SUNH-2012.6.30-10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2012
or
o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number: 1-12040
SUN HEALTHCARE GROUP, INC.
(Exact name of Registrant as specified in its charter)
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Delaware | 13-4230695 |
(State of Incorporation) | (I.R.S. Employer Identification No.) |
18831 Von Karman, Suite 400
Irvine, CA 92612
(949) 255-7100
(Address, zip code and telephone number of Registrant)
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 ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer o | Accelerated filer ý |
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Non-accelerated filer o | Smaller reporting company o |
(Do not check if a smaller reporting company) | |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
As of July 31,2012, there were 25,535,462 shares of the Registrant’s $.01 par value Common Stock outstanding.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
Index
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| As of June 30, 2012 | |
| As of December 31, 2011 | |
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| For the three months ended June 30, 2012 and 2011 | |
| For the six months ended June 30, 2012 and 2011 | |
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| For the three months ended June 30, 2012 and 2011 | |
| For the six months ended June 30, 2012 and 2011 | |
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References throughout this document to the Company, “we,” “our” and “us” refer to Sun Healthcare Group, Inc. and its direct and indirect consolidated subsidiaries and not any other person.
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Quarterly Report on Form 10-Q (this “Form 10-Q”) contain “forward-looking” information as that term is defined by the Private Securities Litigation Reform Act of 1995 (the “Act”) and the federal securities laws. Any statements that do not relate to historical or current facts or matters are forward-looking statements. Examples of forward-looking statements include all statements regarding our expectations with respect to our proposed merger transaction with Genesis HealthCare LLC, including the expected closing date of the proposed merger, expected future financial position, results of operations, cash flows, liquidity, financing plans, business strategy, budgets, the impact of reductions in reimbursements and other changes in government reimbursement programs, the scope, timing and effectiveness of our efforts to mitigate the impact on our business of the CMS Final Rule (described below), the outcome and costs of litigation, projected expenses and capital expenditures, growth opportunities, ability to refinance our indebtedness on favorable terms, plans and objectives of management for future operations, and compliance with and changes in governmental regulations. You can identify some of the forward-looking statements by the use of forward-looking words such as “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” “should,” “may” and other similar expressions, although not all forward-looking statements contain these identifying words.
The forward-looking statements are based on the information currently available and are applicable only as of the date of this report. Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results in future periods to differ materially from those projected or contemplated in the forward-looking statements. You are urged to carefully review the disclosures we make concerning risks and other factors that may affect our business and operating results, including those made in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 and in our other reports filed with the Securities and Exchange Commission. The forward-looking statements 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. We caution you that any forward-looking statements made in this Form 10-Q are not guarantees of future performance and that you should not place undue reliance on any of such forward-looking statements, which speak only as of the date of this document. There may be additional risks of which we are presently unaware or that we currently deem immaterial. We do not intend, and undertake no obligation, to update our forward-looking statements to reflect future events or circumstances.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (unaudited)
ASSETS
(in thousands)
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| June 30, 2012 | | December 31, 2011 |
Current assets: | | | |
Cash and cash equivalents | $ | 43,648 |
| | $ | 57,908 |
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Restricted cash | 14,330 |
| | 15,706 |
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Accounts receivable, net of allowance for doubtful accounts of $62,800 | |
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and $67,640 at June 30, 2012 and December 31, 2011, respectively | 212,831 |
| | 202,229 |
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Prepaid expenses and other assets | 27,093 |
| | 29,075 |
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Assets held for sale | 4,537 |
| | — |
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Deferred tax assets | 63,018 |
| | 63,170 |
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Total current assets | 365,457 |
| | 368,088 |
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Property and equipment, net | 145,673 |
| | 148,298 |
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Intangible assets, net | 33,991 |
| | 35,294 |
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Goodwill | 34,905 |
| | 34,496 |
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Restricted cash, non-current | 354 |
| | 353 |
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Deferred tax assets | 124,382 |
| | 123,974 |
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Other assets | 43,152 |
| | 45,163 |
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Total assets | $ | 747,914 |
| | $ | 755,666 |
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See accompanying notes.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (unaudited) (CONTINUED)
LIABILITIES AND STOCKHOLDERS’ EQUITY
(in thousands, except per share data)
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| June 30, 2012 | | December 31, 2011 |
Current liabilities: | | | |
Accounts payable | $ | 44,603 |
| | $ | 55,888 |
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Accrued compensation and benefits | 63,878 |
| | 61,101 |
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Accrued self-insurance obligations, current portion | 57,628 |
| | 57,810 |
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Other accrued liabilities | 47,638 |
| | 43,139 |
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Current portion of long-term debt and capital lease obligations | 967 |
| | 1,017 |
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Total current liabilities | 214,714 |
| | 218,955 |
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Accrued self-insurance obligations, net of current portion | 155,048 |
| | 157,267 |
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Long-term debt and capital lease obligations, net of current portion | 88,242 |
| | 88,768 |
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Unfavorable lease obligations, net | 5,880 |
| | 7,110 |
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Other long-term liabilities | 56,107 |
| | 58,110 |
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Total liabilities | 519,991 |
| | 530,210 |
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Commitments and contingencies |
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Stockholders' equity: | |
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Preferred stock of $.01 par value, authorized 3,333 | |
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shares, zero shares issued and outstanding as of | |
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June 30, 2012 and December 31, 2011 | — |
| | — |
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Common stock of $.01 par value, authorized 41,667 | |
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shares, 25,535 and 25,146 shares issued and outstanding | |
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as of June 30, 2012 and December 31, 2011, respectively | 255 |
| | 251 |
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Additional paid-in capital | 730,242 |
| | 726,861 |
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Accumulated deficit | (501,194 | ) | | (500,427 | ) |
Accumulated other comprehensive loss, net | (1,380 | ) | | (1,229 | ) |
Total stockholders' equity | 227,923 |
| | 225,456 |
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Total liabilities and stockholders' equity | $ | 747,914 |
| | $ | 755,666 |
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See accompanying notes.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)
(in thousands, except per share data)
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| For the Three Months Ended |
| June 30, 2012 | | June 30, 2011 |
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Total net revenues | $ | 457,142 |
| | $ | 470,575 |
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Costs and expenses: | |
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Operating salaries and benefits | 259,506 |
| | 263,461 |
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Self-insurance for workers’ compensation and general and | |
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professional liability insurance | 13,190 |
| | 14,541 |
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Operating administrative expenses | 11,703 |
| | 13,305 |
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Other operating costs | 95,429 |
| | 92,159 |
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Center rent expense | 36,522 |
| | 35,750 |
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General and administrative expenses | 16,048 |
| | 14,952 |
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Depreciation and amortization | 8,504 |
| | 7,629 |
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Provision for losses on accounts receivable | 5,099 |
| | 4,418 |
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Interest, net of interest income of $67 and $82, respectively | 4,429 |
| | 4,854 |
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Transaction costs | 1,838 |
| | — |
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Restructuring costs | — |
| | 167 |
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Total costs and expenses | 452,268 |
| | 451,236 |
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Income before income taxes and discontinued operations | 4,874 |
| | 19,339 |
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Income tax expense | 1,901 |
| | 7,894 |
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Income from continuing operations | 2,973 |
| | 11,445 |
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Loss from discontinued operations, net | (3,953 | ) | | (1,499 | ) |
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Net (loss) income | $ | (980 | ) | | $ | 9,946 |
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Other comprehensive loss, net of tax: | | | |
Loss from cash flow hedge, net of related tax benefit of $53 and $434, respectively | (79 | ) | | (651 | ) |
Other comprehensive loss, net of tax | (79 | ) |
| (651 | ) |
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Comprehensive (loss) income | $ | (1,059 | ) |
| $ | 9,295 |
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Basic earnings per common and common equivalent share: | |
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Income from continuing operations | $ | 0.11 |
| | $ | 0.44 |
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Loss from discontinued operations, net | (0.15 | ) | | (0.06 | ) |
Net (loss) income | $ | (0.04 | ) | | $ | 0.38 |
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Diluted earnings per common and common equivalent share: | |
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Income from continuing operations | $ | 0.11 |
| | $ | 0.44 |
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Loss from discontinued operations, net | (0.15 | ) | | (0.06 | ) |
Net (loss) income | $ | (0.04 | ) | | $ | 0.38 |
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Weighted average number of common and common | |
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equivalent shares outstanding: | |
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Basic | 27,039 |
| | 26,146 |
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Diluted | 27,039 |
| | 26,187 |
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See accompanying notes.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)
(in thousands, except per share data)
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| For the Six Months Ended |
| June 30, 2012 | | June 30, 2011 |
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Total net revenues | $ | 915,635 |
| | $ | 936,883 |
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Costs and expenses: | |
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Operating salaries and benefits | 520,595 |
| | 525,943 |
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Self-insurance for workers’ compensation and general and | |
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professional liability insurance | 28,507 |
| | 29,098 |
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Operating administrative expenses | 24,110 |
| | 26,372 |
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Other operating costs | 191,995 |
| | 183,294 |
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Center rent expense | 72,899 |
| | 71,442 |
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General and administrative expenses | 32,089 |
| | 30,331 |
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Depreciation and amortization | 16,934 |
| | 15,077 |
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Provision for losses on accounts receivable | 9,908 |
| | 9,595 |
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Interest, net of interest income of $135 and $140, respectively | 8,839 |
| | 9,853 |
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Transaction costs | 1,838 |
| | — |
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Restructuring costs | — |
| | 303 |
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Total costs and expenses | 907,714 |
| | 901,308 |
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Income before income taxes and discontinued operations | 7,921 |
| | 35,575 |
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Income tax expense | 3,089 |
| | 14,512 |
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Income from continuing operations | 4,832 |
| | 21,063 |
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Loss from discontinued operations, net | (5,599 | ) | | (3,005 | ) |
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Net (loss) income | $ | (767 | ) | | $ | 18,058 |
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Other comprehensive (loss) income, net of tax: | | | |
(Loss) gain from cash flow hedge, net of related tax (benefit) expense of ($100) and $412, respectively | (761 | ) | | 402 |
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Other comprehensive (loss) income, net of tax | (761 | ) | | 402 |
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Comprehensive (loss) income | $ | (1,528 | ) | | $ | 18,460 |
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Basic earnings per common and common equivalent share: | |
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Income from continuing operations | $ | 0.18 |
| | $ | 0.81 |
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Loss from discontinued operations, net | (0.21 | ) | | (0.11 | ) |
Net (loss) income | $ | (0.03 | ) | | $ | 0.70 |
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Diluted earnings per common and common equivalent share: | |
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Income from continuing operations | $ | 0.18 |
| | $ | 0.81 |
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Loss from discontinued operations, net | (0.21 | ) | | (0.11 | ) |
Net (loss) income | $ | (0.03 | ) | | $ | 0.70 |
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Weighted average number of common and common | |
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equivalent shares outstanding: | |
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Basic | 26,542 |
| | 25,899 |
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Diluted | 26,542 |
| | 25,967 |
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See accompanying notes.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(in thousands)
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| For the Three Months Ended | | For the Six Months Ended |
| June 30, 2012 | | June 30, 2011 | | June 30, 2012 | | June 30, 2011 |
Cash flows from operating activities: | | | | | | | |
Net (loss) income | $ | (980 | ) | | $ | 9,946 |
| | $ | (767 | ) | | $ | 18,058 |
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Adjustments to reconcile net (loss) income to net cash provided by operating activities, including discontinued operations: | | | |
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Depreciation and amortization | 8,504 |
| | 7,863 |
| | 17,086 |
| | 15,544 |
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Amortization of favorable and unfavorable lease intangibles | (507 | ) | | (490 | ) | | (1,020 | ) | | (974 | ) |
Provision for losses on accounts receivable | 5,341 |
| | 4,860 |
| | 10,463 |
| | 10,504 |
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Loss on sale of assets, including discontinued operations, net | 69 |
| | — |
| | 69 |
| | — |
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Stock-based compensation expense | 1,576 |
| | 1,352 |
| | 3,808 |
| | 2,801 |
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Deferred taxes | 103 |
| | 7,944 |
| | (157 | ) | | 9,976 |
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Changes in operating assets and liabilities, net of acquisitions: | | | |
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Accounts receivable | (11,428 | ) | | (7,185 | ) | | (21,209 | ) | | (12,578 | ) |
Restricted cash | (6 | ) | | 18 |
| | 1,375 |
| | (1,928 | ) |
Prepaid expenses and other assets | 573 |
| | 439 |
| | 2,325 |
| | 190 |
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Accounts payable | (4,078 | ) | | (1,582 | ) | | (10,114 | ) | | (3,501 | ) |
Accrued compensation and benefits | 7,384 |
| | (4,018 | ) | | 2,777 |
| | (580 | ) |
Accrued self-insurance obligations | 68 |
| | (2,569 | ) | | (2,401 | ) | | (3,912 | ) |
Income taxes payable | — |
| | (478 | ) | | — |
| | — |
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Other accrued liabilities | 2,892 |
| | (216 | ) | | 4,423 |
| | (946 | ) |
Other long-term liabilities | (2,481 | ) | | (492 | ) | | (2,254 | ) | | (1,218 | ) |
Net cash provided by operating activities | 7,030 |
| | 15,392 |
| | 4,404 |
| | 31,436 |
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Cash flows from investing activities: | |
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Capital expenditures | (7,868 | ) | | (9,319 | ) | | (17,829 | ) | | (18,156 | ) |
Acquisitions, net of cash acquired | — |
| | (356 | ) | | (260 | ) | | (356 | ) |
Net cash used for investing activities | (7,868 | ) | | (9,675 | ) | | (18,089 | ) | | (18,512 | ) |
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Cash flows from financing activities: | |
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Principal repayments of long-term and capital lease obligations | (285 | ) | | (2,800 | ) | | (575 | ) | | (5,598 | ) |
Net cash used for financing activities | (285 | ) | | (2,800 | ) | | (575 | ) | | (5,598 | ) |
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Net (decrease) increase in cash and cash equivalents | (1,123 | ) | | 2,917 |
| | (14,260 | ) | | 7,326 |
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Cash and cash equivalents at beginning of period | 44,771 |
| | 85,572 |
| | 57,908 |
| | 81,163 |
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Cash and cash equivalents at end of period | $ | 43,648 |
| | $ | 88,489 |
| | $ | 43,648 |
| | $ | 88,489 |
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See accompanying notes.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) Nature of Business
References throughout this document to the Company include Sun Healthcare Group, Inc. and our consolidated subsidiaries. In accordance with the Securities and Exchange Commission’s “Plain English” guidelines, this report has been written in the first person. In this document, the words “we,” “our” and “us” refer to Sun Healthcare Group, Inc. and its direct and indirect consolidated subsidiaries and not any other person.
Business
Our subsidiaries provide long-term, post-acute and related specialty healthcare in the United States. We operate through three principal business segments: (i) inpatient services, (ii) rehabilitation therapy services, and (iii) medical staffing services. Inpatient services represent the most significant portion of our business. Our continuing operations include 190 healthcare centers in 23 states as of June 30, 2012.
Pending Merger with Genesis HealthCare LLC
On June 20, 2012, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Genesis HealthCare LLC, a Delaware limited liability company (“Genesis”), and Jam Acquisition LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of Genesis (“Merger Sub”). The Merger Agreement provides that, upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub will be merged with and into us, with us continuing as the surviving corporation and an indirect wholly owned subsidiary of Genesis (the “Merger”). Pursuant to the terms of the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of our common stock, other than treasury shares, shares held by us (other than shares held in a fiduciary capacity that are beneficially owned by third parties), Genesis, Merger Sub or any wholly owned subsidiary of Genesis or us and shares held by stockholders who perfect their appraisal rights under Delaware law, will be converted into the right to receive $8.50 in cash, without interest (the “Merger Consideration”). At the effective time of the Merger, outstanding equity awards with respect to shares of our common stock (whether vested or unvested) will be canceled and converted into the right to receive a cash amount equal to the difference between the Merger Consideration and the exercise price, if any, of such awards. We anticipate that the total amount of funds necessary to pay the aggregate Merger Consideration will be approximately $230 million, not including refinancing of our existing indebtedness or payment of related transaction fees and expenses.
