UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
February 18, 2003
- ------------------
(Date of earliest event reported)
LABORATORY CORPORATION OF AMERICA HOLDINGS
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(Exact name of registrant as specified in its charter)
DELAWARE 1-11353 13-3757370
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(State or other (Commission (IRS Employer
jurisdiction of File Number) Identification
incorporation) Number)
358 SOUTH MAIN STREET, BURLINGTON, NORTH CAROLINA 27215
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(Address of principal executive offices)
336-229-1127
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(Registrant's telephone number, including area code)
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL
INFORMATION AND EXHIBITS
(a) Financial Statement of Business Acquired
The balance sheets of Dynacare Inc. as of June 30, 2002
and as of December 31, 2001 and December 31, 2000 and the related
consolidated statements of operations, stockholders' equity, and
cash flows for the six months ended June 30, 2002 and each of the
years in the three year period ended December 31, 2001 are attached
hereto as Exhibits 99.1 and 99.2 and are incorporated herein by
reference.
(c) Exhibits
23 Consent of Ernst & Young LLP
99.1 Balance sheet of Dynacare Inc. as of June 30, 2002 and the
related consolidated statements of operations, stockholders'
equity, and cash flows for the six months ended June 30, 2002.
99.1 Balance sheet of Dynacare Inc. as of December 31, 2001 and
2000, and the related consolidated statements of operations,
stockholders equity, and cash flows for each of the years in
the three year period ended December 31, 2001.
SIGNATURES
Pursuant to the requirements of the Securities and
Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the
undersigned hereunto duly authorized.
LABORATORY CORPORATION OF AMERICA HOLDINGS
------------------------------------------
(Registrant)
By:/s/ BRADFORD T. SMITH
--------------------------------
Bradford T. Smith
Executive Vice President
and Secretary
Date: February 18, 2003
Exhibit 23
Consent of Independent Auditors
We consent to the incorporation by reference in the following registration
statements of Laboratory Corporation of America Holdings:
Form S-8 (No. 333-102602) DIANON Systems, Inc. 1996 Stock Incentive Plan
DIANON Systems, Inc. 1999 Stock Incentive Plan
DIANON Systems, Inc. 2000 Stock Incentive Plan
DIANON Systems, Inc. 2001 Stock Incentive Plan
UroCor, Inc. Second Amended and Restated 1992
Stock Option Plan
Form S-8 (No. 333-97745) Dynacare Inc. Amended and Restated Employee Stock
Option Plan
Form S-8 (No. 333-90764) Laboratory Corporation of America Holdings Amended
and Restated 2000 Employee Stock Option Plan
Form S-3 (No. 333-71896) $744,000,000 of Liquid Yield Option - Trademark-
Option Notes due 2021 ("LYONs") (Zero Coupon
Subordinated)
Form S-8 (No. 33-43006-99) National Health Laboratories Incorporated 1988
Stock Option Plan
Form S-8 (No. 33-55065) National Health Laboratories Incorporated 1994
Stock Option Plan
Form S-8 (No. 333-39735) Laboratory Corporation of America Holdings 1995
Stock Plan for Non-Employee Directors
Form S-8 (No. 333-94329) Laboratory Corporation of America Holdings Amended
and Restated 1999 Stock Incentive Plan
Form S-8 (No. 333-94331) Laboratory Corporation of America Holdings 1997
Employee Stock Purchase Plan
of our report dated March 20, 2002, with respect to the consolidated financial
statements of Dynacare Inc. included in Exhibit 99.2 of the Current Report on
Form 8-K of Laboratory Corporation of America Holdings, dated February 18,
2003.
/s/ Ernst & Young LLP
Dallas, Texas
February 18, 2003
EXHIBIT 99.1
Dynacare Inc.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
As at
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(in thousands of U.S dollars) June 30, December 31,
2002 2001
(Unaudited) (Audited)
- -----------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 21,893 $ 30,002
Accounts receivable 81,321 72,895
Prepaid expenses 5,018 3,074
Inventory 10,750 11,314
Deferred income taxes 5,059 5,059
- ---------------------------------------------------------------------------
Total current assets 124,041 122,344
Capital assets 51,913 51,722
Goodwill 102,080 100,194
Intangible assets 83,537 81,037
Other assets 24,197 29,028
- ---------------------------------------------------------------------------
$ 385,768 $ 384,325
===========================================================================
LIABILITIES
Current liabilities:
Bank indebtedness $ 7,642 $ 3,890
Accounts payable and accrued liabilities 40,229 48,701
Current portion of deferred income taxes 12,799 12,799
Current portion of long term debt 1,959 2,265
- ---------------------------------------------------------------------------
Total current liabilities 62,629 67,655
Long term debt 202,943 201,811
Deferred income taxes 26,975 22,574
Shareholders' equity:
Capital stock 123,505 122,855
Deficit (29,053) (32,368)
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94,452 90,487
Foreign currency translation adjustment (1,231) 1,798
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93,221 92,285
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$ 385,768 $ 384,325
===========================================================================
2
Dynacare Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the six months ended June 30, (Unaudited)
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(in thousands of U.S. dollars, except per share data)
2002 2001
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Revenues $ 217,898 $ 197,681
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General and operating expenses 188,882 170,146
Depreciation 7,004 5,775
Amortization customer lists and contracts 494 --
Amortization of licenses and goodwill -- 2,788
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196,380 178,709
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Operating earnings 21,518 18,972
Interest expense 8,505 10,645
Disposition of partnership interests 7,120 --
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Earnings before income taxes 5,893 8,327
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Income tax expense
Current 1,670 1,380
Deferred 908 (1,005)
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2,578 373
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Net earnings $ 3,315 $ 7,954
===========================================================================
Earnings per share - Basic $ 0.17 $ 0.47
Earnings per share - Fully-diluted $ 0.16 $ 0.46
CONSOLIDATED STATEMENTS OF DEFICIT
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(in thousands of U.S. dollars) For the six Year
months ended ended
June 30, December 31,
2002 2001
(Unaudited) (Audited)
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Deficit, beginning of period $ (32,368) $ (44,085)
Net earnings 3,315 11,717
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Deficit, end of period $ (29,053) $ (32,368)
============================================================================
3
Dynacare Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended June 30, (Unaudited)
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(in thousands of U.S. dollars) 2002 2001
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CASH FLOWS (USED IN) PROVIDED BY OPERATING ACTIVITIES:
Earnings $ 3,315 $ 7,954
Items not affecting cash and cash equivalents
Depreciation 7,004 5,775
Amortization of customer lists and
contracts 494 --
Amortization of licenses and goodwill -- 2,788
Deferred income taxes 908 (1,006)
Loss on disposition of partnership
interests 6,091 --
Net change in non-cash working capital items (18,658) (9,242)
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(846) 6,269
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CASH FLOW USED IN INVESTING ACTIVITIES:
Acquisition of businesses (1,886) (10,429)
Purchase of capital assets (5,249) (4,204)
Decrease (increase) in other assets - net 280 (3,471)
Payments on disposition of partnership
interests - net (3,716) --
- ----------------------------------------------------------------------
(10,571) (18,104)
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CASH FLOW PROVIDED BY FINANCING ACTIVITIES:
Increase in bank indebtedness 3,752 3,917
Decrease in long term debt (566) (396)
Issuance of capital stock 650 330
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3,836 3,851
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Foreign exchange translation adjustments (528) 55
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Decrease in cash and cash equivalents during
the period (8,109) (7,929)
Cash and cash equivalents, beginning of period 30,002 18,099
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Cash and cash equivalents, end of period $ 21,893 $ 10,170
======================================================================
4
DYNACARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(in thousands of U.S. dollars, except for share and per share amounts)
1. Basis of Presentation
The Company's unaudited interim consolidated financial statements have
been prepared in accordance with Canadian Generally Accepted Accounting
Principles ("GAAP") and the instructions of Form 10-Q and Article 10 of
Regulation S-X.
In the opinion of management, the unaudited interim consolidated financial
statements of the Company reflect all adjustments, which consist only of
normal and recurring adjustments, necessary to present fairly the financial
position as at June 30, 2002 and results of operations and cash flows for
the six months ended June 30, 2002 and 2001. These unaudited interim
consolidated financial statements follow the same accounting policies and
methods of their application as the most recent annual consolidated
financial statements of the Company, except for the adoption of the
Canadian Institute of Chartered Accountants handbook sections 1581 -
Business Combinations and 3062 - Goodwill and Other Intangible Assets
Effective January 1, 2002. Operating results for the six months ended
June 30, 2002, are not necessarily indicative of the operating results
that may be expected for the year ending December 31, 2002.
2. Earnings Per Share
The Company's earnings per share data was computed as follows:
Six months ended June 30, 2002 2001
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Basic earnings per share
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Net earnings $ 3,315 $ 7,954
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Weighted average number of common shares
outstanding during the period 19,331,613 16,891,418
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Basic earnings per share $ 0.17 $ 0.47
==============================================================================
Diluted earnings per share
- ------------------------------------------------------------------------------
Net earnings $ 3,315 $ 7,954
- ------------------------------------------------------------------------------
Weighted average number of common shares
outstanding during the period 19,331,613 16,891,418
Stock options 1,273,674 255,193
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20,605,287 17,146,611
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Diluted earnings per share $ 0.16 $ 0.46
==============================================================================
5
3. Goodwill and Other Intangible Assets - Adoption of CICA 3062
As a result of the Company's adoption of CICA 3062, adjusted net earnings
and earnings per share for the six months ended June 30, 2002 and 2001
related to the Company's goodwill and intangible assets that are no longer
being amortized (including any related income tax effects) are as follows:
For the Six Months Ended June 30, 2002 2001
- -----------------------------------------------------------------------------
Reported net earnings $ 3,315 $ 7,954
Addback: Goodwill amortization -- 842
Addback: Licenses amortization -- 910
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Adjusted net earnings $ 3,315 $ 9,706
=============================================================================
Basic earnings per share
- -----------------------------------------------------------------------------
Reported net earnings $ 0.17 $ 0.47
Goodwill amortization -- .05
Licenses amortization -- .05
- -----------------------------------------------------------------------------
Adjusted net earnings $ 0.17 $ 0.57
=============================================================================
Diluted earnings per share
- -----------------------------------------------------------------------------
Reported net earnings $ 0.16 $ 0.46
Goodwill amortization -- .05
Licenses amortization -- .05
- -----------------------------------------------------------------------------
Adjusted net earnings $ 0.16 $ 0.56
=============================================================================
The Company's licenses and goodwill based on the requirements of CICA 3062
are deemed to have an indefinite useful life and accordingly effective
January 1, 2002, the Company no longer amortizes its licenses and goodwill.
