted to be only so broad as is enforceable. 10.13. ENFORCEMENT OF AGREEMENT. The parties hereto agree that irreparable damage would occur in the event that any of the provisions of this Agreement was not performed in accordance with its specific terms or was otherwise breached. It is accordingly agreed that the parties shall be entitled to an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the terms and provisions hereof in any Delaware Court, this being in addition to any other remedy to which they are entitled at law or in equity. 10.14. SUBSIDIARIES. As used in this Agreement, the word "Subsidiary" when used with respect to any party means any corporation or other organization, whether incorporated or unincorporated, of which such party directly or indirectly owns or controls at least a majority of the securities or other interests having by their terms ordinary voting power to elect a majority of the board of directors or others performing similar functions with respect to such corporation or other organization, or any organization of which such party is a general partner. When a reference is made in this Agreement to Significant Subsidiaries, the words "Significant Subsidiaries" shall refer to Subsidiaries (as defined above) which constitute "significant subsidiaries" under Rule 405 promulgated by the SEC under the Securities Act. 10.15. MATERIALITY. (a) Without limiting what may constitute, for purposes of this Agreement, a Hallmark Material Adverse Effect, any single event or series of related events that exceeds, or the effect or result of which can reasonably be expected to exceed, individually or in the aggregate, $8,000,000 shall be deemed to be material. In determining whether a representation or warranty of Hallmark is true and correct in all material respects, all references to the word "material" shall be disregarded, and any untruth or incorrectness shall be measured, if measurable as a dollar amount, against the definition of materiality in the preceding sentence or any other determination of materiality. (b) Without limiting what may constitute, for purposes of this Agreement, a CHS Material Adverse Effect, any single event or series of related events that exceeds, or the effect or result of which can reasonably be expected to exceed, individually or in the aggregate, $8,000,000 shall be deemed to be material. In determining whether a representation or warranty of CHS or Merger Sub is true and correct in all material respects, all references to the word "material" shall be disregarded, and any untruth or incorrectness shall be measured, if measurable as a dollar amount, against the definition of materiality in the preceding sentence or any other determination of materiality. A-31 IN WITNESS WHEREOF, the parties have executed this Agreement and caused the same to be duly delivered on their behalf on the day and year first written above. COMMUNITY HEALTH SYSTEMS, INC. ATTEST: By: /s/TYREE G. WILBURN By: /s/E. THOMAS CHANEY ---------------------------- ---------------------------- TYREE G. WILBURN E. THOMAS CHANEY COMMUNITY ACQUISITION CORP. ATTEST: By: /s/TYREE G. WILBURN By: /s/E. THOMAS CHANEY ---------------------------- ---------------------------- TYREE G. WILBURN E. THOMAS CHANEY HALLMARK HEALTHCARE CORPORATION ATTEST: By: /s/PETER J. PIZZO, III By: /s/ROBERT M. THORNTON, JR. ---------------------------- ---------------------------- PETER J. PIZZO, III ROBERT M. THORNTON, JR.
A-32 EX-10.2 3 EXHIBIT 10.2 (EXHIBIT C - 94MSE2151) AMENDED EMPLOYMENT AGREEMENT JAMES T. MCAFEE, JR. CHAIRMAN AND CHIEF EXECUTIVE OFFICER AND HALLMARK HEALTHCARE CORPORATION AMENDED EMPLOYMENT AGREEMENT This AGREEMENT, originally dated as of July 1, 1989 and amended as of March 1, 1994, by and between Hallmark Healthcare Corporation (the "Company"), a Delaware corporation with its principal office in Atlanta, Georgia, and James T. McAfee, Jr. ("Officer"), WITNESSETH THAT WHEREAS, the Company is a corporation engaged in providing healthcare and related services to the public; and WHEREAS, the Company wishes to employ Officer and Officer is willing to be employed in an executive, managerial capacity upon the terms and conditions hereinafter set forth; NOW, THEREFORE, in consideration of the mutual covenants and obligations contained herein, the Company hereby agrees to employ Officer and Officer hereby agrees to be employed upon the terms and conditions hereinafter set forth: 1. TERM OF EMPLOYMENT. The Company hereby employs Officer and Officer hereby accepts such employment upon the terms and conditions hereof for a term commencing on the date of this Agreement as set forth above and, subject to the following sentences of this Paragraph, ending on September 30, 1996. Unless Officer's employment under this Agreement is otherwise terminated in accordance with Paragraphs 7, 8, 9, 10, 11 or 12 during the period between March 1 and March 31 of 1996 and March 1 and March 31 each year thereafter, either the Company or Officer may notify the other in writing of the termination of Officer's employment under this Agreement effective as of September 30 of such year. If neither the Company nor Officer shall notify the other in writing during said period between March 1 and March 31 of the termination of employment under this Agreement then, unless Officer's employment is otherwise terminated pursuant to Paragraph 7, 8, 9, 10 11 or 12, this Agreement shall as of September 30 immediately thereafter have a remaining unexpired term of one (1) year. If either the Company or Officer shall notify the other in writing prior to any such March 31 of the termination of employment under this Agreement, such termination shall be effective as of September 30 of the year including such March 31. If this Agreement is terminated by the Company pursuant to this provision other than for reasons described hereafter in Paragraph 7 or 11, Officer will be entitled to (i) be paid monthly for a period of three (3) years after termination, severance pay for each month during such three (3)-year period equal to the highest monthly rate of base salary paid to Officer at any time under Paragraph 3(a) (or in the alternative, at the Company's option, promptly pay to Officer a lump sum severance payment in cash equal to the sum of said monthly payments of base salary over three (3) years, discounted to present value at a discount rate equivalent to the average -2- yield to maturity of Treasury Bills of the United States Government, having a maturity most nearly equivalent to said three (3)-year period, as then being quoted by three dealers therein selected by the Company), (ii) all unpaid bonuses referred to in Paragraphs 3(b), 3(d) and 3(e) which have vested together with that portion of any bonus for the then current fiscal year computed by prorating such bonus to date of termination, (iii) all other vested stock options and benefits, and (iv) all disability, life and medical insurance benefits (as provided prior to such termination) for a period of three (3) years. In the event there are any annual bonuses with respect to a fiscal year which has not ended prior to Officer leaving employment, such bonus shall be paid on a pro rata basis through the date of termination, based upon performance against target through fiscal year end. If this Agreement is terminated by Officer pursuant to this provision for reasons other than those described in Paragraph 8 or 11, Officer shall be entitled to all vested bonuses and all stock options and restricted stock which have vested in accordance with the applicable plan, and vested other benefits but Officer will not be entitled to any severance pay under this Paragraph 1. 2. DUTIES OF OFFICER. Officer will during the continuance of his employment hereunder perform the duties of the Chairman and Chief Executive Officer. Officer will devote a substantial portion of his working time, attention and abilities to his duties as Chairman and Chief -3- Executive Officer and will use his best reasonable efforts to promote the interests and welfare of the Company. To the extent not inconsistent with his duties hereunder, Officer may pursue other business or personal activities. Officer will disclose in advance to the Compensation Committee of the Board of Directors of the Company (the "Committee") in writing any new outside business activities which could conflict with the Company's business. 3. COMPENSATION. (a) BASE SALARY. For all services to be rendered by Officer in any capacity during the period of his employment under this Agreement, including, without limitation, services as a executive, officer, director, or member of any committee of the Company, Officer shall be paid as compensation a base salary at the rate of not less than $500,000 per annum for fiscal 1994 and thereafter, or at such higher rate as may from time to time be fixed by the Committee, payable in accordance with the customary payroll practices of the Company, but in no event less frequently than monthly. (b) ANNUAL BONUS. As additional compensation for all services rendered by Officer during the period of his employment under this Agreement (i.e., subsequent to June 30, 1989), Officer will participate in an Annual Bonus Program hereafter described in Attachment A. Officer will have a target bonus calculated as seventy-five percent (75%) of his base salary, subject to his performance against Company objectives pre-established by the Committee. In -4- the event additional bonus plans are instituted by the Committee, Officer may also be included in said plans at the discretion of such Committee. (c) LONG-TERM STOCK INCENTIVE PLAN--1989. As of the date of this Amended Employment Agreement, the parties acknowledge that the grants and awards to Officer of restricted stock and options under the Long-Term Stock Incentive Plan have vested. (d) AMENDED LONG-TERM CASH INCENTIVE PLAN-1990. As of the date of this Amended Employment Agreement, the parties acknowledge that awards to Officer under the Long-Term Cash Incentive Plan-1990, as amended, have vested and will be paid in accordance with and subject to the conditions contained in such plan, as amended. (e) 1993 LONG-TERM INCENTIVE PLAN. Officer shall also participate in the 1993 Long-Term Incentive Plan, pursuant to which Officer shall be granted an award which, if it becomes vested under the terms of such plan, shall result in the payment to Officer of one hundred percent (100%) of the Officer's annual base salary for each of the Company's fiscal years 1994, 1995 and 1996; and such award shall be payable in accordance with the terms of such plan. (f) 1993 STOCK OPTION PLAN. Officer shall also participate in the 1993 Stock Option Plan. Officer and the Company acknowledge that Officer has been granted an option to purchase 22,606 shares of the Corporation's Class A Common Stock under such -5- Plan; and Officer shall be eligible, in the discretion of the Compensation Committee, to be granted additional options under such Plan. 4. REIMBURSEMENT OF EXPENSES. The Company shall pay, or reimburse Officer in accordance with the Company's prevailing corporate policy for reasonable travel and other expenses incurred by Officer in performing his duties under this Agreement in accordance with corporate policy. Reasonable legal fees and disbursements incurred by Officer in connection with any enforcement of this Agreement shall be reimbursed by the Company provided the Officer prevails in any such enforcement proceedings. 