1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
--- TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
_____ TO _____
COMMISSION FILE NUMBER 1-9550
BEVERLY ENTERPRISES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 62-1691861
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
5111 ROGERS AVENUE, SUITE 40-A
FORT SMITH, ARKANSAS 72919-0155
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (501) 452-6712
INDICATE BY CHECK MARK WHETHER REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO
BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT REGISTRANT WAS REQUIRED
TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR
THE PAST 90 DAYS.
YES X NO
--- ---
SHARES OF REGISTRANT'S COMMON STOCK, $.10 PAR VALUE, OUTSTANDING,
EXCLUSIVE OF TREASURY SHARES, AT JULY 31, 1998 -- 103,256,909
================================================================================
2
BEVERLY ENTERPRISES, INC.
FORM 10-Q
JUNE 30, 1998
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets................ 2
Condensed Consolidated Statements of Income.......... 3
Condensed Consolidated Statements of Cash Flows...... 4
Notes to Condensed Consolidated Financial Statements. 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 9
PART II - OTHER INFORMATION
Item 1. Legal Proceedings........................................ 18
Item 4. Submission of Matters to a Vote of Security Holders...... 19
Item 6. Exhibits and Reports on Form 8-K......................... 19
1
3
PART I
BEVERLY ENTERPRISES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 1998 AND DECEMBER 31, 1997
(DOLLARS IN THOUSANDS)
JUNE 30, DECEMBER 31,
1998 1997
--------- -----------
(UNAUDITED) (NOTE)
ASSETS
Current assets:
Cash and cash equivalents ................................................ $ 41,473 $ 105,230
Accounts receivable - patient, less allowance for doubtful accounts:
1998__$15,459; 1997__$17,879 ........................................... 394,037 384,833
Accounts receivable - nonpatient, less allowance for doubtful accounts:
1998__$427; 1997__$626 ................................................. 23,835 14,400
Notes receivable ......................................................... 6,570 4,409
Operating supplies ....................................................... 29,465 30,439
Deferred income taxes .................................................... 24,549 27,304
Prepaid expenses and other ............................................... 61,689 59,703
----------- -----------
Total current assets .................................................. 581,618 626,318
Property and equipment, net of accumulated depreciation and amortization:
1998__$666,215; 1997__$638,834 .......................................... 1,146,502 1,158,329
Other assets:
Notes receivable, less allowance for doubtful notes:
1998__$3,193; 1997__$2,917 ............................................ 19,369 20,564
Designated and restricted funds .......................................... 74,396 64,233
Goodwill, net ............................................................ 205,075 99,280
Other, net ............................................................... 113,104 104,745
----------- -----------
Total other assets .................................................... 411,944 288,822
----------- -----------
$ 2,140,064 $ 2,073,469
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ......................................................... $ 78,148 $ 75,791
Accrued wages and related liabilities .................................... 124,510 123,146
Accrued interest ......................................................... 14,518 15,108
Other accrued liabilities ................................................ 101,614 98,421
Current portion of long-term obligations ................................. 29,289 31,551
----------- -----------
Total current liabilities ............................................. 348,079 344,017
Long-term obligations ....................................................... 761,403 686,941
Deferred income taxes payable ............................................... 122,643 111,388
Other liabilities and deferred items ........................................ 53,611 68,618
Commitments and contingencies
Stockholders' equity:
Preferred stock, shares authorized: 25,000,000 .......................... -- --
Common stock, shares issued: 1998__110,241,711; 1997__109,890,205 ....... 11,024 10,989
Additional paid-in capital ............................................... 875,787 874,335
Retained earnings ........................................................ 65,825 26,239
Accumulated other comprehensive income ................................... 1,509 1,332
Treasury stock, at cost: 1998__ 7,000,000 shares; 1997__ 4,000,000 shares (99,817) (50,390)
----------- -----------
Total stockholders' equity ............................................ 854,328 862,505
----------- -----------
$ 2,140,064 $ 2,073,469
=========== ===========
NOTE: The balance sheet at December 31, 1997 has been derived from the audited
consolidated financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements.
See accompanying notes.
2
4
BEVERLY ENTERPRISES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
THREE-MONTH AND SIX-MONTH PERIODS ENDED JUNE 30, 1998 AND 1997
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
Net operating revenues ......................... $ 715,415 $ 817,503 $1,409,815 $1,634,219
Interest income ................................ 2,233 3,161 5,260 6,726
---------- ---------- ---------- ----------
Total revenues .......................... 717,648 820,664 1,415,075 1,640,945
Costs and expenses:
Operating and administrative:
Wages and related ......................... 437,253 448,074 856,472 897,856
Other ..................................... 208,872 287,944 419,375 577,874
Interest .................................... 16,593 21,971 32,081 44,687
Depreciation and amortization ............... 23,127 27,725 46,245 54,806
---------- ---------- ---------- ----------
Total costs and expenses ................ 685,845 785,714 1,354,173 1,575,223
---------- ---------- ---------- ----------
Income before provision for income taxes ....... 31,803 34,950 60,902 65,722
Provision for income taxes ..................... 10,258 13,980 21,316 26,289
---------- ---------- ---------- ----------
Net income ..................................... $ 21,545 $ 20,970 $ 39,586 $ 39,433
========== ========== ========== ==========
Net income per share of common stock:
Basic:
Net income per share of common stock ...... $ .21 $ .21 $ .38 $ .40
========== ========== ========== ==========
Shares used to compute net income per share 103,682 97,736 104,838 97,939
========== ========== ========== ==========
Diluted:
Net income per share of common stock ...... $ .20 $ .20 $ .37 $ .38
========== ========== ========== ==========
Shares used to compute net income per share 105,112 109,993 106,289 110,189
========== ========== ========== ==========
Operating results for the three-month and six-month periods ended June 30,
1997 included the operations of Pharmacy Corporation of America, a former
subsidiary that was separated from the Company and merged with another company
on December 3, 1997.
See accompanying notes.
