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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
or
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________ to ___________________
Commission File Number: 000-33217
GENESIS HEALTH VENTURES, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 06-1132947
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
101 East State Street
Kennett Square, Pennsylvania 19348
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(Address, including zip code, of principal executive offices)
(610) 444-6350
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(Registrant's telephone number including area code)
Indicate by check mark whether the registrant has (1) filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.
YES [X] NO [ ]
Indicate by check mark whether the registrant has filed all reports required to
be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934
subsequent to the distribution of securities under a plan confirmed by a court.
YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of August 9, 2002: 40,602,659 shares of common stock issued and
815,150 are to be issued in connection with the Company's plan of Reorganization
confirmed by the Bankruptcy Court on September 20, 2001.
TABLE OF CONTENTS
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS Page
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Part I: FINANCIAL INFORMATION
Item 1. Financial Statements 3
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20
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Item 3. Quantitative and Qualitative Disclosures About Market Risk 36
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Part II: OTHER INFORMATION
Item 1. Legal Proceedings 37
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Item 2. Changes in Securities and Use of Proceeds 39
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Item 3. Defaults Upon Senior Securities 39
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Item 4. Submission of Matters to a Vote of Security Holders 39
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Item 5. Other Information 39
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Item 6. Exhibits and Reports on Form 8-K 39
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SIGNATURES 40
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1
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
As used herein, unless the context otherwise requires, "Genesis," the "Company,"
"we," "our" or "us" refers to Genesis Health Ventures, Inc. and its
subsidiaries.
Statements made in this report, and in our other public filings and releases,
which are not historical facts contain "forward-looking" statements (as defined
in the Private Securities Litigation Reform Act of 1995) that involve risks and
uncertainties and are subject to change at any time. These forward-looking
statements may include, but are not limited to:
o certain statements in "Management's Discussion and Analysis of Financial
Condition and Results of Operations," such as our ability to meet our
liquidity needs, scheduled debt and interest payments, expected future
capital expenditure requirements; to effect repayment of trade payables due
to our primary supplier of pharmacy products; and to successfully implement
our strategic objectives in "Liquidity and Capital Resources - Strategic
Objectives";
o certain statements in the Notes to Unaudited Condensed Consolidated
Financial Statements concerning pro forma adjustments; and
o certain statements in "Legal Proceedings" regarding the effects of
litigation.
The forward-looking statements involve known and unknown risks, uncertainties
and other factors that are, in some cases, beyond our control. You are cautioned
that these statements are not guarantees of future performance and that actual
results and trends in the future may differ materially.
Factors that could cause actual results to differ materially include, but are
not limited to the following:
o changes in the reimbursement rates or methods of payment from Medicare and
Medicaid, or the implementation of other measures to reduce the
reimbursement for our services;
o changes in pharmacy legislation and payment formulas;
o the expiration of enactments providing for additional governmental funding;
o efforts of third party payors to control costs;
o the impact of federal and state regulations;
o changes in payor mix and payment methodologies;
o further consolidation of managed care organizations and other third party
payors;
o competition in our business;
o an increase in insurance costs and potential liability for losses not
covered by, or in excess of, our insurance;
o competition for qualified staff in the healthcare industry;
o our ability to control operating costs;
o our ability to successfully consummate a strategic pharmacy acquisition and
upon consummation to realize anticipated benefits of the integration of
those operations into our existing pharmacy business; and
o an economic downturn or changes in the laws affecting our business in those
markets in which we operate.
Certain of these risks are described in more detail in our Annual Report on
Form 10-K.
2
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Part I: FINANCIAL INFORMATION
Item 1. Financial Statements
Genesis Health Ventures, Inc. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
(in thousands, except share and per share data)
Successor Company Successor Company
June 30, 2002 September 30, 2001
- -----------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and equivalents $ 103,477 $ 32,139
Restricted investments in marketable securities 74,912 51,625
Accounts receivable, net of allowance for doubtful accounts 383,251 399,816
Inventory 62,647 65,222
Prepaid expenses and other current assets 55,519 35,753
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Total current assets 679,806 584,555
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Property, plant and equipment, net 841,971 822,740
Other long-term assets 53,964 60,237
Investments in unconsolidated affiliates 14,843 12,504
Identifiable intangible assets, net 26,955 33,591
Goodwill 304,572 325,593
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Total assets $ 1,922,111 $ 1,839,220
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Liabilities and Shareholders' Equity
Current liabilities:
Current installments of long-term debt $ 9,369 $ 41,241
Accounts payable and accrued expenses 222,757 249,439
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Total current liabilities 232,126 290,680
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Long-term debt 678,100 603,268
Deferred income taxes 3,930 --
Other long-term liabilities 52,607 65,677
Minority interest 9,742 2,137
Redeemable preferred stock, including accrued dividends 44,516 42,600
Shareholders' equity:
Common stock, par $.02, 200,000,000 shares authorized,
40,555,598 and 39,671,279 shares issued and outstanding
at June 30, 2002 and September 30, 2001, respectively, and
815,150 and 1,328,721 shares to be issued at June 30,
2002 and September 30, 2001, respectively 827 820
Additional paid-in capital 840,869 832,710
Retained earnings 59,131 1,136
Accumulated other comprehensive income 263 192
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Total shareholders' equity 901,090 834,858
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Total liabilities and shareholders' equity $ 1,922,111 $ 1,839,220
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See accompanying Notes to Unaudited Condensed Consolidated Financial Statements
3
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Genesis Health Ventures, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Operations
(in thousands, except share and per share data)
Successor Company | Predecessor Company
Three months ended | Three months ended
June 30, 2002 | June 30, 2001
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Net revenues: |
Inpatient services $ 356,424 | $ 338,716
Pharmacy and medical supply services 283,644 | 262,698
Other revenue 42,663 | 40,273
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|
Total net revenues 682,731 | 641,687
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Operating expenses: |
Salaries, wages and benefits 291,751 | 273,162
Cost of sales 169,505 | 155,182
Other operating expenses 155,994 | 151,258
Severance and related costs 12,568 | --
Gain from arbitration award (229) | --
Depreciation and amortization expense 16,471 | 26,496
Lease expense 7,218 | 8,834
Interest expense (contractual interest for the three months ended |
June 30, 2001 was $50,848) 11,245 | 26,872
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Income (loss) from continuing operations before debt restructuring |
and reorganization costs, income tax benefit, equity in net |
earnings (loss) of unconsolidated affiliates and minority interests 18,208 | (117)
Debt restructuring and reorganization costs 2,570 | 17,914
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Income (loss) from continuing operations before income |
tax benefit, equity in net earnings (loss) of unconsolidated |
affiliates and minority interests 15,638 | (18,031)
Income tax benefit (4,212) | --
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Income (loss) from continuing operations before equity in |
net earnings (loss) of unconsolidated affiliates and minority |
interests 19,850 | (18,031)
Equity in net earnings (loss) of unconsolidated affiliates 279 | (173)
Minority interests (592) | 2,077
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Income (loss) from continuing operations before preferred stock 19,537 | (16,127)
dividends |
Preferred stock dividends 656 | 11,375
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Income (loss) from continuing operations 18,881 | (27,502)
Loss from discontinued operations, net of taxes (1,428) | (789)
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Net income (loss) attributed to common shareholders $ 17,453 | $ (28,291)
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Per common share data: |
Basic |
Income (loss) from continuing operations $ 0.46 | $ (0.57)
Loss from discontinued operations (0.03) | (0.02)
Net income (loss) $ 0.42 | $ (0.58)
Weighted average shares 41,341,830 | 48,641,456
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Diluted |
Income (loss) from continuing operations $ 0.45 | $ (0.57)
Loss from discontinued operations (0.03) | (0.02)
Net income (loss) $ 0.42 | $ (0.58)
Weighted average shares 43,470,082 | 48,641,456
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See accompanying Notes to Unaudited Condensed Consolidated Financial Statements
4
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Genesis Health Ventures, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Operations
(in thousands, except share and per share data)
Successor Company | Predecessor Company
Nine months ended | Nine months ended
June 30, 2002 | June 30, 2001
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Net revenues: |
Inpatient services $ 1,058,075 | $ 994,878
Pharmacy and medical supply services 835,428 | 771,671
Other revenue 126,070 | 115,610
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Total net revenues 2,019,573 | 1,882,159
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Operating expenses: |
Salaries, wages and benefits 871,589 | 808,976
Cost of sales 499,932 | 456,562
Other operating expenses 455,680 | 442,985
Severance and related costs 12,568 | --
Gain from arbitration award (21,907) | --
Gain on sale of eldercare center -- | (1,770)
Loss on sale of eldercare center -- | 2,310
Depreciation and amortization expense 48,235 | 79,493
Lease expense 20,737 | 26,958
Interest expense (contractual interest for the nine months ended |
June 30, 2001 was $166,961) 36,862 | 92,264
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Income (loss) from continuing operations before debt restructuring |
and reorganization costs, income tax benefit, equity in net |
earnings (loss) of unconsolidated affiliates and minority interests 95,877 | (25,619)
Debt restructuring and reorganization costs 4,270 | 42,620
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Income (loss) from continuing operations before income |
tax benefit, equity in net earnings (loss) of unconsolidated |
affiliates and minority interests 91,607 | (68,239)
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Income tax benefit 25,416 | --
Income (loss) from continuing operations before equity in |
net earnings (loss) of unconsolidated affiliates and minority |
interests 66,191 | (68,239)
Equity in net income (loss) of unconsolidated affiliates 859 | (1,203)
Minority interests (1,344) | 8,275
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Income (loss) from continuing operations before preferred stock |
dividends 65,706 | (61,167)
Preferred stock dividends 1,916 | 34,124
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Income (loss) from continuing operations 63,790 | (95,291)
Loss from discontinued operations, net of taxes (5,795) | (2,534)
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Net income (loss) attributed to common shareholders $ 57,995 | $ (97,825)
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|
Per common share data: |
Basic |
Income (loss) from continuing operations $ 1.55 | $ (1.96)
Loss from discontinued operations (0.14) | (0.05)
Net income (loss) $ 1.41 | $ (2.01)
Weighted average shares 41,211,603 | 48,641,456
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Diluted |
Income (loss) from continuing operations $ 1.52 | $ (1.96)
Loss from discontinued operations (0.13) | (0.05)
Net income (loss) $ 1.38 | $ (2.01)
Weighted average shares 43,339,666 | 48,641,456
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See accompanying Notes to Unaudited Condensed Consolidated Financial Statements
5
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Genesis Health Ventures, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows
(in thousands)
Successor Company | Predecessor Company
Nine months ended | Nine months ended
June 30, 2002 | June 30, 2001
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Cash flows from operating activities: |
Net income (loss) attributed to common shareholders $ 57,995 | $ (97,825)
Net charges included in operations not requiring funds 118,204 | 181,102
Changes in assets and liabilities: |
Accounts receivable (21,134) | (25,546)
Accounts payable and accrued expenses 24,099 | (35,542)
Refinancing of pharmacy supplier credit terms (42,000) | --
Other, net (4,827) | (3,116)
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Net cash provided by operating activities before debt |
restructuring and reorganization costs 132,337 | 19,073
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Cash paid for debt restructuring and reorganization costs (44,299) | (35,070)
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Net cash provided by (used in) operating activities 88,038 | (15,997)
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Cash flows from investing activities: |
Capital expenditures (32,954) | (32,530)
Net purchases of restricted marketable securities (12,722) | (15,335)
Proceeds from sale of eldercare center -- | 7,471
Purchase of eldercare centers (10,453) | --
Other long-term assets and liabilities, net 5,397 | 5,923
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Net cash used in investing activities (50,732) | (34,471)
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Cash flows from financing activities: |
Net borrowings under working capital revolving credit |
facilities -- | 62,006
Repayment of long-term debt and payment of sinking fund |
requirements (45,968) | (633)
Proceeds from issuance of long-term debt 80,000 | --
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Net cash provided by financing activities 34,032 | 61,373
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Net increase in cash and equivalents 71,338 | 10,905
Cash and equivalents: |
Beginning of period 32,139 | 22,948
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End of period $ 103,477 | $ 33,853
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Supplemental cash flow information: |
Interest paid $ 43,492 | $ 92,395
Income taxes paid (net of receipts) 6,854 | --
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See accompanying Notes to Unaudited Condensed Consolidated Financial Statements
6
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Genesis Health Ventures, Inc. and Subsidiaries
Notes To Unaudited Condensed Consolidated Financial Statements
1. Business
Genesis Health Ventures, Inc. and its subsidiaries ("Genesis" or the "Company")
provide a broad range of healthcare services to the geriatric population,
principally within five geographic markets in the eastern United States. The
Company's operations are comprised of two primary business segments: (1)
inpatient services and (2) pharmacy and medical supply services. Inpatient
services are provided through a network of skilled nursing and assisted living
centers. Pharmacy and medical supply services are provided through long-term
care pharmacies serving approximately 250,000 institutional beds; medical supply
and home medical equipment distribution centers; community-based pharmacies; and
infusion therapy services. The Company's reportable segments are complemented by
an array of other service capabilities through the Genesis ElderCare(R) delivery
model of integrated healthcare networks.
2. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements should be
read in conjunction with the consolidated financial statements and the notes
thereto included in the Company's annual report on Form 10-K for the fiscal year
ended September 30, 2001.
The accompanying condensed consolidated financial statements are unaudited and
have been prepared in accordance with accounting principles generally accepted
in the United States of America. In the opinion of management, the unaudited
condensed consolidated financial statements include all necessary adjustments
consisting of normal recurring accruals, and from June 22, 2000 (the "Petition
Date") to September 30, 2001, all adjustments pursuant to the American Institute
of Certified Public Accountants Statement of Position 90-7, "Financial Reporting
By Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7"), for a
fair presentation of the financial position and results of operations for the
periods presented. Also in accordance with the provisions of SOP 90-7, the
unaudited condensed consolidated balance sheets include all necessary
adjustments incorporating the provisions of fresh-start reporting at September
30, 2001. Certain prior period amounts have been reclassified to conform to the
current period presentation.
3. Factors Affecting Comparability of Financial Information
As a consequence of the implementation of fresh-start reporting effective
September 30, 2001 (see "Footnote 4 - Reorganization"), the financial
information presented in the unaudited condensed consolidated statement of
operations for the three and nine months ended June 30, 2002 and the
corresponding statements of cash flows for the nine month period ended June 30,
2002 are generally not comparable to the financial results for the corresponding
periods in the prior year. To highlight the lack of comparability, a dashed line
separates the pre-emergence financial information from the post-emergence
financial information in the accompanying unaudited condensed consolidated
financial statements and the notes thereto. Any financial information herein
labeled "Predecessor Company" refers to periods prior to the adoption of
fresh-start reporting, while those labeled "Successor Company" refer to periods
following the Company's adoption of fresh-start reporting.
