<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NO. 1-10968
MARINER POST-ACUTE NETWORK, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 74-2012902
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
ONE RAVINIA DRIVE, SUITE 1500 30346
ATLANTA, GEORGIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
(678) 443-7000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |_| No |X|
There were 73,688,379 shares of Common Stock of the registrant issued and
outstanding as of August 11, 2000.
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes |_| No |_| N/A |X| (Due to the recent nature of the
filings made by the registrant and its subsidiaries under Chapter 11 of the
Bankruptcy Code, no plan of reorganization has been confirmed by a bankruptcy
court.)
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
FORM 10-Q
JUNE 30, 2000
<TABLE>
<CAPTION>
TABLE OF CONTENTS
<S> <C>
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements 1
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 21
Item 3. Quantitative and Qualitative Disclosure About Market Risk 38
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 39
Item 2. Changes in Securities and Use of Proceeds 39
Item 3. Defaults Upon Certain Securities 39
Item 4. Submission of Matters to a Vote of Security Holders 39
Item 5. Other Information 39
Item 6. Exhibits and Reports on Form 8-K 40
SIGNATURE PAGE
</TABLE>
<PAGE>
PART 1 FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF JANUARY 18, 2000)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------------------- ---------------------------------
2000 1999 2000 1999
--------------------------------- ---------------------------------
<S> <C> <C> <C> <C>
Net revenues $ 532,534 $ 487,135 $ 1,611,254 $ 1,774,525
Costs and expenses:
Salaries and wages 257,293 264,041 771,383 802,428
Employee benefits 52,309 49,055 165,060 159,342
Nursing, dietary and other supplies 31,901 32,229 96,749 96,109
Ancillary services 55,538 92,304 186,125 323,487
General and administrative 81,329 85,569 241,821 252,055
Rent 22,837 26,955 69,112 80,674
Depreciation and amortization 18,638 33,636 44,275 96,745
Provision for bad debts 14,842 12,816 29,937 91,439
Indirect merger and other expenses 374 17,622 8,785 24,736
Loss (gain) on disposal of assets (1,527) 231,549 (1,397) 231,549
--------------------------------- ---------------------------------
533,534 845,776 1,6011,850 2,158,564
--------------------------------- ---------------------------------
Operating loss (1,000) (358,641) (596) (384,039)
Interest expense (income), net
(Contractual interest for the three and
nine months ended June 30, 2000 was
$62,118 and $179,202, respectively) (2,279) 47,963 57,735 139,176
--------------------------------- ---------------------------------
Income (loss) before reorganization items,
income taxes and minority interest 1,279 (406,604) (58,331) (523,215)
Reorganization items (8,053) - 4,384 -
--------------------------------- ---------------------------------
Income (loss) before income taxes and
minority interest 9,332 (406,604) (62,715) (523,215)
Provision for income taxes - - - 1,000
--------------------------------- ---------------------------------
Income (loss) before minority interest 9,332 (406,604) (62,715) (524,215)
Minority interest (729) 880 (952) 715
--------------------------------- ---------------------------------
Net income (loss) $ 8,603 $ (405,724) $ (63,667) $ (523,500)
================================= =================================
Net income (loss) per share - basic and diluted $ 0.12 $ (5.51) $ (0.86) $ (7.13)
================================= =================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
1
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF JANUARY 18, 2000)
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share amounts)
<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
2000 1999
--------------------------------
(unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 136,896 $ 71,817
Receivables, net of allowances of $110,272 and $87,066 317,267 307,571
Notes receivable, net 5,640 3,259
Supplies 20,502 22,866
Prepaid and other current assets 46,258 36,143
--------------------------------
Total current assets 526,563 441,656
Property and equipment, net of accumulated depreciation of $354,583 and $333,708 468,405 459,553
Goodwill, net 218,401 247,353
Restricted investments 35,784 69,188
Other assets, net 18,566 57,221
--------------------------------
$ 1,267,719 $ 1,274,971
================================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Notes payable and current maturities of long-term debt $ - $ 2,028,226
Accounts payable 79,074 134,829
Accrued compensation 151,159 111,395
Other current liabilities 69,911 113,121
--------------------------------
Total current liabilities 300,144 2,387,571
Liabilities subject to compromise 2,356,460 -
Long-term debt, net - 113,618
Long-term insurance reserves 25,097 80,899
Other liabilities 31,196 78,902
--------------------------------
Total liabilities 2,712,897 2,660,990
Commitments and contingencies
Stockholders' equity (deficit):
Preferred stock, $.01 par value; 5,000,000 shares authorized;
no shares issued - -
Common stock, $.01 par value; 500,000,000 shares authorized;
73,688,379 shares issued 737 737
Capital surplus 980,952 980,952
Accumulated deficit (2,425,060) (2,361,393)
Accumulated other comprehensive loss (1,807) (6,315)
--------------------------------
Total stockholders' equity (deficit) (1,445,178) (1,386,019)
--------------------------------
$ 1,267,719 $ 1,274,971
================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF JANUARY 18, 2000)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED JUNE 30,
--------------------------------
2000 1999
--------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (63,667) $ (523,500)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities
Depreciation and amortization 44,275 96,745
Interest accretion on Senior Notes 13,178 15,819
Equity earnings/minority interest 952 (715)
Reorganization items 4,384 -
Provision for bad debts 29,937 91,439
Change in estimate related to reduction in revenue - 94,433
(Gain) loss on disposal of assets (1,397) 231,549
Changes in operating assets and liabilities:
Receivables (41,007) (17,805)
Supplies 1,991 794
Prepaid and other assets (8,021) 57,001
Accounts payable 12,845 (35,974)
Accrued liabilities and other current liabilities 98,048 (19,812)
Long-term insurance reserves (11,943) (18,853)
Other (3,320) (8,662)
--------------------------------
Net cash provided by (used in) operating activities before reorganization costs 76,255 (37,541)
Payment of reorganization costs, net (15,989) -
--------------------------------
Net cash provided by (used in) operating activities 60,266 (37,541)
Cash flows from investing activities:
Purchases of property and equipment (23,033) (55,796)
Proceeds from sale of assets 8,594 11,090
Restricted investments 22,154 11,329
Net collections on notes receivable 421 3,390
Other - 9,017
--------------------------------
Net cash provided by (used in) investing activities 8,136 (20,970)
Cash flows from financing activities:
Net draws under prepetition credit line 12,702 205,470
Repayment of prepetition long-term debt (12,667) (43,131)
Deferred financing fees - (3,838)
Other (3,358) 4
--------------------------------
Net cash (used in) provided by financing activities (3,323) 158,505
--------------------------------
Increase in cash and cash equivalents 65,079 99,994
Cash and cash equivalents, beginning of period 71,817 3,314
--------------------------------
Cash and cash equivalents, end of period $ 136,896 $ 103,308
================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
3
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 - BASIS OF PRESENTATION
Mariner Post-Acute Network, Inc. (the "Company") provides post-acute health
care services, primarily through the operation of its skilled-nursing
facilities. At June 30, 2000, the Company's significant operations consisted of
(i) approximately 360 inpatient and assisted living facilities containing
approximately 43,000 beds; (ii) approximately 37 institutional pharmacies
servicing more than 1,000 long-term care centers; and (iii) 12 long-term acute
care hospitals with approximately 700 licensed beds. In addition, the Company
has limited physician management operations. The Company operates in 25 states
with significant concentrations of facilities and beds in seven states and
several metropolitan markets.
On January 18, 2000 (the "Petition Date"), the Company and substantially
all of its subsidiaries ("the Company Debtors"), including Mariner Health Group,
Inc. ("Mariner Health") and its subsidiaries (the "Mariner Health Debtors"),
filed voluntary petitions (collectively, the "Chapter 11 Filings") in the United
States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court")
under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code").
The Company is presently operating its business as a debtor-in-possession and is
subject to the jurisdiction of the Bankruptcy Court while a plan of
reorganization is formulated (see Note 2). The Company's need to seek relief
afforded by the Bankruptcy Code is due, in part, to the significant financial
pressure created by the implementation of the Balanced Budget Act of 1997 (the
"Balanced Budget Act").
The accompanying condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and disclosures normally included in the
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, the financial information included
herein reflects all adjustments considered necessary for a fair presentation of
interim results, and, except for the costs described in Notes 2 and 5, all such
adjustments are of a normal and recurring nature. Operating results for interim
periods are not necessarily indicative of the results that may be expected for
the entire year.
The accompanying condensed consolidated financial statements have been
prepared on a going concern basis which assumes continuity of operations and
realization of assets and liquidation of liabilities in the ordinary course of
business. The financial statements do not include any adjustments reflecting the
possible future effects on the recoverability and classification of assets or
the amount and classification of liabilities that may result from the outcome of
uncertainties discussed herein. The accompanying condensed consolidated
financial statements have also been presented in conformity with the American
Institute of Certified Public Accountants Statement of Position 90-7, "Financial
Reporting by Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7").
The statement requires a segregation of liabilities subject to compromise by the
Bankruptcy Court as of the Petition Date and identification of all transactions
and events that are directly associated with the reorganization of the Company.
Pursuant to SOP 90-7, prepetition liabilities are reported on the basis of the
expected amounts of such allowed claims, as opposed to the amounts for which
those claims may be settled. Under a confirmed final plan of reorganization,
those claims may be settled at amounts substantially less than their allowed
amounts.
The Company's recent operating losses, liquidity issues and the
reorganization proceedings raise substantial doubt about the Company's ability
to continue as a going concern. The ability of the Company to continue as a
going concern and the appropriateness of using the going concern basis of
accounting is dependent upon, among other things, the ability to comply with the
terms of the Company DIP Financing (as defined), confirmation of a plan of
reorganization, success of future operations after such confirmation and the
ability to generate sufficient cash from operations and financing sources to
meet obligations.
4
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
These financial statements should be read in conjunction with the audited
consolidated financial statements and notes thereto for the year ended September
30, 1999 included in the Company's Annual Report filed with the Securities and
Exchange Commission on Form 10-K, file No. 1-10968.
NET REVENUES
Net revenues are recorded based upon estimated amounts due from patients
and third party payors for healthcare services provided, including anticipated
settlements under reimbursement agreements with Medicare, Medicaid and other
third party payors. A summary of approximate net revenues by payor type is as
follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------------------------------------------
2000 1999 2000 1999
----------------------------------------------------------------
<S> <C> <C> <C> <C>
Medicaid $ 265,694 $ 234,799 $ 803,062 $ 770,144
Medicare 132,958 115,451 395,899 448,955
Private and other 133,882 136,885 412,293 555,426
----------------------------------------------------------------
$ 532,534 $ 487,135 $ 1,611,254 $ 1,774,525
================================================================
</TABLE>
GOODWILL
Goodwill represents the excess of acquisition cost over the fair value of
net assets acquired in business combinations and is amortized on a straight-line
basis over the estimated useful lives of the related assets. The Company
periodically re-evaluates goodwill and other intangibles and makes any
adjustments, if necessary, whenever events or changes in circumstances indicate
that the carrying amount may not be recoverable or the estimated useful life has
changed. During the quarter ended December 31, 1999, the Company revised its
estimate of the useful life of existing goodwill from 30 and 40 years to 20
years. The net effect of such change was a charge of $1.6 million and $4.2
million or $0.02 per share and $0.06 per share for the three and nine months
ended June 30, 2000, respectively.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform with the
current period presentation.
NOTE 2 - PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
REORGANIZATION
As previously disclosed, on January 18, 2000, the Company, Mariner Health
and substantially all of their respective subsidiaries filed voluntary petitions
for relief under Chapter 11 of the Bankruptcy Code. The Company is presently
operating its business as a debtor-in-possession and is subject to the
jurisdiction of the Bankruptcy Court while a plan of reorganization is
formulated. As a debtor-in-possession, the Company is authorized to operate its
business but may not engage in transactions outside its ordinary course of
business without the approval of the Bankruptcy Court (the "Chapter 11
Proceedings").
5
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
While the Chapter 11 Filings constituted a default under the Company's and
such subsidiaries' various financing arrangements, Section 362 of the Bankruptcy
Code imposes an automatic stay that generally precludes any creditors and other
interested parties under such arrangements from taking any remedial action in
response to any such resulting default outside of the Chapter 11 Proceedings
without obtaining relief from the automatic stay from the Bankruptcy Court. In
addition, under the Bankruptcy Code the Company may assume or reject executory
contracts and unexpired leases, including lease obligations. Parties affected by
these rejections may file claims with the Bankruptcy Court in accordance with
the reorganization process. The Company is actively engaged in the process of
reviewing its executory contracts and unexpired leases and final decisions with
respect to assuming or rejecting the contracts and the approval of the
Bankruptcy Court are still pending.
In connection with the Chapter 11 Filings, the Company obtained a
commitment for $100.0 million in debtor-in-possession ("DIP") financing (the
"Company DIP Financing") from a group of banks led by The Chase Manhattan Bank
("Chase"). Mariner Health also obtained a commitment for $50 million in DIP
financing (the "Mariner Health DIP Financing"; together with the Company DIP
Financing, the "DIP Financings") from a group of banks led by PNC Bank, National
Association ("PNC") (see Note 3).
On January 19, 2000, the Company received approval from the Bankruptcy
Court to pay prepetition and postpetition employee wages, salaries, benefits and
other employee obligations. The Bankruptcy Court also approved orders granting
authority, among other things, to pay prepetition claims of certain critical
vendors, utilities and patient obligations. All other prepetition liabilities at
June 30, 2000 are classified in the condensed consolidated balance sheet as
liabilities subject to compromise. The Company has been and intends to continue
to pay postpetition claims of all vendors and providers in the ordinary course
of business.
The Company and Mariner Health intend to develop separate plans of
reorganization (respectively, the "Company Plan of Reorganization" and the
"Mariner Plan of Reorganization" and collectively, the "Plans of
Reorganization") through negotiations with their respective key creditor
constituencies including their respective senior bank lenders and official
unsecured creditors committees. A substantial portion of prepetition liabilities
are subject to settlement under each of the Plans of Reorganization to be
submitted respectively by the Company and Mariner Health. Each of the Plans of
Reorganization must be voted upon by each impaired class of creditors of the
Company and approved by the Bankruptcy Court. No assurance can be given
regarding the timing of such Plans of Reorganization, the likelihood that such
plans will be developed, or the terms on which such plans may be conditioned. In
addition, there can be no assurances that the Plans of Reorganization will be
approved by requisite holders of claims, confirmed by the Bankruptcy Court, or
that either or both Plans of Reorganization will be consummated. If the Company
Plan of Reorganization is not accepted by the required number of impaired
creditors and equity holders and the Company's exclusive right to file and
solicit acceptance of a plan of reorganization ends, any party in interest may
subsequently file its own plan of reorganization for the Company; the same is
true for Mariner Health if the Mariner Plan of Reorganization is not accepted by
the required number of impaired creditors and equity holders and Mariner
Health's exclusive right to file and solicit acceptance of a plan of
reorganization ends. The Bankruptcy Court may confirm a plan of reorganization
notwithstanding the non-acceptance of the plan by an impaired class of creditors
or equity holders if certain requirements of the Bankruptcy Code are met.
