-----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, WtHFX2KpmmDC+tBWVhyNgxpuMP3+DUDyZyRTY4UsyC1Ek+QQ7yPGugz5ovdlQjrK htMb1i0RNhCjjzUILX4CGg== 0000950116-99-000221.txt : 19990217 0000950116-99-000221.hdr.sgml : 19990217 ACCESSION NUMBER: 0000950116-99-000221 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990216 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GENESIS HEALTH VENTURES INC /PA CENTRAL INDEX KEY: 0000874265 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SKILLED NURSING CARE FACILITIES [8051] IRS NUMBER: 061132947 STATE OF INCORPORATION: PA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-11666 FILM NUMBER: 99538670 BUSINESS ADDRESS: STREET 1: 101 EAST STATE STREET CITY: KENNETT SQUARE STATE: PA ZIP: 19348 BUSINESS PHONE: 6104446350 MAIL ADDRESS: STREET 1: 101 EAST STATE STREET CITY: KENNETT SQUARE STATE: PA ZIP: 19348 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 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 December 31, 1998 or ( ) TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________________ to ___________________ Commission File Number: 1-11666 GENESIS HEALTH VENTURES, INC. (Exact name of registrant as specified in its charter) Pennsylvania 06-1132947 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 101 East State Street Kennett Square, Pennsylvania 19348 (Address, including zip code, of principal executive offices) (610) 444-6350 (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 [ ] Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of February 8, 1999: 35,227,886 shares of common stock TABLE OF CONTENTS
Page CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS............................................1 Part I: FINANCIAL INFORMATION Item 1. Financial Statements.............................................................2 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................9 Item 3. Quantitative and Qualitative Disclosures About Market Risk......................21 Part II: OTHER INFORMATION Item 1. Legal Proceedings.................................................................22 Item 2. Changes in Securities.............................................................22 Item 3. Defaults Upon Senior Securities...................................................22 Item 4. Submission of Matters to a Vote of Security Holders...............................22 Item 5. Other Information.................................................................22 Item 6. Exhibits and Reports on Form 8-K..................................................22 SIGNATURES .........................................................................................23
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS Certain oral statements made by management from time to time and certain statements contained herein, including certain statements in "Management's Discussion and Analysis of Financial Condition and Results of Operations" such as statements concerning Medicaid and Medicare programs and the Company's ability to meet its liquidity needs and control costs, certain statements in "Qualitative and Quantitative Disclosures about Market Risk", certain statements in Notes to Unaudited Condensed Consolidated Financial Statements, such as certain Pro Forma Financial Information; and other statements contained herein regarding matters which are not historical facts are forward looking statements (as such term is defined in the Securities Act of 1933) and because such statements involve risks and uncertainties, actual results may differ materially from those expressed or implied by such forward looking statements. Factors that could cause actual results to differ materially include, but are not limited to those discussed below: 1. Changes in the United States healthcare system, including changes in reimbursement levels under Medicaid and Medicare, implementation of the Medicare prospective payment system and consolidated billing and other changes in applicable government regulations that might affect the profitability of the Company. 2. The Company's substantial indebtedness and significant debt service obligations. 3. The Company's ability to secure the capital and the related cost of such capital necessary to fund its future growth through acquisition and development, as well as internal growth. 4. The Company's continued ability to operate in a heavily regulated environment and to satisfy regulatory authorities, thereby avoiding a number of potentially adverse consequences, such as the imposition of fines, temporary suspension of admission of patients, restrictions on the ability to acquire new facilities, suspension or decertification from Medicaid or Medicare programs, and, in extreme cases, revocation of a facility's license or the closure of a facility, including as a result of unauthorized activities by employees. 5. The occurrence of changes in the mix of payment sources utilized by the Company's customers to pay for the Company's services. 6. The adoption of cost containment measures by private pay sources such as commercial insurers and managed care organizations, as well as efforts by governmental reimbursement sources to impose cost containment measures. 7. The level of competition in the Company's industry, including without limitation, increased competition from acute care hospitals, providers of assisted and independent living and providers of home health care and changes in the regulatory system, such as changes in certificate of need laws in the states in which the Company operates or anticipates operating in the future that facilitate such competition. 8. The Company's ability to identify suitable acquisition candidates, to consummate or complete development projects, or to profitably operate or successfully integrate enterprises into the Company's other operations. 9. The Company's and its payors' and suppliers' ability to implement a Year 2000 readiness program. These and other factors have been discussed in more detail in the Company's periodic reports, including its Annual Report on Form 10-K as amended for the fiscal year ended September 30, 1998. 1 PART I: FINANCIAL INFORMATION Item 1. Financial Statements Genesis Health Ventures, Inc. and Subsidiaries Unaudited Condensed Consolidated Balance Sheets (in thousands, except share and per share data)
December 31, September 30, - ------------------------------------------------------------------------------------------------------------------------------------ 1998 1998 - ------------------------------------------------------------------------------------------------------------------------------------ Assets Current assets: Cash and equivalents $ 8,901 $ 4,902 Investments in marketable securities 24,186 26,658 Accounts receivable, net 405,482 376,023 Cost report receivables 63,861 62,257 Inventory 66,703 63,760 Prepaid expenses and other current assets 34,578 40,579 - ------------------------------------------------------------------------------------------------------------------------------------ Total current assets 603,711 574,179 - ------------------------------------------------------------------------------------------------------------------------------------ Property, plant, and equipment, net 608,692 596,562 Notes receivable and other investments 49,785 47,623 Other long-term assets 77,706 73,904 Investments in unconsolidated affiliates 356,149 344,567 Goodwill and other intangibles, net 974,635 990,533 - ------------------------------------------------------------------------------------------------------------------------------------ Total assets $ 2,670,678 $ 2,627,368 - ------------------------------------------------------------------------------------------------------------------------------------ Liabilities and Shareholders' Equity Current liabilities: Current installments of long-term debt $ 34,160 $ 49,712 Accounts payable and accrued expenses 192,260 218,749 Income taxes payable 4,427 - - ------------------------------------------------------------------------------------------------------------------------------------ Total current liabilities 230,847 268,461 - ------------------------------------------------------------------------------------------------------------------------------------ Long-term debt 1,439,457 1,358,595 Deferred income taxes 69,357 72,828 Deferred gain and other long-term liabilities 50,959 52,412 Shareholders' equity: Series G Cumulative Convertible Preferred Stock, par $.01, authorized 5,000,000 shares, 590,253 issued and outstanding at December 31, 1998 and September 30, 1998 6 6 Common stock, par $.02, authorized 60,000,000 shares, issued and outstanding 35,227,449 and 35,181,848 at December 31, 1998; 35,225,731 and 35,180,130 at September 30, 1997 704 704 Additional paid-in capital 749,500 749,491 Retained earnings 129,601 124,430 Accumulated other comprehensive income 490 684 Treasury stock, at cost (243) (243) - ------------------------------------------------------------------------------------------------------------------------------------ Total shareholders' equity 880,058 875,072 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities and shareholders' equity $ 2,670,678 $ 2,627,368 - ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to unaudited condensed consolidated financial statements 2 Genesis Health Ventures, Inc. and Subsidiaries Unaudited Condensed Consolidated Statements of Operations ( in thousands, except share and per share data)
