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EXHIBIT 7.1
INTROSPECT HEALTHCARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF JUNE 30, 1996
TOGETHER WITH REPORT OF
INDEPENDENT PUBLIC ACCOUNTANTS
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Introspect HealthCare Corporation:
We have audited the accompanying consolidated balance sheet of INTROSPECT
HEALTHCARE CORPORATION and subsidiaries (an Arizona corporation) as of June 30,
1996, and the related consolidated statements of operations, changes in
stockholder's deficit and cash flows for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit 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 audit provides 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 Introspect
HealthCare Corporation and subsidiaries as of June 30, 1996, and the results of
their operations and their cash flows for the year then ended in conformity
with generally accepted accounting principles.
Tucson, Arizona,
September 6, 1996 (except with respect
to the matter discussed in Note 11, as to which
the date is September 11, 1996).
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INTROSPECT HEALTHCARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
JUNE 30, 1996
ASSETS
CURRENT ASSETS:
Cash $ 236,795
Restricted cash (Note 3) 1,145,154
Accounts receivable, less allowance of $211,000 for
doubtful accounts (Note 5) 2,313,133
Prepaid expenses, deposits and other 288,851
-----------
Total current assets 3,983,933
-----------
PROPERTY AND EQUIPMENT (Notes 2, 4 and 7):
Land and improvements 464,930
Buildings and improvements 5,882,984
Equipment and furniture 1,787,913
-----------
Total property and equipment, at cost 8,135,827
Less: Accumulated depreciation (2,971,728)
-----------
Net property and equipment 5,164,099
-----------
OTHER ASSETS:
Deferred financing costs and other, net (Note 2) 173,476
-----------
Total assets $ 9,321,508
===========
LIABILITIES AND STOCKHOLDER'S DEFICIT
CURRENT LIABILITIES:
Line of credit (Notes 3 and 5) $ 1,136,346
Accounts payable 595,794
Accounts payable to related party (Note 6) 610,695
Accrued liabilities 1,027,922
Patient refunds 852,971
Current portion of long-term debt (Note 4) 2,857,856
Current portion of obligations under capital lease (Note 7) 50,369
Property taxes payable 523,615
-----------
Total current liabilities 7,655,568
LONG-TERM DEBT, less current portion (Note 4) 8,163,618
OBLIGATIONS UNDER CAPITAL LEASE, less current portion (Note 7) 4,673
-----------
Total liabilities 15,823,859
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COMMITMENTS AND CONTINGENCIES (Notes 7 and 9)
STOCKHOLDER'S DEFICIT:
Common stock, $1 par value, 100,000,000 shares
authorized, 52,500 shares issued and outstanding 52,500
Additional paid-in capital 225,743
Accumulated deficit (6,780,594)
-----------
Total stockholder's deficit (6,502,351)
-----------
Total liabilities and stockholder's deficit $ 9,321,508
===========
The accompanying notes are an integral part of this consolidated balance sheet.
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INTROSPECT HEALTHCARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED JUNE 30, 1996
REVENUE:
Net patient service revenue (Note 9) $ 15,928,987
Other revenue 239,975
-------------
Total revenue 16,168,962
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OPERATING EXPENSES:
Salaries and wages 6,469,544
Employee benefits 902,509
Supplies and purchased services 4,487,458
Professional fees 1,256,342
Insurance and taxes 302,157
Utilities 272,032
Lease (Note 7) 373,971
Marketing 67,922
General and administrative 496,509
Provision for bad debts 71,634
Interest expense 1,299,272
Depreciation and amortization 534,559
-------------
Total expenses 16,533,909
-------------
NET LOSS $ (364,947)
=============
The accompanying notes are an integral part of this consolidated financial
statement.
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INTROSPECT HEALTHCARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER'S DEFICIT
FOR THE YEAR ENDED JUNE 30, 1996
Common Stock Additional
------------------------ Paid-in Accumulated
Shares Amount Capital Deficit Total
--------- ----------- ------------ ---------------- -------------
BALANCE, June 30, 1995 52,500 $ 52,500 $ 225,743 $ (5,840,552) $ (5,562,309)
Write-off of capitalized
option costs (Note 10) - - - (312,761) (312,761)
Write-off of related party
notes (Note 6) - - - (262,334) (262,334)
Net loss - - - (364,947) (364,947)
------- ------------ ----------- ------------- -------------
BALANCE, June 30, 1996 52,500 $ 52,500 $ 225,743 $ (6,780,594) $ (6,502,351)
======= ============ =========== ============= =============
The accompanying notes are an integral part of this consolidated financial
statement.
