Back to GetFilings.com
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 JUNE 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NUMBERS 333-43549, 333-97293 AND 333-116927
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 - 1,000 shares authorized, $1.00 par value per share; 947
shares issued and outstanding as of August 4, 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 and Six Months Ended June 30, 2004 and 2003.... 3
Condensed Consolidated Balance Sheets, June 30, 2004 and December 31, 2003........................................ 4
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 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............................. 21
Item 3 Quantitative and Qualitative Disclosures About Market Risk........................................................ 46
Item 4 Controls and Procedures........................................................................................... 47
PART II OTHER INFORMATION:
Item 1 Legal Proceedings................................................................................................. 48
Item 2 Changes in Securities and Use of Proceeds......................................................................... 48
Item 3 Defaults Upon Senior Securities................................................................................... 48
Item 4 Submission of Matters to a Vote of Security Holders............................................................... 48
Item 5 Other Information................................................................................................. 48
Item 6 Exhibits and Reports on Form 8-K.................................................................................. 48
SIGNATURES................................................................................................................. 50
EXHIBIT INDEX.............................................................................................................. 51
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EXTENDICARE HEALTH SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(IN THOUSANDS)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2004 2003 2004 2003
--------- --------- --------- --------
REVENUES:
Nursing and assisted living facilities ........................... $ 225,660 $206,204 $ 450,086 $411,009
Outpatient therapy ............................................... 3,009 3,084 5,674 5,728
Other ............................................................ 4,659 3,970 9,069 7,947
--------- --------- --------- ---------
233,328 213,258 464,829 424,684
COSTS AND EXPENSES (INCOME):
Operating ........................................................ 190,599 179,045 380,055 359,541
General and administrative ....................................... 7,333 7,721 14,823 15,559
Lease costs ...................................................... 2,229 2,285 4,493 4,536
Depreciation and amortization .................................... 8,831 9,149 17,512 18,310
Interest expense,net ............................................. 4,384 7,818 10,969 15,720
Valuation adjustment on interest rate caps ....................... 4,320 266 4,393 216
Loss (gain) on disposal of assets and impairment of
long-lived assets ............................................ (4,469) - (2,857) -
Loss on refinancing and retirement of debt ....................... 5,978 - 6,332 -
--------- --------- --------- ---------
219,205 206,284 435,720 413,882
--------- --------- --------- ---------
EARNINGS BEFORE INCOME TAXES ....................................... 14,123 6,974 29,109 10,802
Income tax expense ................................................. 5,297 2,793 10,936 4,333
--------- --------- --------- --------
NET EARNINGS ....................................................... $ 8,826 $ 4,181 $ 18,173 $ 6,469
========= ========= ========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
EXTENDICARE HEALTH SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2004 AND DECEMBER 31, 2003
(IN THOUSANDS EXCEPT SHARE DATA)
JUNE 30, DECEMBER 31,
2004 2003
--------- ------------
ASSETS
Current Assets:
Cash and cash equivalents ................................................... $ 29,471 $ 48,855
Accounts receivable, less allowances of $12,074 and $11,692, respectively.... 97,999 95,338
Assets held under Divestiture Agreement ..................................... - 33,723
Supplies, inventories and other current assets .............................. 8,194 7,436
Income taxes receivable ..................................................... 165 -
Deferred state income taxes ................................................. 4,486 4,260
Due from shareholder and affiliates:
Federal income taxes receivable .......................................... - 8,121
Deferred federal income taxes ............................................ 28,084 22,584
Other .................................................................... - 7,010
--------- ---------
Total current assets ................................................... 168,399 227,327
Property and equipment, net ................................................... 455,018 448,743
Goodwill and other intangible assets, net ..................................... 75,122 75,193
Other assets .................................................................. 47,666 82,086
--------- ---------
Total Assets ........................................................... $ 746,205 $ 833,349
========= =========
LIABILITIES AND SHAREHOLDER'S EQUITY
Current Liabilities:
Current maturities of long-term debt ........................................ $ 931 $ 1,223
Accounts payable ............................................................ 17,722 20,672
Accrued liabilities ......................................................... 108,237 101,614
Deposits held under Divestiture Agreement ................................... - 30,000
Current portion of accrual for self-insured liabilities ..................... 18,000 18,000
Current portion of amounts due to shareholder and affiliate ................. 3,213 -
Income taxes payable ........................................................ - 23
--------- ---------
Total current liabilities .............................................. 148,103 171,532
Accrual for self-insured liabilities .......................................... 25,467 27,063
Long-term debt ................................................................ 300,936 391,695
Deferred state income taxes ................................................... 6,808 7,343
Other long-term liabilities ................................................... 13,880 11,082
Due to shareholder and affiliates:
Deferred federal income taxes .............................................. 34,471 38,490
Other ...................................................................... 16,557 3,484
--------- ---------
Total liabilities ...................................................... 546,222 650,689
--------- ---------
Shareholder's Equity:
Common stock, $1 par value, 1,000 shares authorized, 947 shares issued and
outstanding ............................................................... 1 1
Additional paid-in capital .................................................. 209,115 208,787
Accumulated other comprehensive income (loss) ............................... (193) 985
Accumulated deficit ......................................................... (8,940) (27,113)
--------- ---------
Total Shareholder's Equity ............................................. 199,983 182,660
--------- ---------
Total Liabilities and Shareholder's Equity ............................ $ 746,205 $ 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 SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(IN THOUSANDS)
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2004 JUNE 30, 2003
---------------- ----------------
OPERATING ACTIVITIES:
Net earnings ................................................................. $ 18,173 $ 6,469
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization ......................................... 17,512 18,310
Amortization of deferred financing costs .............................. 839 746
Provision for uncollectible accounts
receivable .......................................................... 5,994 5,097
Provision for self-insured liabilities ................................ 3,300 3,000
Payment of self-insured liability claims .............................. (4,897) (10,319)
Deferred income taxes ................................................. (9,494) 2,362
Valuation adjustment on interest rate caps ............................ 4,393 216
Loss (gain) on disposal of assets and impairment of long-lived assets.. (2,857) --
Loss on refinancing and retirement of debt ............................ 6,332 --
Changes in assets and liabilities:
Accounts receivable .................................................... 2,031 (185)
Supplies, inventories and other current assets ......................... (1,056) (1,055)
Accounts payable ....................................................... (2,950) (929)
Accrued liabilities .................................................... 5,662 (1,351)
Income taxes payable/receivable ........................................ (166) 134
Current due to shareholder and affiliates .............................. 8,823 (623)
--------- --------
Cash provided by operating activities ............................... 51,639 21,872
--------- --------
INVESTING ACTIVITIES:
Proceeds from repayment of notes receivable ............................ 20,552 --
Proceeds from completion of divestiture agreement ...................... 10,000 --
Proceeds from sale of investments ...................................... 4,894 --
Payments for purchase of property and equipment ........................ (11,747) (8,570)
Payments for acquisitions .............................................. (6,454) --
Payments for new construction projects ................................. (6,943) (305)
Changes in other non-current assets .................................. (229) 737
--------- --------
Cash provided by (used in) investing activities ..................... 10,073 (8,138)
--------- --------
FINANCING ACTIVITIES:
Payments of long-term debt ............................................. (219,188) (259)
Proceeds from issuance of long-term debt ............................... 128,082 --
Payment of deferred financing costs .................................... (5,306) --
Payment of interest rate cap fee ....................................... (3,495) --
Payment of tender and call premium and legal expenses .................. (6,921) --
Proceeds from termination of interest rate swap and cap ................ 2,615 --
Advances from shareholder and an affiliate ............................. 22,900 --
Other long-term liabilities ............................................ 217 444
--------- --------
Cash (used in) provided by financing activities ..................... (81,096) 185
--------- --------
Increase (decrease) in cash and cash equivalents ............................. (19,384) 13,919
Cash and cash equivalents, beginning of period ............................... 48,855 24,360
--------- --------
Cash and cash equivalents, end of period ..................................... $ 29,471 $ 38,279
========= ========
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 and six months ended June 30, 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. Significant intercompany accounts and
transactions with subsidiaries have been eliminated from the consolidated
financial statements.
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 CONSTRUCTION
On June 1, 2004, the Company acquired four nursing facilities (321 beds)
in Indiana for $5.0 million in cash. On February 12, 2004, the Company acquired
a nursing facility in Washington, which was previously leased, for $1.4 million
in cash.
In the first half of 2004, the Company completed four construction
projects for a total cost of $10.0 million. The Company added the following beds
or units to existing facilities: 16 units to an assisted living facility in
Kentucky in February 2004, 20 nursing beds to a nursing facility in Wisconsin in
March 2004, and 30 units to an assisted living facility in Wisconsin in May
2004. In addition, the Company opened a new assisted living facility with 40
units in Wisconsin in May 2004.
On December 31, 2003, the Company acquired one nursing facility (99 beds)
in Wisconsin for $4.1 million in cash.
6
3. ASSETS AND DEPOSITS HELD UNDER DIVESTITURE AGREEMENT
Assets Held Under Divestiture AgreemenT
In June 2004, the Company concluded a deferred sales transaction
(described below) with Greystone Tribeca Acquisition, L.L.C. ("Greystone"), by
receipt of the final consideration of $10.0 million on the Vendor Take Back Note
plus $2.6 million of interest, which completed the September 2000 Divestiture
Agreement. Finalizing this transaction resulted in recognition in the second
quarter of 2004 of a gain of $4.9 million and interest income of $1.7 million.
In September 2000, the Company disposed of eleven Florida nursing
facilities (1,435 beds) and four Florida assisted living facilities (135 units)
to Greystone and received 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. For the period from 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. 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 Statement
of Financial Accounting Standards ("SFAS") No. 66 and, accordingly, there was no
gain or loss recorded on the initial transaction. Prior to the finalization of
the agreement, the fixed assets had been classified as "Assets held under
Divestiture Agreement" and 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" were
classified as a current asset and the Company ceased depreciating these assets
as of January 1, 2004.
Deposits Held Under Divestiture Agreement
Prior to finalization of the Divestiture Agreement, the initial cash
proceeds of $30.0 million were classified in the balance sheet as "Deposits held
under Divestiture Agreement." Consistent with the classification of the Assets
Held under Divestiture Agreement, the Deposits held under Divestiture Agreement
were classified as a current liability as of December 31, 2003 and until the
transaction was completed in June 2004.
4. 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 June
30, 2004, accounts receivable from both Medicare and Medicaid state programs,
net of a general contractual allowance, totaled $26.8 million (December 31, 2003
- - $37.2 million). This amount includes $11.4 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 $15.4 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
received a cash settlement of $5.6 million. The settlement did not result in a
significant adjustment from the recorded receivable balance.
7
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. In April 2004, the Company reached a negotiated settlement with the FI in
respect of the remaining two claim years regarding overhead costs. The
settlement will result in the receipt of approximately $7.7 million, $6.6
million of which was received in May 2004. The Company will receive the balance
of the payment upon resolution of other matters concerning the cost report years
under appeal. Upon resolution of these matters, the financial impact of the
related settlement, if any, will be determined.
The Company has hearings scheduled in August and September 2004 for other
Medicare receivable issue in dispute. The hearing in August 2004 involves
various issues amounting to $9.8 million with the FI for facilities purchased in
the Arbor Health Care Company acquisition in 1997. The hearing in September 2004
involves a Director of Nursing staff cost issue in the amount of $3.8 million.
Notes Receivable
As of December 31, 2003, the Company held $21.4 million in notes
receivable due from Tandem Health Care, Inc. ("Tandem"). 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. In June 2004, the Company accepted and received a
cash prepayment of $16.2 million for the remaining $17.0 million of notes
receivable due from Tandem. After payment of the associated selling expenses of
$0.5 million, the Company recognized a loss of $1.3 million, which is recognized
in loss on disposal of assets on the statement of earnings.
