-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PZpR2sR+Ri49sxM+bGBLueUD2Jdj3KYKIvyFifhbmtFNrBHN7Mpx8Ular5YaZh1d 7wbH11Dhj+1ngG5WYsC+Gw== 0000950144-01-505883.txt : 20010815 0000950144-01-505883.hdr.sgml : 20010815 ACCESSION NUMBER: 0000950144-01-505883 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20010630 FILED AS OF DATE: 20010814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MARINER POST ACUTE NETWORK INC CENTRAL INDEX KEY: 0000882287 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SKILLED NURSING CARE FACILITIES [8051] IRS NUMBER: 742012902 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-10968 FILM NUMBER: 1711624 BUSINESS ADDRESS: STREET 1: ONE RAVINA DR STE 1500 STREET 2: STE 800 CITY: ATLANTA STATE: GA ZIP: 30346 BUSINESS PHONE: 6784437000 MAIL ADDRESS: STREET 1: ONE RAVINA DRIVE SUITE 1500 STREET 2: SUITE 800 CITY: ATLANTA STATE: GA ZIP: 30346 FORMER COMPANY: FORMER CONFORMED NAME: LIVING CENTERS OF AMERICA INC DATE OF NAME CHANGE: 19930328 FORMER COMPANY: FORMER CONFORMED NAME: PARAGON HEALTH NETWORK INC DATE OF NAME CHANGE: 19971104 10-Q 1 g71154e10-q.txt MARINER POST-ACUTE NETWORK, INC. 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NO. 1-10968 MARINER POST-ACUTE NETWORK, INC. (Exact Name of Registrant as Specified in its Charter) DELAWARE 74-2012902 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) ONE RAVINIA DRIVE, SUITE 1500 30346 ATLANTA, GEORGIA (Zip Code) (Address of Principal Executive Offices) (678) 443-7000 (Registrant's Telephone Number, Including Area Code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] There were 73,688,379 shares of Common Stock of the registrant issued and outstanding as of August 6, 2001. Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ] N/A [X] (The registrant and its subsidiaries have made filings under chapter 11 of the Bankruptcy Code and are currently in the process of preparing a plan of reorganization. A plan of reorganization for a subsidiary of the registrant, Mariner Health Group, Inc. ("Mariner Health"), and its direct and indirect subsidiaries (collectively, the "Mariner Health Debtors") has been filed by the Mariner Health Debtors' senior secured lenders. The Company has not filed any plan of reorganization for Mariner Health and no plan of reorganization has been filed for the registrant or any subsidiary other than the plan filed by the Mariner Health Debtors' senior secured lenders.) 2 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES FORM 10-Q JUNE 30, 2001 TABLE OF CONTENTS
PAGE ---- PART I - FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements 1 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 23 Item 3. Quantitative and Qualitative Disclosure About Market Risk 41 PART II - OTHER INFORMATION Item 1. Legal Proceedings 42 Item 2. Changes in Securities and Use of Proceeds 43 Item 3. Defaults Upon Certain Securities 43 Item 4. Submission of Matters to a Vote of Security Holders 43 Item 5. Other Information 43 Item 6. Exhibits and Reports on Form 8-K 43 SIGNATURE PAGE 45
3 PART 1 FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION AS OF JANUARY 18, 2000) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands, except per share amounts) (unaudited)
THREE MONTHS NINE MONTHS ENDED JUNE 30, ENDED JUNE 30, -------------------------- ------------------------------- 2001 2000 2001 2000 --------- --------- ----------- ----------- Net revenues $ 524,532 $ 532,534 $ 1,569,457 $ 1,611,254 Costs and expenses: Salaries, wages and benefits 294,594 303,945 892,117 916,823 Nursing, dietary and other supplies 30,559 31,901 91,849 96,749 Ancillary services 57,901 55,538 172,776 186,125 General and administrative 53,492 58,524 155,064 184,259 Insurance 34,432 27,309 90,927 84,570 Rent 15,245 22,837 52,706 69,112 Depreciation and amortization 14,045 18,638 40,033 44,275 Provision for bad debts 7,251 14,842 24,415 29,937 --------- --------- ----------- ----------- Total costs and expenses 507,519 533,534 1,519,887 1,611,850 --------- --------- ----------- ----------- Operating income (loss) 17,013 (1,000) 49,570 (596) Other income (expenses): Interest expense (contractual interest for the three and nine months ended June 30, 2001 was $51,433 and $163,473, respectively and for the three and nine months ended June 30, 2000 was $62,118 and $179,202, respectively) (849) (873) (4,108) (68,089) Interest and dividend income 180 3,152 3,053 10,354 Reorganization items (21,222) 8,053 (29,911) (4,384) Other (41) (729) (437) (952) --------- --------- ----------- ----------- Net income (loss) $ (4,919) $ 8,603 $ 18,167 $ (63,667) ========= ========= =========== =========== Net income (loss) per share - basic and diluted $ (0.07) $ 0.12 $ 0.25 $ (0.86) ========= ========= =========== ===========
The accompanying notes are an integral part of these financial statements 1 4 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION AS OF JANUARY 18, 2000) CONDENSED CONSOLIDATED BALANCE SHEETS (dollars in thousands, except share amounts)
JUNE 30, SEPTEMBER 30, 2001 2000 ------------- ------------- (unaudited) ASSETS Current assets: Cash and cash equivalents $ 201,592 $ 170,468 Receivables, net of allowance for doubtful accounts of $72,572 and $68,691 306,892 282,200 Inventories 22,139 20,670 Prepaid and other current assets 48,264 52,635 -------------- -------------- Total current assets 578,887 525,973 Property and equipment, net of accumulated depreciation of $377,735 and $360,055 431,578 452,413 Goodwill, net of accumulated amortization of $32,328 and $24,035 208,094 217,381 Restricted investments 33,710 35,671 Other assets, net 33,636 19,363 -------------- -------------- $ 1,285,905 $ 1,250,801 ============== ============== LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities: Accounts payable $ 60,749 $ 67,810 Accrued compensation and benefits 81,109 88,340 Accrued insurance obligations 23,661 12,905 Other current liabilities 34,527 47,440 -------------- -------------- Total current liabilities 200,046 216,495 Liabilities subject to compromise 2,368,271 2,371,213 Long-term debt, net -- -- Long-term insurance reserves 104,150 68,987 Other liabilities 34,199 34,283 -------------- -------------- Total liabilities 2,706,666 2,690,978 Commitments and contingencies Stockholders' deficit: Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued -- -- Common stock, $.01 par value; 500,000,000 shares authorized; 73,688,379 shares issued 737 737 Capital surplus 980,952 980,952 Accumulated deficit (2,402,211) (2,420,378) Accumulated other comprehensive loss (239) (1,488) -------------- -------------- Total stockholders' deficit (1,420,761) (1,440,177) -------------- -------------- $ 1,285,905 $ 1,250,801 ============== ==============
The accompanying notes are an integral part of these financial statements. 2 5 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION AS OF JANUARY 18, 2000) CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands) (unaudited)
NINE MONTHS ENDED JUNE 30, ------------------------------ 2001 2000 -------------- -------------- Cash flows from operating activities: Net income (loss) $ 18,167 $ (63,667) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 40,033 44,275 Interest accretion on discounted debt -- 13,178 Equity earnings/minority interest 437 952 Reorganization items 29,911 4,384 Provision for bad debts 24,415 29,937 Gain on disposal of assets -- (1,397) Changes in operating assets and liabilities: Receivables (53,021) (41,007) Inventories (1,968) 1,991 Prepaid and other current assets 11,800 (9,911) Accounts payable 4,277 12,845 Accrued liabilities and other current liabilities (12,580) 98,048 Changes in long-term insurance reserves 35,163 (11,943) Other (118) (1,430) -------------- -------------- Net cash provided by operating activities before reorganization items 96,516 76,255 Payment of reorganization items, net (33,476) (15,989) -------------- -------------- Net cash provided by operating activities 63,040 60,266 Cash flows from investing activities: Purchases of property and equipment (22,878) (23,033) Proceeds from sale of property, equipment and other assets 7,722 8,594 Restricted investments 1,908 22,154 Other 883 421 -------------- -------------- Net cash (used in) provided by investing activities (12,365) 8,136 Cash flows from financing activities: Repayment of prepetition long-term debt (19,551) (2,696) Other -- (627) -------------- -------------- Net cash used in financing activities (19,551) (3,323) -------------- -------------- Increase in cash and cash equivalents 31,124 65,079 Cash and cash equivalents, beginning of period 170,468 71,817 -------------- -------------- Cash and cash equivalents, end of period $ 201,592 $ 136,896 ============== ==============
The accompanying notes are an integral part of these financial statements . 3 6 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) NOTE 1 - NATURE OF BUSINESS REPORTING ENTITY Mariner Post-Acute Network, Inc. through its subsidiaries (collectively, the "Company") provides post-acute health care services, primarily through the operation of skilled-nursing facilities. At June 30, 2001, the Company's significant operations consisted of (i) approximately 340 nursing home and assisted living facilities containing approximately 40,000 beds; (ii) approximately 32 institutional pharmacies servicing more than 1,000 long-term care centers; and (iii) 13 long-term acute care hospitals with approximately 620 licensed beds. The Company operates in 25 states with significant concentrations of facilities and beds in five states and several metropolitan markets. PETITIONS FOR REORGANIZATION UNDER CHAPTER 11 On January 18, 2000 (the "Petition Date"), the Company and substantially all of its subsidiaries ("the Company Debtors"), including Mariner Health Group, Inc. ("Mariner Health") and its subsidiaries (the "Mariner Health Subsidiaries" and collectively with Mariner Health, the "Mariner Health Debtors"), filed voluntary petitions (collectively, the "Chapter 11 Filings") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court") under chapter 11 title 11 of the United States Code (the "Bankruptcy Code"). The Company is presently operating its business as a debtor-in-possession and is subject to the jurisdiction of the Bankruptcy Court while a plan of reorganization is formulated. Neither the Company nor Mariner Health has filed a plan of reorganization. On June 12, 2001, the agents for the Mariner Health Debtors' senior secured lenders under Mariner Health's prepetition senior credit facility (the "MHG Principal Secured Lenders") filed with the Bankruptcy Court a plan of reorganization for Mariner Health which has since been amended (including amendments thereto, "the MHG Bank Groups' Plan") and a proposed disclosure statement for the MHG Bank Groups' Plan; the adequacy of the disclosure statement was subsequently approved by the Bankruptcy Court at a hearing held on August 7, 2001, subject to various amendments in response to objections thereto (see Note 3). The Company's need to seek relief afforded by the Bankruptcy Code is due, in part, to the significant financial pressure created by the implementation of the Balanced Budget Act of 1997. NOTE 2 - BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and disclosures normally included in the financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the financial information included herein reflects all adjustments considered necessary for a fair presentation of interim results, and, except for the costs described in Note 3, all such adjustments are of a normal and recurring nature. Operating results for interim periods are not necessarily indicative of the results that may be expected for the entire year. The accompanying unaudited condensed consolidated financial statements have been prepared on a going concern basis which assumes continuity of operations and realization of assets and settlement of liabilities and commitments in the ordinary course of business. The financial statements do not include any adjustments reflecting the possible future effects on the recoverability and classification of assets or the amount and classification of liabilities that may result from the outcome of uncertainties discussed herein. The accompanying unaudited condensed consolidated financial statements have also been presented in conformity with the American Institute of Certified Public Accountants Statement of Position 90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7"). The statement requires a segregation of liabilities subject to compromise by the Bankruptcy Court as of the Petition Date and identification of all transactions and events that are directly associated with the reorganization of the Company. Pursuant to SOP 90-7, prepetition liabilities are reported on the basis of the expected amounts of such allowed claims, 4 7 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) as opposed to the amounts for which those claims may be settled. Under a confirmed final plan of reorganization, those claims may be settled at amounts substantially less than their allowed amounts. The Company's reorganization proceedings raise substantial doubt about the Company's ability to continue as a going concern. The ability of the Company to continue as a going concern and the appropriateness of using the going concern basis of accounting is dependent upon, among other things, the ability to comply with the terms of the DIP Financings (as defined herein), confirmation of a plan of reorganization, success of future operations after such confirmation and the ability to generate sufficient cash from operations and financing sources to meet obligations. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended September 30, 2000 included in the Company's Annual Report filed with the Securities and Exchange Commission on Form 10-K. NET REVENUES Net revenues are recorded based upon estimated amounts due from patients and third party payors for healthcare services provided, including anticipated settlements under reimbursement agreements with Medicare, Medicaid and other third party payors. A summary of approximate net revenues by payor type is as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, -------------------------------------------------------------- 2001 2000 2001 2000 -------------- -------------- -------------- -------------- Medicaid $ 248,479 $ 265,694 $ 763,146 $ 803,062 Medicare 153,957 132,958 433,166 395,899 Private and other 122,096 133,882 373,145 412,293 -------------- -------------- -------------- -------------- $ 524,532 $ 532,534 $ 1,569,457 $ 1,611,254 ============== ============== ============== ==============
RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. Gains or losses from changes in fair value would be recognized in earnings in the period of change unless the derivative is designated as a hedging instrument. In June 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 137, which amended SFAS 133, delaying its effective date to fiscal years beginning after June 15, 2000. The Company does not currently hold any derivative instruments nor does it engage in hedging activities. The Company adopted this accounting standard as required effective October 1, 2000 and it did not have a material impact on its consolidated financial position or results of operations. In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141"), which is effective for all business combinations completed after June 30, 2001. SFAS No. 141 eliminates the pooling-of-interests method of accounting for business combinations except for qualifying business combinations initiated prior to July 1, 2001. In addition, SFAS No. 141 further clarifies the criteria to recognize intangible assets separately from goodwill. The Company does not expect there to be a material impact on its consolidated financial position, results of operations, or cash flows as a result of adopting this accounting standard. 5 8 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), which establishes new rules on the accounting for goodwill and other intangible assets. Under SFAS No. 142, goodwill and intangible assets with indefinite lives will no longer be amortized; however, they will be subject to annual impairment tests as prescribed by the Statement. Intangible assets with definite lives will continue to be amortized over their estimated useful lives. The amortization provisions of SFAS No. 142 apply immediately to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, companies are required to adopt SFAS No. 142 in their fiscal year beginning after December 15, 2001. SFAS No. 142 will be effective for the Company beginning October 1, 2002. At that time, the Company will perform the required impairment tests on our goodwill and those intangibles deemed to have indefinite lives. Until the Company and Mariner Health file a plan of reorganization that is confirmed by the Bankruptcy Court, the Company cannot currently estimate the impact these impairment tests will have on its consolidated financial position or result of operations. RECLASSIFICATIONS Certain prior period amounts have been reclassified to conform with the current period presentation. NOTE 3 - PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE EVENTS LEADING TO BANKRUPTCY During fiscal year 1999, the Company and Mariner Health experienced significant losses, resulting in certain financial covenant violations under the Company's various loan agreements. In addition, the Company and Mariner Health did not make any scheduled interest and principal payments due subsequent to September 30, 1999 which resulted in an event of default under their respective loan agreements. The inability of the Company and Mariner Health to service or restructure their respective debt and other obligations culminated in the Chapter 11 Filings on January 18, 2000. Except as may be otherwise determined by the Bankruptcy Court overseeing the Chapter 11 Filings, the automatic stay protection afforded by the Chapter 11 Filings generally prevents any action from being taken by creditors with regard to any defaults under the prepetition obligations of the Company and those of its subsidiaries which are debtors in the Chapter 11 Filings. REORGANIZATION As noted previously, on January 18, 2000, the Company, Mariner Health and substantially all of their respective subsidiaries filed voluntary petitions for relief under the Bankruptcy Code. The Company is presently operating its business as a debtor-in-possession and is subject to the jurisdiction of the Bankruptcy Court while a plan of reorganization is formulated. Neither the Company nor Mariner Health has filed a plan of reorganization. As discussed below, certain creditors of Mariner Health have filed a plan of reorganization for Mariner Health. As a debtor-in-possession, the Company is authorized to operate its business but may not engage in transactions outside its ordinary course of business without the approval of the Bankruptcy Court (the "Chapter 11 Proceedings"). While the Chapter 11 Filings constituted a default under the Company's, Mariner Health's and their respective subsidiaries' various financing arrangements, section 362 of the Bankruptcy Code imposes an automatic stay that generally precludes any creditors and other interested parties under such arrangements from taking any remedial action in response to any such default outside of the Chapter 11 Proceedings without obtaining relief from the automatic stay from the Bankruptcy Court. In addition, under the Bankruptcy Code the Company may assume or reject executory contracts and unexpired leases. Parties affected by these rejections may file claims with the Bankruptcy Court in accordance with the reorganization process. The Company is actively engaged in the process of reviewing its executory contracts and unexpired leases and, while some contracts and leases have been assumed or rejected, final decisions with respect to assuming or rejecting most contracts and leases, and the approval of the Bankruptcy Court of the proposed action, are still pending. 6 9 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) In connection with the Chapter 11 Filings, the Company obtained a commitment for $100.0 million in debtor-in-possession ("DIP") financing (the "Company DIP Financing") from a group of banks led by The Chase Manhattan Bank ("Chase"). Mariner Health also obtained a commitment for $50.0 million in DIP financing (the "Mariner Health DIP Financing"; together with the Company DIP Financing, the "DIP Financings") from a group of banks led by PNC Bank, National Association ("PNC"). The commitment under the Company DIP Financing has been reduced to $50.0 million. The commitment under the Mariner Health DIP Financing has been reduced to $25.0 million. (See Note 5). On January 19, 2000, the Company received approval from the Bankruptcy Court to pay prepetition and postpetition employee wages, salaries, benefits and other employee obligations. The Bankruptcy Court also approved orders granting authority, among other things, to pay prepetition claims of certain critical vendors, utilities and patient obligations. All other prepetition liabilities at June 30, 2001 and September 30, 2000 are classified in the condensed consolidated balance sheets as liabilities subject to compromise. The Company has been and intends to continue to pay bona fide postpetition claims of all vendors and providers in the ordinary course of business. The Company and Mariner Health intend to develop a plan or separate plans of reorganization through negotiations with their respective key creditor constituencies including their respective senior bank lenders and official unsecured creditors committees (as used herein, a plan for the Company developed by the Company is the "Company Plan of Reorganization," a plan for Mariner Health developed by Mariner Health is the "Mariner Plan of Reorganization," and collectively, any such plans are the "Plans of Reorganization"). As noted previously, on June 12, 2001, the agents for the MHG Principal Secured Lenders filed with the Bankruptcy Court a plan of reorganization for Mariner Health. The MHG Bank Groups' Plan provides for, among other things, (i) elimination of the Company's equity interest in the Mariner Health Debtors whereby the Company would receive no consideration on account of its claims against and equity interest in the Mariner Health Debtors; (ii) termination of the Company's management of the facilities owned by the Mariner Health Debtors, thus eliminating a significant source of revenue for the Company; and (iii) restructuring and/or discharging of the Mariner Health Debtors' obligation to their creditors. A substantial portion of prepetition liabilities are subject to settlement under the MHG Bank Groups' Plan and any plans of reorganization submitted respectively by the Company and Mariner Health. The adequacy of the disclosure statement filed by the MHG Principal Secured Lenders in connection with the MHG Bank Groups' Plan was approved by the Bankruptcy Court at a hearing held on August 7, 2001. Impaired classes of creditors and equity holders that are entitled to vote must still approve or reject the MHG Bank Groups' Plan once votes for the MHG Bank Groups' Plan are solicited (which solicitation will not be made prior to August 23, 2001, and may be delayed further, at the discretion of the MHG Principal Secured Lenders). The Company cannot predict whether the Bankruptcy Court will confirm the MHG Bank Groups' Plan and, if such plan is confirmed, when and whether such plan would become effective. As of August 10, 2001, neither the Company nor the Mariner Health Debtors had taken any position as to whether to support or oppose confirmation of the MHG Bank Groups' Plan. Any Plans of Reorganization that may be submitted must be: (i) voted upon by impaired classes of creditors and equity holders of the Company and Mariner Health, respectively, that are entitled to vote; and (ii) confirmed by the Bankruptcy Court. No assurance can be given regarding the timing of such Plans of Reorganization, the likelihood that such plans will be developed, or the terms on which such plans may be conditioned. In addition, there can be no assurances that the Plans of Reorganization will be approved by requisite holders of claims and equity holders and confirmed by the Bankruptcy Court, or that either or both Plans of Reorganization will be consummated. If the Company Plan of Reorganization is not accepted by the required number of impaired creditors and equity holders and the Company's exclusive right to file and solicit acceptance of a plan of reorganization ends (see Note 5), any party in interest may subsequently file its own plan of reorganization for the Company. Furthermore, a different plan of reorganization with respect to Mariner Health may be filed by another party in interest. The Bankruptcy Court may confirm a plan of reorganization notwithstanding the non-acceptance of the plan by an impaired class of creditors or equity holders if certain requirements of the Bankruptcy Code are met. 7 10 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) LIABILITIES SUBJECT TO COMPROMISE "Liabilities subject to compromise" refers to liabilities incurred prior to the Chapter 11 Filings. These liabilities, consisting primarily of long-term debt and certain accounts payable and accrued liabilities, represent the Company's estimate of known or potential prepetition claims to be resolved in connection with the Chapter 11 Filings. Such claims remain subject to future adjustments based on negotiations, actions of the Bankruptcy Court, further developments with respect to disputed claims, future rejection of executory contracts or unexpired leases, determination as to the value of any collateral securing claims, treatment under the MHG Bank Groups' Plan or the Plans of Reorganization, and other events. Payment terms for these amounts will be established in connection with the MHG Bank Groups' Plan or Plans of Reorganization. A summary of the principal categories of claims classified as liabilities subject to compromise at June 30, 2001 and September 30, 2000 are as follows (in thousands):
JUNE 30, SEPTEMBER 30, 2001 2000 -------------- ------------- (unaudited) Long-term debt $ 2,128,561 $ 2,149,420 Accounts payable 94,999 82,318 Accrued interest 85,076 85,564 Other accrued liabilities 92,609 86,885 Deferred loan costs (32,974) (32,974) -------------- ------------- $ 2,368,271 $ 2,371,213 ============== =============
Approximately $2.4 billion of liabilities subject to compromise would have been classified as current liabilities at June 30, 2001 if the Chapter 11 Filings had not been filed. In accordance with SOP 90-7, the Company has discontinued accruing interest relating to its debt facilities currently classified as liabilities subject to compromise effective January 18, 2000. Contractual interest for the three months and nine months ended June 30, 2001 was $51.4 million and $163.5 million, respectively, which is $50.6 million and $159.4 million in excess of interest expense included in the accompanying unaudited condensed consolidated financial statements for the three and nine months ended June 30, 2001. Contractual interest for the three and nine months ended June 30, 2000 was $62.1 million and $179.2 million, respectively, which is $61.2 million and $111.1 million in excess of interest expense included in the accompanying unaudited condensed consolidated financial statements for the three and nine months ended June 30, 2000, respectively. Interest expense for the three and nine months ended June 30, 2001 represents interest paid on certain capital leases and other miscellaneous indebtedness. 8 11 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) REORGANIZATION ITEMS Reorganization items consist of income, expenses and other costs directly related to the reorganization of the Company since the Chapter 11 Filings. Reorganization items included in the accompanying unaudited condensed consolidated statements of operations for the three and nine months ended June 30, 2001 and 2000 consist of the following (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------------------- ---------------------------- 2001 2000 2001 2000 --------------- --------------- ------------- -------------- Professional fees $ 13,882 $ 4,223 $ 30,881 $ 15,517 Other reorganization costs 4,304 234 9,561 1,659 Gain on settlement of prepetition accounts payable (1) (428) (40) (617) Net loss (gain) on divestitures 4,251 (10,988) (5,775) (10,988) Interest earned on accumulated cash resulting from Chapter 11 Filings (1,214) (1,094) (4,716) (1,187) -------------- -------------- -------------- -------------- $ 21,222 $ (8,053) $ 29,911 $ 4,384 ============== ============== ============== ==============
