- ------------------------------------------------------------------------------ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 1998. Commission file number: 0-11895 KUALA HEALTHCARE, INC. Formerly named Continental Health Affiliates, Inc. (Exact name of registrant as specified in its charter) Delaware 22-2362097 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 910 Sylvan Avenue Englewood Cliffs, N.J. 07632 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (201) 567-4600 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.06 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 NO X --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of September 23, 1998 the aggregate market value of the voting stock held by non-affiliates of the registrant was $17,598,098. As of September 23, 1998, 3,409,732 shares of the registrant's common stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE: Portions of definitive proxy statement to be filed not later than October 29, 1998 - ------------------------------------------------------------------------------ TABLE OF CONTENTS Part I Page Item 1. Business................................................ 3 - 12 Item 2. Properties.............................................. 12 Item 3. Legal Proceedings....................................... 12 Item 4. Submission of Matters to a Vote of Security Holders..... 12 Part II Item 5. Market Information...................................... 13 Item 6. Selected Consolidated Financial Data.................... 14 Item 7. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations........... 15 - 19 Item 8. Consolidated Financial Statements and Supplementary Data 20 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.................... 20 Part III .............................................................. 21 Part IV Item 14. Exhibits, Consolidated Financial Statements, Financial Statement Schedules, and Reports on Form 8-K............ 22 Signatures ................................................................. Last Page PART I Item 1. Business. General Kuala Healthcare, Inc. ("KUAL") and, together with its subsidiaries, the ("Company") provides a variety of non-hospital based health care services to patients. These alternate-site health care services include long term care and residential health care facilities, home infusion therapy (including enteral and parenteral nutrition and intravenous therapies) and provision of medical products and services, including infusion therapy, to patients in long term care facilities. The Company has also commenced development of three assisted living projects in New Jersey totaling 320 units. It is focused on developing, acquiring and operating assisted living facilities and other forms of senior housing primarily in the northeastern United States, and possibly in some mid-Atlantic and southeastern states. The Company is in the process of disposing of at least some of the assets it has been using in its historical businesses, including some or all of its skilled nursing facilities and, possibly some or all of its stock of Infu-Tech, Inc., a 58% owned publicly traded company through which the Company conducts its home infusion therapy and related businesses. It will use the net proceeds of these asset sales (after payment of related debt) to develop and acquire assisted living facilities. On January 27, 1998, the Company effected a one-for-three reverse split of its common stock. In conjunction with the reverse split, the Company (formerly known as Continental Health Affiliates, Inc.) changed its name to Kuala Healthcare, Inc. Its common stock is listed on the Nasdaq Small Cap Market under the symbol "KUAL". Effective August 10, 1998 the Board of Governors of the Federal Reserve System has included KUAL common stock as qualifying for margin status. Common share and per share amounts in the financial statements reflect the impact of the reverse stock split in all periods. In November 1995, the Company changed its fiscal year to end on June 30 of each year from December 31. Therefore, unless otherwise noted, references to a year are to the fiscal year ending June 30. New Developments In December 1997, the Company acquired a 75% interest in a limited liability company (L.L.C.) to provide institutional pharmacy services. The minority interest is held by Bach's Drug Store, a New Jersey Corporation ("Bach's"), based in Hackettstown, which contributed its existing business to the L.L.C.. The Company paid $210,000 in common stock to a principal of Bach's in consideration for (a) the 75% interest in the L.L.C., (b) a four-year employment agreement (at $120,000/year) with the pharmacist of Bach's (the manager of the L.L.C.) and (c) a four-year lease with the shareholders of Bach's to lease the premises (at $18,000/year) where the L.L.C. operates. The Company has guaranteed the employment and lease agreements. In September 1998, the Company signed a non-binding letter of intent with Care One, L.L.C., a privately held New Jersey based long term care company, to sell Care One a 49% stake in its five nursing homes (with an option to purchase the other 51%) and a 100% interest in the Company's institutional pharmacy business. Furthermore an assisted living joint venture will be formed with the Company initially contributing its 120 unit project based in Norwood, New Jersey. The Company would receive approximately $15 million in cash for its 49% stake in its nursing homes and the 3 Company's institutional pharmacy business. The Company would also receive $2 million for the 49% stake in the assisted living venture with Care One L.L.C.. Nursing Homes As of June 30, 1998, the Company was operating or managing five nursing homes with approximately 800 beds. Typically, the Company provides lodging, meals and nursing assistance to residents of its nursing homes for a per diem charge and provides limited additional treatment for additional charges. The following table provides information about the nursing homes the Company was operating (as owner or as lessee) or managing as of July 1, 1998. Average Occupancy Percentage Years Ended June 30, Number -------------------------- Location of Beds 1996 1997 1998 -------- ------- ---- ---- ---- Nursing Homes Being Operated: Cedar Grove, NJ ................... 180 95% 91% 90% Cape May Courthouse, NJ ........... 116 97% 96% 97% Philadelphia, PA .................. 135 95% 93% 92% West Orange, NJ ................... 131 94% 93% 92% Nursing Homes Being Managed: Norwood, NJ (Heritage) Skilled ........................ 180 98% 94% 94% Residential Care ............... 66 100% 93% 100% As of June 30, 1998, the Company owned the nursing homes in Philadelphia, Cedar Grove, West Orange and the real property of the long term and residential care facility located in Norwood, New Jersey (the "Heritage Facility"). The Company leases the nursing home in Cape May Courthouse. The Company leases the Heritage Facility to Senior Care Foundation, Inc. ("SCF"), a not for profit corporation, for twenty-five years at a rental of $2.4 million per year. The Company manages the Heritage Facility and receives a management fee of 5% of the gross revenues of the Heritage Facility (after the payment of rent to the Company). The operations of Heritage are included in the consolidated financial statements from October 31, 1995, which was when the Company purchased the real property of the Heritage facility. Infusion Therapy and Other Medical Services The Company through Infu-Tech, provides infusion therapy (i.e., administration of nutrients, antibiotics and other medications either intravenously or through feeding tubes) and other medical products to patients in their homes, in Infu-Tech's ambulatory suites and in nursing homes. The Company was one of the early marketers of equipment and nutrients for infusion therapy and was one of the first to market equipment and formulations for intravenous infusion of nutrients and medication outside hospitals. Infu-Tech is organized into three units. The Intravenous Infusion Unit provides a broad range of home, ambulatory and subacute infusion therapy services, including intravenous total parenteral nutrition therapy, antibiotic therapy, enteral nutrition therapy, chemotherapy, chronic pain management therapy, hydration therapy and a variety of other therapies. The Contract Services Unit provides medical products and services, including enteral nutrition therapy, intravenous infusion therapy, 4 urological products and wound care products, to residents in long term care facilities. Infu-Tech's Disease Management Unit continues to focus on developing comprehensive preventive treatment programs for patients with chronic conditions, such as asthma, diabetes, congestive heart failure and sickle cell. Infu-Tech's sales and marketing efforts are primarily directed towards Managed Care. Infu- Tech has over 65 agreements with Managed Care companies covering over 19 million members to provide infusion therapy and other home health services. The agreements with Managed Care companies vary from preferred provider relationships to being one of several providers. Reimbursement is generally on a per diem basis. Infu-Tech's continued marketing efforts directed at managed care companies bring significant opportunity to drive new programs like Disease Management through existing relationships. In 1998, Infu-Tech renewed its non-exclusive distribution agreement with Genzyme Corporation for Ceredase(R) enzyme and Cerezyme(TM), which are the only products approved by the FDA as therapy for patients with Gaucher's disease. Genzyme estimates that there are between 2,000 and 2,500 Gaucher patients in the United States who require treatment with those drugs. Cost of the therapy normally ranges from approximately $150,000 to $250,000 per year per patient. The following table sets forth the percentages of Infu-Tech's revenues, by service unit, from the various therapies, products and services. Year ended Year ended Year ended June 30, 1996 June 30, 1997 June 30, 1998 --------------------------------- ---------------------------------- ---------------------------------- Intravenous Contract Total Intravenous Contract Total Intravenous Contract Total Infusion Services Revenues Infusion Services Revenues Infusion Services Revenues -------- -------- -------- -------- -------- -------- -------- -------- -------- Enteral Nutrition 3% 72% 20% 3% 71% 20% 4% 77% 19% Antibiotic 30% -- 23% 27% -- 20% 19% -- 15% TPN 7% -- 5% 5% -- 4% 6% -- 4% Orthotics -- 1% -- -- -- -- -- -- -- Immune Globulin 8% -- 6% 10% -- 7% 9% -- 7% Ceredase/Cerezyme 27% -- 20% 32% -- 24% 41% -- 33% Wound Care -- 2% 1% -- 1% -- -- -- -- Other 25% 25% 25% 23% 28% 25% 21% 23% 22% -------- -------- -------- -------- -------- -------- -------- -------- -------- 100% 100% 100% 100% 100% 100% 100% 100% 100% ======== ======== ======== ======== ======== ======== ======== ======== ======== Overview of the Home Health Care Industry One of the major factors contributing to the rapid growth of home health care has been the use of alternate site health care to contain the rising costs of health care. Consumers of all types, including governmental bodies, managed care organizations, insurance companies and private payors are recognizing the savings that can be realized by offering care in the home as opposed to institutional settings. In addition, an aging population and patients' preferences for receiving health care in the comfort of the home, combined with advances in medical technology making the delivery of sophisticated treatments in the home a reality, are all contributing to the continued growth of the home health care industry. Managed care organizations are becoming important players in the home health market and have exerted pricing pressure on the providers of home health care services. Such pressure has negatively impacted the profit margins of home health care producers. In addition, as the managed 5 care organizations continue to grow, they may show a preference to deal only with those home health care service providers who can offer a comprehensive range of services throughout such managed care organizations' area of operations. In response, what once was a very fragmented industry is undergoing a wave of consolidation. With the development of additional oral medications to replace medications that are administered intravenously, there has been a decrease in the demand for home infusion therapies. Providers of oral pharmaceuticals are servicing an increasing number of patients who previously required infusion therapies. Intravenous Infusion Therapy Intravenous infusion therapy principally involves the intravenous administration of nutrients, antibiotics or other medications to patients in their homes, in Infu-Tech ambulatory suites, or in Infu-Tech credentialed subacute facilities, often as a continuation of treatment initiated in the hospital. The national non-hospital infusion therapy market has grown to over $4 billion since its inception approximately 17 years ago. The Company believes the primary factors contributing to the rapid growth of the non-hospital infusion therapy market have been health care cost containment pressures, incentives by third party payors to use home care, rapid growth of the elderly population and increased acceptance of home infusion therapy by the medical community and patients. Additionally, the number of therapies that can be administered safely outside the hospital has increased significantly in recent years because of technological innovations such as more sophisticated portable infusion control devices, implantable injection ports, new vascular access devices and advances in drug therapy. Consequently, more infections and diseases that would otherwise have required patients to be hospitalized are now considered treatable without hospitalization. Before accepting a patient for infusion therapy, Infu-Tech consults with the physician or clinician and hospital personnel in assessing the patient's specific medical needs and suitability for home infusion therapy. This assessment process includes an analysis of the patient's physical condition as well as social factors such as the stability of the patient's home life and the availability of family members or others who can assist in the administration of the patient's infusion therapy. Once the patient is accepted for therapy, Infu-Tech provides training and education to the patient and his family or others relating to proper infusion techniques, care and use of equipment, care of infusion sites, and other aspects of the patient's infusion therapy. Infusion therapy equipment, consisting primarily of poles and pumps, is owned or leased by Infu-Tech and provided to patients along with other services. Throughout the course of treatment, all prescribed drugs and solutions are delivered directly to the patient's home or to an Infu-Tech credentialed subacute care facility. In approximately 90% of the cases, Infu-Tech's own pharmacies provide the prescribed drugs, solutions and supplies. Due to geography, patients who cannot be adequately serviced through an Infu-Tech owned pharmacy are covered by one of six satellite pharmacies. Infu-Tech maintains contact with the patient and the patient's physician in order to monitor and, when directed by the physician, refine the patient's plan of care. Infu-Tech's nursing and pharmacy services are available on-call 24 hours a day for consultation, home visits and special prescription needs. A registered nurse clinical-coordinator follows each case and monitors the therapy with the patient, the nurses assigned to the case and the patient's physician. Billing information is coordinated at a central billing department which bills the appropriate payor and tracks payments. 