NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
NOTE 1 - UNAUDITED INTERIM INFORMATION
The accompanying unaudited condensed consolidated financial statements of
Continucare Corporation ("Continucare" or the "Company") have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the
nine-month period ended March 31, 2003 are not necessarily indicative of the
results that may be expected for the year ended June 30, 2003. Except as
otherwise indicated by the context, the terms the "Company" or "Continucare"
mean Continucare Corporation and its consolidated subsidiaries.
The balance sheet at June 30, 2002 has been derived from the audited financial
statements at that date but does not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's Annual Report on Form 10-K for the
year ended June 30, 2002.
Certain reclassifications have been made to the prior year amounts to conform to
the current year presentation.
NOTE 2 - GENERAL
Continucare, which was incorporated on February 1, 1996 as a Florida
corporation, is a provider of integrated outpatient healthcare and home
healthcare services in Florida. Continucare's predecessor, Zanart Entertainment,
Incorporated ("Zanart") was incorporated in 1986. On August 9, 1996, a
subsidiary of Zanart merged into Continucare Corporation (the "Merger"). As a
result of the Merger, the shareholders of Continucare became shareholders of
Zanart, and Zanart changed its name to Continucare Corporation.
In Fiscal 2000, the Company instituted a series of measures intended to reduce
losses and to operate its core business model profitably. In spite of the
measures instituted in Fiscal 2000, the Company experienced a deterioration in
its claims loss ratio in the first and second quarters of both Fiscal 2001 and
2002. This resulted in operating losses and negative cash flow from operations
which prevented the Company from reversing a significant working capital
deficiency which originated in prior years. Negative changes in the claims loss
ratio, such as were experienced in Fiscal 2001 and 2002, are due to increases in
the utilization of health services as well as increases in medical costs without
counterbalancing increases in premium revenues from the Company's contracts with
Health Maintenance Organizations ("HMOs"). While the Company has not experienced
a similar deterioration in its claims loss ratio in the first three quarters of
Fiscal 2003, there can be no assurance that such a deterioration will not occur
during the fourth quarter of Fiscal 2003. If such a deterioration does occur
during the remainder of Fiscal 2003 that, compounded by the limited availability
of additional financing through the credit facility, could significantly strain
the Company's cash flow.
In an effort to streamline it's cost structure and stem anticipated operating
losses, effective January 1, 2003, the Company terminated the Medicare and
Medicaid lines of business for all of the physician contracts associated with
one of its independent practice associations ("IPA"). The terminated IPA, which
consisted of 29 physicians at the time of the termination and is considered
discontinued operations, contributed approximately $4,488,000 in revenue and
generated operating income of approximately $45,000 during the nine-month period
ended March 31, 2003.
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
Severance costs and other exit costs resulting from the termination of the IPA
totaled less than $10,000 and were paid prior to March 31, 2003. At March 31,
2003, liabilities related to discontinued operations of approximately $416,322
consisted primarily of net amounts due to the HMO for medical claims incurred by
the terminated IPA prior to January 1, 2003 and other payables which arose
during the ordinary course of business. There can be no assurances that the
Company will achieve any financial benefits as a result of terminating these IPA
contracts.
On March 31, 2003, the Company's existing credit facility matured. In order to
secure an extension until March 31, 2004, Dr. Phillip Frost, a principal
shareholder of the Company, was required to extend his personal guarantee
through March 31, 2004. In consideration of Dr. Frost's personal guarantee, the
Company issued 1,500,000 shares of restricted stock to an entity related to Dr.
Frost and increased the annual interest rate on a currently outstanding note
payable to an entity related to Dr. Frost from 7% to 9%. (See Notes 3 and 4.) In
addition to Dr. Frost's guarantee, the Company has also agreed that a financial
covenant be added to the credit facility, which requires the Company to maintain
a fixed charge coverage ratio of 1.05 to 1.00 beginning December 31, 2003.
Also on March 31, 2003, the Company modified the terms of the Convertible
Subordinated Notes Payable (the "Notes"). The noteholders have extended the
principal payment of $1,148,000, which was due on October 31, 2003, to October
31, 2006. In consideration for the modification to the Notes, the Company issued
an aggregate of 344,400 shares of restricted stock to the noteholders and
increased the annual interest rate on the deferred principal payment from 7% to
9%. (See Note 3.)