8
5. LINE OF CREDIT AND LONG-TERM DEBT
Summary of Long-term Debt
Long-term debt consisted of the following as of June 30, 2004 and December
31, 2003:
JUNE 30, DECEMBER 31
2004 2003
---------- -----------
(DOLLARS IN THOUSANDS)
9.50% Senior Notes due 2010 ............................................... $149,694 $149,676
9.35% Senior Subordinated Notes due 2007 .................................. -- 200,000
6.875% Senior Subordinated Notes due 2014 ................................. 121,912 --
Industrial Development Revenue Bonds, variable interest rates ranging from
1.03% 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 ............................................................ 10,081 10,054
Other, primarily capital lease obligations ................................ 20 28
-------- --------
Long-term debt before current maturities .................................. 301,867 392,918
Less current maturities ................................................... 931 1,223
-------- --------
Total long-term debt ...................................................... $300,936 $391,695
======== ========
2014 Notes
On April 22, 2004, the Company sold and 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 "Securities Act"). 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 these net proceeds, along
with cash on hand and borrowings under its amended and restated Credit Facility
described below, to purchase for cash the 9.35% Senior Subordinated Notes due
2007 (the "2007 Notes"), tendered in the tender offer described below, to redeem
the 2007 Notes not tendered in the tender offer prior to May 24, 2004 and to pay
related fees and expenses of the tender offer and redemption. Also on April 22,
2004, the Company entered into two interest rate swap agreements and two
interest rate cap agreements. See Note 6 for the terms of the interest rate swap
and cap agreements.
The 2014 Notes are fully and unconditionally guaranteed on a senior
subordinated unsecured basis, jointly and severally, 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.
9
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 during the twelve-month period commencing on May 1 of
the years set forth below:
YEAR REDEMPTION PRICE
---- ----------------
2009........................................ 103.438%
2010........................................ 102.292%
2011........................................ 101.146%
2012 and thereafter......................... 100.000%
2007 Notes
On April 22, 2004, the Company purchased for cash $104.9 million aggregate
principal amount of its 2007 Notes pursuant to a tender offer to purchase any
and all of its then-outstanding $200 million of 2007 Notes. On May 24, 2004, the
Company redeemed and cancelled the remaining $95.1 million of 2007 Notes not
tendered in the tender offer. The holders of the 2007 Notes who tendered their
2007 Notes or whose 2007 Notes were redeemed by the Company were paid a premium
that, in the aggregate, amounted 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 wrote-off deferred finance charges of approximately
$2.4 million related to the 2007 Notes and incurred legal costs estimated at
$0.3 million. In addition, pursuant to the termination of the existing interest
rate swap and cap agreements (discussed below), the Company recorded a gain of
approximately $3.3 million in the second quarter of 2004. Below is a summary of
the loss reported in the second quarter of 2004 relating to these transactions:
(DOLLARS IN
THOUSANDS)
-----------
Tender premium and call premium ............................... $(6,636)
Write-off of deferred finance charges ......................... (2,359)
Legal expenses ................................................ (285)
-------
(9,280)
Gain on termination of interest rate swap and cap agreements... 3,302
-------
$(5,978)
=======
The Company issued the 2007 Notes in December 1997 and were unsecured
senior subordinated obligations of the Company subordinated in right of payment
to all existing and future senior indebtedness of the Company, which included
all borrowings under the Credit Facility as well as all indebtedness not
refinanced by the Credit Facility. The 2007 Notes were to mature on December 15,
2007.
2010 Senior Notes
On June 28, 2002, the Company completed a private placement of $150
million of its 9.5% Senior Notes due July 1, 2010 (the "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 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. The
Company terminated these agreements in April 2004 in connection with the sale
and issuance of the 2014 Notes. See Note 6 for more information on the swap and
cap agreements.
10
The indenture governing the 2010 Senior Notes contains customary covenants
and events of default. Under this indenture, the Company is 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. The Company's fixed charge
coverage ratio is currently in excess of this minimum requirement. The fixed
charge coverage ratio is defined in the indenture governing the 2010 Senior
Notes, 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 consists of net income prior to the
aforementioned fixed charges, and prior to income taxes and losses on disposal
of assets.
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 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 REDEMPTION PRICE
---- ----------------
2006.................................. 104.750%
2007.................................. 102.375%
2008 and thereafter................... 100.000%
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.
Credit Facility
The Company established a senior secured revolving credit facility in June
2002. In connection with the April 2004 offering of the 2014 Notes, the Company
amended and restated its Credit Facility (the "Credit Facility") to, among other
things, extend the maturity date from June 28, 2007 to June 28, 2009 and
increase the total borrowing capacity from $105 million to $155 million.
The Credit Facility 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 senior leverage ratio, the interest rate
is equal to the Eurodollar rate plus a margin of 2.50% to 3.25% per annum or the
base rate plus a margin of 1.50% to 2.25% per annum. The commitment fee is 0.50%
per annum on the undrawn capacity regardless of utilization.
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 Company is permitted to make voluntary prepayments at any time
under the Credit Facility.
As of June 30, 2004 and December 31, 2003, the Company had no borrowings
under 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 $121.3 million as of June
30, 2004.
The Credit Facility requires that the Company comply with various
financial covenants, including fixed charge coverage, debt leverage, and
tangible net worth ratios. The Company is in compliance with all of the
financial covenants as of June 30, 2004.
11
Other Loan Repayments and Refinancing
In February 2004, the Company prepaid in full two Industrial Development
Revenue Bonds totaling $13.0 million, which resulted in a charge to earnings of
$0.4 million to write-off deferred financing costs.
On October 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 in April 2004 the Company refinanced the
facilities with mortgages whose interest rates vary with LIBOR above a minimum
level, and repaid the remaining balance of the note due to the seller.
6. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Objectives and Strategies
As of June 30, 2004, all but $19 million of the Company's outstanding debt
obligations have fixed interest rates. To hedge the fair value of fixed-rate
debt obligations, the Company has entered into interest rate swap agreements
under which it pays a variable rate of interest and receives a fixed rate of
interest. These interest rate swaps are designated as fair value hedges under
SFAS 133 and changes in the market value of the interest rate swaps have no
impact on the statement of earnings unless they are terminated or are no longer
designated as hedges. In addition, the Company has entered into interest rate
cap agreements to limit its exposure to increases in interest rates.
The Company does not speculate using derivative instruments.
Interest Rate Swap and Cap Agreements Entered into in April 2004 and Maturing in
2010 and 2014
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 (the "2010 Swap") with a
notional amount of $150 million. The 2010 Swap effectively converted up to $150
million of fixed interest rate indebtedness into variable interest rate
indebtedness. Under the terms of the 2010 Swap, the counterparty can call the
swap at any time on or after July 1, 2006 with payments as determined under the
agreement. This call option is a mirror image of the embedded call option in the
debt instrument. The swap was designated as a highly-effective fair value hedge,
and as a result, changes in market value of the swap are recorded in earnings
but are offset by changes in market value of the indebtedness so that there is
no net impact on the statement of earnings unless the swap is terminated or no
longer qualifies as a hedge. The Company also entered into an interest rate cap
agreement expiring July 1, 2010 (the "2010 Cap") with a notional amount of $150
million. Under the 2010 Cap, 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 2010 Cap to offset
possible increases in interest payments under the 2010 Swap caused by increases
in market interest rates over a certain level. Under the terms of the 2010 Cap,
the counterparty can call the cap if the 2010 Swap is terminated. The 2010 Cap
was not designated as a hedging instrument under SFAS 133 and, therefore,
changes in market value are recorded in the statement of earnings.
12
With respect to the 2014 Notes, the Company entered into an interest rate
swap agreement expiring May 1, 2014 (the "2014 Swap") with a notional amount of
$125 million. The 2014 Swap effectively converted up to $125 million of fixed
interest rate indebtedness into variable interest rate indebtedness. Under the
terms of the 2014 Swap, the counterparty can call the 2014 Swap at any time on
or after May 1, 2009 with payments as determined under the agreement. This call
option is a mirror image of the embedded call option in the debt instrument. The
2014 Swap was designated as a highly-effective fair value hedge and, as a
result, changes in market value of the swap are recorded in earnings but are
offset by changes in market value of the indebtedness so that there is no net
impact on the statement of earnings unless the swap is terminated or no longer
qualifies as a hedge. The Company also entered into an interest rate cap
agreement expiring May 1, 2014 ("2014 Cap") with a notional amount of $125
million. Under the 2014 Cap, 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 2014 Cap to offset possible increases in
interest payments under the 2014 Swap caused by increases in market interest
rates over a certain level. Under the terms of the 2014 Cap, the counterparty
can call the cap if the 2014 Swap is terminated. The 2014 Cap was not designated
as a hedging instrument under SFAS 133 and, therefore, changes in market value
are recorded in the statement of earnings.
Interest Rate Swap and Cap Agreements Prior to April 2004
In June 2002, the Company entered into an interest rate swap agreement
maturing in 2007 (the "2007 Swap") with a notional amount of $150 million to
hedge the fair value of the fixed-rate 2007 Notes that were repaid during the
second quarter of 2004 (see note 5). The 2007 Swap effectively converted up to
$150 million of fixed interest rate indebtedness into variable interest rate
indebtedness. The 2007 Swap was designated as a fair value hedge and, as a
result, changes in market value of the swap were recorded in earnings, however
there was no impact on the Company's statement of earnings in 2003 and 2004
prior to termination of the swap in April 2004.
Also in June 2002, the Company entered into an interest rate cap agreement
maturing in 2007 (the "2007 Cap") with a notional amount of $150 million. Under
the 2007 Cap, the Company paid a fixed rate of interest equal to 0.24% and
received a variable rate of interest equal to the excess, if any, of the
one-month LIBOR rate, adjusted monthly, over the cap rate of 7%. A portion of
the 2007 Cap with a notional amount of $19 million was 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 2007 Cap
with a notional amount of $131 million was used to offset increases in
variable-rate interest payments under the 2007 Swap to the extent one-month
LIBOR exceeded 7%. This portion of the 2007 Cap was not designated as a hedging
instrument under SFAS 133 and, therefore, changes in market value were recorded
in the statement of earnings.
In April 2004, coterminous with the sale and issuance of the 2014 Notes,
the Company terminated its 2007 Swap and its 2007 Cap for $2.6 million in cash
and an aggregate gain of approximately $3.3 million.
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. There were no cash flow hedges after the
termination of the 2007 Cap in April 2004. Changes in the fair value of interest
rate caps not designated as a hedging instrument are reported in the statement
of earnings.
As of June 30, 2004, the fair value of the interest rate swaps designated
as fair value hedges is a liability of $8.3 million and is offset by an asset of
$8.3 million relating to the changes in market value of the hedged items
(long-term debt obligations). A gain of $0.1 million (net of income tax effect)
was credited to AOCI for the six months ended June 30, 2004 relating to the 2007
Cap. As of June 30, 2004, the fair value of the 2010 Cap is an asset of $2.4
million recorded in other long-term assets and the fair value of the 2014 Cap is
a liability of $3.4 million recorded in other long-term liabilities.
13
The fair value of the Company's interest rate caps are dependent on
projected six-month LIBOR interest rates, that are influenced by long-term
rates, and the volatility of these rates. As a result of a decline in the
volatility of rates in the second quarter of 2004, the value of the Company's
interest rate caps declined and resulted in valuation adjustment expense of $4.3
million compared to $0.3 million in the second quarter of 2003. Valuation
adjustment expense for the six months ended June 30, 2004 was $4.4 million as
compared to $0.2 million for the six months ended June 30, 2003. Valuation
adjustment expense on the interest rate cap, formerly included with interest
income, has been reclassified to a separate line on the statement of earnings.
