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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-14057
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KINDRED HEALTHCARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 61-1323993
(State or other (I.R.S.
jurisdiction Employer Identification
of incorporation or Number)
organization)
680 South Fourth Street
Louisville, Kentucky 40202-2412
(Address of principal (Zip Code)
executive offices)
(502) 596-7300
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange on
Title of Each Class which Registered
------------------- -----------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.25 per share
Series A Warrants to Purchase Common Stock
Series B Warrants to Purchase Common Stock
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K ((S)229.405 of this chapter) is not contained herein, and
will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment of this Form 10-K. [_]
As of January 31, 2002, there were 17,682,917 shares of the Registrant's
common stock, $0.25 par value, outstanding. The aggregate market value of the
shares of the Registrant held by non-affiliates of the Registrant, based on the
closing price of such stock on the NASDAQ on January 31, 2002, was
approximately $467,996,000. For purposes of the foregoing calculation only, all
directors and executive officers of the Registrant have been deemed affiliates.
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [X] No [_]
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Shareholders to be held on April 16, 2002 are incorporated by reference into
Part III of this Form 10-K.
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TABLE OF CONTENTS
Page
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PART I
Item 1. Business............................................................................. 3
Item 2. Properties........................................................................... 37
Item 3. Legal Proceedings.................................................................... 38
Item 4. Submission of Matters to a Vote of Security Holders.................................. 40
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................ 43
Item 6. Selected Financial Data.............................................................. 44
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 45
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................... 66
Item 8. Financial Statements and Supplementary Data.......................................... 66
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. 67
PART III
Item 10. Directors and Executive Officers of the Registrant................................... 67
Item 11. Executive Compensation............................................................... 67
Item 12. Security Ownership of Certain Beneficial Owners and Management....................... 67
Item 13. Certain Relationships and Related Transactions....................................... 67
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................... 68
2
PART I
Item 1. Business
GENERAL
Kindred Healthcare, Inc. provides long-term healthcare services primarily
through the operation of nursing centers and hospitals. At December 31, 2001,
our health services division operated 305 nursing centers (39,293 licensed
beds) in 32 states and a rehabilitation therapy business. Our hospital division
operated 57 hospitals (4,961 licensed beds) in 23 states and an institutional
pharmacy business. All references in this Annual Report on Form 10-K to
"Kindred," "our company," "we," "us," or "our" mean Kindred Healthcare, Inc.
and, unless the context otherwise requires, its consolidated subsidiaries.
On April 20, 2001 (the "Effective Date"), we and our subsidiaries emerged
from proceedings under Chapter 11 of Title 11 of the United States Code (the
"Bankruptcy Code") pursuant to the terms of our Fourth Amended Joint Plan of
Reorganization (the "Plan of Reorganization"). On March 1, 2001, the United
States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court")
approved our Plan of Reorganization. In connection with our emergence, we
changed our name to Kindred Healthcare, Inc.
Since filing for protection under the Bankruptcy Code on September 13, 1999,
we operated our businesses as a debtor-in-possession subject to the
jurisdiction of the Bankruptcy Court. Accordingly, our consolidated financial
statements have been prepared in accordance with the American Institute of
Certified Public Accountants Statement of Position ("SOP") 90-7, "Financial
Reporting by Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7")
and generally accepted accounting principles applicable to a going concern,
which assume that assets will be realized and liabilities will be discharged in
the normal course of business.
In connection with our emergence from bankruptcy, we reflected the terms of
the Plan of Reorganization in our consolidated financial statements by adopting
the fresh-start accounting provisions of SOP 90-7. Under fresh-start
accounting, a new reporting entity is deemed to be created and the recorded
amounts of assets and liabilities are adjusted to reflect their estimated fair
values. For accounting purposes, the fresh-start adjustments have been recorded
in the consolidated financial statements as of April 1, 2001. Since fresh-start
accounting materially changed the amounts previously recorded in our
consolidated financial statements, a black line separates the post-emergence
financial data from the pre-emergence data to signify the difference in the
basis of preparation of the financial statements for each respective entity.
As used in this Form 10-K, the term "Predecessor Company" refers to us and
our operations for periods prior to April 1, 2001, while the term "Reorganized
Company" is used to describe us and our operations for periods thereafter.
On May 1, 1998, Ventas, Inc. ("Ventas") (formerly known as Vencor, Inc.)
completed the spin-off of its healthcare operations to its stockholders through
the distribution of our former common stock (the "Spin-off"). Ventas retained
ownership of substantially all of its real property and leases such real
property to us. In anticipation of the Spin-off, we were incorporated on March
27, 1998 as a Delaware corporation. For accounting purposes, the consolidated
historical financial statements of Ventas became our historical financial
statements following the Spin-off. Any discussion concerning events prior to
May 1, 1998 refers to our businesses as they were conducted by Ventas prior to
the Spin-off.
On September 28, 1995, The Hillhaven Corporation ("Hillhaven") merged into
us. On March 21, 1997, we acquired TheraTx, Incorporated ("TheraTx"), a
provider of rehabilitation and respiratory therapy program management services
to nursing centers and an operator of 26 nursing centers. On June 24, 1997, we
acquired a controlling interest in Transitional Hospitals Corporation
("Transitional"), an operator of 19 long-term acute care hospitals located in
13 states. We completed the merger of our wholly owned subsidiary into
Transitional on August 26, 1997.
3
This Annual Report on Form 10-K includes forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. See
"-Cautionary Statements."
HEALTHCARE OPERATIONS
We are organized into two operating divisions: the health services division,
which provides long-term care services by operating nursing centers and a
rehabilitation therapy business and the hospital division, which provides
long-term acute care services to medically complex patients by operating
hospitals and an institutional pharmacy business. We believe that the
independent focus of each division on the unique aspects and quality concerns
of its business enhances its ability to attract patients, improve operations
and achieve cost containment objectives.
HEALTH SERVICES DIVISION
Our health services division provides quality, cost-effective long-term care
through the operation of a national network of 305 nursing centers (39,293
licensed beds) located in 32 states and a rehabilitation therapy business as of
December 31, 2001. Through our nursing centers, we provide residents with
long-term care services, a full range of pharmacy, medical and clinical
services and routine services, including daily dietary, social and recreational
services. We also provide rehabilitation services, including physical,
occupational and speech therapies to our residents as well as to residents in
nursing facilities operated by other parties.
In addition, at more than 80 of our nursing centers, we offer specialized
programs for patients suffering from Alzheimer's disease. Within these nursing
centers, we provide quality care to these patients by dedicating to them
separate units run by teams of professionals that specialize in the unique
problems experienced by Alzheimer's patients. We believe that we are a leading
provider of nursing care to patients with Alzheimer's disease, based on the
specialization and size of our program for caring for these patients.
We monitor and enhance the quality of care at our nursing centers through
the use of quality assurance and performance improvement committees as well as
family satisfaction surveys. Our quality assurance and performance improvement
committees oversee patient healthcare needs and patient and staff safety.
Physicians serve on these committees as medical directors and advise on
healthcare policies and practices. We conduct surveys of patients' families
periodically and these surveys are reviewed by our performance improvement
committees at each facility to promote quality patient care. Substantially all
of our nursing centers are certified to provide services under Medicare and
Medicaid programs. Our nursing centers have been certified because the quality
of our accommodations, equipment, services, safety, personnel, physical
environment and policies and procedures meet or exceed the standards of
certification set by those programs.
Health Services Division Strategy
Our goal is to become the provider of choice in the markets our health
services division serves, which we believe will allow us to increase our
patient census and enhance our payor mix. In addition, we have implemented
several initiatives to improve our profitability. To supplement these
internally-focused initiatives, we intend to expand selectively our operations
through development and acquisition activities. The principal elements of our
health services division strategy are:
Providing Quality, Clinical-Based Services. The health services division is
focused on qualitative and quantitative clinical performance indicators with
the goal of providing quality care under the cost containment objectives
imposed by government and private payors. In an effort to improve the quality
of the services we deliver, we intend to pursue an aggressive plan to:
. hire and retain quality healthcare personnel by becoming the employer of
choice in the industry,
. establish improved processes to monitor and promote our patient care
objectives,
4
. integrate clinical advice of our chief medical officer and other
physicians into our operational procedures, and
. develop and enhance our internal training programs.
Enhancing Sales and Marketing Programs. We conduct our nursing center
marketing efforts, which focus on the quality of care provided at our
facilities, at the local market level through our nursing center administrators
and admissions coordinators. The marketing efforts of our nursing center
personnel are supplemented by strategies provided by our regional marketing
staffs. In order to increase awareness of our services and the provision of
quality care, we intend to:
. direct a targeted marketing effort at the elderly population, which we
believe is the fastest growing segment in the United States and which
will, therefore, be the driving force behind the growth in our industry
in the coming years, and
. improve our relationships with local referral sources.
Increasing Operating Efficiency. The health services division continually
seeks to improve operating efficiency with a view to maintaining high-quality
care in an environment that demands an increasingly greater control of costs.
We believe that operating efficiency is critical in maintaining our position as
a leading provider of nursing center services in the United States. In our
effort to improve operating efficiency we have:
. centralized administrative functions such as accounting, payroll, legal,
reimbursement, compliance and human resources,
. developed an industry-leading management information system to aid in
financial reporting as well as billing and collecting, and
. focused our efforts to hire and retain quality personnel.
Managing Efficient Delivery of Ancillary Services. We are dedicated to
providing quality nursing services to the patients in our facilities while at
the same time optimizing our operating efficiency. We realigned and refocused
our ancillary services business in response to the decline in the demand for
ancillary services that followed the implementation of the prospective payment
system in 1998. Today, our nursing centers generally provide ancillary services
to their patients through the use of internal staff. We are continuing to
refine the delivery of ancillary services to external customers to maintain
profitability under the cost constraints of the prospective payment system.
Accordingly, over the past two years, the health services division has
terminated many unprofitable external ancillary services contracts and does not
intend to emphasize the marketing of ancillary services contracts to third
parties.
Expanding Selectively Through Acquisitions and Development Activities. We
believe that we are well positioned strategically and financially to pursue
opportunities to expand our business through acquisitions and development
activities on a selective basis. We will evaluate development opportunities to
expand our operations, either through acquiring or leasing individual or small
portfolios of nursing facilities in selected markets or by managing the
operations of third parties. We also will evaluate opportunities to acquire
companies with operations in attractive markets.
5
Selected Health Services Division Operating Data
The following table sets forth certain operating data for the health
services division after reflecting the realignment of the former ancillary
services business for all periods presented (dollars in thousands, except
statistics):
Reorganized |
Company | Predecessor Company
------------| ------------------------------------
Nine months | Three months
ended | ended Year ended December 31,
December 31,| March 31, -----------------------
2001 | 2001 2000 1999
------------| ------------ ----------- -----------
Nursing centers: |
Revenues.......................... $1,348,236 | $ 429,523 $ 1,675,627 $ 1,594,244
Operating income.................. $ 234,500 | $ 70,543 $ 278,738 $ 169,128
Facilities in operation at end of |
period: |
Owned or leased............... 282 | 278 278 282
Managed....................... 23 | 35 34 13
Licensed beds at end of period: |
Owned or leased............... 36,926 | 36,469 36,466 36,912
Managed....................... 2,367 | 3,861 3,723 1,661
Patient days (a).................. 8,583,270 | 2,804,982 11,580,295 11,656,439
Revenues per patient day (a)...... $ 157 | $ 153 $ 145 $ 137
Average daily census (a).......... 31,212 | 31,166 31,640 31,935
Occupancy % (a)................... 84.9 | 85.2 86.1 86.8
Rehabilitation services: |
Revenues.......................... $ 27,451 | $ 10,695 $ 135,036 $ 195,731
Operating income.................. $ 8,112 | $ 690 $ 8,047 $ 2,891
Other ancillary services: |
Revenues.......................... $ - | $ - $ - $ 43,527
Operating income.................. $ 508 | $ 250 $ 4,737 $ 4,166
- --------
(a) Excludes managed facilities.
The term "operating income" is defined as earnings before interest, income
taxes, depreciation, amortization, rent, corporate overhead, unusual
transactions and reorganization items. The term "licensed beds" refers to the
maximum number of beds permitted in the facility under its license regardless
of whether the beds are actually available for patient care. "Patient days"
refers to the total number of days of patient care provided for the periods
indicated. "Average daily census" is computed by dividing each facility's
patient days by the number of calendar days the respective facility is in
operation. "Occupancy %" is computed by dividing average daily census by the
number of licensed beds, adjusted for the length of time each facility was in
operation during each respective period.
Total assets of the health services division were $393 million and $495
million at the end of 2001 and 2000, respectively.
Sources of Nursing Center Revenues
Nursing center revenues are derived principally from Medicare and Medicaid
programs and from private payment patients. Consistent with the nursing center
industry, changes in the mix of the health services division's patient
population among these three categories significantly affect the profitability
of its operations. Although Medicare and higher acuity patients generally
produce the most revenue per patient day, profitability with respect to higher
acuity patients is reduced by the costs associated with the higher level of
nursing care and other services generally required by such patients. We believe
that private payment patients generally constitute the most profitable category
and Medicaid patients generally constitute the least profitable category.
6
The following table sets forth the approximate percentages of nursing center
patient days and revenues derived from the payor sources indicated:
Medicare Medicaid Private and Other
--------------- --------------- ----------------
Patient Patient Patient
Period Days Revenues Days Revenues Days Revenues
- ------ ------- -------- ------- -------- ------- --------
Nine months ended December 31, 2001 14% 32% 67% 47% 19% 21%
Three months ended March 31, 2001.. 15 31 66 47 19 22
Year ended December 31,
2000............................ 13 28 67 49 20 23
1999............................ 12 26 66 49 22 25
For the nine months ended December 31, 2001 and the three months ended March
31, 2001, revenues of the health services division totaled approximately $1.4
billion or 58% and $440 million or 57%, respectively, of our total revenues
(before eliminations).
Both governmental and private third-party payors employ cost containment
measures designed to limit payments made to healthcare providers. Those
measures include the adoption of initial and continuing recipient eligibility
criteria which may limit payment for services, the adoption of coverage
criteria which limit the services that will be reimbursed and the establishment
of payment ceilings which set the maximum reimbursement that a provider may
receive for services. Furthermore, government reimbursement programs are
subject to statutory and regulatory changes, retroactive rate adjustments,
administrative rulings and government funding restrictions, all of which may
materially increase or decrease the rate of program payments to the health
services division for its services.
Medicare. The Medicare Part A program provides reimbursement for extended
care services furnished to Medicare beneficiaries who are admitted to nursing
centers after at least a three-day stay in an acute care hospital. Covered
services include supervised nursing care, room and board, social services,
physical and occupational therapies, pharmaceuticals, supplies and other
necessary services provided by nursing centers.
The Balanced Budget Act of 1997 (the "Balanced Budget Act") established a
prospective payment system ("PPS") for nursing centers for cost reporting
periods beginning on or after July 1, 1998. Prior to the implementation of PPS,
nursing centers were reimbursed by Medicare based on the facility-specific,
reasonable direct and indirect costs of services provided to their patients.
All of our nursing centers adopted PPS on July 1, 1998. The payments received
under PPS cover all services for Medicare patients including all ancillary
services, such as respiratory therapy, physical therapy, occupational therapy,
speech therapy and certain covered pharmaceuticals.
Medicaid. Medicaid is a state-administered program financed by state funds
and matching federal funds. The program provides for medical assistance to the
indigent and certain other eligible persons. Although administered under broad
federal regulations, states are given flexibility to construct programs and
payment methods consistent with their individual goals. Accordingly, these
programs differ in many respects from state to state.
The health services division provides to eligible individuals
Medicaid-covered services consisting of nursing care, room and board and social
services. In addition, states may at their option cover other services such as
physical, occupational and speech therapies and pharmaceuticals. Prior to the
Balanced Budget Act, federal law, generally referred to as the "Boren
Amendment," required Medicaid programs to pay rates that were reasonable and
adequate to meet the costs incurred by an efficiently and economically operated
nursing center providing quality care and services in conformity with all
applicable laws and regulations. Despite the federal requirements,
disagreements frequently arose between nursing centers and states regarding the
adequacy of Medicaid rates. By repealing the Boren Amendment, the Balanced
Budget Act eased the restrictions on the states' ability to reduce their
Medicaid reimbursement levels for such services. In addition, Medicaid programs
are subject to statutory
7
and regulatory changes, administrative rulings, interpretations of policy by
the state agencies and certain government funding limitations, all of which may
materially increase or decrease the level of program payments to nursing
centers operated by the health services division. We believe that the payments
under many of these programs may not be sufficient on an overall basis to cover
the costs of serving certain patients participating in these programs.
Furthermore, the Omnibus Budget Reconciliation Act of 1987, as amended,
mandates an increased emphasis on ensuring quality patient care, which has
resulted in additional expenditures by nursing centers.
Private Payment. The health services division seeks to maximize the number
of private payment patients admitted to its nursing centers, including those
covered under private insurance and managed care health plans. Private payment
patients typically have financial resources (including insurance coverage) to
pay for their monthly services and do not rely on government programs for
support.
We cannot assure you that payments under governmental and private
third-party payor programs will remain at levels comparable to present levels
or will be sufficient to cover the costs allocable to patients eligible for
reimbursement pursuant to such programs. In addition, we cannot assure you that
facilities operated by the health services division, or the provision of
services and supplies by the health services division, will meet the
requirements for participation in such programs. We could be adversely affected
by the continuing efforts of governmental and private third-party payors to
contain the cost of healthcare services. See "-Cautionary Statements."
8
Nursing Center Facilities
The following table lists by state the number of nursing centers and related
licensed beds owned by us or leased from Ventas and other third parties as of
December 31, 2001:
Number of Facilities
------------------------------------------------
Licensed Owned by Leased from Leased from
State Beds Us Ventas (2) Other Parties Managed Total
----- -------- -------- ----------- ------------- ------- -----
Alabama (1)....... 777 - 3 1 2 6
Arizona........... 1,393 - 6 - 6 12
California........ 2,262 4 11 3 1 19
Colorado.......... 695 - 4 1 - 5
Connecticut (1)... 983 - 8 - - 8
Florida (1)....... 2,473 2 15 1 - 18
Georgia (1)....... 1,211 1 5 3 - 9
Idaho............. 880 1 8 - - 9
Indiana........... 4,947 - 14 14 6 34
Kentucky (1)...... 2,076 1 12 4 - 17
Louisiana (1)..... 305 - - 1 1 2
Maine (1)......... 775 - 10 - - 10
Massachusetts (1). 4,181 - 31 3 3 37
Mississippi (1)... 125 - - 1 - 1
Missouri (1)...... 400 - - 3 - 3
Montana (1)....... 446 - 2 1 - 3
Nebraska (1)...... 163 - 1 - - 1
Nevada (1)........ 180 - 2 - - 2
New Hampshire (1). 622 - 3 - 1 4
North Carolina (1) 2,764 - 19 4 - 23
Ohio (1).......... 2,005 - 11 4 - 15
Oregon (1)........ 254 - 2 - - 2
Pennsylvania...... 200 - 1 1 - 2
Rhode Island (1).. 201 - 2 - - 2
Tennessee (1)..... 2,669 - 4 12 - 16
Texas............. 737 - 1 2 1 4
Utah.............. 848 - 5 1 1 7
Vermont (1)....... 310 - 1 - 1 2
Virginia (1)...... 629 - 4 - - 4
Washington (1).... 1,012 1 9 - - 10
Wisconsin (1)..... 2,319 - 12 2 - 14
Wyoming........... 451 - 4 - - 4
------ -- --- -- -- ---
Totals......... 39,293 10 210 62 23 305
====== == === == == ===
- --------
(1) These states have Certificate of Need regulations. See "-Governmental
Regulation-Federal, State and Local Regulation."
(2) See "-Master Lease Agreements."
Health Services Division Management and Operations
Each of our nursing centers is managed by a state-licensed administrator who
is supported by other professional personnel, including a director of nursing,
staff development professional (responsible for employee training), activities
director, social services director, business office manager and, in general,
physical, occupational and speech therapists. The directors of nursing are
state-licensed nurses who supervise our nursing staffs that include registered
nurses, licensed practical nurses and nursing assistants. Staff size and
composition
9
vary depending on the size and occupancy of each nursing center and on the type
of care provided by the nursing center. The nursing centers contract with
physicians who provide medical director services and serve on quality assurance
committees. We provide our facilities with centralized information systems,
human resources management, state and federal reimbursement assistance, state
licensing and certification maintenance, legal, finance and accounting support
and purchasing and facilities management. The centralization of these services
improves efficiency and permits facility staff to focus on the delivery of high
quality nursing services.
Our health services division is managed by a divisional president and a
chief financial officer. Our nursing center operations are divided into four
geographic regions, each of which is headed by an operational vice president.
These four operational vice presidents report to the divisional president. The
clinical issues and quality concerns of the health services division are
managed by the division's chief medical officer and vice president of clinical
operations. District and/or regional staff in the areas of nursing, dietary and
rehabilitation services, state and federal reimbursement, human resources
management, maintenance, sales and financial services supports the health
services division. Regional and district nursing professionals visit each
nursing center periodically to review practices and, where necessary, recommend
improvements in the level of care provided.
Quality Assessment and Improvement
Quality of care is monitored and enhanced by quality assurance or
performance improvement committees and family satisfaction surveys. These
committees oversee patient healthcare needs and patient and staff safety.
Additionally, physicians serve on these committees as medical directors and
advise on healthcare policies and practices. Regional and district nursing
professionals visit each nursing center periodically to review practices and
recommend improvements where necessary in the level of care provided and to
assure compliance with requirements under applicable Medicare and Medicaid
regulations. Surveys of patients' families are conducted from time to time in
which the families are asked to rate various aspects of service and the
physical condition of the nursing centers. These surveys are reviewed by
performance improvement committees at each facility to promote quality patient
care.
The health services division provides training programs for nursing center
administrators, managers, nurses and nursing assistants. These programs are
designed to maintain high levels of quality patient care.
Substantially all of the nursing centers currently are certified to provide
services under Medicare and Medicaid programs. A nursing center's qualification
to participate in such programs depends upon many factors, such as
accommodations, equipment, services, safety, personnel, physical environment
and adequate policies and procedures.
Health Services Division Competition
Our nursing centers compete with other nursing centers and similar long-term
care facilities primarily on the basis of quality of care, reputation, their
location and physical appearance and, in the case of private patients, the
charges for our services. Some competitors are located in buildings that are
newer than those operated by us and may provide services that we do not offer.
Our nursing centers compete on a local and regional basis with other nursing
centers as well as with facilities providing similar services, including
hospitals, extended care centers, assisted living facilities, home health
agencies and similar institutions. The industry includes government-owned,
religious organization-owned, secular not-for-profit and for-profit
institutions. Many of these competitors have greater financial and other
resources than we do. Although there is limited, if any, price competition with
respect to Medicare and Medicaid patients (since revenues received for services
provided to such patients are based generally on fixed rates), there is
significant competition for private payment patients.
In addition, our health services division competes in the fragmented and
highly competitive ancillary services markets. Many nursing centers are
developing internal staff to provide these services, particularly in response
to the implementation of PPS. The primary competitive factors for the ancillary
services markets are quality of services, charges for services and
responsiveness to the needs of patients and families, and the facilities in
which the services are provided.
10
HOSPITAL DIVISION
Our hospital division primarily provides long-term acute care services to
medically complex patients through the operation of a national network of 57
hospitals (which includes four hospitals certified as general acute care
hospitals) with 4,961 licensed beds located in 23 states as of December 31,
2001. We opened our first long-term acute care hospital in 1985 and today
operate the largest network of long-term acute care hospitals in the United
States based on revenues. As a result of our commitment to the long-term acute
care business, we have developed a comprehensive program of care for medically
complex patients which allows us to deliver quality care in a cost-effective
manner. In addition, the hospital division operates an institutional pharmacy
business, which focuses on providing a full array of institutional pharmacy
services to nursing centers and specialized care centers, including the nursing
centers we operate.
In addition to our long-term acute care hospitals, the hospital division
operates four hospitals licensed as general acute care hospitals. A number of
the hospital division's long-term acute care hospitals also provide outpatient
services. General acute care and outpatient services may include inpatient
services, diagnostic services, CT scanning, one-day surgery, laboratory, X-ray,
respiratory therapy, cardiology and physical therapy.
In our hospitals, we treat medically complex patients who suffer from
multiple systemic failures or conditions such as neurological disorders, head
injuries, brain stem and spinal cord trauma, cerebral vascular accidents,
chemical brain injuries, central nervous system disorders, developmental
anomalies and cardiopulmonary disorders. In particular, we have a core
competency in treating patients with pulmonary disorders. Medically complex
patients often are dependent on technology, such as mechanical ventilators,
total parental nutrition, respiratory or cardiac monitors and dialysis
machines, for continued life support. Approximately 50% of our medically
complex patients are ventilator-dependent for some period of time during their
hospitalization. During 2001, the average length of stay for patients in our
long-term acute care hospitals was approximately 37 days. Although the hospital
division's patients range in age from pediatric to geriatric, approximately 70%
of these patients are over 65 years of age.
Our hospital division patients have conditions which require a high level of
monitoring and specialized care, yet may not need the services of a traditional
intensive care unit. Due to their severe medical conditions, these patients
generally are not clinically appropriate for admission to a nursing center and
their medical conditions are periodically or chronically unstable. By combining
selected general acute care services with the ability to care for medically
complex patients, we believe that our long-term acute care hospitals provide
their patients with high quality, cost-effective care.
Our long-term acute care hospitals employ a comprehensive program of care
for their medically complex patients which draws upon the talents of
interdisciplinary teams, including physician specialists. The teams evaluate
medically complex patients upon admission to determine treatment programs. Our
hospital division has developed specialized treatment programs focused on the
needs of medically complex patients. Where appropriate, the treatment programs
may involve the services of several disciplines, such as pulmonary medicine,
infectious disease and physical medicine. In our treatment programs, we
emphasize individual attention to patients.
Hospital Division Strategy
Our goal is to remain a leading operator of long-term acute care hospitals
in terms of both quality of care and operating efficiency. Our strategies for
achieving this goal include:
Maintaining High Quality of Care. The hospital division differentiates its
hospitals through its ability to care for medically complex patients in a
high-quality, cost-effective setting. We are committed to maintaining and
improving the quality of our patient care by dedicating appropriate resources
to each facility and refining our clinical initiatives. In this regard, we have
taken the following measures to improve and maintain the quality of care at our
hospitals:
. Established an integrated quality assessment and improvement program,
administered by a quality review manager, which encompasses utilization
review, quality improvement, infection control and risk management.
11
. Developed and implemented a patient classification system called
CustomCare that is designed to ensure that patients receive the
necessary level of care. This model allows the hospital division to
monitor employee skill mix and manage labor costs.
. Maintained a strategic outcomes program, which includes a concurrent
review of all of our patient population against utilization and quality
screenings, as well as quality of life outcomes data collection and
patient and family satisfaction surveys.
. Implemented a program whereby our hospitals are reviewed by internal
quality auditors for compliance with standards of the Joint Commission
on Accreditation of Health Care Organizations.
. Committed to attracting the highest quality of professional staff within
each market. The hospital division believes that its future success will
depend in part upon its continued ability to hire and retain qualified
healthcare personnel.
. Incorporated the clinical advice of our chief clinical officer, medical
advisory board and other physicians into our operational procedures.
Improving Operating Efficiency. The hospital division is continually
focused on improving operating efficiency and controlling costs while
maintaining quality patient care. Our hospital division seeks to improve
operating efficiencies and control costs by standardizing operations and
optimizing the skill mix of its staff based on the hospital's occupancy and the
clinical needs of its patients. The initiatives we have undertaken to control
our costs and improve efficiency include:
. managing pharmacy costs through adherence to formularies and utilization
management and leveraging drug costs through participation in a group
purchasing organization,
. managing labor costs by adjusting staffing to patient acuity and
fluctuations in census,
. centralizing administrative functions such as accounting, payroll,
legal, reimbursement, compliance and human resources, and
. utilizing industry-leading management information technology to aid in
financial reporting as well as billing and collecting.
Growing Through Business Development and Acquisitions. Our growth strategy
is focused on the development and expansion of our services:
. Hospital-in-Hospital. We look to partner with non-Kindred hospitals in
order to operate 30 to 40 long-term acute care hospital beds within the
partner hospital. Under such arrangements, we would lease space and
purchase ancillary services from our partners and provide them with the
option to discharge their clinically appropriate patients into our care.
. Pulmonary Units. We seek to operate 20 to 30 bed specialty pulmonary
care units within non-Kindred hospitals in attractive markets. Under
such arrangements we would lease space and purchase ancillary services
from our partners. We believe that such arrangements will serve as
bridges to broader hospital-in-hospital opportunities and relationships
within these markets. Since our reorganization, we have opened two new
pulmonary units covering a total of 46 beds.
. Free-standing Hospitals. We seek to add free-standing hospitals in
certain strategic markets. We opened a new free-standing hospital in Las
Vegas, Nevada which contains approximately 90 beds, in December 2001.
. Growing Through Acquisitions. We seek growth opportunities through
strategic acquisitions in selected target markets.
12
Expanding Breadth of Industry Leadership. We are the leading provider of
long-term acute care to patients with pulmonary dysfunction. In addition, we
deliver other services in areas such as wound care, surgery, acute
rehabilitation and pain management. We intend to broaden our expertise beyond
pulmonary services and to leverage our leadership position in pulmonary care to
expand our market strength to other clinical services.
Increasing Higher Margin Commercial Volume. We typically receive higher
reimbursement rates from commercial insurers than we do from the Medicare and
Medicaid programs. As a result, we work to expand relationships with insurers
to increase commercial patient volume. Each of our hospitals employs case
managers who focus on the patient intake and referral process.
Improving Relationships with Referring Providers. Substantially all of the
acute and medically complex patients admitted to our hospitals are transferred
to us by other healthcare providers such as general acute care hospitals,
intensive care units, managed care programs, physicians, nursing centers and
home care settings. Accordingly, we are focused on maintaining strong
relationships with these providers. In order to maintain these relationships,
we employ case managers who are responsible for coordinating admissions and
assessing the nature of services necessary for the proper care of the patient.
Case managers also are responsible for educating healthcare professionals from
referral sources as to the unique nature of the services provided by our
long-term acute care hospitals. Specifically, case managers train and educate
the staffs of referring institutions about long-term acute care hospital
services and the types of patients who could benefit from such services.
Selected Hospital Division Operating Data
The following table sets forth certain operating data for the hospital
division after reflecting the realignment of the former ancillary services
business for all periods presented (dollars in thousands, except statistics):
Reorganized |
Company | Predecessor Company
------------ | ------------------------------------
Nine months | Three months
ended | ended Year ended December 31,
December 31, | March 31, -----------------------
2001 | 2001 2000 1999
------------ | ------------ ---------- --------
Hospitals: |
Revenues................................. $822,935 | $271,984 $1,007,947 $850,548
Operating income......................... $157,613 | $ 54,778 $ 205,858 $132,050
Facilities in operation at end of period. 57 | 56 56 56
Licensed beds at end of period........... 4,961 | 4,867 4,886 4,931
Patient days............................. 802,425 | 273,029 1,044,663 982,301
Revenues per patient day................. $ 1,026 | $ 996 $ 965 $ 866
Average daily census..................... 2,918 | 3,034 2,854 2,691
Occupancy %.............................. 62.6 | 65.3 60.8 56.9
Pharmacy: |
Revenues................................. $176,105 | $ 54,880 $ 204,252 $171,493
Operating income......................... $ 20,831 | $ 6,176 $ 7,421 $ 342
Total assets of the hospital division were $497 million and $354 million at
the end of 2001 and 2000, respectively.
Sources of Hospital Revenues
The hospital division receives payment for its hospital services from
third-party payors, including government reimbursement programs such as
Medicare and Medicaid and non-government sources such as commercial insurance
companies, health maintenance organizations, preferred provider organizations
and contracted providers. Patients covered by non-government payors generally
will be more profitable to the
13
hospital division than those covered by the Medicare and Medicaid programs. The
following table sets forth the approximate percentages of the hospital patient
days and revenues derived from the payor sources indicated:
Medicare Medicaid Private and Other
--------------- --------------- ----------------
Patient Patient Patient
Period Days Revenues Days Revenues Days Revenues
- ------ ------- -------- ------- -------- ------- --------
Nine months ended December 31, 2001 67% 57% 13% 9% 20% 34%
Three months ended March 31, 2001.. 68 56 13 11 19 33
Year ended December 31,
2000............................ 67 55 13 10 20 35
1999............................ 68 58 12 11 20 31
For the nine months ended December 31, 2001 and the three months ended March
31, 2001, revenues of the hospital division totaled approximately $1 billion or
42% and $327 million or 43%, respectively, of our total revenues (before
eliminations). Changes caused by the Balanced Budget Act have reduced Medicare
payments made to the hospital division related to incentive payments under the
Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), allowable costs for
capital expenditures and bad debts, and payments for services to patients
transferred from a general acute care hospital. See "-Governmental
Regulation-Regulatory Changes" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Hospital Facilities
The following table lists by state the number of hospitals and related
licensed beds owned by us or leased from Ventas and other third parties as of
December 31, 2001:
Number of Facilities
----------------------------------------
Licensed Owned by Leased from Leased from
State Beds Us Ventas (2) Other Parties Total
----- -------- -------- ----------- ------------- -----
Arizona........... 109 - 2 - 2
California........ 543 2 6 - 8
Colorado.......... 68 - 1 - 1
Florida (1)....... 536 - 6 1 7
Georgia (1)....... 72 - - 1 1
Illinois (1)...... 545 - 4 1 5
Indiana........... 167 - 2 1 3
Kentucky (1)...... 374 - 1 - 1
Louisiana......... 168 - 1 - 1
Massachusetts (1). 86 - 2 - 2
Michigan (1)...... 400 - 2 - 2
Minnesota......... 92 - 1 - 1
Missouri (1)...... 227 - 2 - 2
Nevada (1)........ 144 1 1 - 2
New Mexico........ 61 - 1 - 1
North Carolina (1) 124 - 1 - 1
Oklahoma.......... 59 - 1 - 1
Pennsylvania...... 115 - 2 - 2
Tennessee (1)..... 49 - 1 - 1
Texas............. 716 2 6 2 10
Virginia (1)...... 164 - 1 - 1
Washington (1).... 80 1 - - 1
Wisconsin......... 62 1 - - 1
----- - -- - --
Totals......... 4,961 7 44 6 57
===== = == = ==
- --------
(1) These states have Certificate of Need regulations. See "-Governmental
Regulation-Federal, State and Local Regulation."
(2) See "-Master Lease Agreements."
14
Quality Assessment and Improvement
The hospital division maintains a strategic outcome program which includes a
centralized pre-admission evaluation program and concurrent review of all of
its patient population against utilization and quality screenings, as well as
clinical outcomes data collection and patient and family satisfaction surveys.
In addition, each hospital has an integrated quality assessment and improvement
program administered by a quality review manager which encompasses utilization
review, quality improvement, infection control and risk management. The
objective of these programs is to ensure that patients are admitted
appropriately to our hospitals and that quality healthcare is provided in a
cost-effective manner.
The hospital division has implemented a program whereby its hospitals are
reviewed by internal quality auditors for compliance with standards of the
Joint Commission on Accreditation of Health Care Organizations. The purposes of
this internal review process are to (a) ensure ongoing compliance with industry
recognized standards for hospitals, (b) assist management in analyzing each
hospital's operations and (c) provide consulting and educational programs for
each hospital to identify opportunities to improve patient care.
Hospital Division Management and Operations
Each of our hospitals has a fully credentialed, multi-specialty medical
staff to meet the needs of the medically complex, long-term acute patient. Each
of our hospitals offers a broad range of physician services including,
pulmonology, internal medicine, infectious diseases, neurology, nephrology,
cardiology, radiology and pathology. In addition, each of our hospitals is
staffed with a multi-disciplinary team of healthcare professionals including: a
professional nursing staff trained to care for long-term acute patients,
respiratory, physical, occupational and speech therapists; pharmacists;
registered dietitians; and social workers.
Substantially all of the acute and medically complex patients admitted to
our hospitals are transferred from other healthcare providers. Patients are
referred from general acute care hospitals, nursing centers and home care
settings. Referral sources include physicians, discharge planners, case
managers of managed care plans, social workers, third-party administrators,
health maintenance organizations and insurance companies. The hospital division
employs case managers who are primarily responsible for coordinating admissions
and assessing the nature of services necessary for the proper care of the
patient. Case managers also are responsible for educating healthcare
professionals from referral sources as to the unique nature of the services
provided by our long-term acute care hospitals. Specifically, case managers
train and educate the staffs of referring institutions about long-term acute
care hospital services and the types of patients who could benefit from such
services.
Each hospital maintains a pre-admission assessment system to evaluate
clinical needs and other information in determining the appropriateness of each
patient referral. Upon admission, each patient's case is reviewed by the
hospital's interdisciplinary team to determine treatment programs. Where
appropriate, the treatment programs may involve the services of several
disciplines, such as pulmonary medicine, infectious disease and physical
medicine.
A hospital chief executive officer supervises and is responsible for the
day-to-day operations at each of our hospitals. Each hospital also employs a
chief financial officer who monitors the financial matters of each hospital,
including the measurement of actual operating results compared to budgets. In
addition, each hospital employs a chief operating officer to oversee the
clinical operations of the hospital and a quality assurance manager to direct
an integrated quality assurance program. We provide centralized services in the
areas of information systems design and development, training, human resources
management, reimbursement expertise, legal advice, technical accounting support
and purchasing and facilities management to each of our hospitals. We believe
that this centralization improves efficiency and allows hospital staff to spend
more time on patient care.
A divisional president and a chief financial officer manage the hospital
division. The operations of the hospitals are divided into three geographic
regions with each region headed by an operational vice president,
15
each of whom reports to the divisional president. Institutional pharmacy
operations also are managed by a vice president who reports to the divisional
president. The clinical issues and quality concerns of the hospital division
are managed by the division's chief clinical officer. Our corporate
headquarters also provides services in the areas of information systems design
and development, training, human resources management, reimbursement expertise,
legal advice, technical accounting support, purchasing and facilities
management.
Hospital Division Competition
As of December 31, 2001, the hospitals operated by the hospital division
were located in 42 geographic markets in 23 states. In each geographic market,
there are general acute care hospitals which provide services comparable to
those offered by our hospitals. In addition, the hospital division believes
that as of December 31, 2001 there were approximately 300 hospitals in the
United States certified by Medicare as general long-term hospitals, some of
which provide similar services to those provided by the hospital division.
Certain competing hospitals are operated by not-for-profit, nontaxpaying or
governmental agencies, which can finance capital expenditures on a tax-exempt
basis, and which receive funds and charitable contributions unavailable to the
hospital division.
Competition for patients covered by non-government reimbursement sources is
intense. The primary competitive factors in the long-term acute care business
include quality of services, charges for services and responsiveness to the
needs of patients, families, payors and physicians. Other companies have
entered the long-term acute care market with licensed hospitals that compete
with our hospitals. The competitive position of any hospital also is affected
by the ability of its management to negotiate contracts with purchasers of
group healthcare services, including private employers, managed care companies,
preferred provider organizations and health maintenance organizations. Such
organizations attempt to obtain discounts from established hospital charges.
The importance of obtaining contracts with preferred provider organizations,
health maintenance organizations and other organizations which finance
healthcare, and its effect on a hospital's competitive position, vary from
market to market, depending on the number and market strength of such
organizations.
OUR REORGANIZATION
As a result of decreased Medicare and Medicaid reimbursement rates
introduced by the Balanced Budget Act and other issues associated with our
company, we were unable to meet our then existing financial obligations,
including rent payable to Ventas and debt service obligations under our then
existing indebtedness. Accordingly, on September 13, 1999, we filed voluntary
petitions for protection under Chapter 11 of the Bankruptcy Code. From the date
of our bankruptcy filing until we emerged from bankruptcy on April 20, 2001, we
operated our businesses as a "debtor-in-possession" subject to the jurisdiction
of the Bankruptcy Court. On March 1, 2001, the Bankruptcy Court approved our
Plan of Reorganization. See note 2 of the notes to consolidated financial
statements.
Pursuant to our Plan of Reorganization, on the Effective Date of the Plan of
Reorganization:
. we issued to certain claimholders, including senior creditors and Ventas,
in exchange for their claims:
. an aggregate of $300 million of senior secured notes, bearing
interest at the London Interbank Offered Rate (as defined in the
agreement) plus 4 1/2%, which began accruing interest approximately
two quarters after the Effective Date,
. an aggregate of 15,000,000 shares of our common stock,
. an aggregate of 2,000,000 Series A warrants, and
. an aggregate of 5,000,000 Series B warrants,
. we entered into a new $120 million revolving credit facility to
provide us with working capital and to be used for other general
corporate purposes,
16
. we entered into amended and restated Master Lease Agreements (as
defined below) with Ventas covering 210 of the nursing centers and 44
of the hospitals that we operate,
. we entered into a registration rights agreement with Ventas and each
holder of 10% or more of our common stock following the exchange
described above, providing such holders with certain shelf, demand
and "piggy-back" registration rights, and
. our then existing senior indebtedness and debt and equity securities
were canceled.
As a result of the exchange described above, the holders of certain claims
acquired control of our company and the holders of our pre-reorganization
common stock relinquished control.
In addition, in connection with our emergence from bankruptcy:
. we changed our name to Kindred Healthcare, Inc.,
. a new board of directors, including representatives of the principal
security holders following the exchange, was appointed, and
. effective April 1, 2001, we adopted fresh-start accounting in
accordance with SOP 90-7. This has resulted in the creation of a new
reporting entity for financial accounting reporting purposes and a
revaluation of our assets and liabilities to reflect their estimated
fair values. Because of the adoption of fresh-start accounting,
amounts previously recorded in our historical financial statements
have changed materially. As a result, our financial statements for
periods after our emergence from bankruptcy are not comparable in all
respects to our financial statements for periods prior to the
reorganization.
MASTER LEASE AGREEMENTS
Under our Plan of Reorganization, we assumed our original master lease
agreements with Ventas and its affiliates and simultaneously amended and
restated the agreements into four new master leases, which we refer to as the
"Master Lease Agreements." The following summary description of the Master
Lease Agreements is qualified in its entirety by reference to the Master Lease
Agreements, as filed with the Securities and Exchange Commission.
Term and Renewals
Each Master Lease Agreement includes land, buildings, structures and other
improvements on the land, easements and similar appurtenances to the land and
improvements, and permanently affixed equipment, machinery and other fixtures
relating to the operation of the leased properties. There are several bundles
of leased properties under each Master Lease Agreement, with each bundle
containing approximately 7 to 12 leased properties. Each bundle contains both
nursing centers and hospitals. All leased properties within a bundle have base
terms ranging from 10 to 15 years beginning from May 1, 1998, subject to
certain exceptions.