5. PARTICIPATION IN BENEFIT PLANS. The payments provided in other paragraphs of this Agreement are in addition to any benefits and perquisites to which Officer may be or may become entitled under any present or future employment benefit and perquisite plan or program, or executive contingent compensation plan of the Company for which senior executives are or shall become eligible, and Officer shall be eligible to receive during the period of his employment under this Agreement, benefits and emoluments for which senior executives are eligible under every plan or program to the extent permissible under the general terms and provisions thereof. -6- In further consideration of his employment by the Company, Officer shall be entitled to the following benefits: (a) Insurance as follows: (1) Health, accident and dental insurance for Officer and his dependents and long-term disability insurance for Officer, all in amounts and coverage comparable to that presently provided by the Company to the most senior officers of the Company. Company shall provide to Officer proof that he and his dependents are properly covered by all of the aforesaid types of insurance without any exclusion or exceptions for pre-existing conditions. (2) Term life insurance in the amount of four times his then-base salary (but in no event greater than $1,500,000), the beneficiary of which will be designated in the sole discretion of Officer. If for any reason during the term hereof any required policy or coverage is cancelled or coverage denied for any reason, the Company agrees to provide Officer with replacement insurance in the required amount so long as said insurance is available at commercially reasonable rates. The Company shall cause so much of said insurance to be included under an Employee Group Term Life Insurance Plan which qualifies under IRC Section 79 so that the cost of said insurance, to the maximum extent allowable by law, will not be includable in the gross taxable income of Officer. (b) The Company shall make available to Officer an Executive Allowance Fund to reimburse Officer for personal legal, accounting, and financial services expenses, reasonable spouse business travel, and country club dues in an amount not to exceed -7- $20,000 per year. Expenses to be reimbursed from the Executive Allowance Fund shall be documented in accordance with prevailing Company policy. The Company shall also make available to Officer an automobile allowance of $20,000 per year less any auto leasing expenses (including insurance, taxes and rentals) paid by the Company in respect of any leased auto provided to Officer. Such automobile allowance shall be in lieu of any reimbursement for auto-related expenses incurred by Officer and no further mileage, insurance or other operating expense shall be required to be paid by the Company (exclusive of rental car expense incurred when travelling away from the Company's home office on Company business). (c) Reimbursement for reasonable initiation fees not to exceed $35,000 at one country club selected by Officer during his employment by the Company. (d) An annual physical examination of Officer to be conducted by a physician that is Board certified to be selected by the Officer and acceptable to the Board of Directors, the complete cost of which shall be borne by the Company to the extent not otherwise paid by insurance or other benefits provided by the Company. The Committee shall be furnished the results of the physical examination. (e) Five (5) weeks of annual paid vacation to be taken in the sole discretion of Officer. To the extent said full five (5) weeks are not taken in any calendar year, up to one (1) week of unused vacation may be carried into the succeeding year. -8- (f) A reasonable number of paid sick days in accordance with prevailing Company policy to be taken solely in the discretion of Officer. 6. INDEMNITY AND DIRECTORS AND OFFICERS LIABILITY INSURANCE. (a) The Company agrees to indemnify and save harmless Officer from all liability and costs incurred (including reasonable attorney's fees and disbursements) as a consequence of claims by third parties, whether or not derivatively on behalf of the Company (or, after a Change of Control as defined in Paragraph 11 hereof, by the Company against the Officer or by the Officer against the Company), resulting from or growing out of Officer's current status as or as a result of his having been a director and/or officer of the Company. The terms, provisions and conditions of the indemnity provided for hereunder are to be the same as those presently provided for under the Certificate of Incorporation and Bylaws of the Company. Said terms, provisions and conditions of indemnity shall remain an obligation of the Company to Officer from and after the date hereof regardless of how the Company might hereafter amend or change its Certificate of Incorporation or Bylaws to provide for different terms, conditions and provisions of indemnity for other officers and directors of the Company. In the event the Company should amend its Certificate of Incorporation or Bylaws to provide for different terms, conditions and provisions of indemnity after the effective date hereof, Officer shall be notified in writing of the change. -9- Officer shall thereafter have thirty (30) days to elect in writing to accept the changed conditions of indemnity or to continue under the terms of indemnity as provided for herein. The Company's agreement to provide indemnity hereunder shall survive the termination of this contract regardless of the cause of termination. The Company shall advance promptly as incurred reasonable fees and disbursements of counsel for Officer in defending Officer against any claims for which the Company would be so required to indemnify Officer provided (i) Officer shall execute a promissory note payable to the Company evidencing such advance if requested by the Company and otherwise comply with such other requirements of Delaware Law or the Certificate of Incorporation or Bylaws of the Company as shall be reasonably requested by the Company and (ii) Officer shall cause such counsel to cooperate fully in good faith with such requests as the Company or its counsel may reasonably make in order to endeavor to keep such legal fees at the minimum level consistent with an adequate defense of Officer. (b) The Company agrees to the extent available at commercially reasonable rates to maintain Directors and Officers Liability Insurance in form and amount substantially equal to that presently maintained by the Company. In the event of a termination of or by Officer hereunder, the Company shall to the extent available at commercially reasonable rates immediately purchase a tail to the then-existing directors and officers liability insurance to provide Officer with continued insurance -10- coverage against claims made as a consequence of his having been a director and/or officer of the Company. Such insurance shall be maintained for a period of twenty-four (24) months in the event of voluntary termination by Officer pursuant to Paragraph 1 and for the period during which Officer shall be entitled to severance pay in the event of any other termination. 7. TERMINATION OF AGREEMENT BY COMPANY FOR CAUSE. The Company may terminate this Agreement for just and substantial cause but only after written notice as approved by a majority of the Board of Directors specifying the cause of such action shall be rendered to Officer. Prior to any such termination, Officer shall be granted an opportunity (together with counsel if so desired by officer) to appear before the Board of Directors and by heard concerning the existence of just and substantial cause. Just and substantial cause shall mean: (1) conviction of a felony or commission of illegal acts involving moral turpitude; and (2) commission of an act or acts of dishonesty on the part of Officer when such acts are intended to result, directly or indirectly, in substantial gain or personal enrichment of Officer at the expense of the Company or otherwise cause harm to the Company. In such event, Officer shall be entitled to vested stock options, salary actually earned prior to termination as well as vested bonuses and vested restricted shares. No severance pay would be owing in the event of termination pursuant to this Paragraph. -11- 8. TERMINATION BY OFFICER. In addition to his right to resign from the Company's employ pursuant to any other provision of this Agreement, Officer may resign from the Company's employ pursuant to the provisions of the next sentence, upon (A) failure to appoint or reappoint Officer to the office of Chairman and Chief Executive Officer; or (B) material changes by the Company in Officer's function, duties or responsibilities which would cause Officer's position with the Company to become of less dignity, responsibility, importance or scope from the position and attributes thereof described in Paragraph 2 or (C) any material breach of this Agreement by the Company which shall continue unremedied after thirty (30) days' prior written notice by Officer to the Company. Upon the occurrence of any event described in clauses (A), (B) or (C), Officer shall have the right to elect to terminate his employment under this Agreement by resignation upon not less than ninety (90) days' prior written notice given within a reasonable period of time not to exceed, except in the case of a continuing breach, three (3) calendar months after the event giving rise to said right to elect. Upon any such termination after the occurrence of an event described in clause (A), (B) or (C), the Company shall pay Officer, or in the event of his subsequent death, pay his beneficiary or beneficiaries, or his estate, as the case may be, each month (or at Officer's option, the Company shall fund a trust satisfactory to Officer with an annuity or lump sum sufficient to -12- permit such trust to make such monthly payments) as severance pay, for the period below described, a sum equal to the highest monthly rate of base salary paid to Officer at any time under this Agreement, plus stock options and restricted share grants which have vested in accordance with the Long-Term Stock Incentive Plan, unpaid bonuses which are vested at time of termination and all vested benefits. In the event there are any bonuses with respect to a fiscal year which has not ended prior to termination, such bonus will be paid on a pro rata basis to date of termination, based upon performance against target through fiscal year end. Payments of base salary shall commence on the last day of the month following the date of said termination and shall continue for three (3) years (inclusive of the ninety (90)-day notice period). Payments of base salary under this Paragraph, shall be offset by payments made pursuant to any other company-paid disability or salary continuation programs. 