Annual Report (Form 10-K), fiscal year 1994

ITEM 1. BUSINESS
American Medical Holdings, Inc. ("Holdings") was organized in July, 1989 to acquire American Medical International, Inc. ("AMI" and, together with Holdings, the "Company"). As a result of this acquisition, Holdings is the owner of all of the outstanding shares of common stock of AMI.
AMI was incorporated in 1957 and in 1960 became the first investor-owned hospital company. Today, the Company is one of the leading hospital management companies in the United States. As of August 31, 1994 AMI operated 36 acute care and one psychiatric hospital containing a total of 9,021 licensed beds. Subsequent to August 31, 1994, AMI, in partnership with unaffiliated third parties, acquired an additional acute care hospital, increasing the total acute care hospitals operated by AMI to 37. AMI focuses on delivering value to its patients and its communities with a full range of quality inpatient and outpatient services including medical, surgical, obstetric, diagnostic, specialty and home health care. The Company also operates ancillary facilities at each of its hospitals, such as ambulatory, occupational and rural healthcare clinics. The Company's hospitals are principally located in the suburbs of major metropolitan areas in 13 states including Texas, Florida and California.
Holdings and AMI are Delaware corporations with principal executive offices located at 14001 Dallas Parkway, Suite 200, P.O. Box 809088, Dallas, Texas 75380-9088. The telephone number for Holdings and AMI at such address is (214) 789-2200.
RECENT DEVELOPMENTS
On October 10, 1994, Holdings, National Medical Enterprises, Inc, a Nevada corporation ("NME") and a wholly-owned subsidiary of NME ("Merger Sub"), executed an Agreement and Plan of Merger (the "Merger Agreement"). Pursuant to the Merger Agreement, Merger Sub will merge with and into Holdings (the "Merger"). As a result of the Merger, Holdings will become a wholly-owned subsidiary of NME and the combined company will be the second-largest healthcare services company in the nation. Under terms of the Merger Agreement each share of common stock of Holdings will be converted into (i) $19.00 in cash, if the closing occurs on or before March 31, 1995, and $19.25 thereafter and (ii) 0.42 of a newly issued share of NME common stock. Under the Merger Agreement, Holdings will pay a special dividend of $0.10 per share before the effective date of the Merger. Following the Merger, Holdings will have the right to nominate three members to the 13 member board of directors of the combined company. The transaction has been approved by shareholders of approximately 61.4% of Holdings' outstanding shares of common stock and, therefore, further action by Holdings' shareholders is not required. The transaction, which is currently anticipated to close in the first quarter of calendar 1995, is subject to certain conditions including, among other things, expiration of any applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.
Management believes that the position of the Company's hospitals in each of their markets, the established physician networks and the alliances being developed with other healthcare providers will be further enhanced by the Merger. Holdings and NME each have a portfolio of hospitals in Florida and California which will strengthen the combined company's presence in each of these markets. The combined company will be strategically positioned to develop new comprehensive healthcare delivery systems with physicians and other healthcare providers in targeted communities and to deal with the current and future changes in the healthcare industry.
On September 1, 1994, a limited partnership, of which AMI is the general partner, acquired Hilton Head Hospital in Hilton Head, South Carolina containing 68 beds. In connection with the Company's efforts to re-establish a presence in Europe, the Company has entered into a joint venture agreement with a community organization (the "Burgergemeinde") located in Cham, Canton Zug, Switzerland. The joint venture will be owned 90% by the Company and 10% by the Burgergemeinde. Under the terms of the proposed transaction, the Company has entered into a long term lease for the land where the existing hospital is located and will then construct a new 56 bed acute care wing, convert an existing structure into a medical office building and renovate and remodel the existing
acute care facility. In addition, the Company plans to contract to provide management, food, physical therapy and rehabilitation services to the hospital, an on-site nursing home and an affiliated retirement community.
PROPERTIES
As of August 31, 1994, the Company owned or leased and operated the following 36 acute care hospitals and one psychiatric hospital. The Company also owned and managed medical office buildings and related healthcare facilities associated with its hospitals, as well as certain undeveloped properties.
EMPLOYEES
As of August 31, 1994, the Company had approximately 30,200 employees, of which approximately 68% were full time employees. Two of the Company's hospitals had labor contracts covering approximately 5% of the Company's employees. Management believes that its relations with its employees are satisfactory.
MEDICAL STAFFS
The medical staff at each hospital generally consists of non-employee physicians. In certain markets, the Company's hospitals have employed physicians to further strengthen and expand the Company's managed care contracting ability. Medical staff members of the Company-owned hospitals who are not employees often serve on the medical staffs of hospitals not owned by the Company and may terminate their relationships with the Company-owned hospitals at any time.
Rules and regulations concerning the medical aspects of each hospital's operations are adopted and enforced by its medical staff. Such rules and regulations provide that the members of the staff elect officers who, together with additional physicians selected by them, supervise all medical and surgical procedures and services. Their supervision is subject to the general oversight of the hospital's Governing Board.
QUALITY OF SERVICES
Management believes the quality of healthcare services is critical in order to attract and retain top physicians and increase the market share of the Company's hospitals. One of the key mechanisms used to monitor the quality of care at the Company's hospitals is a quality assurance program designed to measure patient satisfaction, the Patient Satisfaction Monitoring System ("PSMS").
PSMS utilizes the results of interviews performed by an independent research company of a statistically determined sample group of discharged patients at each hospital to gather patient responses regarding the hospital services provided. Management uses the results as a tool to improve the quality of patient services and satisfaction and believes PSMS has assisted the Company in successfully maintaining and improving the quality of healthcare as perceived by patients and their physicians and thereby contributing to improved net revenues. PSMS is also used by the Company as one of the bases upon which hospital executive directors and other employees are compensated under the Company's incentive compensation program. Management believes that the Company was the first in the industry to directly tie compensation to the attainment of qualitative performance targets.
The Company has also developed and implemented at several of the Company's hospitals systems similar to PSMS designed to (i) measure physician satisfaction, the MD Satisfaction Survey and (ii) emergency room services, Emergency Room PSMS.
COMPETITION
The Company operates its hospitals in competitive markets where other investor-owned and non-profit hospitals operate and provide services that are similar to those offered by the Company's hospitals. Competition among the Company's hospitals and other healthcare providers in the United States has increased in recent years due to a decline in occupancy rates resulting from among other things, changes in government regulation and reimbursement, other cost containment pressures, technology, and most recently, various healthcare reform plans pending in Congress. Additionally, hospitals owned by government agencies or other tax-exempt entities benefit from advantages (e.g., endowments, charitable contributions and tax-exempt financing) which are not available to the Company's hospitals.
Management believes that a hospital's competitive position within local markets is affected by various factors including the quality of healthcare services provided, pricing of healthcare services, the hospital's location and the types of services offered. The Company expects to improve the performance of its hospitals by (i) expanding physician network relationships, thereby attracting and retaining quality physician and medical personnel, (ii) increasing its emphasis on managed care contracting, (iii) developing and marketing new healthcare services targeted to the particular needs of the communities served by its hospitals, (iv) expanding profitable outpatient services, and (v) expanding geographic coverage by developing affiliations and alliances with other providers of service. In addition, the Company will continue to pursue opportunities for growth through acquisitions.
The competitive position of a hospital is also increasingly affected by its ability to negotiate contracts for healthcare services with managed care organizations, including health maintenance organizations ("HMOs"), preferred provider organizations ("PPOs") and other purchasers of group healthcare services. HMOs and PPOs attempt to direct and control use of hospital services through strict utilization management programs and by negotiating provider contracts with only one or a limited number of hospitals in each market area. The importance of negotiating with managed care organizations varies from market to market depending on the market strength of such organizations. In some situations, hospitals have agreed to fixed payments based on the number of managed care enrollees, resulting in the hospital and, in some cases, the physician assuming utilization risk (such contracts are referred to as capitated contracts). Managed care organizations are generally able to obtain, through the use of various contracting mechanisms including capitated contracts, significant discounts from hospital established charges. Management believes that the Company is able to compete effectively for managed care business in part because of its relationships with local physicians, its hospital management teams, its attention to cost controls and quality of service and its strategies to establish service niches in markets served by other hospitals.
SOURCES OF REVENUE
The primary sources of the Company's hospital revenues are room and board and the provision of ancillary medical services. Room and board represents the basic charges for the hospital room and related services, such as general nursing care and meals. Ancillary medical services represent the
charges related to the medical support activities performed by the hospital, such as X-rays, physical therapy and laboratory procedures. The Company receives payments for services rendered to patients from the federal government under Medicare programs and the Civilian Health and Medical Program of Uniformed Services ("CHAMPUS"), state governments under their respective Medicaid programs, managed care organizations ("contracted services"), private insurers, self-insured employers and directly from patients. In addition to revenues received from such programs and patients, the Company receives other non-patient revenues (e.g. cafeteria and gift shop revenues).
The following table presents the percentage of net revenues for fiscal 1994, 1993 and 1992 under each of the following programs:
The Company's hospital revenues received under Medicare, Medicaid, CHAMPUS, Blue Cross and from payers of contracted services are generally less than customary charges for the services covered. The increased percentage of government paid care subjects providers to greater risk associated with reduced government reimbursement. Managed care programs which offer prepaid and discounted medical service packages account for a significant share of the market and have reduced the historical rate of growth of hospital revenues. As a result, new kinds of healthcare strategies and provider networks (e.g. physician networks) are continuing to emerge.
Patients are generally not responsible for any difference between customary hospital charges and amounts reimbursed under Medicare, Medicaid, CHAMPUS and some Blue Cross plans or by payers of contracted services for such services, except to the extent of any exclusions, deductibles or co-insurance features of their coverage. In recent years insurers and other payers have increased the amount of such exclusions, deductibles and co-insurance generally increasing the patient's financial responsibility to directly pay for some services. The increase in the self-pay portion of a patient's financial responsibility may also increase the amount of the Company's uncollectible accounts.
MEDICARE PROGRAM
Under the Medicare program the Company receives reimbursement under a prospective payment system ("PPS") for the routine and ancillary operating costs of most Medicare inpatient hospital services. Psychiatric, long-term care, rehabilitation, pediatric and certain designated cancer research hospitals, as well as psychiatric or rehabilitation units that are distinct parts of a hospital, are currently exempt from PPS and are reimbursed on a cost based system, subject to certain cost caps. It is uncertain what impact, if any, the federal efforts to reform the healthcare system will have on the current method of Medicare reimbursement.
Under PPS, fixed payment amounts per inpatient discharge were established based on the patient's assigned diagnosis related group ("DRG"). DRG's classify patients' treatments for illnesses according to the estimated intensity of hospital resources necessary to furnish care for each principal diagnosis. DRG rates have been established for each individual hospital participating in the Medicare program and are based upon a statistically normal distribution of severity. Patients falling well outside the normal distribution are afforded additional payments and defined as "outliers". Under PPS, hospitals may retain payments in excess of costs but must absorb costs in excess of such payments; therefore hospitals are encouraged to operate at greater efficiency.
DRG rates are updated and recalibrated periodically and have been affected by several recent federal enactments. The index used by the Health Care Financing Administration ("HCFA") to adjust the DRG rates gives consideration to the inflation experienced by hospitals in purchasing goods and services ("market basket"). However, for several years the percentage increases to the DRG rates
have been lower than the percentage increases in the costs of goods and services purchased by hospitals. The market basket is adjusted each federal fiscal year ("FY") which begins on October 1. The market basket for FY 1993 was 4.1%, FY 1994 was 4.3% and for FY 1995 is 3.6%.
The Omnibus Budget Reconciliation Act of 1993 ("OBRA-93") extended the reduction enacted by the Omnibus Budget Reconciliation Act of 1990 ("OBRA-90") in the Medicare DRG payments to healthcare providers through 1997. A substantial number of AMI's hospitals are classified as urban hospitals for reimbursement purposes. The net updates of DRG rates for large urban and other urban hospitals are established as follows: FY 1994 and FY 1995 market basket, minus 2.5%; FY 1996 market basket, minus 2%; and FY 1997 market basket, minus 0.5%. Management cannot predict how future adjustments by Congress and HCFA will affect the profitability of its healthcare facilities.
The Omnibus Budget Reconciliation Act of 1990 required the Secretary of the Department of Health and Human Services ("HHS") to develop a proposal for a PPS for all hospital-based outpatient services and inpatient psychiatric care. The Secretary of HHS' report, which was due on September 1, 1991, has not been submitted. Until such time as the Secretary of HHS has developed a PPS for all hospital-based outpatient services, OBRA-90 directs that payments for the reasonable cost of outpatient hospital services (other than for capital related costs) be reimbursed at 94.2% of such reasonable costs for cost reporting periods falling within FY 1991 through FY 1995. OBRA-93 extended this reduction from FY 1995 through FY 1998.
MEDICARE REIMBURSEMENT FOR CAPITAL COSTS
Subsequent to September 30, 1991 and through FY 1995, capital related payments for inpatient hospital services are made at the rate of 90% of reasonable capital costs until capital PPS becomes applicable at the hospital. The PPS capital costs reimbursement applies an estimated national average of FY 1989 Medicare capital costs per patient discharge updated to FY 1992 by the estimated increase in Medicare capital costs per discharge (the "Federal Rate"). Capital PPS is applicable to cost reports beginning on or after October 1, 1991. Under capital PPS reimbursement a 10 year transition period has been established. A hospital is paid under one of the following two different payment methodologies during this transition period: (i) hospital with a hospital-specific rate (the rate established for a hospital based on the cost report ending on or before December 31, 1990) below the Federal Rate would be paid on a fully prospective payment methodology and (ii) hospitals with a hospital-specific rate above the Federal Rate would be paid based on a hold-harmless payment methodology or 100% of the Federal Rate whichever results in a higher payment. A hospital is paid under one methodology throughout the entire transition. After the transition period, all hospitals would be paid the Federal Rate.
