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EX-32.2 - EXHIBIT 32.2 - LifeCare Holdings, Inc.dex322.htm
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EX-10.2 - EXHIBIT 10.2 - LifeCare Holdings, Inc.dex102.htm
EX-10.1 - EXHIBIT 10.1 - LifeCare Holdings, Inc.dex101.htm
EX-31.2 - EXHIBIT 31.2 - LifeCare Holdings, Inc.dex312.htm
EX-31.1 - EXHIBIT 31.1 - LifeCare Holdings, Inc.dex311.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009.

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to             .

Commission File Number 333-133319

 

 

LIFECARE HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   51-0372090

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification Number)

5560 Tennyson Parkway

Plano, Texas

  75024
(Address of Principal Executive Offices)   (Zip Code)

(469) 241-2100

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changes since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. Please see definition of “accelerated and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer   ¨    Accelerated Filer   ¨
Non-Accelerated Filer   x    Smaller Reporting Company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

As of November 1, 2009, the registrant had 100 shares of Common Stock, par value $0.01 per share, outstanding.

 

 

 


Table of Contents

LIFECARE HOLDINGS, INC.

TABLE OF CONTENTS

 

PART I FINANCIAL INFORMATION   
ITEM 1.  

CONSOLIDATED FINANCIAL STATEMENTS

   3
 

CONDENSED CONSOLIDATED BALANCE SHEETS

   3
 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

   4
 

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER’S DEFICIT

   5
 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

   6
 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

   7
ITEM 2.  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   21
ITEM 3.  

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   31
ITEM 4.  

CONTROLS AND PROCEDURES

   31
PART II OTHER INFORMATION    32
ITEM 1.  

LEGAL PROCEEDINGS

   32
ITEM 6.  

EXHIBITS

   32
SIGNATURES    33

 

2


Table of Contents

PART 1: FINANCIAL INFORMATION

ITEM 1: CONSOLIDATED FINANCIAL STATEMENTS

LIFECARE HOLDINGS, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

September 30, 2009 (unaudited) and December 31, 2008

(In thousands, except share data)

 

     September 30,
2009
    December 31,
2008
 
Assets     

Current assets:

    

Cash and cash equivalents

   $ 54,285      $ 25,262   

Accounts receivable, net of allowance for doubtful accounts of $13,018 and $10,144 respectively

     55,705        66,803   

Income taxes

     1,270        1,279   

Other current assets

     7,724        7,735   
                

Total current assets

     118,984        101,079   

Property and equipment, net

     82,421        86,479   

Other assets

     11,620        12,597   

Identifiable intangibles, net

     16,450        17,305   

Goodwill

     245,370        245,370   
                
   $ 474,845      $ 462,830   
                
Liabilities and Stockholder’s Deficit     

Current liabilities:

    

Current installments of long-term debt

   $ 2,550      $ 2,550   

Current installments of obligations under capital leases

     987        1,252   

Current installment of lease financing obligation

     435        292   

Estimated third-party payor settlements

     6,473        6,231   

Accounts payable

     23,415        26,693   

Accrued payroll

     8,919        9,892   

Accrued vacation

     4,468        3,614   

Accrued insurance

     1,648        900   

Accrued interest

     3,850        8,127   

Accrued other

     4,812        3,642   
                

Total current liabilities

     57,557        63,193   

Long-term debt, excluding current installments

     406,549        384,694   

Obligations under capital leases, excluding current installments

     1,174        1,836   

Lease financing obligation, excluding current installments

     20,152        20,645   

Accrued insurance

     4,184        3,592   

Other noncurrent liabilities

     7,394        9,419   
                

Total liabilities

     497,010        483,379   
                

Commitments and contingencies

    

Stockholder’s deficit:

    

Common stock, $0.01 par value, 100 shares authorized, issued and outstanding

     —          —     

Additional paid-in capital

     172,200        171,965   

Accumulated deficit

     (194,365     (192,514
                

Total stockholder’s deficit

     (22,165     (20,549
                
   $ 474,845      $ 462,830   
                

See accompanying notes to condensed consolidated financial statements.

 

3


Table of Contents

LIFECARE HOLDINGS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

For the three and nine months ended September 30, 2009 and 2008

(In thousands)

(Unaudited)

 

     Three Months     Nine Months  
     2009     2008     2009     2008  

Net patient service revenue

   $ 84,261      $ 82,394      $ 270,930      $ 257,786   
                                

Salaries, wages and benefits

     39,978        40,520        125,573        123,411   

Supplies

     8,269        8,353        25,731        26,209   

Rent

     6,021        6,331        18,902        19,060   

Other operating expenses

     20,447        19,902        65,835        61,475   

Provision for doubtful accounts

     1,103        151        4,210        2,600   

Gain on early extinguishment of debt

     (558     —          (642     —     

Depreciation and amortization

     2,724        3,018        8,104        8,605   

Interest expense, net

     7,613        9,209        23,964        28,135   
                                

Total expenses

     85,597        87,484        271,677        269,495   
                                

Operating loss

     (1,336     (5,090     (747     (11,709

Equity in income (loss) of joint venture

     25        —          (512     —     
                                

Loss before income taxes

     (1,311     (5,090     (1,259     (11,709

Provision for income taxes

     192        835        592        1,259   
                                

Net loss

   $ (1,503   $ (5,925   $ (1,851   $ (12,968
                                

See accompanying notes to condensed consolidated financial statements

 

4


Table of Contents

LIFECARE HOLDINGS, INC. AND SUBSIDIARIES

Condensed Consolidated Statement of Stockholder’s Deficit

For the nine months ended September 30, 2009

(In thousands)

(Unaudited)

 

     Common
Stock
   Additional
Paid-in
Capital
   Accumulated
Deficit
    Total
Stockholder’s
Deficit
 

Balance, December 31, 2008

   $ —      $ 171,965    $ (192,514   $ (20,549

Equity compensation amortization

     —        235      —          235   

Net loss

     —        —        (1,851     (1,851
                              

Balance, September 30, 2009

   $ —      $ 172,200    $ (194,365   $ (22,165
                              

See accompanying notes to condensed consolidated financial statements.

 

5


Table of Contents

LIFECARE HOLDINGS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

For the nine months ended September 30, 2009 and 2008

(In thousands)

(Unaudited)

 

     2009     2008  

Cash flows from operating activities:

    

Net loss

   $ (1,851   $ (12,968

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Depreciation and amortization

     9,759        10,202   

Provision for doubtful accounts

     4,210        2,600   

Equity compensation amortization

     235        203   

Gain on early extinguishment of debt

     (642     —     

Loss on the disposal of assets

     2        —     

Equity in loss of joint venture

     512        —     

Changes in operating assets and liabilities:

    

Patient accounts receivable

     6,887        (2,681

Current income taxes

     9        514   

Prepaid expenses and other current assets

     (76     (213

Other assets

     467        656   

Estimated third-party payor settlements

     242        (3,155

Accounts payable and accrued expenses

     (5,695     4,605   

Other liabilities

     (1,433     1,068   
                

Net cash provided by operating activities

     12,626        831   
                

Cash flows from investing activities:

    

Purchases of property and equipment

     (3,440     (11,722

Investment in joint venture

     (6     —     

Note receivable with joint venture

     (1,400     —     

Sale-leaseback proceeds

     —          3,714   
                

Net cash used in investing activities

     (4,846     (8,008
                

Cash flows from financing activities:

    

Net change in borrowings under the line of credit

     25,000        10,000   

Payments of notes payable and long-term debt

     (2,479     (1,913

Proceeds from capital lease financing

     —          1,802   

Payments on obligations under capital leases

     (927     (1,904

Proceeds from lease financing obligation

     —          3,829   

Payments on lease financing obligation

     (351     (200
                

Net cash provided by financing activities

     21,243        11,614   
                

Net increase in cash and cash equivalents

     29,023        4,437   

Cash and cash equivalents, beginning of period

     25,262        17,816   
                

Cash and cash equivalents, end of period

   $ 54,285      $ 22,253   
                

Supplemental disclosure of cash flow information:

    

Cash:

    

Interest paid

   $ 26,758      $ 31,844   

Net income taxes paid

     583        746   

Noncash:

    

Equipment purchased through capital lease financing

     —          1,157   

Investment in joint venture

     94        —     

See accompanying notes to condensed consolidated financial statements.

 

6


Table of Contents

LifeCare Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

(1) Basis of Presentation

LifeCare Holdings, Inc. (the “Company”) is a wholly owned subsidiary of LCI Holdco, LLC (“Holdco”). Holdco is a wholly owned subsidiary of LCI Holding Company, Inc. (“Holdings”), which is owned by an investor group that includes affiliates of The Carlyle Group and members of the board of directors. The investor group acquired Holdings pursuant to a merger that occurred on August 11, 2005 (the “Merger”).

The accompanying unaudited condensed consolidated financial statements and financial information have been prepared in accordance with generally accepted accounting principles, and reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results of the interim periods. The accompanying financial statements for the three and nine month periods ended September 30, 2009 and 2008 are not necessarily indicative of annualized financial results.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated audited financial statements and notes thereto for the year ended December 31, 2008 included in the Form 10-K we filed on March 31, 2009 with the Securities and Exchange Commission. Certain information and disclosures normally included in the notes to consolidated financial statements have been condensed or omitted as permitted by the rules and regulations of the Securities and Exchange Commission, although we believe the disclosure is adequate to make the information presented not misleading.

 

(2) Summary of Significant Accounting Policies

Use of Estimates

The preparation of the financial statements requires us to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts could differ from those estimates.

Goodwill

We review our goodwill annually, or more frequently if circumstances warrant a more timely review, to determine if there has been an impairment. Per the guidance of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Section 350-20-55, Intangibles-Goodwill and Other-Goodwill-Implementation Guidance and Illustrations, formally FASB Emerging Issues Task Force (“EITF”) Topic No. D-101 Clarification of Reporting Unit Guidance in Paragraph 30 of FASB Statement No. 142, (“EITF Topic No. D-101”), we review goodwill based upon one reporting unit, as the Company is managed as one operating segment in accordance with FASB ASC Subtopic 280-10, Segment Reporting-Overall, formally Statement of Financial Accounting Standards (“SFAS”) No. 131, Disclosures about Segments of an Enterprise and Related Information, (“SFAS 131”). In calculating the fair value of the reporting unit, we use various assumptions including projected cash flows and discount rates. If projected future cash flows decline from the current amounts projected by management, additional impairments may be recorded.

Income Taxes

For the nine months ended September 30, 2009, income tax expense recorded represents the estimated income tax liability for certain state income taxes. We believe that it is more likely than not that no benefit or expense will be realized during 2009 for federal income taxes based on recent taxable loss trends.

We follow the threshold of more-likely-than-not for recognition of tax benefits of uncertain tax positions taken or expected to be taken in a tax return. We record accrued interest and penalties associated with uncertain tax positions, if any, as income tax expense in the condensed consolidated statement of operations.

The federal statute of limitations remains open for original tax returns filed for 2006 through 2008. State jurisdictions generally have statutes of limitations ranging from three to five years. The state income tax impact of federal income tax changes remains subject to examination by various states for a period up to one year after formal notification to the states.

