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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 SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBERS 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
Yes[ ] No [x]
EXTENDICARE HEALTH SERVICES, INC.
INDEX
PART I FINANCIAL INFORMATION: PAGE
Item 1 Financial Statements:
Consolidated Statements of Operations for the Three Months and Nine Months Ended
September 30, 2002 and 2001............................................................. 3
Consolidated Balance Sheets, September 30, 2002 and December 31, 2001........................... 4
Consolidated Statements of Cash Flows for the Nine Months Ended September 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........... 12
Item 3 Quantitative and Qualitative Disclosures About Market Risk...................................... 22
Item 4 Controls and Procedures........................................................................ 23
PART II OTHER INFORMATION:
Item 1 Legal Proceedings............................................................................... 24
Item 2 Changes in Securities and Use of Proceeds....................................................... 24
Item 3 Defaults Upon Senior Securities................................................................. 24
Item 4 Submission of Matters to a Vote of Security Holders............................................. 24
Item 5 Other Information............................................................................... 24
Item 6 Exhibits and Reports on Form 8-K................................................................ 24
SIGNATURES ................................................................................................ 25
CERTIFICATIONS............................................................................................. 26
EXHIBIT INDEX.............................................................................................. 28
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EXTENDICARE HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---- ---- ---- ----
REVENUES:
Nursing and assisted living centers ............ $ 200,368 $ 197,753 $ 586,272 $ 578,378
Outpatient therapy ............................. 2,491 2,357 7,585 7,271
Other .......................................... 3,906 3,915 12,927 12,597
--------- --------- --------- ---------
206,765 204,025 606,784 598,246
COSTS AND EXPENSES:
Operating ...................................... 174,941 179,637 511,449 523,021
General and administrative ..................... 7,786 7,672 24,329 25,011
Lease costs .................................... 2,697 3,641 8,411 11,352
Depreciation and amortization .................. 9,383 9,731 28,228 30,226
Interest expense ............................... 8,784 9,106 24,754 28,937
Interest income ................................ (23) (511) (833) (1,567)
Loss on impairment of long-lived assets ........ -- 1,685 -- 1,685
Loss on disposal of assets and other items ..... -- 16,402 -- 24,246
--------- --------- --------- ---------
203,568 227,363 596,338 642,911
--------- --------- --------- ---------
EARNINGS (LOSS) BEFORE INCOME TAXES .............. 3,197 (23,338) 10,446 (44,665)
Income tax expense (benefit) ..................... 1,192 (9,249) 4,568 (15,126)
--------- --------- --------- ---------
EARNINGS (LOSS) BEFORE EXTRAORDINARY ITEM ........ 2,005 (14,089) 5,878 (29,539)
--------- --------- --------- ---------
Extraordinary loss on early retirement of
debt (net of income taxes, $1,140, and $30,
respectively) .............................. -- -- (1,709) (45)
--------- --------- --------- ---------
NET EARNINGS (LOSS) .............................. $2,005 $(14,089) $4,169 $(29,584)
========= ========= ========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
EXTENDICARE HEALTH SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2002 AND DECEMBER 31, 2001
(DOLLARS IN THOUSANDS)
ASSETS
SEPTEMBER 30, 2002 DECEMBER 31, 2001
------------------ -----------------
CURRENT ASSETS:
Cash and cash equivalents .................................. $ 29,710 $ 997
Accounts receivable, less allowances of $11,834 and $14,577,
respectively ............................................. 99,371 104,236
Supplies, inventories and other current assets ............. 7,405 6,809
Due from shareholder and affiliates:
Federal income taxes receivable ........................ 9,488 9,468
Deferred federal income taxes .......................... 10,763 11,474
Other .................................................. 3,004 --
------------------ ------------------
Total current assets ................................... 159,741 132,984
PROPERTY AND EQUIPMENT ....................................... 439,095 477,830
GOODWILL AND OTHER INTANGIBLE ASSETS ......................... 76,648 77,592
OTHER ASSETS ................................................. 119,320 107,430
------------------ ------------------
Total Assets .......................................... $ 794,804 $ 795,836
================== ==================
LIABILITIES AND SHAREHOLDER'S EQUITY
CURRENT LIABILITIES:
Bank indebtedness .......................................... $ 4 $ 590
Current maturities of long-term debt ....................... 608 12,099
Accounts payable and accrued liabilities ................... 124,296 105,908
Income taxes payable ....................................... 1,495 1,556
Deferred state income taxes payable ........................ 239 --
Due to shareholders and affiliates ......................... -- 8,686
------------------ ------------------
Total current liabilities .............................. 126,642 128,839
ACCRUAL FOR SELF-INSURED LIABILITIES ......................... 55,713 70,341
LONG-TERM DEBT ............................................... 387,442 373,248
OTHER LONG-TERM LIABILITIES .................................. 40,351 44,018
DEFERRED STATE INCOME TAXES .................................. 783 --
DUE TO SHAREHOLDER AND AFFILIATES:
Deferred Federal income taxes and other ................ 24,211 23,388
------------------ ------------------
Total liabilities ..................................... 635,142 639,834
------------------ ------------------
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 ........................ (2,876) (2,367)
Accumulated deficit.......................................... (46,250) (50,419)
------------------ ------------------
Total Shareholder's Equity ............................. 159,662 156,002
------------------ ------------------
Total Liabilities and Shareholder's Equity ................. $ 794,804 $ 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 NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(DOLLARS IN THOUSANDS)
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
------------------ ------------------
OPERATING ACTIVITIES:
Net earnings (loss) ........................................ $ 4,169 $ (29,584)
Adjustments to reconcile net earnings (loss) to net cash
provided from operating activities:
Depreciation and amortization ........................ 29,596 31,799
Provision for uncollectible accounts receivable ...... 7,874 7,302
Provision for self-insured liabilities ............... 3,937 27,552
Payment of self-insured liability claims ............. (18,565) (5,099)
Loss on disposal of assets and other items ........... -- 13,282
Loss on impairment of long-lived assets .............. -- 1,685