The impact of PPS capital reimbursement in the first two years has not been material to Medicare capital reimbursement. The hospital-specific rates for FY 1994 decreased 2.16%. The established Federal Rate for FY 1994 was reduced by 9.33% to $378.34 per patient discharge and for FY 1995 was reduced by 0.4% to $376.83 per patient discharge. Management believes that the decrease in the rate of reimbursement for capital costs will not have a material adverse effect on the Company's results of operations.
MEDICAID PROGRAM
The Medicaid program, created by the Social Security Act, is designed to provide medical assistance to individuals unable to afford care. Medicaid is a joint federal and state program in which states voluntarily participate. Reimbursement rates under the Medicaid program are set by each participating state, and rates and covered services may vary from state to state. Depending on the average income per person in a state, at least 50% of Medicaid funding comes from the federal government, with the balance shared by the state and local governments. The amount of the federal share is called Federal Financial Participation ("FFP"). Each of the Company's facilities is currently an eligible Medicaid provider, although certain of the Company's hospitals do not currently participate as providers of services in their respective state Medicaid programs.
The Omnibus Reconciliation Act of 1981 permitted each state to determine new reimbursement rates for Medicaid inpatient hospital services that are reasonable and adequate to meet the costs which must be incurred by efficiently and economically operated facilities and to assure access to inpatient hospital services by Medicaid recipients. Providers must accept Medicaid payment as payment in full for healthcare services provided to Medicaid patients. Actual payment rates and the methodologies for determining such rates vary from state to state. For example, in Texas, Medicaid inpatient services are reimbursed on a DRG based system, while in Florida, Medicaid inpatient services are reimbursed on a per diem prospective payment system. In many instances, Medicaid reimbursement does not cover a hospital's costs in providing services to Medicaid recipients.
The Company operates hospitals in some states that currently levy taxes on healthcare providers or use healthcare provider donations to meet the state's share of medical assistance expenditures. HCFA issued a final rule on September 13, 1993 whereby funds donated from Medicaid providers and expenditures that are attributable to provider-specific state taxes be offset from Medicaid expenditures incurred on or after January 1, 1992, before calculating the amount of the federal share of FFP. The Company has historically participated in such programs and has received reimbursement to offset a portion of the cost of services provided to indigent patients. Although management believes that as a result of the final rule such reimbursement will be reduced, steps have been taken to offset the anticipated reduction in reimbursement.
The Medicare and Medicaid programs have been subject to continual modification through legislative acts and both federal and state administrative initiatives. The federal or state governments might in the future reduce the funds available under these programs or require more stringent utilization review of hospital facilities. Such actions could have a material adverse impact on the Company's financial condition and results of operations.
CHAMPUS
The Company's hospitals are reimbursed by the federal government's CHAMPUS program for care provided to United States military retirees and dependents. CHAMPUS pays for inpatient acute hospital care on the basis of a prospectively determined rate applied on a per discharge basis using DRGs similar to the Medicare system. At this time, inpatient psychiatric hospital services are reimbursed on an individual hospital's per diem rate calculated based upon the hospital's prior cost experience. There can be no assurance that the CHAMPUS program will continue per diem reimbursement for psychiatric hospital services in the future.
CONTRACTED BUSINESS
Managed care arrangements have typically reimbursed providers based on a percent of charges or on a per diem basis with stop-loss provisions for high severity cases. In more developed markets such as California and Florida, the Company's hospitals are now entering into risk sharing, or capitated, arrangements. These arrangements reimburse the hospital based on a fixed fee per participant in a managed care plan with the hospital assuming the cost of services provided, regardless of the level of utilization. If utilization is higher than anticipated and/or costs are not effectively controlled, such arrangements could produce low or negative operating margins.
COMMERCIAL INSURANCE
The Company's hospitals provide services to individuals covered by private healthcare insurance. Private insurance carriers either reimburse their policy holders or make direct payment to the Company's hospitals based upon the particular hospital's established charges and the particular coverage provided in the insurance policy. Blue Cross is a healthcare financing program that provides its subscribers with hospital benefits through independent organizations that vary from state to state. The Company's hospitals are paid directly by local Blue Cross organizations on the basis agreed to by each hospital and Blue Cross by a written contract. In some states, the local Blue Cross affiliate is believed to be experiencing financial difficulty; however, management does not believe that such difficulties represent a material financial exposure to the Company.
Recently, several commercial insurers have undertaken efforts to limit the costs of hospital services by adopting PPS or DRG based systems. To the extent such efforts are successful, and to the extent that the insurers' systems fail to reimburse hospitals for the costs of providing services to their beneficiaries, such efforts may have a negative impact on the hospitals' net revenue.
REGULATION
LICENSURE, CERTIFICATION AND ACCREDITATION
Healthcare facility construction and operation is subject to federal, state and local regulation relating to the adequacy of medical care, equipment, personnel, operating policies and procedures, fire prevention, rate-setting and compliance with building codes and environmental protection laws. Facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with the various standards necessary for licensing and accreditation. Management believes that all of the Company's healthcare facilities are properly licensed under appropriate state laws and are certified under the Medicare program or are accredited by the Joint Commission on Accreditation of Health Care Organizations ("Joint Commission"), the effect of which is to permit the facilities to participate in the Medicare and Medicaid programs. Should any facility lose its Joint Commission accreditation, or otherwise lose its certification under the Medicare program, the facility would be unable to receive reimbursement from the Medicare and Medicaid programs. Management believes that the Company's facilities are in substantial compliance with applicable federal, state, local and independent review body regulations and standards. The requirements for licensure, certification and accreditation are subject to change and, in order to remain qualified, it may be necessary for the Company to effect changes in its facilities, equipment, personnel and services. Although the Company intends to continue its qualification, there is no assurance that its hospitals will be able to comply in the future.
CERTIFICATES OF NEED
The construction of new facilities, the acquisition of existing facilities, and the addition of new beds or services may be reviewable by state regulatory agencies under a program frequently referred to as a Certificate of Need. The Company operates hospitals in nine states that require state approval under the Certificate of Need program. Such laws generally require appropriate state agency determination of public need and approval prior to beds or services being added, or a related capital amount being spent. Failure to obtain necessary state approval can result in the inability to complete an acquisition or change of ownership, the imposition of civil or, in some cases, criminal sanctions, the inability to receive Medicare or Medicaid reimbursement and/or the revocation of a facility's license.
UTILIZATION REVIEW
In order to ensure efficient utilization of facilities and services, federal regulations require that admissions to and the utilization of facilities by Medicare and Medicaid patients be reviewed periodically by a federally funded Peer Review Organization ("PRO"). Pursuant to federal law, the PRO must review the need for hospitalization and the utilization of services, and may, where appropriate, deny payment for services provided. Each of the Company's facilities has contracted with a PRO and has had in effect a quality assurance program that provides for retrospective patient care evaluation and utilization review. While no PRO has taken adverse action against any of the Company's hospitals to date, PRO review can result in denial of payment for services, recoupment of monies paid to the hospital, assessment of fines or exclusion from the Medicare and Medicaid programs.
STATE RATE-SETTING ACTIVITY
The Company currently operates five facilities in Florida wherein the state has mandated hospital rate-setting. Under Florida law, the maximum annual percentage any hospital may increase its revenue per admission is limited to the hospital's prior year actual revenue per adjusted admission inflated forward by the hospital's applicable current year's maximum allowable rate of increase ("MARI") or the Health Care Cost Containment Board-approved budgeted revenue per adjusted admission. The MARI is the maximum rate at which a hospital is expected to increase its average revenue per adjusted admission for a given period. The Health Care Cost Containment Board, using
the most recent audited actual experience for each hospital, calculates the MARI for each hospital based on the projected rate of increase in the market basket index, adjusted by the hospital's percentage of Medicare, Medicaid and charity care days plus two percentage points. As a result, in Florida, the Company's ability to increase its rates to compensate for increased costs per admission is limited, and the Company's operating margin at Florida facilities may be adversely affected. There can be no assurance that other states in which the Company operates hospitals will not enact rate-setting provisions as well.
FEDERAL LEGISLATION AND RULE-MAKING
The Medicare and Medicaid Antifraud and Abuse Amendments (the "Amendments") are codified under Section 1128B of the Social Security Act. The Amendments provide criminal penalties for individuals or entities that knowingly and willfully offer, pay, solicit or receive remuneration of any kind in order to induce referrals for goods or services reimbursed under the Medicare or state Medicaid programs. The statute on its face is very broad with the types of remuneration covered including kickbacks, bribes and rebates made directly or indirectly, overtly or otherwise, in cash or in kind. In addition, prohibited conduct includes remuneration intended to induce the purchasing, leasing, ordering or arranging for any good, facility or service paid for by Medicare or state Medicaid programs. In addition to criminal penalties (fines of up to $25,000 and imprisonment for up to five years per referral), the Amendments also establish civil monetary penalties and sanctions of excluding violators from Medicare and Medicaid participation. The Office of the Inspector General ("OIG") has taken the position that where physicians hold other than bona fide ownership interests in healthcare providers (e.g., where such ownership is intended to encourage the physicians to utilize the services of the entity in which they have invested) such ownership arrangements violate the Amendments.
In recent years, the courts have suggested that any direct or indirect payment or other financial benefit conferred upon a physician or other referral source may violate the statute if one purpose of any portion of the payment is to induce the physician to refer patients to the entity providing the benefit. Healthcare providers are concerned that many relatively innocuous, or even beneficial, commercial arrangements are technically covered by the Amendments and are, therefore, subject to potential criminal prosecution. The Medicare and Medicaid Patient and Program Protection Act of 1987 added two new provisions specifically addressing the anti-kickback statute. They first authorized the OIG to exclude an individual or entity from participation in the Medicare and Medicaid programs if it is determined through an administrative process that the party has engaged in a prohibited remuneration scheme. In addition, Congress directed the HHS to develop regulations specifying those payment practices that will not be subject to criminal prosecution and not provide a basis for exclusion from the Medicare and Medicaid programs ("safe harbors"). Final regulations were published on July 29, 1991 in the Federal Register. Additional safe harbors were proposed, with a 60 day public comment period, on September 21, 1993. The proposed rule offers protection for investment interests in rural areas, ambulatory surgical centers, and group practices composed exclusively of active investors; practitioner recruitment in rural areas; obstetrical malpractice insurance subsidies; referral arrangements for specialty services; and cooperative hospital service organizations.
Among the criteria contained in the final regulations are criteria for investments, leasing, purchasing and ordering arrangements which would apply to the Company's facilities. The additional proposed regulations will also provide a safe harbor for physician recruitment by facilities in certain rural areas. If adopted, such a safe harbor provision would apply to certain of the Company's facilities. Arrangements with referring physicians involving leasing, purchasing, ordering and recruitment would not constitute illegal remuneration so long as all of the criteria set forth in the safe harbors are met. However, the fact that each provision of such arrangements does not fall within one of the applicable safe harbor criteria does not necessarily mean that the arrangement is illegal.
In order to prevent hospitals from entering into arrangements with physicians that increase the physician payment from Medicare or Medicaid, in January 1991, the OIG issued a management advisory report identifying potential violations of the antifraud and abuse statute with respect to
certain financial arrangements between hospitals and hospital-based physicians. Specifically, the report stated that financial agreements that require physicians to pay more than the fair market value for services provided by the hospital or that compensate physicians for less than the fair market value of goods and services that they provide to hospitals create potential liability for physicians and hospitals engaged in these actions.
In May 1992, the OIG issued a special fraud alert regarding hospital incentives to physicians. The alert identified the following incentive arrangements which, if present, are indications of potentially unlawful activity: (a) payment of any sort of incentive by the hospital each time a physician refers a patient to the hospital, (b) the use of free or significantly discounted office space or equipment (in facilities usually located close to the hospital), (c) provision of free or significantly discounted billing, nursing or other staff services, (d) free training for a physician's office staff in areas such as management techniques, CPT coding and laboratory techniques, (e) guarantees which provide that, if the physician's income fails to reach a predetermined level, the hospital will supplement the remainder up to a certain amount, (f) low-interest or interest-free loans, or loans which may be "forgiven" if a physician refers patients (or some number of patients) to the hospital, (g) payment of the costs of a physician's travel and expenses for conferences, (h) coverage on hospital's group health insurance plans at an inappropriately low cost to the physician and (i) payment for services (which may include consultations at the hospital) which require few, if any, substantive duties by the physician, or payment for services in excess of the fair market value of services rendered.
Certain of the Company's current financial arrangements with physicians, including joint ventures, may not qualify for the current safe harbor exemptions and, as a result, such arrangements risk scrutiny by the OIG and may be subject to enforcement action. As indicated above, the failure of these arrangements to satisfy all of the conditions of the applicable safe harbor criteria does not mean that the arrangements are illegal. Nevertheless, certain of the Company's current financial arrangements with physicians, including joint ventures, and the Company's future development of joint ventures and other financial arrangements with physicians, could be adversely affected by the failure of such arrangements to comply with the safe harbor regulations, or the future adoption of other legislation or regulation in these areas.
Under provisions of the Omnibus Budget Reconciliation Act of 1989 and OBRA-90, referrals of Medicare and Medicaid patients to clinical laboratories with which a referring physician has a financial relationship are prohibited effective January 1, 1991. As of January 1, 1992, any claim for payment submitted to Medicare by a provider must identify the name and provider number of the referring physician and must indicate whether the physician has an ownership or other financial arrangement with the provider. Under the provisions of OBRA-93, referrals of Medicare and Medicaid patients to certain "designated health services" with which a referring physician has a financial relationship will be prohibited as of January 1, 1995. These designated health services include the following: clinical laboratory; physical and occupational therapy services; radiology or other diagnostic services; radiation therapy services; durable medical equipment; parenteral and enteral nutrients, equipment and supplies; prosthetics, orthotics and prosthetic devices; home health services; outpatient prescription drugs; and inpatient and outpatient hospital services. There are a number of exceptions that may apply to the compensation arrangements under which the Company's facility contracts with certain of its physicians including exceptions for bona fide employment relationships, personal service arrangements, and physician recruitment arrangements.
