Genesis Healthcare, Inc. - Quarter Report: 2018 June (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

☒    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended June 30, 2018.

 

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

 

 

Genesis Healthcare, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

 

(610) 444-6350

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  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 ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

 

The number of shares outstanding of each of the issuer’s classes of common stock, as of the close of business on August 8, 2018, was:

Class A common stock, $0.001 par value – 101,090,509 shares

Class B common stock, $0.001 par value –       744,396 shares

Class C common stock, $0.001 par value – 59,700,801 shares

 

 

Genesis Healthcare, Inc.

 

Form 10-Q

Index

 

 

 

 

 

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

 

GENESIS HEALTHCARE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

 

See accompanying notes to unaudited consolidated financial statements.

 

GENESIS HEALTHCARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

 

 

See accompanying notes to unaudited consolidated financial statements.

GENESIS HEALTHCARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(IN THOUSANDS)

(UNAUDITED)

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

GENESIS HEALTHCARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

(1)General Information

 

Description of Business

 

Genesis Healthcare, Inc. is a healthcare services company that, through its subsidiaries (collectively, the Company or Genesis), owns and operates skilled nursing facilities, assisted/senior living facilities and a rehabilitation therapy business.  The Company has an administrative services company that provides a full complement of administrative and consultative services that allows its affiliated operators and third-party operators with whom the Company contracts to better focus on delivery of healthcare services. At June 30, 2018, the Company provides inpatient services through 451 skilled nursing, assisted/senior living and behavioral health centers located in 30 states.  Revenues of the Company’s owned, leased and otherwise consolidated inpatient businesses constitute approximately 86% of its revenues.

 

The Company provides a range of rehabilitation therapy services, including speech pathology, physical therapy, occupational therapy and respiratory therapy.  These services are provided by rehabilitation therapists and assistants employed or contracted at substantially all of the centers operated by the Company, as well as by contract to healthcare facilities operated by others.  The Company has expanded its delivery model for providing rehabilitation services to community-based and at-home settings, as well as internationally in China.  After the elimination of intercompany revenues, the rehabilitation therapy services business constitutes approximately 11% of the Company’s revenues.

 

The Company provides an array of other specialty medical services, including management services, physician services, staffing services, and other healthcare related services, which comprise the balance of the Company’s revenues.

 

Basis of Presentation

 

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP).  In the opinion of management, the consolidated financial statements include all necessary adjustments for a fair presentation of the financial position and results of operations for the periods presented.

 

The consolidated financial statements of the Company include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation. The Company presents noncontrolling interests within the stockholders’ deficit section of its consolidated balance sheets. The Company presents the amount of net loss attributable to Genesis Healthcare, Inc. and net loss attributable to noncontrolling interests in its consolidated statements of operations.

 

The consolidated financial statements include the accounts of all entities controlled by the Company through its ownership of a majority voting interest and the accounts of any variable interest entities (VIEs) where the Company is subject to a majority of the risk of loss from the VIE's activities, or entitled to receive a majority of the entity's residual returns, or both. The Company assesses the requirements related to the consolidation of VIEs, including a qualitative assessment of power and economics that considers which entity has the power to direct the activities that “most significantly impact” the VIE's economic performance and has the obligation to absorb losses of, or the right to receive benefits that could be potentially significant to, the VIE. The Company's composition of VIEs was not material at June 30, 2018.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and do not include all of the disclosures normally required by U.S. GAAP or those normally required in annual reports on Form 10-K. Accordingly, these financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the year ended December 31, 2017 filed with the U.S. Securities and Exchange Commission (the SEC) on Form 10-K on March 16, 2018.

 

Certain prior year disclosure amounts have been reclassified to conform to current period presentation.  Restricted cash had previously been included in restricted cash and investments in marketable securities.  As a result of recently adopted accounting pronouncements, discussed below, restricted cash will be presented separately on the Company’s consolidated balance sheets.  The

provision for losses on accounts receivable has been combined with other operating expenses and general and administrative costs, on the consolidated statement of operations.  See Note 4 – “Net Revenues and Accounts Receivable.”

 

Financial Condition and Liquidity Considerations

 

The accompanying consolidated financial statements have been prepared on the basis the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.