Deferred income taxes ................................ 4,166 (15,704)
Extraordinary loss on early retirement of debt ....... 1,709 45
Changes in assets and liabilities:
Accounts receivable .................................. (5,086) 12,407
Supplies, inventories and prepaid expenses ........... (646) (126)
Debt service trust funds ............................. (171) (173)
Due from shareholder-Federal income taxes ............ (20) 22,542
Accounts payable and accrued liabilities ............. 2,400 290
Income taxes payable/receivable ...................... (60) 639
-------------- ------------
Cash provided from operating activities ........... 29,303 66,857
INVESTING ACTIVITIES:
Payments for purchase of property and equipment ...... (12,638) (9,681)
Proceeds from sale of property and equipment ......... 14,291 7,292
Changes in other non-current assets .................. 1,012 (1,085)
-------------- ------------
Cash provided from (used in) investing activities . 2,665 (3,474)
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt.............. 160,625 --
Payments of deferred financing costs ................. (7,090) --
Other long-term liabilities .......................... 1,726 (1,243)
Payments of long-term debt ........................... (157,931) (61,493)
Changes in bank indebtedness ......................... (585) 1,841
Distribution of minority interests' earnings ......... -- (15)
-------------- ------------
Cash used in financing activities ................. (3,255) (60,910)
-------------- ------------
INCREASE IN CASH AND CASH EQUIVALENTS ...................... 28,713 2,473
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ............. 997 1,641
-------------- ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ................... $ 29,710 $ 4,114
============== ===========
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 an indirect 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
September 30, 2002 and 2001 and for the periods ended September 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 condensed
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. Upon adoption, the Company 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
at least annually. 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 SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2002 2001 2002 2001
------- --------- ------- ---------
Net income (loss), as reported $ 2,005 $ (14,089) $ 4,169 $ (29,584)
Add back: goodwill amortization - 612 - 1,836
------- --------- ------- ---------
Adjusted net income (loss) $ 2,005 $ (13,477) $ 4,169 $ (27,748)
======= ========== ======= ==========
4-ISSUANCE OF SENIOR NOTES
On June 28, 2002, the Company completed a private placement of $150
million of its 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 guaranteed by all existing and future subsidiaries of the
Company. The Senior Notes were issued at a discount of 0.25% from 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 support 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
September 30, 2002.
The Company has no independent assets or operations, the guarantees of
the Senior Notes are full and unconditional, and joint and several, and any of
the Company's subsidiaries that do not guarantee the Senior Notes are minor.
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 entered into interest rate swap and interest rate cap agreements in June
2002, which are fully described under Quantitative Disclosures of this note.
The Company does not speculate using derivative instruments.
Risk Management Policies
The Company assesses interest rate cash flow risk by continually
identifying and monitoring changes in interest rate exposure that may adversely
impact expected cash flows and by evaluating hedging opportunities. The Company
maintains risk management control systems to monitor interest rate cash flow
risk attributable to both the Company's outstanding or forecasted debt
obligations as well as the Company's offsetting hedge positions. The risk
management control systems involve the use of analytical techniques, including
cash flow sensitivity analysis, to estimate the expected impact of changes in
interest rates on the Company's future cash flows.
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") (1.82% as of September 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 changes in market value of the swap are offset by changes in
market value of the hedged item (fixed-rate debt obligations). Therefore,
changes in market value of the swap had no impact on the income statement during
the three months ended September 30, 2002.
8
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 SFAS 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") 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
earnings. As of September 30, 2002, the fair value of the interest rate swap
designated as a fair value hedge is an asset of $7.5 million and is offset by a
liability of $7.5 million relating to the change in market value of the hedged
item (long-term debt obligations). The fair value of the cash-flow hedges is a
liability recorded in other long-term liabilities of $0.2 million and the loss
charged to AOCI (net of income tax effect) for the three months ended September
30, 2002 was $0.1 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 $0.5 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. The Company
expects that the adoption of SFAS No. 144 will have no material effect on the
Company's consolidated financial position or results of operations.
9
The following summarizes the components of the loss from asset
impairment, disposals and other items:
2001
------------------------------------------
PROCEEDS, NET
OF SELLING COSTS NET BOOK
VALUE LOSS
------------------------------------------
(IN THOUSANDS)
Loss from dispositions:
Skilled nursing and assisted living facilities .......... $ 11,296 $ 12,064 $ 768
Other ................................................... 394 680 286
--------------- ---------- -------
$ 11,690 $ 12,744 $ 1,054
Provision for closure and exit costs ........................ 12,228
Provision for adverse development of general and professional
liability costs ......................................... 10,964
-------
Subtotal ................................................ 24,246
Loss on impairment of long-lived assets ..................... 1,685
-------
$25,931
=======
Below is a summary of activity of the accrued liabilities balance
relating to disposed operations (in thousands):
RESIDENT
EMPLOYEE LIABILITY AND RENT OTHER
TERMINATION OTHER CLAIMS EXPENSE EXPENSES(1) TOTAL
------------ ----------- ------- -------- -------
Balance December 31, 2000 ....... $ 32 $ -- $ 698 $ 2,784 $ 3,514
Cash Payments ............... (1,377) (1,113) (234) (5,016) (7,740)
Provisions .................. 1,399 3,163 (464) 8,130 12,228
------------ ----------- ------- ------- -------
Balance December 31, 2001 ....... 54 2,050 -- 5,898 8,002
Cash Payments ............... -- (295) -- (2,094) (2,389)
Provisions (1) .............. -- 295 -- 6,860 7,155
------------ ----------- ------- ------- -------
Balance September 30, 2002 ...... $ 54 $ 2,050 $ -- $10,664 $12,768
============ =========== ======= ======= =======
(1) "Other Expenses" consists of amounts reserved for cost report and other
settlements with the States of Florida and Texas and other Medicare fiscal
intermediaries, collection of receivables and settlement of claims with
suppliers and employees.
