1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
(MARK ONE) FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1997 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER 0-16162
CHILDREN'S COMPREHENSIVE SERVICES, INC.
---------------------------------------
(Exact name of registrant as specified in its charter)
Tennessee 62-1240866
- -------------------------------- -----------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
805 South Church Street, Murfreesboro, Tennessee 37130
- ------------------------------------------------ -----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (615) 896-3100
-----------------------
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 $ .01
-----------------------------
(Title of Class)
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 periods 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 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. ( )
The aggregate market value of voting and non-voting stock held by non-affiliates
of the Company as of September 19, 1997 was $109,293,113 and $-0-, respectively.
The number of shares outstanding of the issuer's common stock, par value $ .01
per share, as of September 19, 1997 was 7,774,633.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the annual meeting of shareholders to be
held November 12, 1997 are incorporated by reference into Part III of this Form
10-K.
Index to Exhibits is Found on Sequentially Numbered Page 63
-1-
2
PART I
ITEM 1. BUSINESS
GENERAL
Children's Comprehensive Services, Inc., a Tennessee corporation formed
in 1985, and subsidiaries (the "Company") is one of the largest for-profit
providers of education, treatment and juvenile justice services for at risk and
troubled youth in the United States. The Company's programs include a
comprehensive continuum of services provided in both residential and
non-residential settings for youth who have severe psychiatric disorders or who
are emotionally disturbed, behaviorally disordered, developmentally delayed or
learning disabled. The Company also provides a limited range of adult behavioral
services at certain of its locations in response to community demand. The
Company provides its services at facilities located in Alabama, Arkansas,
California, Florida, Kentucky, Louisiana, Michigan, Montana, Tennessee, Texas
and Utah. As of June 30, 1997, the Company was providing education, treatment
and juvenile justice services, either directly or through its management
contract with Helicon Incorporated ("Helicon"), to approximately 2,600 youth and
100 adults.
VENDELL TRANSACTION
In June 1997, the Company acquired substantially all the assets of
Vendell Healthcare, Inc. and its subsidiaries ("Vendell") for approximately
$19,477,000 in cash ($18,768,000 of which was paid at closing and $709,000 of
which was paid in September 1997) and the issuance of 642,978 shares of the
Company's Common Stock valued at approximately $7,600,000. Pursuant to this
acquisition, the Company acquired seven residential treatment facilities and 12
non-residential treatment facilities which the Company believes will enhance its
continuum of youth services.
RECENT DEVELOPMENTS
In July 1997 the Company signed a contract with the Michigan Family
Independence Agency for a 30 bed residential program for seriously disturbed,
adjudicated juvenile offenders, representing an expansion of the Company's
behavioral services program in St. Johns, Michigan. In addition, in August 1997,
the Company entered into new contracts with the Utah Department of Corrections
and various school districts in the State of Arkansas. Under the Utah contract,
the Company will provide a 24-bed observation and assessment, short term
residential program for adjudicated male juvenile offenders at its West Jordan,
Utah facility. Under the Arkansas contracts, the Company will serve up to 80
youth in educational programs designed for unruly, conduct disordered youth at
sites in Little Rock, North Little Rock and Bryant, Arkansas.
THE MARKET FOR THE COMPANY'S SERVICES
The Company believes the market for its services for at risk and
troubled youth is large and growing. The population of at risk and troubled
youth ranges from youth who have been abused and neglected to those who are
seriously emotionally disturbed. At one end of the spectrum are at risk youth.
These are youth who are not functioning well in school or at home, exhibit such
behavior as aggressive noncompliance with parents and authority figures, chronic
truancy, fighting, running away and alcohol or drug abuse. Children classified
as requiring special education services comprise a large subset of the at-risk
youth population. Of the 5.1 million children in special education programs
during the 1995-96 school year, 2.6 million were diagnosed as having specific
learning disabilities and over 430,000 were considered seriously emotionally
disturbed. At the other end of the spectrum are troubled youth. These are youth
who have committed serious and/or violent crimes, such as sex offenses,
robberies, assaults and drug trafficking. In 1995, there were 2.7 million
arrests of juveniles under 18 years of age, accounting for 15% of all violent
crime, 32% of all robbery arrests and 25% of all weapons arrests. The Company
believes that factors contributing to the high rate of youth crime include the
ready availability of firearms, the prevalence of drug addiction, violence
portrayed in
-2-
3
the media and the increase in the number of single parent homes. In addition, a
recent census projection stated that the juvenile population in the United
States is expected to reach 74 million by the year 2010. At certain of its
facilities, the Company also provides adult programming and treatment in
response to community demand and the need for such services.
The federal Individuals with Disabilities Education Act mandates that
all children with disabilities be provided a free and appropriate education
which emphasizes special education and related services designed to meet their
unique needs. Governmental agencies traditionally have provided education,
treatment and juvenile justice services for at risk and troubled youth either
directly or through private providers of these services. The Company believes
that the increasing number of youth in the United States and the increasing
prevalence of juvenile crime have resulted in a growing demand for these
services for at risk and troubled youth, which will make it increasingly less
likely that governmental entities will be able to provide the necessary services
directly. As a result, there is a growing trend throughout the United States
toward privatization of education, treatment and juvenile justice services, as
governments of all types face continuing pressure to control costs and improve
the quality of services. Furthermore, the Company believes that, as juvenile
crime and the demand for special education services for at risk and troubled
youth continues to grow and receive increasing levels of attention from
lawmakers and the general public, government funding for juvenile services will
continue to increase. Although the number and scope of privatized services for
at risk and troubled youth has increased dramatically in recent years, the
Company estimates that only a relatively small percentage of these services are
currently privately managed. Based on the combination of the current demographic
and societal factors affecting at risk and troubled youth, the Company believes
that the demand for its services for these youth will continue to escalate and,
increasingly, the private sector will be called upon to meet the growing demands
for these services.
SERVICES PROVIDED BY THE COMPANY
The Company, directly and through programs managed for Helicon,
educates and treats at risk and troubled youth through a comprehensive continuum
of services that are designed to address the specific needs of each youth and to
return the youth to their schools or communities. Additionally, at certain of
its facilities, the Company provides treatment services for adults. The
Company's programs, ranging from non-residential family preservation programs to
24-hour secure facilities, are based predominantly on models designed to achieve
behavior modification through therapy, counseling and, when necessary,
pharmaceuticals. The Company's programs include computer-based
educational/vocational training and comprehensive programs for behavior change,
including individual, group and family counseling, social and independent living
skills training, empathy development, critical thinking and problem solving,
anger management, substance abuse treatment and relapse prevention. These
programs are designed to increase self-control and effective problem-solving; to
teach youth how to understand and consider other people's values, behaviors and
feelings; to show youth how to recognize how their behavior affects other people
and why others respond to them as they do; and to teach them alternative,
responsible, interpersonal behaviors. Although certain youth in the Company's
programs require both drug treatment and therapy, the Company's goal is to
minimize or eliminate the use of drugs whenever possible over the course of its
involvement with the youth. When drug treatment is appropriate, drugs are
prescribed by licensed physicians and may be administered by Company personnel.
The Company believes that the breadth of the Company's services makes the
Company attractive to members of the community and a broad spectrum of payers,
as well as to local, state and federal governmental agencies. As of June 30,
1997, the Company was providing services directly and through management
contracts with Helicon to approximately 1,800 youth and 60 adults in its
non-residential programs and 800 youth and 40 adults in its residential
programs.
Comprehensive Continuum of Services. The Company offers a comprehensive
continuum of services ranging from non-restrictive programs, such as family
preservation and non-residential special education programs, to acute
psychiatric
-3-
4
programs, secure residential and medium-security juvenile correctional
facilities. The Company believes its primary emphasis on education, treatment
and juvenile justice, as well as consistency and flexibility in the delivery of
its services, are critical to the success of its programs. Accordingly, the
Company's programs are tailored to the specific needs of each locality, each
client agency, each population and, most importantly, to the unique needs of
each student or resident. The Company believes that this continuum of services
allows it to address the specific needs of each segment of the at risk and
troubled youth population and to satisfy the demands for such services by a
community. Through its relationship with Helicon, the Company also is able to
deliver services to governmental agencies who are required or elect to contract
with not-for-profit entities for the provision of services offered by the
Company.
NON-RESIDENTIAL PROGRAMS. The Company's non-residential youth services programs
are designed to meet the special needs of at risk and troubled youth and their
families, while enabling the youth to remain in his or her home and community.
As described below, non-residential services provided by the Company include
behavioral day treatment programs, educational day treatment programs,
alternative education programs, diversionary education programs, family
preservation programs, homebound education programs and on-site education
programs in emergency shelters and diagnostic centers. Adult programs provide
primarily behavioral day treatment.
Behavioral Day Treatment Programs. The Company's behavioral day treatment
programs provide therapeutic treatment services to individuals with clinically
definable emotional disorders, including those with severe psychiatric disorders
who are transitioning from acute psychiatric treatment programs to other day
treatment programs, as well as treatment for chemical dependency. Treatment
under these programs includes individual and group therapy, counseling and, in
certain cases, may include pharmaceutical treatment. Each behavioral day
treatment program is overseen by a licensed physician and staffed by one or more
counselors or therapists and registered nurses.
Educational Day Treatment Programs. The Company's educational day treatment
programs provide specialized educational services for youth with clinically
definable emotional disorders. These programs provide the opportunity to remedy
deficits in a student's education and foster the development of responsible
social behaviors. For these students, traditional public school programs have
not been able to sustain motivation or cooperation or have not provided needed
specialized education services. The Company's educational day treatment programs
are staffed with teachers and counselors with expertise in behavioral management
to provide high quality special education services, including specialized
teaching methods, individual and group therapy provided by licensed clinicians,
computer-based curriculum and instructional delivery and designs.
Alternative Education Programs. The Company's alternative education programs
provide educational services to youth who cannot or who are not permitted to
attend public school. These programs are designed to educate at risk youth in a
manner that promotes public safety by reducing disruptive and delinquent
behaviors of students. The principal components of the alternative education
programs include daily computer assisted learning, behavioral counseling, job
placement, transition into public schools, family services and community
service. These programs are designed to provide youth with the education,
credentials and job skills required to be successful adults.
Diversionary Education Programs. The Company's diversionary education programs
provide educational and therapeutic day treatment services to youth whose social
function in school and society has been unsatisfactory, as well as delinquent
and status offending youth and youthful sex offenders. These programs, typically
provided in lieu of incarceration, are designed to break the cycle of repeated
teen delinquency and to strengthen the youth's ties and relationships with his
or her family and community. In addition to individually tailored academic
programs, these programs are designed to provide intensive supervision,
individualized education and counseling, vocational counseling and job placement
and independent living skills in an effort to remotivate the student's interest
-4-
5
in school, develop self-discipline and improve social skills, self-esteem and
cooperation with others.
Family Preservation Programs. The Company's family preservation programs provide
a blend of home-based, intensive crisis intervention services to at risk and
troubled youth and their families. These programs are designed to help the youth
improve their coping and living skills and strengthen and maintain the integrity
of the family, while promoting the healthy growth and development of the at risk
and troubled youth. The objectives of these programs are to improve family
functioning and to keep the youth in the family.
Homebound Education Programs. The Company's homebound education programs provide
educational services to students who are pregnant or who have medical problems
that prevent them from attending school as well as to suspended special
education students. Students in these programs receive focused one-on-one
instruction and continue with the curriculum of the school normally attended by
the student.
On-Site Education Programs in Shelters and Diagnostic Centers. The Company's
shelter education program provides on-site educational services at multiple
locations to at risk and troubled youth who have been removed from their homes
and are in residence at emergency shelters and diagnostic centers. The objective
of this program is to provide continuity in a student's education in a safe and
secure environment while the youth awaits permanent placement.
RESIDENTIAL PROGRAMS. The Company's residential programs provide highly
structured therapeutic environments and comprehensive treatment for at risk and
troubled youth when structured observation is necessary, when severe behavior
management needs are present or when containment and safety are required. As
described below, the Company's residential services include secure residential
programs, detention programs, acute psychiatric treatment programs, residential
psychiatric treatment programs, residential treatment programs, diagnostic and
evaluation services, therapeutic wilderness programs, and group homes. Adult
programs provide primarily acute psychiatric treatment.
Secure Residential Programs. The Company's secure residential programs house
youth that are placed in such programs by the courts or state agencies. While in
the programs, the youth are provided with a wide range of services designed to
change negative behavior including substance abuse education, group counseling,
physical training, education, a student work program and social skills classes.
Each student receives an individualized service plan tailored to meet his or her
particular needs for the duration of the placement.
Detention Programs. The Company's detention programs house youth awaiting
disposition of their court cases. While in detention, the emotional condition
and educational needs of the youth are assessed by the Company to help the
courts determine the appropriate permanent placement following adjudication. In
addition, residents at the Company's detention centers receive educational and
treatment services, such as substance abuse and individual and group counseling,
to provide these youth with a meaningful start towards their rehabilitation.
Acute Psychiatric Treatment Programs. The Company's acute psychiatric treatment
programs provide evaluation and stabilization of individuals with severe
psychiatric disorders. Programs are based on a medical model and consist of
structured and intensive medical and/or behavioral treatments including therapy,
counseling and pharmaceuticals. The programs are supervised by licensed
physicians and represent the first step in treating severe psychiatric
disorders.
Residential Psychiatric Treatment Programs. The Company's residential
psychiatric treatment programs provide medical and behavioral treatment to
behaviorally and emotionally disturbed youth who suffer from depression,
chemical dependency and other psychiatric disorders. These treatment programs
are based on a medical model and are designed to achieve behavior modification
through the use of therapy and medical treatment, including pharmaceuticals.
Medical treatment services are provided by licensed physicians who contract with
the Company to provide such services. Services offered at these programs include
therapy groups, drug education and 12-step recovery meetings. A primary goal of
-5-
6
the Company's residential psychiatric programs is to develop positive support
systems for the adolescents to allow for discharge to a less structured
environment.
Residential Treatment Programs. The Company's residential treatment programs
serve behaviorally and emotionally disturbed youth, such as youth who have
substance abuse problems, youth suffering from depression and youthful sex
offenders. While in the Company's residential treatment centers, youth
participate in individual, group and family therapy, recreation therapy and
educational programs. These programs focus on teaching more appropriate behavior
through cognitive restructuring, behavior management and counseling.
Diagnostic and Evaluation Services. The Company's diagnostic and evaluation
services are designed to provide short-term evaluation and assessment services
to youth who are in state custody.
Therapeutic Wilderness Programs. The Company's short-term therapeutic wilderness
programs are designed for relatively low-risk youth who have failed or performed
below expectations in community-based settings. These programs include
educational and counseling services, and a regimen of structured physical
activity, including drill and ceremony training and work projects. The Company's
wilderness programs are designed to educate youth and teach the discipline and
self-respect necessary to prevent a youth from repeating or engaging in more
serious delinquent behavior.
Group Homes. The Company's group home programs provide shelter care,
transitional services and independent living programs for youth in a family-like
setting in residential neighborhoods. These programs focus on teaching family
living and social skills, and include both individual and group counseling.