The Social Security Act also imposes criminal and civil penalties for making false claims to Medicare and Medicaid for services not rendered or for misrepresenting actual services rendered in order to obtain higher reimbursement. Like the antifraud and abuse statute, this statute is very broad. Careful and accurate coding of claims for reimbursement must be performed to avoid liability under the false claims statutes.
Management exercises care in an effort to structure its arrangements with physicians to comply in all material respects with these laws, and management believes that the Company is in compliance
with the Amendments, however, there can be no assurance that (i) government officials charged with responsibility for enforcing the prohibitions of the Amendments will not assert that the Company or certain transactions in which it is involved are in violation of the Amendments, or (ii) courts will interpret the Amendments in a manner consistent with the practices of the Company.
STATE LEGISLATION
Certain states in which the Company's facilities are located also have enacted statutes which prohibit the payment of kickbacks, bribes and rebates for the referral of patients. Many of these statutes have provisions that closely follow the federal statutes described above, and there have been few actions or interpretations made under such provisions. Management believes that the Company is in substantial compliance with such laws; however, there can be no assurance that government officials who have the responsibility for enforcing such laws will not assert that the Company or certain transactions in which the Company is involved are in violation of such laws, or that such laws will ultimately be interpreted by the government officials in a manner consistent with the practices of the Company.
GENERAL REGULATION
The Company is committed to providing its employees with an equal opportunity work environment that is free from discrimination. In keeping with this commitment, the Company ensures that all human resource programs are administered without regard to race, religion, color, national origin, sex or age. Furthermore, the Company embraces and complies with the American Disabilities Act of 1990 (ADA) and the 1993 Family and Medical Leave Act. Such human resource programs include, but are not limited to, compensation, benefits, application of Company policies, company-sponsored training, educational, social and recreational programs.
The Company is subject to various federal, state and local statutes and ordinances regulating the discharge of materials into the environment, including, without limitation, the disposal of certain medical waste and by-products. Management does not believe that the Company will be required to expend any material amounts in order to comply with these laws and regulations or that compliance will materially affect its capital expenditures, earnings or competitive position.
PROFESSIONAL LIABILITY
As is typical in the healthcare industry, the Company is subject to claims and legal actions by patients in the ordinary course of business. The Company self-insures the professional and general liability claims for nine of its hospitals up to $500,000 per occurrence and for 26 of its hospitals up to $3 million per occurrence. Prior to June, 1993 the self-insured retention was $5 million per occurrence. Coverage for professional and general liability claims for the Company's two remaining hospitals is maintained with outside insurance carriers.
The Company owns a 35% equity interest in an insurance company which insures the excess professional and general liability risks for those hospitals which are self-insured. The excess coverage provided by this insurance company is limited to $25 million per claim. The Company purchases additional excess insurance from a commercial carrier. For the period from January 1986 to February 1991, the Company had no excess coverage for the majority of its hospitals. However, in March 1991, the Company purchased prior acts coverage which substantially reduces the uninsured liability for risks during this period.
The Company maintains an unfunded reserve for its professional liability risks which is based, in part, on actuarial estimates calculated and evaluated by an independent actuary. Actual hospital professional and general liability costs for a particular period are not normally known for several years after the period has ended. The delay in determining the actual cost associated with a particular period is due to the time between the occurrence of an incident, the reporting thereof and the settlement of related claims. As a result, reserves for losses and related expenses are estimated using expected loss reporting patterns determined in conjunction with the actuary and are discounted using a rate of 9% to their present value. Adjustments to the total reserves are determined in conjunction
with the actuary and on an annual basis are recorded by the Company as an increase or decrease in the current year's earnings. Management considers such reserves to be adequate for professional liability risks. Any losses incurred in excess of the established reserves will be recorded as a charge to the earnings of the Company. Any losses incurred within the Company's self-insured limits will be paid out of the Company's cash from operations. While the Company's cash from operations has been adequate to provide for alleged and unforeseen liability claims in the past, there can be no assurance that the Company's cash flow will continue to be adequate to cover such claims.
SEGMENT OPERATING INFORMATION
Holdings' only material business segment is "healthcare," which contributed substantially all of its revenues and operating profits in fiscal 1994. The Company's healthcare business is conducted in the United States.
ITEM 2.



ITEM 2. PROPERTIES
See "ITEM 1. BUSINESS."
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
LITIGATION RELATING TO THE MERGER.
To date, a total of nine purported class action suits (the "Class Actions") have been filed against Holdings and the directors of Holdings (and in two cases against NME). Seven of such Class Actions have been filed in the Delaware Court of Chancery and are entitled (i) JEFFREY STARK AND GARY PLOTKIN V. ROBERT W. O'LEARY, ROBERT J. BUCHANAN, JOHN T. CASEY, ROBERT B. CALHOUN, HARRY J. GRAY, HAROLD J. [SIC] HANDELSMAN, SHELDON S. KING, MELVYN N. KLEIN, DAN W. LUFKIN, WILLIAM E. MAYER AND HAROLD S. WILLIAMS (THE "HOLDINGS DIRECTORS") AND HOLDINGS, C.A. NO. 13792, (ii) 7457 Partners v. the Holdings Directors and Holdings, C.A. No. 13793, (iii) MOISE KATZ V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13794, (iv) CONSTANTINOS KAFALAS V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13795, (v) F. RICHARD MANSON V. THE HOLDINGS DIRECTORS, NME AND HOLDINGS, C.A. NO. 13797, (vi) LISBETH GREENFELD V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13799 and (vii) JOSEPH FRANKEL V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13800 and two purported Class Actions have been filed in the Superior Court of the State of California, County of Los Angeles, entitled RUTH LEWINTER AND RAYMOND CAYUSO V. THE HOLDINGS DIRECTORS (WITH THE EXCEPTION OF HAROLD S. WILLIAMS), NME AND HOLDINGS, CASE NO. BC115206 AND DAVID F. AND SYLVIA GOLDSTEIN V. O'LEARY, NME, AMI, ET AL., CASE NO. BC116104. The seven Class Actions filed in the Delaware Court of Chancery have been consolidated The complaints filed in each of the Class Actions are substantially similar, are brought by purported stockholders of Holdings and, in general, allege that the defendants breached their fiduciary duties to the plaintiffs and other members of the purported class. One of the Class Actions alleges that the defendants have committed or aided and abetted a gross abuse of trust. The complaints further allege that the directors of Holdings wrongfully failed to hold an open auction and encourage bona fide bids for Holdings and failed to take action to maximize value for Holdings stockholders. The complaints seek preliminary and permanent injunctions against the proposed transaction until such time as a transaction to be entered into between Holdings and NME results from bona fide arms' length negotiation and/or requiring a fair auction for Holdings. In addition, if the Merger is consummated, the complaints seek recision or recessionary damages and two of the Class Actions seek an accounting of all profits realized and to be realized by the defendants in connection with the Merger and the imposition of a constructive trust for the benefit of the plaintiffs and other members of the purported classes pending such an accounting. The complaints also seek monetary damages of an unspecified amount together with prejudgment interest and attorneys' and experts' fees. Holdings and NME believe that the complaints are without merit and intend to defend them vigorously.
In addition, Holdings and AMI are subject to claims and suits arising in the ordinary course of business. In the opinion of management, the ultimate resolution of all pending legal proceedings will not have a material adverse effect on the business, results of operations or financial condition of Holdings or AMI.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
Holdings' common stock is traded on the New York Stock Exchange. Holdings owns all of AMI's issued and outstanding common stock and such shares are no longer publicly traded. The following table indicates the quarterly high and low sales prices of Holdings' common stock for the period from September 1, 1992 through August 31, 1994. Certain covenants in the Company's bank credit and other financing agreements restrict the payment of cash dividends on Holdings' common stock (See Item 14(a), Note 5 to the Financial Statements). No dividends were paid on Holdings' common stock for the periods presented. (See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources").
There were 9,134 holders of record of Holdings' shares as of November 9, 1994.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
FIVE YEAR FINANCIAL SUMMARY (IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents were $31.9 million at August 31, 1994 compared to $44.3 million at August 31, 1993. Net cash provided by operating activities increased $12.4 million to $269.6 million for the year ended August 31, 1994 when compared to the same period in the prior year. In May 1994, the Company received $72.4 million related to the disposition of AMI's interest in EPIC Holdings, Inc. as a result of the merger of EPIC Holdings, Inc. with HealthTrust, Inc. -- the Hospital Company. The Company paid income taxes of $86.0 million for the year ended August 31, 1994 of which $25.9 million related to the disposition of AMI's interest in EPIC Holdings, Inc. The long-term debt balance (including current maturities) at August 31, 1994 was $1,297.7 million compared to $1,335.0 million at August 31, 1993.
In fiscal 1994, the Company invested $112.2 million in capital expenditures (excluding acquisitions) and as of August 31, 1994, had approximately $19.5 million of capital expenditure commitments outstanding. Capital expenditures made by the Company are for new construction and renovations to facilitate and accommodate new inpatient and outpatient programs and to develop and acquire new or additional lines of business, including home health, surgery centers and physician practices. In May 1994, the Company completed the purchase of Saint Francis Hospital located in Memphis, Tennessee for a purchase price of approximately $92.0 million. In conjunction with this purchase, in June 1994 the Company completed the acquisition of a management services organization in the Memphis area.
The Company intends to continue to invest in new and existing operations within the healthcare industry. On September 1, 1994, a limited partnership, of which a wholly-owned subsidiary of AMI is the general partner, completed the purchase of Hilton Head Hospital, located in Hilton Head, South Carolina for a purchase price of approximately $23.6 million. Through its subsidiary AMI owns 70% of the limited partnership. In connection with the Company's efforts to re-establish a presence in Europe, the Company has entered into a joint venture agreement with a community organization (the "Burgergemeinde") located in Cham, Canton Zug, Switzerland. The joint venture will be owned 90% by the Company and 10% by the Burgergemeinde. Under the terms of the proposed transaction, the Company will enter into a long term lease for the land where the existing hospital is located and will then construct a new 56 bed acute care wing, convert an existing structure into a medical office building and renovate and remodel the existing acute care facility. In addition, the Company plans to contract to provide management, food, physical therapy and rehabilitation services to the hospital, an on-site nursing home and an affiliated retirement community.
In June 1994, the Company amended its credit facility ("Reducing Revolving Credit Facility") extending the term of the bank commitments thereunder until September 1999 and reducing the rate of interest applicable to amounts outstanding thereunder to, at the option of AMI, (i) adjusted LIBOR plus .875% (subject to reduction upon the satisfaction of certain conditions) or (ii) the alternative base rate specified for the Reducing Revolving Credit Facility. Upon completion of the fiscal 1994 loan compliance report, anticipated to be prior to the end of the first quarter of fiscal 1995, the rate at which interest accrues based on LIBOR will be reduced to LIBOR plus .75%.
The Company repaid (excluding repayments on the Reducing Revolving Credit Facility) $62.2 million of long-term debt during the year ended August 31, 1994 from cash provided by operating activities. During fiscal 1994, the Company (i) made repayments of $28.0 million for the redemption of the remaining principal amount of the 6 3/4% Swiss franc/dollar dual currency senior notes due 1997, (ii) repurchased $15.4 million principal amount of the 15% Junior Subordinated Discount Debentures, Due 2005 and (iii) made repayments of approximately $18.8 million on certain other indebtedness. The amount outstanding under the Reducing Revolving Credit Facility decreased to $266.0 million as of August 31, 1994, from $287.0 million outstanding as of August 31, 1993. Under the Reducing Revolving Credit Facility, $31.3 million in letters of credit were outstanding as of August 31, 1994.
Management believes that sufficient funds will be generated from operations, augmented by borrowings under the Reducing Revolving Credit Facility, to finance operations, capital expenditures and service debt. Scheduled principal payments, excluding amounts that may become due on the Reducing Revolving Credit Facility, are $156.0 million in fiscal 1995, $57.0 million in fiscal 1996, $182.1 million in fiscal 1997, $2.3 million in fiscal 1998, and $2.3 million in fiscal 1999.
The terms of certain indebtedness of the Company impose operating and financial restrictions requiring the Company to maintain certain financial ratios and restrict the Company's ability to incur additional indebtedness and enter into leases and guarantees of debt; to make capital expenditures; to make loans and investments; to pay dividends or repurchase shares of stock; to repurchase, retire or refinance indebtedness prior to maturity; and to purchase or sell assets. The Company has pledged the capital stock of certain direct (first tier) subsidiaries as security for its obligations under the Reducing Revolving Credit Facility and certain other senior indebtedness. In addition, the Company has granted a security interest in its accounts receivable as security for its obligations under the Reducing Revolving Credit Facility. Management believes that the Company is currently in compliance with all covenants and restrictions contained in all financing agreements.
Upon completion of the acquisition of the Company by a wholly-owned subsidiary of National Medical Enterprises, Inc., management believes that the combined company's liquidity will be adequate to finance the Company's hospital operations, capital expenditures and future developments.
