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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, 2004
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 per share; issued
and outstanding 947 shares as of May 11, 2004. All issued and outstanding shares
of Common Stock are held indirectly by Extendicare Inc., a publicly traded
Canadian company.
EXTENDICARE HEALTH SERVICES, INC.
INDEX
PAGE
----
PART I FINANCIAL INFORMATION:
Item 1 Financial Statements:
Condensed Consolidated Statements of Earnings for the Three Months Ended
March 31, 2004 and 2003............................................................................. 3
Condensed Consolidated Balance Sheets, March 31, 2004 and December 31, 2003............................. 4
Condensed Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2004 and 2003........................................................................... 5
Notes to Condensed Consolidated Financial Statements.................................................... 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations................... 18
Item 3 Quantitative and Qualitative Disclosures About Market Risk.............................................. 39
Item 4 Controls and Procedures................................................................................. 40
PART II OTHER INFORMATION:
Item 1 Legal Proceedings....................................................................................... 41
Item 2 Changes in Securities and Use of Proceeds............................................................... 41
Item 3 Defaults Upon Senior Securities......................................................................... 41
Item 4 Submission of Matters to a Vote of Security Holders..................................................... 41
Item 5 Other Information....................................................................................... 41
Item 6 Exhibits and Reports on Form 8-K........................................................................ 41
SIGNATURES............................................................................................................ 43
EXHIBIT INDEX......................................................................................................... 44
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EXTENDICARE HEALTH SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(IN THOUSANDS)
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 2004 MARCH 31, 2003
------------------ ------------------
REVENUES:
Nursing and assisted living facilities.......... $ 224,426 $ 204,805
Outpatient therapy ............................. 2,665 2,644
Other .......................................... 4,410 3,977
------------------ ------------------
231,501 211,426
COSTS AND EXPENSES (INCOME):
Operating ...................................... 189,456 180,496
General and administrative ..................... 7,490 7,838
Lease costs .................................... 2,264 2,251
Depreciation and amortization .................. 8,681 9,161
Interest expense ............................... 8,200 8,495
Interest income ................................ (1,542) (643)
Loss on impairment of long-lived assets ........ 1,612 --
Loss on early retirement of debt ............... 354 --
------------------ ------------------
216,515 207,598
------------------ ------------------
EARNINGS BEFORE INCOME TAXES ..................... 14,986 3,828
Income tax expense ............................. 5,639 1,540
------------------ ------------------
NET EARNINGS ..................................... $ 9,347 $ 2,288
================== ==================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
EXTENDICARE HEALTH SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, 2004 AND DECEMBER 31, 2003
(IN THOUSANDS EXCEPT SHARE DATA)
MARCH 31, DECEMBER 31,
2004 2003
-------------- -----------
ASSETS
Current Assets:
Cash and cash equivalents............................................................ $ 47,893 $ 48,855
Accounts receivable, less allowances of $12,157
and $11,692, respectively......................................................... 93,859 95,338
Assets held under Divestiture Agreement.............................................. 33,723 33,723
Supplies, inventories and other current assets....................................... 8,692 7,436
Deferred state income taxes.......................................................... 5,017 4,260
Due from shareholder and affiliates:
Federal income taxes receivable................................................... 3,017 8,121
Deferred federal income taxes..................................................... 25,614 22,584
Other............................................................................. 6,534 7,010
-------------- ------------
Total current assets............................................................ 224,349 227,327
Property and equipment, net............................................................ 449,638 448,743
Goodwill and other intangible assets, net.............................................. 75,407 75,193
Other assets........................................................................... 78,291 82,086
-------------- ------------
Total Assets...................................................................... $ 827,685 $ 833,349
============== ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Current Liabilities:
Current maturities of long-term debt................................................. $ 1,276 $ 1,223
Accounts payable..................................................................... 17,235 20,672
Accrued liabilities.................................................................. 101,215 101,614
Deposits held under Divestiture Agreement............................................ 30,000 30,000
Current portion of accrual for self-insured liabilities.............................. 18,000 18,000
Income taxes payable................................................................. 1,500 23
-------------- ------------
Total current liabilities....................................................... 169,226 171,532
Accrual for self-insured liabilities .................................................. 25,601 27,063
Long-term debt......................................................................... 378,961 391,695
Deferred state income taxes............................................................ 7,365 7,343
Other long-term liabilities............................................................ 11,573 11,082
Due to shareholder and affiliates:
Deferred federal income taxes....................................................... 38,853 38,490
Other............................................................................... 3,484 3,484
-------------- ------------
Total liabilities............................................................... 635,063 650,689
-------------- ------------
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 income............................................... 1,600 985
Accumulated deficit.................................................................. (17,766) (27,113)
-------------- ------------
Total Shareholder's Equity....................................................... 192,622 182,660
-------------- ------------
Total Liabilities and Shareholder's Equity....................................... $ 827,685 $ 833,349
============== ============
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, 2004 AND 2003
(IN THOUSANDS)
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31,2004 MARCH 31, 2003
------------------ ------------------
OPERATING ACTIVITIES:
Net earnings ........................................... $ 9,347 $ 2,288
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization .................... 8,681 9,161
Amortization of deferred financing costs ......... 377 378
Provision for uncollectible accounts receivable... 3,184 2,335
Provision for self-insured liabilities ........... 1,650 1,500
Payment of self-insured liability claims ......... (3,112) (5,617)
Deferred income taxes ............................ (3,811) 569
Loss on impairment of long-lived assets .......... 1,612 --
Loss on early retirement of debt ................. 354 --
Changes in assets and liabilities:
Accounts receivable .............................. (1,557) 625
Supplies, inventories and other current assets ... (1,255) (1,866)
Accounts payable ................................. (3,437) 1,589
Accrued liabilities .............................. (606) (6,214)
Income taxes payable/receivable .................. 1,477 147
Current due to shareholder and affiliates ........ 5,580 (370)
------------------ ------------------
Cash provided by operating activities ........... 18,484 4,525
------------------ ------------------
INVESTING ACTIVITIES:
Payments for acquisitions ........................ (2,129) --
Payments for new construction projects ........... (3,800) (31)
Payments for purchase of property and equipment .. (5,345) (4,709)
Proceeds from sale of property and equipment ..... 4 17
Changes in other non-current assets............... 4,031 373
------------------ ------------------
Cash used in investing activities ............... (7,239) (4,350)
------------------ ------------------
FINANCING ACTIVITIES:
Payments of long-term debt ....................... (13,397) (129)
Proceeds from issuance of long-term debt ......... 706 --
Other long-term liabilities ...................... 484 506
------------------ ------------------
Cash (used in) provided by financing activities.. (12,207) 377
------------------ ------------------
Increase (decrease) in cash and cash equivalents ....... (962) 552
Cash and cash equivalents, beginning of period ......... 48,855 24,360
------------------ ------------------
Cash and cash equivalents, end of period ............... $ 47,893 $ 24,912
================== ==================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
EXTENDICARE HEALTH SERVICES, INC.
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", unless the context requires otherwise) 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 months ended March 31, 2004 and 2003 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 accounting principles generally
accepted 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, 2003 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 the recoverability of long-lived assets, and provisions for bad debts,
Medicaid and Medicare revenue rate settlements, self-insured general and
professional liability claims, facility closure accruals, workers compensation
accruals, self-insured health and dental claims and income taxes. 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, 2003 contained in the Company's Annual Report on Form
10-K. Certain reclassifications have been made to the 2003 condensed
consolidated financial statements to conform to the presentation for 2004.
2. ACQUISITIONS AND NEW DEVELOPMENTS
On February 12, 2004, the Company acquired a skilled nursing facility in
Washington, which was previously leased, for $1.4 million.
The Company completed two development projects involving additions to
existing facilities. In February 2004, the Company opened 16 units in an
assisted living facility in Kentucky and in March 2004, opened 20 nursing beds
in a skilled nursing facility in Wisconsin.
On December 31, 2003 the Company acquired one skilled nursing facility (99
beds) in Wisconsin for $4.1 million in cash.
6
4. ASSETS (AND DEPOSITS HELD) UNDER DIVESTITURE AGREEMENT
Assets Held Under Divestiture Agreement
In September 2000, the Company disposed of eleven Florida nursing
facilities (1,435 beds) and four Florida assisted living facilities (135 units)
to Greystone Tribeca Acquisition, L.L.C. ("Greystone") for initial cash proceeds
of $30.0 million and contingent consideration in the form of a $10.0 million
Vendor Take Back note and two other contingent and interest bearing notes. The
three notes have an aggregate potential value of up to $30.0 million plus
interest. The notes were due in March 2004 and would have been retired out of
the proceeds from the sale or refinancing of the facilities by Greystone. For
the period September 2000 through March 2004, the Company retained the right of
first refusal to repurchase the facilities. The Company also retained an option
to repurchase the facilities until March 2003; however, the Company elected not
to place an offer to repurchase the facilities. Upon maturity of the notes in
March 2004, unless the facilities were sold or refinanced, the Company was
entitled to receive the $10.0 million Vendor Take Back note and accrued interest
pursuant to the terms of the Vendor Take Back and other contingent notes.
In 2000, the option to repurchase along with the significant portion of
the sales price being contingent, resulted in the disposition being accounted
for as a deferred sale in accordance with SFAS No. 66 and, accordingly, there
was no gain or loss recorded on the initial transaction. The fixed assets have
been classified as "Assets held under Divestiture Agreement", and as of March
31, 2004, had a net book value of $33.7 million. As of December 31, 2003 the
Company anticipated the final consideration to be received in 2004, and
therefore the "Assets held under Divestiture Agreement" have been classified as
a current asset as of December 31, 2003, and the Company ceased depreciating
these assets as of January 1, 2004. Upon receipt of the final consideration, the
Company will record the disposition of the assets and a gain based upon the
difference between the total consideration received and the net book value of
the Assets Held under the Divestiture Agreement.
Deposits Held Under Divestiture Agreement
The initial cash proceeds of $30.0 million have been classified in the
balance sheet as "Deposits held under Divestiture Agreement." Consistent with
the reclassification of the Assets Held under Divestiture Agreement, the
Deposits held under Divestiture Agreement have been classified as a current
liability as of December 31, 2003 and March 31, 2004.
Subsequent Events
For additional information pertaining to Assets (and Deposits Held) Under
Divestiture Agreement, refer to Note 9 - Subsequent Events.
5. OTHER ASSETS
Medicare and Medicaid Settlement Receivables
For Medicare revenues earned prior to the implementation of Medicare
Prospective Payment System ("PPS") on January 1, 1999 and for Medicaid programs
with a retrospective reimbursement system, differences between revenues that the
Company ultimately expects to realize from these programs and amounts received
are reflected as accounts receivable, or as accrued liabilities when payments
have exceeded revenues that the Company ultimately expects to realize. At March
31, 2004, accounts receivable from both Medicare and Medicaid state programs,
net of a general contractual allowance, totaled $32.1 million (December 31, 2003
- - $37.2 million). This amount includes $6.2 million (December 31, 2003 - $11.3
million), that is expected to be substantially collected within one year and is
included within accounts receivable as a current asset. The remaining balance of
$25.9 million (December 31, 2003 - $25.9 million) is reported within "Other
Assets." The Company is pursuing collection of a number of outstanding Medicare
and Medicaid settlement issues.
For a specific staffing cost issue, a settlement of the first year of
seven specific claim years was reached prior to the January 2003 Provider
Reimbursement Review Board ("PRRB") hearing, and during 2003 the Company
continued to negotiate the remaining years in dispute with the Fiscal
Intermediary ("FI"). In January 2004, the Company negotiated and subsequently
7
received a cash settlement of $5.6 million. The settlement did not result in a
significant adjustment from the recorded receivable balance.
For another specific Medicare receivable issue involving the allocation of
overhead costs, the first of three specific claim years was presented to the
PRRB at a hearing in January 2003. The hearing procedures were discontinued
after the parties negotiated a methodology for resolution of the claim for one
of the years in dispute. The negotiated settlement for this and other issues
relating to the 1996 cost report year, resulted in no adjustment to the recorded
receivable balance, and the Company subsequently collected $3.0 million from the
FI. For the remaining two specific claim years, the Company continued to
negotiate with the FI and failing a negotiated settlement, was prepared to
proceed to a PRRB hearing scheduled in April 2004.
The Company has a hearing scheduled in September 2004 for another Medicare
receivable issue in dispute involving a Director of Nursing staff cost issue in
the amount of $3.8 million.
Notes Receivable
The Company holds $21.4 million in notes receivable due from Tandem Health
Care Inc. ("Tandem"). For $17.4 million of the notes that resulted from the sale
of properties in 2001 and 2002, the notes are due between April 2006 and May
2007. In February 2004, Tandem refinanced two of its nursing facilities and the
Company subsequently received prepayment in full of $4.4 million of the notes
receivable held in respect of these properties. The Company also holds a $4.0
million note from Tandem that, along with the $3.7 indemnification escrow funds,
is due in December 2007.