9. ILLNESS OR DISABILITY. It is understood and agreed by the parties that Officer shall not be considered as breaching this Agreement in the event he becomes unable to perform services for the Company because of sickness or disability. In the event that the Company and Officer are unable to agree whether Officer is unable to perform services for the Company because of sickness or disability said decision shall be made by three physicians, one of whom is to be selected by Officer, one of whom is to be selected by the Board, and the -13- third of whom is to be selected by the previous two. The decision of said three physicians shall be binding upon the parties and the cost of such examinations shall be borne by the Company. In the event Officer is unable to perform services for the Company because of sickness or disability, Officer's base salary shall continue at the level as provided in Paragraph 3(a) for a period of eighteen (18) months from the date of the final determination of disability by such panel of three physicians. These payments of base salary shall be reduced by any disability payments (exclusive of any payment for medical expenses payable under group medical insurance plans maintained pursuant to Paragraph 5(a)(1) or any other Company sponsored disability plan. If after a period of six (6) months from the date of the final determination of disability by the panel of three physicians called for above, Officer is unable to resume his duties hereunder because of continuing sickness or disability, then Officer's employment under this Agreement shall be terminated. If the Company disputes whether Officer is able or is unable to return to work, then such determination shall be made by the same panel of physicians described above. In the event Officer is determined to be unable to return to work, he shall be entitled to his base salary as provided in the preceding Paragraph (reduced by any long-term disability payments provided Officer as a result of the coverage pursuant to Paragraph 5(a)(1) or any other Company sponsored long-term disability plan) and to stock options, bonuses, vested restricted stock and any other vested benefits. -14- All disability, life and medical insurance as provided prior to termination shall continue for a period of eighteen (18) months after termination. In the event there are any bonuses with respect to a fiscal year which has not ended prior to Officer leaving employment for disability, such bonus shall be paid on a pro rata basis through the date of termination of employment, based upon performance against target through fiscal year end. 10. DEATH DURING EMPLOYMENT. If Officer dies during the term of this Agreement, the Company shall pay to Officer's estate the compensation which would otherwise be payable to Officer pursuant to this Agreement up to end of the month in which his death occurs. This shall include vested stock options, any unpaid bonuses which are vested as of the date of death, vested restricted stock and vested benefits. In the event there are any bonuses with respect to a calendar year which has not ended prior to Officer's death, such bonus shall be paid on a pro rata basis based upon performance against target for the fiscal year in which death occurs. 11. CHANGE OF CONTROL. In the event of a material change in ownership of the Company or a transfer of all or substantially all of its assets, in either case resulting in Change of Control of the Company prior to September 30, 1996, Officer shall have the right to terminate his employment under this Agreement by (i) resignation on not less -15- than ninety (90) days' prior written notice given within six (6) calendar months after the occurrence of the Change of Control and (ii) by resignation on not less than ninety (90) days' prior written notice given within eighteen (18) calendar months after such Change of Control and within six (6) months after the occurrence of any of the following (A) failure to appoint or reappoint Officer to the office of Chairman and Chief Executive Officer or (B) the making of any material change by the Company in Officer's function, duties or responsibilities which would cause Officer's position with the Company to become of less dignity, responsibility, importance or scope from the position and attributes thereof described in Paragraph 2 or (C) any material breach by the Company not cured within thirty (30) days' of written notice thereof. "Change of Control" shall mean the event by which any "person" (as such term is used in Section 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) either alone or in conjunction with its "affiliates" as that term is defined in Rule 405 of the General Rules and Regulations under the Securities Act of 1933, as amended, or other group of persons, corporations, partnerships or other entities who are not "affiliates" but who are acting in concert, acquire ownership of record or beneficially that number of shares of the outstanding stock of the Company which would allow such person or entity and/or its affiliates, or others acting in concert, to elect a majority of the Board of Directors of the Company; provided, however, "Change of Control" shall not include any acquisition of -16- control referred to above (i) by the Officer acting alone or in concert with one or more of the Company's five most senior officers holding office on the date of this Agreement or (ii) in which the Officer accepts equity securities of the Company or any entity with or into which the Company is merged or consolidated, or which controls or is controlled by the Company or any such entity, except for equity securities accepted or received by the Officer (a) in his capacity as a shareholder and (b) pursuant to stock options and other benefits not materially in excess of those typically available to officers of other publicly held for- profit healthcare companies not subject to a Change of Control. Upon the occurrence of a Change of Control and an election by Officer to terminate his employment, the Company shall pay to Officer, or in the event of his subsequent death, pay his beneficiary or beneficiaries, or his estate, as the case may be, as severance pay, a sum each month for a period of four (4) years after such termination (but inclusive of the ninety (90)-day notice period), equal to the highest monthly rate of base salary paid to Officer at any time under this Agreement. In the alternative to such monthly payments, Officer shall have the right exercisable at any time by written notice to Company to require the Company to (and, in such event, the Company agrees to) (i) promptly fund a trust by lump sum cash or an annuity, in each case in form and substance satisfactory to Officer, in an amount at least sufficient to permit such trust to make such monthly payments over said four (4)-year period or the remainder thereof (inclusive of the ninety -17- (90)-day notice period), as the case may be or, (ii) at Officer's election, promptly pay to Officer a lump sum amount in cash equal to the sum of the forty- eight (48) subsequent monthly payments of base salary at the highest monthly rate of base salary paid to Officer at any time under this Agreement, without discount to present value. Officer will also be entitled under this Paragraph, to all vested benefits (including continuance for said four (4)-year period of all disability, life and medical insurance as provided prior to the Change of Control), restricted shares, options and bonuses, both vested and unvested, such bonuses being prorated to date of termination based upon performance against target for the fiscal year in which such termination occurs. Payments of base salary under this Paragraph, shall be offset by any payments made pursuant to any other Company paid disability or salary continuation program. In the event that any payment or benefit, or any combination of payments or benefits, to Officer hereunder with respect to a termination effective on or before September 30, 1996 is determined to be an "excess parachute payment" pursuant to Section 280G of the Internal Revenue Code of 1986, as amended (the "Code"), then the Company shall pay to Officer, as additional severance pay, an amount equal to the excise tax, if any, imposed upon officer pursuant to Section 4999 of the Code. -18- 12. TERMINATION OF AGREEMENT BY COMPANY FOR REASONS OTHER THAN CAUSE. Unless Officer's employment under this Agreement is otherwise terminated in accordance with Paragraphs 1, 7, 8, 9 10 or 11, the Company may terminate this Agreement for any reason upon ninety (90) days' prior written notice to Officer. If this Agreement is so terminated by the Company pursuant to this Paragraph, Officer will be entitled to (i) be paid monthly for the period of three (3) years following notice of termination (inclusive of the ninety (90) days' notice period), severance pay for each month during such three (3)-year period equal to the highest monthly rate of base salary paid to Officer at any time under Paragraph 3(a) (or, at Officer's election, a lump sum amount in cash equivalent to the present value of the aforesaid monthly payments over the period of three (3) years, discounted at a rate equal to the average yield to maturity of Treasury Bills of the United States Government having a maturity most nearly equivalent to said three (3)-year period as then being offered or quoted by three dealers therein selected by the Company), (ii) bonuses referred to in Paragraph 3(b), 3(d) and 3(e) which have vested together with that portion of any bonus for the then-current fiscal year prorated to date of termination, (iii) restricted shares and stock options which have vested in accordance with the applicable plan or which would otherwise have vested within the fiscal year in which termination occurs and (iv) continuance for said three (3)-year period of all disability, life and medical insurance as provided prior to termination. In the event there are any bonuses with -19- respect to a fiscal year which has not ended prior to Officer leaving employment, such bonuses shall be paid on a pro rata basis through the date of termination of employment, based upon performance against target through fiscal year end. The Company may not terminate Officer's employment hereunder pursuant to this Paragraph after or in contemplation of a "Change of Control" as defined in Paragraph 11. 13. DECISIONS BY COMPANY. Any powers granted to the Committee or the Board of Directors of the Company hereunder may be exercised by the Committee or any other committee appointed by the Board of Directors of the Company, and the Committee or such other committee, if appointed, shall have the general responsibility for the administration and interpretation of this Agreement including determinations of compensation for purposes of paragraph 3. 14. EFFECT OF PRIOR AGREEMENTS. This Agreement contains the entire understanding between the parties hereto and supersedes any prior employment agreement between the Company or any predecessor of the Company and Officer except that this Agreement shall not affect or operate to reduce any benefit or compensation inuring to Officer of a kind elsewhere provided and not expressly provided in this Agreement. -20- 15. CONSOLIDATION, MERGER, OR SALE OF ASSETS. Nothing in the Agreement shall preclude the Company from consolidating or merging into or with or transferring all or substantially all of its assets to another corporation which assumes this Agreement and all obligations and understandings of the Company hereunder. Upon such a consolidation, merger, or transfer of assets and assumption, the term "the Company", as used herein, shall mean such other corporation and this Agreement shall continue in full force and effect, subject to Officer's rights under Paragraph 8 and 11. 16. FEDERAL INCOME TAX WITHHOLDING. The Company may withhold from any benefits payable under this Agreement all Federal, State, City, or other taxes as shall be required pursuant to any law or governmental regulation or ruling. 17. SUCCESSORS BOUND; ASSIGNABILITY. This Agreement shall be binding upon the Company and Officer, their respective heirs, executors, or administrators. This Agreement is nonassignable. 18. MODIFICATION AND WAIVER. (a) AMENDMENT OF AGREEMENT. This Agreement may not be modified or amended except by an instrument in writing signed by the parties hereto. -21- (b) WAIVER. No condition of this Agreement shall be deemed to have been waived, nor shall there be any estoppel against the enforcement of any provisions of this Agreement, except by written instrument of the party charged with such waiver or estoppel. No such written waiver shall be deemed a continuing waiver unless specifically stated therein, and each such waiver shall operate only as to the specific term or condition for the future or as to any act other than that specifically waived. 