XNYS:SKH Skilled Healthcare Group Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
 
(Mark One)
R
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2012.
OR
£
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from              to             .
Commission file number: 001-33459
 
Skilled Healthcare Group, Inc.
(Exact name of registrant as specified in its charter)
  
 
Delaware
 
20-3934755
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
 
 
27442 Portola Parkway, Suite 200
 
 
Foothill Ranch, California
 
92610
(Address of principal executive offices)
 
(Zip Code)
(949) 282-5800
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  £
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  þ    No  £
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
£
 
Accelerated filer
þ
 
 
 
 
 
Non-accelerated filer
£
(do not check if smaller reporting company)
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  £    No  þ
The number of shares outstanding of each of the issuer’s classes of common stock, as of the close of business on April 27, 2012, was:
Class A common stock, $0.001 par value – 21,571,535 shares
Class B common stock, $0.001 par value – 16,936,905 shares
 



Skilled Healthcare Group, Inc.
Form 10-Q
For the Quarterly Period Ended March 31, 2012
Index
 
 
 
Page
Number
Part I.
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
Part II.
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 




PART I — FINANCIAL INFORMATION
Item 1. Financial Statements.
Skilled Healthcare Group, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
 
March 31, 2012
 
December 31, 2011
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
9,881

 
$
16,017

Accounts receivable, less allowance for doubtful accounts of $14,485 and $15,238 at March 31, 2012 and December 31, 2011, respectively
110,013

 
99,764

Deferred income taxes
11,429

 
11,404

Prepaid expenses
7,445

 
6,943

Other current assets
8,732

 
9,203

Total current assets
147,500

 
143,331

Property and equipment, less accumulated depreciation of $101,844 and $95,954 at March 31, 2012 and December 31, 2011, respectively
373,412

 
375,502

Leased facility assets, less accumulated depreciation of $3,535 and $3,398 at March 31, 2012 and December 31, 2011, respectively
10,313

 
10,792

Other assets:
 
 
 
Notes receivable
4,349

 
5,092

Deferred financing costs, net
9,013

 
9,837

Goodwill
84,299

 
84,299

Intangible assets, less accumulated amortization of $3,937 and $7,060 at March 31, 2012 and December 31, 2011, respectively
22,316

 
22,413

Deferred income taxes
10,514

 
11,615

Other assets
34,766

 
32,119

Total other assets
165,257

 
165,375

Total assets
$
696,482

 
$
695,000

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued liabilities
$
51,556

 
$
52,897

Employee compensation and benefits
35,640

 
41,067

Current portion of long-term debt
5,273

 
4,414

Total current liabilities
92,469

 
98,378

Long-term liabilities:
 
 
 
Insurance liability risks
31,442

 
30,567

Other long-term liabilities
17,935

 
17,773

Long-term debt, less current portion
470,273

 
471,069

Total liabilities
612,119

 
617,787

Stockholders’ equity:
 
 
 
Class A common stock, 175,000 shares authorized, $0.001 par value per share; 21,572 and 21,064 at March 31, 2012 and December 31, 2011, respectively
22

 
21

Class B common stock, 30,000 shares authorized, $0.001 par value per share; 16,937 at March 31, 2012 and December 31, 2011
17

 
17

Additional paid-in-capital
372,463

 
371,753

Accumulated deficit
(287,751
)
 
(294,088
)
Accumulated other comprehensive loss
(388
)
 
(490
)
Total stockholders’ equity
84,363

 
77,213

Total liabilities and stockholders’ equity
$
696,482

 
$
695,000

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

3


Skilled Healthcare Group, Inc.
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)
 
 
Three Months Ended March 31,
 
2012
 
2011
Revenue:
 
 
 
Net patient service revenue
$
218,659

 
$
222,578

Leased facility revenue
754

 

 
219,413

 
222,578

Expenses:
 
 
 
Cost of services (exclusive of rent cost of revenue and depreciation and amortization shown below)
183,131

 
175,461

Rent cost of revenue
4,556

 
4,570

General and administrative
6,100

 
6,893

Depreciation and amortization
6,275

 
6,145

 
200,062

 
193,069

Other income (expenses):
 
 
 
Interest expense
(9,565
)
 
(9,946
)
Interest income
145

 
175

Other expense
(29
)
 
(324
)
Equity in earnings of joint venture
471

 
554

Total other income (expenses), net
(8,978
)
 
(9,541
)
Income before provision for income taxes
10,373

 
19,968

Provision for income taxes
4,036

 
8,124

Net income
$
6,337

 
$
11,844

Income per share, basic
 
 
 
       Income per share
$
0.17

 
$
0.32

Income per share, diluted
 
 
 
       Income per share
$
0.17

 
$
0.32

Weighted-average common shares outstanding, basic
37,285

 
37,079

Weighted-average common shares outstanding, diluted
37,407

 
37,326

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.



4


Skilled Healthcare Group, Inc.
Condensed Consolidated Statements of Comprehensive Income
(In thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2012
 
2011
 
 
 
 
Net income
$
6,337

 
$
11,844

Other comprehensive income (loss):
 
 
 
Unrealized (loss) gain on interest rate swap
(33
)
 
18

Investment available for sale
62

 

Reclassification adjustments:
 
 
 
Interest expense on interest rate swap
138

 

Other comprehensive income, before taxes
167

 
18

Income tax expense related to items of other comprehensive income
65

 
7

Other comprehensive income, net of tax
102

 
11

Comprehensive income
$
6,439

 
$
11,855


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


5


Skilled Healthcare Group, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
 
 
Three Months Ended March 31,
 
2012
 
2011
Cash Flows from Operating Activities
 
 
 
Net Income
6,337

 
11,844

Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
6,275

 
6,145

Provision for doubtful accounts
1,775

 
2,457

Non-cash stock-based compensation
1,163

 
998

Excess tax benefits from stock-based payment arrangements
242

 
(295
)
Disposal of property and equipment

 
290

Amortization of deferred financing costs
825

 
826

Deferred income taxes
793

 
10,077

Amortization of discount on debt
144

 
140

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(12,140
)
 
(13,114
)
Payments on notes receivable
743

 
959

Other current and non-current assets
(1,456
)
 
(1,007
)
Accounts payable and accrued liabilities
(1,303
)
 
(2,797
)
Employee compensation and benefits
(5,609
)
 
(5,348
)
Insurance liability risks
1,057

 
538

Other long-term liabilities
132

 
847

Net cash (used in) provided by operating activities
(1,022
)
 
12,560

Cash Flows from Investing Activities
 
 
 
Additions to property and equipment
(3,475
)
 
(2,567
)
Acquisition of home health licenses

 
(350
)
Proceeds from sale of property and equipment

 
400

Net cash used in investing activities
(3,475
)
 
(2,517
)
Cash Flows from Financing Activities
 
 
 
Borrowings under line of credit
13,500

 
55,500

Repayments under line of credit
(13,500
)
 
(67,500
)
Repayments of long-term debt
(1,187
)
 
(931
)
Exercise of stock options

 
26

Excess tax benefits from stock-based payment arrangements
(242
)
 
295

Taxes paid related to net share settlement of equity awards
(210
)
 
(685
)
Net cash used in financing activities
(1,639
)
 
(13,295
)
Decrease in cash and cash equivalents
(6,136
)
 
(3,252
)
Cash and cash equivalents at beginning of period
16,017

 
4,192

Cash and cash equivalents at end of period
$
9,881

 
$
940

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

6


 
Three Months Ended March 31,
 
2012
 
2011
Supplemental cash flow information
 
 
 
Cash paid for:
 
 
 
Interest expense, net of capitalized interest
$
12,203

 
$
12,578

Income tax refunds, net
$
(32
)
 
$
(122
)
Non-cash activities:
 
 
 
Conversion of accounts receivable into notes receivable
$

 
$
1,529

Insurance premium financed
$
1,107

 
$
945

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

7

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


1. Description of Business

Current Business
Skilled Healthcare Group, Inc. ("Skilled") is a holding company that owns subsidiaries that operate long-term care facilities and provide a wide range of post-acute care services, with a strategic emphasis on sub-acute specialty medical care. Skilled and its consolidated wholly-owned companies are collectively referred to as the "Company." As of March 31, 2012, the Company operated facilities in California, Iowa, Kansas, Missouri, Nevada, Nebraska, New Mexico and Texas, including 74 skilled nursing facilities ("SNFs"), which offer sub-acute care and rehabilitative and specialty healthcare skilled nursing care, and 22 assisted living facilities ("ALFs"), which provide room and board and assistance with activities of daily living. Effective April 1, 2011, the Company leased five skilled nursing facilities in California to an unaffiliated third party operator. For a detailed discussion of the lease arrangements, see Note 5 - "Property and Equipment." In addition, through its Hallmark Rehabilitation subsidiary ("Hallmark"), the Company provides a variety of ancillary services such as physical, occupational and speech therapy in Company-operated facilities and unaffiliated facilities. Furthermore, as of March 31, 2012, the Company provided hospice care and home health services in Arizona, California, Idaho, Montana, Nevada and New Mexico. The Company has an administrative services company that provides a full complement of administrative and consultative services that allows affiliated operators and third-party facility operators with whom the Company contracts to better focus on delivery of healthcare services. The Company currently has one such service agreement with an unrelated skilled nursing facility operator. The Company is also a member in a joint venture located in Texas that provides institutional pharmacy services, which currently serves eight of the Company’s SNFs and other facilities unaffiliated with the Company.
Recent Developments    
In April 2012, the Company amended its credit facility to provide for a $100.0 million increase in the size of its term loan, as described in Note 9 - "Debt."