-6-
7
The table below sets forth certain information regarding the Company's
non-residential programs operated by the Company directly or through management
contracts with Helicon:
NON-RESIDENTIAL PROGRAMS
Average
Population Commencement
Location Program Type FY 6/30/97 of Operations
- ---------------- ------------------------------------------- ---------- -------------
COMPANY PROGRAMS
Alabama:
Dothan Behavioral day treatment 16 June 1997
Arkansas:
Little Rock Alternative education -0- June 1997
North Little Rock Alternative education -0- June 1997
California:
San Bernardino Educational day treatment 43 January l980
Grand Terrace Educational day treatment 168 May l985
Beaumont Educational day treatment 33 September l985
Banning Educational day treatment 24 September l985
Victorville Educational day treatment 31 September l987
Mid-Valley Educational day treatment 79 June l988
Ramona Educational day treatment 29 September 1990
Quail Valley Educational day treatment 36 October 1990
Riverside Educational day treatment 109 August 1992
Desert Hot Springs Educational day treatment 4 September 1992
Barstow Educational day treatment 17 April 1994
Chula Vista Educational day treatment 61 February 1994
Steele Canyon Educational day treatment 42 September 1994
Riverside Educational day treatment 23 May 1996
Joshua Tree Educational day treatment 7 September 1996
Riverside Educational day treatment 39 April 1997
Hemet Educational day treatment 14 April 1997
Florida:
Jacksonville Diversionary education 20 September 1995
Highlands County Diversionary education 23 November 1996
Ft. Walton Behavioral day treatment 11 June 1997
Pensacola Behavioral day treatment 19 June 1997
Panama City Behavioral day treatment 16 June 1997
Kentucky:
Bowling Green Behavioral day treatment 17 June 1997
Louisiana:
New Orleans Diversionary education 28 November 1991
New Orleans Family preservation 4 February 1994
-7-
8
NON-RESIDENTIAL PROGRAMS (CONTINUED)
Average
Population Commencement
Location Program Type FY 6/30/97 of Operations
- ---------------- ------------------------------------------- ---------- -------------
Montana:
Butte Behavioral day treatment 18 June 1997
Billings Behavioral day treatment 25 June 1997
Great Falls Behavioral day treatment 20 June 1997
Polson Behavioral day treatment 16 June 1997
Bozeman Behavioral day treatment 20 June 1997
Tennessee:
Nashville Homebound education 88 November 1991
Texas:
Bexar County Alternative education 135 September 1996
Nueces County Alternative education 4 October 1996
Houston Alternative education 20 June 1997
Houston Behavioral day treatment 5 June 1997
HELICON PROGRAMS
Tennessee:
Murfreesboro Family preservation 18 July 1988
Murfreesboro Educational day treatment 23 September 1990
Murfreesboro Diversionary education 40 February 1994
Nashville Diversionary education 40 October 1990
Various On-site educational services in
emergency shelters and diagnostic
centers 359 September 1993
Covington Diversionary education 30 August 1994
Clarksville Diversionary education 40 September 1994
The table below sets forth certain information regarding residential
programs operated by the Company directly or through management contracts with
Helicon:
RESIDENTIAL PROGRAMS
Average
Licensed Population Commencement
Location Program Type Capacity FY 6/30/97 of Operations
- ---------------- ------------------------------------------- -------- ---------- --------------
COMPANY PROGRAMS
Alabama:
Tuscaloosa Detention program 27 23 September 1989
Tuscumbia Detention program 25 22 October 1992
Jasper Therapeutic wilderness program 20 20 November 1994
Eutaw Therapeutic wilderness program 20 16 May 1995
Selma Therapeutic wilderness program 26 17 February 1996
Eufaula Secure residential program 90 57 August 1996
Arkansas:
Benton Acute psychiatric and residential
psychiatric treatment 77 65 June 1997
Florida:
Panama City Acute psychiatric and residential
psychiatric treatment 80 38 June 1997
Kentucky:
Bowling Green Acute psychiatric and residential
treatment 72 49 June 1997
Michigan:
St. Johns Acute psychiatric and secure
residential program 63 10 June 1997
Montana:
Butte Acute psychiatric and residential
psychiatric treatment and detention
program 52 45 June 1997
-8-
9
RESIDENTIAL PROGRAMS (CONTINUED)
Average
Licensed Population Commencement
Location Program Type Capacity FY 6/30/97 of Operations
- ---------------- ------------------------------------------- -------- ---------- --------------
Tennessee:
Murfreesboro Residential treatment 34 34 July l989
Newbern Residential treatment 32 32 July 1990
Clarksville Diagnostic and evaluation services 25 25 May 1992
Johnson City Detention program 12 9 November 1985
Jackson Residential treatment 54 33 December 1996
Texas:
Houston Acute psychiatric and residential
psychiatric treatment 140 45 June 1997
Utah:
West Jordan Acute psychiatric and residential
treatment 80 35 June 1997
HELICON PROGRAMS
California:
Mid-Valley Residential treatment 84 80 June l988
Ramona Residential psychiatric treatment 40 34 November 1984
Riverside Residential treatment 120 113 August 1992
Various 6-Bed group homes 36 29 November 1994
Riverside Secure residential program 30 26 May 1996
In addition to the programs described above, the Company manages
psychiatric units for elderly patients in general medical/surgical hospitals in
two locations in Little Rock, Arkansas in exchange for a fixed monthly fee and
reimbursement of expenses.
OPERATIONAL PROCEDURES
The Company's programs are designed to provide a range of consistent,
high quality and cost-effective education, treatment and juvenile justice
services to meet a wide variety of needs for the various segments of the at risk
and troubled youth population as well as, at some facilities, adult populations.
All acute and certain other facilities of the Company admit patients 24 hours
per day, seven days a week. The Company generally is responsible for the overall
operation of its own and Helicon's facilities and programs, including staff
recruitment, general administration and security and supervision of the youth in
their programs.
Staff Recruitment and Training. The Company has assembled an experienced team of
managers, counselors and staff that blends program expertise with significant
business and financial experience in each area of the Company's operations. The
Company believes that its recruitment, selection and training programs provide
quality personnel experienced in the Company's approach to providing its
programs. The Company's direct care staff includes teachers, counselors, mental
health professionals (including psychiatrists and psychologists), juvenile
justice administrators and licensed clinicians. The Company prefers to recruit
direct care staff who have pursued undergraduate or graduate studies in
education and in the behavioral or social sciences. Physician members of the
direct care staff are generally independent contractors who also maintain a
private practice. In the case of physicians who relocate their practices near
Company facilities, the Company may guarantee a minimum income to such
physicians for a limited period, such as one year.
The Company's internal training policies require the Company's
teachers, counselors, security and other direct care staff to complete extensive
training. Core training includes courses in the major Company program components
such as behavior change education, positive peer culture, discipline and limit
setting, anger management and the teaching of social skills. Annual continuing
education also is required for all direct care staff. The Company demonstrates
its
-9-
10
commitment to its employees' professional development by offering lectures,
classes and training programs, as well as tuition reimbursement benefits.
Quality Assessment. The Company strives to enhance the quality of its program
offerings and the quality of its highly trained and dedicated staff to improve
the positive impact that its programs have on the individuals they serve. The
Company has developed a model of ongoing program evaluation and quality
management which the Company believes provides critical feedback to measure the
quality of its various programs. The Company has implemented its Mastery
Achievement Program ("MAP") at the majority of its facilities and expects to
complete implementation at the remaining facilities during fiscal 1998. The MAP
provides regular feedback on percentage achievement of standards to measure
whether a program is achieving its performance objectives. The quality of care
standard data is computer scanned on a weekly or monthly basis and graphs are
developed which show ongoing visual representations of progress towards meeting
standards. Feedback is then provided to the Company's administrators, corporate
managers and all staff so that each team member is aware on a timely basis if
program standards are being met. The Company believes the MAP is a vital
management tool to evaluate the quality of its programs, and has been useful as
a marketing tool to promote the Company's programs since it provides more
meaningful and significant data than is usually provided by routine contract
licensing monitoring of programs. To expand the scope of the MAP, the Company is
attempting to develop a computer-based program which correlates client
characteristics and program achievements with recidivism data after youth are
released from the Company's various programs.
In addition to measuring performance objectives, the Company has
corporate compliance policies, including an integrity hotline, formulated as a
guide to the ethical and legal conduct of its employees in force at its
principal behavioral residential treatment centers. The Company anticipates
implementing such policies in its remaining facilities during fiscal 1998.
Security. The Company realizes that, in the operation of programs for at risk
and troubled youth, a primary mission is to protect the safety of the community
within a facility, as well as the community outside. Thus, the Company's
programs emphasize security, risk assessment and close supervision by
responsible and well-trained staff.
MARKETING
The Company's marketing activities are directed primarily toward local
and state governmental entities responsible for juvenile justice, social
services providers, education and mental health providers, as well as school
districts and juvenile courts responsible for special programs for at risk and
troubled youth. The Company also markets certain of its programs to the general
public in an effort to increase community awareness of the Company's facilities.
Marketing efforts are conducted and coordinated by the Company's Vice President
of Business Development and other senior management personnel with the aid,
where appropriate, of certain independent consultants.
Marketing to Governmental Agencies. The Company believes that it is able to
design, develop and operate its facilities and programs at a lower cost than
governmental agencies that are responsible for performing such services. The
Company focuses on adherence to proven policies and procedures and efficient
application of financial resources to provide an attractive, cost-effective
alternative to programs operated directly by governmental entities. The Company
generally pursues its governmental business opportunities in one of three ways.
The Company follows the traditional competitive process where a Request for
Proposals ("RFP") or a Request for Qualifications ("RFQ") is issued by a
government agency, with a number of companies responding, or receives
unsolicited requests, generally from local school districts, for the operation
of special education programs, or submits unsolicited proposals for new or
revised services. When the Company receives inquiries from or on behalf of
governmental agencies or local school districts, the Company determines whether
there is an existing need for the Company's services, assesses the legal and
political climate and the
-10-
11
availability of funding and competition, and then conducts an initial cost
analysis to further determine program feasibility.
Generally, governmental agencies responsible for juvenile justice or
youth education and treatment services procure services through RFPs or RFQs. As
part of the Company's process of responding to RFPs, management meets with
appropriate personnel from the agency making the request to best determine the
agency's distinct needs. If the project fits within the Company's strategy, the
Company will then submit a written response to the RFP. A typical RFP requires
bidders to provide detailed information, including the service to be provided by
the bidder, its experience and qualification and the price at which the bidder
is willing to provide the services. The Company has, and intends in the future,
to engage independent consultants to assist it in responding to RFPs. Based on
the proposals received in response to an RFP, the agency will award a contract
to the successful bidder. In addition to issuing formal RFPs, local
jurisdictions may issue an RFQ. In the RFQ process, the requesting agency
selects a firm believed to be most qualified to provide the requested services
and then negotiates the terms of the contract with that firm, including the
price at which its services are to be provided.
The Company also attends and promotes its services at key conferences
throughout the United States where potential government clients are present. Key
management staff are on occasion requested by governmental agencies to make
presentations at such conferences or to provide professional training.
Marketing to the General Public. In marketing its services to the general
public, referral sources and payers, the Company first undertakes market
research to determine the specific behavioral care needs of the communities
served by its facilities. The Company then modifies or develops programs and
services to address those needs and promotes the availability of those programs
and services through the use of community education programs, local talk shows
and newspaper articles, media advertising and yellow pages advertisements.
In addition, Company employees in each facility meet regularly with
potential referral sources, including psychiatrists and other private
physicians, social workers and other community professionals. These
representatives also meet with businesses, managed care organizations and other
referral sources, all in an effort to educate these sources as to the breadth
and quality of the Company's programs.
RELATIONSHIP WITH HELICON
The Company conducts a significant portion of its business through its
relationship with Helicon, a Section 501(c) (3) not-for-profit corporation. As
of June 30, 1997, the Company was providing consulting, management and marketing
services to Helicon at 12 programs. The Company leases three facilities to
Helicon for the operation of certain of its programs. Services provided to
Helicon by the Company include operational, management, marketing, program
design, financial and other support services, including payroll, budgeting and
accounting. The Company is entitled to receive management fees for these
services in an amount equal to 6% of the monthly gross revenues of Helicon's
programs. The payment of these management fees, however, is subordinated in
right of payment to amounts payable by Helicon to fund its programs. For the
fiscal year ended June 30, 1997, and for the three months ended June 30, 1996,
the Company recognized all of the management fee income to which it was
entitled. However, for each of the fiscal years ended March 31, 1996 and 1995,
the Company did not recognize all the management fee income to which it was
entitled due to the inability of Helicon to pay these amounts and there can be
no assurance that the Company will recognize all management fee income to which
it is entitled in the future. As of June 30, 1997, unpaid management fees, lease
payments and advances, plus interest, due to the Company from Helicon totaled
$7,153,000. Based on the current level of operations being maintained by
Helicon, the Company does not anticipate collecting any of, and has fully
reserved, this amount. The Helicon Agreement expires September 1, 1999. The
Company also has guaranteed Helicon's obligations under a bank line of credit
in the amount of $1,000,000.
-11-
12
SOURCES OF REVENUE
The Company's residential centers and day treatment centers receive
payments from (i) the federal government and state governments, pursuant to
contracts with such entities, as well as payments under Medicaid Under 21,
Medicare, CHAMPUS and other governmental programs, (ii) Blue Cross and other
private indemnity carriers, health maintenance organizations, preferred provider
organizations and other managed care programs, (iii) self-insured employers and
(iv) patients directly.
MAJOR CUSTOMERS
During the fiscal year ended June 30, 1997, the Company earned
approximately 17% of its revenues under a contract with the Riverside County
Office of Education, Riverside, California, and approximately 12% of its
revenues under three contracts with the State of Tennessee. The Company's
contract with the Riverside County Office of Education requires that the Company
provide special education and related services, such as transportation,
counseling and language and speech therapy, to those individuals requiring such
services who are referred to one of the Company's schools by Riverside County.
The Company's contracts with the State of Tennessee require that the Company
provide education, treatment, assessment and evaluation services. The contracts
with Riverside County and the State of Tennessee have been renewed for the
period beginning July 1, 1997 through June 30, 1998, under substantially the
same terms and conditions as described above.
REIMBURSEMENT
In addition to receiving revenues pursuant to contracts with state and
local governments, the Company receives payment for services from insurance
companies, HMO's, PPO's, Medicare, Medicaid, CHAMPUS and directly from patients.
Medicaid. The Medicaid program, created by the Social Security Amendments of
1965, is designed to provide medical assistance to welfare recipients, indigent
individuals who meet state eligibility standards, and certain individuals who
meet federally specified poverty guidelines. Medicaid is a joint federal and
state program. Each Medicaid program is financed with federal and state funds
and is operated by the state within federal guidelines requiring coverage of
certain individuals and services and allowing wide latitude in covering
additional individuals and services. Reimbursement rates under the Medicaid
program are set by each participating state, and rates and covered services may
vary from state to state according to a federally approved state plan. The
federal government and many states are currently considering ways to limit the
increase in the level of Medicaid funding which, in turn, could adversely affect
future levels of Medicaid reimbursement received by the Company.
Certain states in which the Company's facilities operate levy taxes on
provider costs or revenues, in part, to fund a portion of the Medicaid program.
The Omnibus Budget Reconciliation Act of 1990 (the "1990 Budget Act") directs
that such provider specific taxes and voluntary contributions must be excluded
from the provider's cost base for Medicaid reimbursement purposes. The Company
currently pays provider specific taxes in two states. The Company cannot predict
how these programs might be modified in the future or how the states would
respond to such modification.
In addition to the standard reimbursement rates paid to the Company
under Medicaid programs, several state programs include a financial benefit for
facilities that treat a disproportionately large volume of Medicaid patients as
a percentage of the total patient population of the facility. These
"disproportionate share" benefits, as they are often called, are subject to
annual review and revision by the particular state governments and could be
substantially reduced or eliminated at any point. The likelihood of such
reductions was substantially increased with the recent enactment of the Balanced
Budget Act of 1997, Public Law 105-33 ("BBA"). The BBA substantially reduces the
level of disproportionate share funding provided to states from 1998 to 2002.
The
-12-
13
savings for the federal government as a result of such reductions are valued at
$10.4 billion. Such reductions in payments will likely result in either
increased state budgetary requirements for furnishing Medicaid services or
further reductions in state payments to providers.
The Company participates in Medicaid Under 21 programs in six states in
which it operates residential facilities. Additionally, the Company may receive
disproportionate share payments under the Medicaid program in three states.
Some states have been granted Medicaid waivers from the federal
government. These waivers allow the state to implement alternative programs and
still receive federal funding. States implementing such programs typically shift
Medicaid beneficiaries to managed care. Several states in which the Company
operates have been granted a Medicaid waiver. In those states, the Company
contracts with a managed care organization to provide services to enrollees who
are covered under the state Medicaid waiver program.
Medicare. Medicare is the federally funded and administered health insurance
program for the aged (individuals age 65 or older) and disabled. The Medicare
program consists of Part A and Part B. Part A covers inpatient services and
services furnished by other institutional health care providers. Part B covers
the services of doctors, suppliers of medical items and outpatient services.
While most health care facilities receive Medicare Part A reimbursement
on a prospective basis based on the patient's diagnosis, psychiatric facilities
are exempt from the Medicare prospective payment system ("PPS") and continue to
be reimbursed on a cost-based system. The 1990 Budget Act, however, directs the
Secretary of Health and Human Services ("HHS") to develop a new prospective
payment methodology for PPS-exempt facilities and to report to Congress on this
matter. As of August 31, 1997, regulations have not been proposed to include
psychiatric facilities in such prospective payment programs.
PPS-exempt facilities are subject to inpatient payment limitations and
incentives established by the Tax Equity and Fiscal Responsibility Act of 1982
("TEFRA"). Under TEFRA, the target rate of permitted increases in cost per case
is established each year by the increase in the cost of a market basket of
hospital goods and services (the "Target Rate"). Facilities with costs less than
the Target Rate per discharge receive their costs plus an additional payment.
Providers with inpatient costs exceeding their Target Rates are subject to a
payment ceiling of 110% of the target amount. The Health Care Financing
Administration ("HCFA"), the agency responsible for administering the Medicare
program, issued a final rule with comment period on August 29, 1997 which
affects PPS-exempt facilities. These rules set forth rate-of-increase limits for
PPS-exempt facilities. There are various effective dates of the rule changes
included in the final rule. In addition, the BBA includes cost containment
provisions limiting the annual increase in payment rates for PPS-exempt
facilities. Under the BBA, PPS-exempt hospitals get a 0% payment update for
fiscal year 1998, then a variable payment update in fiscal years 1999-2002. The
Company has not determined the impact of these regulatory changes and statutory
enactments to the Company. As of June 30, 1997, three Company facilities had
Medicare inpatient utilization and were, therefore, subject to TEFRA payment
limitations and vulnerable to any decrease in Medicare reimbursement.
Annual Cost Reports. In order to receive reimbursement under the Medicare and
Medicaid programs, the Company is required to submit cost reports detailing the
costs incurred by its facilities in providing care to Medicare and Medicaid
enrollees. These cost reports are subject to government audits which may result
in adjustments to the amounts ultimately determined to be due the Company under
these reimbursement programs. These audits often do not result in a final
determination of amounts due to providers under the programs based on costs
until several years have passed. The Company believes, but cannot assure, that
adequate provision has been made for any material adjustments that might result
from all of such audits and that final resolution of all cost reports will not
have a material adverse effect upon the Company's financial position or results
of operations.