On November 6, 2009, new legislation was enacted, “The Worker, Homeownership, and Business Assistance Act of 2009,” whereby businesses may elect to carry back net operating losses for up to five years for losses incurred in either 2008 or 2009. Previously, the carry back period was limited to two years. We are currently evaluating the impact this new law may have our ability to utilize our net operating losses.

Stock Compensation

We estimate the fair value of our equity-based compensation awards on the date of grant, or the date of award modification if applicable, using the Black-Scholes option pricing model. The weighted average fair value of options granted during the nine months ended September 30, 2009 was nominal and was calculated based on the following assumptions: expected volatility of 40%, expected dividend yield of 0%, expected life of 6.25 years, and a risk-free interest rate of 2.07% to 3.09%. Expected volatility was derived using data drawn from other healthcare public companies for five to seven years prior to the date of grant and award modification. The expected life was computed utilizing the simplified method as permitted by the Securities and Exchange Commission’s Staff Accounting Bulletin No. 110, Share-Based Payment. The expected forfeiture rates are 50% and

 

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Table of Contents

LifeCare Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

are based upon a review of our recent history and expectations. The risk-free interest rate is based on the approximate yield on seven-year United States Treasury Bonds as of the date of grant and award modification. There were 60,000 options granted during the nine months ended September 30, 2009 (see note 5).

Recent Accounting Pronouncements

In April 2009, the FASB issued FASB Staff Position FAS 141(R)-1 Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies, (“FSP SFAS 141 (R)-1”) which amends the provisions related to the initial recognition and measurement, subsequent measurement and disclosure of assets and liabilities arising from contingencies in a business combination under FASB Statement No. 141(R), Business Combinations (“SFAS 141(R)”). FSP SFAS 141 (R)-1 amends portions of FASB ASC Topic 805, Business Combinations, and was effective for all business combinations which occur during fiscal years beginning after December 15, 2008. FSP SFAS 141 (R)-1 will impact us to the extent we make future acquisitions.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS 165”). SFAS 165, which amends portions of FASB ASC Subtopic 855-10, Subsequent Events-Overall, establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. We do not anticipate the adoption of SFAS 165 will materially impact us. SFAS 165 was effective for interim or annual financial periods ending after June 15, 2009.

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – a replacement of FASB Statement No. 162 (“SFAS 168”). SFAS 168, which amends portions of FASB ASC Subtopic 105-10, Generally Accepted Accounting Principles-Overall, provides for the FASB Accounting Standards Codification (the “Codification”) to become the single official source of authoritative, nongovernmental U.S. generally accepted accounting principles (“GAAP”). The Codification did not change GAAP but reorganizes the literature. SFAS 168 was effective for interim and annual periods ending after September 15, 2009.

Reclassifications

Certain reclassifications have been made to the consolidated financial statements for prior periods to conform to the presentation of the 2009 consolidated financial statements. Such reclassifications had no impact on net loss or stockholder’s deficit.

 

(3) Net Patient Service Revenue

We recognize in our consolidated financial statements the impact of adjustments, if any, to Medicare reimbursement when the amounts can be reasonably determined. Net revenues for the three and nine months ended September 30, 2009 included increases of $25,000 and $1.3 million, respectively, related to changes in estimates and settlements on prior year cost reports filed with the Medicare program, compared to decreases of $0.1 million and $1.6 million for the three and nine months ended September 30, 2008, respectively.

 

(4) Long-Term Debt

Long-term debt consists of the following (in thousands):

 

     September 30,
2009
    December 31,
2008
 

Senior secured credit facility—term loan

   $ 244,800      $ 246,713   

9 1/4% senior subordinated notes

     129,299        130,531   

Revolving credit facility

     35,000        10,000   
                

Total long-term debt

     409,099        387,244   

Current installments of long-term debt

     (2,550     (2,550
                

Long-term debt, excluding current installments

   $ 406,549      $ 384,694   
                

The senior secured credit facility consists of (i) a $60 million revolving credit facility, subject to availability, including sub-facilities for letters of credit and swingline loans and (ii) a $244.8 million term loan facility. Availability of borrowings under our revolving credit facility are generally dependent upon our ability to meet the maximum leverage ratio test included in the senior secured credit facility.

During the three months ended March 31, 2009, we repurchased $0.2 million of our outstanding senior subordinated notes for $0.1 million. This resulted in us recording a $0.1 million gain, net of the write-off of a nominal amount of capitalized financing costs, on the early extinguishment of this indebtedness. During the three months ended September 30, 2009, we repurchased $1.1 million of our outstanding senior subordinated notes for $0.5 million. This resulted in us recording a $0.6 million gain, net of the write-off of a nominal amount of capitalized financing cost, on the early extinguishment of this indebtedness.

 

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Table of Contents

LifeCare Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

The senior secured credit facility requires us to comply on a quarterly basis with certain financial covenants, including an interest coverage ratio test and a maximum leverage ratio test. These financial covenants become more restrictive on a periodic basis throughout the remaining term of the senior secured credit facility, including the first quarter of 2010. In addition, the senior secured credit facility includes various negative covenants, including limitations on indebtedness, liens, investments, permitted businesses and transactions and other matters, as well as certain customary representations and warranties, affirmative covenants and events of default including payment defaults, breach of representations and warranties, covenant defaults, cross defaults to certain indebtedness, certain events of bankruptcy, certain events under ERISA, material judgments, actual or asserted failure of any guaranty or security document supporting the senior secured credit facility to be in full force and effect, change of control, and certain subjective provisions. We believe we are currently in compliance with the covenants of our senior secured credit facility as amended.

We may not be able to continue to satisfy the covenant requirements in subsequent periods. If we are unable to maintain compliance with the covenants contained in our senior secured credit facility, an event of default would occur. During the continuation of an event of default, the lenders under the senior secured credit facility are entitled to take various actions, including accelerating amounts due under the senior secured credit facility, terminating our access to our revolving credit facility and all other actions generally available to a secured creditor. An uncured event of default would have a material adverse effect on our financial position, results of operations and cash flow. In the event a financial covenant is not met, our senior secured credit facility provides for certain limited cure rights which provide us the ability to issue permitted cure securities in exchange for cash or otherwise receive cash that would be contributed to our capital in an amount that is necessary to satisfy the financial covenant required on a pro forma basis. The cure right amount, if exercised, continues to be considered a component of consolidated EBITDA, as defined in the senior secured credit agreement, on a trailing 4 quarter basis.

 

(5) Stock Options

Successor Stock Option Plan

At September 30, 2009, there were 2,860,000 shares of common stock of Holdings available under the 2005 Equity Incentive Plan (“Plan”) for stock option grants and other incentive awards, including restricted stock units. Options granted generally have an exercise price equal to or greater than the fair market value of the shares on the date of grant and expire 10 years from the date of grant. A restricted stock unit is a contractual right to receive one share of Holdings common stock in the future. Options typically vest one-quarter on each of the first four anniversary dates of the grant and restricted stock units typically vest over three year periods.

Income from the three months ended September 30, 2009 and 2008 and the nine months ended September 30, 2009 and 2008 includes $0.1 million, $0.1 million, $0.2 million, and $0.2 million, respectively, of pre-tax compensation costs related to our stock-based compensation arrangements.

The following table summarizes stock option activity during the nine months ended September 30, 2009:

 

     Number of
Shares
    Weighted
average
exercise
price

Balance at December 31, 2008

   2,370,000      $ 2.50

Granted

   60,000        2.50

Exercised

   —          —  

Forfeited

   (35,000     2.50

Expired

   (25,000     2.50
        

Balance at September 30, 2009

   2,370,000      $ 2.50
        

At September 30, 2009, the weighted average remaining contractual life of outstanding options was 8.1 years. There were 808,000 stock options exercisable at September 30, 2009. At September 30, 2009, the weighted average exercise price of the vested stock options was $2.50, the remaining weighted average contractual life was 6.7 years and they had no intrinsic value.

As of September 30, 2009, there was approximately $0.3 million of total unrecognized compensation costs related to stock options. These costs are expected to be recognized over a period of approximately one year.

Restricted Stock Awards

In March 2009, our chief executive officer and president were granted 400,000 and 300,000 shares, respectively, according to a restricted stock award agreement for meeting certain financial goals for the year ended December 31, 2008. The grant-date per share fair value of these awards was nominal. The shares vest in three equal annual installments beginning on March 24, 2010.

As of September 30, 2009, there was no unrecognized compensation costs related to restricted stock awards.

 

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Table of Contents

LifeCare Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

(6) Regulatory Matters

All healthcare providers are required to comply with a significant number of laws and regulations at the federal and state government levels. These laws are extremely complex, and in many instances, providers do not have the benefit of significant regulatory or judicial interpretation as to how to interpret and/or apply these laws and regulations. The U.S. Department of Justice and other federal agencies are increasing resources dedicated to regulatory investigations and compliance audits of healthcare providers. As a healthcare provider, we are subject to these regulatory efforts. Healthcare providers that do not comply with these laws and regulations may be subject to civil or criminal penalties, the loss of their licenses, or restriction in their ability to participate in various federal and state healthcare programs. We endeavor to conduct our business in compliance with applicable laws and regulations, including healthcare fraud and abuse laws.

We undertake various procedures to assure that our annual cost reports are correctly prepared and filed in accordance with applicable Medicare regulations governing provider reimbursement. During 2004 and 2003, we conducted an internal review of our previously filed cost reports. As a result of this review, which covered the years 1997 through 2001, we made certain adjustments in 2003 to our previously reported allowable home office expenses. The findings of this review and proposed amendments to the home office cost reports were submitted to the Office of Inspector General of the Department of Health and Human Services (“OIG”), which reviewed our findings. On June 12, 2006, we entered into a Settlement Agreement and a Certification of Compliance Agreement (“CCA”) with the OIG that settled these matters. The amount paid in connection with this settlement was approximately $2.6 million, which was funded out of a specific escrow account established as part of the Merger that occurred on August 11, 2005. The CCA was effective for three years. It required, among other things, that we (1) continue to maintain our corporate compliance program, (2) submit an annual report to OIG regarding certain specified items, including our ongoing corporate compliance audit findings in areas such as cost reporting, physician contracting and charge master reviews, and (3) report the occurrence of certain other events.

We filed our third and final annual report summarizing our annual compliance activities with the OIG on August 10, 2009. Upon the OIG’s formal acceptance of this filing, we expect that the CCA will be terminated effective June 12, 2009.

