Pursuant to Rule 424(b)(3)
Reg. No. 333-97293
PROSPECTUS
[EXTENDICARE HEALTH SERVICES, INC. LOGO]
Offer to Exchange
All Outstanding
9 1/2% Senior Notes due 2010
$150,000,000 Aggregate Principal Amount
for
New 9 1/2% Senior Notes due 2010
$150,000,000 Aggregate Principal Amount
- --------------------------------------------------------------------------------
- - We are offering to exchange new registered 9 1/2% Senior Notes due 2010 for
all of our outstanding unregistered 9 1/2% Senior Notes due 2010.
- - The exchange offer expires at 5:00 p.m., New York City time, on December 27,
2002, unless we extend it.
- - The terms of the new notes to be issued are substantially identical to those
of the old notes, except that the new notes will not have securities law
transfer restrictions and registration rights relating to the old notes and
the new notes will not provide for the payment of liquidated damages under
circumstances relating to the timing of the exchange offer.
- - All of our existing and future domestic significant subsidiaries, all of our
existing and future domestic subsidiaries that guarantee or incur any
indebtedness and any other existing or future significant subsidiaries or
restricted subsidiaries that guarantee or otherwise provide direct credit
support for indebtedness of ours or any of our domestic subsidiaries will
fully and unconditionally guarantee the new notes.
- - All outstanding old notes that are validly tendered and not validly withdrawn
will be exchanged.
- - No established trading market for the new notes currently exits. We do not
intend to apply for the new notes to be listed on any securities exchange or
to arrange for any automated quotation system to quote them.
- - Each broker-dealer who acquired its old notes as a result of market-making
activities or other trading activities and thereafter receives new notes
issued for its own account in the exchange offer, must acknowledge that it
will deliver a prospectus in connection with any resale of such new notes
issued in the exchange offer.
- - You may withdraw your tender of old notes any time before the exchange offer
expires.
- - Neither we nor any subsidiary guarantor will receive any proceeds from the
exchange offer.
- - The exchange of notes will not be a taxable event for U.S. federal income tax
purposes.
See "Risk Factors" beginning on page 11 for a discussion of risk factors that
you should consider before deciding to exchange your old notes for new notes.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
- --------------------------------------------------------------------------------
The date of this prospectus is November 26, 2002.
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
----
Prospectus Summary.......................................... 1
Risk Factors................................................ 11
The Exchange Offer.......................................... 19
Use of Proceeds............................................. 28
Capitalization.............................................. 29
Selected Consolidated Historical Financial Data............. 30
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 31
Business.................................................... 53
Management.................................................. 69
Executive Compensation...................................... 71
Certain Relationships and Related Party Transactions........ 75
Description of Other Indebtedness........................... 76
Description of the New Notes................................ 92
Certain U.S. Federal Income Tax Considerations.............. 127
Plan of Distribution........................................ 128
Legal Matters............................................... 128
Experts..................................................... 128
Where You Can Find More Information......................... 128
Index to Consolidated Financial Statements.................. F-1
</Table>
----------------------------
In this prospectus, "we," "us" and "our" and "EHSI" refer to Extendicare
Health Services, Inc. and its subsidiaries on a combined basis, unless the
context indicates otherwise.
You should rely only on the information provided in this prospectus. We
have not authorized anyone to provide you with any different information. The
information in this prospectus is current only as of the date on the cover, and
our business or financial condition and other information in this prospectus may
change after that date.
SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that are intended to
qualify for the safe harbors from liability established by the Private
Securities Litigation Reform Act of 1995. All statements other than statements
of historical fact, including statements regarding anticipated financial
performance, business strategy and management's plans and objectives for future
operations, are forward-looking statements. These forward-looking statements can
be identified as such because the statements generally include words such as
"expect," "intend," "believe," "anticipate," "estimate," "plan" or "objective"
or other similar expressions. These forward-looking statements are subject to
risks and uncertainties that could cause actual results to differ materially
from those expressed in, or implied by, these statements. Some, but not all, of
the risks and uncertainties include those described in the "Risk Factors"
section of this prospectus beginning on page 11 and the following:
- Medicare and Medicaid reimbursement policies;
- resident care litigation, including exposure for punitive damage claims
and increased insurance costs, which among other things caused us to exit
the Florida and Texas markets;
- the shortage of, and the related costs of hiring and retraining,
qualified staff and employees;
i
- federal and state regulations of our business;
- actions of our competitors; and
- fee pressures and slow payment practices by health maintenance
organizations and preferred provider organizations.
We will only update publicly any forward-looking statements contained in
this prospectus, whether as a result of new information, future events or
otherwise, to the extent required by law.
ii
PROSPECTUS SUMMARY
This prospectus summary may not contain all of the information that may be
important to you. This prospectus includes the specific terms of the new notes
we are offering, as well as information regarding our business. We encourage you
to read this prospectus in its entirety.
EXTENDICARE HEALTH SERVICES, INC.
Based upon number of beds, we are one of the largest providers of long-term
care and related services in the United States. Through our network of
geographically clustered facilities, we offer a continuum of healthcare
services, including skilled nursing care, assisted living and related medical
specialty services, such as subacute care and rehabilitative therapy. As of
September 30, 2002, we operated or managed 198 long-term care facilities with
18,311 beds in 15 states, of which 157 were skilled nursing facilities with
16,408 beds and 41 were assisted living and retirement facilities with 1,903
units. In addition, we operated 21 outpatient rehabilitation clinics in four
states. We also provided consulting services to 39 facilities with 4,213 beds in
two states. We receive payment for our services from Medicare, Medicaid, private
insurance, self pay residents and other third party payors. For the twelve month
period ended September 30, 2002, we generated total revenue of $802.6 million
and we had net earnings of $6.3 million.
BUSINESS STRATEGY
The principal elements of our business strategy are to:
- Provide quality, clinically based services;
- Increase our Medicare census through strategies such as focused marketing
efforts, standardized admissions protocols, streamlined admitting
procedures, the dual certification of beds and improved management
communication;
- Leverage presence in small urban markets to improve operating
efficiencies and to offer our customers a broad range of long-term care
and related health services, including assisted living facilities;
- Expand management and consulting services;
- Increase our operating efficiency; and
- Proactively manage our asset portfolio so that we exit markets or sell
facilities which do not meet our performance goals.
NEW CREDIT FACILITY
In connection with the issuance of the old notes, we refinanced all of our
outstanding indebtedness under our then-existing credit facility with the
proceeds of that issuance, and we entered into a new credit facility that
provides senior secured financing of up to $105.0 million on a revolving basis.
As of September 30, 2002, we did not have any borrowings outstanding under this
new credit facility, but we had $39.9 million of letters of credit outstanding
under the new credit facility. Each of the subsidiary guarantees of the old
notes and the new notes guaranteed the new credit facility on a senior basis.
----------------------------
We are an indirect wholly owned subsidiary of Extendicare Inc., a Canadian
publicly traded company. Our principal executive offices are located at 111 West
Michigan Street, Milwaukee, Wisconsin 53203. Our telephone number is (414)
908-8000.
1
THE EXCHANGE OFFER
OLD NOTES..................... On June 28, 2002, we sold to the initial
purchasers $150,000,000 aggregate principal
amount of our 9 1/2% Senior Notes due 2010,
which are fully and unconditionally guaranteed
by:
- all of our existing and future domestic
significant subsidiaries;
- all of our existing and future domestic
subsidiaries that guarantee or incur any
indebtedness; and
- any other existing or future significant
subsidiaries or restricted subsidiaries that
guarantee or otherwise provide direct credit
support for indebtedness of ours or any of
our domestic subsidiaries.
In this prospectus we refer to those senior
notes as the old notes. We issued the old notes
at a discount of 0.25% per old note, which
means the initial purchasers paid less than the
principal amount for the old notes. The initial
purchasers resold those old notes to qualified
institutional buyers pursuant to Rule 144A
under the Securities Act of 1933 and outside
the United States to persons other than United
States persons in offshore transactions meeting
the requirements of Regulation S under the
Securities Act.
REGISTRATION RIGHTS
AGREEMENT..................... When we sold the old notes we entered into a
registration rights agreement with the initial
purchasers in which we agreed, among other
things, to provide to you and all other holders
of these old notes the opportunity to exchange
your unregistered old notes for substantially
identical new notes that we have registered
under the Securities Act. This exchange offer
is being made for that purpose.
NEW NOTES..................... We are offering to exchange the old notes for
9 1/2% Senior Notes due 2010 that have been
registered under the Securities Act, which are
fully and unconditionally guaranteed by:
- all of our existing and future domestic
significant subsidiaries;
- all of our existing and future domestic
subsidiaries that guarantee or incur any
indebtedness; and
- any other existing or future significant
subsidiaries or restricted subsidiaries that
guarantee or otherwise provide direct credit
support for indebtedness of ours or any of
our domestic subsidiaries.
In this prospectus we refer to those registered
senior notes as the new notes. In this
prospectus we may refer to the old notes and
the new notes collectively as the notes. The
terms of the new notes and the old notes are
substantially identical except:
- the new notes will be issued in a transaction
that will have been registered under the
Securities Act;
- the new notes will not contain securities law
restrictions on transfer, and
2
- the new notes will not provide for the
payment of liquidated damages under
circumstances relating to the timing of the
exchange offer.
THE EXCHANGE OFFER............ We are offering to exchange $1,000 principal
amount of the new notes for each $1,000
principal amount of your old notes. As of the
date of this prospectus, $150,000,000 aggregate
principal amount of the old notes are
outstanding. For procedures for tendering, see
"The Exchange Offer -- Procedures for Tendering
Old Notes."
EXPIRATION DATE............... This exchange offer will expire at 5:00 p.m.,
New York City time, on December 27, 2002,
unless we extend it.
RESALES OF NOTES.............. We believe that the new notes issued pursuant
to the exchange offer in exchange for old notes
may be offered for resale, resold and otherwise
transferred by you without compliance with the
registration and prospectus delivery provisions
of the Securities Act if:
- you are not our "affiliate" within the
meaning of Rule 405 under the Securities Act;
- you are acquiring the new notes in the
ordinary course of your business;
- you have not engaged in, do not intend to
engage in, and have no arrangement or
understanding with any person or entity to
participate in, a distribution of the new
notes; and
- you deliver a prospectus, as required by law,
in connection with any resale of those new
notes, see "Plan of Distribution," if you are
a broker-dealer that receives new notes for
your own account in exchange for old notes
that were acquired as a result of
market-making activities or other trading
activities.
If you are an affiliate of ours, or are
engaging in or intend to engage in, or have any
arrangement or understanding with any person to
participate in, a distribution of the new
notes, then:
- you may not rely on the applicable
interpretations of the staff of the SEC;
- you will not be permitted to tender old notes
in the exchange offer; and
- you must comply with the registration and
prospectus delivery requirements of the
Securities Act in connection with any resale
of the old notes.
Each participating broker-dealer that receives
new notes for its own account under the
exchange offer in exchange for old notes that
were acquired by the broker-dealer as a result
of market-making or other trading activity must
acknowledge that it will deliver a prospectus
in connection with any resale of the new notes.
See "Plan of Distribution."
Any broker-dealer that acquired old notes
directly from us may not rely on the applicable
interpretations of the staff of the SEC and
must comply with the registration and
prospectus delivery requirements of the
Securities Act (including being named as a
3
selling securityholder) in connection with any
resales of the old notes or the new notes.
ACCEPTANCE OF OLD NOTES AND
DELIVERY OF NEW NOTES......... We will accept for exchange any and all old
notes that are validly tendered in the exchange
offer and not withdrawn before the offer
expires. The new notes will be delivered
promptly following the exchange offer.
WITHDRAWAL RIGHTS............. You may withdraw your tender of old notes at
any time before the exchange offer expires.
CONDITIONS OF THE EXCHANGE
OFFER......................... The exchange offer is subject to certain
customary conditions, which we may waive.
Please see "The Exchange Offer -- Conditions to
the Exchange Offer" for more information
regarding the conditions to the exchange offer.
CONSEQUENCES OF FAILURE TO
EXCHANGE OLD NOTES............
If you are eligible to participate in the
exchange offer and you do not tender your old
notes, then you will continue to hold your old
notes and you will be subject to all the
limitations and restrictions on transfer
applicable to such old notes. Generally,
untendered old notes will remain restricted
securities and may not be offered or sold,
unless registered under the Securities Act,
except pursuant to an exemption from, or in a
transaction not subject to, the Securities Act
and applicable state securities laws. Other
than in connection with the exchange offer, we
do not currently anticipate that we will
register the old notes under the Securities
Act. The trading market for the old notes could
be adversely affected if some but not all of
the old notes are tendered and accepted in the
exchange offer.
FEDERAL INCOME TAX
CONSEQUENCES.................. The exchange of an old note for a new note in
the exchange offer will not be a taxable event
for United States federal income tax purposes.
Consequently, you will not recognize any gain
or loss upon receipt of the new notes. See
"Certain U.S. Federal Income Tax
Considerations" for a more detailed description
of the tax consequences of the exchange.
USE OF PROCEEDS............... Neither we nor any subsidiary guarantor will
receive any proceeds from the issuance of new
notes pursuant to the exchange offer.
ACCOUNTING TREATMENT.......... We will not recognize any gain or loss on the
exchange of old notes for new notes. See "The
Exchange Offer -- Accounting Treatment."
EXCHANGE AGENT................ U.S. Bank, N.A. is the exchange agent. See "The
Exchange Offer -- Exchange Agent."
4
THE NEW NOTES
The new notes will evidence the same debt as the old notes and will be
governed by the same indenture under which the old notes were issued. The
summary below describes the principal terms of the new notes. The "Description
of the New Notes" section of this prospectus contains a more detailed
description of the terms and conditions of the new notes.
ISSUER........................ Extendicare Health Services, Inc.
NOTES OFFERED................. $150,000,000 in aggregate principal amount of
9 1/2% Senior Notes due 2010.
GUARANTEES.................... All payments, including principal and interest,
with respect to the old notes are and the new
notes will be, fully and unconditionally
guaranteed on a senior unsecured basis, jointly
and severally, by:
- all of our existing and future domestic
significant subsidiaries;
- all of our existing and future domestic
subsidiaries that guarantee or incur any
indebtedness; and
- any other existing or future significant
subsidiaries or restricted subsidiaries that
guarantee or otherwise provide direct credit
support for indebtedness of ours or any of
our domestic subsidiaries.
The old notes and guarantees are, and the new
notes and guarantees will be, our and our
subsidiary guarantors' general unsecured
obligations.
MATURITY DATE................. July 1, 2010.
INTEREST PAYMENT DATES........ January 1 and July 1, commencing January 1,
2003.
RANKING....................... The old notes and guarantees are, and the new
notes and guarantees will be, unsecured and:
- equal in right of payment to all of our and
our subsidiary guarantors' existing and
future unsecured senior indebtedness;
- senior in right of payment to all of our and
our subsidiary guarantors' existing and
future subordinated indebtedness;
- effectively subordinated in right of payment
to all existing and future indebtedness and
other liabilities of any of our existing or
future non-guarantor subsidiaries ($0 as of
September 30, 2002); and
- effectively subordinated in right of payment
to all of our and our subsidiary guarantors'
secured indebtedness, including indebtedness
under our new credit facility, to the extent
of the value of the assets securing that
indebtedness, which consisted primarily of
existing secured indebtedness of $38.4
million as of September 30, 2002.
5
OPTIONAL REDEMPTION........... On or after July 1, 2006, we may redeem all or
part of the notes, at the redemption prices
(expressed as percentages of principal amount)
listed below, plus accrued and unpaid interest,
if any, to the date of redemption, if redeemed
during the 12-month period commencing on July 1
of the years set forth below:
<Table>
<Caption>
REDEMPTION
YEAR PRICE
---- ----------
2006......................................... 104.750%
2007......................................... 102.375%
2008 and thereafter.......................... 100.000%
</Table>
Before July 1, 2005, we may redeem up to 35% of
the aggregate principal amount of outstanding
notes issued under the indenture with the net
cash proceeds of qualified equity offerings.
CHANGE OF CONTROL............. Upon specified change of control events, unless
we have exercised our option to redeem all of
the notes as described above, each holder of a
note will have the right to require us to
repurchase all or a portion of its notes at a
purchase price in cash equal to 101% of the
principal amount, plus accrued and unpaid
interest, if any, to the date of repurchase.
COVENANTS..................... The indenture governing the notes limits our
ability and the ability of our subsidiary
guarantors to, among other things:
- incur additional indebtedness;
- create liens;
- pay dividends on or redeem capital stock;
- make certain investments;
- make restricted payments;
- make certain dispositions of assets;
- engage in certain transactions with
affiliates;
- engage in certain business activities; and
- engage in mergers, consolidations and certain
sales of assets.
The indenture governing the notes also limits
our ability to permit restrictions on the
ability of some of our subsidiaries to pay
dividends or make certain other distributions.
These covenants are subject to important
exceptions and qualifications, as described
under "Description of the New Notes."
6
ABSENCE OF ESTABLISHED MARKET
FOR THE NOTES................. The notes are a new issue of securities, and
there is currently no market for them. We do
not intend to apply for the notes to be listed
on any securities exchange or to arrange for
any quotation system to quote them. The notes
have been designated for trading on the PORTAL
Market(SM). The initial purchasers of the old
notes have advised us that they intend to make
a market for the notes, but they are not
obligated to do so. The initial purchasers may
discontinue any market making in the notes at
any time in their sole discretion. Accordingly,
we cannot assure you that a liquid market will
develop or continue for the notes.
For a discussion of certain risks that you should consider before deciding
to exchange your old notes for new notes, see "Risk Factors."
7
SUMMARY CONSOLIDATED HISTORICAL
FINANCIAL AND OPERATING DATA
The following table summarizes our consolidated historical financial and
operating data (including adjusted historical data, as noted). You should read
this table in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and our consolidated financial
statements and related notes. The summary consolidated financial data as of
December 31, 2001, 2000 and 1999 and for each of the years in the three-year
period ended December 31, 2001 have been derived from our audited consolidated
financial statements included elsewhere in this prospectus. The summary
consolidated financial data as of September 30, 2002 and for the nine-month
periods ended September 30, 2002 and 2001 have been derived from our unaudited
consolidated quarterly financial statements included elsewhere in this
prospectus, and the summary financial data as of September 30, 2001 have been
derived from our unaudited consolidated quarterly financial statements, all of
which, in our opinion, reflect all adjustments necessary to present fairly the
data for such periods. The summary consolidated financial data for the twelve
months ended September 30, 2002 have been derived from our audited consolidated
financial statements for the year ended December 31, 2001 and our unaudited
consolidated quarterly financial statements, all of which are included elsewhere
in this prospectus. Interim results for the nine months ended September 30, 2002
and 2001 are not necessarily indicative of results that can be expected in
future periods. "Operating Data" below are not directly derived from our
financial statements, but have been presented to provide additional data for
your analysis. Twelve months ended September 30, 2002 means the twelve-month
period beginning October 1, 2001 and ending September 30, 2002.
<Table>
<Caption>
TWELVE
MONTHS NINE MONTHS ENDED
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
SEPTEMBER 30, -------------------- ---------------------------------
2002 2002 2001 2001 2000 1999
------------- -------- -------- -------- -------- ---------
(DOLLARS IN THOUSANDS)
INCOME STATEMENT DATA:
Revenues:
Nursing and assisted living
facilities......................... $774,846 $586,272 $578,378 $766,952 $904,847 $ 916,195
Outpatient therapy and medical
supplies........................... 9,829 7,585 7,271 9,515 9,716 43,068
Other................................ 17,970 12,927 12,597 17,640 8,506 8,322
-------- -------- -------- -------- -------- ---------
Total revenues..................... 802,645 606,784 598,246 794,107 923,069 967,585
Costs and expenses:
Operating............................ 671,910 510,117 523,021 684,814 825,172 844,391
General and administrative........... 31,705 24,329 25,011 32,387 46,507 45,524
Lease costs.......................... 11,634 8,411 11,352 14,575 15,731 16,631
Depreciation and amortization........ 38,774 28,228 30,226 40,772 45,434 52,005
Interest, net........................ 32,111 23,921 27,370 35,560 45,155 51,267
Loss (gain) on disposal of assets.... (3,961) (3,961) 1,054 1,054 3,306 37,292
Provision for closure and exit costs
and other items.................... 5,293 5,293 23,192 23,192 3,357 5,482
Loss on impairment of long-lived
assets............................. -- -- 1,685 1,685 20,753 38,173
-------- -------- -------- -------- -------- ---------
(Loss) earnings before income taxes,
minority interests and extraordinary
item................................. 15,179 10,446 (44,665) (39,932) (82,346) (123,180)
Net (loss) earnings.................... $ 6,258 $ 4,169 $(29,584) $(27,495) $(55,121) $ (70,457)
======== ======== ======== ======== ======== =========
RATIO OF EARNINGS TO FIXED
CHARGES(1)........................... 1.39x 1.37x -- -- -- --
</Table>
8
<Table>
<Caption>
TWELVE
MONTHS NINE MONTHS ENDED
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
SEPTEMBER 30, -------------------- ---------------------------------
2002 2002 2001 2001 2000 1999
------------- -------- -------- -------- -------- ---------
(DOLLARS IN THOUSANDS)
BALANCE SHEET DATA (END OF PERIOD):
Cash and cash equivalents............ $ 29,710 $ 29,710 $ 4,114 $ 997 $ 1,641 $ 2,941
Working capital...................... 33,099 33,099 (8,672) 4,145 44,473 67,807
Property and equipment............... 439,095 439,095 479,721 477,830 507,536 610,343
Total assets......................... 794,804 794,804 806,704 795,836 873,590 974,448
Total debt(2)........................ 388,050 388,050 389,654 385,347 451,147 530,155
Shareholder's equity................. 159,662 159,662 153,301 156,002 184,161 237,895
OPERATING DATA:
Number of facilities at end of
period(3)
Nursing-owned...................... 122 122 121 122 126 154
Nursing-leased..................... 17 17 17 17 29 32
Nursing-managed.................... 18 18 18 18 16 6
Nursing-consulting................. 38 38 35 35 12 --
-------- -------- -------- -------- -------- ---------
Total nursing.................... 195 195 191 192 183 192
======== ======== ======== ======== ======== =========
Assisted living and
retirement-owned................. 35 35 35 35 35 39
Assisted living and
retirement-leased................ 1 1 1 1 1 1
Assisted living and
retirement-managed............... 5 5 5 5 5 5
Assisted living and retirement-
consulting....................... 1 1 -- -- -- --
-------- -------- -------- -------- -------- ---------
Total assisted-living and
retirement..................... 42 42 41 41 41 45
======== ======== ======== ======== ======== =========
Rehabilitation
centers-owned/leased............. 21 21 21 20 20 28
Resident capacity at end of period(3)
Nursing (beds)..................... 20,505 20,505 19,687 19,759 18,753 20,143
Assisted living and retirement
(units).......................... 2,019 2,019 1,912 1,912 1,925 1,912
Average occupancy rate(4)
Nursing............................ 89% 90% 87% 88% 88% 86%
Assisted living and retirement..... 83% 83% 83% 83% 85% 80%
Payor source as a percentage of total
revenue
Private pay........................ 25% 24% 25% 25% 25% 28%
Medicare........................... 25% 26% 24% 24% 24% 22%
Medicaid........................... 50% 50% 51% 51% 51% 50%
OTHER FINANCIAL DATA:
Property and equipment capital
expenditures....................... $ 19,305 $ 12,638 $ 9,681 $ 16,348 $ 14,169 $ 25,330
Net cash provided by operating
activities......................... 38,373 29,303 66,857 75,927 32,842 18,643
EBITDA(5)(6)......................... 87,396 63,927 38,862 62,331 35,659 61,039
EBITDAR(5)(6)........................ 99,030 72,338 50,214 76,906 51,390 77,670
Days of Revenues Outstanding......... 45 49 46 48 52 56
</Table>
- ---------------
(1) The ratio of earnings to fixed charges for the year ended December 31, 1998
was 2.63x and the ratio of earnings to fixed charges for the year ended
December 31, 1997 was 2.89x. For the purpose of calculating the ratio of
earnings to fixed charges, earnings consist of (loss) earnings before income
taxes, minority interest and extraordinary item, adjusted to add back
interest expense, amortization of deferred financing costs and estimated
interest within rental expense. Fixed charges consist of interest,
amortization of deferred financing costs and estimated interest within
rental expense. The ratio of earnings to fixed charges for the nine-month
period ended September 30, 2002 and the year ended December 31, 2001, on a
pro forma basis to reflect the issuance of the old notes and the application
of the proceeds from that issuance, was 1.32x and 0.09x, respectively. The
amount of the deficiency (the amount by which fixed charges exceed earnings)
for the nine-month period ended September 30, 2001, and the years ended
December 31, 2001, 2000 and 1999, was $44,665, $39,932, $82,346 and
$123,481, respectively. The amount of the deficiency for the pro forma basis
ratio for the year ended December 31, 2001 was $45,360.
(2) Total debt includes long term debt and current maturities of long term debt.
9
(3) Excludes properties leased and held under Greystone divestiture agreement.
(4) Based upon our operational beds for nursing facilities and units following
one year of operation for assisted living and retirement facilities and
excluding occupancy for facilities under management and specific consulting
services agreements.
(5) "EBITDA" is defined as net (loss) earnings before income taxes, minority
interests and extraordinary item as adjusted for net interest expense,
depreciation, amortization, and non-cash, non recurring losses (gains) on
asset disposals and impairments and provisions for closure and exit costs
and other items, primarily from Florida and Texas (as provided for under the
notes indenture and the new credit facility). "EBITDAR" is defined as EBITDA
as adjusted for lease costs. Our definitions of EBITDA and EBITDAR may not
be comparable to the definitions of EBITDA and EBITDAR used by other
companies. The following table reconciles net (loss) earnings to EBITDA and
EBITDAR:
<Table>
<Caption>
TWELVE
MONTHS NINE MONTHS ENDED
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
SEPTEMBER 30, ------------------ -------------------------------
2002 2002 2001 2001 2000 1999
------------- ------- -------- -------- -------- ---------
(DOLLARS IN THOUSANDS)
(LOSS) EARNINGS BEFORE INCOME TAXES, MINORITY
INTERESTS AND EXTRAORDINARY ITEM............... $15,179 $10,446 $(44,665) $(39,932) $(82,346) $(123,180)
Add:
Loss (gain) on disposal of assets.............. (3,961) (3,961) 1,054 1,054 3,306 37,292
Provision for closure and exit costs and other
items........................................ 5,293 5,293 23,192 23,192 3,357 5,482
Loss on impairment of long-lived assets........ -- -- 1,685 1,685 20,753 38,173
Interest, net.................................. 32,111 23,921 27,370 35,560 45,155 51,267
Depreciation and amortization.................. 38,774 28,228 30,226 40,772 45,434 52,005
------- ------- -------- -------- -------- ---------
EBITDA........................................... 87,396 63,927 38,862 62,331 35,659 61,039
Add: Lease costs................................. 11,634 8,411 11,352 14,575 15,731 16,631
------- ------- -------- -------- -------- ---------
EBITDAR.......................................... $99,030 $72,338 $ 50,214 $ 76,906 $ 51,390 $ 77,670
======= ======= ======== ======== ======== =========
</Table>
(6) We believe it is relevant and helpful to present EBITDA and EBITDAR because
they are used by many lenders, including investors in the notes, to measure
our debt, including the notes. We also understand that EBITDA, or
derivatives thereof, are customarily used by financial and credit analysts
and many investors as a performance measure in evaluating healthcare
companies. Moreover, substantially all of our financing agreements,
including the indenture governing the notes and our new credit agreement,
contain covenants in which EBITDA is used as a measure of financial
performance. Our management uses EBITDA and/or EBITDAR to monitor our
compliance with our financing agreements and as a performance measure when
evaluating EHSI as a whole, our facilities and facilities that we may wish
to acquire.
EBITDA and EBITDAR are not measures of performance under generally accepted
accounting principles in the United States, or GAAP. EBITDA and EBITDAR
should not be considered in isolation or as a substitute for net income,
cash flows from operating activities and other income or cash flow statement
data prepared in accordance with GAAP, or as a measure of profitability or
liquidity.
10
RISK FACTORS
You should consider carefully each of the following risks and all other
information contained in this prospectus before deciding to exchange your old
notes for new notes. The risks and uncertainties described below are not the
only ones we face.
RISKS RELATING TO US AND OUR BUSINESS
WE DEPEND UPON REIMBURSEMENT FOR OUR SERVICES BY THIRD-PARTY PAYORS, AND CHANGES
IN THEIR REIMBURSEMENT LEVELS COULD ADVERSELY AFFECT OUR REVENUES, RESULTS OF
OPERATIONS AND FINANCIAL POSITION.
Substantially all of our long-term and rehabilitation revenues are derived
from private and governmental third-party payors. In 2001, approximately 24% of
our revenues were derived from Medicare, 51% from Medicaid and approximately 25%
from commercial insurers, managed care plans, the Department of Veterans Affairs
and other private pay sources. There are ongoing pressures from many payors to
control health care costs and to reduce or limit increases in reimbursement
rates for medical services. Governmental payment programs are subject to
statutory and regulatory changes, retroactive rate adjustments, administrative
or executive orders and government funding restrictions, all of which may
materially change the amount of payments to us for our services. Medicare
funding levels have changed significantly over the past few years. For example,
in 1998 and 1999, the industry experienced a decline in revenues primarily
attributable to declines in government reimbursement as a result of the Balanced
Budget Act of 1997. The revenue rate reductions from the Balanced Budget Act are
being partially offset by the Balanced Budget Refinement Act of 1999 and the
Benefits Improvement Protective Act of 2000. We cannot assure you that payments
from governmental or private payors will remain at levels comparable to present
levels or will, in the future, be sufficient to cover the costs allocable to
patients eligible for reimbursement pursuant to such programs. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Overview -- Legislative Actions Affecting Revenues" and
"Business -- Government Regulation" for additional information.
THE COST OF GENERAL AND PROFESSIONAL LIABILITY CLAIMS ARE SIGNIFICANT.
We have experienced an increasing trend in the number and severity of
litigation claims asserted against us, including personal injury and wrongful
death claims. We believe 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. This has been particularly the case in Florida and Texas where we
have ceased to operate skilled nursing facilities. Industry sources report the
average cost of a claim in Florida in 2000 was three times higher than most of
the rest of the United States. Florida health care providers experienced four
times the number of claims as providers in most other states experienced. We
ceased all operations in Florida as of December 31, 2000 and all skilled nursing
facility operations in Texas as of September 30, 2001. As a result of the
litigious environment, insurance coverage for general and professional liability
claims has increased and in certain states become unavailable to skilled nursing
facility operators, as insurance companies have refrained from providing
insurance in certain states. We continually review requests for medical records
and claims by facility and by state, and use that information, along with
operational performance measures, to assess whether we should dispose of
additional facilities. At the present time, we have no significant divestiture
plans.
As of December 31, 2001, we have provided for $70.3 million in accruals for
known or potential general and professional liability claims based on claims
experience and an independent actuarial review; however, we may need to increase
our accruals in excess of the amounts we have accrued as a result of future
actuarial reviews and claims that may develop in the future. An adverse
determination in legal proceedings, whether currently asserted or arising in the
future, could have a material adverse effect on us. See "Business -- Insurance."
11
THE SHORTAGE OF QUALIFIED REGISTERED NURSING STAFF AND OTHER HEALTH CARE WORKERS
COULD ADVERSELY AFFECT OUR ABILITY TO ATTRACT, TRAIN AND RETAIN QUALIFIED
PERSONNEL AND COULD INCREASE OPERATING COSTS.
A shortage of nurses and other trained personnel and general inflationary
pressures have forced us to enhance our wage and benefits packages in order to
compete for qualified personnel. In some of the markets where we operate, there
are shortages of health care workers. In order to supplement staffing levels, we
periodically use costly temporary help from staffing agencies.
WE CONDUCT OUR BUSINESS IN A HEAVILY REGULATED INDUSTRY AND OUR FAILURE TO
COMPLY WITH LAWS AND GOVERNMENT REGULATION COULD LEAD TO FINES AND PENALTIES.
We must comply with complex laws and regulations at the federal, state and
local government levels relating to, among other things:
- licensure and certification;
- qualifications of health care and support personnel;
- maintenance of physical plant and equipment;
- staffing levels and quality of health care services;
- maintenance, confidentiality and security issues associated with medical
records;
- relationships with physicians and referral sources;
- billing for services;
- operating policies and procedures; and
- additions or changes to facilities and services.
There are ongoing initiatives at the federal and state levels for
comprehensive reforms affecting the payment for and availability of health care
services. In addition, regulations and policies of regulatory agencies are
subject to change. Aspects of some of these health care initiatives, such as the
termination of Medicare funding improvements and limitations on Medicare
coverage, other pressures to contain health care costs by Medicare, Medicaid and
other payors, as well as increased operational requirements in the
administration of Medicaid, could adversely affect our financial condition or
our results of operations. Revisions to regulatory requirements, changes in
scope and quality of care to residents and revisions to licensure and
certification standards also could potentially have a material impact on us. In
the future, different interpretations or enforcement of existing, new or amended
laws and regulations could result in allegations of impropriety or illegality or
could result in changes requiring capital expenditure programs and operating
expenses.
If we do not comply with applicable laws and regulations, then we could be
subject to liabilities, including criminal penalties and civil penalties and
exclusion of one or more of our facilities from participation in Medicare,
Medicaid and other federal and state health care programs. If one of our
facilities lost its certification under either the Medicare or Medicaid program,
then it would have to cease future admissions and displace residents funded by
the programs from the facility. In order to become re-certified, a facility must
rectify all identified deficiencies and, over a specified period of time, pass a
survey conducted by representatives of the respective programs through
demonstrated care and operations for residents in the facility. Until the
appropriate agency has verified through the "reasonable assurance" process that
the facility can achieve and maintain substantial compliance with all applicable
participation requirements, the facility will not be admitted back into either
the Medicare or Medicaid programs. Medicare and Medicaid re-certification
processes are similar, but different, and are conducted separately.
Re-certification requires considerable staff resources. The loss of
certification from either program can have potentially significant financial
consequences. In 1998, we operated one facility in Maryland that lost its
certification under the Medicare program, and we subsequently closed the
facility. In November 2000, we operated one facility in Indiana that lost its
certification under the Medicare and Medicaid programs but has since been
recertified under both programs.
12
IF WE DO NOT ACHIEVE AND MAINTAIN COMPETITIVE QUALITY OF CARE RATINGS FROM THE
CENTERS FOR MEDICARE AND MEDICAID SERVICES, OUR BUSINESS MAY BE NEGATIVELY
AFFECTED.
The Centers for Medicare and Medicaid Services, or CMS, launched the
Nursing Home Quality Initiative pilot program in April 2002 in Colorado,
Florida, Maryland, Ohio, Rhode Island and Washington. This program, which is
designed to provide consumers with comparative information about nursing home
quality measures, will rate every nursing home operating in these states on nine
quality of care indicators. These quality of care indicators include such
measures as percentages of patients with infections, bedsores and unplanned
weight loss. This comparative data will be made available to the public on CMS's
web site. CMS has announced that if this pilot program is successful, it intends
to expand the initiative to all other states. We currently operate nursing homes
in Ohio and Washington. If we are unable to achieve quality of care ratings in
these states that are comparable or superior to those of our competitors, our
ability to attract and retain patients could be affected and, as a result, our
revenues could decline.
IF WE FAIL TO CULTIVATE NEW OR MAINTAIN EXISTING RELATIONSHIPS WITH THE
PHYSICIANS IN THE COMMUNITIES IN WHICH WE OPERATE, OUR PATIENT BASE MAY
DECREASE.
Our success depends in part upon the admissions and referral practices of
the physicians in the communities in which we operate and our ability to
cultivate and maintain relationships with these physicians. Physicians referring
patients to our facilities are not our employees and are free to refer their
patients to other providers. If we are unable to successfully cultivate and
maintain strong relationships with these physicians, our patient population may
decline.
WE FACE NATIONAL, REGIONAL AND LOCAL COMPETITION.
Our nursing and assisted living facilities compete on a local and regional
basis with other long-term care providers. The number of competing centers in
the local market, the types of services available, quality of care, reputation,
age and appearance of each center and the cost of care in each locality all
affect our ability to compete successfully. The availability and quality of
competing facilities significantly influence occupancy levels in assisted living
facilities. There are relatively few barriers to entry in the assisted living
industry and, therefore, future development of assisted living facilities in the
markets we serve could limit our ability to attract and retain residents, to
maintain or increase resident service fees or to expand our business. See
"Business -- Competition."
STATE EFFORTS TO REGULATE THE CONSTRUCTION OR EXPANSION OF HEALTH CARE PROVIDERS
COULD IMPAIR OUR ABILITY TO EXPAND THROUGH CONSTRUCTION AND REDEVELOPMENT.
Most of the states in which we currently operate have adopted laws to
regulate expansion of skilled nursing facilities. Certificate of need laws
generally require that a state agency approve certain acquisitions or physical
plant changes and determine that a need exists prior to the addition of beds or
services, the implementation of the physical plant changes or the incurrence of
capital expenditures exceeding a prescribed amount. Some states also prohibit,
restrict or delay the issuance of certificates of need. Many states have
established similar certificate of need processes to regulate the expansion of
assisted living facilities.
If certificates of need or other similar approvals are required in order to
expand our operations, our failure or inability to obtain the necessary
approvals, changes in the standards applicable to such approvals and possible
delays and expenses associated with obtaining such approvals could adversely
affect our ability to expand and, accordingly, to increase our revenues and
earnings. We cannot assure you that we will be able to obtain a certificate of
need or other regulatory approval for all future projects requiring such
approval.
Many states in which we operate have implemented moratoria on the granting
of licenses for any additional skilled nursing facility beds. In these states we
may only expand by acquiring existing operations and licensure rights from other
skilled nursing care providers. We cannot guarantee that we will be able to
13
find acceptable acquisition targets in these states and, as a result, we may not
be able to expand in these states.
WE FACE PERIODIC REVIEWS, AUDITS AND INVESTIGATIONS UNDER OUR CONTRACTS WITH
FEDERAL AND STATE GOVERNMENT AGENCIES, AND THESE AUDITS COULD HAVE ADVERSE
FINDINGS THAT MAY NEGATIVELY IMPACT OUR BUSINESS.
As a result of our participation in the Medicare and Medicaid programs, we
are subject to various governmental reviews, audits and investigations to verify
our compliance with these programs and applicable laws and regulations. Private
pay sources also reserve the right to conduct audits. An adverse review, audit
or investigation could result in:
- refunding amounts we have been paid pursuant to the Medicare or Medicaid
programs or from private payors;
- state or federal agencies imposing fines, penalties and other sanctions
on us;
- loss of our right to participate in the Medicare or Medicaid programs or
one or more private payor networks; or
- damages to our reputation in various markets.
Both federal and state government agencies have heightened and coordinated
civil and criminal enforcement efforts as part of numerous ongoing
investigations of health care companies and, in particular, skilled nursing
facilities. The investigations include:
- cost reporting and billing practices;
- quality of care;
- financial relationships with referral sources; and
- medical necessity of services provided.
We also are subject to potential lawsuits under a federal whistleblower
statute designed to combat fraud and abuse in the healthcare industry. These
lawsuits can involve significant monetary and award bounties to private
plaintiffs who successfully bring these suits.
WE ARE REQUIRED TO COMPLY WITH LAWS GOVERNING THE TRANSMISSION AND PRIVACY OF
HEALTH INFORMATION.
The Health Insurance Portability and Accountability Act of 1996 requires us
to comply with standards for the exchange of health information within our
company and with third parties. These include standards for:
- common health care transactions, such as claims information, plan
eligibility, payment information and the use of electronic signatures;
- unique identifiers for providers, employers, health plans and
individuals;
- security;
- privacy; and
- enforcement.
The Department of Health and Human Services has released two standards: one
governing health care transactions and the second relating to the privacy of
individually identifiable health information. Rules governing the security of
health information have been proposed but not finalized. We generally must
comply with the transaction standards by October 2003 and with the privacy
standards by April 2003. The cost of implementing the new standards may require
us to make significant expenditures. If we fail to comply with the new
standards, we could be subject to criminal penalties and civil sanctions.
14
WE MAY MAKE ACQUISITIONS THAT COULD SUBJECT US TO A NUMBER OF OPERATING RISKS.
We anticipate that we may continue to make acquisitions of, investments in,
and strategic alliances with, complementary businesses to enable us to add
services for our customer base and for adjacent markets and to expand each of
our businesses geographically. However, implementation of this strategy entails
a number of risks including:
- inaccurate assessment of undisclosed liabilities;
- entry into markets in which we may have limited or no experience;
- diversion of management's attention from our core business;
- difficulties in assimilating the operations of an acquired business or in
realizing projected efficiencies and cost savings; and
- increasing our indebtedness and limiting our ability to access additional
capital when needed.
Certain changes may be necessary to integrate the acquired businesses into
our operations, to assimilate new employees and to implement reporting,
monitoring, compliance and forecasting procedures.
RISKS RELATING TO THE EXCHANGE OFFER AND THE NEW NOTES
YOU MAY HAVE DIFFICULTY SELLING THE OLD NOTES THAT YOU DO NOT EXCHANGE.
If you do not exchange your old notes for the new notes offered in this
exchange offer, then you will continue to be subject to the restrictions on the
transfer of your old notes. Those transfer restrictions are described in the
indenture governing the notes and in the legend contained on the old notes, and
arose because we originally issued the old notes under exemptions from, and in
transactions not subject to, the registration requirements of the Securities
Act.
In general, you may offer or sell your old notes only if they are
registered under the Securities Act and applicable state securities laws, or if
they are offered and sold under an exemption from those requirements. We do not
intend to register the old notes under the Securities Act.
If a large number of old notes are exchanged for new notes in the exchange
offer, then it may be more difficult for you to sell your unexchanged old notes.
Additionally, if you do not exchange your old notes in the exchange offer, then
you will no longer be entitled to have those notes registered under the
Securities Act. See "The Exchange Offer -- Consequences of Failure to Exchange
Old Notes."
OUR INDEBTEDNESS COULD ADVERSELY AFFECT OUR FINANCIAL HEALTH AND OUR ABILITY TO
FULFILL OUR OBLIGATIONS UNDER THE NEW NOTES.
As of September 30, 2002, our total consolidated indebtedness was
approximately $388.1 million. Our indebtedness could have important consequences
to you including:
- making it more difficult for us to satisfy our obligations with respect
to the notes;
- increasing our vulnerability to general adverse economic and industry
conditions;
- requiring that a portion of our cash flow from operations be used for the
payment of interest on our debt, thereby reducing our ability to use our
cash flow to fund working capital, capital expenditures, acquisitions and
general corporate requirements;
- limiting our ability to obtain additional financing to fund future
working capital, capital expenditures, acquisitions and general corporate
requirements;
- limiting our flexibility in planning for, or reacting to, changes in our
business and the healthcare industry; and
- placing us at a competitive disadvantage to our competitors that have
less indebtedness.
15
We and our subsidiaries may be able to incur additional indebtedness in the
future, including secured indebtedness. The terms of the indenture do not fully
prohibit us or our subsidiaries from doing so. If new indebtedness is added to
our and our subsidiaries' current indebtedness levels, the related risks that we
and they now face could intensify.
WE HAVE HISTORICALLY HAD A DEFICIENCY OF EARNINGS TO FIXED CHARGES AND OUR
EARNINGS IN THE FUTURE MAY NOT BE SUFFICIENT TO COVER THOSE FIXED CHARGES.
For the years ended December 31, 2001, 2000 and 1999, our earnings were
insufficient to cover fixed charges by approximately $39.9 million, $82.3
million and $123.4 million, respectively. Fixed charges consist of interest
expense, including capitalized interest, amortization of fees related to debt
financing and rent expense deemed to be interest. Our earnings in the future may
not be sufficient to cover those fixed charges, including our obligations on the
notes.
COVENANT RESTRICTIONS UNDER OUR NEW CREDIT FACILITY AND OUR INDENTURES MAY LIMIT
OUR ABILITY TO OPERATE OUR BUSINESS.
Our new credit facility, the indenture governing our senior subordinated
notes and the indenture governing the notes contain, among other things,
covenants that may restrict our and our subsidiary guarantors' ability to
finance future operations or capital needs or to engage in other business
activities. Our credit facility and the indentures restrict, among other things,
our ability and the ability of our subsidiaries to:
- incur additional indebtedness;
- create liens;
- pay dividends on or redeem capital stock;
- make certain investments;
- make restricted payments;
- make certain dispositions of assets;
- engage in certain transactions with affiliates;
- engage in certain business activities; and
- engage in mergers, consolidations and certain sales of assets.
In addition, our new credit facility requires us to maintain specified
financial ratios and tests which may require that we take action to reduce our
debt or to act in a manner contrary to our business objectives. Events beyond
our control, including changes in general business and economic conditions, may
affect our ability to meet those financial ratios and tests. We cannot assure
you that we will meet those ratios and tests or that the lenders will waive any
failure to meet those ratios and tests. A breach of any of these covenants would
result in a default under our credit facility and any resulting acceleration
under the credit facility may result in a default under the indenture. If an
event of default under our credit facility occurs, the lenders could elect to
declare all amounts outstanding thereunder, together with accrued interest, to
be immediately due and payable. See the "Description of Other Indebtedness" and
"Description of the New Notes" for additional information.
OUR BUSINESS AND FINANCIAL RESULTS DEPEND ON OUR ABILITY TO GENERATE SUFFICIENT
CASH FLOWS TO SERVICE OUR DEBT OR REFINANCE OUR INDEBTEDNESS ON COMMERCIALLY
REASONABLE TERMS.
Our ability to make payments on and to refinance our debt and to fund
planned expenditures depends on our ability to generate cash flow in the future.
This, to some extent, is subject to general economic, financial, competitive,
legislative and regulatory factors and other factors that are beyond our
control. We cannot assure you that our business will generate cash flows from
operations or that future borrowings will
16
be available to us under our new credit facility in an amount sufficient to
enable us to pay our debt or to fund our other liquidity needs. We cannot assure
you that we will be able to refinance our borrowing arrangements or any other
outstanding debt on commercially reasonable terms or at all. Refinancing our
borrowing arrangements could cause us to:
- pay higher interest;
- be subject to additional or more restrictive covenants than those
outlined above; and
- grant additional security interests in our collateral.
Our inability to generate sufficient cash flow to service our debt or
refinance our indebtedness on commercially reasonable terms would have a
material adverse effect on our business and results of operations.
AS A HOLDING COMPANY, WE RELY ON PAYMENTS FROM OUR SUBSIDIARIES IN ORDER FOR US
TO MAKE PAYMENTS ON THE NOTES.
We are a holding company with no significant operations of our own. Because
our operations are conducted through our subsidiaries, we depend on dividends,
loans, advances and other payments from our subsidiaries in order to allow us to
satisfy our financial obligations. Our subsidiaries are separate and distinct
legal entities and have no obligation to pay any amounts to us, whether by
dividends, loans, advances or other payments. The ability of our subsidiaries to
pay dividends and make other payments to us depends on their earnings, capital
requirements and general financial conditions and is restricted by, among other
things, applicable corporate and other laws and regulations as well as, in the
future, agreements to which our subsidiaries may be a party. Although our
subsidiary guarantors are guaranteeing the notes, each guarantee is subordinated
to all secured debt of the relevant subsidiary guarantor.
ALTHOUGH THE NOTES ARE REFERRED TO AS "SENIOR NOTES," AND THE SUBSIDIARY
GUARANTEES ARE SENIOR OBLIGATIONS OF OUR SUBSIDIARIES, EACH WILL BE EFFECTIVELY
SUBORDINATED TO OUR AND OUR SUBSIDIARY GUARANTORS' SECURED INDEBTEDNESS.
The notes and our subsidiaries' guarantees are effectively subordinated in
right of payment to all of our and our subsidiary guarantors' secured
indebtedness to the extent of the value of the assets securing that
indebtedness, which consists primarily of indebtedness under the new credit
facility. In the event of our or one of our guarantor's bankruptcy, liquidation,
reorganization or other winding up, the assets securing our or our guarantor's
debt, as the case may be, will be available to pay obligations on the notes or
guarantees, only after all such secured debt has been repaid in full from such
assets. There may not be sufficient assets remaining to pay amounts due on any
or all of the notes or guarantees, as the case may be, that are outstanding.
A COURT MAY VOID THE GUARANTEES OF THE NOTES OR SUBORDINATE THE GUARANTEES TO
OTHER OBLIGATIONS OF OUR SUBSIDIARY GUARANTORS.
Although standards may vary depending upon the applicable law, generally
under U.S. federal bankruptcy law and comparable provisions of state fraudulent
transfer laws, a court could void all or a portion of the guarantees of the
notes or subordinate the guarantees to other obligations of our subsidiary
guarantors. If the claims of the holders of the notes against any guarantor were
held to be subordinated in favor of other creditors of that guarantor, the other
creditors would be entitled to be paid in full before any payment could be made
on the notes. If one or more of the guarantees is voided or subordinated, we
cannot assure you that after providing for all prior claims, there would be
sufficient assets remaining to satisfy the claims of the holders of the notes.
WE MAY BE UNABLE TO REPURCHASE THE NOTES IF WE EXPERIENCE A CHANGE IN CONTROL.
If we were to experience a change of control, the indenture governing the
notes and the indenture governing the senior subordinated notes require us to
offer to purchase all of the outstanding notes and
17
senior subordinated notes. Our failure to repay holders tendering notes upon a
change of control will result in an event of default under the notes and the
senior subordinated notes. A change of control or an event of default under the
notes or the senior subordinated notes may also result in an event of default
under our new credit facility, which may result in the acceleration of the
indebtedness under that facility requiring us to repay that indebtedness
immediately. If a change of control were to occur, we cannot assure you that we
would have sufficient funds to repay debt outstanding under the new credit
facility or to purchase the notes, the senior subordinated notes or any other
securities which we would be required to offer to purchase. We expect that we
would require additional financing from third parties to fund any such
purchases, and we cannot assure you that we would be able to obtain financing on
satisfactory terms or at all. See "Description of Other Indebtedness" and
"Description of the New Notes."
NO PUBLIC MARKET EXISTS FOR THE NOTES, AND ANY MARKET FOR THE NOTES MAY BE
ILLIQUID.
The notes are a new issue of securities with no established trading market.
We do not intend to list the notes for trading on any stock exchange or arrange
for any quotation system to quote prices for them. The initial purchasers for
the old notes have informed us that they intend to make a market in the notes.
However, the initial purchasers are not obligated to do so and may cease
market-making activities at any time. As a result, we cannot assure you that an
active trading market will develop or continue for the notes.
18
THE EXCHANGE OFFER
PURPOSE AND EFFECT; REGISTRATION RIGHTS
We sold the old notes on June 28, 2002 in transactions exempt from the
registration requirements of the Securities Act. Therefore, the old notes are
subject to significant restrictions on resale. In connection with the issuance
of the old notes; we entered into a registration rights agreement, which
required that we and the subsidiary guarantors:
- file with the SEC a registration statement under the Securities Act
relating to the exchange offer and the issuance and delivery of the new
notes in exchange for the old notes;
- use our best efforts to cause the SEC to declare the exchange offer
registration statement effective under the Securities Act; and
- use our best efforts to consummate the exchange offer not later than 30
business days following the effective date of the exchange offer
registration statement.
If you participate in the exchange offer, you will, with limited
exceptions, receive new notes that are freely tradable and not subject to
restrictions on transfer. You should see "The Exchange Offer -- Resales of New
Notes" for more information relating to your ability to transfer new notes.
If you are eligible to participate in the exchange offer and do not tender
your old notes, you will continue to hold the untendered old notes, which will
continue to be subject to restrictions on transfer under the Securities Act.
The exchange offer is intended to satisfy our exchange offer obligations
under the registration rights agreement. The above summary of the registration
rights agreement is not complete and is subject to, and qualified by reference
to, all the provisions of the registration rights agreement. A copy of the
registration rights agreement has been filed as an exhibit to the registration
statement that includes this prospectus.
TERMS OF THE EXCHANGE OFFER
We are offering to exchange $150,000,000 in aggregate principal amount of
our 9 1/2% Senior Notes due 2010 that have been registered under the Securities
Act for a like aggregate principal amount of our outstanding unregistered 9 1/2%
Senior Notes due 2010.
Upon the terms and subject to the conditions set forth in this prospectus
and in the accompanying letter of transmittal, we will accept all old notes
validly tendered and not withdrawn before 5:00 p.m., New York City time, on the
expiration date of the exchange offer. We will issue $1,000 principal amount of
new notes in exchange for each $1,000 principal amount of outstanding old notes
we accept in the exchange offer. You may tender some or all of your old notes
under the exchange offer. However, the old notes are issuable in authorized
denominations of $1,000 and integral multiples thereof. Accordingly, old notes
may be tendered only in denominations of $1,000 and integral multiples thereof.
The exchange offer is not conditioned upon any minimum amount of old notes being
tendered.
The form and terms of the new notes will be the same as the form and terms
of the old notes, except that:
- the new notes will be registered with the SEC and thus will not be
subject to the restrictions on transfer or bear legends restricting their
transfer;
- all of the new notes will be represented by global notes in book-entry
form unless exchanged for notes in definitive certificated form under the
limited circumstances described under "Description of the New
Notes -- Book-Entry, Delivery and Form;" and
- the new notes will not provide for registration rights and the payment of
liquidated damages under circumstances relating to the timing of the
exchange offer.
19
The new notes will evidence the same debt as the old notes and will be
issued under, and be entitled to the benefits of, the indenture governing the
old notes.
The new notes will accrue interest from the most recent date to which
interest has been paid on the old notes or, if no interest has been paid, from
the date of issuance of the old notes. Accordingly, registered holders of new
notes on the record date for the first interest payment date following the
completion of the exchange offer will receive interest accrued from the most
recent date to which interest has been paid on the old notes or, if no interest
has been paid, from the date of issuance of the old notes. However, if that
record date occurs prior to completion of the exchange offer, then the interest
payable on the first interest payment date following the completion of the
exchange offer will be paid to the registered holders of the old notes on that
record date.
In connection with the exchange offer, you do not have any appraisal or
dissenters' rights under applicable law or the indenture. We intend to conduct
the exchange offer in accordance with the registration rights agreement and the
applicable requirements of the Securities Exchange Act of 1934 and the rules and
regulations of the SEC. The exchange offer is not being made to, nor will we
accept tenders for exchange from, holder of the old notes in any jurisdiction in
which the exchange offer or the acceptance of it would not be in compliance with
the securities or blue sky laws of the jurisdiction.
We will be deemed to have accepted validly tendered old notes when we have
given oral or written notice of our acceptance to the exchange agent. The
exchange agent will act as agent for the tendering holders for the purpose of
receiving the new notes from us.
If we do not accept any tendered old notes because of an invalid tender or
for any other reason, then we will return certificates for any unaccepted old
notes without expense to the tendering holder as promptly as practicable after
the expiration date.
EXPIRATION DATE; AMENDMENTS
The exchange offer will expire at 5:00 p.m., New York City time, on
December 27, 2002, unless we, in our sole discretion, extend the exchange offer.
If we determine to extend the exchange offer, then we will notify the
exchange agent of any extension by oral or written notice and give each
registered holder notice of the extension by means of a press release or other
public announcement before 9:00 a.m., New York City time, on the next business
day after the previously scheduled expiration date.
We reserve the right, in our sole discretion, to delay accepting any old
notes, to extend the exchange offer or to amend or terminate the exchange offer
if any of the conditions described below under "-- Conditions to the Exchange
Offer" have not been satisfied or waived by giving oral or written notice to the
exchange agent of the delay, extension, amendment or termination. Further, we
reserve the right, in our sole discretion, to amend the terms of the exchange
offer in any manner. We will notify you as promptly as practicable of any
extension, amendment or termination. We will also file a post-effective
amendment to the registration statement of which this prospectus is a part with
respect to any fundamental change in the exchange offer.
PROCEDURES FOR TENDERING OLD NOTES
A holder who wishes to tender old notes in the exchange offer must do
either of the following:
- properly complete, sign and date the letter of transmittal, including all
other documents required by the letter of transmittal; have the signature
on the letter of transmittal guaranteed if the letter of transmittal so
requires; and deliver that letter of transmittal and other required
documents to the exchange agent at the address listed below under
"-- Exchange Agent" on or before the expiration date; or
20
- if the old notes are tendered under the book-entry transfer procedures
described below, transmit to the exchange agent an agent's message, which
agent's message must be received by the exchange agent prior to 5:00
p.m., New York City time, on the expiration date.
In addition, one of the following must occur:
- the exchange agent must receive certificates representing your old notes
along with the letter of transmittal on or before the expiration date, or
- the exchange agent must receive a timely confirmation of book-entry
transfer of the old notes into the exchange agent's account at DTC under
the procedure for book-entry transfers described below along with the
letter of transmittal or a properly transmitted agent's message, on or
before the expiration date; or
- the holder must comply with the guaranteed delivery procedures described
below.
The term "agent's message" means a message, transmitted by a book-entry
transfer facility to and received by the exchange agent and forming a part of
the book-entry confirmation, which states that the book-entry transfer facility
has received an express acknowledgement from the tendering participant stating
that the participant has received and agrees to be bound by the letter of
transmittal, and that we may enforce the letter of transmittal against the
participant.
To be tendered effectively, the exchange agent must receive any physical
delivery of the letter of transmittal and other required documents at the
address set forth below under "-- Exchange Agent" on or before the expiration of
the exchange offer. To receive confirmation of valid tender of old notes, a
holder should contact the exchange agent at the telephone number listed under
"-- Exchange Agent."
Any tender of old notes that is not withdrawn prior to the expiration date
will constitute a binding agreement between the tendering holder and us upon the
terms and subject to the conditions set forth in this prospectus and in the
accompanying letter of transmittal. Only a registered holder of old notes may
tender the old notes in the exchange offer. If a holder completing a letter of
transmittal tenders less than all of the old notes held by that holder, then
that tendering holder should fill in the applicable box of the letter of
transmittal. The amount of old notes delivered to the exchange agent will be
deemed to have been tendered unless otherwise indicated.
The method of delivery of old notes, the letter of transmittal and all
other required documents to the exchange agent is at your election and risk.
Rather than mail these items, we recommend that you use an overnight or hand
delivery service. In all cases, you should allow sufficient time to assure
timely delivery to the exchange agent before the expiration date. Do not send
letters of transmittal or old notes to us.
Generally, an eligible institution must guarantee signatures on a letter of
transmittal or a notice of withdrawal unless the old notes are tendered:
- by a registered holder of the old notes who has not completed the box
entitled "Special Issuance Instructions" or "Special Delivery
Instructions" on the letter of transmittal; or
- for the account of an eligible institution.
If signatures on a letter of transmittal or a notice of withdrawal are
required to be guaranteed, the guarantee must be by a firm which is:
- a member of a registered national securities exchange;
- a member of the National Association of Securities Dealers, Inc.;
- a commercial bank or trust company having an office or correspondent in
the United States; or
- another "eligible institution" within the meaning of Rule 17Ad-15 under
the Securities Exchange Act.