-13-
14
Blue Cross and Commercial Insurance. The Company's facilities provide services
to individuals covered by health care insurance offered by private commercial
insurance carriers, and non-profit hospital service corporations such as Blue
Cross. Blue Cross generally pays facilities covered services at (i) their
established hospital charges, (ii) a percentage thereof, or (iii) rates
negotiated between Blue Cross and the individual facility. Other private
insurance carriers also reimburse their policyholders, or make direct payments
to facilities, for covered services at established charges or a percentage
thereof. Except for patients covered under cost-based Blue Cross plans, as is
the case in Michigan, the privately-insured patient generally is responsible to
the facility for any difference between the amount the insurer paid for covered
items or services and the facility's total charges for the covered items or
services. Private commercial insurance carriers have, over the past few years,
tended toward minimizing lengths of stay in facilities and lowering costs, the
continuation of which could adversely affect the Company and its operations.
GOVERNMENT REGULATION AND HOSPITAL ACCREDITATION
Licensing and Certification. The industry in which the Company operates is
subject to substantial federal, state and local government regulations. Health
care facilities are subject to periodic state licensing inspections and
Medicare, Medicaid and CHAMPUS compliance inspections to determine compliance
with their respective conditions of participation, including standards of care,
staffing, equipment, and cleanliness necessary for continued licensing or
participation in these programs. Contracts entered into between the Company and
federal, state and local governments typically contain substantial reporting
obligations and may require supervision, on-site monitoring and periodic
inspections by representatives of such governmental agencies. In addition, there
are specific laws regulating the civil commitment of psychiatric patients and
the disclosure of information regarding patients being treated for chemical
dependency or behavioral disorders. Many states have adopted a "patient's bill
of rights" which sets forth standards dealing with issues such as using the
least restrictive treatments, insuring patient confidentiality, allowing patient
access to the telephone and mail, allowing the patient to see a lawyer and
requiring the patient to be treated with dignity. The Company believes, but
cannot assure, that its facilities are in substantial compliance with all
applicable laws and regulations governing its operations.
Certificate of Need. Five of the states in which the Company operates have in
effect Certificate of Need ("CON") laws applicable to the services provided by
the Company. Under those laws, a hospital generally must obtain state approval
prior to (i) making capital expenditures in excess of certain threshold amounts,
(ii) expanding or relocating bed capacity or facilities, (iii) acquiring certain
medical equipment, or (iv) instituting certain new services. The general effect
of these laws is to increase the difficulty associated with establishing new or
expanding existing facilities or services. The Company may, however, experience
other adverse effects from state CON requirements or changes in such
requirements, including the possibility that the Company experiences adverse
financial affects because it is unable to expand or modify services in a state
with CON requirements.
Utilization Review. Federal law contains numerous provisions designed to ensure
that services rendered by healthcare facilities to Medicare and Medicaid
patients meet recognized professional standards and are medically necessary, as
well as to ensure that claims for reimbursement are properly filed. These
provisions include a requirement that a sampling of admissions of Medicare and
Medicaid patients must be reviewed by peer review organizations ("PROs") in a
timely manner to determine the medical necessity of the admissions. In addition,
under the Peer Review Improvement Act of 1982 (the "Peer Review Act"), PROs may
deny payment for services provided and, in more extreme cases, have the
authority to recommend to HHS that the provider be fined or excluded from the
Medicare and Medicaid programs.
Each of the Company's acute psychiatric residential facilities has
developed and implemented a quality assurance and improvement program and
implemented procedures for utilization review to meet its obligations under the
-14-
15
Peer Review Act. In the past, PROs have not denied significant amounts of the
Company's charges. Nevertheless, the activities of PROs and other public and
private utilization review agencies will likely continue to have the effect of
causing physicians who practice at the Company's acute psychiatric residential
facilities to reduce the number of patient admissions or their overall length of
stay. The Company believes that compliance with regulations overseen by PROs has
reduced the number of patient admissions and the length of stays of Medicare and
Medicaid patients.
Fraud and Abuse. Various state and federal laws regulate the relationships
between providers of health care services and their referral sources, including
physicians. Among these laws are the provisions of the Social Security Act
addressing illegal remuneration (the "Anti-Kickback Statute"). The Anti-Kickback
statute prohibits providers from soliciting, receiving, offering or paying,
directly or indirectly, any remuneration in order to induce or arrange for
referrals for items or services reimbursed under the Medicare or Medicaid
programs. A provider that violates the Anti-Kickback Statute may be subjected to
felony criminal penalties and substantial civil sanctions, including possible
exclusion from the Medicare or Medicaid programs.
In order to provide guidance to health care providers with respect to
the Anti-Kickback Statute, the Office of Inspector General ("OIG"), in July 1991
and November 1992, issued final regulations creating certain "safe harbors."
These "safe harbors" set out requirements which, if met by an individual or
entity, insulate that individual or entity from an enforcement action under the
Anti-Kickback Statute. New proposed safe harbors were issued in September 1993,
with additional clarifications being issued in July 1994. Compliance with the
Anti-Kickback safe harbors is not required by law. However, failure to comply
means that a provider is not assured of protection from investigation or
prosecution under this statute.
The Company and its subsidiaries have entered into various types of
agreements with physicians and other health care providers in the ordinary
course of operating its facilities, many of which provide for payments to such
persons by the Company as compensation for their services. The most common of
these include medical director and provider agreements with physicians. In
addition, the Company and its subsidiaries have entered into various leases,
management contracts and managed care contracts. Although all of these
contracts, one of which, for example, includes a requirement that contracts with
physicians set the aggregate amount of physician compensation in advance, do
not satisfy all the applicable criteria contained in the Anti-Kickback statute
safe harbor regulations that relate to such arrangements the Company believes
that such contracts do not violate the Anti-Kickback Statute because all of
such arrangements (i) are intended to achieve legitimate business purposes,
(ii) provide compensation that is based on fair market value for items or
services that are actually provided, and (iii) are not dependent on the volume
or value of referrals. However, there can be no assurance that (i) government
enforcement agencies will not assert that certain of these arrangements are in
violation of the Anti-Kickback Statute or (ii) the Anti-Kickback Statute will
ultimately be interpreted by the courts in a manner consistent with the
Company's practices. Additional proposed safe harbors are expected to be
published in the near future by the OIG, including a safe harbor for physician
recruitment. The Company is unable to predict whether its recruitment
arrangements with physicians will comply with any safe harbor regarding
physician recruitment, if adopted.
In 1989, Congress passed the legislation commonly referred to as the
Stark Bill ("Stark I") as part of the Omnibus Budget Reconciliation Act of 1989.
Stark I went into effect on January 1, 1992. Stark I prohibited certain
physician referrals to clinical laboratories in which the physician or close
family member has a "financial relationship." In 1993, Congress passed an
amendment to Stark I which became effective on January 1, 1995. This amendment
is commonly referred to as "Stark II" (collectively "Stark") and expanded the
scope of the referral prohibition to cover referrals for any of 12 "designated
health services." "Designated health services" includes both inpatient and
outpatient hospital services. Thus, Stark prohibits a physician from referring
Medicare patients to an entity in which that physician or a member of the
physician's immediate family
-15-
16
has a "financial relationship" for the provision of inpatient and outpatient
hospital services. "Financial relationship" is defined to include both direct
and indirect "ownership interests in" and "compensation arrangements with" the
entity. Stark provides certain exceptions that exempt certain compensation
arrangements and ownership interests from the statute's prohibitions including
the rental of space and equipment, and certain personal services and management
contracts. At this time, the regulations implementing Stark II have not been
issued but are anticipated to be issued prior to the end of 1997.
The Company has attempted to tailor its financial relationships with
physicians in such a way as not to violate Stark II and similar state statutes.
However, there can be no assurance that (i) government enforcement agencies will
not contend that certain of these financial relationships are in violation of
the Stark legislation, (ii) that the Stark legislation will ultimately be
interpreted by the courts in a manner consistent with the Company's practices,
or (iii) regulations will be issued in the future that will result in an
interpretation by the courts in a manner inconsistent with the Company's
practices. The frequency of federal government investigations and prosecutions
of health care providers under these statutes has increased substantially during
the past twelve months and is expected to continue to grow during the
foreseeable future. Such prosecutions and investigations are expensive to defend
and injurious to a provider's reputation, even when no illegal conduct is
ultimately found. If the federal government were to undertake an investigation
or prosecution of the Company, it would likely have a material effect on the
Company and its operations.
State Legislation. In addition to the statutes mentioned above, some of the
states in which the Company operates also have laws (i) that prohibit
corporations and other entities from employing physicians and practicing
medicine, (ii) that prohibit certain direct and indirect payments or
fee-splitting arrangements between health care providers, and (iii) that
prohibit conduct similar to that prohibited by the Anti-Kickback Statute and
Stark II. In addition, some states restrict certain business relationships
between physicians and pharmacies. Possible sanctions for violation of these
restrictions include loss of licensure and civil and criminal penalties. The
specific content and scope of these statutes vary from state to state, are often
vague and have received infrequent interpretation by the state courts and
regulatory agencies. Although the Company exercises care in an effort to
structure its arrangements with health care providers to comply with the
relevant state statutes, and although management believes that the Company is in
compliance with these laws, there can be no assurance that (i) governmental
officials charged with responsibility for enforcing these laws will not assert
that the Company or certain transactions in which it is involved are in
violation of such laws, and (ii) such state laws will ultimately be interpreted
by the courts in a manner consistent with the practices of the Company, either
of which could have a material adverse effect on the Company.
Other Fraud and Abuse Laws. Various federal statutes impose severe criminal and
civil liability on health care providers that make false statements relating to
claims for payments under the Medicare, Medicaid and other government health
care programs. One of the primary statutes utilized by the government and
private citizens ("whistleblowers") has been the Federal False Claims Act
("FCA"). The FCA imposes liability on individuals or entities that knowingly
present or cause to be presented a false or fraudulent claim for payment to the
United States government. Knowingly includes not only having actual knowledge of
the falsity of the claim but also acting in reckless disregard of the truth or
falsity of the claim. This statute allows for the imposition of a civil penalty
of up to $10,000 for each false claim submitted or caused to be submitted to the
government and three times the amount of the damage to the government. A number
of states have adopted similar laws that impose criminal and civil liability for
the submission of false claims.
In August, 1996, Congress enacted the Health Insurance Portability and
Accountability Act ("HIPAA"), which generally became effective January 1, 1997.
HIPAA strengthens federal health care fraud and abuse law enforcement efforts.
Among other things, the new legislation (i) adds several new offenses, (ii)
expands the scope of certain existing laws by including private health insurance
plans as well as the Medicare and Medicaid programs, (iii) increases penalties
for certain existing offenses, and (iv) significantly increases funding for
-16-
17
health care fraud and abuse detection and prosecution efforts, including
authorizing informants to share in recoveries and establishing a national health
care fraud and abuse data bank.
Among other things, HIPAA prohibits submitting a claim for
reimbursement based on a code that the person knows or "should know" will result
in a greater payment than the code "the person knows or should know" is
applicable to the item or service actually provided. HIPAA also prohibits
offering any inducements to beneficiaries in order to influence them to order or
receive Medicare or Medicaid covered items or services from a particular
provider or practitioner.
The new offenses created by HIPAA and the substantial increase in
funding devoted to health care fraud and abuse enforcement which resulted from
HIPAA, will significantly increase the likelihood that any particular health
care company will be scrutinized and investigated by federal, state and/or local
law enforcement officials. In addition, the increased penalties will strengthen
the ability of enforcement agencies to effect more numerous and larger monetary
settlements with health care providers and businesses than was previously the
case.
Healthcare Reform Initiatives. The Clinton Administration and Congress continue
to focus on health care, including Medicare, with an emphasis on curtailing and
lowering the costs of health care in this country. The BBA represents a
significant step on the part of the President and Congress on this front. The
BBA includes substantial cost-containment measures, allows for the further
expansion of managed care in the Medicare environment and increases several
fraud and abuse penalties. At this time, it is uncertain if any other
significant legislation will be enacted during the upcoming sessions of
Congress. The Company cannot predict which, if any, legislative proposals will
be adopted and, if adopted, the effect such legislation would have on the
Company's business.
Accreditation. All of the Company's facilities providing acute psychiatric
treatment programs have been accredited by the Joint Commission on Accreditation
of Healthcare Organizations ("JCAHO"). The JCAHO is a voluntary national
organization which undertakes a comprehensive review for purposes of
accreditation of health care facilities. In general, hospitals and certain other
health care facilities are initially surveyed by JCAHO within 12 months after
the commencement of operations and resurveyed at triennial intervals thereafter.
JCAHO accreditation is important to maintaining relationships with both public
and private insurers, including Medicare, Medicaid, Blue Cross and other private
insurers. The Company believes that all of its facilities providing acute
psychiatric treatment programs are presently in material compliance with all
JCAHO standards of accreditation. The JCAHO review process is subjective to some
degree, however, and there can be no assurance that the Company's facilities
will be able to maintain their accreditation.
COMPETITION
The youth education, treatment and juvenile justice market is highly
fragmented, with no single company or entity holding a dominant market share.
The Company competes with other for-profit companies, not-for-profit entities,
for-profit and not-for-profit hospitals and governmental agencies that are
responsible for juvenile justice and youth education and treatment. The Company
competes primarily on the basis of the quality, range and price of services
offered, its experience in operating facilities and programs and the reputation
of its personnel. Competitors of the Company may initiate programs similar to
those provided by the Company without substantial capital investment or
experience in management of education, treatment or juvenile justice programs.
Many of the Company's competitors have greater resources than the Company.
Although the Company believes that its facilities compete favorably within local
markets on the basis of, among other things, the range and variety of clinical
programs offered, its expertise in child and adolescent programs, its methods of
managing its operations and utilization of case management systems, and its
commitment to continuous quality improvement and customer service, the Company
also competes in some markets with smaller local companies that may have a
better understanding of the local conditions and may be better able to gain
political
-17-
18
and public acceptance. Certain not-for-profit entities may offer youth programs
at a lower cost than the Company due in part to government subsidies, foundation
grants, tax deductible contributions or other financial resources not available
to for-profit companies.
EMPLOYEES
At June 30, 1997, the Company had 1,265 full-time employees and 713
part-time employees. Of these 1,978 employees, 69 were corporate or regional
administrative staff and 1,909 were involved in program and facility operation
and management. Approximately 80 of the Company's employees are covered by a
Collective Bargaining Agreement between the Company's Butte, Montana facility
and the Rivendell Federation of Health Care Employees, MFT, AFT, AFL-CIO, which
agreement was ratified in December 1996 by the employees who are part of the
Collective Bargaining Unit. The term of the contract expires in December 1997.
In conjunction with the hiring of such employees by the Company, the Collective
Bargaining Unit agreed to certain modifications to the contract. The Company
believes that its relations with its employees are good.
INSURANCE
The Company maintains a $21 million general liability insurance policy
for all of its operations. The Company also maintains insurance in amounts it
deems adequate to cover property and casualty risks, workers' compensation and
director and officer liability. The Company requires that physicians practicing
at its facilities carry medical malpractice insurance to cover their respective
individual professional liabilities. There can be no assurance that the
aggregate amount and kinds of the Company's insurance are adequate to cover all
risks it may incur or that insurance will be available in the future.
Each of the Company's contracts and the statutes of certain states
require the maintenance of insurance by the Company. The Company's contracts
provide that in the event the Company does not maintain such insurance, the
contracting agency may terminate its agreement with the Company. The Company
believes it is in compliance in all material respects with respect to these
requirements.
RISK FACTORS
In order for the Company to utilize the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995, investors are hereby cautioned
that forward looking statements in this report based upon current expectations
involve a number of risks and uncertainties that could cause the Company's
actual results to differ materially from those projected. Accordingly, investors
should consider the following important factors, among others, in reviewing this
report: potential termination or non-renewal of the Company's contracts with
Riverside County, California and the State of Tennessee, upon which the Company
was dependent for approximately 29% of its revenues in fiscal 1997; failure of
governments and governmental agencies that contract with the Company to meet
their payment obligations to the Company or to refer youth to the Company's
programs; decreases in the levels of Medicaid and Medicare funding, which would
likely decrease the Medicaid and Medicare reimbursements received by the
Company's facilities; termination of, or the Company's inability to renew,
contracts on an annual basis; the dependence of the Company's future growth on
the number of youth programs available for privatization and the ability to
obtain awards for such contracts; the Company's inability to integrate Vendell
and its operations, and the operations of any future acquired entities, into the
operations of the Company; the inability of the Company to make additional
attractive acquisitions on favorable terms; future changes in governmental rules
and regulations that could adversely affect the Company's operations; the
Company's failure to fully comply with federal and state laws and other
governmental rules and regulations and any resulting investigations,
prosecutions or settlements; reductions in reimbursements by third party payers
and increasing managed care penetration; increasingly stringent length of stay
and admissions criteria; public resistance to privatization of youth education,
treatment and juvenile justice services; negative publicity generated by
opposition to the Company's facilities by residents in areas surrounding
proposed sites; potential
-18-
19
claims or litigation by participants in the Company's programs arising from
contact with the Company's facilities, programs, personnel or participants;
Helicon's inability to pay future management fees or lease payments, which
collectively represent a significant portion of the Company's business;
dependence on certain key personnel and the ability to attract and retain
additional qualified personnel; competition with for-profit and not-for-profit
entities and governmental agencies responsible for youth education, treatment
and juvenile justice services; seasonality and quarterly fluctuations in
revenues; and the effect of certain anti-takeover provisions in the Company's
charter and bylaws and under Tennessee law. The Company undertakes no obligation
to publicly release any revisions to any forward-looking statements contained
herein to reflect events or circumstances occurring after the date hereof or to
reflect the occurrence of unanticipated events.