The Company's remaining intangible assets continue to be amortized over
their estimated useful life.
4. Segment Information
Management of the Company has determined that the Company operates one
business segment, the provision of clinical laboratory services. The
Company provides clinical laboratory services in two geographic areas,
the United States and Canada.
As at and for the
six months ended
June 30, 2002 2001
- -----------------------------------------------------------------------------
U.S. Canada Total U.S. Canada Total
------- -------- ------- -------- -------- -------
Revenues $163,991 $ 53,907 $217,898 $144,914 $ 52,767 $197,681
6
5. Commitments and Contingencies
In January 2002, one of the Company's partnerships entered into a new
lease, which has resulted in the early termination of its existing lease.
The Company expects to remain it its existing leased premises until October
31, 2002. The lease termination cost has been estimated at $0.4 million,
and will be recorded by the Company in its consolidated financial
statements in the fourth quarter of 2002.
In 1995 the Company sold its retirement homes division. On the sale of
one of the retirement homes, the purchaser assumed two mortgages with a
total balance of $10.9 million at June 30, 2002 and $11.7 million at
December 31, 2001. The Company has not been formally discharged from the
mortgages, however, the Company has been indemnified by the purchaser
and does not expect non-performance. Then mortgages bear interest at 10.0%
per annum and are repayable in 2003 and 2004.
The Company is contingently liable with respect to litigation and claims
which arise from time to time. Litigation is subject to many uncertainties,
and the outcome of individual matters is not predictable. It is reasonably
possible that the final resolution of some of these matters may require the
Company to make expenditures in excess of estimates, over an extended
period of time and in a range of amounts that cannot be reasonably
estimated at this time. However, in the opinion of management, any
liabilities that may arise from these contingencies would not have a
material adverse affect on the financial position and results of operations
of the Company.
6. Disposition of Partnership Interests
During the six month period ended June 30, 2002, the Company reached an
agreement with its partners to terminate its partnerships in Pittsburgh, PA
and Schenectady, NY. The Company recorded a charge of $7.1 million or $4.7
million after tax, in connection with the termination of these
partnerships.
7. Subsequent Event - Acquisition of the Company
On July 25, 2002, Laboratory Corporation of America Holdings ("LabCorp")
completed the acquisition of all of the outstanding stock of the Company
in a combination cash and stock transaction with a combined value of
approximately $495.3 million, including transaction costs. LabCorp also
converted approximately 553,958 unvested stock options of the Company into
297,049 unvested LabCorp options to acquire LabCorp shares at terms
comparable to those under the Company's stock option plan. In conjunction
with this acquisition, LabCorp repaid the Company's existing $204.4 senior
subordinated unsecured notes, including a call premium of approximately
$7.0 million.
16
6
EXHIBIT 99.2 REPORT OF INDEPENDENT AUDITORS To the Shareholders of Dynacare Inc. We have audited the consolidated statements of financial position of Dynacare Inc. as at December 31, 2001 and 2000, and the consolidated statements of operations, deficit and cash flows for each of the years in the three-year period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and United States generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2001 and 2000, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2001, in accordance with Canadian generally accepted accounting principles. /s/ Ernst & Young LLP Dallas, Texas March 20, 2002DYNACARE INC. CONSOLIDATED STATEMENTS OF FINANCIAL POSITION December 31, - --------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 - --------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents (Note 17) $ 30,002 $ 18,099 Accounts receivable (Note 19) 72,895 62,065 Prepaid expenses 3,074 2,654 Inventory 11,314 7,692 Deferred income taxes (Note 11) 5,059 5,956 - --------------------------------------------------------------------------- Total current assets 122,344 96,466 - --------------------------------------------------------------------------- Capital assets (Note 3) 51,722 45,907 Licenses and goodwill (Note 4) 181,231 166,691 Other assets (Note 5) 29,028 39,912 - --------------------------------------------------------------------------- 261,981 252,510 - --------------------------------------------------------------------------- $ 384,325 $ 348,976 =========================================================================== LIABILITIES Current liabilities: Bank indebtedness (Note 6) $ 3,890 $ -- Accounts payable and accrued liabilities 48,701 44,995 Current portion of deferred income taxes (Note 11) 12,799 10,961 Current portion of long-term debt (Note 7) 2,265 5,913 - --------------------------------------------------------------------------- Total current liabilities 67,655 61,869 Long-term debt (Notes 7 and 8) 201,811 202,287 Deferred income taxes (Note 11) 22,574 29,569 - --------------------------------------------------------------------------- 292,040 293,725 - --------------------------------------------------------------------------- SHAREHOLDERS' EQUITY Capital stock (Note 9) 122,855 98,357 Deficit (32,368) (44,085) - --------------------------------------------------------------------------- 90,487 54,272 Foreign currency translation adjustment 1,798 979 - --------------------------------------------------------------------------- 92,285 55,251 - --------------------------------------------------------------------------- $ 384,325 $ 348,976 =========================================================================== Commitments and contingencies (Notes 14 and 15) See accompanying notes to consolidated financial statements Approved on behalf of the Board (signed) Harvey A. Shapiro (signed) William T. Brock Director Director F-2
DYNACARE INC. CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended December 31, - ------------------------------------------------------------------------------- (in thousands of U.S. dollars, except for share and per share amounts) 2001 2000 1999 - ------------------------------------------------------------------------------- C> Revenues (Note 19) $ 402,359 $ 352,919 $ 272,677 - ------------------------------------------------------------------------------- General and operating expenses 349,474 304,809 229,633 Depreciation 12,072 11,368 8,351 Amortization of licenses and goodwill 5,788 5,279 4,707 Severance, relocation and other charges -- 6,750 -- - ------------------------------------------------------------------------------- 367,334 328,206 242,691 - ------------------------------------------------------------------------------- Operating earnings 35,025 24,713 29,986 Interest expense (Notes 6 and 7) 20,431 22,477 19,457 - ------------------------------------------------------------------------------- Earnings before income taxes 14,594 2,236 10,529 Income tax expense (benefit) (Note 11) Current 3,138 3,044 2,706 Deferred (261) (6,833) 2,182 - ------------------------------------------------------------------------------- 2,877 (3,789) 4,888 - ------------------------------------------------------------------------------- Net earnings $ 11,717 $ 6,025 $ 5,641 =============================================================================== Earnings Per Share (Note 18) - ------------------------------------------------------------------------------- Basic $ 0.68 $ 0.48 $ 0.47 =============================================================================== Diluted $ 0.66 $ 0.46 $ 0.45 =============================================================================== Weighted average number of common shares outstanding-Basic 17,211,138 12,482,368 11,880,914 =============================================================================== Weighted average number of common shares outstanding-Diluted 17,885,180 13,143,971 12,464,105 =============================================================================== See accompanying notes to consolidated financial statements CONSOLIDATED STATEMENTS OF DEFICIT Years Ended December 31, - - ---------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 1999 - ------------------------------------------------------------------------------- Deficit, beginning of year $ (44,085) $ (49,343) $ (54,984) Net earnings 11,717 6,025 5,641 Increase in stated capital (Note 9) -- (767) -- - - ---------------------------------------------------------------------------- Deficit, end of year $ (32,368) $ (44,085) $ (49,343) ============================================================================== See accompanying notes to consolidated financial statements F-3
DYNACARE INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, - ----------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 1999 - ----------------------------------------------------------------------------- CASH FLOW FROM OPERATING ACTIVITIES Net earnings $ 11,717 $ 6,025 $ 5,641 Adjustments to reconcile net earnings to net cash provided by operations: Depreciation 12,072 11,368 8,351 Amortization of licenses and goodwill 5,788 5,279 4,707 Deferred income taxes (261) (6,833) 2,182 Gain on sale of capital assets -- (110) (11) Severance, relocation and other charges -- 3,021 -- Change in non-cash working capital, net of effect of acquisitions (Note 17) (6,512) 5,168 (16,106) - ----------------------------------------------------------------------------- 22,804 23,918 4,764 - ----------------------------------------------------------------------------- CASH FLOW USED IN INVESTING ACTIVITIES Acquisition of businesses (Notes 2 and 17) (17,670) (39,551) (21,086) Purchase of capital assets (Note 17) (11,804) (13,852) (10,990) Proceeds from sale of capital assets -- 132 68 Increase in other assets (4,037) (8,436) (5,528) - ------------------------------------------------------------------------------ (33,511) (61,707) (37,536) - ------------------------------------------------------------------------------ CASH FLOW PROVIDED BY FINANCING ACTIVITIES Increase (decrease) in bank indebtedness 3,890 (5,812) (6,855) Proceeds from long-term debt 1,577 4,525 71,078 Repayment of long-term debt (6,054) (6,354) (18,090) Issue of capital stock-net proceeds (Note 9) 24,498 46,433 -- - ------------------------------------------------------------------------------ 23,911 38,792 46,133 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ Foreign exchange translation adjustments (1,301) 769 (1,735) - ------------------------------------------------------------------------------ Increase in cash and cash equivalents during the year 11,903 1,772 11,626 Cash and cash equivalents, beginning of year 18,099 16,327 4,701 - ------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 30,002 $ 18,099 $ 16,327 =============================================================================== See accompanying notes to consolidated financial statements F-4
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands of U.S. dollars, except for share and per share amounts) 1. Summary of significant policies These financial statements have been prepared in accordance with Canadian generally accepted accounting principles (Canadian GAAP), which are in all material respects in accordance with United States generally accepted accounting principles and practices prescribed by the United States and Securities Exchange Commission (U.S. GAAP), except as outlined in Note 21. The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting year. Actual amounts could differ from those estimates. The significant accounting policies are as follows: Nature of business Dynacare Inc. and its subsidiary companies (the Company) provide clinical laboratory services in the United States and Canada. Principles of consolidation The consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiaries. The consolidated financial statements also include the Company's proportionate share of the assets, liabilities, revenues and expenses in the following clinical laboratory partnerships in which it is a participant: HH/DL, L.P. (Texas Partnership) DL/ELLIS, L.L.C. (Ellis Partnership) United/Dynacare L.L.C. (United Partnership) DL/UHS Inc. (Tennessee Partnership) Dynacare/WPAHS L.L.C. (Allegheny Partnership) Dynacare-Gamma Laboratory Partnership (Ontario Partnership) Dynacare Kasper Medical Laboratories (Alberta Partnership) The proportionate consolidation method of accounting is used when contractual arrangements exist which allow for joint control over the strategic operating, investing and financing activities of the entity. On October 31, 2001, the Company purchased the remaining 50% partnership interest in the Texas Partnership from its partner Memorial Health Ventures. Accordingly, subsequent to October 31, 2001, the Company consolidated 100% of the assets, liabilities, revenues and expenses of the Texas Partnership. F-5
