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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C 20549
------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended MARCH 31, 2003
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 111 WEST MICHIGAN STREET 98-0066268
(State or other Jurisdiction of MILWAUKEE, WI 53203 (I.R.S. Employer
Incorporation or Organization) (Address of principal executive office Identification Number)
Including 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]
Common Stock -- authorized 1,000 shares, $1.00 par value; issued and
outstanding 947 shares as of May 12, 2003. All issued and outstanding shares of
Common Stock are held indirectly by Extendicare Inc., a publicly traded Canadian
company.
EXTENDICARE HEALTH SERVICES, INC.
INDEX
PART I FINANCIAL INFORMATION: PAGE
- ------ ---------------------- ----
Item 1 Financial Statements:
Condensed Consolidated Statements of Operations for the Three Months Ended
March 31, 2003 and 2002................................................................... 3
Condensed Consolidated Balance Sheets, March 31, 2003 and December 31, 2002..................... 4
Condensed Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2003 and 2002................................................................... 5
Notes to Condensed 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...................................... 20
Item 4 Controls and Procedures......................................................................... 21
PART II OTHER INFORMATION:
- ------- ------------------
Item 1 Legal Proceedings............................................................................... 22
Item 2 Changes in Securities and Use of Proceeds....................................................... 22
Item 3 Defaults Upon Senior Securities................................................................. 22
Item 4 Submission of Matters to a Vote of Security Holders............................................. 22
Item 5 Other Information............................................................................... 22
Item 6 Exhibits and Reports on Form 8-K................................................................ 22
SIGNATURES ................................................................................................ 23
- ----------
CERTIFICATIONS............................................................................................. 24
- --------------
EXHIBIT INDEX.............................................................................................. 26
- -------------
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EXTENDICARE HEALTH SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND 2002
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 2003 MARCH 31, 2002
------------------ ------------------
REVENUES:
Nursing and assisted living centers... $ 204,805 $ 190,998
Outpatient therapy ................... 2,644 2,452
Other ................................ 3,977 4,791
-------------- --------------
211,426 198,241
COSTS AND EXPENSES (INCOME):
Operating ............................ 180,496 166,604
General and administrative ........... 7,838 8,211
Lease costs .......................... 2,251 3,034
Depreciation and amortization ........ 9,161 9,434
Interest expense ..................... 8,495 8,330
Interest income ...................... (643) (342)
-------------- --------------
207,598 195,271
-------------- --------------
EARNINGS BEFORE INCOME TAXES ........... 3,828 2,970
Income tax expense ................... 1,540 1,313
-------------- --------------
NET EARNINGS ........................... $ 2,288 $ 1,657
============== ==============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
EXTENDICARE HEALTH SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, 2003 AND DECEMBER 31, 2002
(IN THOUSANDS EXCEPT SHARE DATA)
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ....................... $ 24,912 $ 27,016
Accounts receivable, less allowances of $10,197
and $9,309, respectively ..................... 101,050 104,064
Supplies, inventories and other current assets... 9,092 7,226
Income taxes receivable ......................... 371 518
Deferred state income taxes ..................... 5,780 5,810
Due from shareholder and affiliates:
Federal income taxes receivable ............... 12,227 12,292
Deferred federal income taxes ................. 29,544 29,647
Other ......................................... 4,929 4,493
------------ ------------
Total current assets ......................... 187,905 191,066
Property and equipment ............................ 449,574 453,119
Goodwill and other intangible assets .............. 76,045 76,339
Other assets ...................................... 112,245 112,410
------------ ------------
Total Assets ................................. $ 825,769 $ 832,934
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
CURRENT LIABILITIES:
Bank indebtedness ............................... $ -- $ 2,656
Current maturities of long-term debt ............ 721 716
Accounts payable ................................ 22,439 20,850
Accrued liabilities ............................. 94,716 100,879
Current portion of accrual for self-insured
liabilities...................................... 28,000 28,000
------------ ------------
Total current liabilities ...................... 145,876 153,101
Accrual for self-insured liabilities .............. 22,972 27,089
Long-term debt .................................... 397,309 397,434
Deferred state income taxes ....................... 8,569 8,495
Other long-term liabilities ....................... 41,190 40,749
Due to shareholder and affiliates:
Deferred federal income taxes ................... 44,187 43,381
Other ........................................... 3,484 3,484
------------ ------------
Total liabilities ............................ 663,587 673,733
------------ ------------
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 ............ (1,696) (2,388)
Accumulated deficit ............................. (44,910) (47,199)
------------ ------------
Total Shareholder's Equity ................... 162,182 159,201
------------ ------------
Total Liabilities and Shareholder's Equity ... $ 825,769 $ 832,934
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
EXTENDICARE HEALTH SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND 2002
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 2003 MARCH 31, 2002
-------------------- --------------------
OPERATING ACTIVITIES:
Net earnings ........................................... $ 2,288 $ 1,657
Adjustments to reconcile net earnings to net cash
provided from operating activities:
Depreciation and amortization .................... 9,161 9,434
Amortization of deferred financing costs .......... 378 503
Provision for uncollectible accounts receivable... 2,335 2,957
Provision for self-insured liabilities ........... 1,500 1,313
Payment of self-insured liability claims ......... (5,617) (9,181)
Deferred income taxes ............................ 569 1,106
Changes in assets and liabilities:
Accounts receivable .............................. 629 (927)
Supplies, inventories and other current assets.... (1,866) (317)
Accounts payable ................................. 1,589 (4,874)
Accrued liabilities .............................. (6,214) 13,351
Income taxes payable/receivable .................. 147 36
Current due to shareholder and affiliates ........ (370) (4,670)
------------ ------------
Cash provided from operating activities ....... 4,529 10,388
------------ ------------
INVESTING ACTIVITIES:
Payments for purchase of property and equipment... (4,740) (3,130)
Proceeds from sale of property and equipment ..... 17 1,729
Changes in other non-current assets .............. 369 1,060
------------ ------------
Cash used for investing activities ............ (4,354) (341)
------------ ------------
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt ......... - 11,000
Other long-term liabilities ...................... 506 903
Payments of long-term debt ....................... (129) (23,822)
Proceeds from (repayments of) bank indebtedness... (2,656) 3,868
------------ ------------
Cash used for financing activities ............ (2,279) (8,051)
------------ ------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ....... (2,104) 1,996
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ......... 27,016 997
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ............... $ 24,912 $ 2,993
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Extendicare Health Services, Inc. and its subsidiaries (hereafter
referred to as the "Company") operates in one reporting segment, nursing and
assisted living facilities, throughout the United States. The Company is an
indirect wholly owned subsidiary of Extendicare Inc. ("Extendicare"), a Canadian
publicly traded company.
BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements as of, and
for the three month periods ended, March 31, 2003 and 2002 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, 2002 has been derived from audited
financial statements.
The preparation of financial statements in conformity with accounting
principles generally accepted 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.
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.
These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto for the
year ended December 31, 2002 contained in the Company's Annual Report on Form
10-K. Certain reclassifications have been made to the 2002 condensed
consolidated financial statements to conform to the presentation for 2003.
2. NEW ACCOUNTING PRONOUNCEMENTS
In May 2002, the FASB issued 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 adopted the provisions of this standard in the
first quarter of 2003 and has modified the presentation of its financial
statements for the comparative 2002 period 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 apply to exit or disposal activities initiated after December 31,
2002.
6
3. GAIN ON DISPOSAL OF ASSETS, PROVISION FOR CLOSURE AND EXIT COSTS, AND
IMPAIRMENT OF LONG-LIVED ASSETS
In May 2002, Tandem Health Care, Inc. ("Tandem") exercised its option
to purchase seven leased properties in Florida from the Company for gross
proceeds of $28.6 million, consisting of cash of $15.6 million and $13.0 million
in 8.5% five-year notes (net proceeds of $25.5 million). Until this date, Tandem
operated these facilities under a lease agreement with a purchase option. The
carrying value of the seven facilities was $21.5 million. The Company applied
$12.4 million of the proceeds to reduce bank debt and, as a result recorded a
gain on the sale of the assets of $4.0 million, inclusive of the deferred gain
of $2.2 million from the sale of two leased nursing properties in April 2001.
The transaction also involved the conversion of $1.9 million in preferred shares
received in the April 2001 transaction into $1.9 million 8.5% notes, due in
April 2006.
In May 2002, the Company recorded a provision for closure and exit
costs relating to the divested Florida operations of $5.3 million relating to
cost report settlement issues, and the settlement of claims with suppliers and
employees.
Below is a summary of activity of the accrued liabilities balance
relating to divested operations and facility closures:
RESIDENT
EMPLOYEE LIABILITY AND RENT OTHER
TERMINATION OTHER CLAIMS EXPENSE EXPENSES(1) TOTAL
-------------- --------------- --------- ------------- -------
(IN THOUSANDS)
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 ............ -- (1,231) -- (3,460) (4,691)
Provisions(2) ............ -- 295 -- 6,112 6,407
-------- -------- -------- -------- --------
Balance December 31, 2002... $ 54 $ 1,114 $ -- $ 8,550 $ 9,718
======== ======== ======== ======== ========
Cash Payments ............ -- -- -- (104) (104)
Provisions ............... -- -- -- -- --
-------- -------- -------- -------- --------
Balance March 31, 2003 ..... $ 54 $ 1,114 $ -- $ 8,446 $ 9,614
======== ======== ======== ======== ========
(1) The liability for 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) The provision of $6,407 for 2002 includes the provision for closure and
exit costs of $5,293, selling expenses of $1,200 relating to the sale of
assets to Tandem less other items of $86.
4. ACQUISITION OF PREVIOUSLY-LEASED FACILITIES
On October 1, 2002 the Company completed a transaction which exercised
its right to acquire seven previously-leased nursing facilities in the states of
Ohio and Indiana for $17.9 million. The purchase included cash of $7.4 million
and a $10.5 million interest bearing 10-year note. Negotiation on the interest
rate continues with the vendor who holds the note and, failing any agreement,
will be settled through arbitration.
5. OTHER ASSETS
The Company is pursuing settlement of a number of outstanding Medicaid
and Medicare receivables. As of March 31, 2003 the balance of outstanding
Medicaid and Medicare receivables was $44.0 million, net of an allowance of
$15.4 million. For one specific issue involving the allocation of overhead costs
totaling $14.8 million, the first of three specific claim years was presented to
the Provider Reimbursement Review Board ("PRRB") at a hearing on January 30,
2003. The hearing procedures were discontinued after the parties negotiated a
methodology for resolution of the claim, and an administrative resolution has
been signed by the Fiscal Intermediary ("FI") and the Company to settle the
amount, which will be determined later in 2003. For another specific issue
involving a staffing cost matter totaling $7.3 million, a settlement of the
first year of seven specific claim years was reached
7
prior to the PRRB hearing, and an agreement has been reached with the FI to
continue to negotiate the remaining years in dispute. For both issues, further
negotiations on the remaining years under appeal are to occur during 2003. No
adjustment to the receivable amount can be determined until negotiations are
concluded on a majority of the remaining claim years under appeal.
6. LINE OF CREDIT AND LONG-TERM DEBT
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") which
were issued at a discount of 0.25% of par to yield 9.54%. In January 2003, the
Company completed its offer to exchange new 9.5% Senior Notes due 2010 that have
been registered under the Securities Act of 1933 for the Notes issued in June
2002. The terms of the new Senior Notes are identical to the terms of the Senior
Notes issued in June 2002 and are guaranteed by all existing and future active
subsidiaries of the Company.
The Company used the proceeds of $149.6 million from the Senior Notes
to pay related fees and expenses of $8.3 million, to retire $124.5 million of
indebtedness outstanding under its previous credit facility and Term Loans, to
refinance $6.3 million of other debt, and for general corporate purposes. The
retirement of the previous credit facility resulted in a loss on early
retirement of debt of $2.8 million ($1.7 million after income taxes). Also on
June 28, 2002, the Company entered into an interest rate swap agreement and an
interest rate cap agreement. See Note 7 for terms of these agreements.
