FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the quarterly period ended February 29, 1996 ------------------------------------ OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the transition period from to ----------------------- --------------------- Commission file number 0-13879 ------------------------------------------------------- SALICK HEALTH CARE, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 95-4333272 - ------------------------------- -------------------------------- (State or other jurisdiction of (I.R.S Employer incorporation or organization) identification number) 8201 Beverly Boulevard, Los Angeles, California 90048-4520 - --------------------------------------------------------------------- (Address of principal executive offices) (Zip code) (213) 966-3400 - --------------------------------------------------------------------- (Registrant's telephone number, including area code) No Change - --------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO_____ ----- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: 5,657,115 shares of common stock, $.001 par value at March 31, 1996 - ------------------------------------------------------------------------------- 5,640,082 shares of callable puttable common stock, - -------------------------------------------------------------------------------- $.001 par value, at March 31, 1996 - -------------------------------------------------------------------------------- Exhibit Index on Page 21 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SALICK HEALTH CARE, INC. CONSOLIDATED BALANCE SHEETS ASSETS February 29, 1996 August 31, 1995 ------------------ ---------------- (UNAUDITED) Current assets: Cash $ 378,000 $ 642,000 Marketable securities 46,580,000 44,631,000 Accounts receivable, less allowance for doubtful accounts of $3,353,000 and $2,885,000 42,253,000 36,248,000 Inventories 1,801,000 1,305,000 Prepaid expenses 2,256,000 1,677,000 Other current assets 2,333,000 1,967,000 Refundable income taxes 2,545,000 2,545,000 Deferred income taxes 3,326,000 5,047,000 ------------ ------------ Total current assets 101,472,000 94,062,000 Property and equipment, at cost, less accumulated depreciation and amortization of $36,735,000 and $32,841,000 105,736,000 101,651,000 Deposits 706,000 725,000 Deferred income taxes 862,000 Goodwill, net 5,613,000 5,494,000 Other assets 5,838,000 5,166,000 ------------ ------------ $220,227,000 $207,098,000 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable to bank $ 33,379,000 $ 18,072,000 Accounts payable and accrued liabilities 35,092,000 41,063,000 Income taxes payable 2,311,000 Current portion of long-term obligations 3,169,000 4,952,000 ------------ ------------ Total current liabilities 73,951,000 64,087,000 Deferred income taxes 67,000 Capitalized lease obligations, less current portion 4,792,000 5,235,000 Long-term debt, less current portion 4,842,000 5,910,000 Other liabilities 2,000,000 2,400,000 Minority interest (30,000) (29,000) ------------ ------------ Total liabilities 85,555,000 77,670,000 ------------ ------------ 2 SALICK HEALTH CARE, INC. CONSOLIDATED BALANCE SHEETS February 29, 1996 August 31, 1995 ----------------- --------------- (UNAUDITED) Commitments and contingencies Stockholders' equity: Preferred stock, $.001 par value, 5,000,000 shares authorized, none issued Common stock, $.001 par value, 15,000,000 shares authorized, 5,657,115 shares issued and outstanding 6,000 6,000 Callable puttable common stock, $.001 par value, 7,500,000 shares authorized, 5,640,082 and 5,634,082 shares issued and outstanding 5,000 5,000 Additional paid in capital 79,810,000 79,738,000 Unrealized holding gains 229,000 44,000 Retained earnings 54,622,000 49,635,000 ------------ ------------ Total stockholders' equity 134,672,000 129,428,000 ------------ ------------ $220,227,000 $207,098,000 ============ ============ See accompanying notes to consolidated financial statements. 3 SALICK HEALTH CARE, INC. CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Months Ended Six Months Ended February 29, February 28, February 29, February 28, ------------------ ----------------- ------------- ------------- 1996 1995 1996 1995 ------------------ ----------------- ------------- ------------- Revenues: Operating revenues, net $39,110,000 $38,170,000 $76,624,000 $74,346,000 Operating expenses: Medical supplies and services 7,459,000 6,601,000 14,300,000 12,982,000 Salaries and related costs 16,400,000 15,774,000 31,621,000 30,344,000 Other administrative expenses 5,606,000 5,048,000 11,080,000 10,455,000 Contract and occupancy costs 4,250,000 4,183,000 8,234,000 7,886,000 Depreciation and amortization 2,211,000 2,039,000 4,377,000 4,079,000 ----------- ----------- ----------- ----------- Total expenses 35,926,000 33,645,000 69,612,000 65,746,000 ----------- ----------- ----------- ----------- Operating income 3,184,000 4,525,000 7,012,000 8,600,000 Merger transaction expenses (526,000) (526,000) Net interest income 252,000 264,000 956,000 281,000 Net investment gains (losses) 192,000 (63,000) 277,000 (124,000) Minority interest 225,000 550,000 ----------- ----------- ----------- ----------- Income before income taxes and cumulative effect of change in accounting principle 3,628,000 4,425,000 8,245,000 8,781,000 Provision for income taxes 1,411,000 1,825,000 3,258,000 3,543,000 ----------- ----------- ----------- ----------- Income before cumulative effect of change in accounting principle 2,217,000 2,600,000 4,987,000 5,238,000 Cumulative effect on prior years (to August 31, 1994) of expensing pre-operating costs as incurred, net of income taxes (3,588,000) ----------- ----------- ----------- ----------- Net income $ 2,217,000 $ 2,600,000 $ 4,987,000 $ 1,650,000 =========== =========== =========== =========== 4 SALICK HEALTH CARE, INC. CONSOLIDATED STATEMENTS OF INCOME (CONTINUED) (UNAUDITED) Three Months Ended Six Months Ended February 29, February 28, February 29, February 28, ------------------ ----------------- ------------ ------------- 1996 1995 1996 1995 ------------------ ----------------- ------------ ------------- Earnings per share: Primary: Income before cumulative effect of change in accounting principle $ 0.20 $ 0.26 $ 0.44 $ 0.56 Cumulative effect on prior years (to August 31, 1994) of expensing pre-operating costs as incurred (0.38) ------------ ------------ ------------ ------------ Net earnings per share $ 0.20 $ 0.26 $ 0.44 $ 0.18 ============ ============ ============ ============ Fully diluted: Income before cumulative effect change in accounting principle $ 0.20 $ 0.25 $ 0.44 $ 0.53 Cumulative effect on prior years (to August 31, 1994) of expensing pre-operating costs as incurred (0.34) ------------ ------------ ------------ ------------ Net earnings per share $ 0.20 $ 0.25 $ 0.44 $ 0.19 ============ ============ ============ ============ Weighted average number of shares used in computing earnings per share: Primary 11,309,000 9,985,000 11,308,000 9,414,000 ============ ============ ============ ============ Fully diluted 11,309,000 10,738,000 11,309,000 10,736,000 ============ ============ ============ ============ See accompanying notes to consolidated financial statements. 5 SALICK HEALTH CARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Six Months Ended February 29, February 28, ------------- ------------- 1996 1995 ------------- ------------- Cash flow provided (used) by operations: Net income $ 4,987,000 $ 1,650,000 Add items not requiring cash: Depreciation and amortization 4,377,000 4,079,000 Amortization of debt issue costs 23,000 Deferred income taxes 792,000 (248,000) Minority interest in net loss, net of distributions (1,000) (673,000) Cumulative effect on prior years (to August 31, 1994) of expensing pre-operating costs as incurred 5,981,000 Changes in assets and liabilities: Accounts receivable (6,005,000) (8,049,000) Inventories (496,000) (203,000) Prepaid expenses (579,000) (679,000) Other current assets (366,000) 121,000 Deposits and other assets (807,000) 92,000 Accounts payable and accrued liabilities (6,379,000) 1,997,000 Income taxes payable 2,311,000 (1,718,000) ------------ ------------ Net cash flow provided (used) by operations (2,166,000) 2,373,000 ------------ ------------ Cash flow provided (used) by investing activities: Increase in marketable securities (1,764,000) (921,000) Additions to property and equipment (8,180,000) (14,428,000) Payment for purchase of acquisitions (168,000) (150,000) ------------ ------------ Net cash flow used by investing activities (10,112,000) (15,499,000) ------------ ------------ Cash flow provided (used) by financing activities: Reduction of capitalized lease obligations (530,000) (470,000) Decrease of long-term debt (2,835,000) (876,000) Notes payable to bank 15,307,000 12,172,000 Issuance of common stock 72,000 811,000 ------------ ------------ Net cash flow provided by financing activities 12,014,000 11,637,000 ------------ ------------ 6 SALICK HEALTH CARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (UNAUDITED) Six Months Ended February 29, February 28, ------------ ------------ 1996 1995 ------------ ------------ Decrease in cash $(264,000) $(1,489,000) Cash, beginning of period 642,000 1,692,000 --------- ----------- Cash, end of period $ 378,000 $ 203,000 ========= =========== Schedule of non-cash investing and financing activities: Conversion of 7.25% convertible subordinated debentures due January 31, 2001 into common stock $25,575,000 =========== Capital lease obligations incurred for property and equipment $ 70,000 $ 2,265,000 ========= =========== Deferred bond issue costs $ 400,000 =========== Unrealized holding gains (losses) $ 185,000 $ (100,000) ========= =========== See accompanying notes to consolidated financial statements. 7 SALICK HEALTH CARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1 - In the opinion of management, the information furnished reflects all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair statement of the interim financial information. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted. It is suggested that these condensed financial statements be read in conjunction with the financial statements and notes thereto included in the Company's August 31, 1995 audited financial statements. The results of operations for the three and six month periods ended February 29, 1996 are not necessarily indicative of the operating results for the full year. Note 2 - In fiscal 1995, the Company changed its method of accounting from deferral to expensing pre-operating costs as incurred. In prior years, pre-operating costs had been deferred and amortized over a three year period upon commencement of facility operations. In fiscal 1995 fourth quarter, giving effect to the first quarter, the Company recorded the cumulative effect of the change in accounting principle of $3,588,000, net of income taxes of $2,393,000. In the accompanying financial statements, the fiscal 1995 periods have been restated to reflect the current and cumulative effects of the change in accounting principle. This change in accounting for pre-operating costs was adopted as management believes this method of accounting better reflects the Company's current methods of operations and it conforms to the method followed by Zeneca Group, PLC, the beneficial owner of more than 50% of the Company's common equity. Note 3 - On December 27, 1995, a Columbia/HCA Healthcare Corporation subsidiary, the owner of one of the Company's Cancer Center affiliated hospitals, Westlake Medical Center, announced that it was closing Westlake Medical Center. Under the terms of the agreement with Columbia/HCA, a subsidiary of the Company had the right to and gave notice of its intent to purchase Westlake Medical Center with the purchase price of the hospital being determined by three appraisers taking into account, among others, the fact that the hospital is intended to be used for the treatment of patients with cancer, kidney disease, organ transplantation, AIDS and related illnesses. The Company expects the purchase to be consummated during the summer of 1996. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SECOND FISCAL QUARTER ENDED FEBRUARY 29, 1996 COMPARED TO SECOND FISCAL QUARTER - ------------------------------------------------------------------------------- ENDED FEBRUARY 28, 1995 - ----------------------- Operating revenues increased in the second quarter of fiscal 1996 by 2.5% to $39,110,000 from $38,170,000 in the second quarter of fiscal 1995. Operating income was $3,184,000 or 29.6% below the prior year's second quarter and operating margins were 8.1% and 11.9% in the quarters ended February 29, 1996 and February 28, 1995, respectively. Income before taxes and the cumulative effect of change in accounting principle described below and in the notes to the consolidated financial statements was reduced by 18% to $3,628,000 in the current fiscal quarter from $4,425,000 in fiscal 1995. Net income was $2,217,000, as compared to $2,600,000 in the prior year's second quarter. For the six month periods, operating revenues increased by 3.1% to $76,624,000 from $74,346,000 with operating income of $7,012,000 or 18.5% less than the prior six month period. Income before the cumulative effect of change in accounting principle decreased $251,000 or 4.8% representing 6.5% of operating revenues, down from 7% for the corresponding six month period. Weighted average shares outstanding used in computing earnings per share increased over the second quarter and six month periods in fiscal 1995 due to exercise of stock options in connection with the Company's April 13, 1995 merger with a subsidiary of Zeneca Limited and conversion of the Company's subordinated convertible debentures in January 1995. The quarter and six month results reflect an increase in business particularly in the volume of the Company's managed care business which generally has lower reimbursement rates, an increase in the total dollar amounts of payments received for the Company's services and programs under capitated (per member per month) agreements and other changes, primarily consisting of reductions in reimbursement resulting in an increase in the Company's contractual allowance expense. Revenues, operating income and net income were also affected by expansion of the Company's services and programs, additional costs in connection with the opening and operations of permanent facilities at Alta Bates and Mount Sinai Comprehensive Cancer Centers, the results of operations of the Company's recently acquired Walnut Creek, California facility which is affiliated with the Alta Bates Comprehensive Cancer Center, the expansion of programs and the addition of personnel and related costs to support and expand the Company's development, strategic planning, information systems and physician network activities. During second quarter fiscal 1996 the Company has acquired The Breast Center in Van Nuys, California, the first free-standing multidisciplinary breast center in the United States and one of the nation's most highly respected medical facilities in the field of breast disease. In addition, the Company entered into an agreement with Pacific Hematology-Oncology Associates (PHOA), a highly respected physician group specializing in oncology in San Francisco. Under the terms of this agreement, PHOA facilities and physicians are a San Francisco affiliate facility for the Alta Bates Comprehensive Cancer Center. 