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, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NUMBER 0-16162
CHILDREN'S COMPREHENSIVE SERVICES, INC.
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(Exact name of registrant as specified in its charter)
Tennessee 62-1240866
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
3401 West End Ave., Ste 400 Nashville, Tennessee 37203
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (615) 250-0000
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Registrant's former address: 3401 West End Ave., Ste 500 Nashville, Tennessee
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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
Common Stock Purchase Rights
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(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 stock held by non-affiliates of the Company
as of September 17, 1999 was $20,005,000.
The number of shares outstanding of the issuer's common stock, par value $ .01
per share, as of September 17, 1999 was 7,300,026.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the annual meeting of shareholders to be
held November 17, 1999 are incorporated by reference into Part III of this Form
10-K.
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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 oldest and largest
for-profit providers of 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, learning disabled, medically fragile or
autistic. 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, Hawaii, Kentucky, Louisiana, Ohio, Michigan, Montana, Pennsylvania,
Tennessee, Texas and Utah. As of June 30, 1999, the Company was providing
education, treatment and juvenile justice services, either directly or through
its management contract with Helicon Incorporated ("Helicon"), to approximately
4,000 at-risk youth. In addition, the Company provides management services to
community mental health centers, behavioral units in medical facilities and
third parties.
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, and 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 5.8 million children in special education
programs during the 1996-97 school year, 2.7 million were diagnosed as having
specific learning disabilities and over 447,000 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 1996, there were 2.9
million arrests of juveniles under 18 years of age, accounting for 19% of all
violent crime, 37% of all burglary arrests, 24% of all weapons arrests and 15%
of murder and aggravated assault arrests. Juveniles were involved in 14% of all
drug arrests in 1996. Between 1992 and 1996, juvenile arrests for drug abuse
violations increased 120%. 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 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 provides
adult programming and treatment in response to community demand and the need for
such services. The Company also provides management services to other entities
providing services to both youth and adults.
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
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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 continue 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 have increased dramatically in recent years, the Company
estimates that 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 increase, 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. At certain of its facilities
and managed locations, 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 also provides education to medically fragile youth. New services and
programs are regularly developed to address the specific needs of an identified
at-risk or troubled youth population, such as serious criminal offenders,
juvenile sex offenders or female specific populations. The Company believes that
the breadth of its services makes the Company attractive to members of the
community and a broad spectrum of payors, as well as to local, state and federal
governmental agencies. As of June 30, 1999, the Company was providing services
directly and through management contracts with Helicon to approximately 2,600
youth in its non-residential programs and 1,400 youth 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 programs and secure residential facilities. The Company believes its
primary emphasis on providing a comprehensive continuum of services for at-risk
youth, as well as consistency and flexibility in the delivery of its services,
are critical
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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 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 each 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. The Company also provides educational services to
medically fragile youth. 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. Sites for these
programs can vary from an office complex to a national forest.
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
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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
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.
Secure Residential Programs. The Company's secure residential programs,
including gender specific 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,
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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
the Company's residential psychiatric treatment 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 for youth who are in state custody and require diagnostic
services or behavioral observation. While in the Company's diagnostic and
evaluation programs, youth receive an educational workup in addition to
psychological evaluations.
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.
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Management Services. In addition to management services provided to Helicon, the
Company provides management services to Community Mental Health Centers
("CMHCs"), behavioral units in medical/surgical facilities and to other third
parties. Contract terms vary in length from one to three years with
reimbursement based on the services being provided. Services are provided in
both residential and non-residential settings.
The table below sets forth certain information regarding the Company's
non-residential and residential programs operated by the Company directly or
through management contracts. Licensed capacity is provided for the Company's
residential facilities.
Average
Licensed Population FY Commencement of
Location Program Type Capacity 99 Operations
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COMPANY PROGRAMS
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Alabama Behavioral day treatment 16 June 1997
Detention, Therapeutic wilderness,
Secure residential, Residential treatment 248 207 September 1998
Arkansas Alternative education 159 June 1997
Acute and residential psychiatric treatment 77 73 June 1997
California Educational day treatment 1,125 January 1980
Florida Behavioral day treatment, Diversionary education,
Alternative education 120 September 1995
Acute and residential psychiatric treatment 80 37 June 1997
Hawaii Educational day treatment 12 January 1999
Kentucky Behavioral day treatment 40 June 1997
Acute psychiatric and residential treatment 72 58 June 1997
Louisiana Diversionary education, Family preservation 35 November 1991
Michigan Acute psychiatric treatment, Secure
residential 63 40 June 1997
Montana Alternative education, Behavioral day treatment 165 June 1997
Acute and residential psychiatric
treatment, Detention 52 40 June 1997
Ohio Secure residential 30 15 March 1999
Pennsylvania Residential treatment 60 22 November 1998
Tennessee Homebound education 171 November 1991
Detention, Residential treatment,
Diagnostic and evaluation services,
Residential psychiatric treatment 339 291 November 1985
Texas Alternative education, Educational day treatment 344 September 1996
Acute and residential psychiatric treatment,
Secure residential 180 146 October 1997
Utah Acute psychiatric and residential treatment 80 70 June 1997
HELICON PROGRAMS
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Tennessee Family preservation, Education day treatment,
Diversionary education, On-site educational
services in emergency shelters and diagnostic
centers 285 July 1988
California Residential treatment, Residential psychiatric
treatment, Secure residential,
6-bed group homes 310 504 June 1988
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In addition to the programs described above, at June 30, 1999, the
Company had management contracts with medical facilities and third parties at
six locations in Arkansas, Tennessee, Texas and Florida. Three of the Company's
contracts were residential based. Each of the contracts has original terms from
one to three years. These contracts typically provide 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 of the Company's facilities admit patients 24 hours
a 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
private practices. 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 commitment to its employees' professional development by offering lectures,
classes and training programs.
Quality Management. 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 almost all of its facilities. 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 of compliance
with program standards. 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
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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. Also, the Company's, as well as other JCAHO accredited
facilities are required to participate in the JCAHO ORYX project. In response,
the Company has implemented an assessment system that is expected to provide
additional data about the quality of the Company's outcomes relative to similar
facilities.
In addition to measuring performance objectives, the Company has a
corporate compliance policy, including an integrity hotline, formulated as a
guide to the ethical and legal conduct of its employees. The Company has
implemented this policy at all its facilities.
Security. The Company realizes that, in the operation of programs for at-risk
and troubled youth, a primary mission is to insure 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 markets to behavioral health managed care providers,
physicians, businesses and parents for certain behavioral health services. The
Company also markets certain of its programs to the general public in an effort
to increase community awareness of the Company's facilities. In addition, the
Company markets its management services to Community Mental Health Centers,
medical/surgical hospitals and other smaller behavioral health providers.
Marketing efforts are conducted and coordinated by the Company's Vice President
of Business Development and other senior management personnel, individual
facility personnel, and 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 (1)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, (2)receives
unsolicited requests, generally from local school districts, for the operation
of special education programs, or (3)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, the availability of funding, siting issues and competition,
and then conducts an initial cost analysis to further determine program
feasibility.
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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 sometimes engages 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 Referral Sources and the General Public. In marketing its services
to the general public, referral sources and payors, 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.
Marketing of Management Services. The Company markets management services to
Community Mental Health Centers, behavioral units in medical/surgical facilities
and to third parties. Services under these agreements are provided in both
residential and non-residential settings.
RELATIONSHIP WITH HELICON
The Company conducts a portion of its business through its relationship
with Helicon, a Section 501(c)(3) not-for-profit corporation. As of June 30,
1999, 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 under a Consulting and Marketing Agreement (the "Helicon Agreement")
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 based on the 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. As of June 30, 1999, unpaid management fees, lease payments and
advances for years prior to 1996, plus interest, due to the Company from Helicon
totaled in excess of $7,000,000. Based on the current level of operations being
maintained by Helicon, the Company does not anticipate collecting any of, and
has
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fully reserved, this amount. The Helicon Agreement expires in September 2004.
The Company also has guaranteed Helicon's obligations under a bank line of
credit in the amount of $1,500,000.
MAJOR CUSTOMERS
During the fiscal year ended June 30, 1999, the Company had no
customers which generated 10% or more of its consolidated revenues.
SOURCES OF REVENUE
The Company's residential centers and day treatment centers receive
payments from (i) the federal government and state and local 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. In addition, the Company receives
management fees from entities, including Helicon, to which management services
are provided.
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.
The Company participates in Medicaid Under 21 programs in six states in
which it operates residential facilities.
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
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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 generally covers inpatient
services and services furnished by other institutional health care providers.
Part B generally covers the services of doctors, suppliers of medical items and
outpatient services.
While most short term acute care health care facilities receive
Medicare Part A reimbursement on a prospective basis based on the patient's
diagnosis, psychiatric facilities are exempt (PPS Exempt) from the Medicare
prospective payment system 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, 1999,
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.
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 modified various reimbursement provisions for PPS-exempt
facilities. Among other changes, reductions in reimbursement to PPS-exempt
facilities occurred, specifically, reductions in reimbursement for capital costs
and for Medicare bad debts. There are various effective dates of the rule
changes included in the final rule. In addition, the Balanced Budget Act of
1997("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 BBA of 1997 also significantly reduced the incentive
payments to PPS exempt facilities which have costs below their target amount and
also reduced the amount of costs reimbursed when a facility's costs exceeds its
target amount. In addition, the BBA established an additional national median
limit applicable to PPS exempt facilities. As of June 30, 1999, two Company
facilities had Medicare inpatient utilization and were, therefore, subject to
TEFRA payment limitations, the national median limits, as well as other BBA
provisions 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 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.
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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. 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 effects 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
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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
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
do not satisfy all the applicable requirements (one of which, for example,
includes a requirement that contracts with physicians to set the aggregate
amount of physician compensation in advance) 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 future by the OIG, including a safe harbor for
physician recruitment. The Company is unable
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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 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. In January 1998, HCFA issued proposed
regulations implementing Stark II. HCFA is currently reviewing comments to the
proposed regulations and final regulations are not expected for some time.
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) the regulations when issued in final form will result in an
interpretation by the courts in a manner consistent with the Company's
practices.
