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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C 20549
[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
COMMISSION FILE NUMBER 333-43549 AND 333-97293
EXTENDICARE HEALTH SERVICES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 8051 98-0066268
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
111 WEST MICHIGAN STREET
MILWAUKEE, WI 53203-2903
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE)
(414) 908-8000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
EXTENDICARE HEALTH SERVICES, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE
- ------- --------------------- ----
Item 1 Financial Statements:
Consolidated Statements of Operations for the three months and six months ended
June 30, 2002 and 2001........................................................................ 3
Consolidated Balance Sheets, June 30, 2002 and December 31, 2001...................................... 4
Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001................. 5
Notes to Consolidated Financial Statements............................................................ 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations................. 11
Item 3 Quantitative and Qualitative Disclosures about Market Risk............................................ 18
PART II. OTHER INFORMATION:
- -------- ------------------
Item 1 Legal Proceedings..................................................................................... 20
Item 2 Change in Securities.................................................................................. 20
Item 3 Defaults Upon Senior Securities....................................................................... 20
Item 4 Submission of Matters to a Vote of Security Holders................................................... 20
Item 5 Other Information..................................................................................... 20
Item 6 Exhibits and Reports on Form 8-K...................................................................... 20
Signatures............................................................................................ 21
Exhibit Index......................................................................................... 22
Certification Pursuant to 18 U.S.C. Section 1350 -- Chairman of the Board and Chief Executive Officer. 23
Certification Pursuant to 18 U.S.C. Section 1350 -- Vice President, Chief Financial Officer and
Treasurer....................................................................................... 24
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EXTENDICARE HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2002 2001 2002 2001
--------------------------- ---------------------------
REVENUES:
Nursing and assisted living centers ..................... $ 194,906 $ 194,069 $ 385,904 $ 380,625
Outpatient therapy ....................................... 2,642 2,592 5,094 4,914
Other .................................................... 4,230 4,128 9,021 8,682
--------- --------- --------- ---------
201,778 200,789 400,019 394,221
COSTS AND EXPENSES:
Operating ................................................ 169,904 173,320 336,508 343,384
General and administrative ............................... 8,332 8,915 16,543 17,339
Lease costs .............................................. 2,680 3,894 5,714 7,711
Depreciation and amortization ............................ 9,411 10,197 18,845 20,495
Interest expense ......................................... 7,640 9,548 15,970 19,831
Interest income .......................................... (468) (623) (810) (1,056)
Loss on disposal of assets and other items ............... -- 6,435 -- 7,844
--------- --------- --------- ---------
197,499 211,686 392,770 415,548
--------- --------- --------- ---------
EARNINGS (LOSS) BEFORE INCOME TAXES ........................ 4,279 (10,897) 7,249 (21,327)
Income tax expense (benefit) ............................... 2,063 (2,198) 3,376 (5,877)
--------- --------- --------- ---------
EARNINGS (LOSS) BEFORE EXTRAORDINARY
ITEM ....................................................... 2,216 (8,699) 3,873 (15,450)
--------- --------- --------- ---------
Extraordinary loss on early retirement of debt (net of
income taxes, $1,140, $30, $1,140 and $30,
respectively) ........................................ (1,709) (45) (1,709) (45)
--------- --------- --------- ---------
NET EARNINGS (LOSS) ........................................ $ 507 $ (8,744) $ 2,164 $ (15,495)
========= ========= ========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
EXTENDICARE HEALTH SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2002 AND DECEMBER 31, 2001
(DOLLARS IN THOUSANDS)
ASSETS
JUNE 30, 2002 DECEMBER 31, 2001
------------- -----------------
CURRENT ASSETS:
Cash and cash equivalents .................................................................. $ 28,867 $ 997
Accounts receivable, less allowances of $13,644 and $14,577, respectively .................. 94,577 104,236
Supplies, inventories and other current assets ............................................. 7,190 6,809
Due from shareholder:
Federal income taxes receivable ........................................................ 9,488 9,468
Deferred federal income taxes .......................................................... 11,202 11,474
--------- ---------
Total current assets ................................................................... 151,324 132,984
PROPERTY AND EQUIPMENT ....................................................................... 442,349 477,830
GOODWILL AND OTHER INTANGIBLE ASSETS ......................................................... 76,963 77,592
OTHER ASSETS ................................................................................. 121,299 107,430
--------- ---------
Total Assets .......................................................................... $ 791,935 $ 795,836
========= =========
LIABILITIES AND SHAREHOLDER'S EQUITY
CURRENT LIABILITIES:
Bank indebtedness .......................................................................... $ -- $ 590
Current maturities of long-term debt ....................................................... 674 12,099
Accounts payable and accrued liabilities ................................................... 114,860 105,908
Income taxes payable ....................................................................... 1,538 1,556
Deferred state income taxes ................................................................ 44 --
Due to shareholders and affiliates ......................................................... 2,972 8,686
--------- ---------
Total current liabilities .............................................................. 120,088 128,839
ACCRUAL FOR SELF-INSURED LIABILITIES ......................................................... 58,470 70,341
LONG-TERM DEBT ............................................................................... 390,039 373,248
OTHER LONG-TERM LIABILITIES .................................................................. 39,876 44,018
DEFERRED STATE INCOME TAXES .................................................................. 795 --
DUE TO SHAREHOLDER AND AFFILIATES:
Deferred Federal income taxes and other ................................................ 24,196 23,388
--------- ---------
Total liabilities ..................................................................... 633,464 639,834
--------- ---------
SHAREHOLDER'S EQUITY:
Common stock, $1 par value, 1,000 shares authorized,
947 shares issued and outstanding ...................................................... 1 1
Additional paid-in capital .................................................................. 208,787 208,787
Accumulated other comprehensive loss ........................................................ (2,062) (2,367)
Accumulated deficit ......................................................................... (48,255) (50,419)
--------- ---------
Total Shareholder's Equity ............................................................. 158,471 156,002
--------- ---------
Total Liabilities and Shareholder's Equity ................................................. $ 791,935 $ 795,836
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
EXTENDICARE HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(DOLLARS IN THOUSANDS)
SIX MONTHS ENDED JUNE SIX MONTHS ENDED JUNE
30, 2002 30, 2001
--------------------- ---------------------
OPERATING ACTIVITIES:
Net earnings (loss) .................................................................. $ 2,164 $ (15,495)
Adjustments to reconcile net earnings (loss) to net cash
provided from operating activities:
Depreciation and amortization .................................................. 19,873 21,555
Provision for uncollectible accounts receivable ............................... 5,349 4,203
Provision for self-insured liabilities ......................................... 2,625 6,750
Payment of self-insured liability claims ....................................... (14,496) (2,632)
Loss on disposal of assets and other items ..................................... -- 7,844
Deferred income taxes .......................................................... 2,988 (6,254)
Extraordinary loss on early retirement of debt ................................. 1,709 45
Changes in assets and liabilities:
Accounts receivable ............................................................ 2,122 23,230
Supplies, inventories and prepaid expenses ..................................... (512) 1,922
Debt service trust funds ....................................................... (91) (87)
Due from shareholder-Federal income taxes ...................................... (20) 22,542
Accounts payable and accrued liabilities ....................................... (1,510) (11,075)
Income taxes payable/receivable ................................................ (18) 384
--------- ---------
Cash provided from operating activities ..................................... 20,183 52,932
INVESTING ACTIVITIES:
Payments for purchase of property and equipment ................................ (7,445) (6,195)
Proceeds from sale of property and equipment ................................... 14,267 6,912
Changes in other non-current assets ............................................ 1,459 (590)
--------- ---------
Cash provided from investing activities ..................................... 8,281 127
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt ....................................... 160,625 --
Payments of deferred financing costs ........................................... (7,090) --
Other long-term liabilities .................................................... 1,720 (1,505)
Payments of long-term debt ..................................................... (155,259) (54,686)
Changes in bank indebtedness ................................................... (590) 2,118
Distribution of minority interests' earnings ................................... -- (15)
--------- ---------
Cash used for financing activities .......................................... (594) (54,088)
--------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ..................................... 27,870 (1,029)
CASH AND CASH EQUIVALENTS BEGINNING OF PERIOD ........................................ 997 1,641
--------- ---------
CASH AND CASH EQUIVALENTS END OF PERIOD .............................................. $ 28,867 $ 612
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
The accompanying condensed consolidated financial statements reflect
the operations of Extendicare Health Services, Inc. and its subsidiaries
("Extendicare" or the "Company") in accordance with accounting principles
generally accepted in the United States of America. Extendicare, a Delaware
corporation, is a wholly owned subsidiary of Extendicare Inc., a Canadian
corporation.