The lack of comparability in the accompanying unaudited condensed consolidated
financial statements is most apparent in the Company's capital costs (lease,
interest, depreciation and amortization), as well as with income taxes, minority
interests, debt restructuring and reorganization costs, and preferred dividends.
Management believes that business segment operating revenues and operating
income of the Predecessor Company are generally comparable to those of the
Successor Company.
7
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4. Reorganization
Background.
On June 22, 2000, Genesis and certain of its direct and indirect subsidiaries
filed for voluntary relief under Chapter 11 of the United States Code (the
"Bankruptcy Code") with the United States Bankruptcy Court for the District of
Delaware (the "Bankruptcy Court"). On the same date, a 43.6% owned affiliate of
Genesis, The Multicare Companies, Inc. and certain of its direct and indirect
subsidiaries ("Multicare") and certain of its affiliates also filed for relief
under Chapter 11 of the Bankruptcy Code with the Bankruptcy Court (singularly
and collectively referred to herein as "the Chapter 11 cases" unless the context
otherwise requires).
Genesis and Multicare's financial difficulties were attributed to a number of
factors. First, the federal government made fundamental changes to the
reimbursement for medical services provided to individuals. The changes had a
significant adverse impact on the healthcare industry as a whole and on Genesis'
and Multicare's cash flows. Second, the federal reimbursement changes
exacerbated a long-standing problem of inadequate reimbursement by the states
for medical services provided to indigent persons under the various state
Medicaid programs. Third, numerous other factors adversely affected Genesis and
Multicare's cash flows, including increased labor costs, increased professional
liability and other insurance costs, and increased interest rates. Finally, as a
result of declining governmental reimbursement rates and in the face of rising
inflationary costs, Genesis and Multicare were too highly leveraged to service
their debt, including their long-term lease obligations.
On October 2, 2001, (the "Effective Date"), Genesis and Multicare consummated a
joint plan of reorganization (the "Plan") under Chapter 11 of the Bankruptcy
Code (the "Reorganization") pursuant to a September 20, 2001 order entered by
the Bankruptcy Court approving the Plan proposed by Genesis and Multicare. The
principal provisions of the Plan were as follows:
o Multicare became a wholly-owned subsidiary of Genesis. Genesis previously
owned 43.6% of Multicare and managed its skilled nursing and assisted
living facilities under the Genesis Eldercare(R) brand name;
o New senior notes, new convertible preferred stock, new common stock and new
warrants were issued to Genesis and Multicare's creditors. Approximately
93% of the Successor Company's new common stock, $242.6 million in new
senior notes and new preferred stock with a liquidation preference of $42.6
million were issued to the Genesis and Multicare senior secured creditors.
New one year warrants to purchase an additional 11% of the new common stock
and approximately 7% of the new common stock have been or will be issued to
the Genesis and Multicare unsecured creditors;
o Holders of Genesis and Multicare pre-Chapter 11 preferred and common stock
received no distribution and those instruments were canceled;
o Claims between Genesis and Multicare were set-off against one another and
any remaining claims were waived and released; and
o A new Board of Directors was constituted.
On the Effective Date, and in connection with the consummation of the Plan, the
Successor Company entered into a new Senior Credit Facility (defined in
"Footnote 6 - Long-Term Debt").
8
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In accordance with SOP 90-7, the Company has recorded all expenses incurred as a
result of the bankruptcy filing separately as debt restructuring and
reorganization costs. A summary of the principal categories of debt
restructuring and reorganization costs are as follows (in thousands):
Successor | Predecessor || Successor | Predecessor
Company | Company || Company | Company
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| || |
Three | Three || Nine | Nine
months | months || months | months
ended | ended || ended | ended
June 30, | June 30, || June 30, | June 30,
2002 | 2001 || 2002 | 2001
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Professional, bank and other fees $ 2,570 | $ 10,628 || $ 2,570 | $ 28,840
Employee benefit related costs, including | || |
severance -- | 3,022 || -- | 8,876
Exit costs of terminated businesses -- | 4,264 || -- | 4,904
Post confirmation mortgage adjustment -- | -- || 1,700 | --
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Total $ 2,570 | $ 17,914 || $ 4,270 | $ 42,620
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Professional, bank and other fees recorded in the three and nine months ended
June 30, 2002 represent post confirmation liabilities payable to the United
States Trustee related to Chapter 11 cases that remained open through the nine
month period ended June 30, 2002. With the exception of three cases which remain
open, all of the Chapter 11 cases were closed subsequent to June 30, 2002. The
post confirmation mortgage adjustment recorded during the nine months ended June
30, 2002 is the result of a settlement reached with the lender of a pre-petition
mortgage obligation for an amount that exceeded the estimated loan value
established in the September 30, 2001 fresh-start balance sheet by $1.7 million.
Fresh-Start Reporting.
For financial reporting purposes, the Company adopted the provisions of
fresh-start reporting effective September 30, 2001. In connection with the
adoption of fresh-start reporting, a new entity was deemed created for financial
reporting purposes, the provisions of the Company's reorganization plan were
implemented, assets and liabilities were adjusted to their estimated fair values
and the Company's accumulated deficit was eliminated.
Merger of Genesis and Multicare.
In accordance with the Plan, Multicare became a wholly-owned subsidiary of
Genesis on the Effective Date. Under fresh-start reporting, the Company
consolidated its 100% interest in Multicare as of September 30, 2001. Genesis
previously owned 43.6% of Multicare.
The consummation of the Company's Plan constitutes a change in the controlling
interests of the Company. The provisions of the Plan have a material effect on
the operating results of the Successor Company in the periods following the
Reorganization.
The following unaudited pro forma statement of operations information gives
effect to the Plan as if it were consummated on October 1, 2000. The unaudited
pro forma statement of operations information has been prepared to reflect the
consolidation of the financial results of Multicare, with no minority interest.
The pro forma statement of operations information includes consideration for the
Company's new capital structure, the elimination of restructuring related
charges, and changes in depreciation and amortization expense following the
revaluation of assets and liabilities to their estimated fair value. The pro
forma statement of operations information does not necessarily reflect the
results of operations that would have occurred had the Reorganization actually
occurred at the beginning of the period presented.
9
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Nine Months
Ended June 30,
(Unaudited, in thousands, except per share amounts) 2001
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Pro Forma Statement of Operations Information:
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Total net revenues $ 1,882,159
Net income from continuing operations 35,036
Net income from continuing operations per common share - Basic 0.85
Net income from continuing operations per common share - Diluted $ 0.85
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5. Certain Significant Risks and Uncertainties
Revenue Sources.
The Company receives revenues from Medicare, Medicaid, private insurance,
self-pay residents, other third party payors and long-term care facilities which
utilize our pharmacy and other specialty medical services. The healthcare
industry is experiencing the effects of the federal and state governments' trend
toward cost containment, as government and other third party payors seek to
impose lower reimbursement and utilization rates and negotiate reduced payment
schedules with providers. These cost containment measures, combined with the
increasing influence of managed care payors and competition for patients, have
resulted in reduced rates of reimbursement for services provided by the Company.
The Company receive approximately 61% of its customer service revenues from
Medicare and Medicaid. See "Part I: Item 1 - Business - Revenue Sources" herein
and in the Company's Annual Report on Form 10-K.
A number of the provisions of the Balanced Budget Refinement Act ("BBRA") and
the Benefits Improvement Protection Act ("BIPA") enactments providing additional
funding for Medicare participating skilled nursing facilities expire on
September 30, 2002. Expiring provisions are estimated to, on average, reduce per
beneficiary per diems by $34. On April 23, 2002, the Centers for Medicare and
Medicaid Services ("CMS") issued a press statement announcing that the agency
would not proceed with its previously announced changes in the skilled nursing
facility case-mix classification system. In its announcement, CMS made it clear
that case-mix refinements would be postponed for a full year. CMS issued notice
of fiscal year 2003 rates in the Federal Register, July 31, 2002. Effective
October 1, 2002, rates will be increased by a 2.6% annual market basket
adjustment. CMS estimates that even with this upward adjustment, average rates
will be 8.8% lower than the current year because of the reduced payment caused
by the expiring statutory add-ons.
The House of Representatives passed a package of Medicare amendments in late
June, 2002. Under the House-passed measure, portions of the expiring provisions
would be retained. The BBRA increase of 4% would expire, and the BIPA 16.6%
add-on to the nursing portion of the SNF PPS rates would be reduced to 12% in
2003, 10% in 2004, and 8% in 2005. Under this proposal, fiscal year 2003 rates
would be 5.2% lower than the current year. The Senate is expected to consider
Medicare provider relief during September. Details of the Senate leadership
proposal have not been released. It is premature to forecast the outcome of
Congressional action.
The Company's estimate of the impact of the "SNF Medicare Cliff", factoring in
the administrative decision not to proceed with changes in the case mix
refinements at this time and without factoring in any additional Congressional
action, exposes the skilled nursing facility sector to a 10% reduction. For the
Company, this could have an adverse revenue impact exceeding $35 million
annually. The Company is very involved with trade organizations representing the
skilled nursing facility sector in aggressively pursing strategies to minimize
the potentially adverse impact.
There may be additional provisions in the Medicare legislation affecting the
Company's other businesses. Congress is expected to consider changes affecting
pharmacy, rehabilitation therapy, diagnostic services and the payment for
services in other health settings.
10
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It is not possible to fully quantify the effect of recent legislation, the
interpretation or administration of such legislation or any other governmental
initiatives on the Company's business. Accordingly, there can be no assurance
that the impact of these changes or any future healthcare legislation will not
adversely affect the Company's business. There can be no assurance that payments
under governmental and private third party payor programs will be timely, will
remain at levels comparable to present levels or will, in the future, be
sufficient to cover the costs allocable to patients eligible for reimbursement
pursuant to such programs. The Company's financial condition and results of
operations may be affected by the reimbursement process, which in our industry
is complex and can involve lengthy delays between the time that revenue is
recognized and the time that reimbursement amounts are settled.
Legal Proceedings Potentially Affecting Revenues.
Certain service contracts permit the Company's NeighborCare(R) pharmacy
operations to provide services to HCR Manor Care, constituting approximately ten
percent and five percent of the net revenues of NeighborCareand Genesis,
respectively. These service contracts with HCR Manor Care are the subject of
certain litigation. See "Part II: Other Information, Item 1 - Legal Proceedings"
herein and in the Company's Annual Report on Form 10-K. See also "Footnote 13 -
Arbitration Award".
6. Long-Term Debt
Long-term debt at June 30, 2002 and September 30, 2001 consists of the
following (in thousands):
June 30, September 30,
2002 2001
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Secured debt
Senior Credit Facility
Term Loan $ 282,287 $ 285,000
Delayed Draw Term Loan 79,438 --
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Total Senior Credit Facility 361,725 285,000
Senior Secured Notes 242,605 242,605
Mortgage and other secured debts 83,139 116,904
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Total debt 687,469 644,509
Less:
Current installments of long-term debt (9,369) (41,241)
- ------------------------------------------------------------------------------------------------------------
Long-term debt $ 678,100 $ 603,268
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Senior Credit Facility.
On the Effective Date, and in connection with the consummation of the Plan, the
Successor Company entered into a Senior Credit Facility consisting of the
following: (1) a $150 million revolving line of credit (the "Revolving Credit
Facility"); (2) a $285 million term loan (the "Term Loan"); and (3) an $80
million delayed draw term loan (the "Delayed Draw Term Loan") (collectively the
"Senior Credit Facility"). The outstanding amounts under the Term Loan and the
Delayed Draw Term Loan bear interest at the London Inter-bank Offered Rate
("LIBOR") plus 3.50%, or approximately 5.36% at June 30, 2002. The outstanding
amounts under the Revolving Credit Facility, if any, bear interest based upon a
performance related grid.
The Senior Credit Facility requires the Successor Company to maintain compliance
with certain financial and non-financial covenants, including minimum EBITDAR
(as defined); limitations on capital expenditures, maximum leverage ratios,
minimum fixed charge coverage ratios and minimum net worth.
In June 2002, the Senior Credit Facility was amended in order to extend the date
by which the Company is required to achieve certain levels of fixed versus
variable interest rate exposure. As amended, by September 30, 2002, the Company
is required to either enter into interest rate swap agreements that effectively
fix or cap the interest cost on at least 50% of its consolidated debt or
refinance such debt to achieve a mix of fixed rate debt of at least 50%. At June
30, 2002, the Company's debt mix is approximately 12% fixed-rate and 88%
variable-rate.
11
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The Revolving Credit Facility is available to fund obligations under the Plan
and for general working capital requirements. The Revolving Credit Facility
matures on October 2, 2006. Usage under the Revolving Credit Facility is subject
to a Borrowing Base (as defined) calculation based upon real property collateral
value and a percentage of eligible accounts receivable (as defined). Excluding
an approximately $0.9 million posted letter of credit, no borrowings were
outstanding under the Revolving Credit Facility at June 30, 2002.
The Delayed Draw Term Loan, as originally contracted, was to be used to (1) fund
the purchase price of a proposed acquisition of a pharmacy operation; (2) pay
certain outstanding amounts owed to ElderTrust on certain loans secured by
mortgages; (3) fund the exercise of an option to purchase three eldercare
centers; and (4) to make other Specific Payments (as defined). Once repaid, the
Delayed Draw Term Loan cannot be re-borrowed. The Delayed Draw Term Loan
amortizes at a rate of one percent per year, and matures on April 2, 2007. As a
result of subsequent developments in the Company's bid to consummate a proposed
acquisition of a pharmacy operation, the Delayed Draw Term Loan was amended in
December 2001 to allow available borrowings that were otherwise earmarked for
the proposed pharmacy transaction to be used to restructure credit terms with
NeighborCare(R) pharmacy's primary supplier of pharmacy products.
In the nine months ended June 30, 2002, the Company borrowed approximately $42
million from the Delayed Draw Term Loan to finance the repayment of all trade
balances due to NeighborCare pharmacy's primary supplier of pharmacy products.