We have commenced mailing the proxy statement to our stockholders and will hold a special stockholders meeting concerning the transaction on September 5, 2012. The transaction is expected to close in the fall of 2012 subject to the satisfaction of customary closing conditions, including, among other things, (i) the affirmative vote of a majority of the outstanding shares of our common stock in favor of the adoption of the Merger Agreement, (ii) the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, (iii) the receipt of other required governmental approvals, (iv) the absence of any law or order prohibiting the consummation of the Merger, (v) subject to certain materiality exceptions, the accuracy of our representations and warranties in the Merger Agreement, (vi) the performance in all material respects of our covenants in the Merger Agreement, (vii) the absence of any material adverse effect on us between June 20, 2012 and consummation of the Merger and (viii) compliance by us with our obligations under certain third party contracts.
Transaction Costs
During the three and six months ended June 30, 2012, we incurred $1.8 million of transaction costs in connection with the pending merger with Genesis. These costs consist primarily of legal fees and financial advisory fees.
Other Information
The accompanying unaudited consolidated financial statements have been prepared in accordance with our customary accounting practices and accounting principles generally accepted in the United States (“GAAP”) for interim financial statements. In our opinion, the accompanying interim consolidated financial statements are a fair statement of our financial position at June 30, 2012, and our consolidated results of operations and cash flows for the three- and six-month periods ended June 30, 2012 and 2011. These statements are unaudited, and certain information and footnote disclosures normally included in our annual consolidated financial statements have been condensed or omitted, as permitted under the applicable rules and regulations of the
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Securities and Exchange Commission. The accompanying unaudited consolidated financial statements reflect all adjustments, consisting of only normal recurring items. Readers of these statements should refer to our audited consolidated financial statements and notes thereto for the year ended December 31, 2011, which are included in our Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Form 10-K”).
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of significant contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include determination of impairment for goodwill and other long-lived assets, third-party payor settlements, allowances for doubtful accounts, self-insurance obligations, loss accruals and income taxes. Actual results could differ from those estimates.
Recent Accounting Pronouncements
The FASB issued an Accounting Standards Update in June 2011 regarding the presentation of comprehensive income within financial statements. GAAP now requires that comprehensive income and its components of net income and other comprehensive income be presented in either (1) a single continuous statement of comprehensive income or (2) two separate but consecutive statements. This new guidance is now effective for us and our accompanying consolidated financial statements have been presented with one single continuous statement of comprehensive income.
Reclassifications
Certain reclassifications have been made to the prior period financial statements to conform to the 2012 financial statement presentation. We have reclassified the results of operations of nine skilled nursing centers of our Inpatient Services segment (see Note 4 – “Discontinued Operations”) for all periods presented to discontinued operations within the income statement, in accordance with GAAP.
(2) Long-Term Debt, Capital Lease Obligations and Hedging Arrangements
Long-term debt and capital lease obligations consisted of the following as of the periods indicated (in thousands):
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| June 30, 2012 | | December 31, 2011 |
Revolving loans | $ | — |
| | $ | — |
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Mortgage note payable due monthly through 2014, interest at | |
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at a rate of 8.5%, collateralized by real property with | |
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carrying values totaling $1.7 million | 1,695 |
| | 2,076 |
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Term loans | 87,328 |
| | 87,389 |
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Capital leases | 186 |
| | 320 |
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Total long-term obligations | 89,209 |
| | 89,785 |
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Less amounts due within one year | (967 | ) | | (1,017 | ) |
Long-term obligations, net of current portion | $ | 88,242 |
| | $ | 88,768 |
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The scheduled or expected maturities of long-term obligations as of June 30, 2012, were as follows (in thousands):
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For the twelve months ending June 30: |
2013 | $ | 967 |
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2014 | 914 |
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2015 | — |
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2016 | — |
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2017 | 87,328 |
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| $ | 89,209 |
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We manage interest expense using a mix of fixed and variable rate debt, and, to help manage borrowing costs, we may enter into interest rate swap agreements. Under these arrangements, we agree to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated by reference to an agreed-upon notional principal amount. We also may enter into interest rate cap agreements that effectively limit the maximum interest rate that we pay on an agreed to notional principal
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
amount. We use interest rate hedges to manage interest rate risk related to borrowings. Our intent is to only enter into such arrangements that qualify for hedge accounting treatment in accordance with GAAP. Accordingly, we designate all such arrangements as cash-flow hedges and perform initial and quarterly effectiveness testing using the hypothetical derivative method. To the extent that such arrangements are effective hedges, changes in fair value are recognized through other comprehensive income. Ineffectiveness, if any, would be recognized in earnings.
Our credit agreement requires that at least 50% of our term loans be subject to at least a three-year hedging agreement. To satisfy this requirement, we executed two hedging instruments on January 18, 2011: a two-year interest rate cap and a two-year “forward starting” interest rate swap. The two-year interest rate cap limits our exposure to increases in interest rates for $82.5 million of debt through December 31, 2012. This cap is effective when LIBOR rises above 1.75%, effectively fixing the interest rate on $82.5 million of our term loans at 8.75% through December 31, 2012. The fee for this interest rate cap arrangement was $0.3 million, which will be amortized to interest expense over the life of the arrangement. The two-year “forward starting” interest rate swap effectively converts the interest rate on $82.5 million of our term loans to a fixed rate from January 1, 2013 through December 31, 2014. LIBOR is fixed at 3.185%, making the all-in rate effectively a fixed 10.185% for this portion of the term loans. There was no fee for this swap agreement. Both arrangements qualify for hedge accounting treatment.
The fair values of our hedging agreements as presented in the consolidated balance sheets are as follows (in thousands):
|
| | | | | | | | | | | |
| Derivatives |
| June 30, 2012 | | December 31, 2011 |
| Balance Sheet Location | | Fair Value | | Balance Sheet Location | | Fair Value |
Derivatives designated as hedging instruments: | Other Long-Term | | | | Other Long-Term | | |
Interest rate hedging agreements | Liabilities | | $ | 2,299 |
| | Liabilities | | $ | 2,049 |
|
The effect of the interest rate swap agreements on our consolidated comprehensive income, net of related taxes, for the three months ended June 30 is as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Amount of Loss in Other Comprehensive Loss | | Gain Reclassified from Accumulated Other Comprehensive Loss to Income (ineffective portion) |
| 2012 | | 2011 | | 2012 | | 2011 |
Derivatives designated as cash flow hedges: | | | | | | | |
Interest rate hedging agreements | $ | (79 | ) | | $ | (651 | ) | | $ | — |
| | $ | — |
|
The effect of the interest rate swap agreements on our consolidated comprehensive income, net of related taxes, for the six months ended June 30 is as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Amount of (Loss)/Gain in Other Comprehensive (Loss)/Income | | Gain Reclassified from Accumulated Other Comprehensive Income to Income (ineffective portion) |
| 2012 | | 2011 | | 2012 | | 2011 |
Derivatives designated as cash flow hedges: | | | | | | | |
Interest rate hedging agreements | $ | (761 | ) | | $ | 402 |
| | $ | — |
| | $ | — |
|
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(3) Fair Value of Financial Instruments
The estimated fair values of our financial instruments were as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| June 30, 2012 | | December 31, 2011 |
| Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value |
Cash and cash equivalents | $ | 43,648 |
| | $ | 43,648 |
| | $ | 57,908 |
| | $ | 57,908 |
|
Restricted cash | $ | 14,684 |
| | $ | 14,684 |
| | $ | 16,059 |
| | $ | 16,059 |
|
Long-term debt and capital lease obligations, | |
| | |
| | |
| | |
|
including current portion | $ | 89,209 |
| | $ | 88,807 |
| | $ | 89,785 |
| | $ | 74,545 |
|
Interest rate hedging agreements | $ | 2,299 |
| | $ | 2,299 |
| | $ | 2,049 |
| | $ | 2,049 |
|
The cash and cash equivalents and restricted cash carrying amounts approximate fair value because of the short maturity of these instruments. At June 30, 2012 and December 31, 2011, the fair value of our long-term debt, including current maturities, and our interest rate hedging agreements was based on estimates using present value techniques that are significantly affected by the assumptions used concerning the amount and timing of estimated future cash flows and discount rates that reflect varying degrees of risk.
GAAP establishes a hierarchy for ranking the quality and reliability of the information used to determine fair values. The applicable guidance requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:
Level 1: Unadjusted quoted market prices in active markets for identical assets or liabilities.
| |
Level 2: | Unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability. |
Level 3: Unobservable inputs for the asset or liability.
We endeavor to utilize the best available information in measuring fair value. The following tables summarize the valuation of our financial instruments by the above pricing levels as of June 30, 2012 and December 31, 2011, respectively (in thousands):
|
| | | | | |
| June 30, 2012 |
| Total | | Unadjusted Quoted Market Prices (Level 1) | | Significant Other Observable Inputs (Level 2) |
Interest rate hedging agreements – liability | $2,299 | | $— | | $2,299 |
|
| | | | | |
| December 31, 2011 |
| Total | | Unadjusted Quoted Market Prices (Level 1) | | Significant Other Observable Inputs (Level 2) |
Interest rate hedging agreements - liability | $2,049 | | $— | | $2,049 |
We currently have no other financial instruments subject to fair value measurement on a recurring basis. The fair value for our cash and cash equivalents and restricted cash disclosed above were determined by Level 1 valuation techniques and our long-term debt and capital lease obligations fair value above was determined by Level 2 valuation techniques.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(4) Discontinued Operations
The results of operations of assets to be disposed of, disposed assets and the losses related to these divestitures have been classified as discontinued operations for all periods presented in the accompanying consolidated income statements as their operations and cash flows have been (or will be) eliminated from our ongoing operations and we will not have any significant continuing involvement in their operations after their disposal.
During the six months ended June 30, 2012, we developed plans to dispose of eight skilled nursing centers and one assisted living center, which are classified as discontinued operations. The disposal plans for these centers involves the sale of the centers to unaffiliated third-party operators. All of these centers are located in either the Oklahoma or the Rhode Island markets. All of the centers described above were formerly part of our Inpatient Services segment, and their historical results have been reclassified to discontinued operations for all periods presented in accordance with GAAP. As of June 30, 2012, the $4.5 million in assets held for sale for these centers consisted of (i) a net carrying amount of $3.2 million of property and equipment, (ii) $0.8 million of other non-current assets and (iii) $0.5 million of prepaid expenses and other assets.
A summary of the discontinued operations for the periods presented is as follows (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended |
| June 30, 2012 | | June 30, 2011 |
| Inpatient Services | | Other | | Total | | Inpatient Services | | Other | | Total |
Net operating revenues | $ | 13,555 |
| | $ | — |
| | $ | 13,555 |
| | $ | 19,533 |
| | $ | — |
| | $ | 19,533 |
|
| | | | | | | | | | | |
Loss from discontinued operations, net (1) | $ | (3,949 | ) | | $ | (4 | ) | | $ | (3,953 | ) | | $ | (1,490 | ) | | $ | (9 | ) | | $ | (1,499 | ) |
(1) Net of related tax benefit of $1,598 and $982, respectively
|
| | | | | | | | | | | | | | | | | | | | | | | |
| For the Six Months Ended |
| June 30, 2012 | | June 30, 2011 |
| Inpatient Services | | Other | | Total | | Inpatient Services | | Other | | Total |
Net operating revenues | $ | 30,301 |
| | $ | — |
| | $ | 30,301 |
| | $ | 39,678 |
| | $ | — |
| | $ | 39,678 |
|
| | | | | | | | | | | |
Loss from discontinued operations, net (1) | $ | (5,593 | ) | | $ | (6 | ) | | $ | (5,599 | ) | | $ | (2,987 | ) | | $ | (18 | ) | | $ | (3,005 | ) |
(1) Net of related tax benefit of $2,650 and $1,963, respectively
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(5) Commitments and Contingencies
(a) Insurance
We self-insure for certain insurable risks, including general and professional liabilities, workers' compensation liabilities and employee health insurance liabilities, through the use of self-insurance or retrospective and self-funded insurance policies and other hybrid policies, which vary by the states in which we operate. There is a risk that amounts funded to our self-insurance programs may not be sufficient to respond to all claims asserted under those programs. Insurance reserves represent estimates of future claims payments. This liability includes an estimate of the development of reported losses and losses incurred but not reported. Provisions for changes in insurance reserves are made in the period of the related coverage. An independent actuarial analysis is prepared twice a year to assist management in determining the adequacy of the self-insurance obligations booked as liabilities in our financial statements. The methods of making such estimates and establishing the resulting reserves are reviewed periodically and are based on historical paid claims information and nationwide nursing home trends. Any adjustments resulting from such reviews are reflected in current earnings. Claims are paid over varying periods, and future payments may be different than the estimated reserves.
We evaluate the adequacy of our self-insurance reserves on a quarterly basis and perform detailed actuarial analyses semi-annually in the second and fourth quarters. The analyses use generally accepted actuarial methods in evaluating the workers’ compensation reserves and general and professional liability reserves. For both the workers’ compensation reserves and the general and professional liability reserves, those methods include reported and paid loss development methods, expected loss method and the reported and paid Bornhuetter-Ferguson methods. Reported loss methods focus on development of case reserves for incurred losses through claims closure. Paid loss methods focus on development of claims actually paid to date. Expected loss methods are based upon an anticipated loss per unit of measure. The Bornhuetter-Ferguson method is a combination of loss development methods and expected methods.
The foundation for most of these methods is our actual historical reported and/or paid loss data, over which we have effective internal controls. We utilize third-party administrators (“TPAs”) to process claims and to provide us with the data utilized in our semi-annual actuarial analyses. The TPAs are under the oversight of our in-house risk management and legal functions. The purpose of these functions is to properly administer the claims so that the historical data is reliable for estimation purposes. Case reserves, which are approved by our legal and risk management departments, are determined based on our estimate of the ultimate settlement of individual claims. In instances where our historical data are not statistically credible, stable, or mature, we supplement our experience with skilled nursing industry benchmark reporting and payment patterns.