Subsequent Events
For additional information pertaining to Medicare and Medicaid Settlement
Receivables, refer to Note 9 - Subsequent Events.
6. LINE OF CREDIT AND LONG-TERM DEBT
Summary of Long-term Debt
Long-term debt consisted of the following as of March 31, 2004 and
December 31, 2003:
MARCH 31, DECEMBER 31
2004 2003
----------- -----------
(IN THOUSANDS)
Senior Notes due 2010........................................................... $ 149,685 $ 149,676
Senior Subordinated Notes due 2007.............................................. 200,000 200,000
Industrial Development Revenue Bonds, variable interest rates ranging from
1.00% to 6.25%, maturing through 2014, secured by certain facilities.......... 20,160 33,160
Mortgage notes payable, interest rates ranging from 3.0% to 10.5%, maturing
through 2012.................................................................. 10,368 10,054
Other, primarily capital lease obligations...................................... 24 28
----------- -----------
Long-term debt before current maturities........................................ 380,237 392,918
Less current maturities......................................................... 1,276 1,223
=========== ===========
Total long-term debt............................................................ $ 378,961 $ 391,695
=========== ===========
On June 28, 2002, the Company completed a private placement of $150
million of its 9.5% Senior Notes due July 1, 2010 (the "2010 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 2010 Senior Notes are identical to the terms of
the 2010 Senior Notes issued in June 2002 and are guaranteed by all existing and
future active subsidiaries of the Company. Also on June 28, 2002, the Company
entered into an interest rate swap agreement and an interest rate cap agreement.
See Note 7 for the terms of the swap and cap agreements.
8
Concurrent with the sale of the 2010 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, 2004 and
December 31, 2003, the Company had no borrowings from the Credit Facility. The
unused portion of the Credit Facility, that is available for working capital and
corporate purposes, after reduction for outstanding letters of credit of $33.7
million, was $71.3 million as of March 31, 2004.
The Credit Facility is secured by a perfected, first priority security
interest in certain tangible and intangible assets and all of the Company's
capital stock and the capital stock of the Company's subsidiary guarantors. The
Credit Facility is also secured by a pledge of 65% of the voting shares of the
voting stock of the Company and the Company's subsidiary guarantor's foreign
subsidiaries, if any. The credit facility contains customary covenants and
events of default and is subject to various mandatory prepayment and commitment
reductions.
The 2010 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 2010 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 all of the financial covenants as of
March 31, 2004.
The Company has no independent assets or operations, the guarantees of the
2010 Senior Notes are full and unconditional, and joint and several, and any of
the Company's subsidiaries that do not guarantee the 2010 Senior Notes are
minor. There are no significant restrictions on the ability of the Company to
obtain funds from its subsidiaries by loan or dividend.
In December 1997, the Company issued $200 million of 9.35% Senior
Subordinated Notes due 2007 (the "2007 Notes"). The 2007 Notes are unsecured
senior subordinated obligations of the Company subordinated in right of payment
to all existing and future senior indebtedness of the Company, which includes
all borrowings under the Credit Facility as well as all indebtedness not
refinanced by the Credit Facility. At March 31, 2004, Extendicare Inc. held
$27.9 million of the 2007 Notes. The 2007 Notes mature on December 15, 2007.
Interest on the 2007 Notes is payable semi-annually.
The 2007 Notes are redeemable at the option of the Company. The redemption
prices, if redeemed during the 12-month period beginning on December 15 of the
year indicated, are as follows:
YEAR PERCENTAGE
- ---------------------------------- ----------
2003.............................. 103.117%
2004.............................. 101.558%
2005 and thereafter............... 100.000%
9
Subsequent Events
For additional information pertaining to the Company's line of credit and
long-term debt, refer to Note 9 - Subsequent Events.
7. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Objectives and Strategies
After the issuance of the 2010 Senior Notes in June 2002, 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") (1.09% as of March 31, 2004), adjustable monthly, plus a spread of
4.805% and receives a fixed rate of 9.35%. Under the terms of the interest rate
swap, the counterparty can call the swap upon 30 days notice. 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 2003 or 2004.
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%. Under the terms of the interest rate
cap, the counterparty can call the cap upon 30 days notice. A portion of the
interest rate cap with a notional amount of $19 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 $131 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.
The Company does not speculate using derivative instruments.
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, 2004, the fair value of the interest rate swap
designated as a fair value hedge is an asset of $3.8 million and is offset by a
liability of $3.8 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, which was $0.1 million as of
March 31, 2004. A gain of $40,000 (net of income tax effect) was credited to
AOCI for the three months ended March 31, 2004. 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, which was $0.7 million as of March 31,
2004. 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.
Subsequent Events
For additional information pertaining to the Company's accounting for
derivative instruments and hedging activities, refer to Note 9 - Subsequent
Events.
8. GAIN ON DISPOSAL OF ASSETS, PROVISION FOR CLOSURE AND EXIT COSTS, AND
IMPAIRMENT OF LONG-LIVED ASSETS
The Company operates two nursing facilities that are adjacent to each
other in Indiana, both of which require capital renovations. After evaluation of
the respective operations, in March 2004 the Company made a decision, subject to
State of
10
Indiana approval, to consolidate the two operations into one renovated facility.
Upon completion of the renovations, the refurbished facility will accommodate
all residents within both facilities, however, the total available beds will be
decreased by 46. The consolidation of the two operations is expected to be
complete by March 2005. As a result of the decision to close the one facility,
the Company recorded a provision of $1.6 million for impairment of long-lived
assets.
Reserves for divested operations and facility closures primarily relate to
provisions for the settlement of Medicare and Medicaid claims and other amounts
with third parties. The settlement of such amounts depends on actions by those
third parties and negotiations by the Company, and therefore may not be resolved
within the next or several years. Below is a summary of activity of the accrued
liabilities balance relating to divested operations and facility closures:
MEDICARE,
MEDICAID RESIDENT AND
AND SUPPLIER EMPLOYEE
CLAIMS CLAIMS OTHER TOTAL
------------ ------------ ----------- -----------
(IN THOUSANDS)
Balance December 31, 2001................ $ 1,896 $ 2,305 $ 3,801 $ 8,002
Cash Payments.......................... (863) (1,051) (2,777) (4,691)
Provisions (1)......................... 7,066 64 (723) 6,407
------------ ------------ ----------- -----------
Balance December 31, 2002................ 8,099 1,318 301 9,718
Cash Payments.......................... (565) (824) (141) (1,530)
Provisions (2)......................... (897) -- -- (897)
------------ ------------ ----------- -----------
Balance December 31, 2003................ $ 6,637 $ 494 $ 160 $ 7,291
Cash Payments.......................... (264) -- -- (264)
------------ ------------ ----------- -----------
Balance March 31, 2004................... $ 6,373 $ 494 $ 160 $ 7,027
============ ============ =========== ===========
(1) In 2002, provisions include a provision for closure and exit costs of $5.3
million and selling expenses of $1.2 million relating to the sale of
Florida assets.
(2) In 2003, provisions include the write-off of $1.3 million of previously
accrued Medicare claims receivable relating to discontinued operations.
9. SUBSEQUENT EVENTS
Issuance of New 2014 Notes and Repayment of 2007 Notes
On April 5, 2004, the Company commenced a tender offer to purchase any and
all of its outstanding $200 million 2007 Notes. Approximately 61% of the 2007
Notes (which represents the percentage of 2007 Notes not owned by Extendicare
Inc.) were tendered in the tender offer and repaid on April 22, 2004. The
Company intends to redeem the 2007 Notes not tendered in the tender offer on May
24, 2004.
On April 22, 2004, the Company issued $125 million aggregate principal
amount of 6.875% Senior Subordinated Notes due May 1, 2014 (the "2014 Notes"),
pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as
amended. The 2014 Notes were issued at a price of 97.5001% of par to yield
7.23%.
The net proceeds from the issuance of the 2014 Notes were approximately
$117.4 million (net of a discount of $3.1 million and fees and expenses of $4.5
million). The Company used a portion of these net proceeds to purchase for cash
approximately $104.9 million aggregate principal amount of the 2007 Notes
tendered in the tender offer and it intends to use the remaining net proceeds,
to, among other things, redeem any 2007 Notes not tendered in the tender offer
and to pay related fees and expenses of the tender offer and redemption.
The 2014 Notes are fully and unconditionally guaranteed on a senior
subordinated basis by all of the Company's existing and future domestic
significant subsidiaries, all of the Company's existing and future domestic
subsidiaries that guarantee or incur any indebtedness and any other existing and
future significant subsidiaries or restricted subsidiaries that guarantee or
otherwise provide direct credit support for indebtedness of the Company or any
of its domestic subsidiaries. The 2014 Notes and guarantees are general
unsecured obligations of the Company and the Company's subsidiaries.
On or after May 1, 2009, the Company may redeem all or part of the 2014
Notes, at the redemption prices (expressed as percentages of principal amount)
listed below, plus accrued and unpaid interest, if any, to the date of
redemption, if redeemed
11
during the twelve-month period commencing on May 1 of the years set forth below:
REDEMPTION
YEAR PRICE
---- -----
2009........................................ 103.438%
2010........................................ 102.292%
2011........................................ 101.146%
2012 and thereafter......................... 100.000%
Subject to the conditions of the tender offer, the holders of the 2007
Notes who validly tendered their 2007 Notes or whose 2007 Notes were redeemed by
the Company are entitled to the premium that, in the aggregate, amounts to
approximately $6.6 million. As a result of the tender offer, redemption and
repayment of the 2007 Notes, in the second quarter of 2004, the Company will
write-off deferred finance charges of approximately $2.4 million related to the
2007 Notes and incur legal costs estimated at $0.3 million. In addition,
pursuant to termination of the Company's existing interest rate swap and cap
agreements (discussed below), the Company will record a gain of approximately
$3.3 million which will be recognized in the second quarter of 2004. The net
after tax impact to "Accumulated Deficit" is a loss of approximately $3.9
million. Below is a summary of the adjustment to the Company's "Accumulated
Deficit" account:
(Dollars in
thousands)
-----------
Tender premium............................................................... $ (3,670)
Call premium................................................................. (2,966)
Write-off of deferred finance charges........................................ (2,359)
Estimated legal expenses..................................................... (250)
Gain on termination of interest rate swap and cap agreements................. 3,302
-----------
Total before income taxes.................................................... (5,943)
Income taxes................................................................. 2,080
-----------
Net impact to Accumulated deficit............................................ $ (3,863)
===========
Amendment and Restatement of Credit Facility
In connection with the offering of the 2014 Notes, the Company amended and
restated its current credit facility. The terms of the amended and restated
credit facility included the following changes, among other things:
- a two year maturity extension, to June 28, 2009;
- an additional $50.0 million of senior secured financing on a
revolving basis, resulting in total borrowing capacity of $155.0
million;
- an interest rate spread which ranges from the Eurodollar rate plus
2.50% per annum to 3.25% per annum or the base rate plus 1.50% per
annum to 2.25% per annum, subject, in each case, to adjustments
based on the Company's senior leverage ratio;
- a commitment fee of 0.50% per annum on the undrawn capacity
regardless of utilization;
- a requirement that the Company maintain a maximum senior leverage
ratio starting at 4.25 to 1 and reducing to 4.00 to 1 in 2007;
- a requirement that the Company maintain a maximum senior secured
leverage ratio starting at 2.25 to 1 and reducing to 2.00 to 1 in
2007; and
- changes to the collateral securing the facility to permit the
Company to substitute certain assets with other assets.
12
The Company expects to borrow approximately $30.0 million under the
amended and restated credit facility to partially fund the redemption of any and
all of the outstanding $200.0 million 2007 Notes. Under the credit facility,
"EBITDA" is defined as net income (loss) before income taxes, interest expense
net of interest income, depreciation and amortization, and non-cash,
non-recurring (gains) and losses, including disposal of assets, provision for
closure and exit costs and other items, early retirement of debt and impairment
of long-lived assets. Based on the Company's adjusted capitalization and EBITDA
for the quarter ended March 31, 2004, all borrowings to be drawn under the
amended and restated credit facility will initially bear interest at a rate per
annum equal to:
- the Eurodollar rate plus 2.75%; or
- the Base Rate plus 1.75%,
and thereafter, in each case, subject to adjustments based on our senior
leverage ratio.
Interest Rate Swap and Cap Agreements
In April 2004, coterminous with the issuance of the 2014 Notes, the
Company terminated its existing interest rate swap and cap agreements for an
aggregate gain of approximately $3.3 million to be recognized in the second
quarter of 2004. This swap was a hedge against the 2007 Notes. In addition, to
hedge the Company's exposure to fluctuations in market value, on April 22, 2004,
the Company entered into two new interest rate swap agreements and two new
interest rate cap agreements relating to the 2010 Senior Notes and the 2014
Notes.