 

In evaluating the Company’s ability to continue as a going concern, management considered the conditions and events that could raise substantial doubt about the Company’s ability to continue as a going concern for 12 months following the date the Company’s financial statements were issued (August 9, 2018). Management considered the recent results of operations as well as the Company’s current financial condition and liquidity sources, including current funds available, forecasted future cash flows and the Company’s conditional and unconditional obligations due before August 9, 2019.  Based upon such considerations, management determined that the Company is able to continue as a going concern for 12 months following the date of issuance of these financial statements (August 9, 2018).

 

The Company’s results of operations have been negatively impacted by the persistent pressure of healthcare reforms enacted in recent years.  This challenging operating environment has been most acute in the Company’s inpatient segment, but also has had a detrimental effect on the Company’s rehabilitation therapy segment and its customers.  In recent years, the Company has implemented a number of cost mitigation strategies to offset the negative financial implications of this challenging operating environment.  These strategies have been successful in recent years, however, the negative impact of continued reductions in skilled patient admissions, shortening lengths of stay, escalating wage inflation and professional liability losses, combined with the increased cost of capital through escalating lease payments accelerated in 2017. 

 

In response to these issues, the Company entered into a number of agreements, amendments and new financing facilities (the Restructuring Transactions) during the six months ended June 30, 2018.  See Note 3 – “Significant Transactions and Events – Restructuring Transactions.”  In total, these agreements and amendments are estimated to reduce the Company’s annual cash fixed charges by approximately $62.0 million beginning January 1, 2018.  The new financing agreements provided $70.0 million of additional cash and borrowing availability, increasing the Company’s liquidity and financial flexibility.  In connection with the Restructuring Transactions, the Company entered into a new asset based lending facility agreement, replacing its prior revolving credit facilities (the Revolving Credit Facilities) and eliminating its forbearance agreement.  Also in connection with the Restructuring Transactions, the Company amended the financial covenants in all of its material loan agreements and all but two of its material master leases.  Financial covenants beginning in 2018 were amended to account for changes in the Company’s capital structure as a result of the Restructuring Transactions and to account for the current business climate.  The Company received waivers from the counterparties to two of its material master leases, for which agreements to amend financial covenants were not attained, with respect to compliance with financial covenants. 

 

Recently Adopted Accounting Pronouncements

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers and all related amendments (ASC 606), which serves to supersede most existing revenue recognition guidance, including guidance specific to the healthcare industry. ASC 606 provides a principles-based framework for recognizing revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services and requires enhanced disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The Company adopted ASC 606 effective January 1, 2018 using the modified retrospective transition method.  There was no cumulative effect on the opening balance of accumulated deficit as a result of adopting the standard as of January 1, 2018.  Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. See Note 4 – “Net Revenues and Accounts Receivable.”

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01), which is intended to improve the recognition and measurement of financial instruments. The new guidance requires equity investments be measured at fair value with changes in fair value recognized in net income; simplifies the impairment assessment of equity investments without readily determinable fair values; eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value; and requires separate presentation of financial assets and financial liabilities by measurement category.  The Company adopted the new guidance effective January 1, 2018.  The adoption of ASU 2016-01 did not have a material impact on the Company’s consolidated financial condition and results of operations.

 

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15), which addresses how certain cash receipts and cash payments should be presented and classified in the statement of cash flows. The Company adopted the new guidance effective January 1, 2018.  Upon assessment of the cash flow issues subject to amendment, the adoption of  ASU 2016-15 did not have a material impact on the Company’s consolidated statements of cash flows.

 

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (230): Restricted Cash (ASU 2016-18), which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows.  The Company adopted the new guidance effective January 1, 2018.  To better accommodate the adoption of  ASU 2016-18, the Company has elected to separately disclose restricted cash on its consolidated balance sheets for all periods presented. The adoption of  ASU 2016-18 did not have a material impact on the Company’s consolidated statements of cash flows.

 

In January 2017, the FASB issued ASU No. 2017-01, Business Combination (805): Clarifying the Definition of a Business (ASU 2017-01), which provides guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The Company adopted the new guidance effective January 1, 2018.  The Company does not expect the adoption of ASU 2017-01 to have a material impact on its consolidated financial condition and results of operations.