9 The Company's change in accounting principle from deferring to expensing pre-operating costs when incurred, as described in Note 2 to the consolidated financial statements adversely affected both fiscal 1995 and 1996 second quarter and six month operating income, net income and earnings per share. The Company adopted this method of accounting for pre-operating costs in fiscal 1995 based on management's belief that this method of accounting better reflects the Company's current methods of operations and as it also conforms to the method followed by Zeneca Group, PLC, the beneficial owner of more than 50% of the Company's common equity. The cumulative effect of the change in accounting principle resulted in a non-recurring, non-cash charge of $3,588,000 net of income taxes of $2,393,000, as of the beginning of fiscal year 1995. Second quarter primary and fully diluted earnings per share decreased to $0.20 from $0.26 and $0.25, respectively. For the six months ended February 29, 1996, earnings per share, on a primary basis, increased to $0.44 from $0.18 and on a fully diluted basis to $0.44 from $0.19 due to the cumulative effect on prior years in the change of accounting method. Net interest income increased to $956,000 from $281,000 in the six month period primarily as the result of the call of the Company's 7-1/4% Convertible Debentures. Net investment income increased over the second quarter and six month 1995 amounts due to capital gains realized in the Company's marketable securities portfolio. No assurances can be made that investment income will continue as it is dependent on a variety of sources which are beyond the Company's control. Fiscal 1995 second quarter net income and earnings per share were adversely affected due to non-recurring transaction expenses of $526,000 in connection with the Company's Agreement and Plan of Merger with Zeneca Limited. Operating results have been and will continue to be adversely affected by reductions in reimbursement rates mandated by Congress, including those pursuant to the Omnibus Budget Reconciliation Acts (OBRA) of 1990-1993 which impact health care providers for many services provided to Medicare beneficiaries. The principal reductions applicable to the Company are a continuation of the 5.8% reduction in reimbursement of outpatient cost-based programs through fiscal year 1998; a continuation of the 10% reduction in hospital outpatient capital reimbursement through fiscal year 1998; and a change in the manner of reimbursement for Erythropoietin for dialysis patients, effective January 1, 1991 which was further reduced beginning on January 1, 1994. The Company has implemented strategies, including programs to increase both Medicare and non- Medicare patient volume and the implementation of cost control programs, that have substantially mitigated the effect of these changes. See "Impact of Inflation and Changing Regulation." Total operating expenses relative to operating revenues increased 3.7% for the second quarter of fiscal 1996 and 2.4% for the six months of fiscal 1996, before interest and investment expense, as compared to the prior year. Medical supplies and services expense increased by $858,000 and $1,318,000 during the quarter and six month periods, a 1.8% and 1.2% increase, respectively, as a percentage of revenues, primarily the result of activity under the Company's capitated fee program, increasing complexity in cancer 10 and dialysis treatment modalities and supplier price escalations. The addition of professional, corporate, administrative and other personnel necessitated by current and anticipated expansion and growth, primarily in Cancer Center and related operations, and increases in compensation and payroll taxes caused salaries and related costs to increase by $626,000 and $1,277,000 in the three and six month periods in 1996 compared to 1995. As compared to the prior year periods, other administrative expenses for fiscal 1996 increased 1.1% for the quarter and .4% for the six months, as a percent of operating revenues. Contract and occupancy costs decreased .1% in the quarter and increased .1% in the six month period, respectively, as a percentage of net operating revenues, principally resulting from increased contract costs under contractual agreement terms with certain of the Company's affiliated hospitals. Depreciation and amortization increased by $172,000 and $298,000 as compared to the second fiscal quarter and six months of 1995 due to depreciation of additional clinic equipment placed in service during the past year. Income taxes were calculated at a 39.5% rate in the fiscal 1996 six month period versus 40.3% in the prior year six month period. The Company expects to utilize available federal capital loss carrryforwards in the current fiscal year, lowering the Company's tax rates and increasing cash flow. LIQUIDITY AND CAPITAL COMMITMENTS Presently existing and internally generated funds and credit facilities are expected to be sufficient to satisfy the Company's requirements for working capital and capital expenditures relating to its present operations in fiscal 1996. The accelerated development, establishment or acquisition of a significant number of additional Cancer Centers and/or dialysis centers or other acquisitions or operations may require borrowing or equity financing by the Company. Working capital at February 29, 1996 was $27,521,000. The decrease in working capital during the current period as compared to fiscal 1995 year end is principally due to increased short term borrowings to finance facilities construction. The increase in accounts receivable at February 29, 1996 as compared to August 31, 1995 is due to the previously mentioned increased revenues which resulted from growth in patient volumes and services provided at the Company's cancer centers and dialysis facilities. The Company's principal sources of liquidity consist of cash on hand, interest-bearing investments, internal cash flow and a