7. DUE TO SHAREHOLDER AND AFFILIATE
Extendicare held $27.9 million of the 2007 Notes prior the refinancing.
Pursuant to the tender offer, in May 2004, the 2007 Notes held by Extendicare
were redeemed for approximately $28.8 million in cash. Subsequently in May 2004,
Extendicare purchased for market value all of the Company's investment of
125,000 common shares in Omnicare Inc. ("Omnicare") for $4.9 million in cash,
which resulted in a gain of $0.9 million. In addition, Extendicare advanced
through the Company's parent company $22.9 million, of which $14.0 million was
through an affiliate to the Company. As a result, as of June 30, 2004, the
Company owes to its shareholder and an affiliate $19.8 million, of which $3.2
million has been classified as a current payable. As of December 31, 2003, the
Company had a current receivable from shareholder and an affiliate of $7.0
million and a long-term payable of $3.5 million.
8. GAIN (LOSS) ON DISPOSAL OF ASSETS AND IMPAIRMENT OF LONG-LIVED ASSETS
The following summarizes the components of the gain (loss) on the disposal
of assets and impairment of long-lived assets:
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 2004 JUNE 30, 2004
------------- -------------
(DOLLARS IN THOUSANDS)
Gain (loss) on disposal of assets:
Completion of Divestiture Agreement with Greystone (note 3) $ 4,872 $ 4,872
Loss on repayment of notes due from Tandem (note 4) ....... (1,266) (1,266)
Gain on sale of Omnicare shares to Extendicare (note 7) ... 863 863
------- -------
4,469 4,469
Impairment of skilled nursing facility in Indiana ............ --- (1,612)
------- -------
$ 4,469 $ 2,857
======= =======
In March 2004, the Company 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, the
Company made a decision, subject to State of Indiana approval, to consolidate
the two operations into one renovated facility, which 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, 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:
14
MEDICARE,
MEDICAID RESIDENT AND
AND SUPPLIER EMPLOYEE
CLAIMS CLAIMS OTHER TOTAL
------------ ------------ ------ --------
(DOLLARS IN THOUSANDS)
Balance December 31, 2002... $ 8,099 $ 1,318 $ 301 $ 9,718
Cash Payments ............ (565) (824) (141) (1,530)
Provisions (1) ........... (897) -- -- (897)
------- ------- ----- -------
Balance December 31, 2003... 6,637 494 160 7,291
Cash Payments ............ (717) -- -- (717)
------- ------- ----- -------
Balance June 30, 2004 ...... $ 5,920 $ 494 $ 160 $ 6,574
======= ======= ===== =======
(1) In 2003, provisions include the write-off of $1.3 million of previously
accrued Medicare claims receivable relating to discontinued operations.
9. LOSS ON REFINANCING AND RETIREMENT OF DEBT
The following summarizes the components of the loss on refinancing and
retirement of debt:
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 2004 JUNE 30, 2004
------------- -------------
(DOLLARS IN THOUSANDS)
Loss on early retirement of 2007 Notes (note 5) ......................... $ 9,280 $ 9,280
Loss on early retirement of Industrial Development Revenue Bonds (note 5) -- 354
------- -------
9,280 9,634
Gain on termination of interest rate swap and cap (note 6) .............. (3,302) (3,302)
------- -------
$ 5,978 $ 6,332
======= =======
10. INTEREST EXPENSE, NET
The following summarizes the components of interest expense, net:
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------- ----------------------
2004 2003 2004 2003
---- ---- ---- ----
(DOLLARS IN THOUSANDS)
Interest expense........................ $ 6,658 $ 8,566 $ 14,858 $ 17,061
Interest income......................... (2,274) (748) (3,889) (1,341)
------- -------- -------- -------
$ 4,384 $ 7,818 $ 10,969 $ 15,720
======== ========= ======== ========
The valuation adjustment on interest rate cap, formerly included with
interest income, has been reclassified to a separate line on the statement of
earnings. Refer to Note 6.
11. SUBSEQUENT EVENTS
Transfer of Operations of Skilled Nursing Facility in Chippewa Falls, Wisconsin
In June 2004, in response to facility citations for survey deficiencies of
its nursing facility in Chippewa Falls, Wisconsin, the Company reached a
tentative agreement with the State of Wisconsin to transfer the operations to a
new licensee.
15
In July, the Company finalized an agreement to transfer operations of its
nursing facility, effective August 1, 2004, to Lakeside Health L.L.C. ("Lakeside
Health"), a subsidiary of Benedictine Health Dimensions, Inc. ("Benedictine")
for a term of three years. Under the terms of the agreement, Lakeside Health
will be responsible for all operating costs, including rent to the Company and
Benedictine will manage the nursing facility for a fee. The Company will receive
rental income of $0.5 million per annum, however be responsible to fund Lakeside
Health for any and all net operating losses, as defined in the agreement, from
the nursing facility and to provide working capital advances of approximately
$2.0 million. Based upon the terms of the agreement and future changes imposed
by the State of Wisconsin on the plan of correction and licensed bed capacity of
the facility, the Company may be required to take a charge for asset impairment
under SFAS No. 144. The nursing facility incurred a loss before lease costs,
depreciation, interest and income taxes of $0.5 million for the six months ended
June 30, 2004 as compared to net earnings before these items of $0.5 million for
the year ended December 31, 2003.
Kentucky Medicaid Rates
In July 2004, the State of Kentucky received approval from the Centers for
Medicare and Medicaid Services ("CMS") of a state plan amendment and waiver that
will become effective July 1, 2004. The impact of the plan amendment and waiver
is estimated to increase the Company's net earnings by approximately $3.0
million per year.
CMS Announcement concerning Medicare Rates Effective October 2004.
On July 30, 2004, CMS announced in the federal register, a 2.8% increase
in Medicare rates effective October 1, 2004. In addition, CMS stated that it had
not concluded the study on the resource utilization groupings classifications
and, as a result, the implementation of a RUGs Refinement change, where all or
part of the enhancement is discontinued will be delayed until October 1, 2005.
Commencement of Exchange Offer
In July 2004, the Company commenced its offer to exchange new 2014 Notes
that have been registered under the Securities Act for the 2014 Notes issued in
April 2004. The terms of the new 2014 Notes are identical to the terms of the
2014 Notes issued in April 2004 and are fully and unconditionally guaranteed on
a senior subordinated unsecured basis, jointly and severally, by all existing
and future domestic significant subsidiaries of the Company, all existing and
future domestic subsidiaries of the Company that guarantee or incur any
indebtedness, and any other existing and future significant subsidiaries or
restricted subsidiaries of the Company that guarantee or otherwise provide
direct credit support for indebtedness of the Company or any of the Company's
domestic subsidiaries. The Company anticipates that the offer to exchange the
2014 Notes will be completed in August 2004.
16
12. COMPREHENSIVE INCOME
Comprehensive Income is as follows for the periods shown:
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2004 JUNE 30, 2003 JUNE 30, 2004 JUNE 30, 2003
------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS)
NET EARNINGS ...................................................... $ 8,826 $ 4,181 $ 18,173 $ 6,469
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized gain (loss) on investments, before tax ............. (3,089) 1,427 (2,131) 2,550
Gain (loss) on cash flow hedges, before tax ................... 100 (72) 167 (58)
------- ------- -------- -------
Other comprehensive income, before tax ........................ (2,989) 1,355 (1,964) 2,492
Income tax provision related to items of other
comprehensive income........................................ 1,196 542 786 987
------- ------- -------- -------
Other comprehensive income (loss), net of tax ................. (1,793) 813 (1,178) 1.505
------- ------- -------- -------
COMPREHENSIVE INCOME ............................................. $ 7,033 $ 4,994 $ 16,995 $ 7,974
======= ======= ======== =======
13. COMMITMENTS AND CONTINGENCIES
Capital Expenditures
As of June 30, 2004, the Company had capital expenditure purchase
commitments outstanding of approximately $9.1 million.
In the first half of 2004, the Company completed four construction
projects for a total cost of $10.0 million. As of June 30, 2004, the Company has
11 new construction projects in progress, which are expected to add 18 nursing
units and 366 assisted living units. The total estimated cost of the projects is
$42.0 million, and they are expected to be completed in 2005 and 2006. Total
costs incurred through June 30, 2004 on these projects were approximately $1.6
million and purchase commitments of $15.0 million are outstanding.
Insurance and Self-insured Liabilities
The Company insures certain risks with affiliated insurance subsidiaries
of Extendicare and third-party insurers. The insurance policies cover
comprehensive general and professional liability (including malpractice
insurance) for the Company's health providers, assistants and other staff as it
relates to their respective duties performed on the Company's behalf, property
coverage, workers' compensation and employers' liability in amounts and with
such coverage and deductibles as determined by the Company, based on the nature
and risk of its businesses, historical experiences, availability and industry
standards. The Company also self insures for health and dental claims, in
certain states for workers' compensation and employers' liability and for
general and professional liability claims. Self-insured liabilities with respect
to general and professional liability claims are included within the accrual for
self-insured liabilities.
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.
17
Omnicare Preferred Provider Agreement
In 1998, the Company disposed of its pharmacy operations to Omnicare.
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 contained a number of
provisions that involved 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.
In 2002, in connection with its agreements to provide pharmacy services to
the Company, Omnicare 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 June 30, 2004, the Company has certain
facilities under plans of correction, including the citations for its nursing
facility in Chippewa Falls, Wisconsin (note 11). While it is not possible to
estimate the final outcome of the required corrective action, the Company has
accrued for known costs.
18
14. 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, 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 six months ended June 30, 2004, the Company
estimates that it received an average $25.28 per resident day, which on an
annualized basis amounts to $20.0 million related to the RUGs Refinements. For
additional information pertaining to the RUGs refinement, refer to note 11 -
Subsequent Events.
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
net earnings would be $1.3 million in 2004, increasing to $3.3 million in 2006.
As of June 30, 2004, the States of Pennsylvania, Indiana 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 June 30, 2004.
19
Interests in Unrelated Long Term Care Providers
Through the divestiture program in Texas and Florida, the Company has
amounts due 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 June 30, 2004, the Company had $7.1 million in
non-current amounts receivable due from unrelated long-term care providers in
Florida and Texas; and owns $14.9 million in nursing home properties in Texas
and Florida. For the six months ended June 30, 2004 and 2003, the Company earned
$3.2 million and $2.8 million, respectively, in management and consulting fees,
and $1.4 million and $0.9 million, respectively, in rental revenue from
unrelated long-term care operators that were operating in properties owned by
the Company. 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
June 30, 2004 and December 31, 2003 the Company had $39.6 million and $51.2
million, respectively, of gross Medicare and Medicaid settlement receivables
with a related contractual allowance of $12.8 million and $14.0 million,
respectively. 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 $43.5 million and $45.1 million in accruals for
self-insured liabilities as of June 30, 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.
20
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. We are an indirect wholly owned subsidiary of Extendicare
Inc., or Extendicare, a Canadian publicly traded company. Through our subsidiary
network of geographically clustered facilities, we offer a continuum of
healthcare services, including nursing care, assisted living and related medical
specialty services, such as subacute care and rehabilitative therapy. As of June
30, 2004, we operated or managed 191 long-term care facilities with 17,220 beds
in 13 states, of which 151 were nursing facilities with 15,279 beds and 40 were
assisted living and retirement facilities with 1,941 units. We also provided
consulting services to 77 facilities with 9,446 beds in five states. In
addition, we operated 23 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 quarterly report on Form 10-Q 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 other filings with the Securities
and Exchange Commission, 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.
21
EXECUTIVE OVERVIEW
Our business strategy and competitive strengths remain unchanged from that
outlined in Item 1 of our Annual Report on Form 10-K for the year ended December
31, 2003. 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.