 

Recently Issued Accounting Pronouncements

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02), which amended authoritative guidance on accounting for leases. The new provisions require that a lessee of operating leases recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The lease liability will be equal to the present value of lease payments, with the right-of-use asset based upon the lease liability. The classification criteria for distinguishing between finance (or capital) leases and operating leases are substantially similar to the previous lease guidance, but with no explicit bright lines. As such, operating leases will result in straight-line rent expense similar to current practice. For short term leases (term of 12 months or less), a lessee is permitted to make an accounting election not to recognize lease assets and lease liabilities, which would generally result in lease expense being recognized on a straight-line basis over the lease term. The guidance is effective for annual and interim periods beginning after December 15, 2018, and will require application of the new guidance at the beginning of the earliest comparable period presented. Early adoption is permitted. ASU 2016-02 must be adopted using a modified retrospective approach, which includes a number of optional practical expedients. The adoption of ASU 2016-02 is expected to have a material impact on the Company’s financial position as a result of the recognition of the right-of-use assets and liabilities associated with operating leases as well as the impact of those assets and liabilities currently accounted for as financing obligations. The Company has established a cross-functional implementation team and is currently reviewing all lease agreements and service contracts which may contain an embedded lease.  The Company has begun to design

changes to existing processes in conjunction with its review of lease agreements.  The Company will adopt the new lease standard effective January 1, 2019 and expects to elect certain available transitional practical expedients.

 

In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which permits entities to reclassify the disproportionate income tax effects of the Tax Cuts and Jobs Act (Tax Reform Act) on items within accumulated other comprehensive income (loss) to retained earnings. These disproportionate income tax effect items are referred to as "stranded tax effects."  Amendments in this update only relate to the reclassification of the income tax effects of the Tax Reform Act.  Other accounting guidance that requires the effect of changes in tax laws or rates to be included in net income from continuing operations is not affected by this update.  ASU 2018-02 is effective for the Company beginning January 1, 2019 and should be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Reform Act is recognized.  The adoption of ASU 2018-02 will not have a material impact on the Company’s consolidated financial statements.

 

In March 2018, the FASB issued ASU 2018-05, Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118.  The amendments in this update provide guidance on when to record and disclose provisional amounts for certain income tax effects of the Tax Reform Act.  The amendments also require any provisional amounts or subsequent adjustments to be included in net income from continuing operations.  Additionally, this ASU discusses required disclosures that an entity must make with regard to the Tax Reform Act.  This ASU is effective immediately as new information is available to adjust provisional amounts that were previously recorded.  The Company has adopted this standard as of January 1, 2018 and will continue to evaluate indicators that may give rise to a change in its tax provision as a result of the Tax Reform Act.

 

(2)   Certain Significant Risks and Uncertainties

 

Revenue Sources

 

The Company receives revenues from Medicare, Medicaid, private insurance, self-pay residents, other third-party payors and long-term care facilities that utilize its rehabilitation therapy and other services.  The Company’s inpatient services segment derives approximately 78% of its revenue from Medicare and various state Medicaid programs.  The following table depicts the Company’s inpatient services segment revenue by source for the three and six months ended June 30, 2018 and 2017.

 

 

The sources and amounts of the Company’s revenues are determined by a number of factors, including licensed bed capacity and occupancy rates of inpatient facilities, the mix of patients and the rates of reimbursement among payors.  Likewise, payment for ancillary medical services, including services provided by the Company’s rehabilitation therapy services business, varies based upon the type of payor and payment methodologies.  Changes in the case mix of the patients as well as payor mix among Medicare, Medicaid and private pay can significantly affect the Company’s profitability.

 

It is not possible to quantify fully the effect of legislative changes, the interpretation or administration of such legislation or other governmental initiatives on the Company’s business and the business of the customers served by the Company’s rehabilitation therapy business.  The potential impact of reforms to the United States healthcare system, including potential material changes to the delivery of healthcare services and the reimbursement paid for such services by the government or other third party payors, is uncertain at this time.  Also, initiatives among managed care payors, conveners and referring acute care hospital systems to reduce

lengths of stay and avoidable hospital admissions and to divert referrals to home health or other community-based care settings could have a continuing adverse impact on the Company’s business. Accordingly, there can be no assurance that the impact of any future healthcare legislation, regulation or actions by participants in the health care continuum will not adversely affect the Company’s business.  There can be no assurance that payments under governmental and private third-party payor programs will be timely, will remain at levels similar to present levels or will, in the future, be sufficient to cover the costs allocable to patients eligible for reimbursement pursuant to such programs.  The Company’s financial condition and results of operations are and will continue to be affected by the reimbursement process, which in the healthcare industry is complex and can involve lengthy delays between the time that revenue is recognized and the time that reimbursement amounts are settled.