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Cash equivalents Cash equivalents consist of short-term investments, which have remaining maturities of three months or less from the date of purchase, and are carried at cost which approximates market. Revenue recognition Revenues are recognized on the accrual basis at the time services are provided, which for clinical laboratories approximate the time test results are reported. Revenues are stated net of all contractual allowances and discounts. Depreciation Capital assets are stated at cost. Depreciation is provided on the declining-balance basis at the annual rates set out below: Buildings............................................5% Medical equipment...................................20% Furniture and fixtures..............................20% Computer equipment..................................30% Motor vehicles......................................30% Leasehold improvements are amortized on the straight-line basis over the term of the lease, plus one renewal option. Inventory Inventory is stated at the lower of cost determined on a first-in, first-out basis, and replacement cost. Licenses and goodwill Licenses and goodwill, which arise on acquisitions, are recorded at cost and are amortized on the straight-line basis primarily over 40 years. The amortization policy has been adopted after consideration of various factors including the essential nature and continuing demand for laboratory services, barriers to entry, the perpetual nature of licenses, and a significant market share created in a number of the markets in which the Company operates. Laboratory licenses are required to operate clinical laboratories and to receive reimbursement in Ontario. Although new licenses are rarely issued, existing licenses of the Company and its competitors have been routinely renewed on an annual basis, provided the laboratory adheres to certain regulations. The Company complies with the applicable regulations, has never had a license renewal denied and as such believes it is unlikely that these licenses will be revoked. The Company reviews the valuation and amortization of licenses and goodwill on a regular basis, taking into consideration any events or circumstances that might have impaired the carrying value. The amount of impairment, if any, is measured based on undiscounted projected cash flow compared to the carrying value. F-6
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Foreign currency translation a) Reporting Currency Effective July 1, 2000, the Company adopted the U.S. dollar as its reporting currency as more than 50% of the Company's revenues are generated in the United States, coupled with the Company's continued growth in the United States. Prior to July 1, 2000, the Company's consolidated financial statements were presented in Canadian dollars. The consolidated financial statements and notes for all periods prior to June 30, 2000, have been restated in U.S. dollars in accordance with Canadian generally accepted accounting principles using the July 1, 2000, exchange rate of Cdn$1.48 per U.S.$1.00. The functional currencies of each of the Company's operations in the United States and Canada are unchanged. The assets and liabilities of the Company's operations having a functional currency other than the U.S. dollar are translated into U.S. dollars using the exchange rate in effect at the year-end, and revenues and expenses are translated at the average rate during the year. The average and year-end U.S. to Canadian dollar exchange rate was $1.55 and $1.59 (2000 - $1.50 and $1.50), respectively. Exchange gains or losses on translation of the Company's net investment in these operations are included in the foreign currency translation adjustment component of shareholders' equity. The exchange gains or losses accumulated in the foreign currency translation adjustment component of shareholders' equity are not included in operations until realized through a reduction in the Company's net investment in such operations. b) Foreign Exchange Transactions Foreign exchange translation adjustments arising from long-term debt repayable in a currency different than an operation's functional currency are deferred over the remaining term of the debt or, if the long-term debt is designated as a hedge of the net investment in self-sustaining foreign operations, exchange translation adjustments are included in the foreign currency translation adjustment component of shareholders' equity. Income taxes The Company follows the liability method of tax allocation. Under this method, deferred tax assets and liabilities are recognized based on the temporary differences between the accounting and tax bases of assets and liabilities. The calculation of deferred tax assets and liabilities is based on substantially enacted tax rates and laws that will be in effect when the temporary differences are expected to reverse (Note 11). Financial instruments The Company does not hold or issue financial instruments for trading purposes. Amounts receivable or payable under currency swaps, utilized as hedges, are included in the statement of financial position as either long-term assets or long-term liabilities. Foreign exchange gains or losses on the related hedged assets or liabilities are included in the carrying amount of such assets and liabilities, and are matched against the related gains and losses on the currency swaps. Costs for purchased interest rate swap agreements are amortized to interest expense over the term of the swaps. Unamortized costs are included in other assets in the statement of financial position. Payments and receipts under interest rate swap contracts are recognized as adjustments to interest expense. F-7
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Earnings per share Earnings per share are calculated on net earnings using the weighted average number of shares outstanding. Fully diluted earnings per share are calculated on the weighted average number of shares outstanding during the year assuming all the dilutive stock options had been exercised into common shares of the Company at the beginning of the year, or date of issuance, if later. The treasury stock method is used in recognizing the use of proceeds that could be obtained upon exercise of stock options in computing fully diluted earnings per share. The treasury stock method assumes that the proceeds received by the Company upon the exercise of stock options would be used to purchase common shares outstanding at the average market price during the year. Stock-based compensation plans The Company has two stock-based compensation plans, which are described in Note 9. No compensation expense is recognized for these plans when stock options are issued to employees or directors. Any consideration paid by employees on exercise of stock options is credited to share capital. 2. Acquisitions The Company has acquired clinical laboratories and has accounted for these acquisitions using the purchase method. The purchase price has been allocated as follows: December 31, - - ---------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 - ------------------------------------------------------------------------------ Capital and other assets $ 300 $ 4,705 Goodwill 17,870 36,172 - ------------------------------------------------------------------------------ Net assets $ 18,170 $ 40,877 ============================================================================== Purchase consideration: Cash $ 11,580 $ 38,497 Promissory notes payable 2,077 1,326 Short-term liabilities 4,513 1,054 - ------------------------------------------------------------------------------ $ 18,170 $ 40,877 ============================================================================== On October 31, 2001, the Company purchased the remaining 50% partnership interest in the Texas Partnership from its partner Memorial Health Ventures for a purchase price of $7.2 million. The purchase price consideration included cash of $2.0 million, promissory notes payable of $1.0 million and an assumption of net short-term liabilities of $4.2 million. The goodwill arising on the acquisition of $7.2 million is not subject to amortization. This accounting treatment is in accordance with the Canadian Institute of Chartered Accountants Handbook Section, Goodwill and other Intangible Assets - 3062 (CICA - - 3062), which states that acquisitions of goodwill and intangible assets made after June 30, 2001 and deemed to have an indefinite life, will no longer be amortized but will be subject to annual impairment tests. All other goodwill and other intangible assets acquired prior to or as of June 30, 2001, continued to be amortized during the year ended December 31, 2001. Beginning on January 1, 2002, all goodwill and other intangible assets deemed to have an indefinite life will no longer be amortized but will be subject to annual impairment tests. F-8
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In June 2001, the Company through two of its partnerships in the United States, purchased the laboratory assets and operations of two laboratories located in Texas and Illinois for a purchase price of $2.3 million. The purchase price consideration included cash of $1.2 million, short-term liabilities of $0.1 million and a promissory note payable of $1.0 million. The goodwill arising on these acquisitions of $2.3 million is being amortized over terms ranging from 3 to 30 years. Additionally, in July 2001, the Company through a joint venture in the United States purchased the laboratory assets and operations of another laboratory in Illinois. The purchase price consideration was cash of $0.4 million. The goodwill arising on the acquisition of $0.4 million is being amortized over 15 years. On March 1, 2001, the Company purchased the laboratory assets and operations of Medical Arts Laboratory located in Oklahoma for a purchase price of $7.7 million. The purchase price consideration included cash of $7.5 million and short-term liabilities of $0.2 million. The goodwill arising on the acquisition of $7.5 million is being amortized over 40 years. In March 2000, the Company acquired the outstanding common shares of a clinical laboratory located in Alabama for a purchase price of $23.8 million. The purchase price consideration included cash of $22.0 million, long-term debt of $1.2 million and short-term liabilities of $0.6 million. The goodwill arising on the acquisition of $20.9 million is being amortized over 40 years. In addition, during 2000 the Company purchased the assets and operations of five clinical laboratory operations located in the United States for a purchase price of $14.7 million. The purchase price consideration included cash of $14.1 million, promissory notes payable of $0.1 million and short-term liabilities of $0.5 million. The goodwill arising on these acquisitions of $14.3 million is being amortized over periods ranging from 15 to 40 years. Also during 2000, the Company entered into a partnership with a hospital located in Pennsylvania. The Company's capital contribution to the partnership was cash of $2.4 million. The goodwill arising on the partnership formation of $1.0 million is being amortized over 30 years. Results of operations of the above acquisitions have been included in the statement of operations from the respective dates of acquisition. On October 1, 2000, the Company sold its direct ownership interests of certain of its operations located in Texas to the Texas Partnership for proceeds of $17.6 million which represented the value of the Company's investment in these operations. The purchase price for these acquisitions was financed by the Company and in return the Company received preferred partnership units on which it was entitled to earn a 20% return. The preferential partnership units had proposed terms of repayment of three years or more subject to certain provisions in the capital contribution agreement. Immediately following the Company's purchase of the remaining 50% partnership interest in the Texas Partnership, the Company's preferred partnership units, including the accrued investment income on these units, were converted into capital units of the partnership. F-9
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. CAPITAL ASSETS December 31, - ----------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 - ----------------------------------------------------------------------------- Land $ 3,493 $ 3,665 Buildings 8,783 9,123 Medical equipment 19,867 15,491 Leasehold improvements 14,206 10,964 Furniture and fixtures 5,038 4,046 Computer equipment 38,053 30,102 Vehicles 1,098 692 - ----------------------------------------------------------------------------- 90,538 74,083 Accumulated depreciation (38,816) (28,176) - ----------------------------------------------------------------------------- $ 51,722 $ 45,907 ============================================================================= 4. LICENSES AND GOODWILL December 31, - ------------------------------------------------------------------------------ (in thousands of U.S. dollars) 2001 2000 - ------------------------------------------------------------------------------- Licenses $ 149,038 $ 157,820 Goodwill 156,915 133,794 - ------------------------------------------------------------------------------- 305,953 291,614 Accumulated amortization and impairment (1) (124,722) (124,923) - ------------------------------------------------------------------------------- $ 181,231 $ 166,691 =============================================================================== (1) During 1997, the Company completed a major review of its laboratory operations and as a result of certain adverse changes in the clinical laboratory industry and its businesses, an impairment charge of $79.4 million was recorded. 5. Other assets December 31, - ------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 - ------------------------------------------------------------------------------- Investments and property held for sale $ 6,773 $ 19,305 Currency swap receivable 12,373 7,312 Amounts receivable 3,374 4,422 Deferred financing costs (1) 6,508 8,873 - ------------------------------------------------------------------------------- $ 29,028 $ 39,912 =============================================================================== (1) Net of accumulated amortization of $7.5 million at December 31, 2001 (2000 - $6.0 million). F-10