This change in credit terms has resulted in reduced pharmacy product acquisition
costs, partially offset by an increase in interest expense on the incremental
Delayed Draw Term Loan borrowings. In addition, the Company utilized
approximately $10 million from the Delayed Draw Term Loan to fund the exercise
of the purchase option on three eldercare centers, previously described, and the
Company utilized approximately $28 million from the Delayed Draw Term Loan to
satisfy certain mortgages as previously described. The Delayed Draw Term Loan is
fully drawn at June 30, 2002 and is being repaid with no additional borrowings
available under the Delayed Draw Term Loan.
Senior Secured Notes.
On the Effective Date, and in connection with the consummation of the Plan, the
Successor Company entered into an indenture agreement in the principal amount of
$242.6 million (the "Senior Secured Notes"). The Senior Secured Notes bear
interest at LIBOR plus 5.0% (approximately 6.86% at June 30, 2002), amortize one
percent each year and mature on April 2, 2007.
Other Secured Indebtedness.
During the nine months ended June 30, 2002, the Company refinanced approximately
$28.0 million of other secured indebtedness with proceeds from the Delayed Draw
Term Loan and used approximately $9.9 million in cash to make an unscheduled
principle payment to reduce outstanding mortgage debt. At June 30, 2002, the
Company had approximately $83.1 million of other secured debt consisting
principally of revenue bonds and secured bank loans.
7. Income Taxes
The Company's income tax for the three and nine months ended June 30, 2002 was a
benefit of $4.2 million and an expense of $25.4 million, respectively. This
provision includes a $10.3 million reduction to tax expense realized in the
third quarter 2002 resulting from the Job Creation and Worker Assistance Act of
2002 which extended the net operating loss carryback period.
12
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The Company realizes tax benefits through the realization of Net Operating Loss
("NOL") carryforwards. Pursuant to SOP 90-7, the income tax benefits of any
future realization of the NOL carryforwards are applied first as a reduction to
goodwill.
8. Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net income
(loss) attributed to common shares (in thousands, except per share data):
Successor | Predecessor || Successor | Predecessor
Company | Company || Company | Company
- -----------------------------------------------------------------------------------------------------------------------------------
Three | Three || Nine | Nine
Months | Months || Months | Months
Ended | Ended || Ended | Ended
June 30, | June 30, || June 30, | June 30,
2002 | 2001 || 2002 | 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Basic: | || |
Numerator: | || |
Income (loss) from continuing operations $ 18,881 | $ (27,502) || $ 63,790 | $ (95,291)
Loss from discontinued operations (1,428) | (789) || (5,795) | (2,534)
Net income (loss) attributed to common | || |
shareholders $ 17,453 | $ (28,291) || $ 57,995 | $ (97,825)
- -----------------------------------------------------------------------------------------------------------------------------------
Denominator: | || |
Weighted average shares 41,342 | 48,641 || 41,212 | 48,641
- -----------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) per share: | || |
Income (loss) from continuing operations $ 0.46 | $ (0.57) || $ 1.55 | $ (1.96)
Loss from discontinued operations (0.03) | (0.02) || (0.14) | (0.05)
Net income (loss) attributed to common | || |
shareholders $ 0.42 | $ (0.58) || $ 1.41 | $ (2.01)
- -----------------------------------------------------------------------------------------------------------------------------------
Diluted: | || |
Numerator: | || |
Income (loss) from continuing operations $ 18,881 | $ (27,502) || $ 63,790 | $ (95,291)
Elimination of preferred dividend requirements | || |
upon assumed conversion of preferred stock 656 | -- || 1,916 | --
- -----------------------------------------------------------------------------------------------------------------------------------
| || |
Income (loss) from continuing operations for | || |
purposes of diluted calculation 19,537 | (27,502) || 65,706 | (95,291)
Loss from discontinued operations (1,428) | (789) || (5,795) | (2,534)
Net income (loss) attributed to common | || |
shareholders for purposes of diluted calculation $ 18,109 | $ (28,291) || $ 59,911 | $ (97,825)
- -----------------------------------------------------------------------------------------------------------------------------------
Denominator: | || |
Weighted average shares - basic 41,342 | 48,641 || 41,212 | 48,641
Add: | || |
Assumed conversion of preferred stock 2,095 | -- || 2,095 | --
Dilutive effect of contingent issuable stock 33 | -- || 33 | --
- -----------------------------------------------------------------------------------------------------------------------------------
Weighted average shares - diluted 43,470 | 48,641 || 43,340 | 48,641
- -----------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) per share: | || |
Income (loss) from continuing operations $ 0.45 | $ (0.57) || $ 1.52 | $ (1.96)
Loss from discontinued operations (0.03) | (0.02) || (0.13) | (0.05)
Net income (loss) attributed to common | || |
shareholders $ 0.42 | $ (0.58) || $ 1.38 | $ (2.01)
- -----------------------------------------------------------------------------------------------------------------------------------
13
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Basic earnings per share is calculated by dividing net income (numerator) by the
weighted average number of shares of common stock outstanding during the
respective reporting period (denominator). Included in the calculation of basic
weighted average shares of 41,341,830 and 41,211,603 for the three and nine
months ended June 30, 2002, respectively, are 815,150 shares to be issued in
connection with a plan confirmed by the bankruptcy court.
Diluted earnings per share is calculated in a manner consistent with basic
earnings per share except that the weighted average shares outstanding are
increased to include additional shares from the assumed conversion of Series A
Convertible Preferred Stock and contingent issuable stock. No conversion of
preferred stock is assumed in the three and nine months ended June 30, 2001
since their effect is antidilutive, however, the conversion of preferred stock
is assumed in the three and nine months ended June 30, 2002 since their effect
is dilutive. No exercise of warrants or employee stock options is assumed for
the three and nine months ended June 30, 2002 since their effect is
antidilutive.
9. Comprehensive Income (Loss)
The following table sets forth the computation of comprehensive income (loss)
(in thousands):
Successor | Predecessor || Successor | Predecessor
Company | Company || Company | Company
- -------------------------------------------------------------------------------------------------------------------------
| || |
Three | Three || Nine | Nine
Months | Months || Months | Months
Ended | Ended || Ended | Ended
June 30, | June 30, || June 30, | June 30,
2002 | 2001 || 2002 | 2001
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) attributed to common | $ (28,291) || $ 57,995 | $ (97,825)
shareholders $ 17,453 | || |
Unrealized gain (loss) on marketable | (105) || 72 | 1,295
securities 317 | || |
- -------------------------------------------------------------------------------------------------------------------------
Total comprehensive income (loss) $ 17,770 | $ (28,396) || $ 58,067 | $ (96,530)
- -------------------------------------------------------------------------------------------------------------------------
10. Discontinued Operations
On October 1, 2001, the Company adopted the provisions of Statement of Financial
Accounting Standards, No. 144 "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 144"). Under SFAS
144, discontinued businesses or assets held for sale are removed from the
results of continuing operations. During the nine months ended June 30, 2002,
the Company classified its ambulance business, five eldercare centers and one
medical supply distribution site as discontinued operations. The results of
operations in the current and prior year periods, along with any costs to exit
such businesses in the current year period, have been classified as discontinued
operations in the condensed consolidated statements of operations. Businesses
sold or closed prior to the Company's adoption of SFAS 144 continue to be
reported in the results of continuing operations.
14
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The following table sets forth the components of losses from discontinued
operations (in thousands):
Successor | Predecessor || Successor | Predecessor
Company | Company || Company | Company
- ----------------------------------------------------------------------------------------------------------------------------
| || |
Three | Three || Nine | Nine
Months | Months || Months | Months
Ended | Ended || Ended | Ended
June 30, | June 30, || June 30, | June 30,
2002 | 2001 || 2002 | 2001
- ----------------------------------------------------------------------------------------------------------------------------
Revenue $ 3,403 | $ 9,054 || $ 17,940 | $ 27,682
Operating losses of discontinued businesses (1,396) | (789) || (3,472) | (2,534)
Loss on discontinuation of businesses (945) | -- || (6,028) | --
Income tax benefit 913 | -- || 3,705 | --
- ----------------------------------------------------------------------------------------------------------------------------
Loss from discontinued operations, net of taxes $ (1,428) | $ (789) || $ (5,795) | $ (2,534)
- ----------------------------------------------------------------------------------------------------------------------------
The loss on discontinuation of businesses includes the write-down of assets to
estimated net realizable value.
The following table sets forth the carrying amounts of the major classes of
assets and liabilities of discontinued operations (in thousands):
Successor Successor
Company Company
- -----------------------------------------------------------------------------------------------------------
June 30, September 30,
2002 2001
- -----------------------------------------------------------------------------------------------------------
Current assets $ 5,508 $ 4,429
Non current assets (including property, plant and equipment) 898 8,224
Current liabilities $ 3,232 $ 2,751
- -----------------------------------------------------------------------------------------------------------
11. Segment Information
The Company's principal operating segments are identified by the types of
products and services from which revenues are derived and are consistent with
the reporting structure of the Company's internal organization.
The Company has two reportable segments: (1) inpatient services and (2) pharmacy
and medical supplies services.
The Company includes in inpatient services revenues all room and board charges
and ancillary service revenue for its eldercare customers at its 188 owned and
leased eldercare centers. The centers offer three levels of care for their
customers: skilled, intermediate and personal.
The Company provides pharmacy and medical supply services through its
NeighborCare(R) pharmacy subsidiaries. Included in pharmacy and medical supply
service revenues are institutional pharmacy revenues, which include the
provision of infusion therapy, medical supplies and equipment provided to
eldercare centers it operates, as well as to independent healthcare providers by
contract. The Company provides these services through 64 institutional
pharmacies (eight are jointly-owned) and 22 medical supply and home medical
equipment distribution centers (four are jointly-owned) located in its various
market areas. In addition, the Company operates 31 community-based pharmacies
(two are jointly-owned) which are located in or near medical centers, hospitals
and physician office complexes. The community-based pharmacies provide
prescription and over-the-counter medications and certain medical supplies, as
well as personal service and consultation by licensed professional pharmacists.
Approximately 91% of the sales attributable to all pharmacy operations are
generated through external contracts with independent healthcare providers with
the balance attributable to centers owned or leased by the Company.
15
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The accounting policies of the segments are the same as those of the
consolidated organization. All intersegment sales prices are market based.
The carrying value of the Company's assets in the following segment information
at June 30, 2002 and September 30, 2001, and the capital costs (depreciation and
amortization, lease expense, and interest), as well as income taxes, minority
interest and preferred dividends for the three and nine months ended June 30,
2002 reflect the provisions of the Plan and the impact of fresh-start reporting.
These costs for periods prior to the Company's emergence from bankruptcy
generally were recorded based on historical costs or contractual agreements and
do not reflect the provisions of the Plan. Accordingly, capital costs of the
Successor Company for the three and nine months ended June 30, 2002 are not
comparable to those of the Predecessor Company for the same period in the prior
year.
Summarized financial information concerning the Company's reportable segments is
shown in the following table. The "All other" category of revenues and operating
income represents operating information of business units below the prescribed
quantitative thresholds. These business units derive revenues from the following
services: rehabilitation therapy, management services, consulting services,
homecare services, physician services, diagnostic services, hospitality
services, group purchasing fees, respiratory health services, staffing services
and other healthcare related services. The "Corporate and other" category
consists of the Company's general and administrative function, for which there
is generally no revenue generated, as well as other unallocated expenses.
Successor | Predecessor || Successor | Predecessor
Company | Company || Company | Company
- --------------------------------------------------------------------------------------------------------------------------------
Three months | Three months || Nine months | Nine months
ended | ended (1) || ended | ended (1)
June 30, | June 30, || June 30, | June 30,
(in thousands) 2002 | 2001 || 2002 | 2001
- --------------------------------------------------------------------------------------------------------------------------------
Revenues: | || |
Inpatient services - external $ 356,424 | $ 338,716 || $ 1,058,075 | $ 994,878
Pharmacy and medical supply services: | || |
External 283,644 | 262,698 || 835,428 | 771,671
Intersegment 26,678 | 25,526 || 79,553 | 72,783
All other: | || |
External 42,663 | 40,273 || 126,070 | 115,610
Intersegment 42,726 | 48,746 || 128,390 | 143,922
Elimination of intersegment revenues (69,404) | (74,272) || (207,943) | (216,705)
- --------------------------------------------------------------------------------------------------------------------------------
Total net revenues $ 682,731 | $ 641,687 || $ 2,019,573 | $ 1,882,159
- --------------------------------------------------------------------------------------------------------------------------------
Operating income (2): | || |
Inpatient services $ 43,818 | $ 42,828 || $ 134,857 | $ 117,662
Pharmacy and medical supply services 27,275 | 27,005 || 80,407 | 71,532
All other 10,935 | 10,753 || 34,507 | 32,961
Corporate and other (29,115) | (18,501) || (69,967) | (48,519)
- --------------------------------------------------------------------------------------------------------------------------------
Total operating income $ 52,913 | $ 62,085 || $ 179,804 | $ 173,636
- --------------------------------------------------------------------------------------------------------------------------------
Capital and other: | || |
Consolidated: | || |
Depreciation and amortization $ 16,471 | $ 26,496 || $ 48,235 | $ 79,493
Lease expense 7,218 | 8,834 || 20,737 | 26,958
Interest expense 11,245 | 26,872 || 36,862 | 92,264
Gain on arbitration award (229) | -- || (21,907) | --
Gain on sale of eldercare center -- | -- || -- | (1,770)
Loss on sale of eldercare center -- | -- || -- | 2,310
Debt restructuring and reorganization | || |
costs 2,570 | 17,914 || 4,270 | 42,620
Income tax provision (benefit) (4,212) | -- || 25,416 | --
Equity in earnings (loss) of | || |
unconsolidated affiliates (279) | 173 || (859) | 1,203
Minority interests 592 | (2,077) || 1,344 | (8,275)
Preferred stock dividends 656 | 11,375 || 1,916 | 34,124
- --------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing | || |
operations 18,881 | (27,502) || 63,790 | (95,291)
Loss from discontinued operations, net | || |
of taxes (1,428) | (789) || (5,795) | (2,534)
- --------------------------------------------------------------------------------------------------------------------------------
Net income (loss) attributed to common | || |
shareholders $ 17,453 | $ (28,291) || $ 57,995 | $ (97,825)
- --------------------------------------------------------------------------------------------------------------------------------
16
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Successor Successor
Company Company
- ---------------------------------------------------------------------------------------------------------
June 30, September 30,
(in thousands) 2002 2001 (1)
- ---------------------------------------------------------------------------------------------------------
Assets:
Inpatient services $ 942,612 $ 1,079,791
Pharmacy and medical supply services 667,459 676,874
Other 312,040 82,555
- ---------------------------------------------------------------------------------------------------------
$ 1,922,111 $ 1,839,220
- ---------------------------------------------------------------------------------------------------------
(1) The June 30, 2001 and September 30, 2001 periods were restated to conform to
the current period presentation which considers direct overhead costs in the
calculation of inpatient services operating income and realigns overhead
businesses within the inpatient services segment for the asset information. The
summary segment information for pharmacy and medical supplies has historically
included direct overhead costs. In accordance with our adoption of SFAS 144, all
segments were restated to remove discontinued businesses from the results of
continuing operations for the period ended June 30, 2001.