6 During 1994, Infu-Tech began also to provide infusion therapy services in ambulatory infusion suites attached to its pharmacies, where patients receive infusion therapy on an out-patient basis. In addition, Infu-Tech began arranging with nursing homes and other subacute facilities to have patients admitted on a short term basis to receive infusion and other subacute therapies. Contract Services Infu-Tech's contract services involve the distribution of products and services to residents in long term care facilities. Products and services are provided through arrangements with the long term care facilities for specific residents' use. Generally, Infu-Tech bills a third party payor, principally Medicare, on behalf of the individual resident. Until late 1990, a large majority of the products and services the Company provided to residents of long term care facilities involved enteral nutrition therapy. Beginning in late 1990, the Company began marketing other products to residents of long term care facilities in circumstances in which these products are eligible for reimbursement under Medicare and other programs. These include, in addition to enteral feeding, parenteral feeding, medical/surgical products, wound care products, urological products and other supplies. Since late 1990, the Contract Services unit has expanded the number of products it offers to nursing homes and other health care institutions, and it expects to offer additional products, embodying advances in health care technology, in the future. On the other hand, changes in reimbursement regulations or interpretations have led the Contract Services unit to reduce sales of products in the past and may do so in the future. As part of providing its products and services to residents in long term care facilities, Infu-Tech handles the procedures for obtaining reimbursement from Medicare and other third party payors for these products and services. Infu-Tech's sales representatives call upon long term care facilities within their respective geographical territories to review the medical status of the facilities' residents in order to determine the needs of individuals for the products and services provided by Infu-Tech. Since most of the residents participate in the Medicare program, the representatives review insurance coverage and the appropriateness of the products and services under Medicare reimbursement regulations. The sales representatives are responsible for processing the paperwork for billing by the central billing department. Orders for products and services are processed through the customer service department at Infu-Tech's corporate offices in Englewood Cliffs and shipped from its Moonachie, New Jersey warehouse. Infu-Tech primarily uses its own trucks for local (New York-New Jersey) deliveries and common carriers for deliveries outside the local area. Other Activities A wholly owned subsidiary of the Company has a non-exclusive distribution agreement with Eli Lilly Export S.A. to market, sell and distribute Lilly's pharmaceuticals in Russia. During 1998 the Company's total sales approximated $660,000 under its arrangement with Lilly. 7 Reimbursement For Services Approximately 70% of the revenues of the five nursing homes the Company operates were third-party reimbursements from Medicare and Medicaid. Governmental reimbursement for nursing home care is at cost-based per diem rates. Infu-Tech is reimbursed for its products and services by Medicare, Medicaid, private payors (private insurance companies, self-insured employers, health maintenance organizations, other managed care systems and patients) and other third party sources. Prior to accepting a patient, Infu-Tech's reimbursement specialists determine the availability and amount of third party coverage and, thereafter, Infu-Tech processes all payment claims on behalf of the patient. Most of Infu-Tech's contract services revenues result from Medicare reimbursement. Infu- Tech has more than thirteen years' experience in billing Medicare. Medicare provides reimbursement for 80% of the amounts shown on fee schedules it has developed. The remaining 20% co-insurance portion is not paid by Medicare, although in most cases, Medicaid reimburses the remaining 20% for "medically indigent" patients. In other cases, Infu-Tech bills other third party payors or patients responsible for co-insurance reimbursement. Infu-Tech often has difficulty collecting the 20% co-insurance portion of charges for Medicare-eligible items, particularly when there is no third party reimbursement and these sums must be collected directly from patients. Inability to collect the 20% co-insurance portion of bills is the principal reason for Infu-Tech's provision for uncollectible accounts. Infu-Tech also bills private payors (primarily private insurance companies, self-insured employers, health maintenance organizations and managed care systems), which generally pay for services and products based upon contracted rates or "reasonable and customary" charges. Infu-Tech's billing specialists work closely with these payors to maximize reimbursement in the shortest possible time. Private payors have been increasingly concerned about cost containment and often seek to negotiate lower rates directly with providers, including Infu-Tech. While these efforts tend to reduce profit margins, Infu-Tech has for several years been able to operate in this environment. The following table details the sources of payments to Infu-Tech during the twelve months ended June 30, 1998: Home Contract Total Infusion Services Revenues -------- -------- -------- Medicare................. 3% 88% 20% Private Pay.............. 91% 12% 75% Medicaid................. 6% - 5% --------- -------- ----- 100% 100% 100% ========= ==== ==== Sales and Marketing The Company's nursing homes have historically been marketed to doctors, hospitals and social services agencies in the areas in which they are located, and directly to patients' families. Recently, they have increasingly been marketed to health maintenance organizations, preferred provider organizations and managed care systems. Each nursing home has an admissions staff which interviews the family, makes financial arrangements and coordinates the admission of the new resident. Infu-Tech's principal sources of patient referrals are health maintenance organizations, physicians, hospital discharge planners, other hospital officials, nursing homes, insurance companies 8 and other managed care systems. Infu-Tech's products and services are marketed through its sales force and clinicians. Infu-Tech's sales force is responsible for establishing and maintaining referral sources. At June 30, 1998, the sales force included 3 full time sales employees and approximately 6 sales and service representatives, who report to their respective regional managers. Sales employees receive a base salary plus commissions based on revenues. Infu-Tech conducts regular sales training programs, intended to enable its sales force to generate more revenue from current and new sources of patient referrals and to assist them in targeting and developing new revenue sources. The "Infu-Tech" trademark is registered and is established in the areas in which Infu-Tech does business. Suppliers The Company purchases supplies, drugs and other materials and leases equipment from many suppliers. The Company has generally not experienced difficulty in purchasing supplies or leasing equipment. The Company believes there are alternative sources for virtually all the supplies and equipment it requires, other than Ceredase(Registered) enzyme and Cerezyme(Trademark), which are available only from one supplier, Genzyme Corp. The Company has a distribution agreement with Genzyme which automatically renews for one year terms unless cancelled at the end of a term on 90 days prior notice. The agreement may also be terminated at any time on 60 days' notice. Potential Liability and Insurance Participants in the health care market are subject to lawsuits based upon alleged negligence or similar legal theories, many of which involve large claims and significant defense costs. The Company could be subject to such suits. The Company maintains general liability insurance, including insurance against professional and products liability, with coverage limits of $10 million. The Company's insurance policy provides coverage on an "occurrence" basis and is subject to annual renewal. A successful claim against the Company in excess of the applicable insurance coverage could have a material adverse effect upon the Company's business and results of operations. Claims against the Company, regardless of their merit or eventual outcome, also may have a material adverse effect upon the Company's reputation. There can be no assurance that the coverage limits of the Company's insurance policies will be adequate. While the Company has been able to obtain liability insurance in the past, such insurance varies in cost, is difficult to obtain and may not be available in the future on acceptable terms or at all. Competition The Company's long-term care and prospective assisted living facilities compete or will compete with other facilities in the areas in which they are located, as well as, to a limited extent, hospitals and home health care providers. Competition is based primarily on location and quality of the facilities and price. The segments of the health care market in which Infu-Tech operates are highly competitive. In each of its lines of business there are relatively few barriers to entry, a limited number of national providers, as many of the large national providers have recently merged, and numerous regional and local providers. The principal competitors for sales to patients in long term care facilities are local providers of health care products and the operators of the facilities themselves. 9 The competitive factors most important in Infu-Tech's lines of business are quality of care and service, on-time delivery, reputation with referring health care professionals, ease of doing business with the provider, ability to develop and maintain the confidence of potential sources of patient referrals and price of service. Some competitors in Infu-Tech's lines of business have also attempted to enhance sales by entering into joint ventures or other financial relationships with potential referral sources. Increasingly stringent, and increasingly enforced, laws prohibiting remuneration between health care providers has reduced these arrangements as a competitive factor. Infu-Tech believes that it competes effectively in each of its service areas with respect to all of the above factors. Some of Infu-Tech's current and potential competitors have or may obtain significantly greater financial and marketing resources than Infu-Tech. It is likely that Infu-Tech will encounter increased competition in the future, which could limit Infu-Tech's ability to maintain or increase its market share and could adversely affect Infu-Tech's operating results. Other types of health care providers, including hospitals, physician groups and home health agencies, have entered, and may continue to enter, Infu-Tech's lines of business. Government Regulation Most states require that a certificate of need be obtained prior to establishing or expanding, a nursing home. However, only a minority of states, inclusive of New Jersey, require obtaining a certificate of need for establishing an assisted living facility. Some states also require governmental approval prior to the acquisition of a nursing home or assisted living facility by a new owner. While the need for certificates of need and approval to acquire facilities could affect the Company in specific instances, the Company does not believe they would significantly impede any efforts the Company might make to expand its overall long term care and assisted living activities. A few states, most notably New York, make it very difficult for nursing homes to be owned by corporations. This could prevent the Company from acquiring or building nursing homes in those states. A New Jersey statute requires that any nursing home in that state which participates in the Medicaid program may not discriminate in admission policy against Medicaid patients until the number of Medicaid patients is a specified percentage (currently 45%) of the beds in the nursing home. Generally, non-Medicaid patient reimbursement is at higher rates than Medicaid patient reimbursement. Health care is an industry subject to extensive regulation and frequent regulatory change. Changes in the law or new interpretations of existing law can have a dramatic effect on permissible activities, the relative cost associated with doing business and the amount of reimbursement by government and third party payors, such as Medicare and Medicaid. Charges under government programs are also subject to audit. A reduction in coverage or payment rates by third party payors, or significant audit adjustments, can have a material adverse effect on the Company's business and results of operations. The Federal government and each of the states in which Infu-Tech currently operates regulate some aspects of Infu-Tech's business. In particular, the operations of Infu-Tech's branch locations are subject to Federal and state laws. Infu-Tech's operations also are subject to state laws governing pharmacies, nursing services and certain types of home health agency activities. Certain of Infu-Tech's employees are subject to state laws and regulations governing the ethics and professional practice of people providing various therapies, pharmacy and nursing. Certificates of need, permits or licenses may be required for certain business activities and may be restricted or otherwise difficult to obtain. Infu-Tech believes it and its employees have all certificates of need, permits and licenses which are required for the business currently being conducted by Infu-Tech. The failure to obtain, renew or 10 maintain any of the required regulatory approvals or licenses could adversely affect Infu-Tech's business and could prevent the location involved from offering products and services to patients. There are Federal laws which generally prohibit any remuneration in return for the referral of Medicare or Medicaid patients, and prohibit the referral of any Medicare or Medicaid patient by a health care practitioner to a provider in which the practitioner has an ownership or financial interest. In addition, the Federal government and several states in which Infu-Tech operates have laws that prohibit financial arrangements, certain direct or indirect payments or fee-splitting arrangements between health care providers. Infu-Tech maintains an internal regulatory compliance review program and uses in house counsel to monitor compliance with all such laws and regulations. Increased attention has been paid recently to enforcement of these laws and regulations. Possible sanctions for failure to comply with these laws and regulations include exclusion from the government programs, loss of license and civil and criminal penalties. Executive Officers of the Company The following is a list of the executive officers of the Company as of June 30, 1998, together with a brief description of the business experience of the last five years of the officers who are not directors. A brief description of the business experience of officers who are directors is included in Item 10, "Directors." Name Office Age ---- ------ --- Jack Rosen Chairman, President and Director 52 Joseph Rosen Vice President, Assistant Secretary and 47 Director Roy Smolarz Executive Vice President and General 47 Counsel Israel Ingberman Secretary, Treasurer and Director 52 Roy Smolarz became Executive Vice President and General Counsel of the Company and of Infu-Tech in March 1998. From December 1992 until March 1998, he was affiliated with Coopers & Lybrand, a public accounting and financial services firm and was a managing director of Coopers & Lybrand Securities LLC. For more than seven years prior to that, he was a corporate vice president and corporate counsel of Paine Webber Incorporated, an investment banking firm. He is a member of the New York and New Jersey Bars and is a Certified Public Accountant. Employees At June 30, 1998, the Company had approximately 950 employees. These employees include 142 full-time management, marketing, technical-professional and clerical personnel. Additionally, the Company's five nursing homes were staffed by approximately 131 full-time management, marketing, technical-professional and clerical personnel, approximately 194 registered or practical nurses and 458 other employees, for a total of approximately 800 people. All of the Company's nursing homes have collective bargaining agreements. The Company believes its relations with its employees are generally satisfactory. As of June 30, 1998, Infu-Tech had approximately 128 employees. Of these employees, two were in executive capacities (in addition to executives of Kuala who rendered services to Infu- Tech), approximately 9 were in sales or service capacities, approximately 57 were in clinical or pharmaceutical capacities and the remainder were administrative or distribution personnel. Infu-Tech's employees are not currently represented by a labor union or other labor organization. Infu-Tech believes that its employee relations are good. 11 Item 2. Description of Properties. As of June 30, 1998, the Company owned a nursing home in Philadelphia, Pennsylvania. It also owned the nursing homes in Cedar Grove and West Orange, New Jersey and the real property of the long term and residential care facility located in Norwood, New Jersey (The "Heritage Facility"). (See Item 1, "Business -- Nursing Homes.") The Company leases the nursing home in Cape May Courthouse, New Jersey. The Company maintains corporate offices in Englewood Cliffs, New Jersey and it leases five branch offices for Infu-Tech's branch operations. Offices provide a home base for sales personnel, clinicians and administrative and technical personnel, as well as storage for excess equipment and supplies. In addition, Infu-Tech maintains a central pharmacy and a warehouse in Moonachie, New Jersey and pharmacies and ambulatory infusion suites in Memphis, Tennessee, Boston, Massachusetts, Philadelphia, Pennsylvania and Fort Lauderdale, Florida. The lease payments for the five branch offices, the central pharmacy, the Memphis, Boston, Philadelphia and Fort Lauderdale pharmacies, the infusion suites and the warehouse total $35,874 per month, payable to unrelated parties. The Company pays rent of $27,720 per month for corporate office space. In communities which cannot be serviced from an Infu-Tech office, staffing and administration is handled by a representative residing in the area. The Company believes its facilities are adequate for its current needs. Item 3. Legal Proceedings. The Company and its subsidiaries are subject to legal proceedings and claims which arise in the ordinary course of its business. The Company does not believe any litigation to which it is a party is likely to have a material adverse effect upon its financial condition or results of operations. Item 4. Submission of Matters to a Vote of Security Holders. One matter was submitted to a vote of security holders during the year ended June 30, 1998. At the Annual Meeting of Stockholders on January 26, 1998, the security holders voted upon an amendment to the Company's to the Certificate of Incorporation which changed (i) the name of the Company to "Kuala Healthcare, Inc." (ii) changed the par value of the common stock from $.02 per share to $.06 per share, (iii) combined the shares of common stock so that each three shares became one share. 