NOTE 4 - DIVESTITURES During the nine months ended June 30, 2001 and 2000, the Company completed the sale of certain inpatient nursing home facilities and other assets which resulted in a net gain on divestitures of approximately $5.8 million and $11.0 million, respectively, which is included in the accompanying unaudited condensed consolidated statements of operations as reorganization items. These divested inpatient nursing home facilities reported net revenues of approximately $44.5 million and $162.6 million for the nine months ended June 30, 2001 and 2000, respectively. The Company anticipates that in the aggregate, these divestitures will improve operating results in future periods. On July 8, 2001, affiliates of the Company completed the restructuring of their lease portfolio with Nationwide Health Properties, Inc. and its affiliates (collectively, "NHP"). Previously, affiliates of the Company had terminated their leases and transitioned operations of three facilities in Indiana to designees of NHP pursuant to an agreement between the parties which was approved by the Bankruptcy Court in June. Effective as of July 31, 2001, affiliates of the Company conveyed their interests as tenant/sublessor in a facility located in Gilroy, California to NHP and rejected their leases regarding eleven facilities located in Texas, but agreed, in connection with the rejection, to continue to operate these facilities for a limited period of time in return for a rental abatement and the payment of a management fee to the Company to enable operations of the facilities to be transitioned to NHP's designee in an orderly fashion. If no such designee is able to assume operation of the Texas facilities on a timely basis, then the Company will enter into further negotiations regarding these facilities. Concurrently, affiliates of the Company assumed their lease obligations and the Company reaffirmed its guaranties regarding four facilities in California and two facilities in Illinois, and, as a part thereof, obtained a $0.3 million rental concession with respect to one facility in Illinois and favorable covenant amendments under the assumed leases. Damages under the rejected leases in Texas were limited to existing security deposits totaling approximately $0.8 million. The parties further agreed to a mutual release of all liabilities not otherwise addressed in the relevant settlement agreement. During the three months ended June 30, 2000, the Company, through its GranCare subsidiaries leased twenty-two facilities from Senior Housing Properties Trust ("SHPT") and its wholly-owned subsidiary SPTMNR Properties Trust ("SPTMNR"), both of which succeeded to the interests of Health and Retirement Properties Trust ("HRPT") to various agreements (collectively, the "SNH Entities"). On June 30, 2000, the Company, SPTMNR and SHPT executed a settlement agreement, which was approved by the Bankruptcy Court on May 10, 2000, whereby: (a) the Company obtained fee simple ownership of five facilities of the SNH health care portfolio which the 9 12 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Company had previously leased in the past; (b) seventeen facilities leased by the Company and related personal property were assigned to affiliates of the SNH Entities; (c) a cash collateral deposit of $15 million and shares of HRPT and SPTMNR stock, with a market value of $7.2 million, were conveyed to the SNH Entities; and (d) the Company agreed to manage the seventeen facilities transferred to the SNH Entities during a transition period of approximately six months. Upon termination of the management agreement, the Company has had no further relationship with or obligations to the SNH Entities. As a result of the settlement, the Company realized a net gain of approximately $11.1 million which is included as part of the Company's net loss (gain) on divestitures in the accompanying condensed consolidated statements of operations as reorganization items. NOTE 5 - DEBT Long-term debt at June 30, 2001 and September 30, 2000 is summarized in the following table (in thousands):
JUNE 30, SEPTEMBER 30, 2001 2000 -------------- ---------------- (unaudited) Senior credit facilities: Senior Credit Facility $ 893,119 $ 905,981 Mariner Health Senior Credit Facility 233,835 233,835 Mariner Health Term Loan Facility 192,439 192,439 Subordinated debt: Senior Subordinated Notes 274,121 274,121 Senior Subordinated Discount Notes 220,071 220,071 Mariner Health Senior Subordinated Notes 103,136 103,136 Other, including capital lease obligations 211,840 219,837 -------------- -------------- 2,128,561 2,149,420 Less amounts subject to compromise (2,128,561) (2,149,420) -------------- -------------- Total long-term debt $ -- $ -- ============== ==============
PREPETITION DEBT Due to the failure to make scheduled payments, comply with certain financial covenants and the commencement of the Chapter 11 Proceedings, the Company is in default on substantially all of its prepetition debt obligations. Except as otherwise may be determined by the Bankruptcy Court, the automatic stay protection afforded by the Chapter 11 Filings generally prevents any action from being taken with regard to any of the defaults under the prepetition debt obligations. These obligations are classified in the accompanying unaudited condensed consolidated financial statements as liabilities subject to compromise at June 30, 2001 and September 30, 2000. The obligations of the Company under its senior credit facility are guaranteed by substantially all of the Company's subsidiaries other than the Omega Debtors (as defined herein), Mariner Health, and the Mariner Health Subsidiaries, and are secured by substantially all of the otherwise unencumbered owned assets of the Company and such subsidiaries. Mariner Health's obligations under its senior credit facility, which includes a revolving credit facility and term loan facility, are guaranteed by substantially all of the Mariner Health Subsidiaries and are secured by substantially all of the otherwise unencumbered assets of Mariner Health and such subsidiary guarantors. Mariner Health and the Mariner Health Subsidiaries are treated as unrestricted subsidiaries under the Company's debt facilities. Unlike other subsidiaries of the Company (the "Non-Mariner Health Subsidiaries"), Mariner Health and the Mariner Health Subsidiaries neither guarantee the Company's obligations under the Company's debt facilities nor pledge their assets to secure such obligations. Correspondingly, the Company and the Non-Mariner Health Subsidiaries do not guarantee or assume any obligations under the Mariner Health debt facilities. Mariner Health and the Mariner Health Subsidiaries 10 13 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) are not subject to the covenants contained in the Company's debt facilities, and the covenants contained in the Mariner Health debt facilities are not binding on the Company and the Non-Mariner Health Subsidiaries. No principal payments have been made on prepetition indebtedness since the Petition Date with the exception of repayments made against the Company's senior credit facility, as adequate protection payments pursuant to the Final Company DIP Order (as defined herein), primarily resulting from the application of net cash proceeds received from the sales of certain facilities and other assets, and notional amounts related to certain other indebtedness, including capital equipment leases. In addition, during July 2001, Mariner Health made a $15.0 million repayment against the Mariner Health senior credit facilities as an adequate protection payment pursuant to the amendment to the Mariner Health DIP Credit Agreement, which, among other things, extended the maturity date of the Mariner Health DIP Financing to December 31, 2001 (see "Debtor in Possession Financing for Mariner Health" below). DEBTOR-IN-POSSESSION FINANCING FOR THE COMPANY In connection with the Chapter 11 Filings, the Company entered into a $100.0 million debtor-in-possession financing agreement (as amended from time to time, the "Company DIP Credit Agreement") with a group of banks (the "Company DIP Lenders") led by Chase. On March 20, 2000 the Bankruptcy Court granted final approval (the "Final Company DIP Order,") of the Company DIP Financing. The Company DIP Credit Agreement initially established a $100.0 million secured revolving credit facility to provide funds for working capital and other lawful corporate purposes for use by the Company and the other Company Debtors. The Company DIP Credit Agreement currently provides that amounts outstanding under the Company DIP Financing may not at any time exceed the maximum borrowing amounts established for the Company under the Final Company DIP Order or the Company's borrowing base of eligible accounts receivable (the "Company Borrowing Base"). Up to $10.0 million of the Company DIP Financing may be utilized for the issuance of letters of credit as needed in the business of the Company Debtors. Interest accrues on the principal amount outstanding under the Company DIP Financing at a per annum rate of interest equal to the Alternative Base Rate ("ABR") of Chase plus three percent (3%) and is payable monthly in arrears. During the existence and continuation of a default in the payment of any amount due and payable by the Company Debtors under the Company DIP Credit Agreement, interest will accrue at the default rate of ABR plus five percent (5%) per annum. The terms of the Company DIP Financing require that the Company prepay principal to the extent that the principal amount outstanding under the Company DIP Financing at any time exceeds the Company Borrowing Base then in effect. To the extent proceeds of loans under the Company DIP Financing are used to complete the construction of certain healthcare facilities (which proceeds are not permitted to exceed $8.8 million), proceeds from the sale of any such properties must be used first to repay any portion of the loans made pursuant to the Company DIP Financing, with 75% of any remaining net cash proceeds to be applied as an adequate protection payment to the lenders under the Company's prepetition senior credit facility and the remaining 25% of such excess net cash proceeds to be retained by the Company or its applicable subsidiary as additional working capital. Pursuant to the terms of the Final Company DIP Order, 75% of the net cash proceeds of other asset sales approved by the Bankruptcy Court and the requisite Company DIP Lenders are to be applied as an adequate protection payment to the lenders under the Company's prepetition senior credit facility. The Company has the right to make optional prepayments in increments of $1.0 million, and to reduce the commitment under the Company DIP Credit Agreement in increments of $5.0 million. The obligations of the Company under the Company DIP Credit Agreement are jointly and severally guaranteed by each of the other Company Debtors, except for certain Company Debtors owning or operating facilities (the "Omega Facilities") that are mortgaged to Omega Healthcare Investors, Inc. (the "Omega Debtors") whose guarantee is limited to the negative cash flows of the Omega Debtors pursuant to the Company DIP Credit Agreement. Under the terms of the Final Company DIP Order, the obligations of the Company Debtors under the Company DIP Credit Agreement (the "Company DIP Obligations") constitute allowed super priority administrative expense claims pursuant to section 11 14 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 364(c)(1) of the Bankruptcy Code (subject to a carve out for certain professional fees and expenses incurred by the Company Debtors). The Company DIP Obligations are secured by perfected liens on all or substantially all of the assets of the Company Debtors (excluding bankruptcy causes of action), the priority of which liens (relative to prepetition creditors having valid, non avoidable, perfected liens in those assets and to any "adequate protection" liens granted by the Bankruptcy Court) is established in the Final Company DIP Order and the related cash collateral order entered by the Bankruptcy Court (the "Final Company Cash Collateral Order"). The Bankruptcy Court has also granted certain prepetition creditors of the Company Debtors replacement liens and other rights as "adequate protection" against any diminution of the value of their existing collateral that may result from allowing the Company Debtors to use cash collateral in which such creditors had valid, non-avoidable and perfected liens as of the Petition Date. The discussion contained in this paragraph is qualified in its entirety by reference to the Final Company DIP Order, the Final Company Cash Collateral Order, and related stipulations, and reference should be made to such orders (which are available from the Bankruptcy Court) and stipulations for a more complete description of such terms. The Company DIP Credit Agreement contains customary representations, warranties and other affirmative and restrictive covenants of the Company Debtors, as well as certain financial covenants relating to minimum EBITDA, maximum capital expenditures, and minimum patient census. The breach of such representations, warranties or covenants, to the extent not waived or cured within any applicable grace or cure periods, could result in the Company being unable to obtain further advances under the Company DIP Financing and possibly the exercise of remedies by the Company DIP Lenders, either of which events could materially impair the ability of the Company to successfully reorganize in chapter 11 and to operate as a going concern. Such a default may also impair the ability of the Company Debtors to use cash collateral to fund operations. At June 30, 2001, there were no outstanding borrowings under the Company DIP Credit Agreement. At June 30, 2001, there were letters of credit outstanding under the Company DIP Financing of approximately $6.0 million. The outstanding principal of the Company DIP Financing, together with all accrued and unpaid interest and all other obligations thereunder, was originally due and payable one year from the Petition Date. With the approval of the Bankruptcy Court, the Company Debtors, Chase and the requisite Company DIP Lenders amended the Company DIP Credit Agreement as of January 11, 2001, to (among other things) extend the maturity date of the Company DIP Financing from January 19, 2001 to August 31, 2001 and to provide for the modification of certain financial and other covenants (which have subsequently been modified by an amendment dated as of June 26, 2001 that further extended the maturity date of the Company DIP Financing to December 31, 2001). Effective as of January 19, 2001, the Company also exercised its right under the Company DIP Credit Agreement to reduce the $100.0 million Company DIP Financing commitment to $50.0 million. DEBTOR-IN-POSSESSION FINANCING FOR MARINER HEALTH Among the orders entered by the Bankruptcy Court in the chapter 11 cases of Mariner Health and its subsidiaries, were orders approving (a) the use of cash collateral by the Mariner Health Debtors, and (b) the funding of up to $50.0 million in principal amount at any time outstanding under a debtor-in-possession financing arrangement pursuant to that certain Debtor-in-Possession Credit Agreement dated as of January 20, 2000 (as amended from time to time, the "Mariner Health DIP Credit Agreement") by and among Mariner Health and each of the other Mariner Health Debtors, as co-borrowers thereunder, the lenders signatory thereto as lenders (the "Mariner Health DIP Lenders"), First Union National Bank, as Syndication Agent, PNC Capital Markets, Inc. and First Union Securities, Inc., as co-arrangers, and PNC, as Administrative Agent and Collateral Agent. After a final hearing on February 16, 2000 the Bankruptcy Court entered an order granting final approval of up to $50.0 million of the Mariner Health DIP Financing (the "Final Mariner Health DIP Order"). The Mariner Health DIP Credit Agreement initially established a $50.0 million secured revolving credit facility comprised of a $40.0 million tranche A revolving loan commitment and a $10.0 million tranche B revolving loan 12 15 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) commitment. Under the Mariner Health DIP Credit Agreement's current terms, advances under the Mariner Health DIP Financing may be used by the Mariner Health Debtors (and to a limited degree, by certain joint venture subsidiaries of Mariner Health that are not debtors in the Mariner Health chapter 11 cases) for working capital and other lawful corporate purposes. Amounts outstanding under the Mariner Health DIP Financing may not at any time exceed the maximum borrowing amounts established for the Mariner Health Debtors under the Final Mariner Health DIP Order. Originally, up to $5.0 million of the Mariner Health DIP Financing could be utilized for the issuance of letters of credit as needed in the businesses of the Mariner Health Debtors; however, the letter of credit sublimit was increased to $10.0 million pursuant to the Tenth Amendment to the Mariner Health DIP Credit Agreement dated as of March 20, 2001 (the "Tenth Mariner Health DIP Amendment"). Interest accrues on the principal amount outstanding under the Mariner Health DIP Financing at a per annum rate of interest equal to the "base rate" of PNC (i.e., the higher of the PNC prime rate or a rate equal to the federal funds rate plus 50 basis points) plus the applicable spread, which is 250 basis points. Such interest is due and payable monthly in arrears. During the existence and continuation of any event of default under the Mariner Health DIP Credit Agreement, the interest rates normally applicable to loans under the Mariner Health DIP Financing will be increased by another 250 basis points per annum. The outstanding principal of the Mariner Health DIP Financing, together with all accrued and unpaid interest and all other obligations thereunder, are due and payable on the Commitment Termination Date, defined as the first to occur of (i) January 19, 2001, unless extended (such date having since been extended to December 31, 2001 as discussed below); (ii) the effective date of a joint plan of reorganization for the Mariner Health Debtors; (iii) the date of termination of the exclusivity rights of the Mariner Health Debtors to file a plan of reorganization; (iv) the filing by the Mariner Health Debtors of any plan of reorganization (or the modification of any such plan previously filed with the Bankruptcy Court) not previously approved by the holders of at least 66-2/3% of the outstanding loans or commitments under the Mariner Health DIP Financing; (v) the date of termination of the commitments under the Mariner Health DIP Credit Agreement during the continuation of an event of default thereunder; or (vi) the date on which all or substantially all of the assets or stock of the Mariner Health Debtors is sold or otherwise transferred. Under the current terms of the Mariner Health DIP Credit Agreement, the Mariner Health Debtors must also prepay principal to the extent that the principal amount outstanding under the Mariner Health DIP Financing at any time exceeds the Mariner Health borrowing base then in effect. The Mariner Health borrowing base for any month is an amount equal to $7.5 million in excess of the "Working Capital Facility" borrowings projected for such month in Mariner Health's year 2000 DIP budget, plus (as a result of the Tenth Mariner Health DIP Amendment), the undrawn availability under the $7.9 million letter of credit issued by PNC pursuant to the Mariner Health DIP Credit Agreement to secure Mariner Health's obligations in respect of its replacement surety program (the "Replacement MHG Surety LOC"). The Mariner Health DIP Credit Agreement also provides for mandatory prepayments under the following circumstances: (a) with net cash proceeds from asset sales, the incurrence of certain debt, the issuance of new equity, the receipt of tax refunds exceeding $100,000 in the aggregate, and the receipt of casualty proceeds in excess of $100,000 that are not applied within 60 days after receipt to the repair, rebuilding, restoration or replacement of the assets damaged or condemned (or committed within such period of time to be so applied); and (b) on each business day, the amount of cash held by the Mariner Health Debtors in excess of the sum of $5.0 million plus the aggregate sum of the minimum amount required by depositary banks to be kept in deposit accounts, concentration accounts and other accounts with such banks. Amounts prepaid pursuant to clause (a) of the immediately preceding sentence will permanently reduce the amount of the Mariner Health DIP Financing commitments on a dollar for dollar basis. Amounts prepaid pursuant to clause (b) of the same sentence will not permanently reduce such commitments. The Mariner Health Debtors have the right to make optional prepayments in the minimum principal amount of $1.0 million, and in increments of $100,000 in excess thereof, and, on three business days' notice, to reduce the commitments under 13 16 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) the Mariner Health DIP Credit Agreement in the minimum amount of $5.0 million, or in increments of $1.0 million in excess thereof. As provided in the Final Mariner Health DIP Order, the obligations of the Mariner Health Debtors under the Mariner Health DIP Credit Agreement (together with certain potential cash management system liabilities secured on a pari passu basis therewith, the "Mariner Health DIP Obligations") constitute allowed super priority administrative expense claims pursuant to section 364(c)(1) of the Bankruptcy Code (subject to a carve-out for certain professional fees and expenses incurred by the Mariner Debtors). The Mariner Health DIP Obligations are secured by perfected liens on all or substantially all of the assets of the Mariner Health Debtors (excluding bankruptcy causes of action), the priority of which liens (relative to prepetition creditors having valid, non-avoidable, perfected liens in those assets and to any "adequate protection" liens granted by the Bankruptcy Court) is established in the Final Mariner Health DIP Order and the related cash collateral orders entered by the Bankruptcy Court (the "Mariner Health Cash Collateral Orders"). The Bankruptcy Court has also granted certain prepetition creditors of the Mariner Health Debtors replacement liens and other rights as "adequate protection" against any diminution of the value of their existing collateral that may result from allowing the Mariner Health Debtors to use cash collateral in which such creditors had valid, non-avoidable and perfected liens as of the Petition Date. The discussion contained in this paragraph is qualified in its entirety by reference to the Final Mariner Health DIP Order, the related Mariner Health Cash Collateral Orders, and related stipulations, and reference should be made to such orders (which are available from the Bankruptcy Court) and stipulations for a more complete description of such terms. The Mariner Health DIP Credit Agreement contains customary representations, warranties and other affirmative and restrictive covenants of the Mariner Health Debtors, as well as certain financial covenants relating to minimum profitability, minimum patient census, minimum eligible accounts receivable, maximum variations from Mariner Health's year 2000 DIP budget and maximum capital expenditures. The breach of such representations, warranties or covenants, to the extent not waived or cured within any applicable grace or cure periods, could result in the Mariner Health Debtors being unable to obtain further advances under the Mariner Health DIP Financing and possibly the exercise of remedies by the Mariner Health DIP Lenders, either of which events could materially impair the ability of the Mariner Health Debtors to successfully reorganize in chapter 11 and to operate as a going concern. The occurrence of an event of default under the Mariner Health DIP Credit Agreement may impair the ability of the Mariner Health Debtors to use cash collateral to fund operations. At June 30, 2001, there were no outstanding borrowings or letters of credit issued under the Mariner Health DIP Credit Agreement. During July 2001, PNC issued the Replacement MHG Surety LOC in the amount of $7.9 million. Among its other restrictive covenants, the Mariner Health DIP Credit Agreement limits affiliate transactions with the Company Debtors, but does contemplate weekly overhead payments to the Company equal to 1.25% of projected net nursing home revenues for such month, subject to a monthly "true-up," such that the payments for such month equal 5% of actual net nursing home revenues of the Mariner Health Debtors. Such payments may be suspended by the Mariner Health Debtors if certain defaults specified in the Mariner Health Credit Agreement occur and are continuing, though such fees will still accrue and will become due and payable if and when the subject default has been cured or waived. By amendment dated as of January 19, 2001, and with the approval of the Bankruptcy Court, the Mariner Health DIP Credit Agreement was amended to extend the stated termination date for the Mariner Health DIP Credit Agreement from January 19, 2001 to July 19, 2001, and to reduce the maximum amount of the Mariner Health DIP Financing from $50.0 million to $25.0 million (as a result of which the tranche B component of that credit facility was eliminated). Such amendment also, among other things, imposed a 25 basis point utilization fee on borrowings under the Mariner Health DIP Credit Agreement in excess of $5.0 million and amended certain reporting requirements. An amendment dated as of March 20, 2001, among other things, increased the letter of credit sublimit and the borrowing base to permit the issuance of the Replacement MHG Surety LOC to facilitate implementation of a replacement surety bond program by Mariner Health, which was issued during July 2001. Because the Replacement MHG Surety LOC expires well after the 14 17 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Commitment Termination Date for the Mariner Health DIP Facility, the reimbursement obligations of Mariner Health in connection with the Replacement MHG Surety LOC are secured by cash collateral equal to 105% of the stated amount of such letter of credit, all as required by the Tenth Mariner Health DIP Amendment. On or about May 14, 2001, Mariner Health and representatives of the Mariner Health DIP Lenders and the Mariner Health Principal Secured Lenders entered into a stipulation (the "May 14 Stipulation") (i) extending from May 21, 2001 to July 20, 2001, the Mariner Health Debtors' exclusive right to file a plan of reorganization, and (ii) if they file a plan within that time, extending the Mariner Health Debtor's exclusive right to solicit acceptances of such plan to September 20, 2001; however, such exclusivity rights are modified in that stipulation to permit the Mariner Health Principal Secured Lenders to file their own plan or plans of reorganization for the Mariner Health Debtors and to solicit acceptances thereto, or (at the sole option of the Mariner Health Principal Secured Lenders) to file a joint plan of reorganization with the Mariner Health Debtors and solicit acceptances thereto. The May 14 Stipulation was subsequently approved by the Bankruptcy Court. The May 14 Stipulation constituted a waiver by the Mariner Health DIP Lenders of the covenant in the Mariner Health DIP Credit Agreement that the Mariner Health Debtors file a plan of reorganization by a certain time and an agreement that the modification of the Mariner Health Debtors' exclusivity rights pursuant to that stipulation would not constitute an event of default under the Mariner Health DIP Credit Agreement. NOTE 6 - COMPREHENSIVE INCOME Comprehensive income (loss) includes net income (loss), as well as charges and credits to stockholders' equity (deficit) not included in net income (loss). The components of comprehensive income (loss), net of income taxes, consist of the following (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------------------- ------------------------------- 2001 2000 2001 2000 -------------- -------------- --------------- -------------- Net income (loss) $ (4,919) $ 8,603 $ 18,167 $ (63,667) Net unrealized gains on available-for-sale securities 1,036 4,688 1,249 4,508 -------------- -------------- --------------- --------------- Comprehensive income (loss) $ (3,883) $ 13,291 $ 19,416 $ (59,159) ============== ============== =============== ===============
Accumulated other comprehensive loss, net of income taxes, is comprised of net unrealized losses on available-for-sale securities of $0.2 million and $1.5 million at June 30, 2001 and September 30, 2000, respectively. 15 18 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) NOTE 7 - EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data) in accordance with Financial Accounting Standards No. 128, "Earnings per Share":
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------------------- --------------------------------- 2001 2000 2001 2000 --------------- --------------- --------------------------------- Numerator for basic and diluted income (loss) per share: Net income (loss) $ (4,919) $ 8,603 $ 18,167 $ (63,667) ============== ============== =============== ============== Denominator: Denominator for basic income (loss) per share 73,688 73,688 73,688 73,688 - weighted average shares Effect of dilutive securities - stock options -- -- -- -- -------------- -------------- --------------- -------------- Denominator for diluted income (loss) per share - adjusted weighted average shares and assumed conversions 73,688 73,688 73,688 73,688 ============== ============== =============== ============== Basic and diluted income (loss) per share: Net income (loss) per share $ (0.07) $ 0.12 $ 0.25 $ (0.86) ============= ============= =============== ==============