RESULTS OF OPERATIONS
GENERAL TRENDS
The Company's net revenues have increased as compared with the same period of the prior year as a result of the continued increase in volume from outpatient and inpatient services, the expansion of patient care services and general price increases. The Company has experienced an increase in outpatient volume as compared to the prior year as a result of (i) advanced medical technology and (ii) cost containment pressures from payers to direct more patients from inpatient facilities to less expensive outpatient facilities. Accordingly, several of the Company's hospitals continue to expand or redesign their outpatient facilities and services to accommodate the increased utilization of such facilities. The growth rate of the Company's outpatient revenue realized from the shift of inpatient care services to outpatient care services is expected to occur at a slower pace in the future from the rate experienced in the past, as the use of such services matures. As a result of increased demand for specialized healthcare for both inpatient and outpatient care, the Company has established specialized programs (e.g. long-term care, rehabilitation units, home health) within separate units in the Company's existing hospitals. Regulations are currently being proposed by the Health Care Financing Administration that, if enacted, would limit the opportunity provided by the development of these specialized programs.
Medicare and Medicaid revenues are expected to continue to increase in the future as a larger portion of the general population qualifies for coverage as a result of the aging of the population and expanded state Medicaid programs. This in turn may decrease the Company's overall rate of revenue growth as a result of (i) a corresponding change in payer mix and (ii) the disparity between the rate of increase in the Company's established billing rates and the government's reimbursement rate. The Medicare program reimburses the Company's hospitals primarily based on established rates by a diagnosis related group for acute care hospitals. While Medicare payment rates are indexed for inflation annually, the increases have historically lagged behind actual inflation.
In addition to the Medicare program, states and insurance companies continue to actively negotiate the amounts they will pay for services performed, rather than simply paying healthcare providers their established billing rates. The maturity of managed care environments varies in the markets in which the Company operates. The Company's hospitals that operate in mature managed care markets typically have contributed smaller profit margins than some of the Company's hospitals which operate in less mature markets. Management believes that through cost-containment efforts, the Company is positioned to have a competitive edge in pursuing market share in the managed care environment.
Competition among hospitals and other healthcare providers in the United States has increased over the past several years due to changes in government regulation and reimbursement, various other third party payer cost containment pressures and medical technology. As these factors continue to affect healthcare providers, along with the pending proposals for healthcare reform, the healthcare industry continues to experience a significant increase in the number of mergers and acquisitions occurring between both investor-owned and non-profit hospitals in an effort to further reduce the cost of delivering high quality care.
To offset these factors which may limit net revenue growth, the Company continues to look at providing an increasing array of healthcare services by expanding the Company's operations and by integrating broad healthcare networks. As a result, the Company is developing physician networks and alliances with other healthcare providers to create fully integrated healthcare delivery systems. In addition to expanding services, management believes that its cost containment efforts have been critical in improving and maintaining operating margins while providing a high level of patient care.
A significant portion of the Company's operating costs and expenses are subject to inflationary increases. Since the healthcare industry is labor intensive, salaries and benefits are continually affected by inflation. To control labor costs, the Company has and will continue to monitor, at the hospital level, the daily staff coverage. To control increases in supply costs, management continues to focus on managing such utilization through various mechanisms including (i) improved contract compliance, (ii) development of pharmaceutical formularies to control the usage of new drugs and (iii) aggressive negotiation of supply purchase contracts. To further control costs, the Company continues to expand its case management (i.e. review of associated costs for patient care for specific treatment) in its hospitals. The Company's ability to pass on a certain portion of the increased costs associated with providing healthcare to Medicare/Medicaid patients may be limited by existing government reimbursement programs for healthcare services unless the federal and state governments correspondingly increase the rates of payments under these programs. Although the Company cannot predict its ability to continue to cover future cost increases, management believes that through the continued adherence to the cost containment programs, labor management and reasonable price increases, inflation is not expected to have a material adverse effect on operating margins.
HEALTHCARE REFORM
Although substantive federal healthcare reform has not been legislated, the healthcare industry will continue to be faced with federal and state efforts to reform the delivery system. Any substantive reform is likely to encompass healthcare coverage for an increasing percentage of the U.S. population and could contain provisions which would impose among other things, cost controls on healthcare providers, insurance market reforms to increase the availability of group health insurance to small businesses, requirements that all businesses offer health insurance coverage to their employees, and the creation of a single government health insurance plan (to reduce administrative costs) that would cover all citizens. Reform proposals may also contain significant reductions in the amount of reimbursement received under the Medicare/Medicaid programs. In addition to the proposed healthcare reform, some states, including Florida, have already enacted reforms and continue to consider additional reforms. The type and impact of such reform continues to be debated at both the federal and state levels.
Management believes that some form of federal healthcare reform may occur; however, until such reform is finalized, management cannot predict which proposals will be adopted, if any, and until adopted the impact of any such proposals on the Company's business, results of operations or financial condition.
YEARS ENDED AUGUST 31, 1994, 1993 AND 1992
The following table summarizes certain consolidated results of the Company. AMI's results of operations are the same as that of the Company's; therefore, separate results of operations and a discussion and analysis for AMI are not presented.
The following table sets forth certain operating statistics of the Company's hospitals for the three years ended August 31, 1994.
Net revenues for the year ended August 31, 1994 increased 6.4% to $2,382 million from $2,238 million for the year ended August 31, 1993 as a result of new patient care services, higher utilization of outpatient and ancillary services and higher third party reimbursement rates. Net revenues for the year ended August 31, 1992 of $2,238 million included a benefit of approximately $10 million relating to a Medicare settlement and $69 million relating to facilities sold during fiscal 1992.
A shift in volume from inpatient services to outpatient services over the past three years, the development of home health services and the addition of ancillary facilities at certain of the Company's hospitals have contributed to net revenues from outpatient services accounting for a larger percent of total net patient revenues in recent years. Net revenues from outpatient services accounted for 29.6%, 29.4% and 27.6% of total net patient revenues for the years ended August 31, 1994, 1993 and 1992, respectively. For the year ended August 31, 1994, the Company experienced a greater increase in admissions (5.5% as compared to the year ended August 31, 1993) than seen in prior years, due primarily to the addition of Saint Francis Hospital. Admissions, which were impacted by the addition of Encino Hospital in fiscal 1993 and the disposition of hospitals during fiscal 1992, decreased 1.5% for the year ended August 31, 1993 when compared to the year ended August 31, 1992. Net revenues from inpatient services accounted for 70.4%, 70.6% and 72.4% of total net patient revenues for the years ended August 31, 1994, 1993, and 1992, respectively.
Net revenues derived from Medicare/Medicaid programs for the year ended August 31, 1994, increased 19.1% as compared to the year ended August 31, 1993 as a greater portion of the population continues to qualify for such coverage. Saint Francis Hospital, which derives a large portion of its business from Medicare patients, contributed to the increase in net revenues derived from Medicare/ Medicaid programs. An increasing number of various third party payers, including states, insurance
companies and employers' networks, are negotiating contracted amounts paid for services rendered, accounting for the increase in contracted business and a corresponding decline in non-contracted business.
Expense management continues to be a significant factor in maintaining the operating margin experienced by the Company (13.7% for the years ended August 31, 1994 and 1993 and 12.1% for the year ended August 31, 1992). The sale of facilities during fiscal 1992, which operated at a slightly lower margin, also contributed to the increase in the Company's operating margin for the year ended August 31, 1993. The Company's adherence to the cost control program implemented by management in fiscal 1992 has continued to stabilize operating costs and expenses as a percent of net revenues. Labor management (i.e. hospital staffing monitored with volume) and the decline in benefit costs as a result of changes implemented in the employee benefits program has decreased labor costs for the years ended August 31, 1994 and 1993 as a percent of net revenues compared to the year ended August 31, 1992.
For the year ended August 31, 1994 operating expenses (excluding depreciation and amortization) increased 6.4% over the year ended August 31, 1993. Approximately one-third of the overall increase is due to operating expenses associated with Saint Francis Hospital. As a percent of net revenues, operating expenses for the year ended August 31, 1994 remained flat as compared to the year ended August 31, 1993. The decrease in total operating costs and expenses for the year ended August 31, 1993 as compared to the year ended August 31, 1992 was primarily due to the following adjustments recognized during fiscal 1992: (i) the disposition of hospitals during fiscal 1992, (ii) an $11.0 million adjustment to salaries and benefits to increase reserves associated with workers' compensation liabilities as a result of adverse development on claims arising from prior periods, (iii) the impact of an adverse adjustment to the provision for uncollectible accounts for the refinement in procedures used to estimate bad debts and (iv) a foreign currency translation loss of $7.8 million. Foreign currency translation was immaterial for the years ended August 31, 1994 and 1993.
The gains on the sales of securities for the years ended August 31, 1994 and 1992 are the result of the sale of various securities of EPIC Holdings, Inc. and EPIC Healthcare Group, Inc.
Interest expense, net decreased to $154 million for the year ended August 31, 1994 from $166 million for the year ended August 31, 1993 and $204 million for the year ended August 31, 1992 as a result of debt refinancings in fiscal 1994 and 1993 and the use of cash from operations and the proceeds from the sale of facilities in fiscal 1992 to reduce outstanding indebtedness. The year ended August 31, 1993 includes a refund of $8.6 million for excess interest paid to the Internal Revenue Service in prior periods.
The tax provision for each of the years ended August 31, 1994, 1993 and 1992 is greater than that which would occur using the Company's marginal tax rate against its income before taxes, minority equity interest and extraordinary loss, due in large part to the amortization of cost in excess of net assets acquired not being deductible for tax provision purposes. In August 1993, the Revenue Reconciliation Act of 1993 was enacted increasing the corporate income tax rate to 35% from 34% effective January 1, 1993.
The extraordinary loss on early extinguishment of debt is a result of the redemption or repurchase of debt prior to its stated maturity.
ITEM 8.


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data set forth in the Index to Financial Statements and Financial Statement Schedules on page are filed as part of this Annual Report on Form 10-K.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.



ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF HOLDINGS AND AMI
DIRECTORS OF HOLDINGS AND AMI
Certain information concerning each director of Holdings and AMI is set forth below:
ARRANGEMENTS WITH RESPECT TO THE ELECTION OF DIRECTORS
Pursuant to the amended and restated stockholders agreement (the "Stockholders Agreement") as currently in effect, by and among Holdings, the GKH Investments, L.P., a Delaware limited partnership (the "Fund"), GKH Private Limited ("GKHPL"), Mellon Bank, N.A., as trustee of First Plaza Group Trust, a trust organized under New York law ("First Plaza"), MBLP, MIP, certain management investors as defined in the Stockholders Agreement the ("Management Investors") and others, the Fund, together with GKHPL, has the power to designate a majority of the nominees for Holdings' board of directors (the "Board") and thereby effectively control the selection of executive officers and other key employees and the establishment of Holdings' and AMI's operating policies. MBLP and MIP are entitled to designate up to two nominees for Holdings' Board and the Management Investors are entitled to designate at least one (but not more than two) of the nominees for Holdings' Board. The Stockholders Agreement also requires each of the parties to vote all shares of common stock held thereby for all of the persons nominated pursuant to the Stockholders Agreement. The rights and obligations of the parties to designate and vote for nominees for Holdings' Board terminate as to a party under certain circumstances, including the failure to maintain its ownership of Holdings' common stock at specified levels.
ARRANGEMENTS WITH RESPECT TO OTHER MATTERS
In addition to the provisions with respect to the election of directors discussed above, the Stockholders Agreement also restricts the ability of Holdings and AMI to take certain corporate actions, including amending their respective charter documents without the consent of certain of the parties thereto. The Stockholders Agreement also provides for certain rights-of-first-refusal, contains restrictions on dispositions of common stock and requires the parties thereto to sell their shares of common stock in certain circumstances if the Fund proposes to sell all of its shares of common stock by way of merger or similar transaction. By maintaining their percentage ownership of common stock, the Fund and its permitted transferees as defined in the Stockholders Agreement ("Permitted Transferees") and MBLP and its Permitted Transferees may effectively have the power to determine the policies of Holdings and AMI, the persons constituting their management and the outcome of corporate actions requiring stockholder approval by majority action. Certain benefits to each party under the Stockholders Agreement terminate if such party no longer owns specified minimum amounts of common stock.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The compensation and stock option committee of the Board currently is comprised of Messrs. Williams, King and Mayer. None of the individuals who were members of the compensation and stock option committees of the Board during fiscal 1994 are present or former officers or employees of Holdings or AMI. See "Directors and Executive Officers of Holdings and AMI." Corporations wholly owned by two members of the compensation and stock option committee, Messrs. Klein and Lufkin, serve as general partners of GKH. A corporation wholly owned by another member of the compensation and stock option committee, Mr. Gray, is a limited partner of GKH.
GKH rendered certain consulting services to Holdings during fiscal 1994 in connection with the sale of AMI's interest in EPIC Holdings, Inc. for which GKH received compensation of approximately $2.3 million. The Company believes that the amount of fees it paid to GKH is equivalent to or less than customary fees paid or that would have been by the Company to unaffiliated third parties for comparable services. See "Certain Relationships and Related Transactions -- Sale of a Business." In years prior to fiscal 1993, GKH rendered certain management and financial services to Holdings for which it received compensation on terms customary in the investment banking business. Holdings is not presently under any obligation to retain GKH in the future although it may choose to do so at any time and from time to time. As of November 9, 1994, the Fund and GKHPL owned an aggregate of 25,653,764 shares of common stock, or approximately 32%, of the outstanding common stock. See "Security Ownership of Certain Beneficial Owners and Management;" "Arrangements with Respect to the Election of Directors;" and "Arrangements with Respect to Other Matters."