12 PART II Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters. The Company's shares are listed on the Nasdaq Small Cap Market. The Company's shares became marginable as of August 10, 1998, pursuant to the Board of Governors of the Federal Reserve System Listing. According to the National Quotation Bureau, Inc. the high bid and low bid prices of the common stock during each calendar quarter during 1996, 1997 and June 30, 1998 were as follows: (All prices reflect the one-for-three reverse split) High Low Bid Bid --- --- 1996: First Quarter 4 1/8 3 3/16 Second Quarter 6 3/16 3 Third Quarter 7 1/2 3 9/16 Fourth Quarter 6 3/8 4 7/8 1997: First Quarter 11 7/16 7 1/2 Second Quarter 9 3/16 7 1/2 Third Quarter 9 3/8 6 Fourth Quarter 9 3/16 5 5/8 1998: First Quarter 8 7/16 4 5/8 Second Quarter 9 1/8 6 1/4 The Company has not declared any cash dividends on its Common Stock since the Common Stock was initially sold to the public in 1983, and the Company has no current plans to declare any dividends on its Common Stock. Dividends on the Company's 5% Exchangeable Preferred Stock are cumulative and are payable semi-annually on January 27 and July 27 at the rate of $5 per share per year, when and as declared by the Company's Board of Directors. The dividends on the 13,884 outstanding shares of 5% Exchangeable Preferred Stock total less than $70,000 per year. Under Delaware law, the Company is only permitted to pay dividends out of accumulated surplus or the current or prior year's net profits. At June 30, 1998, the Company had a surplus of $2,716,000 and during the twelve months ended June 30, 1998, it had a net loss of ($3,080,000). At September 23, 1998 there were 254 holders of record of the Company's Common Stock. 13 set r m 132 Item 6. Selected Financial Data. The following table sets forth selected financial data of the Company and should be read in conjunction with the audited consolidated financial statements for the years ended June 30, 1998, 1997, 1996, the six months ended June 30, 1995 and for the year ended December 31, 1994, and the related notes included elsewhere in this Report: Six Months Years Ended Years Ended June 30, Ended June 30, December 31, -------------------------------- -------------- ---------- 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- (In thousands, except per share amounts) Revenues ....................................... $ 63,926 $ 70,694 $ 69,880 $ 28,724 $ 54,378 -------- -------- -------- -------- -------- Income (loss) from operations .................. 1,262 3,007 4,116 (924) (917) Interest and dividend income ................... 225 104 221 183 98 Interest and other financing costs ............. 4,904 (6,343) (4,044) (632) (1,481) Other income, net .............................. 746 541 550 458 877 Minority interest .............................. (154) (395) (494) 353 375 -------- -------- -------- -------- -------- Income (loss) before income taxes .............. (2,825) $ (3,086) 349 562 (1,048) Provision (benefit) for income taxes ........... 149 662 270 -- (341) -------- -------- -------- -------- -------- Income (loss)before extraordinary items ........ (2,974) (3,748) 79 (562) (707) Extraordinary items (a) ........................ (106) 5,191 777 -- 1,058 -------- -------- -------- -------- -------- Net income (loss) .............................. (3,080) 1,443 856 (562) 351 Preferred Dividends ............................ (114) (130) (70) (35) (69) -------- -------- -------- -------- -------- Net income (loss) available to common shareholders .............................. $ (3,194) $ 1,313 $ 786 $ (597) $ (282) ======== ======== ======== ======== ======== Earnings (loss) per share: Basic: Earnings (loss) before extraordinary items .. $ (.92) $ (1.15) $ -- $ (.08) $ (.09) Extraordinary items ......................... $ (.03) $ 1.54 $ .28 $ -- $ .13 -------- -------- -------- -------- -------- Basic Earnings (loss) per share(1).............. $ (.95) $ .39 $ .28 $ (.08) $ .04 ======== ======== ======== ======== ======== Diluted: Earnings (loss) before extraordinary items... $ (.92) $ (1.15) $ -- $ (.08) $ (.09) -------- -------- -------- -------- -------- Extraordinary items.......................... $ (.03) $ 1.54 $ .28 $ -- $ .13 -------- -------- -------- -------- -------- Diluted Earnings (loss) per share(2)............ $ (.95) $ .39 $ .28 $ (.08) $ .04 -------- -------- -------- -------- -------- Six Months Years Ended Years Ended June 30, Ended June 30, December 31, ------------------------------ -------------- ------------ BALANCE SHEET DATA 1998 1997 1996 1995 1994 --------------------------------------------------------------- (In thousands) - --------------------------------------------------------------------------------------------------------- Working capital (deficit) ........... $ (1,300) $ 512 $ 45 $ (6,060) $ (4,392) Total assets ........................ 66,517 71,350 75,572 29,675 30,485 Total liabilities and deferred income 61,223 61,313 67,847 28,119 27,980 Minority interest ................... 2,578 2,424 2,029 1,524 1,877 Mandatorily redeemable preferred stock .............................. 1,114 1,989 3,500 -- -- Stockholders' equity ................ 2,716 5,624 2,196 32 628 (a)In 1998 includes net gains on extinguishment of debt and loss on sale of a medical facility in West Orange, NJ. In 1997 includes net gains on sale of land, two nursing homes and an exchange of the Company's common stock at a lesser amount than the recorded liability. (1)Based on 3,375,661, 3,381,068 and 2,806,119 shares outstanding in June 30, 1998, 1997 and 1996. Share amounts for 1997 and 1996 are restated. (2)Based on 3,375,661, 3,385,746 and 2,816,400 shares outstanding in June 30, 1998, 1997 and 1996. Share amounts for 1997 and 1996 are restated. 14 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Results of Operations Twelve Months Ended June 30, 1998 Compared with Twelve Months Ended June 30, 1997 Total revenues of $63,926,000 were $6,768,000 or 9% lower in the 1998 period compared to the same period of the prior year. The reduction in revenue from the prior period was primarily attributable to the sale of two facilities, Oceanside Convalescent Center, Atlantic City, New Jersey as well as King David Center in West Palm Beach, Florida. It also reflected a reduction of $500,000 in anticipated medicare receipts in order to more reasonably estimate the balance in consideration of the current reimbursement environment. Infusion therapy and other medical services revenues increased by $2,271,000 or 8%, from $26,661,000 in 1997 to $28,932,000 in 1998, primarily due to a $1,410,000, or 7% increase in home infusion division revenues and revenues from the Company's majority interest in Bach's institutional pharmacy, acquired in December, 1997. This increase in revenues is offset by decreased therapy days and lower pricing on sales through managed care organizations. Personnel costs decreased by $6,344,000 or 12% for the current twelve months. This decrease is primarily attributed to the sale of the two nursing facilities previously mentioned, partially offset by a bonus payable of $642,000 and $108,000 by Infu-Tech to the Company's Chairman of the Board and President (who also is the Chairman of the Board and President of Infu-Tech, Inc.), under bonus arrangements tied to increases in the price of the Company's and Infu-Tech's stock. This decrease also reflected normal cost of living increases. Costs of medical and nutritional products sold to patients and other customers increased by $2,808,000 or 21%, from $13,224,000 in 1997 to $16,032,000 in 1998. As a percentage of infusion therapy and other medical services revenues, medical and nutritional product costs increased from 51% in 1997 to 56% in 1998. This increase in product costs as a percentage of sales is partially attributable to increased pricing pressures from certain vendors and the Company's need to secure immunoglobulin products which due to a national shortage are only available at a premium price. These products were needed to provide continued treatment for existing patients. Health care and lodging expenses, which are incurred in connection with nursing home services decreased by $1,984,000 or 20%. This decrease is attributed to the sale of the two nursing facilities previously mentioned. Selling, general and administrative costs in 1998 increased by $578,000, or 9% from $6,683,000 in 1997 to $7,261,000 in 1998, due primarily to the Company's majority interest in Bach's Pharmacy, acquired in December 1997. The Company increased the provision for uncollectible accounts from $447,000 in 1997 to $625,000 in 1998. The increase in the provision includes the effect of unresolved prior claims regarding previously owned facilities, as well as a comprehensive evaluation of days outstanding of its accounts receivable. Other income, net of $746,000 in 1998 primarily consisted of write offs of accounts payable the Company does not believe it will be required to pay and unrealized foreign currency translation gain. Other income, net of $541,000 in 1997 primarily consisted of $308,000 of income resulting from 15 the re-evaluation of accruals, an unrealized foreign currency translation gain of $161,000 and $72,000 of deferred income. Minority interest in earnings of subsidiaries of $154,000 in 1998 and $395,000 in 1997 represents the portion of the net income of Infu-Tech allocable to minority stockholders. For 1998, this amount also includes $75,000 attributable to the minority interest in Bach's Pharmacy. The provision for income taxes of $149,000 in 1998 reflects a full charge for Infu-Tech, a 58% owned subsidiary which files its own federal tax return. Fiscal year 1998 includes an extraordinary loss of $106,000 as follows: During the second quarter of fiscal 1998, the Company prepaid debt of approximately $300,000 and received a $150,000 credit which was recorded as an extraordinary gain. During the fourth quarter of fiscal 1998, the Company sold a medical facility in West Orange, New Jersey, reflecting an extraordinary loss of $256,000. The preferred stock dividend does not include dividends on mandatorily redeemable preferred stock issued as part of an October 31, 1995 refinancing which is accounted for as interest and financing costs. The net loss realized by common shareholders in 1998 was $3,194,000 or 95 cents per share (basic) compared to a net income available to common shareholders in 1997 of $1,313,000 or 39 cents per share (basic). Twelve Months Ended June 30, 1997 Compared with Twelve Months Ended June 30, 1996 Total revenues of $70,694,000 were $814,000 or 1% higher in the 1997 period compared to the same period of the prior year. This is due to an improved patient mix yielding higher reimbursement, the inclusion of the Heritage Facility, for twelve months compared to eight months in the prior period while being partially offset by lower occupancy at the West Palm Beach, Cedar Grove and the Heritage facilities and the exclusion of the Hilltop facility (sold in May 1996) for the current twelve months. Infusion therapy and other medical services revenues increased by $1,365,000 or 6% to $26,000,000 in 1997, primarily due to a $913,000, or 4% increase in home infusion division revenues. This increase is primarily attributed to a 3% increase in the number of patients serviced, although these patients experienced shorter terms of therapy and pricing negotiated with managed care companies was discounted. Costs of medical and nutritional products sold to patients and other customers increased by $1,594,000 or 13%, from $11,920,000 in 1996 to $13,514,000 in 1997. As a percentage of total revenues, medical and nutritional product costs increased from 48% in 1996 to 52% in 1997. The increase in the nutritional product costs as a percentage of sales is partially attributable to the increased pricing pressures from certain vendors. Health care and lodging expenses, which are incurred in connection with nursing home services decreased by $960,000 or 9%. A review of old accounts payable and outstanding checks resulted in the company writing back to income an aggregate of $565,000 of which $417,000 was reflected in the fourth quarter. The prior year included four months of rent expense incurred prior to the October 1995 Nomura refinancing. The rent expenses have been replaced by interest and depreciation charges. The Hilltop facility was sold in May 1996 and thus no health care and lodging expenses have been incurred in fiscal 16 1997. During the year, the Company settled litigation with a vendor which enabled $460,000 to be released from payables into income. The Heritage facility is included for twelve months compared to eight months in the prior year. Selling, general and administrative costs decreased by $175,000, or 3%. A review of old accounts payables and outstanding checks resulted in the Company writing back to income an aggregate of $415,000. Due to an October 31, 1995 refinancing for the acquisition of four facilities, depreciation and amortization expenses increased by $269,000 and interest and other financing costs increased by $2,299,000. Other income, net of $541,000 in 1997 primarily consisted of $308,000 of income resulting from the re-evaluation of accruals, an unrealized foreign currency translation gain of $161,000 and $72,000 of deferred income. Other income of $550,000 in 1996 consisted of deferred income of $543,000, an unrealized foreign translation gain of $130,000, which were offset by miscellaneous expense. Minority interest in earnings of subsidiary of $395,000 in 1997 and $494,000 in 1996 represents the portion of the net income of Infu-Tech allocable to minority stockholders. The provision for income taxes of $662,000 in 1997 reflects a full tax charge for Infu-Tech, a 58% owned subsidiary which files its own federal tax return. Fiscal year 1997 includes extraordinary gains of $5,191,000 as follows: In December 1996 the Company sold 8 acres of land which secured a five year $1.5 million loan and utilized the proceeds to pay-down that borrowing recording a gain of $875,000. In March 1997, the Company agreed to convert certain liabilities into Common Stock of the Company. The transaction resulted in an increase to shareholders equity of $2,542,000 of which $1,192,000 is reflected as an extraordinary gain in the results of operations. In June 1997, the Company sold Oceanside Convalescent Center, Atlantic City, N.J. as well as King David Center in West Palm Beach, FL. The sale