(2) In May 2002, Tandem exercised its option to purchase seven properties. Based
upon facts known in 2002, the Company increased the overall provision and
accrued liabilities balance relating to Florida disposed operations for defined
claims and expenses in an amount equal to the gross sales proceeds over the
adjusted carrying value of the assets sold to Tandem to cover these claims.
7- COMMITMENTS AND CONTINGENCIES
Capital Expenditures
At September 30, 2002, the Company had capital expenditure purchase
commitments outstanding of approximately $4.5 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 (including
malpractice insurance for the Company's health providers, assistants and other
staff as it relates to their respective duties performed on the Company's
behalf), property coverage, workers' compensation and employer's liability
insurance in amounts and with such coverage and deductibles determined by the
Company, based on the nature and risks of its business, historical experiences,
availability and industry standards. The Company also self-insures for health
and dental claims, in certain states for workers' compensation and employers'
liability and
10
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.
Omnicare Preferred Provider Agreement
In connection with its agreements to provide pharmacy services to the
Company, Omnicare, Inc. has requested arbitration for a lost profits claim
related to the Company's disposition of assets, primarily in Florida. Damage
amounts, if any, cannot be reasonably estimated based on information available
at this time. An arbitration hearing has not yet been scheduled.
8- COMPREHENSIVE EARNINGS (LOSS)
Comprehensive Earnings (Loss) is as follows for the periods shown
(dollars in thousands):
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
------------- ------------- ------------- -------------
2002 2001 2002 2001
NET EARNINGS (LOSS) ...................... $ 2,005 $ (14,089) $ 4,169 $ (29,584)
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized gain (loss) on investments,
before tax ....................... (1,338) 391 (2,538) 48
Gain (loss) on cash flow hedges,
before tax ....................... (17) (271) 1,559 (2,014)
------------- ------------- ------------- -------------
Other comprehensive income (loss),
before tax ....................... (1,355) 120 (979) (1,966)
Income tax (provision) benefit related
to items of other comprehensive
income (loss) .................... 541 (57) 469 690
------------- ------------- ------------- -------------
Other comprehensive income (loss), net
of tax ........................... (814) 63 (510) (1,276)
------------- ------------- ------------- -------------
COMPREHENSIVE EARNINGS (LOSS) ........... $ 1,191 $ (14,026) $ 3,659 $ (30,860)
============= ============= ============= =============
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.
Prior to October 1, 2002, Medicare funding included temporary
incremental funding enhancements enacted by Congress in 1999 and 2000. These
funding enhancements fell into two categories: (i) "Legislative Add-ons", which
included a 16.66% add-on to the nursing component of the Resource Utilization
Groupings III (RUGs) rate and a 4% base adjustment; and (ii) "RUGs Refinements",
which included the initial 20% add-on for 15 RUGs categories, and subsequent
redistribution of the 20% add-on from three RUGs categories to 14 rehabilitation
categories at 6.7%.
11
The Legislative Add-ons expired on September 30, 2002 and the Company's
Medicare funding has been reduced pending additional legislation. Based upon the
Medicare case mix and census over the nine month period ended September 30, 2002
the Company estimates that it received an average rate of $31.22 per resident
day relating to the Legislative Add-ons. However, on October 1, 2002 long-term
care providers received a 2.6% market basket increase in Medicare rates. Based
on the Medicare case mix and census for the nine months of 2002, the impact of
these two items is a net decline in the average rate of $26.47 per resident day,
which on an annualized basis going forward amounts to revenue of approximately
$16.1 million. Extensive discussions and negotiations are underway within the
U.S. House of Representatives and Senate regarding the Legislative Add-ons. It
is not possible to predict the outcome of these deliberations. A decision not to
restore all or part of the enhancements could have a significant negative effect
on the Company.
With respect to the RUGs Refinements, on April 23, 2002 the Centers for
Medicare and Medicaid Services announced its intention to delay the refinement
of the RUGs categories, thereby extending the related funding enhancements for
at least one additional year to September 30, 2003. Based upon the Medicare case
mix and census over the past nine month period ended September 30, 2002, the
Company estimates that it received an average rate of $24.59 per resident day,
which on an annualized basis amounts to revenue of approximately $14.9 million
related to the RUGs Refinements. A decision to discontinue all or part of the
enhancements could have a significant negative effect on the Company.
10-SUBSEQUENT EVENT
On October 18, 2002 the Company purchased seven previously leased
nursing facilities in Ohio and Indiana for $17.9 million. The purchase price
included cash of $7.4 million and a $10.5 million 10-year note which bears an
interim interest rate of 10.5% which is subject to arbitration.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
OVERVIEW
Based on number of beds, the Company is one of the largest providers of
long-term care and related services in the United States. As of September 30,
2002, the Company operates 139 nursing facilities (14,082 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 (147 units) and provides selected consulting services to
38 nursing facilities (4,097 beds) and 1 assisted living facility (116 beds)
owned by third parties. In total, the Company operates, manages or provides
selected consulting services to 237 long-term care facilities (22,524 beds) in
16 states, of which 195 are nursing facilities (20,505 beds) and 42 are assisted
living and retirement facilities (2,019 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.
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 related 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.