revolving bank line of credit of $80,000,000. At February 29, 1996, $33,379,000 had been borrowed under the revolving bank line of credit. The line of credit agreement provides various options for interest rates. Unless the Company elects an optional interest rate, borrowings under the line of credit are subject to the bank's prime rate of interest. At February 29, 1996, the Company held in its portfolio cash, government and investment grade debt securities and equity securities. These investments represent 100% of the total portfolio at fair value and reflect the Company's policy to invest its funds in government and investment grade 11 securities. In accordance with Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities ("SFAS 115"), the Company has increased the carrying value of its portfolio to fair value of $46,580,000 from cost of $46,351,000. As of February 29, 1996, the Company's five largest investments in municipal and corporate debt securities, all of which were investment grade aggregated $6,871,000 at fair value, with cost of $6,949,000. The single largest investment approximated $2,425,000 with a cost of $2,431,000. Capital expenditures for the remainder of fiscal year 1996 and the April 1996 distribution to former common stockholders pursuant to the merger are presently estimated to be approximately $48,000,000. As to these and other needs, certain equipment and/or facilities may be acquired through leases or purchase-finance agreements. IMPACT OF INFLATION AND CHANGING REGULATION The largest single component of the Company's revenue continues to be reimbursement at rates which are set or regulated by federal or individual state authorities. These reimbursement rates are also subject to periodic adjustment for certain factors, including changes in legislation and regulations, those imposed pursuant to the federal and individual state budgets, inflation, area wage indices and costs incurred in rendering the services. The reimbursement rates may in the future, as they have in the past, also be affected by the impact of managed care organizations, cost containment and other legislation, competition, third party payor changes or other governmental administrative controls or limitations. Changes in the Medicare and Medicaid system and reimbursement have been proposed by both Republican and Democrat members of Congress. While the Company expects changes in reimbursement to occur, this may be limited to extensions of previously implemented reductions scheduled to expire or may include additional changes. The ultimate impact of any of the above described and other changes that may occur and their effect on the Company's business cannot be predicted, in part due to budgetary constraints and the rapidly evolving changes in the health care system generally. Under federal Medicare law, most hospital inpatients covered by Medicare are classified into diagnostic related groups ("DRGs") based on such factors as primary admitting diagnosis and surgical procedure. Payment to hospitals for the care of a patient covered under the DRG system is generally set at a predetermined amount based on the DRG assigned the patient. The federal government, as well as many states and third party payors, are investigating or have adopted these or other modifications to their reimbursement formula in an effort to contain costs. This type of program provides an incentive for hospitals to plan and deliver their services more efficiently. The Omnibus Budget Reconciliation Act of 1990 amended the definition of "inpatient hospital services" to include all services for which payment may be made under the DRG system that are provided by a hospital or an entity wholly- owned or operated by the hospital to a patient during the three days immediately preceding the date of the patient's admission (or one day for hospitals and hospital units excluded from the DRG system under technical 12 changes enacted in October 1994), if such services are diagnostic services (including clinical diagnostic laboratory tests) or are other services related to the admission, as defined by the Secretary of Health and Human Services ("the Secretary"). Such services are not reimbursable separately as hospital outpatient services under Medicare Part B. These provisions have been in effect since 1991. On January 12, 1994, the Secretary issued interim final regulations implementing this provision and on September 1, 1995, the Secretary announced she will revise the regulations to recognize that only the one day immediately preceding the date of the patient's admission would be considered to be not reimbursable separately as hospital outpatient services for hospitals and hospital units excluded from the DRG system. In recent years there have been a number of statutory and regulatory changes that affect Medicare reimbursement for services furnished to hospital outpatients. Prior to October 1, 1987, Medicare generally had reimbursed hospital outpatient services on the basis of the reasonable costs (as determined pursuant to regulations) incurred by the hospital. On October 1, 1987, Medicare began reimbursing hospitals for certain surgery services furnished to hospital outpatients on the basis of the lower of reasonable costs or an amount based on a blend of the hospital's reasonable costs and a prospectively set fee schedule amount. On October 