 

Laws and regulations governing the Medicare and Medicaid programs, and the Company’s business generally, are complex and are often subject to a number of ambiguities in their application and interpretation. The Company believes that it is in substantial compliance with all applicable laws and regulations.  However, from time to time the Company and its affiliates are subject to pending or threatened lawsuits and investigations involving allegations of potential wrongdoing, some of which may be material or involve significant costs to resolve and/or defend, or may lead to other adverse effects on the Company and its affiliates including, but not limited to, fines, penalties and exclusion from participation in the Medicare and/or Medicaid programs.

 

Concentration of Credit Risk

 

The Company is exposed to the credit risk of its third-party customers, many of whom are in similar lines of business as the Company and are exposed to the same systemic industry risks of operations as the Company, resulting in a concentration of risk.  These include organizations that utilize the Company’s rehabilitation services, staffing services and physician service offerings, engaged in similar business activities or having economic features that would cause their ability to meet contractual obligations, including those to the Company, to be similarly affected by changes in regulatory and systemic industry conditions. 

 

Management assesses its exposure to loss on accounts at the customer level.  The greatest concentration of risk exists in the Company’s rehabilitation services business where it has over 200 distinct customers, many being chain operators with more than one location.  The four largest customers of the Company’s rehabilitation services business comprise $62.1 million, approximately 54%, of the net outstanding contract receivables in the rehabilitation services business at June 30, 2018.  One customer, which is a related party of the Company, comprises $36.5 million, approximately 32%, of the net outstanding contract receivables in the rehabilitation services business at June 30, 2018.  See Note 16 – “Related Party Transactions.”    An adverse event impacting the solvency of several of these large customers resulting in their insolvency or other economic distress would have a material impact on the Company. 

 

The Company’s business is subject to a number of other known and unknown risks and uncertainties, which are discussed in Part II. Item 1A, “Risk Factors” of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017, which was filed with the SEC on March 16, 2018, and in the Company’s Quarterly Reports on Form 10-Q, including the risk factors discussed herein in Part II. Item 1A.

 

Covenant Compliance

 

Should the Company fail to comply with its debt and lease covenants at a future measurement date, it could, absent necessary and timely waivers and/or amendments, be in default under certain of its existing debt and lease agreements. To the extent any cross-default provisions may apply, the default could have an even more significant impact on the Company’s financial position.

 

Although the Company is in compliance and projects to be in compliance with its material debt and lease covenants, the ongoing uncertainty related to the impact of healthcare reform initiatives may have an adverse impact on the Company’s ability to remain in compliance with its covenants. Such uncertainty includes changes in reimbursement patterns, patient admission patterns, bundled payment arrangements, as well as potential changes to the Patient Protection and Affordable Care Act of 2010 currently being considered in Congress, among others.

The Company’s ability to maintain compliance with its debt and lease covenants depends in part on management’s ability to increase revenue and control costs. Due to continuing changes in the healthcare industry, as well as the uncertainty with respect to changing referral patterns, patient mix, and reimbursement rates, it is possible that future operating performance may not generate sufficient operating results to maintain compliance with its quarterly debt and lease covenant compliance requirements.  Should the Company fail to comply with its debt and lease covenants at a future measurement date, it would, absent necessary and timely waivers and/or amendments, be in default under certain of its existing credit agreements.  To the extent any cross-default provisions may apply, the default would have an even more significant impact on the Company’s financial position.

 

There can be no assurance that the confluence of these and other factors will not impede the Company’s ability to meet its debt and lease covenants in the future.

 

(3)   Significant Transactions and Events

 

Restructuring Transactions

 

Overview

 

In the first quarter of 2018, the Company entered into a number of agreements, amendments and new financing facilities further described below in an effort to strengthen significantly its capital structure.  In total, the Restructuring Transactions are estimated to reduce the Company’s annual cash fixed charges by approximately $62.0 million beginning in 2018 and provided $70.0 million of additional cash and borrowing availability, increasing the Company’s liquidity and financial flexibility.