Three months ended December 31, - --------------------------------------------------------------------------------------------------------------------- 1998 1997 - --------------------------------------------------------------------------------------------------------------------- Net revenues: Pharmacy and medical supply services $ 236,217 $ 68,696 Inpatient services 176,032 180,805 Other revenue 66,955 53,064 - --------------------------------------------------------------------------------------------------------------------- Total net revenues 479,204 302,565 - --------------------------------------------------------------------------------------------------------------------- Operating expenses: Operating expenses 393,082 233,342 General corporate expense 14,968 12,037 Depreciation and amortization 17,807 11,686 Lease expense 6,367 6,643 Interest expense, net 27,323 19,643 - --------------------------------------------------------------------------------------------------------------------- Earnings before income taxes, equity in net income (loss) of unconsolidated affiliates and extraordinary items 19,657 19,214 Income taxes 7,378 7,013 - --------------------------------------------------------------------------------------------------------------------- Earnings before equity in net income (loss) of unconsolidated affiliates and extraordinary items 12,279 12,201 Equity in net income (loss) of unconsolidated affiliates (892) 621 - --------------------------------------------------------------------------------------------------------------------- Earnings before extraordinary items 11,387 12,822 Extraordinary items, net of tax (1,799) (1,924) - --------------------------------------------------------------------------------------------------------------------- Net income 9,588 10,898 Preferred stock dividend 4,417 - - --------------------------------------------------------------------------------------------------------------------- Net income available to common shareholders $ 5,171 $ 10,898 - --------------------------------------------------------------------------------------------------------------------- Per common share data: Basic Earnings before extraordinary items $ 0.20 $ 0.37 Net income $ 0.15 $ 0.31 Weighted average shares of common stock and equivalents 35,217,418 35,079,426 - --------------------------------------------------------------------------------------------------------------------- Diluted Earnings before extraordinary items $ 0.20 $ 0.36 Net income $ 0.15 $ 0.31 Weighted average shares of common stock and equivalents 35,380,732 35,594,481 - ---------------------------------------------------------------------------------------------------------------------
See accompanying notes to unaudited condensed consolidated financial statements 3 Genesis Health Ventures, Inc. and Subsidiaries Unaudited Condensed Consolidated Statements of Cash Flows (in thousands)
Three months ended December 31, 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 5,170 $ 10,898 Net charges included in operations not requiring funds 21,880 14,644 Changes in assets and liabilities excluding the effects of acquisitions: Accounts receivable (29,459) (12,312) Accounts payable and accrued expenses (22,364) (8,622) Other, net 911 (527) - ----------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) operations $ (23,862) $ 4,081 - ----------------------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Capital expenditures (17,551) (10,925) Payments for acquisitions and related costs, net of cash acquired (4,125) (41,174) Investments in unconsolidated affiliates (12,474) (326,641) Cash paid for assets held for sale - (20,109) Sale of marketable securities 2,472 - Notes receivable and other investment and other asset additions, net (2,692) (12,805) - ----------------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (34,370) (411,654) - ----------------------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Net borrowings (repayments) under working capital revolving credit facility 65,539 (164,800) Repayment of long term debt and payment of sinking fund requirements (120,429) (1,973) Proceeds from issuance of long-term debt 120,200 600,000 Debt issuance costs (3,088) (19,648) Purchase of common stock call options - (4,442) Stock options exercised 9 313 - ----------------------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 62,231 409,450 - ----------------------------------------------------------------------------------------------------------------------------------- Net increase in cash and equivalents: 3,999 1,877 Cash and equivalents Beginning of period 4,902 11,651 - ----------------------------------------------------------------------------------------------------------------------------------- End of period $ 8,901 $ 13,528 - ----------------------------------------------------------------------------------------------------------------------------------- Supplemental disclosure of cash flow information: Interest paid $ 35,660 $ 22,550 Income taxes paid $ 186 $ - - -----------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to unaudited condensed consolidated financial statements 4 GENESIS HEATLH VENTURES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. General The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's annual report on Form 10-K for the fiscal year ended September 30, 1998. The information furnished is unaudited but reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial information for the periods shown. Such adjustments are of a normal recurring nature. Interim results are not necessarily indicative of results expected for the full year. Certain prior period balances have been reclassified to conform with the current period presentation. 2. Long-Term Debt Genesis entered into a credit agreement pursuant to which the lenders provided Genesis and its subsidiaries a credit facility totaling $1,250,000,000 (the "Credit Facility") for the purpose of: refinancing certain existing indebtedness of Genesis; funding interest and principal payments on the facilities and certain remaining indebtedness; funding permitted acquisitions; funding Genesis' commitments in connection with the Vitalink Transaction; and funding Genesis' and its subsidiaries' working capital for general corporate purposes, including fees and expenses of the transactions. The Credit Facility consists of three term loans with original balances of $200,000,000 each (collectively, the "Term Loans"), a $650,000,000 revolving credit loan (the "Revolving Facility"), which includes one or more Swing Loans (collectively, the "Swing Loan Facility") in integral principal multiples of $500,000 up to an aggregate unpaid principal amount of $20,000,000. The Term Loans amortize in quarterly installments beginning in Fiscal 1998 through 2005, of which $21,419,000 is payable in Fiscal 1999. The Term Loans consist of (i) a six year term loan with an outstanding balance of $130,525,000 at December 31, 1998 (the "Tranche A Term Facility"); (ii) a seven year term loan with an outstanding balance of $153,687,000 (the "Tranche B Term Facility"); and (iii) an eight year term loan with an outstanding balance of $173,450,000 (the "Tranche C Term Facility"). The Revolving Facility becomes payable in full on September 30, 2003. The third amendment to the Credit Facility, dated December 15, 1998, made the financial covenants for certain periods less restrictive, permitted a portion of the proceeds of subordinated debt offerings to repay indebtedness under the Revolving Facility and increased the interest rates applying to the Term Loans and the Revolving Facility. The revised financial covenants accommodate the projected impact of PPS beginning in fiscal 1999 and the non-cash charges in the fourth quarter of fiscal 1998. The Credit Facility is secured by a first priority security interest in all of the stock, partnership interests and other equity of all of Genesis' present and future subsidiaries (including Genesis ElderCare Corp.) other than the stock of Multicare and its subsidiaries. Loans under the Credit Facility bear, at Genesis' option, interest at the per annum Prime Rate as announced by the administrative agent, or the applicable Adjusted LIBO Rate plus, in either event, a margin (the "Annual Applicable Margin") that is dependent upon a certain financial ratio test. Loans under the Tranche A Term Facility and Revolving Facility have an Annual Applicable Margin of .75% for Prime Rate loans and 2.5% (an effective rate of 7.90% at December 31, 1998) for LIBO Rate loans. Loans under the Tranche B Term Facility have an Annual Applicable Margin of 1.25% for Prime Rate loans and 3.0% (an effective rate of 8.40% at December 31, 1998) for LIBO Rate loans. Loans under the Tranche C Term Facility have an Annual Applicable Margin of 1.5% for Prime Rate loans and 3.25% (an effective rate of 8.65% at December 31, 1998) for LIBO Rate loans. Loans under the Swing Loan Facility bear interest at the Prime Rate unless otherwise agreed to by the parties. Subject to meeting certain financial ratios, the above referenced interest rates are reduced. The Credit Facility contains a number of covenants that, among other things, restrict the ability of Genesis and its subsidiaries to dispose of assets, incur additional indebtedness, make loans and investments, pay dividends, engage in 5 mergers or consolidations, engage in certain transactions with affiliates and change control of capital stock, and to make capital expenditures; prohibit the ability of Genesis and its subsidiaries to prepay debt to other persons, make material changes in accounting and reporting practices, create liens on assets, give a negative pledge on assets, make acquisitions and amend or modify documents; causes Genesis and its affiliates to maintain the Management Agreement, the Put/Call Agreement, as defined, and corporate separateness; and will cause Genesis to comply with the terms of other material agreements, as well as comply with usual and customary covenants for transactions of this nature. In December 1998, the Company issued $125,000,000, 9 7/8% Senior Subordinated Notes due 2009 at a price of 96.1598% resulting in net proceeds of $120,200,000. Interest on the notes is payable semi-annually on January 15 and July 15 of each year, commencing July 15, 1999. Approximately $59,900,000 of the net proceeds were used to repay portions of the Tranche A, B and C Term Facilities and approximately $59,900,000 of the net proceeds were used to repay a portion of the Revolving Facility. 3. Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share applicable to common shares: (amounts are in thousands except per share data):