The use of multiple methods tends to eliminate any biases that one particular method might have. Management’s judgment based upon each method’s inherent limitation is applied when weighting the results of each method. The results of each of the methods are estimates of ultimate losses which include the case reserves plus an estimate for future development of these reserves based on past trends, and an estimate for losses incurred but not reported. These results are compared by accident year, and an estimated unpaid loss and allocated loss adjustment expense is determined for the open accident years based on judgment reflecting the range of estimates produced by the methods.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Activity in our professional liability and workers’ compensation self-insurance reserves as of and for the periods ended June 30, 2012 and 2011 is as follows (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, 2012 | | For the Six Months Ended June 30, 2012 |
| Professional Liability | | Workers’ Compensation | | Total | | Professional Liability | | Workers’ Compensation | | Total |
Gross balance, beginning of period | $ | 118,626 |
| | $ | 87,542 |
| | $ | 206,168 |
| | $ | 120,856 |
| | $ | 87,241 |
| | $ | 208,097 |
|
Less: anticipated insurance recoveries | (2,390 | ) | | (21,930 | ) | | (24,320 | ) | | (2,390 | ) | | (21,930 | ) | | (24,320 | ) |
Net balance, beginning of period | $ | 116,236 |
| | $ | 65,612 |
| | $ | 181,848 |
| | $ | 118,466 |
| | $ | 65,311 |
| | $ | 183,777 |
|
| | | | | | | | | | | |
Current year provision, continuing operations | 7,500 |
| | 5,690 |
| | 13,190 |
| | 15,635 |
| | 12,872 |
| | 28,507 |
|
Current year provision, discontinued operations | 567 |
| | 526 |
| | 1,093 |
| | 1,034 |
| | 851 |
| | 1,885 |
|
Claims paid, continuing operations | (6,695 | ) | | (4,077 | ) | | (10,772 | ) | | (13,114 | ) | | (8,903 | ) | | (22,017 | ) |
Claims paid, discontinued operations | (914 | ) | | (615 | ) | | (1,529 | ) | | (4,183 | ) | | (985 | ) | | (5,168 | ) |
Amounts paid for administrative services and other | (576 | ) | | (1,462 | ) | | (2,038 | ) | | (1,720 | ) | | (3,472 | ) | | (5,192 | ) |
| | | | | | | | | | | |
Net balance, end of period | $ | 116,118 |
| | $ | 65,674 |
| | $ | 181,792 |
| | $ | 116,118 |
| | $ | 65,674 |
| | $ | 181,792 |
|
Plus: anticipated insurance recoveries | 2,388 |
| | 22,268 |
| | 24,656 |
| | 2,388 |
| | 22,268 |
| | 24,656 |
|
Gross balance, end of period | $ | 118,506 |
| | $ | 87,942 |
| | $ | 206,448 |
| | $ | 118,506 |
| | $ | 87,942 |
| | $ | 206,448 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, 2011 | | For the Six Months Ended June 30, 2011 |
| Professional Liability | | Workers’ Compensation | | Total | | Professional Liability | | Workers’ Compensation | | Total |
Gross balance, beginning of period | $ | 110,742 |
| | $ | 97,775 |
| | $ | 208,517 |
| | $ | 113,971 |
| | $ | 96,585 |
| | $ | 210,556 |
|
Less: anticipated insurance recoveries | (2,100 | ) | | (28,100 | ) | | (30,200 | ) | | (2,100 | ) | | (28,100 | ) | | (30,200 | ) |
Net balance, beginning of period | $ | 108,642 |
| | $ | 69,675 |
| | $ | 178,317 |
| | $ | 111,871 |
| | $ | 68,485 |
| | $ | 180,356 |
|
| | | | | | | | | | | |
Current year provision, continuing operations | 8,375 |
| | 6,166 |
| | 14,541 |
| | 15,348 |
| | 13,750 |
| | 29,098 |
|
Current year provision, discontinued operations | 482 |
| | 408 |
| | 890 |
| | 949 |
| | 792 |
| | 1,741 |
|
Claims paid, continuing operations | (8,277 | ) | | (4,049 | ) | | (12,326 | ) | | (17,792 | ) | | (8,716 | ) | | (26,508 | ) |
Claims paid, discontinued operations | (1,380 | ) | | (497 | ) | | (1,877 | ) | | (1,726 | ) | | (863 | ) | | (2,589 | ) |
Amounts paid for administrative services and other | (800 | ) | | (1,667 | ) | | (2,467 | ) | | (1,608 | ) | | (3,412 | ) | | (5,020 | ) |
| | | | | | | | | | | |
Net balance, end of period | $ | 107,042 |
| | $ | 70,036 |
| | $ | 177,078 |
| | $ | 107,042 |
| | $ | 70,036 |
| | $ | 177,078 |
|
Plus: anticipated insurance recoveries | 2,273 |
| | 26,150 |
| | 28,423 |
| | 2,273 |
| | 26,150 |
| | 28,423 |
|
Gross balance, end of period | $ | 109,315 |
| | $ | 96,186 |
| | $ | 205,501 |
| | $ | 109,315 |
| | $ | 96,186 |
| | $ | 205,501 |
|
The anticipated insurance recoveries relate primarily to our workers’ compensation programs associated with policy years 1996 through 2001 where the claim losses have exceeded the policies' aggregate retention limits. Obligations above these retention limits are covered by our excess insurance carriers, which all have carrier ratings of at least “A,” “XIV” or better.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
A summary of the assets and liabilities related to insurance risks at June 30, 2012 and December 31, 2011 is as indicated below (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2012 | | | | December 31, 2011 |
| | Professional Liability | | Workers’ Compensation | | Total | | | | | | Professional Liability | | Workers’ Compensation | | Total |
Assets: | | | | | | | | | | | | | | | |
Restricted cash (1) | | | | | | | | | | | | | |
Current | | $ | 5,458 |
| | $ | 8,523 |
| | $ | 13,981 |
| | | | | $ | 6,254 |
| | $ | 9,332 |
| | $ | 15,586 |
|
Non-current | | — |
| | — |
| | — |
| | | | | — |
| | — |
| | — |
|
| | $ | 5,458 |
| | $ | 8,523 |
| | $ | 13,981 |
| | | | | $ | 6,254 |
| | $ | 9,332 |
| | $ | 15,586 |
|
| | | | | | | | | | | | | | | |
Anticipated insurance recoveries (2) | | | | | | | | | | | |
Current | | $ | 483 |
| | $ | 2,820 |
| | $ | 3,303 |
| | | | | $ | 524 |
| | $ | 2,730 |
| | $ | 3,254 |
|
Non-current | | 1,905 |
| | 19,448 |
| | 21,353 |
| | | | | 1,866 |
| | 19,200 |
| | 21,066 |
|
| | $ | 2,388 |
| | $ | 22,268 |
| | $ | 24,656 |
| | | | | $ | 2,390 |
| | $ | 21,930 |
| | $ | 24,320 |
|
Total Assets | | $ | 7,846 |
| | $ | 30,791 |
| | $ | 38,637 |
| | | | | $ | 8,644 |
| | $ | 31,262 |
| | $ | 39,906 |
|
| | | | | | | | | | | | | | |
Liabilities: | | | | | | | | | | | | | |
Self-insurance liabilities (3)(4) | | | | | | | | | | | | | |
Current | | $ | 29,946 |
| | $ | 21,454 |
| | $ | 51,400 |
| | | | | $ | 28,758 |
| | $ | 22,074 |
| | $ | 50,832 |
|
Non-current | | 88,560 |
| | 66,488 |
| | 155,048 |
| | | | | 92,099 |
| | 65,168 |
| | 157,267 |
|
Total Liabilities | | $ | 118,506 |
| | $ | 87,942 |
| | $ | 206,448 |
| | | | | $ | 120,857 |
| | $ | 87,242 |
| | $ | 208,099 |
|
| |
(1) | Total restricted cash includes cash collateral deposits and other cash held by third parties. Total restricted cash above excludes $703 and $473 at June 30, 2012 and December 31, 2011, respectively, held for bank collateral, various mortgages, bond payments and capital expenditures on HUD-insured buildings. |
| |
(2) | Anticipated insurance recovery assets are presented as Other Assets (both current and long-term) in our June 30, 2012 and December 31, 2011 consolidated balance sheets. |
| |
(3) | Total self-insurance liabilities above exclude $6,228 and $6,978 at June 30, 2012 and December 31, 2011, respectively, related to our employee health insurance liabilities. |
| |
(4) | Total self-insurance liabilities for workers’ compensation claims are collateralized, in addition to the restricted cash, by letters of credit of $57,538 as of June 30, 2012 and $55,335 as of December 31, 2011. |
(b) Litigation
Between June 27, 2012 and July 16, 2012, we, the members of our board of directors, Genesis and Merger Sub have been named as defendants in a purported class action lawsuit filed in the Court of Chancery of the State of Delaware in connection with the transactions contemplated by the Merger Agreement with Genesis and in four additional separate lawsuits that were filed in the Superior Court of the State of California, County of Orange. The suits allege, among other things, that our directors breached their fiduciary duties to our stockholders in entering into the Merger Agreement pursuant to an unfair process, and that we, Genesis and Merger Sub aided and abetted the alleged breaches of fiduciary duties. In addition, the Delaware complaint alleges that the preliminary proxy statement filed by us on July 12, 2012 omits or misrepresents material information. The suits seek, among other things, to enjoin consummation of the merger. At this stage, it is not possible to predict the outcome of the proceedings and their impact on us. We believe the allegations made in the complaints are without merit and intend to vigorously defend these actions.
We are a party to various legal actions and administrative proceedings and are subject to various claims arising in the ordinary course of our business, including claims that our services have resulted in injury or death to the residents of our centers and claims relating to employment and commercial matters. The ability to predict the ultimate outcome of such matters involves judgments, estimates and inherent uncertainties. Although we intend to vigorously defend ourselves in these matters, there can be no assurance that the outcomes of these matters will not have a material adverse effect on our results of operations, financial condition or cash flows. In certain states in which we have operations, insurance coverage for the risk of punitive damages arising from general
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
and professional liability litigation may not be available due to state law public policy prohibitions. There can be no assurance that we will not be liable for punitive damages awarded in litigation arising in states for which punitive damage insurance coverage is not available.
We operate in an industry that is extensively regulated. As such, in the ordinary course of business, we are continuously subject to state and federal regulatory scrutiny, supervision and control. Such regulatory scrutiny often includes inquiries, investigations, examinations, audits, site visits and surveys, some of which are non-routine. In addition to being subject to direct regulatory oversight of state and federal regulatory agencies, the industries in which we operate are frequently subject to the regulatory supervision of fiscal intermediaries. If a provider is found to have engaged in improper practices, it could be subject to civil, administrative or criminal fines, penalties or restitutionary relief; and reimbursement authorities could also seek the suspension or exclusion of the provider or individual from participation in their program. We believe 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. Adverse determinations in legal proceedings or governmental investigations, whether currently asserted or arising in the future, could have a material adverse effect on our financial position, results of operations or cash flows.
In November 2010, a jury verdict was rendered in a Kentucky state court against us for $2.75 million in compensatory damages and $40 million in punitive damages. On February 25, 2011, the trial court judge reduced the punitive damage award to $24.75 million. The case involves claims for professional negligence resulting in wrongful death. We disagree with the jury's verdict and believe that it is not supported by the facts of the case or applicable law. Our appeal is currently pending with the Kentucky Court of Appeals. We believe our reserves are adequate for this matter.
(c) Other Inquiries
From time to time, fiscal intermediaries and Medicaid agencies examine cost reports filed by predecessor operators of our skilled nursing centers. If, as a result of any such examination, it is concluded that overpayments to a predecessor operator were made, we, as the current operator of such centers, may be held financially responsible for such overpayments. At this time, we are unable to predict the outcome of any existing or future examinations.
(d) Genesis Termination Fee
The Merger Agreement contains customary representations and warranties and pre-closing covenants. It contains termination provisions for each of us and Genesis, and provides that in certain specified circumstances, we must pay Genesis a termination fee equal to $6.9 million and up to $1.0 million of reasonable, out of pocket expenses incurred by Genesis in connection with the Merger Agreement.
(6) Income Taxes
The provision for income taxes of $1.9 million and $3.1 million for the three and six months ended June 30, 2012, respectively, results in an effective tax rate of approximately 39% for both periods. The provision for income taxes of $7.9 million and $14.5 million for the three and six months ended June 30, 2011, respectively, resulted in an effective tax rate of approximately 41% for both periods. The rates for 2012 and 2011 differ from the statutory tax rate of 35% primarily due to state taxes.
The realization of our deferred tax assets is dependent upon generation of taxable income during periods in which deductions and/or credits can be utilized. As a result, we consider the level of historical taxable income, historical non-recurring credits and charges, the scheduled reversal of deferred tax liabilities, tax-planning strategies and projected future taxable income in determining the amount of the valuation allowance. The valuation allowance of $17.9 million at June 30, 2012 and December 31, 2011 relates primarily to state net operating loss (“NOL”) carryforwards and other deferred tax assets for which realization is uncertain.
In evaluating the need to establish a valuation allowance on our net deferred tax assets, all items of positive evidence (e.g., future sources of taxable income, including the ability to reliably forecast and to continue our mitigation initiatives implemented in 2011) and negative evidence (e.g., impact of the Centers for Medicare and Medicaid Services ("CMS") final rule for skilled nursing facilities for the 2012 federal fiscal year, which commenced on October 1, 2011 (the "CMS Final Rule") and subsequent impairment of goodwill in 2011) were considered. We were in a cumulative pre-tax book loss of approximately $217 million for the three-year period ended December 31, 2011. However, because approximately $324 million of the book expenses (principally
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
related to our 2011 non-cash loss on asset impairment for goodwill and other intangibles) were not deductible for tax purposes, we generated taxable income and utilized existing net operating loss carryforwards in each of the last three years. As a result of the negative impact of the CMS Final Rule on our business, we commenced a broad based mitigation initiative in 2011, which includes infrastructure cost reductions. Our ability to generate sufficient future taxable income to realize our deferred tax assets is dependent on our ability to continue our mitigation initiatives. Based upon our current estimates of future taxable income, we believe that we will more likely than not realize our net deferred tax assets. However, if we are unable to continue realizing enough savings through our mitigation initiative to offset the negative impact of the CMS Final Rule, we may be required to increase our valuation allowance in future periods.
After consideration of the November 2010 restructuring of our former parent company, which, among other matters resulted in Sabra Health Care REIT, Inc. holding substantially all of our former parent’s owned real property, and utilization of NOL carryforwards through 2011, the Internal Revenue Code (“IRC”) Section 382 annual base limitation to be applied to our tax attribute carryforwards is approximately $7.4 million. Accordingly, our NOL and tax credit carryforwards have been reduced to take into account this limitation and the respective carryforward periods for these tax attributes. As a result of unused IRC Section 382 limitations from prior years and post-ownership change NOLs, we estimate there is approximately $47.6 million of NOLs which can be used to offset U.S. taxable income in 2012. Considering annual IRC Section 382 limitations and built-in gains, we estimate a total of approximately $145.4 million of utilizable NOL carryforwards to offset taxable income in 2012 and future years.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(7) Segment Information
We operate predominantly in the long-term care segment of the healthcare industry. We are a provider of long-term, sub-acute and related ancillary care services to nursing home patients. Our reportable segments are composed of operating segments, which are aggregated, comprising strategic business units that provide different products and services. They are managed separately because each business has different marketing strategies due to differences in types of customers, distribution channels and capital resource needs. More complete descriptions and accounting policies of the segments are described in Note 13 – “Segment Information” and Note 2 – “Summary of Significant Accounting Policies” of our 2011 Form 10-K. The following tables summarize, for the periods indicated, operating results and other financial information, by business segment (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | |
As of and for the | | | | | | | | | | | |
Three Months Ended | | | | | | | | | | | |
June 30, 2012 | | | | | | | | | | | |
| Inpatient Services | | Rehabilitation Therapy Services | | Medical Staffing Services | | Corporate | | Intersegment Eliminations | | Consolidated |
| | | | | | | | | | | |
Revenues from external customers | $ | 405,135 |
| | $ | 29,197 |
| | $ | 22,804 |
| | $ | 6 |
| | $ | — |
| | $ | 457,142 |
|
Intersegment revenues | — |
| | 32,804 |
| | 719 |
| | — |
| | (33,523 | ) | | — |
|
Total net revenues | 405,135 |
| | 62,001 |
| | 23,523 |
| | 6 |
| | (33,523 | ) | | 457,142 |
|
| | | | | | | | | | | |
Operating salaries and benefits | 189,415 |
| | 52,465 |
| | 17,626 |
| | — |
| | — |
| | 259,506 |
|
Self-insurance for workers’ compensation and | | | | | | | | | | | |
general and professional liability insurance | 12,157 |
| | 610 |
| | 359 |
| | 64 |
| | — |
| | 13,190 |
|
Other operating costs | 123,820 |
| | 2,364 |
| | 2,768 |
| | — |
| | (33,523 | ) | | 95,429 |
|
General and administrative expenses(1) | 8,841 |
| | 2,240 |
| | 621 |
| | 16,049 |
| | — |
| | 27,751 |
|
Provision for losses on | | | | | | | | | | | |
accounts receivable | 4,614 |
| | 366 |
| | 119 |
| | — |
| | — |
| | 5,099 |
|
Segment operating income (loss) | $ | 66,288 |
| | $ | 3,956 |
| | $ | 2,030 |
| | $ | (16,107 | ) | | $ | — |
| | $ | 56,167 |
|
| | | | | | | | | | | |
Center rent expense | 36,207 |
| | 145 |
| | 170 |
| | — |
| | — |
| | 36,522 |
|
Depreciation and amortization | 7,115 |
| | 260 |
| | 187 |
| | 942 |
| | — |
| | 8,504 |
|
Interest, net | (8 | ) | | — |
| | (3 | ) | | 4,440 |
| | — |
| | 4,429 |
|
Net segment income (loss) | $ | 22,974 |
| | $ | 3,551 |
| | $ | 1,676 |
| | $ | (21,489 | ) | | $ | — |
| | $ | 6,712 |
|
| | | | | | | | | | | |
Identifiable segment assets | $ | 392,959 |
| | $ | 17,884 |
| | $ | 20,073 |
| | $ | 283,325 |
| | $ | 20,863 |
| | $ | 735,104 |
|
Goodwill | $ | 30,297 |
| | $ | 75 |
| | $ | 4,533 |
| | $ | — |
| | $ | — |
| | $ | 34,905 |
|
Segment capital expenditures | $ | 7,363 |
| | $ | 152 |
| | $ | 60 |
| | $ | 293 |
| | $ | — |
| | $ | 7,868 |
|
______________________________________
(1) General and administrative expenses include operating administrative expenses.