With respect to the 2010 Senior Notes, the Company entered into an
interest rate swap agreement expiring July 1, 2010 with a notional amount of
$150.0 million. This agreement effectively converted up to $150.0 million of
fixed interest rate indebtedness into variable interest rate indebtedness. Under
the terms of this interest rate swap agreement, the counterparty can call the
swap at any time on or after July 1, 2006 with payments as determined under the
agreement. The Company also entered into an interest rate cap agreement expiring
July 1, 2010 with a notional amount of $150.0 million. Under this cap agreement,
the Company paid on April 22, 2004 an upfront fee of $3.5 million to the
counterparty that will be amortized to interest expense over the term of the
cap. The Company will receive a variable rate of interest equal to the excess,
if any, of the six-month LIBOR rate, adjusted semi-annually, over the cap rate
of 7%. The Company uses the interest rate cap to offset possible increases in
interest payments under the interest rate swap agreement expiring July 1, 2010
caused by increases in market interest rates over a certain level. Under the
terms of the interest rate cap agreement, the counterparty can call the cap if
the interest rate swap agreement expiring July 1, 2010 is terminated.
With respect to the 2014 Notes, on April 22, 2004, the Company entered
into an interest rate swap agreement expiring May 1, 2014 with a notional amount
of $125.0 million. This agreement effectively converted up to $125.0 million of
fixed interest rate indebtedness into variable interest rate indebtedness. Under
the terms of this interest rate swap agreement, the counterparty can call the
swap at any time on or after May 1, 2009 with payments as determined under the
agreement. The Company also entered into an interest rate cap agreement expiring
May 1, 2014 with a notional amount of $125.0 million. Under this cap agreement,
the Company pays a fixed rate of interest equal to 0.75% to the counterparty and
receives a variable rate of interest equal to the excess, if any, of the
six-month LIBOR rate, adjusted semi-annually, over the cap rate of 7%. The
Company uses the interest rate cap to offset possible increases in interest
payments under the interest rate swap agreement expiring May 1, 2014 caused by
increases in market interest rates over a certain level. Under the terms of the
interest rate cap agreement, the counterparty can call the cap if the interest
rate swap agreement expiring May 1, 2014 is terminated.
13
Refinancing of Loan Resulting From Acquisition of Previously-leased Facilities
On October 1, 2002 the Company completed a transaction in which it
exercised its right to acquire seven previously-leased nursing facilities in the
states of Ohio and Indiana for $17.9 million. The purchase price included cash
of $7.4 million and a $10.5 million interest bearing 10-year note. The interest
rate on the note was subject to negotiation and failing an agreement would have
been settled through arbitration. In the latter part of 2003, the Company
prepaid $4.5 million against the note and agreed to refinance the balance of the
10-year note. On April 15, 2004 the Company refinanced the facilities with
mortgages whose interest rates vary with LIBOR, and repaid the remaining balance
of the note due to the seller.
Settlement of Medicare Receivable Issue
In April 2004, the Company reached a negotiated settlement with the FI in
respect on the remaining two years of a specific issue involving the allocation
of overhead costs. The settlement will result in the payment of approximately
$7.7 million to the Company, of which $6.5 million will be received in May 2004
and the balance upon conclusion of resolution of other matters concerning the
cost report years under appeal. There are certain matters related to the
settlement and cost report years that were appealed that have to be resolved
with the FI, which could influence the financial impact of the settlement. The
Company anticipates that the resolution of these matters and the determination
of the financial impact of the settlement, if any, will be recorded within the
second quarter of 2004 financial results.
Settlement on Greystone Transaction
In April 2004, the Company concluded negotiations with Greystone and as a
result will receive the final consideration of $10.0 million on the Vendor Take
Back note plus $2.6 million of interest, and therefore complete the September
2000 Divestiture Agreement. The interest payment was received on April 29, 2004
and the $10.0 million note payment will be received in June 2004. The initial
transaction in 2000 was treated as a deferred sale, as a significant portion of
the proceeds was contingent, and the Company held an option to repurchase the
facilities. The finalization of this transaction will result in the recognition
in the second quarter of 2004 of a pre-tax gain from the sale of assets of $4.8
million and interest income of $1.6 million.
Opening of New Assisted Living Facility
On May 1, 2004, the Company opened a new assisted living facility (40
units) in Chippewa Falls, Wisconsin.
10. COMPREHENSIVE INCOME
Comprehensive Income is as follows for the periods shown:
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
(IN THOUSANDS)
NET EARNINGS ........................................................ $ 9,347 $ 2,288
OTHER COMPREHENSIVE INCOME:
Unrealized gain on investments, before tax....................... 958 1,123
Gain on cash flow hedges, before tax............................. 67 14
-------------- --------------
Other comprehensive income, before tax........................... 1,025 1,137
Income tax provision related to items of other
comprehensive income ........................................ (410) (445)
-------------- --------------
Other comprehensive income, net of tax........................... 615 692
-------------- --------------
COMPREHENSIVE INCOME................................................ $ 9,962 $ 2,980
============== ==============
14
11. COMMITMENTS AND CONTINGENCIES
Capital Expenditures
As of March 31, 2004, the Company had capital expenditure purchase
commitments outstanding of approximately $8.6 million. During the first quarter
of 2004, the Company completed and opened an addition to a nursing facility (20
beds) and an addition to an assisted living facility (16 units) with a total
cost of approximately $3.5 million. In addition, the Company has entered into
construction agreements for additions to one nursing facility (18 beds),
additions to three assisted living facilities (71 units) and the construction of
one free-standing assisted living facility (40 units), which was opened on May
1, 2004. The Company expects one of the remaining four projects to be completed
in 2004 and the other three projects in early 2005. The total cost of these five
projects is approximately $11.7 million and purchase commitments of $6.8 million
are outstanding.
The Company has also approved eight additional development projects, which
are expected to be completed in 2005 or later, that will expand or add to our
assisted living facilities (329 units). The total cost of these eight projects
is approximately $36.3 million and $1.5 million of purchase commitments are
outstanding.
Insurance and Self-insured Liabilities
The Company insures certain risks with affiliated insurance subsidiaries
of Extendicare Inc. 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.
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 diligent to address 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, 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 that 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 has 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 for the years 2001 and 2002, and should this matter not be settled,
the matter will be taken to arbitration. Provisions for settlement of this claim
are included within the financial statements.
15
In 2002, in connection with its agreements to provide pharmacy services to
the Company, Omnicare, Inc. has 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.
Regulatory Risks
All providers are subject to surveys and inspections by state and federal
authorities to ensure compliance with applicable laws and licensure requirements
of the Medicare and Medicaid programs. The survey process is intended to review
the actual provision of care and services, and remedies for assessed
deficiencies can be levied based upon the scope and severity of the cited
deficiencies. Remedies range from the assessment of fines to the withdrawal of
payments under the Medicare and Medicaid programs. Should a deficiency not be
addressed through a plan of correction, a facility can be decertified from the
Medicare and Medicaid program. As of March 31, 2004, the Company has certain
facilities under plans of correction. While it is not possible to estimate the
final outcome of the required corrective action, the Company has accrued for
known costs.
12. UNCERTAINTIES AND CERTAIN SIGNIFICANT RISKS
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 that 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.
Prior to October 1, 2002, the incremental Medicare relief packages
received from the Balanced Budget Refinement Act ("BBRA") and the Benefits
Improvement and Protection Act ("BIPA") provided a total of $2.7 billion in
temporary Medicare funding enhancements to the long-term care industry. The
funding enhancements implemented by the BBRA and BIPA fall into two categories.
The first category is "Legislative Add-ons" which included a 16.66% add-on to
the nursing component of the Resource Utilization Groupings ("RUGs") rate and
the 4% base adjustment. On September 30, 2002, the Legislative Add-ons expired,
or "Medicare Cliff", resulting in a reduction in Medicare rates for all
long-term care providers and a reduction of approximately $16.7 million per
annum in Medicare funding for the Company.
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. In
April 2002, the Centers for Medicare and Medicaid Services ("CMS") announced
that it would delay the refinement of the RUGs categories thereby extending the
related funding enhancements until September 30, 2003. In May 2003, CMS released
a rule to maintain the current RUGs classification until October 1, 2004.
Further to, but independent of this, Congress enacted legislation directing CMS
to conduct a study on the RUGs classification system and report its
recommendations by January 2005. The implementation of a RUGs refinement change,
where all or part of the enhancement is discontinued, could have a significant
impact on the Company. Based upon the Medicare case mix and census for the
quarter ended March 31, 2004, the Company estimates that it received an average
$25.27 per resident day, which on an annualized basis amounts to $20.5 million
related to the RUGs Refinements.
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. Under the
plan announced by CMS, the reimbursement level would be reduced to 70% over a
three year period 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 Part A co-insurance
reimbursement plan applicable to hospitals. CMS did not implement the rule
change effective October 1, 2003, and continues to review the proposed plan. The
Company estimates that should this plan be implemented, the negative impact on
16
net earnings would be $1.3 million in 2004, increasing to $3.3 million in 2006.
As of March 31, 2004, the States of Pennsylvania, Indiana, Oregon and
Washington have proposed state plan amendments and waivers pertaining to the
fiscal year commencing July 1, 2003 that are awaiting review and approval by
CMS. As the state plan amendments and waivers have not been approved, the
Company has recorded revenues based upon amounts received. Based upon the final
and CMS approved state plan amendments and waivers, changes in Medicaid rates
and any associated provider taxes could result in adjustments to earnings for
the period from July 1, 2003 to March 31, 2004.
Interests in Unrelated Long Term Care Providers
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, 2004, the Company had $17.0 million in
notes and $7.0 million in non-current amounts receivable due from unrelated
long-term care providers in Florida and Texas; and owns $15.4 million in nursing
home properties in Texas and Florida. For the three months ended March 31, 2004
and 2003, the Company earned $1.6 million and $1.4 million, respectively, in
management and consulting fees, and $0.6 million and $0.4 million, respectively,
in rental revenue from unrelated long-term care operators that were operating in
properties owned by the Company as of March 31, 2004. As a result, the earnings
and cash flow of the Company can be influenced by the financial stability of
these unrelated long-term operators.
Medicare and Medicaid Receivables
The Company is attempting to settle a number of outstanding Medicare and
Medicaid receivables. Normally such items are resolved during an annual audit
process and no provision is required. However, where differences exist between
the Company and the FI, the Company may record a general provision. The Company
continues to negotiate on the remaining issues and when appropriate seek
resolution from the PRRB. No adjustment to the receivable amount can be
determined until negotiations are concluded on a majority of issues that are
involved in the cost reporting years under appeal. Though the Company remains
confident that it will successfully settle the issues, an unsuccessful
conclusion could negatively impact the Company's earnings and cash flow. As of
March 31, 2004 and December 31, 2003 the Company had $46.1 million and $51.2
million, respectively, of gross Medicare and Medicaid settlement receivables
with a related contractual allowance of $14.0 million at both dates. The net
amount receivable represents the Company's estimate of the amount collectible on
Medicare and Medicaid prior period cost reports.
Accrual for Self-Insured Liabilities
The Company had $43.6 million and $45.1 million in accruals for
self-insured liabilities as of March 31, 2004 and December 31, 2003,
respectively. 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.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
We are one of the largest providers of long-term care and related services
in the United States. Through our subsidiary network of geographically clustered
facilities, we offer a continuum of healthcare services, including skilled
nursing care, assisted living and related medical specialty services, such as
subacute care and rehabilitative therapy. As of March 31, 2004, we operated or
managed 186 long-term care facilities with 16,901 beds in 13 states, of which
147 were skilled nursing facilities with 15,030 beds and 39 were assisted living
and retirement facilities with 1,871 units. We also provided consulting services
to 72 facilities with 8,839 beds in five states. In addition, we operated 24
outpatient rehabilitation clinics in four states. We receive payment for our
services from Medicare, Medicaid, private insurance, self-pay residents and
other third party payors.
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 goals 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 reflect our beliefs and
assumptions, and are based on information currently available to us.
Forward-looking statements are subject to risks, uncertainties and other factors
that could cause actual results, performance or achievements or industry results
to be materially different 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 " section of our Annual Report on Form 10-K for
the fiscal year ended December 31, 2003 and include the following:
- Medicare and Medicaid payment levels and reimbursement methodologies
and the application of such methodologies and policies adopted by
the government and its fiscal intermediaries;
- liabilities and claims asserted against us, such as resident care
litigation, including our exposure for punitive damage claims and
increased insurance costs;
- national and local economic conditions, including their effect on
the ability to hire and retain qualified staff and employees and the
associated costs;
- federal and state regulation of our business and change in such
regulations, as well as our compliance with such regulations;
- actions by our competitors; and
- our ability to maintain and increase census levels.
All forward-looking statements contained in this Form 10-Q are expressly
qualified in their entirety by the cautionary statements set forth or referred
to above. We assume no obligation to update any forward-looking statement.
18
EXECUTIVE OVERVIEW
Our business strategy and competitive strengths remain unchanged from that
outlined in Item 1 of our Annual Report on Form 10-K. Our key business goals are
to:
- strengthen both Medicare and total average daily census;
- improve operating cash flow;
- actively improve our asset portfolio through renovation, expansion
or acquisition of facilities, or where appropriate, to divest
facilities that fail to meet our performance goals;
- diversify within the long-term care industry in the areas of
rehabilitative clinics and management, consulting, accounting and
purchasing services; and
- manage resident care liability claim settlements.