-19-
20
ITEM 2. PROPERTIES
The table below sets forth certain information regarding the Company's
properties:
Number of
State Nature of Occupation Facilities
- ---------------- -------------------- ----------
Non-Residential:
Alabama Lease 1
Arkansas Lease 2
California Own 4
California Lease 13
Florida Lease 5
Kentucky Own 1
Louisiana Lease 1
Montana Lease 5
Tennessee Lease 1
Texas Own 1
Texas Lease 1
Texas Right to occupy (1) 1
Residential:
Alabama Right to occupy (1) 6
Arkansas Own 1
Florida Own 1
Kentucky Own 1
Michigan Own 1
Montana Own 1
Tennessee Own 2
Tennessee Right to occupy (1) 2
Tennessee Lease 1
Texas Own 1
Utah Own 1
- ----------
(1) The Company acquired a right to occupy the facilities indicated
rent-free for the duration of the Company's contracts to provide these
programs.
The Company owns its non-residential office and educational treatment
center in Grand Terrace, California, its educational treatment centers in
Victorville, Hemet and Riverside, California, its residential treatment centers
in Murfreesboro and Newbern, Tennessee, and its behavioral treatment centers in
Arkansas, Florida, Kentucky, Michigan, Montana, Texas and Utah. The Company
leases all other facilities on a short-term basis (generally one to five years)
in the particular locality where it conducts its programs. For the fiscal year
ended June 30, 1997, the Company's total rental expense for property was
approximately $671,000. In addition, the Company also has obtained a right to
occupy certain facilities rent-free during the effectiveness of the Company's
contracts to provide education and treatment programs in Alabama, Tennessee and
Texas. The Company owns real estate and improvements in Riverside and Ramona,
California, and Murfreesboro, Tennessee which it leases to Helicon pursuant to
lease agreements which expire July 31, 2019, December 31, 1997 and January 31,
1999, respectively.
The Company owns its corporate headquarters office building located in
Murfreesboro, Tennessee. This office building contains approximately 8,800
square feet of office space. The Company also leases corporate office space in
Nashville, Tennessee of approximately 10,000 square feet. The Company believes
its facilities are suitable for its current operations and programs.
-20-
21
ITEM 3. LEGAL PROCEEDINGS
In October 1995, a civil action was filed in the Circuit Court of Colbert
County, Alabama, against the Company and certain of the Company's employees in
connection with the circumstances surrounding the alleged wrongful death of a
juvenile enrolled at the Company's wilderness program in Jasper, Alabama. The
Company's investigation indicated that the juvenile had physical impairments
prior to his enrollment in the wilderness program, which may have contributed to
his death. The complaint, among other things, alleged negligence and civil
rights violations on the part of the Company and certain of its employees, and
sought an unspecified amount of damages. In July 1996, the Company reached a
confidential settlement of this lawsuit which did not have a material adverse
effect on the Company's financial condition or results of operations.
In December 1992, the Company received an audit report from the California
Department of Social Services alleging overpayments of approximately $315,000 at
its 6-bed group homes for the years 1991 and 1992. The Company is contesting
this determination and filed a rate protest with the Department of Social
Services in February 1993. An Informal Hearing was concluded in October 1995.
The Hearing Auditors' Report of Findings was issued in March 1996, and in April
1996, the Company filed a Request for Formal Hearing. The Formal Hearing has not
been completed. A provision for liability of approximately $201,000 is included
in accrued other expenses at June 30, 1997.
The Company is involved in various other legal proceedings, none of which
are expected to have a material effect on the Company's financial position or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to shareholders during the fourth quarter of the
fiscal year.
-21-
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock trades on The Nasdaq Stock Market's National
Market under the symbol "KIDS". The following table sets forth the high and low
sale prices for each full quarter within the Company's past two fiscal years, as
well as for the quarter ended June 30, 1996. High and low sale prices for the
fiscal year ended March 31, 1996 have been retroactively adjusted to reflect the
Company's 1 for 2 reverse stock split of the Common Stock effected March 21,
1996.
Year Ended June 30, 1997 High Low
------------------------------ ------ ------
Quarter Ended: June 30 15 7/8 10 1/2
March 31 14 10 3/4
December 31 19 12
September 30 25 1/4 15 1/2
Transitional Period Ended
June 30, 1996
------------------------------
Quarter Ended: June 30 27 9 3/4
Year Ended March 31, l996
------------------------------
Quarter Ended: March 31 11 7/8 6 7/8
December 31 8 5 3/4
September 30 7 1/2 4 1/2
June 30 5 1/2 4 1/2
HOLDERS
As of September 19, 1997 the Company had approximately 282 shareholders of
record of its Common Stock.
DIVIDENDS
The Company has never declared or paid a cash dividend on its Common
Stock. It is the present policy of the Company's Board of Directors to retain
all available earnings to support operations; therefore, the Company does not
anticipate declaring or paying cash dividends on its Common Stock for the
foreseeable future. The declaration and payment of cash dividends in the future
will be determined based on a number of factors, including the Company's
earnings, financial condition, liquidity requirements, restrictions in financing
agreements and other factors deemed relevant by the Board of Directors. The
Company's current revolving credit agreement prohibits the Company from
declaring dividends in excess of 25% of the Company's net income during any
fiscal year.
-22-
23
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial information for the year ended
June 30, 1997, the three months ended June 30, 1996, (pursuant to the Company's
change in its fiscal year end from March 31 to June 30) and the years ended
March 31, 1996, 1995, 1994, and 1993 has been derived from the financial
statements of the Company and should be read in conjunction with the financial
statements, the related notes thereto and other financial information included
elsewhere herein.
Year Ended Three Months Year Ended March 31,
June 30, Ended June 30, ---------------------------------------------------
1997 1996 1996 1995 1994 1993
---------- -------------- -------- -------- ------- -------
(In thousands of dollars, except per share data)
Statement of Income Data:
Revenue:
Operating revenue(1) $ 34,812 $ 6,482 $ 23,630 $ 20,575 $ 18,849 $ 24,541
Management fee income 1,376 311 1,036 367 -0- -0-
-------- ------- -------- -------- -------- --------
Total revenue 36,188 6,793 24,666 20,942 18,849 24,541
-------- ------- -------- -------- -------- --------
Operating Expenses:
Employee compensation and benefits 22,315 4,063 15,010 12,676 11,619 16,605
Purchased services and other
expenses 7,413 1,182 4,628 3,969 3,601 7,235
Depreciation and amortization 1,013 191 1,025 1,080 1,277 2,072
Other operating expenses 101 25 101 101 193 595
-------- ------- -------- -------- -------- --------
Total operating expenses 30,842 5,461 20,764 17,826 16,690 26,507
-------- ------- -------- -------- -------- --------
Income (loss) from operations 5,346 1,332 3,902 3,116 2,159 (1,966)
Interest (income) expense, net (654) 168 833 1,187 1,397 1,136
Other (income) expense, net (15) -0- -0- (44)(2) 455(3) 7,674(4)
-------- ------- --------- -------- -------- --------
Income (loss) before income taxes
and extraordinary item 6,015 1,164 3,069 1,973 307 (10,776)
Provision (benefit) for income taxes (8) 311 491 69 -0- -0-
-------- ------- -------- -------- -------- --------
Income before extraordinary item 6,023 853 2,578 1,904 307 (10,776)
Extraordinary item, net of tax 377 -0- 54 -0- -0- -0-
-------- ------- -------- -------- -------- --------
Net income (loss) $ 5,646 $ 853 $ 2,524 $ 1,904 $ 307 $(10,776)
======== ======= ======== ======== ======== ========
Net income (loss) per share:
Fully diluted(5) $ .79 $ .15 $ .44 $ .37 $ .08 $ (3.52)
Dividends declared per share -- -- -- -- -- --
Balance Sheet Data:
Working capital (deficit) 23,952 5,057 3,904 1,422 (9,847) (11,279)
Total assets 69,448 22,582 22,122 19,449 20,146 21,330
Long term debt and capital
lease obligations 11,655 6,000 6,052 6,924 8 1,312
Shareholders' equity $49,751 $13,102 $ 12,032 $ 9,456 $ 5,786 $ 4,788
(1) The Company's transfer, effective January 1, 1993, of its California
residential treatment operations to Helicon is the principal reason for
the decline in operating revenue for fiscal 1994 compared to fiscal
1993.
(2) Amount consists of write down of property of $122, net of other income
of $166.
(3) Amount consists of write off of advances to Helicon of $1,024, net of
other income of $569.
(4) Amount consists of write off of advances to Helicon of $1,145, write
off of costs in excess of net assets of purchased businesses of $5,188,
write off of deferred costs of $567, provision for restructuring
expenses of $759 and loss on disposition of property of $15.
(5) Net income (loss) per share--fully diluted--for fiscal 1995, 1994, and
1993 has been retroactively adjusted to reflect the 1 for 2 reverse
split of the Company's Common Stock effected March 21, 1996.
-23-
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and this Annual Report on Form 10-K contains
forward-looking statements and should be read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto included elsewhere herein.
For this purpose, any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the foregoing, the words "believes", "anticipates", "plans", "expects" and
similar expressions are intended to identify forward-looking statements. There
are a number of important factors that could cause the Company's actual results
to differ materially from those indicated by such forward-looking statements.
These factors include, without limitation, those set forth above under
"Business--Risk Factors." The Company undertakes no obligation to publicly
release any revisions to any forward-looking statements contained herein to
reflect events or circumstances occurring after the date hereof or to reflect
the occurrence of unanticpated events.
GENERAL
As of June 30, 1997, the Company was providing education, treatment and
juvenile justice services, either directly or through management contracts with
Helicon, to approximately 2,600 youth and 100 adults. Revenues under the
Company's programs are recognized as services are rendered. The Company's
programs are delivered in both non-residential and residential settings, with
the majority of the Company's revenues currently generated by non-residential
programs. The Company's nonresidential programs, which historically have
generated higher operating margins than the Company's residential facilities,
generally receive revenues based on per diem rates. The Company's residential
facilities generally receive revenues under either fixed fee contracts or at
per diem rates.
In June 1997, the Company acquired substantially all the assets of
Vendell Healthcare, Inc. and its subsidiaries ("Vendell") for approximately
$19,477,000 in cash ($18,768,000 of which was paid at closing and $709,000 of
which was paid in September 1997) and the issuance of 642,978 shares of the
Company's Common Stock valued at approximately $7,600,000. Pursuant to this
acquisition, the Company acquired seven residential treatment facilities and 12
non-residential treatment facilities which the Company believes will enhance its
continuum of youth services.
The Company receives management fee income from Helicon for consulting,
management and marketing services rendered pursuant to the Helicon Agreement. As
of June 30, 1997, the Company was providing consulting, management and marketing
services to Helicon at 12 programs. In addition, Helicon also leases three
facilities owned by the Company to operate certain of its programs. Pursuant to
the Helicon Agreement, the Company is entitled to receive for these services
management fee income in an amount equal to 6% of the monthly gross revenues of
Helicon's programs. The payment of these management fees, however, is
subordinated in right of payment to amounts payable by Helicon to fund its
programs. For the fiscal year ended June 30, 1997, and for the three months
ended June 30, 1996, the Company recognized all of the management fee income to
which it was entitled. However, for each of the fiscal years ended March 31,
1996 and 1995, the Company did not recognize all of the management fee income to
which it was entitled due to the inability of Helicon to pay these amounts. The
Helicon Agreement expires September 1, 1999. At June 30, 1997, unpaid management
fees, lease payments and advances, plus interest, due the Company from Helicon
totaled $7,153,000. The Company has fully reserved this amount. Future payments
received from Helicon on these amounts, if any, will be recognized by the
Company on the cash basis. The Company has also guaranteed Helicon's obligations
under a bank line of credit in the amount of $1,000,000. See "--Liquidity and
Capital Resources."
-24-
25
Employee compensation and benefits include facility and program payrolls
and related taxes, as well as employee benefits, including insurance and
worker's compensation coverage. Employee compensation and benefits also includes
general and administrative payroll and related benefit costs, including salaries
and supplemental compensation of officers.
Purchased services and other expenses include all expenses not otherwise
presented separately in the Company's statements of operations. Significant
components of these expenses at the operating level include items such as food,
utilities, supplies, rent and insurance. Significant components of these
expenses at the administrative level include legal, accounting, investor
relations, marketing, consulting and travel expense.
The Company's effective tax rate is less than the statutory tax rate
primarily because of the utilization of tax net operating loss carryforwards for
which no tax benefit had been recognized prior to the quarterly period ended
December 31, 1996. The Company currently has regular tax net operating loss
carryforwards of $2,112,000, utilization of which is subject to annual
limitations pursuant to the provisions of Internal Revenue Code Section 382.
The Company's quarterly results may fluctuate significantly as a result of
a variety of factors, including the timing of the opening of new programs. When
the Company opens a new program, the program may be unprofitable until the
program's population, and net revenues contributed by the program, approach
intended levels, primarily because the Company staffs its programs in
anticipation of achieving such levels. The Company's quarterly results may also
be impacted by seasonality, as revenues generated by youth education and
treatment services are generally seasonal in nature, fluctuating with the
academic school year.
RESULTS OF OPERATIONS
Due to the change in fiscal year end, the presentations of the Company's
financial position and results of operations for the year ended June 30, 1997
are not comparable to the presentations of its financial position and results of
operations for the year ended March 31, 1996.
The following table sets forth, for the periods indicated, the percentage
relationship to total revenues of certain items in the Company's statements of
income:
Year Ended Three Months Year Ended Year Ended
June 30, Ended June 30, March 31, March 31,
1997 1996 1996 1995
---------- -------------- ---------- ---------
Operating revenues 96.2% 95.4% 95.8% 98.2%
Management fee income 3.8 4.6 4.2 1.8
----- ----- ----- -----
TOTAL REVENUES 100.0 100.0 100.0 100.0
----- ----- ----- -----
Employee compensation
and benefits 61.6 59.8 60.8 60.5
Purchased services and
other expenses 20.5 17.4 18.8 19.0
Depreciation and
amortization 2.8 2.8 4.2 5.1
Related party rent .3 .4 .4 .5
----- ----- ----- ---
TOTAL OPERATING EXPENSES 85.2 80.4 84.2 85.1
----- ----- ----- -----
Income from operations 14.8 19.6 15.8 14.9
Other (income) expense:
Interest expense .9 2.9 3.5 5.7
Interest income (2.7) (.5) (.1) --
Other income -- -- -- (.8)
Write down of property -- -- -- .6
Provision for income
taxes -- 4.6 2.0 .3
Extraordinary item,
net of tax 1.0 -- .2 --
----- ----- ----- -----
NET INCOME 15.6% 12.6% 10.2% 9.1%
===== ===== ===== =====
-25-
26
FISCAL 1997 (YEAR ENDED JUNE 30, 1997) VERSUS FISCAL 1996 (YEAR ENDED MARCH 31,
1996)
Total revenues for fiscal 1997 increased by $11,522,000 or 46.7% to
$36,188,000, as compared to $24,666,000 for fiscal 1996. Total operating
revenues for fiscal 1997 increased by $11,182,000 or 47.3% to $34,812,000, as
compared to $23,630,000 for fiscal 1996. The increase in operating revenues
results primarily from the opening of eight new programs during fiscal 1997 and
from significant increases in student enrollment at seven of the Company's
programs. Additionally, approximately $3,300,000 of the increase in operating
revenues over the prior fiscal year is attributable to the Company's June 1997
purchase of substantially all the assets of Vendell Healthcare, Inc.
("Vendell").
Management fee income recognized under the Helicon Agreement for fiscal
1997 increased $253,000, or 24.4%, to $1,289,000, as compared to $1,036,000 for
fiscal 1996. Additional management fee income of $87,000 was recognized under
management contracts acquired pursuant to the Vendell asset purchase. Management
fee income of $217,000 for fiscal 1996 was not recognized by the Company due to
the inability of Helicon to pay those amounts.
Employee compensation and benefits for fiscal 1997 increased $7,305,000,
or 48.7%, to $22,315,000, as compared to $15,010,000 for fiscal 1996. As a
percentage of total revenues, employee compensation and benefits increased to
61.6% for fiscal 1997 from 60.8% for fiscal 1996. The increase in employee
compensation and benefits over the prior year results primarily from the
addition of employees to support the growth in the number and scope of the
Company's programs, from the Vendell asset purchase, and from inefficiencies
experienced during the early stages of certain programs.
Purchased services and other expenses for fiscal 1997 increased
$2,785,000, or 60.2%, to $7,413,000, as compared to $4,628,000 for fiscal 1996.
As a percentage of total revenues, purchased services and other expenses
increased to 20.5% for fiscal 1997 from 18.8% for fiscal 1996. The increase in
purchased services and other expenses over the prior year results primarily from
the Company's growth, both from new programs and from the Vendell asset
purchase, as well as from increases in consulting, investor relations, legal and
travel expenses.
Depreciation and amortization decreased $12,000, or 1.2%, to $1,013,000
for fiscal 1997 from $1,025,000 for fiscal 1996. The decrease in depreciation
and amortization over the prior fiscal year is attributable primarily to the
reduction in amortization of non-competition agreements from approximately
$250,000 in fiscal 1996 to $-0- in fiscal 1997, net of depreciation and
amortization incurred at one of the Company's programs opened during fiscal 1997
and from depreciation associated with the Vendell asset purchase.