During the six months ended June 30, 2004, we continued to improve
Medicare average daily census, while our total census remained comparable to the
prior year. In June 2004, we acquired for $5.0 million in cash four nursing
facilities (321 beds) in Indiana. We completed four construction projects during
the six months ended June 30, 2004, which increased operational capacity at one
nursing facility and two assisted living facilities and added one new
free-standing assisted living facility. We have approved 11 additional
construction projects to add 18 nursing beds and 366 assisted living facility
units. Eight of the construction projects will be completed in 2005 and the
remainder are scheduled to be completed in 2006.
We initiated and completed in the second quarter of 2004 several
transactions that reduced our level of debt and, as a result, will improve our
operating cash flow and cash resources. In April 2004, we sold and issued $125.0
million aggregate principal amount of 6.875% Senior Subordinated Notes due 2014,
or 2014 Notes. The net proceeds from the sale and issuance of the 2014 Notes
were approximately $117.4 million, net of a $3.1 million discount and fees and
expenses of $4.5 million. We used these net proceeds, together with borrowings
under our amended and restated credit facility to purchase for cash
approximately $104.9 million aggregate principal amount of 9.35% Senior
Subordinated Notes due 2007, or 2007 Notes, validly tendered in the tender offer
that we commenced in April 2004 and to redeem any 2007 Notes not tendered in the
tender offer or cancelled. In addition, in April 2004, coterminous with the sale
and issuance of the 2014 Notes, we terminated our existing interest rate swap
and cap agreements for an aggregate gain of $3.3 million. 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
9.50% Senior Notes due 2010, or the 2010 Senior Notes, and the 2014 Notes. As a
result of our debt refinancing, we lowered our long-term debt and debt to equity
ratio from $392.9 million and 2.2 to 1, respectively, as of December 31, 2003 to
$301.9 million and 1.5 to 1 as of June 30, 2004; and reduced our weighted
average interest rate to approximately 5.5% as of June 30, 2004 compared to 7.7%
as of March 31, 2004, and 7.5% as of December 31, 2003.
22
We also monetized to cash $30.6 million in notes that were formerly
outstanding from our Florida divestiture program and reduced our balance of
Medicare settlement receivables. We accepted and received in February and in
June 2004, a total of $20.6 million in cash prepayments for all outstanding
notes receivable from Tandem Health Care, Inc., or Tandem, and as a result
recorded a loss in the second quarter of $1.3 million. In June 2004, we
concluded the deferred sales transaction with Greystone Tribeca Acquisition,
L.L.C., or Greystone, by receipt of the final consideration of $10.0 million on
the Vendor Take Back Note plus $2.6 million in interest, which completed the
September 2000 Divestiture Agreement. As a result, in the second quarter, we
recognized a gain on sale of assets of $4.9 million and related interest income
of $1.7 million. 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 resulted in the receipt of $6.6 million in cash
in May 2004. These settlements did not result in any significant adjustment from
the recorded receivable balance.
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 the Medicare and 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. 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 with applicable
regulations and to respond to inspections, investigations and/or enforcement
actions. In June 2004, as a result of facility citations for survey deficiencies
in a nursing facility in Chippewa Falls, Wisconsin, we reached a tentative
agreement with the State of Wisconsin to transfer the operations to a new
licensee. In July 2004, we entered into an agreement to transfer the operations
to Benedictine Health Dimensions, Inc., or Benedictine, another long-term care
provider, effective in August 2004. Federal law requires each state to have a
Medicaid Fraud Control Unit, which is responsible for investigating provider
fraud and resident abuse. We are aware of investigations by these units in
Kentucky and Wisconsin. The investigations have not been sufficiently developed
to enable us to predict an outcome.
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 not significantly different when including all nursing
facilities.
PERCENTAGE OF TOTAL NURSING REVENUES
------------------------------------------
FOR THREE MONTHS FOR SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
------------------ ------------------
2004 2003 2004 2003
------ ------ ------ ------
Medicare .............. 32.1% 29.8% 32.4% 29.3%
Private and other ..... 17.8% 18.8% 17.8% 18.7%
----- ----- ----- -----
Quality Mix ........ 49.9% 48.6% 50.2% 48.0%
Medicaid .............. 50.1% 51.4% 49.8% 52.0%
----- ----- ----- -----
Total .............. 100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
23
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 our nursing and assisted living facilities by percentage of total
revenue and the level of quality mix presented on a same facility basis. These
percentages are not significantly different when including all nursing
facilities.
PERCENTAGE OF TOTAL NURSING AND ASSISTED LIVING REVENUES
--------------------------------------------------------
FOR THREE MONTHS FOR SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
--------------------- ----------------------
2004 2003 2004 2003
------ ------ ------ ------
Medicare .............. 30.7% 28.5% 31.0% 28.0%
Private and other ..... 21.1% 22.2% 21.1% 22.1%
----- ----- ----- -----
Quality Mix ........ 51.8% 50.7% 52.1% 50.1%
Medicaid .............. 48.2% 49.3% 47.9% 49.9%
----- ----- ----- -----
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 HMOs 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 contract with to provide services.
LEGISLATIVE ACTIONS AFFECTING REVENUES
BBRA and Temporary Funding Enhancements. Prior to October 1, 2002, the
incremental Medicare relief packages received from the Balanced Budget
Refinement Act, or BBRA, and 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 included a 16.66% add-on to the nursing component of the Resource
Utilization Groups, 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 $16.3 million per annum in Medicare funding
for our 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. The 20% 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 of 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 on the Medicare case mix and census for the six months
ended June 30, 2004, the impact of the 6.26% Medicare rate increase increased
our revenues by $7.3 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 announced their support to spend the administrative fix
over the next fiscal period on direct care and services for residents. In
October 2003, CMS published notice to 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.
24
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 that maintained the current RUGs classifications
until October 1, 2004. Further to, but independent of this, Congress enacted
legislation directing CMS to conduct a study on the resource utilization
grouping classification system and report its recommendations by January 2005.
On July 30, 2004 CMS stated that it had not concluded the study on the resource
utilization groupings classifications and, as a result, the implementation of a
RUGs Refinement change, where all or part of the enhancement is discontinued
will be delayed until October 1, 2005. Based upon the Medicare case mix and
census for the six months ended June 30, 2004, we estimate that we received an
average $25.28 per resident day, which on an annualized basis amounts to $20.0
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 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 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 $4.6 million could be recorded in 2004
pertaining to the 12-month period ended June 30, 2004. Without approval, we
could record a negative adjustment to earnings of up to $5.0 million in 2004
pertaining to this same 12-month period. In Indiana, approval of the original
amendment and waiver submitted could result in the recording of net incremental
earnings of $3.0 million in 2004 pertaining to the 12-month period ended June
30, 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 $0.6 million to earnings may be required. In June 2004, CMS approved the
state plan amendment and waiver submitted by the state of Oregon. The net
favorable impact of $0.3 million was recorded in the second quarter of 2004. For
the remaining states, 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 June 30, 2004.
SIGNIFICANT EVENTS AND DEVELOPMENTS
EVENTS OF THE SIX MONTHS ENDED JUNE 30, 2004
Improvement in Medicare Census. Medicare average daily census for the six
months ended June 30, 2004, or 2004 period, increased to 2,155 from 1,983 for
the six months ended June 30, 2003, or 2003 period, on a same facility basis,
representing a 8.7% increase over 2003. Total average daily census for the 2004
period increased slightly to 12,890 from 12,851 for 2003 period 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 period.
Tender Offer/Redemption and Sale and Issuance of 2014 Notes. On April 5,
2004, we commenced a tender offer to purchase any and all of our outstanding
$200.0 million 2007 Notes. Approximately $104.9 million aggregate principal
amount of outstanding 2007 Notes were validly tendered in the tender offer,
which we purchased for cash. Any and all of the outstanding 2007 Notes that were
not tendered in the tender offer were either cancelled or redeemed for cash and
cancelled as of May 24, 2004.
25
On April 22, 2004, we sold and issued $125 million aggregate principal
amount of 2014 Notes pursuant to Rule 144A and Regulation S under the Securities
Act of 1933, as amended, or the Securities Act. The 2014 Notes were issued at a
price of 97.5001% of par to yield 7.23%. The net proceeds from the sale and
issuance of the 2014 Notes were approximately $117.4 million, net of a $3.1
million discount and fees and expenses of $4.5 million. We used these net
proceeds, together with cash on hand and borrowings under our amended and
restated credit facility to purchase for cash approximately $104.9 million
aggregate principal amount of 2007 Notes validly tendered in the tender offer
and to redeem any 2007 Notes not tendered in the tender offer or cancelled prior
to May 24, 2004. See "Liquidity and Capital Resources" for more information
regarding the 2014 Notes.
As a result of the tender offer, redemption and repayment of the 2007
Notes, in the second quarter of 2004, we wrote-off deferred finance charges of
approximately $2.4 million related to the 2007 Notes and incurred legal costs of
$0.3 million. In addition, pursuant to the termination of our existing interest
rate swap and cap agreements (discussed below), we recorded a gain of
approximately $3.3 million recognized in the second quarter of 2004. The net
impact to earnings was a loss of approximately $6.0 million. Below is a summary
of the loss recognized in the second quarter of 2004 relating to these
transactions.
(DOLLARS IN
THOUSANDS)
-----------
Tender premium and call premium ................................. $(6,636)
Write-off of deferred finance charges ........................... (2,359)
Legal expenses .................................................. (285)
-------
(9,280)
Gain on termination of interest rate swap and cap agreements .... 3,302
-------
$(5,978)
=======
Amendment and Restatement of Credit Facility. In connection with the April
22, 2004 closing of the sale and issuance of 2014 Notes, we amended and restated
our credit facility. The terms of our amended and restated credit facility
include 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 LIBOR 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 our senior
leverage ratio;
- a commitment fee of 0.50% per annum on the undrawn capacity
regardless of utilization;
- changes to the collateral securing the facility to permit us to
substitute certain assets with other assets.
See "Liquidity and Capital Resources" for more information regarding the credit
facility.
Interest Rate Swap and Cap Agreements. In April 2004, coterminous with the
sale and issuance of the 2014 Notes, we terminated our existing interest rate
swap and cap agreements for an aggregate gain of $3.3 million recognized in the
second quarter of 2004. 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. See "Liquidity and Capital Resources" for more information regarding our
interest rate swap and cap agreements.
Redemption of 2007 Notes held by and Advances from Extendicare.
Extendicare held $27.9 million of the 2007 Notes prior the refinancing. Pursuant
to the tender offer, in May 2004, the 2007 Notes held by Extendicare were
redeemed for approximately $28.8 million in cash. Subsequently in May 2004,
Extendicare purchased for cash at market value all of our investment, of 125,000
shares, in Omnicare Inc., or Omnicare, for $4.9 million, which resulted in a
gain of $0.9 million. In addition, Extendicare advanced through our parent
company $22.9 million, of which $14.0 million was through an affiliate to the
Company. As a result, as at June 30, 2004 the Company owes $19.8 million to its
shareholder and a affiliate.
26
Other Loan Repayments and Refinancing. 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. In October 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 in April 2004 we refinanced
the facilities with mortgages whose interest rates vary with LIBOR above a
minimum level, and repaid the remaining balance of the note due to the seller.
Prepayment of Tandem Notes Receivable. 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 June 2004, we accepted and received a cash prepayment of $16.2 million for
the remaining $17.0 million of notes receivable due from Tandem. After payment
of the associated selling expenses of $0.5 million, we recognized a loss of $1.3
million on this transaction.
Completion of Greystone Tribeca Acquisition, L.L.C. Divestiture Agreement.
During the second quarter of 2004, we received the final consideration of $10.0
million on the Vendor Take Back Note plus interest of $2.6 million that
completed the September 2000 Divestiture Agreement. 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. In the quarter
ended June 30, 2004, we recognized a gain on sale of assets of $4.9 million and
interest income of $1.7 million relating to the finalization of this
transaction.