3
5
BEVERLY ENTERPRISES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1998 AND 1997
(UNAUDITED)
(IN THOUSANDS)
1998 1997
---------- ----------
Cash flows from operating activities:
Net income ........................................................................... $ 39,586 $ 39,433
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization .................................................... 46,245 54,806
Provision for reserves on patient, notes and other receivables, net .............. 9,495 19,818
Amortization of deferred financing costs ......................................... 1,207 1,336
Gains on dispositions of facilities and other assets, net ........................ (15,160) (20,842)
Deferred taxes ................................................................... 9,509 6,632
Net increase (decrease) in insurance related accounts ............................ (19,959) 383
Changes in operating assets and liabilities, net of acquisitions and dispositions:
Accounts receivable - patient ............................................... (46,992) (33,960)
Operating supplies .......................................................... (391) (2,036)
Prepaid expenses and other receivables ...................................... 1,690 (727)
Accounts payable and other accrued expenses ................................. 16,599 829
Income taxes payable ........................................................ (3,539) (4,309)
Other, net .................................................................. 302 154
--------- ---------
Total adjustments ......................................................... (994) 22,084
--------- ---------
Net cash provided by operating activities ................................. 38,592 61,517
Cash flows from investing activities:
Payments for acquisitions, net of cash acquired .................................. (127,632) (45,373)
Capital expenditures ............................................................. (63,539) (70,317)
Proceeds from dispositions of facilities and other assets, net ................... 67,274 143,409
Collections on notes receivable and REMIC investment ............................. 764 18,441
Other, net ....................................................................... (11,793) (3,263)
--------- ---------
Net cash provided by (used for) investing activities ................. (134,926) 42,897
Cash flows from financing activities:
Revolver borrowings .............................................................. 571,000 772,000
Repayments of Revolver borrowings ................................................ (476,000) (838,000)
Proceeds from issuance of long-term obligations .................................. ___ 3,534
Repayments of long-term obligations .............................................. (16,286) (28,242)
Purchase of common stock for treasury ............................................ (49,263) (14,736)
Proceeds from exercise of stock options .......................................... 2,977 2,546
Deferred financing costs ......................................................... (582) (354)
Proceeds from designated funds, net .............................................. 731 833
--------- ---------
Net cash provided by (used for) financing activities ........................ 32,577 (102,419)
--------- ---------
Net increase (decrease) in cash and cash equivalents ........................................ (63,757) 1,995
Cash and cash equivalents at beginning of period ............................................ 105,230 69,761
--------- ---------
Cash and cash equivalents at end of period .................................................. $ 41,473 $ 71,756
========= =========
Supplemental schedule of cash flow information: Cash paid during the period
for:
Interest (net of amounts capitalized) ................................................ $ 31,464 $ 42,637
Income taxes (net of refunds) ........................................................ 15,346 23,966
See accompanying notes
4
6
BEVERLY ENTERPRISES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
(i) The condensed consolidated financial statements included herein have
been prepared by the Company, without audit, and include all adjustments of a
normal recurring nature which are, in the opinion of management, necessary for a
fair presentation of the results of operations for the three-month and six-month
periods ended June 30, 1998 and 1997 pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations, although the Company believes that the
disclosures in these condensed consolidated financial statements are adequate to
make the information presented not misleading. These condensed consolidated
financial statements should be read in conjunction with the Company's
consolidated financial statements and the notes thereto included in the
Company's 1997 Annual Report on Form 10-K filed with the Securities and Exchange
Commission. The results of operations for the three-month and six-month periods
ended June 30, 1998 are not necessarily indicative of the results for a full
year. Unless the context indicates otherwise, the Company means Beverly
Enterprises, Inc. and its consolidated subsidiaries.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts 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. Actual results could differ from those estimates.
In 1997, the Company adopted Statement of Financial Accounting Standards
No. 128, "Earnings per Share," ("SFAS No. 128"). SFAS No. 128 replaced the
calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is similar to the previously reported
fully diluted earnings per share. Earnings per share amounts for all periods
have been presented, and where appropriate, restated to conform with the
requirements of SFAS No. 128.
The following table sets forth the computation of basic and diluted
earnings per share for the three-month and six-month periods ended June 30 (in
thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
1998 1997 1998 1997
-------- -------- -------- --------
NUMERATOR:
Numerator for basic earnings per share - income
available to common stockholders .................. $ 21,545 $ 20,970 $ 39,586 $ 39,433
Effect of dilutive securities:
5 1/2% convertible subordinated debentures,
net of income taxes ............................... -- 1,238 -- 2,476
-------- -------- -------- --------
Numerator for diluted earnings per share - income
available to common stockholders after assumed
conversions ....................................... $ 21,545 $ 22,208 $ 39,586 $ 41,909
======== ======== ======== ========
DENOMINATOR:
Denominator for basic earnings per share - weighted
average shares .................................... 103,682 97,736 104,838 97,939
Effect of dilutive securities:
Employee stock options ............................ 1,430 1,004 1,451 997
5 1/2% convertible subordinated debentures ........ -- 11,253 -- 11,253
-------- -------- -------- --------
Dilutive potential common shares .................... 1,430 12,257 1,451 12,250
-------- -------- -------- --------
Denominator for diluted earnings per share - adjusted
weighted average shares and assumed conversions ... 105,112 109,993 106,289 110,189
======== ======== ======== ========
Basic earnings per share .............................. $ 0.21 $ 0.21 $ 0.38 $ 0.40
======== ======== ======== ========
Diluted earnings per share ............................ $ 0.20 $ 0.20 $ 0.37 $ 0.38
======== ======== ======== ========
5
7
BEVERLY ENTERPRISES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income," ("SFAS
No. 130") which requires the presentation of comprehensive income in a company's
financial statement disclosures. Comprehensive income represents all changes in
the equity of a company during the reporting period, including net income, as
well as charges and credits directly to retained earnings which are excluded
from net income. The components of comprehensive income, net of income taxes,
consist of the following for the three-month and six-month periods ended June 30
(in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ---------------------
1998 1997 1998 1997
-------- -------- -------- --------
Net income ............................ $ 21,545 $ 20,970 $ 39,586 $ 39,433
Unrealized gains (losses) on securities (269) ___ 177 ___
-------- -------- -------- --------
Comprehensive income .................. $ 21,276 $ 20,970 $ 39,763 $ 39,433
======== ======== ======== ========
Accumulated other comprehensive income, net of income taxes, is made up of
unrealized gains on securities of $1,509,000 and $1,332,000 at June 30, 1998 and
December 31, 1997, respectively.
In March 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," ("SOP 98-1") which is required to be adopted in financial
statements for periods beginning after December 15, 1998. SOP 98-1 provides
guidance on accounting for the costs of computer software developed or obtained
for internal use. The Company will adopt SOP 98-1 in its consolidated financial
statements by the first quarter of 1999. The Company has not completed its
review of SOP 98-1 but does not expect there to be a material effect on its
consolidated financial position or results of operations.
In April 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities," ("SOP 98-5") which is required
to be adopted in financial statements for periods beginning after December 15,
1998. SOP 98-5 provides guidance on the financial reporting of start-up costs
and organization costs. It requires costs of start-up activities and
organization costs to be expensed as incurred. Initial application of SOP 98-5
will require the Company to report all previously capitalized start-up costs and
organization costs as a cumulative effect of a change in accounting principle.
The Company will adopt SOP 98-5 in its consolidated financial statements by the
first quarter of 1999 and does not expect the cumulative effect adjustment to
exceed $10,000,000.
Certain prior year amounts have been reclassified to conform with the 1998
presentation.
