-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Eg8BDLgKb3TV9EJ2j7WAETZJqjzPDm7BMbMH2ZaiXpOm2GBdbJx+zoWDN7uN+JZe ELu6u+6Xe5euEA8Kv/S2KA== 0000950144-01-509108.txt : 20020410 0000950144-01-509108.hdr.sgml : 20020410 ACCESSION NUMBER: 0000950144-01-509108 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN HOMEPATIENT INC CENTRAL INDEX KEY: 0000879181 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-HOME HEALTH CARE SERVICES [8082] IRS NUMBER: 621474680 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-19532 FILM NUMBER: 1788089 BUSINESS ADDRESS: STREET 1: 5200 MARYLAND WAY STREET 2: MARYLAND FARMS OFFICE PARK CITY: BRENTWOOD STATE: TN ZIP: 37027 BUSINESS PHONE: 6152218884 MAIL ADDRESS: STREET 1: MARYLAND FARMS OFFICE PARK STREET 2: 5200 MARYLAND WAY CITY: BRENTWOOD STATE: TN ZIP: 37027 FORMER COMPANY: FORMER CONFORMED NAME: DIVERSICARE INC /DE DATE OF NAME CHANGE: 19930328 10-Q 1 g72751e10-q.txt AMERICAN HOMEPATIENT, INC. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 CHECK ONE FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2001 ------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO __________. AMERICAN HOMEPATIENT, INC. -------------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 0-19532 62-1474680 -------- ------- ---------- (STATE OR OTHER JURISDICTION OF (COMMISSION (IRS EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION) FILE NUMBER)
5200 MARYLAND WAY, SUITE 400, BRENTWOOD, TENNESSEE 37027 --------------------------------------------------------- (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (615) 221-8884 -------------- (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) NONE ------------------------------------------------------- (FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGES SINCE LAST REPORT.) INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO [ ] 16,327,389 ------------------------------------ (OUTSTANDING SHARES OF THE ISSUER'S COMMON STOCK AS OF NOVEMBER 8, 2001) TOTAL NUMBER OF SEQUENTIALLY NUMBERED PAGES IS 38 1 PART I. FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS --------------------------------------------- (unaudited)
ASSETS December 31, September 30, 2000 2001 ------------- ------------- CURRENT ASSETS Cash and cash equivalents $ 12,081,000 $ 13,857,000 Restricted cash 179,000 166,000 Accounts receivable, less allowance for doubtful accounts of $40,862,000 and $34,404,000, respectively 75,465,000 63,471,000 Inventories 15,522,000 12,248,000 Prepaid expenses and other current assets 1,489,000 1,743,000 ------------- ------------- Total current assets 104,736,000 91,485,000 ------------- ------------- PROPERTY AND EQUIPMENT, at cost 184,661,000 179,575,000 Less accumulated depreciation and amortization (131,663,000) (131,660,000) ------------- ------------- Property and equipment, net 52,998,000 47,915,000 ------------- ------------- OTHER ASSETS Excess of cost over fair value of net assets acquired, net 197,491,000 191,088,000 Investment in joint ventures 7,918,000 8,200,000 Deferred financing costs, net 3,269,000 3,290,000 Other assets, net 12,102,000 10,682,000 ------------- ------------- Total other assets 220,780,000 213,260,000 ------------- ------------- $ 378,514,000 $ 352,660,000 ============= =============
(Continued) 2 AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS --------------------------------------------- (unaudited) (Continued)
LIABILITIES AND SHAREHOLDERS' EQUITY December 31, September 30, 2000 2001 ------------- ------------- CURRENT LIABILITIES Current portion of long-term debt and capital leases $ 2,679,000 $ 7,435,000 Accounts payable 16,449,000 17,388,000 Other payables 2,478,000 3,295,000 Accrued expenses: Payroll and related benefits 8,204,000 9,604,000 Interest 1,748,000 1,170,000 Insurance 5,162,000 6,137,000 Other 13,345,000 8,295,000 ------------- ------------- Total current liabilities 50,065,000 53,324,000 ------------- ------------- NONCURRENT LIABILITIES Long-term debt and capital leases, less current portion 296,473,000 282,734,000 Other noncurrent liabilities 5,737,000 4,723,000 ------------- ------------- Total noncurrent liabilities 302,210,000 287,457,000 ------------- ------------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY Preferred stock, $.01 par value; authorized 5,000,000 shares; none issued and outstanding -- -- Common stock, $.01 par value; authorized 35,000,000 shares; issued and outstanding, 15,856,000 and 16,327,000 shares, respectively 159,000 163,000 Paid-in capital 173,777,000 173,975,000 Accumulated deficit (147,697,000) (162,259,000) ------------- ------------- Total shareholders' equity 26,239,000 11,879,000 ------------- ------------- $ 378,514,000 $ 352,660,000 ============= =============
The accompanying notes to interim condensed consolidated financial statements are an integral part of these statements. 3 AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES INTERIM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS ------------------------------------------------------- (unaudited)
Three Months Ended Sept. 30, Nine Months Ended Sept. 30, ---------------------------- --------------------------- 2000 2001 2000 2001 ----------- ----------- ------------ ------------ REVENUES Sales and related service revenues $42,914,000 $40,131,000 $128,372,000 $126,452,000 Rentals and other revenues 47,354,000 46,348,000 138,637,000 138,724,000 Earnings from joint ventures 1,236,000 1,136,000 3,519,000 3,335,000 ----------- ----------- ------------ ------------ Total revenues 91,504,000 87,615,000 270,528,000 268,511,000 ----------- ----------- ------------ ------------ EXPENSES Cost of sales and related services, excluding depreciation and amortization 21,102,000 18,611,000 64,107,000 62,205,000 Operating 53,699,000 53,183,000 161,654,000 158,127,000 General and administrative 4,110,000 3,792,000 11,141,000 11,682,000 Depreciation and amortization 9,572,000 8,109,000 28,556,000 24,086,000 Amortization of deferred financing costs 550,000 662,000 1,660,000 1,960,000 Interest 7,730,000 6,334,000 22,774,000 21,934,000 Loss on sale of rehab centers -- 2,629,000 -- 2,629,000 ----------- ----------- ------------ ------------ Total expenses 96,763,000 93,320,000 289,892,000 282,623,000 ----------- ----------- ------------ ------------ LOSS FROM OPERATIONS BEFORE INCOME TAXES (5,259,000) (5,705,000) (19,364,000) (14,112,000) PROVISION FOR INCOME TAXES 150,000 150,000 450,000 450,000 ----------- ----------- ------------ ------------ NET LOSS $(5,409,000) $(5,855,000) $(19,814,000) $(14,562,000) =========== =========== ============ ============ NET LOSS PER COMMON SHARE - Basic $ (0.35) $ (0.34) $ (1.27) $ (0.87) =========== =========== ============ ============ - Diluted $ (0.35) $ (0.34) $ (1.27) $ (0.87) =========== =========== ============ ============ WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - Basic 15,661,000 17,020,000 15,620,000 16,704,000 =========== =========== ============ ============ - Diluted 15,661,000 17,020,000 15,620,000 16,704,000 =========== =========== ============ ============
The accompanying notes to interim condensed consolidated financial statements are an integral part of these statements. 4 AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------------------------- (unaudited)
Nine Months Ended Sept. 30, ----------------------------------- 2000 2001 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(19,814,000) $(14,562,000) Adjustments to reconcile net loss to net cash provided from (used in) operating activities: Depreciation and amortization 28,556,000 24,086,000 Amortization of deferred financing costs 1,660,000 1,960,000 Equity in earnings of unconsolidated joint ventures (1,315,000) (1,802,000) Minority interest 134,000 224,000 Loss on sale of rehab centers -- 2,629,000 Change in assets and liabilities, net of effects from joint venture dissolutions and sales of centers: Restricted cash -- 13,000 Accounts receivable, net 2,566,000 6,739,000 Inventories 2,706,000 839,000 Prepaid expenses and other current assets (163,000) (606,000) Income tax payable 397,000 (1,637,000) Accounts payable, other payables and accrued expenses (2,097,000) 294,000 Other non current liabilities (9,000) 101,000 Other assets 304,000 581,000 ------------ ------------ Net cash provided from operating activities 12,925,000 18,859,000 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of centers -- 7,825,000 Proceeds from joint venture dissolutions 931,000 -- Additions to property and equipment, net (13,877,000) (15,443,000) Distributions from unconsolidated joint ventures, net 1,319,000 1,520,000 Distributions to minority interest owners (179,000) (223,000) ------------ ------------ Net cash used in investing activities (11,806,000) (6,321,000) ------------ ------------
(Continued) 5 AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------------------------- (unaudited) (Continued)
Nine Months Ended Sept. 30, ----------------------------------- 2000 2001 ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments on debt and capital leases (12,189,000) (8,983,000) Proceeds from issuance of debt 377,000 -- Proceeds from Employee Stock Purchase Plan 168,000 202,000 Deferred financing costs (1,221,000) (1,981,000) ------------ ------------ Net cash used in financing activities (12,865,000) (10,762,000) ------------ ------------ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (11,746,000) 1,776,000 CASH AND CASH EQUIVALENTS, beginning of period 28,123,000 12,081,000 ------------ ------------ CASH AND CASH EQUIVALENTS, end of period $ 16,377,000 $ 13,857,000 ============ ============ SUPPLEMENTAL INFORMATION: Cash payments of interest $ 21,619,000 $ 22,419,000 ============ ============ Cash payments of income taxes $ 300,000 $ 2,195,000 ============ ============
The accompanying notes to interim condensed consolidated financial statements are an integral part of these statements. 6 AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2001 AND 2000 1. ORGANIZATION AND BACKGROUND American HomePatient, Inc. (the "Company") was incorporated in Delaware in September 1991. The Company's principal executive offices are located at 5200 Maryland Way, Suite 400, Brentwood, Tennessee 37027-5018, and its telephone number at that address is (615) 221-8884. The Company provides home health care services and products consisting primarily of respiratory and infusion therapies and the rental and sale of home medical equipment and home health care supplies. For the nine months ended September 30, 2001, such services represented 59%, 17% and 24%, respectively of revenues. These services and products are paid for primarily by Medicare, Medicaid and other third-party payors. As of September 30, 2001, the Company provided these services to patients primarily in the home through 293 centers in 36 states: Alabama, Arizona, Arkansas, Colorado, Connecticut, Delaware, Florida, Georgia, Illinois, Iowa, Kansas, Kentucky, Maine, Maryland, Michigan, Minnesota, Mississippi, Missouri, Nebraska, Nevada, New Jersey, New Mexico, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Virginia, Washington, West Virginia and Wisconsin. From its inception through 1997 the Company experienced substantial growth primarily as a result of its strategy of acquiring and operating home health care businesses. Beginning in 1998, the Company's strategy shifted from acquiring new businesses to focusing more on internal growth, integrating its acquired operations and achieving operating efficiencies. 2. BANK CREDIT FACILITY The Company is the borrower under a credit facility (the "Bank Credit Facility") between the Company and Bankers Trust Company, as agent for a syndicate of lenders (the "Lenders"). The Company's breach of several of the financial covenants in its Credit Agreement and its failure to make a scheduled principal payment due March 15, 2001 caused the Company to be not in compliance with certain covenants of its Credit Agreement. The Company, on June 8, 2001, entered into a Fifth Amended and Restated Credit Agreement (the "Amended Credit Agreement") that provided a new loan to the Company from which the proceeds were used to pay off all existing loans under the Credit Agreement. The Amended Credit Agreement also includes modified financial covenants and a revised amortization schedule. In addition, the Amended Credit Agreement no longer contains a revolving loan component; all existing indebtedness is now in the form of a term loan which matures on December 31, 2002. The Amended Credit Agreement requires principal payments of $750,000 on September 30, 2001 and December 31, 2001; a principal payment of $11.6 million on March 31, 2002; principal payments of $1.0 million on June 30, 2002 and September 30, 2002; and a balloon payment of $281.5 million on December 31, 2002. As of November 8, 2001 the Company has paid the $750,000 principal payment due on September 30, 2001, as well as the $750,000 principal payment due on December 31, 2001 and $9.3 million of the $11.6 million principal payment due on March 31, 2002. However, there currently is no commitment as to how the balloon payment due on December 31, 2002 will be satisfied. The Amended Credit Agreement further provides for mandatory prepayments of principal from the Company's excess cash flow and 7 from the proceeds of the Company's sales of securities, sales of assets, tax refunds or excess casualty loss payments. Substantially all of the Company's assets have been pledged as security for borrowings under the Bank Credit Facility. Indebtedness under the Bank Credit Facility, as of November 8, 2001, totals $289.2 million (which includes letters of credit totaling $3.4 million). As part of the Second Amendment to the Fourth Amended and Restated Credit Agreement, the Company agreed to issue on March 31, 2001 warrants to the Lenders representing 19.999% of the Common Stock of the Company issued and outstanding as of March 31, 2001. To fulfill these obligations, warrants to purchase 3,265,315 shares of Common Stock were issued to the Lenders on June 8, 2001. Fifty percent of these warrants are exercisable at any time after issuance and the remaining fifty percent are exercisable on and after September 30, 2001. The exercise price of the warrants is $0.01 per share. As of November 8, 2001 these warrants have not been exercised. Management's cash flow projections and related operating plans indicate the Company can remain in compliance with the new financial covenants under the Amended Credit Agreement and meet its expected obligations throughout 2001. However, as with all projections, there is uncertainty as to whether management's projections can be achieved. In any event of noncompliance or default under the Amended Credit Agreement, the Lenders have the ability to demand payment of all outstanding amounts and there is currently no commitment as to how any such demand would be satisfied by the Company. Any demands for repayment by the Lenders, or the inability to obtain waivers in the event of noncompliance with covenants, or the inability to refinance the related debt upon maturity at December 31, 2002 would have a material adverse impact on the financial position, results of operations and cash flows of the Company. There can be no assurance that future cash flow from operations will be sufficient to cover debt obligations, especially those obligations due at maturity of the Bank Credit Facility. 