NOTE 8 - INCOME TAXES Due to the nature and composition of the Company's deferred tax assets and the changes in the Company's valuation allowance, the Company does not expect to incur income tax expense regarding the net profits generated during the current fiscal year. Additionally, the Company has not reduced its deferred asset valuation allowance any further due to the continuing uncertainty of future profitability. Consequently, the Company maintains a valuation allowance which completely offsets all net deferred tax assets generated from the Company's losses. NOTE 9 - COMMITMENTS AND CONTINGENCIES LITIGATION As is typical in the healthcare industry, the Company is and will be subject to claims that its services have resulted in resident injury or other adverse effects, the risks of which will be greater for higher acuity residents receiving services from the Company than for other long-term care residents. In addition, resident, visitor, and employee injuries will also subject the Company to the risk of litigation. The Company has experienced an increasing trend in the number and severity of litigation and claims asserted against the Company. Management believes that this trend is endemic to the long-term care industry and is a result of the increasing number of large judgments, including large punitive damage awards, against long-term care providers in recent years resulting in an increased awareness by plaintiff's lawyers of potentially large recoveries. In certain states in which the Company has significant operations, including California and Florida, insurance coverage for the risk of punitive and certain other damages arising from general and professional liability litigation is not available due to state law public policy prohibitions. There can be no assurance that the Company will not be liable for punitive or other damages awarded in litigation arising in states for which insurance coverage is not available for such damages. The Company also believes that there has been, and will continue to be, an 16 19 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) increase in governmental investigations of long-term care providers, particularly in the area of Medicare/Medicaid false claims as well as an increase in enforcement actions resulting from these investigations. While the Company believes that it provides quality care to the patients in its facilities and materially complies with all applicable regulatory requirements, given the Company's current financial difficulties, an adverse determination in a legal proceeding or governmental investigation, whether currently asserted or arising in the future, could have a material adverse effect on the Company. From time to time, the Company and its subsidiaries have been parties to various legal proceedings in the ordinary course of their respective businesses. In the opinion of management, except as described below, there are currently no proceedings which, individually, if determined adversely to the Company and after taking into account the insurance coverage maintained by the Company, would have a material adverse effect on the Company's financial position or results of operations. Although the Company believes that any of the proceedings not discussed below will not individually have a material adverse impact on the Company if determined adversely to the Company, given the Company's current financial condition and change in the Company's general liability and professional liability insurance policies, settling a large number of cases within the Company's $1 million self-insured retention limit could have a material adverse effect on the Company. On August 26, 1996, a class action complaint was asserted against GranCare, Inc. ("GranCare"), a wholly-owned subsidiary of the Company, in the Denver, Colorado District Court, Salas, et al v. GranCare, Inc. and AMS Properties, Inc. d/b/a Cedars Healthcare Center, Inc., case no. 96-CV-4449. On March 15, 1998, the Court entered an Order in which it certified a class action in the matter. On June 10, 1998, the Company filed a Motion to Dismiss all claims and Motion for Summary Judgment Precluding Recovery of Medicaid Funds and these motions were partially granted by the Court on October 30, 1998. Plaintiffs' Motion for Reconsideration was denied by the Court on November 19, 1998, the Court's decision was certified as a final judgment on December 10, 1998, and plaintiffs then filed a writ with the Colorado Supreme Court, which was denied, and an appeal with the Colorado Court of Appeal. In accordance with the Company's voluntary filing under chapter 11 of the Bankruptcy Code and more particularly, ss. 362 of that Code, this matter was stayed on January 18, 2000. However, the Company did agree to limited relief from the stay in order to allow for certain parts of the appeal to continue. The Company filed a Request for Rehearing on February 2, 2001 and on March 22, 2001, the Court denied this Request as well as the Request for Rehearing by Plaintiffs. On April 18, 2001 the Court of Appeals was notified of the applicability of the Bankruptcy Stay and the Company's reservation of its rights to take a Writ to the Colorado Supreme Court when the Stay is lifted. The Company currently believes it is unlikely for this matter to ultimately survive as a class action and given this and the current posture of the case, this matter is not in a position to be evaluated in regard to a favorable outcome or in regard to the range of potential loss. The Company will continue in its opposition to the class action and further intends to vigorously contest all remaining allegations. On March 18, 1998, a complaint was filed under seal by a former employee against the Company, certain of its predecessor entities and affiliates in the United States District Court for the Northern District of Alabama, alleging, inter alia, employment discrimination, wrongful discharge, negligent hiring, violation of the Federal False Claims Act, and retaliation under the False Claims Act. The action is titled Powell, et al. v. Paragon Health Inc., et al., civil action No. CV-98-0630-S. The complaint has been unsealed and the Company has been advised that the government has declined to intervene in this matter under the Federal False Claims Act. In accordance with the Company's voluntary filing under chapter 11 of the Bankruptcy Code and more particularly, ss. 362 of that Code, this matter was stayed on January 18, 2000. On August 25, 1998, a complaint was filed by the United States against the Company's GranCare and International X-Ray subsidiaries and certain other parties under the Civil False Claims Act and in common law and equity. The lawsuit, U.S. v. Sentry X-Ray, Ltd., et al., civil action no. 98-73722, was filed in United States District Court for the Eastern District of Michigan. Valley X-Ray operates a mobile X-Ray company in Michigan. A Company subsidiary, International X-Ray, owns a minority partnership interest in defendant Valley X- Ray. The case asserts five 17 20 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) claims for relief, including two claims for violation of the Civil False Claims Act, two alternative claims of common law fraud and unjust enrichment, and one request for application of the Federal Debt Collection Procedures Act. The two primary allegations of the complaint are that (i) the X-Ray company received Medicare overpayments for transportation costs in the amount of $657,767; and (ii) the X-Ray company "upcoded" Medicare claims for EKG services in the amount of $631,090. The United States has requested treble damages as well as civil penalties of $5,000 to $10,000 for each of the alleged 388 submitted Medicare claims. The total damages sought varies from $5.3 million to $7.2 million. As the result of a motion filed by the Company on November 23, 1998, GranCare was dismissed from the case. In accordance with the Company's voluntary filing under chapter 11 of the Bankruptcy Code and more particularly, ss. 362 of that Code, this matter was stayed on January 18, 2000. On October 1, 1998, a class action complaint was asserted against certain of the Company's predecessor entities and affiliates and certain other parties in the Tampa, Florida, Circuit Court, Ayres, et al v. Donald C. Beaver, et al, case no. 98-7233. The complaint asserted three claims for relief, including breach of fiduciary duty against one group of defendants, breach of fiduciary duty against another group of defendants, and civil conspiracy arising out of issues involving facilities previously operated by the Brian Center Corporation or one of its subsidiaries, and later by a subsidiary of Living Centers of America, Inc. ("LCA"), a wholly-owned subsidiary of the Company, as a result of the merger with Brian Center Corporation. All defendants submitted Motions to Dismiss which were heard by the Court on September 15, 1999. The Court granted Defendant Donald C. Beaver's Motion to Dismiss on December 6, 1999. In accordance with the Company's voluntary filing under chapter 11 of the Bankruptcy Code and more particularly, ss. 362 of that Code, this matter was stayed on January 18, 2000. On or about April 19, 2000 plaintiffs filed an Amending Petition seeking to bring Donald C. Beaver back into the case as a defendant. Mr. Beaver has filed a Motion to Dismiss the Amending Petition and no date for hearing has been set. In accordance with the Company's voluntary filing under chapter 11 of the Bankruptcy Code, and more particularly, ss. 362 of the Bankruptcy Code, all proceedings against the Company have been stayed. Very little discovery has been conducted and accordingly, this case is not in a position to be evaluated in regard to the probability of a favorable outcome or in regard to the range of potential loss. The Company intends to vigorously contest the request for class certification, as well as all alleged claims made. On November 16, 1998, a complaint was filed under seal by a former employee against the Company, certain of its predecessor entities and affiliates in the United States District Court for the Southern District of Texas, alleging violation of the Federal False Claims Act. The action is titled United States ex rel. Nelius, et al., v. Mariner Health Group, Inc., et al., civil action No. H-98-3851. To date, the Government has declined to intervene. The complaint which was unsealed, has been amended to add additional relators and allegations under the Federal False Claims Act. In response to the Notice of Stay submitted under 11 U.S.C. ss. 362, the District Court, on January 26, 2000, dismissed the plaintiffs' claims against defendants subject to reinstatement within thirty (30) days after the stay is discontinued. The Company intends to vigorously contest the alleged claims herein. On October 27, 1999, the Company was served with a Complaint in United States ex rel. Cindy Lee Anderson Rutledge and Partnership for Fraud Analysis and State of Florida ex rel. Cindy Lee Anderson Rutledge Group, Inc., ARA Living Centers, Inc. and Living Centers of America, Inc., No. 97-6801, filed in the United States District Court for the Eastern District of Pennsylvania. This action originally was filed under seal on November 5, 1997, by relators Cindy Lee Anderson Rutledge and the Partnership for Fraud Analysis under the Federal False Claims Act and the Florida False Claims Act. The Complaint alleges that the Company is liable under the Federal False Claims Act and the Florida False Claims Act for alleged violations of regulations pertaining to the training and certification of nurse aides at former LCA facilities. After conducting an investigation in which the Company cooperated by producing documents responsive to an administrative subpoena and allowing certain employee interviews, the United States Department of Justice elected not to intervene. The district court unsealed the Complaint on October 15, 1999. On December 14, 1999, the Company filed a motion to dismiss the relators' complaint. In accordance with the Company's voluntary filing under chapter 11 of the Bankruptcy Code and more particularly, ss. 362 of that Code, this matter was stayed on January 18, 2000. The Company intends vigorously to defend this action. 18 21 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) On approximately January 20, 2000, the OIG issued subpoenas duces tecum to the Company and Summit Medical Management (a subsidiary of the Company). The subpoenas request documents relating to the purchase of Summit Medical Management and other subsidiaries. In addition, the subpoenas request other broad categories of documents. The Company is cooperating with the investigation and has retained experienced counsel to assist in responding to the subpoenas and advise the Company with respect to this investigation. This investigation is still in its preliminary stages; therefore, the Company is unable to predict the outcome of this matter. On approximately August 31, 2000, the United States Attorney for Eastern District of Michigan issued a subpoena duces tecum to Cambridge East. The subpoena requests medical records and other broad categories of documents. The Company has produced a substantial amount of documents responsive to the subpoena. The Company is cooperating with the investigation and has retained experienced counsel to assist in responding to the subpoena and to advise the Company with respect to this investigation. This investigation is still in its preliminary stages; therefore, the Company is unable to predict the outcome of this matter. On October 5, 2000, NovaCare Holdings, Inc. ("NCH") filed a complaint (the "NCH Complaint") in the Chapter 11 Proceedings commencing Adversary Proceeding No. 00-1577 (MFW), NovaCare Holdings, Inc. v. Mariner Post-Acute Network, Inc., et al. The Company and various subsidiaries (the "defendant subsidiaries") are named as defendants in the NCH Complaint. In the NCH Complaint, NCH alleges that its predecessors in interest (hereinafter also referred to as "NCH") were party to contracts with various subsidiaries of the Company under which NCH provided services to patients at various facilities of such subsidiaries. It further alleges that pursuant to these contracts, NCH provided certain services for which it was paid, but with respect to which the Health Care Financing Administration ("HCFA") (which subsequently was renamed the Centers for Medicare and Medicaid Services, or "CMS") disallowed the facilities' claims for reimbursement (the "NCH HCFA Disallowances"). After the NCH HCFA Disallowances, NCH allegedly provided credits to the facilities equal to the amount of the NCH HCFA Disallowances. Appeals of the NCH HCFA Disallowances were filed, and NCH alleges that it holds a constructive trust or equitable lien on any amounts which may be recovered from HCFA as a result of such appeals. In the alternative, NCH alleges that it holds an administrative priority claim for any such amounts that are paid by HCFA and not turned over to NCH. The aggregate amount of the credits that are related to the NCH HCFA Disallowances and with respect to which NCH asserts a constructive trust, an equitable lien, and/or an administrative priority claim is $8,163,930. In addition, NCH asserts administrative priority claims as well as claims for an equitable lien and constructive trust for attorneys fees and expenses relating to the appeals of other disallowance decisions by HCFA (the "Other HCFA Disallowances"); the NCH Complaint states that NCH has incurred at least $275,000 of such expenses. On November 9, 2000, the Company and the defendant subsidiaries filed a motion to dismiss ("Motion to Dismiss") the NCH Complaint, arguing that the constructive trust/equitable lien claims are barred by res judicata based upon prior financing orders of the Bankruptcy Court, and that the claims seeking administrative priority fail to state claims upon which such relief may be granted. On December 12, 2000, the Bankruptcy Court heard oral argument with respect to the Motion to Dismiss, took the matter under submission, and requested further briefing. In early November, NCH filed a motion ("Motion to Enjoin Settlement") which seeks to enjoin the Company and the defendant subsidiaries from settling claims against HCFA relating to the NCH HCFA Disallowances and to require that any funds recovered with respect to such claims be segregated. The Company and the defendant subsidiaries have filed an opposition. In addition the Company has filed a motion for summary judgment (the "Motion for Summary Judgment") on those counts of the complaint which are directed against the Company and its subsidiaries. A hearing on the Motion to Enjoin Settlement and on the Motion for Summary Judgment has been deferred until the Bankruptcy Court rules on the Motion to Dismiss. The parties are currently waiting for the Bankruptcy Court to rule on the Motion to Dismiss. The Company and the defendant subsidiaries intend to contest the case vigorously. 19 22 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) NOTE 10 - SEGMENT INFORMATION The following tables exhibit the segment reporting of the Company for the three and nine months ended June 30, 2001 and 2000 (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ----------------------------- ------------------------------- 2001 2000 2001 2000 --------- ----------- ----------- ----------- Revenues from external customers: Nursing home services $ 441,394 $ 448,698 $ 1,325,351 $ 1,344,326 Pharmacy services 54,311 56,319 161,217 184,716 Other 28,827 27,517 82,889 82,212 --------- ----------- ----------- ----------- $ 524,532 $ 532,534 $ 1,569,457 $ 1,611,254 ========= =========== =========== =========== Intersegment revenues: Pharmacy services $ 12,964 $ 13,415 $ 37,890 $ 39,676 Other 72 71 214 214 --------- ----------- ----------- ----------- $ 13,036 $ 13,486 $ 38,104 $ 39,890 ========= =========== =========== =========== Net income (loss): Nursing home services $ 21,265 $ 58,332 $ 104,566 $ 143,050 Pharmacy services 212 909 (375) (1,957) Other (507) (10,933) 3,261 (13,289) --------- ----------- ----------- ----------- $ 20,970 $ 48,308 $ 107,452 $ 127,804 ========= =========== =========== =========== JUNE 30, 2001 ------------ Assets: Nursing home services $ 969,851 Pharmacy services 95,563 Other 82,103 ----------- $ 1,147,517 ===========
20 23 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) The following tables reconcile the Company's segment reporting to the totals on the Company's unaudited condensed consolidated financial statements for the three and nine months ended June 30, 2001 and 2000 (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, --------------------------- ------------------------------- 2001 2000 2001 2000 --------------------------- ------------------------------- Revenues: External revenues for reportable segments $ 524,532 $ 532,534 $ 1,569,457 $ 1,611,254 Intersegment revenues for reportable segments 13,036 13,486 38,104 39,890 Elimination of intersegment revenue (13,036) (13,486) (38,104) (39,890) --------------------------- ------------------------------- Consolidated revenues $ 524,532 $ 532,534 $ 1,569,457 $ 1,611,254 =========================== =============================== Net income (loss): Net income for reportable segments $ 20,970 $ 48,308 $ 107,452 $ 127,804 Corporate overhead (25,889) (39,705) (89,285) (191,471) --------------------------- ------------------------------- Consolidated net income (loss) $ (4,919) $ 8,603 $ 18,167 $ (63,667) =========================== =============================== JUNE 30, 2001 ----------- Assets: Assets for reportable segments $ 1,147,517 Corporate overhead 1,429,026 Elimination of intersegment assets (1,290,638) ----------- $ 1,285,905 ===========
NOTE 11 - SUBSEQUENT EVENTS At a hearing held on August 7, 2001, the Bankruptcy Court approved an amendment, dated as of June 26, 2001, to the Company DIP Credit Agreement, which extended the scheduled termination date of the Company DIP Credit Facility from August 31, 2001, to December 31, 2001, and modified certain financial covenants in the Company DIP Credit Agreement. By amendment to the Mariner Health DIP Credit Agreement dated as of July 19, 2001, and approved by the Bankruptcy Court at its August 7, 2001 hearing in the Mariner Health Chapter 11 Cases, the stated termination date of the Mariner Health DIP Credit Agreement was extended to December 31, 2001, in exchange for, among other things, the payment of $15.0 million to the Mariner Health Principal Secured Lenders as an adequate protection payment. The Company, GranCare, and the Omega Debtors entered into a Settlement Agreement with Omega dated as of August 1, 2001 (the "Omega Settlement Agreement"), proposing to restructure the $58.8 million prepetition mortgage loan (the "Omega Loan") between Omega and Professional Health Care Management, Inc., a wholly owned subsidiary of GranCare ("PHCMI"), and resolve related disputes, by modifying the Omega Loan and entering into certain related transactions (collectively, the "Omega Loan Modification"). 21 24 MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Under the terms of the Omega Settlement Agreement, Omega has agreed with the Company, GranCare and the Omega Debtors to modify the Omega Loan (anticipated at closing to be in the amount of approximately $59.7 million, the "Amended Omega Loan") by (i) extending the maturity thereof from 2007 to 2010, with a one-time, 11-year extension option; (ii) providing for a catch-up payment or payments of post-December 31, 2000 interest on the Omega Loan at the compromise rate of $525,000 per month, plus an additional $300,000 (representing interest at the rate of 11.25% per annum on the $8.0 million of principal on the Omega Loan excluded from the parties' calculation of the $525,000 per month compromise interest amount); (iii) providing for interest-only payments after closing of the Omega Loan Modification at a substantially reduced interest rate (11.57% per annum, compared to the current contractual rate of over 16%); (iv) granting PHCMI a one-time option to prepay the Amended Omega Loan in full between February 1, 2005 and July 31, 2005, at a prepayment price of 103% of par, plus accrued and unpaid interest; (v) releasing the Company, GranCare and the Omega Debtors from liability arising prior to the closing of the Omega Loan Modification (including the GranCare "keepwell" agreement contained in the prepetition Omega loan agreement), other than liability arising in connection with the Omega Settlement Agreement and the loan documents evidencing, guaranteeing and securing the Amended Omega Loan (the "Amended Omega Loan Documents"); (vi) providing for payment to Omega of an annual amendment fee equal to 25% of free cash flow from the Omega Facilities, and until the occurrence of certain events, a monthly amendment fee equal to 50% of the "return on equity" component of Medicaid reimbursement received from the State of North Carolina with respect to the North Carolina Omega Facilities; and (vii) providing for the management of the facilities subject to the Omega Loan by the Company for a monthly base management fee of 5% of Omega Facility revenues, plus an annual incentive management fee equal to 75% of free cash flow from such facilities (reducing to 70% under certain circumstances). PHCMI will remain the borrower under the Amended Omega Loan, as it is under the Omega Loan. The Amended Omega Loan will be guaranteed by PHCMI's subsidiaries which are the licensed operators of the Omega Facilities (the "Michigan Subsidiary Guarantors"), and also by another Company subsidiary, Living Centers - PHCM, Inc. ("LC-PHCM", and together with the Michigan Subsidiary Guarantors, the "Omega Guarantors"), as the owner of the Omega Facilities located in North Carolina (such guaranties being referred to herein as the "Amended Omega Guaranties"). The Amended Omega Loan and the Amended Omega Guaranties will be secured by (i) amended mortgages or deeds of trust on the Omega Facilities, (ii) amended, blanket security interests in the personal property assets of PHCMI and the Omega Guarantors, and (iii) pledges of the issued and outstanding capital stock of PHCMI and each of the Michigan Subsidiary Guarantors. In addition, PHCMI has agreed in the Omega Settlement Agreement to assign its residual 50% undivided interest in the $9.0 million purchase money note (the "Ciena Note") received from the affiliate of Ciena Healthcare Management, Inc. which acquired four former Michigan Omega Facilities from PHCMI on or about February 1, 2001 (the "Ciena Facilities"). (The other 50% interest was previously assigned by PHCMI to Omega at the closing of the sale of the Ciena Facilities, in return for a $4.5 million credit against the Omega Loan obligations.) The consideration for the assignment of PHCMI's remaining interest in the Ciena Note would be approximately $3.5 million, plus 50% of aggregate principal payments received under the Ciena Note in excess of $8 million and 50% of interest payments received under the Ciena Note in excess of $960,000 annually. The Omega Loan Modification is subject to the approval of the Bankruptcy Court and of the Company's DIP Lenders. A motion seeking Bankruptcy Court approval was filed on August 2, 2001, with a hearing on the matter set for August 22, 2001. The Company can give no assurances that the required approvals will be obtained. The Company has reserved the option to cause the issued and outstanding capital stock of LC-PHCM to be transferred, in one or more successive transfers, to PHCMI, which would make LC-PHCM a wholly-owned subsidiary of PHCMI, and to sell 51% of the issued and outstanding capital stock of PHCMI to a third-party unrelated to either Omega or the Company (the "Majority PHCMI Equity Sale"). The terms of the Majority PHCMI Equity Sale are currently being negotiated. 22 25 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company through its subsidiaries is one of the nation's largest providers of post-acute health care services, primarily through the operation of skilled nursing facilities. At June 30, 2001, the Company's significant operations consisted of (i) approximately 340 inpatient and assisted living facilities containing approximately 40,000 beds; (ii) approximately 32 institutional pharmacies servicing more than 1,000 long-term care centers; and (iii) 13 long-term acute care hospitals with approximately 620 licensed beds. The Company operates in 25 states with significant concentrations of facilities and beds in five states and several metropolitan markets. On January 18, 2000 (the "Petition Date"), the Company and substantially all of its subsidiaries (the "Company Debtors"), including Mariner Health Group, Inc. ("Mariner Health") and its subsidiaries (the "Mariner Health Subsidiaries" and collectively with Mariner Health, the "Mariner Health Debtors"), filed voluntary petitions (collectively, the "Chapter 11 Filings") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court") under chapter 11 title 11 of the United States Code (the "Bankruptcy Code"). The Company is presently operating its business as a debtor-in-possession subject to the jurisdiction of the Bankruptcy Court while a plan or plans of reorganization are formulated. Neither the Company nor Mariner Health has filed a plan of reorganization. On June 12, 2001, the agents for the Mariner Health Debtors' senior secured lenders under Mariner Health's prepetition senior credit facility (the "MHG Principal Secured Lenders") filed with the Bankruptcy Court a plan of reorganization for Mariner Health which has since been amended (including amendments thereto, "the MHG Bank Groups' Plan") and a proposed disclosure statement for the MHG Bank Groups' Plan; the adequacy of the disclosure statement was subsequently approved by the Bankruptcy Court at a hearing held on August 7, 2001, subject to various amendments in response to objections thereto. The MHG Bank Groups' Plan provides for, among other things, (i) elimination of the Company's equity interest in the Mariner Health Debtors whereby the Company would receive no consideration on account of its claims against and equity interest in the Mariner Health Debtors; (ii) termination of the Company's management of the facilities owned by the Mariner Health Debtors, thus eliminating a significant source of revenue for the Company; and (iii) restructuring and/or discharging of the Mariner Health Debtors' obligation to their creditors. Impaired classes of creditors and equity holders that are entitled to vote must still approve or reject the MHG Bank Groups' Plan once votes for the MHG Bank Groups' Plan are solicited (which solicitation will not be made prior to August 23, 2001, and may be delayed further, at the discretion of the MHG Principal Secured Lenders). The Company cannot predict whether the Bankruptcy Court will confirm the MHG Bank Groups' Plan and, if such plan is confirmed, when and whether such plan would become effective. As of August 10, 2001, neither the Company nor the Mariner Health Debtors had taken any position as to whether to support or oppose confirmation of the MHG Bank Groups' Plan. As a debtor-in-possession, the Company is authorized to operate its business but may not engage in transactions outside its ordinary course of business without the approval of the Bankruptcy Court (the "Chapter 11 Proceedings"). The Chapter 11 Proceedings raise substantial doubt about the Company's ability to continue as a going concern. The ability of the Company to continue as a going concern and the appropriateness of using the going concern basis of accounting is dependent upon, among other things, the ability of the Company to comply with the terms of its various commitments of debtor-in-possession financing, confirmation of a plan of reorganization, success of future operations after such confirmation and the ability to generate sufficient cash from operations and financing sources to meet obligations. Any plan or plans of reorganization and other actions during the Chapter 11 Proceedings could change materially the amounts currently recorded in the unaudited condensed consolidated financial statements (see Note 3 of the unaudited condensed consolidated financial statements). RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the business segment data in Note 10 of the unaudited condensed consolidated financial statements. 23 26 Net revenues for inpatient nursing home services accounted for $441.4 million and $1,325.4 million of the Company's $524.5 million and $1,569.5 million total revenues for the three and nine months ended June 30, 2001, respectively. Nursing home services revenues are derived from the provision of routine and ancillary services and are a function of occupancy rates in the Company's nursing facilities and payor mix. Weighted average occupancy, as identified in the following table, increased by 1.5% and 1.6%, respectively, over the comparable three and nine month periods from fiscal year 2000 to fiscal year 2001.