6
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
LIABILITIES SUBJECT TO COMPROMISE
"Liabilities subject to compromise" refers to liabilities incurred prior to
the commencement of the Chapter 11 Filings. These liabilities, consisting
primarily of long-term debt and certain accounts payable and accrued
liabilities, represent the Company's estimate of known or potential prepetition
claims to be resolved in connection with the Chapter 11 Filings. Such claims
remain subject to future adjustments based on negotiations, actions of the
Bankruptcy Court, further developments with respect to disputed claims, future
rejection of executory contracts or unexpired leases, determination as to the
value of any collateral securing claims, treatment under the Plans of
Reorganization and other events. Payment terms for these amounts will be
established in connection with the Plans of Reorganization.
A summary of the principal categories of claims classified as liabilities
subject to compromise at June 30, 2000 are as follows (in thousands):
Long-term debt:
Senior credit facilities:
Senior Credit Facility $ 914,127
Mariner Health Senior Credit Facility 233,834
Mariner Health Term Loan Facility 192,439
Subordinated debt:
Senior Subordinated Notes 274,039
Senior Subordinated Discount Notes 217,181
Mariner Health Senior Subordinated Notes 103,130
Other, including capital lease obligations 216,026
----------------
2,150,776
Accounts payable 73,460
Accrued interest 80,327
Other accrued liabilities 83,386
Deferred loan costs (31,489)
----------------
$ 2,356,460
================
Approximately $2.3 billion of liabilities subject to compromise would have
been classified as current liabilities if the Chapter 11 Filings had not been
filed.
In accordance with SOP 90-7, the Company has discontinued accruing interest
relating to its debt facilities currently classified as liabilities subject to
compromise effective January 18, 2000. Contractual interest for the three month
and nine month periods ended June 30, 2000 was $62.1 million and $179.2 million,
respectively, which is $62.1 million and $112.0 million in excess of interest
expense included in the accompanying condensed consolidated financial statements
for the three month and nine month periods ended June 30, 2000, respectively.
7
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
CHANGE IN ACCOUNTING ESTIMATES
In the three months ended June 30, 1999, the Company recorded $94.4 million
of adjustments to reduce the estimated amount due from third party payors, of
which $11.7 million was recorded to reduce the estimated amount receivable from
cost reports filed or settled during the period.
The remaining $82.7 million of adjustments was recorded to reflect amounts
due to the Medicare program for previously received reimbursement and to reduce
the estimated amount receivable from all Medicare cost report appeal items and
primarily pertains to related party adjustments asserted by Medicare
intermediaries through the intermediaries' reopening of certain Mariner Health
cost reports. These reopenings were to incorporate adjustments that reduced the
allowable costs of rehabilitation therapy services furnished to the Mariner
Health facilities by Mariner Health's rehabilitation subsidiaries. At June 30,
1999, Mariner Health had received revised notices of program reimbursement
("NPRs") for approximately fifty 1995 and 1996 cost reports of its facilities
which resulted in reductions in reimbursable cost of approximately $16.9
million. The Company is vigorously disputing the intermediaries' overpayment
determinations through the appeal process; however, a favorable outcome cannot
be assured at this time.
In lieu of recoupment by the fiscal intermediary, the Company reached an
agreement with the Healthcare Financing Administration ("HCFA") and the
intermediary and implemented an extended repayment plan. The balance as of the
date of the agreement was approximately $15.9 million, which was repaid over a
period of one year. As of June 30, 2000, all payments have been made. The
intermediary has notified Mariner Health that it intends to issue NPRs for the
remaining facility cost reports (1997 through 1999) starting in fiscal year
2000. As part of the Chapter 11 process, Mariner Health entered into a
stipulation with the U.S. Department of Health and Human Services whereby, among
other things, HCFA will not recoup certain prepetition overpayments for other
than the current cost reporting years for the pendancy of Mariner Health's DIP
obligations. Accordingly, repayment obligations which may arise from the
issuance of NPRs may be stayed for an interim period. Should the NPRs result in
a repayment requirement not within the purview of the stipulation, or after the
pendancy of the DIP obligations, the Company and Mariner Health would seek to
enter into an extended repayment plan with HCFA at that time.
The loss per share of this $94.4 million change in estimate was
approximately ($1.28) and ($1.29) for the three and nine months ended June 30,
1999, respectively.
NOTE 3 - DEBT
PREPETITION DEBT
Due to the failure to make scheduled payments, comply with certain
financial covenants and the commencement of the Chapter 11 cases, the Company is
in default on substantially all of its debt obligations. Except as otherwise may
be determined by the Bankruptcy Court, the automatic stay protection afforded by
the Chapter 11 Filings prevents any action from being taken with regard to any
of the defaults under the prepetition debt obligations. These obligations are
classified as current liabilities at September 30, 1999 and as liabilities
subject to compromise at June 30, 2000.
The obligations of the Company under the Senior Credit Facility are
guaranteed by substantially all of the Company's subsidiaries other than Mariner
Health and its subsidiaries, and are secured by substantially all of the
otherwise unencumbered owned assets of the Company and such subsidiaries.
Mariner Health's obligations under the Mariner Health Senior Credit Facility are
guaranteed by substantially all of its subsidiaries and are secured by
8
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
substantially all of the otherwise unencumbered assets of Mariner Health and
such subsidiary guarantors. Mariner Health and its subsidiaries are treated as
unrestricted subsidiaries under the Company's debt facilities. Unlike other
subsidiaries of the Company (the "Non-Mariner Subsidiaries"), Mariner Health and
its subsidiaries neither guarantee the Company's obligations under the Company's
debt facilities nor pledge their assets to secure such obligations.
Correspondingly, the Company and the Non-Mariner Subsidiaries do not guarantee
or assume any obligations under the Mariner Health debt facilities. Mariner
Health and its subsidiaries are not subject to the covenants contained in the
Company's debt facilities, and the covenants contained in the Mariner Health
debt facilities are not binding on the Company and the Non-Mariner Subsidiaries.
No interest has been paid or accrued on prepetition indebtedness since the
Petition Date and no principal payments have been made since such time with the
exception of repayments made against the Senior Credit Facility as adequate
protection payments pursuant to the Final Company DIP Order (as defined),
resulting from the application of 75% of net cash proceeds received from the
sales of certain facilities and other assets (see Note 6), and notional amounts
related to certain other indebtedness, including capital equipment leases.
DEBTOR-IN-POSSESSION FINANCING FOR THE COMPANY
In connection with the Chapter 11 Filings, the Company entered into a
$100.0 million debtor-in-possession financing agreement (the "Company DIP Credit
Agreement") with a group of banks (the "Company DIP Lenders") led by Chase. On
March 20, 2000 the Bankruptcy Court granted final approval (the "Final Company
DIP Order,") of the Company DIP Financing.
The Company DIP Credit Agreement establishes a one-year, $100.0 million
secured revolving credit facility to provide funds for working capital and other
lawful corporate purposes for use by the Company and the other Company Debtors;
provided, however, that amounts outstanding under the Company DIP Financing may
not at any time exceed the maximum borrowing amounts established for the Company
under the Final Company DIP Order or the Company's borrowing base of eligible
accounts receivable (the "Company Borrowing Base"). Up to $10.0 million of the
Company DIP Financing may be utilized for the issuance of letters of credit as
needed in the business of the Company Debtors. Interest accrues on the principal
amount outstanding under the Company DIP Financing at a per annum rate of
interest equal to the Alternative Base Rate of Chase plus three percent (3%) and
is payable monthly in arrears. During the existence and continuation of a
default in the payment of any amount due and payable by the Company Debtors
under the Company DIP Credit Agreement, interest will accrue at the default rate
of ABR plus five percent (5%) per annum.
The outstanding principal of the Company DIP Financing, together with all
accrued and unpaid interest and all other obligations thereunder, are due and
payable one year from the Petition Date. The Company must also prepay principal
to the extent that the principal amount outstanding under the Company DIP
Financing at any time exceeds the Company Borrowing Base then in effect. To the
extent proceeds of loans under the Company DIP Financing are used to complete
the construction of certain healthcare facilities that are part of the Synthetic
Lease (as defined in "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources of the
Company - Other Factors Affecting Liquidity and Capital Resources") (which
proceeds are not permitted to exceed $8.8 million), proceeds from the sale of
any such properties must be used first to repay any portion of the loans made
pursuant to the Company DIP Financing, with 75% of any remaining net cash
proceeds to be applied as an adequate protection payment to the lenders under
the prepetition Senior Credit Facility and the remaining 25% of such excess net
cash proceeds to be retained by the Company or its applicable subsidiary as
additional working capital. Pursuant to the terms of the Final Company DIP
Order, 75% of the net cash proceeds of other asset sales approved by the
Bankruptcy Court and the requisite Company DIP Lenders are to be applied as an
adequate protection payment to the lenders under the prepetition Senior Credit
Facility. The Company has the right
9
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
to make optional prepayments in increments of $1.0 million, and to reduce the
commitment under the Company DIP Credit Agreement in increments of $5.0 million.
The obligations of the Company under the Company DIP Credit Agreement are
jointly and severally guaranteed by each of the other Company Debtors, except
for the subsidiaries (the "Omega Debtors") which operate those sixteen
facilities which are mortgaged to Omega Healthcare Investors, Inc. which
guarantee is limited to the negative cash flows of the debtors, pursuant to the
Company DIP Agreement. Under the terms of the Final Company DIP Order, the
obligations of the Company Debtors under the Company DIP Credit Agreement (the
"Company DIP Obligations") constitute allowed superiority administrative
expense claims pursuant to Section 364(c)(1) of the Bankruptcy Code (subject to
a carve out for certain professional fees and expenses incurred by the Company
Debtors. The Company DIP Obligations are secured by perfected liens on all or
substantially all of the assets of the Company Debtors (excluding bankruptcy
causes of action), the priority of which liens (relative to prepetition
creditors having valid, non avoidable, perfected liens in those assets and to
any "adequate protection" liens granted by the Bankruptcy Court) is established
in the Initial Company DIP Order and the related cash collateral order entered
by the Bankruptcy Court (the "Final Company Cash Collateral Order"). The
Bankruptcy Court has also granted certain prepetition creditors of the Company
Debts replacement liens and other rights as "adequate protection" against any
diminution of the value of their existing collateral that may result from
allowing the Company Debtors to use cash collateral in which such creditors had
valid, non-avoidable and perfected liens as of the Petition Date. The discussion
contained in this paragraph is qualified in its entirety by reference to the
Final DIP Order, the Final Company Cash Collateral Order, and related
stipulations, and reference should be made to such orders (which are available
from the Bankruptcy Court) and stipulations for a more complete description of
such terms.
The Company DIP Credit Agreement contains customary representations,
warranties and other affirmative and restrictive covenants of the Company
Debtors, as well as certain financial covenants relating to minimum EBITDA,
maximum capital expenditures, and minimum patients census. The breach of such
representations, warranties or covenants, to the extent not waived or cured
within any applicable grace or cure periods, could result in the Company being
unable to obtain further advances under the Company DIP Financing and possibly
the exercise of remedies by the Company DIP Lenders, either of which events
could materially impair the ability of the Company to successfully reorganize in
Chapter 11 and to operate as a going concern. Such a default may also impair the
ability of the Company Debtors to use cash collateral to fund operations. At
June 30, 2000, there were no outstanding borrowings under the Company DIP Credit
Agreement.
DEBTOR-IN-POSSESSION FINANCING FOR MARINER HEALTH
Among the orders entered by the Bankruptcy Court on the Petition Date in
the Chapter 11 cases of Mariner Health and its subsidiaries, were orders
approving (a) the use of cash collateral by the Mariner Health Debtors, and (b)
the funding of up to $15.0 million in principal amount at any time outstanding
under a debtor-in-possession financing arrangement (the "Mariner Health DIP
Financing" and together with the Company DIP Financing, the "DIP Financings")
pursuant to that certain Debtor-in-Possession Credit Agreement dated as of
January 20, 2000 (as amended from time to time, the "Mariner Health DIP Credit
Agreement") by and among Mariner Health and each of the other Mariner Health
Debtors, as co-borrowers thereunder, the lenders signatory thereto as lenders
(the "Mariner Health DIP Lenders"), First Union National Bank, as Syndication
Agent, PNC Capital Markets, Inc. and First Union Securities, Inc., as
co-arrangers, and PNC Bank, National Association, as Administrative Agent and
Collateral Agent. After a final hearing on February 16, 2000 the Bankruptcy
Court entered an order granting final approval of up to $50.0 million of the
Mariner Health DIP Financing (the "Final Mariner Health DIP Order").
10
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The Mariner Health DIP Credit Agreement establishes a one-year, $50.0
million secured revolving credit facility comprised of a $40.0 million tranche A
revolving loan commitment and a $10.0 million tranche B revolving loan
commitment. Borrowings under the tranche B loan require the approval of lenders
holding at least 75% of the credit exposure under the Mariner Health DIP Credit
Agreement. Advances under the Mariner Health DIP Financing may be used by the
Mariner Health Debtors (and to a limited degree, by certain joint venture
subsidiaries of Mariner Health that are not debtors in the Mariner Health
Chapter 11 cases) for working capital and other lawful corporate purposes.
Amounts outstanding under the Mariner Health DIP Financing may not at any time
exceed the maximum borrowing amounts established for the Mariner Health Debtors
under the Final Mariner Health DIP Order. Up to $5.0 million of the Mariner
Health DIP Financing may be utilized for the issuance of letters of credit as
needed in the businesses of the Mariner Health Debtors.
Interest accrues on the principal amount outstanding under the Mariner
Health DIP Financing at a per annum rate of interest equal to the "base rate" of
PNC (i.e., the higher of the PNC prime rate or a rate equal to the federal funds
rate plus 50 basis points) plus the applicable spread, which is 250 basis points
for tranche A and 300 basis points for tranche B. Such interest is due and
payable monthly in arrears. During the existence and continuation of any event
of default under the Mariner Health DIP Credit Agreement, the interest rates
normally applicable to tranche A loans and tranche B loans under the Mariner
Health DIP Financing will be increased by another 250 basis points per annum.
The outstanding principal of the Mariner Health DIP Financing, together
with all accrued and unpaid interest and all other obligations thereunder, are
due and payable in one year or, if earlier, on the Commitment Termination Date,
which is defined as the first to occur of (i) January 19, 2001; (ii) the
effective date of a joint plan of reorganization for the Mariner Health Debtors;
(iii) the date of termination of the exclusivity rights of the Mariner Health
Debtors to file a plan of reorganization; (iv) the filing by the Mariner Health
Debtors of any plan of reorganization (or the modification of any such plan
previously filed with the Bankruptcy Court) not previously approved by the
holders of at least 66-2/3% of the outstanding loans or commitments under the
Mariner Health DIP Financing; (v) the date of termination of the commitments
under the Mariner Health DIP Credit Agreement during the continuation of an
event of default thereunder; or (vi) the date on which all or substantially all
of the assets or stock of the Mariner Health Debtors is sold or otherwise
transferred. The Mariner Health Debtors must also prepay principal to the extent
that the principal amount outstanding under the Mariner Health DIP Financing at
any time exceeds the Mariner Health borrowing base then in effect. The Mariner
Health borrowing base for any month is an amount equal to $7.5 million in excess
of the "Working Capital Facility" borrowings projected for such month in Mariner
Health's year 2000 DIP budget. The Mariner Health DIP Credit Agreement also
provides for mandatory prepayments under the following circumstances: (a) with
net cash proceeds from asset sales, the incurrence of certain debt, the issuance
of new equity, the receipt of tax refunds exceeding $100,000 in the aggregate,
and the receipt of casualty proceeds in excess of $100,000 that are not applied
within 60 days after receipt to the repair, rebuilding, restoration or
replacement of the assets damaged or condemned (or committed within such period
of time to be so applied); and (b) on each business day, the amount of cash held
by the Mariner Health Debtors in excess of the sum of $5.0 million plus the
aggregate sum of the minimum amount required by depositary banks to be kept in
deposit accounts, concentration accounts and other accounts with such banks.