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. As of March 31, 2003 the Company
had no borrowings under the Revolving Credit Facility. The unused portion of the
Revolving Credit Facility, that is available for working capital and corporate
purposes, after reduction for outstanding letters of credit of $41.4 million,
was $63.6 million as of March 31, 2003.
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 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 March
31, 2003.
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.
7. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Objectives and Strategies Prior to Issuance of Senior Notes
Prior to the issuance of the Senior Notes in June 2002, the Company had
variable-rate long-term debt of approximately $124.5 million, which 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 payments.
8
When the Company issued the fixed-rate Senior Notes these interest rate swaps
were terminated by the Company in June 2002 with a cash payment of $635,000 and
charged to loss on early retirement of debt.
Objectives and Strategies 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. 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") (1.28% as of
March 31, 2003), 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, as a
result, changes in the market value of the swap had no impact on the income
statement during 2002 or 2003.
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 a hedging instrument under SFAS 133.
Quantitative Disclosures
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 March 31, 2003, the fair value of the interest rate swap
designated as a fair value hedge is an asset of $9.2 million and is offset by a
liability of $9.2 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 as of March
31, 2003 and the gain credited to AOCI (net of income tax effect) for the three
months ended March 31, 2003 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 as of March 31, 2003 of $0.7 million.
During 2003, 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.
8. COMMITMENTS AND CONTINGENCIES
Capital Expenditures
At March 31, 2003, the Company had capital expenditure purchase
commitments outstanding of approximately $3.5 million.
Insurance and Self-insured Liabilities
The Company insures certain risks with affiliated insurance
subsidiaries of Extendicare and 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 employers' liability in amounts and with
such coverage and deductibles as determined by the Company, based on the nature
and risk of its businesses, 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 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.
9
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 provided.
The U.S. Department of Justice and other federal agencies are
increasing resources dedicated to regulatory investigations and compliance
audits of healthcare providers. The Company is diligently addressing these
regulatory efforts.
Omnicare Preferred Provider Agreement
In 1998, the Company disposed of its pharmacy operations to Omnicare,
Inc.. Subsequently, the Company entered into a Preferred Provider Agreement with
Omnicare, the terms of which enabled Omnicare to execute Pharmacy Service
Agreements and Consulting Service Agreements with all of the Company's skilled
nursing facilities. Under the terms of the agreement, the Company secured "per
diem" pricing arrangements for pharmacy supplies for the first four years of the
Agreement, which period expired December 2002. The Preferred Provider Agreement
contains a number of provisions which involve sophisticated calculations to
determine the "per diem" pricing during this first four-year period. Under the
"per diem" pricing arrangement, pharmacy costs fluctuate based upon occupancy
levels in the facilities. The "per diem" rates were established assuming a
declining "per diem" value over the initial four years of the contract to
coincide with the phase-in of the Medicare PPS rates. Omnicare subsequently
asserted that "per diem" rates for managed care and Medicare beneficiaries are
subject to an upward adjustment based upon a comparison of per diem rates to
pricing models based on Medicaid rates.
In 2001, the Company and Omnicare brought a matter to arbitration,
involving a "per diem" pricing rate billed for managed care residents. This
matter was subsequently settled and amounts reflected in the financial results.
The parties are currently negotiating the pricing of drugs for Medicare
residents and should this matter not be settled, the matter will be taken to
arbitration. Provision for settlement of this claim is included within the
financial statements.
In 2002, in connection with its agreements to provide pharmacy services
to the Company, Omnicare, Inc. requested arbitration for an alleged 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. The
Company believes it has interpreted correctly 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.
9. COMPREHENSIVE EARNINGS
Comprehensive Earnings is as follows for the periods shown (dollars in
thousands):
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, 2003 MARCH 31, 2002
-------------- --------------
NET EARNINGS .............................. $ 2,288 $ 1,657
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized gain (loss) on investments,
before tax ........................... 1,123 (858)
Gain on cash flow hedges, before tax.. 14 758
---------- ----------
Other comprehensive income (loss),
before tax ........................... 1,137 (100)
Income tax (provision) benefit related
to items of other comprehensive
income (loss) ........................ (445) 78
---------- ----------
Other comprehensive income (loss), net
of tax ............................... 692 (22)
---------- ----------
COMPREHENSIVE EARNINGS ................... $ 2,980 $ 1,635
========== ==========
10
10. UNCERTAINTIES AND CERTAIN SIGNIFICANT RISKS
Medicare and Medicaid funding
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 healthcare 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 Benefits Improvement and Protection
Act of 2000 ("BIPA") provided a total of $2.7 billion in temporary Medicare
funding enhancements to provide some interim relief 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 a
16.66% add-on to the nursing component of the Resource Utilization Groupings
("RUGs") rate and a 4% base adjustment. The second category is "RUGs
Refinements" which involves an initial 20% add-on for 15 RUGs categories
identified as having high intensity, non-therapy ancillary services. The 20%
add-ons from three RUGs categories were later redistributed to 14 rehabilitation
categories at an add-on rate of 6.7% each.
On September 30, 2002 the Legislative Add-ons expired resulting in a
reduction in Medicare funding for all long-term care providers. The Company
estimated that based upon the Medicare case mix and census for the nine months
ended September 30, 2002, it received, on average rate of $31.22 per resident
day related to the Legislative Add-ons. This decline in Medicare rates was
partially offset by a 2.6% market basket increase received on October 1, 2002.
For the three months ended March 31, 2003 the average daily Medicare Part A rate
was $290.78, as compared to $312.32 for the three months ended March 31, 2002.
Based upon the Medicare case mix and census in the first quarter of 2003, the
lower average Medicare Part A rate, primarily resulting from the loss of the
Legislative Add-ons, reduced revenues by $3.8 million for the three months ended
March 31, 2003 as compared to the three months ended March 31, 2002.