21
If the letter of transmittal is signed by a person other than the
registered holder of any outstanding old notes, the original notes must be
endorsed or accompanied by appropriate powers of attorney. The power of attorney
must be signed by the registered holder exactly as the registered holder(s)
name(s) appear(s) on the old notes and an eligible institution must guarantee
the signature on the power of attorney.
If the letter of transmittal, or any old notes or powers of attorney are
signed by trustees, executors, administrators, guardians, attorneys-in-fact,
officers of corporations or others acting in a fiduciary or representative
capacity, these persons should so indicate when signing. Unless waived by us,
they should also submit evidence satisfactory to us of their authority to so
act.
If you wish to tender old notes that are registered in the name of a
broker, dealer, commercial bank, trust company or other nominee, you should
promptly instruct the registered holder to tender on your behalf. If you wish to
tender on your behalf, you must, before completing the procedures for tendering
old notes, either register ownership of the old notes in your name or obtain a
properly completed bond power from the registered holder. The transfer of
registered ownership may take considerable time.
We will determine in our sole discretion all questions as to the validity,
form, eligibility, including time of receipt, and acceptance of old notes
tendered for exchange. Our determination will be final and binding on all
parties. We reserve the absolute right to reject any and all tenders of old
notes not properly tendered or old notes our acceptance of which might, in the
judgment of our counsel, be unlawful. We also reserve the absolute right to
waive any defects, irregularities or conditions of tender as to any particular
old notes. Our interpretation of the terms and conditions of the exchange offer,
including the instructions in the letter of transmittal, will be final and
binding on all parties. Unless waived, any defects or irregularities in
connection with tenders of old notes must be cured within the time period we
determine. Neither we, the exchange agent nor any other person will incur any
liability for failure to give you notification of defects or irregularities with
respect to tenders of your old notes.
By tendering, you will represent to us that:
- any new notes that the holder receives will be acquired in the ordinary
course of its business;
- the holder has no arrangement or understanding with any person or entity
to participate in the distribution of the new notes;
- if the holder is not a broker-dealer, that it is not engaged in and does
not intend to engage in the distribution of the new notes;
- if the holder is a broker-dealer that will receive new notes for its own
account in exchange for old notes that were acquired as a result of
market-making activities or other trading activities, that it will
deliver a prospectus, as required by law, in connection with any resale
of those new notes (see "Plan of Distribution"); and
- the holder is not our "affiliate," as defined in Rule 405 of the
Securities Act, or, if the holder is our affiliate, it will comply with
any applicable registration and prospectus delivery requirements of the
Securities Act.
If any holder or any such other person is our "affiliate," or is engaged in
or intends to engage in or has an arrangement or understanding with any person
to participate in a distribution of the new notes to be acquired in the exchange
offer, then that holder or any such other person:
- may not rely on the applicable interpretations of the staff of the SEC;
- is not entitled and will not be permitted to tender old notes in the
exchange offer; and
- must comply with the registration and prospectus delivery requirements of
the Securities Act in connection with any resale transaction.
Each broker-dealer who acquired its old notes as a result of market-making
activities or other trading activities and thereafter receives new notes issued
for its own account in the exchange offer, must
22
acknowledge that it will deliver a prospectus in connection with any resale of
such new notes issued in the exchange offer. The letter of transmittal states
that by so acknowledging and by delivering a prospectus, a broker-dealer will
not be deemed to admit that it is an "underwriter" within the meaning of the
Securities Act. See "Plan of Distribution" for a discussion of the exchange and
resale obligations of broker-dealers in connection with the exchange offer.
Any broker-dealer that acquired old notes directly from us may not rely on
the applicable interpretations of the staff of the SEC and must comply with the
registration and prospectus delivery requirements of the Securities Act
(including being named as a selling securityholder) in connection with any
resales of the old notes or the new notes.
ACCEPTANCE OF OLD NOTES FOR EXCHANGE; DELIVERY OF NEW NOTES
Upon satisfaction of all conditions to the exchange offer, we will accept,
promptly after the expiration date, all old notes properly tendered and will
issue the new notes promptly after acceptance of the old notes.
For purposes of the exchange offer, we will be deemed to have accepted
properly tendered old notes for exchange when we have given oral or written
notice of that acceptance to the exchange agent. For each old note accepted for
exchange, you will receive a new note having a principal amount equal to that of
the surrendered old note.
In all cases, we will issue new notes for old notes that we have accepted
for exchange under the exchange offer only after the exchange agent timely
receives:
- certificates for your old notes or a timely confirmation of book-entry
transfer of your old notes into the exchange agent's account at DTC; and
- a properly completed and duly executed letter of transmittal and all
other required documents or a properly transmitted agent's message.
If we do not accept any tendered old notes for any reason set forth in the
terms of the exchange offer or if you submit old notes for a greater principal
amount than you desire to exchange, we will return the unaccepted or
non-exchanged old notes without expense to you. In the case of old notes
tendered by book-entry transfer into the exchange agent's account at DTC under
the book-entry procedures described below, we will credit the non-exchanged old
notes to your account maintained with DTC.
BOOK-ENTRY TRANSFER
We understand that the exchange agent will make a request within two
business days after the date of this prospectus to establish accounts for the
old notes at DTC for the purpose of facilitating the exchange offer, and any
financial institution that is a participant in DTC's system may make book-entry
delivery of old notes by causing DTC to transfer the old notes into the exchange
agent's account at DTC in accordance with DTC's procedures for transfer.
Although delivery of old notes may be effected through book-entry transfer at
DTC, the exchange agent must receive a properly completed and duly executed
letter of transmittal with any required signature guarantees, or an agent's
message in lieu of a letter of transmittal, and all other required documents at
its address listed below under "-- Exchange Agent" on or before the expiration
date, or if you comply with the guaranteed delivery procedures described below,
within the time period provided under those procedures.
23
GUARANTEED DELIVERY PROCEDURES
If you wish to tender your old notes and your old notes are not immediately
available, or you cannot deliver your old notes, the letter of transmittal or
any other required documents or comply with DTC's procedures for transfer before
the expiration date, then you may participate in the exchange offer if:
- the tender is made through an eligible institution;
- before the expiration date, the exchange agent receives from the eligible
institution a properly completed and duly executed notice of guaranteed
delivery, substantially in the form provided by us, by facsimile
transmission, mail or hand delivery, containing:
-- the name and address of the holder and the principal amount of old
notes tendered;
-- a statement that the tender is being made thereby; and
-- a guarantee that within three New York Stock Exchange trading days
after the expiration date, the certificates representing the old notes
in proper form for transfer or a book-entry confirmation and any other
documents required by the letter of transmittal will be deposited by
the eligible institution with the exchange agent; and
- the exchange agent receives the properly completed and executed letter of
transmittal as well as certificates representing all tendered old notes
in proper form for transfer, or a book-entry confirmation, and all other
documents required by the letter of transmittal within three New York
Stock Exchange trading days after the expiration date.
WITHDRAWAL RIGHTS
You may withdraw your tender of old notes at any time before the exchange
offer expires.
For a withdrawal to be effective, the exchange agent must receive a written
notice of withdrawal at its address listed below under "-- Exchange Agent." The
notice of withdrawal must:
- specify the name of the person who tendered the old notes to be
withdrawn;
- identify the old notes to be withdrawn, including the principal amount,
or, in the case of old notes tendered by book-entry transfer, the name
and number of the DTC account to be credited, and otherwise comply with
the procedures of DTC; and
- if certificates for old notes have been transmitted, specify the name in
which those old notes are registered if different from that of the
withdrawing holder.
If you have delivered or otherwise identified to the exchange agent the
certificates for old notes, then, before the release of these certificates, you
must also submit the serial numbers of the particular certificates to be
withdrawn and a signed notice of withdrawal with the signatures guaranteed by an
eligible institution, unless the holder is an eligible institution.
We will determine in our sole discretion all questions as to the validity,
form and eligibility, including time of receipt, of notices of withdrawal. Our
determination will be final and binding on all parties. Any old notes so
withdrawn will be deemed not to have been validly tendered for purposes of the
exchange offer. We will return any old notes that have been tendered but that
are not exchanged for any reason to the holder, without cost, as soon as
practicable after withdrawal, rejection of tender or termination of the exchange
offer. In the case of old notes tendered by book-entry transfer into the
exchange agent's account at DTC, the old notes will be credited to an account
maintained with DTC for the old notes. You may retender properly withdrawn old
notes by following one of the procedures described under "-- Procedures for
Tendering Old Notes" at any time on or before the expiration date.
24
CONDITIONS TO THE EXCHANGE OFFER
Notwithstanding any other term of the exchange offer, we will not be
required to accept for exchange, or to exchange new notes for, any old notes if
in our reasonable judgement:
- the new notes to be received will not be tradable by the holder, without
restriction under the Securities Act and the Securities Exchange Act and
without material restrictions under the blue sky or securities laws of
substantially all of the states of the United States;
- the exchange offer, or the making of any exchange by a holder of old
notes, would violate any applicable law or applicable interpretation by
the staff of the SEC; or
- any action or proceeding is instituted or threatened in any court or by
or before any governmental agency with respect to the exchange offer
which, in our judgment, would reasonably be expected to impair our
ability to proceed with the exchange offer.
The conditions listed above are for our sole benefit and we may assert them
regardless of the circumstances giving rise to any condition. Subject to
applicable law, we may waive these conditions in our discretion in whole or in
part at any time and from time to time. If we waive these conditions, then we
intend to continue the exchange offer for at least five business days after the
waiver. If we fail at any time to exercise any of the above rights, the failure
will not be deemed a waiver of those rights, and those rights will be deemed
ongoing rights which may be asserted at any time and from time to time.
We will not accept for exchange any old notes tendered, and will not issue
new notes in exchange for any old notes, if at that time a stop order is
threatened or in effect with respect to the registration statement of which this
prospectus is a part or the qualification of the indentures under the Trust
Indenture Act of 1939.
EXCHANGE AGENT
U.S. Bank, N.A. is the exchange agent for the exchange offer. You should
direct any questions and requests for assistance and requests for additional
copies of this prospectus, the letter of transmittal or the notice of guaranteed
delivery to the exchange agent addressed as follows:
By Hand, Overnight Mail, Courier, or Registered or Certified Mail:
U.S. Bank Trust Center
180 East Fifth Street
St. Paul, MN 55101
Attention: Specialized Finance Group
By Facsimile:
(651) 244-1537
Attention: Specialized Finance Group
Delivery of the letter of transmittal to an address other than as listed
above or transmission via facsimile other than as listed above will not
constitute a valid delivery of the letter of transmittal.
FEES AND EXPENSES
We will pay the expenses of the exchange offer. We will not make any
payments to brokers, dealers or others soliciting acceptances of the exchange
offer. We are making the principal solicitation by mail; however, our officers
and employees may make additional solicitations by facsimile transmission,
e-mail, telephone or in person. You will not be charged a service fee for the
exchange of your old notes, but we may require you to pay any transfer or
similar government taxes in certain circumstances.
25
TRANSFER TAXES
You will be obligated to pay any transfer taxes applicable to the transfer
of the old notes pursuant to the exchange offer.
ACCOUNTING TREATMENT
We will record the new notes in our accounting records at the same carrying
values as the old notes, which is the aggregate principal amount of the old
notes, as reflected in our accounting records on the date of exchange.
Accordingly, we will not recognize any gain or loss for accounting purposes in
connection with the exchange offer.
RESALES OF NEW NOTES
Based on interpretations of the staff of the SEC, as set forth in no-action
letters to third parties, we believe that new notes issued under the exchange
offer in exchange for old notes may be offered for resale, resold and otherwise
transferred by any old note holder without further registration under the
Securities Act and without delivery of a prospectus that satisfies the
requirements of Section 10 of the Securities Act if:
- the holder is not our "affiliate" within the meaning of Rule 405 under
the Securities Act;
- the new notes are acquired in the ordinary course of the holder's
business; and
- the holder does not intend to participate in a distribution of the new
notes.
Any holder who exchanges old notes in the exchange offer with the intention
of participating in any manner in a distribution of the new notes must comply
with the registration and prospectus delivery requirements of the Securities Act
in connection with a secondary resale transaction.
This prospectus may be used for an offer to resell, resale or other
transfer of new notes. With regard to broker-dealers, only broker-dealers that
acquired the old notes as a result of market-making activities or other trading
activities may participate in the exchange offer. Each broker-dealer that
receives new notes for its own account in exchange for old notes, where the old
notes were acquired by the broker-dealer as a result of market-making activities
or other trading activities, must acknowledge that it will deliver a prospectus
in connection with any resale of the new notes. Please see "Plan of
Distribution" for more details regarding the transfer of new notes.
CONSEQUENCES OF FAILURE TO EXCHANGE OLD NOTES
Holders who desire to tender their old notes in exchange for new notes
registered under the Securities Act should allow sufficient time to ensure
timely delivery. Neither we nor the exchange agent is under any duty to give
notification of defects or irregularities with respect to the tenders of old
notes for exchange.
Old notes that are not tendered or are tendered but not accepted will,
following the consummation of the exchange offer, continue to be subject to the
provisions in the indenture regarding the transfer and exchange of the old notes
and the existing restrictions on transfer set forth in the legend on the old
notes and in the offering memorandum, dated June 20, 2002, relating to the old
notes. Except in limited circumstances with respect to the specific types of
holders of old notes, we will have no further obligation to provide for the
registration under the Securities Act of such old notes. In general, old notes,
unless registered under the Securities Act, may not be offered or sold except
pursuant to an exemption from, or in a transaction not subject to, the
Securities Act and applicable state securities laws. We do not anticipate that
we will take any action to register the untendered old notes under the
Securities Act or under any state securities laws.
Upon completion of the exchange offer, holders of the old notes will not be
entitled to any further registration rights under the registration rights
agreement, except under limited circumstances.
26
Old notes that are not exchanged in the exchange offer will remain
outstanding and continue to accrue interest and will be entitled to the rights
and benefits their holders have under the indenture relating to the old notes
and the new notes. Holders of the new notes and any old notes that remain
outstanding after consummation of the exchange offer will vote together as a
single class for purposes of determining whether holders of the requisite
percentage of the class have taken certain actions or exercised certain rights
under the indenture.
27
USE OF PROCEEDS
This exchange offer is intended to satisfy our obligations under the
registration rights agreement entered into in connection with the issuance of
the old notes. Neither we nor any subsidiary guarantor will receive any proceeds
from the issuance of the new notes. In consideration for issuing the new notes
as contemplated by this prospectus, we will receive the old notes in like
principal amount, the terms of which are identical in all material respects to
the new notes. The old notes surrendered in exchange for the new notes will be
retired and canceled and cannot be reissued. Accordingly, the issuance of the
new notes will not result in any increase or decrease in our indebtedness.
We used the net proceeds of approximately $145.1 million from the sale of
the old notes to pay related fees and expenses and for the following purposes:
- approximately $127.5 million to refinance our old credit facility, which,
at the time of the offering of the old notes, bore annual interest of
4.48% and was scheduled to mature on December 31, 2003 and 2004;
- approximately $3.8 million to refinance an industrial development revenue
bond, which, at the time of the offering of the old notes, bore annual
interest at a rate of 2.0% and was scheduled to mature in 2015;
- approximately $2.5 million to refinance a promissory note, which, at the
time of the offering of the old notes, bore annual interest at a rate of
10.75% and was scheduled to mature in 2010; and
- the remainder for general corporate purposes.
28
CAPITALIZATION
The following table sets forth the cash and cash equivalents and our
consolidated capitalization as of September 30, 2002 on an actual basis. You
should read this table in conjunction with our consolidated financial statements
and the related notes to the consolidated financial statements included in this
prospectus. See "Use of Proceeds," "Summary Consolidated Historical Financial
and Operating Data," "Selected Consolidated Historical Financial Data,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Description of Other Indebtedness."
<Table>
<Caption>
SEPTEMBER 30,
2002
-------------
ACTUAL
-------------
(UNAUDITED)
(DOLLARS IN
THOUSANDS)
Cash and cash equivalents................................... $ 29,710
========
Total debt:
New credit facility(1).................................... --
Industrial development revenue bonds...................... 33,535
Promissory notes, mortgages and capital lease
obligations............................................ 4,882
9.50% Senior Notes due 2010............................... 149,633
9.35% Senior Subordinated Notes due 2007.................. 200,000
--------
Total debt........................................... 388,050
--------
Shareholder's equity:
Common stock.............................................. 1
Additional paid-in capital................................ 208,787
Accumulated other comprehensive loss...................... (2,876)
Accumulated deficit....................................... (46,250)
--------
Total shareholder's equity........................... 159,662
--------
Total capitalization................................. $547,712
========
</Table>
- ---------------
(1) Subject to certain conditions, we may borrow up to $105.0 million under our
new credit facility. As of September 30, 2002 we have $39.9 million of
letters of credit outstanding under the new credit facility.
29
SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA
The following table summarizes our selected consolidated historical
financial data, which you should read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our consolidated financial statements and related notes, which should be read in
their entirety. The selected consolidated financial data have been derived from
our consolidated financial statements. The unaudited interim period selected
consolidated financial data, in our opinion, reflect all adjustments necessary
to present fairly the data for such periods. Interim results for the nine months
ended September 30, 2002 are not necessarily indicative of results that can be
expected in future periods.
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------- ---------------------------------------------------------
2002 2001 2001 2000 1999 1998 1997
-------- -------- -------- -------- --------- ---------- ----------
(DOLLARS IN THOUSANDS)
INCOME STATEMENT DATA:
Revenues(1):
Nursing and assisted living
facilities.................. $586,272 $578,378 $766,952 $904,847 $ 916,195 $ 990,066 $ 796,006
Outpatient therapy and medical
supplies.................... 7,585 7,271 9,515 9,716 43,068 141,131 113,206
Other......................... 12,927 12,597 17,640 8,506 8,322 9,238 6,949
-------- -------- -------- -------- --------- ---------- ----------
Total revenues............ 606,784 598,246 794,107 923,069 967,585 1,140,435 916,161
Costs and expenses:
Operating..................... 510,117 523,021 684,814 825,172 844,391 953,639 747,016
General and administrative.... 24,329 25,011 32,387 46,507 45,524 45,432 40,510
Lease costs................... 8,411 11,352 14,575 15,731 16,631 15,895 10,213
Depreciation and
amortization................ 28,228 30,226 40,772 45,434 52,005 53,723 35,290
Interest, net................. 23,921 27,370 35,560 45,155 51,267 55,831 24,002
Loss (gain) on disposal of
assets...................... (3,961) 1,054 1,054 3,306 37,292 (93,337) --
Provision for closure and exit
costs and other items....... 5,293 23,192 23,192 3,357 5,482 -- --
Loss on impairment of
long-lived assets........... -- 1,685 1,685 20,753 38,173 -- --
-------- -------- -------- -------- --------- ---------- ----------
(Loss) earnings before income
taxes, minority interests and
extraordinary item............ 10,446 (44,665) (39,932) (82,346) (123,180) 109,252 59,130
Net (loss) earnings............. $ 4,169 $(29,584) $(27,495) $(55,121) $ (70,457) $ 27,264 $ 25,763
======== ======== ======== ======== ========= ========== ==========
BALANCE SHEET DATA (END OF
PERIOD):
Cash and cash equivalents....... $ 29,710 $ 4,114 $ 997 $ 1,641 $ 2,941 $ 1,084 $ 1,418
Working capital................. 33,099 (8,672) 4,145 44,473 67,807 17,477 95,184
Property and equipment.......... 439,095 479,721 477,830 507,536 610,643 700,141 688,169
Total assets.................... 794,804 806,704 795,836 873,590 974,448 1,135,477 1,229,249
Total debt(2)................... 388,050 389,654 385,347 451,147 530,155 547,748 713,324
Shareholder's equity............ 159,662 153,301 156,002 184,161 237,895 311,629 281,772
</Table>
- ---------------
(1) Revenues have been restated for consistency to reflect therapy services
within nursing facilities.
(2) Total debt includes long term debt and current maturities of long term debt.
30
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Based on number of beds, we are one of the largest providers of long-term
care and related services in the United States. As of September 30, 2002, we
operated 139 nursing facilities with 14,082 beds and 36 assisted living and
retirement facilities with 1,756 units that we owned or leased in 13 states. In
addition, we managed 18 nursing facilities with 2,326 beds and five assisted
living and retirement facilities with 147 units and provided selected consulting
services to 38 nursing facilities with 4,097 beds and one assisted living
facility with 116 beds owned by third parties. In total, we operated, managed or
provided selected consulting services to 237 long-term care facilities with
22,524 beds in 16 states, of which 195 were nursing facilities with 20,505 beds
and 42 were assisted living and retirement facilities with 2,019 units.
Revenues
We derive revenues by providing healthcare services in our network of
facilities, including long-term care services such as nursing care, assisted
living and related medical services such as subacute care and rehabilitative
therapy. We derive nursing and assisted living facility revenues by providing
routine and ancillary services for our facilities' residents. We derive
outpatient therapy and medical supplies revenues by providing outpatient therapy
services at our clinics and to outside third parties.
We generate our revenue from Medicare, Medicaid and private pay sources.
The following table sets forth our Medicare, Medicaid and private pay sources of
revenue by percentage of total revenue:
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31
------------------- ------------------------
2002 2001 2001 2000 1999
---- ---- ---- ---- ----
Medicare............................................. 26% 23% 24% 24% 22%
Medicaid............................................. 49% 52% 51% 51% 50%
Private.............................................. 25% 25% 25% 25% 28%
</Table>
Legislative Actions Affecting Revenues
Prior to October 1, 2002, the incremental Medicare relief packages received
from the Balanced Budget Refinement Act and the Benefits Improvement and
Protection Act provided a total of $2.7 billion in temporary Medicare funding
enhancements to the long-term care industry. The funding enhancements
implemented by the Balanced Budget Refinement Act and Benefits Improvement and
Protection Act fall into two categories. The first category is "legislative
add-ons," which includes the 16.66% add-on to the nursing component of the
resource utilization groupings rate and the 4% base adjustment. The second
category is "resource utilization groupings refinements" which involved an
initial 20% add-on for 15 resource utilization groupings categories identified
as having high intensity, non-therapy ancillary services. Twenty percent add-ons
from three resource utilization groupings categories were later redistributed to
14 rehabilitation categories at an add-on rate of 6.7% each.
The legislative add-ons expired on September 30, 2002 and our Medicare
funding has been reduced pending additional legislation. Based upon the Medicare
case mix and census over the nine month period ended September 30, 2002, we
estimate that we received an average rate of $31.22 per resident day relating to
the legislative add-ons. However, on October 1, 2002 long-term care providers
received a 2.6% market basket increase in Medicare rates. Based on the Medicare
case mix and census for the first nine months of 2002, the impact of these two
items is a net decline in the average rate of $26.47 per resident day, which on
an annualized basis going forward amounts to revenue of approximately $16.1
million. Extensive discussions and negotiations are underway within the U.S.
House of Representatives and Senate regarding the legislative add-ons. It is not
possible to predict the outcome of these deliberations. A decision not to
restore all or part of the enhancements could have a significant negative effect
on us.
31
On April 23, 2002, the Centers for Medicare and Medicaid Services announced
that they would delay the implementation of resource utilization groupings
refinements, thereby extending the related add-ons for at least one additional
government fiscal year to September 30, 2003. We estimate the average per diem
effect to us of resource utilization groupings refinements to be $24.59 per day,
or $14.9 million annually.
Income Taxes
Income tax benefit in 2001 was $12.5 million compared to $27.7 million in
2000. Our effective tax rate was 31.3% in 2001 as compared to 33.6% in 2000. In
assessing the realizability of deferred tax assets, we consider whether it is
more likely than not that all or some portion of the deferred tax assets will
not be realized. The ultimate realization of deferred tax assets depends upon us
generating future taxable income during the periods in which temporary
differences become deductible. We consider the scheduled reversal of deferred
tax liabilities, projected future taxable income and tax planning strategies in
making this assessment. In 2001 and 2000 we recorded a valuation allowance of
$2.8 million and $3.2 million, respectively. The amount of the deferred tax
assets considered realizable could be reduced if estimates of future taxable
income during the carry forward period are reduced.
Asset Impairment Costs
We are required to accrue for asset impairment costs when indicators of
impairment are present and the undiscounted cash flows from the assets do not
appear to be sufficient to recover the assets' carrying value. The impairment
loss is measured by comparing the fair value of the asset to its carrying
amount. Accordingly, we have estimated the future cash flows of each facility
and reduced the corresponding carrying value to the estimated fair value, where
appropriate. Such estimates are subject to change due to factors both within and
outside our control. If those changes reduce estimated future cash flows, we may
be required to record further impairment provisions in subsequent periods. We
recorded provisions of $1.7 million in 2001 and $20.7 million in 2000, related
to the impairment of assets.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States, or GAAP. For a
full discussion of our accounting policies as required by GAAP, please see the
accompanying notes to the consolidated financial statements. We consider the
accounting policies discussed below to be critical to an understanding of our
financial statements because their application requires significant judgment and
reliance on estimations of matters that are inherently uncertain. Specific risks
related to these critical accounting policies are described below.
Revenue Recognition and Accounts Receivable
We derive our revenues primarily from providing long-term healthcare
services in the nursing and assisted living facilities we operate. Nursing
facility revenue results from the payment for services and products from federal
and state-funded cost reimbursement programs as well as private pay residents.
More than 75% of our revenues are derived from services provided under various
federal or state medical assistance programs.
We recognize nursing home revenues in the period in which we provide
services and or deliver products at established rates less contractual
adjustments. Contractual adjustments include differences between our established
billing rates and amounts estimated by management as reimbursable under various
reimbursement formulas or contracts in effect. Estimation differences between
final settlements and amounts recorded in previous years are reported as
adjustments to revenues in the period such settlements are determined. Due to
the complexity of the laws and regulations governing the federal and state
reimbursement programs, there is a possibility that recorded estimates may
change by a material amount.
We derive assisted living facility revenue primarily from private pay
residents in the period in which we provide services and at rates we establish
based upon the services provided and market conditions in the area of operation.
32
We record accounts receivable at the net realizable value we expect to
receive from federal and state reimbursement programs, other third-party payors
or from individual residents. More than 60% of our accounts receivable are
generated from services provided under various federal and state reimbursement
programs. We continually monitor and adjust our allowances associated with these
receivables. We record allowances for bad debts from other third-party payors or
from individual residents based upon our historical experience by payor type.
Prior to the implementation of the prospective payment system in 1999,
Medicare was a cost-based reimbursement program, and in the ordinary course of
business we continue to have ongoing discussions with the fiscal intermediary
regarding the treatment of various items related to prior years' cost reports.
Normally disputes are resolved in the audit process; however, we record general
provisions for disagreements that require settlement through a formal appeal
process.
As detailed in Note 12(c) to our consolidated financial statements, we
appealed to the Provider Reimbursement Review Board an issue involving the
reimbursement of workers' compensation costs. During September 2000, the board
issued a decision that supported our position. In December 2000, the
administrator for the Centers for Medicare and Medicaid Services confirmed the
board's September 2000 decision. This resulted in a favorable settlement of
$12.4 million, including a recovery recorded in revenue of $10.3 million of the
general provision recorded in 1999. In addition, we reached a settlement on
another staffing cost issue resulting in a recovery of $2.4 million, including a
recovery of $1.7 million of the general provision recorded in 1999. In total, a
recovery of $12.0 million was recorded in 2000 relating to the general provision
recorded in 1999.
We also estimate whether the receivable may be collected within one year
and reflect those receivables not expected to be collected within one year as
non-current. We record allowances for bad debts from other third-party payors or
from individual patients based upon our historical experience by payor type. If
circumstances change, for instance due to economic downturn, higher than
expected defaults or denials, our estimates of the recoverability of our
receivables could be reduced by a material amount. Our allowance for doubtful
accounts for current accounts receivable totaled $14.5 million and $16.3 million
at December 31, 2001 and 2000, respectively. Our allowance for doubtful accounts
for non-current accounts receivable totaled $15.4 million at December 31, 2001
and 2000.
Valuation of Assets and Asset Impairment
We state property and equipment at cost less accumulated depreciation and
amortization. We depreciate and amortize these assets using a straight-line
method based upon the estimated lives of the assets. Goodwill represents the
cost of the acquired net assets in excess of their fair market values. Effective
January 1, 2002 we adopted SFAS No. 142 and no longer amortize goodwill and
intangible assets with indefinite useful lives. Instead we test for impairment
at least annually; whereas prior to 2002, these assets were amortized using a
straight-line method over a period of no more than forty years. Other intangible
assets, consisting of the cost of leasehold rights, are deferred and amortized
over the term of the lease including renewal options. We periodically assess the
recoverability of long-lived assets, including property and equipment, goodwill
and other intangibles, when there are indications of potential impairment based
upon the estimates of undiscounted future cash flows. The amount of any
impairment is calculated by comparing the estimated fair market value with the
carrying value of the related asset. We consider such factors as current
results, trends and future prospects, current market value and other economic
and regulatory factors in performing these analyses.
A substantial change in the estimated future cash flows for these assets
could materially change the estimated fair values of these assets, possibly
resulting in an additional impairment. In response to the implementation of the
Medicare prospective payment system, increased litigation, insurance costs in
certain states and increased operational costs resulting from changes in
legislation and regulatory scrutiny, over the past several years we have focused
on divesting under-performing nursing and assisted living facilities and
non-core health care assets. As detailed in Footnote 4 to our consolidated
financial
33
statements, losses from asset impairments and disposals and provisions for
closure and exit costs and other items have totaled $25.9 million, $27.4 million
and $80.9 million in 2001, 2000 and 1999, respectively.
Self-Insured Liabilities
Insurance coverage for patient care liability and other risks has become
increasingly difficult to obtain. We insure certain risks with affiliated
insurance subsidiaries of Extendicare Inc. and third-party insurers. The
insurance policies cover comprehensive general and professional liability,
property coverage, workers' compensation and employer's liability insurance in
amounts and with such coverage and deductibles as we deem appropriate, based on
the nature and risks of our business, historical experiences and industry
standards. We self-insure for health and dental claims, in certain states for
workers' compensation and employer's liability, and since January 2000, for
general and professional liability claims.
We accrue our self-insured liabilities based upon past trends and
information received from an independent actuary. We regularly evaluate the
appropriateness of the carrying value of the self-insured liabilities through an
independent actuarial review. Our estimate of the accrual for general and
professional liability costs is significantly influenced by assumptions, which
are limited by the uncertainty of predictions concerning future events, and
assessments regarding expectations of several factors. Such factors include, but
are not limited to: the frequency and severity of claims, which can differ
materially by jurisdiction in which we operate; coverage limits of third-party
reinsurance; the effectiveness of the claims management process; and uncertainty
regarding the outcome of litigation.
Changes in our level of retained risk, and other significant assumptions
that underlie our estimate of self-insured liabilities, could have a material
effect on the future carrying value of the self-insured liabilities. For
example, in 2000, we experienced adverse claims development. In 2000 our per
claim retained risk increased significantly for general and professional
liability coverage mainly due to the level of risks associated with our Florida
and Texas operations. We no longer operate nursing or assisted living facilities
in Florida or nursing operations in Texas. However, as a result of the increase
in the frequency and severity of claims, in 2001 we recorded an additional $11.0
million provision for resident care liability. Our accrual for self-insured
liabilities totaled $70.3 million and $50.0 million at December 31, 2001 and
2000, respectively.
Deferred Tax Assets
Our results of operations are included in the consolidated federal tax
return of our U.S. parent company. Accordingly, federal current and deferred
income taxes payable are transferred to our parent company. Deferred tax assets
and liabilities are recognized to reflect the expected future tax consequences
attributed to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carry forwards. We measure deferred tax assets and
liabilities using enacted tax rates expected to apply to taxable income in the
years in which we expect those temporary differences to be recovered or settled.
We establish a valuation allowance based upon our estimate of whether it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of deferred tax assets depends upon us
generating future taxable income during the periods in which those temporary
differences become deductible. We consider the scheduled reversal of deferred
tax liabilities, projected future taxable income and tax planning strategies in
making this assessment. We have established a valuation allowance for our net
state deferred tax assets totaling $6.9 million and $4.1 million at December 31,
2001 and 2000.
SIGNIFICANT EVENTS
A number of significant factors adversely affected our industry and us over
the past few years, including the following:
- Inadequate funding levels in some states or resident classifications in
both the Medicaid and Medicare programs. For example, in 2001 we received
on average $333 per day for a Medicare resident, while care for similar
residents funded under the Medicaid program averaged $117 per
34
day. According to the Health Care Industry Market Update dated February
6, 2002, which is published by the Centers for Medicare and Medicaid
Services, Medicaid programs inadequately fund our industry.
- Increased litigation settlements and insurance costs for general and
professional liability claims. A report issued by AON Risk Consultants
for the American Health Care Association in February 2002 indicates that
the average insurance cost for general liability and professional
liability increased at an average of 24% per year from 1990, when the
average cost was $240 per bed, to $2,360 per bed in 2001. The report
further states that the increased cost for general and professional
liability coverage has absorbed approximately 20% of the average Medicaid
reimbursement rate increase from 1995 to 2000.
- Increased costs incurred as a result of increased regulatory
requirements. For example, we have estimated that the cost of compliance
with the Health Insurance Portability and Accountability Act regulations
that come into effect in 2002 and 2003, including upgrading computer
software, modifying operating practices, purchasing equipment and
training employees, will exceed $500,000.
- Increased wages and premiums paid to nursing assistants, domestic staff
and temporary agencies for professional nursing staff. These increases
are mainly due to generally low unemployment levels and a national
shortage of qualified nurses. Our wages increased 6.9% in 2001 over 2000
and we incurred temporary agency costs of $18.4 million in 2001, which
includes an agency margin of approximately 25% to 30%, compared to $16.9
million in 2000. Medicaid rates increased only 4.5% in this same period.
According to an article published in the March/April 2002 Volume of the
North Carolina Medical Journal, between 2000 and 2010 there will be
874,000 more care workers needed in the long term care industry.
According to the U.S. Labor Department, there will be a 1.0 million
shortfall of professional nurses by 2010.
Asset Divestitures
On May 31, 2002, Tandem Health Care, Inc. exercised its option to purchase
seven properties that it leased from us in Florida for gross proceeds of $28.6
million, consisting of cash of $15.6 million and $13.0 million in 8.5% five year
notes. The carrying value of the seven facilities was $25.3 million. We applied
$12.4 million of the proceeds to reduce our bank debt and, as a result, we
recorded a gain on the sale of assets of $4.0 million, inclusive of the deferred
gain of $2.2 million from the April 2001 transaction described below.
In 2001, we transferred all of our Texas nursing home operations to
affiliates of Senior Health Properties-Texas, Inc. The transaction involved 17
nursing homes, with a capacity of 1,421 residents. We now lease four of these
facilities to Senior Health-Texas under a five-year lease, which will expire in
September 2006, and sublease 12 of these facilities to Senior Health-Texas under
an eleven-year sublease, which will expire in February 2012. The final property
was sublet for one month to a Senior Health-Texas affiliate until October 31,
2001, the remainder of the lease term. The Senior Health-Texas affiliate
transferred the operations of this final property to an unrelated third party
and terminated its leasehold interest on November 1, 2001. We receive annual
rental income from the properties of approximately $3.8 million, which is $1.8
million more than our current annual lease costs. Our annual rental income will
escalate in alignment with the increases in rent expense under the existing
leases and in alignment with improvements in operating income for the owned
facilities. Senior Health-Texas has a right of first refusal with respect to any
offer to purchase one or more of the four owned facilities.
In April 2001, Tandem exercised its option to purchase two leased
properties in Florida. Upon Tandem's exercise of its option, we received gross
proceeds of $11.4 million, consisting of cash of $7.0 million, a $2.5 million
8.5% interest-bearing five-year note and $1.9 million in 9% cumulative dividend
preferred shares, mandatorily redeemable after five years. The carrying value of
the two facilities on our books was $9.2 million. We deferred a potential gain
on the sale of these assets of $2.2 million because a significant portion of the
proceeds had not been received (FASB 66) and the ultimate determination of the
gain was dependent on Tandem exercising some or all of the remaining purchase
options available to
35
it. We applied $4.0 million of the net proceeds to reduce our term bank debt.
In 2000, we disposed of or leased all 32 of our facilities with 3,427 beds
in Florida through a series of transactions. We sold two Florida nursing
facilities in separate transactions in July and December 2000. In September
2000, we entered into an agreement involving 15 facilities with Greystone
Tribeca Acquisition LLC in which we retain an interest in the properties in the
form of a series of interest bearing notes, which have an aggregate value of up
to $30.0 million. The notes have a maximum term of three and one half years and
may be retired at any time out of the proceeds from the sale or refinancing of
the facilities by Greystone. During the term of the notes, the Company retains
an interest in these facilities by way of a right of first refusal and an option
to repurchase the facilities in March 2004, which if not accepted, will trigger
repayment of the balance of the notes. The option to repurchase, along with the
significant portion of the sales price being contingent, results in the
disposition being accounted for as a deferred sale. This particular transaction,
while not accounted for as a sale, resulted in initial net cash proceeds of
$30.0 million in addition to the contingent notes. In December 2000, we
transferred the operations and leased the properties of nine Florida facilities
to Tandem and of six Florida facilities to Senior Health Properties-South, Inc.
Under the leases, the Tandem and Senior Health Properties-South have options to
purchase their respective properties. We also sold two formerly closed
facilities, which together with the Florida divestitures, resulted in total cash
proceeds of $37.7 million, of which $33.1 million was used to reduce our bank
debt. The dispositions, in addition to provisions for the closure of two nursing
and one assisted living facilities and provisions for other non-core assets,
resulted in a total loss from the disposition of assets of $6.7 million in 2000,
including a loss on disposal of assets of $3.3 million and a provision for
closure and exit costs of $3.4 million.
We have recorded provisions for all estimated future costs related to
operations that we disposed of. Those estimates were made at the time of
disposition and can be subject to revisions which may impact our future
earnings.
As a result of the divestiture programs in Florida and Texas, we received,
in addition to cash proceeds, notes and preferred shares, retained ownership of
certain nursing home properties and entered into on-going consulting service
agreements with operators in these two states. As of December 31, 2001, we:
- held an aggregate of $8.4 million in notes and preferred shares from
Tandem;
- owned 13 leased nursing home properties in Florida and four leased
nursing home properties in Texas with a net book value of $41.6 million;
and
- subleased 12 properties in Texas to another long-term care operator.
The six remaining Florida leases expire in December 2005. The Texas leases
expire in September 2006 and the Texas subleases expire in February 2012. In
addition, we provide on-going management and consulting services to and earn
rental income from the operators of these facilities. As of December 31, 2001,
we had $9.2 million in accounts receivable from long-term care operators for
whom we provided management and consulting services, which included interim
working capital advances related to the transfer of ownership. As a result, our
earnings and cash flow can be influenced by the financial stability of these
unrelated companies.
Purchase of Ohio and Indiana Facilities
On October 18, 2002 we purchased three skilled nursing facilities in Ohio
and four skilled nursing facilities in Indiana that we previously leased for an
aggregate purchase price of $17.9 million. The purchase price consisted of $7.4
million in cash and a $10.5 million ten-year note, which bears interest at a
rate to be determined by arbitration (currently being accrued at 10.5%).
Other Items
On an ongoing basis we review the levels of our overall reserves for losses
related to our Florida and Texas operations, which reserves were initially
established when we decided to exit these states. See footnote 4 to our
consolidated financial statements. During 2002, as a result of events which
became
36
known to us in 2002, we concluded that we should increase our overall reserve by
$5.3 million for cost report and other settlements with the states of Florida
and Texas and other Medicare fiscal intermediaries, collection of receivables,
and settlement of claims with suppliers and employees.
In April 2000, the Provider Reimbursement Review Board heard our appeal
involving workers' compensation costs reimbursements. In December 2000, the
administrator for the Centers for Medicare and Medicaid Services confirmed the
review board's September 2000 decision resulting in a favorable settlement of
$12.4 million, including the recovery of a $10.3 million accrual recorded in
1999. In addition, we reached a settlement on another staffing cost issue
resulting in a recovery of $2.4 million, including a recovery of a $1.7 million
accrual recorded in 1999. In total, a recovery of $12.0 million was recorded in
2000 relating to accruals recorded in 1999.
At September 30, 2002, we were attempting to settle a number of outstanding
Medicare and Medicaid receivables. Normally such issues are resolved during an
annual audit process and no provisions are required. However, where differences
exist between us and the fiscal intermediary, we may record a general provision.
For two specific Medicare issues, totaling an estimated $22.1 million, we and
the fiscal intermediary are working to resolve the issues, but failure to
resolve such issues will result in the issues being settled by proceeding to the
Provider Reimbursement Review Board in the first quarter of 2003. The two issues
involve the allocation of overhead costs and a staffing cost issue. Though we
remain confident that we will successfully settle the issues, an unsuccessful
conclusion could impair our earnings and anticipated cash flow. As of September
30, 2002, we had $62.2 million of gross Medicare and Medicaid settlement
receivables with a related allowance for doubtful accounts of $15.4 million. The
net amount receivable represents our estimate of the amount collectible on
Medicare and Medicaid prior period cost reports.
We entered into a preferred provider agreement with Omnicare Inc. pursuant
to the disposition of our pharmacy operations in 1998. The terms of the
preferred provider agreement enabled Omnicare to execute pharmacy service
agreements and consulting service agreements with all of our skilled nursing
facilities. In 2001, we and Omnicare brought a matter to arbitration involving
the "per diem" pricing rates billed for managed care residents. This matter was
subsequently settled and the amount of the settlement is reflected within our
financial results. We and Omnicare are currently negotiating the pricing of
drugs for Medicare residents and should this matter not be settled, the matter
will be taken to arbitration. In addition, in connection with its agreements to
provide pharmacy services, Omnicare, has requested arbitration for a lost
profits claim related our disposition of assets, primarily in Florida. Damage
amounts, if any, cannot be reasonably estimated based on information available
at this time. An arbitration hearing for this matter has not yet been scheduled.
We believe we have interpreted and complied with the terms of the preferred
provider agreement; however, we cannot assure you that other claims will not be
made with respect to the agreement.
37
RESULTS FROM OPERATIONS:
The following table sets forth details of our revenues and earnings as a
percentage of total revenues:
<Table>
<Caption>
NINE MONTHS
ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31
---------------- ---------------------------
2002 2001 2001 2000 1999
----- ----- ----- ----- -----
Revenues
Nursing and assisted living facilities............ 96.6% 96.7% 96.6% 98.0% 94.7%
Outpatient therapy and medical supplies........... 1.3 1.2 1.2 1.1 4.5
Other............................................. 2.1 2.1 2.2 0.9 0.8
----- ----- ----- ----- -----
100.0 100.0 100.0 100.0 100.0
Operating and general and administrative costs...... 88.1 91.6 90.3 94.5 92.0
Lease, depreciation and amortization................ 6.0 6.9 7.0 6.6 7.1
Interest, net....................................... 3.9 4.6 4.5 4.9 5.3
Loss (gain) on disposal of assets................... (0.7) 0.1 0.1 0.3 3.8
Provision for closure and exit costs and other
items............................................. 0.9 3.9 3.0 0.4 0.6
Loss on impairment of long-lived assets............. -- 0.3 0.2 2.2 3.9
----- ----- ----- ----- -----
Earnings (loss) before taxes...................... 1.8 (7.4) (5.1) (8.9) (12.7)
Income tax expense (benefit)........................ 0.8 (2.5) (1.6) (3.0) (5.5)
----- ----- ----- ----- -----
Earnings (loss) before minority interests and
extraordinary item............................. 1.0 (4.9) (3.5) (5.9) (7.2)
Extraordinary item.................................. 0.3 -- -- (0.1) --
----- ----- ----- ----- -----
Net (loss) earnings............................ 0.7% (4.9)% (3.5)% (6.0)% (7.2)%
===== ===== ===== ===== =====
</Table>
Average occupancy in our long-term care facilities was as follows:
<Table>
<Caption>
NINE MONTHS
ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31
---------------- ---------------------------
2002 2001 2001 2000 1999
----- ----- ----- ----- -----
Skilled nursing facilities.......................... 90.0% 87.4% 87.5% 87.5% 85.9%
Assisted living facilities.......................... 83.1% 83.2% 83.1% 84.6% 80.3%
</Table>
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 2001
Revenues
Revenues in the nine months ended September 30, 2002 were $606.8 million,
representing an increase of $8.6 million, or 1.4%, from $598.2 million in the
nine months ended September 30, 2001. The increase in revenues includes a $43.5
million increase in revenues from nursing and assisted living facilities and
other businesses operated during both the nine months ended September 30, 2002
and 2001 ("same facility operations") and an increase of $0.7 million from other
revenue, partially offset by a decrease of $35.6 million in revenues from
divested nursing facilities.
Revenues from same-facility operations increased $43.5 million due to:
- an increase of $43.4 million, or 8.0%, as a result of an overall higher
percentage of Medicare residents and increased Medicaid rates;
- a 1.5% increase in resident census from an average daily census of 13,925
in 2001 to 14,141 in 2002; and
- an increase of $0.1 million when comparing periods due to more favorable
Medicaid cost settlements in 2002.
38
Our key Medicare and Medicaid results and statistics for our nursing
operations on a same-facility basis in the first nine months of 2002 and 2001
are summarized as follows:
<Table>
<Caption>
MEDICARE MEDICAID
-------------------------------- ----------------------------------
NINE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30,
SEPTEMBER 30, ----------------------------------
-------------------------------- INCREASE
2002 2001 INCREASE 2002 2001 (DECREASE)
------ ------ -------- ------ ------ ----------
Average daily rate................. $ 337 $ 329 2.4% $ 126 $ 120 5.0%
Residents as a percent of total.... 13.1% 11.5% 13.9% 68.6% 69.7% (1.6%)
Average daily census............... 1,663 1,431 16.2% 8,703 8,681 0.3%
</Table>
Operating and General and Administrative Costs
Operating and general and administrative costs decreased $13.6 million, or
2.5%, between periods, of which $11.9 million was a decrease in expenses for
insurance and liability claims, primarily related to our divestiture of our
Texas nursing facilities, and $34.1 million related to reduced operating costs
attributable to nursing facilities divested during 2001. Operating and general
and administrative costs on a same-facility basis increased $32.4 million, or a
6.6% increase on a same-facility basis, and included:
- an increase in wage and benefit costs of $17.8 million, or a 5.1%
increase;
- an increase in contracted food and laundry services totaling $6.9 million
relating to services that were formerly provided by employees;
- a $3.9 million increase in drug expense due to higher resident census and
higher drug prices;
- an increase in outside therapy services of $2.5 million relating to
increased therapy revenues; and
- a $1.3 million increase in bad debt expense.
Lease Costs, Depreciation and Amortization
Depreciation and amortization decreased $2.0 million to $28.2 million for
the first nine months of 2002 compared to $30.2 million for the first nine
months of 2001. This decrease was primarily a result of a $1.8 million decrease
relating to the adoption of SFAS No. 142, "Goodwill and Other Intangible
Assets," which requires that goodwill no longer be amortized to earnings. The
remaining $0.2 million decrease was primarily a result of divestitures.
Lease costs decreased $2.9 million when comparing periods, including $1.9
million as a result of divestitures and $1.0 million as a result of facilities
that we continue to operate.
Interest
Interest expense, net of interest income, decreased $3.5 million to $23.9
million for the first nine months of 2002 compared to $27.4 million for the
first nine months of 2001. The decrease was primarily due to a reduction in the
average debt level to $383.5 million during the first nine months of 2002
compared to $413.0 million during the first nine months of 2001 resulting from
our use of divestiture proceeds and an income tax refund during 2001 to reduce
bank debt balances. The weighted average interest rate of all long-term debt
decreased to 7.70% during the first nine months of 2002 compared to
approximately 8.49% during the first nine months of 2001. This decrease was
primarily due to lower market interest rates during 2002 prior to the issuance
of the fixed-rate senior notes on June 28, 2002, the proceeds of which were used
to refinance floating-rate debt.
Loss on Impairment of Long-Lived Assets
When our management commits us to a plan for disposal of assets, we adjust
assets held for disposal to the lower of the assets' carrying value or the fair
value less selling costs. In September 2001, we
39
formally decided to lease all owned, and sublease all leased, nursing facilities
in Texas. As a result of the transaction, and based on the terms of the lease
with Senior Health-Texas, we recorded in 2001 a provision of $1.7 million for
impairment of Texas nursing properties in accordance with Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of."
Loss (Gain) on Disposal of Assets and Provision for Closure and Exit Costs and
Other Items
For 2002, we recorded a gain on disposal of assets of $4.0 million relating
to the sale of seven properties in Florida to Tandem and a provision for closure
and exit costs of $5.3 million. The gain of $4.0 million includes a deferred
gain of $2.2 million from the April 2001 sale of two other properties to Tandem.
The provision for closure and exit costs relates to an increase in the overall
disposition reserve for cost report and other settlements with the states of
Florida and Texas and other Medicare fiscal intermediaries, collection of
receivables, and settlement of claims with suppliers and employees.
For 2001, we recorded a loss on disposal of assets of $1.0 million and a
provision for closure and exit costs and other items of $23.2 million. On
September 30, 2001, we transferred all Texas nursing homes to Senior
Health-Texas. As a result of the Texas transaction, as well as the closure and
sale of one nursing home and two other properties in Wisconsin, we provided $3.7
million for related disposal and closure costs. We also made additional
provisions of $20.5 million relating to previously ceased operations, including
$19.0 million related to the nursing facilities in Florida. This $19.0 million
consists of an $11.0 million provision related to Florida claims for years prior
to 2001 based upon an actuarial review of resident liability costs, and an $8.0
million provision for Florida closure and exit costs.
Income Taxes
Income tax expense in the first nine months of 2002 was $4.6 million
compared to an income tax benefit of $15.1 million in the first nine months of
2001. Our effective tax rate was 43.7% in the first nine months of 2002 as
compared to 33.9% in the first nine months of 2001. The increase in the
effective tax rate results from the impact of certain permanent adjustments
which increased the effective rate when applied to pre-tax earnings compared to
decreasing the effective rate when applied to pre-tax loss for 2001 and the
reversal of current and prior year state deferred income tax benefits. When we
assess the realizability of deferred tax assets, we consider whether it is more
likely than not that some portion or all of the deferred tax assets will not be
realized and record a valuation allowance if required. The ultimate realization
of deferred tax assets depends upon us generating future taxable income during
the periods in which those temporary differences become deductible. We consider
the scheduled reversal of deferred tax liabilities, projected future taxable
income and tax planning strategies when we make this assessment.
Extraordinary Item
The extraordinary loss in 2002 of $1.7 million, net of income tax, was due
to the early extinguishment in June 2002 of our debt using proceeds from the
issuance of the old notes. The extraordinary loss in 2001 of $45,000, net of
income tax effect, was related to the write-off of deferred financing costs in
connection with debt reduction upon the sale of nursing facilities.
Net Earnings (Loss)
Net earnings in the first nine months of 2002 were $4.2 million compared to
a net loss of $29.6 million in the first nine months of 2001. Net earnings prior
to loss (gain) on disposal of assets, provision for closure and exit costs and
other items, loss on impairment of long-lived assets and extraordinary items,
after applicable income tax effect, was $6.7 million for the first nine months
of 2002 compared to a net loss of $13.1 million for the first nine months of
2001. The fluctuation was caused by the reasons noted above.
40
Related Party Transactions
We insure certain risks, including comprehensive general liability,
property coverage and excess workers' compensation/employer's liability
insurance, with Laurier Indemnity Company and Laurier Indemnity Ltd., affiliated
insurance subsidiaries of Extendicare Inc. We recorded approximately $7.4
million of expenses for this purpose for the nine months ended September 30,
2002 and $4.7 million for the nine months ended September 30, 2001.
We purchase computer hardware and software support services from Virtual
Care Provider, Inc., an affiliated subsidiary of Extendicare Inc. Expenses
related to these services were $5.9 million for the nine months ended September
30, 2002 and $5.0 million for the nine months ended September 30, 2001.
YEAR ENDED DECEMBER 31, 2001 COMPARED WITH YEAR ENDED DECEMBER 31, 2000
Revenues
Revenues for the year ended December 31, 2001 were $794.1 million,
representing a decrease of $129.0 million, or 14.0%, from $923.1 million for the
year ended December 31, 2000. The decrease in revenues is attributable to:
- a decrease of $154.6 million, relating to the divestiture of nursing and
assisted living facilities primarily in Florida and Texas;
- the one-time recovery of $8.9 million in revenue in 2000 on a
same-facility basis pertaining to the settlement of the workers
compensation issue through the Provider Reimbursement Review Board and
the staffing cost issue with the fiscal intermediary; and
- a decrease of $0.4 million from outpatient therapy divestitures in 2000,
offset in part by an increase of $3.6 million from new management services
contracts and an increase of $31.3 million in revenue from nursing and assisted
living facilities and other businesses operated during both 2001 and 2000.
Revenues from same-facility operations increased $31.3 million in 2001 due
to:
- a $33.5 million increase, or a 4.8% increase on a same-facility basis,
from increased rates, partially offset by a 0.9% decline in overall
resident census from an average daily census of 14,055 in 2000 to an
average daily census of 13,928 in 2001;
- a $1.5 million decrease due to more favorable Medicaid cost settlements
in 2000;
- a $1.4 million decrease as a result of the accrual in 2000 for blood
glucose revenue for the period of October 1, 1997 through December 31,
2000 due to favorable rulings regarding reimbursement litigation with our
fiscal intermediary; and
- a $0.7 million increase from other business operations.
Our key Medicare and Medicaid results and statistics for our nursing
operations on a same-facility basis in 2001 and 2000 are summarized as follows:
<Table>
<Caption>
MEDICAID
MEDICARE ----------------------------------
-------------------------------- INCREASE
2001 2000 INCREASE 2001 2000 (DECREASE)
------ ------ -------- ------ ------ ----------
Average daily rate............... $ 334 $ 316 5.7% $ 121 $ 115 4.5%
Residents as a percent of
total.......................... 11.4% 10.7% 69.6% 70.2%
Average daily census............. 1,427 1,341 6.4% 8,676 8,812 (1.5%)
</Table>
Overall, our average daily Medicare rate increased 3.7% to $333 during 2001
compared to $321 during 2000, and our average daily Medicaid rate increased 4.5%
to $117 in 2001 compared to $112 in 2000.
41
Operating and General and Administrative Costs
Operating and general and administrative costs in 2001 decreased $154.5
million, or 17.7%, as compared to 2000. The decrease was caused by a $49.5
million decrease in expenses for insurance and liability claims, primarily
relating to our disposal of our Florida operations, and a $134.7 million
reduction in operating costs, other than insurance and liability claims,
attributable to operations closed or nursing facilities divested during 2001 and
2000. The increase in operating and general and administrative costs on a
same-facility basis, excluding expenses for insurance and liability claims, was
$29.7 million, a 4.7% increase on a same-facility basis. The increase is
attributable to:
- an increase in wage and benefit costs of $29.8 million, a 6.9% increase
on a same-facility basis;
- an increase in drug expense of $2.4 million primarily due to settlement
of 1999 contracted drug charges in 2001;
- an increase in utility costs of $1.1 million due to higher rates in 2001;
- a decrease in workers' compensation costs of $3.1 million due to
favorable actuarial adjustments for prior years in 2001;
- a decrease in bad debt expense of $2.4 million; and
- a net increase in other operating and administrative expenses of $2.0
million, or a 0.3% increase on a same-facility basis.
We had $70.3 million in accruals for known or potential general and
professional liability claims at December 31, 2001 based upon claims experience
and actuarial estimates. Based upon such claims experience and independent
actuarial review, we believe that our accrual is adequate to cover any losses
from general and professional liability claims. Though we regularly evaluate
these accruals and we believe they are adequate and fairly stated, the accruals
are subject to adjustment, which could have a material impact on our earnings.
The timing of the settlement of the claims could influence cash flow and our
ability to meet financial covenants under our existing credit facility or the
new credit facility.
In 1998, we sold our pharmacy operations to Omnicare, Inc. In connection
with that sale, we entered into a preferred provider agreement with Omnicare.
Under the terms of this preferred provider agreement, Omnicare pharmacies are
required to execute pharmacy service agreements and pharmacy consulting
agreements to provide pharmacy supplies and services to all of our skilled
nursing facilities. Pricing under the agreement is to be competitive within the
local marketplace. Omnicare may not charge us rates that are higher than the
most favorable rates that Omnicare charges for similarly situated beneficiaries
in the same marketplace. We secured per diem pricing arrangements for pharmacy
supplies provided to residents with managed care and Medicare payor sources for
the first four years of the agreement, which period expires in December 2002.
The preferred provider agreement contains a number of provisions that involve
sophisticated calculations to determine the per diem pricing during this first
four-year period. Under a per diem pricing agreement pharmacy costs fluctuate
based upon occupancy levels in the facilities. The per diem rates were
established assuming a declining per diem value over the initial four years of
the contract to coincide with the phase-in of the Medicare prospective payment
system rates.
Subsequent to December 31, 2001, Omnicare made claims regarding per diem
pricing rates billed for Medicare residents for 2001 and 2002. Provisions for
settlement of the claims are included within the financial statements. We
believe we have properly interpreted and complied with the terms of the
preferred provider agreement; however, we cannot assure you that other claims
will not be made with respect to the agreement.
We record a provision for bad debts in relation to revenues recorded based
upon our past experience and we believe our reserves are adequate. We
continually review and refine our reserve estimation process and the adequacy of
our reserve, but we cannot guarantee that our estimates accurately reflect the
future credit losses that we may incur and therefore our estimates can be
subject to future adjustments.
42
Lease Costs, Depreciation and Amortization
Lease costs decreased $1.2 million from 2000 to 2001. We lease seven
nursing homes in Indiana and Ohio and, in accordance with the lease agreement,
exercised our right to purchase the properties in September 2000. On October 18,
2002 we closed the purchase of the facilities for an aggregate purchase price of
$17.9 million. The purchase price consisted of $7.4 million in cash and a $10.5
million ten-year note, which bears interest at a rate to be determined by
arbitration (currently being accrued at 10.5%). The net book value of the leased
facilities is $4.2 million, and the 2001 earnings from their operations were
approximately $2.2 million.
Depreciation and amortization decreased $4.7 million to $40.8 million in
2001 compared to $45.5 million in 2000. This decrease included a $1.4 million
decrease as a result of divestitures and a $3.3 million decrease from
same-facility operations as a result of assets becoming fully depreciated and
reduced depreciation relating to losses recorded in 2001 and 2000 for impairment
of depreciable assets.
Interest
Interest expense, net of interest income, decreased $9.6 million to $35.6
million in 2001 compared to $45.2 million in 2000. The decrease was primarily
due to a reduction in our average debt level to $406.5 million during 2001
compared to $478.3 million during 2000, resulting from our use of divestiture
proceeds and income tax refunds during both years to reduce our bank debt. The
weighted average interest rate of all long-term debt decreased to approximately
9.31% during 2001 compared to approximately 9.73% during 2000 due to an overall
decline in interest rates.
