-----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, CuI+KTh8Rc9Cav2pV8F96TT89Ubq277cxzAUB7qYA21UmcSbOPMWEg7yOLWwHWHp 9JRfxYUP8w9y8tbd8LHmtA== 0000950136-99-001064.txt : 19990816 0000950136-99-001064.hdr.sgml : 19990816 ACCESSION NUMBER: 0000950136-99-001064 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TRANSWORLD HEALTHCARE INC CENTRAL INDEX KEY: 0000890634 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-HOME HEALTH CARE SERVICES [8082] IRS NUMBER: 133098275 STATE OF INCORPORATION: NY FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-11570 FILM NUMBER: 99687297 BUSINESS ADDRESS: STREET 1: 555 MADISON AVENUE CITY: NEW YORK STATE: NY ZIP: 10022 BUSINESS PHONE: 2127500064 MAIL ADDRESS: STREET 1: 555 MADISON AVENUE CITY: NEW YORK STATE: NY ZIP: 10022 FORMER COMPANY: FORMER CONFORMED NAME: TRANSWORLD HOME HEALTHCARE INC DATE OF NAME CHANGE: 19940728 10-Q 1 QUARTERLY REPORT SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Quarterly Period Ended June 30, 1999 Commission File Number 1-11570 ------------------------------------------------------------- Transworld Healthcare, Inc. ------------------------------------------------------------- (Exact name of Registrant as specified in its charter) New York 13-3098275 ------------------ -------------- (State or other jurisdiction of (I.R.S Employer incorporation or organization Identification No.) 555 Madison Avenue, New York, New York 10022 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (212) 750-0064 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at August 1, 1999 - ------------ ----------------------------- Common Stock 17,551,076 Shares Transworld Healthcare, Inc. Third Quarter Report On Form 10-Q Table of Contents Part I. Page Item 1. Financial Statements (Unaudited).................................. 3 Condensed Consolidated Balance Sheets June 30, 1999 and September 30, 1998..................... 4 Condensed Consolidated Statements of Operations For the Three and Nine Months Ended June 30, 1999 and June 30, 1998.......................... 5 Condensed Consolidated Statements of Cash Flows For the Nine Months Ended June 30, 1999 and June 30, 1998.......................... 6 Notes to Condensed Consolidated Financial Statements............................................... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................ 15 Part II. Item 3. Defaults Upon Senior Securities................................... 27 Item 6. Exhibits and Reports on Form 8-K.................................. 27 The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward looking statements. This Quarterly Report contains certain forward looking statements and information that are based on the beliefs of management as well as assumptions made by and information currently available to management. The statements contained in this Quarterly Report relating to matters that are not historical facts are forward looking statements that involve risks and uncertainties, including, but not limited to, future demand for the company's products and services, general economic conditions, government regulation, competition and customer strategies, capital deployment, the impact of pricing and reimbursement and other risks and uncertainties. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated or expected. Page 2 PART I Item 1. Financial Statements (Unaudited) The financial statements of Transworld Healthcare, Inc. (the "Company") begin on page 4. Page 3 TRANSWORLD HEALTHCARE, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
JUNE 30, SEPTEMBER 30, 1999 1998 ------------ --------------- ASSETS Current assets: Cash and temporary investments $ 6,565 $ 10,413 Accounts receivable, less allowance for doubtful accounts of $18,367 and $16,437 30,679 32,223 Inventories 3,099 4,188 Deferred income taxes 7,420 6,732 Prepaid expenses and other current assets 5,254 4,382 -------- -------- Total current assets 53,017 57,938 Property & equipment, net 9,720 9,888 Intangible assets, net of accumulated amortization of $9,173 and $6,408 99,477 105,784 Deferred income taxes 6,078 3,483 Other assets 2,305 2,615 -------- -------- Total assets $170,597 $179,708 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt, including obligations under capital leases $ 55,767 $ 40 Accounts payable 5,067 2,728 Accrued expenses 15,654 12,901 Income taxes payable 3,727 3,022 Acquisitions payable 99 -------- -------- Total current liabilities 80,215 18,790 Long-term debt, including obligations under capital leases 8 57,307 Deferred income taxes and other 1,666 1,706 -------- -------- Total liabilities 81,889 77,803 -------- -------- Commitments and contingencies Stockholders' equity: Preferred stock, $.01 par value; authorized 2,000 shares, issued and outstanding - none Common stock, $.01 par value; authorized 40,000 shares, issued and outstanding - 17,551 and 17,536 shares 176 175 Additional paid-in capital 125,526 125,461 Accumulated other comprehensive (loss) income (4,900) 2,946 Retained deficit (32,094) (26,677) -------- -------- Total stockholders' equity 88,708 101,905 -------- -------- Total liabilities and stockholders' equity $170,597 $179,708 ======== ========
See notes to condensed consolidated financial statements. Page 4 TRANSWORLD HEALTHCARE, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED -------------------------- --------------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1999 1998 1999 1998 Revenues: Net patient services $20,419 $17,652 $ 58,345 $ 51,652 Net respiratory, medical equipment and supplies sales 14,893 19,821 51,273 55,497 Net infusion services 2,222 2,388 6,921 7,840 ------- ------- -------- -------- Total revenues 37,534 39,861 116,539 114,989 ------- ------- -------- -------- Cost of revenues: Patient services 13,827 12,222 39,833 35,832 Respiratory, medical equipment and supplies sales 8,652 10,876 29,286 31,116 Infusion services 1,704 1,685 5,392 5,459 ------- ------- -------- -------- Total cost of revenues 24,183 24,783 74,511 72,407 ------- ------- -------- -------- Gross profit 13,351 15,078 42,028 42,582 Selling, general and administrative expenses 16,611 13,152 43,570 37,662 Special charges 2,030 2,030 554 ------- ------- -------- -------- Operating (loss) income (5,290) 1,926 (3,572) 4,366 Interest income (49) (156) (191) (498) Interest expense 1,287 1,540 4,016 4,818 ------- ------- -------- -------- (Loss) income before income taxes (6,528) 542 (7,397) 46 (Benefit) provision for income taxes (2,061) 271 (1,980) 23 ------- ------- -------- -------- Net (loss) income $(4,467) $ 271 $ (5,417) $ 23 ======= ======= ========= ======== Net (loss) income per share of common stock: Basic and diluted $ (.25) $ .02 $ (.31) $ - ------- ------- -------- -------- Weighted average number of common shares outstanding: Basic 17,551 17,535 17,545 17,257 ======= ======= ========= ======== Diluted 17,551 17,579 17,545 17,796 ======= ======= ========= ========
See notes to condensed consolidated financial statements. Page 5 TRANSWORLD HEALTHCARE, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED ---------------------------- JUNE 30, JUNE 30, 1999 1998 ---------- ---------- Cash flows from operating activities: Net (loss) income $ (5,417) $ 23 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 5,270 4,613 Provision for doubtful accounts 9,535 5,743 Deferred income tax (3,283) Changes in assets and liabilities: Increase in accounts receivable (9,123) (8,067) Decrease (increase) in inventories 994 (526) Increase in prepaid expenses and other assets (1,312) (1,011) Increase (decrease) in accounts payable and other liabilities 6,654 (1,500) -------- -------- Net cash provided by (used in) operating activities 3,318 (725) -------- -------- Cash flows from investing activities: Capital expenditures (2,007) (2,603) Payments received from the sale of Health Management, Inc. 32,328 Advances to and investment in Health Management, Inc. (11,021) Proceeds from sale of Radamerica, Inc. 1,204 Purchase of subsidiaries and assets - net of cash acquired (3,081) (529) Payments on acquisition payable (131) (350) Other, net 43 -------- -------- Net cash (used in) provided by investing activities (5,176) 19,029 -------- -------- Cash flows from financing activities: Payments on revolving loan (1,500) (25,000) Payments on long-term debt (70) (40) Payments for debt issuance costs (18) (17) Stock options and warrants exercised, including tax benefit 66 6,512 Other, net (19) -------- -------- Net cash used in financing activities (1,522) (18,564) -------- -------- Effect of exchange rate on cash (468) 208 -------- -------- Decrease in cash (3,848) (52) Cash and temporary investments, beginning of period 10,413 10,626 -------- -------- Cash and temporary investments, end of period $ 6,565 $ 10,574 ======== ======== Supplemental cash flow information: Cash paid for interest $ 3,142 $ 4,115 ======== ======== Cash paid for income taxes, net $ 444 $ 1,488 ======== ========