Income from operations increased $1,444,000, or 37.0%, to $5,346,000 for
fiscal 1997 from $3,902,000 for fiscal 1996, and decreased as a percentage of
total revenues to 14.8% for fiscal 1997 from 15.8% for fiscal 1996, as a result
of the factors described above.
Interest expense decreased $548,000, or 63.1%, to $321,000 for fiscal 1997
from $869,000 for fiscal 1996. The decrease in interest expense over the prior
fiscal year is attributed principally to the prepayment of the Company's
long-term debt on October 1, 1996 and the related elimination of deferred loan
cost amortization, net of interest incurred in June 1997 pursuant to the Vendell
asset purchase.
Interest income for fiscal 1997 increased $939,000 to $975,000, as
compared to $36,000 for fiscal 1996. The increase in interest income over the
prior year is attributable primarily to the increase in cash available for
investment from operations and from the Company's public offering of stock
completed in August 1996.
-26-
27
Provision for income tax expense for fiscal 1997 decreased $499,000 to
$(8,000) from $491,000 for fiscal 1996. The decrease in provision for income tax
expense compared to the prior year results primarily from a nonrecurring credit
to income tax expense of $1,783,000, related to the reversal of a portion of the
valuation allowance against the Company's deferred tax assets during the period
ended December 31, 1996, net of the impact of an increase in the Company's
effective tax rate.
Loss on early extinguishment of debt for fiscal 1997 of $612,000, before
the related income tax benefit of $235,000, resulted from the prepayment of the
Company's outstanding indebtedness to National Health Investors, Inc. As a
result of the prepayment of this debt, the Company incurred a prepayment penalty
of approximately $493,000, and wrote off deferred loan costs totalling $119,000.
Loss on early extinguishment of debt for fiscal 1996 of $64,000, before the
related income tax benefit of $10,000, resulted from the write off of deferred
loan costs associated with the Company's term loan with T. Rowe Price Strategic
Partners Fund II, L.P. ("Strategic Partners") which was repaid.
THREE MONTHS ENDED JUNE 30, 1996 VERSUS JUNE 30, 1995
Total revenues for the three months ended June 30, 1996 increased
$1,169,000, or 20.8%, to $6,793,000 as compared to $5,624,000 for the three
months ended June 30, 1995. Operating revenues for the three months ended June
30, 1996 increased $964,000, or 17.5%, to $6,482,000 as compared to $5,518,000
for the three months ended June 30, 1995. The increase in operating revenues
results primarily from the opening of three new programs during fiscal 1996
which were in operation throughout the entire three months ended June 30, 1996,
and from significant increases in student enrollment at four of the Company's
programs.
Management fee income recognized under the Helicon Agreement increased
$205,000 to $311,000 for the three months ended June 30, 1996 as compared to
$106,000 for the three months ended June 30, 1995. Additional management fee
income of $217,000 for the three months ended June 30, 1995 was not recognized
by the Company due to the inability of Helicon to pay those amounts.
Employee compensation and benefits for the three months ended June 30,
1996 increased $648,000, or 19.0%, to $4,063,000 as compared to $3,415,000 for
the three months ended June 30, 1995. As a percentage of total revenues,
employee compensation and benefits decreased to 59.8% for the three months ended
June 30, 1996 from 60.7% for the three months ended June 30, 1995. The increase
in employee compensation and benefits over the same period in the prior year
results primarily from the opening of three new programs during fiscal 1996
which were in operation throughout the entire three months ended June 30, 1996,
from significant expansion at two of the Company's programs, and from an
increase in the amounts accrued under the Company's incentive compensation
plans.
Purchased services and other expenses for the three months ended June
30, 1996 increased $96,000, or 8.8%, to $1,182,000 as compared to $1,086,000 for
the three months ended June 30, 1995. As a percentage of total revenues,
purchased services and other expenses decreased to 17.4% for the three months
ended June 30, 1996 from 19.3% for the three months ended June 30, 1995. The
increase in purchased services and other expenses over the same period in the
prior year is attributable primarily to the opening of three new programs during
fiscal 1996 which were in operation throughout the entire three months ended
June 30, 1996, and from increases in consulting, audit and travel expenses, net
of a reduction in legal expense.
Depreciation and amortization for the three months ended June 30, 1996
decreased $73,000, or 27.7%, to $191,000 as compared to $264,000 for the three
months ended June 30, 1995. The decrease in depreciation and amortization
-27-
28
compared to the same period in the prior year is attributable primarily to the
reduction in amortization of non-competition agreements from approximately
$62,000 for the three months ended June 30, 1995 to $-0- for the three months
ended June 30, 1996.
Income from operations for the three months ended June 30, 1996
increased $498,000, or 59.7%, to $1,332,000 as compared to $834,000 for the
three months ended June 30, 1995, and increased as a percentage of total
revenues to 19.6% for the three months ended June 30, 1996 from 14.8% for the
three months ended June 30, 1995 as a result of the factors described above.
Interest expense for the three months ended June 30, 1996 decreased
$40,000, or 16.7%, to $200,000 as compared to $240,000 for the three months
ended June 30, 1995. The decrease in interest expense is attributed primarily to
a reduction in the average balance of debt outstanding and to a decrease in the
amortization of deferred loan costs.
Interest income increased $30,000 to $32,000 for the three months ended
June 30, 1996 as compared to $2,000 for the three months ended June 30, 1995.
The increase in interest income over the same period in the prior year is
attributable primarily to the increase in cash available for investment.
Provision for income taxes for the three months ended June 30, 1996
increased $222,000 to $311,000 as compared to $89,000 for the three months ended
June 30, 1995. The Company's effective tax rate is less than the statutory tax
rate because of the utilization of tax net operating loss carryforwards for
which no tax benefit had previously been recognized.
FISCAL 1996 (YEAR ENDED MARCH 31, 1996) VERSUS FISCAL 1995 (YEAR ENDED MARCH 31,
1995)
Total revenues for fiscal 1996 increased by $3,724,000 or 17.8% to
$24,666,000, as compared to $20,942,000 for fiscal 1995. Total operating
revenues for fiscal 1996 increased by $3,055,000 or 14.8% to $23,630,000, as
compared to $20,575,000 for fiscal 1995. The increase in operating revenues
results primarily from the opening of three new programs during fiscal 1996,
from the opening of two programs during fiscal 1995 which were in operation
throughout all of fiscal 1996, and from significant increases in student
enrollment at four of the Company's programs. Additionally, an increase in the
per diem rate at the Company's California campuses, effective in July 1995,
generated approximately 8% of the increase in operating revenues.
Management fee income recognized under the Helicon Agreement for fiscal
1996 increased $669,000, or 182.3%, to $1,036,000, as compared to $367,000 for
fiscal 1995. Additional management fee income of $217,000 for fiscal 1996 and
$703,000 for fiscal 1995 was not recognized by the Company due to the inability
of Helicon to pay these amounts.
Employee compensation and benefits for fiscal 1996 increased $2,334,000,
or 18.4%, to $15,010,000, as compared to $12,676,000 for fiscal 1995. As a
percentage of total revenues, employee compensation and benefits increased to
60.8% for fiscal 1996 from 60.5% for fiscal 1995. The increase in employee
compensation and benefits over the same period in the prior year results
primarily from the opening in fiscal 1996 of three new programs, from the impact
of two programs opened during fiscal 1995 which were in operation throughout all
of fiscal 1996 and from increased staffing requirements at certain other
programs. The Company also increased corporate and regional personnel costs in
fiscal 1996, primarily for operations support, business development and quality
assurance to support the growth and expansion of the Company's operations.
-28-
29
Purchased services and other expenses for fiscal 1996 increased $659,000,
or 16.6%, to $4,628,000, as compared to $3,969,000 for fiscal 1995. As a
percentage of total revenues, purchased services and other expenses decreased to
18.8% for fiscal 1996 from 19.0% for fiscal 1995. The increase in purchased
services and other expenses over the same period in the prior year results
primarily from the opening of three new programs, from the impact of two
programs opened during fiscal 1995 which were in operation throughout all of
fiscal 1996, from significant expansion at one of the Company's programs, and
from increases in consulting, business development, legal, investor relations
and travel expense.
Depreciation and amortization decreased $55,000, or 5.1%, to $1,025,000
for fiscal 1996 from $1,080,000 for fiscal 1995. Depreciation and amortization
for fiscal 1996 and 1995 includes amortization expense of $250,000 under the
Company's non-competition agreements. These agreements were completely amortized
at March 31, 1996.
Income from operations increased $786,000, or 25.2%, to $3,902,000 for
fiscal 1996 from $3,116,000 for fiscal 1995, and increased as a percent of total
revenues to 15.8% for fiscal 1996 from 14.9% for fiscal 1995, as a result of the
factors described above.
Interest expense decreased $319,000, or 26.9%, to $869,000 for fiscal 1996
from $1,188,000 for fiscal 1995. The decrease in interest expense is
attributable primarily to a reduction in the average balance of debt outstanding
and to a decrease in the amortization of deferred loan costs.
Other income during fiscal 1996 decreased by $166,000, or 100.0%, to $-0-,
as compared to $166,000 for fiscal 1995. Other income for fiscal 1995 consisted
primarily of $150,000 received by the Company pursuant to a settlement of
certain workers compensation litigation.
Provision for income tax expense increased $422,000 to $491,000 for fiscal
1996 from $69,000 for fiscal 1995. The Company's effective tax rate is
significantly less than the statutory tax rate because of the utilization of tax
net operating loss carryforwards for which no tax benefit had previously been
recognized. The increase in the Company's effective tax rate over the same
period in the prior year results from the presence of annual limitations on the
utilization of the net operating loss carryforwards pursuant to Internal Revenue
Code Section 382.
In fiscal 1996, the Company also incurred a loss on the early
extinguishment of debt of $64,000 before the related income tax benefit of
$10,000, resulting from the writeoff of deferred loan costs.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities for fiscal 1997 was $4,491,000 on
net income of $5,646,000 as compared to $3,461,000 for fiscal 1996 on net income
of $2,524,000. Working capital at June 30, 1997 was $23,952,000, as compared to
$5,057,000 at June 30, 1996, and the current ratio at June 30, 1997 was 4.1:1,
as compared to 2.7:1 at June 30, 1996.
Cash used by investing activities was $23,061,000 for fiscal 1997 as
compared to $232,000 for fiscal 1996. The increase in fiscal 1997 as compared to
fiscal 1996 is due primarily to the purchase of the Vendell assets and to an
increase in cash outlays for the purchase of property and equipment. Cash
provided by financing activities was $28,893,000 for fiscal 1997 as compared to
cash used by financing activities of $871,000 for fiscal 1996, due primarily to
the receipt of net proceeds of $23,359,000 from the issuance of shares of the
Company's Common Stock in its public offering of Common Stock completed in
August 1996.
In September 1994, the Company obtained a $2.5 million one-year revolving
line of credit from First American National Bank ("FANB"). In January 1996, the
Company's line of credit was reduced to $2.0 million, in order to facilitate
Helicon's obtaining a $500,000 line of credit from FANB. As a further condition
to the granting of Helicon's line of credit, the Company agreed to guarantee
-29-
30
Helicon's performance under such line. In November 1996, Helicon's line, and the
Company's guarantee, were increased to $1 million. At June 30, 1997, there were
no amounts outstanding under Helicon's line of credit.
The Company's $2.0 million line of credit matured on September 30, 1996,
and, on November 8, 1996, the Company entered into a new loan and security
agreement with FANB. Under the terms of this agreement, FANB has made available
to the Company, for acquisition financing and working capital requirements, a
revolving line of credit for up to $13,000,000. The initial term of the
agreement extends through November 1, 1999. The credit facility bears interest
at either (i) the one, two or three month LIBOR rate plus an applicable margin,
which ranges between 1.35% and 2.10% and is dependent on the ratio of funded
debt to operating earnings or (ii) FANB's index rate, at the Company's option.
The line of credit is secured primarily by the Company's accounts receivable and
equipment. The balance outstanding under the line of credit at June 30, 1997,
$11,450,000, was borrowed in June 1997 to fund the cash portion of the Vendell
asset purchase.
The Company's line of credit requires the Company to comply with certain
restrictive covenants with respect to its business and operations and to
maintain certain financial ratios. The restrictive covenants prohibit the
Company, without the prior consent of its lender, from entering into major
corporate transactions, such as a merger, tender offer or sale of its assets,
and from incurring additional indebtedness in excess of $1,000,000. The
agreement also prohibits the Company from declaring dividends in excess of 25%
of net income during any fiscal year.
Capital expenditures during fiscal 1998 are expected to include the
replacement of existing capital assets as necessary, as well as the expenditures
associated with the opening of new programs and facilities, including the
possible purchase of certain real estate and improvements. The Company also may
consider possible strategic acquisitions, including acquisitions of existing
programs and other companies engaged in the youth services business. The
Company, however, has no agreements, arrangements or commitments with respect to
any such acquisitions.
Current obligations, typically due within thirty days or less, are
expected to be funded with cash flow from operations and borrowings under the
Company's line of credit. Management believes that operations, remaining
proceeds from the August 1996 public offering and amounts available under its
line of credit will provide sufficient cash flow for the next twelve months and
that long-term liquidity requirements will be met from cash flow from operations
and outside financing sources.
INFLATION
Inflation has not had a significant impact on the Company's results of
operation since inception. Certain of the Company's existing contracts provide
for annual price increases based upon changes in the Consumer Price Index.
IMPACT OF ACCOUNTING CHANGES
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per
Share" and No. 129, "Disclosure of Information about Capital Structure," which
are required to be adopted on December 31, 1997. At that time, the Company will
be required to change the method currently used to compute earnings per share
and to restate all prior periods. Under the new requirements for calculating
primary earnings per share, the dilutive effect of stock options will be
excluded. The impact of SFAS 128 on the calculation of primary and fully diluted
earnings per share is not expected to be material and the adoption of SFAS No.
129 is not expected to materially alter disclosures presently being provided.
In June 1997,the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which establishes standards for the reporting and display of
comprehensive income and its components. This Statement requires that all items
that are income be
-30-
31
reported in a financial statement that is displayed with the same prominence as
other financial statements. The Statement was only recently issued, and the
Company has not yet determined the impact of adoption on its disclosure
requirements.
In June 1997, the FASB also issued SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information," which changes the way public
companies report segment information in annual financial statements and also
requires those companies to report selected segment information in interim
financial reports to shareholders. This Statement is effective for financial
statements for fiscal years beginning after December 15, 1997. This Statement
was only recently issued, and the Company has not yet determined the impact of
adoption on its disclosure requirements.
-31-
32
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
The information called for under Item 7A. is not required for fiscal 1997
as the Company's market capitalization was less than $2.5 billion as of January
28, 1997.
-32-
33
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-33-
34
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Children's Comprehensive Services, Inc.
We have audited the accompanying consolidated balance sheets of Children's
Comprehensive Services, Inc. and subsidiaries as of June 30, 1997 and 1996, and
the related consolidated statements of income, shareholders' equity, and cash
flows for the year ended June 30, 1997, the three months ended June 30, 1996,
and each of the two years in the period ended March 31, 1996. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and 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 consolidated financial position of
Children's Comprehensive Services, Inc. and subsidiaries at June 30, 1997 and
1996, and the consolidated results of their operations and their cash flows for
the year ended June 30, 1997, the three months ended June 30, 1996, and each of
the two years in the period ended March 31, 1996, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
Ernst & Young LLP
Nashville, Tennessee
August 13, 1997
-34-
35
CHILDREN'S COMPREHENSIVE SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
June 30,
---------------------
1997 1996
------- -------
(dollars in thousands)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $13,641 $ 3,318
Accounts receivable, net of allowance
for doubtful accounts of $2,361
in 1997 and $143 in 1996 16,001 4,025
Prepaid expenses 604 300
Deferred income taxes 362 -0-
Other current assets 1,121 404
------- -------
TOTAL CURRENT ASSETS 31,729 8,047
PROPERTY AND EQUIPMENT, net of accumulated
depreciation of $5,908 in 1997 and $4,994
in 1996 36,321 14,183
DEFERRED INCOME TAXES, net of valuation
allowance of $150 in 1997 and
$2,027 in 1996 614 -0-
NOTE RECEIVABLE 217 217
COST IN EXCESS OF NET ASSETS ACQUIRED,
at cost, net of accumulated
amortization of $4 in 1997 and
$-0- in 1996 372 -0-
OTHER ASSETS AND DEFERRED CHARGES, at cost,
net of accumulated amortization of
$91 in 1997 and $346 in 1996 195 135
------- -------
TOTAL ASSETS $69,448 $22,582
======= =======
-35-
36
CHILDREN'S COMPREHENSIVE SERVICES, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
June 30,
---------------------
1997 1996
-------- -------
(dollars in thousands)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,620 $ 540
Current maturities - long term debt -0- 206
Current portion - capital leases 40 -0-
Income taxes payable 143 492
Accrued employee compensation 3,062 997
Accrued other expenses 2,744 595
Deferred revenue 168 160
------- -------
TOTAL CURRENT LIABILITIES 7,777 2,990
LONG TERM DEBT 11,450 6,000
OBLIGATION UNDER CAPITAL LEASES 205 -0-
DEFERRED INCOME TAXES -0- 125
OTHER LIABILITIES 265 365
------- -------
TOTAL LIABILITIES 19,697 9,480
------- -------
SHAREHOLDERS' EQUITY
Preferred stock, par value $1.00 per
share--10,000,000 shares authorized -0- -0-
Common stock, par value $ .01 per share
--50,000,000 shares authorized; issued
and outstanding 7,769,656 shares in 1997
and 5,492,201 shares in 1996 78 55
Additional paid-in capital 56,618 25,638
Accumulated (deficit) (6,945) (12,591)
------- -------
TOTAL SHAREHOLDERS' EQUITY 49,751 13,102
------- -------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $69,448 $22,582
======= =======
See notes to consolidated financial statements.