BASIS OF PRESENTATION
The accompanying financial statements include the accounts of the
Company and its majority-owned subsidiaries. All transactions between
Extendicare and its majority-owned subsidiaries have been eliminated.
The accompanying condensed consolidated financial statements as of June
30, 2002 and 2001 and for the periods ended June 30, 2002 and 2001 are unaudited
and have been prepared in accordance with the instructions to Form 10-Q and do
not include all of the information and the footnotes required by generally
accepted accounting principles in the United States of America for complete
statements. In the opinion of management, all adjustments necessary for a fair
presentation of such financial statements have been included. The condensed
consolidated balance sheet information as of December 31, 2001 has been derived
from audited financial statements.
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States of America requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Management's most significant estimates
include provision for bad debts, provision for Medicaid and Medicare revenue
rate settlements, recoverability of long-lived assets, provision for
self-insured general and professional liability, facility closure accruals,
workers compensation accruals and self-insured health and dental claims. Actual
results could differ from those estimates.
Certain reclassifications have been made to the 2001 consolidated
financial statements to conform to the presentation for 2002.
These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto for the
year ended December 31, 2001 contained in the Company's Annual Report on Form
10-K.
2- NEW ACCOUNTING PRONOUNCEMENTS
In May 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13 and Technical
Corrections". The most significant provision of SFAS No. 145 addresses the
termination of extraordinary item treatment for gains and losses on early
retirement of debt. The Company will be required to adopt the provisions of this
standard beginning on January 1, 2003. The Company plans to adopt the provisions
of this standard in the first quarter of 2003 and will be required to modify the
presentation of its year 2002 and 2001 results by recording the loss on early
retirement of debt in earnings before income taxes.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Exit and
Disposal Activities". The provisions of SFAS No. 146 modify the accounting for
the costs of exit and disposal activities by requiring that liabilities for
these activities be recognized when the liability is incurred. Previous
accounting literature permitted recognition of some exit and disposal
liabilities at the date of commitment to an exit plan. The provisions of this
statement will be effective for exit or disposal activities initiated after
December 31, 2002.
6
3- ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLE ASSETS
As of July 1, 2001, the Company adopted SFAS No. 141, "Business
Combinations", and, as of January 1, 2002, the Company adopted SFAS No. 142,
"Goodwill and Other Intangible Assets". Statement 141 requires that all business
combinations be accounted for under a single method -- the purchase method.
Statement 142 requires that goodwill and intangible assets with an indefinite
life no longer be amortized to earnings, but instead be reviewed for impairment.
The amortization of goodwill and intangible assets with an indefinite life
ceased upon adoption of the Statement. Under SFAS No. 142, the Company is
required to evaluate its existing intangible assets and goodwill that were
acquired in purchase business combinations, and to make any necessary
reclassifications in order to conform with the new classification criteria in
SFAS No. 141 for recognition separate from goodwill. The Company was required to
reassess the useful lives and residual values of all intangible assets acquired,
and make any necessary amortization period adjustments by the end of the first
interim period after adoption. If an intangible asset is identified as having an
indefinite useful life, the Company was required to test the intangible asset
for impairment in accordance with the provisions of SFAS No. 142 within the
first interim period. Impairment is measured as the excess of carrying value
over the fair value of intangible asset with an indefinite life.
As of January 1, 2002, the Company had unamortized goodwill in the
amount of $72.1 million (cost of $83.3 million less accumulated amortization of
$11.2 million) which is subject to the provisions of SFAS No. 142. Upon adoption
of SFAS No. 142, the Company reviewed goodwill for impairment and these tests
indicated that no impairment existed but no assurance can be given that
impairment will not exist in the future.
The following table shows what net income would have been had SFAS No.
142 been applied in the comparable prior year period (dollars in thousands):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- ---------------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net income (loss), as reported ............... $ 507 $ (8,744) $ 2,164 $(15,495)
Add back: goodwill amortization .............. -- 612 -- 1,224
-------- -------- -------- --------
Adjusted net income (loss) ................... $ 507 $ (8,132) $ 2,164 $(14,271)
======== ======== ======== ========
4- ISSUANCE OF SENIOR NOTES
On June 28, 2002, the Company completed a private placement of $150
million in 9.5% Senior Notes due July 1, 2010 (the "Senior Notes") in accordance
with Rule 144A and Regulation S of the Securities Act of 1933. The Senior Notes
are generally guaranteed by all existing and future active subsidiaries of the
Company. The Senior Notes were issued at a price of 99.75% of par to yield
9.54%.
The Company used the proceeds of $149.6 million from the Senior Notes
to pay related fees and expenses of $7.1 million, to retire $127.5 million of
indebtedness outstanding under its previous credit facility, to refinance $6.3
million of other debt, and for general corporate purposes. Also on June 28,
2002, the Company entered into an interest rate swap agreement and an interest
rate cap agreement. See note 5 for details.
Concurrent with the sale of the Senior Notes, the Company established a
new five-year $105 million senior secured revolving credit facility (the "Credit
Facility") that is used to back letters of credit and for general corporate
purposes. Borrowings under the Credit Facility bear interest, at the Company's
option, at the Eurodollar rate or the prime rate, plus applicable margins,
depending upon the Company's leverage ratio.
The Senior Notes and the Credit Facility contain a number of covenants,
including: restrictions on the payment of dividends by the Company; limitations
on capital expenditures, investments, redemptions of the Company's common stock
and changes of control of the Company; as well as financial covenants, including
fixed charge coverage, debt leverage, and tangible net worth ratios. The Company
is required to make mandatory prepayments of principal upon the occurrence of
certain events, such as certain asset sales and certain issuances of securities.