Amounts prepaid pursuant to clause (a) of the immediately preceding sentence
will permanently reduce the amount of the Mariner Health DIP Financing
commitments on a dollar for dollar basis (first tranche A, and then tranche B).
Amounts prepaid pursuant to clause (b) of the same sentence will not permanently
reduce such commitments. The Mariner Health Debtors have the right to make
optional prepayments in the minimum principal amount of $1.0 million, and in
increments of $100,000 in excess thereof, and, on three business days' notice,
to reduce the commitments under the Mariner Health DIP Credit Agreement in the
minimum amount of $5.0 million, or in increments of $1.0 million in excess
thereof.
11
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
As provided in the Final Mariner Health DIP Order, the obligations of the
Mariner Health Debtors under the Mariner Health DIP Credit Agreement (together
with certain potential cash management system liabilities secured on a pari
passu basis therewith, the "Mariner Health DIP Obligations") constitute allowed
superpriority administrative expense claims pursuant to Section 364(c)(1) of the
Bankruptcy Code (subject to a carve-out for certain professional fees and
expenses incurred by the Mariner Debtors). The Mariner Health DIP Obligations
will be secured by perfected liens on all or substantially all of the assets of
the Mariner Health Debtors (excluding bankruptcy causes of action), the priority
of which liens (relative to prepetition creditors having valid, non-avoidable,
perfected liens in those assets and to any "adequate protection" liens granted
by the Bankruptcy Court) is established in the February 16 Mariner Health DIP
Order and the related cash collateral orders entered by the Bankruptcy Court..
The Bankruptcy Court has also granted certain prepetition creditors of the
Mariner Health Debtors replacement liens and other rights as "adequate
protection" against any diminution of the value of their existing collateral
that may result from allowing the Mariner Health Debtors to use cash collateral
in which such creditors had valid, non-avoidable and perfected liens as of the
Petition Date. The discussion contained in this paragraph is qualified in its
entirety by reference to the February 16 Mariner Health DIP Order, the related
Mariner Health Cash Collateral Orders, and related stipulations, and reference
should be made to such orders (which are available from the Bankruptcy Court)
and stipulations for a more complete description of such terms.
The Mariner Health DIP Credit Agreement contains customary representations,
warranties and other affirmative and restrictive covenants of the Mariner Health
Debtors, as well as certain financial covenants relating to minimum EBITDAR,
minimum patient census, minimum eligible accounts receivable, maximum variations
from Mariner Health's year 2000 DIP budget and maximum capital expenditures. The
breach of such representations, warranties or covenants, to the extent not
waived or cured within any applicable grace or cure periods, could result in the
Mariner Health Debtors being unable to obtain further advances under the Mariner
Health DIP Financing and possibly the exercise of remedies by the Mariner Health
DIP Lenders, either of which events could materially impair the ability of the
Mariner Health Debtors to successfully reorganize in Chapter 11 and to operate
as a going concern. Included among the events of default is the termination of
the Mariner Health Debtor's exclusive right to file a plan or plans of
reorganization in any of their Chapter 11 cases other than as the result of the
filing of a plan or plans of reorganization acceptable to the lenders; the
Marnier Health exclusivity period currently is scheduled to expire on August 18,
2000. The occurrence of an event of default under the Mariner Health DIP Credit
Agreement may impair the ability of the Mariner Health Debtors to use cash
collateral to fund operations. At June 30, 2000, there were no outstanding
borrowings under the Mariner Health DIP Credit Agreement.
Among its other restrictive covenants, the Mariner Health DIP Credit
Agreement limits affiliate transactions with the Company Debtors, but does
contemplate weekly overhead payments to the Company equal to 1.25% of projected
net inpatient revenues for such month, subject to a monthly "true-up," such that
the payments for such month equal 5% of actual net inpatient revenues of the
Mariner Health Debtors. Such payments may be suspended by the Mariner Health
Debtors if certain defaults specified in the Mariner Health Credit Agreement
occur and are continuing, though such fees will still accrue and will become due
and payable if and when the subject default has been cured or waived.
NOTE 4 - INDIRECT MERGER AND OTHER EXPENSES
For the nine months ended June 30, 2000, indirect merger and other expenses
totaled approximately $8.8 million and included approximately $5.5 million of
costs incurred to outside professionals related to the Company's defaults in
connection with its indebtedness prior to the Petition Date, approximately $2.5
million of costs incurred related to the closure of its therapy business and
$0.7 million of other expenses.
12
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
For the nine months ended June 30, 1999, indirect merger and other expenses
totaled approximately $24.7 million and included approximately $14.1 million of
costs related to the Mariner Health merger and other operating costs incurred to
reduce overhead, approximately $3.5 million of costs incurred related to the
closure of its therapy business and approximately $7.1 million of other
expenses.
NOTE 5 - REORGANIZATION ITEMS
Reorganization items consist of income, expenses and other costs directly
related to the reorganization of the Company since the Chapter 11 Filings.
Reorganization items included in the condensed consolidated statements of
operations for the three and nine months ended June 30, 2000 consist of the
following (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
JUNE 30, 2000 JUNE 30, 2000
--------------------------------
<S> <C> <C>
Professional fees $ 4,223 $ 12,665
DIP financing fees - 2,852
Other reorganization costs 234 1,659
Net gain on divestitures (10,988) (10,988)
Gain on settlement of prepetition accounts payable (428) (617)
Interest earned on accumulated cash resulting from
Chapter 11 Filings (1,094) (1,187)
---------------- ---------------
$ (8,053) $ 4,384
================ ===============
</TABLE>
NOTE 6 - DIVESTITURES
FISCAL YEAR 2000 DIVESTITURES
The Company, through its GranCare subsidiaries leased twenty-two
facilities from Senior Housing Properties Trust ("SHPT") and its wholly-owned
subsidiary SPTMNR Properties Trust ("SPTMNR"), which succeeded to the interests
of Health and Retirement Properties Trust ("HRPT") to various agreements,
(collectively, the "SNH Entities"). On June 30, 2000, the Company, SPTMNR and
SHPT executed a settlement agreement (the "SNH Settlement"), which was approved
by the Bankruptcy Court on May 10, 2000, whereby: (a) the Company obtained fee
simple ownership of five facilities of the SNH health care portfolio which the
Company had previously leased in the past, along with the seventeen other
facilities described in clause (b); (b) seventeen facilities leased by the
Company and related personal property were assigned to affiliates of the SNH
Entities; (c) a cash collateral deposit of $15 million and shares of HRPT and
SPTMNR stock, with a market value of $7.2 million, were retained by the SNH
Entities; and (d) the Company agreed to manage the seventeen facilities
transferred to the SNH Entities during a transition period that is expected to
last less than six months. Upon termination of the management agreement, the
Company will have no further relationship with or obligations to the SNH
Entities. As a result of the settlement, the Company realized a net gain of
approximately $10.0 million which is included as part of the Company's net gain
on divestitures and included in the accompanying condensed consolidated
statements of operations as reorganization items.
During the quarter ended December 31, 1999, the Company completed the sale
of certain facilities and other assets which resulted in a net gain on sale of
approximately $1.4 million. In addition, during the period from the Petition
Date through June 30, 2000, the Company also completed the sale of other
facilities and assets which
13
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
resulted in a net gain of approximately $0.3 million. The Company also divested
itself of certain leased and managed properties during the quarter ended June
30, 2000. The Company anticipates that in the aggregate, these divestitures will
improve operating results in future periods.
The Company also disposed of its remaining home health operations during
the nine months ended June 30, 2000 and recorded a net gain on divestiture of
approximately $0.7 million.
FISCAL YEAR 1999 DIVESTITURES
Effective May 31, 1999, the Company terminated all of its contracts to
provide therapy services, other than contracts to provide therapy services to
hospitals, to both unaffiliated third-parties and to the Company's skilled
nursing facilities. As a result of the contract terminations and the closure of
the therapy business, the Company recorded a loss on the disposal of the
goodwill associated with the therapy business of $228.5 million during the three
months ended June 30, 1999 which is included in the accompanying condensed
consolidated statements of operations as loss (gain) on disposal of assets.
NOTE 7 - COMPREHENSIVE INCOME
Comprehensive income (loss) includes net loss, as well as charges and
credits to stockholders' equity (deficit) not included in net loss. The
components of comprehensive income (loss), net of income taxes, consist of the
following (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
-----------------------------------------------------------------
2000 1999 2000 1999
--------------- ---------------- ----------------- ----------------
<S> <C> <C> <C> <C>
Net income (loss) $ 8,603 $ (405,724) $ (63,667) $ (523,500)
Net unrealized losses on available-for-sale
securities (4,751) (896) (4,931) (3,144)
Realization of losses on available-for-sale
securities 9,439 - 9,439 -
--------------- ----------------- ---------------- ----------------
Comprehensive income (loss) $ 13,291 $ (406,620) $ (59,159) $ (526,644)
=============== ================= ================ ================
</TABLE>
Accumulated other comprehensive loss, net of income taxes, is comprised of
net unrealized losses on available-for-sale securities of $1,807 and $6,315 at
June 30, 2000 and September 30, 1999, respectively.
NOTE 8 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share (in thousands, except per share data) in accordance with
Financial Accounting Standards No. 128, "Earnings per Share":
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
-----------------------------------------------------------------
2000 1999 2000 1999
-----------------------------------------------------------------
<S> <C> <C> <C> <C>
Numerator for basic and diluted loss per share:
</TABLE>
14
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Net income (loss) $ 8,603 $ (405,724) $ (63,667) $ (523,500)
=================================================================
Denominator:
Denominator for basic loss per share -
weighted average shares 73,688 73,581 73,688 73,380
Effect of dilutive securities - stock options - - - -
-----------------------------------------------------------------
Denominator for diluted loss per share -
adjusted weighted average shares and
assumed conversions 73,688 73,581 73,688 73,380
=================================================================
Basic and diluted income (loss) per share:
Net income (loss) per share $ 0.12 $ (5.51) $ (0.86) $ (7.13)
=================================================================
</TABLE>
NOTE 9 - INCOME TAXES
The Company has established a valuation allowance which completely offsets
all net deferred tax assets generated from the Company's losses.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
LITIGATION
As is typical in the healthcare industry, the Company is and will be
subject to claims that its services have resulted in resident injury or other
adverse effects, the risks of which will be greater for higher acuity residents
receiving services from the Company than for other long-term care residents. In
addition, resident, visitor, and employee injuries will also subject the Company
to the risk of litigation. The Company has experienced an increasing trend in
the number and severity of litigation claims asserted against the Company.
Management believes that this trend is endemic to the long-term care industry
and is a result of the increasing number of large judgments, including large
punitive damage awards, against long-term care providers in recent years
resulting in an increased awareness by plaintiff's lawyers of potentially large
recoveries. In certain states in which the Company has significant operations,
including California and Florida, insurance coverage for the risk of punitive
damages arising from general and professional liability litigation is not
available due to state law public policy prohibitions. There can be no assurance
that the Company will not be liable for punitive damages awarded in litigation
arising in states for which punitive damage insurance coverage is not available.
The Company also believes that there has been, and will continue to be, an
increase in governmental investigations of long-term care providers,
particularly in the area of Medicare/Medicaid false claims as well as an
increase in enforcement actions resulting from these investigations. While the
Company believes that it provides quality care to the patients in its facilities
and materially complies with all applicable regulatory requirements, given the
Company's current financial difficulties and lack of liquidity, an adverse
determination in a legal proceeding or governmental investigation, whether
currently asserted or arising in the future, could have a material adverse
effect on the Company.
From time to time, the Company and its subsidiaries have been parties to
various legal proceedings in the ordinary course of their respective businesses.
In the opinion of management, except as described below, there are currently no
proceedings which, individually, if determined adversely to the Company and
after taking into account
15
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
the insurance coverage maintained by the Company, would have a material adverse
effect on the Company's financial position or results of operations. Although
the Company believes that any of the proceedings not discussed below will not
individually have a material adverse impact on the Company if determined
adversely to the Company, given the Company's current financial condition, lack
of liquidity and change in the Company's GL/PL insurance policy, settling a
large number of cases within the Company's $1 million self-insured retention
limit could have a material adverse effect on the Company.
On August 26, 1996, a class action complaint was asserted against GranCare
in the Denver, Colorado District Court, Salas, et al v. GranCare, Inc. and AMS
Properties, Inc. d/b/a Cedars Healthcare Center, Inc., case no. 96-CV-4449. On
March 15, 1998, the Court entered an Order in which it certified a class action
in the matter. On June 10, 1998, the Company filed a Motion to Dismiss all
claims and Motion for Summary Judgment Precluding Recovery of Medicaid Funds and
these motions were partially granted by the Court on October 30, 1998.
Plaintiffs' Motion for Reconsideration was denied by the Court on November 19,
1998, the Court's decision was certified as a final judgment on December 10,
1998, and plaintiffs then filed a writ with the Colorado Supreme Court and an
appeal with the Colorado Court of Appeal. This Supreme Court writ has been
denied, the Court of Appeal matter has been briefed and Oral Argument has been
set for January 18, 2000. In accordance with the Company's voluntary filing
under Chapter 11 of the United States Bankruptcy Code and more particularly, ss.
362 of that Code, this matter was stayed on January 18, 2000. However, the
Company did agree to limited relief from the stay in order to allow for certain
parts of the appeal to continue. The Company will continue in its opposition to
all appeals and further intends to vigorously contest the remaining allegations
of class status.
On March 18, 1998, a complaint was filed under seal by a former employee
against the Company, certain of its predecessor entities and affiliates in the
United States District Court for the Northern District of Alabama, alleging,
inter alia, employment discrimination, wrongful discharge, negligent hiring,
violation of the Federal False Claims Act, and retaliation under the False
Claims Act. The action is titled Powell, et al. v. Paragon Health Inc., et al.,
civil action No. CV-98-0630-S. The complaint has been unsealed and the Company
has been advised that the government has declined to intervene in this matter
under the Federal False Claims Act. In accordance with the Company's voluntary
filing under Chapter 11 of the United States Bankruptcy Code and more
particularly, ss. 362 of that Code, this matter was stayed on January 18, 2000.
The Company is vigorously contesting the alleged claims.
On August 25, 1998, a complaint was filed by the United States against the
Company's GranCare and International X-Ray subsidiaries and certain other
parties under the Civil False Claims Act and in common law and equity. The
lawsuit, U.S. v. Sentry X-Ray, Ltd., et al., civil action no. 98-73722, was
filed in United States District Court for the Eastern District of Michigan.