The federal government has made investigating, prosecuting and pursuing
other enforcement activities of these federal laws a major priority and the
government scrutiny of health care providers' compliance with these laws is
expected to increase 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
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(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.
Effective July 1, 1998 the State of California implemented new
legislation which eliminated reimbursement to school districts for excused
student absences. The legislation is designed to incentivize school districts
that have low absentee rates, and to encourage improvement in school attendance
throughout the state. While written for public school districts, this
legislation has impacted the Company's California educational day treatment
programs, which historically have been compensated for excused student absences.
Certain of the Company's contracts with school districts now provide no
compensation for excused student absences, generally in exchange for a higher
per diem rate. In addition, the legislation placed funding in the hands of the
school districts through block grants, thereby creating the potential for the
districts to undertake implementation of their own programs. To date, only one
of the Company's school district customers has started a program which competes
with services provided by the Company. The Company has recently received a
number of referrals from this district for children who had been enrolled in the
district's program. The Company continues to monitor the implementation of this
legislation.
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
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
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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. In addition, several
initiatives have been introduced which propose "parity" of mental health
benefits with other medical benefits as well as increased funding for children's
programs. At this time, it is uncertain if any 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. Failure to maintain JCAHO
accreditation at the company's facilities may have a material adverse effect on
the Company's operations.
COMPETITION
The at-risk youth services 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
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.
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EMPLOYEES
At June 30, 1999, the Company had 1,900 full-time employees and 890
part-time employees. Of these 2,790 employees, 90 were corporate or regional
administrative staff and 2,700 were involved in program and facility operation
and management. Approximately 100 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 January 1998 by the employees who are part of the
Collective Bargaining Unit. The term of the contract expires in December 2000.
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: the Company's exposure to the Year 2000 issue, both from internal and
external sources; 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 an aggregate of approximately 16% of its
revenues in fiscal 1999; changes in funding mechanisms in the State of
California that might reduce or eliminate payment to the Company; 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 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 laws, 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 payors and increasing managed care penetration;
increasingly stringent length of stay and admissions criteria; public resistance
to privatization of youth education, treatment and
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juvenile justice services; negative publicity generated by opposition to the
Company's facilities by residents in areas surrounding proposed sites; potential
claims or litigation by participants in the Company's programs arising from
contact with the Company's facilities, programs, personnel or participants,
including claims related to deaths or injuries at the Company's facilities;
Helicon's inability to pay future management fees or lease payments; 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.
ITEM 2. PROPERTIES
The table below sets forth certain information regarding the Company's
properties:
Nature of Number of
State Occupation Facilities
----- ---------- ----------
Non-Residential:
Alabama Lease 1
Arkansas Lease 4
California Own 6
California Lease 14
Florida Lease 6
Hawaii Lease 1
Kentucky Own 1
Louisiana Lease 1
Montana Lease 6
Tennessee Lease 1
Texas Lease 3
Texas Right to occupy (1) 1
Residential:
Alabama Right to occupy (1) 6
Alabama Own 1
Arkansas Own 1
Florida Own 1
Kentucky Own 1
Michigan Own 1
Montana Own 1
Ohio Lease 1
Pennsylvania Lease 1
Tennessee Own 4
Tennessee Right to occupy (1) 2
Tennessee Lease 1
Texas Own 1
Texas Right to occupy (1) 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.
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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 Ashland City, Murfreesboro, Nashville and Newbern, Tennessee, and its
behavioral treatment centers in Alabama, Arkansas, Florida, Kentucky, Michigan,
Montana, Tennessee, 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, 1999, the Company's
total rental expense for property was approximately $2,129,000 . In addition,
the Company also has obtained a right to occupy certain facilities rent-free
during the effective period 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, 2002 and January 31, 2004, respectively.
In August 1999, the Company consolidated its corporate offices located
in Murfreesboro and Nashville, Tennessee into approximately 23,000 square feet
of leased corporate office space in Nashville, Tennessee. Following this
consolidation, the Company sold its Murfreesboro corporate office building in
September 1999. The Company believes its facilities are suitable for its current
operations and programs.
ITEM 3. LEGAL PROCEEDINGS
In June 1999, a petition was filed by the State of Montana against the
Company primarily alleging negligence in connection with a suicide at the
Company's facility in June 1998. In September 1999, the Company entered into an
agreement with the State of Montana whereby the Company did not admit guilt or
wrongdoing of any kind. Under this agreement, the State of Montana will defer
prosecution for six months, subject to the Company's compliance with certain
terms and conditions, including the payment of approximately $12,000 for the
state's cost of investigation. Upon the Company's compliance with the terms and
conditions of the agreement, the State's complaint will then be dismissed.
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.
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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.
Year Ended June 30, 1999 High Low
--------------------------- ------ ------
Quarter Ended: June 30 6 15/16 5 3/8
March 31 15 3/4 5
December 31 14 1/2 7 3/4
September 30 16 1/4 7
Year Ended June 30, 1998 High Low
--------------------------- ------ ------
Quarter Ended: June 30 20 1/2 13 1/2
March 31 22 1/2 17
December 31 21 7/8 16
September 30 21 7/8 13 5/8
HOLDERS
As of September 17, 1999 the Company had approximately 258 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.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected financial information for the years ended June 30,
1999, 1998 and 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 and 1995 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.
All amounts for periods prior to fiscal 1998 have been restated to reflect the
pooling of interests transaction with Ventures that was consummated during
fiscal 1998.
Three Months
Year Ended June 30, Ended Year Ended March 31,
--------------------------------------- June 30, ------------------
1999 1998(1) 1997 1996 1996 1995
--------- -------- -------- ------- ------- --------
(In thousands of dollars, except per share data)
Statement of Income Data:
Revenue:
Operating revenue $ 111,812 $ 90,266 $ 34,812 $ 6,482 $23,630 $ 20,575
Management fee income 3,665 3,733 2,481 566 1,710 906
--------- -------- -------- ------- ------- --------
Total revenue 115,477 93,999 37,293 7,048 25,340 21,481
--------- -------- -------- ------- ------- --------
Operating Expenses:
Employee compensation and benefits 70,875 55,367 22,656 4,139 15,224 12,817
Purchased services and other expenses 31,512 26,610 7,872 1,307 5,095 4,535
Depreciation and amortization 3,492 2,142 1,013 191 1,025 1,080
Other operating expenses 115 115 101 25 101 101
--------- -------- -------- ------- ------- --------
Total operating expenses 105,994 84,234 31,642 5,662 21,445 18,533
--------- -------- -------- ------- ------- --------
Income from operations 9,483 9,765 5,651 1,386 3,895 2,948
Interest (income) expense, net 1,226 195 (616) 178 869 1,223
Other (income) expense, net (55) (1,740)(2) (15) -- -- (44)
--------- -------- -------- ------- ------- --------
Income before income taxes, extraordinary item
and cumulative effect of accounting change 8,312 11,310 6,282 1,208 3,026 1,769
Provision (benefit) for income taxes 3,284 4,357 (8) 311 491 69
--------- -------- -------- ------- ------- --------
Income before extraordinary item and cumulative
effect of accounting change 5,028 6,953 6,290 897 2,535 1,700
Extraordinary item, net of tax -- -- 377 -- 54 --
Cumulative effect of accounting change, net of tax 20 -- -- -- -- --
--------- -------- -------- ------- ------- --------
Net Income $ 5,008 $ 6,953 $ 5,913 $ 897 $ 2,481 $ 1,700
========= ======== ======== ======= ======= ========
Net income per share:
Diluted $ 0.66 $ 0.84 $ 0.81 $ 0.15 $ 0.43 $ 0.33
Dividends declared per share -- -- -- -- -- --
Balance Sheet Data:
Working capital $ 17,782 $ 29,867 $ 23,853 $ 4,663 $ 3,488 $ 1,041
Total assets 98,631 80,201 69,768 22,832 22,406 19,674
Long term debt and capital lease obligations 24,854 11,611 11,655 6,000 6,052 6,924
Shareholders' equity 56,230 57,832 49,695 12,779 11,665 9,132
(1) Fiscal 1998 reflects the first full year of results from the Company's
acquisition of substantially all the assets of Vendell Healthcare, Inc.
in June 1997.
(2) Amount consists of gain on exchange of Texas properties of $1,530 and
gain on repayment by Helicon of $217 of amounts due for prior years
management fees, which had been fully reserved.
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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 unanticipated events.
GENERAL
As of June 30, 1999, the Company was providing education, treatment and
juvenile justice services, either directly or through management contracts, to
approximately 4,000 youth. 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. The Company's non-residential
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 at per
diem rates or under fixed fee contracts. The Company also receives revenues from
management consulting contracts with other entities, including Helicon.
In January 1998, the Company effected a merger with Ventures Healthcare of
Gainesville, Inc. ("Ventures"). The merger was accounted for as a pooling of
interests. The Company's financial statements have been restated to reflect the
merger which was consummated effective January 1, 1998. The Company issued
146,580 shares of Common Stock pursuant to this transaction.
In September 1998, the Company acquired Ameris Health Systems, Inc.
("Ameris") for net consideration of approximately $12,500,000 in cash. Ameris,
through its wholly-owned subsidiary, American Clinical Schools, Inc., operates
residential juvenile sex offender programs in Tennessee, Alabama and
Pennsylvania with an aggregate capacity of 228 licensed beds. Pursuant to this
transaction, the Company also purchased a note receivable for $2,500,000 in
cash. The payment of this note, which matured and was collected in September
1999, was guaranteed by $2,500,000 cash escrowed in conjunction with this
transaction.
In December 1998, the Company acquired Somerset, Inc., the operator of a
200-seat educational day treatment program located in southern California.
Consideration for this transaction consisted of approximately $8,200,000 in cash
and $2,400,000 in notes payable.