19. SEVERABILITY. If for any reason, any provision of this Agreement is held invalid, such invalidity shall not affect any other provision of this Agreement not held so invalid, and each such other provision shall to the full extent consistent with law continue in full force and effect. If any provision of this Agreement shall be held invalid in part, such invalidity shall in no way affect the rest of such provision not held so invalid, and the rest of such provisions, together with all other provisions of this Agreement, shall to the full extent consistent with law continue in full force and effect. 20. HEADINGS. The headings or paragraphs herein are included solely for convenience of reference and shall not control the meaning or interpretation of any of the provisions of this Agreement. -22- 21. GOVERNING LAW. This Agreement has been executed and delivered in the State of Georgia and its validity, interpretation, performance, and enforcement shall be governed by the laws of said State. IN WITNESS WHEREOF, the Company has caused this Amended Employment Agreement to be executed by an officer thereunto duly authorized, and Officer has signed this Agreement, all as of the day and year first above written. HALLMARK HEALTHCARE CORPORATION ("Company") By: /s/ ROBERT M. THORNTON, JR. --------------------------- Robert M. Thornton, Jr. President /s/ JAMES T. MCAFEE, JR. ------------------------ JAMES T. McAFEE, JR. ("Officer") -23- ATTACHMENT A ANNUAL BONUS PLAN An Annual Bonus Plan for senior management has been instituted by the Company and shall be continued during employment of the Officer. The amount of the annual bonus shall be determined annually by the Committee in relation to results achieved by participants in the Annual Bonus Plan based on the degree of achievement by the Company of its strategic and financial targets. The degree to which the targets are achieved will be determined at fiscal year end and produce a payout for participants proportionately greater for above target performance and proportionately smaller for below target performance. Targets may include, but are not limited to, such items as cash flow, census and operating income as established by the Committee after consultation with the Chief Executive Officer. The Annual Bonus Plan shall be subject to amendment, modification and interpretation by the Committee and any such amendment, modification or interpretation shall be binding on all participants. EX-10.3 4 EXHIBIT 10.3 (EXHIBIT B - 94MSE2151) SECOND AMENDMENT TO EMPLOYMENT AGREEMENT SECOND AMENDMENT TO EMPLOYMENT AGREEMENT, dated as of June 10, 1994 between Hallmark Healthcare Corporation (the "Company"), a Delaware corporation with its principal office in Atlanta, Georgia and James T. McAfee, Jr. ("Officer"), an individual residing in Atlanta. RECITALS: The Company and Officer are parties to an Employment Agreement dated as of July 1, 1989 as amended March 1, 1994 (the Employment Agreement as so amended is referred to herein as the "Amended Employment Agreement"). On June 10, 1994 the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Community Health Systems, Inc. ("CHS") pursuant to which the Company will merge (the "Merger") with a wholly owned subsidiary of CHS. Under Section 11 of the Amended Employment Agreement, Officer will have the right to terminate his employment and to receive, among other things, monthly severance pay over four years in an amount equal to the highest monthly rate of base salary paid to Officer at any time under the Amended Employment Agreement. The Company and Officer have been advised that there is a risk that the severance payments may be deemed to be a "excess parachute payment" under Section 280G of the Internal Revenue Code of 1986, as amended (the "Code"). The Company and Officer desire to amend the Amended Employment Agreement in such a manner as to avoid such risk. The parties agree as follows: 1. AMENDMENT OF SECTION 11 OF THE AMENDED EMPLOYMENT AGREEMENT. Section 11 of the Amended Employment Agreement is hereby amended in its entirety to read as follows: "11. CHANGE OF CONTROL. In the event of a material change in ownership of the Company or a transfer of all or substantially all of its assets, in either case resulting in Change of Control of the Company prior to September 30, 1996, Officer shall have the right to terminate his employment under this Agreement by (i) resignation on not less than ninety (90) days' prior written notice given within six (6) calendar months after the occurrence of the Change of Control and (ii) by resignation on not less than ninety (90) days' prior written notice given within eighteen (18) calendar months after such Change of Control and within six (6) months after the occurrence of any of the following (A) failure to appoint or reappoint Officer to the office of Chairman and Chief Executive Officer or (B) the making of any material change by the Company in Officer's function, -2- duties or responsibilities which would cause Officer's position with the Company to become of less dignity, responsibility, importance or scope from the position and attributes thereof described in Paragraph 2 or (C) any material breach by the Company not cured within thirty (30) days' of written notice thereof. "Change of Control" shall mean the event by which any "person" (as such term is used in Section 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) either alone or in conjunction with its "affiliates" as that term is defined in Rule 405 of the General Rules and Regulations under the Securities Act of 1933, as amended, or other group of persons, corporations, partnerships or other entities who are not "affiliates" but who are acting in concert, acquire ownership of record or beneficially that number of shares of the outstanding stock of the Company which would allow such person or entity and/or its affiliates, or others acting in concert, to elect a majority of the Board of Directors of the Company; provided, however, "Change of Control" shall not include any acquisition of control referred to above (i) by the Officer acting alone or in concert with one or more the Company's five most senior officers holding office on the date of this Agreement or (ii) in which the Officer accepts equity securities of the Company or any entity with or into which the Company is merged or consolidated, or which controls or is controlled by the Company or any such entity, except for equity securities accepted or received by the Officer (a) in his capacity as a shareholder and (b) pursuant to stock options and other benefits not materially in excess of those typically available to officers of other publicly held for-profit healthcare companies not subject to a Change of Control. Upon the occurrence of a Change of Control and an election by Officer to terminate his employment, the Company shall pay to Officer, or in the event of his subsequent death, pay his beneficiary or beneficiaries, or his estate, as the case may be, as severance pay, a sum each month for a period of four (4) years after such termination (but inclusive of the ninety (90)-day notice period), equal to the highest monthly rate of base salary paid to Officer at any time under this Agreement, not to exceed $34,166.66 per month. In the alternative to such monthly payments, Officer shall have the right exercisable at any time by written notice to Company to require the Company to (and, in such event, the Company agrees to) (i) promptly fund a trust by lump sum cash or an annuity, in each case in form and substance satisfactory to Officer, in an amount at least sufficient to permit such trust to make such monthly payments (not to exceed $34,166.66 per month) over said four (4)-year period or the remainder thereof (inclusive of the ninety (90)-day notice period), as the case may be or, (ii) at Officer's election, promptly pay to Officer a lump sum amount in cash equal to the sum of the forty-eight (48) subsequent monthly payments of base salary at the highest monthly rate of base salary paid to Officer at any time under this Agreement, without discount to present value; provided however, such lump sum payment shall not exceed $1,640,000. Officer will also be entitled under this Paragraph, to (1) options on 84,296 shares of common stock of the Company at an exercise price of $0.70 per share and 22,606 shares of common stock of the Company at an exercise price of $13.00 per share pursuant to the Long-Term Stock Incentive Plan-1989 and 1993 Stock Option Plan, respectively, (2) a pro rated bonus of $93,750 under the Company's annual bonus plan for the period from July 1, 1994 through September 30, 1994, (3) a pro rated bonus of $125,000 under the Company's 1993 Long Term Incentive Plan (the "1993 Incentive Plan") for the period from July 1, 1994 through September 30, 1994, (4) -3- such bonus which is due under the Company's 1993 Long-Term Incentive Plan for the year ended June 30, 1994 based on the audited financial statements of the Company without regard to non-recurring costs associated with the proposed merger of the Company with a subsidiary of Community Health Systems, Inc., and (5) a payment of $233,570 in lieu of continuance in any benefit plans described in Section 5 hereof, including without limitation all disability, life and medical insurance or other benefits provided prior to the Change of Control. Payments of base salary under this Paragraph, shall be offset by any payments made pursuant to any other Company paid disability or salary continuance program. The following additional provisions shall apply to payments made under this Section 11: (A) Notwithstanding anything to the contrary contained in this Section 11, in the event that any payment received or to be received by Officer under this Section 11 ("Severance Payment") would be subject to the excise tax (the "Excise Tax") imposed by section 4999 of the Internal Revenue Code of 1986, as amended (the "Code") (in whole or in part), the Severance Payment shall be reduced (but not below zero) until no portion of such payment would be subject to the Excise Tax. For purposes of this limitation, (i) no portion of such payments, the receipt or enjoyment of which Officer shall have effectively waived in writing, shall be taken into account; (ii) only the portion of such payment which constitutes a "parachute payment" within the meaning of section 280G(b)(2) of the Code shall be taken into account, determined without regard to any payment or benefit received, or to be received by Officer pursuant to the terms of this Agreement or of any other plan, arrangement or agreement of the Company (or any affiliate) entered into prior to a change in control of the Company other than the Severance Payment; (iii) such payment shall be reduced only to the extent necessary so that such payments would not be subject to the Excise Tax; and (iv) the value of any noncash benefit or any deferred payment or benefit included in such payment shall be determined in accordance with the principles of sections 280G(d)(3) and (4) of the Code. The Company or its successor in interest will analyze the total compensation payable hereunder as a result of a Change in Control immediately after such Change in Control occurs and propose such changes as may, in the good faith opinion of the Company, be necessary to reduce the Severance Payment until no portion of such payment would be subject to the Excise Tax. Officer and the Company shall endeavor in good faith to agree upon any reduction which may be necessary to meet the foregoing standard. If Officer and the Company are unable to agree within 30 days, the matter shall be referred to independent tax counsel selected by Officer and reasonably acceptable to the Company whose determination concerning the amount of the reduction in the Severance Payment, if any, shall be binding -4- on the parties. The reasonable fees and