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INTROSPECT HEALTHCARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30, 1996
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (364,947)
Adjustments to reconcile net loss to net cash provided by
operating activities-
Depreciation and amortization 534,559
Provision for bad debts 71,634
Loss on disposal of assets 8,514
Changes in operating assets and liabilities:
Accounts receivable (112,561)
Prepaid expenses, deposits and other (34,711)
Deferred financing costs and other, net (43,687)
Accounts payable (280,500)
Accounts payable to related party 610,695
Accrued liabilities (74,796)
Patient refunds 15,829
Property taxes payable 60,130
--------------
Net cash provided by operating activities 390,159
--------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (132,096)
--------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in related party advances 21,691
Increase in restricted cash (906,728)
Net payments on line of credit (560,406)
Principal payments under capital lease obligations (43,643)
Net proceeds from long-term borrowings 1,420,241
--------------
Net cash used in financing activities (68,845)
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INCREASE IN CASH 189,218
CASH, beginning of year 47,577
--------------
CASH, end of year $ 236,795
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Interest $ 1,242,630
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SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
During 1996, the Company forgave amounts due from related parties totaling
$262,334.
During 1996, the Company wrote off $312,761 of costs capitalized in
connection with developing the purchase option agreement further
discussed in Note 10.
The accompanying notes are an integral part of this consolidated financial
statement.
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INTROSPECT HEALTHCARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1996
(1) DESCRIPTION OF BUSINESS:
Introspect HealthCare Corporation (the Company), an Arizona corporation, is a
wholly owned subsidiary of Diversification Association, Inc. (DAI), an Arizona
corporation. The Company is the sole shareholder of Desert Hills Center for
Youth and Families, Inc. and Ocotillo Pediatric Services, Inc. Desert Hills
Center for Youth and Families, Inc. (Desert Hills), located in Tucson, Arizona,
is a behavioral health and diversified youth services company for children and
adolescents. Ocotillo Pediatric Services, Inc. provides medical services to
Desert Hills patients.
As is further discussed in Note 10, effective July 1, 1995, the Company entered
into an agreement with Youth Services International, Inc. (YSI) to manage the
Company. YSI also acquired an option to purchase the common stock of the
Company. YSI exercised this option in September 1996 (see Note 11).
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All material intercompany transactions and
accounts have been eliminated in consolidation.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is computed using the
straight-line method over the following estimated useful lives:
Land improvements 30 years
Buildings and improvements 30 years
Equipment and furniture 5 years
Equipment held under capital leases is depreciated over the term of the lease
or the economic life of the related asset, whichever is shorter.
Expenditures for major renewals and betterments are capitalized while repairs
and maintenance are charged to expense as incurred. The cost and related
accumulated depreciation of assets retired or disposed of are removed from the
asset and accumulated depreciation accounts with any gain or loss recognized
currently.
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FINANCING AND TRANSACTION COSTS
Deferred financing costs are amortized on a straight-line basis over the term
of the related debt. At June 30, 1996, accumulated amortization totaled
$414,147.
INCOME TAXES
The Company computes its income taxes in accordance with Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes (SFAS No. 109).
Deferred income taxes arise from temporary differences resulting from certain
expenses reported for financial reporting purposes in periods other than those
in which they are reportable for income tax purposes.
The components of the provision for income taxes are as follows:
Current income tax provision (benefit) $ -
Deferred income tax provision (benefit) (144,519)
Valuation allowance 144,519
------------
Total income tax provision (benefit) $ -
============
Deferred income tax assets and liabilities at June 30, 1996, are as follows:
Deferred income tax assets $ 144,519
Deferred income tax liabilities -
Valuation allowance (144,519)
------------
Total $ -
============
The Company, its subsidiaries and its parent file consolidated federal and
state income tax returns. The Company does not possess an intercompany tax
sharing agreement and does not recognize benefits for losses which may be
utilized by the parent. At June 30, 1996, the Company had no federal or state
net operating loss carryforwards.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at June 30, 1996, and the reported amounts of
revenues and expenses during the year then ended. Actual results could differ
from those estimates.