(2) Operating income is defined as income after operating expenses as they
appear on the Company's unaudited condensed consolidated statements of
operations and is calculated by subtracting salaries, wages and benefits, cost
of sales and other operating expenses, including severance and related costs for
the period ended June 30, 2002, from net revenues.
12. Restricted Assets
At June 30, 2002 and September 30, 2001, the Company reported restricted
investments in marketable securities of $74.9 million and $51.6 million,
respectively, which are held by Liberty Health Corp. LTD. ("LHC"), Genesis'
wholly-owned captive insurance subsidiary incorporated under the laws of
Bermuda. The investments held by LHC are restricted by statutory capital
requirements in Bermuda. In addition, certain of these investments are pledged
as security for letters of credit issued by LHC. As a result of such
restrictions and encumbrances, Genesis and LHC are precluded from freely
transferring funds through intercompany loans, advances or cash dividends.
13. Arbitraton Award
On February 14, 2002, the arbitrator ruled in favor of NeighborCare(R) on all
claims and counterclaims in the lawsuit involving Manor Care, Inc. and Manorcare
Health Services, Inc. ("Manor Care"). The arbitrator found that Manor Care did
not lawfully terminate the Master Service Agreements with NeighborCare, so that
those contracts remain in full force and effect until the end of September 2004.
The arbitrator awarded NeighborCare $23.0 million in damages, of which $21.7 was
recognized in the second quarter of 2002, for respondents' failure to allow
NeighborCare to exercise its right under the Master Service Agreements to
service facilities owned and operated by a subsidiary of respondent Manor Care.
In addition, the arbitrator terminated his prior ruling that allowed respondents
to withhold 10% of their payments to NeighborCare, and respondents paid
NeighborCare an additional $8.8 million in funds representing the amounts
withheld during the course of the Arbitration pursuant to the arbitrator's prior
ruling.
In response to post-award motions filed by NeighborCare and by respondents, the
arbitrator recalculated NeighborCare's damages, reducing them by approximately
$2.0 million, and ruled that NeighborCare is not obligated, as a result of
certain past events, to renegotiate the prices it offers to respondents for
pharmacy and infusion therapy products and services. There is no financial
statement impact as a result of this decision as the Company was accounting for
the remaining amount in dispute as a gain contingency.
Through June 30, 2002, the Company recorded a net gain of $21.9 million
resulting from the award in the Manor Care arbitration. See "Part II: Other
Information, Item 1 - Legal Proceedings" herein and in the Company's Annual
Report of Form 10-K.
17
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14. Other Events
Management Transition.
On May 28, 2002, the Company announced that Michael R. Walker resigned as Chief
Executive Officer of the Company. The Company's Board of Directors appointed
Robert H. Fish as interim Chief Executive Officer. On June 21, 2002, the Company
announced that David C. Barr resigned as Vice Chairman. Mr. Barr will continue
with the Company as a consultant. The Company recognized approximately $12.6
million in severance and related costs in the fiscal quarter ended June 30, 2002
relating to the transition agreements with Mr. Walker and Mr. Barr.
Medical Supplies Services Agreement.
During the third quarter, NeighborCare entered into a seven year agreement with
Medline Industries, Inc. ("Medline") for the fulfillment of NeighborCare's bulk
medical supply services to its customers. Under the agreement Medline will
provide order intake, warehousing, delivery and invoicing services. NeighborCare
will earn a service fee from Medline for providing traditional sales and
marketing services, calculated as a percentage of the revenues earned by Medline
for sales to NeighborCare customers. As a result of this agreement, NeighborCare
will no longer recognize revenue for the sale of bulk medical supplies to its
customers. The agreement does not include certain products and services. It is
estimated that the agreement will result in an annual reduction of medical
supply revenue of approximately $45 million with no significant impact on net
income.
15. Subsequent Event
Age Institute Settlement Agreement.
On July 9, 2002, Genesis and the AGE Entities entered into a Settlement
Agreement and Mutual Release whereby the adversary proceeding and all
counterclaims were dismissed with prejudice. Pursuant to the settlement, Genesis
will receive a cash payment of approximately $0.5 million on or before December
31, 2002 and a five year promissory note in the principle amount of
approximately $1.6 million. Existing promissory notes due to Genesis totaling
approximately $7.2 million were reaffirmed. The Company has fully reserved
amounts due from AGE Entities, and intends to recognize any recovery as amounts
become recoverable. In addition, beginning January 1, 2003, Genesis and the AGE
Entities will enter into three year contracts (with two successive renewal terms
of three years each) for the provision of pharmacy services at each of the 20
currently owned and operated AGE facilities.
NCS Transaction.
On July 28, 2002, the Company and the Company's wholly-owned subsidiary, Geneva
Sub, Inc. ("Geneva Sub"), entered into an agreement and plan of merger (the
"Merger Agreement") with NCS HealthCare, Inc. ("NCS"), pursuant to which NCS
will become a wholly owned subsidiary of the Company (the "NCS Transaction").
NCS provides institutional pharmacy services to approximately 203,000 long-term
care and assisted living beds in 36 states. The merger will consolidate the
operations of NCS and NeighborCare.
Under the terms of the Merger Agreement, each share of NCS class A and class B
common stock will be converted into 0.1 of a share of Genesis common stock. The
NCS Transaction has been approved by the Boards of Directors of both Genesis and
NCS, as well as by a special committee of independent directors of NCS.
At the closing of the NCS Transaction, Genesis will repay in full the
outstanding debt of NCS, which includes $206 million of senior debt, and will
redeem $102 million of 5.75% convertible subordinated debentures of NCS,
including any accrued and unpaid interest. In total, the NCS Transaction
purchase price is estimated at $340 million, net of the application of
approximately $20 million in excess cash at NCS.
Genesis intends to finance the cash portion of the purchase price with existing
cash on hand, and through an expansion of its existing senior credit facility.
18
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Consummation of the NCS Transaction, which is expected to occur in the fourth
calendar quarter of 2002, is subject to regulatory approval, approval by the NCS
stockholders and other customary conditions. In connection with the NCS
Transaction, two NCS directors holding approximately 65% of the voting power in
NCS have entered into Voting Agreements with the Company and NCS ("Voting
Agreements") in which they agreed to, and have granted a limited proxy to the
Company to, vote in favor of the Merger Agreement and against certain other
actions specified in the Voting Agreements.
Since the Merger Agreement was entered, seven separate lawsuits have been filed
alleging in general that certain officers and directors of NCS breached their
fiduciary duties to the NCS stockholders by entering into the Merger Agreement
and Voting Agreements. The plaintiffs in these lawsuits seek, among other
things, to preliminarily and permanently enjoin the NCS Transaction.
In two of the lawsuits, the Company and Geneva Sub were also named as
defendants. On August 1, 2002, Omnicare, Inc. filed a lawsuit in the Court of
Chancery, County of New Castle, State of Delaware against NCS, its directors,
the Company and Geneva Sub. In its amended complaint, filed August 12, 2002,
Omnicare alleges, among other things, that by agreeing to the terms of the
Voting Agreements and the Merger Agreement, the named NCS directors breached
their statutory obligation to manage NCS and breached their fiduciary duties to
NCS and NCS stockholders; that the grant of proxy under the Voting Agreements
violated NCS's certificate of incorporation and resulted in the shares of NCS
class B common stock subject to those agreements (which carry 10 votes per
share) being converted automatically into shares of NCS class A common stock
(which carry 1 vote per share); and that the termination fee that would be paid
by NCS to the Company under some circumstances is unreasonably high and
therefore unenforceable. Omnicare also alleges that the Company and Geneva Sub
aided and abetted the NCS directors in breaching their fiduciary duties to NCS
stockholders by entering into the Voting Agreements and Merger Agreement.
Omnicare is asking that the court to (i) declare that the NCS class B shares
subject to the Voting Agreements have been irrevocably converted into NCS class
A shares; (ii) declare the Merger Agreement null and void; (iii) preliminarily
and permanently enjoin NCS, the NCS directors, the Company and Geneva Sub from
taking further steps or actions with respect to the Voting Agreements and the
Merger Agreement; (iv) preliminarily and permanently enjoin the Company and
Geneva Sub from aiding and abetting the named NCS directors from breaching their
fiduciary duties; (v) declare the Termination Fee unreasonable, invalid and
unenforceable; and (vi) grant Omnicare such other relief as the court deems just
and proper, including the cost and disbursements of the action and reasonable
attorneys' fees.
On August 7, 2002, Dolphin Limited Partnership L.L.P. ("Dolphin"), on behalf of
all holders of NCS Class A common stock (other than the named NCS defendant
directors), filed a lawsuit in the Court of Chancery, County of New Castle,
State of Delaware against NCS, its directors, the Company and Genesis Sub (sic).
In its complaint, Dolphin alleges that the named NCS directors breached their
fiduciary duties to holders of NCS Class A common stock by, among other things,
entering into the Voting Agreements and the Merger Agreement, refusing to
consider Omnicare's bid and not conditioning the NCS Transaction on the approval
of the holders of the NCS Class A common stock as a separate class. Dolphin also
alleges that the Company aided and abetted the named NCS directors in breaching
their fiduciary duties to the holders of NCS Class A common stock. Dolphin is
asking that the court to (i) declare that the action is a class action and
certify Dolphin as the class representative and Dolphin's counsel as the class
counsel; (ii) enjoin, preliminarily and permanently, the NCS Transaction; (iii)
direct that the NCS Transaction be conditioned on the approval of the holders of
NCS Class A common stock as a separate class; (iv) rescind the NCS Transaction
in the event that it occurs prior to the court's final judgment or award the
holders of NCS Class A common stock recissory damages; (v) direct that the named
defendants account to Dolphin and the holders of NCS Class A common stock for
all damages caused by the defendants and account for all profits and any special
benefits obtained as a result of the alleged breaches of fiduciary duties; (vi)
award Dolphin the costs and disbursements of the action, including a reasonable
allowance for the fees and expenses of Dolphin's attorneys and experts; and
(vii) grant Dolphin and the holders of NCS Class A common stock such further
relief as the court deems just and proper.
No court dates have been set for these matters. The Company believes that the
allegations set forth in these lawsuits are without merit and intends to
contest them vigorously; however, the ultimate outcome of these lawsuits cannot
be predicted with certainty. These lawsuits could adversely affect the Company's
ability to consummate the NCS Transaction by end of the fourth calendar quarter
of 2002, if at all.
19
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Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
General
Since we began operations in July 1985, we have focused our efforts on providing
an expanding array of specialty medical services to elderly customers. We
generate revenues primarily from two sources: inpatient services and pharmacy
and medical supply services. However, we also derive revenue from other sources.
Inpatient services revenues include all room and board charges and ancillary
service revenue for our eldercare customers at our 188 owned and leased
eldercare centers. The centers offer three levels of care for their customers:
skilled, intermediate and personal.
We provide pharmacy and medical supply services through our NeighborCare(R)
pharmacy operations. Included in pharmacy and medical supply service revenues
are institutional pharmacy revenues, which include the provision of infusion
therapy, medical supplies and equipment provided to eldercare centers operated
by us, as well as to independent healthcare providers by contract. We provide
these services through 64 institutional pharmacies (eight are jointly-owned) and
22 medical supply and home medical equipment distribution centers (four are
jointly-owned) located in our various market areas. In addition, we operate 31
community-based pharmacies (two are jointly-owned), which are located in or near
medical centers, hospitals and physician office complexes. The community-based
pharmacies provide prescription and over-the-counter medications and certain
medical supplies, as well as personal service and consultation by licensed
professional pharmacists.
We include the following service revenue in other revenues: rehabilitation
therapy services, management fees, consulting services, homecare services,
physician services, diagnostic services, hospitality services, group purchasing
fees, respiratory health services, staffing services and other healthcare
related services.
Certain Transactions and Events
NCS Transaction.
On July 28, 2002, we and our wholly-owned subsidiary, Geneva Sub, Inc. ("Geneva
Sub"), entered into an agreement and plan of merger (the "merger agreement")
with NCS HealthCare, Inc. ("NCS"), pursuant to which NCS will become our
wholly-owned subsidiary (the "NCS transaction"). NCS provides institutional
pharmacy services to approximately 203,000 long-term care and assisted living
beds in 36 states. The merger will consolidate the operations of NCS and
NeighborCare.
Under the terms of the merger agreement, each share of NCS class A and class B
common stock will be converted into 0.1 of a share of our common stock. The NCS
transaction has been approved by the boards of directors of both us and NCS, as
well as by a special committee of independent directors of NCS.
At the closing of the NCS transaction, we will repay in full the outstanding
debt of NCS, which includes $206 million of senior debt, and will redeem $102
million of 5.75% convertible subordinated debentures of NCS, including any
accrued and unpaid interest. In total, the NCS transaction purchase price is
estimated at $340 million, net of the application of approximately $20 million
in excess cash at NCS.
We intend to finance the cash portion of the purchase price with existing cash
on hand, and through an expansion of our existing senior credit facility.
Consummation of the NCS transaction, which is expected to occur in the fourth
calendar quarter of 2002, is subject to regulatory approval, approval by the NCS
stockholders and other customary conditions. In connection with the NCS
transaction, two NCS directors holding approximately 65% of the voting power in
NCS have entered into voting agreements with us and NCS (the "voting
agreements") in which they agreed to, and have granted a limited proxy to us to,
vote in favor of the merger agreement and against certain other actions
specified in the voting agreements.
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Since the merger agreement was entered, seven separate lawsuits have been filed
alleging in general that certain officers and directors of NCS breached their
fiduciary duties to the NCS stockholders by entering into the merger agreement
and voting agreements. The plaintiffs in these lawsuits seek, among other
things, to preliminarily and permanently enjoin the NCS transaction.