disbursements of such independent tax counsel shall be paid by the Company. (B) If a claim is made by the Internal Revenue Service as to the non- deductibility of any Severance Payment or for any Excise Tax in respect of any Severance Payment, the Company shall promptly notify Officer. The Company shall, at the Company's expense, take such action or permit Officer to take such action as Officer may reasonably request with respect to the contest of any such asserted liability, including without limitation, resisting payment thereof. The Company shall not settle or compromise a contest that it is otherwise required to pursue hereunder if Officer in good faith withholds consent to such settlement. The Company may decline to contest any such claim notwithstanding Officer's request if, the Company shall (i) waive any right to payment pursuant to subsection (C) hereof and (ii) agree to indemnify and hold harmless Officer on an after tax basis for (a) any Excise Tax which may be imposed in respect of any such Severance Payment and (b) any cost or expense, including without limitation, attorneys fees and disbursements, if any, incurred by Officer in connection with the contest or settlement of any such Excise Tax. (C) If it is established pursuant to a final determination of a court or an Internal Revenue Service proceeding that, notwithstanding the good faith of Officer and the Company in applying the terms of clause (a) above, any Severance Payment paid to Officer or for Officer's benefit exceeded the limitation contained in clause (A) above, then Officer shall pay to the Company within 30 days of receipt of notice of such final determination or opinion, an amount equal to the sum of (x) the excess of the payment paid to Officer or for Officer's benefit over the maximum payment that should have been paid to or for Officer's benefit taking into account the limitations contained in Section 2(a) hereof and (y) interest on the amount set forth in clause (x) of this sentence at the applicable federal rate (as defined in section 1274(d) of the Code) from the date of Officer's receipt of such excess until the date of such payment." 2. EFFECTIVE DATE FOR AMENDMENTS. The amendments to Section 11 of the Amended Employment Agreement set forth in paragraph 1 hereof shall take effect on the Effective Date of the Merger. If the Merger Agreement is terminated by the parties thereto without the Merger's having occurred, this Agreement shall have no further force or effect. -5- IN WITNESS WHEREOF, the Company has caused this Amended Employment Agreement to be executed by an officer thereunto duly authorized, and Officer has signed this Agreement, all as of the day and year first above written. HALLMARK HEALTHCARE CORPORATION ("Company") By: /s/ ROBERT M. THORNTON, JR. ------------------------------ Robert M. Thornton, Jr. President /s/ JAMES T. MCAFEE, JR. ------------------------------ JAMES T. McAFEE, JR. ("Officer") EX-10.4 5 EXHIBIT 10.4 (EXHIBIT D - 94MSE2151) AMENDED EMPLOYMENT AGREEMENT ROBERT M. THORNTON, JR. PRESIDENT, CHIEF OPERATING OFFICER AND CHIEF FINANCIAL OFFICER AND HALLMARK HEALTHCARE CORPORATION AMENDED EMPLOYMENT AGREEMENT This AGREEMENT, originally dated as of July 1, 1989 and amended as of March 1, 1994, by and between Hallmark Healthcare Corporation (the "Company"), a Delaware corporation with its principal office in Atlanta, Georgia, and Robert M. Thornton, Jr. ("Officer"), WITNESSETH THAT WHEREAS, the Company is a corporation engaged in providing healthcare and related services to the public; and WHEREAS, the Company wishes to employ Officer and Officer is willing to be employed in an executive, managerial capacity upon the terms and conditions hereinafter set forth; NOW, THEREFORE, in consideration of the mutual covenants and obligations contained herein, the Company hereby agrees to employ Officer and Officer hereby agrees to be employed upon the terms and conditions hereinafter set forth: 1. TERM OF EMPLOYMENT. The Company hereby employs Officer and Officer hereby accepts such employment upon the terms and conditions hereof for a term commencing on the date of this Agreement as set forth above and, subject to the following sentences of this Paragraph, ending on September 30, 1996. Unless Officer's employment under this Agreement is otherwise terminated in accordance with Paragraphs 7, 8, 9, 10, or 11 during the period between March 1 and March 31 of 1996 and March 1 and March 31 each year thereafter, either the Company or Officer may notify the other in writing of the termination of Officer's employment under this Agreement effective as of September 30 of such year. If neither the Company nor Officer shall notify the other in writing during said period between March 1 and March 31 of the termination of employment under this Agreement then, unless Officer's employment is otherwise terminated pursuant to Paragraph 7, 8, 9, 10 or 11, this Agreement shall as of September 30 immediately thereafter have a remaining unexpired term of one year. If either the Company or Officer shall notify the other in writing prior to any such March 31 of the termination of employment under this Agreement, such termination shall be effective as of September 30 of the year including such March 31. If this Agreement is terminated by the Company pursuant to this provision other than for reasons described hereafter in Paragraph 7 or 10, Officer will be entitled to (i) be paid monthly for a period of two (2) years after termination, severance pay for each month during such two year period equal to the highest monthly rate of base salary paid to Officer at any time under Paragraph 3(a) (or in the alternative, at the Company's option, promptly pay to Officer a lump sum severance payment in cash equal to the sum of said monthly payments of base salary over two years, discounted to present value at a discount rate equivalent to the average yield to maturity of Treasury Bills of the United States Government, having a maturity most nearly equivalent to said two-year period, as then being quoted by three dealers therein selected by the Company), -2- (ii) all unpaid bonuses referred to in Paragraphs 3(b), 3(d) and 3(e) which have vested together with that portion of any bonus for the then current fiscal year computed by prorating such bonus to date of termination, and (iii) all other vested stock options and benefits. In the event there are any annual bonuses with respect to a fiscal year which has not ended prior to Officer leaving employment, such bonus shall be paid on a pro rata basis through the date of termination, based upon performance against target through fiscal year end. If this Agreement is terminated by Officer pursuant to this provision for reasons other than those described in Paragraph 10, Officer shall be entitled to all vested bonuses and all stock options and restricted stock which have vested in accordance with the applicable plan, and vested other benefits but Officer will not be entitled to any severance pay under this Agreement or any unvested benefits, options, bonuses or restricted stock. 2. DUTIES OF OFFICER. Officer will, effective on November 23, 1993 and during the continuance of his employment hereunder, perform the duties of the President, Chief Operating Officer and Chief Financial Officer. Officer will devote such amount of his working time, attention and abilities to his duties as President, Chief Operating Officer and Chief Financial Officer as are reasonably required to fully perform such duties and will use his best reasonable efforts to promote the interests and welfare of the Company. Should any question arise between the Officer and the Company as to whether -3- such Officer is devoting or has devoted sufficient time, attention and abilities to his duties, the opinion of the Company's Chief Executive Officer shall be dispositive of such question. To the extent not inconsistent with his duties hereunder, Officer may pursue other business or personal activities. Officer will disclose in advance to the Company's Chief Executive Officer and to the Compensation Committee of the Board of Directors in writing any new outside business activities which could conflict with the Company's business. The Officer shall not pursue any new outside business activity to which the Company's Chief Executive Officer expresses objection in writing to such Officer. 3. COMPENSATION. (a) BASE SALARY. For all services to be rendered by Officer in any capacity during the period of his employment under this Agreement, including, without limitation, services as a executive, officer, director, or member of any committee of the Company, Officer shall be paid as compensation a base salary at the rate of not less than $320,000 per annum (to be prorated for fiscal 1994 from November 23, 1993) for fiscal 1994 and thereafter, or at such higher rate as may from time to time be fixed by the Compensation Committee (the "Committee") of the Board of Directors of the Company, payable in accordance with the customary payroll practices of the Company, but in no event less frequently than monthly. (b) ANNUAL BONUS. As additional compensation for all services rendered by Officer during the period of his employment -4- under this Agreement (i.e. subsequent to June 30, 1989), Officer will participate in an Annual Bonus Program hereafter described in Attachment A. Officer will have a target bonus calculated as sixty percent (60%) of his base salary, subject to his performance against Company objectives pre-established by the Committee. In the event additional bonus plans are instituted by the Committee, Officer may also be included in said plans at the discretion of such Committee. (c) LONG-TERM STOCK INCENTIVE PLAN--1989. As of the date of this Amended Employment Agreement, the parties acknowledge that the grants and awards to Officer of restricted stock and options under the Long-Term Stock Incentive Plan have vested. (d) AMENDED LONG-TERM CASH INCENTIVE PLAN--1990. As of the date of this Amended Employment Agreement, the parties acknowledge that awards to Officer under the Long-Term Cash Incentive Plan-1990, as amended, have vested and will be paid in accordance with and subject to the conditions contained in such plan, as amended. (e) 1993 LONG-TERM INCENTIVE PLAN. Officer shall also participate in the 1993 Long-Term Incentive Plan, pursuant to which Officer shall be granted an award which, if it becomes vested under the terms of such plan, shall result in the payment to Officer of 80% of the Officer's annual base salary for each of the Company's fiscal years 1994, 1995 and 1996; and such award shall be payable in accordance with the terms of such plan. (f) 1993 STOCK OPTION PLAN. Officer shall also participate in the 1993 Stock Option Plan. Officer and the Company -5- acknowledge that Officer has been granted an option to purchase 13,564 shares of the Corporation's Class A Common Stock under such Plan; and Officer shall be eligible, in the discretion of the Compensation Committee, to be granted additional options under such Plan. 4. REIMBURSEMENT OF EXPENSES. The Company shall pay, or reimburse Officer in accordance with the Company's prevailing corporate policy for reasonable travel and other expenses incurred by Officer in performing his duties under this Agreement in accordance with corporate policy. Reasonable legal fees and disbursements incurred by Officer in connection with any enforcement of this Agreement shall be reimbursed by the Company provided the Officer prevails in any such enforcement proceedings. 