The Company is permitted to make voluntary prepayments at any time under the
Credit Facility. The Senior Notes are redeemable at the option of the Company
starting on July 1, 2006. The
7
redemption prices, if redeemed during the 12-month period beginning on July 1 of
the year indicated, are as follows:
YEAR PERCENTAGE
2006............................ 104.750%
2007............................ 102.375%
2008 and thereafter............. 100.000%
The Company is in compliance with the financial covenants as of June 30, 2002.
5- ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Prior to Issuance of Senior Notes
Prior to the issuance of the Senior Notes in June 2002 (see Note 4),
the Company had variable-rate long-term debt of approximately $127 million which
it used to finance its operations. These debt obligations exposed the Company to
variability in interest payments due to changes in interest rates. The Company
hedged a portion of its variable-rate debt through interest rate swaps
designated as cash-flow hedges with a notional amount of $25 million maturing in
February 2003 under which the Company received variable interest rate payments
and made fixed rate interest rate payments. When the Company issued the
fixed-rate Senior Notes, the proceeds were used to payoff the variable-rate debt
which was being hedged by the interest rate swaps. These interest rate swaps
were terminated by the Company in June 2002 with a cash payment of $635,000.
After Issuance of Senior Notes
After the issuance of the Senior Notes, all but $32 million of the
Company's outstanding debt obligations have fixed interest rates. The market
value of these fixed-rate debt obligations vary based on changes in interest
rates.
Management believes that it is prudent to limit the variability of the
market value of its fixed-rate debt obligations. To meet this objective, the
Company has entered into an interest rate swap in June 2002. This swap
effectively changes the fixed-rate cash flows on fixed-rate long-term debt to
variable-rate cash flows. Under the interest rate swap, the Company pays
variable interest rate payments and receives fixed interest rate payments. In
addition, the Company uses an interest rate cap to offset possible increases in
interest payments under the interest rate swap caused by increases in market
interest rates over a certain level and also as a cash flow hedge to effectively
limit increases in interest payments under its variable-rate debt obligations.
The Company does not speculate using derivative instruments.
Quantitative Disclosures
In June 2002, the Company entered into an interest rate swap (used to
hedge the fair value of fixed-rate debt obligations) with a notional amount of
$150 million maturing in December 2007. Under this swap, the Company pays a
variable rate of interest equal to the one month London Interbank Borrowing rate
("LIBOR") (1.84% as of June 30, 2002), adjustable monthly, plus a spread of
4.805% and receives a fixed rate of 9.35%. This swap is designated as a fair
value hedge and had no impact on the income statement during the three months
ended June 30, 2002.
Also in June 2002, the Company entered into an interest rate cap with
a notional amount of $150 million maturing in December 2007. Under this cap, the
Company pays a fixed rate of interest equal to 0.24% and receives a variable
rate of interest equal to the excess, if any, of the one month LIBOR rate,
adjusted monthly, over the cap rate of 7%. A portion of the interest rate cap
with a notional amount of $32 million is designated as a hedging instrument
(cash-flow hedge) to effectively limit possible increases in interest payments
under variable-rate debt obligations. The remainder of the interest rate cap
with a notional amount of $118 million is used to offset increases in
variable-rate interest payments under the interest rate swap to the extent one
month LIBOR exceeds 7%. This portion of the interest rate cap is not designated
as hedging instruments under FAS 133.
Changes in the fair value of a derivative that is highly effective and
that is designated and qualifies as a fair-value hedge, along with the loss or
gain on the hedged asset or liability of the hedged item that is attributable to
the hedged risk are recorded in earnings. Changes in the fair value of cash flow
hedges are reported as Accumulated Other Comprehensive Income ("AOCI")
8
as a component of Shareholder's Equity. Changes in the fair value of the portion
of the interest rate cap not designated as a hedging instrument is reported in
net income or loss. As of June 30, 2002, the fair value of the interest rate
swap designated as a fair value hedge is a liability recorded in other long-term
liabilities of $0.1 million. The fair value of the cash-flow hedges is a
liability recorded in other long-term liabilities of $0.1 million and the gain
credited to AOCI (net of income tax effect) for the three months ended June 30,
2002 was $0.5 million. The fair value of the portion of the interest rate cap
not designated as a hedging instrument is a liability recorded in other
long-term liabilities of $0.1 million. During the year ending December 31, 2002,
none of the gains or losses in AOCI (net of income tax effect) related to the
interest rate cap are expected to be reclassified into interest expense as a
yield adjustment of the hedged debt obligation.
6- ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS
As of January 1, 2002, the Company adopted SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets" (SFAS No. 144). SFAS No.
144 addresses financial accounting and reporting for the impairment or disposal
of long-lived assets. This Statement amends SFAS No. 121, which the Company
previously adopted, to provide that goodwill and other intangible assets be
evaluated for impairment under SFAS No. 142 (see Note 3) rather than under SFAS
No. 121 or SFAS No. 144. SFAS No. 144 requires that tangible long-lived assets
be reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. If the carrying
amount of an asset exceeds its estimated future cash flows, an impairment charge
is recognized by the amount by which the carrying amount exceeds the fair value
of the asset. SFAS No. 144 requires companies to separately report discontinued
operations and extends that reporting to a component of an entity that either
has been disposed of (by sale, abandonment, or in a distribution to owners) or
is classified as held for sale. Assets to be disposed of are reported at the
lower of the carrying amount or fair value less costs to sell.
7- COMMITMENTS AND CONTINGENCIES
Capital Expenditures
At June 30, 2002, the Company had capital expenditure purchase
commitments outstanding of approximately $4.0 million.
Insurance and Self-Insured Liabilities
The Company insures certain risks with affiliated insurance
subsidiaries of Extendicare Inc. and certain third-party insurers. The insurance
policies cover comprehensive general and professional liability, property
coverage, workers' compensation and employer's liability insurance in amounts
and with such coverage and deductibles as the Company deems appropriate, based
on the nature and risks of its business, historical experiences and industry
standards. The Company also self-insures for health and dental claims, in
certain states for workers' compensation and employers' liability and from
January 2000, for general and professional liability claims. Self-insured
liabilities with respect to general and professional liability claims are
included within the accrual for self-insured liabilities.
Litigation
The Company and its subsidiaries are defendants in actions brought
against them from time to time in connection with their operations. While it is
not possible to estimate the final outcome of the various proceedings at this
time, such actions generally are resolved within amounts accrued.
The U.S. Department of Justice and other Federal agencies are
increasing resources dedicated to regulatory investigations and compliance
audits of health care providers. The Company is diligent to address these
regulatory matters.