Valley X-Ray operates a mobile X-Ray company in Michigan. A Company subsidiary,
International X-Ray, owns a minority partnership interest in defendant Valley X-
Ray. The case asserts five claims for relief, including two claims for violation
of the Civil False Claims Act, two alternative claims of common law fraud and
unjust enrichment, and one request for application of the Federal Debt
Collection Procedures Act. The two primary allegations of the complaint are that
(i) the X-Ray company received Medicare overpayments for transportation costs in
the amount of $657,767; and (ii) the X-Ray company "upcoded" Medicare claims for
EKG services in the amount of $631,090. The United States has requested treble
damages as well as civil penalties of $5,000 to $10,000 for each of the alleged
388 submitted Medicare claims. The total damages sought varies from $5.3 million
to $7.2 million. The Company is vigorously contesting all claims and filed two
motions to dismiss on behalf of its subsidiaries on November 23, 1998. The
United States has agreed to the motion to dismiss GranCare as a party. The Court
has heard a motion to dismiss the Civil False Claims Act and other claims
against International X-Ray. The Company is awaiting the Court's decision. In
accordance with the Company's voluntary filing under Chapter 11 of the United
States Bankruptcy Code and more particularly, ss. 362 of that Code, this matter
was stayed on January 18, 2000.
16
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
On October 1, 1998, a class action complaint was asserted against certain
of the Company's predecessor entities and affiliates and certain other parties
in the Tampa, Florida, Circuit Court, Ayres, et al v. Donald C. Beaver, et al,
case no. 98-7233. The complaint asserted three claims for relief, including
breach of fiduciary duty against one group of defendants, breach of fiduciary
duty against another group of defendants, and civil conspiracy arising out of
issues involving facilities previously operated by the Brian Center Corporation
or one of its subsidiaries, and later by a subsidiary of LCA, as a result of the
merger with Brian Center Corporation. All defendants submitted Motions to
Dismiss which were heard by the Court on September 15, 1999. The Court granted
Defendant, Donald C. Beaver's, Motion to Dismiss on December 6, 1999. Very
little discovery has been conducted and accordingly, this case is not in a
position to be evaluated in regard to the probability of a favorable outcome or
in regard to the range of potential loss. In accordance with the Company's
voluntary filing under Chapter 11 of the United States Bankruptcy Code and more
particularly, ss. 362 of that Code, this matter was stayed on January 18, 2000.
However, an amended complaint was filed and Donald C. Beaver is attempting to
remove this action from the Bankruptcy Court. The Company intends to vigorously
contest the request for class certification, as well as all alleged claims made.
On November 16, 1998, a complaint was filed under seal by a former employee
against the Company, certain of its predecessor entities and affiliates in the
United States District Court for the Southern District of Texas, alleging
violation of the Federal False Claims Act. The action is titled United States ex
rel. Nelius, et al., v. Mariner Health Group, Inc., et al., civil action No.
H-98-3851. The complaint which was unsealed, has been recently amended to add
additional relators and allegations under the Federal False Claims Act. The
Company has been advised that the government is evaluating its decision not to
intervene with regard to the amended complaint and relators. The Company will
vigorously contest the alleged claims. In addition, a three judge panel of the
United States Court of Appeals for the Fifth Circuit recently held that qui tam
lawsuits in which the government does not intervene are unconstitutional under
the Take Care Clause of Article II of the United States Constitution. The Court
declined to rule whether qui tam suits in which the government does intervene
are unconstitutional. The full bench of the U.S. Court of Appeals for the Fifth
Circuit agreed November 15, 1999, to review this decision. Riley v. St. Luke's
Episcopal Hospital, No. 97-20948, rehearing en banc granted (5th Cir., 1999),
but has since stayed hearing pending the outcome of another matter which is
presently pending before the United States Supreme Court. The outcome of these
cases could favorably effect this action. In response to the Notice of Stay
submitted under 11 U.S.C. ss. 362, the District Court, on January 26, 2000,
dismissed the plaintiffs' claims against defendants subject to reinstatement
within thirty (30) days after the stay is discontinued. The Company intends to
vigorously contest the alleged claims herein.
On approximately June 8, 1999, the OIG issued a subpoena duces tecum to
Mariner of Catonsville. The subpoena requests medical records pertaining to
eighteen residents. The subpoena also requests other broad categories of
documents. The Company has produced a substantial amount of documents responsive
to the Subpoena. The Company is cooperating with the investigation and has
retained experienced counsel to assist in responding to the subpoena and to
advise the Company with respect to this investigation. This investigation is
still in its preliminary stages; therefore, the Company is unable to predict the
outcome of this matter.
On October 27, 1999, the Company was served with a Complaint in United
States ex rel. Cindy Lee Anderson Rutledge and Partnership for Fraud Analysis
and State of Florida ex rel. Cindy Lee Anderson Rutledge Group, Inc., ARA Living
Centers, Inc. and Living Centers of America, Inc., No. 97-6801, filed in the
United States District Court for the Eastern District of Pennsylvania. This
action originally was filed under seal on November 5, 1997, by relators Cindy
Lee Anderson Rutledge and the Partnership for Fraud Analysis under the Federal
False Claims Act and the Florida False Claims Act. The Complaint alleges that
the Company is liable under the Federal False Claims Act and the Florida False
Claims Act for alleged violations of regulations pertaining to the training and
certification of nurse aides at former LCA facilities. After conducting an
investigation in which the Company cooperated by producing documents responsive
to an administrative subpoena and allowing certain employee
17
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
interviews, the United States Department of Justice elected not to intervene.
The district court unsealed the Complaint on October 15, 1999. On December 14,
1999, the Company filed a motion to dismiss the relators' complaint. In
accordance with the Company's voluntary filing under Chapter 11 of the United
States Bankruptcy Code and more particularly, ss. 362 of that Code, this matter
was stayed on January 18, 2000. The Company intends vigorously to defend this
action.
On approximately January 20, 2000, the OIG issued subpoenas duces tecum to
Mariner Post-Acute Network, Inc. and Summit Medical Management (a subsidiary of
the Company). The subpoenas request documents relating to the purchase of Summit
Medical Management and other subsidiaries. In addition, the subpoenas request
other broad categories of documents. The Company is cooperating with the
investigation and has retained experienced counsel to assist in responding to
the subpoenas and advise the Company with respect to this investigation. This
investigation is still in its preliminary stages; therefore, the Company is
unable to predict the outcome of this matter.
18
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 11 - SEGMENT INFORMATION
The following tables exhibit the segment reporting of the Company for the
three and nine months ended June 30, 2000 and 1999 (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------------------------------------------
2000 1999 2000 1999
----------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues from external customers:
Nursing home services $ 474,915 $ 371,010 $ 1,419,205 $ 1,354,639
Pharmacy services 56,319 68,325 184,716 216,241
Other 1,300 13,580 7,333 42,040
Therapy (segment disposed of) - 34,220 - 161,605
----------------------------------------------------------------
$ 532,534 $ 487,135 $ 1,611,254 $ 1,774,525
================================================================
Intersegment revenues:
Pharmacy services $ 13,415 $ 14,912 $ 39,676 $ 39,782
Other 71 529 214 1,861
Therapy (segment disposed of) - 21,350 - 99,278
----------------------------------------------------------------
$ 13,486 $ 36,791 $ 39,890 $ 140,921
================================================================
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------------------------------------------
2000 1999 2000 1999
----------------------------------------------------------------
Net income (loss):
Nursing home services $ 52,960 $ (61,251) $ 137,678 $ (7,524)
Pharmacy services 909 (4,992) (1,957) 7,226
Other (5,186) (1,139) (6,171) (956)
Therapy (segment disposed of) (375) (237,532) (1,746) (236,548)
----------------------------------------------------------------
$ 43,308 $ (304,914) $ 127,804 $ (237,802)
================================================================
JUNE 30,
2000
----------------
Assets:
Nursing home services $ 1,041,719
Pharmacy services 110,241
Other 59,687
Therapy (segment disposed of) 32,331
----------------
$ 1,243,978
================
</TABLE>
19
<PAGE>
MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
(DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The following tables reconcile the Company's segment reporting to the
totals on the Company's condensed consolidated financial statements for the
three and nine months ended June 30, 2000 and 1999 (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------------------------------------------
2000 1999 2000 1999
----------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
External revenues for reportable segments $ 532,534 $ 487,135 $ 1,611,254 $ 1,774,525
Intersegment revenues for reportable segments 13,486 36,791 39,890 140,921
Elimination of intersegment revenue (13,486) (36,791) (39,890) (140,921)
----------------------------------------------------------------
Consolidated revenues $ 532,534 $ 487,135 $ 1,611,254 $ 1,774,525
================================================================
Net income (loss):
Net income (loss) for reportable segments $ 48,308 $ (304,914) $ 127,804 $ (237,802)
Corporate overhead (39,705) (100,810) (191,471) (285,698)
----------------------------------------------------------------
Consolidated net income (loss) $ 8,603 $ (405,724) $ (63,667) $ (523,500)
================================================================
JUNE 30,
2000
----------------
Assets:
Assets for reportable segments $ 1,243,978
Corporate overhead 1,463,581
Elimination of intersegment assets (1,439,840)
----------------
$ 1,267,719
================
</TABLE>
20
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is one of the nation's largest providers of post-acute health
care services, primarily through the operation of its skilled nursing
facilities. As of June 30, 2000, the Company's significant operations consist of
(i) approximately 360 inpatient and assisted living facilities containing
approximately 43,000 beds; (ii) approximately 37 institutional pharmacies
servicing more than 1,000 long-term care centers; and (iii) 12 long-term acute
care hospitals with approximately 700 licensed beds. In addition, the Company
has limited physician management operations. The Company operates in 25 states
with significant concentrations of facilities and beds in seven states and
several metropolitan markets.
Historically, the Company also (i) operated a large contract rehabilitation
therapy business that provided comprehensive therapy programs and services, on a
contractual basis, to over 1,200 inpatient healthcare facilities throughout the
United States; (ii) operated approximately 170 outpatient rehabilitation therapy
clinics in eighteen states; (iii) managed specialty medical programs in
acute-care hospitals through more than 100 hospital relationships in nineteen
states (the Company had exited this line of business as of March 31, 2000); and
(iv) operated more than thirty home health, hospice and private duty nursing
branches in seven states (the "Divested Businesses"). Primarily as a result of
changes in Medicare reimbursement effected under the Balanced Budget Act of 1997
(the "Balanced Budget Act"), these businesses began to generate, or were
anticipated to generate, significant operating losses and negative cash flow and
have been divested or closed.
On January 18, 2000, the Company and substantially all of its subsidiaries
(the "Company Debtors"), including Mariner Health and its subsidiaries (the
"Mariner Health Debtors"), filed voluntary petitions (collectively, the "Chapter
11 Filings") in the United States Bankruptcy Court for the District of Delaware
(the "Bankruptcy Court") under Chapter 11 of Title 11 of the United States Code
(the "Bankruptcy Code"). The Company currently is operating its business as a
debtor-in-possession subject to the jurisdiction of the Bankruptcy Court. The
Company's recent operating losses, liquidity issues and the Chapter 11 Cases
raise substantial doubt about the Company's ability to continue as a going
concern.
The ability of the Company to continue as a going concern and the
appropriateness of using the going concern basis of accounting is dependent
upon, among other things, the ability to comply with the terms of the Company
DIP Financing, confirmation of a plan of reorganization, success of future
operations after such confirmation and the ability to generate sufficient cash
from operations and financing sources to meet obligations. Any plan of
reorganization and other actions during the Chapter 11 Cases could change
materially the amounts currently recorded in the condensed consolidated
financial statements (see Notes 2 and 3 of the condensed consolidated financial
statements).
During the quarter ended June 30, 2000, the Company divested itself of
approximately 24 owned, leased and managed skilled nursing facilities. The net
results of these divestitures are expected to have a positive effect on
operating results (see Note 6 of the condensed consolidated financial
statements).
At June 30, 2000, working capital was approximately $226.4 million as
compared to a working capital deficiency of approximately ($1.9) billion at
September 30, 1999. The increase in working capital is primarily attributable to
the reclassification of the Company's debt facilities, accrued interest and
other related liabilities from current liabilities at September 30, 1999 to
liabilities subject to compromise at June 30, 2000 in accordance with the
requirements of American Institute of Certified Public Accountants Statement of
Position 90-7, "Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code" ("SOP 90-7").
21
<PAGE>
The following discussion and analysis should be read in conjunction with
the business segment data in Note 11 of the condensed consolidated financial
statements.
GENERAL
The Company's revenues and profitability are affected by ongoing efforts of
third-party payors to contain healthcare costs by limiting reimbursement rates,
increasing case management review and negotiating reduced contract pricing. The
Company's percentage of total net patient revenues derived from Medicare and
Medicaid programs were 25.0% and 49.9%, respectively, for the quarter ended June
30, 2000. The Federal Medicare program restricts inpatient coverage to patients
who require skilled care. State-administered Medicaid programs generally provide
more restricted coverage and lower reimbursement rates than private pay sources.
Private payors accounted for 25.1% of the Company's total net patient revenues
for the quarter ended June 30, 2000.
The administrative procedures associated with the Medicare cost
reimbursement program, with respect to facilities and periods not subject to the
Prospective Payment System ("PPS"), generally preclude final determination of
amounts due the Company until annual cost reports are audited or otherwise
reviewed and settled with the applicable fiscal intermediaries and
administrative agencies. Certain Medicare fiscal intermediaries have made audit
adjustments to settle cost reports for some of the Company's facilities that
reduce the amount of reimbursement that was previously received by the
facilities. The Company believes that it has properly recorded revenue under
cost reimbursement programs based on the facts and current regulations. If the
Company was to receive adverse adjustments that it had not contemplated in
recording its revenue in the past, the differences could be significant to the
Company's results of operations in the period of final determination (see
"-Liquidity and Capital Resources"). Under PPS, the Company is still required to
file cost reports; however, the audit and settlement process of Medicare cost
reports is not expected to have a material impact on total Medicare revenue. See
"-Liquidity and Capital Resources." As part of the bankruptcy process the
Company, Mariner Health and their subsidiaries are engaged in discussions with
the HealthCare Financing Administration ("HCFA") to potentially settle some or
all matters related to historical cost-based reimbursement. It is not possible
to estimate as yet whether this process will result in material differences of
amounts previously recorded or the effects on future cash flows.
RESULTS OF OPERATIONS
Revenues from nursing home operations accounted for $474.9 million and
$1,419.2 million of the Company's $532.5 million and $1,611.3 million total
revenues for the three and nine months ended June 30, 2000, respectively.
Nursing home revenues are derived from the provision of routine and ancillary
services and are a function of occupancy rates and payor mix in the Company's
long-term care facilities. Weighted average occupancy, as identified in the
following table increased by 1.5% and decreased by (0.3)% over the comparable
three and nine month periods from 1999 to 2000.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
-----------------------------------------------------
2000 1999 2000 1999
-----------------------------------------------------
<S> <C> <C> <C> <C>
Weighted average licensed bed count 45,592 48,139 46,247 48,141
Weighted average number of residents 39,355 40,808 39,696 41,456
Weighted average occupancy 86.3% 84.8% 85.8% 86.1%
</TABLE>
Payor mix is the source of payment for the services provided and consists
of private pay, Medicare and Medicaid. Private pay includes revenues from
individuals who pay directly for services without government assistance through
the Medicare and Medicaid programs, managed care companies, commercial insurers,
health maintenance organizations, Veteran's Administration contractual payments
and payments for services provided
22
<PAGE>
under contract management programs. Managed care as a payor source to nursing
home operators is likely to increase over the next several years and management
is preparing the Company's infrastructure for more managed care contracting.