See notes to condensed consolidated financial statements. Page 6 TRANSWORLD HEALTHCARE, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share data) (Unaudited) Note 1: Basis of Presentation Transworld Healthcare, Inc. (the "Company") is a provider of a broad range of home health care services and products with operations in the United States and the United Kingdom ("U.K."). The Company provides the following services and products to patients in their homes: (i) patient services, including nursing and para-professional services; (ii) specialty mail-order pharmaceuticals, medical supplies, respiratory therapy and home medical equipment; and (iii) infusion therapy. The Condensed Consolidated Financial Statements included herein are unaudited and include all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations of the interim period 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. These condensed financial statements should be read in conjunction with the Company's Form 10-K for the year ended September 30, 1998. Prior year's financial statements have been reclassified to conform to the current year's presentation. Note 2: Earnings Per Share Basic earnings per share ("EPS") is computed using the weighted average number of common shares outstanding, after giving effect to issuable shares per agreements. Diluted EPS is computed using the weighted average number of common shares outstanding, after giving effect to issuable shares per agreements and dilutive stock options and warrants using the treasury stock method. For the three and nine months ended June 30, 1999, the Company had an incremental weighted average of 118 and 159, respectively, of options and warrants which are not included in the diluted calculation as the effect of such inclusion would be antidilutive due to a net loss position. In addition, at June 30, 1999 and June 30, 1998, the Company had options and warrants to purchase 3,731 and 4,019 shares of common stock, respectively, ranging in price from $4.31 to $12.45 and $6.38 to $12.45 per share, respectively, that were not included in the computation of diluted EPS because the exercise price was greater than the average market price of the common shares during these periods. Page 7 TRANSWORLD HEALTHCARE, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont.) (In thousands, except per share data) (Unaudited) Note 2: Earnings Per Share (cont.) The earnings per share calculations for the three and nine months ended June 30, 1999 and 1998, were computed as follows:
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, 1999 JUNE 30, 1998 JUNE 30, 1999 JUNE 30, 1998 ------------------- ------------------ ------------------ ----------------- Net (loss) income $(4,467) $271 $(5,417) $23 =================== ================== ================== ================= Weighted average number of shares 17,551 17,190 17,545 16,369 outstanding Weighted average number of shares issuable per agreements - 345 - 888 ------------------- ------------------ ------------------ ----------------- Weighted average number of shares used in basic calculation 17,551 17,535 17,545 17,257 Incremental shares, after application of treasury stock method, of stock options and warrants - 44 - 539 ------------------- ------------------ ------------------ ----------------- Weighted average numbers of shares used in diluted calculation 17,551 17,579 17,545 17,796 =================== ================== ================== ================= Net (loss) income per share of common stock: Basic and diluted $(0.25) 0.02 $(0.31) $ - =================== ================== ================== =================
Note 3: Comprehensive Income Effective October 1, 1998, the Company adopted the provisions of Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This statement establishes standards for the reporting and display of comprehensive income and its components. Components of comprehensive income include net income and all other non-owner changes in equity, such as the change in the cumulative translation adjustment. The following table displays comprehensive income for the three and nine months ended June 30, 1999 and 1998: THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------------ ----------------------- 1999 1998 1999 1998 ------------ ----------- ----------- ----------- Net loss (income) $ (4,467) $ 271 $ (5,417) $ 23 Change in cumulative adjustment (2,395) (371) (7,846) 3,229 ------------ ----------- ----------- ----------- Comprehensive (loss) income $ (6,862) $ (100) $(13,263) $ 3,252 ============ =========== =========== =========== Page 8 TRANSWORLD HEALTHCARE, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont.) (In thousands, except per share data) (Unaudited) Note 4: Significant Risk and Uncertainties The Company has recorded a net deferred tax asset of $11,989 reflecting the benefit of $33,634 in loss carryforwards, which expire primarily in 2018. Realization is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes it is more likely than not that all of the deferred tax asset will be realized. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. Note 5: Debt At June 30, 1999, the Company was in technical default of its senior secured revolving credit facility (the "Credit Facility") due to non-compliance with certain financial covenants (debt to earnings before interest, taxes, depreciation and amortization ("EBITDA"), interest coverage and minimum EBITDA). As a result of this default, the Credit Facility was classified as current at June 30, 1999. The Company is in active discussions with the bank group regarding waiver of the existing default, which the bank group has expressed a desire to accommodate. In addition, the Company is currently seeking alternative financing but there can be no assurance that any such financing will be available to the Company, or if available, will be on terms acceptable to the Company. If alternative financing is not available and the Company is unable to secure necessary amendments to waive the defaults described above it could have a material adverse effect on the cash flows and financial position of the Company. Excluding any repayment of the Credit Facility, the Company believes it has adequate capital resources to conduct its operations for the next twelve months. During the nine months ended June 30, 1999, the Company amended the Credit Facility to allow for further expansion of its U.K. operations. In addition, the Company reduced its borrowings under the Credit Facility by $1,500. Note 6: Commitments and Contingencies On February 4, 1997, Patient Care Systems, Inc. ("PCS") filed a lawsuit against Dermaquest Surgical Supply, Inc. ("Dermaquest") and Transworld HealthCare, Inc. in the Court of Common Pleas of Chester County, Pennsylvania, for breach of contract, conversion, unjust enrichment and misrepresentation. Subsequently, PCS withdrew all claims except Page 9 TRANSWORLD HEALTHCARE, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont.) (In thousands, except per share data) (Unaudited) Note 6: Commitments and Contingencies (cont.) for its breach of contract claim. On April 22, 1997, Dermaquest filed a counterclaim against PCS for breach of contract. The action related to a contract initially entered into between Dermaquest and PCS to market alternating pressure mattresses. A jury trial in this matter began on June 28, 1999. On July 2, 1999, the jury reached their verdict finding in favor of PCS on its breach of contract claim in the amount of $825 and finding in favor of Dermaquest on its breach of contract counterclaim in the amount of $58. Dermaquest and the Company have filed post-trial motions seeking a new trial or a reduction in the verdict from $825 to $168. Under Pennsylvania law, PCS cannot