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. BANK INDEBTEDNESS The Company has a $35.0 million revolving credit facility for working capital purposes in the United States which can be drawn to a maximum amount of the lesser of i) $35.0 million or ii) 80% of all eligible receivables plus 50% of eligible inventory. The Company has pledged the accounts receivable and inventory of the Company's U.S. wholly owned subsidiaries as collateral for this facility. This facility matures on September 12, 2002, and bears interest at a fluctuating rate per annum as follows: i) prime rate loans, at U.S. prime plus the applicable margin in effect and ii) Euro loans, at adjusted Euro rate plus the applicable Euro margin. In Canada, the Company has revolving credit facilities for working capital purposes totaling approximately Cdn$23.3 million ($14.6 million). Collateral for these operating facilities consists of an assignment of certain accounts receivable and inventory. Interest on these credit facilities varies between Canadian prime rate and prime plus 2%. For the year ended December 31, 2001, interest on the Company's operating loans amounted to $0.3 million (2000 - $1.6 million, 1999 - $0.6 million). 7. LONG-TERM DEBT December 31, - ------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 - ------------------------------------------------------------------------------- $195 million (2000--$195 million) senior unsecured notes payable, interest at 10.75% maturing in 2006 and other long-term debt with interest ranging from 0% to 10.1% maturing through 2006 $ 204,076 $ 208,200 Less: current portion (2,265) (5,913) - ------------------------------------------------------------------------------- $ 201,811 $ 202,287 =============================================================================== The senior unsecured notes are redeemable in whole or in part at the option of the Company on or after January 15, 2001, at a premium redemption price of 105.375% decreasing to par on January 15, 2004 and thereafter. The indenture governing the senior unsecured notes contains certain restrictions including restrictions on the payment of dividends and the incurrence of additional indebtedness. At December 31, 2001, long-term debt includes Canadian denominated debt Totaling Cdn$6.0 million ($3.7 million) (2000 - Cdn$6.8 million ($4.5 million)). For the year ended December 31, 2001, interest on long-term debt amounted to $20.1 million (2000 - $21.2 million, 1999 - $20.2 million). For the year ended December 31, 2001, the average interest rate on bank indebtedness and long-term debt including the effect of the interest rate swaps was 9.8% (2000 - 10.3%, 1999 - 10.4%). F-11
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The long-term debt at December 31, 2001, is repayable as follows: (in thousands of U.S. dollars) - ------------------------------------------------------------------------------- 2002 $ 2,265 2003 2,723 2004 1,819 2005 425 2006 195,160 Thereafter 1,684 - ------------------------------------------------------------------------------- $204,076 =============================================================================== 8. FINANCIAL INSTRUMENTS The Company does not hold or issue financial instruments for trading purposes. A limited number of financial instruments are used to manage well-defined risks associated with fluctuations in foreign currencies and to manage interest costs. The Company's currency swap agreement effectively converts a portion of its U.S. dollar denominated borrowings to Canadian dollars to match the Company's Canadian dollar denominated assets and cash flows. Under interest rate swaps, the Company agrees with its counterparty to exchange, at specified intervals, the difference between fixed rate and floating rate interest amounts calculated by reference to an agreed upon notional principal amount. The amounts exchanged are based on the notional amounts, however, the notional amounts do not represent the Company's exposure to credit or market loss. The net effect of the swaps is to convert certain fixed rate liabilities which mature in 2006 to fixed and variable rate liabilities. The counterparty to the financial instruments is an international financial institution. The Company has not obtained collateral or other security to support the financial instruments. Although the Company is potentially exposed to credit loss, it does not anticipate nonperformance by the counterparty given its high credit rating. On January 24, 1996, the Company entered into a currency and interest rate swap agreement, with a ten-year term to January 15, 2006, whereby $85.0 million of long-term debt was swapped into $116.5 million Canadian dollar denominated debt. On February 29, 2000, Dynacare Inc. entered into cross currency and interest rate swap agreements due January 15, 2006, whereby Dynacare Inc. has swapped $85.5 million Canadian dollar denominated receivables due from certain of its subsidiaries for $58.9 million. These same subsidiaries have swapped in aggregate $85.5 million Canadian dollar denominated debt due to Dynacare Inc. into $58.9 million. As at December 31, 2001, the Company has entered into a number of interest rate swaps. The net effect is to convert fixed rate debt, which mature in 2006 to fixed and variable rate debt with maturity terms ranging from three months to four years with a weighted average interest rate of 9.8% (2000 - 11.0%). At maturity, both fixed and variable rate swaps are automatically renewable at the option of the Company. F-12
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The only financial instrument that potentially subjects the Company to concentrations of credit risk is accounts receivable. However, this credit risk is reduced as a significant amount of accounts receivable are from hospitals under long-term contracts in the United States and government agencies in Canada. The Company does not foresee a credit risk associated with receivables from hospitals in the United States and government agencies in Canada. The Company believes that the allowance for doubtful accounts is adequate to provide for normal credit losses with respect to its remaining accounts receivable. The carrying amount of cash and cash equivalents, accounts receivable, other amounts receivable, bank indebtedness, and accounts payable and accrued liabilities are considered to be representative of their respective fair values. The fair value of the borrowed funds is determined by recent market quotations and by discounting the future contractual cash flows under current financing arrangements, at discount rates which represent borrowing rates presently available to the Company for loans with similar terms and remaining maturity, less costs of settlement. The fair value of interest rate and currency swaps is based on quoted market prices from financial institutions for similar financial instruments. At December 31, 2001, the estimated fair value for the long-term debt is $211.3 million (2000 - $197.1 million). The estimated fair value of favorable currency and interest rate swaps at December 31, 2001, is $27.5 million (2000 - $12.6 million) and the estimated fair value of unfavorable currency and interest rate swaps is $9.3 million (2000 - $5.3 million). 9. CAPITAL STOCK The Company's share capital is comprised as follows: December 31, - ------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 - ------------------------------------------------------------------------------- Authorized Unlimited number of common shares Issued and outstanding common shares: Common shares (2001- 19,278,977; 2000 - 16,883,914) $122,855 $ 98,357 - ------------------------------------------------------------------------------- $122,855 $ 98,357 =============================================================================== On November 16, 2001, the Company completed a public offering of its common shares. The Company issued 2,300,000 common shares for total proceeds of $25.3 million (before after tax costs of $1.4 million). In addition, as part of the equity offering principal shareholders of the Company sold 2,300,000 common shares for gross proceeds of $25.3 million. On November 22, 2000, the Company completed an initial public offering of its common shares. The Company issued 5,003,000 of common shares for total proceeds of $50.0 million (before after tax costs of $3.6 million). F-13
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Upon the closing of the Company's initial public offering of its common shares, the Company converted all of its outstanding classes of common shares (including common shares issuable upon exercise of the Company's stock options) into a single class of common shares on a one-for-one basis and completed a 0.6927-for-1 reverse stock split of all its outstanding common shares (including common shares issuable upon exercise of the Company's stock options). As a result of the conversion and reverse stock split, 8,636,790 Class B common shares and 8,514,811 Class C common shares were exchanged into 11,880,914 common shares of the Company. All prior years capital stock and stock option information presented has been adjusted for the Company's special and common share conversion and reverse stock split. On September 28, 2000, all of the Company's outstanding special shares were converted into Class B common shares and Class C common shares at a rate of 1.5504 Class B or C common shares for each special share. Additionally, on September 28, 2000, the Company by the way of a Board of Directors resolution increased its stated capital by $0.8 million on 666,720 Class B common shares. Under executive and employee stock option plans, the Company may grant stock options to its executives and employees for up to 2,909,340 common shares. A summary of the status of the Company's stock option plans for common shares is presented below: (i) Stock options for common shares - Executive Stock Option Plan December 31, - ------------------------------------------------------------------------------------------------------------------ 2001 2000 1999 - ------------------------------------------------------------------------------------------------------------------- Weighted- Weighted- Weighted- average average average Stock exercise Stock exercise Stock exercise options price options price options price - ------------------------------------------------------------------------------------------------------------------- Outstanding at beginning of year 1,454,669 Cdn $ 9.38 1,454,669 Cdn $ 9.38 1,420,034 Cdn $ 9.31 Granted - - - - 34,635 Cdn $ 12.27 Exercised - - - - - - Cancelled - - - - - - - -------------------------------------------------------------------------------------------------------------------- Outstanding at end of year 1,454,669 Cdn $ 9.38 1,454,669 Cdn $ 9.38 1,454,699 Cdn $ 9.38 ===================================================================================================================== - -------------------------------------------------------------------------------------------------------------------- Stock options exercisable at year-end 1,454,699 Cdn $ 9.38 1,454,669 Cdn $ 9.38 581,868 Cdn $ 9.38 - -------------------------------------------------------------------------------------------------------------------- Weighted-average fair value of stock options granted during the year $ Nil $ Nil Cdn $ 2.01 - --------------------------------------------------------------------------------------------------------------------- The contractual remaining life of the stock options outstanding at December 31, 2001, is approximately five years. F-14