3. GOVERNMENT INVESTIGATION On June 11, 2001, a settlement agreement (the "Settlement") was entered among the Company, the United States of America, acting through the United States Department of Justice ("DOJ") and on behalf of the Office of Inspector General of the Department of Health and Human Services ("OIG") and the TRICARE Management Activity, and a former Company employee, as relator. This Settlement was approved by the United States District Court for the Western District of Kentucky, the court in which the relator's false claim action was filed. The Settlement covers alleged improprieties by the Company during the period from January 1, 1995 through December 31, 1998, including allegedly improper billing activities and allegedly improper remuneration to and contracts with physicians, hospitals and other healthcare providers. The Company has been dealing with the issues covered by the Settlement since February 1998, when the OIG served a subpoena on the Company at its Pineville, Kentucky center. Pursuant to the Settlement, the Company made an initial payment of $3.0 million in the second quarter of 2001 and has agreed to make additional payments in the principal amount of $4.0 million, together with interest on this amount, in installments due at various times over the next 57 months. The Company has also agreed to pay the relator's attorneys fees and expenses, the amount of which will be determined by binding arbitration. The Company recorded a $7.5 million reserve in the fourth quarter of 2000 based upon the expectation of a settlement. The Settlement does not resolve the relator's claims that the Company discriminated against him as a 8 result of his reporting alleged violations of the law to the government. The Company denies and intends to vigorously defend these claims. The Company also was named as a defendant in two other False Claims Act cases. In each of those cases the DOJ declined to intervene and such cases were subsequently dismissed in March 2001. The first of these cases, United States ex. rel. Kirk S. Corsello v. Lincare, et al. (N.D. Ga.), was dismissed with prejudice on the motion of the Company on March 9, 2001. Mr. Corsello has appealed the dismissal and the parties are awaiting the court's decision in the case. The Company cannot predict when the appeals court decision will be handed down, or the outcome of the appeal. Mr. Corsello's qui tam complaint alleged that the Company and numerous other unrelated defendants, including other large DME suppliers, engaged in a kickback scheme to provide free or below market value equipment and medicine to physicians who would in turn refer patients to the defendants in violation of the False Claims Act. The other case, United States ex. rel. Alan D. Hutchison v. Respironics, et al. (S.D. NY and N.D. Ga.), was dismissed without prejudice on Mr. Hutchison's own motion on March 22, 2001. Since that date, the Company has not been served with any additional papers in this case. Mr. Hutchison's qui tam complaint alleged that the Company and numerous other unrelated defendants filed false claims with Medicare for ventilators that the defendants allegedly knew were not medically necessary. The Company was informed in May, 2001 that the United States government is investigating its conduct during periods after December 31, 1998, and the Company believes that this investigation was prompted by another qui tam complaint against the Company under the False Claims Act. The Company has not seen a complaint in this action, but believes that it contains allegations similar to the ones investigated by the government in connection with the False Claims Act case covered by the Settlement discussed above. The Company believes that this case will be limited to allegedly improper activities occurring after December 31, 1998. There can be no assurances as to the final outcome of the pending False Claims Act lawsuits or any pending or future investigation by the government. Possible outcomes include, among other things, the repayment of reimbursements previously received by the Company related to improperly billed claims, the imposition of fines or penalties, and the suspension or exclusion of the Company from participation in the Medicare, Medicaid and other government reimbursement programs. The outcome of any of the pending lawsuits and investigations could have a material adverse effect on the Company. 4. MEDICARE REIMBURSEMENT ISSUES The Medicare reimbursement rate for oxygen related services was reduced by 25% beginning January 1, 1998 as a result of the Balanced Budget Act of 1997 (the "Medicare Oxygen Reimbursement Reduction") with an additional reduction of 5% beginning January 1, 1999. The reimbursement rate for certain drugs and biologicals covered under Medicare was also reduced by 5% beginning January 1, 1998. The Company is one of the nation's largest providers of home oxygen services to patients, many of whom are Medicare recipients, and is therefore significantly affected by this legislation. Medicare oxygen reimbursements account for approximately 27% of the Company's year-to-date revenues and will account for approximately 29% of the Company's ongoing revenues following the September 2001 sale of the rehab centers (See Note 5). In January 2001, federal legislation was signed into law that provided for a one-time increase beginning July 1, 2001 in Medicare reimbursement rates for home medical 9 equipment, excluding oxygen related services, based on the consumer price index (CPI). The Company estimates that this CPI increase will increase revenue and pre-tax income by approximately $1.0 million over the third and fourth quarters of 2001 and $1.0 million on an annual basis thereafter. 5. SALES OF ASSETS OF CENTERS In the quarter ended September 30, 2001, the Company recorded a pre-tax loss of $2.6 million related to the sale of the assets of its rehab centers. Effective September 1, 2001, the Company sold substantially all of the assets of its rehab centers to United Seating and Mobility, L.L.C., a Missouri limited liability company. United Seating and Mobility, L.L.C. is owned in part by a former employee of the rehab centers, who is no longer an employee of the Company effective with the sale. The rehab centers were sold for approximately $7.7 million, of which $7.2 million was received in cash at closing with the remainder to be paid on February 28, 2002. The cash proceeds of the sale were used to pay down debt under the Company's Bank Credit Facility. The rehab centers provided custom-built seating and positioning systems and custom-built wheelchairs to patients with impaired mobility and generated approximately $22.0 million in annualized revenues with minimal earnings before interest, taxes, depreciation and amortization. In addition, the Company sold two unprofitable infusion centers in April, 2001 and an unprofitable respiratory and home medical equipment center in July, 2001 for approximately $0.6 million in cash. The cash proceeds of these sales were used to pay down debt under the Company's Bank Credit Facility. 6. EARNINGS PER SHARE Under the standards established by Statement of Financial Accounting Standards No. 128, earnings per share is measured at two levels: basic earnings per share and diluted earnings per share. Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the year. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares after considering the additional dilution related to convertible preferred stock, convertible debt, options and warrants. In computing diluted earnings per share, the outstanding stock warrants and stock options are considered dilutive using the treasury stock method. However, these incremental shares were excluded from the computation of diluted earnings 10 per share as the effect of their inclusion was anti-dilutive. The following information is necessary to calculate earnings per share for the periods presented:
(unaudited) ------------------------------------------------------------------- Three Months Ended Sept. 30, Nine Months Ended Sept. 30, ----------------------------- ------------------------------- 2000 2001 2000 2001 ----------- ----------- ------------ ------------ Net loss $(5,409,000) $(5,855,000) $(19,814,000) $(14,562,000) =========== =========== ============ ============ Weighted average common shares outstanding 15,661,000 17,020,000 15,620,000 16,704,000 ----------- ----------- ------------ ------------ Effect of dilutive options and warrants -- -- -- -- Adjusted diluted common shares outstanding 15,661,000 17,020,000 15,620,000 16,704,000 =========== =========== ============ ============ Net loss per common share - Basic $ (0.35) $ (0.34) $ (1.27) $ (0.87) =========== =========== ============ ============ - Diluted $ (0.35) $ (0.34) $ (1.27) $ (0.87) =========== =========== ============ ============
7. BASIS OF FINANCIAL STATEMENTS The interim condensed consolidated financial statements of the Company for the nine months ended September 30, 2001 and 2000 herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management of the Company, the accompanying unaudited interim consolidated financial statements reflect all adjustments (consisting of only normally recurring accruals) necessary to present fairly the financial position at September 30, 2001 and the results of operations and the cash flows for the nine months ended September 30, 2001 and 2000. The results of operations for the nine months ended September 30, 2001 and 2000 are not necessarily indicative of the operating results for the entire respective years. These unaudited interim consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company's Annual Report on Form 10-K/A for the year ended December 31, 2000. Certain reclassifications have been made to the 2000 consolidated financial statements to conform to the 2001 presentation. 8. COMPREHENSIVE LOSS Comprehensive loss for the nine months ended September 30, 2001 and 2000 was comprised solely of net losses. 11 9. NEW FINANCIAL ACCOUNTING STANDARDS Statement of Financial Accounting Standards No. 133, as amended, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133") has been issued effective for fiscal years beginning after June 15, 2000. SFAS No. 133, as amended, requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. The Company adopted the provisions of SFAS No. 133, as amended, effective January 1, 2001, as required; however, the Company's adoption of SFAS No. 133, as amended, did not have a material effect on the Company's financial position or results of operations. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101") regarding revenue recognition in financial statements. SAB 101 was effective January 1, 2000 but implementation was delayed until the fourth quarter of 2000. The Company's implementation of SAB 101 in the fourth quarter of 2000 did not have a material impact on its financial position, results of operations or cash flows on a quarterly or annual basis. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141") and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also specifies criteria which intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 requires that intangible assets with finite useful lives be amortized, and that goodwill and intangible assets with indefinite lives no longer be amortized, but instead be tested for impairment at least annually. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The Company is required to adopt the provisions of SFAS No. 141 immediately and SFAS No. 142 effective January 1, 2002. Furthermore, any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase business combination completed after June 30, 2001 will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-SFAS No. 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized until the adoption of SFAS No. 142. As of the date of adoption, the Company expects to have unamortized goodwill in the amount of $189.7 million which will be subject to the transition provisions of SFAS No. 141 and 142. Amortization expense related to goodwill was $1.4 million and $4.2 million for the quarter and the nine months ended September 30, 2001, respectively. Because of the extensive effort needed to comply with adopting SFAS No. 141 and 142, it is not practicable to reasonably estimate the impact of adopting these Statements on the Company's financial statements at the 12 date of this report, including whether any transitional impairment losses will be required to be recognized as a cumulative effect of a change in accounting principle. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143") effective for fiscal years beginning after June 15, 2002. SFAS 143 requires that a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The Company does not expect the future adoption of SFAS 143 to have a material effect on its financial position or results of operations. In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144") effective for fiscal years beginning after December 15, 2001. SFAS 144 establishes a single accounting model for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and broadens the presentation of discontinued operations to include more disposal transactions. The Company has not yet determined the impact of the January, 2002 adoption of SFAS 144 on its financial position or results of operations. 13 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THIS QUARTERLY REPORT ON FORM 10-Q INCLUDES FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 INCLUDING, WITHOUT LIMITATION, STATEMENTS CONTAINING THE WORDS "BELIEVES," "ANTICIPATES," "INTENDS," "EXPECTS," "ESTIMATES," "PROJECTS", "MAY," "WILL", "LIKELY" AND WORDS OF SIMILAR IMPORT. SUCH STATEMENTS INCLUDE STATEMENTS CONCERNING THE COMPANY'S BUSINESS STRATEGY, OPERATIONS, COST SAVINGS INITIATIVES, FUTURE COMPLIANCE WITH ACCOUNTING STANDARDS, INDUSTRY, ECONOMIC PERFORMANCE, FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES, EXISTING GOVERNMENT REGULATIONS AND CHANGES IN, OR THE FAILURE TO COMPLY WITH, GOVERNMENTAL REGULATIONS, PROJECTIONS, FUTURE COMPLIANCE WITH BANK CREDIT FACILITY COVENANTS, LEGISLATIVE PROPOSALS FOR HEALTHCARE REFORM, THE ABILITY TO ENTER INTO JOINT VENTURES, STRATEGIC ALLIANCES AND ARRANGEMENTS WITH MANAGED CARE PROVIDERS ON AN ACCEPTABLE BASIS, AND CHANGES IN REIMBURSEMENT POLICIES. SUCH STATEMENTS ARE SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN SUCH FORWARD-LOOKING STATEMENTS BECAUSE OF A NUMBER OF FACTORS, INCLUDING THOSE IDENTIFIED IN THE "RISK FACTORS" SECTION AND ELSEWHERE IN THIS QUARTERLY REPORT ON FORM 10-Q. THE FORWARD-LOOKING STATEMENTS ARE MADE AS OF THE DATE OF THIS QUARTERLY REPORT ON FORM 10-Q AND THE COMPANY DOES NOT UNDERTAKE TO UPDATE THE FORWARD-LOOKING STATEMENTS OR TO UPDATE THE REASONS THAT ACTUAL RESULTS COULD DIFFER FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS. GENERAL The Company provides home health care services and products to patients through its 293 centers in 36 states. These services and products are primarily paid for by Medicare, Medicaid and other third-party payors. The Company has three principal services or product lines: home respiratory services, home infusion services and home medical equipment and supplies. Home respiratory services include oxygen systems, nebulizers, aerosol medications and home ventilators and are provided primarily to patients with severe and chronic pulmonary diseases. Home infusion services are used to administer nutrients, antibiotics and other medications to patients with medical conditions such as neurological impairments, infectious diseases or cancer. The Company also sells and rents a variety of home medical equipment and supplies, including wheelchairs, hospital beds and ambulatory aids. 14 The following table sets forth the percentage of the Company's revenues represented by each line of business for the periods presented:
Nine Months Ended Sept. 30, --------------------------- 2000 2001 ---- ---- Home respiratory therapy services 56% 59% Home infusion therapy services 20 17 Home medical equipment and medical supplies 24 24 --- --- Total 100% 100% === ===
Prior to 1998, the Company had significantly expanded its operations through a combination of home health care acquisitions and joint ventures and strategic alliances with integrated health care delivery systems, as well as internal growth. In 1998, the Company purposefully slowed its growth by acquisitions compared to prior years to focus more on existing operations. As amended, the Company's Credit Agreement requires bank consent for acquisitions or investments in new joint ventures. During 2000, the Company converted six of its previously 50% owned joint ventures to wholly owned operations as a result of the withdrawal of the hospital partners from the partnerships. As a result of these transactions, the results of operations of these joint ventures have been consolidated into the financial results of the Company. Previously, these joint ventures were accounted for under the equity method. In the fourth quarter of 2000, the Company and its hospital partner sold substantially all of the assets of the Amarillo, Texas partnership to a third party and discontinued operations in preparation for dissolving the Amarillo partnership in 2001. The Company did not acquire any businesses or develop any new joint ventures during 2000 and 2001 other than the conversion of previously 50% owned joint ventures to wholly owned operations. GOVERNMENT REGULATION General. The Company, as a participant in the health care industry, is subject to extensive federal, state and local regulation. In addition to the False Claims Act and other federal and state anti-kickback and self-referral laws applicable to all of the Company's operations (discussed more fully below), the operations of the Company's home health care centers are subject to federal laws covering the repackaging and dispensing of drugs (including oxygen) and regulating interstate motor-carrier transportation. Such centers also are subject to state laws (most notably licensing and controlled substances registration) governing pharmacies, nursing services and certain types of home health agency activities. The Company's operations are also subject to a series of laws and regulations dating back to the Omnibus Budget Reconciliation Act of 1987 ("OBRA 1987") which apply to the Company's operation. Periodic changes have occurred from time to time since the enactment of OBRA 1987, including reimbursement reductions and changes to payment rules. The Federal False Claims Act imposes civil liability on individuals or entities that submit false or fraudulent claims to the government for payment. False Claims Act penalties for violations can include sanctions, including civil monetary penalties. As a provider of services under the 15 federal reimbursement programs such as Medicare, Medicaid and TRICARE (formerly CHAMPUS), the Company is subject to the anti-kickback statute, also known as the "fraud and abuse law." This law prohibits any bribe, kickback, rebate or remuneration of any kind in return for, or as an inducement for, the referral of patients for government-reimbursed health care services. The Company may also be affected by the federal physician self-referral prohibition, known as the "Stark Law", which, with certain exceptions, prohibits physicians from referring patients to entities with which they have a financial relationship. Many states in which the Company operates have adopted similar self-referral laws, as well as laws that prohibit certain direct or indirect payments or fee-splitting arrangements between health care providers, under the theory that such arrangements are designed to induce or to encourage the referral of patients to a particular provider. In many states, these laws apply to services reimbursed by all payor sources. In 1996, the Health Insurance Portability and Accountability Act ("HIPAA") introduced a new category of federal criminal health care fraud offenses. If a violation of a federal criminal law relates to a health care benefit, then an individual is guilty of committing a Federal Health Care Offense. The specific offenses are: health care fraud; theft or embezzlement; false statements, obstruction of an investigation; and money laundering. These crimes can apply to claims submitted not only to government reimbursement programs such as Medicare, Medicaid and TRICARE, but to any third-party payor, and carry penalties including fines and imprisonment. The Company must follow strict requirements with paperwork and billing. As required by law, it is Company policy that certain service charges (as defined by Medicare) falling under Medicare Part B are confirmed with a Certificate for Medical Necessity ("CMN") signed by a physician. In January, 1999, the OIG published a draft Model Compliance Plan for the Durable Medical Equipment, Prosthetics, Orthotics and Supply Industry. The OIG has stressed the importance for all health care providers to have an effective compliance plan. The Company has created and implemented a compliance program, which it believes meets the elements of the OIG's Model Plan for the industry. As part of its compliance program, the Company performs internal audits of the adequacy of billing documentation. The Company's policy is to voluntarily refund to the government any reimbursements previously received for claims with insufficient documentation that are identified in this process and that cannot be corrected. The Company periodically reviews and updates its policies and procedures in an effort to comply with applicable laws and regulations; however, certain proceedings have been and may in the future be commenced against the Company alleging violations of applicable laws governing the operation of the Company's business and its billing practices. There can be no assurance that federal, state or local governments will not change existing standards or impose additional standards. In addition, the Balanced Budget Act of 1997 introduced several government initiatives which are either in the planning or implementation stages and which, when fully implemented, could have a material adverse impact on reimbursement for products and services provided by the Company. These initiatives include: (i) Prospective Payment System ("PPS") and Consolidated Billing requirements for skilled nursing facilities and PPS for home health agencies, which do not affect the Company directly but could affect the Company's contractual relationships with such entities (the consolidated billing requirement was subsequently reversed by the Omnibus Budget bill, signed into law by President Clinton on November 23, 1999); (ii) pilot projects in Polk County, Florida and San Antonio, Texas which began on October 1, 1999 and February 1, 2001, respectively, to determine the efficacy of competitive bidding for certain durable medical 16 equipment ("DME"), under which Medicare reimbursements for certain items are reduced between 17% and 31% from the current fee schedules (the Company is participating in both pilot projects); and (iii) deadlines (as yet undetermined) for obtaining Medicare and Medicaid surety bonds for home health agencies and DME suppliers. The Company is also subject to state laws governing Medicaid, professional training, licensure, financial relationships with physicians and the dispensing and storage of pharmaceuticals. The facilities operated by the Company must comply with all applicable laws, regulations and licensing standards and many of the Company's employees must maintain licenses to provide some of the services offered by the Company. Additionally, certain of the Company's employees are subject to state laws and regulations governing the professional practice of respiratory therapy, pharmacy and nursing. Information about individuals and other health care providers who have been sanctioned or excluded from participation in government reimbursement programs is readily available on the Internet, and all health care providers, including the Company, are held responsible for carefully screening entities and individuals they employ or do business with, to avoid contracting with an excluded provider. The federal government may impose sanctions, including financial penalties, on companies that contract with excluded providers. Health care law is an area of extensive and dynamic regulatory oversight. Changes in laws or regulations or new interpretations of existing laws or regulations can have a dramatic effect on permissible activities, the relative costs associated with doing business, and the amount and availability of reimbursement from government and other third-party payors. Compliance with these extensive, complex and frequently changing laws and regulations is difficult. In recent years, various state and federal regulatory agencies have stepped up investigative and enforcement activities with respect to the health care industry, and many health care providers, including the Company and other durable medical equipment