Three Months Ended Three Months Ended December 31, 1998 December 31, 1997 ------------------- ------------------ Basic Earnings Per Share: Income before extraordinary items $ 6,970 $ 12,822 Extraordinary items (1,799) (1,924) -------- -------- Net income available to common shareholders $ 5,171 $ 10,898 -------- -------- Weighted average shares 35,217 35,079 -------- -------- Earnings per share before extraordinary items $ 0.20 $ 0.37 -------- -------- Earnings per share $ 0.15 $ 0.31 -------- -------- Diluted Earnings Per Share: Income before extraordinary items $ 6,970 $ 12,822 Extraordinary items (1,799) (1,924) -------- -------- Net income available to common shareholders $ 5,171 $ 10,898 -------- -------- Weighted Average Shares & Common Stock Equivalents: Common shares 35,217 35,079 Dilutive effect of unexcercised stock options 164 515 -------- -------- Total 35,381 35,594 -------- -------- Earnings per share before extraordinary items $ 0.20 $ 0.36 -------- -------- Earnings per share $ 0.15 $ 0.31 -------- --------
6 4. Pro Forma Financial Information On August 28, 1998, Genesis and its wholly-owned subsidiary V Acquisition Corporation ("Newco") consummated an Agreement and Plan of Merger (the "Merger Agreement") with Vitalink Pharmacy Services, Inc., a Delaware corporation ("Vitalink"), pursuant to which Vitalink merged with and into Newco (the "Vitalink Transaction"). Each share of Vitalink Common Stock, par value $.01 per share (the "Vitalink Common Stock"), was converted in the merger into the right to receive (i) .045 shares of Genesis Series G Cumulative Convertible Preferred Stock, par value $.01 per share (the "Genesis Preferred"), (ii) $22.50 in cash, or (iii) a combination of cash and shares of Genesis Preferred (collectively, the "Merger Consideration"). The Merger Consideration paid to stockholders of Vitalink to acquire their shares (including shares which may have been issued upon the exercise of outstanding options) was $590,200,000 of which 50% was paid in cash and 50% in Genesis Preferred. The Genesis Preferred has a face value of approximately $295,100,000 and an initial dividend of 5.9375% and generally is not transferable without the consent of the Company. The Genesis Preferred is convertible into Genesis common stock, par value $.02 per share (the "Common Stock"), at $37.20 per share and it may be called for conversion after April 26, 2001, provided the price of Common Stock reaches certain trading levels and after April 26, 2002, subject to a market-based call premium. As a result of the merger, Genesis assumed approximately $87,000,000 of indebtedness Vitalink had outstanding. The cash portion of the purchase price was funded through borrowings under the Credit Facility. The Vitalink Transaction is being accounted for under the purchase method and the related goodwill is being amortized over a forty year period. Genesis entered into a stock purchase agreement with Multicare and certain subsidiaries pursuant to which Genesis acquired all of the outstanding capital stock and limited partnership interests of certain subsidiaries of Multicare that are engaged in the business of providing institutional pharmacy services to third parties for $50,000,000 (the "Pharmacy Purchase"), subject to adjustment. The Company completed the Pharmacy Purchase effective January 1, 1998, which was accounted for under the purchase method and the related goodwill is being amortized over forty years. The following unaudited pro forma statement of operations information gives effect to the Vitalink Transaction and the Pharmacy Purchase as though they had occurred on October 1, 1997, after giving effect to certain adjustments, including recognition of goodwill amortization, additional depreciation expense and increased interest expense on debt related to the transaction. The pro forma financial information, which includes preliminary allocations of purchase price to goodwill and property, plant and equipment that are subject to change, does not necessarily reflect the results of operations that would have occurred had the transactions occurred at the beginning of period presented.
(In thousands, except per share data) Three Months Ended Pro Forma Statement of Operations Information: December 31, 1997 ----------------- Total net revenue $ 446,298 Income before extraordinary items 11,092 Net income 9,168 Earnings per share, before extraordinary items, diluted 0.31 Earnings per share, diluted $ 0.26
7 5. Summary Financial Information of Unconsolidated Affiliate The following unaudited summary financial data for the Multicare Companies is as of, and for the three months ended, December 31, 1998. Multicare is the Company's only material unconsolidated affiliate. (in thousands) December 31, 1998 -------------------- Total assets $ 1,711,274 Long-term debt 735,522 Total liabilities $ 980,614 Three Months Ended December 31, 1998 -------------------- Revenues $ 168,484 Net loss $ (2,578) 6. Comprehensive Income In October 1998, the Company adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("Statement 130"). Statement 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the adoption of Statement 130 had no impact on the Company's net income available to common shareholders. Statement 130 requires unrealized gains or losses on the Company's available-for-sale securities be included in other comprehensive income. The following table sets forth the computation of comprehensive income (amounts are in thousands):
Three Months Ended Three Months Ended December 31, 1998 December 31, 1997 ----------------------- ----------------------- Net income available to common shareholders $ 5,171 $10,898 Unrealized gain (loss) on marketable securities (194) 89 ----------------------- ----------------------- Total comprehensive income $ 4,977 $10,987 ----------------------- -----------------------
Accumulated other comprehensive income, which is composed of net unrealized gains and losses on marketable securities, was $490,000 and $185,000 at December 31, 1998 and 1997, respectively. 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations General Since the Company began operations in July 1985, it has focused its efforts on providing an expanding array of specialty medical services to elderly customers. The Company generates revenues from three sources: pharmacy and medical supply services, inpatient services and other revenue. The Company provides pharmacy and medical supply services through its NeighborCare (SM) pharmacy subsidiaries. Included in pharmacy and medical supply service revenues are institutional pharmacy revenues, which include the provision of infusion therapy, medical supplies and equipment provided to eldercare centers it operates, as well as to independent healthcare providers by contract. The pharmacy services provided in these settings are tailored to meet the needs of the institutional customer. These services include highly specialized packaging and dispensing systems, computerized medical records processing and 24-hour emergency services. The Company's institutional pharmacy and medical supply services were developed to provide the products and support services required in the healthcare market. Institutional pharmacy services are designed to help assure quality of care and to control costs at the facilities served. Medical supply services are designed to assure availability and control through maintenance of a comprehensive inventory, extensive delivery services and special ordering and tracking systems. The Company also provides pharmacy consulting services to assure proper and effective drug therapy. The Company provides these services through 79 institutional pharmacies (of which one is jointly-owned) and 14 distribution centers located in its various market areas. In addition, the Company operates 33 community-based pharmacies which are located in or near medical centers, hospitals and physician office complexes. The community-based pharmacies provide prescription and over-the-counter medications and certain medical supplies, as well as personal service and consultation by licensed professional pharmacists. Approximately 89% of the sales attributable to all pharmacy operations in Fiscal 1998 were generated through external contracts with independent healthcare providers with the balance attributable to centers owned or leased by the Company. The Company includes in inpatient service revenue all room and board charges and ancillary service revenue for its eldercare customers at its 113 owned and leased eldercare centers. The centers offer three levels of care for their customers: skilled, intermediate and personal. Skilled care provides 24-hour per day professional services of a registered nurse; intermediate care provides less intensive nursing care; and personal care provides for the needs of customers requiring minimal supervision and assistance. Each eldercare center is supervised by a licensed healthcare administrator and employs a Medical Director to supervise the delivery of healthcare services to residents and a Director of Nursing to supervise the nursing staff. The Company maintains a corporate quality assurance program to monitor regulatory compliance and to enhance the standard of care provided in each center. The Company includes the following in other revenues: rehabilitation therapy, management fees, capitation fees, homecare services, physician services, transportation services, diagnostic services, hospitality services, group purchasing fees and other healthcare related services. Certain Transactions Vitalink Transaction On August 28, 1998, Genesis and its wholly-owned subsidiary V Acquisition Corporation ("Newco") consummated an Agreement and Plan of Merger (the "Merger Agreement") with Vitalink Pharmacy Services, Inc., a Delaware corporation ("Vitalink"), pursuant