Settlement of Medicare Receivable Issues. In January 2004, we negotiated
and subsequently received a cash settlement of $5.6 million for a specific
staffing cost issue involving six specific claims years. The settlement did not
result in any significant adjustment from the recorded receivable balance. In
April 2004, in respect of two cost reporting years under appeal, we reached a
negotiated settlement with the Fiscal Intermediary, or FI, regarding an issue
involving the allocation of overhead costs. The settlement will result in our
receiving a payment of approximately $7.7 million, $6.6 million of which we
received in May 2004. We will receive the balance of the payment upon resolution
of other matters concerning the cost report years under appeal. There are
certain matters related to the settlement and the cost report years that were
appealed that have to be resolved with the FI, which could influence the
financial impact of the settlement.
Acquisitions. On February 12, 2004, we acquired a nursing facility in
Washington, which we had previously leased, for $1.4 million. On June 1, 2004,
we acquired four nursing facilities (321 beds) in Indiana for cash of
approximately $5.0 million. Our financial results include the operations of a
newly acquired nursing facility in Wisconsin (99 beds) that was purchased on
December 31, 2003 for cash of $4.1 million.
Construction Projects. In the six months ended June 30, 2004, we completed
four construction projects for a total cost of $10.0 million, which included a
new free-standing assisted living facility with 40 units, two additions to
existing assisted living facilities adding 46 units, and an addition of 20
nursing beds to an existing nursing facility. We have 11 additional construction
projects in progress, which are expected to add 18 nursing beds and 366 assisted
living units. The projects are to be completed in 2005 and 2006, and have a
total cost of approximately $42.0 million.
Management and Consulting Services. We commenced managing two new nursing
facilities and transferred management responsibilities to another long-term care
provider, while retaining consulting services for fourteen facilities.
Consolidation of Two 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. We expect consolidation of the
two operations 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.
27
EVENTS SUBSEQUENT TO JUNE 30, 2004
Kentucky Medicaid Rates. In July 2004, the State of Kentucky received
approval from CMS of a state plan amendment and waiver which will become
effective July 1, 2004. The plan amendment and waivers are expected to increase
net earnings by approximately $3.0 million per year.
Transfer of Operations of Nursing Facility in Chippewa Falls, Wisconsin.
In June 2004, in response to facility citations for survey deficiencies in our
nursing facility in Chippewa Falls, Wisconsin, we reached a tentative agreement
with the State of Wisconsin to transfer the operations to a new licensee.
In July, we finalized an agreement to transfer operations of the nursing
facility, effective August 1, 2004, to Lakeside Health L.L.C., or Lakeside
Health, a subsidiary of Benedictine Health Dimensions, Inc., or Benedictine, for
a term of three years. Under the terms of the agreement, Lakeside Health will be
responsible for all operating costs, including rent payable to us, and
Benedictine will manage the nursing facility for a fee. We will receive rental
income of $0.5 million per annum, however be responsible to fund Lakeside Health
for any and all net operating losses, as defined in the agreement, from the
nursing facility and to provide working capital advances of approximately $2.0
million. Based upon the terms of the agreement and future changes imposed by the
State of Wisconsin on the plan of correction and licensed bed capacity of the
facility, we may be required to take a charge for asset impairment under
Statement of Financial Accounting Standards No. 144. The facility incurred a
loss before lease costs, depreciation, interest and income taxes of $0.5 million
for the six months ended June 30, 2004 compared to earnings before these items
of $0.5 million for the year ended December 31, 2003.
Commencement of Exchange Offer. In July 2004, we commenced its offer to
exchange new 2014 Notes that have been registered under the Securities Act for
the 2014 Notes issued in April 2004. The terms of the new 2014 Notes are
identical to the terms of the 2014 Notes issued in April 2004 and are fully and
unconditionally guaranteed on a senior subordinated unsecured basis, jointly and
severally, 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 of ours that guarantee or otherwise provide direct
credit support for our indebtedness or any of our domestic subsidiaries'
indebtedness. We anticipate the offer to exchange the 2014 Notes to be completed
in August 2004.
CMS Announcement Concerning Medicare Rates Effective October 2004. On July
30, 2004, CMS announced in the federal register a 2.8% increase in Medicare
rates effective October 1, 2004. In addition, CMS stated that it had not
concluded the study on the resource utilization groupings classifications and,
as a result, the implementation of a RUGs Refinement change, where all or part
of the enhancement is discontinued will be delayed until October 1, 2005.
EVENTS PRIOR TO 2004
The most significant event in 2003 was the continued improvement in total
census, particularly Medicare census. Total Average Daily Census, or ADC,
increased to 12,901 in 2003 from 12,727 in 2002 and 12,465 in 2001 on a same
facility basis, representing a 1.4% increase over 2002 and 3.5% over 2001.
Medicare ADC increased to 1,997 in 2003 from 1,699 in 2002 and 1,427 in 2001 on
a same facility basis, representing a 17.5% increase over 2002, and 39.9% over
2001. The improvement in census was the direct result of a number of our
initiatives, including the implementation of consistent admission practices, the
Medicare certification of all our skilled nursing facility beds and senior
management's focus on census, all of which drove the improved financial results
for the 2003 fiscal year.
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.
On December 31, 2003, we acquired a 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) and to four
assisted living facilities (87 units), and the construction of one new
free-standing assisted living facility.
28
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. In the first six months of 2004,
we accepted and received $30.6 million in cash in settlement of outstanding
notes from Tandem and Greystone. As of June 30, 2004, we:
- held $7.1 million in non-current amounts receivable from Senior
Health - South, Inc., or Senior Health - South, and Senior Health -
Texas, Inc., or 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 $14.9 million, and subleased another 12 properties in
Texas.
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 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 June 30, 2004, we had $7.1 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 2002, as a result of events that became known to us
then, we concluded that we should increase our overall reserves by $5.3 million
for cost report and other settlements with the State of Florida and other
Medicare fiscal intermediaries, collection of receivables and settlement of
claims with suppliers and employees. 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 be assured that other claims will not be made with
respect to the agreement.
Medicare and Medicaid Settlement Receivables. As of June 30, 2004, we are
pursuing settlement of a number of outstanding Medicare and Medicaid receivable
balances, which in aggregate, have a net book value of $26.8 million. For
Medicare revenues earned prior to the implementation of 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.
29
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 our
receipt of approximately $7.7 million, $6.6 million of which we received in May,
2004, and the balance of which we will receive 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. Upon resolution of these matters, we will determine the
financial impact of the settlement, if any.
We have hearings scheduled in August and September 2004 for other Medicare
settlement receivable issues in dispute. The hearing in August 2004 involves
various issues amounting to $9.8 million with the FI for facilities purchased
with the 1997 Arbor Health Care Company acquisition. The hearing in September
2004 involves 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.
Self-Insured Liabilities. We have $43.5 million in accruals for
self-insured liabilities with respect to general and professional liability
claims as of June 30, 2004. We have estimated that approximately $18.0 million
of this liability will be paid within the next twelve 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 is 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.
30
EBITDA and EBITDA Percentage
EBITDA is defined as net earnings (loss) before income taxes, interest
expense net of interest income, valuation adjustment on interest rate caps,
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 2010 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.
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 and six months ended June 30, 2004 to the same
periods in 2003. The same facility basis figures exclude the December 2003
acquisition of a nursing facility in Manitowoc, Wisconsin, the newly-constructed
assisted living facility completed in May 2004, and the June 2004 acquisition of
four nursing facilities in Indiana.
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 skilled nursing facilities.
THREE MONTHS SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
------------------ ------------------
2004 2003 2004 2003
------ ------ ------ ------
Medicare .............. 2,131 1,999 2,178 1,983
Private and other ..... 2,227 2,205 2,203 2,219
------ ------ ------ ------
Quality Mix ........ 4,358 4,204 4,381 4,202
Medicaid .............. 8,711 8,623 8,642 8,649
------ ------ ------ ------
Total ............ 13,069 12,827 13,023 12,851
====== ====== ====== ======
The following table sets forth for the three months ended June 30, 2004
and 2003 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 JUNE 30
--------------------------------------------
2004 2003
-------------------- --------------------
% CHANGE
% OF % OF 2004 TO
ADC TOTAL ADC TOTAL 2003
------ ------ ------ ------ --------
Medicare .............. 2,104 16.3% 1,999 15.6% 5.3%
Private and other ..... 2,184 16.9% 2,205 17.2% (1.0%)
------ ----- ------ ----- ---
Quality Mix ........... 4,288 33.2% 4,204 32.8% 2.0%
Medicaid .............. 8,613 66.8% 8,623 67.2% (0.1%)
------ ----- ------ ----- ---
Total ............ 12,901 100.0% 12,827 100.0% 0.6%
====== ===== ====== ===== ===
31
The following table sets forth for the six months ended June 30, 2004 and
2003 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.
SIX MONTHS ENDED JUNE 30
------------------------------------
2004 2003
---------------- ---------------- % Change
% OF % OF 2004 to
ADC TOTAL ADC TOTAL 2003
------ ------ ------ ------ --------
Medicare................... 2,155 16.7% 1,983 15.4% 8.7%
Private and other.......... 2,184 17.0% 2,219 17.3% (1.6%)
------ ------ ------ ------ --------
Quality Mix................ 4,339 33.7% 4,202 32.7% 3.3%
Medicaid................... 8,551 66.3% 8,649 67.3% (1.1%)
------ ------ ------ ------ --------
Total 12,890 100.0% 12,851 100.0% 0.3%
====== ====== ====== ====== ========
On a same facility basis, total ADC increased 0.3% between the six months
ended June 30, 2004 and 2003. On a same facility basis, Medicare ADC increased
8.7% between 2004 and 2003. As a result, the percentage of Medicare ADC to all
payor sources increased to 16.8% in 2004, as compared to 15.4% 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.
All Nursing and Assisted Living Facilities - Occupancy and Number of Facilities
Under Operation
Below are tables setting forth occupancy percentages, ADC and operational
resident capacity for the three months ended June 30, 2004 and 2003.
All Facilities:
The below table is for all our nursing and assisted living facilities in
total:
OCCUPANCY OPERATIONAL RESIDENT
PERCENTAGE ADC CAPACITY
------------------- ------------------ --------------------
2004 2003 2004 2003 2004 2003
---- ---- ---- ---- ---- ----
Nursing.............................. 91.4% 91.2% 13,069 12,827 14,293 14,068
Assisted Living...................... 85.1% 85.6% 1,495 1,483 1,757 1,732
Nursing and Assisted Living.......... 90.7% 90.6% 14,564 14,310 16,050 15,800
Same Facility Basis:
The below table is for all of our nursing and assisted living facilities on a
same facility basis:
OCCUPANCY OPERATIONAL RESIDENT
PERCENTAGE ADC CAPACITY
------------------- ------------------ --------------------
2004 2003 2004 2003 2004 2003
---- ---- ---- ---- ---- ----
Nursing.............................. 91.4% 91.2% 12,901 12,827 14,109 14,068
Assisted Living...................... 85.1% 85.6% 1,495 1,483 1,757 1,732
Nursing and Assisted Living.......... 90.7% 90.6% 14,396 14,310 15,866 15,800
Occupancy percentages decreased within the assisted living facilities to
85.1% for the three months ended June 30, 2004 from 85.6% in the comparable 2003
period. The decrease in occupancy percentage within the assisted living
facilities was due to the opening in 2004 of several new wings at certain of the
facilities that were not yet fully occupied as of June 30, 2004.
32
Below are tables setting forth occupancy percentages, ADC and operational
resident capacity for the six months ended June 30, 2004 and 2003.