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(3) RESTRICTED CASH:
The Company maintains a lockbox account at a financial institution. The cash
deposited in this account is restricted for payments on the Company's line of
credit (see Note 5). The Company also maintains a $1,000,000 certificate of
deposit with a financial institution as collateral for outstanding debt.
(4) LONG-TERM DEBT:
Long-term debt consists of the following as of December 31:
Note payable to Meditrust Mortgage, Inc., interest at
12.5%, payable in monthly installments of $74,354 including
interest, maturing on July 1, 2000, collateralized by
equipment and real property. $ 7,862,087
Note payable to Meditrust Mortgage, Inc., interest at
9%, matured in 1994, collateralized by equipment and
real property. 216,483
Note payable to Century HealthCare Corporation, interest
at 8%, payable in monthly principal and interest installments
of $16,452 through maturity on June 30, 1995. Interest at 18%
on all past due principal and accrued interest amounts. 363,754
Note payable to YSI, interest imputed at 21%, payable in
quarterly installments of $30,000 through October 2000,
unsecured. 305,219
Note payable to YSI, interest at the prime rate plus 2%,
(10.75% as of June 30, 1996), payable in monthly interest
only installments, due on demand, but in no event later
than the earlier of June 30, 2000 or termination of the
Purchase Option and Management Agreement further
discussed in Note 10, secured by certificate of deposit. 1,000,000
Note payable to DAI, varying interest based on various
money market accounts and payable on demand,
maturing the earlier of June 30, 2000, or upon YSI's
exercise of its purchase option further discussed in Note 10. 1,000,000
Note payable to DAI, interest at 10%, payable in quarterly
interest only installments, maturing the earlier of June 30,
2000, or upon YSI's exercise of its purchase option further
discussed in Note 10. 100,000
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Notes payable to DAI, interest at 10%, payable in monthly
principal and interest installments of $3,965, maturing in
June 2000, unsecured (Note 6). 156,323
Note payable to Ford Motor Credit, interest at 7.9%, payable
in monthly installments of $620 including interest, secured
by automobile. 17,608
-----------
11,021,474
Less: Current portion (2,857,856)
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Long-term debt, net of current portion $ 8,163,618
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The Company is renegotiating its note payable to Century HealthCare
Corporation, which matured in June 1995. The Company is also in default of its
$216,483 note payable from Meditrust, which matured in 1994. Additionally, the
$1,000,000 and $100,000 notes payable to DAI became due and payable upon YSI's
exercise of its purchase option as disclosed in Note 11. Accordingly, all
amounts due under these notes have been classified as current liabilities in
the accompanying consolidated balance sheet.
Maturities of long-term debt as of June 30, 1996, are as follows:
Year Ending
June 30,
---------------
1997 $ 2,857,856
1998 259,375
1999 291,735
2000 327,847
2001 195,112
Thereafter 7,089,549
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$ 11,021,474
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(5) LINE OF CREDIT:
In May 1994, the Company and Congress Financial Corporation (Congress) entered
into a lending agreement under which Congress agreed to advance funds to the
Company on eligible patient accounts receivable up to 80% of the net value of
the receivables. Eligible accounts receivable and the net value of the
receivables were determined by Congress. Interest on the line of credit is at
prime plus 2.5% and is payable as the accounts receivable are collected (see
Note 3), and the line is secured by the accounts receivable. In August 1996,
this agreement, which expired May 5, 1996, was extended through December 31,
1996.
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(6) RELATED PARTY TRANSACTIONS:
During 1996, the Company forgave amounts due from DAI and its subsidiaries
totaling $262,334. These transactions were treated as dividends and were
recorded as direct charges against accumulated deficit in the accompanying
consolidated statement of changes in stockholder's deficit.
As is further discussed in Note 4, the Company has three notes payable to DAI.
Total amounts outstanding under these notes payable was $1,256,323 as of June
30, 1996. Interest expense incurred on notes payable to DAI totaled $27,421 in
1996.
YSI's fee for managing the Company is based upon a formula defined in the
management agreement discussed in Note 10. No management fees were earned
under this agreement in 1996.