At our option, all, but not less than all, of the leased properties in a
bundle may be extended for one five-year renewal term beyond the base term at
the then existing rental rate plus the then existing escalation amount per
annum. We may further extend for two additional five-year renewal terms beyond
the first renewal term at the greater of the then existing rental rate plus the
then existing escalation amount per annum or the then fair market value rental
rate. The rental rate during the first renewal term and any additional renewal
term in which rent due is based on the then existing rental rate will escalate
each year during such term(s) at the applicable escalation rate.
We may not extend the Master Lease Agreements beyond the base term or any
previously exercised renewal term if, at the time we seek such extension and at
the time such extension takes effect, (1) an event of default has
17
occurred and is continuing or (2) a Medicare/Medicaid event of default (as
described below) and/or a licensed bed event of default (as described below)
has occurred and is continuing with respect to three or more leased properties
subject to a particular Master Lease Agreement. The base term and renewal term
of each Master Lease Agreement are subject to termination upon default by us
(subject to certain exceptions) and certain other conditions described in the
Master Lease Agreements.
Rental Amounts and Escalators
Each Master Lease Agreement is commonly known as a triple-net lease or an
absolute-net lease. Accordingly, in addition to rent, we are required to pay
the following: (1) all insurance required in connection with the leased
properties and the business conducted on the leased properties, (2) all taxes
levied on or with respect to the leased properties (other than taxes on the net
income of Ventas) and (3) all utilities and other services necessary or
appropriate for the leased properties and the business conducted on the leased
properties.
Under each Master Lease Agreement, the aggregate annual rent is referred to
as base rent. Base rent equals the sum of current rent and accrued rent. We are
obligated to pay the portion of base rent that is current rent, and unpaid
accrued rent will be paid as set forth below.
From the effective date of the Master Lease Agreements through April 30,
2004, base rent will equal the current rent. Under the Master Lease Agreements,
the annual aggregate base rent owed by us currently is $180.7 million. For the
period from May 1, 2001 through April 30, 2004, annual aggregate base rent
payable in cash will escalate at an annual rate of 3 1/2% over the prior period
base rent if certain revenue parameters are obtained. The Company paid rents to
Ventas approximating $135.6 million for the nine months ended December 31,
2001, $45.4 million for the three months ended March 31, 2001, $181.6 million
for 2000 and $191.2 million for 1999.
Each Master Lease Agreement also provides that beginning May 1, 2004, the
annual aggregate base rent payable in cash will escalate at an annual rate of
2% (plus, upon the occurrence of certain events, an additional annual accrued
escalator amount of 1 1/2% of the prior period base rent) which will accrete
from year to year including an interest accrual at the London Interbank Offered
Rate plus 4 1/2% to be added to the annual accreted amount. This interest will
not be added to the aggregate base rent in subsequent years.
The unpaid accrued rent will become payable upon the refinancing of our
existing credit agreements or the termination or expiration of the applicable
Master Lease Agreement.
Reset Rights
During the one-year period commencing in July 2006, Ventas will have a
one-time option to reset the base rent, current rent and accrued rent under
each Master Lease Agreement to the then fair market rental of the leased
properties. Upon exercising this reset right, Ventas will pay us a fee equal to
a prorated portion of $5 million based upon the proportion of base rent payable
under the Master Lease Agreement(s) with respect to which rent is reset to the
total base rent payable under all of the Master Lease Agreements. The
determination of the fair market rental will be effectuated through the
appraisal procedures in the Master Lease Agreements.
Use of the Leased Property
The Master Lease Agreements require that we utilize the leased properties
solely for the provision of healthcare services and related uses and as Ventas
may otherwise consent. We are responsible for maintaining or causing to be
maintained all licenses, certificates and permits necessary for the leased
properties to comply with various healthcare regulations. We also are obligated
to operate continuously each leased property as a provider of healthcare
services.
18
Events of Default
Under each Master Lease Agreement, an "Event of Default" will be deemed to
occur if, among other things:
. we fail to pay rent or other amounts within five days after notice,
. we fail to comply with covenants, which failure continues for 30 days
or, so long as diligent efforts to cure such failure are being made,
such longer period (not over 180 days) as is necessary to cure such
failure,
. certain bankruptcy or insolvency events occur, including filing a
petition of bankruptcy or a petition for reorganization under the
Bankruptcy Code,
. an event of default arising from our failure to pay principal or
interest on our senior secured notes or any other indebtedness exceeding
$50 million,
. the maturity of the senior secured notes or any other indebtedness
exceeding $50 million is accelerated,
. we cease to operate any leased property as a provider of healthcare
services for a period of 30 days,
. a default occurs under any guaranty of any lease or the indemnity
agreements with Ventas,
. we or our subtenant lose any required healthcare license, permit or
approval or fail to comply with any legal requirements as determined by
a final unappealable determination,
. we fail to maintain insurance,
. we create or allow to remain certain liens,
. we breach any material representation or warranty,
. a reduction occurs in the number of licensed beds in a facility,
generally in excess of 10% (or less than 10% if we have voluntarily
"banked" licensed beds) of the number of licensed beds in the applicable
facility on the commencement date (a "licensed bed event of default"),
. Medicare or Medicaid certification with respect to a participating
facility is revoked and re-certification does not occur for 120 days
(plus an additional 60 days in certain circumstances) (a
"Medicare/Medicaid event of default"),
. we become subject to regulatory sanctions as determined by a final
unappealable determination and fail to cure such regulatory sanctions
within its specified cure period for any facility, we fail to cure a
breach of any permitted encumbrance within the applicable cure period
and, as a result, a real property interest or other beneficial property
right of Ventas is at material risk of being terminated, or
. we fail to cure the breach of any of the obligations of Ventas as lessee
under any existing ground lease within the applicable cure period and,
if such breach is a non-monetary, non-material breach, such existing
ground lease is at material risk of being terminated.
Remedies for an Event of Default
Except as noted below, upon an Event of Default under one of the Master
Lease Agreements, Ventas may, at its option, exercise the following remedies:
(1) after not less than ten days' notice to us, terminate the Master Lease
Agreement to which such Event of Default relates, repossess any leased
property, relet any leased property to a third party and require that we pay to
Ventas, as liquidated damages, the net present value of the rent for the
balance of the term, discounted at the prime rate,
(2) without terminating the Master Lease Agreement to which such Event of
Default relates, repossess the leased property and relet the leased property
with us remaining liable under such Master Lease Agreement for all
19
obligations to be performed by us thereunder, including the difference, if any,
between the rent under such Master Lease Agreement and the rent payable as a
result of the reletting of the leased property, and
(3) seek any and all other rights and remedies available under law or in
equity.
In addition to the remedies noted above, under the Master Lease Agreements,
in the case of a facility-specific event of default Ventas may terminate a
Master Lease Agreement as to the leased property to which the Event of Default
relates, and may, but need not, terminate the entire Master Lease Agreement.
Each of the Master Lease Agreements includes special rules relative to
Medicare/Medicaid events of default and licensed bed events of default. In the
event a Medicare/Medicaid event of default and/or a licensed bed event of
default occurs and is continuing (a) with respect to not more than two
properties at the same time under a Master Lease Agreement that covers 41 or
more properties and (b) with respect to not more than one property at the same
time under a Master Lease Agreement that covers 21 to and including 40
properties, Ventas may not exercise termination or dispossession remedies
against any property other than the property or properties to which the event
of default relates. Thus, in the event Medicare/Medicaid events of default and
licensed bed events of default would occur and be continuing (a) with respect
to one property under a Master Lease Agreement that covers less than 20
properties, (b) with respect to two or more properties at the same time under a
Master Lease Agreement that covers 21 to and including 40 properties, or (c)
with respect to three or more properties at the same time under a Master Lease
Agreement that covers 41 or more properties, then Ventas would be entitled to
exercise all rights and remedies available to it under the Master Lease
Agreements.
Assignment and Subletting
Except as noted below, the Master Lease Agreements provide that we may not
assign, sublease or otherwise transfer any leased property or any portion of a
leased property as a whole (or in substantial part), including by virtue of a
change of control, without the consent of Ventas, which may not be unreasonably
withheld if the proposed assignee (1) is a creditworthy entity with sufficient
financial stability to satisfy its obligations under the related Master Lease
Agreement, (2) has not less than four years experience in operating healthcare
facilities, (3) has a favorable business and operational reputation and
character and (4) has all licenses, permits, approvals and authorizations to
operate the facility and agrees to comply with the use restrictions in the
related Master Lease Agreement. The obligation of Ventas to consent to a
subletting or assignment is subject to the reasonable approval rights of any
mortgagee and/or the lenders under its credit agreement. We may sublease up to
20% of each leased property for restaurants, gift shops and other stores or
services customarily found in hospitals or nursing centers without the consent
of Ventas, subject, however, to there being no material alteration in the
character of the leased property or in the nature of the business conducted on
such leased property.
In addition, each Master Lease Agreement allows us to assign or sublease (a)
without the consent of Ventas, 10% of the nursing center facilities in each
Master Lease Agreement and (b) with Ventas' consent (which consent will not be
unreasonably withheld, delayed or conditioned), two hospitals in each Master
Lease Agreement, if either (i) the applicable regulatory authorities have
threatened to revoke an authorization necessary to operate such leased property
or (ii) we cannot profitably operate such leased property. Any such proposed
assignee/sublessee must satisfy the requirements listed above and it must have
all licenses, permits, approvals and other authorizations required to operate
the leased properties in accordance with the applicable permitted use. With
respect to any assignment or sublease made under this provision, Ventas agrees
to execute a nondisturbance and attornment agreement with such proposed
assignee or subtenant. Upon any assignment or subletting, we will not be
released from our obligations under the applicable Master Lease Agreement.
Subject to certain exclusions, we must pay to Ventas 80% of any
consideration received by us on account of an assignment and 80% (50% in the
case of existing subleases) of sublease rent payments (roughly equal to revenue
net of specified allowed expenses attributable to a sublease, and specifically
defined in the Master Lease Agreements), provided that Ventas' right to such
payments will be subordinate to that of our lenders.
20
Ventas will have the right to approve the purchaser at a foreclosure of one
or more of our leasehold mortgages by our lenders. Such approval will not be
unreasonably withheld so long as such purchaser is creditworthy, reputable and
has four years experience in operating healthcare facilities. Any dispute
regarding whether Ventas has unreasonably withheld its consent to such
purchaser will be subject to expedited arbitration.
Under the Master Lease Agreements, Ventas has a right to sever properties
from the existing leases in order to create additional leases, a device adopted
to facilitate its financing flexibility. In such circumstances, our aggregate
lease obligations remain unchanged. Ventas exercised this severance right with
respect to Master Lease Agreement No. 1 to create a new lease of 40 nursing
centers (the "CMBS Lease") and mortgaged these properties in connection with a
securitized mortgage financing. The CMBS Lease is in substantially the same
form as the other Master Lease Agreements with certain modifications requested
by Ventas' lender and required to be made by us pursuant to the Master Lease
Agreements. The transaction closed on December 12, 2001.
GOVERNMENTAL REGULATION
Medicare and Medicaid
Medicare is a federal program that provides certain hospital and medical
insurance benefits to persons age 65 and over and certain disabled persons.
Medicaid is a medical assistance program administered by each state pursuant to
which healthcare benefits are available to certain indigent patients. Within
the Medicare and Medicaid statutory framework, there are substantial areas
subject to administrative rulings, interpretations and discretion that may
affect payments made under Medicare and Medicaid. A substantial portion of our
revenues are derived from patients covered by the Medicare and Medicaid
programs. See "-Health Services Division-Sources of Nursing Center Revenues"
and "-Hospital Division-Sources of Hospital Revenues."
Federal, State and Local Regulation
In the ordinary course of our business, we are subject regularly to
inquiries, investigations and audits by federal and state agencies that oversee
applicable healthcare regulations.
The extensive federal, state and local regulations affecting the healthcare
industry include, but are not limited to, regulations relating to licensure,
conduct of operations, ownership of facilities, addition of facilities,
allowable costs, services and prices for services. In addition, various laws
including antikickback, antifraud and abuse amendments codified under the
Social Security Act prohibit certain business practices and relationships that
might affect the provision and cost of healthcare services reimbursable under
Medicare and Medicaid, including the payment or receipt of remuneration for the
referral of patients whose care will be paid by Medicare or other governmental
programs. Sanctions for violating these antikickback amendments include
criminal penalties and civil sanctions, including fines and possible exclusion
from government programs such as the Medicare and Medicaid programs. The U.S.
Department of Health and Human Services has issued regulations that describe
some of the conduct and business relationships permissible under the
antikickback amendments. The fact that a given business arrangement does not
fall within one of these safe harbors does not render the arrangement per se
illegal. Business arrangements of healthcare service providers that fail to
satisfy the applicable criteria, however, risk increased scrutiny and possible
sanctions by enforcement authorities.
In addition, Section 1877 of the Social Security Act, which restricts
referrals by physicians of Medicare and other government-program patients to
providers of a broad range of designated health services with which they have
ownership or certain other financial arrangements, was amended effective
January 1, 1995, to broaden significantly the scope of prohibited physician
referrals under the Medicare and Medicaid programs. Many states have adopted or
are considering similar legislative proposals, some of which extend beyond the
Medicaid program, to prohibit the payment or receipt of remuneration for the
referral of patients and physician self-referrals regardless of the source of
payment for the care. These laws and regulations are complex and limited
21
judicial or regulatory interpretation exists. We do not believe our
arrangements are in violation of these prohibitions. We cannot assure you,
however, that governmental officials charged with responsibility for enforcing
the provisions of these prohibitions will not assert that one or more of our
arrangements are in violation of such provisions.
The Balanced Budget Act also includes a number of antifraud and abuse
provisions. The Balanced Budget Act contains additional civil monetary
penalties for violations of the antikickback amendments discussed above and
imposes an affirmative duty on providers to ensure that they do not employ or
contract with persons excluded from the Medicare program. The Balanced Budget
Act also provides a minimum ten-year period for exclusion from participation in
federal healthcare programs for persons or entities convicted of a prior
healthcare offense.
The Federal Health Insurance Portability and Accountability Act of 1996,
commonly known as "HIPAA," signed into law on August 21, 1996, amended, among
other things, Title XI of the U.S. Code (42 U.S.C. (S)1301 et seq.) to broaden
the scope of fraud and abuse laws to include all health plans, whether or not
they are reimbursed under federal programs. In addition, HIPAA also mandates
the adoption of regulations aimed at standardizing transaction formats and
billing codes for documenting medical services, dealing with claims submissions
and protecting the privacy and security of individually identifiable health
information. HIPAA regulations that standardize transactions and code sets
became final in the fourth quarter of 2000. These regulations do not require
healthcare providers to submit claims electronically, but require standard
formatting for those that do. We currently submit our claims electronically and
will continue to do so. We will be required to comply with HIPAA transaction
and code set standards by October 2003.
Final HIPAA privacy regulations were published in December 2000. These
privacy regulations apply to "protected health information," which is defined
generally as individually identifiable health information transmitted or
maintained in any form or medium, excluding certain education records and
student medical records. The privacy regulations seek to limit the use and
disclosure of most paper and oral communications, as well as those in
electronic form, regarding an individual's past, present or future physical or
mental health or condition, or relating to the provision of healthcare to the
individual or payment for that healthcare, if the individual can or may be
identified by such information. HIPAA provides for the imposition of civil or
criminal penalties if protected health information is improperly disclosed. We
must comply with the privacy regulations by April 2003.
HIPAA's security regulations have not yet been finalized. The proposed
security regulations specify administrative procedures, physical safeguards and
technical services and mechanisms designed to ensure the privacy of protected
health information. We will be required to comply with the security regulations
26 months after the regulations become final.
We are currently evaluating the impact of compliance with HIPAA regulations,
but we have not completed our analysis or finalized the estimated costs of
compliance. We cannot assure you that our compliance with the HIPAA regulations
will not have an adverse affect on our financial position, results of
operations or cash flows.
We believe that the regulatory environment surrounding the long-term care
industry has intensified, particularly for large for-profit, multi-facility
providers like us. In the State of Florida, for example, a new statute requires
the State to revoke, absent sufficient mitigating factors, all licenses of
commonly controlled facilities even if only one facility has serious regulatory
deficiencies. The federal government has imposed extensive enforcement
policies, resulting in a significant increase in the number of inspections,
citations of regulatory deficiencies and other regulatory sanctions including
terminations from the Medicare and Medicaid programs, bars on Medicare and
Medicaid payments for new admissions and civil monetary penalties. Such
sanctions can have a material adverse effect on our results of operations,
liquidity and financial position. We vigorously contest such sanctions where
appropriate, and in several cases have obtained injunctions preventing
imposition of these
22
regulatory sanctions. While we generally have been successful to date in
contesting these sanctions, these cases involve significant legal expense and
the time of management and we cannot assure you that we will be successful in
the future.
Certificates of Need and State Licensing. Certificate of need, or CON,
regulations control the development and expansion of healthcare services and
facilities in certain states. Certain states also require regulatory approval
prior to certain changes in ownership of a nursing center or hospital. Certain
states that do not have CON programs may have other laws or regulations that
limit or restrict the development or expansion of healthcare facilities. We
operate nursing centers in 23 states and hospitals in 12 states that require
state approval for the expansion of our facilities and services under CON
programs. To the extent that CONs or other similar approvals are required for
expansion of the operations of our nursing centers or hospitals, either through
facility acquisitions, expansion or provision of new services or other changes,
such expansion could be affected adversely by the failure or inability to
obtain the necessary approvals, changes in the standards applicable to such
approvals or possible delays and expenses associated with obtaining such
approvals.
We are required to obtain state licenses to operate each of our nursing
centers and hospitals and to ensure their participation in government programs.
Once a nursing center or hospital becomes licensed and operational, it must
continue to comply with federal, state and local licensing requirements in
addition to local building and life-safety codes. All of our nursing centers
and hospitals have the necessary licenses.
Health Services Division
The development and operation of nursing centers and the provision of
healthcare services are subject to federal, state and local laws relating to
the adequacy of medical care, equipment, personnel, operating policies, fire
prevention, rate-setting and compliance with building codes and environmental
laws. Nursing centers are subject to periodic inspection by governmental and
other authorities to assure continued compliance with various standards,
continued licensing under state law, certification under the Medicare and
Medicaid programs and continued participation in the Veterans Administration
program. The failure to obtain, retain or renew any required regulatory
approvals or licenses could adversely affect nursing center operations.
Medicare and Medicaid and other Federal Regulation. The nursing centers
operated and managed by the health services division are licensed either on an
annual or bi-annual basis and generally are certified annually for
participation in Medicare and Medicaid programs through various regulatory
agencies that determine compliance with federal, state and local laws. These
legal requirements relate to the quality of the nursing care provided, the
qualifications of the administrative personnel and nursing staff, the adequacy
of the physical plant and equipment and continuing compliance with the laws and
regulations governing the operation of nursing centers. Federal regulations
affect the survey process for nursing centers and the authority of state survey
agencies and the Centers for Medicare and Medicaid Services ("CMS") to impose
sanctions on facilities based upon noncompliance with certain requirements.
Available sanctions include, but are not limited to, imposition of civil
monetary penalties, temporary suspension of payment for new admissions,
appointment of a temporary manager, suspension of payment for eligible patients
and suspension or decertification from participation in the Medicare and
Medicaid programs.
We believe that substantially all of our nursing centers are in substantial
compliance with applicable Medicare and Medicaid requirements of participation.
In the ordinary course of business, however, the nursing centers receive
statements of deficiencies from regulatory agencies. In response, the health
services division implements plans of correction to address the alleged
deficiencies. In most instances, the regulatory agency will accept the
facility's plan of correction and place the nursing center back into compliance
with regulatory requirements. In some cases or upon repeat violations, the
regulatory agency may take a number of adverse actions against the nursing
center. These adverse actions may include the imposition of fines, temporary
suspension of admission of new patients to the nursing center, decertification
from participation in the Medicaid and/or Medicare programs and, in extreme
circumstances, revocation of the nursing center's license.
23
The health services division also is subject to federal and state laws that
govern financial and other arrangements between healthcare providers. These
laws often prohibit certain direct and indirect payments or fee-splitting
arrangements between healthcare providers that are designed to induce or
encourage the referral of patients to, or the recommendation of, a particular
provider for medical products and services. Such laws include the antikickback
amendments discussed above. These provisions prohibit, among other things, the
offer, payment, solicitation or receipt of any form of remuneration in return
for the referral of Medicare and Medicaid patients. In addition, some states
restrict certain business relationships between physicians and pharmacies, and
many states prohibit business corporations from providing, or holding
themselves out as a provider of, medical care. Possible sanctions for violation
of any of these restrictions or prohibitions include loss of licensure or
eligibility to participate in reimbursement programs as well as civil and
criminal penalties. These laws vary from state to state.
In certain circumstances, federal law mandates that conviction for certain
abusive or fraudulent behavior with respect to one nursing center may subject
other facilities under common control or ownership to disqualification from
participation in the Medicare and Medicaid programs. In addition, some
regulations provide that all nursing centers under common control or ownership
within a state are subject to delicensure if any one or more of such facilities
are delicensed.
Hospital Division
Medicare and Medicaid and other Federal Regulation. The hospital division
is subject to various federal and state regulations. In order to receive
Medicare reimbursement, each hospital must meet the applicable conditions of
participation set forth by the U.S. Department of Health and Human Services
relating to the type of hospital, its equipment, personnel and standard of
medical care, as well as comply with state and local laws and regulations. We
have developed a management system to facilitate our compliance with the
various standards and requirements. Each hospital employs a person who is
responsible for an ongoing quality assessment and improvement program.
Hospitals undergo periodic on-site Medicare certification surveys, which
generally are limited if the hospital is accredited by the Joint Commission on
Accreditation of Health Care Organizations. As of December 31, 2001, all of the
hospitals operated by the hospital division were certified as Medicare
providers and 52 of such hospitals also were certified by their respective
state Medicaid programs. A loss of certification could affect adversely a
hospital's ability to receive payments from the Medicare and Medicaid programs.
Since 1983, Medicare has reimbursed general short-term acute care hospitals
under a prospective payment system. Under the hospital prospective payment
system, Medicare inpatient costs are reimbursed based upon a fixed payment
amount per discharge using diagnosis related groups. The diagnosis-related
group payment under the hospital prospective payment system is based upon the
national average cost of treating a Medicare patient's condition. Although the
average length of stay varies for each diagnosis related group, the average
stay for all Medicare patients subject to the hospital prospective payment
system is approximately six days. An additional outlier payment is made for
patients with higher treatment costs. Outlier payments are only designed to
cover marginal costs. Accordingly, the hospital prospective payment system
creates an economic incentive for general short-term acute care hospitals to
discharge medically complex Medicare patients as soon as clinically possible.
Hospitals that are certified by Medicare as general long-term acute care
hospitals are excluded from the hospital prospective payment system. We believe
that the incentive for short-term acute care hospitals to discharge medically
complex patients as soon as clinically possible creates a substantial referral
source for our long-term acute care hospitals.
The Social Security Amendments of 1983 excluded certain hospitals, including
general long-term acute care hospitals, from the hospital prospective payment
system. A general long-term acute care hospital is defined as a hospital that
has an average length of stay greater than 25 days. Inpatient operating costs
for general long-term acute care hospitals are reimbursed under the cost-based
reimbursement system, subject to a computed target rate per discharge for
inpatient operating costs established by TEFRA. As discussed below, the
Balanced Budget Act made significant changes to TEFRA's provisions.
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Prior to the Balanced Budget Act, Medicare operating costs per discharge in
excess of the computed target rate were reimbursed at the rate of 50% of the
excess, up to 10% of the computed target rate. Hospitals whose operating costs
were lower than the computed target rate were reimbursed their actual costs
plus an incentive. For cost report periods beginning on or after October 1,
1997, the Balanced Budget Act reduced the incentive payments to an amount equal
to 15% of the difference between the actual costs and the computed target rate,
but not to exceed 2% of the computed target rate. Costs in excess of the
computed target rate are still being reimbursed at the rate of 50% of the
excess, up to 10% of the computed target rate, but the threshold to qualify for
such payments was raised from 100% to 110% of the computed target rate.
Since the adoption of the Balanced Budget Act, a new provider will no longer
receive unlimited cost-based reimbursement for its first few years in
operation. Instead, for the first two years, it will be paid the lower of its
costs or 110% of the median of TEFRA's computed target rate for 1996 adjusted
for inflation. During this two-year period, new providers are not eligible to
receive TEFRA relief or incentive payments discussed in the previous paragraph.
As of December 31, 2001, all of our long-term acute care hospitals were
subject to TEFRA's computed target rate provisions. The reduction in TEFRA's
incentive payments has had a material adverse effect on our hospital division's
operating results. These reductions, which began between May 1, 1998 and
September 1, 1998 with respect to our hospitals, are expected to have a
material adverse impact on hospital division revenues in the future and may
impact adversely our ability to develop additional free-standing, long-term
acute care hospitals.
We also operate four general acute care hospitals that are subject to the
short-term acute care hospital prospective payment system and are not subject
to TEFRA's computed target rate provisions.
Medicare and Medicaid reimbursements generally are determined from annual
cost reports that we file, which are subject to audit by the respective agency
administering the programs. We believe that adequate provisions for loss have
been recorded to reflect any adjustments that could result from audits of these
cost reports.
Federal regulations provide that admission to and utilization of hospitals
by Medicare and Medicaid patients must be reviewed by peer review organizations
in order to ensure efficient utilization of hospitals and services. A peer
review organization may conduct such review either prospectively or
retroactively and may, as appropriate, recommend denial of payments for
services provided to a patient. The review is subject to administrative and
judicial appeal. Each of the hospitals operated by our hospital division
employs a clinical professional to administer the hospital's integrated quality
assurance and improvement program, including its utilization review program.
Peer review organization denials have not had a material adverse effect on the
hospital division's operating results.
The antikickback amendments discussed above prohibit certain business
practices and relationships that might affect the provision and cost of
healthcare services reimbursable under federal healthcare programs. Sanctions
for violating these amendments include criminal and civil penalties and
exclusion from federal healthcare programs. Pursuant to the Medicare and
Medicaid Patient and Program Protection Act of 1987, the U.S. Department of
Health and Human Services and the Office of the Inspector General specified
certain safe harbors that describe conduct and business relationships
permissible under the antikickback amendments. These safe harbor regulations
have resulted in more aggressive enforcement of the antikickback amendments by
the U.S. Department of Health and Human Services and the Office of the
Inspector General.
Section 1877 of the Social Security Act, commonly known as "Stark I," states
that a physician who has a financial relationship with a clinical laboratory
generally is prohibited from referring patients to that laboratory. The Omnibus
Budget Reconciliation Act of 1993 contains provisions, commonly known as "Stark
II," amending Section 1877 to expand greatly the scope of Stark I. Effective
January 1995, Stark II broadened the referral limitations of Stark I to
include, among other designated health services, inpatient and outpatient
hospital
25
services. Under Stark I and Stark II, a "financial relationship" is defined as
an ownership interest or a compensation arrangement. If such a financial
relationship exists, the entity generally is prohibited from claiming payment
for such services under the Medicare or Medicaid programs. Compensation
arrangements generally are exempted from Stark I and Stark II if, among other
things, the compensation to be paid is set in advance, does not exceed fair
market value and is not determined in a manner that takes into account the
volume or value of any referrals or other business generated between the
parties. These laws and regulations, however, are complex and the industry has
the benefit of limited judicial or regulatory interpretation. We believe that
business practices of providers and financial relationships between providers
have become subject to increased scrutiny as healthcare reform efforts continue
on the federal and state levels.
The pharmacy operations within the hospital division are subject to
regulation by the various states in which business is conducted as well as by
the federal government. The pharmacies are regulated under the Food, Drug and
Cosmetic Act and the Prescription Drug Marketing Act, which are administered by
the U.S. Food and Drug Administration. Under the Comprehensive Drug Abuse
Prevention and Control Act of 1970, which is administered by the United States
Drug Enforcement Administration, dispensers of controlled substances must
register with the Drug Enforcement Administration, file reports of inventories
and transactions and provide adequate security measures. Failure to comply with
such requirements could result in civil or criminal penalties.
Joint Commission on Accreditation of Health Care Organizations. Hospitals
receive accreditation from the Joint Commission on Accreditation of Health Care
Organizations, a nationwide commission that establishes standards relating to
the physical plant, administration, quality of patient care and operation of
medical staffs of hospitals. Generally, hospitals and certain other healthcare
facilities are required to have been in operation at least six months in order
to be eligible for accreditation by the Joint Commission. After conducting
on-site surveys, the Joint Commission awards accreditation for up to three
years to hospitals found to be in substantial compliance with Joint Commission
standards. Accredited hospitals are periodically resurveyed, at the option of
the Joint Commission, upon a major change in facilities or organization and
after merger or consolidation. As of December 31, 2001, all of the hospitals
operated by the hospital division were accredited by the Joint Commission. The
hospital division intends to seek and obtain Joint Commission accreditation for
any additional facilities it may purchase or lease and convert into long-term
acute care hospitals. We do not believe that the failure to obtain Joint
Commission accreditation at any hospital would have a material adverse effect
on the hospital division's results of operations.
Regulatory Changes
The Balanced Budget Act contained extensive changes to the Medicare and
Medicaid programs intended to reduce the projected amount of increase in
payments under those programs over a five year period. Virtually all spending
reductions were derived from reimbursements to providers and changes in program
components. The Balanced Budget Act has affected adversely the revenues in both
of our operating divisions.
The Balanced Budget Act established PPS for nursing centers for cost
reporting periods beginning on or after July 1, 1998. All of our nursing
centers adopted PPS on July 1, 1998. During the first three years, the per diem
rates for nursing centers were based on a blend of facility-specific costs and
federal rates. Effective July 1, 2001, the per diem rates were based solely on
federal rates. The payments received under PPS cover all services for Medicare
patients including all ancillary services, such as respiratory therapy,
physical therapy, occupational therapy, speech therapy and certain covered
pharmaceuticals.
The Balanced Budget Act also reduced payments made to our hospitals by
reducing TEFRA incentive payments, allowable costs for capital expenditures and
bad debts, and payments for services to patients transferred from a general
acute care hospital. The reductions in allowable costs for capital expenditures
became effective October 1, 1997. The reductions in the TEFRA incentive
payments and allowable costs for bad debts became effective between May 1, 1998
and September 1, 1998. The reductions in payments for services to
26
patients transferred from a general acute care hospital became effective
October 1, 1998. These reductions have had a material adverse impact on
hospital revenues. In addition, these reductions also may affect adversely the
hospital division's ability to develop or acquire additional free-standing,
long-term acute care hospitals in the future.
Under PPS, the volume of ancillary services provided per patient day to
nursing center patients also has declined dramatically. Medicare reimbursements
to nursing centers under PPS include substantially all services provided to
patients, including ancillary services. Prior to the implementation of PPS, the
costs of such services were reimbursed under cost-based reimbursement rules.
The decline in the demand for ancillary services since the implementation of
PPS is mostly attributable to efforts by nursing centers to reduce operating
costs. As a result, many nursing centers have elected to provide ancillary
services to their patients through internal staff. In response to PPS and a
significant decline in the demand for ancillary services, we realigned our
former ancillary services division in 1999 by integrating its physical
rehabilitation, speech and occupational therapy businesses into the health
services division and assigning its institutional pharmacy business to the
hospital division. Our respiratory therapy and other ancillary businesses were
discontinued.
Since November 1999, various legislative and regulatory actions have
provided a measure of relief from the impact of the Balanced Budget Act. In
November 1999, the Balance Budget Refinement Act (the "BBRA") was enacted.
Effective April 1, 2000, the BBRA (a) implemented a 20% upward adjustment in
the payment rates for the care of higher acuity patients, effective until the
enactment of a revised Resource Utilization Grouping payment system and (b)
allowed nursing centers to transition more rapidly to the federal payment
rates. The BBRA also imposed a two-year moratorium on certain therapy
limitations for skilled nursing center patients covered under Medicare Part B.
Effective October 1, 2000, the BBRA increased all PPS payment categories by 4%
through September 30, 2002.
In April 2000, CMS published a proposed rule which set forth updates to the
Resource Utilization Grouping payment rates used under PPS for nursing centers.
On July 31, 2000, CMS issued a final rule that indefinitely postponed any
refinements to the Resource Utilization Grouping categories used under PPS. As
a result, the 20% upward adjustment for certain higher acuity Resource
Utilization Grouping categories set forth in the BBRA was automatically
extended until the Resource Utilization Grouping refinements are enacted. On
July 31, 2001, CMS issued another final rule which did not establish such
refinements, and accordingly, the 20% adjustment will remain in place until the
Resource Utilization Grouping categories are refined.
In December 2000, the Medicare, Medicaid, and State Child Health Insurance
Program Benefits Improvement and Protection Act of 2000 ("BIPA") was enacted to
provide up to $35 billion in additional funding to the Medicare and Medicaid
programs over the next five years. Under BIPA, the nursing component for each
Resource Utilization Grouping category was increased by 16.66% over the
existing rates for skilled nursing care for the period April 1, 2001 through
September 30, 2002. BIPA also provided some relief from scheduled reductions to
the annual inflation adjustments to the Resource Utilization Grouping payment
rates through September 2002.
In addition, BIPA slightly increased payments for inpatient services and
TEFRA incentive payments for long-term acute care hospitals. Allowable costs
for bad debts also were increased by 15%. Both of these provisions became
effective for cost reporting periods beginning on or after September 1, 2001.
Despite the recent legislation and regulatory actions discussed above,
Medicare revenues recorded under PPS in our health services division are less
than the cost-based reimbursement we received before the enactment of the
Balanced Budget Act. In addition, the recent legislation did not impact
materially the reductions in Medicare revenues received by our hospitals as a
result of the Balanced Budget Act. Furthermore, we cannot assure you that the
increased revenues from the BBRA or BIPA will continue after September 30, 2002.
27
There continues to be legislative and regulatory proposals that would impose
more limitations on government and private payments to providers of healthcare
services. Congress has directed the Secretary of the U.S. Department of Health
and Human Services to develop a prospective payment system applicable
specifically to long-term acute care hospitals by October 1, 2001. The new
prospective payment system would be effective for cost report periods beginning
on or after October 1, 2002. This payment system would not impact us until
September 1, 2003. As of February 28, 2002, the Secretary had not proposed such
a prospective payment system. Congress has further directed that if the
Secretary is unable to implement a prospective payment system specific to
long-term acute care hospitals by October 1, 2002, the Secretary shall instead
implement, as of such date, a prospective payment system for long-term acute
care hospitals based upon existing hospital diagnosis-related groups modified
where feasible to account for resource use of long-term acute care hospital
patients. We cannot predict the content or timing of such regulations.
By repealing the Boren Amendment, the Balanced Budget Act eased existing
impediments on the ability of states to reduce their Medicaid reimbursement
levels. Many states are considering or have enacted measures that are designed
to reduce their Medicaid expenditures and to make certain changes to private
healthcare insurance. Some states also are considering regulatory changes that
include a moratorium on the designation of additional long-term acute care
hospitals. Additionally, regulatory changes in the Medicaid reimbursement
system applicable to the hospital division also are being considered. There
also are legislative proposals including cost caps and the establishment of
Medicaid prospective payment systems for nursing centers.
We could be adversely affected by the continuing efforts of governmental and
private third-party payors to contain healthcare costs. We cannot assure you
that payments under governmental and private third-party payor programs will
remain at levels comparable to present levels or will be sufficient to cover
the costs allocable to patients eligible for reimbursement pursuant to such
programs. In addition, we cannot assure you that the facilities we operate, or
the provision of services and supplies by us, will meet the requirements for
participation in such programs.
We cannot assure you that future healthcare legislation or other changes in
the administration or interpretation of governmental healthcare programs will
not have a material adverse effect on our results of operations, liquidity or
financial position.
CORPORATE INTEGRITY AGREEMENT
We have entered into a Corporate Integrity Agreement with the Office of
Inspector General of the U.S. Department of Health and Human Services to
promote our compliance with the requirements of Medicare, Medicaid and all
other federal healthcare programs. Under the Corporate Integrity Agreement, we
are implementing a comprehensive internal quality improvement program and a
system of internal financial controls in our nursing centers, hospitals and
regional and corporate offices. We have retained sufficient flexibility under
the Corporate Integrity Agreement to design and implement the agreement's
requirements to enable us to focus our efforts on developing improved systems
and processes for providing quality care. Our failure to comply with the
material terms of the agreement could lead to suspension or exclusion from
further participation in federal healthcare programs. We believe that many of
the requirements of the Corporate Integrity Agreement are necessary to achieve
our patient care objectives and are similar to the procedures used by other
healthcare providers to comply with existing laws and regulations.
The Corporate Integrity Agreement became effective on April 20, 2001 and
applies to us and our managed entities. The Corporate Integrity Agreement also
will apply to newly acquired facilities after a phase-in period of six months.
As required by the Corporate Integrity Agreement, we have engaged the Long
Term Care Institute, Inc. to monitor and evaluate our quality improvement
program and report its findings to the Office of the Inspector General.
28
The Corporate Integrity Agreement includes compliance requirements which
obligate us to:
. Adopt and implement written standards on federal healthcare program
requirements with respect to financial and quality of care issues.
. Conduct training each year for all employees to promote compliance with
federal healthcare requirements. Every employee will undergo a minimum of
two hours of general compliance training annually. We also will provide
annually at least two hours of specific training, tailored to issues
affecting employees with certain job responsibilities, as well as a
minimum of two hours of training for care-giving employees focused on
quality care. In addition, we will continue to operate our internal
compliance hotline.
. Put in place a comprehensive internal quality improvement program, which
will include establishing committees at the facility, regional and
corporate levels to review quality-related data, direct quality
improvement activities and implement and monitor corrective action plans.
We focus on integrating compliance responsibilities with operational
functions. We recognize that our compliance with applicable laws and
regulations depends on individual employee action as well as our
operations. The Long Term Care Institute, Inc. has assisted in program
development and will evaluate its integrity and effectiveness for the
Office of the Inspector General.
. Enhance our current system of internal financial controls to promote
compliance with federal healthcare program requirements on billing and
related financial issues, including a variety of internal audit and
compliance reviews. We have retained an independent review organization to
evaluate the integrity and effectiveness of our internal systems. The
independent review organization will report annually its findings to the
Office of the Inspector General.
. Notify the Inspector General within 30 days of our discovery of any
ongoing investigation or legal proceeding conducted or brought by a
governmental entity or its agents involving any allegation that we have
committed a crime or engaged in a fraudulent activity, and within 30 days
of our determination that we have received a substantial overpayment
relating to any federal healthcare program or any other matter that a
reasonable person would consider a potential violation of the federal
fraud and abuse laws or other criminal or civil laws related to any
federal healthcare program.
. Submit annual reports to the Inspector General demonstrating compliance
with the terms of the Corporate Integrity Agreement, including the
findings of our internal audit and review program. We submitted an
implementation report to the Office of Inspector General in August 2001.
The Corporate Integrity Agreement contains standard penalty provisions for
breach, which include stipulated cash penalties ranging from $1,000 per day to
$2,500 per day for each day we are in breach of the agreement. If we fail to
remedy our breach in the time specified in the agreement, we can be excluded
from participation in federal healthcare programs.
INFORMATION SYSTEMS
Our information systems strategy is focused on utilizing industry-leading
technology to allow us to operate efficiently and effectively under fixed
reimbursement levels and increased regulatory compliance requirements. Our
information systems activities are determined by the operational strategies and
priorities of each of our operating divisions.
Our integrated financial system allows for timely monthly reporting of
financial results on a company-wide basis. In addition, extensive data
warehouse capabilities across each operating division allows us to access
sophisticated clinical and financial management information at a local,
regional and corporate level, enhancing our ability to manage operational
performance. In 2000, we began the installation of a new integrated human
resources and payroll system in all of our hospitals and the corporate office.
We will complete the implementation of this system in our nursing centers by
the second quarter of 2002.
29
In 2001, we implemented new education tracking and event reporting systems
to support the Corporate Integrity Agreement. Our internet-based distance
learning tool provides a cost-effective method to deliver timely training to
employees. Company-wide access to various data through internet-based solutions
has improved operating efficiencies and reduced administrative costs.
The information systems for the health services division provide support for
product line management and third-party reimbursement. The resident care system
is an internally developed business application that captures patient
assessment data to ensure that minimum data set assessment forms are filed
accurately and timely with reimbursement sources in each state. Our clinical
care management system blends clinical and financial results within our data
warehouse to provide a decision support platform for delivering high quality
care in an economical manner. Our quality reporting system, based on the
industry-standard quality indicators used by CMS, allows each facility to
monitor and manage the quality of care being delivered. An internet-based
patient referral system is enhancing the health services division's
relationships with hospital discharge planners by facilitating the search to
locate appropriate nursing centers for patients and automating the
communication of critical patient data between the discharging and admitting
facilities.
Our hospitals utilize ProTouch(TM), an internally developed electronic
patient medical record system that was designed specifically for the long-term
acute care environment. ProTouch(TM) is a software application that allows
nurses, physicians and other clinicians to enter clinical information during
the patient care delivery process and view an electronic patient chart. Various
clinical indicators are passed from ProTouch(TM) to our data warehouse to allow
analysis of outcomes by patient populations and ultimately develop best
practices to improve patient care. A new internally developed system,
CustomCare, classifies patients based on a combination of acuity and required
nursing interventions, which allows us to monitor employee skill mix and manage
labor costs. Our information systems also assist us in managing staffing levels
and monitoring quality indicators at the facility, regional and corporate
levels. As HIPAA regulations are finalized, we are enhancing all of our systems
to meet the government-mandated patient data privacy and security requirements.
Our information systems architecture provides a reliable, scalable
infrastructure that is based on personal computers in the facilities connected
by a wide-area network to our centralized data center in Louisville, Kentucky.
Our information system network allows us to operate and centrally monitor over
8,000 distributed personal computers and 1,000 servers on a continuous basis.
ADDITIONAL INFORMATION
Employees
As of December 31, 2001, we had approximately 39,500 full-time and 13,300
part-time and per diem employees. We had approximately 3,000 unionized
employees under 27 collective bargaining agreements as of December 31, 2001.
The healthcare industry currently is facing a shortage of qualified
personnel, such as nurses, certified nurse assistants, nurse's aides and other
important providers of healthcare. As a result, we are experiencing challenges
in retaining qualified staff due to this high demand. Our hospitals are
particularly dependent on nurses for patient care. The difficulty our nursing
centers and hospitals are experiencing in having and retaining qualified
personnel has increased our average wage rate and forced us to increase our use
of contract nursing personnel. We may continue to experience increases in our
labor costs primarily due to higher wages and greater benefits required to
attract and retain qualified healthcare personnel. Our ability to control labor
costs will significantly affect our future operating results.
Professional Liability Insurance
Our healthcare operations are primarily insured for professional liability
risks by our wholly owned, limited purpose insurance subsidiary, Cornerstone
Insurance Company. Cornerstone insures initial losses up to specified
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coverage levels per occurrence and in the aggregate. Coverages for losses in
excess of those insured by Cornerstone are maintained through unaffiliated
commercial insurance carriers. Effective November 30, 2000, Cornerstone insures
all claims arising in Florida up to a per occurrence limit without the benefit
of any aggregate coverage limit through unaffiliated commercial insurance
carriers.
