| Delaware (State or other jurisdiction of incorporation or organization) |
04-3307188 (IRS employer identification no.) |
| One Beacon Street, Boston, Massachusetts (Address of principal executive offices) |
02108 (Zip Code) |
* Harborside Healthcare Corporation is filing this report voluntarily in order to comply with Section 4.02 of its Indenture dated May 10, 2001, among Harborside Healthcare Corporation and United States Trust Company of New York and is not required to file this report pursuant to either Section 13 or 15(d) of the Securities Exchange Act of 1934
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 No X * (see explanatory note above)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ]. * (see explanatory note above)
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes No X * (see explanatory note above)
At March 30, 2003, the registrant had 7,877,166 shares of all classes of Common Stock outstanding.
Documents incorporated by reference: None
Certain statements in this Form 10-K, including information set forth under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, constitute “Forward-Looking Statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”). Harborside Healthcare Corporation and its subsidiaries (the "Company") desires to take advantage of certain “safe harbor” provisions of the Reform Act and is including this special note to enable the Company to do so. Forward-looking statements included in this Form 10-K, or hereafter included in other publicly available documents filed with the Securities and Exchange Commission, reports to the Company's stockholders and other publicly available statements issued or released by the Company involve known and unknown risks, uncertainties, and other factors which could cause the Company’s actual results, performance (financial or operating) or achievements to differ materially from the future results, performance (financial or operating) or achievements expressed or implied by such forward-looking statements. The Company believes the following important factors could cause such a material difference to occur:
1. The occurrence of changes in the mix of payment sources utilized by the
Company's patients to pay for the Company's services.
2. The adoption of cost containment measures by private pay sources such as
commercial insurers and managed care organizations, as well as efforts by
governmental reimbursement sources to impose cost containment measures.
3. Changes in the United States healthcare system, including changes in
reimbursement levels and the method of reimbursement, under Medicaid and
Medicare, and other changes in applicable government regulations that might
affect the profitability of the Company.
4. The Company’s continued ability to operate in a heavily regulated
environment and to satisfy regulatory authorities, thereby avoiding a
number of potentially adverse consequences, such as the imposition of
fines, temporary suspension of admission of patients, restrictions on the
ability to acquire new facilities, suspension or decertification from
Medicaid or Medicare programs, and in extreme cases, revocation of a
facility’s license or the closure of a facility, including as a result
of unauthorized activities by employees.
5. The Company’s ability to secure the capital and the related cost of
such capital necessary to fund its future growth through acquisition and
development, as well as internal growth.
6. Changes in certificate of need laws that might increase competition in the
Company’s industry, including, particularly, in the states in which
the Company currently operates or anticipates operating in the future.
7. The Company’s ability to staff its facilities appropriately with
qualified healthcare personnel, including in times of shortages of such
personnel and to maintain a satisfactory relationship with labor unions.
8. The level of competition in the Company’s industry, including without
limitation, increased competition from acute care hospitals, providers of
assisted and independent living and providers of home healthcare and
changes in the regulatory system in the state in which the Company operates
that facilitate such competition.
9. The continued availability of insurance for the inherent risks of liability
in the healthcare industry.
10. Price increases in pharmaceuticals, durable medical equipment and other
items.
11. The Company’s reputation for delivering high-quality care and its
ability to attract and retain patients, including patients with relatively
high acuity levels.
12. Changes in general economic conditions, including changes that pressure
governmental reimbursement sources to reduce the amount and scope of
healthcare coverage.
The foregoing review of significant factors should not be construed as exhaustive or as an admission regarding the adequacy of disclosures previously made by the Company.
Except as required by law, the Company undertakes no obligation to publicly update any forward looking statements, whether as a result of new information, future events or otherwise.
2
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PART I
ITEM 1. BUSINESS 4
ITEM 2. PROPERTIES 14
ITEM 3. LEGAL PROCEEDINGS 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS 16
ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA 17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 19
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 31
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 31
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE 59
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 59
ITEM 11. EXECUTIVE COMPENSATION 61
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS 64
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 66
ITEM 14. CONTROLS AND PROCEDURES 66
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K 66
SIGNATURES 73
CERTIFICATIONS 74
3
PART I
GENERAL OVERVIEW
Subsidiaries of Harborside Healthcare Corporation provide high quality long-term care, subacute care and other specialty medical services in four principal geographic regions: the Southeast (Florida), the Midwest (Ohio and Indiana), New England (Connecticut, Massachusetts, New Hampshire and Rhode Island), and the Mid-Atlantic (New Jersey and Maryland). Within these regions, as of December 31, 2002, subsidiaries of Harborside Healthcare Corporation operated 55 long-term care facilities (53 skilled nursing facilities, one residential care facility and one independent living facility). As of December 31, 2002, these 55 facilities had licenses for 6,567 skilled nursing beds, 6 assisted living beds, 115 residential care beds and 24 rest home beds, and also operated 49 independent living beds. One facility operated by a subsidiary of Harborside Healthcare Corporation includes 115 of the licensed residential care beds while another facility contains 49 independent living beds. Of the 55 facilities operated by subsidiaries of Harborside Healthcare Corporation as of December 31, 2002, 18 are owned, 36 are leased and one is managed.
Subsidiaries of Harborside Healthcare Corporation (on a consolidated basis, the “Company” or “Harborside”) provide traditional skilled nursing care, a wide range of subacute care programs (such as orthopedic, CVA/stroke, cardiac, pulmonary and wound care), as well as programs for the provision of care to Alzheimer's and hospice patients. As part of its subacute services, the Company provides physical, occupational and speech rehabilitation therapy services at Company-operated facilities. Through September 1999, the Company also provided rehabilitation therapy services under contracts with non-affiliated long-term care facilities through a wholly-owned subsidiary. During the third quarter of 1999, the Company terminated its contracts with non-affiliated facilities and ceased providing therapy services to non-affiliated facilities.
Harborside was formed in Delaware in March 1996, in anticipation of an initial public offering (the “IPO”), in order to combine under its control the operations of various long-term care facilities and ancillary businesses (the “Predecessor Entities”) which had operated since 1988. The Company completed the IPO, on June 14, 1996 and issued 3,600,000 shares of common stock at $11.75 per share. Immediately prior to the IPO the owners of the Predecessor Entities contributed their interests in such Predecessor Entities to the Company and received 4,400,000 shares of the Company’s common stock (the “Reorganization”).
On April 15, 1998, Harborside entered into a Merger Agreement with HH Acquisition Corp. (“MergerCo”), an entity organized for the sole purpose of effecting a merger on behalf of Investcorp S.A., certain of its affiliates and certain other international investors (the “New Investors”). On August 11, 1998, MergerCo merged with and into Harborside, with Harborside as the surviving corporation. In the merger, each share not retained by existing shareholders was converted into $25 in cash, representing in the aggregate, cash payments of approximately $184 million. Holders of outstanding stock options of the Company converted the majority of their options into cash at $25 per underlying share (less applicable exercise price and withholding taxes) with aggregate payments of approximately $8 million. In connection with the transaction and prior to the merger, the New Investors made cash common equity contributions of $158.5 million, net of issuance costs, to MergerCo, and MergerCo obtained gross proceeds of $99.5 million through the issuance of 11% Senior Subordinated Discount Notes (“Discount Notes”) due 2008 and $40 million through the issuance of 13.5% Exchangeable Preferred Stock (“Preferred Stock”) mandatorily redeemable in 2010. In the third quarter of 1998, Harborside recorded a charge to income from operations of $37 million for direct and other costs related to the merger transaction. In connection with the merger and the related refinancings, the Company exercised purchase options for seven facilities which had been financed through synthetic leases. As a result of the transaction, and pursuant to the Merger Agreement, the New Investors acquired approximately 91% of the post-merger common stock of Harborside. The remaining 9% of the common stock was retained by existing shareholders, including management. As a result of the merger, Harborside shares were de-listed from the New York Stock Exchange.
In March 2001, the Company entered into an agreement (the “Restructuring Agreement”) with Investcorp S.A. and the holders of more than a majority in interest of the Company’s Discount Notes and Preferred Stock for purposes of implementing a restructuring of the Discount Notes and Preferred Stock. The Restructuring Agreement contemplated that the Company would offer to exchange for each $1,000 amount at maturity of outstanding Discount Notes a combination of the following: (1) 0.5899118 of a new 12% Senior Subordinated Discount Note due 2007 (the “New Notes”) each having a principal amount at maturity equal to $1,000 and an original issue price of $685.67 (assuming that the New Notes were issued on May 4, 2001), (2) $88.2353 in cash and (3) common stock purchase warrants for approximately 10.9 shares of its Class A Common Stock. The Company would also offer to exchange common stock purchase warrants for approximately 10.7 shares of its Class A Common Stock for each $1,000 liquidation preference of Preferred Stock (based on the aggregate liquidation preference to be outstanding on May 1, 2001) plus any dividends accrued on such Preferred Stock after May 1, 2001. In conjunction with the restructuring proposal, the Company would solicit consents from holders of outstanding Discount Notes and Preferred Stock to amendments to the Indenture governing the Discount Notes and to the Certificate of Designation governing the Preferred Stock that would eliminate or modify certain restrictive covenants and other provisions contained in the Indenture and the Certificate of Designation and would substantially eliminate the preferences of the Preferred Stock, including the reduction of the liquidation preference from $1,000 to $0.01 per share and the elimination of the right of holders to be paid dividends on shares of Preferred Stock. Also, the Company would issue to Investcorp S.A. (or one or more of its affiliates or designees) up to 15,000 shares of a new series of 13% convertible exchangeable preferred stock (the “New Preferred Stock”) and 1,854,422 common stock purchase warrants for a total purchase price of up to $15,000,000.
On April 6, 2001 the Company initiated the exchange offer and consent solicitation contemplated by the Restructuring Agreement. On May 10, 2001, the Company completed the exchange offer and consent solicitation, thereby implementing each of the elements of the Restructuring Agreement. All of the outstanding Discount Notes and 99.96% of the shares of Preferred Stock were tendered and exchanged in the exchange offer. As
4a result of the exchange, (1) the Company had an aggregate principal amount at maturity of $100,276,000 of New Notes outstanding and an aggregate liquidation preference of $15,000,000 (as of May 10, 2001) of New Preferred Stock outstanding, (2) warrants were issued to holders of Discount Notes, to holders of Preferred Stock, and to Investcorp S.A. representing the right to purchase an aggregate of approximately 15%, 5% and 15%, respectively, of the total number of shares of all classes of the Company’s common stock on a fully diluted basis (excluding shares issuable upon conversion of the New Preferred Stock, each share of which will initially be convertible into 150 shares of Class A Common Stock), and (3) the Company paid $15,000,000 in cash as partial consideration for the tendered Discount Notes.
The reduction in the liquidation preference of the Preferred Stock was completed on May 10, 2001, as contemplated by the Restructuring Agreement. The carrying amount of the Preferred Stock was reduced from $57,595,000 to $576, and the amount of the reduction, net of unamortized deferred financing costs related to the issuance of the Preferred Stock (approximately $1,011,000 at May 10, 2001), was directly transferred to the Company’s Accumulated Deficit account. With the exchange of the New Notes for the Discount Notes (the “Note Exchange”), the carrying value of the accreted principal of the Discount Notes was reduced to $68,890,000, and the amount of the reduction, net of the aggregate cash payment of $15,000,000, was directly transferred to the Company’s Long-term Accrued Interest account. Subsequent to their issuance, the carrying amount of the New Notes increases as the result of accretion and results in a corresponding decrease in the carrying amount of Long-term Accrued Interest. Interest expense on the New Notes is recognized such that a constant effective interest rate is applied to the aggregate carrying amount of the New Notes and Long-term Accrued Interest for all periods between the issuance date and the maturity date of the New Notes.
In connection with an amendment to the Company’s revolving credit facility (the “Credit Facility”) and the implementation of the Restructuring Agreement, the Company incurred a non-recurring charge of $9,045,000. The charge resulted from the write-off of approximately $1,500,000 of unamortized deferred financing costs incurred when the Credit Facility was obtained, the write-off of approximately $3,400,000 of unamortized deferred financing costs related to the issuance of the Discount Notes, and the recognition of various investment advisory, legal and other fees associated with these events of $4,145,000.
The New Notes were issued at a discount and interest on the New Notes accretes until August 1, 2004. Cash interest payments will be paid semi-annually in arrears beginning on February 1, 2005 based on the fully accreted value of the New Notes and a 12% cash interest payment rate. The New Notes mature on August 1, 2007. The New Preferred Stock is mandatorily redeemable on February 1, 2008. The holders of the New Preferred Stock are entitled to dividends quarterly in arrears beginning August 1, 2001 and payable in additional shares of New Preferred Stock. Warrants to purchase a total of 4,326,641 shares of common stock at $0.01 per share were issued on May 10, 2001.
PATIENT SERVICES
Basic Patient Services
Basic patient services are those traditionally provided to elderly patients in long-term care facilities to assist with the activities of daily living and to provide general medical care. The Company provides 24-hour skilled nursing care by registered nurses, licensed practical nurses and certified nursing aides in all of its skilled nursing facilities. Each skilled nursing facility is managed by an on-site licensed administrator who is responsible for the overall operation of the facility, including the quality of care provided. The medical needs of patients at the Company’s licensed skilled nursing facilities are supervised by a medical director, who is a licensed physician. Although treatment of patients is the responsibility of their own attending physicians, who are not employed by the Company, the medical director monitors all aspects of delivery of care. The Company also provides support services, including dietary services, therapeutic recreational activities, social services, housekeeping and laundry services, pharmaceutical and medical supplies and routine rehabilitation therapy.
Each skilled nursing facility offers a number of individualized therapeutic activities designed to enhance the quality of life of its patients. These activities include entertainment events, musical productions, trips, arts and crafts and volunteer and other programs that encourage community interaction.
Specialty Medical Services
Specialty medical services are those provided to patients with medically complex needs, who generally require more extensive treatment and a higher level of skilled nursing care. These services typically generate higher net patient service revenues per patient day than basic patient services as a result of increased levels of care and the provision of ancillary services.
Subacute Care. Subacute care is goal-oriented, comprehensive care designed for an individual who has had an acute illness, injury, or exacerbation of a disease process. Subacute care is typically rendered immediately after, or instead of, acute hospitalization in order to treat one or more specific, active, complex medical conditions or in order to administer one or more technically complex treatments. The Company provides subacute care services at all of its existing skilled nursing facilities in such areas as complex medical, cardiac recovery, digestive, immuno-suppressed disease, post-surgical, wound, CVA/stroke care, hemodialysis, infusion therapy, and diabetes and pain management.
In facilities that have shown strong demand for subacute services, the Company has developed subacute units. Each unit contains 20 to 60 beds and is specially staffed and equipped for the delivery of subacute care. Patients in these units typically require high levels of nursing care and the services of physicians, therapists, dietitians, clinical pharmacists or psycho/social counselors. Certain patients may also require life support or monitoring equipment. Because patient goals are generally rehabilitation-oriented, lengths of stay in distinct subacute units are generally not expected to substantially exceed 30 days.
5Alzheimer’s Care. The Company has also developed units that provide care for patients with Alzheimer’s disease. As of December 31, 2002, the Company operated dedicated Alzheimer’s units at eleven facilities.
OPERATIONS
Facilities. Each of the Company's skilled nursing facilities is supervised by a licensed facility administrator who is responsible for all aspects of the facility's operations. The facility administrator oversees (i) a director of nursing who supervises a staff of registered nurses, licensed practical nurses and certified nursing aides, (ii) a director of admissions who is responsible for developing local marketing strategies and programs and (iii) various other departmental supervisors. The Company also contracts with one or more licensed physicians at each facility to serve as medical directors for the purpose of supervising the medical management of patients. Facilities with subacute or specialty medical units or programs may also contract with physician specialists to serve as rehabilitation or specialty program medical directors in areas such as physiatry (physical medicine), neurology or gero-psychology. Facilities may also employ or contract for additional clinical staff such as nurse liaisons, case managers, therapists and program directors. Department supervisors at each of the Company's facilities oversee personnel who provide dietary, maintenance, laundry, housekeeping, therapy and social services. In addition, a business office staff at each facility routinely performs administrative functions, including billing, payroll and accounts payable processing. The Company's corporate and regional staff provide support services such as quality assurance, management training, clinical consultation and support, management information systems, risk management, human resource policies and procedures, operational support, accounting and reimbursement expertise.
Regions. The Company seeks to cluster its long-term care facilities in selected geographic regions to establish a strong competitive position as well as to position the Company as a healthcare provider of choice to managed care and private payors in these markets. The Company's facilities currently serve four principal geographic regions: the Southeast (Florida), the Midwest (Ohio and Indiana), New England (Connecticut, Massachusetts, New Hampshire and Rhode Island), and the Mid-Atlantic (New Jersey and Maryland). The Company maintains regional operating offices in Palm Harbor, Florida; Beachwood, Ohio; Indianapolis, Indiana; Topsfield, Massachusetts; West Hartford, Connecticut; and Sharon, New Hampshire. Each region is supervised by a regional director of operations who directs the efforts of a team of professional support staff in the areas of clinical services, marketing, bookkeeping, human resources and engineering. Other Company staff, who are principally based in the regions, provide support and assistance to all of the Company's facilities in the areas of subacute services, managed care contracting, reimbursement services, risk management, data processing and training. Financial control is maintained through financial and accounting policies established at the corporate level for use at each facility. The Company has standardized operating policies and procedures and continually monitors operating performance to assure consistency and quality of operations.
Continuous Quality Improvement Program. The Company has developed a continuous quality improvement program which is designed to monitor, evaluate and improve the delivery of patient care. The program is supervised by the Company’s Senior Vice President of Clinical Services and the Vice President of Quality Assurance and Improvement and consists of the standardization of policies and procedures, routine site visits and assessments and a quality control system for patient care and physical plant compliance. Pursuant to its quality control system, the Company routinely collects information from patients, family members, referral sources, employees and state survey agencies which is then compiled, analyzed and distributed throughout the Company in order to monitor the quality of care and services provided.
The Company’s continuous quality improvement program is modeled after guidelines for long-term care and subacute facilities promulgated by the Joint Commission on Accreditation of Healthcare Organizations (“JCAHO”), a nationally recognized accreditation agency for hospitals and other healthcare organizations. The Company believes that JCAHO accreditation is an important factor in gaining provider contracts from managed care and commercial insurance companies. As of December 31, 2002, 35 of the Company’s 53 skilled nursing facilities had received accreditation.
MARKETING
The Company’s marketing program is designed to attract patients who will have a favorable impact on the Company’s profits and quality mix of revenues. The Company establishes monthly occupancy and revenue goals for each of its facilities and maintains marketing objectives to be met by each facility. The Company’s Vice President of Marketing and Managed Care is principally responsible for the development and implementation of the Company’s marketing program. Regional marketing directors provide routine support to the facility-based admissions directors through the development of facility-based marketing strategies, competitive assessments and routine visits.
The Company uses a decentralized marketing approach in order to capitalize on each facility’s strengths and reputation in the community it serves. Admissions staff at each facility are primarily responsible for marketing basic medical services and developing semi-annual marketing plans in consultation with the Company’s regional marketing and operations staff. Basic medical services are marketed to area physicians, hospital discharge planning personnel, individual patients and their families and community referral sources. Facility personnel also market the Company’s specialty medical services to these sources. Corporate and regional personnel who specialize in subacute care, managed care and reimbursement also assist in the marketing of specialty medical services.
SOURCES OF REVENUES
The Company derives its revenues primarily from private pay sources, the Federal Medicare program for certain elderly and disabled patients and state Medicaid programs for indigent patients. The Company’s revenues are influenced by a number of factors, including (i) the bed capacity of its facilities, (ii) the occupancy rates of its facilities, (iii) the payor mix of its facilities and the rates of reimbursement among payor categories (private and other, Medicare and Medicaid)
6and (iv) the extent to which subacute and other specialty medical and ancillary services are utilized by the patients and paid for by the respective payment sources. The Company employs specialists to monitor reimbursement rules, policies and related developments in order to comply with all reporting requirements and to assist the Company in receiving reimbursements. Although Medicare and higher acuity patients generally produce the highest revenue per patient day, costs associated with the higher acuity needs of these patients also tend to be higher. The Company believes that Medicaid patients generally produce the lowest profit margins.
The following table identifies the Company’s percentage of net revenues attributable to each of its payor sources for the periods indicated:
PERCENTAGE OF TOTAL NET REVENUES BY PAYOR (1)
YEAR ENDED DECEMBER 31,
----------------------
2000 2001 2002
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Private and other .............. 25.8% 22.6% 19.7%
Medicare ....................... 25.0 30.7 33.1
Medicaid ....................... 49.2 46.7 47.2
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Total ........................ 100.0% 100.0% 100.0%
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(1) Total net revenues exclude net revenues of the Larkin Chase Center which is owned by the Bowie Center Limited Partnership (“Bowie L.P.”). The Company owns a 75% partnership interest in Bowie L.P. but records its investment in Bowie L.P. using the equity method of accounting. See Note A to the Company's consolidated financial statements included elsewhere in this report.
Private and Other. Private and other net revenues include payments from individuals who pay directly for services without governmental assistance and payments from commercial insurers, HMOs, PPOs, Blue Cross organizations, workers’ compensation programs, hospice programs and other similar payment sources. The Company’s rates for private pay patients are typically higher than rates for patients eligible for assistance under state Medicaid programs. The Company’s private pay rates vary from facility to facility and are influenced primarily by the rates charged by other providers in the local market and by the Company’s ability to distinguish its services from those provided by its competitors. Private pay rates are generally established on a facility-specific fee schedule, while in the case of managed care, they are either negotiated on a case-by-case basis with the payor or are fixed by contract. Rates charged to private pay patients are not subject to regulatory control in any of the states in which the Company operates.
Medicare. All but one of the Company's skilled nursing facilities are certified Medicare providers. Medicare is a federally funded and administered health insurance program primarily designed for individuals who are age 65 or over and are entitled to receive Social Security benefits. The Medicare program consists of two parts. The first part, Part A, covers inpatient hospital services and certain services furnished by other institutional healthcare providers, such as skilled nursing facilities. The Medicare Part A program provides reimbursement for skilled nursing services provided to Medicare beneficiaries who are admitted to skilled nursing care facilities following a minimum three-day stay in an acute care hospital. Part A covered services include skilled nursing care, rehabilitative therapy treatment, social services, pharmaceuticals and medical supplies in addition to other services. Part A coverage for services delivered in a skilled nursing facility requires a three-day stay in an acute care hospital and is limited to a specified term (generally 100 days per "spell of illness"), requires beneficiaries to share some of the cost of covered services through a co-insurance payment and requires beneficiaries to meet certain qualifying criteria. The second part of the Medicare program, Part B, covers the services of doctors, suppliers of medical items and services and various types of outpatient services. Part B services include physical, speech and occupational therapy and durable medical equipment and other ancillary services of the type provided by long-term care or acute care facilities. Part B services generally require beneficiaries to share the cost of covered services through an annual deductible amount and a co-insurance payment. Prior to December 31, 1998 there were no limits on duration of coverage for Part B services.
Through December 31, 1998, the Medicare Part A program reimbursed the Company for covered services under a cost-based reimbursement system for its allowable direct and indirect costs. During any given cost reporting period through December 31, 1998, the Company’s facilities would each be reimbursed by the Medicare program through an interim daily payment rate, based on the most recent filed cost reports. At the end of the cost reporting period, each facility would file a cost report for the cost reporting period. A settlement payment would occur to reconcile the filed cost report amount to the total of interim payments made to the facility. Audits of the filed cost report could result in additional payments being made to the Company or in recoupments from the Company. To date, adjustments from Medicare audits have not had a material adverse effect upon the Company.
In August of 1997, the Balanced Budget Act of 1997 (the “BBA”) was enacted. The BBA provided a prospective payment system (“PPS”) for skilled nursing facilities to be implemented for cost reporting years beginning on or after July 1, 1998. The Company’s facilities began to be reimbursed in accordance with the BBA beginning January 1, 1999. During the first three years of PPS, the Part A Medicare per diem rates were based on a blend of facility-specific rates and federal rates. Beginning on January 1, 2002, the per diem rates were based solely on federal rates. As a result of the implementation of PPS, the Company’s Medicare Part A per diem rate declined from $397 in 1998 to $290 in 1999. The Company’s average Medicare Part A rate during fiscal 2001 and fiscal 2002 was significantly affected by changes to the Medicare payment system in those years. See “Government Regulation ” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The BBA also implemented a prospective payment system for Part B services. Prior to January 1, 1999, the Company was reimbursed for Part B services on a cost reimbursement basis. Beginning January 1, 1999, Medicare Part B services began being reimbursed on a fee screen basis. These fee screens are revised by the Centers for Medicare and Medicaid Services (“CMS”) on an annual basis. The BBA also imposed an annual limitation on Part B therapy charges of $1,500 per beneficiary.
7Medicaid. All of the Company's skilled nursing facilities participate in the Medicaid programs of the states in which they are located. Medicaid is a state-administered reimbursement program for indigent patients financed by state funds (and in certain states, county funds) and matching federal funds. Although administered under Federal regulations, states have substantial flexibility to design programs and determine reimbursement rates, and as a result, individuals programs and reimbursement rates vary significantly from state to state. The Federal government retains the right to approve or disapprove individual state plans.
Until the enactment of the BBA, a Federal Medicaid statute, generally referred to as the “Boren Amendment,” required Medicaid programs to provide reimbursement rates that were reasonable and adequate to cover the costs that would be incurred by efficiently and economically operated facilities while providing services in conformity with state and federal laws, regulations and quality and safety standards. The BBA repealed the Boren Amendment effective October 1, 1997 and allowed the states to develop their own standards for determining Medicaid payment rates. In the past, several states’ healthcare provider organizations and providers have initiated litigation challenging the Medicaid reimbursement methodologies employed in such states, asserting that reimbursement payments are not adequate to reimburse an efficiently operated facility for the costs of providing Medicaid covered services. The repeal of the Boren Amendment provides states with greater flexibility to amend individual state programs and potentially reduce state Medicaid payments to skilled nursing facilities. Medicaid covered services vary by state, but generally include nursing care, room and board, and social services. Additionally, some states provide reimbursement for pharmaceuticals, rehabilitative therapy treatment and other services.
The Company has been in the past and could be in the future, adversely affected by the continuing efforts of governmental third-party payors to control health care expenditures.
MANAGEMENT INFORMATION SYSTEMS
The Company’s information systems strategy is to provide its facilities with extensive and timely information, which will allow them to operate efficiently under prospective payment reimbursement systems. A cornerstone of this strategy is to avoid the high costs and risks associated with the internal development of significant transaction processing systems. Whenever possible, the Company’s buys well-tested software and avoids the costs and risks inherent in customizing these systems. The Company also places high importance on the interconnection of transactional and clinical data through its extensive data warehouse capabilities.
All of the Company’s facilities are supported by a centralized, integrated financial reporting system which processes financial transactions and which enables Company personnel to monitor and respond on a timely basis to key operating and financial data and budget variances. Using its data warehouse, the Company monitors its occupancy levels, payor mix and overall staffing and temporary labor utilization on a daily basis. The Company utilizes a payroll processing service company to process payroll transactions and maintain human resources files for employees at all of its facilities. The Company’s clinical system captures the data necessary to obtain proper reimbursement from the Federal Part A Medicare program as well as certain state Medicaid programs. The Company’s clinical system also provides data essential to the Company’s clinical services, continuous quality improvement program.
GOVERNMENTAL REGULATION
The Federal government and all states in which the Company operates regulate various aspects of the Company’s business. In addition to the regulation of payment rates by governmental payor sources, the development and operation of long-term care facilities and the provision of long-term care services are subject to Federal, state and local licensure and certification laws which regulate with respect to a facility, among other matters, the number of beds, the services provided, the distribution of pharmaceuticals, equipment, staffing requirements, patients’ rights, operating policies and procedures, fire prevention measures, environmental matters and compliance with building and safety codes. There can be no assurance that Federal, state or local governmental regulations will not change or be subjected to new interpretations that impose additional restrictions which might adversely affect the Company’s business.
All of the skilled nursing facilities operated by the Company are licensed under applicable state laws and possess the required Certificates of Need (“CON”) from responsible state authorities. All of the Company’s skilled nursing facilities are licensed as providers under the Medicaid programs of the states in which they operate. All but one of the Company’s skilled nursing facilities are certified as providers under the Medicare program. Both the initial and continuing qualification of a skilled nursing care facility to participate in such programs depend upon many factors, including accommodations, equipment, services, non-discrimination policies against indigent patients, patient care, quality of life, patients’ rights, safety, personnel, physical environment and adequacy of policies, procedures and controls. Licensing, certification and other applicable standards vary from jurisdiction to jurisdiction and are revised periodically. State agencies survey or inspect all skilled nursing care facilities on a regular basis to determine whether such facilities are in compliance with the requirements for participation in government-sponsored third-party payor programs. In some cases, or upon repeat violations, the reviewing agency has the authority to take various adverse actions against a facility, including the imposition of fines, temporary suspension of admission of new patients to the facility, suspension or decertification from participation in the state Medicaid program or the Medicare program, offset of amounts due against future billings to the Medicare or Medicaid programs, denial of payments under the state Medicaid program for new admissions, reduction of payments, restrictions on the ability to acquire new facilities and, in extreme circumstances, revocation of a facility’s license or closure of a facility.
The Company believes that its facilities are in substantial compliance with all statutes, regulations, standards and requirements applicable to its business, including applicable Medicaid and Medicare regulatory requirements. However, in the ordinary course of its business, the Company from time to time receives notices of deficiencies for failure to comply with various regulatory requirements. In most cases, the Company and the reviewing agency will agree upon corrective measures to be taken to bring the facility into compliance. Although the Company has been subject to
8some fines, statements of deficiency and other corrective actions have not had a material adverse effect on the Company.
The Company believes that the regulatory environment surrounding the long-term care industry has intensified, particularly for multi-facility for-profit operators. The Federal government has imposed intensive enforcement policies resulting in a significant increase in the number of inspections, citations of regulatory deficiencies, and other regulatory sanctions including terminations from the Medicare and Medicaid programs, bars on Medicare and Medicaid payments for new admissions and civil monetary penalties. There can be no assurance that future agency inspections and the actions taken by the reviewing agency based upon such inspections will not have a material adverse effect on the Company’s results of operations, cash flows or its financial position.
Certificates of Need. All but one of the states (Indiana) in which the Company operates have adopted CON or similar laws that generally require that a state agency determine that a need exists prior to the construction of new skilled nursing facilities, the addition or reduction of licensed beds or services, the implementation of other changes, the incurrence of certain capital expenditures, and, in certain states, the approval of certain acquisitions and changes in ownership or the closure of a skilled nursing facility. State CON approval is generally issued for a specific project or number of beds, specifies a maximum expenditure, is sometimes subject to an inflation adjustment, and requires implementation of the proposal within a specified period of time. Failure to obtain the necessary state approval can result in the inability of the facility to provide the service, operate the facility or complete the acquisition, addition or other change and can also result in adverse reimbursement action or the imposition of sanctions or other adverse action on the facility’s license.
Medicare. A substantial portion of the Company's revenues are derived from the Medicare program. See "Sources of Revenues." All but one of the Company's skilled nursing facilities are certified Medicare providers. Medicare is a federally funded and administered health insurance program primarily designed for individuals who are age 65 or over and are entitled to receive Social Security benefits. The Medicare program consists of two parts. The first part, Part A, covers inpatient hospital services and certain services furnished by other institutional healthcare providers, such as skilled nursing facilities. The Medicare Part A program provides reimbursement for skilled nursing services provided to Medicare beneficiaries who are admitted to skilled nursing facilities following a minimum three-day stay in an acute care hospital. Part A covered services include skilled nursing care, rehabilitative therapy treatment, social services, pharmaceuticals and medical supplies in addition to other services. Part A coverage for services delivered in a skilled nursing care facility requires a three-day stay in an acute care hospital, is limited to a specified term (generally 100 days per "spell of illness"), requires beneficiaries to share some of the cost of covered services through a co-insurance payment and requires beneficiaries to meet certain qualifying criteria. The second part of the Medicare program, Part B, covers the services of doctors, suppliers of medical items and services and various types of outpatient services. Part B services include physical, speech and occupational therapy and durable medical equipment and other ancillary services of the type provided by skilled nursing or acute care facilities. Part B services generally require beneficiaries to share the cost of covered services through a an annual deductible amount and a co-insurance payment. Prior to December 31, 1998 there were no limits on duration of coverage for Part B services.
Over the past several years, the Federal government has enacted three significant laws that dramatically affected the payment methodology through which skilled nursing facilities are reimbursed by the Medicare program. The first, the BBA, was enacted in August 1997 and significantly amended the reimbursement methodology of the Medicare program. In addition to offering new Medicare health plan options and increasing the penalties related to healthcare fraud and abuse, the BBA provided for a prospective payment system for skilled nursing facilities to be implemented for cost report periods beginning on or after July 1, 1998. Through December 31, 1998, the Medicare Part A program reimbursed the Company for covered services under a cost-based reimbursement system for its allowable direct and indirect costs.
Medicare PPS was being phased in over a period of four years, beginning with skilled nursing facility cost reporting periods ending on or after July 1, 1998. “New facilities,” which first received Medicare payment on or after October 1, 1995, moved to the federal per diem rate effective with the cost report periods beginning on or before July 1, 1998 and did not have a transitional period. All other facilities were “phased-in” by a formula effective with the cost report period beginning on or after July 1, 1998 and through which Medicare PPS blended together facility-specific rates and federal industry per diems according to the following schedule: Year One -- 75% facility-specific, 25% federal per diem; Year Two -- 50% each; Year Three -- 25% facility-specific, 75% federal per diem; Year Four -- 100% federal per diem. As a result of Medicare PPS being effective for cost reports beginning on or after July 1, 1998, Medicare PPS did not directly impact the Company’s Medicare reimbursement until the fiscal year beginning January 1, 1999. With full implementation, effective January 1, 2002, Medicare PPS resulted in each Medicare certified skilled nursing facility being reimbursed on a per diem rate (the “Federal per diem rate”) basis with acuity-based per diem rates being established as applicable to all Medicare Part A beneficiaries who are residents of the skilled nursing facility. The acuity-based per diem rates are determined by classifying each patient into one of forty-four resource utilization groups (“RUG”) using the data captured by completing the minimum data assessment (“MDS”) required by CMS. Each RUG classification is assigned its own Federal per diem rate by CMS. The Federal per diem rates are all-inclusive rates through which the skilled nursing facility is reimbursed for its routine, ancillary and capital costs. The Federal Medicare PPS rates were developed by CMS based on a blend of allowable costs from hospital-based and freestanding skilled nursing facility cost reports for reporting periods beginning in Federal Fiscal Year 1995 (i.e., October 1, 1994 -- September 30, 1995). CMS updated costs to the first year of Medicare PPS using a skilled nursing facility market basket inflation index standardized for facility differences in case-mix and for geographic variations in wages. Providers that received “new provider” exemptions from the routine cost limits were excluded from the database used to compute the federal payment rates. In addition, costs related to payments for exceptions to the routine cost limits were excluded from the database used to compute the federal payment rates. The facility-specific portion was based on each facility’s Medicare cost report for cost reporting periods beginning in Federal Fiscal Year 1995, including routine cost limit exception and exemption payments up to 150% of the routine cost limit, the allowable costs to be updated under Medicare PPS for the skilled nursing facility market basket minus 1% through 1999 and the full skilled nursing facility market basket after 1999. A variety of other adjustments are made in developing the Medicare PPS rates pursuant to the BBA and the regulations.