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (ii) Stock options for common shares - Employee Stock Option Plan December 31, - --------------------------------------------------------------------------------------------------------------------- 2001 2000 1999 - --------------------------------------------------------------------------------------------------------------------- Weighted- Weighted- Weighted- average average average Stock exercise Stock exercise Stock exercise options price options price options price - --------------------------------------------------------------------------------------------------------------------- Outstanding at beginning of year 306,507 Cdn $ 11.02 393,107 Cdn $ 10.91 304,788 Cdn $ 9.31 Granted 631,400 $ 9.89 - - 102,173 Cdn $ 15.49 Exercised (95,063) Cdn $ 9.48 - - - - Cancelled (90,325) Cdn $ 13.92 (86,600) Cdn $ 10.55 (13,854) Cdn $ 9.31 - - ------------------------------------------------------------------------------------------------------------------- Outstanding at end of year 752,519 (1) 306,507 Cdn $ 11.02 393,107 Cdn $ 10.91 ====================================================================================================================== - - ------------------------------------------------------------------------------------------------------------------- Stock options exercisable at year-end 89,880 (1) 145,114 Cdn $ 10.18 81,739 Cdn $ 9.31 - - ------------------------------------------------------------------------------------------------------------------- Weighted-average fair value of stock options granted during the year $ 9.89 $ Nil Cdn $ 2.53 ====================================================================================================================== (1) Employee stock options outstanding and stock options exercisable as of December 31, 2001 have a weighted average exercise price of $9.34 (Cdn$14.47) and $7.14 (Cdn$11.06), respectively. The contractual remaining life of the stock options outstanding at December 31, 2001 is approximately four years for 118,973 stock options and approximately six years for the balance of 633,546 stock options. The stock options vest as to 20% each year on the anniversary date of the stock option grant. 10. SEVERANCE, RELOCATION AND OTHER CHARGES Upon the completion of the Company's initial public offering of its common shares in November 2000, the Company recorded severance, relocation and other charges of $6.7 million. These charges are as follows: Severance, lease termination and other costs of $1.9 million related to the relocation of the Company's corporate offices from Toronto, Canada to Dallas, Texas. As at December 31, 2001, and December 31, 2000, $1.4 million and $0.3 million, respectively, of these costs were paid; Termination costs of $0.8 million to terminate an employment contract with a senior executive officer. As at December 31, 2000, $0.8 million of these costs were paid; Amounts paid of approximately $2.1 million to certain of the Company's senior executives to enable them to repay in full outstanding loans made to them by the Company and associated taxes which became due as a result. As at December 31, 2000, $2.1 million of these costs were paid; and Other non-cash restructuring charges of $1.9 million, which primarily includes termination of a services contract. F-15
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Severance, relocation and other charges of $0.2 million no longer considered payable have been reflected in the Company's statement of operations for the year ended December 31, 2001. 11. INCOME TAXES a) Deferred income tax expense for the year ended December 31, 2001 was reduced by $3.0 million due to enacted tax rate reductions of 6% announced by the Ontario provincial government on May 9, 2001. The tax rate reduction will be phased in over the period of 2002 to 2005. Deferred income tax expense for the year ended December 31, 2000 was reduced by $6.1 million due to enacted tax rate reductions announced by the Canadian federal and provincial governments in 2000. These tax rate reductions are being phased in over the period of 2001 to 2005. The income tax expense (benefit) for the years ended December 31, 2001, 2000 and 1999 reflect a $1.2 million, $2.5 million and $0.9 million, respectively, reduction in the Company's valuation allowance thereby recognizing the benefit of certain deferred tax assets. It is the Company's expectation that under its current business strategy it will generate sufficient taxable income to fully realize these tax benefits. b) The provision for income taxes differs from the amount computed by applying the Canadian corporate tax rates to income before income taxes. The reason for this difference is as follows: Years Ended December 31, - - ------------------------------------------------------------------------------------------------------------------ (in millions of U.S. dollars) 2001 2000 1999 - - ------------------------------------------------------------------------------------------------------------------ Canadian corporate income tax rate 42.12% 43.95% 44.62% - - ------------------------------------------------------------------------------------------------------------------ Provision for income taxes based on corporate income tax rate $ 6.2 $ 1.0 $ 4.7 Increase (decrease) in taxes resulting from: Non-deductible licenses and goodwill amortization 0.2 0.2 - Non-deductible expenses 0.2 0.5 0.2 Loss (income) from U.S. sources taxed at lower tax rates (1.6) 0.7 (0.2) Minimum corporate tax (not calculated on the basis of income) 0.6 0.5 0.4 Reduction in valuation allowance (1.2) (2.5) (0.9) Substantively enacted tax rate reductions (3.0) (6.1) - U.S. state income taxes, net of U.S. federal benefit 1.3 1.5 0.7 Other income tax items 0.2 0.4 - - - ------------------------------------------------------------------------------------------------------------------ Provision for income tax expense (benefit) as recorded $ 2.9 $ (3.8) $ 4.9 ===================================================================================================================== F-16
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS c) The principal items giving rise to the deferred portion of income tax expense (benefit) are as follows: Years Ended December 31, - - -------------------------------------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 1999 - - -------------------------------------------------------------------------------------------------------------- Net operating loss carryforwards $ 1,057 $ (4,016 $ (5,472) Deferred deductions 2,103 (3,146) (2,179) Deferred financing and restricted interest carryforwards 452 2,725 741 Deferred earnings (1,835) 2,144 9,175 Licenses and goodwill 328 1,058 134 Capital and other assets 1,812 2,955 698 Substantively enacted tax rate reductions (3,000) (6,089) - - - -------------------------------------------------------------------------------------------------------------- 917 (4,369) 3,097 Reduction in valuation allowance (1,178) (2,464) (915) - - -------------------------------------------------------------------------------------------------------------- Income tax expense (benefit) $ (261)$ (6,833) $ 2,182 ================================================================================================================ d) The geographical components of earnings (loss) before income taxes are summarized below: Years Ended December 31, - - -------------------------------------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 1999 - - -------------------------------------------------------------------------------------------------------------- United States $ (1,052)$ (5,851)$ 3,718 Canada 15,646 8,087 6,811 - - -------------------------------------------------------------------------------------------------------------- $ 14,594 $ 2,236 $ 10,529 ================================================================================================================= e) The provision for income tax expense (benefit) is summarized as follows: Years Ended December 31, - - --------------------------------------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 1999 - - --------------------------------------------------------------------------------------------------------------- Current: United States $ 2,648 $ 2,658 $ 1,497 Canada 490 386 1,209 - - --------------------------------------------------------------------------------------------------------------- 3,138 3,044 2,706 - - --------------------------------------------------------------------------------------------------------------- Deferred: United States (1,236) (4,890) (299) Canada 975 (1,943) 2,481 - - --------------------------------------------------------------------------------------------------------------- (261) (6,833) 2,182 - - --------------------------------------------------------------------------------------------------------------- $ 2,877 $ (3,789) $ 4,888 ================================================================================================================== F-17
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS f) The Company's deferred tax assets and liabilities are as follows: December 31, - - ------------------------------------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 1999 - - ------------------------------------------------------------------------------------------------------------- Current deferred tax assets: Net operating loss carryforwards $ 7,931 $ 11,427 $ 13,417 Deferred deductions 5,507 7,913 4,035 - - ------------------------------------------------------------------------------------------------------------- 13,438 19,340 17,452 - - ------------------------------------------------------------------------------------------------------------- Non-current deferred tax assets: Net operating loss carryforwards 9,481 7,678 1,852 Unrealized foreign exchange losses 1,053 496 - Deferred financing and restricted interest carryforwards 1,358 1,555 1,989 - - ------------------------------------------------------------------------------------------------------------- 11,892 9,729 3,841 - - ------------------------------------------------------------------------------------------------------------- Total deferred tax assets 25,330 29,069 21,293 Valuation allowance for deferred tax assets - (1,178) (3,642) - - ------------------------------------------------------------------------------------------------------------- Net deferred tax assets $ 25,330 $ 27,891 $ 17,651 =============================================================================================================== Current deferred tax liability: Deferred earnings $ 21,178 $ 24,345 $ 22,480 - - ------------------------------------------------------------------------------------------------------------- Non-current deferred tax liabilities: Licenses and goodwill 25,487 29,691 35,120 Capital and other assets 8,979 8,429 5,300 - - ------------------------------------------------------------------------------------------------------------- 34,466 38,120 40,420 - - ------------------------------------------------------------------------------------------------------------- Total deferred tax liabilities $ 55,644 $ 62,465 $ 62,900 =============================================================================================================== Net current deferred tax liabilities $ 7,740 $ 5,005 $ 5,028 Net non-current deferred tax liabilities 22,574 29,569 40,221 - - ------------------------------------------------------------------------------------------------------------- Total net deferred tax liabilities $ 30,314 $ 34,574 $ 45,249 =============================================================================================================== g) At December 31, 2001, the Company had net operating losses available for carryforward in the amount of $20.8 million and $27.0 million in the United States and Canada, respectively (2000 - $9.1 million and $35.6 million) to offset against taxable income in future years. These losses expire periodically to 2008 and 2021 for Canada and the United States, respectively. 12. PENSION PLAN The Company participates in a defined contribution 401(k) plan, which covers all United States employees meeting certain eligibility requirements. The Company matches employee contributions to the 401(k) plan at a rate of up to a 100% of the first 2% of the employee's salary, subject to the Internal Revenue Service annual contribution limits. In addition, the Company contributes an employer profit sharing amount of 1% of the employee's salary as defined by the plan. For the years ended December 31, 2001, 2000 and 1999, the Company's expense related to the 401(k) plan totaled $2.2 million, $1.8 million and $1.2 million, respectively. F-18
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In addition, the Company participates in various group retirement savings plans in Canada. Generally, the Company matches employee contributions to these plans at a rate of up to 3% of the employee's salary. The Company's expense related to these plans for the years ended December 31, 2001, 2000 and 1999 totaled $0.6 million, $0.5 million and $0.3 million, respectively. 13. RELATED PARTY TRANSACTIONS For the years ended December 31, 2001, 2000 and 1999 consulting fees charged to the Company by shareholders were $Nil, $0.6 million and $0.7 million, respectively. These arrangements were terminated upon completion of the Company's initial public offering in 2000. 14. COMMITMENTS The Company is committed under existing operating leases at December 31, 2001, to the following payments: (in thousands of U.S. dollars) - - --------------------------------------------------------------------------- 2002 $ 14,329 2003 $ 11,436 2004 $ 8,899 2005 $ 7,415 2006 $ 5,721 Thereafter $ 35,052 15. CONTINGENCIES In January 2002, one of the Company's partnerships entered into a new lease, which may result in the early termination of its existing lease. An estimate of the lease termination cost, if any, is not currently determinable. In 1995, the Company sold its retirement homes division. On the sale of one of the retirement homes, the purchaser assumed two mortgages with a total balance of $11.7 million at December 31, 2001, (2000 - $12.3 million). The Company has not been formally discharged from the mortgages, however, the Company has been indemnified by the purchaser and does not expect non-performance. The mortgages bear interest at 10.0% per annum and are repayable in 2003 and 2004. The Company is contingently liable with respect to litigation and claims which arise from time to time. Litigation is subject to many uncertainties, and the outcome of individual matters is not predictable. It is reasonably possible that the final resolution of some of these matters may require the Company to make expenditures in excess of estimates, over an extended period of time and in a range of amounts that cannot be reasonably estimated at this time. However, in the opinion of management, any liabilities that may arise from these contingencies would not have a material adverse affect on the financial position and results of operations of the Company. F-19