suppliers, have received subpoenas and other requests for information in connection with their business operations and practices. From time to time the Company also receives notices and subpoenas from various government agencies concerning plans to audit the Company, or requesting information regarding certain aspects of the Company's business. The Company cooperates with the various agencies in responding to such subpoenas and requests. The Company expects to incur additional legal expenses in the future in connection with existing and future investigations. The government has broad authority and discretion in enforcing applicable laws and regulations; therefore, the scope and outcome of any such investigations, inquiries, or legal actions cannot be predicted. There can be no assurance that federal, state or local governments will not impose additional regulations upon the Company's activities nor that the Company's activities will not be found to have violated some of the governing laws and regulations. Any such regulatory changes or findings of violations of laws could adversely affect the Company's business and financial position, and could even result in the exclusion of the Company from participating in Medicare, Medicaid, and other government reimbursement programs. Legal Proceedings. On June 11, 2001, a settlement agreement (the "Settlement") was entered among the Company, the United States of America, acting through the United States Department of Justice ("DOJ") and on behalf of the Office of Inspector General of the Department of Health and Human Services ("OIG") and the TRICARE Management Activity, and a former Company employee, as relator. This Settlement was approved by the United 17 States District Court for the Western District of Kentucky, the court in which the relator's false claim action was filed. The Settlement covers alleged improprieties by the Company during the period from January 1, 1995 through December 31, 1998, including allegedly improper billing activities and allegedly improper remuneration to and contracts with physicians, hospitals and other healthcare providers. The Company has been dealing with the issues covered by the Settlement since February 1998, when the OIG served a subpoena on the Company at its Pineville, Kentucky center. Pursuant to the Settlement, the Company made an initial payment of $3.0 million in the second quarter of 2001 and has agreed to make additional payments in the principal amount of $4.0 million, together with interest on this amount, in installments due at various times over the next 57 months. The Company has also agreed to pay the relator's attorneys fees and expenses, the amount of which will be determined by binding arbitration. The Company recorded a $7.5 million reserve in the fourth quarter of 2000 based upon the expectation of a settlement. The Settlement does not resolve the relator's claims that the Company discriminated against him as a result of his reporting alleged violations of the law to the government. The Company denies and intends to vigorously defend these claims. The Company also was named as a defendant in two other False Claims Act cases. In each of those cases the DOJ declined to intervene and such cases were subsequently dismissed in March 2001. The first of these cases, United States ex. rel. Kirk S. Corsello v. Lincare, et al. (N.D. Ga.), was dismissed with prejudice on the motion of the Company on March 9, 2001. Mr. Corsello has appealed the dismissal and the parties are awaiting the court's decision in the case. The Company cannot predict when the appeals court decision will be handed down, or the outcome of the appeal. Mr. Corsello's qui tam complaint alleged that the Company and numerous other unrelated defendants, including other large DME suppliers, engaged in a kickback scheme to provide free or below market value equipment and medicine to physicians who would in turn refer patients to the defendants in violation of the False Claims Act. The other case, United States ex. rel. Alan D. Hutchison v. Respironics, et al. (S.D. NY and N.D. Ga.), was dismissed without prejudice on Mr. Hutchison's own motion on March 22, 2001. Since that date, the Company has not been served with any additional papers in this case. Mr. Hutchison's qui tam complaint alleged that the Company and numerous other unrelated defendants filed false claims with Medicare for ventilators that the defendants allegedly knew were not medically necessary. The Company was informed in May, 2001 that the United States is investigating its conduct during periods after December 31, 1998, and the Company believes that this investigation was prompted by another qui tam complaint against the Company under the False Claims Act. The Company has not seen a complaint in this action, but believes that it contains allegations similar to the ones investigated by the government in connection with the False Claims Act case covered by the Settlement discussed above. The Company believes that this second case will be limited to allegedly improper activities occurring after December 31, 1998. There can be no assurances as to the final outcome of any pending False Claims Act lawsuits. Possible outcomes include, among other things, the repayment of reimbursements previously received by the Company related to improperly billed claims, the imposition of fines or penalties, and the suspension or exclusion of the Company from participation in the Medicare, Medicaid and other government reimbursement programs. The outcome of any pending lawsuits could have a material adverse effect on the Company. 18 MEDICARE REIMBURSEMENT FOR OXYGEN THERAPY SERVICES The Medicare reimbursement rate for oxygen related services was reduced by 25% beginning January 1, 1998 as a result of the Balanced Budget Act of 1997 (the "Medicare Oxygen Reimbursement Reduction") with an additional reduction of 5% beginning January 1, 1999. The reimbursement rate for certain drugs and biologicals covered under Medicare was also reduced by 5% beginning January 1, 1998. The Company is one of the nation's largest providers of home oxygen services to patients, many of whom are Medicare recipients, and is therefore significantly affected by this legislation. Medicare oxygen reimbursements account for approximately 27% of the Company's year-to-date revenues and will account for approximately 29% of the Company's ongoing revenues following the September 2001 sale of the rehab centers. In January 2001, federal legislation was signed into law that provided for a one-time increase beginning July 1, 2001 in Medicare reimbursement rates for home medical equipment, excluding oxygen related services, based on the consumer price index (CPI). The Company estimates that this CPI increase will increase revenue and pre-tax income by approximately $1.0 million over the third and fourth quarters of 2001 and $1.0 million on an annual basis thereafter. RESULTS OF OPERATIONS The Company reports its revenues as follows: (i) sales and related services; (ii) rentals and other income; and (iii) earnings from hospital joint ventures. Sales and related services revenues are derived from the provision of infusion therapies, the sale of home medical equipment and supplies, the sale of aerosol and respiratory therapy equipment and supplies and services related to the delivery of these products. Rentals and other revenues are derived from the rental of home health care equipment, enteral pumps and equipment related to the provision of respiratory therapies. The majority of the Company's hospital joint ventures are not consolidated for financial statement reporting purposes. Earnings from hospital joint ventures represent the Company's equity in earnings from unconsolidated hospital joint ventures and management and administrative fees from unconsolidated hospital joint ventures. Cost of sales and related services includes the cost of equipment, drugs and related supplies sold to patients. Operating expenses include center labor costs, delivery expenses, selling costs, occupancy costs, costs related to rentals other than depreciation, billing center costs, provision for doubtful accounts, field management and other operating costs. General and administrative expenses include corporate and senior management expenses. In the quarter ended September 30, 2001, the Company recorded a pre-tax loss of $2.6 million related to the sale of the assets of its rehab centers. Effective September 1, 2001, the Company sold substantially all of the assets of its rehab centers to United Seating and Mobility, L.L.C., a Missouri limited liability company. United Seating and Mobility, L.L.C. is owned in part by a former employee of the rehab centers, who is no longer an employee of the Company effective with the sale. The rehab centers were sold for approximately $7.7 million, of which $7.2 million was received in cash at closing with the remainder to be paid on February 28, 2002. The cash proceeds of the sale were used to pay down debt under the Company's Bank Credit Facility. The rehab centers provided custom-built seating and positioning systems and custom-built wheelchairs to patients with impaired mobility and generated approximately $22.0 million in annualized revenues with minimal earnings before interest, taxes, depreciation and amortization. 19 In addition, the Company sold two unprofitable infusion centers in April, 2001 and an unprofitable respiratory and home medical equipment center in July, 2001 for approximately $0.6 million in cash. The cash proceeds of these sales were used to pay down debt under the Bank Credit Facility. The following table and discussion sets forth items from the statements of operations, excluding the previously discussed non-recurring charge, as a percentage of revenues: PERCENTAGE OF REVENUES (EXCLUDING NON-RECURRING CHARGE)
Three Months Ended Nine Months Ended September 30 September 30 --------------------- --------------------- 2000 2001 2000 2001 ----- ----- ----- ----- Revenues 100.0% 100.0% 100.0% 100.0% Costs and expenses: Cost of sales and related services 23.1 21.2 23.7 23.2 Operating expenses 58.7 60.7 59.8 58.9 General and administrative 4.5 4.3 4.1 4.4 Depreciation and amortization 10.4 9.3 10.6 8.9 Amortization of deferred financing costs 0.6 0.8 0.6 0.7 Interest 8.4 7.2 8.4 8.2 ----- ----- ----- ----- Total costs and expenses 105.7% 103.5% 107.2% 104.3% ----- ----- ----- ----- Loss from operations before income taxes (5.7)% (3.5)% (7.2)% (4.3)% ===== ===== ===== =====
The Company's operating results since 1998 have been negatively impacted by the following factors. First, the Company has been greatly impacted by the 30% reduction in Medicare oxygen reimbursement rates (25% reduction effective January 1, 1998 with an additional 5% reduction effective January 1, 1999). The Company estimates that revenue and pre-tax income have been reduced by approximately $21.9 million in the nine months of 2000 and 2001, as a result of the 25% and the additional 5% reductions. Second, beginning in the latter half of 1998, the Company experienced a decline in revenues attributable to the exit and de-emphasis of certain lower margin business lines and by the termination of several managed care contracts (with continued effect into 1999, 2000 and 2001). Third, the Company has halted the acquisition of home health care businesses and its joint venture development program. Fourth, accounts receivable have been adversely affected by a tougher payor environment and by process problems at the operating and billing center levels (caused by the consolidation of billing centers and employee turnover) which has resulted in higher bad debt expense in 1998 and 1999. Further, the Company's implementation of process improvements in the billing and collection functions was slower than anticipated. In order to drive internal revenue growth during the latter half of 1998, the Company embarked on a strategy to increase market share by focusing primarily on increasing respiratory revenues in existing centers. Concurrently, the Company determined that certain "non-core", lower margin products and services should be eliminated during the year. It also exited certain 20 contracts and businesses perceived to be lower margin during the third and fourth quarters of 1998. The result was a substantial decrease in revenues as well as in profitability beginning in the latter half of 1998. A new management team joined the Company in the fourth quarter of 1998, consisting of a new president and chief executive officer, a new chief operating officer and a new chief financial officer. Recognizing the negative impacts of the Company's business strategy, the new management ceased the exiting of business lines and contracts by mid-December of 1998. Subsequently, a new strategy was developed and implemented to restore the Company's revenues and decrease expenses. Key points of this strategy are: 1. Stabilize and increase profitable revenues - respiratory therapies remain a primary focus of the Company. However, the Company has broadened its offering and sales focus to include other profitable business lines such as enteral nutrition, HME rental, and select infusion therapy services. The Company has also re-directed its efforts to increase revenues for certain managed care contracts - both new and existing. The Company is actively pursuing, and has entered into, new managed care contracts that it considers an opportunity for profitable revenue. 