(ii) The provisions for income taxes for the three-month and six-month
periods ended June 30, 1998 and 1997 were based on estimated annual effective
tax rates of 35% and 40%, respectively. The Company's estimated annual effective
tax rate decreased to 35% in 1998 primarily due to the impact of the sale of
American Transitional Hospitals, Inc. (see Note iii) and the benefit of certain
tax credits. The Company's estimated annual effective tax rate in 1997 was
different than the federal statutory rate primarily due to the impact of state
income taxes and amortization of nondeductible goodwill. The provisions for
income taxes consist of the following for the three-month and six-month periods
ended June 30 (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
1998 1997 1998 1997
---------- -------- -------- --------
Federal:
Current $ 5,276 $ 10,009 $ 9,337 $ 15,307
Deferred 2,877 2,075 7,825 6,915
State:
Current 1,392 3,079 2,470 4,350
Deferred 713 (1,183) 1,684 (283)
-------- -------- -------- --------
$ 10,258 $ 13,980 $ 21,316 $ 26,289
======== ======== ======== ========
(iii) During the six months ended June 30, 1998, the Company purchased 57
outpatient clinics, 47 home health centers, eight nursing facilities (823 beds),
one assisted living center (48 units), one previously leased nursing facility
(120 beds) and certain other assets for approximately $62,900,000 cash,
approximately $1,700,000 acquired debt and approximately $2,800,000 closing and
other costs. Also, during such period, the Company sold three nursing facilities
(270 beds) and certain other assets for cash proceeds of approximately
$2,300,000, assumed debt of approximately $4,600,000 and closing and other costs
of approximately $2,300,000. The Company recognized net pre-tax losses during
the six months ended June 30, 1998 of approximately $3,000,000 as a result of
these dispositions. The operations of these facilities and certain other assets
were immaterial to the Company's consolidated financial position and results of
operations.
6
8
BEVERLY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
In June 1998, the Company completed the sale of its American Transitional
Hospitals ("ATH") subsidiary to Select Medical Corporation for cash of
approximately $65,300,000 and assumed debt of approximately $2,400,000. ATH
operates 15 transitional hospitals (893 beds) in eight states which address the
needs of patients requiring intense therapy regimens, but not necessarily the
breadth of services provided within traditional acute care hospitals. The
Company recognized net pre-tax gains of approximately $18,200,000 as a result of
this disposition. The operations of ATH were immaterial to the Company's
consolidated financial position and results of operations.
In July 1998, the Company completed the acquisition of Theraphysics Corp
("Theraphysics"), a privately-owned specialty managed care organization for cash
of approximately $67,900,000; assumed debt of approximately $2,800,000; and
closing and other costs of approximately $3,400,000. Theraphysics operates 38
outpatient rehabilitation facilities in four states and designs healthcare and
workers compensation solutions for employers, health maintenance organizations,
insurers, physicians and hospitals through a base of owned rehabilitation
practices and a network of affiliated providers. The operations of Theraphysics
are immaterial to the Company's consolidated financial position and results of
operations.
(iv) In June 1996, the Company announced that its Board of Directors had
authorized a stock repurchase program whereby the Company may repurchase, from
time to time on the open market, up to a total of 10,000,000 shares of its
outstanding Common Stock. In December 1997, the Company repurchased 4,000,000
shares of its Common Stock through an accelerated stock repurchase transaction
at a cost of approximately $56,100,000 (approximately $5,700,000 of which was
paid during 1998). In April 1998, through a similar transaction, the Company
repurchased 3,000,000 shares at a cost of approximately $43,700,000. The
repurchases were financed primarily through borrowings under the Company's
Revolver/Letter of Credit Facility. Since June 1996, the Company has repurchased
approximately 9,300,000 shares of its outstanding Common Stock under the stock
repurchase program. On June 2, 1998, the Company announced that its Board of
Directors had authorized an increase in its stock repurchase program. The
Company may repurchase from time to time on the open market, up to an additional
10,000,000 shares of its outstanding Common Stock. The Company is subject to
certain restrictions under its credit arrangements related to the repurchase
of its outstanding Common Stock.
(v) On March 4, 1998, a jury in California returned a verdict of $95,100,000
against a nursing facility operated by a subsidiary of the Company. The verdict,
which was based on findings of fraud as well as negligence and abuse, consisted
of $365,580 in compensatory damages and $94,700,000 in punitive damages. At a
post-trial hearing on June 3, 1998, the trial judge reduced the compensatory
damages to $125,000 and reduced the punitive damages to $3,000,000. The Company
believes that these reduced damages are excessive, and it intends to
aggressively pursue all appellate remedies available to it.
On July 23, 1998, the Company announced that it is the subject of a federal
government investigation relating to the allocation to the Medicare program of
certain nursing labor costs in its skilled nursing facilities from 1990 to 1997.
The federal government has not disclosed the origin of this investigation or its
intended scope. The investigation is being conducted by the Office of Inspector
General of the Department of Health and Human Services and by the Department of
Justice. The Company has received subpoenas and has provided substantial
information voluntarily. The Company has been informed that its independent
auditors, Ernst & Young LLP, also received a subpoena relating to its evaluation
of the Company's internal controls. The Company has also been notified by
its current Medicare fiscal intermediary, Blue Cross of California, that it
intends to examine cost reports of the Company's facilities with respect to the
areas that are the focus of the government investigation.
7
9
BEVERLY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
Skilled nursing facilities are required to allocate labor costs to
Medicare-certified units on an equitable basis. The Company has relied on a
variety of internal and external processes and practices that are designed to
ensure compliance with this requirement. The Company believes that its
cost-reporting policies and procedures are consistent with government
regulations and reflect industry norms for determination of these cost
allocations. However, a determination that the Company has violated these
regulations could have a material adverse effect on the Company's consolidated
financial position and results of operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - General".
There are various other lawsuits and regulatory actions pending against the
Company arising in the normal course of business, some of which seek punitive
damages that are generally not covered by insurance. The Company does not
believe that the ultimate resolution of these matters will have a material
adverse effect on the Company's consolidated financial position or results of
operations.
8
10
BEVERLY ENTERPRISES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
JUNE 30, 1998
(UNAUDITED)
GENERAL
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, and other information provided by the
Company from time to time, contains certain "forward-looking" statements as that
term is defined by the Private Securities Litigation Reform Act of 1995. All
statements regarding the Company's expected future financial position, results
of operations, cash flows, continued performance improvements, ability to
service its debt obligations, finance growth opportunities, respond to changes
in government regulations, and similar statements including, without limitation,
those containing words such as "believes," "anticipates," "expects," "intends,"
"estimates," "plans," and other similar expressions are forward-looking
statements. Forward-looking statements involve known and unknown risks and
uncertainties that may cause the Company's actual results in future periods to
differ materially from those projected or contemplated in the forward-looking
statements as a result of, but not limited to, the following factors: national
and local economic conditions; the effect of government regulation and changes
in regulations governing the healthcare industry, including the Company's
compliance with such regulations; changes in Medicare and Medicaid payment
levels; liabilities and other claims asserted against the Company, including the
outcome of the federal government investigation (see below); the ability to
attract and retain qualified personnel; the availability and terms of capital to
fund acquisitions; the competitive environment in which the Company operates;
demographic changes; the ability of the Company and its significant vendors,
suppliers and payors to timely locate and correct all relevant computer codes
and identify and remediate date-sensitive embedded chips prior to the year 2000;
and the availability and cost of labor and materials. Given these risks and
uncertainties, the Company can give no assurances that these forward-looking
statements will, in fact, transpire and, therefore, cautions investors not to
place undue reliance on them.
FEDERAL GOVERNMENT INVESTIGATION
On July 23, 1998, the Company announced that it is the subject of a federal
government investigation relating to the allocation to the Medicare program of
certain nursing labor costs in its skilled nursing facilities from 1990 to 1997.