All Facilities:
The below table is for all our nursing and assisted living facilities in
total:
OCCUPANCY OPERATIONAL RESIDENT
PERCENTAGE ADC CAPACITY
------------------- -------------------- ---------------------
2004 2003 2004 2003 2004 2003
---- ---- ---- ---- ---- ----
Nursing............................... 91.4% 91.3% 13,023 12,851 14,254 14,082
Assisted Living....................... 85.9% 85.5% 1,491 1,492 1,737 1,744
Nursing and Assisted Living........... 90.8% 90.6% 14,514 14,343 15,991 15,826
Same Facility Basis:
The below table is for all of our nursing and assisted living facilities on a
same facility basis:
OCCUPANCY OPERATIONAL RESIDENT
PERCENTAGE ADC CAPACITY
------------------- -------------------- ---------------------
2004 2003 2004 2003 2004 2003
---- ---- ---- ---- ---- ----
Nursing ................... 91.3% 91.3% 12,890 12,851 14,112 14,082
Assisted Living ........... 85.9% 85.5% 1,491 1,492 1,737 1,744
Nursing and Assisted Living 90.7% 90.6% 14,381 14,343 15,849 15,826
Occupancy percentages increased within the assisted living facilities to
85.9% for the six months ended June 30, 2004 from 85.5% in the comparable 2003
period. 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
JUNE 30, DECEMBER 31,
2004 2003
---- ----
Percent of facilities owned .............. 94.4% 93.7%
Number of facilities under operation...... 179 174
The percentage of facilities owned increased during 2004 due to the
purchase in February 2004 of a previously leased facility in the State of
Washington, the opening in May 2004 of a new assisted living facility in the
State of Wisconsin, and the purchase in June 2004 of four nursing facilities in
the State of Indiana.
33
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 SIX MONTHS
JUNE 30 ENDED JUNE 30
------- -------------
2004 2003 2004 2003
------- -------- -------- ------
Medicare (Part A and Part B)...... $357.65 $322.14 $352.12 $320.16
Private and other................. $189.68 $184.66 $191.20 $182.91
Medicaid.......................... $136.33 $128.95 $136.22 $130.29
------- ------- ------- -------
Total ........................ $181.51 $168.64 $181.63 $168.67
======= ======= ======= =======
During the 2003 quarter, we recorded negative prior period Medicaid
revenue adjustments of $0.2 million. There were no such adjustments during the
2004 quarter.
During the six months ended June 30, 2004, we recorded favorable prior
period Medicaid revenue adjustments of $1.4 million pursuant to the settlement
of state cost reports. During the comparable 2003 period, we recorded favorable
prior period Medicaid revenue adjustments of $2.5 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 SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
---------------------------- -------------------------------
2004 2003 CHANGE 2004 2003 CHANGE
------- ------- ------ ------- ------- ------
Medicare (Part A and Part B)...... $357.65 $322.14 11.0% $352.12 $320.16 10.0%
Private and other................. $189.68 $184.66 2.7% $191.20 $182.91 4.5%
Medicaid.......................... $136.31 $129.18 5.5% $135.35 $128.67 5.2%
------- ------- ------ ------- ------- ------
Total ........................ $181.50 $168.80 7.5% $181.05 $167.58 8.0%
======= ======= ====== ======= ======= ======
Medicare Part A only.............. $324.50 $293.83 10.4% $321.17 $292.33 9.9%
The Medicare rate increased 10.0% in the 2004 period compared to the 2003
period, 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.
34
EBITDA and EBITDA Percentage
The following table sets forth a reconciliation of net income before taxes
and EBITDA.
THREE MONTHS SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
------------- -------------
2004 2003 2004 2003
---- ---- ---- ----
(DOLLARS IN THOUSANDS)
Net income before income taxes ................. $ 14,123 $ 6,974 $ 29,109 $ 10,802
Add (deduct):
Depreciation and amortization ................ 8,831 9,149 17,512 18,310
Interest expense, net ........................ 4,384 7,818 10,969 15,720
Valuation adjustment on interest rate caps .... 4,320 266 4,393 216
Loss (gain) on disposal of assets
and impairment of long-lived assets............. (4,469) -- (2,857) --
Loss on refinancing and retirement of debt ... 5,978 -- 6,332 --
-------- -------- -------- --------
EBITDA ......................................... $ 33,167 $ 24,207 $ 65,458 $ 45,048
======== ======== ======== ========
The following table sets forth the calculations of EBITDA percentages:
THREE MONTHS SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
------------------- ---------------------
2004 2003 2004 2003
---- ---- ---- ----
(DOLLARS IN THOUSANDS)
EBITDA.................................... $ 33,167 $ 24,207 $ 65,458 $ 45,048
Revenues................................... $233,328 $213,258 $464,829 $426,684
EBITDA as percentage of total revenues..... 14.2% 11.4% 14.1% 10.6%
EBITDA, as a percentage of total revenues, increased to 14.1% in the 2004
period from 10.6% in the 2003 period. The increase was attributable to the
improvement in Medicare census (8.7%) and reductions in certain operating costs
as a percentage of revenues, primarily wages and benefits.
RESULTS FROM OPERATIONS
The following table sets forth details of our revenues and earnings as a
percentage of total revenues:
THREE MONTHS SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
------------- -------------
2004 2003 2004 2003
---- ---- ---- ----
Revenues
Nursing and assisted living facilities.. .... 96.7% 96.7% 96.8% 96.8%
Outpatient therapy .......................... 1.3 1.4 1.2 1.3
Other ....................................... 2.0 1.9 2.0 1.9
----- ----- ----- -----
100.0 100.0 100.0 100.0
Operating and general and administrative.costs. 84.8 87.5 84.9 88.4
Lease costs, depreciation and amortization .... 4.7 5.4 4.7 5.4
Interest expense, net ......................... 1.9 3.7 2.4 3.7
Valuation adjustment on interest rate cap...... 1.8 0.1 0.9 --
Loss (gain) on disposal of assets and
impairment of long-lived assets (1.9) -- (0.6) --
Loss on refinancing and retirement of debt..... 2.6 -- 1.4 --
----- ----- ----- -----
Earnings before income taxes .................. 6.1 3.3 6.3 2.5
Income tax expense ............................ 2.3 1.3 2.4 1.0
----- ----- ----- -----
Net earnings .................................. 3.8% 2.0% 3.9% 1.5%
===== ===== ===== =====
35
THREE MONTHS ENDED JUNE 30, 2004 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2003
REVENUES
Revenues in the three months ended June 30, 2004, or 2004 quarter,
increased $20.0 million, or 9.4%, to $233.3 million from $213.3 million in the
three months ended June 30, 2003, or 2003 quarter. Outpatient therapy and other
revenues increased by $0.6 million in the 2004 quarter due to increased rental
revenue from our leased Florida facilities and consulting revenues from new
contracts.
Revenues from nursing and assisted living facilities increased $19.5
million in the 2004 quarter compared to the 2003 quarter, including $2.6 million
as a result of the acquisition of a nursing facility in Wisconsin on December
31, 2003, the newly-constructed assisted living facility completed in May 2004
in Wisconsin, and the acquisition of four nursing facilities in Indiana in June
2004. Revenues from nursing and assisted living facilities on a same facility
basis increased $16.9 million, or 8.2%. This increase was attributable to the
following:
DOLLARS IN
MILLIONS
--------
- - a 5.5% increase (excluding prior year adjustments) in the average daily
nursing Medicaid rate (which included
cost-offset funding as a result of increased state assessments and bed taxes of $1.8 million).................. $ 5.4
- - an increase in Medicare revenues due to the 6.26% Medicare Part A rate increase effective October 1, 2003...... 3.6
- - an increase in Medicare revenues due to the improvement in RUGs mix and other factors.......................... 2.2
- - an increase in nursing ancillary revenues...................................................................... 1.7
- - an increase in Medicare residents from 15.6% of total in the 2003 quarter to 16.3% in the 2004 quarter......... 1.5
- - increases in other average daily nursing rates................................................................. 1.0
- - an increase in nursing resident ADC from 12,827 in the 2003 quarter to 12,901 in the 2004 quarter.............. 0.8
- - an increase in assisted living revenues due to increased occupancy and higher rates............................ 0.5
-------
16.7
These increases were adjusted by:
- - no prior year revenue adjustments recorded in the 2004 quarter compared to unfavorable prior year adjustments
of $0.2 million recorded in the 2003 quarter................................................................... 0.2
-------
Total increase in revenues from same facility nursing and assisted living centers................................ $ 16.9
=======
OPERATING AND GENERAL AND ADMINISTRATIVE COSTS
Operating and general and administrative costs increased $11.2 million, or 6.0%,
in the 2004 quarter compared to the 2003 quarter, including $2.0 million as a
result of the acquisition of a nursing facility in Wisconsin on December 31,
2003, the newly-constructed assisted living facility completed in May 2004 in
Wisconsin, and the acquisition of four nursing facilities in Indiana in June
2004. Operating and general and administrative costs on a same facility basis
increased $9.2 million, or 4.9%. This increase was attributable to the
following:
DOLLARS IN
MILLIONS
--------
- - wages, benefits and contracted staffing, which included an average wage rate increase of 2.5%............ $ 5.9
- - state assessments and bed taxes.......................................................................... 1.8
- - drug expense due to higher resident census, Medicare mix and drug prices................................. 1.2
- - other operating expenses................................................................................. 0.3
-------
Total increase in same facility operating and general and administrative costs............................. $ 9.2
=======
36
LEASE COSTS, DEPRECIATION AND AMORTIZATION
Lease costs decreased $0.1 million to $2.2 million when comparing the 2004
quarter to the 2003 quarter. Depreciation and amortization decreased $0.3
million to $8.8 million in the 2004 quarter compared to $9.1 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, which was offset by an increase of $0.3 million from other items.
INTEREST EXPENSE, NET
Interest expense, net of interest income, decreased $3.4 million to $4.4
million for the 2004 quarter compared to $7.8 million for the 2003 quarter. The
weighted average interest rate of all long-term debt decreased to 6.62% during
the 2004 quarter compared to approximately 7.79% during the 2003 quarter.
Interest income was $1.5 million higher in the 2004 quarter than in the 2003
quarter primarily due to $1.7 million in interest income from Greystone that
resulted from the completion of the Divestiture Agreement. The average debt
level decreased to $357.5 million during the 2004 quarter compared to $397.9
million during the 2003 quarter.
VALUATION ADJUSTMENT ON INTEREST RATE CAPS
The valuation adjustment on interest rate caps was $4.4 million for the
2004 quarter compared to $0.3 million in the 2003 quarter. The value of the caps
decreased in the 2004 quarter due to a decrease in volatility in projected
future six-month LIBOR interest rates. The valuation adjustment on the interest
rate caps, formerly included in interest income, but been reclassified to a
separate line on the income statement.
GAIN (LOSS) ON DISPOSAL OF ASSETS AND IMPAIRMENT OF LONG-LIVED ASSETS
Gain on disposal of assets was $4.5 million for the 2004 quarter. The
completion in June 2004 of the September 2000 Divestiture Agreement with
Greystone resulted in cash proceeds of $10.0 million from the Vendor Take Back
Note and a gain of $4.9 million. In addition, the sale at market value to
Extendicare of our investment, of 125,000 common shares, in Omnicare for $4.9
million in cash, resulted in a gain of $0.9 million. These gains were offset by
a loss of $1.3 million from prepayment of notes receivable from Tandem at a
discount.
LOSS ON REFINANCING AND RETIREMENT OF DEBT
Loss on refinancing and retirement of debt was $6.0 million for the 2004
quarter. The early retirement of the 2007 Notes resulted in a loss of $9.3
million; however, this was partially offset by a $3.3 million gain on the
termination of our interest rate swap and cap agreements. Refer to "Significant
Events and Developments" for the component costs of the refinancing of the 2007
Notes for further information. The interest rate swap and cap maturing in 2007
were terminated due to the early retirement of the 2007 Notes.