We believe that our insurance is adequate in amount and coverage. There can
be no assurance that in the future such insurance will be available at a
reasonable price or that we will be able to maintain adequate levels of
professional liability insurance coverage.
CAUTIONARY STATEMENTS
Certain statements made in this Annual Report on Form 10-K and the documents
we incorporate by reference in this Annual Report include forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended and Section 21E of the Securities Exchange Act of 1934, as amended. All
statements regarding our expected future financial position, results of
operations, cash flows, financing plans, business strategy, budgets, capital
expenditures, competitive positions, growth opportunities, plans and objectives
of management and statements containing the words such as "anticipate,"
"approximate," "believe," "plan," "estimate," "expect," "project," "could,"
"should," "will," "intend," "may" and other similar expressions, are
forward-looking statements. Such forward-looking statements are inherently
uncertain, and you must recognize that actual results may differ materially
from our expectations as a result of a variety of factors, including, without
limitation, those discussed below. Such forward-looking statements are based on
management's current expectations and include known and unknown risks,
uncertainties and other factors, many of which we are unable to predict or
control, that may cause our actual results or performance to differ materially
from any future results or performance expressed or implied by such
forward-looking statements. These statements involve risks, uncertainties and
other factors discussed below and detailed from time to time in our filings
with the Securities and Exchange Commission. Factors that may affect our plans
or results include, without limitation:
. our ability to operate pursuant to the terms of our debt obligations and
the Master Lease Agreements,
. our ability to meet our rental and debt services obligations,
. adverse developments with respect to our liquidity or results of
operations,
. our ability to attract and retain key executives and other healthcare
personnel,
. increased operating costs due to shortages in qualified nurses and other
healthcare personnel,
. the effects of healthcare reform and government regulations,
interpretation of regulations and changes in the nature and enforcement of
regulations governing the healthcare industry,
. changes in the reimbursement rates or methods of payment from third-party
payors, including the Medicare and Medicaid programs and the new
prospective payment system for long-term acute care hospitals,
. national and regional economic conditions, including their effect on the
availability and cost of labor, materials and other services,
. our ability to control costs, including labor costs, in response to the
prospective payment system, implementation of the Corporate Integrity
Agreement and other regulatory actions,
. our ability to comply with the terms of our Corporate Integrity Agreement,
. the effect of a restatement of our previously issued consolidated
financial statements, and
. the increase in costs of defending and insuring against alleged patient
care liability claims.
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Many of these factors are beyond our control. We caution you that any
forward-looking statements made by us are not guarantees of future performance.
We disclaim any obligation to update any such factors or to announce publicly
the results of any revisions to any of the forward-looking statements to
reflect future events or developments.
Changes in the reimbursement rates or methods of payment from third-party
payors, including the Medicare and Medicaid programs, or the implementation of
other measures to reduce reimbursement for our services could result in a
substantial reduction in our revenues and operating margins.
We depend on reimbursement from third-party payors, including the Medicare
and Medicaid programs, for substantially all of our revenues. For the year
ended December 31, 2001, we derived approximately 71% of our total revenues
from the Medicare and Medicaid programs and approximately 29% from private
third-party payors, such as commercial insurance companies, health maintenance
organizations, preferred provider organizations and contracted providers.
The Medicare and Medicaid programs are highly regulated and subject to
frequent and substantial changes. The Balanced Budget Act, which established a
plan to balance the federal budget by fiscal year 2002, contained extensive
changes to the Medicare and Medicaid programs intended to reduce significantly
the projected amount of increase in payments under those programs. The Balanced
Budget Act, among other things:
. substantially reduced Medicare reimbursement payments to our nursing
centers by establishing a prospective payment system covering
substantially all services provided to Medicare patients, including
ancillary services such as respiratory therapy, physical therapy,
occupational therapy, speech therapy and certain covered pharmaceuticals,
. reduced payments made to our hospitals by reducing the TEFRA incentive
payments, allowable costs for capital expenditures and bad debts, and
payments for services to patients transferred from a general acute care
hospital, and
. repealed the federal payment standard for Medicaid reimbursement levels
often referred to as the "Boren Amendment" for hospitals and nursing
centers.
Congress has directed the Secretary of the U.S. Department of Health and
Human Services to develop a prospective payment system applicable specifically
to long-term acute care hospitals by October 1, 2001. The new prospective
payment system would be effective for cost report periods beginning on or after
October 1, 2002. This payment system would not impact us until September 1,
2003. As of February 28, 2002, the Secretary had not proposed such a
prospective payment system. Congress has further directed that if the Secretary
is unable to implement a prospective payment system specific to long-term acute
care hospitals by October 1, 2002, the Secretary shall instead implement, as of
such date, a prospective payment system for long-term acute care hospitals
based upon existing hospital diagnosis-related groups modified where feasible
to account for resource use of long-term acute care hospital patients. We
cannot predict the content or timing of such regulations.
There continues to be legislative and regulatory proposals that would impose
further limitations on government and private payments to providers of
healthcare services. By repealing the Boren Amendment, the Balanced Budget Act
eased existing impediments on the ability of states to reduce their Medicaid
reimbursement levels. In some cases, states have enacted or are considering
enacting measures that are designed to reduce their Medicaid expenditures and
to make certain changes to private healthcare insurance.
In addition, private third-party payors are continuing their efforts to
control healthcare costs through direct contracts with healthcare providers,
increased utilization review and greater enrollment in managed care programs
and preferred provider organizations. These private payors increasingly are
demanding discounted fee structures and the assumption by healthcare providers
of all or a portion of the financial risk.
32
We could be adversely affected by the continuing efforts of governmental and
private third-party payors to contain the amount of reimbursement we receive
for healthcare services. We cannot assure you that reimbursement payments under
governmental and private third-party payor programs will remain at levels
comparable to present levels or will be sufficient to cover the costs allocable
to patients eligible for reimbursement pursuant to such programs. Future
changes in the reimbursement rates or methods of third-party payors, including
the Medicare and Medicaid programs, or the implementation of other measures to
reduce reimbursement for our services could result in a substantial reduction
in our net operating revenues. Our operating margins may continue to be under
pressure because of deterioration in pricing flexibility, changes in payor mix
and growth in operating expenses in excess of increases in payments by
third-party payors. In addition, as a result of competitive pressures, our
ability to maintain operating margins through price increases to private
patients is limited. See "Business-Governmental Regulation."
Our failure to pay rent, or Ventas' exercise of its right to reset the annual
aggregate minimum rent, under the Master Lease Agreements could materially
adversely affect our liquidity, financial condition and results of operations.
We currently lease 210 of our 305 nursing centers and 44 of our 57 hospitals
from Ventas under our Master Lease Agreements. Our failure to pay the rent or
otherwise comply with a material provision of any of our Master Lease
Agreements with Ventas would result in an "Event of Default" under such Master
Lease Agreement. Upon an Event of Default, remedies available to Ventas
include, without limitation, terminating such Master Lease Agreement,
repossessing and reletting the leased properties and requiring us to remain
liable for all obligations under such Master Lease Agreement, including the
difference between the rent under such Master Lease Agreement and the rent
payable as a result of reletting the leased properties, or requiring us to pay
the net present value of the rent due for the balance of the term of such
Master Lease Agreement. The exercise of such remedies could have a material
adverse effect on our financial condition and our business.
In addition, the Master Lease Agreements provide Ventas with a one-time
option, that may be exercised by Ventas within one year from July 2006, to
reset the annual aggregate minimum rent under one or more of the Master Lease
Agreements to the then current fair market rental of the relevant leased
properties in exchange for a payment to us. Accordingly, if the operations or
value of our leased properties improve, the relevant fair market rental
likewise may increase over the current rental if the option is exercised. If
Ventas were to exercise this option, the potential increase in our annual
aggregate minimum rent payments could be so substantial as to have a material
adverse effect on our financial condition and results of operations. See
"Business-Master Lease Agreements."
We have limited operational flexibility since we lease substantially all of our
facilities.
We lease substantially all of our facilities from Ventas and other third
parties. Under our leases, we generally are required to operate continuously
our leased properties as a provider of healthcare services. In addition, these
leases generally limit or restrict our ability to assign the lease to another
party. Our failure to comply with these lease provisions would result in an
event of default under the leases and subject us to material damages. Given
these restrictions, we may be forced to continue operating non-profitable
facilities to avoid defaults under our leases. See "Business-Master Lease
Agreements."
We could experience significant increases to our operating costs due to
shortages in qualified nurses and other healthcare professionals.
The market for qualified nurses and other healthcare professionals is highly
competitive. We, like other healthcare providers, have experienced difficulties
in attracting and retaining qualified personnel such as nurses, certified
nurse's assistants, nurse's aides and other important providers of healthcare.
Our hospitals are particularly dependent on nurses for patient care. Salaries,
wages and benefits were approximately 57% of our revenues for the year ended
December 31, 2001. The difficulty our nursing centers and hospitals are
experiencing
33
in hiring and retaining qualified personnel has increased our average wage rate
and forced us to increase our use of contract nursing personnel. We may
continue to experience increases in our labor costs primarily due to higher
wages and greater benefits required to attract and retain qualified healthcare
personnel. Our ability to control labor costs will significantly affect our
future operating results.
We operate 18 nursing centers in the State of Florida. The State of Florida
recently enacted legislation establishing certain minimum staffing requirements
for nursing centers operating in that state. Beginning January 1, 2002, each
Florida nursing center must satisfy certain minimum hours of direct care per
resident per day by both licensed nurses and certified nursing assistants and
certain minimum staff/patient ratios for both licensed nurses and certified
nurse assistants. The implementation of these staffing requirements in Florida
is not contingent upon any additional appropriation of state funds in any
budget act or other statute. Other states in which we operate nursing centers
and hospitals also may establish minimum staffing requirements in the future.
Our ability to satisfy such staffing requirements will depend upon our ability
to attract and retain the qualified nurses, certified nurse assistants and
other staff. Failure to comply with such minimum staffing requirements may
result in the imposition of fines or other sanctions. If states do not
appropriate sufficient additional funds (through Medicaid program
appropriations or otherwise) to pay for any additional operating costs
resulting from such minimum staffing requirements, our profitability may be
adversely affected.
We may not be able to meet our substantial rent and debt service requirements.
A substantial portion of our cash flows from operations is dedicated to the
payment of rents related to our leased properties as well as interest on our
outstanding indebtedness of $213 million at December 31, 2001. If we are unable
to generate sufficient funds to meet our obligations, we may be required to
refinance, restructure or otherwise amend some or all of such obligations, sell
assets or raise additional cash through the sale of our equity. We cannot
assure you that such restructuring activities, sales of assets or issuances of
equity can be accomplished or, if accomplished, would raise sufficient funds to
meet these obligations. Our high degree of leverage and related financial
covenants:
. require us to dedicate a substantial portion of our cash flow to payments
on our rent and interest obligations, thereby reducing the availability of
cash flow to fund working capital, capital expenditures and other general
corporate activities,
. require us to pledge as collateral substantially all of our assets, and
. require us to maintain certain debt coverage and financial ratios at
specified levels, thereby reducing our financial flexibility.
These provisions:
. could have a material adverse effect on our ability to withstand
competitive pressures or adverse economic conditions (including adverse
regulatory changes),
. could affect adversely our ability to make material acquisitions, obtain
future financing or take advantage of business opportunities that may
arise, and
. increase our vulnerability to a downturn in general economic conditions or
in our business.
Significant legal actions, particularly in the State of Florida, could subject
us to increased operating costs and substantial uninsured liabilities, which
could materially and adversely affect our liquidity, financial condition and
results of operations.
We have experienced substantial increases in both the number and size of
patient care liability claims in recent years. In addition to large
compensatory claims, plaintiffs' attorneys increasingly are seeking significant
punitive damages and attorney's fees. As a result, general and professional
liability costs have become increasingly expensive and unpredictable.
34
We operate 18 nursing centers and seven hospitals in the State of Florida.
In Florida, general liability and professional liability costs for the
long-term care industry have become increasingly expensive and difficult to
estimate. Many insurance companies are exiting the State of Florida or severely
restricting their underwriting of long-term care general liability insurance in
that state. Insurers have decided that they cannot provide coverage when faced
with the magnitude of losses and the explosive growth of claims in that state.
Accordingly, our overall general liability costs per bed in Florida are
substantially higher than other states and continue to escalate. The Florida
legislature recently has enacted certain tort reforms relating to professional
liability claims. We are currently unable to determine what impact, if any,
this legislation may have on our claims experience in Florida.
We insure our professional liability risks primarily through a wholly owned,
limited purpose insurance subsidiary. The limited purpose insurance subsidiary
insures initial losses up to specified coverage levels per occurrence and in
the aggregate. Coverages for losses in excess of those levels are maintained
through unaffiliated commercial insurance carriers. Effective November 30,
2000, the limited purpose insurance subsidiary insures all claims arising in
Florida up to a per occurrence limit without the benefit of any aggregate
coverage limit through unaffiliated commercial insurance carriers. We maintain
general liability insurance and professional malpractice liability insurance in
amounts and with deductibles that management believes are sufficient for our
operations. However, our insurance coverage might not cover all claims against
us or continue to be available to us at a reasonable cost. If we are unable to
maintain adequate insurance coverage or are required to pay punitive damages,
we may be exposed to substantial liabilities. We also are subject to lawsuits
under a federal whistleblower statute designed to combat fraud and abuse in the
healthcare industry. These lawsuits can involve significant monetary and award
bounties to private plaintiffs who successfully bring these suits.
We conduct business in a heavily regulated industry, and changes in regulations
or violations of regulations may result in increased costs or sanctions that
reduce our revenues and profitability.
In the ordinary course of our business, we are subject regularly to
inquiries, investigations and audits by federal and state agencies that oversee
healthcare regulations.
The extensive federal, state and local regulations affecting the healthcare
industry include, but are not limited to, regulations relating to licensure,
conduct of operations, ownership of facilities, addition of facilities,
allowable costs, services and prices for services. See "Business-Governmental
Regulation." In particular, various laws including, antikickback, antifraud and
abuse amendments codified under the Social Security Act, prohibit certain
business practices and relationships that might affect the provision and cost
of healthcare services reimbursable under Medicare and Medicaid, including the
payment or receipt of remuneration for the referral of patients whose care will
be paid by Medicare or other governmental programs. Sanctions for violating the
antikickback, antifraud and abuse amendments under the Social Security Act
include criminal penalties and civil sanctions, including fines and possible
exclusion from government programs such as Medicare and Medicaid.
In addition, the Social Security Act broadly defines the scope of prohibited
physician referrals under the Medicare and Medicaid programs to providers with
which they have ownership or certain other financial arrangements. Many states
have adopted or are considering similar legislative proposals, some of which
extend beyond the Medicaid program, to prohibit the payment or receipt of
remuneration for the referral of patients and physician self-referrals
regardless of the source of the payment for the care. These laws and
regulations are complex and limited judicial or regulatory interpretation
exists. We cannot assure you that governmental officials charged with
responsibility for enforcing the provisions of these laws and regulations will
not assert that one or more of our arrangements are in violation of the
provisions of such laws and regulations.
We believe that the regulatory environment surrounding the long-term care
industry has intensified, particularly for large for-profit, multi-facility
providers like us. In the State of Florida, for example, a new statute requires
the State to revoke, absent sufficient mitigating factors, all licenses of
commonly controlled facilities even if only one facility has serious regulatory
deficiencies. The federal government has imposed intensive
35
enforcement policies resulting in a significant increase in the number of
inspections, citations of regulatory deficiencies and other regulatory
sanctions, including terminations from the Medicare and Medicaid programs, bars
on Medicare and Medicaid payments for new admissions and civil monetary
penalties. If we fail to comply with the extensive laws and regulations
applicable to our businesses, we could become ineligible to receive government
program reimbursement, suffer civil or criminal penalties or be required to
make significant changes to our operations. In addition, we could be forced to
expend considerable resources responding to an investigation or other
enforcement action under these laws or regulations. Furthermore, should we lose
licenses for a number of our facilities as a result of regulatory action or
otherwise, we could be in default under our Master Lease Agreements and our
credit agreements.
We are unable to predict the future course of federal, state and local
regulation or legislation, including Medicare and Medicaid statutes and
regulations, or the intensity of federal and state enforcement actions. Changes
in the regulatory framework and sanctions from various enforcement actions
could have a material adverse effect on our liquidity, financial condition and
results of operations.
If we fail to attract patients and residents and compete effectively with other
healthcare providers, our revenues and profitability may decline.
The long-term healthcare services industry is highly competitive. Our
nursing centers compete on a local and regional basis with other nursing
centers and other long-term healthcare providers. Some of our competitors'
facilities are located in newer buildings and may offer services not provided
by us or are operated by entities having greater financial and other resources
than us. Our hospitals face competition from general acute care hospitals and
long-term hospitals that provide services comparable to those offered by our
hospitals. Many competing general acute care hospitals are larger and more
established than our hospitals. We may experience increased competition from
existing hospitals as well as hospitals converted, in whole or in part, to
specialized care facilities.
The long-term industry is divided into a variety of competitive areas that
market similar services. These competitors include nursing centers, hospitals,
extended care centers, assisted living facilities, home health agencies and
similar institutions. Our facilities generally operate in communities that also
are served by similar facilities operated by our competitors. Certain of our
competitors are operated by not-for-profit, non-taxpaying or governmental
agencies that can finance capital expenditures on a tax-exempt basis and that
receive funds and charitable contributions unavailable to us. Our facilities
compete based on factors such as our reputation for quality care; the
commitment and expertise of our staff and physicians; the quality and
comprehensiveness of our treatment programs; charges for services; and the
physical appearance, location and condition of our facilities. We also compete
with other companies in providing rehabilitation therapy services and
institutional pharmacy services. Many of these competing companies have greater
financial and other resources than we have. We cannot assure you that increased
competition in the future will not adversely affect our financial condition and
results of operations.
If we fail to comply with our Corporate Integrity Agreement, we could be
subject to severe sanctions.
We have entered into a Corporate Integrity Agreement with the Office of
Inspector General of the U.S. Department of Health and Human Services to
promote our compliance with the requirements of Medicare, Medicaid and all
other federal healthcare programs. On April 20, 2001, our Corporate Integrity
Agreement became effective. Under the Corporate Integrity Agreement, we must
implement a comprehensive internal quality improvement program and a system of
internal financial controls in our nursing centers, hospitals and regional and
corporate offices. We also are subject to extensive reporting requirements
under the Corporate Integrity Agreement pursuant to which we must inform the
Office of the Inspector General of the U.S. Department of Health and Human
Services of (1) the findings of our internal audit and review program, (2) any
investigations or legal proceedings brought or conducted by any governmental
entity involving an allegation that we have committed any crime or engaged in
any fraudulent activity, (3) any billing, reporting or other practices
36
or policies that have resulted in our receipt of any substantial overpayment
under any federal healthcare program and the corresponding corrective plan that
we have implemented, (4) certain "material deficiencies" as defined in the
Corporate Integrity Agreement, and (5) other compliance-related matters
addressed in the Corporate Integrity Agreement. The Corporate Integrity
Agreement will be effective for five years. A breach of the Corporate Integrity
Agreement could subject us to substantial monetary penalties and exclusion from
participation in the Medicare and Medicaid programs. Any such sanctions could
have a material adverse effect on our financial condition and results of
operations. See "Business-Corporate Integrity Agreement."
Financial information related to our post-emergence operations is limited.
Since we emerged from bankruptcy on April 20, 2001, there is limited
operating and financial data available from which to analyze our operating
results and cash flows based on the terms of our Plan of Reorganization. As a
result of fresh-start accounting, you also will be unable to compare
information reflecting our results of operations and financial condition after
our emergence to prior periods.
Future acquisitions may use significant resources, may be unsuccessful and
could expose us to unforeseen liabilities.
As part of our growth strategy, we intend to selectively pursue acquisitions
of nursing centers, long-term acute care hospitals, pharmacies and other
related healthcare operations. Acquisitions may involve significant cash
expenditures, debt incurrence, additional operating losses, amortization of
certain intangible assets of acquired companies, dilutive issuances of equity
securities and expenses that could have a material adverse effect on our
financial condition and results of operations. Acquisitions involve numerous
risks, including:
. difficulties integrating acquired operations, personnel and information
systems,
. diversion of management's time from existing operations,
. potential loss of key employees or customers of acquired companies, and
. assumption of the liabilities and exposure to unforeseen liabilities of
acquired companies, including liabilities for failure to comply with
healthcare regulations.
We cannot assure you that we will succeed in obtaining financing for
acquisitions at a reasonable cost, or that such financing will not contain
restrictive covenants that limit our operating flexibility. We also may be
unable to operate acquired facilities profitably or succeed in achieving
improvements in their financial performance.
Item 2. Properties
For information concerning the nursing centers and hospitals operated by us,
see "Business-Health Services Division-Nursing Center Facilities,"
"Business-Hospital Division-Hospital Facilities," and "Business-Master Lease
Agreements." We believe that our facilities are adequate for our future needs
in such locations.
In December 1998, we purchased an approximately 287,000 square foot building
located in Louisville, Kentucky as our corporate headquarters to consolidate
corporate employees from several locations.
We are subject to various federal, state and local laws and regulations
governing the use, discharge and disposal of hazardous materials, including
medical waste products. Compliance with these laws and regulations is not
expected to have a material adverse effect on us. It is possible, however, that
environmental issues may arise in the future which we cannot now predict.
37
Item 3. Legal Proceedings
Summary descriptions of various significant legal and regulatory activities
follow.
Our subsidiary, formerly named TheraTx, Incorporated, is a plaintiff in a
declaratory judgment action entitled TheraTx, Incorporated v. James W. Duncan,
Jr., et al., No. 1:95-CV-3193, filed in the United States District Court for
the Northern District of Georgia and currently pending in the United States
Court of Appeals for the Eleventh Circuit, No. 99-11451-FF. The defendants
asserted counterclaims against TheraTx under breach of contract, securities
fraud, negligent misrepresentation and other fraud theories for allegedly not
performing as promised under a merger agreement related to TheraTx's purchase
of a company called PersonaCare, Inc. and for allegedly failing to inform the
defendants/counterclaimants prior to the merger that TheraTx's possible
acquisition of Southern Management Services, Inc. might cause the suspension of
TheraTx's shelf registration under relevant rules of the Securities and
Exchange Commission. The court granted summary judgment for the
defendants/counterclaimants and ruled that TheraTx breached the shelf
registration provision in the merger agreement, but dismissed the defendants'
remaining counterclaims. Additionally, the court ruled after trial that
defendants/counterclaimants were entitled to damages and prejudgment interest
in the amount of approximately $1.3 million and attorneys' fees and other
litigation expenses of approximately $700,000. We and the
defendants/counterclaimants both appealed the court's rulings. The United
States Court of Appeals for the Eleventh Circuit affirmed the trial court's
rulings in TheraTx's favor, with the exception of the damages award, and
certified the question of the proper calculation of damages under Delaware law
to the Delaware Supreme Court. The Delaware Supreme Court issued an opinion on
June 1, 2001, which sets forth a rule for determining such damages but did not
calculate any actual damages. On June 25, 2001, the Eleventh Circuit remanded
the action to the trial court to render a decision consistent with the Delaware
Supreme Court's ruling. On July 24, 2001, the defendants filed a Notice of
Bankruptcy Stay in the trial court. We are defending the action vigorously.
On August 13, 2001, we and TheraTx filed an Objection and Complaint in an
action entitled Vencor, Inc. and TheraTx Inc. v. James W. Duncan, et al.,
Adversary Proceeding No. 01-6117 (MFW), in the Bankruptcy Court. The complaint
seeks to subordinate and disallow the defendants' bankruptcy claim or,
alternatively, to reduce the claim by and recover from the defendants a
preferential payment made by the debtors to the defendants. The complaint also
seeks an injunction against any efforts by the defendants to enforce the
judgment ultimately granted in the above related litigation pending in the
Northern District of Georgia.
We are pursuing various claims against private insurance companies who
issued Medicare supplement insurance policies to individuals who became
patients of our hospitals. After the patients' Medicare benefits are exhausted,
the insurance companies become liable to pay the insureds' bills pursuant to
the terms of these policies. We have filed numerous collection actions against
various of these insurers to collect the difference between what Medicare would
have paid and the hospitals' usual and customary charges. These disputes arise
from differences in interpretation of the policy provisions and federal and
state laws governing such policies. Various courts have issued various rulings
on the different issues, some of which have been adverse to us and most of
which have been appealed. We intend to continue to pursue these claims
vigorously.
A class action lawsuit entitled A. Carl Helwig v. Vencor, Inc., et al., was
filed on December 24, 1997 in the United States District Court for the Western
District of Kentucky (Civil Action No. 3-97CV-8354). The class action claims
were brought by an alleged stockholder of our predecessor against us and Ventas
and certain of our and Ventas' current and former executive officers and
directors and those of Ventas. The complaint alleges that we, Ventas and
certain of our and Ventas' current and former executive officers during a
specified time frame violated Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934, by, among other things, issuing to the investing public a
series of false and misleading statements concerning Ventas' then current
operations and the inherent value of its common stock. The complaint further
alleges that as a result of these purported false and misleading statements
concerning Ventas' revenues and successful acquisitions, the price of the
common stock was artificially inflated. In particular, the complaint alleges
that the defendants issued false and misleading
38
financial statements during the first, second and third calendar quarters of
1997 which misrepresented and understated the impact that changes in Medicare
reimbursement policies would have on Ventas' core services and profitability.
The complaint further alleges that the defendants issued a series of materially
false statements concerning the purportedly successful integration of Ventas'
acquisitions and prospective earnings per share for 1997 and 1998 which the
defendants knew lacked any reasonable basis and were not being achieved. The
suit seeks damages in an amount to be proven at trial, pre-judgment and
post-judgment interest, reasonable attorneys' fees, expert witness fees and
other costs, and any extraordinary equitable and/or injunctive relief permitted
by law or equity to assure that the plaintiff has an effective remedy. In
December 1998, the defendants filed a motion to dismiss the case. The court
converted the defendants' motion to dismiss into a motion for summary judgment
and granted summary judgment as to all defendants. The plaintiff appealed the
ruling to the United States Court of Appeals for the Sixth Circuit. On April
24, 2000, the Sixth Circuit affirmed the district court's dismissal of the
action on the grounds that the plaintiff failed to state a claim upon which
relief could be granted. On July 14, 2000, the Sixth Circuit granted the
plaintiff's petition for a rehearing en banc. On May 31, 2001, the Sixth
Circuit issued its en banc decision reversing the trial court's dismissal of
the complaint. The defendants filed a Petition for Certiorari seeking review of
the Sixth Circuit's decision in the United States Supreme Court on September
27, 2001. The parties entered into a stipulation and agreement of settlement of
this action on December 26, 2001, which is subject to approval by the federal
district court. The settlement payment to the certified class will be $3
million, which will include the costs of administration and plaintiffs'
attorney fees, plus interest, and will be paid by the defendants' directors and
officers insurance carrier.
A shareholder derivative suit entitled Thomas G. White on behalf of Vencor,
Inc. and Ventas, Inc. v. W. Bruce Lunsford, et al., Case No. 98CI03669, was
filed on July 2, 1998 in the Jefferson County, Kentucky, Circuit Court. The
suit was brought on behalf of us and Ventas against certain current and former
executive officers and directors of ours and Ventas. The complaint alleges that
the defendants damaged us and Ventas by engaging in violations of the
securities laws, engaging in insider trading, fraud and securities fraud and
damaging our reputation and that of Ventas. The plaintiff asserts that such
actions were taken deliberately, in bad faith and constitute breaches of the
defendants' duties of loyalty and due care. The complaint is based on
substantially similar assertions to those made in the class action lawsuit
entitled A. Carl Helwig v. Vencor, Inc., et al., discussed above. The suit
seeks unspecified damages, interest, punitive damages, reasonable attorneys'
fees, expert witness fees and other costs, and any extraordinary equitable
and/or injunctive relief permitted by law or equity to assure that we and
Ventas have an effective remedy. We believe that the allegations in the
complaint are without merit and intend to defend this action vigorously.
A class action lawsuit entitled Jules Brody v. Transitional Hospitals
Corporation, et al., Case No. CV-S-97-00747-PMP, was filed on June 19, 1997 in
the United States District Court for the District of Nevada on behalf of a
class consisting of all persons who sold shares of Transitional common stock
during the period from February 26, 1997 through May 4, 1997, inclusive. The
complaint alleges that Transitional purchased shares of its common stock from
members of the investing public after it had received a written offer to
acquire all of the Transitional common stock and without making the required
disclosure that such an offer had been made. The complaint further alleges that
defendants disclosed that there were "expressions of interest" in acquiring
Transitional when, in fact, at that time, the negotiations had reached an
advanced stage with actual firm offers at substantial premiums to the trading
price of Transitional's stock having been made which were actively being
considered by Transitional's Board of Directors. The complaint asserts claims
pursuant to Sections 10(b), 14(e) and 20(a) of the Securities Exchange Act of
1934, and common law principles of negligent misrepresentation, and names as
defendants Transitional as well as certain former senior executives and
directors of Transitional. The plaintiff seeks class certification, unspecified
damages, attorneys' fees and costs. In June 1998, the court granted our motion
to dismiss with leave to amend the Section 10(b) claim and the state law claims
for misrepresentation. The court denied our motion to dismiss the Section 14(e)
and Section 20(a) claims, after which we filed a motion for reconsideration. On
March 23, 1999, the court granted our motion to dismiss all remaining claims
and the case was dismissed. The plaintiff appealed this ruling to the United
States Court of Appeals for the Ninth Circuit. On February 7, 2002, the Ninth
Circuit affirmed the district court's dismissal of the case.
39
In connection with our Plan of Reorganization, we, Ventas and the U.S.
Department of Justice, acting on behalf of itself, the U.S. Department of
Health and Human Services' Office of Inspector General and CMS, entered into a
government settlement, which resolved all known claims arising out of all known
investigations being made by the Department of Justice and the Office of
Inspector General including certain pending qui tam, or whistleblower, actions.
Under the government settlement, the government was required to move to dismiss
with prejudice to the United States and the relators (except for certain claims
which will be dismissed without prejudice to the United States in certain of
the cases) the pending qui tam actions as against any or all of us and our
subsidiaries, Ventas and any current or former officers, directors and
employees of either entity. The last pending case, United States, et al., ex
rel. Phillips-Minks, et al., v. Transitional Corp., et al., was dismissed as to
our defendants by the United States District Court for the Southern District of
California on December 21, 2001. All pending qui tam actions covered by the
government settlement have now been dismissed as against these defendants.
In connection with our Spin-off from Ventas, liabilities arising from
various legal proceedings and other actions were assumed by us and we agreed to
indemnify Ventas against any losses, including any costs or expenses, it may
incur arising out of or in connection with such legal proceedings and other
actions. The indemnification provided by us also covers losses, including costs
and expenses, which may arise from any future claims asserted against Ventas
based on the former healthcare operations of Ventas. In connection with our
indemnification obligation, we assumed the defense of various legal proceedings
and other actions. Under our Plan of Reorganization, we agreed to continue to
fulfill our indemnification obligations arising from the Spin-off.
We are a party to certain legal actions and regulatory investigations
arising in the normal course of our business. We are unable to predict the
ultimate outcome of pending litigation and regulatory investigations. In
addition, there can be no assurance that the U.S. Department of Justice, CMS or
other regulatory agencies will not initiate additional investigations related
to our businesses in the future, nor can there be any assurance that the
resolution of any litigation or investigations, either individually or in the
aggregate, would not have a material adverse effect on our results of
operations, liquidity or financial position. In addition, the above litigation
and investigations (as well as future litigation and investigations) are
expected to consume the time and attention of our management and may have a
disruptive effect upon our operations.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
40
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are the names, ages (as of January 1, 2002) and present and
past positions of the persons who are the current executive officers of Kindred:
Name Age Position
- ---- --- --------
Edward L. Kuntz............ 56 Chairman of the Board and Chief Executive Officer
Paul J. Diaz............... 40 President and Chief Operating Officer
Richard A. Lechleiter...... 43 Senior Vice President, Chief Financial Officer and
Treasurer
Frank J. Battafarano....... 51 President, Hospital Division
Donald D. Finney........... 54 President, Health Services Division
Richard E. Chapman......... 53 Chief Administrative and Information Officer and
Senior Vice President
James H. Gillenwater, Jr... 44 Senior Vice President, Planning and Development
M. Suzanne Riedman......... 50 Senior Vice President and General Counsel
William M. Altman.......... 42 Vice President of Compliance and Government
Programs
Edward L. Kuntz has served as our Chairman of the Board and Chief Executive
Officer since January 1999. He also served as President until January 2002. He
served as our President, Chief Operating Officer and director from November
1998 to January 1999. Mr. Kuntz was Chairman and Chief Executive Officer of
Living Centers of America, Inc., a leading provider of long-term healthcare,
from 1992 to 1997. After leaving Living Centers of America, Inc., he served as
an advisor and consultant to a number of healthcare services and investment
companies and was affiliated with Austin Ventures, a venture capital firm. In
addition, Mr. Kuntz served as Associate General Counsel and later as Executive
Vice President of ARA Living Centers until the formation of Living Centers of
America, Inc. in 1992.
Paul J. Diaz has served as our President and Chief Operating Officer since
January 2002. From 1996 to July 1998, he served in various executive capacities
with Mariner Health Group, Inc. ("Mariner Health"), most recently as Executive
Vice President and Chief Operating Officer. Prior to joining Mariner Health,
Mr. Diaz was Chief Executive Officer of Allegis Health Services, Inc. where he
also previously served as Chief Financial Officer and General Counsel. Since
leaving Mariner Health, he has served as the managing member of Falcon Capital
Partners, LLC, a private investment and consulting firm specializing in
healthcare restructurings and as Chairman and Chief Executive Officer of
Capella Senior Living, LLC.
Richard A. Lechleiter, a certified public accountant, has served as our
Senior Vice President, Chief Financial Officer and Treasurer since February 25,
2002. He served as Vice President, Finance and Corporate Controller from April
1998 to February 2002 and also has served as Treasurer since July 1998. Mr.
Lechleiter served as Vice President, Finance and Corporate Controller of our
predecessor from November 1995 to April 1998. From June 1995 to November 1995,
he was Director of Finance for our predecessor. Mr. Lechleiter was Vice
President and Controller of Columbia/HCA Healthcare Corp. from September 1993
to May 1995, of Galen Health Care, Inc. from March 1993 to August 1993, and of
Humana Inc. from September 1990 to February 1993.
Frank J. Battafarano has served as our President, Hospital Division since
November 1998. He served as our Vice President of Operations from April 1998 to
November 1998. He held the same position with our predecessor from February
1998 to April 1998. From May 1996 to January 1998, Mr. Battafarano served as
Senior Vice President of the central regional office of our predecessor. From
January 1992 to April 1996, he served as an executive director and hospital
administrator for our predecessor.
Donald D. Finney has served as our President, Health Services Division since
January 1999. During 1998, Mr. Finney was Chief Executive Officer of HCMF
Corporation, a privately held post-acute and assisted living provider. From
January 1997 to December 1997, he served as Chief Operating Officer of
Summerville
41
Healthcare Group, Inc., an operator of assisted living facilities. He served as
President of the Facilities Division of GranCare, Inc. from July 1995 to
January 1997. From October 1990 to July 1995, Mr. Finney served as Chief
Operating Officer of Evergreen Healthcare, Inc., an operator of long-term care
and assisted living facilities.
Richard E. Chapman has served as our Chief Administrative and Information
Officer and Senior Vice President since January 2001. From April 1998 to
January 2001, he served as our Senior Vice President and Chief Information
Officer. Mr. Chapman served as Senior Vice President and Chief Information
Officer of our predecessor from October 1997 to April 1998. From March 1993 to
October 1997, he was Senior Vice President of Information Systems of
Columbia/HCA Healthcare Corp., Vice President of Galen Health Care, Inc. from
March 1993 to August 1993, and Vice President of Humana Inc. from September
1988 to February 1993.
James H. Gillenwater, Jr. has served as our Senior Vice President, Planning
and Development since April 1998. Mr. Gillenwater served as Senior Vice
President, Planning and Development of our predecessor from December 1996 to
April 1998. From November 1995 through December 1996, he served as Vice
President, Planning and Development of our predecessor and was Director of
Planning and Development from 1989 to November 1995.
M. Suzanne Riedman, an attorney, has served as our Senior Vice President and
General Counsel since August 1999. She served as our Vice President and
Associate General Counsel from April 1998 to August 1999. Ms. Riedman held the
same positions with our predecessor from January 1997 to April 1998. She joined
our predecessor as counsel in September 1995 and became Associate General
Counsel in January 1996. Ms. Riedman served as counsel to another large
long-term healthcare provider in various capacities from 1990 to 1995. Prior to
that time, Ms. Riedman was in the private practice of law for 11 years.
William M. Altman, an attorney, has served as our Vice President of
Compliance and Government Programs since October 1999. He served as Operations
Counsel in our law department from May 1998 to September 1999. He held the same
position with our predecessor from June 1996 through April 1998. Prior to
joining our predecessor, Mr. Altman was in the private practice of law for ten
years and held other consulting and government positions in healthcare.
As noted above, Mr. Diaz served as Executive Vice President and Chief
Operating Officer of Mariner Health until July 1998. On July 31, 1998, Paragon
Health Network, Inc., the predecessor to Mariner Post-Acute Networks, Inc.
("Mariner Post-Acute") acquired Mariner Health. On January 18, 2000, Mariner
Post-Acute and substantially all of its subsidiaries, including Mariner Health,
filed voluntary petitions under Title 11 of the Bankruptcy Code in the United
States Bankruptcy Court for the District of Delaware.
42
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
MARKET PRICE FOR COMMON STOCK
AND DIVIDEND HISTORY
Our common stock commenced trading on the OTC Bulletin Board on April 26,
2001 under the symbol "KIND." Our common stock was initially issued on April
20, 2001 in connection with our Plan of Reorganization. Between April 20, 2001
and April 26, 2001, there was no public market for our common stock. Since
November 8, 2001, our common stock has been quoted on the NASDAQ National
Market under the symbol "KIND." The prices in the table below, for the calendar
quarters indicated, represent the high and low sale prices for our common stock
as reported by the OTC Bulletin Board and the NASDAQ, as applicable, during
2001. No cash dividends have been paid on the common stock during such periods.
Sales Price of
Common Stock
--------------
High Low
------ ------
2001
----
Second Quarter (since April 26, 2001) $51.00 $22.25
Third Quarter........................ $67.90 $46.00
Fourth Quarter....................... $59.50 $45.89
Our debt instruments contain covenants that restrict, among other things,
our ability to pay dividends. Any determination to pay dividends in the future
will be dependent upon our results of operations, financial condition,
contractual restrictions, restrictions imposed by applicable laws and other
factors deemed relevant by our board of directors.
The prices noted above represent inter-dealer prices, without retail
mark-up, mark-down or commission, and may not necessarily represent actual
transactions.
As of January 31, 2002, there were approximately 600 holders of record of
our common stock.
43
Item 6. Selected Financial Data
KINDRED HEALTHCARE, INC.
SELECTED FINANCIAL DATA
(In thousands, except for per share amounts and statistics)
Reorganized |
Company | Predecessor Company
------------|--------------------------------------------------------------
Nine | Three
months | months
ended | ended Year ended December 31,
December 31,|March 31, --------------------------------------------------
2001 | 2001 2000 1999 1998 1997
------------|---------- ----------- ----------- ----------- -----------
Statement of Operations Data: |
Revenues............................... $2,329,019 |$ 752,409 $ 2,888,542 $ 2,665,641 $ 2,999,739 $ 3,116,004
---------- |---------- ----------- ----------- ----------- -----------
Salaries, wage and benefits............ 1,316,581 | 427,649 1,623,955 1,566,227 1,753,023 1,788,053
Supplies............................... 295,598 | 94,319 374,540 347,789 340,053 347,127
Rent................................... 195,284 | 76,995 307,809 305,120 234,144 89,474
Other operating expenses............... 375,090 | 126,701 503,770 964,413 947,889 446,340
Depreciation and amortization.......... 50,219 | 18,645 73,545 93,196 124,617 123,865
Interest expense....................... 21,740 | 14,000 60,431 80,442 107,008 102,736
Investment income...................... (9,285)| (1,919) (5,393) (5,188) (4,688) (6,057)
---------- |---------- ----------- ----------- ----------- -----------
2,245,227 | 756,390 2,938,657 3,351,999 3,502,046 2,891,538
---------- |---------- ----------- ----------- ----------- -----------
Income (loss) before reorganization |
items and income taxes................ 83,792 | (3,981) (50,115) (686,358) (502,307) 224,466
Reorganization items................... - | (53,666) 12,636 18,606 - -
---------- |---------- ----------- ----------- ----------- -----------
Income (loss) before income taxes...... 83,792 | 49,685 (62,751) (704,964) (502,307) 224,466
Provision for income taxes............. 36,450 | 500 2,000 500 76,099 89,338
---------- |---------- ----------- ----------- ----------- -----------
Income (loss) from operations.......... 47,342 | 49,185 (64,751) (705,464) (578,406) 135,128
Extraordinary gain (loss) on |
extinguishment of debt, net of income |
taxes................................. 4,313 | 422,791 - - (77,937) (4,195)
Cumulative effect of change in |
accounting for start-up costs......... - | - - (8,923) - -
---------- |---------- ----------- ----------- ----------- -----------
Net income (loss).................. $ 51,655 |$ 471,976 $ (64,751) $ (714,387) $ (656,343) $ 130,933
========== |========== =========== =========== =========== ===========
Earnings (loss) per common share: |
Basic: |
Income (loss) from operations......... $ 3.05 |$ 0.69 $ (0.94) $ (10.03) $ (8.47) $ 1.96
Extraordinary gain (loss) on |
extinguishment of debt.............. 0.28 | 6.02 - - (1.14) (0.06)
Cumulative effect of change in |
accounting for start-up costs....... - | - - (0.13) - -
---------- |---------- ----------- ----------- ----------- -----------
Net income (loss).................. $ 3.33 |$ 6.71 $ (0.94) $ (10.16) $ (9.61) $ 1.90
========== |========== =========== =========== =========== ===========
Diluted: |
Income (loss) from operations......... $ 2.59 |$ 0.69 $ (0.94) $ (10.03) $ (8.47) $ 1.92
Extraordinary gain (loss) on |
extinguishment of debt.............. 0.24 | 5.90 - - (1.14) (0.06)
Cumulative effect of change in |
accounting for start-up costs....... - | - - (0.13) - -
---------- |---------- ----------- ----------- ----------- -----------
Net income (loss).................. $ 2.83 |$ 6.59 $ (0.94) $ (10.16) $ (9.61) $ 1.86
========== |========== =========== =========== =========== ===========
Shares used in computing earnings |
(loss) per common share: |
Basic................................. 15,505 | 70,261 70,229 70,406 68,343 68,938
Diluted............................... 18,258 | 71,656 70,229 70,406 68,343 70,359
|
Financial Position: |
Working capital (deficit).............. $ 316,847 |$ 286,037 $ 267,161 $ 195,011 $ (682,569) $ 431,113
Assets................................. 1,508,874 | 1,330,022 1,334,414 1,235,974 1,774,372 3,334,739
Long-term debt......................... 212,269 | - - - 6,600 1,919,624
Long-term debt in default classified as |
current............................... - | - - - 760,885 -
Liabilities subject to compromise...... - | 1,278,223 1,260,373 1,159,417 - -
Stockholders' equity (deficit)......... 590,481 | (480,930) (471,734) (406,022) 307,747 905,350
|
Operating Data: |
Number of nursing centers: |
Owned or leased....................... 282 | 278 278 282 278 296
Managed............................... 23 | 35 34 13 13 13
Number of nursing center licensed beds: |
Owned or leased....................... 36,926 | 36,469 36,466 36,912 36,701 38,694
Managed............................... 2,367 | 3,861 3,723 1,661 1,661 1,689
Number of nursing center patient days |
(a)................................... 8,583,270 | 2,804,982 11,580,295 11,656,439 11,939,266 12,622,238
Nursing center occupancy % (a)......... 84.9 | 85.2 86.1 86.8 87.3 90.5
Number of hospitals.................... 57 | 56 56 56 57 60
Number of hospital licensed beds....... 4,961 | 4,867 4,886 4,931 4,979 5,273
Number of hospital patient days........ 802,425 | 273,029 1,044,663 982,301 947,488 767,810
Hospital occupancy %................... 62.6 | 65.3 60.8 56.9 54.0 52.9
- -------
(a) Excludes managed facilities.