9The BBA also required skilled nursing facilities to institute “consolidated billing” for a variety of services and supplies. Under consolidated billing, the skilled nursing facility must submit all Medicare claims for all the Part A services and supplies that its residents receive, with the exception of certain services, including those provided by physicians. Payments for these services and supplies billed on a consolidated basis are made directly to the skilled nursing facility, whether or not the services were provided directly by the skilled nursing facility or by others under a contractual arrangement. The skilled nursing facility is responsible for paying the provider of the services or the supplier.
The BBA also implemented a prospective payment system for Part B services. Prior to January 1, 1999, the Company was reimbursed for Part B services on a cost reimbursement basis. Beginning January 1, 1999, Medicare Part B services began being reimbursed on a fee screen basis. These fee screens are revised by the CMS on an annual basis. The BBA also imposed an annual limitation on Part B therapy charges of $1,500 per beneficiary, separately for physical/speech therapy and occupational therapy, and imposed a future requirement to implement consolidated billing for Part B services.
On November 29, 1999, the second major law, the “Balanced Budget Refinement Act” of 1999 (the “BBRA”) was signed into law. The BBRA was designed to mitigate some of the effects of the BBA. The BBRA allowed skilled nursing facilities to elect transition to the full Federal per diem rate at the beginning of their cost reporting periods for cost periods beginning on or after January 1, 2000. Using the election allowed by the BBRA, the Company chose to move fourteen facilities to the full Federal per diem rate effective January 1, 2000. As a result, as of December 31, 2000, the Company used the full Federal per diem rate to calculate Medicare revenue at twenty-three of its skilled nursing facilities. Additionally, the BBRA increased the Federal per diem rates by 20% for fifteen RUG categories (three rehabilitative therapy RUG categories, twelve non-rehabilitative therapy RUG categories) beginning on April 1, 2000. These increased rates were to stay in effect until the later of (a) October 1, 2000 or (b) the date CMS implements a revised PPS system that more accurately reimburses the costs of caring for medically complex patients. The BBRA also provided for a four percent temporary increase in the Federal per diem rates for all RUG categories for a two-year period beginning October 1, 2000. The BBRA also excluded certain supplies and services that were formerly required to be reimbursed by a skilled nursing facility’s PPS rate. The BBRA also eliminated the annual provider limitations on Part B therapy charges per beneficiary for calendar year 2000 and 2001.
In December 2000, the third major law, the Medicare, Medicaid, and State Child Health Insurance Program Benefits Improvement and Protection Act of 2000 (“BIPA”) was enacted. BIPA temporarily increased the existing nursing rate component of the Federal per diem rate, for each RUG category, by 16.66% from April 1, 2001 through September 30, 2002. In addition, BIPA eliminated the 20% add-ons (provided by the BBRA) for the three rehabilitative therapy RUG categories and substituted 6.7% add-ons for all fourteen rehabilitative therapy RUG categories. The 6.7% add-ons are scheduled to stay in effect until CMS implements a revised PPS system as contemplated by the BBRA. BIPA also extended the moratorium on the annual limitation on Part B therapy charges of $1,500 per beneficiary through calendar year 2002 and repealed the BBA requirement to implement consolidated billing for Part B services.
On September 30, 2002, certain increases in Medicare reimbursement for skilled nursing facilities provided for under the BBRA and BIPA expired: (i) the four percent increase in the Federal per diem Medicare Part A rates for all RUG categories granted by the BBRA, which had been in effect since October 1, 2000, and (ii) the 16.66% increase to the nursing rate component of the Federal per diem Medicare Part A rates for all RUG categories, which had been in effect since April 1, 2001. In addition to these reimbursement reductions, effective October 1, 2002, the Company’s Medicare Part A rates also experienced an increase of approximately 2.6% reflecting the Medicare program’s annual inflationary increase. The Medicare program increases the Part A rates for skilled nursing facilities annually on the first of October. Historically, these inflationary increases have not kept pace with the rate of inflation experienced by operators of skilled nursing facilities.
The net effect of (i) the two reductions in Medicare Part A reimbursement effective September 30, 2002, and (ii) and the annual inflationary increase effective October 1, 2002, was to lower the Company’s Medicare Part A per diem rate from $358 during the third quarter of fiscal 2002 to $331 during the fourth quarter of fiscal 2002. The Company’s reduction of $27 per Medicare Part A day had the effect of reducing revenues by approximately $2,330,000 during the fourth quarter of fiscal 2002.
The effect of the two reductions by themselves (excluding the effect of the inflationary increase) was to lower the Company’s Medicare Part A per diem rate by approximately $37 per Medicare Part A day from the third quarter of fiscal 2002 to the fourth quarter of fiscal 2002. Assuming that the average Medicare Part A daily census experienced by the Company during the fourth quarter of fiscal 2002 was held constant, the impact of the two reductions in Medicare Part A reimbursement effective September 30, 2002 would be to reduce the Company’s annualized revenues by approximately $12,668,000.
The two year moratorium on the annual limitation on Part B therapy charges of $1,500 per day, separately for physical/speech therapy and occupational therapy, expired on December 31, 2002; however, CMS has stated that it will not begin enforcing the annual therapy limitations until July 1, 2003.
Medicaid. All but one of the Company's skilled nursing facilities participate in the Medicaid programs of the states in which they are located. Medicaid is a state-administered reimbursement program for indigent patients financed by state funds (and in certain states, county funds) and matching federal funds. Although administered under Federal regulations, states have substantial flexibility to design programs and determine reimbursement rates, and as a result, individuals programs and reimbursement rates vary significantly from state to state. The Federal government retains the right to approve or disapprove individual state plans.
Until the enactment of the BBA, a Federal Medicaid statute, generally referred to as the “Boren Amendment,” required Medicaid programs to provide reimbursement rates that were reasonable and adequate to cover the costs that would be incurred by efficiently and economically operated facilities while providing services in conformity with state and federal laws, regulations and quality and safety standards. The BBA repealed the Boren Amendment effective October 1, 1997 and allowed the states to develop their own standards for determining Medicaid payment rates. In the past, several states’ healthcare provider organizations and providers have initiated litigation challenging the Medicaid reimbursement methodologies employed in such states, asserting that reimbursement payments are not adequate to reimburse an efficiently operated facility for the costs of providing Medicaid covered services. The repeal of the Boren Amendment provides states with greater flexibility to amend individual state programs and potentially reduce state Medicaid payments to skilled nursing
10facilities. Medicaid covered services vary by state, but generally includes nursing care, room and board, and social services. Additionally, some states provide reimbursement for pharmaceuticals, rehabilitative therapy treatment and other services.
The Medicaid programs in the states in which the Company operates pay a per diem rate for providing services to Medicaid patients based on the facility’s reasonable allowable costs incurred in providing services, subject to cost ceilings applicable to patient care, other operating costs and capital costs. Some state Medicaid programs in which the Company currently operates currently include incentive allowances for providers whose costs are less than certain ceilings.
There are generally two types of Medicaid reimbursement rates: retrospective and prospective, although many states have adopted plans that have both retrospective and prospective features. A retrospective rate is determined after completion of a cost report by the service provider and is designed to reimburse expenses. Typically, an interim rate, based upon historical cost factors and inflation is paid by the state during the cost reporting period and a cost settlement is made following an audit of the filed cost report. Such adjustments may result in additional payments being made to the Company or in recoupments from the Company, depending on actual performance and the limitations within an individual state plan.
The more prevalent type of Medicaid reimbursement rate is the prospective rate. Under a prospective plan, the state sets its rate of payment for the period before services are rendered. Actual costs incurred by operators during a period are used by the state to establish the prospective rate for subsequent periods. The provider must accept the prospective rate as payment in full for all services rendered. Subsequent audits may provide a basis for the state program to retroactively recoup monies.
To date, adjustments from Medicaid audits have not had a material adverse effect on the Company. Although there can be no assurance that future adjustments will not have a material adverse effect on the Company, the Company believes that it has properly applied the various payment formulas and that it is not likely that audit adjustments would have a material adverse effect on the Company.
Potential Healthcare Reform. In addition to extensive existing governmental healthcare regulation, there are numerous legislative and executive initiatives at the federal and state levels for comprehensive reforms affecting the payment for and availability of healthcare services. It is not clear at this time what proposals, if any, will be adopted or, if adopted, what effect such proposals would have on the Company’s business. Aspects of certain of these proposals, such as reductions in funding of Medicaid programs, or changes in the administration of Medicaid at the state level, could materially adversely affect the Company. Additionally, the BBA repealed the Boren Amendment effective October 1, 1997 and allows the states to develop their own standards for determining Medicaid payment rates. The BBA provides certain procedural restrictions on the states’ ability to amend state Medicaid programs by requiring that the states use a public process to establish payment methodologies including a public comment and review process. The repeal of the Boren Amendment provides states with greater flexibility to amend individual state programs and potentially reduce state Medicaid payments to skilled nursing facilities. There can be no assurance that currently proposed or future healthcare legislation or other changes in the administration or interpretation of governmental healthcare programs will not have an adverse effect on the Company.
Fee Splitting and Referrals. The Company is also subject to federal and state laws that govern financial and other arrangements between healthcare providers. Federal laws, as well as the laws of certain states, prohibit direct or indirect payments or fee splitting arrangements between healthcare providers that are designed to induce or encourage the referral of patients to, or the recommendation of, a particular provider for medical products and services. These laws include the federal “anti-kickback law” which prohibits, among other things, the offer, payment, solicitation or receipt of any form of remuneration in return for the referral of Medicare and Medicaid patients. A wide array of relationships and arrangements, including ownership interests in a company by persons in a position to refer patients and personal service agreements have, under certain circumstances, been alleged to violate these provisions. Certain discount arrangements may also violate these laws. Because of the broad reach of these laws, the federal government has published certain “safe harbors,” which set forth the requirements under which certain relationships will not be considered to violate such laws. A violation of the federal anti-kickback law could result in the loss of eligibility to participate in Medicare or Medicaid, or in criminal penalties. Violation of state anti-kickback laws could lead to loss of licensure, significant fines and other penalties.
Various federal and state laws regulate the relationship between healthcare providers and physicians, including employment or service contracts and investment relationships. These laws include the broadly worded fraud and abuse provisions of the Medicaid and Medicare statutes, which prohibit various transactions involving Medicaid or Medicare covered patients or services. In particular, the Omnibus Budget Reconciliation Act of 1993 (“OBRA 93”) contains provisions which greatly expand the federal prohibition on physician referrals to entities with which they have a financial relationship. Effective January 1, 1995, OBRA 93 prohibits any physician with a financial relationship (defined as a direct or indirect ownership or investment interest or compensation arrangement) with an entity from making a referral for “designated health services” to that entity and prohibits that entity from billing for such services. “Designated health services” do not include skilled nursing services but do include many services which long-term care facilities provide to their patients, including physical therapy, occupational therapy, infusion therapy and enteral and parenteral nutrition. Various exceptions to the application of this law exist, including one which protects the payment of fair market compensation for the provision of personal services, so long as various requirements are met. Violations of these provisions may result in civil or criminal penalties for individuals or entities and/or exclusion from participation in the Medicaid and Medicare programs. Various state laws contain analogous provisions, exceptions and penalties. The Company believes that in the past it has been, and in the future it will be, able to arrange its business relationships so as to comply with these provisions.
Each of the Company’s skilled nursing care facilities has at least one medical director that is a licensed physician. The medical directors may from time to time refer their patients to the Company’s facilities in their independent professional judgment. The physician anti-referral restrictions and prohibitions could, among
11other things, require the Company to modify its contractual arrangements with its medical directors or prohibit its medical directors from referring patients to the Company. From time to time, the Company has sought guidance as to the interpretation of these laws. However, there can be no assurance that such laws will ultimately be interpreted in a manner consistent with the practices of the Company.
The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) broadened the scope of fraud and abuse laws to include all health plans, whether or not they are reimbursed under Federal programs. HIPAA also mandated the adoption of federal regulations designed to (a) standardize transaction formats and billing codes for documenting health care services, determining eligibility and processing claims for payment; and (b) protect the privacy and security of individually identifiable health information. Final HIPAA regulations that standardize transactions and code sets were issued during the third quarter of 2000. The ultimate compliance date was subsequently modified by legislation to require health care providers and health plans to either comply with the HIPAA transaction code set standards beginning in October of 2002 or submit a written plan to the federal government by October of 2002 describing specific plans for compliance by October of 2003. The regulations do not require healthcare providers to submit claims electronically, but do require standard formatting for those that do so. The Company currently submits most claims electronically and expects to continue to do so. The Company has submitted, on behalf of all owned, operated and affiliated entities and health plans, an Electronic Transactions and Code Sets Compliance Extension Plan and copies of all CMS approval/confirmation for each entity are maintained on file at the Company’s corporate offices. The Company is currently evaluating the impact of the Transactions and Code Sets provisions but does expect to fully comply in accordance with each model compliance plan filed previously filed with the Centers for Medicare and Medicaid services. On February 20, 2003, the U.S. Department of Health and Human Services published modifications to the final transaction standards; however, the October 2003 compliance date was not changed.
Final HIPAA privacy regulations were published during the fourth quarter of 2000. However, on March 21, 2002, the U.S. Department of Health and Human Services released a proposed rule which if finally adopted would modify the regulations published during 2000. In general, the regulations apply to “protected health information”, which is defined as individually identifiable health information transmitted or maintained in any form or medium, excluding certain education records and student medical records. The privacy regulations seek to limit the use and disclosure of most paper and oral communications, as well as those in electronic form, regarding an individual’s past, present or future physical or mental health or condition, or relating to the provision of health care to the individual or payment of that health care. The regulations further impose requirements on health care providers to contractually obligate certain of their subcontractors who may receive protected health care information during the course of rendering services on behalf of such health care provider to abide by certain privacy requirements as well. In addition, the current HIPAA regulations provide that certain state privacy laws may not be preempted by HIPAA. Accordingly, the Company, in certain instances, will remain subject to various state privacy laws in jurisdictions in which it currently operates facilities. HIPAA provides for the imposition of civil and criminal penalties if protected health information is improperly disclosed. The Company must comply with applicable privacy regulations by April of 2003. The Company is continuing to evaluate the impact of the privacy regulations on its operations but anticipates that it will be able to comply with those HIPAA requirements that have been adopted.
HIPAA’s security regulations have not been finalized. The proposed security regulations specify administrative procedures, physical safeguards, and technical services and mechanisms designed to ensure that protected health information remains secure. The proposed security rules contemplate a compliance date of 24 months after the effective date of the final rule published in the Federal Register, although it is possible that such compliance date will differ and could align with the compliance date for the privacy regulations depending on when the security regulations are ultimately finalized.
Management continues to evaluate the likely effects of HIPAA on the Company and its operations. At this time management believes that the Company will be able to comply with the HIPAA requirements that have been adopted to date, and that the costs of compliance will not have a material adverse effect on the Company’s results of operations, cash flows or financial position.
COMPETITION
The long-term care industry is highly competitive. The Company competes with other providers of long-term care on the basis of the scope and quality of services offered, the rate of positive medical outcomes, cost-effectiveness and the reputation and appearance of its long-term care facilities. The Company also competes in recruiting qualified healthcare personnel, in acquiring and developing additional facilities and in obtaining CONs. The Company’s current and potential competitors include national, regional and local long-term care providers, some of whom have substantially greater financial and other resources and may be more established in their communities than the Company. The Company also faces competition from assisted living facility operators as well as providers of home healthcare. In addition, certain competitors are operated by not-for-profit organizations and similar businesses which can finance capital expenditures and acquisitions on a tax-exempt basis or receive charitable contributions unavailable to the Company.
In general, consolidation in the long-term care industry has resulted in the Company being faced with larger competitors, many of whom have significant financial and other resources. The Company expects that this continuing consolidation may increase the competition for the acquisition of long-term care facilities.
The Company believes that state regulations which require a CON before a new long-term care facility can be constructed or additional licensed beds can be added to existing facilities reduce the possibility of overbuilding and promote higher utilization of existing facilities. CON legislation is currently in place in all states in which the Company operates or expects to operate with the exception of Indiana where the CON program expired as of June 30, 1998. Several of the states in which the Company operates have imposed moratoriums on the issuance of CONs for new skilled nursing facility beds. A relaxation of CON requirements could lead to an increase in competition. In addition, as cost containment measures have reduced occupancy rates at acute care hospitals, a number of these hospitals
12have converted portions of their facilities into subacute units. In the states in which the Company currently operates, these conversions are subject to state CON regulations. The Company believes that the application of the new Medicare PPS rules have made such conversions less desirable.
EMPLOYEES
As of December 31, 2002, the Company employed approximately 8,850 facility-based personnel on a full- and part-time basis. The Company’s corporate and regional staff consisted of 164 persons as of such date. Approximately 615 employees at ten of the Company’s facilities are covered by collective bargaining agreements. Although the Company believes that it maintains good relationships with its employees and the unions that represent certain of its employees, it cannot predict the impact of continued or increased union representation or organizational activities on its future operations.
The Company believes that the attraction and retention of dedicated, skilled and experienced nursing and other professional staff has been and will continue to be a critical factor in the successful growth of the Company. The Company believes that its wage rates and benefit packages for nursing and other professional staff are commensurate with market rates and practices.
The Company competes with other healthcare providers in attracting and retaining qualified or skilled personnel. The long-term care industry has, at times, experienced shortages of qualified personnel. A continued shortage of nurses or other trained personnel or general economic inflationary pressures may require the Company to enhance its wage and benefits package in order to compete with other employers. There can be no assurance that the Company’s labor costs will not increase or, if they do, that they can be matched by corresponding increases in private-payor revenues or governmental reimbursement. Failure by the Company to attract and retain qualified employees, to control its labor costs or to match increases in its labor expenses with corresponding increases in revenues could have a material adverse effect on the Company.
INSURANCE
During the year ended December 31, 1998, the Company implemented a general and professional liability insurance program that, for the period from September 1, 1998 to August 31, 2001, limited the Company’s self-retention risk for this program to a maximum of $25,000 per year. The long-term care industry has seen the cost of maintaining traditional professional liability insurance increase significantly over the past several years, especially in the State of Florida. Most insurance companies are unwilling to underwrite new professional liability policies in the State of Florida. In May 2001, tort reform legislation was enacted in Florida. This legislation provided caps on punitive damages, limits to add-on legal fees, stricter rules of evidence and a shorter statute of limitations period. Given the tremendous increase in professional liability premiums and the tort reform legislation that was enacted in the State of Florida in May 2001, the Company concluded that it would be more cost effective to assume a higher level of retained risk for professional liability claims. As a result, the Company implemented a new general and professional liability program, effective September 1, 2001, which resulted in the Company maintaining an unaggregated self-insured retention of $2,000,000 per occurrence for locations outside of Florida and completely retaining risk at the Florida facilities. As of December 1, 2002, the Company’s unaggregated self-insured retention increased to $10,000,000 per occurrence for locations outside of Florida. The Company maintains an accrual for estimated unpaid losses including unreported claims. The amount of the accrual is determined through an estimation process that uses information from both the Company’s records as well as industry data. The Company uses an independent actuary to help estimate the required general and professional liability accrual. Factors reviewed include the frequency of expected claims, the average cost per claim, emerging industry trends, changes in regulatory environment (such as the recently enacted Florida tort reform legislation) and the expected effect of various operational and risk management initiatives. The Company will continue to evaluate its insurance accrual requirements on a quarterly basis. Required adjustments to the Company’s general and professional liability accrual will be recorded in the accounting period in which the change in estimate occurs. There can be no assurances that the recent Florida tort reform legislation will have a positive impact on claims activity, that the coverage limits of the Company’s insurance program will be adequate or that insurance will continue to be available to the Company in the future. (See Note M to the Company’s consolidated financial statements included elsewhere in this report.)
13The following table summarizes certain information regarding the Company’s facilities as of December 31, 2002:
SUMMARY OF FACILITIES
YEAR OWNED/
FACILITY LOCATION ACQUIRED LEASED/MANAGED BEDS
- -------- -------- ----------- --------------- -----
SOUTHEAST REGION
Florida
Huntington Place Rockledge 1994 Leased 100 (2)
Sunset Point Clearwater 1990 Owned 120 (2)
Orchard Ridge New Port Richey 1990 Owned 120 (2)
Lakeside Pavilion Naples 1989 Leased 120 (2)
Oakhurst Ocala 1990 Owned 180 (2)
Bay Tree Palm Harbor 1990 Owned 120 (2)
Pinebrook Rehabilitation Venice 1989 Leased 120 (2)
Springwood Sarasota 1990 Leased 120 (2)
Westbay Oldsmar 1990 Owned 120 (2)
------
1,120
MIDWEST REGION
Ohio
Defiance Defiance 1993 Leased 100 (2)
Northwestern Ohio Bryan 1993 Leased 189 (2)
Swanton Swanton 1995 Leased 100 (2)
Perrysburg Perrysburg 1990 Owned 100 (2)
Troy Troy 1989 Leased 195 (2)
Beachwood Beachwood 1996 Leased 274 (2)
Broadview Broadview Heights 1996 Leased 159 (2)
Westlake I Westlake 1996 Leased 153 (2)
Westlake II Westlake 1996 Leased 106 (2)
Dayton Dayton 1997 Owned 100 (2)
Laurelwood Dayton 1997 Owned 115 (3)
New Lebanon New Lebanon 1997 Owned 126 (2)
Point Place Toledo 1998 Owned 98 (4)
Sylvania Sylvania 1998 Owned 150 (2)
Marietta Marietta 2001 Leased 150 (2)
Indiana
Decatur Indianapolis 1988 Owned 88 (2)
Indianapolis Indianapolis 1988 Leased 104 (2)
New Haven New Haven 1990 Leased 120 (2)
Terre Haute Terre Haute 1990 Owned 120 (2)
------
2,547
NEW ENGLAND REGION
Connecticut
Arden House Hamden 1997 Leased 360 (2)
Governor's House Simsbury 1997 Leased 73 (2)
Madison House Madison 1997 Leased 90 (2)
The Reservoir West Hartford 1997 Leased 75 (2)
Willows Woodbridge 1997 Leased 90 (2)
Glen Hill Danbury 1998 Owned 100 (2)
Glen Crest Danbury 1998 Owned 49 (5)
Massachusetts
Maplewood Amesbury 1997 Leased 120 (2)
Cedar Glen Danvers 1997 Leased 100 (2)
Danvers-Twin Oaks Danvers 1997 Leased 101 (2)
Northshore Saugus 1997 Leased 80 (2)
The Stone Institute Newton Upper Falls 1997 Managed 106 (6)
Falmouth Falmouth 2002 Leased 120 (2)
Mashpee Mashpee 2002 Leased 120 (2)
Wakefield Wakefield 2002 Leased 149 (2)
Westfield Westfield 2002 Leased 98 (2)
14
New Hampshire
Applewood Winchester 1996 Leased 70 (2)
Crestwood Milford 1996 Leased 82 (2)
Milford Milford 1996 Leased 52 (2)
Northwood Bedford 1996 Leased 147 (2)
Pheasant Wood Peterborough 1996 Leased 99 (2)
Westwood Keene 1996 Leased 87 (2)
Rhode Island
Greenwood Warwick 1998 Owned 136 (2)
Pawtuxet Village Warwick 1998 Owned 131 (2)
------
2,635
MID-ATLANTIC REGION
Maryland
Harford Gardens Baltimore 1997 Leased 163 (2)
Larkin Chase Center Bowie 1994 Owned (1) 120 (2)
New Jersey
Woods Edge Bridgewater 1988 Leased 176 (2)
------
459
Total 6,761 (7)
=====
(1) Owned by Bowie L.P. The Company's interest in Bowie L.P. is pledged to the
facility's mortgage lender. The Company has guaranteed the indebtedness of
Bowie L.P.
(2) Indicated number of beds is comprised entirely of licensed skilled nursing
facility beds.
(3) Indicated number of beds is comprised entirely of licensed residential care
beds.
(4) Indicated number of beds consists of 92 licensed skilled nursing facility
beds and 6 licensed assisted living facility beds.
(5) Indicated number of beds is comprised entirely of independent living beds.
(6) Indicated number of beds consists of 82 licensed skilled nursing facility
beds and 24 licensed rest home beds.
(7) As of December 31, 2002, the Company had licenses for 6,567 skilled nursing
facility beds, 6 assisted living facility beds, 115 residential care beds
and 24 rest home beds and also operated 49 independent living beds.
The Company maintains its Corporate offices in Boston as well as regional offices in Palm Harbor, Florida; Beachwood, Ohio, Indianapolis, Indiana; Topsfield, Massachusetts; West Hartford, Connecticut; and Sharon, New Hampshire. The Company considers its properties to be in good operating condition and suitable for the purposes for which they are being used.
The Company is a party to claims and legal actions arising in the ordinary course of business. Management does not believe that unfavorable outcomes in any such matters, individually or in the aggregate, would have a material adverse effect on the Company’s financial condition, results of operations or liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company’s stockholders during the last quarter of the Company’s fiscal year ended December 31, 2002.
15PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS' MATTERS
No market information is available because no current established trading market exists for the Company's securities.
The Company has not declared or paid any cash dividends on its common stock since its formation in 1996. The Company does not anticipate paying cash dividends on its common stock for the foreseeable future and intends to retain all of its earnings for reinvestment in the operations and activities of the Company. Any future decision as to the payment of dividends will be at the discretion of the Company’s Board of Directors. The Company’s ability to pay dividends is also limited by the terms of current (and possibly future) lease and financing arrangements that restrict, among other things, the ability of the Company’s subsidiaries to distribute funds to the Company.
Information concerning securities authorized for issuance under equity compensation plans appears in Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”
16ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
The following table sets forth selected consolidated financial data for the Company. The selected historical consolidated financial data for each of the years in the five year period ended December 31, 2002 have been derived from the Company’s consolidated financial statements, which have been audited by PricewaterhouseCoopers LLP, our independent accountants. The financial data set forth below should be read in conjunction with the Consolidated Financial Statements and the Notes thereto, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
(dollars in thousands, except per share amounts)
YEAR ENDED DECEMBER 31,
-----------------------
1998 1999 2000 2001 2002
----------- ----------- ----------- ----------- -----------
Statement of operations data:
Total net revenues ..................... $ 311,044 $ 300,615 $ 322,672 $ 346,738 $ 400,224
----------- ----------- ----------- ----------- -----------
Expenses:
Facility operating ..................... 246,000 248,795 259,780 282,194 332,049
General and administrative ............. 15,422 17,808 17,993 19,043 20,220
Service charges paid to former affiliate 1,291 1,173 1,083 979 759
Amortization of prepaid management fee . 500 1,200 1,200 1,200 1,200
Depreciation and amortization .......... 6,350 10,249 10,210 9,355 9,889
Facility rent .......................... 22,412 22,394 24,275 28,889 30,611
Merger costs ........................... 37,172 -- -- -- --
Financial restructuring costs .......... -- -- -- 9,045 --
Facility reorganization costs .......... -- -- -- 1,080 --
Restructuring costs .................... -- 5,745 -- -- --
Financing costs ........................ -- -- -- -- 2,835
Loss on termination of capital lease ... -- -- 8,914 -- --
---------- ----------- ----------- ----------- -----------
Total expenses .......................... 329,147 307,364 323,455 351,785 397,563
---------- ----------- ----------- ----------- -----------
Income (loss) from operations .......... (18,103) (6,749) (783) (5,047) 2,661
Other:
Interest expense, net .................. 11,271 20,895 21,675 11,945 8,056
Other expense (income) ................. (167) 261 (74) (315) 24
---------- ----------- ----------- ----------- -----------
Loss before income taxes ................ (29,207) (27,905) (22,384) (16,677) (5,419)
Income tax expense (benefit) ............ (5,020) (10,304) 14,322 225 240
----------- ----------- ----------- ----------- -----------
Net loss ................................ (24,187) (17,601) (36,706) (16,902) (5,659)
Preferred stock dividends ............... (2,296) (6,004) (6,853) (3,774) (2,223)
----------- ----------- ----------- ----------- -----------
Loss applicable to common shares ... $ (26,483) $(23,605) $ (43,559) $ (20,676) $ (7,882)
=========== =========== =========== =========== ===========
Loss per common share:
Basic and Diluted .................. $ (3.42) $ (3.25) $ (6.00) $ (2.82) $ (1.05)
=========== =========== =========== =========== ===========
Weighted average number of common shares
used in per share computations:
Basic and Diluted ................... 7,742,000 7,261,000 7,261,000 7,335,000 7,541,000
17
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA (continued)
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------
1998 1999 2000 2001 2002
----------- ----------- ----------- ----------- -----------
Operational data (as of end of year) (1):
Facilities ............................. 50 50 50 51 55
Licensed beds .......................... 6,120 6,124 6,124 6,274 6,761
Average occupancy rate (2) .............. 92.3% 90.9% 90.1% 88.9% 87.8%
Patient days (3):
Private and other ....................... 503,234 489,074 455,491 415,861 391,607
Medicare ................................ 196,222 219,924 238,574 293,257 352,326
Medicaid ................................ 1,169,258 1,240,228 1,246,735 1,207,004 1,311,654
----------- ----------- ----------- ----------- -----------
Total ................................... 1,868,714 1,949,226 1,940,800 1,916,122 2,055,587
=========== =========== =========== =========== ===========
Sources of total net revenues:
Private and other (4) ................... 30.2% 28.9% 25.8% 22.6% 19.7%
Medicare ................................ 27.7% 21.8% 25.0% 30.7% 33.1%
Medicaid ................................ 42.1% 49.3% 49.2% 46.7% 47.2%
Balance sheet data:
Working capital ......................... $ 36,403 $ 36,536 $ 33,280 $ 22,076 $ 32,462
Total assets ............................ 264,536 283,233 203,097 193,369 221,343
Total debt .............................. 134,680 171,245 179,116 116,654 143,318
Capital lease obligation ................ 55,531 54,700 -- -- --
Stockholders' equity (deficit) (5) (6) .. 83 (23,522) (67,074) (31,167) (39,290)
(1) Includes one managed facility with 106 licensed beds.
(2) "Average occupancy rate" is computed by dividing the number of billed bed
days by the total number of available licensed bed days during each of the
periods indicated. This calculation includes all facilities operated by the
Company excluding managed facilities.
(3) "Patient Days" includes billed bed days for the facilities operated by the
Company excluding billed bed days of managed facilities and the one
facility accounted for using the equity method.
(4) Consists primarily of revenues derived from private pay individuals,
managed care organizations, HMO's, hospice programs, commercial insurers,
management fees from managed facilities, and through September 1999,
rehabilitation therapy revenues from non-affiliated facilities.
(5) In accordance with Securities and Exchange Commission requirements, the
carrying amount of the Company's 13.5% Exchangeable Preferred Stock is
excluded from total stockholders' equity (deficit). As of December 31,
1998, 1999 and 2000, the carrying amount of the Company's 13.5%
Exchangeable Preferred Stock was $42,293,000, $48,277,000 and $55,112,000,
respectively.
(6) In accordance with Securities and Exchange Commission requirements, the
carrying amount of the Company's 13% Convertible Exchangeable Preferred
Stock is excluded from total stockholders' equity (deficit). As of December
31, 2001 and 2002, the carrying amount of the Company's 13% Convertible
Exchangeable Preferred Stock was $16,286,000 and $18,509,000, respectively.
18
Subsidiaries of Harborside Healthcare Corporation, provide high-quality long-term care, subacute care and specialty medical services in the eastern United States. Harborside Healthcare Corporation has focused on establishing strong local market positions with high-quality facilities in four principal geographic regions: the Southeast (Florida), the Midwest (Ohio and Indiana), New England (Connecticut, Massachusetts, New Hampshire and Rhode Island) and the Mid-Atlantic (New Jersey and Maryland). As of December 31, 2002, subsidiaries of Harborside Healthcare Corporation operated 55 facilities (18 owned, 36 leased and one managed) with a total of 6,761 licensed beds. As described in Note A to the audited consolidated financial statements of Harborside Healthcare Corporation included elsewhere in this report, Harborside Healthcare Corporation accounts for its investment in one of its owned facilities using the equity method of accounting. Subsidiaries of Harborside Healthcare Corporation (on a consolidated basis, the “Company” or “Harborside”) provide a broad continuum of medical services including: (i) traditional skilled nursing care and (ii) specialty medical services, including a variety of subacute care programs such as orthopedic rehabilitation, CVA/stroke care, cardiac recovery, pulmonary rehabilitation and wound care, as well as distinct programs for the provision of care to Alzheimer's and hospice patients. As part of its subacute services, the Company provides physical, occupational and speech rehabilitation therapy services at Company-operated facilities. Through September 1999, the Company also provided rehabilitation therapy services under contracts with non-affiliated long-term care facilities through a wholly-owned subsidiary. During the third quarter of 1999, the Company terminated its contracts with non-affiliated facilities and ceased providing therapy services to non-affiliated facilities.
The Company was formed in Delaware in March 1996, in anticipation of an initial public offering (the “IPO”), in order to combine under its control the operations of various long-term care facilities and ancillary businesses (the “Predecessor Entities”) which had operated since 1988. The Company completed the IPO on June 14, 1996 and issued 3,600,000 shares of common stock at $11.75 per share. The owners of the Predecessor Entities contributed their interests in such Predecessor Entities to the Company and received 4,400,000 shares of the Company’s common stock.
On April 15, 1998, Harborside entered into a Merger Agreement with HH Acquisition Corp. (“MergerCo”), an entity organized for the sole purpose of effecting a merger on behalf of Investcorp S.A., certain of its affiliates and certain other international investors (the “New Investors”). On August 11, 1998, MergerCo merged with and into Harborside, with Harborside Healthcare Corporation as the surviving corporation. As a result of the transaction, and pursuant to the Merger Agreement, the New Investors acquired approximately 91% of the post-merger common stock of Harborside. The remaining 9% of the common stock was retained by existing shareholders, including management. As a result of the merger, Harborside shares were de-listed from the New York Stock Exchange.
The merger was approved by a majority of the Company’s shareholders at a special meeting held on August 11, 1998. Each share not retained by existing shareholders was converted into $25 in cash, representing in the aggregate, cash payments of approximately $184 million. Holders of outstanding stock options of the Company converted the majority of their options into cash at $25 per underlying share (less applicable exercise price and withholding taxes) with aggregate payments of approximately $8 million.
In connection with the transaction and prior to the merger, the New Investors made cash common equity contributions of $158.5 million, net of issuance costs, to MergerCo, and MergerCo obtained gross proceeds of $99.5 million through the issuance of 11% Senior Subordinated Discount Notes (“Discount Notes”) due 2008 and $40 million through the issuance of 13.5% Exchangeable Preferred Stock (“Preferred Stock”) mandatorily redeemable in 2010. In connection with the merger, Harborside also entered into a new $250 million collateralized credit facility. In the third quarter of 1998, Harborside recorded a charge to income from operations of approximately $37 million for direct and other costs related to the Merger transaction. In connection with the merger and the related refinancings, the Company exercised purchase options for seven facilities which had been financed through synthetic leases.