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, --------------------- ---------------------- 2001 2000 2001 2000 --------------------- ---------------------- Weighted average licensed bed count 39,448 45,592 40,914 46,247 Total average residents 34,627 39,355 35,739 39,696 Weighted average occupancy 87.8% 86.3% 87.4% 85.8%
Payor mix is the source of payment for the services provided and consists of Medicare, Medicaid and private pay. Private pay includes revenue from individuals who pay directly for services (without government assistance through the Medicare and Medicaid programs) and from managed care companies, commercial insurers, health maintenance organizations, Veteran's Administration contractual payments, and payments for services provided under contract management programs. Managed care as a payor source to nursing home operators is likely to increase over the next several years. However, revenue from managed care payors does not constitute a significant portion of the Company's revenue at this time. Reimbursement rates from government sponsored programs, such as Medicare and Medicaid, are strictly regulated and subject to funding appropriations from federal and state governments. Changes in reimbursement rates, including the implementation of the Prospective Payment System ("PPS") for Medicare Part A patients beginning July 1, 1998 and the fee screen schedules and therapy caps for Medicare Part B patients beginning January 1, 1999 (although the therapy caps temporarily have been suspended), have adversely affected the Company resulting in significantly lower Medicare revenues than the Company would have received under the previous cost based payment methodology. Ongoing efforts of third-party payors to contain healthcare costs by limiting reimbursement rates, increasing case management review and negotiating reduced contract pricing continue to affect the Company's revenues and profitability. The federal Medicare program restricts inpatient coverage to patients who require skilled care. State-administered Medicaid programs generally provide more restricted coverage and lower reimbursement rates than private pay sources. In addition, the administrative procedures associated with the Medicare cost reimbursement program, with respect to facilities and periods not subject to PPS, generally preclude final determination of amounts due the Company until annual cost reports are audited or otherwise reviewed and settled with the applicable fiscal intermediaries and administrative agencies. Certain Medicare fiscal intermediaries have made audit adjustments to settle cost reports for some of the Company's facilities that reduce the amount of reimbursement that was previously received by the facilities. The Company believes that it has properly recorded revenue under cost reimbursement programs based on the facts and current regulations. If the Company were to receive adverse adjustments that it had not contemplated in recording its revenue in the past, the differences could be significant to the Company's results of operations in the period of final determination. See "--Liquidity and Capital Resources." Under PPS, the Company is still required to file cost reports; however, the audit and settlement process of Medicare cost reports is not expected to have a material impact on total Medicare revenue. See "--Liquidity and Capital Resources." As part of the bankruptcy process the Company, Mariner Health and their respective subsidiaries are engaged in discussions with the Health Care Financing Administration ("HCFA") (which subsequently was renamed the Centers for Medicare and Medicaid Services, or "CMS") to potentially settle some or all matters related to historical cost-based reimbursement (the "HCFA Global Settlement"). It is not possible to estimate at this time whether this process will result in material differences of amounts previously recorded or the effects on future cash flows. 24 27 The table below presents the approximate percentage of the Company's net patient revenues derived from the various sources of payment for the periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------------- ------------------------ 2001 2000 2001 2000 ------------------------- ------------------------ Medicaid 47.4% 49.9% 48.6% 49.8% Medicare 29.3% 25.0% 27.6% 24.6% Private and other 23.3% 25.1% 23.8% 25.6%
THIRD QUARTER FISCAL 2001 COMPARED TO THIRD QUARTER FISCAL 2000 Net revenues totaled $524.5 million for the three months ended June 30, 2001, a decrease of approximately $8.0 million or 1.5% from the comparable period in fiscal year 2000. The decrease is primarily attributable to a decrease of approximately $7.3 million or 1.6% in net revenues for inpatient nursing home services. The impact of the divestiture of inpatient nursing home facilities resulted in a decrease in net revenues of approximately $45.5 million for the three months ended June 30, 2001 as compared to the three months ended June 30, 2000. The decrease in net revenues was partially offset by an increase of approximately $38.2 million from the third quarter of fiscal year 2000 to the third quarter of fiscal year 2001 for the current portfolio of inpatient nursing home facilities. The increase resulted primarily from higher average per diem rates during the three months ended June 30, 2001 as compared to the three months ended June 30, 2000, mainly due to increases in Medicare rates (6.7%) and Medicaid rates (7.6%) as a result of recent legislative relief to mitigate the reduction in reimbursement under PPS (see "-Healthcare Regulatory Matters"). In addition, although census remained relatively stable for the third quarter of fiscal year 2001 as compared to the third quarter of fiscal year 2000, there was a slight improvement in revenue by payor mix which also resulted in increased revenues for the third quarter of the current fiscal year as compared to the third quarter of the prior fiscal year. Costs and expenses, excluding depreciation and amortization, totaled $493.5 million for the three months ended June 30, 2001, a decrease of $21.4 million or 4.2% from the comparable period of fiscal year 2000. These costs and expenses primarily consist of salaries, wages, and employee benefits, which represent approximately $294.6 million or 59.7% of the total for the three months ended June 30, 2001 as compared to $303.9 million or $59.0% of the total for the three months ended June 30, 2000. Various federal, state and local regulations impose, depending on the services provided, a variety of regulatory standards for the type, quality, and level of personnel required to provide care or services. The regulatory requirements have an impact on staffing levels, as well as the mix of staff, and therefore impact salaries, wages and employee benefits. The decrease in salaries, wages and benefits of approximately $9.4 million for the three months ended June 30, 2001 as compared to the same period in fiscal year 2000 is due to multiple factors including the impact of the divestiture of inpatient nursing home facilities and the Company's continued efforts to reduce overhead costs. This reduction has been partially offset by rising labor costs in certain of its markets and the Company is expecting this trend to continue for the foreseeable future (see "--Liquidity and Capital Resources"). Rent decreased approximately $7.6 million or 33.2% to $15.2 million for the three months ended June 30, 2001 as compared to the same period in fiscal year 2000 mainly due to the impact of the divestiture of inpatient nursing home facilities. Provision for bad debts for the three months ended June 30, 2001 was $7.3 million, a decrease of approximately $7.6 million or 51.1% from the comparable period of the prior fiscal year. The decrease is attributed to an additional provision for bad debts recorded by the Company during the three months ended June 30, 2000 for receivables retained from the sale of the Company's then remaining home health operations in fiscal year 2000. General and administrative expenses, which include the indirect administrative costs associated with operating the Company and its lines of business, decreased approximately $5.0 million or 8.6% to $53.5 million for the three months ended June 30, 2001 as compared to the same period in fiscal year 2000, mainly as a result of the Company's continued efforts to reduce overhead costs. Depreciation and amortization costs were $14.1 million for the three months ended June 30, 2001, a decrease of approximately $4.6 million or 24.6%, which is due to the impact of the divestiture of inpatient nursing home facilities and the result of the Company recording an impairment charge of $19.4 million in the fourth quarter of fiscal year 2000. 25 28 Effective January 18, 2000, the Company discontinued accruing interest relating to its debt facilities currently classified as liabilities subject to compromise in accordance with the American Institute of Certified Public Accountants Statement of Position 90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7"). Contractual interest for the three months ended June 30, 2001 and 2000 was $51.4 million and $62.1 million, respectively, which is $50.6 million and $61.2 million in excess of interest expense included in the unaudited condensed consolidated financial statements. Reorganization items totaled $21.2 million for the three months ended June 30, 2001 as compared to ($8.1) million for the three months ended June 30, 2000. The increase of approximately $29.3 million is attributable to approximately $11.0 million of net gain on divestitures included in reorganization items for the three months ended June 30, 2000 as compared to a net loss on divestitures of approximately $4.3 million included in reorganization items for the three months ended June 30, 2001. During the three months ended June 30, 2000, the Company realized a net gain of approximately $11.1 million due to a settlement agreement reached with Senior Housing Properties related to certain leased facilities (see Note 4 of the unaudited condensed consolidated financial statements). Professional fees included in reorganization items, which primarily consist of expenses for consulting, legal and auditing services incurred in connection with the reorganization of the Company under Chapter 11, also increased $9.7 million from $4.2 million for the three months ended June 30, 2000 to $13.9 million for the three months ended June 30, 2001. Reorganization items consist of income, expenses and other costs directly related to the reorganization of the Company incurred in connection with the Chapter 11 Filings (see Note 3 of the unaudited condensed consolidated financial statements). FISCAL 2001 YEAR TO DATE COMPARED TO FISCAL 2000 YEAR TO DATE Net revenues totaled $1,569.5 million for the nine months ended June 30, 2001, a decrease of approximately $41.8 million or 2.6% from the comparable period in fiscal year 2000. The decrease is primarily attributable to a decrease of approximately $23.5 million or 12.7% in net revenues for pharmacy services due to a decline in the number of beds served during the nine months ended June 30, 2001 as compared to the nine months ended June 30, 2000. In addition, the closure of five institutional pharmacies during fiscal year 2000 also contributed to the decrease in pharmacy services revenue. Net revenues for inpatient nursing home services decreased approximately $19.0 million or 1.4% for the nine months ended June 30, 2001 as compared to the nine months ended June 30, 2000. The impact of the divestiture of inpatient nursing home facilities resulted in a decrease in net revenues of approximately $118.1 million for the nine months ended June 30, 2001 as compared to the nine months ended June 30, 2000. This decrease in net revenues was partially offset by an increase of approximately $99.1 million from the nine months ended June 30, 2000 to the nine months ended June 30, 2001 for the current portfolio of inpatient nursing home facilities. The increase resulted primarily from higher average per diem rates during the nine months ended June 30, 2001 as compared to the nine months ended June 30, 2000 mainly due to increases in Medicaid rates (7.4%) and Medicare rates (4.3%) as a result of recent legislative relief to mitigate the reduction in reimbursement under PPS (see "- Healthcare Regulatory Matters"). In addition, although census remained relatively stable for the nine months ended June 30, 2001 as compared to comparable period of the prior year, there was a slight improvement in revenue by payor mix which also resulted in increased revenues for the current year as compared to the prior year. Costs and expenses, excluding depreciation and amortization, totaled $1,479.9 million for the nine months ended June 30, 2001, a decrease of $87.7 million or 5.6% from the comparable period of fiscal year 2000. These costs and expenses primarily consist of salaries, wages, and employee benefits, which represent approximately $892.1 million or 60.3% of the total for the nine months ended June 30, 2001 as compared to $916.8 million or 58.5% of the total for the nine months ended June 30, 2000. Various federal, state and local regulations impose, depending on the services provided, a variety of regulatory standards for the type, quality, and level of personnel required to provide care or services. The regulatory requirements have an impact on staffing levels, as well as the mix of staff, and therefore impact salaries, wages and employee benefits. The decrease in salaries, wages and benefits of approximately $24.7 million for the nine months ended June 30, 2001 as compared to the same period in fiscal year 2000 is due to multiple factors including the impact of the divestiture of inpatient nursing home facilities and the Company's continued efforts to reduce overhead costs. This reduction has been partially offset by rising labor costs in certain of its markets and the Company expects this trend to continue for the foreseeable future. See "--Liquidity and Capital Resources"). The cost of ancillary services, which includes pharmaceuticals and therapy decreased approximately $13.3 million or 7.2% for the nine 26 29 months ended June 30, 2001 as compared to the nine months ended June 30, 2000. Costs for ancillary services are affected by the level of service provided and patient acuity and the decrease is primarily a result of a reduction in pharmacy services volume offset in part by an increase in per unit drug costs and a change in pharmacy product mix. Rent decreased approximately $16.4 million or 23.7% to $52.7 million for the nine months ended June 30, 2001 as compared to the same period in fiscal year 2000 mainly due to the impact of the divestiture of inpatient nursing home facilities. General and administrative expenses, which include the indirect administrative costs associated with operating the Company and its lines of business, decreased approximately $29.2 million or 15.8% for the nine months ended June 30, 2001 as compared to the same period in fiscal year 2000 mainly as a result of the Company's continued efforts to reduce overhead costs. Depreciation and amortization costs were $40.0 million for the nine months ended June 30, 2001, a decrease of approximately $4.2 million or 9.6%, which is due to the impact of the divestiture of inpatient nursing home facilities and the result of the Company recording an impairment charge of $19.4 million in the fourth quarter of fiscal year 2000. Effective January 18, 2000, the Company discontinued accruing interest relating to its debt facilities currently classified as liabilities subject to compromise in accordance with SOP 90-7. Contractual interest for the nine months ended June 30, 2001 and 2000 was $163.5 million and $179.2 million, respectively, which is $159.4 million and $111.1 million in excess of interest expense included in the unaudited condensed consolidated financial statements. Reorganization items totaled $29.9 million for the nine months ended June 30, 2001 as compared to $4.4 million for the nine months ended June 30, 2001. The increase of approximately $25.5 million is attributable to an increase of approximately $15.4 million for professional fees incurred in connection with the reorganization of the Company under Chapter 11. In addition, net gain on divestiture included in reorganization items decreased from $11.0 million for the nine months ended June 30, 2000 to $5.8 million for the nine months ended June 30, 2001. During the nine months ended June 30, 2000, the Company realized a net gain of approximately $10.0 million due to a settlement agreement reached with Senior Housing Properties related to certain leased facilities (see Note 4 of the unaudited condensed consolidated financial statements). Reorganization items consist of income, expenses and other costs directly related to the reorganization of the Company incurred in connection with the Chapter 11 Filings (see Note 3 of the unaudited condensed consolidated financial statements). SEASONALITY The Company's revenues and operating income generally fluctuate from quarter to quarter. This seasonality is related to a combination of factors which include the timing of third party payment rate changes, the number of work days in a given period and seasonal census cycles. LIQUIDITY AND CAPITAL RESOURCES OF THE COMPANY Overview. Cash and cash equivalents were $201.6 million at June 30, 2001. The Company and its subsidiaries also have available $75.0 million in DIP financing, as described below, none of which was borrowed as of such date except for approximately $6.0 million of letters of credit issued under the Company DIP Financing. In addition, during July 2001 PNC issued the Replacement MHG Surety LOC (as defined herein) under the Mariner Health DIP Financing in the amount of $7.9 million. Subsequent to June 30, 2001, Mariner Health posted approximately $8.3 million of cash collateral with PNC Bank to collateralize the MHG Replacement Surety LOC, and made a $15.0 million adequate protection payment to the Mariner Health Principal Secured Lenders in connection with the extension of the Mariner Health DIP Credit Facility to December 31, 2001. During the nine months ended June 30, 2001 working capital increased $69.3 million from $309.5 million at September 30, 2000 to $378.8 million at June 30, 2001. Cash provided by operating activities was $63.0 million for the nine months ended June 30, 2001 as compared to $60.3 million provided by operating activities for the nine months ended June 30, 2000. Receivables increased $53.0 million in the nine months ended June 30, 2001 principally in the Company's nursing home segment resulting from an increase in average days outstanding due to multiple factors including increased nursing home services revenues in the nine month period ended June 30, 2001 as compared to the nine month period ended September 30, 2000 and seasonal cycles, including timing of third party payments. Long-term insurance reserves increased approximately $35.2 million 27 30 resulting from the provision for the current period and reduction in claims settled due to the automatic stay protection afforded by the Chapter 11 Filings. Cash used in investing activities was $12.4 million for the nine months ended June 30, 2001 as compared to $8.1 million provided by investing activities for the nine months ended June 30, 2000. Cash used in investing activities primarily consisted of the use of $22.9 million related to capital expenditures for the nine months ended June 30, 2001. Cash used in investing activities also included $7.7 million of proceeds from the sale of property, equipment and other assets (see Note 4 of the unaudited condensed consolidated financial statements). Cash used in financing activities was $19.6 million in the nine months ended June 30, 2001 as compared to cash used in financing activities of $3.3 million for the nine months ended June 30, 2000. Cash used in financing activities included principal repayments of prepetition long-term debt of $19.6 million for the nine months ended June 30, 2001. The primary sources of revenue for the Company are the federal Medicare program and the state Medicaid programs. Although payment cycles for these programs vary, payments generally are made within 30 to 60 days after services are provided. For Medicare cost reporting periods beginning July 1, 1998 and thereafter, the federal Medicare program converted to PPS for skilled nursing facility services. Since the end of the third quarter of 1999, all of the Company's skilled nursing facilities have been reimbursed under PPS, which provides acuity-based rates that are established at the beginning of the Medicare reporting year. See "--Healthcare Regulatory Matters." Payments for nursing facility services that are provided to Medicaid recipients are paid at rates that are set by each individual state's Medicaid program. For cost reporting periods that ended before the start of PPS, the facilities were (and to the extent final cost reports for prior periods are not settled, still are) reimbursed under Medicare on the basis of reasonable and necessary costs as determined from annual cost reports. This retrospective settlement system resulted in final cost report settlements that generally were not finally settled until two years after the end of the cost reporting period and that could be further delayed by appeals and litigation. PPS has had a material adverse effect on the Company's financial condition and, although the effects of PPS have been somewhat ameliorated by recent legislation, PPS is in large part responsible for the inability of the Company to operate under its existing capital structure. See "--Healthcare Regulatory Matters." The Company provides certain services and supplies between subsidiary companies, some of which are charged at cost and others of which are charged at market rates. Subject to certain exceptions, Medicare's "related organization principle" generally requires that services and supplies furnished to nursing facilities by related entities be included in the nursing facility's reimbursable cost at the cost of the supplying entity. The Company believes that the services and supplies furnished to nursing facilities at market rates qualify for exception to the related organization principle. Certain of the Company's Medicare fiscal intermediaries have taken the position that the related party transactions do not qualify for this exception to the related party rules and have made adjustments that reduce Medicare allowable cost to the cost of the supplying entity. During the third quarter of fiscal 1999, the intermediaries for the Mariner Health facilities reopened previously settled cost reports to impose such related party adjustments for services furnished to the facilities by Mariner Health's rehabilitation subsidiary. All related party adjustments have been or will be appealed, if not resolved in connection with the HCFA Global Settlement, to the Provider Reimbursement Review Board (the "PRRB") and through the full appeal process as is warranted. The adjustments affect only periods during which the facilities were reimbursed for Medicare on the basis of reasonable and necessary cost; there would not be any impact for periods that are reimbursed under PPS. During the third quarter of fiscal 1999, the Medicare fiscal intermediaries for the subsidiaries operated by Mariner Health reopened approximately fifty 1995 and 1996 cost reports and issued revised notices of program reimbursement ("NPRs") imposing prudent buyer or related party adjustments as well as applying an administrative resolution related to the cost report treatment of admissions costs. The reopenings resulted in reductions in reimbursable costs of approximately $16.9 million. The Company believes that it has substantial arguments for both issues and has appealed the adjustments to the PRRB. In lieu of recoupment by the fiscal intermediary, the Company reached an agreement with HCFA and the intermediary and implemented an extended repayment plan. The balance as of the date of the agreement was approximately $15.9 million, which was repaid over a period of one year. The intermediary has 28 31 completed audit procedures but has not issued NPR's for most of the remaining cost based Mariner Health cost reports (1997 and 1998). As part of the chapter 11 process, the Company and Mariner Health entered into stipulations with the U.S. Department of Health and Human Services whereby, among other things, HCFA will not recoup certain prepetition overpayments for the pendancy of the Company's and Mariner Health's DIP Financing (as defined below) obligations. Accordingly, repayment obligations which may arise from the issuance of NPRs may be stayed for an interim period. Should the NPRs result in a repayment requirement not within the purview of the stipulation, or after the pendancy of the DIP obligations, the Company and Mariner Health would seek to enter into an extended repayment plan with HCFA at that time. However, the Company expects that all of the open cost-based cost reporting periods will be included in the HCFA Global Settlement. See "--Results of Operations." However, there can be no assurance that the HCFA Global Settlement will include all open cost-based cost reporting periods. Although the Company has over the course of the last year seen a reduction in its labor costs through the divestiture of facilities and various business lines as well as corporate overhead reductions, this reduction has been partially offset by wage increases for various nursing staff positions in certain markets in which the Company plans to continue operations. While this has not yet had a material adverse effect on the Company's operations, there can be no assurance that an increase in nursing staff wages will not have such an effect in the future. The Company believes that these increases are a result of a decrease in the number of people entering the nursing profession and an increased demand for nurses in the healthcare industry. The Company has experienced increased staffing requirements in order to maintain compliance with various Medicaid Programs. The Company anticipates that the nursing staff shortage will accelerate, especially in light of a demographic review indicating that a significant percentage of people engaged in the nursing profession are nearing retirement age with no significant group of younger nursing staff candidates to fill anticipated vacancies. The Company is exploring ways in which to address this problem, including recruiting labor from overseas and providing incentives for nurses to remain in the Company's employment. General liability and professional liability ("GL/PL") insurance costs for the long-term care industry, particularly in Florida and Texas, where the Company maintains significant operations, continue to rise at a dramatic rate. Significant increases in the number of claims and the amount of an average