to which Vitalink merged with and into Newco (the "Vitalink Transaction"). Each share of Vitalink Common Stock, par value $.01 per share (the "Vitalink Common Stock"), was converted in the merger into the right 9 to receive (i) .045 shares of Genesis Series G Cumulative Convertible Preferred Stock, par value $.01 per share (the "Genesis Preferred"), (ii) $22.50 in cash, or (iii) a combination of cash and shares of Genesis Preferred (collectively, the "Merger Consideration"). The Merger Consideration paid to stockholders of Vitalink to acquire their shares (including shares which may have been issued upon the exercise of outstanding options) was $590,200,000, of which 50% was paid in cash and 50% in Genesis Preferred. The Genesis Preferred has a face value of approximately $295,100,000 and an initial dividend of 5.9375% and generally is not transferable without the consent of the Company. The Genesis Preferred is convertible into Genesis common stock, par value $.02 per share (the "Common Stock"), at $37.20 per share and it may be called for conversion after April 26, 2001, provided the price of Common Stock reaches certain trading levels and after April 26, 2002, subject to a market-based call premium. As a result of the merger, Genesis assumed approximately $87,000,000 of indebtedness Vitalink had outstanding. The cash portion of the purchase price was funded through borrowings under the Credit Facility. See "Liquidity and Capital Resources." Pursuant to four agreements with HCR-Manor Care, Vitalink provides pharmaceutical products and services, enteral and parenteral therapy supplies and services, urological and ostomy products, intravenous products and services and pharmacy consulting services to facilities operated by HCR-Manor Care (the "Service Contracts"). Vitalink is not restricted from providing similar contracts to non-HCR-Manor Care facilities. The current term of each of the Service Contracts extends through September 2004, subject to annual renewals provided therein. New Courtland On July 14, 1998, the Company announced that it received notice from NewCourtland, Inc. ("NewCourtland"), owner of eight nursing centers in the Philadelphia area, of the termination of its management agreements for these centers effective July 31, 1998. This notice follows the revocation on June 25, 1998 of the operating license at one of the NewCourtland centers. The center had a long-standing history of regulatory compliance difficulties dating back many years prior to Genesis' management. The Company believes that the termination notice was inappropriate and has instituted suit against NewCourtland and other related parties to recover unpaid balances due Genesis, the estimated future operating profits of the terminated management agreements, as well as consequential damages. The annualized revenue from the contracts is approximately $3,800,000. ElderTrust Transactions On January 30, 1998, Genesis successfully completed deleveraging transactions with ElderTrust, a newly formed Maryland healthcare real estate investment trust. Genesis, a co-registrant on the ElderTrust initial public offering, received approximately $78,000,000 in proceeds from the sale of 13 properties to ElderTrust, including four properties it had purchased from Crozer-Keystone Health System in anticipation of resale to ElderTrust. Genesis received an additional $14,000,000 from the sale of a loan and two additional assisted living facilities and the recoupment of amounts advanced and expenses incurred in connection with the formation of ElderTrust. The sale of properties to ElderTrust resulted in a gain of approximately $12,000,000 which has been deferred and is being amortized over the ten year term of the lease contracts with ElderTrust. Additionally, ElderTrust has funded approximately $14,200,000 of a $15,100,000 commitment to finance the development and expansion of three additional assisted living facilities. Genesis repaid a portion of the revolving credit component of the Credit Facility with the proceeds from these transactions. In September 1998, the Company sold its leasehold rights and option to purchase seven eldercare facilities acquired in its November 1993 acquisition of Meridian Healthcare, Inc. to ElderTrust for $44,000,000, including $35,500,000 in cash and an $8,500,000 note. As part of the transaction, Genesis will continue to sublease the facilities for ten years with an option to extend the lease until 2018 at an initial annual lease obligation of approximately $10,000,000. The transaction resulted in a gain of approximately $43,700,000 which has been deferred and is being amortized over the ten year lease term of the lease contracts with ElderTrust. The Company also anticipates entering into transactions with ElderTrust in the future. 10 Multicare Transaction In October 1997, Genesis ElderCare Corp., a Delaware Corporation owned 43.6% by Genesis and the remainder by The Cypress Group (together with its affiliates, "Cypress"), TPG Partners II, L.P., (together with its affiliates, "TPG") and Nazem, Inc. (together with its affiliates "Nazem"), acquired The Multicare Companies, Inc. ("Multicare"), pursuant to a tender offer (the "Tender Offer") and the merger (the "Merger" or the "Multicare Transaction"). Multicare is in the business of providing eldercare and specialty medical services in selected geographic regions. Included among the operations acquired by Genesis ElderCare Corp. are operations relating to the provision of (i) eldercare services including skilled nursing care, assisted living, Alzheimer's care and related support activities traditionally provided in eldercare facilities, (ii) specialty medical services consisting of (1) sub-acute care such as ventilator care, intravenous therapy and various forms of coma, pain and wound management and (2) rehabilitation therapies such as occupational, physical and speech therapy and stroke and orthopedic rehabilitation and (iii) management services and consulting services to eldercare centers. In connection with the Merger, Multicare and Genesis entered into a management agreement (the "Management Agreement") pursuant to which Genesis manages Multicare's operations. The Management Agreement has a term of five years with automatic renewals for two years unless either party terminates the Management Agreement. Genesis is paid a fee of six percent of Multicare's net revenues for its services under the Management Agreement provided that payment of such fee in respect of any month in excess of the greater of (i) $1,991,666 and (ii) four percent of Multicare's consolidated net revenues for such month, shall be subordinate to the satisfaction of Multicare's senior and subordinate debt covenants; and provided, further, that payment of such fee shall be no less than $23,900,000 in any given year. Under the Management Agreement, Genesis is responsible for Multicare's non-extraordinary sales, general and administrative expenses (other than certain specified third-party expenses), and all other expenses of Multicare will be paid by Multicare. Genesis also entered into an asset purchase agreement (the "Therapy Purchase Agreement") with Multicare and certain of its subsidiaries pursuant to which Genesis acquired all of the assets used in Multicare's outpatient and inpatient rehabilitation therapy business for $24,000,000 subject to adjustment (the "Therapy Purchase") and a stock purchase agreement (the "Pharmacy Purchase Agreement") with Multicare and certain subsidiaries pursuant to which Genesis acquired all of the outstanding capital stock and limited partnership interests of certain subsidiaries of Multicare that are engaged in the business of providing institutional pharmacy services to third parties for $50,000,000 (the "Pharmacy Purchase"), subject to adjustment. The Company completed the Pharmacy Purchase effective January 1, 1998. The Company completed the Therapy Purchase in October 1997. In addition, Genesis, Cypress, TPG and Nazem entered into an agreement (the "Put/Call Agreement") pursuant to which, among other things, Genesis has the option, on the terms and conditions set forth in the Put/Call Agreement to purchase (the "Call") Genesis ElderCare Corp. Common Stock held by Cypress, TPG and Nazem commencing on October 9, 2001 and for a period of 270 days thereafter, at a price determined pursuant to the terms of the Put/Call Agreement. Cypress, TPG and Nazem have the option, on the terms and conditions set forth in the Put/Call Agreement, to require Genesis to purchase (the "Put") such Genesis ElderCare Corp. common stock commencing on October 9, 2002 and for a period of one year thereafter, at a price determined pursuant to the Put/Call Agreement. Genesis Eldercare Corp. paid approximately $1,492,000,000 to (i) purchase the Multicare Shares pursuant to the Tender Offer and the Merger, (ii) pay fees and expenses incurred in connection with the completion of the Tender Offer, Merger and the financing transactions in connection with therewith, (iii) refinance certain indebtedness of Multicare and (iv) make certain cash payments to employees. Of the funds required to finance the foregoing, approximately $745,000,000 were furnished as capital contributions by the Genesis Eldercare Corp. from the sale of its common stock to Cypress, TPG, Nazem and Genesis. Cypress, TPG and Nazem purchased shares of Genesis ElderCare Corp. common stock for a purchase price of $210,000,000, $199,500,000 and $10,500,000, respectively, and Genesis purchased shares of Genesis ElderCare Corp. common stock for a purchase price of $325,000,000 in consideration for 43.6% of the 11 common stock of Genesis ElderCare Corp. The balance of the funds necessary to finance the foregoing came from (i) the proceeds of loans from a syndicate of lenders in the aggregate amount of $525,000,000 and (ii) $246,800,000 of bridge financing which was refinanced upon completion of the sale of 9% Senior Subordinated Notes due 2007 sold by a subsidiary of Genesis ElderCare Corp. on