However, revenue from managed care payors does not constitute a significant
portion of the Company's revenue at this time.
Reimbursement rates from government sponsored programs, such as Medicare
and Medicaid, are strictly regulated and subject to funding appropriations from
federal and state governments. Changes in reimbursement rates, including the
implementation of the PPS for the Part A Medicare system and fee screen
schedules and therapy caps for Part B Medicare patients that began on January 1,
1999, have adversely affected the Company resulting in significantly lower
Medicare revenues than the Company would have received under the old payment
methodology. These Medicare changes drove the Company's decision to terminate
its contracts to provide therapy services during the third fiscal quarter of
1999 and to liquidate that line of business. In June of 1999 the Company's
nursing homes were able to internally employ therapists to provide services
which were previously contracted. See "-Liquidity and Capital Resources". The
table below presents the approximate percentage of the Company's net patient
revenues derived from the various sources of payment for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
-----------------------------------------------------
2000 1999 2000 1999
-----------------------------------------------------
<S> <C> <C> <C> <C>
Private and other 25.1% 28.1% 25.6% 31.3%
Medicare 25.0% 23.7% 24.6% 25.3%
Medicaid 49.9% 48.2% 49.8% 43.4%
</TABLE>
The combined mix of private/other and Medicare revenue was 50.1% and 50.2%
for the three and nine month periods ended June 30, 2000, respectively, as
compared to 51.8% and 56.6% for the same periods in 1999. The net revenues from
the non-nursing home operations are primarily reimbursed by facility providers
which are considered private pay sources. The impact of decreased therapy
revenue resulting from the Company exiting the business of providing therapy
services to unaffiliated third parties has decreased the percentage of private
revenue for the Company. As of June 30, 1999, all of the Company's nursing homes
had converted to PPS based Medicare payments which has influenced the comparison
of revenue mix between the three and nine month periods ended June 30, 1999 and
2000. See "-Liquidity and Capital Resources".
Costs and expenses, excluding depreciation and amortization, indirect
merger and other expenses, and loss (gain) on disposal of assets primarily
consist of salaries, wages, and employee benefits. Various federal, state and
local regulations impose, depending on the services provided, a variety of
regulatory standards for the type, quality and level of personnel required to
provide care or services. The regulatory requirements have an impact on staffing
levels, as well as the mix of staff, and therefore impact salaries, wages and
employee benefits. The cost of ancillary services, which includes
pharmaceuticals and therapy, is also affected by the level of service provided
and patient acuity. General and administrative expenses include the indirect
administrative costs associated with operating the Company and its lines of
business.
SEASONALITY
The Company's revenues and operating income generally fluctuate from
quarter to quarter. This seasonality is related to a combination of factors
which include the timing of third party payment rate changes, the number of work
days in the period and seasonal census cycles.
23
<PAGE>
THIRD QUARTER FISCAL 2000 COMPARED TO THIRD QUARTER FISCAL 1999
Net revenues comprising nursing home and non-nursing home operations
totaled $532.5 million for the quarter ended June 30, 2000, an increase of $45.4
million or 9.3%, as compared to the same period for fiscal 1999. Nursing home
operations accounted for $103.9 million of the revenue increase mainly as a
result of a reduction in revenues during the quarter ended June 30, 1999 of
$94.4 million. The reduction resulted from a change in estimate to reduce the
estimated amount due from third-party payors. This change in estimate included
$11.7 million to reduce the estimated amount receivable from cost reports filed
or settled during the period. The remaining $82.7 million was recorded to
reflect amounts due to the Medicare program for previously received
reimbursement and to reduce the estimated amount receivable from all Medicare
cost report appeal items and primarily pertains to related party adjustments
asserted by Medicare intermediaries through the May 1999 reopening of certain
Mariner Health Medicare cost reports for 1995, 1996, and 1997. Excluding the
change in estimate, net revenues from nursing home operations increased 2.0%.
This increase was a result of favorable rate variances, primarily with Medicaid
and Medicare Part B, for the quarter ended June 30, 2000 as compared to the same
period for fiscal 1999.
Revenues for non-nursing home operations, which consist principally of
pharmacy services for the three months ended June 30, 2000 and consisted
principally of pharmacy and therapy services for the three months ended June 30,
1999, decreased by $58.5 million. This decrease consisted of $34.2 million as a
result of the termination of all contracts to provide therapy services to
unrelated third parties effective May 31, 1999 and the divestiture or closure of
the Divested Businesses. In addition there was a $12.0 million revenue decrease
for pharmacy services compared to the same period for fiscal 1999. The pharmacy
revenue decrease was the result of a reduction in the number of beds being
served.
Indirect merger and other expenses totaled $0.3 million for the quarter
ended June 30, 2000, a decrease of $17.2 million or 97.9% as compared to the
same period fiscal 1999. The decrease was primarily the result of costs incurred
during fiscal 1999 related to the Mariner Health Merger, costs resulting from
the closure of the therapy business and other operating costs incurred to reduce
overhead.
Costs and expenses, excluding indirect merger and other expenses,
depreciation and amortization expenses, and loss (gain) on disposal of assets,
totaled $507.5 million for the quarter ended June 30, 2000, a decrease of $55.4
million or 9.8% as compared to the same period for fiscal 1999. The decrease was
primarily the result of a decrease in ancillary services expense of $36.8
million. The decrease in this cost category was primarily attributable to the
Company significantly reducing overhead costs and the loss of the Divested
Businesses.
For the three months ended June 30, 2000, depreciation and amortization
costs were $18.6 million, a decrease of $15.0 million from the prior year
comparable period. This decrease was principally the result of the Company
recording an impairment charge of $995.9 million in the fourth quarter of fiscal
year 1999.
Provision for bad debts totaled $14.8 million, an increase of $2.0 million
for the quarter ended June 30, 2000. The increase is attributed to additional
provision for receivables retained from the sale of the Company's home health
operations in fiscal 2000.
Loss (gain) on disposal of assets decreased $233.1 million as compared to
the same period for fiscal 1999. The decrease is attributable to the fact that
during the three months ended June 30, 1999, the Company terminated all of its
contracts to provide therapy services, other than contracts to provide therapy
services to hospitals, to both unaffiliated third-parties and to the Company's
skilled nursing facilities which resulted in a loss on the disposal of the
goodwill associated with the therapy business of $228.5 million.
For the three months ended June 30, 2000, interest expense, net of interest
income totaled approximately $(2.3) million, a decrease of $50.2 million. The
Company stopped recording interest expense relating to its debt facilities
effective January 18, 2000 in accordance with the requirements of SOP 90-7.
24
<PAGE>
Reorganization items related to the Chapter 11 proceedings of ($8.1)
million for the quarter ended June 30, 2000 includes $4.2 million in
professional fees, $0.2 million of other reorganization costs and ($11.0)
million of net gains on divestitures, which are partially offset by interest
income earned on accumulated cash resulting from the Chapter 11 filings of $1.1
million and gains on settlement of prepetition accounts payable of $0.4 million.
FISCAL 2000 YEAR TO DATE COMPARED TO FISCAL 1999 YEAR TO DATE
Net revenues comprising nursing home and non-nursing home operations
totaled $1,611.3 million for the nine months ended June 30, 2000, a decrease of
$16.3 million or 9.2%, as compared to the same period for fiscal 1999. Nursing
home operations increased $64.6 million or 4.8%, as compared to the same period
for fiscal 1999, mainly as a result of a reduction in revenues during the
quarter ended June 30, 1999 of $94.4 million. The reduction resulted from a
change in estimate to reduce the estimated amount due from third-party payors.
This change in estimate included $11.7 million to reduce the estimated amount
receivable from cost reports filed or settled during the period. The remaining
$82.7 million was recorded to reflect amounts due to the Medicare program for
previously received reimbursement and to reduce the estimated amount receivable
from all Medicare cost report appeal items and primarily pertains to related
party adjustments asserted by Medicare intermediaries through the May 1999
reopening of certain Mariner Health Medicare cost reports for 1995, 1996, and
1997. Excluding the change in estimate Excluding the change in estimate, net
revenues from nursing home operations decreased 2.1% as a result of implementing
PPS beginning July 1, 1998 through April 1, 1999, causing significantly reduced
Medicare revenues.
Revenues for non-nursing home operations, which consist principally of
pharmacy services for the nine months ended June 30, 2000 and consisted
principally of pharmacy and therapy services for the nine months ended June 30,
1999, decreased by $227.8 million. This decrease consisted of $161.6 million as
a result of the termination of all contracts to provide therapy services to
unrelated third parties effective May 31, 1999 and the divestiture or closure of
the Divested Businesses. In addition there was a $31.5 million revenue decrease
for pharmacy services compared to the same period for fiscal 1999. The pharmacy
revenue decrease was the result of a reduction in the number of beds being
served as well as lower revenues attributable to the loss of a contract to
provide respiratory services.
Indirect merger and other expenses totaled $8.8 million for the nine months
ended June 30, 2000, a decrease of $16.0 million or 64.5% as compared to the
same period for fiscal 1999. The decrease was primarily the result of costs
incurred during fiscal 1999 related to the Mariner Health Merger, costs
resulting from the closure of the therapy business, and other operating costs
incurred to reduce overhead.
Costs and expenses excluding indirect merger and other expenses,
depreciation and amortization expenses, and loss (gain) on disposal of assets
totaled $1,551.7 million for the nine months ended June 30, 2000, a decrease of
$253.8 million or 1.4% as compared to the same period for fiscal 1999. The
decrease was primarily the result of costs for payroll and employee benefits,
which decreased by $25.3 million, while ancillary expenses decreased by $137.4
million. The decrease in these two cost categories was primarily attributable to
the Company significantly reducing overhead costs and the loss of the Divested
Businesses.
For the nine months ended June 30, 2000, depreciation and amortization
costs were $44.3 million, a decrease of $52.5 million from the prior year
comparable period. This decrease was principally the result of the Company
recording an impairment charge of $995.9 million in the fourth quarter of fiscal
year 1999.
Provision for bad debts totaled $29.9 million, a decrease of $61.5 million
for the nine months ended June 30, 2000. The decrease is attributable to
increased provision in fiscal year 1999 due to the increased aging and
uncollectible accounts in both the Company's pharmacy and therapy accounts
receivable. In addition, the Company experienced deterioration in its nursing
home accounts receivable due to the multiple complexities involved with a
25
<PAGE>
change to PPS billing, system conversions or consolidation and turnover of
facility-level billing and collection personnel.
Loss (gain) on disposal of assets decreased $232.9 million as compared to
the same period for fiscal 1999. The decrease is attributable to the fact that
during the three months ended June 30, 1999, the Company terminated all of its
contracts to provide therapy services, other than contracts to provide therapy
services to hospitals, to both unaffiliated third-parties and to the Company's
skilled nursing facilities which resulted in a loss on the disposal of the
goodwill associated with the therapy business of $228.5 million.
For the nine months ended June 30, 2000, interest expense, net of interest
income totaled approximately $57.7 million, a decrease of $81.4 million. The
Company stopped recording interest expense relating to its debt facilities
effective January 18, 2000 in accordance with the requirements of SOP 90-7.
Reorganization items related to the Chapter 11 proceedings of $4.4 million
includes $12.7 million in professional fees, $2.9 million in financing costs
primarily related to the DIP Financings, $1.7 million of other reorganization
costs and $11.0 of net gains on divestitures, which are partially offset by
interest income earned on accumulated cash resulting from the Chapter 11 filings
of $1.2 million and gains on settlement of prepetition accounts payable of $0.6
million.
LIQUIDITY AND CAPITAL RESOURCES OF THE COMPANY
Cash and cash equivalents were $136.9 million at June 30, 2000. At June 30,
2000, working capital was approximately $226.4 million as compared to a working
capital deficiency of approximately ($1.9) billion at September 30, 1999. The
increase in working capital is primarily attributable to the reclassification of
the Company's debt facilities, accrued interest and other related liabilities
from current liabilities at September 30, 1999 to liabilities subject to
compromise at June 30, 2000 in accordance with the requirements of SOP 90-7.
Cash provided by operating activities was $60.3 million in the nine months ended
June 30, 2000, as compared to $37.5 million used in operating activities for the
nine months ended June 30, 1999. The Company and its subsidiaries also have
available $150.0 million in DIP Financing, as described below, none of which has
been borrowed as of June 30, 2000.
Cash provided by investing activities was $8.1 million in the nine months
ended June 30, 2000, as compared to $21.0 million used in investing activities
for the nine months ended June 30, 1999. Investing activities included the use
of $23.0 million related to capital expenditures for the nine months ended June
30, 2000. These capital expenditures were offset by the change in restricted
investments which were provided for the payment of insurance claims.
Cash used in financing activities was $3.3 million in the nine months
ended June 30, 2000, as compared to cash provided by financing activities of
$158.5 million for the nine months ended June 30, 1999. Cash provided by
financing activities included $12.7 million in net draws under prepetition
credit line and principal repayments of $12.7 million for the nine months ended
June 30, 2000.
The primary source of revenues for the Company are the State Medicaid
programs and federal Medicare program. The Company receives payment for nursing
facility services based on rates that are set by individual state Medicaid
programs. Although payment cycles for these programs vary, payments generally
are made within 30 to 60 days after services are provided. For Medicare cost
reporting periods beginning July 1, 1998 and after, the federal Medicare program
converted to PPS for skilled nursing facility services. All of the Company's
skilled nursing facilities are currently reimbursed under PPS. The prospective
payment system provides acuity-based rates that are established at the beginning
of the Medicare reporting year.
For cost reporting periods that ended before the start of PPS, the
facilities were (and to the extent final cost reports for prior periods are not
settled, still are) reimbursed under Medicare on the basis of reasonable and
necessary cost as determined from annual cost reports. This retrospective
settlement system resulted in final cost
26
<PAGE>
report settlements that generally were not finally settled until two years after
the end of the cost reporting period and that could be further delayed by
appeals and litigation.
PPS has had a material adverse effect on the Company's financial condition.
While the effects of PPS have been somewhat ameliorated by recent legislation,
PPS is in large part responsible for the inability of the Company to operate
under its existing capital structure. See "-Healthcare Regulatory Matters."
PPS reduced the cash flows of both the pharmacy and therapy businesses'
customers, which resulted in an increased aging and uncollectable accounts in
both businesses' accounts receivable due to the multiple complexities involved
with the customers' change to Medicare PPS billing. The Company's facilities
were phased into PPS based upon their cost report years (approximately 20
facilities during the fourth quarter of 1998; approximately 115 facilities
during the first quarter of 1999; approximately 135 facilities during the second
quarter of 1999; and approximately 85 facilities during the third quarter of
1999.). All facilities are now being paid by Medicare under PPS and revenue
recorded for the prior nine months of fiscal year 2000 consists of the aggregate
payments expected from Medicare for individual claims at the appropriate payment
rates. The PPS billing methodology is extremely complex and its implementation
is resource intensive. The Company has a commitment to training and compliance
and has established procedures to address PPS issues as they arise.