In the first quarter of 2004, we continued to improve Medicare average
daily census, while our total census remained comparable to the prior year. We
completed two of the seven renovation projects in the first quarter of 2004,
which increased operational capacity at one nursing and one assisted living
facility. And in May 2004, we opened a new (40 units) assisted living facility.
The remaining projects continue to be on schedule, one of which is to be
completed in 2004 and the three other projects in early 2005. We also have
approved eight additional development projects to be completed in 2005 or later
that will expand or add 329 units to our assisted living facilities. We expect
to close on an acquisition of five nursing facilities (423 beds) in Indiana and
Wisconsin by the end of May 2004.
We initiated and completed after the end of the first quarter of 2004
several transactions that will improve our operating cash flow and cash
resources. In April 2004, we issued $125 million of 6.875% Senior Subordinated
Notes due 2014, or the 2014 Notes, and will use the proceeds to purchase for
cash all $200 million of the 9.35% Senior Subordinated Notes due 2007. After
terminating our existing swap and cap agreements, we entered into two new swap
and cap agreements and amended our Credit Facility. As a result of the debt
refinancing, we will lower our long-term debt from $380.2 million as at March
31, 2004 to $332.1 million; and reduce our weighted average interest rate to
approximately 5.1%, as compared to 7.7% as at March 31, 2004. At, and subject
to, these current interest rates and debt levels, the refinancing of our debt
will result in annual interest savings of approximately $12.4 million.
In February 2004, we received prepayment in full of $4.4 million of notes
receivable from Tandem Health Care, Inc. or Tandem. In January 2004, we
negotiated and subsequently received a cash settlement of $5.6 million, for all
remaining years of a Medicare settlement receivable involving a staffing cost
matter. In April 2004, we reached a negotiated settlement with our Fiscal
Intermediary, or FI, on one Medicare settlement receivable issue that will
result in the collection of approximately $7.7 million, of which $6.5 million
will be received in May 2004. In April 2004, we concluded negotiations with
Greystone Tribeca Acquisition, L.L.C., or Greystone, and received on April 29,
2004 interest on the notes of $2.6 million and will receive by June 2004 payment
on the $10.0 million Vendor Take Back note.
We operate in a competitive marketplace and depend substantially on
revenues derived from governmental third-party payors, with the remainder of our
revenues derived from commercial insurers, managed care plans, and private
individuals. The on-going pressures from Medicare and state Medicaid programs,
along with other payors seeking to control costs and/or limit reimbursement
rates for medical services, are but one of the business risks that we face as
outlined in detail within Item 1 of our Annual Report on Form 10-K. We also
operate in a heavily regulated industry, subject to the scrutiny of federal and
state regulators. Each of our facilities must comply with regulations regarding
staffing levels, resident care standards, occupational health and safety,
resident confidentiality, billing and reimbursement, environmental and
biological and other standards. Government agencies have steadily increased
their enforcement activity over the past several years. As a result, we are
continually allocating increased resources to ensure compliance and respond to
inspections, investigations and/or enforcement actions. Federal law requires
each state to have a Medicaid Fraud Control Unit, which is responsible for
investigating provider fraud and resident abuse in Medicaid funded facilities.
We are aware of investigations by these units involving one facility each in
Kentucky and Wisconsin. The investigations have not been sufficiently developed
to enable us to predict an outcome.
19
REVENUES
We derive revenues by providing routine and ancillary healthcare services
to residents in our network of facilities. Long-term healthcare services
provided to our residents include services such as nursing care, assisted living
and related medical services, such as subacute care. We also derive revenues by
providing rehabilitative therapy to outside third parties at our rehabilitation
clinics, and earn management and consulting revenues from other long-term care
organizations.
Nursing facilities
Within our nursing facilities, we generate our revenue from Medicare,
Medicaid and private pay sources. Medicaid rates are generally lower than rates
earned from Medicare, private, commercial insurance and other sources, and
therefore, an important performance measurement is "quality mix", which is
defined as revenues or census earned from payor sources other than from Medicaid
programs. The following table sets forth our Medicare, Medicaid and private pay
sources of revenue of our nursing facilities by percentage of total revenue and
the level of quality mix presented on a same facility basis. These percentages
are the same when including all nursing facilities.
PERCENTAGE OF TOTAL
NURSING REVENUES
FOR THREE MONTHS
ENDED MARCH 31
-------------------
2004 2003
----- -----
Medicare............................... 32.7% 28.8%
Private and other...................... 17.8% 18.6%
----- -----
Quality Mix......................... 50.5% 47.4%
Medicaid............................... 49.5% 52.6%
----- -----
Total............................... 100.0% 100.0%
===== =====
Nursing and Assisted Living Facilities
Within our assisted living facilities, we generate our revenue primarily
from private pay sources, with a small portion earned from Medicaid where states
offer such programs. The following table sets forth our Medicare, Medicaid and
private pay sources of revenues for all nursing and assisted living facilities
by percentage of total revenue and the level of Quality Mix:
PERCENTAGE OF TOTAL NURSING AND ASSISTED LIVING REVENUES
FOR THREE MONTHS ENDED MARCH 31
--------------------------------------------------------
FOR ALL FACILITIES SAME FACILITY BASIS
---------------------- ------------------------
2004 2003 2004 2003
------ ------ ------ ------
Medicare..................................... 31.3% 27.5% 31.2% 27.5%
Private and other............................ 21.1% 22.0% 21.1% 22.0%
------ ------ ------ ------
Quality Mix............................... 52.4% 49.5% 52.3% 49.5%
Medicaid..................................... 47.6% 50.5% 47.7% 50.5%
------ ------ ------ ------
Total..................................... 100.0% 100.0% 100.0% 100.0%
====== ====== ====== ======
Other Revenues
We derive outpatient therapy revenues by providing rehabilitation therapy
services to outside third parties at our clinics. The revenue sources are
primarily HMO's and commercial insurance, workers compensation, Medicare,
Medicaid and other sources, including self-pay clients. Management and
consulting fees are paid directly from the long-term care organizations that we
are contracted to provide services with.
20
LEGISLATIVE ACTIONS AFFECTING REVENUES
Balanced Budget Refinement Act and Temporary Funding Enhancements
Prior to October 1, 2002, the incremental Medicare relief packages
received from the Balanced Budget Refinement Act, or BBRA, and the Benefits
Improvement and Protection Act, or BIPA, provided a total of $2.7 billion in
temporary Medicare funding enhancements to the long-term care industry. The
funding enhancements implemented by BBRA and BIPA fall into two categories. The
first category is "Legislative Add-ons," which includes a 16.66% add-on to the
nursing component of the Resource Utilization Groupings, or RUGs rate and a 4%
base adjustment. The Legislative Add-ons expired on September 30, 2002,
hereafter referred to as the "Medicare Cliff", resulting in a reduction of
approximately $16.7 million per annum in Medicare funding for our skilled
nursing facilities. The second category is "RUGs Refinements" which involved an
initial 20% add-on for 15 RUGs categories identified as having high intensity,
non-therapy ancillary services. Twenty percent add-ons from three RUGs
categories were later redistributed to 14 rehabilitation categories at an add-on
rate of 6.7% each.
Administrative Fix - October 1, 2003
Effective October 1, 2003, the Centers for Medicare and Medicaid Services,
or CMS, increased Medicare rates by 6.26% reflecting (1) a cumulative forecast
correction or Administrative Fix to correct past years under-funded rate
increases, which increased the Federal base payment rates by 3.26%, and (2) the
annual market basket increase of 3.0%. We estimated that based on the Medicare
case mix for the nine month period ended September 30, 2003, these Medicare rate
increases would add approximately $18.45 per Medicare day. Based upon the
Medicare case mix and census in the first quarter of 2004, the impact of the
6.26% Medicare rate increase increased our revenues by $3.7 million, offset by
higher labor and other operating costs. In order to maintain their commitment to
Senator Grassley and CMS in providing the Administrative Fix, in October 2003
the Alliance for Quality Nursing Home Care (which is a membership of large
long-term care providers) and the American Health Care Association, or AHCA,
announced its support to spend the Administrative Fix over the next fiscal
period on direct care and services for its residents. In October 2003, CMS
published notice to skilled nursing facilities that within future cost reports,
it will require confirmation that the Administrative Fix funding was spent on
direct patient care and related expenses.
Future Medicare Changes
With respect to the RUGs Refinements, in April 2002, CMS announced that it
would delay the refinement of the RUGs categories thereby extending the related
funding enhancements until September 30, 2003. In May 2003, CMS released a rule
to maintain the current RUGs classification until October 1, 2004. Further to,
but independent of this, Congress enacted legislation directing CMS to conduct a
study on the RUGs classification system and report its recommendations by
January 2005. Based upon the Medicare case mix and census for the quarter ended
March 31, 2004, we estimate that we received an average $25.27 per resident day,
which on an annualized basis amounts to $20.5 million related to the RUGs
Refinements. The implementation of a RUGs refinement change, where all or part
of the enhancement is discontinued, could have a significant impact on us.
In February 2003, CMS announced its plan to reduce its level of
reimbursement for uncollectible Part A co-insurance. Under the plan announced by
CMS, the reimbursement level would be reduced to 70% over a three year period as
follows: 90% effective for the government fiscal year commencing October 1,
2003; 80% effective for the government fiscal year commencing October 1, 2004;
and 70% effective for government fiscal years commencing on or after October 1,
2005. This plan is consistent with the Part A co-insurance reimbursement plan
applicable to hospitals. CMS did not implement the rule change effective October
1, 2003, and continues to review the proposed plan. We estimate that, should
this plan be implemented, the negative impact to our net earnings would be $1.3
million in 2004, increasing to $3.3 million in 2006.
Medicaid Rates Subject to CMS Approval
Some of the states in which we operate, including Pennsylvania, Indiana,
Oregon and Washington have submitted proposed state plan amendments and waivers
pertaining to the fiscal year commencing July 1, 2003 which are awaiting review
and approval by CMS. The retrospective plan amendments and waivers seek to
increase the level of federal funding for the states' Medicaid programs and, if
approved, would result in providing skilled nursing facilities with revenue rate
increases to
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offset new or increased provider taxes. Since the plan amendments and waivers
have not been approved, we have recorded revenues based upon amounts received.
In Pennsylvania, should CMS approve the State's plan amendment and waiver as
submitted, incremental earnings, net of the provider tax, of $2.8 million could
be recorded in 2004 pertaining to the nine month period ended March 31, 2004.
Without approval, we could record a negative adjustment to earnings of up to
$4.5 million in 2004 pertaining to this same nine-month period. In Indiana,
approval of the original amendment and waiver submitted could result in the
recording of net incremental earnings of $2.3 million in 2004 pertaining to the
nine-month period ended March 31, 2004, and there would be no impact if the plan
were not approved. In Washington, the state has proceeded to implement the
provider tax and fund the incremental Medicaid rates, while seeking approval
from CMS on their proposal. If the plan is not approved, a retroactive negative
adjustment of no greater than $0.5 million to earnings may be required. The
impact of Oregon's plan amendment and waiver is not significant to us. We
anticipate that amendments will be made to the original plans submitted to CMS
and cannot, therefore, predict the outcome of these plan submissions or their
impact on us and our results of operations. Based upon the final CMS approved
state plan amendments and waivers, changes in Medicaid rates and any associated
provider taxes could result in adjustments to earnings for the period from July
1, 2003 to March 31, 2004.
SIGNIFICANT EVENTS AND DEVELOPMENTS
EVENTS OF 2004 QUARTER
Medicare average daily census for the three months ended March 31, 2004,
or 2004 quarter, increased to 2,206 from 1,966 for the three months ended March
31, 2003, or 2003 quarter, on a same facility basis, representing a 12.2%
increase over 2003. Total average daily census for the 2004 quarter increased
slightly to 12,880 from 12,875 for 2003 quarter on a same facility basis. The
improvement in Medicare census was the direct result of a number of our
initiatives, including the implementation of consistent admission practices, the
Medicare certification of all our nursing facility beds and senior management's
focus on census, all of which drove the improved financial results for the 2004
quarter.
Our financial results include the operations of one newly acquired
facility in Wisconsin that was purchased on December 31, 2003. On February 12,
2004, we acquired a skilled nursing facility in Washington, which we had
previously leased, for $1.4 million. In the 2004 quarter, we completed for a
total cost of $3.5 million two development projects involving additions to
existing facilities adding 16 units to one assisted living facility in Kentucky
and 20 nursing beds to one nursing facility in Wisconsin. We commenced managing
two new nursing facilities and transferred management responsibilities to
another long-term care provider, while retaining consulting services for nine
facilities.