44
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
You should read the following discussion together with the selected
financial data in Item 6 and our consolidated financial statements included in
this report.
Overview
We provide long-term healthcare services primarily through the operation of
nursing centers and hospitals. At December 31, 2001, our health services
division operated 305 nursing centers with 39,293 licensed beds in 32 states
and a rehabilitation therapy business. Our hospital division operated 57
hospitals with 4,961 licensed beds in 23 states and an institutional pharmacy
business.
On May 1, 1998, Ventas completed the Spin-off through the distribution of
our former common stock to its stockholders. Ventas retained ownership of
substantially all of its real property and leases this real property to us
under the Master Lease Agreements. In anticipation of the Spin-off, we were
incorporated on March 27, 1998. For accounting purposes, the consolidated
historical financial statements of Ventas became our historical financial
statements following the Spin-off.
From September 13, 1999 until April 20, 2001, we operated our businesses as
a debtor-in-possession subject to the jurisdiction of the Bankruptcy Court. On
April 20, 2001, the Plan of Reorganization became effective and we emerged from
bankruptcy with our current capital structure and amended Master Lease
Agreements with Ventas. In connection with our emergence from bankruptcy, we
changed our name to Kindred Healthcare, Inc.
Regulatory Changes
The Balanced Budget Act contained extensive changes to the Medicare and
Medicaid programs intended to reduce the projected amount of increase in
payments under those programs over a five year period. Virtually all spending
reductions were derived from reimbursements to providers and changes in program
components. The Balanced Budget Act has affected adversely the revenues in each
of our operating divisions.
The Balanced Budget Act established PPS for nursing centers for cost
reporting periods beginning on or after July 1, 1998. All of our nursing
centers adopted PPS on July 1, 1998. During the first three years, the per diem
rates for nursing centers were based on a blend of facility-specific costs and
federal rates. Effective July 1, 2001, the per diem rates were based solely on
federal rates. The payments received under PPS cover all services for Medicare
patients including all ancillary services, such as respiratory therapy,
physical therapy, occupational therapy, speech therapy and certain covered
pharmaceuticals.
The Balanced Budget Act also reduced payments made to our hospitals by
reducing TEFRA incentive payments, allowable costs for capital expenditures and
bad debts, and payments for services to patients transferred from a general
acute care hospital. These reductions have had a material adverse impact on
hospital revenues. In addition, these reductions also may affect adversely the
hospital division's ability to develop or acquire additional free-standing,
long-term acute care hospitals in the future.
Under PPS, the volume of ancillary services provided per patient day to
nursing center patients also has declined dramatically. Medicare reimbursements
to nursing centers under PPS include substantially all services provided to
patients, including ancillary services. Prior to the implementation of PPS, the
costs of such services were reimbursed under cost-based reimbursement rules.
The decline in the demand for ancillary services since the implementation of
PPS is mostly attributable to efforts by nursing centers to reduce operating
costs. As a result, many nursing centers have elected to provide ancillary
services to their patients through internal staff. In response to PPS and a
significant decline in the demand for ancillary services, we realigned our
former ancillary services division in 1999 by integrating the physical
rehabilitation, speech and occupational therapy businesses into the health
services division and assigning the institutional pharmacy business to the
hospital division. Our respiratory therapy and other ancillary businesses were
discontinued.
45
Since November 1999, various legislative and regulatory actions have
provided a measure of relief from the impact of the Balanced Budget Act. In
November 1999, the BBRA was enacted. Effective April 1, 2000, the BBRA (a)
implemented a 20% upward adjustment in the payment rates for the care of higher
acuity patients, effective until the enactment of a revised Resource
Utilization Grouping payment system and (b) allowed nursing centers to
transition more rapidly to the federal payment rates. The BBRA also imposed a
two-year moratorium on certain therapy limitations for skilled nursing center
patients covered under Medicare Part B. Effective October 1, 2000, the BBRA
increased all PPS payment categories by 4% through September 30, 2002.
In April 2000, CMS published a proposed rule which set forth updates to the
Resource Utilization Grouping payment rates used under PPS for nursing centers.
On July 31, 2000, CMS issued a final rule that indefinitely postponed any
refinements to the Resource Utilization Grouping categories used under PPS. As
a result, the 20% upward adjustment for certain higher acuity Resource
Utilization Grouping categories set forth in the BBRA was automatically
extended until the Resource Utilization Grouping refinements are enacted. On
July 31, 2001, CMS issued another final rule which did not establish such
refinements, and accordingly, the 20% adjustment will remain in place until the
Resource Utilization Grouping categories are refined.
In December 2000, BIPA was enacted to provide up to $35 billion in
additional funding to the Medicare and Medicaid programs over the next five
years. Under BIPA, the nursing component for each Resource Utilization Grouping
category increased by 16.66% over the existing rates for skilled nursing care
for the period April 1, 2001 through September 30, 2002. BIPA also provided
some relief from scheduled reductions to the annual inflation adjustments to
the Resource Utilization Grouping payment rates through September 2002.
In addition, BIPA slightly increased payments for inpatient services and
TEFRA incentive payments for long-term acute care hospitals. Allowable costs
for bad debts also were increased by 15%. Both of these provisions became
effective for cost reporting periods beginning on or after September 1, 2001.
Despite the recent legislation and regulatory actions discussed above,
Medicare revenues recorded under PPS in our health services division are less
than the cost-based reimbursement we received before the enactment of the
Balanced Budget Act. In addition, the recent legislation did not impact
materially the reductions in Medicare revenues received by our hospitals as a
result of the Balanced Budget Act. Furthermore, we cannot assure you that the
increased revenues from the BBRA and BIPA will continue after September 30,
2002.
There continues to be legislative and regulatory proposals that would impose
more limitations on government and private payments to providers of healthcare
services. Congress has directed the Secretary of the U.S. Department of Health
and Human Services to develop a prospective payment system applicable
specifically to long-term acute care hospitals by October 1, 2001. The new
prospective payment system would be effective for cost report periods beginning
on or after October 1, 2002. This payment system would not impact us until
September 1, 2003. As of February 28, 2002, the Secretary had not proposed such
a prospective payment system. Congress has further directed that if the
Secretary is unable to implement a prospective payment system specific to
long-term acute care hospitals by October 1, 2002, the Secretary shall instead
implement, as of such date, a prospective payment system for long-term acute
care hospitals based upon existing hospital diagnosis-related groups modified
where feasible to account for resource use of long-term acute care hospital
patients. We cannot predict the content or timing of such regulations.
By repealing the Boren Amendment, the Balanced Budget Act eased existing
impediments on the ability of states to reduce their Medicaid reimbursement
levels. Many states are considering or have enacted measures that are designed
to reduce their Medicaid expenditures and to make certain changes to private
healthcare insurance. Some states also are considering regulatory changes that
include a moratorium on the designation of additional long-term acute care
hospitals. Additionally, regulatory changes in the Medicaid reimbursement
system applicable to the hospital division also are being considered. There
also are legislative proposals including cost caps and the establishment of
Medicaid prospective payment systems for nursing centers.
46
We could be affected adversely by the continuing efforts of governmental and
private third-party payors to contain healthcare costs. We cannot assure you
that payments under governmental and private third-party payor programs will
remain at levels comparable to present levels or will be sufficient to cover
the costs allocable to patients eligible for reimbursement pursuant to such
programs. In addition, we cannot assure you that the facilities we operate, or
the provision of services and supplies by us, will meet the requirements for
participation in such programs.
We cannot assure you that future healthcare legislation or other changes in
the administration or interpretation of governmental healthcare programs will
not have a material adverse effect on our results of operations, liquidity or
financial position.
Basis of Presentation
Since filing for protection under the Bankruptcy Code on September 13, 1999,
we had operated our businesses as a debtor-in-possession subject to the
jurisdiction of the Bankruptcy Court. Accordingly, our consolidated financial
statements were prepared in accordance with SOP 90-7 and generally accepted
accounting principles applicable to a going concern, which assume that assets
will be realized and liabilities will be discharged in the normal course of
business.
In connection with our emergence from bankruptcy, we reflected the terms of
the Plan of Reorganization in our consolidated financial statements by adopting
the fresh-start accounting provisions of SOP 90-7. Under fresh-start
accounting, a new reporting entity is deemed to be created and the recorded
amounts of assets and liabilities are adjusted to reflect their estimated fair
values. For accounting purposes, the fresh-start adjustments were recorded in
our consolidated financial statements as of April 1, 2001. Since fresh-start
accounting materially changed the amounts previously recorded in our
consolidated financial statements, a black line separates the post-emergence
financial data from the pre-emergence financial data to signify the difference
in the basis of preparation of the financial statements for each respective
entity. See note 3 of the notes to consolidated financial statements.
While the adoption of fresh-start accounting as of April 1, 2001 materially
changed the amounts previously recorded in our consolidated financial
statements, we believe that our business segment operating income prior to
April 1, 2001 is generally comparable to our business segment operating income
after April 1, 2001. However, our capital costs (rent, interest, depreciation
and amortization) prior to April 1, 2001 that were based on pre-petition
contractual agreements and historical costs are not comparable to those capital
costs recorded after April 1, 2001. In addition, our reported financial
position and cash flows for periods prior to April 1, 2001 generally are not
comparable to those for periods thereafter.
In connection with the implementation of fresh-start accounting, we recorded
an extraordinary gain of $422.8 million from the restructuring of our debt in
accordance with the provisions of the Plan of Reorganization. Other significant
adjustments also were recorded to reflect the provisions of the Plan of
Reorganization and the fair values of our assets and liabilities as of April 1,
2001. For accounting purposes, these transactions have been reflected in our
operating results for the three months ended March 31, 2001.
Critical Accounting Policies
Our discussion and analysis of the financial condition and results of
operations are based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these financial statements requires the
use of estimates and judgments that affect the reported amounts and related
disclosures of commitments and contingencies. We rely on historical experience
and on various other assumptions that we believe to be reasonable under the
circumstances to make judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
may differ materially from these estimates.
47
We believe the following critical accounting policies, among others, affect
the more significant judgments and estimates used in the preparation of our
consolidated financial statements.
Revenue recognition
We have agreements with third-party payors that provide for payments to our
hospitals and nursing centers. These payment arrangements may be based upon
prospective rates, reimbursable costs, established charges, discounted charges
or per diem payments. Net patient service revenue is reported at the estimated
net realizable amounts from Medicare, Medicaid, other third-party payors and
individual patients for services rendered. Retroactive adjustments that are
likely to result from future examinations by third-party payors are accrued on
an estimated basis in the period the related services are rendered and adjusted
as necessary in future periods based upon final settlements. See note 7 of the
notes to consolidated financial statements for a discussion of significant
changes in estimates for certain third-party reimbursements recorded in the
fourth quarter of 1999.
A summary of revenues by payor type follows (in thousands):
Reorganized |
Company | Predecessor Company
------------|-----------------------------------
Nine months |Three months
ended | ended Year ended December 31,
December 31,| March 31, ----------------------
2001 | 2001 2000 1999
------------|------------ ---------- ----------
Medicare......... $ 901,505 | $288,390 $1,050,758 $ 918,395
Medicaid......... 799,428 | 233,160 925,356 902,032
Private and other 673,794 | 245,532 969,557 906,849
---------- | -------- ---------- ----------
2,374,727 | 767,082 2,945,671 2,727,276
Elimination...... (45,708)| (14,673) (57,129) (61,635)
---------- | -------- ---------- ----------
$2,329,019 | $752,409 $2,888,542 $2,665,641
========== | ======== ========== ==========
Collectibility of accounts receivable
Accounts receivable consist primarily of amounts due from the Medicare and
Medicaid programs, other government programs, managed care health plans,
commercial insurance companies and individual patients. Estimated provisions
for doubtful accounts are recorded to the extent it is probable that a portion
or all of a particular account will not be collected.
In evaluating the collectibility of accounts receivable, we consider a
number of factors, including the age of the accounts, changes in collection
patterns, the composition of patient accounts by payor type, the status of
ongoing disputes with third-party payors and general industry conditions.
Actual collections of accounts receivable in subsequent periods may require
changes in the estimated provision for loss. Changes in these estimates are
charged or credited to the results of operations in the period of the change.
The provision for doubtful accounts totaled $16.3 million for the nine
months ended December 31, 2001, $6.3 million for the three months ended March
31, 2001, $28.9 million for 2000 and $114.6 million for 1999. See note 7 of the
notes to consolidated financial statements for a discussion of significant
provisions for doubtful accounts recorded in the fourth quarter of 1999.
Allowances for insurance risks
We insure a substantial portion of our professional liability risks and,
beginning in 2001, workers compensation through a wholly owned, limited purpose
insurance subsidiary. Provisions for loss for these risks
48
are based upon independent actuarially determined estimates. The allowance for
professional liability risks includes an amount determined from reported claims
and an amount, based on past experiences, for losses incurred but not reported.
These liabilities are necessarily based on estimates and, while management
believes that the provision for loss is adequate, the ultimate liability may be
in excess of or less than the amounts recorded. The methods used in determining
these liabilities are continually reviewed and any adjustments are currently
reflected in earnings.
The provision for self-insured professional liability risks aggregated $49.2
million for the nine months ended December 31, 2001, $12.0 million for the
three months ended March 31, 2001, $47.2 million for 2000 and $61.3 million for
1999. The provision for self-insured workers compensation risks was $21.0
million for the nine months ended December 31, 2001 and $8.0 million for the
three months ended March 31, 2001. The cost of workers compensation insurance
totaled $27.3 million for 2000 and $24.3 million for 1999. See note 7 of the
notes to consolidated financial statements for a description of significant
changes in estimates for professional liability risks recorded in the fourth
quarter of 1999.
Accounting for income taxes
The provision for income taxes is based upon our estimate of taxable income
or loss for each respective accounting period. We recognize an asset or
liability for the deferred tax consequences of temporary differences between
the tax bases of assets and liabilities and their reported amounts in the
financial statements. These temporary differences will result in taxable or
deductible amounts in future years when the reported amounts of assets are
recovered or liabilities are settled. We also recognize as deferred tax assets
the future tax benefits from net operating and capital loss carryforwards.
We have limited operating experience as a restructured organization.
Furthermore, there are significant uncertainties with respect to future
Medicare payments to both our nursing centers and hospitals which could affect
materially the realization of certain deferred tax assets. Accordingly, we have
recognized deferred tax assets related to net operating and capital loss
carryforwards only to the extent they are anticipated to be recognized through
2002. A valuation allowance is provided for deferred tax assets to the extent
the realizability of the deferred tax assets is uncertain. Net deferred tax
assets totaled $32.3 million at December 31, 2001.
If all or a portion of the pre-reorganization deferred tax asset is realized
in the future, or considered "more likely than not" to be realized by us, the
reorganization intangible recorded in connection with fresh-start accounting
will be reduced accordingly. If the reorganization intangible is eliminated in
full, other intangible assets will then be reduced, with any excess treated as
an increase to capital in excess of par value.
Valuation of long-lived assets and reorganization value in excess of amounts
allocable to identifiable assets
We regularly review the carrying value of certain long-lived assets and
identifiable intangible assets with respect to any events or circumstances that
indicate an impairment or an adjustment to the amortization period is
necessary. If circumstances suggest the recorded amounts cannot be recovered,
calculated based upon estimated future undiscounted cash flows, the carrying
values of these assets are reduced to fair value.
Reorganization value in excess of amounts allocable to identifiable assets
represents the portion of reorganization value that could not be attributable
to specific tangible or identified intangible assets recorded in connection
with fresh-start accounting. In connection with the June 2001 issuance of
Statement of Financial Accounting Standards ("SFAS") No. 142 ("SFAS 142"),
"Goodwill and Other Intangible Assets," we will cease to amortize
reorganization value in excess of amounts allocable to identifiable assets
beginning on January 1, 2002. In lieu of amortization, we are required to
perform a transitional impairment test for the excess reorganization value
recorded as of January 1, 2002. We do not currently expect to record an
impairment loss upon completion of the transitional impairment test. After the
transitional impairment test, the reorganization value and any additional
goodwill amounts must be tested annually for impairment using a fair-value
based approach.
49
Recent Accounting Pronouncements
In October 2001, the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of
Long-Lived Assets," which supersedes SFAS No. 121 ("SFAS 121"), "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of" and amends Accounting Principles Board Opinion No. 30 ("APB 30"),
"Reporting Results of Operations-Reporting the Effects of Disposal of a Segment
of a Business," by requiring that long-lived assets that are to be disposed of
by sale be measured at the lower of book value or fair value less the costs of
disposal. SFAS 144 eliminates the APB 30 requirements that discontinued
operations be measured at net realizable value, and that future operating
losses be included under "discontinued operations" in the financial statements.
This new pronouncement will become effective for us beginning on January 1,
2002.
In June 2001, the FASB issued SFAS No. 141 ("SFAS 141"), "Business
Combinations," which provides that all business combinations should be
accounted for using the purchase method of accounting and establishes criteria
for the initial recognition and measurement of goodwill and other intangible
assets recorded in connection with a business combination. The provisions of
SFAS 141 apply to all business combinations initiated after June 30, 2001 and
to all business combinations accounted for by the purchase method that are
completed after June 30, 2001.
As previously discussed, the FASB issued SFAS 142, which establishes the
accounting for goodwill and other intangible assets following their
recognition. SFAS 142 applies to all goodwill and other intangible assets
whether acquired singly, as part of a group, or in a business combination. SFAS
142 also applies to excess reorganization value recognized in accordance with
SOP 90-7. The new pronouncement provides that goodwill should not be amortized
but should be tested for impairment annually using a fair-value based approach.
In addition, SFAS 142 provides that intangible assets other than goodwill
should be amortized over their useful lives and reviewed for impairment in
accordance with existing guidelines. SFAS 142 will become effective for us
beginning on January 1, 2002. Upon adoption, we will be required to perform a
transitional impairment test for the excess reorganization value recorded as of
January 1, 2002. Any impairment loss recorded as a result of the transitional
impairment test will be treated as a change in accounting principle. The
adoption of SFAS 142 is not expected to result in an impairment to the excess
reorganization value recorded in the balance sheet at December 31, 2001. In
addition, amortization expense for 2002 will be reduced by approximately $6
million.
Effective January 1, 2001, we adopted SFAS No. 133 ("SFAS 133"), "Accounting
for Derivative Instruments and Hedging Activities." The adoption of SFAS 133
did not have a material impact on our financial position or results of
operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB 101"). SAB 101 provides guidance on revenue recognition and related
disclosures and was effective beginning October 1, 2000. We were previously
following the requirements provided under SAB 101 and, accordingly, the
implementation of this pronouncement had no impact on our financial position or
results of operations.
Effective January 1, 1999, we adopted SOP 98-5, "Reporting on the Costs of
Start-Up Activities" ("SOP 98-5"), which requires us to expense start-up costs,
including organizational costs, as incurred. In accordance with the provisions
of SOP 98-5, we wrote off $8.9 million of such unamortized costs as a
cumulative effect of a change in accounting principle in the first quarter of
1999.
In the first quarter of 1999, we adopted SOP 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP
98-1 provides guidance on accounting for the costs of computer software
developed or obtained for internal use. The adoption of SOP 98-1 did not have a
material effect on our consolidated financial position or results of operations.
50
Results of Operations
Since our adoption of fresh-start accounting did not have a material effect
on the comparability of our segment operating income, we have combined the
respective operating results of the Reorganized Company and the Predecessor
Company for fiscal 2001 and compared these results to the historical operating
results of the Predecessor Company for fiscal 2000 and 1999.
A summary of our operating data follows (dollars in thousands):
Reorganized | Predecessor
Company | Company Combined Predecessor Company
-----------------|-------------- ---------- ----------------------
Nine months | Three months Year ended December 31,
ended | ended ----------------------------------
December 31, 2001|March 31, 2001 2001 2000 1999
-----------------|-------------- ---------- ---------- ----------
Revenues: |
Health services division: |
Nursing centers............... $1,348,236 | $429,523 $1,777,759 $1,675,627 $1,594,244
Rehabilitation services....... 27,451 | 10,695 38,146 135,036 195,731
Other ancillary services...... - | - - - 43,527
Elimination................... - | - - (77,191) (128,267)
---------- | -------- ---------- ---------- ----------
1,375,687 | 440,218 1,815,905 1,733,472 1,705,235
Hospital division: |
Hospitals..................... 822,935 | 271,984 1,094,919 1,007,947 850,548
Pharmacy...................... 176,105 | 54,880 230,985 204,252 171,493
---------- | -------- ---------- ---------- ----------
999,040 | 326,864 1,325,904 1,212,199 1,022,041
---------- | -------- ---------- ---------- ----------
2,374,727 | 767,082 3,141,809 2,945,671 2,727,276
Elimination of pharmacy charges |
to our nursing centers....... (45,708) | (14,673) (60,381) (57,129) (61,635)
---------- | -------- ---------- ---------- ----------
$2,329,019 | $752,409 $3,081,428 $2,888,542 $2,665,641
========== | ======== ========== ========== ==========
Operating income (loss): |
Health services division: |
Nursing centers............... $ 234,500 | $ 70,543 $ 305,043 $ 278,738 $ 169,128
Rehabilitation services....... 8,112 | 690 8,802 8,047 2,891
Other ancillary services...... 508 | 250 758 4,737 4,166
---------- | -------- ---------- ---------- ----------
243,120 | 71,483 314,603 291,522 176,185
Hospital division: |
Hospitals..................... 157,613 | 54,778 212,391 205,858 132,050
Pharmacy...................... 20,831 | 6,176 27,007 7,421 342
---------- | -------- ---------- ---------- ----------
178,444 | 60,954 239,398 213,279 132,392
Corporate overhead............. (85,239) | (28,697) (113,936) (113,823) (108,947)
---------- | -------- ---------- ---------- ----------
336,325 | 103,740 440,065 390,978 199,630
Unusual transactions........... 5,425 | - 5,425 (4,701) (412,418)
Reorganization items........... - | 53,666 53,666 (12,636) (18,606)
---------- | -------- ---------- ---------- ----------
$ 341,750 | $157,406 $ 499,156 $ 373,641 $ (231,394)
========== | ======== ========== ========== ==========
51
Reorganized | Predecessor
Company | Company Combined Predecessor Company
-----------------|-------------- ----------- -----------------------
Nine months | Three months Year ended December 31,
ended | ended -----------------------------------
December 31, 2001|March 31, 2001 2001 2000 1999
-----------------|-------------- ----------- ----------- -----------
Nursing Center Data: |
Revenue mix %: |
Medicare................ 32 | 31 32 28 26
Medicaid................ 47 | 47 47 49 49
Private and other....... 21 | 22 21 23 25
|
Patient days (a): |
Medicare................ 1,218,663 | 411,783 1,630,446 1,541,934 1,436,288
Medicaid................ 5,750,949 | 1,860,256 7,611,205 7,735,567 7,718,963
Private and other....... 1,613,658 | 532,943 2,146,601 2,302,794 2,501,188
---------- | ---------- ----------- ----------- -----------
8,583,270 | 2,804,982 11,388,252 11,580,295 11,656,439
========== | ========== =========== =========== ===========
Revenues per patient day: |
Medicare................ $ 349 | $ 325 $ 343 $ 303 $ 290
Medicaid................ 111 | 109 111 106 101
Private and other....... 175 | 175 175 169 161
Weighted average...... 157 | 153 156 145 137
|
Hospital Data: |
Revenue mix %: |
Medicare................ 57 | 56 57 55 58
Medicaid................ 9 | 11 10 10 11
Private and other....... 34 | 33 33 35 31
|
Patient days: |
Medicare................ 534,583 | 185,731 720,314 704,152 669,976
Medicaid................ 103,377 | 34,872 138,249 134,754 119,849
Private and other....... 164,465 | 52,426 216,891 205,757 192,476
---------- | ---------- ----------- ----------- -----------
802,425 | 273,029 1,075,454 1,044,663 982,301
========== | ========== =========== =========== ===========
Revenues per patient day: |
Medicare................ $ 877 | $ 820 $ 862 $ 789 $ 740
Medicaid................ 733 | 871 768 773 743
Private and other....... 1,693 | 1,703 1,696 1,693 1,382
Weighted average...... 1,026 | 996 1,018 965 866
- --------
(a) Excludes managed facilities.
52
Health Services Division-Nursing Centers
Revenues increased 6% in 2001 to $1.8 billion. On a same-store basis, our
average daily patient census declined 1.4% from last year (including a 6.9%
decline in private census). Substantially all of the increase in revenues was
attributable to increased Medicare and Medicaid funding and price increases to
private payors. Medicaid revenues per patient day increased 5% in 2001, while
private rates grew by 3%. Medicare revenues per patient day grew 13% to $343 in
2001 compared to $303 last year. The increase in Medicare funding was primarily
attributable to reimbursement increases associated with the BBRA and BIPA. As
previously discussed, the BBRA established, among other things, a 20% increase
in Medicare payment rates for higher acuity patients effective April 1, 2000
and a 4% increase in all PPS payments beginning on October 1, 2000. Under the
provisions of BIPA, the nursing component of each Resource Utilization Grouping
category was increased 16.66% over the existing rates for skilled nursing care
beginning on April 1, 2001. As a result, the provisions of the BBRA increased
Medicare reimbursement to our nursing centers by approximately $47 million in
2001, while BIPA added approximately $30 million of additional revenues in 2001.
Revenues increased 5% in 2000 to $1.7 billion. Same-store patient days were
relatively unchanged in 2000 compared to 1999. Substantially all of the
increase in revenues was attributable to increased Medicare and Medicaid
funding and price increases to private payors. Medicaid and private payor rates
both increased approximately 5% in 2000 compared to 1999. Medicare revenues per
patient day grew 5% to $303 in 2000 from $290 in 1999 primarily as a result of
reimbursement increases approximating $21 million associated with the BBRA.
Nursing center operating income increased 9% in 2001 to $305 million.
Operating margins improved to 17.2% in 2001 from 16.6% last year. While our
operating income in 2001 was positively impacted by increased Medicare funding,
we also incurred substantial increases in professional liability and employee
health costs. Professional liability costs were $53 million in 2001 compared to
$40 million in 2000. Employee health costs increased to $53 million in 2001
from $46 million in 2000.
Nursing center operating income in 2000 totaled $279 million compared to
$169 million in 1999. A substantial portion of the improvement in 2000 resulted
from operating efficiencies related to the fourth quarter 1999 realignment of
our former ancillary services division and growth in revenues. In addition, the
provision for doubtful accounts declined in 2000 to $23 million from $51
million in 1999 as a result of improved collection processes.
Health Services Division-Rehabilitation Services
Revenues declined 72% in 2001 to $38 million. The decline in revenues was
primarily attributable to the transfer of all remaining rehabilitation services
provided to our company-operated nursing centers to the internal staff of those
nursing centers on January 1, 2001. Revenues for these services approximated
$77 million in 2000. Revenues also declined as a result of the elimination of
unprofitable external contracts.
Revenues declined 31% in 2000 to $135 million from $196 million in 1999. The
decline was primarily attributable to reduced customer demand for ancillary
services in response to fixed reimbursement rates under PPS and the elimination
of unprofitable external contracts. Approximately one-half of the revenue
decline in 2000 was attributable to nursing centers that we operate. Under PPS,
Medicare reimbursement for ancillary services provided to nursing center
patients is a component of the total reimbursement allowed per nursing center
patient. As a result, many nursing center customers (including our nursing
centers) elected to provide ancillary services to their patients through
internal staff and no longer contract with outside parties for ancillary
services.
Operating income totaled $9 million in 2001 compared to $8 million in 2000.
Substantially all of the operating income in both years resulted from contracts
with external customers. Revenues in 2000 for rehabilitation services provided
to our own nursing centers approximated the costs of these services. As a
result, the 2000 operating results do not reflect any operating income related
to intercompany transactions.
Operating income in 2000 increased to $8 million from $3 million in 1999.
The provision for doubtful accounts in 1999 was approximately $32 million
higher than in 2000, reflecting collection uncertainties related to financially
troubled nursing center customers.
53
While the health services division will continue to provide rehabilitation
services to nursing center customers, revenues and operating income related to
these services may decline.
Health Services Division-Other Ancillary Services
Other ancillary services refers to certain ancillary businesses (primarily
respiratory therapy) that were discontinued as part of the realignment of our
former ancillary services division in the fourth quarter of 1999. Operating
results for 2000 reflect a $4 million favorable adjustment for doubtful
accounts resulting from collections from discontinued customer accounts. See
note 5 of the notes to consolidated financial statements for a description of
the ancillary services division realignment.
Hospital Division-Hospitals
Revenues increased 9% in 2001 to $1.1 billion. Our hospital patient days
grew 3% and our aggregate revenues per patient day increased 6%. Medicare
revenues per patient day grew 9% while Medicaid and private rates were
relatively unchanged from last year. Our hospitals are paid by Medicare under
cost-based reimbursement rules, subject to certain limitations.
We provide care to patients covered by Medicare supplement insurance
policies which generally become effective when a patient's Medicare benefits
are exhausted. Disputes related to the level of payments to our hospitals have
arisen with private insurance companies issuing these policies as a result of
different interpretations of policy provisions and federal and state laws
governing the policies. While we continue to pursue favorable resolutions of
these claims, we recorded provisions for loss aggregating $17 million in 2001
and $20 million in 2000. See "Legal Proceedings."
Revenues increased 19% in 2000 to $1.0 billion from $851 million in 1999.
Revenues for 1999 were adversely impacted by certain third-party reimbursement
issues discussed below.
Prior to September 1999, our hospital Medicare revenues included
reimbursement for expenses related to certain costs associated with providing
hospital-based ancillary services to nursing center customers. The
U.S. Department of Justice objected to including these costs on the Medicare
cost reports filed by our hospitals. Medicare revenues related to the
reimbursement of these costs aggregated $18 million in 1999. In connection with
the negotiation of the government settlement during our bankruptcy, we agreed
to discontinue recording these revenues beginning September 1, 1999. Revenues
in 1999 also were reduced by adjustments for changes in estimates for certain
third-party reimbursements aggregating $60 million. Provisions for loss for the
Medicare supplement insurance disputes discussed above aggregated $19 million
in 1999.
Excluding the effect of the previously discussed third-party reimbursement
issues, including the Medicare supplement insurance disputes, hospital revenues
grew 13% to $1.03 billion in 2000 compared to $912 million in 1999. The
increase was primarily attributable to patient day growth of 6% in 2000. In
addition, price increases to private payors also contributed to hospital
revenue growth in 2000.
Hospital operating income rose 3% in 2001 to $212 million. Operating margins
declined to 19.4% in 2001 from 20.4% in 2000. Despite increases in patient
volumes and revenues, our hospital operating margins declined in 2001 primarily
as a result of growth in labor and benefit costs. Aggregate labor and benefit
costs increased 12% to $552 million in 2001 from $492 million in 2000. The rise
in labor costs is primarily attributable to increased rates of pay necessary to
attract and retain qualified nurses and other healthcare professionals. We
believe that hospital operating margins may decline in the future as a result
of these wage pressures.
Hospital operating income in 2000 totaled $206 million compared to $132
million in 1999. Excluding the previously discussed reimbursement issues,
operating income totaled $226 million in 2000 and $192 million in 1999. Growth
in adjusted operating income in 2000 was primarily attributable to revenue
growth.
54
Hospital Division-Pharmacy
Revenues increased 13% in 2001 to $231 million and 19% in 2000 to $204
million. The increase in both periods resulted primarily from growth in the
number of nursing center customers. At December 31, 2001, we provided pharmacy
services to nursing centers containing 56,400 licensed beds, including 29,600
licensed beds we operate. The aggregate number of customer licensed beds at
December 31, 2000 totaled 51,400 compared to 48,900 at December 31, 1999.
Our pharmacies reported operating income of $27 million in 2001 compared to
$7 million in 2000. Growth in pharmacy operating income resulted from increased
revenues and an improvement in the ratio of cost of goods sold to 60.1% in 2001
from 62.0% in 2000. We also substantially improved our cash collections in
2001, resulting in an $8 million reduction in the provision for doubtful
accounts.
Pharmacy operating income in 2000 grew to $7 million from $342,000 in 1999,
primarily as a result of increased revenues. The cost of goods sold ratio in
2000 increased to 62.0% from 58.6% in 1999.
Corporate Overhead
Operating income for our operating divisions excludes allocations of
corporate overhead. These costs aggregated $114 million in both 2001 and 2000
and $109 million in 1999. As a percentage of revenues (before eliminations),
corporate overhead totaled 3.6% in 2001, 3.9% in 2000 and 4.0% in 1999.
Fourth Quarter Adjustments in 1999
Preparation of the financial statements requires a number of estimates and
judgments that are based upon the best available evidence at the time. In
addition, management regularly reviews the methods used to recognize revenues
and allocate costs to ensure that the financial statements reflect properly the
results of interim periods.
In addition to the unusual transactions discussed below, during the fourth
quarter of 1999, we recorded certain adjustments which significantly impacted
operating results. A summary of these adjustments follows (in millions):
Health Services
Division
---------------- Hospital Division
Nursing Ancillary -----------------
Centers Services Hospitals Pharmacy Corporate Total
------- --------- --------- -------- --------- ------
(Income)/expense
Provision for doubtful accounts................ $40.2 $26.8 $ 6.5 $ 8.9 $ 82.4
Medicare supplement insurance disputes......... 18.8 18.8
Third-party reimbursements and contractual
allowances, including amounts due from
government agencies and other payors that are
subject to dispute........................... 2.0 59.6 61.6
Professional liability risks................... 14.7 0.4 1.8 0.1 17.0
Employee benefits.............................. (6.3) (1.5) (1.8) (9.6)
Incentive compensation......................... 2.2 (1.9) (1.1) (0.8)
Inventories.................................... 0.9 6.3 7.2
Other.......................................... 1.7 (0.4) 2.0 (4.4) $(2.8) (3.9)
----- ----- ----- ----- ----- ------
$55.4 $25.3 $85.0 $ 9.8 $(2.8) $172.7
===== ===== ===== ===== ===== ======
We regularly review our accounts receivable and record provisions for loss
based upon the best available evidence. Factors such as changes in collection
patterns, the composition of patient accounts by payor type, the status of
ongoing disputes with third-party payors (including both government and
non-government sources), the effect of increased regulatory activities, general
industry conditions and our financial condition and the financial condition of
our ancillary service customers, among other things, are considered by
management in determining the expected collectibility of accounts receivable.
55
During 1999, we recorded significant adjustments in the fourth quarter
related to contractual allowances and doubtful accounts in each of our
divisions. These adjustments represented changes in estimates resulting from
management's assessment of its collection processes, the general financial
deterioration of the long-term healthcare industry and the realignment of the
ancillary services business (including the cancellation of unprofitable
contracts and the discontinuance of certain services) and our bankruptcy filing
in September 1999.
In addition, we recorded a significant adjustment in the fourth quarter of
1999 related to professional liability risks. This adjustment was recorded
based upon actuarially determined estimates completed in the fourth quarter and
reflects substantial increases in claims and litigation activity in our nursing
center business during 1999.
Unusual Transactions
Operating results for each of the last three years include certain unusual
transactions. These transactions were included in other operating expenses in
the consolidated statement of operations for the respective periods in which
they were recorded. See note 6 of the notes to consolidated financial
statements.
2001
Operating results for 2001 included income of $3.2 million in the third
quarter related to the favorable resolution of certain litigation related to a
previously subleased nursing center facility. We also recorded a $2.2 million
gain in the fourth quarter in connection with the resolution of a loss
contingency related to a partnership interest.
2000
Operating results for 2000 included a $4.5 million gain on the sale of a
closed hospital recorded in the second quarter and a $9.2 million write-off of
an impaired investment recorded in the third quarter.
1999
The following table summarizes the pretax impact of unusual transactions
recorded during 1999 (in millions):
Quarters
-------------------------
First Second Third Fourth Year
----- ------ ----- ------ ------
(Income)/expense
Asset valuation losses:
Long-lived asset impairment..................... $330.4 $330.4
Investment in Behavioral Healthcare Corporation. $15.2 15.2
Cancellation of software development project....... 5.6 5.6
Realignment of ancillary services division......... 56.3 56.3
Retirement plan curtailment........................ 7.3 7.3
Corporate properties............................... (2.4) (2.4)
--- ----- --- ------ ------
$ - $20.8 $ - $391.6 $412.4
=== ===== === ====== ======
Long-lived asset impairment-SFAS 121 requires impairment losses to be
recognized for long-lived assets used in operations when indications of
impairment are present and the estimate of undiscounted future cash flows
56
is not sufficient to recover asset carrying amounts. SFAS 121 also requires
that long-lived assets held for disposal be carried at the lower of carrying
value or fair value less costs of disposal, once management has committed to a
plan of disposal.
Operating results and related cash flows for 1999 did not meet management's
expectations. These expectations were the basis upon which we valued our
long-lived assets at December 31, 1998, in accordance with SFAS 121. In
addition, certain events occurred in 1999 which had a negative impact on our
operating results and were expected to impact negatively our operations in the
future. In connection with the negotiation of the government settlement during
our bankruptcy, we agreed to exclude certain expenses from our hospital
Medicare cost reports beginning September 1, 1999 for which we had been
reimbursed in prior years. Medicare revenues related to the reimbursement of
such costs aggregated $18 million in 1999. In addition, hospital revenues in
1999 were reduced by approximately $19 million as a result of disputes with
certain insurers who issued Medicare supplement insurance policies to
individuals who became patients of our hospitals. We also reviewed the expected
impact of the BBRA enacted in November 1999 and the realignment of the
ancillary services business completed in the fourth quarter of 1999. The actual
and expected future impact of these issues served as an indication to
management that the carrying values of our long-lived assets may be impaired.
In accordance with SFAS 121, management estimated the future undiscounted
cash flows for each of its facilities and compared these estimates to the
carrying values of the underlying assets. As a result of these estimates, we
reduced the carrying amounts of the assets associated with 71 nursing centers
and 21 hospitals to their respective estimated fair values. The determination
of the fair values of the impaired facilities was based upon the net present
value of estimated future cash flows.
A summary of the impairment charges follows (in millions):
Property and
Goodwill Equipment Total
-------- ------------ ------
Health services division..... $ 18.3 $ 37.7 $ 56.0
Hospital division............ 198.9 75.5 274.4
------ ------ ------
$217.2 $113.2 $330.4
====== ====== ======
Investment in Behavioral Healthcare Corporation-In connection with the
Transitional merger, we acquired a 44% voting equity interest (61% equity
interest) in Behavioral Healthcare Corporation, an operator of psychiatric and
behavioral clinics. In the second quarter of 1999, we wrote off our remaining
investment in Behavioral Healthcare Corporation aggregating $15.2 million as a
result of deteriorating financial performance.
Cancellation of software development project-In the second quarter of 1999,
we canceled a nursing center software development project and charged
previously capitalized costs to operations.
Realignment of ancillary services division-As discussed in note 5 of the
notes to consolidated financial statements, we realigned our ancillary services
division in the fourth quarter of 1999. As a result, we recorded a charge
aggregating $56.3 million, including the write-off of goodwill totaling $42.3
million. The remainder of the charge related to the write-down of certain
equipment to net realizable value and the recording of employee severance costs.
Retirement plan curtailment-In December 1999, the Board of Directors
approved the curtailment of benefits under our supplemental executive
retirement plan, resulting in an actuarially determined charge of $7.3 million.
Under the terms of the curtailment, plan benefits were vested for each eligible
participant through December 31, 1999 and the accrual of future benefits under
the plan was substantially eliminated. The Board of Directors also deferred the
time at which certain benefits would be paid to eligible participants. The plan
was terminated in February 2001. However, the termination will have no effect
on the future payment of vested benefits under the plan.
57
Corporate properties-During 1999, we adjusted estimated property loss
provisions recorded in 1998, resulting in a pretax credit of $2.4 million.
Capital Costs
As previously discussed, the adjustments recorded in connection with
fresh-start accounting materially changed the recorded amounts for rent,
interest, depreciation and amortization in our consolidated statement of
operations for the nine months ended December 31, 2001. As a result, our
capital costs after April 1, 2001 are not comparable to our capital costs prior
to April 1, 2001.
Capital costs for the nine months ended December 31, 2001 reflect the terms
of the Plan of Reorganization and include the effects of reduced rent
obligations under the Master Lease Agreements and interest costs incurred in
connection with the debt obligations that we assumed at the time of our
emergence from bankruptcy. Depreciation and amortization for the nine month
period were recorded based on asset carrying amounts that were adjusted in
fresh-start accounting to reflect fair value on April 1, 2001.
During the pendency of our bankruptcy, we recorded the contractual amount of
interest expense related to our former $1.0 billion bank credit facility and
the rents due to Ventas under the pre-petition master lease agreements. No
interest costs were recorded related to our former $300 million 9 7/8%
Guaranteed Senior Subordinated Notes due 2005 since the filing of our
bankruptcy. Contractual interest expense not accrued for the $300 million
9 7/8% Guaranteed Senior Subordinated Notes totaled $7.3 million for the three
months ended March 31, 2001, $29.6 million for 2000 and $8.9 million for 1999.
Income Taxes
The provision for income taxes is based upon our estimate of taxable income
or loss for each respective accounting period and includes the effect of
certain non-taxable and non-deductible items, such as reorganization intangible
amortization and the increase or decrease in the deferred tax valuation
allowance.