Periodically the Centers for Medicare & Medicaid Services (“CMS”) will conduct surveys of hospitals and other health care providers as a condition of participation in the Medicare program. The purpose of these surveys is to ensure that healthcare providers are in compliance with various governmental requirements related to adequacy of medical care, equipment, personnel, operating policies and procedures, maintenance of adequate records, compliance with building codes and environmental protection and healthcare fraud and abuse. On July 24, 2009, we received a notice from CMS that pursuant to a routine inspection related to the physical plant of one of our hospitals, certain deficiencies and conditions were noted to exist which must be corrected. Subsequent to this notice, we implemented corrective plans to remedy the deficiencies and conditions that were cited in the CMS notification, and, in a limited number of cases, we requested and were granted time-limited waivers for certain matters that will require additional time to remedy. As a result of the corrective actions and the receipt of certain waivers, we were notified by CMS on October 15, 2009, that the hospital is now in compliance with the Medicare conditions of participation and that the hospital is no longer subject to termination of its participation in the Medicare program as a result of the initial deficiencies and conditions. If the hospital is not successful in addressing the deficiencies and conditions in a timely manner as permitted by the waivers granted by CMS, which extend through June 1, 2010, then CMS reserves the right to deem the hospital to be out of compliance with certain Medicare conditions of participation and may terminate the hospital from participation in the Medicare program. The termination of this hospital from the Medicare program would have a material adverse effect on our results of operations and cash flows. We are in the process of correcting the remaining deficiencies and conditions for which waivers were granted and believe that these issues will be successfully resolved in a timely manner and that the hospital will continue to comply with the conditions of participation as set forth by CMS.

 

(7) Commitments and Contingencies

At the time of Hurricane Katrina, we operated an 82-bed facility in New Orleans located in Memorial Medical Center. In the aftermath of the hurricane, an investigation was conducted by the Louisiana Attorney General’s office. The investigation culminated in a Grand Jury being convened in February of 2007 to determine if criminal charges should be filed against three individuals, who were not our employees, but who were caring for patients in Memorial Medical Center after the hurricane. Two of the individuals were subsequently granted immunity and the Grand Jury declined to indict the third. Neither the Company nor its employees have been named in any lawsuits or matters related to illegal or criminal activities associated with Hurricane Katrina.

We are currently defending ourselves against a variety of Hurricane Katrina related lawsuits or matters under review by the Louisiana Patient Compensation Fund. We are vigorously defending ourselves in these lawsuits, however, we cannot predict the ultimate resolution of these matters. We maintained $15.0 million of general and professional liability insurance during this period, subject to a $1.0 million per claim retention. We believe that under our insurance policies, only one retention is applicable to the Hurricane Katrina matters since these matters all arose from a single event, process or condition. However, our insurance carrier sent reservation of rights letters which challenged, among other things, the application of one retention to the Hurricane Katrina related matters. On June 5, 2009, we reached an agreement with the insurance carrier regarding the reservation of rights matters whereby they will continue to pay all costs, indemnification and related expenses for the Hurricane Katrina claims in consideration for $1.0 million to be paid by us, payable in three equal installments, due July 1, 2009, March 31, 2010, and March 31, 2011.

 

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LifeCare Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

Significant reductions in the patient service revenues earned by a hospital may occur if we are unable to maintain the certification of the hospital as a long-term acute care (“LTAC”) hospital in accordance with Medicare regulations. Additionally, many of our hospitals operate in space leased from general acute care hospitals (“host hospitals”); consequently, these “hospitals within a hospital” (“HIH”) are subject to additional specific Medicare HIH regulations in addition to the general LTAC hospital regulations. The HIH regulations are designed to ensure that the hospitals are organizationally and functionally independent of their host hospitals. If an LTAC hospital located in a host hospital fails to meet the HIH regulations, it may also lose its status as an LTAC hospital. The determinations are made on an annual basis.

A provider that loses its ability to receive Medicare payments pursuant to the Long-Term Acute Care Prospective Payment System (“PPS”) must go through the same certification process as new LTAC hospital providers must go through to obtain their initial certification to be reimbursed pursuant to PPS. During this re-certification period, which could range from six to nine months, the provider would be paid for providing services to Medicare beneficiaries at rates that are lower than rates currently paid pursuant to PPS.

During December 2006, we entered into an agreement to form a new joint venture with an unrelated party in the New Orleans market to own and operate a LTAC hospital in the market. During 2007, we contributed to the joint venture our hospital licenses, Medicare provider numbers and certain remaining equipment from our former New Orleans operations in exchange for a 49.99% ownership in the joint venture. In connection with this joint venture, we guaranteed, via the issuance of a letter of credit, $0.8 million of a $1.5 million line of credit established by the new joint venture. The joint venture’s line of credit was secured by certain assets, including accounts receivable and moveable equipment of the joint venture, along with our letter of credit. Pursuant to FASB ASC Subtopic 460-10, Guarantees-Overall, formally FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, we previously established a carrying value of $0.8 million associated with this guarantee, which was recorded in other noncurrent liabilities. On April 2, 2009, the letter of credit was drawn in full by the lender pursuant to their right to exercise the guarantee. On May 1, 2009, we sold our 49.99% ownership in the joint venture for $0.2 million, in the form of a promissory note from the purchaser, for which we provided a full reserve.

We have certain other pending and threatened litigation and claims incurred in the ordinary course of business. We believe (based, in part, on the advice of legal counsel) that the probable resolution of such contingencies will not exceed our insurance coverage and will not materially affect our consolidated financial position, results of operations or liquidity.

 

(8) Fair Value of Financial Instruments

The carrying amount of cash and cash equivalents, accounts receivable, third-party payor settlements, short-term receivables in self insurance trusts, and accounts payable and accrued expenses approximates fair value because of the short-term maturity of these instruments. The carrying amount of these obligations is a reasonable estimate of fair value.

The Senior Secured Credit Facility and the Senior Subordinated Notes are traded in private institutional markets. The carrying amount of the Senior Secured Credit Facility and the Senior Subordinated Notes was $244.8 million and $129.3 million, respectively, at September 30, 2009. Using available quoted market prices, the fair values of the Senior Secured Credit Facility and the Senior Subordinated Notes were approximately $198.3 million and $55.6 million, respectively, at September 30, 2009. The fair values are based on quoted market prices at each balance sheet date; however, these quoted market prices represent Level 2 inputs because the markets in which the Senior Secured Credit Facility and the Senior Subordinated Notes trade are not active. The revolving credit facility has a carrying value of $35.0 million at September 30, 2009. Using available quoted market prices for the Senior Secured Credit Facility as a basis, we estimated the fair market value of the revolving credit facility at $30.2 million. This valuation is categorized as a Level 2 in the valuation hierocracy.

 

(9) Joint Venture

On September 1, 2009, we, along with a subsidiary of Select Medical Corporation (“Select”), each contributed our hospital operations, located in the Muskegon, Michigan market, and related licenses and provider numbers, along with $1.5 million in cash and net assets, into a newly formed limited liability company, in exchange for each receiving a 50% ownership in the newly formed entity. The joint venture, which is currently comprised of 51 beds in two separate locations in the Muskegon market, will be managed by Select. The $1.5 million cash contributions made by each party were comprised of a $0.1 million equity contribution and a $1.4 million note receivable (“Subordinated Note”). The 50% ownership we have in the joint venture is held by a newly formed subsidiary of the Company and has been designated as a non-guarantor subsidiary pursuant to our senior secured credit facility. The Subordinated Notes bear an interest rate of 10% and will mature on August 31, 2019. The joint venture may make quarterly payments on the Subordinated Notes with available cash flows prior to the maturity.

 

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LifeCare Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

(10) Subsequent Events

Management has evaluated subsequent events through the date the financial statements were issued on November 13, 2009, and there were no material subsequent events requiring disclosure in or amendment to these financial statements.

 

(11) Financial Information for Subsidiary Guarantors and Non-guarantor Subsidiaries under the Senior Subordinated Notes

The senior subordinated notes are fully and unconditionally guaranteed by substantially all of our wholly-owned subsidiaries (the “Subsidiary Guarantors”), however, certain of our subsidiaries did not guarantee the senior subordinated notes (the Non-Guarantor Subsidiaries”).

Presented below is condensed consolidating financial information for LifeCare Holdings, Inc., the Subsidiary Guarantors, and the Non-Guarantor Subsidiaries for the three and nine months ended at September 30, 2009 and 2008. The equity method has been used with respect to investments in subsidiaries. Separate financial statements of the Subsidiary Guarantors are not presented.

 

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LifeCare Holdings, Inc.

Condensed Consolidating Balance Sheet

September 30, 2009

(in thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Totals
 
Assets           

Current assets:

          

Cash and cash equivalents

   $ —        $ 54,284      $ 1      $ —        $ 54,285   

Accounts receivable, net of allowance for doubtful accounts

     —          52,923        2,782        —          55,705   

Due to/from related parties

     114,290        (99,867     (14,423     —          —     

Income taxes

     1,784        (514     —          —          1,270   

Other current assets

     —          7,329        395        —          7,724   
                                        

Total current assets

     116,074        14,155        (11,245     —          118,984   

Investment in subsidiary

     273,751        —          —          (273,751     —     

Property and equipment, net

     —          59,036        23,385        —          82,421   

Other assets

     7,213        2,853        1,554        —          11,620   

Identifiable intangibles, net

     —          16,450        —          —          16,450   

Goodwill

     —          245,370        —          —          245,370   
                                        

Total assets

   $ 397,038      $ 337,864      $ 13,694      $ (273,751   $ 474,845   
                                        
Liabilities and Stockholder’s Equity (Deficit)           

Current liabilities:

          

Current installments of long-term debt

   $ 2,550      $ —        $ —        $ —        $ 2,550   

Current installments of obligations under capital leases

     —          779        208        —          987   

Current installments of lease financing obligation

     —          —          435        —          435   

Estimated third-party payor settlements

     —          5,624        849        —          6,473   

Accounts payable

     754        21,955        706        —          23,415   

Accrued payroll

     —          8,649        270        —          8,919   

Accrued vacation

     —          4,297        171        —          4,468   

Accrued insurance

     —          1,648        —          —          1,648   

Accrued interest

     3,850        —          —          —          3,850   

Accrued other

     —          4,596        216        —          4,812   
                                        

Total current liabilities

     7,154        47,548        2,855        —          57,557   

Long-term debt, excluding current installments

     406,549        —          —          —          406,549   

Obligations under capital leases, excluding current installments

     —          944        230        —          1,174   

Lease financing obligation, excluding current installments

     —          —          20,152        —          20,152   

Accrued insurance

     —          4,184        —          —          4,184   

Other noncurrent liabilities

     5,500        1,894        —          —          7,394   
                                        

Total liabilities

     419,203        54,570        23,237        —          497,010   

Commitments and contingencies

          

Stockholder’s equity (deficit):

          

Common stock

     —          —          —          —          —     

Additional paid-in capital

     172,200        63        1,500        (1,563     172,200   

Retained earnings (accumulated deficit)

     (194,365     283,231        (11,043     (272,188     (194,365
                                        

Total stockholder’s equity (deficit)

     (22,165     283,294        (9,543     (273,751     (22,165
                                        
   $ 397,038      $ 337,864      $ 13,694      $ (273,751   $ 474,845   
                                        

 

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LifeCare Holdings, Inc.