of these facilities yielded $2,124,000 of an extraordinary gain. In addition, the Company sold a 15% interest in a limited partnership for $700,000 which in 1987, purchased a property in Teaneck, New Jersey from the Company and constructed a 224-bed congregate care facility. A forfeited deposit by a potential nursing home buyer resulted in a gain of $300,000. The extraordinary gain of $777,000 in fiscal year 1996 resulted primarily from the sale of assets relating to the Hilltop facility. The preferred stock dividend does not include dividends on mandatorily redeemable preferred stock issued as part of as October 31, 1995 refinancing, which is accounted for as interest and financing costs. The net income available to common shareholders in 1997 was $1,313,000 or 39 cents per share (restated) (basic) compared to a net income available to common shareholders in 1996 of $786,000 or 28 cents per share (restated) (basic). Liquidity and Capital Resources At June 30, 1998, the Company had stockholders' equity of $2,716,000 and total liabilities of $61,223,000. At June 30, 1998, debt amounted to $45,947,000, the majority of which arose from a refinancing of four facilities in October of 1995. Other debt included SFr 662,215 (approximately $370,000) principal amount of 6% Swiss franc denominated bonds which remain unpaid although they 17 matured on June 27, 1995 (the "Bonds"); SFr 619,500 (approximately $410,000) principal amount of 8% Swiss franc denominated bonds originally due June 27, 1998 (amended repayment schedule requires payment of four equal quarterly installments ending June 1999); $1,213,000 principal amount of 8% notes due 1999; and $3,400,000 principal amount of 6% notes due 2003. On October 31, 1995, the Company obtained a 15 year borrowing of $41.0 million secured by mortgages on four of the company's nursing homes and a five year borrowing of $1.5 million secured by 8 acres of land in West Orange, New Jersey. In addition, four subsidiaries of the Company sold preferred stock for a total of $3.5 million. The $46.0 million borrowing allowed the Company to purchase 4 nursing homes (three of which previously had been operated by the Company under leases and the fourth of which the Company had sold in 1990 and managed under a management contract since then) and to repay $301,000, and extend the balance of a $601,000 secured note which would have matured in December 1995. At the same time, the company converted $1,476,000 of trade payables into a three year note. In September 1996 the Company converted an additional $904,467 of trade payables into one to three year notes. In December 1996, The Company sold the 8 acres of land which secured a five year $1.5 million loan and utilized the proceeds to pay-down that borrowing, leaving a balance of $454,000. The Company exercised its right to prepay that loan in full by December 31, 1997 and recognized a $150,000 credit. In June 1997 the Company sold one of the nursing homes which had secured the October 31, 1995 borrowing and issuance of preferred stock. The proceeds of the sale were used, in part, to pay down the 15 year borrowing and redeem the preferred stock. The balance of the 15 year borrowing is $36,483,000 and the balance of the preferred stock outstanding is $1,114,000 at June 30, 1998. The Company's cash and cash equivalents balance decreased from $3,796,000 at June 30, 1997 to $395,000 at June 30, 1998. Included in the June 30, 1998 balance is $163,000 held by Infu-Tech. In connection with the initial public offering of Infu-Tech common stock, the Company entered into a management and non-competition agreement with Infu-Tech, extended to July 2000, which prohibits Infu- Tech from lending money to (or borrowing money from) the remainder of the Company. Operating activities used $987,000 of cash primarily due to a net loss of $3,080,000, partially offset by an increase in payables and other current liabilities of $1,113,000 and an increase in accounts receivable of $1,042,000. At June 30, 1998, the balance in net accounts receivable for Infu-Tech was $6.9 million compared to $6.4 million at June 30, 1997, resulting from increased sales and slower collections, partially offset by write-offs of old balances. This reclassification reduced the Company's accounts receivable from 102 days sales outstanding ("DSO") at June 30, 1997 to 96 DSO at year end. The 96 DSO compares favorably to an industry average of 125 days. The 96 DSO is a result of continuing delays in claims processing experienced by managed care companies and Medicare. The Company has limited arrangements under which it can make borrowings. At June 30, 1998, the Company had a working capital deficit of $1,300,000. Excluding Infu-Tech, which had working capital of $3,502,000, the Company had a working capital deficit of $4,802,000. Further, at June 30, 1998, Infu-Tech's cash and cash equivalents of $163,000 were $349,000 less than the balance of $512,000 at June 30, 1997 and its accounts payable of $5,057,000 were $769,000 higher than the $4,288,000 at June 30, 1997. During the twelve months ended June 30, 1998, the Company repaid $1,828,000 of debt, $875,000 of mandatorily redeemable preferred stock and paid preferred dividends of $114,000. 18 At June 30, 1998, the Company has approximately $3.9 million of debt due the upcoming year. The Company is required to make mandatory principal redemption payments with regard to its subsidiaries' Preferred Stock of $73,000 per month. While the Company continues to experience tight cash flow constraints, it expects to meet ongoing obligations. It is focused on generating sufficient funds through operating cash flow or the realization of assets into cash to meet those obligations. Impact of Year 2000 The Company is in the process of conducting a review of its business systems, including its computer systems, and has sent written inquiries to its customers, distributors and vendors as to their progress in identifying and addressing problems that their systems may face in correctly interpreting and processing date information as the year 2000 approaches and is reached. This review is expected to be completed by March 1999. Based on this review, the Company will implement a plan to achieve year 2000 compliance. The Company believes that it will achieve year 2000 compliance in a manner which will be non-disruptive to its operations. In addition, the Company has commenced work on various types of contingency planning to address potential problem areas with internal systems, suppliers and other third parties. Year 2000 compliance should not have a material adverse effect on the Company, including the Company's financial condition, results of operations or cash flow. The Company has incurred no costs to date to year 2000 problems. The Company estimates the cost of its year 2000 efforts to be approximately $650,000. The total cost estimate is based on management's current assessment and is subject to change. However, the Company may encounter problems with supplier and or revenue sources which could adversely affect the Company's financial condition, results of operations or cash flow. The Company cannot accurately predict the occurrence and or outcome of any such problems, nor can the dollar amount of such problem be estimated. In addition, there can be no assurance that the failure of third parties to achieve year 2000 compliance would not have a material adverse effect on the Company. Item 6. Financial Statements and Supplementary Data. The consolidated financial statements and supplementary data required by this item appear beginning at page F-1. Item 7. Disagreements on Accounting and Financial Disclosure. Not Applicable. 19 PART III Part III Items 10 through 13 to be filed by October 29, 1998 as part of definitive proxy statement. 20 PART IV Item 14. Exhibits, Financial Statements Schedule, and Reports on Form 8-K (a) Documents filed as part of this Report. 1. Financial Statements Listed on Index to Consolidated Financial Statements and Financial Statement Schedule. 2. Financial Statement Schedule Listed on Index to Consolidated Financial Statements and Financial Statement Schedule. 3. The following exhibits are filed with this Report or incorporated by reference: 3(a) Certificate of Incorporation, as amended. (1)(6) 3(b) By-Laws, as amended. (1) 4(a) Specimen of Common Stock Certificate. (1) 4(b) Public Bond Issue Agreement dated as of May 31, 1985 with Banque Gutzwiller, Kurz, Bungener S.A. as representative of a consortium of Swiss financial institutions. (2) 4(c) Indenture dated as of September 4, 1986 relating to 14-1/8% Subordinated Debentures due 1996. (3) 4(d) Supplemental Indenture No. 1 dated as of September 27, 1991. (10) 10(a) Agreement dated July 20, 1987 among Continental Teaneck Realty, Inc., Forest City Residential Development, Inc. and the Company. (4) 10(b) Certificate and Articles of Limited Partnership of CR Teaneck Limited Partnership . (4) 10(c) Lease dated November 28, 1988 between Midlantic National bank, Trustee, and Jayber, Inc. (5) 10(d) Lease dated November 28, 1988 between Midlantic National Bank, Trustee, and Jayber, Inc. (5) 10(e) Lease dated December 28, 1998 between Midlantic National Bank & Trust Company/Florida, Trustee, and P.V.M. Associates, Inc. (5) 21 10(f) Management Agreement dated as of January 1, 1994 between Senior Care Foundation and Continental Norwood, Inc. (8) 10(g) Distribution Agreement between Infu-Tech, Inc. and Genzyme Corporation dated November 11, 1994. 10(h) 1996 Key Employees and Key Personnel Stock Option Plan. (9) 10(i) Employment Agreement dated November 1, 1996 between Continental Health Affiliates, Inc. and Jack Rosen. 11 Calculation of Earnings Per Share. 13 1998 Annual Report to Stockholders - to be furnished by amendment - that report, except for any portions which are expressly incorporated by reference this filing, is not to be deemed "filed" as part of this filing. 21 List of Subsidiaries (b) Reports on Form 8-K filed during the quarter ended December 31, 1994. None (c) The exhibits to this Report are listed item 14(a)3. (d) The financial statement schedule required by Regulation S-X which is excluded from the annual Report to Stockholders by Rule 14a-3(b)(1) is listed in Item 14(a)(2). FOOTNOTES (1) Incorporated by reference to Registration Statement No. 2-81823. (2) Incorporated by reference to Registration Statement No. 33-611 (3) Incorporated by reference to Registration Statement No. 33-6341 (4) Incorporated by reference to Report on Form 10-K for the year ended December 31, 1987. (5) Incorporated by reference to Report on Form 10-K for the year ended December 31, 1988. (6) Incorporated by reference to definitive proxy statement dated July 13, 1989. (7) Incorporated by reference to Registration Statements Nos. 33-74474 and 33-7476. (8) Incorporated by reference to Report on Form 10-K for the year ended December 31, 1993. (9) Incorporated by reference to definitive proxy statement approved at the 1996 Annual Meeting of Shareholders. 22 KUALA HEALTHCARE, INC. CONSOLIDATED FINANCIAL STATEMENTS June 30, 1998, 1997 and 1996 (With Independent Auditors' Report Thereon) KUALA HEALTHCARE, INC. Index to Consolidated Financial Statements and Financial Statement Schedule Page ---- 1. Consolidated Financial Statements: Independent Auditors' Report.........................................F-3 Balance Sheets June 30, 1998 and 1997..........................................F-4 Statements of Operations: Years Ended June 30, 1998, 1997 and 1996........................F-5 Statements of Stockholders' Equity: Years Ended June 30, 1998, 1997 and 1996........................F-6 Statements of Cash Flows: Years Ended June 30, 1998, 1997 and 1996.................F-7 - F-8 Notes to Consolidated Financial Statements.....................F-9 - F-30 2. Financial Statement Schedule: Valuation and Qualifying Accounts...................................S - 1 Other schedules are omitted because of the absence of conditions under which they are required or because the required information is given the consolidated financial statements or notes thereto. Independent Auditors' Report The Board of Directors and Stockholders Kuala Healthcare, Inc. We have audited the consolidated financial statements of Kuala Healthcare, Inc. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kuala Healthcare, Inc. and subsidiaries as of June 30, 1998 and 1997 and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG Peat Marwick LLP October 8, 1998 New York, New York F-3 KUALA HEALTHCARE, INC. Consolidated Balance Sheets (Dollars in thousands, except per share amounts) June 30, ------------------------- ASSETS 1998 1997 ---- ---- Current Assets: Cash and cash equivalents..........................................$ 395 $ 3,796 Patients' funds.................................................... 204 188 Accounts receivable, net of allowances for uncollectible accounts of $3,681 and $4,252................................... 13,763 13,346 Inventories........................................................ 1,987 1,861 Deferred income taxes.............................................. 551 702 Prepaid expenses and other current assets.......................... 993 803 ------------- ------------- Total current assets.......................................... 17,893 20,696 Property and equipment, at cost, net of accumulated depreciation of $5,937 and $4,916.................................. 44,724 46,991 Goodwill, net of accumulated amortization ............................... 125 139 Other assets............................................................. 3,775 3,524 ------------- ------------- Total assets..................................................$ 66,517 $ 71,350 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Short-term borrowings..............................................$ 28 $ 105 Current portion of long-term debt.................................. 3,916 5,686 Income taxes payable............................................... 180 437 Accounts payable................................................... 10,389 9,696 Other current liabilities.......................................... 4,680 4,260 ------------- ------------- Total current liabilities..................................... 19,193 20,184 Long-term debt, net of current portion................................... 40,916 41,129 Mandatorily redeemable preferred stock (includes $875 and $1,166 current portion)............................................ 1,114 1,989 ------------- ------------- Total liabilities............................................. 61,223 63,302 Minority interest in subsidiaries........................................ 2,578 2,424 Commitments and contingencies Stockholders' equity: Preferred stock, $.02 par value; $100 liquidation preference per share..................................................... 1 1 Series A 11% convertible preferred stock $.02 par value, 1,200 shares authorized, $1,000 liquidation preference, per share, 34 shares outstanding.............................. 34 34 Common stock, $.06 par value; 5,000,000 shares authorized; 3,409,299 and 3,373,034 shares outstanding 208 206 Additional paid- capital........................................... 23,571 23,401 Accumulated deficit................................................ (21,098) (18,018) -------------- ------------- Total stockholders' equity.................................... 2,716 5,624 ------------- ------------- Total liabilities and stockholders' equity $ 66,517 $ 71,350 ============= ============= See accompanying notes to consolidated financial statements. F-4 KUALA HEALTHCARE, INC. Consolidated Statements of Operations (Dollars in thousands, except per share amounts) Years Ended June 30, ------------------------------------------ 1998 1997 1996 ---- ---- ---- Revenues: Nursing home services.......................................$ 34,994 $ 44,033 $ 44,440 Infusion therapy and other medical services 28,932 26,661 25,440 -------------- ------------- ------------ Total revenues...................................... 63,926 70,694 69,880 -------------- ------------- ------------- Operating expenses: Personnel................................................... 28,902 35,284 32,955 Medical and nutritional product............................. 16,032 13,224 12,001 Health care and lodging..................................... 8,146 10,130 11,090 Selling, general and administrative......................... 7,261 6,683 6,858 Provision for uncollectible accounts........................ 625 447 1,210 Depreciation and amortization............................... 1,698 1,919 1,650 -------------- ------------- ------------- Total operating expenses............................ 