Holdings, the Fund, GKHPL, MBLP, MIP and First Plaza, among others, entered into a registration rights agreement dated as of October 26, 1989 and as subsequently amended (the "Registration Rights Agreement"), pursuant to which the Fund, together with GKHPL, MBLP, MIP and/or First Plaza and their respective Permitted Transferees, have, at specified times, certain rights to demand that Holdings register all or part of their shares of common stock under the Securities Act of 1933, as amended (the "Securities Act"). Upon exercise of these rights, Holdings will generally be obligated to register such shares at its own expense. In addition, if Holdings proposes to register any of its equity securities under the Securities Act (except for, among other things, equity securities registered for issuance pursuant to employee benefit plans), the parties to the Registration Rights Agreement may include shares of common stock in such registration, subject, however, to pro rata reduction to the extent Holdings determines it is necessary.
EXECUTIVE OFFICERS OF HOLDINGS AND AMI
Certain information concerning the executive officers of Holdings and AMI is set forth below:
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), requires Holdings' executive officers and directors and persons who beneficially own more than 10% of the common stock to file reports of initial ownership and changes in ownership of common stock with the Commission. Based solely on a review of such reports furnished to Holdings, Holdings believes that during fiscal 1994, its executive officers, directors and beneficial owners of more than 10% of the common stock complied with all Section 16(a) filing requirements.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
Holdings is a holding company, all of whose business activities are conducted by its operating subsidiaries. Accordingly, executive officers of Holdings hold identical positions with AMI.
The following table sets forth certain information with respect to the compensation paid by Holdings during the last three fiscal years ended August 31, 1994 to its Chief Executive Officer and to each of its four other most highly compensated executive officers (collectively with the Chief Executive Officer, the "named executive officers"):
SUMMARY COMPENSATION TABLE
OPTIONS GRANTS IN LAST FISCAL YEAR
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES
The following table provides information on the value of unexercised options held by each of the named executive officers at August 31, 1994. None of the named executive officers exercised any options during fiscal 1994.
LONG-TERM INCENTIVE PLAN -- AWARDS IN LAST FISCAL YEAR
The following table provides information on long-term incentive plan awards to each of the named executive officers in fiscal 1994.
PENSION PLAN
The following table shows the estimated annual benefits payable upon normal retirement to participating employees, including, without limitation, the named executive officers, pursuant to AMI's basic Pension Plan (the "Pension Plan") as augmented by either the Supplemental Executive Retirement Plan, with respect to employees who become eligible collectively to participate prior to July 1989 or the Supplemental Benefit Plan, which is substantially identical with respect to employees who become eligible to participate in or after July 1989 (collectively "SERP") and Social Security for persons in specified remuneration and years of service classifications.
ANNUAL BENEFITS FOR YEARS OF SERVICE INDICATED
Under the Pension Plan, a retiring participant receives a percentage of his "earnings" (as defined under the Pension Plan) at the time of his last day of active employment with Holdings and AMI which, if calculated as of the date hereof for the named executive officers, would equal the rate used to determine the amount shown for each such person in the 1994 "Salary" column of Holdings Summary Compensation Table. Benefits are computed on a straight life annuity, contingent annuitant basis or years certain in life, at the election of the named executive officer, and are not subject to any deduction for Social Security amounts.
Certain key executives of AMI, including all of the named executive officers, are eligible under SERP for supplemental annual retirement benefits upon retirement at age 65 generally after at least 10 years of service. The amount of a covered executive's benefit is computed in accordance with a formula based on such individual's final average earnings and his years of service up to 20 years. The benefits are subject to deduction for estimated primary Social Security benefits payable at age 65 and further reduction for benefits vested under the AMI Pension Plan.
Participants are generally 100% vested after they have reached 10 years of service. SERP provides for early retirement for terminated participants with 10 to 15 years of service at age 55 with reduced benefits. Those with 16 or more years of service retire at age 55 with unreduced benefits.
As of August 31, 1994, Messrs. O'Leary, Casey, Chamison, French and Smith, have 4, 3, 3, 2, 16 credited years, respectively, of service under the basic Pension Plan, and 8,8,8,3 and 20 credited years, respectively, of service under SERP. In connection with the Merger, Holdings has entered into an agreement with each of the named executive officers that provides each of such executive officers, full vesting in and 20 years of service under the SERP upon a change of control (which term would include consummation of the Merger). As a result of the Merger, each of such individuals will be entitled to maximum benefits under the SERP. See "Certain Relationships and Related Transactions -- Actions Taken in Connection with the Merger."
DIRECTORS' COMPENSATION
During fiscal 1994, all directors of Holdings who were not employees of Holdings or any of its subsidiaries received compensation for serving on the Board or on a committee thereof. Such directors received $25,000 for serving on the Board. In addition, such directors received $1,000 for each meeting they attended and $500 for each telephonic meeting in which they participated. Mr. Williams received $10,000 for his services as the Chairman of the Audit Committee.
Under Holdings' Directors' Retirement Plan, an outside director who has served on the Board for at least five full years, or an employee director (regardless of whether he later becomes an outside director) who has served on the Board for at least ten full years is entitled, after reaching the age of 65 and upon retirement from the Board, to receive an annual retirement benefit in an amount equal to the annual director's fee in effect at the time of retirement. For purposes of this plan, an outside director is one who is not, at the time of his retirement from the Board, an employee of Holdings or any of its subsidiaries or affiliates. In fiscal 1994, the Directors' Retirement Plan was amended to provide that all individuals who were outside directors on September 1, 1994 (specifically, Messrs. Buchanan, Calhoun, Gray, Handelsman, King, Klein, Lufkin, Mayer and Williams) were eligible to participate in the Directors' Retirement Plan regardless of their respective years of service as a member of the Board of Directors. Outside directors, including retired directors, may be covered by AMI's basic health insurance plan. AMI also maintains a Directors' Deferred Compensation Plan pursuant to which directors are permitted to defer a portion of their directors' fees. Amounts deferred accrue interest at stipulated rates and are payable upon retirement from the Board.
EMPLOYMENT AGREEMENTS
Holdings has entered into a letter of understanding, as amended to date, with Robert W. O'Leary pursuant to which Mr. O'Leary serves as a director and Chairman of the Board and Chief Executive Officer of each of Holdings and AMI. Under this agreement, Mr. O'Leary receives an annual base salary of $750,000, which may be increased from time to time, and participates in the Incentive Plan. Pursuant to this agreement, Holdings made a $600,000 interest-free loan to Mr. O'Leary during fiscal 1992. The loan is forgiven by Holdings in monthly increments of $16,667 commencing September 30, 1991 and as of August 31, 1994 the total amount of the loan was forgiven. Holdings has agreed to pay to Mr. O'Leary, in the event his employment as Chairman and Chief Executive Officer is terminated for any reason other than "cause," an amount equal to 15 months base compensation (excluding bonus) determined on the basis of his annual salary for the fiscal year then most recently commenced. Additionally, pursuant to his agreement with Holdings, Mr. O'Leary is entitled to receive, in the event of a "Change of Control" (as defined therein), the above-referenced severance payment, acceleration of all benefits payable to him pursuant to the Incentive Plan and certain specified payments in respect of all unexercised options then held by him. Consummation of the Merger will constitute a Change of Control under this Agreement.
Holdings has entered into a letter of understanding, as amended to date, with John T. Casey pursuant to which Mr. Casey serves as the President and Chief Operating Officer of each of Holdings and AMI. Under this agreement, Mr. Casey receives an annual base salary of $362,000, which may be increased from time to time, and participates in the Incentive Plan. During fiscal 1993, Holdings made a $375,000 interest-free loan to Mr. Casey. The loan, which is due and payable 10 days after the termination of Mr. Casey's employment, is forgiven by the Company in monthly increments of $10,417 commencing August 31, 1993 and continuing for so long as Mr. Casey serves as President and Chief Operating Officer of Holdings. See the Summary Compensation Table on page 27 for the amount forgiven during fiscal 1994. Holdings has agreed to pay to Mr. Casey, in the event his employment as the President and Chief Operating Officer of the Company is terminated for any reason other than "cause," an amount equal to 12 months base compensation (excluding bonus) determined on the basis of his annual salary for the fiscal year then most recently commenced. Additionally, pursuant to his agreement with Holdings, Mr. Casey is entitled to receive, in the event of a "Change of Control" (as defined therein), the above-referenced severance payment, acceleration of all benefits payable to him pursuant to the Incentive Plan and certain specified payments in respect of all unexercised options
then held by him and forgiveness of any then outstanding balance under the above-referenced loan. Consummation of the Merger will constitute a Change of Control under this Agreement. Mr. Casey's Management Stock Agreement generally provides certain "Put" and "Call" rights to him and Holdings, respectively, with respect to certain shares of his common stock upon termination of his employment with Holdings. See "Certain Relationships and Other Transactions -- Management Investors."
Holdings has entered into a letter of understanding, as amended to date, with Alan J. Chamison pursuant to which Mr. Chamison serves as an Executive Vice President of each of Holdings and AMI. Under this agreement, Mr. Chamison receives an annual base salary of $362,000, which may be increased from time to time, and participates in the Incentive Plan. Pursuant to this agreement, Holdings made a $375,000 interest-free loan to Mr. Chamison during 1991. This loan, which is due and payable 10 days after the termination of Mr. Chamison's employment, is forgiven by Holdings in monthly increments of $10,417 commencing October 31, 1991, and as of August 31, 1994, the total amount of the loan was forgiven. Holdings has agreed to pay to Mr. Chamison, in the event his employment as an Executive Vice President of the Company is terminated for any reason other than "cause," an amount equal to 12 months base compensation (excluding bonus) determined on the basis of his annual salary for the fiscal year then most recently commenced. Additionally, pursuant to his agreement with Holdings, Mr. Chamison is entitled to receive, in the event of a "Change of Control" (as defined therein), the above-referenced severance payment, acceleration of all benefits payable to him pursuant to the Incentive Plan and certain specified payments in respect of all unexercised options then held by him. Consummation of the Merger will constitute a Change of Control under this Agreement.
Holdings has entered into a letter of understanding, as amended, with O. Edwin French pursuant to which Mr. French serves as a Senior Vice President of each of Holdings and AMI. Under this Agreement, Mr. French receives an annual base salary of $225,000, which may be increased from time to time, and participates in the Incentive Plan. Holdings has agreed to pay to Mr. French, in the event his employment as Senior Vice President of Holdings is terminated for any reason other than "cause," an amount equal to 12 months base compensation (excluding bonus) determined on the basis of his annual salary for the fiscal year then most recently commenced. Additionally, pursuant to his agreement with Holdings, Mr. French is entitled to receive, in the event of the occurrence of a "Change of Control" (as defined therein), the above-referenced severance payment, acceleration of all benefits payable to him pursuant to the Incentive Plan and certain specified payments in respect of all unexercised options then held by him. Consummation of the Merger will constitute a Change of Control under this Agreement.
AMI has also entered into an agreement with Mr. W. Randolph Smith. The terms of such agreement provide that under certain circumstances, upon termination, Mr. Smith will be entitled to receive one year's salary and benefits. Mr. Smith's agreement does not provide for any change of control payments. Mr. Smith's Management Stock Agreement generally provides certain "Put" and "Call" rights to him and Holdings, respectively, with respect to certain shares of his common stock upon termination of his employment with Holdings. See "Certain Relationships and Other Transactions -- Management Investors."
CHANGE OF CONTROL ARRANGEMENTS
On October 10, 1994, Holdings and NME jointly announced the signing of a definitive merger agreement pursuant to which a wholly-owned subsidiary of NME will be merged with and into Holdings, with Holdings continuing as the surviving corporation. As a result of the Merger, each share of common stock of Holdings will be converted into the right to receive $19.00 (if the closing occurs on or before March 31, 1995, otherwise $19.25) and 0.42 of a share of common stock of NME. Under the terms of the merger agreement, Holdings will pay a dividend of $0.10 per share prior to consummation of the Merger and Holdings will be entitled to nominate three individuals to be elected to the 13 member board of directors of the surviving corporation. In connection with the Merger, the Company has entered into certain agreements with members of the Company's management. In addition, certain existing arrangements and agreements between the Company and members of its management and Board of Directors will be affected by the Merger. See "Certain Relationships and Related Transactions -- Actions Taken in Connection with the Merger."
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information, as of November 9, 1994, regarding the beneficial ownership of Common Stock by (i) each stockholder known by the Company to be the beneficial owner of more than 5% of the Common Stock, (ii) all directors, (iii) each of the named executive officers and (iv) all directors and executive officers as a group. Unless otherwise noted, the persons named in the table have sole voting and investment power with respect to all shares shown as beneficially owned by them.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ACTIONS TAKEN IN CONNECTION WITH THE MERGER
Upon the occurrence of the Merger, certain executive officers of Holdings, including the named executive officers may be subject to the potential imposition of excise tax under Section 4999 of the Code to the extent that payments received by such executive officers as the result of the Merger are deemed to constitute excess parachute payments under Section 280G of the Code. Holdings has agreed to make payments to such affected executive officers in an amount equal to all excise taxes payable by each such executive officer on such deemed excess parachute payments (the "Gross-Up Payment"), including any excise tax payable by reason of the Gross Up Payment; provided however, that the maximum aggregate Gross-Up Payments which Holdings may be obligated to pay shall in no event exceed $8 million, which, if necessary, will be divided pro rata among the affected executive officers. In order for an executive officer to be eligible to receive Gross-Up Payments, such affected executive officer must agree in writing to accept the merger consideration (including the mix of cash and securities, if applicable) payable to Holdings' stockholders in general upon consummation of the Merger, with respect to any Holdings' stock options then held by the affected executive officer, nothwithstanding any provision in the executive's employment or stock option agreement or the Holdings Stock Option Plans to the contrary regarding payment in cash.