9
8- COMPREHENSIVE EARNINGS (LOSS)
Comprehensive Earnings (Loss) is as follows for the periods shown (dollars in
thousands):
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2002 JUNE 30, 2001 JUNE 30, 2002 JUNE 30, 2001
------------- ------------- ------------- -------------
NET EARNINGS (LOSS) ...................................... $ 507 $ (8,744) $ 2,164 $(15,495)
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized loss on investments, before tax ........... (342) (300) (1,200) (343)
Gain (loss) on cash flow hedges, before tax ......... 818 (331) 1,576 (1,743)
-------- -------- -------- --------
Other comprehensive income (loss), before tax ........ 476 (631) 376 (2,086)
Income tax (provision) benefit related to items of
other comprehensive income (loss) ............... (149) 236 (71) 747
-------- -------- -------- --------
Other comprehensive income (loss), net of tax ........ 327 (395) 305 (1,339)
-------- -------- -------- --------
COMPREHENSIVE EARNINGS (LOSS) ........................... $ 834 $ (9,139) $ 2,469 $(16,834)
======== ======== ======== ========
9- UNCERTAINTIES AND CERTAIN SIGNIFICANT RISKS
The Company's earnings are highly contingent on Medicare and Medicaid
funding rates, and the effective management of staffing and other costs of
operations which are strictly monitored through State and Federal regulatory
authorities. The Company is unable to predict whether the federal or any state
government will adopt changes in their reimbursement systems, or if adopted and
implemented, what effect such initiatives would have on the Company. Limitations
on Medicare and Medicaid reimbursement for health care services are continually
proposed. Changes in applicable laws and regulations could have an adverse
effect on the levels of reimbursement from governmental, private and other
sources.
The incremental Medicare relief packages received from the Balanced
Budget Refinement Act of 1999 ("BBRA") and the Benefit Improvement and
Protection Act of 2000 ("BIPA") provide a total of $2.7 billion in temporary
Medicare funding enhancements to the long-term care industry. The funding
enhancements implemented by the BBRA and BIPA fall into two categories. The
first category is "Legislative Add-ons" which included the 16.66% add-on to the
nursing component of the Resource Utilization Groupings III ("RUGs") rate and
the 4% base adjustment. The Legislative Add-ons are currently scheduled to
sunset on September 30, 2002. The Company has estimated the average per diem
effect of the Legislative Add-ons to be $32.00, or $19.0 million annually.
Currently there is extensive discussions and negotiations within the U. S. House
of Representatives and Senate regarding these Legislative Add-ons. It is not
possible to predict the final outcome of any legislation. A decision to
discontinue all or part of the Legislative Add-ons could have a significant
impact on the Company.
The second category is "RUGs Refinements", which involved an initial
20% add-on for 15 RUGs categories identified as having high intensity,
non-therapy ancillary services. Under BIPA, the Center for Medicare and Medicaid
Services ("CMS") later redistributed the 20% add-ons from three RUGs categories
to 14 Rehab categories at 6.7%. On April 23, 2002, the CMS announced that it
would delay the implementation of the RUGs Refinements, thereby extending the
related add-ons for at least one additional government fiscal year (September
30, 2003).
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATION
The Company is a provider of long-term care and related services in the
United States. As of June 30, 2002, the Company operates 139 nursing facilities
(14,091 beds) and 36 assisted living and retirement facilities (1,756 units)
located in 13 states. The Company also manages 18 nursing facilities (2,326
beds) and five assisted living and retirement facilities (156 units) and
provides selected consulting services to 34 nursing facilities (3,195 beds)
owned by third parties. In total, the Company operates, manages or provides
selected consulting services to 232 long-term care facilities (21,524 beds) in
16 states, of which 191 are nursing facilities (19,612 beds) and 41 are assisted
living and retirement facilities (1,912 units).
FORWARD-LOOKING STATEMENTS
Statements contained in this report that are not historical facts are
forward-looking statements. Forward-looking statements can be identified because
they generally contain the words "anticipate", "believe", "estimate", "expect",
"objective", "project", or similar expression. Such forward-looking statements
are necessarily estimates reflecting the best judgment of the party making such
statements based upon current information and involve a number of risks and
uncertainties and other factors that may cause actual results, performance or
achievements of the Company to differ materially from those expressed or implied
in the statements. In addition to the assumptions and other factors referred to
specifically in connection with these statements, such factors are identified in
the Company's filings with United States securities regulators and include, but
are not limited to, the following: changes in the health care industry in
general and the long-term care industry in particular because of political and
economic influences; changes in regulations governing the industry and the
Company's compliance with such regulations; changes in government funding levels
for health care services; resident care litigation and other claims asserted
against the Company; the Company's ability to attract and retain qualified
personnel; the availability and terms of capital to fund the Company's capital
expenditures; changes in competition; and demographic changes. Given these risks
and uncertainties, readers are cautioned not to place undue reliance on the
Company's forward-looking statements.
SIGNIFICANT ASSET DIVESTITURES IN 2002 AND 2001
The following is a summary of significant events in 2002 and 2001.
On May 31, 2002, Tandem Health Care, Inc. ("Tandem") exercised its
option to purchase seven leased properties in Florida for gross proceeds of
$28.6 million, consisting of cash of $15.6 million and $13.0 million in 8.5%
interest-bearing, five-year notes. The Company's carrying value of the seven
facilities was $25.3 million. The Company applied $12.4 million of the net
proceeds to reduce its bank debt. No gain or loss was recognized on the sale as
this transaction is part of the provision for the Company's previously announced
plans to dispose of its Florida operations.
As of October 1, 2001, the Company transferred all of its Texas nursing
home operations to Senior Health Properties-Texas, Inc. ("Senior Health-Texas").
The transaction involved 17 nursing homes, with a capacity of 1,421 residents,
of which 13 facilities are now subleased by the Company and the remainder leased
on a five-year term from the Company. Senior Health-Texas will operate the
subleased facilities for their remaining lease terms, one of which expired on
October 31, 2001 and the remainder of which will expire in February 2012. The
owner of the property whose lease expired on October 31, 2001 subsequently
assumed responsibility for the operations on this date. The annual rental income
is approximately $3.8 million, or $1.8 million in excess of the Company's
current annual lease costs, and will escalate in alignment with the existing
lease and in alignment with Medicaid rate increases for the owned facilities.
Senior Health-Texas has the right of first refusal on the purchase of the four
owned facilities.
In April 2001, Tandem exercised its option to purchase two leased
properties in Florida for gross proceeds of $11.4 million, consisting of cash of
$7.0 million, a $2.5 million 8.5% interest bearing five-year note and $1.9
million in 9% cumulative dividend preferred shares, mandatorily redeemable after
five years. The Company's carrying value of the two facilities was $9.2 million.
Tandem continued to operate seven nursing homes under a lease agreement with the
Company, with an option to purchase these facilities anytime during the lease
term. The gain on sale of $2.1 million was deferred as the ultimate
determination of the gain was dependent on Tandem exercising all remaining
options and the transaction is part of the provision for the Company's
previously announced plans to dispose of its Florida operations. The Company
applied $4.0 million of the net proceeds to reduce its bank debt. See discussion
of the May 31, 2002 transaction above.