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
2002 2001 2002 2001
---- ---- ---- ----
Medicare 26.1% 23.4% 25.7% 23.7%
Medicaid............................................. 49.4% 51.7% 49.7% 51.0%
Private Pay.......................................... 24.5% 24.9% 24.6% 25.3%
LEGISLATIVE ACTIONS AFFECTING REVENUES
Prior to October 1, 2002 the incremental Medicare relief packages
received from the Balanced Budget Refinement Act and the Benefits Improvement
and Protection Act provided a total of $2.7 billion in temporary Medicare
funding enhancements to the long-term care industry. The funding enhancements
implemented by the Balanced Budget Refinement Act and Benefits Improvement and
Protection Act fall into two categories: (i) "Legislative Add-ons," which
included a 16.66% add-on to the nursing component of the Resource Utilization
Groupings III (RUGs) rate and a 4% base adjustment; and (ii) "RUGs
13
Refinements", which included the initial 20% add-on for 15 RUGs categories, and
the subsequent redistribution of the 20% add-on from three RUGs categories to 14
rehabilitation categories at 6.7%.
The Legislative Add-ons expired on September 30, 2002 and the Company's
Medicare funding has been reduced pending additional legislation. Based upon the
Medicare case mix and census over the nine month period ended September 30, 2002
the Company estimates that it received an average rate of $31.22 per resident
day relating to the Legislative Add-ons. However, on October 1, 2002 long-term
care providers received a 2.6% market basket increase in Medicare rates. Based
on the Medicare case mix and census for the nine months of 2002, the impact of
these two items is a net decline in the average rate of $26.47 per resident day,
which on an annualized basis going forward amounts to revenue of approximately
$16.1 million. Extensive discussions and negotiations are underway within the
U.S. House of Representatives and the Senate regarding the Legislative Add-ons.
It is not possible to predict the outcome of these deliberations. A decision not
to restore all or part of the enhancements could have a significant negative
effect on the Company.
With respect to the RUGs refinements, on April 23, 2002 the Centers for
Medicare and Medicaid Serviced announced its intention to delay the refinement
of the RUGs categories, thereby extending the related funding enhancements for
at least one additional year to September 30, 2003. Based upon the Medicare case
mix and census over the past nine month period ended September 30, 2002, the
Company estimates that it received an average rate of $24.59 per resident day,
which on an annualized basis amounts to revenue of approximately $14.9 million
related to the RUGs Refinements. A decision to discontinue all or part of the
enhancements could have a significant negative effect on the Company.
SIGNIFICANT EVENTS IN 2002 AND 2001
ASSET DIVESTITURES
On May 31, 2002, Tandem Health Care, Inc. ("Tandem") exercised its option
to purchase seven properties that it leased from the Company in Florida for
gross proceeds of $28.6 million, consisting of cash of $15.6 million and $13.0
million in 8.5% five-year notes. The Company's carrying value of the seven
facilities was $25.3 million. At the time of this transaction the Company
reviewed the levels of its overall reserves for losses related to its Florida
operations, which reserves were initially established when the Company decided
to exit Florida. The Company concluded, based on the facts known to it, that it
should increase the overall reserve for Florida divestitures for defined claims
and expenses in an amount equal to the excess of the gross sale proceeds over
the adjusted carrying value of the assets sold to Tandem in order to cover these
claims. Consequently, the Company did not recognize any income to its statement
of operations as a result of this transaction. The Company applied $12.4 million
of the proceeds to reduce its bank debt.
As of October 1, 2001, the Company transferred all of its Texas nursing
home operations to affiliates of Senior Health Properties-Texas, Inc. ("Senior
Health-Texas"). The transaction involved 17 nursing homes, with a capacity of
1,421 residents. The Company now leases four of these facilities to Senior
Health-Texas under a five-year lease, which will expire in September 2006, and
subleases 12 of these facilities to Senior Health-Texas under an eleven-year
sublease, which will expire in February 2012. The final property was sublet for
one month to a Senior Health-Texas affiliate until October 31, 2001, the
remainder of the lease term. The Senior Health-Texas affiliate transferred the
operations of this final property to an unrelated third party and terminated its
leasehold interest on November 1, 2001. The Company receives annual rental
income from the properties of approximately $3.8 million, which is $1.8 million
more than the Company's current annual lease costs. The Company's annual rental
income will escalate in alignment with the increases in rent expense under the
existing leases and in alignment with improvements in operating income for the
owned facilities. Senior Health-Texas has a right of first refusal with respect
to any offer to purchase one or more 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% 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. The Company
did not recognize any gain or loss on the sale as a significant portion of the
proceeds had not been received (FASB No. 66) and since the ultimate
determination of the gain was dependent on Tandem exercising some or all of the
remaining purchase options available to it. The Company applied $4.0 million of
the net proceeds to reduce its bank debt.
14
OTHER ITEMS
At September 30, 2002 the Company was attempting to settle a number of
outstanding Medicare and Medicaid receivables. Normally such issues are resolved
during an annual audit process and no provisions are required. However, where
differences exist between the Company and the fiscal intermediary, the Company
may record a general provision. For two specific Medicare issues, totaling an
estimated $22.1 million, the Company and the fiscal intermediary are working to
resolve the issues, however, failure to resolve such matters will result in the
issues being settled by proceeding to the Provider Reimbursement Review Board in
the first quarter of 2003. The two issues involve the allocation of overhead
costs and a staffing cost issue. Though the Company remains confident that it
will successfully settle the issues, an unsuccessful conclusion could impair the
Company's earnings and anticipated cash flow. As of September 30, 2002, the
Company had $62.2 million of gross Medicare and Medicaid settlement receivables
with a related allowance for doubtful accounts of $15.4 million. The net amount
receivable represents the Company's estimate of the amount collectible on
Medicare and Medicaid prior period cost reports.