With respect to the RUGs Refinements, on April 23, 2002 CMS announced
that it would delay the refinement of the RUGs categories thereby extending the
related funding enhancements for at least one additional year to September 30,
2003. Further to this, in the budget report released in February 2003, President
Bush proposed additional funding to extend the RUGs Refinements to September 30,
2004 and though the President's budget has not been passed, the Centers for
Medicare and Medicaid Services ("CMS") has agreed verbally with the extension of
the RUGs refinements to September 30, 2004. Based upon the Medicare case mix and
census for the quarter ended March 31, 2003, the Company has estimated that it
received an average $23.97 per resident day, which on an annualized basis
amounts to $17.2 million related to the RUGs Refinements. A decision to
discontinue all or part of the enhancement could have a significant impact on
the Company.
In January 2003, CMS announced that the moratorium on implementing
payment caps for outpatient Part B therapy services, which were scheduled to
take effect on January 1, 2003, would be extended for six months until July 1,
2003. The impact of a payment cap cannot be reasonably estimated based on the
information available at this time, however, such a cap would reduce therapy
revenues.
11
In February 2003, CMS announced its plan to reduce its level of
reimbursement for uncollectible Part A co-insurance. Under current law, skilled
nursing facilities are reimbursed 100% for any bad debts incurred. Over the next
three years, CMS plans to phase down the reimbursement level to 70% as follows:
90% effective for the government fiscal year commencing October 1, 2003; 80% for
the government fiscal year commencing October 1, 2004; and 70% for the
government fiscal year commencing October 1, 2005 and thereafter. This plan is
consistent with the bad debt reimbursement plan for hospitals. The Company
estimates that should this plan be implemented, the impact on net earnings would
be $1.0 million in 2004, increasing to $2.5 million in 2006. These estimates are
based upon historical experience and known state reimbursement changes which may
be different in the future and, as such, are subject to change.
In May 2003, CMS released a proposed rule to increase Medicare rates by
2.9% effective October 1, 2003 and to maintain the current RUGs classification
until September 2004.
Assets from Divested Operations
Through the divestiture program in Texas and Florida, the Company has
assumed notes from the purchasers and retained ownership of certain nursing home
properties, which the Company leases to other unrelated long-term care
providers. In aggregate, as of March 31, 2003, the Company has $21.5 million in
notes and owns $17.0 million in nursing home properties in Texas and Florida.
For the three months ended March 31, 2003 and 2002, the Company earned
management and consulting fees of $1.4 million and $1.4 million, respectively,
and rental revenue of $0.4 million and $1.4 million, respectively, from
properties owned and leased to unrelated long-term care operators. As a result,
the earnings and cash flow of the Company can be influenced by the financial
stability of these unrelated long-term operators.
Accrual for Self-Insured Liabilities
The Company has $51.0 million in accruals for self-insured liabilities
as of March 31, 2003. Though the Company has been successful in exiting from the
states of Texas and Florida and limiting future exposure to general liability
claims in these states, the timing and eventual settlement costs for these
claims cannot be precisely defined.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
OVERVIEW
Based on number of beds, we are one of the largest providers of
long-term care and related services in the United States. As of March 31, 2003,
we operated 139 nursing facilities (14,096 beds) and 36 assisted living and
retirement facilities (1,756 units) located in 13 states. In addition, we
managed 17 nursing facilities (2,254 beds) and five assisted living and
retirement facilities (156 units) and provided selected consulting services to
40 nursing facilities (4,457 beds) and one assisted living facility (116 beds)
owned by third parties. In total, we operated, managed or provided selected
consulting services to 238 long-term care facilities (22,835 beds) in 16 states,
of which 196 are nursing facilities (20,807 beds) and 42 are assisted living and
retirement facilities (2,028 units).
FORWARD-LOOKING STATEMENTS
This Form 10-Q report contains forward-looking statements that are
intended to qualify for the safe harbors from liability established by the
Private Securities Litigation Reform Act of 1995. All statements other than
statements of historical fact, including statements regarding anticipated
financial performance, business strategy and management's plans and objectives
for future operations, are forward-looking statements. These forward-looking
statements can be identified as such because the statements generally include
words such as "expect," "intend," "believe," "anticipate," "estimate," "plan" or
"objective" or other similar expressions. These forward-looking statements are
subject to risks and uncertainties that could cause actual results to differ
materially from those expressed in, or implied by, these statements. Some, but
not all, of the risks and uncertainties include those described in the "Risk
Factors of the Industry" section of our Annual Report on Form 10-K for the year
ended December 31, 2002 and include the following:
12
o Medicare and Medicaid reimbursement policies;
o resident care litigation, including exposure for punitive damage
claims and increased insurance costs, which among other things
caused us to exit Florida and Texas markets;
o the shortage of, and related costs of hiring and retraining
qualified staff and employees;
o federal and state regulation of our business;
o actions by our competitors; and
o fee pressures and slow payment practices by health maintenance
organizations and preferred provider organizations.
All forward-looking statements contained in this report are based upon
information available at the time the statement is made and we assume no
obligation to update any forward-looking statement.
REVENUES
We derive revenues by providing healthcare services in our 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. We derive nursing and assisted living facility revenues
by providing routine and ancillary services for our facilities' residents. We
derive outpatient therapy revenue by providing such services to outside third
parties at our clinics.
We generate our revenue from Medicare, Medicaid and private pay
sources. The following table sets forth our Medicare, Medicaid and private pay
sources of revenue by percentage of total revenue:
THREE MONTHS ENDED
MARCH 31,
---------
2003 2002
---- ----
Medicare......................................... 27.1% 25.5%
Medicaid.......................................... 48.9% 49.5%
Private Pay....................................... 24.0% 25.0%
LEGISLATIVE ACTIONS AFFECTING REVENUES
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 healthcare 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 Benefits Improvement and Protection
Act of 2000 ("BIPA") provided a total of $2.7 billion in temporary Medicare
funding enhancements to provide some interim relief 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 a
16.66% add-on to the nursing component of the Resource Utilization Groupings
("RUGs") rate and a 4% base adjustment. The second category is "RUGs
Refinements" which involves an initial 20% add-on for 15 RUGs categories
identified as having high intensity, non-therapy ancillary services. The 20%
add-ons from three RUGs categories were later redistributed to 14 rehabilitation
categories at an add-on rate of 6.7% each.