execute on a jury verdict until it is reduced to a judgement. Further, in Pennsylvania, no judgement will be entered on a jury's verdict until the disposition of any post-trial motions. Oral argument on Dermaquest and the Company's post-trial motions is scheduled for October 6, 1999. Management of the Company intends to continue to defend the proceedings vigorously and believes the ultimate outcome will not have a material adverse effect on the Company's results of operations or financial position. On April 13, 1998, a shareholder of the Company, purporting to sue derivatively on behalf of the Company, commenced a derivative suit in the Supreme Court of the State of New York, County of New York, entitled Kevin Mak, derivatively and on behalf of Transworld Healthcare, Inc., Plaintiff, vs. Timothy Aitken, Scott A. Shay, Lewis S. Ranieri, Wayne Palladino and Hyperion Partners II L.P., Defendants, and Transworld Healthcare, Inc., Nominal Defendant, Index No. 98-106401. The suit alleges that certain officers and directors of the Company, and Hyperion Partners II L.P. ("HPII"), breached fiduciary duties to the Company and its shareholders, in connection with a transaction, approved by a vote of the Company's shareholders on March 17, 1998, in which the Company was to issue certain shares of stock to HPII in exchange for certain of Health Management, Inc.'s ("HMI") trade payables. The action seeks injunctive relief against this transaction, and damages, costs and attorneys' fees in unspecified amounts. The transaction subsequently closed and the plaintiff has, on numerous occasions, stipulated to extend the defendants' time to respond to this suit. The most recent stipulation provides for an extension to September 30, 1999. On July 11 and July 22, 1997, the Company's RespiFlow, Inc. ("RespiFlow") and MK Diabetic Support Services, Inc. ("MK") subsidiaries, respectively, each received a letter (the "Audit Letters") from the Office of Audit Services (a division of the U.S. Department of Health and Human Services, Office of Inspector General) ("OIG"). The Audit Letters indicate, among other things, that the OIG is conducting an industry-wide audit of marketing fees and commissions paid from pharmacies to home medical equipment companies. The Company has been informed that the audit has been extended to cover the Company's DermaQuest, Inc. subsidiary. The Company is cooperating fully with the OIG and has produced documentation Page 10 TRANSWORLD HEALTHCARE, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont.) (In thousands, except per share data) (Unaudited) Note 6: Commitments and Contingencies (cont.) which it believes is responsive to the requests set forth in the Audit Letters. While the Company believes that its former arrangements with home medical equipment suppliers do not violate any Federal or state laws, it cannot predict whether the audit will ultimately result in any liability to the government and in such event, the amount thereof. There can be no assurance that such amount, if any, will not have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows. On November 19, 1997, the Company was notified by the Office of the United States Attorney for the Eastern District of Texas that it, RespiFlow, MK, and other non-affiliated entities had been named defendants in a qui tam action under the Federal False Claims Act. The qui tam action was filed under seal in the United States District Court, and it will remain under seal while the government evaluates the merits of the lawsuit and decides whether to intervene and take over the conduct of the litigation. The government has not made a copy of the sealed complaint available to the Company; however, the Company has been informed that no individuals associated with it or its affiliates have been named as defendants. The Company further understands that the issues raised in the lawsuit involve payments to durable medical equipment dealers who acted as the Company's marketing representatives. The Company cannot predict whether the Federal government will intervene in this action or whether the outcome of this action will have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows. During the normal course of business the Company continues to carefully monitor and review its submission of Medicare, Medicaid and all other claims for reimbursement. The Company believes that it is substantially in compliance, in all material respects, with the applicable provisions of the Federal statutes, regulations and laws and applicable state laws. Because of the broad and sometimes vague nature of these laws, there can be no assurance that an enforcement action will not be brought against the Company, or that the Company will not be found to be in violation of one or more of these provisions. At present, the Company cannot anticipate what impact, if any, subsequent administrative or judicial interpretation of the applicable Federal and state laws may have on the Company's consolidated financial position, results of operations or cash flows. Effective October 1, 1997, HMI became a wholly-owned subsidiary of the Company. Page 11 TRANSWORLD HEALTHCARE, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont.) (In thousands, except per share data) (Unaudited) Note 6: Commitments and Contingencies (cont.) HMI and certain of its current and former officers have been named as defendants in an alleged class action lawsuit filed on April 3, 1997 in the United States District Court for the Eastern District of New York formerly entitled Nicholas Volonnino et al. v. Health Management, Inc., W. James Nicol, Paul S. Jurewicz and James Mieszala, 97 Civ. 1646. The action was amended on September 12, 1997, and is now entitled Dennis Baker et al. v. Health Management, Inc., BDO Seidman, LLP, Transworld HealthCare, Inc., W. James Nicol, Paul S. Jurewicz and James Mieszala. This action alleges claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, arising out of misrepresentations and omissions by HMI in connection with certain of its previous securities filings and press releases. The Company is being sued as an alleged control person of HMI, based upon its acquisition of 49% of HMI's outstanding common stock on January 13, 1997. The action now purports to represent a class of persons who purchased shares of HMI common stock between April 26, 1996 and March 17, 1997, the date HMI announced that it would have to restate certain of its financial statements and that it was renegotiating its deal with the Company. The action seeks unspecified compensatory damages for the harm sustained as a result of the alleged wrongdoing. On November 19, 1997, HMI and the individual defendants filed a motion to dismiss the claims against them for failure to state proper claims for relief. The Company made a similar motion on November 24, 1997. The plaintiffs responded to this motion on February 20, 1998 and the defendants served a reply brief on March 30, 1998. Oral argument on this motion was held on November 13, 1998. The court denied defendants' motion to dismiss on November 13, 1998 and directed the parties to mediate in an attempt to settle the action. Defendants served their answer to the amended complaint on January 13, 1999. Following mediation, a memorandum of understanding, dated March 16, 1999, setting forth the terms of the settlement of this action, was executed by the plaintiffs, and the Company, W. James Nicol, Paul S. Jurewicz and James Mieszala, and HMI (the "HMI Defendants") and National Union Fire Insurance Company of Pittsburgh, Pennsylvania ("National"). On June 23, 1999, an Agreement of Partial Settlement was executed that implemented the terms of the memorandum of understanding. The total settlement amount to be paid by the HMI Defendants is $2,375. It has been agreed that $275 of the settlement amount will be paid directly by the Company, with the remainder to be covered by National and the Company's directors' and officers' insurance policy carrier. On July 26, 1999, the plaintiffs and BDO Siedman LLP entered into a preliminary agreement to settle the claims against BDO Siedman LLP for $100. All parties will enter into an amended stipulation of settlement that will be presented to the court. The terms of the proposed settlement is subject to court approval. On July 16, 1999, all parties appeared before the court