In March 2004 we concluded the evaluation of two nursing facilities that
operate adjacent to one another in Indiana, both of which require capital
renovations. After evaluation of the respective operations, we made a decision,
subject to State of Indiana approval, to consolidate the two operations into one
renovated facility, that upon completion, will accommodate all residents within
both facilities however decrease the total available nursing beds by 46. The
consolidation of the two operations is expected to be completed by March 2005.
As a result of the decision to close the one facility, we have recorded a
provision of $1.6 million for impairment of long-lived assets.
In February 2004, Tandem refinanced two of its skilled nursing facilities
and we subsequently received prepayment in full of $4.4 million of notes
receivable held in respect of certain properties. In February 2004, we prepaid
in full two Industrial Development Revenue Bonds totaling $13.0 million. The
repayment of this debt resulted in a charge to earnings of $0.4 million to
write-off deferred financing costs.
EVENTS SUBSEQUENT TO 2004 QUARTER
Issuance of New 2014 Notes and Repayment of 2007 Notes
On April 5, 2004, we commenced a tender offer to purchase any and all of
its outstanding $200 million 2007 Notes. Approximately 61% of the 2007 Notes
(which represents the percentage of 2007 Notes not owned by Extendicare Inc.)
were tendered in the tender offer and repaid on April 22, 2004. We intend to
redeem the 2007 Notes not tendered in the tender offer on May 24, 2004.
22
On April 22, 2004, we issued $125 million aggregate principal amount of
6.875% Senior Subordinated Notes due May 1, 2014, or 2014 Notes, pursuant to
Rule 144A and Regulation S under the Securities Act of 1933, as amended. The
2014 Notes were issued at a price of 97.5001% of par to yield 7.23%.
The net proceeds from the issuance of the 2014 Notes were approximately
$117.4 million (net of a discount of $3.1 million and fees and expenses of $4.5
million). We used a portion of these net proceeds to purchase for cash
approximately $104.9 million aggregate principal amount of the 2007 Notes
tendered in the tender offer and we intend to use the remaining net proceeds,
to, among other things, redeem any 2007 Notes not tendered in the tender offer
and to pay related fees and expenses of the tender offer and redemption.
The 2014 Notes are fully and unconditionally guaranteed on a senior
subordinated basis by all of our existing and future domestic significant
subsidiaries, all of our existing and future domestic subsidiaries that
guarantee or incur any indebtedness and any other existing and future
significant subsidiaries or restricted subsidiaries that guarantee or otherwise
provide direct credit support for indebtedness of ours or any of our domestic
subsidiaries. The 2014 Notes and guarantees are our and our subsidiary
guarantors' general unsecured obligations.
On or after May 1, 2009, we may redeem all or part of the 2014 Notes, at
the redemption prices (expressed as percentages of principal amount) listed
below, plus accrued and unpaid interest, if any, to the date of redemption, if
redeemed during the twelve-month period commencing on May 1 of the years set
forth below:
REDEMPTION
YEAR PRICE
---- -----
2009....................... 103.438%
2010....................... 102.292%
2011....................... 101.146%
2012 and thereafter........ 100.000%
Subject to the conditions of the tender offer, the holders of the 2007
Notes who validly tendered their 2007 Notes or whose 2007 Notes were redeemed by
us are entitled to the premium that, in the aggregate, amounts to approximately
$6.6 million. As a result of the tender offer, redemption and repayment of the
2007 Notes, in the second quarter of 2004, we will write-off deferred finance
charges of approximately $2.4 million related to the 2007 Notes and incur legal
costs estimated at $0.3 million. In addition, pursuant to termination of our
existing interest rate swap and cap agreements (discussed below), we will record
a gain of approximately $3.3 million which will be recognized in the second
quarter of 2004. The net after tax impact to "Accumulated Deficit" is a loss of
approximately $3.9 million. Below is a summary of the adjustment to our
"Accumulated Deficit" account:
(Dollars in
thousands)
----------
Tender premium..................................... $ (3,670)
Call premium....................................... (2,966)
Write-off of deferred finance charges.............. (2,359)
Estimated legal expenses........................... (250)
Gain on termination of interest rate swap and
cap agreements.................................. 3,302
----------
Total before income taxes.......................... (5,943)
Income taxes....................................... 2,080
----------
Net impact to Accumulated deficit.................. $ (3,863)
==========
Amendment and Restatement of Credit Facility
In connection with the offering of the 2014 Notes, we amended and restated
our current credit facility. The terms of the amended and restated credit
facility included the following changes, among other things:
- a two year maturity extension, to June 28, 2009;
23
- an additional $50.0 million of senior secured financing on a
revolving basis, resulting in total borrowing capacity of $155.0
million;
- an interest rate spread which ranges from the Eurodollar rate plus
2.50% per annum to 3.25% per annum or the base rate plus 1.50% per
annum to 2.25% per annum, subject, in each case, to adjustments
based on the our senior leverage ratio;
- a commitment fee of 0.50% per annum on the undrawn capacity
regardless of utilization;
- a requirement that we maintain a maximum senior leverage ratio
starting at 4.25 to 1 and reducing to 4.00 to 1 in 2007;
- a requirement that we maintain a maximum senior secured leverage
ratio starting at 2.25 to 1 and reducing to 2.00 to 1 in 2007; and
- changes to the collateral securing the facility to permit us to
substitute certain assets with other assets.
We expect to borrow approximately $30.0 million under the amended and
restated credit facility to partially fund the redemption of any and all of the
outstanding $200.0 million 2007 Notes. Based on our adjusted capitalization and
EBITDA for the quarter ended March 31, 2004, all borrowings to be drawn under
the amended and restated credit facility will initially bear interest at a rate
per annum equal to:
- the Eurodollar rate plus 2.75%; or
- the Base Rate plus 1.75%,
and thereafter, in each case, subject to adjustments based on our senior
leverage ratio.
Interest Rate Swap and Cap Agreements
In April 2004, coterminous with the issuance of the 2014 Notes, we
terminated our existing interest rate swap and cap agreements for an aggregate
gain of $3.3 million to be recognized in the second quarter of 2004. This swap
was a hedge against the 2007 Notes. In addition, to hedge our exposure to
fluctuations in market value, we entered into two new interest rate swap
agreements and two new interest rate cap agreements relating to the 2010 Senior
Notes and the 2014 Notes.
With respect to the 2010 Senior Notes, we entered into an interest rate
swap agreement expiring July 1, 2010 with a notional amount of $150.0 million.
This agreement effectively converted up to $150.0 million of fixed interest rate
indebtedness into variable interest rate indebtedness. Under the terms of this
interest rate swap agreement, the counterparty can call the swap at any time on
or after July 1, 2006 with payments as determined under the agreement. We also
entered into an interest rate cap agreement expiring July 1, 2010 with a
notional amount of $150.0 million. Under this cap agreement, we paid on April
22, 2004 an upfront fee of $3.5 million to the counterparty that will be
amortized to interest expense over the term of the cap. We will receive a
variable rate of interest equal to the excess, if any, of the six-month London
Interbank Borrowing Rate, or LIBOR, adjusted semi-annually, over the cap rate of
7%. We will use the interest rate cap to offset possible increases in interest
payments under the interest rate swap agreement expiring July 1, 2010 caused by
increases in market interest rates over a certain level. Under the terms of the
interest rate cap agreement, the counterparty can call the cap if the interest
rate swap agreement expiring July 1, 2010 is terminated.
With respect to the 2014 Notes, on April 22, 2004 we entered into an
interest rate swap agreement expiring May 1, 2014 with a notional amount of
$125.0 million. This agreement effectively converted up to $125.0 million of
fixed interest rate indebtedness into variable interest rate indebtedness. Under
the terms of this interest rate swap agreement, the counterparty can call the
swap at any time on or after May 1, 2009 with payments as determined under the
agreement. We also entered into an interest rate cap agreement expiring May 1,
2014 with a notional amount of $125.0 million. Under this cap agreement, we pay
a fixed rate of interest equal to 0.75% to the counterparty and receive a
variable rate of interest equal to the excess, if any, of the six-month LIBOR
rate, adjusted semi-annually, over the cap rate of 7%. We will use the interest
rate cap to offset
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possible increases in interest payments under the interest rate swap agreement
expiring May 1, 2014 caused by increases in market interest rates over a certain
level. Under the terms of the interest rate cap agreement, the counterparty can
call the cap if the interest rate swap agreement expiring May 1, 2014 is
terminated.
Refinancing of Loan Resulting From Acquisition of Previously-leased Facilities
On October 1, 2002 we completed a transaction in which we exercised our
right to acquire seven previously-leased nursing facilities in the states of
Ohio and Indiana for $17.9 million. The purchase price included cash of $7.4
million and a $10.5 million interest bearing 10-year note. The interest rate on
the note was subject to negotiation and failing an agreement would have been
settled through arbitration. In the latter part of 2003, we prepaid $4.5 million
against the note and agreed to refinance the balance of the 10-year note. On
April 15, 2004 we refinanced the facilities with mortgages whose interest rates
vary with LIBOR, and repaid the remaining balance of the note due to the seller.
Settlement of Medicare Receivable Issue
In April 2004, we reached a negotiated settlement with the Fiscal
Intermediary, or FI, in respect of the remaining two years of a specific issue
involving the allocation of overhead costs. The settlement will result in the
payment of approximately $7.7 million, of which $6.5 million will be received in
May 2004 and the balance upon conclusion of resolution of other matters
concerning the cost report years which were under appeal. There are certain
matters related to the settlement and cost report years under appeal have to be
resolved with the FI, which could influence the financial impact of the
settlement. We anticipate that the resolution of these matters and the
determination of the financial impact of the settlement, if any, will be
recorded within the second quarter financial results.
Settlement on Greystone Transaction
In April 2004, we concluded negotiations with Greystone and will receive
the final consideration of $10.0 million on the Vendor Take Back note plus $2.6
million of interest, therefore complete the September 2000 Divestiture
Agreement. The interest payment was received on April 29, 2004 and the $10.0
million note payment will be received in June 2004. The initial transaction in
2000 was treated as a deferred sale, as a significant portion of the proceeds
was contingent, and we held an option to repurchase the facilities. The
finalization of this transaction will result in the recognition in the second
quarter of 2004 of a pre-tax gain from the sale of assets of $4.8 million and
interest income of $1.6 million.
Opening of New Assisted Living Facility
On May 1, 2004 we opened a new assisted living facility (40 units) in
Chippewa Falls, Wisconsin. We expect one of the remaining four projects to be
completed in 2004, and the other three projects in phase one to be completed in
early 2005.
Pending Acquisition of Five Nursing Facilities
We have signed an agreement and expect to close by the end of May 2004 on
an acquisition, for approximately $8.0 million in cash, of five nursing
facilities (423 beds) in Indiana and Wisconsin.
Acquisition of Land for Development
In April 2004, we acquired, for $0.3 million, a piece of land adjacent to
a nursing facility in Manitowoc, Wisconsin that we acquired in December 2003.
25
EVENTS PRIOR TO 2004
Purchase and Construction of New Facilities and Beds
On December 31, 2003, we acquired a skilled nursing facility (99 beds) in
Manitowoc, Wisconsin for $4.1 million. During 2003, we commenced seven new
developments involving additions to two nursing facilities (38 beds), additions
to four assisted living facilities (87 units) and the construction of one new
free-standing assisted living facility (40 units). In late 2003, we also
approved for development, but not commenced, the expansion of, or addition to,
eight assisted living facilities totaling 329 units for an approximate cost of
$36.3 million. None of these projects will be completed in 2004.
Medicare Funding
The October 2003 Medicare rate increase, which included an Administrative
Fix of 3.26% in addition to the market basket increase of 3%, was partial
recognition by CMS of past under-funding of the industry.
SIGNIFICANT ASSETS AND LIABILITIES
Assets, Liabilities and Contingencies Resulting from Divestiture Program
As a result of the divestiture programs in Florida and Texas, we received
cash proceeds and notes, and we retained interest in, or ownership of, certain
skilled nursing home properties and entered into ongoing consulting service
agreements with operators in these two states. As of March 31, 2004, we:
- held an interest, through $30.0 million in contingent notes, in 15
long-term facilities with Greystone;
- held $17.0 million in notes due from Tandem ($13.0 million due in
May 2007 and $4.0 million due in December 2007) and $7.0 million in
non-current amounts receivable from Senior Health -- South and
Senior Health -- Texas; and
- owned six leased skilled nursing home properties in Florida and four
leased skilled nursing home properties in Texas with a net book
value of $15.4 million, and subleased another 12 properties in
Texas.
In September 2000, we disposed of 15 long-term care facilities in Florida
to Greystone for initial cash proceeds of $30.0 million and contingent
consideration in the form of a $10.0 million Vendor Take Back note and two other
contingent and interest bearing notes. The three notes have an aggregate
potential value of up to $30.0 million plus interest and would have been retired
out of the proceeds from the sale or refinancing of the facilities by Greystone.