11
RESULTS FROM OPERATION
The following table sets forth details of revenues and earnings as a
percentage of total revenues:
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
-------------------- ---------------------
2002 2001 2002 2001
----- ----- ----- -----
Revenues:
Nursing and assisted living centers ..................... 96.6% 96.7% 96.5% 96.6%
Outpatient therapy ...................................... 1.3 1.3 1.3 1.2
Other ................................................... 2.1 2.0 2.2 2.2
----- ----- ----- -----
100.0 100.0 100.0 100.0
Expenses:
Operating and general and administrative costs .......... 88.3 90.8 88.3 91.5
Lease, depreciation and amortization .................... 6.0 7.0 6.1 7.1
Interest, net ........................................... 3.6 4.4 3.8 4.8
Loss on disposal of assets and other items .............. -- 3.2 -- 2.0
----- ----- ----- -----
Earnings (loss) before taxes ............................ 2.1 (5.4) 1.8 (5.4)
Provision (benefit) for income taxes .................... 1.0 (1.1) 0.8 (1.5)
----- ----- ----- -----
Earnings (loss) before extraordinary item ............... 1.1 (4.3) 1.0 (3.9)
Extraordinary item, net of tax .......................... 0.8 -- 0.4 --
----- ----- ----- -----
NET EARNINGS (LOSS) .................................. 0.3% (4.3)% 0.6% (3.9)%
===== ===== ===== =====
REVENUES
The Company's revenues are derived through the provision of healthcare
services in its network of facilities, including long-term care services such as
nursing care, assisted living and other specialized medical services such as
subacute care and rehabilitative therapy. Nursing and assisted living facility
revenues are derived from the provision of routine and ancillary services for
the Company's residents. Outpatient therapy revenue is derived from providing
outpatient therapy services at Company clinics, and to outside third parties.
Outpatient therapy revenue increased in the six months ended June 30, 2002
compared to the same period in 2001.
The Company derives its revenue from Medicare, Medicaid and private pay
sources. The following table sets forth the Company's Medicare, Medicaid and
private pay sources of revenue by percentage of total revenue:
THREE MONTHS ENDED JUNE 30 SIX MONTHS ENDED JUNE 30,
-------------------------- -------------------------
2002 2001 2002 2001
---- ---- ---- ----
Medicare .................................................. 25.5% 24.3% 25.5% 23.9%
Medicaid .................................................. 50.1% 50.2% 49.8% 50.7%
Private Pay ............................................... 24.4% 25.5% 24.7% 25.4%
Pursuant to the Balanced Budget Act of 1997 ("BBA"), as of January 1,
1999 all of the Company's skilled nursing facilities were on the Medicare
Prospective Payment System ("PPS"), which changed significantly the manner in
which skilled nursing facilities are paid for inpatient services provided to
Medicare beneficiaries. In year one (1999 for the Company), Medicare PPS rates
were based on 75% of the 1995 facility-specific Medicare costs (as adjusted by
inflation) and 25% of the federally-determined PPS rate based upon the acuity
level of Medicare skilled nursing facility patients, as defined by the federally
mandated RUGs patient classification system. Unless a skilled nursing facility
provider chose to be reimbursed at 100% of the federally-determined
acuity-adjusted rate allowed under the BBRA the following applied: in year two,
Medicare PPS rates were based 50% on the 1995 facility-specific costs (as
adjusted for inflation) and 50% on the federally-determined acuity-adjusted PPS
rate; in year three, Medicare PPS rates were based 25% on the 1995
facility-specific costs (as adjusted for inflation) and 75% on
12
the federally-determined acuity-adjusted PPS rate; and in year four and
thereafter, Medicare PPS rates are based entirely on the federally-determined
acuity-adjusted PPS rate. As of January 1, 2002, all facilities are reimbursed
upon the full federally-determined acuity-adjusted PPS rate.
In November 1999, Congress and the President reached agreement on a
package of Medicare program revisions that restored $2.7 billion in Medicare
funding for skilled nursing facilities ("SNFs") over the next three years
thereby restoring some of the funding that had been eliminated or excluded by
the BBA. The BBRA made numerous revisions including: (1) the option for a
skilled nursing provider to choose between the higher of current law, as
described above, or 100% of the federally-determined acuity-adjusted PPS rate
effective for cost reporting periods starting on or after January 1, 2000; (2) a
temporary 20% increase in the revenue value for the federal rate or the federal
component of the blended rate (homes subject to the full federal rate would
receive 100% of the enhancement) for 15 of the 44 RUGs to recognize the costs
associated with the more medically complex patients, for the period April 1,
2000 through September 30, 2000 to allow CMS to implement a refinement of RUGs
rates; (3) a 4% increase in the federal component of the blended rate for all of
the RUGs effective for each of the periods October 1, 2000 through September 30,
2001 and October 1, 2001 through September 30, 2002; and (4) certain other Part
A changes, of lesser significance to the Company, but included a two year
moratorium effective January 1, 2000 on the $1,500 caps on speech and physical
therapy and occupational therapy (which had a favorable impact on the Company's
Part B Medicare revenue). The Company subsequently identified 18 facilities and
filed the necessary applications in order to benefit from the full Federal PPS
rate.
In December 2000, Congress and the President approved an additional $35
billion Medicare relief package through the BIPA of which approximately $2.0
billion was expected to benefit SNFs. The BIPA: (1) increased the nursing
component of all RUGs categories by 16.66% over an 18-month period commencing
April 1, 2001, and requires the Comptroller General to complete a study of
nursing staff ratios by August 1, 2002; (2) modified the PPS inflation
adjustment to remove the negative 1% factor for the 2001 year and establish a
minus 0.5% factor for years 2002 and 2003; (3) redistributed the 20% Part A
enhancement, provided by the BBRA and implemented for three RUGs categories
across all 14 rehabilitation RUGs categories effective April 1, 2001; and (4)
continued the moratorium on the two $1,500 caps on speech and physical therapy
and occupational therapy through 2002. Also, the BIPA required the Department of
Health and Human Services ("HHS") to issue a final regulation establishing a
Medicaid "upper payment limit", which will limit the amount of funds a state may
raise through the process of intergovernmental fund transfers (IGTs). Following
the announcement, the Company identified 10 skilled nursing facilities and had
filed the necessary applications in order to benefit from the full Federal PPS
rate. The Company had 38 skilled nursing facilities at the full federal rate
during 2001.
The incremental Medicare relief packages received from BBRA and BIPA
provide a total $2.7 billion in temporary Medicare funding enhancements to the
long-term care industry. The funding enhancements implemented by the BBRA and
BIPA fall into two categories. The first category is "Legislative Add-ons" which
included the 16.66% add-on to the nursing component of the RUGs rate and the 4%
base adjustment. The Legislative Add-ons are currently scheduled to sunset on
September 30, 2002. The Company has estimated the average per diem effect of the
Legislative Add-ons to be $32.00, or $19.0 million annually. Currently there is
extensive discussions and negotiations within the U. S. House of Representatives
and Senate regarding these Legislative Add-ons. It is not possible to predict
the final outcome of any legislation. A decision to discontinue all or part of
the Legislative Add-ons could have a significant impact on the Company.