to discuss the proposed settlement. At that time, the court certified the class of plaintiffs to include all persons or entities who purchased or otherwise acquired the common stock of HMI between April 26, 1996 and March 17, 1997 inclusive, except the defendants and related parties. Page 12 TRANSWORLD HEALTHCARE, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont.) (In thousands, except per share data) (Unaudited) Note 6: Commitments and Contingencies (cont.) On July 2, 1998, a former shareholder of HMI purporting to sue on behalf of a class of shareholders of HMI as of June 6, 1997, commenced a suit in the Delaware Chancery Court, New Castle County, entitled Kathleen S. O'Reilly v. Transworld HealthCare, Inc., W. James Nicol, Andre C. Dimitriadis, Dr. Timothy J. Triche and D. Mark Weinberg, Civil Action No. 16507-NC. The suit alleges that the Company, as majority shareholder of HMI, and the then-directors of HMI, breached fiduciary duties to the minority shareholders of HMI by approving a merger between HMI and a subsidiary of the Company for allegedly inadequate consideration. The suit seeks an accounting, damages, attorney's fees and other expenses, all in unspecified amounts. The defendants filed a motion to dismiss this action on September 18, 1998. The plaintiffs filed a response to this motion on November 6, 1998. The defendants filed a reply brief on December 23, 1998. Oral argument on the motion occurred on April 6, 1999 and, to date, the court has not issued a decision. Under HMI's Certificate of Incorporation and Bylaws, certain officers and directors may be entitled to indemnification, or advancement of expenses for legal fees in connection with the above lawsuits. HMI may be required to make payments in respect thereof in the future. HMI has been named as a defendant in a lawsuit filed on November 25, 1997 in the Chancery Court of the State of Delaware for New Castle County entitled Clifford E. Hotte v. Health Management, Inc., CA No. 16060NC. The plaintiff in that action is seeking reimbursement and advancement of legal fees and expenses in the amount of $1,000. HMI filed its answer to that suit on December 23, 1997. The plaintiff in the suit subsequently moved for partial summary judgment seeking advancements of fees in the amount of $824; the court granted that motion on March 18, 1998, and granted a preliminary injunction directing HMI to make that payment by March 20, 1998. On March 20, 1998 HMI informed the court that it had no unencumbered assets from which to make such a payment. On April 3, 1998, the court appointed a receiver for HMI to determine if HMI is capable of complying with that order. In addition, a former director of HMI through her attorneys had demanded advancement of legal fees and expenses in the amount of $150, and two officers of HMI also have demanded an advancement of an unspecified amount of additional legal fees and expenses. The enforcement division of the Securities and Exchange Commission (the "Commission") has issued a formal order of investigation relating to matters arising out of HMI's public announcement on February 27, 1996 that HMI would have to restate its financial statements for prior periods as a result of certain accounting irregularities. HMI is fully cooperating with this investigation and has responded to the requests of the Commission for documentary evidence. Page 13 TRANSWORLD HEALTHCARE, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont.) (In thousands, except per share data) (Unaudited) Note 6: Commitments and Contingencies (cont.) The outcomes of certain of the foregoing lawsuits and the investigation with respect to HMI are uncertain and the ultimate outcomes could have a material adverse affect on the Company. The Company is involved in various other legal proceedings and claims incidental to its normal business activities. The Company is vigorously defending its position in all such proceedings. Management believes these matters should not have a material adverse impact on the financial condition, cash flows or results of operations of the Company. Page 14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations THREE MONTHS ENDED JUNE 30, 1999 VS. THREE MONTHS ENDED JUNE 30, 1998 Revenues. Total revenues decreased by $2,327,000 or 5.8% to $37,534,000 for the three months ended June 30, 1999 from $39,861,000 for the three months ended June 30, 1998. This decrease was primarily attributable to declines in revenue experienced by the U.S. specialty mail-order pharmacy operation ($4,646,000) and the sale in July 1998 of the Company's Transworld Home Healthcare Nursing Division, Inc. ("TNI") subsidiary ($2,433,000). Partly offsetting the decrease from the U.S. Operations was a favorable variance ($5,200,000) from the Company's United Kingdom (U.K.) nursing operations as a result of continued expansion, increased billing rates and core business growth. Cost of Revenues. Cost of revenues decreased by $600,000 to $24,183,000 for the three months ended June 30, 1999 from $24,783,000 for the three months ended June 30, 1998. As a percentage of total revenues, cost of revenues for the three months ended June 30, 1999 increased to 64.4% in comparison to 62.2% for the three months ended June 30, 1998. Cost of revenues as a percentage of revenues increased for infusion services (76.7% for the three months ended June 30, 1999 versus 70.6% for the prior period), increased for respiratory, medical equipment and supplies sales operations (58.1% for the three months ended June 30, 1999 versus 54.9% for the prior period) and decreased for patient services (67.7% for the three months ended June 30, 1999 versus 69.2% in the prior period). The increase in respiratory, medical equipment and sales operations is attributable to patients selecting higher cost products rather than generically equivalent products in the Company's specialty mail-order pharmacy operation. The increase in infusion services is due to an increase in therapies with higher product costs. The decline in patient services resulted primarily from increased billing rates. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $3,459,000 or 26.3% to $16,611,000 for the three months ended June 30, 1999 from $13,152,000 for the three months ended June 30, 1998. This increase was due to additional bad debt expense ($3,655,000) principally as a result of fully reserving for DermaQuest, Inc.'s accounts receivables based on more current information. In addition, there was higher levels of overhead in the U.K. Operations due to its continued expansion ($1,289,000), offset by reductions of $1,034,000 resulting from a restructuring of the Company's U.S. specialty mail-order pharmacy operations. The sale of TNI also reduced selling, general and administrative expenses by $578,000. Special Charges. During the three months ended June 30, 1999, the Company incurred $2,030,000 of special charges primarily as a result of attempted acquisitions and additional legal reserves. Page 15 Results of Operations (cont.) Operating (Loss) Income. The Company incurred an operating loss of $5,290,000 for the three months ended June 30, 1999 compared to operating income of $1,926,000 for the three months ended June 30, 1998. Excluding the $2,030,000 of special charges and $3,655,000 of additional bad debt expenses, the Company would have recorded operating income of $395,000. Interest Income. Interest income decreased by $107,000 to $49,000 for the three months ended June 30, 1999 from $156,000 for the three months ended June 30, 1998. This decrease was attributable to lower interest income earned on a lower level of funds invested. Interest Expense. Interest expense decreased by $253,000 to $1,287,000 for the three months ended June 30, 1999 from $1,540,000 for the three months ended June 30, 1998. This favorable variance was primarily attributable to a lower level of borrowings under the Company's senior secured revolving credit facility (the "Credit Facility") combined with a reduced borrowing rate. (Benefit)Provision for Income Taxes. The Company recorded a benefit from income taxes amounting to $2,061,000 for the three months ended June 30, 1999 versus a provision of $271,000 in the comparable prior period. The change from the prior year is attributable to the Company being in a taxable income position last year versus a taxable loss position in the current year. Management expects that it is more likely than not that future levels of income will be sufficient to realize the deferred tax assets, as recorded. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. Net Loss (Income). As a result of the foregoing, the Company incurred a net loss of $4,467,000 for the three months ended June 30, 1999 compared to net income of $271,000 for the three months ended June 30, 1998. NINE MONTHS ENDED JUNE 30, 1999 VS. NINE MONTHS ENDED JUNE 30, 1998 Revenues. Total revenues increased by $1,550,000 or 1.3% to $116,539,000 for the nine months ended June 30, 1999 from $114,989,000 for the nine months ended June 30, 1998. This increase was primarily attributable to the Company's U.K. Operations, specifically, nursing ($14,043,000) and respiratory, medical equipment and supplies sales ($264,000). The U.K. Operations increased principally due to continued expansion, increased billing rates and core business growth. These increases were partly offset by decreases in the Company's U.S. respiratory, medical equipment and supplies sales operations ($4,481,000) and infusion services ($919,000) primarily attributable to a reduction in the number of patients serviced and the incremental impact of the Balanced Budget Act of 1997 ("the Balanced Budget Act"), which reduced revenue $611,000. In addition, the increase in revenue was also offset by the sale of TNI ($7,350,000). Page 16 Results of Operations (cont.) Pursuant to the passage of the Balanced Budget Act, a 10% reduction in Medicare reimbursement of diabetic testing strips and a 5% reduction in Medicare reimbursement of respiratory drugs became effective January 1, 1998. These reductions reduced revenue, increased cost of revenues as a percentage of revenues and decreased gross profit for respiratory, medical equipment and supplies sales effective with the reimbursement reduction (as discussed herein). Cost of Revenues. Cost of revenues increased by $2,104,000 to $74,511,000 for the nine months ended June 30, 1999 from $72,407,000 for the nine months ended June 30, 1998. As a percentage of total revenues, cost of revenues for the nine months ended June 30, 1999 increased to 63.9% in comparison to 63.0% for the nine months ended June 30, 1998. Cost of revenues as a percentage of revenues increased for infusion services (77.9% for the nine months ended June 30, 1999 versus 69.6% for the nine months ended June 30, 1998) increased for respiratory, medical equipment and supplies sales operations (57.1% for the nine months ended June 30, 1999 versus 56.1% for the nine months ended June 30, 1998) and declined for patient services (68.3% for the nine months ended June 30, 1999 versus 69.4% for the nine months ended June 30, 1998). The increase in infusion services and respiratory, medical equipment and supplies sales operations is due to an increase in therapies and respiratory sales in the U.S. Operations with higher product costs. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $5,908,000 or 15.7% to $43,570,000 for the nine months ended June 30, 1999 from $37,662,000 for the nine months ended June 30, 1998. This increase was due to additional bad debt expense ($3,655,000) principally as a result of fully reserving for DermaQuest, Inc.'s accounts receivables based on more current information. In addition, there was higher levels of overhead in the U.K. Operations ($2,865,000) due to its continued expansion and the U.S. specialty mail-order pharmacy operations incurred additional costs for overhead related to sales and collection efforts in the U.S. operations during the first half of fiscal 1999 ($1,942,000). These increases were offset by an overhead reduction program in the specialty mail-order pharmacy operations ($1,297,000). The sale of TNI accounted for an additional cost savings of $1,797,000. Special Charges. During the three months ended June 30, 1999, the Company incurred $2,030,000 of special charges primarily as a result of attempted acquisitions and additional legal reserves. During the nine months ended June 30, 1998, the Company incurred $554,000 of special charges primarily relating to costs incurred from its attempted acquisitions of Healthcall Group plc and Apria Healthcare Group, Inc. Operating (Loss) Income. The Company incurred an operating loss of $3,572,000 for the nine months ended June 30, 1999 compared to operating income of $4,366,000 for the nine months ended June 30, 1998. Excluding the $2,030,000 of special charges and $3,655,000 of additional bad debt expenses, the Company would have recorded operating income of $2,113,000. Page 17 Results of Operations (cont.) Interest Income. Interest income decreased by $307,000 to $191,000 for the nine months ended June 30, 1999 from $498,000 for the nine months ended June 30, 1998. This decrease was attributable to lower interest income earned on a lower level of funds invested. Interest Expense. Interest expense decreased by $802,000 to $4,016,000 for the nine months ended June 30, 1999 from $4,818,000 for the nine months ended June 30, 1998. This favorable variance was primarily attributable to a lower level of borrowings under the Company's Credit Facility combined with a reduced borrowing rate. (Benefit) Provision for Income Taxes. The Company recorded a benefit for income taxes amounting to $1,980,000 for the nine months ended June 30, 1999 versus a tax provision of $23,000 in the comparable prior period. The change from the prior year is attributable to the Company being in a taxable income position last year versus a taxable loss position in the current year. Management expects that it is more likely than not that future levels of income will be sufficient to realize the deferred tax assets, as recorded. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. Net Loss (Income). As a result of the foregoing, the Company incurred a net loss of $5,417,000 for the nine months ended June 30, 1999 compared to net income of $23,000 for the nine months ended June 30, 1998. Page 18 Liquidity and Capital Resources During the nine months ended June 30, 1999 the Company generated $3,318,000 from its operating activities. Cash flow from operating activities, combined with the use of existing cash, funded a $1,500,000 payment to further reduce the Company's Credit Facility and the following investing activities: $3,212,000 for further expansion of the Company's U. K. Operations and $2,007,000 for capital expenditures. Healthcare Reimbursement. Political, economic and regulatory influences are resulting in fundamental changes in the healthcare industry in the U.S. The Company anticipates that Congress and state legislatures will continue to review and assess alternative healthcare delivery systems and payment methods. Sales of a large portion of the Company's products depend to a significant extent on the availability of reimbursement to the Company's customers by government and private insurance plans. Effective October 1, 1998, new Medicare reimbursement guidelines generally provide that quarterly orders of diabetic supplies to existing customers must be administratively verified before shipment and that all doctors orders for diabetic supplies are valid for a period of nine months. In addition, the new regulations require that Type I Medicare diabetic customers who test more frequently than three times per day or Type II Medicare diabetic customers who test more frequently than one time per day visit their physician every nine months and maintain a thirty day log book for compliance. Management believes that the increased administrative burden created by these new regulations has resulted in increased operating expenses at its U.S. specialty mail-order pharmacy operations. Accounts Receivable. The Company maintains a cash management program that focuses on the reimbursement function, as growth in accounts receivable has been the main operating use of cash historically. At June 30, 1999 and September 30, 1998, $30,679,000 (18.0%) and $32,223,000 (17.9%), respectively, of the Company's total assets consisted of accounts receivable. The accounts receivable are substantially due from third-party payors which generally require substantial documentation in order to process claims. The collection time for accounts receivable is typically the longest for services that relate to new