Although the financial statements have been prepared assuming that the Company
will continue as a going concern, there is significant uncertainty as to whether
the Company will be able to fund its obligations and satisfy its debt
obligations as they become due in Fiscal 2003. At March 31, 2003, the working
capital deficit was approximately $9,870,000, total indebtedness accounted for
approximately 91% of the Company's total capitalization and the Company had
principal and interest of approximately $1,822,000 outstanding under the credit
facility. On April 14, 2003, the Company restructured the terms of a $3,850,000
contract modification note with an HMO. Pursuant to the restructuring, the
contract modification note was canceled. (See Note 9.) The Company plans to fund
its capital commitments, operating cash requirements and satisfy its obligations
from a combination of cash on hand and operating cash flow improvements realized
from decreased utilization, HMO premium increases and advantageous HMO benefit
changes. The Company continues to focus on strengthening its core business unit
by enhancing its physician network, streamlining its operations and implementing
measures to contain the rising costs of providing health services to its
members. Such measures include, among other things, emphasizing preventive care,
encouraging frequent health check-ups, monitoring compliance with drug
therapies, entering into contracts with health care providers such as medical
specialists and recommending that its members utilize hospitals and outpatient
facilities that have favorable rate structures. There can be no assurances that
such measures will provide sufficient cash flow to fund the Company's cash
requirements in Fiscal 2003.
NOTE 3 - CONVERTIBLE SUBORDINATED NOTES PAYABLE AND RELATED PARTY NOTES PAYABLE
On October 30, 1997, the Company issued $46,000,000 of 8% Convertible
Subordinated Notes originally due on October 31, 2002 (the "Original Notes").
The Company completed a series of repurchases and troubled debt restructurings
in Fiscal 2000 and 2001, including a restructuring effective June 30, 2001
whereby the Company issued a new convertible note (the "New Note') with a
principal balance of $912,195 to Frost Nevada Limited Partnership ("Frost
Nevada"), an entity controlled by Dr. Phillip Frost who was a director of the
Company at the time of the restructuring. The New Note was issued on modified
terms negotiated between the Company and Frost Nevada in exchange for Notes that
were purchased by Frost Nevada from certain of the holders of the Original Notes
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
in a private transaction between the parties. In July 2001, Frost Nevada
transferred approximately 13% of the New Note in a private transaction to a
group of six investors (the "Investor Group"). Mr. Angel, the Company's
president and chief executive officer, and an entity controlled by Mr. Angel
comprise 40% of the Investor Group. The notes issued to Frost Nevada and the
Investor Group, or their successors, are collectively referred to as the
"Related Party Notes." Also effective June 30, 2001, new notes (collectively,
the "Notes") were issued to the remaining holders of the Original Notes, on
modified terms negotiated between the Company and such holders, in exchange for
their Original Notes, as amended.
Effective March 31, 2003, the Company further modified the terms of the Notes
(the "Fiscal 2003 Note Modification") to, among other things, extend the
principal payment of $1,148,000, which was originally due on October 31, 2003,
to October 31, 2006. As a result, the first principal payment on the Notes will
be due on October 31, 2004. In consideration for the Fiscal 2003 Note
Modification, the Company issued an aggregate of 344,400 shares of restricted
stock to the noteholders and increased the annual interest rate on the deferred
principal payment of $1,148,000 from 7% to 9%. The shares issued, which were
valued at $120,540 based on the closing price of the Company's common stock on
March 31, 2003, have been recorded as a deferred financing cost which will be
amortized over the remaining term of the Notes. The additional interest expense
resulting from the Fiscal 2003 Note Modification on the deferred principal
payment will be recorded as the interest becomes due and payable.
The outstanding principal balance of the Notes at March 31, 2003 was
approximately $3,913,000. The balance of the outstanding Notes on the balance
sheet of approximately $4,425,000 includes interest accrued through March 31,
2003 of approximately $46,000 and interest of approximately $466,000 which will
be payable in quarterly payments through October 31, 2005.
Also, effective March 31, 2003, Dr. Frost extended his personal guarantee on the
Company's credit facility. (See Note 4.) As part of the consideration given to
Dr. Frost for his personal guarantee, the interest rate on the Related Party
Note to Frost Nevada, with an outstanding principal balance of approximately
$797,000 at March 31, 2003, was increased from 7% to 9%. This additional
interest expense will be recorded as the interest becomes due and payable.