The term “segment operating income (loss)” is defined as earnings before center rent expense, depreciation and amortization, interest, restructuring costs, transaction costs, income tax expense and discontinued operations.
The term “net segment income (loss)” is defined as earnings before restructuring costs, transaction costs, income tax expense and discontinued operations.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
|
| | | | | | | | | | | | | | | | | | | | | | | |
As of and for the | | | | | | | | | | | |
Three Months Ended | | | | | | | | | | | |
June 30, 2011 | | | | | | | | | | | |
| Inpatient Services | | Rehabilitation Therapy Services | | Medical Staffing Services | | Corporate | | Intersegment Eliminations | | Consolidated |
| | | | | | | | | | | |
Revenues from external customers | $ | 418,584 |
| | $ | 29,979 |
| | $ | 21,998 |
| | $ | 14 |
| | $ | — |
| | $ | 470,575 |
|
Intersegment revenues | — |
| | 33,225 |
| | 699 |
| | — |
| | (33,924 | ) | | — |
|
Total net revenues | 418,584 |
| | 63,204 |
| | 22,697 |
| | 14 |
| | (33,924 | ) | | 470,575 |
|
| | | | | | | | | | | |
Operating salaries and benefits | 192,826 |
| | 53,494 |
| | 17,141 |
| | — |
| | — |
| | 263,461 |
|
Self-insurance for workers’ compensation and | | | | | | | | | | | |
general and professional liability insurance | 13,480 |
| | 642 |
| | 352 |
| | 67 |
| | — |
| | 14,541 |
|
Other operating costs | 120,844 |
| | 2,540 |
| | 2,699 |
| | — |
| | (33,924 | ) | | 92,159 |
|
General and administrative expenses(1) | 10,264 |
| | 2,431 |
| | 609 |
| | 14,953 |
| | — |
| | 28,257 |
|
Provision for losses on | | | | | | | | | | | |
accounts receivable | 4,025 |
| | 316 |
| | 77 |
| | — |
| | — |
| | 4,418 |
|
Segment operating income (loss) | $ | 77,145 |
| | $ | 3,781 |
| | $ | 1,819 |
| | $ | (15,006 | ) | | $ | — |
| | $ | 67,739 |
|
| | | | | | | | | | | |
Center rent expense | 35,453 |
| | 127 |
| | 170 |
| | — |
| | — |
| | 35,750 |
|
Depreciation and amortization | 6,354 |
| | 227 |
| | 187 |
| | 861 |
| | — |
| | 7,629 |
|
Interest, net | (31 | ) | | — |
| | — |
| | 4,885 |
| | — |
| | 4,854 |
|
Net segment income (loss) | $ | 35,369 |
| | $ | 3,427 |
| | $ | 1,462 |
| | $ | (20,752 | ) | | $ | — |
| | $ | 19,506 |
|
| | | | | | | | | | | |
Identifiable segment assets | $ | 701,565 |
| | $ | 16,490 |
| | $ | 19,571 |
| | $ | 337,425 |
| | $ | 20,864 |
| | $ | 1,095,915 |
|
Goodwill | $ | 345,800 |
| | $ | 75 |
| | $ | 4,533 |
| | $ | — |
| | $ | — |
| | $ | 350,408 |
|
Segment capital expenditures | $ | 7,869 |
| | $ | 224 |
| | $ | 19 |
| | $ | 1,207 |
| | $ | — |
| | $ | 9,319 |
|
______________________________________
(1) General and administrative expenses include operating administrative expenses.
The term “segment operating income (loss)” is defined as earnings before center rent expense, depreciation and amortization, interest, restructuring costs, transaction costs, income tax expense and discontinued operations.
The term “net segment income (loss)” is defined as earnings before restructuring costs, transaction costs, income tax expense and discontinued operations.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
|
| | | | | | | | | | | | | | | | | | | | | | | |
As of and for the | | | | | | | | | | | |
Six Months Ended | | | | | | | | | | | |
June 30, 2012 | | | | | | | | | | | |
| Inpatient Services | | Rehabilitation Therapy Services | | Medical Staffing Services | | Corporate | | Intersegment Eliminations | | Consolidated |
| | | | | | | | | | | |
Revenues from external customers | $ | 810,923 |
| | $ | 59,826 |
| | $ | 44,873 |
| | $ | 13 |
| | $ | — |
| | $ | 915,635 |
|
Intersegment revenues | — |
| | 66,267 |
| | 1,550 |
| | — |
| | (67,817 | ) | | — |
|
Total net revenues | 810,923 |
| | 126,093 |
| | 46,423 |
| | 13 |
| | (67,817 | ) | | 915,635 |
|
| | | | | | | | | | | |
Operating salaries and benefits | 379,124 |
| | 106,359 |
| | 35,112 |
| | — |
| | — |
| | 520,595 |
|
Self-insurance for workers’ compensation and | | | | | | | | | | | |
general and professional liability insurance | 26,445 |
| | 1,219 |
| | 715 |
| | 128 |
| | — |
| | 28,507 |
|
Other operating costs | 249,488 |
| | 4,861 |
| | 5,463 |
| | — |
| | (67,817 | ) | | 191,995 |
|
General and administrative expenses(1) | 18,101 |
| | 4,770 |
| | 1,236 |
| | 32,092 |
| | — |
| | 56,199 |
|
Provision for losses on | | | | | | | | | | | |
accounts receivable | 9,044 |
| | 781 |
| | 83 |
| | — |
| | — |
| | 9,908 |
|
Segment operating income (loss) | $ | 128,721 |
| | $ | 8,103 |
| | $ | 3,814 |
| | $ | (32,207 | ) | | $ | — |
| | $ | 108,431 |
|
| | | | | | | | | | | |
Center rent expense | 72,282 |
| | 279 |
| | 338 |
| | — |
| | — |
| | 72,899 |
|
Depreciation and amortization | 14,144 |
| | 511 |
| | 371 |
| | 1,908 |
| | — |
| | 16,934 |
|
Interest, net | (28 | ) | | — |
| | (3 | ) | | 8,870 |
| | — |
| | 8,839 |
|
Net segment income (loss) | $ | 42,323 |
| | $ | 7,313 |
| | $ | 3,108 |
| | $ | (42,985 | ) | | $ | — |
| | $ | 9,759 |
|
| | | | | | | | | | | |
Identifiable segment assets | $ | 392,959 |
| | $ | 17,884 |
| | $ | 20,073 |
| | $ | 283,325 |
| | $ | 20,863 |
| | $ | 735,104 |
|
Goodwill | $ | 30,297 |
| | $ | 75 |
| | $ | 4,533 |
| | $ | — |
| | $ | — |
| | $ | 34,905 |
|
Segment capital expenditures | $ | 16,020 |
| | $ | 562 |
| | $ | 112 |
| | $ | 1,135 |
| | $ | — |
| | $ | 17,829 |
|
______________________________________
(1) General and administrative expenses include operating administrative expenses.
The term “segment operating income (loss)” is defined as earnings before center rent expense, depreciation and amortization, interest, restructuring costs, transaction costs, income tax expense and discontinued operations.
The term “net segment income (loss)” is defined as earnings before restructuring costs, transaction costs, income tax expense and discontinued operations.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
|
| | | | | | | | | | | | | | | | | | | | | | | |
As of and for the | | | | | | | | | | | |
Six Months Ended | | | | | | | | | | | |
June 30, 2011 | | | | | | | | | | | |
| Inpatient Services | | Rehabilitation Therapy Services | | Medical Staffing Services | | Corporate | | Intersegment Eliminations | | Consolidated |
| | | | | | | | | | | |
Revenues from external customers | $ | 832,471 |
| | $ | 60,077 |
| | $ | 44,314 |
| | $ | 21 |
| | $ | — |
| | $ | 936,883 |
|
Intersegment revenues | — |
| | 65,920 |
| | 1,321 |
| | — |
| | (67,241 | ) | | — |
|
Total net revenues | 832,471 |
| | 125,997 |
| | 45,635 |
| | 21 |
| | (67,241 | ) | | 936,883 |
|
| | | | | | | | | | | |
Operating salaries and benefits | 383,756 |
| | 107,629 |
| | 34,558 |
| | — |
| | — |
| | 525,943 |
|
Self-insurance for workers’ compensation and | | | | | | | | | | | |
general and professional liability insurance | 26,979 |
| | 1,285 |
| | 699 |
| | 135 |
| | — |
| | 29,098 |
|
Other operating costs | 240,268 |
| | 4,708 |
| | 5,559 |
| | — |
| | (67,241 | ) | | 183,294 |
|
General and administrative expenses(1) | 20,277 |
| | 4,829 |
| | 1,264 |
| | 30,333 |
| | — |
| | 56,703 |
|
Provision for losses on | | | | | | | | | | | |
accounts receivable | 8,979 |
| | 640 |
| | (24 | ) | | — |
| | — |
| | 9,595 |
|
Segment operating income (loss) | $ | 152,212 |
| | $ | 6,906 |
| | $ | 3,579 |
| | $ | (30,447 | ) | | $ | — |
| | $ | 132,250 |
|
| | | | | | | | | | | |
Center rent expense | 70,845 |
| | 254 |
| | 343 |
| | — |
| | — |
| | 71,442 |
|
Depreciation and amortization | 12,560 |
| | 453 |
| | 374 |
| | 1,690 |
| | — |
| | 15,077 |
|
Interest, net | (37 | ) | | — |
| | 1 |
| | 9,889 |
| | — |
| | 9,853 |
|
Net segment income (loss) | $ | 68,844 |
| | $ | 6,199 |
| | $ | 2,861 |
| | $ | (42,026 | ) | | $ | — |
| | $ | 35,878 |
|
| | | | | | | | | | | |
Identifiable segment assets | $ | 701,565 |
| | $ | 16,490 |
| | $ | 19,571 |
| | $ | 337,425 |
| | $ | 20,864 |
| | $ | 1,095,915 |
|
Goodwill | $ | 345,800 |
| | $ | 75 |
| | $ | 4,533 |
| | $ | — |
| | $ | — |
| | $ | 350,408 |
|
Segment capital expenditures | $ | 14,376 |
| | $ | 953 |
| | $ | 72 |
| | $ | 2,755 |
| | $ | — |
| | $ | 18,156 |
|
______________________________________
(1) General and administrative expenses include operating administrative expenses.
The term “segment operating income (loss)” is defined as earnings before center rent expense, depreciation and amortization, interest, restructuring costs, transaction costs, income tax expense and discontinued operations.
The term “net segment income (loss)” is defined as earnings before restructuring costs, transaction costs, income tax expense and discontinued operations.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Measurement of Segment Income
We evaluate financial performance and allocate resources primarily based on income or loss from operations before income taxes, excluding any unusual items. The following table reconciles net segment income to consolidated income before income taxes and discontinued operations (in thousands):
|
| | | | | | | |
| For the Three Months Ended June 30, |
| 2012 | | 2011 |
Net segment income | $ | 6,712 |
| | $ | 19,506 |
|
Transaction costs | (1,838 | ) | | — |
|
Restructuring costs | — |
| | (167 | ) |
Consolidated income before income taxes | | | |
and discontinued operations | $ | 4,874 |
| | $ | 19,339 |
|
|
| | | | | | | |
| For the Six Months Ended June 30, |
| 2012 | | 2011 |
Net segment income | $ | 9,759 |
| | $ | 35,878 |
|
Transaction costs | (1,838 | ) | | — |
|
Restructuring costs | — |
| | (303 | ) |
Consolidated income before income taxes | | | |
and discontinued operations | $ | 7,921 |
| | $ | 35,575 |
|
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Our subsidiaries are providers of nursing, rehabilitative and related specialty healthcare services primarily to the senior population in the United States. Our core business is providing inpatient services, primarily through 158 skilled nursing centers, 13 combined skilled nursing, assisted and independent living centers, 10 assisted living centers, 2 independent living centers and 7 mental health centers with 21,349 licensed beds located in 23 states as of June 30, 2012. Our subsidiaries also provide hospice services, rehabilitation therapy services and temporary medical staffing services to skilled nursing centers.
Pending Merger with Genesis HealthCare LLC
On June 20, 2012, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Genesis HealthCare LLC, a Delaware limited liability company (“Genesis”), and Jam Acquisition LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of Genesis (“Merger Sub”). The Merger Agreement provides that, upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub will be merged with and into us, with us continuing as the surviving corporation and an indirect wholly owned subsidiary of Genesis (the “Merger”). Pursuant to the terms of the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of our common stock, other than treasury shares, shares held by us (other than shares held in a fiduciary capacity that are beneficially owned by third parties), Genesis, Merger Sub or any wholly owned subsidiary of Genesis or us and shares held by stockholders who perfect their appraisal rights under Delaware law, will be converted into the right to receive $8.50 in cash, without interest (the “Merger Consideration”). At the effective time of the Merger, outstanding equity awards with respect to shares of our common stock (whether vested or unvested) will be canceled and converted into the right to receive a cash amount equal to the difference between the Merger Consideration and the exercise price, if any, of such awards. We anticipate that the total amount of funds necessary to pay the aggregate Merger Consideration will be approximately $230 million, not including refinancing of our existing indebtedness or payment of related transaction fees and expenses.
We have commenced mailing the proxy statement to our stockholders and will hold a special stockholders meeting concerning the transaction on September 5, 2012. The transaction is expected to close in the fall of 2012 subject to the satisfaction of customary closing conditions, including, among other things, (i) the affirmative vote of a majority of the outstanding shares of our common stock in favor of the adoption of the Merger Agreement, (ii) the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, (iii) the receipt of other required governmental approvals, (iv) the absence of any law or order prohibiting the consummation of the Merger, (v) subject to certain materiality exceptions, the accuracy of our representations and warranties in the Merger Agreement, (vi) the performance in all material respects of our covenants in the Merger Agreement, (vii) the absence of any material adverse effect on us between June 20, 2012 and consummation of the Merger and (viii) compliance by us with our obligations under certain third party contracts.
2011 Restructuring
On July 29, 2011, the Centers for Medicare and Medicaid Services (“CMS”) released its final rule for skilled nursing facilities for the 2012 federal fiscal year, which commenced on October 1, 2011 (the “CMS Final Rule”). As a result of the expected negative impact of the CMS Final Rule on our business, we implemented a broad-based mitigation initiative, which included infrastructure cost reductions without affecting the quality of our patient care. These reductions in infrastructure costs were, and continue to be, necessary to mitigate the impact on our business and remain in compliance with financial covenants under our credit agreement. For additional information regarding the impact to us of the CMS Final Rule, please see "Medicare" below.
Revenues from Medicare, Medicaid and Other Sources
We receive revenues from Medicare, Medicaid, commercial insurance, self-pay residents, other third party payors and healthcare centers that utilize our specialty medical services. The sources and amounts of our inpatient services revenues are determined by a number of factors, including the number of licensed beds and occupancy rates of our centers, the acuity level of patients and the rates of reimbursement among payors. Federal and state governments continue to focus on methods to curb spending on health care programs such as Medicare and Medicaid, and pressures on federal and state budgets resulting from the current economic conditions in the United States may intensify these efforts. This focus has not been limited to skilled nursing centers, but includes specialty services provided by us, such as skilled therapy services, to third parties. We cannot at this time predict the extent to which proposals limiting federal or state expenditures will be adopted or, if adopted and implemented, what effect, if any, such proposals will have on us. Efforts to impose reduced coverage, greater discounts and more stringent cost controls by
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
government and other payors are expected to continue.