patients or additional services requiring medical review for existing patients. Management's goal is to maintain accounts receivable levels equal to or less than industry average, which would tend to mitigate the risk of recurrence of negative cash flows from operations by reducing the required investment in accounts receivable and thereby increasing cash flows from operations. Days sales outstanding ("DSOs") is a measure of the average number of days taken by the Company to collect its accounts receivable, calculated from the date services are rendered. At June 30, 1999 and September 30, 1998, the Company's average DSOs were 74 and 72, respectively. Page 19 Liquidity and Capital Resources (cont.) Credit Facility. Loans under the Company's senior secured revolving Credit Facility are collateralized by, among other things, a lien on substantially all of the Company's and its subsidiaries' assets, a pledge of the Company's ownership interest in its subsidiaries and guaranties by the Company's subsidiaries. The Credit Facility provides that subject to the terms thereof, the Company may make borrowings either at the Base Rate (as defined in the Credit Facility), plus 1% or the Eurodollar Rate, plus 2%. As of June 30, 1999 and August 1, 1999, Eurodollar Rate borrowings bore interest at rates of 6.94% to 7.06% and 7.19% to 7.25%, respectively. During the nine months ended June 30, 1999, the Company reduced its borrowings under the Credit Facility by $1,500,000 and amended the Credit Facility to allow for further expansions of its U.K. Operations. As of August 1, 1999, the Company had $55,755,000 outstanding under the Credit Facility and the unused portion of the Credit Facility was $23,645,000. Additional loans to the Company will require the approval of the required lenders in accordance with the terms of the Credit Facility. Subject to certain exceptions, the Credit Facility prohibits or restricts, among other things, the incurrence of liens, the incurrence of indebtedness, certain fundamental corporate changes, dividends, the making of specified investments and certain transactions with affiliates. In addition, the Credit Facility contains affirmative and negative financial covenants customarily found in agreements of this kind, including the maintenance of certain financial ratios, such as interest coverage, debt to earnings before interest, taxes, depreciation and amortization ("EBITDA") and minimum EBITDA. As of June 30, 1999 the Company was in technical default of the Credit Facility due to non-compliance with certain financial covenants (debt to EBITDA, interest coverage and minimum EBITDA). As a result of this default the Credit Facility has been reclassified as current as of June 30, 1999. The Company is in active discussions with the bank group regarding waiver of the existing default, which the bank group has expressed its interest in accommodating. In addition, the Company is currently seeking alternative financing but there can be no assurance that any such financing will be available to the Company, or if available, will be on terms acceptable to the Company. If alternative financing is not available and the Company is unable to secure necessary amendments to waive the defaults described above it could have a material adverse effect on the cash flows and financial position of the Company. Excluding any repayment of the Credit Facility, the Company believes it has adequate capital resources to conduct its operations for the next twelve months. Year 2000. The Year 2000 computer issue refers to potential conditions in computer programs whereby a two-digit field rather than a four-digit field is used to define the applicable year. Unless corrected, some computer programs may be unable to appropriately function on January 1, 2000 because these programs will read the "00" in the year 2000 as Page 20 Liquidity and Capital Resources (cont.) January 1, 1900. If uncorrected, the problem could result in computer system failures or equipment and medical device malfunctions (affecting patient diagnosis and treatment) thereby disrupting the Company's business operations and subjecting the Company to potentially significant legal liabilities. During the early part of 1998, the Company formed a task force consisting of members of senior management, in-house legal counsel, representatives from each of the Company's operating subsidiaries (in both the U.S. and the U.K.), and other Company personnel. The task force also consults with the Company's insurance carrier and risk management advisors. The task force developed an action plan to address the potential problems of the Year 2000, which considered the following critical phases: (i) the Company's state of readiness; (ii) risks of the Company's Year 2000 issues; (iii) costs to address Year 2000 compliance; and (iv) the Company's contingency plans. Company's State of Readiness. The information technology ("IT") and IT infrastructure portions of the Company's Year 2000 project, address the inventory, assessment, necessary corrective actions, testing and implementation of external vendor products, mission critical third-party software and internally developed software. In that regard, the Company believes it has identified (in both the U.S. and the U.K.), the various software applications that may be potentially impacted. The Company has completed an assessment of all IT related components and the Company anticipates, in most respects, remediation of external vendor products, mission critical third-party software and internally developed software to be completed by September 30, 1999. The Company also believes that by September 30, 1999, implementation and testing of all remediation will be completed. With respect to the non-IT portion of the Company's Year 2000 project, the Company has undertaken a program to inventory, assess and correct or replace (where necessary) impacted mission critical as well as non-mission critical vendor and supplier products (including but not limited to drugs, medical supplies and specialty mail-order pharmaceutical products), medical equipment, telephone systems, postage machines and other related equipment with Year 2000 risk. These types of supplies and equipment play a vital role in the day to day operations of the Company. The Company is in the process (in both the U.S. and the U.K.) of contacting vendors and suppliers, analyzing and acting upon information provided to replace or otherwise amend any devices or equipment that pose a Year 2000 impact. The Company is prioritizing its non-IT efforts by allocating resources to equipment and medical devices that will have a direct impact on patient safety and health with a goal of minimizing and/or eliminating the associated risks. The Company recognizes, to a certain degree, that it is relying upon information that is being provided by equipment and medical device manufacturers regarding the Year 2000 status of their respective products. While the Company is attempting to evaluate information provided by its present vendors and suppliers, there can be no assurance that in all instances accurate information is being provided. The Company has completed an assessment of potentially non-IT affected components and the Company Page 21 Liquidity and Capital Resources (cont.) anticipates completing, in most respects, any required corrective actions by September 30, 1999. The Company also expects that by September 30, 1999 implementation and testing of all remediation will be completed. Risks of the Company's Year 2000 Issues. Failure from any of the aforementioned IT and/or non-IT equipment and components, including the support from third parties, could have a material adverse impact on the Company's operations (in both the U.S. and the U.K.) resulting in the potential inability to provide health care services to its patients. This inability could result in the loss of revenue (which at the present time is unable to be quantified) and give rise to litigation. In addition, the Company relies heavily upon third-party payors, including to a large extent governmental payors such as Medicare and Medicaid in the U.S. and the National Health Service in the U.K. for accurate and timely reimbursement of claims, often through the use of electronic data interfaces. Although much has been published publicly stating that the government