2. Summary of Significant Accounting Policies

Basis of Presentation
The accompanying condensed consolidated financial statements as of March 31, 2012 and for the three months ended March 31, 2012 and 2011 (collectively, the "Interim Financial Statements"), are unaudited. Certain information and footnote disclosures normally included in the Company’s annual consolidated financial statements have been condensed or omitted, as permitted under applicable rules and regulations. Readers of the Interim Financial Statements should refer to the Company's audited consolidated financial statements and notes thereto for the year ended December 31, 2011, which are included in the Company's 2011 Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC"). Management believes that the Interim Financial Statements reflect all adjustments that are of a normal and recurring nature necessary to fairly present the Company's financial position and results of operations and cash flows in all material respects as of the dates and for the periods presented. The results of operations presented in the Interim Financial Statements are not necessarily representative of operations for the entire year.
The accompanying Interim Financial Statements include the accounts of Skilled and its consolidated wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.
Estimates and Assumptions
The preparation of the Interim Financial Statements in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") requires management to consolidate subsidiary financial information and make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. The most significant estimates in the Interim Financial Statements relate to revenue, allowance for doubtful accounts, the self-insured portion of general and professional liability and workers' compensation claims and income taxes. Actual results could differ materially from those estimates.
Information regarding the Company's significant accounting policies is contained in Note 2 - "Summary of Significant Accounting Policies" in the Company's 2011 Annual Report on Form 10-K filed with the SEC.
Reclassifications
Certain prior year amounts have been reclassified to conform to current year presentation, including $0.7 million of taxes paid related to net share settlement of equity awards in the Condensed Consolidated Statements of Cash Flows for the three

8

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

months ended March 31, 2011 that were reclassified from operating activities to financing activities.
Notes Receivable
As of March 31, 2012 and December 31, 2011, notes receivable, net were approximately $7.4 million and $8.1 million, respectively, of which $3.0 million was reflected as current assets as of March 31, 2012 and December 31, 2011, with the remaining balances reflected as long-term assets. Interest rates on these notes approximate market rates as of the date the notes were originated.
As of March 31, 2012, two of the Company's rehabilitation therapy services business customers were responsible for $7.2 million, or 98.2% of the total notes receivable balance. These notes receivable, as well as the trade receivables from these customers and one additional customer, are guaranteed both by the assets of the customers as well as personally by the principal owners of the customers. As of March 31, 2012, these three customers represented 63.6% of the accounts receivable for the Company's rehabilitation therapy services business and approximately 54.3% of the external revenue of the rehabilitation therapy services business for the three months ended March 31, 2012. The remaining notes receivable of $0.2 million, or 1.8% of the aggregate notes receivable balance, are primarily past due accounts converted from accounts receivable to notes receivable.
The notes receivable allowance for uncollectibility as of March 31, 2012 and December 31, 2011 were $0.1 million and $0.2 million, respectively.
Recent Accounting Pronouncements
In May 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS ("ASU 2011-04"). This ASU represents the converged guidance of the FASB and the International Accounting Standards Board on fair value measurement. ASU 2011-04 sets forth common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term "fair value." The adoption of ASU 2011-04 became effective for the Company's interim and annual periods beginning January 1, 2012. and did not have a material impact on the Company's consolidated financial statements as the changes relate only to additional disclosures.
In June 2011, the FASB issued ASU No 2011-05, Presentation of Comprehensive Income ("ASU 2011-05"), which revises the manner in which companies present comprehensive income in their financial statements. The new guidance removes the current option to report other comprehensive income and its components in the statement of changes in equity and instead requires presenting in one continuous statement of comprehensive income or two separate but consecutive statements. The adoption of ASU 2011-05 became effective for the Company's interim and annual periods beginning January 1, 2012. The Company applied the two-statement approach, presenting components of net income in the statement of income and the components and total of other comprehensive income along with a total for comprehensive income in the statement of comprehensive income.
In July 2011, the Emerging Issues Task Force (EITF) of the FASB reached a consensus that would require health care entities to separately present bad debt expense related to patient service revenue as a reduction of patient service revenue (net of contractual allowances and discounts) on the income statement for entities that do not assess a patient's ability to pay prior to rendering services.  Further, it was determined, net presentation of bad debt expense in revenue would only apply to bad debts that are not related to patient service revenue, to entities that do not provide services prior to assessing a patient's ability to pay, or to entities that recognize revenue only after deciding that collection is reasonably assured.  In addition, the final consensus requires health care entities to disclose information about the activity in the allowance for doubtful accounts, such as recoveries and write-offs, by using a mixture of qualitative and quantitative data.  It also requires disclosure of our policies for (i) assessing the timing and amount of uncollectible revenue recognized as bad debt expense; and (ii) assessing collectability in the timing and amount of revenue (net of contractual allowances and discounts).  The adoption of this guidance became effective for the Company's interim and annual periods beginning January 1, 2012. As the Company assesses the collectability of revenues at the time of admission, there was no impact to the Company's consolidated financial statements.
In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment, ("ASU 2011-08"), which amends the guidance in Accounting Standard Codification ("ASC') 350-20, "Intangibles - Goodwill and Other." Under ASU 2011-08, entities have the option, under certain circumstances, of performing a qualitative assessment before calculating the fair value of the reporting unit when testing goodwill for impairment. If the fair value of the reporting unit is determined, based on qualitative factors, to be more likely than not less than the carrying amount of the reporting unit, then entities are required to perform the two-step goodwill impairment test. The adoption of ASU 2011-08 became effective for the Company's interim and annual periods beginning January 1, 2012. There was no impact to the Company's consolidated financial statements.
In November 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities, ("ASU 2011-11"). This ASU require an entity to disclose information about offsetting and related arrangements

9

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

to enable users of its financial statements to understand the effect of those arrangements on its financial position. The adoption of ASU 2011-11 becomes effective for the Company's interim and annual periods beginning on or after January 1, 2013. The Company does not believe the adoption of this guidance will have a material impact on its consolidated financial statements.

3. Income Per Share of Class A Common Stock and Class B Common Stock
The Company computes income per share of Class A common stock and Class B common stock in accordance with FASB ASC Topic 260, Earnings per Share, using the two-class method. The Company's Class A common stock and Class B common stock are identical in all respects, except with respect to voting rights and except that each share of Class B common stock is convertible into one share of Class A common stock under certain circumstances. Net income is allocated on a proportionate basis to each class of common stock in the determination of income per share.
Basic income per share was computed by dividing net income by the weighted-average number of outstanding shares for the period. Dilutive earnings per share is computed by dividing net income plus the effect of assumed conversions (if applicable) by the weighted-average number of outstanding shares after giving effect to all potential dilutive common stock, including options, warrants, common stock subject to repurchase and convertible preferred stock, if any. The following table sets forth the computation of basic and diluted loss per share of Class A common stock and Class B common stock for the three months ended March 31, 2012 and 2011 (amounts in thousands, except per share data):
 
Three months ended March 31, 2012
 
Three months ended March 31, 2011
 
Class A
 
Class B
 
Total
 
Class A
 
Class B
 
Total
Income per share, basic
 
 
 
 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
 
 
 
 
Allocation of net income
$
3,458

 
$
2,879

 
$
6,337

 
$
6,416

 
$
5,428

 
$
11,844

Income per share, diluted
 
 
 
 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
 
 
 
 
Allocation of net income
$
3,468

 
$
2,869

 
$
6,337

 
$
6,452

 
$
5,392

 
$
11,844

Denominator for basic and diluted income per share:
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding, basic
20,348

 
16,937

 
37,285

 
20,086

 
16,993

 
37,079

Plus: incremental shares related to dilutive effect of stock options and restricted stock, if applicable
122

 

 
122

 
247

 

 
247

Adjusted weighted-average common shares outstanding, diluted
20,470

 
16,937

 
37,407

 
20,333

 
16,993

 
37,326

Income per share, basic:
 
 
 
 
 
 
 
 
 
 
 
Income per share
$
0.17

 
$
0.17

 
$
0.17

 
$
0.32

 
$
0.32

 
$
0.32

Income per share, diluted:
 
 
 
 
 
 
 
 
 
 
 
Income per share
$
0.17

 
$
0.17

 
$
0.17

 
$
0.32

 
$
0.32

 
$
0.32

The following were excluded from the weighted-average diluted shares computation for the three months ended March 31, 2012 and 2011, as their inclusion would have been anti-dilutive (shares in thousands):
 
 
Three Months Ended March 31,
 
2012
 
2011
Options to purchase common shares
464

 
38

Non-vested common shares
850

 
261

Total excluded
1,314

 
299

 


4. Business Segments
The Company has three reportable operating segments: (i) long-term care services ("LTC"), which includes the operation of SNFs and ALFs and is the most significant portion of the Company's business' administrative services for an unrelated SNF operator, and the facility lease revenue from a third-party operator; (ii) therapy services, which includes the Company's rehabilitation therapy services business; and (iii) hospice and home health services, which includes the Company's hospice and home health businesses. The "other" category in the table below includes general and administrative items. The Company's

10

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

reporting segments are business units that offer different services, and that are managed differently due to the nature of the services provided.
At March 31, 2012, LTC services included 74 wholly-owned SNF operating companies that offer post-acute, rehabilitative and specialty skilled nursing care, as well as 22 wholly-owned ALF operating companies that provide room and board and social services. Therapy services included rehabilitative services such as physical, occupational and speech therapy provided in the Company's facilities and in unaffiliated facilities. Hospice and home health services were provided by the Company's wholly owned subsidiary to patients.
The Company evaluates performance and allocates capital resources to each segment based on an operating model that is designed to maximize the quality of care provided and profitability. Accordingly, earnings from continuing operations before net interest, tax, depreciation and amortization, non-core expenses ("Adjusted EBITDA") and rent cost of revenue ("Adjusted EBITDAR") is used as the primary measure of each segment’s operating results because it does not include such costs as interest expense, income taxes, depreciation, amortization and rent cost of revenue which may vary from segment to segment depending upon various factors, including the method used to finance the original purchase of a segment or the tax law of the states in which a segment operates. By excluding these items, the Company is better able to evaluate operating performance of the segment by focusing on more controllable measures. General and administrative expenses are not allocated to any segment for purposes of determining segment profit or loss, and are included in the "other" category in the selected segment financial data that follows. The accounting policies of the reporting segments are the same as those described in Note 2, "Summary of Significant Accounting Policies." Intersegment sales and transfers are recorded at cost plus standard mark-up; intersegment transactions have been eliminated in consolidation.
The following table sets forth selected financial data consolidated by business segment (dollars in thousands): 

11

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
Long-Term
Care Services
 
Therapy Services
 
Hospice & Home Health Services
 
Other
 
Elimination
 
Total
Three months ended March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
Net patient service revenue from external customers
$
166,338

 
$
26,115

 
$
26,206

 
$

 
$

 
$
218,659

Leased facility revenue
754

 

 

 

 

 
754

Intersegment revenue
754

 
15,982

 

 