On September 30, 2002 the Legislative Add-ons expired resulting in a
reduction in Medicare funding for all long-term care providers. The Company
estimated that based upon the Medicare case mix and census for the nine months
ended September 30, 2002, it received, on average rate of $31.22 per resident
day related to the Legislative Add-ons. This decline in Medicare rates was
partially
13
offset by a 2.6% market basket increase received on October 1, 2002. For the
three months ended March 31, 2003 the average daily Medicare Part A rate was
$290.78, as compared to $312.32 for the three months ended March 31, 2002. Based
upon the Medicare case mix and census in the first quarter of 2003, the lower
average Medicare Part A rate, primarily resulting from the loss of the
Legislative Add-ons, reduced revenues by $3.8 million for the three months ended
March 31, 2003 as compared to the three months ended March 31, 2002.
With respect to the RUGs Refinements, on April 23, 2002 CMS announced
that it would delay the refinement of the RUGs categories thereby extending the
related funding enhancements for at least one additional year to September 30,
2003. Further to this, in the budget report released in February 2003, President
Bush proposed additional funding to extend the RUGs Refinements to September 30,
2004 and though the President's budget has not been passed, the Centers for
Medicare and Medicaid Services ("CMS") has agreed verbally with the extension of
the RUGs refinements to September 30, 2004. Based upon the Medicare case mix and
census for the quarter ended March 31, 2003, the Company has estimated that it
received an average $23.97 per resident day, which on an annualized basis
amounts to $17.2 million related to the RUGs Refinements. A decision to
discontinue all or part of the enhancement could have a significant impact on
the Company.
In May 2003, CMS released a proposed rule to increase Medicare rates by
2.9% effective October 1, 2003 and to maintain the current RUGs classification
until September 2004.
CRITICAL ACCOUNTING POLICIES
For a full discussion of our accounting policies as required by
accounting principles in the United States, refer to the accompanying notes to
the consolidated financial statements in our Annual Report on Form 10K for the
year ended December 31, 2002. Our disclosures in such report on Form 10K have
not materially changed since that report was filed. We consider our accounting
policies to be critical to an understanding of our financial statements because
their application requires significant judgement and reliance on estimations of
matters that are inherently uncertain. Specific risks relate to the accounting
policies applied in revenue recognition and the valuation of accounts
receivable, the valuation of assets and determination of asset impairment, the
accrual for self-insured liabilities and accounting for deferred income taxes.
SIGNIFICANT EVENTS IN 2003 AND 2002
ISSUANCE OF SENIOR NOTES
On June 28, 2002 we completed a private placement of $150 million of
our 9.5% Senior Notes due July 1, 2010, which were issued at a discount of 0.25%
of par to yield 9.54%. In January 2003, we completed the offer to exchange our
9.5% Senior Notes due 2010 that have been registered under the Securities Act of
1933 for the Notes issued in June 2002. The terms of the new Senior Notes are
identical to the terms of the Senior Notes issued in June 2002 and are
guaranteed by all of our existing and future active subsidiaries.
We used the proceeds of $149.6 million to pay $8.3 million of related
fees and expenses, retire $130.8 million of debt (consisting of $124.5 million
outstanding under the previous credit facility and $6.3 million of other debt),
and the remainder for general corporate purposes. We had hedged a portion of our
previous variable-rate long-term debt through an interest rate swap with a
notional amount of $25 million maturing in February 2003. Upon refinancing of
the debt, we terminated this swap with a cash payment of $0.6 million. This
amount and other deferred financing costs related to the previous credit
facility resulted in a loss on early retirement of debt of $2.8 million ($1.7
million after income taxes) in June 2002.
PURCHASE OF PREVIOUSLY-LEASED FACILITIES
In October 2002, we purchased three skilled nursing facilities in Ohio
and four skilled nursing facilities in Indiana that we previously leased for an
aggregate purchase price of $17.9 million. The purchase price consisted of $7.4
million in cash and a $10.5 million ten-year note, which bears interest at a
rate under negotiation with the vendor, (currently being accrued at 10.5%).
Failing any agreement, the interest rate will be determined through arbitration.
14
ASSET DIVESTITURES AND PROVISION FOR CLOSURE AND EXIT COSTS
In May 2002, Tandem Health Care, Inc. exercised its option to purchase
seven properties that it leased from us 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 (net proceeds of $25.5 million). The carrying value of the seven
facilities was $21.5 million. We applied $12.4 million of the proceeds to reduce
our bank debt and, as a result, we recorded a gain on the sale of assets of $4.0
million, inclusive of the deferred gain of $2.2 million from the sale of two
leased nursing properties in April 2001 to Tandem.
We review on an ongoing basis the level of our overall reserves for
losses related to our Florida and Texas operations, which reserves were
initially established when we decided to exit these states. See footnote 4 to
our consolidated financial statements in our Annual Report on Form 10K for the
year ended December 31, 2002. As a result of events which became known to us in
2002, we concluded in the second quarter of 2002 that we should increase our
overall reserves by $5.3 million for cost report and other settlements with the
state of Florida and other Medicare fiscal intermediaries, collection of
receivables, and settlement of claims with suppliers and employees.
OTHER ITEMS
We continue to negotiate settlement on a number of outstanding Medicare
and Medicaid receivables. Normally such issues are resolved during an annual
audit process; however we record general provisions for disagreements that
require settlement through a formal appeal process. For one specific issue
involving the allocation of overhead costs totaling $14.8 million, the first of
three specific claim years was presented to the Provider Reimbursement Review
Board ("PRRB") at a hearing on January 30, 2003. The hearing procedures were
discontinued after the parties negotiated a methodology for resolution of the
claim, and an administrative resolution has been signed by the Fiscal
Intermediary and us to settle the amount, which will be determined later in
2003. For another specific issue involving a staffing cost issue totaling $7.3
million, a settlement of the first year of seven specific claim years was
reached prior to the PRRB hearing, and an agreement has been reached with the
Fiscal Intermediary to continue to negotiate the remaining years in dispute.