claim continue. Insurance markets have responded to this significant increase by severely restricting the availability of long-term care GL/PL coverage. As a result of the changes described above, fewer companies are engaged in insuring long-term care companies; and those that do offer insurance coverage do so at a very high cost. This is in large part a result of plaintiff lawyer activity in certain markets in which the Company operates. The Company anticipates that this trend will continue, and that its GL/PL costs will continue to increase. These increases have already had an adverse effect on the Company's operations. The Company is attempting to address this issue through supporting tort reform initiatives in certain markets, and has had very limited success in this regard. On May 4, 2001, the Florida legislature passed a bill, which was signed into law and went into effect on May 15, 2001, designed to provide insurance reform for nursing homes and increase quality of care (the "Florida Tort Reform Act"). The Company is unable to ascertain at this time what effect, if any, the Florida Tort Reform Act will have on its GL/PL insurance costs. No assurance can be given that the Company's GL/PL costs will not continue to rise, that GL/PL coverage will be available to the Company in the future, or that the tort reform initiatives will be successful or have the desired outcome. As previously noted, the MHG Principal Secured Lenders filed with the Bankruptcy Court the MHG Bank Groups' Plan and a proposed disclosure statement with respect thereto; the adequacy of the proposed disclosure statement was subsequently approved by the Bankruptcy Court at a hearing held on August 7, 2001. The MHG Bank Groups' Plan contemplates the termination of the existing management arrangement pursuant to which the Company manages Mariner Health's assets. In the event that the MHG Bank Groups' Plan is confirmed by the Bankruptcy Court, the revenue to the Company provided by the existing management arrangement would no longer be available and this loss of revenues would have an adverse effect on the Company. Accordingly, if the MHG Bank Groups' Plan is confirmed, the Company will be required to substantially reduce its overhead costs. No assurance can be given as to whether the Company can achieve these reductions in an expeditious fashion. Prepetition Debt. Due to the failure to make scheduled payments, comply with certain financial covenants and the commencement of the Chapter 11 Proceedings, the Company is in default on all, or substantially all, of its prepetition debt obligations. Except as otherwise may be determined by the Bankruptcy Court, the automatic stay protection afforded by the Chapter 11 Filings prevents any action from being taken with regard to any of the defaults under the prepetition debt obligations. These obligations are classified as liabilities subject to compromise at June 30, 2001 and September 30, 2000. The obligations of the Company under its senior credit facility are guaranteed by substantially all of the Company's subsidiaries other than the Omega Debtors, Mariner Health and the Mariner Health Subsidiaries, and are secured by substantially all of the otherwise unencumbered owned assets of the Company and such subsidiaries. Mariner Health's obligations under its senior credit facility are guaranteed by substantially all of the Mariner Health Subsidiaries and are secured by substantially all of the otherwise unencumbered assets of Mariner Health and such subsidiary guarantors. Unlike other subsidiaries of the Company (the "Non-Mariner Health Subsidiaries"), Mariner Health and the Mariner Health Subsidiaries neither guarantee the Company's obligations under the Company's debt facilities nor pledge their assets to secure such obligations. Correspondingly, the Company and the Non-Mariner Health Subsidiaries do not guarantee or assume any obligations under the Mariner Health debt facilities. Mariner Health and the Mariner 29 32 Health Subsidiaries are not subject to the covenants contained in the Company's debt facilities, and the covenants contained in the Mariner Health debt facilities are not binding on the Company and the Non-Mariner Health Subsidiaries. No principal payments have been made on prepetition indebtedness since the Petition Date with the exception of repayments made against the Company's senior credit facility, primarily as a result of the application of certain cash proceeds received from the sales of certain facilities and other assets, adequate protection payments with regard to certain mortgaged facilities, and notional amounts related to certain capital equipment leases, as adequate protection payments, as more particularly described below (see "--Debtor-in-Possession Financing for the Company"). In addition, during July 2001, Mariner Health made a $15.0 million repayment against the Mariner Health senior credit facilities as an adequate protection payment pursuant to the amendment to the Mariner Health DIP Credit Agreement, which, among other things, extended the maturity date of the Mariner Health DIP Financing to December 31, 2001 (see "--Debtor-in-Possession Financing for Mariner Health"). Debtor-in-Possession Financing for the Company. In connection with the Chapter 11 Filings, the Company entered into a $100.0 million debtor-in-possession financing agreement (as amended from time to time, the "Company DIP Credit Agreement") with a group of banks (the "Company DIP Lenders") led by The Chase Manhattan Bank ("Chase"). On March 20, 2000 the Bankruptcy Court granted final approval (the "Final Company DIP Order") of the Company DIP Financing. The Company DIP Credit Agreement initially established a $100.0 million secured revolving credit facility to provide funds for working capital and other lawful corporate purposes for use by the Company and the other Company Debtors. At the request of the Company, the size of the Company DIP Financing was reduced to $50.0 million on January 11, 2001. The Company DIP Credit Agreement provides that amounts outstanding under the Company DIP Financing may not at any time exceed the maximum borrowing amounts established for the Company under the Final Company DIP Order or the Company's borrowing base of eligible accounts receivable (the "Company Borrowing Base"). Up to $10.0 million of the Company DIP Financing may be utilized for the issuance of letters of credit as needed in the business of the Company Debtors. Interest accrues on the principal amount outstanding under the Company DIP Financing at a per annum rate of interest equal to the Alternative Base Rate of Chase ("ABR") plus three percent (3%) and is payable monthly in arrears. During the existence and continuation of a default in the payment of any amount due and payable by the Company Debtors under the Company DIP Credit Agreement, interest will accrue at the default rate of ABR plus five percent (5%) per annum. The terms of the Company DIP Financing require that the Company prepay principal to the extent that the principal amount outstanding under the Company DIP Financing at any time exceeds the Company Borrowing Base then in effect. To the extent proceeds of loans under the Company DIP Financing are used to complete the construction of certain healthcare facilities (which proceeds are not permitted to exceed $8.8 million), proceeds from the sale of any such properties must be used first to repay any portion of the loans made pursuant to the Company DIP Financing, with 75% of any remaining net cash proceeds to be applied as an adequate protection payment to the lenders under the Company's prepetition senior credit facility, and the remaining 25% of such excess net cash proceeds to be retained by the Company or its applicable subsidiary as additional working capital. Pursuant to the terms of the Final Company DIP Order, 75% of the net cash proceeds of other asset sales approved by the Bankruptcy Court and the requisite Company DIP Lenders are to be applied as an adequate protection payment to the lenders under the Company's prepetition senior credit facility. The Company has the right to make optional prepayments in increments of $1.0 million, and to reduce the commitment under the Company DIP Credit Agreement in increments of $5.0 million. The obligations of the Company under the Company DIP Credit Agreement are jointly and severally guaranteed by each of the other Company Debtors, except for certain Company Debtors owning facilities mortgaged to Omega Healthcare Investors, Inc. (the "Omega Debtors") whose guarantee is limited to the negative cash flows of the Omega Debtors, pursuant to the Company DIP Credit Agreement, the Final Company DIP Order and the Final Company Cash Collateral Order (defined below). Under the terms of the Final Company DIP Order, the obligations of the Company Debtors under the Company DIP Credit Agreement (the "Company DIP Obligations") constitute allowed superiority administrative expense claims pursuant to section 364(c)(1) of the Bankruptcy Code (subject to a carve out for certain professional fees and expenses incurred by the Company Debtors). The Company DIP Obligations are secured by 30 33 perfected liens on all or substantially all of the assets of the Company Debtors (excluding bankruptcy causes of action), the priority of which liens (relative to prepetition creditors having valid, non avoidable, perfected liens in those assets and to any "adequate protection" liens granted by the Bankruptcy Court) is established in the Final Company DIP Order and the related cash collateral order entered by the Bankruptcy Court (the "Final Company Cash Collateral Order"). The Bankruptcy Court has also granted certain prepetition creditors of the Company Debtors replacement liens and other rights as "adequate protection" against any diminution of the value of their existing collateral that may result from allowing the Company Debtors to use cash collateral in which such creditors had valid, non-avoidable and perfected liens as of the Petition Date. The discussion contained in this paragraph is qualified in its entirety by reference to the Final Company DIP Order, the Final Company Cash Collateral Order, and related stipulations, and reference should be made to such orders (which are available from the Bankruptcy Court) and stipulations for a more complete description of such terms. The Company DIP Credit Agreement contains customary representations, warranties and other affirmative and restrictive covenants of the Company Debtors, as well as certain financial covenants relating to minimum EBITDA, maximum capital expenditures, and minimum patient census. The breach of such representations, warranties or covenants, to the extent not waived or cured within any applicable grace or cure periods, could result in the Company being unable to obtain further advances under the Company DIP Financing and possibly the exercise of remedies by the Company DIP Lenders, either of which events could materially impair the ability of the Company to successfully reorganize in chapter 11 and to operate as a going concern. Such a default may also impair the ability of the Company to use cash collateral to fund operations. At June 30, 2001, no revolving loans were outstanding under the Company DIP Financing and approximately $6.0 million of letters of credit issued under the Company DIP Credit Agreement were outstanding. The outstanding principal of the Company DIP Financing, together with all accrued and unpaid interest and all other obligations thereunder, was originally due and payable one year from the Petition Date. With the approval of the Bankruptcy Court, the Company Debtors, Chase and the requisite Company DIP Lenders amended the Company DIP Credit Agreement as of January 11, 2001, to (among other things) extend the maturity date of the Company DIP Financing from January 19, 2001 to August 31, 2001. Effective as of January 19, 2001, the Company exercised its right under the Company DIP Credit Agreement to reduce the $100.0 million Company DIP Financing commitment to $50.0 million. The scheduled termination date of the Company DIP Credit Facility was subsequently extended to December 31, 2001 by amendment to the Company DIP Credit Agreement dated as of June 26, 2001, and approved by the Bankruptcy Court on August 7, 2001. Debtor-in-Possession Financing for Mariner Health. Among the orders entered by the Bankruptcy Court on the Petition Date in the Chapter 11 Proceedings of Mariner Health and its subsidiaries were orders approving (a) the use of cash collateral by the Mariner Health Debtors, and (b) the funding of up to $50.0 million in principal amount at any time outstanding under a debtor-in-possession financing arrangement (the "Mariner Health DIP Financing" and together with the Company DIP Financing, the "DIP Financings") pursuant to that certain Debtor-in-Possession Credit Agreement dated as of January 20, 2000 (as amended from time to time, the "Mariner Health DIP Credit Agreement") by and among Mariner Health and each of the other Mariner Health Debtors, as co-borrowers thereunder, the lenders signatory thereto as lenders (the "Mariner Health DIP Lenders"), First Union National Bank, as Syndication Agent, PNC Capital Markets, Inc. and First Union Securities, Inc., as co-arrangers, and PNC Bank, National Association ("PNC"), as Administrative Agent and Collateral Agent. After a final hearing on February 16, 2000, the Bankruptcy Court entered into an order granting final approval of the Mariner Health DIP Financing (the "Final Mariner Health DIP Order"). The Mariner Health DIP Credit Agreement initially established a $50.0 million secured revolving credit facility comprised of a $40.0 million tranche A revolving loan commitment and a $10.0 million tranche B revolving loan commitment. At the request of Mariner Health, the size of the Mariner Health DIP Financing was reduced to $25.0 million on January 19, 2001. As a result of such reduction, the $10.0 million tranche B revolving loan commitment was eliminated. Under the Mariner Health DIP Credit Agreement's terms, advances under the Mariner Health DIP Financing may be used by the Mariner Health Debtors (and to a limited degree, by certain joint venture subsidiaries of Mariner Health that are not debtors in the Mariner Health Chapter 11 Proceedings) for working capital and other lawful corporate purposes. Amounts outstanding under the Mariner Health DIP Financing may not at any time exceed the 31 34 maximum borrowing amounts established for the Mariner Health Debtors under the Final Mariner Health DIP Order. Originally, up to $5.0 million of the Mariner Health DIP Financing could be utilized for the issuance of letters of credit as needed in the businesses of the Mariner Health Debtors; however, the letter of credit sublimit was increased to $10.0 million pursuant to the Tenth Amendment to the Mariner Health DIP Credit Agreement dated as of March 20, 2001 (the "Tenth Mariner Health DIP Amendment"). Interest accrues on the principal amount outstanding under the Mariner Health DIP Financing at a per annum rate of interest equal to the "base rate" of PNC (i.e., the higher of the PNC prime rate or a rate equal to the federal funds rate plus 50 basis points) plus the applicable spread, which is 250 basis points. Such interest is due and payable monthly in arrears. During the existence and continuation of any event of default under the Mariner Health DIP Credit Agreement, the interest rates normally applicable to loans under the Mariner Health DIP Financing will be increased by another 250 basis points per annum. The outstanding principal of the Mariner Health DIP Financing, together with all accrued and unpaid interest and all other obligations thereunder, are due and payable on the Commitment Termination Date, defined as the first to occur of (i) January 19, 2001, unless extended (see discussion below regarding extensions to date); (ii) the effective date of a joint plan of reorganization for the Mariner Health Debtors; (iii) the date of termination of the exclusivity rights of the Mariner Health Debtors to file a plan of reorganization; (iv) the filing by the Mariner Health Debtors of any plan of reorganization (or the modification of any such plan previously filed with the Bankruptcy Court) not previously approved by the holders of at least 66-2/3% of the outstanding loans or commitments under the Mariner Health DIP Financing; (v) the date of termination of the commitments under the Mariner Health DIP Credit Agreement during the continuation of an event of default thereunder; or (vi) the date on which all or substantially all of the assets or stock of the Mariner Health Debtors is sold or otherwise transferred. Under the Mariner Health DIP Credit Agreement's current terms, the Mariner Health Debtors must also prepay principal to the extent that the principal amount outstanding under the Mariner Health DIP Financing at any time exceeds the Mariner Health borrowing base then in effect. The Mariner Health borrowing base for any month is an amount equal to $7.5 million in excess of the "Working Capital Facility" borrowings projected for such month in Mariner Health's year 2000 DIP budget, plus (as a result of the Tenth Mariner Health DIP Amendment), the undrawn availability under the $7.9 million letter of credit issued by PNC pursuant to the Mariner Health DIP Credit Agreement to secure Mariner Health's obligations in respect of its replacement surety program (the "Replacement MHG Surety LOC"). The Mariner Health DIP Credit Agreement also provides for mandatory prepayments under the following circumstances: (a) with net cash proceeds from asset sales, the incurrence of certain debt, the issuance of new equity, the receipt of tax refunds exceeding $100,000 in the aggregate, and the receipt of casualty proceeds in excess of $100,000 that are not applied within 60 days after receipt to the repair, rebuilding, restoration or replacement of the assets damaged or condemned (or committed within such period of time to be so applied); and (b) on each business day, the amount of cash held by the Mariner Health Debtors in excess of the sum of $5.0 million plus the aggregate sum of the minimum amount required by depositary banks to be kept in deposit accounts, concentration accounts and other accounts with such banks. Amounts prepaid pursuant to clause (a) of the immediately preceding sentence will permanently reduce the amount of the Mariner Health DIP Financing commitments on a dollar for dollar basis. Amounts prepaid pursuant to clause (b) of the same sentence will not permanently reduce such commitments. The Mariner Health Debtors have the right to make optional prepayments in the minimum principal amount of $1.0 million, and in increments of $100,000 in excess thereof, and, on three business days' notice, to reduce the commitments under the Mariner Health DIP Credit Agreement in the minimum amount of $5.0 million, or in increments of $1.0 million in excess thereof. As provided in the Final Mariner Health DIP Order, the obligations of the Mariner Health Debtors under the Mariner Health DIP Credit Agreement (together with certain potential cash management system liabilities secured on a pari passu basis therewith, the "Mariner Health DIP Obligations") constitute allowed super priority administrative expense claims pursuant to section 364(c)(1) of the Bankruptcy Code (subject to a carve-out for certain professional fees and expenses incurred by the Mariner Debtors). The Mariner Health DIP Obligations are secured by perfected liens on all or substantially all of the assets of the Mariner Health Debtors (excluding bankruptcy causes of action), the priority of which liens (relative to prepetition creditors having valid, non-avoidable, perfected liens in those assets and to any "adequate protection" liens granted by the Bankruptcy Court) is established in the Final Mariner Health DIP Order and the related cash collateral orders entered by the Bankruptcy Court (the "Mariner Health Cash Collateral Order"). The Bankruptcy Court has also granted certain prepetition creditors of the Mariner Health Debtors replacement liens and 32 35 other rights as "adequate protection" against any diminution of the value of their existing collateral that may result from allowing the Mariner Health Debtors to use cash collateral in which such creditors had valid, non-avoidable and perfected liens as of the Chapter 11 Filings. The discussion contained in this paragraph is qualified in its entirety by reference to the Final Mariner Health DIP Order, the related Mariner Health Cash Collateral Orders, and related stipulations, and reference should be made to such orders (which are available from the Bankruptcy Court) and stipulations for a more complete description of such terms. The Mariner Health DIP Credit Agreement contains customary representations, warranties and other affirmative and restrictive covenants of the Mariner Health Debtors, as well as certain financial covenants relating to minimum EBITDAR, minimum patient census, minimum eligible accounts receivable, maximum variations from Mariner Health's year 2000 DIP budget and maximum capital expenditures. The breach of such representations, warranties or covenants, to the extent not waived or cured within any applicable grace or cure periods, could result in the Mariner Health Debtors being unable to obtain further advances under the Mariner Health DIP Financing and possibly the exercise of remedies by the Mariner Health DIP Lenders, either of which events could materially impair the ability of the Mariner Health Debtors to successfully reorganize in chapter 11 and to operate as a going concern. Among its other restrictive covenants, the Mariner Health DIP Credit Agreement limits affiliate transactions with the Company Debtors, but does contemplate weekly overhead payments to the Company equal to 1.25% of projected net inpatient revenues for the then-current month, subject to a monthly "true-up," such that the payments for such month equal 5% of actual net inpatient revenues of the Mariner Health Debtors. Such payments may be suspended by the Mariner Health Debtors if certain defaults specified in the Mariner Health DIP Credit Agreement occur and are continuing, though such fees will still accrue and will become due and payable if and when the subject default has been cured or waived. By amendment dated as of January 19, 2001, and with the approval of the Bankruptcy Court, the Mariner Health DIP Credit Agreement was amended to extend the stated termination date of the Mariner Health DIP Credit Agreement from January 19, 2001 to July 19, 2001 (which has subsequently been extended by amendment dated as of July 19, 2001, to December 31, 2001), and to reduce the maximum amount of the Mariner Health DIP Financing from $50.0 million to $25.0 million (as a result of which the tranche B component was eliminated). Such amendment also, among other things, extended the deadline for filing a plan of reorganization to February 20, 2001, imposed a 25 basis point utilization fee on borrowings under the Mariner Health DIP Financing in excess of $5.0 million and amended certain reporting requirements. An amendment dated as of March 20, 2001, among other things, increased the letter of credit sublimit and the borrowing base to permit the issuance of a $7.9 million letter of credit (the "MHG Replacement Surety LOC") to facilitate implementation of a replacement surety bond program by Mariner Health, which was issued in July 2001. Because the MHG Replacement Surety LOC expires well after the Commitment Termination Date for the Mariner Health DIP Facility, the March 20, 2001 amendment required such letter of credit to be 105% cash collateralized. On or about May 14, 2001, Mariner Health and representatives of the Mariner Health DIP Lenders and the Mariner Health prepetition senior bank group (the "Mariner Health Principal Secured Lenders") entered into a stipulation (the "May 14 Stipulation") (i) extending from May 21, 2000 to July 20, 2001, the Mariner Health Debtors' exclusive right to file a plan of reorganization, and (ii) if they file a plan within that time, extending the Mariner Health Debtor's exclusive right to solicit acceptances of such plan to September 20, 2001; however, such exclusivity rights are modified in that stipulation to permit the Mariner Health Principal Secured Lenders to file their own plan or plans of reorganization for the Mariner Health Debtors and to solicit acceptances thereto, or (at the sole option of the Mariner Health Principal Secured Lenders) to file a joint plan of reorganization with the Mariner Health Debtors and solicit acceptances thereto. The May 14 Stipulation was subsequently approved by the Bankruptcy Court. The May 14 Stipulation constituted a waiver by the Mariner Health DIP Lenders of the covenant in the Mariner Health DIP Credit Agreement that the Mariner Health Debtors file a plan of reorganization by a certain time and an agreement that the modification of the Mariner Health Debtors' exclusivity rights pursuant to that stipulation would not constitute an event of default under the Mariner Health DIP Credit Agreement. 