In March 2001, the Company entered into an agreement (the “Restructuring Agreement”) with Investcorp S.A. and the holders of more than a majority in interest of the Company’s Discount Notes and Preferred Stock for purposes of implementing a restructuring of the Discount Notes and Preferred Stock. The Restructuring Agreement contemplated that the Company would offer to exchange for each $1,000 amount at maturity of outstanding Discount Notes a combination of the following: (1) 0.5899118 of a new 12% Senior Subordinated Discount Note due 2007 (the “New Notes”) each having a principal amount at maturity equal to $1,000 and an original issue price of $685.67 (assuming that the New Notes were issued on May 4, 2001), (2) $88.2353 in cash and (3) common stock purchase warrants for approximately 10.9 shares of its Class A Common Stock. The Company would also offer to exchange common stock purchase warrants for approximately 10.7 shares of its Class A Common Stock for each $1,000 liquidation preference of Preferred Stock (based on the aggregate liquidation preference to be outstanding on May 1, 2001) plus any dividends accrued on such Preferred Stock after May 1, 2001. In conjunction with the restructuring proposal, the Company would solicit consents from holders of outstanding Discount Notes and Preferred Stock to amendments to the Indenture governing the Discount Notes and to the Certificate of Designation governing the Preferred Stock that would eliminate or modify certain restrictive covenants and other provisions contained in the Indenture and the Certificate of Designation and would substantially eliminate the preferences of the Preferred Stock, including the reduction of the liquidation preference from $1,000 to $0.01 per share and the elimination of the right of holders to be paid dividends on shares of Preferred Stock. Also, the Company would issue to Investcorp S.A. (or one or more of its affiliates or designees) up to 15,000 shares of a new series of 13% convertible exchangeable preferred stock (the “New Preferred Stock”) and 1,854,422 common stock purchase warrants for a total purchase price of up to $15,000,000.
19On April 6, 2001 the Company initiated the exchange offer and consent solicitation contemplated by the Restructuring Agreement. On May 10, 2001, the Company completed the exchange offer and consent solicitation, thereby implementing each of the elements of the Restructuring Agreement. All of the outstanding Discount Notes and 99.96% of the shares of Preferred Stock were tendered and exchanged in the exchange offer. As a result of the exchange, (1) the Company had an aggregate principal amount at maturity of $100,276,000 of New Notes outstanding and an aggregate liquidation preference of $15,000,000 (as of May 10, 2001) of New Preferred Stock outstanding, (2) warrants were issued to holders of Discount Notes, to holders of Preferred Stock, and to Investcorp S.A. representing the right to purchase an aggregate of approximately 15%, 5% and 15%, respectively, of the total number of shares of all classes of the Company’s common stock on a fully diluted basis (excluding shares issuable upon conversion of the New Preferred Stock, each share of which will initially be convertible into 150 shares of Class A Common Stock), and (3) the Company paid $15,000,000 in cash as partial consideration for the tendered Discount Notes.
The reduction in the liquidation preference of the Preferred Stock was completed on May 10, 2001, as contemplated by the Restructuring Agreement. The carrying amount of the Preferred Stock was reduced from $57,595,000 to $576, and the amount of the reduction, net of unamortized deferred financing costs related to the issuance of the Preferred Stock (approximately $1,011,000 at May 10, 2001), was directly transferred to the Company’s Accumulated Deficit account. With the exchange of the New Notes for the Discount Notes (the “Note Exchange”), the carrying value of the accreted principal of the Discount Notes was reduced to $68,890,000, and the amount of the reduction, net of the aggregate cash payment of $15,000,000, was directly transferred to the Company’s Long-term Accrued Interest account. Subsequent to their issuance, the carrying amount of the New Notes increases as the result of accretion and results in a corresponding decrease in the carrying amount of Long-term Accrued Interest. Interest expense on the New Notes is recognized such that a constant effective interest rate is applied to the aggregate carrying amount of the New Notes and Long-term Accrued Interest for all periods between the issuance date and the maturity date of the New Notes.
In connection with an amendment to the Company’s revolving credit facility (the “Credit Facility”) and the implementation of the Restructuring Agreement, the Company incurred a non-recurring charge of $9,045,000. The charge resulted from the write-off of approximately $1,500,000 of unamortized deferred financing costs incurred when the Credit Facility was obtained, the write-off of approximately $3,400,000 of unamortized deferred financing costs related to the issuance of the Discount Notes, and the recognition of various investment advisory, legal and other fees associated with these events of $4,145,000.
The New Notes were issued at a discount and interest on the New Notes accretes until August 1, 2004. Cash interest payments will be paid semi-annually in arrears beginning on February 1, 2005 based on the fully accreted value of the New Notes and a 12% cash interest payment rate. The New Notes mature on August 1, 2007. The New Preferred Stock is mandatorily redeemable on February 1, 2008. The holders of the New Preferred Stock are entitled to dividends quarterly in arrears beginning August 1, 2001 and payable in additional shares of New Preferred Stock. Warrants to purchase a total of 4,326,641 shares of common stock at $0.01 per share were issued on May 10, 2001.
REVENUES
The Company’s total net revenues include net patient service revenues, and beginning in 1995, rehabilitation therapy service revenues from contracts with non-affiliated long-term care facilities until the third quarter of 1999 when these contracts were terminated. The Company derives its net patient service revenues primarily from private pay sources, the federal Medicare program for certain elderly and disabled patients and state Medicaid programs for indigent patients. The Company’s total net revenues are influenced by a number of factors, including: (i) the licensed bed capacity of its facilities; (ii) the occupancy rates of its facilities; (iii) the payor mix of its facilities and the rates of reimbursement among payor categories (private and other, Medicare and Medicaid); and (iv) the extent to which subacute and other specialty medical and ancillary services are utilized by the patients and paid for by the respective payment sources. Private net patient service revenues are recorded at established per diem billing rates. Net patient service revenues to be reimbursed under contracts with third-party payors, primarily the Medicare and Medicaid programs, are recorded at amounts estimated to be realized under these contractual arrangements. The Company employs specialists to monitor reimbursement rules, policies and related developments in order to comply with all reporting requirements and to assist the Company in receiving reimbursements.
The table set forth below identifies the percentage of the Company’s total net revenues attributable to each of its payor sources for each of the periods indicated. The increase in Medicare revenues as a percentage of total revenues during fiscal 2001 and fiscal 2002 is significantly affected by changes in the Company’s average Medicare Part A per diem rate in those years resulting from changes to the Medicare payment system. The Federal government implemented the Medicare Prospective Payment System (“PPS”) effective January 1, 1999. Implementation of PPS was effective for all of the Company’s facilities beginning January 1, 1999 and caused the Company’s average Medicare Part A per diem rate to decrease from $397 per day in 1998 to $290 per day in 1999. On November 29, 1999, the Balanced Budget Refinement Act of 1999 (the “BBRA”) was enacted. The BBRA allowed skilled nursing facilities to elect transition to the full Federal per diem rate at the beginning of their cost reporting periods for periods beginning on or after January 1, 2000. Using this election the Company chose to move fourteen facilities to the full Federal per diem rate effective January 1, 2000. Additionally, the BBRA increased the Federal per diem rates by 20% for fifteen RUG categories (three rehabilitative therapy RUG categories, twelve non-rehabilitative therapy RUG categories) beginning April 1, 2000. The BBRA also provided a temporary four percent increase in the Federal per diem rates for all RUG categories for a two-year period beginning October 1, 2000. In December 2000, the Medicare, Medicaid, and State Child Health Insurance Program Benefits Improvement and Protection Act of 2000 (“BIPA”) was enacted. BIPA temporarily increased the existing nursing rate component of the Federal per diem rate, for each RUG category, by 16.66% effective April 1, 2001 through September 30, 2002. In addition, BIPA eliminated the 20% add-ons (provided by the BBRA) for the three rehabilitative therapy RUG categories and substituted 6.7% add-ons for all fourteen rehabilitative therapy RUG categories. The 6.7% add-ons are scheduled to stay in effect until CMS implements a revised PPS system as contemplated by the BBRA. On October 1, 2002, certain increases in Medicare reimbursement for skilled nursing facilities provided for under the BBRA and BIPA expired. The four percent
20increase in the Federal per diem Medicare Part A rates for all RUG categories granted by the BBRA, which had been in effect since October 1, 2000 expired on September 30, 2002. The 16.66% increase to the nursing rate component of the Federal per diem Medicare Part A rates for all RUG categories, which had been in effect since April 1, 2001, expired on September 30, 2002. In addition to these reimbursement reductions, effective October 1, 2002, the Company’s Medicare Part A rates also experienced an increase of approximately 2.6% reflecting the Medicare program’s annual inflationary increase. The Medicare program increases the Part A rates for skilled nursing facilities annually on the first of October. Historically, these inflationary increases have not kept pace with the rate of inflation experienced by operators of skilled nursing facilities.
The net effect of (i) the two reductions in Medicare Part A reimbursement, effective September 30, 2002, and (ii) and the annual inflationary increase effective October 1, 2002, was to lower the Company’s Medicare Part A per diem rate from $358 during the third quarter of fiscal 2002 to $331 during the fourth quarter of fiscal 2002. The Company’s reduction of $27 per Medicare Part A day had the effect of reducing revenues by approximately $2,330,000 during the fourth quarter of fiscal 2002. The effect of the two reductions by themselves (excluding the effect of the inflationary increase) was to lower the Company’s Medicare Part A per diem rate by approximately $37 per Medicare Part A day from the third quarter of fiscal 2002 to the fourth quarter of fiscal 2002. Assuming that the average Medicare Part A daily census experienced by the Company during the fourth quarter of fiscal 2002 was held constant, the impact of the two reductions in Medicare Part A reimbursement effective September 30, 2002 would be to reduce the Company’s annualized revenues by approximately $12,668,000.
Primarily as the result of the effects of the BBRA, the Company’s average Medicare Part A payment rate increased from $290 per Medicare patient day during fiscal 1999 to $322 per Medicare patient day during fiscal 2000. Primarily as the result of the effects of BIPA, the Company’s average Medicare Part A payment rate increased from $322 per Medicare patient day during fiscal 2000 to $340 per Medicare patient day during fiscal 2001 and to $346 per Medicare patient day during 2002. The increase in Medicare revenues as a percentage of total net revenues from fiscal 2000 to fiscal 2001 was primarily the result of the rate increases noted above. The increase in Medicare revenues as a percentage of total net revenues from fiscal 2001 to fiscal 2002 was primarily the result of an increase in Medicare patient days.
TOTAL NET REVENUES (1)
2000 2001 2002
------ ------ ------
Private and other....... 25.8% 22.6% 19.7%
Medicare ............... 25.0 30.7 33.1
Medicaid ............... 49.2 46.7 47.2
------ ------ ------
Total ................ 100.0% 100.0% 100.0%
====== ====== ======
(1) Total net revenues exclude net revenues of the Larkin Chase Center which is
owned by Bowie Center Limited Partnership ("Bowie L.P."). The Company owns
a 75% partnership interest in Bowie L.P. but records its investment in
Bowie L.P. using the equity method of accounting. See Note A to the
Company's consolidated financial statements included elsewhere in this
report.
OPERATING EXPENSES
The Company’s facility operating expenses consist primarily of payroll and employee benefits related to nursing, rehabilitation therapy services, housekeeping and dietary services provided to patients, as well as maintenance and administration of the facilities. Other significant facility operating expenses include the cost of medical and pharmacy supplies, food, utilities, insurance and taxes. The Company’s general and administrative expenses include costs associated with its regional and corporate operations.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of the financial condition and results of operations of the Company are based on the Company’s consolidated financial statements, included elsewhere within this report, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the use of estimates and judgments that affect the reported amounts and related disclosures of commitments and contingencies. We rely on historical experience and on various other assumptions that we believe to be reasonable under the circumstances to make judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates.
REVENUE RECOGNITION
Net patient service revenues to be reimbursed by contracts with third-party payors, primarily the Medicare and Medicaid programs, are recorded at the amount estimated to be realized under these contractual arrangements. The Company separately estimates revenues due from each third-party with which it has a contractual arrangement and records anticipated settlements with these parties in the contractual period during which services were rendered. The amounts actually reimbursable under Medicare and Medicaid are determined by filing cost reports, which are then audited and generally retroactively adjusted by the payor. Legislative changes to state or Federal reimbursement systems may also retroactively affect recorded revenues. Changes in estimated revenues due in connection with Medicare and Medicaid may be recorded by the Company subsequent to the year of origination and prior to final settlement based on improved estimates. Such adjustments and final settlements with third-party payors, which could materially and adversely affect the Company, are reflected in operations at the time of the adjustment or settlement.
21PROVISION FOR DOUBTFUL ACCOUNTS
Accounts receivable consist primarily of amounts due from third party payors (the Medicare and Medicaid programs, other governmental programs, managed care companies and commercial insurance companies) as well as amounts due from private individuals. Estimated provisions for doubtful accounts are recorded to the extent that it is probable that a portion or all of a particular account receivable will not be collected. We estimate the provision for doubtful accounts based on a number of factors including payor type, historical collection patterns and the age of the receivable. Changes in estimates for particular accounts receivable are recorded in the period in which the change occurs.
IMPAIRMENT OF PROPERTY AND EQUIPMENT AND INTANGIBLE ASSETS
The Company reviews the carrying value of its property and equipment and intangible assets on a quarterly basis. The Company’s review is undertaken to determine if current facts and circumstances suggest that the assets have been impaired or that the lives of the assets need to be changed. As part of its review, the Company considers a number of factors including local market developments, changes in the regulatory environment, historical financial performance, recent operating results and projected future cash flows. Any impairment would be recognized in operating results if a diminution in value considered to be other than temporary were to occur. During the years ended December 31, 2000, 2001 and 2002, the Company recognized adjustments to the carrying value of its deferred financing costs in connection with amendments to the Company’s Credit Facility and the early termination of a capital lease. (See Notes H and I to the Company’s consolidated financial statements included elsewhere in this report.) During the year ended December 31, 2002, the Company was obligated to purchase two facilities (the “Synthetic Lease Properties”) at a pre-determined price ($13,700,000) in connection with the termination and refinancing of the Company’s Credit Facility. The carrying value of the Synthetic Lease Properties was recorded at the purchase price ($13,700,000), less a charge of $1,700,000 to reflect uncertainties related to the value of these properties in connection with the expiration of a significant portion of Medicare reimbursement effective October 1, 2002. This charge is included as a component of the non-recurring Financing Costs totaling $2,835,000 incurred during the year ended December 31, 2002 in connection with the refinancing of the Company’s Credit Facility.
INSURANCE RESERVES
The Company retains a significant amount of self-insurance risk for its employee health benefits and workers compensation programs, and beginning on September 1, 2001, its general liability and professional liability risks. The Company maintains stop-loss insurance such that the Company’s liability for health insurance and workers’ compensation losses is limited. At the end of each accounting period, the Company records an accrued expense for (a) estimated health benefit claims including claims incurred but not reported and (b) estimated workers’ compensation claims including claims incurred but not reported. The Company estimates these accruals based on a number of factors including historical experience, industry trends, recent claims history, programs implemented to control claims, and actuarial reports. These accruals are by necessity based on estimates and are subject to ongoing revision as conditions change and as new data presents itself. Adjustments to estimated liabilities are recorded in the accounting period in which the change in estimate occurs.
During the year ended December 31, 1998, the Company implemented a general and professional liability insurance program which, for the period from September 1, 1998 to August 31, 2001, limited the Company’s self-retention risk for this program to a maximum of $25,000 per year. The long-term care industry has seen the cost of maintaining traditional professional liability insurance increase significantly over the past several years, especially in the State of Florida. Most insurance companies are unwilling to underwrite new professional liability policies in the State of Florida. In May 2001, tort reform legislation was enacted in Florida. This legislation provides caps on punitive damages, limits to add-on legal fees, stricter rules of evidence and a shorter statute of limitations period. Given the tremendous increase in professional liability premiums and the tort reform legislation that was enacted in the State of Florida in May 2001, the Company concluded that it would be more cost effective to assume a higher level of retained risk for professional liability claims. As a result, the Company implemented a new general and professional liability program, effective September 1, 2001, which resulted in the Company maintaining an unaggregated self-insured retention of $2,000,000 per occurrence for locations outside of Florida and completely retaining risk at the Florida facilities. As of December 1, 2002, the Company’s unaggregated self-insured retention increased to $10,000,000 per occurrence outside of Florida. The Company maintains an accrual for estimated unpaid losses including unreported claims.The amount of the accrual is determined through an estimation process that uses information from both the Company’s records as well as industry data. The Company uses an independent actuary to help estimate the required general and professional liability accrual. Factors reviewed include the frequency of expected claims, the average cost per claim, emerging industry trends, changes in regulatory environment (such as the recently enacted Florida tort reform legislation) and the expected effect of various operational and risk management initiatives. The Company will continue to evaluate its insurance accrual requirements on a quarterly basis. Required adjustments to the Company’s general and professional liability accrual will be recorded in the accounting period in which the change in estimate occurs. (See Note M to the Company’s consolidated financial statements included elsewhere in this report.)
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”). Companies are required to adopt SFAS 143 in their fiscal year beginning after June 15, 2002. SFAS 143 requires that obligations associated with the retirement of a tangible long-lived asset be recorded as a liability when these obligations are incurred, with the amount of the liability initially measured at fair value. Upon recognizing a liability, an entity must capitalize the cost by recognizing an increase in the carrying amount of the related long-lived asset, accrete the liability over time to its present value each period, and depreciate the capitalized cost over the useful life of the related asset. Upon settlement of
22the liability, the obligation is either settled for its recorded amount or a gain or loss is recognized. The Company does not believe that the adoption of SFAS 143 will have a material impact on its financial position, results of operations, or cash flows.
In July 2002, the FASB issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). SFAS 146 replaces Emerging Issues Task Force Issue No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity”. SFAS 146 requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The Company does not believe that the adoption of SFAS 146 will have a material impact on its financial position, results of operations, or cash flows.
On November 25, 2002, the FASB issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34.” FIN 45 clarifies the requirements of FASB Statement No. 5, “Accounting for Contingencies” (“SFAS 5”), relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 requires that, upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation. FIN 45 is applicable to guarantees that encompass guarantees based on changes in an underlying asset, liability or equity security, guarantees that are made on behalf of another entity’s performance, certain indemnification agreements and indirect guarantees of the indebtedness of others. The recognition and measurement provisions of FIN 45 are effective prospectively for guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for reporting periods ending after December 15, 2002. The Company has made the required disclosures in the consolidated financial statements as of December 31, 2002 and is in the process of assessing the impact of FIN 45 recognition and measurement provisions on its consolidated financial statements. The Company does not believe that the adoption of FIN 45 will have a significant impact on its financial statements.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures about the method of accounting for stock-based employee compensation and the effect of the method used on reported financial results. SFAS No. 148 amends Accounting Principles Board (“APB”) Opinion No. 28, “Interim Financial Reporting,” to require these disclosures in interim financial information. The Company continues to account for their stock-based employee compensation under APB Opinion 25, but has adopted the new disclosure requirements of the SFAS No. 148 for the year ended December 31, 2002. Additional information related to the Company’s stock option plans is detailed in Note E of the Notes to the Consolidated Financial Statements.
In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin (“ARB”) No. 51 (“ARB 51”).“ The primary objectives of FIN 46 are to provide guidance on the identification of, and financial reporting for, entities for which control is achieved through means other than through voting rights; such entities are known as variable-interest entities (“VIEs”). FIN 46 provides guidance that determines (1) whether consolidation is required under the “controlling financial interest” model of ARB 51, “Consolidated Financial Statements,” or (b) other existing authoritative guidance, or alternatively, (2) whether the variable-interest model under FIN 46 should be used to account for existing and new entities. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. FIN 46 is effective for VIEs which are created after January 31, 2003 and for all VIEs for the first fiscal year or interim period beginning after June 15, 2003. The Company has evaluated the provisions of FIN 46 and determined that this Interpretation will have no material effect currently on its consolidated financial statements.
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Total Net Revenues. Total net revenues increased by $53,486,000 or 15.4%, from $346,738,000 in 2001 to $400,224,000 in 2002. The increase in total revenues, from 2001 to 2002, was primarily due to the operation of five additional facilities. The Company began operating a leased skilled nursing facility in Marietta, Ohio on November 1, 2001, and four leased skilled nursing facilities in Massachusetts on March 1, 2002. Approximately, $28,125,000, or 52.6%, of the increase in revenues from 2001 to 2002 resulted from the operation of these five new facilities. The remainder of the revenue increase was attributable to higher average revenues per patient day at the Company’s “same store” facilities. The average occupancy rate at the Company’s “same store” facilities decreased from 88.9% for the year ended December 31, 2001 to 88.3% for the year ended December 31, 2002. Average net patient service revenues (including ancillary services) per patient day at the Company’s “same store” facilities increased from $179 for the year ended December 31, 2001 to $194 for the year ended December 31, 2002. The Company’s “same store” average Medicare Part A per diem rate increased from $340 per Medicare patient day for the year ended December 31, 2001 to $346 per Medicare patient day for the year ended December 31, 2002, while the Company’s “same store” average per diem Medicaid rate increased from $134 for the year ended December 31, 2001 to $145 for the year ended December 31, 2002.
The Balanced Budget Refinement Act of 1999 (“BBRA”) temporarily increased the Federal per diem Medicare Part A rates by 20% for fifteen resource utilization groups (“RUG”) categories (three rehabilitative therapy RUG categories, twelve non-rehabilitative RUG categories) beginning on April 1, 2000. These increased rates were to stay in effect until the date on which the Centers for Medicare and Medicaid Services (“CMS”) implements a revised prospective payment system (“PPS”) that more accurately reimburses the costs of caring for medically complex patients. The BBRA also provided for a four percent temporary increase in the Federal per diem Medicare Part A rates for all RUG categories for a two-year period beginning October 1, 2000. In December 2000, the Medicare, Medicaid, and State Child Health Insurance Program Benefits Improvement and Protection Act of 2000 (“BIPA”) was enacted. BIPA temporarily increased the existing nursing rate component of the Federal per diem Medicare Part A rate, for each RUG category, by 16.66% effective April
231, 2001 through September 30, 2002. In addition, BIPA eliminated the 20% add-ons (provided by the BBRA) for the three rehabilitative therapy RUG categories and substituted 6.7% add-ons for all fourteen rehabilitative therapy RUG categories. The 6.7% add-ons are scheduled to stay in effect until CMS implements a revised PPS system as contemplated by the BBRA
On September 30, 2002, certain increases in Medicare reimbursement for skilled nursing facilities provided for under the BBRA and BIPA expired: (i) the four percent increase in the Federal per diem Medicare Part A rates for all RUG categories granted by the BBRA, which had been in effect since October 1, 2000, and (ii) the 16.66% increase to the nursing rate component of the Federal per diem Medicare Part A rates for all RUG categories, which had been in effect since April 1, 2001. In addition to these reimbursement reductions, effective October 1, 2002, the Company’s Medicare Part A rates also experienced an increase of approximately 2.6% reflecting the Medicare program’s annual inflationary increase. The Medicare program increases the Part A rates for skilled nursing facilities annually on the first of October. Historically, these inflationary increases have not kept pace with the rate of inflation experienced by operators of skilled nursing facilities.
The net effect of (i) the two reductions in Medicare Part A reimbursement effective September 30, 2002, (ii) and the annual inflationary increase effective October 1, 2002, was to lower the Company’s Medicare Part A per diem rate from $358 during the third quarter of fiscal 2002 to $331 during the fourth quarter of fiscal 2002. The Company’s reduction of $27 per Medicare Part A day had the effect of reducing revenues by approximately $2,330,000 during the fourth quarter of fiscal 2002.
The effect of the two reductions by themselves (excluding the effect of the inflationary increase) was to lower the Company’s Medicare Part A per diem rate by approximately $37 per Medicare Part A day from the third quarter of fiscal 2002 to the fourth quarter of fiscal 2002. Assuming that the average Medicare Part A daily census experienced by the Company during the fourth quarter of fiscal 2002 was held constant, the impact of the two reductions in Medicare Part A reimbursement effective September 30, 2002 would be to reduce the Company’s annualized revenues by approximately $12,668,000.
The Company’s quality mix of private, Medicare and insurance revenues was 53.3% for the year ended December 31, 2001 as compared to 52.8% for the year ended December 31, 2002.
Facility Operating Expenses. Facility operating expenses increased by $49,855,000, or 17.7%, from $282,194,000 in 2001 to $332,049,000 in 2002. Approximately $25,671,000, or 51.5%, of this increase resulted from the operation of the five additional facilities. The remainder of the increase in operating expenses in 2002 was primarily the result of higher expenditures for employee wages, benefit costs and insurance expense at “same store” facilities.
General and Administrative; Service Charges Paid to Former Affiliate. General and administrative expenses increased by $1,177,000 or 6.2%, from $19,043,000 in 2001 to $20,220,000 in 2002. The Company reimburses a former affiliate for data processing services provided to the Company. During 2001, such reimbursements totaled $979,000 compared to $759,000 in 2002.
Amortization of Prepaid Management Fees. Amortization of prepaid management fees was $1,200,000 in 2001 and 2002. (See Note O to the Company’s consolidated financial statements included elsewhere in this report.)
Depreciation and Amortization.Depreciation and amortization increased from $9,355,000 in 2001 to $9,889,000 in 2002.
Facility Rent. Facility rent expense increased by $1,722,000 from $28,889,000 in 2001 to $30,611,000 in 2002. Most of the increase in rent expense was associated with the leasing of the new Ohio facility and the four new Massachusetts facilities.
Financial Restructuring Costs.In connection with an amendment to the Company’s bank credit facility and the financial restructuring completed during the year ended December 31, 2001, the Company recorded non-recurring charges totaling $9,045,000. The charges resulted from the write-off of unamortized deferred financing costs related to obtaining the Company’s bank credit facility and issuing its Discount Notes, and the recognition of various investment advisory, legal and other fees associated with completing the amendment to the bank credit facility and the financial restructuring. (See Note H to the Company’s consolidated financial statements included elsewhere in this report.)
Facility Reorganization Costs. During the year ended December 31, 2001, the Company incurred a non-recurring charge of $1,080,000 in connection with its decision to revise the marketing approach for facilities operated through subsidiaries in Florida. The Company determined that a local community-based marketing approach would better serve the needs of these facilities. The marketing approach stresses ties to the local community and required renaming these facilities in order to emphasize this approach. In connection with this effort, the Company also restructured certain of its subsidiaries effective October 1, 2001. In order to implement this strategy, the Company incurred non-recurring marketing, legal and other expenses.
Financing Costs. On September 13, 2002, the Company entered into a new three-year collateralized credit facility (the “Secured Credit Facility”) that provides access to a maximum of $100 million. Borrowings under the Secured Credit Facility were used to repay all amounts owed in connection with the termination of the Company’s previous Credit Facility (including amounts outstanding in connection with a $13,700,000 synthetic lease obligation) as well as related closing costs and expenses. In connection with entering into the Secured Credit Facility, the Company incurred non-recurring Financing Costs totaling approximately $2,835,000. This non-recurring charge includes a charge of $1,700,000 recorded in connection with the termination of a synthetic lease for two of the Company’s facilities made through the Company’s prior Credit Facility. The significant terms of the Secured Credit Facility and the components of the non-recurring Financing Costs are described in Note H to the consolidated financial statements included elsewhere in this report.
24Interest Expense, net. Interest expense, net, decreased from $11,945,000 in 2001 to $8,056,000 in 2002. This decrease is primarily the result of the restructuring of the Company’s Discount Notes which was completed in May 2001. The restructuring of the Discount Notes reduced both the carrying amount of the debt and its effective interest rate. (See Note H to the Company’s consolidated financial statements included elsewhere in this report.)
Income Tax Expense. For the year ended December 31, 2001, income tax expense was $225,000, all of which related to state income taxes. For the year ended December 31, 2002, income tax expense was $240,000, all of which related to state income taxes. (See Note K to the Company’s consolidated financial statements included elsewhere in this report.)
Net Loss. The Company's net loss decreased from $16,902,000 in 2001 to $5,659,000 in 2002.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Total Net Revenues. Total net revenues increased by $24,066,000 or 7.5%, from $322,672,000 in 2000 to $346,738,000 in 2001. The Company began operating a leased facility in Marietta, Ohio on November 1, 2001. This facility generated approximately $1,250,000 of revenues during the year ended December 31, 2001. Most of the remaining increase in total revenues was the result of higher average revenues per patient day. The average occupancy rate at all of the Company’s facilities decreased from 90.1% for the year ended December 31, 2000 to 88.9% for the year ended December 31, 2001. Average net patient service revenues (including ancillary services) per patient day at the Company’s facilities increased from $164 for the year ended December 31, 2000 to $179 for the year ended December 31, 2001. The Company’s average Medicare Part A per diem rate increased from $322 per Medicare patient day for the year ended December 31, 2000 to $340 per Medicare patient day for the year ended December 31, 2001, while the Company’s average per diem Medicaid rate increased from $127 for the year ended December 31, 2000 to $134 for the year ended December 31, 2001. The Balanced Budget Refinement Act of 1999 (“BBRA”) temporarily increased the Federal per diem Medicare Part A rates by 20% for fifteen RUG categories (three rehabilitative therapy RUG categories, twelve non-rehabilitative RUG categories) beginning on April 1, 2000. These increased rates will stay in effect until the date on which the Centers for Medicare and Medicaid Services (“CMS”), previously known as the Health Care Financing Administration, implements a revised PPS system that more accurately reimburses the costs of caring for medically complex patients. The Company believes that it is unlikely that a new PPS system will be implemented prior to October 1, 2002. The BBRA also provided for a four percent temporary increase in the Federal per diem Medicare Part A rates for all RUG categories for a two-year period beginning October 1, 2000. In December 2000, the Medicare, Medicaid, and State Child Health Insurance Program Benefits Improvement and Protection Act of 2000 (“BIPA”) was enacted. BIPA temporarily increased the existing nursing rate component of the Federal per diem Medicare Part A rate, for each RUG category, by 16.66% effective April 1, 2001 through September 30, 2002. In addition, BIPA eliminated the 20% add-ons (provided by the BBRA) for the three rehabilitative therapy RUG categories and substituted 6.7% add-ons for all fourteen rehabilitative therapy RUG categories.
Primarily as the result of the Medicare rate increases implemented on April 1, 2000 and 2001, the Company’s average Medicare Part A payment rate increased from $322 per Medicare patient day for the year ended December 31, 2000 to $340 per Medicare patient day for the year ended December 31, 2001. The Company’s quality mix of private, Medicare and insurance revenues was 50.8% for the year ended December 31, 2000 as compared to 53.3% for the year ended December 31, 2001.
Facility Operating Expenses. Facility operating expenses increased by $22,414,000, or 8.6%, from $259,780,000 in 2000 to $282,194,000 in 2001. Approximately $1,000,000 of this expense increase resulted from the operation of the Company’s Marietta, Ohio facility commencing on November 1, 2001. Most of the remaining increase in operating expenses in 2001 was the result of higher expenditures for employee benefit costs and temporary nursing personnel. The increase in employee benefits costs are driven primarily by higher costs associated with maintaining the Company’s health insurance plan. The Company’s health insurance plan expense increased by $2,060,000 from 2000 to 2001. Consistent with other long-term care providers, the Company continues to find it difficult to recruit and retain employees, most notably nursing personnel. As a result of these difficulties, the Company has been forced to rely more heavily on temporary nursing personnel. The expense associated with temporary nursing personnel increased by $3,108,000, or 29.6%, from 2000 to 2001.
General and Administrative; Service Charges Paid to Former Affiliate. General and administrative expenses increased by $1,050,000 or 5.8%, from $17,993,000 in 2000 to $19,043,000 in 2001. The Company reimburses a former affiliate for data processing services provided to the Company. During 2000, such reimbursements totaled $1,083,000 compared to $979,000 in 2001.
Amortization of Prepaid Management Fees. Amortization of prepaid management fees was $1,200,000 in 2000 and 2001. (See Note N to the Company’s consolidated financial statements included elsewhere in this report.)
Depreciation and Amortization. Depreciation and amortization decreased from $10,210,000 in 2000 to $9,355,000 in 2001. Depreciation expense decreased primarily as the result of the refinancing of the Company’s four Cleveland-area facilities. On September 27, 2000, the Company terminated its capital leases for these properties and entered into new operating leases for each of the Cleveland facilities. (See Note I to the Company’s consolidated financial statements included elsewhere in this report.) As a result of this transaction, the Company’s annual depreciation and interest expense decreased by approximately $1,400,000 and $4,100,000, respectively, while the Company’s annual rent expense increased by approximately $5,900,000. The Company’s amortization expense decreased in 2001 primarily as a result of the write-off of deferred financing costs in September 2000 and the first half of 2001. The write-off of deferred financing costs in the first half of 2001 were made in connection with amendments to the Company’s bank credit facility and the financial restructuring completed in the second quarter of 2001.
25Facility Rent. Facility rent expense increased by $4,614,000 from $24,275,000 in 2000 to $28,889,000 in 2001. Most of the increase in rent expense occurred as a result of the Company terminating capital leases for four facilities in the Cleveland area in September 2000 and entering into four new operating leases for these facilities.
Financial Restructuring Costs. In connection with an amendment to the Company’s bank credit facility and the financial restructuring completed during the year ended December 31, 2001, the Company recorded non-recurring charges totaling $9,045,000. The charges resulted from the write-off of unamortized deferred financing costs related to obtaining the Company’s bank credit facility and issuing its Discount Notes, and the recognition of various investment advisory, legal and other fees associated with completing the amendment to the bank credit facility and the financial restructuring. (See Note H to the Company’s consolidated financial statements included elsewhere in this report.)
Facility Reorganization Costs. During the year ended December 31, 2001, the Company incurred a non-recurring charge of $1,080,000 in connection with its decision to revise the marketing approach for facilities operated through subsidiaries in Florida. The Company determined that a local community-based marketing approach would better serve the needs of these facilities. The marketing approach stresses ties to the local community and required renaming these facilities in order to emphasize this approach. In connection with this effort, the Company also restructured certain of its subsidiaries effective October 1, 2001. In order to implement this strategy, the Company incurred non-recurring marketing, legal and other expenses.
Interest Expense, net. Interest expense, net, decreased from $21,675,000 in 2000 to $11,945,000 in 2001. This decrease is the result of the refinancing of the Cleveland-area facilities in September 2000 and the restructuring of the Company’s Discount Notes completed in May 2001. The termination of the Cleveland-area capital leases reduced the Company’s interest expense by approximately $4,100,000 on an annual basis. The restructuring of the Discount Notes reduced both the carrying amount of the debt and its effective interest rate. (See Note H to the Company’s consolidated financial statements included elsewhere in this report.)
Income Tax Expense. During the year ended December 31, 2000, the Company’s deferred income tax assets were eliminated (through an adjustment to the related valuation allowance) due to uncertainty regarding future realization of these assets, resulting in income tax expense of $14,322,000 for that year. For the year ended December 31, 2001, income tax expense (all related to state income taxes) was $225,000. (See Note K to the Company’s consolidated financial statements included elsewhere in this report.)