is working to solve its own Year 2000 issues in a timely manner, the Company has received no assurance that their systems and interfaces will be converted timely. Failure of any of the Company's third-party payors, especially governmental payors, to solve their Year 2000 issues could have a material adverse effect on the Company's financial condition, cash flows, and results of operations. Costs to Address Year 2000 Compliance. As of August 1, 1999 costs incurred for all efforts of the Company's Year 2000 action plan amount to $159,000 and have not been material to the Company. These costs have been expensed as incurred and have been funded by operating cash flows. The remaining cost of the Year 2000 project is expected to be approximately $64,000 and is based upon the best estimates from the Company's management and the Year 2000 task force. This cost will also be expensed as incurred and be funded by operating cash flows. These estimates as well as anticipated completion dates were derived by consideration of availability of resources, utilizing assumptions and relying upon third party representations. However, there can be no assurances that these estimates will be achieved and actual results could be materially different. The Company's Contingency Plans. Each operating subsidiary (both in the U.S. and the U.K.) has been asked to develop a contingency plan to restore the material functions of each of its systems or activities in the case of a Year 2000 failure. The respective subsidiaries are in the process of completing these plans and will make them more comprehensive, as additional information becomes available through testing and external sources. There can be no assurance that the Company will be able to complete all of the modifications in the required time frame, that unanticipated events will not occur or that the Company will be able to identify all Year 2000 issues before problems arise. In addition, the Company has no assurance that third-party payors and vendors will have the ability to identify Page 22 Liquidity and Capital Resources (cont.) and solve all or substantially all their Year 2000 issues. Therefore, there can be no assurance that the Year 2000 issue will not have a material adverse effect on the Company's financial position, cash flows and results of operations. Litigation. On February 4, 1997, Patient Care Systems, Inc. ("PCS") filed a lawsuit against DermaQuest Surgical Supply, Inc. ("Dermaquest") and Transworld HealthCare, Inc. in the Court of Common Pleas of Chester County, Pennsylvania, for breach of contract, conversion, unjust enrichment and misrepresentation. Subsequently, PCS withdrew all claims except for its breach of contract claim. On April 22, 1997, Dermaquest filed a counterclaim against PCS for breach of contract. The action related to a contract initially entered into between Dermaquest and PCS to market alternating pressure mattresses. A jury trial in this matter began on June 28, 1999. On July 2, 1999, the jury reached their verdict finding in favor of PCS on its breach of contract claim in the amount of $825,000 and finding in favor of Dermaquest on its breach of contract counterclaim in the amount of $58,000. Dermaquest and the Company have filed post-trial motions seeking a new trial or a reduction in the verdict from $825,000 to $168,000. Under Pennsylvania law, PCS cannot execute on a jury verdict until it is reduced to a judgement. Further, in Pennsylvania, no judgement will be entered on a jury's verdict until the disposition of any post-trial motions. Oral argument on Dermaquest and the Company's post-trial motions is scheduled for October 6, 1999. Management of the Company intends to continue to defend the proceedings vigorously and believes the ultimate outcome will not have a material adverse effect on the Company's results of operations or financial position. On April 13, 1998, a shareholder of the Company, purporting to sue derivatively on behalf of the Company, commenced a derivative suit in the Supreme Court of the State of New York, County of New York, entitled Kevin Mak, derivatively and on behalf of Transworld Healthcare, Inc., Plaintiff, vs. Timothy Aitken, Scott A. Shay, Lewis S. Ranieri, Wayne Palladino and Hyperion Partners II L.P., Defendants, and Transworld Healthcare, Inc., Nominal Defendant, Index No. 98-106401. The suit alleges that certain officers and directors of the Company, and Hyperion Partners II L.P. ("HPII"), breached fiduciary duties to the Company and its shareholders, in connection with a transaction, approved by a vote of the Company's shareholders on March 17, 1998, in which the Company was to issue certain shares of stock to HPII in exchange for certain of HMI's trade payables. The action seeks injunctive relief against this transaction, and damages, costs and attorneys' fees in unspecified amounts. The transaction subsequently closed and the plaintiff has, on numerous occasions, stipulated to extend the defendants' time to respond to this suit. The most recent stipulation provides for an extension to September 30, 1999. Page 23 Liquidity and Capital Resources (cont.) On July 11 and July 22, 1997, the Company's RespiFlow, Inc. ("RespiFlow") and MK Diabetic Support Services, Inc. ("MK") subsidiaries, respectively, each received a letter (the "Audit Letters") from the Office of Audit Services (a division of the U.S. Department of Health and Human Services, Office of Inspector General) ("OIG"). The Audit Letters indicate, among other things, that the OIG is conducting an industry-wide audit of marketing fees and commissions paid from pharmacies to home medical equipment companies. The Company has been informed that the audit has been extended to cover the Company's DermaQuest, Inc. subsidiary. The Company is cooperating fully with the OIG and has produced documentation which it believes is responsive to the requests set forth in the Audit Letters. While the Company believes that its former arrangements with home medical equipment suppliers do not violate any Federal or state laws, it cannot predict whether the audit will ultimately result in any liability to the government and in such event, the amount thereof. There can be no assurance that such amount, if any, will not have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows. On November 19, 1997, the Company was notified by the Office of the United States Attorney for the Eastern District of Texas that it, RespiFlow, MK, and other non-affiliated entities had been named defendants in a qui tam action under the Federal False Claims Act. The qui tam action was filed under seal in the United States District Court, and it will remain under seal while the government evaluates the merits of the lawsuit and decides whether to intervene in and take over the conduct of the litigation. The government has not made a copy of the sealed complaint available to the Company; however, the Company has been informed that no individuals associated with it or its affiliates have been named as defendants. The Company further understands that the issues raised in the lawsuit involve payments to durable medical equipment dealers who acted as the Company's marketing representatives. The Company cannot predict whether the Federal government will intervene in this action or whether the outcome of this action will have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows. During the normal course of business the Company continues to carefully monitor and review its submission of Medicare, Medicaid and all other claims for reimbursement. The Company believes that it is substantially in compliance, in all material respects, with the applicable provisions of the Federal statutes, regulations and laws and applicable state laws. Because of the broad and sometimes vague nature of these laws, there can be no assurance that an enforcement action will not be brought against the Company, or that the Company will not be found to be in violation of one or more of these provisions. At present, the Company cannot anticipate what impact, if any, subsequent administrative or judicial interpretation of the applicable Federal and state laws may have on the Company's consolidated financial position, results of operations or cash flows. Effective October 1, 1997, HMI became a wholly-owned subsidiary of the Company. Page 24 Liquidity and