The federal government has not disclosed the origin of this investigation or its
intended scope. The investigation is being conducted by the Office of Inspector
General of the Department of Health and Human Services and by the Department of
Justice. The Company has received subpoenas and has provided substantial
information voluntarily. The Company has been informed that its independent
auditors, Ernst & Young LLP, also received a subpoena relating to its evaluation
of the Company's internal controls. The Company has also been notified by its
current Medicare fiscal intermediary, Blue Cross of California, that it intends
to examine cost reports of the Company's facilities with respect to the areas
that are the focus of the government investigation.
Skilled nursing facilities are required to allocate labor costs to
Medicare-certified units on an equitable basis. The Company has relied on a
variety of internal and external processes and practices that are designed to
ensure compliance with this requirement. The Company believes that its
cost-reporting policies and procedures are consistent with government
regulations and reflect industry norms for determination of these cost
allocations. However, a determination that the Company has violated these
regulations could have a material adverse effect on the Company's consolidated
financial position and results of operations.
It is too early to predict the outcome or effect that the ongoing
investigation, and related media coverage, could have on the Company's
consolidated financial position or results of operations. If the Company were
found to be in violation of federal or state laws relating to Medicare,
Medicaid or similar programs, the Company could be subject to substantial
monetary fines, civil and criminal penalties and exclusion from participation
in the Medicare and Medicaid programs. Any such finding could have a material
adverse effect on the Company's consolidated financial position and results of
operations.
GOVERNMENTAL REGULATION AND REIMBURSEMENT
Healthcare system reform and concerns over rising Medicare and Medicaid costs
continue to be high priorities for both the federal and state governments. In
August 1997, the President signed into law the Balanced Budget Act of 1997 (the
"1997 Act") in which Congress included numerous program changes directed at
balancing the federal budget. The legislation changes Medicare and Medicaid
policy in a number of ways, including: (i) development of new Medicare and
Medicaid health plan options; (ii) creation of additional safeguards against
healthcare fraud and abuse; (iii) repeal of the Medicaid "Boren Amendment"
payment standard; (iv) a 10% reduction in Part B therapy costs for the period
from January 1, 1998 through July 1, 1998, at which time reimbursement for these
services will be based on fee schedules established by the Health Care Financing
Administration ("HCFA") of the Department of Health and Human Services ("HHS");
(v) the phase in of a Medicare prospective payment system ("PPS") for skilled
nursing facilities effective July 1, 1998 (which will be in effect for the
Company in January 1999); and (vi) establishment of limitations on Part B
therapy charges per beneficiary per year. The legislation includes new
opportunities for providers to focus further on patient outcomes by creating
alternative patient delivery structures. At this time, the Company has not been
able to fully assess the impact of these changes, due in part to uncertainty as
to the details of implementation and interpretation of the legislation by HCFA
and, therefore, no assurances can be made as to the ultimate impact of this
legislation or future healthcare reform legislation on the Company's
consolidated financial position, results of operations, or cash flows. However,
future federal budget legislation and federal and state regulatory changes may
negatively impact the Company.
PPS will be in effect for the Company on January 1, 1999 and will
significantly change the manner in which its skilled nursing facilities are paid
for inpatient services provided to Medicare beneficiaries. PPS will be phased
in over a three year period. In year one (1999 for the Company), Medicare PPS
rates will be based 75% on 1995 facility-specific Medicare costs (as adjusted
for inflation) and 25% will be federally-determined based upon the acuity level
of Medicare patients served in the Company's skilled nursing facilities. In
year two, Medicare PPS rates will be based 50% on 1995 facility-specific costs
and 50% on the federally-determined acuity-adjusted rate. In year three,
Medicare PPS rates will be based 25% on 1995 facility-specific costs and 75% on
the federally-determined acuity-adjusted rate. In year four, Medicare PPS
rates will be based on the federally-determined acuity-adjusted rate.
The Company is currently analyzing its 1995 facility-specific costs, as well
as the current acuity level of Medicare patients in its skilled nursing
facilities, to estimate the impact of PPS on the Company's 1999 net operating
revenues. In addition, the Company is identifying the significant changes in
its facility-specific costs since 1995 to determine the major reasons for such
changes. Based on such analyses, the Company will develop facility-specific
plans to deliver care to Medicare patients at a lower cost and in a manner
consistent with PPS requirements. The Company has not yet finalized its
facility-specific plans. However, such plans may result in material changes in
staffing in the Company's skilled nursing facilities, primarily in the area of
rehabilitation services. The Company is also analyzing whether other cost
reductions can be achieved in its skilled nursing facilities. If the Company is
unable to execute facility-specific plans to reduce the cost of care to Medicare
patients, PPS could have a material adverse effect on the Company's consolidated
financial position and results of operations.
PPS also imposes significant documentation requirements on skilled nursing
facilities to demonstrate the acuity level of Medicare patients and other
factors which will directly impact billing and payment rates to the Company, as
well as compliance with PPS rules and regulations. The Company is implementing
new and enhanced information systems to help ensure compliance with PPS.
Company-wide training on PPS, and other 1997 Act provisions, is also in
progress. As a result of these and other preparations, the Company believes it
will be positioned to operate effectively under PPS by January 1, 1999.
During the second quarter of 1998, final rules were issued by HCFA which
established guidelines for maximum reimbursement to skilled nursing facilities
for contracted speech and occupational therapy services based on equivalent
salary amounts for on-staff therapists. In addition, these rules revised the
salary equivalency rules previously in effect for physical and respiratory
therapy services. The Company has not experienced, and does not expect the new
rules to have, a material adverse effect on its consolidated results of
operations or cash flows because of the following: (i) the Company currently
provides the majority of its therapy services through on-staff therapists; and
(ii) the salary equivalency guidelines cease to apply to skilled nursing
facilities once the 1997 Act provisions for PPS become effective.
9
11
BEVERLY ENTERPRISES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
The Company believes that its facilities are in substantial compliance with
currently applicable Medicaid and Medicare conditions of participation. In the
ordinary course of its business, however, the Company receives notices of
deficiencies for failure to comply with various regulatory requirements. The
Company reviews such notices and takes appropriate corrective action. In most
cases, the Company and the reviewing agency will agree upon the steps to be
taken to bring the facility into compliance with regulatory requirements. In
some cases or upon repeat violations, the reviewing agency may take a number of
adverse actions against a facility. These adverse actions can include the
imposition of fines, temporary suspension of admission of new patients to the
facility, decertification from participation in the Medicaid or Medicare
programs and, in extreme circumstances, revocation of a facility's license.
The Social Security Act and regulations of HHS provide for exclusion of
providers and related persons from participation in the Medicare and Medicaid
programs if they have been convicted of a criminal offense related to the
delivery of an item or service under either of these programs or if they have
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. Furthermore, individuals or entities and their affiliates may
be excluded from the Medicare and Medicaid programs under certain circumstances
including conviction relating to fraud, license revocation or suspension, or
failure to furnish services of adequate quality.
The "fraud and abuse" anti-kickback provisions of the Social Security Act
(presently codified in Section 1128B(b) of the Social Security Act, hereinafter
the "Antifraud Amendments") make it a criminal felony offense to knowingly and
willfully offer, pay, solicit or receive remuneration in order to induce
business for which reimbursement is provided under government health programs,
including Medicare and Medicaid. The Antifraud Amendments have been broadly
interpreted to make remuneration of any kind, including many types of business
and financial arrangements among providers, potentially illegal if any purpose
of the remuneration or financial arrangement is to induce a referral.