In addition to its acquisitions, the Company opened the following new
programs during fiscal 1999:
- September 1998 - a 150-chair education day treatment program in the
Alexander Training School in Little Rock, Arkansas
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- September 1998 - a 30-chair educational day treatment program in
Russelville, Kentucky
- November 1998 - a 40-bed residential treatment center in El Paso,
Texas
- January 1999 - a 20-chair educational day treatment program in Hilo,
Hawaii
- February 1999 - a 28-bed secure juvenile detention center in
Dyersburg, Tennessee
- March 1999 - a 30-bed secure residential program for adolescent
female offenders in Mansfield, Ohio
- March 1999 - a 48-bed secure residential program for serious
adolescent female offenders in the Company's Longview, Texas
facility
The Company receives management fee income from third parties for services
provided in managing a unit or facility. Reimbursement for these services is
typically based on a fixed fee plus reimbursement of expenses. Also, the Company
receives management fee income from Helicon, Inc. for consulting, management and
marketing services rendered pursuant to the Helicon Agreement. As of June 30,
1999, 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. The Helicon
Agreement expires in September 2004. At June 30, 1999, unpaid management fees,
lease payments and advances for years prior to 1997, plus interest, due the
Company from Helicon totaled in excess of $7,000,000. 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
$1,500,000. See "--Liquidity and Capital Resources."
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 income. 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 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.
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RESULTS OF OPERATIONS
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 June 30,
----------------------------
1999 1998 1997
------ ------ ------
Operating revenues 96.8% 96.0% 93.3%
Management fee income 3.2 4.0 6.7
------ ------ ------
Total revenues 100.0 100.0 100.0
------ ------ ------
Employee compensation and benefits 61.4 58.9 60.8
Purchased services and other expenses 27.3 28.3 21.0
Depreciation and amortization 3.0 2.3 2.7
Related party rent 0.1 0.1 0.3
------ ------ ------
Total operating expenses 91.8 89.6 84.8
------ ------ ------
Income from operations 8.2 10.4 15.2
Other (income) expense:
Interest expense 1.5 1.0 1.0
Interest income (0.4) (0.7) (2.7)
Other income -- (1.9) --
Provision for income taxes 2.8 4.6 --
Extraordinary item, net of tax -- -- 1.0
Cumulative effect of accounting change -- -- --
------ ------ ------
Net income 4.3% 7.4% 15.9%
====== ====== ======
FISCAL 1999 (YEAR ENDED JUNE 30, 1999) VERSUS FISCAL 1998 (YEAR ENDED JUNE 30,
1998)
Total revenues for fiscal 1999 increased by $21,478,000 or 22.8% to
$115,477,000, as compared to $93,999,000 for fiscal 1998. Operating revenues for
fiscal 1999 increased by $21,546,000 or 23.9% to $111,812,000, as compared to
$90,266,000 for fiscal 1998. The increase in operating revenues results from
acquisitions (16%), new programs (4%) and the net increase in revenues at
existing programs (3%). Included as part of acquisitions are programs purchased
by the Company in the developmental stage.
Management fee income recognized under the Helicon Agreement for fiscal
1999 increased $29,000 to $1,322,000, as compared to $1,293,000 for fiscal 1998.
Management fee income from other sources decreased 4.0%, from $2,440,000 in
fiscal 1998 to $2,343,000 in fiscal 1999 due to the termination of an acquired
contract.
Employee compensation and benefits for fiscal 1999 increased $15,508,000,
or 28.0%, to $70,875,000, as compared to $55,367,000 for fiscal 1998. As a
percentage of total revenues, employee compensation and benefits increased to
61.4% for fiscal 1999 from 58.9% for fiscal 1998. The increase in employee
compensation and benefits over the prior year is primarily the result of the
Company's growth, both from new programs and acquisitions. The increase in
employee compensation and benefits as a percent of revenues over the prior year
-25-
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results primarily from the opening of programs combined with intentional
overstaffing at the Company's Montana facility.
Purchased services and other expenses for fiscal 1999 increased
$4,902,000, or 18.4%, to $31,512,000, as compared to $26,610,000 for fiscal
1998. As a percentage of total revenues, purchased services and other expenses
decreased to 27.3% for fiscal 1999 from 28.3% for fiscal 1998. The increase in
purchased services and other expenses over the prior year results primarily from
the Company's growth, both from new programs and acquisitions.
Depreciation and amortization increased $1,350,000, or 63.0%, to
$3,492,000 for fiscal 1999 from $2,142,000 for fiscal 1998. The increase in
depreciation and amortization over the prior fiscal year is attributable
primarily to the depreciation associated with the purchase of equipment plus
depreciation and goodwill amortization associated with the Company's
acquisitions.
Income from operations decreased $282,000, or 2.9%, to $9,483,000 for
fiscal 1999 from $9,765,000 for fiscal 1998, and decreased as a percentage of
total revenues to 8.2% for fiscal 1999 from 10.4% for fiscal 1998, as a result
of the factors described above.
Interest expense increased $725,000, or 74.6%, to $1,697,000 for fiscal
1999 from $972,000 for fiscal 1998. The increase in interest expense over the
prior fiscal year is attributable principally to interest on the debt incurred
as part of the Somerset acquisition.
Interest income for fiscal 1999 decreased $306,000 to $471,000, as
compared to $777,000 for fiscal 1998. The decrease in interest income over the
prior year is attributable primarily to the decrease in cash available for
investment following the Ameris acquisition and the Company's repurchase of a
portion of its common stock.
Other income decreased from $1,740,000 in fiscal 1998 to $55,000 in fiscal
1999. Other income for fiscal 1998 is primarily attributable to a recognized
gain in the amount of $1,530,000 arising from an exchange of properties and a
one-time payment from Helicon of management fees, for which a reserve had
previously been established, in the amount of $217,000. Other income for fiscal
1999 results primarily from the recognition of a portion of the gain on a prior
year sale of property pursuant to receipt of the final payment on a note
receivable.
Provision for income taxes for fiscal 1999 decreased to $3,284,000 from
$4,357,000 for fiscal 1998. The decrease results primarily from the decrease in
taxable income for fiscal 1999 versus fiscal 1998.
Pursuant to the adoption of Accounting Standards Executive Committee
Statement of Position 98-5, "Reporting on Costs of Start-Up Activities",
effective July 1, 1998, the Company wrote off, as a cumulative effect of a
change in accounting principle, previously capitalized start-up costs in the
amount of $20,000, net of tax.
FISCAL 1998 (YEAR ENDED JUNE 30, 1998) VERSUS FISCAL 1997 (YEAR ENDED JUNE 30,
1997)
Total revenues for fiscal 1998 increased by $56,706,000 or 152.1% to
$93,999,000, as compared to $37,293,000 for fiscal 1997. Operating revenues for
fiscal 1998 increased by $55,454,000 or 159.3% to $90,266,000, as compared to
$34,812,000 for fiscal 1997. The increase in operating revenues results
primarily from the Vendell acquisition which was effective in June 1997. The
opening of new programs during fiscal 1998, including programs utilizing the
Vendell assets, and increases in student enrollment at several of the Company's
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programs also contributed to the increase in revenues. Approximately $48,000,000
of the increase in operating revenues over the prior fiscal year is attributable
to the Vendell assets purchased in June 1997.
Management fee income recognized under the Helicon Agreement for fiscal
1998 was relatively constant at $1,293,000, as compared to $1,289,000 for fiscal
1997. Management fee income from other sources, including management fees earned
by Ventures, increased 104.7%, from $1,192,000 in fiscal 1997 to $2,440,000 in
fiscal 1998.
Employee compensation and benefits for fiscal 1998 increased $32,711,000,
or 144.4%, to $55,367,000, as compared to $22,656,000 for fiscal 1997. As a
percentage of total revenues, employee compensation and benefits decreased to
58.9% for fiscal 1998 from 60.8% for fiscal 1997. The increase in employee
compensation and benefits over the prior year is primarily the result of the
Company's growth, both from new programs and the Vendell asset purchase. The
decrease in employee compensation and benefits as a percent of revenues over the
prior year results primarily from the acquired Vendell facilities, which utilize
employee compensation less than the Company's historical programs.
Purchased services and other expenses for fiscal 1998 increased
$18,738,000, or 238.1%, to $26,610,000, as compared to $7,872,000 for fiscal
1997. As a percentage of total revenues, purchased services and other expenses
increased to 28.3% for fiscal 1998 from 21.0% for fiscal 1997. 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. The increase in purchased services and other expenses as a percentage
of revenues is primarily the result of the acquired Vendell facilities. The
acquired Vendell facilities utilize purchased services, primarily contract
medical services (psychiatrists, psychologists, etc.), to a greater extent than
the Company's historical programs.
Depreciation and amortization increased $1,129,000, or 111.5%, to
$2,142,000 for fiscal 1998 from $1,013,000 for fiscal 1997. The increase in
depreciation and amortization over the prior fiscal year is attributable
primarily to the depreciation associated with the Vendell asset purchase and the
depreciation of tangible assets plus goodwill amortization associated with the
Chad transaction.
Income from operations increased $4,114,000, or 72.8%, to $9,765,000 for
fiscal 1998 from $5,651,000 for fiscal 1997, and decreased as a percentage of
total revenues to 10.4% for fiscal 1998 from 15.2% for fiscal 1997, as a result
of the factors described above.
Interest expense increased $613,000, or 170.8%, to $972,000 for fiscal
1998 from $359,000 for fiscal 1997. The increase in interest expense over the
prior fiscal year is attributable principally to interest on the debt incurred
in June 1997 pursuant to the Vendell asset purchase.
Interest income for fiscal 1998 decreased $198,000 to $777,000, as
compared to $975,000 for fiscal 1997. The decrease in interest income over the
prior year is attributable primarily to the decrease in cash available for
investment following the Vendell asset purchase, offset by cash generated from
operations.
Other income increased from $15,000 in fiscal 1997 to $1,740,000 in fiscal
1998. Other income for fiscal 1998 is primarily attributable to a recognized
gain in the amount of $1,530,000 arising from an exchange of properties and a
one-time payment from Helicon of management fees, for which a reserve had
previously been established, in the amount of $217,000.
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Provision for income taxes for fiscal 1998 increased to $4,357,000 from
$(8,000) for fiscal 1997. The increase results primarily from a fiscal 1997
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, combined with an increase in the Company's pre-tax income.