August 11, 1997. Results of Operations Three months ended December 31, 1998 compared to three months ended December 31, 1997 The Company's total net revenues for the quarter ended December 31, 1998 were $479,204,000 compared to $302,565,000 for the quarter ended December 31, 1997, an increase of $176,639,000 or 58%. Pharmacy and medical supply service revenue increased $167,521,000 to $236,217,000 from $68,696,000, of which approximately $128,700,000 is attributed to the Vitalink Transaction, approximately $20,700,000 is attributed to the Multicare Pharmacy Purchase, and the remaining increase of $18,121,000 is primarily due to other volume growth in the institutional, medical supply and community based pharmacies. Inpatient service revenue declined $4,773,000 or 3% to $176,032,000 from $180,805,000, attributed principally to the Company's October 1, 1998 implementation of the Medicare Prospective Payment System ("PPS") and an overall decline in census. Under PPS, the average Medicare rate per day was reduced to approximately $305 per patient day during the quarter ended December 31, 1998 compared to approximately $364 per patient day for the comparable period last year. There were 121,466 Medicare patient days during the quarter ended December 31, 1998 compared to 123,161 days for the comparable period last year. Total patient days declined approximately 9,000 patient days to 1,251,000 during the quarter ended December 31, 1998 compared to 1,260,000 patient days during the comparable period last year. The decline in overall census is principally attributed to survey and other regulatory matters at several of the Company's eldercare centers which the Company believes have been resolved. Other revenues increased approximately $13,900,000 from $53,064,000 to $66,955,000. This increase is attributed to growth in capitation fees earned, rehabilitation revenues and other service related businesses. The Company's operating expenses before depreciation, amortization, lease expense, and interest expense were $408,050,000 for the quarter ended December 31, 1998 compared to $245,379,000 for the quarter ended December 31, 1997, an increase of $162,671,000 or 66%, of which approximately $106,000,000 is attributed to the Vitalink Transaction, approximately $14,700,000 is attributed to the Multicare Pharmacy Purchase, and the remaining increase of $41,971,000 is attributed to growth in the institutional pharmacy, medical supply and contract therapy divisions, capitated expenses, as well as increased costs of community-based programs. Increased depreciation and amortization expense of $6,121,000 is attributed to the depreciation of fixed assets and amortization of goodwill and deferred financing costs in connection with the Multicare Pharmacy Purchase and the Vitalink Transaction. Interest expense increased $7,680,000 or 39%. This increase in interest expense was primarily due to additional borrowings used to finance the Multicare Pharmacy Purchase, the Vitalink Transaction, and an increase in the Company's weighted average borrowing rate on the Credit Facility. This increase is offset by interest savings as a result of the repayment of indebtedness from proceeds received in connection with the ElderTrust Transactions. In connection with the early repayment and restructuring of debt in the quarters ended December 31, 1998 and 1997, the Company recorded an extraordinary loss, net of tax of approximately $1,799,000 ($2,902,000 before tax) and $1,924,000 ($3,030,000 before tax), respectively, to write-off unamortized deferred financing fees. In the quarter ended December 31, 1998, the Company accrued $4,417,000 of dividends on the Genesis Preferred issued in connection with the Vitalink Transaction. 12 Liquidity and Capital Resources General Working capital increased $67,146,000 to $372,864,000 at December 31, 1998 from $305,718,000 at September 30, 1998. Accounts receivable increased approximately $29,459,000 during this period, of this increase approximately $6,000,000 relates to the impact of a rehabilitation services agreement entered into during the current quarter and the remaining increase is principally due to the continuing shift in business mix to ancillary services, particularly the home medical equipment and infusion therapy lines of business, which typically have a longer collection period. As a result, days revenue in accounts receivable increased approximately seven days to 77 days for the quarter ended December 31, 1998 compared to the quarter ended September 30, 1998. Accounts payable and accrued expenses declined during the quarter ending December 31, 1998, principally due to the timing of routine operating payments, including interest and compensation related costs. As a result of the growth in accounts receivable and the timing of payments, the Company's use of cash flow from operations for the three months ended December 31, 1998 was approximately $23,900,000 compared to a source of cash of approximately $4,100,000 for the three months ended December 31, 1997. Investing activities for the three months ended December 31, 1998 include approximately $17,600,000 of capital expenditures primarily related to the development of assisted living facilities, betterments and expansion of existing eldercare centers and investment in data processing hardware and software. The additional investment in unconsolidated affiliates of approximately $12,500,000 during the December 1998 quarter represents the Company's limited partnership investment in four assisted living properties with which it has entered into a management contract, and four assisted living properties under development which it will manage upon completion of construction. During the three months ended December 31, 1998, other long term assets increased approximately $3,802,000, principally due to subordinated management fees due from Multicare. The Vitalink and ElderTrust Transactions The total consideration paid to stockholders of Vitalink to acquire their shares (including shares which may have been issued upon the exercise of outstanding options) was $590,200,000, of which 50% was paid in cash and 50% in Genesis Preferred. As a result of the merger, Genesis assumed approximately $87,000,000 of indebtedness Vitalink had outstanding. The Genesis Preferred has a face value of approximately $295,100,000 and an initial dividend of 5.9375% and generally is not transferable without the consent of the Company. The Genesis Preferred is convertible into Common Stock at $37.20 per share and it may be called for conversion after April 26, 2001, provided the price of Common Stock reaches certain levels and after April 26, 2002, subject to a market-based call premium. The cash portion of the purchase price was funded through borrowings under the Credit Facility. On January 30, 1998, Genesis successfully completed deleveraging transactions with ElderTrust, a newly formed Maryland healthcare real estate investment trust. Genesis, a co-registrant on the ElderTrust initial public offering, received approximately $78,000,000 in proceeds from the sale of 13 properties to ElderTrust, including four properties it had purchased from Crozer-Keystone Health System in anticipation of resale to ElderTrust. Genesis received an additional $14,000,000 from the sale of a loan and two additional assisted living facilities and the recoupment of amounts advanced and expenses incurred in connection with the formation of ElderTrust. The sale of properties to ElderTrust resulted in a gain of approximately $12,000,000 which has been deferred and is being amortized over the ten year term of the lease contracts with ElderTrust. Additionally, ElderTrust has funded approximately $14,200,000 of a $15,100,000 commitment to finance the development and expansion of three additional assisted living facilities. Genesis repaid a portion of the revolving credit component of its Credit Facility with the proceeds from these transactions. In September 1998, the Company sold its leasehold rights and option to purchase seven eldercare facilities acquired in its November 1993 acquisition of Meridian Healthcare, Inc. to ElderTrust for $44,000,000, including $35,500,000 in cash and an $8,500,000 note. As part of the 13 transaction, Genesis will continue to sublease the facilities for ten years with an option to extend the lease until 2018 at an initial annual lease obligation of approximately $10,000,000. The transaction resulted in a gain of approximately $43,700,000 which has been deferred and is being amortized over the ten year lease term of the lease contracts with ElderTrust. The Company also anticipates entering into transactions with ElderTrust in the future. Credit Facility Genesis entered into a credit agreement pursuant to which the lenders provided Genesis and its subsidiaries a credit facility totaling $1,250,000,000 (the "Credit Facility") for the purpose of: refinancing certain existing indebtedness of Genesis; funding interest and principal payments on the facilities and certain remaining indebtedness; funding permitted acquisitions; funding Genesis' commitments in connection with the Vitalink Transaction; and funding Genesis' and its subsidiaries' working capital for general corporate purposes, including fees and expenses of the transactions. The Credit Facility consists of three term loans with original balances of $200,000,000 each (collectively, the "Term Loans"), a $650,000,000 revolving credit loan (the "Revolving Facility"), which includes one or more Swing Loans (collectively, the "Swing Loan Facility") in integral principal multiples of $500,000 up to an aggregate unpaid principal amount of $20,000,000. The Term Loans amortize in quarterly installments beginning in Fiscal 1998 through 2005, of which $21,419,000 is payable in Fiscal 1999. The Term Loans consist of (i) a six year term loan with an outstanding balance of $130,525,000 at December 31, 1998 (the "Tranche A Term Facility"); (ii) a seven year term loan with an outstanding balance of $153,687,000 (the "Tranche B Term Facility"); and (iii) an eight year term loan with an outstanding balance of $173,450,000 (the "Tranche C Term Facility"). The Revolving Facility becomes payable in full on September 30, 2003. The third amendment to the Credit Facility, dated December 15, 1998, made the financial covenants for certain periods less restrictive, permitted a portion of the proceeds of subordinated debt offerings to repay indebtedness under the Revolving Facility and increased the interest rates applying to the Term Loans and the Revolving Facility. The revised financial covenants accommodate the projected impact of PPS beginning in fiscal 1999 and the non-cash charges in the fourth quarter of fiscal 1998. The Credit Facility is secured by a first priority security interest in all of the stock, partnership interests and other equity of all of Genesis' present and future subsidiaries (including Genesis ElderCare Corp.) other than the stock of Multicare and its subsidiaries. Loans under the Credit Facility bear, at Genesis' option, interest at the per annum Prime Rate as announced by the administrative agent, or the applicable Adjusted LIBO Rate plus, in either event, a margin (the "Annual Applicable Margin") that is dependent upon a certain financial ratio test. Loans under the Tranche A Term Facility and Revolving Facility have an Annual Applicable Margin of .75% for Prime Rate loans and 2.5% (an effective rate of 7.90% at December 31, 1998) for LIBO Rate loans. Loans under the Tranche B Term Facility have an Annual Applicable Margin of 1.25% for Prime Rate loans and 3.0% (an effective rate of 8.40% at December 31,, 1998) for LIBO Rate loans. Loans under the Tranche C Term Facility have an Annual Applicable Margin of 1.5% for Prime Rate loans and 3.25% (an effective rate of 8.65% at December 31, 1998) for LIBO Rate loans. Loans under the Swing Loan Facility bear interest at the Prime Rate unless otherwise agreed to by the parties. Subject to meeting certain financial ratios, the above referenced interest rates are reduced. The Credit Facility contains a number of covenants that, among other things, restrict the ability of Genesis and its subsidiaries to dispose of assets, incur additional indebtedness, make loans and investments, pay dividends, engage in mergers or consolidations, engage in certain transactions with affiliates and change control of capital stock, and to make capital expenditures; prohibit the ability of Genesis and its subsidiaries to prepay debt to other persons, make material changes in accounting and reporting practices, create liens on assets, give a negative pledge on assets, make acquisitions and amend or modify documents; causes Genesis and its affiliates to maintain the Management Agreement, the Put/Call Agreement, as defined, and corporate separateness; and will cause Genesis to comply with the terms of other material agreements, as well as comply with usual and customary covenants for transactions of this nature. 14 In December 1998, the Company issued $125,000,000, 9 7/8% Senior Subordinated Notes due 2009, at a price of 96.1598% resulting in net proceeds of $120,200,000. Interest on the notes is payable semi-annually on January 15 and July 15 of each year, commencing July 15, 1999. Approximately $59,900,000 of the net proceeds were used to repay portions of the Tranche A, B and C Term Facilities and approximately $59,900,000 of the net proceeds were used to repay a portion of the Revolving Facility. The Multicare Transaction In connection with the Multicare Transaction, Genesis, Cypress, TPG and Nazem entered into an agreement (the "Put/Call Agreement") pursuant to which, among other things, Genesis will have the option, on the terms and conditions set forth in the Put/Call Agreement to purchase (the "Call") Genesis ElderCare Corp. Common Stock held by Cypress, TPG and Nazem commencing on October 9, 2001 and for a period of 270 days thereafter, at a price determined pursuant to the terms of the Put/Call Agreement. Cypress, TPG and Nazem will have the option, on the terms and conditions set forth in the Put/Call Agreement, to require Genesis to purchase (the "Put") such Genesis ElderCare Corp. common stock commencing on October 9, 2002 and for a period of one year thereafter, at a price determined pursuant to the Put/Call Agreement. The prices determined for the Put and Call are based on a formula that calculates the equity value attributable to Cypress', TPG's and Nazem's Genesis ElderCare Corp. common stock, plus a portion of the Genesis pharmacy business (the "Calculated Equity Value"). The Calculated Equity Value will be determined based upon a multiple of Genesis ElderCare Corp.'s earnings before interest, taxes, depreciation, amortization and rental expenses, as adjusted ("EBITDAR") after deduction of certain liabilities, plus a portion of the EBITDAR related to the Genesis pharmacy business. The multiple to be applied to EBITDAR will depend on whether the Put or the Call is being exercised. Any payment to Cypress, TPG or Nazem under the Call or the Put may be in the form of cash or Genesis common stock at Genesis' option. Upon exercise of the Call, Cypress, TPG and Nazem will receive at a minimum their original investment plus a 25% compound annual return thereon regardless of the Calculated Equity Value. Any additional Calculated Equity Value attributable to Cypress', TPG's or Nazem's Genesis ElderCare Corp. common stock will be determined on the basis set forth in the Put/Call Agreement which provides generally for additional Calculated Equity Value of Genesis ElderCare Corp. to be divided based upon the proportionate share of the capital contributions of the stockholders to Genesis ElderCare Corp. Upon exercise of the Put by Cypress, TPG or Nazem, there will be no minimum return to Cypress, TPG or Nazem; and any payment to Cypress, TPG or Nazem will be limited to Cypress' TPG's or Nazem's share of the Calculated Equity Value based upon a formula set forth in the terms of the Put/Call Agreement. Cypress', TPG's and Nazem's rights to exercise the Put will be accelerated upon an event of bankruptcy of Genesis, a change of control of Genesis, an extraordinary dividend or distribution or the occurrence of the leverage recapitalization of Genesis. Upon an event of acceleration or the failure by Genesis to satisfy its obligations upon exercise of the Put, Cypress, TPG and Nazem will have the right to terminate the Stockholders' Agreement, dated October 9, 1997, by and among the Company, Genesis ElderCare Corp., Cypress, TPG and Nazem, and Management Agreement and to control the sale or liquidation of Genesis ElderCare Corp. In the event of such sale, the proceeds from such sale will be distributed among the parties as contemplated by the formula for the Put option exercise price and Cypress, TPG and Nazem will retain a claim against Genesis for the difference, if any, between the proceeds of such sale and the put option exercise price. In the event of a bankruptcy or change of control of Genesis, the option price shall be payable solely in cash provided any such payment will be subordinated to the payment of principal and interest under the Credit Facility. 15 Legislative and Regulatory Issues Legislative and regulatory action has resulted in continuing change in the Medicare and Medicaid reimbursement programs which has adversely impacted the Company. The changes have limited, and are expected to continue to limit, payment increases under these programs. Also, the timing of payments made under the Medicare and Medicaid programs is subject to regulatory action and governmental budgetary constraints; in recent years, the time period between submission of claims and payment has increased. Implementation of the Company's strategy to expand specialty medical services to independent providers should reduce the impact of changes in the Medicare and Medicaid reimbursement programs on the Company as a whole. Within the statutory framework of the Medicare and Medicaid programs, there are substantial areas subject to administrative rulings and interpretations which may further affect payments made under those programs. Further, the federal and state governments may reduce the funds available under those programs in the future or require more stringent utilization and quality reviews of eldercare centers or other providers. There can be no assurances that adjustments from Medicare or Medicaid audits will not have a material adverse effect on the Company. Pursuant to the Balanced Budget Act of 1997 (the "Balance Budget Act") commencing with cost reporting periods beginning on July 1, 1998, PPS began to be phased in for skilled nursing facilities at a per diem rate for all covered Part A skilled nursing facility services as well as many services for which payment may be made under Part B when a beneficiary who is a resident of a skilled nursing facility receives covered skilled nursing facility care. The consolidated per diem rate is adjusted based upon the resource utilization group ("RUG"). In addition to covering skilled nursing facility services, this consolidated payment will also cover rehabilitation and non-rehabilitation ancillary services. Physician services, certain nurse practitioner and physician assistant services, among others, are not included in the per diem rate. For the first three cost reporting periods beginning on or after July 1, 1998, the per diem rate will be based on a blend of a facility specific-rate and a federal per diem rate. In subsequent periods, and for facilities first receiving payments for Medicare services on or after October 1, 1995, the federal per diem rate will be used without any facility specific blending. The Balanced Budget Act also required consolidated billing for skilled nursing facilities. Under the Balanced Budget Act, the skilled nursing facility must submit all Medicare claims for Part A and Part B services received by its residents with the exception of physician, nursing, physician