Accordingly, joint ventures, space and equipment rentals, management and
personal services contracts, and certain investment arrangements among providers
may be suspect.
In 1991, HHS promulgated regulations which describe certain arrangements that
would not be subject to enforcement action under the Social Security Act (the
"Safe Harbors"). The Safe Harbors described in the regulations are narrow,
leaving unprotected a wide range of economic relationships that many hospitals,
physicians and other healthcare providers consider to be legitimate business
arrangements not prohibited by the Antifraud Amendments. The regulations do not
purport to describe comprehensively all lawful relationships between healthcare
providers and referral sources, and clearly provide that arrangements that do
not qualify for Safe Harbor protection are not automatically deemed to violate
the Antifraud Amendments. Thus, skilled nursing facilities and other healthcare
providers having arrangements or relationships that do not fall within a Safe
Harbor may not be required to alter them in order to ensure compliance with the
Social Security Act provisions. Although failure to qualify for a Safe Harbor
may subject a particular arrangement or relationship to increased regulatory
scrutiny, the fact that a particular relationship or arrangement does not fall
within one of the Safe Harbors does not in and of itself mean the relationship
or arrangement is unlawful. In 1993, HHS published proposed regulations for
comment in the Federal Register establishing additional Safe Harbors.
Additionally, in 1994, HHS published a proposed rule aimed at clarifying the
existing Safe Harbors. As of July 1, 1998, these regulations had not been
adopted in final form. The Company cannot predict the final form that these
regulations and rules will take or their effect, if any, on the Company's
business.
In addition to the Antifraud Amendments, Section 1877 of the Social Security
Act (known as the "Stark Law") imposes restrictions on financial relationships
between physicians and certain entities. The Stark Law provides that if a
physician (or an immediate family member of a physician) has a financial
relationship with an entity that furnishes certain designated health services,
the physician may not refer a Medicare or Medicaid patient to the entity, and
the entity may not bill for services provided unless an exception to the
financial relationship exists. Designated health services include certain
10
12
BEVERLY ENTERPRISES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
services furnished by the Company, such as physical therapy, occupational
therapy, prescription drugs and home health. The types of financial
relationships that can trigger the referral and billing prohibitions are broad
and include ownership or investment interests, as well as compensation
arrangements. Penalties for violating the law are severe, including denial of
payment for services furnished pursuant to prohibited referrals, civil monetary
penalties of $15,000 for each item claimed, assessments equal to 200% of the
dollar value of each such service provided, and exclusion from the Medicare and
Medicaid programs.
On August 14, 1995, final regulations were published interpreting the
original provisions of the Stark Law that became effective January 1, 1992.
These provisions relate to entities that furnish clinical laboratory services,
commonly referred to as "Stark I." Expanded restrictions as applied to the
additional designated health services (referred to as "Stark II") became
effective as of January 1, 1995. Proposed regulations implementing Stark II were
published on January 9, 1998. The Company cannot predict the final form that
such regulations will take or the effect that Stark II or the regulations
promulgated thereunder will have on the Company.
Many states in which the Company operates also have laws that prohibit
payments to physicians for patient referrals with statutory language similar to
the Antifraud Amendments, but with broader effect since they apply regardless of
the source of payment for care. These statutes typically provide criminal and
civil penalties, as well as loss of licensure. Many states also have passed
legislation similar to Stark, but with broader effect, since the legislation
applies regardless of the source of payment for care. The scope of these state
laws is broad and little precedent exists for their interpretation or
enforcement.
On August 21, 1996, President Clinton signed significant new federal health
reform legislation known as the Health Insurance Portability and Accountability
Act of 1996 ("HIPAA"). The new law includes comprehensive and far-reaching
revisions or supplements to the Antifraud Amendments. Under HIPAA, healthcare
fraud, now defined as knowingly and willfully executing or attempting to execute
a "scheme or device" to defraud any healthcare benefit program, is made a
federal criminal offense. In addition, for the first time, federal enforcement
officials will have the ability to exclude from Medicare and Medicaid any
investors, officers and managing employees associated with business entities
that have committed healthcare fraud, even if the investor, officer or employee
had no actual knowledge of the fraud. HIPAA also establishes a new violation for
the payment of inducements to Medicare or Medicaid beneficiaries in order to
influence those beneficiaries to order or receive services from a particular
provider or practitioner. Most of the provisions of HIPAA became effective
January 1, 1997. HIPAA was followed by the 1997 Act. The 1997 Act also contained
a significant number of new fraud and abuse provisions. For example, civil
monetary penalties ("CMP") may now be imposed for violations of the
anti-kickback provisions of the Medicare and Medicaid statute (previously,
exclusion or criminal prosecution were the only actions under the anti-kickback
statute), as well as contracting with an individual or entity that the provider
knows or should know is excluded from a federal healthcare program. The 1997 Act
provides for a CMP of $50,000 and damages of not more than three times the
amount of remuneration in the prohibited activity.
In 1976, Congress established the Office of Inspector General ("OIG") at HHS
to identify and eliminate fraud, abuse and waste in HHS programs and to promote
efficiency and economy in HHS departmental operations. The OIG carries out this
mission through a nationwide program of audits, investigations and inspections.
In order to provide guidance to healthcare providers on ways to engage in
legitimate business practices and avoid scrutiny under the fraud and abuse
statutes, the OIG has from time to time issued "fraud alerts" identifying
segments of the healthcare industry and particular practices that are
particularly vulnerable to abuse. The OIG has issued three fraud alerts
targeting the skilled nursing industry: an August 1995 alert relating to the
provision of medical supplies to nursing facilities, the fraudulent billing for
medical supplies and equipment and fraudulent supplier transactions; a May 1996
alert focusing on the provision of fraudulent professional services to nursing
facility residents; and a March 1998 alert addressing the interrelationship
between hospice services and the nursing home industry, and potentially illegal
practices and arrangements. The fraud
11
13
BEVERLY ENTERPRISES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
alerts encourage persons having information about potentially abusive practices
or transactions to report such information to the OIG.
In addition to laws addressing referral relationships, several federal laws
impose criminal and civil sanctions for fraudulent and abusive billing
practices. The federal False Claims Act imposes sanctions, consisting of
monetary penalties of up to $10,000 for each claim and treble damages, on
entities and persons who knowingly present or cause to be presented a false or
fraudulent claim for payment to the United States. Section 1128B(a) of the
Social Security Act prohibits the knowingly and willful making of a false
statement or representation of a material fact in relation to the submission of
a claim for payment under government health programs (including the Medicare and
Medicaid programs). Violations of this provision constitute felony offenses
punishable by fines and imprisonment. The new HIPAA provisions establish
criminal penalties for fraud, theft, embezzlement, and the making of false
statements in relation to healthcare benefits programs (which includes private,
as well as government programs).