Loss on Impairment of Long-Lived Assets
When we commit to a plan for disposal of assets, assets held for disposal
are adjusted to the lower of the assets' carrying value or the fair value less
selling costs. In September 2001, we decided to lease all owned, and sublease
all leased, nursing facilities in Texas. As a result of the transaction and
based on the terms of the lease with Senior Health-Texas, in 2001 we recorded a
provision of $1.7 million for impairment of Texas nursing properties in
accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of."
In December 2000, we decided to sell or lease all of our remaining
operations in Florida and completed two transactions to accomplish that
decision. Both transactions resulted in providing the two operators with an
option to purchase the properties within the lease term. In December 2000, we
recorded a provision of $15.9 million for impairment of Florida properties and
reported a provision for closure and exit costs of $1.1 million related to the
termination of our Florida operational staff. In addition, in December 2000, we
determined that a $4.8 million adjustment was required for non-Florida
properties resulting in a total impairment provision for 2000 of $20.7 million.
Loss on Disposal of Assets and Provision for Closure and Exit Costs and Other
Items
For 2001, we recorded a loss on disposal of assets of $1.0 million and a
provision for closure and exit costs and other items of $23.2 million. On
September 30, 2001, we transferred all Texas nursing homes to Senior
Health-Texas. As a result of the Texas transaction, as well as the closure and
sale of one nursing home and two other properties in Wisconsin, we provided $3.7
million for related disposal and closure costs. We also made additional
provisions of $20.5 million relating to previously ceased operations, including
$19.0 million related to the nursing facilities in Florida. This $19.0 million
consists of an $11.0 million provision related to Florida claims for years prior
to 2001 based upon an actuarial review of resident liability costs, and an $8.0
million provision for Florida closure and exit costs.
In 2000, we disposed or leased all of our operations in Florida consisting
of 32 facilities with 3,427 beds through a series of transactions, two of which
involved lease agreements with operators who have an option to purchase the
properties and one in which we retain an interest in the properties through the
contingent consideration terms of the agreement. In addition, we sold two
formerly closed facilities. In the
43
aggregate these five transactions, along with other asset sales, resulted in
cash proceeds of $37.7 million, of which $33.1 million was applied to reduce our
debt. The sale of the Florida facilities resulted in a pre-tax provision for
closure and exit costs of $1.6 million. In addition, in states other than
Florida, we recorded provisions for closure and exit costs of $1.7 million for
the closure of two nursing and one assisted living facilities and $0.6 million
for the disposition of other non-core assets. For 2000, the total loss from the
disposal of assets was $3.3 million and the total provision for closure and exit
costs and other items was $3.4 million.
Income Taxes
We have recorded a financial statement benefit for federal and state tax
losses and other deferred tax assets based upon our future anticipated taxable
earnings. As of December 31, 2001, the valuation allowance was $6.9 million,
primarily relating to state net operating losses to reflect limited carry
forward periods and reductions in various states apportionment. The allowance
was increased by $2.8 million in 2001 and $3.2 million in 2000.
Extraordinary Item
The extraordinary loss in 2001 of $45,000, net of income tax effect, is
related to the write-off of deferred financing costs in connection with debt
reduction with the proceeds of sales of nursing facilities. The extraordinary
loss in 2000 of $0.4 million, net of income tax effect, is related to the
write-off of deferred financing costs in connection with the repayment of debt
repayment upon the sale of nursing and assisted living facilities and upon
receipt of an income tax refund.
Net Loss
The net loss in 2001 was $27.5 million compared to a net loss of $55.1
million in 2000. The net loss prior to loss on disposal of assets, provision for
closure and exit costs and other items, loss on impairment of long-lived assets
and extraordinary item, after applicable income tax effect, was $11.0 million
for 2001 compared to a comparable net loss of $37.1 million for 2000 due to the
changes noted above.
YEAR ENDED DECEMBER 31, 2000 COMPARED WITH YEAR ENDED DECEMBER 31, 1999
Revenues
Revenues for the year ended December 31, 2000 were $923.1 million,
representing a decrease of $44.5 million, or 4.6%, from $967.6 million for the
year ended December 31, 1999. The $44.5 million decrease in revenues includes a
$33.4 million decrease in outpatient therapy and medical supplies revenues due
to the divestiture of the home health operations and contracted therapy
operations in 1999 and 2000 and a decrease of $85.1 million from nursing and
assisted living facility divestitures, net of the opening of newly constructed
facilities. These decreases were partially offset by a $74.0 million increase in
revenue from facilities operated during each of the years.
Revenues from same-facility operations increased $74.0 million due to:
- a $27.4 million reduction in revenue recorded in 1999 relating to a
general provision for disputed Medicare receivables based on cost reports
filed for 1995 to 1998;
- a $12.0 million increase in revenue in 2000 relating to two disputed
Medicare receivable issues, which were provided for in 1999 and settled
in favor of the Company;
- a favorable ruling for the billing of blood glucose claims for the period
of October 1, 1997 through December 31, 2000, which resulted in a $3.6
million revenue increase in 2000; and
- an additional $31 million of revenues, or a 4.6% increase on a
same-facility basis, due to improvements in census and increased Medicaid
rates, partially offset by the decline in Medicare rates.
44
Our average daily Medicaid rate increased to $112 in 2000 compared to $106
in 1999 and the percent of Medicaid-related revenue to total revenues increased
slightly to 51% in 2000 from 50% in 1999. In 1999, the average rate for Medicare
Part A services was approximately $323 per patient day as compared to the
average of $304 per patient day in 2000. The percentage of Medicare patients in
skilled nursing facilities increased to 10.9% in 2000 from 10.8% in 1999, and
during 2000 the total number of Medicare patient days was 649,000. The percent
of Medicare-related revenue to total revenues increased to 24% in 2000 from 22%
in 1999.
Operating and General and Administrative Costs
Operating and general and administrative costs in 2000 decreased $18.4
million or 2.1% compared to 1999, of which $47.7 million related to costs saved
from the closing of operations or divestitures of nursing homes in 1999 and
2000, net of newly constructed facilities. The increase in operating and general
and administrative costs on a same-facility basis was $29.3 million, a 4.7%
increase on a same-facility basis, and included:
- an increase in wage-related costs of $19.0 million;
- an increase in workers' compensation costs of $5.7 million due to higher
premiums in 2000 and more favorable actuarial adjustments in 1999 as
compared to 2000;
- an increase in insurance expense and liability claim provisions of $6.3
million due to increased premiums and adverse experience; and
- an increase in bad debt expense of $2.2 million, partially offset by a
$3.9 million decrease, or a 0.6% decrease on a same-facility basis, in
other operating and administrative expenses.
Lease costs, Depreciation and Amortization
Total lease costs and depreciation and amortization decreased $7.5 million
in 2000 compared to 1999. Lease costs decreased by $0.9 million as a result of
divestitures. Depreciation and amortization expense decreased $6.6 million also
due to divestitures.
Interest
Interest expense, net of interest income, decreased $6.1 million to $45.2
million in 2000 compared with $51.3 million in 1999. The decrease was primarily
due to a reduction in the average debt level to $478.3 million during 2000
compared to $575.5 million during 1999 resulting from our use of divestiture
proceeds and our income tax refund to reduce our bank debt. This decrease was
partially offset by an increase in the weighted average interest rate of all
long-term debt to approximately 9.73% during 2000 compared to approximately
9.12% during 1999.
Loss on Impairment of Long-Lived Assets
Loss on impairment of long-lived assets decreased to $20.8 million for 2000
from $38.2 million for 1999 for the reasons discussed below.
We record impairment losses recognized for long-lived assets used in
operations when indicators of impairment are present and the estimated
undiscounted cash flows do not appear to be sufficient to recover the assets'
carrying amounts. The impairment loss is measured by comparing the fair value of
the asset to its carrying amount. In addition, once management has committed the
organization to a plan for disposal, assets held for disposal are adjusted to
the lower of the assets' carrying value and its fair value less costs to sell.
Accordingly, we have estimated the future cash flows of each facility and
reduced the carrying value to its estimated fair value.
In December 2000, we decided to sell or lease all of our remaining
operations in Florida and completed two transactions to accomplish that
decision. Both transactions resulted in providing the two operators with an
option to purchase the properties within the lease term. In December 2000, we
recorded
45
a provision of $15.9 million for impairment of Florida properties plus a
provision of $1.1 million for costs related to the termination of our Florida
operational staff. In addition, in December 2000, we determined that a $4.8
million adjustment was required for non-Florida properties resulting in a total
impairment provision for 2000 of $20.7 million.
In the fourth quarter of 1999, we completed an evaluation of the financial
impact of changes in the insurance marketplace, increased costs resulting from
changes in legislation and regulatory scrutiny and decreased Medicare rates. As
a result of that evaluation we recorded an aggregate provision for impairment of
goodwill, property and equipment of $38.2 million, of which all but $3.9 million
related to facilities or assets located in Florida.
Loss on Disposal of Assets and Provision for Closure and Exit Costs and Other
Items
In 2000, we disposed or leased all of our operations in Florida consisting
of 32 facilities with 3,427 beds through a series of transactions, two of which
involved lease agreements with operators who have an option to purchase the
properties and one in which we retain an interest in the properties through the
contingent consideration terms of the agreement. In addition, we sold two
formerly closed facilities. In the aggregate these five transactions, along with
other asset sales, resulted in cash proceeds of $37.7 million, of which $33.1
million was applied to reduce our debt. The sale of the Florida facilities
resulted in a pre-tax provision for closure and exit costs of $1.6 million. In
addition, in states other than Florida, we recorded provisions for closure and
exit costs of $1.7 million for the closure of two nursing and one assisted
living facilities and $0.6 million for the disposition of other non-core assets.
For 2001, the total loss from the disposal of assets was $3.3 million and the
total provision for closure and exit costs and other items was $3.4 million.
In 1999, we sold nine nursing facilities, six of which were in Florida, and
our home health operation for $62.3 million, resulting in a pre-tax loss of
$37.3 million. We also made a provision for closure and exit costs of $5.5
million. We applied the net after-tax proceeds from these dispositions to reduce
debt by approximately $44.8 million. The six Florida facilities sold in 1999
were sold through the sale of a subsidiary in the fourth quarter, which resulted
in a pre-tax loss on sale of assets of $35.9 million and a current tax benefit
of $29.0 million relating to the recovery of prior years taxes. We also sold our
home health operations in the fourth quarter of 1999, which resulted in a loss
on sale of assets of $1.6 million.
Start-up Costs
We had start-up losses in 2000 associated with newly constructed facilities
opened in 1999 of $1.0 million compared to $4.1 million in 1999. There were no
new facilities opened during 2000.
Income Taxes
Income tax expense for 2000 was a $27.7 million benefit as compared to a
$52.8 million benefit in 1999. Our effective tax rates were 33.7% in 2000 as
compared to 42.9% in 1999. The benefit was less in 2000 due to the recovery of
taxes resulting from the disposition of nursing facilities through the share
transaction in 1999 (see note 4 to the Consolidated Financial Statements).
Extraordinary Item
The extraordinary loss from early retirement of debt, net of income tax
effect, increased to $442,000 for 2000 from $342,000 for 1999. Both amounts
relate to the write-off of deferred financing costs in connection with repayment
of debt with the proceeds of sales of nursing and assisted living facilities.
Net Loss
The net loss for 2000 was $55.1 million compared to a net loss of $70.5
million for 1999. The net loss prior to loss on impairment of long-lived assets,
loss on disposal of assets, and provision for closure and
46
exit costs and other items and extraordinary item, after applicable income tax
effect, was $37.1 million for 2000 compared to a comparable net loss of $27.5
million for 1999.
LIQUIDITY AND CAPITAL RESOURCES
Overview of Changes in Liquidity -- Nine Months Ended September 30, 2002
Compared To Nine Months Ended September 30, 2001
We had cash and cash equivalents of $29.7 million at September 30, 2002 and
$1.0 million at December 31, 2001. We generated cash flow of $29.3 million from
operating activities for the nine months ended September 30, 2002 compared with
$66.9 million in the comparable period of 2001. The $37.6 million reduction in
cash flow from operations was the result of the 2001 tax refund of $22.5
million, a $15.4 million reduction in accounts receivable net of changes in
accounts payable, primarily relating to divested operations, and increased
payments of self-insured general liability claims of $13.5 million, partly
offset by improved cash flow from operations of $13.8 million.
Our working capital, excluding cash and borrowings included in current
liabilities, decreased $11.8 million from $15.8 million at December 31, 2001 to
$4.0 million at September 30, 2002. The decrease resulted primarily from a
decrease in accounts receivable of $4.8 million and an $18.4 million increase in
accounts payable and accrued liabilities. These decreases in working capital
were partially offset by a $8.7 million decrease in amounts due to shareholder
and affiliates and a $3.0 million increase in amounts due from shareholder and
affiliates.
Accounts receivable at September 30, 2002 were $99.4 million compared with
$104.2 million at December 31, 2001, representing a decrease of $4.8 million.
The reduction in accounts receivable included a $6.5 million decrease within the
nursing operations, an increase of $0.4 million within the outpatient therapy
operations and a $1.3 million increase in receivables from long-term care
operators for which we provide management and consulting services. The $1.3
million increase was primarily attributable to transitional working capital
advances to the nursing facilities transferred to Senior Health-Texas and Senior
Health-South. Within the nursing operations, billed patient care and other
receivables decreased $5.1 million while third-party payor settlement
receivables, based on Medicare and Medicaid cost reports, decreased $1.4
million. The decrease in billed patient care receivables of $5.1 million
included a decrease of $8.7 million due to our improved collection efforts. The
remaining increase of $3.6 million reflects an increase of $9.6 million due to
rate increases, partially offset by a decrease of $6.0 million due to the sale
or closure of nursing facilities and assisted living facilities.
The decrease in settlement receivables of $1.4 million from December 31,
2001 to September 30, 2002 included decreases of $1.0 million from collections
of Medicare settlements, $2.3 million for collections from Medicare of
uncollectible co-insurance amounts recorded as revenue in 2002 and 2001 and $1.4
million for collection of Medicaid cost report settlements. These decreases were
partially offset by an increase of $3.3 million in revenue recorded in 2002 for
anticipated Medicare reimbursement of uncollectible co-insurance amounts.
Property and equipment decreased $38.7 million from December 31, 2001 to a
total of $439.1 million at September 30, 2002. The decrease was the result of
depreciation expense of $27.3 million and asset disposals of $26.1 million
primarily relating to the sale of seven formerly leased Florida properties to
Tandem. These decreases were partially offset by capital expenditures of $12.7
million and an increase of $1.9 million included in depreciation expense
relating to the reclassification of the net book value of property and equipment
related to the disposal of nursing facilities to Greystone from "property and
equipment" to "other assets".
Total borrowings, including bank indebtedness and both current and
long-term maturities of debt, totaled $388.1 million at September 30, 2002. This
represents an increase of $2.1 million from December 31, 2001. The issuance of
the old notes in June 2002 resulted in the increase, which was reduced by the
use of $0.8 million of proceeds from the collection of notes receivables, $19.4
million of proceeds from the sale of property and the use of cash from operating
activities to reduce borrowings. The
47
weighted average interest rate of all of our long-term debt was 8.74% at
September 30, 2002 and such debt had maturities ranging from 2002 to 2014.
As of September 30, 2002, our parent, Extendicare Inc., held $27.9 million,
or 14.0%, of our outstanding senior subordinated notes.
Cash provided from investing activities was $2.7 million for the nine
months ended September 30, 2002 compared to $3.5 million used for investing
activities in the comparable period of 2001. The increase was primarily due to
our receipt of an additional $7.0 million in proceeds from the sale of property
and equipment in 2002, $1.0 million from the collection of notes receivable in
2002 and a $1.2 million increase from changes in other non-current assets. These
increases were partially offset by a decrease of $3.0 million as a result of
increased purchases of property and equipment.
Cash used for financing activities decreased by $57.6 million to $3.3
million for the nine months ended September 30, 2002 compared to $60.9 million
in the comparable period of 2001. The decrease is primarily due to:
- a $160.6 million increase in proceeds from issuance of long-term debt, of
which $149.6 million was from the issuance of the old notes;
- a $2.9 million increase in cash from other liabilities;
- a $2.4 million decrease from cash used for bank indebtedness;
- a decrease of $96.4 million from increased payments of long-term debt in
2002; and
- a $7.1 million decrease from cash used for the payment of deferred
financing costs associated with the issuance of the old notes.
Overview of Changes in Liquidity -- Year Ended December 31, 2001 Compared To
Year Ended December 31, 2000
We had cash and cash equivalents of $1.0 million at December 31, 2001 and
$1.6 million at December 31, 2000. Cash flow generated from operating activities
was $75.9 million for 2001 compared with $32.8 million in 2000.
We experienced a decrease in working capital, excluding cash and borrowings
included in current liabilities, of $40.3 million from $56.1 million at December
31, 2000 to $15.8 million at December 31, 2001. The decrease in working capital
resulted primarily from a decrease in taxes recoverable of $14.1 million, a
decrease in accounts receivable of $25.8 million and a $2.6 million decrease in
inventories, supplies and prepaid expense, the majority of which were converted
to cash to reduce borrowings. These decreasing components of working capital
were partially offset by a $1.7 million decrease in accounts payable and accrued
liabilities and a $0.6 million decrease in due to shareholders and affiliates.
Current and deferred taxes recoverable decreased from $33.5 million at
December 31, 2000 to $19.4 million at December 31, 2001, representing a decrease
of $14.1 million. The decrease was due to a tax refund of $22.5 million,
partially offset by a current year tax benefit of $0.6 million, a 2000 return
versus close adjustment of $7.5 million and payments of $0.3 million.
Accounts receivable at December 31, 2001 were $104.2 million compared with
$130.0 million at December 31, 2000, representing a decrease of $25.8 million.
The reduction in accounts receivable included a $32.3 million decrease within
the nursing operations, a decrease of $1.8 million within the outpatient therapy
operations and an $8.3 million increase in receivables from long-term care
operators for which management and consulting services are provided. The $8.3
million increase was primarily attributable to transitional working capital
advances to the nursing facilities transferred to Senior Health-Texas and Senior
Health-South. Within the nursing operations, billed patient care and other
receivables decreased $28.5 million and third-party payor settlement receivables
decreased $3.8 million. The decrease in billed patient care receivables of $28.5
million included a decrease of $17.3 million due to an improvement in our
collection efforts between periods. The remaining decrease of $11.2 million
reflects a
48
decrease of $17.1 million due to the sale or closure of nursing facilities and
assisted living facilities, partially offset by an increase of $5.9 million due
to rate increases.
The decrease in settlement receivables of $3.8 million from December 31,
2000 to December 31, 2001 is attributable to:
- the collection of a Pennsylvania Medicaid $4.8 million settlement
recorded as revenue in 2000;
- the collection of $2.2 million as a result of Medicaid settlements;
- collections from Medicare of $3.7 million of uncollectible co-insurance
amounts recorded as revenue in 2000; and
- $1.8 million received as a result of Medicare cost report settlements.
These collections were partially offset by:
- $4.0 million in additional revenue recorded in 2001 as a result of
Medicaid cost report settlements;
- $3.9 million in additional revenue recorded 2001 for anticipated Medicare
reimbursement for uncollectible coinsurance amounts; and
- an $0.8 million increase in settlement receivables as a result of the
reclassification of settlements from long-term accounts receivable to
current.
Property and equipment decreased $29.7 million from December 31, 2000 to a
total of $477.8 million at December 31, 2001. The decrease was the result of
depreciation expense of $36.6 million, asset disposals of $10.5 million and
asset write-downs of $1.7 million. These decreases were partially offset by
capital expenditures of $16.3 million and an increase of $2.8 million as a
result of the reclassification of the net book value of property and equipment
related to the disposal of nursing facilities to Greystone from other assets to
property and equipment.
Total borrowings, including bank indebtedness and both current and
long-term maturities of debt, totaled $385.9 million at December 31, 2001,
representing a decrease of $65.7 million from December 31, 2000. The decrease
was attributable to the use of $22.5 million from a tax refund, $4.0 million
from the sale of nursing facilities and the use of cash from operating
activities to reduce borrowings. The weighted average interest rate of all
long-term debt was 6.92% at December 31, 2001 and such debt had maturities
ranging from 2002 to 2014.
During 2001, our parent, Extendicare Inc., and/or one of its wholly owned
subsidiaries acquired $19.0 million of our senior subordinated notes. As of
December 31, 2001, Extendicare Inc. and/or one of its wholly owned subsidiaries
held $27.9 million, or 14.0%, of the outstanding senior subordinated notes.
Cash used in investing activities was $10.1 million for 2001 compared to
$50.5 million provided by investing activities in 2000. The decrease was
primarily due to:
- a $29.0 million income tax recovery on sales of operations in 2000;
- $30.0 million in proceeds received in 2000 from the divestiture agreement
relating to Florida facilities; and
- a $2.2 million increase in payments for the purchase of property and
equipment.
Cash used for financing activities decreased by $18.2 million to $66.5
million for 2001 compared to $84.7 million for 2000. The decrease is primarily
due to:
- a decrease of $14.5 million in payments of long-term debt;
- a $5.4 million increase in cash provided by bank indebtedness;
- a $1.3 million decrease in other liabilities; and
- a $3.0 million decrease in proceeds from issuance of long-term debt.
49
Liquidity and Capital Resources -- Historical
As of December 31, 2001, borrowings, including bank indebtedness and both
current and long-term maturities of debt, totaled $385.9 million, representing a
decrease of $65.7 million from December 31, 2000.
We have a $200 million revolving credit facility, of which we have waived
$25 million pursuant to an amendment to the borrowing agreement in the second
quarter of 1999. Borrowing availability under this line of credit totaled $74.3
million at December 31, 2001 as a result of our outstanding borrowings of $63.0
million, letters of credit in the amount of $37.7 million and the $25.0 million
waived under the amendment.
Our existing credit facility matures on December 31, 2003, at which time
all outstanding borrowings are due. The Tranche A term loan matures on December
31, 2003 with annual repayments of $6.6 million in 2002 and $6.1 million in
2003, payable in quarterly installments. The Tranche B term loan matures on
December 31, 2004 with annual repayments, payable in quarterly installments, of
$1.0 million in 2002 and $0.6 million in 2003, with the balance of $59.1 million
due in 2004.
Our existing credit facility contains a number of covenants, including
restrictions on our payment of dividends, redemption of our common stock and any
change of control of EHSI. The credit facility also contains financial
covenants, including a fixed charge coverage ratio, debt leverage ratios, and a
net worth ratio. We are required to make mandatory prepayments of principal upon
the occurrence of certain events, such as certain asset sales and certain
issuances of securities. We are permitted to make voluntary prepayments at any
time. Such prepayments may, under certain conditions, reduce the amounts
available to be borrowed under the credit facility.
We were in compliance with the financial covenants of our existing credit
facility as of December 31, 2001. The financial covenants under this credit
facility continue to become more stringent over the term of the facility. While
we have a strategy to remain in compliance, there can be no assurance that we
will meet future covenant requirements. Our available bank lines can be affected
by our ability to remain in compliance, or if not, would depend upon our ability
to amend the covenants or refinance the debt.
The senior subordinated notes are our unsecured senior subordinated
obligations, subordinated in right of payment to all of our existing and future
senior indebtedness, which includes all borrowings under the existing credit
facility as well as all indebtedness not refinanced by that credit facility. The
senior subordinated notes mature on December 15, 2007. We pay interest on the
senior subordinated notes semi-annually.
Principal payments on long-term debt due within the next five years and
thereafter are as follows (dollars in thousands):
<Table>
2002........................................................ $ 12,099
2003........................................................ 70,597
2004........................................................ 60,031
2005........................................................ 920
2006........................................................ 880
After 2006.................................................. 240,820
--------
$385,347
========
</Table>
50
At December 31, 2001, we were committed to making the following minimum
rental payments under non-cancelable operating leases (dollars in thousands):
<Table>
2002........................................................ $12,169
2003........................................................ 9,397
2004........................................................ 8,987
2005........................................................ 8,865
2006........................................................ 6,325
After 2006.................................................. 33,208
-------
Total minimum payments............................... $78,951
=======
</Table>
Liquidity and Capital Resources Following the Issuance of the Old Notes
In connection with the issuance of the old notes, we refinanced all
outstanding indebtedness under our existing credit facility with the proceeds
from that issuance and we entered into a new credit facility that provides
senior secured financing of up to $105.0 million on a revolving basis. As of
September 30, 2002, we did not have any borrowings outstanding under this new
credit facility, but we had $39.9 million of letters of credit outstanding under
the new credit facility. The new credit facility will terminate on June 28,
2007. Borrowings drawn during the first four fiscal quarters following closing
of the new credit facility will initially bear interest, at our option, at an
annual rate equal to:
- LIBOR, plus 3.50%; or
- the Base Rate, as defined in our new credit facility, plus 2.50%;
thereafter, in each case, subject to adjustments based on financial performance.
Our obligations under the new credit facility are guaranteed by:
- Extendicare Holdings, Inc., our direct parent;
- each of our current and future domestic subsidiaries excluding certain
inactive subsidiaries; and
- any other current or future foreign subsidiaries that guarantee or
otherwise provide direct credit support for any U.S. debt obligations of
ours or any of our domestic subsidiaries;
and is secured by a perfected first priority security interest in certain of our
tangible and intangible assets and all of our and our subsidiary guarantors'
capital stock. The new credit facility is also secured by a pledge of 65% of the
voting stock of our and our subsidiary guarantors' foreign subsidiaries, if any.
Borrowings under our new credit facility require compliance with various
financial covenants, including a minimum fixed charge coverage ratio, a minimum
tangible net worth, a maximum senior leverage ratio and a maximum senior secured
leverage ratio. Our new credit facility contains customary covenants and events
of default and is subject to various mandatory prepayments and commitment
reductions.
The new credit facility requires that we comply with various financial
covenants, on a consolidated basis including:
- a minimum fixed charge coverage ratio starting at 1.10 to 1 and
increasing to 1.20 to 1 in 2005;
- a minimum tangible net worth starting at 85% of our tangible net worth at
March 31, 2002 and increasing by 50% of our net income for each fiscal
quarter plus 100% of any additional equity we raise;
- a maximum senior leverage ratio starting at 4.25 to 1 and reducing to
4.00 to 1 in 2005; and
- a maximum senior secured leverage ratio starting at 1.75 to 1 and
reducing to 1.50 to 1 in 2005.
To hedge our exposure to fluctuations in interest rates, we entered into a
five-year interest rate swap contract with a notional amount of $150 million.
The contract effectively converted up to $150 million of our fixed interest rate
indebtedness into variable interest rate indebtedness.
51
Also in June 2002, we entered into a five year interest rate cap with a
notional amount of $150 million. Under this cap, we pay a fixed rate of interest
equal to 0.24% and receive a variable rate of interest equal to the excess, if
any, of the one month LIBOR rate, adjusted monthly, over the cap rate of 7%. We
use the interest rate cap to offset possible increases in interest payments
under the interest rate swap caused by increases in market interest rates over a
certain level and also as a cash flow hedge to effectively limit increases in
interest payments under our variable-rate debt obligations.
We believe that our cash from operations and anticipated growth, together
with other available sources of liquidity, including borrowings available under
our new credit facility, will be sufficient for the foreseeable future to fund
anticipated capital expenditures and make required payments of principal and
interest on our debt, including payments due on the notes and obligations under
our new credit facility.
Qualitative Disclosures
We use interest rate swaps to hedge the fair value of our debt obligations
and interest rate caps as a cash flow hedge of our variable-rate debt and also
to offset possible increases in variable-rate payments under our interest rate
swap related to increases in market interest rates.
We also have market risk relating to investments in stock and stock
warrants that we obtained in connection with the 1998 sale of our pharmacy
operations. In effect, these holdings can be considered contingent purchase
price whose value, if any, may not be realized for several years. These stock
and warrant holdings are subject to various trading and exercise limitations. We
intend to hold them until we believe the market opportunity is appropriate to
trade or exercise the holdings.
We monitor the markets to adequately determine the appropriate market
timing to sell or otherwise act with respect to our stock and warrant holdings
in order to maximize the value of these instruments. With the exception of the
above holdings, we do not enter into derivative instruments for any purpose
other than cash flow hedging purposes. That is, we do not speculate using
derivative instruments and do not engage in trading activity of any kind.
Quantitative Disclosures
The table below presents principal, or notional, amounts and related
weighted average interest rates by year of maturity for our debt obligations and
interest rate swaps as of September 30, 2002 (dollars in thousands):
<Table>
<Caption>
AFTER FAIR
2002 2003 2004 2005 2006 2006 TOTAL VALUE
---- ---- ---- ---- ---- -------- -------- --------
LONG-TERM DEBT:
Fixed Rate............................ $287 $624 $654 $620 $573 $353,292 $356,050 $376,280
Average Interest Rate................. 6.22% 6.26% 6.34% 6.24% 5.86% 9.41% 9.38%
Variable Rate......................... -- -- -- -- -- $ 32,000 $ 32,000 $ 24,472
Average Interest Rate................. -- -- -- -- -- 1.63% 1.63%
INTEREST RATE SWAPS: (fixed to
variable)
Notional Amount....................... -- -- -- -- -- $150,000 $150,000 $(7,471)
Average Pay Rate (variable rate)...... -- -- -- -- -- -- 6.63%
Average Receive Rate (fixed rate)..... -- -- -- -- -- -- 9.35%
INTEREST RATE CAPS:
Notional Amount..................... -- -- -- -- -- $150,000 $150,000 $ 664
</Table>
The above table incorporates only those exposures that existed as of
September 30, 2002 and does not consider those exposures or positions which
could arise after that date or future interest rate movements. As a result, the
information presented above has limited predictive value. Our ultimate results
with respect to interest rate fluctuations will depend upon the exposures that
arise during the period, our hedging strategies at the time and interest rate
movements.
52
BUSINESS
EXTENDICARE HEALTH SERVICES, INC.
Based upon number of beds, we are one of the largest providers of long-term
care and related services in the United States. Through our network of
geographically clustered facilities, we offer a continuum of healthcare
services, including skilled nursing care, assisted living and related medical
specialty services, such as subacute care and rehabilitative therapy. As of
September 30, 2002, we operated or managed 198 long-term care facilities with
18,311 beds in 15 states, of which 157 were skilled nursing facilities with
16,408 beds and 41 were assisted living and retirement facilities with 1,903
units. In addition, we operated 21 outpatient rehabilitation clinics in four
states. We also provided consulting services to 39 facilities with 4,213 beds in
two states. We receive payment for our services from Medicare, Medicaid, private
insurance, self pay residents and other third party payors. For the twelve month
period ended September 30, 2002, we generated total revenue of $802.6 million
and we had net earnings of $6.3 million.
We focus on our core skilled nursing facility operations, while continuing
to grow our complementary long-term care services. By emphasizing quality care
of patients and by clustering several long-term care facilities together within
the geographic areas we serve, we hope to build upon our reputation as a leading
provider of a full range of long-term care services in our communities and, as a
result, to continue to improve our Medicare census and occupancy rate. For the
nine months ended September 30, 2002, our average occupancy rate was 90.0% in
our skilled nursing facilities and 83.1% in our assisted living facilities.
THE LONG-TERM CARE INDUSTRY
According to the Health Care Industry Market Update report issued in
February 2002 by the Centers for Medicare and Medicaid Services (formerly the
Health Care Financing Administration), long-term care spending related to
nursing facilities was estimated at approximately $92.2 billion in 2000. The
aging of the U.S. population is a leading driver of demand for long-term care
services. According to the U.S. Census Bureau, there are approximately 35
million Americans aged 65 or older, representing 12.4% of the total U.S.
population. The Centers for Medicare and Medicaid Services have projected the
annual growth rate through 2020 for persons over 65 will be 1.8%, and 2.6% for
persons over 85. In 2000, approximately 1.6 million or 4.5% of all persons aged
65 and over were living in a nursing facility, compared to 1.6 million or 5.1%
in 1990. The long-term care industry is fragmented, with the 10 largest nursing
facility companies accounting for 18.5% of the total facility beds.
As the number of people over age 65 continues to grow and as advances in
medical technology continue to increase life expectancies, healthcare costs are
expected to rise faster than the availability of resources from
government-sponsored healthcare programs. In response to these rising costs,
governmental and private pay sources in the United States have adopted cost
containment measures that encourage reduced lengths of stay in acute care
hospitals. As a result, an increasing number of patients require a high degree
of monitoring, intensive and specialized medical care, 24-hour per day nursing
services and a comprehensive array of rehabilitative therapies. This trend has
increased the demand for these services from long-term care, home healthcare,
outpatient facilities, hospices and assisted living facilities to provide some
or all of these services in place of acute care hospitals. Long-term care
companies with information systems to process clinical and financial data and
that provide a broad range of healthcare services are in a more competitive
position than traditional acute care and rehabilitation hospitals to contract
with managed care companies and other payors to provide a continuum of services
to the elderly population.
COMPETITIVE STRENGTHS
Leading Provider of Long-Term Care Services. We are among the largest
providers of long-term care services in the United States. As of September 30,
2002, we owned, leased or managed 198 long-term care facilities with 18,311
beds. Our scope of operations allows us to achieve economies of scale in
purchasing and contracting with suppliers and customers. For example, through
our subsidiary, United Professional Services, Inc., we purchase for nursing
facilities in numerous states in addition to the facilities we operate
53
or manage. Through our affiliate, Virtual Care Provider, Inc., we also provide
technology support services to unaffiliated long-term care facilities.
Significant Facility Ownership. We own rather than lease a majority of our
properties, unlike a number of other long-term care providers. As of September
30, 2002, we owned 157 facilities and had the option to purchase an additional
seven facilities, or a combined 93.7% of the total number of facilities we
operated. We believe that owning properties increases our operating flexibility
by allowing us to:
- refurbish facilities to meet changing consumer demands;
- add assisted living and retirement facilities adjacent to our skilled
nursing facilities;
- divest facilities and exit markets at our discretion; and
- more directly control our occupancy costs.
Focus on Core Business. Over the past four years, we have successfully
identified and disposed of business segments that did not fit within our core
business and facilities located in states with unacceptable litigation risks.
These dispositions included the 1998 sale of our institutional pharmacy
operation, the 1999 and 2000 sale or lease of all of our facilities in Florida
and the 2001 lease or sublease of all our skilled nursing operations in Texas.
We intend to continue to focus on owning and managing long-term care facilities.
In addition, we will continue to review the performance of our current
facilities and exit markets or sell facilities that do not meet our performance
goals. At the present time, we have no significant divestiture plans.
Dual Medicare and Medicaid Certification. We have certified substantially
all of our beds for the provision of care to both Medicare and Medicaid
patients. We believe that dual certification increases the likelihood of higher
occupancy rates by increasing the availability of beds to patients who require a
specific bed certification. In addition, dual certification allows our
facilities to easily shift patients from one level of care and reimbursement to
another without physically moving the patient.
Management Focus on Key Performance Drivers. We believe that our senior
management, as well as our field personnel, are proficient at focusing on the
key areas that drive revenues, profits and cash flows. Our senior management has
identified three critical drivers of operating and financial performance:
- improving census, particularly increasing our Medicare census;
- expediting billing and collections; and
- controlling labor costs.
Every level of management, starting with our chief executive officer,
devotes a significant portion of its time to improving these drivers. We believe
that this attention has resulted in substantial improvement in several of our
key operating metrics.
For the nine month period ended September 30, 2002, the occupancy rate for
our skilled nursing facilities was 90.0%, or 2.6 percentage points higher than
the 87.4% occupancy rate for the nine month period ended September 30, 2001. For
the nine month period ended September 30, 2002, our Medicare revenues were 25.7%
of total revenues, or 2.0 percentage points higher than our Medicare revenues
percentage for the nine month period ended September 30, 2001, which was 23.7%.
Through consistent emphasis on admissions protocols, attention to older and
larger account balances and proactive collection efforts at regional and head
offices, we have improved our accounts receivable management. Days of revenues
outstanding have dropped from approximately 59 days in 1998 to 49 days as of
September 30, 2002.
We have employed a variety of strategies to control labor costs and
minimize the use of temporary staff. Our strategies include adjusting wage
scales, offering greater flexibility in staffing and improving overall job
satisfaction. Regular wages as a percent of revenues have declined to 46.1% in
the nine months ended September 30, 2002 from 46.5% in the nine months ended
September 30, 2001, while temporary wages as a percent of revenues in the same
periods decreased to 1.3% from 2.7%.
54
Geographic Diversity. We operate or manage facilities located in specific
markets across 15 states throughout the Northeast, Midwest, South and Northwest
regions of the United States. No state contains more than 18% of our facilities
or 20% of our beds or generates more than 21% of our EBITDA. Each state is
unique in terms of its competitive dynamics as well as political and regulatory
environment. Each state administers its own Medicaid program, which constitutes
a significant portion of our revenue. Our diversified market scope limits our
exposure to events or trends that may occur in any individual state, including
changes in any state's Medicaid reimbursement program and in regional and local
economic conditions and demographics.
Experienced and Proven Management Team. Our management has demonstrated
competency in dealing with major changes in the reimbursement environment
resulting from the shift to the prospective payment system, or PPS. In addition,
management determined that the best way to address the extremely litigious
environments in Florida and Texas was to cease operating in those markets.
During these challenging times, we have retained substantially all of our
executive and operating management team.
BUSINESS STRATEGY
The principal elements of our business strategy are to:
Provide Quality, Clinically Based Services. We engage in outcomes
management, forecasting and continuous quality improvement processes at the
facility, regional and corporate level. In recognition of increased state
regulatory oversight, we have an internal team of field-based quality validation
specialists who are responsible for mirroring the regulatory survey process and
regularly communicating with our outcomes management specialists in our
corporate office. On-site data is integrated with clinical indicators, facility
human resource data and state regulatory outcomes to provide a detailed picture
of problems, challenges and successes in achieving performance at all levels of
our organization. This information pool allows us to determine best practices
for duplication in similarly situated facilities. We emphasize these programs
when marketing our services to acute care providers, community organizations and
physicians in the communities we serve.
Increase Medicare Census. We continue to develop and implement strategies
and capabilities to attract residents, with a focus on increasing Medicare
census. As of September 30, 2002, Medicare payments represented approximately
26% of our total net revenues, up from 22% in 1999. Senior management has worked
with our regional and local management teams to develop strategies to continue
to increase this percentage. Strategies such as focused marketing efforts,
standardized admissions protocols, streamlined admitting procedures, the dual
certification of beds and improved management communication have driven this
improvement. In addition to increasing our facilities' profitability, the
increased Medicare census expands the market for our service related businesses
as Medicare patients utilize significant ancillary services.
Leverage Presence in Small Urban Markets. We geographically cluster our
long-term care facilities and services in small urban markets in order to
improve operating efficiencies and to offer our customers a broad range of
long-term care and related health services, including assisted living
facilities. Future expansion of our owned nursing facility operations is
anticipated to be through the selective acquisition and construction of new
facilities in areas that are in close proximity to existing facilities, where
management is experienced in dealing with the regulatory and reimbursement
environments, where the facility can participate as an active member of the
nursing facility association and where the facility's reputation is established.
Expand Management and Consulting Services. We seek to increase the number
of management and consulting contracts with third party operators. We have
knowledge and expertise in both the operational and administrative aspects of
the long-term care sector. We believe that the increasingly complex and
administratively burdensome nature of the long-term care sector, coupled with
our commitment and reputation as a leading, high-quality operator, will drive
demand for new contracts. We believe this strategy is a logical extension of our
business model and competencies and will drive growth without requiring
substantial capital expenditures.
55
Increase Operating Efficiency. We are focused on reducing operating costs
by improving our communications systems, streamlining documentation and
strengthening the formalization of procedures to approve expenditures. We are
reducing duplication of roles at the corporate and regional levels. We continue
to seek to improve our utilization of regional resources by adding management
and consulting contracts to our existing regions, thereby enabling us to spread
the semi-fixed costs of our regional structure over a wider base of facilities.
Proactively Manage Our Asset Portfolio. While we have made significant
progress over the last several years in disposing of non-core and
under-performing assets, we will continue to review our asset portfolio and exit
markets or sell facilities which do not meet our performance goals.
OPERATIONS
Organizational Structure of Operations
Our operations are organized into a number of different direct and indirect
wholly-owned subsidiaries primarily for legal and tax purposes. We manage our
operations as a single unit. Operating policies and procedures are substantially
the same in each subsidiary. As can be seen on the following chart, several of
our subsidiaries own and operate a significant number of our total portfolio of
facilities. No single facility generates more than 2% of total revenues.
The following chart shows how we and our active subsidiaries are organized.
56
<Table>
EXTENDICARE HEALTH SERVICES, INC.
HEALTH POCONOS, INC. ADULT SERVICES UNLIMITED, INC. EXTENDICARE HEALTH NETWORK, INC.
- United Professional Services, Inc.
- The Progressive Step Corporation
- Fiscal Services Group, LLC
- Partners Health Group, LLC
- Partners Health Group - Texas, LLC
- Partners Health Group - Louisiana, LLC
- Partners Health Group - Florida, LLC
EXTENDICARE HEALTH FACILITY HOLDINGS, INC.
Extendicare Homes, Inc. Extendicare of Indiana, Inc. Arbors East, Arbors at Marshall
- Indiana Health & Rehabilitation - Indiana Health & Inc. Toledo, Inc. Properties,
Centers Partnership (90%) Rehabilitation Centers Inc.
- Treasure Isle Care Center, LLC Partnership (10%) - Milford
- Concordia Manor, LLC Care, LLC
- First Coast Health and
Rehabilitation Center, LLC
- Jackson Heights Rehabilitation
Center, LLC
- Fir Lane Terrace Convalescent
Center, Inc.
- New Castle Care, LLC
- Kaufman Street, WV, LLC
Extendicare Health Facilities, Inc.
- Alpine Health and Rehabilitation Center, LLC
- The Oaks Residential and Rehabilitation Center, LLC
- South Heritage Health & Rehabilitation Center, LLC
- Greenbriar Care, LLC
- Heritage Care, LLC
- New Horizon Care, LLC
- Palm Court Care, LLC
- Richey Manor, LLC
- Winter Haven Health and Rehabilitation Center, LLC
- Colonial Care, LLC
- Greenbrook Care, LLC
- Lady Lake Care, LLC
- Rockledge Care, LLC
- North Rehabilitation Care, LLC
- Northern Health Facilities, Inc.
- Columbus Rehabilitation Care, LLC
- Rockmill Care, LLC
- Waterville Care, LLC
- Canton Care, LLC
- Oregon Care, LLC
- Arbors West Care, LLC
- Hilliard Care, LLC
- London Care, LLC
- Arbors at Fairlawn Realty OH, LLC
- Arbors at Bayonet Point, LLC
- Kissimmee Care, LLC
- Orange Park Care, LLC
- Blanchester Care, LLC
- Arbors West Realty OH, LLC
- Winter Haven Care, LLC
- Rocksprings Care, LLC
- Arbors at Sylvania Care, LLC
- Safety Harbor Care, LLC
- Columbus Rehabilitation Realty OH, LLC
- Arbors at Fairlawn Care, LLC
- Arbors at Tampa, LLC
- Port Charlotte Care, LLC
- Woodsfield Care, LLC
- Gallipolis Care, LLC
- Marietta Care, LLC
- Arbors at Sylvania Realty OH, LLC
- Jacksonville Care, LLC
- Seminole Care, LLC
- Sarasota Care, LLC
- Delaware Care, LLC
- Dayton Care, LLC
- Extendicare Great Trail, Inc.
- Great Trail Care, LLC
</Table>
57
Nursing Care
We provide a broad range of long-term nursing care, including skilled
nursing services, subacute care and rehabilitative therapy services, to assist
patients in the recovery from acute illness or injury. We provide nursing care
and therapy services to persons who do not require the more extensive and
specialized services of a hospital. Our nursing facilities employ registered
nurses, licensed practical nurses, therapists, certified nursing assistants and
qualified healthcare aides who provide care as prescribed by each resident's
attending physician. All of our nursing facilities provide daily dietary
services, social services and recreational activities, as well as basic services
such as housekeeping and laundry.
Assisted Living and Retirement Facilities
In our assisted living facilities, we provide residential accommodations,
activities, meals, security, housekeeping and assistance in the activities of
daily living to seniors who require some support, but not the level of nursing
care provided in a nursing facility. Our retirement communities provide
activities, security, transportation, special amenities, comfortable apartments,
housekeeping services and meals. Our assisted living facilities enhance the
value of an existing nursing facility in situations where the two facilities
operate side by side. This allows us to better serve the communities in which we
operate by providing a broader continuum of services. Most of our assisted
living facilities are within close proximity to our nursing facilities.
Management and Selected Consulting Services
We apply our operating expertise and knowledge in long-term care by
providing either full management services or selected consulting services to
third parties.
Through our wholly owned subsidiary, Partners Health Group, LLC, we provide
full management services utilizing our experienced professionals who have
considerable knowledge and expertise in both the operational and administrative
aspects of the long-term care industry. For full management contracts, we
consult on all aspects of operating a long-term care facility, including the
areas of nursing, dietary, laundry and housekeeping. Contracts are structured as
fee-for-service contracts, with the fees sometimes being based on a percentage
of revenues. The contracts generally have terms ranging from one to five years.
Through our wholly owned subsidiary, Fiscal Services Group, LLC, we provide
selected consulting services, which include selected accounting or cost
reimbursement services. Accounting services can include billing, accounts
receivable tracking, payroll, invoice processing, financial reporting, tax and
cost reimbursement services. Contracts are structured as fee-for-service
contracts, with the fees sometimes being based on a percentage of revenues. The
contracts generally have terms ranging from one to five years.
In addition, Virtual Care Provider, Inc., a wholly owned subsidiary of our
parent, Extendicare Inc., provides information technology services to us and
unrelated third parties on a fee-for-services basis.
Group Purchasing
Through United Professional Services, Inc., one of our wholly owned
subsidiaries, we provide purchasing services for nursing facilities in numerous
states in addition to the facilities we own or manage. We offer substantial cost
reductions for members of the purchasing group through the contractual volume-
based arrangements made with a variety of industry suppliers for food, supplies
and capital equipment.
Rehabilitative Therapy
We operate rehabilitative therapy clinics within our wholly owned
subsidiary, The Progressive Step Corporation. As of September 30, 2002, we
operated 21 clinics: ten in Pennsylvania, one in Ohio, one in Texas and nine in
Wisconsin. These clinics provide services to outpatients requiring physical,
occupational and/or speech-language therapy. In addition, our Pennsylvania
clinics provide respiratory and psychological and social services.
We provide rehabilitative therapy services on an inpatient and outpatient
basis. We have expanded all of our nursing facilities' therapy units, with some
facilities offering 1,500 to 5,000 square feet of therapy
58
space. We have developed therapy programs to provide patient-centered,
outcome-oriented subacute and rehabilitative care. At the majority of our
facilities, we employ physical, occupational and/or speech-language therapists
who provide rehabilitative therapy services to both inpatient and outpatient
clients.
Expansion
Plans for expanding our operations are developed from sources such as:
- personal contacts that we have in the long-term care industry;
- information made available to us and that we make available to others
through state and nationally based associations; and
- investment and financing firms and brokers.
All acquisitions and the undertaking of new contracts for management and
consulting services involve a process of due diligence in which the operational,
building and financial aspects of the undertaking are investigated.
SOURCES OF PAYMENT
The principal reimbursement sources for our nursing services are:
- Medicaid, a state-administered program financed by state funds and
matching federal funds, providing health insurance coverage for certain
persons in financial need, regardless of age, and which may supplement
Medicare benefits for financially needy persons aged 65 or older.
Medicaid reimbursement formulas are established by each state with the
approval of the federal government in accordance with federal guidelines.
All of the states in which we operate currently use cost-based
reimbursement systems, which generally may be categorized as prospective
or retrospective in nature. Under a prospective system, per diem rates
are established based upon the historical cost of providing services
during a prior year, adjusted to reflect factors such as inflation and
any additional service required to be performed. Many of the prospective
payment systems under which we operate contain an acuity measurement
system, which adjusts rates based on the care needs of the resident.
Retrospective systems operate similar to the pre-PPS Medicare program
where nursing facilities are paid on an interim basis for services
provided, subject to adjustments based on allowable costs, which are
generally submitted on an annual basis;
- Medicare, which is a federally funded health-insurance program providing
health insurance coverage for persons aged 65 or older and certain
disabled persons, which provides reimbursement for inpatient services for
hospitals, nursing facilities and certain other healthcare providers and
patients requiring daily professional skilled nursing and other
rehabilitative care (Part A Medicare) and services for suppliers of
certain medical items, outpatient services and doctors' services (Part B
Medicare). Medicare pays for the first 20 days of stay in a skilled
nursing facility in full and the next 80 days above a daily coinsurance
amount, after the individual has qualified for Medicare coverage by a
three day hospital stay; and
- private pay, which consist of individuals, private insurance companies,
HMOs, PPOs, other charge-based payment sources, HMO Medicare risk plans,
Blue Cross and the Department of Veterans Affairs.
We estimate that Medicare and Medicaid accounted for approximately 26% and
50% of our revenues, respectively, for the nine months ended September 30, 2002,
as compared to 24% and 51% of revenues for the year ended 2001, 24% and 51% of
revenues for the year ended 2000 and 22% and 50% of revenues for the year ended
1999. These payors have set maximum reimbursement levels for payments for
nursing services and products. The healthcare policies and programs of these
agencies have been subject to changes in payment methodologies during the past
several years. There can be no assurance that future changes will not reduce
reimbursements for nursing services from these sources.
We derive assisted living facility revenue primarily from private pay
residents at rates we establish based upon the services we provide and market
conditions in the area of operation. Approximately 38 states provide or have
approval to provide Medicaid reimbursement for services in assisted living
facilities
59
covering board and care. An additional six states plan to add Medicaid coverage
of services in the near future.
QUALITY OF CARE AND EMPLOYEE TRAINING
Our "Commitment to Residents" emphasizes our corporate philosophy of
treating residents with dignity and respect, a philosophy which we implement and
monitor through rigorous standards that we periodically assess and update. At a
regional level, our area directors of care management lead a department that is
primarily responsible for establishing care and service standards, policies and
procedures and auditing care and service delivery systems. They also provide
direction and training for all levels of the staff within the nursing facilities
and assisted living facilities. Our area directors of care management develop
programs and standards for all professional disciplines and services provided to
our customers, including nursing, dietary, social services, activities, ethical
practices, mental health services, behavior management, quality validation and
continuous quality improvement.
Employee training at all levels is an integral part of our on-going efforts
to improve and maintain our service quality. Each new nursing facility
administrator and assisted living facility manager or director of nursing is
required to attend a week of company-provided training to ensure that he or she
understands all aspects of nursing facility operations, including clinical,
management and business operations. We conduct additional training for these
individuals and all other staff on a regional or local basis.
MARKETING
Most of our long-term care facilities are located in smaller urban
communities. We focus our marketing efforts predominantly at the local level. We
believe that residents selecting a long-term care facility are strongly
influenced by word-of-mouth and referrals from physicians, hospital discharge
planners, community leaders, neighbors and family members. The administrator of
each long-term care facility is, therefore, a key element of our marketing
strategy. Each administrator is responsible for developing relationships with
potential referral sources. Administrators are supported through a regional team
of marketing personnel, which establish the overall marketing strategy, develop
relationships with HMO and PPO organizations and provide marketing direction
with training and community specific promotional materials. We aim to be the
provider of choice in the communities we serve.
COMPETITION
The long-term care industry in the United States is highly competitive with
companies offering a variety of similar services. We face local and regional
competition from other healthcare providers, including for-profit and
not-for-profit organizations, hospital-based nursing units, rehabilitation
hospitals, home health agencies, medical supplies and services agencies and
rehabilitative therapy providers. Newer assisted living facilities can attract
an element of the former private pay nursing facility admissions that require a
lesser degree of care. Significant competitive factors affecting the placement
of residents in nursing and assisted living facilities include quality of care,
services offered, reputation, physical appearance, location and, in the case of
private-pay residents, cost of the services. We focus our marketing efforts on
word-of-mouth reputation and referrals from each community's medical and
healthcare professionals.
Our medical services and supplies operation and our group purchasing
operation compete with other similar operations ranging from small local
operators to companies that have a national scope and distribution capability.
We also compete with other providers in the acquisition and development of
additional facilities. Other competitors may accept a lower rate of return and
therefore, present significant price competition. Also, tax-exempt
not-for-profit organizations may finance acquisitions and capital expenditures
on a tax-exempt basis or receive charitable contributions unavailable to us.
PROPERTIES
At September 30, 2002, we owned, leased or managed 198 long-term care
facilities with 18,311 beds in 15 states, of which 157 were nursing facilities
with 16,408 beds and 41 were assisted living facilities with 1,903 units. In
addition, we own long-term care properties of which 10 were nursing properties
with
60
1,065 beds that were leased and operated by unrelated nursing home providers. We
also retain an interest in, but do not operate, 11 nursing properties with 1,435
beds and four assisted living properties with 135 units. At September 30, 2002,
we also operated 21 rehabilitative therapy clinics: ten in Pennsylvania, one in
Ohio, one in Texas and nine in Wisconsin. The following table lists by state,
the nursing, assisted living and retirement facilities that we owned, leased or
managed at September 30, 2002:
<Table>
<Caption>
OWNED LEASED(1)(2) MANAGEMENT TOTAL
---------------------- ---------------------- ---------------------- ----------------------
RESIDENT RESIDENT RESIDENT RESIDENT
FACILITIES CAPACITY FACILITIES CAPACITY FACILITIES CAPACITY FACILITIES CAPACITY
---------- -------- ---------- -------- ---------- -------- ---------- --------
Ohio.................... 22 2,118 10 1,091 1 70 33 3,279
Pennsylvania............ 21 2,224 -- -- 14 1,230 35 3,454
Wisconsin............... 34 2,659 -- -- -- -- 34 2,659
Indiana................. 16 1,476 4 469 -- -- 20 1,945
Washington.............. 19 1,497 4 363 -- -- 23 1,860
Kentucky................ 19 1,549 -- -- -- -- 19 1,549
Texas................... 2 110 -- -- -- -- 2 110
Minnesota............... 11 1,292 -- -- -- -- 11 1,292
Oregon.................. 5 294 -- -- -- -- 5 294
Arkansas................ 4 277 -- -- -- -- 4 277
Idaho................... 2 179 -- -- -- -- 2 179
Delaware................ 1 120 -- -- -- -- 1 120
West Virginia........... 1 120 -- -- -- -- 1 120
Louisiana............... -- -- -- -- 3 567 3 567
Massachusetts........... -- -- -- -- 5 606 5 606
--- ------ -- ----- -- ----- --- ------
Total................... 157 13,915 18 1,923 23 2,473 198 18,311
=== ====== == ===== == ===== === ======
Nursing................. 122 12,224 17 1,858 18 2,326 157 16,408
Assisted living......... 35 1,691 1 65 5 147 41 1,903
Consulting services(3):
Florida............... -- -- -- -- -- -- 23 2,866
Texas................. -- -- -- -- -- -- 16 1,347
--- ------ -- ----- -- ----- --- ------
TOTAL, INCLUDING CONSULTING SERVICES.................................................................. 237 22,524
=== ======
Breakdown by type of facility:
Nursing............................................................................................. 195 20,505
Assisted living..................................................................................... 42 2,019
--- ------
TOTAL, INCLUDING CONSULTING SERVICES.................................................................. 237 22,524
=== ======
OTHER PROPERTIES:
Nursing facilities under lease(4)..................................................................... 10 1,065
Properties under divestiture agreement(5):
Nursing............................................................................................. 11 1,435
Assisted living..................................................................................... 4 135
--- ------
Total properties under divestiture agreement..................................................... 15 1,570
--- ------
TOTAL OTHER PROPERTIES................................................................................ 25 2,635
=== ======
Breakdown by type of facility:
Nursing............................................................................................. 21 2,500
Assisted living..................................................................................... 4 135
--- ------
TOTAL OTHER PROPERTIES................................................................................ 25 2,635
=== ======
</Table>
- -------------------------
(1) Except those referred to in note (2) below, the remaining life of the
leases, including renewal options exercisable solely by us, ranges from five
months to ten years, the average being four years. We retain an option to
purchase the leased property for 12 of the 18 leased properties. For lease
payment information, please see Note 13 to our consolidated financial
statements.
61
(2) As of September 30, 2002 seven leased facilities in Ohio and Indiana were on
a month-to-month lease arrangement. On October 18, 2002, we purchased these
properties for an aggregate purchase price of $17.9 million.
(3) Consulting services provided to the facilities listed include billing,
accounts receivable tracking, invoice processing, payroll, financial
reporting and cost reimbursements services.
(4) The Company owns 10 skilled nursing properties held under lease arrangements
with two unrelated long-term care operators whose terms include an option to
purchase the properties. Senior Health Properties -- South leases six
properties whose term matures on December 31, 2006. Senior Health
Properties, Texas -- Inc. leases 4 properties whose term matures on
September 30, 2006. In addition, Senior Health Properties, Texas -- Inc.
subleases 12 leased facilities whose term matures in February 2012. The
facilities we lease to Senior Health Properties -- South, Inc. and Senior
Health Properties -- Texas, Inc. are included in the facilities for which we
provide consulting services.
(5) We retain an interest in 11 nursing facilities with 1,435 beds and four
assisted living facilities with 135 units in Florida pursuant to the
Greystone divestiture agreement. Pursuant to this agreement we retain
contingent consideration in the form of a series of interest bearing notes
which have an aggregate potential value of up to $30.0 million plus
interest. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Significant Events -- Asset Divestitures."
The number of skilled nursing beds and assisted living units identified in
the above table and throughout this report represents the approximate number of
operational beds and units that we currently use. The number of operational beds
and units is subject to periodic changes and can be less than the licensed
number of beds approved by the state due to market and other factors.
GOVERNMENT REGULATION
Various federal, state and local governmental authorities in the United
States regulate the provision of institutional care through nursing facilities.
Though we believe our operations comply with the laws governing our industry, we
cannot guarantee that we will be in absolute compliance with all regulations at
all times. Failure to comply may result in significant penalties, including
exclusion from the Medicare and Medicaid programs, which could have a material
adverse effect on our business. We cannot assure you that governmental
authorities will not impose additional restrictions on our activities that might
adversely affect our business. In addition to the information presented below,
please see "Risk Factors -- Risks Relating to Us and Our Business" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Significant Events -- Asset Divestitures.
General Regulatory Requirements
Nursing facilities, assisted living facilities and other healthcare
businesses are subject to licensure and other state and local regulatory
requirements. In addition, in order for a nursing facility to be approved for
payment under the Medicare and Medicaid reimbursement programs, it must meet the
participation requirements of the Social Security Act and related regulations.
The regulatory requirements for nursing facility licensure and participation in
Medicare and Medicaid generally prescribe standards relating to provision of
services, resident rights, staffing, employee training, physical environment and
administration. Nursing and assisted living facilities are generally subject to
unannounced annual inspections by state or local authorities for purposes of
licensure and for purposes of certification under Medicare and Medicaid, in the
case of nursing facilities. These surveys will also confirm that nursing
facilities continue to meet Medicare and Medicaid participation standards. All
of our nursing facilities are licensed under applicable state laws. In addition,
all of our nursing facilities are certified to participate in the Medicare
program, the Medicaid program or both.