For the period September 2000 through March 2004, we retained the right of first
refusal to repurchase the facilities. We also retained an option to repurchase
the facilities until March 2003; however, we elected not to place an offer to
repurchase the facilities. Upon maturity of the notes in March 2004, unless the
facilities were sold or refinanced, we were entitled to receive the $10.0
million Vendor Take Back note and accrued interest pursuant to the terms of the
Vendor Take Back and other contingent notes. The notes were due in March 2004,
however repayment of the notes and interest were delayed due to negotiations
with Greystone. In 2000, the option to repurchase along with the significant
portion of the sales price being contingent, resulted in the disposition being
accounted for as a deferred sale in accordance with SFAS No. 66, and
accordingly, there was no gain or loss recorded on the initial transaction. The
fixed assets have been classified as "Assets held under Divestiture Agreement",
and as of March 31, 2004, had a net book value of $33.7 million. As of December
31, 2003, we anticipated the final consideration to be received in 2004, and
therefore the "Assets held under Divestiture Agreement" were classified as a
current asset of December 31, 2004 and we ceased depreciating these assets as of
January 1, 2004. As described in "Events Subsequent to 2004 Quarter," in April
2004 we concluded negotiations with Greystone and received an interest payment
of $2.6 million in April 2004, and will receive by June 2004 the $10.0 million
Vendor Take Back note. The finalization of this transaction will result in the
recognition of a pre-tax gain from the sale of assets of $4.8 million and
interest income of $1.6 million in the second quarter of 2004.
We lease six Florida properties to Senior Health -- South with lease
expiration dates in December 2006. We lease four Texas properties to Senior
Health -- Texas with lease expiration dates in September 2006 and sublease 12
Texas properties
26
to Senior Health -- Texas with sublease expiration dates in February 2012. In
addition, we provide on-going consulting services to Senior Health -- South and
Senior Health -- Texas and earn rental income from the operators of these
facilities. As of March 31, 2004, we had $7.0 million in non-current accounts
receivable due from Senior Health -- Texas and Senior Health -- South. As a
result, our earnings and cash flow can be influenced by the financial stability
of these unrelated companies.
We have recorded provisions for all estimated future costs related to
operations that we disposed of. Those estimates were made at the time of
disposition, recorded in a divested operations liability account and can be
subject to revisions which may impact our future earnings. On an on-going basis,
we review the levels 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. During 2003, we settled certain Medicare and Medicaid
claims and charged to the divested operations liability account approximately
$1.3 million.
We entered into a preferred provider agreement with Omnicare, Inc.
pursuant to the disposition of our 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 our skilled nursing
facilities. In connection with its agreements to provide pharmacy services,
Omnicare has requested arbitration for an alleged lost profits claim related 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 yet been scheduled. We believe we
have interpreted correctly and complied with the terms of the preferred provider
agreement; however, we cannot assure you that other claims will not be made with
respect to the agreement.
Medicare and Medicaid Settlement Receivables
As of March 31, 2004, we are pursuing settlement of a number of
outstanding Medicare and Medicaid receivable balances, which, in aggregate, have
a net book value of $32.1 million. For Medicare revenues earned prior to the
implementation of the Prospective Payment System, or PPS, and Medicaid programs
with a retrospective reimbursement system, differences between revenues that we
ultimately expect to be realized from these programs and amounts received are
reflected as accounts receivable, or as accrued liabilities when payments have
exceeded revenues that we ultimately expect to receive. For Medicare pre-PPS
claims, normally such issues are resolved during the audit process, however, we
record general provisions for disagreements that require settlement through a
formal appeal process.
For a specific staffing cost issue, a settlement of the first year of
seven specific claim years was reached prior to the January 2003 Provider
Reimbursement Review Board, or PRRB, hearing. During 2003, we continued to
negotiate the remaining years in dispute with the FI. In January 2004, we
negotiated and subsequently received a cash settlement of $5.6 million for all
remaining years of the staffing cost settlement matter. The settlement resulted
in no significant adjustment to the recorded receivable balance.
For another specific issue involving the allocation of overhead costs, the
first of three specific claim years was presented to the PRRB at a hearing in
January 2003. The hearing procedures were discontinued after the parties
negotiated a methodology for resolution of the claim. The negotiated settlement
for this and other issues relating to the 1996 cost report year resulted in no
adjustment to the recorded receivable balance, and we subsequently collected
$3.0 million from the FI. For the remaining two specific claim years, in April
2004, we reached a negotiated settlement with the FI that will result in the
payment of approximately $7.7 million, of which $6.5 million will be received in
May, 2004 and the balance upon conclusion of resolution of other matters
concerning the cost report years which were under appeal. There are certain
matters related to the settlement and cost report years that were appealed that
have to be resolved with the FI, which could influence the financial impact of
the settlement. We anticipate that the resolution of these matters and the
determination of the financial impact of the settlement, if any, will be
recorded within the second quarter of 2004.
We have a hearing scheduled in September 2004 for another Medicare
receivable issue in dispute involving a Director of Nursing staff cost issue in
the amount of $3.8 million. We continue to work on the balance of other Medicare
claims with the FI and on an on-going basis with each of the states in respect
of Medicaid receivables.
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Self-Insured Liabilities.
We have $43.6 million in accruals for self-insured liabilities with
respect to general and professional liability claims as of March 31, 2004. We
have estimated that approximately $18.0 million of this liability will be paid
within the next 12 months. The majority of the liability balance was accrued
during the period that we operated in Florida and Texas.
KEY PERFORMANCE INDICATORS
We manage our business through monitoring certain key performance
indicators. The most important key performance indicators are:
Census
Census is defined as the number of residents occupying a bed (or unit in
the case of an assisted living facility).
Average Daily Census
Average Daily Census, or ADC, is the number of residents occupying a bed
over a period of time, divided by the number of days in that period.
Occupancy Percentage
Occupancy is measured as the percentage of census relative to the total
available resident beds. Total available resident beds are the number of beds
(or units in the case of an assisted living facility) available for occupancy
multiplied by the number of days in the period.
Quality Mix
Quality mix is the measure of the level of non-Medicaid census. In most
states, Medicaid is the most unattractive payor source as rates are the lowest
of all payor types.
Average Revenue Rate by Payor Source
The average revenue rate by each payor source influences our focus and
marketing efforts to place certain resident payor types and in certain states
varies based on the acuity of care required by a resident. The change in revenue
rates is largely dictated by CMS and state governments.
EBITDA and EBITDA Percentage
EBITDA is defined as net income (loss) before income taxes, interest
expense net of interest income, depreciation and amortization, and non-cash,
non-recurring (gains) and losses, including disposal of assets, provision for
closure and exit costs and other items, early retirement of debt and impairment
of long-lived assets. EBITDA is not a measure of performance under accounting
principles generally accepted in the United States of America, or GAAP. We use
EBITDA as a key performance indicator and EBITDA expressed as a percentage of
total revenues as a measurement of margin. We understand that EBITDA, or
derivatives thereof, are customarily used by lenders, financial and credit
analysts, and many investors as a performance measure in evaluating healthcare
acquisitions. Moreover, substantially all of our financing agreements, including
the indenture governing our Senior Notes and our credit facility, contain
covenants in which EBITDA is used as a measure of compliance. Thus, we use
EBITDA to monitor our compliance with these financing agreements. EBITDA should
not be considered in isolation or as a substitute for net income, cash flows
from operating activities and other income or cash flow statement data prepared
in accordance with GAAP, or as a measure of profitability or liquidity.
28
REVIEW OF KEY PERFORMANCE INDICATORS
In order to compare our performance between periods, we assess the key
performance indicators for all of our facilities, as well as the facilities that
we operated in all reported periods, or same facility operations. Set forth
below, we provide an analysis of our key performance indicators in total, and
where appropriate, on a same facility basis and discuss the significant trends
when comparing the three months ended March 31, 2004 to the same period in 2003.
The same facility basis figures exclude the December 2003 acquisition of the new
nursing facility in Manitowoc, Wisconsin.
Skilled Nursing Facilities - ADC and Quality Mix
The following table sets forth the ADC, by type of payor, and the Quality
Mix for all of our nursing facilities.
THREE MONTHS ENDED MARCH 31
--------------------------------------------------
FOR ALL FACILITIES SAME FACILITY BASIS
-------------------- ---------------------
2004 2003 2004 2003
---- ---- ---- ----
Medicare............... 2,225 1,966 2,206 1,966
Private and other...... 2,179 2,233 2,185 2,233
------ ------ ------ ------
Quality Mix......... 4,404 4,199 4,391 4,199
Medicaid............... 8,574 8,676 8,489 8,676
------ ------ ------ ------
Total.............. 12,978 12,875 12,880 12,875
====== ====== ====== ======
The following table sets forth the ADC, by type of payor and percentage of
ADC by payor type for all of our nursing facilities, presented on a same
facility basis, and showing the percentage change in ADC between years.
THREE MONTHS ENDED MARCH 31
--------------------------------------------------------------
2004 2003
-------------------- ------------------- % CHANGE
% OF % OF 2004 TO
ADC TOTAL ADC TOTAL 2003
--- ----- --- ----- ----
Medicare.............. 2,206 17.1% 1,966 15.3% 12.2%
Private and other..... 2,185 17.0% 2,233 17.3% (2.1%)
------ ----- ------ ---- ----
Quality Mix........... 4,391 34.1% 4,199 32.6% 4.6%
Medicaid.............. 8,489 65.9% 8,676 67.4% (2.2%)
------ ----- ------ ----- ----
Total............. 12,880 100.0% 12,875 100.0% 0.0%
====== ===== ====== ===== ====
On a same facility basis, total ADC remained virtually unchanged between
2004 and 2003. On a same facility basis, Medicare ADC increased 12.2% between
2004 and 2003. As a result, the percentage of Medicare ADC to all payor sources
increased to 17.1% in 2004, as compared to 15.3% in 2003. The improvement in
census was the direct result of a number of initiatives, including an
implementation of consistent admission practices, the Medicare certification of
all nursing facility beds, and senior management's focus on census, all of which
drove the improved financial results for 2004.
29
All Skilled Nursing and Assisted Living Facilities - Occupancy
The following table sets forth occupancy percentages, ADC and operational
resident capacity for all of our nursing and assisted living facilities in total
for the three months ended March 31, 2004 and 2003.
OCCUPANCY OPERATIONAL RESIDENT
PERCENTAGE ADC CAPACITY
--------------- ----------------- ---------------------
2004 2003 2004 2003 2004 2003
---- ---- ---- ---- ---- ----
Nursing.............. 91.3% 91.3% 12,978 12,875 14,215 14,096
Assisted Living...... 86.7% 85.5% 1,488 1,501 1,716 1,756
Nursing and
Assisted Living.... 90.8% 90.7% 14,466 14,376 15,931 15,852
The following table sets forth occupancy percentages, ADC and operational
resident capacity for all of our nursing and assisted living facilities on a
same facility basis for the three months ended March 31, 2004 and 2003.
OCCUPANCY OPERATIONAL RESIDENT
PERCENTAGE ADC CAPACITY
---------------- ---------------- --------------------
2004 2003 2004 2003 2004 2003
---- ---- ---- ---- ---- ----
Nursing............... 91.2% 91.3% 12,880 12,875 14,116 14,096
Assisted Living....... 86.7% 85.5% 1,488 1,716 1,756
1,501
Nursing and
Assisted Living..... 90.8% 90.7% 14,368 14,376 15,832 15,852
Occupancy percentages increased within the assisted living facilities to
86.7% in 2004 quarter from 85.5% in the 2003 quarter. The improvement in
occupancy within the assisted living facilities was due to the implementation of
regional marketing personnel to assist local managers in improving their
marketing efforts and changes in management personnel in certain facilities.
The following table sets forth the number of facilities under operation.
AS OF AS OF
MARCH 31 DECEMBER 31
-------- -----------
2004 2003
---- ----
Percent of facilities owned................... 94.3% 93.7%
Number of facilities under operation.......... 174 174
The percentage of facilities owned increased in the 2004 quarter due to
the purchase of a previously leased facility in the state of Washington.
Skilled Nursing Facilities - Average Revenue per Resident Day by Payor Source
The following table sets forth the average nursing revenue per resident
day by payor source, including ancillary revenue and the impact of prior year
revenue adjustments
THREE MONTHS
ENDED MARCH 31
-------------------
2004 2003
---- ----
Medicare (Part A and Part B)........ $346.82 $318.12
Private and other................... $192.77 $181.16
Medicaid............................ $136.11 $131.63
------- -------
Total .......................... $181.75 $168.71
======= =======
30
During the 2004 quarter we recorded prior period Medicaid revenue
adjustments of $1.3 million pursuant to the settlement of state cost reports.
During the 2003 quarter, we recorded prior period Medicaid revenue adjustments
of $2.7 million, which included a recovery of $1.5 million in Medicaid revenues
resulting from a favorable court decision in the State of Ohio relating to the
recovery of alleged government overpayments for adjudicated Medicaid cost report
periods.
The following table sets forth the average revenue rate by payor source,
excluding the above-mentioned revenue adjustments, and the percentage changes
between years. In addition, the Medicare - Part A rate is also reported.