Holdings has agreed that if, in connection with or subsequent to a change of control (which term would include the consummation of the Merger), the employment of certain executive officers of Holdings is terminated for any reason, or the membership of a current director on the Company's Board of Directors is terminated for any reason, then such affected individual shall be entitled to continue coverage under the terms of Holdings' group health insurance plan until the earlier of the date such affected individual (a) becomes eligible for Medicare, or (b) otherwise fails to pay any applicable premium. This coverage is in addition to any continuation coverage that may otherwise be required by law.
Holdings has entered into an agreement with each of Messrs. O'Leary, Casey, Chamison, French, Kugelman, Sabatino, Bailey and Murdock pursuant to which such individuals, upon a change in control (which term has been defined to include consummation of the Merger), will be fully vested in all amounts payable under the Incentive Plans, including all deferred amounts. Additionally, each of these individuals will be deemed to have satisfied their respective maximum fiscal 1995 target performance goals under the Incentive Plans entitling each of them to 100% of their fiscal 1995 awards. The maximum award for which each of Messrs. O'Leary, Casey, Chamison, French, Kugelman, Sabatino, Bailey and Murdock may be entitled under the Incentive Plans for fiscal 1995 is $479,115, $227,136, $227,136, $117,219, $219,625, $81,120, $65,572 and $65,572, respectively, and the amount
currently deferred for each of such individuals is $374,815, $207,840, $207,840, $107,894, $35,607, $56,390, $57,832, and $57,832, respectively. See "Executive Compensation -- Long-Term Incentive Plan -- Awards in Last Fiscal Year."
First Boston and GKH rendered consulting services to Holdings in relation to the Merger for which First Boston and GKH each will receive compensation of $5.0 million plus reasonable out-of-pocket costs. The Company believes that the amount of fees to be paid to First Boston and GKH is equivalent to or less than customary fees that would be paid by the Company to unaffiliated third parties for comparable services.
SALE OF BUSINESS
In May 1994, the Company sold AMI's interest in EPIC Holdings, Inc. pursuant to a merger of EPIC Holdings, Inc. with HealthTrust, Inc -- the Hospital Company. As a result of this disposition, the Company received $72.4 million and paid $2.3 million in compensation to GKH, for representing the Company in connection with the transaction. See "Security Ownership of Certain Beneficial Owners and Management."
LETTERS OF CREDIT
Dalfort Corporation, an entity associated with HGM Associates, a Nevada limited partnership and a general partner of GKH ("Dalfort"), agreed to provide credit support (the "L/C Commitment") to domestic hospital subsidiaries of AMI in the form of guaranties by Dalfort to issuers of standby letters of credit, bonds and other surety type instruments for the account of any domestic hospital subsidiary of AMI (the "L/C Guarantees"). The L/C Commitment extended only to L/C Guarantees with a term not exceeding twelve months and in an aggregate face amount not exceeding $30 million outstanding at any time. Holdings and its subsidiaries were jointly and severally liable to reimburse Dalfort for any amounts paid pursuant to the L/C Commitment. The L/C Commitment was replaced on August 18, 1993 with other financing extended by an unaffiliated third party. AMI paid Dalfort a fee of $750,000 during fiscal 1993.
FIRST BOSTON AND AFFILIATES
The Company is not presently under any obligation to retain First Boston for advisory or other services although it may choose to do so at any time and from time to time. As of November 9, 1994, certain affiliates of First Boston owned an aggregate of 11,305,450 shares of Common Stock, or approximately 15%, of the outstanding Common Stock. See "Security Ownership of Certain Beneficial Owners and Management;" "Arrangements with Respect to the Election of Directors;" and "Arrangements with Respect to Other Matters."
MANAGEMENT INVESTORS
Pursuant to certain Management Stock Subscription Agreements (the "Management Stock Agreements") entered into in connection with and subsequent to the acquisition of AMI by Holdings (the "Acquisition"), certain current and former officers and key employees of AMI and its subsidiaries (collectively, the "Management Investors") purchased shares of common stock and, in most cases, were granted options pursuant to the Key Plan. The Management Investors, except for John T. Casey and a former officer of Holdings, used, among other funds, amounts received in consideration of the cancellation of options to purchase shares of AMI common stock ("AMI Shares") in connection with the Acquisition, to purchase the shares of common stock.
Pursuant to the Management Stock Agreements, upon termination of a Management Investor's employment with AMI or its subsidiaries prior to the fifth anniversary of the Acquisition, Holdings had the right to require such Management Investor to sell his shares of common stock to Holdings (the "Call"), and, upon certain events resulting in the termination of a Management Investor's employment with Holdings or its subsidiaries, the Management Investor had the right to require Holdings to
repurchase his shares of Common Stock (the "Put"), in each case at a price determined by a formula generally based on fair value and the factual circumstances giving rise to the exercise of either the Put or Call. The fifth anniversary of the Acquisition was October 26, 1994. The Put right will not be available to any Management Investor whose employment is terminated for "cause" (as defined in the Management Stock Agreements). In addition, Holdings may defer its obligation to purchase Common Stock pursuant to the exercise of a Call or a Put if the consummation of such purchase would violate any law or regulation or would cause Holdings to be in default under the terms of any of its indebtedness. Upon exercise of a Call or Put, any unexercised options held by the Management Investor will be terminated upon payment by Holdings to the Management Investor of the price specified in such Management Investor's Management Stock Agreement.
Pursuant to the Management Stock Agreements, the Management Investors have agreed not to transfer their common stock, except for certain permitted transfers, for five years after their purchase thereof, and, in addition, have granted Holdings, first, and the other parties to the Stockholders Agreement, second, a right of first refusal in respect of third party offers to purchase the common stock received by the Management Investors after the expiration of such five year period.
During fiscal 1994, Holdings paid an aggregate of $19,996 to one Management Investor in satisfaction of its obligations upon exercise of Put rights under such person's Management Stock Agreement.
LOANS TO EXECUTIVE OFFICERS
In prior fiscal years, Holdings made interest-free loans of $600,000, $375,000 and $375,000 to Messrs. O'Leary, Casey and Chamison, respectively, which loans are forgiven in equal monthly increments. As of November 9, 1994, the remaining balances of $199,992 and $135,409 on interest-free loans made by Holdings to Messrs. O'Leary and Chamison, respectively, where forgiven in full. As of November 9, 1994, the interest-free loan to Mr. Casey had an outstanding principal balance of $213,536 and is being forgiven by Holdings in equal monthly increments of $10,417. In the event of the occurrence of a "Change of Control" (as defined in the letter of understanding between Holdings and Mr. Casey), which includes consummation of the Merger, the remaining balance of the loan will be forgiven. The largest aggregate amount outstanding during fiscal 1994 to each of Messrs. O'Leary, Casey and Chamison pursuant to such loans were $199,992, $135,409 and $364,583, respectively. See "Executive Compensation -- Employment Agreements."
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1 and 2 Financial Statements and Financial Statement Schedules.
The financial statements and financial statement schedules set forth in the Index to Financial Statements and Financial Statement Schedules on page are filed as part of this Annual Report on Form 10-K.
(b) Reports on Form 8-K.
No reports on Form 8-K have been filed during the last quarter of fiscal 1994.
(c) List of Exhibits.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 the registrants have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized, in the City of Dallas, State of Texas, on the day of November, 1994. The following officers and directors have executed this report as of November 16, 1994.
AMERICAN MEDICAL HOLDINGS, INC. AMERICAN MEDICAL INTERNATIONAL, INC.
By /s/ ALAN J. CHAMISON
-------------------------------------- Alan J. Chamison Executive Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below, by the following persons in the capacities indicated:
SIGNATURE TITLE - ----------------------------------- -----------------------------------------
/s/ ROBERT W. O'LEARY* - ----------------------------------- Chairman and Chief Executive Officer Robert W. O'Leary (Principal Executive Officer)
/s/ ALAN J. CHAMISON Executive Vice President and - ----------------------------------- Chief Financial Officer Alan J. Chamison (Principal Financial Officer)
/s/ BARY G. BAILEY - ----------------------------------- Vice President, Controller Bary G. Bailey (Principal Accounting Officer)
/s/ J. ROBERT BUCHANAN, M.D.* - ----------------------------------- Director J. Robert Buchanan, M.D.
/s/ ROBERT B. CALHOUN, JR.* - ----------------------------------- Director Robert B. Calhoun, Jr.
/s/ JOHN T. CASEY* - ----------------------------------- Director John T. Casey
/s/ HARRY J. GRAY* - ----------------------------------- Director Harry J. Gray
SIGNATURE TITLE - ----------------------------------- -----------------------------------------
/s/ HAROLD S. HANDELSMAN* - ----------------------------------- Director Harold S. Handelsman
/s/ SHELDON S. KING* - ----------------------------------- Director Sheldon S. King
/s/ MELVYN N. KLEIN* - ----------------------------------- Director Melvyn N. Klein
/s/ DAN W. LUFKIN* - ----------------------------------- Director Dan W. Lufkin
/s/ WILLIAM E. MAYER* - ----------------------------------- Director William E. Mayer
/s/ ROBERT W. O'LEARY* - ----------------------------------- Director Robert W. O'Leary
/s/ HAROLD M. WILLIAMS* - ----------------------------------- Director Harold M. Williams
*By: /s/ BARY G. BAILEY - ----------------------------------- Bary G. Bailey As Attorney-In-Fact
AND FINANCIAL STATEMENT SCHEDULES
ITEM 14(A).
All other schedules are not submitted because they are not applicable, not required, or the information is included in the consolidated financial statements or notes thereto.
Separate financial statements of the parent company have been omitted since restricted net assets of consolidated subsidiaries are less than 25% of consolidated net assets.
REPORT OF INDEPENDENT ACCOUNTANTS
To The Boards of Directors and Shareholders of American Medical Holdings, Inc. and American Medical International, Inc.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of cash flows and of shareholders' equity present fairly, in all material respects, the financial position of American Medical Holdings, Inc. and subsidiaries and American Medical International, Inc. and subsidiaries at August 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Companies' management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Dallas, Texas October 20, 1994
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AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ASSETS
See Notes to Consolidated Financial Statements.
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) LIABILITIES AND SHAREHOLDERS' EQUITY
See Notes to Consolidated Financial Statements.
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
See Notes to Consolidated Financial Statements.
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
See Notes to Consolidated Financial Statements.
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
FOR THE THREE YEARS ENDED AUGUST 31, 1994
See Notes to Consolidated Financial Statements
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
American Medical Holdings, Inc. ("Holdings") was organized in July 1989 to acquire American Medical International, Inc. ("AMI" and, together with Holdings, the "Company"). As a result of this transaction, Holdings is the owner of all of the outstanding shares of common stock of AMI.
The accompanying consolidated financial statements include the accounts of Holdings, AMI and all majority owned subsidiary companies and have been prepared in accordance with generally accepted accounting principles. All significant intercompany accounts and transactions have been eliminated. Certain reclassifications have been made to prior years' financial statements to be consistent with the fiscal 1994 presentation.
AMI's financial statements are the same as Holdings' financial statements, except for the components of shareholders' equity, and for the years ended August 31, 1993 and 1992 the impact of Holdings' common stock subject to repurchase obligations (See Note 9 Capital Stock).
CASH AND CASH EQUIVALENTS
All highly liquid debt instruments purchased with an original maturity of three months or less are considered to be cash equivalents.
ACCOUNTS RECEIVABLE
The Company receives payment for services rendered to patients from (i) the federal and state governments under the Medicare, Medicaid and CHAMPUS programs, (ii) privately sponsored managed care programs for which payment is made based on terms defined under contracts and (iii) other payers. As of August 31, 1994 and 1993, government patient receivables represented approximately 37% and 30%, respectively, contracted patient receivables represented approximately 32% and 35%, respectively, and other third party payer receivables represented approximately 31% and 35%, respectively of net patient receivables.
Receivables from government agencies represent a concentrated group of credit for the Company; however, management does not believe that there are any credit risks associated with these governmental agencies. The only other significant credit concentration is with various Blue Cross affiliates. The remaining balance of payers including entities and individuals involved in diverse activities, and subject to differing economic conditions, do not represent any known concentrated credit risks to the Company. Furthermore, management continually monitors and adjusts its reserves and allowances associated with these receivables.
INVENTORY OF SUPPLIES
Inventories are stated at the lower of cost (first-in, first-out) or market.
PROPERTY AND EQUIPMENT
Amounts capitalized as part of property and equipment, including additions and improvements to existing facilities, are recorded at cost, including interest capitalized during construction which is computed at the cost of funds borrowed. Maintenance costs and repairs are expensed as incurred. Buildings and improvements and equipment are depreciated using the straight-line method of depreciation over their estimated useful lives. The estimated lives of buildings and improvements are generally 20 to 25 years and equipment is 3 to 15 years.
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INVESTMENTS
Investments are accounted for under either the equity method or the cost method. Investments accounted for under the cost method are stated at the lower of cost or market in the accompanying financial statements.
COST IN EXCESS OF NET ASSETS ACQUIRED
Cost in excess of net assets acquired is being amortized over 40 years from the original acquisition date of AMI resulting in an annual amortization of approximately $32.0 million. The cumulative amortization of cost in excess of net assets acquired as of August 31, 1994 and 1993 is $157.2 million and $125.2 million, respectively.
DEFERRED COSTS
Deferred financing costs are amortized under the interest method over the term of the expected life of the debt. Costs incurred prior to the opening of new facilities and costs incurred in the development of data processing systems are deferred and amortized on a straight-line basis over a two to five-year period.
INCOME TAXES
Income taxes are computed in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," which requires deferred tax liabilities or assets be recognized for the anticipated tax effects of temporary differences that arise as a result of differences in the book basis and tax basis of assets and liabilities.