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 16. SEGMENTED INFORMATION Management has determined that the Company operates in two geographic segments, the provision of clinical laboratory services in the United States and Canada. As at and for the year ended December 31, - - --------------------------------------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 - - --------------------------------------------------------------------------------------------------------------- U.S. Canada Total - - --------------------------------------------------------------------------------------------------------------- Revenues $ 297,334 $ 105,025 $ 402,359 Net earnings (loss) $ (2,464) $ 14,181 $ 11,717 - - --------------------------------------------------------------------------------------------------------------- Total assets $ 230,162 $ 154,163 $ 384,325 Capital assets and licenses and goodwill $ 145,332 $ 87,621 $ 232,953 Purchase of capital assets - net $ 10,255 $ 2,118 $ 12,373 - - --------------------------------------------------------------------------------------------------------------- Laboratory revenue by payor type: Canadian government agencies $ - $ 94,293 $ 94,293 Long-term hospital contracts $ 57,180 $ - $ 57,180 Community (non-hospital) and other $ 240,154 $ 10,732 $ 250,886 - ----------------------------------------------------------------------------------------------------------------- As at and for the years ended December 31, - - ---------------------------------------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2000 1999 - - ----------------------------------------------------------------------------------------------------------------- U.S. Canada Total U.S. Canada Total - - ----------------------------------------------------------------------------------------------------------------- Revenues $ 250,747 $ 102,172 $ 352,919$ 173,566 $ 99,111 $ 272,677 Net earnings (loss) $ (3,619) $ 9,644 $ 6,025$ 2,519 $ 3,122 $ 5,641 - - ------------------------------------------------------------------------------------------------------------------ Total assets $ 214,476 $ 134,500 $ 348,976$ 133,287 $ 155,232 $ 288,519 Capital assets and licenses and goodwill $ 117,541 $ 95,057 $ 212,598$ 75,448 $ 98,522 $ 173,970 Purchase of capital assets - net $ 12,302 $ 2,463 $ 14,765$ 8,667 $ 2,323 $ 10,990 - - ------------------------------------------------------------------------------------------------------------------ Laboratory revenue by payor type: Canadian government agencies $ - $ 90,405 $ 90,405$ - $ 87,645 $ 87,645 Long-term hospital contracts $ 52,232 $ 1,863 $ 54,095$ 49,056 $ 2,129 $ 51,185 Community (non-hospital) and other $ 198,515 $ 9,904 $ 208,419$ 124,510 $ 9,337 $ 133,847 - - ------------------------------------------------------------------------------------------------------------------ 17. Consolidated statements of cash flows Supplementary disclosure required for the Company's consolidated statements of cash flows is as follows: Income taxes paid For the year ended December 31, 2001, income taxes paid by the Company were $4.8 million (2000 - $4.2 million, 1999 - $3.2 million). Interest payments For the year ended December 31, 2001, interest paid by the Company was $21.9 million (2000 - $18.8 million, 1999 - $18.5 million). F-20
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Business Combinations The Company's total purchase price consideration for acquisitions made in 2001, 2000, and 1999 was $18.2 million, $40.9 million and $27.3 million, respectively. The Company did not acquire cash in any of its acquisitions. The total purchase price consideration was comprised of cash paid of $11.6 million (2000 - $38.5 million, 1999 - $20.8 million), promissory notes payable of $2.1 million (2000 - $1.3 million, 1999 - $6.2 million), and the assumption of short-term liabilities of $4.5 million (2000 - $1.1 million, 1999 - $0.3 million). Capital assets For the year ended December 31, 2001, capital assets were acquired at an aggregate cost of $12.4 million (2000 - $14.8 million, 1999 - $11.0 million) of which $0.6 million (2000 - $0.9 million, 1999 - $Nil) were financed by means of capital leases. Cash and cash equivalents December 31, - - ------------------------------------------------------------------------------------------------------------------ (in thousands of U.S. dollars) 2001 2000 1999 - - ------------------------------------------------------------------------------------------------------------------ Cash $ 13,146 $ 7,850 $ 2,057 Short-term investments with initial maturities of three months or less at acquisition 16,856 10,249 14,270 - - ------------------------------------------------------------------------------------------------------------------ $ 30,002 $ 18,099 $ 16,327 ==================================================================================================================== Change in non-cash working capital Years Ended December 31, - - ------------------------------------------------------------------------------------------------------------------ (in thousands of U.S. dollars) 2001 2000 1999 - - ------------------------------------------------------------------------------------------------------------------ Accounts receivable $ (4,178) $ (1,395) $ (21,876) Prepaid expenses (339) 2,897 (21) Inventory (2,729) 273 (2,042) Accounts payable and accrued liabilities 734 3,393 7,833 - - ------------------------------------------------------------------------------------------------------------------ $ (6,512) $ 5,168 $ (16,106) ==================================================================================================================== F-21
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 18. Earnings per share Earnings per share data was computed as follows: Years Ended December 31, - - ------------------------------------------------------------------------------------------------------------------ (in thousands of U.S. dollars, except for share and per share amounts) 2001 2000 1999 - - ------------------------------------------------------------------------------------------------------------------ Basic earnings per share Net earnings $ 11,717 $ 6,025 $ 5,641 - - ------------------------------------------------------------------------------------------------------------------ Weighted average number of common shares outstanding during the year 17,211,138 12,482,368 11,880,914 - - ------------------------------------------------------------------------------------------------------------------ Basic earnings per share $ 0.68 $ 0.48 $ 0.47 ==================================================================================================================== Diluted earnings per share Net earnings $ 11,717 $ 6,025 $ 5,641 - - ------------------------------------------------------------------------------------------------------------------ Weighted average number of common shares outstanding during the year 17,211,138 12,482,368 11,880,914 Stock options 674,042 661,603 583,191 - - ------------------------------------------------------------------------------------------------------------------ 17,885,180 13,143,971 12,464,105 - - ------------------------------------------------------------------------------------------------------------------ Diluted earnings per share $ 0.66 $ 0.46 $ 0.45 ==================================================================================================================== 19. MAJOR CUSTOMERS The Company's laboratories in Canada are subject to certain regulatory controls issued by the Ontario Ministry of Health and Long-Term Care and the Ministry of Health and Wellness, Province of Alberta. Revenues received from government agencies approximates 23% of total revenues for the year ended December 31, 2001 (26% in 2000). As at December 31, 2001 and 2000 approximately 16% and 17%, respectively, of accounts receivable were due from these government agencies. In the United States, the Company earns a portion of its revenues from U.S. government agencies (Medicare/Medicaid). These revenues constituted approximately 14% of total revenues for the year ended December 31, 2001 (13% in 2000). As at December 31, 2001 and 2000 approximately 21% and 18%, respectively, of accounts receivable were due from the Medicare/Medicaid programs. In arriving at net revenues, certain allowances and discounts are deducted relating to the Company's reimbursement agreement with the Ontario government in Canada and contractual allowances for certain payors in the United States. The laboratory industry in Ontario is subject to an agreement with the provincial government wherein each laboratory is allocated a fixed share of the overall industry reimbursement each year. Factors can arise to cause an individual laboratory to receive more than its pro rata share of reimbursement obligating it to repay the Ontario government for such excess. An estimate of the excess is withheld by the Ontario government from monthly payments made to the Company with any residual amounts payable being settled subsequent to year end. In the United States, payment arrangements for laboratory services performed for certain payors include prospectively determined rates for service, discounted charges, capitation and other arrangements. F-22
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The calculation of these allowances and discounts and the resultant reserve on the balance sheet requires estimates and assumptions based on a number of different factors including the Company's past experiences. Despite the use of the Company's best estimates, it is reasonably possible that these amounts could change based on experience and other factors. Allowances and discounts of $181.2 million, $138.1 million and $71.9 million for the years ended December 31, 2001, 2000 and 1999, respectively, have been deducted in arriving at net revenues. Included in accounts receivable as at December 31, 2001, 2000 and 1999, are allowances and discounts of $56.9 million, $50.2 million, and $26.6 million, respectively. The laws and regulations governing these programs are extremely complex and subject to interpretation. As a result, there is at least a reasonable possibility that recorded estimates could change by a material amount in the near term. 20. JOINT VENTURES AND PARTNERSHIPS The Company conducts certain of its businesses through incorporated and unincorporated partnerships in which the Company has a 73% or less interest. Condensed combined statements of financial position, statements of operations and statements of cash flows based on the Company's proportionate interests in these partnerships are presented below. Certain costs recorded at the corporate level, have not been allocated to the operating results of the partnerships. December 31, - - ----------------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 1999 - - ----------------------------------------------------------------------------------------- Current assets $ 21,174 $ 27,088 $ 28,293 Other assets 99,082 116,229 106,916 - - ----------------------------------------------------------------------------------------- 120,256 143,317 135,209 - - ----------------------------------------------------------------------------------------- Current liabilities 13,689 13,712 12,855 Long-term debt 2,384 2,883 2,939 - - ----------------------------------------------------------------------------------------- 16,073 16,595 15,794 - - ----------------------------------------------------------------------------------------- Net investment in partnerships $ 104,183 $ 126,722 $ 119,415 =========================================================================================== Years Ended December 31, - - ----------------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 1999 - - ----------------------------------------------------------------------------------------- Revenues $ 164,429 $ 149,412 $ 137,633 General and operating expenses 127,416 113,660 100,833 Depreciation 3,894 3,262 3,108 Amortization of licenses and goodwill 2,469 2,210 2,265 - - ----------------------------------------------------------------------------------------- Earnings before income taxes $ 30,650 $ 30,280 $ 31,427 =========================================================================================== Cash provided by operating activities $ 30,962 $ 35,689 $ 33,678 - - ----------------------------------------------------------------------------------------- Cash used in investing activities $ (2,482)$ (14,788)$ (2,858) - - ----------------------------------------------------------------------------------------- Cash used in financing activities $ (29,292)$ (23,944)$ (31,136) - - ----------------------------------------------------------------------------------------- F-23