2. Decrease and control operating expenses - the Company took aggressive steps beginning in 1999 to decrease operating and general and administrative expenses. The Company continues to monitor and closely manage its field and overhead expenses. 3. Decrease DSO and bad debt - the Company has four key initiatives in place to improve accounts receivable performance: (i) proper staffing and training; (ii) process redesign and standardization; (iii) consolidation of billing center activities; and (iv) billing center specific goals geared toward improved cash collections and reduced accounts receivable. The Company's recovery of revenues is taking longer than originally anticipated. During 2000, the Company determined that additional sales infrastructure would be required to accelerate revenue growth and in May, 2000, the Company hired a new Vice President of Sales and Marketing. Six directors of sales were subsequently hired with the directive of working in conjunction with the Vice President of Sales and Marketing and the vice presidents of the Company's geographic operating areas to facilitate the implementation of revenue growth strategies at the field level. The Company also analyzed market data and referral/utilization trends to identify a subset of approximately forty centers with the greatest potential for market share gain. The directors of sales are accountable for sales activity specifically for these "target centers". These target centers also serve as primary pilot sites for new sales and marketing initiatives. In addition, a new Director of Managed Care joined the Company at the end of 2000. With new expertise in place, the Company is now focusing its efforts on maximizing revenues both with existing and new contracts through more strategic price negotiations and improved operational strategies for implementation. Effective April 1, 2001 rather than reporting to the area vice presidents, the Company's billing centers began reporting directly to the Corporate Reimbursement Department under the leadership of the Vice President of Reimbursement and six directors of compliance and reimbursement. This new organizational structure allows field management more time to focus 21 on revenue growth as well as add specialized knowledge and focused management resources to the billing function. The Company does not anticipate renewing its acquisition activities nor its joint venture development during 2001 as it continues focusing its efforts on existing operations. THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2000 The results of operations between 2001 and 2000 are impacted by the conversions of several unconsolidated joint ventures to wholly owned businesses during 2000, as well as the asset sales of several centers in 2001. REVENUES. Revenues decreased from $91.5 million for the quarter ended September 30, 2000 to $87.6 million for the same period in 2001, a decrease of $3.9 million, or 4%. The termination of a services contract in January, the sale of two unprofitable infusion centers in April, the sale of an unprofitable respiratory and home medical equipment center in July, and the sale of the rehab centers in September have negatively impacted current quarter revenues by approximately $4.8 million. This decrease is also attributable to a decline of approximately $0.3 million in revenues as a result of the loss of patients from a dissolved joint venture to a new service provider. Beginning in the second quarter of 2000, the Company consolidated six previously 50% owned joint ventures, partially offsetting the lost revenues and adding approximately $0.3 million in revenue to the current quarter. Without these occurrences, revenue for the quarter would have increased by $0.9 million compared to last year, or 1%. Following is a discussion of the components of revenues: Sales and Related Services Revenues. Sales and related services revenues decreased from $42.9 million for the quarter ended September 30, 2000 to $40.1 million for the same period in 2001, a decrease of $2.8 million, or 7%. This decrease is attributable to approximately $2.0 million in lost sales revenues related to a January 1, 2001 services contract termination, and $2.6 million in lost sales revenues due to the sale of two unprofitable infusion centers in April, the sale of an unprofitable respiratory and home medical center in July, and the sale of the rehab centers in September. These decreases were offset by additional sales revenues of approximately $0.1 million from the accounting consolidation of six of the Company's previously 50% owned joint ventures and increased sales as a result of the Company's sales and marketing initiatives. Rentals and Other Revenues. Rentals and other revenues decreased from $47.4 million for the quarter ended September 30, 2000 to $46.3 million for the same period in 2001, a decrease of $1.1 million, or 2%. This decrease is attributable to a decline of approximately $0.3 million in rental revenues as a result of the loss of patients from a dissolved joint venture to a new service provider, and $0.2 million related to the sale of an unprofitable respiratory and home medical center in July 2001. These decreases were offset by additional rental revenues of approximately $0.2 million from the accounting consolidation of six of the Company's previously 50% owned joint ventures. Earnings from Hospital Joint Ventures. Earnings from hospital joint ventures decreased slightly from $1.2 million for the quarter ended September 30, 2000 to $1.1 million for the quarter ended September 30, 2001. 22 COST OF SALES AND RELATED SERVICES. Cost of sales and related services decreased from $21.1 million for the quarter ended September 30, 2000 to $18.6 million for the same period in 2001, a decrease of $2.5 million, or 12%. As a percentage of sales and related services revenues, cost of sales and related services decreased from 49% for the quarter ended September 30, 2000 to 46% for the same period in 2001. This decrease is attributable to a higher level of favorable physical inventory adjustments, the Company's reassessment of required reserve levels due to additional corporate oversight of the physical inventory process, and the sale of the rehab centers, which contributed lower margins. Recently in 2001, Dey Labs received FDA approval for "DuoNeb", a mixture of albuterol sulfate and ipratropium bromide. The Company currently compounds the drug for use in its aerosol medications business. When DuoNeb becomes commercially available, providers may be required by law to purchase the premixed drug, as the FDA prohibits compounding without a medical justification when an FDA approved drug is already commercially available. The Company expects that its costs for DuoNeb will be substantially higher than the Company's cost to compound, which may have a material impact on cost of sales and the results of operations. The Company is investigating various alternatives to minimize the potential negative impact related to the sale and marketing of DuoNeb. OPERATING EXPENSES. Operating expenses decreased from $53.7 million for the quarter ended September 30, 2000 to $53.2 million for the same period in 2001, a decrease of $0.5 million, or 1%. This decrease is attributable to a reduction of $0.7 million in operating expenses as a result of the sale of the rehab centers, offset somewhat by additional operating expenses of $0.2 million from the accounting consolidation of six of the Company's previously 50% owned joint ventures. Bad debt expense was 5.7% of revenue for the quarter ended September 30, 2000 compared to 6.1% of revenue for the same period in 2001. Bad debt expense in the current quarter reflects a temporary slow down in cash collections in September, resulting primarily from payment processing problems experienced by Texas Medicaid during the month and a general delay in payments received by the Company during the first few weeks following the September 11th terrorist attacks. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses decreased from $4.1 million for the quarter ended September 30, 2000 to $3.8 million for the same period in 2001, a decrease of $0.3 million, or 7%. As a percentage of revenues, general and administrative expenses were 4.5% and 4.3% for the quarters ended September 30, 2000 and 2001, respectively. This decrease is attributable to lower consulting and legal fees, offset somewhat by higher personnel expenses as a result of the billing initiatives, corporate compliance activities and increased marketing efforts. DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses decreased from $9.6 million for the quarter ended September 30, 2000 to $8.1 million for the same period in 2001, a decrease of $1.5 million, or 16%. This decrease is primarily attributable to lower levels of rental equipment depreciation due to certain property and equipment becoming fully depreciated, and a lower level of unfavorable physical inventory adjustments in the quarter ended September, 2001 compared to the same period in 2000. AMORTIZATION OF DEFERRED FINANCING COSTS. Amortization of deferred financing costs increased from $0.6 million for the quarter ended September 30, 2000 to $0.7 million for the 23 same period in 2001, an increase of $0.1 million or 17%. This increase is primarily attributable to additional deferred financing costs associated with amendments to the Credit Agreement. In addition, in the fourth quarter of 2000, the Company recorded the estimated fair value of warrants ($686,000) to be issued to the Lenders in connection with the Second Amendment to the Credit Agreement and the related amortization of these costs using the effective interest rate method. INTEREST. Interest expense decreased from $7.7 million for the quarter ended September 30, 2000, to $6.3 million for the same period in 2001, a decrease of $1.4 million, or 18% which is attributable to reductions in the prime borrowing rate and lower principal amounts outstanding. NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2000 The results of operations between 2001 and 2000 are impacted by the conversions of several unconsolidated joint ventures to wholly owned businesses during 2000, as well as the asset sales of several centers in 2001. REVENUES. Revenues decreased from $270.5 million for the nine months ended September 30, 2000 to $268.5 million for the same period in 2001, a decrease of $2.0 million, or 1%. The termination of a services contract in January, the sale of two unprofitable infusion branches in April, the sale of an unprofitable respiratory and home medical equipment branch in July, and the sale of the rehab centers in September have negatively impacted revenues by approximately $9.5 million during the first nine months of 2001. This decrease is also attributable to a decline of approximately $1.3 million in revenues as a result of the loss of patients from a dissolved joint venture to a new service provider. Beginning in the second quarter of 2000 the Company consolidated six previously 50% owned joint ventures, adding approximately $3.5 million in revenue to the current nine month period. Without these occurrences, revenue for the nine months ended September 30, 2001 would have increased by $5.3 million, or 2%, compared to the same period last year. This increase is primarily attributable to revenue growth as a result of the Company's sales and marketing initiatives. Following is a discussion of the components of revenues: Sales and Related Services Revenues. Sales and related services revenues decreased from $128.4 million for the nine months ended September 30, 2000 to $126.5 million for the same period in 2001, a decrease of $1.9 million, or 1%. This decrease is attributable to approximately $5.9 million in lost sales revenues related to a January 1, 2001 services contract termination, and $3.4 million in lost sales revenues due to the sale of two unprofitable infusion centers in April, the sale of an unprofitable respiratory and home medical center in July, and the sale of the rehab centers in September. These decreases were offset by additional sales revenues of approximately $1.0 million from the accounting consolidation of six of the Company's previously 50% owned joint ventures and increased sales as a result of the Company's sales and marketing initiatives. Rentals and Other Revenues. Rentals and other revenues increased from $138.6 million for the nine months ended September, 2000 to $138.7 million for the same period in 2001, an increase of $0.1 million. This increase is primarily attributable to additional rental revenues of approximately $2.8 million from the accounting consolidation of six of the Company's previously 50% owned joint ventures. This increase was offset by an approximate $1.3 million decline in rental revenues as a result of the loss of patients from a dissolved joint venture to a new service provider and $0.2 million related to the sale of an unprofitable 24 respiratory and home medical center in July 2001. Earnings from Hospital Joint Ventures. Earnings from hospital joint ventures decreased from $3.5 million for the nine months ended September 30, 2000 to $3.3 million for the same period in 2001, a decrease of $0.2 million, or 6%, which is primarily attributable to the accounting consolidation of six of the Company's previously 50% owned joint ventures. These previously 50% owned joint ventures contributed $0.3 million in earnings from hospital joint ventures to the nine month period ended September 30, 