62
Environmental Laws and Regulations
Some federal and state laws govern the handling and disposal of medical,
infectious and hazardous waste. If an entity fails to comply with those laws or
the related regulations, the entity could be subject to fines, criminal
penalties and other enforcement actions. Federal regulations established by the
Occupational Safety and Health Administration impose additional requirements on
us with regard to protecting employees from exposure to blood borne pathogens.
We have developed policies for the handling and disposal of medical, infectious
and hazardous waste to assure that each of our facilities complies with those
laws and regulations. We incur ongoing operational costs to comply with
environmental laws and regulations. However, we have not had to make material
capital expenditures to comply with those laws and regulations. We believe that
we substantially comply with applicable laws and regulations governing these
requirements.
Health Insurance Portability and Accountability Act
The administrative simplification provisions of the Health Insurance
Portability and Accountability Act mandate a set of interlocking regulations
that will establish the uniform coding conventions and record formats across all
payor types for all electronic transactions central to the processing of all
healthcare claims and health plan enrollments. These standards will allow
entities within the healthcare system to exchange medical, billing and other
information and to process transactions in a more timely and cost effective
manner. These new transactions and code sets must be implemented by October
2003. Also, new privacy standards will go into effect on April 14, 2003 that
will require operational changes throughout the healthcare industry in the
handling of all patient information. The privacy standards are designed to
protect the privacy of patients' medical information. While the Bush
administration and Congress could reexamine these privacy standards, it is
unlikely there will be changes to the standards or to the effective date.
Security and other standards are expected to be issued in 2002. All standards
are required to be fully implemented within two years of final issuance, with
civil and criminal penalties established for noncompliance. We have established
a work task force to review and implement the standards required by the
legislation and we are currently on schedule to comply with the requirements.
Nursing Facility Regulation
The Centers for Medicare and Medicaid Services has established regulations
to implement survey, certification and enforcement procedures. The survey
process is intended to review the actual provision of care and services, with an
emphasis on resident outcomes to determine whether the care provided meets the
assessed needs of the individual residents. Surveys are generally conducted on
an unannounced annual basis by state survey agencies. Remedies are assessed for
deficiencies based upon the scope and severity of the cited deficiencies. The
regulations specify that the remedies are intended to motivate facilities to
return to compliance and to facilitate the removal of chronically poor
performing facilities from the program. Remedies range from:
- directed plans of correction, directed in-service training and state
monitoring for minor deficiencies;
- denial of Medicare or Medicaid reimbursement for existing residents or
new admissions and civil money penalties up to $3,000 per day for
deficiencies that do not immediately jeopardize resident health and
safety; and
- appointment of temporary management, termination from the program and
civil money penalties of up to $10,000 for one or more deficiencies that
immediately jeopardize resident health or safety.
The regulations allow state survey agencies to identify alternative
remedies that must be approved by the Centers for Medicare and Medicaid Services
prior to implementation.
Facilities with acceptable regulatory histories generally are given an
opportunity to correct deficiencies by a date certain, usually within six
months. The Centers for Medicare and Medicaid Services will continue payments
and refrain from imposing sanctions, unless the facility does not return to
compliance.
63
Facilities with deficiencies that immediately jeopardize resident health and
safety and those that are classified as poor performing facilities are not given
an opportunity to correct their deficiencies prior to the assessment of
remedies. From time to time, we receive notices from federal and state
regulatory agencies alleging deficiencies for failing to comply with all
components of the regulations. While we do not always agree with the positions
taken by the agencies, we review all such notices and take corrective action
when appropriate. Due to the fact that the regulatory process provides us with
limited appeal rights, many alleged deficiencies are not challenged even if we
do not agree with the allegation.
While we try to comply with all applicable regulatory requirements, from
time to time some of our nursing facilities have been sanctioned as a result of
deficiencies alleged by the Centers for Medicare and Medicaid Services or state
survey agencies. In November 2000, we operated one facility in Indiana that lost
its certification under the Medicare and Medicaid programs, but that facility
has since been recertified under both programs. We cannot assure you that we
will not be sanctioned and penalized in the future.
The Centers for Medicare and Medicaid Services has launched the Nursing
Home Quality Initiative pilot program with the states of Colorado, Florida,
Maryland, Ohio, Rhode Island and Washington. This program, which is designed to
provide consumers with comparative information about nursing home quality
measures, will rate every nursing home operating in these states on nine quality
of care indicators. These quality of care indicators include such measures as
percentages of patients with infections, bedsores and unplanned weight loss.
This comparative data will be made available to the public on the Centers' web
site and is expected to be published in local newspapers. The Centers for
Medicare and Medicaid Services has announced that if this pilot program is
successful, it intends to expand the initiative to all other states. We believe
that we have appropriate systems and mechanisms in place to monitor care and
service delivery. We expect that our facilities that may not substantially
comply with the regulations will ultimately substantially comply. We cannot
predict whether we will comply in the future and we could be adversely affected
if a substantial portion of our facilities were determined to not comply with
applicable regulations. We currently operate nursing homes in Ohio and
Washington.
Restrictions on Acquisitions and Construction
Acquisition and construction of additional nursing facilities are subject
to state regulation. Most of the states in which we currently operate have
adopted laws to regulate expansion of skilled nursing facilities. Certificate of
need laws generally require that a state agency approve certain acquisitions or
physical plant changes and determine that a need exists prior to the addition of
beds or services, the implementation of the physical plant changes or the
incurrence of capital expenditures exceeding a prescribed amount. Some states
also prohibit, restrict or delay the issuance of certificates of need. In
addition, in most states the reduction of beds or the closure of a facility
requires the approval of the appropriate state regulatory agency. Our nursing
facility expansions comply with all state regulations regarding expansion. Prior
to engaging in any regulated expansion project, we have obtained certificates of
need, if required by law. If we decide to reduce beds or close a facility, we
could be adversely affected by a failure to obtain or a delay in obtaining such
approval. To the extent that a certificate of need or other similar approvals
are required for expansion of our operations, either through facility
acquisitions, construction of new facilities or additions to existing
facilities, or expansion or provision of new services or other changes, our
expansion proposals could be adversely affected by an inability to obtain the
necessary approvals, changes in the standards applicable to such approvals and
possible delays and expenses associated with obtaining such approvals.
Acquisition, construction and operation of assisted living facilities are
subject to less stringent regulation than nursing facilities and, in the absence
of uniform federal regulations, states develop their own regulations. However,
since 1999 the term "assisted living facility" has been defined in 29 state
regulations and statutes, and approximately half of the remaining states have
regulations currently in effect or have proposed regulations regarding assisted
living facilities. Virtually every state has a licensure process, registration
process or some other form of regulation that may apply to assisted living
providers. If an assisted living provider supplies services that meet the
definition of a licensed level of care in the state, the provider must be
licensed. Licensure regulations can apply to admission and discharge criteria
and the variety and type of services provided. Many states require that buyers
submit building plans and receive
64
state approval prior to construction. However, the approval process is different
from the certificate of need procedure, as it is more of a clearance process
than a demand formula. Assisted living facilities must meet a stringent set of
building construction and design regulations including the Life Safety Code
(NFPA101). State regulators conduct inspections of assisted living facilities on
a periodic basis similar to their inspections of nursing facilities in most
cases. Our assisted living facilities are compliant in all material respects
with applicable state licensure, building construction and design regulations.
Regulation of Fraud and Related Matters
Because we participate in federal and state health care programs, we are
subject to a variety of federal and state laws that are intended to prevent
health care fraud and abuse. These laws are punishable by criminal and/or civil
sanctions, including, in some instances, exclusion from participation in federal
health programs, including Medicare, Medicaid and Department of Veterans Affairs
health programs. These laws, which include, but are not limited to,
anti-kickback laws, false claims laws, physician self-referral laws and federal
criminal health care fraud laws, are discussed in further detail below.
Management believes that both we and our subsidiaries have been and continue to
be in substantial compliance with all of these laws as they apply to us.
We believe our billing practices, operations and compensation and financial
arrangements with referral sources and others materially comply with applicable
federal and state requirements. However, we cannot assure you that a
governmental authority will not interpret such requirements in a manner
inconsistent with our interpretation and application. If we fail to comply, even
inadvertently, with any of these requirements, we could be required to alter our
operations and/or refund payments to the government. In addition, we could be
subject to significant penalties. Even if we successfully defend against any
action against us for violating these laws or regulations, we would likely be
forced to incur significant legal expenses and divert our management's attention
from the operation of our business. Any of these actions, individually or in the
aggregate, could have a material adverse effect on our business and financial
results. We cannot reasonably predict whether enforcement activities will
increase at the federal or state level or the effect of any such increase on our
business.
The illegal remuneration provisions of the Social Security Act make it a
felony to solicit, receive, offer to pay or pay any kickback, bribe or rebate in
return for referring a resident for any item or service or in return for
purchasing, leasing, ordering, recommending or arranging for any good, facility,
service or item, for which payment may be made under the federal healthcare
programs. A violation of the illegal remuneration statute may result in the
imposition of criminal penalties, including imprisonment for up to five years,
the imposition of a fine of up to $25,000, civil penalties and exclusion from
participating in federal health programs.
Recognizing that the law is broad and may technically prohibit beneficial
arrangements, the Office of Inspector General of the Department of Health and
Human Services developed regulations addressing those types of business
arrangements that will not be subject to scrutiny under the law. These safe
harbors describe activities that may technically violate the act, but which are
not to be considered illegal when carried on in conformance with the
regulations. For example, the safe harbors cover activities such as contracting
with physicians or other individuals that have the potential to refer business
to us that would ultimately be billed to a federal health program. Failure to
qualify for safe harbor protection does not mean that an arrangement is illegal.
Rather, the arrangement must be analyzed under the anti-kickback statute to
determine whether there is an intent to pay or receive remuneration in return
for referrals. Conduct and business arrangements that do not fully satisfy one
of the safe harbors may result in increased scrutiny by government enforcement
authorities. In addition, some states have anti-kickback laws that may apply
regardless of whether a federal health care program is involved. Although our
business arrangements may not always satisfy all the criteria of a safe harbor,
we believe that our operations are in material compliance with federal and state
anti-kickback laws.
Under the federal "Stark II" law, physicians are prohibited from making a
referral to an entity for the furnishing of designated health services,
including therapy services, for which Medicare or Medicaid may pay, if the
physician, or an immediate family member of the physician, has a financial
relationship, including ownership interests and compensation arrangements, with
that entity, and the relationship fails to
65
meet a statutory or regulatory exception to the rule. The penalties for
violating this act include denial of payment, additional financial penalties and
exclusion from participating in federal health programs. In addition, a number
of states have enacted their own versions of self-referral laws.
The Federal False Claims Act and similar state statutes prohibit
presenting, a false or misleading claim for payment under a federal program.
Violations can result in significant civil penalties, treble damages and
exclusion from participation in federal programs. Liability arises, primarily,
when an entity knowingly submits a false claim for reimbursement to the federal
government. However, enforcement over the past few years has expanded the
traditional scope of this act to cover quality of care issues, especially in the
skilled nursing facility context. In addition to the civil provisions of the
False Claims Act, the federal government can use several other criminal statutes
to prosecute persons who submit false or fraudulent claims for payment to the
federal government.
Federal law provides that practitioners, providers and related persons may
not participate in most federal healthcare programs, including the Medicare and
Medicaid programs, if the individual or entity has been convicted of a criminal
offense related to the delivery of an item or service under these programs or if
the individual or entity has been convicted, under state or federal law, of a
criminal offense relating to neglect or abuse of residents in connection with
the delivery of a healthcare item or service. Other individuals or entities may
be, but are not required to be, excluded from such programs under certain
circumstances, including the following:
- conviction related to fraud;
- conviction relating to obstruction of an investigation;
- conviction relating to a controlled substance;
- licensure revocation or suspension;
- exclusion or suspension from state or federal healthcare programs;
- filing claims for excessive charges or unnecessary services or failure to
furnish medically necessary services;
- ownership or control by an individual who has been excluded from the
Medicaid and/or Medicare programs, against whom a civil monetary penalty
related to the Medicaid and/or Medicare programs has been assessed or who
has been convicted of the crimes described in this paragraph; and
- the transfer of ownership or control interest in an entity to an
immediate family or household member in anticipation of, or following, a
conviction, assessment or exclusion.
Cross Decertification and De-Licensure
In some circumstances, if one facility is convicted of abusive or
fraudulent behavior, then other facilities under common control or ownership may
be decertified from participating in Medicaid or Medicare programs. Executive
Order 12549 prohibits any corporation or facility from participating in federal
contracts if it or its principals have been barred, suspended or are ineligible
or have been voluntarily excluded from participating in federal contracts. In
addition, some state regulations provide that all facilities under common
control or ownership licensed within a state may be de-licensed if any one or
more of the facilities are de-licensed. To date, neither we nor our subsidiaries
have experienced any cross-decertifications and none of our or our subsidiaries
facilities have been de-licensed.
Office of the Inspector General
In 1995, a major anti-fraud demonstration project, "Operation Restore
Trust" was announced by the Office of the Inspector General, which guaranteed
funding for fraud and abuse activities and coordinated efforts among multiple
federal and state agencies. A primary purpose for the operation is to scrutinize
the activities of healthcare providers who are reimbursed under the Medicare and
Medicaid programs. Initial investigation efforts have focused on skilled nursing
facilities, home health and hospice agencies and durable medical equipment
suppliers in Texas, Florida, New York, Illinois and California. In May 1997, The
Department of Health and Human Services announced that the operation would be
expanded in the future to include several other types of healthcare services and
several additional states, with the intent
66
that it will ultimately be a nationwide operation. Over the longer term, the
operation's enforcement actions could include criminal prosecutions, suit for
civil penalties and/or Medicare, Medicaid or federal healthcare program
exclusions. Prior to our November 1997 acquisition of Arbor Health Care Company,
one of its subsidiary's facilities was charged with inadequately documented
therapy services. Following this investigation, Arbor adopted measures to
strengthen its documentation relating to reimbursable services. While we do not
believe that we are the target of any such investigation under operation restore
trust, we cannot assure you that we will not expend substantial amounts to
cooperate with any such investigation or to defend allegations that may arise
from an investigation. If a government agency finds that any of our practices
failed to comply with the anti-fraud provisions, we could be materially
adversely affected.
Compliance Program
Compliance with federal, state and local laws and regulations and our
internal policies has always been and continues to be a priority of ours. In
March 2000, the Office of the Inspector General issued guidance to the skilled
nursing care industry regarding elements that should be included in an effective
compliance plan. In 2001, we formalized our existing compliance efforts by
issuing our corporate compliance program, incorporating the elements included in
the guidance issued by the Office of the Inspector General. As part of the
compliance program, our employees must acknowledge their responsibility to
comply with relevant laws, regulations and policies, including our compliance
program.
New Initiatives
There are ongoing initiatives at the federal and state levels for
comprehensive reforms affecting the payment for and availability of health care
services. Aspects of some of these health care initiatives, such as the
termination of Medicare funding improvements and limitations on Medicare
coverage, other pressures to contain health care costs by Medicare, Medicaid and
other payors, as well as increased operational requirements in the
administration of Medicaid, could adversely affect us. We cannot predict the
ultimate content, timing or effect of any health care reform legislation, nor
can we estimate the impact of potential legislation on us.
INSURANCE
We currently maintain insurance policies for property coverage, workers'
compensation and employer's liability insurance in amounts and with such
coverage and deductibles as we believe adequate, based on availability, the
nature and risks of our business, historical experience and industry standards.
These policies are obtained through both affiliated subsidiaries of Extendicare
Inc. and third-party insurers. We self-insure for health and dental claims,
workers' compensation and employer's liability in certain states. Management
believes that our skilled nursing facilities, assisted living facilities and
rehabilitation therapy clinics are adequately insured.
As a result of limited availability from third party insurers or
availability at an excessive cost or deductible, since January 1, 2000, we
generally self insure for comprehensive general and professional liability
(including malpractice insurance for our health providers, assistants and other
staff, as it relates to their respective duties performed on our behalf) up to a
certain amount per incident. In January 2000, our retained risk for general and
professional liability coverage increased significantly resulting in us
providing accruals based upon past claims and actuarial estimates of the
ultimate cost to settle claims. Those risks were significantly reduced when we
ceased operations of all Florida facilities in 2000 and Texas nursing facilities
in the fourth quarter of 2001. As of December 31, 2001, we have provided for
$70.3 million in accruals for known or potential general and professional
liability claims based on claims experience and an independent actuarial review.
Based upon such claims experience and independent actuarial review, we believe
that our accrual is adequate to cover any losses from general and professional
liability claims. Of the risks that we self-insure, general and professional
liability claims are the most volatile and significant.
LEGAL PROCEEDINGS
We and our subsidiaries are defendants in actions against us or them from
time to time in connection with our operations and due to the nature of our
business. These actions may include civil or criminal
67
actions resulting from personal injury and wrongful death suits arising out of
allegations of professional malpractice brought against us, one or more of our
facilities or the individuals who work at particular facilities. We are unable
to predict the ultimate outcome of pending litigation and other investigations.
We cannot assure you that claims will not arise that are in excess of our
insurance coverage, are not covered by our insurance coverage or result in
punitive damages being assessed against us. In addition, we cannot assure you
that the United States Department of Justice, the Centers for Medicare and
Medicaid or other regulatory agencies will not initiate investigations related
to our businesses in the future. A successful claim against us that is not
covered by, or is in excess of, our insurance could have a material adverse
effect on our financial condition and results of operations. Claims against us,
regardless of their merit or eventual outcome, would require management to
devote time to matters unrelated to the operation of our business and, due to
publicity, may also have a material adverse effect on our ability to attract
residents or expand our business.
For additional information regarding legal proceedings, please see "Risk
Factors -- Risks Relating to Us and Our Business" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
EMPLOYEES
As of December 31, 2001, we employed approximately 19,000 people, including
approximately 3,600 registered and licensed practical nurses, 7,200 nursing
assistants, 1,600 therapists, 5,100 dietary, domestic, maintenance and other
staff and 1,300 administrative employees who work at our corporate offices and
facilities. We have approximately 38 collective bargaining agreements, 15 of
which expire within 12 months of September 30, 2002, among six unions covering
approximately 2,700 employees. We believe that we have a good relationship with
our employees.
68
MANAGEMENT
DIRECTORS AND OFFICERS
The following table sets forth information with respect to our executive
officers and directors:
<Table>
<Caption>
NAME AGE POSITION
---- --- --------
Melvin A. Rhinelander..................... 52 Chairman of the Board and Chief Executive
Officer and Director
Mark W. Durishan.......................... 54 Vice President, Chief Financial Officer,
Treasurer and Director
Richard L. Bertrand....................... 53 Senior Vice President, Development
Philip W. Small........................... 46 Senior Vice President, Strategic Planning
and Investor Relations and Director
Roch Carter............................... 63 Vice President, General Counsel and
Assistant Secretary
Douglas J. Harris......................... 47 Vice President and Controller
L. William Wagner......................... 54 Vice President, Human Resources
</Table>
Melvin A. Rhinelander is our Chairman and Chief Executive Officer and one
of our directors. He has been with us and our affiliated companies since 1977
and has served in a number of senior management positions. Mr. Rhinelander has
been President of Extendicare Inc. since August 1999, a director since May 2000
and its Chief Executive Officer since August 2000. He has been an officer of our
company since 1989 and a director since 1998. He has been our Chief Executive
Officer since December 1999 and Chairman of our Board of Directors since August
2000. In addition, Mr. Rhinelander is Chief Executive Officer of Extendicare
(Canada) Inc.
Mark W. Durishan has been our Chief Financial Officer, Treasurer and one of
our Vice Presidents and directors since joining us in August 1999. At that time
he also joined Extendicare Inc. Prior to joining us, Mr. Durishan was Senior
Vice-President of Finance and Operations for Blue Cross and Blue Shield of
Minnesota where he served in such capacity from 1995 to 1998. From 1991 to 1995,
Mr. Durishan was Chief Financial Officer of Graduate Health System of
Philadelphia, a healthcare corporation encompassing seven hospitals, a
100,000-member HMO, a captive insurance company and a home health agency. During
his career, Mr. Durishan was a partner at Coopers & Lybrand responsible for the
Philadelphia and Washington healthcare consulting offices. Mr. Durishan has over
32 years of experience in the healthcare industry.
Richard L. Bertrand is our Senior Vice President, Development. Mr. Bertrand
joined EHSI in 1983 as our Vice President of Finance. From 1983 to 1995 he
served as our Vice President of Finance and later as our Senior Vice President
of Finance and Chief Financial Officer. Beginning in 1995, Mr. Bertrand served
as our Senior Vice President, Reimbursement and later as our Senior Vice
President, Development. Prior to joining us, Mr. Bertrand served as Vice
President and Controller of Extendicare Inc. from 1977 to 1983. Prior to that,
he was a staff accountant and supervisor with the accounting firm of Thorne
Riddell from 1972 to 1976.
Philip W. Small joined us in June 2001 as our Senior Vice President,
Strategic Planning and Investor Relations. At that time he also joined
Extendicare Inc. He was appointed to our Board of Directors on December 31,
2001. Prior to joining us, Mr. Small served 15 years at Beverly Enterprises
Corporation, Fort Smith, Arkansas, in various financial capacities, the most
recent being Executive Vice President, Strategic Planning and Operations Support
and acting Chief Financial Officer. His prior experience includes serving as
Director, Reimbursement for HCA Management Company of Atlanta, Georgia. Mr.
Small has over 20 years of experience in the healthcare industry.
Roch Carter was appointed our Vice President, General Counsel and Assistant
Secretary in January 1998. He joined us in 1974 as Legal Counsel and he was
subsequently appointed our General Counsel in 1985. Prior to joining us, Mr.
Carter was an attorney with the United States Attorney's office
69
in Milwaukee. Mr. Carter was also an attorney with the City of Milwaukee and was
in practice with Young and McManus, S.C. Mr. Carter has over 28 years of
experience in healthcare law and practice.
Douglas J. Harris joined us in December 1999 as our Controller and one of
our Vice Presidents. From 1994 through 1999, Mr. Harris was the Managing
Director of Extendicare (U.K.) Limited. Mr. Harris has been with us and our
affiliated companies since 1981 and has held positions in various financial
capacities. Prior to joining us, Mr. Harris was an audit supervisor with KPMG.
L. William Wagner joined us in 1987 as Vice President of Human Resources.
Prior to joining us, Mr. Wagner was Vice President of Human Resources for ARA
Living Centers and Director of Personnel for General Foods Corp. Mr. Wagner has
17 years of experience in the healthcare industry and over 23 years of human
resources experience.
70
EXECUTIVE COMPENSATION
COMPENSATION OF NAMED EXECUTIVE OFFICERS
The following summary compensation table details compensation information
for the three fiscal years ended December 31, 2001, 2000 and 1999 for each of
our Chief Executive Officer and the four other most highly compensated executive
officers (collectively, the "named executive officers").
SUMMARY COMPENSATION TABLE
(AMOUNTS IN U.S. DOLLARS, EXCEPT WHERE NOTED)
<Table>
<Caption>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
-------------------------------------- ------------------
NAME AND PRINCIPAL OTHER ANNUAL SECURITIES ALL OTHER
POSITION WITH THE SALARY BONUS COMPENSATION(1) UNDERLYING OPTIONS COMPENSATION(2)
COMPANY YEAR ($) ($) ($) (#) ($)
------------------ ---- ---------- ------- --------------- ------------------ ---------------
M.A. Rhinelander....... 2001 400,000 200,000 38,420 100,000 9,073
President and Chief 2000 370,832 200,000 46,303 75,000 7,917
Executive Officer 1999 225,000 -- -- 50,000 3,654
of Extendicare Inc.;
Chairman and Chief
Executive Officer of
Extendicare Health
Services, Inc.
J.G. McLaughlin(3)..... 2001 275,000 75,000 -- 20,000 8,686
President and Chief 2000 275,000 40,000 -- 20,000 9,036
Operating Officer 1999 216,666/ -- -- 50,000 4,587/
Cdn 37,500 Cdn 2,088
M.W. Durishan(4)....... 2001 250,000 80,000 -- 20,000 12,377
Vice President, 2000 250,000 40,000 -- 20,000 13,125
Finance and Chief 1999 104,165 -- -- 50,000 4,635
Financial Officer of
Extendicare Inc.; Vice
President, Chief
Financial Officer and
Treasurer of
Extendicare Health
Services, Inc.
R.L. Bertrand.......... 2001 215,000 80,000 -- 15,000 40,282
Senior Vice President, 2000 215,000 100,000 -- 15,000 38,957
Development 1999 210,000 -- -- 5,000 38,105
P.W. Small(5).......... 2001 145,833 55,000 -- 50,000 12,500
Senior Vice President, 2000 -- -- -- -- --
Strategic Planning 1999 -- -- -- -- --
and Investor Relations
of Extendicare Inc. and
Extendicare Health
Services, Inc.
</Table>
- ---------------
NOTES:
(1) The aggregate amount of perquisites and other benefits for each named
executive officer is less than the lesser of $50,000 or 10% of total annual
salary and bonus. In the case of M.A. Rhinelander, the amount is comprised
of car allowance and flexible account.
(2) For M.A. Rhinelander and J.G. McLaughlin these amounts reflect premiums paid
by the Company for term life insurance and long-term disability. All other
compensation, in the case of R.L. Bertrand, P.W. Small and M.W. Durishan,
includes payments for life insurance and long-term disability premiums and
contributions to a deferred compensation plan and a defined contribution
retirement plan. The amount of salary and/or bonus deferred by the named
executive officer is included within the figures set forth in the "Salary"
and/or "Bonus" columns in the above table. EHSI's contribution
71
is included within the "All Other Compensation" column. The amounts
contributed by the officer and EHSI's matching portion contributed to the
deferred compensation plan are as follows:
<Table>
<Caption>
NAMED EXECUTIVE OFFICER 2001 2000 1999
- ----------------------- ------- ------- -------
R.L. BERTRAND
Officer contribution.................................... $21,500 $21,500 $21,000
Officer interest........................................ 11,298 11,597 7,710
EHSI contribution....................................... 10,750 10,750 10,500
EHSI interest........................................... 5,649 5,799 3,855
M.W. DURISHAN
Officer contribution.................................... $21,354 $25,000 $ 9,271
Officer interest........................................ 3,273 2,066 130
EHSI contribution....................................... 10,677 12,500 4,635
EHSI interest........................................... 1,637 1,033 65
</Table>
(3) J.G. McLaughlin was appointed President and Chief Operating Officer in March
1999. Prior to his relocation to the United States in March, his salary was
in Canadian dollars.
(4) M.W. Durishan commenced employment with the Company in August 1999.
(5) P.W. Small commenced employment with the Company in June 2001.
DEFERRED COMPENSATION PLAN
We maintain a non-qualified, deferred compensation plan (consisting of
individual agreements), which is offered to all highly compensated employees as
prescribed by the Internal Revenue Service. The maximum amount of annual
compensation that may be deferred is 10% of the employee's base salary,
excluding any bonus. We match up to 50% of the amount deferred, and the combined
amount earns interest at the prime rate. Our matching payment, plus interest,
vests to the employee over eight years. Amounts deferred and vested matching
amounts are payable upon the death, disability or termination of the employee.
Amounts deferred are not guaranteed, are "at risk" and are subject to our
ability to make the scheduled payments. Our deferred compensation liabilities
are unfunded and unsecured.
EXECUTIVE RETIREMENT PLAN
We provide an executive retirement program for certain of our key officers
and executives. Under the program we contribute 10% of the participant's base
salary into an account to be invested in certain mutual funds at the
participant's discretion. The amounts in the executive retirement program vest
upon certain events which are specified in the participant's executive
retirement program plan, and by discretionary actions by the Board of Directors
of Extendicare Inc. A graduated vesting schedule applies for some program
participants if we terminate the participant. Any funds that we invest or assets
that we acquire pursuant to the program continue to be a part of our general
funds. No party, other than EHSI, has any interest in such funds. To the extent
that any participant acquires a right to receive payment from us under the
executive retirement program, such right shall be no greater than the right of
any unsecured general creditor of ours. We expense the amounts we fund into the
executive retirement program on a monthly basis.
STOCK OPTION PLAN
Extendicare Inc.'s stock option plan provides for the grant, from time to
time, at the discretion of Extendicare Inc.'s board of directors, to certain
directors, officers and employees of the Extendicare Inc. group of companies, of
options to purchase subordinate voting shares of Extendicare Inc. for cash. The
plan provides that the exercise price of any options granted not be less than
the closing price (or, if there is no closing price, the simple average of the
bid and ask price) for the subordinate voting shares as quoted on The Toronto
Stock Exchange on the trading day prior to the date of grant. It also permits
72
options to be exercised for a period not to exceed either five or ten years from
the date of grant, as determined by the Extendicare Inc. board of directors at
the time the option is granted. The options vest equally over the first four
years and the plan contains provisions for appropriate adjustments in the event
of corporate reorganizations of Extendicare Inc.
At December 31, 2001, a total of 4,776,350 subordinate voting shares of
Extendicare Inc. were reserved under the plan, of which 2,342,875 subordinate
voting shares were subject to outstanding options and 2,433,475 were available
for grant.
The following table summarizes stock options granted during 2001 to our
named executive officers under the Extendicare Inc. stock option plan:
OPTION/SAR GRANTS IN FISCAL YEAR 2001
<Table>
<Caption>
NUMBER POTENTIAL REALIZABLE
OF PERCENT OF VALUE AT ASSUMED
SECURITIES TOTAL ANNUAL RATES OF STOCK
UNDERLYING OPTIONS/SARS PRICE APPRECIATION FOR
OPTIONS/ GRANTED TO EXERCISE OR BASE OPTION TERM (CDN$)
SARS EMPLOYEES IN PRICE ----------------------
NAME GRANTED FISCAL YEAR (CDN $ PER SHARE) 5% 10% EXPIRATION DATE
---- ---------- ------------ ----------------- --------- --------- ---------------
M.A. Rhinelander..... 100,000 13.26% $3.70 $102,224 $225,889 Feb. 20, 2006
J.G. McLaughlin...... 20,000 2.65 3.70 20,445 45,178 Feb. 20, 2006
M.W. Durishan........ 20,000 2.65 3.70 20,445 45,178 Feb. 20, 2006
R.L. Bertrand........ 15,000 1.99 3.70 15,334 33,883 Feb. 20, 2006
P.W. Small........... 50,000 6.63 5.70 78,740 173,995 May 31, 2006
</Table>
These amounts do not represent the present value of the options. The
amounts shown represent what would be received upon exercise five years after
the date of grant, assuming certain rates of stock price appreciation during the
entire period. Actual gains, if any, on stock option exercises are dependent on
future performance of the Extendicare Inc. common stock and overall market
conditions. In addition, actual gains depend upon whether, and the extent to
which, the options actually vest.
The following table summarizes options exercised during 2001 and option
values at December 31, 2001 for our named executive officers.
AGGREGATED OPTION/SAR EXERCISED IN FISCAL YEAR 2001
AND FISCAL YEAR-END OPTION/SAR VALUES
<Table>
<Caption>
NUMBER OF SECURITIES
UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS/SAR
SHARES AT FISCAL YEAR-END AT FISCAL YEAR-END
ACQUIRED VALUE (#) ($)
ON EXERCISE REALIZED ---------------------------- ----------------------------
NAME (#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------ ----------- ------------- ----------- -------------
M.A. Rhinelander........... -- -- 68,750 181,250 72,188 326,563
J.G. McLaughlin............ -- -- 80,000 60,000 35,750 93,250
M.W. Durishan.............. -- -- 30,000 60,000 14,500 72,000
R.L. Bertrand.............. -- -- 26,250 28,750 9,938 53,063
P.W. Small................. -- -- -- 50,000 -- --
</Table>
- ---------------
NOTE:The closing price of the Extendicare Inc. subordinate voting shares on The
Toronto Stock Exchange on December 31, 2001 was Cdn $5.25.
RETIREMENT ARRANGEMENTS
M.A. Rhinelander, J.G. McLaughlin and R.L. Bertrand are covered by
retirement arrangements established by Extendicare Inc. The arrangements provide
for a benefit of 4% of the best three consecutive years of base salary for each
year of service to a maximum of 15 years and 1% per year thereafter. The
73
base salary for determination of the retirement arrangements, as summarized in
the pension plan table below, is based upon the salary set forth in the summary
compensation table. These arrangements provide a maximum benefit guarantee of
60% of base salary after 15 years of service and 70% after 25 years of service.
Normal retirement age is 60 years, or 55 years with our consent. We have
consented to Messrs. Rhinelander and McLaughlin retiring with full benefits at
age 55. Retirement benefits are payable as an annuity over the lifetime of the
executive with a portion continuing to be paid to the executive's spouse after
the death of the executive. As of December 31, 2001, projected years of credited
service at retirement for Messrs. Rhinelander, McLaughlin and Bertrand are 33
years, 24 years, and 33 years, respectively.
Estimated annual benefits payable upon retirement of the specified
compensation and years of credited service classifications are as shown in the
following table:
PENSION PLAN TABLE
<Table>
<Caption>
YEARS OF SERVICE AS AN EXECUTIVE
---------------------------------------------------
REMUNERATION ($) 15 20 25 30 35
---------------- ------- ------- ------- ------- -------
200,000........................................ 120,000 130,000 140,000 140,000 140,000
250,000........................................ 150,000 162,500 175,000 175,000 175,000
300,000........................................ 180,000 195,000 210,000 210,000 210,000
350,000........................................ 210,000 227,500 245,000 245,000 245,000
400,000........................................ 240,000 260,000 280,000 280,000 280,000
450,000........................................ 270,000 292,000 315,000 315,000 315,000
</Table>
Messrs. Durishan and Small are not participants in these arrangements, but
are participants in a money purchase, 401(K) plan and a deferred compensation
plan established for U.S. executives.
TERMINATION OF EMPLOYMENT ARRANGEMENTS
Messrs. Rhinelander and McLaughlin each have a termination of employment
arrangement with Extendicare Inc. that provides for one month of salary for each
year of service up to a maximum of 24 months' severance.
74
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
We are an indirect wholly owned subsidiary of Extendicare Inc. and we
insure certain risks, including comprehensive general liability, property
coverage and excess workers' compensation/employer's liability insurance, with
Laurier Indemnity Company and Laurier Indemnity Ltd., affiliated insurance
subsidiaries of Extendicare Inc. We recorded approximately $5.7 million, $20.7
million and $13.9 million of expenses for this purpose in the fiscal years ended
December 31, 2001, 2000 and 1999, respectively.
We entered into a capital lease in 1999 relating to computer equipment with
Laurier Indemnity Company. In the first quarter of 2000, we exercised our option
to purchase the equipment for $1.3 million. The consolidated statement of
operations includes interest expense related to this lease of $0.1 million in
2000 and $0.3 million in 1999.
In January 2001, we established an arrangement for computer hardware and
software support services with Virtual Care Provider, Inc., an affiliated
subsidiary of Extendicare Inc. The annual cost of services was $6.5 million in
2001.
At December 31, 2001, 2000 and 1999, we had a non-interest bearing loan
payable to Extendicare Holdings, Inc., our immediate parent, in the amount of
approximately $3.5 million with no specific due date. We used the proceeds of
the loan for working capital.
For federal tax purposes we file as part of a consolidated group of
companies, of which Extendicare Holdings is the parent. Extendicare Holdings (a
subsidiary of Extendicare Inc.) holds all of Extendicare Inc.'s U.S. operations,
including EHSI. We have a tax sharing arrangement with Extendicare Holdings
pursuant to which we had a receivable of $1.0 million at December 31, 2001,
$10.0 million at December 31, 2000 and $31.1 million at December 31, 1999. Under
this tax sharing arrangement, a U.S. consolidated income tax return is filed by
Extendicare Holdings and, for purposes of determining each member's share of the
tax liability in such return, each member of the affiliated group computes its
separate U.S. income tax liability for regular income tax purposes (but not for
alternative minimum tax purposes) as if it had filed a separate U.S. income tax
return. Such amount is reflected as a federal income tax expense and as an
intercompany payable to Extendicare Holdings on each member's separate financial
statements. If a member incurs a net operating loss, such net operating loss is
tax benefited (for regular tax purposes only) in the year the net operating loss
is incurred. Such amount is reflected as a reduction in federal income tax
expense and as an intercompany receivable from Extendicare Holdings on each
member's separate financial statements. Similarly, the federal income tax
receivable and payable is recorded on the separate financial statement of
Extendicare Holdings. Each member's separate intercompany balances are
transferred to Extendicare Holdings through the intercompany payable and
receivable account.
In addition to the amounts discussed in the preceding two paragraphs, we
had non-interest bearing current amounts due to (from) affiliates as follows:
<Table>
<Caption>
DECEMBER 31,
-----------------------------
AFFILIATE PURPOSE 2001 2000 1999
--------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Extendicare Holdings, Sale of pharmacy contract rights $ 7,300 $10,000 $10,000
Inc.
Extendicare Holdings, Intercompany operating expenses (1,319) (2,629) (1,113)
Inc.
Crown Properties, Inc. Working capital advances 1,946 1,946 1,946
Laurier Indemnity Company Intercompany insurance premium 3,823 -- 1,351
Virtual Care Provider, Working capital advances (3,064) -- --
Inc.
------- ------- -------
$ 8,686 $ 9,317 $12,184
======= ======= =======
</Table>
As of December 31, 2001, Extendicare Inc. and/or one of its wholly owned
subsidiaries held $27.9 million, or 14.0%, of our outstanding senior
subordinated notes.
75
DESCRIPTION OF OTHER INDEBTEDNESS
NEW CREDIT FACILITY
Our new credit facility is governed by a credit agreement among us,
Extendicare Holdings, Inc., the several lenders from time to time party to the
credit agreement, Lehman Brothers Inc., as arranger, Lehman Commercial Paper
Inc., as administrative agent, and certain other financial institutions. The
following description is a summary of the material provisions of our new credit
facility. It does not include all of the provisions of the credit agreement and
the ancillary agreements required thereby. We have filed the credit agreement as
an exhibit to the registration statement of which this prospectus is a part. Our
new credit facility is a senior secured revolving credit facility providing for
loans of up to $105.0 million. The new credit facility will terminate on June
28, 2007. As a secured obligation, the credit facility is effectively senior in
right of payment to the new notes to the extent of the value of the collateral
securing the credit facility. The new credit facility will be used for our
working capital needs and other general corporate purposes.
Interest Rate; Fees. All borrowings drawn during the first four fiscal
quarters following closing of the new credit facility will initially bear
interest, at our option, at a rate per annum equal to:
- LIBOR, plus 3.50%; or
- the Base Rate, as defined in the new credit facility (generally the
published prime rate), plus 2.50%;
thereafter, in each case, subject to adjustments based on changes in our senior
leverage ratio. The spread over LIBOR ranges from 3.00% per annum to 4.00% per
annum and the spread over the Base Rate ranges from 2.00% per annum to 3.00% per
annum.
In addition to paying interest on outstanding principal under the new
credit facility, we are required to pay a commitment fee to the lenders in
respect of the unutilized commitments under the facility. The commitment fee is
payable quarterly in arrears at a rate ranging from 0.50% per annum to 0.75% per
annum, depending on the extent to which we make use of the new credit facility.
Guarantees; Security. Our obligations under the new credit facility are
fully, unconditionally and irrevocably guaranteed on a joint and several basis
by:
- Extendicare Holdings, Inc., our direct parent;
- each of our current and future domestic subsidiaries excluding certain
inactive subsidiaries; and
- any other current or future foreign subsidiaries that guarantee or
otherwise provide direct credit support for any U.S. debt obligations of
ours or any of our domestic subsidiaries.
In addition, the new credit facility is secured by a perfected first
priority security interest in certain of our tangible and intangible assets,
including substantially all of our personal property such as accounts
receivable, inventory, equipment and intangibles; by mortgages on the real
estate associated with 105 of our facilities; and by all of our and our
subsidiary guarantors' capital stock. The new credit facility is also secured by
a pledge of 65% of the voting stock of our and our subsidiary guarantors'
foreign subsidiaries, if any.
Repayment. All or any portion of the outstanding loans under the new credit
facility may be prepaid at any time and commitments may be terminated in whole
or in part at our option without premium or penalty. The new credit facility is
subject to various mandatory prepayments from the net cash proceeds received by
us in connection with the incurrence of other indebtedness, from net cash
proceeds of some asset sales, from amounts recovered by us in connection with
casualty losses and condemnation events, and from purchase price refunds
received by us in connection with acquisitions.
76
Certain Financial Covenants. The new credit facility requires that we
comply with various financial covenants, on a consolidated basis, including:
- a minimum fixed charge coverage ratio starting at 1.10 to 1 and
increasing to 1.20 to 1 in 2005;
- a minimum tangible net worth starting at 85% of our tangible net worth at
March 31, 2002 and increasing by 50% of our net income for each fiscal
quarter plus 100% of any additional equity we raise;
- a maximum senior leverage ratio starting at 4.25 to 1 and reducing to
4.00 to 1 in 2005; and
- a maximum senior secured leverage ratio starting at 1.75 to 1 and
reducing to 1.50 to 1 in 2005.
Disposition of Assets. Neither we nor our parent may dispose of property
now owned or which we may acquire in the future, nor may we issue or sell any
shares of our subsidiaries' stock, except as provided below:
- the sale of obsolete or worn out property in the ordinary course of
business;
- the sale of inventory in the ordinary course of business and the leasing,
as lessor, of our facilities in the ordinary course of business, provided
that the lease income will contribute to consolidated EBITDA, as defined
in the new credit facility, in an amount substantially equivalent to the
contribution of such facilities to consolidated EBITDA if such facilities
were operated by us;
- the sale of assets by our subsidiaries to us, and sale of assets by us to
our subsidiaries;
- the sale or issuance of any subsidiary's stock to us or other
subsidiaries;
- the disposition in the ordinary course of business of cash and cash
equivalents and other investment securities;
- the disposition of property in an asset swap, provided that the amount of
consolidated EBITDA attributed to such property, for the period of four
consecutive fiscal quarters most recently ended prior to the date of such
disposition, does not exceed $5,000,000, and the amount of consolidated
EBITDA attributable to property acquired in such a swap, for the period
of four consecutive fiscal quarters most recently ended prior to the date
of such disposition, is not less than 90% of the consolidated EBITDA for
such period of the asset swap;
- the disposition of our Texas nursing home operations (17 nursing homes
with a capacity of 1,421 residents) and our Florida facilities (32
facilities with 3,427 beds) in transactions resulting in receipt by us of
fair market value for the transferred properties;
- the disposition of notes or other non-cash consideration received in
connection with dispositions of our Texas nursing home operations and
Florida facilities referred to in the immediately preceding bullet point;
- the disposition of other assets in sales for fair market value, provided
that the aggregate amount of cash proceeds of such dispositions does not
exceed, while the new credit facility is in effect:
- $60,000,000, so long as, at the time of such disposition, the
consolidated senior secured leverage ratio, as defined in the new credit
facility, is not at least 0.50 lower than the maximum consolidated
senior secured leverage ratio permitted by the new credit facility at
the time of such disposition; or
- $100,000,000, so long as, at the time of such disposition, the
consolidated senior secured leverage ratio is at least 0.50 lower than
the maximum consolidated senior secured leverage ratio permitted
pursuant to the new credit facility at the time of such disposition, and
not more than 75% of cash proceeds of all such dispositions is
attributable to dispositions of properties subject to mortgages in favor
of lenders; and
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- any settlement of or payment in respect of any property or casualty
insurance claim or any condemnation proceeding relating to any asset,
provided that we prepay the loans by an amount equal to the amount of
cash proceeds from such settlement, and provided further, however, that
cash proceeds from such settlements combined with cash proceeds from
other dispositions of assets that do not exceed $20,000,000 in any fiscal
year may be excluded from such mandatory prepayment.
Additional Indebtedness and Guaranty Obligations. Neither we nor our parent
may incur or assume any indebtedness, except the following:
- indebtedness pursuant to the new credit facility;
- our indebtedness to any subsidiary and indebtedness of any wholly-owned
subsidiary guarantor to us or to any other subsidiary, provided that such
indebtedness is subordinated to our obligations under the new credit
facility;
- indebtedness in an aggregate principal amount not to exceed $5,000,000 at
any one time outstanding;
- indebtedness outstanding as of June 28, 2002 listed on a schedule to the
new credit facility and any refinancings, refundings, renewals or
extensions thereof, without any increase in the principal amount or any
shortening of the maturity of principal amount;
- guarantee obligations made in the ordinary course of business by us or
any of our subsidiaries of our obligations or those of any of our
subsidiary guarantors;
- indebtedness in respect of the senior notes in an aggregate principal
amount not to exceed $150,000,000;
- non-recourse debt that in an aggregate principal amount at any time
outstanding does not exceed:
- $50,000,000, at any time when our senior, unsecured, noncredit enhanced
debt is rated lower than either B1 or BB- by Moody's or Standard &
Poor's, respectively; or
- $75,000,000, at any time when our senior, unsecured, noncredit enhanced
debt is rated at least as high as B1 and BB- by Moody's and Standard &
Poor's, respectively;
- indebtedness of any subsidiary incurred in connection with the investment
by any subsidiary in the land, buildings and equipment of an aggregate of
seven nursing facilities located in Ohio and Indiana which investment
transactions closed on October 18, 2002 in an aggregate principal amount
not to exceed $10,200,000 and our guarantee obligations in respect
thereof;
- indebtedness in respect of existing letters of credit described in Annex
B attached to the new credit facility; and
- additional indebtedness in an aggregate principal amount not to exceed
$5,000,000 at any one time outstanding.
Optional Payments and Modifications of Debt Instruments. We may not make or
offer to make any optional or voluntary payment, prepayment, repurchase or
redemption of, or otherwise voluntarily or optionally defease the senior
subordinate notes or the senior notes, or segregate funds, for any such
purposes, or enter into any derivative or similar transaction with any party
obligating our parent, us or any of our subsidiaries to make payments to such
party as a result of any change in market value of the senior subordinated notes
or the senior notes. We may not repurchase or redeem any or all of the senior
notes or the senior subordinated notes upon occurrence of a change of control.
We may not amend, modify or change any terms of the senior subordinated notes or
the senior notes, other than those changes that would extend the maturity or
reduce the amount of any payment of principal, reduce the rate or extend the
date for payment of interest, or relax any covenant or other restriction
applicable to our parent, to us or to any of our subsidiaries, and which does
not involve the payment of a consent fee. We may not designate any indebtedness
other than our obligations under the new credit facility, as "designated senior
indebtedness"
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for the purposes of the senior subordinated note indenture. Neither our parent
nor we may amend our respective certificates of incorporation in any manner
adverse to the lenders.
Restricted Payments. Neither our parent nor we may declare or pay any
dividend on, or make any payment on the account of, or set apart assets for a
sinking fund for, the purchase, redemption, retirement or other acquisition of,
any capital stock of our parent, our capital stock, or capital stock of our
subsidiaries, or make any other distribution in respect thereof, or enter into
any derivatives or other similar transactions with any party obligating our
parent, us or any of our subsidiaries to make payments to such party as a result
of any change in market value of any such stock mentioned above. This limitation
does not apply to the following:
- any subsidiary making such restricted payments to us or to any subsidiary
guarantor; and
- disbursements made by us to our parent to permit our parent:
- to pay corporate expenses incurred in ordinary course of business and/or
to pay dividends to Extendicare Inc., to pay our parent's proportionate
share of corporate overhead expenses incurred in the ordinary course of
business, not to exceed $5,000,000 in any fiscal year; and
- and pay any taxes which are due and payable by our parent and by us as
part of a consolidated group, provided that the amount of taxes
allocated to us is determined on an arm's-length basis.
Creation of Liens. We may not create, incur or permit any liens on our
property, whether now owned or acquired in the future, except the following:
- liens for taxes not yet due or which are being contested in good faith by
appropriate proceedings, provided we maintain adequate reserves in
conformity with GAAP;
- mechanics' and similar liens arising in the ordinary course of business
which are not overdue for a period of more than 30 days or that are being
contested in good faith by appropriate proceedings;
- deposits or pledges in connection with workers' compensation,
unemployment insurance, and other related social security programs;
- deposits to secure the performance of bids, trade contracts, leases,
statutory obligations, surety bonds, performance bonds and other
obligations of a like nature, and letters of credit issued in support of
any of the foregoing, in each case incurred in the ordinary course of
business;
- easements and similar encumbrances incurred in the ordinary course of
business that, in aggregate, are not substantial in amount and which do
not in any case materially detract from the value of our property or
materially interfere with our ordinary course of business;
- existing liens securing existing indebtedness disclosed on schedules
attached to the new credit facility, provided that no such lien is spread
to cover any additional property, and the amount of indebtedness secured
is not increased;
- liens securing indebtedness incurred in connection with acquisition of
fixed or capital assets, provided that such liens are created
simultaneously with such acquisitions, such liens do not encumber any
property other than the property financed, and the amount of indebtedness
secured is not increased;
- liens in favor of the lenders created pursuant to the security documents
under the new credit facility;
- the interest of a lessor under any lease entered into by us or by our
subsidiaries in the ordinary course of business and covering only the
assets so leased;
- liens on land, buildings and equipment of an aggregate of seven nursing
facilities located in Ohio and Indiana acquired by us in a transaction
that closed on October 18, 2002;
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- liens securing non-recourse debt permitted under the new credit facility,
provided that such liens encumber only the assets financed with the
proceeds of such permitted non-recourse debt and the capital stock of any
non-recourse subsidiary created to incur such permitted nonrecourse debt;
and
- all other liens so long as neither the aggregate outstanding principal
amount of the obligations secured by such liens nor aggregate fair market
value of the assets subject to such liens exceeds $5,000,000 at any one
time, and such liens do not attach to any receivables or property subject
to a mortgage in favor of the lenders.
Investments. We may not make any advance, loan, extension of credit, by way
of guarantee or otherwise, or capital contribution to, or purchase any capital
stock, bonds, notes, debentures or other debt securities of, or any assets
constituting an ongoing business from, or make any other investment in, any
other person except:
- extensions of trade credit in ordinary course of business consistent with
past practice;
- investments that are issued or unconditionally guaranteed by the United
States government or any agency thereof, maturing within one year from
the date of acquisition;
- certificates of deposit, time deposits, Eurodollar time deposits or
overnight bank deposits having maturities of six months or less from the
date of acquisition issued by any lender or any commercial bank organized
under the laws of the United States or any state thereof having combined
capital and surplus of not less than $500,000,000;
- commercial paper rated at least A-2 by Standard & Poor's or P-2 by
Moody's;
- repurchase obligations of any lender or any commercial bank satisfying
the above requirements having a term of not more than 30 days with
respect to securities issued or fully guaranteed or insured by the United
States government;
- securities rated at least A by Standard & Poor's or A by Moody's with
maturities of one year or less from the date of acquisition issued or
fully guaranteed by any state of the United States, or any political
subdivision or taxing authority thereof;
- securities with maturities of six months or less backed by standby
letters of credit issued by any lender or any commercial bank satisfying
the requirements described above in the second bullet point of this
section;
- shares of money market mutual or similar funds which invest exclusively
in assets satisfying the requirements set forth above;
- our subordinated indebtedness and guarantee obligations to any
subsidiary, and subordinated indebtedness and guarantee obligations of
any wholly-owned subsidiary guarantor to us or any other subsidiary;
- advances for business expenses and loans to our employees, our parent's
employees and employees of our subsidiaries in the ordinary course of
business in an aggregate amount not to exceed $2.5 million at any one
time outstanding;
- investments in assets (other than inventory) useful in our business made
with proceeds received from any asset sale, insurance settlement or a
refund that does not have to be used to prepay the Loans under the new
credit facility;
- investments in our subsidiary guarantors;
- investments in the land, buildings, and equipment of an aggregate of
seven nursing facilities located in Ohio and Indiana which investment
transactions closed on October 18, 2002; and
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- additional investments and consolidated growth capital expenditures,
provided that
- such investments and expenditures are for the acquisition or improvement
of assets to be used in the same type of business that we are engaged in
on the date of the new credit facility;
- such investments and expenditures are not limited when the consolidated
senior leverage ratio is less than 2.50 to 1.00;
- the aggregate amount of all such investments and expenditures at any
time when the consolidated senior leverage ratio is greater than 2.50 to
1.00 may not exceed (A) $20,000,000 for any particular investment or
expenditure or (B) an aggregate amount of all such investments and
expenditures while the new credit facility is in effect of $60,000,000
plus, at any time when the consolidated senior secured leverage ratio is
at least 0.25 lower than the maximum level permitted, an additional
amount, not exceeding $30,000,000 in aggregate, equal to the aggregate
net cash proceeds from asset sales; and
- that no default or event of default has occurred and is continuing.
Mergers or Consolidations. We may not enter into any merger or
consolidation and we may not liquidate, wind up or dissolve ourselves or dispose
of all or substantially all of our property or business, except that any of our
subsidiaries may be merged or consolidated with us, provided that we are the
continuing or surviving corporation, or with or into any subsidiary guarantor
provided that the subsidiary guarantor is the continuing or surviving
corporation or simultaneously with such transaction, the continuing or surviving
corporation becomes a subsidiary guarantor and appropriate amendments to the
guarantee and collateral agreement are made; and any subsidiary may dispose of
any or all of its assets, upon voluntary liquidation or otherwise, to us or any
subsidiary guarantor.
Capital Expenditures. We may not make or commit to make any expenditures
for the acquisition or leasing of fixed or capital assets or additions to
equipment which are required to be capitalized under GAAP on our balance sheet,
except for the following:
- capital expenditures in the ordinary course of business, other than
expenditures representing the purchase price for the acquisition,
construction or expansion of a facility, provided that in determining
such expenditures, for any period which includes any date on or prior to
the date of disposition of the facilities in Texas and Florida, all
capital expenditures attributable to these properties are not included;
- capital expenditures made with the proceeds received from sale of assets
and insurance settlements which do not have to be used for mandatory
prepayment of loans; and
- consolidated growth capital expenditures otherwise permitted under the
new credit facility. See "-- Investments."
New Lines of Business. We may not enter into any business, either directly
or through any subsidiary, except for those businesses in which we are engaged
on the date of the new credit facility or that are reasonably related thereto.
Transactions with Affiliates. We may not enter into any transaction,
including, without limitation, any purchase, sale, lease or exchange of
property, the rendering of any service or the payment of any management,
advisory, or similar fees, with any affiliate of ours, other than our parent or
any subsidiary guarantor, unless such transaction is:
- otherwise permitted under the new credit facility;
- is in our ordinary course of business; and
- is not upon terms that are less favorable to us, our parent or such
subsidiary than would have been obtained in a comparable arm's-length
transaction with a person that is not an affiliate.
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Other Covenants. The new credit facility also contains other usual and
customary negative and affirmative covenants.
Events of Default. The new credit facility contains events of default
including, subject to customary cure periods and materiality thresholds:
- failure to make payments when due;
- material inaccuracies of representations and warranties;
- breach of covenants;
- certain cross-defaults and cross-accelerations;
- events of insolvency, bankruptcy or similar events;
- certain judgments against us;
- certain occurrences with respect to employee benefit plans;
- failure to remain eligible or participate in Medicaid or Medicare
programs;
- failure of guarantees to remain in effect;
- failure of certain liens and security documents to remain enforceable;
- the occurrence of an event of default under any mortgage;
- the senior subordinated notes or guarantees of the senior subordinated
notes cease to be subordinated to the obligations under the new credit
facility and the credit facility guarantees; and
- the occurrence of a change in control.
If such a default occurs, the lenders under the new credit facility would
be entitled to take various actions, including all actions permitted to be taken
by a secured creditor, the acceleration of amounts due under the new credit
facility and requiring that all such amounts be immediately paid in full.
9.35% SENIOR SUBORDINATED NOTES DUE 2007
We issued $200.0 million aggregate principal amount of senior subordinated
notes under an indenture dated December 1, 1997 among us, the guarantors (as
defined in the indenture), and the Bank of Nova Scotia Trust Company of New
York, as trustee in connection with our acquisition of Arbor Health Care
Company. The senior subordinated notes mature on December 15, 2007 and are
callable on December 15, 2002 at 104.675% of par. Interest on the senior
subordinated notes accrues at the rate of 9.35% per year and is payable
semiannually on each June 15 and December 15, to the persons who are registered
holders at the close of business on the May 31 or November 30 next preceding the
applicable interest payment date.
The following description is a summary of the material provisions of our
1997 indenture. It does not include all of the provisions of the 1997 indenture
and the ancillary agreements required thereby. We have filed our 1997 indenture
as an exhibit to our registration statement on Form S-4 filed with the SEC on
December 31, 1997.
Subordination. The senior subordinated notes are our unsecured obligations
and are junior in right of payment to all of our senior debt, including the
notes. The senior subordinated notes are also effectively junior in right of
payment to all of the senior debt of the subsidiary guarantors of the senior
subordinated notes.
Redemption. We may redeem the senior subordinated notes at our option, in
whole or in part, upon not less than 30 nor more than 60 days' notice, at the
redemption prices set forth below plus accrued and
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unpaid interest, if any, to the applicable redemption date, if redeemed during
the twelve-month period beginning on December 15, of the years indicated below:
<Table>
<Caption>
YEAR PERCENTAGE
---- ----------
2002........................................................ 104.675%
2003........................................................ 103.117%
2004........................................................ 101.558%
2005 and thereafter......................................... 100.000%
</Table>
Change of Control. If we experience a change of control, as defined in the
1997 indenture, each holder of the senior subordinated notes has the right to
require that we purchase all or a portion of such holder's senior subordinated
notes at a purchase price equal to 101% of the principal amount of the senior
subordinated notes plus accrued and unpaid interest to the date of purchase.
Asset Sales. We will not, and will not permit any of our restricted
subsidiaries, as defined in the 1997 indenture, to, directly or indirectly,
engage in an asset sale, as defined in the 1997 indenture, unless:
(i) we receive consideration at the time of such asset sale at least
equal to the fair market value of the assets sold or otherwise disposed of;
and
(ii) at least 75% of the consideration received by us is in the form
of cash or cash equivalents, provided that the principal amount of any
indebtedness, as defined in the 1997 indenture, for money borrowed, as
reflected on our consolidated balance sheet, as defined in the 1997
indenture:
(a) is assumed by any transferee of any such assets or other
property in such asset sale; or
(b) with respect to the sale or other disposition of all of the
capital stock, as defined in the 1997 indenture, of any restricted
subsidiary, remains the liability of such subsidiary subsequent to such
sale or other disposition, but only to the extent that such assumption,
sale or other disposition, as the case may be, is effected on a basis
under which there is no further recourse to us or any of our restricted
subsidiaries with respect to such liability, shall be deemed to be cash
for purposes of this provision.
We may apply, and may permit our restricted subsidiaries to apply, an
amount equal to net proceeds of an asset sale, at our option, within 365 days
after the consummation of such an asset sale:
(i) to permanently reduce indebtedness under the credit agreement,
dated as of November 26, 1997, by and among us, Extendicare Holdings, Inc.
and the subsidiary guarantors (as defined in the credit agreement) and
Nations Bank, N.A., as agent, and the lenders (as defined in the credit
agreement), and to correspondingly reduce the commitments, if any, with
respect to the 1997 credit agreement;
(ii) to permanently reduce our senior indebtedness, as defined in the
1997 indenture, or any senior indebtedness of a guarantor, as defined in
the 1997 indenture; or
(iii) to acquire all or substantially all of the assets of, a majority
of the voting stock of or other long-term assets of another permitted
business, as defined in the 1997 indenture.