62,664 67,687 65,764 -------------- ------------- ------------- Income from operations.............................. 1,262 3,007 4,116 Interest and dividend income...................................... 225 104 221 Interest and other financing costs................................ ( 4,904) (6,343) (4,044) Other income, net................................................. 746 541 550 Less: Minority interest in earnings of subsidiary (154) (395) (494) -------------- ------------- ------------- Income (loss) before income taxes and extraordinary items............................... (2,825) (3,086) 349 Provision for income taxes........................................ 149 662 270 -------------- ------------- ------------- Income (loss) before extraordinary gains (2,974) (3,748) 79 Extraordinary gains (losses) ..................................... (106) 5,191 777 --------------- ------------- ------------- Net income (loss)................................... (3,080) 1,443 856 Preferred dividends............................................... (114) (130) (70) --------------- ------------- ------------- Net income (loss) applicable to common shareholders......................................$ (3,194) $ 1,313 $ 786 =============== ============= ============= Income (loss) per share: Income (loss) before extraordinary gains (losses) $ (0.92) $ (1.15) $ 0.00 Extraordinary gains (losses)................................ (0.03) 1.54 0.28 --------------- --------------- --------------- Net income (loss) per share Basic ...........................................$ (0.95) $ 0.39 $ 0.28 ============== ============== =============== Diluted .........................................$ (0.95) $ 0.39 $ 0.28 ============== ============== =============== Basic weighted average number of common and common shares .............................................. 3,375,661 3,381,068 2,806,119 Diluted weighted average number of common and common shares .............................................. 3,375,661 3,385,746 2,816,400 See accompanying notes to consolidated financial statements. F-5 KUALA HEALTHCARE, INC. Consolidated Statements of Stockholders' Equity Years Ended June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) Additional Total Preferred Stock Common Stock Paid- Accumulated Stockholder's Shares Amount Shares Amount Capital Deficit Equity(Deficit) ------ ------ ------ ------ ------- ------- --------------- Balance, June 30, 1995........... 13,884 $ 1 7,830,059 $ 156 $ 20,192 $ (20,317) $ 32 Exercise stock options....... -- -- 21,000 -- 21 -- 21 Debt to equity conversion -- -- 1,435,157 30 1,327 -- 1,357 Preferred dividends.......... -- -- -- -- (70) -- (70) Net income................... -- -- -- -- -- 856 856 ------ ---------------------- ------- ----------- ---------- ------------ Balance, June 30, 1996........... 13,884 $ 1 9,286,216 $ 186 $ 21,470 $ (19,461) $ 2,196 New stock issued............. -- -- -- -- 100 -- 100 Exercise stock options....... -- -- 12,150 1 11 -- 12 Warrants ............. -- -- -- -- 98 -- 98 Debt to equity conversions -- -- 820,735 19 1,852 -- 2,005 Preferred Series A 11% -- 34 -- -- -- -- 34 Preferred dividends.......... -- -- -- -- (130) -- (130) Net income................... -- -- -- -- -- 1,443 1,443 ------ ----- --------- -------- ----------- ---------- ------------- Balance, June 30, 1997 (a)....... 13,884 $ 35 10,119,101 $ 206 $ 23,401 $ (18,018) $ 5,624 Restated balance June 30, 1997 .......... 13,884 $ 35 3,373,034 $ 206 $ 23,401 $ (18,018) $ 5,624 New stock issued............. -- -- -- -- -- -- -- Exercise stock options....... -- -- 7,784 -- 76 -- 76 Warrants ............. -- -- -- -- -- -- -- Bach's Investment............ -- -- 28,481 2 208 -- 210 Debt to equity conversions -- -- -- -- -- -- -- Preferred Series A 11% -- -- -- -- -- -- -- Preferred dividends.......... -- -- -- -- (114) -- (114) Net income (loss)............ -- -- -- -- -- (3,080) (3,080) ------- ----- ---------- -------- ----------- ----------- ------------- Balance, June 30, 1998........... 13,884 $35 3.409,299 $ 208 $ 23,571 $ (21,098) $ 2,716 =========== ===== ========== ======== ============ ============= ============= (a) common stock share amounts at June 30, 1997 and prior are before the reverse stock split which was effective on January 27, 1998. See accompanying notes to consolidated financial statements. F-6 KUALA HEALTHCARE, INC. Consolidated Statement of Cash Flows (Dollars in thousands, except per share amounts) Years Ended June 30, -------------------------------------- 1998 1997 1996 ---- ---- ---- Operating activities: Net income (loss)....................................$ (3,080) $ 1,443 $ 856 Adjustments to reconcile net income (loss) to net cash provided by (used ) operating activities: Depreciation and amortization expense................ 1,698 1,919 1,537 Warrants issued ..................................... -- 98 -- Amortization of deferred financing cost.............. 143 517 266 Provision for uncollectible accounts................. 625 447 1,210 Amortization of deferred income...................... -- (72) (543) Provision for deferred income taxes.................. 151 172 195 (Gain) loss on foreign currency debt................. (82) (161) (130) Extraordinary losses (gains)......................... 106 (3,316) (693) Minority interest.................................... 154 395 494 Net gains on extinguishment of debt.................. -- -- (84) Increase (decrease) in cash due to changes in: Patients funds....................................... (16) (4) -- Accounts receivable.................................. (1,042) (3,517) (5,349) Inventories.......................................... (126) 135 (310) Prepaid expenses and other current assets............ (190) 348 (35) Other assets......................................... (184) (228) (2,755) Taxes payable........................................ (257) 437 -- Accounts payable..................................... 693 2,687 (2,174) Other current liabilities............................ 420 1,014 1,717 Other liabilities.................................... -- (16) (227) ------------- ------------- ------------- Net cash (used in) provided by operating activities.................................. (987) 2,298 (6,025) -------------- ------------- ------------- Investing activities: Expenditures for property and equipment.............. (814) (374) (39,848) Acquisition of Universal Home Infusion............... -- (190) 2,390 Cash received on sale of facilities.................. -- 8,116 -- Proceeds from sale of building....................... 1,141 -- -- -------------- ------------- ------------- Net cash (used in) provided by investing activities........................... 327 7,552 (37,458) -------------- ------------- ------------- (Continued on next page) F-7 KUALA HEALTHCARE, INC. Consolidated Statement of Cash Flows (Dollars in thousands, except per share amounts) Years Ended June 30, -------------------------------------- 1998 1997 1996 ---- ---- ---- Financing activities: Net proceeds from not-for-profit borrowings........$ -- $ -- $ -- Net proceeds from long-term borrowings............. -- -- 47,592 Payments on debt................................... (1,828) (7,406) (1,706) Payment of preferred dividends..................... (114) (83) (70) Payments on mandatorily redeemable preferred stock................................ (875) (1,511) -- Cost of debt exchange offers........................ -- -- -- Net proceeds from exercise of common stock options.................................. 76 46 21 ------------- ------------- ------------- Net cash (used in) provided by financing activities..................................... (2,741) (8,954) 45,837 ------------- ------------- ------------- Net (decrease) increase cash and cash equivalents............................ (3,401) 896 2,354 Cash and cash equivalents, beginning of the period..................................... 3,796 2,900 546 ------------- ------------- ------------- Cash and cash equivalents, end of the period.....................................$ 395 $ 3,796 $ 2,900 ------------- ------------- ------------- Supplemental disclosure of cash flow data: Interest paid..................................$ 4,647 $ 5,600 $ 4,292 ============= ============= ============= Income taxes paid..............................$ 154 $ 110 $ 26 ============= ============= ============= Non cash investing and financing activity: Property and equipment obtained under capital lease obligation....................$ -- $ -- $ 223 Acquisition of property and equipment for forgiveness of receivable...................$ -- $ -- $ 7,399 Conversion of trade payable into notes $ -- 904 -- Conversion of convertible notes $ -- $ -- $ 1,357 Debt to equity conversions.........................$ -- $ 1,824 $ -- Dividend conversion to common stock................$ -- $ 47 $ -- Stock issued in connection with acquisition............................$ 210 $ 100 $ -- See accompanying notes to consolidated financial statements. F-8 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) 1. The Company Kuala Healthcare, Inc. ("The Company" or "KUAL") present operations consist primarily of nursing home services and infusion therapy and other medical services. Nursing home services include the ownership, leasing, operation and management of nursing homes. Infusion therapy and other medical services include enteral and other medical services, primarily for patients in nursing homes, and intravenous and other infusion therapies for patients at home and in nursing homes. However, the Company has commenced development of three assisted living projects in New Jersey, totaling 320 beds, and is seeking to focus on developing, acquiring and operating assisted living facilities and other forms of senior housing, primarily, in the northeastern United States and possibly in some mid- Atlantic and southeastern states. The Company is subject to certain risks and uncertainties as a result of changes that could occur in the health care industry, including changes in Medicare and Medicaid reimbursement rates. 2. Significant Accounting Policies Basis of Consolidation The consolidated financial statements include the accounts of KUAL and its subsidiaries (the "Company"). All significant intercompany accounts and transactions have been eliminated in consolidation. KUAL owns 58% of the common stock of Infu-Tech, Inc. ("Infu-Tech"); the other 42% is publicly traded. The minority interest in the consolidated financial statements represents the minority stockholders' proportionate share of equity in Infu-Tech. Accounting Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Reverse Stock Split In January 1998, the Company effected a one-for-three reverse split of its common stock. All per share amounts of common stock reflect this split. Cash and Cash Equivalents Cash and cash equivalents at June 30, 1998 and 1997 includes $163 and $512, respectively, held by Infu-Tech. In connection with Infu-Tech's initial public offering (see note 3), a management and non-competition agreement between KUAL and Infu-Tech, which was extended to July 2000, prohibits Infu-Tech from lending money to (or borrowing money from) KUAL and its other subsidiaries subsequent to December 31, 1992. The Company classifies all highly liquid investments with maturities of three months or less when purchased as cash equivalents. Reclassifications Certain items have been reclassified in the 1997 consolidated balance sheet to conform to the 1998 balance sheet. F-9 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) Patients' Funds Patients' funds represent cash balances which have been deposited by the Company into separate bank accounts and are restricted for the use of patients. The related liability is included in other current liabilities. Revenue Recognition Revenue is reported at the net amounts estimated to be realized from patients, third-party payors and others for services rendered. The Company receives payments for services to eligible patients under Medicare and various state Medicaid programs. Approximately 55% (1998), 54% (1997) and 60% (1996) of total revenues were derived from such medical assistance programs. Revenues under these programs are based upon government approved rates which are subject to audit. In the opinion of management, retroactive adjustments, if any, would not be material to the Company's financial position or results of operations. Inventories Inventories, which consist of medical and nutritional products and supplies, are valued at the lower of cost (first-in, first-out method) or market. Long-Lived Assets Depreciation of property and equipment is computed using the straight-line method at rates that charge the cost of various classes of assets over the periods of expected use. The range of useful lives estimated for buildings and improvements is generally 7 to 40 years, and the range for furniture and equipment is three to ten years. Leasehold improvements are amortized over the lesser of the term of the lease or the estimated life of the asset. Goodwill is being amortized over periods ranging from 7 to 40 years. Deferred Financing Costs Deferred financing costs (included in other assets) incurred in connection with the issuance of long-term debt are being amortized on a straight-line basis over the term of the related debt agreements. In the event of an early retirement of debt, these costs would be written off in an amount relative to the amount of principal retired. Income Taxes Income taxes are provided for on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Employee Stock Options The Company accounts for its stock option plans and its employee stock purchase plan in accordance with the provisions of the Accounting Principles Board's Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees." Effective July 1, 1996 the Company adopted the Financial Accounting Standards Board" Statement of Financial Accounting Standard No. 123 "Accounting for Stock Based Compensation." Accordingly, the Company has elected to provide pro forma disclosures as required by SFAS 123. Earnings Per Share In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, Earning Per Share ("EPS"), which is effective for both interim and annual periods ending after December 15, 1997. This standard changes the way companies compute F-10 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) EPS to require all companies to show "basic" and "dilutive" EPS and is to be retroactively applied, including each 1997 interim quarter. Basic earnings per share is based on the net income for the relevant period divided by the weighted average number of shares issued and outstanding during the period. For purposes of the diluted earning per share calculation, the exercise or conversion of all dilutive potential common shares is included, for the years ended June 30, 1998, 1997 and 1996. As of June 30, 1998, the Company had basic and dilutive 3,375,661 common shares outstanding. During 1998, no potentially dilutive shares were considered due to the loss for the year. 3. Extraordinary Gains (Losses) Extraordinary gains (losses) reflected in the financial statements result from the following: June 30, 1998 1997 1996 ---- ---- ---- Net gain on extinguishment of debt.........................$ 150 $ -- $ 84 Gain on conversion of liabilities to equity................ -- 1,192 -- Forfeited deposit.......................................... -- 300 -- Disposal of assets......................................... (256) 3,699 693 ----------- ---------- --------- $ (106) $ 5,191 $ 777 =========== ========== ========= 4. Acquisitions and Dispositions Sale of Assets Fiscal 1998 ----------- In June 1998, a Company subsidiary sold a medical building located in West Orange, New Jersey for an extraordinary loss of $256. Fiscal 1997 ----------- In December 1996, the Company sold 8 acres of land contiguous to the West Orange Facility for an extraordinary gain of $875. In June 1997, facilities in West Palm Beach, Florida and Atlantic City, New Jersey were sold. The Company recorded an extraordinary gain of $2.1 million. In June 1997, the Company sold its 15% interest in a limited partnership which owned and operated a congregate care facility in Teaneck, New Jersey for an extraordinary gain of $700,000. Fiscal 1996 ----------- In May 1996, the Company closed its nursing home in Pine Brook, New Jersey and sold the assets of that nursing home, other than the land and buildings and certain current assets, to another health care provider for $2,390. The Company recorded an extraordinary gain of $693. Nursing Home Group On October 31, 1995, the Company obtained $41,000 in mortgage loans secured by four nursing home facilities located in West Orange, Cedar Grove and Norwood, New Jersey and West Palm Beach, Florida, and proceeds from the issuance of subsidiary Floating Rate Series A Cumulative Preferred Stock totaling $3,500. In addition, the Company obtained a $1,500 loan secured by a mortgage on approximately 8 acres of land located in West Orange, New Jersey. F-11 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) The combined proceeds, totaling $46,000 were used to purchase the West Orange, Cedar Grove and West Palm Beach facilities which were previously operated under operating leases and to purchase the real property of the long term and residential care facility located in Norwood, New Jersey (the "Heritage Facility"), which the Company has been managing since 1988 on behalf of a not for profit corporation ("SCF"). Proceeds of the sale of the West Palm Beach property were used to pay down the mortgage loans and redeem $1,000 of preferred stock. At June 30, 1998 the balance of the mortgage loan is $35,368 and $1,114 of preferred stock is outstanding. As a result of the previously noted purchase of the Heritage Facility by the Company, the Company now owns the facility and manages the operations of SCF. Since October 31, 1995, SCF has been included in the consolidated financial statements of the Company. 5. Property and Equipment Property and equipment, at cost, is comprised as follows: June 30, -------- 1998 1997 ---- ---- Land and improvements...........................................$ 6,049 $ 6,232 Buildings and improvements...................................... 38,908 41,458 Furniture and equipment......................................... 4,614 3,285 Leasehold improvements.......................................... 915 751 Construction progress.......................................... 175 181 ----------- ----------- 50,661 51,907 Less: accumulated depreciation and amortization................. 5,937 4,916 ----------- ----------- $ 44,724 $ 46,991 =========== =========== 6. Long-Term Debt Long-term debt is comprised as follows: June 30, -------- 1998 1997 ---- ---- 6% notes due 2003 .................................................$ 3,400 $ 3,400 6% convertible bonds in the face amount of 662,215 Swiss francs, due June 27, 1995(a)................................. 370 453 8% face amount of Swiss francs 619,500 due June 27, 1998(a) 407 424 8% notes due 1999 (b).............................................. 1,213 1,213 Nomura financing (c) (excludes preferred stock) (d)................ 36,483 37,295 8 1/2% to 11% mortgage notes (e)................................... 2,400 2,963 Other (f).......................................................... 559 1,067 ----------- ---------- 44,832 46,815 Less: current portion 3,916 5,686 ----------- ----------- $ 40,916 $ 41,129 =========== =========== F-12 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) (a) The principal balance of SFr 2,900,000 (approximately $2,525,000) and accrued interest of SFr 174,000 (approximately $152,000) pertaining to the Company's 6% Swiss franc denominated convertible bonds (the "Bonds") was due on June 27, 1995. The Company did not make these payments to redeem the Bonds. Non-payment did not result in a default under any other financing agreements. Between June 30, 1995 and June 30, 1996, the Company acquired SFr 2,164,000 principal amount of Bonds, including accrued interest on those Bonds, for a total of SFr 1,122,375 and $315,000 plus a SFr 619,500 note originally maturing in June 1998 (this note is scheduled to be repaid in four equal installments ending June 1999). During the year ended June 30, 1998 the Company acquired an additional SFr 85,000 principal amount of bonds (with interest) for $78,000. (b) In September 1993, the Company acquired SFr 4,005,000 (approximately $2,647) principal amount of Bonds in exchange for 10,579 shares of 5% exchangeable preferred stock ("Preferred Stock") and $965 principal amount (which included accrued interest on those Bonds) of 8% notes due 1999 ("8% Notes"). In October 1993, the Company acquired an additional SFr 1,250,000 (approximately $826) principal amount of Bonds in exchange for 3,305 shares of Preferred Stock and $248 principal amount of 8% Notes. Interest on the 8% Notes is payable on January 27 and July 27. The Company has the option to redeem in part or in full the 8% Notes at any time for par. (c) On October 31, 1995, the Company obtained mortgage loans of $41.0 million and $1.5 million and subsidiaries issued $3.5 million of preferred stock (see (f)). The proceeds of this financing were used to purchase three nursing homes which had been sold and leased back in 1988, to reacquire the Heritage Facility, which the Company had sold in 1990 to a non-profit corporation and had been operating under a management agreement, and to retire debt. The $41.0 million mortgage loan bears interest at 9.86% per annum and requires payments of principal and interest totaling $4.28 million per year for 15 years. If the Company is unable to pay the balance of $28.19 million which will remain due at the end of 15 years, the interest rate on the mortgage loan will increase, and all cash flow from the mortgaged facilities will have to be used to amortize the balance of the mortgage loan. The mortgage has been paid down by $3,484 with the proceeds of the sale of the West Palm Beach facility. The $1.5 million mortgage loan was paid down and the mortgaged property released. The remaining balance of that loan is $387. (d) The $3.5 million of subsidiary preferred stock requires cumulative dividends which have been charged to interest expense, equal to interest at LIBOR plus 13% on the liquidation preference of the preferred stock. The preferred stock is mandatorily redeemable in monthly installments at the rate of $876,000 per year in 1998 through 2000. $1,000 of preferred stock was redeemed using the proceeds of the sale of the West Palm Beach facility. The payments during the period from October 31, 1995 to June 30, 1996 with regard to the $42.5 million of mortgage loans and the $3.5 million subsidiary preferred stock totaled approximately $3.6 million and $1,511 for the period July 1, 1996 to June 30, 1997. Under the terms of the $41 million loan and $3.5 million subsidiary preferred stock, use of the cash receipts of the four facilities is restricted to: mortgage payments, real estate taxes, insurance F-13 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) and carrying charges, operating expenses, and payment of preferred stock dividends, with any excess retained by the facility. (e) The 8 1/2 to 11% mortgages include debt consisting of an Economic Development Authority mortgage loan ("EDA. loan") with a principal balance of $747 at June 30, 1998 payable monthly installments, including interest at 11%, through 2009. The EDA. loan is secured by property with a net book value of approximately $1,464 at June 30, 1998. The remaining mortgage notes are payable in monthly installments, including interest at notes ranging from 10% to 12% with final payments due between 1997 and 2009. These are secured by properties with an aggregate net book value of approximately $2,623 at June 30, 1998. (f) On October 31, 1995, the Company negotiated, and subsequent to June 30, 1998 amended, terms to convert $1,464 in trade accounts payable into notes with interest at a rate of 10%. This agreement was amended to allow for the payment of the balance due on the notes, along with additional accounts payable, over 24 months, commencing September 1998. The monthly payment of principal and interest of $62 will fully amortize the loan at the end of the term. Current principal payments due under the terms of the note total $744. On October 2, 1996, the Company also negotiated terms to convert $143 in trade accounts payable into a note with interest at 10%. Subsequent to June 30, 1998, the agreement was amended to allow for the payment of the balance due on the notes over 13 months, commencing October 1998. To fully amortize the note, two payments of approximately $7, followed by ten payments of approximately $5 with a final payment of approximately $4 will be due. The Company has aggregate maturities of debt in each of the five year periods ending on June 30 subsequent to June 30, 1998 as follows: 1999-$ 3,916; 2000-$ 562; 2001-$ 611; 2002-$ 661; and 2003-$ 4,112. F-14 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) 7. Other Current Liabilities Other current liabilities are comprised as follows: June 30, -------- 1998 1997 ---- ---- Accrued interest.......................$ 265 $ 293 Accrued payroll and related expenses... 3,955 3,063 Other accrued liabilities.............. 460 904 ----------- ----------- $ 4,680 $ 4,260 =========== =========== Effective May 1, 1997, the nursing home group is covered under a third party health insurance plan. Under the previous self-insured health insurance program, the Company's estimate of its liability for both outstanding as well as incurred but not reported claims is based upon its historical loss experience and is included as a component of accrued payroll and related expenses. 8. Stockholders' Equity During 1997, 41,666 warrants (adjusted for the one-for-three reverse split of Company common stock) were issued to financial consultants of the Company. The costs of the warrants had been calculated at $54 and charged to expense. 33,333 of the warrants are two year warrants, with 11,111 shares at an exercise price of $6.00, 11,111 shares at an exercise price of $7.50, and 11,111 shares with an exercise price of $9.00. The remaining 8,333 warrants expired prior to June 30, 1998. Preferred Stock In 1993, the Company issued 13,884 shares of Preferred Stock as part of an exchange offer to holders of its Bonds. Each share of Preferred Stock has a liquidation preference of $100. Dividends on the Preferred Stock are cumulative and are payable on January 27 and July 27 at the annual rate of $5 per share, when and as declared by the Company's Board of Directors. The Preferred Stock is exchangeable for Infu-Tech common stock at an exchange price of $6.20 liquidation preference of Preferred Stock per share of Infu-Tech common stock, subject to adjustment to prevent dilution. The shares of Infu-Tech common stock issuable upon the exchange of Preferred Stock are shares owned by KUAL. All (but not less than all) of the Preferred Stock is redeemable at the Company's option at any time when the current market price of Infu-Tech common stock has for at least 20 consecutive trading days been at least 120% of the exchange price, upon at least 45 days' notice at a redemption price equal to the liquidation preference of the shares being redeemed plus accumulated unpaid dividends on those shares. Shares may be exchanged for Infu-Tech common stock during the 45-day period. The Company may not pay any dividends or make any other distributions on, or repurchase, its common stock or any other of its stock which ranks junior to the Preferred Stock if the Company is not at the time current in its dividend payments on the Preferred Stock. F-15 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) On October 4, 1996, the Company completed an exchange offer to holders of its 14 1/8% Subordinated Debentures that were due on September 1, 1996. The Company offered for each $1 principal amount of subordinated debentures a share of a new 11% convertible Preferred Stock with a liquidation preference of $1. Of the total of $1,200 subordinated debentures outstanding, $474 principal elected to exchange into Series A 11% Convertible Preferred Stock. After the three years, the Preferred Stock will be convertible into common stock which has a market value totaling 100% of the liquidation preference of the Preferred Stock or for cash if the Company elects to. During the period ended June 30, 1997, $440 face amount of the Series A Convertible Preferred Stock converted into common stock of the Company, leaving $34 face amount of the Series A Convertible Preferred Stock outstanding at June 30, 1998 and 1997. Stock Option Plans The 1989 Key Employees and Key Personnel Stock Option Plan (the "1989 Plan") authorized the Company to grant stock purchase options relating to a maximum of 400,000 shares of common stock. Options may not be granted at a price that is less than 100% of fair market value on the date of the grant (110% of fair market value for persons owning 10% or more of the Company's common stock). Options become exercisable six months after the date of the grant and after the employee has been employed for 12 months, and are exercisable for a term of up to ten years. In January 1997, the Company adopted the 1996 Key Employees and Key Personnel Stock Option Plan, which replaced the 1989 Plan. The 1996 Plan authorized 500,000 additional shares and the conditions are essentially the same as the 1989 Plan. F-16 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) Stock option transactions for the years ended June 30, 1998, 1997 and 1996 are summarized as follows: Weighted Average Number Option Price of Shares Per Share Outstanding, June 30, 1995................................... 112,017 $2.88 Granted (1989 Plan).......................................... 174,917 $3.03 Exercised (1989 Plan) ....................................... (7,000) $1.96 Cancelled (1989 Plan)........................................ (1,350) $1.20 ---------- Outstanding, June 30, 1996................................... 278,584 $3.00 Granted (1989 Plan).......................................... 90,667 $8.46 Exercised (1989 Plan)........................................ (333) $2.82 Cancelled (1989 Plan)........................................ (7,517) $3.18 ---------- Outstanding, June 30, 1997................................... 361,401 $1.46 Granted (1996 Plan).......................................... 225,481 $7.22 Exercised (1996 Plan)........................................ (23,983) $6.83 Cancelled (1996 Plan)........................................ (7,983) $3.38 ---------- ----- Outstanding June 30, 1998.................................... 554,916 $5.44 ========== ===== Options to purchase 819,818 shares were available for grant at June 30, 1998 under the 1996 Plan. The following table summarizes information about stock options outstanding at June 30, 1998: Number Weighted Weighted Number Weighted Range of Outstanding Average Remaining Average Exercisable at Average Exercise Prices at 6/30/98 Contractual Life Years Exercise Price 6/30/98 Exercise Price --------------- ---------- ---------------------- -------------- ------- -------------- $0.75 - $3.75 223,769 5.4 $2.80 173,769 $ 3.61 $4.13 - $6.36 164,777 8.7 $5.45 59,777 $15.02 $7.00 - $15.00 166,370 9.6 $8.97 99,703 $14.96 --------- ------------ ----------- ------ ------ 554,916 7.7 $5.44 333,249 $ 9.05 ========= ============ =========== ======= ====== KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) The Company has computed, for pro forma disclosure purposes for the weighted average fair value per option granted under the stock option plan to be $5.93, $2.19 and $.93 for 1998,1997 and 1996, respectively. The computations were made using the Black-Scholes model, as prescribed by SFAS 123, with the following weighted average assumptions for grants 1998, 1997 and 1996: Years Ended June 30, -------------------- 1998 1997 1996 ------------------------ Risk-free interest rate............... 4.9% 4.9% 5.1% Expected dividend yield............... 0% 0% 0% Expected term until exercise (years) 8.8 6.9 4.00 Expected volatility................... 68.66% 66.67% 75.72% Other Stock Options In January 1994, the Company's Chairman of the Board was granted a seven-year option to purchase 500,000 shares of the Company's common stock for $1 per share. Infu-Tech Stock Option Plans In July 1992, Infu-Tech adopted a stock option plan (the "Infu-Tech Plan") under which it is authorized to grant stock options to designated employees, officers and directors of the Company. The Plan authorized grant of stock options up to a maximum of 150,000 shares of common stock. In 1994, the maximum number of shares which may be granted under the Plan was increased to 300,000 shares of common stock. Options may not be granted at a price that is less than 100% of fair market value on the date of the grant (110% of fair market value for persons owning 10% or more of Infu-Tech common stock). Options become exercisable 12 months after the date of the grant and are exercisable until ten years from the date of grant. In January 1997, Infu-Tech adopted the 1996 Key Employees and Key Personnel Stock Option Plan which replaced the 1992 Plan. The Plan authorized 500,000 shares and the conditions are essentially the same as the 1992 Plan. F-18 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) Stock option transactions related to the Infu-Tech plan for the years ended June 30, 1998, 1997 and 1996 are summarized as follows: Weighted average Number Option Price of shares Per Share --------- ---------------- Outstanding, June 30, 1995............. 