A joint federal/state initiative, Operation Restore Trust, was created in
1995 to apply to nursing homes, home health agencies, and suppliers of medical
equipment to these providers in the five states of New York, Florida,
California, Illinois and Texas. The program was subsequently expanded to
hospices in these states as well. The program is designed to focus audit and law
enforcement efforts on geographic areas and provider types receiving large
concentrations of Medicare and Medicaid funds. According to HHS statistics, the
targeted states account for nearly 40% of all Medicare and Medicaid
beneficiaries. Under Operation Restore Trust, the OIG and HCFA have undertaken a
variety of activities to address fraud and abuse by nursing homes, home health
providers and medical equipment suppliers. These activities will include
financial audits, creation of a Fraud and Waste Report Hotline, and increased
investigations and enforcement activity.
On May 20, 1997, HHS announced that Operation Restore Trust will be expanded
during the next two years to include twelve additional states (Arizona,
Colorado, Georgia, Louisiana, Massachusetts, Missouri, New Jersey, Ohio,
Pennsylvania, Tennessee, Virginia and Washington), as well as several other
types of healthcare services. Over the longer term, it is anticipated that
Operation Restore Trust investigative techniques will be used in all 50 states,
and will be applied throughout the Medicare and Medicaid programs.
In addition to increasing the resources devoted to investigating allegations
of fraud and abuse in the Medicare and Medicaid programs, federal and state
regulatory and law enforcement authorities are taking an increasingly strict
view of the requirements imposed on healthcare providers by the Social Security
Act and Medicare and Medicaid regulations. Although the Company believes that it
is in material compliance with such laws, a determination that the Company has
violated such laws, or even the public announcement that the Company was being
investigated concerning possible violations, could have a material adverse
effect on the Company.
The Company's future operating performance will continue to be affected by
the issues facing the long-term healthcare industry as a whole, including the
maintenance of occupancy, its ability to continue to expand higher margin
businesses, the availability of nursing, therapy and other personnel, the
adequacy of funding of governmental reimbursement programs, the demand for
nursing home care and the nature of any healthcare reform measures that may be
taken by the federal government, as discussed above, as well as by any state
governments. The Company's ability to control costs, including its wages and
related expenses which continue to rise and represent the largest component of
the Company's operating and administrative expenses, will also significantly
impact its future operating results.
IMPACT OF THE YEAR 2000 ISSUE
The year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time-sensitive software may recognize a date using
12
14
BEVERLY ENTERPRISES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
"00" as the year 1900 rather than the year 2000. This could result in system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
Based on an ongoing assessment, the Company has determined that it will be
required to modify or replace significant portions of its hardware and software
so that its computer systems will function properly with respect to dates in the
year 2000 and thereafter. The Company presently believes that with modifications
to existing hardware and software and conversions to new hardware and software,
the year 2000 issue will not pose significant operational problems for its
computer systems. However, if such modifications and conversions are not made,
or are not completed timely, the year 2000 issue could have a material impact on
the operations of the Company.
The Company has initiated formal communications with all of its significant
suppliers, payors and large customers to determine the extent to which the
Company's systems and operations are vulnerable to those third parties' failure
to remediate their own year 2000 issues. Examples of such issues include, but
are not limited to, electronic interfaces with external agents such as payors,
suppliers and banks, as well as internal operational issues such as
date-sensitive security systems and elevators, in addition to patient service
equipment that has microprocessors with date functionality. There can be no
assurance that the systems of other companies, as well as those of the federal
and state governments, on which the Company's systems and operations rely, will
be timely converted and will not have an adverse effect on the Company's systems
or ongoing operations.
The Company will utilize both internal and external resources to reprogram,
or replace, and test the hardware and software for year 2000 modifications. The
Company anticipates completing its reprogramming phase of the year 2000 project
by December 31, 1998 and will continue with the testing phase during 1999. Since
assessments of the year 2000 issue currently remain ongoing, the Company has not
yet been able to fully quantify the costs of its year 2000 remediation.
The Company will continue to assess each of its operations and their year
2000 readiness. At this time, the Company believes that appropriate actions are
being taken and expects to complete its overall year 2000 remediation prior to
any anticipated impact on its operations. However, there can be no assurance
that these assumptions will be achieved, and actual results could differ
materially from those anticipated. Specific factors that might cause such
material differences include, but are not limited to, the availability and cost
of personnel trained in this area, the ability to locate and correct all
relevant computer codes, third party modification plans and similar
uncertainties.
OPERATING RESULTS
SECOND QUARTER 1998 COMPARED TO SECOND QUARTER 1997
Operating results for 1997 included the operations of Pharmacy Corporation of
America ("PCA"), a former subsidiary that was separated from the Company and
merged with another company on December 3, 1997. Net income was $21,545,000 for
the second quarter of 1998, as compared to net income of $20,970,000 for the
same period in 1997. Income before provision for income taxes was $31,803,000
for the second quarter of 1998, as compared to $34,950,000 for the same period
in 1997. The Company had an estimated annual effective tax rate of 35% and 40%
in 1998 and 1997, respectively. The Company's estimated annual effective tax
rate decreased to 35% in 1998 primarily due to the impact of the sale of
American Transitional Hospitals, Inc. ("ATH") and the benefit of certain tax
credits. The Company's estimated annual effective tax rate in 1997 was different
than the federal statutory rate primarily due to the impact of state income
taxes and amortization of nondeductible goodwill.
Net operating revenues and operating and administrative costs decreased
approximately $102,100,000 and $89,900,000, respectively, for the second quarter
of 1998, as compared to the same period in 1997. These decreases consist of the
following: decreases in net operating revenues and operating and administrative
costs of approximately $123,300,000 and
13
15
BEVERLY ENTERPRISES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
$108,500,000, respectively, due to the operations of PCA; and decreases in net
operating revenues and operating and administrative costs of approximately
$32,000,000 and $27,900,000, respectively, due to the disposition of, or lease
terminations on, three nursing facilities in 1998 and 68 nursing facilities in
1997; partially offset by increases in net operating revenues and operating and
administrative costs of approximately $16,400,000 and $13,500,000, respectively,
for facilities which the Company operated during each of the quarters ended June
30, 1998 and 1997 ("same facility operations"); and increases in net operating
revenues and operating and administrative costs of approximately $36,800,000 and
$33,000,000, respectively, due to the acquisitions of nursing facilities and
outpatient, home health and hospice businesses during 1998 and 1997.
The increase in net operating revenues for same facility operations for the
second quarter of 1998, as compared to the same period in 1997, was due to the
following: approximately $25,700,000 due to increases in room and board rates;
partially offset by approximately $5,100,000 due to a decrease in same facility
occupancy to 89.0% for the second quarter of 1998, as compared to 89.7% for the
same period in 1997; and approximately $4,200,000 due primarily to a decrease in
ancillary revenues as a result of hiring therapists on staff as opposed to
contracting for their services.
The increase in operating and administrative costs for same facility
operations for the second quarter of 1998, as compared to the same period in
1997, was due to the following: approximately $16,100,000 due to increased wages
and related expenses principally due to higher wages and greater benefits
required to attract and retain qualified personnel and the hiring of therapists
on staff as opposed to contracting for their services; approximately
$3,700,000 due to increases in nursing supplies and other variable costs;
approximately $2,300,000 due primarily to increases in purchased ancillary
products; and approximately $300,000 due to various other items. These increases
in operating and administrative costs were partially offset by approximately
$8,900,000 due to a decrease in contracted therapy expenses as a result of
hiring therapists on staff as opposed to contracting for their services.