The Company entered into a Preferred Provider Agreement with Omnicare
Inc. pursuant to the disposition of its pharmacy operations in 1998. The terms
of the Preferred Provider Agreement enabled Omnicare to execute Pharmacy Service
Agreements and Consulting Service Agreements with all of the Company's skilled
nursing facilities. In 2001, the Company and Omnicare brought a matter to
arbitration involving the "per diem" pricing rates billed for managed care
residents. This matter was subsequently settled and amounts reflected within the
financial results. The parties continue to negotiate the pricing of Medicare
residents and should this matter not be settled, the matter will be taken to
arbitration. In addition, in connection with its agreements to provide pharmacy
services, Omnicare, has requested arbitration for a lost profits claim related
to the Company's disposition of assets, primarily in Florida. Damage amounts, if
any, cannot be reasonably estimated based on information available at this time.
An arbitration hearing for this matter has not yet been scheduled. The Company
believes it has interpreted and has complied with the terms of the Preferred
Provider Agreement; however, there can be no assurance that other claims will
not be made with respect to the Agreement.
15
RESULTS FROM OPERATION
The following table sets forth details of revenues and earnings as a
percentage of total revenues:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----
Revenues:
Nursing and assisted living centers .......... 96.9% 96.9% 96.6% 96.7%
Outpatient therapy ........................... 1.2 1.2 1.3 1.2
Other ........................................ 1.9 1.9 2.1 2.1
----- ----- ----- -----
100.0 100.0 100.0 100.0
Expenses:
Operating and general and administrative costs 88.4 91.9 88.3 91.6
Lease, depreciation and amortization ......... 5.8 6.5 6.0 6.9
Interest, net ................................ 4.2 4.2 3.9 4.6
Loss on impairment of long-lived assets ...... -- 0.8 -- 0.3
Loss on disposal of assets and other items ... -- 8.0 -- 4.0
----- ----- ----- -----
Earnings (loss) before taxes ................. 1.6 (11.4) 1.8 (7.4)
Provision (benefit) for income taxes ......... 0.6 (4.5) 0.8 (2.5)
----- ----- ----- -----
Earnings (loss) before extraordinary item .... 1.0 (6.9) 1.0 (4.9)
Extraordinary item, net of tax ............... -- -- 0.3 --
----- ----- ----- -----
NET EARNINGS (LOSS) ....................... 1.0% (6.9)% 0.7% (4.9)%
===== ===== ===== =====
Average occupancy in the Company's long-term care facilities was as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2002 2001 2002 2001
---- ---- ---- ----
Skilled nursing facilities........................... 90.8% 87.9% 90.0% 87.4%
Assisted living facilities........................... 84.5% 82.5% 83.1% 83.2%
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED WITH THREE MONTHS ENDED SEPTEMBER
30, 2001
REVENUES
Revenues in the three months ended September 30, 2002 ("2002 quarter")
were $206.8 million, representing an increase of $2.8 million (1.3%) from $204.0
million in the three months ended September 30, 2001 ("2001 quarter"). The
increase in revenues includes a $15.1 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 $12.5 million in
revenues from divested nursing facilities.
Revenues from same-facility nursing and assisted living operations
increased $15.1 million due to:
- an increase of $15.8 million or 8.6%, as a result of an overall
higher percentage of Medicare residents and increased Medicaid
rates
- an increase of 2.0% in resident census from an average daily
census of 13,974 in 2001 to 14,259 in 2002; and offset by,
16
- a decrease of $0.7 million when comparing periods due to less
favorable Medicaid cost settlements in 2002.
The Company's key Medicare and Medicaid results and statistics for the
nursing operations on a same-facility basis in the third quarter of 2002 and
2001 are summarized as follows:
MEDICARE MEDICAID
-------------------------------- --------------------------------
THREE MONTHS ENDED SEPTEMBER 30, THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------- --------------------------------
INCREASE INCREASE
2002 2001 (DECREASE) 2002 2001 (DECREASE)
---- ---- ---------- ---- ---- ----------
Average daily rate ................. $ 338 $ 332 1.8% $ 126 $ 121 4.1%
Residents as a percentage of total . 13.3% 11.3% 17.7% 68.5% 69.9% (2.0%)
Average daily census ............... 1,702 1,415 20.3% 8,746 8,756 (0.1%)
OPERATING AND GENERAL AND ADMINISTRATIVE COSTS
Operating and general and administrative costs decreased $4.6 million
or 2.5% between periods, of which $6.5 million was a decrease in expenses for
insurance and liability claims, primarily related to the Company's divestiture
of its Texas nursing facilities, and $12.5 million related to reduced operating
costs attributable to nursing facilities divested during 2001. Operating and
general and administrative costs on a same-facility basis increased $14.4
million, or an 8.7% increase on a same-facility basis, and included:
- an increase in wage and benefit costs of $8.4 million, or a 7.1%
increase;
- an increase in contracted food and laundry services totaling $3.3
million relating to services that were formerly provided by
employees;
- a $1.3 million increase in drug expense due to higher resident
census and drug prices;
- an increase in outside therapy services purchased of $0.8 million
relating to increased therapy ; and
- a net increase in other operating and administrative expenses of
$0.6 million.
LEASE COSTS, DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased $0.3 million to $9.4 million
for the 2002 quarter compared to $9.7 million for the 2001 quarter. This
decrease was net of 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 $0.9 million when comparing periods, including
$0.6 million as a result of divestitures and $0.3 million as a result of
facilities that the Company continues to operate.
INTEREST
Interest expense (net of interest income) increased $0.2 million to
$8.8 million in the 2002 quarter compared to $8.6 million in the 2001 quarter.