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 totaling $119,000.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities for fiscal 1999 was $4,466,000 on
net income of $5,008,000 as compared to $10,069,000 for fiscal 1998 on net
income of $6,953,000. Working capital at June 30, 1999 was $17,782,000, as
compared to $29,867,000 at June 30, 1998.
Cash used by investing activities was $27,788,000 for fiscal 1999 as
compared to $3,729,000 for fiscal 1998. The increase in fiscal 1999 as compared
to fiscal 1998 is due primarily to the purchase of Ameris and Somerset. Cash
provided by financing activities was $5,029,000 for fiscal 1999 as compared to
$78,000 for fiscal 1998, due primarily to the increase in the Company's
borrowings under its line of credit used to fund acquisitions, offset by the
Company's repurchase of its Common Stock.
The Company has a credit agreement with SunTrust Bank and First American
National Bank (jointly "the Lenders"), the term of which extends through
December 1, 2001. Under the terms of this agreement, the Lenders have made
available to the Company, for acquisition financing and working capital
requirements, a revolving line of credit for up to $25,000,000. The credit
facility bears interest at either (i) the one, two, three or six month LIBOR
rate plus an applicable margin, which ranges between .75% and 1.75% and is
dependent on the ratio of funded debt to earnings before interest, taxes,
depreciation and amortization, or (ii) SunTrust Bank's index rate plus an
applicable margin, which ranges between .00% and .50%, at the Company's option.
At June 30, 1999, the outstanding balance under the line of credit was
$8,500,000.
Additionally, effective December 1, 1998, the Company entered into a term
loan with the Lenders in the amount of $15,000,000 at a fixed interest rate. The
term loan is for a period of seven years. The Company's effective rate of
interest on the loan is 8.10%. No payment of principal is required until
December 2001, at which time increasing payments that amortize the loan fully
are due over the remaining four years of the agreement.
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 under this
agreement prohibit the Company, without the prior consent of the Lenders, 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
$500,000. The agreement also prohibits the Company from declaring dividends in
excess of 25% of the Company's net income during any fiscal year. The line of
credit and term loan are secured primarily by the Company's accounts receivable
and equipment.
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Pursuant to the Somerset transaction, the Company issued a note payable to
the sellers totaling $2,375,000. This note bears interest at 6%, will amortize
fully over the three year period ending December 1, 2001, and is secured by the
Company's real estate and improvements purchased pursuant to the Somerset
transaction. At June 30, 1999, $2,008,000 was outstanding under the note.
The Company has also agreed to guarantee Helicon's performance under a
$1.5 million line of credit from First American National Bank ("FANB"). At June
30, 1999, there was $757,000 outstanding under Helicon's line of credit.
Capital expenditures during fiscal 2000 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.
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, cash on hand,
amounts available under its line of credit and outside financing sources 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
operations 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 June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for
Derivative Instruments and Hedging Activities. Subsequently, SFAS No. 137 was
issued, deferring the effective date of SFAS No. 133 for one year. This
Statement requires all derivative financial instruments to be recorded on the
balance sheet at fair value. This results in offsetting changes in fair values
or cash flows of both the hedge and the hedged item being recognized in earnings
in the same period. Changes in fair value of derivatives not meeting the
Statement's hedge criteria are included in income. The Company expects to adopt
the new Statement July 1, 2000. The Company does not expect the adoption of this
Statement to have a material effect on its results of operations or financial
position.
YEAR 2000
The Year 2000 ("Y2K") issue involves the inability of some computers or
microprocessors to correctly handle the century change that will occur at
midnight, December 31, 1999. The Y2K issue, which also includes a number of
related problems, affects nearly every business in the world. The Company's
assessment of potential Y2K problems has focused on three areas: (i) the
Company's information technology ("IT") systems, (ii) its non-IT systems, and
(iii) its relationships with third parties. The Company has completed an
assessment of its IT systems' exposure to the Y2K-related problems, and
currently believes that its main IT systems, which include billing, accounting,
and payroll systems, are Y2K compliant. Although the Company has not tested the
Y2K compliance of such systems, such systems have been represented as Y2K
compliant
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by the vendors thereof. Certain less-critical IT systems as well as certain
individual computers and associated software are not currently Y2K compliant,
however, the Company expects to replace these systems or make them Y2K compliant
as needed.
The Company has also assessed the exposure of its non-IT systems (such as
time clocks) to Y2K problems, and does not believe that Y2K issues related to
non-IT systems will have a material adverse effect on the Company's results of
operations, financial position or cash flows.
The Company has made an assessment of the Y2K readiness of its payors and
other third parties with whom it does business. The Company has contacted all
material payors and other third parties in an attempt to minimize the effect of
any Y2K issues that may arise. Despite efforts that the Company may make in this
regard, there can be no assurance that the systems of other companies with whom
it does business will be compliant.
To date, the Company has incurred no material expenses related to the Y2K
compliance of its IT and non-IT systems. The Company believes that the costs
associated with finalizing the Y2K compliance of such systems will neither
materially increase the Company's future capital expenditures nor materially
affect the Company's results of operations.
The Company believes that its most likely worst case Y2K scenario is that
some of its material third party payors will not be Y2K compliant and will have
difficulty processing and paying the Company's bills, which could affect the
Company's cash flows. The Company has developed a contingency plan to address
this scenario.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
At June 30, 1999, the Company had only cash equivalents, invested in high
grade, very short term securities, which are not typically subject to material
market risk. The Company has outstanding loans at both fixed and variable rates.
For loans with fixed interest rates, a hypothetical 10% change in interest rates
would have no impact on the Company's future earnings and cash flows related to
these instruments. A hypothetical 10% change in interest rates would have an
immaterial impact on the fair values of these instruments. For loans with
variable interest rates, a hypothetical 10% change in interest rates would have
an immaterial impact on the Company's future earnings, cash flows and fair
values related to these instruments.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
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, 1999 and 1998, and
the related consolidated statements of income, shareholders' equity, and cash
flows for each of the three years in the period ended June 30, 1999. 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, 1999 and
1998, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended June 30, 1999, 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.
As discussed in Note A to the consolidated financial statements, the Company
changed its method of accounting for start-up costs in fiscal 1999.
Ernst & Young LLP
Nashville, Tennessee
August 17, 1999, except for Note L,
as to which the date is September 3, 1999
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CHILDREN'S COMPREHENSIVE SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
June 30,
--------------------
1999 1998
------- --------
(dollars in thousands)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,774 $ 20,067
Accounts receivable, net of allowance
for doubtful accounts of $1,952 in 1999 and
$1,865 in 1998 24,692 17,809
Prepaid expenses 1,063 634
Deferred income taxes 1,212 525
Other current assets 4,678 1,577
------- --------
TOTAL CURRENT ASSETS 33,419 40,612
PROPERTY AND EQUIPMENT, net of accumulated
depreciation of $10,570 in 1999 and $7,831
in 1998 50,811 37,162
DEFERRED INCOME TAXES, net of valuation
allowance of $150 in 1998 -- 785
COST IN EXCESS OF NET ASSETS ACQUIRED,
at cost, net of accumulated amortization of
$683 in 1999 and $53 in 1998 13,398 1,180
OTHER ASSETS AND DEFERRED CHARGES, at cost,
net of accumulated amortization of $240
in 1999 and $150 in 1998 1,003 462
------- --------
TOTAL ASSETS $98,631 $ 80,201
======= ========
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CHILDREN'S COMPREHENSIVE SERVICES, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
June 30,
--------------------
1999 1998
------- --------
(dollars in thousands)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 3,834 $ 1,901
Current portion - long-term debt and capital leases 817 44
Income taxes payable 702 136
Accrued employee compensation 5,842 5,082
Accrued other expenses 2,404 2,193
Deferred revenue 2,038 1,389
------- --------
TOTAL CURRENT LIABILITIES 15,637 10,745
DEFERRED TAXES PAYABLE 1,910 --
LONG-TERM DEBT 24,741 11,450
OBLIGATION UNDER CAPITAL LEASES 113 161
OTHER LIABILITIES -- 13
------- --------
TOTAL LIABILITIES 42,401 22,369
------- --------
SHAREHOLDER'S EQUITY
Preferred stock, par value $1.00 per
share--10,000,000 shares authorized -- --
Common stock, par value $ .01 per share
--50,000,000 shares authorized; issued
and outstanding 7,295,526 shares in 1999
and 8,038,783 shares in 1998 73 80
Additional paid-in capital 51,217 57,820
Retained earnings/accumulated (deficit) 4,940 (68)
------- --------
TOTAL SHAREHOLDERS' EQUITY 56,230 57,832
------- --------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $98,631 $ 80,201
======= ========
See notes to consolidated financial statements.
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CHILDREN'S COMPREHENSIVE SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Year Ended June 30,
-------------------------------------
1999 1998 1997
--------- -------- --------
(In thousands, except per share amounts)
Revenues:
Operating revenues $ 111,812 $ 90,266 $ 34,812
Management fee income 3,665 3,733 2,481
--------- -------- --------
TOTAL REVENUES 115,477 93,999 37,293
--------- -------- --------
Operating expenses:
Employee compensation and benefits 70,875 55,367 22,656
Purchased services and other expenses 31,512 26,610 7,872
Depreciation and amortization 3,492 2,142 1,013
Related party rent 115 115 101
--------- -------- --------
TOTAL OPERATING EXPENSES 105,994 84,234 31,642
--------- -------- --------
Income from operations 9,483 9,765 5,651
Other (income) expense:
Interest expense 1,697 972 359
Interest income (471) (777) (975)
Other income (55) (1,740) (15)
--------- -------- --------
TOTAL OTHER (INCOME) EXPENSE, NET 1,171 (1,545) (631)
--------- -------- --------
Income before income taxes, extraordinary item
and cumulative effect of accounting change 8,312 11,310 6,282
Provision (benefit) for income taxes 3,284 4,357 (8)
--------- -------- --------
Income before extraordinary item and cumulative
effect of accounting change 5,028 6,953 6,290
Extraordinary item:
Loss on early extinguishment of debt,
net of income tax benefit of $235 -- -- 377
--------- -------- --------
Income before cumulative effect of accounting change 5,028 6,953 5,913
Cumulative effect of accounting change,
net of income tax benefit of $12 20 -- --
--------- -------- --------
NET INCOME $ 5,008 $ 6,953 $ 5,913
========= ======== ========
Basic earnings per common share:
Before extraordinary item and cumulative
effect of accounting change $ 0.67 $ 0.87 $ 0.88
Extraordinary item -- -- (0.05)
Cumulative effect of accounting change -- -- --
--------- -------- --------
NET INCOME $ 0.67 $ 0.87 $ 0.83
========= ======== ========
Diluted earnings per common share:
Before extraordinary item and cumulative
effect of accounting change $ 0.66 $ 0.84 $ 0.86
Extraordinary item -- -- (0.05)
Cumulative effect of accounting change -- -- --
--------- -------- --------
NET INCOME $ 0.66 $ 0.84 $ 0.81
========= ======== ========
Weighted average shares outstanding:
Basic 7,450 7,983 7,096
Diluted 7,585 8,233 7,322
See notes to consolidated financial statements.