Further negotiations on the remaining years under appeal are to occur during
2003. No adjustment to the receivable amount can be determined until
negotiations are concluded on a majority of the remaining claim years under
appeal. As of March 31, 2003 we had $59.4 million in gross Medicare and Medicaid
settlement receivables with a related allowance for doubtful accounts of $15.4
million. The net amounts receivable represents our estimate of the amount
collectible on Medicare and Medicaid prior period cost reports.
We entered into a Preferred Provider Agreement with Omnicare, Inc.
pursuant to the divestiture of its pharmacy operation in 1998. We and Omnicare
are currently negotiating the 2001 and 2002 pricing of drugs for Medicare
residents and should this matter not be settled, the matter will be taken to
arbitration. In connection with its agreement to provide pharmacy services,
Omnicare has requested arbitration for an alleged lost profits claim relating to
our 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 been scheduled. We believe that we
have interpreted correctly and complied with the terms of the Preferred Provider
Agreement; however there can be no assurances that other claims will not be made
with respect to this agreement.
15
RESULTS FROM OPERATIONS:
The following table sets forth details of revenues and earnings as a
percentage of total revenues:
THREE MONTHS
ENDED
MARCH 31,
----------------------------
2003 2002
---------- ----------
Revenues:
Nursing and assisted living centers.......... 96.9% 96.3%
Outpatient therapy........................... 1.3 1.2
Other........................................ 1.8 2.5
---------- ----------
100.0 100.0
Expenses:
Operating and general and administrative
costs..................................... 89.1 88.2
Lease, depreciation and amortization......... 5.4 6.3
Interest, net................................ 3.8 4.0
---------- ----------
Earnings (loss) before taxes................. 1.8 1.5
Provision (benefit) for income taxes......... 0.7 0.7
---------- ----------
Net earnings (loss)..................... 1.1% 0.8%
========== ==========
Average occupancy in our long-term care facilities was as follows:
THREE MONTHS ENDED
MARCH 31,
---------
2003 2002
---- ----
Skilled nursing facilities........................ 91.3% 89.5%
Assisted living facilities........................ 85.5% 81.8%
THREE MONTHS ENDED MARCH 31, 2003 COMPARED WITH THREE MONTHS ENDED MARCH 31,
2002
REVENUES
Revenues in the three months ended March 31, 2003 ("2003 quarter")
were $211.4 million, representing an increase of $13.2 million, or 6.7%, from
$198.2 million in the three months ended March 31, 2002 ("2002 quarter").
Outpatient therapy and other revenues declined by $0.6 million primarily due
to the sale of the previously leased facilities to Tandem.
Revenues from nursing and assisted living facilities increased
$13.8 million due to:
o a 2.0% increase in nursing resident census from an average daily
census of 12,618 in the 2002 quarter to 12,875 in the 2003
quarter, which increased revenues by $4.1 million;
o an increase in Medicare residents from 13.0% of total residents
in the 2002 quarter to 15.3% in the 2003 quarter, which
increased revenues by $4.0 million;
o a 4% increase in the average daily nursing Medicaid rate, which
increased revenues by $3.2 million;
o increases in other average daily nursing rates, which resulted
in additional revenues of $2.0 million;
o an increase in nursing ancillary revenues of $1.9 million,
primarily due to increased therapy services;
16
o a recovery of $1.5 million in Medicaid revenues as the outcome
of a favorable court decision in the State of Ohio relating to
the recovery of alleged government overpayments for adjudicated
Medicaid cost report periods. The Company continues to review
prior year cost report settlements as it relates to the court's
decision;
o an increase in assisted living revenues of $0.7 million due to
increased occupancy and higher rates; and
o an increase of $0.2 million when comparing periods due to more
favorable cost settlements in 2003.
These increases were offset by a decrease of $3.8 million in Medicare
revenue primarily relating to the expiration of the Legislative Add-ons as of
October 1, 2002.
Our key Medicare and Medicaid results and statistics for our nursing
operations, including ancillary revenues, for the three months ended March 31,
2003 and 2002 are summarized as follows:
MEDICARE MEDICAID
--------------------------------------- -----------------------------------
2003 2002 CHANGE 2003 2002 CHANGE
------------ ------------ ------------ ------------ ------------ ------
Average daily rate......... $ 318 $ 337 (5.6%) $ 132 $ 125 5.6%
Residents as a percent of 15.3% 13.0% 17.7% 67.4% 68.6% (1.7%)
total......................
Average daily census....... 1,966 1,640 19.9% 8,675 8,653 0.3%
The Medicare Part A average daily rate decreased from $312.32 for the
2002 quarter to $290.78 for the 2003 quarter, primarily relating to the loss of
Legislative Add-ons as discussed above.
OPERATING AND GENERAL AND ADMINISTRATIVE COSTS
Operating and general and administrative costs increased $13.5 million,
or 7.7%, between periods, and included increases of:
o wages and benefits of $8.4 million and contracted staffing for
food and laundry services of $2.4 million totaling $10.8 million,
or a 8.7% increase, of which 5.8% is attributable to wage rate
increases;
o drug expense of $0.8 million due to higher resident census and
higher drug prices;
o supplies expense of $0.9 million primarily due to higher
occupancy; and
o other operating and general and administrative expenses of $1.6
million.
These increases were partially offset by a $0.6 million decrease in bad
debt expense.
LEASE COSTS, DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased $0.2 million to $9.2 million
for the 2003 quarter compared to $9.4 million for the 2002 quarter. Lease costs
decreased $0.8 million when comparing periods, including $0.5 million as a
result of the purchase of previously leased facilities in 2002 and $0.3 million
relating to other facilities that we continue to operate.