1, 1988, this blended payment system was extended to radiology services furnished to hospital outpatient patients; the blended payment system was extended further to certain other diagnostic services on October 1, 1989. In addition, the amount of the blend that is based on the hospital's reasonable costs has decreased; currently, the blend is based 42% on hospital costs for surgery and radiology services, and 50% on hospital costs for other diagnostic services. For surgery services reimbursed under the blend, the fee schedule portion of the blend is based on the amount of payment that ambulatory surgery centers would receive for the procedure. For radiology and diagnostic services reimbursed under the blend, the fee schedule portion of the blend is based on the amount that physicians would receive if the procedure were furnished in a physician's office under the Medicare physician fee schedule. Under the Omnibus Budget Reconciliation Act of 1989, effective January 1, 1992, Medicare reimbursement for physician services began a five year transition to the use of a physician fee schedule based on a "resource-based relative value scale." That physician fee schedule, through the blended payment system described above, has affected the amount of Medicare reimbursement for hospital outpatient departments providing outpatient radiology, radiation therapy, surgery and certain diagnostic services. There is also the possibility of the establishment of a prospective payment for certain Medicare-reimbursed hospital outpatient services. Congress had requested that the Health Care Financing Administration ("HCFA"), which administers Medicare, prepare recommendations concerning the establishment of such a prospective payment system. HCFA submitted its recommendations to Congress in March 1995 and included a proposal to phase in such a prospective payment system, beginning first with outpatient surgery, radiology, and other diagnostic services. The details of the proposed payment system, including the amounts of payment that would be made for each 13 procedure, have not been finalized by HCFA. Adoption of HCFA's recommendation would require a change in the Medicare law by Congress,and senior HCFA staff have stated that even if Congress enacted such a change in 1996, the new system would not likely be implemented until January 1997, at the earliest. Under HCFA's proposal, services other than surgery, radiology, and other diagnostic services would not be reimbursed under a new prospective payment system until further research is completed. The Company cannot predict what will be the effect, if any, on revenues or income which may result from the adoption by Congress of HCFA's recommendations for a Medicare prospective payment for hospital outpatient services. HCFA in its March 1995 report to Congress made two other recommendations concerning proposed changes in the Medicare law. First, HCFA proposed that the Medicare law be changed to modify the way that the amount of beneficiary coinsurance for outpatient services is computed. Second, HCFA proposed that Medicare law be changed to correct what has been described as the "formula driven overpayment" which HCFA states results in Medicare payments for hospital outpatient surgery, radiology and other diagnostic services that are greater than what was intended by Congress. In its report, HCFA suggested several ways in which the Medicare law could be changed to address these issues, either with or without the enactment of a prospective payment system for hospital outpatient services. The alternatives suggested by HCFA generally would result in an overall reduction in payments for hospital outpatient services furnished to Medicare beneficiaries and, if enacted, could adversely affect the Company's revenues and income. However, it is uncertain which alternative, if any, Congress will enact, and it is impossible to determine what impact, if any, such changes might have on the Company's revenues and income. Effective October 1, 1991, Medicare payments for hospital outpatient services made on a reasonable cost basis and the cost portion of outpatient services paid on the basis of a blended amount, were reduced by 5.8%. Under the Omnibus Reconciliation Act of 1993 ("OBRA 1993"), Congress extended this reduction through federal fiscal year 1998. Effective October 1, 1991, Medicare has reimbursed the capital costs allocated to outpatient departments on the basis of 90% of reasonable costs. Under OBRA 1993, Congress extended this 10% reduction in hospital outpatient capital cost reimbursement through federal fiscal year 1998. Also under OBRA 1993, the amount which Medicare reimburses for clinical laboratory services was reduced. Effective November 1, 1990, the Medicare fiscal intermediary for the Company's dialysis facilities changed the method of reimbursing medications provided to Medicare dialysis patients from charge-based reimbursement to reimbursement based on reasonable costs. This change has reduced the amount of reimbursement to the Company for such medications and other regulatory changes potentially could further reduce such reimbursement. In addition, effective January 1, 1991, the method of reimbursement for EPO furnished to dialysis patients was changed from its former structure (80% of $40 per treatment dosage for up to 10,000 units and 80% of $70 per