The second category is "RUGs Refinements" which involved an initial 20%
add-on for 15 RUGs categories identified as having high intensity, non-therapy
ancillary services (20% add-ons from three RUGs categories were later
redistributed to 14 Rehab categories at 6.7%). On April 23, 2002, the CMS
announced that it would leave in place the current classification system which
will result in the continuation of funding received from the RUGs Refinements.
Average occupancy in nursing facilities for the six months ended June
30, 2002 and 2001 was 89.7% and 87.1%; and for assisted living facilities, 82.4%
and 83.5%, respectively.
13
THREE MONTHS ENDED JUNE 30, 2002 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2001
REVENUES
Revenues in the three months ended June 30, 2002 ("2002 quarter") were
$201.8 million, representing an increase of $1.0 million (0.5%) from $200.8
million in the three months ended June 30, 2001 ("2001 quarter"). The increase
in revenues includes a $13.0 million increase in revenues from nursing and
assisted living facilities and other business operated during both the 2002 and
the 2001 quarters ("same-facility operations") and an increase of $0.2 million
from other revenue, partially offset by a decrease of $12.2 million in revenues
from divested nursing facilities.
Revenues from same-facility nursing and assisted living operations
increased $13.0 million due to: (1) a 1.7% increase in resident census (average
daily census or "ADC" increased from 13,878 in 2001 to 14,110 in 2002), a higher
Medicare ADC (ADC increased from 1,423 in 2001 to 1,645 in 2002), and increased
Medicaid rates, collectively which increased revenues by $12.5 million or 6.9%
increase on a same-facility basis; and (2) an increase of $0.5 million when
comparing periods due to more favorable Medicaid cost settlements in 2002.
For nursing operations, the Company's average daily Medicare rate
decreased to $337 (0.9%) in the 2002 quarter compared to $340 in the 2001
quarter on a same-facility basis. The percentage of Medicare residents, on a
same-facility basis, increased to 13.0% in the 2002 quarter from 11.5% in the
2001 quarter. The Company's average daily Medicaid rate increased to $127 (6.7%)
in the 2002 quarter compared to $119 in the 2001 quarter on a same-facility
basis. The percentage of Medicaid residents decreased to 68.8% in the 2002
quarter from 69.8% in the 2001 quarter; the average daily census for Medicaid
residents was 8,710 in the 2002 quarter as compared to 8,668 in the 2001 quarter
on a same-facility basis.
OPERATING AND GENERAL AND ADMINISTRATIVE COSTS
Operating and general and administrative costs decreased $4.0 million
or 2.2% between periods, of which $4.1 million was a decrease in expenses for
insurance and liability claims (primarily related to the Company's divestiture
of its Texas nursing facilities), and $10.8 million related to reduced operating
costs (other than insurance and liability claims) attributable to nursing
facilities divested during 2001. The increase in operating and general and
administrative costs on a same-facility basis (excluding expenses for insurance
and liability claims) was $10.9 million (a 6.7% increase on a same-facility
basis) and included: (1) an increase in wage and benefit costs of $4.3 million
(a 3.7% increase on a same-facility basis); (2) an increase in contracted food
and laundry services totaling $2.5 million related to services that were
formerly provided by employees; (3) an increase in drug expense of $1.7 million
primarily due to escalating drug costs; (4) an increase in outside therapy
services of $1.0 million; (5) an increase in bad debt expense of $0.5 million;
and (6) a net increase in other operating and general and administrative
expenses of $0.9 million (a 0.6% increase on a same-facility basis).
LEASE COSTS, DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased $0.8 million to $9.4 million
for the 2002 quarter compared to $10.2 million for the 2001 quarter. This
decrease included a $0.3 million decrease as a result of divestitures and a $0.6
million decrease relating to the adoption of SFAS No. 142, "Goodwill and Other
Intangible Assets", which requires that goodwill no longer be amortized to
earnings.
Lease costs decreased $1.2 million when comparing periods, including
$0.6 million as a result of divestitures and $0.6 million as a result of
continuing operations.
INTEREST
Interest expense (net of interest income) decreased $1.7 million to
$7.2 million in the 2002 quarter compared to $8.9 million in the 2001 quarter.
The decrease was primarily due to a decrease in the weighted average interest
rate of all long-term debt to 7.17% during the 2002 quarter compared to
approximately 8.47% during the 2001 quarter, as well as a reduction in the
average debt level to $377.5 million during the 2002 quarter compared to $406.9
million during the 2001 quarter resulting from the Company's use of divestiture
proceeds and an income tax refund during 2001 to reduce bank debt balances.
14
LOSS ON DISPOSAL OF ASSETS AND OTHER ITEMS
A loss of $5.5 million was recorded in the 2001 quarter for costs
relating to the disposal or lease during 2000 of the Company's Florida
operations. An additional loss of $0.9 million was recorded in the 2001 quarter
for other nursing facilities closed in 2000 and the disposition of other
non-core assets.
INCOME TAXES
Income tax expense in the 2002 quarter was $2.1 million compared to an
income tax benefit of $2.2 million in the 2001 quarter. The Company's effective
tax rate was 48.2% in 2002 as compared to 20.2% in 2001. The increase in the
effective tax rate results from the reversal of current and prior year state
deferred income tax benefits. In assessing the realizability of deferred tax
assets, management considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized, and accordingly
records a valuation allowance if required. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected future
taxable income, and tax planning strategies in making this assessment.
EXTRAORDINARY ITEM
The extraordinary loss in 2002 of $1.7 million (net of income tax
effect) was due to the early extinguishment in June 2002 of the Company's debt
using proceeds from the issuance of the Senior Notes. The extraordinary loss in
2001 of $45,000 (net of income tax effect) was related to the write-off of
deferred financing costs in connection with debt reduction upon the sale of
nursing facilities.
NET EARNINGS (LOSS)
Net earnings in the 2002 quarter were $0.5 million compared to a net
loss of $8.7 million in the 2001 quarter. The net earnings prior to loss on
disposal of assets and other items and extraordinary item (after applicable
income tax effect) was $2.2 million in the 2002 quarter compared to a net loss
of $4.5 million for the 2001 quarter. The fluctuation is for the reasons noted
above.
SIX MONTHS ENDED JUNE 30, 2002 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2001
REVENUES
Revenues in the six months ended June 30, 2002 were $400.0 million,
representing an increase of $5.8 million (1.5%) from $394.2 million in the six
months ended June 30, 2001. The increase in revenues includes a $28.4 million
increase in revenues from nursing and assisted living facilities and other
business operated during the six months ended June 30, 2002 and 2001
("same-facility operations") and an increase of $0.5 million from other revenue,
partially offset by a decrease of $23.1 million in revenues from divested
nursing facilities.
Revenues from same-facility nursing and assisted living operations
increased $28.4 million due to: (1) a 1.3% increase in resident census (average
daily census or `ADC" increased from 13,906 in 2001 to 14,081 in 2002), a higher
Medicare ADC (ADC increased from 1,439 in 2001 to 1,643 in 2002), and increased
Medicaid rates, collectively which increased revenues by $27.5 million or 7.7%
increase on a same-facility basis; and (2) an increase of $0.9 million when
comparing periods due to more favorable Medicaid cost settlements in 2002.