-35-
36
CHILDREN'S COMPREHENSIVE SERVICES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock, Retained
$.01 par value Additional earnings/ Total
----------------------- Paid-In Accumulated Shareholders'
Shares Amount Capital (Deficit) Equity
---------- ------ -------- ------- --------
(dollars in thousands)
Balance at July 1, 1996 5,641,365 $ 56 $ 25,657 $(12,934) $ 12,779
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 5,913 5,913
---------- ---- -------- ------- --------
Balance at June 30, 1997 7,916,236 79 56,637 (7,021) 49,695
Stock issued:
Exercise of options 58,789 -- 98 98
Exercise of warrant 5,758 -- 30 30
Acquisition of Chad 58,000 1 1,065 1,066
Stock registration costs (10) (10)
Net income for the year 6,953 6,953
---------- ---- -------- ------- --------
Balance at June 30, 1998 8,038,783 80 57,820 (68) 57,832
Stock issued:
Exercise of options 78,700 1 460 461
Pursuant to employee stock
purchase plan 23,043 -- 109 109
Shares repurchased (845,000) (8) (7,104) (7,112)
Stock registration costs (68) (68)
Net income for the year 5,008 5,008
---------- ---- -------- ------- --------
Balance at June 30, 1999 7,295,526 $ 73 $ 51,217 $ 4,940 $ 56,230
========== ==== ======== ======= ========
See notes to consolidated financial statements.
-36-
37
CHILDREN'S COMPREHENSIVE SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended June 30,
----------------------------------------
1999 1998 1997
-------- -------- --------
(in thousands)
OPERATING ACTIVITIES
Net income $ 5,008 $ 6,953 $ 5,913
Adjustments to reconcile net income to
net cash provided by operating
activities:
Deferred income taxes (530) (334) (1,101)
Depreciation 2,783 1,973 935
Amortization 709 169 78
Amortization of deferred loan costs 114 33 31
Provision for bad debts 1,275 1,329 (155)
Other -- -- (7)
Loss on early extinguishment of debt -- -- 119
Cumulative effect of accounting change 20 -- --
Changes in operating assets and
liabilities, net of effects from
acquisitions:
Accounts receivable (6,064) (2,732) (1,928)
Prepaid expenses (367) 18 224
Other current assets (403) (223) (509)
Accounts payable 1,057 207 16
Accrued employee compensation 188 2,063 (72)
Accrued other expenses (83) 884 1,591
Income taxes payable 123 (7) (349)
Other liabilities 636 (264) (290)
-------- -------- --------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 4,466 10,069 4,496
-------- -------- --------
INVESTING ACTIVITIES
Purchase of assets of Vendell
Healthcare, Inc. -- (709) (19,477)
Purchase of assets of AR&D, Inc. -- -- (999)
Purchase of Chad Youth Center -- (1,202) --
Purchase of Ameris Health Systems, Inc. (12,499) -- --
Purchase of Somerset, Inc. (8,175) -- --
Purchase of note receivable (2,500) -- --
Purchase of property and equipment (4,293) (2,217) (2,458)
Proceeds from sale of property and
equipment 29 866 11
Other assets (350) (467) (138)
-------- -------- --------
NET CASH (USED) BY
INVESTING ACTIVITIES $(27,788) $ (3,729) $(23,061)
-------- -------- --------
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38
CHILDREN'S COMPREHENSIVE SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Year Ended June 30,
----------------------------------------
1999 1998 1997
-------- -------- --------
(in thousands)
FINANCING ACTIVITIES
Proceeds from revolving lines
of credit and long-term
borrowings $ 36,071 $ -- $ 11,695
Principal payments on revolving
lines of credit, long-term
borrowings and capital lease
obligations (24,432) (40) (6,206)
Repurchase of shares of common
stock (7,112) -- --
Proceeds from issuance of common
stock, net 570 128 23,423
Stock registration costs (68) (10) (19)
-------- -------- --------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 5,029 78 28,893
-------- -------- --------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (18,293) 6,418 10,328
Cash and cash equivalents at
beginning of year 20,067 13,649 3,321
-------- -------- --------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 1,774 $ 20,067 $ 13,649
======== ======== ========
SUPPLEMENTAL INFORMATION
Income taxes paid $ 3,426 $ 4,569 $ 1,107
Interest paid 1,363 963 309
See notes to consolidated financial statements.
-38-
39
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business -- Children's Comprehensive Services, Inc. and its subsidiaries
(the Company) provide a continuum of services to at-risk and troubled youth. The
Company emphasizes education, treatment and juvenile justice services, 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, Hawaii, Kentucky, Louisiana, Michigan, Montana, Ohio,
Pennsylvania, Tennessee, Texas and Utah. The Company also provides consulting,
management and marketing services to other entities, including 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.
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 -- For fiscal years prior to July 1,
1998, contract pre-opening costs (incremental direct costs incurred to open
facilities in new market areas) were amortized using the straight-line method
over the lesser of the initial contract term or one year. Effective July 1,
1998, the Company adopted Accounting Standards Executive Committee Statement of
Position ("SOP") 98-5, "Reporting on Costs of Start-Up Activities", under which
all pre-opening costs are expensed as incurred. 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 fifteen 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.
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40
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 -- Financial Accounting Standards Board ("FASB")
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of," 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
intangible assets.
Stock Based Compensation -- The Company grants stock options for a fixed
number of shares to employees and directors 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.
Income Per Common Share -- The Company calculates income per common share
in accordance with SFAS No. 128, "Earnings per Share". The computation of basic
income per common share is based on the weighted average number of shares
outstanding. Diluted income per common share includes the effect of common stock
equivalents, consisting of dilutive stock options and warrants, and uses the
treasury stock method in calculating dilution.
Income Taxes -- Income taxes are accounted for under the provisions of
SFAS 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.
Start-Up Costs -- SOP 98-5, "Reporting on Costs of Start-Up Activities"
changes the way in which public companies account for start-up costs. The SOP
requires entities, upon adoption, to write off as a cumulative effect of a
change in accounting principle any previously capitalized start-up or
organizational costs. In the fourth quarter of fiscal 1999, the Company elected
to adopt the SOP effective July 1, 1998.
-40-
41
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The effect of adoption is summarized below by quarter for fiscal 1999.
(in thousands except per share amounts) First Second Third
------- ------- -------
Total revenues-as reported and
as restated $23,200 $27,965 $31,549
Income from operations as reported 1,078 2,525 3,514
Income from operations as restated 1,080 2,263 3,278
Net income as reported 666 1,359 1,841
Net income as restated 648 1,200 1,698
Income per share, diluted:
Net income as reported 0.09 0.18 0.25
Income per share, diluted:
Net income as restated 0.08 0.16 0.22
Reclassifications -- Certain reclassifications have been made to the prior
year financial statements to conform to the fiscal 1999 presentation.
New Pronouncements -- Effective July 1, 1998, the Company adopted SFAS No.
130, "Reporting Comprehensive Income", which establishes the standards for the
reporting and display of comprehensive income and its components. This Statement
requires that all items that are components of comprehensive income be reported
in a financial statement that is displayed with the same prominence as other
financial statements. During fiscal 1999, 1998 and 1997, the Company had no
items of other comprehensive income.
Effective July 1, 1998, the Company adopted SFAS No. 131, "Disclosure
about Segments of an Enterprise and Related Information" which requires public
companies to report segment information in annual financial statements and also
requires those companies to report selected segment information in interim
financial reports to shareholders. The Company has determined that it has only
one reportable segment.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." Subsequently SFAS No. 137 was issued,
deferring the effective date of SFAS No. 133 for one year. This Statement
requires all derivative financial instruments to be recorded on the balance
sheet at fair value. This results in the offsetting changes in fair values or
cash flows of both the hedge and the hedged item being recognized in earnings in
the same period. Changes in fair value of derivatives not meeting the
Statement's hedge criteria are included in income. The Company expects to adopt
the new Statement July 1, 2000. The Company does not expect the adoption of this
Statement to have a material effect on its results of operations or financial
position.
-41-
42
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B--ACQUISITIONS AND MERGERS
In December 1998, the Company acquired Somerset, Inc. ("Somerset"), the
operator of a 200-seat educational day treatment program located in southern
California. Consideration for this transaction consisted of approximately $8.2
million in cash and $2.4 million in notes payable. This transaction has been
accounted for as a purchase. Pro forma results of operations for fiscal 1999 and
1998 as if the acquisition had occurred on July 1, 1997 would not differ
materially from reported amounts.
In September 1998, the Company acquired Ameris Health Systems, Inc.
("Ameris") for net consideration of approximately $12.5 million in cash. Ameris,
through its wholly-owned subsidiary, American Clinical Schools, Inc., operates
residential juvenile sex offender programs in Tennessee, Alabama and
Pennsylvania with an aggregate capacity of 228 licensed beds. This transaction
has been accounted for as a purchase. Pursuant to this transaction, the Company
also purchased a note receivable for $2.5 million which was collected subsequent
to year end. Pro forma results of operations for fiscal 1999 and 1998 as if the
acquisition had occurred on July 1, 1997 would not differ materially from
reported amounts. Cost in excess of net assets acquired totaled approximately
$13.1 million for the Ameris and Somerset acquisitions, and is being amortized
over fifteen years.