Net Loss. The Company's net loss decreased from $36,706,000 in 2000 to $16,902,000 in 2001.
LIQUIDITY AND CAPITAL RESOURCES
The Company’s primary cash needs are for acquisitions, capital expenditures, working capital, debt service and general corporate purposes. The Company has historically financed these requirements primarily through a combination of internally generated cash flow, mortgage financing and operating leases, in addition to funds borrowed under a credit facility. The Company’s existing leased facilities are leased from either the owner of the facilities, or from an investment entity that has purchased the facilities from the owner. The Company’s existing facility leases generally require it to make monthly lease payments and pay all property operating costs. The Company generally negotiates leases which provide for extensions beyond the initial lease term and an option to purchase the leased facility. In some cases, the option to purchase the leased facility is at a price based on the fair market value of the facility at the time the option is exercised. In other cases, the lease for the facility sets forth a fixed purchase option price which the Company believes is equal to the fair market value of the facility at the inception date of such lease, thus allowing the Company to realize the value appreciation of the facility while maintaining financial flexibility.
In connection with the leveraged recapitalization completed on August 11, 1998, the Company obtained gross proceeds of $99.5 million through the issuance of 11% Senior Subordinated Discount Notes (the “Discount Notes”) due 2008 and $40 million through the issuance of 13.5% Exchangeable Preferred Stock (the “Preferred Stock”) mandatorily redeemable in 2010. Interest on the Discount Notes was to accrete at 11% per annum until August 1, 2003 and then become payable in cash, semi-annually in arrears, beginning on February 1, 2004. Dividends on the Preferred Stock were payable, at the option of the Company, in additional shares of the Preferred Stock until August 1, 2003. After that date dividends were required to be paid in cash. In August 1998, the Company also entered into a $250 million collateralized credit facility (the “Credit Facility”). The terms of the Credit Facility originally provided up to $75 million on a revolving credit basis plus an additional $175 million initially funded on a revolving basis that would convert to a term loan on an annual basis on each anniversary of the closing. During the first four years of the Credit Facility, any or all of the full $250 million of availability under the Credit Facility could be used for synthetic lease financings. Interest was based on either LIBOR or prime rates of interest (plus applicable margins determined by the Company’s leverage ratio) at the election of the Company. The Credit Facility contained various financial and other restrictive covenants and limited aggregate borrowings under the Credit Facility to a predetermined multiple of earnings before interest, taxes, depreciation and amortization (“EBITDA”).
During the first quarter of 1999, the Company determined that its anticipated financial results for that quarter would cause the Company to be out of compliance with certain financial covenants of the Credit Facility. The Company’s reduced level of EBITDA during the first quarter of 1999 was attributable to transitional difficulties associated with the implementation of the new Medicare prospective payment system which became effective at all of the Company’s facilities on January 1, 1999. Such transitional difficulties resulted in lower than expected revenues, primarily due to fewer than expected Medicare patient days, lower Medicare Part A rates, reduced revenues from therapy services provided to non-affiliated long-term care centers and a reduction in revenues from the provision of Medicare Part B services at the Company’s own facilities. In response, during the first quarter of 1999, the Company initiated additional facility-based training directed towards the documentation requirements of the revised Medicare reimbursement system. The Company also continued to refine its
26admission and assessment protocols in order to increase patient admissions and introduced a series of targeted initiatives to lower operating expenses. Such initiatives included wage and staffing reductions (primarily related to the delivery of rehabilitative therapy services and indirect nursing support) and renegotiation of vendor contracts. All of the staffing reductions were implemented, on or prior to, April 1, 1999. Effective March 30, 1999, the Company obtained an amendment (the “First Amendment”) to the Credit Facility which limited borrowings under the Credit Facility to an aggregate of $58,500,000 (exclusive of undrawn letters of credit outstanding as of March 30, 1999) and which modified certain financial covenants. Beginning with the first quarter of 1999, the First Amendment replaced the original financial covenants with one new financial covenant, a minimum cumulative amount of EBITDA. The original financial covenants provided maximum ratios of total indebtedness to EBITDA and senior indebtedness to EBITDA, and a minimum debt service coverage ratio. The First Amendment required minimum amounts of EBITDA, measured quarterly, but calculated on a rolling twelve-month basis, through December 31, 2000. As long as the Company met or exceeded the required minimum cumulative amounts of EBITDA, the Company could access the Credit Facility for general corporate purposes, subject to the reduced amount of availability.
Until September 27, 2000, the Company, through a wholly owned limited partnership, leased and operated four facilities in Ohio (the “Cleveland Facilities”) which it acquired in 1996 through capital leases. Each of the four leases contained an option to purchase the facility beginning July 1, 2001 and each lease was guaranteed by the Company. The guaranty provided that failure by the Company to have a specified minimum consolidated net worth at the end of any two consecutive quarters would be an event of default under the guaranty, which in turn would be an event of default under each lease. During the third quarter of 1999, the Company recorded a $5.7 million restructuring charge to terminate its contracts to provide rehabilitation therapy services to non-affiliated long-term care facilities. As a result of this restructuring charge, the Company’s consolidated net worth as of September 30, 1999 (as calculated for purposes of this requirement) had fallen below the required level. The Company anticipated that its net worth would continue to be below the required level at December 31, 1999, which would have resulted in an event of default under each of these leases with the Company potentially facing the loss of these operations. Such default could also have triggered cross-defaults under the Company’s other lease and debt obligations. In December 1999, the Company paid $5 million to its landlord and obtained an option (the “New Option”) to acquire the Cleveland Facilities. The Company borrowed $5 million from an affiliate of Investcorp S.A. to fund this payment. The New Option allowed the Company to exercise its right to purchase the Cleveland Facilities beginning as of the date of the New Option, required the Company to complete the acquisition prior to December 31, 2000 and provided a waiver of the net worth covenant through that date. The Company exercised the New Option on June 30, 2000 and on September 27, 2000, the Company terminated the Cleveland Facilities capital leases and assigned its purchase rights for these facilities to an investment entity (organized by Investcorp S.A.) for $5.0 million, which acquired the Cleveland Facilities on September 27, 2000. On that date, the Company entered into new operating leases for each of the Cleveland Facilities with combined annual rent expense of approximately $5.9 million. The Company also repaid the $5.0 million loan from an affiliate of Investcorp S.A. As a result of the capital lease termination, the Company recorded a non-recurring charge of $8.9 million. (See Note I to the Company’s consolidated financial statements included elsewhere in this report.) The principal components of this charge included the write-off of capital leased assets in excess of the related capital lease obligation ($5.7 million) and the write-off of deferred financing costs ($1.8 million) originally incurred in obtaining the Company’s Credit Facility. In order to complete the Cleveland Facility leasing transaction, the Company was required to obtain the release of certain collateral held by the bank group that provided the Credit Facility. The Company obtained the release of the collateral as part of an amendment (the “Second Amendment”) to the Credit Facility, which also resulted in a permanent reduction of the Company’s maximum borrowings under the Credit Facility from $250 million to $150 million and an increase in the Company’s borrowing rate. As a result of the permanent reduction in funds available through the Credit Facility, the Company was required to write off a proportionate amount of the deferred financing costs incurred when the credit facility was originally obtained.
On March 28, 2001, the Company obtained an additional amendment (the “Third Amendment”) to the Credit Facility in order to be able to complete the financial restructuring of the Company’s Discount Notes and Preferred Stock discussed below. The Third Amendment resulted in a permanent reduction of the Company’s maximum borrowings under the Credit Facility from $150 million to $60 million, revised certain financial covenants, changed the maturity date of the Credit Facility to March 31, 2004 and increased the Company’s borrowing rate. The Third Amendment also required the Company to repay, on an annual basis, the greater of $5.0 million or 50% of the Company’s excess cash flow (as defined). As a result of the permanent reduction in funds available through the Credit Facility, the Company was required to write off approximately $2.6 million of deferred financing costs incurred when the Credit Facility was obtained. (See Note H to the Company’s consolidated financial statements included elsewhere in this report.)
In March 2001, the Company entered into an agreement (the “Restructuring Agreement”) with Investcorp S.A. and the holders of more than a majority in interest of the Company’s Discount Notes and Preferred Stock for purposes of implementing a restructuring of the Discount Notes and Preferred Stock. The Restructuring Agreement contemplated that the Company would offer to exchange for each $1,000 amount at maturity of outstanding Discount Notes a combination of the following: (1) 0.5899118 of a new 12% Senior Subordinated Discount Note due 2007 (the “New Notes”) each having a principal amount at maturity equal to $1,000 and an original issue price of $685.67 (assuming that the New Notes were issued on May 4, 2001), (2) $88.2353 in cash and (3) common stock purchase warrants for approximately 10.9 shares of its Class A Common Stock. The Company would also offer to exchange common stock purchase warrants for approximately 10.7 shares of its Class A Common Stock for each $1,000 liquidation preference of Preferred Stock (based on the aggregate liquidation preference to be outstanding on May 1, 2001) plus any dividends accrued on such Preferred Stock after May 1, 2001. In conjunction with the restructuring proposal, the Company would solicit consents from holders of outstanding Discount Notes and Preferred Stock to amendments to the Indenture governing the Discount Notes and to the Certificate of Designation governing the Preferred Stock that would eliminate or modify certain restrictive covenants and other provisions contained in the Indenture and the Certificate of Designation and would substantially eliminate the preferences of the Preferred Stock, including the reduction of the liquidation preference from $1,000 to $0.01 per share and the elimination of the right of holders to be paid dividends on shares of Preferred Stock. Also, the Company would issue to Investcorp S.A. (or one or more of its affiliates or designees) up to 15,000 shares of a new series of 13% convertible exchangeable preferred stock (the “New Preferred Stock”) and 1,854,422 common stock purchase warrants for a total purchase price of up to $15,000,000.
On April 6, 2001 the Company initiated the exchange offer and consent solicitation contemplated by the Restructuring Agreement. On May 10, 2001, the Company completed the exchange offer and consent solicitation, thereby implementing each of the elements of the
27Restructuring Agreement. All of the outstanding Discount Notes and 99.96% of the shares of Preferred Stock were tendered and exchanged in the exchange offer. As a result of the exchange, (1) the Company had an aggregate principal amount at maturity of $100,276,000 of New Notes outstanding and an aggregate liquidation preference of $15,000,000 (as of May 10, 2001) of New Preferred Stock outstanding, (2) warrants were issued to holders of Discount Notes, to holders of Preferred Stock, and to Investcorp S.A. representing the right to purchase an aggregate of approximately 15%, 5% and 15%, respectively, of the total number of shares of all classes of the Company’s common stock on a fully diluted basis (excluding shares issuable upon conversion of the New Preferred Stock, each share of which will initially be convertible into 150 shares of Class A Common Stock, and (3) the Company paid $15,000,000 in cash as partial consideration for the tendered Discount Notes.
The reduction in the liquidation preference of the Preferred Stock was completed on May 10, 2001, as contemplated by the Restructuring Agreement, the carrying amount of the Preferred Stock was reduced from $57,595,000 to $576 and the amount of the reduction, net of unamortized deferred financing costs related to the issuance of the Preferred Stock (approximately $1,011,000 at May 10, 2001), was directly transferred to the Company’s Accumulated Deficit account. With the exchange of the New Notes for the Discount Notes (the “Note Exchange”), the carrying value of the accreted principal of the Discount Notes was reduced to $68,890,000, and the amount of the reduction, net of the aggregate cash payment of $15,000,000, was directly transferred to the Company’s Long-term Accrued Interest account. Subsequent to their issuance, the carrying amount of the New Notes increases as the result of accretion and results in a corresponding decrease in the carrying amount of Long-term Accrued Interest. Interest expense on the New Notes is recognized such that a constant effective interest rate is applied to the aggregate carrying amount of the New Notes and Long-term Accrued Interest for all periods between the issuance date and the maturity date of the New Notes.
In connection with the Third Amendment to the Credit Facility and the implementation of the Restructuring Agreement, the Company incurred a non-recurring charge of $9,045,000. The charge resulted from the write-off of approximately $1,500,000 of unamortized deferred financing costs incurred when the Credit Facility was obtained, the write-off of approximately $3,400,000 of unamortized deferred financing costs related to the issuance of the Discount Notes, and the recognition of various investment advisory, legal and other fees associated with these events approximating $4,145,000.
The New Notes were issued at a discount and interest on the New Notes accretes until August 1, 2004. Cash interest payments will be paid semi-annually in arrears beginning on February 1, 2005 based on the fully accreted value of the New Notes and a 12% cash interest payment rate. The New Notes mature on August 1, 2007. The New Preferred Stock is mandatorily redeemable on February 1, 2008. The holders of the New Preferred Stock are entitled to dividends quarterly in arrears beginning August 1, 2001 and payable in additional shares of New Preferred Stock. Warrants to purchase a total of 4,326,641 shares of common stock at $0.01 per share were issued on May 10, 2001.
On September 13, 2002, the Company entered into a new credit facility (the “Secured Credit Facility”). Borrowings under the Secured Credit Facility were used to repay all amounts owed in connection with the Credit Facility (including the $13,700,000 purchase obligation associated with a synthetic lease made through the Credit Facility) and the Credit Facility was terminated. As a result of the termination of the Credit Facility, the Company wrote off approximately $666,000 of unamortized deferred financing costs incurred when the Credit facility was obtained, recognized a $1,700,000 charge in connection with the termination of the synthetic lease and $469,000 of other costs related to the termination of the Credit Facility.
As of December 31, 2002, total borrowings under the Secured Credit Facility were approximately $60,420,000 and consisted of borrowings under the term loan of approximately $43,015,000 and $17,405,000 of undrawn letters of credit. As of December 31, 2002, the Company had approximately $24,580,000 of funding available under the Secured Credit Facility.
The Company’s operating activities in 2001 provided net cash of $19,235,000 as compared to providing net cash of $17,116,000 in 2002.
Net cash used by investing activities was $13,061,000 during 2001 as compared to $23,687,000 used in 2002. The primary use of cash for investing purposes during 2001 was to fund additions of property and equipment associated with the maintenance of the Company’s long-term care facilities. The primary use of cash for investing purposes during 2002 was to fund additions to property and equipment. During the year ended December 31, 2002, $13,700,000 of cash was used to fund the termination of a synthetic lease for two of the Company’s properties. During the period the synthetic lease was in effect, the operating results of these facilities were included with the operating results of the Company; however, in accordance with accounting for synthetic leases, the fixed assets of these properties and the related debt of $13,700,000, were not included in the Company’s consolidated balance sheet. Rather than recognizing interest on the $13,700,000 purchase commitment then outstanding, as well as depreciation on the fixed assets of the two facilities, the Company recognized as rent expense the payments made in connection with the synthetic lease. The Company’s “Additions to Property and Equipment” for the year ended December 31, 2002 include approximately $9,609,000 with respect to the termination of the synthetic lease and acquisition of the two properties. Most of the remainder of the cash used during 2002 to fund additions of property and equipment was associated with the maintenance of the Company’s long-term care facilities. The Company used approximately $6,219,000 to fund additions to deferred financing and other intangibles. Of this amount, approximately $2,391,000 reflected the recording of goodwill in connection with the acquisition of two properties that the Company had previously leased by means of a synthetic lease. Additionally, the Company incurred approximately $3,821,000 of deferred financing costs in connection with obtaining the Secured Credit Facility.
Net cash used by financing activities was $7,649,000 in 2001 as compared to net cash provided by financing activities of $17,490,000 in 2002. The financing activities during the year ended December 31, 2001 included the issuance of $15,000,000 of New Preferred Stock, a payment of $15,000,000 to the holders of the Discount Notes and a repayment of $7,500,000 of borrowings outstanding under the Credit Facility. The financing activities during the year ended December 31, 2002 included $43,015,000 of borrowings under the Secured Credit Facility and the repayment of all amounts ($25,250,000, including $23,250,000 paid at termination) due under the Credit Facility, excluding the $13,700,000 purchase obligation associated with a synthetic lease.
28As of December 31, 2002, in addition to borrowings outstanding under the Secured Credit Facility and the Discount Notes (which had an accreted balance of $83,399,000), the Company had two mortgage loans outstanding totaling $16,904,000. One mortgage loan had an outstanding principal balance of $15,422,000 of which $14,880,000 is due at maturity in 2004. This loan bears interest at an annual rate of 10.65% plus additional interest equal to 0.3% of the difference between the operating revenues of the four mortgaged facilities in each applicable year and operating revenues during the twelve-month base period. The Company’s other mortgage loan, which encumbers a single facility, had an outstanding principal balance of $1,482,000 at December 31, 2002, of which $1,338,000 is due in 2010.
Harborside expects that its capital expenditures for 2003, excluding acquisitions of new long-term care facilities, will aggregate approximately $6,000,000. Harborside’s expected capital expenditures will relate to maintenance capital expenditures, systems enhancements, special construction projects and other capital improvements. Harborside expects that its future facility acquisitions will be financed primarily through operating leases or assumed debt. Harborside may be required to obtain additional equity financing to finance any significant acquisitions in the future, to refinance the New Notes when they mature on August 1, 2007 or to refinance the New Preferred Stock when it becomes mandatorily redeemable on February 1, 2008.
The Company owns a 75% interest in a partnership that owns one facility. The Company accounts for its investment in this partnership using the equity method. The Company has guaranteed a loan of approximately $5,600,000 made to this partnership to refinance a loan that funded the construction of the facility and provided working capital. The loan is also collateralized by additional collateral pledged by the non-affiliated partner. The loan was to mature on May 31, 2002, but was extended by the lender. The loan currently matures on March 31,2003, but the Partnership is currently negotiating replacement financing with the lender on terms substantially similar to the existing financing. The partnership agreement states that each partner will contribute an amount in respect of any liability incurred by a partner in connection with a guarantee of the partnership’s debt, so that partners each bear their proportionate share of any liability based on their percentage ownership of the partnership.
The Company is highly leveraged, which makes it vulnerable to changes in general economic conditions. The Company’s ability to repay or refinance its debt will depend on, among other things, financial, business, market, competitive and other conditions, many of which are beyond the control of the Company. The Company believes that, taken together, its current cash balances, internally generated cash flow and availability under its credit facilities should result in the Company having adequate cash resources to meet its debt service and other financial obligations for at least the next twelve months.
CONTRACTUAL OBLIGATIONS
The following table provides information about the Company’s contractual obligations as of December 31, 2002, excluding current liabilities except for the current portion of long-term debt.
Payments due by Years
Total 2003 2004 and 2005 2006 and 2007 After 2007
------------ ------------ ------------ ------------ ------------
Long-term debt ................ $143,318,000 $ 303,000 $ 58,196,000 $ 83,440,000 $ 1,379,000
Preferred Stock ............... 35,469,000 -- -- -- 35,469,000
Operating leases .............. 209,567,000 29,885,000 60,098,000 40,366,000 79,218,000
------------ ------------ ------------ ------------ ------------
Total contractual and cash
obligations ................... $388,354,000 $ 30,188,000 $118,294,000 $123,806,000 $116,066,000
============ ============ ============ ============ ============
The Company issued $15,000,000 of New Preferred Stock on May 10, 2001. As long as the Company’s New Notes remain outstanding, the New Preferred Stock is entitled to dividends at a rate of 13% per annum compounded quarterly and payable in additional shares of New Preferred Stock. The New Preferred Stock is mandatorily redeemable on February 1, 2008.
During the year ended December 31, 1998, the Company implemented a general and professional liability insurance program that, for the period from September 1, 1998 to August 31, 2001, limited the Company’s self-retention risk for this program to a maximum of $25,000 per year. The long-term care industry has seen the cost of maintaining traditional professional liability insurance increase significantly over the past several years, especially in the State of Florida. Most insurance companies are unwilling to underwrite new professional liability policies in the State of Florida. In May 2001, tort reform legislation was enacted in Florida. This legislation provides caps on punitive damages, limits to add-on legal fees, stricter rules of evidence and a shorter statute of limitations period. Given the tremendous increase in professional liability premiums and the tort reform legislation that was enacted in the State of Florida in May 2001, the Company concluded that it would be more cost effective to assume a higher level of retained risk for professional liability claims. As a result, the Company implemented a new general and professional liability program, effective September 1, 2001, which resulted in the Company maintaining an unaggregated self-insured retention of $2,000,000 per occurrence for locations outside of Florida and completely retaining risk at the Florida facilities. As of December 1, 2002, the Company’s unaggregated self-insured retention increased to $10,000,000 per occurrence outside of Florida. As of December 31, 2002, the Company maintained a Claims Reserve in the amount of $8,721,000 for incurred but not reported claims. The amount of the reserve was determined through an estimation process that used information from both the Company’s records as well as industry data. The Company uses an independent actuary to help estimate the required general and professional liability reserve. Factors reviewed include the frequency of expected claims, the average cost per claim, emerging industry trends, changes in regulatory environment (such as the recently enacted
29Florida tort reform legislation) and the expected effect of various operational and risk management initiatives. The Company will continue to evaluate its insurance reserve requirements on a quarterly basis. Required adjustments to the Company’s general and professional liability reserve will be recorded in the accounting period in which the change in estimate occurs. There can be no assurances the recent Florida tort reform legislation will have a positive impact on claims activity, that the coverage limits of the Company’s insurance program will be adequate or that insurance will continue to be available to the Company in the future. (See Note M to the Company’s consolidated financial statements included elsewhere in this report.)
The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) broadened the scope of fraud and abuse laws to include all health plans, whether or not they are reimbursed under Federal programs. HIPAA also mandated the adoption of federal regulations designed to (a) standardize transaction formats and billing codes for documenting health care services, determining eligibility and processing claims for payment; and (b) protect the privacy and security of individually identifiable health information. Final HIPAA regulations that standardize transactions and code sets were issued during the third quarter of 2000. The ultimate compliance date was subsequently modified by legislation to require health care providers and health plans to either comply with the HIPAA transaction code set standards beginning in October of 2002 or submit a written plan to the federal government by October of 2002 describing specific plans for compliance by October of 2003. The regulations do not require healthcare providers to submit claims electronically, but do require standard formatting for those that do so. The Company currently submits most claims electronically and expects to continue to do so. The Company is currently evaluating its plans for compliance by October of 2002 or submitting the required plan describing its plans for compliance by October of 2003.
Final HIPAA privacy regulations were published during the fourth quarter of 2000. However, on March 27, 2002, the U.S. Department of Health and Human Services published in the Federal Register a proposed rule which if finally adopted would modify the regulations published during 2000. In general, the regulations apply to “protected health information”, which is defined as individually identifiable health information transmitted or maintained in any form or medium, excluding certain education records and student medical records. The privacy regulations seek to limit the use and disclosure of most paper and oral communications, as well as those in electronic form, regarding an individual’s past, present or future physical or mental health or condition, or relating to the provision of health care to the individual or payment of that health care. The regulations further impose requirements on health care providers to contractually obligate certain of their contractors who may receive protected health care information during the course of rendering services on behalf of such health care provider to abide by certain privacy requirements as well. In addition, the current HIPAA regulations provide that certain state privacy laws may not be preempted by HIPAA. Accordingly, the Company, in certain instances, will remain subject to various state privacy laws in jurisdictions in which it currently operates facilities. HIPAA provides for the imposition of civil and criminal penalties if protected health information is improperly disclosed. The Company must comply with the privacy regulations by April of 2003. Given the issuance of the recent proposed rulemaking, it is uncertain the extent to which the regulations that were published in 2000 will change. The Company is continuing to evaluate the impact of the privacy regulations on its operations.
HIPAA’s security regulations have not been finalized. The proposed security regulations specify administrative procedures, physical safeguards, and technical services and mechanisms designed to ensure that protected health information remains secure. The proposed security rules contemplate a compliance date of 24 months after the effective date of the final rule published in the Federal Register, although it is possible that such compliance date will differ and could align with the compliance date for the privacy regulations depending on when the security regulations are ultimately finalized.
The Company is currently working in conjunction with its software vendors to evaluate the impact of HIPAA regulations on the Company’s systems and operating procedures. The Company has not yet completed its analysis or its estimate of the expected costs of compliance with the HIPAA regulations. There can be no assurances that compliance with HIPAA regulations will not have an adverse effect on the Company’s results of operations, cash flows or its financial position.
SEASONALITY
Harborside’s earnings generally fluctuate from quarter to quarter. This seasonality is related to a combination of factors which include, among other things, the timing of Medicaid and Medicare rate increases, seasonal census cycles and the number of calendar days in a given quarter.
INFLATION
The healthcare industry is labor intensive. Wages and other labor related costs are especially sensitive to inflation. Shortages in the labor market or general inflationary pressure could have a significant effect on the Company. In addition, suppliers attempt to pass along rising costs to the Company in the form of higher prices. When faced with increases in operating costs, the Company has generally increased its charges for services. The Company’s operations could be adversely affected if it is unable to recover future cost increases or if it experiences significant delays in Medicare and Medicaid revenue sources increasing their rates of reimbursement.
30QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Most of the Company’s debt obligations bear interest at fixed rates and are not affected by changes in market interest rates; however, borrowings under the Company’s Secured Credit Facility are sensitive to changes in interest rates. Under the Secured
Credit Facility, interest is based on either LIBOR or prime rates of interest, at the Company’s election, plus applicable margins, and, for the term loan, subject to a floor of 7%. As the prime and LIBOR rates of interest increase, interest expense associated with the Company’s borrowings under the Secured Credit Facility would also increase, subject to existing floors and the impact of any hedging activities. An increase of 1% in the applicable rate would increase the Company’s annual interest cost by approximately $430,000.
The Company did not experience significant changes in interest rates during the year ended December 31, 2002. As part of the Company’s risk management program, the Company continuously reviews its overall exposure to interest rate risk and evaluates the benefits of interest rate hedging through the use of derivative instruments, such as interest rate swaps or caps. By entering into an interest rate swap or caps, the Company can effectively transform variable rate debt into fixed rate debt. The Company did not have any interest rate swap arrangements outstanding during the year ended December 31, 2001. As described in Note H to the consolidated financial statements of the Company included elsewhere in this report, the Company purchased a $40,000,000 interest rate cap effective September 1, 2002.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES: Report of Independent Accountants.........................................................32 Consolidated Balance Sheets as of December 31, 2001 and 2002..............................33 Consolidated Statements of Operations for the years ended December 31, 2000, 2001 and 2002......................................................................34 Consolidated Statements of Changes in Stockholders' Deficit for the years ended December 31, 2000, 2001 and 2002.........................................................35 Consolidated Statements of Cash Flows for the years ended December 31, 2000, 2001 and 2002.......................................................................36 Notes to Consolidated Financial Statements................................................3731
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors of
Harborside Healthcare Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, changes in stockholders’ deficit,
and cash flows present fairly, in all material respects, the financial position
of Harborside Healthcare Corporation and its subsidiaries (the
“Company”) at December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002 in conformity with accounting principles generally accepted in
the United States of America. These financial statements are the responsibility
of the Company’s management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
March 28, 2003
32
HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share and per share amounts)
AS OF DECEMBER 31,
2001 2002
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents ............................................ $ 9,249 $ 20,168
Accounts receivable, net of allowances for doubtful
accounts of $3,979 and $6,555 respectively ........................ 45,502 46,978
Prepaid expenses and other ........................................... 11,628 15,153
--------- ---------
Total current assets ............................................. 66,379 82,299
Restricted cash (Note C) ............................................... 5,898 6,611
Property and equipment, net (Note D) ................................... 108,989 116,705
Deferred financing and other intangibles, net (Note E) ................. 3,916 8,153
Other assets, net (Notes O and H) ...................................... 700 88
Note receivable (Note F) ............................................... 7,487 7,487
--------- ---------
Total assets ....................................................... $ 193,369 $ 221,343
========= =========
LIABILITIES
Current liabilities:
Current maturities of long-term debt (Note H) ........................ $ 2,776 $ 303
Accounts payable ..................................................... 14,711 14,648
Employee compensation and benefits ................................... 19,270 26,039
Other accrued liabilities ............................................ 6,878 5,960
Accrued interest ..................................................... 147 482
Current portion of deferred income ................................... 521 395
--------- ---------
Total current liabilities .......................................... 44,303 47,827
Claims reserve (Note M) ................................................ 1,467 8,721
Long-term portion of deferred income (Note G) .......................... 1,487 894
Long-term debt (Note H) ................................................ 113,878 143,015
Long-term accrued interest (Note H) .................................... 47,115 41,667
--------- ---------
Total liabilities .................................................. 208,250 242,124
--------- ---------
Commitments and contingencies (Notes G and M)
13% Convertible exchangeable preferred stock, redeemable,
$.01 par value with a liquidation value of $1,000 per share;
100,000 shares authorized;
16,286 and 18,509 shares issued and outstanding, respectively (Note L) 16,286 18,509
STOCKHOLDERS' DEFICIT (Note L)
Common stock, $.01 par value, 40,700,000 shares
authorized and 15,275,664 shares issued ............................... 153 153
Additional paid-in capital ............................................. 187,976 185,753
Common stock in treasury, at cost, 7,379,165 and
7,398,498 shares, respectively ......................................... (183,746) (183,746)
Accumulated other comprehensive loss ................................... -- (241)
Accumulated deficit .................................................... (35,550) (41,209)
--------- ---------
Total stockholders' deficit ........................................ (31,167) (39,290)
--------- ---------
Total liabilities and stockholders' deficit ........................... $ 193,369 $ 221,343
========= =========
The accompanying notes are an integral part of the consolidated financial statements.
33
HARBORSIDE HEATHCARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share amounts)
FOR THE YEARS ENDED DECEMBER 31,
2000 2001 2002
--------- --------- -------
Total net revenues ................................ $ 322,672 $ 346,738 $ 400,224
--------- --------- ---------
Expenses:
Facility operating .............................. 259,780 282,194 332,049
General and administrative ...................... 17,993 19,043 20,220
Service charges paid to former affiliate (Note O) 1,083 979 759
Amortization of prepaid management fee (Note O) . 1,200 1,200 1,200
Depreciation and amortization ................... 10,210 9,355 9,889
Facility rent ................................... 24,275 28,889 30,611
Loss on termination of capital lease (Note I) ... 8,914 -- --
Financial restructuring cost (Note H) ........... -- 9,045 --
Facility reorganization costs (Note P) .......... -- 1,080 --
Financing costs (Note H) ........................ -- -- 2,835
--------- --------- ---------
Total expenses ................................. 323,455 351,785 397,563
--------- --------- ---------
Income (loss) from operations .................... (783) (5,047) 2,661
Other:
Interest expense, net ............................. 21,675 11,945 8,056
Other (income) expense .......................... (74) (315) 24
--------- --------- ---------
Loss before income taxes .......................... (22,384) (16,677) (5,419)
Income tax expense (Note K) ....................... 14,322 225 240
--------- --------- ---------
Net loss .......................................... (36,706) (16,902) (5,659)
Preferred stock dividends ......................... (6,853) (3,774) (2,223)
---------- --------- ---------
Loss applicable to common shares .................. $ (43,559) $(20,676) $ (7,882)
========== ======== =========
Loss per common share (Note L):
Basic and Diluted ........................ $ (6.00) $ (2.82) $ (1.05)
========= ======== =========
The accompanying notes are an integral part of the consolidated financial statements.
34
HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT
(dollars in thousands)
FOR THE YEARS ENDED DECEMBER 31, 2000, 2001 and 2002
Accumulated
Additional Other
Common Paid-in Treasury Comprehensive Accumulated
Stock Capital Stock Loss Deficit Total
--------- --------- --------- --------- --------- ---------
Stockholders' deficit, December 31, 1999 ........ 146 198,603 (183,746) -- (38,525) (23,522)
Preferred stock dividends .................... -- (6,853) -- -- -- (6,853)
Issuance of restricted shares (664,500 shares) 7 -- -- -- -- 7
Net loss ..................................... -- -- -- -- (36,706) (36,706)
--------- --------- --------- --------- --------- ---------
Stockholders' deficit, December 31, 2000 ........ 153 191,750 (183,746) -- (75,231) (67,074)
Preferred stock dividends .................... -- (3,774) -- -- -- (3,774)
Reduction of liquidation preference and
exchange of 131/2% exchangeable
preferred stock (Note L) .................... -- -- -- -- 56,583 56,583
Net loss ..................................... -- -- -- -- (16,902) (16,902)
--------- --------- --------- --------- --------- ---------
Stockholders' deficit, December 31, 2001 ........ 153 187,976 (183,746) -- (35,550) (31,167)
--------- --------- --------- --------- --------- ---------
Preferred stock dividends ..................... -- (2,223) -- -- -- (2,223)
Comprehensive loss:
Net loss ..................................... -- -- -- -- (5,659) (5,659)
Unrealized loss on derivative instrument ..... -- -- -- (241) -- (241)
--------- --------- --------- --------- --------- ---------
Total comprehensive loss ................... -- -- -- (241) (5,659) (5,900)
--------- --------- --------- --------- --------- ---------
Stockholders' deficit, December 31, 2002 ........ $ 153 $ 185,753 $(183,746) $ (241) $ (41,209) $ (39,290)
========= ========= ========= ========= ========= =========
The accompanying notes are an integral part of the consolidated financial statements.
35
HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
FOR THE YEARS ENDED DECEMBER 31,
2000 2001 2002
-------- -------- --------
Operating activities:
Net loss ........................................... $(36,706) $(16,902) $ (5,659)
Adjustments to reconcile net loss to net
cash provided (used) by operating activities:
Depreciation of property and equipment ............. 7,776 7,682 8,710
Amortization of deferred financing and other
non-current assets ................................ 2,434 1,673 1,179
Amortization of prepaid management fee 1,200 1,200 1,200
Amortization of deferred income .................... (680) (518) (489)
Accretion of senior subordinated discount notes .... 13,095 10,400 9,174
Amortization of long-term accrued interest ......... -- (3,002) (5,448)
Amortization of loan costs
and fees (included in rental and interest expense) 143 143 137
Accretion of interest on capital lease obligation .. 2,753 -- --
Noncash lease termination costs .................... 7,542 -- --
Noncash issuance of restricted shares .............. 7 -- --
Noncash financial restructuring charge ............. -- 4,896 --
Noncash charges related to refinancing ............. -- -- 436
-------- -------- --------
(2,436) 5,572 9,240
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable ........ 1,509 3,157 (1,476)
(Increase) decrease in prepaid expenses and other . 6,343 1,552 (4,025)
Decrease in deferred income taxes ................. 14,252 -- --
Increase (decrease) in accounts payable ........... 1,555 3,828 (63)
Increase in employee compensation and benefits .... 1,844 3,405 6,769
Increase (decrease) in accrued interest ........... (102) (323) 335
Increase (decrease) in other accrued liabilities .. 793 577 (918)
Increase in income taxes payable .................. 2,608 -- --
Increase in claims reserve accrual ................ -- 1,467 7,254
-------- -------- --------
Net cash provided by operating activities ........ 26,366 19,235 17,116
-------- -------- --------
Investing activities:
Additions to property and equipment ............... (6,199) (11,582) (16,426)
Additions to deferred financing and other
non-current assets ............................... (118) (386) (6,219)
Transfers to restricted cash, net ................. (2,385) (1,093) (713)
Purchase of interest rate cap ..................... -- -- (329)
-------- -------- --------
Net cash used by investing activities ............. (8,702) (13,061) (23,687)
-------- -------- --------
Financing activities:
Issuance of New Preferred Stock ................... -- 15,000 --
Payment to holders of Discount Notes .............. -- (15,000) --
Receipt of cash in connection with lease .......... -- 102 --
Repayment of revolving line of credit ............. -- (7,500) (25,250)
Borrowings under secured credit facility .......... -- -- 43,015
Payment of note payable to affiliate .............. (5,000) -- --
Payment of long-term debt ......................... (224) (245) (275)
Principal payments of capital lease obligation .... (3,084) -- --
Dividends paid on exchangeable preferred stock .... (18) (6) --
-------- -------- --------
Net cash provided (used) by financing activities (8,326) (7,649) 17,490
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 9,338 (1,475) 10,919
Cash and cash equivalents, beginning of year ....... 1,386 10,724 9,249
-------- -------- --------
Cash and cash equivalents, end of year ............. $ 10,724 $ 9,249 $ 20,168
======== ======== ========
Supplemental Disclosure:
Interest paid .................................... $ 7,129 $ 6,163 $ 4,877
Income taxes paid ................................ $ 130 $ 257 $ 226
Accretion of preferred dividends ................. $ 6,835 $ 3,768 $ 2,223
The accompanying notes are an integral part of the consolidated financial statements.