We have reduced our net deferred tax assets by a valuation allowance to the
extent we do not believe it is "more likely than not" that the asset ultimately
will be realizable. If all or a portion of the pre-reorganization deferred tax
asset is realized in the future, or considered "more likely than not" to be
realizable by us, the reorganization intangible recorded in connection with
fresh-start accounting will be reduced accordingly. If the reorganization
intangible is eliminated in full, other intangible assets will then be reduced,
with any excess treated as an increase to capital in excess of par value. As of
December 31, 2001, we had reduced the valuation allowance established in
fresh-start accounting by approximately $44.6 million which resulted in a
corresponding reduction to reorganization value in excess of amounts allocable
to identifiable assets.
In connection with the reorganization, we realized a gain from the
extinguishment of certain indebtedness. This gain will not be taxable since the
gain resulted from the reorganization under the Bankruptcy Code. However, we
will be required, as of the beginning of our 2002 taxable year, to reduce
certain tax attributes including (a) net operating losses, (b) certain tax
credits and (c) tax bases in assets in an amount equal to such gain on
extinguishment. Our reorganization on April 20, 2001 constituted an ownership
change under Section 382 of the Internal Revenue Code and the use of any of our
net operating losses and tax credits generated prior to the ownership change,
that are not reduced pursuant to the provisions discussed above, will be
subject to an overall annual limitation of approximately $22 million.
Our net operating losses at December 31, 2001 approximated $257 million
after reductions in the attributes discussed above. These carryforwards expire
in various amounts through 2021.
58
Consolidated Results
We reported net income from operations of $47 million for the nine months
ended December 31, 2001, resulting from improved operating income and the
significant impact of the Plan of Reorganization. For the three months ended
March 31, 2001, we reported net income from operations of $49 million,
including a gain of $54 million recorded in connection with fresh-start
accounting. For 2000, we reported a net operating loss of $65 million,
including $13 million of costs incurred in connection with our restructuring
activities. Net losses from operations aggregated $705 million for 1999,
including $19 million of restructuring costs.
Liquidity
Cash flows from operations before reorganization items aggregated $191
million for the nine months ended December 31, 2001, $40 million for the three
months ended March 31, 2001, $194 million for 2000 and $247 million for 1999.
Operating cash flows for all periods were sufficient to fund reorganization
costs and capital expenditures.
Cash and cash equivalents totaled $191 million at December 31, 2001. Based
upon our cash position, expected cash flows, capital spending and the
availability of borrowings under our revolving credit facility, we believe we
have the necessary financial resources to satisfy our expected liquidity needs
on both a short-term and long-term basis.
In May 2001, we repaid approximately $56 million in full satisfaction of our
obligation owed to CMS. The transaction was financed through the use of
existing cash. In the fourth quarter of 2001, we completed the public offering
of approximately 2.1 million shares of our common stock. Proceeds from the
offering aggregating $90 million were used to repay a portion of our
outstanding senior secured notes.
In connection with the emergence from bankruptcy, we entered into a
five-year $120 million revolving credit facility (including a $40 million
letter of credit subfacility) on April 20, 2001. Our revolving credit facility
constitutes a working capital facility for general corporate purposes including
payments related to our obligations under the Plan of Reorganization. Direct
borrowings under our revolving credit facility will bear interest, at our
option, at (a) prime (or, if higher, the federal funds rate plus 1/2%) plus 3%
or (b) the London Interbank Offered Rate (as defined in the agreement) plus 4%.
The revolving credit facility is collateralized by substantially all of our
assets, including certain owned real property. In connection with our equity
offering, the amount of available borrowings under the revolving credit
facility was reduced to $75 million. At December 31, 2001, there were no
outstanding borrowings under our revolving credit facility.
As part of our Plan of Reorganization, we also issued $300 million of senior
secured notes on April 20, 2001. Our senior secured notes have a maturity of
seven years and bear interest at the London Interbank Offered Rate (as defined
in the agreement) plus 4 1/2%. The interest on our $300 million senior secured
notes began to accrue in November 2001. For accounting purposes, we recorded
the appropriate interest costs from April 2001 to November 2001 and intend to
amortize the amount accrued during the interest-free period over the remaining
life of the debt. Our senior secured notes are collateralized by a second
priority lien on substantially all of our assets, including certain owned real
property.
The terms of our senior secured notes and our revolving credit facility
include certain covenants which limit our annual capital expenditures and limit
the amount of debt we may incur in financing acquisitions. In addition, these
agreements restrict our ability to transfer funds to the parent company or
repurchase our common stock and prohibit the payment of cash dividends to our
stockholders. At December 31, 2001, we were in compliance with the terms of our
revolving credit facility and our senior secured notes.
59
Future payments due under long-term debt, lease obligations and certain
other contractual commitments as of December 31, 2001 follows (in thousands):
Payments Due by Period
-----------------------------------------------------------------------------------------
Letters of General
Senior Other Non-cancelable Operating Leases Credit and Unsecured
Secured Long-term ------------------------------- Guarantees Creditor
Year Notes Debt Ventas(a) Other Total of Indebtedness Obligations Total
- ---- -------- --------- ---------- -------- ---------- --------------- ----------- ----------
2002...... $ - $ 418 $ 180,714 $ 51,056 $ 231,770 $1,741 $ 6,166 $ 240,095
2003...... - 258 180,714 44,558 225,272 - 5,720 231,250
2004...... - 63 180,714 34,062 214,776 - 2,860 217,699
2005...... - 69 180,714 32,476 213,190 - - 213,259
2006...... - 75 180,714 29,414 210,128 6,314 - 216,517
Thereafter 210,500 1,304 610,928 118,084 729,012 - - 940,816
-------- ------ ---------- -------- ---------- ------ ------- ----------
Total... $210,500 $2,187 $1,514,498 $309,650 $1,824,148 $8,055 $14,746 $2,059,636
======== ====== ========== ======== ========== ====== ======= ==========
- --------
(a) See "Business-Master Lease Agreements-Rental Amounts and Escalators."
As previously reported, we were informed by the U.S. Department of Justice
that we and Ventas were the subjects of ongoing investigations into various
Medicare reimbursement issues, including hospital cost reporting issues,
ancillary services billing practices and various quality of care issues in the
hospitals and nursing centers formerly operated by Ventas and currently
operated by us. The claims of the Department of Justice were settled through
the government settlement contained in the Plan of Reorganization. The
government settlement also provides for the dismissal of certain pending claims
and lawsuits filed against us. See notes 2 and 21 of the notes to consolidated
financial statements and "Legal Proceedings."
In January 2000, we filed our hospital cost reports for the year ended
August 31, 1999. These documents are filed annually in settlement of amounts
due to or from the various agencies administering the reimbursement programs.
These cost reports indicated amounts due to Medicare aggregating $58 million.
This liability arose during 1999 as part of our routine settlement of Medicare
reimbursement overpayments. Such amounts were classified as liabilities subject
to compromise in our unaudited condensed consolidated balance sheet and,
accordingly, no funds were disbursed by us in settlement of such pre-petition
liabilities. Under the terms of the Plan of Reorganization, this obligation was
discharged.
Capital Resources
Capital expenditures totaled $79 million for the nine months ended December
31, 2001, $22 million for the three months ended March 31, 2001, $80 million
for 2000 and $111 million for 1999. Excluding acquisitions, capital
expenditures could approximate $75 million in 2002. We believe that our capital
expenditure program is adequate to improve and equip existing facilities.
Capital expenditures in all periods were financed through internally generated
funds. At December 31, 2001, the estimated cost to complete and equip
construction in progress approximated $9 million.
In May 2001, we sold our investment in Behavioral Healthcare Corporation for
$40 million. Under the terms of our revolving credit facility and senior
secured notes, proceeds from the sale of assets will be available to fund
future capital expenditures for a period of approximately one year from the
sale. Any proceeds not expended during that period would be used to permanently
reduce the commitments under our revolving credit facility to as low as $75
million and repay any outstanding loans in excess of such commitment. Any
remaining proceeds would be used to repay loans under our senior secured notes.
For accounting purposes, we have classified the $6 million of remaining funds
from the sales of assets as "cash-restricted" in our consolidated balance sheet
at December 31, 2001.
60
Related Party Transactions
Pursuant to the Plan of Reorganization, we issued to certain claimholders in
exchange for their claims an aggregate of (1) $300 million of our senior
secured notes, (2) 15,000,000 shares of common stock, (3) 2,000,000 Series A
warrants, and (4) 5,000,000 Series B warrants. Each of the Series A warrants
and the Series B warrants have a five-year term with an exercise price of
$30.00 and $33.33 per share, respectively. As a result of the exchange
described above, the holders of certain claims acquired control of us and the
holders of our former common stock relinquished control.
In connection with the Plan of Reorganization, we also entered into a
registration rights agreement with Appaloosa Management L.P., Franklin Mutual
Advisers, LLC, Goldman, Sachs & Co. and Ventas Realty, Limited Partnership (the
"Registration Rights Agreement"). The Registration Rights Agreement requires us
to use our reasonable best efforts to file, cause to be declared effective and
keep effective for at least two years or until all of their shares of common
stock or warrants are sold, a "shelf" registration statement covering sales of
such security holders' shares of common stock and warrants or, in the case of
Ventas, the distribution of some or all of the shares of our common stock that
it owns to the Ventas stockholders. We filed the shelf registration statement
on Form S-3 with the Securities and Exchange Commission on September 19, 2001.
The shelf registration statement became effective on November 7, 2001.
The Registration Rights Agreement also provides that, subject to certain
limitations, each security holder party thereto has the right to demand that we
register all or a part of the common stock and warrants acquired by that
security holder pursuant to the Plan of Reorganization, provided that the
estimated market value of the common stock and warrants to be registered is at
least $10 million in the aggregate or not less than 5% of the common stock and
warrants. We are required to use our reasonable best efforts to effect any such
registration. Such registrations will be at our expense, subject to certain
exceptions.
In addition, under the Registration Rights Agreement, the security holders
party thereto have certain rights to require us to include in any registration
statement that we file with respect to any offering of equity securities
(whether for our own account or for the account of any holders of our
securities) such amount of common stock and warrants as are requested by the
security holder to be included in the registration statement, subject to
certain exceptions. Such registrations will be at our expense, subject to
certain exceptions. As discussed below, the parties to the Registration Rights
Agreement participated in our public equity offering in the fourth quarter of
2001.
Pursuant to Amendment No. 1 to the Registration Rights Agreement dated as of
August 13, 2001, the parties to the Registration Rights Agreement agreed to
extend the deadline for us to file a "shelf" registration statement from 120
days to 150 days after the Effective Date. As noted above, we filed a shelf
registration statement with the Securities and Exchange Commission on September
19, 2001 and the shelf registration statement was declared effective on
November 7, 2001.
Pursuant to Amendment No. 2 to the Registration Rights Agreement dated as of
October 22, 2001, the parties to the Registration Rights Agreement agreed to an
exception to certain restrictions in the Registration Rights Agreement to allow
Ventas to distribute up to 350,000 shares of our common stock that it owns to
its stockholders on or after December 24, 2001.
In the fourth quarter of 2001, we completed a public offering of
approximately 3.6 million shares of our common stock priced at $46.00 per
share. In the offering, we sold approximately 2.1 million newly issued shares
and certain of the holders of five percent or more of our common stock
participated in the offering as selling shareholders.
61
In addition, Goldman, Sachs & Co. acted as co-lead manager in the public
offering. In accordance with the underwriting agreement entered into between
various parties, including us and Goldman, we paid Goldman approximately $2.9
million in underwriting commissions.
In connection with the Plan of Reorganization, we also entered into and
assumed several agreements with Ventas. In addition to our common stock
received by Ventas, we amended and restated the Master Lease Agreements with
Ventas and paid Ventas a $4.5 million cash payment in April 2001 as additional
future rent. We also assumed and agreed to continue to perform our obligations
under various agreements (the "Spin-off Agreements") entered into at the time
of the Spin-off. Descriptions of the agreements with Ventas are summarized
below.
Master Lease Agreements
Under the Plan of Reorganization, we assumed the original master lease
agreements with Ventas and its affiliates and simultaneously amended and
restated the agreements into the Master Lease Agreements. See "Business-Master
Lease Agreements."
Spin-off Agreements and Other Arrangements Under the Plan of Reorganization
In order to govern certain of the relationships between us and Ventas after
the Spin-off and to provide mechanisms for an orderly transition, we entered
into the Spin-off Agreements with Ventas at the time of the Spin-off. Except as
noted below, the following agreements between Ventas and us were assumed by us
and certain of these agreements were simultaneously amended in accordance with
the terms of the Plan of Reorganization.
Tax Allocation Agreement and Tax Refund Escrow Agreement
The Tax Allocation Agreement, entered into at the time of the Spin-off, was
assumed by us under the Plan of Reorganization and then amended and
supplemented by the Tax Refund Escrow Agreement (as defined below). Both of
these agreements are described below.
The Tax Allocation Agreement provides that we will be liable for, and will
hold Ventas harmless from and against, (1) any taxes of Kindred and its then
subsidiaries (the "Kindred Group") for periods after the Spin-off, (2) any
taxes of Ventas and its then subsidiaries (the "Ventas Group") or the Kindred
Group for periods prior to the Spin-off (other than taxes associated with the
Spin-off) with respect to the portion of such taxes attributable to assets
owned by the Kindred Group immediately after completion of the Spin-off and (3)
any taxes attributable to the Spin-off to the extent that we derive certain tax
benefits as a result of the payment of such taxes. Under the Tax Allocation
Agreement, we would be entitled to any refund or credit in respect of taxes
owed or paid by us under (1), (2) or (3) above. Our liability for taxes for
purposes of the Tax Allocation Agreement would be measured by Ventas' actual
liability for taxes after applying certain tax benefits otherwise available to
Ventas other than tax benefits that Ventas in good faith determines would
actually offset tax liabilities of Ventas in other taxable years or periods.
Any right to a refund for purposes of the Tax Allocation Agreement would be
measured by the actual refund or credit attributable to the adjustment without
regard to offsetting tax attributes of Ventas.
Under the Tax Allocation Agreement, Ventas would be liable for, and would
hold us harmless against, any taxes imposed on the Ventas Group or the Kindred
Group other than taxes for which the Kindred Group is liable as described in
the above paragraph. Ventas would be entitled to any refund or credit for taxes
owed or paid by Ventas as described in this paragraph. Ventas' liability for
taxes for purposes of the Tax Allocation Agreement would be measured by the
Kindred Group's actual liability for taxes after applying certain tax benefits
otherwise available to the Kindred Group other than tax benefits that the
Kindred Group in good faith determines would actually offset tax liabilities of
the Kindred Group in other taxable years or periods. Any right to a refund
would be measured by the actual refund or credit attributable to the adjustment
without regard to offsetting tax attributes of the Kindred Group.
62
On the Effective Date, we entered into the Tax Refund Escrow Agreement and
First Amendment to the Tax Allocation Agreement (the "Tax Refund Escrow
Agreement") with Ventas governing our relative entitlement to certain tax
refunds received on or after September 13, 1999 by Ventas or us for the tax
periods prior to and including the Spin-off that each has received or may
receive in the future. The Tax Refund Escrow Agreement amends and supplements
the Tax Allocation Agreement. Under the terms of the Tax Refund Escrow
Agreement, refunds ("Subject Refunds") received on or after September 13, 1999
by either Ventas or us with respect to federal, state or local income, gross
receipts, windfall profits, transfer, duty, value-added, property, franchise,
license, excise, sales and use, capital, employment, withholding, payroll,
occupational or similar business taxes (including interest, penalties and
additions to tax, but excluding certain refunds), for taxable periods ending on
or prior to May 1, 1998 ("Subject Taxes") were deposited into an escrow account
with a third-party escrow agent on the Effective Date.
The Tax Refund Escrow Agreement provides that each party shall notify the
other of any asserted Subject Tax liability of which it becomes aware, that
either party may request that asserted liabilities for Subject Taxes be
contested, that neither party may settle such a contest without the consent of
the other, that each party shall have a right to participate in any such
contest, and that the parties generally shall cooperate with regard to Subject
Taxes and Subject Refunds and shall mutually and jointly control any audit or
review process related thereto. The funds in the escrow account may be released
from the escrow account to pay Subject Taxes and as otherwise provided therein.
The Tax Refund Escrow Agreement provides generally that we and Ventas waive
our respective rights under the Tax Allocation Agreement to make claims against
each other with respect to Subject Taxes satisfied by the escrow funds,
notwithstanding the indemnification provisions of the Tax Allocation Agreement.
To the extent that the escrow funds are insufficient to satisfy all liabilities
for Subject Taxes that are finally determined to be due (such excess amount,
"Excess Taxes"), the relative liability of Ventas and Kindred to pay such
Excess Taxes shall be determined as provided in the Tax Refund Escrow
Agreement. Disputes under the Tax Refund Escrow Agreement, and the
determination of the relative liability of Ventas and Kindred to pay Excess
Taxes, if any, are governed by the arbitration provision of the Tax Allocation
Agreement.
Interest earned on the escrow funds or included in refund amounts received
from governmental authorities will be distributed equally to us and Ventas on
an annual basis. For the year ended December 31, 2001, we have recorded
approximately $368,000 of interest income related to the escrow funds. Any
escrow funds remaining in the escrow account after no further claims may be
made by governmental authorities with respect to Subject Taxes or Subject
Refunds (because of the expiration of statutes of limitation or otherwise) will
be distributed equally to us and Ventas.
Agreement of Indemnity-Third Party Leases
In connection with the Spin-off, Ventas assigned its former third-party
lease obligations (i.e., leases under which an unrelated third party is the
landlord) as a tenant or as a guarantor of tenant to us. The lessors of these
properties may claim that Ventas remains liable on these third-party leases
assigned to us. Under the terms of the Agreement of Indemnity-Third Party
Leases, we have agreed to indemnify and hold Ventas harmless from and against
all claims against Ventas arising out of these third-party leases. Under the
Plan of Reorganization, we assumed and agreed to fulfill our obligations under
the Agreement of Indemnity-Third Party Leases.
Agreement of Indemnity-Third Party Contracts
In connection with the Spin-off, Ventas assigned its former third-party
guaranty agreements to us. Ventas may remain liable on these third-party
guarantees assigned to us. Under the terms of the Agreement of Indemnity-Third
Party Contracts, we have agreed to indemnify and hold Ventas harmless from and
against all claims against Ventas arising out of these third-party guarantees
assigned to us. The third-party guarantees were entered into in connection with
certain acquisitions and financing transactions that occurred prior to the
Spin-off. Under the Plan of Reorganization, we assumed and agreed to fulfill
our obligations under the Agreement of Indemnity-Third Party Contracts.
63
Assumption of Other Liabilities
In connection with the Spin-off, we agreed to assume and to indemnify Ventas
for any and all liabilities that may arise out of the ownership or operation of
the healthcare operations either before or after the date of the Spin-off. The
indemnification provided by us also covers losses, including costs and
expenses, which may arise from any future claims asserted against Ventas based
on these healthcare operations. In addition, at the time of the Spin-off, we
agreed to assume the defense, on behalf of Ventas, of any claims that were
pending at the time of the Spin-off, and which arose out of the ownership or
operation of the healthcare operations. We also agreed to defend, on behalf of
Ventas, any claims asserted after the Spin-off which arise out of the ownership
and operation of the healthcare operations. Under the Plan of Reorganization,
we assumed and agreed to perform our obligations under these indemnifications.
In connection with the Spin-off, we entered into a Development Agreement and
a Participation Agreement with Ventas. Under the terms of the Development
Agreement, we agreed that upon completion of each development property, Ventas
would have the option to purchase the development property from us at a
purchase price equal to the amount of our actual costs in acquiring, developing
and improving such development property prior to the purchase date. If Ventas
purchased the development property, we would lease the development property
from Ventas. The annual base rent under such a lease would have been ten
percent of the actual costs incurred by us in acquiring and developing the
development property. The other terms of the lease for the development property
would have been substantially similar to those set forth in the original master
lease agreements.
Under the terms of the Participation Agreement, we had a right of first
offer to become the lessee of any real property acquired or developed by Ventas
which was to be operated as a hospital, nursing center or other healthcare
facility, provided that we negotiated a mutually satisfactory lease arrangement
with Ventas. The Participation Agreement also provided, subject to certain
terms, that we would provide Ventas with a right of first offer to purchase or
finance any healthcare related real property that we determined to sell or
mortgage to a third party, provided that we negotiated mutually satisfactory
terms for such purchase or mortgage with Ventas.
The Participation Agreement and the Development Agreement were terminated on
the Effective Date. Kindred and Ventas are deemed to have waived any and all
damages, claims, liabilities, obligations, and causes of action related to or
arising out of these agreements.
Terminated Arrangements with Ventas
We also entered into certain agreements, stipulations and orders with Ventas
both prior to and during the pendency of our bankruptcy proceedings governing
certain aspects of the business relationships between us and Ventas prior to
the Effective Date. In March 1999, we served Ventas with a demand for mediation
seeking a reduction in rent and other concessions under our former master lease
agreements with Ventas. Shortly thereafter, we entered into a series of
standstill and tolling agreements with Ventas which provided that both
companies would postpone any claims either may have against the other and
extend any applicable statutes of limitation. As a result of our failure to pay
rent, Ventas served us with notices of nonpayment under the original master
lease agreements. Subsequently, we entered into further amendments to the
second standstill and the tolling agreements with Ventas to extend the time
during which no remedies may be pursued by either party and to extend the date
by which we could cure our failure to pay rent.
In connection with the bankruptcy, we entered into a stipulation with Ventas
that provided for the payment by us of a reduced aggregate monthly rent of
approximately $15.1 million. The Bankruptcy Court approved the stipulation. The
stipulation also continued to toll any statutes of limitations for claims that
might have been asserted by us against Ventas and provided that we would
continue to fulfill our indemnification obligations arising from the Spin-off.
The stipulation automatically renewed for one-month periods unless either party
provided a 14-day notice of termination.
64
In May 2000, the Bankruptcy Court approved a tax stipulation agreement
between us and Ventas. The tax stipulation provided that certain refunds of
federal, state and local taxes received by either party on or after September
13, 1999 would be held by the recipient of such refunds in segregated interest
bearing accounts. The tax stipulation required notification before either party
could withdraw funds from the segregated accounts.
The stipulation and tax stipulation were each terminated on the Effective
Date and are of no further force or effect.
Other Related Party Transactions
As part of the Spin-off, we issued $17.7 million of our former 6% Series A
Non-Voting Convertible Preferred Stock to Ventas as part of the consideration
for the assets transferred from Ventas to us. The former preferred stock (par
value $1,000) included a ten-year mandatory redemption provision and was
convertible into our former common stock at a price of $12.50 per share. In
connection with the purchases of the former preferred stock, we loaned certain
officers 90% of the purchase price ($15.9 million) of the former preferred
stock (the "Preferred Stock Loans"). Each Preferred Stock Loan was evidenced by
a promissory note which had a ten year term and bore interest at 5.74%, payable
annually. No principal payments were due under the promissory notes until their
maturity. The promissory notes were secured by a first priority security
interest in the former preferred stock purchased by each such officer. As of
December 31, 2000, $15.7 million of these loans remained outstanding. The terms
of the Preferred Stock Loans with certain former officers were amended in
connection with their severance agreements to provide, generally, that (a) the
Preferred Stock Loan will not be due and payable until April 30, 2008, (b)
payments on the Preferred Stock Loan will be deferred until the fifth
anniversary of the date of termination, (c) interest payments will be forgiven
if the average closing price of the former common stock for the 90 days prior
to any interest payment date is less than $8.00 and (d) during the five-day
period following the expiration of the fifth anniversary of the date of
termination, the former officer would have had the right to put the former
preferred stock underlying the Preferred Stock Loan to us at par.
In August 1999, we entered into agreements with certain officers which
permitted such officer to put the former preferred stock to us for an amount
equal to the outstanding principal and interest on the officer's Preferred
Stock Loan (the "Preferred Stock Agreements"). The officer could put the former
preferred stock to us after January 1, 2000. During our bankruptcy, we could
not honor the terms of the Preferred Stock Agreements. The Preferred Stock
Agreements were entered into with each officer employed by us in August 1999
who owned the former preferred stock.
Under the terms of the Plan of Reorganization, the Preferred Stock
Agreements were canceled in exchange for the cancellation of the Preferred
Stock Loans. In addition, the former preferred stock was canceled without any
consideration.
Other Information
Effects of Inflation and Changing Prices
We derive a substantial portion of our revenues from the Medicare and
Medicaid programs. In recent years, significant cost containment measures
enacted by Congress and certain state legislatures have limited our ability to
recover our cost increases through increased pricing of our healthcare
services. Medicare revenues in our nursing centers are subject to fixed
payments under PPS. Medicaid reimbursement rates in many states in which we
operate nursing centers also are based on fixed payment systems. Generally,
these rates are adjusted annually for inflation. However, these adjustments may
not reflect the actual increase in our costs of providing healthcare services.
In addition, by repealing the Boren Amendment, the Balanced Budget Act eased
existing impediments on the states' ability to reduce their Medicaid
reimbursement levels to our nursing centers. Medicare revenues in our hospitals
also have been reduced by the Balanced Budget Act.
65
During 2000, the BBRA provided a measure of relief to the Medicare
reimbursement reductions imposed by the Balanced Budget Act. Effective April 1,
2001, BIPA provided additional Medicare reimbursement to our nursing centers
and hospitals. We believe that the provisions of the BBRA and BIPA will have a
positive effect on our operating results in 2002, particularly in the health
services division. However, the 4% increase in all PPS payments under the BBRA
and the 16.66% increase in the skilled nursing care component of each Resource
Utilization Grouping category under BIPA are scheduled to expire on September
30, 2002. We cannot assure you that these Medicare reimbursement increases will
continue after September 30, 2002.
We believe that our operating margins may continue to be under pressure
because of continuing regulatory scrutiny and growth in operating expenses,
including labor costs and professional liability claims, in excess of increases
in payments by third-party payors. In addition, as a result of competitive
pressures, our ability to maintain operating margins through price increases to
private patients is limited.
Litigation
We are a party to certain material litigation. See "Legal Proceedings."
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The following discussion of our exposure to market risk contains
"forward-looking statements" that involve risks and uncertainties. The
information presented has been prepared using certain assumptions considered
reasonable in light of information currently available to us. Given the
unpredictability of interest rates as well as other factors, actual results
could differ materially from those projected in such forward-looking
information.
Our only significant exposure to market risk relates to changes in the
London Interbank Offered Rate which affect the interest paid on our borrowings.
The following table provides information about our financial instruments
that are sensitive to changes in interest rates. The table presents principal
cash flows and related weighted average interest rates by expected maturity
date.
Interest Rate Sensitivity
Principal (Notional) Amount by Expected Maturity
Average Interest Rate
(Dollars in thousands)
Expected Maturities Fair
--------------------------------------- Value
2002 2003 2004 2005 2006 Thereafter Total 12/31/01
---- ---- ---- ---- ---- ---------- -------- --------
Liabilities:
Long-term debt, including amounts due within one
year:
Fixed rate................................... $418 $258 $ 63 $ 69 $ 75 $ 1,304 $ 2,187 $ 2,246
Average interest rate........................ 9.8% 9.7% 8.8% 8.8% 8.8% 8.8%
Variable rate................................ $ - $ - $ - $ - $ - $210,500 $210,500 $210,500
Average interest rate (a)
- --------
(a) Interest is payable, at our option, at one, two, three or six month London
Interbank Offered Rate plus 4 1/2%.
Item 8. Financial Statements and Supplementary Data
The information required by this Item 8 is included in appendix pages F-2
through F-48 of this Annual Report on Form 10-K.
66
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Items 10, 11, 12 and 13. Directors and Executive Officers of the Registrant;
Executive Compensation; Security Ownership of Certain Beneficial Owners and
Management; and Certain Relationships and Related Transactions
The information required by these Items other than the information set forth
above under Part I, "Executive Officers of the Registrant," is omitted because
we are filing a definitive proxy statement pursuant to Regulation 14A not later
than 120 days after the end of the fiscal year covered by this Annual Report on
Form 10-K which includes the required information. The required information
contained in our proxy statement is incorporated herein by reference.
67
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) Index to Consolidated Financial Statements and Financial Statement
Schedules:
Page
----
Report of Independent Accountants............................................................ F-2
Consolidated Financial Statements:
Consolidated Statement of Operations:
Reorganized Company-for the nine months ended December 31, 2001
Predecessor Company-for the three months ended March 31, 2001 and for the years ended
December 31, 2000 and 1999............................................................ F-3
Consolidated Balance Sheet:
Reorganized Company-December 31, 2001
Predecessor Company-December 31, 2000................................................... F-4
Consolidated Statement of Stockholders' Equity (Deficit):
Reorganized Company-for the nine months ended December 31, 2001
Predecessor Company-for the three months ended March 31, 2001 and for the years ended
December 31, 2000 and 1999............................................................ F-5
Consolidated Statement of Cash Flows:
Reorganized Company-for the nine months ended December 31, 2001
Predecessor Company-for the three months ended March 31, 2001 and for the years ended
December 31, 2000 and 1999............................................................ F-6
Notes to Consolidated Financial Statements................................................ F-7
Quarterly Consolidated Financial Information (Unaudited).................................. F-47
Financial Statement Schedule (a):
Schedule II-Valuation and Qualifying Accounts:
Reorganized Company-for the nine months ended December 31, 2001
Predecessor Company-for the three months ended March 31, 2001 and for the years ended
December 31, 2000 and 1999............................................................ F-48
- --------
(a) All other schedules have been omitted because the required information is
not present or not present in material amounts.
68
(a)(2) Index to Exhibits:
Exhibit
Number Description of Document
- ------ -----------------------
2.1 Fourth Amended Joint Plan of Reorganization of Vencor, Inc. and Affiliated Debtors under Chapter 11
of the Bankruptcy Code. Exhibit 2.1 to the Current Report on Form 8-K of the Company dated
March 19, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
2.2 Order Confirming the Fourth Amended Joint Plan of Reorganization of Vencor, Inc. and Affiliated
Debtors under Chapter 11 of the Bankruptcy Code, as entered by the United States Bankruptcy Court
for the District of Delaware on March 16, 2001. Exhibit 2.2 to the Current Report on Form 8-K of the
Company dated March 19, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
3.1 Amended and Restated Certificate of Incorporation of the Company. Exhibit 4.1 to the Company's
Registration Statement on Form S-3 filed August 31, 2001 (Comm. File No. 333-68838) is hereby
incorporated by reference.
3.2 Amended and Restated Bylaws of the Company.
4.1 Articles IV, IX, X and XII of the Restated Certificate of Incorporation of the Company is included in
Exhibit 3.1.
4.2 Warrant Agreement, dated as of April 20, 2001, between the Company and Wells Fargo Bank
Minnesota, National Association, as Warrant Agent (including forms of Series A Warrant Certificate
and Series B Warrant Certificate, respectively). Exhibit 4.1 to the Company's Form 8-A dated
April 20, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
4.3 The Company's 2000 Stock Option Plan. Exhibit 4.1 to the Company's Registration Statement on
Form S-8 (Reg. No. 333-59598) is hereby incorporated by reference.
4.4 The Company's Restricted Share Plan. Exhibit 4.2 to the Company's Registration Statement on
Form S-8 (Reg. No. 333-59598) is hereby incorporated by reference.
4.5 Kindred Healthcare, Inc. 2001 Stock Option Plan. Exhibit 4.1 to the Company's Registration Statement
on Form S-8 (Reg. No. 333-62022) is hereby incorporated by reference.
4.6 Kindred Healthcare, Inc. 2001 Stock Option Plan for Non-Employee Directors. Exhibit 4.2 to the
Company's Registration Statement on Form S-8 (Reg. No. 333-62022) is hereby incorporated by
reference.
4.7 Amendment No. One to Kindred Healthcare, Inc. 2001 Stock Option Plan for Non-Employee
Directors. Exhibit 4.7 to the Company's Form 10-Q for the quarterly period ended June 30, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.1 $120,000,000 Credit Agreement dated as of April 20, 2001, among Kindred Healthcare Operating, Inc.,
the Company, the Lenders party thereto, the Swingline Bank party thereto, the LC Issuing Banks party
thereto, Morgan Guaranty Trust Company of New York, as Administrative Agent and Collateral Agent
and General Electric Capital Corporation, as Documentation Agent and Collateral Monitoring Agent.
Exhibit 10.1 to the Company's Form 10-Q for the quarterly period ended June 30, 2001 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.2 Amendment No. 1 dated as of November 28, 2001, under the $120,000,000 Credit Agreement dated as
of April 20, 2001 among Kindred Healthcare Operating, Inc., the Company, the Lenders, Swingline
Bank and LC Issuing Banks party thereto, JPMorgan Chase Bank (formerly named Morgan Guaranty
Trust Company of New York), as Administrative Agent and Collateral Agent, and General Electric
Capital Corporation, as Documentation Agent and Collateral Monitoring Agent.
10.3 Credit Agreement Providing for the Issuance of $300,000,000 Senior Secured Notes due 2008 dated as
of April 20, 2001 among Kindred Healthcare Operating, Inc., the Company, the Lenders party thereto
and Morgan Guaranty Trust Company of New York, as Collateral Agent and Administrative Agent.
Exhibit 10.2 to the Company's Form 10-Q for the quarterly period ended June 30, 2001 (Comm. File
No. 001-14057) is hereby incorporated by reference.
69
Exhibit
Number Description of Document
- ------ -----------------------
10.4 Amendment No. 1 dated as of November 28, 2001 under the $300,000,000 Credit Agreement dated as
of April 20, 2001 among Kindred Healthcare Operating, Inc., the Company, the Lenders party thereto
and JPMorgan Chase Bank (formerly named Morgan Guaranty Trust Company of New York), as
Administrative Agent and Collateral Agent.
10.5 Registration Rights Agreement, dated April 20, 2001 among the Company and the Initial Holders (as
defined therein). Exhibit 10.1 to the Company's Form 8-A dated April 20, 2001 (Comm. File No.
001-14057) is hereby incorporated by reference.
10.6 Amendment No. 1 to Registration Rights Agreement dated as of August 18, 2001 among Kindred
Healthcare, Inc. and the Initial Holders (as defined therein). Exhibit 4.5 to the Company's Registration
Statement on Form S-3 filed August 31, 2001 (Comm. File No. 333-68838) is hereby incorporated by
reference.
10.7 Amendment No. 2 to Registration Rights Agreement dated as of October 22, 2001 among Kindred
Healthcare, Inc. and the Initial Holders (as defined therein). Exhibit 4.6 to the Company's Registration
Statement on Form S-3 filed August 31, 2001 (Comm. File No. 333-68838) is hereby incorporated by
reference.
10.8 Master Trust Agreement dated January 17, 2000 by and between Vencor, Inc. and Norwest Bank
Minnesota, National Association. Exhibit 10.5 to the Company's Form 10-Q for the quarterly period
ended March 31, 2000 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.9 Vencor Retirement Savings Plan Amended and Restated effective as of March 1, 2000. Exhibit 10.6 to
the Company's Form 10-Q for the quarterly period ended March 31, 2000 (Comm. File No.
001-14057) is hereby incorporated by reference.
10.10 Amendment No. 1 to the Vencor Retirement Savings Plan dated September 26, 2000. Exhibit 10.8 to
the Company's Form 10-Q for the quarterly period ended September 30, 2000 (Comm. File No.
001-14057) is hereby incorporated by reference.
10.11 Amendment No. 2 to the Vencor Retirement Savings Plan.
10.12 Amendment No. 3 to the Kindred 401(k) Plan.
10.13 Retirement Savings Plan for Certain Employees of Vencor and its Affiliates Amended and Restated
effective as of March 1, 2000. Exhibit 10.7 to the Company's Form 10-Q for the quarterly period ended
March 31, 2000 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.14 Amendment No. 1 to the Retirement Savings Plan for Certain Employees for Vencor and its Affiliates
dated September 26, 2000. Exhibit 10.9 to the Company's Form 10-Q for the quarterly period ended
September 30, 2000 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.15 Amendment No. 2 to the Retirement Savings Plan for Certain Employees of Vencor and its Affiliates.
10.16 Amendment No. 3 to the Kindred and Affiliates 401(k) Plan.
10.17 Tax Allocation Agreement dated as of April 30, 1998 by and between Vencor, Inc. and Ventas, Inc.
Exhibit 10.9 to the Company's Form 10-Q for the quarterly period ended June 30, 1998 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.18 Agreement of Indemnity-Third Party Leases dated as of April 30, 1998 by and between Vencor, Inc.
and its subsidiaries and Ventas, Inc. Exhibit 10.11 to the Company's Form 10-Q for the quarterly
period ended June 30, 1998 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.19 Agreement of Indemnity-Third Party Contracts dated as of April 30, 1998 by and between Vencor, Inc.
and its subsidiaries and Ventas, Inc. Exhibit 10.12 to the Company's Form 10-Q for the quarterly
period ended June 30, 1998 (Comm. File No. 001-14057) is hereby incorporated by reference.
70
Exhibit
Number Description of Document
- ------ -----------------------
10.20 Form of Indemnification Agreement between the Company and certain of its officers and employees.
Exhibit 10.31 to the Ventas, Inc. Form 10-K for the year ended December 31, 1995 (Comm. File No.
1-10989) is hereby incorporated by reference.
10.21 Form of Indemnification Agreement between the Company and each member of its board of directors
dated October 29, 2001.
10.22 Amended and Restated Agreement and Plan of Merger. Appendix A to Amendment No. 2 to the
Ventas, Inc. Registration Statement on Form S-4 (Reg. No. 33-59345) is hereby incorporated by
reference.
10.23 Agreement and Plan of Merger dated as of February 9, 1997 among TheraTx, Incorporated, Vencor,
Inc. and Peach Acquisition Corp. ("Peach"). Exhibit (c)(1) to the Statement on Schedule 14D-1 of
Ventas, Inc. and Peach, dated February 14, 1997 (Comm. File No. 1-10989) is hereby incorporated by
reference.
10.24 Amendment No. 1 to Agreement and Plan of Merger dated as of February 28, 1997 among TheraTx,
Incorporated, Vencor, Inc. and Peach. Exhibit (c)(3) of Amendment No. 2 to the Statement on
Schedule 14D-1 of Ventas, Inc. and Peach, dated March 3, 1997 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.25 Asset Purchase Agreement between Transitional Hospitals Corporation and Behavioral Healthcare
Corporation, dated October 22, 1996. Exhibit 99.1 to the Current Report on Form 8-K of Transitional
dated October 22, 1996 (Comm. File No. 1-7008) is hereby incorporated by reference.
10.26 Agreement and Plan of Merger between Transitional Hospitals Corporation and Behavioral Healthcare
Corporation, dated October 22, 1996. Exhibit 99.2 to the Current Report on Form 8-K of Transitional
dated October 22, 1996 (Comm. File No. 1-7008) is hereby incorporated by reference.
10.27 First Amendment to Asset Purchase Agreement between Transitional Hospitals Corporation and
Behavioral Healthcare Corporation dated November 30, 1996. Exhibit 99.1 to the Current Report on
Form 8-K of Transitional dated December 16, 1996 (Comm. File No. 1-7008) is hereby incorporated
by reference.
10.28 Amendment to Agreement and Plan of Merger between Transitional Hospitals Corporation and
Behavioral Healthcare Corporation, dated November 30, 1996. Exhibit 99.2 to the Current Report on
Form 8-K of Transitional dated December 16, 1996 (Comm. File No. 1-7008) is hereby incorporated
by reference.
10.29* Vencor, Inc. Deferred Compensation Plan dated April 30, 1998. Exhibit 10.25 to the Company's
Registration Statement on Form S-4 (Reg. No. 333-57953) is hereby incorporated by reference.
10.30* Amendment No. 1 to the Vencor, Inc. Deferred Compensation Plan. Exhibit 10.2 to the Company's
Form 10-Q for the quarterly period ended March 31, 2001 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.31 Tax Refund Escrow Agreement and First Amendment to the Tax Allocation Agreement made and
entered into as of the 20th of April 2001 by and between the Company and each of its subsidiaries and
Ventas, Inc., Ventas Realty Limited Partnership and Ventas LP Realty, L.L.C.
10.32* Vencor, Inc. Supplemental Executive Retirement Plan dated January 1, 1998, as amended. Exhibit
10.27 to the Company's Registration Statement on Form S-4 (Reg. No. 333-57953) is hereby
incorporated by reference.
10.33* Amendment No. Two to Supplemental Executive Retirement Plan dated as of January 15, 1999.
Exhibit 10.48 to the Company's Form 10-K for the year ended December 31, 1999 (Comm. File No.
001-14057) is hereby incorporated by reference.
10.34* Amendment No. Three to Supplemental Executive Retirement Plan dated as of December 31, 1999.
Exhibit 10.49 to the Company's Form 10-K for the year ended December 31, 1999 (Comm. File No.
001-14057) is hereby incorporated by reference.
71
Exhibit
Number Description of Document
- ------ -----------------------
10.35* Amendment No. 4 to the Vencor, Inc. Supplemental Executive Retirement Plan. Exhibit 10.3 to the
Company's Form 10-Q for the quarterly period ended March 31, 2001 (Comm. File No. 001-14057) is
hereby incorporated by reference.
10.36* Company's 2000 Long-Term Incentive Plan, dated effective as of January 1, 2001. Exhibit 10.46 to the
Company's Form 10-K for the year ended December 31, 2000 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.37* Amendment No. One to the Company's Long-Term Incentive Plan, dated effective as of June 21, 2001.
Exhibit 10.12 to the Company's Form 10-Q for the quarterly period ended June 30, 2001 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.38* Form of Kindred Healthcare Operating, Inc. Change-in-Control Severance Agreement. Exhibit 10.28 to
the Company's Registration Statement on Form S-4 (Reg. No. 333-57953) is hereby incorporated by
reference.
10.39* Employment Agreement dated as of February 12, 1999 between Vencor Operating, Inc. and Edward L.
Kuntz. Exhibit 10.3 to the Company's Form 10-Q for the quarterly period ended March 31, 1999
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.40* Employment Agreement dated as of September 28, 1998 between Vencor Operating, Inc. and Richard
A. Schweinhart. Exhibit 10.57 to the Company's Form 10-K for the year ended December 31, 1999
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.41* Amendment No. 1 to the Employment Agreement dated December 21, 2001 by and between Kindred
Healthcare Operating, Inc. and Richard A. Schweinhart.
10.42* Employment Agreement dated as of July 28, 1998 between Vencor Operating, Inc. and Richard E.
Chapman. Exhibit 10.58 to the Company's Form 10-K for the year ended December 31, 1999 (Comm.
File No. 001-14057) is hereby incorporated by reference.
10.43* Amendment No. 1 to the Employment Agreement dated December 21, 2001 by and between Kindred
Healthcare Operating, Inc. and Richard E. Chapman.
10.44* Employment Agreement dated as of January 4, 1999 between Vencor Operating, Inc. and Donald D.
Finney. Exhibit 10.4 to the Company's Form 10-Q for the quarterly period ended March 31, 1999
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.45* Amendment No. 1 to Employment Agreement dated as of November 5, 1999 between Vencor
Operating, Inc. and Donald D. Finney. Exhibit 10.60 to the Company's Form 10-K for the year ended
December 31, 1999 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.46* Amendment No. 2 to Employment Agreement dated December 21, 2001 by and between Kindred
Healthcare Operating, Inc. and Donald D. Finney.