 
(16,736
)
 

Total revenue
$
167,846

 
$
42,097

 
$
26,206

 
$

 
$
(16,736
)
 
$
219,413

Operating income (loss)
$
18,138

 
$
2,948

 
$
4,531

 
$
(6,266
)
 
$

 
$
19,351

Interest expense, net of interest income
 
 
 
 
 
 
 
 
 
 
(9,420
)
Other expense
 
 
 
 
 
 
 
 
 
 
(29
)
Equity in earnings of joint venture
 
 
 
 
 
 
 
 
 
 
471

Income before provision for income taxes
 
 
 
 
 
 
 
 
 
 
$
10,373

Depreciation and amortization
$
5,671

 
$
168

 
$
277

 
$
159

 
$

 
$
6,275

Segment capital expenditures
$
2,405

 
$
277

 
$
203

 
$
590

 
$

 
$
3,475

Adjusted EBITDA
$
23,780

 
$
3,116

 
$
4,868

 
$
(5,696
)
 
$

 
$
26,068

Adjusted EBITDAR
$
28,014

 
$
3,116

 
$
5,182

 
$
(5,688
)
 
$

 
$
30,624

Three months ended March 31, 2011
 
 
 
 
 
 
 
 
 
 
 
Net patient service revenue from external customers
$
182,323

 
$
22,190

 
$
18,065

 
$

 
$

 
$
222,578

Leased facility revenue

 

 

 

 

 

Intersegment revenue
390

 
17,121

 

 

 
(17,511
)
 

Total revenue
$
182,713

 
$
39,311

 
$
18,065

 
$

 
$
(17,511
)
 
$
222,578

Operating income (loss)
$
27,276

 
$
5,959

 
$
3,333

 
$
(7,059
)
 
$

 
$
29,509

Interest expense, net of interest income
 
 
 
 
 
 
 
 
 
 
(9,771
)
Other expense
 
 
 
 
 
 
 
 
 
 
(324
)
Equity in earnings of joint venture
 
 
 
 
 
 
 
 
 
 
554

Income before provision for income taxes
 
 
 
 
 
 
 
 
 
 
$
19,968

Depreciation and amortization
$
5,692

 
$
98

 
$
204

 
$
151

 
$

 
$
6,145

Segment capital expenditures
$
2,247

 
$
51

 
$
155

 
$
114

 
$

 
$
2,567

Adjusted EBITDA
$
33,318

 
$
6,057

 
$
3,583

 
$
(6,157
)
 
$

 
$
36,801

Adjusted EBITDAR
$
37,635

 
$
6,060

 
$
3,819

 
$
(6,143
)
 
$

 
$
41,371

    










    







12

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

A reconciliation of Adjusted EBITDA and Adjusted EBITDAR to net income is as follows (dollars in thousands):
 
Three Months Ended March 31,
 
2012
 
2011
Adjusted EBITDAR
$
30,624

 
$
41,371

Rent cost of revenue
(4,556
)
 
(4,570
)
Adjusted EBITDA
26,068

 
36,801

Depreciation and amortization
(6,275
)
 
(6,145
)
Interest expense
(9,565
)
 
(9,946
)
Interest income
145

 
175

Disposal of property and equipment

 
(290
)
Expenses related to the exploration of strategic alternatives

 
(242
)
Exit costs related to Northern California divestiture

 
(385
)
Provision for income taxes
(4,036
)
 
(8,124
)
Net income
$
6,337

 
$
11,844

The following table presents the segment assets as of March 31, 2012 compared to December 31, 2011 (dollars in thousands):
 
 
Long-Term
Care  Services
 
Therapy Services
 
Hospice & Home Health Services
 
Other
 
Total
March 31, 2012:
 
 
 
 
 
 
 
 
 
Segment total assets
$
463,984

 
$
56,697

 
101,613

 
$
74,188

 
$
696,482

Goodwill and intangibles included in total assets
$
1,910

 
$
23,693

 
81,012

 
$

 
$
106,615

December 31, 2011:
 
 
 
 
 
 
 
 
 
Segment total assets
$
461,225

 
$
53,927

 
97,913

 
$
81,935

 
$
695,000

Goodwill and intangibles included in total assets
$
1,994

 
$
23,693

 
81,025

 
$

 
$
106,712


5. Property and Equipment
Property and equipment consisted of the following as of March 31, 2012 and December 31, 2011 (in thousands):

 
March 31, 2012
 
December 31, 2011
Land and land improvements
$
64,984

 
$
64,984

Buildings and leasehold improvements
326,274

 
323,887

Furniture and equipment
78,288

 
75,497

Construction in progress
5,710

 
7,088

 
475,256

 
471,456

Less accumulated depreciation
(101,844
)
 
(95,954
)
 
$
373,412

 
$
375,502


Leased facility assets consisted of the following as of March 31, 2012 and December 31, 2011 (in thousands):
 
March 31, 2012
 
December 31, 2011
Leased facility assets
13,848

 
14,190

Less accumulated depreciation
(3,535
)
 
(3,398
)
 
10,313

 
10,792


The Company began leasing five skilled nursing facilities in California to an unaffiliated third party operator in April 2011 and signed a 10-year lease with two 10-year extension options exercisable by the lessee.

13

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)



6. Commitments and Contingencies
Litigation
Humboldt County Injunction
In connection with the September 2010 settlement of certain class action litigation (the "Humboldt County Action") against Skilled and certain of its subsidiaries, including twenty-two California nursing facilities operated by Skilled's subsidiaries, Skilled and its defendant subsidiaries entered into settlement agreements with the applicable plaintiffs and agreed to an injunction. The settlement was approved by the Superior Court of California, Humboldt County on November 30, 2010. Under the terms of the settlement agreements, the defendant entities deposited a total of $50.0 million into escrow accounts to cover settlement payments to class members, notice and claims administration costs, reasonable attorneys' fees and costs and certain other payments. The court subsequently approved payments from the escrow of up to approximately $24.8 million for attorneys' fees and costs and $10,000 to each of the three named plaintiffs.  In addition, approximately $9.3 million of settlement proceeds have been distributed to approximately 3,900 of an estimated 43,000 class members. Pursuant to the injunction, the twenty-two defendants that operate California nursing facilities must provide specified nurse staffing levels, comply with specified state and federal laws governing staffing levels and posting requirements, and provide reports and information to a court-appointed auditor. The injunction will remain in effect for a period of twenty-four months unless extended for additional three-month periods as to those defendants that may be found in violation. Defendants demonstrating compliance for an eighteen-month period may petition for early termination of the injunction. The defendants are required to demonstrate over the term of the injunction that the costs of the injunction meet a minimum threshold level pursuant to the settlement agreement, which level, initially $9.6 million, is reduced by the portion attributable to any defendant in the case that no longer operates a skilled nursing facility during the injunction period. The injunction costs include, among other things, costs attributable to (i) enhanced reporting requirements; (ii) implementing advanced staffing tracking systems; (iii) fees and expenses paid to an auditor and special master; (iv) increased labor and labor related expenses; and (v) lost revenues attributable to admission decisions based on compliance with the terms and conditions of the injunction. To the extent the costs of complying with the injunction are less than the agreed upon threshold amount, the defendants will be required to remit any shortfall to the settlement fund. In April 2011, five of the subsidiary defendants transferred their operations to an unaffiliated third party skilled nursing facility operator. The remaining defendants continue to monitor their compliance with the terms of the injunction and to provide the applicable reports and information to the court-appointed auditor.
BMFEA Matter
On April 15, 2009, two of Skilled's wholly-owned companies, Eureka Healthcare and Rehabilitation Center, LLC, which at the time operated Eureka Healthcare and Rehabilitation Center (the "Facility"), and Skilled Healthcare, LLC, the administrative services provider for the Facility, were served with a search warrant that relates to an investigation of the Facility by the California Attorney General's Bureau of Medi-Cal Fraud & Elder Abuse ("BMFEA"). The search warrant related to, among other things, records, property and information regarding certain enumerated patients of the Facility and covered the period from January 1, 2007 through the date of the search. The Facility represented less than 1% of the Company's revenue and less than 0.3% of its Adjusted EBITDA in 2010. Nevertheless, although the Company is unable to assess the potential exposure, any fines or penalties that may result from the BMFEA's investigation could be significant. Eureka Healthcare and Rehabilitation Center, LLC transferred its operations in April 2011 to an unaffiliated third party skilled nursing facility operator. The Company is committed to working cooperatively with the BMFEA on this matter.
Insurance
The Company maintains insurance for workers' compensation, general and professional liability, employee benefits liability, property, casualty, directors’ and officers’ liability, inland marine, crime, boiler and machinery, automobile, employment practices liability and earthquake and flood. The Company believes that its insurance programs are adequate and where there has been a direct transfer of risk to the insurance carrier, the Company does not recognize a liability in the consolidated financial statements.
Workers' Compensation. The Company has maintained workers' compensation insurance as statutorily required. Most of its commercial workers' compensation insurance purchased is loss sensitive in nature, except as noted below. As a result, the Company is responsible for adverse loss development. Additionally, the Company self-insures the first unaggregated $1.0 million per workers' compensation claim for all California, New Mexico and Nevada skilled nursing and assisted living businesses. The Company has elected not to carry workers' compensation insurance in Texas and it may be liable for negligence claims that are asserted against it by its Texas-based employees. For the policy periods up to December 31, 2011, the Company has purchased guaranteed cost policies for its Kansas, Missouri, Iowa and Nebraska skilled nursing and assisted living businesses, as well as all of its hospice and home health businesses. There are no deductibles associated with these programs. Beginning January 1, 2012, the Company self insures the first $0.25 million for these businesses. The Company