Interest expense decreased approximately $5,400,000 as compared to the same
period in 1997 primarily due to the conversion of the Company's 5 1/2%
convertible subordinated debentures to Common Stock in the third quarter of
1997, as well as the repayments of the Company's 7 5/8% convertible subordinated
debentures, the 8 3/4% Notes and certain other notes and mortgages during the
fourth quarter of 1997 with the proceeds from the PCA transaction. The decrease
in depreciation and amortization expense of approximately $4,600,000 as compared
to the same period in 1997 was affected by the following: approximately
$5,100,000 decrease related to the operations of PCA and approximately
$1,300,000 decrease due to the dispositions of, or lease terminations on,
certain nursing facilities; partially offset by an increase of approximately
$1,800,000 primarily due to acquisitions, as well as capital additions and
improvements.
SIX MONTHS 1998 COMPARED TO SIX MONTHS 1997
Net income was $39,586,000 for the six months ended June 30, 1998, as
compared to net income of $39,433,000 for the same period in 1997. Income before
provision for income taxes was $60,902,000 for the six months ended June 30,
1998, as compared to $65,722,000 for the same period in 1997.
14
16
BEVERLY ENTERPRISES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
Net operating revenues and operating and administrative costs decreased
approximately $224,400,000 and $199,900,000, respectively, for the six months
ended June 30, 1998, as compared to the same period in 1997. These decreases
consist of the following: decreases in net operating revenues and operating and
administrative costs of approximately $245,700,000 and $212,300,000,
respectively, due to the operations of PCA; and decreases in net operating
revenues and operating and administrative costs of approximately $80,400,000 and
$74,700,000, respectively, due to the disposition of, or lease terminations on,
three nursing facilities in 1998 and 68 nursing facilities in 1997; partially
offset by increases in net operating revenues and operating and administrative
costs of approximately $41,400,000 and $33,500,000, respectively, for facilities
which the Company operated during each of the six months ended June 30, 1998 and
1997 ("same facility operations"); and increases in net operating revenues and
operating and administrative costs of approximately $60,300,000 and $53,600,000,
respectively, due to the acquisitions of nursing facilities and outpatient, home
health and hospice businesses during 1998 and 1997.
The increase in net operating revenues for same facility operations for the
six months ended June 30, 1998, as compared to the same period in 1997, was due
to the following: approximately $54,300,000 due to increases in room and board
rates; partially offset by approximately $8,300,000 due to a decrease in same
facility occupancy to 89.2% for the six months ended June 30, 1998, as compared
to 89.8% for the same period in 1997; approximately $2,800,000 due to a decrease
in ancillary revenues as a result of hiring therapists on staff as opposed to
contracting for their services; and approximately $1,800,000 due to various
other items.
The increase in operating and administrative costs for same facility
operations for the six months ended June 30, 1998, as compared to the same
period in 1997, was due to the following: approximately $33,200,000 due to
increased wages and related expenses principally due to higher wages and greater
benefits required to attract and retain qualified personnel and the hiring of
therapists on staff as opposed to contracting for their services; approximately
$6,100,000 due to increases in nursing supplies and other variable costs;
approximately $6,000,000 due primarily to increases in purchased ancillary
products; and approximately $2,200,000 due to various other items. These
increases in operating and administrative costs were partially offset by
approximately $14,000,000 due to a decrease in contracted therapy expenses as a
result of hiring therapists on staff as opposed to contracting for their
services.
Interest expense decreased approximately $12,600,000 as compared to the same
period in 1997 primarily due to the conversion of the Company's 5 1/2%
convertible subordinated debentures to Common Stock in the third quarter of
1997, as well as the repayments of the Company's 7 5/8% convertible subordinated
debentures, the 8 3/4% Notes and certain other notes and mortgages during the
fourth quarter of 1997 with the proceeds from the PCA transaction. The decrease
in depreciation and amortization expense of approximately $8,600,000 as compared
to the same period in 1997 was affected by the following: approximately
$9,900,000 decrease related to the operations of PCA and approximately
$3,600,000 decrease due to the dispositions of, or lease terminations on,
certain nursing facilities; partially offset by an increase of approximately
$4,900,000 primarily due to capital additions and improvements, as well as
acquisitions.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," ("SOP 98-1") which is required to be adopted in financial
statements for periods beginning after December 15, 1998. SOP 98-1 provides
guidance on accounting for the costs of computer software developed or obtained
for internal use. The Company will adopt SOP 98-1 in its consolidated financial
statements by the first quarter of 1999. The Company has not completed its
review of SOP 98-1 but does not expect there to be a material effect on its
consolidated financial position or results of operations.
15
17
BEVERLY ENTERPRISES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
In April 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities," ("SOP 98-5") which is required
to be adopted in financial statements for periods beginning after December 15,
1998. SOP 98-5 provides guidance on the financial reporting of start-up costs
and organization costs. It requires costs of start-up activities and
organization costs to be expensed as incurred. Initial application of SOP 98-5
will require the Company to report all previously capitalized start-up costs and
organization costs as a cumulative effect of a change in accounting principle.
The Company will adopt SOP 98-5 in its consolidated financial statements by the
first quarter of 1999 and does not expect the cumulative effect adjustment to
exceed $10,000,000.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1998, the Company had approximately $41,500,000 in cash and cash
equivalents and net working capital of approximately $233,500,000. The Company
had approximately $249,700,000 of unused commitments under its Revolver/Letter
of Credit Facility as of June 30, 1998.
Net cash provided by operating activities for the six months ended June 30,
1998 was approximately $38,600,000. Net cash used for investing activities and
net cash provided by financing activities were approximately $134,900,000 and
$32,600,000, respectively, for the six months ended June 30, 1998. The Company
received net cash proceeds of approximately $67,300,000 from the dispositions of
facilities and other assets. Such net cash proceeds, along with cash generated
from operations, net borrowings under its Revolver/Letter of Credit Facility and
cash on hand, were used to fund acquisitions of approximately $127,600,000, to
fund capital expenditures totaling approximately $63,500,000, to repay
approximately $16,300,000 of long-term obligations and to repurchase shares of
Common Stock.
In June 1996, the Company announced that its Board of Directors had
authorized a stock repurchase program whereby the Company may repurchase, from
time to time on the open market, up to a total of 10,000,000 shares of its
outstanding Common Stock. In December 1997, the Company repurchased 4,000,000
shares of its Common Stock through an accelerated stock repurchase transaction
at a cost of approximately $56,100,000 (approximately $5,700,000 of which was
paid during 1998). In April 1998, through a similar transaction, the Company
repurchased 3,000,000 shares at a cost of approximately $43,700,000. The
repurchases were financed primarily through borrowings under the Company's
Revolver/Letter of Credit Facility. Since June 1996, the Company has repurchased
approximately 9,300,000 shares of its outstanding Common Stock under the stock
repurchase program. On June 2, 1998, the Company announced that its Board of
Directors had authorized an increase in its stock repurchase program. The
Company may repurchase from time to time on the open market, up to an additional
10,000,000 shares of its outstanding Common Stock. The Company is subject to
certain restrictions under its credit arrangements related to the repurchase of
its outstanding Common Stock.