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 21. DIFFERENCES BETWEEN U.S. AND CANADIAN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES The effects on the Company's consolidated financial statements resulting from the differences between Canadian and U.S. generally accepted accounting principles ("GAAP") as described in 21(a) to 21(j) are presented in the consolidated financial information that follows: CONSOLIDATED BALANCE SHEETS (A) - U.S. GAAP December 31, - - ------------------------------------------------------------------------------ (in thousands of U.S. dollars) 2001 2000 - - ------------------------------------------------------------------------------ ASSETS Current assets: Cash and cash equivalents $ 26,831 $ 17,856 Accounts receivable 54,626 39,225 Prepaid expenses 2,294 1,844 Inventory 8,380 4,797 Deferred income taxes 5,059 5,956 - - ------------------------------------------------------------------------------ Total current assets 97,190 69,678 - - ------------------------------------------------------------------------------ Capital assets 41,641 30,899 Goodwill 103,521 76,989 Other assets 31,648 37,268 Equity investments 104,183 125,141 - - ------------------------------------------------------------------------------ 280,993 270,297 - - ------------------------------------------------------------------------------ $ 378,183 $ 339,975 ================================================================================ LIABILITIES Current liabilities: Accounts payable $ 9,133 $ 4,323 Accrued liabilities 26,995 28,346 Current portion of deferred income taxes 12,799 10,961 Current portion of long-term debt 1,872 5,524 - - ------------------------------------------------------------------------------ Total current liabilities 50,799 49,154 Long-term debt 205,532 199,716 Deferred income taxes 21,485 34,534 - - ------------------------------------------------------------------------------ 277,816 283,404 - - ------------------------------------------------------------------------------ SHAREHOLDERS' EQUITY Capital stock 126,173 101,514 Deficit (30,531) (47,785) - - ------------------------------------------------------------------------------ 95,642 53,729 Accumulated other comprehensive earnings 4,725 2,842 - - ------------------------------------------------------------------------------ 100,367 56,571 - - ------------------------------------------------------------------------------ $ 378,183 $ 339,975 ============================================================================== F-24
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE EARNINGS (A) - U.S. GAAP Years Ended December 31, - - ---------------------------------------------------------------------------------------------------------------- (in thousands of U.S. dollars, except for share and per share 2001 2000 1999 amounts) - - ---------------------------------------------------------------------------------------------------------------- Revenues $ 237,929 $ 203,922 $ 134,581 Earnings from equity investments 30,676 29,565 30,364 - - ---------------------------------------------------------------------------------------------------------------- 268,605 233,487 164,945 - - ---------------------------------------------------------------------------------------------------------------- General and operating expenses 223,662 192,811 128,793 Depreciation 8,179 8,095 5,225 Amortization of goodwill 2,645 2,337 1,728 Severance, relocation and other charges - 6,750 - - - ---------------------------------------------------------------------------------------------------------------- 234,486 209,993 135,746 - - ---------------------------------------------------------------------------------------------------------------- Operating earnings 34,119 23,494 29,199 Interest expense 19,920 22,124 18,949 - - ---------------------------------------------------------------------------------------------------------------- Earnings before income taxes 14,199 1,370 10,250 - - ---------------------------------------------------------------------------------------------------------------- Income taxes expense (benefit): Current 3,138 3,030 2,701 Deferred (6,193) (866) 2,159 - - ---------------------------------------------------------------------------------------------------------------- (3,055) 2,164 4,860 - - ---------------------------------------------------------------------------------------------------------------- Net earnings (loss) 17,254 (794) 5,390 Other comprehensive earnings, net of tax 1,883 1,516 327 - - ---------------------------------------------------------------------------------------------------------------- Comprehensive earnings $ 19,137 $ 722 $ 5,717 =================================================================================================================== Earnings (Loss) Per Share - - ---------------------------------------------------------------------------------------------------------------- Basic $ 1.00 $ (0.06) $ 0.45 =================================================================================================================== Diluted $ 0.96 $ (0.06) $ 0.43 =================================================================================================================== Weighted average number of common shares outstanding-Basic 17,211,138 12,482,368 11,880,914 =================================================================================================================== Weighted average number of common shares outstanding-Diluted 17,885,180 13,143,971 12,464,105 =================================================================================================================== F-25
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Consolidated Statements of Cash Flows(a) - U.S. GAAP Years Ended December 31, - - ------------------------------------------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 1999 - - ------------------------------------------------------------------------------------------------------------------- CASH FLOW FROM OPERATING ACTIVITIES Net earnings (loss) $ 17,254 $ (794) $ 5,390 Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities: Depreciation 8,179 8,095 5,225 Amortization of goodwill 2,645 2,337 1,728 Deferred income taxes (6,193) (866) 2,159 Severance, relocation and other charges - 3,021 - Equity earnings (net of distributions to partners) (2,021) 4,418 (6,150) Gain on sale of capital assets - (110) (11) Stock compensation 161 660 - Change in assets and liabilities, net of effects of acquisitions: Accounts receivable (1,385) (3,037) (18,129) Prepaid expenses (239) 2,700 (216) Inventory (2,119) 225 (1,198) Accounts payable and accrued liabilities (2,371) 3,324 4,756 - - ------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) operating activities 13,911 19,973 (6,446) - - ------------------------------------------------------------------------------------------------------------------- CASH FLOW FROM INVESTING ACTIVITIES Decrease (increase) in equity investments 3,450 (3,901) 135 Acquisition of businesses (14,486) (37,681) (20,005) Purchase of capital assets (7,158) (7,745) (8,234) Proceeds from sale of capital assets - 132 38 Increase in other assets (4,175) (7,670) (6,420) - - ------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (22,369) (56,865) (34,486) - - ------------------------------------------------------------------------------------------------------------------- F-26
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, - - --------------------------------------------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 1999 - - --------------------------------------------------------------------------------------------------------------------- Cash flow from financing activities Decrease in bank indebtedness - (6,679) (1,768) Proceeds from long-term debt 778 4,738 69,156 Repayment of long-term debt (4,792) (5,806) (16,841) Issue of capital stock - net proceeds 24,498 46,433 - - - --------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 20,484 38,686 50,547 - - --------------------------------------------------------------------------------------------------------------------- - - --------------------------------------------------------------------------------------------------------------------- Foreign exchange translation adjustments (3,051) 2,435 2,716 - - --------------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents during the year 8,975 4,229 12,331 Cash and cash equivalents, beginning of year 17,856 13,627 1,296 - - --------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 26,831 $ 17,856 $ 13,627 ======================================================================================================================= SUPPLEMENTAL DISCLOSURE REQUIRED UNDER U.S. GAAP: Years Ended December 31, - - --------------------------------------------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 1999 - - --------------------------------------------------------------------------------------------------------------------- Rental expense $ 6,273 $ 5,044 $ 3,172 ======================================================================================================================= The effects on the Company's consolidated earnings (loss) from operations resulting from the differences between Canadian and U.S. GAAP are as follows: Years Ended December 31, - - ---------------------------------------------------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 1999 - - ---------------------------------------------------------------------------------------------------------------------- Net earnings based on Canadian GAAP $ 11,717 $ 6,025 $ 5,641 Earnings from equity investments (c) (234) (250) (250) Stock compensation (f) (161) (660) - Change in reporting currency (g) - 60 (17) Income taxes (i) 5,932 (5,969) 16 - - ---------------------------------------------------------------------------------------------------------------------- Net earnings (loss) based on U.S. GAAP 17,254 (794) 5,390 Adjustment to reconcile to comprehensive earnings: Foreign currency translation adjustment 1,883 1,516 327 - - ---------------------------------------------------------------------------------------------------------------------- Comprehensive earnings based on U.S. GAAP $ 19,137 $ 722 $ 5,717 ========================================================================================================================= F-27
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company's cumulative effect of these adjustments on the consolidated shareholders' equity of the Company is as follows December 31, - - ------------------------------------------------------------------------------------------------------------------ (in thousands of U.S. dollars) 2001 2000 1999 - - ------------------------------------------------------------------------------------------------------------------ Shareholders' equity based on Canadian GAAP $ 92,285 $ 55,251 $ 1,646 Amortization of licenses and goodwill (b) (6,980) (6,980) (6,980) Earnings from equity investments (c) (2,832) (2,592) (2,342) Write-down in equity investments (d) (4,357) (4,357) (4,357) Stock compensation (f) (821) (660) - Start-up costs and capitalized interest (h) (1,661) (1,661) (1,661) Foreign currency translation 2,582 1,357 267 Income taxes (i) 22,151 16,213 22,182 - - ------------------------------------------------------------------------------------------------------------------ Shareholders' equity based on U.S. GAAP $ 100,367 $ 56,571 $ 8,755 ==================================================================================================================== The significant differences between Canadian GAAP and the principles prescribed by U.S. GAAP and U.S. securities regulations and the impact on the consolidated financial statements are described as follows: (a) Equity method of accounting for joint ventures and partnerships APB Opinion 18 and Statement of Position 78-9 generally require that investments in corporate and unincorporated joint ventures and partnerships are to be accounted for by the equity method. Under Canadian GAAP, investments in joint ventures and partnerships are accounted for by the proportionate consolidation method, as the use of the equity method is not permitted. The use of the proportionate consolidation method as compared to the equity method of accounting from a financial presentation perspective impacts almost all areas of the Company's consolidated balance sheets, statements of the operations and comprehensive earnings, and cash flow statements and as a result this financial information has been presented in its entirety. The proportionate consolidation and equity method of accounting do not impact the Company's consolidated shareholders' equity or net earnings (loss) for the years presented. (b) Amortization of licenses and goodwill Prior to December 31, 1990, the Company did not amortize certain components of licenses and goodwill on the basis that they were considered to have an indefinite life. Commencing January 1, 1991, the Company began amortizing the cost of licenses and goodwill on a straight-line basis primarily over 40 years to comply with the pronouncement of the Canadian Institute of Chartered Accountants requiring the amortization of intangible assets. Licenses in Ontario are required to perform specific tests and receive reimbursement for these tests. U.S. GAAP requires the cost of intangible assets to be amortized from the date of acquisition over a period not exceeding 40 years. (c) Earnings from equity investments Under the equity method of accounting, the Company's ownership interest in certain licenses and goodwill has been reclassified and appropriately accounted for in the equity investments account. The additional amortization of these licenses and goodwill has been reflected in the earnings from equity investments. F-28