5. PARTICIPATION IN BENEFIT PLANS. The payments provided in other paragraphs of this Agreement are in addition to any benefits and perquisites to which Officer may be or may become entitled under any present or future employment benefit and perquisite plan or program, or executive contingent compensation plan of the Company for which senior executives are or shall become eligible, and Officer shall be eligible to receive during the period of his employment under this Agreement, benefits and emoluments for which senior executives are eligible under every plan or program to the extent permissible under the general terms and provisions thereof. -6- In further consideration of his employment by the Company, Officer shall be entitled to the following benefits: (a) Insurance as follows: (1) Health, accident and dental insurance for Officer and his dependents and long-term disability insurance for Officer, all in amounts and coverage comparable to that presently provided by the Company to the Officer as the same may be adjusted from time to time by the Committee. (2) Term life insurance in the amount of three times his then-base salary (but in no event greater than $1,000,000), the beneficiary of which will be designated in the sole discretion of Officer. The Company will provide for said coverage by including Officer in the Company's existing Employee Group Term Life Insurance Plan. If for any reason during the term hereof any required policy or coverage is cancelled or coverage denied for any reason, the Company agrees to provide Officer with replacement insurance in the required amount so long as said insurance is available at commercially reasonable rates. (b) The Company shall make available to Officer an Executive Allowance Fund to reimburse Officer for personal legal, accounting, and financial services expenses, reasonable spouse business travel, other expenses and country club dues in an amount not to exceed $15,000 per year. Expenses to be reimbursed from the Executive Allowance fund shall be documented in accordance with prevailing Company policy. The Company shall also make available to the Executive an automobile allowance of $15,000 per year less any auto leasing expenses (including insurance, taxes -7- and rentals) paid by the Company in respect of any leased auto provided to Officer. Such automobile allowance shall be in lieu of any reimbursement for auto-related expenses incurred by Officer and no further mileage, insurance or other operating expense shall be required to be paid by the Company (exclusive of rental car expense incurred when travelling away from the Company's home office on Company business). (c) Reimbursement for reasonable initiation fees not to exceed $25,000 at one country club selected by Officer and approved by the Company's Chief Executive Officer. (d) An annual physical examination of Officer to be conducted by a physician that is Board certified to be selected by the Officer and acceptable to the Company's Chief Executive Officer, the cost of which shall be borne by the Company to the extent not otherwise paid by insurance or other benefits provided by the Company. A copy thereof shall be furnished to such Chief Executive Officer. (e) Four (4) weeks of annual paid vacation. To the extent said four weeks are not taken in any calendar year, up to one week of unused vacation may be carried into the succeeding year. (f) A reasonable number of paid sick days as established from time to time by corporate policy as approved by the Committee. 6. INDEMNITY AND DIRECTORS AND OFFICERS LIABILITY INSURANCE. The Company agrees to indemnify and save harmless Officer from all liability and costs incurred (including -8- reasonable attorney's fees and disbursements) as a consequence of claims by third parties, whether or not derivatively on behalf of the Company (or, after a Change of Control as defined in Paragraph 10 hereof, by the Company against the Officer or by the Officer against the Company), resulting from or growing out of Officer's current status as or as a result of his having been a director and/or officer of the Company. The terms, provisions and conditions of the indemnity provided for hereunder are to be the same as those presently provided for under the Certificate of Incorporation and Bylaws of the Company. Said terms, provisions and conditions of indemnity shall remain an obligation of the Company to Officer from and after the date hereof regardless of how the Company might hereafter amend or change its Certificate of Incorporation or Bylaws to provide for different terms, conditions and provisions of indemnity for other officers and directors of the Company. In the event the Company should amend its Certificate of Incorporation or Bylaws to provide for different terms, conditions and provisions of indemnity after the effective date hereof, Officer shall be notified in writing of the change. Officer shall thereafter have thirty (30) days to elect in writing to accept the changed conditions of indemnity or to continue under the terms of indemnity as provided for herein. The Company's agreement to provide indemnity hereunder shall survive the termination of this contract regardless of the cause of termination. The Company shall advance promptly as incurred reasonable fees and disbursements of counsel for Officer in defending Officer against any claims for which the Company would -9- be so required to indemnify Officer provided (i) Officer shall execute a promissory note payable to the Company evidencing such advance if requested by the Company and otherwise comply with such other requirements of Delaware Law or the Certificate of Incorporation or Bylaws of the Company as shall be reasonably requested by the Company and (ii) Officer shall cause such counsel to cooperate fully in good faith with such requests as the Company or its counsel may reasonably make in order to endeavor to keep such legal fees at the minimum level consistent with an adequate defense of Officer. (a) The Company agrees to the extent available at commercially reasonable rates to maintain while Officer is employed hereunder Directors and Officers Liability Insurance in form and amount substantially equal to that presently maintained by the Company. 7. TERMINATION OF AGREEMENT BY COMPANY FOR CAUSE. The Company may terminate this Agreement for just and substantial cause but only after written notice as approved by a majority of the Board of Directors specifying the cause of such action shall be rendered to Officer. Just and substantial cause shall mean: (1) conviction of a felony or commission of illegal acts involving moral turpitude; and (2) commission of an act or acts of dishonesty on the part of Officer when such acts are intended to result, directly or indirectly, in substantial gain or personal enrichment of Officer at the expense of the Company or otherwise cause harm to the Company. In such event, Officer shall -10- be entitled to vested stock options, salary actually earned prior to termination as well as vested bonuses and vested restricted shares. No severance pay would be owing in the event of termination pursuant to this Paragraph. 8. ILLNESS OR DISABILITY. In the event Officer is, in the opinion of the Committee, unable for a period of three months or more to perform services for the Company because of sickness or disability, Officer's employment hereunder shall be terminated and Officer's base salary shall continue at the level as provided in paragraph 3(a) for a period of twelve (12) months thereafter. All disability, life and medical insurance provided by the Company prior to termination shall continue for a period of twelve (12) months after such termination. In such event, Officer shall be entitled to stock options, vested bonuses together with that portion of any bonus for the then-current fiscal year prorated to date of termination (based upon performance against target through fiscal year end), vested restricted stock and other vested benefits. Payments of base salary under this Paragraph shall be reduced by any disability payments provided Officer as a result of the coverage maintained pursuant to Paragraph 5(a)(1) or in any other Company sponsored disability plan. 9. DEATH DURING EMPLOYMENT. If Officer dies during the term of this Agreement, the Company shall pay to Officer's estate the compensation which would -11- otherwise be payable to Officer pursuant to this Agreement up to end of the month in which his death occurs. This shall include vested stock options, any unpaid bonuses which are vested as of the date of death, vested restricted stock and vested benefits. In the event there are any bonuses with respect to a calendar year which has not ended prior to Officer's death, such bonus shall be paid on a pro rata basis based upon performance against target for the fiscal year in which death occurs. 10. CHANGE OF CONTROL. In the event of a material change in ownership of the Company or a transfer of all or substantially all of its assets, in either case resulting in Change of Control of the Company prior to September 30, 1996, Officer shall have the right to terminate his employment under this Agreement by (i) resignation on not less than ninety (90 days' prior written notice given within six calendar months after the occurrence of the Change of Control and (ii) by resignation on not less than ninety (90) days' prior written notice given within eighteen calendar months after such Change of Control and within six months after the occurrence of either of the following (A) failure to appoint or reappoint Officer to the office of President, Chief Operating Officer and Chief Financial Officer or (B) the making of any material change by the Company in Officer's function, duties or responsibilities which would cause Officer's position with the Company to become of less dignity, responsibility, importance or scope from the position and attributes thereof described in Paragraph 2 or -12- (C) any material breach by the Company not cured within 30 days of written notice thereof. "Change of Control" shall mean the event by which any "person" (as such term is used in Section 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) either alone or in conjunction with its "affiliates" as that term is defined in Rule 405 of the General Rules and Regulations under the Securities Act of 1933, as amended, or other group of persons, corporations, partnerships or other entities who are not "affiliates" but who are acting in concert, acquire ownership of record or beneficially that number of shares of the outstanding stock of the Company which would allow such person or entity and/or its affiliates, or others acting in concert, to elect a majority of the Board of Directors of the Company; provided, however, "Change of Control" shall not include any acquisition of control referred to above (i) by the Officer acting alone or in concert with one or more of the Company's five most senior officers holding office on the date of this Agreement or (ii) in which the Officer accepts equity securities of the Company or any entity with or into which the Company is merged or consolidated, or which controls or is controlled by the Company or any such entity, except for equity securities accepted or received by the Officer (a) in his capacity as a shareholder and (b) pursuant to stock options and other benefits not materially in excess of those typically available to officers of other publicly held for-profit healthcare companies not subject to a Change of Control. Upon the occurrence of a Change of Control and an election by Officer to terminate his employment, the Company shall pay to Officer, or in -13- the event of his subsequent death, pay his beneficiary or beneficiaries, or his estate, as the case may be, as severance pay, a sum each month for a period of three (3) years after such termination (but inclusive of the ninety (90) day notice period), equal to the highest monthly rate of base salary paid to Officer at any time under this Agreement, but in no event beyond the date Officer attains, or would have attained, the age of sixty-five (65). In the alternative to such monthly payments, Officer shall have the right exercisable at any time by written notice to Company to require the Company to (and, in such event, the Company agrees to) (i) promptly fund a trust by lump sum cash or an annuity, in each case in form and substance satisfactory to Officer, in an amount at least sufficient to permit such trust to make such monthly payments over said three- year period or the remainder thereof (inclusive of the ninety (90) day notice period), as the case may be or, (ii) at Officer's election, promptly pay to Officer a lump sum amount in cash equal to the sum of the thirty-six (36) subsequent monthly payments of base salary at the highest monthly rate of base salary paid to Officer at any time under this Agreement, without discount to present value. Officer will also be entitled under this Paragraph, to all vested benefits (including continuance for said three-year period of all disability, life and medical insurance as provided prior to the Change of Control), restricted shares, options and bonuses, both vested and unvested, such bonuses being prorated to date of termination based upon performance against target for the fiscal year in which such termination occurs. Payments of base salary -14- under this Paragraph, shall be offset by any payments made pursuant to any other Company paid disability or salary continuation program. 