The 2002 quarter included a $0.5 million unrealized loss relating to the change
in market value of an interest rate cap which did not qualify for hedge
accounting treatment. The weighted average interest rate of all long-term debt
decreased to 8.11% during the 2002 quarter (which includes the effect of net
receipts of $0.9 million under an interest rate swap and cap) compared to
approximately 8.41% during the 2001 quarter (which includes the effect of net
payments of $0.3 million under interest rate swaps). The average debt level
decreased to $388.9 million during the 2002 quarter compared to $392.4 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.
17
LOSS ON IMPAIRMENT OF LONG-LIVED ASSETS
When management commits the organization to a plan for disposal, assets
held for disposal are adjusted to the lower of the assets' carrying value or the
fair value less selling costs. In September 2001, the Company made a formal
decision to lease all owned, and sublease all leased, nursing facilities in
Texas. As a result of the transaction, and based on the terms of the lease with
Senior Health-Texas, the Company recorded in the 2001 quarter a provision of
$1.7 million for impairment of Texas nursing properties in accordance with FASB
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of."
LOSS ON DISPOSAL OF ASSETS AND OTHER ITEMS
A loss of $ 16.4 million was recorded in the 2001 quarter for the
disposal or closure of facilities and settlements of previously ceased
operations. On September 30, 2001, subject to third party approvals including
state licensure, the Company transferred all Texas nursing homes to Senior
Health-Texas. Under Texas law, governmental approvals are retroactively
effective following successful completion of a survey under new management. As a
result of the Texas transaction, and the closure and sale of one nursing home
and one other property in Wisconsin, the Company made a provision of $3.3
million for related disposal and closure costs. The Company also made additional
provisions relating to previously sold operations, which totalled $2.1 million
and related to nursing homes in Florida and its former pharmacy operation. Based
upon an actuarial review of resident liability costs, the Company recorded an
$11.0 million additional provision related to Florida claims for years prior to
2001.
INCOME TAXES
Income tax expense in the 2002 quarter was $1.2 million compared to an
income tax benefit of $9.2 million in the 2001 quarter. The Company's effective
tax rate was 37.3% in 2002 as compared to 39.6% in 2001.
NET EARNINGS (LOSS)
Net earnings in the 2002 quarter were $2.0 million compared to a net
loss of $14.1 million in the 2001 quarter. The net earnings, excluding loss on
disposal of assets and other items, loss on impairment of long-lived assets and
extraordinary item, after applicable income tax effect, were $2.0 million in the
2002 quarter compared to a net loss of $2.7 million for the 2001 quarter.
RELATED PARTY TRANSACTIONS
The Company insures certain risks, including comprehensive general
liability, property coverage and excess workers' compensation/employer's
liability insurance, with Laurier Indemnity Company and Laurier Indemnity, Ltd.,
affiliated insurance subsidiaries of Extendicare Inc. The Company recorded
approximately $2.5 million of expenses for this purpose in the 2002 quarter, and
a credit to expense of $0.6 million in the 2001 quarter due to an adjustment for
prior 2001 quarterly periods.
The Company purchases computer hardware and software support services
from Virtual Care Provider, Inc., an affiliated subsidiary of Extendicare Inc.
Expenses related to these services were $2.1 million in the 2002 quarter and
$1.6 million in the 2001 quarter.
18
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 2001
REVENUES
Revenues in the nine months ended September 30, 2002 were $606.8
million, representing an increase of $8.6 million (1.4%) from $598.2 million in
the nine months ended September 30, 2001. The increase in revenues includes a
$43.5 million increase in revenues from nursing and assisted living facilities
and other business operated during the nine months ended September 30, 2002 and
2001 ("same-facility operations") and an increase of $0.7 million from other
revenue, partially offset by a decrease of $35.6 million in revenues from
divested nursing facilities.
Revenues from same-facility nursing and assisted living operations
increased $43.5 million due to:
- an increase of $43.4 million or 8.0%, as a result of an overall
higher percentage of Medicare residents and increased Medicaid
rates, and
- an increase of 1.5% in resident census from an average daily
census of 13,925 in 2001 to 14,141 in 2002; and
- an increase of $0.1 million when comparing periods due to more
favorable Medicaid cost settlements in 2002.
The Company's key Medicare and Medicaid results and statistics for the
nursing operations on a same-facility basis in the nine months of 2002 and 2001
are summarized as follows:
MEDICARE MEDICAID
------------------------------- -------------------------------
NINE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
------------------------------- -------------------------------
INCREASE INCREASE
2002 2001 (DECREASE) 2002 2001 (DECREASE)
Average daily rate .................... $ 337 $ 329 2.4% $ 126 $ 120 5.0%
Residents as a percentage of total .... 13.1% 11.5% 13.9% 68.6% 69.7% (1.6%)
Average daily census .................. 1,663 1,431 16.2% 8,703 8,681 0.3%
OPERATING AND GENERAL AND ADMINISTRATIVE COSTS
Operating and general and administrative costs decreased $12.3 million
or 2.2% between periods, of which $11.9 million was a decrease in expenses for
insurance and liability claims, primarily related to the Company's divestiture
of its Texas nursing facilities, and $34.1 million related to reduced operating
costs attributable to nursing facilities divested during 2001. Operating and
general and administrative costs on a same-facility basis increased $33.7
million, or a 6.9% increase on a same-facility basis, and included:
- an increase in wage and benefit costs of $17.8 million, or a 5.1%
increase;
- an increase in contracted food and laundry services totaling $6.9
million relating to services that were formerly provided by
employees;
- a $3.9 million increase in drug expense due to higher resident
census and higher drug prices;
- an increase in outside therapy services purchased of $2.5 million
relating to increased therapy revenues;
- a $1.3 million increase in bad debt expense; and
- a net increase in other operating and administrative expenses of
$1.3 million.