In July 1998, the Company completed the acquisition of Theraphysics Corp
("Theraphysics"), a privately-owned specialty managed care organization for cash
of approximately $67,900,000; assumed debt of approximately $2,800,00; and
closing and other costs of approximately $3,400,000. Theraphysics operates 38
outpatient rehabilitation facilities in four states and designs healthcare and
workers compensation solutions for employers, health maintenance organizations,
insurers, physicians and hospitals through a base of owned rehabilitation
practices and a network of affiliated providers. The operations of Theraphysics
are immaterial to the Company's consolidated financial position and results of
operations.
The Company believes that its existing cash and cash equivalents, working
capital from operations, borrowings under its banking arrangements, issuance of
certain debt securities and refinancings of certain existing indebtedness will
be adequate to repay its debts due within one year of approximately $29,300,000,
to make normal recurring capital additions and improvements of approximately
$102,000,000, to make selective acquisitions, including the purchase of
previously leased facilities, to construct new facilities, and to meet working
capital requirements for the twelve months ending June 30, 1999.
Any potential settlement of the federal government investigation could result
in a substantial additional liability for the Company. The timing and amount of
such ultimate liability cannot, at this time, be reasonably estimated; however,
it is possible that the ultimate resolution of this investigation could have a
material adverse effect on the Company's consolidated financial position,
results of operations and cash flows.
As of June 30, 1998, the Company had total indebtedness of approximately
$790,700,000 and total stockholders' equity of approximately $854,300,000. The
ability of the Company to satisfy its long-term obligations will be dependent
upon its future performance, which will be subject to prevailing economic
conditions and to financial, business and other factors beyond the Company's
control, such as federal and state healthcare reform. In addition, healthcare
service providers, such as the Company, operate in an industry that is currently
subject to significant changes from business combinations, new strategic
alliances, legislative reform, increased regulatory oversight, aggressive
marketing practices by competitors and market pressures. In this environment,
the Company is frequently contacted by, and otherwise engages in discussions
with, other healthcare companies and financial advisors regarding possible
strategic alliances, joint ventures, business combinations and other financial
alternatives. The terms of substantially all of the Company's debt instruments
require
16
18
BEVERLY ENTERPRISES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
the Company to repay or refinance indebtedness under such debt instruments in
the event of a change of control. There can be no assurance that the Company
will have the financial resources to repay such indebtedness upon a change of
control. See "--General."
17
19
PART II
BEVERLY ENTERPRISES, INC.
OTHER INFORMATION
JUNE 30, 1998
(UNAUDITED)
ITEM 1. LEGAL PROCEEDINGS
On March 4, 1998, a jury in California returned a verdict of $95,100,000
against a nursing facility operated by a subsidiary of the Company. The verdict,
which was based on findings of fraud as well as negligence and abuse, consisted
of $365,580 in compensatory damages and $94,700,000 in punitive damages. At a
post-trial hearing on June 3, 1998, the trial judge reduced the compensatory
damages to $125,000 and reduced the punitive damages to $3,000,000. The Company
believes that these reduced damages are excessive, and it intends to
aggressively pursue all appellate remedies available to it.
On July 23, 1998, the Company announced that it is the subject of a federal
government investigation relating to the allocation to the Medicare program of
certain nursing labor costs in its skilled nursing facilities from 1990 to 1997.
The federal government has not disclosed the origin of this investigation or its
intended scope. The investigation is being conducted by the Office of Inspector
General of the Department of Health and Human Services and by the Department of
Justice. The Company has received subpoenas and has provided substantial
information voluntarily. The Company has been informed that its independent
auditors, Ernst & Young LLP, also received a subpoena relating to its evaluation
of the Company's internal controls. The Company has also been notified by its
current Medicare fiscal intermediary, Blue Cross of California, that it intends
to examine cost reports of the Company's facilities with respect to the areas
that are the focus of the government investigation.
Skilled nursing facilities are required to allocate labor costs to
Medicare-certified units on an equitable basis. The Company has relied on a
variety of internal and external processes and practices that are designed to
ensure compliance with this requirement. The Company believes that its
cost-reporting policies and procedures are consistent with government
regulations and reflect industry norms for determination of these cost
allocations. However, a determination that the Company has violated these
regulations could have a material adverse effect on the Company's consolidated
financial position and results of operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- General."
There are various other lawsuits and regulatory actions pending against the
Company arising in the normal course of business, some of which seek punitive
damages that are generally not covered by insurance. The Company does not
believe that the ultimate resolution of these matters will have a material
adverse effect on the Company's consolidated financial position or results of
operations.
18
20
BEVERLY ENTERPRISES, INC.
OTHER INFORMATION (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 28, 1998, the Company held its Annual Meeting of Stockholders in Fort
Smith, Arkansas, for the purposes of electing nine members of the Board of
Directors, approving the Beverly Enterprises, Inc. Annual Incentive Plan,
ratifying the appointment of Ernst & Young LLP as independent auditors for 1998
and transacting such other business as may have properly come before the meeting
or any adjournment thereof.
The following table sets forth the directors elected at such meeting and the
number of votes cast for and withheld for each director:
DIRECTOR FOR WITHHELD
-------- ---------- ---------
Beryl F. Anthony, Jr................................ 94,246,238 270,809
David R. Banks...................................... 94,122,291 394,756
Carolyne K. Davis, R.N., Ph. D...................... 94,245,745 271,302
James R. Greene..................................... 94,252,853 264,194
Boyd W. Hendrickson................................. 94,279,073 237,974
Edith E. Holiday.................................... 94,279,543 237,504
Jon E. M. Jacoby.................................... 94,244,302 272,745
Risa J. Lavizzo-Mourey, M.D......................... 94,280,179 236,868
Marilyn R. Seymann.................................. 94,280,625 236,422
The Beverly Enterprises, Inc. Annual Incentive Plan was approved at the
meeting. The following table sets forth the number of votes for and against, as
well as abstentions as to this matter:
For.................................. 91,443,745
Against.............................. 2,876,511
Abstentions.......................... 196,791
The appointment of Ernst & Young LLP as independent auditors for 1998 was
ratified at the meeting. The following table sets forth the number of votes for
and against, as well as abstentions as to this matter:
For ................................... 94,369,384
Against................................ 69,375
Abstentions............................ 66,091
ITEM 6(a). EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
27.1 Financial Data Schedule for the six months ended June 30, 1998
27.2 Restated Financial Data Schedule for the six months ended June 30,
1997
ITEM 6(b). REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the quarter ended
June 30, 1998.
19
21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
BEVERLY ENTERPRISES, INC.
Registrant
Dated: August 14, 1998 By: /s/ PAMELA H. DANIELS
----------------------
Pamela H. Daniels
Vice President, Controller and
Chief Accounting Officer
20
22
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- ------------
27.1 Financial Data Schedule for the six months ended June 30, 1998
27.2 Restated Financial Data Schedule for the six months ended June 30,
1997
21