33 36 Omega Settlement. After extensive negotiations with Omega, the Company, GranCare and the Omega Debtors entered into a Settlement Agreement with Omega dated as of August 1, 2001 (the "Omega Settlement Agreement"), proposing to restructure the Company's existing $58.8 million prepetition mortgage loan (the "Omega Loan") from Omega to Professional Health Care Management, Inc., a wholly owned subsidiary of GranCare ("PHCMI") and resolve related disputes, by modifying the Omega Loan and entering into certain related transactions (collectively, the "Omega Loan Modification"). The Omega Debtors are the owners or operators of nine skilled nursing facilities in Michigan and three skilled nursing facilities in North Carolina (collectively, the "Omega Facilities"). Under the terms of the Omega Settlement Agreement, Omega has agreed with the Company, GranCare and the Omega Debtors to modify the Omega Loan (anticipated at closing to be in the amount of approximately $59.7 million, the "Amended Omega Loan") by (i) extending the maturity thereof from 2007 to 2010, with a one-time, 11-year extension option; (ii) providing for a catch-up payment or payments of post-December 31, 2000 interest on the Omega Loan at the compromise rate of $525,000 per month, plus an additional $300,000 (representing interest at the rate of 11.25% per annum on the $8.0 million of principal on the Omega Loan excluded from the parties' calculation of the $525,000 per month compromise interest amount); (iii) providing for interest-only payments after closing of the Omega Loan Modification at a substantially reduced interest rate (11.57% per annum, compared to the current contractual rate of over 16%); (iv) granting PHCMI a one-time option to prepay the Amended Omega Loan in full between February 1, 2005 and July 31, 2005, at a prepayment price of 103% of par, plus accrued and unpaid interest; (v) releasing the Company, GranCare and the Omega Debtors from liability arising prior to the closing of the Omega Loan Modification (including the GranCare "keepwell" agreement contained in the prepetition Omega loan agreement), other than liability arising in connection with the Omega Settlement Agreement and the loan documents evidencing, guaranteeing and securing the Amended Omega Loan (the "Amended Omega Loan Documents"); (vi) providing for payment to Omega of an annual amendment fee equal to 25% of free cash flow from the Omega Facilities, and until the occurrence of certain events, a monthly amendment fee equal to 50% of the "return on equity" component of Medicaid reimbursement received from the State of North Carolina with respect to the North Carolina Omega Facilities; and (vii) providing for the management of the facilities subject to the Omega Loan by the Company for a monthly base management fee of 5% of Omega Facility revenues, plus an annual incentive management fee equal to 75% of free cash flow from such facilities (reducing to 70% under certain circumstances). PHCMI will remain the borrower under the Amended Omega Loan, as it is under the Omega Loan. The Amended Omega Loan will be guaranteed by PHCMI's subsidiaries which are the licensed operators of the Omega Facilities (the "Michigan Subsidiary Guarantors"), and also by another Company subsidiary, Living Centers - PHCM, Inc. ("LC-PHCM", and together with the Michigan Subsidiary Guarantors, the "Omega Guarantors"), as the owner of the Omega Facilities located in North Carolina (such guaranties being referred to herein as the "Amended Omega Guaranties"). The Amended Omega Loan and the Amended Omega Guaranties will be secured by (i) amended mortgages or deeds of trust on the Omega Facilities, (ii) amended, blanket security interests in the personal property assets of PHCMI and the Omega Guarantors, and (iii) pledges of the issued and outstanding capital stock of PHCMI and each of the Michigan Subsidiary Guarantors. In addition, PHCMI has agreed in the Omega Settlement Agreement to assign its residual 50% undivided interest in the $9.0 million purchase money note (the "Ciena Note") received from the affiliate of Ciena Healthcare Management, Inc. which acquired four former Michigan Omega Facilities from PHCMI on or about February 1, 2001 (the "Ciena Facilities"). (The other 50% interest was previously assigned by PHCMI to Omega at the closing of the sale of the Ciena Facilities, in return for a $4.5 million credit against the Omega Loan obligations.) The consideration for the assignment of PHCMI's remaining interest in the Ciena Note would be approximately $3.5 million, plus 50% of aggregate principal payments received under the Ciena Note in excess of $8 million and 50% of interest payments received under the Ciena Note in excess of $960,000 annually. The Omega Loan Modification is subject to the approval of the Bankruptcy Court and of the Company's DIP Lenders. A motion seeking Bankruptcy Court approval was filed on August 2, 2001, with a hearing on the matter set for August 22, 2001. The Company can give no assurances that the required approvals will be obtained. 34 37 The Company has reserved the option to cause the issued and outstanding capital stock of LC-PHCM to be transferred, in one or more successive transfers, to PHCMI, which would make LC-PHCM a wholly-owned subsidiary of PHCMI, and to sell 51% of the issued and outstanding capital stock of PHCMI to a third-party unrelated to either Omega or the Company (the "Majority PHCMI Equity Sale"). The terms of the Majority PHCMI Equity Sale are currently being negotiated. Healthcare Regulatory Matters. The Balanced Budget Act of 1997 (the "Balanced Budget Act") contains numerous changes to the Medicare and Medicaid programs with the intent of slowing the growth of payments under these programs by $115.0 billion and $13.0 billion, through the end of 2001 and 2002, respectively. Approximately 50% of the savings are to be achieved through a reduction in the growth of payments to providers and physicians. These cuts have had, and will continue to have, a material adverse effect on the Company. The Balanced Budget Act amended the Medicare program by revising the payment system for skilled nursing services. Historically, nursing homes were reimbursed by the Medicare program based on the actual costs of services provided. However, the Balanced Budget Act required the establishment of PPS, a system where Medicare payments are prospectively determined for nursing homes for cost reporting periods beginning on or after July 1, 1998. During the first three years of PPS, nursing homes will receive a fixed per diem rate for each of their Medicare Part A patients, based on a blend of facility specific rates and Federal acuity adjusted rates. Thereafter, the per diem rates will be based solely on Federal acuity adjusted rates. Subsumed in this per diem rate are ancillary services, such as pharmacy and rehabilitation services, which historically have been provided to many of the Company's nursing facilities by the Company's pharmacy and therapy subsidiaries. The inclusion of ancillary services in the PPS per diem payments has resulted in significantly lower margins in the Company's pharmacy operations as a result of increased pricing competition, a change in buying patterns by customers and the decision by the Company to exit certain businesses previously operated by the Company such as its third party therapy, home health and hospital contract management businesses. Since the passage of the Balanced Budget Act, Congress has passed additional legislation intended to temporarily mitigate the reduction in reimbursement for skilled nursing facilities ("SNFs") under PPS. First, in November 1999, Congress passed the Medicare Balanced Budget Refinement Act ("BBRA"). Second, in December of 2000, Congress passed the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000 ("BIPA"). Effective April 1, 2000, the BBRA temporarily increased the PPS per diem rates by 20 percent for 15 patient acuity categories, including medically complex patients, pending revisions to PPS. The increases will remain in effect until HCFA implements a refined schedule of payment rates for the Resource Utilization Groups ("RUG") system that better accounts for nontherapy ancillary services medically-complex patients. The revised payment rates may be more or less than the temporary 20 percent increase under the BBRA. The BBRA also provides for a 4% increase in the federal per diem rate for all patient acuity categories for the government fiscal years 2001 and 2002. Among other things, BIPA eliminates the scheduled reduction in the SNF market basket update in government fiscal year 2001 and is implemented in two phases. Specifically, the update rate for the period from October 1, 2000 through June 30, 2001 is the market basket index ("MBI") increase minus one percentage point; the update for the period from April 1, 2001 through September 30, 2001 is the MBI increase plus one percentage point. This increase will not be included when determining PPS payment rates for subsequent periods. In the government fiscal years 2002 and 2003, payment updates will equal the MBI increase minus one-half of a percentage point. Temporary increases in the federal per diem rates under the BBRA will be in addition to these payment increases. BIPA also increases payment for the nursing component of each RUG payment category by 16.66% for services furnished after April 1, 2001 and before October 1, 2002. Moreover, BIPA further refines certain consolidated billing requirements established by the BBA. Specifically, effective January 1, 2001, the law limits consolidated billing requirements to items and services furnished to SNF residents in a Medicare Part A covered stay and to therapy services covered under Medicare Part B. For residents not covered under a Part A stay (e.g., Part A benefits exhausted), SNFs may choose to bill for non-therapy Part B services and supplies, or they may elect to have suppliers continue to bill Medicare directly for these services. BIPA also modifies the treatment of the rehabilitation patient categories to ensure that Medicare payments for skilled nursing facility residents with "ultra high" and "high" rehabilitation therapy needs are appropriate in relation to payments for residents needing "medium" or "low" levels of therapy. Specifically, effective for services furnished on or after April 1, 2001 and before implementation of a refined RUG payment system, BIPA increases the federal per diem payments for all 14 rehabilitation categories by 6.7%. Additionally, the 20 percent additional payment provided for under the BBRA for three rehabilitation categories is removed to make this provision budget neutral. BIPA also permits the Secretary of 35 38 Health and Human Services (the "Secretary") to establish a process for geographic reclassification of SNFs based upon the method used for inpatient hospitals. As of July 1, 1999, all of the Company's SNFs were receiving Medicare payments under PPS. In connection with the implementation of PPS, the government has implemented a temporary payment system to transition SNFs from the prior cost-based payment system to a payment system based entirely on federal per diem rates. PPS transition rates vary from facility to facility depending on each facility's base period cost that comprises the facility specific component of the rates and the wage adjuster that is applied to the federal component of the PPS payment rates. For many of the Company's facilities, the facility specific base period cost is higher than the base period cost that was used to develop the transitional PPS payment rates. For some facilities, however, the facility base period cost is lower than the base period cost used to develop the PPS transitional rates. Under BBRA, SNFs are allowed to elect transition to the permanent federal rate at the beginning of their cost reporting periods beginning on or after January 1, 2000. SNFs may make the election up to 30 days after the start of their cost reporting period. The Company has taken advantage of this election where appropriate. The Balanced Budget Act also revised the reimbursement methodology for therapy services under Medicare Part B. Historically, Medicare Part B therapy services were reimbursed based on the cost of the services provided, subject to prudent buyer and salary equivalency restrictions. In November 1998, certain fee screen schedules were published setting forth the amounts that can be charged for specific therapy services. Additionally, the Balanced Budget Act sets forth maximum per beneficiary limits of $1,500 per provider for physical therapy and speech pathology and $1,500 per provider for occupational therapy. Both the fee screens and per beneficiary limits were effective for services rendered following December 31, 1998. The imposition of fee screens, together with the inclusion of ancillary services in the federal per diem rate, has had a material adverse effect on the Company's therapy business resulting in the decision by the Company to terminate its contract and third party therapy operations. The BBRA temporarily mitigates the Balanced Budget Act limitations by providing that the therapy caps will not apply in government fiscal years 2000 and 2001. The BBRA requires the Secretary to conduct focused medical reviews of therapy services during government fiscal years 2000 and 2001, with an emphasis on claims for services provided to residents of SNFs. The BBRA also requires the Secretary to study and to submit recommendations to Congress on therapy utilization patterns in government fiscal year 2000 compared to those in the government fiscal years 1998 and 1999. Moreover, BIPA extends the moratorium on the therapy caps for one additional year, through 2002. It also extends the requirement for focused reviews of therapy claims for the same period. The BBRA also excludes certain items and services from the formerly all-inclusive SNF per diem rates under PPS. Specifically, the following items and services will become separately reimbursable outside of PPS rates: (i) ambulance services furnished to an individual in conjunction with renal dialysis services; (ii) chemotherapy items and administration services (as identified by certain HCFA Common Procedure Coding System ("HCPCS") codes); (iii) radioisotope services (as identified by certain HCPCS codes); and (iv) customized prosthetic devices (artificial limbs) and other custom prostheses if provided to a SNF resident and intended to be used after discharge (as identified by certain HCPCS codes and other instances chosen by HCFA). Payment for such items and services, which are "passed-through" the per diem payment rates, will be made under Part B of Medicare, in conformance with Part B payment rules. Although these items are separately reimbursed from the PPS rate, the BBRA also directs HCFA to make appropriate adjustments to the PPS payments rates to reflect the fact that certain items and services have been excluded, in order to ensure budget neutrality. In the process of finalizing certain Medicare cost reports or reopening previously finalized cost reports filed by various of the Company's Medicare provider facilities, certain Medicare fiscal intermediaries have issued NPRs, which include significant audit adjustments that reduce the amount of reimbursement that previously was received by the facilities. The adjustments are based, for the most part, on denials of exception to the related organization principles (described below) with regard to services and supplies furnished to the Company's facilities by the Company's pharmacy and rehabilitation companies. Adjustments are also based on reductions to costs claimed for therapy services under prudent buyer principles (described below). 36 39 The prudent buyer principle states, in part, "the prudent and cost-conscious buyer not only refuses to pay more than the going price for an item or service, he also seeks to economize by minimizing cost." Certain of the fiscal intermediaries have alleged that the Company was not prudent in its purchase of occupational therapy and speech pathology services prior to HCFA's establishing salary equivalency guidelines, effective April 1998. Fiscal intermediaries calculated facilities' costs to provide services through employed therapists and reduced costs claimed on the cost reports for providing services through contracts and adjusted the cost reports accordingly. Appeals were filed with the PRRB and resulted in a favorable outcome. However, on review the Social Security Administrator reversed the PRRB and restored the intermediaries' adjustments. The Company received a favorable judicial decision on its initial prudent buyer appeal and currently is negotiating a settlement with HCFA for all if its prudent buyer appeals as part of the HCFA Global Settlement. The related organization principle states, in part, "a provider's allowable cost for services, facilities, and supplies furnished by a party related to the provider are the costs the related party incurred in furnishing the items in question." The regulations provide for an exception to the related organization principle if certain requirements are met and the Company believes that it meets these requirements with respect to services its facilities previously received from related pharmacy and rehabilitation subsidiaries. Some fiscal intermediaries have denied the request for exception and have made adjustments to reduce the allowable cost that is included in nursing facility cost reports to the cost of the related organization. The Company has requested PRRB appeals for these adjustments, but the appeals have not yet been heard. There can be no assurance that the Company will prevail in the appeal process. On January 12, 2001, the Secretary issued final regulations to implement changes to the Medicaid "upper payment limit" requirements. The purpose of the rule is to stop states from using certain accounting techniques to inappropriately obtain extra federal Medicaid matching funds that are not necessarily spent on health care services for Medicaid beneficiaries. Although the rule will be phased in over eight years to reduce the adverse impact on certain states, the rule eventually could result in decreased federal funding to some state Medicaid programs, which, in turn, could prompt certain states to reduce Medicaid reimbursements to providers, including nursing facilities. Other federal legislation requires major changes in the transmission and retention of health information by the Company. The Health Insurance Portability and Accountability Act of 1996 ("HIPAA") mandates, among other things, the adoption of standards for the exchange of electronic health information in an effort to encourage overall administrative simplification and enhance the effectiveness and efficiency of the healthcare industry. Among the standards that the Department of Health and Human Services will adopt pursuant to HIPAA are standards for the following: electronic transactions and code sets; unique identifiers for providers, employers, health plans and individuals; security and electronic signatures; privacy; and enforcement. Although HIPAA was intended ultimately to reduce administrative expenses and burdens faced within the healthcare industry, the Company believes that the law will result in significant and costly changes. The Department of Health and Human Services has released two rules to date mandating the use of new standards with respect to certain healthcare transactions and health information. The first rule requires the use of uniform standards for common healthcare transactions, including healthcare claims information, plan eligibility, referral certification and authorization, claims status, plan enrollment and disenrollment, payment and remittance advice, plan premium payments and coordination of benefits. It also establishes standards for the use of electronic signatures. The second rule released by the Department of Health and Human Services imposes new standards relating to the privacy of individually identifiable health information. These standards not only require the Company's compliance with rules governing the use and disclosure of protected health information, but they also require the Company to impose those rules, by contract, on any business associate to whom such information is disclosed. Rules governing the security of health information have been proposed but have not yet been issued in final form. The Department of Health and Human Services finalized the new transaction standards on August 17, 2000, and the Company will be required to comply with them by October 16, 2002. The privacy standards were issued on December 28, 2000, and became effective on April 14, 2001 with a compliance date of April 14, 2003. Sanctions for failing to comply with HIPAA include criminal penalties and civil sanctions. The Company is in the process of quantifying the costs associated with HIPAA compliance and believes they may be material. 37 40 Other Factors Affecting Liquidity and Capital Resources. In addition to outstanding principal and accrued interest payments on its long-term indebtedness which generally are suspended as the consequence of the Chapter 11 Filings, the Company has significant rent obligations relating to its leased facilities. Without giving any effect to any potential restructuring of current rent obligations, the Company's total estimated rent obligations for fiscal year 2001 are approximately $70.3 million, of which approximately $15.2 million and $52.7 million were incurred in the three and nine months ended June 30, 2001, respectively. In connection with its review of its portfolio of facilities, the Company anticipates continuing to divest itself of under-performing facilities, which will have a favorable impact on the Company's rent obligations. The Company's operations require capital expenditures for renovations of existing facilities in order to continue to meet regulatory requirements, to upgrade facilities for the treatment of subacute patients and accommodate the addition of specialty medical services, and to improve the physical appearance of its facilities for marketing purposes. In addition, there are capital expenditures required for completion of certain existing facility expansions and new construction projects in process, as well as supporting non-nursing home operations. Capital expenditures totaled $22.9 million for the nine months ended June 30, 2001 as compared to $23.0 million for the comparable nine months ended June 30, 2000. Capital expenditures in the nine months ended June 30, 2001 and 2000 were financed principally through internally generated funds. The Company has experienced an increasing trend in the number and severity of litigation claims asserted against the Company. Management believes that this trend is endemic to the long-term care industry and is a result of the increasing number of large judgments against long-term care providers in recent years resulting in an increased awareness by plaintiff's lawyers of potentially large recoveries. The Company also believes that there has been, and will continue to be, an increase in governmental investigatory activity of long-term care providers, particularly in the area of false claims. While the Company believes that it provides quality care to the patients in its facilities and materially complies with all applicable regulatory requirements, an adverse determination in a legal proceeding or governmental investigation, whether currently asserted or arising in the future, could have a material adverse effect on the Company. See "--Legal Proceedings." The Company currently maintains two captive insurance subsidiaries to provide for reinsurance obligations under workers' compensation, general and professional liability, and automobile liability for losses that occurred prior to April 1, 1998. These obligations are funded with long-term, fixed income investments, which are not available to satisfy other obligations of the Company. The Company currently purchases excess liability insurance only. Due to the hardening of the liability insurance market for the long-term care industry, the Company currently maintains an unaggregated $1 million self-insured retention per claim. Prior to July 31, 1999, the Company's liability insurance policies included aggregated stop loss features limiting the Company's out-of-pocket exposure. With stop loss insurance unavailable to the Company, the expected direct costs have continued to increase. This increased exposure will have a delayed negative effect on operating cash flow as claims develop over the next several years. The Mariner Health DIP Credit Agreement limits the ability of the Mariner Health Debtors from engaging in affiliate transactions and making restricted payments, specifically including payments to the Company Debtors. However, the Mariner Health DIP Credit Agreement permits, among other things, weekly overhead payments to the Company (see "--Mariner Health Debtor-in-Possession Financing" above), the purchase of pharmaceutical goods and services from certain Company Debtors, the allocation to, and payment by, the Mariner Health Debtors of their share of certain taxes, insurance obligations and employee benefit obligations paid for and administered on a consolidated basis by the Company, and certain ordinary course transactions which are on terms no less favorable to the subject Mariner Health Debtors than the terms obtainable from a non-affiliate, and for which the approval of the requisite Mariner Health DIP Lenders and the Bankruptcy Court have been obtained. At September 30, 2000, the Company, excluding Mariner Health, had, in the aggregate, approximately $93.9 million in its corporate concentration bank accounts that was available to be used for ongoing operations, subject to the terms and restrictions of the Final Company Cash Collateral Orders and the Final Company DIP Order. The aggregate amount in the Company's corporate concentration account at July 27, 2001 was approximately $122.2 38 41 million. The Company expects a significant portion of this cash will be used in the funding of any plan of reorganization. At September 30, 2000, Mariner Health had, in the aggregate, approximately $16.2 million in its corporate concentration bank accounts that was available to be used for ongoing operations, subject to the terms and restrictions of the Mariner Health Cash Collateral Orders and the Final Mariner Health DIP Order. The aggregate amount in Mariner Health's corporate concentration account at July 27, 2001 was approximately $12.4 million. Mariner Health expects a significant portion of this money will be used in the funding of any plan of reorganization, including the MHG Bank Groups' Plan if approved by the required number of impaired creditors and equity holders. While management believes that the Company's cash should be sufficient to fund the Company's working capital needs for the foreseeable future, the use of this cash collateral is prohibited under the Bankruptcy Code absent an order of the Bankruptcy Court permitting the use of the cash collateral. The use of the Company's cash collateral to fund working capital is currently permitted by the respective DIP financings. While management believes that the amounts available to the Company Debtors from the Company DIP Financing and cash collateral will be sufficient to fund the operations of the Company Debtors until such time as the Company Debtors are able to take the steps necessary to structure a plan of reorganization that will be acceptable to creditors and confirmed by the Bankruptcy Court, there can be no assurances in this regard; a default under the Company DIP Credit Agreement may impair the ability of the Company Debtors to use cash collateral to fund operations. Finally, there can be no assurance that any plan of reorganization confirmed in connection with the Chapter 11 Filings of the Company Debtors will allow the Company Debtors to operate profitably under PPS or give the Company Debtors sufficient liquidity to meet their operational needs. The ability of the Company Debtors to fund such requirements will depend, among other things, on future economic conditions and on financial, business and other factors, many of which are beyond the control of the Company Debtors. While management believes that the amounts available to the Mariner Health Debtors from the Mariner Health DIP Financing and cash collateral will be sufficient to fund the operations of the Mariner Health Debtors until such time as the Mariner Health Debtors are able to take the steps necessary to structure a plan of reorganization that will be acceptable to creditors and confirmed by the Bankruptcy Court or until the MHG Bank Groups' Plan receives the required approval from the impaired