-36-
37
CHILDREN'S COMPREHENSIVE SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Year Ended Three Months Ended Year Ended Year Ended
June 30, June 30, March 31, March 31,
1997 1996 1996 1995
---------- ------------------ ---------- -----------
(In thousands, except per share amounts)
Revenues:
Operating revenues $ 34,812 $ 6,482 $ 23,630 $ 20,575
Management fee income 1,376 311 1,036 367
-------- ------- -------- --------
TOTAL REVENUES 36,188 6,793 24,666 20,942
-------- ------- -------- --------
Operating expenses:
Employee compensation and benefits 22,315 4,063 15,010 12,676
Purchased services and other expenses 7,413 1,182 4,628 3,969
Depreciation and amortization 1,013 191 1,025 1,080
Related party rent 101 25 101 101
-------- ------- -------- --------
TOTAL OPERATING EXPENSES 30,842 5,461 20,764 17,826
-------- ------- -------- --------
Income from operations 5,346 1,332 3,902 3,116
Other (income) expense:
Interest:
Banks and other 321 200 820 968
Related parties -0- -0- 49 220
Interest income (975) (32) (36) (1)
Write down of property -0- -0- -0- 122
Other income (15) -0- -0- (166)
-------- ------- -------- --------
TOTAL OTHER (INCOME) EXPENSE, NET (669) 168 833 1,143
-------- ------- -------- --------
Income before income taxes and
extraordinary item 6,015 1,164 3,069 1,973
Provision (benefit) for income taxes (8) 311 491 69
-------- ------- -------- --------
Income before extraordinary item 6,023 853 2,578 1,904
Extraordinary item:
Loss on early extinguishment of debt,
net of income tax benefit of $235
in 1997 and $10 in 1996 377 -0- 54 -0-
-------- ------- -------- --------
NET INCOME $ 5,646 $ 853 $ 2,524 $ 1,904
======== ======= ======== ========
Earnings per common share:
Income before extraordinary item $ .84 $ .15 $ .46 $ .38
Extraordinary item (.05) -0- (.01) -0-
-------- ------- -------- --------
NET INCOME $ .79 $ .15 $ .45 $ .38
======== ======= ======== ========
Earnings per common share- assuming full dilution:
Income before extraordinary item $ .84 $ .15 $ .45 $ .37
Extraordinary item (.05) -0- (.01) -0-
-------- ------- -------- --------
NET INCOME $ .79 $ .15 $ .44 $ .37
======== ======= ======== ========
Weighted average shares outstanding:
Primary 7,175 5,763 5,596 5,045
Fully diluted 7,175 5,780 5,688 5,115
See notes to consolidated financial statements.
-37-
38
CHILDREN'S COMPREHENSIVE SERVICES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock,
$.01 par value Additional Total
------------------ Paid-In Accumulated Shareholders'
Shares Amount Capital (Deficit) Equity
--------- ------ --------- ----------- -------------
(dollars in thousands)
Balance at April 1, 1994 3,688,811 $37 $23,621 $(17,872) $ 5,786
Stock issued:
Exercise of warrant 1,662,080 17 1,831 1,848
Exercise of options 5,000 -0- 10 10
Stock registration costs (92) (92)
Net income for the year 1,904 1,904
--------- --- ------- -------- ------
Balance at March 31, 1995 5,355,891 54 25,370 (15,968) 9,456
Stock issued:
Exercise of options 22,875 -0- 63 63
Stock redeemed:
Fractional shares redeemed from
one for two reverse split (40) -0- -0- -0-
Warrant adjustment 16 16
Stock registration costs (27) (27)
Net income for the year 2,524 2,524
--------- --- ------- -------- -------
Balance at March 31, 1996 5,378,726 54 25,422 (13,444) 12,032
Stock issued:
Exercise of warrant 50,000 -0- 100 100
Exercise of options 66,059 1 116 117
Net income for the period 853 853
--------- --- ------- -------- -------
Balance at June 30, 1996 5,494,785 55 25,638 (12,591) 13,102
Stock issued:
Exercise of options 56,893 1 63 64
Public offering,
net of issue costs of $1,841 1,575,000 16 23,343 23,359
Acquisition of assets of
Vendell Healthcare, Inc. 642,978 6 7,593 7,599
Stock registration costs (19) (19)
Net income for the year 5,646 5,646
--------- --- ------- -------- -------
Balance at June 30, 1997 7,769,656 $78 $56,618 $(6,945) $49,751
========= === ======= ======== =======
See notes to consolidated financial statements.
-38-
39
CHILDREN'S COMPREHENSIVE SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended Three Months Ended Year Ended Year Ended
June 30, June 30, March 31, March 31,
1997 1996 1996 1995
------------ ----------------- ----------- ----------
(in thousands)
OPERATING ACTIVITIES
Net income $ 5,646 $ 853 $ 2,524 $ 1,904
Adjustments to reconcile net income to
net cash provided by operating
activities:
Deferred income taxes (1,101) -0- -0- -0-
Depreciation 935 191 775 830
Amortization 78 -0- 250 250
Amortization of deferred loan costs 31 14 74 163
Provision for bad debts (155) -0- 38 83
Write down of property -0- -0- -0- 122
Other (7) -0- 19 (16)
Loss on early extinguishment of debt 119 -0- 64 -0-
Changes in operating assets and
liabilities, net of effects from
purchase of assets of Vendell
Healthcare, Inc. and AR&D, Inc:
Accounts receivable (1,928) 443 (1,074) (289)
Prepaid expenses 224 3 (37) 62
Other current assets (445) (150) (120) (51)
Accounts payable 16 (118) -0- (99)
Accrued employee compensation (72) (573) 854 (290)
Accrued other expenses 1,591 (53) (25) (451)
Income taxes payable (349) 181 242 69
Deferred revenue 8 -0- (23) 31
Other liabilities (100) -0- (100) (100)
-------- ------- -------- --------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 4,491 791 3,461 2,218
-------- ------- -------- --------
INVESTING ACTIVITIES
Purchase of assets of Vendell
Healthcare, Inc. (19,477) -0- -0- -0-
Purchase of assets of AR&D, Inc. (999) -0- -0- -0-
Purchase of property and equipment (2,458) (68) (252) (359)
Proceeds from sale of property and
equipment 11 -0- 38 15
Other assets (138) (2) (18) (233)
-------- ------- -------- --------
NET CASH (USED) BY
INVESTING ACTIVITIES $(23,061) $ (70) $ (232) $ (577)
-------- ------- -------- --------
-39-
40
CHILDREN'S COMPREHENSIVE SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Year Ended Three Months Ended Year Ended Year Ended
June 30, June 30, March 31, March 31,
1997 1996 1996 1995
---------- ----------------- ---------- ---------
FINANCING ACTIVITIES
Proceeds from revolving lines
of credit, long-term
borrowings and capital lease
obligations $11,695 $ -0- $ 3,436 $ 15,246
Principal payments on revolving
lines of credit, long-term
borrowings and capital lease
obligations (6,206) (47) (3,612) (16,265)
Principal payments on notes
payable and long-term
borrowings - related parties -0- -0- (731) (1,197)
Principal payments on mortgage
notes payable -0- -0- -0- (1,300)
Proceeds from issuance of Common
Stock, net 23,423 217 63 1,858
Stock registration costs (19) -0- (27) (92)
-------- ------- ------- --------
NET CASH PROVIDED (USED) BY
FINANCING ACTIVITIES 28,893 170 (871) (1,750)
------- ------- ------- --------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 10,323 891 2,358 (109)
Cash and cash equivalents at
beginning of period 3,318 2,427 69 178
------- ------- ------- --------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $13,641 $ 3,318 $ 2,427 $ 69
======= ======= ======= ========
SUPPLEMENTAL INFORMATION
Income taxes paid $ 1,107 $ -0- $ 239 $ -0-
Interest paid 271 1,174 793 956
See notes to consolidated financial statements.
-40-
41
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business - Children's Comprehensive Services, Inc. and its subsidiaries
(the Company) provide a broad range of services, with emphasis on education,
treatment and juvenile justice services for at risk and troubled youth,
primarily to federal, state and local governmental entities charged with the
responsibility for providing such services. The Company offers these services
through the operation and management of education and treatment programs and
both open and secured residential treatment centers in Alabama, Arkansas,
California, Florida, Kentucky, Louisiana, Michigan, Montana, Tennessee, Texas
and Utah. The Company also provides consulting, management and marketing
services to a not-for-profit corporation which provides similar services.
Basis of Consolidation -- The consolidated financial statements include
the accounts of Children's Comprehensive Services, Inc. and its subsidiaries.
All significant intercompany transactions and balances have been eliminated.
Change in Fiscal Year End -- In March 1997, the Board of Directors voted
to change the Company's fiscal year end from March 31 to June 30, effective with
the three month period ended June 30, 1996.
Cash Equivalents -- The Company considers all highly liquid investments
with a maturity of four months or less when purchased to be cash equivalents.
Property and Equipment -- Property and equipment are recorded at cost
and depreciated using the straight-line method over the following estimated
useful lives:
Land improvements 30 years
Buildings and improvements 2 - 30 years
Furniture and equipment 3 - 7 years
Other Assets and Deferred Charges -- Contract pre-opening costs
(incremental direct costs incurred to open facilities in new market areas) are
amortized using the straight-line method over the lesser of the initial
contract term or one year. Deferred loan costs are amortized over the term of
the related loans. Amortization of deferred loan costs is included in interest
expense.
Cost in Excess of Net Assets Acquired -- The cost in excess of net
assets acquired is amortized using the straight-line method over periods ranging
from fifteen to twenty-five years.
Revenue Recognition -- Revenues from youth education, treatment and
juvenile justice contracts with governmental entities are recognized as services
are rendered. Revenues from acute psychiatric and behavioral day treatment
services are recognized as such services are rendered, at the Company's
estimated net realizable amounts from the recipient, third party payors and
others for the service rendered. The receivables arising from such contracts or
services are unsecured and generally are due within thirty days.
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 amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
-41-
42
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Fair Value of Financial Instruments -- The following methods and
assumptions were used by the Company in estimating its fair value disclosures
for the following financial instruments:
Cash and Cash Equivalents -- The carrying amounts reported approximate
fair value.
Accounts Receivable and Accounts Payable -- The carrying amounts
reported approximate fair value.
Long Term Debt and Capital Leases -- The carrying amounts reported
approximate fair value. The fair value of the Company's long term debt
and capital leases are estimated using discounted cash flow analyses,
based on the Company's current incremental borrowing rates for similar
types of borrowing arrangements.
Long-Lived Assets - - In March 1995, the FASB issued Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of," which requires impairment losses to be recorded on long-lived
assets used in operations when indicators of impairment are present and
undiscounted cash flows estimated to be generated by those assets are less than
the assets carrying amount. Accordingly, when indicators of impairment are
present, the Company periodically evaluates the carrying value of property and
equipment and intangibles.
Stock Based Compensation -- The Company grants stock options for a
fixed number of shares to employees with an exercise price equal to the fair
value of the shares at the date of grant. The Company accounts for stock option
grants in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and, accordingly, recognizes no
compensation expense for the stock option grants.
Net Income Per Common Share -- The computation of net income per
common share is based on the weighted average number of shares outstanding and
common stock equivalents, consisting of dilutive stock options and warrants.
Income Taxes -- Income taxes are accounted for under the provisions of
Financial Accounting Standards Board Statement No. 109, "Accounting for Income
Taxes". Deferred income tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rate and laws that will be in effect when
the differences are expected to reverse.
Reclassifications -- Certain reclassifications have been made in the
1996 and 1995 financial statements to conform to the 1997 presentation.
-42-
43
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B--ACQUISITIONS
In April 1997, the Company acquired substantially all the assets of
AR&D, Inc. ("ARD"). Based in Riverside, California, ARD operated two schools for
special education children. The acquisition has been accounted for as a
purchase. The total consideration paid was approximately $999,000. Cost in
excess of net assets acquired of approximately $376,000 will be amortized over
fifteen years. Operations of ARD have been included in the consolidated income
statements from April 1997 through June 1997.
In June 1997, the Company acquired substantially all the assets of
Vendell Healthcare, Inc. and its subsidiaries ("Vendell"). Based in Nashville,
Tennessee, Vendell operated residential facilities for adolescents and adults.
The residential facilities are located in seven states. The Vendell asset
acquisition was accounted for as a purchase. The total consideration paid
consisted of approximately $18,768,000 in cash and $7,600,000 (642,978 shares)
in shares of the Company's Common Stock. Of the $18,768,000 in cash,
approximately $3,900,000 was deposited in escrows to cover certain offsets and
contingencies. The $18,768,000 in cash included approximately $6,368,000 used by
the Company to purchase the net working capital of Vendell, an amount which was
estimated at closing. The final net working capital of Vendell has been
determined to be approximately $7,077,000. The difference, $709,000, is included
in accrued other expenses at June 30, 1997. Also included in accrued other
expenses is approximately $494,000 of health insurance claims under Vendell's
self-funded health insurance program.
The Company's financial statements for the year ended June 30, 1997,
for the three months ended June 30, 1996 and for the year ended March 31, 1996
do not include the results of operations for Vendell for the periods prior to
June 2, 1997, the effective date of the acquisition. The following summarizes
the unaudited consolidated pro forma results of operations, assuming the
acquisition had occurred at the beginning of the fiscal year ended June 30, 1997
and, for comparability purposes due to the change in the Company's fiscal year
end from March 31 to June 30, the twelve months ended June 30, 1996:
Year Ended Twelve Months Ended
June 30, June 30,
1997 1996
---------- -------------------
Revenue $84,346,000 $ 82,686,000
Income (loss) before
extraordinary item 9,537,000 (24,780,000)
Net income (loss) 9,089,000 (24,834,000)
Net income (loss) per
common share $ 1.17 $ (3.86)
NOTE C--PROPERTY AND EQUIPMENT
Property and equipment consists of: June 30,
--------------------------
1997 1996
----------- ------------
Land and improvements $ 3,387,000 $ 1,491,000
Buildings and improvements 33,613,000 14,826,000
Furniture and equipment 4,907,000 2,860,000
Construction in progress 322,000 -0-
----------- -----------
42,229,000 19,177,000
Less accumulated depreciation (5,908,000) (4,994,000)
----------- -----------
$36,321,000 $14,183,000
=========== ===========
-43-
44
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE D--CAPITAL LEASE OBLIGATIONS
Equipment under capital leases of $245,000 and $-0- has been
included in property and equipment as of June 30, 1997 and 1996. The related
accumulated amortization balances totaled $-0- and $-0-, respectively.
Future minimum payments, by fiscal year and in the aggregate, under the
capital leases are as follows:
1998 $ 62,000
1999 62,000
2000 62,000
2001 62,000
2002 63,000
--------
Total minimum lease payments 311,000
Amount representing interest (66,000)
--------
Present value of minimum lease
payments (including $40,000 classified
as current) $245,000
========
NOTE E--NOTE RECEIVABLE
On September 29, 1995, the Company sold its idle residential treatment
center in Ramona, California for $255,000, receiving a cash down payment of
$38,000 and a note receivable of $217,000. The note receivable bears interest at
7% per annum, and is due September 29, 1998. The Company realized a gain of
$67,000 on the sale of this property. Of this amount, $10,000 was recognized as
income during the year ended March 31, 1996. The balance, $57,000, will be
recognized as income upon collection of the underlying note receivable.
NOTE F--HELICON INCORPORATED
Helicon, Incorporated ("Helicon"), a 501(c)(3) tax exempt company not
affiliated with the Company, operates youth treatment programs in California and
youth education programs in Tennessee. The majority of youth in Helicon youth
treatment programs are also involved in the Company's educational treatment
programs.
The Company provides management and marketing services to Helicon for
which it is entitled to a management fee in the amount of 6% of the monthly
gross revenue of Helicon's programs. The management agreement expires September
1, 1999. Management fee income totaled $1,289,000, $1,036,000, and $367,000 for
the years ended June 30, 1997, March 31, 1996, and March 31, 1995, respectively,
and $311,000 for the three months ended June 30, 1996. Additional management fee
income of $217,000 and $703,000 for the years ended March 31, 1996 and 1995,
respectively, was not recognized due to the inability of Helicon to pay these
amounts.
-44-
45
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE F--HELICON INCORPORATED (continued)
The Company also leases real property to Helicon. Real estate and
improvements with a cost of $10,290,000 and a carrying value of $8,768,000 were
leased, under operating lease arrangements, to Helicon at June 30, 1997. Future
minimum rental income due under these operating leases as of June 30, 1997 is as
follows:
Year ending June 30:
1998 $ 877,700
1999 776,000
2000 720,000
2001 720,000
2002 720,000
2003 and thereafter 12,300,000
-----------
Total $16,113,700
===========
Lease income totaled $892,000, $857,000 and $857,000 for the years
ended June 30, 1997, March 31, 1996 and March 31, 1995, respectively, and
$214,000 for the three months ended June 30, 1996.
Prior to fiscal 1995, Helicon was unable to pay either management fees
or lease payments. Additionally, the Company advanced Helicon $1,024,000 during
fiscal 1994 and $1,145,000 during fiscal 1993. At June 30, 1997, unpaid
management fees, lease payments and advances due the Company totaled $5,587,000.