178,250 $4.57 Granted ..................... 60,100 $2.60 Cancelled ..................... (17,300) $2.64 Exercised ..................... (12,750) $1.21 ------- ----- Outstanding, June 30, 1996............. 208,300 $4.37 Granted ..................... 461,744 $4.16 Cancelled ..................... (41,400) $4.71 Exercised ..................... (10,750) $2.46 ------- ----- Outstanding, June 30, 1997............. 617,894 $4.24 ======= ===== Granted ..................... 213,500 $5.23 Cancelled ..................... (77,800) $3.92 Exercised ..................... (8,900) $3.27 ------- ----- Outstanding, June 30, 1998............. 744,694 $4.59 ======= ===== Options to purchase 136,562 shares were available for grant at June 30, 1998 under Infu-Tech's 1996 Plan. The following table summaries information about Infu-Tech stock options outstanding at June 30, 1998: Number Weighted Weighted Number Weighted Range of Outstanding Average Remaining Average Exercisable at Average Exercise Prices at 6/30/98 Contractual Life Exercise Price 6/30/98 Exercise Price --------------- ----------- ----------------- -------------- -------------- -------------- $1.00 - $3.13 56,450 7.2 $2.38 56,450 $2.38 $3.38 - $4.13 138,576 8.8 $3.69 113,076 $4.51 $4.25 200,000 8.6 $4.25 200,000 $4.25 $4.50 - $5.88 193,668 9.5 $5.10 178,668 $5.53 $6.00 - $7.00 156,000 7.0 $6.25 110,000 $8.86 -------- ------- --------- --------- --------- 744,694 8.5 $4.65 658,194 $5.25 ======== ======= ========= ========= ========= F-19 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) Infu-Tech computed, the pro forma weighted average fair value per option granted under the stock option plan to be $5.92, $3.41 and $2.10 for 1998, 1997 and 1996. The computations were made using the Black-Scholes model, as prescribed by SFAS 123, with the following weighted average assumptions for grants in 1998, 1997 and 1996: Years Ended June 30, -------------------- 1998 1997 1996 ---------------------- Risk-free interest rate................... 4.2% 4.9% 5.1% Expected dividend yield................... 0% 0% 0% Expected term until exercise (years)...... 8.2 8.5 5.4 Expected volatility....................... 60.79% 68.61% 84.68% If the Company had accounted for its plans and the Infu-Tech plans in accordance with SFAS 123, the Company's net income (loss) and net income (loss) per share applicable to common shareholders would have decrease as reflected in the following pro forma amounts: Years Ended June 30, -------------------- 1998 1997 1996 ---------------------- Net Income: (Loss)........................ As reported............................$ (3,194) $ 1,313 $ 786 Pro forma.............................. (3,880) 730 730 Net Income (loss) per share: Basic as reported......................$ (.95) $ .39 $ .28 Basic pro forma........................ (1.15) .00 .35 Net Income (loss) per share: Diluted as reported...................$ ( .95) $ .39 $ .28 Diluted pro forma..................... (1.15) .00 .35 The pro forma effects on net income may not be representative of the effects in future years since compensation costs are primarily attributed to the year of grant as vesting is within one year. F-20 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) 9. Related Party Transactions At December 31, 1989, the three nursing homes controlled and partially owned by the Principal Stockholders (including the Chairman of the Board of the Company) owed the Company $2,804 which included amounts for supplies, services and management fees. The Chairman of the Board of the company no longer has an ownership interest in two of the nursing homes described below. However, the Principal Stockholders asserted on behalf of the three nursing homes that management fees for all years should have been limited to amounts eligible for reimbursement from Medicare and Medicaid. Early in 1990, this dispute was resolved, with the three nursing homes agreeing to pay a total of $1,940 in satisfaction of all their obligations to the Company at December 31, 1989. During 1992, the settlement agreement between the company and the three nursing homes was modified, whereby the February 1992 balance of $1,046 would be paid in sixteen equal quarterly payments of $76 (including interest at 7 1/2%) beginning June 15, 1992 and continuing through March 15, 1996. In January 1995, the settlement agreement was further modified to provide for a $227 principal and interest payment to be made on or before March 30, 1995 (which payment was received) and the remaining principal balance of $626 to be paid in twelve equal quarterly payments of $60 (including interest at 8 1/2%) beginning July 1, 1995 and continuing through March 31, 1998. The $227 payment included all previously unpaid principal under the prior agreement through December 31, 1993 and all accrued interest under that agreement through March 30, 1995. In June 1997, a credit of $300 was applied against the balance then due. The credit arose because the purchase price obtained by the Company for the sale of a property in Atlantic City was enhanced by $300 due to the contemporaneous sale of a property owned by the principal shareholders to the same buyer. There was no balance remaining on the modified settlement agreement at June 30, 1998. Interest income includes $0, $30 and $44 of interest on this receivable for 1998, 1997 and 1996, respectively. One of the Company's nursing homes was on several occasions forced to temporarily evacuate its residents due to weather-related emergencies. The residents were evacuated to a nursing home controlled and partially owned by the Principal Stockholders. Management believes this course of action was preferable to the alternatives. The Company paid the nursing home to which the residents were evacuated at that nursing home's daily Medicaid rate. Amounts charged to health care and lodging expenses as a result of this were $0, $0 and $31 in 1998, 1997 and 1996, respectively. In 1998, 1997 and 1996, the Company was charged $31, $46 and $73, respectively, by a corporation owned by the Company's Chairman of the Board for use of an airplane owned by that corporation. The Company believes the rates it was charged for use of that airplane were lower than those which would have been available from an independent charter company for use of a similar airplane. Included in selling, general and administrative expenses in 1996 is rent expense of $326, for office space leased from an entity owned by the Principal Stockholders. Space is no longer owned by the Principal Stockholders. The Company administered a self-funded health plan on behalf of three nursing homes controlled and partially owned by the Company's Principal Stockholders (the "Principal Stockholders' Nursing Homes"). Included in accounts receivable at June 30, 1998 and 1997 are amounts due from the Principal Stockholders' Nursing Homes of $15 and $15, respectively. Included in the balance sheet were additional amounts due from entities owned by the Principal Stockholders totaling $246 at June 1998 and $246 at June 30, 1997. F-21 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) John A. Schepisi is the president of Senior Care Foundation, Inc., the owner of the Heritage Facility, which is included in the consolidated financial statements. He is also a partner a law firm which provides legal services to the Company. 10. Income Taxes The provision (benefit) for income taxes on income (loss) from operations is presented below: Years Ended June 30, -------------------- 1998 1997 1996 ---- ---- ---- Current: Federal..................... $ -- $ 425 $ 70 State .................. -- 90 5 ------ ----- ------ -- 515 75 ------ ----- ------ Deferred: Federal..................... 124 143 165 State .................. 25 29 30 Other .................. -- -- ------ ----- ------ 149 172 195 ------ ----- ------ $ 149 $ 662 $ 270 ====== ===== ====== Infu-Tech had recorded a Federal and state income tax payable of $194 which is included in other current liabilities in the accompanying June 30, 1998 balance sheet. F-22 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) The following table reconciles the Federal income tax provision (benefit) computed at statutory Federal income tax rates applied to income (loss) from continuing operations to the provision (benefit) for income taxes. Years Ended June 30, -------------------- 1998 1997 1996 ---- ---- ---- Federal income tax provision (benefit) at statutory rate applied to income (loss) from continuing operations..................$ (961) $ (1,049) $ 119 State income tax provision, (benefit), net of Federal income tax benefit (194) (216) 24 Extraordinary gains (loss)...................... (36) 2,128 319 Change in valuation allowance................... 1,292 -- (203) Allowance for temporary differences -- (162) -- Permanent difference arising from acquisitions and dispositions -- -- -- Refunds of prior years' Federal income taxes -- -- Other ......................................... 48 (39) 11 -------- --------- --------- $ 149 $ 662 $ 270 ======== ========= ========= The Company has approximately $11,947 of net operating tax loss carryforwards for federal income tax purposes which will expire in the years 2005 through 2011. F-23 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets are as follows: June 30, ------------------------ 1998 1997 ---- ---- Net deferred income tax assets: Allowances for uncollectible accounts receivable.....................$ 1,509 $ 1,743 Net operating tax loss carryforwards................................. 4,551 3,225 Cumulative unrealized losses on translation of foreign currency debt...................................................... 34 (66) Compensated absences, principally due to accrual for financial reporting purposes....................................... 335 328 Difference between book and tax bases of investment in subsidiary......................................................... (686) (662) Difference between book and tax bases of property and equipment.......................................................... 74 89 Other ....................................................... 103 122 ----------- ---------- Sub-total........................................................ 5,920 4,779 Valuation allowance...................................................... (5,369) (4,077) ----------- ---------- Net deferred income tax assets.....................................$ 551 $ 702 =========== ========== A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. Based upon the Company's historical losses from operations before extraordinary gains, the Company has recorded a valuation allowance of $5,369. This represents a 100% valuation allowance for all net deferred income tax assets, except for part of those pertaining to its 58% owned subsidiary, Infu-Tech. Infu-Tech has historically been profitable and anticipates taxable income in future years. In the opinion of management, Infu-Tech will realize the net deferred income tax assets. F-24 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) 11. Other Income, Net Other income (expense) is comprised as follows: Years Ended June 30, -------------------- 1998 1997 1996 ---- ---- ---- Gains on sales and leasebacks of property and equipment ...............................$ -- $ -- $ 417 Gains (losses) on translation of foreign currency debt................................ 82 161 130 Amortization of deferred income related to non-compete agreement ....................... -- 72 126 Other, net ...................................... 664(a) 308 (123) ------ --------- ---------- $ 746 $ 541 $ 550 ====== ========= ========== (a) Of this amount, $543 relates to the review and writeoff of accounts payable, partially related to the previous sale of two nursing homes. 12. Commitments and Contingencies Lease Commitments The Company is obligated under various operating leases for nursing homes, office space and equipment with initial terms expiring at various dates through 2002. The leases generally require the Company to pay all costs of maintaining the leased properties. The Company has options to renew certain of these leases for periods ranging from 7 to 80 years. The following is a schedule of future minimum annual rental payments required under operating leases as of June 30, 1998: Year ending Nursing June 30, Homes Office Equipment Total ----------- ------- ------ --------- ----- 1999............................. 318 370 3 691 2000............................. 321 325 --- 646 2001............................. 286 49 --- 335 2002............................. 266 25 --- 291 2003 and thereafter.............. 200 4 --- 204 ------ ------ ---- ------ $1,705 $1,259 $ 3 $2,967 ====== ====== ==== ====== Rent expense was $901, $668 and $2,764 in 1998, 1997 and 1996, respectively. F-25 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) Employment Commitments The Company has an employment agreement with its Chairman of the Board and President, who is also Chairman of the Board of Infu-Tech, Inc., through July 2000. He renders services to Kuala for a salary of $250 per year. Pursuant to this employment agreement, he is entitled to a bonus based upon an increase in the market capitalization of the Company (based on a fixed number of shares as defined in the agreement), above the 1995 base year. As of June 30, 1998, a bonus payable of $642 has been reflected which is net of $108 payable by Infu-Tech. No amount was earned in the prior period, prior to the 1:3 reverse stock split of the Company, that was effected in January 1998. Contingencies The Company is obligated to issue 33,333 shares of common stock, should the holders of warrants of the Company's common stock, which expire in December 1998, elect to exercise their warrants, at an average of $7.50 per share. The Company recorded as a receivable an amount of $591 based on a settlement of Medicaid audits. The Company has received a payment of $175, with the balance being held by a State agency to offset purported claims. The Company has filed a legal action to enforce the settlement to receive the balance of the settlement amount. Participants in the health care market are subject to lawsuits based upon alleged negligence or similar legal theories. The Company currently has in force general liability insurance, including professional and product liability, with coverage limits of $10 million, per occurance, which is subject to annual renewal. The Company has not recorded any related loss liabilities as of June 30, 1998. In March 1997, the Company exchanged 600,000 shares of common stock to extinguish liabilities of $2,542, based on the fair value of shares. Of this, $1,192 was reflected as an extraordinary gain in the results of operations in 1997. In the opinion of management, the ultimate liability with respect to these activities will not materially affect the financial position or results of operations of the Company. 13. Distribution Agreement In November 1994, the Company entered into a distribution agreement with a drug manufacturer under which the company provides a specific home infusion therapy utilizing the manufacturer's drug. This agreement was renewed in January 1998 for another year. Under this agreement, accounts payable to the drug manufacturer ($1,210 at June 30, 1998) are secured by the Company's inventories of the drug ($118 at June 30, 1998) and related accounts receivable ($1,121 at June 30, 1998). 14. Business and Credit Concentrations The Company generally does not require collateral or other security in extending credit to patients; however, the Company routinely obtains assignment of (or is otherwise entitled to receive) patients' benefits payable under health insurance programs, plans or policies (e.g., Medicare, Medicaid, Blue Cross, health maintenance organizations, and commercial insurance policies). At June 30, 1998, the Company had gross receivables from the Federal Government (Medicare) of approximately $3,600 and from various state Medicaid programs of approximately $3,500 at June 30,1998 and $5,243 and $4,982, respectively, at June 30, 1997. F-26 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) 15. Business Segment Data The Company's operations are conducted primarily through two business segments: nursing home services and Infu-Tech, which provides infusion therapy and other medical services to the non-hospital based health care market. Information about the Company's operations is presented below. Operating income is comprised of total revenues less operating expenses, excluding expenses incurred at the corporate headquarters. The elimination of inter-segment revenues is included in other services and eliminations. Years Ended June 30, ----------------------------------------- 1998 1997 1996 ---- ---- ---- Revenues: Nursing home services...........................