For nursing operations, the Company's average daily Medicare rate
increased to $337 (2.8%) in the first six months of 2002 compared to $328 in the
first six months of 2001 on a same-facility basis. The percentage of Medicare
residents, on a same-facility basis, increased to 13.0% in the first six months
of 2002 from 11.6% in the first six months of 2001. Similarly, the Company's
average daily Medicaid rate increased to $126 (6.2%) in the first six months of
2002 compared to $119 in the first six months of 2001 on a same-facility basis.
The percentage of Medicaid residents decreased to 68.7% in the first six months
of 2002
15
from 69.6% in the first six months of 2001; the average daily census for
Medicaid residents was 8,681 in the first six months of 2002 as compared to
8,643 in the first six months of 2001 on a same-facility basis.
OPERATING AND GENERAL AND ADMINISTRATIVE COSTS
Operating and general and administrative costs decreased $7.7 million
or 2.1% between periods, of which $5.5 million was a decrease in expenses for
insurance and liability claims (primarily related to the Company's divestiture
of its Texas nursing facilities), and $21.6 million related to reduced operating
costs (other than insurance and liability claims) attributable to nursing
facilities divested during 2001. The increase in operating and general and
administrative costs on a same-facility basis (excluding expenses for insurance
and liability claims) was $19.4 million (a 6.0% increase on a same-facility
basis) and included: (1) an increase in wage and benefit costs of $9.5 million
(a 4.1% increase on a same-facility basis); (2) an increase in contracted food
and laundry services totaling $3.9 million related to services that were
formerly provided by employees; (3) an increase in drug expense of $2.5 million
primarily due to escalating drug costs; (4) an increase in outside therapy
services of $1.6 million; (5) an increase in bad debt expense of $1.3 million;
and (6) a net increase in other operating and general and administrative
expenses of $0.6 million (a 0.2% increase on a same-facility basis).
LEASE COSTS, DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased $1.7 million to $18.8 million
for the first six months of 2002 compared to $20.5 million for the first six
months of 2001. This decrease included a $0.7 million decrease as a result of
divestitures and a $1.2 million decrease relating to the adoption of SFAS No.
142, "Goodwill and Other Intangible Assets", which requires that goodwill no
longer be amortized to earnings.
Lease costs decreased $2.0 million when comparing periods, including
$1.3 million as a result of divestitures and $0.7 million as a result of
continuing operations.
INTEREST
Interest expense (net of interest income) decreased $3.6 million to
$15.2 million in the first six months of 2002 compared to $18.8 million in the
first six months of 2001. The decrease was primarily due to a reduction in the
average debt level to $380.8 million during the first six months of 2002
compared to $423.3 million during the first six months of 2001 resulting from
the Company's use of divestiture proceeds and an income tax refund during 2001
to reduce bank debt balances, as well as a decrease in the weighted average
interest rate of all long-term debt to 7.49% during the first six months of 2002
compared to approximately 8.53% during the first six months of 2001.
LOSS ON DISPOSAL OF ASSETS AND OTHER ITEMS
A loss of $6.9 million was recorded in the first six months of 2001 for
costs relating to the disposal or lease during 2000 of the Company's Florida
operations. An additional loss of $0.9 million was recorded in 2001 for nursing
facilities closed in 2000 and the disposition of other non-core assets.
INCOME TAXES
Income tax expense in the first six months of 2002 was $3.4 million
compared to an income tax benefit of $5.9 million in the first six months of
2001. The Company's effective tax rate was 46.6% in the first six months of 2002
as compared to 27.6% in the first six months of 2001. The increase in the
effective tax rate results from the reversal of current and prior year state
deferred income tax benefits. In assessing the realizability of deferred tax
assets, management considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized, and accordingly
records a valuation allowance if required. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected future
taxable income, and tax planning strategies in making this assessment.
16
EXTRAORDINARY ITEM
The extraordinary loss in 2002 of $1.7 million (net of income tax
effect) was due to the early extinguishment in June 2002 of the Company's debt
using proceeds from the issuance of the Senior Notes. The extraordinary loss in
2001 of $45,000 (net of income tax effect) was related to the write-off of
deferred financing costs in connection with debt reduction upon the sale of
nursing facilities.
NET EARNINGS (LOSS)
Net earnings in the first six months of 2002 were $2.2 million compared
to a net loss of $15.5 million in the first six months of 2001. The net loss
prior to loss on disposal of assets and other items and extraordinary items was
$3.9 million for the first six months of 2002 and was $10.4 million for the
first six months of 2001. The fluctuation is for the reasons noted above.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW OF CHANGES IN LIQUIDITY
The Company had cash and cash equivalents of $28.9 million at June 30,
2002 and $1.0 million at December 31, 2001. Cash flow generated from operating
activities was $20.2 million for the six months ended June 30, 2002 compared
with $52.9 million in the comparable period of 2001. The $32.7 million reduction
in cash flow from operations was the result of the 2001 tax refund of $22.5
million, a $11.5 million reduction in accounts receivable net of changes in
accounts payable (primarily relating to divested operations) and increased
payments of self-insured general liability claims of $11.9 million, partly
offset by improved cash flow from operations of $13.2 million.
The Company experienced a decrease in working capital (excluding cash
and borrowings included in current liabilities) of $12.8 million from $15.8
million at December 31, 2001 to $3.0 million at June 30, 2002. The decrease in
working capital resulted primarily from a decrease in accounts receivable of
$9.6 million and a $9.0 million increase in accounts payable and accrued
liabilities. These decreasing components of working capital were partially
offset by a $5.7 million decrease in amounts due to shareholders and affiliates.
Accounts receivable at June 30, 2002 were $94.6 million compared with
$104.2 million at December 31, 2001, representing a decrease of $9.6 million.
The reduction in accounts receivable included an $11.0 million decrease within
the nursing operations, an increase of $0.4 million within the outpatient
therapy operations, and a $1.0 million increase in receivables from long-term
care operators for which management and consulting services are provided. The
$1.0 million increase was primarily attributable to transitional working capital
advances to the nursing facilities transferred to Senior Health-Texas and Senior
Health-South. Within the nursing operations, billed patient care and other
receivables decreased $9.4 million and third-party payor settlement receivables
(based on Medicare and Medicaid cost reports) decreased $1.6 million. The
decrease in billed patient care receivables of $9.4 million included a decrease
of $11.7 million due to an improvement in collection efforts by the Company
between periods. The remaining increase of $2.3 million reflects an increase of
$5.9 million due to rate increases, partially offset by a decrease of $3.6
million due to the sale or closure of nursing facilities and assisted living
facilities.
The decrease in settlement receivables of $1.6 million from December
31, 2001 to June 30, 2002 included decreases of (1) $1.5 million from
collections of Medicare settlements; (2) $1.5 million for collections from
Medicare of uncollectible co-insurance amounts recorded as revenue in 2002 and
2001; and (3) $0.5 million for collection of Medicaid cost report settlements.