In addition, due to recent adverse economic conditions, we have experienced reduced demand for the specialty services that we provide to third parties. If economic conditions do not improve or worsen, we may experience additional reductions in demand for the specialty services we provide. We are unable at this time to predict the impact or extent of such reduced demand.
The following table sets forth the total nonaffiliated revenues and percentage of revenues by payor source for our continuing operations, on a consolidated and on an inpatient operations only basis, for the periods indicated (dollars in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | |
|
| For the Three Months Ended | | For the Six Months Ended |
Sources of Revenues |
| June 30, 2012 |
| June 30, 2011 | | June 30, 2012 | | June 30, 2011 |
|
|
|
|
|
|
| | | | | | |
Consolidated: |
|
|
|
|
|
| | | | | | |
Medicaid |
| $ | 188,851 |
| 41.3 | % |
| 179,578 |
| 38.2 | % | | $ | 375,293 |
| 41.0 | % | | $ | 357,223 |
| 38.1 | % |
Medicare |
| 133,399 |
| 29.2 |
|
| 154,193 |
| 32.8 |
| | 269,688 |
| 29.5 | % | | 305,443 |
| 32.6 | % |
Private pay and other |
| 111,487 |
| 24.4 |
|
| 113,457 |
| 24.0 |
| | 223,911 |
| 24.4 | % | | 227,861 |
| 24.4 | % |
Managed care and commercial insurance |
| 23,405 |
| 5.1 |
|
| 23,347 |
| 5.0 |
| | 46,743 |
| 5.1 | % | | 46,356 |
| 4.9 | % |
Total |
| $ | 457,142 |
| 100.0 | % |
| 470,575 |
| 100.0 | % | | $ | 915,635 |
| 100.0 | % | | $ | 936,883 |
| 100.0 | % |
|
|
|
|
|
|
| | | | | | |
Inpatient Only: |
|
|
|
|
|
| | | | | | |
Medicaid |
| $ | 188,837 |
| 46.6 | % |
| 179,557 |
| 42.9 | % | | $ | 375,260 |
| 46.3 | % | | $ | 357,152 |
| 42.9 | % |
Medicare |
| 128,829 |
| 31.8 |
|
| 149,710 |
| 35.8 |
| | 260,346 |
| 32.1 | % | | 296,318 |
| 35.6 | % |
Private pay and other |
| 64,349 |
| 15.9 |
|
| 66,257 |
| 15.8 |
| | 129,203 |
| 15.9 | % | | 133,200 |
| 16.0 | % |
Managed care and commercial insurance |
| 23,120 |
| 5.7 |
|
| 23,060 |
| 5.5 |
| | 46,114 |
| 5.7 | % | | 45,801 |
| 5.5 | % |
Total |
| $ | 405,135 |
| 100.0 | % |
| 418,584 |
| 100.0 | % | | $ | 810,923 |
| 100.0 | % | | $ | 832,471 |
| 100.0 | % |
Medicare
Medicare is available to nearly every United States citizen 65 years of age and older. It is a broad program of health insurance designed to help the nation's elderly meet hospital, hospice, home health and other health care costs. Health insurance coverage extends to certain persons under age 65 who qualify as disabled or those having end-stage renal disease. Medicare is comprised of four related health insurance programs. Medicare Part A provides for inpatient services including hospital, skilled long-term care, hospice and home healthcare. Medicare Part B provides for outpatient services including physicians' services, diagnostic service, durable medical equipment, skilled therapy services and medical supplies. Medicare Part C is a managed care option (“Medicare Advantage”) for beneficiaries who are entitled to Part A and enrolled in Part B. Medicare Part D is a benefit that provides prescription drug benefits for both Medicare and Medicare/Medicaid dually eligible patients.
Medicare reimburses our skilled nursing centers for Medicare Part A services under the Prospective Payment System (“PPS”) as defined by the Balanced Budget Act of 1997 and subsequent legislative and rule changes. PPS regulations predetermine a payment amount per patient, per day, based on the 1995 costs of treating patients indexed forward. Prior to October 1, 2010, the amount to be paid was determined by classifying each patient into one of 53 Resource Utilization Groups (“RUGs”), which were collectively referred to as “RUGs III”. After October 1, 2010, the RUGs were expanded to 66 categories to provide further refinement and are referred to collectively as “RUGs IV”. Each RUGs level represents the level of services required to treat the patient's condition or level of acuity.
The RUGs III system reimbursed for therapy service delivered concurrently, in a group or individually, at the same rate. The RUGs IV system changes maintain the same reimbursement methodology for group and individual therapy, but only considers concurrent therapy if it is delivered to two patients and divides the services between the two patients that receive the services. Changes were also made to the required qualifications for each RUGs level.
On July 29, 2011, CMS released the CMS Final Rule for skilled nursing facilities for the 2012 federal fiscal year that commenced on October 1, 2011. Pursuant to the CMS Final Rule, Medicare Part A payment rates were reduced by 12.6% (i.e., the Medicare rate parity adjustment) to correct what CMS perceived as a lack of parity between RUGs III and RUGs IV. The CMS Final Rule also changed the reimbursement rules associated with group therapy and introduced new change-of-therapy provisions as patients move through their post-acute stay. The CMS Final Rule therapy reimbursement changes resulted in further reductions in our
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
revenues from the Medicare program (prior to implementation of our therapy mitigation plans) and also served to increase our costs of providing such therapy services. On October 1, 2011, we also received a net 1.7% market basket increase to our prospective Medicare rates. Based on operating results through the end of the second quarter of 2012, we continue to expect the impact of the CMS Final Rule on our full year 2012 operations to be a year-over-year reduction in income before income taxes of approximately $40.0 million to $45.0 million due to the ramp-up nature of many elements of our management mitigation plans.
The following table sets forth the average amounts of inpatient Medicare Part A revenues per patient, per day, recorded by our healthcare centers for the periods indicated:
|
| | | | | | |
For the Three Months Ended | | For the Six Months Ended |
June 30, 2012 | | June 30, 2011 | | June 30, 2012 | | June 30, 2011 |
$461.80 | | $520.51 | | $462.46 | | $521.31 |
Under current law, there are limits on reimbursement provided under Medicare Part B for therapy services. An automatic exception process has been in place for patients residing in skilled nursing centers. That exception process will continue through December 31, 2012. Beginning October 1, 2012, through December 31, 2012, a new provision for a manual medical review process has been added to request exceptions to the therapy caps for services above certain thresholds. Instructions regarding the manual medical review process have not yet been released by CMS.
CMS has notified providers that they would not issue a Notice of Proposed Rulemaking - SNF for the 2013 fiscal year, which commences on October 1, 2012. They instead issued an Update Notice on July 27, 2012, which makes the updates that are required by current law rather than implementing policy changes. This Update Notice provides for a market basket increase of 2.5%, which is reduced by a productivity adjustment of 0.7%, generating a net increase of 1.8%. We estimate that the net impact of this Update Notice on our skilled nursing operations will result in increased revenues of approximately $1.9 million per quarter. Any additional changes prior to October 1, 2013 would require legislative action.
On February 17, 2012, Congress passed the Middle Class Tax Relief and Job Creation Act of 2011, which included a provision reducing the reimbursement of Medicare bad debts. Medicare bad debts are primarily generated when states do not reimburse the provider for co-insurance for Medicare/Medicaid dually eligible patients. Providers are not permitted to bill this co-insurance to any other party when Medicaid does not reimburse the provider cost of service. Prior to this legislation, Medicare reimbursed providers 100% for this uncollectable co-insurance associated with dually eligible patients. Under the newly enacted legislation, Medicare will now phase in a reduction in the percentage of reimbursement for uncollectable co-insurance starting with cost reports beginning in federal fiscal year 2013, which primarily impacts our cost reports beginning on January 1, 2013. It is not clear if states will reimburse for dually eligible patient co-insurance under the state Medicaid programs as a result of this new legislation. If states do not begin to reimburse for dually eligible patient co-insurance then we are projecting the result will be a reduction in our revenues from reimbursement of Medicare bad debts of approximately $2.3 million in 2013, $4.7 million in 2014 and $6.7 million in subsequent years. Fourteen of the twenty-three states in which we operate do not reimburse the Medicaid co-insurance for dually eligible patients.
On August 2, 2011, Congress passed the Budget Control Act of 2011, which created The Joint Select Committee on Deficit Reduction. This Committee was tasked to find $1.5 trillion in savings by November 23, 2011. The Committee was unable to reach an agreement and as a result, sequestration as provided for in the Budget Control Act was triggered. Sequestration will result in a 2% reduction in Medicare payments effective January 1, 2013, which we estimate will reduce our revenues by approximately $2.5 million per quarter in 2013.
Historically we have been able to mitigate a portion of revenue reductions resulting from changes in CMS' reimbursement regulations.
We receive Medicare reimbursements for hospice care at daily or hourly rates based on the level of care furnished to the patient. Our ability to receive Medicare reimbursement for our hospice services is subject to two limitations:
| |
· | If inpatient days of care provided to all patients at a hospice exceed 20% of the total days of hospice care provided by that hospice for an annual period, then payment for days in excess of this limit are paid for at the lower routine home care rate. |
| |
· | Overall payments made by Medicare on a per hospice program basis are subject to a cap amount at the end of an annual period. The cap amount is calculated by multiplying the number of first time Medicare hospice beneficiaries during the |
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
year by the Medicare per beneficiary cap amount, resulting in that hospice's aggregate cap, which is the allowable amount of total Medicare payments that hospice can receive for that cap year. If a hospice program exceeds its aggregate cap, then the hospice must repay the excess.
In July 2012, CMS issued its final rule for hospice services for the 2013 federal fiscal year. The rule includes a market basket increase of 0.9%. We estimate that the net impact on our hospice service operations will be a net increase of 1.1% in our reimbursement rates, which we estimate will result in increased revenues of approximately $0.2 million per quarter.
In July 2011, CMS issued its final rule for hospice services for the 2012 federal fiscal year. The rule includes a market basket increase of 3.0% and a 0.6% decrease resulting from a phase out of the wage index budget neutrality factor. We estimate that the net impact on our hospice service operations of these two adjustments and updated wage index data will be an increase of 2.2% in our reimbursement rates, which we estimate will result in increased revenues of approximately $0.3 million per quarter.
Medicaid
Medicaid is a state-administered program financed by state funds and federal matching funds. The program provides for medical assistance to the indigent and certain other eligible persons. Although administered under broad federal regulations, states are given flexibility to construct programs and payment methods. Each state in which we operate nursing and rehabilitation centers has its own unique Medicaid reimbursement system.
Medicaid outlays are a significant component of state budgets, and there have been cost containment pressures on Medicaid outlays for nursing homes. The recent economic downturn has caused many states to institute freezes on or reductions in Medicaid spending to address state budget concerns.
Twenty-one of the states in which our Inpatient Services segment operates impose a provider tax on nursing homes as a method of increasing federal matching funds paid to those states for Medicaid.
The following table sets forth the average amounts of inpatient Medicaid revenues per patient, per day (excluding any impact of individually identifiable state-imposed provider taxes), recorded by our healthcare centers for the periods indicated:
|
| | | | | | |
For the Three Months Ended | | For the Six Months Ended |
June 30, 2012 | | June 30, 2011 | | June 30, 2012 | | June 30, 2011 |
$180.08 | | $175.49 | | $179.36 | | $174.59 |
For comparison purposes, the following table sets forth the average amounts of inpatient Medicaid revenues per patient, per day (including the impact from individually identifiable state-imposed provider taxes), recorded by our healthcare centers for the periods indicated:
|
| | | | | | |
For the Three Months Ended | | For the Six Months Ended |
June 30, 2012 | | June 30, 2011 | | June 30, 2012 | | June 30, 2011 |
$162.91 | | $160.19 | | $162.26 | | $159.41 |
Managed Care and Insurance
During the three months ended June 30, 2012, we received 5.1% of our revenues from managed care and insurance, of which the Medicare Advantage program is the primary component. As discussed above, Medicare Advantage is the managed care option for Medicare beneficiaries. Medicare Advantage is administered by contracted third party payors. The managed care and insurance payors are continuing their efforts to control healthcare costs through direct contracts with healthcare providers and increased utilization review. These payors are increasingly demanding discounted fee structures and the assumption by healthcare providers of all or a portion of the financial risk.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
The following table sets forth the average amounts of inpatient revenues per patient, per day, recorded by our healthcare centers from these revenue sources for the periods indicated below.
|
| | | | | | |
For the Three Months Ended | | For the Six Months Ended |
June 30, 2012 | | June 30, 2011 | | June 30, 2012 | | June 30, 2011 |
$371.57 | | $380.42 | | $379.47 | | $374.50 |
Private Payors, Veterans and Other
During the three months ended June 30, 2012, we received 24.4% of our revenues from private payors, veterans’ coverage, healthcare centers that utilize our specialty medical services, self-pay center residents and other third party payors. These private and other payors are continuing their efforts to control healthcare costs. Private payor rates are set at a price point that enables continued competition; they are driven by the markets in which our healthcare centers operate.
The following table sets forth the average amounts of inpatient revenues per patient, per day, recorded by our healthcare centers from these revenue sources for the periods indicated:
|
| | | | | | |
For the Three Months Ended | | For the Six Months Ended |
June 30, 2012 | | June 30, 2011 | | June 30, 2012 | | June 30, 2011 |
$190.00 | | $188.15 | | $190.09 | | $192.13 |
Other Reimbursement Matters
Net revenues realizable under third-party payor agreements are subject to change due to examination and retroactive adjustment by payors during the settlement process. Under cost-based reimbursement plans, payors may either delay or disallow, in whole or in part, requests for reimbursement based on determinations that certain costs are not reimbursable or reasonable or because additional supporting documentation is necessary. We recognize revenues from third-party payors and accrue estimated settlement amounts in the period in which the related services are provided. We estimate these settlement balances by making determinations based on our prior settlement experience and our understanding of the applicable reimbursement rules and regulations.