Condensed Consolidating Statement of Operations

For the Three Months Ended September 30, 2009

(in thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Totals
 

Net patient service revenue

   $ —        $ 81,461      $ 2,800      $ —        $ 84,261   
                                        

Salaries, wages and benefits

     79        38,312        1,587        —          39,978   

Supplies

     —          7,963        306        —          8,269   

Rent

     —          5,854        167        —          6,021   

Other operating expenses

     237        19,328        882        —          20,447   

Provision for doubtful accounts

     —          1,044        59        —          1,103   

Gain on early extinguishment of debt

     (558     —          —          —          (558

Depreciation and amortization

     —          2,379        345        —          2,724   

Intercompany (income) expenses

     557        (754     197        —          —     

Interest expense, net

     7,164        17        432        —          7,613   
                                        

Total expenses

     7,479        74,143        3,975        —          85,597   
                                        

Operating income (loss)

     (7,479     7,318        (1,175     —          (1,336

Earnings in investments in subsidiaries

     (5,976     —          —          5,976        —     

Equity in income of joint venture

     —          —          25        —          25   
                                        

Income (loss) before income taxes

     (1,503     7,318        (1,150     (5,976     (1,311

Provision for income taxes

     —          192        —          —          192   
                                        

Net income (loss)

   $ (1,503   $ 7,126      $ (1,150   $ (5,976   $ (1,503
                                        

 

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LifeCare Holdings, Inc.

Condensed Consolidating Statement of Operations

For the Nine Months Ended September 30, 2009

(in thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Totals
 

Net patient service revenue

   $ —        $ 265,205      $ 5,725      $ —        $ 270,930   
                                        

Salaries, wages and benefits

     244        120,745        4,584        —          125,573   

Supplies

     —          25,097        634        —          25,731   

Rent

     —          18,410        492        —          18,902   

Other operating expenses

     1,366        62,443        2,026        —          65,835   

Provision for doubtful accounts

     —          4,099        111        —          4,210   

Gain on early extinguishment of debt

     (642     —          —          —          (642

Depreciation and amortization

     —          7,067        1,037        —          8,104   

Intercompany (income) expenses

     485        (884     399        —          —     

Interest expense, net

     22,431        286        1,247        —          23,964   
                                        

Total expenses

     23,884        237,263        10,530        —          271,677   
                                        

Operating income (loss)

     (23,884     27,942        (4,805     —          (747

Earnings in investments in subsidiaries

     (22,033     —          —          22,033        —     

Equity in income (loss) of joint venture

     —          (537     25        —          (512
                                        

Income (loss) before income taxes

     (1,851     27,405        (4,780     (22,033     (1,259

Provision for income taxes

     —          592        —          —          592   
                                        

Net income (loss)

   $ (1,851   $ 26,813      $ (4,780   $ (22,033   $ (1,851
                                        

 

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LifeCare Holdings, Inc.

Condensed Consolidating Statement of Cash Flows

For the Nine Months Ended September 30, 2009

(in thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Totals
 

Cash flows from operating activities:

          

Net income (loss)

   $ (1,851   $ 26,813      $ (4,780   $ (22,033   $ (1,851

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

          

Depreciation and amortization

     1,655        7,067        1,037        —          9,759   

Provision for doubtful accounts

     —          4,099        111        —          4,210   

Equity compensation amortization

     235        —          —          —          235   

Gain on early extinguishment of debt

     (642     —          —          —          (642

Loss on the disposition of assets

     —          2        —          —          2   

Equity in loss of joint venture

     —          537        (25     —          512   

Changes in operating assets and liabilities:

          

Patient accounts receivable

     —          8,961        (2,074     —          6,887   

Current income taxes

     —          9        —          —          9   

Prepaid expenses and other current assets

     —          145        (221     —          (76

Change in investments in subsidiary

     (22,033     —          —          22,033        —     

Other assets

     —          467        —          —          467   

Due to/from related parties

     5,444        (9,428     3,984        —          —     

Estimated third-party payor settlements

     —          (1,452     1,694        —          242   

Accounts payable and accrued expenses

     (3,829     (2,733     867        —          (5,695

Other liabilities

     —          (1,433     —          —          (1,433
                                        

Net cash provided by (used in) operating activities

     (21,021     33,054        593        —          12,626   
                                        

Cash flows from investing activities:

          

Purchases of property and equipment

     —          (3,296     (144     —          (3,440

Investment in joint venture

     (1,500     —          (6     1,500        (6

Note receivable with joint venture

     —          —          (1,400     —          (1,400
                                        

Net cash used in investing activities

     (1,500     (3,296     (1,550     1,500        (4,846
                                        

Cash flows from financing activities:

          

Equity investments

     —          —          1,500        (1,500     —     

Net change in borrowings under the line of credit

     25,000        —          —          —          25,000   

Payments of notes payable and long-term debt

     (2,479     —          —          —          (2,479

Payments on obligations under capital leases

     —          (735     (192     —          (927

Payment on lease financing obligation

     —          —          (351     —          (351
                                        

Net cash provided by (used in) financing activities

     22,521        (735     957        (1,500     21,243   
                                        

Net increase in cash and cash equivalents

     —          29,023        —          —          29,023   

Cash and cash equivalents, beginning of period

     —          25,261        1        —          25,262   
                                        

Cash and cash equivalents, end of period

   $ —        $ 54,284      $ 1      $ —        $ 54,285   
                                        

 

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LifeCare Holdings, Inc.

Condensed Consolidating Balance Sheet

December 31, 2008

(in thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Totals
 
Assets           

Current assets:

          

Cash and cash equivalents

   $ —        $ 25,261      $ 1      $ —        $ 25,262   

Accounts receivable, net of allowance for doubtful accounts

     —          65,984        819        —          66,803   

Due to/from related parties

     118,651        (108,211     (10,440     —          —     

Income taxes

     1,785        (506     —          —          1,279   

Other current assets

     —          7,407        328        —          7,735   
                                        

Total current assets

     120,436        (10,065     (9,292     —          101,079   

Investment in subsidiary

     250,219        —          —          (250,219     —     

Property and equipment, net

     —          62,173        24,306        —          86,479   

Other assets

     8,893        3,704        —          —          12,597   

Identifiable intangibles, net

     —          17,305        —          —          17,305   

Goodwill

     —          245,370        —          —          245,370   
                                        
   $ 379,548      $ 318,487      $ 15,014      $ (250,219   $ 462,830   
                                        
Liabilities and Stockholder’s Equity (Deficit)           

Current liabilities:

          

Current installments of long-term debt

   $ 2,550      $ —        $ —        $ —        $ 2,550   

Current installments of obligations under capital leases

     —          992        260        —          1,252   

Current installment of lease financing obligations

     —          —          292        —          292   

Estimated third-party payor settlements

     —          7,075        (844     —          6,231   

Accounts payable

     (774     27,309        158        —          26,693   

Accrued payroll

     —          9,758        134        —          9,892   

Accrued vacation

     —          3,526        88        —          3,614   

Accrued insurance

     —          900        —          —          900   

Accrued interest

     8,127        —          —          —          8,127   

Accrued other

     —          3,468        174        —          3,642   
                                        

Total current liabilities

     9,903        53,028        262        —          63,193   

Long-term debt, excluding current installments

     384,694        —          —          —          384,694   

Obligations under capital leases, excluding current installments

     —          1,466        370        —          1,836   

Lease-financing obligation, excluding current installments

     —          —          20,645        —          20,645   

Accrued insurance

     —          3,592        —          —          3,592   

Other noncurrent liabilities

     5,500        3,919        —          —          9,419   
                                        

Total liabilities

     400,097        62,005        21,277        —          483,379   

Stockholder’s equity (deficit):

          

Common stock

     —          —          —          —          —     

Additional paid-in capital

     171,965        63        —          (63     171,965   

Retained earnings (accumulated deficit)

     (192,514     256,419        (6,263     (250,156     (192,514
                                        

Total stockholder’s equity (deficit)

     (20,549     256,482        (6,263     (250,219     (20,549
                                        
   $ 379,548      $ 318,487      $ 15,014      $ (250,219   $ 462,830   
                                        

 

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LifeCare Holdings, Inc.

Condensed Consolidating Statement of Operations

For the Three Months Ended September 30, 2008

(in thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Totals
 

Net patient service revenue

   $ —        $ 82,039      $ 355      $ —        $ 82,394   
                                        

Salaries, wages and benefits

     62        39,528        930        —          40,520   

Supplies

     —          8,256        97        —          8,353   

Rent

     —          6,239        92        —          6,331   

Other operating expenses

     303        19,160        439        —          19,902   

Provision for doubtful accounts

     —          144        7        —          151   

Depreciation and amortization

     —          2,524        494        —          3,018   

Intercompany (income) expenses

     696        (723     27        —          —     

Interest expense, net

     8,747        14        448        —          9,209   
                                        

Total expenses

     9,808        75,142        2,534        —          87,484   
                                        

Operating income (loss)

     (9,808     6,897        (2,179     —          (5,090

Earnings in investments in subsidiaries

     4,647        —          —          (4,647     —     
                                        

Income (loss) before income taxes

     (5,161     6,897        (2,179     (4,647     (5,090

Provision for income taxes

     764        71        —          —          835   
                                        

Net income (loss)

   $ (5,925   $ 6,826      $ (2,179   $ (4,647   $ (5,925
                                        

 

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LifeCare Holdings, Inc.

Condensed Consolidating Statement of Operations

For the Nine Months Ended September 30, 2008

(in thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Totals
 

Net patient service revenue

   $ —        $ 257,393      $ 393      $ —        $ 257,786   
                                        

Salaries, wages and benefits

     215        120,938        2,258        —          123,411   

Supplies

     —          26,057        152        —          26,209   

Rent

     —          18,692        368        —          19,060   

Other operating expenses

     834        59,537        1,104        —          61,475   

Provision for doubtful accounts

     —          2,592        8        —          2,600   

Depreciation and amortization

     —          7,928        677        —          8,605   

Intercompany (income) expenses

     4,051        (4,078     27        —          —     

Interest expense, net

     27,009        242        884        —          28,135   
                                        

Total expenses

     32,109        231,908        5,478        —          269,495   
                                        

Operating income (loss)

     (32,109     25,485        (5,085     —          (11,709

Earnings in investments in subsidiaries

     19,904        —          —          (19,904     —     
                                        

Income (loss) before income taxes

     (12,205     25,485        (5,085     (19,904     (11,709

Provision for income taxes

     763        496        —          —          1,259   
                                        

Net income (loss)

   $ (12,968   $ 24,989      $ (5,085   $ (19,904   $ (12,968
                                        

 

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LifeCare Holdings, Inc.