19
LEASE COSTS, DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased $2.0 million to $28.2 million
for the first nine months of 2002 compared to $30.2 million for the first nine
months of 2001. This decrease included a $1.8 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. The remaining $0.2 million
decrease is primarily a result of divestitures.
Lease costs decreased $2.9 million when comparing periods, including
$1.9 million as a result of divestitures and $1.0 million as a result of
continuing operations.
INTEREST
Interest expense (net of interest income) decreased $3.5 million to
$23.9 million in the first nine months of 2002 compared to $27.4 million in the
first nine months of 2001. The decrease was primarily due to a reduction in the
average debt level to $383.5 million during the first nine months of 2002
compared to $413.0 million during the first nine months of 2001 resulting from
the Company's use of divestiture proceeds and an income tax refund during 2001
to reduce bank debt balances. The weighted average interest rate of all
long-term debt decreased to 7.70% for the first nine months of 2002 compared to
approximately 8.49% for the first nine months of 2001. This decrease was
primarily due to lower market interest rates during 2002 prior to the issuance
of the fixed-rate Senior Notes on June 28, 2002, the proceeds of which were used
to refinance floating-rate debt.
LOSS ON IMPAIRMENT OF LONG-LIVED ASSETS
When management commits the organization to a plan for disposal, assets
held for disposal are adjusted to the lower of the assets' carrying value or the
fair value less selling costs. In September 2001, the Company made a formal
decision to lease all owned, and sublease all leased, nursing facilities in
Texas. As a result of the transaction, and based on the terms of the lease with
Senior Health-Texas, the Company recorded in 2001 a provision of $1.7 million
for impairment of Texas nursing properties in accordance with FASB Statement No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of."
LOSS ON DISPOSAL OF ASSETS AND OTHER ITEMS
A loss of $24.2 million was recorded in 2001 for the disposal or
closure of facilities and settlements of previously ceased operations. On
September 30, 2001, the Company transferred all Texas nursing homes to Senior
Health-Texas. As a result of the Texas transaction, as well as the closure and
sale of one nursing home and two other property in Wisconsin, the Company
provided $3.7 million for related disposal and closure costs. The Company also
made additional provisions of $20.5 million relating to previously ceased
operations, including $19.0 million related to the nursing facilities in
Florida. This $19.0 million consists of an $11.0 million provision related to
Florida claims for years prior to 2001 based upon an actuarial review of
resident liability costs, and an $8.0 million provision for Florida closure and
exit costs.
INCOME TAXES
Income tax expense in the first nine months of 2002 was $4.6 million
compared to an income tax benefit of $15.1 million in the first nine months of
2001. The Company's effective tax rate was 43.7% in the first nine months of
2002 as compared to 33.9% in the first nine months of 2001. The increase in the
effective tax rate results from the impact of certain permanent adjustments
which increased the effective rate when applied to pre-tax earnings compared to
decreasing the effective rate when applied to pre-tax loss for 2001 and the
reversal of current and prior year state deferred income tax benefits. In
assessing the value of deferred tax assets, the Company considers whether it is
more likely than not that all or some portion of the deferred tax assets will
not be realized. 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. The Company considers the scheduled
reversal of deferred tax liabilities, projected future taxable income, and tax
planning strategies in making this assessment.
20
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 nine months of 2002 were $4.2 million
compared to a net loss of $29.6 million in the first nine months of 2001. The
net earnings, excluding loss on disposal of assets and other items, loss on
impairment of long-lived assets and extraordinary items, after applicable income
tax effect, was $5.9 million for the first nine months of 2002 compared to a net
loss of $13.1 million for the first nine months of 2001.
RELATED PARTY TRANSACTIONS
The Company insures certain risks, including comprehensive general
liability, property coverage and excess workers' compensation/employer's
liability insurance, with Laurier Indemnity Company and Laurier Indemnity, Ltd.,
affiliated insurance subsidiaries of Extendicare Inc. The Company recorded
approximately $7.4 million and $4.7 million of expenses for this purpose for the
nine months ended September 30, 2002 and 2001, respectively.
The Company purchases computer hardware and software support services
from Virtual Care Provider, Inc., an affiliated subsidiary of Extendicare Inc.
Expenses related to these services were $5.9 million and $5.0 million for the
nine months ended September 30, 2002 and 2001, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company had cash and cash equivalents of $29.7 million at September
30, 2002 and $1.0 million at December 31, 2001. Cash flow generated from
operating activities was $29.3 million for the nine months ended September 30,
2002 compared with $66.9 million in the comparable period of 2001. The $37.6
million reduction in cash flow from operations was the result of the 2001 tax
refund of $22.5 million, a $15.4 million reduction in cash flow relating to
accounts receivable net of changes in accounts payable (primarily relating to
divested operations) and increased payments of self-insured general liability
claims of $13.5 million, partly offset by improved cash flow from other
operations of $13.8 million.
The Company's working capital, excluding cash and borrowings included
in current liabilities, decreased $11.8 million from $15.8 million at December
31, 2001 to $4.0 million at September 30, 2002. The decrease resulted primarily
from a decrease in accounts receivable of $4.8 million and a $18.4 million
increase in accounts payable and accrued liabilities. These decreasing
components of working capital were partially offset by an $8.7 million decrease
in amounts due to shareholder and affiliates and a $3.0 million increase in
amounts due from shareholder and affiliates.