classes of creditors and is subsequently confirmed by the Bankruptcy Court, there can be no assurances in this regard; a default under the Mariner Health DIP Credit Agreement may impair the ability of the Mariner Health Debtors to use cash collateral to fund operations. Finally, there can be no assurance that any plan of reorganization confirmed in connection with the Chapter 11 Filings of the Mariner Health Debtors will allow the Mariner Health Debtors to operate profitably under PPS or give the Mariner Health Debtors sufficient liquidity to meet their operational needs. The ability of the Mariner Health Debtors to fund such requirements will depend, among other things, on future economic conditions and on financial, business and other factors, many of which are beyond the control of the Mariner Health Debtors. CAUTIONARY STATEMENTS Information provided herein by the Company contains, and from time to time the Company may disseminate materials and make statements which may contain "forward-looking" information, as that term is defined by the Private Securities Litigation Reform Act of 1995 (the "Act"). In particular, the information contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" contains information concerning the Company's plan to restructure its debt obligations and other financial commitments. The aforementioned forward looking statements, as well as other forward looking statements made herein, are qualified in their entirety by these cautionary statements, which are being made pursuant to the provisions of the Act and with the intention of obtaining the benefits of the "safe harbor" provisions of the Act. The Company cautions investors that any forward-looking statements made by the Company are not guarantees of future performance and that actual results may differ materially from those in the forward-looking statements as a result of various factors, including, but not limited to, the following: (i) There can be no assurance that the amounts available to the Company through the DIP Financings will be sufficient to fund the operations of the Company until such time as the Company is able to propose a Plan of 39 42 Reorganization that will be acceptable to creditors and confirmed by the court overseeing the Company's Chapter 11 Filings. (ii) There can be no assurance that the Company will be able to continue to use cash collateral to fund its working capital needs. (iii) There can be no assurance that any Plan of Reorganization confirmed in connection with the Chapter 11 Filings will allow the Company to operate profitably under PPS or give the Company sufficient liquidity to meet its operational needs. (iv) There can be no assurances as to whether or not the MHG Bank Groups' Plan will be confirmed, and the impact confirmation of that plan may have on the Company, Mariner Health or their respective creditors and shareholders. (v) There can be no assurance regarding the future availability or terms of financing in light of the Company's Chapter 11 Filings. (vi) There can be no assurance regarding any adverse actions which may be taken by creditors or landlords of the Company which may have the effect of preventing or unduly delaying confirmation of a Plan of Reorganization in connection with the Company's Chapter 11 Filings. (vii) The Company may have difficulty in attracting patients or labor as a result of its Chapter 11 Filings. (viii) The Company may be subject to increased regulatory oversight as a result of its Chapter 11 Filings. (ix) In recent years, an increasing number of legislative proposals have been introduced or proposed by Congress and in some state legislatures which would effect major changes in the healthcare system. However, the Company cannot predict the type of healthcare reform legislation which may be proposed or adopted by Congress or by state legislatures. Accordingly, the Company is unable to assess the effect of any such legislation on its business. There can be no assurance that any such legislation will not have a material adverse impact on the future growth, revenues, and net income of the Company. (x) The Company derives substantial portions of its revenues from third-party payors, including government reimbursement programs such as Medicare and Medicaid, and some portions of its revenues from nongovernmental sources, such as commercial insurance companies, health maintenance organizations and other charge-based contracted payment sources. Both governmental and non-governmental payors have undertaken cost-containment measures designed to limit payments to healthcare providers. There can be no assurance that payments under governmental and non-governmental payor programs will be sufficient to cover the costs allocable to patients eligible for reimbursement. The Company cannot predict whether or what proposals or cost-containment measures will be adopted in the future or, if adopted and implemented, what effect, if any, such proposals might have on the operations and financial condition of the Company. (xi) The Company is subject to extensive federal, state and local regulations governing licensure, conduct of operations at existing facilities, construction of new facilities, purchase or lease of existing facilities, addition of new services, certain capital expenditures, cost-containment and reimbursement for services rendered. The failure to obtain or renew required regulatory approvals or licenses, the failure to comply with applicable regulatory requirements, the delicensing of facilities owned, leased or managed by the Company or the disqualification of the Company from participation in certain federal and state reimbursement programs, or the imposition of harsh enforcement sanctions could have a material adverse effect upon the operations and financial condition of the Company. (xii) There can be no assurance that an adverse determination in a legal proceeding or governmental investigation, whether currently asserted or arising in the future, will not have a material adverse effect on the Company's financial position. 40 43 (xiii) There can be no assurance that the Company can continue to obtain insurance coverage similar to that it currently maintains or that such current or future coverage will be adequate to satisfy adverse determinations against the Company. In addition, the Company's Chapter 11 Filings may disrupt its operations and may result in a number of other operational difficulties, including the following: (a) The Company's ability to access capital markets will likely be limited; (b) The Company's senior management may be required to expend a substantial amount of time and effort structuring a Plan of Reorganization, which could have a disruptive impact on management's ability to focus on the operation of the Company's business; (c) The Company may be unable to retain top management and other key personnel; (d) The Company may experience a reduction in the census at its skilled nursing facilities and hospitals; and (e) Suppliers to the Company may stop providing supplies or services to the Company or provide such supplies or services only on "cash on delivery," "cash on order" or other terms that could have an adverse impact on the Company's cash flow. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK None. 41 44 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS As is typical in the healthcare industry, the Company is and will be subject to claims that its services have resulted in resident injury or other adverse effects, the risks of which will be greater for higher acuity residents receiving services from the Company than for other long-term care residents. In addition, resident, visitor and employee injuries will also subject the Company to the risk of litigation. The Company has experienced an increasing trend in the number and severity of litigation and claims asserted against the Company. Management believes that this trend is endemic to the long-term care industry and is a result of the increasing number of large judgments, including large punitive damage awards, against long-term care providers in recent years resulting in an increased awareness by plaintiff's lawyers of potentially large recoveries. In certain states in which the Company has significant operations, including California and Florida, insurance coverage for the risk of punitive and certain other damages arising from general and professional liability litigation is not available due to state law public policy prohibitions. There can be no assurance that the Company will not be liable for punitive or other damages awarded in litigation arising in states for which insurance coverage is not available for such damages. The Company also believes that there has been, and will continue to be, an increase in governmental investigations of long-term care providers, particularly in the area of Medicare/Medicaid false claims, as well as an increase in enforcement actions resulting from these investigations. While the Company believes that it provides quality care to the patients in its facilities and materially complies with all applicable regulatory requirements, given the Company's current financial difficulties and lack of liquidity, an adverse determination in a legal proceeding or governmental investigation, whether currently asserted or arising in the future, could have a material adverse effect on the Company. From time to time, the Company and its subsidiaries have been parties to various legal proceedings in the ordinary course of their respective businesses. In the opinion of management, other than as set forth below, there have been no material developments in the litigation matters set forth in the Company's Annual Report on Form 10-K for the year ended September 30, 2000. As a result of the Chapter 11 Filings, all matters described in the Company's Annual Report on Form 10-K for the year ended September 30, 2000 were stayed on January 18, 2000. While the automatic stay remains in effect, the Company has agreed to relief from the automatic stay in certain limited circumstances. On August 26, 1996, a class action complaint was asserted against GranCare, Inc. ("GranCare"), a wholly-owned subsidiary of the Company, in the Denver, Colorado District Court, Salas, et al v. GranCare, Inc. and AMS Properties, Inc. d/b/a Cedars Healthcare Center, Inc., case no. 96-CV-4449. On March 15, 1998, the Court entered an Order in which it certified a class action in the matter. On June 10, 1998, the Company filed a Motion to Dismiss all claims and Motion for Summary Judgment Precluding Recovery of Medicaid Funds and these motions were partially granted by the Court on October 30, 1998. Plaintiffs' Motion for Reconsideration was denied by the Court on November 19, 1998, the Court's decision was certified as a final judgment on December 10, 1998, and plaintiffs then filed a writ with the Colorado Supreme Court, which was denied, and an appeal with the Colorado Court of Appeal. In accordance with the Company's voluntary filing under chapter 11 of the Bankruptcy Code and more particularly, ss. 362 of that Code, this matter was stayed on January 18, 2000. However, the Company did agree to limited relief from the stay in order to allow for certain parts of the appeal to continue. The Company filed a Request for Rehearing on February 2, 2001 and on March 22, 2001, the Court denied this Request as well as the Request for Rehearing by Plaintiffs. On April 18, 2001 the Court of Appeals was notified of the applicability of the Bankruptcy Stay and the Company's reservation of its rights to take a Writ to the Colorado Supreme Court when the Stay is lifted. The Company currently believes it is unlikely for this matter to ultimately survive as a class action and given this and the current posture of the case, this matter is not in a position to be evaluated in regard to a favorable outcome or in regard to the range of potential loss. The Company will continue in its opposition to the class action and further intends to vigorously contest all remaining allegations. On October 5, 2000, NovaCare Holdings, Inc. ("NCH") filed a complaint (the "NCH Complaint") in the Chapter 11 Proceedings commencing Adversary Proceeding No. 00-1577 (MFW), NovaCare Holdings, Inc. v. Mariner Post-Acute Network, Inc., et al. The Company and various subsidiaries (the "defendant subsidiaries") are named as 42 45 defendants in the Complaint. In the NCH Complaint, NCH alleges that its predecessors in interest (hereinafter also referred to as "NCH") were party to contracts with various subsidiaries of the Company under which NCH provided services to patients at various facilities of such subsidiaries. It further alleges that pursuant to these contracts, NCH provided certain services for which it was paid, but with respect to which HCFA disallowed the facilities' claims for reimbursement (the "NCH HCFA Disallowances"). After the NCH HCFA Disallowances, NCH allegedly provided credits to the facilities equal to the amount of the NCH HCFA Disallowances. Appeals of the NCH HCFA Disallowances were filed, and NCH alleges that it holds a constructive trust or equitable lien on any amounts which may be recovered from HCFA as a result of such appeals. In the alternative, NCH alleges that it holds an administrative priority claim for any such amounts that are paid by HCFA and not turned over to NCH. The aggregate amount of the credits that are related to the NCH HCFA Disallowances and with respect to which NCH asserts a constructive trust, an equitable lien, and/or an administrative priority claim is $8,163,930. In addition, NCH asserts administrative priority claims as well as claims for an equitable lien and constructive trust for attorneys fees and expenses relating to the appeals of other disallowance decisions by HCFA (the "Other HCFA Disallowances"); the NCH Complaint states that NCH has incurred at least $275,000 of such expenses. On November 9, 2000, the Company and the defendant subsidiaries filed a motion ("Motion to Dismiss") to dismiss the NCH Complaint, arguing that the constructive trust/equitable lien claims are barred by res judicata based upon prior financing orders of the Bankruptcy Court, and that the claims seeking administrative priority fail to state claims upon which such relief may be granted. On December 12, 2000, the Bankruptcy Court heard oral argument with respect to the motion to dismiss, took the matter under submission, and requested further briefing. In early November, NCH filed a motion ("Motion to Enjoin Settlement") which seeks to enjoin the Company and the defendant subsidiaries from settling claims against HCFA relating to the NCH HCFA Disallowances and to require that any funds recovered with respect to such claims be segregated. The Company and the defendant subsidiaries have filed an opposition. In addition the company has filed a motion for summary judgment ("Motion for Summary Judgment") on those counts of the complaint which are directed against the Company and its subsidiaries. A hearing on the Motion to Enjoin Settlement and on the Motion for Summary Judgment has been deferred until the Bankruptcy Court rules on the Motion to Dismiss. The parties are currently waiting for the Bankruptcy Court to rule on the Motion to Dismiss. The Company and the defendant subsidiaries intend to contest the case vigorously. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS UPON CERTAIN SECURITIES The Company made the Chapter 11 Filings on January 18, 2000. As a result, no principal or interest payments are being made since such time on prepetition indebtedness, with the exception of repayments made as a result of the application of net cash proceeds received from the sales of certain facilities and other assets and notional amounts related to certain other indebtedness, including capital equipment leases, until a Plan of Reorganization defining the payment terms has been approved by the Bankruptcy Court. Additional information regarding the Chapter 11 Filings is set forth elsewhere in this Form 10-Q, including Note 3 to the unaudited condensed consolidated financial statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations." ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. 43 46 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Twelfth Amendment, dated July 19, 2001, to Debtor-in-Possession Credit Agreement, dated January 20, 2000 (the "Mariner Health DIP Credit Agreement"), by and among Mariner Health Group, Inc. ("Mariner Health"), the Mariner Health subsidiaries party to the Mariner Health DIP Credit Agreement, the lenders party to the Mariner Health DIP Credit Agreement, First Union National Bank as syndication agent, PNC Capital Markets, Inc. and First Union Securities, Inc. both as co-arrangers and PNC Bank, National Association as collateral and administrative agent and as an issuing bank for the letters of credit issued in connection with the Mariner Health DIP Credit Agreement. 10.2 Fourth Amendment, dated June 26, 2001, to Revolving Credit and Guaranty Agreement dated January 18, 2000 (the "Company DIP Credit Agreement"), by and among the Company, the Guarantors (as named in the Company DIP Credit Agreement), The Chase Manhattan Bank ("Chase"), the other financial institutions party thereto (together with Chase, the "Banks") and Chase as Agent for the Banks. (b) Reports on Form 8-K None 44 47 SIGNATURES Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MARINER POST-ACUTE NETWORK, INC. (Registrant) By: /s/ William C. Straub ------------------------------------- Vice President, Controller, and Chief Accounting Officer (duly authorized Officer and Chief Accounting Officer) Date: August 14, 2001 45 EX-10.1 3 g71154ex10-1.txt TWELFTH AMENDMENT, DATED JULY 19, 2001 1 TWELFTH AMENDMENT TO DEBTOR-IN-POSSESSION CREDIT AGREEMENT As of July 19, 2001 Reference is made to that certain Debtor-In-Possession Credit Agreement dated as of January 20, 2000 (as heretofore amended, the "DIP CREDIT AGREEMENT"), by and among Mariner Health Group, Inc., a Delaware corporation ("MHG"), as debtor and debtor-in-possession, and each of MHG's subsidiaries listed on the signature pages thereof, each as debtor and debtor-in-possession (each such subsidiary and MHG individually referred to herein as a "BORROWER" and, collectively, on a joint and several basis, as the "BORROWERS"); the Lenders listed on the signature pages thereof; First Union National Bank, as syndication agent; PNC Capital Markets, Inc. and First Union Securities, Inc., as co-arrangers; and PNC Bank, National Association, as collateral agent and administrative agent (in such capacity, "ADMINISTRATIVE AGENT"), and as an issuing bank for Letters of Credit thereunder. Capitalized terms used herein without definition herein shall have the meanings assigned to such terms in the DIP Credit Agreement and the Borrowing Order. Borrowers and Lenders desire to amend the DIP Credit Agreement to extend the maturity date of the DIP Credit Agreement. The Lenders are prepared to do so solely on the terms and conditions herein. NOW, THEREFORE, for and in consideration of the foregoing premises, the mutual covenants and agreements hereinafter set forth and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Borrowers and the Lenders hereby agree as follows: The Borrowers and the undersigned Lenders hereby agree that the definition of "Stated Maturity Date" is hereby amended by deleting the reference to "July 19, 2001" contained therein and substituting therefor "December 31, 2001." On and after the Twelfth Amendment Effective Date (as defined below), each reference in the DIP Credit Agreement to "this Agreement", "hereunder", "hereof", "herein" or words of like import referring to the DIP Credit Agreement, and each reference in the other Financing Documents to the "DIP Credit Agreement", "thereunder", "thereof" or words of like import referring to the DIP Credit Agreement, shall mean and be a reference to the DIP Credit Agreement as amended through the date thereof, including by this Twelfth Amendment to Debtor-In-Possession Credit Agreement (this "TWELFTH AMENDMENT"; the DIP Credit Agreement, as so amended, being the "AMENDED AGREEMENT"). Without limiting the generality of the provisions of Section 11.05 of the DIP Credit Agreement, the amendment set forth above shall be limited precisely as written, and nothing in this Twelfth Amendment shall be deemed to prejudice any right or remedy that the 2 Administrative Agent or any Lender may now have or may have in the future under or in connection with the DIP Credit Agreement or any of such other Financing Documents. Except as specifically amended by this Twelfth Amendment, the DIP Credit Agreement and such other Financing Documents shall remain in full force and effect and are hereby ratified and confirmed. In order to induce Lenders to enter into this Twelfth Amendment, each Borrower, by its execution of a counterpart of this Twelfth Amendment, represents and warrants that, subject to obtaining the approval of the Court to the execution, delivery and performance of this Twelfth Amendment, (a) such Borrower has the corporate or other power and authority and all material Governmental Approvals required to enter into this Twelfth Amendment and to carry out the transactions contemplated by, and perform its obligations under, the Amended Agreement, (b) the execution and delivery of this Twelfth Amendment and the performance of the Amended Agreement have been duly authorized by all necessary corporate or other action on the part of such Borrower, (c) the execution and delivery by such Borrower of this Twelfth Amendment and the performance by such Borrower of the Amended Agreement do not and will not contravene, or violate, any Applicable Laws (including an applicable order of the Court) or any provision of its Organizational Documents, or constitute a default under any agreement or other instrument binding upon it (which default, in the case of such instruments or agreements, would give rise to rights enforceable on a post-Petition Date basis) or result in or require the imposition of any Liens (other than the Liens created by the Collateral Documents) on any of its assets, (d) the execution and delivery by such Borrower of this Twelfth Amendment and the performance by such Borrower of the Amended Agreement do not and will not require any action by or in respect of, or filing with, any governmental body, agency or official, (e) this Twelfth Amendment and the Amended Agreement have been duly executed and delivered by such Borrower and constitute the valid and binding obligations of such Borrower, enforceable in accordance with their respective terms, except as may be limited by general principles of equity, and (f) after giving effect to this Twelfth Amendment, no event has occurred and is continuing or will result from the consummation of the transactions contemplated by this Twelfth Amendment that would constitute a Default. This Twelfth Amendment may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed and delivered shall be deemed an original, but all such counterparts together shall constitute but one and the same instrument. This Twelfth Amendment shall become effective (the date of such effectiveness being the "TWELFTH AMENDMENT EFFECTIVE DATE") as of July 19, 2001 provided the following conditions shall have been met: (a) the Borrowers and each of the Lenders shall have executed counterparts of this Twelfth Amendment and the Borrowers and the Administrative Agent shall have received written or telephonic notification of such execution and authorization of delivery thereof, (b) the Administrative Agent shall have received from the Borrowers, for distribution to the undersigned Lenders in accordance with their respective Percentages, an amendment fee of 1% of the aggregate Tranche A Commitments of such Lenders after giving effect to this Twelfth Amendment, (c) PNC Bank, National Association, as administrative agent under the Existing Credit Facilities (the "PREPETITION AGENT"), shall have received an adequate protection payment from the Borrower an amount to be agreed to by the Borrowers and the Prepetition Agent, for the ratable benefit of each of the Existing Lenders, in partial satisfaction of the Prepetition Indebtedness due under the Existing Credit Facilities (to be applied by the Prepetition Agent in accordance with the terms of the Existing Credit Facilities), (d) the Court Agent 2 3 shall have entered an order, in form and substance satisfactory to the Lenders, approving this Twelfth Amendment, the amendment fee and the adequate protection payment referenced above, and (e) the Administrativeshall have received evidence satisfactory to it that all outstanding statements of O'Melveny & Myers LLP, Buchanan Ingersoll, P.C., Houlihan Lokey Howard & Zukin and Deloitte Consulting, L.L.C. that are received by MHG prior to 12:00 Noon (New York City time) on July 13, 2001 have been paid in full. THIS TWELFTH AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE GOVERNED BY, AND SHALL BE CONSTRUED AND ENFORCED IN ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE OF NEW YORK (INCLUDING WITHOUT LIMITATION SECTION 5-1401 OF THE GENERAL OBLIGATIONS LAW OF THE STATE OF NEW YORK), WITHOUT REGARD TO CONFLICTS OF LAWS PRINCIPLES. [Remainder of page intentionally left blank] 3 4 BORROWERS: MARINER HEALTH GROUP, INC. AID & ASSISTANCE, INC. BEECHWOOD HERITAGE RETIREMENT COMMUNITY, INC. BRIDE BROOK NURSING & REHABILITATION CENTER, INC. COMPASS PHARMACY SERVICES, INC. COMPASS PHARMACY SERVICES OF MARYLAND, INC. COMPASS PHARMACY SERVICES OF TEXAS, INC. CYPRESS NURSING FACILITY, INC. LONG RIDGE NURSING AND REHABILITATION CENTER, INC. LONGWOOD REHABILITATION CENTER, INC. MARINER HEALTH AT BONIFAY, INC. MARINER HEALTH CARE, INC. MARINER HEALTH CARE OF ATLANTIC SHORES, INC. MARINER HEALTH CARE OF DELAND, INC. MARINER HEALTH CARE OF FORT WAYNE, INC. MARINER HEALTH CARE OF GREATER LAUREL, INC. MARINER HEALTH CARE OF INVERNESS, INC. MARINER HEALTH CARE OF LAKE WORTH, INC. MARINER HEALTH CARE OF MACCLENNY, INC. MARINER HEALTH CARE OF METROWEST, INC. MARINER HEALTH CARE OF NASHVILLE, INC. MARINER HEALTH CARE OF NORTH HILLS, INC. MARINER HEALTH CARE OF ORANGE CITY, INC. MARINER HEALTH CARE OF PALM CITY, INC. MARINER HEALTH CARE OF PINELLAS POINT, INC. MARINER HEALTH CARE OF PORT ORANGE, INC. MARINER HEALTH CARE OF SOUTHERN CONNECTICUT, INC. MARINER HEALTH CARE OF TOLEDO, INC. MARINER HEALTH CARE OF TUSKAWILLA, INC. MARINER HEALTH CARE OF WEST HILLS, INC. MARINER HEALTH CENTRAL, INC. MARINER HEALTH HOME CARE, INC. MARINER HEALTH OF FLORIDA, INC. MARINER HEALTH OF JACKSONVILLE, INC. MARINER HEALTH OF MARYLAND, INC. MARINER HEALTH OF ORLANDO, INC. MARINER HEALTH OF PALMETTO, INC. MARINER HEALTH OF SEMINOLE COUNTY, INC. MARINER HEALTH OF TAMPA, INC. MARINER HEALTH RESOURCES, INC. MARINER PHYSICIAN SERVICES, INC. MARINER PRACTICE CORPORATION MARINER - REGENCY HEALTH PARTNERS, INC. MARINERSELECT STAFFING SOLUTIONS, INC. MARINER SUPPLY SERVICES, INC. MEDREHAB, INC.