Condensed Consolidating Statement of Cash Flows

For the Nine Months Ended September 30, 2008

(in thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Totals
 

Cash flows from operating activities:

          

Net income (loss)

   $ (12,968   $ 24,989      $ (5,085   $ (19,904   $ (12,968

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

          

Depreciation and amortization

     1,597        7,928        677        —          10,202   

Provision for doubtful accounts

     —          2,592        8        —          2,600   

Equity compensation amortization

     203        —          —          —          203   

Changes in operating assets and liabilities:

          

Patient accounts receivable

     —          (2,282     (399     —          (2,681

Current income taxes

     610        (96     —          —          514   

Prepaid expenses and other current assets

     301        (322     (192     —          (213

Change in investments in subsidiary

     (19,904     —          —          19,904        —     

Other assets

     (81     737        —          —          656   

Due to/from related parties

     25,205        (32,973     7,768        —          —     

Estimated third-party payor settlements

     —          (3,155     —          —          (3,155

Accounts payable and accrued expenses

     (3,050     8,361        (706     —          4,605   

Other liabilities

     —          1,068        —          —          1,068   
                                        

Net cash provided by (used in) operating activities

     (8,087     6,847        2,071        —          831   
                                        

Cash from investing activities:

          

Purchases of property and equipment

     —          (6,170     (5,552     —          (11,722

Sale-leaseback proceeds

     —          3,714        —          —          3,714   
                                        

Net cash used in investing activities

     —          (2,456     (5,552     —          (8,008
                                        

Cash flows from financing activities:

          

Proceeds from lease financing obligation

     —          —          3,829        —          3,829   

Payment on lease financing obligation

     —          —          (200     —          (200

Net change in borrowings under the line of credit

     10,000        —          —          —          10,000   

Payments of notes payable and long-term debt

     (1,913     —          —          —          (1,913

Proceeds from capital lease financing

     —          1,802        —          —          1,802   

Payments on obligations under capital leases

     —          (1,757     (147     —          (1,904
                                        

Net cash provided by financing activities

     8,087        45        3,482        —          11,614   
                                        

Net increase in cash and cash equivalents

     —          4,436        1        —          4,437   

Cash and cash equivalents, beginning of period

     —          17,816        —          —          17,816   
                                        

Cash and cash equivalents, end of period

   $ —        $ 22,252      $ 1      $ —        $ 22,253   
                                        

 

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ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion and analysis should be read in conjunction with our condensed consolidated financial statements and the accompanying notes.

Company Overview

We began operations in 1993 and have grown our business through developing and acquiring hospitals to become a leading operator of long-term acute care (“LTAC”) hospitals in the United States. As of September 30, 2009, we operated 19 hospitals located in 9 states, consisting of eight “hospital within a hospital” facilities (27% of beds) and 11 freestanding facilities (73% of beds). Through these 19 long-term acute care hospitals, we operate a total of 1,059 licensed beds and employ approximately 3,100 people, the majority of whom are registered or licensed nurses and respiratory therapists. Additionally, we hold a 50% investment in a joint venture for a 51-bed LTAC hospital operation located in Muskegon, Michigan.

We believe we have developed a reputation for excellence in providing treatment for patients with complex medical needs requiring extended treatment. Our patients have serious medical conditions such as respiratory failure, chronic pulmonary disease, nervous system disorders, infectious diseases and severe wounds. They generally require a high level of monitoring and specialized care, yet may not require the continued services of an intensive care unit. Due to their serious medical conditions, our patients are generally not clinically appropriate for admission to a skilled nursing facility or inpatient rehabilitation facility. By combining general acute care services with a focus on long-term treatment, we believe that our hospitals provide medically complex patients with better and more cost-effective outcomes.

LifeCare Holdings, Inc. (the “Company”) is a wholly owned subsidiary of LCI Holdco, LLC (“Holdco”). Holdco is a wholly owned subsidiary of LCI Holding Company, Inc. (“Holdings”), which is owned by an investor group that includes affiliates of The Carlyle Group and members of the board of directors. The investor group acquired Holdings pursuant to a merger that occurred on August 11, 2005 (the “Merger”). Subsequent to the merger in late August 2005, the impact of Hurricane Katrina forced the closure of three hospitals we operated in the New Orleans market. At the time of their closure, these three hospitals had combined annual revenues of approximately $44 million.

Recent Trends and Events

Hospital Openings and Closings

In April 2008, we opened a new 60-bed freestanding facility in Boise, Idaho, and added 10 beds to our Denver, Colorado facility.

On September 1, 2009, we, along with a subsidiary of Select Medical Corporation (“Select”), each contributed our hospital operations, located in the Muskegon, Michigan market, and related licenses and provider numbers, along with $1.5 million in cash and net assets, into a newly formed limited liability company in exchange for each receiving a 50% ownership in the newly formed entity. The joint venture, which is currently comprised of 51 beds in two separate locations in the Muskegon market, will be managed by Select. The $1.5 million cash contributions made by each party were comprised of a $0.1 million equity contribution and a $1.4 million note receivable (“Subordinated Note”). The 50% ownership we have in the joint venture is held by a newly formed subsidiary of the Company and has been designated as a non-guarantor subsidiary pursuant to our senior secured credit facility. The Subordinated Note bears an interest rate of 10% and will mature on August 31, 2019. The joint venture may make quarterly payments with available cash flows prior to the maturity.

Regulatory Changes

Approximately 59.1% and 60.9% of our total net patient service revenue for the nine months ended September 30, 2009 and 2008, respectively, came from Medicare reimbursement. Our industry is subject to extensive government regulation, including regulation of the Medicare reimbursement process. Changes in these regulations can have a material impact on the way we operate our business and on our results of operations. Currently, Congress is considering various healthcare reforms that could materially impact the Medicare program and could have a material adverse effect on our business, financial position, results of operations and liquidity. These reforms could also negatively impact commercial insurance companies, which could likewise negatively impact the rates we receive for providing services to commercial pay patients.

2009 Interim Final Rule

On June 3, 2009, the Centers for Medicare & Medicaid Services (“CMS”) published an interim final rule whereby CMS is adopting a new table of Medicare-Severity Diagnosis Related Groups (“MS-LT-DRG”) relative weights for all discharges from LTAC hospitals on or after June 3, 2009 through the remainder of fiscal year 2009, which ends on September 30, 2009 (the “2009 Interim Final Rule”). CMS indicated in the interim final rule that it misapplied its established methodology in the calculation of the budget neutrality factor in determining the relative weights for the 2009 fiscal year. Accordingly, CMS has revised the MS-LT-DRG relative weights with this interim final rule to correct the misapplication. The initial budget neutrality factor used by CMS was 1.04186, which CMS states was calculated using unadjusted recalibrated relative weights rather than using the normalized relative weights. The

 

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revised calculation resulted in a budget neutrality factor of 1.0030401. The application of this revised budget neutrality factor resulted in a reduction in the relative weights of approximately 3.9% for the 2009 fiscal year (beginning October 1, 2008). There are certain regulatory restrictions that prevent a retroactive correction of this calculation adjustment; therefore, CMS is only applying the corrected weights to LTAC hospital discharges occurring on or after June 3, 2009 through September 30, 2009.

The 2009 Final Rule

On July 31, 2009, the CMS displayed their final annual payment update for LTAC hospitals for the 2010 rate year, which will be effective for all discharges on or after October 1, 2009 (the “2009 Final Rule”). The 2009 Final Rule includes a net increase in the standard federal rate of $783 to $39,897, or 2.0%, which is based on a market basket update of 2.5% less an adjustment of 0.5% to account for changes in documentation and coding practices. The 2009 Final Rule also includes a decrease in the high-cost outlier fixed-loss amount to $18,425 from $22,960. Additionally, the 2009 Final Rule includes updates to the weighting of MS-LT-DRGs, which CMS indicates will be budget neutral for aggregate LTAC hospital payments. CMS has estimated that the changes for the 2010 rate year, taken as a whole, will result in an increase of 3.3% in Medicare reimbursement to LTAC hospitals. Individual hospitals, however, may see varying effects of this proposed rule depending upon their Medicare patient population and their specific base rate changes due to geographical location.

The 2009 Final Rule also finalized the interim final rule issued on June 3, 2009, discussed previously, as well as the June 3, 2009 supplement to the proposed rule previously published by CMS on May 1, 2009. This rule updates the rate year 2010 LTAC- Prospective Payment System (“PPS”) payments by revising the table of MS-LTC-DRG relative weights for the rate year 2010, which is based on the amended fiscal year 2009 weights. These changes have been taken into account in the CMS impact calculations outlined above.

The American Recovery and Reinvestment Act of 2009

On February 17, 2009, legislation known as the American Recovery and Reinvestment Act of 2009 (“2009 Act”) was signed into law. This legislation included certain amendments to the Medicare, Medicaid and SCHIP Extension Act of 2007 (discussed below), including the application of the moratorium granted to LTAC hospitals regarding the “25 Percent Rule” as it applies to certain “grandfathered” LTAC satellite hospitals. Prior to the 2009 Act amendment, CMS’ interpretation of the moratorium provisions was such that grandfathered “satellites” were excluded from the moratorium; however, the 2009 Act clarified that the provisions of the moratorium are applicable to “grandfathered” LTAC satellite hospitals.

CMS Changes to DRG Weighting for Fiscal 2009

On July 31, 2008, CMS issued its final regulations regarding the re-weighting of MS-LT-DRGs that became effective for discharges on or after October 1, 2008. CMS indicated that these changes were made in a budget-neutral manner and that aggregate LTAC hospital payments would be unaffected by these changes. It is likely, however, that individual hospitals will see varying effects of this rule depending upon the acuity levels of their Medicare patient populations. As discussed previously, CMS issued the 2009 Interim Final Rule, which modified the MS-LT-DRG re-weighting contained in the July 31, 2008 regulations.

The 2008 Final Rule

On May 2, 2008, CMS issued its annual regulatory update regarding Medicare reimbursement for LTAC hospitals that became effective for all discharges on or after July 1, 2008 (the “2008 Final Rule”). The 2008 Final Rule included, among other things, (1) an increase in the standard federal rate to $39,114, which represented a 2.7% increase, and (2) an increase in the high-cost outlier threshold of $2,222 to $22,960. Additionally, CMS changed the timetable for annual updates to a fiscal year schedule starting on October 1 instead of July 1, which will result in the 2009 rate year rates being in effect for 15 months beginning July 1, 2008. CMS estimated that the changes for the 2009 rate year, taken as a whole, would result in an increase of 2.5% in Medicare reimbursement to LTAC hospitals. Individual hospitals, however, are expected to see varying effects of this rule depending on their Medicare patient population and their specific base rate changes due to geographic location.

The Medicare, Medicaid and SCHIP Extension Act of 2007

On December 29, 2007, legislation known as the Medicare, Medicaid and SCHIP Extension Act of 2007 (the “SCHIP Extension Act”) was signed into law and became effective for cost reporting periods beginning after December 29, 2007. This legislation provides for, among other things:

 

  1) enhanced medical necessity reviews of LTAC hospital cases and a mandated study by the Secretary of Health and Human Services on the establishment of LTAC hospital certification criteria;

 

  2) three-year moratoriums on the following:

 

  a. the establishment of a LTAC hospital or satellite facility, subject to exceptions for facilities under development;

 

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  b. an increase in the number of beds at a LTAC hospital or satellite facility, subject to exceptions for states where there is only one LTAC hospital or upon request following the closure or decrease in the number of beds at a LTAC hospital within the state;

 

  c. the application of the so-called “25 Percent Rule” to freestanding and grandfathered LTAC hospitals;

 

  d. the very short-stay outlier payment reductions to LTAC hospitals initially implemented on May 11, 2007; and

 

  e. the application of a one-time budget neutrality adjustment of payment rates to LTAC hospitals under the PPS;

 

  3) a three-year period during which certain types of LTAC hospitals that are co-located within another hospital may admit up to 50% of their patients from the host hospitals and still be paid according to the LTAC hospital PPS;

 

  4) a three-year period during which certain types of LTAC hospitals that are co-located with an urban single hospital or a hospital that generates more than 25% of the Medicare discharges in a metropolitan statistical area (“MSA Dominant hospital”) may admit up to 75% of their patients from such urban single hospital or MSA Dominant hospital and still be paid according to the LTAC prospective payment system; and

 

  5) the elimination of the July 1, 2007 market basket increase in the standard federal payment rate of 0.71%, effective for discharges occurring on or after April 1, 2008.