INTEREST
Interest expense, net of interest income, decreased $0.1 million to
$7.9 million for the 2003 quarter compared to $8.0 million for the 2002 quarter.
The weighted average interest rate of all long-term debt decreased to 7.74%
during the 2003 quarter compared to approximately 7.82% during the 2002 quarter.
Net interest expense was net of net interest income of $1.1 million from
interest rate swaps in the 2003 quarter and included $0.7 million of net
interest expense from interest rate swaps in the 2002 quarter. The average debt
level increased to $398.1 million during the 2003 quarter compared to $384.2
17
million during the 2002 quarter.
INCOME TAXES
Income tax expense for the 2003 quarter was $1.5 million compared to
$1.3 million for the 2002 quarter. Our effective tax rate was 40.2% for the 2003
quarter as compared to 43.9% for the 2002 quarter. When we assess the
realizability of deferred tax assets, we consider whether it is more likely than
not that some portion or all of the deferred tax assets will not be realized and
record a valuation allowance, if required. The ultimate realization of deferred
tax assets depends upon us generating future taxable income during the periods
in which those temporary differences become deductible. We consider the
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies when we make this assessment.
NET EARNINGS
Net earnings for the 2003 quarter were $2.3 million compared to $1.7
million for the 2002 quarter. The improvement in net earnings is due to the
reasons described above.
RELATED PARTY TRANSACTIONS
We insure 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. We recorded approximately $2.6
million and $2.7 million of expenses for this purpose for the three months ended
March 31, 2003 and 2002, respectively.
We purchase computer hardware and software support services from
Virtual Care Provider, Inc., an affiliated subsidiary of Extendicare Inc.
Expenses related to these services were $1.4 million and $1.6 million for the
three months ended March 31, 2003 and 2002, respectively.
LIQUIDITY AND CAPITAL RESOURCES
We had cash and cash equivalents of $24.9 million at March 31, 2003 and
$27.0 million at December 31, 2002. We generated cash flow of $4.5 million from
operating activities for the three months ended March 31, 2003 compared with
$10.4 million in the comparable period in 2002. The $5.9 million reduction in
cash flow from operations was primarily the result of a net decrease in 2003 of
$4.6 million in accounts payable and accrued liabilities compared to a net
increase in 2002 of $8.5 million. This item was partially offset by decreased
payments in 2003 of self-insured general liability claims of $3.6 million and
decreased payments of amounts due to an affiliate for insurance of $3.8 million.
Our working capital, excluding cash and borrowings included in current
liabilities, increased $3.5 million from $14.3 million at December 31, 2002 to
$17.8 million at March 31, 2003. The increase resulted primarily from a $4.6
million net decrease in accounts payable and accrued liabilities and an increase
in supplies, inventories and other current assets of $1.9 million primarily due
to payments for insurance. These increases in working capital were partially
offset by a $3.1 million decrease in accounts receivable.
Accounts receivable at March 31, 2003 were $101.0 million compared with
$104.1 million at December 31, 2002, representing a decrease of $3.1 million.
The reduction in accounts receivable included a $3.2 million decrease within the
nursing operations and an increase of $0.1 million within the outpatient therapy
operations. Within the nursing operations, billed patient care and other
receivables decreased $0.9 million and third-party payor settlement receivables,
based on Medicare and Medicaid cost reports, decreased $2.3 million. The
decrease in billed patient care receivables of $0.9 million included a decrease
of $2.4 million due to our improved collection efforts. The remaining increase
of $1.5 million was due to rate increases.
The decrease in settlement receivables of $2.3 million from December
31, 2002 to March 31, 2003 included decreases of $0.8 million from collections
18
of Medicare settlements, $1.6 million for collections of Medicare co-insurance
amounts recorded as revenue in 2002 and $2.4 million for Medicaid cost report
settlements. These decreases were partially offset by an increase of $2.5
million in revenue in 2003 for anticipated Medicare reimbursement for
uncollectible co-insurance amounts.
Property and equipment decreased $3.5 million from December 31, 2002 to
a total of $449.6 million at March 31, 2003. The decrease was the result of
depreciation expense of $8.2 million and asset disposals of $0.1 million. These
decreases were partially offset by capital expenditures of $4.8 million.
Total borrowings, including bank indebtedness and both current and
long-term maturities of debt, totaled $398.0 million at March 31, 2003. This
represents a decrease of $2.8 million from December 31, 2002. This decrease is
due to repayments.
The weighted average interest rate of all of our long-term debt was
7.62% at March 31, 2003 and 7.74% for the quarter ended March 31, 2003
(including the effects of the interest rate swap and cap) and such debt had
maturities ranging from 2003 to 2014.
As of March 31, 2003, our parent, Extendicare Inc., held $27.9 million,
or 14.0%, of our outstanding Senior Subordinated Notes.
Cash used in investing activities increased $4.1 million to $4.4
million for the three months ended March 31, 2003 compared to $0.3 million for
the comparable period of 2002. The increase was primarily due to an increase of
$1.6 million in purchases of property and equipment, a decrease in the proceeds
from the sale of property and equipment of $1.7 million and a decrease in the
collection of notes receivable of $0.9 million.
Cash used in financing activities was $2.3 million for the three months
ended March 31, 2003 compared to $8.1 million in the comparable period of 2002.
The decrease of $5.8 million was due to decreased payments of debt totaling
$23.7 million, offset by the following:
o a decrease in proceeds of $11.0 million from the issuance of
long-term debt;
o a $6.5 million increase in cash used for bank indebtedness; and
o a $0.4 million increase in cash used for other liabilities.
On June 28, 2002, we refinanced all outstanding indebtedness under our
then existing credit facility with the proceeds from the issuance of our 9.5%
Senior Notes due 2010 and we entered into a new credit facility that provides
senior secured financing of up to $105.0 million on a revolving basis. As of
March 31, 2003, we did not have any borrowings outstanding under this new credit
facility, but we had $41.4 million of letters of credit outstanding thereunder.