14

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

recognizes a liability in its consolidated financial statements for its estimated self-insured workers' compensation risks. Historically, estimated liabilities have been sufficient to cover actual claims.
General and Professional Liability. The Company's services subject it to certain liability risks. Malpractice and similar claims may be asserted against the Company if its services are alleged to have resulted in patient injury or other adverse effects. The Company is subject to malpractice and similar claims and other litigation in the ordinary course of business.
Effective September 1, 2008, the Company's California-based skilled nursing facility companies purchased individual general and professional liability insurance policies for claims reported through August 31, 2011, with a per occurrence and annual aggregate coverage limit of $1.0 million and $3.0 million, respectively, and an unaggregated $0.1 million per claim self-insured retention. Effective September 1, 2008, the Company also had an excess liability policy for claims reported through August 31, 2011, with a $14.0 million per loss limit and an $18.0 million annual aggregate limit for losses arising from claims in excess of $1.1 million for the California skilled nursing facilities and in excess of $1.0 million for all other businesses.
Effective September 1, 2011, the Company purchased excess liability policies with $25.0 million per loss and annual aggregate limits for claims in excess of $1.0 million per loss for all businesses. These policies will remain in force for an initial period of one year. Effective September 1, 2011, the Company also self-insures professional liability claims at its California based SNF subsidiaries through its wholly-owned offshore captive insurance company, Fountain View Reinsurance, Ltd. (the "Captive"), for claims up to $1.0 million.
The Company retains an unaggregated self-insured retention of $1.0 million per claim for all of its businesses other than its hospice and home health businesses, which are insured under a separate general and professional liability insurance policy with a $1.0 million per loss limit. The excess liability policy referenced above is also applicable to this policy.
Employee Medical Insurance. Medical preferred provider option programs are offered as a component of the Company's employee benefits. The Company retains a self-insured amount up to a contractual stop loss amount of $0.3 million deductible for most participants on its preferred provider organization plan and all other employee medical plans are guaranteed cost plans for the Company.
A summary of the liabilities related to insurance risks are as follows (dollars in thousands):
 
As of March 31, 2012
 
As of December 31, 2011
 
General and
Professional
 
Employee
Medical
 
Workers’
Compensation
 
Total
 
General and
Professional
 
Employee
Medical
 
Workers’
Compensation
 
Total
Current
$
4,955

(1)  
$
2,265

(2)  
$
4,416

(2)  
$
11,636

 
$
4,955

(1)  
$
2,083

(2) 
$
4,416

(2) 
$
11,454

Non-current
19,668

  

 
11,774

  
31,442

 
19,042

  

  
11,525

  
30,567

 
$
24,623

  
$
2,265

  
$
16,190

  
$
43,078

 
$
23,997

  
$
2,083

  
$
15,941

  
$
42,021


(1)
Included in accounts payable and accrued liabilities.
(2)
Included in employee compensation and benefits.
Hallmark Indemnification
Hallmark, the Company's wholly-owned rehabilitation services company, provides physical, occupational and speech therapy services to various unaffiliated skilled nursing facilities. These unaffiliated skilled nursing facilities are reimbursed for these services from the Medicare Program and other third-party payors. Hallmark has indemnified these unaffiliated skilled nursing facilities from a portion of certain disallowances of these services. Additionally, to the extent a Recovery Audit Contractor ("RAC") is successful in making a claim for recoupment of revenue from any of these skilled nursing facilities, the Company will typically be required to indemnify them for its charges associated with this loss.
Financial Guarantees
Substantially of all Skilled's wholly-owned subsidiaries guarantee the Company's 11.0% senior subordinated notes due 2014 (the "2014 Notes") and the Company's first lien senior secured credit facility. These guarantees are full and unconditional and joint and several. Other subsidiaries of Skilled that are not guarantors of the foregoing debt obligations are considered minor. On April 12, 2012, the Company delivered an irrevocable notice that it will redeem the entire $130.0 million of the 2014 Notes, effective May 12, 2012.

7. Stockholders' Equity

15

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss refers to revenue, expenses, gains, and losses that are recorded as an element of stockholders' equity but are excluded from net income. The Company's other comprehensive income consists of net deferred gains and losses on certain derivative instruments accounted for as cash flow hedges and gains and losses from investments available for sale. Details of other comprehensive income are included in the Company's Statement of Comprehensive Income.
 
2007 Incentive Award Plan
The fair value of the stock option grants for the three months ended March 31, 2012 and 2011 under FASB ASC Topic 718, Compensation – Stock Compensation, was estimated on the dates of the grants using the Black-Scholes option pricing model with the following assumptions:
 
 
Three Months Ended March 31,
 
2012
 
2011
Risk-free interest rate
1.75
%
 
2.80
%
Expected Life
6.25 years

 
6.25 years

Dividend yield
%
 
%
Volatility
70.81
%
 
50.00
%
Weighted-average fair value
$
5.44

 
$
6.61

There were 106,748 and 60,491 new stock options granted in the three months ended March 31, 2012 and 2011, respectively.
There were no options exercised during the three months ended March 31, 2012 and 2,770 options were exercised during the three months ended March 31, 2011. As of March 31, 2012, there was $1.6 million of unrecognized compensation cost related to outstanding stock options, net of forecasted forfeitures. This amount is expected to be recognized over a weighted-average period of 2.3 years. To the extent the forfeiture rate is different than the Company has anticipated, stock-based compensation related to these awards will be different from the Company's expectations.
The following table summarizes stock option activity during the three months ended March 31, 2012 under the Skilled Healthcare Group, Inc. Amended and Restated 2007 Incentive Award Plan:
 
 
Number of
Shares
 
Weighted-
Average
Exercise
Price
 
Weighted-
Average
Remaining
Contractual
Term
(in years)
 
Aggregate
Intrinsic
Value
(in thousands)
Outstanding at January 1, 2012
1,033,299

 
$
9.12

 
 
 
 
Granted
106,748

 
$
6.74

 
 
 
 
Exercised

 
n/a

 
 
 
 
Forfeited or cancelled
(4,000
)
 
$
15.50

 
 
 
 
Outstanding at March 31, 2012
1,136,047

 
$
8.85

 
7.48

 
$
947

Fully vested and expected to vest at March 31, 2012
1,110,134

 
$
8.86

 
7.45

 
$
921

Exercisable at March 31, 2012
644,596

 
$
10.02

 
6.84

 
$
406

Aggregate intrinsic value represents the value of Skilled's closing stock price on the New York Stock Exchange on the last trading day of the fiscal period in excess of the exercise price, multiplied by the number of options outstanding or exercisable.
 
Compensation related to stock option grants and stock awards included in general and administrative expenses was $0.8 million and $0.6 million for the three months ended March 31, 2012 and 2011, respectively. The amount of compensation included in cost of services was $0.4 million for both of the three months ended March 31, 2012 and 2011.

8. Fair Value Measurements
Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair value. These

16

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions. The following table summarizes the valuation of the Company’s interest rate hedge transaction and contingent consideration as of March 31, 2012 by the FASB ASC Topic 820, "Fair Value Measurement and Disclosures," fair value hierarchy (dollars in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Interest rate hedges
$

 
$
(696
)
 
$

 
$
(696
)
Available for sale securities
 
 
$
1,062

 
 
 
$
1,062

Contingent consideration – acquisitions
$

 
$

 
$
(7,341
)
 
$
(7,341
)
In June 2010, the Company entered into an interest rate cap agreement (which expired December 31, 2011) and an interest rate swap agreement in order to manage fluctuations in cash flows resulting from interest rate risk. The interest rate swap agreement is for a notional amount of $70.0 million with a LIBOR rate not to exceed 2.3% from January 2012 to June 2013. The Company continues to assess its exposure to interest rate risk on an ongoing basis.
The interest rate swap is required to be measured at fair value on a recurring basis. The fair value of the interest rate swap contract is determined by calculating the value of the discounted cash flows of the difference between the fixed interest rate of the interest rate swap and the counterparty’s forward LIBOR curve, which is the input used in the valuation. The forward LIBOR curve is readily available in public markets or can be derived from information available in publicly quoted markets. Therefore, the Company has categorized the interest rate swap as Level 2. The Company obtained the counterparty’s calculation of the valuation of the interest rate swap as well as a forward LIBOR curve from another investment bank and recalculated the valuation of the interest rate swap, which agreed with the counterparty’s calculation.
The Company's wholly owned offshore captive insurance company is required by regulatory agencies to set aside assets to comply with the laws of the jurisdiction in which it operates. These assets consist of restricted cash and available for sale securities, which are included in other assets in the Company's consolidated March 31, 2012 balance sheet. The Company's available for sale securities are U.S. government securities with an amortized cost basis and aggregate fair value of $1.0 million and $1.1 million, respectively, as of March 31, 2012. Net unrealized gains included in other comprehensive income on the Company's available for sale securities totaled $0.1 million for the three months ended March 31, 2012.
On May 1, 2010, the Company acquired substantially all of the assets of five Medicare-certified hospice companies and four Medicare-certified home health companies located in Arizona, Idaho, Montana and Nevada (which is sometimes referred to herein as the "Hospice/Home Health Acquisition"). As part of the purchase agreement, the purchase consideration included cash, promissory notes, contingent consideration, and deferred cash payments. The contingent consideration arrangement requires the Company to pay contingent payments should the acquired operations achieve certain financial targets based on EBITDA, as defined in the acquisition agreement, which was filed as an exhibit to the Company’s Report on Form 10-Q filed with the SEC on May 4, 2010. The contingent consideration is up to $7.0 million over a period of 5 years. The fair value of the contingent consideration was estimated using a probability-weighted discounted cash flow model. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement. The contingent consideration was recorded at the date of acquisition in the amount of $4.9 million. As of March 31, 2012, the contingent consideration had a fair value of $4.8 million. This is included in the Company’s accounts payable and accrued liabilities on the balance sheet. The change in fair value related to the contingent consideration is included in the Company's depreciation and amortization on the statements of operations. There has been no change in the valuation technique of the contingent consideration from December 31, 2011 to March 31, 2012.
On July 1, 2011, a wholly-owned subsidiary of the Company acquired Altura Homecare & Rehab ("Altura"). The acquisition includes a contingent earn-out consideration which can be earned based on the achievement of an EBITDA threshold. The contingent consideration is up to $1.5 million over a period of 3 years following the closing. The fair value of the contingent consideration was estimated using a probability-weighted discounted cash flow model. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement. The fair value of the earn-out at the acquisition date and at March 31, 2012 was $1.3 million.
On October 24, 2011, wholly-owned subsidiaries of the Company acquired substantially all of the assets of Cornerstone Hospice, Inc. ("Cornerstone"). The acquisition includes a contingent earn-out consideration which can be earned based on the achievement of an EBITDA threshold. The contingent consideration is up to $1.5 million over a period of 5 years following the closing. The fair value of the contingent consideration was estimated using a probability-weighted discounted cash flow model. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement. The fair value of the earn-out at the acquisition date and at March 31, 2012 was $1.2 million.
As discussed above, EBITDA is the basis for calculating the contingent consideration. The unobservable inputs to the