Additionally, the SCHIP Extension Act expanded the definition of a LTAC hospital. Historically, for a hospital to be certified as a LTAC hospital, the primary requirement was the average length of stay for Medicare patients, measured annually at the end of a cost report period, be in excess of 25 days. The SCHIP Extension Act modified this definition to include, among other items, that the LTAC hospital has a patient review process that screens patients prior to admission for appropriateness of admission, validates within 48 hours of admission that patients meet admission criteria, regularly evaluates patients during their stay and assesses available discharge options when patients fail to continue to meet stay criteria.

We believe that the additional certification criteria will not impact the certification status of our LTAC hospitals.

CMS Changes to DRG Weighting for Fiscal 2008

On August 1, 2007, CMS issued final inpatient prospective payment system regulations for fiscal year 2008. These regulations established a new Medicare severity-based patient classification system for fiscal year 2008 for LTAC hospitals. The MS-LT-DRG system created additional severity-adjusted categories for most diagnoses, resulting in an expansion of the number of Diagnosis Related Groups (“DRGs”) from 538 to 745. CMS stated that MS-LT-DRG weights were developed in a budget neutral manner and as such, the estimated aggregate payments under LTAC PPS would be unaffected by the annual recalibration of MS-LT-DRG payment weights. CMS provided for a two year phase-in period to mitigate the transition in payments for short-term acute and LTAC PPS providers. In fiscal 2008, provider reimbursements were based 50% on new MS-LT-DRGs and 50% on existing DRGs. For fiscal 2009, 100% of provider reimbursements will be based on new MS-LT-DRGs.

CMS also stated that future annual updates to the DRG classifications and relative weights will be made in a budget neutral manner, effective October 1, 2007. As such, it is expected that the estimated aggregate industry LTAC hospital PPS payments would be unaffected by the annual recalibration of DRG payment weights.

The 2007 Final Rule

On May 1, 2007, CMS issued its annual regulatory update regarding Medicare reimbursement for LTAC hospitals (the “2007 Final Rule”) that was effective for all discharges on or after July 1, 2007. This rule was amended on June 29, 2007, by revising the high cost outlier threshold. CMS estimated that the impact of the 2007 Final Rule was an overall net decrease in payments to all Medicare certified LTAC hospitals of approximately 1.2%. The 2007 Final Rule included, among other things, (1) an increase to the standard federal payment rate of 0.71% (subsequently eliminated effective April 1, 2008, as provided for in the SCHIP Extension Act as previously discussed); (2) revisions to payment methodologies impacting short-stay outliers, which reduce payments by 0.9% (also subsequently modified by the SCHIP Extension Act via three-year moratorium on this new provision); (3) adjustments to the wage index component of the federal payment resulting in projected reductions in payment of 0.5%; (4) an increase in the high cost outlier threshold per discharge to $20,738, resulting in projected reimbursement reductions of 0.4%; and (5) an extension of the policy known as the “25 Percent Rule” to all LTAC hospitals, with a three-year phase in, which CMS projects will not result in payment reductions for the first year of implementation (also subsequently modified by the SCHIP Extension Act via a three-year moratorium on this provision).

A significant policy change contained in the 2007 Final Rule was the application of the so-called “25 Percent Rule” to all LTAC hospitals. The result of this policy change was that all LTAC hospitals were to be paid the LTAC PPS rates for admissions from a single referral source up to 25% of aggregate Medicare admissions. Admissions in excess of the 25% threshold were to be paid at a lesser amount based upon short-term acute care hospital rates. Patients admitted who had previously reached a high cost outlier status in the referring short-term hospital were not counted when computing compliance with this limitation. As discussed previously, these provisions were modified by the SCHIP Extension Act and the 2009 Act.

 

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Regulatory Matters

On June 12, 2006 we entered into a Settlement Agreement and a Certification of Compliance Agreement (“CCA”) with the Office of Inspector General of the Department of Health and Human Services (“OIG”) that settled certain cost report matters for the years 1997 to 2001. The amount paid in connection with this settlement was approximately $2.6 million, which was funded out of a specific escrow account established as part of the Merger that occurred on August 11, 2005. The CCA was effective for three years. It required, among other things, that we (1) continue to maintain our corporate compliance program, (2) submit an annual report to the OIG regarding certain specified items, including our on-going corporate compliance audit findings in areas such as cost reports, physician contracting and charge master reviews, and (3) report the occurrence of certain other events.

We filed our third and final annual report summarizing our annual compliance activities with the OIG on August 10, 2009. Upon the OIG’s acceptance of this filing, we expect that the CCA will be terminated effective June 12, 2009.

Periodically the Centers for Medicare & Medicaid Services (“CMS”) will conduct surveys of hospitals and other health care providers as a condition of participation in the Medicare program. The purpose of these surveys is to ensure that healthcare providers are in compliance with various governmental requirements related to adequacy of medical care, equipment, personnel, operating policies and procedures, maintenance of adequate records, compliance with building codes and environmental protection and healthcare fraud and abuse. On July 24, 2009, we received a notice from CMS that pursuant to a routine inspection related to the physical plant of one of our hospitals, certain deficiencies and conditions were noted to exist which must be corrected. Subsequent to this notice, we implemented corrective plans to remedy the deficiencies and conditions that were cited in the CMS notification, and, in a limited number of cases, we requested and were granted time-limited waivers for certain matters that will require additional time to remedy. As a result of the corrective actions and the receipt of certain waivers, we were notified by CMS on October 15, 2009, that the hospital is now in compliance with the Medicare conditions of participation and that the hospital is no longer subject to termination of its participation in the Medicare program as a result of the initial deficiencies and conditions. If the hospital is not successful in addressing the deficiencies and conditions in a timely manner as permitted by the waivers granted by CMS, which extend through June 1, 2010, then CMS reserves the right to deem the hospital to be out of compliance with certain Medicare conditions of participation and may terminate the hospital from participation in the Medicare program. The termination of this hospital from the Medicare program would have a material adverse effect on our results of operations and cash flows. We are in the process of correcting the remaining deficiencies and conditions for which waivers were granted and believe that these issues will be successfully resolved in a timely manner and that the hospital will continue to comply with the conditions of participation as set forth by CMS.

Sources of Revenue

We are reimbursed for our services provided to patients by a number of sources, including the federal Medicare program and commercial payors. Payment arrangements include prospectively determined rates per discharge, reimbursed costs, discounted charges and per diem rates. Our net patient service revenue consists of the amounts that we estimate to be reimbursable from each of the applicable non-governmental payors and the Medicare and Medicaid programs. We account for the differences between the estimated reimbursement rates and our standard billing rates as contractual adjustments, which are deducted from gross revenues to arrive at net revenues. We record accounts receivable resulting from such payment arrangements net of contractual allowances. Net patient service revenues generated directly from the Medicare program approximated 59.1% and 60.9% of total net patient service revenue for the nine months ended September 30, 2009 and 2008, respectively. Net patient service revenues generated from non-Medicare payors were primarily from commercial payors.

Laws and regulations governing provider reimbursement pursuant to the Medicare program are complex and subject to interpretation. The Medicare reimbursement amounts reported in our financial statements are based upon estimates and, as such, are subject to adjustment until such time as our billings and cost reports are filed and settled with the appropriate regulatory authorities. Federal regulations require that providers participating in the Medicare program submit annual cost reports associated with services provided to program beneficiaries. In addition, payments under LTAC hospital PPS are subject to review by the regulatory authorities, including enhanced medical necessary reviews pursuant to the SCHIP Extension Act and the Recovery Audit Contractor (“RAC”) program pursuant to the Tax Relief and Health Care Act of 2006. These reviews primarily focus on the accuracy of the DRG assigned to each discharged patient and normally occur after the completion of the billing process.

The annual cost reports are subject to review and adjustment by CMS through its fiscal intermediaries. These reviews may not occur until several years after a provider files its cost reports and often results in adjustments to amounts reported by providers in their cost reports as a result of the complexity of the regulations and the inherent judgment that is required in the application of certain provisions of provider reimbursement regulations. Since these reviews of filed cost reports occur periodically, there is a possibility that recorded estimated Medicare reimbursement reflected in our consolidated financial statements and previously filed cost reports may change by a material amount in future periods. We recognize in our consolidated financial statements the impact of adjustments, if any, to estimated Medicare reimbursement when the amounts can be reasonably determined.

 

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Total Expenses

Total expenses consist of salaries, wages and benefits, supplies, which includes expenses related to drug and medical supplies, rent, other operating expenses, provision for doubtful accounts, depreciation and amortization and interest expense. Other operating expenses include expenses such as contract labor, legal and accounting fees, insurance and contracted services purchased from host hospitals.

Other Operating Metrics

We use certain operating metrics in the management of our facility operations. These include:

Licensed beds. Licensed beds represent beds for which a facility has been granted approval to operate from the applicable state licensing agency. These licensed beds are used in the determination of average licensed beds and occupancy rates.

Average licensed beds. We compute average licensed beds by computing a weighted average based upon the number of licensed beds in place for each month within the reporting period.

Admissions. Admissions are the total number of patients admitted to our facilities during the reporting period.

Patient days. Patient days are the cumulative number of days that licensed beds are occupied in our facilities for the entire reporting period. We also refer to patient days as our census.

Average length of stay (days). We compute average length of stay in days by dividing patient days for discharged patients by discharges.

Occupancy rates. We compute our occupancy rate by determining the percentage of average licensed beds that are occupied for a 24-hour period during a reporting period. The occupancy rate provides a measure of the utilization of inpatient rooms.

Net patient service revenue per patient day. This measure is determined by dividing our total net patient service revenue by the number of patient days in a reporting period. We use this metric to provide a measure of the net patient service revenue generated for each patient day.

Critical Accounting Matters

This discussion and analysis of our financial condition and results of operation is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of those financial statements requires the use of estimates and judgments that affect the reported amounts and related disclosures. We rely on historical experience and other assumptions that we believe are reasonable at the time in forming the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual amounts may differ from these estimates.

We believe that the following critical accounting policies as more fully described in our annual financial statements as of December 31, 2008 as filed in the Form 10-K, affect the more significant judgments and estimates used in the preparation of our consolidated financial statements.

 

   

Revenue recognition

 

   

Accounts receivable and allowance for doubtful accounts

 

   

Insurance Risks

 

   

Impairment of Long-Lived Assets

 

   

Accounting for income taxes

 

   

Accounting for stock-based compensation

Goodwill

We review our goodwill annually, or more frequently if circumstances warrant a more timely review, to determine if there has been an impairment. Per the guidance of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Section 350-20-55, Intangibles-Goodwill and Other-Goodwill-Implementation Guidance and Illustrations, formally FASB Emerging Issues Task Force (“EITF”) Topic No. D-101 Clarification of Reporting Unit Guidance in Paragraph 30 of FASB Statement No. 142, (“EITF Topic No. D-101”), we review goodwill based upon one reporting unit, as the Company is managed as one operating segment in accordance with FASB ASC Subtopic 280-10, Segment Reporting-Overall, formally Statement of Financial Accounting Standards (“SFAS”) No. 131, Disclosures about Segments of an Enterprise and Related Information, (“SFAS 131”). In calculating the fair value of the reporting unit, we use various assumptions including projected cash flows and discount rates. If projected future cash flows decline from the current amounts projected by management, additional impairments may be recorded.