36Subsidiaries of Harborside Healthcare Corporation, on a consolidated basis, (the "Company" or "Harborside"), operate long-term care facilities and, until September 1999, provided rehabilitation therapy services to non-affiliated long-term care facilities. As of December 31, 2002, the Company owned eighteen facilities, operated thirty-six additional facilities under various leases and managed one facility. The Company accounts for its investment in one 75% owned facility using the equity method of accounting.
The Company was incorporated in Delaware on March 19, 1996 and was formed as a holding company in anticipation of an initial public offering (the “IPO”), to combine under the control of a single corporation the operations of various business entities which were all under the majority control of several related stockholders.
On April 15, 1998, the Company entered into a Merger Agreement (the “Merger”) with HH Acquisition Corp. (“MergerCo”), an entity organized for the sole purpose of effecting a merger on behalf of Investcorp S.A., certain of its affiliates and certain other international investors (the “New Investors”). The New Investors made common equity cash contributions totaling $165 million ($158.5 million, net of issuance costs). On August 11, 1998, MergerCo merged with and into the Company, with Harborside Healthcare Corporation as the surviving corporation. As a result of the transaction, and pursuant to the Merger, the New Investors acquired approximately 91% of the post-merger common stock of the Company. The remaining 9% of the common stock was retained by existing shareholders, including management. As a result of the Merger, the Company’s shares were de-listed from the New York Stock Exchange.
The Merger was approved by a majority of the Company’s shareholders at a special meeting held on August 11, 1998. Each share not retained by existing shareholders was converted into $25 in cash, representing in the aggregate, cash payments of approximately $184 million. The converted shares (7,349,832 shares) were recorded at cost as treasury stock and represent a deduction from the Company’s stockholders’ deficit. Holders of outstanding stock options of the Company converted the majority of their options into cash at $25 per underlying share (less applicable exercise price and withholding taxes) with aggregate payments of approximately $8 million.
In connection with the transaction and prior to the Merger, the New Investors made cash common equity contributions of $158.5 million, net of issuance costs, to MergerCo, and MergerCo obtained gross proceeds of $99.5 million through the issuance of 11% Senior Subordinated Discount Notes (“Discount Notes”) due 2008 and $40 million through the issuance of 13.5% Exchangeable Preferred Stock (“Preferred Stock”) mandatorily redeemable in 2010. In the third quarter of 1998, Harborside recorded a charge to income from operations of $37 million for direct and other costs related to the Merger transaction. In connection with the Merger and the related refinancings, the Company exercised purchase options for seven facilities which had been previously financed through synthetic leases.
The Company uses the following accounting policies for financial reporting purposes:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
Total Net Revenues
Total net revenues include net patient service revenues, management fees from managed facilities and the facility accounted for using the equity method, and, through September 1999, rehabilitation therapy service revenues from contracts to provide rehabilitation therapy services to non-affiliated long-term care facilities.
Net patient service revenues payable by patients at the Company's facilities are recorded at established billing rates. Net patient service revenues to be reimbursed by contracts with third-party payors, primarily the Medicare and Medicaid programs, are recorded at the amount estimated to be realized under these contractual arrangements. Revenues from the Medicare program prior to January 1, 1999 and from Medicaid programs are generally based on reimbursement of the reasonable direct and indirect costs of providing services to program participants or a prospective payment system. The Company separately estimates revenues due from each third-party with which it has a contractual arrangement and records anticipated settlements with these parties in the contractual period during which services were rendered. The amounts actually reimbursable under Medicare prior to January 1, 1999 and Medicaid are determined by filing cost reports which are then audited and generally retroactively adjusted by the payor. Legislative changes to state or Federal reimbursement systems may also retroactively affect recorded revenues. Changes in estimated revenues due in connection with Medicare and Medicaid may be recorded by the Company subsequent to the year of origination and prior to final settlement based on improved estimates. Such adjustments and final settlements with third-party payors, which could materially and adversely affect the Company, are reflected in operations at the time of the adjustment or settlement. Accounts receivable, net, at
37December 31, 2001 and 2002, include $8,467,000 and $7,691,000, respectively, of estimated settlements due from third-party payors and $2,401,000 and $1,336,000, respectively, of estimated settlements due to third-party payors.
Concentrations
A significant portion of the Company’s revenues are derived from the Medicare and Medicaid programs. There have been, and the Company expects that there will continue to be, a number of proposals to limit reimbursement allowable to long-term care facilities under these programs. Approximately 74%, 77%, and 80% of the Company’s net revenues in the years ended December 31, 2000, 2001 and 2002, respectively, are from the Company’s participation in the Medicare and Medicaid programs. As of December 31, 2001 and 2002, $25,862,000 and $26,995,000, respectively, of net accounts receivable were due from the Medicare and Medicaid programs.
Facility Operating Expenses
Facility operating expenses include expenses associated with the normal operations of a long-term care facility. The majority of these costs consist of payroll and employee benefits related to nursing, rehabilitation therapy services, housekeeping and dietary services provided to patients, as well as maintenance and administration of the facilities. Other significant facility operating expenses include: the cost of medical and pharmacy supplies, food and utilities. Through September 1999, facility operating expenses included expenses associated with rehabilitation therapy services rendered by the Company under contracts to provide rehabilitation therapy services to non-affiliated long-term care facilities.
Provision for Doubtful Accounts
Provisions for uncollectible accounts receivable of $3,610,000, $3,998,000 and $5,043,000 are included in facility operating expenses for the years ended December 31, 2000, 2001 and 2002, respectively. Individual patient accounts deemed to be uncollectible are written off against the allowance for doubtful accounts.
Use of Estimates
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 amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the period reported. Actual results could differ from those estimates. Estimates are used when accounting for the collectibility of receivables, depreciation and amortization, health benefit, workers’ compensation and general and professional liability claims, taxes and contingencies.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Expenditures that extend the lives of affected assets are capitalized, while maintenance and repairs are charged to expense as incurred. Upon the retirement or sale of an asset, the cost of the asset and any related accumulated depreciation are removed from the balance sheet, and any resulting gain or loss is included in net loss.
Depreciation expense is estimated using the straight-line method. Depreciation is calculated using the following estimated useful lives:
Buildings and improvements 31.5 to 40 years (limited to the life of lease, for leased facilies)
Furniture and equipment 3 to 10 years
Land improvements 8 to 40 years
Deferred Financing and Other Non-Current Assets
Deferred financing costs consist of costs incurred in obtaining financing (primarily loans and facility leases). These costs are amortized using the straight-line method (which approximates the interest method) over the term of the related financial obligation (See Notes E and H).
38In connection with each of its acquisitions, the Company reviewed the assets of the acquired facilities and assessed their relative fair value in comparison to the purchase price. Covenants not-to-compete are being amortized using the straight-line method over the period during which competition is restricted. Goodwill resulted from the acquisition of certain assets for which the negotiated purchase prices exceeded the allocations of the fair market value of identifiable assets. The Company’s policy is to evaluate each acquisition separately and identify an appropriate amortization period for goodwill based on the acquired property’s characteristics. Through December 31, 2001, goodwill was amortized using the straight-line method over a 15 to 40 year period. In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), which was effective January 1, 2002. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing impairments of goodwill. As of December 31, 2001, the Company’s intangible assets included no assets that were classified as goodwill. As of December 31, 2002, the Company’s intangible assets included $2,391,000 of assets that are classified as goodwill. The recognition of this goodwill related to the acquisition of two facilities in September 2002 that had previously been operated by the Company through synthetic leases. (See Notes G and H.) Assessment of Long-Lived Assets
The Company reviews, on a quarterly basis, the carrying value of its long-lived assets (primarily property and equipment and deferred financing and other non-current assets) to assess the recoverability of these assets; any impairments would be recognized in operating results if a diminution in value considered to be other than temporary were to occur. As part of this assessment, the Company reviews the expected future net operating cash flows from its facilities, as well as the values included in appraisals of its facilities, which have periodically been obtained in connection with various financial arrangements. (See Notes H and I).
Cash and Cash Equivalents
Cash and cash equivalents consist of highly liquid investments with maturities of three months or less at the date of their acquisition by the Company.
Restricted Cash
Restricted cash consists of cash in escrow accounts as required by several of the Company’s leases and other financing arrangements.
Income Taxes
The Company determines deferred taxes in accordance with Statement of Financial Accounting Standards (“SFAS”) 109, Accounting for Income Taxes, which requires that deferred tax assets and liabilities be computed based on the difference between the financial statement and income tax basis of assets and liabilities using enacted marginal tax rates. Deferred income tax expenses or credits are based on the changes in the assets or liabilities from period to period. A valuation allowance reduces deferred tax assets when it is more likely than not that some portion or all of the deferred tax assets will not be recognized (See Note K).
New Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”). Companies are required to adopt SFAS 143 in their fiscal year beginning after June 15, 2002. SFAS 143 requires that obligations associated with the retirement of a tangible long-lived asset be recorded as a liability when these obligations are incurred, with the amount of the liability initially measured at fair value. Upon recognizing a liability, an entity must capitalize the cost by recognizing an increase in the carrying amount of the related long-lived asset, accrete the liability over time to its present value each period, and depreciate the capitalized cost over the useful life of the related asset. Upon settlement of the liability, the obligation is either settled for its recorded amount or a gain or loss is recognized. The Company does not believe that the adoption of SFAS 143 will have a material impact on its financial position, results of operations, or cash flows.
In July 2002, the FASB issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). SFAS 146 replaces Emerging Issues Task Force Issue No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity”. SFAS 146 requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The Company does not believe that the adoption of SFAS 146 will have a material impact on its financial position, results of operations, or cash flows.
On November 25, 2002, the FASB issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34.” FIN 45 clarifies the requirements of FASB Statement No. 5, “Accounting for Contingencies” (“SFAS 5”), relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 requires that, upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation. FIN 45 is applicable to guarantees that encompass guarantees based on changes in an underlying asset, liability or equity security, guarantees that are made on behalf of another entity’s performance, certain indemnification agreements and indirect guarantees of the indebtedness of others. The recognition and measurement provisions of FIN 45 are effective prospectively for guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for reporting periods ending after December 15, 2002. The Company has made the required disclosures in the consolidated financial statements as of December 31, 2002 and is in the process of assessing the impact of FIN 45 recognition and measurement provisions on its consolidated financial statements. The Company does not believe that the adoption of FIN 45 will have a significant impact on its financial statements.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures about the method of accounting for stock-based employee compensation and the effect of the method used on reported financial results. SFAS No. 148 amends Accounting Principles Board (“APB”) Opinion No. 28, “Interim Financial Reporting,” to require these disclosures in interim financial information. The Company continues to account for their stock-based employee compensation under APB Opinion 25, but has adopted the new disclosure requirements of the SFAS 148 for the year ended December 31, 2002. Additional information related to the Company’s stock option plans is detailed in Note L of the Notes to the Consolidated Financial Statements.
39In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin (“ARB”) No. 51 (“ARB 51”).“ The primary objectives of FIN 46 are to provide guidance on the identification of, and financial reporting for, entities for which control is achieved through means other than through voting rights; such entities are known as variable-interest entities (“VIEs”). FIN 46 provides guidance that determines (1) whether consolidation is required under the “controlling financial interest” model of ARB 51, “Consolidated Financial Statements,” or (b) other existing authoritative guidance, or alternatively, (2) whether the variable-interest model under FIN 46 should be used to account for existing and new entities. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. FIN 46 is effective for VIEs which are created after January 31, 2003 and for all VIEs for the first fiscal year or interim period beginning after June 15, 2003. The Company has evaluated the provisions of FIN 46 and determined that this Interpretation will have no material effect currently on its consolidated financial statements.
The Company’s property and equipment are stated at cost less accumulated depreciation and consist of the following as of December 31:
2001 2002
------------ ------------
Land .............................. $ 7,238,000 $ 8,522,000
Land improvements ................. 3,943,000 4,087,000
Buildings and improvements ........ 100,626,000 111,658,000
Equipment, furnishings and fixtures 35,364,000 34,916,000
------------ ------------
147,171,000 159,183,000
Less accumulated depreciation ..... 38,182,000 42,478,000
------------ ------------
$108,989,000 $116,705,000
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Deferred financing and other non-current assets are stated at cost less accumulated amortization and consist of the following as of December 31:
2001 2002
----------- -----------
Deferred financing costs .......... $ 7,991,000 $ 9,408,000
Goodwill .......................... -- 2,391,000
Covenant not-to-compete ........... 1,200,000 1,200,000
----------- -----------
9,191,000 12,999,000
Less accumulated amortization...... 5,275,000 4,846,000
----------- -----------
$ 3,916,000 $ 8,153,000
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On December 1, 1997, the Company acquired five long-term care facilities in Connecticut. The Company financed this acquisition through an operating lease with the seller. In connection with this acquisition, the Company received a note receivable from the owners in the amount of $7,487,000. Interest is earned at the rate of 9% per annum, and payments are due monthly, in arrears, commencing January 1, 1998 and continuing until November 30, 2010, at which time the entire principal balance is due. The proceeds of the note were used by the owner to repay certain indebtedness. The note is collateralized by various mortgage interests and other collateral.
The Company leases certain long-term care facilities and equipment under operating leases. The Company’s existing leased facilities are leased either from the owner of the facilities or from a real estate investment trust or other real estate entity that has purchased the facilities from the owner. The Company’s existing facility leases generally require it to make monthly lease payments and pay all property operating costs. The Company generally negotiates leases that provide for extensions beyond the initial lease term and an option to purchase the leased facility. In some cases, the option to purchase the leased facility is at a price based on the fair market value of the facility at the time the option is to be exercised. In other cases, the lease sets forth a fixed purchase option price.
40Future minimum rent commitments under the Company’s non-cancelable operating leases as of December 31, 2002 are as follows:
Real Estate Equipment Total
------------ ------------ ------------
2003 $ 29,638,000 $ 247,000 $ 29,885,000
2004 29,995,000 13,000 30,008,000
2005 30,090,000 -- 30,090,000
2006 21,498,000 -- 21,498,000
2007 18,868,000 -- 18,868,000
Thereafter 79,218,000 -- 79,218,000
------------ ------------ ------------
$209,307,000 $ 260,000 $209,567,000
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The Company has a mortgage payable (the “Mortgage”) in the amount of $15,422,000 at December 31, 2002. The Mortgage is cross-collateralized by the assets of four of the Company’s facilities (the “Four Facilities”). The Mortgage bears interest at the annual rate of 10.65%. Additional interest payments are also required in an amount equal to 0.3% of the difference between the operating revenues of the Four Facilities in each applicable year and the operating revenues of the Four Facilities during a twelve-month base period which commenced October 1, 1995. The Mortgage places certain restrictions on the Four Facilities; among them, the agreement restricts their ability to incur additional debt or to make significant dispositions of assets. The Four Facilities are also required to maintain a debt service coverage ratio of at least 1.2 to 1.0 (as defined in the loan agreement) and a current ratio of at least 1.0 to 1.0. The Mortgage contains a prepayment penalty calculated in accordance with a formula.
A subsidiary of the Company assumed a first mortgage note (the “Note”) with a remaining balance of $1,482,000 as part of the acquisition of a long-term care facility in 1988. The Note requires the annual retirement of principal in the amount of $20,000. The Company pays interest monthly at the rate of 14% per annum on the outstanding principal amount until maturity in October 2010, when the remaining unpaid principal balance of $1,338,000 is due. The Note is collateralized by the property and equipment of the facility.
On August 11, 1998, in connection with the Merger, the Company entered into a six-year $250,000,000 collateralized credit facility (the “Credit Facility”). During the first four years of the Credit Facility, up to $250,000,000 could be used in connection with synthetic lease financing. Proceeds of the loans could be used for working capital, capital expenditures, acquisitions and general corporate purposes. Interest was based on either LIBOR or prime rates of interest (plus applicable margins), at the election of the Company. The Credit Facility required that the Company maintain an interest/rent coverage ratio which varied by year, and limited aggregate borrowings under the Credit Facility to a predetermined multiple of EBITDA.
During the first quarter of 1999, the Company determined that its anticipated financial results for that quarter would cause the Company to be out of compliance with certain financial covenants of the Credit Facility. Accordingly, the Company obtained an amendment (the “First Amendment”) to the Credit Facility effective March 30, 1999 which temporarily limited borrowings under the Credit Facility to an aggregate of $58,500,000 (exclusive of undrawn letters of credit outstanding as of March 30, 1999) and which modified certain financial covenants. In order to complete the Cleveland Facility leasing transaction (See Note I), the Company was required to obtain the release of certain collateral held by the bank group which provided the Credit Facility. The Company obtained the release of the collateral as part of an amendment (the “Second Amendment”) to the Credit Facility, which also resulted in a permanent reduction of the Company’s maximum borrowings under the Credit Facility from $250 million to $150 million and an increase in the Company’s borrowing rate. As a result of the permanent reduction in funds available through the Credit Facility, the Company was required to write off a proportionate amount of the deferred financing costs incurred when the Credit Facility was obtained.
On March 28, 2001, the Company obtained an additional amendment (the “Third Amendment”) to the Credit Facility in order to be able to implement the financial restructuring of the Company’s Discount Notes and Preferred Stock discussed below. The Third Amendment resulted in a permanent reduction of the Company’s maximum borrowings under the Credit Facility from $150 million to $60 million, revised certain financial covenants, changed the maturity date of the Credit Facility to March 31, 2004 and increased the Company’s borrowing rate. The Third Amendment also required the Company to repay, on an annual basis, the greater of $5,000,000 or 50% of the Company’s excess cash flow (as defined). As a result of the permanent reduction in funds available through the Credit Facility, the Company was required to write off a proportionate amount of the deferred financing costs incurred when the Credit Facility was obtained.
On September 13, 2002, the Company entered into a new three-year collateralized credit facility (the “Secured Credit Facility”) that provides access to a maximum of $100 million. Borrowings under the Secured Credit Facility were used to repay all amounts owed in connection with the termination of the Company’s previous Credit Facility (including amounts outstanding in connection with a $13,700,000 synthetic lease obligation) as well as related closing costs and expenses. The terms of the Secured Credit Facility provide a maximum of $25 Million on a revolving credit basis and a maximum of $75 Million in the form of a term loan. Proceeds from the Secured Credit Facility can be used for the acquisition of additional healthcare facilities (including required working capital), joint venture investments, letters of credit, and general corporate purposes. The Secured Credit Facility is collateralized by substantially all of the Company’s patient accounts receivable, certain real estate and a first or second priority interest in the capital stock of certain of the Company’s subsidiaries. Interest on the revolving credit facility is payable monthly in arrears at a rate of LIBOR plus 4.25% (or Prime plus 1.25%) at the election of the Company. The terms of the Secured Credit Facility initially limit availability through the term loan to $60 million, but this amount may be increased to $75 Million at the election of the Company after the occurrence of certain events. Interest on the term loan is payable monthly in arrears at the rate of LIBOR plus 4.1% with a minimum interest rate of 7%. The Secured Credit Facility contains a number of restrictive covenants that, among other things,
41restrict the Company’s ability to dispose of certain assets, limits the Company’s ability to declare and pay certain dividends, and requires the Company to maintain a minimum occupancy, as well as predetermined levels of fixed charge coverage and debt service coverage as defined in the loan agreement. As of December 31, 2002, total borrowings under the Secured Credit Facility were approximately $60,420,000 and consisted of borrowings under the term loan of approximately $43,015,000 and $17,405,000 of undrawn letters of credit. As of December 31, 2002, the Company had approximately $24,580,000 of funding available under the Secured Credit Facility. As of December 2002, the interest rate on the term loan outstanding under the Secured Credit Facility was 7.0%.
In connection with entering into the Secured Credit Facility, the Company incurred non-recurring Financing Costs totaling $2,835,000. This non-recurring charge includes $1,700,000 recorded in connection with the termination of a synthetic lease for two of the Company’s facilities (the “Synthetic Lease Properties”) made through the Company’s prior Credit Facility. The Company was obligated to purchase the Synthetic Lease Properties at a pre-determined price ($13,700,000) upon the occurrence of certain events including a termination of the prior Credit Facility. The carrying value of the Synthetic Lease Properties was recorded at the purchase price ($13,700,000), less a charge of $1,700,000 to reflect uncertainties related to the value of these properties in connection with the expiration of a significant portion of Medicare reimbursement effective October 1, 2002. (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources”.) Additionally, the Company wrote off un-amortized deferred financing costs associated with the prior Credit Facility ($666,000), recognized bonus payments to executive officers for securing the replacement financing (totaling $350,000) and incurred certain other professional and recording costs.
In connection with obtaining the Secured Credit Facility, the Company purchased an interest rate cap on $40 million notional principal amount that matures on September 1, 2005. This interest rate cap is intended to provide the Company partial protection from exposure to the floating interest rate associated with $40 million of term loan borrowings. The entire amount of this interest rate cap has been designated an effective cash flow hedge to limit possible increases in interest payments on its term loan. The interest rate cap limits the Company’s exposure to an increase in the underlying LIBOR rate to (a) 5.23% if LIBOR is less than 6.23% or (b) 6.23% if LIBOR increases above 6.23%.
Changes in the fair market value of a derivative that is highly effective and is designated and qualifies as a cash flow hedge, are reported as “Accumulated Other Comprehensive Income or Loss” (“AOCIL”) in the “Stockholders’ Deficit” section of the Company’s consolidated balance sheet. On December 31, 2002, the fair market value of the interest rate cap was $88,000 which amount was included in “Other Assets, net”. A loss of $241,000 was charged to AOCIL for the year ended December 31, 2002. None of the losses in AOCIL related to the interest rate cap are expected to be reclassified into interest expense as a yield adjustment of the hedged debt obligation during the next twelve months.
In connection with the Merger on August 11, 1998, the Company issued $170,000,000 principal amount at maturity (approximately $99,500,000 gross proceeds) of Discount Notes. Each Discount Note was issued with a principal amount at maturity of $1,000 and an original issue price of $585.25. Interest on the Discount Notes accreted in accordance with a predetermined formula on a semi-annual basis on February 1, and August 1, of each year. Cash interest was not to accrue on the Discount Notes until August 1, 2003. In March 2001, the Company entered into an agreement (the “Restructuring Agreement”) with Investcorp S.A. and the holders of more than a majority in interest of the Company’s Discount Notes and Preferred Stock for purposes of implementing a restructuring of the Discount Notes and Preferred Stock. The Restructuring Agreement contemplated that the Company would offer to exchange for each $1,000 amount at maturity of outstanding Discount Notes a combination of the following: (1) 0.5899118 of a new 12% Senior Subordinated Discount Note due 2007 (the “New Notes”) each having a principal amount at maturity equal to $1,000 and an original issue price of $685.67 (assuming that the New Notes were issued on May 4, 2001), (2) $88.2353 in cash and (3) common stock purchase warrants for approximately 10.9 shares of its Class A Common Stock. The Company would also offer to exchange common stock purchase warrants for approximately 10.7 shares of its Class A Common Stock for each $1,000 liquidation preference of Preferred Stock (based on the aggregate liquidation preference to be outstanding on May 1, 2001) plus any dividends accrued on such Preferred Stock after May 1, 2001. In conjunction with the restructuring proposal, the Company would solicit consents from holders of outstanding Discount Notes and Preferred Stock to amendments to the Indenture governing the Discount Notes and to the Certificate of Designation governing the Preferred Stock that would eliminate or modify certain restrictive covenants and other provisions contained in the Indenture and the Certificate of Designation and would substantially eliminate the preferences of the Preferred Stock, including the reduction of the liquidation preference from $1,000 to $0.01 per share and the elimination of the right of holders to be paid dividends on shares of Preferred Stock. Also, the Company would issue to Investcorp S.A. (or one or more of its affiliates or designees) up to 15,000 shares of a new series of 13% convertible exchangeable preferred stock (the “New Preferred Stock”) and 1,854,422 common stock purchase warrants for a total purchase price of up to $15,000,000.
On April 6, 2001, the Company initiated the exchange offer and consent solicitation contemplated by the Restructuring Agreement. On May 10, 2001, the Company completed the exchange offer and consent solicitation, thereby implementing each of the elements of the Restructuring Agreement. All of the outstanding Discount Notes and 99.96% of the Preferred Stock shares were tendered and exchanged in the exchange offer. As a result of the exchange, (1) the Company had an aggregate principal amount at maturity of $100,276,000 of New Notes outstanding and an aggregate liquidation preference of $15,000,000 (as of May 10, 2001) of New Preferred Stock outstanding, (2) warrants were issued to holders of Discount Notes, to holders of Preferred Stock, and to Investcorp S.A. representing the right to purchase an aggregate of approximately 15%, 5% and 15%, respectively, of the total number of shares of all classes of the Company’s common stock on a fully diluted basis (excluding shares issuable upon conversion of the New Preferred Stock, each share of which are initially convertible into 150 shares of Class A Common Stock), and (3) the Company paid $15,000,000 in cash as partial consideration for the tendered Discount Notes.
The reduction in the liquidation preference of the Preferred Stock was completed on May 10, 2001, as contemplated by the Restructuring Agreement. The carrying amount of the Preferred Stock was reduced from $57,595,000 to $576, and the amount of the reduction, net of unamortized deferred financing costs related to the issuance of the Preferred Stock (approximately $1,011,000 at May 10, 2001), was directly transferred to the Company’s Accumulated Deficit account. With the exchange
42of the New Notes for the Discount Notes, the carrying value of the accreted principal of the Discount Notes was reduced to $68,890,000, and the amount of the reduction, net of the aggregate cash payment of $15,000,000, was directly transferred to the Company’s Long-term Accrued Interest account. Subsequent to their issuance, the carrying amount of the New Notes increases as the result of accretion and results in a corresponding decrease in the carrying amount of Long-term Accrued Interest. Interest expense on the New Notes is recognized such that a constant effective interest rate is applied to the aggregate carrying amount of the New Notes and Long-term Accrued Interest for all periods between the issuance date and the maturity date of the New Notes.
In connection with the Third Amendment to the Credit Facility and the implementation of the Restructuring Agreement, the Company incurred a non-recurring charge of $9,045,000. This charge resulted from the write-off of approximately $1,500,000 of unamortized deferred financing costs incurred when the Credit Facility was obtained, the write-off of approximately $3,400,000 of unamortized deferred financing costs related to the issuance of the Discount Notes, and the recognition of various investment advisory, legal and other fees associated with these events of $4,145,000.
The New Notes were issued at a discount and interest on the New Notes accretes until August 1, 2004. Cash interest payments will be paid semi-annually in arrears beginning on February 1, 2005 based on the fully accreted value of the New Notes and a 12% cash interest payment rate. The New Notes mature on August 1, 2007.
At any time on or prior to August 1, 2003, the New Notes may be redeemed, in whole but not in part, at the option of the Company upon the occurrence of a “Change of Control” (as defined) in accordance with the prescribed procedures and the payment of any applicable premium (as defined). Upon the occurrence of a Change in Control, unless all New Notes have been called for redemption, each holder of the New Notes will have the right to require, in accordance with the prescribed procedures, the Company to repurchase all or any part of the New Notes at a price equal to 101% of the accreted value of the New Notes. The New Notes must be redeemed in whole on August 1, 2007.
Upon the voluntary or involuntary liquidation of the Company, holders of the New Notes will be entitled to be paid in full 100% of principal and accrued interest out of the assets available for distribution after holders of senior debt have been paid in full. The New Notes are unsecured, subordinate to existing and future senior debt of the Company, but senior in right with all existing and future subordinated debt of the Company. Certain of the subsidiaries of the Company have jointly and severally guaranteed the Company’s payment obligations (subject to maximum amounts per subsidiary) under the New Notes (see Note R). Each New Note guaranteed by such subsidiary is subordinated to any senior debt of such guarantor. The Company derives substantially all of its income from operations through its subsidiaries and consequently, the New Notes are effectively subordinated to the potential claims of creditors of all of the subsidiaries of the Company irrespective of subsidiary guarantees. The New Notes also contain certain restrictive covenants which limit the ability of the Company to incur debt, issue preferred stock, merge or dispose of substantially all of its assets.
Interest expense charged to operations for the years ended December 31, 2000, 2001 and 2002 was $23,007,000, $13,270,000 and $8,991,000, respectively.
As of December 31, 2001 and 2002, the Company’s long-term debt, excluding the current portion, consisted of the following:
2001 2002
------------ ------------
12% Senior subordinated discount notes
due 2007 .......................... $ 74,225,000 $ 83,399,000
Mortgages payable .................... 16,903,000 16,601,000
Revolving loans under Credit Facility 22,750,000 --
Loans under Secured Credit Facility .. -- 43,015,000
------------ ------------
$113,878,000 $143,015,000
============ ============
As of December 31, 2002, future long-term debt maturities associated with the Company’s debt are as follows:
2003 $ 303,000
2004 15,161,000
2005 43,035,000
2006 20,000
2007 83,420,000
Thereafter 1,379,000
--------------
$143,318,000
============
Substantially all of the Company’s assets are subject to liens under long-term debt or operating lease agreements. The Company believes that, taken together, its current cash balances, internally generated cash flow and availability under its credit facilities should result in the Company having adequate cash resources to meet its debt service and other financial obligations for at least the next twelve months.
43Until September 27, 2000, the Company, through a wholly owned limited partnership, leased and operated four facilities in Ohio (the “Cleveland Facilities”) which it acquired in 1996 through capital leases. Each of the four leases contained an option to purchase the facility beginning July 1, 2001 and each lease was guaranteed by the Company. The guaranty provided that failure by the Company to have a specified minimum consolidated net worth at the end of any two consecutive quarters would be an event of default under the guaranty, which in turn would be an event of default under each lease. As a result of a restructuring charge, the Company’s consolidated net worth as of September 30, 1999 (as calculated for purposes of this requirement) had fallen below the required level. The Company anticipated that its net worth would continue to be below the required level at December 31, 1999, which would have resulted in an event of default under each of these leases with the Company potentially facing the loss of these operations. Such default could also have triggered cross-defaults under the Company’s other lease and debt obligations. In December 1999, the Company paid $5 million to its landlord and obtained an option (the “New Option”) to acquire the Cleveland Facilities. The Company borrowed $5 million from an affiliate of Investcorp S.A. to fund this payment. The New Option allowed the Company to exercise its right to purchase the Cleveland Facilities beginning as of the date of the New Option, required the Company to complete the acquisition prior to December 31, 2000 and provided a waiver of the net worth covenant through that date. The Company exercised the New Option on June 30, 2000.
On September 27, 2000, the Company terminated the Cleveland Facilities capital leases and assigned its purchase rights for these facilities to an investment entity organized by Investcorp, for $5.0 million, which simultaneously acquired the Cleveland Facilities. On that date, the Company entered into new operating leases for each of the Cleveland Facilities with combined annual rent expense of approximately $5.9 million. The Company used the proceeds of the purchase rights assignment to repay the $5.0 million note payable from an affiliate of Investcorp S.A. As a result of the capital lease termination, the Company recorded a non-recurring charge of $8.9 million. The principal components of this charge included the write-off of capital leased assets in excess of related capital lease obligation ($5.7 million) and the write-off of deferred financing costs ($1.8 million) related to the Company’s Credit Facility. In order to complete the Cleveland Facility leasing transaction, the Company was required to obtain the release of certain collateral held by the bank group which provided the Credit Facility. The Company obtained the release of the collateral as part of an amendment to the Company’s Credit Facility, which also resulted in a permanent reduction of the Company’s maximum borrowings under the Credit Facility from $250 million to $150 million and an increase in the Company’s borrowing rate. As a result of the permanent reduction in funds available through the Credit Facility, the Company was required to write off a proportionate amount of the deferred financing costs incurred when the Credit Facility was originally obtained.
On December 21, 2001, the Cleveland Facilities were sold to an unaffiliated real estate investment trust and the Company entered into new operating leases with that entity.
The Company maintains an employee 401(k) defined contribution plan. All employees who have worked at least one thousand hours and have completed one year (nine months effective January 1, 2002) of continuous service are eligible to participate in the plan. The plan is subject to the provisions of the Employee Retirement Income Security Act of 1974. Employee contributions to this plan may be matched at the discretion of the Company. The Company contributed $298,000, $385,000 and $323,000 to the plan in 2000, 2001 and 2002, respectively.
In September 1995, the Company established a Supplemental Executive Retirement Plan (the “SERP”) to provide benefits to key employees. Participants may defer up to 25% of their compensation which is matched by the Company at a rate of 50% (up to 10% of base salary). Vesting in the matching portion occurs in January of the second year following the plan year in which contributions were made. The Company amended the SERP effective January 1, 2003 to eliminate additional employer matching contributions effective as of that date.
As required by SFAS 109, the Company annually evaluates the positive and negative evidence bearing upon the realizability of its deferred tax assets. The Company has considered the recent and historical results of operations and concluded; in accordance with the applicable accounting methods that it is more likely than not that a certain portion of the deferred tax assets will not be realizable. To the extent that an asset will not be realizable, a valuation allowance is established. The tax effects of temporary differences giving rise to deferred tax assets as of December 31, 2001 and 2002 are as follows:
2001 2002
------------ ------------
Deferred tax assets:
Reserves ....................... $ 3,046,000 $ 11,971,000
Rental payments ................ 687,000 330,000
Interest payments .............. 20,466,000 22,471,000
Net operating loss carryforwards 19,211,000 18,298,000
Other .......................... 414,000 187,000
Valuation allowance ............ (29,411,000) (37,961,000)
------------ ------------
Total deferred tax assets ...... $ 14,413,000 $ 15,296,000
============ ============
Deferred tax liabilities:
Depreciation & Amortization .... $ 14,413,000 $ 15,296,000
============ ============
44
The Company continually reviews its deferred tax accounts and in the fourth quarter of 2002 recorded an incremental net deferred tax asset and corresponding valuation allowance of approximately $6,689,000.