The balance of the outstanding Related Party Notes on the balance sheet at March
31, 2003 of approximately $1,093,000 includes interest accrued through March 31,
2003 of approximately $16,000 and interest of approximately $165,000 which will
be payable in quarterly payments through the current maturity date of October
31, 2005.
NOTE 4 -CREDIT FACILITY
The Company has entered into a credit facility agreement ("Credit Facility"),
which provides a revolving loan of $3,000,000. On March 31, 2003, the Credit
Facility matured. In order to secure an extension until March 31, 2004, Dr.
Frost, a principal shareholder of the Company, was required to extend his
personal guarantee of the Credit Facility through March 31, 2004. In addition to
Dr. Frost's guarantee, the Company has also agreed that a financial covenant be
added to the Credit Facility, which requires the Company to maintain a fixed
charge coverage ratio of 1.05 to 1.00 beginning on December 31, 2003. Interest
under the Credit Facility is payable monthly at 2.9% plus the 30-day Dealer
Commercial Paper Rate which was 1.23% on March 31, 2003. In addition, to the
guarantee discussed above, all assets of the Company serve as collateral for the
Credit Facility. At March 31, 2003, the outstanding principal and interest
balance of the Credit Facility was $1,822,000.
In consideration of Dr. Frost's personal guarantee, the Company issued 1,500,000
shares of restricted stock to an entity related to Dr. Frost and increased the
annual interest rate on a currently outstanding note payable to an entity
related to Dr. Frost from 7% to 9%. (See Note 3.) The shares of common stock
issued, which were valued at $525,000 based on the closing price of the
Company's common stock on March 31, 2003 when the guarantee was granted, have
been recorded as a deferred financing cost which will be amortized over the
term of the guarantee which expires March 31, 2004.
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
NOTE 5 - INCOME/LOSS PER SHARE
Options and warrants to purchase the Company's common stock were not included in
the computation of diluted income/loss per share because the effect would be
antidilutive. The dilutive effect resulting from the convertible feature of the
Notes and Related Party Notes is reflected in the weighted average share
computation for the three-month period ended March 31, 2003. No shares from the
potential conversion of the Notes and Related Party Notes were included in the
weighted average share computation for the other periods presented as the
effect would be antidilutive.
NOTE 6 - DIRECTOR COMPENSATION
The Board of Directors granted 100,000 fully vested stock options to all Board
members who served in that capacity during calendar years 2001 and 2002.
Additionally 100,000 fully vested stock options were awarded to the two newly
elected members of the Board. The stock options have an exercise price of $.36
and are valid for a ten-year period. The Board members were given the
opportunity to elect to receive this compensation in the form of restricted
stock instead of stock options. On September 23, 2002, two of the Board members
elected to receive their award in the form of stock options for their service in
calendar years 2001 and 2002, a combined total of 400,000 options. Also on
September 23, 2002, five of the Board members elected to receive their award in
the form of restricted stock for their service in calendar years 2001 and 2002,
a combined total of 800,000 shares of restricted stock. The value of the
restricted stock awarded of $112,000 (based on the closing price of the
Company's common stock on September 23, 2002) has been recorded as director
compensation in the first quarter of Fiscal 2003.
During October 2002, the Board appointed Dr. Jack Nudel as a new member of the
Board. At the time of this appointment, the Board granted 100,000 fully vested
stock options to Dr. Nudel with the opportunity to elect to receive this
compensation in the form of restricted stock. On October 30, 2002, Dr. Nudel
elected to receive this award in the form of restricted stock. The value of the
100,000 shares of restricted stock awarded of $11,000 (based on the closing
price of the Company's common stock on October 30, 2002) was recorded as
director compensation in the second quarter of Fiscal 2003.
NOTE 7 - CONTINGENCIES
The Company is a party to the case of JOAN LINDAHL V. HUMANA MEDICAL PLAN, INC.,
COLUMBIA HOSPITAL COPRORATION OF SOUTH BROWARD D/B/A WESTSIDE REGIONAL MEDICAL
CENTER, INPHYNET CONTRACTING SERVICES, INC., CONTINUCARE MEDICAL MANAGEMENT,
INC., LUIS GUERRERO AND JARSLAW PARKOLAP. This case was filed on January 24,
2002 in the Circuit Court of the 17th Judicial Circuit in and for Broward
County, Florida and served on the companies and individuals in February 2003.