assistant and certain related services, even if such services were provided by outside suppliers. Medicare will pay the skilled nursing facilities directly for all services on the consolidated bill and outside suppliers of services to residents of the skilled nursing facilities must collect payment from the skilled nursing facility. Although consolidated billing was scheduled to begin July 1, 1998 for all services, it has been delayed until further notice for beneficiaries in a Medicare Part A stay in a skilled nursing facility not yet using PPS and for the Medicare Part B stay. There can be no assurance that the Company will be able to provide skilled nursing services at a cost below the established Medicare level. Effective April 10, 1998, regulations were adopted by the Health Care Financing Administration, which revise the methodology for determining the reasonable cost for contract therapy services, including physical therapy, respiratory therapy, occupational therapy and speech language pathology. Under the regulations, the reasonable costs for contract therapy services are limited to geographically-adjusted salary equivalency guidelines. However, the revised salary equivalency guidelines will no longer apply when the PPS system applicable to the particular setting for contract therapy services (e.g. skilled nursing facilities, home health agencies, etc.) goes into effect. The Balanced Budget Act also repealed the Boren Amendment federal payment standard for Medicaid payments to Medicaid nursing facilities effective October 1, 1997. The Boren Amendment required Medicaid payments to certain health care providers to be reasonable and adequate in order to cover the costs of efficiently and economically operated health care facilities. States must now use a public notice and comment period in order to determine rates and provide interested parties a reasonable opportunity to 16 comment on proposed rates and the justification for and the methodology used in calculating such rates. There can be no assurance that budget constraints or other factors will not cause states to reduce Medicaid reimbursement to nursing facilities and pharmacies or that payments to nursing facilities and pharmacies will be made on timely basis. The law also grants greater flexibility to states to establish Medicaid managed care projects without the need to obtain a federal waiver. Although these waiver projects generally exempt institutional care, including nursing facilities and institutional pharmacy services, no assurances can be given that these projects ultimately will not change the reimbursement system for long-term care, including pharmacy services from fee-for-service to managed care negotiated or capitated rates. The Company anticipates that federal and state governments will continue to review and assess alternative health care delivery systems and payment methodologies. In July 1998, the Clinton Administration issued a new initiative to promote the quality of care in nursing homes. This initiative includes, but is not limited to (i) increased enforcement of nursing home safety and quality regulations; (ii) increased federal oversight of state inspections of nursing homes; (iii) prosecution of egregious violations of regulations governing nursing homes; (iv) the publication of nursing home survey results on the Internet; and (v) continuation of the development of the Minimum Data Set ("MDS"), a national automated clinical data system. Accordingly, with this new initiative, it may become more difficult for eldercare facilities to maintain licensing and certification. The Company may experience increased costs in connection with maintaining its licenses and certifications as well as increased enforcement actions. In addition, beginning January 1, 1999, outpatient therapy services furnished by a skilled nursing facility to a resident not under a covered Part A stay or to non-residents who receive outpatient rehabilitation services will be paid according to the Medicare Physician Fee Schedule. Anticipated Impact of Healthcare Reform Based upon assumptions, the Company estimates that the adverse revenue impact of PPS in Fiscal 1999 will be approximately $28,000,000 on the Genesis centers and approximately $18,000,000 on the Multicare centers. In each of Fiscal 2000-2002, the Company estimates the adverse revenue impact of PPS on its Genesis centers will approximate an additional $8,000,000. The Company estimates that the adverse revenue impact of PPS on the Multicare eldercare centers will be approximately an additional $13,000,000 in Fiscal 2000 and an additional $5,000,000 in each of Fiscal 2001 and 2002. The Genesis eldercare centers began implementation of PPS on October 1, 1998 and the majority of the Multicare eldercare centers began implementation of PPS on January 1, 1999. The actual impact of PPS on the Company's earnings in Fiscal 1999 will depend on many variables which can not be quantified at this time, including regulatory changes, patient acuity, patient length of stay, Medicare census, referral patterns, ability to reduce costs and growth of ancillary business. Other The Board of Directors approved a Senior Executive Stock Ownership Program. Under the terms of the program, certain of the Company's current senior executive employees are required to own shares of the Company's Common Stock having a market value based upon a multiple of the executive's salary. Each executive is required to own the shares within three years of the date of the adoption of the program. Subject to applicable laws, the Company may lend funds to one or more of the senior executive employees for his or her purchase of the Company's Common Stock. As of December 31, 1998, the Company loaned approximately $3,000,000 to senior executive employees to purchase the Company's Common Stock. Certain of the Company's other outstanding loans contain covenants which, without the prior consent of the lenders, limit certain activities of the Company. Such covenants contain limitations relating to the merger or consolidation of the Company and the Company's ability to secure indebtedness, make guarantees, grant security interests and declare dividends. In addition, the Company must maintain certain minimum levels of cash flow and debt service coverage, and must maintain certain ratios of liabilities to net worth. Under these loans, the Company is restricted from paying cash dividends on the Common Stock, unless certain conditions are met. The Company has not declared or paid any cash dividends on its Common Stock since its inception. 17 The Company believes that its liquidity needs can be met by expected operating cash flow and availability of borrowings under its Revolving Facility. At January 31, 1999, approximately $576,200,000 was outstanding under the Revolving Facility, and approximately $62,000,000 was available under the Revolving Facility after giving effect to approximately $11,800,000 in outstanding letters of credit issued under the Revolving Facility. Seasonality The Company's earnings generally fluctuate from quarter to quarter. This seasonality is related to a combination of factors which include the timing of Medicaid rate increases, seasonal census cycles, and the number of calendar days in a given quarter. Impact of Inflation The healthcare industry is labor intensive. Wages and other labor costs are especially sensitive to inflation and marketplace labor shortages. To date, the Company has offset its increased operating costs by increasing charges for its services and expanding its services. Genesis has also implemented cost control measures to limit increases in operating costs and expenses but cannot predict its ability to control such operating cost increases in the future. See "Cautionary Statements Regarding Forward Looking Statements." Year 2000 Compliance The Company has implemented a process to address its Year 2000 compliance issues. The process includes (i) an inventory and assessment of the compliance of the essential systems and equipment of the Company and of year 2000 mission critical suppliers, customers, and other third parties, (ii) the remediation of non-compliant systems and equipment, and (iii) contingency planning. The Company is in the process of conducting its inventory, assessment and remediation of its information technology ("IT") systems, equipment and non-IT systems and equipment (embedded technology) and has completed approximately 70% of its internal inventory and assessment and approximately 30% of the systems and equipment of critical suppliers, customers and other third parties. With respect to the Year 2000 compliance of critical third parties, the Company derives a substantial portion of its revenues from the Medicare and Medicaid programs. Congress' General Accounting Office ("GAO") concluded in September 1998 that it would be highly unlikely that all Medicare systems will be compliant on time to ensure the delivery of uninterrupted benefits and services into the Year 2000. While the Company does not receive payments directly from Medicare, but from intermediaries, the GAO statement is interpreted to apply as well to these intermediaries. Recently, the HCFA Administrator asserted that all systems necessary to make payments to fiscal intermediaries would be compliant. The Administrator provided further assurance that intermediary systems would also be compliant well in advance of the deadline. Nonetheless, the Company intends to actively confirm the Year 2000 readiness status for each intermediary and to work cooperatively to ensure appropriate continuing payments for services rendered to all government-insured patients. The Company is remediating its critical IT and non-IT systems and equipment. The Company has also begun contingency planning in the event that essential systems and equipment fail to be Year 2000 compliant. The Company is planning to be Year 2000 complaint for all its essential systems and equipment by September 30, 1999, although there can be no assurance that it will achieve its objective by such date or by January 1, 2000, or that such potential non-compliance will not have a material adverse effect on the Company's business, financial condition or results of operations. In addition there can be no assurance that all of the Company's critical suppliers and other third parties will be Year 2000 complaint by January 1, 2000, or that such potential non-compliance will not have a material adverse effect on the Company's business, financial condition or results of operations. 