17

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

determination of the fair value of the contingent consideration include assumptions as to the ability of the acquired companies to meet their EBITDA targets and discount rates used in the calculation. Should the actual EBITDA generated by the acquired companies increase or decrease as compared to our assumptions, the fair value of the contingent consideration obligations would increase or decrease, up to the contracted limit. As the timing of contingent payments go further into the future, discount rate assumptions increase due to the increased uncertainty of the EBITDA that may be generated in those periods.
The Company's assumptions range from the acquired companies achieving none, a portion, or all of the consideration, and discount rates range from 4% - 7%.
Below is a table listing the Level 3 rollforward as of March 31, 2012 (in thousands):
Level 3 Rollforward
 
Value at January 1, 2012
$
7,210

Change in fair value
131

Value at March 31, 2012
$
7,341


9. Debt
The Company’s long-term debt is summarized as follows (dollars in thousands):
 
 
As of March 31, 2012
 
As of December 31, 2011
Term Loan, due 2016, interest rate based on LIBOR (subject to a 1.50% floor) plus 3.75% or 5.25% at March 31, 2012 and December 31, 2011; collateralized by substantially all assets of the Company.
317,100

 
337,100

Term Loan due 2016, interest rate based on the Prime rate, or 3.25% plus 2.75%, or 6.00% at March 31, 2012 and December 31, 2011; collateralized by substantially all assets of the Company.
25,700

 
6,600

Senior Subordinated Notes due 2014, interest rate 11.00% at March 31, 2012 and December 31, 2011; interest payable semiannually.
130,000

 
130,000

Term Loan and Senior Subordinated Notes original issue discount
(1,977
)
 
(2,117
)
Notes payable due December 2018, interest rate fixed at 6.50%, payable in monthly installments, collateralized by a first priority deed of trust.
1,232

 
1,269

Hospice/Home Health Acquisition note, interest rate fixed at 6.00%, payable in annual installments.
1,476

 
1,474

Cornerstone Acquisition note, interest rate fixed at 5.50%, payable in annual installments.
995

 
993

Insurance premiums financed
1,020

 
164

Total long-term debt
475,546

 
475,483

Less amounts due within one year
(5,273
)
 
(4,414
)
Long-term debt, net of current portion
$
470,273

 
$
471,069


Term Loan and Revolving Loan
On April 9, 2010, the Company entered into an up to $360.0 million senior secured term loan and a $100.0 million revolving credit facility ("Restated Credit Agreement") that amended and restated the senior secured term loan and revolving credit facility that were set to mature in June 2012. The credit arrangements provided under the Amended and Restated Credit Agreement are collectively referred to herein as the Company's senior secured credit facility.
The senior secured term loan requires principal payments of 0.25%, or $0.9 million, of the original principal amount issued on the last business day of each of March, June, September and December, commencing on June 30, 2010, with the balance due April 9, 2016. Amounts borrowed under the senior secured term loan may be prepaid at any time without penalty, except for LIBOR breakage costs. Commitments under the revolving credit facility terminate on April 9, 2015. The senior secured term loan matures on April 9, 2016. Amounts borrowed pursuant to the senior secured credit facility are secured by substantially all of the Company's assets.
As of March 31, 2012, $341.0 million was outstanding, net of original issue discount ("OID"), under the existing term loan. No amounts were outstanding on the revolving credit facility.

18

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Under the senior secured credit facility, the Company must maintain compliance with specified financial covenants measured on a quarterly basis. The senior secured credit facility also includes certain additional affirmative and negative covenants, including limitations on the incurrence of additional indebtedness, liens, investments in other businesses and capital expenditures. Also under the senior secured credit facility, subject to certain exceptions and minimum thresholds, the Company is required to apply all of the proceeds from any issuance of debt, as much as half of the proceeds from any issuance of equity, 50% of the Company's annual Consolidated Excess Cash Flow, as defined in the Amended and Restated Credit Agreement, and amounts received in connection with any sale of the Company's assets to repay the outstanding amounts under the Restated Credit Agreement.
Loans outstanding under the Restated Credit Agreement bear interest, at the Company's election, either at the prime rate plus an initial margin of 2.75% or the London Interbank Offered Rate ("LIBOR") plus an initial margin of 3.75%. Under the terms of the Restated Credit Agreement there is a LIBOR floor of 1.50%. The Company has a 0.5% commitment fee on the unused portion of the revolving credit facility. The Company has the right to increase its borrowings under the revolving credit facility up to an aggregate amount of $150 million provided that the Company is in compliance with the Restated Credit Agreement, that the additional debt would not cause any covenant violation of the Restated Credit Agreement, and that existing or new lenders within the Restated Credit Agreement or new lenders agree to increase their commitments. To reduce the risk related to interest rate fluctuations, the Restated Credit Agreement required the Company to enter into an interest rate swap, cap or similar agreement to effectively fix or cap the interest rate on 40% of its funded long-term debt within three months of April 2010 commencement of the senior secured credit facility. The Company entered into two interest rate hedge transactions, as described in Note 8 - "Fair Value Measurements," in order to comply with this requirement.
In April 2012, the Company amended its senior secured credit facility agreement to increase the size of the senior secured term loan by $100.0 million.  The incremental senior secured term loan bears interest at LIBOR (subject to a floor of 1.50%) plus a margin of 5.25%. As part of the refinancing, the interest rate on the existing senior secured term loan was amended to match the interest rate of the incremental term loan. The interest rate on the existing revolving credit facility was also amended to LIBOR plus a margin of 4.50%. There is no longer a LIBOR floor on the revolving credit facility. Under the April 2012 amendment, the quarterly term loan principal payments increase to 0.63%, or $2.6 million, beginning June 30, 2012. Additionally, the portion of the annual Consolidated Excess Cash Flow to be applied to term debt reductions increased to 75%. Substantially all of the Company's assets are pledged as collateral under the senior secured credit facility.
Senior Subordinated Notes
The 2014 Notes were issued in December 2005 in the aggregate principal amount of $200.0 million, with an interest rate of 11.0% and a discount of $1.3 million. Interest is payable semiannually in January and July of each year. The 2014 Notes mature on January 15, 2014. The 2014 Notes are unsecured senior subordinated obligations and rank junior to all of the Company's existing and future senior indebtedness, including indebtedness under the senior secured credit facility. The 2014 Notes are guaranteed on a senior subordinated basis by certain of the Company's current and future subsidiaries.
Effective January 15, 2012, the Company became entitled to redeem all or a portion of the 2014 Notes upon not less than 30 nor more than 60 days notice, at a redemption price (expressed in percentages of principal amount on the redemption date) of 100.0%. On April 12, 2012, the Company delivered an irrevocable notice to the trustee of the Senior Subordinated Notes that we redeem the entire $130.0 million of the 2014 Notes, effective May 12, 2012. The proceeds from the incremental senior secured term loan (as well as a draw on the revolving portion of the senior secured credit facility) have been deposited with the trustee for the 2014 Notes to fully fund the redemption of the outstanding 2014 Notes in May 2012 at par plus accrued interest.
Other Debt
The Company issued $10.0 million of promissory notes as part of the purchase consideration for the Hospice/Home Health Acquisition. The notes bear interest at 6.0% with $2.0 million of principal due annually beginning November 1, 2010. During 2011, the notes were substantially paid down leaving a remaining balance of $1.5 million. The promissory notes are payable to the selling entities, of which the President and Chief Operating Officer, and the Senior Vice President, of Signature Hospice & Home Health, LLC are significant shareholders. Signature Hospice & Home Health, LLC is a consolidated subsidiary of Skilled holding 100% interests in the operating companies for the Hospice/Home Health Acquisition.

10. Subsequent events
For a detailed discussion of the Company's subsequent event related to the refinancing of debt, see Note 9 - "Debt."


19


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in understanding and assessing the trends and significant changes in our results of operations and financial condition as of the dates and for the periods presented. Historical results may not indicate future performance. Our forward-looking statements, which reflect our current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those contemplated by these statements. Factors that may cause differences between actual results and those contemplated by forward-looking statements include, but are not limited to, those discussed in our Annual Report on Form 10-K for the year ended December 31, 2011 and our subsequent reports on Form 10-Q and Form 8-K filed with the Securities and Exchange Commission (the “SEC”). As used in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, the words, “we,” “our,” and “us” refer to Skilled Healthcare Group, Inc. and its wholly-owned subsidiaries. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our condensed consolidated financial statements and related notes included in this report.
Business Overview
We are a holding company with subsidiaries that operate skilled nursing facilities, assisted living facilities, hospices, home health providers and a rehabilitation therapy business. We have an administrative service company that provides a full complement of administrative and consultative services that allows our affiliated operators and third-party operators with whom we contract to better focus on delivery of healthcare services. We have one such service agreement with an unrelated facility operator. These subsidiaries focus on providing high-quality care to our patients. Our subsidiaries that operate skilled nursing facilities have a strong commitment to treating patients who require a high level of skilled nursing care and extensive rehabilitation therapy, whom we refer to as high-acuity patients. As of March 31, 2012, we owned or leased 74 skilled nursing facilities and 22 assisted living facilities, together comprising 10,397 licensed beds. We also lease five skilled nursing facilities in California to an unaffiliated third party operator. Our skilled nursing and assisted living facilities, approximately 77.2% of which we own, are located in California, Texas, Iowa, Kansas, Missouri, Nebraska, Nevada and New Mexico, and are generally clustered in large urban or suburban markets. For the three months ended March 31, 2012, we generated approximately 72.5% of our revenue from our skilled nursing facilities, including our integrated rehabilitation therapy services at these facilities. The remainder of our revenue is generated from our assisted living services, rehabilitation therapy services provided to third-party facilities, hospice care and home health services, and or lease of five skilled nursing facilities to an unaffiliated third party operators.