treatment dosage of 10,000 or more units) to provide for payment of 80% of $11.00 per 1,000 units. This change in EPO reimbursement has been partially offset by a $1.00 per treatment increase in the composite rate reimbursement for outpatient 14 dialysis services. In addition, pursuant to OBRA 1993, reimbursement for EPO was further reduced beginning January 1, 1994 to 80% of $10.00 per 1,000 units. The Secretary announced on September 1, 1995 that she will not at this time adjust the current composite rate. The overall impact of the EPO reimbursement change has adversely affected the Company's revenues and earnings. The effect of these changes may be mitigated by the Company's ability to increase its patient volume both at the same sites and at additional centers, to increase its non-Medicare and other regulated patient volume and to implement other cost controls and cost reduction strategies. To address these changes, the Company has expanded its programs and services in order to increase patient volume, and instituted other programs to achieve efficiencies in staffing, purchasing and scheduling. Legislation in Florida limits charges for certain health care services provided to non-Medicare/Medicaid patients. A substantial portion of this law has been challenged, a portion declared unconstitutional and is being appealed in the federal court system and will not be enforced until after such resolution; however, the limitations on rates respecting radiation therapy services provided at freestanding, not hospital-based facilities, presently remains in effect. As substantially all of the Company's radiation therapy services are hospital-based, the effect of the legislation has not had a material effect on the Company's operations. Florida also has legislation precluding or limiting referrals by physicians to facilities in which they have an ownership, control or investment relationship (the Florida Patient/Self- Referral Act). One of the Company's radiation facilities in South Florida currently has three physician investors who own less than two percent (2%) in total and who make no referrals to the facility. The Company believes it is in full compliance with the law. Florida adopted legislation effective in 1994 which is aimed at health care coverage for presently uninsured residents and encouraging the formation of purchasing alliances for health care services. This legislation is principally aimed at small employer groups. As it is now configured, the Company cannot predict its future effect upon the Company and its operations. However, the Company, as part of its overall strategy is in the process of developing various plans to be offered to employer groups, purchasing alliances, health maintenance organizations, managed care and other payors. The first of these plans has been successfully marketed in Florida with a major capitated (per member, per month) agreement entered into with Physician's Corporation of America currently covering 120,000 members in South Florida. To the extent that legislation or regulations may be enacted in the future which may include outpatient services furnished to Medicare beneficiaries in a prospective payment system, the Company cannot predict whether or to what extent such a change would adversely affect its revenues or earnings. In addition, in 1995 Congress began considering extensive changes to the Medicare and Medicaid programs. Medicare changes under consideration include, among others, (1) a change in the formula used to calculate hospital outpatient reimbursement under the blended payment system 15 which generally would result in reducing reimbursement amounts; (2) an extension of the current 5.8% reduction in hospital outpatient reasonable cost reimbursement through the year 2002; (3) a reduction in reimbursement for hospital outpatient department capital-related costs of 85% of such reasonable costs for federal fiscal years 1996-2002; (4) the introduction of a prospective payment system for home health services, effective October 1996; (5) reductions in payment for clinical laboratory services; (6) the elimination of updates in payments for ambulatory surgical center services from 1996-2002; (7) various other reductions in the amount of payment for physician and hospital services; and (8) the introduction of additional choices of health plans for Medicare beneficiaries in addition to the current fee-for-service and Medicare HMO option. Proposed Medicaid changes include the replacement of the existing federal/state program with block grants to the states and reduced federal oversight over state plans. The enactment of large cuts in the amount of Medicare and Medicaid reimbursement for providers could have an adverse effect on the Company's revenues. At this point in time, however, it is uncertain which, if any, of these or other changes to the Medicare and Medicaid programs will be enacted into law, and the Company is unable to predict how the enactment of any such changes might affect the Company in the future. The Company believes that the provision of health care will continue to evolve, that rules and regulations will continue to change and, therefore, regularly monitors developments. The Company may modify its agreements and operations from time to time as the business and regulatory environments change. While the Company believes it will be able