 

In connection with the Restructuring Transactions, the Company entered into a new asset based lending facility agreement, replacing its prior Revolving Credit Facilities, expanding its term loan borrowings, amending its real estate loans with Welltower Inc. (Welltower) while refinancing some of those loan amounts through new real estate loans.  The new asset based lending facility agreement and real estate loans are financed through MidCap Funding IV Trust and MidCap Financial Trust (collectively, MidCap), respectively.  For further information on these debt refinancings, see Note 8 – “Long-Term Debt.”  Also in connection with the Restructuring Transactions, the Company amended the financial covenants in all of its material loan agreements and all but two of its material master leases.  Financial covenants beginning in 2018 were amended to account for changes in the Company’s capital structure as a result of the Restructuring Transactions and to account for the current business climate. 

 

Welltower Master Lease Amendment

 

On February 21, 2018, the Company entered into a definitive agreement with Welltower to amend the Welltower Master Lease (the Welltower Master Lease Amendment).  The Welltower Master Lease Amendment reduces the Company’s annual base rent payment by $35.0 million effective retroactively as of January 1, 2018, reduces the annual rent escalator from approximately 2.9% to 2.5% on April 1, 2018 and further reduces the annual rent escalator to 2.0% beginning January 1, 2019.  In addition, the Welltower Master Lease Amendment extends the initial term of the master lease by five years to January 31, 2037 and extends the renewal term of the master lease by five years to December 31, 2048.  The Welltower Master Lease Amendment also provides a potential upward rent reset, conditioned upon achievement of certain upside operating metrics, effective January 1, 2023.  If triggered, the incremental rent from the rent reset is capped at $35.0 million.

 

Omnibus Agreement

 

On February 21, 2018, the Company entered into an Omnibus Agreement with Welltower and Omega Healthcare Investors, Inc. (Omega), pursuant to which Welltower and Omega committed to provide up to $40.0 million in new term loans and amend the current term loan agreement to, among other things, accommodate a refinancing of the Company’s existing asset based credit facility, in each case subject to certain conditions, including the completion of a restructuring of certain of the Company’s other material debt and lease obligations. 

 

The Omnibus Agreement also provides that upon satisfying certain conditions, including raising new capital that is used to pay down certain indebtedness owed to Welltower and Omega, (a) $50.0 million of outstanding indebtedness owed to Welltower will be written off and (b) the Company may request conversion of not more than $50.0 million of the outstanding balance of the Company’s Welltower Real Estate Loans into equity.  If the proposed equity conversion would result in any adverse REIT qualification, status or compliance consequences to Welltower, then the debt that would otherwise be converted to equity shall instead be converted into a loan incurring paid in kind interest at 2% per annum compounded quarterly, with a term of ten years commencing on the date the applicable conditions precedent to the equity conversion have been satisfied.  Moreover, the Company agreed to support Welltower in connection with the sale of certain of Welltower’s interests in facilities covered by the Welltower Master Lease, including negotiating and entering into definitive new master lease agreements with third party buyers.

 

In connection with the Omnibus Agreement, the Company agreed to issue warrants to Welltower and Omega to purchase 900,000 shares and 600,000 shares, respectively, of the Company’s Class A Common Stock at an exercise price equal to $1.33 per share.  Issuance of the warrant to Welltower is subject to the satisfaction of certain conditions.  The warrants may be exercised at any time during the period commencing six months from the date of issuance and ending five years from the date of issuance. 

 

Lease Transactions and Divestitures

 

Sabra Divestitures

 

On April 1, 2018, the Company divested five skilled nursing facilities.  All five of the skilled nursing facilities, three located in Massachusetts and two located in Kentucky, were terminated from their respective master lease agreements with Sabra Health Care REIT, Inc. (Sabra).  The five skilled nursing facilities generated annual revenues of $28.5 million and pre-tax net loss of $2.9 million.  On May 4, 2018, Sabra completed the sale and lease termination of one skilled nursing facility in California that had been closed in 2017.  The Company recognized a net gain on the write off of certain lease liabilities, offset by exit costs, of $0.7 million on the six skilled nursing facilities.

 

On June 1, 2018, Sabra completed the sale and lease termination of 12 skilled nursing facilities located in Florida and New Hampshire.  As a result of the sale, the Company will receive an annual rent credit of $12.0 million for the remainder of the lease term.  The Company continues to operate these facilities under a new lease with a new landlord, Next Healthcare. See Note 16 – “Related Party Transactions.”  As a result of the sale, the Company recognized accelerated depreciation expense of $6.0 million on the property and equipment sold and a gain on the write off of certain lease liabilities of $7.0 million.