In February 1998, the Company acquired Chad Youth Enhancement Center, Inc.
("Chad"), a 46 bed residential treatment center located in Ashland City,
Tennessee for $1.2 million in cash and $1.1 million (58,000 shares) of the
Company's Common Stock. This transaction has been accounted for as a purchase.
Cost in excess of net assets acquired of approximately $857,000 is being
amortized over fifteen years. Pro forma results of operations for fiscal 1998
and 1997 as if the acquisition had occurred on July 1, 1996 would not differ
materially from reported amounts.
In January 1998, the Company effected a merger with Ventures Healthcare of
Gainesville, Inc. ("Ventures"). Ventures provides management services to
Community Mental Health Centers and other not for profit entities. The merger
was accounted for as a pooling of interests. The Company's financial statements
have been restated for all periods presented to reflect the merger. The Company
issued 146,580 shares of common stock pursuant to this transaction.
In June 1997, the Company acquired substantially all the assets of Vendell
Healthcare, Inc. and its subsidiaries ("Vendell"). Based in Nashville,
Tennessee, Vendell operated primarily residential facilities located in seven
states. The Vendell asset acquisition was accounted for as a purchase. The total
consideration paid consisted of approximately $19,477,000 in cash and $7,600,000
(642,978 shares) in shares of the Company's Common Stock. The $19,477,000 in
cash included approximately $7,077,000 used by the Company to purchase the net
working capital of Vendell. The Company's financial statements for the year
ended June 30, 1997 do not include the results of operations for Vendell for the
periods prior to June 2, 1997, the effective date of the acquisition.
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 since April 1997.
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43
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C--PROPERTY AND EQUIPMENT
Property and equipment consists of:
June 30,
--------------------------------
1999 1998
------------ ------------
Land and improvements $ 4,990,000 $ 3,516,000
Buildings and improvements 46,656,000 34,810,000
Furniture and equipment 9,651,000 6,661,000
Construction in progress 84,000 6,000
------------ ------------
61,381,000 44,993,000
Less accumulated depreciation (10,570,000) (7,831,000)
------------ ------------
$ 50,811,000 $ 37,162,000
============ ============
NOTE D--CAPITAL LEASE OBLIGATIONS
Equipment under capital leases of $147,000 and $196,000 has been included
in property and equipment as of June 30, 1999 and 1998. The related accumulated
amortization balances totaled $98,000 and $49,000, respectively.
Future minimum payments, by fiscal year and in the aggregate, under the
capital leases are as follows:
Year ending June 30:
2000 $ 62,000
2001 62,000
2002 63,000
---------
Total minimum lease payments 187,000
Amount representing interest (25,000)
---------
Present value of minimum lease payments
(including $49,000 classified as current) $ 162,000
=========
NOTE E--HELICON INCORPORATED
Helicon, Inc. ("Helicon"), a 501(c)(3) tax exempt corporation 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 of 6% of the monthly gross revenue of
Helicon's programs. The management agreement expires September 2004. Management
fee income totaled $1,322,000, $1,293,000 and $1,289,000 for the years ended
June 30, 1999, 1998 and 1997, respectively.
-43-
44
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE E--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 $7,534,000 were
leased, under operating lease arrangements, to Helicon at June 30, 1999. Future
minimum rental income due under these operating leases as of June 30, 1999 is as
follows:
Year ending June 30:
2000 $ 953,000
2001 953,000
2002 953,000
2003 885,000
2004 and thereafter 11,636,000
-----------
Total $15,380,000
===========
Lease income totaled $953,000, $946,000 and $892,000 for the years ended
June 30, 1999, 1998 and 1997, respectively.
Prior to fiscal 1997, Helicon was unable to pay all management fees, lease
payments, or advances owed the Company. At June 30, 1999, such unpaid management
fees, lease payments, advances and interest due the Company on the obligations
totaled in excess of $7 million. The total amount due 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.
Helicon has obtained through First American National Bank ("FANB") a $1.5
million revolving line of credit. This line of credit matures in October 1999.
The Company facilitated Helicon in this process by agreeing to guarantee
Helicon's performance under the line of credit. At June 30, 1999, the balance
outstanding under Helicon's line of credit was $757,000.
NOTE F -- LONG-TERM DEBT AND LINE OF CREDIT
The Company has a credit agreement with SunTrust Bank and First American
National Bank (jointly "the Lenders"), the term of which extends through
December 1, 2001. Under the terms of this agreement, the Lenders have made
available to the Company, for acquisition financing and working capital
requirements, a revolving line of credit for up to $25,000,000. The credit
facility bears interest at either (i) the one, two, three or six month LIBOR
rate plus an applicable margin, which ranges between .75% and 1.75% and is
dependent on the ratio of funded debt to earnings before interest, taxes,
depreciation and amortization, or (ii) SunTrust Bank's index rate plus an
applicable margin, which ranges between .00% and .50%, at the Company's option.
At June 30, 1999, the outstanding balance under the line of credit was
$8,500,000.
-44-
45
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE F -- LONG-TERM DEBT AND LINE OF CREDIT (continued)
Additionally, effective December 1998, the Company entered into a term
loan with the Lenders in the amount of $15,000,000 at an effective fixed
interest rate of 8.10%. Proceeds of the loan were used to repay the $11,450,000
borrowed under the Company's previous line of credit with FANB, which had been
used to partially fund the cash portion of the Vendell asset purchase, and to
fund a portion of the Ameris acquisition. The term loan is for a period of seven
years. No payment of principal is required until December 2001.
The Company's line of credit and term loan require 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 the Lenders, 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
$500,000. The agreement also prohibits the Company from declaring dividends in
excess of 25% of the Company's net income during any fiscal year. The line of
credit and term loan are secured primarily by the Company's accounts receivable
and equipment.
Pursuant to the Somerset transaction, the Company issued a note payable to
the sellers totaling $2,375,000. This note bears interest at 6%, will amortize
fully over the three year period ending December 1, 2001, and is secured by the
Company's real estate and improvements purchased pursuant to the Somerset
transaction. At June 30, 1999, $2,008,000 was outstanding under the note.
Future principal maturities of long-term debt are as follows at June 30,
1999:
Year Ending June 30:
2000 $ 767,000
2001 815,000
2002 10,601,000
2003 3,475,000
2004 and thereafter 9,850,000
------------
Total 25,508,000
Less current portion (767,000)
------------
Total long-term $ 24,741,000
============
During fiscal 1997, the Company used approximately $6,158,000 of the net
proceeds from its public offering of stock to prepay all of the Company's
outstanding indebtedness to National Health Investors, Inc. ("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.
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46
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G--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, 1999 and 1998
are as follows:
June 30,
------------------------------
1999 1998
----------- -----------
Deferred tax liabilities:
Depreciation and amortization $ 2,356,000 $ 93,000
Other 125,000 125,000
----------- -----------
Total deferred tax liabilities 2,481,000 218,000
----------- -----------
Deferred tax assets:
Net operating loss and credit
carryforwards 879,000 1,130,000
Accrued expenses 1,054,000 526,000
Other -- 22,000
----------- -----------
Total deferred tax assets 1,933,000 1,678,000
Valuation allowance for deferred
tax assets (150,000) (150,000)
----------- -----------
Net deferred tax assets 1,783,000 1,528,000
----------- -----------
Net deferred tax liabilities (assets) $ 698,000 $(1,310,000)
=========== ===========
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 believes
that $1,783,000 of the deferred tax assets will be realized. Accordingly, a
valuation allowance of $150,000 has been recorded for certain net operating loss
carryforwards which will not likely be realized.
Income tax expense (benefit) is allocated in the financial statements as
follows:
Year Ended June 30,
----------------------------------------------
1999 1998 1997
----------- ----------- ---------
Income before extraordinary item
and cumulative effect of accounting
change $ 3,284,000 $ 4,357,000 $ (8,000)
Extraordinary item -- -- (235,000)
Cumulative effect of accounting change (12,000) -- --
----------- ----------- ---------
Total $ 3,272,000 $ 4,357,000 $(243,000)
=========== =========== =========
-46-
47
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G--INCOME TAXES (continued)
The provision (benefit) for income taxes applicable to income before
extraordinary item and cumulative effect of accounting change is as follows:
Year Ended June 30,
-------------------------------------------------
1999 1998 1997
----------- ----------- -----------
Current:
Federal $ 3,156,000 $ 3,808,000 $ 718,000
State 658,000 883,000 375,000
----------- ----------- -----------
3,814,000 4,691,000 1,093,000
----------- ----------- -----------
Deferred:
Federal (192,000) (247,000) (1,100,000)
State (338,000) (87,000) (1,000)
----------- ----------- -----------
(530,000) (334,000) (1,101,000)
----------- ----------- -----------
Provision (benefit) for income taxes $ 3,284,000 $ 4,357,000 $ (8,000)
=========== =========== ===========
The reconciliation of income tax attributable to income before
extraordinary item and cumulative effect of accounting change computed at the
federal statutory tax rate of 35% for the years ended June 30, 1999 and 1998 and
34% for the year ended June 30, 1997, to income tax expense (benefit) is as
follows:
Year Ended June 30,
-------------------------------------------------
1999 1998 1997
----------- ----------- -----------
Income tax expense at
federal statutory rate $ 2,909,000 $ 3,959,000 $ 2,045,000
Change in valuation
allowance -- -- (1,877,000)
Reversal of previously recorded
tax accruals (263,000) (141,000) (478,000)
State income tax, net of federal
benefit 338,000 517,000 258,000
Goodwill amortization 212,000 -- --
Nondeductible expenses 88,000 22,000 44,000
----------- ----------- -----------
Provision (benefit) for income
taxes $ 3,284,000 $ 4,357,000 $ (8,000)
=========== =========== ===========
At June 30, 1999, the Company had regular tax net operating loss
carryforwards of $990,000 which expire from 2002 through 2010. Utilization of
$571,000 of the net operating loss carryforwards is subject to an annual
limitation of $40,000 pursuant to Internal Revenue Code Section 382.