11. TERMINATION OF AGREEMENT BY COMPANY FOR REASONS OTHER THAN CAUSE. Unless Officer's employment under this Agreement is otherwise terminated in accordance with Paragraph 1, 7, 8, 9 or 10, the Company may terminate this Agreement for any reason upon 90 days' prior written notice to Officer. If this Agreement is so terminated by the Company pursuant to this Paragraph, Officer will be entitled to (i) be paid monthly for the period of two (2) years following termination, severance pay for each month during such two-year period equal to the highest monthly rate of base salary paid to Officer at any time under Paragraph 3(a) (or, at Officer's election, a lump sum amount in cash equivalent to the present value of the aforesaid monthly payments over the said one-year period, discounted at a rate equal to the average yield to maturity of Treasury Bills of the United States Government having a maturity of one year as then being offered or quoted by three dealers therein selected by the Company), (ii) bonuses referred to in Paragraph 3(b), 3(d) and 3(e) which have vested together with that portion of any bonus for the then-current fiscal year prorated to date of termination, (iii) restricted shares and stock options which have vested in accordance with the applicable plan or which would otherwise have vested within the fiscal year in which termination occurs and (iv) continuance for said two-year period of all disability, life and medical insurance as provided -15- prior to termination. In the event there are any annual bonuses with respect to a fiscal year which has not ended prior to Officer leaving employment, such bonuses shall be paid on a pro rata basis through the date of termination of employment, based upon performance against target through fiscal year end. The Company may not terminate Officer's employment hereunder pursuant to this Paragraph after or in contemplation of a "Change of Control" as defined in Paragraph 10. 12. DECISIONS BY COMPANY. Any powers granted to the Committee or the Board of Directors of the Company hereunder may be exercised by the Committee or any other committee appointed by the Board of Directors of the Company, and the Committee or such other committee, if appointed, shall have the general responsibility for the administration and interpretation of this Agreement including determinations of compensation for purposes of paragraph 3. 13. EFFECT OF PRIOR AGREEMENTS. This Agreement contains the entire understanding between the parties hereto and supersedes any prior employment agreement between the Company or any predecessor of the Company and Officer except that this Agreement shall not affect or operate to reduce any benefit or compensation inuring to Officer of a kind elsewhere provided and not expressly provided in this Agreement. -16- 14. CONSOLIDATION, MERGER, OR SALE OF ASSETS. Nothing in the Agreement shall preclude the Company from consolidating or merging into or with or transferring all or substantially all of its assets to another corporation which assumes this Agreement and all obligations and understandings of the Company hereunder. Upon such a consolidation, merger, or transfer of assets and assumption, the term "the Company", as used herein, shall mean such other corporation and this Agreement shall continue in full force and effect, subject to Officer's rights under Paragraph 10. 15. FEDERAL INCOME TAX WITHHOLDING. The Company may withhold from any benefits payable under this Agreement all Federal, State, City, or other taxes as shall be required pursuant to any law or governmental regulation or ruling. 16. SUCCESSORS BOUND; ASSIGNABILITY. This Agreement shall be binding upon the Company and Officer, their respective heirs, executors, or administrators. This Agreement is nonassignable. 17. MODIFICATION AND WAIVER. (a) AMENDMENT OF AGREEMENT. This Agreement may not be modified or amended except by an instrument in writing signed by the parties hereto. (b) WAIVER. No condition of this Agreement shall be deemed to have been waived, nor shall there be any estoppel against the -17- enforcement of any provisions of this Agreement, except by written instrument of the party charged with such waiver or estoppel. No such written waiver shall be deemed a continuing waiver unless specifically stated therein, and each such waiver shall operate only as to the specific term or condition for the future or as to any act other than that specifically waived. 18. SEVERABILITY. If for any reason, any provision of this Agreement is held invalid, such invalidity shall not affect any other provision of this Agreement not held so invalid, and each such other provision shall to the full extent consistent with law continue in full force and effect. If any provision of this Agreement shall be held invalid in part, such invalidity shall in no way affect the rest of such provision not held so invalid, and the rest of such provisions, together with all other provisions of this Agreement, shall to the full extent consistent with law continue in full force and effect. 19. HEADINGS. The headings or paragraphs herein are included solely for convenience of reference and shall not control the meaning or interpretation of any of the provisions of this Agreement. -18- 20. GOVERNING LAW. This Agreement has been executed and delivered in the State of Georgia and its validity, interpretation, performance, and enforcement shall be governed by the laws of said State. IN WITNESS WHEREOF, the Company has caused this Amended Employment Agreement to be executed by an officer thereunto duly authorized, and Officer has signed this Agreement, all as of the day and year first above written. HALLMARK HEALTHCARE CORPORATION By: /s/ JAMES T. MCAFEE, JR. --------------------------- James T. McAfee, Jr. Chairman /s/ ROBERT M. THORNTON, JR. --------------------------- Robert M. Thornton, Jr. -19- ATTACHMENT A ANNUAL BONUS PLAN An Annual Bonus Plan for senior management has been instituted by the Company and shall be continued during employment of the Officer. The amount of the annual bonus shall be determined annually by the Committee in relation to results achieved by participants in the Annual Bonus Plan based on the degree of achievement by the Company of its strategic and financial targets. The degree to which the targets are achieved will be determined at fiscal year end and produce a payout for participants proportionately greater for above target performance and proportionately smaller for below target performance. Targets may include, but are not limited to, such items as cash flow, census and operating income as established by the Committee after consultation with the Chief Executive Officer. The Annual Bonus Plan shall be subject to amendment, modification and interpretation by the Committee and any such amendment, modification or interpretation shall be binding on all participants. EX-10.5 6 EXHIBIT 10.5 (EXHIBIT A - 94MSE2151) SECOND AMENDMENT TO EMPLOYMENT AGREEMENT SECOND AMENDMENT TO EMPLOYMENT AGREEMENT, dated as of June 10, 1994 between Hallmark Healthcare Corporation (the "Company"), a Delaware corporation with its principal office in Atlanta, Georgia and Robert M. Thornton, Jr. ("Officer"), an individual residing in Atlanta. RECITALS: The Company and Officer are parties to an Employment Agreement dated as of July 1, 1989 as amended March 1, 1994 (the Employment Agreement as so amended is referred to herein as the "Amended Employment Agreement"). On June 10, 1994 the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Community Health Systems, Inc. ("CHS") pursuant to which the Company will merge (the "Merger") with a wholly owned subsidiary of CHS. Under Section 10 of the Amended Employment Agreement, Officer will have the right to terminate his employment and to receive, among other things, monthly severance pay over three years in an amount equal to the highest monthly rate of base salary paid to Officer at any time under the Amended Employment Agreement. The Company and Officer have been advised that there is a risk that the severance payments may be deemed to be a "excess parachute payment" under Section 280G of the Internal Revenue Code of 1986, as amended (the "Code"). The Company and Officer desire to amend the Amended Employment Agreement in such a manner as to avoid such risk. The parties agree as follows: 1. AMENDMENT OF SECTION 10 OF THE AMENDED EMPLOYMENT AGREEMENT. Section 10 of the Amended Employment Agreement is hereby amended in its entirety to read as follows: "10. CHANGE OF CONTROL. In the event of a material change in ownership of the Company or a transfer of all or substantially all of its assets, in either case resulting in Change of Control of the Company prior to September 30, 1996, Officer shall have the right to terminate his employment under this Agreement by (i) resignation on not less than ninety (90) days' prior written notice given within six (6) calendar months after the occurrence of the Change of Control and (ii) by resignation on not less than ninety (90) days' prior written notice given within eighteen (18) calendar months after such Change of Control and within six (6) months after the occurrence of either of the following (A) failure to appoint or reappoint Officer to the office of President, Chief Operating -2- Officer and Chief Financial Officer or (B) the making of any material change by the Company in Officer's function, duties or responsibilities which would cause Officer's position with the Company to become of less dignity, responsibility, importance or scope from the position and attributes thereof described in Paragraph 2 or (C) any material breach by the Company not cured within thirty (30) days' of written notice thereof. "Change of Control" shall mean the event by which any "person" (as such term is used in Section 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) either alone or in conjunction with its "affiliates" as that term is defined in Rule 405 of the General Rules and Regulations under the Securities Act of 1933, as amended, or other group of persons, corporations, partnerships or other entities who are not "affiliates" but who are acting in concert, acquire ownership of record or beneficially that number of shares of the outstanding stock of the Company which would