Recent Accounting Pronouncements
Discussion of recent accounting pronouncements can be found in the “Recent Accounting Pronouncements” portion of Note 1 – “Nature of Business” to our consolidated financial statements included in this Form 10-Q.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
Results of Operations
The following tables set forth our unaudited historical consolidated income statements and certain percentage relationships for the periods presented (dollars in thousands):
|
| | | | | | | | | | | | | |
| For the Three Months Ended | | As a Percentage of Net Revenues |
| June 30, 2012 | | June 30, 2011 | | June 30, 2012 | | June 30, 2011 |
Total net revenues | $ | 457,142 |
| | $ | 470,575 |
| | 100.0 | % | | 100.0 | % |
Costs and expenses: | |
| | |
| | | | |
Operating salaries and benefits | 259,506 |
| | 263,461 |
| | 56.8 |
| | 56.0 |
|
Self-insurance for workers’ compensation and | |
| | | | | | |
general and professional liabilities | 13,190 |
| | 14,541 |
| | 2.9 |
| | 3.1 |
|
Other operating costs (1) | 107,132 |
| | 105,464 |
| | 23.4 |
| | 22.4 |
|
Center rent expense | 36,522 |
| | 35,750 |
| | 8.0 |
| | 7.6 |
|
General and administrative expenses | 16,048 |
| | 14,952 |
| | 3.5 |
| | 3.2 |
|
Depreciation and amortization | 8,504 |
| | 7,629 |
| | 1.9 |
| | 1.6 |
|
Provision for losses on accounts receivable | 5,099 |
| | 4,418 |
| | 1.1 |
| | 0.9 |
|
Interest, net | 4,429 |
| | 4,854 |
| | 1.0 |
| | 1.0 |
|
Other (2) | 1,838 |
| | 167 |
| | 0.4 |
| | — |
|
Income before income taxes and discontinued operations | 4,874 |
| | 19,339 |
| | 1.1 |
| | 4.1 |
|
Income tax expense | 1,901 |
| | 7,894 |
| | 0.4 |
| | 1.7 |
|
Income from continuing operations | 2,973 |
| | 11,445 |
| | 0.7 |
| | 2.4 |
|
Loss from discontinued operations, net | (3,953 | ) | | (1,499 | ) | | (0.9 | ) | | (0.3 | ) |
Net (loss) income | $ | (980 | ) | | $ | 9,946 |
| | (0.2 | )% | | 2.1 | % |
Supplemental Financial Information (3): | |
| | |
| | | | |
EBITDA | $ | 17,807 |
| | $ | 31,822 |
| | 3.9 | % | | 6.8 | % |
Adjusted EBITDA | $ | 17,807 |
| | $ | 31,989 |
| | 3.9 | % | | 6.8 | % |
Adjusted EBITDAR | $ | 54,329 |
| | $ | 67,739 |
| | 11.9 | % | | 14.4 | % |
|
| | | | | | | | | | | | | |
| For the Six Months Ended | | As a Percentage of Net Revenues |
| June 30, 2012 | | June 30, 2011 | | June 30, 2012 | | June 30, 2011 |
Total net revenues | $ | 915,635 |
| | $ | 936,883 |
| | 100.0 | % | | 100.0 | % |
Costs and expenses: | | | | | | | |
Operating salaries and benefits | 520,595 |
| | 525,943 |
| | 56.9 |
| | 56.1 |
|
Self-insurance for workers’ compensation and | |
| | | | | | |
general and professional liabilities | 28,507 |
| | 29,098 |
| | 3.1 |
| | 3.1 |
|
Other operating costs (1) | 216,105 |
| | 209,666 |
| | 23.6 |
| | 22.4 |
|
Center rent expense | 72,899 |
| | 71,442 |
| | 8.0 |
| | 7.6 |
|
General and administrative expenses | 32,089 |
| | 30,331 |
| | 3.5 |
| | 3.2 |
|
Depreciation and amortization | 16,934 |
| | 15,077 |
| | 1.8 |
| | 1.6 |
|
Provision for losses on accounts receivable | 9,908 |
| | 9,595 |
| | 1.1 |
| | 1.0 |
|
Interest, net | 8,839 |
| | 9,853 |
| | 1.0 |
| | 1.1 |
|
Other (2) | 1,838 |
| | 303 |
| | 0.2 |
| | — |
|
Income before income taxes and discontinued operations | 7,921 |
| | 35,575 |
| | 0.9 |
| | 3.8 |
|
Income tax expense | 3,089 |
| | 14,512 |
| | 0.3 |
| | 1.5 |
|
Income from continuing operations | 4,832 |
| | 21,063 |
| | 0.5 |
| | 2.2 |
|
Loss from discontinued operations, net | (5,599 | ) | | (3,005 | ) | | (0.6 | ) | | (0.3 | ) |
Net (loss) income | $ | (767 | ) | | $ | 18,058 |
| | (0.1 | )% | | 1.9 | % |
Supplemental Financial Information (3): | |
| | |
| | | | |
EBITDA | $ | 33,694 |
| | $ | 60,505 |
| | 3.7 | % | | 6.5 | % |
Adjusted EBITDA | $ | 33,694 |
| | $ | 60,808 |
| | 3.7 | % | | 6.5 | % |
Adjusted EBITDAR | $ | 106,593 |
| | $ | 132,250 |
| | 11.6 | % | | 14.1 | % |
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
(1) Operating administrative expenses are included in “other operating costs” above.
(2) Other expenses consist of transaction costs and restructuring costs.
(3) We define EBITDA as net income before loss from discontinued operations, interest expense (net of interest income), income tax expense, depreciation and amortization. EBITDA margin is EBITDA as a percentage of revenue. Adjusted EBITDA is EBITDA adjusted for restructuring costs. Adjusted EBITDA margin is Adjusted EBITDA as a percentage of revenue. Adjusted EBITDAR is Adjusted EBITDA before center rent expense. Adjusted EBITDAR margin is Adjusted EBITDAR as a percentage of revenue.
We believe that the presentation of EBITDA, Adjusted EBITDA and Adjusted EBITDAR provides useful information regarding our operational performance because they enhance the overall understanding of the financial performance and prospects for the future of our core business activities.
Specifically, we believe that a presentation of EBITDA, Adjusted EBITDA and Adjusted EBITDAR provides consistency in our financial reporting and provides a basis for the comparison of results of core business operations between our current, past and future periods. EBITDA, Adjusted EBITDA and Adjusted EBITDAR are three of the primary indicators we use for planning and forecasting in future periods, including trending and analyzing the core operating performance of our business from period-to-period without the effect of GAAP expenses, revenues and gains that are unrelated to the day-to-day performance of our business. We also use EBITDA, Adjusted EBITDA and Adjusted EBITDAR to benchmark the performance of our business against expected results, analyzing year-over-year trends as described below and to compare our operating performance to that of our competitors.
In addition to other financial measures, including net segment income, we use EBITDA, Adjusted EBITDA and Adjusted EBITDAR to assess the performance of our core business operations, to prepare operating budgets and to measure our performance against those budgets on a consolidated, segment and a center-by-center level. EBITDA, Adjusted EBITDA and Adjusted EBITDAR are useful in this regard because they do not include such costs as interest expense (net of interest income), income taxes and depreciation and amortization expense, which may vary from business unit to business unit and period-to-period depending upon various factors, including the method used to finance the business, the amount of debt that we have determined to incur, whether a center is owned or leased, the date of acquisition of a facility or business, the original purchase price of a facility or business unit or the tax law of the state in which a business unit operates. These types of charges are dependent on factors unrelated to our underlying business. The additional items we exclude from Adjusted EBITDA and Adjusted EBITDAR are also charges that we believe are unrelated to the operation of our underlying business. As a result, we believe that the use of EBITDA, Adjusted EBITDA and Adjusted EBITDAR provides a meaningful and consistent comparison of our underlying business between periods by eliminating certain items required by GAAP which have little or no significance in our day-to-day operations.
We also make capital allocations to each of our centers based on the centers’ lease terms and their expected Adjusted EBITDA returns. We establish compensation and bonus programs for our center-level employees that are based upon the achievement of pre-established Adjusted EBITDA targets.
Despite the importance of these measures in analyzing our underlying business, maintaining our financial requirements, designing incentive compensation and for our goal setting both on an aggregate and facility level basis, EBITDA, Adjusted EBITDA and Adjusted EBITDAR are non-GAAP financial measures that have no standardized meaning defined by GAAP. As the items excluded from EBITDA, Adjusted EBITDA and Adjusted EBITDAR are significant components in understanding and assessing our financial performance, EBITDA, Adjusted EBITDA and Adjusted EBITDAR should not be considered in isolation or as alternatives to net income, cash flows generated by or used in operating, investing or financing activities or other financial statement data presented in the consolidated financial statements included in this Form 10-Q as indicators of financial performance or liquidity. Therefore, our EBITDA, Adjusted EBITDA and Adjusted EBITDAR measures have limitations as analytical tools, and they should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
| |
• | they do not reflect our cash expenditures, or future requirements for capital expenditures, or contractual commitments; |
| |
• | they do not reflect changes in, or cash requirements for, our working capital needs; |
| |
• | they do not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debt; |
| |
• | they do not reflect any income tax payments we may be required to make; |
| |
• | although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future in order to remain competitive in the market, and EBITDA, Adjusted EBITDA and Adjusted EBITDAR do not reflect any cash requirements for such replacements; |
| |
• | they are not adjusted for all non-cash income or expense items that are reflected in our consolidated statements of cash flows; and |
| |
• | other companies in our industry may calculate these measures differently than we do, which may limit their usefulness as comparative measures. |
We compensate for these limitations by using EBITDA, Adjusted EBITDA and Adjusted EBITDAR only to supplement net income on a basis prepared in conformance with GAAP in order to provide a more complete understanding of the factors and trends affecting our business. We strongly encourage investors to consider net income determined under GAAP as compared to EBITDA, Adjusted EBITDA and Adjusted EBITDAR, and to perform their own analysis, as appropriate.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
The following table provides a reconciliation of our net (loss) income, which is the most directly comparable financial measure presented in accordance with GAAP, to EBITDA, Adjusted EBITDA and Adjusted EBITDAR for the periods indicated (in thousands):
|
| | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| 2012 | | 2011 | | 2012 | | 2011 |
Net (loss) income | (980 | ) | | 9,946 |
| | $ | (767 | ) | | $ | 18,058 |
|
Plus: | |
| | |
| | |
| | |
|
Loss from discontinued operations, net | 3,953 |
| | 1,499 |
| | 5,599 |
| | 3,005 |
|
Income tax expense | 1,901 |
| | 7,894 |
| | 3,089 |
| | 14,512 |
|
Interest expense, net | 4,429 |
| | 4,854 |
| | 8,839 |
| | 9,853 |
|
Depreciation and amortization | 8,504 |
| | 7,629 |
| | 16,934 |
| | 15,077 |
|
EBITDA | $ | 17,807 |
| | $ | 31,822 |
| | $ | 33,694 |
| | $ | 60,505 |
|
Plus: | |
| | |
| | |
| | |
|
Restructuring costs | — |
| | 167 |
| | — |
| | 303 |
|
Adjusted EBITDA | $ | 17,807 |
| | $ | 31,989 |
| | $ | 33,694 |
| | $ | 60,808 |
|
Plus: | |
| | |
| | |
| | |
|
Center rent expense | 36,522 |
| | 35,750 |
| | 72,899 |
| | 71,442 |
|
Adjusted EBITDAR | $ | 54,329 |
| | $ | 67,739 |
| | $ | 106,593 |
| | $ | 132,250 |
|
The following discussion of the “Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011” is based, in part, on the financial information presented in Note 7 – “Segment Information” in our consolidated financial statements included in this Form 10-Q.
Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011
The following summarizes our results of operations on a consolidated basis. A more detailed discussion and analysis of the results of operations of each of our segments (Inpatient Services, Rehabilitation Therapy Services, Medical Staffing Services and Corporate) is provided below under “Segment Information.”
Total net revenues decreased $13.4 million, or 2.9%, to $457.1 million for the three months ended June 30, 2012 from $470.6 million for the three months ended June 30, 2011. We reported net loss for the three months ended June 30, 2012 of $1.0 million and net income of $9.9 million for the three months ended June 30, 2011.
The decrease in net revenues for the 2012 period included $13.4 million of reduced revenues in our Inpatient Services segment and a $0.8 million decrease in nonaffiliated revenues from our Medical Staffing segment, which were partially offset by a $0.8 million increase in nonaffiliated revenues from our Rehabilitation Therapy Services segment.
Operating salaries and benefits decreased $4.0 million, or 1.5%, to $259.5 million (56.8% of net revenues) for the three months ended June 30, 2012 from $263.5 million (56.0% of net revenues) for the three months ended June 30, 2011. The decrease resulted primarily from decreased wages and benefits in our housekeeping and laundry departments following the outsourcing of the majority of our housekeeping and laundry services.
Self-insurance for workers’ compensation and general and professional liability insurance expense decreased $1.4 million, or 9.3%, to $13.2 million (2.9% of net revenues) for the three months ended June 30, 2012 from $14.5 million (3.1% of net revenues) for the three months ended June 30, 2011, which was primarily due to decreased claims-related activity in our workers' compensation programs.
Other operating costs increased $1.7 million, or 1.6%, to $107.1 million (23.4% of net revenues) for the three months ended June 30, 2012 from $105.5 million (22.4% of net revenues) for the three months ended June 30, 2011. The increase was primarily due to increased provider taxes, coupled with increases in purchased services for housekeeping and laundry services.
Center rent expense increased $0.8 million, or 2.2%, to $36.5 million (8.0% of net revenues) for the three months ended June 30, 2012 from $35.8 million (7.6% of net revenues) for the three months ended June 30, 2011. The increase was primarily attributable to the scheduled inflationary increases in accordance with our lease agreements.
General and administrative expenses increased $1.1 million, or 7.3%, to $16.0 million (3.5% of net revenues) for the three
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
months ended June 30, 2012 from $15.0 million (3.2% of net revenues) for the three months ended June 30, 2011. The increase was primarily due to increased compensation and benefits.
Depreciation and amortization increased $0.9 million, or 11.5%, to $8.5 million (1.9% of net revenues) for the three months ended June 30, 2012 from $7.6 million (1.6% of net revenues) for the three months ended June 30, 2011. The increase was due to new property and equipment placed into service since June 30, 2011.
The provision for losses on accounts receivable increased $0.7 million, or 15.4%, to $5.1 million (1.1% of net revenues) for the three months ended June 30, 2012 from $4.4 million (0.9% of net revenues) for the three months ended June 30, 2011. The increase resulted primarily from higher reserves recorded on older accounts receivable balances.
Net interest expense decreased $0.4 million, or 8.8%, to $4.4 million (1.0% of net revenues) for the three months ended June 30, 2012 from $4.9 million (1.0% of net revenues) for the three months ended June 30, 2011 due to lower aggregate indebtedness.
Segment Information
The following table sets forth the amount and percentage of certain elements of total net revenues for the three months ended June 30, 2012 (dollars in thousands):
|
| | | | | | | | | | | | | |
| 2012 | | 2011 |
Inpatient Services | $ | 405,135 |
| | 88.6 | % | | $ | 418,584 |
| | 89.0 | % |
Rehabilitation Therapy Services | 62,001 |
| | 13.6 |
| | 63,204 |
| | 13.4 |
|
Medical Staffing Services | 23,523 |
| | 5.1 |
| | 22,697 |
| | 4.8 |
|
Corporate | 6 |
| | — |
| | 14 |
| | — |
|
Intersegment Eliminations | (33,523 | ) | | (7.3 | ) | | (33,924 | ) | | (7.2 | ) |
Total net revenues | $ | 457,142 |
| | 100.0 | % | | $ | 470,575 |
| | 100.0 | % |
Inpatient Services revenues include revenues billed to patients for therapy and medical staffing provided by our affiliated operations. The following table sets forth a summary of the intersegment revenues for the three months ended June 30 (in thousands):
|
| | | | | | | |
| 2012 | | 2011 |
Rehabilitation Therapy Services | $ | 32,804 |
| | $ | 33,225 |
|
Medical Staffing Services | 719 |
| | 699 |
|
Total intersegment revenue | $ | 33,523 |
| | $ | 33,924 |
|
The following table sets forth the amount of net segment income for the three months ended June 30 (in thousands):
|
| | | | | | | |
| 2012 | | 2011 |
Inpatient Services | $ | 22,974 |
| | $ | 35,369 |
|
Rehabilitation Therapy Services | 3,551 |
| | 3,427 |
|
Medical Staffing Services | 1,676 |
| | 1,462 |
|
Net segment income before Corporate | 28,201 |
| | 40,258 |
|
Corporate | (21,489 | ) | | (20,752 | ) |
Net segment income | $ | 6,712 |
| | $ | 19,506 |
|
Our reportable segments are strategic business units that provide different products and services. They are managed separately because each business has different marketing strategies due to differences in types of customers, distribution channels and capital resource needs. We evaluate the operational strengths and performance of each segment based on financial measures, including net segment income. Net segment income is defined as earnings before income tax expense, restructuring costs and discontinued operations. Net segment income for the three months ended June 30, 2012 for (1) our Inpatient Services segment decreased $12.4 million, or 35.0%, to $23.0 million, (2) our Rehabilitation Therapy Services segment increased $0.1 million, or 3.6%, to $3.6 million and (3) our Medical Staffing Services segment increased $0.2 million, or 14.6%, to $1.7 million in comparison to the three months ended June 30, 2011, due to the factors discussed below for each segment. We use net segment income among other things to help identify opportunities for improvement and assist in allocating resources to each segment.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
Inpatient Services
Total net revenues decreased $13.4 million, or 3.2%, to $405.1 million for the three months ended June 30, 2012 from $418.6 million for the three months ended June 30, 2011. The decrease was primarily the result of:
|
| |
- | a $21.8 million decrease in Medicare revenues as a result of a $13.0 million decrease from lower Medicare Part A rates primarily resulting from the CMS Final Rule parity rate adjustment and a $10.0 million decrease due to a lower customer base, offset in part by a $1.2 million increase in Medicare Part B revenues; |
| |
- | a $1.6 million decrease in private revenues consisting of a $2.3 million decrease due to a lower customer base partially offset by an increase of $0.7 million from higher rates; and
|
| |
- | a $0.3 million decrease in other revenue including commercial and managed care, veterans' coverage and other various inpatient services; |
| |
| Offset in part by: |
| |
- | a $9.2 million increase in Medicaid revenues due to a $4.7 million increase related to higher rates and a $4.5 million increase as a result of a higher customer base; and
|
| |
- | a $1.0 million increase in hospice revenues due mostly to internal growth in customer base.
|
Operating salaries and benefits expenses decreased $3.4 million, or 1.8%, to $189.4 million for the three months ended June 30, 2012 from $192.8 million for the three months ended June 30, 2011. The decrease was attributable to the following:
|
| |
- | a decrease of $3.8 million due to the outsourcing of housekeeping and laundry services in many centers to a third party service provider; and |
| |
- | a $0.6 million decrease in overtime for all staff;
|
| |
| Offset in part by: |
| |
- | an increase of $1.0 million in staff compensation and benefits to remain competitive in local markets. |
Self-insurance for workers’ compensation and general and professional liability insurance expense decreased $1.3 million, or 9.8%, to $12.2 million for the three months ended June 30, 2012 as compared to $13.5 million for the three months ended June 30, 2011, which was primarily due to decreased claims-related activity in our workers' compensation programs.