Pending the final application of any such net proceeds, as defined in the
1997 indenture, we may temporarily reduce senior revolving debt or otherwise
invest such net proceeds temporarily in cash equivalents.
Any net proceeds from asset sales that are not applied within the 365-day
period will be deemed to constitute excess proceeds, as defined in the 1997
indenture. When the aggregate amount of excess proceeds exceeds $15.0 million,
we will be required to make an offer to all holders of notes and additional
notes, if any, to purchase, on a pro rata basis, the principal amount of notes
and additional notes, if any, equal in amount to the excess proceeds, and not
just the amount thereof that exceeds $15.0 million, at a purchase price in cash
in an amount equal to 100% of the principal amount thereof plus accrued and
unpaid interest thereon to the date of purchase, in accordance with the
procedures set forth in the 1997 indenture. If the aggregate principal amount of
notes and additional notes, if any, surrendered by the holders of such notes
exceeds the amount of excess proceeds, the trustee shall select the notes and
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additional notes to be purchased on a pro rata basis. Upon completion of such
offer to purchase, the amount of excess proceeds shall be reset at zero, subject
to any subsequent asset sale.
In the event of the transfer of substantially all, but not all, of our
property and assets and the property and assets of our restricted subsidiaries
as an entirety to a person in a transaction permitted under "Merger,
Consolidation or Sale of Assets" below, the successor corporation will be deemed
to have sold our properties and assets and the properties and assets of our
restricted subsidiaries not so transferred for purposes of this covenant, and
will comply with the provisions of this covenant with respect to such sale as if
it were an asset sale. In addition, the fair market value of such properties and
assets sold shall be deemed to be net proceeds for purposes of this covenant.
If at any time we or any of our restricted subsidiaries convert into or
sell or otherwise dispose of for cash any non-cash consideration we receive in
connection with any asset sale, then such conversion or disposition will
constitute an asset sale under this covenant and the net proceeds of such
conversion or disposition will be applied in accordance with this covenant.
We will comply with the requirements of Section 14(e) of, and Rule 14e-1
under, the Exchange Act and any other securities laws and regulations thereunder
to the extent such laws and regulations are applicable in connection with the
repurchase of the notes and additional notes, if any, as a result of a change of
control or an asset sale.
Restricted Payments. We will not, and will not permit any of our restricted
subsidiaries to, directly or indirectly:
(i) declare or pay any dividend or make any distribution, whether in
cash, securities or other property, on account of any class of our equity
interests, as defined in the 1997 indenture, or to holders thereof,
including, without limitation, any payment in connection with any merger or
consolidation in which we are involved, other than dividends or
distributions payable solely in our equity interests, other than
disqualified stock, as defined in the 1997 indenture, or to us;
(ii) purchase, redeem or otherwise acquire or retire for value any of
our equity interests other than any equity interests owned by us;
(iii) make any principal payment on, or purchase, redeem, defease or
otherwise acquire or retire for value any of our indebtedness that is pari
passu with or subordinated to the notes or the guarantees prior to any
scheduled repayment date, mandatory sinking fund payment date or final
maturity date, except at final maturity, other than through our purchase,
redemption or acquisition of our indebtedness through the issuance in
exchange therefor of equity interests, other than disqualified stock; or
(iv) make any restricted investment, unless, at the time of and after
giving effect to such restricted payment:
(a) no default, as defined in the 1997 indenture, or event of
default, as defined in the 1997 indenture, shall have occurred and be
continuing or would occur as a consequence of the restricted payment;
(b) we would, at the time of such restricted payment and after
giving pro forma effect thereto as if such restricted payment had been
made at the beginning of the applicable four-quarter period, have been
permitted to incur at least $1.00 of additional indebtedness pursuant to
the fixed charge coverage ratio test set forth in the second paragraph
of "Incurrence of Indebtedness and Issuance of Preferred Stock"
covenant; and
(c) such restricted payment, together with the aggregate amount of
all other restricted payments made by us and our restricted subsidiaries
after the date of the 1997 indenture, excluding restricted payments
permitted by paragraphs (ii), (iii) and (iv) below, is less than the sum
of:
- 50% of our consolidated net income, as defined in the 1997
indenture, for the period, taken as one accounting period, from the
beginning of the first fiscal quarter commencing
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after the date of the 1997 indenture to the end of our most
recently ended fiscal quarter for which internal financial
statements are available at the time of such restricted payment,
or, if such consolidated net income for such period is a deficit,
less 100% of such deficit; plus
- 100% of the aggregate net cash proceeds received by us since the
date of the 1997 indenture from the issue or sale of our equity
interests or our debt securities that have been converted into such
equity interests, other than equity interests or convertible debt
securities, sold to one of our restricted subsidiaries or
unrestricted subsidiaries and other than disqualified stock or debt
securities that have been converted into disqualified stock or from
a contribution to our capital; plus
- an amount equal to the net reduction in restricted investments by
us and our restricted subsidiaries, after the date of the 1997
indenture, upon the disposition, liquidation or repayment,
including by way of dividends, thereof, but only to the extent such
amounts are not included in consolidated net income and not to
exceed in the case of any restricted investment, the amount of the
restricted investment previously made by us and our restricted
subsidiaries; plus
- $10 million.
The preceding paragraphs (b) and (c) will not prohibit:
(i) the payment of any dividend within 60 days after the date of
declaration of the dividend, if at the date of declaration such payment
would have complied with the provisions of the 1997 indenture;
(ii) the making of any restricted investment in exchange for, or out
of the proceeds of, the substantially concurrent sale, other than to a
restricted subsidiary or to any unrestricted subsidiary, of our equity
interests, other than disqualified stock, or from a contribution to our
capital; provided that any net cash proceeds that are utilized for any such
restricted investment, and any net income resulting from such sale, shall
be excluded from paragraph (c);
(iii) the redemption, repurchase, retirement or other acquisition of
any of our equity interests in exchange for, or out of the proceeds of, the
substantially concurrent sale of other of our equity interests, other than
any disqualified stock, as defined in the 1997 indenture, or from a
contribution to our capital; provided that any net cash proceeds that are
utilized for any such acquisition, and any net income resulting from such
acquisition, shall be excluded from paragraph (c); or
(iv) the defeasance, redemption or repurchase of pari passu or
subordinated indebtedness with the net cash proceeds from an incurrence of
permitted refinancing indebtedness or the substantially concurrent sale,
other than to a restricted subsidiary of our equity interests, other than
disqualified stock, or from a contribution to our capital; provided that
any net cash proceeds that are utilized for any such transaction, and any
net income resulting from such transaction, shall be excluded from
paragraph (c).
The amount of all restricted payments, other than cash, shall be the fair
market value on the date of the restricted payment of the asset(s) proposed to
be transferred, pursuant to the restricted payment. Not later than the date of
making any restricted payment we will deliver to the trustee an officers'
certificate stating that all such restricted payments are permitted and we will
set forth the basis upon which the calculations required by this covenant were
computed.
Incurrence of Indebtedness and Issuance of Preferred Stock. We will not,
and will not permit any of our restricted subsidiaries to, directly or
indirectly, create, incur, issue, assume, guaranty or otherwise become directly
or indirectly liable, with respect to any indebtedness, including acquired
indebtedness, as defined in the 1997 indenture, and we will not issue any
disqualified stock and will not permit any of our
85
restricted subsidiaries to issue any shares of preferred stock; provided,
however, that we may incur indebtedness, including acquired indebtedness, and we
may issue shares of disqualified stock if:
(i) the fixed charge coverage ratio for our most recently ended four
full fiscal quarters for which internal financial statements are available
immediately preceding the date on which such additional indebtedness is
incurred or such disqualified stock is issued would have been equal to at
least 2.25 to 1, determined on a pro forma basis, including a pro forma
application of the net proceeds, as if the additional indebtedness had been
incurred, or the disqualified stock had been issued, as the case may be, at
the beginning of such four-quarter period; and
(ii) no default or event of default will have occurred or would occur
as a consequence thereof.
This covenant will not prohibit the incurrence of any of the following
items of indebtedness by the subsidiary guarantors:
(a) our incurrence of indebtedness under the 1997 credit agreement and
the guarantees thereof by the subsidiary guarantors, provided that the
aggregate principal amount at any time outstanding, with letters of credit
being deemed to have a principal amount equal to the maximum potential
liability and our restricted subsidiaries thereunder, will not exceed $600
million, after giving effect to the repayment of the loan under the 1997
credit agreement with the proceeds of the offering of the outstanding
notes, less the aggregate amount of all net proceeds of asset sales applied
to permanently reduce the outstanding amount or the commitments with
respect to such indebtedness described under "Asset Sales";
(b) the incurrence by us and the guarantors of indebtedness
represented by the notes, other than the additional notes, and the note
guarantees;
(c) the incurrence by us and the guarantors of existing indebtedness,
as defined in the 1997 indenture;
(d) the incurrence by us of permitted refinancing indebtedness, as
defined in the 1997 indenture, in exchange for, or the net proceeds of
which are used to refund, refinance or replace any indebtedness that is
permitted to be incurred under paragraphs (b) and (c) above;
(e) the incurrence by us or any of our restricted subsidiaries of
intercompany indebtedness owed to us or any of the subsidiary guarantors;
provided that, in the case of our indebtedness, such obligations shall be
unsecured and subordinated in all respects to our obligations pursuant to
the notes; and provided, however, that:
- any subsequent issuance or transfer of equity interests that results
in any such indebtedness being held by a person other than us or a
wholly owned restricted subsidiary, as defined in the 1997 indenture;
and
- any sale or other transfer of any such indebtedness to a person that
is not either us or our wholly owned restricted subsidiary shall be
deemed, in each case, to constitute an incurrence of such indebtedness
by us or our restricted subsidiary, as the case may be.
(f) the incurrence by us or any guarantor of hedging obligations, as
defined in the 1997 indenture;
(g) the incurrence by us or any guarantor of indebtedness represented
by capital lease obligations, as defined in the 1997 indenture, mortgage
financings or purchase money obligations, as defined in the 1997 indenture,
in each case incurred for the purpose of financing all or any part of the
purchase price or cost of construction or improvement of property, plant or
equipment used in our business or the business of a guarantor, in an
aggregate principal amount, including all permitted refinancing
indebtedness incurred to refund, refinance or replace any indebtedness
incurred pursuant to this paragraph (g), not to exceed 3.5% of consolidated
tangible assets, as defined in the 1997 indenture, at any time outstanding;
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(h) the incurrence by us and any guarantor of indebtedness permitted
under the first paragraph of this covenant or paragraph (d) of this
covenant; and
(i) the incurrence by us and our restricted subsidiaries of
indebtedness, in addition to indebtedness permitted by any other clause of
this paragraph, in an aggregate principal amount at any time outstanding
not to exceed $25 million.
For purposes of determining compliance with this covenant, in the event
that an item of indebtedness outstanding or to be incurred meets the criteria of
more than one of the types of indebtedness described in the previous paragraphs,
we, in our sole discretion, may classify such item of indebtedness and only be
required to include the amount and type of such indebtedness in one of such
clauses.
Liens. We will not, and will not permit any of our restricted subsidiaries
to, directly or indirectly, create, incur, assume or suffer to exist any lien,
as defined in the 1997 indenture, on any of its assets securing any indebtedness
other than senior indebtedness, unless the notes, in our case, or the note
guarantees, in the case of the guarantors, are secured equally and ratably with
such other indebtedness; provided that, if such other indebtedness is by its
terms expressly subordinate to the notes or the note guarantees, the lien
securing such subordinate or junior indebtedness shall be subordinate and junior
to the lien securing the notes or the note guarantees with the same relative
priority as such subordinated or junior indebtedness shall have with respect to
the notes or the note guarantees.
Dividend and Other Payment Restrictions Affecting Restricted
Subsidiaries. We will not, and will not permit any of our restricted
subsidiaries to, directly or indirectly, create, permit to exist or become
effective any encumbrance or restriction on the ability of any restricted
subsidiary to:
(i) pay dividends or make any other distributions to us or any other
of our restricted subsidiaries on its capital stock or with respect to any
other interest or participation in, or measured by, its profits, or pay any
indebtedness owed to us or any of our restricted subsidiaries;
(ii) make loans or advances to us or any of our restricted
subsidiaries;
(iii) sell, lease or transfer any of its properties or assets to us or
any of our restricted subsidiaries; or
(iv) guarantee our obligations evidenced by the notes or any renewals,
refinancings, replacements, refundings or extensions thereof, except for
such encumbrances or restrictions existing under or by reason of:
(a) existing indebtedness as in effect on the date of the 1997
indenture;
(b) the 1997 credit agreement as in effect on the date of the 1997
indenture, and any amendments, modifications, restatements, renewals,
increases, supplements, refundings, replacements or refinancings of the
1997 credit agreement, provided that such amendments, modifications,
restatements, renewals, increases, supplements, refundings, replacements
or refinancings are no more restrictive with respect to such dividend
and other payment restrictions than those contained in the 1997 credit
agreement as in effect on the date of the 1997 indenture;
(c) the 1997 indenture, the notes and the note guarantees;
(d) applicable law;
(e) any instrument governing acquired indebtedness or capital stock
of a person acquired by us or any of our restricted subsidiaries as in
effect at the time of such acquisition, except to the extent such
acquired indebtedness was incurred in connection with or in
contemplation of such acquisition, which encumbrance or restriction is
not applicable to any person, or the properties or assets of any person,
other than the person, or the property or assets of the person, so
acquired, provided that in the case of indebtedness, such indebtedness
was permitted by the terms of the 1997 indenture to be incurred;
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(f) any document or instrument governing indebtedness incurred
pursuant to paragraph (g) under the caption "Incurrence of Indebtedness
and Issuance of Preferred Stock," provided that any such restriction
contained in such paragraph relates only to the asset or assets
constructed or acquired in connection therewith;
(g) any instrument that is a lease, license, conveyance or contract
or similar property or asset entered into or acquired in the ordinary
course of business and consistent with past practices that restricts in
a customary manner the subletting, assignment or transfer of any
property;
(h) permitted refinancing indebtedness of indebtedness described in
paragraphs (a), (b) and (d) of this covenant, provided that the
restrictions contained in the agreements governing such permitted
refinancing indebtedness are no more restrictive than those contained in
the agreements governing the indebtedness being refinanced;
(i) secured indebtedness otherwise permitted to be incurred
pursuant to the provisions described under "Liens" the terms of which
limit the right of the debtor to dispose of the assets securing such
indebtedness; or
(j) any agreement entered into for the direct or indirect sale or
disposition of all or substantially all of the capital stock or assets
of such restricted subsidiary, provided that the transaction
contemplated thereby shall be consummated not later than 90 days after
the date of such agreement.
Limitation on Layering Debt. The 1997 indenture provides that we and each
guarantor will not incur, create, issue, assume, guarantee or otherwise become
liable for any indebtedness or guarantee, as applicable, that is subordinate or
junior in right of payment to any senior indebtedness and senior in any respect
in right of payment to the notes or such guarantor's note guarantee,
respectively.
Line of Business. We will not, and will not permit any of our restricted
subsidiaries to, engage to any material extent, in any business other than the
ownership, operation and management of nursing facilities and related
businesses.
Merger, Consolidation or Sale of Assets. We will not, and we will not
permit any restricted subsidiary to, in a single transaction or series of
related transactions consolidate or merge with or into, other than the
consolidation or merger of one of our wholly owned restricted subsidiaries with
another of one of our wholly owned restricted subsidiaries or into us, or
directly and/or indirectly through our restricted subsidiaries sell, assign,
transfer, lease, convey or otherwise dispose of all or substantially all of our
or our restricted subsidiaries' properties or assets determined on a
consolidated basis for our restricted subsidiaries taken as a whole, in one or
more related transactions to, another corporation, person or entity unless:
(i) either:
(a) we, in a transaction involving us, or such restricted
subsidiary, in a transaction involving a restricted subsidiary, are the
surviving corporation; or
(b) in a transaction involving us or such restricted subsidiary,
the entity or the person formed by or surviving any such consolidation
or merger or to which such sale, assignment, transfer, lease, conveyance
or other disposition was made is a corporation organized or existing
under the laws of the United States of America and expressly assumes all
of our obligations under the notes and the 1997 indenture or such
restricted subsidiary under the relevant note guarantee and the 1997
indenture, as the case may be, pursuant to a supplemental indenture in a
form reasonably satisfactory to the trustee;
(ii) immediately after such transaction no default or event of default
exists;
(iii) in the case of a transaction involving us, we, or the entity or
person formed by or surviving any such consolidation or merger, or to which
such sale, assignment, transfer, lease, conveyance or other disposition was
made, will, at the time of the transaction and after giving pro forma
effect to
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such transaction as if such transaction had occurred at the beginning of
the applicable four-quarter period, be permitted to incur at least $1.00 of
additional indebtedness pursuant to the fixed charge coverage ratio test
set forth in the first paragraph of the covenant described above under the
caption "Incurrence of Indebtedness and Issuance of Preferred Stock;"
(iv) if, as a result of any such transaction, our or our guarantor's
property or assets would become subject to a lien securing indebtedness not
permitted by the terms of the 1997 indenture described above under the
caption "Liens," we, any such guarantor or the surviving entity, as the
case may be, will have secured the notes and the relevant note guarantee,
as required by such provisions; and
(v) we will have delivered to the trustee an officers' certificate
and, except in the case of a merger of a restricted subsidiary into us or
into another of our wholly owned restricted subsidiaries, an opinion of
counsel, each stating that such transaction and any supplemental indenture
with respect thereto, comply with all of the terms of this covenant and
that all conditions precedent provided for in this provision relating to
such transaction or series of transactions have been complied with.
For purposes of this covenant, the transfer of all or substantially all of
the properties or assets of one or more of our restricted subsidiaries, the
capital stock of which constitutes all or substantially all of our properties
and assets, will be deemed to be the transfer of all or substantially all of our
properties and assets.
Transactions with Affiliates. We will not permit any of our restricted
subsidiaries to, directly or indirectly, after the date of the 1997 indenture,
in any one transaction or a series of related transactions, enter into any
affiliate transaction, other than exempt affiliate transactions, unless:
(i) such affiliate transaction is on terms that are no less favorable
to us or the relevant restricted subsidiary than those that would have been
obtained in a comparable arm's length transaction by us or such restricted
subsidiary with a person that is not an affiliate and
(ii) the Company delivers to the trustee:
(a) with respect to any affiliate transaction entered into after
the date of the 1997 indenture involving aggregate consideration in
excess of $5.0 million, a resolution of our Board of Directors set forth
in an officers' certificate certifying that such affiliate transaction
complies with clause (i) above and that such affiliate transaction has
been approved by a majority of the disinterested members of our Board of
Directors or, if there are no disinterested members of the Board of
Directors at the time, a written opinion issued by an independent
financial advisor of national standing that such affiliate transaction
is fair to us or such restricted subsidiary, as the case may be, from a
financial point of view; and
(b) with respect to any affiliate transaction involving aggregate
consideration in excess of $10.0 million, a written opinion issued by an
independent financial advisor of national standing that such affiliate
transaction is fair to us or such restricted subsidiary, as the case may
be, from a financial point of view.
Limitation on Issuances and Sales of Capital Stock of Restricted
Subsidiaries. We will not permit any restricted subsidiary to issue any capital
stock, other than to us, or one of our wholly owned restricted subsidiaries and
we will not, and will not permit any restricted subsidiary to, transfer, convey,
sell, lease or otherwise dispose of any capital stock of any restricted
subsidiary to any person, other than to us or our wholly owned restricted
subsidiary; provided, however, that this covenant will not prohibit:
(i) the sale or other disposition of all, but not less than all, of
the issued and outstanding capital stock of a restricted subsidiary owned
by us and our restricted subsidiaries in compliance with the other
provisions of the 1997 indenture; or
(ii) the ownership by directors of director's qualifying shares or the
ownership by foreign nationals of capital stock of any restricted
subsidiary, to the extent mandated by applicable law.
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We will not permit any restricted subsidiary to issue any preferred stock.
Events of Default. The following events would be an event of default under
the senior subordinated notes:
- the failure to pay interest on the senior subordinated notes when the
same becomes due and payable and the default continues for a period of 30
days;
- the failure to pay the principal of or premium on any senior subordinated
note when due, if any;
- the failure to perform or comply with:
- limitations concerning the consolidation, merger or disposal of all or
substantially all of our assets;
- limitations concerning the issuance of additional indebtedness and/or
preferred stock by us or any of our subsidiaries;
- limitations concerning the payment of dividends and/or special
distributions to our shareholders, our redemption of any outstanding
equity interest for value, or our principal payment of any outstanding
indebtedness subordinate to the senior subordinated notes;
- our obligation to buy back the senior subordinated notes in the event of
a change in control; or
- limitations concerning certain dispositions of our assets or the assets
of our subsidiaries to another corporation, person or entity;
in each case, within the time periods specified in the 1997 indenture;
- the default in the performance, or breach, of any covenant or agreement
of us or any subsidiary guarantor, other than a default in the
performance, or breach, of a covenant or agreement that is specifically
dealt with elsewhere in the 1997 indenture, and the default or breach
continues for a period of 60 days after the trustee has given us or the
holders of at least 25% aggregate principal amount of the senior
subordinated notes then outstanding have given us and the trustee a
written notice specifying such default or breach and requiring it to be
remedied and stating that such notice is a "Notice of Default;"
- an event of default under any mortgage, indenture or instrument under
which there may be issued or by which there may be secured or evidenced
any indebtedness for money borrowed by us or any of our restricted
subsidiaries (or the payment of which is guaranteed by us or any of our
restricted subsidiaries), which default:
- is caused by a failure to pay principal of such indebtedness at final
maturity of such indebtedness; or
- results in the acceleration of such indebtedness prior to its express
maturity; and
in each case, the principal amount of any such indebtedness, together with
the principal amount of any other such indebtedness as to which there has
been a payment default or the maturity of which has been so accelerated,
exceeds in the aggregate $20 million;
- the failure by us or any of our restricted subsidiaries to pay one or
more final judgments the uninsured portion of which exceeds in the
aggregate $20,000,000, which judgment or judgments are not paid,
discharged or stayed for a period of 60 days;
- any judicial proceeding holds any guarantee of the senior subordinated
notes to be unenforceable or invalid or any guarantee of the senior
subordinated notes ceases to be in full force and effect, other than in
accordance with the terms of the indenture related to the senior
subordinated notes, or any such guarantor denies that it has any further
liability under any senior subordinated note guarantee, or gives notice
to such effect, other than by reason of the termination of the 1997
indenture or the release of any such senior subordinated note guarantee
in accordance with the 1997 indenture;
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- the entry of a decree or order by a court having jurisdiction adjudging
us or any restricted subsidiary as bankrupt or insolvent, or approving as
properly filed a petition seeking reorganization, arrangement,
adjustments or composition of or in respect of us or any restricted
subsidiary under the Federal Bankruptcy Code or any other applicable
federal or state law, or appointing a receiver, trustee or other similar
official of us or any restricted subsidiary or of any substantial part of
our property, or ordering the winding up or liquidation of our affairs,
and any such decree or order continues unstayed and in effect for a
period of 90 consecutive days; or
- our institution or any restricted subsidiary's institution of proceedings
to be adjudicated as bankrupt or insolvent, or the consent by us or them
to the institution of bankruptcy or insolvency proceedings against us or
them, or the filings by us or them of a petition or answer or consent
seeking reorganization or relief under the Federal Bankruptcy Code or any
other applicable federal or state law, or the consent by us or them to
the filing of any such petition or to the appointment of a receiver,
trustee or other similar official of us or them or of any substantial
part of our or their property, or the making by us or them of an
assignment for the benefit of creditors, or the admission by us or them
in writing of our or their inability to pay our or their debts generally
as they become due.
If an event of default shall occur and be continuing, other than a default
upon certain events of bankruptcy or insolvency, the trustee or the holders of
at least 25% in aggregate principal amount of outstanding senior subordinated
notes may, and the trustee at the request of such holders will, declare the
principal of and accrued interest on all the outstanding senior subordinated
notes to be immediately due and payable and, upon any such declaration, such
principal and such interest will become due and payable immediately.
If an event of default occurs because a court declares us or any of our
restricted subsidiaries bankrupt or insolvent or because we or any of our
restricted subsidiaries institute bankruptcy or insolvency proceedings and, in
each case, the default is continuing, then the principal of and accrued interest
on all of the outstanding senior subordinated notes will automatically become
and be immediately due and payable without any declaration or other act by the
trustee or any holder of the senior subordinated notes.
INDUSTRIAL DEVELOPMENT REVENUE BONDS
In connection with some of our acquisitions and related improvements, we
have borrowed the proceeds of industrial revenue bonds issued by various cities
in Minnesota and one city in Pennsylvania that cover the purchase price of such
acquired businesses. As of September 30, 2002, approximately $33.5 million of
these bonds were outstanding and senior to our outstanding long-term
indebtedness, including the notes and our senior subordinated notes. The bonds
mature between 2008 and 2014 and have interest rates between 1.40% and 6.25%.
Four of the bonds with principal amounts aggregating $32.0 million are secured
by irrevocable letters of credit totaling $33.0 million, which remained
outstanding following the issuance of the old notes.
OTHER DEBT
As of September 30, 2002, we had $4.9 million of other senior debt, $3.8
million of which was in the form of mortgage notes held by a seller of certain
facilities in Indiana. The mortgage notes are senior to our outstanding
long-term indebtedness, including the notes and our senior subordinated notes
with respect to such facilities. The mortgage debt has an interest rate of 7.25%
and matures in 2007. The remaining indebtedness is related to capital leases,
promissory notes and other obligations.
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DESCRIPTION OF THE NEW NOTES
We issued the old notes and we will issue the new notes under an indenture
among us, the Subsidiary Guarantors and U.S. Bank, N.A., as trustee. We refer to
the old notes and the new notes collectively as the notes. The terms of the
notes include those stated in the indenture and those made part of the indenture
by reference to the Trust Indenture Act of 1939.
The following description is a summary of the material provisions of the
indenture. It does not include all of the provisions of the indenture. We urge
you to read the indenture because it, and not this description, defines your
rights as holders of the notes. We have filed the indenture as an exhibit to the
registration statement of which this prospectus is a part. Copies of the
indenture are available as set forth below under "-- Additional Information."
Certain defined terms used in this description but not defined below under
"-- Certain Definitions" have the meanings assigned to them in the indenture. In
this description, "we," "us" and "our" refer only to Extendicare Health
Services, Inc. and not to any of its subsidiaries.
The registered Holder of a note will be treated as its owner of for all
purposes. Only registered Holders will have rights under the indenture.
BRIEF DESCRIPTION OF THE NOTES AND THE GUARANTEES
THE NOTES
The old notes are, and the new notes will be:
- our general unsecured obligations;
- senior in right of payment to all of our existing and any future
subordinated Indebtedness, including the Senior Subordinated Notes;
- pari passu in right of payment with all of our existing and any future
unsecured Indebtedness that is not by its terms expressly subordinated to
the notes;
- effectively junior in right of payment to our existing and future secured
Indebtedness, including up to $105.0 million under the Credit Agreement,
to the extent of the value of the collateral securing that Indebtedness;
and
- guaranteed by all of our existing and future domestic Significant
Subsidiaries, all of our existing and future Domestic Subsidiaries that
guarantee or incur any Indebtedness and any other existing or future
Significant Subsidiaries or Restricted Subsidiaries that guarantee or
otherwise provide direct credit support for Indebtedness of ours or any
of our Domestic Subsidiaries.
THE SUBSIDIARY GUARANTEES
Each subsidiary guarantee of the old notes is, and each subsidiary
guarantee of the new notes will be:
- a joint and several, full and unconditional, senior unsecured obligation
of each Subsidiary Guarantor;
- senior in right of payment to all existing and any future subordinated
Indebtedness, including the guarantees of the outstanding Senior
Subordinated Notes, of that Subsidiary Guarantor;
- pari passu in right of payment with all existing and any future
Indebtedness of that Subsidiary Guarantor that is not by its terms
expressly subordinated to the guarantee of the notes; and
- effectively junior in right of payment to the existing and future secured
Indebtedness of that Subsidiary Guarantor, including the guarantee of our
Credit Agreement, to the extent of the value of the collateral securing
that Indebtedness.
As of the date of the indenture, all of our existing subsidiaries were
"Restricted Subsidiaries." However, under the circumstances described below
under "-- Designation of Restricted and Unrestricted
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Subsidiaries," we are permitted to designate certain of our subsidiaries as
"Unrestricted Subsidiaries." Unrestricted Subsidiaries will not be subject to
many of the restrictive covenants in the indenture and will not guarantee the
notes.
As of September 30, 2002, we had approximately $388.1 million of
Indebtedness outstanding on a consolidated basis (including the old notes),
approximately $38.4 million of which was secured. As of September 30, 2002,
because we have $39.9 million of letters of credit outstanding under the new
credit facility, we had undrawn borrowing capacity of $65.1 million under the
Credit Agreement.
PRINCIPAL, MATURITY AND INTEREST
We will initially issue up to $150.0 million in aggregate principal amount
of new notes in exchange for a like amount of old notes. We may issue additional
notes from time to time after this offering. Any offering of additional notes is
subject to the "-- Incurrence of Indebtedness and Issuance of Preferred Stock"
covenant described below. The notes and any additional notes subsequently issued
under the indenture will be treated as a single class for all purposes under the
indenture, including, without limitation, waivers, amendments, redemptions and
offers to purchase. We will issue notes in denominations of $1,000 and integral
multiples of $1,000. The notes will mature on July 1, 2010.
Interest on the notes will accrue at the rate of 9 1/2% per annum and will
be payable semi-annually in arrears on January 1 and July 1, commencing on
January 1, 2003. We will make each interest payment to the Holders of record on
the immediately preceding December 15 and June 15.
Interest on the notes will accrue from the date of original issuance of the
old notes or, if interest has already been paid, from the date it was most
recently paid. Interest will be computed on the basis of a 360-day year
comprised of twelve 30-day months.
METHODS OF RECEIVING PAYMENTS ON THE NOTES
If a Holder has given wire transfer instructions to us, we will pay all
principal, interest and premium, if any, on that Holder's notes in accordance
with those instructions. All other payments on notes will be made at the office
or agency of the paying agent and registrar within the City and State of New
York unless we elect to make interest payments by check mailed to the Holders at
their address set forth in the register of Holders.
PAYING AGENT AND REGISTRAR FOR THE NOTES
The trustee will initially act as paying agent and registrar. We may change
the paying agent or registrar without prior notice to the Holders of the notes,
and we or any of our Subsidiaries may act as paying agent or registrar.
TRANSFER AND EXCHANGE
A Holder may transfer or exchange notes in accordance with the indenture.
The registrar and the trustee may require a Holder to furnish appropriate
endorsements and transfer documents in connection with a transfer of notes.
Holders will be required to pay all taxes due on transfer. We are not required
to transfer or exchange any note selected for redemption. Also, we are not
required to transfer or exchange any note for a period of 15 days before a
selection of notes to be redeemed.
SUBSIDIARY GUARANTEES
The old notes are, and the new notes will be, guaranteed on a senior
unsecured basis by all of our existing and future domestic Significant
Subsidiaries, all of our existing and future Domestic Subsidiaries that
guarantee or incur any Indebtedness and any other existing and future
Significant Subsidiaries or Restricted Subsidiaries that guarantee or otherwise
provide direct credit support for Indebtedness of ours or any of our Domestic
Subsidiaries. These Subsidiary Guarantees are and will be joint and several
obligations of the Subsidiary Guarantors. The obligations of each Subsidiary
Guarantor under its
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Subsidiary Guarantee are and will be limited as necessary to prevent that
Subsidiary Guarantee from constituting a fraudulent conveyance under applicable
law, after giving effect to all other obligations of that Subsidiary Guarantor
including its guarantee of all obligations under the Credit Agreement. See "Risk
Factors -- Risks Related to the Exchange Offer and the New Notes -- A court may
void the guarantees of the notes or subordinate the guarantees to other
obligations of our subsidiary guarantors."
A Subsidiary Guarantor may not sell or otherwise dispose of all or
substantially all of its assets to, or consolidate with or merge with or into
(whether or not such Subsidiary Guarantor is the surviving Person), another
Person, other than us or another Subsidiary Guarantor, unless:
(1) immediately after giving effect to that transaction, no Default or
Event of Default exists; and
(2) either:
(a) the Person acquiring the property in any such sale or
disposition or the Person formed by or surviving any such consolidation
or merger assumes all the obligations of that Subsidiary Guarantor under
the indenture, its Subsidiary Guarantee and the registration rights
agreement pursuant to a supplemental indenture satisfactory to the
trustee; or
(b) the Net Proceeds of such sale or other disposition are applied
in accordance with the provisions of the indenture relating to Asset
Sales.
The Subsidiary Guarantee of a Subsidiary Guarantor will be released:
(1) in connection with any sale or other disposition of all or
substantially all of the assets of that Subsidiary Guarantor (including by
way of merger or consolidation) to a Person that is not (either before or
after giving effect to such transaction) a Subsidiary of ours, if the sale
or other disposition complies with the provisions of the indenture relating
to Asset Sales;
(2) in connection with any sale of all of the Capital Stock of a
Subsidiary Guarantor to a Person that is not (either before or after giving
effect to such transaction) a Subsidiary of ours, if the sale complies with
the provisions of the indenture relating to Asset Sales; or
(3) if we designate any Restricted Subsidiary that is a Subsidiary
Guarantor as an Unrestricted Subsidiary in accordance with the applicable
provisions of the indenture.
See "-- Repurchase at the Option of Holders -- Asset Sales."
OPTIONAL REDEMPTION
On or prior to July 1, 2005, we may on one or more occasions redeem up to
35% of the aggregate principal amount of notes issued under the indenture at a
redemption price of 109.500% of the principal amount thereof, plus accrued and
unpaid interest and Liquidated Damages, if any, to the redemption date, with the
net cash proceeds of any Qualified Equity Offering of our common stock; provided
that:
(1) at least 65% of the aggregate principal amount of notes issued
under the indenture remains outstanding immediately after the occurrence of
such redemption (excluding notes held by us and our Subsidiaries); and
(2) the redemption occurs within 90 days of the date of the closing of
such Qualified Equity Offering.
Except pursuant to the preceding paragraph, the notes will not be
redeemable at our option prior to July 1, 2006.
On or after July 1, 2006, we may redeem all or a part of the notes upon not
less than 30 nor more than 60 days' notice, at the redemption prices (expressed
as percentages of principal amount) set forth
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below plus accrued and unpaid interest on the notes redeemed, to the applicable
redemption date, if redeemed during the twelve-month period beginning on July 1
of the years indicated below:
<Table>
<Caption>
YEAR PERCENTAGE
- ---- ----------
2006........................................................ 104.750%
2007........................................................ 102.375%
2008 and thereafter......................................... 100.000%
</Table>
MANDATORY REDEMPTION
We are not required to make mandatory redemption or sinking fund payments
with respect to the notes.
REPURCHASE AT THE OPTION OF HOLDERS
CHANGE OF CONTROL
If a Change of Control occurs, each Holder of notes will have the right to
require us to repurchase all or any part (equal to $1,000 or an integral
multiple of $1,000) of that Holder's notes pursuant to a Change of Control Offer
on the terms set forth in the indenture. In the Change of Control Offer, we will
offer a Change of Control Payment in cash equal to 101% of the aggregate
principal amount of notes repurchased plus accrued and unpaid interest on the
notes repurchased, to the date of purchase. Subject to compliance with the
provisions of the third succeeding paragraph, within 30 days following any
Change of Control, we will mail a notice to the trustee and each Holder
describing the transaction or transactions that constitute the Change of Control
and offering to repurchase notes on the Change of Control Payment Date specified
in the notice, which date will be no earlier than 30 days and no later than 60
days from the date such notice is mailed, pursuant to the procedures required by
the indenture and described in such notice. We will comply with the requirements
of Rule 14e-1 under the Exchange Act and any other securities laws and
regulations thereunder to the extent those laws and regulations are applicable
in connection with the repurchase of the notes as a result of a Change of
Control. To the extent that the provisions of any securities laws or regulations
conflict with the Change of Control provisions of the indenture, we will comply
with the applicable securities laws and regulations and will not be deemed to
have breached our obligations under the Change of Control provisions of the
indenture by virtue of such conflict.
On the Change of Control Payment Date, we will, to the extent lawful:
(1) accept for payment all notes or portions of notes properly
tendered pursuant to the Change of Control Offer;
(2) deposit with the paying agent an amount equal to the Change of
Control Payment in respect of all notes or portions of notes properly
tendered; and
(3) deliver or cause to be delivered to the trustee the notes properly
accepted together with an officers' certificate stating the aggregate
principal amount of notes or portions of notes being purchased by us.
The paying agent will promptly mail to each Holder of notes properly
tendered the Change of Control Payment for such notes, and the trustee will
promptly authenticate and mail (or cause to be transferred by book entry) to
each Holder a new note equal in principal amount to any unpurchased portion of
the notes surrendered, if any; provided that each new note will be in a
principal amount of $1,000 or an integral multiple of $1,000.
Prior to complying with any of the provisions of this "Change of Control"
covenant, but in any event within 90 days following a Change of Control, we will
either repay all outstanding Senior Debt or obtain the requisite consents, if
any, under all agreements governing outstanding Senior Debt to permit the
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repurchase of notes required by this covenant. We will publicly announce the
results of the Change of Control Offer on or as soon as practicable after the
Change of Control Payment Date.
The provisions described above that require us to make a Change of Control
Offer following a Change of Control will be applicable whether or not any other
provisions of the indenture are applicable. Except as described above with
respect to a Change of Control, the indenture does not contain provisions that
permit the Holders of the notes to require that we repurchase or redeem the
notes in the event of a takeover, recapitalization or similar transaction.
We will not be required to make a Change of Control Offer upon a Change of
Control if a third party makes the Change of Control Offer in the manner, at the
times and otherwise in compliance with the requirements set forth in the
indenture applicable to a Change of Control Offer made by us and purchases all
notes properly tendered and not withdrawn under the Change of Control Offer.
The definition of Change of Control includes a phrase relating to the
direct or indirect sale, lease, transfer, conveyance or other disposition of
"all or substantially all" of our properties or assets and the properties or
assets of our Subsidiaries taken as a whole. Although there is a limited body of
case law interpreting the phrase "substantially all," there is no precise
established definition of the phrase under applicable law. Accordingly, the
ability of a Holder of notes to require us to repurchase its notes as a result
of a sale, lease, transfer, conveyance or other disposition of less than all of
our assets and the assets of our Subsidiaries taken as a whole to another Person
or group may be uncertain.
ASSET SALES
We will not, and will not permit any of our Restricted Subsidiaries to,
consummate an Asset Sale unless:
(1) we (or the Restricted Subsidiary, as the case may be) receive
consideration at the time of the Asset Sale at least equal to the fair
market value of the assets sold or otherwise disposed of (evidenced by a
resolution of our Board of Directors set forth in an officers' certificate
delivered to the trustee);
(2) if we (or the Restricted Subsidiary, as the case may be) receive
consideration at the time of the Asset Sale greater than $7.5 million, the
fair market value of the assets sold or otherwise disposed of is determined
by Parent's Board of Directors (such determination to be evidenced by a
resolution set forth in an officers' certificate delivered to the trustee)
or in a written opinion issued by an independent appraisal firm or
financial advisor of national standing; and
(3) at least 75% of the consideration received in the Asset Sale by us
or such Restricted Subsidiary is in the form of cash, Cash Equivalents or
Replacement Assets.
For purposes of this provision only, each of the following will be deemed
to be cash:
(a) any liabilities of ours or any of our Restricted Subsidiaries, as
shown on our or such Restricted Subsidiary's most recent balance sheet
(other than contingent liabilities and liabilities that are by their terms
subordinated to the notes or any Restricted Subsidiary's Subsidiary
Guarantee), that are assumed by the transferee of any such assets pursuant
to a customary novation agreement that releases us or such Restricted
Subsidiary from further liability;
(b) any securities, notes or other obligations received by us or any
such Restricted Subsidiary from such transferee that are contemporaneously,
subject to ordinary settlement periods, converted by us or such Restricted
Subsidiary into cash, to the extent of the cash received in that
conversion; and
(c) any Designated Non-Cash Consideration received by us or any of our
Restricted Subsidiaries in the Asset Sale.
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Within 365 days after the receipt of any Net Proceeds from an Asset Sale,
we and our Restricted Subsidiaries may apply those Net Proceeds at our option:
(1) to repay Senior Debt and, if the Senior Debt repaid is revolving
credit Indebtedness, to correspondingly permanently reduce commitments with
respect thereto;
(2) to acquire all or substantially all of the assets of, or a
majority of the Voting Stock of, another Permitted Business; or
(3) to acquire other long-term assets that are used or useful in a
Permitted Business.
Pending the final application of any Net Proceeds, we may temporarily
reduce revolving credit borrowings or otherwise invest the Net Proceeds in any
manner that is not prohibited by the indenture.
Any Net Proceeds from Asset Sales that are not applied or invested within
such 365-day period will constitute "Excess Proceeds." When the aggregate amount
of Excess Proceeds exceeds $15.0 million, we will make an offer (which offer may
be made at any time within such 365-day period) to all holders of notes and
Additional Notes, if any, and all holders of other Indebtedness that is pari
passu with the notes containing provisions similar to those set forth in the
indenture with respect to offers to purchase or redeem with the proceeds of
sales of assets (an "Asset Sale Offer"), to purchase, on a pro rata basis, the
maximum principal amount of notes and Additional Notes, if any, and such other
pari passu Indebtedness equal in amount to the Excess Proceeds (and not just the
amount thereof that exceeds $15.0 million). The offer price in any Asset Sale
Offer will be equal to 100% of the principal amount thereof plus accrued and
unpaid interest to the date of purchase, in accordance with the procedures set
forth in the indenture, and will be payable in cash. If any Excess Proceeds
remain after consummation of an Asset Sale Offer, we may use those Excess
Proceeds for any purpose not otherwise prohibited by the indenture. If the
aggregate principal amount of notes and Additional Notes, if any, and other pari
passu Indebtedness surrendered by holders thereof exceeds the amount of Excess
Proceeds, the trustee will select the notes and Additional Notes and other pari
passu Indebtedness to be purchased as described below under "Selection and
Notice." Upon completion of each Asset Sale Offer, the amount of Excess Proceeds
will be reset at zero.
We will comply with the requirements of Rule 14e-1 under the Exchange Act
and any other securities laws and regulations thereunder to the extent those
laws and regulations are applicable in connection with each repurchase of notes
pursuant to an Asset Sale Offer. To the extent that the provisions of any
securities laws or regulations conflict with the Asset Sale provisions of the
indenture, we will comply with the applicable securities laws and regulations
and will not be deemed to have breached our obligations under the Asset Sale
provisions of the indenture by virtue of such conflict.
SELECTION AND NOTICE
If less than all of the notes are to be redeemed or purchased at any time,
the trustee will select notes for redemption or purchase as follows:
(1) if the notes are listed on any national securities exchange, in
compliance with the requirements of the principal national securities
exchange on which the notes are listed; or
(2) if the notes are not listed on any national securities exchange,
on a pro rata basis, by lot or by such method as the trustee deems fair and
appropriate.
No notes of $1,000 or less can be redeemed in part. Notices of redemption
will be mailed by first class mail at least 30 but not more than 60 days before
the redemption date to each Holder of notes to be redeemed at its registered
address, except that redemption notices may be mailed more than 60 days prior to
a redemption date if the notice is issued in connection with a defeasance of the
notes or a satisfaction and discharge of the indenture. Notices of redemption
may not be conditional.
If any note is to be redeemed in part only, the notice of redemption that
relates to that note will state the portion of the principal amount of that note
that is to be redeemed. A new note in principal amount equal to the unredeemed
portion of the original note will be issued in the name of the Holder of notes
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upon cancellation of the original note. Notes called for redemption become due
on the date fixed for redemption. On and after the redemption date, interest
ceases to accrue on notes or portions of them called for redemption.
CERTAIN COVENANTS
RESTRICTED PAYMENTS
We will not, and will not permit any of our Restricted Subsidiaries to,
directly or indirectly:
(1) declare or pay any dividend or make any other payment or
distribution on account of our Equity Interests (including, without
limitation, any payment in connection with any merger or consolidation in
which we are involved) or to the direct or indirect holders of our Equity
Interests in their capacity as such (other than dividends or distributions
payable solely in our Equity Interests (other than Disqualified Stock) or
to us);
(2) purchase, redeem or otherwise acquire or retire for value
(including, without limitation, in connection with any merger or
consolidation in which we are involved) any of our Equity Interests;
(3) make any payment on or with respect to, or purchase, redeem,
defease or otherwise acquire or retire for value any Subordinated
Indebtedness, except (A) a payment of interest or principal at the Stated
Maturity thereof or (B) Subordinated Indebtedness acquired in anticipation
of satisfying a sinking fund obligation, principal installment or payment
of principal upon final maturity of such Subordinated Indebtedness, in each
case acquired within one year of the date of the sinking fund obligation,
principal installment or payment of principal upon maturity; or
(4) make any Restricted Investment
(all such payments and other actions set forth in these clauses (1) through (4)
above being collectively referred to as "Restricted Payments"), unless, at the
time of and after giving effect to such Restricted Payment:
(a) no Default or Event of Default has occurred and is continuing or
would occur as a consequence of such Restricted Payment;
(b) we would, at the time of such Restricted Payment and after giving
pro forma effect thereto as if such Restricted Payment had been made at the
beginning of the applicable four-quarter period, have been permitted to
incur at least $1.00 of additional Indebtedness pursuant to the Fixed
Charge Coverage Ratio test set forth in the first paragraph of the
"Incurrence of Indebtedness and Issuance of Preferred Stock" covenant; and
(c) such Restricted Payment, together with the aggregate amount of all
other Restricted Payments made by us and our Restricted Subsidiaries after
the date of the indenture (excluding Restricted Payments permitted by
clauses (2) and (3) of the next paragraph), is less than the sum, without
duplication, of:
(I) 50% of our Consolidated Net Income for the period (taken as one
accounting period) from April 1, 2002 to the end of our most recently
ended fiscal quarter for which internal financial statements are
available at the time of such Restricted Payment (or, if such
Consolidated Net Income for such period is a deficit, less 100% of such
deficit), plus
(II) 100% of the aggregate net cash proceeds received by us since
the date of the indenture from the issue or sale of our Equity Interests
(other than Disqualified Stock) or Equity Interests of any of our parent
entities (which proceeds are received as a contribution to our common or
non-redeemable preferred equity capital) or from the issue or sale of
convertible or exchangeable Disqualified Stock or convertible or
exchangeable debt securities of ours that have been converted into or
exchanged for such Equity Interests (other than Equity Interests or
Disqualified Stock or debt securities sold to a Subsidiary of ours);
plus
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(III) to the extent that any Restricted Investment that was made
after the date of the indenture is sold for cash or otherwise liquidated
or repaid for cash, the lesser of (A) the cash return of capital with
respect to such Restricted Investment (less the cost of disposition, if
any) and (B) the initial amount of such Restricted Investment.
So long as no Default has occurred and is continuing or would be caused
thereby, the preceding provisions will not prohibit:
(1) the payment of any dividend within 60 days after the date of
declaration of the dividend, if at the date of declaration the dividend
payment would have complied with the provisions of the indenture;
(2) the redemption, repurchase, retirement, defeasance or other
acquisition of any Subordinated Indebtedness or of any of our Equity
Interests by conversion into, or by an exchange for, shares of our Equity
Interests (other than Disqualified Stock), or in exchange for, or out of
the net cash proceeds of the substantially concurrent sale (other than to
any of our Restricted Subsidiaries) of, our Equity Interests (other than
Disqualified Stock); provided that the amount of any such net cash proceeds
that are utilized for any such redemption, repurchase, retirement,
defeasance or other acquisition will be excluded from clause (c)(II) of the
preceding paragraph;
(3) the repurchase, retirement, or redemption of any Subordinated
Indebtedness with the proceeds from an Asset Sale to the extent required by
the agreement governing such Subordinated Indebtedness but only (a) if we
have complied with the covenant described under "Repurchase at the Option
of Holders -- Asset Sales" and (b) to the extent of the Excess Proceeds
remaining after the offer made to holders of the notes pursuant to the
Asset Sale;
(4) the defeasance, redemption, repurchase or other acquisition of
Subordinated Indebtedness with the net cash proceeds from an incurrence of
Permitted Refinancing Indebtedness; and
(5) other Restricted Payments in an aggregate amount since the date of
the indenture not to exceed $10.0 million.
The amount of all Restricted Payments (other than cash) will be the fair
market value on the date of the Restricted Payment of the asset(s) or securities
proposed to be transferred or issued by us or such Restricted Subsidiary, as the
case may be, pursuant to the Restricted Payment. The fair market value of any
assets or securities that are required to be valued by this covenant will be
determined by our Board of Directors, whose resolutions with respect thereto
will be delivered to the trustee. The Board of Directors' determination must be
based upon an opinion or appraisal issued by an accounting, appraisal or
investment banking firm of national standing if the fair market value exceeds
$5.0 million. Not later than the date of making any Restricted Payment, we will
deliver to the trustee an officers' certificate stating that such Restricted
Payment is permitted and setting forth the basis upon which the calculations
required by this "Restricted Payments" covenant were computed, together with a
copy of any fairness opinion or appraisal required by the indenture.
INCURRENCE OF INDEBTEDNESS AND ISSUANCE OF PREFERRED STOCK
We will not, and will not permit any of our Restricted Subsidiaries to,
directly or indirectly, create, incur, issue, assume, guarantee or otherwise
become directly or indirectly liable, contingently or otherwise, with respect to
(collectively, "incur") any Indebtedness (including Acquired Debt), and we will
not issue any Disqualified Stock and will not permit any of our Restricted
Subsidiaries to issue any shares of preferred stock; provided, however, that we
may incur Indebtedness (including Acquired Debt) or issue Disqualified Stock,
and any of our Subsidiary Guarantors may incur Indebtedness, if the Fixed Charge
Coverage Ratio for our most recently ended four full fiscal quarters for which
internal financial statements are available immediately preceding the date on
which such additional Indebtedness is incurred or such Disqualified Stock is
issued would have been at least 2.00 to 1, determined on a pro forma basis
(including a pro forma application of the net proceeds therefrom), as if the
additional Indebtedness had been
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incurred or the preferred stock or Disqualified Stock had been issued, as the
case may be, at the beginning of such four-quarter period.
The first paragraph of this covenant will not prohibit the incurrence of
any of the following items of Indebtedness (collectively, "Permitted Debt"):
(1) our incurrence of additional Indebtedness and letters of credit
under Credit Facilities and Guarantees thereof by the Subsidiary
Guarantors; provided that the aggregate principal amount of all
Indebtedness of ours and our Restricted Subsidiaries incurred pursuant to
this clause (1) (with letters of credit being deemed to have a principal
amount equal to the maximum potential liability of us and our Subsidiary
Guarantors thereunder) does not exceed an amount equal to $105.0 million
less (a) 50% of all proceeds received from Securitization Transactions and
(b) the aggregate amount of Net Proceeds from an Asset Sale applied by us
and our Restricted Subsidiaries since the date of the indenture to repay
Indebtedness thereunder or to permanently reduce the availability of
revolving credit Indebtedness pursuant to the provisions described above
under the heading "-- Repurchase at the Option of Holders -- Asset Sales;"
(2) the incurrence by us and our Restricted Subsidiaries of the
Existing Indebtedness;
(3) the incurrence by us of Indebtedness represented by the notes and
the incurrence by the Subsidiary Guarantors of the Subsidiary Guarantees of
the notes;
(4) the incurrence by us or any of our Subsidiary Guarantors of
Indebtedness represented by Capital Lease Obligations, mortgage financings
or purchase money obligations, in each case incurred for the purpose of
financing all or any part of the purchase price or cost of construction or
improvement of property, plant or equipment used in our business or the
business of such Subsidiary Guarantor, in an aggregate principal amount,
including all Permitted Refinancing Indebtedness incurred to refund,
refinance or replace any Indebtedness incurred pursuant to this clause (4),
not to exceed 3.5% of Consolidated Tangible Assets at any time outstanding;
(5) the incurrence by us or any of our Restricted Subsidiaries of
Permitted Refinancing Indebtedness in exchange for, or the net proceeds of
which are used to refund, refinance or replace Indebtedness (other than
intercompany Indebtedness) that was incurred under the first paragraph of
this covenant or clauses (2), (3), (4) or (10) of this paragraph;
(6) the incurrence by us or any of our Restricted Subsidiaries of
intercompany Indebtedness owed to us or any of the Subsidiary Guarantors;
provided, however, that:
(a) if we are the obligor on such Indebtedness, such Indebtedness
must be expressly subordinated to the prior payment in full in cash of
all Obligations with respect to the notes;
(b) if a Subsidiary Guarantor is the obligor on such Indebtedness,
such Indebtedness is expressly subordinated to the prior payment in full
in cash of such Subsidiary Guarantor's Subsidiary Guarantee; and
(c) (i) any subsequent issuance or transfer of Equity Interests
that results in any such Indebtedness being held by a Person other than
us or a Subsidiary Guarantor and (ii) any sale or other transfer of any
such Indebtedness to a Person that is not either us or a Subsidiary
Guarantor will be deemed, in each case, to constitute an incurrence of
such Indebtedness by us or such Subsidiary Guarantor, as the case may
be, that was not permitted by this clause (6);
(7) the incurrence by us or any of our Restricted Subsidiaries of
Hedging Obligations that are incurred in the normal course of business for
the purpose of fixing or hedging currency, commodity or interest rate risk
(including with respect to any floating rate Indebtedness that is permitted
by the terms of the indenture to be outstanding in connection with the
conduct of our respective businesses and not for speculative purposes);
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(8) the guarantee by us or any of the Subsidiary Guarantors of our
Indebtedness or Indebtedness of one of our Restricted Subsidiaries that was
permitted to be incurred by another provision of this covenant;
(9) the incurrence by our Unrestricted Subsidiaries of Non-recourse
Debt; provided, however, that if any such Indebtedness ceases to be
Non-recourse Debt of an Unrestricted Subsidiary, such event will be deemed
to be an incurrence of Indebtedness by a Restricted Subsidiary of ours that
was not permitted by this clause (9); and
(10) the incurrence by us or any of our Restricted Subsidiaries of
additional Indebtedness in an aggregate principal amount (or accreted
value, as applicable) at any time outstanding, including all Permitted
Refinancing Indebtedness incurred to refund, refinance or replace any
Indebtedness incurred pursuant to this clause (10), not to exceed $25.0
million (which amount may be incurred, in whole or in part, under any of
the Credit Facilities); provided that no more than $10.0 million of such
additional Indebtedness shall be incurred by Restricted Subsidiaries that
are not Subsidiary Guarantors.
For purposes of determining compliance with this covenant, in the event
that an item of proposed Indebtedness meets the criteria of more than one of the
categories of Permitted Debt described in clauses (1) through (10) above as of
the date of incurrence thereof or is entitled to be incurred pursuant to the
first paragraph of this covenant, we will, in our sole discretion, at the time
the proposed Indebtedness is incurred, (x) classify all or a portion of that
item of Indebtedness on the date of its incurrence under either the first
paragraph of this covenant or under any category of Permitted Debt, (y)
reclassify at a later date all or a portion of that or any other item of
Indebtedness as being or having been incurred in any manner that complies with
this covenant and (z) elect to comply with this covenant and the applicable
definitions in any order.
We will not incur, create, issue, assume, guarantee or otherwise become
liable for any Indebtedness that is subordinate or junior in right of payment to
any Senior Debt of ours and not subordinate or junior in right of payment to the
notes; provided, however, that no Indebtedness of ours will be deemed to be
contractually subordinated in right of payment solely by virtue of being
unsecured. No Subsidiary Guarantor will incur, create, issue, assume, guarantee
or otherwise become liable for any Indebtedness that is subordinate or junior in
right of payment to the Senior Debt of such Subsidiary Guarantor and not
subordinate or junior in right of payment to such Subsidiary Guarantor's
Subsidiary Guarantee; provided, however, that no Indebtedness of a Subsidiary
Guarantor will be deemed to be contractually subordinated in right of payment
solely by virtue of being unsecured.
Indebtedness will be deemed to have been incurred by the survivor of a
merger, at the time of such merger and, with respect to an acquired Subsidiary,
at the time of such acquisition.
LIENS
We will not, and will not permit any of our Restricted Subsidiaries to,
directly or indirectly, create, incur, assume or suffer to exist any Lien of any
kind securing Indebtedness, Attributable Debt or trade payables on any asset now
owned or hereafter acquired or any proceeds therefrom, or assign or convey any
right to receive income therefrom, except Permitted Liens.
DIVIDEND AND OTHER PAYMENT RESTRICTIONS AFFECTING RESTRICTED SUBSIDIARIES
We will not, and will not permit any of our Restricted Subsidiaries to,
directly or indirectly, create or permit to exist or become effective any
consensual encumbrance or restriction on the ability of any Restricted
Subsidiary to:
(1) pay dividends or make any other distributions on or in respect of
its Capital Stock to us or any of our Restricted Subsidiaries, or with
respect to any other interest or participation in, or measured by, its
profits, or pay any Indebtedness owed to us or any other of our Restricted
Subsidiaries;
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(2) make any loans or advances to us or any other of our Restricted
Subsidiaries; or
(3) sell, lease or transfer any of its properties or assets to us or
any other of our Restricted Subsidiaries; or
(4) guarantee our obligations.
However, the preceding restrictions will not apply to encumbrances or
restrictions existing under or by reason of:
(1) agreements as in effect on the date of the indenture or subsequent
agreements relating to our Indebtedness or Indebtedness of any Subsidiary
Guarantor and any amendments, modifications, restatements, renewals,
increases, supplements, refundings, replacements or refinancings of those
agreements; provided that the amendments, modifications, restatements,
renewals, increases, supplements, refundings, replacement or refinancings
are not materially more restrictive, taken as a whole, with respect to such
dividend and other payment restrictions than those contained in those
agreements on the date of the indenture;
(2) the indenture, the notes and the Subsidiary Guarantees;
(3) applicable law;
(4) any instrument governing Indebtedness or Capital Stock of a Person
acquired by us or any of our Restricted Subsidiaries as in effect at the
time of such acquisition (except to the extent such Indebtedness or Capital
Stock was incurred in connection with or in contemplation of such
acquisition), which encumbrance or restriction is not applicable to any
Person, or the properties or assets of any Person, other than the Person,
or the property or assets of the Person, so acquired; provided that, in the
case of Indebtedness, such Indebtedness was permitted by the terms of the
indenture to be incurred;
(5) customary non-assignment provisions in leases entered into in the
ordinary course of business;
(6) purchase money obligations for property acquired in the ordinary
course of business that impose restrictions on that property of the nature
described in clause (3) of the preceding paragraph;
(7) any agreement for the sale or other disposition of a Restricted
Subsidiary that restricts distributions by that Restricted Subsidiary
pending its sale or other disposition;
(8) Permitted Refinancing Indebtedness; provided that the restrictions
contained in the agreements governing such Permitted Refinancing
Indebtedness are not materially more restrictive, taken as a whole, than
those contained in the agreements governing the Indebtedness being
refinanced;
(9) Liens securing Indebtedness otherwise permitted to be incurred
under the provisions of the "Liens" covenant that limit the right of the
debtor to dispose of the assets subject to such Liens; and
(10) provisions with respect to the disposition or distribution of
assets or property in joint venture agreements, asset sale agreements,
stock sale agreements and other similar agreements entered into in the
ordinary course of business.