The Company provides certain services and supplies between subsidiary
companies, some of which are charged at cost and others of which are charged at
market rates. Subject to certain exceptions, Medicare's "related organization
principle" generally requires that services and supplies furnished to nursing
facilities by related entities be included in the nursing facility's
reimbursable cost at the cost of the supplying entity. The Company believes that
the services and supplies furnished to nursing facilities at market rates
qualify for exception to the related organization principle. Certain of the
Company's Medicare fiscal intermediaries have taken the position that the
related party transactions do not qualify for this exception to the related
party rules and have made adjustments that reduce Medicare allowable cost to the
cost of the supplying entity. During the third quarter of fiscal 1999, the
intermediaries for the Mariner Health facilities reopened previously settled
cost reports to impose such related party adjustments for services furnished to
the facilities by Mariner Health's rehabilitation subsidiary. All related party
adjustments have been or will be appealed to the Provider Reimbursement Review
Board and through the full appeal process as is warranted. The adjustments
affect only periods during which the facilities were reimbursed for Medicare on
the basis of reasonable and necessary cost; there would not be any impact for
periods that are reimbursed under PPS.
During the third quarter of fiscal 1999, the Medicare fiscal intermediaries
for the subsidiaries operated by Mariner Health reopened approximately fifty
1995 and 1996 cost reports and issued revised notices of program reimbursement
("NPRs") imposing prudent buyer or related party adjustments as well as applying
an administrative resolution related to the cost report treatment of admissions
cost. The reopenings resulted in reductions in reimbursable cost of
approximately $16.9 million. The Company believes that it has substantial
arguments for both issues and will appeal the adjustments to the Provider
Reimbursement and Review Board ("PRRB"). In lieu of recoupment by the fiscal
intermediary, the Company reached an agreement with HCFA and the intermediary
and implemented an extended repayment plan. The balance as of the date of the
agreement was approximately $15.9 million, which was repaid over a period of one
year. As of June 30, 2000, all payments have been made. The intermediary has
notified Mariner Health that it intends to issue NPRs for the remaining facility
cost reports (1997 through 1999) starting in fiscal year 2000. As part of the
Chapter 11 process, Mariner Health entered into a stipulation with the U.S.
Department of Health and Human Services whereby, among other things, HCFA will
not recoup certain prepetition overpayments for other than the current cost
reporting years for the pendancy of Mariner Health's DIP obligations.
Accordingly, repayment obligations which may arise from the issuance of NPRs may
be stayed for an interim period. Should the NPRs result in a repayment
requirement not within the purview of the stipulation, or after the pendancy of
the DIP obligations, the Company and Mariner Health would seek to enter into an
extended repayment plan with HCFA at that time.
27
<PAGE>
PREPETITION DEBT. Due to the failure to make scheduled payments, comply
with certain financial covenants and the commencement of the Chapter 11 cases,
the Company is in default on all, or substantially all, of its prepetition debt
obligations. Except as otherwise may be determined by the Bankruptcy Court, the
automatic stay protection afforded by the Chapter 11 Filings prevents any action
from being taken with regard to any of the defaults under the prepetition debt
obligations. These obligations are classified as current liabilities at
September 30, 1999 and as liabilities subject to compromise at June 30, 2000.
The obligations of the Company under the Senior Credit Facility are
guaranteed by substantially all of the Company's subsidiaries other than Mariner
Health and its subsidiaries, and are secured by substantially all of the
otherwise unencumbered owned assets of the Company and such subsidiaries.
Mariner Health's obligations under the Mariner Health Senior Credit Facility are
guaranteed by substantially all of its subsidiaries and are secured by
substantially all of the otherwise unencumbered assets of Mariner Health and
such subsidiary guarantors. Mariner Health and its subsidiaries are treated as
unrestricted subsidiaries under the Company's debt facilities. Unlike other
subsidiaries of the Company (the "Non-Mariner Subsidiaries"), Mariner Health and
its subsidiaries neither guarantee the Company's obligations under the Company's
debt facilities, except for that certain obligation regarding the Company's
total return swap, nor pledge their assets to secure such obligations.
Correspondingly, the Company and the Non-Mariner Subsidiaries do not guarantee
or assume any obligations under the Mariner Health debt facilities. Mariner
Health and its subsidiaries are not subject to the covenants contained in the
Company's debt facilities, and the covenants contained in the Mariner Health
debt facilities are not binding on the Company and the Non-Mariner Subsidiaries.
No interest has been paid or accrued on prepetition indebtedness since the
Petition Date and no principal payments have been made since such time with the
exception of repayments made against the Senior Credit Facility as a result of
the application of 75% of net cash proceeds received from the sales of certain
facilities and other assets and notional amounts related to certain capital
equipment leases.
DEBTOR-IN-POSSESSION FINANCING FOR THE COMPANY. In connection with the
Chapter 11 Filings, the Company entered into a $100.0 million
debtor-in-possession financing agreement (the "Company DIP Credit Agreement")
with a group of banks (the "Company DIP Lenders") led by The Chase Manhattan
Bank ("Chase"). On March 20, 2000 the Bankruptcy Court granted final approval
(the "Final Company DIP Order") of the Company DIP Financing.
The Company DIP Credit Agreement establishes a one-year, $100.0 million
secured revolving credit facility to provide funds for working capital and other
lawful corporate purposes for use by the Company and the other Company Debtors;
provided, however, that amounts outstanding under the Company DIP Financing may
not at any time exceed the maximum borrowing amounts established for the Company
under the Final Company DIP Order or the Company's borrowing base of eligible
accounts receivable (the "Company Borrowing Base"). Up to $10.0 million of the
Company DIP Financing may be utilized for the issuance of letters of credit as
needed in the business of the Company Debtors. Interest accrues on the principal
amount outstanding under the Company DIP Financing at a per annum rate of
interest equal to the Alternative Base Rate of Chase plus three percent (3%) and
is payable monthly in arrears. During the existence and continuation of a
default in the payment of any amount due and payable by the Company Debtors
under the Company DIP Credit Agreement, interest will accrue at the default rate
of ABR plus five percent (5%) per annum.
The outstanding principal of the Company DIP Financing, together with all
accrued and unpaid interest and all other obligations thereunder, are due and
payable one year from the Petition Date. The Company must also prepay principal
to the extent that the principal amount outstanding under the Company DIP
Financing at any time exceeds the Company Borrowing Base then in effect. To the
extent proceeds of loans under the Company DIP Financing are used to complete
the construction of certain healthcare facilities that are part of the Synthetic
Lease (as defined) (which proceeds are not permitted to exceed $8.8 million),
proceeds from the sale of any such properties must be used first to repay any
portion of the loans made pursuant to the Company DIP Financing, with 75% of any
remaining net cash proceeds to be applied as an adequate protection payment to
the lenders under the
28
<PAGE>
Senior Credit Facility, and the remaining 25% of such excess net cash proceeds
to be retained by the Company or its applicable subsidiary as additional working
capital. Pursuant to the terms of the Final Company DIP Order, 75% of the net
cash proceeds of other asset sales approved by the Bankruptcy Court and the
requisite Company DIP Lenders are to be applied as an adequate protection
payment to the lenders under the prepetition Senior Credit Facility. The Company
has the right to make optional prepayments in increments of $1.0 million, and to
reduce the commitment under the Company DIP Credit Agreement in increments of
$5.0 million.
The obligations of the Company under the Company DIP Credit Agreement are
jointly and severally guaranteed by each of the other Company Debtors, except
for certain Company Debtors owning facilities mortgaged to Omega Healthcare
Investors, Inc. (the "Omega Debtors") who's guarantee is limited to the negative
cash flows of the Omega Debtors, pursuant to the Company DIP Agreement. Under
the terms of the Final Company DIP Order, the obligations of the Company Debtors
under the Company DIP Credit Agreement (the "Company DIP Obligations"")
constitute allowed superiority administrative expense claims pursuant to Section
364(c)(1) of the Bankruptcy Code (subject to a carve out for certain
professional fees and expenses incurred by the Company Debtors. The Company DIP
Obligations are secured by perfected liens on all or substantially all of the
assets of the Company Debtors (excluding bankruptcy causes of action), the
priority of which liens (relative to prepetition creditors having valid, non
avoidable, perfected liens in those assets and to any "adequate protection"
liens granted by the Bankruptcy Court) is established in the Initial Company DIP
Order and the related cash collateral order entered by the Bankruptcy Court (the
"Final Company Cash Collateral Order"). The Bankruptcy Court has also granted
certain prepetition creditors of the Company Debts replacement liens and other
rights as "adequate protection" against any diminution of the value of their
existing collateral that may result from allowing the Company Debtors to use
cash collateral in which such creditors had valid, non-avoidable and perfected
liens as of the Petition Date. The discussion contained in this paragraph is
qualified in its entirety by reference to the Final DIP Order, the Final Company
Cash Collateral Order, and related stipulations, and reference should be made to
such orders (which are available from the Bankruptcy Court) and stipulations for
a more complete description of such terms.
The Company DIP Credit Agreement contains customary representations,
warranties and other affirmative and restrictive covenants of the Company
Debtors, as well as certain financial covenants relating to minimum EBITDA,
maximum capital expenditures, and minimum patients census. The breach of such
representations, warranties or covenants, to the extent not waived or cured
within any applicable grace or cure periods, could result in the Company being
unable to obtain further advances under the Company DIP Financing and possibly
the exercise of remedies by the Company DIP Lenders, either of which events
could materially impair the ability of the Company to successfully reorganize in
Chapter 11 and to operate as a going concern. Such a default may also impair the
ability of the Company to use cash collateral to fund operations.
DEBTOR-IN-POSSESSION FINANCING FOR MARINER HEALTH. Among the orders entered
by the Bankruptcy Court on the Petition Date in the Chapter 11 cases of Mariner
Health and its subsidiaries were orders approving (a) the use of cash collateral
by the Mariner Health Debtors, and (b) the funding of up to $15.0 million in
principal amount at any time outstanding under a debtor-in-possession financing
arrangement (the "Mariner Health DIP Financing" and together with the Company
DIP Financing, the "DIP Financings") pursuant to that certain
Debtor-in-Possession Credit Agreement dated as of January 20, 2000 (as amended
from time to time, entered into a $50.0 million debtor-in-possession financing
agreement (the "Mariner Health DIP Credit Agreement") by and among Mariner
Health and each of the other Mariner Health Debtors, as co-borrowers thereunder,
the lenders signatory thereto as lenders (the "Mariner Health DIP Lenders"),
First Union National Bank, as Syndication Agent, PNC Capital Markets, Inc. and
First Union Securities, Inc., as co-arrangers, and PNC Bank, National
Association, as Administrative Agent and Collateral Agent. After a final hearing
on February 16, 2000, the Bankruptcy Court entered into an order granting final
approval of up to $50.0 million of the Mariner Health DIP Financing (the "Final
Mariner Health DIP Order").
The Mariner Health DIP Credit Agreement establishes a one-year, $50.0
million secured revolving credit facility comprised of a $40.0 million tranche A
revolving loan commitment and a $10.0 million tranche B revolving loan
commitment. Borrowings under the tranche B loan require the approval of lenders
holding at least 75% of the
29
<PAGE>
credit exposure under the Mariner Health DIP Credit Agreement. Advances under
the Mariner Health DIP Financing may be used by the Mariner Health Debtors (and
to a limited degree, by certain joint venture subsidiaries of Mariner Health
that are not debtors in the Mariner Health Chapter 11 cases) for working capital
and other lawful corporate purposes. Amounts outstanding under the Mariner
Health DIP Financing may not at any time exceed the maximum borrowing amounts
established for the Mariner Health Debtors under the Final Mariner Health DIP
Order. Up to $5.0 million of the Mariner Health DIP Financing may be utilized
for the issuance of letters of credit as needed in the businesses of the Mariner
Health Debtors.
Interest accrues on the principal amount outstanding under the Mariner
Health DIP Financing at a per annum rate of interest equal to the "base rate" of
PNC (i.e., the higher of the PNC prime rate or a rate equal to the federal funds
rate plus 50 basis points) plus the applicable spread, which is 250 basis points
for tranche A and 300 basis points for tranche B. Such interest is due and
payable monthly in arrears. During the existence and continuation of any event
of default under the Mariner Health DIP Credit Agreement, the interest rates
normally applicable to tranche A loans and tranche B loans under the Mariner
Health DIP Financing will be increased by another 250 basis points per annum.
The outstanding principal of the Mariner Health DIP Financing, together
with all accrued and unpaid interest and all other obligations thereunder, are
due and payable in one year or, if earlier, on the Commitment Termination Date,
which is defined as the first to occur of (i) January 19, 2001; (ii) the
effective date of a joint plan of reorganization for the Mariner Health Debtors;
(iii) the date of termination of the exclusivity rights of the Mariner Health
Debtors to file a plan of reorganization (currently scheduled to expire on
August 18, 2000); (iv) the filing by the Mariner Health Debtors of any plan of
reorganization (or the modification of any such plan previously filed with the
Bankruptcy Court) not previously approved by the holders of at least 66-2/3% of
the outstanding loans or commitments under the Mariner Health DIP Financing; (v)
the date of termination of the commitments under the Mariner Health DIP Credit
Agreement during the continuation of an event of default thereunder; or (vi) the
date on which all or substantially all of the assets or stock of the Mariner
Health Debtors is sold or otherwise transferred. The Mariner Health Debtors must
also prepay principal to the extent that the principal amount outstanding under
the Mariner Health DIP Financing at any time exceeds the Mariner Health
borrowing base then in effect. The Mariner Health borrowing base for any month
is an amount equal to $7.5 million in excess of the "Working Capital Facility"
borrowings projected for such month in Mariner Health's year 2000 DIP budget.
The Mariner Health DIP Credit Agreement also provides for mandatory prepayments
under the following circumstances: (a) with net cash proceeds from asset sales,
the incurrence of certain debt, the issuance of new equity, the receipt of tax
refunds exceeding $100,000 in the aggregate, and the receipt of casualty
proceeds in excess of $100,000 that are not applied within 60 days after receipt
to the repair, rebuilding, restoration or replacement of the assets damaged or
condemned (or committed within such period of time to be so applied); and (b) on
each business day, the amount of cash held by the Mariner Health Debtors in
excess of the sum of $5.0 million plus the aggregate sum of the minimum amount
required by depositary banks to be kept in deposit accounts, concentration
accounts and other accounts with such banks. Amounts prepaid pursuant to clause
(a) of the immediately preceding sentence will permanently reduce the amount of
the Mariner Health DIP Financing commitments on a dollar for dollar basis (first
tranche A, and then tranche B). Amounts prepaid pursuant to clause (b) of the
same sentence will not permanently reduce such commitments. The Mariner Health
Debtors have the right to make optional prepayments in the minimum principal
amount of $1.0 million, and in increments of $100,000 in excess thereof, and, on
three business days' notice, to reduce the commitments under the Mariner Health
DIP Credit Agreement in the minimum amount of $5.0 million, or in increments of
$1.0 million in excess thereof.