Significant components of the provision for income taxes for the years ended December 31, 2000, 2001 and 2002 are as follows:
2000 2001 2002
----------- ----------- -----------
Current:
Federal
State ............. $ 70,000 $ 225,000 $ 240,000
----------- ----------- -----------
Total current .......... 70,000 225,000 240,000
----------- ----------- -----------
Deferred:
Federal ........... 11,596,000 -- --
State ............. 2,656,000 -- --
----------- ----------- -----------
Total deferred ......... 14,252,000 -- --
----------- ----------- -----------
Total income tax expense $14,322,000 $ 225,000 $ 240,000
=========== =========== ===========
The reconciliation of income tax computed at statutory rates to income tax for the years ended December 31, 2000, 2001 and 2002 are as follows:
2000 2001 2002
---- ---- ----
Statutory rate............................$ (7,834,000) 35.0% $ (5,837,000) 35.0% $ (1,897,000) 35.0%
State income tax, net of federal benefit.. (1,765,000) 7.9 146,000 (0.9) (88,000) 1.4
Permanent differences..................... 198,000 (0.9) 287,000 (1.7) 364,000 (7.0)
Change in valuation allowance............. 23,461,000 (104.8) 5,336,000 (32.0) 1,861,000 (34.1)
Net operating loss - rate differential.... 90,000 (0.4) 156,000 (0.9) - -
Other..................................... 172,000 (0.8) 137,000 (0.8) - -
------------ ------- ------------- ------ ------------ ------
$ 14,322,000 (64.0%) $ 225,000 (1.3)% $ 240,000 (4.7%)
============ ======= ============= ====== ============ ======
Common Stock
On August 11, 1998, as a result of the Merger, the Company authorized the issuance of 500,000 shares of preferred stock with a par value of $.01 per share and 19,000,000 shares (comprised of five classes) of common stock, each with a par value of $.01 per share, consisting of Harborside Class A Common Stock, Harborside Class B Common Stock, Harborside Class C Common Stock, Harborside Class D Common Stock and Common Stock (collectively “Harborside Common Stock”). Effective April 4, 2001, the Company’s Certificate of Incorporation was amended to (a) increase the authorized number of shares of the Company’s Class A Common Stock from 1,200,000 shares to 11,700,000 shares and (b) increase the authorized number of shares of the Company’s Common Stock from 9,500,000 shares to 20,000,000 shares. On November 19, 2001, the Company’s Certificate of Incorporation was again amended to increase the authorized number of shares of the Company’s Class C Common Stock from 1,580,000 shares to 2,280,000 shares.
The numbers of shares of Harborside Common Stock authorized and outstanding as of December 31, 2001 and 2002 are as follows:
2001 2002
---- ----
Authorized Outstanding Authorized Outstanding
Shares Shares Shares Shares
---------- ---------- ---------- ----------
Title
Harborside Class A Common Stock ..... 11,700,000 661,332 11,700,000 661,332
Harborside Class B Common Stock ..... 6,700,000 5,940,000 6,700,000 5,940,000
Harborside Class C Common Stock ..... 2,280,000 1,275,167 2,280,000 1,255,834
Harborside Class D Common Stock ..... 20,000 20,000 20,000 20,000
Common Stock ........................ 20,000,000 -- 20,000,000 --
---------- ---------- ---------- ----------
Total ............................... 40,700,000 7,896,499 40,700,000 7,877,166
========== ========== ========== ==========
Holders of shares of Harborside Class A Common Stock and Common Stock are entitled to one vote per share on all matters as to which stockholders may be entitled to vote pursuant to Delaware General Corporate Law (“the DGCL”). Holders of shares of Harborside Class D Common Stock are entitled to 330 votes per share on all matters as to which stockholders may be entitled to vote pursuant to the DGCL. Holders of Harborside Class B Common Stock or Harborside Class C Common Stock will not have any voting rights, except that the holders of the Harborside Class B Common Stock and Harborside Class C Common Stock will have the right to vote as a class to the extent required under the laws of the State of Delaware.
45Upon the occurrence of a sale of 100% of the outstanding equity securities or substantially all of the assets of the Company, a merger as a result of which the ownership of the Harborside Common Stock is changed to the extent of 100%, or a public offering of any equity securities of the Company, each share of Harborside Class A Common Stock, Harborside Class B Common Stock, Harborside Class C Common Stock and Harborside Class D Common Stock will convert into one share of Common Stock of the Company.
Restricted Stock
On September 29, 2000, the Company issued 664,500 shares of restricted Class C common stock (the “Restricted Shares”) to employees of the Company. As part of this restricted stock issuance, 507,705 options granted on August 11, 1998 to purchase shares of the Company’s Class C common stock at $25.00 per share were cancelled. The purpose of the restricted stock issuance was to better enable the Company to retain and motivate key employees. The Restricted Shares generally vest over varying periods of time through December 31, 2003. As of December 31, 2002, 467,501 Restricted Shares were vested. Unvested shares are restricted as to disposition and subject to forfeiture under certain circumstances. The value of the Restricted Shares on the date of grant was approximately $7,000.
Preferred Stock
In connection with the Merger on August 11, 1998, the Company issued 40,000 shares of Preferred Stock. The holders of the Preferred Stock were entitled to receive quarterly dividend payments in arrears beginning November 1, 1998. Dividends were payable in cash or in additional shares of Preferred Stock, at the option of the Company, until August 1, 2003. After August 1, 2003, dividends were to be paid only in cash. During the years ended December 31, 1999, 2000 and 2001, all dividends except for fractional shares amounting to $20,000, $18,000 and $6,000, respectively, were paid in additional shares.
In March 2001, the Company entered into the Restructuring Agreement with Investcorp S.A. and the holders of more than a majority in interest of the Company’s Discount Notes and Preferred Stock for purposes of implementing a restructuring of the Discount Notes and the Preferred Stock (See Note H). On May 10, 2001, the Company completed an exchange offer and consent solicitation, thereby implementing each of the elements of the Restructuring Agreement. As part of the exchange offer, 99.96% of the Preferred Stock shares were tendered and warrants were issued to holders of the Preferred Stock representing the right to purchase (at an exercise price of $0.01 per share) an aggregate of approximately 5% of the total number of shares of all classes of the Company’s common stock on a fully diluted basis (excluding shares issuable upon conversion of the New Preferred Stock, each share of which are initially convertible into 150 shares of Class A Common Stock). As contemplated by the Restructuring Agreement, on May 10, 2001, the liquidation preference of the Preferred Stock was reduced from $1,000 to $0.01 per share and the carrying amount of the Preferred Stock was reduced from $57,595,000 to $576. The amount of this reduction, net of unamortized deferred financing costs related to the issuance of the Preferred Stock (approximately $1,011,000 at May 10, 2001), was directly transferred to the Company’s Accumulated Deficit account.
In connection with the financial restructuring, the Company issued 15,000 shares of New Preferred Stock for a purchase price of $15,000,000. The New Preferred Stock had an initial liquidation preference of $15,000,000 and is entitled to dividends at the greater of: (a) a rate of 13% per annum compounded quarterly and payable in additional shares of New Preferred Stock, or at any time while no New Notes are outstanding, in cash and (b) an amount equal to the dividends payable on outstanding shares of Class A Common Stock, payable quarterly in the same form as such dividends are payable. The New Preferred Stock is mandatorily redeemable on February 1, 2008. Shares of the New Preferred Stock will generally not be redeemable by the Company until August 1, 2004 and thereafter will be redeemable at a premium, which will decline ratably to par by August 1, 2007. In the event of a Change in Control (as defined), the Company may redeem the New Preferred Stock as a whole, but not in part, at a price equal to 100% of the applicable liquidation preference including accrued but unpaid dividends and a “make whole premium” until August 1, 2004. If the Company does not redeem the New Preferred Stock in the event of a Change in Control, the holders of the New Preferred Stock may require the Company to make an offer to purchase the outstanding shares of New Preferred Stock at a price equal to 101% of the applicable liquidation preference. Each share of the New Preferred stock is convertible: (a) into 150 shares of the Company’s Class A Common Stock at any time at the option of the holder; (b) and subject to compliance with certain financial covenants, will also be exchangeable into the New Notes of the Company due 2008, at the option of the Company on any dividend payment date, subject to certain requirements and procedures. The exchange debentures would rank surbordinate to the New Notes.
Upon any voluntary or involuntary liquidation of the Company, holders of the New Preferred Stock will be entitled to be paid out of the assets available for distribution, the liquidation preference per share plus an amount equal to all accumulated and unpaid dividends, before any distribution is made to the holders of Harborside Common Stock. Holders of the New Preferred Stock have no voting rights except as provided by law and in the Certificate of Designation. In the event that dividends are not paid for any six quarterly periods, or upon certain other events, the number of directors constituting the Company’s Board of Directors would be adjusted to permit the holders of the majority of the then outstanding New Preferred Stock, voting separately as a class, to elect two directors.
The Certificate of Designation also contains certain restrictive covenants that limit the Company’s restricted subsidiaries from making certain payments or investments and which limit the Company’s ability to incur debt, issue preferred stock, merge or dispose of substantially all of its assets.
46As of December 31, 2002, preferred stock dividends accrete based on the following schedule:
2003 $ 2,526,000
2004 2,871,000
2005 3,262,000
2006 3,708,000
2007 4,214,000
Thereafter 380,000
-------------
$16,961,000
===========
Common Stock Warrants
As part of the financial restructuring (See Note H), the Company issued Common Stock Warrants (the “Warrants”) to holders of the Discount Notes, to holders of the Preferred Stock, and to Investcorp S.A. representing the right to purchase an aggregate of approximately 15%, 5% and 15%, respectively, of the total number of shares of all classes of the Company’s common stock on a fully diluted basis (excluding shares issuable upon conversion of the New Preferred Stock, each share of which are initially convertible into 150 shares of Class A Common Stock). Warrants to purchase an aggregate total of 4,326,641 shares were issued on May 10, 2001. Each warrant entitles the holder thereof to purchase one share of Class A Common Stock at an exercise price of $0.01 per share. The Warrants will be exercisable at the earliest to occur of (a) a Change of Control, (b) an initial public offering of the Company’s Common Stock, (c) the full redemption of all of the New Notes at the Company’s option and (d) August 1, 2009.
Earnings (Loss) per Common Share Computation
Basic earnings (loss) per common share is computed by dividing net earnings (loss) less preferred stock dividends by the weighted average number of common shares outstanding. Common shares outstanding exclude nonvested Restricted Shares in the amounts of 171,000, 578,000 and 343,000 for the years ended December 31, 2000, 2001 and 2002, respectively. The computation of diluted earnings (loss) per share is similar to that of basic earnings (loss) per share except that the number of common shares is increased to reflect the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. Dilutive potential common shares for the Company consist of shares issuable upon exercise of the Company’s stock options.
The following table sets forth the computation of basic and diluted earnings (loss) per common share for the years ended December 31, 2000, 2001 and 2002:
2000 2001 2002
------------ ------------ ------------
Numerator:
Net loss ................................................... $(36,706,000) $(16,902,000) $ (5,659,000)
Preferred stock dividends .................................. (6,853,000) (3,774,000) (2,223,000)
------------ ------------ ------------
Loss applicable to common shares ........................... $(43,559,000) $(20,676,000) $ (7,882,000)
============ ============ ============
Denominator:
Weighted average shares outstanding ............................. 7,432,000 7,913,000 7,884,000
Adjustment for nonvested Restricted Shares ................. (171,000) (578,000) (343,000)
------------ ------------ ------------
Denominator for basic and diluted loss per common share -
adjusted weighted - average shares and assumed conversions.. 7,261,000 7,335,000 7,541,000
============ ============ ============
Basic and diluted loss per common share .................... $ (6.00) $ (2.82) $ (1.05)
============ ============ ============
For the years ended December 31, 2000, 2001 and 2002, the weighted-average shares outstanding for the following potentially dilutive securities were excluded from the computation of diluted loss per common share because the effect would have been antidilutive:
2000 2001 2002
--------- --------- ---------
Options to purchase common stock ............... 492,512 214,131 1,006,415
Non-vested shares of restricted stock .......... 170,664 578,420 342,702
Conversion rights of convertible preferred stock -- 1,494,960 2,515,749
Warrants to purchase common stock .............. -- 2,797,499 4,326,641
--------- --------- ---------
663,176 5,085,010 8,191,507
========= ========= =========
Stock Option Plans
During 1996, the Company established two stock option plans, the 1996 Stock Option Plan for Non-employee Directors (the “Director Plan”) and the 1996 Long-Term Stock Incentive Plan (the “Stock Plan”). Directors of the Company who were not employees, or affiliates of the Company, were eligible to participate in the Director Plan. On the date of the IPO, each of the four non-employee
47directors was granted options to acquire 15,000 shares of the Company’s common stock at the IPO price. On January 1 of each year, each non-employee director received an additional grant for 3,500 shares at the fair market value on the date of grant. Options issued under the Director Plan became exercisable on the first anniversary of the date of grant and terminated upon the earlier of ten years from date of grant or one year from date of termination as a director. Through the Directors Retainer Fee Plan, non-employee directors of the Company could also elect to receive all or a portion of their director fees in shares of the Company’s common stock. The Stock Plan was administered by the Stock Plan Committee of the Board of Directors which was composed of outside directors who were not eligible to participate in this plan. The Stock Plan authorized the issuance of non-qualified stock options, incentive stock options, stock appreciation rights, restricted stock and other stock-based awards. Options granted during the years ended December 31, 1996 and 1997, were granted with exercise prices equal to or greater than the fair market value of the stock on the date of grant. Options granted under the stock plan during 1996 and 1997 vested over a three-year period and had a maximum term of ten years. A maximum of 800,000 shares of common stock were reserved for issuance in connection with these plans.
In connection with the Merger, all holders of options issued through the Director Plan and the Stock Plan had the right to retain their options or to have their options converted into cash at $25.00 per underlying share less the applicable exercise price (and taxes required to be withheld by the Company). Holders of options representing options to purchase 109,994 shares of stock retained their options while the remainder (representing 648,923 options) exercised their right to convert their options into cash.
In connection with the Merger, the Company adopted the Harborside Healthcare Corporation Stock Incentive Plan (the “Stock Option Plan”). The Stock Option Plan is administered by the Board of Directors of the Company. The Board of Directors designates which employees of the Company will be eligible to receive awards under the Stock Option Plan, and the amount, timing, and other terms and conditions applicable to such awards. All options granted under the Stock Option Plan during 1998 were granted with an exercise price equal to $25.00, equal to the fair market value of the stock on the date of grant. Options granted under the Stock Option Plan during 1998 were to vest at the end of a seven year period or earlier if certain financial performance criteria were met. All options granted under the Stock Option Plan during 1998 and still outstanding as of September 29, 2000 were cancelled on that date in connection with the issuance of the Restricted Shares. A maximum of 1,600,000 shares have been reserved for issuance in connection with the Stock Option Plan.
Information with respect to options granted under the Director Plan, the Stock Plan and the Stock Option Plan is as follows:
Options Outstanding: Number Exercise Price Weighted-Average
of Shares Per Share Exercise Price
--------- ---------- ----------------
Balance at December 31, 1999 637,226 $ 8.15 - $25.00 $22.94
- -----------------------------------------------------------------------------------
Cancelled (527,232) $ 25.00 $25.00
Balance at December 31, 2000 109,994 $ 8.15 - $21.69 $13.07
- -----------------------------------------------------------------------------------
Granted 883,000 $ 1.25 $ 1.25
- -----------------------------------------------------------------------------------
Balance at December 31, 2001 992,994 $ 1.25 - $21.69 $ 2.53
- -----------------------------------------------------------------------------------
Granted 50,500 $ 1.25 $ 1.25
- -----------------------------------------------------------------------------------
Balance at December 31, 2002 1,043,494 $ 1.25 - $21.69 $ 2.50
===================================================================================
As of December 31, 2000, there were 109,994 exercisable options at a weighted-average exercise price of $13.07. As of December 31, 2001, there were 336,244 exercisable options at a weighted-average exercise price of $5.12. At December 31, 2002, there were 564,119 exercisable options at a weighted-average exercise price of $3.55.
In 1996, the Company adopted SFAS 123, “Accounting for Stock-Based Compensation.” SFAS 123 requires that companies either recognize compensation expense for grants of stock, stock options, and other equity instruments based on fair value, or provide pro forma disclosure of net income and earnings per share in the notes to the financial statements. The Company has adopted the disclosure provisions of SFAS 123, and has applied Accounting Principles Board Opinion 25 and related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its stock option plans. Had compensation cost for the Company’s stock-based compensation plans been determined based on the fair value at the grant dates as calculated in accordance with SFAS 123, the Company’s unaudited pro forma net loss and pro forma net loss per share for the years ended December 31, 2000, 2001 and 2002 would have been reduced to the amounts indicated below:
2000 2001 2002
---- ---- ----
Loss Loss Loss Loss Loss Loss
Applicable to Per Common Applicable to Per Common Applicable to Per Common
Common Shares Share Diluted Common Shares Share Diluted Common Shares Share Diluted
------------- ------------- ------------- ------------- ------------- -------------
As
Reported $(43,559,000) $(6.00) $(20,676,000) $(2.82) $(7,882,000) $(1.05)
Pro
Forma $(43,559,000) $(6.00) $(20,676,000) $(2.82) $(7,882,000) $(1.05)
48
The weighted average fair value of options granted was $0 in 2001 and 2002. The fair value for each stock option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: an expected life of five years, no dividend yield, and a risk-free interest rate of 4.75%. Expected volatility of 0% (except for 109,994 in options held by senior management; such options have an assumed volatility of 40%) was assumed for the year ended December 31, 2001 and 2002.
The Company is involved in legal actions and claims in the ordinary course of its business. It is the opinion of management, based on the advice of legal counsel, that such litigation and claims will be resolved without material effect on the Company’s consolidated financial position, results of operations or liquidity.
The Company self-insures for health benefits provided to a majority of its employees. The Company maintains stop-loss insurance such that the Company’s liability for losses is limited. The Company recognizes an expense for estimated health benefit claims incurred including claims but not reported at the end of each year.
The Company self-insures for most workers’ compensation claims. The Company maintains stop-loss insurance such that the Company’s liability for losses is limited. The Company accrues for estimated workers’ compensation claims including claims incurred but not reported at the end of each year.
During the year ended December 31, 1998, the Company implemented a general and professional liability insurance program which, for the period from September 1, 1998 to August 31, 2001, limited the Company’s self-retention risk for this program to a maximum of $25,000 per year. The Company implemented a new general and professional liability program effective, September 1, 2001, which resulted in the Company maintaining an unaggregated self-insured retention of $2,000,000 per occurrence for locations outside of Florida and completely retaining risk at the Florida facilities. As of December 1, 2002, the Company’s unaggregated self-insured retention increased to $10,000,000 per occurrence for locations outside of Florida. As of December 31, 2002, the Company maintains a Claims Reserve in the amount of $8,721,000 for estimated unpaid losses including unreported claims. The liabilities for incurred but not reported claims not covered by third-party insurance are discounted at 8% to obtain their present value based on estimated claim payments as determined by an independent actuary. The amount of the reserve was determined through an estimation process that used information from both the Company’s records as well as industry data. The Company uses an independent actuary to help estimate the required general and professional liability reserve. Factors reviewed include the frequency of expected claims, the average cost per claim, emerging industry trends, changes in regulatory environment and the expected effect of various operational and risk management initiatives. The Company will continue to evaluate its insurance reserve requirements on a quarterly basis. Required adjustments to the Company’s general and professional liability reserve will be recorded in the accounting period in which the change in estimate occurs.
The Company owns a 75% interest in a partnership which owns one facility. The Company accounts for its investment in this partnership using the equity method. The Company has guaranteed a loan of approximately $5,600,000 made to this partnership to refinance a loan which funded the construction of the facility and provided working capital. The loan is also collateralized by additional collateral pledged by the non-affiliated partner. The loan was to mature on May 31, 2002, but was extended by the lender. The loan currently matures on March 31, 2003, but the Partnership is currently negotiating replacement financing with the lender on terms substantially similar to the existing financing. The partnership agreement states that each partner will contribute an amount in respect of any liability incurred by a partner in connection with a guarantee of the partnership’s debt, so that partners each bear their proportionate share of any liability based on their percentage ownership of the partnership.
The methods and assumptions used to estimate the fair value of each class of financial instruments, for those instruments for which it is practicable to estimate that value, and the estimated fair values of the financial instruments are as follows:
Cash and Cash Equivalents
The carrying amount approximates fair value because of the short effective maturity of these instruments.
Note Receivable
The carrying value of the note receivable approximates its fair value at December 31, 2001 and 2002, based on the yield of the note and the present value of expected cash flows.
Long-term Debt
The fair value of the Company’s fixed rate long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. At December 31, 2002, the fair market value of the Company’s New Notes was approximately $54,149,000. The book value of the Company’s New Notes was $83,399,000. The Company estimates that the fair value of its remaining fixed rate debt approximates its carrying amount.
49A former affiliate of the Company provides data processing services to the Company in return for a monthly fee. Total service charges under this arrangement were $1,083,000, $979,000 and $759,000, for the years ended December 31, 2000, 2001 and 2002, respectively.
At the time of the Merger, Investcorp International Inc. received a $6,000,000 management advisory and consulting service fee which is being expensed on a straight-line basis over the life of the related five year agreement. The expense recognized by the Company in connection with this management agreement during the years ended December 31, 2000, 2001 and 2002 was $1,200,000, $1,200,000 and $1,200,000, respectively.
As of December 31, 2001 the net payable due to Bowie, L.P. was approximately $0.4 million. As of December 31, 2002 the net payable due to Bowie, L.P. was approximately $1.3 million.
During the year ended December 31, 2001, the Company recorded a non-recurring charge of $1,080,000 in connection with its decision to revise the marketing approach for facilities operated through subsidiaries in Florida. The Company determined that a local community-based marketing approach would better serve the needs of these facilities. The marketing approach stresses ties to the local community and required renaming these facilities in order to emphasize this approach. In connection with this effort, the Company also restructured certain of its subsidiaries effective October 1, 2001. In order to implement this strategy, the Company recognized certain non-recurring marketing, legal and other expenses.
Certain of the Company’s subsidiaries are precluded from guaranteeing the debt of the parent company (the “Non-Guarantors”), based on current agreements in effect. The Company’s remaining subsidiaries (the “Guarantors”) are not restricted from serving as guarantors of the parent company debt. The Guarantors are comprised of Harborside Healthcare Limited Partnership, Belmont Nursing Center Corp., Orchard Ridge Nursing Center Corp., Oakhurst Manor Nursing Center Corp., Riverside Retirement Limited Partnership, Harborside Connecticut Limited Partnership, Harborside of Florida Limited Partnership, Harborside of Ohio Limited Partnership, Harborside Healthcare Baltimore Limited Partnership, Harborside of Cleveland Limited Partnership, Harborside of Dayton Limited Partnership, Harborside Massachusetts Limited Partnership, Harborside of Rhode Island Limited Partnership, Harborside North Toledo Limited Partnership, Harborside Healthcare Advisors Limited Partnership, Harborside Toledo Corp., KHI Corporation, Harborside Danbury Limited Partnership, Harborside Acquisition Limited Partnership V, Harborside Acquisition Limited Partnership VI, Harborside Acquisition Limited Partnership VII, Harborside Acquisition Limited Partnership VIII, Harborside Acquisition Limited Partnership IX, Harborside Acquisition Limited Partnership X, Sailors, Inc., New Jersey Harborside Corp., Bridgewater Assisted Living Limited Partnership, Maryland Harborside Corp., Harborside Homecare Limited Partnership, Harborside Rehabilitation Limited Partnership, Harborside Healthcare Network Limited Partnership and Harborside Health I Corporation.
The information which follows presents the condensed consolidating financial position as of December 31, 2001 and 2002; the condensed consolidating results of operations for the years ended December 31, 2000, 2001 and 2002; and the condensed consolidating cash flows for the years ended December 31, 2000, 2001 and 2002 of (a) the parent company only (“the Parent”), (b) the combined Guarantors, (c) the combined Non-Guarantors, (d) eliminating entries and (e) the Company on a consolidated basis.
50
HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES
Condensed Consolidating Balance Sheet
As of December 31, 2001
(dollars in thousands except share and per share amounts)
Parent Guarantors Non-Guarantors Elimination Consolidated
--------- --------- -------------- ----------- ------------
ASSETS
Current assets:
Cash and cash equivalents ....................... $ -- $ 7,886 $ 1,363 $ -- $ 9,249
Accounts receivable, net of allowance
for doubtful accounts ......................... -- 32,531 12,971 -- 45,502
Intercompany receivable ......................... 141,929 -- -- (141,929) --
Prepaid expenses and other ...................... 1,400 9,308 920 -- 11,628
--------- --------- --------- --------- ---------
Total current assets ............................... 143,329 49,725 15,254 (141,929) 66,379
Restricted cash .................................... -- 5,130 768 -- 5,898
Investments in limited partnerships ................ 15,584 -- 4,044 (19,628) --
Property and equipment, net ........................ -- 87,815 21,174 -- 108,989
Deferred financing and other
non-current assets, net ........................... 677 2,330 909 -- 3,916
Other assets, net .................................. 700 -- -- -- 700
Note receivable .................................... -- 7,487 -- -- 7,487
--------- --------- --------- --------- ---------
Total assets ....................................... $ 160,290 $ 152,487 $ 42,149 $(161,557) $ 193,369
========= ========= ========= ========= =========
LIABILITIES
Current liabilities:
Current maturities of long-term debt ............ $ 2,500 $ 22 $ 254 $ -- $ 2,776
Accounts payable ................................ -- 12,514 2,197 -- 14,711
Intercompany payable ............................ -- 112,416 13,567 (125,983) --
Employee compensation and benefits .............. -- 16,153 3,117 -- 19,270
Other accrued liabilities ....................... -- 5,800 1,078 -- 6,878
Accrued interest ................................ 147 -- -- -- 147
Current portion of deferred income .............. -- -- -- 521 521
--------- --------- --------- --------- ---------
Total current liabilities .......................... 2,647 146,905 20,213 (125,462) 44,303
Claims reserve ..................................... -- 1,467 -- -- 1,467
Long-term portion of deferred income ............... -- 534 1,474 (521) 1,487
Long-term debt ..................................... 96,975 1,481 15,422 -- 113,878
Long-term accrued interest ......................... 47,115 -- -- -- 47,115
--------- --------- --------- --------- ---------
Total liabilities .................................. 146,737 150,387 37,109 (125,983) 208,250
--------- --------- --------- --------- ---------
13% Convertible
exchangeable preferred stock, redeemable,
$.01 par value with a liquidation
value of $1,000 per share; 100,000 shares
authorized; 16,286 shares issued and outstanding ... 16,286 -- -- -- 16,286
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock, $.01 par value, 40,700,000
shares authorized, 15,275,664 shares issued ........ 153 2,569 3,885 (6,454) 153
Additional paid-in capital ......................... 187,748 -- -- 228 187,976
Common stock in treasury,
at cost, 7,379,165 shares .......................... (183,746) -- -- -- (183,746)
Retained earnings (accumulated deficit) ............ (6,888) (25,224) (5,919) 2,481 (35,550)
Partners' equity ................................... -- 24,755 7,074 (31,829) --
--------- --------- --------- --------- ---------
Total stockholders' equity (deficit) ............... (2,733) 2,100 5,040 (35,574) (31,167)
--------- --------- --------- --------- ---------
Total liabilities and stockholders'
equity (deficit) ................................... $ 160,290 $ 152,487 $ 42,149 $(161,557) $ 193,369
========= ========= ========= ========= =========
51
HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES
Condensed Consolidating Balance Sheet
As of December 31, 2002
(dollars in thousands except share and per share amounts)
Parent Guarantors Non-Guarantors Elimination Consolidated
--------- --------- --------- --------- ------------
ASSETS
Current assets:
Cash and cash equivalents ....................... $ -- $ 19,544 $ 624 $ -- $ 20,168
Accounts receivable, net of allowance
for doubtful accounts ......................... -- 35,286 11,692 -- 46,978
Intercompany receivable ......................... 118,476 -- -- (118,476) --
Prepaid expenses and other ...................... 864 13,286 1,003 -- 15,153
--------- --------- --------- --------- ----------
Total current assets ............................... 119,340 68,116 13,319 (118,476) 82,299
Restricted cash .................................... -- 6,024 587 -- 6,611
Investments in limited partnerships ................ 15,584 -- 4,044 (19,628) --
Property and equipment, net ........................ -- 96,195 20,510 -- 116,705
Deferred financing and other
non-current assets, net ........................... -- 7,477 676 -- 8,153
Other assets, net .................................. 88 -- -- -- 88
Note receivable .................................... -- 7,487 -- -- 7,487
--------- --------- --------- --------- ---------
Total assets ....................................... $ 135,012 $ 185,299 $ 39,136 $(138,104) $ 221,343
========= ========= ========= ========= =========
LIABILITIES
Current liabilities:
Current maturities of long-term debt .......... $ -- $ 25 $ 278 $ -- $ 303
Accounts payable ................................ -- 13,290 1,358 -- 14,648
Intercompany payable ............................ -- 87,843 14,662 (102,505) --
Employee compensation and benefits .............. -- 23,114 2,925 -- 26,039
Other accrued liabilities ....................... -- 5,045 915 -- 5,960
Accrued interest ................................ -- 482 -- -- 482
Current portion of deferred income .............. -- -- -- 395 395
--------- --------- --------- --------- ---------
Total current liabilities .......................... -- 129,799 20,138 (102,110) 47,827
Claims reserve ..................................... -- 8,218 503 -- 8,721
Long-term portion of deferred income ............... -- 184 1,105 (395) 894
Long-term debt ..................................... 83,399 44,472 15,144 -- 143,015
Long-term accrued interest ......................... 41,667 -- -- -- 41,667
--------- --------- --------- --------- ---------
Total liabilities .................................. 125,066 182,673 36,890 (102,505) 242,124
--------- --------- --------- --------- ---------
13% Convertible
exchangeable preferred stock, redeemable,
$.01 par value with a liquidation
value of $1,000 per share; 100,000 shares
authorized; 18,509 shares issued and outstanding ... 18,509 -- -- -- 18,509
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock, $.01 par value, 40,700,000
shares authorized, 15,275,664 shares issued ........ 153 2,569 3,885 (6,454) 153
Additional paid-in capital ......................... 185,526 -- -- 227 185,753
Common stock in treasury,
at cost, 7,398,498 shares .......................... (183,746) -- -- -- (183,746)
Accumulated other comprehensive loss ............... (241) -- -- -- (241)
Retained earnings (accumulated deficit) ............ (10,255) (24,698) (8,713) 2,457 (41,209)
Partners' equity ................................... -- 24,755 7,074 (31,829) --
--------- --------- --------- --------- ---------
Total stockholders' equity (deficit) ............... (8,563) 2,626 2,246 (35,599) (39,290)
--------- --------- --------- --------- ---------
Total liabilities and stockholders'
equity (deficit) ................................... $ 135,012 $ 185,299 $ 39,136 $(138,104) $ 221,343
========= ========= ========= ========= =========
52
HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES
Condensed Consolidating Statement of Operations
For the year ended December 31, 2000
(dollars in thousands)
Parent Guarantors Non-Guarantors Elimination Consolidated
--------- --------- --------- --------- ---------
Total net revenues ................................. $ -- $ 222,479 $ 102,217 $ (2,024) $ 322,672
--------- --------- --------- --------- ---------
Expenses:
Facility operating .............................. -- 177,732 84,072 (2,024) 259,780
General and administrative ...................... -- 17,993 -- -- 17,993
Service charges paid to former affiliate ........ -- 1,083 -- -- 1,083
Amortization of prepaid management fee .......... 1,200 -- -- -- 1,200
Depreciation and amortization ................... 1,808 6,469 1,933 -- 10,210
Facility rent ................................... -- 15,629 8,646 -- 24,275
Loss on termination of capital lease ............ -- 8,914 -- -- 8,914
Management fees paid to affiliates .............. -- (6,045) 6,045 -- --
--------- --------- --------- --------- ---------
Total expenses ..................................... 3,008 221,775 100,696 (2,024) 323,455
--------- --------- --------- --------- ---------
Income (loss) from operations ...................... (3,008) 704 1,521 -- (783)
Other:
Interest expense, net ........................... 4,028 15,941 1,706 -- 21,675
Other income ....................................... -- -- -- (74) (74)
--------- --------- --------- --------- ---------
Income (loss) before income taxes .................. (7,036) (15,237) (185) 74 (22,384)
Income tax expense ................................. 14,322 -- -- -- 14,322
--------- --------- --------- --------- ---------
Net income (loss) .................................. $ (21,358) $ (15,237) $ (185) $ 74 $ (36,706)
========= ========= ========= ========= =========
HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES
Condensed Consolidating Statement of Operations
For the year ended December 31, 2001
(dollars in thousands)
Parent Guarantors Non-Guarantors Elimination Consolidated
--------- --------- --------- --------- ---------
Total net revenues ................................. $ -- $ 250,547 $ 102,686 $ (6,495) $ 346,738
--------- --------- --------- --------- ---------
Expenses:
Facility operating .............................. -- 202,412 86,277 (6,495) 282,194
General and administrative ...................... 67 18,976 -- -- 19,043
Service charges paid to former affiliate ........ -- 979 -- -- 979
Amortization of prepaid management fee .......... 1,200 -- -- -- 1,200
Depreciation and amortization ................... 525 6,717 2,113 -- 9,355
Facility rent ................................... -- 20,476 8,413 -- 28,889
Financial restructuring costs ................... 8,645 400 -- -- 9,045
Facility reorganization costs ................... -- 1,080 -- -- 1,080
Management fees paid to affiliates .............. -- (6,489) 6,489 -- --
--------- --------- --------- --------- ---------
Total expenses ..................................... 10,437 244,551 103,292 (6,495) 351,785
Income (loss) from operations ...................... (10,437) 5,996 (606) -- (5,047)
Other:
Interest expense, net ........................... 2,278 7,813 1,854 -- 11,945
Other income ....................................... -- -- -- (315) (315)
--------- --------- --------- --------- ---------
Income (loss) before income taxes .................. (12,715) (1,817) (2,460) 315 (16,677)
Income tax expense ................................. 225 -- -- -- 225
--------- --------- --------- --------- ---------
Net income (loss) .................................. $ (12,940) $ (1,817) $ (2,460) $ 315 $ (16,902)
========= ========= ========= ========= =========
53
HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES
Condensed Consolidating Statement of Operations
For the year ended December 31, 2002
(dollars in thousands)
Parent Guarantors Non-Guarantors Elimination Consolidated
--------- --------- --------- --------- ---------
Total net revenues ................................. $ -- $ 336,950 $ 73,053 $ (9,779) $ 400,224
--------- --------- --------- --------- ---------
Expenses:
Facility operating .............................. -- 280,707 61,121 (9,779) 332,049
General and administrative ...................... 114 20,106 -- -- 20,220
Service charges paid to former affiliate ........ -- 759 -- -- 759
Amortization of prepaid management fee .......... 1,200 -- -- -- 1,200
Depreciation and amortization ................... 227 7,391 2,271 -- 9,889
Facility rent ................................... -- 24,618 5,993 -- 30,611
Refinancing costs ............................... 450 2,385 -- -- 2,835
Management fees paid to affiliates .............. -- (4,742) 4,742 -- --
--------- --------- --------- --------- ---------
Total expenses ..................................... 1,991 331,224 74,127 (9,779) 397,563
Income (loss) from operations ...................... (1,991) 5,726 (1,074) -- 2,661
Other:
Interest expense, net ........................... 1,136 5,200 1,720 -- 8,056
Other expense ...................................... -- -- -- 24 24
--------- --------- --------- --------- ---------
Income (loss) before income taxes .................. (3,127) 526 (2,794) (24) (5,419)
Income tax expense ................................. 240 -- -- -- 240
--------- --------- --------- --------- ---------
Net income (loss) .................................. $ (3,367) $ 526 $ (2,794) $ (24) $ (5,659)
========= ========= ========= ========= =========
54
HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES
Condensed Consolidating Statement of Cash Flows
For the year ended December 31, 2000
(dollars in thousands)
Parent Guarantors Non-Guarantors Elimination Consolidated
--------- -------- ------------ ----------- ---------
Operating activities:
Net cash provided by operating activities ............. $ 5,029 $ 19,097 $ 2,240 $ -- $ 26,366
--------- -------- -------- -------- --------
Investing activities:
Additions to property and equipment .............. -- (4,467) (1,732) -- (6,199)
Additions to deferred financing and
other non-current assets ........................ (11) (275) 168 -- (118)
Transfers to restricted cash, net ................ -- (2,290) (95) -- (2,385)
-------- -------- -------- -------- --------
Net cash used by investing activities ................. (11) (7,032) (1,659) -- (8,702)
-------- -------- -------- -------- --------
Financing activities:
Payment of note payable to affiliate ......... (5,000) -- -- -- (5,000)
Payment of long-term debt ........................ -- (19) (205) -- (224)
Principal payments of capital lease obligation ... -- (3,084) -- -- (3,084)
Dividends paid on exchangeable preferred stock ... (18) -- -- -- (18)
-------- -------- -------- -------- --------
Net cash used by financing activities ................. (5,018) (3,103) (205) -- (8,326)
-------- -------- -------- -------- --------
Net increase in cash and cash equivalents ............. -- 8,962 376 -- 9,338
Cash and cash equivalents, beginning of year .......... -- 355 1,031 -- 1,386
-------- -------- -------- -------- --------
Cash and cash equivalents, end of year ................ $ -- $ 9,317 $ 1,407 $ -- $ 10,724
======== ======== ======== ======== ========
Supplemental Disclosure:
Interest paid ..................................... $ 1,325 $ 5,243 $ 561 $ -- $ 7,129
Income taxes paid ................................. $ 130 $ -- $ -- $ -- $ 130
Accretion of preferred dividends .................. $ 6,835 $ -- $ -- $ -- $ 6,835
55
HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES
Condensed Consolidating Statement of Cash Flows
For the year ended December 31, 2001
(dollars in thousands)
Parent Guarantors Non-Guarantors Elimination Consolidated
-------- ------------ -------------- -----------
Operating activities:
Net cash provided by operating activities ............. $ 7,404 7,959 $ 3,872 $ -- $ 19,235
-------- -------- -------- -------- --------
Investing activities:
Additions to property and equipment .............. -- (7,973) (3,609) -- (11,582)
Additions to deferred financing and
other non-current assets ........................ -- (386) -- -- (386)
Transfers to restricted cash, net ................ -- (1,014) (79) -- (1,093)
-------- -------- -------- -------- --------
Net cash used by investing activities ................. -- (9,373) (3,688) -- (13,061)
-------- -------- -------- -------- --------
Financing activities:
Issuance of New Preferred Stock .............. 15,000 -- -- -- 15,000
Payment to holders of Discount Notes ......... (15,000) -- -- -- (15,000)
Receipt in connection with lease ................. 102 -- -- -- 102
Payment on revolving line of credit .............. (7,500) -- -- -- (7,500)
Payment of long-term debt ........................ -- (17) (228) -- (245)
Dividends paid on preferred stock ................ (6) -- -- -- (6)
------- -------- -------- -------- --------
Net cash used by financing activities ................. (7,404) (17) (228) -- (7,649)
-------- -------- -------- -------- --------
Net decrease in cash and cash equivalents ............. -- (1,431) (44) -- (1,475)
Cash and cash equivalents, beginning of year .......... -- 9,317 1,407 -- 10,724
-------- -------- -------- -------- --------
Cash and cash equivalents, end of year ................ $ -- $ 7,886 $ 1,363 $ -- $ 9,249
======== ======== ======== ======== ========
Supplemental Disclosure:
Interest paid ..................................... $ 1,175 $ 4,030 $ 958 $ -- $ 6,163
Income taxes paid ................................. $ 257 $ -- $ -- $ -- $ 257
Accretion of preferred dividends .................. $ 3,768 $ -- $ -- $ -- $ 3,768
56
HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES
Condensed Consolidating Statement of Cash Flows
For the year ended December 31, 2002
(dollars in thousands)
Parent Guarantors Non-Guarantors Elimination Consolidated
-------- -------- ------------- ----------- ------------
Operating activities:
Net cash provided by operating activities ............. $ 25,579 $ (9,287) $ 824 $ -- $ 17,116
--------- -------- --------- ---------- --------
Investing activities:
Additions to property and equipment .............. -- (14,935) (1,491) -- (16,426)
Additions to deferred financing and
other non-current assets ........................ -- (6,219) -- -- (6,219)
Transfers (to) from restricted cash, net ......... -- (894) 181 -- (713)
Purchase of interest rate cap .................... (329) -- -- -- (329)
-------- -------- -------- --------- --------
Net cash used by investing activities ................. (329) (22,048) (1,310) -- (23,687)
-------- -------- -------- --------- --------
Financing activities:
Payment on revolving line of credit .............. (25,250) -- -- -- (25,250)
Borrowings under secured credit facility ......... -- 43,015 -- -- 43,015
Payment of long-term debt ........................ -- (22) (253) -- (275)
-------- -------- -------- --------- --------
Net cash provided (used) by financing activities ...... (25,250) 42,993 (253) -- 17,490
-------- -------- -------- --------- --------
Net increase (decrease) in cash and cash equivalents .. -- 11,658 (739) -- 10,919
Cash and cash equivalents, beginning of year .......... -- 7,886 1,363 -- 9,249
-------- -------- -------- --------- --------
Cash and cash equivalents, end of year ................ $ -- $ 19,544 $ 624 $ -- $ 20,168
======== ======== ======== ========= ========
Supplemental Disclosure:
Interest paid ..................................... $ 688 $ 3,148 $ 1,041 $ -- $ 4,877
Income taxes paid ................................. $ 226 $ -- $ -- $ -- $ 226
Accretion of preferred dividends .................. $ 2,223 $ -- $ -- $ -- $ 2,223
57
The Company’s unaudited quarterly financial information follows:
Year Ended December 31, 2000
----------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------------- ------------- ------------- ------------- --------------
Total net revenues ........................ $ 78,976,000 $ 79,414,000 $ 80,927,000 $ 83,355,000 $ 322,672,000
Income (loss) from operations ............. 2,075,000 2,379,000 (6,219,000) 982,000 (783,000)
Loss before
income taxes ............................. (3,949,000) (3,325,000) (11,944,000) (3,166,000) (22,384,000)
Income tax (benefit) expense .............. (1,540,000) (1,297,000) (4,658,000) 21,817,000 14,322,000
------------- ------------- ------------- ------------- -------------
Net loss .................................. (2,409,000) (2,028,000) (7,286,000) (24,983,000) (36,706,000)
Preferred stock dividends ................. (1,630,000) (1,685,000) (1,741,000) (1,797,000) (6,853,000)
------------- ------------- ------------- ------------- -------------
Loss applicable to
common shares ............................. (4,039,000) (3,713,000) (9,027,000) (26,780,000) (43,559,000)
============= ============= ============= ============= =============
Loss per
common share:
Basic and Diluted ...................... $ (0.56) $ (0.51) $ (1.24) $ (3.69) $ (6.00)
============= ============= ============= ============= ============
Year Ended December 31, 2001
----------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------------- ------------- ------------- ------------- -------------
Total net revenues ........................ $ 82,086,000 $ 86,127,000 $ 88,210,000 $ 90,315,000 $ 346,738,000
Income (loss) from operations ............. (1,767,000) (4,815,000) 1,593,000 (58,000) (5,047,000)
Loss before
income taxes ............................. (6,436,000) (7,734,000) (455,000) (2,052,000) (16,677,000)
Income tax expense ........................ -- -- -- 225,000 225,000
------------- ------------- ------------- ------------- -------------
Net loss .................................. (6,436,000) (7,734,000) (455,000) (2,277,000) (16,902,000)
Preferred stock dividends ................. (1,860,000) (905,000) (497,000) (512,000) (3,774,000)
------------- ------------- ------------- ------------- -------------
Loss applicable to
common shares ............................. (8,296,000) (8,639,000) (952,000) (2,789,000) (20,676,000)
============= ============= ============= ============= =============
Loss per
common share:
Basic and Diluted ...................... $ (1.13) $ (1.18) $ (0.13) $ (0.38) $ (2.82)
============= ============= ============= ============ ============
Year Ended December 31, 2002
----------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------------- ------------- ------------- ------------- -------------
Total net revenues ........................ $ 94,511,000 $ 101,011,000 $ 103,756,000 $ 100,946,000 $ 400,224,000
Income (loss) from operations ............. 2,094,000 2,263,000 (638,000) (1,058,000) 2,661,000
Income (loss) before
income taxes ............................. 1,000 457,000 (2,349,000) (3,528,000) (5,419,000)
Income tax expense ........................ 60,000 60,000 60,000 60,000 240,000
------------- ------------- ------------- ------------- -------------
Net income (loss) ......................... (59,000) 397,000 (2,409,000) (3,588,000) (5,659,000)
Preferred stock dividends ................. (529,000) (547,000) (564,000) (583,000) (2,223,000)
------------- ------------- ------------- ------------- -------------
Loss applicable to
common shares ............................. (588,000) (150,000) (2,973,000) (4,171,000) (7,882,000)
============= ============= ============= ============= =============
Loss per common share (1):
Basic and Diluted ...................... $ (0.08) $ (0.02) $ (0.39) $ (0.55) $ (1.05)
============= ============= ============= ============= ============
(1) Due to rounding, the addition of loss per common share by quarter may not
equal total loss per common share for the year.