 

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Results of Operations

The following table sets forth operations results for each of the periods presented (in thousands):

 

     Three Months Ended
September 30
    Nine Months Ended
September 30
 
     2009     2008     2009     2008  

Net patient service revenue

   $ 84,261      $ 82,394      $ 270,930      $ 257,786   

Salaries, wages and benefits

     39,978        40,520        125,573        123,411   

Supplies

     8,269        8,353        25,731        26,209   

Rent

     6,021        6,331        18,902        19,060   

Other operating expenses

     20,447        19,902        65,835        61,475   

Provision for doubtful accounts

     1,103        151        4,210        2,600   

Gain on early extinguishment of debt

     (558     —          (642     —     

Depreciation and amortization

     2,724        3,018        8,104        8,605   

Interest expense, net

     7,613        9,209        23,964        28,135   
                                

Total expenses

     85,597        87,484        271,677        269,495   
                                

Operating loss

     (1,336     (5,090     (747     (11,709

Equity in income (loss) of joint venture

     25        —          (512     —     
                                

Loss before income taxes

     (1,311     (5,090     (1,259     (11,709

Provision for income taxes

     192        835        592        1,259   
                                

Net loss

   $ (1,503   $ (5,925   $ (1,851   $ (12,968
                                

Operating Statistics

The following table sets forth operating statistics for each of the periods presented:

 

     Three Months Ended
September 30
    Nine Months Ended
September 30
 
     2009     2008     2009     2008  

Number of hospitals within hospitals (end of period)

     8        9        8        9   

Number of freestanding hospitals (end of period)

     11        11        11        11   

Number of total hospitals (end of period)

     19        20        19        20   

Licensed beds (end of period)

     1,059        1,079        1,059        1,079   

Average licensed beds (1)

     1,072        1,079        1,077        1,056   

Admissions

     1,832        1,974        6,039        6,315   

Patient days

     52,868        55,329        169,640        176,927   

Occupancy rate

     53.6     55.7     57.7     61.1

Percent net patient service revenue from Medicare

     55.2     60.4     59.1     60.9

Percent net patient service revenue from commercial payors and Medicaid (2)

     44.8     39.6     40.9     39.1

Net patient service revenue per patient day

   $ 1,594      $ 1,489      $ 1,597      $ 1,457   

 

(1) The average licensed beds are only calculated on the beds at locations that were open for operations during the applicable periods.
(2) The percentage of net patient service revenue from Medicaid is less than one percent for each of the periods presented.

Three Months Ended September 30, 2009 Compared to Three Months Ended September 30, 2008

Net Revenues

Our net patient service revenue increased by $1.9 million, or 2.3%, for the three months ended September 30, 2009, to $84.3 million from $82.4 million for the comparable period in 2008. Patient days and admissions decreased by 4.4% and 7.2%, respectively, during the three months ended September 30, 2009 as compared to the same period in 2008.

The $1.9 million increase in net patient service revenue was comprised of a $0.2 million increase in adjustments related to changes in estimates and settlements on cost reports previously filed with the Medicare program, offset by an unfavorable variance of $3.7 million attributable to the decrease in patient days, with a remaining increase of $5.4 million attributable to an increase in revenue per patient day.

 

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During the three months ended September 30, 2009 our net patient service revenue per patient day was $1,594, as compared to $1,489 for the 2008 period, an increase of 7.1%. The increase in net patient service revenue on a per patient day basis during the 2009 period was primarily the result of annual inflationary increases in our standard charge rates and certain of our contracts with commercial payors, a higher acuity level of the patients treated in the 2009 period, and the marginal increases contained in recent annual regulatory updates implemented by CMS during 2008.

Total Expenses

Total expenses decreased by $1.9 million to $85.6 million for the three months ended September 30, 2009 as compared to $87.5 million for the comparable period in 2008. The decrease of $1.9 million was primarily the result of a decrease of $0.5 million in salaries, wages and benefits, a decrease of $1.6 million in net interest expense and the recognition of a gain of $0.6 million on the early extinguishment of debt, offset by an increase in the provision for doubtful accounts of $1.0 million.

The decrease in salaries, wages and benefits was primarily attributable to the decrease in patient volumes as previously discussed offset by increases attributable to the treatment of higher acuity patients during the 2009 period and annual inflationary increases. The decrease in interest expense was due to lower interest rates on our term debt offset by increased borrowings against our revolving credit facility. The increase in the provision for doubtful accounts was due to a benefit recognized during the 2008 period from collections during the period in excess of amounts previously reserved on certain accounts.

Income Tax Expense

For the three months ended September 30, 2009, income tax expense recorded represents the estimated income tax liability for certain state income taxes. We believe that it is more likely than not that no benefit or expense will be realized during 2009 for federal income taxes based on recent taxable loss trends.

Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008

Net Revenues

Our net patient service revenue increased by $13.1 million, or 5.1%, for the nine months ended September 30, 2009, to $270.9 million from $257.8 million for the comparable period in 2008. Patient days and admissions decreased by 4.1% and 4.4%, respectively, for the nine months ended September 30, 2009 as compared to the same period in 2008.

The $13.1 million increase in net patient service revenue was comprised of a $2.9 million increase in adjustments related to changes in estimates and settlements on cost reports previously filed with the Medicare program, offset by an unfavorable variance of $10.7 million attributable to the decrease in patient days, with a remaining increase of $20.9 million attributable to an increase in revenue per patient day. The net increase of $2.9 million for adjustments to previously filed cost reports was comprised of a favorable adjustment of $1.3 million recorded in the nine months ended September 30, 2009 offset by an unfavorable adjustment of $1.6 million recorded in the nine months ended September 30, 2008.

During the nine months ended September 30, 2009 and 2008, our net patient service revenue per patient day was $1,597 and $1,457, respectively. However, exclusive of the cost report reimbursement adjustments discussed previously, net patient service revenue per patient day for the nine months ended September 30, 2009 and 2008 was $1,589 and $1,466, respectively, or an increase of 8.4%. The increase in net patient service revenue on a per patient day basis during the 2009 period was primarily the result of annual inflationary increases in our standard charge rates and certain of our contracts with commercial payors, an increase in the percentage of our revenues generated from commercial payors, a higher acuity level of the patients treated in the 2009 period, and the marginal increases contained in recent annual regulatory updates implemented by CMS during 2008.

Total Expenses

Total expenses increased by $2.2 million to $271.7 million for the nine months ended September 30, 2009 as compared to $269.5 million for the comparable period in 2008. The increase of $2.2 million in total expenses was primarily the result of an increase in salaries, wages and benefits of $2.2 million, an increase in other operating expenses of $4.4 million and an increase of $1.6 million in the provision for doubtful accounts, offset by a decrease in net interest expense of $4.2 million.

The increase in salaries, wages and benefits was primarily attributable to the treatment of higher acuity patients during the 2009 period and annual inflationary increases. The increase in other operating expenses was primarily attributable to an increase in clinical purchased services as a result of the treatment of higher acuity patients, and an increase in insurance expenses during the three months ended June 30, 2009, as a result of the agreement with the insurance carriers in the amount of $1.0 million related to the Hurricane Katrina matters. The increase in the provision for doubtful accounts was due to a benefit recognized during the 2008 period from collections during the period in excess of amounts previously reserved on certain accounts. The decrease in interest expense was due to lower interest rates on our term debt offset by increased borrowings against our revolving credit facility.

 

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Income Tax Expense

For the nine months ended September 30, 2009, income tax expense recorded represents the estimated income tax liability for certain state income taxes. We believe that it is more likely than not that no benefit or expense will be realized during 2009 for federal income taxes based on recent taxable loss trends.

Liquidity and Capital Resources

Our primary sources of liquidity are cash on hand, expected cash flows generated by operations, and availability of borrowings under a revolving credit facility. Availability of borrowings under our revolving credit facility are generally dependent upon our ability to meet the maximum leverage ratio test included in the senior secured credit facility. Our primary liquidity requirements are for debt service on our senior secured credit facilities and the notes, capital expenditures and working capital.

At September 30, 2009, our debt structure consisted of $129.3 million aggregate principal amount of senior subordinated notes, which matures on August 11, 2013, a senior secured credit facility, consisting of (i) a $244.8 million term loan facility which matures on August 11, 2012, and (ii) a $60.0 million revolving credit facility, subject to availability, of which $35.0 million is outstanding, including sub-facilities for letters of credit and swingline loans, which matures on August 11, 2011. We also have capital lease obligations of $2.2 million with varying maturities. The full amount available under the term loan facility was used in connection with the Merger.

The senior secured credit facility requires us to comply on a quarterly basis with certain financial covenants, including an interest coverage ratio test and a maximum leverage ratio test. These financial covenants become more restrictive on a periodic basis throughout the remaining term of the senior secured credit facility, including the first quarter of 2010. In addition, the senior secured credit facility includes various negative covenants, including limitations on indebtedness, liens, investments, permitted businesses and transaction and other matters, as well as certain customary representations and warranties, affirmative covenants and events of default including payment defaults, breach of representations and warranties, covenant defaults, cross defaults to certain indebtedness, certain events of bankruptcy, certain events under ERISA, material judgments, actual or asserted failure of any guaranty or security document supporting the senior secured credit facility to be in full force and effect, change of control, and certain subjective provisions. We believe we are currently in compliance with the covenants of our senior secured credit facility as amended.

The interest rates per annum applicable to loans, other than swingline loans, under our senior secured credit facility are, at our option, equal to either an alternate base rate or an adjusted LIBOR rate for a one-, two-, three- or six-month interest period, or a nine- or twelve-month period if available, in each case, plus an applicable margin. The applicable margins on the loans as amended are currently (1) 3.25% for alternate base rate revolving loans, (2) 4.25% for adjusted LIBOR revolving loans, (3) 3.25% for alternate base rate term loans and (4) 4.25% for adjusted LIBOR term loans. These margins are subject to reduction based upon the ratio of our total indebtedness to our consolidated adjusted EBITDA (as defined in the credit agreement governing our senior secured credit facility, as amended). At September 30, 2009, the interest rate applicable to the $244.8 million under our term loan facility was 4.74%, and the weighted average rate on the $35.0 million outstanding balance of the revolving credit facility was 4.44%.

We may not be able to continue to satisfy the covenant requirements in subsequent periods. If we are unable to maintain compliance with the covenants contained in our senior secured credit facility, an event of default would occur. During the continuation of an event of default, the lenders under the senior secured credit facility are entitled to take various actions, including accelerating amounts due under the senior secured credit facility, terminating our access to our revolving credit facility and all other actions generally available to a secured creditor. An uncured event of default would have a material adverse effect on our financial position, results of operations and cash flow. In the event a financial covenant is not met, our senior secured credit facility provides for certain limited cure rights which provide us the ability to issue permitted cure securities in exchange for cash or otherwise receive cash that would be contributed to our capital in an amount that is necessary to satisfy the financial covenant required on a pro forma basis. The cure right amount, if exercised, continues to be considered a component of consolidated EBITDA, as defined in the senior secured credit agreement, on a trailing 4 quarter basis.