S-1 5 MEDREHAB OF INDIANA, INC. MEDREHAB OF LOUISIANA, INC. MEDREHAB OF MISSOURI, INC. MERRIMACK VALLEY NURSING & REHABILITATION CENTER, INC. METHUEN NURSING & REHABILITATION CENTER, INC. MHC REHAB. CORP. MHC TRANSPORTATION, INC. MYSTIC NURSING & REHABILITATION CENTER, INC. NATIONAL HEALTH STRATEGIES, INC. PARK TERRACE NURSING & REHABILITATION CENTER, INC. PENDLETON NURSING & REHABILITATION CENTER, INC. PINNACLE CARE CORPORATION PINNACLE CARE CORPORATION OF HUNTINGTON PINNACLE CARE CORPORATION OF NASHVILLE PINNACLE CARE CORPORATION OF SENECA PINNACLE CARE CORPORATION OF SUMTER PINNACLE CARE CORPORATION OF WILLIAMS BAY PINNACLE CARE CORPORATION OF WILMINGTON PINNACLE CARE MANAGEMENT CORPORATION PINNACLE PHARMACEUTICALS, INC. PINNACLE PHARMACEUTICAL SERVICES, INC. PINNACLE REHABILITATION, INC. PINNACLE REHABILITATION OF MISSOURI, INC. PRISM CARE CENTERS, INC. PRISM HEALTH GROUP, INC. PRISM HOME CARE COMPANY, INC. PRISM HOME CARE, INC. PRISM HOME HEALTH SERVICES, INC. PRISM HOSPITAL VENTURES, INC. PRISM REHAB SYSTEMS, INC. REGENCY HEALTH CARE CENTER OF SEMINOLE COUNTY, INC. SASSAQUIN NURSING & REHABILITATION CENTER, INC. TAMPA MEDICAL ASSOCIATES, INC. THE OCEAN PHARMACY, INC. TRI-STATE HEALTH CARE, INC. WINDWARD HEALTH CARE, INC. BY: -------------------------------------------------- Boyd P. Gentry Vice President for each of the foregoing Borrowers
S-2 6 IHS REHAB PARTNERSHIP, LTD. BY: MARINER HEALTH CARE OF NASHVILLE, INC., its General Partner By: --------------------------------------------- Name: Title: MARINER HEALTH PROPERTIES IV, LTD. BY: MARINER HEALTH OF FLORIDA, INC., its General Partner By: --------------------------------------------- Name: Title: MARINER HEALTH PROPERTIES VI, LTD. BY: MARINER HEALTH OF FLORIDA, INC., its General Partner By: --------------------------------------------- Name: Title: SEVENTEENTH STREET ASSOCIATES LIMITED PARTNERSHIP BY: TRI-STATE HEALTH CARE, INC., its General Partner By: --------------------------------------------- Name: Title:
S-3 7 ALLEGIS HEALTH AND LIVING CENTER AT HERITAGE HARBOUR, L.L.C. BY: MARINER HEALTH OF MARYLAND, INC., its General Partner By: ------------------------------------------ Name: Title:
S-4 8 AGENTS AND LENDERS: PNC BANK, NATIONAL ASSOCIATION, Individually as a Continuing Lender and as Administrative Agent, Collateral Agent and LC Issuing Bank By: ----------------------------------------------------- Name: Title:
S-5 9 FIRST UNION NATIONAL BANK, individually as a Continuing Lender and as Syndication Agent By: ----------------------------------------------------- Name: Title:
S-6 10 CREDIT LYONNAIS NEW YORK BRANCH, individually as a Continuing Lender By: ------------------------------- Name: Title:
S-7 11 BANK AUSTRIA CREDITANSTALT CORPORATE FINANCE, INC. individually as a Continuing Lender By: ------------------------------------------ Name: Title: By: ------------------------------------------ Name: Title: S-8
EX-10.2 4 g71154ex10-2.txt FOURTH AMENDMENT, DATED JUNE 26, 2001 1 FOURTH AMENDMENT TO REVOLVING CREDIT AND GUARANTY AGREEMENT FOURTH AMENDMENT, dated as of June 26, 2001 (the "Amendment"), to the REVOLVING CREDIT AND GUARANTY AGREEMENT, dated as of January 18, 2000, among MARINER POST-ACUTE NETWORK, INC., a Delaware corporation (the "Borrower"), a debtor and debtor-in-possession under Chapter 11 of the Bankruptcy Code, the Guarantors named therein (the "Guarantors"), THE CHASE MANHATTAN BANK, a New York banking corporation ("Chase"), each of the other financial institutions party thereto (together with Chase, the "Banks") and THE CHASE MANHATTAN BANK, as Agent for the Banks (in such capacity, the "Agent"): W I T N E S S E T H: WHEREAS, the Borrower, the Guarantors, the Banks and the Agent are parties to that certain Revolving Credit and Guaranty Agreement, dated as of January 18, 2000, as amended by the First Amendment to Revolving Credit and Guaranty Agreement dated as of February 16, 2000, the Second Amendment to Revolving Credit and Guaranty Agreement dated as of March 20, 2000 and the Third Amendment to Revolving Credit and Guaranty Agreement dated as of January 11, 2001 (as the same may be further amended, modified or supplemented from time to time, the "Credit Agreement"); and WHEREAS, the Borrower and the Guarantors have requested that from and after the Effective Date (as hereinafter defined) of this Amendment, the Credit Agreement be amended subject to and upon the terms and conditions set forth herein; NOW, THEREFORE, in consideration of the foregoing premises, the mutual covenants hereinafter set forth and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, it is agreed by the parties as follows: 1. As used herein all terms that are defined in the Credit Agreement shall have the same meanings herein. 2. Section 1.01 of the Credit Agreement is hereby amended by inserting the following new definitions in appropriate alphabetical order: "Fourth Amendment" shall mean the Fourth Amendment to Revolving Credit and Guaranty Agreement, dated as of June 26, 2001. "Second Amending Order" shall have the meaning set forth in paragraph 8 of the Fourth Amendment. 2 2 3. The definition of the term "Maturity Date" set forth in Section 1.01 of the Credit Agreement is hereby amended in its entirety to read as follows: "Maturity Date" shall mean December 31, 2001. 4. Section 6.04 of the Credit Agreement is hereby amended in its entirety to read as follows: 6.04. CAPITAL EXPENDITURES. (a) Make Capital Expenditures (other than Special Capital Expenditures) in excess of (i) $22,000,000 during the Borrower's fiscal year ending September 30, 2001, and (ii) $6,000,000 during the three (3)-month period ending December 31, 2001. (b) Make Special Capital Expenditures in excess of (i) $5,650,000 during the Borrower's fiscal year ending September 30, 2001, and (ii) $1,000,000 during the three (3)-month period ending December 31, 2001. (c) In the case of any Health Care Facility that is leased from, or subject to a lien in favor of, a Real Estate Financier, make Capital Expenditures or Special Capital Expenditures other than for normal routine maintenance or as required to maintain applicable Health Care Permits. As used in this section, the following terms shall have the meanings specified below: "APS" shall mean American Pharmaceutical Services, Inc. and its Subsidiaries. "LTAC's" shall mean the long-term acute care facilities listed as such on Exhibit A to the Fourth Amendment. "Omega Facilities" shall mean the facilities listed as such on Exhibit A to the Fourth Amendment. "Special Capital Expenditures" shall mean, during any period, any Capital Expenditures incurred during such period by the Borrower or any Guarantor relating to the Omega Facilities, the LTAC's or APS, or in connection with Health Care Facilities identified by the Borrower in the Three-Year Business Plan to be sold or otherwise disposed of, or to settlements with creditors approved by 2 3 the Bankruptcy Court, to the extent that the amount of such Capital Expenditures was not included in the Borrower's Three-Year Business Plan. "Three-Year Business Plan" shall mean Borrower's three-year business plan delivered to the Agent, revised as of May 31, 2000. 5. Section 6.05 of the Credit Agreement is hereby amended by inserting the following dates and the following amounts at the end of the table set forth therein: "September 30, 2001 $51,670,000 October 31, 2001 $58,329,000 November 30, 2001 $64,988,000 December 31, 2001 $71,647,000
6. Section 6.14 of the Credit Agreement is hereby amended by deleting the dates "June 30, 2001", "July 31, 2001" and "August 31, 2001" and the percentages set opposite such dates appearing in the table set forth therein and inserting in lieu thereof the following: "June 30, 2001 85.2% July 31, 2001 85.2% August 31, 2001 85.3% September 30, 2001 85.3% October 31, 2001 85.5% November 30, 2001 85.5% December 31, 2001 85.5%"
7. Clause (j) of Section 7.01 of the Credit Agreement is hereby amended by inserting the parenthetical phrase "(other than pursuant to the First Amending Order and the Second Amending Order)" immediately following the words "modifying either of the Orders" appearing at the end thereof. 8. Except as set forth in the following sentence, this Amendment shall not become effective until the date (the "Effective Date") on which (i) this Amendment shall have been executed by the Borrower, the Guarantors, the Banks and the Agent, and the Agent shall have received evidence satisfactory to it of such execution, (ii) the Borrower shall have paid to the Agent, for the respective account of the Banks, an amendment fee in an aggregate amount equal to $400,000, and (iii) the Bankruptcy Court shall have entered an order satisfactory in form and substance to the Agent (the "Second Amending Order") authorizing the terms of this Amendment (including the payment of the fees provided for in clause (ii) of this paragraph). Notwithstanding anything to the contrary set forth in the preceding sentence, the amendment of Section 6.04 of the Credit Agreement appearing in paragraph 4 above shall become effective on the date on which the condition set forth in clause (i) of the preceding sentence shall have been satisfied (except that the word "Banks" in such clause shall be read as "Required Banks" solely for purposes of this sentence), and irrespective of whether the conditions described in clauses (ii) and (iii) of the preceding sentence have been satisfied. 3 4 9. Except to the extent hereby amended, the Credit Agreement and each of the Loan Documents remain in full force and effect and are hereby ratified and affirmed. 10. The Borrower agrees that its obligations set forth in Section 10.05 of the Credit Agreement shall extend to the preparation, execution and delivery of this Amendment, including the reasonable fees and disbursements of special counsel to the Agent. 11. This Amendment shall be limited precisely as written and shall not be deemed (a) to be a consent granted pursuant to, or a waiver or modification of, any other term or condition of the Credit Agreement or any of the instruments or agreements referred to therein or (b) to prejudice any right or rights which the Agent or the Banks may now have or have in the future under or in connection with the Credit Agreement or any of the instruments or agreements referred to therein. Whenever the Credit Agreement is referred to in the Credit Agreement or any of the instruments, agreements or other documents or papers executed or delivered in connection therewith, such reference shall be deemed to mean the Credit Agreement as modified by this Amendment. 12. This Amendment may be executed in any number of counterparts and by the different parties hereto in separate counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which taken together shall constitute but one and the same instrument. 13. This Amendment shall be governed by, and construed in accordance with, the laws of the State of New York. 4 5 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the day and the year first written. BORROWER: MARINER POST-ACUTE NETWORK, INC. By: ---------------------------------------- Name: Title: GUARANTORS: AMERICAN MEDICAL INSURANCE BILLING SERVICES, INC. AMERICAN PHARMACEUTICAL SERVICES, INC. AMERICAN REHABILITY SERVICES, INC. AMERICAN-CAL MEDICAL SERVICES, INC. AMERRA PROPERTIES, INC. AMS GREEN TREE, INC. AMS PROPERTIES, INC. APS HOLDING COMPANY, INC. APS PHARMACY MANAGEMENT, INC. BRIAN CENTER HEALTH & RETIREMENT/ ALLEGHANY, INC. BRIAN CENTER HEALTH & RETIREMENT/ BASTIAN, INC. BRIAN CENTER HEALTH & RETIREMENT/ TAMPA, INC. BRIAN CENTER HEALTH & RETIREMENT/ WALLACE, INC. BRIAN CENTER MANAGEMENT CORPORATION BRIAN CENTER NURSING CARE/AUSTELL, INC. BRIAN CENTER NURSING CARE/FINCASTLE, INC. BRIAN CENTER NURSING CARE/HICKORY, INC. BRIAN CENTER OF ASHEBORO, INC. BRIAN CENTER OF CENTRAL COLUMBIA, INC. CAMBRIDGE BEDFORD, INC. CAMBRIDGE EAST, INC. CAMBRIDGE NORTH, INC. CAMBRIDGE SOUTH, INC. CLINTONAIRE NURSING HOME, INC. CONNERWOOD HEALTHCARE, INC. 5 6 CORNERSTONE HEALTH MANAGEMENT COMPANY CRESTMONT HEALTH CENTER, INC. DEVCON HOLDING COMPANY EH ACQUISITION CORP. EH ACQUISITION CORP. II EH ACQUISITION CORP. III EVERGREEN HEALTHCARE LTD., L.P. EVERGREEN HEALTHCARE, INC. FRENCHTOWN NURSING HOME, INC. GC SERVICES, INC. GCI BELLA VITA, INC. GCI CAMELLIA CARE CENTER, INC. GCI COLTER VILLAGE, INC. GCI EAST VALLEY MEDICAL & REHABILITATION CENTER, INC. GCI FAITH NURSING HOME, INC. GCI HEALTH CARE CENTERS, INC. GCI JOLLEY ACRES, INC. GCI PALM COURT, INC. GCI PRINCE GEORGE, INC. GCI REHAB, INC. GCI SPRINGDALE VILLAGE, INC. GCI THERAPIES, INC. GCI VILLAGE GREEN, INC. GCI-CAL THERAPIES COMPANY GCI-WISCONSIN PROPERTIES, INC. GRANCARE HOME HEALTH SERVICES, INC. GRANCARE OF MICHIGAN, INC. GRANCARE OF NORTH CAROLINA, INC. GRANCARE OF NORTHERN CALIFORNIA, INC. GRANCARE SOUTH CAROLINA, INC. GRANCARE, INC. HAWK'S-PERIMETER, INC. HERITAGE NURSING HOME, INC. HERITAGE OF LOUISIANA, INC. HMI CONVALESCENT CARE, INC. HOSPICE ASSOCIATES OF AMERICA, INC. HOSTMASTERS, INC. INTERNATIONAL HEALTH CARE MANAGEMENT, INC. INTERNATIONAL X-RAY, INC. LC MANAGEMENT COMPANY LCA OPERATIONAL HOLDING COMPANY LCR, INC. LIVING CENTERS - EAST, INC. LIVING CENTERS - PHCM, INC. 6 7 LIVING CENTERS - ROCKY MOUNTAIN, INC. LIVING CENTERS - SOUTHEAST DEVELOPMENT CORPORATION LIVING CENTERS - SOUTHEAST, INC. LIVING CENTERS DEVELOPMENT COMPANY LIVING CENTERS HOLDING COMPANY LIVING CENTERS LTCP DEVELOPMENT COMPANY LIVING CENTERS OF TEXAS, INC. MADONNA NURSING CENTER, INC. MED-THERAPY REHABILITATION SERVICES, INC. MIDDLEBELT NURSING HOME, INC. MIDDLEBELT-HOPE NURSING HOME, INC. NAN-DAN CORP. NATIONAL HERITAGE REALTY, INC. NIGHTINGALE EAST NURSING CENTER, INC. OMEGA/INDIANA CARE CORP. PROFESSIONAL HEALTH CARE MANAGEMENT, INC. PROFESSIONAL RX SYSTEMS, INC. REHABILITY HEALTH SERVICES, INC. RENAISSANCE MENTAL HEALTH CENTER, INC. ST. ANTHONY NURSING HOME, INC. SUMMIT HOSPITAL HOLDINGS, INC. SUMMIT HOSPITAL OF EAST GEORGIA, INC. SUMMIT HOSPITAL OF SOUTHEAST ARIZONA, INC. SUMMIT HOSPITAL OF SOUTHEAST TEXAS, INC. SUMMIT HOSPITAL OF SOUTHWEST LOUISIANA, INC. SUMMIT HOSPITAL OF WEST GEORGIA, INC. SUMMIT INSTITUTE FOR PULMONARY MEDICINE AND REHABILITATION, INC. SUMMIT INSTITUTE OF AUSTIN, INC. SUMMIT INSTITUTE OF WEST MONROE, INC. 7 8 SUMMIT MEDICAL HOLDINGS, LTD. SUMMIT MEDICAL MANAGEMENT, INC. By: ---------------------------------------- Name: Title: THE CHASE MANHATTAN BANK, INDIVIDUALLY AND AS AGENT By: ---------------------------------------- Name: Title: BANK OF AMERICA, N.A. By: ---------------------------------------- Name: Title: SRV-HIGHLAND, INC. By: ---------------------------------------- Name: Title: GLENEAGLES TRADING LLC By: ---------------------------------------- Name: Title: GENERAL ELECTRIC CAPITAL CORPORATION By: ---------------------------------------- Name: Title: 8 9 FOOTHILL CAPITAL CORPORATION By: ---------------------------------------- Name: Title: GOLDMAN SACHS CREDIT PARTNERS L.P. By: ---------------------------------------- Name: Title: BHF (USA) CAPITAL CORPORATION By: ---------------------------------------- Name: Title: By: ---------------------------------------- Name: Title: BDC FINANCE L.L.C. By: ---------------------------------------- Name: Title: HELLER HEALTHCARE FINANCE, INC. By: ---------------------------------------- Name: Title: BAYERISCHE HYPO- UND VEREINSBANK AG NEW YORK BRANCH By: ---------------------------------------- Name: Title: By: ---------------------------------------- Name: Title: 9 10 MUIRFIELD TRADING LLC By: ---------------------------------------- Name: Title: KEMPER FLOATING RATE FUND By: ---------------------------------------- Name: Title: TORONTO DOMINION (NEW YORK), INC. By: ---------------------------------------- Name: Title: 10 11 EXHIBIT A TO FOURTH AMENDMENT Omega Facilities
Name of Facility Subsidiary Lessee/Operator ---------------- -------------------------- 1. Cambridge South Healthcare Center Cambridge South, Inc. Beverly Hills, MI 2. Clinton-Aire Healthcare Center ClintonAire Nursing Home, Clinton Township, MI Inc. 3. Crestmont Health Care Center Crestmont Health Center, Fenton, MI Inc. 4. Heritage Manor Nursing Center Heritage Nursing Home, Inc. Flint, MI 5. Nightingale Healthcare Center Nightingale East Nursing Warren, MI Center, Inc. 6. Hope Healthcare Center Middlebelt-Hope Nursing Westland, MI Home, Inc. 7. Bedford Villa Healthcare Center Cambridge Bedford, Inc. Southfield, MI 8. Cambridge East Healthcare Center Cambridge East, Inc. Madison Heights, MI 9. Cambridge North Healthcare Center Cambridge North, Inc. Clawson, MI 10. Brian Center Health and Rehabilitation Center - Statesville PHCM Statesville, NC 11. Brian Center Health and Rehabilitation Center - Goldsboro PHCM
12 GOLDSBORO, NC 12. Brian Center Health and Rehabilitation Center -Durham PHCM Durham, NC 13. Frenchtown Healthcare Center Frenchtown Nursing Home, Monroe, MI (SOLD 2/1/01) Inc. 14. St. Anthony Health Care Center St. Anthony Nursing Home, Warren, MI (SOLD 2/1/01) Inc. 15. Madonna Healthcare Center Madonna Nursing Home, Inc. Detroit, MI (SOLD 2/1/01) 16. Middlebelt Healthcare Center Middlebelt Nursing Home, Livonia, MI (SOLD 2/1/01) Inc.
LTAC'S
Name of Facility Subsidiary Lessee/Operator ---------------- -------------------------- 1. Summit Hospital of Northeast Summit Institute of West Monroe, Louisiana, West Monroe, LA Inc. 2. Summit Hospital of Northwest Summit Institute for Pulmonary Louisiana, Bossier City, LA Medicine and Rehabilitation, Inc. 3. Summit Hospital of Southwest Summit Hospital of Southwest Louisiana, Sulphur, LA Louisiana, Inc. 4. Summit Hospital of Southeast Summit Hospital of Southwest Arizona, Inc., Tucson, AZ Arizona, Inc. 5. Specialty Hospital of Houston Cornerstone Health Management Houston, TX Company 6. Specialty Hospital of Houston Cornerstone Health Management (Clear Lakes Campus),Houston, TX Company 7. Specialty Hospital of Austin Cornerstone Health Management Houston, TX Company 8. Specialty Hospital of Austin Cornerstone Health Management (St. David's Campus), Austin, TX Company
13 9. Specialty Hospital of Austin Cornerstone Health Management (North Austin Medical Center), Company Austin, TX 10. Summit Hospital of Central Texas, Summit Institute of Austin, Inc. Austin, TX 11. Specialty Hospital of New Orleans Cornerstone Health Management New Orleans, LA Company 12. Compass Hospital of Dallas Summit Medical Management, Inc. De Soto, TX 13. Compass Hospital of San Antonio Summit Medical Management, Inc. San Antonio, TX 14. Specialty Hospital of Mahoning Cornerstone Health Management Valley, Youngstown, OH Company 15. Specialty Hospital of Lorain, Mariner Specialty Hospital Group Lorain, OH 16. Compass Hospital of Phoenix Summit Medical Management, Inc. Phoenix, AZ
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