58
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The Company pays no additional remuneration to its employees or to executives of Investcorp S.A. for serving as directors.
The following table sets forth certain information regarding the current directors and executive officers of the Company:
Name and Principal Offices with the Company
NAME AGE POSITION ---- --- -------- Stephen L. Guillard 53 Chairman, Chief Executive Officer and Director Damian N. Dell'Anno 43 President, Chief Operating Officer and Director William H. Stephan 46 Senior Vice President, Chief Financial Officer and Director Lars C. Haegg 37 Director James O. Egan 54 Director William C. McCollum 31 Director Bruce Tully 53 Director
Stephen L. Guillard has served as Chief Executive Officer of the Company since March 21, 1996 (and President from March 21, 1996 through August 30, 2001) and of the predecessors of the Company since May 1988 and as a Director and Chairman of the Board of the Company since its incorporation in March 1996. Mr. Guillard previously served as Chairman, President and Chief Executive Officer of Diversified Health Services (“DHS”), a long-term care company which Mr. Guillard co-founded in 1982. DHS operated approximately 7,500 long-term care and assisted living beds in five states. Mr. Guillard has a total of 29 years of experience in the long-term care industry and is a licensed Nursing Home Administrator.
Damian N. Dell’Anno has served as President of the Company since August 30, 2001, as Chief Operating Officer since March 21, 1996 and as a Director since August 1998. Mr. Dell’Anno previously had served as Executive Vice President of Operations of the Company since March 21, 1996 and its predecessors since 1994. From 1993 to 1994, he served as the head of the specialty services group for the predecessors of the Company and was instrumental in developing the Company’s rehabilitation therapy business. From 1989 to 1993, Mr. Dell’Anno was Vice President of Reimbursement for the predecessors of the Company. From 1988 to 1989, Mr. Dell’Anno served as Director of Budget, Reimbursement and Cash Management for The Mediplex Group, Inc. (“Mediplex”), a long-term care company. Mr. Dell’Anno has a total of 19 years of experience in the long-term care industry.
William H. Stephan has served as Senior Vice President and Chief Financial Officer of the Company since March 21, 1996 and its predecessors since joining the Company in 1994. Mr. Stephan has served as a Director of the Company since August 1998. From 1986 to 1994, Mr. Stephan was a Manager in the health care practice of Coopers & Lybrand LLP. His clients there included long-term care facilities, continuing care retirement centers, physician practices and acute care hospitals. Mr. Stephan is a Certified Public Accountant and a member of the Healthcare Financial Management Association.
Lars C. Haegg has served as a Director of Investcorp S.A. since 1998. Prior to joining Investcorp S.A., Mr. Haegg worked with McKinsey & Company where he was responsible for leading consulting teams for media, retail and electronics clients. Mr. Haegg previously worked with Strategic Planning Associates (now Mercer Management Consulting) in the telecommunications and consumer goods sectors. He is a director of Stratus Computer Systems International S.A. and H.S. TelePacific Holdings Corp.
James O. Egan has served as a Director of Investcorp S.A. since January 1999. Prior to joining Investcorp S.A., he was employed by KPMG, an accounting firm, as a Partner; Riverwood International, a paperboard, packaging and machinery company, as Senior Vice President and Chief Financial Officer; and Coopers & Lybrand LLP, an accounting firm, as a Partner. He is a director of CSK Auto Corporation, Werner Holding Co. (DE), Inc., IWO Holdings, Inc. (Independent Wireless One Corporation) and Jostens Inc.
William C. McCollum has served as a Director of Investcorp S.A. since May 1996. Prior to joining Investcorp S.A., Mr. McCollum was a financial Analyst with Chase Securities Inc. He is a director of the Neptune Technology Group Holdings Inc.
Bruce Tully has served as a Director of Investcorp S.A. since June 2002. Prior to joining Investcorp S.A., Mr. Tully co-founded a venture capital firm, funded in part by Deutsche Bank. Mr. Tully had previously been an employee of Bankers Trust (which was acquired by Deutsche Bank in 1999) providing debt, equity, and merger and acquisition services for some of the country’s premier financial sponsors firms.
59EXECUTIVE OFFICERS
The following table sets forth certain information with respect to the executive officers of the Company:
NAME AGE POSITION - ---- --- -------- Stephen L. Guillard 53 Chief Executive Officer and Director Damian N. Dell'Anno 43 President, Chief Operating Officer and Director William H. Stephan 46 Senior Vice President, Chief Financial Officer and Director Bruce J. Beardsley 39 Senior Vice President of Acquisitions Steven Raso 38 Senior Vice President of Operations * Information on Mr. Guillard, Mr. Dell'Anno and Mr. Stephan appears above.
Bruce J. Beardsley has served as Senior Vice President of Acquisitions since March 21, 1996 and its predecessors since 1994. From 1992 to 1994, he was Vice President of Planning and Development of the Company with responsibility for the development of specialized services, planning and engineering. From 1990 to 1992, he was an Assistant Vice President of the Company responsible for risk management and administrative services. From 1988 to 1990, Mr. Beardsley served as Special Projects Manager of the Company. Prior to joining the Company in 1988, Mr. Beardsley was a commercial and residential real estate appraiser.
Steven V. Raso served as Senior Vice President of Operations from 1998 to 2003. From 1994 to 1998, he served as Vice President of Reimbursement for the Company and he served as Director of Reimbursement and Budgets from 1989 to 1994. In these capacities, Mr. Raso was responsible for various aspects of Company Operations, including the Medicare and Medicaid reimbursement cost reporting functions, including audits, appeals, licensing and rate determinations. Mr. Raso also oversaw the budgeting, accounts receivable and compliance departments within the Company.
* Mr. Raso's service as the Company's Senior Vice President of Operations ceased in March 2003.
60ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the cash and non-cash compensation for 2002, 2001 and 2000 awarded to or earned by the Chief Executive Officer and the four other most highly compensated executive officers of the Company (collectively, the “Named Executive Officers”).
Annual Compensation Long Term Compensation
------------------- ----------------------
Awards Payouts
Other Securities
Annual Restricted Underlying All Other
Name and Bonus Compen- Stock Options/ Compen-
Principal Position Year Salary (1)(2) sation Award(s)(3) SARs sation (4)
- ------------------ ---- ------- ------- --------- ----------- ---- ----------
Stephen L. Guillard 2002 $ 496,159 $ 125,000 $ - $ - - $ 36,977
Chief Executive 2001 423,094 95,000 - - 320,000 34,794
Officer 2000 397,523 86,250 - 1,550 - 28,280
Damian N. Dell'Anno 2002 347,319 70,000 - - - 20,420
President and Chief 2001 300,780 70,000 - - 150,000 17,768
Operating Officer 2000 281,259 45,000 - 1,010 - 13,750
William H. Stephan 2002 297,681 60,000 - - - 15,566
Senior Vice 2001 253,842 55,000 - - 105,000 13,349
President and 2000 227,692 38,000 - 700 - 11,295
Chief Financial
Officer
Bruce J. Beardsley 2002 272,886 55,000 - - - 16,573
Senior Vice 2001 238,078 50,000 - - 105,000 14,415
President of 2000 226,249 40,000 - 700 - 11,000
Acquisitions
Steven V. Raso 2002 198,462 40,000 - - - 12,686
Senior Vice 2001 181,538 35,000 - - 67,500 11,515
President of 2000 177,499 28,000 - 490 - 8,750
Operations
(1) On May 23, 2001, in recognition of the successful completion of the
Company's financial restructuring plan, the Company's Board of Directors
awarded bonus payments in the amounts of $95,000, $70,000, $55,000, $50,000
and $35,000 to Messrs. Guillard, Dell'Anno, Stephan, Beardsley and Raso,
respectively.
(2) On September 27, 2002 the Board of Directors, in recognition of the
successful refinancing of the Company's Credit Facility, awarded bonus
payments in the amounts of $125,000, $70,000, $60,000, $55,000 and $40,000
to Messrs. Guillard, Dell'Anno, Stephan, Beardsley and Raso, respectively.
(3) On September 29, 2000, the Company granted 155,000, 101,000, 70,000, 70,000
and 49,000 shares of restricted stock to Messrs. Guillard, Dell'Anno,
Stephan, Beardsley and Raso, respectively. As part of this stock issuance,
options granted on August 11, 1998 to purchase shares of the Company's
Class C common stock at $25.00 per share in the amounts of 160,904,
104,666, 72,641, 72,641, and 50,771 shares for Messrs. Guillard, Dell'Anno,
Stephan, Beardsley and Raso, respectively, were cancelled. One-third of the
shares of restricted stock vest annually beginning on December 31, 2001. As
of December 31, 2001, the aggregate restricted stock holdings for each of
the Named Executive Officers consisted of the following: Mr. Guillard,
155,000 shares with a value of $1,510; Mr. Dell'Anno, 101,000 shares with a
value of $1,010; Mr. Stephan, 70,000 shares with a value of $700; Mr.
Beardsley, 70,000 shares with a value of $700; and Mr. Raso, 49,000 shares
with a value of $490.
(4) Includes matching contributions made by the Company under its Supplemental
Executive Retirement Plan and 401(k) Plan.
61
The Company did not grant any stock options or stock appreciation rights to its named executives during 2002.
The following table sets forth information concerning the aggregate number of exercisable and unexercisable stock options and stock appreciation rights held by the named executives as of the end of 2002. No stock options were exercised by the Named Executive Officers during 2002.
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE MONEY
OPTIONS/SARS AT OPTIONS/SARS AT
FISCAL YEAR END FISCAL YEAR END
EXERCISABLE/ EXERCISABLE/
NAME UNEXERCISABLE UNEXERCISABLE (1)
---- ------------- -----------------
Stephen L. Guillard 160,000/160,000 $ -
Damian N. Dell'Anno 85,560/75,000 -
William H. Stephan 90,832/52,500 -
Bruce J. Beardsley 91,662/52,500 -
Steven V. Raso 55,690/33,750 -
(1) Underlying shares are not publicly traded and are subject to repurchase by
the Company under certain circumstances at the employee's cost or at the
then current value of the underlying share, as determined by the Company's
Board of Directors upon the termination of the employee's employment with
the Company. None of these options are classified as in-the-money for
purposes of this table. The Company has not established any recent
valuations for such shares.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with Messrs. Guillard, Dell’Anno, Stephan, Beardsley and Raso (collectively, the “Employment Agreements”). Under the terms of the Employment Agreements, Mr. Guillard serves as Chief Executive Officer of the Company, Mr. Dell’Anno serves as President and Chief Operating Officer of the Company, Mr. Stephan serves as Senior Vice President and Chief Financial Officer of the Company, Mr. Beardsley serves as Senior Vice President of Acquisitions of the Company and Mr. Raso serves as Senior Vice President of Operations of the Company. Through March 31, 1999, Messrs. Guillard, Dell’Anno, Stephan, Beardsley and Raso received minimum annual base salaries of $345,000, $225,000, $190,000, $200,000 and $140,000, respectively. The salaries of Messrs. Guillard, Dell’Anno, Stephan, Beardsley and Raso were to be increased to $375,000, $240,000, $200,000, $215,000 and $150,000, respectively, effective April 1, 1999. Through December 31, 1999, Messrs. Guillard, Dell’Anno, Stephan, Beardsley and Raso elected to forgo the scheduled compensation adjustments. In January 2000, the amounts of compensation due to these individuals as a result of these elective deferrals were paid by the Company, and as of January 1, 2000, the salaries of Messrs. Guillard, Dell’Anno, Stephan, Beardsley, and Raso were increased to $375,000, $270,000, $200,000, $215,000 and $170,000, respectively. On March 1, 2000, Mr. Stephan’s salary was increased to $225,000. On August 11, 2001, the salaries of Messrs. Guillard, Dell’Anno, Stephan, Beardsley and Raso were increased to $500,000, $350,000, $300,000, $275,000 and $200,000, respectively.
In response to a reduction in Federal funding of the Medicare program, Messrs. Guillard, Dell’Anno, Stephan, Beardsley and Raso voluntarily elected to reduce their salaries by ten percent effective December 1, 2002. The salaries of Messrs. Guillard, Dell’Anno, Stephan, Beardsley and Raso were reduced to $450,000, $315,000, $270,000, $247,500 and $180,000, respectively, effective December 1, 2002. Under the terms of these Employment Agreements, the salaries of each officer will be subject to further adjustment at the discretion of the Compensation Committee of the Board of Directors of the Company.
The Employment Agreements also provide (i) for an annual bonus to be paid to Messrs. Guillard, Dell’Anno, Stephan, Beardsley and Raso, part of which will be based upon achievement of specific performance targets and part of which will be discretionary, in maximum amounts of 120% of base salary in the case of Mr. Guillard, 96% of base salary in the case of Mr. Dell’Anno and 78% of base salary in the cases of Messrs. Stephan, Beardsley and Raso, and (ii) that upon termination of employment prior to an initial public offering, the Company will have certain rights to call from such officers shares of Harborside Common Stock owned by such officers (including shares underlying then-exercisable stock options), and such officers will have certain rights to put such shares to an affiliate of Investcorp (subject to a right of first refusal in favor of the Company).
Each officer has the right to terminate his Employment Agreement on 30 days notice. The Company has the right to terminate an Employment Agreement without obligation for severance only for Good Cause (as defined in the Employment Agreements). The Employment
62Agreements provide for severance benefits to be paid in the event an officer’s employment is terminated if such termination is, in the case of termination by the Company, without Good Cause, or, in the case of termination by an officer, for Good Reason (as defined in the Employment Agreements). If the Company terminates the employment of an officer without Good Cause or the officer terminates his employment for Good Reason, the officer will be entitled to receive severance benefits which will include (i) the vesting of the pro rata portion of stock options subject to vesting in the then current year attributable to the part of the year that the officer was employed, (ii) the ability to exercise vested stock options for the period ending on the earlier of the date that is 180 days from the date his employment is terminated or the specific expiration date stated in the options, and (iii) in the case of Mr. Guillard, for the period ending 30 months after termination, in the case of Mr. Dell’Anno, for the period ending 24 months after termination, and in the cases of Messrs. Stephan, Beardsley and Raso, for the period ending 18 months after termination, payment of the officer’s compensation at the rate most recently in effect; subject to such officer’s compliance with noncompetition and nonsolicitation covenants for such 18, 24 or 30 month period, as applicable.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
Effective September 15, 1995, Harborside established a Supplemental Executive Retirement Plan (“SERP”) to provide benefits for key employees of Harborside. Participants may defer up to 25% of their salary and bonus compensation by making contributions to the SERP. Amounts deferred by the participant are credited to his or her account and are always fully vested. Through December 31, 2002, Harborside matched 50% of amounts contributed until 10% of base salary had been contributed. In response to a recent reduction in Federal funding of the Medicare program, the Company amended the SERP effective January 1, 2003 to eliminate additional employer matching contributions effective as of that date. Matching contributions made by Harborside become vested as of January 1 of the second year following the end of the plan year for which contributions were credited, provided the employee is still employed with Harborside on that date. In addition, participants will be fully vested in such matching contribution amounts in the case of death or permanent disability or at the discretion of Harborside. Participants are eligible to receive benefits distributions upon retirement or in certain pre-designated years. Participants may not receive distributions prior to a pre-designated year, except in the case of termination, death or disability or demonstrated financial hardship. Only amounts contributed by the employee may be distributed because of financial hardship. Although amounts deferred and Company matching contributions are deposited in a “rabbi trust,” they are subject to risk of loss. If Harborside becomes insolvent, the rights of participants in the SERP would be those of an unsecured general creditor of Harborside.
STOCK INCENTIVE PLAN
In connection with the Merger, the Company adopted the Harborside Healthcare Corporation Stock Incentive Plan (the “Stock Option Plan”). Initially, 806,815 shares were made available to be awarded under the Stock Option Plan, representing approximately 10% of the shares of common stock of Harborside outstanding immediately after the Merger, determined after giving effect to the exercise of the options issued or issuable under the Stock Option Plan. Options to purchase 602,996 shares of Class C Common Stock were granted to members of the Company’s management upon consumation of the Merger. All options granted under the Stock Option Plan during 1998 were granted with an exercise price equal to $25.00, equal to the fair market value of the stock on the date of grant. Options granted under the Stock Option Plan during 1998 were to vest at the end of a seven year period or earlier if certain financial performance criteria were met. All options granted under the Stock Option Plan during 1998 and still outstanding as of September 29, 2000 were cancelled on that date in connection with the issuance of the Restricted Shares.
Effective November 19, 2001, the Company granted options to purchase 883,000 shares of common stock with an exercise price equal to $1.25 per share. These options become exercisable to the extent of one-fourth of the number of option shares on December 31, 2001, one-fourth of the number of option shares on December 31, 2002, one-fourth of the number of option shares on December 31, 2003 and one-fourth of the number of option shares on December 31, 2004. In certain circumstances, vesting of these options is accelerated. These options terminate (with certain exceptions) thirty days after the seventh anniversary of their date of grant. All options granted under the Stock Option Plan during 2001 were granted with an exercise price not less than the fair market value of the stock on the date of grant.
Effective September 25, 2002, the Company granted options to purchase 50,500 shares of common stock with an exercise price equal to $1.25 per share. These options become exercisable to the extent of one-fourth of the number of option shares on December 31, 2002, one-fourth of the number of option shares on December 31, 2003, one-fourth of the number of option shares on December 31, 2004 and one-fourth of the number of option shares on December 31, 2005. In certain circumstances, vesting of these options is accelerated. These options terminate (with certain exceptions) thirty days after the seventh anniversary of their date of grant. All options granted under the Stock Option Plan during 2002 were granted with an exercise price not less than the fair market value of the stock on the date of grant.
The Stock Option Plan is administered by the Board of Directors of the Company. The Board of Directors designates which employees of the Company will be eligible to receive awards under the Stock Option Plan, and the amount, timing, and other terms and conditions applicable to such awards. A maximum of 1,600,000 shares have been reserved for issuance in connection with the Stock Option Plan.
63The following table provides equity compensation plan information at December 31, 2002:
Equity Compensation Plan Information
Number of securities
Number of securities remaining available for
to be issued Weighted-average future issuance under
upon exercise exercise price of equity compensation plans
outstanding options, outstanding options, (excluding securities
Plan category warrants and rights warrants and rights reflected in column (a))
------------- ------------------- ------------------- ------------------------
(a) (b) (c)
Equity compensation
plans approved by
security holders 1,043,494 $2.50 1,500
Equity compensation
plans not approved
by security holders - - -
----------- ------- ----------
Total 1,043,494 $2.50 1,500
=========== ======= ==========
PRINCIPAL SHAREHOLDERS
The Company is authorized to issue shares of five classes of common stock, each with a par value of $0.01, consisting of Class A Common Stock (“Harborside Class A Common Stock”), Class B Common Stock (“Harborside Class B Common Stock”), Class C Common Stock (“Harborside Class C Common Stock”), Class D Common Stock (“Harborside Class D Common Stock”) and Common Stock (“Common Stock”) (collectively “Harborside Common Stock”). Harborside Class A Common Stock, Harborside Class D Common Stock and Common Stock are the only classes of the Company’s common stock that have the power to vote. Holders of Harborside Class B Common Stock and Harborside Class C Common Stock do not have any voting rights, except that the holders of Harborside Class B Common Stock and Harborside Class C Common Stock have the right to vote as a class to the extent required under the laws of the State of Delaware.
As of March 1, 2003, there were 661,332 shares of Harborside Class A Common Stock, 20,000 shares of Harborside Class D Common Stock and no shares of Common Stock outstanding. Holders of shares of Harborside Class A Common Stock and Common Stock of the Company are entitled to one vote per share on all matters as to which stockholders may be entitled to vote pursuant to the DGCL. Holders of Harborside Class D Common Stock are entitled to 330 votes per share on all matters as to which stockholders may be entitled to vote pursuant to the DGCL.
As a result of the consummation of the Merger, the New Investors beneficially own all of the outstanding Harborside Class D Common Stock, constituting approximately 91% of the outstanding voting power of the Company, and pre-Merger stockholders, including certain members of management, beneficially own all of the outstanding Harborside Class A Common Stock, constituting approximately 9% of the outstanding voting power of the Company. In addition, the New Investors own 5,940,000 shares of Harborside Class B Common Stock and 640,000 shares of Harborside Class C Common Stock.
The following table sets forth certain information regarding the beneficial ownership of the voting stock of the Company as of March 1, 2003. The table sets forth, as of that date, (i) each person known by the Company to be the beneficial owner of more than 5% of any class of voting stock of the Company, (ii) each person who was a director of the Company or a Named Executive Officer of the Company and (iii) all directors of the Company and executive officers of the Company as a group. None of the Company’s directors or officers own shares of Harborside Class D Common Stock. Unless otherwise indicated, each of the stockholders shown in the table below has sole voting and investment power with respect to the shares beneficially owned.
64
HARBORSIDE CLASS A COMMON STOCK
(9% Of Voting Power)
Name and address of Number of Number of Percent of
Beneficial Owner (1) Shares (2) Options (3) Total Class (4)
- -------------------- ---------- ------------ ----- ---------
George Krupp (5) 196,079 -- 196,079 29.6
Douglas Krupp (5) 196,079 -- 196,079 29.6
Stephen L. Guillard 177,688 -- 177,688 26.9
Damian N. Dell'Anno 47,563 10,560 58,123 8.7
Bruce J. Beardsley -- 39,162 39,162 5.6
William H. Stephan 400 38,332 38,732 5.5
Steven V. Raso -- 21,940 21,940 3.2
Lars C. Haegg -- -- -- --
James O. Egan -- -- -- --
William C. McCollum -- -- -- --
Bruce Tully -- -- -- --
All directors and executive
officers asa group (9 persons) 225,651 109,994 335,645 43.5
HARBORSIDE CLASS D COMMON STOCK
(91% Of Voting Power)
Number of Percent of
Name and address of Beneficial Owner Shares (2) Class
- ------------------------------------ ---------- -----
INVESTCORP S.A. (6)(7).................... 20,000 100.0
SIPCO Limited (8)......................... 20,000 100.0
CIP Limited (9)(10)....................... 18,400 92.0
Ballet Limited (9)(10).................... 1,840 9.2
Denary Limited (9)(10).................... 1,840 9.2
Gleam Limited (9)(10)..................... 1,840 9.2
Highlands Limited (9)(10)................. 1,840 9.2
Nobel Limited (9)(10)..................... 1,840 9.2
Outrigger Limited (9)(10)................. 1,840 9.2
Quill Limited (9)(10)..................... 1,840 9.2
Radial Limited (9)(10).................... 1,840 9.2
Shoreline Limited (9)(10)................. 1,840 9.2
Zinnia Limited (9)(10).................... 1,840 9.2
INVESTCORP Investment Equity Limited (7).. 1,600 8.0
(1) The address of each person listed in the table as a holder of Harborside
Class A Common Stock is c/o Harborside Healthcare Corporation, One Beacon
Street, Boston, Massachusetts 02108.
(2) As used in the table above, a beneficial owner of a security includes any
person who, directly or indirectly, through contract, arrangement,
understanding, relationship, or otherwise has or shares (i) the power to
vote, or direct the voting of, such security or (ii) investment power which
includes the power to dispose, or to direct the disposition of, such
security.
(3) Includes shares of stock that are subject to options exercisable within 60
days of March 1, 2002.
(4) Reflects the percentage such shares and options represent of the number of
outstanding shares of such class of the Company's common stock after giving
effect to the exercise of options owned by such person or persons.
(5) The shares beneficially owned by George Krupp are owned of record by The
George Krupp 1994 Family Trust ("GKFT"). The shares beneficially owned by
Douglas Krupp are owned of record by The Douglas Krupp 1994 Family Trust
("DKFT"). The trustees of both GKFT and DKFT are Lawrence I. Silverstein,
Paul Krupp and M. Gordon Ehrlich (the "Trustees"). The Trustees share
control over the power to dispose of the assets of GKFT and DKFT and thus
each may be deemed to beneficially own the shares held by GKFT and DKFT;
however, each of the Trustees disclaims beneficial ownership of all of such
shares.
(6) Investcorp S.A. does not directly own any stock in the Company. The number
of shares shown as owned by Investcorp S.A. includes all of the shares
owned by INVESTCORP Investment Equity Limited (See note (7) below).
Investcorp S.A. owns no stock in Ballet Limited, Denary Limited, Gleam
Limited, Highlands Limited, Noble Limited, Outrigger Limited, Quill
Limited, Radial Limited, Shoreline Limited, Zinnia Limited, or in the
beneficial owners of these entities (See note (10) below). Investcorp S.A.
may be deemed to share beneficial ownership of the shares of voting stock
of the Company held by these entities because the entities have entered
into revocable management services or similar agreements with an affiliate
of Investcorp S.A., pursuant to which each such entities has granted such
affiliate the authority to direct the voting and disposition of the Company
voting stock owned by such entity for so long as such agreement is in
effect. Investcorp S.A. is a Luxembourg corporation with its address at 37
rue Notre-Dame, Luxembourg.