Industry Trends
Medicare and Medicaid Reimbursement
Rising healthcare costs due to a variety of factors, including an aging population and increasing life expectancies, has generated growing demand for post-acute healthcare services, such as skilled nursing, assisted living, home health care, hospice care and rehabilitation therapy, in recent years. In an effort to mitigate the cost of providing healthcare benefits, third party payors including Medicare, Medicaid, managed care providers, insurance companies and others have increasingly encouraged the treatment of patients in lower-cost care settings. As a result, in recent years skilled nursing facilities, which typically have significantly lower cost structures than acute care hospitals and certain other post-acute care settings, have generally been serving larger populations of higher-acuity patients than in the past. Despite this growth in demand, uncertainty over Medicare and Medicaid reimbursement rates persists. Medicare and Medicaid reimbursement rates are subject to change from time to time and, because revenue derived directly or indirectly from Medicare and Medicaid reimbursement has historically comprised a substantial portion of our consolidated revenue, a reduction in rates could materially and adversely impact our revenue.
Medicare reimburses our skilled nursing facilities under a prospective payment system ("PPS") for certain inpatient covered services. Under the PPS, facilities are paid a predetermined amount per patient, per day, based on the anticipated costs of treating patients. The amount to be paid is determined by classifying each patient into a resource utilization group ("RUG") category that is based upon each patient's acuity level. In October 2010, the number of RUG categories was expanded from 53 to 66 as part of the implementation of the RUGs IV system and the introduction of a revised and substantially expanded patient assessment tool called the minimum data set (MDS) version 3.0.
On July 29, 2011, the Centers for Medicare & Medicaid Services ("CMS") issued a final rule providing for, among other things, a net 11.1% reduction in PPS payments to skilled nursing facilities for CMS's fiscal year 2012 (which began October 1, 2011) as compared to PPS payments in CMS's fiscal year 2011 (which ended September 30, 2011). The 11.1% reduction is on a net basis, after the application of a 2.7% market basket increase, and reduced by a 1.0% multi-factor productivity adjustment required by the Patient Protection and Affordable Care Act of 2010 ("PPACA"). The final CMS rule also adjusted the method by which group therapy is counted for reimbursement purposes, and changed the timing in which patients who are receiving therapy must be reassessed for purposes of determining their RUG category.

20


Should future changes in PPS include further reduced rates or increased standards for reaching certain reimbursement levels (including as a result of automatic cuts tied to federal deficit cut efforts or otherwise), our Medicare revenues derived from our skilled nursing facilities (including rehabilitation therapy services provided at our skilled nursing facilities) could be reduced, with a corresponding adverse impact on our financial condition and results of operation. Our rehabilitation therapy, hospice and home health care businesses are also to a large degree directly or indirectly dependent on (and therefore affected by changes in) Medicare and Medicaid reimbursement rates. For example, our rehabilitation therapy business may have difficulty increasing or maintaining the rates it has negotiated with third party nursing facilities in light of the reduced PPS reimbursement rates that took effect on October 1, 2011 as discussed above.
We also derive a substantial portion of our consolidated revenue from Medicaid reimbursement, primarily through our skilled nursing business. Medicaid programs are administered by the applicable states and financed by both state and federal funds. Medicaid spending nationally has increased substantially in recent years, becoming an increasingly significant component of state budgets. This, combined with slower state revenue growth and other state budget demands, has led both the federal government and many states, including California and other states in which we operate, to institute measures aimed at controlling the growth of Medicaid spending (and in some instances reducing it).
Historically, adjustments to reimbursement under Medicare and Medicaid have had a significant effect on our revenue and results of operations. Recently enacted, pending and proposed legislation and administrative rulemaking at the federal and state levels could have similar effects on our business. Efforts to impose reduced reimbursement rates, greater discounts and more stringent cost controls by government and other payors are expected to continue for the foreseeable future and could adversely affect our business, financial condition and results of operations. Additionally, any delay or default by the federal or state governments in making Medicare and/or Medicaid reimbursement payments could materially and adversely affect our business, financial condition and results of operations.

Federal Health Care Reform
In addition to the matters described above affecting Medicare and Medicaid participating providers, PPACA enacted several reforms with respect to skilled nursing facilities, home health agencies and hospices, including payment measures to realize significant savings of federal and state funds by deterring and prosecuting fraud and abuse in both the Medicare and Medicaid programs. While many of the provisions of PPACA will not take effect for several years or are subject to further refinement through the promulgation of regulations, some key provisions of PPACA are presently effective.
Enhanced CMPs and Escrow Provisions. PPACA includes expanded civil monetary penalty ("CMP") and related provisions applicable to all Medicare and Medicaid providers. CMS rules adopted to implement applicable provisions of PPACA also provide that assessed CMPs may be collected and placed in whole or in part into an escrow pending final disposition of the applicable administrative and judicial appeals processes. To the extent our businesses are assessed large CMPs that are collected and placed into an escrow account pending lengthy appeals, such actions could adversely affect our results of operations.
Nursing Home Transparency Requirements. In addition to expanded CMP provisions, PPACA imposes new transparency requirements for Medicare-participating nursing facilities. In addition to previously required disclosures regarding a facility's owners, management and secured creditors, PPACA expanded the required disclosures to include information regarding the facility's organizational structure, additional information on officers, directors, trustees and "managing employees" of the facility (including their names, titles, and start dates of services), and information regarding certain parties affiliated with the facility. The new transparency provisions could result in the potential for greater government scrutiny and oversight of the ownership and investment structure for skilled nursing facilities, as well as more extensive disclosure of entities and individuals that comprise part of skilled nursing facilities' ownership and management structure.
Face-to-Face Encounter Requirements. PPACA imposes new patient face-to-face encounter requirements on home health agencies and hospices to establish a patient's ongoing eligibility for Medicare home health services or hospice services, as applicable. A certifying physician or other designated health care professional must conduct the face-to-face encounters within specified timeframes, and failure of the face-to-face encounter to occur and be properly documented during the applicable timeframes could render the patient's care ineligible for reimbursement under Medicare.
Suspension of Payments During Pending Fraud Investigations. PPACA provides the federal government with expanded authority to suspend Medicare and Medicaid payment if a provider is investigated for allegations or issues of fraud. This suspension authority creates a new mechanism for the federal government to suspend both Medicare and Medicaid payments for allegations of fraud, independent of whether a state exercises its authority to suspend Medicaid payments pending a fraud investigation. To the extent the suspension of payments provision is applied to one of our businesses for allegations of fraud, such a suspension could adversely affect our results of operations.

21


Overpayment Reporting and Repayment; Expanded False Claims Act Liability. PPACA enacted several important changes that expand potential liability under the federal False Claims Act. Overpayments related to services provided to both Medicare and Medicaid beneficiaries must be reported and returned to the applicable payor within specified deadlines, or else they are considered obligations of the provider for purposes of the federal False Claims Act. This new provision substantially tightens the repayment and reporting requirements generally associated with operations of health care providers to avoid False Claims Act exposure.
Home and Community Based Services. PPACA provides that, beginning in October 2011, states can provide home and community-based attendant services and supports through the Community First Choice State plan option. States choosing to provide home and community based services under this option must make them available to assist with activities of daily living, instrumental activities of daily living and health related tasks under a plan of care agreed upon by the individual and his/her representative. For states that elect to make coverage of home and community-based services available through the Community First Choice State plan option, the percentage of the state's Medicaid expenses paid by the federal government will increase by 6 percentage points. PPACA also included additional measures related to the expansion of community and home based services and authorized states to expand coverage of community and home-based services to individuals who would not otherwise be eligible for them. The expansion of home-and-community based services could reduce the demand for the facility based services that we provide.
Health Care-Acquired Conditions. PPACA provides that the Secretary of Health and Human Services must prohibit payments to states for any amounts expended for providing medical assistance for certain medical conditions acquired during the patient's receipt of health care services. CMS adopted a final rule to implement this provision of PPACA in the third quarter of 2011. The new rule prohibits states from making payments to providers under the Medicaid program for conditions that are deemed to be reasonably preventable. It uses Medicare's list of preventable conditions in inpatient hospital settings as the base (adjusted for the differences in the Medicare and Medicaid populations) and provides states the flexibility to identify additional preventable conditions and settings for which Medicaid payment will be denied.
Anti-Kickback Statute Amendments. PPACA amended the Anti-Kickback Statute so that (i) a claim that includes items or services violating the Anti-Kickback Statute also would constitute a false or fraudulent claim under the federal False Claims Act and (ii) the intent required to violate the Anti-Kickback Statute is lowered such that a person need not have actual knowledge or specific intent to violate the Anti-Kickback Statute in order for a violation to be deemed to have occurred. These modifications of the Anti-Kickback Statute could expose us to greater risk of inadvertent violations of the statute and to related liability under the federal False Claims Act.
The provisions of PPACA discussed above are examples of recently-enacted federal health reform provisions that we believe may have a material impact on the long-term care profession generally and on our business. However, the foregoing discussion is not intended to constitute, nor does it constitute, an exhaustive review and discussion of PPACA. It is possible that other provisions of PPACA may be interpreted, clarified, or applied to our businesses in a way that could have a material adverse impact on our business, financial condition and results of operations. Similar federal and/or state legislation that may be adopted in the future could have similar effects.
Revenue
Revenue by Service Offering

We operate our business in three reportable operating segments: (i) long-term care services, which includes the operation of skilled nursing and assisted living facilities and is the most significant portion of our business; (ii) therapy services, which includes our rehabilitation therapy services business; and (iii) hospice and home health services, which includes our hospice and home health businesses. Our reporting segments are business units that offer different services, and that are managed separately due to the nature of services provided.
In our long-term care services segment, we derive the majority of our revenue by providing skilled nursing care and integrated rehabilitation therapy services to residents in our network of skilled nursing facilities. The remainder of our long-term care segment revenue is generated by our assisted living facilities, by our administration of an unaffiliated third party skilled nursing facility, and from our leasing of five skilled nursing facilities to an unaffiliated third party operator. In our therapy services segment, we derive revenue by providing rehabilitation therapy services to third-party facilities. In our hospice and home health services segment, we provide hospice and home health services.
The following table shows the revenue and percentage of our total revenue generated by each of these segments for the periods presented (dollars in thousands):

22



 
Three Months Ended March 31,
 
 
 
2012
 
2011
 
 
 
Revenue
Dollars
 
Revenue
Percentage
 
Revenue
Dollars
 
Revenue
Percentage
 
Increase/(Decrease)
Dollars
 
Percentage
Long-term care services:
 
 
 
 
 
 
 
 
 
 
 