10.47* Employment Agreement dated as of July 28, 1998 between Vencor Operating, Inc. and Frank J.
Battafarano. Exhibit 10.63 to the Company's Form 10-K for the year ended December 31, 1999
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.48* Amendment to Employment Agreement dated as of September 28, 1998 between Vencor Operating,
Inc. and Frank J. Battafarano. Exhibit 10.64 to the Company's Form 10-K for the year ended December
31, 1999 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.49* Amendment No. 2 to Employment Agreement dated as of November 5, 1999 between Vencor
Operating, Inc. and Frank J. Battafarano. Exhibit 10.65 to the Company's Form 10-K for the year
ended December 31, 1999 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.50* Amendment No. 3 to Employment Agreement dated December 21, 2001 by and between Kindred
Healthcare Operating, Inc. and Frank J. Battafarano.
72
Exhibit
Number Description of Document
- ------ -----------------------
10.51* Employment Agreement dated as of July 28, 1998 between Vencor Operating, Inc. and James H.
Gillenwater, Jr. Exhibit 10.66 to the Company's Form 10-K for the year ended December 31, 1999
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.52* Amendment No. 1 to Employment Agreement dated December 21, 2001 by and between Kindred
Healthcare Operating, Inc. and James H. Gillenwater, Jr.
10.53* Employment Agreement dated as of July 28, 1998 between Vencor Operating, Inc. and M. Suzanne
Riedman. Exhibit 10.67 to the Company's Form 10-K for the year ended December 31, 1999 (Comm.
File No. 001-14057) is hereby incorporated by reference.
10.54* Amendment to Employment Agreement dated as of September 28, 1998 between Vencor Operating,
Inc. and M. Suzanne Riedman. Exhibit 10.68 to the Company's Form 10-K for the year ended
December 31, 1999 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.55* Amendment No. 2 to Employment Agreement dated as of November 5, 1999 between Vencor
Operating, Inc. and M. Suzanne Riedman. Exhibit 10.69 to the Company's Form 10-K for the year
ended December 31, 1999 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.56* Amendment No. 3 to Employment Agreement dated December 21, 2001 by and between Kindred
Healthcare Operating, Inc. and M. Suzanne Riedman.
10.57* Employment Agreement dated as of July 28, 1998 between Vencor Operating, Inc. and Richard A.
Lechleiter. Exhibit 10.70 to the Company's Form 10-K for the year ended December 31, 1999 (Comm.
File No. 001-14057) is hereby incorporated by reference.
10.58* Amendment to Employment Agreement dated as of September 28, 1998 between Vencor Operating,
Inc. and Richard A. Lechleiter. Exhibit 10.71 to the Company's Form 10-K for the year ended
December 31, 1999 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.59* Amendment No. 2 to Employment Agreement dated as of November 5, 1999 between Vencor
Operating, Inc. and Richard A. Lechleiter. Exhibit 10.72 to the Company's Form 10-K for the year
ended December 31, 1999 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.60* Amendment No. 3 to Employment Agreement dated December 21, 2001 by and between Kindred
Healthcare Operating, Inc. and Richard A. Lechleiter.
10.61* Employment Agreement dated as of December 21, 2001 between Kindred Healthcare Operating, Inc.
and William M. Altman.
10.62 Amended and Restated Master Lease Agreement No. 1 dated as of April 20, 2001 for Lease Executed
by Ventas Realty, Limited Partnership, as Lessor and Vencor, Inc. and Vencor Operating, Inc. as
Tenant. Exhibit 10.4 to the Company's Form 10-Q for the quarterly period ended June 30, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.63 Amended and Restated Master Lease Agreement No. 2 dated as of April 20, 2001 for Lease Executed
by Ventas Realty, Limited Partnership, as Lessor and Vencor, Inc. and Vencor Operating, Inc. as
Tenant. Exhibit 10.5 to the Company's Form 10-Q for the quarterly period ended June 30, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.64 Amended and Restated Master Lease Agreement No. 3 dated as of April 20, 2001 for Lease Executed
by Ventas Realty, Limited Partnership, as Lessor and Vencor, Inc. and Vencor Operating, Inc. as
Tenant. Exhibit 10.6 to the Company's Form 10-Q for the quarterly period ended June 30, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.65 Amended and Restated Master Lease Agreement No. 4 dated as of April 20, 2001 for Lease Executed
by Ventas Realty, Limited Partnership, as Lessor and Vencor, Inc. and Vencor Operating, Inc. as
Tenant. Exhibit 10.7 to the Company's Form 10-Q for the quarterly period ended June 30, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
73
Exhibit
Number Description of Document
- ------ -----------------------
10.66 Master Lease Agreement dated as of December 12, 2001 by and among Ventas Realty, Limited
Partnership, as Lessor, and Kindred Healthcare, Inc. and Kindred Healthcare Operating, Inc., as
Tenants.
10.67 Master Lease among Health Care Property Investors, Inc. and Health Care Property Partners,
collectively, as Lessors and Kindred Nursing Centers East, L.L.C., Kindred Nursing Centers West,
L.L.C. and Kindred Nursing Centers Limited Partnership, collectively, as Lessee, dated May 16, 2001.
Exhibit 10.11 to the Company's Form 10-Q for the quarterly period ended June 30, 2001 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.68 Agreement and Plan of Reorganization between the Company and Ventas, Inc. Exhibit 10.1 to the
Company's Form 10, as amended, dated April 27, 1998 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.69 Cash Escrow Agreement dated April 20, 2001 by and among the Company, Ventas, Inc. and State
Street Bank and Trust Company, as Escrow Agent. Exhibit 10.8 to the Company's Form 10-Q for the
quarterly period ended June 30, 2001 (Comm. File No. 001-14057) is hereby incorporated by
reference.
10.70 Excess Stock Trust Agreement by and among the Company, as Settlor, Ventas, Inc., and State Street
Bank and Trust Company, N.A., as Trustee, dated April 20, 2001. Exhibit 10.9 to the Company's Form
10-Q for the quarterly period ended June 30, 2001 (Comm. File No. 001-14057) is hereby incorporated
by reference.
10.71 Corporate Integrity Agreement between the Office of Inspector General of the Department of Health
and Human Services and Vencor, Inc. Exhibit 10.7 to the Company's Form 10-Q for the quarterly
period ended September 30, 2000 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.72 Revised Charter for the Audit and Compliance Committee of the Board of Directors of Kindred
Healthcare, Inc. Exhibit 10.1 to the Company's Form 10-Q for the quarterly period ended
September 30, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.73 Other Debt Instruments--Copies of debt instruments for which the related debt is less than 10% of
total assets will be furnished to the Securities and Exchange Commission upon request.
21 List of Subsidiaries.
23.1 Consent of Independent Accountants.
- --------
* Compensatory plan or arrangement required to be filed as an exhibit pursuant
to Item 14(c) of Annual Report on Form 10-K.
(b) Reports on Form 8-K.
We filed a Current Report on Form 8-K on December 12, 2001 announcing that
the underwriters for our public equity offering had exercised their
over-allotment option to purchase 327,035 shares of our common stock priced at
$46.00 per share. This Current Report also indicated that the net proceeds
received by us from the exercise of the over-allotment option were used to
repay a portion of the outstanding borrowings under our senior secured notes.
(c) Exhibits.
The response to this portion of Item 14 is submitted as a separate section
of this Report.
(d) Financial Statement Schedules.
The response to this portion of Item 14 is included in appendix page F-48 of
this Report.
74
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Date: March 1, 2002
KINDRED HEALTHCARE, INC.
/s/ Edward L. Kuntz
By: _______________________________
Edward L. Kuntz
Chairman of the Board and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ James Bolin Director March 1, 2002
- -----------------------------
James Bolin
/s/ Michael J. Embler Director March 1, 2002
- -----------------------------
Michael J. Embler
/s/ Garry N. Garrison Director March 1, 2002
- -----------------------------
Garry N. Garrison
/s/ Isaac Kaufman Director March 1, 2002
- -----------------------------
Isaac Kaufman
/s/ John H. Klein Director March 1, 2002
- -----------------------------
John H. Klein
/s/ Edward L. Kuntz Chairman of the Board and March 1, 2002
- ----------------------------- Chief Executive Officer
Edward L. Kuntz (Principal Executive
Officer)
/s/ Richard A. Lechleiter Senior Vice President, Chief March 1, 2002
- ----------------------------- Financial Officer and
Richard A. Lechleiter Treasurer (Principal
Financial Officer)
/s/ John J. Lucchese Vice President, Finance and March 1, 2002
- ----------------------------- Corporate Controller
John J. Lucchese (Principal Accounting
Officer)
/s/ David A. Tepper Director March 1, 2002
- -----------------------------
David A. Tepper
75
KINDRED HEALTHCARE, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
Page
----
Report of Independent Accountants.............................................................. F-2
Consolidated Financial Statements:
Consolidated Statement of Operations:
Reorganized Company - for the nine months ended December 31, 2001
Predecessor Company - for the three months ended March 31, 2001 and for the years ended
December 31, 2000 and 1999.............................................................. F-3
Consolidated Balance Sheet:
Reorganized Company - December 31, 2001
Predecessor Company - December 31, 2000................................................... F-4
Consolidated Statement of Stockholders' Equity (Deficit):
Reorganized Company - for the nine months ended December 31, 2001
Predecessor Company - for the three months ended March 31, 2001 and for the years ended
December 31, 2000 and 1999.............................................................. F-5
Consolidated Statement of Cash Flows:
Reorganized Company - for the nine months ended December 31, 2001
Predecessor Company - for the three months ended March 31, 2001 and for the years ended
December 31, 2000 and 1999.............................................................. F-6
Notes to Consolidated Financial Statements.................................................. F-7
Quarterly Consolidated Financial Information (Unaudited).................................... F-47
Financial Statement Schedule (a):
Schedule II - Valuation and Qualifying Accounts:
Reorganized Company - for the nine months ended December 31, 2001
Predecessor Company - for the three months ended March 31, 2001 and for the years ended
December 31, 2000 and 1999.............................................................. F-48
- --------
(a) All other schedules have been omitted because the required information is
not present or not present in material amounts.
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Kindred Healthcare, Inc.:
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Kindred Healthcare, Inc. and its subsidiaries at December 31, 2001
and 2000, and the results of their operations and their cash flows for the nine
months ended December 31, 2001, the three months ended March 31, 2001 and the
years ended December 31, 2000 and 1999, in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedule listed in the accompanying index
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.
These financial statements and financial statement schedule are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements and financial statement schedule based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As more fully described in Notes 1 and 3 to the consolidated financial
statements, the consolidated financial statements reflect the application of
fresh-start reporting as of April 1, 2001 and, therefore, consolidated
financial statements for periods after April 1, 2001 are not comparable in all
respects to consolidated financial statements for periods prior to such date.
/s/ PRICEWATERHOUSECOOPERS LLP
Louisville, Kentucky
February 5, 2002
F-2
KINDRED HEALTHCARE, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands, except per share amounts)
Reorganized |
Company | Predecessor Company
------------|-----------------------------------
Nine months |Three months
ended | ended Year ended December 31,
December 31,| March 31, ----------------------
2001 | 2001 2000 1999
------------|------------ ---------- ----------
Revenues.............................................. $2,329,019 | $752,409 $2,888,542 $2,665,641
---------- | -------- ---------- ----------
Salaries, wages and benefits.......................... 1,316,581 | 427,649 1,623,955 1,566,227
Supplies.............................................. 295,598 | 94,319 374,540 347,789
Rent.................................................. 195,284 | 76,995 307,809 305,120
Other operating expenses.............................. 375,090 | 126,701 503,770 964,413
Depreciation and amortization......................... 50,219 | 18,645 73,545 93,196
Interest expense...................................... 21,740 | 14,000 60,431 80,442
Investment income..................................... (9,285)| (1,919) (5,393) (5,188)
---------- | -------- ---------- ----------
2,245,227 | 756,390 2,938,657 3,351,999
---------- | -------- ---------- ----------
Income (loss) before reorganization items and income |
taxes............................................... 83,792 | (3,981) (50,115) (686,358)
Reorganization items.................................. - | (53,666) 12,636 18,606
---------- | -------- ---------- ----------
Income (loss) before income taxes..................... 83,792 | 49,685 (62,751) (704,964)
Provision for income taxes............................ 36,450 | 500 2,000 500
---------- | -------- ---------- ----------
Income (loss) from operations......................... 47,342 | 49,185 (64,751) (705,464)
Extraordinary gain on extinguishment of debt, net of |
income taxes of $2,700 for the nine months ended |
December 31, 2001................................... 4,313 | 422,791 - -
Cumulative effect of change in accounting for start-up |
costs............................................... - | - - (8,923)
---------- | -------- ---------- ----------
Net income (loss)................................ 51,655 | 471,976 (64,751) (714,387)
Preferred stock dividend requirements................. - | (261) (1,046) (1,046)
---------- | -------- ---------- ----------
Income (loss) available to common stockholders... $ 51,655 | $471,715 $ (65,797) $ (715,433)
========== | ======== ========== ==========
Earnings (loss) per common share: |
Basic: |
Income (loss) from operations...................... $ 3.05 | $ 0.69 $ (0.94) $ (10.03)
Extraordinary gain on extinguishment of debt....... 0.28 | 6.02 - -
Cumulative effect of change in accounting for |
start-up costs................................... - | - - (0.13)
---------- | -------- ---------- ----------
Net income (loss)................................ $ 3.33 | $ 6.71 $ (0.94) $ (10.16)
========== | ======== ========== ==========
Diluted: |
Income (loss) from operations...................... $ 2.59 | $ 0.69 $ (0.94) $ (10.03)
Extraordinary gain on extinguishment of debt....... 0.24 | 5.90 - -
Cumulative effect of change in accounting for |
start-up costs................................... - | - - (0.13)
---------- | -------- ---------- ----------
Net income (loss)................................ $ 2.83 | $ 6.59 $ (0.94) $ (10.16)
========== | ======== ========== ==========
Shares used in computing earnings (loss) per common |
share: |
Basic.............................................. 15,505 | 70,261 70,229 70,406
Diluted............................................ 18,258 | 71,656 70,229 70,406
See accompanying notes.
F-3
KINDRED HEALTHCARE, INC.
CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
Reorganized |Predecessor
Company | Company
------------|------------
December 31,|December 31,
2001 | 2000
------------|------------
ASSETS |
Current assets: |
Cash and cash equivalents........................................................ $ 190,799 |$ 184,642
Cash-restricted.................................................................. 18,025 | 10,674
Insurance subsidiary investments................................................. 99,101 | 62,453
Accounts receivable less allowance for loss of $108,891 - 2001 |
and $139,445 - 2000............................................................. 418,827 | 322,483
Inventories...................................................................... 29,720 | 29,707
Other............................................................................ 75,501 | 85,893
---------- |-----------
831,973 | 695,852
Property and equipment, at cost: |
Land............................................................................. 28,560 | 26,380
Buildings........................................................................ 243,011 | 248,175
Equipment........................................................................ 221,380 | 389,824
Construction in progress......................................................... 15,254 | 29,207
---------- |-----------
508,205 | 693,586
Accumulated depreciation......................................................... (44,323)| (300,881)
---------- |-----------
463,882 | 392,705
Reorganization value in excess of amounts allocable to identifiable assets |
less accumulated amortization of $5,742............................................ 107,660 | -
Goodwill less accumulated amortization of $28,779................................... - | 159,277
Other............................................................................... 105,359 | 86,580
---------- |-----------
$1,508,874 |$ 1,334,414
========== |===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) |
Current liabilities: |
Accounts payable................................................................. $ 100,473 |$ 115,468
Salaries, wages and other compensation........................................... 198,471 | 184,860
Due to third-party payors........................................................ 37,285 | 44,561
Other accrued liabilities........................................................ 138,571 | 81,452
Income taxes..................................................................... 39,908 | 2,350
Long-term debt due within one year............................................... 418 | -
---------- |-----------
515,126 | 428,691
|
Long-term debt...................................................................... 212,269 | -
Professional liability risks........................................................ 136,764 | 101,209
Deferred credits and other liabilities.............................................. 54,234 | 14,132
Liabilities subject to compromise................................................... - | 1,260,373
|
Series A preferred stock (subject to compromise at December 31, 2000)............... - | 1,743
|
Commitments and contingencies |
|
Stockholders' equity (deficit): |
Reorganized Company preferred stock, $0.25 par value; authorized 1,000 shares; |
none issued and outstanding..................................................... - | -
Predecessor Company preferred stock, $1.00 par value; authorized 10,000 shares; |
none issued and outstanding..................................................... - | -
Reorganized Company common stock, $0.25 par value; authorized 39,000 shares; |
issued 17,683 shares-December 31, 2001.......................................... 4,421 | -
Predecessor Company common stock, $0.25 par value; authorized 180,000 shares; |
issued 70,261 shares-December 31, 2000.......................................... - | 17,565
Capital in excess of par value................................................... 549,169 | 667,168
Deferred compensation............................................................ (14,764)| -
Retained earnings (accumulated deficit).......................................... 51,655 | (1,156,467)
---------- |-----------
590,481 | (471,734)
---------- |-----------
$1,508,874 |$ 1,334,414
========== |===========
See accompanying notes.
F-4
KINDRED HEALTHCARE, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands)
Shares of Common Stock Par Capital
---------------------- Value in Excess Retained
Reorganized Predecessor Common of Par Deferred Earnings
Company Company Stock Value Compensation (Deficit) Total
----------- ----------- -------- --------- ------------ ----------- ---------
Predecessor Company:
Balances, December 31, 1998................ - 70,146 $ 17,537 $ 665,447 $ - $ (375,237) $ 307,747
Net loss................................. (714,387) (714,387)
Issuance of common stock in connection
with employee benefit plans............. 132 33 309 342
Preferred stock dividend requirements.... (1,046) (1,046)
Other.................................... 1,322 1,322
------ ------- -------- --------- -------- ----------- ---------
Balances, December 31, 1999................ - 70,278 17,570 667,078 - (1,090,670) (406,022)
Net loss................................. (64,751) (64,751)
Issuance (forfeiture) of common stock
in connection with employee benefit
plans................................... (17) (5) 35 30
Preferred stock dividend requirements.... (1,046) (1,046)
Other.................................... 55 55
------ ------- -------- --------- -------- ----------- ---------
Balances, December 31, 2000................ - 70,261 17,565 667,168 - (1,156,467) (471,734)
Net income for the three months ended
March 31, 2001.......................... 471,976 471,976
Preferred stock dividend requirements.... (261) (261)
Other.................................... 19 19
Fresh-start accounting adjustments....... 15,000 (70,261) (13,815) (235,898) 684,752 435,039
------ ------- -------- --------- -------- ----------- ---------
- ----------------------------------------------------------------------------------------------------------------------------
Reorganized Company:
Balances, April 1, 2001.................... 15,000 - 3,750 431,289 - - 435,039
Net income for the nine months ended
December 31, 2001....................... 51,655 51,655
Proceeds from public offering of
common stock, net of fees and
expenses of $5,937...................... 2,077 519 89,087 89,606
Grant of non-vested restricted stock and
discounted common stock options......... 400 100 21,362 (21,462) -
Issuance of vested restricted stock...... 200 50 7,650 7,700
Deferred compensation amortization....... 6,698 6,698
Other.................................... 6 2 (219) (217)
------ ------- -------- --------- -------- ----------- ---------
Balances, December 31, 2001................ 17,683 - $ 4,421 $ 549,169 $(14,764) $ 51,655 $ 590,481
====== ======= ======== ========= ======== =========== =========
See accompanying notes.
F-5
KINDRED HEALTHCARE, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
Reorganized |
Company | Predecessor Company
------------|---------------------------------
Nine months |Three months Year ended
ended | ended December 31,
December 31,| March 31, --------------------
2001 | 2001 2000 1999
------------|------------ --------- ---------
Cash flows from operating activities:
Net income (loss).............................................. $ 51,655 | $ 471,976 $ (64,751) $(714,387)
Adjustments to reconcile net income (loss) to net cash |
provided by operating activities: |
Depreciation and amortization................................. 50,219 | 18,645 73,545 93,196
Amortization of deferred compensation costs................... 6,698 | - - -
Provision for doubtful accounts............................... 16,346 | 6,305 28,911 114,578
Deferred income taxes......................................... 12,263 | - - -
Extraordinary gain on extinguishment of debt.................. (4,313) | (422,791) - -
Unusual transactions.......................................... (5,425) | - 4,701 411,615
Reorganization items.......................................... - | (53,666) 12,636 18,606
Cumulative effect of change in accounting for start-up costs.. - | - - 8,923
Other......................................................... (4,655) | 1,357 17,166 19,247
Change in operating assets and liabilities: |
Accounts receivable.......................................... (31,001) | (14,668) (21,590) 90,428
Inventories and other assets................................. 18,698 | 12,476 (20,154) 5,868
Accounts payable............................................. (300) | (10,845) 15,639 25,580
Income taxes................................................. 17,582 | 108 2,961 6,431
Due to third-party payors.................................... (16,570) | 2,051 (4,278) 99,370
Other accrued liabilities.................................... 79,504 | 28,628 149,279 67,616
--------- | --------- --------- ---------
Net cash provided by operating activities |
before reorganization items............................... 190,701 | 39,576 194,065 247,071
Payment of reorganization items................................ (47,937) | (3,745) (8,525) (15,684)
--------- | --------- --------- ---------
Net cash provided by operating activities.................. 142,764 | 35,831 185,540 231,387
--------- | --------- --------- ---------
Cash flows from investing activities: |
Purchase of property and equipment............................. (65,243) | (22,038) (79,988) (111,493)
Acquisition of healthcare facilities........................... (14,152) | - - -
Sale of investment in Behavioral Healthcare Corporation........ 40,000 | - - -
Sale of other assets........................................... 7,933 | - 15,241 12,289
Surety bond deposits........................................... (300) | - (4,647) (17,213)
Net change in investments...................................... (27,973) | (28,178) (46,904) 6,377
Other.......................................................... 809 | 224 1,731 (2,548)
--------- | --------- --------- ---------
Net cash used in investing activities...................... (58,926) | (49,992) (114,567) (112,588)
--------- | --------- --------- ---------
Cash flows from financing activities: |
Repayment of long-term debt.................................... (149,161) | (4,355) (18,696) (26,776)
Net change in borrowings under revolving lines of credit....... - | - - 55,000
Payment of debtor-in-possession deferred financing costs....... - | (100) (1,226) (3,752)
Issuance of common stock....................................... 89,796 | - - -
Other.......................................................... 11,172 | (5,971) (14,759) (29,472)
--------- | --------- --------- ---------
Net cash used in financing activities...................... (48,193) | (10,426) (34,681) (5,000)
--------- | --------- --------- ---------
Change in cash and cash equivalents.............................. 35,645 | (24,587) 36,292 113,799
Cash and cash equivalents at beginning of period................. 155,154 | 184,642 148,350 34,551
--------- | --------- --------- ---------
Cash and cash equivalents at end of period....................... $ 190,799 | $ 160,055 $ 184,642 $ 148,350
========= | ========= ========= =========
Supplemental information: |
Interest payments.............................................. $ 3,847 | $ 2,606 $ 11,930 $ 35,783
Income tax payments (refunds).................................. 6,605 | 392 (713) (5,931)
Rent payments to Ventas, Inc................................... 135,609 | 45,401 181,603 191,235
See accompanying notes.
F-6
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ACCOUNTING POLICIES
Reporting Entity
Kindred Healthcare, Inc. ("Kindred" or the "Company") provides long-term
healthcare services primarily through the operation of nursing centers and
hospitals. The Company's health services division operates nursing centers and
a rehabilitation therapy business. The Company's hospital division operates
long-term acute care hospitals and an institutional pharmacy business.
On April 20, 2001 (the "Effective Date"), the Company and its subsidiaries
emerged from proceedings under Chapter 11 of Title 11 of the United States Code
(the "Bankruptcy Code") pursuant to the terms of the Company's Fourth Amended
Joint Plan of Reorganization (the "Plan of Reorganization"), as modified at the
confirmation hearing by the United States Bankruptcy Court for the District of
Delaware (the "Bankruptcy Court"). In connection with its emergence, the
Company changed its name to Kindred Healthcare, Inc.
Since filing for protection under the Bankruptcy Code on September 13, 1999,
the Company operated its businesses as a debtor-in-possession subject to the
jurisdiction of the Bankruptcy Court. Accordingly, the consolidated financial
statements of the Company have been prepared in accordance with the American
Institute of Certified Public Accountants Statement of Position ("SOP") 90-7,
"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code"
("SOP 90-7") and generally accepted accounting principles applicable to a going
concern, which assume that assets will be realized and liabilities will be
discharged in the normal course of business.
In connection with its emergence from bankruptcy, the Company reflected the
terms of the Plan of Reorganization in its consolidated financial statements by
adopting the fresh-start accounting provisions of SOP 90-7. Under fresh-start
accounting, a new reporting entity is deemed to be created and the recorded
amounts of assets and liabilities are adjusted to reflect their estimated fair
values. For accounting purposes, the fresh-start adjustments have been recorded
in the consolidated financial statements as of April 1, 2001. Since fresh-start
accounting materially changed the amounts previously recorded in the Company's
consolidated financial statements, a black line separates the post-emergence
financial data from the pre-emergence data to signify the difference in the
basis of presentation of the financial statements for each respective entity.
As used in these financial statements, the term "Predecessor Company" refers
to the Company and its operations for periods prior to April 1, 2001, while the
term "Reorganized Company" is used to describe the Company and its operations
for periods thereafter.
While the adoption of fresh-start accounting as of April 1, 2001 materially
changed the amounts previously recorded in the consolidated financial
statements of the Predecessor Company, management believes that business
segment operating income of the Predecessor Company is generally comparable to
that of the Reorganized Company. However, capital costs (rent, interest,
depreciation and amortization) of the Predecessor Company that were based on
pre-petition contractual agreements and historical costs are not comparable to
those of the Reorganized Company. In addition, the reported financial position
and cash flows of the Predecessor Company for periods prior to April 1, 2001
generally are not comparable to those of the Reorganized Company.
In connection with the implementation of fresh-start accounting, the Company
recorded an extraordinary gain of $422.8 million from the restructuring of its
debt in accordance with the provisions of the Plan of Reorganization. Other
significant adjustments were also recorded to reflect the provisions of the
Plan of Reorganization and the fair values of the assets and liabilities of the
Reorganized Company as of April 1, 2001. For accounting purposes, these
transactions have been reflected in the operating results of the Predecessor
Company for the three months ended March 31, 2001.
F-7
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1 - ACCOUNTING POLICIES (Continued)
Reporting Entity (Continued)
On May 1, 1998, Ventas, Inc. ("Ventas") (formerly known as Vencor, Inc.)
completed the spin-off of its healthcare operations to its stockholders through
the distribution of the Company's former common stock (the "Spin-off"). Ventas
retained ownership of substantially all of its real property and leases such
real property to the Company. In anticipation of the Spin-off, the Company was
incorporated on March 27, 1998 as a Delaware corporation. For accounting
purposes, the consolidated historical financial statements of Ventas became the
Company's historical financial statements following the Spin-off.
Basis of Presentation
The consolidated financial statements include all subsidiaries. Significant
intercompany transactions have been eliminated. Investments in affiliates in
which the Company has a 50% or less interest are accounted for by either the
equity or cost method.
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles and include amounts
based upon the estimates and judgments of management. Actual amounts may differ
from these estimates.
Impact of Recent Accounting Pronouncements
In October 2001, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 144 ("SFAS
144"), "Accounting for the Impairment or Disposal of Long-Lived Assets," which
supersedes SFAS No. 121 ("SFAS 121"), "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and amends
Accounting Principles Board Opinion No. 30 ("APB 30"), "Reporting Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business," by
requiring that long-lived assets that are to be disposed of by sale be measured
at the lower of book value or fair value less the costs of disposal. SFAS 144
eliminates the APB 30 requirements that discontinued operations be measured at
net realizable value, and that future operating losses be included under
"discontinued operations" in the financial statements. This new pronouncement
will become effective for the Company beginning on January 1, 2002.
In June 2001, the FASB issued SFAS No. 141 ("SFAS 141"), "Business
Combinations," which provides that all business combinations should be
accounted for using the purchase method of accounting and establishes criteria
for the initial recognition and measurement of goodwill and other intangible
assets recorded in connection with a business combination. The provisions of
SFAS 141 apply to all business combinations initiated after June 30, 2001 and
to all business combinations accounted for by the purchase method that are
completed after June 30, 2001.
In addition, the FASB issued in June 2001 SFAS No. 142 ("SFAS 142"),
"Goodwill and Other Intangible Assets," which establishes the accounting for
goodwill and other intangible assets following their recognition. SFAS 142
applies to all goodwill and other intangible assets whether acquired singly, as
part of a group, or in a business combination. SFAS 142 also applies to excess
reorganization value recognized in accordance with SOP 90-7. The new
pronouncement provides that goodwill should not be amortized but should be
tested for impairment annually using a fair-value based approach. In addition,
SFAS 142 provides that intangible assets other than goodwill should be
amortized over their useful lives and reviewed for impairment in accordance
with existing guidelines. SFAS 142 will become effective for the Company
beginning on January 1, 2002. Upon adoption, the Company will be required to
perform a transitional impairment test for the excess reorganization value
recorded as of January 1, 2002. Any impairment loss recorded as a result of the
transitional impairment test
F-8
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1 - ACCOUNTING POLICIES (Continued)
Impact of Recent Accounting Pronouncements (Continued)
will be treated as a change in accounting principle. The adoption of SFAS 142
is not expected to result in an impairment to the excess reorganization value
recorded in the balance sheet at December 31, 2001.
Effective January 1, 2001, the Company adopted SFAS No. 133 ("SFAS 133"),
"Accounting for Derivative Instruments and Hedging Activities." The adoption of
SFAS 133 did not have a material impact on the Company's financial position or
results of operations.
In December 1999, the Securities and Exchange Commission (the "Commission")
issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements" ("SAB 101"). SAB 101 provides guidance on revenue recognition and
related disclosures and was effective beginning October 1, 2000. The Company
was previously following the requirements provided under SAB 101 and,
accordingly, the implementation of this pronouncement had no impact on the
Company's financial position or results of operations.
Effective January 1, 1999, the Company adopted SOP 98-5, "Reporting on the
Costs of Start-Up Activities" ("SOP 98-5"), which requires the Company to
expense start-up costs, including organizational costs, as incurred. In
accordance with the provisions of SOP 98-5, the Company wrote off $8.9 million
of such unamortized costs as a cumulative effect of a change in accounting
principle in the first quarter of 1999.
In the first quarter of 1999, the Company adopted SOP 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP
98-1"). SOP 98-1 provides guidance on accounting for the costs of computer
software developed or obtained for internal use. The adoption of SOP 98-1 did
not have a material effect on the Company's consolidated financial position or
results of operations.
Reclassifications
Certain prior year amounts have been reclassified to conform with the
current year presentation.
Revenues
Revenues are recorded based upon estimated amounts due from patients and
third-party payors for healthcare services provided, including anticipated
settlements under reimbursement agreements with Medicare, Medicaid and other
third-party payors.
A summary of revenues by payor type follows (in thousands):
Reorganized |
Company | Predecessor Company
------------|-----------------------------------
Nine months |Three months
ended | ended Year ended December 31,
December 31,| March 31, ----------------------
2001 | 2001 2000 1999
------------|------------ ---------- ----------
Medicare......... $ 901,505 | $288,390 $1,050,758 $ 918,395
Medicaid......... 799,428 | 233,160 925,356 902,032
Private and other 673,794 | 245,532 969,557 906,849
---------- | -------- ---------- ----------
2,374,727 | 767,082 2,945,671 2,727,276
Elimination...... (45,708)| (14,673) (57,129) (61,635)
---------- | -------- ---------- ----------
$2,329,019 | $752,409 $2,888,542 $2,665,641
========== | ======== ========== ==========
F-9
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1 - ACCOUNTING POLICIES (Continued)
Cash, Cash Equivalents and Cash-Restricted
Cash, cash equivalents and cash-restricted include highly liquid investments
with an original maturity of three months or less when purchased.
Cash-restricted consists primarily of amounts related to patient trust
accounts, compensating balance arrangements with financial institutions and, at
December 31, 2001, amounts derived from the sale of assets available to repay
debt or fund future capital expenditures.
Insurance Subsidiary Investments
The Company maintains investments, consisting principally of money market
securities, primarily for the payment of claims and expenses related to
self-insured professional liability risks and workers compensation claims.
These investments have been categorized as available-for-sale and are
classified in the accompanying consolidated balance sheet based upon their
original maturities.
Accounts Receivable
Accounts receivable consist primarily of amounts due from the Medicare and
Medicaid programs, other government programs, managed care health plans,
commercial insurance companies and individual patients. Estimated provisions
for doubtful accounts are recorded to the extent it is probable that a portion
or all of a particular account will not be collected.
In evaluating the collectibility of accounts receivable, the Company
considers a number of factors, including the age of the accounts, changes in
collection patterns, the composition of patient accounts by payor type, the
status of ongoing disputes with third-party payors and general industry
conditions.
Inventories
Inventories consist primarily of medical supplies and are stated at the
lower of cost (first-in, first-out) or market.
Property and Equipment
Depreciation expense, computed by the straight-line method, was $44.2
million for the nine months ended December 31, 2001, $16.0 million for the
three months ended March 31, 2001, $60.9 million for 2000 and $68.9 million for
1999. Depreciation rates for buildings range generally from 20 to 45 years.
Estimated useful lives of equipment vary from 5 to 15 years.
Reorganization Value in Excess of Amounts Allocable to Identifiable Assets
Reorganization value in excess of amounts allocable to identifiable assets
represents the portion of reorganization value of the Company at April 1, 2001
that could not be attributable to specific tangible or identified intangible
assets recorded in connection with fresh-start accounting. Reorganization value
in excess of amounts allocable to identifiable assets is amortized using the
straight-line method over 20 years. Amortization expense recorded for the nine
months ended December 31, 2001 totaled $5.7 million.
F-10
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1 - ACCOUNTING POLICIES (Continued)
Goodwill
Effective January 1, 2000, the Company began amortizing pre-emergence
goodwill using the straight-line method principally over 20 years. Prior
thereto, goodwill was amortized over 40 years. Amortization expense recorded
for the three months ended March 31, 2001 and the years ended December 31, 2000
and 1999 totaled $2.5 million, $11.7 million and $23.3 million, respectively.
In the fourth quarter of 1999, in connection with the realignment of its
former ancillary services division, the Company wrote off all goodwill
associated with its rehabilitation therapy business. See Note 5.
Long-Lived Assets
The Company regularly reviews the carrying value of certain long-lived
assets and the related identifiable intangible assets with respect to any
events or circumstances that indicate an impairment or an adjustment to the
amortization period is necessary. If circumstances suggest the recorded amounts
cannot be recovered, calculated based upon estimated future cash flows
(undiscounted), the carrying values of such assets are reduced to fair value.
See Note 6.
Insurance Risks
Provisions for loss for professional liability risks and workers
compensation are based upon independent actuarially determined estimates. The
provisions for loss related to professional liability risks retained by the
Company's wholly owned, limited purpose insurance subsidiary are discounted
based upon management's estimate of long-term investment yields and independent
actuarial estimates of claim payment patterns. To the extent that subsequent
claims information varies from management's estimates, earnings are charged or
credited. See Note 12.
Derivative Instruments
Prior to May 15, 2000, the Company was a party to interest rate swap
agreements that eliminated the impact of changes in interest rates on certain
outstanding floating rate debt. Each interest rate swap agreement was
associated with all or a portion of the principal balance of a specific debt
obligation. These agreements involved the exchange of amounts based on variable
rates for amounts based on fixed interest rates over the life of the agreement,
without an exchange of the notional amount upon which the payments were based.
The differential paid or received as interest rates changed was accrued and
recognized as an adjustment of interest expense related to the debt, and the
related amount payable to or receivable from counterparties was included in
accrued interest. The fair values of the swap agreements were not recognized in
the consolidated financial statements. Gains and losses on terminations of
interest rate swap agreements were deferred (included in other assets) and
amortized as an adjustment to interest expense over the remaining term of the
original contract life of the terminated swap agreement.
Comprehensive Income
The Company has no other components of comprehensive income and as a result,
comprehensive income or loss is equal to the net income or loss presented in
the accompanying statement of operations.
Earnings per Common Share
Basic earnings per common share are based upon the weighted average number
of common shares outstanding. No incremental shares are included in the 2000
and 1999 calculations of the diluted loss per common share since the result
would be antidilutive.
F-11
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2 - REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
On April 20, 2001, the Company and its subsidiaries emerged from bankruptcy
pursuant to the terms of the Plan of Reorganization. The Company and
substantially all of its subsidiaries filed voluntary petitions with the
Bankruptcy Court for protection under Chapter 11 of the Bankruptcy Code on
September 13, 1999.
Following emergence, the Company is continuing to resolve proofs of claims
filed in connection with the bankruptcy. On the Effective Date, the automatic
stay imposed by the Bankruptcy Code was terminated.
Plan of Reorganization
The Plan of Reorganization represents a consensual arrangement among Ventas,
the Company's former senior bank lenders (the "Senior Lenders"), holders of the
Company's former $300 million 9 7/8% Guaranteed Senior Subordinated Notes due
2005 (the "1998 Notes"), the U.S. Department of Justice (the "DOJ"), acting on
behalf of the U.S. Department of Health and Human Services' Office of the
Inspector General (the "OIG"), and the Centers for Medicare and Medicaid
Services ("CMS") (collectively, the "Government") and the advisors to the
official committee of unsecured creditors.
The following is a summary of certain material provisions of the Plan of
Reorganization. The summary does not purport to be complete and is qualified in
its entirety by reference to all of the provisions of the Plan of
Reorganization, as filed with the Commission.
The Plan of Reorganization provided for, among other things, the following
distributions:
Senior Lender Claims-On the Effective Date, the Senior Lenders received new
senior subordinated secured notes aggregating $300 million, bearing interest at
the London Interbank Offered Rate ("LIBOR") (as defined in the agreement) plus
4 1/2%, with a maturity of seven years (the "Senior Secured Notes"). The
interest on the Senior Secured Notes began to accrue in November 2001 and, in
lieu of interest payments, the Company paid a $25.9 million obligation under
the Government Settlement (as defined below) within the first two full fiscal
quarters following the Effective Date as described below. In addition, holders
of the Senior Lender claims received an aggregate distribution of 9,826,092
shares of the new common stock of Kindred on the Effective Date.
Subordinated Noteholder Claims-The holders of the 1998 Notes and the
remaining $2.4 million of the Company's former 8 5/8% Senior Subordinated Notes
due 2007 (collectively, the "Subordinated Noteholder Claims") received, in the
aggregate, 3,675,408 shares of Kindred common stock on the Effective Date. In
addition, the holders of the Subordinated Noteholder Claims received warrants
issued by the Company for the purchase of an aggregate of 7,000,000 shares of
Kindred common stock, with a five-year term, comprised of warrants to purchase
2,000,000 shares at a price per share of $30.00 and warrants to purchase
5,000,000 shares at a price per share of $33.33 (collectively, the "Warrants").
Ventas Claim-Ventas received the following treatment under the Plan of
Reorganization:
On the Effective Date, the four master leases and a single facility lease
with Ventas were assumed and simultaneously amended and restated as of the
effective date of the Plan of Reorganization (the "Master Lease Agreements").
The principal economic terms of the Master Lease Agreements are as follows:
(1) A decrease of $52 million in the aggregate minimum rent from the
annual rent as of May 1, 1999 to a new initial aggregate minimum rent of
$174.6 million (subject to the escalation described below).
(2) Annual aggregate minimum rent payable in cash will escalate at an
annual rate of 3 1/2% over the prior period annual aggregate minimum rent
for the period from May 1, 2001 through April 30, 2004.
F-12
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2 - REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)
Plan of Reorganization (Continued)
Thereafter, annual aggregate minimum rent payable in cash will escalate at
an annual rate of 2% (plus, upon the occurrence of certain events, an
additional annual accrued escalator amount of 1 1/2% of the prior period
annual aggregate minimum rent) which will accrete from year to year (with an
interest accrual at LIBOR plus 4 1/2%). All accrued rent will be payable
upon the repayment or refinancing of the Senior Secured Notes, after which
the annual aggregate minimum rent payable in cash will escalate at an annual
rate of 3 1/2% and there will be no further accrual feature. The annual
escalator in each period is contingent upon the attainment of certain
financial targets as described in the Master Lease Agreements.
(3) A one-time option, that can be exercised by Ventas 5 1/4 years after
the Effective Date, to reset the annual aggregate minimum rent under one or
more of the Master Lease Agreements to the then current fair market rental
in exchange for a payment of $5 million (or a pro rata portion thereof if
fewer than all of the Master Lease Agreements are reset) to the Company.
(4) Under the Master Lease Agreements, the "Event of Default" provisions
also were substantially modified and provide Ventas with more flexibility in
exercising remedies for events of default.
In addition to the Master Lease Agreements, Ventas received a distribution
of 1,498,500 shares of Kindred common stock on the Effective Date.
Ventas and the Company also entered into the Tax Escrow Refund Agreement and
First Amendment to the Tax Allocation Agreement as of the Effective Date that
provides for the escrow of approximately $30 million of federal, state and
local refunds until the expiration of the applicable statutes of limitation for
the auditing of the refund applications (the "Tax Refund Escrow Agreement").
The escrowed funds will be available for the payment of certain tax
deficiencies during the escrow period except that all interest paid by the
government in connection with any refund or earned on the escrowed funds will
be distributed equally to the parties. At the end of the escrow period, the
Company and Ventas will each be entitled to 50% of any proceeds remaining in
the escrow account.
All agreements and indemnification obligations between the Company and
Ventas, except those modified by the Plan of Reorganization, were assumed by
the Company as of the Effective Date.
United States Claims-The claims of the Government (other than claims of the
Internal Revenue Service and criminal claims, if any) were settled through a
government settlement with the Company and Ventas which was effectuated through
the Plan of Reorganization (the "Government Settlement").
Under the Government Settlement, the Company paid the Government a total of
$25.9 million as follows:
(1) $10 million was paid on the Effective Date, and
(2) an aggregate of $15.9 million was paid during the first two full
fiscal quarters following the Effective Date, plus accrued interest at the
rate of 6% per annum beginning as of the Effective Date.
Under the Government Settlement, Ventas will pay the Government a total of
$103.6 million as follows:
(1) $34 million was paid on the Effective Date, and
(2) the remainder will be paid over five years, bearing interest at the
rate of 6% per annum beginning as of the Effective Date.
F-13
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2 - REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)
Plan of Reorganization (Continued)
In addition, the Company agreed to repay the remaining balance of the
obligations owed to CMS (approximately $59 million as of the Effective Date)
pursuant to the terms previously agreed to by the Company (the "CMS Agreement").
As previously announced, the Company entered into a Corporate Integrity
Agreement with the OIG as part of the overall Government Settlement. The
Corporate Integrity Agreement became effective on the Effective Date. The
Government Settlement also provided for the dismissal of certain pending claims
and lawsuits filed against the Company.