THREE MONTHS
ENDED MARCH 31 PERCENTAGE
------------------- CHANGE FROM
2004 2003 2004 TO 2003
---- ---- ------------
Medicare (Part A and Part B)........ $346.82 $318.12 9.0%
Private and other................... $192.77 $181.16 6.4%
Medicaid............................ $134.37 $128.15 4.9%
------- ------- ---
Total .......................... $180.60 $167.63 7.7%
======= ======= ===
Medicare Part A only................ $317.99 $290.78 9.4%
The Medicare rate increased 9.0%, of which 6.26% was the result of the
October 2003 Medicare rate increase that included an Administrative Fix of
3.26%. The balance of the increase is attributable to an increase in the acuity
and level of rehabilitative residents admitted.
EBITDA and EBITDA Percentage
The following table sets forth a reconciliation of net income before taxes
and EBITDA.
THREE MONTHS
ENDED MARCH 31
--------------
2004 2003
---- ----
Net income before income taxes................. $ 14,986 $ 3,828
Add (deduct):
Depreciation and amortization................ 8,681 9,161
Interest expense............................. 8,200 8,495
Interest income.............................. (1,542) (643)
Loss on impairment of long-lived assets...... 1,612 --
Loss on early retirement of debt............. 354 --
-------- --------
EBITDA......................................... $ 32,291 $ 20,841
======== ========
The following table sets forth the calculations of EBITDA percentages:
THREE MONTHS
ENDED MARCH 31
--------------
2004 2003
---- ----
EBITDA....................................... $ 32,291 $ 20,841
Revenues..................................... $231,501 $211,426
EBITDA as percentage of total revenues....... 13.9% 9.9%
EBITDA, as a percentage of total revenues, increased to 13.9% in the 2004
quarter from 9.9% in the 2003 quarter. The increase was attributable to the
improvement in Medicare census (12.2%) and reductions in certain operating costs
as a percentage of revenues, primarily wages and benefits.
31
RESULTS FROM OPERATIONS
The following table sets forth details of our revenues and earnings as a
percentage of total revenues:
THREE MONTHS
ENDED MARCH 31
--------------
2004 2003
---- ----
Revenues
Nursing and assisted living facilities............ 96.9% 96.9%
Outpatient therapy................................ 1.2 1.3
Other............................................. 1.9 1.8
----- -----
..................................................... 100.0 100.0
Operating and general and administrative costs...... 85.1 89.1
Lease, depreciation and amortization................ 4.7 5.4
Interest, net....................................... 2.9 3.7
Loss on impairment of long-lived assets............. 0.7 --
Loss on early retirement of debt.................... 0.2 --
----- -----
Earnings before income taxes........................ 6.4 1.8
Income tax expense.................................. 2.4 0.7
----- -----
Net earnings........................................ 4.0% 1.1%
===== =====
THREE MONTHS ENDED MARCH 31, 2004 COMPARED WITH THREE MONTHS ENDED MARCH 31,
2003
REVENUES
Revenues in the three months ended March 31, 2004, or 2004 quarter,
increased $20.1 million, or 9.5%, to $231.5 million from $211.4 million in the
three months ended March 31, 2003, or 2003 quarter. Outpatient therapy and other
revenues increased by $0.5 million in the 2004 quarter due to increased lease
revenue and management and consulting revenue.
32
Revenues from nursing and assisted living facilities increased $19.6
million in the 2004 quarter compared to the 2003 quarter including $1.6 million
as a result of the acquisition of a facility in Manitowoc, Wisconsin on December
31, 2003. Revenues from nursing and assisted living facilities on a same
facility basis increased $18.0 million. This increase was attributable to the
following:
DOLLARS IN
MILLIONS
--------
- - a 5.0% increase (excluding prior period adjustments) in the average daily nursing Medicaid rate
(which included cost-offset funding as a result of increased state assessments and bed taxes of
$1.6 million)............................................................................................ $ 5.0
- - an increase in Medicare revenues due to the 6.26% increase in the Medicare Part A rate effective
October 1, 2003.......................................................................................... 3.7
- - an increase in Medicare residents from 15.3% of total residents in the 2003 quarter to 17.1% in
the 2004 quarter......................................................................................... 3.4
- - increase due to one extra day in the 2004 quarter........................................................ 2.1
- - increases in other average daily nursing rates........................................................... 1.9
- - an increase in Medicare revenues due to the improvement in RUGs mix and other factors.................... 1.7
- - an increase in nursing ancillary revenues................................................................ 1.1
- - an increase in assisted living revenues due to increased occupancy and higher rates...................... 0.5
----
19.4
These increases were offset by:
- - favorable prior year revenue adjustments recorded in the 2003 quarter consisting of (a) a
recovery of $1.5 million in Medicaid revenues in the 2003 quarter as the outcome of a favorable
court decision in the State of Ohio, and (b) $1.3 million in favorable settlements of prior year
state cost reports, in excess of $1.4 million of settlements of prior year state cost reports
recorded in 2004......................................................................................... (1.4)
-----
Total increase in revenues from same facility nursing and assisted living centers........................... $18.0
=====
OPERATING AND GENERAL AND ADMINISTRATIVE COSTS
Operating and general and administrative costs increased $8.6 million, or
4.6%, in the 2004 quarter compared to the 2003 quarter, including $1.2 million
as a result of the acquisition of a facility in Manitowoc, Wisconsin facility on
December 31, 2003. Operating and general and administrative costs on a same
facility basis increased $7.4 million. This increase was attributable to the
following:
DOLLARS IN
MILLIONS
--------
- - wages and benefits of $2.6 million and contracted staffing for food, laundry and therapy services
of $0.5 million, totaling $3.1 million, or a 2.2% increase, which included an average wage rate
increase of 1.6% in nursing operations....................................................................... $ 3.1
- - state assessments and bed taxes.............................................................................. 1.6
- - drug expense due to higher resident census, Medicare mix and drug prices..................................... 1.4
- - bad debt expense............................................................................................. 0.8
- - other operating expenses..................................................................................... 0.5
-----
Total increase in same facility operating and general and administrative costs.................................. $ 7.4
=====
33
LEASE COSTS, DEPRECIATION AND AMORTIZATION
Lease costs were unchanged at $2.3 million for both the 2004 quarter and
the 2003 quarter. Depreciation and amortization decreased $0.5 million to $8.7
million in the 2004 quarter compared to $9.2 million in the 2003 quarter. This
decrease included a decrease of $0.6 million as a result of the discontinuation
of depreciation on assets held for divestiture as of January 1, 2004, offset by
an increase of $0.1 million from other items.
INTEREST
Interest expense, net of interest income, decreased $1.2 million to $6.7
million for the 2004 quarter compared to $7.9 million for the 2003 quarter. The
weighted average interest rate of all long-term debt increased to 7.79% during
the 2004 quarter compared to approximately 7.74% during the 2003 quarter.
Interest income was $0.9 million higher in the 2004 quarter than in the 2003
quarter primarily due to $1.0 million in interest income from Greystone that was
previously not recognized. The average debt level decreased to $384.7 million
during the 2004 quarter compared to $398.1 million during the 2003 quarter.
LOSS ON IMPAIRMENT OF LONG-LIVED ASSETS
In March 2004 we concluded the evaluation of two nursing facilities in
Indiana and made a decision, subject to State of Indiana approval, and after
renovation to one of the two facilities, to consolidate the two operations into
one. As a result of the decision to close the one facility, we have recorded a
provision of $1.6 million for impairment of long-lived assets.
LOSS ON EARLY RETIREMENT OF DEBT
The loss on the early retirement of debt in the 2004 quarter of $0.4
million was due to the extinguishment, in February 2004, of two Industrial
Development Revenue Bonds totaling $13.0 million.
INCOME TAXES
Income tax expense for the 2004 quarter was $5.6 million compared to $1.5
million for the 2003 quarter. Our effective tax rate was 37.6% for the 2004
quarter as compared to 40.2% for the 2003 quarter. The decrease in the effective
tax rate resulted from current and prior year state deferred income tax benefits
and the impact of permanent items between the two years. 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 2004 quarter were $9.3 million compared to $2.3
million for the 2003 quarter. The improvement in net earnings was due to the
reasons described herein.
RELATED PARTY TRANSACTIONS
We insure certain risks, including comprehensive general liability,
property coverage, excess workers' compensation and employer's liability
insurance, with Laurier Indemnity Company and Laurier Indemnity Ltd., affiliated
insurance subsidiaries of Extendicare Inc., our Canadian indirect parent. We
recorded approximately $2.8 million and $2.6 million of expenses for this
purpose for the 2004 quarter and 2003 quarter, respectively. Also, for the 2004
quarter, we recorded a credit to expense of $1.0 million relating to prior year
workers' compensation policies with Laurier Indemnity Company.
34
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 $1.2 million and $1.7 million for the 2004
quarter and 2003 quarter, respectively.
LIQUIDITY AND CAPITAL RESOURCES
SOURCES AND USES OF CASH
We had cash and cash equivalents of $47.9 million at March 31, 2004 and
$48.9 million at December 31, 2003. We generated cash flow of $18.5 million from
operating activities for the 2004 quarter compared with $4.5 million in the 2003
quarter. We used cash flow of $7.2 million for investing activities in the 2004
quarter as compared to $4.4 million in the 2003 quarter. We used cash flow of
$12.2 million for financing activities in the 2004 quarter as compared to
providing cash flow of $0.4 million from financing activities in the 2003
quarter.
The increase in cash flow from operating activities of $14.0 million in
the 2004 quarter compared to the 2003 quarter was primarily due to an
improvement in earnings, the collection in the 2004 quarter of $6.1 million of
Medicare settlement receivables, and a reduction of $2.5 million in payments for
self-insured liabilities.
Our working capital decreased $0.7 million from $55.8 million at December
31, 2003 to $55.1 million at March 31, 2004.
Accounts receivable at March 31, 2004 were $93.9 million compared with
$95.3 million at December 31, 2003, representing a decrease of $1.4 million. The
reduction in accounts receivable included a $2.5 million decrease within the
nursing operations offset by an increase of $1.0 million in interest income due
from Greystone and a $0.1 million increase in outpatient therapy receivables.
Within the nursing operations, billed patient care and other receivables
increased $2.6 million while, based on Medicare and Medicaid cost reports,
third-party payor settlement receivables decreased $5.1 million.
The decrease in settlement receivables of $5.1 million from December 31,
2003 to March 31, 2004 included decreases of $6.0 million from the collection of
Medicare settlements and $2.3 million from the collection of Medicare
co-insurance amounts. These decreases were partially offset by an increase of
$2.7 million relating to revenue in the 2004 quarter for anticipated Medicare
reimbursement for uncollectible co-insurance amounts and an increase of $0.5
million from Medicaid cost report settlements.
Property and equipment increased $0.9 million from December 31, 2003 to a
total of $449.6 million at March 31, 2004. The increase was the result of (1)
total capital expenditures of $10.7 million, which included $3.8 million from
construction of new developments and $1.5 million from the February 2004
acquisition of a previously-leased nursing facility in Washington, plus (2)
other items of $0.2 million. This increase was partially offset by depreciation
expense of $8.4 million and a provision for impairment of long-lived assets of
$1.6 million.
Total long-term debt, including both current and long-term maturities of
debt, totaled $380.2 million at March 31, 2004. This represents a decrease of
$12.7 million from December 31, 2003, including a decrease of $13.0 million due
to the prepayment of Industrial Development Revenue Bonds.
Cash used in investing activities was $7.2 million for the 2004 quarter
compared to $4.4 million for the 2003 quarter. The change of $2.8 million was
due to payments for acquisitions of $2.1 million in the 2004 quarter, payments
for new construction projects of $3.8 million in the 2004 quarter, an increase
in the 2004 quarter compared to the 2003 quarter of $0.6 million in purchases of
property and equipment, and an increase in other non-current assets of $0.7
million, partially offset by the collection of note receivables of $4.4 million.
Cash used in financing activities was $12.2 million for the 2004 quarter
compared to $0.4 million provided from financing activities for the comparable
2003 quarter. The change of $12.6 million primarily related to a $13.0 million
prepayment of Industrial Development Revenue Bonds.
35
DEBT INSTRUMENTS
Summary of Long-term Debt
Long-term debt consisted of the following as of March 31, 2004 and
December 31, 2003:
MARCH 31, DECEMBER 31
2004 2003
---- ----
(IN THOUSANDS OF DOLLARS)
Senior Notes due 2010........................................ $ 149,685 $ 149,676
Senior Subordinated Notes due 2007........................... 200,000 200,000
Industrial Development Revenue Bonds, variable
interest rates ranging from 1.00% to 6.25%,
maturing through 2014, secured by certain facilities..... 20,160 33,160
Mortgage notes payable, interest rates ranging
from 3.0% to 10.5%, maturing through 2012................ 10,368 10,054
Other, primarily capital lease obligations................... 24 28
---------- ---------
Long-term debt before current maturities..................... 380,237 392,918
Less current maturities...................................... 1,276 1,223
========== =========
Total long-term debt......................................... $ 378,961 $ 391,695
========== =========
The weighted average interest rate of all of our long-term debt (including
the effects of the interest rate swap and cap agreements discussed below) was
7.70% and 7.52% as of March 31, 2004 and December 31, 2003, respectively. Our
long-term debt instruments have maturities ranging from 2004 to 2014.