 

On June 29, 2018, Sabra completed the sale and lease termination of eight skilled nursing facilities and one assisted/senior living facility located in seven different states.  As a result of the sale, the Company will receive an annual rent credit of $7.4 million for the remainder of the lease term.  The Company continues to operate these facilities under a lease agreement with a new landlord.  The new lease has a ten-year initial term, one five-year renewal option and initial annual rent of $7.4 million  As a result of the sale, the Company recognized accelerated depreciation expense of $3.6 million on the property and equipment sold and a gain on the write off of certain lease liabilities of $2.9 million.

 

Second Spring Divestitures

 

On June 1, 2018 and on June 13, 2018, Second Spring Healthcare Investments (Second Spring) completed the sale and lease termination of eight skilled nursing facilities located in Pennsylvania and four skilled nursing facilities located in New Jersey, respectively.  The combined 12 skilled nursing facilities generated annual revenues of $146.2 million and pre-tax net loss of $19.3 million.  As a result of the sale and lease termination, the Company recognized a capital lease net asset and obligation write-down of $16.8 million, a financing obligation net asset write-down of $113.3 million and a financing obligation write-down of $134.5 million.  The resulting gain of $21.2 million was offset by $6.3 million of exit costs.  In the three months ended June 30, 2018, there was accelerated depreciation expense of $5.3 million on the property and equipment sold.

 

Other Lease Amendments and Divestitures

 

For the six months ended June 30, 2018, the Company divested or amended the lease agreements to six other skilled nursing facilities. The lease agreement to one behavioral outpatient clinic expired on June 30, 2018.  As a result of these lease amendments and divestitures, the Company recognized a loss for exit costs and the write off of certain lease assets of $3.3 million.

 

In total for the six months ended June 30, 2018, the Company recorded a net gain on lease transactions and divestitures of $22.2 million which is included in other (income) loss on the consolidated statements of operations.

 

(4)   Net Revenues and Accounts Receivable

 

Revenue Streams

 

Inpatient Services

 

The Company generates revenues primarily by providing services to patients within its facilities. The Company uses interdisciplinary teams of experienced medical professionals to provide services prescribed by physicians. These teams include registered nurses, licensed practical nurses, certified nursing assistants and other professionals who provide individualized comprehensive nursing care. Many of the Company’s facilities are equipped to provide specialty care, such as on-site dialysis, ventilator care, cardiac and pulmonary management, as well as standard services, such as room and board, special nutritional programs, social services, recreational activities and related healthcare and other services. The Company assesses collectibility on all accounts prior to providing services.

 

Rehabilitation Therapy Services

 

The Company generates revenues by providing rehabilitation therapy services, including speech-language pathology, physical therapy, occupational therapy and respiratory therapy at its skilled nursing facilities and assisted/senior living facilities, as well as facilities of third-party skilled nursing operators and other outpatient settings.  The majority of revenues generated by rehabilitation therapy services rendered are billed to contracted third party providers.

 

Other Services

 

The Company generates revenues by providing an array of other specialty medical services, including physician services, staffing services, and other healthcare related services.

 

Revenue Recognition

 

The Company generates revenues, primarily by providing healthcare services to its customers. Revenues are recognized when control of the promised good or service is transferred to our customers, in an amount that reflects the consideration the Company expects to be entitled from patients, third-party payers (including government programs and insurers) and others, in exchange for those goods and services. 

 

Performance obligations are determined based on the nature of the services provided.  The majority of the Company’s healthcare services represent a bundle of services that are not capable of being distinct and as such, are treated as a single performance obligation satisfied over time as services are rendered.  The Company also provides certain ancillary services which are not included in the bundle of services, and as such, are treated as separate performance obligations satisfied at a point in time, if and when, those services are rendered.