-47-
48
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G--INCOME TAXES (continued)
At June 30, 1999, the Company had state net operating loss carryforwards
of $4,471,000 which expire in 2014.
NOTE H--SHAREHOLDERS' EQUITY
Warrants -- The Company had warrants to purchase 9,616 shares of common stock
outstanding at July 1, 1996, at an exercise price of $5.20 per share. Warrants
to purchase -0-, 5,758 and -0- shares were exercised during fiscal 1999, 1998
and 1997, respectively. Warrants to purchase 3,858 shares remain outstanding at
June 30, 1999.
Stock Options -- The following table sets forth outstanding stock options under
the Company's stock option plans as of June 30, 1999, 1998, 1997, and 1996 for
the purchase of the Company's Common Stock:
Weighted
Average
Option Exercise
Options Shares Prices Price
- ---------------------------- ---------- ------------ ------------
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 0.96
Forfeited (2,398) 5.25-15.38 7.78
------------ ------------ ------------
Outstanding at June 30, 1997 588,450 .62-18.00 8.99
Granted 170,500 17.64-18.25 17.72
Exercised (58,789) .62-15.38 1.67
Forfeited (5,874) 5.25-15.38 13.96
------------ ------------ ------------
Outstanding at June 30, 1998 694,287 1.50-18.25 11.72
Granted 595,550 5.85-12.82 9.49
Exercised (78,700) 1.50- 7.00 5.86
Forfeited (183,566) 10.85-17.64 16.25
------------ ------------ ------------
Outstanding at June 30, 1999 1,027,571 $3.25-18.25 $ 10.07
============
Options exercisable and shares available for future grant are as follows:
June 30,
-----------------------------------
1999 1998 1997
------- ------- -------
Options exercisable 391,847 371,091 295,785
Shares available for grant 333,875 767,825 338,848
-48-
49
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE H--SHAREHOLDERS' EQUITY (continued)
The following table summarizes information about stock options outstanding at
June 30, 1999:
Options Outstanding Options Exercisable
----------------------------------------------------- -------------------------
Weighted
Number Average Weighted Number Weighted
Range of Outstanding Remaining Average Exercisable Average
Exercise at June 30, Contractual Exercise at June 30, Exercise
Prices 1999 Life Price 1999 Price
-------- ----------- ----------- -------- ----------- --------
$ 3.25- 7.00 322,314 8 $ 5.1340 152,314 $ 4.0310
8.00-11.00 377,550 9 10.8500 -- --
12.00-18.25 327,707 8 14.0154 239,533 14.2035
------------ ---------- ---------
$ 3.25-18.25 1,027,571 391,847
========== =========
Options exercisable at June 30, 1999, 1998 and 1997 had weighted average
exercise prices of $10.37, $5.41 and $3.37, respectively.
The Company's 1987 Employee Stock Option Plan expired in June 1997, and no
additional options will be awarded under that plan. The Company's 1989 Stock
Option Plan for Non-Employee Directors was replaced by the 1997 Stock Incentive
Plan which was approved by the Company's shareholders at the 1997 Annual
Meeting.
The following table summarizes common shares reserved at June 30, 1999:
Warrants 3,858
1987 Employee Stock Option Plan 333,746
1989 Stock Option Plan for Non-Employee Directors 30,000
1997 Stock Incentive Plan 663,825
---------
Total common shares reserved 1,031,429
=========
SFAS No. 123, "Accounting for Stock-Based Compensation" 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.
-49-
50
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE H--SHAREHOLDERS' EQUITY (continued)
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, 1999, 1998, and 1997, respectively:
risk-free interest rate of 7.5%; no annual dividend yield; volatility factor of
.898, .477 and .477 based on daily closing prices for the year; 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 June 30,
-----------------------------------------
1999 1998 1997
--------- --------- ---------
Pro forma net income $ 1,979 $ 5,745 $ 5,531
Pro forma earnings per share
Basic $ 0.27 $ 0.72 $ 0.78
Diluted 0.26 0.70 0.76
Because SFAS No. 123 is applicable only to options granted subsequent to
March 31, 1995, its pro forma effect was not fully reflected until 1998. The
weighted average fair value per share for options granted during the years ended
June 30, 1999, 1998 and 1997 totaled $9.49, $9.94 and $8.79, respectively. The
estimated remaining contractual life of options outstanding is 8 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 F) prohibits the
Company from declaring dividends in excess of 25% of the Company's net income
during any fiscal year.
Share Repurchase -- In August 1998, the Company announced that its Board of
Directors had authorized the repurchase of up to 1,000,000 shares of the
Company's Common Stock. During fiscal 1999, the Company repurchased 845,000
shares of stock which were retired.
-50-
51
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE H--SHAREHOLDERS' EQUITY (continued)
Shareholder Rights Plan - The Company's Board of Directors has adopted a
shareholder rights plan to protect the interests of the Company's shareholders
if the Company is confronted with coercive or unfair takeover tactics by
encouraging third parties interested in acquiring the Company to negotiate with
the Board of Directors. The shareholder rights plan is a plan by which the
Company has distributed rights ("Rights") to purchase (at the rate of one Right
per share of common stock) shares of common stock at an exercise price of $75.00
per Right. The Rights are attached to the common stock and may be exercised only
if a person or group acquires 10% or more of the outstanding common stock. Upon
such an event, the Rights "flip-in" and each holder of a Right will thereafter
have the right to receive, upon exercise, common stock having a value equal to
two times the exercise price. All Rights beneficially owned by the acquiring
person or group triggering the "flip-in" will be null and void. Additionally, if
a third party were to take certain action to acquire the Company, such as a
merger or other business combination, the Rights would "flip-over" and entitle
the holder to acquire shares of the acquiring person with a value of two times
the exercise price. The Rights are redeemable by the Company at any time before
they become exercisable for $0.01 per Right and expire in 2008. In order to
prevent dilution, the exercise price and number of Rights per share of common
stock will be adjusted to reflect splits and combinations of, and common stock
dividends on, the common stock.
NOTE I--EARNINGS PER COMMON SHARE
Pursuant to the Company effecting a merger with Ventures effective January
1, 1998 which was accounted for as a pooling of interests, the Company has
restated earnings per share for all prior periods.
Year Ended June 30,
-------------------------------------------------
1999 1998 1997
------------- ------------- -------------
Numerator
Numerator for basic and
diluted earnings per share:
Income before extraordinary item
and cumulative effect of
accounting change $ 5,028,000 $ 6,953,000 $ 6,290,000
Extraordinary item -- -- 377,000
Cumulative effect of accounting
change 20,000 -- --
------------- ------------- -------------
Net income $ 5,008,000 $ 6,953,000 $ 5,913,000
============= ============= =============
Denominator
Denominator for basic earnings per
share:weighted-average shares 7,450,063 7,982,624 7,096,436
Effect of dilutive stock options
and warrants 134,804 250,618 225,417
------------- ------------- -------------
Denominator for diluted earnings per
share:adjusted-weighted-average
shares 7,584,867 8,233,242 7,321,853
============= ============= =============
-51-
52
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I--EARNINGS PER COMMON SHARE (continued)
Year Ended June 30,
-------------------------------------------------
1999 1998 1997
------------- ------------- -------------
Basic earnings per share
Before extraordinary item and
cumulative effect of accounting
change $ 0.67 $ 0.87 $ 0.88
Extraordinary item -- -- (0.05)
Cumulative effect of accounting change -- -- --
------------- ------------- -------------
Net income $ 0.67 $ 0.87 $ 0.83
============= ============= =============
Diluted earnings per share
Before extraordinary item and
cumulative effect of accounting
change $ 0.66 $ 0.84 $ 0.86
Extraordinary item -- -- (0.05)
Cumulative effect of accounting change -- -- --
------------- ------------- -------------
Net income $ 0.66 $ 0.84 $ 0.81
============= ============= =============
Securities that could potentially dilute basic income per share in the
future that were not included in the computation of diluted income per share
because to do so would have been antidilutive for fiscal 1999 and 1998 were
approximately 914,000 and 44,000 shares, respectively.
NOTE J--EMPLOYEE BENEFIT PLANS
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 20% 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 discretionary
contributions have been made under the plan. Administrative costs under the plan
totaled $45,000, $25,000 and $25,000 for the years ended June 30, 1999, 1998,
and 1997, respectively.
Pursuant to shareholder approval, the Company implemented an Employee
Stock Purchase Plan in January 1999. Under this plan, eligible employees can
elect to have amounts withheld from their compensation which are used to
purchase stock in the Company at 85% of the lesser of the market price of the
stock at the beginning or the end of each calendar quarter. Withholding amounts
are fixed at the beginning of each calendar quarter. During fiscal 1999, 23,043
shares of the Company's common stock were purchased at prices ranging from $4.73
to $4.78 per share.
-52-
53
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K--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, 1999:
Year ending June 30:
2000 $2,219,000
2001 1,835,000
2002 1,482,000
2003 1,094,000
2004 and thereafter 745,000
----------
Total $7,375,000
==========
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, 1999, 1998 and 1997 was $3,040,0000, $2,301,000 and $896,000,
respectively. Aggregate future minimum rentals to be received under
noncancelable subleases totaled approximately $45,000 at June 30, 1999.
NOTE L--CONTINGENCIES
Montana Litigation - In June 1999, a petition was filed by the State of Montana
in the Justice Court of Montana against the Company primarily alleging
negligence in connection with a suicide at the Company's facility in fiscal
1998. In September, 1999 the Company entered into an agreement with the State of
Montana whereby the Company did not admit guilt or wrongdoing of any kind. Under
this agreement, the State of Montana will defer prosecution for six months,
subject to the Company's compliance with certain terms and conditions, including
the payment of approximately $12,000 for the state's cost of investigation. Upon
the Company's compliance with the terms and conditions of the agreement, the
State's complaint will then be dismissed.
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.
Laws and Regulations -- Laws and regulations governing Medicare and Medicaid
programs are complex and subject to interpretation. The Company believes that it
is in substantial compliance with all applicable laws and regulations.