The complaint alleges vicarious liability for medical malpractice and seeks
damages in excess of $15,000. The Company intends to defend this case
vigorously.
The Company is a party to the case of ELBA GONZALEZ AND EFRAIN PELLOT AS
PERSONAL REPRESENTATIVES OF THE ESTATE OF NICHOLAS PELLOT, DECEASED, AND ELBA
GONZALEZ AND EFRAIN PELLOT, INDIVIDUALLY AND JOINTLY AS SURVIVING PARENTS V.
CONTINUCARE CORPORATION; MICHAEL J. CAVANAUGH, M.D.; GUYLENE KERNISANT,
A.R.N.P.; DIAGNOSTIC TESTING GROUP, INC. AND JOHN H. SOKOLOWICZ, M.D. This case
was filed on March 12, 2002 in the Circuit Court of the 11th Judicial Circuit in
and for Dade County, Florida and served on the companies and individuals in
March 2002. The complaint alleges vicarious liability for medical malpractice
and seeks damages in excess of $15,000. Trial was originally set for June 2,
2003; however, the court has granted a continuance and a new trial date has not
been set. The Company intends to defend this case vigorously.
Two subsidiaries of the Company are parties to the case of NANCY FEIT ET AL. V.
KENNETH BLAZE, D.O. KENNETH BLAZE., D.O., P.A.; SHERIDAN HEALTHCORP, INC.; WAYNE
RISKIN, M.D.; KAHN AND RISKIN, M.D., P.A.; CONTINUCARE PHYSICIAN PRACTICE
MANAGEMENT, INC., D/B/A ARTHRITIS AND RHEUMATIC DISEASE SPECIALTIES, INC.; JAMES
JOHNSON, D.C. AND JOHNSON & FALK, D.C., P.A. The case was filed in December 1999
in the Circuit Court of the 17th Judicial Circuit in and for Broward County,
Florida and served on the companies in April 2000. The complaint alleges
10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
vicarious liability for medical malpractice and seeks damages in excess of
$15,000. The Company filed its answer on May 3, 2000. Discovery is still
proceeding at a slow pace. The Company has made a demand for assumption of
defense and indemnification from Kahn and Riskin, M.D., P.A. and Wayne Riskin,
M.D. The demand was initially rejected, but is currently being re-evaluated by
their new attorney. The Company and the carriers for Kahn & Riskin, M.D. have
been discussing apportionment of responsibilities. The Company intends to defend
this case vigorously.
A decision has been rendered in the case of WARREN GROSSMAN, M.D., ALAN REICH,
M.D., AND RICHARD STRAIN, M.D. V. CONTINUCARE PHYSICIAN PRACTICE MANAGEMENT,
INC. AND CONTINUCARE CORPORATION. On June 27, 2002, the court issued its ruling,
dismissing all claims asserted by one of the Plaintiffs. The court found the
Company had improperly terminated the employment contract of the other two
Plaintiffs', but awarded each only nominal damages in the amount of One Dollar
($1) each. The Company requested reimbursement for attorney's fees as to two of
the Plaintiffs and requested the court to deny any request for attorney fees as
to the other Plaintiff based on the award of only nominal damages. The
Plaintiffs' also asserted a right to reimbursement of certain attorney's fees.
The hearing to address these matters was initially heard on March 18, 2003 and
was continued on May 8, 2003. The court ruled that none of the parties will
obtain reimbursement of their attorney fees and costs.
The Company is also involved in other legal proceedings incidental to its
business that arise from time to time out of the ordinary course of
business-including, but not limited to, claims related to the alleged
malpractice of employed and contracted medical professionals, workers'
compensation claims and other employee-related matters, and minor disputes with
equipment lessors and other vendors.