General Unsecured Creditors Claims-The general unsecured creditors of the
Company will be paid the full amount of their allowed claims existing as of the
date of the Company's filing for protection under the Bankruptcy Code. These
amounts generally will be paid in equal quarterly installments over three years
beginning on September 30, 2001. The Company will pay interest on these claims
at the rate of 6% per annum from the Effective Date, subject to certain
exceptions. A convenience class of unsecured creditors, consisting of creditors
holding allowed claims in an amount less than or equal to $3,000, were paid in
full within 30 days of the Effective Date.
Preferred Stockholder and Common Stockholder Claims-The holders of the
former preferred stock and common stock of the Company did not receive any
distributions under the Plan of Reorganization. The former preferred stock and
common stock were canceled on the Effective Date.
Other Significant Provisions-As of the Effective Date, a new board of
directors, including representatives of the principal security holders
following the Effective Date, was appointed.
A restricted share plan was approved under the Plan of Reorganization that
provided for the issuance of 600,000 shares of Kindred common stock to certain
key employees of the Company. The restricted shares are non-transferable and
subject to forfeiture until they have vested generally over a four-year period.
In addition, a new stock option plan was approved under the Plan of
Reorganization for the issuance of stock options for up to 600,000 shares of
Kindred common stock to certain key employees of the Company. The Plan of
Reorganization also approved a long-term incentive plan that provides cash
bonus awards to certain key employees on the attainment by the Company of
specified performance goals, and also provided for the continuation of the
Company's management retention plan and the payment of certain performance
bonuses on the Effective Date.
Matters Related to Emergence
On the Effective Date, the Company entered into a five-year $120 million
senior revolving credit facility (including a $40 million letter of credit
subfacility) (the "Credit Facility") which constitutes a working capital
facility for general corporate purposes including payments related to the
Company's obligations under the Plan of Reorganization. Direct borrowings under
the Credit Facility will bear interest, at the option of the Company, at (a)
prime (or, if higher, the federal funds rate plus 1/2%) plus 3% or (b) LIBOR
(as defined in the agreement) plus 4%. The Credit Facility is collateralized by
substantially all of the assets of the Company and its subsidiaries, including
certain owned real property.
On the Effective Date, the Company filed a registration statement on Form
8-A with the Commission to register the Kindred common stock and Warrants under
Section 12(g) of the Securities Exchange Act of 1934 (the "Exchange Act").
F-14
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2 - REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)
Liabilities Subject to Compromise
A substantial portion of pre-petition liabilities were subject to settlement
under the Plan of Reorganization. "Liabilities subject to compromise" refers to
liabilities incurred prior to September 13, 1999. These liabilities, consisting
primarily of long-term debt, amounts due to third-party payors and certain
accounts payable and accrued liabilities, represented the Company's estimate of
known or potential claims to be resolved in connection with the bankruptcy.
Payment terms for these amounts were set forth in the Plan of Reorganization.
All pre-petition liabilities, other than those for which the Company
received Bankruptcy Court approval to pay, are classified in the consolidated
balance sheet as liabilities subject to compromise. A summary of the principal
categories of claims classified as liabilities subject to compromise at
December 31, 2000 follows (in thousands):
Long-term debt:
Senior lender claims................. $ 510,908
1998 Notes........................... 300,000
Amounts due under the CMS Agreement.. 63,405
8 5/8% Senior Subordinated Notes..... 2,391
Unamortized deferred financing costs. (10,306)
Other................................ 2,873
----------
869,271
----------
Due to third-party payors............... 116,062
Accounts payable........................ 36,053
Income taxes............................ 13,478
Accrued liabilities:
Interest............................. 90,655
Ventas rent.......................... 81,902
Other................................ 52,952
----------
225,509
----------
$1,260,373
==========
NOTE 3 - FRESH-START ACCOUNTING
As previously discussed, the Company adopted the provisions of fresh-start
accounting as of April 1, 2001. In adopting fresh-start accounting, the Company
engaged an independent financial advisor to assist in the determination of the
reorganization value or fair value of the entity. The independent financial
advisor determined an estimated reorganization value of $762 million before
considering any long-term debt or other obligations assumed in connection with
the Plan of Reorganization. This estimate was based upon the Company's cash
flows, selected comparable market multiples of publicly traded companies,
operating lease obligations and other applicable ratios and valuation
techniques. The estimated total equity value of the Reorganized Company
aggregating $435 million was determined after taking into account the values of
the obligations assumed in connection with the Plan of Reorganization.
F-15
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3 - FRESH-START ACCOUNTING (Continued)
A reconciliation of fresh-start accounting recorded as of April 1, 2001
follows (in thousands):
Predecessor Reorganized
Company Fresh-start Company
-------------- -------------------------------------------- -------------
Debt
March 31, 2001 Restructuring Adjustments Reclassifications April 1, 2001
-------------- ------------- ----------- ----------------- -------------
ASSETS
Current assets:
Cash and cash equivalents.................... $ 160,055 $ - $ (4,901)(i) $ - $ 155,154
Cash-restricted.............................. 11,008 (2,763)(a) 6,000 (i) - 14,245
Insurance subsidiary investments............. 90,617 - - - 90,617
Accounts receivable less allowance for loss.. 330,846 73,138 (b) - - 403,984
Inventories.................................. 29,132 - - - 29,132
Other........................................ 74,732 1,360 (a) - - 76,092
----------- --------- --------- --------- ----------
696,390 71,735 1,099 - 769,224
Property and equipment......................... 708,232 - (268,528)(j) - 439,704
Accumulated depreciation....................... (316,862) - 316,862 (j) - -
----------- --------- --------- --------- ----------
391,370 - 48,334 - 439,704
Reorganization value in excess of amounts
allocable to identifiable assets............. - - 157,958 (k) - 157,958
Goodwill....................................... 156,765 - (156,765)(l) - -
Investment in affiliates....................... 7,824 - 40,282 (m) - 48,106
Other.......................................... 77,673 (7,668)(a) (1,823)(i) - 70,925
2,795 (c) (52)(j)
----------- --------- --------- --------- ----------
$ 1,330,022 $ 66,862 $ 89,033 $ - $1,485,917
=========== ========= ========= ========= ==========
LIABILITIES AND STOCKHOLDERS'
EQUITY (DEFICIT)
Current liabilities:
Accounts payable............................. $ 90,279 $ (2,264)(b) $ (4,030)(i) $ 1,602 (r) $ 85,587
Salaries, wages and other compensation....... 178,319 - (93)(i) 1,404 (r) 195,841
7,700 (n)
8,511 (o)
Due to third-party payors.................... 47,773 (4,569)(b) - 10,651 (r) 53,855
Other accrued liabilities.................... 91,132 2,795 (c) 25,337 (o) 43,865 (r) 189,029
25,900 (d)
Income taxes................................. 2,850 - - 14,867 (r) 17,717
Long-term debt due within one year........... - - - 18,316 (r) 18,316
----------- --------- --------- --------- ----------
410,353 21,862 37,425 90,705 560,345
Long-term debt................................. - 300,000 (e) - 43,606 (r) 343,606
Professional liability risks................... 106,505 - - - 106,505
Deferred credits and other liabilities......... 14,128 - (1,777)(p) 28,071 (r) 40,422
Liabilities subject to compromise.............. 1,278,223 2,580 (a) (2,028)(i) (162,382)(r) -
(113,576)(b) (2,726)(p)
(902,755)(f)
(94,285)(g)
(3,051)(h)
Series A preferred stock (subject to compromise
at March 31, 2001)............................ 1,743 (1,743)(h) - - -
Stockholders' equity (deficit):
Reorganized Company common stock, par
value....................................... - 3,750 (h) - - 3,750
Predecessor Company common stock, par
value....................................... 17,565 - (17,565)(q) - -
Capital in excess of par value............... 667,187 431,289 (h) 17,565 (q) (684,752)(s) 431,289
Retained earnings (accumulated deficit)...... (1,165,682) (11,651)(a) 5,427 (i) 684,752 (s) -
193,547 (b) 48,282 (j)
(25,900)(d) 157,958 (k)
(300,000)(e) (156,765)(l)
902,755 (f) 40,282 (m)
94,285 (g) (7,700)(n)
(430,245)(h) (33,848)(o)
4,503 (p)
----------- --------- --------- --------- ----------
(480,930) 857,830 58,139 - 435,039
----------- --------- --------- --------- ----------
$ 1,330,022 $ 66,862 $ 89,033 $ - $1,485,917
=========== ========= ========= ========= ==========
F-16
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3 - FRESH-START ACCOUNTING (Continued)
(a) To record the effect of the Tax Refund Escrow Agreement.
(b) To record the discharge of pre-petition accounts receivable, allowances
for loss and liabilities related to the Medicare program in connection
with the Government Settlement.
(c) To record deferred financing costs incurred in connection with the
Credit Facility and the Senior Secured Notes.
(d) To record the Government Settlement obligation.
(e) To record the issuance of the Senior Secured Notes.
(f) To record the discharge of indebtedness in accordance with the Plan of
Reorganization (in thousands):
Senior lender claims................... $510,908
Subordinated noteholder claims......... 302,391
Accrued interest....................... 99,185
Unamortized deferred financing costs... (9,729)
--------
$902,755
========
(g) To write off accrued Ventas rent discharged in accordance with the Plan
of Reorganization.
(h) To record the issuance of Kindred common stock and Warrants and
eliminate the preferred stock (and related loans) and accrued dividends
of the Predecessor Company in accordance with the Plan of Reorganization.
(i) To record miscellaneous provisions of the Plan of Reorganization.
(j) To adjust the property and equipment to fair value and to write off
previously recorded accumulated depreciation.
(k) To record the reorganization value of the Company in excess of amounts
allocable to identifiable assets.
(l) To write off historical goodwill of the Predecessor Company.
(m) To adjust investment in affiliates to fair value.
(n) To record the value of the vested portion of restricted stock in
accordance with the Plan of Reorganization.
(o) To record reorganization costs consisting primarily of professional fees
and management compensation to be paid in accordance with the Plan of
Reorganization.
(p) To adjust allowances for loss related to property disposals and
non-income tax deficiencies.
(q) To eliminate the common stock of the Predecessor Company.
(r) To reclassify the pre-petition priority, secured and unsecured claims
that were assumed by the Company in accordance with the Plan of
Reorganization.
(s) To eliminate the historical accumulated deficit and adjust stockholders'
equity to reflect the fair value of the Company's total equity.
F-17
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 4 - PRO FORMA INFORMATION
The following unaudited pro forma condensed financial information gives
effect to the Plan of Reorganization assuming that the effective date occurred
on January 1, 2000 (in thousands, except per share amounts):
Year ended December 31,
-----------------------
2001 2000
---------- ----------
Revenues...................... $3,081,428 $2,888,542
Income from operations........ 57,600 16,540
Net income.................... 61,913 16,540
Earnings per common share:
Basic:
Income from operations... $ 3.74 $ 1.09
Net income............... 4.02 1.09
Diluted:
Income from operations... $ 3.25 $ 0.99
Net income............... 3.49 0.99
The pro forma results exclude reorganization items recorded prior to April
1, 2001. The pro forma results are not necessarily indicative of the financial
results that might have resulted had the effective date of the Plan of
Reorganization occurred on January 1, 2000.
NOTE 5 - ANCILLARY SERVICES DIVISION REALIGNMENT
During 1999, the Company operated its ancillary services business which
provided respiratory and rehabilitation therapies and medical and pharmacy
management services to nursing centers and other healthcare providers. As a
result of significant declines in the demand for ancillary services caused by
the Balanced Budget Act of 1997 (the "Balanced Budget Act"), management
completed a realignment of its ancillary services division in the fourth
quarter of 1999. The division's physical rehabilitation, speech and
occupational therapies were integrated into the Company's health services
division and the institutional pharmacy business was assigned to the hospital
division. The respiratory therapy and other ancillary businesses were
discontinued.
In connection with the realignment, the Company recorded a charge
aggregating $56.3 million in the fourth quarter of 1999. See Note 6.
NOTE 6 - UNUSUAL TRANSACTIONS
Operating results for each of the last three years include certain unusual
transactions. These transactions were included in other operating expenses in
the consolidated statement of operations for the respective periods in which
they were recorded.
2001
Operating results for the nine months ended December 31, 2001 include a
pretax gain of $3.2 million recorded in connection with the Company's favorable
resolution of a legal dispute in the third quarter and a pretax gain of $2.2
million in connection with the resolution of a loss contingency related to a
partnership interest in the fourth quarter.
F-18
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 6 - UNUSUAL TRANSACTIONS (Continued)
2000
Operating results for 2000 included a $4.5 million gain on the sale of a
closed hospital recorded in the second quarter and a $9.2 million write-off of
an impaired investment recorded in the third quarter.
1999
The following table summarizes the pretax impact of unusual transactions
recorded during 1999 (in millions):
Quarters
-------------------------
First Second Third Fourth Year
----- ------ ----- ------ ------
(Income)/expense
Asset valuation losses:
Long-lived asset impairment..................... $330.4 $330.4
Investment in Behavioral Healthcare Corporation. $15.2 15.2
Cancellation of software development project....... 5.6 5.6
Realignment of ancillary services division......... 56.3 56.3
Retirement plan curtailment........................ 7.3 7.3
Corporate properties............................... (2.4) (2.4)
---- ----- ---- ------ ------
$ - $20.8 $ - $391.6 $412.4
==== ===== ==== ====== ======
Long-lived asset impairment-SFAS 121 requires impairment losses to be
recognized for long-lived assets used in operations when indications of
impairment are present and the estimate of undiscounted future cash flows is
not sufficient to recover asset carrying amounts. SFAS 121 also requires that
long-lived assets held for disposal be carried at the lower of carrying value
or fair value less costs of disposal, once management has committed to a plan
of disposal.
Operating results and related cash flows for 1999 did not meet management's
expectations. These expectations were the basis upon which the Company valued
its long-lived assets at December 31, 1998, in accordance with SFAS 121. In
addition, certain events occurred in 1999 which had a negative impact on the
Company's operating results and were expected to impact negatively its
operations in the future. In connection with the negotiation of the Government
Settlement during the bankruptcy, the Company agreed to exclude certain
expenses from its hospital Medicare cost reports beginning September 1, 1999
for which the Company had been reimbursed in prior years. Medicare revenues
related to the reimbursement of such costs aggregated $18 million in 1999. In
addition, hospital revenues in 1999 were reduced by approximately $19 million
as a result of disputes with certain insurers who issued Medicare supplement
insurance policies to individuals who became patients of the Company's
hospitals. The Company also reviewed the expected impact of the Balance Budget
Refinement Act (the "BBRA") enacted in November 1999 (which provided a measure
of relief for some of the impact of the Balanced Budget Act) and the
realignment of its ancillary services division completed in the fourth quarter
of 1999. The actual and expected future impact of these issues served as an
indication to management that the carrying values of the Company's long-lived
assets may be impaired.
In accordance with SFAS 121, management estimated the future undiscounted
cash flows for each of its facilities and compared these estimates to the
carrying values of the underlying assets. As a result of these estimates, the
Company reduced the carrying amounts of the assets associated with 71 nursing
centers and 21 hospitals to their respective estimated fair values. The
determination of the fair values of the impaired facilities was based upon the
net present value of estimated future cash flows.
F-19
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 6 - UNUSUAL TRANSACTIONS (Continued)
1999 (Continued)
A summary of the impairment charges follows (in millions):
Property
and
Goodwill Equipment Total
-------- --------- ------
Health services division......................... $ 18.3 $ 37.7 $ 56.0
Hospital division................................ 198.9 75.5 274.4
------ ------ ------
$217.2 $113.2 $330.4
====== ====== ======
Investment in Behavioral Healthcare Corporation-In connection with the
acquisition of Transitional Hospitals Corporation ("Transitional") in 1997, the
Company acquired a 44% voting equity interest (61% equity interest) in
Behavioral Healthcare Corporation ("BHC"), an operator of psychiatric and
behavioral clinics. In the second quarter of 1999, the Company wrote off its
remaining investment in BHC aggregating $15.2 million as a result of
deteriorating financial performance.
In May 2001, the Company sold its investment in BHC for $40 million. No gain
or loss was recorded in connection with this transaction because the Company
reflected the fair value of the investment on April 1, 2001 in connection with
fresh-start accounting. Under the terms of the Credit Facility and the Senior
Secured Notes, proceeds from the sale of assets are available to fund future
capital expenditures for a period of approximately one year from the sale. Any
proceeds not expended during that period would be used to permanently reduce
the commitments under the Credit Facility to as low as $75 million and repay
any outstanding loans in excess of such commitment. Any remaining proceeds
would be used to repay loans under the Senior Secured Notes.
Cancellation of software development project-In the second quarter of 1999,
the Company canceled a nursing center software development project and charged
previously capitalized costs to operations.
Realignment of ancillary services division-As discussed in Note 5, the
Company realigned its ancillary services division in the fourth quarter of
1999. As a result, the Company recorded a charge aggregating $56.3 million,
including the write-off of goodwill totaling $42.3 million. The remainder of
the charge related to the write-down of certain equipment to net realizable
value and the recording of employee severance costs.
Retirement plan curtailment-In December 1999, the Board of Directors
approved the curtailment of benefits under the Company's supplemental executive
retirement plan, resulting in an actuarially determined charge of $7.3 million.
Under the terms of the curtailment, plan benefits were vested for each eligible
participant through December 31, 1999 and the accrual of future benefits under
the plan was substantially eliminated. The Board of Directors also deferred the
time at which certain benefits would be paid to eligible participants. The plan
was terminated in February 2001. However, the termination will have no effect
on the future payment of vested benefits under the plan.
Corporate properties-During 1999, the Company adjusted estimated property
loss provisions recorded in 1998, resulting in a pretax credit of $2.4 million.
F-20
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 7 - FOURTH QUARTER ADJUSTMENTS IN 1999
In addition to the unusual transactions discussed in Note 6, during the
fourth quarter of 1999, the Company recorded certain adjustments which
significantly impacted operating results. A summary of these adjustments
follows (in millions):
Health Services
Division Hospital Division
---------------- -----------------
Nursing Ancillary
Centers Services Hospitals Pharmacy Corporate Total
------- --------- --------- -------- --------- ------
(Income)/expense
Provision for doubtful accounts............ $40.2 $26.8 $ 6.5 $ 8.9 $ 82.4
Medicare supplement insurance disputes..... 18.8 18.8
Third-party reimbursements and contractual
allowances, including amounts due from
government agencies and other payors that
are subject to dispute................... 2.0 59.6 61.6
Professional liability risks............... 14.7 0.4 1.8 0.1 17.0
Employee benefits.......................... (6.3) (1.5) (1.8) (9.6)
Incentive compensation..................... 2.2 (1.9) (1.1) (0.8)
Inventories................................ 0.9 6.3 7.2
Other...................................... 1.7 (0.4) 2.0 (4.4) $(2.8) (3.9)
----- ----- ----- ----- ----- ------
$55.4 $25.3 $85.0 $ 9.8 $(2.8) $172.7
===== ===== ===== ===== ===== ======
The Company regularly reviews its accounts receivable and records provisions
for loss based upon the best available evidence. Factors such as changes in
collection patterns, the composition of patient accounts by payor type, the
status of ongoing disputes with third-party payors (including both government
and non-government sources), the effect of increased regulatory activities,
general industry conditions and the financial condition of the Company and its
ancillary service customers, among other things, are considered by management
in determining the expected collectibility of accounts receivable.
During 1999, the Company recorded significant adjustments in the fourth
quarter related to contractual allowances and doubtful accounts in each of its
divisions. These adjustments represented changes in estimates resulting from
management's assessment of its collection processes, the general financial
deterioration of the long-term healthcare industry and the realignment of the
Company's ancillary services division (including the cancellation of
unprofitable contracts and the discontinuance of certain services) and the
bankruptcy filing in September 1999.
In addition, the Company recorded a significant adjustment in the fourth
quarter of 1999 related to professional liability risks. This adjustment was
recorded based upon actuarially determined estimates completed in the fourth
quarter and reflects substantial increases in claims and litigation activity in
the Company's nursing center business during 1999.
F-21
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 8 - EARLY EXTINGUISHMENT OF DEBT
In connection with the restructuring of its debt in accordance with the
provisions of the Plan of Reorganization, the Company realized an extraordinary
gain of $422.8 million. For accounting purposes, this gain has been reflected
in the operating results of the Predecessor Company for the three months ended
March 31, 2001.
A summary of the extraordinary gain follows (in thousands):
Liabilities restructured:
Debt obligations:
Senior lender claims........................ $ 510,908
Subordinated noteholder claims.............. 302,391
Accrued interest............................ 99,185
Unamortized deferred financing costs........ (9,729)
----------
902,755
Amounts related to prior year Medicare cost reports 193,547
Accrued Ventas rent................................ 94,285
Other.............................................. (6,857)
----------
1,183,730
----------
Consideration exchanged:
Senior secured notes............................ 300,000
Kindred common stock............................ 368,339
Warrants........................................ 66,700
Government settlement obligation................ 25,900
----------
760,939
----------
$ 422,791
==========
On May 30, 2001, the Company prepaid the outstanding balance in full
satisfaction of its obligations under the CMS Agreement, resulting in an
extraordinary gain of $1.4 million. The transaction was financed through the
use of existing cash.
In the fourth quarter of 2001, the Company prepaid $89.5 million of the
Senior Secured Notes, resulting in an extraordinary gain of $2.9 million. The
transaction was financed from proceeds of the public offering of Kindred common
stock.
F-22
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9 - EARNINGS PER SHARE
Earnings per common share are based upon the weighted average number of
common shares outstanding during the respective periods. The diluted
calculation of earnings per common share for the Reorganized Company includes
the dilutive effect of the Warrants issued in connection with the Plan of
Reorganization and stock options and non-vested restricted stock issued under
various incentive plans. For the three months ended March 31, 2001, the diluted
calculation of earnings per common share for the Predecessor Company includes
the dilutive effect of its former convertible preferred stock.
A computation of the earnings per common share follows (in thousands, except
per share amounts):
Reorganized |
Company | Predecessor Company
------------ | --------------------------------
Nine months | Three months Year ended
ended | ended December 31,
December 31, | March 31, -------------------
2001 | 2001 2000 1999
------------ | ------------ -------- ---------
Earnings (loss): |
Income (loss) from operations.......................................... $47,342 | $ 49,185 $(64,751) $(705,464)
Extraordinary gain on extinguishment of debt........................... 4,313 | 422,791 - -
Cumulative effect of change in accounting for start-up costs........... - | - - (8,923)
------- | -------- -------- ---------
Net income (loss)...................................................... 51,655 | 471,976 (64,751) (714,387)
Preferred stock dividend requirements.................................. - | (261) (1,046) (1,046)
------- | -------- -------- ---------
Income (loss) available to common stockholders - basic computation..... 51,655 | 471,715 (65,797) (715,433)
Elimination of preferred stock dividend requirements upon assumed |
conversion of preferred stock......................................... - | 261 - -
------- | -------- -------- ---------
Net income (loss) - diluted computation................................ $51,655 | $471,976 $(65,797) $(715,433)
======= | ======== ======== =========
Shares used in the computation: |
Weighted average shares outstanding - basic computation................ 15,505 | 70,261 70,229 70,406
Dilutive effect of the Warrants, employee stock options and non-vested |
restricted stock...................................................... 2,753 | - - -
Assumed conversion of preferred stock.................................. - | 1,395 - -
------- | -------- -------- ---------
Adjusted weighted average shares outstanding - diluted computation..... 18,258 | 71,656 70,229 70,406
======= | ======== ======== =========
Earnings (loss) per common share: |
Basic: |
Income (loss) from operations......................................... $ 3.05 | $ 0.69 $ (0.94) $ (10.03)
Extraordinary gain on extinguishment of debt.......................... 0.28 | 6.02 - -
Cumulative effect of change in accounting for start-up costs.......... - | - - (0.13)
------- | -------- -------- ---------
Net income (loss).................................................. $ 3.33 | $ 6.71 $ (0.94) $ (10.16)
======= | ======== ======== =========
Diluted: |
Income (loss) from operations......................................... $ 2.59 | $ 0.69 $ (0.94) $ (10.03)
Extraordinary gain on extinguishment of debt.......................... 0.24 | 5.90 - -
Cumulative effect of change in accounting for start-up costs.......... - | - - (0.13)
------- | -------- -------- ---------
Net income (loss).................................................. $ 2.83 | $ 6.59 $ (0.94) $ (10.16)
======= | ======== ======== =========
F-23
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 10 - BUSINESS SEGMENT DATA
The Company operates two business segments: the health services division and
the hospital division. The health services division operates nursing centers
and a rehabilitation therapy business. The hospital division operates hospitals
and an institutional pharmacy business.
The following table summarizes the Company's financial information by
operating segment and gives effect to the realignment of the former ancillary
services division for all periods presented. The Company defines operating
income as earnings before interest, income taxes, depreciation, amortization
and rent. Operating income reported for each of the Company's business segments
excludes the allocation of corporate overhead.
Reorganized |
Company | Predecessor Company
------------ | -----------------------------------
Nine months | Three months Year ended
ended | ended December 31,
December 31, | March 31, ----------------------
2001 | 2001 2000 1999
------------ | ------------ ---------- ----------
| (In thousands)
Revenues: |
Health services division: |
Nursing centers........................................... $1,348,236 | $429,523 $1,675,627 $1,594,244
Rehabilitation services................................... 27,451 | 10,695 135,036 195,731
Other ancillary services.................................. - | - - 43,527
Elimination............................................... - | - (77,191) (128,267)
---------- | -------- ---------- ----------
1,375,687 | 440,218 1,733,472 1,705,235
Hospital division: |
Hospitals................................................. 822,935 | 271,984 1,007,947 850,548
Pharmacy.................................................. 176,105 | 54,880 204,252 171,493
---------- | -------- ---------- ----------
999,040 | 326,864 1,212,199 1,022,041
---------- | -------- ---------- ----------
2,374,727 | 767,082 2,945,671 2,727,276
Elimination of pharmacy charges to Company nursing centers. (45,708) | (14,673) (57,129) (61,635)
---------- | -------- ---------- ----------
$2,329,019 | $752,409 $2,888,542 $2,665,641
========== | ======== ========== ==========
Income (loss) from operations: |
Operating income (loss): |
Health services division: |
Nursing centers.......................................... $ 234,500 | $ 70,543 $ 278,738 $ 169,128
Rehabilitation services.................................. 8,112 | 690 8,047 2,891
Other ancillary services................................. 508 | 250 4,737 4,166
---------- | -------- ---------- ----------
243,120 | 71,483 291,522 176,185
Hospital division: |
Hospitals................................................ 157,613 | 54,778 205,858 132,050
Pharmacy................................................. 20,831 | 6,176 7,421 342
---------- | -------- ---------- ----------
178,444 | 60,954 213,279 132,392
Corporate overhead........................................ (85,239) | (28,697) (113,823) (108,947)
Unusual transactions...................................... 5,425 | - (4,701) (412,418)
Reorganization items...................................... - | 53,666 (12,636) (18,606)
---------- | -------- ---------- ----------
Operating income (loss).................................. 341,750 | 157,406 373,641 (231,394)
Rent......................................................... (195,284) | (76,995) (307,809) (305,120)
Depreciation and amortization................................ (50,219) | (18,645) (73,545) (93,196)
Interest, net................................................ (12,455) | (12,081) (55,038) (75,254)
---------- | -------- ---------- ----------
Income (loss) before income taxes............................ 83,792 | 49,685 (62,751) (704,964)
Provision for income taxes................................... 36,450 | 500 2,000 500
---------- | -------- ---------- ----------
$ 47,342 | $ 49,185 $ (64,751) $ (705,464)
========== | ======== ========== ==========
F-24
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 10 - BUSINESS SEGMENT DATA (Continued)
Reorganized |
Company | Predecessor Company
------------|--------------------------------
Nine months |Three months Year ended
ended | ended December 31,
December 31,| March 31, -------------------
2001 | 2001 2000 1999
------------|------------ ---------- --------
| (In thousands)
Rent: |
Health services division: |
Nursing centers..................... $ 123,047 | $44,253 $ 176,802 $171,278
Rehabilitation services............. 75 | 39 429 340
Other ancillary services............ 4 | - 114 2,038
---------- | ------- ---------- --------
123,126 | 44,292 177,345 173,656
Hospital division: |
Hospitals........................... 68,571 | 30,839 123,766 121,496
Pharmacy............................ 2,953 | 941 3,614 3,799
---------- | ------- ---------- --------
71,524 | 31,780 127,380 125,295
Corporate............................. 634 | 923 3,084 6,169
---------- | ------- ---------- --------
$ 195,284 | $76,995 $ 307,809 $305,120
========== | ======= ========== ========
Depreciation and amortization: |
Health services division: |
Nursing centers..................... $ 16,693 | $ 7,219 $ 27,896 $ 25,149
Rehabilitation services............. 24 | - 4 13,162
Other ancillary services............ - | 129 613 1,027
---------- | ------- ---------- --------
16,717 | 7,348 28,513 39,338
Hospital division: |
Hospitals........................... 17,519 | 5,457 21,170 33,231
Pharmacy............................ 1,446 | 627 2,098 2,733
---------- | ------- ---------- --------
18,965 | 6,084 23,268 35,964
Corporate............................. 14,537 | 5,213 21,764 17,894
---------- | ------- ---------- --------
$ 50,219 | $18,645 $ 73,545 $ 93,196
========== | ======= ========== ========
Capital expenditures: |
Health services division.............. $ 13,315 | $ 7,962 $ 28,451 $ 42,144
Hospital division..................... 19,830 | 8,901 23,675 23,918
Corporate: |
Information systems................. 20,266 | 3,496 25,475 40,777
Other............................... 11,832 | 1,679 2,387 4,654
---------- | ------- ---------- --------
$ 65,243 | $22,038 $ 79,988 $111,493
========== | ======= ========== ========
Assets at end of period: |
Health services division.............. $ 392,938 | $ 494,636
Hospital division..................... 497,057 | 354,302
Corporate............................. 618,879 | 485,476
---------- | ----------
$1,508,874 | $1,334,414
========== | ==========
F-25
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 11 - INCOME TAXES
The provision for income taxes is based upon management's estimate of
taxable income or loss for each respective accounting period. The Company
recognizes an asset or liability for the deferred tax consequences of temporary
differences between the tax bases of assets and liabilities and their reported
amounts in the financial statements. These temporary differences will result in
taxable or deductible amounts in future years when the reported amounts of the
assets are recovered or liabilities are settled. The Company also recognizes as
deferred tax assets the future tax benefits from net operating and capital loss
carryforwards. A valuation allowance is provided for deferred tax assets if it
is more likely than not that some portion or all of the net deferred tax assets
will not be realized.
Provision for income taxes consists of the following (in thousands):
Reorganized |
Company | Predecessor Company
------------ | -------------------------
Nine months | Three months Year ended
ended | ended December 31,
December 31, | March 31, ------------
2001 | 2001 2000 1999
------------ | ------------ ------ ----
Current: |
Federal.............................. $20,805 | $ - $ - $ -
State................................ 3,382 | 500 2,000 500
------- | ---- ------ ----
24,187 | 500 2,000 500
Deferred............................. 12,263 | - - -
------- | ---- ------ ----
$36,450 | $500 $2,000 $500
======= | ==== ====== ====
Reconciliation of federal statutory tax expense to the provision for income
taxes follows (in thousands):
Reorganized |
Company | Predecessor Company
------------ | --------------------------------
Nine months | Three months Year ended
ended | ended December 31,
December 31, | March 31, -------------------
2001 | 2001 2000 1999
------------ | ------------ -------- ---------
Income tax expense (benefit) at |
federal rate......................... $29,327 | $ 17,390 $(21,963) $(249,861)
State income tax expense (benefit), |
net of federal income tax expense |
(benefit)............................ 2,933 | 1,739 (2,197) (24,985)
Goodwill amortization................. 2,211 | 999 3,997 8,541
Write-off of goodwill................. - | - - 99,902
Valuation allowance................... - | 685 12,222 154,933
Reorganization items.................. - | (20,946) 7,372 4,672
Other items, net...................... 1,979 | 633 2,569 7,298
------- | -------- -------- ---------
$36,450 | $ 500 $ 2,000 $ 500
======= | ======== ======== =========
F-26
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 11 - INCOME TAXES (Continued)
A summary of deferred income taxes by source included in the consolidated
balance sheet at December 31 follows (in thousands):
Reorganized Company | Predecessor Company
---------------------- | ----------------------
2001 | 2000
---------------------- | ----------------------
Assets Liabilities | Assets Liabilities
--------- ----------- | --------- -----------
Property and equipment...................... $ 26,150 $ - | $ 74,818 $ -
Insurance................................... 33,437 - | 33,747 -
Doubtful accounts........................... 72,829 - | 140,526 -
Compensation................................ 26,575 - | 21,785 -
Net operating losses........................ 98,878 - | 79,915 -
Other....................................... 39,649 1,918 | 47,484 26,054
--------- ------ | --------- -------
297,518 $1,918 | 398,275 $26,054
====== | =======
Reclassification of deferred tax liabilities (1,918) | (26,054)
--------- | ---------
Net deferred tax assets..................... 295,600 | 372,221
Valuation allowance......................... (263,307) | (372,221)
--------- | ---------
$ 32,293 | $ -
========= | =========
Deferred income taxes totaling $20.8 million at December 31, 2001 are
included in other current assets, and deferred income taxes totaling $11.5
million at December 31, 2001 are included in other assets.
In connection with fresh-start accounting, the Company's assets and
liabilities were recorded at their respective fair values. Deferred tax assets
and liabilities were then recognized for the tax effects of the differences
between fair values and tax bases. In addition, deferred tax assets were
recognized for future tax benefits of net operating loss carryforwards ("NOLs")
and other deferred tax credits.
To the extent management believes the pre-emergence net deferred tax asset
will more likely than not be realized, a reduction in the valuation allowance
established in fresh-start accounting will be recorded. The reduction in this
valuation allowance will first reduce reorganization value in excess of amounts
allocable to identifiable assets recorded in fresh-start accounting and other
intangible assets, with any excess being treated as an increase to capital in
excess of par value. As of December 31, 2001, the Company had reduced the
valuation allowance established in fresh-start accounting by approximately
$44.6 million which resulted in a corresponding reduction to reorganization
value in excess of amounts allocable to identifiable assets.
In connection with the reorganization, the Company realized a gain from the
extinguishment of certain indebtedness. This gain will not be taxable since the
gain resulted from the reorganization under the Bankruptcy Code. However, the
Company will be required, as of the beginning of its 2002 taxable year, to
reduce certain tax attributes relating to the Company including (a) NOLs, (b)
certain tax credits and (c) tax bases in assets in an amount equal to such gain
on extinguishment. The reorganization of the Company on the Effective Date
constituted an ownership change under Section 382 of the Internal Revenue Code
and the use of any of the Company's NOLs and tax credits generated prior to the
ownership change, that are not reduced pursuant to the provisions discussed
above, will be subject to an overall annual limitation of approximately $22
million.
The Company had NOLs of approximately $257 million (after the reductions in
the attributes discussed above) at December 31, 2001. These NOLs expire in
various amounts through 2021.
F-27
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 12 - INSURANCE RISKS
The Company insures a substantial portion of its professional liability
risks and, beginning in 2001, workers compensation through a wholly owned,
limited purpose insurance subsidiary. Coverage for losses in excess of those
insured by the insurance subsidiary are maintained through unaffiliated
commercial insurance carriers. The provision for self-insured professional
liability risks aggregated $49.2 million for the nine months ended December 31,
2001, $12.0 million for the three months ended March 31, 2001, $47.2 million
for 2000 and $61.3 million for 1999. The provision for self-insured workers
compensation risks was $21.0 million for the nine months ended December 31,
2001 and $8.0 million for the three months ended March 31, 2001. The cost of
workers compensation insurance totaled $27.3 million for 2000 and $24.3 million
for 1999.
Provisions for loss for professional liability risks retained by the
insurance subsidiary have been discounted based upon management's estimate of
long-term investment yields and independent actuarial estimates of claim
payment patterns. The interest rate used to discount funded professional
liability risks in each of the last three years was 5%. Amounts equal to the
discounted loss provision are funded annually. The Company does not fund the
portion of professional liability risks related to estimated claims that have
been incurred but not reported. Accordingly, these liabilities are not
discounted.
A summary of the assets and liabilities related to insurance risks included
in the consolidated balance sheet at December 31 follows (in thousands):
Reorganized Company | Predecessor Company
----------------------------------|----------------------------------
2001 | 2000
----------------------------------|----------------------------------
Professional Workers |Professional Workers
Liability Compensation Total | Liability Compensation Total
------------ ------------ --------|------------ ------------ --------
Assets: |
Current: |
Insurance subsidiary |
investments................ $ 69,877 $29,224 $ 99,101| $ 62,453 $ - $ 62,453
Reinsurance recoverables..... 5,584 - 5,584| 11,090 - 11,090
Deposits..................... - 1,640 1,640| - 1,640 1,640
Other........................ - - -| 56 728 784
-------- ------- --------| -------- ------- --------
75,461 30,864 106,325| 73,599 2,368 75,967
Non-current: |
Insurance subsidiary |
investments................ 16,976 - 16,976| 2,134 - 2,134
Reinsurance recoverables..... 8,840 - 8,840| 10,533 - 10,533
Deposits..................... 3,400 - 3,400| - - -
Other........................ 313 1,491 1,804| 323 821 1,144
-------- ------- --------| -------- ------- --------
29,529 1,491 31,020| 12,990 821 13,811
-------- ------- --------| -------- ------- --------
$104,990 $32,355 $137,345| $ 86,589 $ 3,189 $ 89,778
======== ======= ========| ======== ======= ========
Liabilities: |
Allowance for insurance risks: |
Current...................... $ 26,529 $ 7,982 $ 34,511| $ 17,888 $15,925 $ 33,813
Non-current.................. 136,764 25,793 162,557| 101,209 821 102,030
-------- ------- --------| -------- ------- --------
$163,293 $33,775 $197,068| $119,097 $16,746 $135,843
======== ======= ========| ======== ======= ========
F-28
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 13 - LONG-TERM DEBT
Capitalization
A summary of long-term debt at December 31 follows (in thousands):
Reorganized|Predecessor
Company | Company
-----------|-----------
2001 | 2000
-----------|-----------
Senior Secured Notes due 2008 (effective floating rate |
averaging 8.1%)........................................... $210,500 | $ -
Term A Loan, 7.9% to 8.6% (rates generally floating) |
payable in periodic installments through 2003............. - | 224,623
Term B Loan, 8.4% to 9.1% (rates generally floating) |
payable in periodic installments through 2005............. - | 226,491
Bank revolving credit agreement due 2003 (floating rates |
averaging 10%)............................................ - | 59,794
9 7/8% Guaranteed Senior Subordinated Notes due 2005........ - | 300,000
8 5/8% Senior Subordinated Notes due 2007................... - | 2,391
Amounts due to CMS, 13.4% payable in monthly installments |
through 2004.............................................. - | 63,405
Unamortized deferred financing costs........................ - | (10,306)
Other....................................................... 2,187 | 2,873
-------- | ---------
Total debt, average life of 6 years (rates averaging |
8.1%).................................................. 212,687 | 869,271
Amounts due within one year................................. (418) | -
Amounts subject to compromise............................... - | (869,271)
-------- | ---------
Long-term debt........................................... $212,269 | $ -
======== | =========
In accordance with the terms of the agreement, the aggregate commitments
under the Credit Facility were reduced to $75 million upon the consummation of
the public offering of Kindred common stock in the fourth quarter of 2001.
In connection with the bankruptcy, the Company entered into a $100 million
debtor-in-possession financing agreement (the "DIP Financing"). The DIP
Financing was initially comprised of a $75 million tranche A revolving loan and
a $25 million tranche B revolving loan. Interest was payable at prime plus
2 1/2% on the tranche A loan and prime plus 4 1/2% on the tranche B loan. The
DIP Financing was terminated on the Effective Date.
In connection with the Spin-off, the Company consummated the $1.0 billion
credit agreement which included: (a) a five-year $300 million revolving credit
facility (the "Revolving Credit Facility"), (b) a $250 million Term A Loan (the
"Term A Loan") payable in various installments over five years, (c) a
$250 million Term B Loan (the "Term B Loan") payable in installments of 1% per
year with the outstanding balance due in seven years and (d) a $200 million
Bridge Loan (the "Bridge Loan") which was repaid in September 1998 primarily
from the proceeds of the sale of the Company's investment in an affiliate.
Interest was payable, depending on certain leverage ratios and other factors,
at a rate of prime plus 2% to 3 1/2% for the Revolving Credit Facility, LIBOR
plus 3/4% to 3% for the Term A Loan, and LIBOR plus 2 1/4% to 3 1/2% for the
Term B Loan.
Other Information
The Company was a party to an interest rate swap agreement that eliminated
the impact of changes in interest rates on $100 million of floating rate debt
outstanding. The agreement provided for fixed rates on $100 million of floating
rate debt at 6.4% plus 3/8% to 1 1/8% and expired in May 2000. The fair value
of the swap agreements, or the estimated amount the Company would have paid to
terminate the agreements based on current interest rates, was not recognized in
the consolidated financial statements in 2000.
F-29
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 13 - LONG-TERM DEBT (Continued)
Other Information (Continued)
Scheduled maturities of long-term debt in years 2003 through 2006
approximate $258,000, $63,000, $69,000 and $75,000, respectively.
The estimated fair value of the Company's long-term debt was $213 million
and $537 million at December 31, 2001 and 2000, respectively, compared to
carrying amounts aggregating $213 million and $880 million.
The terms of the Company's Senior Secured Notes and Credit Facility include
certain covenants which limit annual capital expenditures and limit the amount
of debt that may be incurred in financing acquisitions. In addition, these
agreements restrict the Company's ability to transfer funds to the parent
company or repurchase its common stock and prohibit the payment of cash
dividends to stockholders.
NOTE 14 - LEASES
The Company leases real estate and equipment under cancelable and
non-cancelable arrangements. Future minimum payments under non-cancelable
operating leases are as follows (in thousand):
Minimum Payments
--------------------------
Year Ventas Other Total
---- -------- -------- --------
2002............................................. $180,714 $ 51,056 $231,770
2003............................................. 180,714 44,558 225,272
2004............................................. 180,714 34,062 214,776
2005............................................. 180,714 32,476 213,190
2006............................................. 180,714 29,414 210,128
Thereafter....................................... 610,928 118,084 729,012
NOTE 15 - CONTINGENCIES
Management continually evaluates contingencies based upon the best available
evidence. In addition, allowances for loss are provided currently for disputed
items that have continuing significance, such as certain third-party
reimbursements and deductions that continue to be claimed in current cost
reports and tax returns.
Management believes that allowances for losses have been provided to the
extent necessary and that its assessment of contingencies is reasonable.
Principal contingencies are described below:
Revenues-Certain third-party payments are subject to examination by
agencies administering the programs. The Company is contesting certain
issues raised in audits of prior year cost reports.