INCOME TAXES
Income tax expense for the 2004 quarter was $5.3 million compared to $2.8
million for the 2003 quarter. Our effective tax rate was 37.5% for the 2004
quarter compared to 40.0% 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.
37
NET EARNINGS
Net earnings for the 2004 quarter were $8.8 million compared to $4.2
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. We recorded approximately $2.7 million of
expenses for this purpose for both the 2004 quarter and 2003 quarter.
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.
Extendicare held $27.9 million of the 2007 Notes prior the refinancing.
Pursuant to the tender offer, in May 2004 the 2007 Notes held by Extendicare
were redeemed for approximately $28.8 million in cash. Subsequently in May 2004,
Extendicare purchased for at market value all of our 125,000 common share
investment in Omnicare, for $4.9 million in cash, which resulted in a gain of
$0.9 million. In addition, Extendicare advanced through our parent company $22.9
million, of which $14.0 million was through an affiliate. As a result, as at
June 30, 2004, we owed $19.8 million to our shareholder and an affiliate.
SIX MONTHS ENDED JUNE 30, 2004 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2003
REVENUES
Revenues in the six months ended June 30, 2004, or 2004 period, increased
$40.1 million, or 9.5%, to $464.8 million from $424.7 million in the six months
ended June 30, 2003, or 2003 period. Outpatient therapy and other revenues
increased by $1.1 million in the 2004 period due to increased lease revenue and
management and consulting revenue.
Revenues from nursing and assisted living facilities increased $39.1
million in the 2004 period compared to the 2003 period, including $4.2 million
as a result of the acquisition of a nursing facility in Wisconsin on December
31, 2003, the newly-constructed assisted living facility completed in May 2004
in Wisconsin, and the acquisition of four nursing facilities in Indiana in June
2004. Revenues from nursing and assisted living facilities on a same facility
basis increased $34.9 million, or 8.5%. This increase was attributable to the
following:
38
DOLLARS IN
MILLIONS
----------
- - a 5.2% increase (excluding prior year adjustments) in the average daily nursing Medicaid rate (which
included cost-offset funding as a result of increased state assessments and bed taxes of $3.4 million).................. $ 10.3
- - an increase in Medicare revenues due to the 6.26% Medicare Part A rate increase effective October 1, 2003............... 7.3
- - an increase in Medicare residents from 15.4% of total in the 2003 period to 16.7% in the 2004 period.................... 5.0
- - increases in other average daily nursing rates.......................................................................... 2.8
- - an increase in Medicare revenues due to the improvement in RUGs mix and other factors................................... 3.9
- - an increase in nursing ancillary revenues............................................................................... 2.8
- - increase due to one extra day in the 2004 period........................................................................ 2.1
- - an increase in assisted living revenues due to increased occupancy and higher rates..................................... 1.0
- - a increase in nursing resident ADC census from 12,851 in the 2003 period to 12,890 in the 2004 period................... 0.8
-----
36.0
These increases were offset by:
- - favorable prior year revenue adjustments recorded in the 2004 period of $1.4 million compared to favorable prior
year revenue adjustments of $2.5 million recorded in the 2003 period, which included a recovery of $1.5 million in
Medicaid revenues relating to the outcome of a favorable court decision in the State of Ohio............................ (1.1)
----
Total increase in revenues from same facility nursing and assisted living centers......................................... $ 34.9
======
OPERATING AND GENERAL AND ADMINISTRATIVE COSTS
Operating and general and administrative costs increased $19.8 million, or
5.3%, in the 2004 period compared to the 2003 period, including $3.3 million as
a result of the acquisition of a nursing facility in Wisconsin on December 31,
2003, the newly-constructed assisted living facility completed in May 2004 in
Wisconsin, and the acquisition of four nursing facilities in Indiana in June
2004. Operating and general and administrative costs on a same facility basis
increased $16.5 million, or 4.4%. This increase was attributable to the
following:
DOLLARS IN
MILLIONS
----------
- - wages, benefits and contracted staffing, which included an average wage rate increase of 2.0%............ $ 9.0
- - state assessments and bed taxes.......................................................................... 3.4
- - drug expense due to higher resident census, Medicare mix and drug prices................................. 2.6
- - bad debt expense......................................................................................... 0.9
- - other operating expenses................................................................................. 0.6
----
Total increase in same facility operating and general and administrative costs............................. $16.5
=====
LEASE COSTS, DEPRECIATION AND AMORTIZATION
Lease costs were unchanged at $4.5 million for both the 2004 period and
the 2003 period. Depreciation and amortization decreased $0.8 million to $17.5
million in the 2004 period compared to $18.3 million in the 2003 period. This
decrease included a decrease of $1.3 million as a result of the discontinuation
of depreciation on assets held for divestiture as of January 1, 2004, which was
offset by an increase of $0.5 million from other items.
39
INTEREST EXPENSE, NET
Interest expense, net of interest income, decreased $4.7 million to $11.0
million for the 2004 period compared to $15.7 million for the 2003 period. The
weighted average interest rate of all long-term debt decreased to 7.23% during
the 2004 period compared to approximately 7.76% during the 2003 period. Interest
income was $2.5 million higher in the 2004 period than in the 2003 period
primarily due to $2.6 million in interest income from Greystone that resulted
from the completion of the Divestiture Agreement. The average debt level
decreased to $371.1 million during the 2004 period compared to $398.0 million
during the 2003 period.
VALUATION ADJUSTMENT ON INTEREST RATE CAPS
The valuation adjustment on interest rate caps was $4.4 million for the
2004 period compared to $0.2 million in the 2003 period. The value of the caps
decreased in the 2004 quarter due to a decrease in volatility in the projected
future six-month LIBOR interest rates. The valuation adjustment on the interest
rate caps, formerly included in interest income, but been reclassified to a
separate line on the income statement.
GAIN (LOSS) ON DISPOSAL OF ASSETS AND IMPAIRMENT OF LONG-LIVED ASSETS
Gain on disposal of assets was $2.9 million for the 2004 period. The
completion in June 2004 of the September 2000 Divestiture Agreement with
Greystone resulted in cash proceeds of $10.0 million from the Vendor Take Back
Note and a gain of $4.9 million. In addition, the sale at market value to
Extendicare of our investment of 125,000 common shares, in Omnicare for $4.9
million in cash, resulted in a gain of $0.9 million. These gains were offset by
a loss of $1.3 million from prepayment of notes receivable from Tandem at a
discount and a $1.6 million loss from impairment of long-lived assets.
The $1.6 million impairment loss was recorded in March 2004, when 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 REFINANCING AND RETIREMENT OF DEBT
Loss on refinancing and retirement of debt was $6.3 million for the 2004
period. This loss included a loss of $9.3 million on the early retirement of the
2007 Notes and a loss of $0.3 million on the early retirement of Industrial
Development Revenue Bonds. Refer to "Significant Events and Developments" for
the component costs of the refinancing of the 2007 Notes. These losses were
offset by a $3.3 million gain on termination of the interest rate swap and cap.
The interest rate swap and cap maturing in 2007 were terminated due to the early
retirement of the 2007 Notes.
INCOME TAXES
Income tax expense for the 2004 period was $10.9 million compared to $4.3
million for the 2003 period. Our effective tax rate was 37.6% for the 2004
period compared to 40.1% for the 2003 period. 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 period were $18.2 million compared to $6.5
million for the 2003 period. The improvement in net earnings was due to the
reasons described herein.
40
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. We recorded approximately $5.4 million
and $5.3 million of expenses for this purpose for the 2004 period and 2003
period, respectively. Also, for the 2004 period, we recorded a credit to expense
of $1.0 million relating to prior year workers' compensation policies with
Laurier Indemnity Company.
We purchase computer hardware and software support services from Virtual
Care Provider, Inc., an affiliated subsidiary of Extendicare. Expenses related
to these services were $2.4 million and $3.5 million for the 2004 period and
2003 period, respectively.
Extendicare held $27.9 million of the 2007 Notes prior the refinancing.
Pursuant to the tender offer, in May 2004 the 2007 Notes held by Extendicare
were redeemed for approximately $28.8 million in cash. Subsequently in May 2004,
Extendicare purchased for at market value all of our 125,000 common share
investment in Omnicare, for $4.9 million in cash, which resulted in a gain of
$0.9 million. In addition, Extendicare advanced through our parent company $22.9
million, of which $14.0 million was through an affiliate. As a result, as at
June 30, 2004, we owe $19.8 million to our shareholder and an affiliate.
LIQUIDITY AND CAPITAL RESOURCES
SOURCES AND USES OF CASH
We had cash and cash equivalents of $29.5 million at June 30, 2004 and
$48.9 million at December 31, 2003. We generated cash flow of $51.6 million from
operating activities for the 2004 period compared with $21.9 million in the 2003
period. We provided cash flow of $10.1 million from investing activities in the
2004 period compared to $8.1 million used in investing activities in the 2003
period. We used cash flow of $81.1 million for financing activities in the 2004
period compared to $0.2 million provided from financing activities in the 2003
period.
The increase in cash flow from operating activities of $29.7 million in
the 2004 period compared to the 2003 period was primarily due to an improvement
in earnings, the collection in the 2004 period of $12.4 million of Medicare
settlement receivables, a reduction of $5.4 million in payments for self-insured
liabilities and an increase of $9.5 million in amounts due to shareholder and
affiliates.
Our working capital decreased $35.5 million from $55.8 million at December
31, 2003 to $20.3 million at June 30, 2004.
Accounts receivable at June 30, 2004 were $98.0 million compared with
$95.3 million at December 31, 2003, representing an increase of $2.7 million.
The increase in accounts receivable included a $2.6 million increase within the
nursing operations and an increase of $0.1 million in outpatient therapy
receivables. Within the nursing operations, billed patient care and other
receivables increased $2.5 million and third-party payor settlement receivables,
based on Medicare and Medicaid cost reports, increased $0.1 million.
The increase in settlement receivables of $0.1 million from December 31,
2003 to June 30, 2004 included increases of $10.5 million from the
reclassification of settlement receivables from other assets to accounts
receivables, $6.3 million relating to revenue in the 2004 period for anticipated
Medicare reimbursement for uncollectible co-insurance and $0.2 million from
Medicaid cost report settlements and other items. These increases were partially
offset by decreases of $12.4 million from the collection of Medicare settlements
and $4.5 million from the collection of Medicare co-insurance amounts.
Property and equipment increased $6.3 million from December 31, 2003 to
$455.0 million at June 30, 2004. The increase was the result of normal capital
expenditures of $11.7 million, $6.9 million from new construction projects, $1.5
million from the February 2004 acquisition of a previously-leased nursing
facility in Washington and $5.0 million from the June 2004 acquisition of four
nursing facilities in Indiana. This increase was partially offset by
depreciation expense of $16.9 million, a provision for impairment of long-lived
assets of $1.6 million and other items of $0.3 million.
41
Total long-term debt, including both current and long-term maturities of
debt, totaled $301.9 million at June 30, 2004. This represents a decrease of
$91.1 million from December 31, 2003, including (1) a decrease of $200 million
due to the prepayment of the 2007 Notes, (2) an increase of $121.9 million due
to the sale and issuance of the 2014 Notes, and (3) a decrease of $13.0 million
due to the prepayment of Industrial Development Revenue Bonds.
Cash provided by investing activities was $10.1 million for the 2004
period compared to cash used in investing activities of $8.1 million for the
2003 period. The increase was due to proceeds in 2004 of (1) $10.0 million from
the completion of the sale of nursing facilities to Greystone, (2) $4.9 million
from sale of Omnicare shares, and (3) $20.6 million from collection of note
receivables due from Tandem. These items were partially offset by increases in
expenditures in 2004 compared to 2003 of (1) $6.5 million for acquisitions, (2)
$6.6 million for new construction projects, (3) $3.2 million in purchases of
property and equipment, and (4) an increase in other non-current assets of $1.1
million.