NET REVENUES
The Company's sources of revenues are primarily provided from patient services and are presented net of reserves to recognize the difference between the hospitals' established billing rates for covered services and the amounts paid by third party or private payers. Patient revenues received under government and privately sponsored insurance programs are based on cost as defined under the programs or at predetermined rates based upon the diagnosis, plus capital costs, return on equity and other adjustments rather than customary charges. Adjustments are recorded in the period the services are rendered based on estimated amounts to be reimbursed and contract interpretations, however, such adjustments are generally subject to final audit and settlement. Net revenues include adjustments for the years ended August 31, 1994, 1993 and 1992 of $2.1 billion, $1.9 billion and $1.8 billion, respectively. In management's opinion, the reserves established are adequate to cover the ultimate liabilities that may result from final settlements.
The Company provides healthcare services free of charge to individuals who meet certain financial or economic criteria (i.e. charity care). The billings for such services have not been recognized as receivables or revenues in the financial statements since they are not expected to result in cash flows.
TRANSLATION OF FOREIGN CURRENCIES
Revaluation gains or losses on assets and liabilities denominated in currencies other than the functional currency are included in the determination of income. Revaluation gains or losses for debt denominated in foreign currencies for the years ended August 31, 1994 and 1993 were immaterial. Revaluation losses for debt denominated in foreign currencies for the year ended August 31, 1992 totaled $7.8 million. As of September 1, 1992, substantially all of the Company's foreign denominated debt obligations have been redeemed or the Company has entered into swap agreements that hedge
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) against any future fluctuations and, therefore, eliminated any future material revaluation gains or losses associated with the applicable debt obligations (See Note 5 Long Term Debt -- Swap Agreements).
2. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company uses the following methods and assumptions to estimate the fair value of its financial instruments at August 31, 1994:
CASH AND CASH EQUIVALENTS
The carrying value of cash and cash equivalents approximates fair value due to the short-term nature of these instruments.
INVESTMENTS
The Company has various investments for which the determination of the fair value is not practicable.
LONG-TERM DEBT
Fair values of publicly traded notes have been determined using the quoted market prices at August 31, 1994. The fair value of certain non-publicly traded notes is based on cash flows discounted using interest rates found on comparable traded securities. The aggregate carrying value of long-term debt at August 31, 1994, of $1,297.7 million had an estimated fair value of $1,392.3 million.
3. ACQUISITIONS Effective May 1, 1994, the Company completed the purchase of Saint Francis Hospital located in Memphis, Tennessee. In conjunction with this purchase, in June 1994 the Company completed the acquisition of a management services organization in the Memphis area. During fiscal 1994, the Company also acquired additional outpatient businesses, including home health, diagnostic centers and physician practices.
During fiscal 1993, the Company merged the operations of AMI's Tarzana Regional Medical Center with the operations of HealthTrust, Inc. -- The Hospital Company's ("HealthTrust") Encino Hospital. AMI owns 75% of the combined hospital operations and therefore the results of operations for the hospitals are fully consolidated with the results of operations of the Company for periods subsequent to January 1, 1993.
4. DISPOSITIONS During 1994, AMI recognized a $69.3 million pre-tax gain ($43.4 million net of tax), related to the sale of the Company's interest in EPIC Holdings, Inc. During fiscal 1992, the Company completed the sale of $89.3 million principal amount of Zero Coupon Notes Due 2001, issued by EPIC Healthcare Group, Inc. in September 1988 as partial consideration for AMI's sale of certain hospitals. AMI also completed the sale of its investment in EPIC Holdings, Inc. Class A and Class B Preferred Stock for aggregate cash proceeds of $130 million. The total pre-tax gain recorded in fiscal 1992 from these transactions was $119.8 million ($80.7 million, net of tax). The gains on the sale of the EPIC securities in fiscal 1994 and 1992 is presented in the accompanying financial statements as "Gains on sales of securities."
During fiscal 1992, the Company sold four domestic acute care hospitals for aggregate cash proceeds of approximately $100.1 million. These assets were valued at their respective sales prices, and therefore, no gains or losses were recognized from these sales in fiscal 1992.
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. LONG-TERM DEBT The components of Holding's and AMI's long-term debt at August 31, 1994 and 1993 are summarized as follows (in thousands):
REVOLVING CREDIT FACILITY
The Company's $600 million revolving credit facility ("Reducing Revolving Credit Facility") was amended in June 1994 extending the term to September 1999 and reducing the rate at which interest accrues. Amounts outstanding under the Reducing Revolving Credit Facility will accrue interest, at the option of AMI, at (i) adjusted LIBOR plus .875% (subject to reduction upon the satisfaction of certain conditions) or (ii) at the alternative base rate specified for the Reducing Revolving Credit Facility. Upon completion of the fiscal 1994 loan compliance report, anticipated to be prior to the end of the first quarter of fiscal 1995, the rate at which interest accrues based on LIBOR will be reduced to LIBOR plus .75%. Under the Reducing Revolving Credit Facility, $31.3 million in letters of credit were outstanding as of August 31, 1994.
SWAP AGREEMENTS
AMI has entered into swap agreements which hedge any foreign currency gains or losses on the L37 million senior notes, face amount $62.7 million, and the SFr.78 million bonds, face amount $52.4 million. At August 31, 1994 no loss would be recognized if the counter parties to these swap agreements failed to perform their obligations.
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. LONG-TERM DEBT (CONTINUED) DEBT COVENANTS
The terms of certain of the Company's indebtedness impose operating and financial restrictions requiring the Company to maintain certain financial ratios and restrict the Company's ability to incur additional indebtedness and enter into leases and guarantees of debt; to make capital expenditures; to make loans and investments; to pay dividends or repurchase shares of stock; to repurchase, retire or refinance indebtedness prior to maturity, and to purchase or sell assets. The Company has pledged the capital stock of certain direct (first tier) subsidiaries as security its obligations under the Reducing Revolving Credit Facility and certain other senior indebtedness. In addition, the Company has granted a security interest in its accounts receivable as security for its obligations under the Reducing Revolving Credit Facility. Management believes that the Company is currently in compliance with all covenants and restrictions contained in all financing agreements.
MATURITIES OF LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
As of August 31, 1994 the maturities of long-term debt, including capital lease obligations, for the five years ending August 31, 1999 are $156.0 million in fiscal 1995, $57.0 million in fiscal 1996, $182.1 million in fiscal 1997, $2.3 million in fiscal 1998 and $2.3 million in fiscal 1999.
CONVERTIBLE SUBORDINATED DEBT
Convertible subordinated debentures are unsecured obligations of the Company and are redeemable at declining premiums prior to their respective payment dates. The 9 1/2% Convertible Subordinated Debentures Due 2001, of which $3.4 million and $3.3 million was outstanding at August 31, 1994 and 1993, respectively, are convertible at $24.38 per share into 209,639 shares of Holdings' common stock at August 31, 1994, net of unamortized discount of $1.7 million. The 8 1/4% Convertible Subordinated Debentures Due 2008 of which $7.3 million and $7.2 million was outstanding at August 31, 1994 and 1993, respectively, are convertible at $40.00 per share into 361,400 shares of Holdings' common stock at August 31, 1994 net of unamortized discount of $7.1 million.
6. BENEFIT PLANS
PENSION PLANS
The Company has defined benefit pension plans (the "Plans") covering substantially all of the Company's employees. The benefits are based on years of service and the employee's base compensation as defined in the Plans. The Company's policy is to fund pension costs accrued within the limits allowed under federal income tax regulations. Contributions are intended to provide not only for benefits attributed to credited service to date, but also for those expected to be earned in the future.
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. BENEFIT PLANS (CONTINUED) In accordance with SFAS No. 87 Holdings and AMI have recorded an adjustment to recognize a minimum pension liability. The following table sets forth the funded status of the Plans and amounts recognized in the consolidated financial statements as of August 31, 1994 and 1993 (in thousands):
Holdings' and AMI's net pension cost for the years ended August 31, 1994, 1993 and 1992 includes the following components (in thousands):
In addition, Holdings and AMI have a unfunded supplemental defined benefit retirement plan for Company executives ("SERP"). The following table sets forth the amounts recognized for the unfunded SERP in the consolidated financial statements as of August 31, 1994 and 1993 (in thousands):
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. BENEFIT PLANS (CONTINUED) Holdings' and AMI's net cost of the SERP plan for the years ended August 31, 1994, 1993 and 1992 includes the following components (in thousands):
The weighted-average discount rate used in determining the actuarial present value of the projected benefit obligation for the SERP and the pension plan approximated 8.75% and 7.5% as of August 31, 1994 and 1993, respectively. The rate of increase in future compensation levels for the pension plan was 5.0%, 3.5% and 5.0% for the years ended August 31, 1994, 1993 and 1992, respectively. The rate of increase in future compensation levels for the SERP was 6.0%, 5.0% and 8.0% for the years ended August 31, 1994, 1993 and 1992, respectively. The expected long-term rate of return on assets was 10.0% for the years ended August 31, 1994 and 1993, for the pension plan.
DEFERRED SAVINGS PLAN
The Company also has a tax deferred savings plan. Expenses relating to this plan were $8.8 million, $7.3 million and $5.6 million for the years ended August 31, 1994, 1993 and 1992, respectively, for Holdings and AMI.
OTHER
The Company does not provide any post-retirement or post-employment healthcare or life insurance benefits to retired or former employees.
Disclosures for the Company's Options Plans and the Employee Stock Purchase Plan are included in Note 9 Capital Stock.
7. PROFESSIONAL LIABILITY RISKS As is typical in the healthcare industry, the Company is subject to claims and legal actions by patients in the ordinary course of business. The Company self-insures the professional and general liability claims for nine of its hospitals up to $500,000 per occurrence and for 26 of its hospitals up to $3 million per occurrence. Prior to June 1993, the self-insured retention was $5 million per occurrence. Coverage for professional and general liability claims for the Company's two remaining hospitals is maintained with outside insurance carriers.
The Company owns a 35% equity interest in an insurance company which insures excess professional and general liability risks for those hospitals which are self-insured. The excess coverage provided by this insurance company is limited to $25 million per claim. The Company purchases additional excess insurance from a commercial carrier. For the period from January 1986 to February 1991, the Company had no excess coverage for the majority of its hospitals. However, in March 1991 the Company purchased prior acts coverage which substantially reduces the uninsured liability for claims during this period. For the years ended August 31, 1994, 1993 and 1992, the Company paid $4.3 million, $5.0 million and $4.6 million, respectively, in premiums to this insurance company. In fiscal 1993 and 1992, the Company received distributions of prior year premiums of $2.4 million and $3.8 million, respectively, from this insurance company. In fiscal 1994, the Company received no distributions of prior years premiums. The Company also received dividends of $3.5 million, $2.7 million and $4.7 million from this insurance company in fiscal 1994, 1993 and 1992, respectively.
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. PROFESSIONAL LIABILITY RISKS (CONTINUED) The Company maintains an unfunded reserve for its professional liability risks which is based, in part, on actuarial estimates calculated and evaluated by an independent actuary. Actual hospital professional and general liability costs for a particular period are not normally known for several years after the period has ended. The delay in determining the actual cost associated with a particular period is due to the amount of lapsed time between the occurrence of an incident, the reporting thereof and the settlement of related claims. As a result, reserves for losses and related expenses are estimated using expected loss reporting patterns determined in conjunction with the actuary and are discounted using a rate of 9% to their present value. Adjustments to the total reserves are determined in conjunction with the actuary and on an annual basis are recorded by the Company as an increase or decrease in the current year's earnings.
As of August 31, 1994 and 1993, the unfunded reserve for self insurance was $118.8 million and $117.6 million, respectively, of which $15.7 and $17.0 million in fiscal 1994 and 1993, respectively is included in current liabilities. For the fiscal years ended August 31, 1994, 1993 and 1992, payments for claims and expenses totaled $15.7 million, $19.3 million and $17.1 million, respectively. For the fiscal years ended August 31, 1994, 1993 and 1992, the Company recorded self insurance expense of $16.9 million, $19.7 million and $13.5 million, respectively.
8. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases certain office space, office equipment and medical equipment. Future minimum payments under these operating leases for fiscal 1995, 1996, 1997, 1998, 1999 and thereafter are $35.3 million, $22.2 million, $17.4 million, $13.9 million, $10.0 million and $38.2 million, respectively. Future minimum payments for six acute care hospitals leased under a REIT agreement are $36.9 million for each of the years ended fiscal 1995, 1996, 1997, and 1998, $23.3 million for fiscal 1999 and $43.5 million for the remaining years thereafter. In addition, the Company incurs certain additional rents (contingency rents), in relation to the REIT agreements, based on a percentage of the increase in net revenues. These additional rents were $6.7 million, $6.4 million and $5.7 million for the years ended August 31, 1994, 1993 and 1992, respectively.
CONSTRUCTION COMMITMENTS
The Company has approximately $19.5 million of construction commitments outstanding for new construction and renovations as of August 31, 1994.
GUARANTEES
The Company has guaranteed long-term debt and lease obligations of unconsolidated subsidiaries and affiliates aggregating $30.8 million at August 31, 1994.