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The differences in the book value and amortization of licenses and goodwill arose from the 1997 licenses and goodwill impairment charge, which under Canadian and U.S. GAAP totaled $79.4 million and $69.1 million, respectively. In addition, under U.S. GAAP, licenses and goodwill accounted for through the equity investments have been amortized since the date of acquisition, whereas under Canadian GAAP there was no amortization prior to 1991. (d) Write-down in equity investments The write-down in equity investments for U.S. GAAP purposes arises as the write-down in certain of the Company's licenses and goodwill are accounted for through the equity investments account, whereas for Canadian GAAP purposes they have been proportionately consolidated. U.S. to Canadian GAAP differences in the write-down of equity investments of $4.4 million arose due to the following: (i) under U.S. GAAP, licenses and goodwill accounted for through the equity investments account have been amortized since the date of acquisition, whereas under Canadian GAAP there was no amortization prior to 1990; and (ii) different methods were used in the calculation of the cash flows to determine the fair value of the licenses and goodwill held through equity investments. The calculation of the licenses and goodwill impairment under U.S. GAAP does not include an allocation of interest expense but is based upon a discounted cash flow. Under Canadian GAAP, the cash flow is undiscounted and includes an allocation of interest. (e) Business Acquisitions (unaudited) For U.S. GAAP purposes, "APB Opinion 16 - Business Combinations" requires supplemental pro forma information on business acquisitions made during the years ended December 31, 2001 and 2000 to be disclosed as part of the notes to the acquiror's consolidated financial statements. The pro forma information shown below includes revenues and net earnings prepared both on a U.S. and Canadian GAAP basis. The unaudited pro forma results of operations of the Company for the years ended December 31, 2001 and 2000 assuming that the Company's acquisitions made during 2001, had been consummated as of January 1, 2000 is as follows: CANADIAN GAAP Years Ended December 31, - - --------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 - - --------------------------------------------------------------------------- Revenues $ 424,429 $ 394,839 - - --------------------------------------------------------------------------- Net earnings $ 7,689 $ 5,952 - - --------------------------------------------------------------------------- U.S. GAAP Years Ended December 31, - - --------------------------------------------------------------------------- (in thousands of U.S. dollars) 2001 2000 - - --------------------------------------------------------------------------- Revenues $ 314,209 $ 297,122 - - --------------------------------------------------------------------------- Net earnings $ 13,226 $ (867) - - --------------------------------------------------------------------------- F-29
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Results of operations of the Company's acquisitions for 2001 and 2000 have been included in the statement of operations and comprehensive earnings from the respective dates of acquisition. (f) Stock compensation At December 31, 2001, the Company had two stock option plans, which are described below and in Note 9. For U.S. GAAP requirements, the Company applies APB Opinion 25 and related Interpretations, Accounting for Stock Issued to Employees, in accounting for its plans and follows the disclosure requirements as set out by Statement of Financial Accounting Standards - No. 123, Accounting for Stock-Based Compensation (FASB 123). For the year ended December 31, 2001, under APB Opinion 25, the compensation cost charged to earnings was $0.2 million (2000 - $0.7 million, 1999 - $Nil). If the compensation cost for the Company's stock-based compensation plan had been determined based on the fair value at the dates the awards were granted under those plans consistent with the method of FASB 123, the pro forma net earnings (loss) under U.S. GAAP would have been as follows: Years Ended December 31, - - ------------------------------------------------------------------------------------------------------------------ (in thousands of U.S. dollars, except per share amounts) 2001 2000 1999 - - ------------------------------------------------------------------------------------------------------------------ Pro forma net earnings (loss) $ 15,815 $ (461) $ 5,054 - - ------------------------------------------------------------------------------------------------------------------ Pro forma earnings (loss) per share $ 0.92 $ (0.04) $ 0.43 - - ------------------------------------------------------------------------------------------------------------------ Beginning on November 22, 2000, which is the date the Company completed an initial public offering of its common shares, the fair value of each option grant of common shares for all options is estimated using an option-pricing model for public companies with the following assumptions for the period November 17, 2000 (initial market trade date) to December 31, 2000; dividend yield of Nil%, risk-free interest rate range of 4.73% to 5.93% and expected life of five years. Using the same stock option pricing model, the following assumptions were used by the Company for the year ended December 31, 2001: dividend yield of Nil%, risk-free interest rate range of 1.73% to 5.02% and expected life of five years and volatility factor of 0.90. Prior to the Company's initial public offering of its common shares the fair value of each option grant of common shares for all options was estimated on the date of the option grant using an option-pricing model for non-public companies with the following assumptions: dividend yield of Nil%, risk-free interest rate range of 4.76% to 5.07% and expected life of five years. (g) Foreign Currency Translation Effective July 1, 2000, the Company adopted the U.S. dollar as its reporting currency. Prior to this change the Canadian dollar had been used as the Company's reporting currency. Under Canadian GAAP, the Company's financial statements for all periods presented through June 30, 2000, have been translated from Canadian dollars to U.S. dollars using the exchange rate in effect at July 1, 2000. Under U.S GAAP, the financial statements for periods prior to the change in reporting currency must be translated to U.S. dollars using the current rate method, which uses year end or annual average exchange rates as appropriate. F-30
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (h) Start-up Costs and Capitalized Interest The Company's policy has been to capitalize certain carrying costs, including interest, on real estate properties under development until the property became operational, which was deemed to be the earlier of when break-even cash flow was achieved and a reasonable time period after substantial completion, not to exceed 30 months. U.S. GAAP requires that interest costs incurred on real estate properties be capitalized, but only during the year in which the asset is being readied for its intended use. The Company's real estate retirement properties were disposed in 1995. (i) Income taxes Effective January 1, 2000, the Company adopted CICA - 3465, which is substantially similar with the Statement of Financial Accounting Standards - No. 109, Accounting for Income Taxes in the United States. CICA - 3465 and FASB 109 require the liability method of tax allocation for accounting for income taxes. Under the liability method of tax allocation, deferred tax assets and liabilities are recognized based on the temporary differences between the accounting and tax bases of assets and liabilities. Changes in income tax rates under CICA - 3465 are recorded when the tax rates have been substantially enacted. Under U.S. GAAP, changes in income tax rates are recorded when the change in income tax rates have been legislated. As of December 31, 2001, all of the tax rate reductions previously announced by the federal and provincial governments have been legislated. (j) Accounting Pronouncements (i) Financial Instruments Financial Accounting Standards Board Statement No. 133, Accounting for Derivative Instruments and Hedging Activities (FASB 133), requires companies to recognize all of its derivative instruments as either assets or liabilities in the statement of financial position at fair value. FASB 133 is effective for the Company on January 1, 2001. The accounting for changes in fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as either a fair value hedge, cash flow hedge or a hedge of a net investment in a foreign operation. The Company's cross currency and interest rate swap derivative instruments are designated as fair value hedges. The fair value of the Company's cross currency and interest rate swap derivative instruments under U.S. GAAP has resulted in an increase in the Company's hedge asset and a corresponding increase in its $195 million senior notes of $6.1 million (2000 - $0.3 million). Under U.S. GAAP, for derivative instruments that are designated and qualify as a fair value hedge (i.e., hedging the exposure to changes in the fair value of an asset or a liability or an identified portion thereof that is attributable to a particular risk), the gain or loss on the derivative instrument as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings during the year of the change in fair values. For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), F-31
DYNACARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same year or years during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized in current earnings during the year of change. For derivative instruments that are designated and qualify as a hedge of a net investment in a foreign currency, the gain or loss is reported in other comprehensive income as part of the cumulative translation adjustment to the extent it is effective. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in current earnings during the year of change. Canadian GAAP does not provide for other comprehensive income. In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141 - Business Combinations (FASB 141), and No. 142 - Goodwill and Other Intangible Assets (FASB 142), effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and intangible assets deemed to have an indefinite life will no longer be amortized but will be subject to annual impairment tests in accordance with FASB 141 and FASB 142. Other intangible assets will continue to be amortized over their useful life. FASB 141 and FASB 142 are consistent with the new accounting pronouncements introduced under Canadian generally accepted accounting principles. It is estimated that the Company's net earnings for the year ended December 31, 2001 would have increased by approximately $4.0 million, or $0.22 per diluted share, if goodwill and intangible assets deemed to have an indefinite life were not amortized during the year ended December 31, 2001. The Company will perform the required impairment tests of goodwill and intangible assets with an indefinite life effective as of January 1, 2002, and has not yet determined what the impact that the results of the review may have on its net earnings and financial position. (ii) Impairment or Disposal of Long-Lived Assets In August 2001, the Financial Accounting Standards Board issued Standard No. 144 - - - Accounting for the Impairment or Disposal of Long-Lived Assets (FASB 144) effective for fiscal years beginning after December 15, 2001. FASB 144 addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. This statement supersedes FASB 121-Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. FASB 144 retains the fundamental provisions of FASB 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. The Company has not yet determined what the effect of FASB 144 will be on its net earnings and financial position. (iii) Stock Compensation The Canadian Institute of Chartered Accountants has recently released CICA - 3870 - Stock-Based Compensation and Other Stock-Based Payments. This standard is effective for the fiscal year beginning January 1, 2002 and is similar to U.S. accounting requirements, APB Opinion 25 and FASB 123. Following the adoption by the Company of CICA 3870, the Company does not expect any U.S. to Canadian GAAP differences related to stock compensation. 22. COMPARATIVE FIGURES. For the years ended December 31, 2001, 2000 and 1999, certain taxes of $1.6 million, $1.3 million and $1.2 million have been reclassified from general and operating expenses and reflected as part of income tax expense as these taxes are based on earnings.