to structure its agreements and operations in accordance with applicable law, there can be no assurance that its arrangements will be as successful or not be successfully challenged. Labor costs represent the largest dollar component of the Company's total expenses and necessary increases in the number of personnel, salaries, hourly rates and insurance costs have resulted in higher dollar amounts of operating expenses. Rental rates are subject to annual adjustments pursuant to escalation clauses in the respective leases. In addition, suppliers have sought to pass along their rising costs to the Company. A significant portion of these higher costs, however, has been offset by the use of new procedures and equipment, changes in staff scheduling, improvement in purchase price negotiations and utilization of supplies, and by increases in treatment and services volume. Changes in reimbursement rates for Medicare patients have a significant impact on the results of operations. The rate of inflation has not had a significant impact on the results of operations. 16 SALICK HEALTH CARE, INC. PART II OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders (a) On January 18, 1996, the Registrant held its Annual Meeting of Stockholders. (b) Proxies for the meeting were solicited pursuant to Regulation 14 under the Securities Exchange Act of 1934, there was no solicitation in opposition to management's nominees as listed in the Proxy Statement and all of such nominees were elected. (c) At the Annual Meeting, a proposal to consider and approve amendments to the Company's certificate of incorporation to increase the authorized number of Directors from ten to twelve, six of whom would be elected by the holders of the Company's Common Stock and six of whom would be elected by the holders of the Company's Callable Puttable Common Stock was approved by 100% of the outstanding Common Stock (5,657,115 shares) voting separately as a class and by the following vote of the Callable Puttable Common Stock voting separately as a class and voting together with the Common Stock as a single class (there were no broker non- votes): Callable Puttable Common Stock: For Against Abstained ----------- ------- --------- 15,774,588 3,664 945 Callable Puttable Common Stock and Common Stock voting together as a class: For Against Abstained ----------- ------- --------- 10,736,555 3,664 945 17 SALICK HEALTH CARE, INC. PART II OTHER INFORMATION At the Meeting, the following persons were elected by the vote indicated (there were no abstentions or broker non-votes) to serve until the next annual meeting of stockholders and until their successors are duly elected and qualified: Elected by Holders of Callable Puttable Common Stock: Vote Name For Withheld ---- ---------- -------- Bernard Salick, M.D. 21,415,004 21,308 Leslie F. Bell 21,415,004 21,308 Michael T. Fiore 21,415,004 21,308 Barbara Bromley-Williams 21,415,004 21,308 Thomas Mintz, M.D. 21,415,004 21,308 Patrick W. Jeffries 21,415,004 21,308 Elected by Holders of Common Stock: Name For ---- --------- Dr. Thomas F. W. McKillop 5,657,115 Robert C. Black 5,657,115 John G. Goddard 5,657,115 Dr. Michael G. Carter 5,657,115 Alan I. H. Pink 5,657,115 Item 5. Other Information At the Board of Directors' meeting on January 18, 1996, Allen L. Johnson was elected as a Director of the Company to fill the vacancy on the Board of Directors to be elected by the holders of Common Stock. Since 1986 Mr. Allen has served as President and Chief Executive Officer of the Medical Center of Delaware. Previously, Mr. Allen was President and Chief Executive Officer of St. Vincent Medical Center in Toledo, Ohio. Mr. Allen has also held executive management positions with Farley Health Care Corporation and St. Vincent Corporate Services, Inc. in Toledo, Ohio and with Henry Ford Hospital Services Corporation and Henry Ford Hospital in Detroit, Michigan. 18 SALICK HEALTH CARE, INC. PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: 3(a) Certificate of Incorporation of Salick Health Care, Inc. Incorporated by reference to Annex B to the Proxy Statement Prospectus of the Company dated March 13, 1995 forming part of the Company's Registration Statement on Form S-4 dated March 13, 1995 - No. 33-58057. 3(b) Certificate of Amendment of Certificate of Incorporation of Salick Health Care, Inc. 10(a) Employment Agreement with Patrick W. Jeffries. 11 Computation of Net Earnings per Common Share. 27 Financial Data Schedule. (b) Reports on Form 8-K. During the quarter ended February 29, 1996 no reports on Form 8-K were filed. 19 SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant had duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. SALICK HEALTH CARE, INC. ------------------------------------ (Registrant) /s/ BERNARD SALICK, M.D. ------------------------------------ Date: April 15, 1996 Bernard Salick, M.D. Chairman and Chief Executive Officer (Duly Authorized Officer) /s/ BLAIR L. HUNDAHL ------------------------------------ Date: April 15, 1996 Blair L. Hundahl Senior Vice President-Finance (Principal Accounting Officer) 20 SALICK HEALTH CARE, INC. EXHIBIT INDEX Exhibit ------- 3(b) Certificate of Amendment of Certificate of Incorporation of Salick Health Care, Inc. 10(a) Employment Agreement with Patrick W. Jeffries. 11 Computation of Net Earnings per Common Share. 27 Financial Data Schedule 21