Skilled nursing facilities
$
158,983

 
72.5
%
 
$
175,344

 
78.8
%
 
$
(16,361
)
 
(9.3
)%
Assisted living facilities
6,914

 
3.2

 
6,724

 
3.0

 
190

 
2.8

Administration of third party facility
441

 
0.2

 
255

 
0.1

 
186

 
72.9

Facility lease revenue
754

 
0.3

 

 

 
754

 
100.0

Total long-term care services
167,092

 
76.2

 
182,323

 
81.9

 
(15,231
)
 
(8.4
)
Therapy services:
 
 
 
 
 
 
 
 
 
 
 
Third-party rehabilitation therapy services
26,115

 
11.9

 
22,190

 
10.0

 
3,925

 
17.7

Total therapy services
26,115

 
11.9

 
22,190

 
10.0

 
3,925

 
17.7

Hospice & home health services:
 
 
 
 
 
 
 
 
 
 
 
Hospice
19,754

 
9.0

 
14,326

 
6.4

 
5,428

 
37.9

Home Health
6,452

 
2.9

 
3,739

 
1.7

 
2,713

 
72.6

Total hospice & home health services
26,206

 
11.9

 
18,065

 
8.1

 
8,141

 
45.1

Total
$
219,413

 
100.0
%
 
$
222,578

 
100.0
%
 
$
(3,165
)
 
(1.4
)%
Sources of Revenue
The following table sets forth revenue consolidated by state in dollars and as a percentage of total revenue for the periods presented (dollars in thousands):
 
Three Months Ended March 31,
 
2012
 
2011
 
Revenue Dollars
 
Percentage of
Revenue
 
Revenue Dollars
 
Percentage of
Revenue
California
$
88,228

 
40.2
%
 
$
94,953

 
42.7
%
Texas
45,660

 
20.8

 
46,348

 
20.8

New Mexico
24,601

 
11.2

 
22,171

 
10.0

Kansas
15,703

 
7.2

 
17,857

 
8.0

Missouri
15,120

 
6.9

 
15,319

 
6.9

Nevada
15,348

 
7.0

 
14,719

 
6.6

Arizona
3,998

 
1.8

 
2,893

 
1.3

Montana
3,641

 
1.7

 
2,875

 
1.3

Iowa
2,927

 
1.3

 
2,971

 
1.3

Idaho
2,423

 
1.1

 
2,191

 
1.0

Nebraska
859

 
0.4

 

 

Other
905

 
0.4

 
281

 
0.1

Total
$
219,413

 
100.0
%
 
$
222,578

 
100.0
%
Long-Term Care Services Segment
Skilled Nursing Facilities. Within our skilled nursing facilities, we generate our revenue from Medicare, Medicaid, managed care providers, insurers, private pay and other sources. We believe that our skilled mix, which we define as the number of Medicare and non-Medicaid managed care patient days at our skilled nursing facilities divided by the total number of patient days at our skilled nursing facilities for any given period, is an important indicator of our success in attracting high-acuity patients because it represents the percentage of our patients who are reimbursed by Medicare and managed care payors, for whom we receive higher reimbursement rates. Most of our skilled nursing facilities include our Express RecoveryTM program. This program uses a dedicated unit within a skilled nursing facility to deliver a comprehensive rehabilitation and

23


recovery regimen in accommodations specifically designed to serve high-acuity patients.
Assisted Living Facilities. Within our assisted living facilities, which are mostly in Kansas, we generate our revenue primarily from private pay sources, with a small portion earned from Medicaid or other state specific programs.
Leased Facility Revenue. We lease five skilled nursing facilities in California to an unaffiliated third party operator. For additional information on the lease arrangement, see Note 5 - "Property and Equipment."
Therapy Services Segment
As of March 31, 2012, we provided rehabilitation therapy services to a total of 188 healthcare facilities, including 64 of our facilities, as compared to 179 facilities, including 67 of our facilities, as of March 31, 2011. In addition, we have contracts to manage the rehabilitation therapy services for our 10 healthcare facilities in New Mexico. The net increase of 9 facilities serviced was comprised of 27 new facilities serviced, net of 18 cancellations. The net decrease in the number of our facilities that we provided rehabilitation therapy services to is because we reduced the number of owned facilities since the prior period. Rehabilitation therapy revenue derived from servicing our own facilities is included in our revenue from skilled nursing facilities. Our rehabilitation therapy business receives payment for services from the third-party facilities that it serves based on negotiated patient per diem rates or a negotiated fee schedule based on the type of service rendered.
Hospice and Home Health Services Segment
Hospice. As of March 31, 2012, we provided hospice care in Arizona, California, Idaho, Montana, Nevada and New Mexico. We derive substantially all of the revenue from our hospice business from Medicare and managed care reimbursement.
Federal law imposes a Medicare payment cap on hospice service programs. We monitor the impact of the Medicare cap on our hospice business by attempting to address our average length-of-stay on a market-by-market basis. A key component of this strategy is to analyze each hospice program's mix of patients and referral sources to achieve a desirable mix of the types of patients and referral sources that we serve in each of our programs.
Home Health. We provided home health care in Arizona, California, Idaho, Montana, Nevada and New Mexico as of March 31, 2012. We derive the majority of the revenue from our home health business from Medicare. Net service revenue is recorded under the Medicare payment program based on a 60-day episodic payment rate that is subject to downward adjustment based on certain variables.
Regulatory and Other Governmental Actions Affecting Revenue

We derive a substantial portion of our revenue from government Medicare and Medicaid programs. In addition, our rehabilitation therapy services, for which we receive payment from private payors, is significantly dependent on Medicare and Medicaid funding, as those private payors are primarily funded or reimbursed by these programs. The following table summarizes the amount of revenue that we received from each of our payor classes by segment in the periods presented (dollars in thousands):

 
Three Months Ended March 31,
 
2012
 
2011
 
Long-Term Care Services
 
Therapy Services
 
Hospice & Home Health Services
 
Total Revenue
 
Revenue Percentage
 
Long-Term Care Services
 
Therapy Services
 
Hospice & Home Health Services
 
Total Revenue
 
Revenue Percentage
Medicare
$
53,457

 
$

 
$
23,242

 
$
76,699

 
35.0
%
 
$
71,317

 
$

 
$
16,900

 
$
88,217

 
39.6
%
Medicaid
64,844

 

 
419

 
65,263

 
29.7

 
63,822

 

 
209

 
64,031

 
28.8

Subtotal Medicare and Medicaid
118,301

 

 
23,661

 
141,962

 
64.7

 
135,139

 

 
17,109

 
152,248

 
68.4

Managed Care
23,373

 

 
1,105

 
24,478

 
11.2

 
22,003

 

 
191

 
22,194

 
10.0

Private pay and other
25,418

 
26,115

 
1,440

 
52,973

 
24.1

 
25,181

 
22,190

 
765

 
48,136

 
21.6

Total
$
167,092

 
$
26,115

 
$
26,206

 
$
219,413

 
100.0
%
 
$
182,323

 
$
22,190

 
$
18,065

 
$
222,578

 
100.0
%


24



Medicare. Medicare is a federal health insurance program for people age 65 or older, people under age 65 with certain disabilities, and people of all ages with End-Stage Renal Disease. Part A of the Medicare program includes hospital insurance that helps to cover hospital inpatient care and skilled nursing facility inpatient care under certain circumstances (e.g., up to 100 days of inpatient skilled nursing coverage following a 3-day qualifying hospital stay, and no custodial or long-term care). It also helps cover hospice care and some home health care. Skilled nursing facilities are paid on the basis of a prospective payment system, or PPS. The PPS payment rates are adjusted for case mix and geographic variation in wages and cover all costs of furnishing covered skilled nursing facilities services (routine, ancillary, and capital-related costs). The amount to be paid is determined by classifying each patient into a resource utilization group, or RUG, category, which is based upon the patient's acuity level. CMS generally evaluates and adjusts payment rates on an annual basis.
Medicaid. Medicaid is a state-administered medical assistance program for the indigent, operated by the individual states with the financial participation of the federal government. Each state has relatively broad discretion in establishing its Medicaid reimbursement formulas and coverage of service, which must be approved by the federal government in accordance with federal guidelines. All states in which we operate cover long-term care services for individuals who are Medicaid eligible and qualify for institutional care. Providers must accept the Medicaid reimbursement level as payment in full for services rendered. Medicaid programs generally make payments directly to providers, except in cases where the state has implemented a Medicaid managed care program, under which providers receive Medicaid payments from managed care organizations (MCOs) that have subcontracted with the Medicaid program. All states in which we currently do business have all, or a portion of, their Medicaid population enrolled in a Medicaid MCO.
Managed Care. Our managed care patients consist of individuals who are insured by a third-party entity, typically called a senior Health Maintenance Organization, or senior HMO plan, or are Medicare beneficiaries who assign their Medicare benefits to a senior HMO plan.
Private Pay and Other. Private pay and other sources consist primarily of individuals or parties who directly pay for their services or are beneficiaries of the Department of Veterans Affairs.
Critical Accounting Estimates
Discussion of our critical accounting policies and estimates is included under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, which we filed with the SEC on February 13, 2012.