ISSUANCES AND SALES OF CAPITAL STOCK OF RESTRICTED SUBSIDIARIES
We will not, and will not permit any of our Restricted Subsidiaries to,
transfer, convey, sell, lease or otherwise dispose of any Capital Stock of any
of our Restricted Subsidiaries to any Person (other than to us or another
Restricted Subsidiary of ours), unless (i) such transfer, conveyance, sale,
lease or other disposition is of all the Capital Stock of such Restricted
Subsidiary, and (ii) the Net Proceeds from such transfer, conveyance, sale,
lease or other disposition are applied in accordance with the provisions
described above under "-- Repurchase at the Option of Holders -- Asset Sales;"
provided that this clause (a) will not apply to any pledge of Capital Stock of
any Restricted Subsidiary of ours securing Indebtedness under
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Credit Facilities, including the Credit Agreement, or any exercise of remedies
in connection therewith, and (b) will not permit any Restricted Subsidiary of
ours to issue any of its Equity Interests (other than, if necessary, shares of
its Capital Stock constituting directors' qualifying shares or ownership by
foreign nationals) to any Person other than us or another Restricted Subsidiary
of ours.
MERGER, CONSOLIDATION OR SALE OF ASSETS
We may not, directly or indirectly: (1) consolidate or merge with or into
another Person (whether or not we are the surviving corporation) or (2) sell,
assign, transfer, convey or otherwise dispose of all or substantially all of our
properties or assets and the properties or assets of our Restricted Subsidiaries
taken as a whole, in one or more related transactions, to another Person;
unless:
(a) either: (x) we are the surviving corporation; or (y) the Person
formed by or surviving any such consolidation or merger (if other than us)
or to which such sale, assignment, transfer, conveyance or other
disposition has been made is a corporation organized or existing under the
laws of the United States, any state of the United States or the District
of Columbia;
(b) the Person formed by or surviving any such consolidation or merger
(if other than us) or the Person to which such sale, assignment, transfer,
conveyance or other disposition has been made assumes all of our
obligations under the notes and the indenture pursuant to a supplemental
indenture reasonably satisfactory to the trustee;
(c) immediately after such transaction no Default or Event of Default
exists;
(d) we or the Person formed by or surviving any such consolidation or
merger (if other than us), or to which such sale, assignment, transfer,
conveyance or other disposition has been made will, on the date of such
transaction after giving pro forma effect thereto and any related financing
transactions as if the same had occurred at the beginning of the applicable
four-quarter period, be permitted to incur at least $1.00 of additional
Indebtedness pursuant to the Fixed Charge Coverage Ratio test set forth in
the "Incurrence of Indebtedness and Issuance of Preferred Stock" covenant;
and
(e) we, or the Person formed by or surviving any such consolidation or
merger (if other than us), or to which such sale, assignment, transfer,
conveyance or other disposition has been made, will have delivered to the
trustee an officers' certificate and an opinion of counsel, each stating
that such transaction and any supplemental indenture entered into in
connection therewith complies with all of the terms of this covenant and
that all conditions precedent provided for in this covenant relating to
such transaction or series of transactions have been complied with.
In addition, we may not, directly or indirectly, lease all or substantially
all of our properties or assets, in one or more related transactions, to any
other Person.
The Person formed by or surviving any consolidation or merger (if other
than us) will succeed to, and be substituted for, and may exercise every right
and power of ours under the indenture, but, in the case of a lease of all or
substantially all our assets, we will not be released from the obligation to pay
the principal of and interest on the notes.
DESIGNATION OF RESTRICTED AND UNRESTRICTED SUBSIDIARIES
Our Board of Directors may designate any Restricted Subsidiary to be an
Unrestricted Subsidiary if that designation would not cause a Default. If a
Restricted Subsidiary is designated as an Unrestricted Subsidiary, the aggregate
fair market value of all outstanding Investments owned by us and our Restricted
Subsidiaries in the Subsidiary properly designated will be deemed to be an
Investment made as of the time of the designation and will reduce the amount
available for Restricted Payments under the first paragraph of the "Restricted
Payments" covenant or Permitted Investments, as determined by us. That
designation will only be permitted if the Investment would be permitted at that
time and if the Restricted Subsidiary otherwise meets the definition of an
Unrestricted Subsidiary. Our Board of Directors may
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redesignate any Unrestricted Subsidiary to be a Restricted Subsidiary if the
redesignation would not cause a Default.
TRANSACTIONS WITH AFFILIATES
We will not, and will not permit any of our Restricted Subsidiaries to,
make any payment to, or sell, lease, transfer or otherwise dispose of any of our
or our Restricted Subsidiaries' respective properties or assets to, or purchase
any property or assets from, or enter into or make or amend any transaction,
contract, agreement, understanding, loan, advance or guarantee with, or for the
benefit of, any Affiliate (each, an "Affiliate Transaction"), unless:
(1) the Affiliate Transaction is on terms that are no less favorable
to us or the relevant Restricted Subsidiary than those that would have been
obtained in a comparable transaction by us or such Restricted Subsidiary
with a Person that is not an Affiliate; and
(2) we deliver to the trustee:
(a) with respect to any Affiliate Transaction or series of related
Affiliate Transactions involving aggregate consideration in excess of
$5.0 million, a resolution of our Board of Directors set forth in an
officers' certificate certifying that such Affiliate Transaction
complies with this covenant and that such Affiliate Transaction has been
approved by a majority of the disinterested members of our Board of
Directors or Parent's Board of Directors, or, if there are no
disinterested members of the approving Board of Directors at the time, a
written opinion issued by an independent appraisal firm or financial
advisor of national standing that such Affiliate Transaction is fair to
us or such Restricted Subsidiary, as the case may be, from a financial
point of view; and
(b) with respect to any Affiliate Transaction or series of related
Affiliate Transactions involving aggregate consideration in excess of
$10.0 million, a written opinion issued by an independent financial
advisor of national standing that such Affiliate Transaction is fair to
us or such Restricted Subsidiary, as the case may be, from a financial
point of view.
The following items will not be deemed to be Affiliate Transactions and,
therefore, will not be subject to the provisions of the prior paragraph:
(1) transactions between or among us and/or our Restricted
Subsidiaries;
(2) transactions with a Person that is an Affiliate of ours solely
because we own an Equity Interest in such Person;
(3) advances to our officers or officers of any of our Restricted
Subsidiaries in the ordinary course of business to provide for the payment
of reasonable expenses incurred by such persons in the performance of their
responsibilities to us or such Restricted Subsidiary or in connection with
any relocation;
(4) sales of Equity Interests (other than Disqualified Stock) to
Affiliates of ours;
(5) fees and compensation paid to and indemnity provided on behalf of
our directors, officers or employees or any of our Restricted Subsidiaries
in the ordinary course of business;
(6) any employment agreement that is in effect on the date of the
indenture and any such employment agreement entered into by us or any of
our Restricted Subsidiaries after the date of the indenture in the ordinary
course of our business or the business of such Restricted Subsidiary;
(7) any Restricted Payment that is not prohibited by the covenant set
forth under the covenant entitled "Restricted Payments;"
(8) any sale, conveyance or other transfer of accounts receivable and
other related assets customarily transferred in a Securitization
Transaction;
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(9) payment of premiums to and the receipt of proceeds of insurance
from, Laurier Indemnity Company and Laurier Indemnity Company, Ltd.;
(10) payments to or receipts from Extendicare Holdings, Inc. pursuant
to any tax sharing agreement entered into for the purpose of preparing a
consolidated tax return of Extendicare Holdings, Inc.;
(11) payments to or receipts from Virtual Care Provider, Inc. in
connection with the provision of technology services to third parties
pursuant to the terms of management, consulting or other similar
agreements; and
(12) transactions pursuant to the services agreement between us and
Virtual Care Provider, Inc. relating to certain services provided by us and
Virtual Care Provider, Inc. to each other as in effect on the date the
notes are first issued.
ADDITIONAL SUBSIDIARY GUARANTEES
If we or any of our Restricted Subsidiaries acquires or creates another
domestic Significant Subsidiary or any other Domestic Subsidiary that guarantees
or incurs any Indebtedness or any other Significant Subsidiary or Restricted
Subsidiary that guarantees or otherwise provides direct credit support for
Indebtedness of ours or any of our Domestic Subsidiaries after the date of the
indenture, then that newly acquired or created Significant Subsidiary, Domestic
Subsidiary or other Restricted Subsidiary will execute and deliver to the
trustee a supplemental indenture providing for a Subsidiary Guarantee and
deliver an opinion of counsel satisfactory to the trustee within 10 business
days of the date on which it was acquired or created; provided, however, that
the foregoing will not apply to Subsidiaries that have properly been designated
as Unrestricted Subsidiaries in accordance with the indenture for so long as
they continue to constitute Unrestricted Subsidiaries.
SALE AND LEASEBACK TRANSACTIONS
We will not, and will not permit any of our Restricted Subsidiaries to,
enter into any sale and leaseback transaction; provided that we or any
Subsidiary Guarantor may enter into a sale and leaseback transaction if:
(1) we or that Subsidiary Guarantor could have (a) incurred
Indebtedness in an amount equal to the Attributable Debt relating to such
sale and leaseback transaction under the Fixed Charge Coverage Ratio test
in the first paragraph of the "Incurrence of Indebtedness and Issuance of
Preferred Stock" covenant and (b) incurred a Lien to secure such
Indebtedness pursuant to the "Liens" covenant;
(2) the gross cash proceeds of that sale and leaseback transaction are
at least equal to the fair market value, as determined in good faith by our
Board of Directors and set forth in an officers' certificate delivered to
the trustee, of the property that is the subject of that sale and leaseback
transaction; and
(3) the transfer of assets in that sale and leaseback transaction is
permitted by, and we apply the proceeds of such transaction in compliance
with, the "Asset Sales" covenant.
BUSINESS ACTIVITIES
We will not, and will not permit any Restricted Subsidiary to, engage in
any business other than Permitted Businesses, except to such extent as would not
be material to us and our Subsidiaries taken as a whole.
PAYMENTS FOR CONSENT
We will not, and will not permit any of our Restricted Subsidiaries to,
directly or indirectly, pay or cause to be paid any consideration, whether by
way of interest, fee or otherwise, to or for the benefit of
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any Holder of notes for or as an inducement to any consent, waiver or amendment
of any of the terms or provisions of the indenture or the notes unless such
consideration is offered to be paid and is paid to all Holders of the notes that
consent, waive or agree to amend in the time frame set forth in the solicitation
documents relating to such consent, waiver or agreement.
REPORTS
Whether or not required by the SEC, so long as any notes are outstanding,
we will furnish to the Holders of notes, within the time periods specified in
the SEC's rules and regulations:
(1) all quarterly and annual financial information that would be
required to be contained in a filing with the SEC on Forms 10-Q and 10-K if
we were required to file such Forms, including a "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and, with
respect to the annual information only, a report on the annual financial
statements by our certified independent accountants; and
(2) all current reports that would be required to be filed with the
SEC on Form 8-K if we were required to file such reports.
If we have designated any of our Subsidiaries as Unrestricted Subsidiaries,
then the quarterly and annual financial information required by the preceding
paragraph will include a reasonably detailed presentation, either on the face of
the financial statements or in the footnotes thereto, and in Management's
Discussion and Analysis of Financial Condition and Results of Operations, of the
financial condition and results of operations of us and our Restricted
Subsidiaries separate from the financial condition and results of operations of
our Unrestricted Subsidiaries.
In addition, following the consummation of the exchange offer, whether or
not required by the SEC, we will file a copy of all of the information and
reports referred to in clauses (1) and (2) above with the SEC for public
availability within the time periods specified in the SEC's rules and
regulations (unless the SEC will not accept such a filing) and make such
information available to securities analysts and prospective investors upon
request. In addition, we and the Subsidiary Guarantors have agreed that, for so
long as any notes remain outstanding, we will furnish to the Holders and to
securities analysts and prospective investors, upon their request, the
information required to be delivered pursuant to Rule 144A(d)(4) under the
Securities Act.
EVENTS OF DEFAULT AND REMEDIES
Each of the following is an "Event of Default":
(1) default for 30 days in the payment when due of interest on the
notes;
(2) default in payment when due of the principal of or premium, if
any, on the notes;
(3) failure by us or any of our Restricted Subsidiaries to comply with
the "Restricted Payments," "Incurrence of Indebtedness and Issuance of
Preferred Stock" or "Merger, Consolidation or Sale of Assets" covenants;
(4) failure by us or any of our Restricted Subsidiaries for 30 days
after notice to comply with the provisions described under the headings
"Repurchase at the Option of Holders -- Asset Sales" and "Repurchase at the
Option of Holders -- Change of Control;"
(5) failure by us or any of our Restricted Subsidiaries for 60 days
after notice to comply with any other covenant or agreement in the
indenture or the notes;
(6) default under any mortgage, indenture or instrument under which
there may be issued or by which there may be secured or evidenced any
Indebtedness for money borrowed by us or any of our Restricted Subsidiaries
(or the payment of which is guaranteed by us or any of our Restricted
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Subsidiaries) whether such Indebtedness or guarantee now exists, or is
created after the date of the indenture, if that default:
(a) is caused by a failure to pay principal of, or interest or
premium, if any, on such Indebtedness prior to the expiration of the
grace period provided in such Indebtedness on the date of such default
(a "Payment Default"); or
(b) results in the acceleration of such Indebtedness prior to its
express maturity,
and, in each case, the principal amount of any such Indebtedness,
together with the principal amount of any other such Indebtedness under
which there has been a Payment Default or the maturity of which has been
so accelerated, aggregates $20.0 million or more;
(7) failure by us or any of our Restricted Subsidiaries to pay final
judgments (to the extent not fully covered by insurance) aggregating in
excess of $20.0 million, which judgments are not paid, discharged or stayed
for a period of 60 consecutive days;
(8) except as permitted by the indenture, any Subsidiary Guarantee is
held in any judicial proceeding to be unenforceable or invalid or ceases
for any reason to be in full force and effect or any Subsidiary Guarantor,
or any Person acting on behalf of any Subsidiary Guarantor, denies or
disaffirms its obligations under its Subsidiary Guarantee; and
(9) certain events of bankruptcy or insolvency described in the
indenture with respect to us or any of our Significant Subsidiaries.
In the case of an Event of Default arising from certain events of
bankruptcy or insolvency, with respect to us, any Subsidiary that is a
Significant Subsidiary or any group of Subsidiaries that, taken together, would
constitute a Significant Subsidiary, all outstanding notes will become due and
payable immediately without further action or notice. If any other Event of
Default occurs and is continuing, the trustee or the Holders of at least 25% in
principal amount of the then outstanding notes may declare all the notes to be
due and payable immediately.
Holders of the notes may not enforce the indenture or the notes except as
provided in the indenture. Subject to certain limitations, Holders of a majority
in principal amount of the then outstanding notes may direct the trustee in its
exercise of any trust or power. The trustee may withhold from Holders of the
notes notice of any continuing Default or Event of Default if it determines that
withholding notes is in their interest, except a Default or Event of Default
relating to the payment of principal or interest or Liquidated Damages.
The Holders of a majority in aggregate principal amount of the notes then
outstanding by notice to the trustee may on behalf of the Holders of all of the
notes waive any existing Default or Event of Default and its consequences under
the indenture except a continuing Default or Event of Default in the payment of
interest or Liquidated Damages on, or the principal of, the notes.
In the case of any Event of Default occurring by reason of any willful
action or inaction taken or not taken by us or on our behalf with the intention
of avoiding payment of the premium that we would have had to pay if we then had
elected to redeem the notes pursuant to the optional redemption provisions of
the indenture, an equivalent premium will also become and be immediately due and
payable to the extent permitted by law upon the acceleration of the notes. If an
Event of Default occurs prior to July 1, 2006, by reason of any willful action
(or inaction) taken (or not taken) by us or on our behalf with the intention of
avoiding the prohibition on redemption of the notes prior to July 1, 2006, then
the premium specified in the indenture will also become immediately due and
payable to the extent permitted by law upon the acceleration of the notes.
We are required to deliver to the trustee annually a statement regarding
compliance with the indenture. Upon becoming aware of any Default or Event of
Default, we are required to deliver to the trustee a statement specifying such
Default or Event of Default.
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NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of ours or of
any Subsidiary Guarantor, as such, will have any liability for any obligations
of ours or of the Subsidiary Guarantors under the notes, the indenture, the
Subsidiary Guarantees, or for any claim based on, in respect of, or by reason
of, such obligations or their creation. Each Holder of notes by accepting a note
waives and releases all such liability. The waiver and release are part of the
consideration for issuance of the notes. The waiver may not be effective to
waive liabilities under the federal securities laws.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
We may, at our option and at any time, elect to have all of our obligations
discharged with respect to the outstanding notes and all obligations of the
Subsidiary Guarantors discharged with respect to their Subsidiary Guarantees
("Legal Defeasance") except for:
(1) the rights of Holders of outstanding notes to receive payments in
respect of the principal of, or interest or premium and Liquidated Damages,
if any, on such notes when such payments are due from the trust referred to
below;
(2) our obligations with respect to the notes concerning issuing
temporary notes, registration of notes, mutilated, destroyed, lost or
stolen notes and the maintenance of an office or agency for payment and
money for security payments held in trust;
(3) the rights, powers, trusts, duties and immunities of the trustee,
and our and the Subsidiary Guarantors' obligations in connection therewith;
and
(4) the Legal Defeasance provisions of the indenture.
In addition, we may, at our option and at any time, elect to have our
obligations and the obligations of the Subsidiary Guarantors released with
respect to certain covenants that are described in the indenture ("Covenant
Defeasance") and thereafter any omission to comply with those covenants will not
constitute a Default or Event of Default with respect to the notes. In the event
Covenant Defeasance occurs, certain events (not including non-payment,
bankruptcy, receivership, rehabilitation and insolvency events) described under
"-- Events of Default and Remedies" will no longer constitute an Event of
Default with respect to the notes.
In order to exercise either Legal Defeasance or Covenant Defeasance:
(1) we must irrevocably deposit with the trustee, in trust, for the
benefit of the Holders of the notes, cash in U.S. dollars, non-callable
Government Securities, or a combination of cash in U.S. dollars and
non-callable Government Securities, in amounts as will be sufficient, in
the opinion of a nationally recognized firm of independent public
accountants, to pay the principal of, or interest and premium and
Liquidated Damages, if any, on the outstanding notes on the Stated Maturity
or on the applicable redemption date, as the case may be, and we must
specify whether the notes are being defeased to maturity or to a particular
redemption date;
(2) in the case of Legal Defeasance, we must deliver to the trustee an
opinion of counsel reasonably acceptable to the trustee confirming that (a)
we have received from, or there has been published by, the Internal Revenue
Service a ruling or (b) since the date of the indenture, there has been a
change in the applicable federal income tax law, in either case to the
effect that, and based thereon such opinion of counsel will confirm that,
the Holders of the outstanding notes will not recognize income, gain or
loss for federal income tax purposes as a result of such Legal Defeasance
and will be subject to federal income tax on the same amounts, in the same
manner and at the same times as would have been the case if such Legal
Defeasance had not occurred;
(3) in the case of Covenant Defeasance, we must deliver to the trustee
an opinion of counsel reasonably acceptable to the trustee confirming that
the Holders of the outstanding notes will not recognize income, gain or
loss for federal income tax purposes as a result of such Covenant
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Defeasance and will be subject to federal income tax on the same amounts,
in the same manner and at the same times as would have been the case if
such Covenant Defeasance had not occurred;
(4) no Default or Event of Default has occurred and is continuing on
the date of such deposit (other than a Default or Event of Default
resulting from the borrowing of funds to be applied to such deposit);
(5) such Legal Defeasance or Covenant Defeasance will not result in a
breach or violation of, or constitute a default under, any material
agreement or instrument (excluding the indenture) to which we or any of our
Subsidiaries is a party or by which we or any of our Subsidiaries is bound;
(6) we must deliver to the trustee an officers' certificate stating
that the deposit was not made by us with the intent of preferring the
Holders of notes over our other creditors with the intent of defeating,
hindering, delaying or defrauding our creditors or others; and
(7) we must deliver to the trustee an officers' certificate and an
opinion of counsel, each stating that all conditions precedent relating to
the Legal Defeasance or the Covenant Defeasance have been complied with.
AMENDMENT, SUPPLEMENT AND WAIVER
Except as provided in the next two succeeding paragraphs, the indenture or
the notes may be amended or supplemented with the consent of the Holders of at
least a majority in principal amount of the notes, including Additional Notes,
if any, then outstanding voting as a single class (including, without
limitation, consents obtained in connection with a purchase of, or tender offer
or exchange offer for notes), and any existing Default or Event of Default
except a continuing Default or Event of Default in the payment of interest or
Liquidated Damages on, or the principal of, the notes or compliance with any
provision of the indenture or the notes may be waived with the consent of the
Holders of a majority in principal amount of the notes, including Additional
Notes, if any, then outstanding voting as a single class (including, without
limitation, consents obtained in connection with a purchase of, or tender offer
or exchange offer for notes).
Without the consent of each Holder affected, an amendment or waiver may not
(with respect to any notes held by a non-consenting Holder):
(1) reduce the principal amount of notes whose Holders must consent to
an amendment, supplement or waiver;
(2) reduce the principal of or change the fixed maturity of any note
or alter the provisions with respect to the redemption of the notes;
(3) make any change in the provisions of the indenture described above
under the heading "-- Repurchase at the Option of Holders;"
(4) reduce the rate of or change the time for payment of interest on
any note;
(5) waive a Default or Event of Default in the payment of principal
of, or interest or premium, if any, on the notes (except a rescission of
acceleration of the notes by the Holders of at least a majority in
aggregate principal amount of the notes and a waiver of the payment default
that resulted from such acceleration);
(6) make any note payable in money other than that stated in the
notes;
(7) make any change in the provisions of the indenture relating to
waivers of past Defaults or the rights of Holders of notes to receive
payments of principal of, or interest or premium or Liquidated Damages, if
any, on the notes;
(8) waive a redemption payment with respect to any note;
(9) release any Subsidiary Guarantor from any of its obligations under
its Subsidiary Guarantee or the indenture, except in accordance with the
terms of the indenture; or
(10) make any change in the preceding amendment and waiver provisions.
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Notwithstanding the preceding, without the consent of any Holder of notes,
we, the Subsidiary Guarantors and the trustee may amend or supplement the
indenture or the notes:
(1) to cure any ambiguity, defect or inconsistency;
(2) to provide for uncertificated notes in addition to or in place of
certificated notes;
(3) to provide for the assumption by a successor corporation of our
obligations under the indenture in the case of a merger or consolidation or
sale of all or substantially all of our assets;
(4) to make any change that would provide any additional rights or
benefits to the Holders of notes or that does not adversely affect the
legal rights under the indenture of any such Holder; or
(5) to make any change to comply with any requirement of the SEC in
order to effect or maintain the qualification of the indenture under the
Trust Indenture Act.
SATISFACTION AND DISCHARGE
The indenture will be discharged and will cease to be of further effect as
to all notes issued thereunder, when:
(1) either:
(a) all notes that have been authenticated, except lost, stolen or
destroyed notes that have been replaced or paid and notes for whose
payment money has been deposited in trust and thereafter repaid to us,
have been delivered to the trustee for cancellation; or
(b) all notes that have not been delivered to the trustee for
cancellation have become due and payable by reason of the mailing of a
notice of redemption or otherwise or will become due and payable within
one year, and we have irrevocably deposited or caused to be deposited
with the trustee as trust funds in trust solely for the benefit of the
Holders, cash in U.S. dollars, non-callable Government Securities, or a
combination of cash in U.S. dollars and non-callable Government
Securities, in such amounts as will be sufficient without consideration
of any reinvestment of interest, to pay and discharge the entire
indebtedness on the notes not delivered to the trustee for cancellation
for principal, premium and Liquidated Damages, if any, and accrued
interest to the date of maturity or redemption;
(2) no Default or Event of Default has occurred and is continuing on
the date of the deposit or will occur as a result of the deposit and the
deposit will not result in a breach or violation of, or constitute a
default under, any other instrument to which we or any Subsidiary Guarantor
is a party or by which we or any Subsidiary Guarantor is bound;
(3) we have paid or caused to be paid all sums payable by us under the
indenture; and
(4) we have delivered irrevocable instructions to the trustee under
the indenture to apply the deposited money and/or proceeds from
non-callable Government Securities toward the payment of the notes at
maturity or the redemption date, as the case may be.
In addition, we must deliver an officers' certificate and an opinion of
counsel to the trustee stating that all conditions precedent to satisfaction and
discharge have been satisfied.
CONCERNING THE TRUSTEE
If the trustee becomes a creditor of ours or of any Subsidiary Guarantor,
the indenture limits its right to obtain payment of claims in certain cases, or
to realize on certain property received in respect of any such claim as security
or otherwise. The trustee will be permitted to engage in other transactions;
however, if it acquires any conflicting interest, it must (i) eliminate such
conflict within 90 days, (ii) apply to the SEC for permission to continue or
(iii) resign.
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The Holders of a majority in principal amount of the then outstanding notes
will have the right to direct the time, method and place of conducting any
proceeding for exercising any remedy available to the trustee, subject to
certain exceptions. The indenture provides that in case an Event of Default
occurs and is continuing, the trustee will be required, in the exercise of its
power, to use the degree of care of a prudent man in the conduct of his own
affairs. Subject to such provisions, the trustee will be under no obligation to
exercise any of its rights or powers under the indenture at the request of any
Holder of notes, unless such Holder has offered to the trustee security and
indemnity satisfactory to it against any loss, liability or expense.
ADDITIONAL INFORMATION
Anyone who receives this prospectus may obtain a copy of the indenture
without charge by writing to us at the address set forth in the "Summary"
section of this prospectus.
BOOK-ENTRY, DELIVERY AND FORM
The new notes will be issued in fully registered book entry form, and will
be represented by one or more global notes in minimum denominations of $1,000
and integral multiples of $1,000 in excess of $1,000. All Holders of new notes
who exchanged their old notes in the exchange offer will hold their interests
through the global notes regardless of whether they purchased their interests
pursuant to Rule 144A under the Securities Act or Regulation S.
The global notes will be deposited upon issuance with the trustee as
custodian for The Depository Trust Company ("DTC"), in New York, New York, and
registered in the name of Cede & Co., as nominee of DTC (such nominee being
referred to herein as the "Global Note Holder"), in each case for credit to an
account of a direct or indirect participant in DTC as described below.
Except as set forth below, the global notes may be transferred, in whole
and not in part, only to another nominee of DTC or to a successor of DTC or its
nominee. Beneficial interests in the global notes may not be exchanged for notes
in certificated form except in the limited circumstances described below. See
"-- Exchange of Global Notes for Certificated Notes." Except in the limited
circumstances described below, owners of beneficial interests in the global
notes will not be entitled to receive physical delivery of notes in certificated
form.
Transfers of beneficial interests in the global notes will be subject to
the applicable rules and procedures of DTC and its direct or indirect
participants (including, if applicable, those of the Euroclear System
("Euroclear") and Clearstream Banking S.A. ("Clearstream") through which Holders
of the old notes issued pursuant to Regulation S initially held such notes),
which may change from time to time.
DEPOSITORY PROCEDURES
The following description of the operations and procedures of DTC,
Euroclear and Clearstream are provided solely as a matter of convenience. These
operations and procedures are solely within the control of the respective
settlement systems and are subject to changes by them. We take no responsibility
for these operations and procedures and urge investors to contact the system or
their participants directly to discuss these matters.
DTC has advised us that DTC is a limited-purpose trust company created to
hold securities for its participating organizations (collectively, the
"Participants") and to facilitate the clearance and settlement of transactions
in those securities between Participants through electronic book-entry changes
in accounts of its Participants. The Participants include securities brokers and
dealers (including the initial purchasers), banks, trust companies, clearing
corporations and certain other organizations. Access to DTC's system is also
available to other entities such as banks, brokers, dealers and trust companies
that clear through or maintain a custodial relationship with a Participant,
either directly or indirectly (collectively, the "Indirect Participants").
Persons who are not Participants may beneficially own securities held by or on
behalf of DTC only through the Participants or the Indirect Participants. The
ownership
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interests in, and transfers of ownership interests in, each security held by or
on behalf of DTC are recorded on the records of the Participants and Indirect
Participants.
DTC has also advised us that, pursuant to procedures established by it:
(1) upon deposit of the global notes, DTC will credit the accounts of
Participants with portions of the principal amount of the global notes; and
(2) ownership of these interests in the global notes will be shown on,
and the transfer of ownership of these interests will be effected only
through, records maintained by DTC (with respect to the Participants) or by
the Participants and the Indirect Participants (with respect to other
owners of beneficial interest in the global notes).
Investors in the global notes who are Participants in DTC's system may hold
their interests therein directly through DTC. Investors in the global notes who
are not Participants may hold their interests therein indirectly through
organizations (including Euroclear and Clearstream) which are Participants in
such system. All interests in a global note, including those held through
Euroclear or Clearstream, may be subject to the procedures and requirements of
DTC. Those interests held through Euroclear or Clearstream may also be subject
to the procedures and requirements of such systems. The laws of some states
require that certain Persons take physical delivery in definitive form of
securities that they own. Consequently, the ability to transfer beneficial
interests in a global note to such Persons will be limited to that extent.
Because DTC can act only on behalf of Participants, which in turn act on behalf
of Indirect Participants, the ability of a Person having beneficial interests in
a global note to pledge such interests to Persons that do not participate in the
DTC system, or otherwise take actions in respect of such interests, may be
affected by the lack of a physical certificate evidencing such interests.
Except as described below, owners of interest in the global notes will not
have notes registered in their names, will not receive physical delivery of
notes in certificated form and will not be considered the registered owners or
"Holders" thereof under the indenture for any purpose.
Payments in respect of the principal of, and interest and premium and
Liquidated Damages, if any, on a global note registered in the name of DTC or
its nominee will be payable to DTC in its capacity as the registered Holder
under the indenture. Under the terms of the indenture, we and the trustee will
treat the Persons in whose names the notes, including the global notes, are
registered as the owners of the notes for the purpose of receiving payments and
for all other purposes. Consequently, neither we, the trustee nor any agent of
ours or the trustee has or will have any responsibility or liability for:
(1) any aspect of DTC's records or any Participant's or Indirect
Participant's records relating to or payments made on account of beneficial
ownership interest in the global notes or for maintaining, supervising or
reviewing any of DTC's records or any Participant's or Indirect
Participant's records relating to the beneficial ownership interests in the
global notes; or
(2) any other matter relating to the actions and practices of DTC or
any of its Participants or Indirect Participants.
DTC has advised us that its current practice, upon receipt of any payment
in respect of securities such as the notes (including principal and interest),
is to credit the accounts of the relevant Participants with the payment on the
payment date unless DTC has reason to believe it will not receive payment on
such payment date. Each relevant Participant is credited with an amount
proportionate to its beneficial ownership of an interest in the principal amount
of the relevant security as shown on the records of DTC. Payments by the
Participants and the Indirect Participants to the beneficial owners of notes
will be governed by standing instructions and customary practices and will be
the responsibility of the Participants or the Indirect Participants and will not
be the responsibility of DTC, the trustee or us. Neither we nor the trustee will
be liable for any delay by DTC or any of its Participants in identifying the
beneficial owners of the notes, and we and the trustee may conclusively rely on
and will be protected in relying on instructions from DTC or its nominee for all
purposes.
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Transfers between Participants in DTC will be effected in accordance with
DTC's procedures, and will be settled in same-day funds, and transfers between
participants in Euroclear and Clearstream will be effected in accordance with
their respective rules and operating procedures.
Cross-market transfers between the Participants in DTC, on the one hand,
and Euroclear or Clearstream participants, on the other hand, will be effected
through DTC in accordance with DTC's rules on behalf of Euroclear or
Clearstream, as the case may be, by its respective depositary; however, such
cross-market transactions will require delivery of instructions to Euroclear or
Clearstream, as the case may be, by the counterparty in such system in
accordance with the rules and procedures and within the established deadlines
(Brussels time) of such system. Euroclear or Clearstream, as the case may be,
will, if the transaction meets its settlement requirements, deliver instructions
to its respective depositary to take action to effect final settlement on its
behalf by delivering or receiving interests in the relevant global note in DTC,
and making or receiving payment in accordance with normal procedures for
same-day funds settlement applicable to DTC. Euroclear participants and
Clearstream participants may not deliver instructions directly to the
depositories for Euroclear or Clearstream.
DTC has advised us that it will take any action permitted to be taken by a
Holder of notes only at the direction of one or more Participants to whose
account DTC has credited the interests in the global notes and only in respect
of such portion of the aggregate principal amount of the global notes as to
which such Participant or Participants has or have given such direction.
However, if there is an Event of Default under the notes, DTC reserves the right
to exchange the global notes for notes in certificated form, and to distribute
such notes to its Participants.
Although DTC, Euroclear and Clearstream have agreed to the foregoing to
facilitate transfers of interests in the global notes among participants in DTC,
Euroclear and Clearstream, they are under no obligation to perform or to
continue to perform such procedures, and may discontinue such procedures at any
time. Neither we nor the trustee nor any of their respective agents will have
any responsibility for the performance by DTC, Euroclear or Clearstream or their
respective participants or indirect participants of their respective obligations
under the rules and procedures governing their operations.
EXCHANGE OF GLOBAL NOTES FOR CERTIFICATED NOTES
A global note is exchangeable for definitive notes in registered
certificated form ("Certificated Notes") if:
(1) DTC (a) notifies us that it is unwilling or unable to continue as
depositary for the global notes and we fail to appoint a successor
depositary or (b) has ceased to be a clearing agency registered under the
Exchange Act;
(2) we, at our option, notify the trustee in writing that we elect to
cause the issuance of the Certificated Notes; or
(3) there has occurred and is continuing a Default or Event of Default
with respect to the notes.
In addition, beneficial interests in a global note may be exchanged for
Certificated Notes upon prior written notice given to the trustee by or on
behalf of DTC in accordance with the indenture. In all cases, Certificated Notes
delivered in exchange for any global note or beneficial interests in global
notes will be registered in the names, and issued in any approved denominations,
requested by or on behalf of the depositary (in accordance with its customary
procedures).
EXCHANGE OF CERTIFICATED NOTES FOR GLOBAL NOTES
Certificated Notes may be exchanged for beneficial interests in any global
note at any time.
SAME DAY SETTLEMENT AND PAYMENT
We will make payments in respect of the notes represented by the global
notes (including principal, premium, if any, interest and Liquidated Damages, if
any) by wire transfer of immediately available funds
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to the accounts specified by the Global Note Holder. We will make all payments
of principal, interest and premium and Liquidated Damages, if any, with respect
to Certificated Notes by wire transfer of immediately available funds to the
accounts specified by the Holders of Certificated Notes or, if no such account
is specified, by mailing a check to each such Holder's registered address. The
notes represented by the global notes are expected to be eligible to trade in
the PORTAL Market(SM) and to trade in DTC's Same-Day Funds Settlement System,
and any permitted secondary market trading activity in such notes will,
therefore, be required by DTC to be settled in immediately available funds. We
expect that secondary trading in any Certificated Notes will also be settled in
immediately available funds.
CERTAIN DEFINITIONS
Set forth below are certain defined terms used in the indenture. Reference
is made to the indenture for a full disclosure of all such terms, as well as any
other capitalized terms used herein for which no definition is provided.
"Acquired Debt" means, with respect to any specified Person:
(1) Indebtedness of any other Person existing at the time such other
Person is merged with or into or became a Subsidiary of such specified
Person, whether or not such Indebtedness is incurred in connection with, or
in contemplation of, such other Person merging with or into, or becoming a
Subsidiary of, such specified Person; and
(2) Indebtedness secured by a Lien encumbering any asset acquired by
such specified Person.
"Affiliate" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person. For purposes of this definition, "control,"
as used with respect to any Person, means the possession, directly or
indirectly, of the power to direct or cause the direction of the management or
policies of such Person, whether through the ownership of voting securities, by
agreement or otherwise; provided that beneficial ownership of 10% or more of the
Voting Stock of a Person will be deemed to be control. For purposes of this
definition, the terms "controlling," "controlled by" and "under common control
with" have correlative meanings.
"Asset Sale" means the sale, lease, conveyance or other disposition of any
assets or rights (including, without limitation, (x) a sale and leaseback, (y)
the issuance, sale or other transfer of any Equity Interests in any of our
Unrestricted Subsidiaries, and (z) the receipt of proceeds of insurance paid on
account of the loss of or damage to any asset and awards of compensation for any
asset taken by condemnation, eminent domain or similar proceeding, and including
the receipt of proceeds of business interruption insurance) in each case, in one
or a series of related transactions that have a fair market value in excess of
$1.0 million or for Net Proceeds in excess of $1.0 million; provided that the
sale, conveyance or other disposition of all or substantially all of the assets
of us and our Restricted Subsidiaries taken as a whole will be governed by the
provisions of the indenture described above under "-- Repurchase at the Option
of Holders -- Change of Control" and/or the provisions described above under
"-- Merger, Consolidation or Sale of Assets" and not by the provisions of the
"-- Asset Sales" covenant.
Notwithstanding the preceding, the following items will not be deemed to be
Asset Sales:
(1) the sale, lease or other disposition of equipment, inventory,
accounts receivable or other assets or rights in the ordinary course of
business;
(2) a transfer of assets or rights by us to a Subsidiary Guarantor or
by a Subsidiary Guarantor of ours to us or to another Subsidiary Guarantor
of ours;
(3) an issuance of Equity Interests by a Subsidiary Guarantor to us or
to another Subsidiary Guarantor of ours;
(4) a Restricted Payment or Permitted Investment that is permitted by
the "Restricted Payments" covenant;
(5) the sale of property or equipment that has become worn out,
obsolete or damaged;
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(6) the sale or other disposition of Cash Equivalents;
(7) the sale of accounts receivable pursuant to a Securitization
Transaction; or
(8) the designation of any Restricted Subsidiary as an Unrestricted
Subsidiary or the contribution to the capital of any Unrestricted
Subsidiary in accordance with the provisions described under "Designation
of Restricted and Unrestricted Subsidiaries."
"Attributable Debt" in respect of a sale and leaseback transaction means,
at the time of determination, the greater of (a) the fair value of the property
subject to such arrangement (as determined in good faith by our Board of
Directors) or (b) the present value (discounted at the interest rate borne by
the notes, compounded annually) of the total obligations of the lessee for
rental payments during the remaining term of the lease included in such sale and
leaseback transaction, including any period for which such lease has been
extended or may, at the option of the lessor, be extended.
"Board of Directors" means:
(1) with respect to a corporation, the board of directors of the
corporation;
(2) with respect to a partnership, the board of directors of the
general partner of the partnership; and
(3) with respect to any other Person, the board or committee of such
Person serving a similar function.
"Capital Lease Obligation" means, at the time any determination is to be
made, the amount of the liability in respect of a capital lease that would at
that time be required to be capitalized on a balance sheet in accordance with
GAAP.
"Capital Stock" means:
(1) in the case of a corporation, any and all shares, including common
stock and preferred stock;
(2) in the case of an association or business entity, any and all
shares, interests, participations, rights or other equivalents (however
designated) of corporate stock;
(3) in the case of a partnership or limited liability company,
partnership or membership interests (whether general or limited); and
(4) any other interest or participation that confers on a Person the
right to receive a share of the profits and losses of, or distributions of
assets of, the issuing Person.
"Cash Equivalents" means:
(1) United States dollars;
(2) securities issued or directly and fully guaranteed or insured by
the United States government or any agency or instrumentality of the United
States government (provided that the full faith and credit of the United
States is pledged in support of those securities) having maturities of not
more than six months from the date of acquisition;
(3) certificates of deposit and eurodollar time deposits with
maturities of six months or less from the date of acquisition, bankers'
acceptances with maturities not exceeding six months and overnight bank
deposits, in each case, with any lender party to the Credit Agreement or
with any domestic commercial bank having capital and surplus in excess of
$500.0 million and a Thomson Bank Watch Rating of "B" or better;
(4) repurchase obligations with a term of not more than seven days for
underlying securities of the types described in clauses (2) and (3) above
entered into with any financial institution meeting the qualifications
specified in clause (3) above;
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(5) commercial paper having the highest rating obtainable from Moody's
Investors Service, Inc. or Standard & Poor's Rating Services and in each
case maturing within six months after the date of acquisition; and
(6) money market funds at least 95% of the assets of which constitute
Cash Equivalents of the kinds described in clauses (1) through (5) of this
definition.
"Change of Control" means the occurrence of any of the following:
(1) any sale, lease, exchange or other transfer (in one transaction or
a series of related transactions) of all or substantially all of our assets
to any Person or group of related Persons for purposes of Section 13(d) of
the Exchange Act (a "Group"), together with any Affiliates thereof (whether
or not otherwise in compliance with the provisions of the indenture);
(2) the approval by the holders of our Capital Stock of any plan or
proposal for the liquidation or dissolution of us (whether or not otherwise
in compliance with the provisions of the indenture);
(3) any Person or Group (other than Parent or any direct or indirect
wholly owned Subsidiary of Parent) becomes the owner, directly or
indirectly, beneficially or of record, of shares representing more than 35%
of the aggregate ordinary voting power represented by our issued and
outstanding Capital Stock on a fully-diluted basis;
(4) the replacement of a majority of Parent's or our Board of
Directors over a two-year period from the directors who constituted
Parent's or our Board of Directors, as applicable, at the beginning of such
period, and such replacement shall not have been approved by a vote of at
least a majority of Parent's or our Board of Directors, as applicable, then
still in office who either were members of such Board of Directors at the
beginning of such period or whose election as a member of such Board of
Directors was previously so approved; or
(5) we consolidate with, or merge with or into, any Person, or any
Person consolidates with, or merges with or into, us, in any such event
pursuant to a transaction in which any of our outstanding Voting Stock or
the outstanding Voting Stock of such other Person is converted into or
exchanged for cash, securities or other property, other than any such
transaction where our Voting Stock outstanding immediately prior to such
transaction is converted into or exchanged for Voting Stock (other than
Disqualified Stock) of the surviving or transferee Person constituting a
majority of the outstanding shares of such Voting Stock of such surviving
or transferee Person (immediately after giving effect to such issuance).
"Consolidated Cash Flow" means, with respect to any specified Person for
any period, the Consolidated Net Income of such Person for such period plus:
(1) an amount equal to any extraordinary loss plus any net loss
realized by such Person or any of its Subsidiaries in connection with an
Asset Sale, to the extent such losses were deducted in computing such
Consolidated Net Income; plus
(2) provision for taxes based on income or profits of such Person and
its Restricted Subsidiaries for such period, to the extent that such
provision for taxes was deducted in computing such Consolidated Net Income;
plus
(3) consolidated interest expense of such Person and its Restricted
Subsidiaries for such period, whether paid or accrued and whether or not
capitalized (including, without limitation, amortization of debt issuance
costs and original issue discount, non-cash interest payments, the interest
component of any deferred payment obligations, the interest component of
all payments associated with Capital Lease Obligations, imputed interest
with respect to Attributable Debt, commissions, discounts and other fees
and charges incurred in respect of letter of credit or bankers' acceptance
financings, and net of the effect of all payments made or received pursuant
to Hedging Obligations), to the extent that any such expense was deducted
in computing such Consolidated Net Income; plus
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(4) depreciation, amortization (including amortization of goodwill and
other intangibles but excluding amortization of prepaid cash expenses that
were paid in a prior period) and other non-cash expenses (excluding any
such non-cash expense to the extent that it represents an accrual of or
reserve for cash expenses in any future period) of such Person and its
Restricted Subsidiaries for such period to the extent that such
depreciation, amortization and other non-cash expenses were deducted in
computing such Consolidated Net Income; minus
(5) non-cash items increasing such Consolidated Net Income for such
period, other than the accrual of revenue in the ordinary course of
business,
in each case, on a consolidated basis and determined in accordance with GAAP.
"Consolidated Net Income" means, with respect to any specified Person for
any period, the aggregate of the Net Income of such Person and its Restricted
Subsidiaries for such period, on a consolidated basis, determined in accordance
with GAAP; provided that:
(1) the Net Income (but not loss) of any Person that is not a
Restricted Subsidiary or that is accounted for by the equity method of
accounting will be included only to the extent of the amount of dividends
or distributions paid in cash to the specified Person or a Restricted
Subsidiary of the Person;
(2) the Net Income of any Restricted Subsidiary will be excluded to
the extent that the declaration or payment of dividends or similar
distributions by that Restricted Subsidiary of that Net Income is not at
the date of determination permitted without any prior governmental approval
(that has not been obtained) or, directly or indirectly, by operation of
the terms of its charter or any agreement, instrument, judgment, decree,
order, statute, rule or governmental regulation applicable to that
Restricted Subsidiary or its stockholders; and
(3) the cumulative effect of a change in accounting principles will be
excluded.
"Consolidated Senior Debt Leverage Ratio" means the ratio of (1)
consolidated Indebtedness of us and our Restricted Subsidiaries (other than
Subordinated Indebtedness) as of the date of the transaction giving rise to the
need to calculate such Consolidated Senior Debt Leverage Ratio to (2)
Consolidated Cash Flow for the four full fiscal quarters immediately preceding
the date of the transaction giving rise to the need to calculate such
Consolidated Senior Debt Leverage Ratio taken as one period.
"Consolidated Tangible Assets" means the total assets, less goodwill and
other intangibles, shown on our most recent consolidated balance sheet,
determined on a consolidated basis in accordance with GAAP less all write-ups
(other than write-ups in connection with acquisitions) subsequent to the date of
the indenture in the book value of any asset (except any such intangible assets)
owned by us or any of our Restricted Subsidiaries.
"Credit Agreement" means that certain Credit Agreement, dated as of the
date of the indenture, by and among us, the Subsidiary Guarantors, Lehman
Commercial Paper Inc., as administrative agent, and the lenders party thereto,
including any related notes, guarantees, security and collateral documents,
instruments and agreements executed in connection therewith.
"Credit Facilities" means one or more debt facilities or agreements
(including, without limitation, the Credit Agreement) or commercial paper
facilities, in each case with banks or other lenders providing for revolving
credit loans, term loans, notes, receivables financing (including through the
sale of receivables to such lenders or to special purpose entities formed to
borrow from such lenders against such receivables) or letters of credit, in each
case, as amended, restated, modified, renewed, refunded, replaced, restructured,
restated or refinanced (including any agreement to extend the maturity thereof
and adding additional borrowers or guarantors) in whole or in part from time to
time under the same or any other agent, lender or group of lenders and including
increasing the amount of available borrowings thereunder; provided that such
increase is permitted by the "Incurrence of Indebtedness and Issuance of
Preferred Stock" covenant above.
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"Default" means any event that is, or with the passage of time or the
giving of notice or both would be, an Event of Default.
"Designated Non-Cash Consideration" means the fair market value of total
consideration received by us or any of our Restricted Subsidiaries in connection
with an Asset Sale that is so designated as Designated Non-Cash Consideration
pursuant to an officer's certificate, setting forth the basis of such valuation,
executed by our principal executive officer and principal financial officer,
less the amount of cash or Cash Equivalents received in connection with the
Asset Sale; provided, however, the total amount of Designated Non-Cash
Consideration outstanding at one time does not exceed the greater of $15.0
million and 2.5% of Consolidated Tangible Assets.
"Disqualified Stock" means any Capital Stock that, by its terms (or by the
terms of any security into which it is convertible, or for which it is
exchangeable, in each case at the option of the holder of the Capital Stock), or
upon the happening of any event, matures or is mandatorily redeemable, pursuant
to a sinking fund obligation or otherwise, or redeemable at the option of the
holder of the Capital Stock, in whole or in part, on or prior to the date that
is 91 days after the date on which the notes mature. Notwithstanding the
preceding sentence, any Capital Stock that would constitute Disqualified Stock
solely because the holders of the Capital Stock have the right to require us to
repurchase such Capital Stock upon the occurrence of a Change of Control or an
Asset Sale will not constitute Disqualified Stock if the terms of such Capital
Stock provide that we may not repurchase or redeem any such Capital Stock
pursuant to such provisions unless such repurchase or redemption complies with
the "-- Restricted Payments" covenant.
"Domestic Subsidiary" means any Restricted Subsidiary of ours that was
formed under the laws of the United States or any state of the United States or
the District of Columbia.
"Equity Interests" means Capital Stock and all warrants, options or other
rights to acquire Capital Stock (but excluding any debt security that is
convertible into, or exchangeable for, Capital Stock).
"Existing Indebtedness" means Indebtedness of us and our Subsidiaries
(other than Indebtedness under the Credit Agreement) in existence on the date of
the indenture, until such amounts are repaid.
"Fixed Charges" means, with respect to any specified Person for any period,
the sum, without duplication, of:
(1) the consolidated interest expense of such Person and its
Restricted Subsidiaries for such period, whether paid or accrued,
including, without limitation, amortization of debt issuance costs and
original issue discount, non-cash interest payments, the interest component
of any deferred payment obligations, the interest component of all payments
associated with Capital Lease Obligations, imputed interest with respect to
Attributable Debt, commissions, discounts and other fees and charges
incurred in respect of letter of credit or bankers' acceptance financings,
and net of the effect of all payments made or received pursuant to Hedging
Obligations; plus
(2) the consolidated interest of such Person and its Restricted
Subsidiaries that was capitalized during such period; plus
(3) any interest expense on Indebtedness of another Person that is
Guaranteed by such Person or secured by a Lien on assets of such Person,
whether or not such Guarantee or Lien is called upon; plus
(4) the product of (a) all dividends, whether paid or accrued and
whether or not in cash, on any series of preferred stock of such Person or
any of its Restricted Subsidiaries other than dividends on Equity Interests
payable solely in Equity Interests of such Person (other than Disqualified
Stock) or to such Person or one of its Restricted Subsidiaries, times (b) a
fraction, the numerator of which is one and the denominator of which is one
minus the then current combined federal, state and local statutory tax rate
of such Person, expressed as a decimal, in each case, on a consolidated
basis and in accordance with GAAP.
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"Fixed Charge Coverage Ratio" means, with respect to any specified Person
for any period, the ratio of the Consolidated Cash Flow of such Person and its
Restricted Subsidiaries for such period to the Fixed Charges of such Person and
its Restricted Subsidiaries for such period. In the event that the specified
Person or any of its Restricted Subsidiaries incurs, assumes, Guarantees,
repays, repurchases or redeems any Indebtedness (other than ordinary working
capital borrowings) or issues, repurchases or redeems preferred stock subsequent
to the commencement of the reference period for which the Fixed Charge Coverage
Ratio is being calculated and on or prior to the date on which the event for
which the calculation of the Fixed Charge Coverage Ratio is made (the
"Calculation Date"), then the Fixed Charge Coverage Ratio will be calculated
giving pro forma effect to such incurrence, assumption, Guarantee, repayment,
repurchase or redemption of Indebtedness, or such issuance, repurchase or
redemption of preferred stock, and the use of the proceeds therefrom as if the
same had occurred at the beginning of the applicable four-quarter reference
period; provided, however, that the Fixed Charges of such Person attributable to
interest on any Indebtedness under a revolving credit facility computed on a pro
forma basis will be computed based on the average daily balance of such
Indebtedness during the four-quarter reference period and using the interest
rate in effect at the end of such period.
In addition, for purposes of calculating the Fixed Charge Coverage Ratio:
(1) acquisitions that have been made by the specified Person or any of
its Restricted Subsidiaries, including through mergers or consolidations
and including any related financing transactions, during the four-quarter
reference period or subsequent to such reference period and on or prior to
the Calculation Date will be given pro forma effect (calculated in
accordance with Regulation S-X) as if they had occurred on the first day of
the four-quarter reference period and Consolidated Cash Flow for such
reference period will be calculated without giving effect to clause (3) of
the proviso set forth in the definition of Consolidated Net Income;
(2) the Consolidated Cash Flow attributable to discontinued operations
as determined in accordance with GAAP, and operations or businesses
disposed of prior to the Calculation Date will be excluded; and
(3) the Fixed Charges attributable to discontinued operations, as
determined in accordance with GAAP, and operations or businesses disposed
of prior to the Calculation Date, will be excluded, but only to the extent
that the obligations giving rise to such Fixed Charges will not be
obligations of the specified Person or any of its Restricted Subsidiaries
following the Calculation Date.
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as have been approved by a significant segment of the accounting
profession, which are in effect on the date of the indenture.
"Guarantee" means a guarantee other than by endorsement of negotiable
instruments for collection in the ordinary course of business, direct or
indirect, in any manner including, without limitation, by way of a pledge of
assets or through letters of credit or reimbursement agreements in respect
thereof, of all or any part of any Indebtedness.
"Hedging Obligations" means, with respect to any specified Person, the
obligations of such Person under:
(1) interest rate swap agreements, interest rate cap agreements and
interest rate collar agreements;
(2) other agreements or arrangements designed to protect such Person
against fluctuations in interest rates; and
(3) foreign exchange contracts, currency swap agreements or other
agreements or arrangements designed to protect such Person against
fluctuations in currency values.
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"Holder" means a Person in whose name a note is registered.
"Indebtedness" means, with respect to any specified Person, any
indebtedness of such Person, whether or not contingent:
(1) in respect of borrowed money;
(2) evidenced by bonds, notes, debentures or similar instruments or
letters of credit (or reimbursement agreements in respect thereof);
(3) in respect of banker's acceptances;
(4) representing Capital Lease Obligations;
(5) representing the balance deferred and unpaid of the purchase price
of any property, except any such balance that constitutes an accrued
expense or trade payable; or
(6) representing any Hedging Obligations;
if and to the extent any of the preceding items (other than letters of credit
and Hedging Obligations) would appear as a liability upon a balance sheet of the
specified Person prepared in accordance with GAAP. In addition, the term
"Indebtedness" includes all Indebtedness of others secured by a Lien on any
asset of the specified Person (whether or not such Indebtedness is assumed by
the specified Person) and, to the extent not otherwise included, the Guarantee
by the specified Person of any Indebtedness of any other Person.
The amount of any Indebtedness outstanding as of any date will be:
(1) the accreted value of the Indebtedness, in the case of any
Indebtedness issued with original issue discount; and
(2) the principal amount of the Indebtedness, together with any
interest on the Indebtedness that is more than 30 days past due, in the
case of any other Indebtedness.
"Investments" means, with respect to any Person, all direct or indirect
investments by such Person in other Persons (including Affiliates) in the forms
of loans (including Guarantees or other obligations), advances or capital
contributions (excluding commission, travel and similar advances to officers and
employees made in the ordinary course of business), purchases or other
acquisitions for consideration of Indebtedness, Equity Interests or other
securities, together with all items that are or would be classified as
investments on a balance sheet prepared in accordance with GAAP; provided that
Investments shall not be deemed to include extensions of trade credit by us or
any of our Restricted Subsidiaries on commercially reasonable terms in
accordance with normal trade practices. If we or any of our Subsidiaries sells
or otherwise disposes of any Equity Interests of any direct or indirect
Subsidiary of ours such that, after giving effect to any such sale or
disposition, such Person is no longer a Subsidiary of ours, we will be deemed to
have made an Investment on the date of any such sale or disposition equal to the
fair market value of the Equity Interests of such Subsidiary not sold or
disposed of in an amount determined as provided in the final paragraph of the
"Restricted Payments" covenant. The acquisition by us or any of our Subsidiaries
of a Person that holds an Investment in a third Person will be deemed to be an
Investment by us or such Subsidiary in such third Person in an amount equal to
the fair market value of the Investment held by the acquired Person in such
third Person in an amount determined as provided in the final paragraph of the
"Restricted Payments" covenant.
"Lien" means, with respect to any asset, any mortgage, lien, pledge,
charge, security interest or encumbrance of any kind in respect of such asset,
whether or not filed, recorded or otherwise perfected under applicable law,
including any conditional sale or other title retention agreement, any lease in
the nature thereof, any option or other agreement to sell or give a security
interest in and any filing of or agreement to give any financing statement under
the Uniform Commercial Code (or equivalent statutes) of any jurisdiction.
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"Net Income" means, with respect to any specified Person, the net income
(loss) of such Person, determined in accordance with GAAP and before any
reduction in respect of preferred stock dividends, excluding, however:
(1) any gain (but not loss), together with any related provision for
taxes on such gain (but not loss), realized in connection with: (a) any
Asset Sale or (b) the disposition of any securities by such Person or any
of its Restricted Subsidiaries or the extinguishment of any Indebtedness of
such Person or any of its Restricted Subsidiaries; and
(2) any extraordinary gain (but not loss), together with any related
provision for taxes on such extraordinary gain (but not loss).
"Net Proceeds" means the aggregate cash proceeds received by us or any of
our Restricted Subsidiaries in respect of any Asset Sale (including, without
limitation, any cash received upon the sale or other disposition of any non-cash
consideration, including Designated Non-Cash Consideration, deemed to be cash
pursuant to the provisions of "Repurchase at the Option of Holders-Asset Sales,"
received in any Asset Sale), net of the direct costs relating to such Asset
Sale, including, without limitation, legal, accounting and investment banking
fees, and sales commissions, and any relocation expenses incurred as a result of
the Asset Sale, taxes paid or payable as a result of the Asset Sale, in each
case, after taking into account any available tax credits or deductions and any
tax sharing arrangements, and amounts required to be applied to the repayment of
Indebtedness, other than Senior Debt, secured by a Lien on the asset or assets
that were the subject of such Asset Sale, and any reserve for adjustment in
respect of the sale price of such asset or assets established in accordance with
GAAP.
"Non-recourse Debt" means Indebtedness:
(1) as to which neither we nor any of our Restricted Subsidiaries (a)
provides credit support of any kind (including any undertaking, agreement
or instrument that would constitute Indebtedness), (b) is directly or
indirectly liable as a guarantor or otherwise, or (c) constitutes the
lender;
(2) no default with respect to which (including any rights that the
holders thereof may have to take enforcement action against an Unrestricted
Subsidiary) would permit upon notice, lapse of time or both any holder of
any other Indebtedness (other than the notes) of ours or any of our
Restricted Subsidiaries to declare a default on such other Indebtedness or
cause the payment thereof to be accelerated or payable prior to its stated
maturity; and
(3) as to which the lenders have been notified in writing that they
will not have any recourse to our stock or assets or the stock or assets of
any of our Restricted Subsidiaries.
"Obligations" means any principal, interest, penalties, fees,
indemnifications, reimbursements, damages and other liabilities payable under
the documentation governing any Indebtedness.
"Parent" means Extendicare, Inc., a corporation organized under the laws of
Canada.