These decreases were partially offset by an increase of $1.9 million in revenue
recorded in 2002 for anticipated Medicare reimbursement for uncollectible
co-insurance amounts.
Property and equipment decreased $35.5 million from December 31, 2001
to a total of $442.3 million at June 30, 2002. The decrease was the result of
depreciation expense of $18.2 million and asset disposals with net book values
of $26.0 million, primarily relating to the sale of seven Florida leased
properties to Tandem as discussed earlier. These decreases were partially offset
by capital expenditures of $7.4 million and an increase of $1.3 million
(included in depreciation expense) relating to the
17
reclassification of the net book value of property and equipment related to the
disposal of nursing facilities to Greystone from Property and equipment to other
assets.
Total borrowings, including bank indebtedness and both current and
long-term maturities of debt, totaled $390.7 million at June 30, 2002
representing an increase of $4.8 million from December 31, 2001. The increase
resulted from the issuance of new debt as discussed above, partially offset by
the use of $0.8 million from the collection of notes receivable, $19.4 million
from the sale of property, and the use of cash from operating activities to
reduce borrowings. The weighted average interest rate of all long-term debt was
8.76% at June 30, 2002 and such debt had maturities ranging from 2002 to 2014.
As of June 30, 2002, Extendicare Inc. and/or one of its wholly owned
subsidiaries held $27.9 million (14.0%) of the Company's outstanding senior
subordinated notes.
Cash provided from investing activities was $8.3 million for the six
months ended June 30, 2002 compared to $0.1 million in the comparable period of
2001. The increase was primarily due to: (1) a $7.3 million increase in proceeds
from the sale of property and equipment in 2002; (2) $1.0 million from the
collection of notes receivable in 2002; and (3) a $1.2 million increase from
changes in other non-current assets. These increases were partially offset by a
decrease of $1.2 million as a result of increased purchases of property and
equipment.
Cash used for financing activities decreased by $53.5 million to $0.6
million for the six months ended June 30, 2002, compared to a use of funds of
$54.1 million in the comparable period in 2001. The decrease is primarily due
to: (1) a $160.6 million increase in proceeds from issuance of long-term debt of
which $149.6 million was from the issuance of the Senior Notes; (2) a $3.2
million increase in cash from other liabilities in 2002; (3) a $2.7 million
decrease from cash used for bank indebtedness; (4) a decrease of $100.5 million
from increased payments of long-term debt in 2002; and (5) a $7.1 million
decrease from cash used for the payment of deferred financing costs associated
with the issuance of the Senior Notes.
LIQUIDITY AND CAPITAL RESOURCES
The Company has a $105 million Revolving Credit Facility. Borrowing
availability under this line of credit totaled $64.6 million at June 30, 2002
(net of letters of credit in the amount of $40.4 million). The Company is in
compliance with the financial covenants of its credit facility as of June 30,
2002.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Qualitative Disclosures
As discussed in Note 5 to the Financial Statements, the Company uses
interest rate swaps to hedge the fair value of its debt obligations and interest
rate caps as a cash flow hedge of its variable-rate debt and also to offset
possible increases in variable-rate payments on its interest rate swap related
to increases in market interest rates over the cap rate.
The Company also has market risk relating to investments in stock and
stock warrants obtained in connection with the 1998 sale of the Company's
pharmacy operations. In effect, these holdings can be considered contingent
purchase price whose value, if any, may not be realized for several years. These
stock and warrant holdings are subject to various trading and exercise
limitations and will be held until such time that management believes the market
opportunity is appropriate to trade or exercise such holdings.
With respect to the stock and warrant holdings, management monitors the
market to adequately determine the appropriate market timing to act in order to
maximize the value of these instruments. With the exception of the above
holdings, the Company does not enter into derivative instruments for any purpose
other than cash flow hedging purposes. That is, the Company does not speculate
using derivative instruments and does not engage in trading activity of any
kind.
18
Quantitative Disclosures
The table below presents principal (or notional) amounts and related
weighted average interest rates by year of maturity for the Company's debt
obligations and interest rate swaps and caps (dollars in thousands).
AFTER FAIR
2002 2003 2004 2005 2006 2006 TOTAL VALUE
---- ---- ---- ---- ---- ---- ----- -----
LONG-TERM DEBT:
Fixed Rate ....................... $ 436 $ 674 $ 710 $ 700 $ 644 $355,549 $358,713 $362,204
Average Interest Rate ............ 6.48% 6.59% 6.69% 6.74% 6.40% 9.41% 9.39%
Variable Rate .................... -- -- -- -- -- $ 32,000 $ 32,000 $ 19,310
Average Interest Rate ............ 1.60% 1.60%
INTEREST RATE SWAPS:
Notional Amount .................. -- -- -- -- -- $150,000 $150,000 $ 106
Average Pay Rate
(variable rate) ................ -- -- -- -- -- -- 6.65%
Average Receive Rate
(fixed rate) ................... -- -- -- -- -- -- 9.35%
INTEREST RATE CAPS:
Notional Amount .................. -- -- -- -- -- $150,000 $150,000 $ 88
The above table incorporates only those exposures that exist as of June
30, 2002 and does not consider those exposures or positions which could arise
after that date or future interest rate movements. As a result, the information
presented above has limited predictive value. The Company's ultimate results
with respect to interest rate fluctuations will depend upon the exposures that
arise during the period, the Company's hedging strategies at the time and
interest rate movements.
19
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings other than litigation
arising in the ordinary course of business. Management believes, on the basis of
information furnished by legal counsel, that none of these actions will have a
material effect on the financial position or results of operations of the
Company.
ITEM 2. CHANGE IN SECURITIES
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) List of Exhibits:
99.1 Certification Pursuant to 18 U.S.C. Section 1350 -- Chairman
of the Board and Chief Executive Officer
99.2 Certification Pursuant to 18 U.S.C. Section 1350 -- Vice
President, Chief Financial Officer and Treasurer
(b) Reports on Form 8-K
On July 2, 2002, the Company filed Form 8-K relating to its issuance on
June 28, 2002 of $150 million of 9.5% Senior Notes due July 1, 2010 in
a private placement. The Senior Notes were issued at a price of 99.75%
of par to yield 9.54%.
20
EXTENDICARE HEALTH SERVICES, INC.
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 thereunto duly authorized.
EXTENDICARE HEALTH SERVICES, INC.
Date: August 14, 2002 By: /s/ MARK W. DURISHAN
--------------- -------------------------------------
Mark W. Durishan
Vice President, Chief Financial
Officer and Treasurer
(principal financial officer and
principal accounting officer)
21
EXTENDICARE HEALTH SERVICES, INC.
EXHIBIT INDEX
99.1 Certification Pursuant to 18 U.S.C. Section 1350 -- Chairman of the
Board and Chief Executive Officer
99.2 Certification Pursuant to 18 U.S.C. Section 1350 -- Vice President,
Chief Financial Officer and Treasurer
22