 

The Company determines the transaction price based on contractually agreed-upon amounts or rates, adjusted for estimates of variable consideration, such as implicit price concessions.  The Company utilizes the expected value method to determine the

amount of variable consideration that should be included to arrive at the transaction price, using contractual agreements and historical reimbursement experience within each payor type. Variable consideration also exists in the form of settlements with Medicare and Medicaid as a result of retroactive adjustments due to audits and reviews. The Company applies constraint to the transaction price, such that net revenues are recorded only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in the future. If actual amounts of consideration ultimately received differ from the Company’s estimates, the Company adjusts these estimates, which would affect net revenues in the period such variances become known.  Adjustments arising from a change in the transaction price were not significant for the three and six months ended June 30, 2018.

 

The Company has elected a practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component due to its expectation that the period between the time the service is provided and the time payment is received will be one year or less.

 

Adoption of ASC 606

 

The Company’s adoption of ASC 606 primarily impacts the presentation of revenues due to the inclusion of variable consideration in the form of implicit price concessions contained in certain of its contracts with customers.  Under ASC 606, amounts estimated to be uncollectable are generally considered implicit price concessions that are a direct reduction to net revenues. Prior to adoption of ASC 606, such amounts were classified as provision for losses on accounts receivable.  For the three and six months ended June 30, 2018, the Company recorded approximately $22.0 million and $46.8 million, respectively, of implicit price concessions as a direct reduction of net revenues that would have been recorded as operating expenses prior to the adoption of ASC 606.  The adoption of ASC 606 is not expected to have a material impact on net income on an ongoing basis. To the extent there are material subsequent events that affect the payor's ability to pay, such amounts are recorded within operating expenses. 

 

At June 30, 2018, the remaining balance of allowance for doubtful accounts previously disclosed on the consolidated balance sheets relating to accounts receivable with December 31, 2017 and prior service dates is $277.4 million.

 

The Company has reclassified the provision for losses on accounts receivable of $24.0 million and $47.5 million for the three and six months ended June 30, 2017, respectively, to other operating expenses in the consolidated statements of operations. These reclassifications had no effect on the reported results of operations.

 

Under ASC 606, the Company recognizes revenue in the statements of operations and contract assets on the consolidated balance sheets only when services have been provided.  Since the Company has performed its obligation under the contract, it has unconditional rights to the consideration recorded as contract assets and therefore classifies those billed and unbilled contract assets as accounts receivable.

 

Under ASC 606, payments that the Company receives from customers in advance of providing services represent contract liabilities.  Such payments primarily relate to private pay patients, which are billed monthly in advance.  The Company had no material contract liabilities or activity as of and for the three and six months ended June 30, 2018.

 

Disaggregation of Revenues

 

The Company disaggregates revenue from contracts with customers by reportable operating segments and payor type. The Company notes that disaggregation of revenue into these categories achieves the disclosure objectives to depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors.  The payment terms and conditions within the Company's revenue-generating contracts vary by contract type and payor source.  Payments are generally received within 30 to 60 days after billed.  See Note 6 – “Segment Information.”

 

The composition of net revenues by payor type and operating segment for the three and six months ended June 30, 2018 and 2017 are as follows (in thousands):

 

 

 

 

 

(5)Loss Per Share

 

The Company has three classes of common stock.  Classes A and B are identical in economic and voting interests.  Class C has a 1:1 voting ratio with the other two classes, representing the voting interests of the noncontrolling interest of the legacy FC-GEN Operations Investment, LLC (FC-GEN) owners. Class C common stock is a participating security; however, it shares in a de minimis economic interest and is therefore excluded from the denominator of the basic earnings (loss) per share (EPS) calculation.

 

Basic EPS was computed by dividing net loss by the weighted-average number of outstanding common shares for the period. Diluted EPS is computed by dividing net loss plus the effect of assumed conversions (if applicable) by the weighted-average number of outstanding common shares after giving effect to all potential dilutive common shares.

 

A reconciliation of the numerator and denominator used in the calculation of basic and diluted net loss per common share follows (in thousands, except per share data):

 

 

The following shares were excluded from the computation of diluted net loss per common share in the three and six months ended June 30, 2018 and 2017, as their inclusion would have been anti-dilutive (in thousands):

 

 

The combined impact of the assumed conversion to common stock and related tax implications attributable to the noncontrolling interest, the grants under the 2015 Omnibus Equity Incentive Plan, and the stock warrants are anti-dilutive to EPS because the Company is in a net loss position for the three and six months ended June 30, 2018. As of June 30, 2018, there were 59.7 million units attributable to the noncontrolling interests outstanding.