In two of the lawsuits, we and Geneva Sub were also named as defendants. On
August 1, 2002, Omnicare, Inc. filed a lawsuit in the Court of Chancery, County
of New Castle, State of Delaware against NCS, its directors, us and Geneva Sub.
In its amended complaint, filed August 12, 2002, Omnicare alleges, among other
things, that by agreeing to the terms of the voting agreements and the merger
agreement, the named NCS directors breached their statutory obligation to manage
NCS and breached their fiduciary duties to NCS and NCS stockholders; that the
grant of proxy under the voting agreements violated NCS's certificate of
incorporation and resulted in the shares of NCS class B common stock subject to
those agreements (which carry 10 votes per share) being converted automatically
into shares of NCS class A common stock (which carry 1 vote per share); and that
the termination fee that would be paid by NCS to us under some circumstances is
unreasonably high and therefore unenforceable. Omnicare also alleges that we and
Geneva Sub aided and abetted the NCS directors in breaching their fiduciary
duties to NCS stockholders by entering into the voting agreements and merger
agreement. Omnicare is asking the court to (i) declare that the NCS class B
shares subject to the voting agreements have been irrevocably converted into NCS
class A shares; (ii) declare the merger agreement null and void; (iii)
preliminarily and permanently enjoin NCS, the NCS directors, us and Geneva Sub
from taking further steps or actions with respect to the voting agreements and
the merger agreement; (iv) preliminarily and permanently enjoin us and Geneva
Sub from aiding and abetting the named NCS directors from breaching their
fiduciary duties; (v) declare the termination fee unreasonable, invalid and
unenforceable; and (vi) grant Omnicare such other relief as the court deems just
and proper, including the cost and disbursements of the action and reasonable
attorneys' fees.
On August 7, 2002, Dolphin Limited Partnership L.L.P. ("Dolphin"), on behalf of
all holders of NCS Class A common stock (other than the named NCS defendant
directors), filed a lawsuit in the Court of Chancery, County of New Castle,
State of Delaware against NCS, its directors, us and Genesis Sub (sic). In its
complaint, Dolphin alleges that the named NCS directors breached their fiduciary
duties to holders of NCS Class A common stock by, among other things, entering
into the voting agreements and the merger agreement, refusing to consider
Omnicare's bid and not conditioning the NCS transaction on the approval of the
holders of the NCS Class A common stock as a separate class. Dolphin also
alleges that we aided and abetted the named NCS directors in breaching their
fiduciary duties to the holders of NCS Class A common stock. Dolphin is asking
that the court to (i) declare that the action is a class action and certify
Dolphin as the class representative and Dolphin's counsel as the class counsel;
(ii) enjoin, preliminarily and permanently, the NCS transaction; (iii) direct
that the NCS transaction be conditioned on the approval of the holders of NCS
Class A common stock as a separate class; (iv) rescind the NCS transaction in
the event that it occurs prior to the court's final judgment or award the
holders of NCS Class A common stock recissory damages; (v) direct that the named
defendants account to Dolphin and the holders of NCS Class A common stock for
all damages caused by the defendants and account for all profits and any special
benefits obtained as a result of the alleged breaches of fiduciary duties; (vi)
award Dolphin the costs and disbursements of the action, including a reasonable
allowance for the fees and expenses of Dolphin's attorneys and experts; and
(vii) grant Dolphin and the holders of NCS Class A common stock such further
relief as the court deems just and proper.
No court dates have been set for these matters. We believe that the allegations
set forth in these lawsuits are without merit and intend to contest them
vigorously; however, the ultimate outcome of these lawsuits cannot be predicted
with certainty. These lawsuits could adversely affect our ability to consummate
the NCS transaction by end of the fourth calendar quarter of 2002, if at all.
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Management Transition.
On May 28, 2002, we announced that Michael R. Walker resigned as our Chief
Executive Officer. Our Board of Directors appointed Robert H. Fish as interim
Chief Executive Officer. On June 21, 2002, we announced that David C. Barr
resigned as Vice Chairman. Mr. Barr will continue with us as a consultant. We
recognized approximately $12.6 million in severance and related costs in the
fiscal quarter ended June 30, 2002 relating to the transition agreements with
Mr. Walker and Mr. Barr.
Medical Supplies Services Agreement.
During the third quarter, NeighborCare entered into a seven year agreement with
Medline Industries, Inc. ("Medline") for the fulfillment of NeighborCare's bulk
medical supply services to its customers. Under the agreement Medline will
provide order intake, warehousing, delivery and invoicing services. NeighborCare
will earn a service fee from Medline for providing traditional sales and
marketing services, calculated as a percentage of the revenues earned by Medline
for sales to NeighborCare customers. As a result of this agreement, NeighborCare
will no longer recognize revenue for the sale of bulk medical supplies to its
customers. The agreement does not include certain products and services. It is
estimated that the agreement will result in an annual reduction of medical
supply revenue of approximately $45 million with no significant impact on net
income.
Reorganization:
Background.
On June 22, 2000, (the "Petition Date") we and certain of our direct and
indirect subsidiaries filed for voluntary relief under Chapter 11 of the United
States Code (the "Bankruptcy Code") with the United States Bankruptcy Court for
the District of Delaware (the "Bankruptcy Court"). On the same date, our 43.6%
owned affiliate, The Multicare Companies, Inc. and certain of its direct and
indirect subsidiaries ("Multicare") and certain of its affiliates also filed for
relief under Chapter 11 of the Bankruptcy Code with the Bankruptcy Court
(singularly and collectively referred to herein as "the Chapter 11 cases" unless
the context otherwise requires).
Our and Multicare's financial difficulties were attributed to a number of
factors. First, the federal government made fundamental changes to the
reimbursement for medical services provided to individuals. The changes had a
significant adverse impact on the healthcare industry as a whole and on our and
Multicare's cash flows. Second, the federal reimbursement changes exacerbated a
long-standing problem of inadequate reimbursement by the states for medical
services provided to indigent persons under the various state Medicaid programs.
Third, numerous other factors adversely affected our and Multicare's cash flows,
including increased labor costs, increased professional liability and other
insurance costs, and increased interest rates. Finally, as a result of declining
governmental reimbursement rates and in the face of rising inflationary costs,
we and Multicare were too highly leveraged to service our debt, including our
long-term lease obligations.
On October 2, 2001, (the "Effective Date"), we and Multicare consummated a joint
plan of reorganization (the "Plan") under Chapter 11 of the Bankruptcy Code (the
"Reorganization") pursuant to a September 20, 2001 order entered by the
Bankruptcy Court approving the Plan proposed by us, and Multicare. The principal
provisions of the Plan were as follows:
o Multicare became our wholly-owned subsidiary. We previously owned 43.6% of
Multicare and managed its skilled nursing and assisted living facilities
under the Genesis Eldercare(R) brand name;
o New senior notes, new convertible preferred stock, new common stock and new
warrants were issued to our and Multicare's creditors. Approximately 93% of
new common stock, $242.6 million in new senior notes and new preferred
stock with a liquidation preference of $42.6 million were issued to our and
Multicare's senior secured creditors. New one year warrants to purchase an
additional 11% of the new common stock and approximately 7% of the new
common stock have been or will be issued to our and Multicare's unsecured
creditors;
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o Holders of our and Multicare's pre-Chapter 11 preferred and common stock
received no distribution and those instruments were canceled;
o Claims between us and Multicare were set-off against one another and any
remaining claims were waived and released; and
o A new Board of Directors was constituted.
On the Effective Date, and in connection with the consummation of the Plan, we
entered into a Senior Credit Facility consisting of the following: (1) a $150
million revolving line of credit (the "Revolving Credit Facility"); (2) a $285
million term loan (the "Term Loan") and (3) an $80 million delayed draw term
loan (the "Delayed Draw Term Loan") (collectively the "Senior Credit Facility").
In accordance with SOP 90-7 (as defined below under "Fresh-Start Reporting"), we
recorded all expenses incurred as a result of the Bankruptcy filing separately
as debt restructuring and reorganization costs. A summary of the principal
categories of debt restructuring and reorganization costs follows (in
thousands):
Successor | Predecessor || Successor | Predecessor
Company | Company || Company | Company
- ----------------------------------------------------------------------------------------------------------------------------------
Three | Three || Nine | Nine
months | months || months | months
ended | ended || ended | ended
June 30, | June 30, || June 30, | June 30,
2002 | 2001 || 2002 | 2001
- ----------------------------------------------------------------------------------------------------------------------------------
Professional, bank and other fees $ 2,570 | $ 10,628 || $ 2,570 | $ 28,840
Employee benefit related costs, including severance -- | 3,022 || -- | 8,876
Exit costs of terminated businesses -- | 4,264 || -- | 4,904
Post confirmation mortgage adjustment -- | -- || 1,700 | --
- ----------------------------------------------------------------------------------------------------------------------------------
Total $ 2,570 | $ 17,914 || $ 4,270 | $ 42,620
- ----------------------------------------------------------------------------------------------------------------------------------
Professional, bank and other fees recorded in the three and nine months ended
June 30, 2002 represent post confirmation liabilities payable to the United
States Trustee related to the Chapter 11 cases that remained open through the
nine month period ended June 30, 2002. With the exception of three cases which
remain open, all of the Chapter 11 cases were closed subsequent to June 30,
2002. The post confirmation mortgage adjustment recorded during the nine months
ended June 30, 2002 is the result of a settlement reached with the lender of a
pre-petition mortgage obligation for an amount that exceeded the estimated loan
value established in the September 30, 2001 fresh-start balance sheet by $1.7
million.
Fresh-Start Reporting.
Upon emergence from our Chapter 11 proceedings, we adopted the principles of
fresh-start reporting in accordance with the American Institute of Certified
Public Accountants Statement of Position 90-7, "Financial Reporting By Entities
in Reorganization Under the Bankruptcy Code" ("SOP 90-7") / ("fresh-start
reporting"). For financial reporting purposes, we adopted the provisions of
fresh-start reporting effective September 30, 2001. In connection with the
adoption of fresh-start reporting, a new entity was deemed created for financial
reporting purposes, the provisions of our Plan were implemented, assets and
liabilities were adjusted to their estimated fair values and our accumulated
deficit was eliminated.
Factors Affecting Comparability of Financial Information.
As a consequence of the implementation of fresh-start reporting effective
September 30, 2001, the financial information presented in the unaudited
condensed consolidated statement of operations for the three and nine months
ended June 30, 2002 and the statement of cash flows for the nine months ended
June 30, 2002 are generally not comparable to the financial results for the
corresponding periods in the prior year. To highlight the lack of comparability,
a dashed line separates the pre-emergence financial information from the
post-emergence financial information in the accompanying unaudited condensed
consolidated financial statements and the notes thereto. Any financial
information herein labeled "Predecessor Company" refers to periods prior to the
adoption of fresh-start reporting, while those labeled "Successor Company" refer
to periods following adoption of fresh-start reporting.
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The lack of comparability in the accompanying unaudited condensed consolidated
financial statements is most apparent in our capital costs (lease, interest,
depreciation and amortization), as well as with income taxes, minority
interests, debt restructuring and reorganization costs, and preferred dividends.
We believe that business segment operating revenue and operating income of the
Predecessor Company are generally comparable to those of the Successor Company.
Results of Operations
Three months ended June 30, 2002 compared to three months ended June 30, 2001
Inpatient Services
Inpatient services revenue increased $17.7 million, or 5%, to $356.4 million for
the three months ended June 30, 2002 from $338.7 million for the same period in
the previous year. Approximately $19.9 million of the growth is principally
attributed to increased payment rates. Our average rate per patient day for the
three months ended June 30, 2002 was $183 compared to $169 for the comparable
period in the prior year. Our revenue Quality Mix (Medicare, private pay and
insurance payors) for the three months ended June 30, 2002 declined to 51.7%
from 51.8% for the comparable period in the prior year. The remaining decline in
revenue of approximately $2.2 million resulted from eldercare center
divestitures. Total patient days decreased 59,054 to 1,966,187 during the three
months ended June 30, 2002 compared to 2,025,241 during the comparable period
last year. Of this decrease, 52,909 patient days are attributed to divestitures
of eldercare centers in the prior year period. The remaining decrease of 6,145
patient days is the result of a decline in overall occupancy.
Operating expenses for the three months ended June 30, 2002 increased $16.7
million, or 6%, to $312.6 million from $295.9 million for the same period in the
prior year. The primary cost for this segment is salary, wage and benefit costs,
which increased $13.0 million, or 8% for the three month period ended June 30,
2002 to $176.6 million from $163.6 million for the same period in the prior
year. This increase is net of a reduction of approximately $2.2 million in
salary, wage and benefit costs resulting from the divestiture of eldercare
centers. Salary, wage and benefit costs, considering the impact of divested
eldercare centers, increased $15.2 million, or 9%, driven by inflationary cost
increases and the relative mix of employed labor versus agency labor costs. As a
percentage of net revenue, salary, wage and benefit costs, once adjusted for the
impact of divested eldercare centers, increased to 49.5% for the three months
ended June 30, 2002, compared to 48.0% for the comparable period in the prior
year. This increase is the result of continued pressure on wage and benefit
related costs mitigated by less reliance on agency labor (primarily nursing
costs) resulting from improved hiring and retention trends. Other operating
expenses, once reduced for the impact of new and divested eldercare centers
($1.1 million for the three months ended June 30, 2001), increased $4.8 million,
or 4%, to $136.0 million for the three months ended June 30, 2002 compared to
$131.2 million for the same period last year. The increase was primarily driven
by additional ancillary supply costs to treat a higher acuity customer base of
approximately $3.0 million, increased property and general liability insurance
of approximately $0.6 million and other operating costs of approximately $2.2
million. These increases were offset by reduced bad debt expense of $0.4 million
and declining agency labor costs (principally nursing costs) of approximately
$0.6 million. External labor agencies charge us a premium labor rate compared to
salary, wages and benefits earned by employees. The declining reliance upon such
external labor agencies serves to reduce overall operating expense while
increasing salary, wages and benefits costs.
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Operating income increased $1.0 million, to $43.8 million for three months ended
June 30, 2002 from $42.8 million for the same period in the prior year.