2000. COST OF SALES AND RELATED SERVICES. Cost of sales and related services decreased from $64.1 million for the nine months ended September 30, 2000 to $62.2 million for the same period in 2001, a decrease of $1.9 million, or 3%. As a percentage of sales and related services revenues, cost of sales and related services decreased from 50% for the nine months ended September 30, 2000 to 49% for the same period in 2001. This decrease is attributable to a higher level of favorable physical inventory adjustments, the Company's reassessment of required reserve levels due to additional corporate oversight of the physical inventory process, and the sale of the rehab centers, which contributed lower margins. Recently in 2001, Dey Labs received FDA approval for "DuoNeb", a mixture of albuterol sulfate and ipratropium bromide. The Company currently compounds the drug for use in its aerosol medications business. When DuoNeb becomes commercially available, providers may be required by law to purchase the premixed drug, as the FDA prohibits compounding without a medical justification when an FDA approved drug is already commercially available. The Company expects that its costs for DuoNeb will be substantially higher than the Company's cost to compound, which may have a material impact on cost of sales and the results of operations. The Company is investigating various alternatives to minimize the potential negative impact related to the sale and marketing of DuoNeb. OPERATING EXPENSES. Operating expenses decreased from $161.7 million for the nine months ended September 30, 2000 to $158.1 million for the same period in 2001, a decrease of $3.6 million, or 2%. This decrease is attributable to lower bad debt expense and a reduction of $0.7 million in operating expenses as a result of the sale of the rehab centers, offset somewhat by additional operating expenses of $2.8 million from the accounting consolidation of six of the Company's previously 50% owned joint ventures. Bad debt expense was 7.0% of revenue for the nine months ended September 30, 2000 compared to 4.7% of revenue for the same period in 2001. The improvement in bad debt expense is attributable to improved cash collections resulting from the process redesign, standardization and consolidation of billing center activities. Also, in the second quarter of 2001, bad debt expense was favorably impacted by the reversal of approximately $0.7 million in previously established reserves as a result of the collection of past due balances associated with a terminated services contract. Without this reserve reversal, bad debt expense as a percentage of revenues would have been 5.0% for the nine months ended September 30, 2001. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased from $11.1 million for the nine months ended September 30, 2000 to $11.7 million for the same period in 2001, an increase of $0.6 million, or 5%. This increase is attributable to higher personnel expenses in the nine months ended September 30, 2001 as a result of the billing 25 initiatives, corporate compliance activities and increased marketing efforts, offset by lower consulting and legal fees. As a percentage of revenues, general and administrative expenses were 4.1% and 4.4% for the nine months ended September 30, 2000 and 2001, respectively. DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses decreased from $28.6 million for the nine months ended September 30, 2000 to $24.1 million for the same period in 2001, a decrease of $4.5 million, or 16%. This decrease is primarily attributable to lower levels of rental equipment depreciation due to certain property and equipment becoming fully depreciated, and a lower level of unfavorable physical inventory adjustments in the nine months ended September 30, 2001 compared to the same period in 2000. AMORTIZATION OF DEFERRED FINANCING COSTS. Amortization of deferred financing costs increased from $1.7 million for the nine months ended September 30, 2000 to $2.0 million for the same period in 2001, an increase of $0.3 million, or 18%. This increase is primarily attributable to additional deferred financing costs associated with amendments to the Credit Agreement. In addition, in the fourth quarter of 2000, the Company recorded the estimated fair value of warrants ($686,000) to be issued to the Lenders in connection with the Second Amendment to the Credit Agreement and the related amortization of these costs using the effective interest rate method. INTEREST. Interest expense decreased from $22.8 million for the nine months ended September 30, 2000, to $21.9 million for the same period in 2001, a decrease of $0.9 million, or 4%. This decrease is attributable to reductions in the prime borrowing rate and lower principal amounts outstanding. LIQUIDITY AND CAPITAL RESOURCES At September 30, 2001 the Company's working capital was $38.2 million and the current ratio was 1.72x as compared to working capital of $54.7 million and a current ratio of 2.09x at December 31, 2000. The Company is the borrower under a credit facility (the "Bank Credit Facility") between the Company and Bankers Trust Company, as agent for a syndicate of Lenders (the "Lenders"). The Company's breach of several of the financial covenants in its Credit Agreement and its failure to make a scheduled principal payment due March 15, 2001 caused the Company to be not in compliance with certain covenants of its Credit Agreement. The Company, on June 8, 2001, entered into a Fifth Amended and Restated Credit Agreement (the "Amended Credit Agreement") that provided a new loan to the Company from which the proceeds were used to pay off all existing loans under the Credit Agreement. The Amended Credit Agreement also includes modified financial covenants and a revised amortization schedule. In addition, the Amended Credit Agreement no longer contains a revolving loan component; all existing indebtedness is now in the form of a term loan which matures on December 31, 2002. The Amended Credit Agreement requires principal payments of $750,000 on September 30, 2001 and December 31, 2001; a principal payment of $11.6 million on March 31, 2002; principal payments of $1.0 million on June 30, 2002 and September 30, 2002; and a balloon payment of $281.5 million on December 31, 2002. As of November 8, 2001 the Company has paid the $750,000 principal payment due on September 30, 2001 as well as the $750,000 principal payment due on December 31, 2001 and $9.3 million of the $11.6 million principal payment due on March 31, 2002. However, there currently is no commitment as to how the balloon 26 payment due on December 31, 2002 will be satisfied. The Amended Credit Agreement further provides for mandatory prepayments of principal from the Company's excess cash flow and from the proceeds of the Company's sales of securities, sales of assets, tax refunds or excess casualty loss payments. Substantially all of the Company's assets have been pledged as security for borrowings under the Bank Credit Facility. Indebtedness under the Bank Credit Facility, as of November 8, 2001, totals $289.2 million (which includes letters of credit totaling $3.4 million). The Amended Credit Agreement further provides for the payment to the Lenders of certain fees. These fees include a restructuring fee of $1.2 million (paid on the effective date of the Amended Credit Agreement), $200,000 payable on each of December 31, 2001, March 31, 2002 and June 30, 2002, as well as $459,000 payable on September 30, 2002. In addition, the Company has an obligation to pay the agent an annual administrative fee of $75,000 and an annual fee of .50% of the average outstanding indebtedness on each anniversary of the Amended Credit Agreement. The Amended Credit Agreement contains various financial covenants, the most restrictive of which relate to measurements of EBITDA, leverage, interest coverage ratios, and collections of accounts receivable. The Amended Credit Agreement also contains provisions for periodic reporting. The Amended Credit Agreement also contains restrictions which, among other things, impose certain limitations or prohibitions on the Company with respect to the incurrence of indebtedness, the creation of liens, the payment of dividends, the redemption or repurchase of securities, investments, acquisitions, capital expenditures, sales of assets and transactions with affiliates. The Company is not permitted to make acquisitions or investments in joint ventures without the consent of Lenders holding a majority of the lending commitments under the Bank Credit Facility. In addition, proceeds of all of the Company's accounts receivable are transferred daily into a bank account at PNC Bank, N.A. which, under the terms of a Concentration Bank Agreement, requires that all amounts in excess of $3.0 million be transferred to an account at Bankers Trust Company in the Company's name. Upon occurrence of an event of default under the Amended Credit Agreement, the Lenders have the right to instruct PNC Bank, N.A. and Bankers Trust Company to cease honoring any drafts under the accounts and apply all amounts in the bank accounts against the indebtedness owed to the Lenders. Interest is payable on the unpaid principal amount under the Amended Credit Agreement, at the election of the Company, at either a Base Lending Rate or an Adjusted Eurodollar Rate (each as defined in the Amended Credit Agreement), plus an applicable margin of 2.75% and 3.50%, respectively. As of September 30, 2001 the weighted average borrowing rate was 9.8%. The Company is also required to pay additional interest in the amount of 4.50% per annum on that principal portion outstanding of the Amended Credit Agreement that is in excess of four times Adjusted EBITDA as defined by the Amended Credit Agreement. Upon the occurrence and continuation of an event of default under the Amended Credit Agreement, interest is payable upon demand at a rate that is 2.00% per annum in excess of the interest rate otherwise payable under the Amended Credit Agreement and the Company no longer has the right to borrow at the Adjusted Eurodollar Rate plus the applicable margin. Upon the occurrence and continuation of an event of default under the Amended Credit Agreement, new borrowings would have to be made at the Base Lending Rate plus the applicable margin, which is a substantially higher rate of interest. 27 The Company was required to issue on March 31, 2001 warrants to the Lenders representing 19.999% of the Common Stock of the Company issued and outstanding as of March 31, 2001, pursuant to the terms of the Second Amendment to the Fourth Amended and Restated Credit Agreement (which amendment was entered into on April 14, 1999). To fulfill these obligations, warrants to purchase 3,265,315 shares of Common Stock were issued to the Lenders on June 8, 2001. Fifty percent of these warrants are exercisable at any time after issuance and the remaining fifty percent are exercisable on and after September 30, 2001. The exercise price of the warrants is $0.01 per share. As of November 8, 2001 these warrants have not been exercised. Management's cash flow projections and related operating plans indicate the Company can remain in compliance with the new financial covenants under the Amended Credit Agreement and meet its expected obligations throughout 2001. However, as with all projections, there is uncertainty as to whether management's projections can be achieved. In any event of noncompliance or default under the Amended Credit Agreement, the Lenders have the ability to demand payment of all outstanding amounts and there is currently no commitment as to how any such demand would be satisfied by the Company. Any demands for repayment by the Lenders, or the inability to obtain waivers in the event of noncompliance with covenants, or the inability to refinance the related debt upon maturity at December 31, 2002 would have a material adverse impact on the financial position, results of operations and cash flows of the Company. There can be no assurance that future cash flow from operations will be sufficient to cover debt obligations, especially those obligations due upon maturity of the Bank Credit Facility. The Company's future liquidity will continue to be dependent upon the relative amounts of current assets (principally cash, accounts receivable and inventories) and current liabilities (principally accounts payable and accrued expenses). In that regard, accounts receivable can have a significant impact on the Company's liquidity. The Company has various types of accounts receivable, such as receivables from patients, contracts, and former owners of acquisitions. The majority of the Company's accounts receivable are patient receivables. Accounts receivable are generally outstanding for longer periods of time in the health care industry than many other industries because of requirements to provide third-party payors with additional information subsequent to billing and the time required by such payors to process claims. Certain accounts receivable frequently are outstanding for more than 90 days, particularly where the account receivable relates to services for a patient receiving a new medical therapy or covered by private insurance or Medicaid. Net patient accounts receivable were $74.5 million and $62.2 million at December 31, 2000 and September 30, 2001, respectively. The decrease in net patient accounts receivable is due in part to the sale of the rehab centers, which included net patient