Additionally, interest due but not recognized on these past due obligations
totaled $1,566,000. The total amount due, $7,153,000, has been fully reserved by
the Company. Based on the current level of operations being maintained by
Helicon, management does not anticipate collecting any of these amounts. Future
payments received on these amounts, if any, will be recognized by the Company on
the cash basis.
In January 1996, Helicon obtained through First American National Bank
("FANB") a $500,000 revolving line of credit, which was increased in November
1996 to $1 million. This line of credit bears interest at prime + 3/4% (9.25% at
June 30, 1997) and matures in September 1997. The Company facilitated Helicon in
this process by agreeing to reduce its then existing line of credit with FANB
from $2.5 million to $2.0 million and further by agreeing to guarantee Helicon's
performance under the line of credit. At June 30, 1997, the balance outstanding
under Helicon's line of credit was $-0-.
NOTE G--LINE OF CREDIT
The Company's $2.0 million line of credit with FANB matured on
September 30, 1996, and, on November 8, 1996, the Company entered into a new
loan and security agreement with FANB. Under the terms of this agreement, FANB
has made available to the Company, for acquisition financing and working capital
requirements, a revolving line of credit for up to $13,000,000. The initial term
of the agreement extends through November 1, 1999. The credit facility bears
interest at either (i) the one, two or three month LIBOR rate plus an applicable
margin, which ranges between 1.35% and 2.10% and is dependent on the ratio of
funded debt to operating earnings or (ii) FANB's index rate, at the Company's
option. The line of credit is secured primarily by the Company's accounts
receivable and equipment.
45
46
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G--LINE OF CREDIT (continued)
The Company's line of credit with FANB requires the Company to comply
with certain restrictive covenants with respect to its business and operations
and to maintain certain financial ratios. The restrictive covenants under this
agreement prohibit the Company, without the prior consent of its lender, from
entering into major corporate transactions, such as a merger, tender offer or
sale of its assets, and from incurring additional indebtedness in excess of
$1,000,000. The agreement also prohibits the Company from declaring dividends in
excess of 25% of the Company's net income during any fiscal year.
NOTE H--LONG TERM DEBT
In September 1994, the Company entered into agreements with National
Health Investors, Inc. ("NHI") and T. Rowe Price Strategic Partners Fund II,
L.P. ("Strategic Partners"). The Company obtained five-year term loans from NHI
and Strategic Partners for $6.5 million (at 11.5% per annum) and $1.0 million
(at 12% per annum), respectively. During fiscal 1997, the Company used
approximately $6,158,000 of the net proceeds from its public offering of stock
(See Note J) to prepay all of the Company's outstanding indebtedness to NHI. The
Company incurred a prepayment penalty of approximately $493,000, and wrote off
deferred loan costs of approximately $119,000, in connection with the early
extinguishment of the NHI loan. During fiscal 1996, the Company made unscheduled
principal payments of approximately $708,000 towards the Strategic Partners
loan, resulting in the retirement of the remaining obligation under that loan.
The Company wrote off deferred loan costs of approximately $64,000 in connection
with the early extinguishment of the Strategic Partners loan.
In June 1997, the Company borrowed $11,450,000 under its line of credit
with FANB (See Note G) to fund the cash portion of the Vendell asset purchase.
(See Note B.) This amount bears interest at FANB's index rate (8.5% at June 30,
1997).
Future principal maturities of long-term debt are as follows at June 30, 1997:
Year Ending June 30:
1998 $ -0-
1999 -0-
2000 11,450,000
-----------
Total 11,450,000
Less current portion -0-
-----------
Total long-term $11,450,000
===========
46
47
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I--INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax liabilities and assets as of June 30,
1997 and June 30, 1996 are as follows:
June 30,
---------------------------------
1997 1996
---------- -----------
Deferred tax liabilities:
Depreciation and amortization $ 421,000 $ 311,000
Other 125,000 125,000
---------- -----------
Total deferred tax liabilities 546,000 436,000
---------- -----------
Deferred tax assets:
Net operating loss and credit
carryforwards 1,289,000 1,935,000
Accrued expenses 361,000 381,000
Other 22,000 22,000
---------- -----------
Total deferred tax assets 1,672,000 2,338,000
Valuation allowance for deferred
tax assets (150,000) (2,027,000)
---------- -----------
Net deferred tax assets 1,522,000 311,000
---------- -----------
Net deferred tax liabilities (assets) $ (976,000) $ 125,000
========== ===========
Management has evaluated the need for a valuation allowance for all or
a portion of the deferred tax assets. Based upon taxable income in prior
carryback years and from the forecast of future pretax book income, management
determined in fiscal 1997 that $1,877,000 of the deferred tax assets as of June
30, 1996 would more likely than not be realized. Accordingly, $1,877,000 of the
valuation allowance was released in the second quarter of the year ended June
30, 1997. A valuation allowance of $150,000 has been recorded for certain net
operating loss carryforwards which will not likely be realized. The valuation
allowance decreased by $1,877,000 during the year ended June 30, 1997.
47
48
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I--INCOME TAXES (continued)
Income tax expense (benefit) is allocated in the financial statements as
follows:
Year Ended Three Months Ended Year Ended Year Ended
June 30, June 30, March 31, March 31,
1997 1996 1996 1995
--------- ------------------ ---------- ----------
Income before extraordinary
item $ (8,000) $311,000 $491,000 $69,000
Extraordinary item (235,000) -0- (10,000) -0-
--------- -------- -------- -------
Total $(243,000) $311,000 $481,000 $69,000
========= ======== ======== =======
The provision (benefit) for income taxes applicable to income before
extraordinary item is as follows:
Year Ended Three Months Ended Year Ended Year Ended
June 30, June 30, March 31, March 31,
1997 1996 1996 1995
----------- ------------------ ----------- ---------
Current:
Federal $ 718,000 $283,000 $364,000 $36,000
State 375,000 28,000 127,000 33,000
----------- -------- -------- -------
1,093,000 311,000 491,000 69,000
----------- -------- -------- -------
Deferred:
Federal (1,100,000) -0- -0- -0-
State (1,000) -0- -0- -0-
----------- -------- -------- -------
(1,101,000) -0- -0- -0-
----------- -------- -------- -------
Provision (benefit) for
income taxes $ (8,000) $311,000 $491,000 $69,000
=========== ======== ======== =======
The reconciliation of income tax attributable to income before
extraordinary item computed at the federal statutory tax rates to income tax
expense (benefit) is as follows:
Year Ended Three Months Ended Year Ended Year Ended
June 30, June 30, March 31, March 31,
1997 1996 1996 1995
----------- ------------------ ---------- -------
Income tax expense at
federal statutory rate $ 2,045,000 $ 396,000 $1,043,000 $ 660,000
Change in valuation
allowance (1,877,000) (363,000) (648,000) (620,000)
Provision for (reversal
of) previously recorded
tax accruals (478,000) 259,000 -0- -0-
State income tax, net of
federal benefit 258,000 19,000 84,000 22,000
Nondeductible expenses 44,000 -0- 12,000 7,000
----------- -------- ---------- ---------
Provision (benefit) for
income taxes $ (8,000) $ 311,000 $ 491,000 $ 69,000
=========== ========= ========== =========
At June 30, 1997, the Company had regular tax net operating loss
carryforwards of $2,112,000 which expire from 2002 through 2010. Utilization
of $700,000 of the net operating loss carryforwards is subject to an annual
limitation of $40,000 pursuant to Internal Revenue Code Section 382.
48
49
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J--SHAREHOLDERS' EQUITY
Public Offering of Stock -- On August 22, 1996, the Company completed a public
offering of 2,645,000 shares of Common Stock, 1,575,000 shares of which were
sold by the Company and 1,070,000 shares of which were sold by certain
shareholders of the Company. Net proceeds to the Company, after underwriting
discount and offering expenses, were approximately $23,359,000. Supplemental pro
forma net income per share (unaudited) assumes that the proceeds from the
Company's public offering of stock were received as of July 1, 1996, and
immediately used to retire the Company's long-term debt whose balance, as of
that time, was $6,206,000. Supplemental pro forma net income per share totaled
$.81 for fiscal 1997.
Reverse Stock Split -- Effective March 21, 1996, the Company effected a 1 for 2
reverse stock split, whereby each two shares of the Company's $.01 par value
Common Stock were exchanged for one share. The number of shares and per share
amounts in the consolidated financial statements for the years ended March 31,
1996 and 1995 have been retroactively adjusted to reflect the reverse stock
split.
Warrants -- The following table sets forth outstanding warrants as of June 30,
1997, June 30, 1996, March 31, 1996 and March 31, 1995 for the purchase of the
Company's Common Stock:
Exercise Weighted Average
Warrants Shares Prices Exercise Price
- ---------------------------- --------- ----------- ----------------
Outstanding at April 1, 1994 1,802,080 $1.11-16.50 $ 1.68
Granted 8,000 6.25 6.25
Exercised (1,662,080) 1.11 1.11
Expired/Exchanged (90,000) 3.25-16.50 12.08
---------- ----------- ------
Outstanding at March 31, 1995 58,000 2.00-6.25 2.59
Granted 9,616 5.20 5.20
Exercised -- -- --
Expired/Exchanged (8,000) 6.25 6.25
---------- ----------- ------
Outstanding at March 31, 1996 59,616 2.00- 5.20 2.52
Granted -- -- --
Exercised (50,000) 2.00 2.00
Expired/Exchanged -- -- --
---------- ----------- ------
Outstanding at June 30, 1996 9,616 5.20 5.20
Granted -- -- --
Exercised -- -- --
Expired/Exchanged -- -- --
---------- ----------- ------
Outstanding at June 30, 1997 9,616 $ 5.20 $ 5.20
========== =========== ======
49
50
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J--SHAREHOLDERS' EQUITY (continued)
Stock Options -- The following table sets forth outstanding stock options under
the Company's stock option plans as of June 30, 1997, June 30, 1996, March 31,
1996, and March 31, 1995 for the purchase of the Company's Common Stock:
Option Weighted Average
Options Shares Prices Exercise Price
- ---------------------------- ------- ------------ --------------
Outstanding at April 1, 1994 266,425 $ .62- 8.00 $ 3.38
Granted 138,750 3.25- 6.13 3.41
Exercised (5,000) 1.125-3.00 2.06
Forfeited (5,000) 5.75- 8.00 6.88
------- ------------- ------
Outstanding at March 31, 1995 395,175 .62- 8.00 4.99
Granted 89,250 5.25 5.25
Exercised (22,875) 1.125-5.75 2.77
Forfeited (47,500) 7.00- 8.00 7.05
------- ------------- ------
Outstanding at March 31, 1996 414,050 .62- 7.00 3.38
Granted 64,500 15.38 15.38
Exercised (66,059) .62- 5.25 1.92
Forfeited -- -- --
------- ------------- ------
Outstanding at June 30, 1996 412,491 .62-15.38 5.49
Granted 235,250 12.00-18.00 13.18
Exercised (56,893) .62- 5.25 .96
Forfeited (2,398) 5.25-15.38 7.78
------- ------------- ------
Outstanding at June 30, 1997 588,450 $ .62-18.00 $ 8.99
======= ============= ------
Options exercisable and shares available for future grant are as follows:
June 30, June 30, March 31, March 31,
1997 1996 1996 1995
-------- -------- -------- ---------
Options exercisable 295,785 295,009 336,050 395,175
Shares available for
grant 338,848 506,700 571,200 612,950
The following table summarizes information about stock options
outstanding at June 30, 1997:
Options Outstanding Options Exercisable
- --------------------------------------------------------------------------------------- --------------------------------
Number Number
Outstanding at Weighted Weighted Exercisable at Weighted
Range of June 30, Average Remaining Average Exercise June 30, Average
Exercise Prices 1997 Contractual Life Price 1997 Exercise Price
- ----------------------------------------------------------------------------------------------------------------------------
$ .62- 3.25 144,375 6 $ 2.44 144,375 $ 2.44
5.25- 7.00 144,925 5 5.91 118,838 6.05
12.00-18.00 299,150 9 13.65 32,572 16.28
------------ ------- -------
$ .62-18.00 588,450 295,785
======= =======
Options exercisable at June 30, 1996, March 31, 1996 and March 31, 1995
had weighted average exercise prices of $3.37, $2.95 and $3.36, respectively.
The Company's 1987 Employee Stock Option Plan expired June 2, 1997, and
no additional options will be awarded under that plan. Included in the options
granted during fiscal 1997 are 65,000 options which have been granted under the
Company's proposed 1997 Stock Incentive Plan. These options, none of which were
exercisable at June 30, 1997, have been granted subject to shareholder approval
at the 1997 Annual Meeting of the proposed 1997 Stock Incentive Plan, and are
excluded from the table below summarizing common shares reserved.
50
51
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J--SHAREHOLDERS' EQUITY (continued)
The following table summarizes common shares reserved at June 30, 1997:
Warrants 9,616
1987 Employee Stock Option Plan 493,450
l989 Stock Option Plan for Non-Employee Directors 70,000
-------
Total common shares reserved 573,066
=======
In October 1995, the Financial Accounting Standards Board issued SFAS
No. 123 "Accounting for Stock-Based Compensation." This new standard defines a
fair value based method of accounting for an employee stock option or similar
equity instrument. This statement gives entities a choice of recognizing related
compensation expense by adopting the new fair value method or to continue to
measure compensation using the intrinsic value approach under Accounting
Principles Board (APB) Opinion No. 25 "Accounting for Stock Issued to
Employees," the former standard. The Company has elected to follow APB No. 25
and related Interpretations in accounting for its stock compensation plans
because, as discussed below, the alternative fair value accounting provided for
under SFAS No. 123 requires use of option valuation models that were not
developed for use in valuing employee stock options. Under APB No. 25, because
the exercise price of the Company's employee stock options equals the market
price of the underlying stock on the date of grant, no compensation expense is
recognized.
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, which also requires that the information be determined
as if the Company has accounted for its employee stock options granted
subsequent to March 31, 1995 under the fair value method of that Statement. The
fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions for the years ended June 30, 1997, March 31, 1996 and the three
months ended June 30, 1996: risk-free interest rate of 6.23%; no annual divided
yield; volatility factor of .704 based on weekly closing prices since April
1996; and an expected option life of 6 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows:
Year Ended Three Months Ended Year Ended
June 30, June 30, March 31,
1997 1996 1996
---------- ------------------ ----------
Pro forma net income $5,411 $821 $2,466
Pro forma earnings per share
Primary $ .75 $.14 $ .44
Fully diluted .75 .14 .43
51
52
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J--SHAREHOLDERS' EQUITY (continued)
Because SFAS No. 123 is applicable only to options granted subsequent
to March 31, 1995, its pro forma effect will not be fully reflected until 1998.
The weighted average fair value per share for options granted during the years
ended June 30, 1997, and March 31, 1996, and the three months ended June 30,
1996 totaled $8.79, $3.02 and $10.45, respectively. The estimated remaining
contractual life of options outstanding is 7.12 years.
Preferred Stock -- The shareholders of the Company have authorized the issuance
of up to 10 million shares of preferred stock, $1.00 par value, on such terms as
the directors of the Company may determine, with full authority in the Board of
Directors to fix series, conversion rights and other provisions applicable to
such preferred stock. No specific terms or provisions have been set, and no
preferred shares have been issued.
Dividends -- The Company's revolving credit agreement (see Note G) prohibits the
Company from declaring dividends in excess of 25% of the Company's net income
during any fiscal year.
NOTE K--EMPLOYEE BENEFIT PLAN
The Company has a Salary Reduction Plan under section 401(k) of the
Internal Revenue Code. Under this plan, employees paid on a salary only basis
may defer not less than 1% and not more than 10% of pre-tax compensation each
year, subject to Internal Revenue Service limitations, through contributions to
a designated investment fund. Under the provisions of the plan, the Company may
contribute a discretionary amount to be determined each year. No contributions
have been made under the plan. Administrative costs under the plan totaled
$25,000, $17,000, and $21,000 for the years ended June 30, 1997, March 31, 1996,
and March 31, 1995, respectively, and $1,000 for the three months ended June 30,
1996.
NOTE L--COMMITMENTS
The following is a schedule, by year, of future minimum rental payments
required under operating leases that have initial or remaining terms in excess
of one year as of June 30, 1997:
Year ending June 30:
1998 $1,396,000
1999 877,000
2000 528,000
2001 159,000
2002 and thereafter 141,000
----------
TOTAL $3,101,000
==========
Certain of the leases have renewal options of up to 5 years. Total
rental expense for all operating leases and other rental arrangements for the
years ended June 30, 1997, March 31, 1996, and March 31, 1995 was $896,000,
$587,000, and $448,000, respectively, and $167,000 for the three months ended
June 30, 1996. Aggregate future minimum rentals to be received under
noncancelable subleases totaled approximately $337,000 at June 30, 1997.
52
53
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M--CONTINGENCIES
Alabama Wilderness Program Wrongful Death Litigation -- In October 1995, a civil
action was filed in the Circuit Court of Colbert County, Alabama, against the
Company and certain of the Company's employees in connection with the
circumstances surrounding the alleged wrongful death of a juvenile enrolled at
the Company's wilderness program in Jasper, Alabama. The Company's investigation
indicated that the juvenile had physical impairments prior to his enrollment in
the wilderness program, which may have contributed to his death. The complaint,
among other things, alleged negligence and civil rights violations on the part
of the Company and certain of its employees, and sought an unspecified amount of
damages. In July 1996, the Company reached a confidential settlement of this
lawsuit which did not have an adverse effect on the Company's financial
condition or results of operations.