Pharmacy and medical supply services
Pharmacy and medical supply services revenue (before intersegment eliminations)
increased $22.1 million, or 8%, to $310.3 million for the three months ended
June 30, 2002 compared to $288.2 million for the three months ended June 30,
2001. Revenues from intersegment customers, which are eliminated in
consolidation, increased approximately $1.2 million, or 5%, to $26.7 million for
the three months ended June 30, 2002 compared to $25.5 million for the same
period of the prior year. The remaining increase in net pharmacy and medical
supply service revenues of approximately $20.9 million, or 8%, is due primarily
to rate increases and shifts in customer and product mix with external
customers.
Cost of sales (before intersegment eliminations) increased $15.7 million, or 9%,
for the three month period ended June 30, 2002, to $195.1 million from $179.4
million for the same period in the prior year. Of this growth, $13.8 million is
attributed to pharmacy and medical supply revenue growth, and $1.9 million is
attributed to changes in customer and product mix. As a percentage of revenue,
cost of sales for the three month period ended June 30, 2002 was 62.9% compared
to 62.2% for the comparable period in the prior year. Other operating expenses
for this segment, including salaries, wages and benefits, increased $6.1
million, or 8%, to $87.9 million for the three months ended June 30, 2002
compared to $81.8 million for the same period in the prior year. As a percentage
of revenue, other operating costs were 28% for the three month periods ended
June 30, 2002 and 2001.
Operating income increased $0.3 million, to $27.3 million for three months ended
June 30, 2002 from $27.0 million for the same period in the prior year.
During the second quarter of fiscal 2002, we borrowed approximately $42 million
from the Delayed Draw Term Loan to finance the repayment of all trade balances
due to NeighborCare(R) pharmacy's primary supplier of pharmacy products. This
change in credit terms resulted in reduced pharmacy product acquisition costs.
All Other
All other includes operating information of business units below the prescribed
quantitative thresholds. These business units derive revenues and expenses from
the following services: rehabilitation therapy, management services, consulting
services, homecare services, physician services, diagnostic services,
hospitality services, group purchasing fees, respiratory health services,
staffing services and other healthcare related services. Revenues, including
intersegment revenues, from these business units decreased approximately $3.6
million to $85.4 million from $89.0 million for the three month periods ended
June 30, 2002 and June 30, 2001, respectively. The decline was primarily caused
by less management fee revenue resulting from the post-bankruptcy termination of
the Multicare management agreement, offset by growth in other service related
businesses' revenue.
Operating income for all other businesses increased $0.1 million, to $10.9
million for three months ended June 30, 2002 from $10.8 million for the same
period in the prior year.
Corporate and other
The "Corporate and other" category consists of our general and administrative
function and other unallocated amounts, for which there is generally no revenue
generated. Operating expenses increased $10.6 million in the three months ended
June 30, 2002 to $29.1 million compared to $18.5 million in the comparable
period in the prior year. Of this increase, $12.6 million relates to severance
and related costs incurred in the three months ended June 30, 2002 related to
the resignations of our Chief Executive Officer and our Vice Chairman, and
approximately $1.6 million is principally attributed to labor related and other
operating expense growth in our corporate support functions. These increases are
offset by reductions of approximately $1.2 million in expense levels for our
cash based incentive compensation program and an executive non-cash stock based
compensation program, approximately $2.1 million for a settlement agreement
recorded in the three months ended June 30, 2001, and approximately $0.3 million
related to other unallocated employee benefit costs.
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Capital costs and other
Our capital costs for the three months ended June 30, 2002 reflect the impact of
fresh-start reporting following our emergence from bankruptcy. Those adjustments
materially changed the recorded amounts of capital costs, most notably
depreciation and amortization, lease expense, interest expense, income taxes,
minority interest and preferred stock dividends, and as a result, will not be
comparable to those for the three months ended June 30, 2001.
Depreciation and amortization expense decreased $10.0 million to $16.5 million
for the three months ended June 30, 2002 compared to $26.5 million for the same
period in the prior year. The decrease was primarily caused by the impact of
fresh-start reporting on the carrying value of our property, plant and
equipment, which were adjusted to their estimated fair values as of September
30, 2001, and our October 1, 2001 adoption of an accounting pronouncement which
prohibits the amortization of unimpaired goodwill.
Lease expense decreased $1.6 million for the three months ended June 30, 2002,
to $7.2 million compared to $8.8 million for the same period in the prior year.
Of this decrease, approximately $0.6 million is attributed to the divestiture or
lease modifications of certain leased eldercare centers. The remaining decrease
of approximately $1.0 million is principally attributed to the discharge in
bankruptcy of our lease financing facility.
Interest expense decreased $15.7 million for the three months ended June 30,
2002, to $11.2 million compared to $26.9 million for the same period in the
prior year. For the three months ended June 30, 2001, in accordance with SOP
90-7, we ceased accruing interest following the Petition Date on certain
long-term debt instruments classified as liabilities subject to compromise. Our
contractual interest expense for the three months ended June 30, 2001 was $50.8
million, leaving $23.9 million of interest expense unaccrued for that period as
a result of the Chapter 11 cases. Interest expense for the three months ended
June 30, 2002 has been accrued at the contractual rates. Contractual interest
expense for the three months ended June 30, 2002 decreased by $39.6 million
compared to the same period in the prior year. This decrease is attributed to
the overall reduction of debt levels following our emergence from bankruptcy in
addition to a lower weighted average borrowing rate.
In June 2002, we recorded an additional gain of $0.2 million resulting from the
award in the HCR Manor Care arbitration. See "Part II: Other Information, Item 1
- - Legal Proceedings" herein and in the Company's Annual Report of Form 10-K.
During the three months ended June 30, 2002, we recorded approximately $2.6
million for post confirmation liabilities payable to the United States Trustee
related to the Chapter 11 cases that remained open. With the exception of three
cases which remain open, all of the Chapter 11 cases were closed subsequent to
June 30, 2002. During the same period in the prior year, we recorded legal,
bank, accounting and other costs of approximately $10.6 million in connection
with the Chapter 11 cases. In addition, we incurred costs of $3.0 million in the
three months ended June 30, 2001 for certain bankruptcy related salary and
benefit related costs, principally for a court approved special recognition
program. Also, we incurred approximately $4.3 million of costs associated with
the divestiture of certain businesses.
Minority interest decreased $2.7 million during the three months ended June 30,
2002 to ($0.6) million compared to $2.1 million for the comparable period in the
prior year. This decrease is primarily due to the 56.4% interest in the net
losses of Multicare attributable to the joint venture partners in the three
months ended June 30, 2001. Upon our emergence from bankruptcy, we and Multicare
merged, effectively terminating the joint venture and any interest the joint
venture partners had in Multicare.
Preferred stock dividends decreased $10.7 million to $0.7 million during the
three months ended June 30, 2002 compared to $11.4 million for the comparable
period in the prior year. This decrease is attributed to the cancellation of our
Predecessor Company preferred stock and related dividends, and offset with
dividends on $42.6 million of Series A Redeemable Preferred Stock issued in
connection with the Plan. At June 30, 2002, there were 425,946 shares of Series
A Redeemable Preferred Stock outstanding.
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Losses from discontinued operations increased $0.6 million for the three months
ended June 30, 2002, to ($1.4) million from ($0.8) million for the same period
in the prior year. On October 1, 2001, we adopted the provisions of Statement of
Financial Accounting Standards, No. 144 "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 144").
Under SFAS 144, discontinued businesses or assets held for sale are removed from
the results of continuing operations. During the three months ended June 30,
2002, three businesses were identified as discontinued operations. The results
of operations in the current year and prior year periods, along with any costs
to exit such businesses in the current year period, have been classified as
discontinued operations in the accompanying financial statements. Businesses
sold or closed prior to our adoption of SFAS 144 continue to be reported in the
results of continuing operations.
Nine months ended June 30, 2002 compared to nine months ended June 30, 2001
Inpatient Services
Inpatient services revenue increased $63.1 million, or 6%, to $1,058.0 million
for the nine months ended June 30, 2002 from $994.9 million for the same period
in the previous year. Approximately $75.2 million is principally attributed to
increased payment rates and higher Quality Mix as a percentage of total patient
days. Our average rate per patient day for the nine months ended June 30, 2002
was $179 compared to $165 for the comparable period in the prior year. This
increase in the average rate per patient day is principally driven by the effect
of BIPA on our average Medicare rate per patient day, which increased to $337
for the nine months ended June 30, 2002 compared to $323 for the comparable
period in the prior year. As time passes, BIPA will have a diminishing impact on
the fiscal year-to-date revenue and rate comparisons since its economic or
financial benefit was realized April 1, 2001. Our revenue Quality Mix for the
nine months ended June 30, 2002 was 51.4% compared to 51.1% for the comparable
period in the prior year. These rate and Quality Mix increases are offset by a
decrease in revenue of approximately $12.1 million resulting from eldercare
center divestitures. Total patient days decreased 161,686 to 5,961,730 during
the nine months ended June 30, 2002 compared to 6,123,416 during the comparable
period last year. Of this decrease, 164,462 patient days are attributed to
eldercare center divestitures and decreased operating census of 5,579 patient
days as the result of a decline in overall occupancy; offset by the addition of
8,355 patient days of two new eldercare centers.
Operating expenses for the nine months ended June 30, 2002 increased $46.0
million, or 5%, to $923.2 million from $877.2 million for the same period in the
prior year. The primary cost for this segment is salary, wage and benefit costs,
which increased $30.6 million, or 6% for the nine months ended June 30, 2002 to
$519.8 million from $489.2 million for the same period in the prior year. This
increase includes the reduction of approximately $9.1 million in salary, wage
and benefit costs resulting from eldercare center divestitures. Salary, wage and
benefit costs, considering the impact of divested eldercare centers, increased
$39.7 million, or 8%, driven by inflationary cost increases and the relative mix
of employed labor versus agency labor costs. As a percentage of net revenue,
salary, wage and benefit costs, once adjusted for the impact of divested
eldercare centers, was approximately 49.1% for the nine months ended June 30,
2002 compared to 48.9% for the comparable period in the prior year, despite a
disproportionate per diem rate growth, largely created by the effect of BIPA,
previously discussed. The inpatient services segment has experienced continued
pressure on wage and benefit related costs mitigated by less reliance on agency
labor (primarily nursing costs) resulting from improved hiring and retention
trends. Other operating expense, once reduced for the impact of divested
eldercare centers ($4.1 million for the nine months ended June 30, 2001),
increased $19.5 million, or 5%, to $403.4 million for the nine months ended June
30, 2002 compared to $383.9 million for the same period last year. The increase
was primarily driven by approximately $10.7 million of additional ancillary
supply costs to treat a higher acuity customer base, increased property and
general liability insurance of approximately $1.8 million and other operating
costs of approximately $7.6 million; offset by decreased agency labor costs
(principally nursing costs) of approximately $0.6 million. External labor
agencies charge the Company a premium labor rate compared to salary, wage and
benefits earned by employees.
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Operating income increased $17.2 million, to $134.9 million for nine months
ended June 30, 2002 from $117.7 million for the same period in the prior year.
Pharmacy and medical supply services
Pharmacy and medical supply services revenue (before intersegment eliminations)
increased $70.5 million, or 8%, to $915.0 million for the nine months ended June
30, 2002 compared to $844.5 million for nine months ended June 30, 2001.
Revenues from intersegment customers, which are eliminated in consolidation,
increased approximately $6.8 million, or 9%, to $79.6 million for the nine
months ended June 30, 2002 compared to $72.8 million for the same period in the
prior year. The remaining increase in net pharmacy and medical supply service
revenues of approximately $63.7 million, or 8%, is due primarily to rate
increases and shifts in customer and product mix with external customers.
Cost of sales (before intersegment eliminations) increased $50.0 million, or
10%, for the nine months ended June 30, 2002, to $576.3 million from $526.3
million for the same period in the prior year. Of this growth, $44.0 million is
attributed to pharmacy and medical supply revenue growth, and $6.0 million is
attributed to changes in customer and product mix. As a percentage of revenue,
cost of sales for the nine months ended June 30, 2002 was 63.0% compared to
62.3% for the comparable period in the prior year. Other operating expenses for
this segment, including salaries, wages and benefits, increased $11.4 million,
or 5%, to $258.0 million for the nine months ended June 30, 2002 compared to
$246.6 million for the same period in the prior year. As a percentage of
revenue, other operating costs declined to 28% for nine months ended June 30,
2002 from 29% for the comparable period in the prior year. This decline is
attributed to improved cost control and the absorption of fixed costs by the
relative level of revenue.
Operating income increased $8.9 million, to $80.4 million for nine months ended
June 30, 2002 from $71.5 million for the same period in the prior year.
During the second quarter of fiscal 2002, we borrowed approximately $42 million
from the Delayed Draw Term Loan to finance the repayment of all trade balances
due to NeighborCare pharmacy's primary supplier of pharmacy products. This
change in credit terms resulted in reduced pharmacy product acquisition costs.
All Other
All other includes operating information of business units below the prescribed
quantitative thresholds. These business units derive revenues and expenses from
the following services: rehabilitation therapy, management services, consulting
services, homecare services, physician services, diagnostic services,
hospitality services, group purchasing fees, respiratory health services,
staffing services and other healthcare related services. Revenues, including
intersegment revenues, from these business units decreased approximately $5.0
million to $254.5 million from $259.5 million for nine months ended June 30,
2002 and June 30, 2001, respectively. The decline was primarily caused by less
management fee revenue resulting from the post-bankruptcy termination of the
Multicare management agreement, offset by growth in other service related
businesses' revenue.
Operating income for all other businesses increased $1.5 million, to $34.5
million for nine months ended June 30, 2002 from $33.0 million for the same
period in the prior year.
Corporate and other
The "Corporate and other" category consists of our general and administrative
function and other unallocated amounts, for which there is generally no revenue
generated. Operating expenses increased $21.5 million in the nine months ended
June 30, 2002 to $70.0 million compared to $48.5 million in the comparable
period in the prior year. Of this increase, $12.6 million relates to severance
and related costs incurred in the nine months ended June 30, 2002 related to the
resignation of our Chief Executive Officer and our Vice Chairman, approximately
$6.4 million is related to increased expense levels for our cash based incentive
compensation program and an executive non-cash stock based compensation program,
approximately $2.3 million relates to other unallocated employee benefit costs,
and the remaining increase of approximately $5.8 million is principally
attributed to labor related and other operating expense growth in our corporate
support functions. These increases are offset by approximately $2.1 million for
a settlement agreement recorded in the nine months ended June 30, 2001 and a
$3.5 million charge recognized in the nine months ended in June 30, 2001 in
connection with the renegotiation of the pharmacy supply agreement with our
principle supplier of pharmacy related products. These negotiations resulted in
more beneficial credit terms and improved pricing on certain products.