accounts receivable of $5.6 million. Average days' sales in accounts receivable was approximately 76 and 71 days at December 31, 2000 and September 30, 2001, respectively. The Company's level of DSO and net patient receivables reflect the extended time required to obtain necessary billing documentation, the ongoing efforts to implement a standardized model for reimbursement and the consolidation of billing activities. Net cash provided from operating activities was $12.9 million and $18.9 million for the nine months ended September 30, 2000 and 2001, respectively, which is primarily due to the current year decrease in net accounts receivable, offset by the current year payment of $3.0 million related to the government investigation and income taxes paid of $1.8 million related 28 to a federal income tax audit assessment covering the period 1994 through 1998. Net cash used in investing activities was $11.8 million and $6.3 million for the nine months ended September 30, 2000 and 2001, respectively. Capital expenditures were $13.9 million for the nine months ended September 30, 2000 compared to $15.4 million for the same period in 2001, proceeds from joint venture dissolutions contributed $0.9 million for the nine months ended September 30, 2000, and the sale of centers contributed $7.8 million for the same period in 2001. Net cash used in financing activities was $12.9 million and $10.8 million for the nine months ended September 30, 2000 and 2001, respectively. The cash used in financing activities for the nine months ended September 30, 2000 and 2001 primarily relates to principal payments and deferred financing costs for the Bank Credit Facility offset by proceeds from the Employee Stock Purchase Plan. The Company's principal capital requirements are for working capital, capital expenditures and debt service. The Company has financed and intends to continue to finance these requirements with existing cash balances, net cash provided by operations and other available capital expenditure financing vehicles. Management believes that these sources will support the Company's current level of operations assuming the Company maintains compliance with its debt covenants and the due dates of amounts outstanding under the Bank Credit Facility are not accelerated. A principal payment of $11.6 million is due March 31, 2002 under the Bank Credit Facility. As of November 8, 2001 the Company has paid $9.3 million in principal towards this requirement with existing cash balances and proceeds from the sales of its centers. Management also believes these sources are adequate to fund the Settlement in the government investigation based upon the payment terms, as more fully described in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Government Regulation." However, the Company currently has no commitment as to how the balloon payment due on December 31, 2002 under the Bank Credit Facility will be satisfied. RISK FACTORS This section summarizes certain risks, among others, that should be considered by stockholders and prospective investors in the Company. Substantial Leverage. The Company maintains a significant amount of debt pursuant to the Bank Credit Facility. If an event of default occurs under the Amended Credit Agreement or the indebtedness is not paid at maturity, the Lenders have the right to exercise remedies detailed in the Bank Credit Facility section of this document. In addition, proceeds of all of the Company's accounts receivable are transferred daily into a bank account at PNC Bank, N.A. which, under the terms of a Concentration Bank Agreement, requires that all amounts in excess of $3.0 million be transferred to an account at Bankers Trust Company in the Company's name. Upon the occurrence of an event of default under the Amended Credit Agreement, the Lenders have the right to instruct PNC Bank, N.A. and Bankers Trust Company to cease honoring any drafts under the accounts and apply all amounts in the bank accounts against the indebtedness owed to the Lenders. Interest is payable on borrowings under the Amended Credit Agreement, at the election of the Company, at either a Base Lending Rate or an Adjusted Eurodollar Rate (each as defined in the Amended Credit Agreement) plus a margin of 2.75% and 3.50%, respectively. Also, additional interest of 4.50% accrues on that portion of the outstanding indebtedness of the Bank Credit Facility that is in excess of four times Adjusted EBITDA as defined by the 29 Amended Credit Agreement. Upon the occurrence of an event of default under the Amended Credit Agreement, interest is payable by the Company at 2.00% per annum in excess of the rate provided by the Amended Credit Agreement and the Company no longer has the right to utilize the Adjusted Eurodollar Rate plus the applicable margin. Upon the occurrence of or event of default under the Amended Credit Agreement, all new loans would bear interest at the Base Lending Rate plus the applicable margin, which is currently a substantially higher rate of interest. The Amended Credit Agreement further provides for the payment to the Lenders of certain fees. These fees include a restructuring fee of $1.2 million (paid on the effective date of the Amended Credit Agreement), $200,000 payable on each of December 31, 2001, March 31, 2002 and June 30, 2002, as well as $459,000 payable on September 30, 2002. In addition, the Company has an obligation to pay the agent an annual administrative fee of $75,000 and an annual fee of .50% of the average outstanding indebtedness on each anniversary of the Amended Credit Agreement. The occurrence of a default by the Company under the Amended Credit Agreement could have a material adverse effect on the Company's liquidity, business, financial condition and results of operations. The degree to which the Company is leveraged may impair the Company's ability to finance, through its own cash flow or from additional financing, its future operations or pursue its business strategy and could make the Company more vulnerable to economic downturns, competitive and payor pricing pressures and adverse changes in government regulation. There can be no assurance that future cash flow from operations will be sufficient to cover scheduled debt obligations. Additional sources of funds may be required and there can be no assurance the Company will be able to obtain additional funds on acceptable terms, if at all. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." Government Regulation. The Company is subject to extensive and frequently changing federal, state and local regulation. In addition, new laws and regulations are adopted periodically to regulate new and existing products and services in the health care industry. Changes in laws or regulations or new interpretations of existing laws or regulations can have a dramatic effect on operating methods, costs and reimbursement amounts provided by government and other third-party payors. There can be no assurance that the Company is in compliance with all applicable existing laws and regulations or that the Company will be able to comply with legislative enactments of new laws or regulations. Changes in applicable laws or any failure to comply with existing or future laws, regulations or standards could have a material adverse effect on the Company's results of operations, financial condition, business or prospects. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Government Regulation - Legal Proceedings." Government Investigations and Federal False Claims Act Cases. In addition to the regulatory initiatives mentioned above, the OIG has received funding to expand and intensify its auditing of the health care industry in an effort better to detect and remedy errors in Medicare and Medicaid billing. The Company has reason to believe a qui tam complaint has been filed against the Company under the False Claims Act alleging violations of law occurring after December 31, 1998. The Company has not seen a complaint in this action, but believes that it contains allegations similar to the ones alleged in the Settlement recently entered in connection with the False Claims Act case originating with the Pineville, Kentucky 30 center described above. The Company believes that this case will be limited to allegedly improper activities occurring after December 31, 1998. There can be no assurances as to the final outcome of the pending False Claims Act lawsuits or of any lawsuits that may be filed in the future. Possible outcomes include, among other things, the repayment of reimbursements previously received by the Company related to improperly billed claims, the imposition of fines or penalties, and the suspension or exclusion of the Company from participation in the Medicare, Medicaid and other government reimbursement programs. The outcome of any of the pending lawsuits could have a material adverse effect on the Company. See "Business - Government Regulation and Legal Proceedings." Collectibility of Accounts Receivable. The Company has substantial accounts receivable, as well as days sales outstanding of 71 days as of September 30, 2001. The Company has implemented four key initiatives to improve accounts receivable performance: (i) proper staffing and training; (ii) process redesign and standardization; (iii) consolidation of billing center activities; and (iv) billing center specific goals geared toward improved cash collections and reduced accounts receivable. No assurances can be given, however, that future bad debt expense will not increase above current operating levels as a result of continuing difficulties associated with the Company's billing activities and meeting payor documentation requirements and claim submission deadlines. Liquidity. Effective at the close of business on September 1, 1999, Nasdaq de-listed the Company's common stock and it is no longer listed for trading on the Nasdaq National Market. As a result, trading of the Company's common stock is conducted on the over-the-counter market ("OTC") or, on application by broker-dealers, in the NASD's Electronic Bulletin Board using the Company's current trading symbol, AHOM. As a result of the de-listing, the liquidity of the Company's common stock and its price have been adversely affected which may have limited the Company's ability to raise additional capital. Infrastructure. As the Company continues to refine its business model, it may need to implement enhanced operational and financial systems and may require additional employees and management, and operational and financial resources. There can be no assurance that the Company will successfully (i) implement and maintain any such operational and financial systems, or (ii) apply the human, operational and financial resources needed to manage a developing and expanding business. Failure to implement such systems successfully and use such resources effectively could have a material adverse effect on the Company's results of operations, financial condition or prospects. Medicare Reimbursement for Oxygen Therapy and Other Services. Oxygen therapy reimbursement from Medicare accounts for approximately 27% of the Company's year-to-date revenues and will account for approximately 29% of the Company's ongoing revenues following the September 2001 sale of the rehab centers. The Balanced Budget Act of 1997, as amended, reduced Medicare reimbursement rates for oxygen and certain oxygen equipment to 75% of 1997 levels beginning January 1, 1998 and to 70% of 1997 levels beginning January 1, 1999. Reimbursement for drugs and biologicals was reduced by 5% beginning January 1, 1998. Effective January 1, 1998, payments for parenteral and enteral nutrition ("PEN") were frozen at 1995 levels, through the year 2002. Effective October 1, 1999, Medicare established new guidelines for respiratory assist devices ("RAD"), which include 31 continuous positive airway pressure devices, bi-level respiratory devices (without backup) and bi-level respiratory devices with back up. The changes require additional documentation in order to continue coverage on existing patients as well as new coverage and qualifying criteria for new patients. In addition, the bi-level respiratory device (without backup) was transferred from a frequently serviced item to "capped rental." Currently, respiratory assist devices account for approximately $35.5 million in annualized revenues. Medicare is also considering the transfer of non-invasive positive pressure ventilators from a frequently serviced item to "capped rental." The effective date of this change is unknown. Medicare also has the option of developing fee schedules for PEN and home dialysis supplies and equipment, although currently there is no timetable for the development or implementation of such fee schedules. Following promulgation of a final rule, the Centers for Medicare and Medicaid Services ("CMS"), formerly known as the Healthcare Financing Administration ("HCFA"), will also have "inherent reasonableness" authority to modify payment rates for all Medicare Part B items and services by as much as 15% without industry consultation, publication or public comment if the rates are "grossly excessive" or "grossly deficient." Possible future changes in the basis for calculating Medicare's reimbursement rates for Albuterol and other respiratory medications could result in a reimbursement reduction for these products, the timing and extent of which are not known at this time. The Company cannot be certain that additional