Cash used in financing activities was $81.1 million for the 2004 period
compared to $0.2 million provided from financing activities for the comparable
2003 period. The change of $81.3 million primarily related to the long-term debt
transactions discussed herein plus the payments of fees and expenses relating to
those transactions, partially offset by advances from shareholder and affiliate
of $22.9 million.
DEBT INSTRUMENTS
Summary of Long-term Debt
Long-term debt consisted of the following as of June 30, 2004 and December
31, 2003:
JUNE 30, DECEMBER 31
2004 2003
-------- -----------
(DOLLARS IN THOUSANDS)
9.50% Senior Notes due 2010 .................................................... $149,694 $149,676
6.875% Senior Subordinated Notes due 2014 ...................................... 121,912 --
9.35% Senior Subordinated Notes due 2007 ....................................... -- 200,000
Industrial Development Revenue Bonds, variable interest rates ranging from 1.03%
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 ................................................................ 10,081 10,054
Other, primarily capital lease obligations ..................................... 20 28
-------- --------
Long-term debt before current maturities ....................................... 301,867 392,918
Less current maturities ........................................................ 931 1,223
-------- --------
Total long-term debt ........................................................... $300,936 $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
5.48% and 7.52% as of June 30, 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.
42
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 indenture governing the 2010 Senior Notes, 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 consists of net earnings 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."
2014 Notes
On April 22, 2004, we sold and issued $125 million aggregate principal
amount of the 2014 Notes pursuant to Rule 144A and Regulation S under the
Securities Act. 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 these net proceeds, along with cash on hand
and borrowings under our amended and restated credit facility described below to
purchase for cash the 2007 Notes, validly tendered in the tender offer, to
redeem the 2007 Notes not tendered in the tender offer prior to May 24, 2004 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 unsecured basis, jointly and severally, 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 of ours
that guarantee or otherwise provide direct credit support for our indebtedness
or the indebtedness of 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:
YEAR REDEMPTION PRICE
---- ----------------
2009................................. 103.438%
2010................................. 102.292%
2011................................. 101.146%
2012 and thereafter.................. 100.000%
Before May 1, 2007, we may redeem up to 35% of the aggregate principal
amount of outstanding 2014 Notes under the indenture with the net cash proceeds
of qualified equity offerings.
In April 2004, S&P assigned a "B-" rating to the 2014 Notes.
2007 Notes
On April 22, 2004, we purchased for cash $104.9 million aggregate
principal amount of our 2007 Notes pursuant to a tender offer to purchase any
and all of our then-outstanding $200 million of 2007 Notes. On May 24, 2004, we
redeemed and cancelled the remaining $95.1 million of 2007 Notes not tendered in
the tender offer. The holders of the 2007 Notes who tendered their 2007 Notes or
whose 2007 Notes were redeemed by us were paid a premium that, in the aggregate,
amounted to approximately $6.6 million.
43
Credit Facility
We established a senior secured revolving credit facility in June 2002. In
connection with the April 2004 offering of the 2014 Notes, we amended and
restated our senior secured revolving credit facility to, among other things,
extend the maturity date from June 28, 2007 to June 28, 2009 and increase the
total borrowing capacity from $105 million to $155 million.
The credit facility is used to back letters of credit and for general
corporate purposes. Borrowings under the credit facility bear interest, at our
option, at the Eurodollar rate or the prime rate, plus applicable margins.
Depending upon our senior leverage ratio, the interest rate is equal to the
Eurodollar rate plus a margin of 2.50% to 3.25% per annum or the base rate plus
a margin of 1.50% to 2.25% per annum. The commitment fee is 0.50% per annum on
the undrawn capacity regardless of utilization.
As of June 30, 2004 and December 31, 2003, the Company had no borrowings
under 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 $121.3 million as of June
30, 2004.
The credit facility is secured by a perfected, first priority security
interest in certain tangible and intangible assets and all of our capital stock
and the capital stock of our subsidiary guarantors. The credit facility is also
secured by a pledge of 65% of our voting shares of the voting stock of our and
our 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. We are permitted to make
voluntary prepayments at any time under the credit facility.
The credit facility requires that we comply with various financial
covenants, including fixed charge coverage, debt leverage, and tangible net
worth ratios. We are in compliance with all of the financial covenants as of
June 30, 2004.
In April 2004, S&P assigned a "BB-" rating to the amended and restated
Credit Facility.
Interest Rate Swap and Cap Agreements
In April 2004, coterminous with the sale and issuance of the 2014 Notes,
we terminated our existing interest rate swap and cap agreements for an
aggregate gain of $3.3 million recognized in the second quarter of 2004. 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, or 2010 Swap, with a notional amount of
$150.0 million. The 2010 Swap effectively converted up to $150.0 million of
fixed interest rate indebtedness into variable interest rate indebtedness. Under
the terms of the 2010 Swap, the counterparty can call the swap at any time on or
after July 1, 2006 with payments as determined under the agreement. This call
option is a mirror image of the embedded call option in the debt instrument. The
2010 Swap was designated as a highly-effective fair value hedge, and as a
result, changes in market value of the swap are recorded in earnings but are
offset by changes in market value of the indebtedness so that there is no net
impact on the statement of earnings unless the swap is terminated or no longer
qualifies as a hedge. We also entered into an interest rate cap agreement
expiring July 1, 2010, 2010 Cap, with a notional amount of $150.0 million. Under
the 2010 Cap, we paid 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 LIBOR
rate, adjusted semi-annually, over the cap rate of 7%. We use the 2010 Cap to
offset possible increases in interest payments under the 2010 Swap caused by
increases in market interest rates over a certain level. Under the terms of the
2010 Cap, the counterparty can call the cap if the 2010 Swap is terminated. The
2010 Cap was not designated as a hedging instrument under SFAS 133 and,
therefore, changes in market value are recorded in the statement of earnings.
44
With respect to the 2014 Notes, we also entered into an interest rate swap
agreement expiring May 1, 2014, or 2014 Swap, 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 the 2014 Swap, the counterparty can call the swap at any time on or
after May 1, 2009 with payments as determined under the agreement. This call
option is a mirror image of the embedded call option in the debt instrument. The
2014 Swap was designated as a highly-effective fair value hedge, and as a
result, changes in market value of the swap are recorded in earnings but are
offset by changes in market value of the indebtedness so that there is no net
impact on the statement of earnings unless the swap is terminated or no longer
qualifies as a hedge. We also entered into an interest rate cap agreement
expiring May 1, 2014, 2014 Cap, with a notional amount of $125.0 million. Under
the 2014 Cap, 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 use
the 2014 Cap to offset possible increases in interest payments under the 2014
Swap caused by increases in market interest rates over a certain level. Under
the terms of the 2014 Cap, the counterparty can call the cap if the 2014 Swap is
terminated. The 2014 Cap was not designated as a hedging instrument under SFAS
133 and, therefore, changes in market value are recorded in the statement of
earnings.
Off Balance Sheet Arrangements
We have no significant off balance sheet arrangements.
Cash Management
As of June 30, 2004, we held cash and cash equivalents of $29.5 million.
The majority of excess cash is held in overnight investments and Certificates of
Deposit, 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.
During the 2004 period, we completed four construction projects for a
total cost of $10.0 million. We have 11 additional construction projects in
progress to add 18 nursing beds and 366 assisted living units to be completed in
2005 and 2006 at a total approximate cost of $42.0 million. Total costs incurred
through June 30, 2004 on these projects are approximately $1.6 million and
purchase commitments of $15.0 million are outstanding.
At June 30, 2004, we have accrued provisions for settlement of
self-insured liabilities of $43.5 million in respect of general and professional
liability claims. Claim payments were $4.9 million and $10.3 million for the six
months ended June 30, 2004 and 2003, 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
$43.5 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 June 30, 2004.
45
CONTRACTUAL OBLIGATIONS
Set forth below is a table showing the estimated timing of payments under
our contractual obligations as of June 30, 2004:
PAYMENTS DUE BY PERIOD
-------------------------------------------------------------------------
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
------------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Long-term debt....................... $ 301,867 $ 931 $ 2,059 $ 8,271 $ 290,606
Operating lease commitments.......... 44,463 8,827 12,155 7,277 16,204
------------- ----------- ----------- ----------- ------------
Total................................ $ 346,330 $ 9,758 $ 14,214 $ 15,548 $ 306,810
============= =========== =========== =========== ============
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 our 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 to limit our exposure to increases in interest rates.
We also have market risk relating to investments in 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 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.
46
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 June 30, 2004:
MATURITY DATE THROUGH JUNE 30,
-------------------------------------------------------------------------------------
ESTIMATED
2005 2006 2007 2008 2009 THEREAFTER TOTAL FAIR VALUE
------- -------- --------- -------- ------- ----------- ---------- ----------
(DOLLARS IN THOUSANDS)
LONG-TERM DEBT:
Fixed Rate .......................... $ 931 $ 1,020 $ 1,039 $ 3,657 $4,614 $ 271,606 $ 282,867 $ 294,754
Average Interest Rate ............... 7.08% 5.81% 5.81% 6.86% 6.96% 5.74% 5.78%
Variable Rate ....................... -- -- -- -- -- $ 19,000 $ 19,000 $ 19,000
Average Interest Rate ............... -- -- -- -- -- 1.05% 1.05%
INTEREST RATE SWAPS:
(fixed to variable)
Notional Amount ..................... -- -- -- -- -- $ 275,000 $ 275,000 $ 8,307
Average Pay Rate (variable rate) .... -- -- -- -- -- 5.39% 5.39%
Average Receive Rate (fixed rate) ... -- -- -- -- -- 8.31% 8.31%
INTEREST RATE CAPS:
Notional Amount ................... -- -- -- -- -- $ 275,000 $ 275,000 $ 933
The above table incorporates only those exposures that existed as of June
30, 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.
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.
47
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 13 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
On August 3, 2004, we announced the appointment of Richard Bertrand to the
position of Chief Financial Officer replacing Mark Durishan, effective September
1, 2004. Mr. Durishan, Chief Financial Officer since 1999, will be retiring in
early 2005. Mr. Bertrand will assume the CFO role while Mr. Durishan will
continue with the Company leading its Sarbanes-Oxley initiatives, overseeing the
year-end audit and completing other special projects. Mr. Bertrand, Chartered
Accountant, has 28 years experience with Extendicare and is currently our Senior
Vice President, Development. Mr. Bertrand joined Extendicare in 1976 serving in
various financial capacities including Vice President of Finance and Controller.
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
48
(b) Reports on Form 8-K
Form 8-K furnished on May 7, 2004, announcing, pursuant to Items 7
and 12, earnings for the quarter ended March 31, 2004.
Form 8-K filed on April 23, 2004, announcing pursuant to Items 5 and
7 that we completed our sale of $125 million aggregate principal amount of
our 2014 Notes.
Form 8-K filed on April 16, 2004, announcing pursuant to Items 5 and
7 that we priced $125 million aggregate principal amount of our 2014 Notes
to be issued pursuant to Rule 144A and Regulation S under the Securities
Act.
Form 8-K filed on April 9, 2004, announcing pursuant to Items 5 and
7 our intention to sell up to $125 million principal amount of 2014 Notes
in a private placement in accordance with Rule 144A and Regulation S under
the Securities Act.
49
EXTENDICARE HEALTH SERVICES, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EXTENDICARE HEALTH SERVICES, INC.
Date: August 6, 2004 By:/s/ Mark W. Durishan
------------------------------
Mark W. Durishan
Vice President, Chief Financial
Officer and Treasurer
(principal financial officer and
principal accounting officer)
50
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
51