18 The Company currently estimates that its aggregate costs directly related to Year 2000 compliance efforts will be approximately $1,100,000, of which approximately $550,000 has been spent through December 31, 1998. The Company's Year 2000 efforts are ongoing and its overall plan and cost estimations will continue to evolve, as new information becomes available. The Company's analysis of its Year 2000 issues is based in part on information from third party suppliers; there can be no assurance that such information is accurate or complete. The failure of the Company or third parties to be fully Year 2000 compliant for essential systems and equipment by January 1, 2000 could result in interruptions of normal business work operations. The Company's potential risks include (i) the inability to deliver patient care related services in the Company's facilities and / or in non-affiliated facilities, (ii) the delayed receipt of reimbursement from the Federal or State governments, private payors, or intermediaries, (iii) the failure of security systems, elevators, heating systems or other operational systems and equipment of the Company's facilities and (iv) the inability to receive critical equipment and supplies from vendors. Each of these events could have a material adverse affect on the Company's business, results of operations and financial condition. Contingency plans for the Company's Year 2000-related issues continue to be developed and include, but are not limited to, identification of alternate suppliers, alternate technologies and alternate manual systems. The Company is planning to have contingency plans completed for essential systems and equipment by June 30, 1999; however, there can be no assurance that it will meet this objective by such date or by January 1, 2000. The Year 2000 disclosure set forth above is intended to be a "Year 2000 statement" as such term is defined in the Year 2000 Information and Readiness Disclosure Act of 1998 (the "Year 2000 Act") and, to the extent such disclosure relates to Year 2000 processing of the Company or to products or services offered by the Company, is also intended to be "Year 2000 Readiness Disclosure" as such term is defined in the Year 2000 Act. New Accounting Pronouncements In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information ("Statement 131"). Statement 131 supersedes Statement of Financial Accounting Standards No. 14, Financial Reporting of a Business Enterprise, and establishes new standards for reporting information about operation segments in annual financial statements and requires selected information about operating segments in interim financial reports. Statement 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. Statement 131 is effective for years beginning after December 15, 1997, or the Company's fiscal year end September 30, 1999. This statement affects reporting in financial statements only and will have no impact on the Company's results of operations, financial condition or liquidity. In March 1998, the Accounting Standards Executive Committee issued Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use ("Statement 98-1"). Once the capitalization criteria of Statement 98-1 have been met, external directs costs of materials and services consumed in developing or obtaining internal-use computer software; payroll and payroll-related costs for employees who are directly associated with and who devote time to the internal-use computer software project (to the extent of the time spent directly on the project); and interest costs incurred when developing computer software for internal use should be capitalized. Training costs and data conversion costs, should be expensed as incurred. Statement 98-1 is effective for financial statements for fiscal years beginning after December 15, 1998, with earlier application encouraged. The Company adopted the provisions of Statement 98-1 in its fiscal year ended September 30, 1998. 19 In April 1998, the Accounting Standards Executive Committee issued Statement of Position 98-5, Reporting on the Costs of Start-Up Activities ("Statement 98-5"). Statement 98-5 requires costs of start-up activities, including organizational costs, to be expensed as incurred. Start-up activities are defined as those one-time activities related to opening a new facility, introducing a new product or service, conducting businesses in a new territory, conducting business with a new process in an existing facility, or commencing a new operation. Statement 98-5 is effective for fiscal years beginning after December 15, 1998 or the Company's fiscal year ending September 30, 2000. The Company currently estimates the adoption of Statement 98-5 will result in a charge of approximately $1,500,000, net of tax, which will be recorded as a cumulative effect of a change in accounting principle. In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("Statement 133"). Statement 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Statement 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure the instrument at fair value. The accounting changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. This Statement is effective for all fiscal quarters beginning after June 15, 1999. The Company intends to adopt this accounting standard as required. The adoption of this standard is not expected to have a material impact on the Company's earnings or financial position. 20 Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company is exposed to the impact of interest rate changes. In the normal course of business, the Company employs established policies and procedures to manage its exposure to changes in interest rates. The Company's objective in managing its exposure to interest rate changes is to limit the impact of such changes on earnings and cash flows and to lower its overall borrowing costs. To achieve its objectives, the Company primarily uses interest rate swaps to manage net exposure to interest rate changes related to its portfolio of borrowings. Notional amounts of interest rate swap agreements are used to measure interest to be paid or received relating to such agreements and do not represent an amount of exposure to credit loss. The fair value of interest rate swap agreements is the estimated amount the Company would receive or pay to terminate the swap agreement at the reporting date, taking into account current interest rates. The estimated amount the Company would pay to terminate its interest rate swap agreements outstanding at December 31, 1998 is approximately $28,151,000. The carrying value of fixed rate and variable rate debt approximates fair value. The table below represents the contractual or notional balances of the Company's fixed rate and market sensitive instruments at expected maturity dates and the weighted average interest rates.
Expected Maturity ($ in thousands) 1999 2000 2001 2002 2003 Thereafter Total ----------- ----------- ----------- ----------- ------------- ------------- ------------ Fixed rate debt $ 12,794 $ 14,890 $ 7,174 $ 3,627 $ 3,387 $ 439,184 $ 481,056 Weighted average rate 9.25% 9.08% 9.19% 9.34% 9.36% 9.56% 9.53% ----------- ----------- ----------- ----------- ------------- ------------- ------------ Variable rate debt $ 21,366 $ 28,670 $ 28,670 $ 35,972 $547,299 $ 330,584 $ 992,561 Weighted average rate L+2.59% L+2.57% L+2.57% L+2.55% L+2.50% L+3.13% L+2.69% ----------- ----------- ----------- ----------- ------------- ------------- ------------ Variable to Fixed Swaps $ - $ - $220,000 $ 50,000 $ 100,000 $ 320,000 $ 690,000 Weighted average rate Pay fixed rate - - 5.50% 5.75% 4.98% 6.83% 6.06% Weighted average rate Receive variable rate - - L L L L+1.38% L+1.17% ----------- ----------- ----------- ----------- ------------- ------------- ------------ Fixed to Variable Swaps $ - $ - $ - $ - $ - $ 320,000 $ 320,000 Weighted average rate Pay variable rate - - - - - L L Weighted average rate Receive fixed rate - - - - - 7.58% 7.58% ----------- ----------- ----------- ----------- ------------- ------------- ------------
L - three-month LIBO rate (approximately 5.40% at December 31, 1998) 21 PART II: OTHER INFORMATION Item 1. Legal Proceedings Not Applicable Item 2. Changes in Securities Not Applicable Item 3. Defaults Upon Senior Securities Not Applicable Item 4. Submission of Matters to Vote of Security Holders None Item 5. Other Information Not Applicable Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Number Description 27 Financial Data Schedule (b) Reports on Form 8-K On November 13, 1998, the Company filed a current report on Form 8K/A amending the current report on Form 8K dated August 28, 1998 to include or incorporate by reference certain financial information regarding the Vitalink Transaction. 22 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereto duly authorized. GENESIS HEALTH VENTURES, INC. Date: February 12, 1999 /s/ George V. Hager, Jr. ------------------------------------ George V. Hager, Jr. Senior Vice President and Chief Financial Officer 23 EX-27 2
5 0000874265 GENESIS HEALTH VENTURES, INC. 1 US DOLLARS 3-MOS SEP-30-1999 OCT-01-1998 DEC-31-1998 1 8,901,000 24,186,000 470,700,000 (61,006,000) 66,703,000 607,923,000 740,590,000 131,898,000 2,674,890,000 235,059,000 0 0 6,000 704,000 879,348,000 2,674,890,000 479,204,000 479,204,000 0 408,050,000 24,174,000 0 27,323,000 19,657,000 7,378,000 11,387,000 0 (1,799,000) 0 5,171,000 0.15 0.15
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