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Capital costs and other
Our capital costs for the nine months ended June 30, 2002 reflect the impact of
fresh-start reporting following our emergence from bankruptcy. Those adjustments
materially changed the recorded amounts of capital costs, most notably
depreciation and amortization, lease expense, interest expense, income taxes,
minority interest and preferred stock dividends, and as a result, will not be
comparable to those for the nine months ended June 30, 2001.
Depreciation and amortization expense decreased $31.3 million to $48.2 million
for the nine months ended June 30, 2002 compared to $79.5 million for the same
period in the prior year. The decrease was primarily caused by the impact of
fresh-start reporting on the carrying value of our property, plant and
equipment, which were adjusted to their estimated fair values as of September
30, 2001, and our October 1, 2001 adoption of an accounting pronouncement which
prohibits the amortization of unimpaired goodwill.
Lease expense decreased $6.3 million for the nine months ended June 30, 2002, to
$20.7 million compared to $27.0 million for the same period in the prior year.
Of this decrease, approximately $1.7 million is attributed to the divestitures
or lease modifications of certain leased eldercare centers. The remaining
decrease of approximately $4.6 million is principally attributed to the
discharge in bankruptcy of our lease financing facility.
Interest expense decreased $55.4 million for the nine months ended June 30,
2002, to $36.9 million compared to $92.3 million for the same period in the
prior year. For the nine months ended June 30, 2001, in accordance with SOP
90-7, we ceased accruing interest following the Petition Date on certain
long-term debt instruments classified as liabilities subject to compromise. Our
contractual interest expense for the nine months ended June 30, 2001 was $167.0
million, leaving $74.7 million of interest expense unaccrued for that period as
a result of the Chapter 11 cases. Interest expense for the nine months ended
June 30, 2002 has been accrued at the contractual rates. Contractual interest
expense for the nine months ended June 30, 2002 decreased by $130.1 million
compared to the same period in the prior year. This decrease is attributed to
the overall reduction of debt levels following our emergence from bankruptcy in
addition to a lower weighted average borrowing rate.
During the nine months ended June 30, 2002, we recorded a net gain of $21.9
million resulting from the award in the Manor Care arbitration. See "Part II:
Other Information, Item 1 - Legal Proceedings" herein and in the Company's
Annual Report of Form 10-K.
In October 2000, we sold an idle 232 bed eldercare center for cash consideration
of approximately $7.0 million, resulting in a net gain on sale of approximately
$1.8 million. In April 2001, we sold an operational 121 bed eldercare center for
cash consideration of approximately $0.5 million. The sale resulted in a net
loss of approximately $2.3 million.
During the nine months ended June 30, 2002, we recorded approximately $2.6
million for post confirmation liabilities payable to the United States Trustee
related to Chapter 11 cases that remained open. With the exception of three
cases which remain open, all of the Chapter 11 cases were closed subsequent to
June 30, 2002. In that same period we recorded a post confirmation charge
resulting from a settlement reached with the lender of a pre-petition mortgage
obligation for an amount that exceeded the estimated loan value established in
the September 30, 2001 fresh-start balance sheet by approximately $1.7 million.
During the nine months ended June 30, 2001, we recorded legal, bank, accounting
and other costs of approximately $28.8 million in connection with the Chapter 11
cases. In addition, we incurred costs of $8.9 million in the nine months ended
June 30, 2001 for certain bankruptcy related salary and benefit related costs,
principally for a court approved special recognition program. Also in that same
period, we incurred approximately $4.9 million of costs associated with the
divestiture of certain businesses.
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Minority interest decreased $9.6 million during the nine months ended June 30,
2002 to a loss of $1.3 million compared to $8.3 million for the comparable
period in the prior year. This decrease is primarily due to the 56.4% interest
in the net losses of Multicare attributable to the joint venture partners during
the nine months ended June 30, 2001. Upon our emergence from bankruptcy, we and
Multicare merged, effectively terminating the joint venture and any interest the
joint venture partners had in Multicare.
Preferred stock dividends decreased $32.2 million to $1.9 million during the
nine months ended June 30, 2002 compared to $34.1 million for the comparable
period in the prior year. This decrease is attributed to the cancellation of our
Predecessor Company preferred stock and related dividends, and offset with
dividends on $42.6 million of Series A Redeemable Preferred Stock issued in
connection with the Plan. At June 30, 2002, there were 425,946 shares of Series
A Redeemable Preferred Stock outstanding.
Losses from discontinued operations increased $3.3 million for the nine months
ended June 30, 2002, to $5.8 million from $2.5 million for the same period in
the prior year. During the nine months ended June 30, 2002, we identified seven
businesses as discontinued operations. The results of operations in the current
year and prior year periods, along with any costs to exit such businesses in the
current year period, have been classified as discontinued operations in the
attached financial highlights and consolidated statements of operations.
Businesses sold or closed prior to our October 1, 2001 adoption of SFAS 144
continue to be reported in the results of continuing operations.
Liquidity and Capital Resources
Working Capital and Cash Flows
At June 30, 2002, we had cash and equivalents of $103.5 million, net working
capital of $447.7 million and approximately $149.1 million of unused commitment
under our $150 million Revolving Credit Facility.
At June 30, 2002, we had restricted investments in marketable securities of
$74.9 million, which are held by Liberty Health Corp. LTD., referred to as LHC,
our wholly-owned captive insurance subsidiary incorporated under the laws of
Bermuda. The investments held by LHC are restricted by statutory capital
requirements in Bermuda. In addition, certain of these investments are pledged
as security for letters of credit issued by LHC. As a result of such
restrictions and encumbrances, we and LHC are precluded from freely transferring
funds through intercompany loans, advances or cash dividends.
Our cash flow from operations before debt restructuring and reorganization costs
for the nine months ended June 30, 2002 was a source of cash of $132.3 million
compared to a source of cash of $19.1 million for the nine months ended June 30,
2001, principally due to reduced interest and lease payments following our
reorganization, improvement in the collection of accounts receivable, receipt of
$21.9 million in cash proceeds for an arbitration award and the timing of vendor
payments and employee wages. During the second quarter of fiscal 2002, we
borrowed approximately $42 million from the Delayed Draw Term Loan to finance
the repayment of all trade balances due to NeighborCare(R) Pharmacy's primary
supplier of pharmacy products. This change in credit terms resulted in reduced
pharmacy product acquisition costs, partially offset by an increase in interest
expense on the incremental Delayed Draw Term Loan borrowings. Assuming no future
changes in variable rates of interest, the net impact of this transaction is
positive to our cash flows. Cash payments for debt restructuring and
reorganization costs were approximately $44.3 million during the nine months
ended June 30, 2002 compared to $35.1 million for the same period in the prior
year. We believe that cash flow from operations, along with available borrowings
under our Revolving Credit Facility, are sufficient to meet our current
liquidity needs.
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Our days sales outstanding at June 30, 2002 was approximately 53 days compared
to approximately 60 days at September 30, 2001. This reduction is principally
due to improvement in the collection of accounts receivable.
On January 30, 2002, the Compensation Committee of the Board of Directors
approved a cash-based incentive compensation program that provides for awards to
eligible employees based upon the achievement of certain specified minimum
targets directly related to our consolidated financial performance. The
incentive compensation program provides for awards to eligible employees on a
graduated basis as actual operating performance exceeds certain minimum
financial targets.
Our net cash used for investing activities for the nine months ended June 30,
2002 was $50.7 million, and includes approximately $33.0 million of capital
expenditures. Capital expenditures consist primarily of betterments and
expansion of eldercare centers and investments in data processing hardware and
software. In order to maintain our physical properties in a suitable condition
to conduct our business and meet regulatory requirements, we expect to continue
to incur capital expenditure costs at levels at or above those for the nine
months ended June 30, 2002 for the foreseeable future.
Our investing activities for the nine months ended June 30, 2002 also include:
approximately $12.7 million in net investments in restricted investments in
marketable securities, representing the current period funding of self insured
workers' compensation and general / professional liability insurance retentions
held by LHC; and approximately $10.5 million in connection with the exercise of
an option to purchase three formerly leased eldercare centers.
Our cash flows from investing activities for the nine months ended June 30, 2001
include approximately $7 million of cash proceeds from the sale of an eldercare
center.
Our financing activities for the nine months ended June 30, 2002, resulted in
net cash inflows of $34.0 million, and include approximately $80.0 million of
cash proceeds from borrowings under the Delayed Draw Term Loan, of which, $10.0
million were used to finance the price of the purchase option previously
described, and $28.0 million was used to refinance several mortgages at more
favorable rates of interest. The Delayed Draw Term Loan was amended in December
2001 to allow $42.0 million of available credit under that loan to be used to
restructure credit terms with NeighborCare(R) pharmacy's primary supplier of
pharmacy products, as previously discussed. The Delayed Draw Term Loan is fully
drawn at June 30, 2002 and is being repaid with no additional borrowings
available under the Delayed Draw Term Loan.
In June 2002, the Senior Credit Facility was amended in order to extend the date
by which we are required to achieve certain levels of fixed versus variable
interest rate exposure. As amended, by September 30, 2002, we are required to
either enter into interest rate swap agreements that effectively fix or cap the
interest cost on at least 50% of its consolidated debt or refinance such debt to
achieve a mix of fixed rate debt of at least 50%. At June 30, 2002, our debt mix
is approximately 12% fixed-rate and 88% variable-rate.
For the nine months ended June 30, 2002, we incurred approximately $20.7 million
of lease obligation costs and expect to continue to incur lease costs at or
above levels approximating those for the nine months ended June 30, 2002 for the
foreseeable future.
We believe that we have adequate capital resources at our disposal to fund
currently anticipated capital expenditures as well as current and projected debt
service requirements.
Strategic Objectives
We are focusing our efforts on the following strategic objectives in order to
improve overall operating performance and efficiency:
o evaluate and reduce corporate overhead;
o implement pharmacy and medical supply segment margin expansion plans;
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o pursue operational efficiencies in the inpatient services segment;
o retain a permanent Chief Executive Officer;
o pursue selective acquisitions; and
o evaluate and rationalize under-performing assets and business lines.
Our plan to evaluate and reduce corporate overhead will result in the
elimination of certain duplicative and non-critical positions. We expect to
implement this plan in the fourth fiscal quarter of 2002.
The primary elements of our pharmacy and medical supply segment margin expansion
plans include reducing product acquisition costs, improving labor utilization,
evaluating segment specific overhead costs and improving credit administration.
The primary elements of our inpatient services segment operational efficiency
improvements include a continued focus on increasing quality payor mix,
improving labor utilization, consolidating key business processes and better
leveraging our existing infrastructure within core markets to improve occupancy.
We have engaged an outside executive search firm to identify and recruit a
permanent Chief Executive Officer.
We continue to critically evaluate selective acquisitions, particularly pharmacy
and other health service related businesses. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Certain Transactions
and Events - NCS Transaction".
In the normal course of business, we continually evaluate the performance of our
operating units, with an emphasis on selling or closing under-performing or
non-strategic assets.
There can be no assurances that we will be successful in implementing any of our
strategic objectives. Nor can there be any assurances that, if implemented, such
objectives will achieve desired results.
NCS Transaction
At the closing of the NCS transaction, we will repay in full the outstanding
debt of NCS which includes $206 million of senior debt, and will redeem $102
million of 5.75% convertible subordinated debentures, including any accrued and
unpaid interest. In total, the NCS transaction purchase price is estimated at
$340 million, net of the application of approximately $20 million in excess cash
at NCS.
We intend to finance the cash portion of the purchase price with existing cash
on hand, and through an expansion of an existing senior credit facility.
Financial Commitments
Requests for providing commitments to extend financial guarantees and extend
credit are reviewed and approved by senior management. Management regularly
reviews all outstanding commitments, letters of credit and financial guarantees,
and the results of these reviews are considered in assessing the need for any
reserves for possible credit and guarantee loss.
We have posted $1.9 million of outstanding letters of credit. The letters of
credit guarantee performance to third parties of various trade activities. The
letters of credit are not recorded as liabilities on our balance sheet unless
they are utilized by the third party. The financial risk approximates the amount
of outstanding letters of credit.
We have extended approximately $7.4 million in working capital lines of credit
to certain jointly owned and managed companies, of which $5.0 million were
unused at June 30, 2002. Credit risk represents the accounting loss that would
be recognized at the reporting date if the affiliate companies were deemed
unable to repay any amounts utilized under the working capital lines of credit.
Commitments to extend credit to third parties are conditional agreements
generally having fixed expiration or termination dates and specific interest
rates and purposes.
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We are a party to joint venture partnerships whereby our ownership interests are
less than 50% of the total capital of the partnerships. We account for these
partnerships using the equity method of accounting and, therefore, the assets,
liabilities and operating results of these partnerships are not consolidated
with ours. Although we are not contractually obligated to fund operating losses
of these partnerships, in certain cases, we have extended credit to such joint
venture partnerships in the past and may decide to do so in the future in order
to realize economic benefits from our joint venture relationship. Management
assesses the creditworthiness of such partnerships in the same manner it does
other third-parties. We have provided $10.9 million of financial guarantees
related to loan commitments of four jointly owned and managed companies. We have
also provided $11.1 million of financial guarantees related to lease obligations
of one jointly-owned and managed company. The guarantees are not recorded as
liabilities on our balance sheet unless we are required to perform under the
guarantee. Credit risk represents the accounting loss that would be recognized
at the reporting date if counter-parties failed to perform completely as
contracted. The credit risk amounts are equal to the contractual amounts,
assuming that the amounts are fully advanced and that no amounts could be
recovered from other parties.
Warrants
In connection with our Reorganization, we issued warrants to purchase 4,559,475
shares of new common stock. This represents approximately 11% of the new common
stock issued on the Effective Date. The warrants expire on October 2, 2002 and
have an exercise price of $20.33 per share of new common stock.
Income Taxes
Our income tax for the three and nine months ended June 30, 2002 was a benefit
of $4.2 million and an expense of $25.4 million, respectively. This provision
includes a $10.3 million reduction to tax expense realized in the third quarter
2002 resulting from the Job Creation and Worker Assistance Act of 2002 which
extended the net operating loss carryback period.
The Company realizes tax benefits through the realization of Net Operating Loss
("NOL") carryforwards. Pursuant to SOP 90-7, the income tax benefits of any
future realization of the NOL carryforwards are applied first as a reduction to
goodwill.