2010 Senior Notes
On June 28, 2002, we refinanced all outstanding indebtedness under our
then existing credit facility with the proceeds from the issuance of $150.0
million of our 2010 Senior Notes.
The subsidiary guarantees of the 2010 Senior Notes are full and
unconditional, and joint and several, and any of our subsidiaries that do not
guarantee the 2010 Senior Notes are minor. There are no significant restrictions
on the ability of us to obtain funds from our subsidiaries by loan or dividend.
The indenture governing the 2010 Senior Notes contains customary covenants
and events of default. Under this indenture, we are also restricted from
incurring indebtedness if the fixed charge coverage ratio, determined on a pro
forma basis, is less than or equal to 2.0 to 1. Our fixed charge coverage ratio
is currently in excess of this minimum requirement. The fixed charge coverage
ratio is defined under our 2010 Senior Notes agreement, and is represented by a
ratio of consolidated cash flow to fixed charges. In general, fixed charges
consist of interest expense, including capitalized interest, amortization of
fees related to debt financing and rent expense deemed to be interest, and
consolidated cash flow is net income prior to the aforementioned fixed charges,
and prior to income taxes and losses on disposal of assets.
In October 2003, the 2010 Senior Notes were upgraded by Standard & Poor's
Ratings Services, or S&P, from "B-" to "B," and the credit facility was upgraded
from "BB-" to "BB." In April 2004, the 2010 Senior Notes were upgraded by
Moody's Investors Service from "B2" to "B1."
2007 Notes
As of March 31, 2004, we had $200.0 million of 2007 Notes outstanding. The
2007 Notes are unsecured obligations subordinated in right of payment to all of
our existing and future senior indebtedness, which includes all borrowings under
our credit facility as well as all indebtedness not refinanced by our credit
facility.
As of December 31, 2003, Extendicare Inc. held $27.9 million, or 14.0%, of
the 2007 Notes. In October 2003, the 2007 Notes were upgraded by S&P from "CCC+"
to "B-."
For additional information pertaining to the tender offer for any and all
of the outstanding 2007 Notes, see "Events of 2004 - Subsequent to 2004
Quarter."
36
Credit Facility
On June 28, 2002, we entered into a credit facility that provides senior
secured financing of up to $105.0 million on a revolving basis. As of March 31,
2004, we did not have any borrowings outstanding under this credit facility, but
we had $33.7 million of letters of credit outstanding thereunder. The credit
facility will terminate on June 28, 2007. As of December 31, 2003 and continuing
through March 31, 2004, based upon financial performance, borrowings drawn under
the credit facility bear interest, at our option, at an annual rate equal to:
- LIBOR plus 3.25%; or
- the Base Rate plus 2.25%.
Our obligations under the credit facility are guaranteed by:
- Extendicare Holdings, Inc., our direct parent;
- each of our current and future domestic subsidiaries excluding
certain inactive subsidiaries; and
- 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.
Our obligations under the credit facility 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 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 credit facility
contains customary covenants and events of default and is subject to various
mandatory prepayments and commitment reductions. The credit facility requires
that we comply with various financial covenants, on a consolidated basis
including:
- a minimum fixed charge coverage ratio of 1.10 to 1 and increasing to
1.20 to 1 in 2005;
- a minimum tangible net worth that started at 85% of our tangible net
worth at March 31, 2002 and increases by 50% of our net income for
each fiscal quarter plus 100% of any additional equity we raise;
- a maximum senior leverage ratio of 4.25 to 1 and reducing to 4.00 to
1 in 2005; and
- a maximum senior secured leverage ratio of 1.75 to 1 and reducing to
1.50 to 1 in 2005.
We were in compliance with these financial covenants as of March 31, 2004.
For additional information pertaining to the credit facility, see "Events
of 2004 - Subsequent to 2004 Quarter."
Interest Rate Swap and Cap Agreements
To hedge our exposure to fluctuations in the market value of the 2010
Senior Notes, we entered into a five-year interest rate swap agreement with a
notional amount of $150.0 million. The agreement effectively converted up to
$150.0 million of our fixed interest rate indebtedness into variable interest
rate indebtedness. Under the terms of the interest rate swap agreement, the
counterparty can call the swap upon 30 days notice.
Also in June 2002, we entered into a five-year interest rate cap agreement
with a notional amount of $150.0 million. Under this cap agreement, 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 agreement 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
37
debt obligations. Under the terms of the interest rate swap agreement, the
counterparty can call the swap upon 30 days notice. For additional information
regarding the termination of the interest rate swap and cap agreements, and the
two new interest rate swap and cap agreements that we entered into, see "Events
of 2004 - Subsequent to 2004 Quarter."
Off Balance Sheet Arrangements
We have no significant off balance sheet arrangements.
Cash Management
As of March 31, 2004, we held cash and cash equivalents of $47.9 million.
The majority of excess cash is held in Certificate of Deposits, or CDs, that are
invested for periods of less than 90 days. We forecast on a regular basis
monthly cash flows to determine the investment periods of CDs and monitor daily
the incoming and outgoing expenditures to ensure available cash is invested on a
daily basis.
FUTURE LIQUIDITY AND CAPITAL RESOURCES
We believe that our cash from operations and anticipated growth, together
with other available sources of liquidity, including borrowings available under
our 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.
At March 31, 2004, we have made or are committed to make capital
expenditures in respect of seven new developments, which will add 165 beds
during 2004 and 2005. Two of these projects adding 32 beds were completed during
the first quarter of 2004. The total expected cost of these seven projects is
$15.2 million, of which $4.3 million was expended in 2003, $3.6 million was
expended in 2004, and $6.8 million is committed to be expended on these
projects. Approximately $0.5 million of the planned amounts for these projects
have not yet been committed.
We have also approved eight new assisted living facility developments that
will add 329 units and have an approximate cost of $36.3 million. As of March
31, 2004, $0.2 million has been expended and $1.5 million is committed to be
expended for these developments. These new developments are scheduled to open in
2005 and later.
At March 31, 2004, we have accrued provisions for settlement of
self-insured liabilities of $43.6 million in respect of general and professional
liability claims. Claim payments were $3.1 million and $5.6 million for the 2004
quarter and 2003 quarter, respectively. The accrual for self-insured liabilities
includes estimates of the cost of both reported claims and claims incurred but
not yet reported. We exited the nursing facility markets of the highly litigious
States of Florida and Texas in 2000 and 2001, respectively. As a result,
accruals for general and professional liabilities have declined significantly
from the 2001 level. We estimate that $18.0 million of the total $43.6 million
liability will be paid within the next fiscal year. The timing of payments is
not directly within our control, and therefore, estimates are subject to change
in the future. We believe we have provided sufficient provisions as of March 31,
2004.
CONTRACTUAL OBLIGATIONS
Set forth below is a table showing the estimated timing of payments under
the contractual obligations as of March 31, 2004:
PAYMENTS DUE BY PERIOD
----------------------
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
----- ------ --------- --------- -------
(IN THOUSANDS)
Long-term debt............ $ 380,237 $ 1,007 $ 2,957 $ 205,567 $ 170,706
Operating lease commitments 46,936 8,550 13,609 7,375 17,402
---------- ------- -------- --------- ---------
Total..................... $ 427,173 $ 9,557 $ 16,566 $ 212,942 $ 188,108
========== ======= ======== ========= =========
After giving effect to the April 2004 issuance of the 2014 Notes, the
repurchase or redemption of our 2007 Notes and
38
anticipated borrowings under our amended and restated credit facility,
contractual obligations due in three to five years will decrease to $12.9
million, and contractual obligations due in more than five years will increase
to $340.0 million.
CRITICAL ACCOUNTING POLICIES
For a full discussion of our accounting policies as required by accounting
principles generally accepted in the United States, refer to the Management's
Discussion and Analysis section of the Annual Report on Form 10K for the year
ended December 31, 2003. 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.
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. 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, 2004 (dollars in thousands):
AFTER FAIR
2004 2005 2006 2007 2008 2008 TOTAL VALUE
------- ------- -------- -------- ------- --------- --------- ---------
LONG-TERM DEBT:
Fixed Rate.......................... $ 1,007 $ 1,465 $ 1,492 $204,346 $ 1,221 $ 151,706 $ 361,237 $ 386,745
Average Interest Rate............... 8.56% 7.85% 7.90% 9.31% 9.50% 9.51% 9.38%
Variable Rate....................... -- -- -- -- -- $ 19,000 $ 19,000 $ 19,000
Average Interest Rate............... -- -- -- -- -- 1.01% 1.01%
INTEREST RATE SWAPS:
(fixed to variable)
Notional Amount..................... -- -- -- $150,000 -- -- $ 150,000 $ (3,800)
Average Pay Rate (variable rate).... -- -- -- 5.90% -- -- 5.90%
Average Receive Rate (fixed
rate)............................... -- -- -- 9.35% -- -- 9.35%
INTEREST RATE CAPS:
Notional Amount................... -- -- -- $150,000 -- -- $ 150,000 $ 787
The above table incorporates only those exposures that existed as of March
31, 2004 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.
39
In April 2004, we issued $125 million of aggregate principal amount of
2014 Notes and will use the proceeds, together with borrowings under our amended
and restated credit facility and cash on hand, to purchase for cash all of the
$200 million of the 2007 Notes. After terminating our existing swap and cap
agreement, we entered into two new swap and cap agreements hedging the 2010
Senior Notes and 2014 Notes, and amended our credit facility. As a result, the
percentage of fixed to variable rate debt will change.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
The Company's management evaluated, with the participation of the
Company's Chairman of the Board and Chief Executive Officer, and Vice President
and Chief Financial Officer and Treasurer, the effectiveness of the design and
operation of the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934) as
of the end of the 2004 quarter. Based upon their evaluation of these disclosure
controls and procedures, the Chairman of the Board and Chief Executive Officer,
and Vice President and Chief Financial Officer and Treasurer concluded that the
disclosure controls and procedures were effective as of the end of the 2004
quarter to ensure that material information relating to the Company (including
its consolidated subsidiaries) was made known to them by others within those
entities, particularly during the period in which this Quarterly Report on Form
10-Q was being prepared.
Changes in internal controls
There were no changes in the Company's internal controls over financial
reporting that occurred during the 2004 quarter that have materially affected,
or are reasonably likely to materially affect, the Company's internal controls
over financial reporting.
40
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There were no material developments related to our legal proceedings
during the 2004 quarter. For further information regarding our legal
proceedings, refer to Item 3 - Legal Proceedings in our Annual Report on Form
10-K for the year ended December 31, 2003 as well as the paragraphs which
discuss litigation and the Omnicare Preferred Provider Agreement in Note 11 of
the condensed consolidated financial statements included in this Form 10-Q.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On April 30, 2004, we completed our cash tender offer for any and all of
our $200 million outstanding 2007 Notes and related consent solicitation. We
received the required consents in the consent solicitation to eliminate
substantially all of the restrictive covenants in the indenture governing the
2007 Notes, other than the covenants to pay principal of and interest on the
2007 Notes when due, and eliminate or modify related events of default. Holders
of the 2007 Notes who tendered their 2007 Notes and consented to the revisions
to the indenture governing the 2007 Notes are deemed to have released and waived
any and all claims they may have arising from any prior non-compliance by us,
our affiliates or our subsidiaries under such indenture. Holders of 2007 Notes
that did not tender their 2007 Notes are no longer entitled to the benefits of
certain restrictive covenants and related events of default contained in the
indenture governing the 2007 Notes prior to our receiving the requisite consent
to revise such indenture.
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:
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 - Chairman of the Board and Chief Executive Officer
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 - Vice President, Chief Financial Officer and Treasurer
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 - Chairman of the Board and Chief Executive Officer and Vice
President, Chief Financial Officer and Treasurer
41
(b) Reports on Form 8-K
Form 8-K furnished on February 20, 2004, relating to a press release dated
February 19, 2004, which announced earnings for the quarter ended December
31, 2003, pursuant to items 7 and 12.
Form 8-K furnished on March 18, 2004, relating to a press release dated
March 18, 2004, which announced the appointment of Phil Small as the
Company's Executive Vice President and Chief Operating Officer pursuant to
items 5 and 7.
42
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 13, 2004 By: /s/ Mark W. Durishan
----------------------------------
Mark W. Durishan
Vice President, Chief Financial
Officer and Treasurer
(principal financial officer and
principal accounting officer)
43
EXTENDICARE HEALTH SERVICES, INC.
EXHIBIT INDEX
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 -
Chairman of the Board and Chief Executive Officer
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 -
Vice President, Chief Financial Officer and Treasurer
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 -
Chairman of the Board and Chief Executive Officer, and Vice President,
Chief Financial Officer and Treasurer
44