As provided in the Final Mariner Health DIP Order, the obligations of the
Mariner Health Debtors under the Mariner Health DIP Credit Agreement (together
with certain potential cash management system liabilities secured on a pari
passu basis therewith, the "Mariner Health DIP Obligations") constitute allowed
superpriority administrative expense claims pursuant to Section 364(c)(1) of the
Bankruptcy Code (subject to a carve-out for certain professional fees and
expenses incurred by the Mariner Debtors). The Mariner Health DIP Obligations
will be secured by perfected liens on all or substantially all of the assets of
the Mariner Health Debtors (excluding
30
<PAGE>
bankruptcy causes of action), the priority of which liens (relative to
prepetition creditors having valid, non-avoidable, perfected liens in those
assets and to any "adequate protection" liens granted by the Bankruptcy Court)
is established in the February 16 Mariner Health DIP Order and the related cash
collateral orders entered by the Bankruptcy Court.. The Bankruptcy Court has
also granted certain prepetition creditors of the Mariner Health Debtors
replacement liens and other rights as "adequate protection" against any
diminution of the value of their existing collateral that may result from
allowing the Mariner Health Debtors to use cash collateral in which such
creditors had valid, non-avoidable and perfected liens as of the Petition Date.
The discussion contained in this paragraph is qualified in its entirety by
reference to the February 16 Mariner Health DIP Order, the related Mariner
Health Cash Collateral Orders, and related stipulations, and reference should be
made to such orders (which are available from the Bankruptcy Court) and
stipulations for a more complete description of such terms.
The Mariner Health DIP Credit Agreement contains customary representations,
warranties and other affirmative and restrictive covenants of the Mariner Health
Debtors, as well as certain financial covenants relating to minimum EBITDAR,
minimum patient census, minimum eligible accounts receivable, maximum variations
from Mariner Health's year 2000 DIP budget and maximum capital expenditures. The
breach of such representations, warranties or covenants, to the extent not
waived or cured within any applicable grace or cure periods, could result in the
Mariner Health Debtors being unable to obtain further advances under the Mariner
Health DIP Financing and possibly the exercise of remedies by the Mariner Health
DIP Lenders, either of which events could materially impair the ability of the
Mariner Health Debtors to successfully reorganize in Chapter 11 and to operate
as a going concern. Included among the events of default is the termination of
the Mariner Health Debtor's exclusive right to file a plan or plans of
reorganization in any of their Chapter 11 cases other than as the result of the
filing of a plan or plans of reorganization acceptable to the lenders; the
Marnier Health exclusivity period currently is scheduled to expire on August 18,
2000. The occurrence of an event of default under the Mariner Health DIP Credit
Agreement may impair the ability of the Mariner Health Debtors to use cash
collateral to fund operations.
Among its other restrictive covenants, the Mariner Health DIP Credit
Agreement limits affiliate transactions with the Company Debtors, but does
contemplate weekly overhead payments to the Company equal to 1.25% of projected
net inpatient revenues for the then-current month, subject to a monthly
"true-up," such that the payments for such month equal 5% of actual net
inpatient revenues of the Mariner Health Debtors. Such payments may be suspended
by the Mariner Health Debtors if certain defaults specified in the Mariner
Health DIP Credit Agreement occur and are continuing, though such fees will
still accrue and will become due and payable if and when the subject default has
been cured or waived.
HEALTHCARE REGULATORY MATTERS. The Balanced Budget Act contains numerous
changes to the Medicare and Medicaid programs with the intent of slowing the
growth of payments under these programs by $115.0 billion and $13.0 billion,
respectively, through the year ended 2002. Approximately 50% of the savings were
to be achieved through a reduction in the growth of payments to providers and
physicians. These cuts have had, and will continue to have, a material adverse
effect on the Company.
The Balanced Budget Act amended the Medicare program by revising the
payment system for skilled nursing services. Historically, nursing homes were
reimbursed by the Medicare program based on the actual costs of services
provided. However, the Balanced Budget Act required the establishment of a PPS
system for nursing homes for cost reporting periods beginning on or after July
1, 1998. Under PPS, nursing homes receive a fixed per diem rate for each of
their Medicare Part A patients which, during the first three years, is based on
a blend of facility specific rates and Federal acuity adjusted rates.
Thereafter, the per diem rates will be based solely on Federal acuity adjusted
rates. Subsumed in this per diem rate are ancillary services, such as pharmacy
and rehabilitation services, which historically have been provided to many of
the Company's nursing facilities by the Company's pharmacy and therapy
subsidiaries. The inclusion of ancillary services in the PPS per diem has
resulted in significantly lower margins in the Company's pharmacy operations as
a result of increased pricing competition, a change in buying patterns by
customers and the decision by the Company to exit certain businesses previously
operated by the Company such as its third party therapy, home health and
hospital contract management businesses.
31
<PAGE>
On May 12, 1998, HCFA published the "Interim Final Rule" for the skilled
nursing facility ("SNF") PPS along with the acuity adjusted federal PPS rates
for Part A Medicare patients and the facility specific inflation factors
effective from July 1, 1998 through September 30, 1999 and the inflation factors
that are used to adjust the facility specific base period cost to the payment
rates for periods beginning July 1, 1998 through periods beginning September 30,
1999. On July 30, 1999, HCFA published the "Final Rule" for PPS along with
acuity adjusted federal PPS rates that are effective October 1, 1999 through
September 30, 2000, and the inflation factors that are used to adjust an
individual facility's specific base period cost to payment rates for periods
beginning October 1, 1999 through periods beginning September 1, 2000. The
acuity adjusted federal PPS rates and facility specific inflation factor that
are published along with the Final Rule follow the guidance included in the
Interim Final Rule and do not provide any long-term relief from the overall
effect of PPS on Medicare revenue decreases. On November 29, 1999, President
Clinton signed into law H.R. 3194, the "Consolidated Appropriations Act" (the
"CAA") (P.L. 106-113), legislation designed to mitigate the effects of the
Balanced Budget Act . While the CAA is expected to ameliorate somewhat the
adverse effects of the Balanced Budget Act, the Company believes the CAA will
have only a nominal positive effect on its operating results. The CAA, however,
temporarily increases the acuity adjusted PPS rates by 20 percent for 15 acuity
categories. As evidenced by the language of the CAA, this payment increase is
intended to compensate SNFs for the provision of care to medically complex
patients, pending appropriate refinements to the PPS system (which have been
preliminarily issued). SNFs providing care to patients falling within every
non-rehabilitation acuity category above the presumptive (rebuttable) Medicare
eligibility line will benefit from this increase. Three acuity categories
falling within the "high" and "medium" rehabilitation category also are subject
to the increase. The increased payments were scheduled to begin on April 1,
2000, and end before the later of (A) October 1, 2000, or (B) the date HCFA
implements a refined PPS system that better accounts for medically-complex
patients. Neither the CAA nor the accompanying Conference Report provides HCFA
with specific directions regarding such refinements to the PPS system. On July
31, 2000, HCFA withdrew its revision to the acuity system that it planned to
implement October 1, 2000 and will leave in place the 20% increases in 15
specified rug categories until they can develop a more refined system. In
addition, the CAA provides for a four percent increase in the federal per diem
payment rates for all acuity categories in both fiscal years 2001 and 2002. This
increase will not be built into the base payment rates, however, and therefore
future updates to the federal payment rates will be calculated from the initial
base rate.
As of July 1, 1999, all of the Company's SNFs are receiving Medicare
payment through PPS, although transition PPS rates vary from facility to
facility depending on each facility's base period cost that comprises the
facility specific component of the rates and the facility's geographic location
that defines the wage adjuster that is applied to the acuity adjusted federal
component of the rates. For most of the Company's facilities, the facility
specific base period cost is higher than the base period cost that was used to
develop the acuity adjusted federal rates. For some facilities, however, the
facility base period cost is lower than the base period cost used to develop the
PPS rates. The CAA allows SNFs to elect transition to the full federal rate at
the beginning of their cost reporting periods beginning on or after January 1,
2000. SNFs may make the election up to 30 days after the start of their cost
reporting period. The Company has taken advantage of this waiver where
appropriate.
The Balanced Budget Act also repealed the Boren Amendment ("Boren"), which
had required state Medicaid programs to reimburse nursing facilities for the
costs that are incurred by efficiently and economically operated providers in
order to meet quality and safety standards. Because of the repeal of Boren,
states now have considerable flexibility in establishing Medicaid payment rates.
In addition, Boren provided a dispute resolution mechanism whereby providers
could challenge Medicaid rates set by the various states, the repeal of which
will now make it more difficult to challenge these rates in the future. At least
one state, North Carolina, is proposing to change its Medicaid payment rates
and/or payment methodology. However, it is unclear how the procedural
protections imposed by the Balanced Budget Act will constrain these types of
changes. Pending the publication of a final rule implementing the procedural
limitations of the Balanced Budget Act , the Company anticipates that other
states may attempt to change their payment rate methodologies, and that such
changes could result in a reduction in payments to nursing facilities.
32
<PAGE>
The Balanced Budget Act also revised the reimbursement methodology for
therapy services under Medicare Part B. Historically, Medicare Part B therapy
services were reimbursed based on the cost of the services provided, subject to
prudent buyer and salary equivalency restrictions. In November 1998, certain fee
screen schedules were published setting forth the amounts that can be charged
for specific therapy services. Additionally, the Balanced Budget Act set forth
maximum per beneficiary limits of $1,500 per provider for physical therapy and
speech pathology and $1,500 per provider for occupational therapy. Both the fee
screens and per beneficiary limits were effective for services rendered
following December 31, 1998. The imposition of fee screens, together with the
inclusion of ancillary services in the federal per diem, has had a material
adverse effect on the Company's therapy business resulting in the decision by
the Company to terminate its contracts to provide therapy services. The CAA
temporarily mitigates the Balanced Budget Act limitations by providing that the
therapy caps will not apply in 2000 and 2001. The CAA requires the Secretary of
Health and Human Services (the "Secretary") to conduct focused medical reviews
of therapy services during 2000 and 2001, with an emphasis on claims for
services provided to residents of SNFs. The CAA also requires the Secretary to
study and to submit recommendations to Congress on therapy utilization patterns
in 2000 compared to those in 1998 and 1999.
The CAA also excludes certain items and services from the formerly
all-inclusive SNF per diem rates. Specifically, the following items and services
will become separately reimbursable outside of the PPS rates: (1) ambulance
services furnished to an individual in conjunction with renal dialysis services;
(2) chemotherapy items and administration services (as identified by certain
HCFA Common Procedure Coding System ("HCPCS") codes); (3) radioisotope services
(as identified by certain HCPCS codes); and (4) customized prosthetic devices
(artificial limbs) and other custom prostheses if provided to a SNF resident and
intended to be used after discharge (as identified by certain HCPCS codes and
other instances chosen by HCFA). Payment for such items and services, which are
"passed-through" the per diem payment rates, will be made under Part B, in
conformance with Part B payment rules. Although these items are separately
reimbursed from the PPS rate, the CAA also directs HCFA to make appropriate
adjustments to the PPS payments rates to reflect the fact that certain items and
services have been excluded, and to ensure budget neutrality. Thus, HCFA is
directed to make an appropriate proportional reduction in PPS payments at that
time.
In the process of finalizing certain Medicare cost reports or reopening
previously finalized cost reports filed by various of the Company's Medicare
provider facilities, certain Medicare fiscal intermediaries have issued NPRs,
which include significant audit adjustments that reduce the amount of
reimbursement that previously was received by the facilities. The adjustments
are based, for the most part, on denials of exception to the related
organization principles with regard to services and supplies furnished to the
facilities by the Company's pharmacy and rehabilitation companies and on
reductions to costs claimed for therapy services under the prudent buyer
principles.
The prudent buyer principle states, in part, "the prudent and
cost-conscious buyer not only refuses to pay more than the going price for an
item or service, he also seeks to economize by minimizing cost." Certain of the
fiscal intermediaries have alleged that the Company was not prudent in its
purchase of occupational therapy and speech pathology services prior to HCFA's
establishing salary equivalency guidelines, effective April 1998. Fiscal
intermediaries calculated facilities' costs to provide services through employed
therapists and reduced costs claimed on the cost reports for providing services
through contracts and adjusted the cost reports accordingly. Appeals were filed
with the PRRB and resulted in a favorable outcome. However, on review the Social
Security Administrator reversed the PRRB and restored the intermediaries'
adjustments. The Company received a favorable judicial decision on its prudent
buyer appeal and currently is negotiating a settlement with HCFA for all of its
prudent buyer appeals.
The related organization principle states, in part, "a provider's allowable
cost for services, facilities, and supplies furnished by a party related to the
provider are the costs the related party incurred in furnishing the items in
question." The regulations provide for an exception to the related organization
principle if certain requirements are met and the Company believes that it meets
these requirements with respect to services its facilities previously received
from related pharmacy and rehabilitation subsidiaries. Some fiscal
intermediaries have denied the request for exception and have made adjustments
to reduce the allowable cost that is included in nursing facility cost
33
<PAGE>
reports to the cost of the related organization. The Company has requested PRRB
appeals for these adjustments, but the appeals have not yet been heard. There
can be no assurance that the Company will prevail in the appeal process.
OTHER FACTORS AFFECTING LIQUIDITY AND CAPITAL RESOURCES. In addition to
principal and interest payments on its long-term indebtedness, the Company has
significant rent obligations relating to its leased facilities. Without giving
any effect to any potential restructuring of current rent obligations, the
Company's total estimated rent obligations for fiscal year 2000 are
approximately $90 million, of which approximately $69.1 million was paid in the
nine months ended June 30, 2000. In connection with its review of its portfolio
of facilities, the Company anticipates continuing to divest itself of
under-performing facilities, which will have a favorable impact on the Company's
rent obligations.
The Company's operations require capital expenditures for renovations of
existing facilities in order to continue to meet regulatory requirements, to
upgrade facilities for the treatment of subacute patients and accommodate the
addition of specialty medical services, and to improve the physical appearance
of its facilities for marketing purposes. In addition, there are capital
expenditures required for completion of certain existing facility expansions and
new construction projects in process, as well as supporting non-nursing home
operations. Capital expenditures totaled $23.0 million for the nine months ended
June 30, 2000 as compared to $55.8 million for the comparable period in fiscal
1999. Capital expenditures in fiscal 2000 were financed through internally
generated funds. Capital expenditures for fiscal 1999 were financed principally
through borrowings under the Company's credit lines. The Company estimates that
total capital expenditures for the fiscal year ending September 30, 2000 will be
approximately $30 million.
The Company has a lease arrangement, originally providing for up to $100.0
million to be used as a funding mechanism for future skilled nursing facility
construction, lease conversions, and other facility acquisitions (the "Synthetic
Lease"). This leasing program historically has allowed the Company to complete
these projects without committing significant financing resources. The lease is
an unconditional "triple net" lease for a period of seven years with the annual
lease obligation a function of the amount spent by the lessor to acquire or
construct the project, a variable interest rate, and commitment and other fees.