"Permitted Business" means the lines of business conducted by us and our
Restricted Subsidiaries on the date of the indenture and the businesses
reasonably related thereto within the healthcare services sector.
"Permitted Investments" means:
(1) any Investment in us or in one of our Wholly Owned Restricted
Subsidiaries;
(2) any Investment outstanding as of the date hereof;
(3) any Investment in Cash Equivalents;
(4) loans and advances to employees and officers of us and our
Restricted Subsidiaries in the ordinary course of business for bona fide
business purposes not in excess of $1.0 million at any one time
outstanding;
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(5) Investments in prepaid expenses, negotiable instruments held for
collection and lease, utility and workers' compensation, performance and
other similar deposits;
(6) any Investment by us or any of our Restricted Subsidiaries in a
Person engaged in a Permitted Business, if as a result of such Investment:
(a) such Person becomes one of our Wholly Owned Restricted
Subsidiaries; or
(b) such Person is merged, consolidated or amalgamated with or
into, or transfers or conveys substantially all of its assets to, or is
liquidated into, us or one of our Wholly Owned Restricted Subsidiaries;
(7) any Investment made as a result of the receipt of non-cash
consideration (including Designated Non-Cash Consideration) from an Asset
Sale that was made pursuant to and in compliance with the covenant
described above under "-- Repurchase at the Option of Holders -- Asset
Sales;"
(8) any acquisition of assets, Equity Interests or other securities
solely in exchange for the issuance of our Equity Interests (other than
Disqualified Stock);
(9) any Investments received in compromise of obligations of such
Persons incurred in the ordinary course of trade creditors or customers
that were incurred in the ordinary course of business, including pursuant
to any plan of reorganization or similar arrangement upon the bankruptcy or
insolvency of any trade creditor or customer;
(10) Hedging Obligations;
(11) any Investment made in a Special Purpose Vehicle in connection
with a Securitization Transaction or to provide adequate capital to a
Special Purpose Vehicle in anticipation of one or more Securitization
Transactions; and
(12) other Investments in any Person having an aggregate fair market
value (measured on the date each such Investment was made and without
giving effect to subsequent changes in value), when taken together with all
other Investments made pursuant to this clause (12) that are at the time
outstanding, not to exceed $10.0 million.
"Permitted Liens" means:
(1) Liens securing Indebtedness under Credit Facilities, including the
Credit Agreement, where such Indebtedness was permitted by the terms of the
indenture to be incurred;
(2) Liens in favor of us or the Subsidiary Guarantors;
(3) Liens on property of a Person existing at the time such Person is
merged with or into or consolidated with us or any Restricted Subsidiary of
ours; provided that such Liens were in existence prior to the contemplation
of such merger or consolidation and do not extend to any assets other than
those of the Person merged into or consolidated with us or such Restricted
Subsidiary;
(4) Liens on property existing at the time of acquisition of the
property by us or any of our Restricted Subsidiaries; provided that such
Liens were in existence prior to the contemplation of such acquisition;
(5) Liens to secure the performance of statutory obligations, surety
or appeal bonds, performance bonds or other obligations of a like nature;
(6) Liens to secure Indebtedness (including Capital Lease Obligations)
permitted by clause (4) of the second paragraph of the "Incurrence of
Indebtedness and Issuance of Preferred Stock" covenant covering only the
assets acquired with such Indebtedness;
(7) Liens existing on the date of the indenture;
122
(8) Liens for taxes, assessments or governmental charges or claims
that are not yet delinquent or that are being contested in good faith by
appropriate proceedings promptly instituted and diligently concluded;
provided that any reserve or other appropriate provision as is required in
conformity with GAAP has been made therefor;
(9) pledges or deposits in the ordinary course of business to secure
lease obligations or nondelinquent obligations under workers' compensation,
unemployment insurance or similar legislation;
(10) easements, rights-of-way, restrictions, minor defects or
irregularities in title and other similar charges or encumbrances not
interfering in any material respect with our business or assets or the
business or assets of any of our Subsidiaries incurred in the ordinary
course of business;
(11) Liens to secure Hedging Obligations;
(12) Liens incurred in connection with a sale and leaseback
transaction permitted under "Sale and Leaseback Transactions" that do not
exceed 5% of our Consolidated Tangible Assets; and
(13) Liens incurred by us or any Restricted Subsidiary of ours with
respect to obligations that do not exceed $10.0 million at any one time
outstanding; provided that such amount shall be reduced by any amount
incurred under clause (12) above.
"Permitted Refinancing Indebtedness" means any Indebtedness of ours or any
of our Restricted Subsidiaries issued in exchange for, or the net proceeds of
which are used to extend, refinance, renew, replace, defease or refund other
Indebtedness of ours or any of our Restricted Subsidiaries (other than
intercompany Indebtedness); provided that:
(1) the principal amount (or accreted value, if applicable) of such
Permitted Refinancing Indebtedness does not exceed the principal amount (or
accreted value, if applicable) of the Indebtedness extended, refinanced,
renewed, replaced, defeased or refunded (plus all accrued interest on the
Indebtedness and the amount of all expenses and premiums incurred in
connection therewith);
(2) such Permitted Refinancing Indebtedness has a final maturity date
later than the final maturity date of, and has a Weighted Average Life to
Maturity equal to or greater than the Weighted Average Life to Maturity of,
the Indebtedness being extended, refinanced, renewed, replaced, defeased or
refunded;
(3) either
(a) if the Indebtedness being extended, refinanced, renewed,
replaced, defeased or refunded is subordinated in right of payment to
the notes (including the Senior Subordinated Notes), such Permitted
Refinancing Indebtedness has a final maturity date later than the final
maturity date of, and is subordinated in right of payment to, the notes
on terms at least as favorable to the Holders of notes as those
contained in the documentation governing the Indebtedness being
extended, refinanced, renewed, replaced, defeased or refunded, or
(b) with respect to only the Senior Subordinated Notes, at the time
of such incurrence our Consolidated Senior Debt Leverage Ratio would
have been less than 2.75 to 1; provided that when calculating such
ratio, pro forma effect will be given to (A) the incurrence of such
Indebtedness and the application of the proceeds therefrom, including to
refinance the Senior Subordinated Notes and (B) the acquisition (whether
by purchase, merger or otherwise) or disposition (whether by sale,
merger or otherwise) of any company, entity or business acquired or
disposed of by us or our Restricted Subsidiaries, as the case may be,
since the first day of the four-quarter period referred to in the
definition of Consolidated Senior Debt Leverage Ratio as if such
acquisition or disposition had occurred at the beginning of such
four-quarter period; and
(4) such Indebtedness is incurred either by us or by the Subsidiary
who is the obligor on the Indebtedness being extended, refinanced, renewed,
replaced, defeased or refunded.
123
"Person" means any individual, corporation, partnership, joint venture,
association, joint-stock company, trust, unincorporated organization, limited
liability company or government or other entity.
"Qualified Equity Offering" means any underwritten public or any private
offering of our Capital Stock (excluding Disqualified Stock) or any of Parent's
Capital Stock (excluding Disqualified Stock), in the latter case, only to the
extent that the net cash proceeds therefrom are contributed to our common or
non-redeemable preferred equity capital.
"Replacement Assets" means any properties or assets used or useful in a
Permitted Business.
"Restricted Investment" means an Investment other than a Permitted
Investment.
"Restricted Subsidiary" of a Person means any Subsidiary of the referent
Person that is not an Unrestricted Subsidiary.
"SEC" means the Securities and Exchange Commission.
"Securitization Transaction" means any sale, conveyance or other
disposition by us or any of our Restricted Subsidiaries of any accounts
receivable or any interest therein to a Special Purpose Vehicle.
"Senior Debt" means:
(1) all Indebtedness of ours or of any Subsidiary Guarantor
outstanding under Credit Facilities and all Hedging Obligations with
respect thereto;
(2) any other Indebtedness of ours or of any Subsidiary Guarantor
permitted to be incurred under the terms of the indenture, unless the
instrument under which such Indebtedness is incurred expressly provides
that it is on a parity with or subordinated in right of payment to the
notes or any Subsidiary Guarantee; and
(3) all Obligations with respect to the items listed in the preceding
clauses (1) and (2).
Notwithstanding anything to the contrary in the preceding, Senior Debt will
not include:
(1) any liability for federal, state, local or other taxes owed or
owing by us;
(2) any Indebtedness of ours to any of our Subsidiaries or other
Affiliates;
(3) any trade payables; or
(4) the portion of any Indebtedness that is incurred in violation of
the indenture.
"Senior Subordinated Notes" means our 9.35% Senior Subordinated Notes due
2007.
"Significant Subsidiary" means any Subsidiary that would be a "significant
subsidiary" as defined in Article 1, Rule 1-02 of Regulation S-X, promulgated
pursuant to the Securities Act, as such Regulation is in effect on the date of
the indenture.
"Special Purpose Vehicle" means a bankruptcy-remote entity or trust or
other special purpose entity which is formed by us, any Subsidiary of ours or
any other Person for the purpose of, and engages in no material business other
than, acting as a buyer in a Securitization Transaction or other similar
transactions of accounts receivable or other similar assets, financing the
purchases it makes as such a buyer and realizing, directly or indirectly, on
such accounts receivable or other similar assets.
"Stated Maturity" means, with respect to any installment of interest or
principal on any series of Indebtedness (including, without limitation, a
scheduled repayment or a scheduled sinking fund payment), the date on which the
payment of interest or principal was scheduled to be paid in the original
documentation governing such Indebtedness, and will not include any contingent
obligations to repay, redeem or repurchase any such interest or principal prior
to the date originally scheduled for the payment thereof.
"Subordinated Indebtedness" means any Indebtedness (whether outstanding on
the Issue Date or thereafter incurred, including the Senior Subordinated Notes)
that is subordinated or junior in right of
124
payment to the notes or the Subsidiary Guarantees pursuant to a written
agreement, executed by the Person to whom such Indebtedness is owed, to that
effect.
"Subsidiary" means, with respect to any specified Person:
(1) any corporation, association or other business entity of which
more than 50% of the total voting power of shares of Capital Stock entitled
(without regard to the occurrence of any contingency) to vote in the
election of directors, managers or trustees of the corporation, association
or other business entity is at the time owned or controlled, directly or
indirectly, by that Person or one or more of the other Subsidiaries of that
Person (or a combination thereof); and
(2) any partnership (a) the sole general partner or the managing
general partner of which is such Person or a Subsidiary of such Person or
(b) the only general partners of which are that Person or one or more
Subsidiaries of that Person (or any combination thereof).
"Subsidiary Guarantee" means the Guarantee of the notes by each of the
Subsidiary Guarantors pursuant to the indenture and any additional Guarantee of
the notes to be executed by any Subsidiary of ours pursuant to the covenant
described above under "-- Additional Subsidiary Guarantees."
"Subsidiary Guarantors" means all of our existing and future domestic
Significant Subsidiaries, all of our existing and future Domestic Subsidiaries
that guarantee or incur any Indebtedness and any other existing or future
Significant Subsidiaries or Restricted Subsidiaries that guarantee or otherwise
provide direct credit support for Indebtedness of ours or any of our Domestic
Subsidiaries.
"Unrestricted Subsidiary" means any Subsidiary of ours (or any successor to
any of them) that is designated by our Board of Directors as an Unrestricted
Subsidiary pursuant to a board resolution, but only to the extent that such
Subsidiary:
(1) has no Indebtedness other than Non-Recourse Debt;
(2) is not party to any agreement, contract, arrangement or
understanding with us or any Restricted Subsidiary of ours unless the terms
of any such agreement, contract, arrangement or understanding are no less
favorable to us or such Restricted Subsidiary than those that might be
obtained at the time from Persons who are not Affiliates of ours;
(3) is a Person with respect to which neither we nor any of our
Restricted Subsidiaries has any direct or indirect obligation (a) to
subscribe for additional Equity Interests or (b) to maintain or preserve
such Person's financial condition or to cause such Person to achieve any
specified levels of operating results;
(4) has not guaranteed or otherwise directly or indirectly provided
credit support for any Indebtedness of ours or any of our Restricted
Subsidiaries; and
(5) has at least one director on its Board of Directors that is not a
director or executive officer of ours or any of our Restricted Subsidiaries
and has at least one executive officer that is not a director or executive
officer of ours or any of our Restricted Subsidiaries.
Any designation of a Subsidiary of ours as an Unrestricted Subsidiary will
be evidenced to the trustee by filing with the trustee a certified copy of the
board resolution giving effect to such designation and an officers' certificate
certifying that such designation complied with the preceding conditions and was
permitted by the "-- Restricted Payments" covenant. If, at any time, any
Unrestricted Subsidiary would fail to meet the preceding requirements as an
Unrestricted Subsidiary, it will thereafter cease to be an Unrestricted
Subsidiary for purposes of the indenture and any Indebtedness of such Subsidiary
will be deemed to be incurred by a Restricted Subsidiary of ours as of such date
and, if such Indebtedness is not permitted to be incurred as of such date under
the "-- Incurrence of Indebtedness and Issuance of Preferred Stock" covenant, we
will be in default of such covenant. Our Board of Directors may at any time
designate any Unrestricted Subsidiary to be a Restricted Subsidiary; provided
that such designation will be deemed to be an incurrence of Indebtedness by one
of our Restricted Subsidiaries of any outstanding Indebtedness of such
Unrestricted Subsidiary and such designation will only be permitted if
125
(1) such Indebtedness is permitted under the "-- Incurrence of Indebtedness and
Issuance of Preferred Stock" covenant, calculated on a pro forma basis as if
such designation had occurred at the beginning of the four-quarter reference
period; (2) no Default or Event of Default would be in existence following such
designation; and (3) such Subsidiary executes and delivers to the trustee a
supplemental indenture providing for a Subsidiary Guarantee.
"Voting Stock" of any Person as of any date means the Capital Stock of such
Person that is at the time entitled to vote in the election of the Board of
Directors of such Person.
"Weighted Average Life to Maturity" means, when applied to any Indebtedness
at any date, the number of years obtained by dividing:
(1) the sum of the products obtained by multiplying (a) the amount of
each then remaining installment, sinking fund, serial maturity or other
required payments of principal, including payment at final maturity, in
respect of the Indebtedness, by (b) the number of years (calculated to the
nearest one-twelfth) that will elapse between such date and the making of
such payment; by
(2) the then outstanding principal amount of such Indebtedness.
126
CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS
THIS SUMMARY IS OF A GENERAL NATURE AND IS INCLUDED HEREIN SOLELY FOR
INFORMATIONAL PURPOSES. IT IS NOT INTENDED TO BE, NOR SHOULD IT BE CONSTRUED AS
BEING, LEGAL OR TAX ADVICE. NO REPRESENTATION WITH RESPECT TO THE CONSEQUENCES
OF ANY PARTICULAR PURCHASER OF THE NEW NOTES IS MADE. PROSPECTIVE PURCHASERS
SHOULD CONSULT THEIR OWN TAX ADVISORS WITH RESPECT TO THEIR PARTICULAR
CIRCUMSTANCES.
The following general discussion summarizes the material U.S. federal
income tax aspects of the exchange offer to holders of old notes. The discussion
is for general information purposes only, is limited to U.S. federal income tax
consequences of the exchange offer, and does not consider the aspects of the
ownership and dispositions of the old notes or the new notes. A discussion of
the U.S. federal income tax consequences of holding and disposing of the notes
is contained in the offering memorandum with respect to the old notes.
The following summary deals only with notes held as capital assets by
purchasers at the issue price who are U.S. holders and not with special classes
of holders, such as dealers in securities or currencies, financial institutions,
life insurance companies, tax-exempt entities, persons holding notes as part of
a hedge, conversion, constructive sale transaction, straddle or other risk
reduction strategy, and persons whose functional currency is not the U.S.
dollar. Persons considering the purchase of notes should consult their own tax
advisors concerning these matters and as to the tax treatment under foreign,
state and local tax laws and regulations. We cannot provide any assurance that
the Internal Revenue Service will not challenge the conclusions stated below. We
have not sought and will not seek a ruling from the Internal Revenue Service on
any of the matters discussed below.
This summary is based upon the Internal Revenue Code of 1986, Treasury
Regulations, Internal Revenue Service rulings and pronouncements and judicial
decisions now in effect, all of which are subject to change at any time. Changes
in this area of law may be applied retroactively in a manner that could cause
the tax consequences to vary substantially from the consequences described
below, possibly adversely affecting a U.S. holder of notes. The authorities on
which this discussion is based are subject to various interpretations, and it is
therefore possible that the federal income tax treatment of the exchange of old
notes for the new notes may differ from the treatment described below.
The exchange of old notes for the new notes under the terms of the exchange
offer should not constitute a taxable exchange. As a result:
- A holder should not recognize taxable gain or loss as a result of
exchanging old notes for the new notes under the terms of the exchange
offer;
- The holder's holding period of the new notes should include the holding
period of the old notes exchanged for the new notes; and
- A holder's adjusted tax basis in the new notes should be the same as the
adjusted tax basis, immediately before the exchange, of the old notes
exchanged for the new notes.
127
PLAN OF DISTRIBUTION
If you are a broker-dealer and hold old notes for your own account as a
result of market-making activities or other trading activities and you receive
new notes in exchange for old notes in the exchange offer, then you may be a
statutory underwriter and must acknowledge that you will deliver a prospectus in
connection with any resale of these new notes. This prospectus, as it may be
amended or supplemented from time to time, may be used by a broker-dealer in
connection with resales of new notes received in exchange for old notes where
such old notes were acquired as a result of market-making activities or other
trading activities. We acknowledge and, unless you are a broker-dealer, you must
acknowledge that you are not engaged in, do not intend to engage in, and have no
arrangement or understanding with any person to participate in a distribution of
new notes. We have agreed that we will make this prospectus, as amended or
supplemented, available to any broker-dealer for use in connection with any such
resale.
Neither we nor any subsidiary guarantor will receive any proceeds in
connection with the exchange offer or any sale of new notes by broker-dealers.
New notes received by broker-dealers for their own account pursuant to the
exchange offer may be sold from time to time in one or more transactions in the
over-the-counter market, in negotiated transactions, through the writing of
options on the new notes or a combination of these methods of resale, at market
prices prevailing at the time of resale, at prices related to such prevailing
market prices or negotiated prices. Any resale may be made directly to
purchasers or to or through brokers or dealers who may receive compensation in
the form of commissions or concessions from any such broker-dealers or the
purchasers of any such new notes. Any broker-dealer that resells new notes that
were received by it for its own account pursuant to the exchange offer and any
broker-dealer that participates in a distribution of such new notes may be
deemed to be an "underwriter" within the meaning of the Securities Act and any
profit on any such resale of new notes and any commissions or concessions
received by any such persons may be deemed to be underwriting compensation under
the Securities Act. The letter of transmittal states that by acknowledging that
it will deliver, and by delivering, a prospectus, a broker-dealer will not be
deemed to admit that it is an "underwriter" within the meaning of the Securities
Act. See "The Exchange Offer -- Resales of New Notes."
LEGAL MATTERS
Foley & Lardner, Milwaukee, Wisconsin, will issue an opinion about some
legal matters with respect to the new notes and the new guarantees.
EXPERTS
The consolidated financial statements of Extendicare Health Services, Inc.
and subsidiaries as of December 31, 2001 and 2000, and for each of the years in
the three-year period ended December 31, 2001 and the related financial
statement schedule have been included herein in reliance upon the reports of
KPMG LLP, independent accountants, appearing elsewhere herein, and upon the
authority of said firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports and other information with
the Securities and Exchange Commission. You may read and copy any document we
file at the SEC's public reference rooms at 450 Fifth Street, N.W., Washington,
D.C. and at regional offices in New York, New York and Chicago, Illinois. Please
call the SEC at 1-800-SEC-0330 for further information on the public reference
rooms. Our SEC filings are also available to the public at the SEC's web site at
http://www.sec.gov.
128
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<Table>
Independent Auditors' Report................................ F-2
Consolidated Balance Sheets as of September 30, 2002
(unaudited) and as of December 31, 2001 and 2000.......... F-3
Consolidated Statements of Operations for the Nine Months
Ended September 30, 2002 and 2001 (unaudited) and for the
Years Ended December 31, 2001, 2000 and 1999.............. F-4
Consolidated Statements of Changes in Shareholder's Equity
for the Nine Months Ended September 30, 2002 (unaudited)
and for the Years Ended December 31, 2001, 2000 and
1999...................................................... F-5
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2002 and 2001 (unaudited) and for the
Years Ended December 31, 2001, 2000 and 1999.............. F-6
Notes to Consolidated Financial Statements.................. F-7
</Table>
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Extendicare Health Services, Inc.:
We have audited the accompanying consolidated balance sheets of Extendicare
Health Services, Inc. and subsidiaries (the Company) as of December 31, 2001 and
2000, and the related consolidated statements of operations, shareholder's
equity, and cash flows for each of the years in the three-year period ended
December 31, 2001. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Extendicare
Health Services, Inc. and subsidiaries as of December 31, 2001 and 2000, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America.
/s/ KPMG LLP
Milwaukee, Wisconsin
February 6, 2002
F-2
EXTENDICARE HEALTH SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA)
<Table>
<Caption>
DECEMBER 31,
SEPTEMBER 30, --------------------
2002 2001 2000
------------- -------- --------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.............................. $ 29,710 $ 997 $ 1,641
Accounts receivable, less allowances of $11,834,
$14,577 and $16,329, respectively................... 99,371 104,236 130,032
Supplies, inventories and other current assets......... 7,405 6,809 9,454
Due from shareholder:
Federal income taxes receivable..................... 9,488 9,468 24,235
Deferred federal income taxes....................... 10,763 11,474 10,782
Other............................................... 3,004 -- --
-------- -------- --------
Total current assets................................ 159,741 132,984 176,144
Property and equipment (Note 5).......................... 439,095 477,830 507,536
Deferred state income taxes.............................. -- -- 386
Goodwill and other intangible assets (Note 6)............ 76,648 77,592 81,310
Other assets (Note 7).................................... 119,320 107,430 108,214
-------- -------- --------
Total Assets........................................ $794,804 $795,836 $873,590
======== ======== ========
LIABILITIES AND SHAREHOLDER'S EQUITY
CURRENT LIABILITIES:
Bank indebtedness...................................... $ 4 $ 590 $ 538
Current maturities of long-term debt (Note 8).......... 608 12,099 12,706
Accounts payable....................................... 22,581 23,172 22,211
Accrued liabilities (Note 9)........................... 101,715 82,736 85,374
Income taxes payable................................... 1,495 1,556 1,344
Deferred state income taxes............................ 239 -- 181
Due to shareholder and affiliates...................... -- 8,686 9,317
-------- -------- --------
Total current liabilities........................... 126,642 128,839 131,671
Accrual for self-insured liabilities (Note 10)........... 55,713 70,341 50,087
Long-term debt (Note 8).................................. 387,442 373,248 438,441
Deferred state income taxes.............................. 783 -- --
Other long-term liabilities (Note 11).................... 40,351 44,018 40,716
Due to shareholder and affiliates:
Deferred federal income taxes.......................... 20,727 19,904 25,001
Other.................................................. 3,484 3,484 3,484
Minority interests....................................... -- -- 29
-------- -------- --------
Total liabilities................................... 635,142 639,834 689,429
-------- -------- --------
SHAREHOLDER'S EQUITY:
Common stock, $1 par value, 1,000 shares authorized,
947 shares issued and outstanding................... 1 1 1
Additional paid-in capital............................. 208,787 208,787 208,787
Accumulated other comprehensive loss................... (2,876) (2,367) (1,703)
Accumulated deficit.................................... (46,250) (50,419) (22,924)
-------- -------- --------
Total Shareholder's Equity.......................... 159,662 156,002 184,161
-------- -------- --------
Total Liabilities and Shareholder's Equity.......... $794,804 $795,836 $873,590
======== ======== ========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
EXTENDICARE HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
----------------------- ------------------------------------
2002 2001 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
REVENUES:
Nursing and assisted living centers
(Note 12)....................... $ 586,272 $ 578,378 $ 766,952 $ 904,847 $ 916,195
Outpatient therapy and medical
supplies........................ 7,585 7,271 9,515 9,716 43,068
Other.............................. 12,927 12,597 17,640 8,506 8,322
---------- ---------- ---------- ---------- ----------
606,784 598,246 794,107 923,069 967,585
---------- ---------- ---------- ---------- ----------
COSTS AND EXPENSES (INCOME):
Operating.......................... 510,117 523,021 684,814 825,172 844,391
General and administrative......... 24,329 25,011 32,387 46,507 45,524
Lease costs........................ 8,411 11,352 14,575 15,731 16,631
Depreciation and amortization...... 28,228 30,226 40,772 45,434 52,005
Interest expense................... 24,754 28,937 37,857 46,541 52,499
Interest income.................... (833) (1,567) (2,297) (1,386) (1,232)
Loss (gain) on disposal of assets
(Note 4)........................ (3,961) 1,054 1,054 3,306 37,292
Provision for closure and exit
costs and other items (Note
4).............................. 5,293 23,192 23,192 3,357 5,482
Loss on impairment of long-lived
assets (Note 4)................. -- 1,685 1,685 20,753 38,173
---------- ---------- ---------- ---------- ----------
596,338 642,911 834,039 1,005,415 1,090,765
---------- ---------- ---------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAXES.... 10,446 (44,665) (39,932) (82,346) (123,180)
Income tax expense (benefit) (Note
17)............................. 4,568 (15,126) (12,482) (27,667) (52,841)
---------- ---------- ---------- ---------- ----------
EARNINGS (LOSS) BEFORE MINORITY
INTERESTS AND EXTRAORDINARY ITEM... 5,878 (29,539) (27,450) (54,679) (70,339)
Minority interests................. -- -- -- -- 224
---------- ---------- ---------- ---------- ----------
EARNINGS (LOSS) BEFORE EXTRAORDINARY
ITEM............................... 5,878 (29,539) (27,450) (54,679) (70,115)
Extraordinary loss on early
retirement of debt (net of
income taxes of $1,140, $30,
$30, $257 and $240,
respectively) (Note 8).......... (1,709) (45) (45) (442) (342)
---------- ---------- ---------- ---------- ----------
NET EARNINGS (LOSS).................. $ 4,169 $ (29,584) $ (27,495) $ (55,121) $ (70,457)
========== ========== ========== ========== ==========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
EXTENDICARE HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
(IN THOUSANDS EXCEPT SHARE DATA)
<Table>
<Caption>
RETAINED
ACCUMULATED EARNINGS
COMMON STOCK ADDITIONAL OTHER (ACCUMULATED TOTAL
--------------- PAID-IN COMPREHENSIVE SHAREHOLDER'S SHAREHOLDER'S
SHARES AMOUNT CAPITAL INCOME (LOSS) DEFICIT) EQUITY
------ ------ ---------- ------------- ------------- -------------
BALANCES AT DECEMBER 31, 1998.... 947 $1 $208,787 $ 187 $102,654 $311,629
Comprehensive income (loss):
Unrealized loss on
investments, net of income
taxes..................... -- -- -- (3,277) -- (3,277)
Net loss.................... -- -- -- -- (70,457) (70,457)
--- -- -------- ------- -------- --------
Total comprehensive loss....... -- -- -- (3,277) (70,457) (73,734)
--- -- -------- ------- -------- --------
BALANCES AT DECEMBER 31, 1999.... 947 1 208,787 (3,090) 32,197 237,895
Comprehensive income (loss):
Unrealized gain on
investments, net of income
taxes..................... -- -- -- 1,387 -- 1,387
Net loss.................... -- -- -- -- (55,121) (55,121)
--- -- -------- ------- -------- --------
Total comprehensive income
(loss)...................... -- -- -- 1,387 (55,121) (53,734)
--- -- -------- ------- -------- --------
BALANCES AT DECEMBER 31, 2000.... 947 1 208,787 (1,703) (22,924) 184,161
Comprehensive income (loss):
Unrealized gain on
investments, net of income
taxes..................... -- -- -- 441 -- 441
Unrealized loss on cash flow
hedges, net of income
taxes..................... -- -- -- (1,105) -- (1,105)
Net loss.................... -- -- -- -- (27,495) (27,495)
--- -- -------- ------- -------- --------
Total comprehensive loss....... -- -- -- (664) (27,495) (28,159)
--- -- -------- ------- -------- --------
BALANCES AT DECEMBER 31, 2001.... 947 1 208,787 (2,367) (50,419) 156,002
Comprehensive Income (loss)
(unaudited):
Unrealized loss on
investments, net of income
taxes (unaudited)......... -- -- -- (1,523) -- (1,523)
Unrealized gain on cash flow
hedges, net of income
taxes (unaudited)......... -- -- -- 1,014 -- 1,014
Net earnings (unaudited).... -- -- -- -- 4,169 4,169
--- -- -------- ------- -------- --------
Total comprehensive income
(unaudited)................. -- -- -- (509) 4,169 3,660
--- -- -------- ------- -------- --------
BALANCES AT SEPTEMBER 30, 2002
(UNAUDITED).................... 947 $1 $208,787 $(2,876) $(46,250) $159,662
=== == ======== ======= ======== ========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
EXTENDICARE HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
-------------------- ------------------------------
2002 2001 2001 2000 1999
--------- -------- -------- -------- --------
(UNAUDITED)
OPERATING ACTIVITIES:
Net earnings (loss).................................... $ 4,169 $(29,584) $(27,495) $(55,121) $(70,457)
Adjustments to reconcile net earnings (loss) to net
cash provided from operating activities..............
Depreciation and amortization........................ 29,596 31,799 42,855 47,886 54,254
Provision for self-insured liabilities............... 3,937 27,552 29,177 46,248 4,329
Payment for self-insured liability claims............ (18,565) (5,099) (8,924) (490) --
Provision for punitive damages....................... -- -- -- 9,000 --
Provision for uncollectible accounts receivable...... 7,874 7,302 8,945 17,945 11,905
(Recovery) reserve for settlements with third-party
payors............................................. -- -- -- (11,981) 27,400
Loss (gain) on disposal of assets.................... (3,961) 1,054 1,054 3,306 8,292
Provision for closure and exit costs and other
items.............................................. 5,293 12,228 12,228 3,357 5,482
Loss on impairment of long-lived assets.............. -- 1,685 1,685 20,753 38,173
Deferred income taxes................................ 4,166 (15,704) (13,026) (13,454) (12,848)
Extraordinary loss on early retirement of debt....... 1,709 45 45 442 342
Minority interests................................... -- -- -- -- (224)
Changes in assets and liabilities:
Accounts receivable................................ (5,086) 12,407 16,810 (2,362) 4,314
Non-current accounts receivable.................... -- -- 804 (9,702) --
Supplies, inventories and prepaid expenses......... (646) (126) 2,530 458 111
Debt service trust funds........................... (171) (173) 1 1,863 100
Due from shareholder -- federal income taxes....... (20) 22,542 -- -- --
Accounts payable................................... (12,282) (5,519) 962 (9,986) (4,446)
Accrued liabilities................................ 13,350 5,809 (13,843) (16,368) (33,263)
Income taxes payable/receivable.................... (60) 639 212 169 (1,897)
Current due to shareholder and affiliates.......... -- -- 21,907 879 (12,924)
--------- -------- -------- -------- --------
Cash provided from operating activities............ 29,303 66,857 75,927 32,842 18,643
--------- -------- -------- -------- --------
INVESTING ACTIVITIES:
Proceeds from sale of property and equipment......... 14,291 7,292 7,599 7,642 48,522
Proceeds received from divestiture agreement......... -- -- -- 30,000 --
Income taxes recovered (paid) on sale of
operations......................................... -- -- -- 29,000 (25,000)
Payments for purchases of property and equipment..... (12,638) (9,681) (16,348) (14,169) (25,330)
Changes in other non-current assets.................. 1,012 (1,085) (1,307) (1,945) 1,692
--------- -------- -------- -------- --------
Cash provided by (used in) investing activities.... 2,665 (3,474) (10,056) 50,528 (116)
--------- -------- -------- -------- --------
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt............. 160,625 -- -- 3,048 58,051
Payments of deferred financing costs................. (7,090) -- -- -- --
Payments of long-term debt........................... (157,931) (61,493) (65,797) (80,337) (75,606)
Other long-term liabilities.......................... 1,726 (1,243) (742) (1,435) (4,959)
Bank indebtedness.................................... (585) 1,841 51 (5,357) 5,895
Distribution of minority interests' earnings......... -- (15) (27) (589) (51)
--------- -------- -------- -------- --------
Cash used in financing activities.................. (3,255) (60,910) (66,515) (84,670) (16,670)
--------- -------- -------- -------- --------
(Decrease) increase in cash and cash equivalents....... 28,713 2,473 (644) (1,300) 1,857
Cash and cash equivalents, beginning of year........... 997 1,641 1,641 2,941 1,084
--------- -------- -------- -------- --------
Cash and cash equivalents, end of year................. $ 29,710 $ 4,114 $ 997 $ 1,641 $ 2,941
========= ======== ======== ======== ========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS
Extendicare Health Services, Inc. and its subsidiaries (hereafter referred
to as the "Company") operates, in one reporting segment, nursing and assisted
living facilities throughout the United States. The Company is an indirect
wholly owned subsidiary of Extendicare Inc. ("Extendicare"), a Canadian publicly
traded company.
At December 31, 2001, the Company operated 157 nursing facilities with
capacity for 16,490 beds and 41 assisted living facilities with 1,912 units.
Through its nursing centers, the Company provides nursing, rehabilitative and
other specialized medical services and, in the assisted living facilities, the
Company provides varying levels of assistance with daily living activities to
residents. The Company also provides consulting services to 35 facilities (3,269
beds).
In addition, at December 31, 2001, the Company owned 17 nursing facilities
(1,862 beds), which were leased to and operated by three unrelated nursing home
providers, and retained an interest in (but did not operate) 11 nursing
facilities (1,435 beds) and 4 assisted living facilities (135 units) under a
Divestiture Agreement (see note 4).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a) Principles of Consolidation
The consolidated financial statements of the Company have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Management's most significant estimates include provision for
bad debts, provision for Medicaid and Medicare revenue rate settlements,
recoverability of long-lived assets, provision for general liability, facility
closure accruals, workers compensation accruals and self-insured health and
dental claims. Actual results could differ from those estimates.
The consolidated financial statements include those of the Company and its
subsidiaries and partnerships in which the Company has a controlling interest.
All significant intercompany accounts and transactions with subsidiaries have
been eliminated from the consolidated financial statements.
b) Interim Financial Information (unaudited)
The accompanying consolidated financial statements and related footnote
data as of September 30, 2002 and for the nine months ended September 30, 2002
and 2001 are unaudited and have been prepared in accordance with the
instructions to Rule 10-01 of Regulation S-X and do not include all of the
information and the footnotes required by generally accepted accounting
principles for complete statements. In the opinion of management, all
adjustments necessary for a fair presentation of such financial statements have
been included.
Certain reclassifications have been made to the consolidated financial
statements for the first nine months of 2001 to conform to the presentation for
2002.
c) Cash Equivalents
For purposes of the consolidated statements of cash flows, the Company
considers all highly liquid investments with original maturities of three months
or less to be cash equivalents.
F-7
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
d) Accounts Receivable
Accounts receivable are recorded at the net realizable value expected to be
received from federal and state assistance programs, other third-party payors or
from individual patients. Receivables from government agencies represent the
only concentrated group of credit risk for the Company.
Management does not believe there are any credit risks associated with
these government agencies other than possible funding delays. Accounts
receivable other than from government agencies consist of receivables from
various payors that are subject to differing economic conditions and do not
represent any concentrated credit risks to the Company. Furthermore, management
continually monitors and adjusts its allowances associated with these
receivables.
e) Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and
amortization. Provisions for depreciation and amortization are computed using
the straight-line method at rates based upon the following estimated useful
lives:
<Table>
Land improvements........................ 10 to 25 years
Buildings................................ 30 to 40 years
Building improvements.................... 5 to 30 years
Furniture and equipment.................. Varying periods not exceeding 15 years
Leasehold improvements................... The shorter of the term of the applicable
leases or the useful life of the
improvement
</Table>
Leased nursing home assets held under Option Agreements are stated at cost
less accumulated depreciation. Provisions for depreciation are computed as
outlined above.
Maintenance and repairs are charged to expense as incurred. When property
or equipment is retired or disposed, the cost and related accumulated
depreciation and amortization are removed from the accounts and the resulting
gain or loss is included in the results of operations. Approximately $1,118,000,
$395,000 and $782,000 of costs included in furniture and equipment associated
with developing or obtaining internal-use software were capitalized during the
years ended December 31, 2001, 2000 and 1999, respectively, and are being
amortized over three years.
f) Leases
Leases that substantially transfer all of the benefits and risks of
ownership of property to the Company, or otherwise meet the criteria for
capitalizing a lease under generally accepted accounting principles, are
accounted for as capital leases. An asset is recorded at the time a capital
lease is entered into together with its related long-term obligation to reflect
its purchase and financing. Property and equipment recorded under capital leases
are depreciated on the same basis as previously described. Rental payments under
operating leases are expensed as incurred.
g) Goodwill and Other Intangible Assets
Goodwill represents the cost of acquired net assets in excess of their fair
market values. Amortization of goodwill and other intangible assets is computed
using the straight-line method over a period of no more than forty years in
connection with the acquisitions of long-term care facilities. Other intangible
assets, consisting of the costs of acquiring leasehold rights are deferred and
amortized over the term of the lease including renewal options. Refer to note 3
for the new accounting policy effective January 1, 2002.
F-8
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
h) Impairment of Long-Lived Assets
The Company periodically assesses the recoverability of long-lived assets,
including property and equipment, goodwill and other intangibles, when there are
indications of potential impairment based on estimates of undiscounted future
cash flows. The amount of any impairment is calculated by comparing the
estimated fair market value, with the carrying value of the related asset.
Management considers such factors as current results, trends and future
prospects, current market value, and other economic and regulatory factors, in
performing these analyses.
i) Other Assets
Assets held under Divestiture Agreement are stated at cost less accumulated
depreciation. Provisions for depreciation are computed as outlined above in note
2(d). Direct loan origination costs are deferred and amortized over the life of
the related debt using the effective interest method.
j) Investments
Debt service trust funds and other investment holdings, which are comprised
of fixed interest securities, equity securities, and liquid money market
investments, are considered to be available-for-sale and accordingly, are
reported at fair value. Fair values are based on quoted market prices.
Unrealized gains and losses, net of related tax effects, are reported within
Accumulated Other Comprehensive Income (AOCI) as a separate component of
shareholder's equity. A decline in the market value of any security below cost
that is deemed other than temporary is charged to earnings, resulting in the
establishment of a new cost basis for the security. The cost basis of the debt
service trust funds approximates fair value. Realized gains and losses for
securities classified as available-for-sale are included in the results of
operations and are derived using the specific identification method for
determining the cost of securities sold. Interest income is recognized when
earned.
k) Revenue Recognition
Nursing facility revenue results from the payment for services and products
from federal and state-funded cost reimbursement programs as well as private pay
residents. Revenues are recorded in the period in which services and products
are provided at established rates less contractual adjustments. Contractual
adjustments include differences between the Company's established billing rates
and amounts estimated by management as reimbursable under various reimbursement
formulas or contracts in effect. Estimation differences between final
settlements and amounts recorded in previous years are reported as adjustments
to revenues in the period such settlements are determined. Refer also to note
12.
Assisted living facility revenue is primarily derived from private pay
residents in the period in which the services are provided and at rates
established by the Company based upon the services provided and market
conditions in the area of operation.
l) Derivative Instruments and Hedging Activities
In June 1998 the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Certain Hedging Activities." In June 2000 the FASB
issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activity, an Amendment of SFAS 133." SFAS No. 133 and SFAS No. 138
require that all derivative instruments be recorded on the balance sheet at
their respective fair values. The Company adopted SFAS No. 133 and SFAS No. 138
on January 1, 2001. In accordance with the transition provisions of SFAS 133,
the Company recorded a net-of-tax cumulative-effect-type
F-9
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
adjustment of $195,000 in AOCI to recognize at fair value all derivatives that
are designated as cash-flow hedging instruments.
All derivatives are recognized on the balance sheet at their fair value. On
the date the derivative contract is entered into, the Company designates the
derivative as either a hedge of the fair value of a recognized asset or
liability ("fair value hedge") or a hedge of the variability of cash flows to be
received or paid related to a recognized asset or liability ("cash flow hedge").
The Company assesses, both at the hedge's inception and on an ongoing basis,
whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in fair values or cash flows of hedge items.
When it is determined that a derivative is not highly effective as a hedge or
that it has ceased to be a highly effective hedge, the Company discontinues the
hedge accounting prospectively.
Changes in the fair value of a derivative that is highly effective and that
is designated and qualifies as a fair-value hedge, along with the loss or gain
on the hedged asset or liability of the hedged item that is attributable to the
hedged risk are recorded in earnings. Changes in the fair value of a derivative
that is highly effective and that is designated and qualifies as a cash-flow
hedge are recorded in other comprehensive income, until earnings are affected by
the variability in cash flows of the designated hedged item.
The Company discontinues hedge accounting prospectively when it is
determined that the derivative is no longer effective in offsetting changes in
the fair value or cash flows of the hedged item, the derivative expires or is
sold, terminated, or exercised, or because management determines that
designation of the derivative as a hedging instrument is no longer appropriate.
When hedge accounting is discontinued because it is determined that the
derivative no longer qualifies as an effective fair-value hedge, the Company
continues to carry the derivative on the balance sheet at its fair value, and no
longer adjusts the hedged asset or liability for changes in fair value. In all
other situations in which hedge accounting is discontinued, the Company
continues to carry the derivative at its fair value on the balance sheet, and
recognizes any changes in its fair value in earnings.
For years before 2001, prior to the adoption of SFAS No. 133, the Company
entered into interest rate swap agreements to reduce its exposure to market
risks from changing interest rates. For interest rate swaps, the differential to
be paid or received is accrued and recognized in interest expense and may change
as market interest rates change. If a swap was terminated prior to its maturity,
the gain or loss is recognized over the remaining original life of the swap if
the item hedged remains outstanding, or immediately, if the item hedged does not
remain outstanding.
m) Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the expected future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carry forwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
n) Reclassifications
Certain reclassifications have been made to the 2000 and 1999 consolidated
financial statements to conform to the presentation for 2001.
F-10
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 141, "Business Combinations" (SFAS
No. 141), and SFAS No. 142, "Goodwill and Other Intangible Assets" (SFAS No.
142). SFAS No. 141 requires that the purchase method of accounting be used for
all business combinations. SFAS No. 141 specifies criteria that intangible
assets acquired in a business combination must meet to be recognized and
reported separately from goodwill. SFAS No. 142 will require that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets
with estimable useful lives be amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 121 and subsequently, SFAS No. 144 after its adoption.
The Company adopted the provisions of SFAS No. 141 as of July 1, 2001, and
SFAS No. 142 is effective January 1, 2002. Goodwill and intangible assets
determined to have an indefinite useful life acquired in a purchase business
combination completed after June 30, 2001, but before SFAS No. 142 is adopted in
full, are not amortized. Goodwill and intangible assets acquired in business
combinations completed before July 1, 2001, continued to be amortized and be
tested for impairment prior to the full adoption of SFAS No. 142.
Upon adoption of SFAS No. 142, the Company is required to evaluate its
existing intangible assets and goodwill that were acquired in purchase business
combinations, and to make any necessary reclassifications in order to conform
with the new classification criteria in SFAS No. 141 for recognition separate
from goodwill. The Company will be required to reassess the useful lives and
residual values of all intangible assets acquired, and make any necessary
amortization period adjustments by the end of the first interim period after
adoption. If an intangible asset is identified as having an indefinite useful
life, the Company will be required to test the intangible asset for impairment
in accordance with the provisions of SFAS No. 142 within the first interim
period. Impairment is measured as the excess of carrying value over the fair
value of intangible asset with an indefinite life. Any impairment loss will be
measured as of the date of adoption and recognized as the cumulative effect of a
change in accounting principle in the first interim period. Based on current
market conditions, which could change in the future, management currently
expects that these impairment tests will not have a material impact on the
Company's consolidated financial position or results from operations.
As of January 1, 2002 the Company has unamortized goodwill in the amount of
$72.1 million and unamortized identifiable intangible assets in the amount of
$5.5 million, all of which will be subject to the transition provisions of SFAS
No. 142. Amortization expense related to goodwill was $2.4 million, and $2.1
million for the years ended December 31, 2001, and 2000, respectively.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" (SFAS No. 144). SFAS No. 144
addresses financial accounting and reporting for the impairment or disposal of
long-lived assets. This Statement requires that long-lived assets be reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. If the carrying amount of an
asset exceeds its estimated future cash flows, an impairment charge is
recognized by the amount by which the carrying amount exceeds the fair value of
the asset. SFAS No. 144 requires companies to separately report discontinued
operations and extends that reporting to a component of an entity that either
has been disposed of (by sale, abandonment, or in a distribution to owners) or
is classified as held for sale. Assets to be disposed of are reported at the
lower of the carrying amount or fair value less costs to sell. The Company is
required to adopt SFAS No. 144 on January 1, 2002. The Company expects that the
adoption of SFAS No. 144 will have no material effect on the Company's
consolidated financial position or results of operations.
F-11
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3A. SFAS NO. 142 UPDATE (UNAUDITED)
Amortization expense related to goodwill was $0 and $1.8 million for the
nine months ended September 30, 2002 and 2001, respectively. The Company has
reviewed goodwill for impairment under SFAS No. 142, and these tests indicate
that no impairment currently exists but no assurance can be given that
impairment will not exist in the future.
The following table shows what net income would have been had SFAS No. 142
been applied in the comparable prior year periods:
<Table>
<Caption>
FOR THE
NINE MONTHS
ENDED SEPTEMBER 30, FOR THE YEAR ENDED DECEMBER 31,
-------------------- --------------------------------
2002 2001 2001 2000 1999
------- --------- -------- -------- --------
(UNAUDITED)
(IN THOUSANDS)
Net income (loss) as reported......... $4,169 $(29,584) $(27,495) $(55,121) $(70,457)
Add back: goodwill amortization....... -- 1,836 2,448 2,149 4,044
------ -------- -------- -------- --------
Adjusted net income (loss)............ $4,169 $(27,748) $(25,047) $(52,972) $(66,413)
====== ======== ======== ======== ========
</Table>
3B. NEW ACCOUNTING PRONOUNCEMENTS IN 2002 (UNAUDITED)
In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13 and Technical
Corrections." The most significant provision of SFAS No. 145 addresses the
termination of extraordinary item treatment for gains and losses on early
retirement of debt. The Company will be required to adopt the provisions of this
standard beginning on January 1, 2003. The Company plans to adopt the provisions
of this standard in the first quarter of 2003 and will be required to modify the
presentation of its year 2002, 2001 and 2000 results by recording the loss on
early retirement of debt in earnings before income taxes.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Exit and
Disposal Activities." The provisions of SFAS No. 146 modify the accounting for
the costs of exit and disposal activities by requiring that liabilities for
these activities be recognized when the liability is incurred. Previous
accounting literature permitted recognition of some exit and disposal
liabilities at the date of commitment to an exit plan. The provisions of this
statement will be effective for exit or disposal activities initiated after
December 31, 2002.
4. IMPAIRMENT OF LONG-LIVED ASSETS AND LOSS ON DISPOSAL OF ASSETS
In response to the implementation of Medicare Prospective Payment System
(PPS), increased litigation and insurance costs in certain states, and increased
operational costs resulting from changes in legislation and regulatory scrutiny,
over the past several years the Company has focused on the divestiture of
under-performing nursing and assisted living facilities and the divestiture of
non-core health care assets.
F-12
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following summarizes the components of the loss (gain) on the sale of
assets:
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30, 2002 YEAR ENDED DECEMBER 31, 2001 YEAR ENDED
----------------------------- ----------------------------- DECEMBER 31,
PROCEEDS PROCEEDS -----------------
NET OF NET OF 2000 1999
SELLING NET BOOK SELLING NET BOOK ------- -------
COSTS VALUE (GAIN) COSTS VALUE LOSS LOSS LOSS
-------- -------- ------- -------- -------- ------- ------- -------
(IN THOUSANDS)
Loss (gain) from dispositions:
Skilled nursing and assisted
living facilities.......... $25,500 $21,539 $(3,961) $11,296 $12,064 $ 768 $ 3,306 $35,406
Other........................ 1,791 1,791 -- 394 680 286 -- 1,886
------- ------- ------- ------- ------- ------- ------- -------
$27,291 $23,330 $(3,961) $11,690 $12,744 $ 1,054 $ 3,306 $37,292
======= ======= ======= ======= ======= ======= ======= =======
</Table>
The provision for closure and exit costs and other items is summarized as
follows:
<Table>
<Caption>
NINE MONTHS YEAR ENDED DECEMBER 31,
ENDED ---------------------------
SEPT. 30, 2002 2001 2000 1999
-------------- ------- ------ ------
(IN THOUSANDS)
Provision for closure of the following facilities:
Florida skilled nursing and assisted living....... $ 5,293 $ 7,965 $1,100 $ --
Texas skilled nursing............................. -- 1,200 -- --
Oregon and Washington skilled nursing............. -- -- -- 2,294
Pharmacy.......................................... -- 1,200 -- 986
Other locations................................... -- 1,863 2,257 2,202
------- ------- ------ ------
5,293 12,228 3,357 5,482
Provision for adverse development of general and
professional liability costs...................... -- 10,964 -- --
------- ------- ------ ------
$ 5,293 $23,192 $3,357 $5,482
======= ======= ====== ======
</Table>
F-13
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Below is a summary of activity of the accrued liabilities balance relating
to disposed operations (IN THOUSANDS):
<Table>
<Caption>
RESIDENT
EMPLOYEE LIABILITY AND RENT OTHER
TERMINATION OTHER CLAIMS EXPENSE EXPENSES(1) TOTAL
----------- ------------- ------- ----------- -------
Balance December 31, 1998.............. $ 700 $ -- $ -- $ 500 $ 1,200
Cash Payments........................ (1,078) -- -- (2,063) (3,141)
Provisions........................... 730 -- 190 4,562 5,482
------- ------- ----- ------- -------
Balance December 31, 1999.............. 352 -- 190 2,999 3,541
Cash Payments........................ (1,017) -- (218) (2,149) (3,384)
Provisions........................... 697 -- 726 1,934 3,357
------- ------- ----- ------- -------
Balance December 31, 2000.............. 32 -- 698 2,784 3,514
Cash Payments........................ (1,377) (1,113) (234) (5,016) (7,740)
Provisions........................... 1,399 3,163 (464) 8,130 12,228
------- ------- ----- ------- -------
Balance December 31, 2001.............. 54 2,050 -- 5,898 8,002
------- ------- ----- ------- -------
Cash Payments........................ -- (295) -- (2,094) (2,389)
Provisions(2)........................ -- 295 -- 6,860 7,155
------- ------- ----- ------- -------
Balance September 30, 2002............. $ 54 $ 2,050 $ -- $10,664 $12,768
======= ======= ===== ======= =======
</Table>
- ---------------
(1) The liability for other expenses is reserved for cost report and other
settlements with the states of Florida and Texas and other Medicare fiscal
intermediaries, collection of receivables, and settlement of claims with
suppliers and employees.
(2) Provisions of $7,155 for the nine months ended September 30, 2002 includes
the provision for closure and exit costs of $5,293, selling expenses of
$1,200 relating to the sale of assets to Tandem and other items of $662.
The following reconciles the loss from asset impairment, disposals and
other items to that reported in the cash flow statements. The provision for
general and professional liability costs is removed as it is already reflected
in the line item provision for self-insured liabilities as an item not involving
cash.
<Table>
<Caption>
NINE MONTHS YEAR ENDED DECEMBER 31,
ENDED ------------------------------
SEPT. 30, 2002 2001 2000 1999
-------------- -------- ------- --------
(IN THOUSANDS)
Reconciliation of loss to cash flow statements:
Loss from asset impairment, disposals, provision
for closure and exit costs and other items
per income statement......................... $ 1,332 $ 25,931 $27,416 $ 80,947
Provision for general and professional liability
costs........................................ -- (10,964) -- --
Current taxes related to dispositions........... -- -- -- (29,000)
-------- -------- ------- --------
Loss (gain) on disposal of assets and provision
for closure and exit costs and other items
per cash flow statement...................... $ 1,332 $ 14,967 $27,416 $ 51,947
======== ======== ======= ========
Loss (gain) on disposal of assets............... $ (3,961) $ 1,054 $ 3,306 $ 8,292
Provision for closure and exit costs and other
items........................................ 5,293 12,228 3,357 5,482
Loss on impairment.............................. -- 1,685 20,753 38,173
-------- -------- ------- --------
Total per cash flow statement................... $ 1,332 $ 14,967 $27,416 $ 51,947
======== ======== ======= ========
</Table>
<Table>
<Caption>
NINE MONTHS YEAR ENDED DECEMBER 31,
ENDED ------------------------------
SEPT. 30, 2002 2001 2000 1999
-------------- -------- ------- --------
(IN THOUSANDS)
Reconciliation of cash proceeds from dispositions:
Proceeds, net of selling costs.................. $ 27,241 $ 11,296 $ 8,517 $ 56,222
Cash held in escrow............................. -- -- -- (3,700)
Notes receivable................................ (13,000) (1,793) (875) (4,000)
Preferred shares................................ -- (1,904) -- --
-------- -------- ------- --------
Proceeds from sale of assets in cash flow....... $ 14,291 $ 7,599 $ 7,642 $ 48,522
======== ======== ======= ========
</Table>
F-14
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Impairment of Long-Lived Assets
The Company records impairment losses recognized for long-lived assets used
in operations when indicators of impairment are present and the estimated
undiscounted future cash flows do not appear to be sufficient to recover the
assets' carrying amounts. The impairment loss is measured by comparing the fair
value of the asset to its carrying amount. In addition, once management has
committed the organization to a plan for disposal, assets held for disposal are
adjusted to the lower of the assets' carrying value and the fair value less
costs to sell. Accordingly, management has estimated the future cash flows of
each facility and reduced the carrying value to the estimated fair value, where
appropriate.
In September 2001 the Company made a formal decision to divest of its
nursing facilities (but not assisted living facilities) in Texas and completed a
transaction through which the Company ceased operating these facilities. This
transaction resulted in the Company leasing all four owned facilities and
subleasing the remaining 13 nursing facilities to a third party operator. As a
result of the transaction, the Company recorded a provision of $1.7 million for
impairment of these remaining Texas properties of which all related to leasehold
rights and leasehold improvements on the facilities. Refer to discussion in
"Loss on Disposal of Assets and Other Items".
In December 2000 the Company made a formal decision to divest of all
remaining operations in Florida and completed two transactions through which the
Company leased all of its remaining operations. Both transactions resulted in
providing two operators with a first right to purchase the properties within the
lease term. The Company recorded a provision of $15.9 million for impairment of
these remaining Florida properties plus a provision of $1.1 million for costs
related to the termination of its Florida operational staff. In addition, in
December 2000, the Company determined that a $4.8 million adjustment was
required for non-Florida properties, resulting in a total impairment provision
for 2000 (including Florida) of $20.7 million applicable to goodwill, property
and equipment, of which $2.0 million related to goodwill.
In the fourth quarter of 1999, management recorded an aggregate provision
for impairment of goodwill, property and equipment of $38.2 million, of which
$25.5 million related to goodwill. Of this provision, all but $3.9 million
related to facilities or assets located in Florida.
Loss on Disposal of Assets and Other Items
For 2001, we recorded a loss on disposal of assets of $1.0 million and a
provision for closure and exit costs and other items of $23.2 million, as
discussed below. In September 2001, the Company transferred all nursing
facilities in Texas to Senior Health Properties-Texas, Inc. ("Senior
Health-Texas") resulting in a pre-tax loss of $1.8 million. In addition, the
Company recorded provisions totaling $2.0 million relating to the closure and/or
sale of three nursing properties. The Company made additional provisions of
$20.2 million relating to previously sold operations, of which $19.0 million
relates to the nursing facilities in Florida. This $19.0 million consists of an
$11.0 million provision related to Florida claims for years prior to 2001 based
upon an actuarial review of resident liability costs and an $8.0 million
provision for Florida closure and exit costs. The $11.0 million provision was
the result of an increase in the estimate of the incurred but not yet reported
claims and an increase in the frequency and severity of claims incurred by the
Company.
In September 2001, the Company transferred (via license transfer) the
operations of all its Texas nursing facilities to Senior Health-Texas. The
transaction involved 17 skilled nursing facilities, with a capacity of 1,421
residents, of which 13 facilities are subleased to Senior Health-Texas and the
remainder leased to Senior Health-Texas on a five-year term from the Company.
Senior Health-Texas will operate the subleased facilities for their remaining
lease terms, one of which expired in October 2001, and the remainder expiring
through February 2012. In November 2001, the landlord of the subleased nursing
facility for which the lease term expired in October 2001 assumed operational
responsibility for the facility
F-15
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and the Company is currently providing consulting services to the landlord. The
annual rental income from Senior Health-Texas is approximately $3.8 million per
annum, or $1.8 million in excess of the Company's current annual lease costs,
and will escalate in alignment to the existing lease and in alignment with
Medicaid rate increases for the owned facilities. Senior Health-Texas has the
right to first refusal on the purchase of the four owned facilities.
In April 2001, the Company completed the sale of two leased nursing
properties in Florida, with capacity for 240 residents, for gross proceeds of
$11.4 million. The buyer was Tandem Health Care, Inc. ("Tandem") which had
operated the facilities under a lease agreement with a purchase option. Proceeds
consisted of cash of $7.0 million, a $2.5 million interest-bearing five-year
note and $1.9 million in cumulative dividend preferred shares, mandatorily
redeemable after five years. The Company's carrying value of the two facilities
was $9.2 million. Tandem continues to operate seven nursing facilities under a
lease agreement with the Company, with an option to purchase these facilities at
any time during the lease term. The Company deferred a potential gain on the
sale of these assets of $2.2 million because a significant portion of the
proceeds had not been received (FASB 66) and the ultimate determination of the
gain was dependent on Tandem exercising some or all of the remaining purchase
options available to it. For these reasons, the Company did not record any gain
or loss on the sale. The Company applied $4.0 million of the net cash proceeds
to further reduce its term bank debt.
In 2000, the Company was successful in the disposition or lease of all of
its operations in Florida consisting of 32 facilities (3,427 beds) through a
series of transactions, two of which involved lease agreements with operators
who have an option to purchase the properties, and one in which the Company
retains an interest in the properties through the contingent consideration terms
of the agreement. In addition, the Company sold two formerly closed facilities.
In aggregate these five transactions, along with other asset sales, resulted in
cash proceeds of $37.7 million, of which $33.1 million was applied to reduce
debt. The sale of Florida facilities resulted in a pre-tax provision for closure
and exit costs of $1.6 million. In addition, in states other than Florida, the
Company recorded provisions for closure and exit costs of $1.7 million for the
closure of two nursing and one assisted living facilities and $0.6 million for
the disposition of other non-core assets. For 2000, the total loss from the
disposal of assets was $3.3 million and the total provision for closure and exit
costs and other items was $3.4 million.