California Department of Social Services Audit -- In December 1992, the Company
received an audit report from the California Department of Social Services
alleging overpayments of approximately $315,000 at its 6-bed group homes for the
years 1991 and 1992. The Company is contesting this determination and filed a
rate protest with the Department of Social Services in February 1993. An
Informal Hearing was concluded in October 1995. The Hearing Auditors' Report of
Findings was issued in March 1996, and in April 1996, the Company filed a
Request for Formal Hearing. The Formal Hearing has not been completed. A
provision for liability of approximately $201,000 is included in accrued other
expenses at June 30, 1997 and 1996.
Other Litigation -- The Company is involved in various other legal proceedings,
none of which are expected to have a material effect on the Company's financial
position or results of operations.
NOTE N--RELATED PARTY TRANSACTIONS
In September 1994, Strategic Partners renewed, for a term of five
years, the $1,000,000 balance outstanding under a 12%, one-year term loan made
to the Company in September 1993. During fiscal 1996, the Company made
unscheduled principal payments of approximately $708,000 that retired the
outstanding balance under this loan. The Company wrote off deferred loan costs
of approximately $64,000 in connection with the early extinguishment of the
Strategic Partners loan. David L. Warnock, a director of the Company, serves as
a consultant to Strategic Partners and formerly was President of T. Rowe Price
Strategic Partners II, L.P., the general partner of Strategic Partners.
During fiscal 1995 the Company entered into a one-year agreement with
School Improvement Services, Inc. ("SIS") for marketing and consulting services;
Joseph A. Fernandez, Ed.D. ("Dr. Fernandez"), a director of the Company,
formerly served as President and Chief Executive Officer of School Improvement
Services, Inc. Compensation under this agreement consisted of a fee of $50,000
and warrants for 8,000 shares of the Company's Common Stock, exercisable at
$6.25 per share. Pursuant to certain provisions of this agreement, the number of
shares issuable under this warrant was, during fiscal 1996, adjusted to 9,616,
at a purchase price of $5.20 per share. The Company recognized consulting
expense of approximately $16,000 associated with this adjustment during fiscal
1996. This agreement was renewed during fiscal 1996 for the period of October 1,
1995 through June 30, 1996. Compensation under this agreement during the renewal
period consisted of monthly payments of approximately $4,000. Payments under
this agreement during fiscal 1996 and 1995, including reimbursable expenses,
totaled $52,000 and $34,000, respectively, and $13,000 for the three months
ended June 30, 1997.
53
54
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE N--RELATED PARTY TRANSACTIONS (continued)
In June of 1996, the Company entered into a one-year agreement with
Joseph Fernandez and Associates, Inc. for marketing and consulting services. Dr.
Fernandez serves as President of Joseph Fernandez and Associates, Inc. Pursuant
to the terms of this agreement, Joseph Fernandez and Associates, Inc. will be
paid a monthly fee of approximately $4,000 and will receive warrants for 20,000
shares of Common Stock for each new Company program obtained as a result of
services provided under the agreement that meet specified annual operating
income criteria. Payments under this agreement during fiscal 1997, including
reimbursable expenses, totaled $50,000. During fiscal 1997, pursuant to the
dissolution of SIS, the outstanding warrant for 9,616 shares was cancelled and
reissued to the two principals of SIS. Pursuant to this cancellation, Dr.
Fernandez was issued a warrant for 3,858 shares of the Company's Common Stock,
exercisable through September 30, 2004 at $5.20 per share.
The Company rents certain operating properties from Amy S. Harrison and
Martha A. Petrey, Ph.D., officers and directors of the Company. Payments under
these month-to-month rental arrangements totaled $101,000 for each of the years
ended June 30, 1997, March 31, 1996 and March 31, 1995 and $25,000 for the three
months ended June 30, 1996.
54
55
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE O--SIGNIFICANT CUSTOMERS
Virtually all of the Company's revenues are attributable to contracts
with state and local government and governmental agencies. Such contracts are
typically subject to renewal annually. Contract renewal is affected by the
quality and type of services provided by the Company.
The following summarizes those customers from which in excess of 10% of
the Company's youth services revenues were derived:
% of Operating
Customer Revenue Revenue
--------------------- ----------- ---------------
Year Ended Riverside County
June 30, 1997 Office of Education $ 5,822,000 17%
State of Tennessee 4,127,000 12
---------- --
$9,949,000 29%
========== ==
Three Months Riverside County
Ended Office of Education $1,244,000 19%
June 30, 1996 State of Tennessee 881,000 14
---------- --
$2,125,000 33%
========== ==
Year Ended Riverside County
March 31, 1996 Office of Education $5,360,000 23%
State of Tennessee 3,612,000 15
---------- --
$8,972,000 38%
========== ==
Year Ended Riverside County
March 31, 1995 Office of Education $5,080,000 25%
State of Tennessee 3,636,000 17
---------- --
$8,716,000 42%
========== ==
At June 30, 1997 and 1996, accounts receivable from the above customers
totaled $1,230,000 and $1,233,000, respectively.
55
56
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE P--UNAUDITED FINANCIAL INFORMATION
In March 1997, the Board of Directors voted to change the Company's
fiscal year end from March 31 to June 30, effective with the three month period
ended June 30, 1996. Unaudited financial information for the three month period
ended June 30, 1995 is as follows:
Three Months Ended
Statement of Income June 30, 1995
- ------------------------------------------- ------------------
(dollars in thousands, except per
share amounts)
Revenues:
Operating revenues $5,518
Management fee income 106
------
TOTAL REVENUES 5,624
Operating expenses: ------
Employee compensation and benefits 3,415
Purchased services and other expenses 1,086
Depreciation and amortization 264
Related party rent 25
------
TOTAL OPERATING EXPENSES 4,790
------
Income from operations 834
Other (income) expense:
Interest:
Banks and other 211
Related parties 29
Interest income (2)
------
TOTAL OTHER (INCOME) EXPENSE, NET 238
------
Income before income taxes 596
Provision for income taxes 89
------
NET INCOME $ 507
======
Weighted average shares outstanding 5,557
Earnings per common share:
Primary $ .09
======
Assuming full dilution $ .09
======
56
57
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE P--UNAUDITED FINANCIAL INFORMATION (continued)
Three Months Ended
Statement of Cash Flows June 30, 1995
- ------------------------------------------ ----------------
(in thousands)
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 745
INVESTING ACTIVITIES
Purchase of property and equipment (46)
NET CASH (USED) BY -------
INVESTING ACTIVITIES (46)
-------
FINANCING ACTIVITIES
Proceeds from revolving lines of
credit 1,417
Principal payments on revolving
lines of credit and long-term
borrowings (1,458)
Principal payments on long-term
borrowings - related parties (14)
Stock issue/registration costs (23)
NET CASH (USED) BY -------
FINANCING ACTIVITIES (78)
-------
INCREASE IN CASH AND CASH EQUIVALENTS 621
Cash and cash equivalents at
beginning of period 69
CASH AND CASH EQUIVALENTS -------
AT END OF PERIOD $ 690
=======
57
58
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
INFORMATION REQUIRED BY ITEM 10 (DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT), ITEM 11 (EXECUTIVE COMPENSATION), ITEM 12 (SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT), AND ITEM 13 (CERTAIN RELATIONSHIPS
AND RELATED TRANSACTIONS), will be included in the Company's Proxy Statement to
be filed within 120 days of June 30, 1997 and is incorporated herein by
reference.
58
59
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
The following financial statements of Children's Comprehensive
Services, Inc. are included in Part II, Item 8:
Page
----
Consolidated Balance Sheets-June 30, 1997 and 1996 35
Consolidated Statements of Income for the Years Ended June 30,
1997, March 31, 1996 and 1995 and for the
Three Months Ended June 30, 1996 37
Consolidated Statements of Shareholders' Equity for the Years
Ended June 30, 1997, March 31, 1996 and 1995 and for the
Three Months Ended June 30, 1996 38
Consolidated Statements of Cash Flows for the Years
Ended June 30, 1997, March 31, 1996 and 1995 and
for the Three Months Ended June 30, 1996 39
Notes to Consolidated Financial Statements 41
(2) Financial Statement Schedules
Schedule II - Valuation and qualifying accounts 62
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are not
applicable or not required under their related instructions or the
required information is included in the financial statements or notes
thereto.
(3) Management Contracts and Compensatory Plans or Arrangements
1987 Employee Stock Option Plan, as amended, (included herein as
Exhibit 10.4.)
1989 Stock Option Plan for Non-Employee Directors, (included herein as
Exhibit 10.5.)
1997 Stock Incentive Plan, (included herein as Exhibit 10.14.)
(b) Reports on Form 8-K
Form 8-K Reporting Date -- June 2, 1997
Item Reported - - Item 2. Acquisition or Disposition of Assets.
The Company reported the acquisition of substantially all the assets of
Vendell Healthcare, Inc. and its subsidiaries.
(c) Exhibits
The exhibits listed in the accompanying index to exhibits on page 63
are filed as part of this annual report on Form 10-K.
59
60
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CHILDREN'S COMPREHENSIVE SERVICES, INC.
Date: September 29, 1997 By:/s/William J Ballard
-----------------------------
William J Ballard
Chairman, Chief Executive Officer
and Director
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 Registrant and
in the capacities and on the dates indicated.
Date: September 29, 1997 /s/William J Ballard
-----------------------------
William J Ballard
Chairman, Chief Executive Officer
and Director (Principal Executive
Officer)
Date: September 29, l997 /s/Amy S. Harrison
-----------------------------
Amy S. Harrison
Vice Chairman, President and Director
Date: September 29, 1997 /s/Martha A. Petrey, Ph.D.
-----------------------------
Martha A. Petrey, Ph.D.
Executive Vice President and Director
Date: September 29, 1997 /s/Stephen H. Norris
-----------------------------
Stephen H. Norris
Executive Vice President
Date: September 29, 1997 /s/H. Neil Campbell
-----------------------------
H. Neil Campbell
Executive Vice President
Date: September 29, 1997 /s/Donald B. Whitfield
-----------------------------
Donald B. Whitfield
Vice President - Finance, Secretary
and Treasurer (Principal Financial and
Accounting Officer)
60
61
Date: September 29, 1997 /s/ Thomas B. Clark
-----------------------------
Thomas B. Clark
Director
Date: September 29, 1997 /s/Joseph A. Fernandez, Ed.D.
-----------------------------
Joseph A. Fernandez, Ed.D.
Director
Date: September 29, 1997 /s/David L. Warnock
-----------------------------
David L. Warnock
Director
61
62
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
CHILDREN'S COMPREHENSIVE SERVICES, INC.
COL. C--ADDITIONS
- --------------------------------------------------------------------------------------------------------------------------
COL. A COL. B COL D. COL E.
- --------------------------------------------------------------------------------------------------------------------------
(1) (2)
Balance Charged to Charged to Balance
at Beginning Costs and Other Accounts- Deductions- at End
DESCRIPTION of Period Expenses Describe Describe of Period
- --------------------------------------------------------------------------------------------------------------------------
Year ended June 30, 1997:
Deducted from asset accounts:
Allowance for doubtful
accounts $143,000 $ (155,000) $ 2,373,000(1) $ -0- $2,361,000
-------- ---------- ----------- -------- ----------
Totals $143,000 $ (155,000) $ 2,373,000 $ -0- $2,361,000
======== ========== =========== ======== ==========
Period ended June 30, 1996:
Deducted from asset accounts:
Allowance for doubtful
accounts $146,000 $ -0- $ -0- $ 3,000(2) $ 143,000
-------- ---------- ---------- -------- ----------
Totals $146,000 $ -0- $ -0- $ 3,000 $ 143,000
======== ========== ========== ======== ==========
Year ended March 31, 1996:
Deducted from asset accounts:
Allowance for doubtful
accounts $133,000 $ 38,000 $ -0- $ 25,000(2) $ 146,000
-------- ---------- ---------- -------- ----------
Totals $133,000 $ 38,000 $ -0- $ 25,000 $ 146,000
======== ========== ========== ======== ==========
Year ended March 31, 1995:
Deducted from asset accounts:
Allowance for doubtful
accounts $368,000 $ 83,000 $ -0- $318,000(2) $ 133,000
-------- ---------- ---------- -------- ----------
Totals $368,000 $ 83,000 $ -0- $318,000 $ 133,000
======== ========== ========== ======== ==========
(1) Addition to allowance for doubtful accounts recognized in conjunction
with the Company's purchase of substantially all the assets of Vendell
Healthcare, Inc.
(2) Uncollectible accounts written off against allowance account.
62
63
INDEX TO EXHIBITS
Exhibit
Number Description of Exhibit
- ------- -----------------------
3.1 Restated Charter, as amended. (1)
3.2 By-Laws. (2)
4.1 Specimen Stock Certificate. (6)
10.1 Non-competition Agreement between Registrant and Amy S. Harrison. (3)
10.2 Non-Competition Agreement between Registrant and Martha A. Petrey. (3)
10.3 Registration Agreement between Registrant and Amy S. Harrison and Martha A. Petrey. (3)
10.4 1987 Employee Stock Option Plan, as amended. (7)
10.5 1989 Stock Option Plan for Non-Employee Directors. (4)
10.6 Assignment and Sublease between Registrant and Helicon Incorporated. (5)
10.7 Warrant Agreement dated October 1, 1996, between the Registrant and
Joseph A. Fernandez.
10.8 Consulting and Marketing Agreement effective as of August 1, 1992,
dated September 22, 1994, by and between the Registrant and Helicon
Incorporated. (7)
10.9 Agreement dated as of August 8, 1997 between the Registrant and
Riverside County, California Superintendent of Schools for special
education services.
10.10 Registration Rights Agreement, dated September 20, 1993, by and between
the Registrant and T. Rowe Price Strategic Partners Fund II, L.P. (8)
10.11 Guaranty and Suretyship Agreement dated January 29, 1996, by and
between First American National Bank, the Registrant and Helicon
Incorporated. (8)
10.12 Loan and Security Agreement between First American National Bank and
the Registrant, dated as of November 8, 1996. (9)
10.13 Asset Purchase Agreement by and among Vendell Healthcare, Inc., the
subsidiaries of Vendell Healthcare, Inc. and the Registrant, dated
February 27, 1997. (10)
10.14 1997 Employee Incentive Plan.
10.15 Amendment to Asset Purchase Agreement by and among Vendell Healthcare,
Inc., the subsidiaries of Vendell Healthcare, Inc. and the Registrant.
(11)
10.16 Second Amendment to Asset Purchase Agreement by and among Vendell
Healthcare, Inc., the subsidiaries of Vendell Healthcare, Inc. and the
Registrant. (11)
10.17 Third Amendment to Asset Purchase Agreement by and among Vendell
Healthcare, Inc., the subsidiaries of Vendell Healthcare, Inc. and the
Registrant. (11)
10.18 Warrant Agreement dated October 1, 1996 between the Registrant and
Kenneth W. Miller.
10.19 Lease Agreement dated September 26, 1989 between the Registrant and the
Equitable Life Assurance Society of the United States.
10.20 First Amendment, dated February 21, 1990, to the lease between the
Registrant and the Equitable Life Assurance Society of the United
States.
10.21 Second Amendment, dated March 1, 1993, to the lease between the
Registrant and the Equitable Life Assurance Society of the United
States.
10.22 Third Amendment, dated October 26, 1993, to the lease between
Registrant and the Equitable Life Assurance Society of the United
States.
11 Statement Re: Computation of Per Share Earnings.
21 Subsidiaries of the Registrant.
23 Consent of Ernst & Young LLP.
27 Financial Data Schedule.
(1) Incorporated herein by reference from Registrant's Registration
Statement on Form S-2, filed August 15, 1996 (Reg. No. 333-8387).
(2) Incorporated herein by reference from Registrant's Registration
Statement on Form S-1, filed October 11, 1989 (Reg. No. 33-31527).
(3) Incorporated herein by reference from Registrant's Form 8-K, dated
April 12, 1988, reporting the acquisition of Advocate Schools (File No.
0-16162).
63
64
INDEX TO EXHIBITS (Continued)
(4) Incorporated herein by reference from Registrant's Registration
Statement on Form S-8, filed February 14, 1990 (Reg. No. 2-33-33499).
(5) Incorporated herein by reference from Registrant's Form 10-K for the
fiscal year ended March 31, 1990, dated June 28, 1990 (File No.
0-16162).
(6) Incorporated herein by reference from Registrant's Form 10-K for the
fiscal year ended March 31, 1994, dated June 28, 1994 (File No.
0-16162).
(7) Incorporated herein by reference from Registrant's Form 10-K for the
fiscal year ended March 31, 1995, dated June 28, 1995 (File No.
0-16162).
(8) Incorporated herein by reference from Registrant's Form 10-K for the
fiscal year ended March 31, 1996, dated June 28, 1996 (File No.
0-16162).
(9) Incorporated herein by reference from Registrant's Form 10-Q for the
periods ended December 31, 1996, dated February 13, 1997 (File No.
0-16162).
(10) Incorporated herein by reference from Registrant's Form 10-Q for the
periods ended March 31, 1997, dated May 15, 1997 (File No. 0-16162).
(11) Incorporated herein by reference from Registrant's Form 8-K, dated June
2, 1997, reporting the acquisition of substantially all the assets of
Vendell Healthcare, Inc. (File No. 0-16162).
64