As is further discussed in Note 4, the Company has a note payable to YSI for
consulting services received in 1995. Total amounts outstanding under this
note payable were $305,219 as of June 30, 1996. Interest expense incurred on
this note payable in 1996 totaled $69,219.
The Company borrowed $1,000,000 from YSI during 1996 to fund operating
deficits. Interest expense incurred on this note payable was $83,064 in 1996
and accrued interest payable was $41,064 as of June 30, 1996. Additionally,
during 1996, YSI advanced funds used to pay operating costs of the Company,
which are reflected as accounts payable to related party in the accompanying
consolidated balance sheet.
(7) COMMITMENTS AND CONTINGENCIES:
LITIGATION
The Company is a defendant in various actions related to its healthcare service
activities. It is the opinion of management that resolution of these actions
will not have a materially adverse effect on the Company's financial position.
OPERATING LEASES
The Company leases a building, medical and office equipment and vehicles under
operating leases with terms expiring through April 2000. Most of the lease
agreements provide for renewal options and require payment of property taxes,
maintenance and insurance. Rent expense on these leases was $373,971 in 1996.
Future minimum payments under the leases are for the years ending June 30 as
follows:
1997 $ 68,927
1998 8,644
1999 5,726
2000 2,511
---------
$ 85,808
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CAPITAL LEASE OBLIGATIONS
The Company leases computer equipment under agreements expiring in 1998.
Future payments under the leases are as follows:
1997 $ 57,024
1998 4,752
---------
61,776
Less: Amount representing interest (6,734)
--------
55,042
Less: Current portion (50,369)
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$ 4,673
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(8) RETIREMENT AND BENEFIT PLANS:
The Company has a 401(k) salary deferral plan which allows eligible employees
to defer up to 10% of their salaries. At the Board of Directors' discretion,
employee contributions may be matched by the Company. The Company may also
make additional voluntary contributions, subject to certain limitations, at the
discretion of the Board of Directors. The Company's contribution expense was
$50,665 in 1996.
(9) NET PATIENT SERVICE REVENUE:
The Company provides services to the beneficiaries of CHAMPUS, the Arizona
Health Care Cost Containment System (AHCCCS), Medicaid program, and certain
other payors at contracted amounts unrelated to customary charges. Net patient
service revenue is reported at the estimated realizable amounts, net of charity
allowances and contractual discounts, under reimbursement agreements with
third-party payors. Third-party payor adjustments are accrued in the period
the related services are rendered and adjusted in future periods as final
settlements are determined.
The following table reflects the estimated percentage of total patient service
revenue by payor for the year ended June 30, 1996.
Net Patient
Service Revenue
------------------------
Amount Percent
-------------- -------
CHAMPUS $ 5,455,932 34%
State, including but not limited
to, AHCCCS and Medicaid 3,617,323 23
Community Partnership of
Southern Arizona 3,615,191 23
Commercial and other third 2,692,530 17
party contracts
Self pay and other 548,011 3
-------------- ----
$ 15,928,987 100%
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The Company provides services free of charge or at reduced rates to individuals
who meet certain criteria. Amounts determined to qualify as charity are not
reported as revenue in the accompanying consolidated statement of operations.
(10) PURCHASE OPTION AND MANAGEMENT AGREEMENT:
Effective July 1, 1995, YSI acquired an option to purchase the outstanding
stock of the Company for a period expiring June 30, 2000. The amount paid to
DAI by YSI in 1996 to acquire the option was $350,000. This amount offset
$312,761 of costs capitalized in connection with developing the purchase option
agreement. These costs are recorded as direct charges against accumulated
deficit in 1996 in the accompanying consolidated statement of changes in
stockholder's deficit. The exercise price of the option is based on a formula
which considers, among other things, the "Average Consolidated Revenues" (as
defined) and the debt and other liabilities of the Company.
Concurrent with the purchase of the option, the Company and YSI entered into a
management agreement whereby YSI will manage the Company's operating entities
through June 30, 2000. During this period, YSI may, but is not required to,
make loans to the Company to fund operating deficits. As further discussed in
Note 6, the Company borrowed $1,000,000 from YSI in 1996 under the provisions
of the management agreement.
(11) SUBSEQUENT EVENT:
On September 11, 1996, YSI exercised its option to purchase the Company and
concurrently retired approximately $9.6 million of outstanding debt.