In December 2000, the Company leased nine Florida nursing facilities (1,033
beds) to Tandem for an 18-month term. In April 2001, Tandem exercised its right
to acquire two of the facilities. Tandem has options to purchase the remaining
facilities at any time during the term of the leases for up to $37.0 million,
less related costs and other credits that may exist at the time the option is
exercised. In 2002, if Tandem holds the remaining leases to term, the Company
will receive rental fees of $3.5 million and incur associated costs in respect
of the leases of approximately $2.0 million. Refer to note 13.
In December 2000, the Company leased six nursing facilities (585 beds) to
Senior Health Properties-South, Inc. ("Senior Health-South") for a 60-month
term. Under the terms of the transaction, Senior Health-South has an option to
purchase the properties for $10.7 million. The Company will earn rental income
based upon the net operating cash flow of the properties, which cannot exceed on
average $2.0 million per annum and has entered into a specific services
consulting agreement over the term of the lease with Senior Health-South. Under
the terms of transaction, the Company has retained a commitment to fund any cash
flow deficiencies for one of the six properties, which the Company anticipates
would not exceed $300,000 per annum. All operations and assets, other than the
land, building and equipment, were transferred to the lessees at the
commencement of the leases at no cost to the lessees. Refer to note 13.
In December 2000, the Company sold one Florida nursing facility (120 beds)
for $3.8 million. Consideration was comprised of notes totaling $1.2 million
(before prepayment discounts) and $2.6 million in cash, of which $932,000 is
held in escrow for settlement for potential claims. The two promissory notes
contain certain prepayment discounts totaling $324,000, which the Company has
assumed will be exercised
F-16
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and therefore the sale resulted in a pre-tax loss of $2.5 million. The Company
applied the net proceeds from this transaction of $1.6 million to reduce debt.
In December 2001, the Company sold the two promissory notes for $825,000 in
cash, which was held in escrow until January 2002.
In September 2000, the Company disposed of eleven Florida nursing
facilities (1,435 beds) and four Florida assisted living facilities (135 units)
to Greystone Tribeca Acquisition L.L.C. ("Greystone") for initial cash proceeds
of $30.0 million and contingent consideration in the form of a series of
interest bearing notes, which have an aggregate potential value of up to $30.0
million plus interest. The notes have a maximum term of three and one half years
and may be retired at any time out of the proceeds from the sale or refinancing
of the facilities by Greystone. During the term of the notes, the Company
retains the right of first refusal and an option to repurchase the facilities in
March 2004, which if not accepted, will trigger repayment of the balance of the
notes. The option to repurchase, along with the significant portion of the sales
price being contingent, results in the disposition being accounted for as a
deferred sale in accordance with Statement of Financial Accounting Standards No.
66 (SFAS 66). There was no gain or loss recorded on the initial transaction, and
the Company will continue to depreciate the fixed assets on its records, which
as of December 31, 2001 had a net book value of $38.8 million and have been
classified under "Other Assets" as "Assets held under Divestiture Agreement".
The initial cash proceeds have been classified within "Other Long-term
Liabilities" in the balance sheet as "Deposits held under Divestiture
Agreement". Additional payments received, including interest, will increase the
deposits net of carrying costs paid. The Company applied the net after tax
proceeds from this transaction of $27.5 million to reduce debt.
In July 2000, the Company sold one Florida nursing facility (119 beds) for
$2.8 million. The sale resulted in a pre-tax gain of $940,000. The Company
applied the net after tax proceeds from this transaction of $2.0 million to
reduce debt.
In May and June, 2000 the Company sold two previously closed nursing
facilities for $2.0 million and $700,000 respectively resulting in pre-tax
losses of $453,000 and $1.1 million, respectively. In June and October 2000,
leases at two of the Company's nursing homes in Oregon (135 operational beds)
expired and were not renewed. Certain equipment assets of these Oregon homes
were sold for $168,000, resulting in no gain or loss. In February 2000, the
Company sold seven outpatient therapy facilities resulting in a pre-tax loss of
$71,000.
In 1999, the Company sold nine nursing facilities, six of which were in
Florida, and its home health operation for $62.3 million resulting in a pre-tax
loss of $37.3 million and made a provision for closure and exit costs of $5.5
million. The Company applied the net after-tax proceeds from these dispositions
to reduce debt by approximately $44.8 million. Of the facilities sold in 1999,
six were through the sale of a subsidiary in the fourth quarter, which resulted
in a pre-tax loss on sale of assets of $35.9 million and a current tax benefit
of $29.0 million relating to the recovery of prior year's taxes. In two separate
transactions, the Company sold three nursing facilities resulting in a pre-tax
gain of $479,000. The Company also sold its home health operation in the fourth
quarter, which resulted in a loss on sale of assets of $1.6 million. The $5.5
million provision for closure and exit costs included a provision of $3.2
million for the closure of two nursing facilities and two other nursing
facilities for which notice had been given not to renew the leases upon their
maturities in June 2000 and September 2000. For these latter two facilities, the
Company concluded operations as planned in 2000. The $5.5 million provision also
included a $2.3 million provision for additional reserves related to the sale of
non-core assets and severance of non-essential personnel.
F-17
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. PROPERTY AND EQUIPMENT
Property and equipment and related accumulated depreciation and
amortization as of December 31 is as follows:
<Table>
<Caption>
2001 2000
-------- --------
(IN THOUSANDS)
Land and land improvements.................................. $ 44,788 $ 48,828
Buildings and improvements.................................. 551,871 555,073
Furniture and equipment..................................... 78,226 88,315
Leasehold improvements...................................... 12,229 18,280
Construction in progress.................................... 1,335 5,506
-------- --------
Property and equipment before accumulated depreciation and
amortization.............................................. 688,449 716,002
Less accumulated depreciation and amortization.............. 210,619 208,466
-------- --------
Total property and equipment................................ $477,830 $507,536
======== ========
</Table>
6. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets consisted of the following at December
31:
<Table>
<Caption>
2001 2000
------- -------
(IN THOUSANDS)
Goodwill.................................................... $83,353 $83,353
Leasehold rights............................................ 11,709 12,347
------- -------
Total goodwill and intangible assets before accumulated
amortization.............................................. 95,062 95,700
Less accumulated amortization............................... 17,470 14,390
------- -------
Goodwill, net............................................... $77,592 $81,310
======= =======
</Table>
7. OTHER ASSETS
Other assets consisted of the following at December 31:
<Table>
<Caption>
2001 2000
-------- --------
(IN THOUSANDS)
Assets held under Divestiture Agreement (see note 4)........ $ 38,812 $ 41,564
Non-current accounts receivable from Medicare and Medicaid
programs, less allowance of $15,419 in 2001 and 2000 (see
Note 12).................................................. 36,410 37,215
Deferred financing costs, net............................... 8,314 9,740
Notes receivable............................................ 6,926 4,875
Indemnification escrow...................................... 3,700 3,700
Common shares held for investment........................... 3,110 2,704
Warrants held for investment................................ 2,820 2,490
Preferred shares held for investment........................ 1,904 --
Security deposits........................................... 1,590 1,552
Debt service and capital expenditure trust funds............ 943 902
Other....................................................... 2,901 3,472
-------- --------
$107,430 $108,214
======== ========
</Table>
F-18
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
2001 2000
-------- --------
(IN THOUSANDS)
Assets held under divestiture agreement:
Land...................................................... $ 3,083 $ 3,083
Building.................................................. 55,527 55,519
Furniture and equipment................................... 9,835 11,468
-------- --------
Assets held under divestiture agreement before accumulated
depreciation and amortization............................. 68,445 70,070
-------- --------
Accumulated depreciation and amortization................... 29,633 28,506
-------- --------
Total assets held under divestiture agreement............... $ 38,812 $ 41,564
======== ========
</Table>
As of December 2001, the Company is pursuing settlement of a number of
outstanding Medicaid and Medicare receivables. Due to the length of the
settlement process, some of those receivables are not expected to be collected
within one year and, as a result, are classified as long-term other assets. For
two specific issues totaling $22.1 million, agreement has been reached with the
Fiscal Intermediary ("FI"), that should resolution not be made in early 2002,
the matters will be reviewed through a mediator between the FI and the Company
prior to either party proceeding to the Provider Reimbursement Review Board
("PRRB"). The two issues involve the allocation of overhead costs and a staffing
cost issue.
Accumulated amortization of deferred financing costs as of December 31,
2001 and 2000 was $8.8 million and $6.7 million, respectively.
8. LINE OF CREDIT AND LONG-TERM DEBT
Long-term debt consisted of the following at December 31:
<Table>
<Caption>
2001 2000
-------- --------
(IN THOUSANDS)
Tranche A Term Loan......................................... $ 12,681 $ 20,272
Tranche B Term Loan......................................... 60,730 63,494
Senior Subordinated Notes................................... 200,000 200,000
Revolving Credit Facility at variable interest rates........ 63,000 115,000
Industrial Development Bonds, variable interest rates
ranging from 1.70% to 6.25%, maturing through 2014,
secured by certain facilities............................. 37,467 39,300
Promissory notes payable, interest rates ranging from 3.0%
to 10.0%, maturing through 2008........................... 4,950 6,356
Mortgages, interest rates ranging from 7.25% to 13.61%
maturing through 2010..................................... 6,458 6,651
Other, primarily capital lease obligations.................. 61 74
-------- --------
Long-term debt before current maturities.................... 385,347 451,147
Less current maturities..................................... 12,099 12,706
-------- --------
Total long-term debt........................................ $373,248 $438,441
======== ========
</Table>
The Company entered into a syndicated bank credit agreement (the "Credit
Facility") dated November 26, 1997, which provided the Company with senior
secured credit facilities of up to $600 million. The Credit Facility consisted
of three term loans, each in the amount of $200 million, as follows: a six-year
revolving credit facility (the "Revolving Credit Facility"); a six-year term
loan (the "Tranche A Term Loan"); and a seven-year term loan (the "Tranche B
Term Loan"). Borrowings under the Credit Facility are secured by the outstanding
common shares and various assets of the Company and
F-19
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
each of its existing and future domestic subsidiaries. As a result of the
decline in financial results, amendments to the Company's Credit Facility in the
second quarter of 1999 included revisions to the financial covenants, increased
interest rates and asset securitization. The Credit Facility was further amended
in the first quarter of 2000 for the 1999 general provision for Medicare
settlements and non-cash provisions for general and professional liability
costs.
On December 2, 1997, the Company issued $200 million of 9.35% Senior
Subordinated Notes due 2007 (the "Subordinated Notes"). The Subordinated Notes
are unsecured senior subordinated obligations of the Company subordinated in
right of payment to all existing and future senior indebtedness of the Company,
which includes all borrowings under the Credit Facility as well as all
indebtedness not refinanced by the Credit Facility. At December 31, 2001,
Extendicare Inc. and/or one of its wholly owned subsidiaries held $27.9 million
of the Senior Subordinated Notes.
The Revolving Credit Facility matures on December 31, 2003, at which time
all outstanding borrowings are due. As part of the amendments to the Credit
Facility, the Company waived its right to $25 million of the Revolving Credit
Facility. The unused portion of the Revolving Credit Facility at December 31,
2001, was $74.3 million (net of letters of credit of $37.7 million and the $25.0
million unavailable portion), which is available for working capital and general
corporate purposes. The Tranche A Term Loan matures on December 31, 2003 with
annual repayments of $6.6 million in 2002 and $6.1 million in 2003, payable in
quarterly installments. The Tranche B Term Loan matures on December 31, 2004
with annual repayments, payable in quarterly installments, of $1.0 million in
2002 and $.6 million in 2003 with the balance of $59.1 million due in 2004.
The Company incurred charges to earnings in 2001 and 2000 from the
write-off of unamortized debt issuance costs incurred in connection with the
reduction of Tranche A and Tranche B borrowings resulting from the recovery of
prior year taxes, and the sale of nursing facilities. Similarly, in 1999 the
Company incurred the write-off of unamortized debt issuance costs resulting from
proceeds of the sale of the home health operations and nine nursing facilities.
The extraordinary loss realized after income taxes totaled $45,000, $442,000 and
$342,000 in 2001, 2000 and 1999, respectively.
The Revolving Credit Facility, the Tranche A Term Loan and the Tranche B
Term Loan bear interest at the Company's option at rates equal to the prime rate
or LIBOR, plus applicable margins, depending upon the Company's leverage ratios.
Applicable margins at December 31, 2001 under the Revolving Credit Facility and
Tranche A Term Loan were 1.50% for prime rate loans and 2.25% for LIBOR based
borrowings. The applicable margin at December 31, 2001 under the Tranche B Term
Loan was 2.25% for prime rate borrowings and 3.00% for LIBOR based borrowings.
The average interest rates outstanding for the Revolving Credit Facility,
Tranche A Term Loan and Tranche B Term Loan at December 31, 2001 were 4.41%,
5.16%, and 4.19%, respectively. The weighted average interest rates were 7.03%
and 9.17% for amounts outstanding on the Revolving Credit Facility during 2001
and 2000, respectively. The average interest rate at December 31, 2001 and 2000
for all outstanding debt was 6.92% and 8.67%, respectively. The Company pays a
commitment fee on the unused portion of the Credit Facility at an annual rate of
0.50%.
The Company is party to two interest rate swap agreements to reduce the
impact of changes in interest rates on certain of its floating rate long-term
debt with two banks. The swaps effectively change the interest rates on $75
million of LIBOR-based borrowings under the Credit Facility to fixed rates
ranging from 5.53% to 5.74% (average of 5.67%), plus the applicable margins. One
swap agreement, with notional amount of $50 million matures on February 27, 2002
and the remaining agreement matures on February 27, 2003. The Company may be
exposed to credit loss in the event of non-performance by the banks under the
swap agreements but does not anticipate such non-performance.
F-20
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Credit Facility contains a number of covenants, such as: restrictions
on the payment of dividends by the Company; redemption of the Company's common
stock and change of control, as defined, of the Company; as well as financial
covenants, including fixed charge coverage, debt leverage, and net worth ratios.
The Company is required to make mandatory prepayments of principal upon the
occurrence of certain events, such as certain asset sales and certain issuances
of securities. The Company is permitted to make voluntary prepayments at any
time. Such prepayments may, under certain conditions, reduce the amounts
available to be borrowed under the Credit Facility.
The Company is in compliance with the financial covenants of its credit
facility as of December 31, 2001. The financial covenants under this credit
facility continue to become more stringent over the term of the facility. While
management has a strategy to remain in compliance, there can be no assurance
that the Company will meet future covenant requirements. The Company's available
bank lines can be affected by its ability to remain in compliance, or if not,
would depend upon management's ability to amend the covenants, or refinance the
debt.
The Revolving Credit Facility matures on December 31, 2003, at which time
all outstanding borrowings are due. The Tranche A Term Loan matures on December
31, 2003 and the Tranche B Term Loan matures on December 31, 2004, and are
payable in quarterly installments as follows:
<Table>
<Caption>
TRANCHE A TRANCHE B
--------- ---------
(IN THOUSANDS)
2002........................................................ $ 6,576 $ 983
2003........................................................ 6,105 629
2004........................................................ -- 59,118
------- -------
$12,681 $60,730
======= =======
</Table>
The Senior Subordinated Notes are unsecured senior subordinated obligations
of the Company subordinated in right of payment to all existing and future
senior indebtedness of the Company, which includes all borrowings under the
Credit Facility as well as all indebtedness not refinanced by the Credit
Facility. The Senior Subordinated Notes mature on December 15, 2007. Interest on
the Senior Subordinated Notes is payable semi-annually.
Principal payments on long-term debt due within the next five years and
thereafter are as follows (dollars in thousands):
<Table>
2002........................................................ $ 12,099
2003........................................................ 70,597
2004........................................................ 60,031
2005........................................................ 920
2006........................................................ 880
After 2006.................................................. 240,820
--------
$385,347
========
</Table>
Interest paid in 2001, 2000 and 1999 was $35.5 million, $47.2 million and
$49.5 million, respectively.
8A. ISSUANCE OF SENIOR NOTES (UNAUDITED)
On June 28, 2002, the Company completed a private placement of $150 million
of its 9.5% Senior Notes due July 1, 2010 (the "Senior Notes") in accordance
with Rule 144A and Regulation S under the Securities Act of 1933. The Senior
Notes are guaranteed by all existing and future active subsidiaries of the
Company. The Senior Notes were issued at a price of 99.75% of par to yield
9.54%.
F-21
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company used the proceeds of $149.6 million from the Senior Notes to
pay related fees and expenses of $7.1 million, to retire $127.5 million of
indebtedness outstanding under its previous credit facility, to refinance $6.3
million of other debt, and for general corporate purposes. Also on June 28,
2002, the Company entered into an interest rate swap agreement and an interest
rate cap agreement.
Concurrent with the sale of the Senior Notes, the Company established a new
five-year $105 million senior secured revolving credit facility (the "Credit
Facility") that is used to back letters of credit and for general corporate
purposes. Borrowings under the Credit Facility bear interest, at the Company's
option, at the Eurodollar rate or the prime rate, plus applicable margins,
depending upon the Company's leverage ratio.
The Senior Notes and the Credit Facility contain a number of covenants,
including: restrictions on the payment of dividends by the Company; limitations
on capital expenditures, investments, redemptions of the Company's common stock
and changes of control of the Company; as well as financial covenants, including
fixed charge coverage, debt leverage, and tangible net worth ratios. The Company
is required to make mandatory prepayments of principal upon the occurrence of
certain events, such as certain asset sales and certain issuances of securities.
The Company is permitted to make voluntary prepayments at any time under the
Credit Facility. The Senior Notes are redeemable at the option of the Company
starting on July 1, 2006. The redemption prices, if redeemed during the 12-month
period beginning on July 1 of the year indicated, are as follows:
<Table>
<Caption>
YEAR PERCENTAGE
---- ----------
2006........................................................ 104.750%
2007........................................................ 102.375%
2008 and thereafter......................................... 100.000%
</Table>
The Company is in compliance with the financial covenants as of September
30, 2002.
The Company has no independent assets or operations, the guarantees of the
Senior Notes are full and unconditional, and joint and several, and any of the
Company's subsidiaries that do not guarantee the Senior Notes are minor.
9. ACCRUED LIABILITIES
Accrued liabilities consisted of the following at December 31:
<Table>
<Caption>
2001 2000
------- -------
(IN THOUSANDS)
Salaries and wages, fringe benefits and payroll taxes....... $34,791 $35,635
Workers' compensation and other claims...................... 10,677 15,908
Medicaid reserves........................................... 8,046 7,935
Real estate, utilities and other taxes...................... 6,070 7,741
Interest.................................................... 2,700 2,773
Reserves for divested operations and facility closures...... 8,002 3,514
Other....................................................... 12,450 11,868
------- -------
$82,736 $85,374
======= =======
</Table>
10. ACCRUAL FOR SELF-INSURED LIABILITIES
The Company insures certain risks with affiliated insurance subsidiaries of
Extendicare, and certain third-party insurers. The insurance policies cover
comprehensive general and professional liability, property
F-22
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
coverage, workers' compensation and employer's liability insurance in amounts
and with such coverage and deductibles as the Company deems appropriate, based
on the nature and risks of its business, historical experiences and industry
standards. The Company also self-insures for health and dental claims, in
certain states for workers' compensation and employer's liability. As a result
of limited availability from third party insurers or availability at an
excessive cost or deductible, since January 2000, we generally self-insure for
comprehensive general and professional liability (including malpractice
insurance for our health providers, assistants and other staff, as it relates to
their respective duties performed on our behalf) up to a certain amount per
incident. In January 2000, our retained risk for general and professional
liability coverage increased significantly resulting in us providing accruals
based on past claims and actuarial estimates of the ultimate cost to settle
claims. Self-insured liabilities with respect to general and professional
liability claims are included within the Accrual for Self-Insured Liabilities.
The Company's accrual for self-insured health and dental claims, and workers'
compensation are included within note 9.
Management regularly evaluates the appropriateness of the carrying value of
the self-insured liability through an independent actuarial review. Of the risks
for which the Company self-insures, general and professional liability claims
are the most volatile and significant. Management's estimate of the accrual for
general and professional liability costs is significantly influenced by
assumptions, which are limited by the uncertainty of predictions concerning
future events, and assessments regarding expectations of several factors. Such
factors include, but are not limited to: the frequency and severity of claims,
which can differ materially by jurisdiction in which the Company operates;
coverage limits of third-party reinsurance; the effectiveness of the claims
management process; and uncertainty regarding the outcome of litigation.
In 2000, the Company experienced adverse claims development resulting in an
increase in the accrual for self-insured liabilities. Consequently, as of
January 1, 2000 the Company's per claim retained risk increased significantly
for general and professional liability coverage mainly due to the level of risks
associated with Florida and Texas operations. In 2001, the Company no longer
operated nursing and assisted living facilities in Florida and as of October 1,
2001 ceased nursing operations in Texas, thereby reducing the level of exposure
to future potential litigation in these litigious states. However, as a result
of an increase in the frequency and severity of claims the Company recorded an
additional $11.0 million provision (refer to note 4) to increase its accrual for
resident care liability in the third quarter of 2001. This additional accrual
was based upon an independent actuarial review and was largely attributable to
potential claims for incidents in Florida and Texas prior to the Company's
cessation of operations in those states. Changes in the Company's level of
retained risk, and other significant assumptions that underlie management's
estimates of self-insured liabilities, could have a material effect on the
future carrying value of the self-insured liabilities as well as the Company's
operating results and liquidity.
11. OTHER LONG-TERM LIABILITIES
Other long-term liabilities consisted of the following at December 31:
<Table>
<Caption>
2001 2000
------- -------
(IN THOUSANDS)
Deposits held under Divestiture Agreement (see note 4)...... $30,000 $30,000
Deferred compensation....................................... 5,487 5,686
Indemnification escrow relating to sold facilities.......... 3,700 3,700
Other....................................................... 4,831 1,330
------- -------
Total other long-term liabilities........................... $44,018 $40,716
======= =======
</Table>
As noted in note 4, the Company disposed of eleven Florida nursing
facilities (1,435 beds) and four Florida assisted living facilities (135 units)
to Greystone for initial cash proceeds of $30.0 million and contingent
consideration in the form of a series of interest bearing notes which have an
aggregate potential
F-23
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
value of up to $30.0 million plus interest. The disposition is being accounted
for as a deferred sale in accordance with SFAS 66 and therefore, the initial
cash proceeds have been classified as "Deposits held under the Divestiture
Agreement". Greystone has not sold or refinanced the properties and therefore
has not triggered the determination and payment of the contingent notes.
The Company maintains an unfunded deferred compensation plan offered to all
corporate employees defined as highly compensated by the Internal Revenue
Service Code in which participants may defer up to 10% of their base salary. The
Company will match up to 50% of the amount deferred. The Company also maintains
non-qualified deferred compensation plans covering certain executive employees.
Expense incurred for Company contributions under such plans were $278,000,
$91,000 and $565,000 in 2001, 2000 and 1999, respectively.
The Company maintains defined contribution retirement 401(k) savings plans,
which are made available to substantially all of the Company's employees. The
Company pays a matching contribution of 17% to 25% of every qualifying dollar
contributed by plan participants, net of any forfeitures. Expenses incurred by
the Company related to the 401(k) savings plans were $1.3 million, $1.4 million
and $1.0 million in 2001, 2000 and 1999, respectively. The Company also
maintains a money purchase plan for three facilities in which the Company pays
amounts based upon the plan participants worked hours and an agreed fixed hourly
rate. Expenses incurred by the Company related to the money purchase plan were
$54,000, $65,000 and $45,000 in 2001, 2000 and 1999, respectively.
12. REVENUES
The Company derived approximately 24%, 24% and 22% of its revenues from
services provided under various federal (Medicare) and approximately 51%, 51%
and 50% of its revenues from services provided under various state (Medicaid)
medical assistance programs in 2001, 2000 and 1999, respectively. The Medicare
program and most state Medicaid programs pay each participating facility on a
prospectively-set per diem rate for each resident, which is based on the
resident's acuity. Most Medicaid programs fund participating facilities using a
case-mix system, paying prospectively set rates. Prior to 1999, the Medicare
program was a cost-based reimbursement program.
a) Balanced Budget Act and the Prospective Payment System
The Balanced Budget Act ("BBA"), signed into law in August 1997, made
numerous changes to the Medicare and Medicaid programs. With respect to the
Medicare program, the BBA established a Prospective Payment System (PPS) for
skilled nursing facility funding certified under the Medicare program. All of
the Company's skilled nursing facilities were funded under the provisions of the
BBA during 1999 and 2000. The PPS establishes a Federal per diem rate for
virtually all covered services and the provisions of the BBA provided that for
skilled nursing facilities in operation prior to 1996, the federal per diem rate
would be phased in over a four-year period. In November 1999, the Balanced
Budget Relief Act ("BBRA") was passed to allow each skilled nursing facility to
apply to adopt the full federal rate effective January 1, 2000 or to continue to
phase in to the federal rate over the next three years. An evaluation was
completed by the management of the Company, to determine the skilled nursing
facilities that would benefit from adoption of the full federal rate, and where
appropriate the Company applied and later received approval to have these
facilities placed on the full federal rate. Effective January 2002, all skilled
nursing facilities are reimbursed at the full federal rate.
With respect to the Medicaid program, the BBA repealed the federal payment
standard which required state Medicaid programs to pay rates that were
reasonable and adequate to meet the costs necessary to efficiently and
economically operate skilled nursing facilities. As a result, states have
considerable flexibility in establishing payment rates for Medicaid services
provided after October 1, 1997.
F-24
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
b) Balanced Budget Refinement Act of 1999 ("BBRA") and Benefits Improvement
and Protection Act of 2000 ("BIPA")
As a result of the industry coming under financial pressure due to the
implementation of PPS and other BBA of 1997 provisions, Congress passed two acts
to provide some relief to the industry, namely the BBRA of 1999 and the BIPA of
2000. These laws contained additional funding provisions to assist providers as
they adjusted to PPS for an interim period. The BBRA of 1999 increased the rate
by 20% for 15 Resource Utilization Groups III ("RUGs") categories identified as
having intensity non-therapy ancillary services deemed to be underfunded. The
BBRA of 1999 also provided for a 4% increase to all RUGs categories on October
1, 2000. The BIPA of 2000 increased the nursing component of the federal rate by
16.66% and replaced the 20% add-on to the three RUGs categories with a 6.7%
add-on for all 14 rehabilitative RUGs categories. As outlined in Note 19,
certain funding enhancements contained within the BBRA of 1999 and BIPA of 2000
are scheduled to sunset on September 30, 2002 and others may not continue,
subject to a rebasing of RUGs categories by The Centers for Medicare and
Medicaid Services ("CMS," formerly the Health Care Financing Administration, or
HCFA). CMS is the government agency that administers the Medicare program and,
at the present time CMS has made no formal announcements regarding the timing or
methodology of any RUGs refinements. Nor has the Congress of the United States
made a formal announcement on the extension of the BBRA of 1999 or BIPA of 2000
funding beyond the expiration.
c) Provision (Recovery) for Outstanding Medicare Receivable
In the normal course of business, the Company has ongoing discussions with
its FI regarding the treatment of various items related to prior years' cost
reports. Normally items are resolved during the audit process and no provisions
are required. For items involving differences of opinion between the Company and
the FI regarding cost report methods, such items can be settled through a formal
appeal process. Should this occur, a general provision for Medicare receivables
may be provided for disagreements, which result in the provider filing an appeal
with the Provider Reimbursement Review Board (PRRB) of the CMS.
During 1999, the FI notified the Company of several adjustments for
services rendered from 1995 through 1998. In the fourth quarter of 1999, the
Company made a decision to file a formal appeal to the PRRB and based upon this
decision, a general provision of $27.4 million was recorded as a reduction of
revenues in 1999. In April 2000, the PRRB heard the Company's first appeal
involving the reimbursement of workers' compensation costs and during September
2000, issued a decision that supported the Company's position. In December 2000,
the Administrator for CMS confirmed the PRRB's decision resulting in a favorable
settlement of $12.4 million, including a recovery recorded in revenue of $10.3
million of the general provision recorded in 1999. In addition, the Company
reached a settlement on another staffing cost issue resulting in a recovery of
$2.4 million including a recovery of $1.7 million of the general provision
recorded in 1999. In total, a recovery of $12.0 million before tax was recorded
in 2000 relating to the general provision recorded in 1999.
Other adjustments relating to prior years' estimated settlements, including
Medicare waiver requests set out above, increased revenues by $1.9 million in
1999.
d) Accounts receivable
The Company had approximately 25%, 30% and 29% as of December 31, 2001,
2000 and 1999, respectively, in accounts receivable derived from services
provided under various federal (Medicare) programs and 38%, 36% and 34% as of
the same dates derived from services provided under various state (Medicaid)
medical assistance programs. The differences between revenues derived under
third-party payor programs and amounts received as payments are reflected as
accounts receivable when revenue is
F-25
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
greater than payments received or as accrued liabilities when payments have
exceeded revenues that the Company ultimately expects to be realized. Accounts
receivable at December 31, 2001 and 2000, which are expected to be substantially
collected within one year, include estimated settlements from third-party payors
of $11.8 million and $15.6 million, respectively.
13. LEASE COMMITMENTS
As a lessee, the Company, at December 31, 2001, was committed under
non-cancelable operating leases requiring future minimum rentals as follows
(dollars in thousands):
<Table>
2002........................................................ $12,169
2003........................................................ 9,397
2004........................................................ 8,987
2005........................................................ 8,865
2006........................................................ 6,325
After 2006.................................................. 33,208
-------
Total minimum payments...................................... $78,951
=======
</Table>
Operating lease costs were $14.6 million, $18.0 million and $18.8 million
in 2001, 2000 and 1999, respectively. These leases expire on various dates
extending to the year 2013 and in many cases contain renewal options.
As a lessor, at December 31, 2001 the Company leases 17 nursing properties
(1,862 beds) to three unrelated operators in Florida and in Texas under the
terms outlined in note 4. The Company will record future revenues as operating
leases and all operators have an option to purchase the facilities during the
term. The lease of seven nursing properties in Florida to Tandem expires in June
2002 and the current annual rental income is $7.0 million. The lease of six
nursing properties to Senior Health-South expires in December 2005, and the
Company earns rental income (based upon the net operating cash flow of the
properties) which on average cannot exceed $2.0 million per annum. Rental income
earned during 2001 totaled $467,000. Senior Health-Texas leases four nursing
properties for a term which expires in October 2006, and subleases another 12
properties until February 2012, all in Texas. The annual rental income is $3.8
million or $1.8 million in excess of the Company's annual lease cost. The cost
and accumulated depreciation of facilities under operating lease arrangements
included in Property and Equipment (refer to note 5) as of December 31, 2001 is
as follows:
<Table>
<Caption>
(IN THOUSANDS)
Land and land improvements.................................. $10,910
Buildings and improvements.................................. 50,677
Furniture and equipment..................................... 15,072
-------
Total property and equipment before accumulated depreciation
and amortization.......................................... 76,659
Less accumulated depreciation and amortization.............. 32,374
-------
Total property and equipment, net........................... $44,285
=======
</Table>
14. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES (UNAUDITED)
Objectives and Strategies Prior to Issuance of Senior Notes
Prior to the issuance of the Senior Notes in June 2002, the Company had
variable-rate long-term debt of approximately $127 million which it used to
finance its operations. These debt obligations exposed the Company to
variability in interest payments due to changes in interest rates. The Company
hedged a
F-26
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
portion of its variable-rate debt through interest rate swaps designated as
cash-flow hedges with a notional amount of $25 million maturing in February 2003
under which the Company received variable interest rate payments and made fixed
rate interest rate payments. When the Company issued the fixed-rate Senior
Notes, the proceeds were used to payoff the variable-rate debt which was being
hedged by the interest rate swaps. These interest rate swaps were terminated by
the Company in June 2002 with a cash payment of $635,000.
Objectives and Strategies After Issuance of Senior Notes
After the issuance of the Senior Notes, all but $32 million of the
Company's outstanding debt obligations have fixed interest rates. The market
value of these fixed-rate debt obligations vary based on changes in interest
rates.
Management believes that it is prudent to limit the variability of the
market value of its fixed-rate debt obligations. To meet this objective, the
Company has entered into an interest rate swap in June 2002. This swap
effectively changes the fixed-rate cash flows on fixed-rate long-term debt to
variable-rate cash flows. Under the interest rate swap, the Company pays
variable interest rate payments and receives fixed interest rate payments. In
addition, the Company uses an interest rate cap to offset possible increases in
interest payments under the interest rate swap caused by increases in market
interest rates over a certain level and also as a cash flow hedge to effectively
limit increases in interest payments under its variable-rate debt obligations.
The Company does not speculate using derivative instruments.
Risk Management Policies
The Company assesses interest rate cash flow risk by continually
identifying and monitoring changes in interest rate exposures that may adversely
impact expected future cash flows and by evaluating hedging opportunities. The
Company maintains risk management control systems to monitor interest rate cash
flow risk attributable to both the Company's outstanding or forecasted debt
obligations as well as the Company's offsetting hedge positions. The risk
management control systems involve the use of analytical techniques, including
cash flow sensitivity analysis, to estimate the expected impact of changes in
interest rates on the Company's future cash flows.
Quantitative Disclosures
In June 2002, the Company entered into an interest rate swap (used to hedge
the fair value of fixed-rate debt obligations) with a notional amount of $150
million maturing in December 2007. Under this swap, the Company pays a variable
rate of interest equal to the one month London Interbank Borrowing rate
("LIBOR") (1.82% as of September 30, 2002), adjustable monthly, plus a spread of
4.805% and receives a fixed rate of 9.35%. This swap is designated as a fair
value hedge and had no impact on the income statement during the nine months
ended September 30, 2002.
Also in June 2002, the Company entered into an interest rate cap with a
notional amount of $150 million maturing in December 2007. Under this cap, the
Company pays a fixed rate of interest equal to 0.24% and receives a variable
rate of interest equal to the excess, if any, of the one month LIBOR rate,
adjusted monthly, over the cap rate of 7%. A portion of the interest rate cap
with a notional amount of $32 million is designated as a hedging instrument
(cash-flow hedge) to effectively limit possible increases in interest payments
under variable-rate debt obligations. The remainder of the interest rate cap
with a notional amount of $118 million is used to offset increases in
variable-rate interest payments under the interest rate swap to the extent one
month LIBOR exceeds 7%. This portion of the interest rate cap is not designated
as a hedging instrument under SFAS 133.
Changes in the fair value of a derivative that is highly effective and that
is designated and qualifies as a fair-value hedge, along with the loss or gain
on the hedged asset or liability of the hedged item that is
F-27
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
attributable to the hedged risk are recorded in earnings. Changes in the fair
value of cash flow hedges are reported as Accumulated Other Comprehensive Income
("AOCI") as a component of Shareholder's Equity. Changes in the fair value of
the portion of the interest rate cap not designated as a hedging instrument is
reported in earnings. As of September 30, 2002, the fair value of the interest
rate swap designated as a fair value hedge is an asset of $7.5 million and is
offset by a liability of $7.5 million relating to the change in market value of
the hedged item (long-term debt obligations). The fair value of the cash-flow
hedges is a liability recorded in other long-term liabilities of $0.2 million.
And the gain credited to AOCI (net of income tax effect) for the nine months
ended September 30, 2002 was $1.0 million. The fair value of the portion of the
interest rate cap not designated as a hedging instrument is a liability recorded
in other long-term liabilities of $0.5 million. During the year ending December
31, 2002, none of the gains or losses in AOCI (net of income tax effect) related
to the interest rate cap are expected to be reclassified into interest expense
as a yield adjustment of the hedged debt obligation.
Quantitative Disclosures as of and for Years Ended December 31, 2001
As of May 29, 2001, $25 million in interest rate swaps maturing February
27, 2003 were terminated in exchange for a cash payment of $0.5 million. This
amount will be amortized to interest expense over the remaining term of the
swap.
As of December 31, 2001, the Company has interest rate swaps (used to hedge
variable-rate cash flow exposure on variable-rate long-term debt) with notional
amounts of $50 million maturing in February 2002 and $25 million maturing in
February 2003.
Interest expense for 2001 includes $22,000 in net gains representing the
cash flow hedge's ineffectiveness arising from differences between the terms of
the interest rate swap and the hedged debt obligation.
Changes in the fair value of interest rate swaps designated as hedging
instruments of the variability of cash flows associated with floating-rate,
long-term debt obligations are reported as AOCI as a component of Shareholder's
Equity. These amounts are subsequently reclassified into interest expense as a
yield adjustment in the same period in which the related interest on the
floating-rate debt obligations affects earnings.
The impact as of January 1, 2001 arising from the adoption of the standards
(relating to the fair value of interest rate swaps) was an increase of $0.2
million in other long-term liabilities and a decrease of $0.2 million in AOCI.
As of December 31, 2001, the fair value of the interest rate swaps
designated as hedging instruments is a liability recorded in other long-term
liabilities of $1.4 million and the loss charged to AOCI (net of income tax
effect) for 2001 is $1.1 million.
During the year ending December 31, 2002, approximately $1.0 million of
losses in AOCI (net of income tax effect) related to the interest rate swaps are
expected to be reclassified into interest expense as a yield adjustment of the
hedged debt obligation.
15. COMMITMENTS AND CONTINGENCIES
Capital Expenditures
The Company as of December 31, 2001 had capital expenditure purchase
commitments outstanding of approximately $5.4 million.
At September 30, 2002, the Company had capital expenditure purchase
commitments outstanding of approximately $4.5 million (unaudited).
F-28
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Insurance
The Company insures certain risks with affiliated insurance subsidiaries of
Extendicare. The cost of general and professional liability insurance premiums
was the most significant insurance expense charged to the Company by the
affiliates. In 2000 and 1999, the premiums charged to the Company for this
general and professional liability coverage increased significantly due to
adverse claims development experienced by the affiliates. Refer to note 9.
Litigation
The Company and its subsidiaries are defendants in actions brought against
them from time to time in connection with their operations. While it is not
possible to estimate the final outcome of the various proceedings at this time,
such actions generally are resolved within amounts provided.
The U.S. Department of Justice and other Federal agencies are increasing
resources dedicated to regulatory investigations and compliance audits of
healthcare providers. The Company is diligent to address these regulatory
efforts.
Omnicare Preferred Provider Agreement
In 1998, the Company disposed of its pharmacy operations to Omnicare, Inc.
In addition, the Company entered into a Preferred Provider Agreement, the terms
of which enabled Omnicare to execute Pharmacy Service Agreements and Consulting
Service Agreements with all of the Company's skilled nursing facilities. Under
the terms of the agreement, the Company secured "per diem" pricing arrangements
for pharmacy supplies for the first four years of the Agreement, which period
expires December 2002. The Preferred Provider Agreement contains a number of
provisions which involve sophisticated calculations to determine the "per diem"
pricing during this first four-year period. Under the "per diem" pricing
arrangement, pharmacy costs fluctuate based upon occupancy levels in the
facilities. The "per diem" rates were established assuming a declining "per
diem" value over the initial four years of the contract to coincide with the
phase-in of the Medicare PPS rates. Omnicare has subsequently asserted that "per
diem" rates for managed care and Medicare beneficiaries are subject to an upward
adjustment based upon a comparison of per diem rates to pricing models based on
Medicaid rates.
In 2001, the Company and Omnicare brought two matters to arbitration,
neither of which involves material financial amounts. The first issue related to
select pricing issues in one state which was resolved by settlement between the
parties. The parties are in the process of resolving the remaining issue, which
is related to the legal interpretation of the Medicaid adjustment provisions,
and the impact of this provision on "per diem" pricing for managed care
residents during 2001 and 2002. Omnicare has indicated that it intends to make
similar claims for Medicare residents for a similar time period. Provisions for
settlement of the claims are included within the financial statements. The
Company believes it has interpreted and has complied with the terms of the
Preferred Provider Agreement; however, there can be no assurance that other
claims will not be made with respect to the agreement.
Omnicare Preferred Provider Agreement Update (Unaudited)
In connection with its agreements to provide pharmacy services to the
Company, Omnicare, Inc. has requested arbitration for a lost profits claim
related to the Company's disposition of assets, primarily in Florida. Damage
amounts, if any, cannot be reasonably estimated based on information available
at this time. An arbitration hearing has not yet been scheduled.
F-29
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Option to Purchase
The Company exercised its right to purchase seven nursing facilities in
Ohio and Indiana prior to the expiration of the lease in September 2000. Since
this date, the Company continues to lease and operate the facilities in good
faith and has held on-going negotiations with the landlord to conclude issues
involved in completing the transaction. Negotiations have to date not resolved
all issues to complete the transaction and may require arbitration to conclude.
The Company believes it has complied fully with the terms of the option and
believes that settlement of outstanding issues can be resolved, however, there
is no assurance that the transaction will be completed. Should the matters be
resolved, approximately $6.4 million of the purchase price would be paid in
cash. As of December 31, 2001 the Company had $4.2 million in leasehold
improvements and equipment relating to these facilities.
Contingent Consideration
The Company received $30.0 million in initial cash proceeds and hold
contingent consideration in the form of a series of interest-bearing notes,
which have an aggregate potential value of up to $30.0 million plus interest.
Refer to note 4 for further details. As of December 31, 2001, Greystone has not
sold or refinanced any of the nursing properties and therefore has not triggered
the determination of the value of the notes and interest or payment of the
notes.
16. TRANSACTIONS WITH SHAREHOLDER AND AFFILIATES
The following is a summary of the Company's transactions with Extendicare
and its affiliates in 2001, 2000 and 1999:
Insurance
The Company insures certain risks with affiliated insurance subsidiaries of
Extendicare. The cost of general and professional liability premiums was the
most significant insurance expense charged to the Company by the affiliates. In
2001, 2000 and 1999, the premiums charged to the Company for this general and
professional liability coverage increased significantly, due to the adverse
claims development experienced by the affiliates. The consolidated statements of
operations for 2001, 2000 and 1999 include intercompany insurance premium
expenses of $5.7 million, $20.7 million and $13.9 million, respectively. These
figures are net of favorable actuarial adjustments for prior years under its
retroactively-rated workers' compensation coverage in the amounts of $0.9
million, $1.3 million and $1.9 million in 2001, 2000 and 1999, respectively. As
noted within note 10, the Company's departure from the State of Florida and the
State of Texas will likely reduce future general and professional liability
coverage expenditures.
Computer Services
In January 2001, the Company established a formal agreement for computer
hardware and software support services with an affiliated subsidiary of
Extendicare. The annual cost of services was $6.5 million and resulted in
savings to the Company of approximately $2.3 million in 2001.
Leases
In 1999, the Company entered into a capital lease relating to computer
equipment with an affiliated subsidiary of Extendicare. In the first quarter of
2000, the Company exercised its option to purchase the equipment for $1.3
million. The consolidated statement of operations includes interest expense of
$110,000 and $319,000 related to this lease for 2000 and 1999, respectively.
F-30
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Other Payables
At December 31, 2001, 2000 and 1999 the Company had a non-interest bearing
payable with no specific due date to a subsidiary company of Extendicare of $3.5
million as of all dates.
Due to Shareholders and Affiliates
Transactions affecting these accounts were general and professional
liability insurance charges, accrued liability claims from an affiliate and
working capital advances to an affiliate in 2001, 2000 and 1999, and charges
(payments) from (to) shareholder and affiliates for income taxes in each of the
three years.
Capital and Other Transactions
During 2001 and 2000, Extendicare and/or one of its wholly owned
subsidiaries acquired $19.0 million and $8.9 million, respectively of the
Company's Senior Subordinated Notes. As of December 31, 2001, Extendicare and/or
one of its wholly owned subsidiaries held $27.9 million (14.0%) of the
outstanding Senior Subordinated Notes.
17. INCOME TAXES
The Company's results of operations are included in the consolidated
federal tax return of its U.S. parent company. Accordingly, Federal current and
deferred income taxes payable are transferred to the Company's parent company.
The provisions for income taxes have been calculated as if the Company was a
separately taxed entity for each of the periods presented in the accompanying
consolidated financial statements.
Total income taxes for the years ended December 31, 2001, 2000 and 1999
were allocated as follows:
<Table>
<Caption>
2001 2000 1999
-------- -------- --------
(IN THOUSANDS)
Loss from continuing operations.................... $(12,482) $(27,667) $(52,841)
Extraordinary item................................. (30) (257) (240)
Shareholder's equity for unrealized gain or (loss)
on investments................................... 295 925 (2,185)
Unrealized loss on cash flow hedges................ (596) -- --
-------- -------- --------
$(12,813) $(26,999) $(55,266)
======== ======== ========
</Table>
F-31
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The income tax expense (benefit) on losses before extraordinary item
consists of the following for the year ended December 31:
<Table>
<Caption>
2001 2000 1999
-------- -------- --------
(IN THOUSANDS)
Federal:
Current.......................................... $ -- $(14,507) $(42,729)
Deferred......................................... (13,193) (12,184) (9,225)
-------- -------- --------
Total Federal...................................... (13,193) (26,691) (51,954)
State:
Current.......................................... 544 294 2,736
Deferred......................................... 167 (1,270) (3,623)
-------- -------- --------
Total State........................................ 711 (976) (887)
-------- -------- --------
Total income tax benefit........................... $(12,482) $(27,667) $(52,841)
======== ======== ========
</Table>
The differences between the effective tax rates on earnings before
provision for income taxes and the United States Federal income tax rate are as
follows:
<Table>
<Caption>
2001 2000 1999
---- ---- ----
Statutory Federal income tax rate........................... 35.0% 35.0% 35.0%
Increase (reduction) in tax rate resulting from:
State income taxes, net of Federal income tax benefit..... 0.8 0.8 0.4
Goodwill and other items.................................. (2.9) (1.5) (1.5)
Impairment of long-lived assets........................... -- -- (6.8)
Increase in valuation allowance........................... (3.1) -- --
Recovery of prior year's taxes............................ -- -- 19.1
Work opportunity credit................................... 1.4 0.6 0.5
Other, net................................................ -- (1.3) (3.8)
---- ---- ----
Effective tax rate.......................................... 31.2% 33.6% 42.9%
==== ==== ====
</Table>
The Company received payments of $22.5 and $47.3 million for federal income
taxes from its U.S. parent in 2001 and 2000, respectively. The Company made
payments of $24.5 million for federal income taxes to its U.S. parent in 1999.
F-32
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the net state deferred tax assets and liabilities as of
December 31 are as follows:
<Table>
<Caption>
2001 2000
------- -------
(IN THOUSANDS)
Deferred tax assets:
Employee benefit accruals................................. $ 1,473 $ 1,516
Accrued liabilities....................................... 3,695 2,642
Accounts receivable reserves.............................. 1,310 1,819
Operating loss carryforwards.............................. 6,354 4,819
Other assets.............................................. 1,648 1,396
------- -------
Subtotal.................................................. 14,480 12,192
Valuation allowance....................................... 6,944 4,149
------- -------
Total deferred tax assets.............................. 7,536 8,043
Deferred tax liabilities:
Depreciation.............................................. 5,777 6,239
Goodwill.................................................. 465 389
Leasehold rights.......................................... 285 349
Miscellaneous............................................. 1,009 861
------- -------
Total deferred tax liabilities......................... 7,536 7,838
------- -------
Net deferred tax assets..................................... $ -- $ 205
======= =======
</Table>
The Company paid state income taxes of $326,000, $98,000 and $4.8 million
in 2001, 2000 and 1999, respectively. As of December 31, 2001 the Company had
$95.8 million of total net operating loss carry forwards available for state
income tax financial reporting purposes which expire from 2002 to 2021. Because
the realizability of these losses is uncertain, the operating loss carry
forwards are offset by a valuation allowance.
The valuation allowance for state deferred tax assets as of December 31,
2001 and 2000 was $6.9 million and $4.1 million, respectively. The net change in
the total valuation allowance for the years ended December 31, 2001 and 2000 was
an increase of $2.8 million and an increase of $3.2 million, respectively. In
assessing the realizability of deferred tax assets, management considers whether
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income,
and tax planning strategies in making this assessment. Management believes it is
more likely than not the Company will realize the benefits of these deductible
differences, net of the valuation allowances.
F-33
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
18. COMPREHENSIVE INCOME
The accumulated balances for each classification of comprehensive income
are as follows:
<Table>
<Caption>
UNREALIZED ACCUMULATED
GAINS OTHER
(LOSSES) ON CASH FLOW COMPREHENSIVE
SECURITIES HEDGES INCOME
----------- --------- -------------
Balance at December 31, 1998.................... $ 187 $ -- $ 187
Net current period change....................... (3,277) (3,277)
------- ------- -------
Balance at December 31, 1999.................... (3,090) -- (3,090)
Net current period change....................... 1,387 1,387
------- ------- -------
Balance at December 31, 2000.................... (1,703) -- (1,703)
Cumulative effect of change in accounting for
hedging activities............................ -- (913) (913)
Net current period change....................... 441 (192) 249
------- ------- -------
Balance at December 31, 2001.................... $(1,262) $(1,105) $(2,367)
======= ======= =======
</Table>
The related tax effects allocated to each component of other comprehensive
income are as follows:
<Table>
<Caption>
TAX
BEFORE-TAX (EXPENSE) NET-OF-TAX
AMOUNT OR BENEFIT AMOUNT
---------- ---------- ----------
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during
the period....................................... $ 736 $(295) $ 441
------- ----- -------
Cash flow hedges:
Cumulative effect of a change in accounting for
derivative instruments and hedging activities.... (1,405) 492 (913)
Net derivative gains (losses)...................... (296) 104 (192)
------- ----- -------
Net current period change.......................... (1,701) 596 (1,105)
------- ----- -------
Other comprehensive income (loss).................. $ (965) $ 301 $ (664)
======= ===== =======
</Table>
19. UNCERTAINTIES AND CERTAIN SIGNIFICANT RISKS
The Company's earnings are highly contingent on Medicare and Medicaid
funding rates, and the effective management of staffing and other costs of
operations which are strictly monitored through State and Federal regulatory
authorities. The Company is unable to predict whether the federal or any state
government will adopt changes in their reimbursement systems, or if adopted and
implemented, what effect such initiatives would have on the Company. Limitations
on Medicare and Medicaid reimbursement for health care services are continually
proposed. Changes in applicable laws and regulations could have an adverse
effect on the levels of reimbursement from governmental, private and other
sources.
As outlined in Note 12(b), the incremental Medicare relief packages
received from BBRA and BIPA provide a total $2.7 billion in temporary Medicare
funding enhancements to the long-term care industry. The funding enhancements
implemented by the BBRA and BIPA fall into two categories. The first category is
"Legislative Add-ons" which included the 16.66% add-on to the nursing component
of the RUGs rate and the 4% base adjustment. The Legislative Add-ons are
currently scheduled to sunset on September 30, 2002. The second category is
"RUGs Refinements" which involved an initial 20% add-on for 15 RUGs categories
identified as having high intensity, non-therapy ancillary services (later
redistributed the 20% add-ons from 3 RUGs categories to 14 Rehab categories at
6.7%). The RUGs
F-34
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Refinements continue until such time as CMS refines the RUGs categories. The
Company has estimated the average per diem effect of the Legislative Add-ons to
be $32.00 and RUGs Refinements to be $25.00. The amount of incremental Medicare
funding related to the Legislative Add-ons and RUGs Refinements is estimated to
be $16.0 million and $13.0 million, respectively. A decision to discontinue all
or part of the enhancement could have a significant impact on the Company.
Through the divestiture program in Texas and Florida, the Company has
assumed notes and preferred shares from the purchasers and retained ownership of
certain nursing home properties. In aggregate, as of December 31, 2001, the
Company has $8.8 million in notes and preferred shares and owns $44.3 million in
nursing home properties in Texas and Florida. In 2001, the Company earned $5.3
million in annual management and consulting fees from unrelated long-term
operators. As a result, the earnings and cash flow of the Company can be
influenced by the financial stability of these unrelated long-term operators.
The Company has $70.3 million in accruals for self-insured liabilities as
of December 31, 2001. Though the Company has been successful in exiting from the
two litigious states of Texas and Florida and limiting future exposure to
general liability claims in these states, the timing and eventual settlement
costs for these claims cannot be precisely defined.
The Company has a high level of indebtedness with debt service obligations
totaling $385.3 million in borrowings at December 31, 2001 representing 63.4% of
total capitalization, compared to a similar ratio of 64.0% at December 31, 2000.
As a result, the degree to which the Company is leveraged could have important
consequences, including, but not limited to the following:
1. A substantial portion of the Company's cash flow from operations
would be dedicated to the payment of principal and interest on the
Company's indebtedness, thereby reducing the funds available for other
purposes;
2. The Company's ability to obtain additional financing within its
current Credit Facility for working capital, capital expenditures,
acquisitions or other purposes may be limited;
3. Certain of the Company's borrowings are at variable rates of
interest, which exposes the Company to the risk of higher interest rates.
The Company expects to satisfy the required payments of principal and
interest on indebtedness from cash flow from operations. However, the Company's
ability to generate sufficient cash flows from operations depends on a number of
internal and external factors, including factors beyond the Company's control
such as prevailing industry conditions. There can be no assurances that cash
flow from operations will be sufficient to enable the Company to service its
debt and meet other obligations.
The Company is in compliance with the financial covenants of its Credit
Facility as of December 31, 2001. The financial covenants under this credit
facility continue to become more stringent over the term of the facility. While
management has a strategy to remain in compliance, there can be no assurance
that the Company will meet future covenant requirements. The Company's available
bank lines can be affected by its ability to remain in compliance, or if not,
would depend upon management's ability to amend the covenant or refinance the
debt.
19A. UNCERTAINTIES AND CERTAIN SIGNIFICANT RISKS UPDATE (UNAUDITED)
The Legislative Add-ons expired on September 30, 2002, and the Company's
Medicare funding has been reduced pending additional legislation. Based upon the
Medicare case mix and census over the nine month period ended September 30, 2002
the Company estimates that it received an average rate of $31.22 per resident
day relating to the Legislative Add-ons. However, on October 1, 2002 long-term
care providers received a 2.6% market basket increase in Medicare rates. Based
on the Medicare case mix and census for the nine months of 2002, the impact of
these two items is a net decline in the average rate of
F-35
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$26.47 per resident day, which on an annualized basis going forward amounts to
revenue of approximately $16.1 million. Extensive discussions and negotiations
are underway within the U.S. House of Representatives and Senate regarding the
Legislative Add-ons. It is not possible to predict the outcome of these
deliberations. A decision not to restore all or part of the enhancements could
have a significant negative effect on the Company.
With respect to the RUGs Refinements, on April 23, 2002 the Centers for
Medicare and Medicaid Services announced its intention to delay the refinement
of the RUGs categories, thereby extending the related funding enhancements for
at least one additional year to September 30, 2003. Based upon the Medicare case
mix and census over the past nine month period ended September 30, 2002, the
Company estimates that it received an average rate of $24.59 per resident day,
which on an annualized basis amounts to revenue of approximately $14.9 million
related to the RUGs Refinements. A decision to discontinue all or part of the
enhancements could have a significant negative effect on the Company.
20. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments at
December 31 are as follows:
<Table>
<Caption>
2001 2000
---------------------- ----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
-------- ---------- -------- ----------
(IN THOUSANDS)
Non-current accounts receivable................. $ 36,410 $ 35,173 $ 37,215 $ 34,644
Other assets.................................... 21,575 21,575 17,213 17,213
Interest rate swaps (liability)................. 1,403 1,403 -- 216
Long-term debt.................................. 385,347 383,902 451,147 461,710
Deferred compensation........................... 5,487 5,487 5,686 5,686
Other long-term liabilities..................... 4,831 4,831 1,330 1,330
Long-term due to affiliate...................... 3,484 3,484 3,484 3,484
</Table>
The carrying values of accounts receivable approximate fair values due to
their short maturities with the exception of certain settlement receivables from
third-party payors which are anticipated to be collected beyond one year. The
fair value of these settlement receivables are estimated based on discounted
cash flows at management's estimated current borrowing rates.
Other assets consist of debt service and capital expenditure trust funds
and other financial instruments, the fair values of which are estimated based on
market prices from the same or similar issues of the underlying investments.
The fair value of the interest rate swaps from various financial
institutions is based on the quoted market prices as provided by the financial
institutions which are counter-parties to the swaps.
The fair value of long-term debt is estimated based on approximate
borrowing rates currently available to the Company for debt equal to the
existing debt maturities. For other long-term liabilities, principally
refundable escrows, it is not practicable to estimate fair value.
21. SUBSEQUENT DEVELOPMENT (UNAUDITED)
On October 18, 2002, the Company purchased seven previously leased nursing
facilities in Ohio and Indiana for an aggregate purchase price of $17.9 million.
The purchase price includes cash of $7.4 million and a $10.5 million ten-year
note bearing interest at a rate to be determined by arbitration, which is
currently being accrued at 10.5%.
F-36
EXTENDICARE HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
22. SUPPLEMENTARY QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the quarterly results of operations for the
years ended December 31, 2001 and 2000 (in thousands):
<Table>
<Caption>
2001
--------------------------------------------------------
1ST 2ND 3RD 4TH TOTAL
-------- -------- -------- -------- --------
Total revenues...................... $193,432 $200,789 $204,025 $195,861 $794,107
======== ======== ======== ======== ========
Loss on impairment of long-lived
assets............................ $ -- $ -- $ (1,685) $ -- $ (1,685)
Loss on disposal of assets and
provision for closure and exit
costs and other items............. (1,409) (6,435) (16,402) -- (24,246)
Earnings (loss) before provision for
income taxes and extraordinary
items............................. (10,430) (10,897) (23,338) 4,733 (39,932)
Provision (benefit) for income
taxes............................. (3,679) (2,198) (9,249) 2,644 (12,482)
-------- -------- -------- -------- --------
Earnings (loss) before extraordinary
items............................. (6,751) (8,699) (14,089) 2,089 (27,450)
Extraordinary items................. -- (45) -- -- (45)
-------- -------- -------- -------- --------
Net earnings (loss)................. $ (6,751) $ (8,744) $(14,089) $ 2,089 $(27,495)
======== ======== ======== ======== ========
</Table>
<Table>
<Caption>
2000
--------------------------------------------------------
1ST 2ND 3RD 4TH TOTAL
-------- -------- -------- -------- --------
Total revenues...................... $227,890 $232,119 $230,110 $232,950 $923,069
======== ======== ======== ======== ========
Loss on impairment of long-lived
assets............................ $ -- $ -- $ -- $(20,753) $(20,753)
Gain (loss) on disposal of assets
and provision for closure and exit
costs and other items............. (195) (1,531) 940 (5,877) (6,663)
Loss before provision for income
taxes and extraordinary items..... (16,445) (11,775) (21,534) (32,592) (82,346)
Benefit for income taxes............ (5,923) (3,892) (7,786) (10,066) (27,667)
-------- -------- -------- -------- --------
Loss before extraordinary items..... (10,522) (7,883) (13,748) (22,526) (54,679)
Extraordinary items................. -- -- (436) (6) (442)
-------- -------- -------- -------- --------
Net loss............................ $(10,522) $ (7,883) $(14,184) $(22,532) $(55,121)
======== ======== ======== ======== ========
</Table>
F-37
$150,000,000
[Extendicare Health Services, Inc. Logo]
EXTENDICARE HEALTH SERVICES, INC.
New 9 1/2% Senior Notes
due 2010
-------------------
PROSPECTUS
-------------------
November 26, 2002