Compliance with such laws and regulations can be subject to future governmental
review and interpretation. Noncompliance could result in regulatory action
including fines, penalties, and exclusion from the Medicare and Medicaid
programs.
NOTE M--RELATED PARTY TRANSACTIONS
In June 1996, the Company entered into a one-year agreement with Joseph
Fernandez and Associates, Inc. for marketing and consulting services. Joseph A.
Fernandez, Ed.D., a director of the Company, serves as President of Joseph
Fernandez and Associates, Inc. This agreement was continued on a month to month
basis from July 1997 until its termination in March 1998. Payments under this
agreement during fiscal 1998 and 1997, including reimbursable expenses, totaled
$33,000 and $50,000, respectively.
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 $115,000, $115,000 and $101,000
for the years ended June 30, 1999, 1998, and 1997, respectively.
-53-
54
CHILDREN'S COMPREHENSIVE SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE N--SIGNIFICANT CUSTOMERS
Much 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
June 30, 1999 None
Year Ended
June 30, 1998 None
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%
============ =========
NOTE O--QUARTERLY FINANCIAL INFORMATION (Unaudited)
The following table sets forth selected quarterly operating data.
Amounts for fiscal 1999 have been restated to reflect the adoption of SOP 98-5
effective July 1, 1998.
1999 1998
------------------------------------- -------------------------------------
First Second Third Fourth First Second Third Fourth
------- ------- ------- ------- ------- ------- ------- -------
(in thousands except per share amounts)
Total revenues $23,200 $27,965 $31,549 $32,763 $20,641 $23,129 $24,980 $25,249
Income from operations 1,080 2,263 3,278 2,862 1,197 2,253 3,407 2,908
Net income before cumulative
effect of accounting change 668 1,200 1,698 1,462 685 1,495 2,987 1,786
Net income 648 1,200 1,698 1,462 685 1,495 2,987 1,786
Income per share, diluted:
Before cumulative effect of 0.09 0.16 0.22 0.20 0.08 0.18 0.36 0.22
accounting change
Net income 0.08 0.16 0.22 0.20 0.08 0.18 0.36 0.22
*******
-54-
55
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, 1999 and is incorporated herein by
reference.
-55-
56
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, 1999 and 1998 33
Consolidated Statements of Income for the Years Ended
June 30, 1999, 1998 and 1997 35
Consolidated Statements of Shareholders' Equity for
the Years Ended June 30, 1999, 1998 and 1997 36
Consolidated Statements of Cash Flows for the Years
Ended June 30, 1999, 1998 and 1997 37
Notes to Consolidated Financial Statements 39
(2) Financial Statement Schedules
Schedule II - Valuation and qualifying accounts 59
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)
Warrant Agreement dated October 1, 1996, between the Registrant and
Joseph A. Fernandez (included herein as Exhibit 10.7)
1997 Stock Incentive Plan (included herein as Exhibit 10.13)
Employment Agreement between the Company and William J Ballard,
effective as of August 19, 1998 (included herein as Exhibit 10.36)
Employment Agreement between the Company and Amy S. Harrison, effective
as of August 19, 1998 (included herein as Exhibit 10.37)
(b) Reports on Form 8-K
None
(c) Exhibits
The exhibits listed in the accompanying index to exhibits on page 60 are
filed as part of this annual report on Form 10-K.
-56-
57
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 28, 1999 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 28, 1999 /s/ William J Ballard
----------------------------------------
William J Ballard
Chairman, Chief Executive Officer
and Director (Principal Executive
Officer)
Date: September 28, l999 /s/ Amy S. Harrison
----------------------------------------
Amy S. Harrison
Vice Chairman, President and Director
Date: September 28, 1999 /s/ Martha A. Petrey, Ph.D.
----------------------------------------
Martha A. Petrey, Ph.D.
Executive Vice President and Director
Date: September 28, 1999 /s/ H. Neil Campbell
----------------------------------------
H. Neil Campbell
Executive Vice President
Date: September 28, 1999 /s/ Donald B. Whitfield
----------------------------------------
Donald B. Whitfield
Vice President - Finance and Chief
Financial Officer (Principal Financial
and Accounting Officer)
Date: September 28, 1999 /s/ John C. Edmunds
----------------------------------------
John C. Edmunds
Vice President - Secretary and
Treasurer
Date: September , 1999
----------------------------------------
Thomas B. Clark
Director
-57-
58
SIGNATURES (CONTINUED)
Date: September 28, 1999 /s/ Joseph A. Fernandez, Ed.D.
----------------------------------------
Joseph A. Fernandez, Ed.D.
Director
Date: September 28, 1999 /s/ David L. Warnock
----------------------------------------
David L. Warnock
Director
-58-
59
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, 1999:
Deducted from asset accounts:
Allowance for doubtful accounts $1,865,000 $ 1,275,000 $ -0- $1,188,000(2) $1,952,000
---------- ----------- ---------- --------- ----------
Totals $1,865,000 $ 1,275,000 $ -0- $1,188,000 $1,952,000
========== =========== ========== ========= ==========
Year ended June 30, 1998:
Deducted from asset accounts:
Allowance for doubtful accounts $2,361,000 $ 1,329,000 $ -0- $1,825,000(2) $1,865,000
---------- ----------- ---------- --------- ----------
Totals $2,361,000 $ 1,329,000 $ -0- $1,825,000 $1,865,000
========== =========== ========== ========= ==========
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
========== =========== ========== ========= ==========
(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.
-59-
60
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)
4.2 Shareholder Rights Agreement (14)
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. (11)
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 First Amendment, dated September 1, 1999, to the Consulting and
Marketing Agreement effective as of August 1, 1992 by and between the
Registrant and Helicon Incorporated.
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 1997 Stock Incentive Plan. (11)
10.14 Lease Agreement dated September 26, 1989 between the Registrant and the
Equitable Life Assurance Society of the United States. (11)
10.15 First Amendment, dated February 21, 1990, to the lease between the
Registrant and the Equitable Life Assurance Society of the United
States. (11)
10.16 Second Amendment, dated March 1, 1993, to the lease between the
Registrant and the Equitable Life Assurance Society of the United
States. (11)
10.17 Third Amendment, dated October 26, 1993, to the lease between
Registrant and the Equitable Life Assurance Society of the United
States. (11)
10.18 Fourth Amendment, dated March 11, 1999, to the lease between Registrant
and the Equitable Life Assurance Society of the United States.
10.19 Fifth Amendment, dated March 31, 1999, to the lease between Registrant
and the Equitable Life Assurance Society of the United States.
10.20 Merger Agreement by and between Ventures Healthcare of Gainesville,
Inc. and the Registrant dated January 19, 1998 (12)
10.21 Merger Agreement by and between Chad Youth Enhancement Center, Inc. and
CLG Management Company, LLC and the Registrant dated February 12, 1998
(12)
10.22 Asset Exchange Agreement by and between Meadow Pines Hospital, Inc. and
the Registrant dated February 23, 1998 (12)
10.23 Agreement and Plan of Merger, dated as of September 9, 1998, between
the Registrant and Ameris Health Systems, Inc. (13)
10.24 Stock Purchase Agreement between the Registrant and William M. Bosic,
Donald J. Bosic, Joseph C. McCoy and Somerset, Inc. (15)
-60-
61
INDEX TO EXHIBITS (Continued)
10.25 First Addendum to Stock Purchase Agreement between the Registrant and
William M. Bosic, Donald J. Bosic, Joseph C. McCoy and Somerset, Inc.
(15)
10.26 Agreement of Purchase and Sale and Joint Escrow Instructions between
the Registrant and BMB Enterprises (15)
10.27 Asset Purchase Agreement between the Registrant and Behavioral Medicine
Professionals, Inc. (15)
10.28 Asset Purchase Agreement between the Registrant and B and B Leasing (15)
10.29 Noncompetition, Confidentiality and Nonsolicitation Agreement between
the Registrant and Joseph C. McCoy (15)
10.30 Noncompetition, Confidentiality and Nonsolicitation Agreement between
the Registrant and Donald J. Bosic (15)
10.31 Noncompetition, Confidentiality and Nonsolicitation Agreement between
the Registrant and William M. Bosic (15)
10.32 Shareholders Rights Plan (16)
10.33 Credit Agreement by and among the Company and SunTrust Bank, Nashville,
N.A. as agent and lender dated December 1, 1998 (17)
10.34 First Amendment to Credit Agreement by and among the Company and
SunTrust Bank, Nashville, N.A. as agent and lender dated December 1,
1998 (18)
10.35 Second Amendment to Credit Agreement by and among the Company and
SunTrust Bank, Nashville, N.A. as agent and lender dated April 20, 1999
(18)
10.36 Employment Agreement between the Company and William J Ballard,
effective as of August 19, 1998 (18)
10.37 Employment Agreement between the Company and Amy S. Harrison, effective
as of August 19, 1998 (18)
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).
(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
period 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
period ended March 31, 1997, dated May 15, 1997 (File No. 0-16162).
(11) Incorporated herein by reference from Registrant's Form 10-K for the
fiscal year ended June 30, 1997, dated September 29, 1997 (File No.
0-16162).
(12) Incorporated herein by reference from Registrant's Form 10-K for the
fiscal year ended June 30, 1998, dated September 29, 1998 (File No.
0-16162).
(13) Incorporated herein by reference from Registrant's Form 8-K, dated
September 24, 1998, reporting the merger agreement with Ameris Health
Systems, Inc. (File No. 0-16162).
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(14) Incorporated herein by reference from Registrant's Form 8-K, dated
November 25, 1998, reporting the adoption of a shareholder rights plan.
(File No. 0-16162).
(15) Incorporated herein by reference from Registrant's Form 8-K, dated
December 16, 1998, reporting the acquisition of Somerset, Inc. (File
No. 0-16162).
(16) Incorporated herein by reference from Registrant's Form S-8 dated
December 22, 1998 (File No. 0-16162).
(17) Incorporated herein by reference from Registrant's Form 10-Q for the
period ended December 31, 1998, dated February 15, 1999 (File No.
0-16162).
(18) Incorporated herein by reference from Registrant's Form 10-Q for the
period ended March 31, 1999, dated May 17, 1999 (File No. 0-16162).
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