Revenue Sources
We receive revenues from Medicare, Medicaid, private insurance, self-pay
residents, other third party payors and long-term care facilities which utilize
our pharmacy and other specialty medical services. The healthcare industry is
experiencing the effects of the federal and state governments' trend toward cost
containment, as government and other third party payors seek to impose lower
reimbursement and utilization rates and negotiate reduced payment schedules with
providers. These cost containment measures, combined with the increasing
influence of managed care payors and competition for patients, have resulted in
reduced rates of reimbursement for services provided by us. We receive
approximately 61% of our customer service revenues from Medicare and Medicaid.
See "Part I: Item 1 - Business - Revenue Sources" herein and in the Company's
Annual Report on Form 10-K.
A number of the provisions of the Balanced Budget Act and the Benefits
Improvement Protection Act enactments providing additional funding for Medicare
participating skilled nursing facilities expire on September 30, 2002. Expiring
provisions are estimated to, on average, reduce per beneficiary per diems by
$34. On April 23, 2002, the Centers for Medicare and Medicaid Services ("CMS")
issued a press statement announcing that the agency would not proceed with its
previously announced changes in the skilled nursing facility case-mix
classification system. In its announcement, CMS made it clear that case-mix
refinements would be postponed for a full year. CMS issued notice of fiscal year
2003 rates in the Federal Register, July 31, 2002. Rates effective October 1,
2002 will be increased by a 2.6% annual market basket adjustment. CMS estimates
that even with this upward adjustment, average rates will be 8.8% lower than the
current year because of the reduced payment caused by the expiring statutory
add-ons.
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The House of Representatives passed a package of Medicare amendments in late
June, 2002. Under the House-passed measure, portions of the expiring provisions
would be retained. The BBRA increase of 4% would expire, and the BIPA 16.6%
add-on to the nursing portion of the SNF PPS rates would be reduced to 12% in
2003, 10% in 2004, and 8% in 2005. Under this proposal fiscal year 2003 rates
would be 5.2% lower than the current year. The Senate is expected to consider
Medicare provider relief during September. Details of the Senate leadership
proposal have not been released. It is premature to forecast the outcome of
Congressional action.
The Company's estimate of the impact of the "SNF Medicare Cliff ", factoring in
the administrative decision not to proceed with changes in the case mix
refinements at this time and without factoring in any additional Congressional
action, exposes the skilled nursing facility sector to a 10% reduction. For the
Company, this could have an adverse revenue impact exceeding $35 million
annually. The Company is very involved with trade organizations representing the
skilled nursing facility sector in aggressively pursing strategies to minimize
the potentially adverse impact.
There may be additional provisions in the Medicare legislation affecting our
other businesses. Congress is expected to consider changes affecting pharmacy,
rehabilitation therapy, diagnostic services and the payment for services in
other health settings.
It is not possible to fully quantify the effect of recent legislation, the
interpretation or administration of such legislation or any other governmental
initiatives on our business. Accordingly, there can be no assurance that the
impact of these changes or any future healthcare legislation will not adversely
affect our business. There can be no assurance that payments under governmental
and private third party payor programs will be timely, will remain at levels
comparable to present levels or will, in the future, be sufficient to cover the
costs allocable to patients eligible for reimbursement pursuant to such
programs. Our financial condition and results of operations may be affected by
the reimbursement process, which in our industry is complex and can involve
lengthy delays between the time that revenue is recognized and the time that
reimbursement amounts are settled.
Certain service contracts permit our NeighborCare(R) pharmacy operations to
provide services to HCR Manor Care, Inc. generating approximately $120 million,
or ten percent and five percent of the net annual revenues, of NeighborCareand
Genesis, respectively. These service contracts with HCR Manor Care are the
subject of certain litigation.
New Accounting Pronouncements
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, "Recission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
Corrections" ("SFAS 145"). SFAS 145 is effective for fiscal years beginning
after May 15, 2002 for provisions related to SFAS No. 4, effective for all
transactions occurring after May 15, 2002 for provisions related to SFAS No. 13
and effective for all financial statements issued on or after May 15, 2002 for
all other provisions of SFAS 145. We have not determined the impact the adoption
of SFAS 145 will have on our results from operations.
In July 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated with
Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 addresses
significant issues regarding the recognition, measurement, and reporting of
costs associated with exit and disposal activities, including restructuring
activities. SFAS No. 146 also addresses recognition of certain costs related to
terminating a contract that is not a capital lease, costs to consolidate
facilities or relocate employees, and termination benefits provided to employees
that are involuntarily terminated under the terms of a one-time benefit
arrangement that is not an ongoing benefit arrangement or an individual deferred
compensation contract. SFAS No. 146 is effective for exit or disposal activities
that are initiated after December 31, 2002.
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Other
We manage the operations of 70 eldercare centers. Under a majority of these
arrangements, we employ the operational staff of the managed business for ease
of benefit administration and bill the related wage and benefit costs on a
dollar-for-dollar basis to the owner of the managed property. In this capacity,
we operate as an agent on behalf of the managed property owner and are not the
primary obligor in the context of a traditional employee / employer
relationship. Historically, we have treated these transactions on a "net basis",
thereby not reflecting the billed labor and benefit costs as a component of our
net revenue or expenses. For the three and nine months ended June 30, 2002, we
billed our managed clients approximately $33.2 million and $108.4 million,
respectively for such labor related costs.
Seasonality
Our earnings generally fluctuate from quarter to quarter. This seasonality is
related to a combination of factors, which include the timing of Medicaid rate
increases, seasonal census cycles, and the number of calendar days in a given
quarter.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to the impact of interest rate changes. In the past, we employed
established policies and procedures to manage our exposure to changes in
interest rates. Our objective in managing exposure to interest rate changes is
to limit the impact of such changes on earnings and cash flows and to lower our
overall borrowing costs. To achieve our objective, we have historically used
interest rate swap agreements to manage net exposure to interest rate changes
related to our portfolio of borrowings. As of June 30, 2002, no interest rate
swap agreements were in place.
In June 2002, the Senior Credit Facility was amended in order to extend the date
by which we are required to achieve certain levels of fixed versus variable
interest rate exposure. As amended, by September 30, 2002, we are required to
either enter into interest rate swap agreements that effectively fix or cap the
interest cost on at least 50% of its consolidated debt or refinance such debt to
achieve a mix of fixed rate debt of at least 50%. At June 30, 2002, our debt mix
is approximately 12% fixed and 88% variable.
At June 30, 2002, we had $604.3 million of debt subject to variable market rates
of interest. For each additional percentage point increase in the LIBOR, we will
incur additional interest expense of approximately $6.0 million annually.
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PART II: OTHER INFORMATION
Item 1. Legal Proceedings
NeighborCare Pharmacy Services, Inc. v. HCR Manor Care, Inc., Manor Care, Inc.
and ManorCare Health Services, Inc.
On May 7, 1999, our wholly-owned subsidiary, NeighborCare, filed a demand for
arbitration under the commercial arbitration rules of the American Arbitration
Association against HCR Manor Care, Inc., Manor Care, Inc. and ManorCare Health
Services, Inc, collectively referred to as the respondents. The AAA arbitration
principally concerns two long-term master service agreements between
NeighborCare and ManorCare Health Services, Inc. Pursuant to one of these
agreements, referred to as the master pharmacy agreement, NeighborCare provides
pharmacy services to long-term care facilities owned or operated by Manor Care.
Pursuant to the other agreement, referred to as the master infusion therapy
agreement, NeighborCare provides infusion therapy products and services to Manor
Care long-term care facilities.
In the AAA arbitration, NeighborCare sought injunctive relief and compensatory
damages in connection with
o respondents' attempt to terminate the master service agreements, and
o respondents' failure to provide NeighborCare with the right to serve as the
preferred provider of pharmacy and infusion therapy services to all Manor
Care long-term care facilities pursuant to the master service agreements.
Respondents filed counterclaims requesting declaratory relief approving the
purported termination of the master service agreements, as well as counterclaims
seeking compensatory damages in connection with alleged overcharges under the
two agreements.
The arbitrator, on May 17, 2000, declined to dismiss NeighborCare's claims for
money damages for breach of its contractual right to serve as the preferred
provider to all Manor Care long-term care facilities. However, the arbitrator
did dismiss, without prejudice, NeighborCare's claim for specific performance of
that right.
On June 15, 2000, in anticipation of our possible bankruptcy filing, the
arbitrator stayed the AAA arbitration. In connection with this stay, the parties
agreed that respondents may pay NeighborCare 90% of the face amount of all
invoices for pharmaceutical and infusion therapy goods and services that
NeighborCare renders to respondents under the master service agreements. The
parties agreed, however, that respondents must continue to pay NeighborCare the
full face amount of all invoices for pharmacy consulting services under the
master service agreements.
On February 14, 2002, the arbitrator ruled in favor of NeighborCare. The
arbitrator found that Manor Care did not lawfully terminate its service
contracts with NeighborCare. As a result, the contracts between NeighborCare and
Manor Care, which expire in October 2004, remain in full force until that time.
The arbitrator also determined that NeighborCare had the right to damages
because it was not offered the opportunity to service facilities owned and
operated by Healthcare & Retirement Corporation of America, Inc., which was
deemed to be an affiliate of Manor Care under the contract. The arbitrator
awarded us $23.4 million, plus pre-judgment interest, in compensatory damages.
In addition, the arbitrator terminated his prior ruling that allowed Manor Care
to withhold 10% of the payments owed to NeighborCare and Manor Care paid us an
additional $8.8 million in funds representing the amounts withheld during the
course of the AAA arbitration pursuant to the arbitrator's prior ruling.
In response to post-decision motions filed by NeighborCare and by respondents,
the Arbitrator recalculated NeighborCare's damages, reducing them by
approximately $2 million, and ruled that NeighborCare is not obligated, as a
result of certain past events, to renegotiate the prices it offers to
respondents for pharmacy and infusion therapy products and services.
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Genesis Health Ventures, Inc. v. HCR Manor Care, Inc., Manor Care, Inc., Paul A.
Ormond, and Stewart Bainum, Jr.
On May 7, 1999, we filed an action in the United States District Court for the
District of Delaware against HCR Manor Care, Inc., Manor Care, Inc., Paul A.
Ormond, and Stewart Bainum, Jr. In this action, we seek compensatory and
punitive damages exceeding $2 million for federal securities fraud, common-law
fraud, negligent misrepresentation and controlling person liability in
connection with material misrepresentations and omissions made by defendants
during the course of our acquisition of Vitalink. We further seek injunctive
relief with respect to Manor Care's failure to dispose of its ownership
interests in Heartland Healthcare Services, a competitor of NeighborCare,
pursuant to a non-competition provision found in a side agreement between
Genesis, Vitalink and Manor Care.
Defendants filed a motion to dismiss or stay this action pending the resolution
of the AAA arbitration. On March 22, 2000, the Court denied the defendants'
motion to dismiss, but granted the motion to stay the case pending resolution of
the AAA arbitration.
Manor Care, Inc. v. Genesis Health Ventures, Inc.
On August 17, 1999, Manor Care filed a lawsuit in the United States District
Court for the District of Delaware against us. In this action, plaintiff brings
claims under the federal securities laws resulting from alleged
misrepresentations and omissions made by us in connection with Manor Care's
acquisition of our series G preferred stock as compensation for its sale of
Vitalink to us. Plaintiff seeks compensatory damages of unspecified amount,
rescission of Manor Care's purchase of the series G preferred stock, and the
return of the consideration paid by Manor Care at the time of our acquisition of
Vitalink from Manor Care.
We filed a motion to dismiss this action. On September 29, 2000, the Court
granted that motion in part and denied it in part. Specifically, the Court
dismissed plaintiff's allegations regarding purportedly fraudulent statements
concerning: our knowledge as to certain legislative changes to the Medicare
program; the effect of our affiliate Multicare on our earnings; our intent with
respect to the issuance of preferred stock; and our ability to declare dividends
on the series G preferred stock. Accordingly, the only allegations that were not
dismissed from this action concern our alleged failure to include certain
financial information in the registration statement we filed in connection with
its acquisition of Vitalink, and allegedly fraudulent statements concerning our
labor relations. Our motion to consolidate this action with the action Genesis
Health Ventures Inc. v. HCR Manor Care, Inc., Manor Care, Inc., Paul A. Ormond,
and Stewart Bainum, Jr., described above, has been denied.
On October 22, 2001, plaintiff filed a motion to reconsider the Court's decision
to dismiss this action in part, and we filed our opposition to that motion. On
December 5, 2001, we filed a motion to dismiss the entire action pursuant to our
Joint Plan of Reorganization and the Bankruptcy Court's order confirming that
reorganization plan, which extinguish plaintiff's claims against us except to
the extent that those claims may be applied as set-off or recoupment against
claims brought by us. (As discussed below, the defendants repled the claims in
this action as affirmative defenses of set-off or recoupment against the claims
we have filed in Genesis Health Ventures, Inc. v. HCR Manor Care, Inc., Civil
Action No. 99-287 (D. Del.).)
The parties have completed briefing on defendants' motion for reconsideration
and Genesis' motion to dismiss, and the parties await the Court's decision as to
whether oral argument on these motions will be held.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Certain Transactions and Events - NCS Transaction" for a discussion
of the lawsuits filed by Omnicare, Inc. and Dolphin Limited Partnership I, L.P.
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Item 2. Changes in Securities and Use of Proceeds - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Amendment No. 2, dated as of June 28, 2002, to the Credit,
Security, Guaranty and Pledge Agreement dated as of
October 2, 2001
(b) Reports on Form 8-K
On July 1, 2002, the Company filed a Report on Form 8-K announcing
that Michael R. Walker resigned as Chief Executive Officer of the
Company and David C. Barr resigned as our Vice Chairman.
On July 29, 2002, the Company filed a Report on Form 8-K reporting
that the Company and a subsidiary of the Company, Geneva Sub, Inc.
entered into a definitive agreement and plan of merger with NCS
Healthcare Inc. (NCS), whereby NCS will become a wholly-owned
subsidiary of the Company.
On August 14, 2002, the Company filed a Report on Form 8-K disclosing
the filing of their officers' certifications of certain of the
Company's previously filed reports and its Report on Form 10-Q filed
on August 14, 2002.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereto duly authorized.
GENESIS HEALTH VENTURES, INC.
Date: August 14, 2002 /s/ George V. Hager, Jr.
----------------------------------
George V. Hager, Jr.
Executive Vice President and Chief
Financial Officer
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