On February 13, 1998, the Company acquired the stock of Rehab Management
Systems, Inc., Integracare, Inc. and J.R. Rehab Associates, Inc. from Integrated
Health Services, Inc. RMS operated numerous rehabilitation clinics in the States
of Florida, Georgia, Alabama, North Carolina and South Carolina as a Medicare
and Medicaid provider of outpatient services. On April 8, 1999, the Company sold
substantially all the assets of RMS and the assumption of certain liabilities to
Kessler Rehabilitation of Florida, Inc. ("Kessler"). On August 13, 1999, RMS was
formally dissolved as a corporation with the state of Florida. During the second
quarter of Fiscal 2002, the Company became aware that the Centers for Medicare
and Medicaid Services ("CMS") was pursuing IHS, Kessler and RMS for collection
of principal and interest for certain alleged Medicare overpayments made to
providers purchased from IHS or linked to the purchased entities through the use
of a common provider number for services rendered during calendar years 1996,
1997 and 1998. The Company was aware of its obligation to CMS for any
overpayments for services rendered by the Providers during calendar years 1997
and 1998. At the time the cost reports were completed and submitted to CMS for
services rendered by the Providers during calendar years 1997 and 1998, the
Company recorded an estimate for the overpayments indicated on those cost
reports. When the Company purchased RMS, the purchase agreement included
indemnification from IHS for any overpayments prior to calendar year 1997.
Subsequent to the Company's purchase of RMS, IHS sought protection under Chapter
11 of the United States Bankruptcy Code and, as such, is protected from CMS' and
RMS' efforts to collect on the Alleged Overpayments that relate to calendar year
1996. During the third quarter of Fiscal 2002, it became clear that CMS was
pursuing the Company as the primary obligor for all of the Alleged Overpayments,
including the calendar year 1996. While the Company disputes the validity of
these claims, in an effort to expedite the resolution of these matters and halt
CMS' aggressive collection procedures which included the threat of withholding
payments to the Company's home health agencies, the Company has entered into a
memorandum of understanding for the 1996 cost report year and has recorded an
approximately $2,441,000 Provision for Medicare Settlement Related to Terminated
Operations during the quarter ended March 31, 2002. Under this Memorandum, the
Company will make monthly payments of $10,000 for 24 months with the balance of
the Memorandum due at the end of the term. The Company has retained the right to
dispute the Alleged Overpayments and continues to review and evaluate all
information available to determine the validity of CMS' claims. During September
2002, the Company requested a reopening of the cost reports and supplied various
documentation for cost report years 1996 and 1997 to demonstrate that the
Alleged Overpayments are incorrect. The accrual for all Alleged Overpayments is
approximately $2,585,000 as of March 31, 2003 and is reflected in current
liabilities.
11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
The Company has recorded a liability for the Alleged Overpayments as discussed
above. Additionally, the Company has recorded an accrual for medical malpractice
claims, which includes amounts for insurance deductibles and legal fees, based
on management's estimate of the ultimate outcome of such claims. No other
liabilities have been recorded for the above matters as it is not possible to
estimate the liability, if any, that will result from the resolution of these
matters.
NOTE 8 - RECENT ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation- Transition and Disclosure- an amendment of FASB Statement No. 123"
("FAS 148"). This statement amends SFAS No. 123 "Accounting for Stock Based
Compensation" ("FAS 123") to provide alternative methods of voluntarily
transitioning to the fair value based method of accounting for stock-based
employee compensation. FAS 148 also amends the disclosure requirements of FAS
123 to require disclosure of the method used to account for stock-based employee
compensation and the effect of the method on reported results in both annual and
interim financial statements. The disclosure provisions will be effective for
the Company 's year ended June 30, 2003. The annual impact of a change to a fair
value model has been previously disclosed in the Company's Annual Report on Form
10-K for the year ended June 30, 2002. The Company has not yet completed the
final evaluation of the options presented by FAS 148. However, within this
fiscal year, the Company expects to reach a determination of whether and, if so,
when to change the Company's existing accounting for stock-based compensation to
the fair value method in accordance with the transition alternatives of FAS 148.
NOTE 9 - SUBSEQUENT EVENT
On April 14, 2003, the Company executed a Physician Group Participation ("PGP")
agreement with one of its HMO partners. Pursuant to the PGP agreement, the
Company will assume certain management responsibilities for the HMO's Medicare,
Commercial and Medicaid members assigned to selected primary care physicians in
Miami-Dade and Broward counties of Florida. Revenue from this contract will
consist of a monthly management fee designed to cover the costs of providing
these services. Simultaneously with the execution of the PGP agreement, the
Company restructured the terms of a $3,850,000 contract modification note with
the HMO. Pursuant to the restructuring, the contract modification note was
cancelled. A portion of the gain to be recognized from the extinguishment of
debt will be deferred and recognized as services are provided under the PGP
agreement, representing an estimate of the potential profits which may have been
obtainable under a similar contract negotiated without the debt restructuring.
12
|