The new credit facility will terminate on June 28, 2007. Borrowings drawn during
the first four fiscal quarters following closing of the new credit facility will
initially bear interest, at our option, at an annual rate equal to:
o LIBOR, plus 3.50%; or
o the Base Rate, as defined in our new credit facility, plus 2.50%;
thereafter, in each case, subject to adjustments based on financial performance.
Our obligations under the new credit facility are guaranteed by:
o Extendicare Holdings, Inc., our direct parent;
o each of our current and future domestic subsidiaries excluding
certain inactive subsidiaries; and
o any other current or future foreign subsidiaries that guarantee
or otherwise provide direct credit support for any U.S. debt
obligations of ours or any of our domestic subsidiaries.
19
Our obligations are secured by a perfected first priority security
interest in certain of our tangible and intangible assets and all of our and our
subsidiary guarantors' capital stock. The new credit facility is also secured by
a pledge of 65% of the voting stock of our and our subsidiary guarantors'
foreign subsidiaries, if any. Our new credit facility contains customary
covenants and events of default and is subject to various mandatory prepayments
and commitment reductions. The new credit facility requires that we comply with
various financial covenants, on a consolidated basis including:
o a minimum fixed charge coverage ratio starting at 1.10 to 1 and
increasing to 1.20 to 1 in 2005;
o a minimum tangible net worth starting at 85% of our tangible net
worth at March 31, 2002 and increasing by 50% of our net income
for each fiscal quarter plus 100% of any additional equity we
raise;
o a maximum senior leverage ratio starting at 4.25 to 1 and
reducing to 4.00 to 1 in 2005; and
o a maximum senior secured leverage ratio starting at 1.75 to 1 and
reducing to 1.50 to 1 in 2005.
We are in compliance with these financial covenants as of March 31,
2003.
To hedge our exposure to fluctuations in the market value of the Senior
Notes, we entered into a five-year interest rate swap contract with a notional
amount of $150 million. The contract effectively converted up to $150 million of
our fixed interest rate indebtedness into variable interest rate indebtedness.
Also in June 2002, we entered into a five-year interest rate cap with a
notional amount of $150 million. Under this cap, we pay a fixed rate of interest
equal to 0.24% and receive 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%. We
use the 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 our variable-rate debt obligations.
We believe that our cash from operations and anticipated growth,
together with other available sources of liquidity, including borrowings
available under our new credit facility, will be sufficient for the foreseeable
future to fund anticipated capital expenditures and make required payments of
principal and interest on our debt, including payments due on the notes and
obligations under our new credit facility.
OFF BALANCE SHEET ARRANGEMENTS
We have no significant off balance sheet arrangements except for the
five-year interest rate swap and the five-year interest rate cap which are
described above.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Qualitative Disclosures
We use interest rate swaps to hedge the fair value of our debt
obligations and interest rate caps as a cash flow hedge of our variable-rate
debt and also to offset possible increases in variable-rate payments under our
interest rate swap related to increases in market interest rates.
We also have market risk relating to investments in stock and stock
warrants that we obtained in connection with the 1998 sale of our pharmacy
operations. In effect, these holdings can be considered contingent purchase
price proceeds whose value, if any, may not be realized for several years. These
stock and warrant holdings are subject to various trading and exercise
limitations. We intend to hold them until we believe the market opportunity is
appropriate to trade or exercise the holdings.
We monitor the markets to adequately determine the appropriate market
timing to sell or otherwise act with respect to our stock and warrant holdings
in order to maximize their value. With the exception of the above holdings, we
do not enter into derivative instruments for any purpose other than cash flow
hedging purposes.
20
That is, we do not speculate using derivative instruments and do 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 our debt obligations and
interest rate swaps as of March 31, 2003 (dollars in thousands):
FAIR
VALUE OF
AFTER LIABILITY
2003 2004 2005 2006 2007 2007 TOTAL (ASSET)
-------- -------- -------- -------- -------- ----------- ----------- -------
LONG-TERM DEBT:
Fixed Rate.......................... $ 581 $ 756 $ 733 $ 698 $203,491 $ 159,770 $ 366,030 $331,221
Average Interest Rate............... 7.46% 7.69% 7.76% 7.64% 9.32% 9.59% 9.42%
Variable Rate....................... -- -- -- -- -- $ 32,000 $ 32,000 $ 28,010
Average Interest Rate............... -- -- -- -- -- 1.24% 1.24%
INTEREST RATE SWAPS: (fixed to
variable)
Notional Amount..................... -- -- -- -- -- $ 150,000 $ 150,000 $ (9,156)
Average Pay Rate (variable rate).... -- -- -- -- -- -- 6.08%
Average Receive Rate (fixed -- -- -- -- -- -- 9.35%
rate)...............................
INTEREST RATE CAPS:
Notional Amount................... -- -- -- -- -- $ 150,000 $ 150,000 $ 883
The above table incorporates only those exposures that existed as of
March 31, 2003 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. Our ultimate results
with respect to interest rate fluctuations will depend upon the exposures that
occur, our 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 with the participation of our 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 Rules 13a-14 (c) and 15d-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, as of the date of such evaluation, in
timely alerting them to material information relating to the Company (including
our consolidated subsidiaries) required to be included in the our periodic SEC
filings.
No significant changes were made in our internal controls nor were
there other factors that could significantly affect these controls subsequent to
the date of that evaluation.
21
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 8 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
None.
22
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: May 14, 2003 By: /s/ Mark W. Durishan
------------- --------------------
Mark W. Durishan
Vice President, Chief Financial
Officer and Treasurer
(principal financial officer and
principal accounting officer)
23
CERTIFICATION
I, Mel 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 functions):
(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/ Mel Rhinelander
--------------------
Mel Rhinelander
Chairman of the Board and Chief Executive Officer
May 14, 2003
24
CERTIFICATION
I, Mark W. Durishan, Vice-President, Chief Financial Officer and Treasurer 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 functions):
(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
May 14, 2003
25
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
26