reimbursement reductions for oxygen therapy services or other services and products provided by the Company will not occur. Reimbursement reductions already implemented have materially adversely affected the Company's revenues and net income, and any such future reductions could have a similar material adverse effect. Dependence on Reimbursement by Third-Party Payors. For the nine months ended September 30, 2001, the percentage of the Company's revenues derived from Medicare, Medicaid and private pay was 49%, 10% and 41%, respectively. The revenues and profitability of the Company are affected by the continuing efforts of all payors to contain or reduce the costs of health care by lowering reimbursement rates, narrowing the scope of covered services, increasing case management review of services and negotiating reduced contract pricing. Any changes in reimbursement levels under Medicare, Medicaid or private pay programs and any changes in applicable government regulations could have a material adverse effect on the Company's revenues and net income. Changes in the mix of the Company's patients among Medicare, Medicaid and private pay categories and among different types of private pay sources may also affect the Company's revenues and profitability. There can be no assurance that the Company will continue to maintain its current payor or revenue mix. Role of Managed Care. As managed care assumes an increasingly significant role in markets in which the Company operates, the Company's success will, in part, depend on retaining and obtaining profitable managed care contracts. There can be no assurance that the Company will retain or obtain such managed care contracts. In addition, reimbursement rates under managed care contracts are likely to continue to experience downward pressure as a result of payors' efforts to contain or reduce the costs of health care by increasing case management review of services and negotiating reduced contract pricing. Therefore, even if the Company is successful in retaining and obtaining managed care contracts, unless the Company also decreases its cost for providing services and increases higher margin services, it will experience declining profit margins. 32 Health Care Initiatives. The health care industry continues to undergo dramatic changes. With the change in administration, new federal health care initiatives, particularly concerning Medicare, may be launched. For example, in June of this year, Department of Health and Human Services Secretary Tommy Thompson unveiled a new name for the agency formerly known as the Health Care Financing Administration. The name change to CMS, Centers for Medicare and Medicaid Services, signaled a restructuring of the agency, as well as reforms designed to make the Medicare and Medicaid programs more effective and responsive to providers and beneficiaries. There can be no assurance that other equally sweeping federal legislative and regulatory initiatives will not be adopted in the future. It is also possible that proposed federal legislation will include language which provides incentives to further encourage Medicare recipients to shift to Medicare at-risk managed care programs, potentially limiting patient access to, and reimbursement for, products and services provided by the Company. Some states are adopting health care programs and initiatives as a replacement for Medicaid. There can be no assurance that the adoption of such legislation or other changes in the administration or interpretation of governmental health care programs or initiatives will not have a material adverse effect on the Company. HIPAA Compliance. HIPAA has mandated an extensive set of regulations to protect the privacy of identifiable health information, which are currently scheduled to become effective in April, 2003. The Company has created a HIPAA Compliance working group that is in the process of identifying information inflow and outflow throughout the organization, which will then be analyzed to determine the appropriate privacy protections the Company will need to put in place to be HIPAA-compliant. The Company is unable to project the cost of HIPAA compliance until the assessment process is complete. Substantial changes to the Company's information management systems required for HIPAA compliance could have a material adverse effect on the Company. No Assurance of Growth. The Company reported a net loss of $14.6 million for the nine months ended September 30, 2001. No assurance can be given that the Company will achieve profitable operations in the near term. The Company intends to expand its business primarily through internal growth of existing operations. There can be no assurance that the Company can achieve growth in revenues. The price of the Company's common stock may fluctuate substantially in response to quarterly variations in the Company's operating and financial results, announcements by the Company or other developments affecting the Company, as well as general economic and other external factors. Ability to Attract and Retain Management. The Company is highly dependent upon its senior management, and competition for qualified management personnel is intense. The Company's current financial results and the ongoing OIG investigation, among other factors, may limit the Company's ability to attract and retain qualified personnel, which in turn could adversely affect profitability. Competition. The home health care market is highly fragmented and competition varies significantly from market to market. In the small and mid-size markets in which the Company primarily operates, the majority of its competition comes from local independent operators or hospital-based facilities, whose primary competitive advantage is market familiarity. In the larger markets, regional and national providers account for a significant portion of competition. Some of the Company's present and potential competitors are significantly larger than the Company and have, or may obtain, greater financial and 33 marketing resources than the Company. In addition, there are relatively few barriers to entry in the local markets served by the Company, and it encounters substantial competition from new market entrants. Liability and Adequacy of Insurance. The provision of health care services entails an inherent risk of liability. Certain participants in the home health care industry may be subject to lawsuits which may involve large claims and significant defense costs. It is expected that the Company periodically will be subject to such suits as a result of the nature of its business. The Company currently maintains product and professional liability insurance intended to cover such claims in amounts which management believes are in keeping with industry standards. There can be no assurance that the Company will be able to obtain liability insurance coverage in the future on acceptable terms, if at all. There can be no assurance that claims in excess of the Company's insurance coverage or claims not covered by the Company's insurance coverage will not arise. A successful claim against the Company in excess of the Company's insurance coverage could have a material adverse effect upon the results of operations, financial condition or prospects of the Company. Claims against the Company, regardless of their merit or eventual outcome, may also have a material adverse effect upon the Company's ability to attract patients or to expand its business. In addition, the Company is self-insured for its workers compensation and health insurance and is at risk for claims up to individual stop loss and aggregate stop loss amounts. NEW FINANCIAL ACCOUNTING STANDARDS Statement of Financial Accounting Standards No. 133, as amended, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133") has been issued effective for fiscal years beginning after June 15, 2000. SFAS No. 133, as amended, requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. The Company adopted the provisions of SFAS No. 133, as amended, effective January 1, 2001, as required; however, the Company's adoption of SFAS No. 133, as amended, did not have a material effect on the Company's financial position or results of operations. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101") regarding revenue recognition in financial statements. SAB 101 was effective January 1, 2000 but implementation was delayed until the fourth quarter of 2000. The Company's implementation of SAB 101 in the fourth quarter of 2000 did not have a material impact on its financial position, results of operations or cash flows on a quarterly or annual basis. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141") and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also specifies criteria which intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 requires that intangible assets with finite useful lives be amortized, and that goodwill and 34 intangible assets with indefinite lives no longer be amortized, but instead be tested for impairment at least annually. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The Company is required to adopt the provisions of SFAS No. 141 immediately and SFAS No. 142 effective January 1, 2002. Furthermore, any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase business combination completed after June 30, 2001 will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-SFAS No. 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized until the adoption of SFAS No. 142. As of the date of adoption, the Company expects to have unamortized goodwill in the amount of $189.7 million which will be subject to the transition provisions of SFAS No. 141 and 142. Amortization expense related to goodwill was $1.4 million and $4.2 million for the quarter and the nine months ended September 30, 2001, respectively. Because of the extensive effort needed to comply with adopting SFAS No. 141 and 142, it is not practicable to reasonably estimate the impact of adopting these Statements on the Company's financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as a cumulative effect of a change in accounting principle. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143") effective for fiscal years beginning after June 15, 2002. SFAS 143 requires that a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The Company does not expect the future adoption of SFAS 143 to have a material effect on its financial position or results of operations. In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144") effective for fiscal years beginning after December 15, 2001. SFAS 144 establishes a single accounting model for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired and broadens the presentation of discontinued operations to include more disposal transactions. The Company has not yet determined the impact of the January, 2002 adoption of SFAS 144 on its financial position or results of operations. 35 ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The chief market risk factor affecting the financial condition and operating results of the Company is interest rate risk. The Company's Bank Credit Facility provides for a floating interest rate. As of September 30, 2001, the Company had outstanding borrowings of approximately $287.8 million, which excludes letters of credit totaling $3.4 million. In the event that interest rates associated with this facility were to increase by 10%, the impact on future cash flows would be approximately $1.0 million. Interest expense associated with other debts would not materially impact the Company as most interest rates are fixed. PART II. OTHER INFORMATION ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K (A) Exhibits. The exhibits filed as part of this Report are listed on the Index to Exhibits immediately following the signature page. (B) Reports on Form 8-K. No reports on Form 8-K have been filed during the quarter for which this report is filed. 36 SIGNATURES Pursuant to the requirements 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. AMERICAN HOMEPATIENT, INC. November 14, 2001 By: /s/Marilyn A. O'Hara --------------------------------- Marilyn A. O'Hara Chief Financial Officer and An Officer Duly Authorized to Sign on Behalf of the registrant 37 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS ------ ----------------------- 3.1 Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement No. 33-42777 on Form S-1). 3.2 Certificate of Amendment to the Certificate of Incorporation of the Company dated October 31, 1991 (incorporated by reference to Exhibit 3.2 to Amendment No. 2 to the Company's Registration Statement No. 33-42777 on Form S-1). 3.3 Certificate of Amendment to the Certificate of Incorporation of the Company dated May 14, 1992 (incorporated by reference to Registration Statement on Form S-8 dated February 16, 1993). 3.4 Certificate of Ownership and Merger merging American HomePatient, Inc. into Diversicare Inc. dated May 11, 1994 (incorporated by reference to Exhibit 4.4 to the Company's Registration Statement No. 33-89568 on Form S-2). 3.5 Certificate of Amendment to the Certificate of Incorporation of the Company dated July 8, 1996 (incorporated by reference to Exhibit 3.5 to the Company's Report of Form 10-Q for the quarter ended June 30, 1996). 3.6 Bylaws of the Company, as amended (incorporated by reference to Exhibit 3.3 to the Company's Registration Statement No. 33-42777 on Form S-1).
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