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Rating Action:

MOODY'S RATES BEVERLY ENTERPRISES' PROPOSED CREDIT FACILITIES Ba3 AND PLANNED SUBORDINATED NOTES ISSUE B2; OUTLOOK IS CHANGED TO NEGATIVE

19 Sep 2003
MOODY'S RATES BEVERLY ENTERPRISES' PROPOSED CREDIT FACILITIES Ba3 AND PLANNED SUBORDINATED NOTES ISSUE B2; OUTLOOK IS CHANGED TO NEGATIVE

Approximately $855 Million of Debt Securities Affected.

New York, September 19, 2003 -- Moody's Investors Service today assigned a rating of Ba3 to Beverly Enterprises, Inc.'s ("Beverly") proposed credit facilities and a B2 rating to its planned $100 million subordinated notes issue. At the same time, Moody's confirmed the existing ratings of the company and changed the outlook to negative.

Moody's is changing the outlook to negative to reflect the company's credit profile's reduced ability to absorb the impact of negative developments without a resulting ratings downgrade, given the deterioration following the Medicare cliff. Moody's also notes that the uncertainty surrounding the execution of Beverly's asset disposition program is a concern, since the company's ability to retain current ratings may be contingent upon its ability to delever through the program. While problems are not anticipated, they may nonetheless arise.

If Beverly successfully completes its asset sales, however, its credit statistics would likely improve to levels consistent with the period prior to October 2002. Just as important, we expect the company's exposure to patient care liability will be significantly reduced.

Ratings Assigned:

• $75 Million Senior Secured Credit Facility due 2007, rated Ba3

• $150 Million Term Loan B due 2008, rated Ba3

• $100 Million Subordinated Notes, rated B2 (subject to review of final terms and documentation)

Ratings Confirmed:

• $200 million 9.625% Senior Unsecured Notes due 2009, rated B1

• Senior Implied Rating at Ba3

Ratings Upgraded:

• Senior Unsecured Issuer Rating, upgraded to B1 ( consistent with the company's senior unsecured notes' ratings)

Ratings to be Withdrawn:

• $150 million Senior Revolving Credit Facility due 2004, rated Ba3

• $180 million 9% Senior Unsecured Notes due 2006, rated B1

While the ratings are being confirmed, there are significant concerns which limit the ratings on the company. These include the company's high leverage, its high reliance on, and the unpredictability of, government reimbursements, the continued surge in costs for patient care liability insurance and the continued pressure expected on wages and benefit expenses, particularly for nursing care due to the nationwide shortages. Two of the issues, cuts in Medicare rates and the jump in insurance expenses, recently combined to erode Beverly's operating earnings significantly.

Positive factors supporting the ratings include the anticipated improvement in leverage, management's relatively conservative approach to financial management and the company's focus on improving operations and reducing costs. Recently, operating trends within management's control have been stabilizing or improving. Examples include the increase in Medicare census, flat to slightly stronger occupancy rates, improving DSO metrics and stability in wages and related expenses as a percent of revenues. Further supporting the ratings is the better than expected 6.26% increase in Medicare rates set for the fiscal year beginning October 2003. The increase is expected to contribute over $30 million to the top line, and may signal greater government support for the industry.

The outlook for the company is negative because of the comparatively weak credit metrics and the uncertainty surrounding the execution of the asset disposition program. Should any adverse event occur in the near term, the ratings may be downgraded. One concern is that a higher than expected increase in insurance expenses could lead to a deterioration in the company's performance. In addition, should unexpected problems with the sale of assets develop, the company's plan to delever may be impacted. Over the near term, Moody's otherwise expects Beverly's operations to improve modestly. We anticipate that modest rate increases and management's continued focus on operations will support more consistent performance. Should the company perform as anticipated, successfully execute on its disposition program and lower leverage to anticipated levels, a change in the rating outlook may be warranted.

Beverly is entering the new credit facilities and plans to issue subordinated notes in order to replace its existing revolver and to refinance certain of its debt obligations, including its senior unsecured notes due 2006. The ratings on the credit facilities take into consideration the security package as well as the amount of secured debt in the capital structure. The rating on the subordinated notes reflects its contractual and effective subordination.

Following the refinancing, leverage at the company will remain mostly unchanged from June 2003 levels. Leverage (Debt/EBITDA) based on June 2003 LQA results was high in the low four times range, with adjusted leverage (for 8x rent) materially higher at the mid five times range. The figures compare unfavorably to 2001 and 2002 year-end metrics, with leverage then in the mid-to-high three times range and adjusted leverage near five times. However, Moody's expects the ratios to come down materially within the next 12 months, with leverage likely approaching low-to-mid three times, and adjusted leverage approaching high four times, as the company reduces debt with proceeds from the sale of assets. The credit statistics may continue to gradually improve going forward, as Moody's believes management is committed to strengthening its balance sheet and improving its credit profile. Ever since new management joined Beverly, the company has keenly focused on reducing debt, and has already reduced debt by about $300 million since year-end 2000.

Cash flow, which in the past has been volatile, remains an area of concern. Cash flow from operations for the near term is expected to be weak, with free cash flow negligible. This is, in part, due to the expected significant payments on accrued patient care liabilities in excess of new accruals. However, Moody's notes that this is a one-time issue related to the company disposal of certain troubled facilities (the company will have to make payments on claims arising in disposed facilities, but will no longer generate cash flow at such facilities). We expect the company's ability to generate cash flow on an ongoing basis to be adequate, with free cash flow to total debt in the high single digit range. We also expect Beverly's near term liquidity to be strong in spite of negligible free cash flow. The company had $135 million in cash as of June 30, 2003, and will have an undrawn $75 million revolver available following the refinancing. The company will also generate significant cash proceeds from asset sales over the near term.

In addition to generating cash and reducing leverage, one of the key benefits expected from the asset disposition is the significant reduction in exposure to patient liability insurance costs. In recent years, expenses have been climbing at high double-digit rates. By selectively selling certain homes with poor litigation track records or in states with litigious environment, the company will be able to reduce its expenses by about a half. The company is also anticipating that growth in expenses will decline going forward. However, Moody's is concerned that the litigation environment in the remaining facilities and states may deteriorate.

The reimbursement environment has been and will continue to be a challenge for the industry as well. Moody's, nonetheless, is optimistic that Beverly will see modest increases in rates. Medicare recently increased rates by 6.26%, including a 3.26% adjustment to correct forecast errors in data used to determine past market basket inflation updates. This may be an indication that the government is more willing to address the industry's concern over Medicare reimbursements. Medicaid rates for the company have also been increasing, although it may come under increase pressure as state governments continue to experience mounting deficits.

Beverly Enterprises, Inc., headquartered in Fort Smith, Arkansas, is a leading provider of post-acute healthcare in the United States, operating 456 facilities in 26 states and Washington D.C.

New York
Patrick Finnegan
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
William K. Lee
Associate Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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