Other operating costs increased $3.0 million, or 2.5%, to $123.8 million for the three months ended June 30, 2012 from $120.8 million for the three months ended June 30, 2011. The increase was attributable to the following:
|
| |
- | a $3.1 million increase in purchased services, driven by a $3.8 million increase related to outsourced housekeeping and laundry services which was partially offset by a $0.7 million decrease in other purchased services; and |
| |
- | a $2.7 million increase in taxes primarily due to increased provider tax rates from a number of states in which we operate; |
| |
| Offset in part by: |
| |
- | a $1.2 million decrease in contract labor mostly driven by reduced expense related to our affiliated therapy services because of lower skilled customer base; |
| |
- | a $1.0 million decrease in supplies of which $0.2 million relates to housekeeping and laundry supplies now included in our outsourcing arrangement discussed above; |
| |
- | a net $0.2 million decrease in all other miscellaneous administrative expenses; and |
| |
- | a $0.4 million increase in rebates and refunds. |
Operating administrative expenses decreased $1.4 million, or 13.9%, to $8.8 million for the three months ended June 30, 2012 compared to $10.3 million for the three months ended June 30, 2011, primarily due to lower salaries, benefits, contract labor, travel, utilities and office lease expense in accordance with our cost mitigation plans necessitated by the impact of the CMS Final Rule.
Center rent expense increased $0.8 million, or 2.1%, to $36.2 million for the three months ended June 30, 2012 from $35.5 million for the three months ended June 30, 2011. The increase was primarily attributable to the scheduled inflationary increases
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
in accordance with our lease agreements.
Depreciation and amortization increased $0.8 million, or 12.0%, to $7.1 million for the three months ended June 30, 2012 from $6.4 million for the three months ended June 30, 2011. The increase was due to new property and equipment placed into service since June 30, 2011.
The provision for losses on accounts receivable increased $0.6 million, or 14.6%, to $4.6 million for the three months ended June 30, 2012 from $4.0 million for the three months ended June 30, 2011. The increase in provision was related to higher reserves recorded on older accounts receivable balances.
Rehabilitation Therapy Services
Total net revenues from the Rehabilitation Therapy Services segment decreased $1.2 million, or 1.9%, to $62.0 million for the three months ended June 30, 2012 from $63.2 million for the three months ended June 30, 2011. The revenue decrease was the result of:
|
| |
- | a decrease of $1.5 million attributable to decreased billable minutes, due to the loss of 11 contracts, net of new contracts; loss of two hospital contracts and two large nonaffiliated chains in conjunction with a decrease in same store affiliated business; |
| |
| Offset in part by: |
| |
- | revenue per minute was essentially flat increasing by $0.2 million due to significant growth in Part B revenue as well as nonaffiliated rate increases combined with an affiliated market basket rate increase; and |
| |
- | an increase of $0.1 million in other revenue, primarily related to increased contract management fees and other miscellaneous revenue. |
Operating salaries and benefits expenses decreased $1.0 million, or 1.9%, to $52.5 million for the three months ended June 30, 2012 from $53.5 million for the three months ended June 30, 2011. The decrease is a reflection of staffing adjustments made to accommodate the decrease in volume in conjunction with increased productivity and decreased health insurance costs.
Medical Staffing Services
Total net revenues from the Medical Staffing Services segment increased $0.8 million, or 3.64%, to $23.5 million for the three months ended June 30, 2012 from $22.7 million for the three months ended June 30, 2011. The increase was primarily the result of:
|
| |
- | an increase of $0.5 million due to an increase in therapy and pharmacy staffing hours; and |
| |
- | an increase of $0.4 million due to an increase in bill rates for nursing; |
| |
| Offset in part by |
| |
- | a decrease of $.01 million due to lower fees earned from the temporary placement of physicians. |
Operating salaries and benefits expenses increased $0.5 million, or 2.8%, to $17.6 million for the three months ended June 30, 2012 as compared to $17.1 million for the three months ended June 30, 2011. The increase in operating salaries and benefits is due to increase in bill hours as well as wage rate increases to remain competitive in local markets.
Corporate
General and administrative expenses not directly attributed to segments increased $1.1 million, or 7.3%, to $16.0 million for the three months ended June 30, 2012 from $15.0 million for the three months ended June 30, 2011. The increase was primarily due to increased benefits.
Interest expense not directly attributed to operating segments decreased $0.4 million, or 9.1%, to $4.4 million for the three months ended June 30, 2012 from $4.9 million for the three months ended June 30, 2011 due to lower aggregate indebtedness.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
The following discussion of the “Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011” is based, in part, on the financial information presented in Note 7 – “Segment Information” in our consolidated financial statements included in this Form 10-Q.
Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011
The following summarizes our results of operations on a consolidated basis. A more detailed discussion and analysis of the results of operations of each of our segments (Inpatient Services, Rehabilitation Therapy Services, Medical Staffing Services and Corporate) is provided below under “Segment Information.”
Total net revenues decreased $21.2 million or 2.3%, to $915.6 million for the six months ended June 30, 2012 from $936.9 million for the six months ended June 30, 2011. We reported net loss for the six months ended June 30, 2012 of $0.8 million and net income of $18.1 million for the six months ended June 30, 2011.
The decrease in net revenues for the 2012 period included $21.5 million of reduced revenues in our Inpatient Services segment and a $0.3 million decrease in nonaffiliated revenues from our Rehabilitation Therapy Services, which were partially offset by a $0.6 million increase in nonaffiliated revenues from our Medical Staffing segment.
Operating salaries and benefits decreased $5.3 million, or 1.0%, to $520.6 million (56.9% of net revenues) for the six months ended June 30, 2012 from $525.9 million (56.1% of net revenues) for the six months ended June 30, 2011. The decrease resulted primarily from decreased wages and benefits in our housekeeping and laundry departments following the outsourcing of the majority of our housekeeping and laundry services.
Self-insurance for workers’ compensation and general and professional liability insurance expense decreased $0.6 million, or 2.0%, to $28.5 million (3.1% of net revenues) for the six months ended June 30, 2012 from $29.1 million (3.1% of net revenues) for the six months ended June 30, 2011, which was primarily due to decreased claims-related activity in our workers' compensation programs.
Other operating costs increased $6.4 million, or 3.1%, to $216.1 million (23.6% of net revenues) for the six months ended June 30, 2012 from $209.7 million (22.4% of net revenues) for the six months ended June 30, 2011. The increase was primarily due to increased provider taxes, coupled with increases in purchased services for housekeeping and laundry services.
Center rent expense increased $1.5 million, or 2.0%, to $72.9 million (8.0% of net revenues) for the six months ended June 30, 2012 from $71.4 million (7.6% of net revenues) for the six months ended June 30, 2011. The increase was primarily attributable to the scheduled inflationary increases in accordance with our lease agreements.
General and administrative expenses increased $1.8 million, or 5.8%, to $32.1 million (3.5% of net revenues) for the six months ended June 30, 2012 from $30.3 million (3.2% of net revenues) for the six months ended June 30, 2011. The increase was primarily due to increased benefits.
Depreciation and amortization increased $1.9 million, or 12.3%, to $16.9 million (1.8% of net revenues) for the six months ended June 30, 2012 from $15.1 million (1.6% of net revenues) for the six months ended June 30, 2011. The increase was due to new property and equipment placed into service since June 30, 2011.
The provision for losses on accounts receivable increased $0.3 million, or 3.3%, to $9.9 million (1.1% of net revenues) for the six months ended June 30, 2012 from $9.6 million (1.0% of net revenues) for the six months ended June 30, 2011. The increase resulted primarily from higher reserves recorded on older accounts receivable balances.
Net interest expense decreased $1.0 million, or 10.3%, to $8.8 million (1.0% of net revenues) for the six months ended June 30, 2012 from $9.9 million (1.1% of net revenues) for the six months ended June 30, 2011 due to lower aggregate indebtedness.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
Segment Information
The following table sets forth the amount and percentage of certain elements of total net revenues for the six months ended June 30 (dollars in thousands):
|
| | | | | | | | | | | | | |
| 2012 | | 2011 |
Inpatient Services | $ | 810,923 |
| | 88.6 | % | | $ | 832,471 |
| | 88.9 | % |
Rehabilitation Therapy Services | 126,093 |
| | 13.8 |
| | 125,997 |
| | 13.4 |
|
Medical Staffing Services | 46,423 |
| | 5.1 |
| | 45,635 |
| | 4.9 |
|
Corporate | 13 |
| | — |
| | 21 |
| | — |
|
Intersegment Eliminations | (67,817 | ) | | (7.5 | ) | | (67,241 | ) | | (7.2 | ) |
Total net revenues | $ | 915,635 |
| | 100.0 | % | | $ | 936,883 |
| | 100.0 | % |
Inpatient Services revenues include revenues billed to patients for therapy and medical staffing provided by our affiliated operations. The following table sets forth a summary of the intersegment revenues for the six months ended June 30 (in thousands):
|
| | | | | | | |
| 2012 | | 2011 |
Rehabilitation Therapy Services | $ | 66,267 |
| | $ | 65,920 |
|
Medical Staffing Services | 1,550 |
| | 1,321 |
|
Total intersegment revenue | $ | 67,817 |
| | $ | 67,241 |
|
The following table sets forth the amount of net segment income for the six months ended June 30 (in thousands):
|
| | | | | | | |
| 2012 | | 2011 |
Inpatient Services | $ | 42,323 |
| | $ | 68,844 |
|
Rehabilitation Therapy Services | 7,313 |
| | 6,199 |
|
Medical Staffing Services | 3,108 |
| | 2,861 |
|
Net segment income before Corporate | 52,744 |
| | 77,904 |
|
Corporate | (42,985 | ) | | (42,026 | ) |
Net segment income | $ | 9,759 |
| | $ | 35,878 |
|
Our reportable segments are strategic business units that provide different products and services. They are managed separately because each business has different marketing strategies due to differences in types of customers, distribution channels and capital resource needs. We evaluate the operational strengths and performance of each segment based on financial measures, including net segment income. Net segment income is defined as earnings before income tax expense, restructuring costs and discontinued operations. Net segment income for the six months ended June 30, 2012 for (1) our Inpatient Services segment decreased $26.5 million, or 38.5%, to $42.3 million, (2) our Rehabilitation Therapy Services segment increased $1.1 million, or 18.0%, to $7.3 million and (3) our Medical Staffing Services segment increased $0.2 million in comparison to the six months ended June 30, 2011, due to the factors discussed below for each segment. We use net segment income among other things to help identify opportunities for improvement and assist in allocating resources to each segment.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
Inpatient Services
Total net revenues decreased $21.5 million, or 2.6%, to $810.9 million for the six months ended June 30, 2012 from $832.5 million for the six months ended June 30, 2011. The decrease was primarily the result of:
|
| |
- | a decrease of $37.9 million in Medicare revenues as a result of a $26.6 million decrease from lower Medicare Part A rates primarily resulting from the CMS Final Rule parity rate adjustment, a $13.9 million decrease due to a lower Medicare customer base, offset by a $2.6 million increase in Medicare Part B revenues;
|
| |
- | a $4.5 million decrease in private revenues due to lower customer base amounting to $3.5 million and a $1.0 million decrease related to rates; and |
| |
| Offset in part by: |
| |
- | an $18.0 million increase in Medicaid revenues consisting of $9.9 million increase from higher rates and an $8.1 million increase from a higher customer base; |
| |
- | a $2.0 million increase in Hospice revenues due mostly to internal growth in customer base; |
| |
- | a $0.7 million increase in other revenues from veteran's coverage and other various inpatient services; and |
| |
- | a $0.2 million increase in managed care and commercial insurance revenues driven by improved rates and customer base. |
Operating salaries and benefits expenses decreased $4.6 million, or 1.2%, to $379.1 million for the six months ended June 30, 2012 from $383.8 million for the six months ended June 30, 2011. The decrease was attributable to the following:
|
| |
- | a decrease of $7.9 million due to the outsourcing of housekeeping and laundry services in many centers to a third party service provider, and |
| |
- | a $1.6 million decrease in overtime for all staff; |
| |
| Offset in part by: |
| |
- | an increase of $4.9 million in staff compensation and benefits to remain competitive in local markets. |
Self-insurance for workers’ compensation and general and professional liability insurance expense decreased $0.5 million, or 2.0%, to $26.4 million for the six months ended June 30, 2012 as compared to $27.0 million for the six months ended June 30, 2011, which was primarily due to decreased claims-related activity in our workers' compensation programs.
Other operating costs increased $9.2 million, or 3.8%, to $249.5 million for the six months ended June 30, 2012 from $240.3 million for the six months ended June 30, 2011. The increase was attributable to the following:
|
| |
- | a $6.7 million increase in purchased services, driven by a $7.9 million increase related to outsourced housekeeping and laundry services which was partially offset by a $1.2 million decrease in other purchased services; and |
| |
- | a $5.7 million increase in taxes primarily due to increased provider tax rates from a number of states in which we operate; |
| |
| Offset in part by: |
| |
- | a $1.5 million decrease in supplies of which $0.3 million relates to housekeeping and laundry supplies now included in our outsourcing arrangement discussed above; |
| |
- | a $0.9 million decrease in contract labor mostly driven by reduced expense related to our affiliated therapy services because of lower skilled customer base and lower nursing contract labor; |
| |
- | a net $0.5 million decrease in all other miscellaneous administrative expenses; and |
| |
- | a $0.3 million increase in rebates and refunds. |
Operating administrative expenses decreased $2.2 million, or 10.7%, to $18.1 million for the six months ended June 30, 2012 compared to $20.3 million for the six months ended June 30, 2011, primarily due to lower salaries, benefits and contract labor expense in accordance with our cost mitigation plans necessitated by the impact of the CMS Final Rule.
Center rent expense increased $1.4 million, or 2.0%, to $72.3 million for the six months ended June 30, 2012 from $70.8
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
million for the six months ended June 30, 2011. The increase was primarily attributable to the scheduled inflationary increases in accordance with our lease agreements.
Depreciation and amortization increased $1.6 million, or 12.6%, to $14.1 million for the six months ended June 30, 2012 from $12.6 million for the six months ended June 30, 2011. The increase was due to new property and equipment placed into service since June 30, 2011.
The provision for losses on accounts receivable was consistent between periods coming in at $9.0 million for the six months ended June 30, 2012 and 2011.