$ 34,994 $ 44,033 $ 44,440 Infu-Tech . . . . .............................. 26,029 26,003 24,114 Other services and eliminations................. 2,903 658 1,326 ----------- ----------- ----------- Consolidated................................$ 63,926 $ 70,694 $ 69,880 =========== =========== =========== Operating income (loss): Nursing home services...........................$ 3,393 $ 3,660 $ 4,329 Infu-Tech . . . . ............................... 617 1,793 1,745 Other services . . ............................. 43 -- -- Expenses incurred at corporate headquarters (2,791) (2,446) (1,958) Interest and dividend income.................... 225 104 221 Interest and other financing costs.............. (4,904) (6,343) (4,044) Other income, net............................... 746 541 550 Less: Minority interest in earnings of subsidiaries .............................. (154) (395) (494) ----------- ----------- ----------- Consolidated................................$ (2,825) $ (3,086) $ 349 =========== =========== =========== Assets: Nursing home services...........................$ 50,506 $ 54,855 $ 61,592 Infu-Tech ................................... 12,122 11,618 9,484 Corporate ................................... 3,889 4,877 7,366 ----------- ----------- ----------- Consolidated................................$ 66,517 $ 71,350 $ 75,572 =========== =========== =========== Depreciation and amortization of property and equipment Nursing home services...........................$ 1,435 $ 1,655 $ 1,331 Infu-Tech ................................... 152 139 108 Corporate ................................... 111 125 98 ----------- ----------- ----------- Consolidated................................$ 1,698 $ 1,919 $ 1,537 =========== =========== =========== Capital expenditures: Nursing home services...........................$ 571 $ 298 $ 47,472 Infu-Tech ................................... 243 62 19 Corporate ................................... -- 14 101 ----------- ----------- ----------- Consolidated ..............................$ 814 $ 374 $ 47,592 =========== =========== =========== F-27 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) 16. Estimated Fair Value of Financial Instruments The estimated fair value of financial instruments has been determined based upon available market information and appropriate valuation methodologies. However, considerable judgement is necessarily required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company might realize in a current market exchange. The use of different market assumptions and or estimation methodologies may have a material effect on the estimated fair value. The carrying amounts of short term financial instruments are reasonable estimates of their fair values. The carrying value of long term debt approximates its fair value. While interest rates have generally declined, the cost of borrowing to the Company has not changed significantly. 17. Fourth Quarter Adjustments and Changes in Estimates Changes in Estimates During the fourth quarter of 1998, the Company conducted a review of annually submitted Medicare cost reports and reflected a reduction of $500 in anticipated Medicare receipts in order to more reasonably estimate the balance in consideration of the current reimbursement environment.. During 1997, the Company evaluated various liabilities and accruals in the nursing home operation. The result of this review enabled the Company to write back to income $1,252 from various liabilities and payables not expected to be paid. Further, a settlement with a vendor enabled the Company to reduce a liability by $460 of which $190 was reflected in the fourth quarter. Fourth Quarter Adjustments. Personnel Expenses As described in note 12 regarding Employment Commitments, the Company reflected a bonus payable of $642 to its Chairman and President during the fourth quarter of fiscal 1998. A bonus payable of $108 by Infu-Tech, Inc. to its and the Company's Chairman of the Board and President was also reflected during the fourth quarter. No such bonus was earned in the prior fiscal year. Extraordinary Losses A Company subsidiary sold a medical building located in West Orange, New Jersey for $1,200, resulting in an extraordinary loss of $256 during the fourth quarter of fiscal 1998. Provision for Uncollectible Accounts The Company conducted a comprehensive review of days outstanding of its accounts receivable. As a result, it increased the provision for uncollectible accounts by approximately $500 during the fourth quarter of 1998 to better estimate their net realizable value. F-28 KUALA HEALTHCARE, INC. Notes to Consolidated Financial Statements June 30, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts) Miscellaneous Accrued Expenses During the fourth quarter of 1998, miscellaneous accrued expenses of approximately $200 were reflected by the Company, primarily attributed to recognition of various legal expenses. The Company's 58% owned subsidiary Infu-Tech recorded the following adjustments in the fourth quarter of fiscal year 1997. No such adjustments were necessary for the fourth quarter of fiscal 1998. Inventory Infu-Tech recorded an inventory adjustment during the fourth quarter of fiscal 1997. A gross amount of $450 before taxes was recorded as a decrease to inventory with a corresponding increase to medical and nutritional product costs. The adjustment arose as a result of a physical inventory conducted on June 30, 1997. Infu-Tech conducted quarterly physical inventory counts during the year. No significant differences arose during these quarterly physical counts. Reserve for Uncollectible Accounts Beginning in the quarter ending March 31, 1997, Infu-Tech reviewed its allowance for uncollectible accounts in light of its changed payor mix. Infu-Tech's business focus is on managed care relationships which now accounts for 73% of its payor mix. The managed care relationships are generally governed by contracts which provide for payment within defined terms. Infu-Tech's collection experience for these contracts has been good and greatly improved from the historical collection experience upon which the allowance for uncollectible accounts had been established. As a result of this review, the allowance for uncollectible accounts was reduced by a total of $1,366 before taxes ($348 in the quarter ending March 31, 1997, and a further $1,018 in the fourth quarter of fiscal 1997) resulting in a credit to the provision for the year of $196 compared to a charge of $1,269 in the prior year. 18. Liquidity During fiscal 1998, the Company experienced a decrease in working capital resulting in a negative current ratio. Although the Company continues to experience cash flow constraints, it anticipates being able to meet its financial obligations from fiscal 1999 operations. In addition, the Company has signed a non-binding letter of intent with a purchaser of nursing homes to sell a 49% interest in five of the Company's nursing homes. Furthermore, cash realized from the sale of certain other assets could assist the Company, where necessary, in meeting its obligations. 19. Subsequent Event In September, 1998, the Company signed a non-binding letter of intent with Care One, LLC, a privately held New Jersey based long term care company, for the acquisition by Care One of a 49% interest in its five nursing homes and a 100% interest in the Company's institutional pharmacy business. Care One would have the option to purchase the remaining 51% interest in the nursing homes in the future. Furthermore, an assisted living joint venture will be formed with the Company initially contributing its 120 unit project based in Norwood, New Jersey. The Company would receive approximately $15 million in cash for its 49% interest in its nursing homes and its institutional pharmacy business. The Company would also receive $2 million for a 49% interest in the assisted living venture. F-29 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. KUALA HEALTHCARE, INC. Date: October , 1998 By: /S/ JACK ROSEN ---------------- --------------------- Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Company and the capacities and on the dates indicated: /S/ JACK ROSEN Chairman of the Board, Director --------------------------- (Principal Executive Officer) Jack Rosen /S/ ROY SMOLARZ Executive Vice President --------------------------- (Principal Financial Officer) Roy Smolarz /S/ KATHLEEN GAGE Principal Accounting Officer --------------------------- Kathleen Gage /S/ JOSEPH ROSEN Director --------------------------- Joseph Rosen /S/ ISRAEL INGBERMAN Director --------------------------- Israel Ingberman /S/ JOSEPH M. GIGLIO Director --------------------------- Joseph M. Giglio /s/ Carl D. Glickman Director --------------------------- Carl D. Glickman /s/ Bruce Slovin Director --------------------------- Bruce Slovin Schedule II KUALA HEALTHCARE, INC. Valuation and Qualifying Accounts (Dollars in thousands) Years Ended June 30, 1998, 1997 and 1996 Column A Column B Column C Column D Column E Additions --------- Balance at Charged to Balance beginning cost and at end Description of period expenses Other Deductions (a) of period ----------- ---------- ---------- ----- -------------- --------- Allowance for uncollectible accounts: 1998 $4,252 $ 625 $ -- $1,196 $3,681 ====== ====== ======== ====== ====== 1997 $4,193 $ (66) $ 513 $ 388 $4,252 ====== ====== ======== ====== ====== 1996 $3,712 $1,210 $ -- $ 729 $4,193 ====== ====== ======== ====== ====== (a) Uncollectible accounts charged-off during the year, net of recoveries. S - 1 Exhibit 11 KUALA HEALTHCARE, INC. Calculation of Earnings Per Share Year ended June 30, 1998 (Dollars in thousands, except per share amounts) Earnings Per Share: (restated for 1:3 common stock split) Net income (loss) available to common shareholders..............$ (3,194) =========== Weighted average shares...................................... 3,375,661 Plus: Incremented shares from assumed conversions warrants .. -- Dilutive potential common shares............................. -- Adjusted weighted average shares............................. 3,375,661 Basic EPS Income (loss) before extraordinary item......................$ (0.92) Extraordinary item........................................... (0.03) ----------- Net income (loss) ...........................................$ (0.95) =========== Diluted EPS Income (loss) before extraordinary item......................$ (0.92) Extraordinary item........................................... (0.03) ----------- Net income .................................................$ (0.95) =========== Exhibit 11.1 KUALA HEALTHCARE, INC. Calculation of Earnings Per Share Year ended June 30, 1997 (Dollars in thousands, except per share amounts) Earnings Per Share: (restated for 1:3 common stock split) Net income available to common shareholders....................$ 1,313 ========== Adjustment of shares outstanding: Weighted average number of shares outstanding........... 3,199,886 Average net additional equivalent shares issuable....... 181,182 ---------- Weighted average number of common and common equivalent shares....................................... 3,381,068 ========== Earnings per share.............................................$ 0.39 ========== Exhibit 11.2 KUALA HEALTHCARE, INC. Calculation of Earnings Per Share Year ended June 30, 1996 (Dollars in thousands except per share amounts) Earnings Per Share: (restated for 1:3 common stock split) Net income available to common shareholders................................$ 786 =========== Adjustment of shares outstanding: Weighted average number of shares outstanding....................... 2,673,879 Average net additional equivalent shares issuable................... 132,240 ----------- Weighted average number of common and common equivalent shares...... 2,806,119 =========== Earnings per share.........................................................$ .28 =========== The above does not give effect to the assumed conversion of the 6% SFr convertible bonds since the effect is antidilutive as shown below: Net income available to common shareholders.........................$ 786 Add after tax effect of eliminating interest expense applicable to 6% SFr convertible bonds........................... 55 ----------- Net income as adjusted..............................................$ 841 =========== Weighted average number of common and common equivalent shares................................................. 2,814,768 Additional weighted average shares from assuming conversion of 6% SFr convertible bonds............................ 6,253 ----------- Weighted average number of common and common equivalent shares, as adjusted.................................... 2,821,021 =========== Earnings per share.........................................................$ .30 =========== Exhibit 21 KUALA HEALTHCARE, INC. AND SUBSIDIARIES The following are the subsidiaries of Kuala Healthcare, Inc.. A) Alternative Care, Inc. (a Massachusetts corporation). B) TNS Nur-Temps, Inc. (a New York corporation). C) Temporary Nursing Services of California, Inc. (a California corporation). D) Temporary Nursing Services of Florida, Inc. (a Florida corporation). E) Temporary Nursing Services of Philadelphia, Inc. (a Pennsylvania corporation). F) Temporary Nursing Services of Kansas, Inc. (a Kansas corporation). G) Temporary Nursing Services of Texas, Inc. (a Texas corporation). H) Infu-Tech, Inc. (a Delaware corporation). 1) Infu-Tech, Inc. (a New Jersey corporation) (formerly Temporary Nursing Services, Inc.). 2) Infu-Tech of Florida, Inc. (a Florida corporation). 3) Infu-Tech of Illinois, Inc. (a Illinois corporation). 4) Infu-Tech of Massachusetts, Inc. (a Massachusetts corporation). 5) Infu-Tech of New York, Inc. (a New York corporation). 6) Infu-Tech of Tennessee, Inc. (a Tennessee corporation). 7) Intrx Medical, Inc. (a New Jersey corporation). I) TNS Nursing Homes, Inc. (a Delaware corporation). 1) Jayber, Inc. (a New Jersey corporation). 2) Pompton Avenue Associates, Inc. (a New Jersey corporation). 3) Cape May Care Center, Inc. (a New Jersey corporation). 4) Hilltop Care Center, Inc. (a New Jersey corporation). 5) P.V.M. Associates, Inc. (a Florida corporation). 6) Continental Beachview, Inc. (a New Jersey corporation). 7) Continental Beachview Realty, Inc. (a New Jersey corporation). 8) Continental Norwood, Inc. (a New Jersey corporation). 9) Continental Norwood Holdings, Inc. (a New Jersey corporation). 10) TNS Nursing Homes of Pennsylvania, Inc. (a Pennsylvania corporation). 11) Continental Teaneck Realty, Inc. (a New Jersey corporation). 12) Continental Riverview Realty, Inc. (a New Jersey corporation). J) Continental Media, Inc. (a Delaware corporation). K) Continental Home Care, Inc. (a New Jersey corporation). 1) Marketech, Inc. (a Delaware corporation). L) TNS Certified Home Health Care Corp. (a New York corporation). M) Mid-South Comprehensive Home Health and Hospice, Inc. (a Tennessee corporation). N) Mid-South Staffing Services, Inc. (a Tennessee corporation). O) Continental Florida Management, Inc. (a Delaware corporation). P) TNS Home Life Support System, Inc. (a New Jersey corporation). Q) CH Acquisition, Inc. (a Delaware corporation). R) CompreMedx Corporation (a Delaware corporation) (formerly CompreMedx Cancer Centers Corporation). 1) Medparc Development Corp. (a New Jersey corporation). 2) CompreMedx Medical Management, Inc. (a New Jersey corporation). 3) Continental Property Management Corp. (a New Jersey corporation). 4) Continental Nutrition Corp. (a Ohio corporation). 5) CompreMedx Case Management, Inc. (a Delaware corporation) (formerly CompreMedx, Inc.). 6) CompreMedx Rehabilitation Services, Inc. (a New Jersey corporation). 7) CompreMedx Pharmaceuticals, Inc. (a New Jersey corporation). S) First American Norwood, Inc. (a New Jersey corporation). T) Cambridge Home Health Care, Inc. (a Delaware corporation). U) Continental Pharmaceuticals International, Inc. (a Delaware corporation) (formerly Continental Sana International, Inc.). V) Continental Pharmaceuticals, Inc. (a Delaware corporation).