65
(7) INVESTCORP Investment Equity Limited is a Cayman Islands corporation, and a
wholly owned subsidiary of Investcorp S.A., with its address at P.O. Box
1111, West Wind Building, George Town, Grand Cayman, Cayman Islands.
(8) SIPCO Limited may be deemed to control Investcorp S.A. through its
ownership of a majority of a company's stock that indirectly owns a
majority of Investcorp's shares. SIPCO Limited's address is P.O. Box 1111,
West Wind Building, George Town, Grand Cayman, Cayman Islands.
(9) CIP Limited ("CIP") owns no stock in the Company. CIP indirectly owns less
than 0.1% of the stock in each of Ballet Limited, Denary Limited, Gleam
Limited, Highlands Limited, Noble Limited, Outrigger Limited, Quill
Limited, Radial Limited, Shoreline Limited and Zinnia Limited (See note
(10) below). CIP may be deemed to share beneficial ownership of the shares
of voting stock of the Company held by such entities because CIP acts as a
director of such entities and the ultimate beneficial stockholders of each
of those entities have granted to CIP revocable proxies in companies that
own those entities' stock. None of the ultimate beneficial owners of such
entities beneficially owns individually more than 5% of the Company's
voting stock.
(10) Each of CIP Limited, Ballet Limited, Denary Limited, Gleam Limited,
Highlands Limited, Noble Limited, Outrigger Limited, Quill Limited, Radial
Limited, Shoreline Limited and Zinnia Limited is a Cayman Islands
corporation with its address at P.O. Box 2197, West Wind Building,
GeorgeTown, Grand Cayman, Cayman Islands.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
ITEM 14. CONTROLS AND PROCEDURES
Our management, including our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended) within 90 days of the date of filing this annual report on Form 10-K. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in ensuring that all material information required to be filed in this annual report has been made known to them in a timely fashion.
There have been no significant changes in internal controls, or in factors that could significantly affect internal controls, subsequent to the date our Chief Executive Officer and Chief Financial Officer completed their evaluation.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)
1. Financial Statements:
See Index to Consolidated
Financial Statements in Item 8 of this annual report.
2. Financial Statement Schedules:
None.
3. Exhibits
The exhibits listed in the accompanying index to exhibits are incorporated by
reference herein or are filed as part of this annual report.
Exhibit
Number Description of Exhibit
2.1** Agreement and Plan of Merger dated as of April 15, 1998
3.1(a)****# Amended and Restated Certificate of Incorporation of the Registrant
3.1(b)**** Certificate of Designation of the Registrant with respect to the Exchangeable
Preferred Stock
3.1(c)** Amended and Restated By-laws of the Registrant
3.1(d)**** Form of Certificate of Incorporation of certain registrants, as amended
66
3.2(a)**** Certificate of Incorporation of Sailors, Inc.
3.1(e)*** Amended Certificate of Designation of the Registrant for the Redeemable Preferred
Stock (formerly known as131/2% Exchangeable Preferred Stock)
3.1(f)*** Certificate of Designation of the Registrant for the 13% Convertible Exchangeable
Preferred Stock
3.2(b)**** Form A of Articles of Organization, Articles of Amendment and Articles of Merger of
certain registrants
3.2(c)**** Form B of Articles of Organization of certain registrants
3.2(d)**** Form of First Amendment to and Restatement of Agreement of Limited Partnership of
certain registrants
3.2(e)**** Form of Agreement of Limited Partnership of certain registrants
3.2(f)**** Amended and Restated Agreement of Limited Partnership of Harborside Healthcare
Limited Partnership, dated as of May 12, 1987, as amended and restated as of
July 1, 1995
3.2(g)**** Agreement of Limited Partnership of KHC Partners, Limited Partners, dated as of May
28, 1987, as amended
3.2(h)**** Form A of Certificate of Limited Partnership of certain registrants
3.2(i)**** Form B of Certificate of Limited Partnership of certain registrants
3.2(j)**** Certificate of Limited Partnership of Bridgewater Assisted Living Limited Partnership
3.2(k)**** First Amendment to and Restatement of Certificate of Limited Partnership of KHC
Partners Limited Partnership (now known as Harborside Healthcare Advisors Limited
Partnership)
3.2(l)**** First Amendment to and Restatement of Certificate of Limited Partnership of Harborside
Acquisition Limited Partnership IV (now known as Harborside Danbury Limited
Partnership)
3.2(m)**** Certificate of Formation and Agreement of Limited Partnership of Riverside Retirement
Limited Partnership, as amended
3.2(n)**** Certificate of Limited Partnership of Harborside Healthcare Limited Partnership
3.2(o)**** Form A of By-laws of certain registrants
3.2(p)**** Form B of By-laws of certain registrants
4.1**** Indenture between MergerCo and the Trustee, dated as of July 31, 1998, with respect to
the Notes
4.2**** Supplemental Indenture between the Registrant, the Guarantors and the Trustee, dated
as of August 11, 1998
4.3****# Form of New Note
4.4**** Registration Rights Agreement, dated July 31, 1998, between the Registrant
(as successor to MergerCo) and the Placement Agents, relating to the Old Notes
4.5**** Certificate of Designation of the Registrant with respect to the Exchangeable
Preferred Stock (filed as Exhibit 3.1.(b))
4.6**** Form of Stock Certificate representing New Preferred Stock
4.7**** Registration Rights Agreement, dated July 31, 1998, between the Registrant
(as successor to MergerCo) and the Placement Agents, relating to the Old
Preferred Stock (filed as Exhibit 1.3)
4.8**** Form of Letter of Transmittal (filed as Exhibit 1.4)
4.9*** Second Supplemental Indenture, dated as of May 10, 2001, between the Registrant,
the Guarantors as defined therein and United States Trust Company of New York,
as trustee, relating to the 11% Senior Subordinated Discount Notes due 2008
67
4.10*** Indenture, dated as of May 10, 2001, among the Registrant, the Guarantors as
defined therein and United States Trust Company of New York, as trustee, relating
to the 12% Senior Subordinated Discount Notes due 2007
10.1(a)* Facility Lease Agreement, dated as of December 31, 1995, between Meditrust Tri-States,
Inc. and HHCI Limited Partnership (New Haven Facility)
10.1(b)* Facility Lease Agreement, dated as of December 31, 1995, between Meditrust Tri-States,
Inc. and HHCI Limited Partnership (Indianapolis Facility)
10.1(c)* Facility Lease Agreement, dated as of December 31, 1995, between Meditrust of Ohio,
Inc. and HHCI Limited Partnership (Troy Facility)
10.1(d)* Facility Lease Agreement, dated as of December 31, 1995, between Meditrust of Florida,
Inc. and HHCI Limited Partnership (Sarasota Facility)
10.1(e)* Facility Lease Agreement, dated as of December 31, 1995, between Meditrust of Florida,
Inc. and HHCI Limited Partnership (Pinebrook Facility)
10.1(f)* Facility Lease Agreement, dated as of December 31, 1995, between Meditrust of Florida,
Inc. and HHCI Limited Partnership (Naples Facility)
10.1(g)* Facility Lease Agreement, dated as of December 31, 1995, between Meditrust of New
Jersey, Inc. and HHCI Limited Partnership (Woods Edge Facility)
10.1(h)* First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust Tri-States, Inc. and HHCI Limited Partnership (New Haven Facility)
10.1(i)* First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust Tri-States, Inc. and HHCI Limited Partnership (Indianapolis Facility)
10.1(j)* First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust of Ohio, Inc. and HHCI Limited Partnership (Troy Facility)
10.1(k)* First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust of Florida, Inc. and HHCI Limited Partnership (Sarasota Facility)
10.1(l)* First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust of Florida, Inc. and HHCI Limited Partnership (Pinebrook Facility)
10.1(m)* First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust of Florida, Inc. and HHCI Limited Partnership (Naples Facility)
10.1(n)* First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust of New Jersey, Inc. and HHCI Limited Partnership (Woods Edge Facility)
10.2(a)* Loan Agreement,dated October 13, 1994, among Meditrust Mortgage Investments, Inc.
and Bay Tree Nursing Center Corporation, Belmont Nursing Center Corporation,
Countryside Care Center Corporation, Oakhurst Manor Nursing Center Corporation,
Orchard Ridge Nursing Center Corporation, Sunset Point Nursing Center Corporation,
West Bay Nursing Center Corporation and Harborside Healthcare Limited Partnership.
10.2(b)* Guaranty, dated October 14, 1994, to Meditrust Mortgage Investments, Inc. from
Harborside Healthcare Limited Partnership
10.2(c)* Environmental Indemnity Agreement, dated October 13, 1994, by and among Bay Tree
Nursing Center Corporation, Belmont Nursing Center Corporation, Countryside Care
Center Corporation, Oakhurst Manor Nursing Center Corporation, Orchard Ridge Nursing
Center Corporation, Sunset Point Nursing Center Corporation, West Bay Nursing
Center Corporation and Harborside Healthcare Limited Partnership and Meditrust
Mortgage Investments, Inc.
10.2(d)* Consolidated and Renewed Promissory Note, dated October 13, 1994, from Bay Tree
Nursing Center Corporation, Belmont Nursing Center Corporation, Countryside Care
Center Corporation, Oakhurst Manor Nursing Center Corporation, Orchard Ridge Nursing
Center Corporation, Sunset Point Nursing Center Corporation, West Bay Nursing
Center Corporation and Harborside Healthcare Limited Partnership and Meditrust
Mortgage Investments, Inc.
68
10.2(e)* Negative Pledge Agreement, dated October 13, 1994, by and among Douglas Krupp,
George Krupp, Bay Tree Nursing Center Corporation, Belmont Nursing Center Corporation, Countryside
Care Center Corporation, Oakhurst Manor Nursing Center Corporation, Orchard
Ridge Nursing Center Corporation, Sunset Point Nursing Center Corporation, West
Bay Nursing Center Corporation and Harborside Healthcare Limited Partnership and
Meditrust Mortgage Investments, Inc.
10.2(f)* Affiliated Party Subordination Agreement, dated October 13, 1994, by and among
Bay Tree Nursing Center Corporation, Belmont Nursing Center Corporation, Countryside
Care Center Corporation, Oakhurst Manor Nursing Center Corporation, Orchard Ridge
Nursing Center Corporation, Sunset Point Nursing Center Corporation, West Bay Nursing
Center Corporation and Harborside Healthcare Limited Partnership and Meditrust
Mortgage Investments, Inc.
10.2(g)* First Amendment to Loan Agreement, dated May 17, 1996, by and among Meditrust
Mortgage Investments, Inc. and Bay Tree Nursing Center Corporation, Belmont Nursing
Center Corporation, Countryside Care Center Corporation, Oakhurst Manor Nursing Center
Corporation, Orchard Ridge Nursing Center Corporation, Sunset Point Nursing
Center Corporation, West Bay Nursing Center Corporation and Harborside
Healthcare Limited Partnership
10.3(a)* Facility Lease Agreement, dated as of January 1, 1996, between Meditrust of New
Hampshire Inc. and Harborside New Hampshire Limited Partnership (Westwood Facility)
10.3(b)* Facility Lease Agreement, dated as of January 1, 1996, between Meditrust of New
Hampshire Inc. and Harborside New Hampshire Limited Partnership (Pheasant Wood
Facility)
10.3(c)* Facility Lease Agreement, dated as of January 1, 1996, between Meditrust of New
Hampshire Inc. and Harborside New Hampshire Limited Partnership (Crestwood Facility)
10.3(d)* Facility Lease Agreement, dated as of January 1, 1996, between Meditrust of New
Hampshire Inc. and Harborside New Hampshire Limited Partnership (Milford Facility)
10.3(e)* Facility Lease Agreement, dated as of January 1, 1996, between Meditrust of New
Hampshire Inc. and Harborside New Hampshire Limited Partnership (Applewood Facility)
10.3(f)* Facility Lease Agreement, dated as of December 31, 1996, between Meditrust of New
Hampshire Inc. and Harborside New Hampshire Limited Partnership (Northwood Facility)
10.3(g)* First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust of New Hampshire, Inc. and Harborside New Hampshire Limited Partnership
(Westwood Facility)
10.3(h)* First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust of New Hampshire, Inc. and Harborside New Hampshire Limited Partnership
(Pheasant Wood Facility)
10.3(i)* First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust of New Hampshire, Inc. and Harborside New Hampshire Limited Partnership
(Crestwood Facility)
10.3(j)* First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust of New Hampshire, Inc. and Harborside New Hampshire Limited Partnership
(Milford Facility)
10.3(k)* First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust of New Hampshire, Inc. and Harborside New Hampshire Limited Partnership
(Applewood Facility)
10.3(l)* First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust of New Hampshire, Inc. and Harborside New Hampshire Limited Partnership
(Northwood Facility)
10.4(a)* Facility Lease Agreement, dated as of March 31, 1995, between Meditrust of Ohio, Inc.
and Harborside of Toledo Limited Partnership (Swanton Facility)
10.4(b)* First Amendment to Facility Lease Agreement, dated as of December 31, 1995, by and
between Harborside Toledo Limited Partnership and Meditrust of Ohio, Inc. (Swanton
Facility)
10.4(c)* Second Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between
Meditrust of Ohio, Inc. and Harborside Toledo Limited Partnership (Swanton Facility)
10.5* Amended and Restated Agreement of Limited Partnership of Bowie Center Limited
Partnership, dated April 7, 1993
10.6* Agreement of Lease, dated March 16, 1993, between Bryan Nursing Home, Inc. and
Harborside of Ohio Limited Partnership (Defiance and Northwestern Ohio Facilities)
69
10.7* First Amendment to Agreement of Lease, dated June 1, 1993, by and between Bryan
Nursing Home, Inc. and Harborside Ohio Limited Partnership
10.8* Option to Purchase Agreement, dated March 16, 1993, by and between Bryan Nursing Home,
Inc. and Harborside Ohio Limited Partnership
10.9(a)* Lease, dated September 30, 1994, between Rockledge T. Limited Partnership and
Harborside of Florida Limited Partnership (Brevard Facility)
10.9(b)* Lease Guaranty, dated September 30, 1994, to Rockledge T. Limited Partnership from
Harborside Healthcare Limited Partnership
10.9(c)* Indemnity Agreement, dated September 30, 1994, between Rockledge T. Limited
Partnership, Harborside of Florida Limited Partnership, Harborside Healthcare Limited
Partnership and Southtrust Bank of Alabama
10.9(d)* Assignment and Security Agreement, dated September 30, 1994, to Rockledge T. Limited
Partnership, Harborside of Florida Limited Partnership and Southtrust Bank of Alabama
10.9(e)* Subordination Agreement (Lease), dated September 30, 1994, between Rockledge T.
Limited Partnership, Harborside of Florida Limited Partnership and Southtrust Bank of
Alabama
10.9(f)* Subordination Agreement (Management), dated September 30, 1994, by and among Rockledge
T. Limited Partnership, Harborside of Florida Limited Partnership, Harborside
Healthcare Limited Partnership and Southtrust Bank of Alabama
10.10(a)****+ Employment Agreement, dated as of August 11, 1998, between the Registrant and Stephen
L. Guillard
10.10(b)****+ Employment Agreement, dated as of August 11, 1998, between the Registrant and Damian
Dell'Anno
10.10(c)****+ Employment Agreement, dated as of August 11, 1998, between the Registrant and Bruce
Beardsley
10.10(d)****+ Employment Agreement, dated as of August 11, 1998, between the Registrant and William
Stephan
10.10(e)****+ Employment Agreement, dated as of August 11, 1998, between the Registrant and Steven
Raso
10.11(a)****+ Management Stock Incentive Plan, established by the Registrant as of August 11, 1998
10.11(b)****+ Form of Stock Option Agreement pursuant to Management Stock Incentive Plan
10.11(c)+ Form of Restricted Stock Agreement pursuant to Management Stock Incentive Plan
10.12(a)*+ 1996 Long-Term Stock Incentive Plan
10.12(b)*+ Form of Nonqualified Stock Option Agreement pursuant to the 1996 Long-Term Stock
Incentive Plan
10.13****+ Form of Put/Call Agreement, dated August 11, 1998, between the Registrant and each of
Messrs. Guillard, Dell'Anno, Beardsley, Stephan and Raso
10.14*+ Supplemental Executive Retirement Plan of the Registrant
10.15* Administrative Services Agreement, dated April 15, 1988, between the Registrant and
The Berkshire Companies Limited Partnership ("BCLP")
10.16* Agreement to Lease, dated as of May 3, 1996, among Westbay Manor Company,
Westbay Manor II Development Company, Royal View Manor Development Company,
Beachwood Care Center Limited Partnership, Royalview Manor Company, Harborside
Health I Corporation and Harborside Healthcare Limited Partnership
10.17* Guaranty by Harborside in favor of Westbay Manor Company, Westbay Manor II Development
Company, Royalview Manor Development Company and Beachwood Care Center Limited
Partnership
10.18**** Master Rights Agreement, dated as of August 11, 1998, by and among the Registrant,
BCLP, certain affiliates of BCLP and the New Investors
70
10.19 (a)**** Credit Agreement, dated as of August 11, 1998, among the Registrant, Chase Securities,
Inc., as Arranger, Morgan Stanley Senior Funding, Inc. and BT Alex. Brown
Incorporated, as Co-Arrangers, Bankers Trust Company, as Documentation Agent, Morgan
Stanley Senior Funding, Inc., as Syndication Agent, The Chase Manhattan Bank, as
Administrative Agent, and the lenders party thereto (the "Lenders")
10.19 (b) First Amendment to Credit Agreement, dated as of March 30, 1999, among the Registrant,
Morgan Stanley Senior Funding, Inc. and BT Alex. Brown Incorporated, as Co-Arrangers,
Bankers Trust Company, as Documentation Agent, Morgan Stanley Senior Funding Inc., as
Syndication Agent, The Chase Manhattan Bank, as Administrative Agent, and the Lenders
10.19 (c) SECOND AMENDMENT, dated as of September 25, 2000 to the Credit Agreement, dated
as of August 11, 1998 among HARBORSIDE HEALTHCARE CORPORATION, a Delaware corporation,
the other entities listed on the signature pages thereof, as joint and several
borrowers thereunder, the banks and other financial institutions or entities parties
thereto, CHASE SECURITIES INC., as arranger, MORGAN STANLEY SENIOR FUNDING, INC. and
BT ALEX. BROWN INCORPORATED, as co-arrangers, MORGAN STANLEY SENIOR FUNDING, INC., as
syndication agent, BANKERS TRUST COMPANY, as documentation agent, and THE CHASE
MANHATTAN BANK, as administrative agent for the Lenders.
10.19 (d) THIRD AMENDMENT, dated as of March 28, 2001, to the Credit Agreement, dated as
of August 11, 1998 (as amended, supplemented or otherwise modified from time to time,
the "Credit Agreement"), among HARBORSIDE HEALTHCARE CORPORATION, a Delaware corporation
(the "Company"), the other entities listed on the signature pages thereof, as joint
and several borrowers thereunder (the Company and such other entities being,
collectively, the "Borrowers"), the banks and other financial institutions or
entities parties thereto (the "Lenders"), CHASE SECURITIES INC., as arranger,
MORGAN STANLEY SENIOR FUNDING, INC. and BT ALEX. BROWN INCORPORATED, as co-arrangers,
MORGAN STANLEY SENIOR FUNDING, INC., as syndication agent, BANKERS TRUST COMPANY,
as documentation agent, and THE CHASE MANHATTAN BANK, as administrative agent for
the Lenders (in such capacity, the "Administrative Agent")
10.21**** HHC 1998-1 Trust Credit Agreement, $238,125,000 Credit Facility, dated as of August
11, 1998, among the Registrant, Chase Securities Inc., as Arranger, Morgan Stanley
Senior Funding, Inc. and BT Alex. Brown Incorporated, as Co-Arrangers, Bankers Trust
Company, as Documentation Agent, Morgan Stanley Senior Funding, Inc., as Syndication
Agent, The Chase Manhattan Bank, as Administrative Agent, and the lenders party thereto
10.22**** Participation Agreement, dated as of August 11, 1998, among Harborside of Dayton
Limited Partnership, as Lessee, HHC 1998-1 Trust, as Lessor, Wilmington Trust Company,
BTD Harborside Inc., Morgan Stanley Senior Funding, Inc. and CSL Leasing, Inc., as
Investors, The Chase Manhattan Bank, as Agent, and the lenders party thereto
10.23**** Lease, dated August 11, 1998, between HHC 1998-1 Trust, as Lessor, and Harborside of
Dayton Limited Partnership, as Lessee
10.24**** Accounts Receivable Intercreditor Agreement (Leased Facilities), dated as of August
11, 1998, among (i) The Chase Manhattan Bank, as administrative agent, (ii) HHC 1998-1
Trust, (iii) CSL Leasing, Inc., BTD Harborside, Inc. and Morgan Stanley Senior
Funding, Inc. and (iv) Meditrust Company LLC
10.25**** Accounts Receivable Intercreditor Agreement (Mortgaged Facilities), dated as of August
11, 1998, among (i) The Chase Manhattan Bank, as administrative agent, (ii) HHC 1998-1
Trust, (iii) CSL Leasing, Inc., BTD Harborside, Inc. and Morgan Stanley Senior
Funding, Inc. and (iv) Meditrust Mortgage Investments, Inc.
10.27**** Agreement for Management Advisory, Strategic Planning and Consulting Services,
dated August 11, 1998, between the Registrant (as successor to MergerCo) and III
10.28**** Second Amendment to Loan Agreement, Consent to Merger and Confirmation of Guaranties,
dated as of July 31, 1998, by and among Bay Tree Nursing Center Corp., Countryside
Cave Center Corp., Sunset Point Nursing Center Corp., West Bay Nursing Center Corp.,
Harborside Healthcare Limited Partnership, Harborside Healthcare Corporation and
Meditrust Mortgage Investments, Inc.
10.29**** Omnibus Amendment to Facility Lease Agreements, Consent to Merger and Confirmation
of Guaranties, dated as of July 31, 1998, by and among Harborside New Hampshire
Limited Partnership, Harborside Toledo Limited Partnership, HHCI Limited Partnership,
Harborside Healthcare Limited Partnership, Harborside Healthcare Corporation and
Meditrust Company LLC
10.30*** LEASE dated September 26, 2000, by and between, HHC BEACHWOOD, INC. as LANDLORD AND
HARBORSIDE OF CLEVELAND LIMITED PARTNERSHIP as TENANT
71
10.31*** LEASE dated September 26, 2000, by and between, HHC BROADVIEW, INC. as LANDLORD AND
HARBORSIDE OF CLEVELAND LIMITED PARTNERSHIP as TENANT
10.32*** LEASE dated September 26, 2000, by and between, HHC WESTBAY, INC. as LANDLORD AND
HARBORSIDE CLEVELAND LIMITED PARTNERSHIP as TENANT
10.33***** Series A Warrant Agreement, dated as of May 10, 2001, between the Registrant
and United States Trust Company of New York, as warrant agent
10.34***** Series B Warrant Agreement, dated as of May 10, 2001, between the Registrant
and United States Trust Company of New York, as warrant agent
10.35***** Warrant Registration Rights Agreement, dated as of May 10, 2001, by the Registrant
for the benefit of holders of Series A Warrants and Series B Warrants
10.36***** Preferred Stock Registration Rights Agreement, dated as of May 10, 2001, between
the Registrant and the investors listed on the signature pages thereto
10.37+ Senior Officer Stock Option Agreement Pursuant to the Harborside Healthcare Stock
Incentive Plan.
10.38+ Stock Option Agreement Pursuant to the Harborside Healthcare Stock Incentive Plan.
21.1 Subsidiaries of the Registrant
99.3(b) Loan and Security Agreement dated September 13, 2002
* Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (Registration No. 333-3096)
** Incorporated by reference to the Registrant's Registration Statement on
Form S-4(Registration No. 333-51633)
*** Incorporated by reference to the Registran's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2000 (Registration No. 333-64679)
**** Incorporated by reference to the Registrant's Registration Statement on Form S-4
(Registration No. 333-64679)
***** Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2001 (Registration No. 333-64679)
# Replaces previously filed exhibit
+ Management contract or compensation plan or arrangement required to be filed as
an exhibit.
(b) Reports on Form 8-K:
None
72
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 31st day of March 2003.
HARBORSIDE HEALTHCARE
CORPORATION
By /s/ Stephen L. Guillard
-----------------------
Chairman, Chief Executive Officer
and Director
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated
/s/ Stephen L. Guillard Chairman, Chief Executive Officer and Director March 31, 2003
- -----------------------
(Principal Executive Officer)
/s/ Damian N. Dell'Anno President, Chief Operating Officer and Director March 31, 2003
- -----------------------
/s/ William H. Stephan Senior Vice President, Chief Financial Officer and Director March 31,2003
- ----------------------
(Principal Financial and Accounting Officer)
/s/ Lars C. Haegg Director March 31, 2003
- -----------------
/s/ James O. Egan Director March 31, 2003
- -----------------
/s/ William C. McCollum Director March 31, 2003
- -----------------------
/s/ Bruce Tully Director March 31, 2003
- ---------------
73
I, Stephen L. Guillard, certify that:
1. I have reviewed this annual report on Form 10-K of Harborside
Healthcare Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of Harborside Healthcare Corporation as of, and for, the
periods presented in this annual report;
4. Harborside Healthcare Corporation's other certifying officer and
I are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and
15d-14) for Harborside Healthcare Corporation and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to Harborside Healthcare Corporation,
including its consolidated subsidiaries, is made known to us by others
within these entities, particularly during the period in which this
annual report is being prepared;
b) evaluated the effectiveness of Harborside Healthcare Corporation's
disclosure controls and procedures as of a date within 90 days prior
to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. Harborside Healthcare Corporation's other certifying officer and I
have disclosed, based on our most recent evaluation, to Harborside
Healthcare Corporation's auditors and Harborside Healthcare
Corporation's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect Harborside Healthcare
Corporation's ability to record, process, summarize and report
financial data and have identified for Harborside Healthcare
Corporation's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in Harborside Healthcare
Corporation's internal controls; and
6. Harborside Healthcare Corporation's other certifying officer and I
have indicated in this annual report whether or not there were
significant changes in internal controls or in other factors that
could significantly affect internal controls subsequent to the date of
our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
/s/ Stephen L. Guillard
------------------------------------------
Stephen L. Guillard,
Chairman and Chief Executive Officer
74
I, William H. Stephan, certify that:
1. I have reviewed this annual report on Form 10-K of Harborside
Healthcare Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of Harborside Healthcare Corporation as of, and for, the
periods presented in this annual report;
4. Harborside Healthcare Corporation's other certifying officer and
I are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and
15d-14) for Harborside Healthcare Corporation and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to Harborside Healthcare Corporation,
including its consolidated subsidiaries, is made known to us by others
within these entities, particularly during the period in which this
annual report is being prepared;
b) evaluated the effectiveness of Harborside Healthcare Corporation's
disclosure controls and procedures as of a date within 90 days prior
to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. Harborside Healthcare Corporation's other certifying officer and I
have disclosed, based on our most recent evaluation, to Harborside
Healthcare Corporation's auditors and Harborside Healthcare
Corporation's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect Harborside Healthcare
Corporation's ability to record, process, summarize and report
financial data and have identified for Harborside Healthcare
Corporation's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in Harborside Healthcare
Corporation's internal controls; and
6. Harborside Healthcare Corporation's other certifying officer and I
have indicated in this annual report whether or not there were
significant changes in internal controls or in other factors that
could significantly affect internal controls subsequent to the date of
our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
/s/ William H. Stephan
------------------------------------------
William H. Stephan,
Senior Vice President and Chief Financial
Officer
75
Harborside Healthcare Corporation
One Beacon Street
Boston, MA 02210
March 30, 2003
Securities and Exchange Commission
450 Fifth Avenue, N.W.
Washington, D.C. 20549
Ladies and Gentlemen:
In accordance with Item
601(b)(4)(iii) of Regulation S-K, Harborside Healthcare Corporation (the
"Company") has not filed herewith any instrument with respect to long
term debt not being registered where the total number of securities authorized
thereunder does not exceed ten percent (10%) of the total assets of the Company
and its subsidiaries on a consolidated basis. The Company hereby agrees to
furnish a copy of any such agreement to the Securities and Exchange Commission
upon request.
Very truly yours,
HARBORSIDE HEALTHCARE CORPORATION
By: /s/ William H. Stephan
----------------------
Chief Financial Officer
76
Exhibit 21.1
Subsidiaries of Harborside Healthcare Corporation as of December 31, 2001:
Jurisdiction of
Incorporation or
Name Organization Doing Business As
----- ------------ -----------------
1. Bay Tree Nursing Center Corp. Massachusetts
2. Belmont Nursing Center Corp. Massachusetts Harborside Healthcare - Perrysburg
3. Bowie Center Limited Partnership Maryland Larkin Chase Nursing and Restorative Center
4. Countryside Care Center Corp. Massachusetts Harborside Healthcare -Terre Haute
5. Harborside of Cleveland
Limited Partnership Massachusetts Harborside Healthcare - Beachwood
Rehabilitation and Nursing Center
Harborside Healthcare - Broadview Heights
Rehabilitation and Nursing
Center
Harborside Healthcare - Westlake I
Rehabilitation and Nursing Center
Harborside Healthcare - Westlake II
Rehabilitation and Nursing Center
6. Huntington Place Limited Partnership Florida Huntington Place Rehabilitation and
(f/k/a Harborside Florida Limited Nursing Center
Partnership)
7. Harborside of Ohio Limited Partnership Massachusetts Harborside Healthcare - Northwest Ohio
Harborside Healthcare - Defiance
8. Harborside Funding Limited Partnership Massachusetts
9. Harborside Health I Corporation Delaware Harborside Nursing Homes, Inc.
10. Harborside Healthcare Advisors Massachusetts
Limited Partnership
11. Harborside Healthcare Limited Massachusetts Allicor
Partnership Harborside Healthcare Management
Limited Partnership
12. Harborside Healthcare Network Florida
Limited Partnership
13. Harborside Homecare Limited Massachusetts Behavioral Health Care
Partnership
77
14. Harborside New Hampshire Massachusetts Harborside Nursing Facilities Limited
Limited Partnership Partnership
Harborside Healthcare - Applewood
Rehabilitation and Nursing Center
Harborside Healthcare - Crestwood
Rehabilitation and Nursing Center
Harborside Healthcare - Milford
Rehabilitation and Nursing Center
Harborside Healthcare - Northwood
Rehabilitation and Nursing Center
Harborside Healthcare - Pheasantwood
Rehabilitation and Nursing Center
Harborside Healthcare - Westwood
Rehabilitation and Nursing Center
15. Harborside Rehabilitation Limited Massachusetts Theracor Rehabilitation Services
Partnership Ready Nurse
16. Harborside Toledo Corporation Massachusetts
17. Harborside Toledo Limited Partnership Massachusetts Harborside Healthcare - Swanton
18. HHCI Limited Partnership Massachusetts Harborside Healthcare - New Haven
Harborside Healthcare - Woods Edge
Harborside Healthcare - Indianapolis
Harborside Healthcare - Troy
19. KHI Corporation Delaware
20. Maryland Harborside Corp. Massachusetts
21. Oakhurst Manor Nursing Center Massachusetts
Corp.
22. Orchard Ridge Nursing Center Massachusetts
Corp.
23. Riverside Retirement Limited Partnership Massachusetts Harborside Healthcare - Decatur
24. Sunset Point Nursing Center Corp. Massachusetts
25. West Bay Nursing Center Corp. Massachusetts
26. Harborside Healthcare Baltimore Limited
Partnership Massachusetts Harborside Healthcare - Harford Gardens
27. Harborside Massachusetts
Limited Partnership Massachusetts Harborside Healthcare - North Shore
Harborside Healthcare - Maplewood
Harborside Healthcare - Cedar Glen
Harborside Healthcare - Danvers
28. Harborside of Dayton
Limited Partnership Massachusetts Harborside Healthcare - Laurelwood
Harborside Healthcare - New Lebanon
Harborside Healthcare - Dayton
78
29. Harborside Connecticut
Limited Partnership Massachusetts Harborside Healthcare - Arden House
Harborside Healthcare - Governor's House
Harborside Healthcare - Willows
Harborside Healthcare - Madison House
Harborside Healthcare - Reservoir
30. Harborside Rhode Island
Limited Partnership Massachusetts Harborside Healthcare - Greenwood
Harborside Healthcare - Pawtuxet Village
31. Harborside North Toledo
Limited Partnership Massachusetts Harborside Healthcare - Sylvania
Harborside Healthcare - Point Place
32. Harborside Danbury
Limited Partnership Massachusetts Harborside Healthcare - Glen Hill
Harborside - Glen Crest
33. Harborside Acquisition
Limited Partnership V Massachusetts
34. Harborside Acquisition
Limited Partnership VI Massachusetts
35. Harborside Acquisition
Limited Partnership VII Massachusetts
36. Harborside Acquisition
Limited Partnership VIII Massachusetts
37. Harborside Acquisition
Limited Partnership IX Massachusetts
38. Harborside Acquisition
Limited Partnership X Massachusetts
39. Sailors, Inc. Delaware
40. New Jersey Harborside Corp. Massachusetts
41. Bridgewater Assisted Living New Jersey
42. Harborside Healthcare Management, LLC Delaware
43. Harborside Administrative Services, LLC Delaware Harborside Healthcare
44. Florida Administrative Services, LLC Delaware Compass Healthcare Services
45. Florida Holdings I, LLC Delaware
46. Florida Holdings II, LLC Delaware
47. Florida Holdings III, LLC Delaware
48. 1775 Huntington Lane, LLC Delaware
79
49. 2600 Highlands Boulevard North, LLC Delaware Bay Tree Rehabilitation and Nursing Center
50. 2900 Twelfth Street North, LLC Delaware Lakeside Pavilion Rehabilitation and
Nursing Center
51. 1501 SE 24th Road, LLC Delaware Oakhurst Rehabilitation and
Nursing Center
52. 4927 Voorhees Road, LLC Delaware Orchard Ridge Rehabilitation and
Nursing Center
53. 1240 Pinebrook Road, LLC Delaware Pinebrook Rehabilitation and
Nursing Center
54. 4602 Northgate Court, LLC Delaware Springwood Rehabilitation and
Nursing Center
55. 1980 Sunset Point Road, LLC Delaware Sunset Point Rehabilitation and
Nursing Center
56. 3865 Tampa Road North, LLC Delaware West Bay Rehabilitation and Nursing Center
57. Massachusetts Holdings I, LLC Delaware
58. Ohio Holdings I, LLC Delaware
59. Marietta Healthcare, LLC Delaware Marietta Nursing and Rehabilitation Center
60. Mashpee Healthcare, LLC Delaware Harborside Healthcare - Mashpee
61. Wakefield Healthcare, LLC Delaware Harborside Healthcare - Wakefield
62. Falmouth Healthcare, LLC Delaware Harborside Healthcare - Falmouth
63. Westfield Healthcare, LLC Delaware Harborside Healthcare - Westfield
64. LTC Leasing, LLC Delaware
80