Capital Resources (cont.) HMI and certain of its current and former officers have been named as defendants in an alleged class action lawsuit filed on April 3, 1997 in the United States District court for the Eastern District of New York formerly entitled Nicholas Volonnino et al. v. Health Management, Inc., W. James Nicol, Paul S. Jurewicz and James Mieszala, 97 Civ. 1646. The action was amended on September 12, 1997, and is now entitled Dennis Baker et al. v. Health Management, Inc., BDO Seidman, LLP, Transworld Healthcare, Inc., W. James Nicol, Paul S. Jurewicz and James Mieszala. This action alleges claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, arising out of misrepresentations and omissions by HMI in connection with certain of its previous securities filings and press releases. The Company is being sued as an alleged control person of HMI, based upon its acquisition of 49% of HMI's outstanding common stock on January 13, 1997. The action now purports to represent a class of persons who purchased shares of HMI common stock between April 26, 1996 and March 17, 1997, the date HMI announced that it would have to restate certain of its financial statements and that it was renegotiating its deal with the Company. The action seeks unspecified compensatory damages for the harm sustained as a result of the alleged wrongdoing. On November 19, 1997, HMI and the individual defendants filed a motion to dismiss the claims against them for failure to state proper claims for relief. The Company made a similar motion on November 24, 1997. The plaintiffs responded to this motion on February 20, 1998 and the defendants served a reply brief on March 30, 1998. Oral argument on this motion was held on November 13, 1998. The court denied defendant's motion to dismiss on November 13, 1998 and directed the parties to mediate in an attempt to settle the action. Defendants served their answer to the amended complaint on January 13, 1999. Following mediation, a memorandum of understanding, dated March 16, 1999, setting forth the terms of the settlement of this action, was executed by the plaintiffs, and the Company, W. James Nicol, Paul S. Jurewicz and James Mieszala, and HMI (the "HMI Defendants") and National Union Fire Insurance Company of Pittsburgh, Pennsylvania ("National"). On June 23, 1999, an Agreement of Partial Settlement was executed that implemented the terms of the memorandum of understanding. The total settlement amount to be paid by the HMI Defendants is $2,375,000. It has been agreed that $275,000 of the settlement amount will be paid directly by the Company, with the remainder to be covered by National and the Company's directors' and officers' insurance policy carrier. On July 26, 1999, the plaintiffs and BDO Siedman LLP entered into a preliminary agreement to settle the claims against BDO Siedman LLP for $100,000. All parties will enter into an amended stipulation of settlement that will be presented to the court. The terms of the proposed settlement is subject to court approval. On July 16, 1999, all parties appeared before the court to discuss the proposed settlement. At that time, the court certified the class of plaintiffs to include all persons or entities who purchased or otherwise acquired the common stock of HMI between April 26, 1996 and March 17, 1997 inclusive, except the defendants and related parties. On July 2, 1998, a former shareholder of HMI purporting to sue on behalf of a class of shareholders of HMI as of June 6, 1997, commenced a suit in the Delaware Chancery Court, New Castle County, entitled Kathleen S. O'Reilly v. Transworld HealthCare, Inc., W. James Page 25 Liquidity and Capital Resources (cont.) Nicol, Andre C. Dimitriadis, Dr. Timothy J. Triche and D. Mark Weinberg, Civil Action No. 16507-NC. The suit alleges that the Company, as majority shareholder of HMI, and the then-directors of HMI, breached fiduciary duties to the minority shareholders of HMI by approving a merger between HMI and a subsidiary of the Company for allegedly inadequate consideration. The suit seeks an accounting, damages, attorney's fees and other expenses, all in unspecified amounts. The defendants filed a motion to dismiss this action on September 18, 1998. The plaintiffs filed a response to this motion on November 6, 1998. The defendants filed a reply brief on December 23, 1998. Oral argument on the motion occurred on April 6, 1999 and, to date, the court has not issued a decision. Under HMI's Certificate of Incorporation and Bylaws, certain officers and directors may be entitled to indemnification, or advancement of expenses for legal fees in connection with the above lawsuits. HMI may be required to make payments in respect thereof in the future. HMI has been named as a defendant in a lawsuit filed on November 25, 1997 in the Chancery Court of the State of Delaware for New Castle County entitled Clifford E. Hotte v. Health Management, Inc., CA No. 16060NC. The plaintiff in that action is seeking reimbursement and advancement of legal fees and expenses in the amount of $1,000,000. HMI filed its answer to that suit on December 23, 1997. The plaintiff in the suit subsequently moved for partial summary judgment seeking advancements of fees in the amount of $824,000; the court granted that motion on March 18, 1998, and granted a preliminary injunction directing HMI to make that payment by March 20, 1998. On March 20, 1998 HMI informed the court that it had no unencumbered assets from which to make such a payment. On April 3, 1998, the court appointed a receiver for HMI to determine if HMI is capable of complying with that order. In addition, a former director of HMI through her attorneys had demanded advancement of legal fees and expenses in the amount of $150,000, and two officers of HMI also have demanded an advancement of an unspecified amount of additional legal fees and expenses. The enforcement division of the Securities and Exchange Commission (the "Commission") has issued a formal order of investigation relating to matters arising out of HMI's public announcement on February 27, 1996 that HMI would have to restate its financial statements for prior periods as a result of certain accounting irregularities. HMI is fully cooperating with this investigation and has responded to the requests of the Commission for documentary evidence. The outcomes of certain of the foregoing lawsuits and the investigation with respect to HMI are uncertain and the ultimate outcomes could have a material adverse affect on the Company. The Company is involved in various other legal proceedings and claims incidental to its normal business activities. The Company is vigorously defending its position in all such proceedings. Management believes these matters should not have a material adverse impact on the financial condition, cash flows or results of operations of the Company. Page 26 PART II Item 3. Defaults Upon Senior Securities At June 30, 1999, the Company was in technical default of its Credit Facility due to non-compliance with certain financial covenants. The Company is in active discussions with the bank group regarding waiver of the existing default, which the bank group has expressed its interest in accommodating. As a result of this default, the Credit Facility was classified as current at June 30, 1999. The Company is currently seeking alternative financing but there can be no assurance that any such financing will be available to the Company, or if available, will be on terms acceptable to the Company. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. 27 Financial Data Schedule (b) Reports on Form 8-K. None. Page 27 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. Dated: August 13, 1999 TRANSWORLD HEALTHCARE, INC. By: /s/ Wayne A. Palladino ----------------------------------------- Wayne A. Palladino Senior Vice President and Chief Financial Officer (Principal Financial Officer and Duly Authorized to Sign on Behalf of Registrant) Page 28 EXHIBIT INDEX Exhibit Description 27 Financial Data Schedule Page 29 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS SEP-30-1999 APR-01-1999 JUN-30-1999 6,565 0 49,046 18,367 3,099 53,017 19,905 10,185 170,597 80,215 0 0 0 176 88,532 170,597 37,534 37,534 24,183 24,183 18,641 0 1,238 (6,528) (2,061) (4,467) 0 0 0 (4,467) (.25) (.25)
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