Accounts receivable at September 30, 2002 were $99.4 million compared
with $104.2 million at December 31, 2001, representing a decrease of $4.8
million. The reduction in accounts receivable included a $6.5 million decrease
within the nursing operations, an increase of $0.4 million within the outpatient
therapy operations, and a $1.3 million increase in receivables from long-term
care operators for which management and consulting services are provided. The
$1.3 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 $5.1 million and third-party payor settlement receivables,
based on Medicare and Medicaid cost reports, decreased $1.4 million. The
decrease in billed patient care receivables of $5.1 million included a decrease
of $8.7 million due to an improvement in collection efforts by the Company
between periods. The remaining increase of $3.6 million reflects an increase of
$9.6 million due to rate increases, partially offset by a decrease of $6.0
million due to the sale or closure of nursing facilities and assisted living
facilities.
21
The decrease in settlement receivables of $1.4 million from December
31, 2001 to September 30, 2002 included decreases of (1) $1.0 million from
collections of Medicare settlements; (2) $2.3 million for collections from
Medicare of uncollectible co-insurance amounts recorded as revenue in 2002 and
2001; and (3) $1.4 million for collection of Medicaid cost report settlements.
These decreases were partially offset by an increase of $3.3 million in revenue
recorded in 2002 for anticipated Medicare reimbursement for uncollectible
co-insurance amounts.
Property and equipment decreased $38.7 million from December 31, 2001
to a total of $439.1 million at September 30, 2002. The decrease was the result
of depreciation expense of $27.3 million and asset disposals of $26.1 million
primarily relating to the sale of seven Florida leased properties to Tandem.
These decreases were partially offset by capital expenditures of $12.7 million
and an increase of $1.9 million (included in depreciation expense) relating to
the 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 $388.1 million at September 30, 2002
representing an increase of $2.1 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
8.74% at September 30, 2002 and such debt had maturities ranging from 2002 to
2014.
As of September 30, 2002, the Company's parent, Extendicare Inc. held
$27.9 million (14.0%) of the Company's outstanding senior subordinated notes.
Cash provided from investing activities was $2.7 million for the nine
months ended September 30, 2002 compared to $3.5 million used for investing
activities in the comparable period of 2001. The increase was primarily due to:
(1) a $7.0 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 $3.0 million as a result of
increased purchases of property and equipment.
Cash used for financing activities decreased by $57.6 million to $3.3
million for the nine months ended September 30, 2002, compared to a use of funds
of $60.9 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 $2.9
million increase in cash from other liabilities in 2002; (3) a $2.4 million
decrease from cash used for bank indebtedness; (4) a decrease of $96.4 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.
The Company has a $105 million Revolving Credit Facility. Borrowing
availability under this line of credit totaled $65.1 million at September 30,
2002 (net of letters of credit in the amount of $39.9 million). The Company is
in compliance with the financial covenants of its credit facility as of
September 30, 2002.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
QUALITATIVE DISCLOSURES
As discussed in note 5 to the condensed consolidated 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.
22
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.
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).
FAIR
VALUE OF
AFTER LIABILITY
2002 2003 2004 2005 2006 2006 TOTAL (ASSET)
---- ---- ---- ---- ---- ---- ----- -------
LONG-TERM DEBT:
Fixed Rate ............ $ 287 $ 624 $ 654 $ 620 $ 573 $ 353,292 $ 356,050 $ 376,280
Average Interest Rate.. 6.22% 6.26% 6.34% 6.24% 5.86% 9.41% 9.38%
Variable Rate ......... -- -- -- -- -- $ 32,000 $ 32,000 $ 24,472
Average Interest Rate.. -- -- -- -- -- 1.63% 1.63%
INTEREST RATE SWAPS:
Notional Amount ....... -- -- -- -- -- $ 150,000 $ 150,000 $ (7,471)
Average Pay Rate
(variable rate) ..... -- -- -- -- -- -- 6.63%
Average Receive Rate
(fixed rate) ........ -- -- -- -- -- -- 9.35%
INTEREST RATE CAPS:
Notional Amount ....... -- -- -- -- -- $ 150,000 $ 150,000 $ 664
The above table incorporates only those exposures that exist as of
September 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.
ITEM 4. CONTROLS AND PROCEDURES
Within 90 days of the date of this report, an evaluation was conducted
under the supervision and participation of the Company's management, including
the Chief Executive Officer and Chief Financial Officer, of the effectiveness of
the design and operation of our disclosure controls and procedures as defined in
Rule 13a 14 (c) under the Securities and Exchange Act of 1934. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the design and operation of these disclosure controls and procedures were
effective in timely alerting them to material information relating to the
Company (including its consolidated subsidiaries) required to be included in the
Company's periodic SEC filings.
No significant changes were made in the Company's internal controls or
were there other factors that could significantly affect these controls
subsequent to the date of that evaluation.
23
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. Refer to the paragraphs which discuss litigation and the Omnicare
Preferred Provider Agreement in note 7 of the condensed consolidated financial
statements.
ITEM 2. CHANGE 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) 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 a Form 8-K reporting under Item 5
the 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 discount of 0.25% from par to yield 9.54%.
24
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: November 14, 2002 By: /s/ Mark W. Durishan
----------------------------------
Mark W. Durishan
Vice President, Chief Financial
Officer and Treasurer
(principal financial officer and
principal accounting officer)
25
CERTIFICATION
I, Melvin A. Rhinelander, Chairman of the Board and Chief Executive Officer of
Extendicare Health Services, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Extendicare
Health Services, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
(c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
/s/ Melvin A. Rhinelander
- -------------------------
Melvin A. Rhinelander
Chairman of the Board and Chief Executive Officer
November 14, 2002
26
CERTIFICATION
I, Mark W. Durishan, Vice-President, Chief Financial Officer and Treasurer of
the Extendicare Health Services, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Extendicare
Health Services, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
(c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
/s/ Mark W. Durishan
- --------------------
Mark W. Durishan
Vice President, Chief Financial Officer and Treasurer
November 14, 2002
27
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
28