We believe that our cash on hand, expected cash flows from operations, and potential availability of borrowings under the revolving portion of our senior secured credit facilities will be sufficient to finance our operations, and meet our scheduled debt service requirements for at least the next twelve months.

We actively seek to identify and evaluate potential acquisition candidates and, from time to time, we review potential acquisitions of businesses. Any acquisitions may require us to issue additional equity or incur additional indebtedness, subject to the limitations contained in our senior secured credit facility.

We and our subsidiaries, affiliates or significant stockholders may from time to time seek to retire or purchase our outstanding debt through cash purchases and/or exchanges for equity securities, in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.

 

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Capital Expenditures

We anticipate that we may incur capital expenditures of approximately $1.4 million during the remainder of 2009 based on our current plans of ongoing capital maintenance expenditure requirements at our existing facilities. We may enter into lease arrangements to finance a portion of these equipment expenditures.

Historical Cash Flow

The following table summarizes the net cash provided by (used in) the statement of cash flows (in thousands):

 

     Nine Months Ended
September 30
 
     2009     2008  

Operating activities

   $ 12,626      $ 831   

Investing activities

     (4,846     (8,008

Financing activities

     21,243        11,614   

For the nine months ended September 30, 2009, cash provided by operating activities was $12.6 million as compared to cash provided of $0.8 million in the comparable period in 2008. For the nine months ended September 30, 2009, we had a net loss of $1.9 million as compared to a net loss of $13.0 million for the same period in 2008.

Accounts receivable decreased by $6.9 million for the nine months ended September 30, 2009 as compared to an increase of $2.7 million for same period during 2008. Days of net patient service revenue in accounts receivable at September 30, 2009 had decreased to 60.8 as compared to 67.0 at December 31, 2008. This decrease was primarily the result of favorable collection trends in the 2009 period as compared to the 2008 period.

Estimated third-party payor settlements provided a net increase in cash of $0.2 million during the 2009 period as compared to a net use of cash of $3.2 million for the nine months ended September 30, 2008.

A decrease in accounts payable and accrued expenses resulted in a net use of cash of $5.7 million for the nine months ended September 30, 2009 as compared to providing net cash of $4.6 million in the comparable period in 2008.

Cash used in investing activities was $4.8 million for the nine months ended September 30, 2009 as compared to a net use of cash of $8.0 million in 2008. Cash used in investing activities during the 2009 period was principally for recurring maintenance capital expenditures in addition to a net use of cash of $1.4 million related to the newly formed joint venture in the Muskegon, Michigan market as previously discussed. Cash used during the 2008 period was principally for the construction of our hospital in Boise, Idaho. This was offset by $3.7 million received in the 2008 period pursuant to our lease agreement with Healthcare REIT, Inc. attributable to our Milwaukee, Wisconsin facility.

Cash provided by financing activities for the nine months ended September 30, 2009 was $21.2 million as compared to cash provided of $11.6 million for the same period in 2008. The nine months ended September 30, 2009 include $25.0 million in net borrowings under the revolving line of credit. During the 2008 period, we received $3.8 million pursuant to the master lease associated with our capital expenditures on our Boise, Idaho hospital project, and received $1.8 million in proceeds by entering into a capital lease on various equipment items.

Seasonality

Our business experiences seasonality resulting in variation in census levels, with the highest census historically occurring in the first quarter of the year and the lowest census occurring in the third quarter of the year.

Inflation

We derive a substantial portion of our revenue from the Medicare program. LTAC hospital PPS payments are subject to fixed payments that generally are adjusted annually for inflation. However, there can be no assurance that these adjustments, if received, will reflect the actual increase in our costs for providing healthcare services.

Labor and supply expenses make up a substantial portion of our operating expense structure. The expenses can be subject to increase in periods of rising inflation.

 

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Forward Looking Statements

This quarterly report contains forward-looking statements regarding, among other things, our financial condition, results of operations, plans, objectives, future performance and business. All statements contained in this document other than historical information are forward-looking statements. Forward-looking statements include, but are not limited to, statements that represent our beliefs concerning future operations, strategies, financial results or other developments, and contain words and phrases such as “may,” “expects,” “believes,” “anticipates,” “estimates,” “should,” or similar expressions. Because these forward-looking statements are based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control or are subject to change, actual results could be materially different. Although we believe that our plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, we cannot assure you that we will achieve or realize these plans, intentions or expectations. Forward-looking statements are inherently subject to risks, uncertainties and assumptions. Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to:

 

   

changes in government reimbursement for our services may have an adverse effect on our future revenues and profitability including, for example, the changes described under “Regulatory Changes”;

 

   

the failure to maintain compliance with our financial covenants could be costly or have a material adverse effect on us;

 

   

the amount of outstanding indebtedness and the restrictive covenants in the agreements governing our indebtedness may limit our operating and financial flexibility;

 

   

the condition of the financial markets, including volatility and deterioration in the capital and credit markets, could have a material adverse effect on the availability and terms of financing sources;

 

   

a government investigation or assertion that we have violated applicable regulations may result in increased costs or sanctions that reduce our revenues and profitability;

 

   

periodic reviews, audits and investigations by federal and government agencies and private payors could result in adverse findings and may negatively impact our revenues and profitability;

 

   

private third party payors for our services may undertake future cost containment initiatives that limit our future revenues and profitability;

 

   

actions that may be brought by individuals on the government’s behalf under the False Claims Act’s qui tam or whistleblower provisions may expose us to unforeseen liabilities;

 

   

the failure of our long-term acute care hospitals to maintain their qualification would cause our revenues and profitability to decline;

 

   

the failure of our “satellite” facilities to qualify for provider-based status with the applicable “main” facilities may adversely affect our results of operations;

 

   

development of new facilities may prove difficult or unsuccessful, use significant resources or expose us to unforeseen liabilities;

 

   

an increase in uninsured and underinsured patients in our hospitals or the deterioration in the collectability of the accounts of such patients could harm our results of operations;

 

   

the failure to maintain established relationships with the physicians in our markets could reduce our revenues and profitability;

 

   

shortages in qualified nurses, therapists and other healthcare professionals or union activity may significantly increase our operating costs;

 

   

competition may limit our ability to grow and result in a decrease in our revenues and profitability;

 

   

the loss of key members of our management team could significantly disrupt our operations;

 

   

the geographic concentration of our facilities in Texas makes us sensitive to economic, regulatory, environmental and other developments in this state;

 

   

adverse changes in individual markets could significantly affect operating results;

 

   

the effect of legal actions or other claims associated with the circumstances arising from Hurricane Katrina could subject us to substantial liabilities;

 

   

the effect of legal actions asserted against us or lack of adequate available insurance could subject us to substantial uninsured liabilities;

 

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an inability to ensure and maintain an effective system of internal controls over financial reporting could expose us to liability;

 

   

the failure to comply with the provisions of any of our Master Lease Agreements could materially adversely affect our financial position, results of operations and liquidity: and,

 

   

the failure to prevent damage or interruption to our systems and operations or to conform to regulatory standards for electronic health records could result in improper functioning, security breaches of our information systems or penalties.

Consequently, such forward-looking statements should be regarded solely as our current plans, estimates and beliefs. We do not intend, and do not undertake, any obligation to update any forward-looking statements to reflect future events or circumstances after the date of this report.

 

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

At September 30, 2009, we had $244.8 million in senior term loans outstanding and a borrowing availability of $18.0 million under our revolving credit facility, each bearing interest at variable rates. Each 0.125% point change in interest rates would result in a $0.4 million annual change in interest expense on our term loans and revolving credit facility loans, assuming that our revolving credit facility is fully drawn.

 

ITEM 4: CONTROLS AND PROCEDURES

We carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered in this report. The disclosure controls and procedures are designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within required time periods, and include controls and disclosures designed to ensure that this information is accumulated and communicated to the company’s management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosures. Based on this evaluation, our principal executive officer and principal financial officer have concluded that as of September 30, 2009 our disclosure controls and procedures were effective to provide reasonable assurance that information required to be included in our periodic Securities and Exchange Commission reports is recorded accurately, processed, summarized and reported within the time periods specified in the relevant Securities and Exchange Commission rules and forms.

In addition, we reviewed our internal controls, and there have been no changes in our internal controls over financial reporting identified in connection with an evaluation that occurred during the quarter ended September 30, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II: OTHER INFORMATION

 

ITEM 1: LEGAL PROCEEDINGS

We are a party to various legal actions that arise in the ordinary course of business, as well as other litigation described elsewhere in this report. These actions are primarily related to malpractice claims covered under insurance policies; however, there may be some legal actions which are not insured. We are unable to predict the ultimate outcome of pending litigation and regulatory and other government investigations, nor can there be any assurance that the resolution of any litigation or investigation, either individually or in the aggregate, would not have a material adverse effect on our financial position, results of operations or liquidity.

At the time of Hurricane Katrina, we operated an 82-bed facility in New Orleans located in Memorial Medical Center. In the aftermath of the hurricane, an investigation was conducted by the Louisiana Attorney General’s office. The investigation culminated in a Grand Jury being convened in February of 2007 to determine if criminal charges should be filed against three individuals, who were not our employees, but who were caring for patients in Memorial Medical Center after the hurricane. Two of the individuals were subsequently granted immunity and the Grand Jury declined to indict the third. Neither the Company nor its employees have been named in any illegal or criminal activities associated with Hurricane Katrina.

We are currently defending ourselves against a variety of Hurricane Katrina related lawsuits and matters under review by the Louisiana Patient Compensation Fund. We are vigorously defending ourselves in these lawsuits, however, we cannot predict the ultimate resolution of these matters. We maintained $15.0 million of general and professional liability insurance during this period, subject to a $1.0 million per claim retention. We believe that under our insurance policies, only one retention is applicable to the Hurricane Katrina matters since these matters all arose from a single event, process or condition. However, our insurance carrier sent reservation of rights letters which challenged, among other things, the application of one retention to the Hurricane Katrina related matters. On June 5, 2009, we reached an agreement with the insurance carrier regarding the reservation of rights matters whereby they will continue to pay all costs, indemnification and related expenses for the Hurricane Katrina claims in consideration for $1.0 million to be paid by us, payable in three equal installments, due July 1, 2009, March 31, 2010, and March 31, 2011.

 

ITEM 1A: RISK FACTORS

No changes.

 

ITEM 6: EXHIBITS

The exhibits to this report are listed in the Exhibit Index.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

LifeCare Holdings, Inc.
By:   /s/    G. WAYNE MCALISTER        
  G. Wayne McAlister
  Chief Executive Officer
By:   /s/    CHRIS A. WALKER        
  Chris A. Walker
  Chief Financial Officer

Dated: November 13, 2009

 

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EXHIBIT INDEX

 

Exhibit

  

Description

10.1    Amended and Restated Executive Employment Agreement with Grant B. Asay.
10.2    Amended and Restated Transaction Bonus Agreement with Grant B. Asay.
31.1    Certification of Chief Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2    Certification of Chief Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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