allow such person or entity and/or its affiliates, or others acting in concert, to elect a majority of the Board of Directors of the Company; provided, however, "Change of Control" shall not include any acquisition of control referred to above (i) by the Officer acting alone or in concert with one or more the Company's five most senior officers holding office on the date of this Agreement or (ii) in which the Officer accepts equity securities of the Company or any entity with or into which the Company is merged or consolidated, or which controls or is controlled by the Company or any such entity, except for equity securities accepted or received by the Officer (a) in his capacity as a shareholder and (b) pursuant to stock options and other benefits not materially in excess of those typically available to officers of other publicly held for-profit healthcare companies not subject to a Change of Control. Upon the occurrence of a Change of Control and an election by Officer to terminate his employment, the Company shall pay to Officer, or in the event of his subsequent death, pay his beneficiary or beneficiaries, or his estate, as the case may be, as severance pay, a sum each month for a period of three (3) years after such termination (but inclusive of the ninety (90)-day notice period), equal to the highest monthly rate of base salary paid to Officer at any time under this Agreement, not to exceed $20,000 per month, but in no event beyond the date Officer attains, or would have attained, the age of sixty-five (65). In the alternative to such monthly payments, Officer shall have the right exercisable at any time by written notice to Company to require the Company to (and, in such event, the Company agrees to) (i) promptly fund a trust by lump sum cash or an annuity, in each case in form and substance satisfactory to Officer, in an amount at least sufficient to permit such trust to make such monthly payments (not to exceed $20,000 per month) over said three (3)-year period or the remainder thereof (inclusive of the ninety (90)-day notice period), as the case may be or, (ii) at Officer's election, promptly pay to Officer a lump sum amount in cash equal to the sum of the thirty-six (36) subsequent monthly payments of base salary at the highest monthly rate of base salary paid to Officer at any time under this Agreement, without discount to present value; provided however, such lump sum payment shall not exceed $720,000. Officer will also be entitled under this Paragraph, to (1) options on 16,879 shares of common stock of the Company at an exercise price of $0.70 per share and 13,564 shares of common stock of the Company at an exercise price of $13.00 per share pursuant to the Long-Term Stock Incentive Plan-1989 and 1993 Stock Option Plan, respectively, (2) a pro rated bonus of $48,000 under the Company's annual bonus plan for the period from July 1, 1994 through -3- September 30, 1994, (3) a pro rated bonus of $64,000 under the Company's 1993 Long Term Incentive Plan (the "1993 Incentive Plan") for the period from July 1, 1994 through September 30, 1994, (4) such bonus which is due under the Company's 1993 Incentive Plan for the year ended June 30, 1994 based on the audited financial statements of the Company without regard to non-recurring costs associated with the proposed merger of the Company with a subsidiary of Community Health Systems, Inc., and (5) a payment of $110,760 in lieu of continuance in any benefit plans described in Section 5 hereof, including without limitation all disability, life and medical insurance or other benefits provided prior to the Change of Control. Payments of base salary under this Paragraph, shall be offset by any payments made pursuant to any other Company paid disability or salary continuance program. The following additional provisions shall apply to payments made under this Section 10: (A) Notwithstanding anything to the contrary contained in this Section 10, in the event that any payment received or to be received by Officer under this Section 10 ("Severance Payment") would be subject to the excise tax (the "Excise Tax") imposed by section 4999 of the Internal Revenue Code of 1986, as amended (the "Code") (in whole or in part), the Severance Payment shall be reduced (but not below zero) until no portion of such payment would be subject to the Excise Tax. For purposes of this limitation, (i) no portion of such payments, the receipt or enjoyment of which Officer shall have effectively waived in writing, shall be taken into account; (ii) only the portion of such payment which constitutes a "parachute payment" within the meaning of section 280G(b)(2) of the Code shall be taken into account, determined without regard to any payment or benefit received, or to be received by Officer pursuant to the terms of this Agreement or of any other plan, arrangement or agreement of the Company (or any affiliate) entered into prior to a change in control of the Company other than the Severance Payment; (iii) such payment shall be reduced only to the extent necessary so that such payments would not be subject to the Excise Tax; and (iv) the value of any noncash benefit or any deferred payment or benefit included in such payment shall be determined in accordance with the principles of sections 280G(d)(3) and (4) of the Code. The Company or its successor in interest will analyze the total compensation payable hereunder as a result of a Change in Control immediately after such Change in Control occurs and propose such changes as may, in the good faith opinion of the Company, be necessary to reduce the Severance Payment until no portion of such payment would be subject to the Excise Tax. Officer and the Company shall endeavor in good faith to agree upon any reduction which may be necessary to meet the foregoing standard. If Officer and the Company are unable to agree within 30 days, the matter shall be referred to independent tax counsel selected by Officer -4- and reasonably acceptable to the Company whose determination concerning the amount of the reduction in the Severance Payment, if any, shall be binding on the parties. The reasonable fees and disbursements of such independent tax counsel shall be paid by the Company. (B) If a claim is made by the Internal Revenue Service as to the non-deductibility of any Severance Payment or for any Excise Tax in respect of any Severance Payment, the Company shall promptly notify Officer. The Company shall, at the Company's expense, take such action or permit Officer to take such action as Officer may reasonably request with respect to the contest of any such asserted liability, including without limitation, resisting payment thereof. The Company shall not settle or compromise a contest that it is otherwise required to pursue hereunder if Officer in good faith withholds consent to such settlement. The Company may decline to contest any such claim notwithstanding Officer's request if, the Company shall (i) waive any right to payment pursuant to subsection (C) hereof and (ii) agree to indemnify and hold harmless Officer on an after tax basis for (a) any Excise Tax which may be imposed in respect of any such Severance Payment and (b) any cost or expense, including without limitation, attorneys fees and disbursements, if any, incurred by Officer in connection with the contest or settlement of any such Excise Tax. (C) If it is established pursuant to a final determination of a court or an Internal Revenue Service proceeding that, notwithstanding the good faith of Officer and the Company in applying the terms of clause (a) above, any Severance Payment paid to Officer or for Officer's benefit exceeded the limitation contained in clause (A) above, then Officer shall pay to the Company within 30 days of receipt of notice of such final determination or opinion, an amount equal to the sum of (x) the excess of the payment paid to Officer or for Officer's benefit over the maximum payment that should have been paid to or for Officer's benefit taking into account the limitations contained in Section 2(a) hereof and (y) interest on the amount set forth in clause (x) of this sentence at the applicable federal rate (as defined in section 1274(d) of the Code) from the date of Officer's receipt of such excess until the date of such payment." -5- 2. EFFECTIVE DATE FOR AMENDMENTS. The amendments to Section 10 of the Amended Employment Agreement set forth in paragraph 1 hereof shall take effect on the Effective Date of the Merger. If the Merger Agreement is terminated by the parties thereto without the Merger's having occurred, this Agreement shall have no further force or effect. IN WITNESS WHEREOF, the Company has caused this Amended Employment Agreement to be executed by an officer thereunto duly authorized, and Officer has signed this Agreement, all as of the day and year first above written. HALLMARK HEALTHCARE CORPORATION ("Company") By: /s/ JAMES T. MCAFEE, JR. ------------------------------- James T. McAfee, Jr. Chairman /s/ ROBERT M. THORNTON, JR. ----------------------------------- Robert M. Thornton, Jr. ("Officer") EX-11.1 7 EXHIBIT 11.1 EXHIBIT 11.1 HALLMARK HEALTHCARE CORPORATION CALCULATION OF AVERAGE NUMBER OF PRIMARY AND FULLY DILUTED COMMON AND COMMON EQUIVALENT SHARES (in thousands)
Year Ended June 30 ----------------------------- 1994 1993 1992 ---- ---- ---- Weighted average Class A common stock 2,964 2,568 2,507 Class B common stock (convertible to Class A common stock) 64 390 390 Common stock equivalents: Effect of the conversion of preferred stock (5 shares of common for 1 share of preferred) 164 198 210 Options and other 489 294 251 ----- ----- ----- Average number of common and common equivalent shares on a primary and fully diluted basis 3,681 3,450 3,358 ----- ----- ----- ----- ----- -----
EX-21.1 8 EXHIBIT 21.1 EXHIBIT 21.1 SUBSIDIARY STATE OF INCORPORATION Northgate Hospital, Inc. Arkansas d/b/a Northgate Hospital d/b/a Sabine Medical Center Neuro Treatment, Inc. Delaware d/b/a RiverNorth Hospital National Healthcare of Mt. Vernon, Inc. Delaware d/b/a Crossroads Community Hospital National Healthcare of Newport, Inc. Delaware d/b/a National Healthcare of Jackson County, Inc. d/b/a Harris Hospital National Healthcare of Sabine, Inc. Delaware d/b/a Sabine Medical Center d/b/a Sabine Medical Center Rural Health Clinic National Healthcare of Holmes County, Inc. Florida d/b/a Doctors Memorial Hospital Health Care of Berrien County, Inc. Georgia d/b/a Berrien County Hospital d/b/a Georgia Home Health Services National Healthcare of Pocahontas, Inc. Arkansas d/b/a Randolph County Medical Center National Healthcare of Decatur, Inc. Delaware d/b/a Parkway Medical Center Hospital National Healthcare of Hartselle, Inc. Delaware d/b/a Hartselle Medical Center National Healthcare of Cullman, Inc. Delaware d/b/a Woodland Community Hospital National Healthcare of Cleveland, Inc. Delaware d/b/a Cleveland Community Hospital NHCI of Hillsboro, Inc. Texas d/b/a Hill Regional Hospital Scenic Mountain Medical Center, Inc. Texas d/b/a Scenic Mountain Medical Center The L. V. Stabler Memorial Hospital of Greenville, Inc. Alabama d/b/a L. V. Stabler Memorial Hospital Hospital Corporation of White County Tennessee d/b/a White County Community Hospital Berrien Nursing Center, Inc. Georgia d/b/a Berrien Nursing Center National Healthcare of Leesville, Inc. Delaware d/b/a Byrd Regional Hospital EX-24.1 9 EXHIBIT 24.1 EXHIBIT 24.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K, into the Company's previously filed Registration Statements on Form S-8, file no 33-40773, file no. 33-54326, file no. 33-54328, file no. 33-53863, file no. 33-53865, file no. 33-53861 and file no. 33-53853. ARTHUR ANDERSEN LLP Atlanta, Georgia September 13, 1994 -----END PRIVACY-ENHANCED MESSAGE-----