LEGAL PROCEEDINGS
LITIGATION RELATING TO THE MERGER (SEE NOTE 17 SUBSEQUENT EVENTS). To date, a total of nine purported class action suits (the "Class Actions") have been filed against Holdings and the directors of Holdings (and in two cases against NME). Seven of such Class Actions have been filed in the Delaware Court of Chancery and are entitled (i) JEFFREY STARK AND GARY PLOTKIN V. ROBERT W. O'LEARY, ROBERT J. BUCHANAN, JOHN T. CASEY, ROBERT B. CALHOUN, HARRY J. GRAY, HAROLD J. [SIC] HANDELSMAN, SHELDON S. KING, MELVYN N. KLEIN, DAN W. LUFKIN, WILLIAM E. MAYER AND HAROLD S. WILLIAMS (THE "HOLDINGS DIRECTORS") AND HOLDINGS, C.A. NO. 13792, (ii)7457 Partners v. the Holdings Directors and Holdings, C.A. No. 13793, (iii) MOISE KATZ V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13794, (iv) CONSTANTINOS KAFALAS V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13795, (v) F. RICHARD MANSON V. THE HOLDINGS DIRECTORS, NME AND HOLDINGS, C.A. NO. 13797, (vi) LISBETH GREENFELD V. THE
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. COMMITMENTS AND CONTINGENCIES (CONTINUED) HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13799 and (vii) JOSEPH FRANKEL V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13800 and two purported Class Actions have been filed in the Superior Court of the State of California, County of Los Angeles, entitled RUTH LEWINTER AND RAYMOND CAYUSO V. THE HOLDINGS DIRECTORS (WITH THE EXCEPTION OF HAROLD S. WILLIAMS), NME AND HOLDINGS, CASE NO. BC115206 AND DAVID F. AND SYLVIA GOLDSTEIN V. O'LEARY, NME, AMI, ET AL., CASE NO. BC116104. The complaints filed in each of the Class Actions are substantially similar, are brought by purported stockholders of Holdings and, in general, allege that the defendants breached their fiduciary duties to the plaintiffs and other members of the purported class. One of the Class Actions alleges that the defendants have committed or aided and abetted a gross abuse of trust. The complaints further allege that the directors of Holdings wrongfully failed to hold an open auction and encourage bona fide bids for Holdings and failed to take action to maximize value for Holdings stockholders. The complaints seek preliminary and permanent injunctions against the proposed transaction until such time as a transaction to be entered into between Holdings and NME results from bona fide arms' length negotiation and/or requiring a fair auction for Holdings. In addition, if the Merger is consummated, the complaints seek recision or recessionary damages and two of the Class Actions seek an accounting of all profits realized and to be realized by the defendants in connection with the Merger and the imposition of a constructive trust for the benefit of the plaintiffs and other members of the purported classes pending such an accounting. The complaints also seek monetary damages of an unspecified amount together with prejudgment interest and attorneys' and experts' fees. Holdings and NME believe that the complaints are without merit and intend to defend them vigorously.
In addition, Holdings and AMI are subject to claims and suits arising in the ordinary course of business. In the opinion of management, the ultimate resolution of all pending legal proceedings will not have a material adverse effect on the business, results of operations or financial condition of Holdings and AMI.
9. CAPITAL STOCK
OPTION PLANS
The Company maintains two stock option plans, the Nonqualified Employee Stock Option Plan (the "Option Plan") and the Nonqualified Performance Stock Option Plan for Key Employees (the "Key Employees Plan"), pursuant to which employees of Holdings and its subsidiaries are eligible to receive stock options to purchase shares of common stock.
The table below summarizes the transactions in the Company's stock option plans for the years ended August 31, 1994, 1993 and 1992 (shares of common stock):
The Option Plan generally provides options that are exercisable at prices ranging from $7.03 to $19.21 per share, vest over a period of five years and expire ten years from the date of grant. The Key
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. CAPITAL STOCK (CONTINUED) Employees Plan generally provides options that are exercisable at prices ranging from $7.03 to $22.17 per share, vest over a period of five to ten years based on the attainment of specified performance goals and expire ten years from the date of grant.
EMPLOYEE STOCK PURCHASE PLAN
In January 1993 the Company adopted an Employee Stock Purchase Plan (the "Plan"). The purpose of the Plan is to provide an incentive for employees of the Company to own Holdings' common stock. The plan allows eligible employees to contribute up to 10% of their base earnings to purchase Holdings' common stock quarterly, through payroll deductions, at 85% of the lower of the closing price on the first or last day of the Plan quarter. The Company has reserved 2,300,000 shares of Holdings' common stock for the Plan.
COMMON STOCK SUBJECT TO REPURCHASE OBLIGATIONS
The Company's obligation to repurchase shares of Holdings' common stock held by certain executive officers no longer exists. Accordingly, the amount related to common stock subject to repurchase obligations was recognized as shareholders' equity as of August 31, 1994. As of August 31, 1993 and 1992, shares of Holdings' common stock subject to repurchase obligations were 431,858 and 445,976, respectively.
10. RELATED PARTY TRANSACTIONS In connection with the sale of the Company's interest in EPIC Holdings, Inc., during fiscal 1994 the Company was represented by and paid a fee of approximately $2.3 million to a major shareholder.
In fiscal 1992, an affiliate of a major shareholder served as the lead managing underwriter of the public offering of 16.2 million shares of Holdings common stock, the issuance of the 13 1/2% Senior Subordinated Notes Due 2001 and the 11% Senior Notes Due 2000. This related party received underwriting fees of $.9 million and in addition received advisory fees of $1.3 million in connection with divestitures during fiscal 1992.
An entity associated with a general partner of a major shareholder agreed to provide credit support to domestic hospital subsidiaries of AMI for which such entity received an annual fee in fiscal 1993 and 1992 of $750,000. The credit support commitment was replaced with the fiscal 1993 refinancing of the bank credit facility.
11. EARNINGS PER SHARE Holdings' earnings per share for the years ended August 31, 1994, 1993 and 1992 is based upon the weighted average number of shares of Holdings' common stock outstanding. The impact of common stock equivalents is not considered since they either have an anti-dilutive effect or the effect on dilution is less than three percent.
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. INCOME TAXES (Provision) benefit for income taxes, excluding the tax effect of minority equity interest and the extraordinary loss, for the years ended August 31, 1994, 1993 and 1992 for Holdings and AMI consists of the following (in thousands):
The net tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities as of August 31, 1994 and 1993 are as follows (in thousands):
The net deferred tax liability of $158.3 million and $173.1 million as of August 31, 1994 and 1993, respectively, includes a current asset of $60.3 million and $38.4 million, respectively, and a noncurrent liability of $218.6 million and $211.5 million, respectively. No valuation allowance has been recorded against any deferred tax asset.
In August 1993, the Revenue Reconciliation Act of 1993 was enacted. Among other tax law changes, such law increased the corporate income tax rate from 34% to 35% effective for the period beginning on or after January 1, 1993. For the year ended August 31, 1994, the U.S. statutory tax rate for the Company is 35%.
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. INCOME TAXES (CONTINUED) Holdings' and AMI's income tax provision differed from the amount computed using the U.S. statutory rate for the years ended August 31, 1994, 1993 and 1992 for the following reasons (in thousands):
Prior to fiscal 1992, Holdings had operating loss and capital loss carryforwards for tax purposes of $42 million and $9 million, respectively, which were fully utilized against net income and capital gains arising in fiscal 1992 and against capital gains on assets sold prior to the acquisition of AMI.
13. EXTRAORDINARY LOSSES ON EARLY EXTINGUISHMENT OF DEBT The Company has recognized extraordinary losses on early extinguishment of debt in fiscal 1994, 1993, and 1992. Fiscal 1994 includes an extraordinary loss of $1.9 million ($3.0 million pre-tax) from the repurchase of $15.4 million principal amount of the 15% Junior Subordinated Discount Debentures Due 2005. Fiscal 1993 includes an extraordinary loss of $25.4 million ($41.0 million pre- tax) from the repurchase or redemption of $146.8 million principal amount of outstanding indebtedness. Fiscal 1992 includes an extraordinary loss of $10.0 million ($15.6 million pre-tax) from the repurchase or redemption of $159.0 million of senior indebtedness and $55.4 million of the 9 7/8% unsecured loan stock due 2011.
14. SUPPLEMENTAL CASH FLOW INFORMATION The Company paid income taxes (net of refunds) of $86.0 million and $83.6 million for the years ended August 31, 1994 and 1993, respectively, and received income tax refunds (net of payments) of $22.5 million for the year ended August 31, 1992. The Company paid interest (net of capitalized costs) for the years ended August 31, 1994, 1993 and 1992 of $108.3 million, $120.5 million and $154.1 million, respectively. Capitalized interest costs were $3.5 million, $1.4 million and $2.6 million for August 31, 1994, 1993 and 1992. Interest income was $2.7 million, $13.9 million and $10.0 million for the years ended August 31, 1994, 1993 and 1992.
NON-CASH TRANSACTIONS
During fiscal 1994, the Company assumed net assets of approximately $92.0 million related to the purchase of Saint Francis Hospital and during fiscal 1993, the Company assumed net assets of approximately $8.0 million as a result of the merger of AMI's Tarzana Regional Medical Center and HealthTrust's Encino Hospital.
For the years ended August 31, 1993 and 1992 an $8.2 million and $9.3 million loss, net of tax, respectively, was recognized as a result of the write-off of the discounts and deferred financing costs associated with the early extinguishment of debt.
For the year ended August 31, 1994 approximately $6.0 million was recognized as an increase in shareholders' equity of Holdings due to the elimination of common stock subject to repurchase
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. SUPPLEMENTAL CASH FLOW INFORMATION (CONTINUED) obligations. For the year ended August 31, 1993 $1.8 million was recognized as a decrease in shareholders' equity of Holdings for the common stock subject to repurchase obligations due to market price changes. For the year ended August 31, 1992, there was no market price change and, therefore, no effect on the value of the common stock subject to repurchase obligations.
In fiscal 1992, the Company recognized $27.1 million of debt as a result of the acquisition of the remaining interest in an entity that was previously unconsolidated.
15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) Quarterly financial information for Holdings and AMI for the two years ended August 31, 1994 is summarized below (in millions, except per share amounts):
The third quarter of fiscal 1994 includes the gain on sale of securities of $43.4 million, net of tax, (See Note 4 Dispositions). The results of operations of Saint Francis Hospital were consolidated with the Company's results of operations effective May 1, 1994.
The fourth quarter of fiscal 1993 reflects a charge of $3.5 million for costs incurred related to the relocation of the Houston regional office to the Dallas headquarters. Additional charges totaling $3.0 million were recognized in previous quarters offset by benefits. Income before extraordinary loss includes an $8.6 million refund of interest paid to the Internal Revenue Service in prior periods. Additionally in the fourth quarter of fiscal 1993, the provision for income taxes includes the impact of a $5.1 million increase in the provision for income taxes due to the enactment of the Revenue Reconciliation Act of 1993 which increased the corporate income tax rate.
16. BUSINESS SEGMENT The Company's only material business segment is "healthcare" which accounted for substantially all of its revenues and operating results for each of the periods presented.
17. SUBSEQUENT EVENTS On October 10, 1994, Holdings, National Medical Enterprises, Inc, a Nevada corporation ("NME") and a wholly-owned subsidiary of NME ("Merger Sub"), executed an Agreement and Plan of Merger (the "Merger Agreement"). Pursuant to the Merger Agreement, Merger Sub will merge with and into Holdings (the "Merger"). As a result of the Merger, Holdings will become a wholly-owned subsidiary of NME and the resulting company will be the second-largest healthcare services company in the nation. Under terms of the Merger Agreement each share of common stock of Holdings will be converted into (i) $19.00 in cash, if the closing occurs on or before March 31, 1995,
AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. SUBSEQUENT EVENTS (CONTINUED) and $19.25 thereafter and (ii) 0.42 of a newly issued share of NME common stock. Under the Merger Agreement, Holdings will pay a special dividend of $0.10 per share before the effective date of the Merger. Following the Merger, Holdings will have the right to nominate three members to the 13 member board of the combined company. Approximately 50% of the Company's indebtedness contains put provisions whereby the holders of such debt have the right to require repayment following a change of control of the Company. The transaction has been approved by shareholders of approximately 61.4% of Holdings' outstanding shares of common stock and, therefore, further action by Holdings' shareholders is not required. The transaction, which is currently anticipated to close in the first quarter of calendar 1995, is subject to certain conditions including, among other things, expiration of any applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.
On September 1, 1994, a limited partnership, of which AMI is the general partner, acquired Hilton Head Hospital in Hilton Head, South Carolina containing 68 beds. In connection with the Company's efforts to re-establish a presence in Europe, the Company has entered into a joint venture agreement with a community organization (the "Burgergemeinde") located in Cham, Canton Zug, Switzerland. The joint venture will be owned 90% by the Company and 10% by the Burgergemeinde. Under the terms of the proposed transaction, the Company has entered into a long term lease for the land where the existing hospital is located and will then construct a new 56 bed acute care wing, convert an existing structure into a medical office building and renovate and remodel the existing acute care facility. In addition, the Company plans to contract to provide management, food, physical therapy and rehabilitation services to the hospital, an on-site nursing home and an affiliated retirement community.
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES
To the Board of Directors of American Medical Holdings, Inc. and American Medical International, Inc.
Our audits of the consolidated financial statements referred to in our report dated October 20, 1994 appearing on page of this Annual Report on Form 10-K also included an audit of the Financial Statement Schedules of American Medical Holdings, Inc. (Holdings) and American Medical International, Inc. (AMI) as of and for the years ended August 31, 1994, August 31, 1993 and August 31, 1992 as listed in Item 14(a) of the Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.
PRICE WATERHOUSE LLP
Dallas, Texas October 20, 1994
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AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES SCHEDULE II -- AMOUNTS RECEIVABLE FROM DIRECTORS, OFFICERS AND EMPLOYEES
FOR THE THREE YEARS ENDED AUGUST 31, 1994
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SCHEDULE V -- PROPERTY AND EQUIPMENT
FOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (DOLLARS IN THOUSANDS)
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AMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES
SCHEDULE VI -- ACCUMULATED DEPRECIATION OF PROPERTY AND EQUIPMENT
FOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (DOLLARS IN THOUSANDS)
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SCHEDULE VIII -- RESERVES FOR UNCOLLECTIBLE ACCOUNTS
FOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (DOLLARS IN THOUSANDS)
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SCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION
FOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (DOLLARS IN THOUSANDS)
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