25



Results of Operations
The following table summarizes some of our key performance indicators, along with other statistics, for each of the periods indicated:
 
 
Three Months Ended March 31,
 
2012
 
2011
Occupancy statistics (skilled nursing facilities):
 
 
 
     Available beds in service at end of period
8,813

 
9,179

     Available patient days
801,526

 
824,753

     Actual patient days
668,431

 
690,808

     Occupancy percentage
83.4
%
 
83.8
%
Skilled mix
22.9
%
 
24.5
%
     Average daily number of patients
7,345

 
7,676

 
 
 
 
Hospice average daily census
1,375

 
992

Home health episodic-based admissions
1,985

 
979

Home health episodic-based recertifications
333

 
148

 
 
 
 
Revenue per patient day (skilled nursing facilities prior to intercompany eliminations)
 
 
 
     LTC only Medicare (Part A)
$
508

 
$
577

     Medicare blended rate (Part A & B)
575

 
630

     Managed care
382

 
391

     Medicaid
158

 
153

     Private and other
181

 
175

     Weighted-average for all
$
240

 
$
254

 
 
 
 
Revenue from (total company):
 
 
 
Medicare
35.0
%
 
39.6
%
Managed care, private pay, and other
35.3

 
31.6

Quality mix
70.3

 
71.2

Medicaid
29.7

 
28.8

Total
100
%
 
100
%
 
 
 
 



    
















26


The following table sets forth details of our revenue, expenses, and net income and other items as a percentage of total revenue for the periods indicated:

 
Three Months Ended March 31,
 
2012
 
2011
Revenue
100.0
 %
 
100.0
 %
Expenses:
 
 
 
Cost of services (exclusive of rent cost of revenue and depreciation and amortization shown below)
83.5

 
78.8

Rent cost of revenue
2.1

 
2.1

General and administrative
2.8

 
3.1

Depreciation and amortization
2.8

 
2.8

 
91.2

 
86.8

Other income (expenses):
 
 
 
Interest expense
(4.4
)
 
(4.5
)
Interest income
0.1

 
0.1

Other income (expense)

 
(0.1
)
Equity in earnings of joint venture
0.2

 
0.2

Total other income (expenses), net
(4.1
)
 
(4.3
)
Income from continuing operations before provision for income taxes
4.7

 
8.9

Provision for income taxes
1.8

 
3.6

Net income
2.9
 %
 
5.3
 %
 
 
 
 
Adjusted EBITDA(1)
11.9
 %
 
16.5
 %
Adjusted EBITDAR(2)
14.0
 %
 
18.6
 %
 
 
 
 
 
Three Months Ended March 31,
 
2012
 
2011
Reconciliation from net income to EBITDA, EBITDAR, Adjusted EBITDA and Adjusted EBITDAR (in thousands):
 
 
 
Net income
$
6,337

 
$
11,844

Interest expense, net of interest income
9,420

 
9,771

Provision for income taxes
4,036

 
8,124

Depreciation and amortization expense
6,275

 
6,145

EBITDA(1)
26,068

 
35,884

Rent cost of revenue
4,556

 
4,570

EBITDAR(2)
30,624

 
40,454

EBITDA(1)
26,068

 
35,884

Disposals of property and equipment

 
290

Expenses related to the exploration of strategic alternatives

 
242

Exit costs related to the Northern California divestiture

 
385

Adjusted EBITDA(1)
26,068

 
36,801

Rent cost of revenue
4,556

 
4,570

Adjusted EBITDAR(2)
$
30,624

 
$
41,371


(1)
We define EBITDA as net income (loss) before depreciation, amortization and interest expense (net of interest income) and the provision for income taxes. Adjusted EBITDA is EBITDA adjusted for non-core business items, which for the periods presented report includes gains or losses on the disposal of property and equipment, expenses related to the exploration of strategic alternatives, and exit costs related to the disposition of certain of our operations in Northern California (each to the extent applicable in the appropriate period.)
(2)
We define EBITDAR as net income (loss) before depreciation, amortization, interest expense (net of interest income), the provision for income taxes and rent cost of revenue. Adjusted EBITDAR is EBITDAR adjusted for the non-core business items listed above for the definition of Adjusted EBITDA (each to the extent applicable in the appropriate

27


period.)
We believe that the presentation of EBITDA, EBITDAR, 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 report of EBITDA, EBITDAR, 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, EBITDAR, Adjusted EBITDA and Adjusted EBITDAR are primary indicators management uses 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 U.S. GAAP, expenses, revenues and gains (losses) that we believe are unrelated to the day-to-day performance of our business. We also use EBITDA, EBITDAR, 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.
Management, including operating company based managers, uses EBITDA, EBITDAR, 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 and segment level. Segment management uses these metrics to measure performance on a business by business level. We typically use Adjusted EBITDA and Adjusted EBITDAR for these purposes on a consolidated basis as the adjustments to EBITDA and EBITDAR are not generally allocable to any individual business unit and we typically use EBITDA and EBITDAR to compare the operating performance of each skilled nursing, assisted living facility, or other business units as well as to assess the performance of our operating segments. EBITDA, EBITDAR, 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, depreciation and amortization expense, rent cost of revenue (in the case of EBITDAR and Adjusted EBITDAR) and special charges, 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 facility 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. We believe these types of charges are dependent on factors unrelated to the underlying business unit performance. As a result, we believe that the use of EBITDA, EBITDAR, Adjusted EBITDA and Adjusted EBITDAR provides a meaningful and consistent comparison of our underlying businesses and facilities between periods by eliminating certain items required by U.S. GAAP which have little or no significance to their day-to-day operations.
Finally, we use Adjusted EBITDA to determine compliance with our debt covenants and assess our ability to borrow additional funds and to finance or expand operations. Our senior secured credit facility uses a measure substantially similar to Adjusted EBITDA as the basis for determining compliance with our financial covenants, specifically our minimum interest coverage ratio and our maximum total leverage ratio, and for determining the interest rate of our first lien term loan. The indenture governing the 2014 Notes also uses a substantially similar measurement for determining the amount of additional debt we may incur. For example, both our senior secured credit facility and the indenture governing the 2014 Notes include adjustments to EBITDA for (i) gain or losses on sale of assets, (ii) the write-off of deferred financing costs of extinguished debt, (iii) pro forma adjustments for acquisitions to show a full year of EBITDA and interest expense, (iv) sponsorship fees paid to Onex which totals $0.5 million annually, (v) non-cash stock compensation and (vi) impairment of long-lived assets. Our noncompliance with these financial covenants could lead to acceleration of amounts due under our senior secured credit facility. In addition, if we cannot satisfy certain financial covenants under the indenture for the 2014 Notes, we cannot engage in certain specified activities, such as incurring additional indebtedness or making certain payments.
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 individual business level basis, EBITDA, EBITDAR, Adjusted EBITDA and Adjusted EBITDAR are non-GAAP financial measures that have no standardized meaning defined by U.S. GAAP. Therefore, our EBITDA, EBITDAR, 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 U.S. 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, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements;

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they are not adjusted for all non-cash income or expense items that are reflected in our consolidated statements of cash flows;
they do not reflect the impact on earnings of charges resulting from certain matters we consider not to be indicative of our ongoing operations; 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, EBITDAR, Adjusted EBITDA and Adjusted EBITDAR only to supplement net income on a basis prepared in conformance with U.S. GAAP in order to provide a more complete understanding of the factors and trends affecting our business. Furthermore, the non-GAAP financial measures that we present may be different from the presentation of similar measures by other companies, so the comparability of the measures among companies may be limited. We strongly encourage investors to consider net income determined under U.S. GAAP as compared to EBITDA, EBITDAR, Adjusted EBITDA and Adjusted EBITDAR, and to perform their own analysis, as appropriate.
Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011
Revenue. Revenue decreased by $3.2 million, or 1.4%, to $219.4 million in the three months ended March 31, 2012 from $222.6 million in the three months ended March 31, 2011.
Long term care services
 
 
Three Months Ended March 31,
 
 
 
2012
 
2011
 
Increase/(Decrease)
 
Revenue
Dollars
 
Revenue
Percentage
 
Revenue
Dollars
 
Revenue
Percentage
 
Dollars
 
Percentage
 
(dollars in millions)
   Skilled nursing facilities
$
158.9

 
72.5
%
 
$
175.3

 
78.8
%
 
$
(16.4
)
 
(9.3
)%
   Assisted living facilities
6.9

 
3.2

 
6.7

 
3.0

 
0.2

 
2.8

   Administration of third party facility
0.5

 
0.2

 
0.3

 
0.1

 
0.2

 
72.9

   Leased facility revenue
0.8

 
0.3

 
$

 

 
0.8

 
100.0

Total long-term care services
$
167.1

 
76.2
%
 
$
182.3

 
81.9
%
 
$
(15.2
)
 
(8.4
)%
Skilled nursing facilities revenue decreased $16.4 million in the first quarter of 2012 as compared to the first quarter of 2011. Revenue decreased $8.4 million for skilled nursing facilities operated for all of the three months ended March 31, 2012 and 2011, primarily as a result of a $9.4 million decrease to a lower weighted average per patient day ("PPD") rate, offset by a $1.0 million increase due to an increase in occupancy rates. We experienced an increase in our average daily census ("ADC") and average length of stay ("ALOS") in our same store skilled nursing facilities in the first quarter of 2012 as compared to the first quarter of 2011. The decrease in PPD rates was primarily a result of the Medicare rate cut discussed below as well as a shift from Medicare days to Managed Medicare days as more seniors elect Medicare Advantage. Medicare Advantage plans are operated by private companies, who Medicare pays a fixed monthly amount per enrollee to provide the enrollees healthcare services that would otherwise be reimbursed through Medicare's standard PPS system. Additionally, there was an increase of $0.6 million in revenue from the acquisition of a lease by our Rehabilitation Center of Omaha in April 2011 offset by a decrease of $8.6 million in revenue from the transfer of operations of five skilled nursing facilities in northern California to an unaffiliated third party operator in April 2011. Our average daily Part A Medicare rate decreased 12.0% to $508 in the three months ended March 31, 2012 from $577 in the three months ended March 31, 2011, primarily due to the decrease of our skilled nursing Medicare rates by 11.1%, effective October 1, 2011, which will continue to negatively impact skilled nursing revenues in future periods. Our average daily Medicaid rate increased 3.3% to $158 per day in the three months ended March 31, 2012 from $153 per day in the three months ended March 31, 2011, primarily due to increased Medicaid rates in California, Kansas, Missouri, and Nevada. These increases in Medicaid rates were substantially offset by increases in the provider taxes in those states. We expect overall Medicaid rates for the states we operate in to stay flat for the states' fiscal 2012 as compared to their fiscal 2011. The increase of $0.2 million at our assisted living facilities in the first quarter of 2012 as compared to the first quarter of 2011 was due to the July 2011 acquisition of Vintage Park at San Martin in Las Vegas, Nevada. Our revenue related to the administration of a third party facility increased $0.2 million in the first quarter of 2012 as compared to the first quarter of 2011.
Therapy services


29


 
Three Months Ended March 31,
 
 
 
2012
 
2011
 
Increase/(Decrease)
 
Revenue
Dollars
 
Revenue
Percentage
 
Revenue
Dollars
 
Revenue
Percentage
 
Dollars
 
Percentage
 
(dollars in millions)
Rehabilitation therapy services
$
42.1

 
19.2
 %
 
$
39.3