Rehabilitation Therapy Services
Total net revenues from the Rehabilitation Therapy Services segment increased $0.1 million, or 0.1%, to $126.1 million for the six months ended June 30, 2012 from $126.0 million for the six months ended June 30, 2011. The revenue increase was the result of:
|
| |
- | an increase of $0.8 million attributable to increased revenue per minute due to significant growth in Part B revenue as well as nonaffiliated rate increases combined with an affiliated market basket rate increase. |
| |
| Offset in part by: |
| |
- | a decrease of $0.7 million attributable to decreased billable minutes due to the loss of 11 contracts, net of new contracts; loss of two large nonaffiliated chains and four hospital contracts. |
Operating salaries and benefits expenses decreased $1.3 million, or 1.2%, to $106.4 million for the six months ended June 30, 2012 from $107.6 million for the six months ended June 30, 2011. The decrease was driven by the aforementioned decline in service volume coupled with decreases in paid mileage, health insurance, help wanted, and travel.
Medical Staffing Services
Total net revenues from the Medical Staffing Services segment increased $0.8 million, or 1.7%, to $46.4 million for the six months ended June 30, 2012 from $45.6 million for the six months ended June 30, 2011. The increase was primarily the result of:
|
| |
- | an increase of $0.8 million due to an increase in therapy and pharmacy staffing hours; and |
| |
- | an increase of $0.3 million due to an increase in bill rates for nurse staffing; |
| |
| Offset in part by: |
| |
- | a decrease of $0.3 million due to lower fees earned from the temporary placement of physicians. |
Operating salaries and benefits expenses increased $0.6 million, or 1.6%, to $35.1 million for the six months ended June 30, 2012 as compared to $34.6 million for the six months ended June 30, 2011. The increase in operating salaries and benefits is due to the increase in staffing hours referenced above.
Corporate
General and administrative expenses not directly attributed to segments increased $1.8 million, or 5.8%, to $32.1 million for the six months ended June 30, 2012 from $30.3 million for the six months ended June 30, 2011. The increase was primarily due to increased compensation and benefits.
Interest expense not directly attributed to operating segments decreased $1.0 million, or 10.3%, to $8.9 million for the six months ended June 30, 2012 from $9.9 million for the six months ended June 30, 2011 due to lower aggregate indebtedness.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
Liquidity and Capital Resources
For the three months ended and as of June 30, 2012, our net loss was $1.0 million and our working capital was $150.7 million. As of June 30, 2012, we had cash and cash equivalents of $43.6 million, $60.0 million available on our revolving credit facility and $89.2 million in borrowings. As of June 30, 2012, we were in compliance with the covenants contained in the credit agreement governing our revolving credit facility and our term loan indebtedness as described under "Loan Agreements" below.
Based on current levels of operations, we believe that our operating cash flows, existing cash reserves and availability for borrowing under our revolving credit facility will provide sufficient funds for our operations, capital expenditures (both discretionary and nondiscretionary) as discussed in our 2011 Form 10-K under “Capital Expenditures”, scheduled debt service payments and our other commitments (as described in the table under “Obligations and Commitments” of our 2011 Form 10-K) at least through the next twelve months. We believe our long-term liquidity needs will be satisfied by these same sources, as well as borrowings as required to refinance indebtedness. Although our credit agreement, which is described under “Loan Agreements” below, contains restrictions on our ability to incur indebtedness, we currently believe that we will be able to refinance existing indebtedness or incur additional indebtedness, if needed. However, there can be no assurance that we will be able to refinance our indebtedness, incur additional indebtedness or access additional sources of capital, such as by issuing debt or equity securities, on terms that are acceptable to us or at all.
Since April 2007, we have relied on our cash flows to provide for operational needs and capital expenditures, and have not relied on revolving credit borrowings. However, there can be no assurance that our operations will continue to provide sufficient cash flow or that refinancing sources will be available in the future, particularly given current economic conditions. We anticipate that we will be able to utilize our revolving credit facility if needed, as we expect to remain in compliance with the covenants contained in our credit agreement for at least the next twelve months. In December 2011, we voluntarily paid down $50 million of term loans in conjunction with amending our credit agreement. The amendment increased our interest rate by 1.25% in return for greater flexibility to our financial covenants. As a result of the expected negative impact of the CMS Final Rule on our business, we implemented a broad-based mitigation initiative, which includes infrastructure cost reductions without affecting the quality of our patient care. These reductions in infrastructure costs were, and continue to be, necessary to mitigate the impact on our business and remain in compliance with financial covenants under our credit agreement. While we do not anticipate that any of our lenders will be unable to lend under our revolving credit facility if we determine to borrow funds, no assurance can be given that one or more of our lenders will be able to fulfill their commitments. We do not depend on cash flows from discontinued operations or sales of assets to provide for future liquidity.
Cash Flows
During the three months ended June 30, 2012, net cash provided by operating activities was $7.0 million as compared to $15.4 million during the three months ended June 30, 2011. The decrease of $8.4 million was primarily due to a $5.9 million payment delay in June by Massachusetts Medicaid, which we subsequently collected in July 2012. The period-over-period decrease in net income of $10.9 million in addition to a decrease of $6.4 million in non-cash adjustments to net income were significantly offset by a decrease in working capital needs driven principally by timing differences on scheduled payroll cycles. For additional information, please see “Results of Operations” above.
During the six months ended June 30, 2012, net cash provided by operating activities was $4.4 million as compared to $31.4 million during the six months ended June 30, 2011. The decrease of $27.0 million was primarily due to a period-over-period decrease in net income of $18.8 million. Additionally, there was a $7.6 million decrease in non-cash adjustments to net income and the $5.9 million payment delay by Massachusetts Medicaid discussed above, partially offset by a $5.3 million decrease in other working capital needs. For additional information, please see “Results of Operations” above.
Net cash used for investing activities of $7.9 million for the three months ended June 30, 2012 and $18.1 million for the six months ended June 30, 2012 were primarily for capital expenditures.
Net cash used for financing activities was $0.3 million for the three months ended June 30, 2012 and $0.6 million for the six months ended June 30, 2012, which were attributable to repayments of long-term debt and capital lease obligations.
Capital Expenditures
We incurred capital expenditures, related primarily to improvements in continuing operations, as reflected in our consolidated statements of cash flows, of $7.9 million and $17.8 million for the three months and six months ended June 30, 2012, respectively.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
Loan Agreements
In October 2010, we entered into a $285.0 million senior secured credit facility (the “Credit Agreement”) with a syndicate of financial institutions led by Credit Suisse, as administrative agent and collateral agent. The Credit Agreement provides for $150.0 million in term loans ($87.3 million was outstanding at June 30, 2012), a $60.0 million revolving credit facility ($30.0 million of which may be utilized for letters of credit) and a $75.0 million letter of credit facility funded by proceeds of additional term loans ($72.6 million was utilized at June 30, 2012). The revolving credit facility was undrawn on June 30, 2012. The final maturity date of the term loans and the letter of credit facility is October 18, 2016 and the revolving credit facility terminates on October 18, 2015.
Availability of amounts under the revolving credit facility is subject to compliance with financial covenants, including an interest coverage test and a leverage covenant. The Credit Agreement contains customary events of default, such as a failure by us to make payment of amounts due, defaults under other agreements evidencing indebtedness, certain bankruptcy events and a change of control (as defined in the Credit Agreement). The Credit Agreement also contains customary covenants restricting certain actions, including incurrence of indebtedness, liens, payment of dividends, repurchase of stock, acquisitions and dispositions, mergers and investments. Our obligations under the Credit Agreement are guaranteed by most of our subsidiaries and are collateralized by our assets and the assets of most of our subsidiaries.
In December 2011, we amended the Credit Agreement and the associated $50.0 million voluntary repayment effectively satisfied any required quarterly principal payments until the facility's maturity in 2016. Accrued interest is payable at the end of an interest period, but no less frequently than every three months. Upon amendment, borrowings under the Credit Agreement bear interest on the outstanding unpaid principal amount at a rate equal to an applicable percentage plus, at our option, either (a) the greater of 1.75% or LIBOR, adjusted for statutory reserves or (b) an alternative base rate determined by reference to the highest of (i) the prime rate announced by Credit Suisse, (ii) the federal funds rate plus 0.5%, and (iii) the greater of 1.75% or one-month LIBOR adjusted for statutory reserves plus 1%. As of June 30, 2012, the applicable percentage for term loans and revolving loans was 6.00% for alternative base rate loans and 7.00% for LIBOR loans. Each year, commencing in 2012, within 90 days of the prior fiscal year end, we are required to prepay a portion of the term loans in an amount based on the prior year's excess cash flows, if any, as defined in the Credit Agreement. In addition to paying interest on outstanding loans under the Credit Agreement, we are required to pay a facility fee of 0.50% per annum to the lenders under the revolving credit facility in respect of the unused revolving commitments.
The Credit Agreement requires that at least 50% of our term loans be subject to at least a three-year hedging agreement. To satisfy this requirement, we executed two hedging instruments on January 18, 2011: a two-year interest rate cap and a two-year “forward starting” interest rate swap. The two-year interest rate cap limits our exposure to increases in interest rates for $82.5 million of debt through December 31, 2012. This cap is effective when LIBOR rises above 1.75%, effectively fixing the interest rate on $82.5 million of our term loans at 8.75% through December 31, 2012. The fee for this interest rate cap arrangement was $0.3 million, which will be amortized to interest expense over the life of the arrangement. The two-year “forward starting” interest rate swap effectively converts the interest rate on $82.5 million of our term loans to a fixed rate from January 1, 2013 through December 31, 2014. LIBOR is fixed at 3.185%, making the all-in rate effectively a fixed 10.185% for this portion of the term loans. There was no fee for this swap agreement. Both arrangements qualify for hedge accounting treatment.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk because we have issued debt that is sensitive to changes in interest rates. We manage our interest rate risk exposure by maintaining a mix of fixed and variable rates of interest on our debt. The following table provides information regarding our market sensitive financial instruments and constitutes a forward-looking statement.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | Fair Value | | Fair Value |
| Expected Maturity Dates - the Twelve Months Ending June 30, | | June 30, | | December 31, |
| 2013 | | 2014 | | 2015 | | 2016 | | 2017 | | Thereafter | | Total | | 2012 (1) | | 2011 (1) |
| (Dollars in thousands) | | | | |
Long-term debt: | | | | | | | | | | | | | | | | | |
Fixed rate debt | $ | 967 |
| | $ | 914 |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 1,881 |
| | $ | 1,916 |
| | $ | 2,450 |
|
Rate | 8.6 | % | | 8.6 | % | | — |
| | — |
| | — |
| | — |
| | |
| | |
| | |
|
Variable rate debt | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 87,328 |
| | $ | — |
| | $ | 87,328 |
| | $ | 86,891 |
| | $ | 72,096 |
|
Rate | — |
| | — |
| | — |
| | — |
| | 8.75 | % | | — |
| | |
| | |
| | |
|
| | | | | | | | | | | | | | | | | |
Interest rate hedges: | |
| | |
| | |
| | |
| | |
| | |
| | |
| | $ | 2,299 |
| | $ | 2,049 |
|
Cap | $ | 82,500 |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | |
| | |
| | |
|
Maximum rate | 1.75 | % | | — |
| | — |
| | — |
| | — |
| | — |
| | |
| | |
| | |
|
Variable to fixed | $ | — |
| | $ | — |
| | $ | 82,500 |
| | $ | — |
| | $ | — |
| | $ | — |
| | |
| | |
| | |
|
Average pay rate | — |
| | — |
| | 3.185 | % | | — |
| | — |
| | — |
| | |
| | |
| | |
|
Average receive rate | — |
| | — |
| | 1.75 | % | | — |
| | — |
| | — |
| | |
| | |
| | |
|
| |
(1) | The fair value of fixed and variable rate debt was determined based on the current rates offered for debt with similar risks and maturities. |
ITEM 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as controls and procedures that are designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of management, including our Chief Executive Officer, William A. Mathies, and our Chief Financial Officer, L. Bryan Shaul, of the effectiveness of the Company’s disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2012.
There were no changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For a description of our legal proceedings, see Note 5(b) – “Commitments and Contingencies – Litigation” of our consolidated financial statements included in this Form 10-Q, which is incorporated by reference to this item.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
ITEM 1A. RISK FACTORS
Except as set forth below, there have been no material changes in our assessment of our risk factors from those set forth in our 2011 Form 10-K.
Failure to consummate or delay in consummating the Merger with Genesis announced on June 20, 2012 for any reason could materially and adversely affect our operations and our stock price.
If the Merger with Genesis is not consummated for any reason, including the failure of our stockholders to adopt the Merger Agreement or the failure to receive the required regulatory approvals, or if there is a delay in the consummation of the Merger, we will be subject to a number of material risks, including:
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• | under certain circumstances as set forth in the Merger Agreement, we could be required to pay to Genesis a termination fee equal to $6,900,000 and up to $1,000,000 of reasonable, out of pocket expenses incurred by Genesis in connection with the Merger Agreement; |
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• | the market price of our common stock may decline to the extent that the current market price of our common stock reflects a market assumption that the Merger will be consummated; |
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• | the possibility exists that certain key employees may terminate their employment with us as a result of the proposed Merger with Genesis even if the proposed Merger is not ultimately consummated; |
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• | the possibility exists that certain residents, patients or payors may decide to terminate or reduce their relationships with us as a result of the proposed Merger with Genesis even if the Merger is not consummated; and |
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• | the diversion of management's attention away from our day-to-day business, limitations on the conduct of our business prior to completing the Merger and other restrictive covenants contained in the Merger Agreement that may impact the manner in which our management is able to conduct our business during the period prior to the consummation of the Merger and the unavoidable disruption to our employees and our business relationships during the period prior to the consummation of the Merger, may make it difficult for us to regain our financial and market position if the Merger does not occur. |
In addition, if the Merger Agreement is terminated and our board of directors determines to seek another business combination, there can be no assurance that we will be able to find a partner willing to provide equivalent or more attractive consideration than the consideration to be provided in the Merger.
Legal proceedings in connection with the Merger could delay or prevent the completion of the Merger.
Five purported class action lawsuits have been filed by stockholders challenging the proposed Merger and seeking, among other things, to enjoin the consummation of the Merger. One of the conditions to the closing of the Merger is that no governmental entity has enjoined the consummation of the Merger. If a plaintiff is successful in obtaining an injunction prohibiting consummation of the Merger, then the injunction may delay the Merger or prevent the Merger from being completed.
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
ITEM 6. EXHIBITS
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2.1 | Agreement and Plan of Merger dated June 20, 2012, by and among Sun Healthcare Group, Inc., Genesis HealthCare LLC and Jam Acquisition LLC (incorporated by reference to Exhibit 2.1 to our Form 8-K filed on June 20, 2012) (the Exhibits and Disclosure Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K and will be provided to the Securities and Exchange Commission upon request) |
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10.1 | Sun Healthcare Group, Inc. 2012 Cash Bonus Plan (incorporated by reference to Exhibit 10.1 to our Form 10-Q filed on May 8, 2012) |
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10.2 | Summary of Amendments to Sun Healthcare Group, Inc. 2011 Executive Retention Bonus Plan |
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10.3 | Form of Change in Control Severance Benefits Agreement (incorporated by reference to Exhibit 10.1 to our Form 8-K filed on June 20, 2012) |
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10.4 | Amendment to Amended and Restated Employment Agreement by and between Sun Healthcare Group, Inc. and L. Bryan Shaul dated as of June 20, 2012 |
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31.1 | Section 302 Sarbanes-Oxley Certification by Chief Executive Officer |
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31.2 | Section 302 Sarbanes-Oxley Certification by Chief Financial Officer |
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32.1 | Section 906 Sarbanes-Oxley Certification by Chief Executive Officer |
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32.2 | Section 906 Sarbanes-Oxley Certification by Chief Financial Officer |
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101.INS | XBRL Instance Document |
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101.SCH | XBRL Taxonomy Extension Schema Document |
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101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document |
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101.LAB | XBRL Taxonomy Extension Label Linkbase Document |
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101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document |
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
SIGNATURE
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 thereunto duly authorized.
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SUN HEALTHCARE GROUP, INC. |
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By: /s/ L. Bryan Shaul |
L. Bryan Shaul |
Executive Vice President and Chief Financial Officer |
(Principal Financial Officer) |
August 1, 2012