The Company guarantees a minimum of approximately 83% of the residual value of
the leased property and also has an option to purchase the properties at any
time prior to the maturity date at a price sufficient to pay the entire amount
financed, accrued interest, and certain expenses. At June 30, 2000,
approximately $66.6 million of this leasing arrangement was utilized. The
leasing program is accounted for as an operating lease under GAAP. The Synthetic
Lease was amended on December 23, 1998 to mirror certain changes made to the
Senior Credit Facility and subsequently amended effective March 31, 1999 to
reduce the commitment to $80 million. Since as of June 30, 1999 the Company has
been in continuous violation of certain of these financial covenants. The
Company ceased making rent payments under the Synthetic Lease in November 1999.
The automatic stay protection afforded by the Chapter 11 Filings prevents any
action from being taken outside the Chapter 11 Proceedings with respect to any
defaults that may exist under the Synthetic Lease unless otherwise determined by
the Bankruptcy Court. One consequence of the defaults under the Synthetic Lease
documents was that the lessor under the Synthetic Lease, FBTC Leasing Corp., has
been unable to make additional borrowings under the related credit facility and
make such proceeds available for the completion of the five facilities currently
under construction. Under the terms of the Company DIP Financing, the Company is
permitted to borrow and spend up to $8.8 million to complete such facilities.
FBTC Leasing Corp., the Company and the Agent for the Synthetic Lenders signed
and filed a stipulation agreeing that the Synthetic Lease transaction will be
treated as a secured financing rather than a true lease for purposes of the
reorganization of the Company Debtors.
The Company has experienced an increasing trend in the number and severity
of litigation claims asserted against the Company. Management believes that this
trend is endemic to the long-term care industry and is a result of the
increasing number of large judgments against long-term care providers in recent
years resulting in an increased awareness by plaintiff's lawyers of potentially
large recoveries. The Company also believes that there has been, and will
continue to be, an increase in governmental investigatory activity of long-term
care providers,
34
<PAGE>
particularly in the area of false claims. While the Company believes that it
provides quality care to the patients in its facilities and materially complies
with all applicable regulatory requirements, an adverse determination in a legal
proceeding or governmental investigation, whether currently asserted or arising
in the future, could have a material adverse effect on the Company. See "-Legal
Proceedings."
The Company currently maintains two captive insurance subsidiaries to
provide for reinsurance obligations under workers' compensation, general and
professional liability, and automobile liability for periods ended prior to
April 1, 1998. These obligations are funded with long-term, fixed income
investments which are not available to satisfy other obligations of the Company.
The Company currently purchases excess liability insurance only. Due to the
hardening of the liability insurance market for the long-term care industry, the
Company currently maintains an unaggregated $1 million self-insured retention
per claim. Prior to July 31, 1999, the Company's liability insurance policies
included aggregated stop loss features limiting the Company's out-of-pocket
exposure. With stop loss insurance unavailable to the Company, the expected
direct costs have continued to increase. This increased exposure will have a
delayed negative effect on operating cash flow as claims develop over the next
several years.
The Mariner Health DIP Credit Agreement limits the ability of the Mariner
Health Debtors from engaging in affiliate transactions and making restricted
payments, specifically including payments to the Company Debtors. However, the
Mariner Health DIP Credit Agreement permits, among other things, weekly overhead
payments to the Company (see "- Mariner Health Debtor-in-Possession Financing"
above), the purchase of pharmaceutical goods and services from certain Company
Debtors, the allocation to, and payment by, the Mariner Health Debtors of their
share of certain taxes, insurance obligations and employee benefit obligations
paid for and administered on a consolidated basis by the Company, and certain
ordinary course transactions which are on terms no less favorable to the subject
Mariner Health Debtors than the terms obtainable from a non-affiliate, and for
which the approval of the requisite Mariner Health DIP Lenders and the
Bankruptcy Court have been obtained.
While management believes that the amounts available to the Company Debtors
from the Company DIP Financing and cash collateral will be sufficient to fund
the operations of the Company Debtors until such time as the Company Debtors are
able to take the steps necessary to structure a plan of reorganization that will
be acceptable to creditors and confirmed by the Bankruptcy Court, there can be
no assurances in this regard; a default under the Company DIP Credit Agreement
may impair the ability of the Company Debtors to use cash collateral to fund
operations. Finally, there can be no assurance that any plan of reorganization
confirmed in connection with the Chapter 11 Filings of the Company Debtors will
allow the Company Debtors to operate profitably under PPS or give the Company
Debtors sufficient liquidity to meet their operational needs. The ability of the
Company Debtors to fund such requirements will depend, among other things, on
future economic conditions and on financial, business and other factors, many of
which are beyond the control of the Company Debtors.
While management believes that the amounts available to the Mariner Health
Debtors from the Mariner Health DIP Financing and cash collateral will be
sufficient to fund the operations of the Mariner Health Debtors until such time
as the Mariner Health Debtors are able to take the steps necessary to structure
a plan of reorganization that will be acceptable to creditors and confirmed by
the Bankruptcy Court, there can be no assurances in this regard; a default under
the Mariner Health DIP Credit Agreement may impair the ability of the Mariner
Health Debtors to use cash collateral to fund operations. Finally, there can be
no assurance that any plan of reorganization confirmed in connection with the
Chapter 11 Filings of the Mariner Health Debtors will allow the Mariner Health
Debtors to operate profitably under PPS or give the Mariner Health Debtors
sufficient liquidity to meet their operational needs. The ability of the Mariner
Health Debtors to fund such requirements will depend, among other things, on
future economic conditions and on financial, business and other factors, many of
which are beyond the control of the Mariner Health Debtors.
Due to the failure to make scheduled payments, comply with certain
financial covenant defaults and the commencement of the Chapter 11 cases, the
Company and Mariner Health have not been able to satisfy the
35
<PAGE>
borrowing conditions under their respective prepetition debt obligations. Under
the terms of the Company DIP Financing, up to $100.0 million is available to
fund the Company's operations, subject to satisfaction of the conditions set
forth in the documents pertaining to the Company DIP Financing, including
borrowing base requirements. Under the terms of the Mariner Health DIP
Financing, up to $50.0 million is available to fund Mariner Health's operations,
subject to satisfaction of the conditions set forth in the documents pertaining
to the Mariner Health DIP Financing, including borrowing base requirements.
IMPACT OF INFLATION. The health care industry is labor intensive. Wages and
other labor-related costs are especially sensitive to inflation. Increases in
wages and other labor-related costs as a result of inflation or the increase in
minimum wage requirements without a corresponding increase in Medicaid and
Medicare reimbursement rates would adversely impact the Company. In certain of
the markets where the Company operates there is a labor shortage that could have
an adverse effect upon the Company's ability to attract or retain sufficient
numbers of skilled and unskilled personnel at reasonable wages. Accordingly,
rising wage rates could have an adverse effect on the Company in certain of its
markets.
CAUTIONARY STATEMENTS
Information provided herein by the Company contains, and from time to time
the Company may disseminate materials and make statements which may contain,
"forward-looking" information, as that term is defined by the Private Securities
Litigation Reform Act of 1995 (the "Act"). In particular, the information
contained in "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources" contains information
concerning the Company's plan to restructure its debt obligations and other
financial commitments. The aforementioned forward looking statements, as well as
other forward looking statements made herein, are qualified in their entirety by
these cautionary statements, which are being made pursuant to the provisions of
the Act and with the intention of obtaining the benefits of the "safe harbor"
provisions of the Act.
The Company cautions investors that any forward-looking statements made by
the Company are not guarantees of future performance and that actual results may
differ materially from those in the forward-looking statements as a result of
various factors, including, but not limited to, the following:
(i) There can be no assurance that the amounts available to the
Company through the DIP Financings will be sufficient to fund
the operations of the Company until such time as the Company is
able to propose a plan of reorganization that will be acceptable
to creditors and confirmed by the court overseeing the Company's
Chapter 11 Filings.
(ii) There can be no assurance that any plan of reorganization
confirmed in connection with the Chapter 11 Filings will allow
the Company to operate profitably under PPS or give the Company
sufficient liquidity to meet its operational needs.
(iii) There can be no assurance regarding the future availability or
terms of financing in light of the Company's Chapter 11 Filings.
(iv) There can be no assurance regarding any adverse actions which
may be taken by creditors or landlords of the Company which may
have the effect of preventing or unduly delaying confirmation of
a plan of reorganization in connection with the Company's
Chapter 11 Filings.
(v) The Company may have difficulty in attracting patients or labor
as a result of its Chapter 11 Filings.
(vi) The Company may be subject to increased regulatory oversight as
a result of its Chapter 11 Filings.
36
<PAGE>
(vii) In recent years, an increasing number of legislative proposals
have been introduced or proposed by Congress and in some state
legislatures which would effect major changes in the healthcare
system. However, the Company cannot predict the type of
healthcare reform legislation which may be proposed or adopted
by Congress or by state legislatures. Accordingly, the Company
is unable to assess the effect of any such legislation on its
business. There can be no assurance that any such legislation
will not have a material adverse impact on the future growth,
revenues and net income of the Company.
(viii) The Company derives substantial portions of its revenues from
third-party payors, including government reimbursement programs
such as Medicare and Medicaid, and some portions of its revenues
from nongovernmental sources, such as commercial insurance
companies, health maintenance organizations and other
charge-based contracted payment sources. Both governmental and
non-governmental payors have undertaken cost-containment
measures designed to limit payments to healthcare providers.
There can be no assurance that payments under governmental and
non-governmental payor programs will be sufficient to cover the
costs allocable to patients eligible for reimbursement,
especially with the implementation of PPS and fee screens with
respect to therapy services. The Company cannot predict whether
or what proposals or cost-containment measures will be adopted
in the future or, if adopted and implemented, what effect, if
any, such proposals might have on the operations and financial
condition of the Company.
(ix) The Company is subject to extensive federal, state and local
regulations governing licensure, conduct of operations at
existing facilities, construction of new facilities, purchase or
lease of existing facilities, addition of new services, certain
capital expenditures, cost-containment and reimbursement for
services rendered. The failure to obtain or renew required
regulatory approvals or licenses, the failure to comply with
applicable regulatory requirements, the delicensing of
facilities owned, leased or managed by the Company or the
disqualification of the Company from participation in certain
federal and state reimbursement programs, or the imposition of
harsh enforcement sanctions could have a material adverse effect
upon the operations and financial condition of the Company.
(x) There can be no assurance that an adverse determination in a
legal proceeding or governmental investigation, whether
currently asserted or arising in the future, will not have a
material adverse effect on the Company's financial position.
In addition, the Company's Chapter 11 Filings may disrupt its
operations and may result in a number of other operational
difficulties, including the following:
(a) The Company's ability to access capital markets will likely be
limited;
(b) The Company's senior management may be required to expend a
substantial amount of time and effort structuring a plan of
reorganization, which could have a disruptive impact on
management's ability to focus on the operation of the Company's
business;
(c) The Company may be unable to retain top management and other key
personnel;
(d) The Company may experience a reduction in the census at its
skilled nursing facilities and hospitals; and
(e) Suppliers to the Company may stop providing supplies or services
to the Company or provide such supplies or services only on
"cash on delivery," "cash on order" or other terms that could
have an adverse impact on the Company's cash flow.
37
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has in the past entered into interest rate swap agreements (the
"Swap Agreements") to manage its interest rate risk. The Swap Agreements
effectively convert a portion of the Company's floating interest rate debt to
fixed interest rate debt. Notional amounts of interest rate agreements are used
to measure interest to be paid or received relating to such agreements and do
not represent an amount of exposure to credit loss. On October 27, 1999, one
remaining Swap Agreement with a notional amount of $20.0 million was terminated
at no cost to the Company.
38
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As is typical in the healthcare industry, the Company is and will be
subject to claims that its services have resulted in resident injury or other
adverse effects, the risks of which will be greater for higher acuity residents
receiving services from the Company than for other long-term care residents. The
Company is, from time to time, subject to such negligence claims and other
litigation. In addition, resident, visitor and employee injuries will also
subject the Company to the risk of litigation. The Company has experienced an
increasing trend in the number and severity of litigation claims asserted
against the Company. Management believes that this trend is endemic to the
long-term care industry and is a result of the increasing number of large
judgments against long-term care providers in recent years resulting in an
increased awareness by plaintiff's lawyers of potentially large recoveries. The
Company also believes that there has been, and will continue to be, an increase
in governmental investigations of long-term care providers, particularly in the
area of Medicare/Medicaid false claims, as well as an increase in enforcement
actions resulting from the investigations. While the Company believes that it
provides quality care to the patients in its facilities and materially complies
with all applicable regulatory requirements, an adverse determination in a legal
proceeding or governmental investigation, whether currently asserted or arising
in the future, could have a material adverse effect on the Company.
From time to time, the Company and its subsidiaries have been parties to
various legal proceedings in the ordinary course of their respective businesses.
In the opinion of management, there have been no material developments in the
litigation matters set forth in the Company's Annual Report on Form 10-K for the
year ended September 30, 1999. As a result of the Chapter 11 Filings, all
matters described in the Company's Annual Report on Form 10-K for the year ended
September 30, 1999 were stayed on January 18, 2000. While the automatic stay
remains in effect, the Company has agreed to relief from the automatic stay in
certain limited circumstances.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON CERTAIN SECURITIES
The Company made the Chapter 11 Filings on January 18, 2000. As a result,
no principal or interest payments are being made since such time on prepetition
indebtedness, with the exception of repayments made against the Senior Credit
Facility as a result of the application of 75% of net cash proceeds received
from the sales of certain facilities and other assets and notional amounts
related to certain other indebtedness, including capital equipment leases, until
a plan of reorganization defining the payment terms has been approved by the
Bankruptcy Court. Additional information regarding the Chapter 11 Filings is set
forth elsewhere in this Form 10-Q, including Notes 2 and 3 to the condensed
consolidated financial statements and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECUTIRY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
39
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Order Under 11 U.S.C.ss.ss.105, 363, 365 and 1146(c) and Fed. R.
Bankr. P. 6004, 6006 and 9019: (i) Approving Settlement
Agreement With Senior Housing Properties Trust And Certain
Related Entities; (ii) Authorizing The Sale Of Rights And
Interests In And To Certain Leased Facilities And Personal
Property To Senior Housing Properties Trust Free And Clear Of
All Liens, Claims, Encumbrances, And Interests; (iii)
Determining That Such Sale Is Exempt From Any Stamp, Transfer,
Recording, Or Similar Tax; (iv) Authorizing The Assumption Of
Certain Leasehold Interests; And (v) Granting Related Relief
Including, A Prohibition Against Recourse
10.2 Form of Settlement Agreement by and among Senior Housing
Properties Trust; SPTMNR Properties Trust; Five Star Quality
Care, Inc.; SHOPCO-AZ, LLC; SHOPCO-CA, LLC; SHOPCO-Colorado,
LLC; SHOPCO-WI, LLC; the Company; GranCare, Inc.; AMS
Properties, Inc.; and GCI Health Care Centers, Inc.
27 Financial Data Schedule
(b) Reports on Form 8-K
None
40
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
MARINER POST-ACUTE NETWORK, INC.
(Registrant)
By: /s/ WILLIAM C. STRAUB
Vice President, Controller, and Chief Accounting Officer
(duly authorized Officer and Chief Accounting Officer)
Date: August 14, 2000
41