Professional liability risks-The Company has provided for loss for
professional liability risks based upon actuarially determined estimates.
Actual settlements may differ from the provisions for loss. See Note 12.
Guarantees of indebtedness-Letters of credit and guarantees of
indebtedness aggregated $8.1 million at December 31, 2001.
Income taxes-Under the terms of the Tax Refund Escrow Agreement, the
Company is contesting adjustments proposed by the Internal Revenue Service
for the years 1997 and 1998.
Litigation-The Company is a party to certain material litigation and
regulatory actions as well as various suits and claims arising in the
ordinary course of business. See Note 21.
F-30
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 16 - CAPITAL STOCK
Public Equity Offering
In the fourth quarter of 2001, the Company completed a public offering of
approximately 2.1 million shares of Kindred common stock. The net proceeds from
the transaction aggregating $89.6 million were used to repay a portion of the
outstanding borrowings under the Senior Secured Notes.
Plan Descriptions
Since its emergence from bankruptcy, the Company has adopted plans under
which restricted stock awards and options to purchase Kindred common stock may
be granted to officers, directors and key employees. Shares authorized under
these plans aggregated 2.2 million. Exercise provisions vary, but most stock
options are exercisable in whole or in part beginning one to four years after
grant and ending five to ten years after grant.
Upon emergence, the Company granted 600,000 shares of restricted stock to
key employees of the Company. On the Effective Date, 200,000 shares of the
restricted stock valued at $7.7 million vested immediately. The remaining
400,000 shares of restricted stock vest over a four-year period. In addition,
the Company granted 964,400 options to purchase Kindred common stock with an
exercise price of $32.00 per share, less than the fair market value of the
Kindred common stock on the date of grant of $38.50 per share.
Unearned compensation related to the restricted stock and discounted stock
option awards is amortized over the vesting period. Compensation expense
related to these awards approximated $6.7 million for the nine months ended
December 31, 2001.
Activity in the various plans is summarized below:
Shares Weighted
Under Option Price per Average
Option Share Exercise Price
---------- ---------------- --------------
Predecessor Company:
Balances, December 31, 1998........... 8,823,634 $ 0.08 to $16.58 $ 5.72
Granted.............................. 423,000 0.63 to 4.50 2.50
Exercised............................ (7,031) 0.34 0.34
Canceled or expired.................. (1,196,924) 0.34 to 16.58 6.19
----------
Balances, December 31, 1999........... 8,042,679 0.08 to 15.09 5.50
Canceled or expired.................. (1,813,066) 0.39 to 14.93 6.98
----------
Balances, December 31, 2000........... 6,229,613 0.08 to 15.09 5.07
Canceled or expired.................. (563,547) 3.81 to 9.80 5.22
Elimination of stock options in
connection with the Plan of
Reorganization..................... (5,666,066) 0.08 to 15.09 5.06
----------
- -----------------------------------------------------------------------------------
Reorganized Company:
Balances, April 1, 2001............... -
Granted.............................. 1,066,900 32.00 to 59.00 34.13
Canceled............................. (96,800) 32.00 to 59.00 33.87
----------
Balances, December 31, 2001........... 970,100 $32.00 to $59.00 $34.15
==========
F-31
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 16 - CAPITAL STOCK (Continued)
Plan Descriptions (Continued)
A summary of stock options outstanding at December 31, 2001 follows:
Options Outstanding Options Exercisable
------------------------------------ ------------------------
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
Range of at December 31, Contractual Exercise at December 31, Exercise
Exercise Prices 2001 Life Price 2001 Price
--------------- --------------- ----------- -------- --------------- --------
$32.00 to $47.50 884,300 6 years $32.18 - -
$49.05 to $59.00 85,800 10 years 54.56 - -
-------
970,100 6 years 34.15 - -
=======
Shares of Kindred common stock available for future grants were 629,900 at
December 31, 2001. Shares of Predecessor Company common stock available for
future grants were 6,001,333 and 3,824,628 at December 31, 2000 and 1999,
respectively.
Statement No. 123 Data
The Company elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under SFAS
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), requires use
of option valuation models that were not developed for use in valuing employee
stock options.
Pro forma information regarding net income and earnings per share is
required by SFAS 123, which also requires that the information be determined as
if the Company has accounted for its employee stock options granted subsequent
to December 31, 1994 under the fair value method of SFAS 123. The fair value of
such options was estimated at the date of grant using a Black-Scholes option
valuation model with the following weighted average assumptions: risk-free
interest rate of 4.59% for 2001, 5.90% for 2000 and 5.30% for 1999; no dividend
yield; expected term of 4 years and volatility factors of the expected market
price of the common stock of .43 for 2001, .85 for 2000 and .82 for 1999.
A Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because the changes in the
subjective input assumptions can affect materially the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the respective vesting period. The
weighted average fair values of options granted during 2001 under a
Black-Scholes valuation model were $17.64 for options issued with an exercise
price less than the market price on the date of grant and $28.08 for options
with an exercise price equal to the market price on the date of grant. There
were no options granted during 2000 and the fair value of options granted
during 1999 was $1.92.
F-32
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 16 - CAPITAL STOCK (Continued)
Statement No. 123 Data (Continued)
Pro forma information follows (in thousands, except per share amounts):
Reorganized |
Company | Predecessor Company
------------ | -----------------------------------
Nine months | Three months
ended | ended Year ended December 31,
December 31, | March 31, ----------------------
2001 | 2001 2000 1999
------------ | ------------ -------- ---------
Pro forma income (loss) available to common |
stockholders............................. $49,910 | $498,767 $(71,296) $(725,319)
Pro forma earnings (loss) per common share: |
Basic................................... $ 3.22 | $ 7.10 $ (1.02) $ (10.30)
Diluted................................. $ 2.71 | $ 6.96 $ (1.02) $ (10.30)
The effects of applying SFAS 123 in the pro forma disclosures are not likely
to be representative of the effects on pro forma net income for future years
since variables such as option grants, cancellations and stock price volatility
included in the disclosures may not be indicative of future activity.
NOTE 17 - EMPLOYEE BENEFIT PLANS
The Company maintains defined contribution retirement plans covering
employees who meet certain minimum eligibility requirements. Benefits are
determined as a percentage of a participant's contributions and generally are
vested based upon length of service. Retirement plan expense was $8.0 million
for the nine months ended December 31, 2001, $3.0 million for the three months
ended March 31, 2001, $8.8 million for 2000 and $10.8 million for 1999. Amounts
equal to retirement plan expense are funded annually.
The Company also maintained a supplemental executive retirement plan
covering certain officers under which benefits were determined based primarily
upon participants' compensation and length of service with the Company. The
cost of the plan aggregated $155,000 for the nine months ended December 31,
2001, $56,000 for the three months ended March 31, 2001, $300,000 for 2000 and
$11.0 million for 1999. In January 1999, the Company funded $3.7 million of
plan obligations to participants through the purchase of annuities. As
discussed in Note 6, the plan was curtailed in December 1999 and terminated in
February 2001.
NOTE 18 - ACCRUED LIABILITIES
A summary of other accrued liabilities at December 31 follows (in thousands):
Reorganized | Predecessor
Company | Company
----------- | -----------
2001 | 2000
----------- | -----------
Professional liability risks........... $ 26,529 | $17,888
Patient accounts....................... 25,105 | 24,490
Taxes other than income................ 23,165 | 16,723
Accrued reorganization items........... 20,075 | 7,032
Other.................................. 43,697 | 15,319
-------- | -------
$138,571 | $81,452
======== | =======
F-33
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS
Pursuant to the Plan of Reorganization, the Company issued to certain
claimholders in exchange for their claims an aggregate of (1) $300 million of
the Senior Secured Notes, (2) 15,000,000 shares of Kindred common stock, (3)
2,000,000 Series A warrants, and (4) 5,000,000 Series B warrants. Each of the
Series A warrants and the Series B warrants have a five-year term with an
exercise price of $30.00 and $33.33 per share, respectively. As a result of the
exchange described above, the holders of certain claims acquired control of the
Company and the holders of the Company's former common stock relinquished
control.
In connection with the Plan of Reorganization, the Company also entered into
a registration rights agreement with Appaloosa Management L.P., Franklin Mutual
Advisers, LLC, Goldman, Sachs & Co. ("Goldman") and Ventas Realty, Limited
Partnership (the "Registration Rights Agreement"). The Registration Rights
Agreement requires the Company to use its reasonable best efforts to file,
cause to be declared effective and keep effective for at least two years or
until all of their shares of Kindred common stock or Warrants are sold, a
"shelf" registration statement covering sales of such security holders' shares
of Kindred common stock and Warrants or, in the case of Ventas, the
distribution of some or all of the shares of Kindred common stock that it owns
to the Ventas stockholders. The Company filed the shelf registration statement
on Form S-3 with the Commission on September 19, 2001. The shelf registration
statement became effective on November 7, 2001.
The Registration Rights Agreement also provides that, subject to certain
limitations, each security holder party thereto has the right to demand that
the Company register all or a part of Kindred common stock and Warrants
acquired by that security holder pursuant to the Plan of Reorganization,
provided that the estimated market value of Kindred common stock and Warrants
to be registered is at least $10 million in the aggregate or not less than 5%
of Kindred common stock and Warrants. The Company is required to use its
reasonable best efforts to effect any such registration. Such registrations
will be at the Company's expense, subject to certain exceptions.
In addition, under the Registration Rights Agreement, the security holders
party thereto have certain rights to require the Company to include in any
registration statement that it files with respect to any offering of equity
securities (whether for the Company's own account or for the account of any
holders of the Company's securities) such amount of Kindred common stock and
Warrants as are requested by the security holder to be included in the
registration statement, subject to certain exceptions. Such registrations will
be at the Company's expense, subject to certain exceptions. As discussed below,
the parties to the Registration Rights Agreement participated in the Company's
public equity offering in the fourth quarter of 2001.
Pursuant to Amendment No. 1 to the Registration Rights Agreement dated as of
August 13, 2001, the parties to the Registration Rights Agreement agreed to
extend the deadline for the Company to file a "shelf" registration statement
from 120 days to 150 days after the Effective Date. As noted above, the Company
filed a shelf registration statement with the Commission on September 19, 2001
and the shelf registration statement was declared effective on November 7, 2001.
Pursuant to Amendment No. 2 to the Registration Rights Agreement dated as of
October 22, 2001, the parties to the Registration Rights Agreement agreed to an
exception to certain restrictions in the Registration Rights Agreement to allow
Ventas to distribute up to 350,000 shares of Kindred common stock that it owns
to its stockholders on or after December 24, 2001.
In the fourth quarter of 2001, the Company completed a public offering of
approximately 3.6 million shares of Kindred common stock priced at $46.00 per
share. In the offering, the Company sold approximately 2.1 million newly issued
shares and certain of the holders of five percent or more of the Kindred common
stock participated in the offering as selling shareholders.
F-34
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
In addition, Goldman acted as co-lead manager in the public offering. In
accordance with the underwriting agreement entered into between various
parties, including the Company and Goldman, the Company paid Goldman
approximately $2.9 million in underwriting commissions.
In connection with the Plan of Reorganization, the Company also entered into
and assumed several agreements with Ventas. In addition to Kindred common stock
received by Ventas, the Company amended and restated its master lease
agreements with Ventas and paid Ventas a $4.5 million cash payment in April
2001 as additional future rent. The Company also assumed and agreed to continue
to perform its obligations under various agreements (the "Spin-off Agreements")
entered into at the time of the Spin-off. Descriptions of the agreements with
Ventas are summarized below.
Master Lease Agreements
Under the Plan of Reorganization, the Company assumed the original master
lease agreements with Ventas and its affiliates and simultaneously amended and
restated the agreements into the Master Lease Agreements. The following summary
description of the Master Lease Agreements is qualified in its entirety by
reference to the Master Lease Agreements, as filed by the Company with the
Commission.
Term and Renewals
Each Master Lease Agreement includes land, buildings, structures and other
improvements on the land, easements and similar appurtenances to the land and
improvements, and permanently affixed equipment, machinery and other fixtures
relating to the operation of the leased properties. There are several bundles
of leased properties under each Master Lease Agreement, with each bundle
containing approximately 7 to 12 leased properties. Each bundle contains both
nursing centers and hospitals. All leased properties within a bundle have base
terms ranging from 10 to 15 years beginning from May 1, 1998, subject to
certain exceptions.
At the Company's option, all, but not less than all, of the leased
properties in a bundle may be extended for one five-year renewal term beyond
the base term at the then existing rental rate plus the then existing
escalation amount per annum. The Company may further extend for two additional
five-year renewal terms beyond the first renewal term at the greater of the
then existing rental rate plus the then existing escalation amount per annum or
the then fair market value rental rate. The rental rate during the first
renewal term and any additional renewal term in which rent due is based on the
then existing rental rate will escalate each year during such term(s) at the
applicable escalation rate.
The Company may not extend the Master Lease Agreements beyond the base term
or any previously exercised renewal term if, at the time the Company seeks such
extension and at the time such extension takes effect, (1) an event of default
has occurred and is continuing or (2) a Medicare/Medicaid event of default (as
described below) and/or a licensed bed event of default (as described below)
has occurred and is continuing with respect to three or more leased properties
subject to a particular Master Lease Agreement. The base term and renewal term
of each Master Lease Agreement are subject to termination upon default by the
Company (subject to certain exceptions) and certain other conditions described
in the Master Lease Agreements.
Rental Amounts and Escalators
Each Master Lease Agreement is commonly known as a triple-net lease or an
absolute-net lease. Accordingly, in addition to rent, the Company is required
to pay the following: (1) all insurance required in
F-35
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENT (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Master Lease Agreements (Continued)
Rental Amounts and Escalators (Continued)
connection with the leased properties and the business conducted on the leased
properties, (2) all taxes levied on or with respect to the leased properties
(other than taxes on the net income of Ventas) and (3) all utilities and other
services necessary or appropriate for the leased properties and the business
conducted on the leased properties.
Under each Master Lease Agreement, the aggregate annual rent is referred to
as base rent. Base rent equals the sum of current rent and accrued rent. The
Company is obligated to pay the portion of base rent that is current rent, and
unpaid accrued rent will be paid as set forth below.
From the effective date of the Master Lease Agreements through April 30,
2004, base rent will equal the current rent. Under the Master Lease Agreements,
the annual aggregate base rent owed by the Company currently is $180.7 million.
For the period from May 1, 2001 through April 30, 2004, annual aggregate base
rent payable in cash will escalate at an annual rate of 3 1/2% over the prior
period base rent if certain revenue parameters are obtained. The Company paid
rents to Ventas approximating $135.6 million for the nine months ended December
31, 2001, $45.4 million for the three months ended March 31, 2001, $181.6
million for 2000 and $191.2 million for 1999.
Each Master Lease Agreement also provides that beginning May 1, 2004, the
annual aggregate base rent payable in cash will escalate at an annual rate of
2% (plus, upon the occurrence of certain events, an additional annual accrued
escalator amount of 1 1/2/% of the prior period base rent) which will accrete
from year to year including an interest accrual at LIBOR plus 4 1/2% to be
added to the annual accreted amount. This interest will not be added to the
aggregate base rent in subsequent years. /
The unpaid accrued rent will become payable upon the refinancing of the
Company's existing credit agreements or the termination or expiration of the
applicable Master Lease Agreement.
Reset Rights
During the one-year period commencing in July 2006, Ventas will have a one
time option to reset the base rent, current rent and accrued rent under each
Master Lease Agreement to the then fair market rental of the leased properties.
Upon exercising this reset right, Ventas will pay the Company a fee equal to a
prorated portion of $5 million based upon the proportion of base rent payable
under the Master Lease Agreement(s) with respect to which rent is reset to the
total base rent payable under all of the Master Lease Agreements. The
determination of the fair market rental will be effectuated through the
appraisal procedures in the Master Lease Agreements.
Use of the Leased Property
The Master Lease Agreements require that the Company utilize the leased
properties solely for the provision of healthcare services and related uses and
as Ventas may otherwise consent. The Company is responsible for maintaining or
causing to be maintained all licenses, certificates and permits necessary for
the leased properties to comply with various healthcare regulations. The
Company also is obligated to operate continuously each leased property as a
provider of healthcare services.
F-36
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Master Lease Agreements (Continued)
Events of Default
Under each Master Lease Agreement, an "Event of Default" will be deemed to
occur if, among other things:
. the Company fails to pay rent or other amounts within five days after
notice,
. the Company fails to comply with covenants, which failure continues for 30
days or, so long as diligent efforts to cure such failure are being made,
such longer period (not over 180 days) as is necessary to cure such
failure,
. certain bankruptcy or insolvency events occur, including filing a petition
of bankruptcy or a petition for reorganization under the Bankruptcy Code,
. an event of default arising from the Company's failure to pay principal or
interest on the Senior Secured Notes or any other indebtedness exceeding
$50 million,
. the maturity of the Senior Secured Notes or any other indebtedness
exceeding $50 million is accelerated,
. the Company ceases to operate any leased property as a provider of
healthcare services for a period of 30 days,
. a default occurs under any guaranty of any lease or the indemnity
agreements with Ventas,
. the Company or its subtenant lose any required healthcare license, permit
or approval or fails to comply with any legal requirements as determined
by a final unappealable determination,
. the Company fails to maintain insurance,
. the Company creates or allows to remain certain liens,
. the Company breaches any material representation or warranty,
. a reduction occurs in the number of licensed beds in a facility, generally
in excess of 10% (or less than 10% if the Company has voluntarily "banked"
licensed beds) of the number of licensed beds in the applicable facility
on the commencement date (a "licensed bed event of default"),
. Medicare or Medicaid certification with respect to a participating
facility is revoked and re-certification does not occur for 120 days (plus
an additional 60 days in certain circumstances) (a "Medicare/Medicaid
event of default"),
. the Company becomes subject to regulatory sanctions as determined by a
final unappealable determination and fails to cure such regulatory
sanctions within its specified cure period for any facility, the Company
fails to cure a breach of any permitted encumbrance within the applicable
cure period and, as a result, a real property interest or other beneficial
property right of Ventas is at material risk of being terminated, or
. the Company fails to cure the breach of any of the obligations of Ventas
as lessee under any existing ground lease within the applicable cure
period and, if such breach is a non-monetary, non-material breach, such
existing ground lease is at material risk of being terminated.
F-37
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Master Lease Agreements (Continued)
Remedies for an Event of Default
Except as noted below, upon an Event of Default under one of the Master
Lease Agreements, Ventas may, at its option, exercise the following remedies:
(1) after not less than ten days' notice to the Company, terminate the
Master Lease Agreement to which such Event of Default relates, repossess any
leased property, relet any leased property to a third party and require that
the Company pay to Ventas, as liquidated damages, the net present value of
the rent for the balance of the term, discounted at the prime rate,
(2) without terminating the Master Lease Agreement to which such Event of
Default relates, repossess the leased property and relet the leased property
with the Company remaining liable under such Master Lease Agreement for all
obligations to be performed by the Company thereunder, including the
difference, if any, between the rent under such Master Lease Agreement and
the rent payable as a result of the reletting of the leased property, and
(3) seek any and all other rights and remedies available under law or in
equity.
In addition to the remedies noted above, under the Master Lease Agreements,
in the case of a facility-specific event of default, Ventas may terminate a
Master Lease Agreement as to the leased property to which the Event of Default
relates, and may, but need not, terminate the entire Master Lease Agreement.
Each of the Master Lease Agreements includes special rules relative to
Medicare/Medicaid events of default and licensed bed events of default. In the
event a Medicare/Medicaid event of default and/or a licensed bed event of
default occurs and is continuing (a) with respect to not more than two
properties at the same time under a Master Lease Agreement that covers 41 or
more properties and (b) with respect to not more than one property at the same
time under a Master Lease Agreement that covers 21 to and including 40
properties, Ventas may not exercise termination or dispossession remedies
against any property other than the property or properties to which the event
of default relates. Thus, in the event Medicare/Medicaid events of default and
licensed bed events of default would occur and be continuing (a) with respect
to one property under a Master Lease Agreement that covers less than 20
properties, (b) with respect to two or more properties at the same time under a
Master Lease Agreement that covers 21 to and including 40 properties, or (c)
with respect to three or more properties at the same time under a Master Lease
Agreement that covers 41 or more properties, then Ventas would be entitled to
exercise all rights and remedies available to it under the Master Lease
Agreements.
Assignment and Subletting
Except as noted below, the Master Lease Agreements provide that the Company
may not assign, sublease or otherwise transfer any leased property or any
portion of a leased property as a whole (or in substantial part), including by
virtue of a change of control, without the consent of Ventas, which may not be
unreasonably withheld if the proposed assignee (1) is a creditworthy entity
with sufficient financial stability to satisfy its obligations under the
related Master Lease Agreement, (2) has not less than four years experience in
operating healthcare facilities, (3) has a favorable business and operational
reputation and character and (4) has all licenses, permits, approvals and
authorizations to operate the facility and agrees to comply with the use
restrictions in the related Master Lease Agreement. The obligation of Ventas to
consent to a subletting or assignment is subject to the reasonable approval
rights of any mortgagee and/or the lenders under its credit agreement.The
Company may sublease up to 20% of each leased property for restaurants, gift
shops and other stores or services customarily found in hospitals or nursing
centers without the consent of Ventas, subject, however, to there being no
material alteration in the character of the leased property or in the nature of
the business conducted on such leased property.
F-38
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Master Lease Agreements (Continued)
Assignment and Subletting (Continued)
In addition, each Master Lease Agreement allows the Company to assign or
sublease (a) without the consent of Ventas, 10% of the nursing center
facilities in each Master Lease Agreement and (b) with Ventas' consent (which
consent will not be unreasonably withheld, delayed or conditioned), two
hospitals in each Master Lease Agreement, if either (i) the applicable
regulatory authorities have threatened to revoke an authorization necessary to
operate such leased property or (ii) the Company cannot profitably operate such
leased property. Any such proposed assignee/sublessee must satisfy the
requirements listed above and it must have all licenses, permits, approvals and
other authorizations required to operate the leased properties in accordance
with the applicable permitted use. With respect to any assignment or sublease
made under this provision, Ventas agrees to execute a nondisturbance and
attornment agreement with such proposed assignee or subtenant. Upon any
assignment or subletting, the Company will not be released from its obligations
under the applicable Master Lease Agreement.
Subject to certain exclusions, the Company must pay to Ventas 80% of any
consideration received by the Company on account of an assignment and 80% (50%
in the case of existing subleases) of sublease rent payments (roughly equal to
revenue net of specified allowed expenses attributable to a sublease, and
specifically defined in the Master Lease Agreements), provided that Ventas'
right to such payments will be subordinate to that of the Company's lenders.
Ventas will have the right to approve the purchaser at a foreclosure of one
or more of the Company's leasehold mortgages by the Company's lenders. Such
approval will not be unreasonably withheld so long as such purchaser is
creditworthy, reputable and has four years experience in operating healthcare
facilities. Any dispute regarding whether Ventas has unreasonably withheld its
consent to such purchaser will be subject to expedited arbitration.
Under the Master Lease Agreements, Ventas has a right to sever properties
from the existing leases in order to create additional leases, a device adopted
to facilitate its financing flexibility. In such circumstances, the Company's
aggregate lease obligations remain unchanged. Ventas exercised this severance
right with respect to Master Lease Agreement No. 1 to create a new lease of 40
nursing centers (the "CMBS Lease") and mortgaged these properties in connection
with a securitized mortgage financing. The CMBS Lease is in substantially the
same form as the other Master Lease Agreements with certain modifications
requested by Ventas' lender and required to be made by the Company pursuant to
the Master Lease Agreements. The transaction closed on December 12, 2001.
Spin-off Agreements and Other Arrangements Under the Plan of Reorganization
In order to govern certain of the relationships between the Company and
Ventas after the Spin-off and to provide mechanisms for an orderly transition,
the Company and Ventas entered into the Spin-off Agreements at the time of the
Spin-off. Except as noted below, the following agreements between Ventas and
the Company were assumed by the Company and certain of these agreements were
simultaneously amended in accordance with the terms of the Plan of
Reorganization.
Tax Allocation Agreement and Tax Refund Escrow Agreement
The Tax Allocation Agreement, entered into at the time of the Spin-off, was
assumed by the Company under the Plan of Reorganization and then amended and
supplemented by the Tax Refund Escrow Agreement. Both of these agreements are
described below.
F-39
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Spin-off Agreements and Other Arrangements Under the Plan of Reorganization
(Continued)
Tax Allocation Agreement and Tax Refund Escrow Agreement (Continued)
The Tax Allocation Agreement provides that the Company will be liable for,
and will hold Ventas harmless from and against, (1) any taxes of the Company
and its then subsidiaries (the "Kindred Group") for periods after the Spin-off,
(2) any taxes of Ventas and its then subsidiaries (the "Ventas Group") or the
Kindred Group for periods prior to the Spin-off (other than taxes associated
with the Spin-off) with respect to the portion of such taxes attributable to
assets owned by the Kindred Group immediately after completion of the Spin-off
and (3) any taxes attributable to the Spin-off to the extent that the Company
derives certain tax benefits as a result of the payment of such taxes. Under
the Tax Allocation Agreement, the Company would be entitled to any refund or
credit in respect of taxes owed or paid by the Company under (1), (2) or (3)
above. The Company's liability for taxes for purposes of the Tax Allocation
Agreement would be measured by Ventas' actual liability for taxes after
applying certain tax benefits otherwise available to Ventas other than tax
benefits that Ventas in good faith determines would actually offset tax
liabilities of Ventas in other taxable years or periods. Any right to a refund
for purposes of the Tax Allocation Agreement would be measured by the actual
refund or credit attributable to the adjustment without regard to offsetting
tax attributes of Ventas.
Under the Tax Allocation Agreement, Ventas would be liable for, and would
hold the Company harmless against, any taxes imposed on the Ventas Group or the
Kindred Group other than taxes for which the Kindred Group is liable as
described in the above paragraph. Ventas would be entitled to any refund or
credit for taxes owed or paid by Ventas as described in this paragraph. Ventas'
liability for taxes for purposes of the Tax Allocation Agreement would be
measured by the Kindred Group's actual liability for taxes after applying
certain tax benefits otherwise available to the Kindred Group other than tax
benefits that the Kindred Group in good faith determines would actually offset
tax liabilities of the Kindred Group in other taxable years or periods. Any
right to a refund would be measured by the actual refund or credit attributable
to the adjustment without regard to offsetting tax attributes of the Kindred
Group.
On the Effective Date, Ventas and the Company entered into the Tax Refund
Escrow Agreement governing their relative entitlement to certain tax refunds
received on or after September 13, 1999 by Ventas or the Company for the tax
periods prior to and including the Spin-off that each has received or may
receive in the future. The Tax Refund Escrow Agreement amends and supplements
the Tax Allocation Agreement. Under the terms of the Tax Refund Escrow
Agreement, refunds ("Subject Refunds") received on or after September 13, 1999
by either Ventas or the Company with respect to federal, state or local income,
gross receipts, windfall profits, transfer, duty, value-added, property,
franchise, license, excise, sales and use, capital, employment, withholding,
payroll, occupational or similar business taxes (including interest, penalties
and additions to tax, but excluding certain refunds), for taxable periods
ending on or prior to May 1, 1998 ("Subject Taxes") were deposited into an
escrow account with a third-party escrow agent on the Effective Date.
The Tax Refund Escrow Agreement provides that each party shall notify the
other of any asserted Subject Tax liability of which it becomes aware, that
either party may request that asserted liabilities for Subject Taxes be
contested, that neither party may settle such a contest without the consent of
the other, that each party shall have a right to participate in any such
contest, and that the parties generally shall cooperate with regard to Subject
Taxes and Subject Refunds and shall mutually and jointly control any audit or
review process related thereto. The funds in the escrow account (the "Escrow
Funds") may be released from the escrow account to pay Subject Taxes and as
otherwise provided therein.
The Tax Refund Escrow Agreement provides generally that Ventas and the
Company waive their respective rights under the Tax Allocation Agreement to
make claims against each other with respect to Subject Taxes satisfied by the
Escrow Funds, notwithstanding the indemnification provisions of the Tax
Allocation Agreement.
F-40
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Spin-off Agreements and Other Arrangements Under the Plan of Reorganization
(Continued)
Tax Allocation Agreement and Tax Refund Escrow Agreement (Continued)
To the extent that the Escrow Funds are insufficient to satisfy all liabilities
for Subject Taxes that are finally determined to be due (such excess amount,
"Excess Taxes"), the relative liability of Ventas and the Company to pay such
Excess Taxes shall be determined as provided in the Tax Refund Escrow
Agreement. Disputes under the Tax Refund Escrow Agreement, and the
determination of the relative liability of Ventas and the Company to pay Excess
Taxes, if any, are governed by the arbitration provision of the Tax Allocation
Agreement.
Interest earned on the Escrow Funds or included in refund amounts received
from governmental authorities will be distributed equally to each of Ventas and
the Company on an annual basis. For the year ended December 31, 2001, the
Company has recorded approximately $368,000 of interest income related to the
Escrow Funds. Any Escrow Funds remaining in the escrow account after no further
claims may be made by governmental authorities with respect to Subject Taxes or
Subject Refunds (because of the expiration of statutes of limitation or
otherwise) will be distributed equally to Ventas and the Company.
Agreement of Indemnity-Third Party Leases
In connection with the Spin-off, Ventas assigned its former third-party
lease obligations (i.e., leases under which an unrelated third party is the
landlord) as a tenant or as a guarantor of tenant to the Company (the "Third
Party Leases"). The lessors of these properties may claim that Ventas remains
liable on the Third Party Leases assigned to the Company. Under the terms of
the Agreement of Indemnity-Third Party Leases, the Company has agreed to
indemnify and hold Ventas harmless from and against all claims against Ventas
arising out of the Third Party Leases. Under the Plan of Reorganization, the
Company assumed and agreed to fulfill its obligations under the Agreement of
Indemnity-Third Party Leases.
Agreement of Indemnity-Third Party Contracts
In connection with the Spin-off, Ventas assigned its former third-party
guaranty agreements to the Company (the "Third Party Guarantees"). Ventas may
remain liable on the Third Party Guarantees assigned to the Company. Under the
terms of the Agreement of Indemnity-Third Party Contracts, the Company has
agreed to indemnify and hold Ventas harmless from and against all claims
against Ventas arising out of the Third Party Guarantees assigned to the
Company. The Third Party Guarantees were entered into in connection with
certain acquisitions and financing transactions that occurred prior to the
Spin-off. Under the Plan of Reorganization, the Company assumed and agreed to
fulfill its obligations under the Agreement of Indemnity-Third Party Contracts.
Assumption of Other Liabilities
In connection with the Spin-off, the Company agreed to assume and to
indemnify Ventas for any and all liabilities that may arise out of the
ownership or operation of the healthcare operations either before or after the
date of the Spin-off. The indemnification provided by the Company also covers
losses, including costs and expenses, which may arise from any future claims
asserted against Ventas based on these healthcare operations. In addition, at
the time of the Spin-off, the Company agreed to assume the defense, on behalf
of Ventas, of any claims that were pending at the time of the Spin-off, and
which arose out of the ownership or operation of the healthcare operations. The
Company also agreed to defend, on behalf of Ventas, any claims asserted after
the Spin-off which arise out of the ownership and operation of the healthcare
operations. Under the Plan of Reorganization, the Company assumed and agreed to
perform its obligations under these indemnifications.
F-41
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Spin-off Agreements and Other Arrangements Under the Plan of Reorganization
(Continued)
Assumption of Other Liabilities (Continued)
In connection with the Spin-off, the Company and Ventas entered into a
Development Agreement and a Participation Agreement. Under the terms of the
Development Agreement, the Company agreed that upon completion of each
development property, Ventas would have the option to purchase the development
property from the Company at a purchase price equal to the amount of the
Company's actual costs in acquiring, developing and improving such development
property prior to the purchase date. If Ventas purchased the development
property, the Company would lease the development property from Ventas. The
annual base rent under such a lease would have been ten percent of the actual
costs incurred by the Company in acquiring and developing the development
property. The other terms of the lease for the development property would have
been substantially similar to those set forth in the original master lease
agreements.
Under the terms of the Participation Agreement, the Company had a right of
first offer to become the lessee of any real property acquired or developed by
Ventas which was to be operated as a hospital, nursing center or other
healthcare facility, provided that the Company and Ventas negotiated a mutually
satisfactory lease arrangement. The Participation Agreement also provided,
subject to certain terms, that the Company would provide Ventas with a right of
first offer to purchase or finance any healthcare related real property that
the Company determined to sell or mortgage to a third party, provided that the
Company and Ventas negotiated mutually satisfactory terms for such purchase or
mortgage.
The Participation Agreement and the Development Agreement were terminated on
the Effective Date. The Company and Ventas are deemed to have waived any and
all damages, claims, liabilities, obligations, and causes of action related to
or arising out of these agreements.
Terminated Arrangements with Ventas
The Company and Ventas also entered into certain agreements, stipulations
and orders both prior to and during the pendency of the Company's bankruptcy
proceedings governing certain aspects of the business relationships between the
Company and Ventas prior to the Effective Date. In March 1999, the Company
served Ventas with a demand for mediation seeking a reduction in rent and other
concessions under its former master lease agreements with Ventas. Shortly
thereafter, the Company and Ventas entered into a series of standstill and
tolling agreements which provided that both companies would postpone any claims
either may have against the other and extend any applicable statutes of
limitation. As a result of the Company's failure to pay rent, Ventas served the
Company with notices of nonpayment under the original master lease agreements.
Subsequently, the Company and Ventas entered into further amendments to the
second standstill and the tolling agreements to extend the time during which no
remedies may be pursued by either party and to extend the date by which the
Company could cure its failure to pay rent.
In connection with the bankruptcy, the Company and Ventas entered into a
stipulation (the "Stipulation") that provided for the payment by the Company of
a reduced aggregate monthly rent of approximately $15.1 million. The Bankruptcy
Court approved the Stipulation. The Stipulation also continued to toll any
statutes of limitations for claims that might have been asserted by the Company
against Ventas and provided that the Company would continue to fulfill its
indemnification obligations arising from the Spin-off. The Stipulation
automatically renewed for one-month periods unless either party provided a
14-day notice of termination.
In May 2000, the Bankruptcy Court approved a tax stipulation agreement
between the Company and Ventas (the "Tax Stipulation"). The Tax Stipulation
provided that certain refunds of federal, state and local taxes
F-42
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Terminated Arrangements with Ventas (Continued)
received by either party on or after September 13, 1999 would be held by the
recipient of such refunds in segregated interest bearing accounts. The Tax
Stipulation required notification before either party could withdraw funds from
the segregated accounts.
The Stipulation and Tax Stipulation were each terminated on the Effective
Date and are of no further force or effect.
Other Related Party Transactions
As part of the Spin-off, the Company issued $17.7 million of its former 6%
Series A Non-Voting Convertible Preferred Stock (the "Preferred Stock") to
Ventas as part of the consideration for the assets transferred from Ventas to
the Company. The Preferred Stock (par value $1,000) included a ten-year
mandatory redemption provision and was convertible into the Company's former
common stock at a price of $12.50 per share. In connection with the purchases
of the Preferred Stock, the Company loaned certain officers 90% of the purchase
price ($15.9 million) of the Preferred Stock (the "Preferred Stock Loans").
Each Preferred Stock Loan was evidenced by a promissory note which had a ten
year term and bore interest at 5.74%, payable annually. No principal payments
were due under the promissory notes until their maturity. The promissory notes
were secured by a first priority security interest in the Preferred Stock
purchased by each such officer. As of December 31, 2000, $15.7 million of these
loans remained outstanding. The terms of the Preferred Stock Loans with certain
former officers were amended in connection with their severance agreements to
provide, generally, that (a) the Preferred Stock Loan will not be due and
payable until April 30, 2008, (b) payments on the Preferred Stock Loan will be
deferred until the fifth anniversary of the date of termination, (c) interest
payments will be forgiven if the average closing price of the former common
stock for the 90 days prior to any interest payment date is less than $8.00 and
(d) during the five-day period following the expiration of the fifth
anniversary of the date of termination, the former officer would have had the
right to put the Preferred Stock underlying the Preferred Stock Loan to the
Company at par.
In August 1999, the Company entered into agreements with certain officers
which permitted such officer to put the Preferred Stock to the Company for an
amount equal to the outstanding principal and interest on the officer's
Preferred Stock Loan (the "Preferred Stock Agreements"). The officer could put
the Preferred Stock to the Company after January 1, 2000. During the Company's
bankruptcy, the Company could not honor the terms of the Preferred Stock
Agreements. The Preferred Stock Agreements were entered into with each officer
employed by the Company in August 1999 who owned the Preferred Stock.
Under the terms of the Plan of Reorganization, the Preferred Stock
Agreements were canceled in exchange for the cancellation of the Preferred
Stock Loans. In addition, the Preferred Stock was canceled without any
consideration.
F-43
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 20 - FAIR VALUE DATA
A summary of fair value data at December 31 follows (in thousands):
Reorganized Company | Predecessor Company
------------------- | -------------------
2001 | 2000
------------------- | -------------------
Carrying Fair | Carrying Fair
Value Value | Value Value
-------- -------- | -------- --------
Cash and cash equivalents................... $190,799 $190,799 | $184,642 $184,642
Cash-restricted............................. 18,025 18,025 | 10,674 10,674
Insurance subsidiary investments............ 116,077 116,077 | 64,587 64,587
Tax refund escrow investments............... 15,706 15,706 | 2,673 2,673
Long-term debt, including amounts due within |
one year.................................. 212,687 212,746 | 879,577 537,330
NOTE 21 - LITIGATION
Summary descriptions of various significant legal and regulatory activities
follow.
The Company's subsidiary, formerly named TheraTx, Incorporated ("TheraTx"),
is a plaintiff in a declaratory judgment action entitled TheraTx, Incorporated
v. James W. Duncan, Jr., et al., No. 1:95-CV-3193, filed in the United States
District Court for the Northern District of Georgia and currently pending in
the United States Court of Appeals for the Eleventh Circuit, No. 99-11451-FF.
The defendants asserted counterclaims against TheraTx under breach of contract,
securities fraud, negligent misrepresentation and other fraud theories for
allegedly not performing as promised under a merger agreement related to
TheraTx's purchase of a company called PersonaCare, Inc. and for allegedly
failing to inform the defendants/counterclaimants prior to the merger that
TheraTx's possible acquisition of Southern Management Services, Inc. might
cause the suspension of TheraTx's shelf registration under relevant rules of
the Commission. The court granted summary judgment for the
defendants/counterclaimants and ruled that TheraTx breached the shelf
registration provision in the merger agreement, but dismissed the defendants'
remaining counterclaims. Additionally, the court ruled after trial that
defendants/counterclaimants were entitled to damages and prejudgment interest
in the amount of approximately $1.3 million and attorneys' fees and other
litigation expenses of approximately $700,000. The Company and the
defendants/counterclaimants both appealed the court's rulings. The United
States Court of Appeals for the Eleventh Circuit affirmed the trial court's
rulings in TheraTx's favor, with the exception of the damages award, and
certified the question of the proper calculation of damages under Delaware law
to the Delaware Supreme Court. The Delaware Supreme Court issued an opinion on
June 1, 2001, which sets forth a rule for determining such damages but did not
calculate any actual damages. On June 25, 2001, the Eleventh Circuit remanded
the action to the trial court to render a decision consistent with the Delaware
Supreme Court's ruling. On July 24, 2001, the defendants filed a Notice of
Bankruptcy Stay in the trial court. The Company is defending the action
vigorously.
On August 13, 2001, the Company and TheraTx filed an Objection and Complaint
in an action entitled Vencor, Inc. and TheraTx Inc. v. James W. Duncan, et al.,
Adversary Proceeding No. 01-6117 (MFW), in the Bankruptcy Court. The complaint
seeks to subordinate and disallow the defendants' bankruptcy claim or,
alternatively, to reduce the claim by and recover from the defendants a
preferential payment made by the debtors to the defendants. The complaint also
seeks an injunction against any efforts by the defendants to enforce the
judgment ultimately granted in the above related litigation pending in the
Northern District of Georgia.
The Company is pursuing various claims against private insurance companies
who issued Medicare supplement insurance policies to individuals who became
patients of the Company's hospitals. After the patients' Medicare benefits are
exhausted, the insurance companies become liable to pay the insureds' bills
pursuant to the terms of these policies. The Company has filed numerous
collection actions against various of these insurers to
F-44
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 21 - LITIGATION (Continued)
collect the difference between what Medicare would have paid and the hospitals'
usual and customary charges. These disputes arise from differences in
interpretation of the policy provisions and federal and state laws governing
such policies. Various courts have issued various rulings on the different
issues, some of which have been adverse to the Company and most of which have
been appealed. The Company intends to continue to pursue these claims
vigorously.
A class action lawsuit entitled A. Carl Helwig v. Vencor, Inc., et al., was
filed on December 24, 1997 in the United States District Court for the Western
District of Kentucky (Civil Action No. 3-97CV-8354). The class action claims
were brought by an alleged stockholder of the Company's predecessor against the
Company and Ventas and certain of the Company's and Ventas' current and former
executive officers and directors and those of Ventas. The complaint alleges
that the Company, Ventas and certain of the Company's and Ventas' current and
former executive officers during a specified time frame violated Sections 10(b)
and 20(a) of the Exchange Act, by, among other things, issuing to the investing
public a series of false and misleading statements concerning Ventas' then
current operations and the inherent value of its common stock. The complaint
further alleges that as a result of these purported false and misleading
statements concerning Ventas' revenues and successful acquisitions, the price
of the common stock was artificially inflated. In particular, the complaint
alleges that the defendants issued false and misleading financial statements
during the first, second and third calendar quarters of 1997 which
misrepresented and understated the impact that changes in Medicare
reimbursement policies would have on Ventas' core services and profitability.
The complaint further alleges that the defendants issued a series of materially
false statements concerning the purportedly successful integration of Ventas'
acquisitions and prospective earnings per share for 1997 and 1998 which the
defendants knew lacked any reasonable basis and were not being achieved. The
suit seeks damages in an amount to be proven at trial, pre-judgment and
post-judgment interest, reasonable attorneys' fees, expert witness fees and
other costs, and any extraordinary equitable and/or injunctive relief permitted
by law or equity to assure that the plaintiff has an effective remedy. In
December 1998, the defendants filed a motion to dismiss the case. The court
converted the defendants' motion to dismiss into a motion for summary judgment
and granted summary judgment as to all defendants. The plaintiff appealed the
ruling to the United States Court of Appeals for the Sixth Circuit. On
April 24, 2000, the Sixth Circuit affirmed the district court's dismissal of
the action on the grounds that the plaintiff failed to state a claim upon which
relief could be granted. On July 14, 2000, the Sixth Circuit granted the
plaintiff's petition for a rehearing en banc. On May 31, 2001, the Sixth
Circuit issued its en banc decision reversing the trial court's dismissal of
the complaint. The defendants filed a Petition for Certiorari seeking review of
the Sixth Circuit's decision in the United States Supreme Court on September
27, 2001. The parties entered into a stipulation and agreement of settlement of
this action on December 26, 2001, which is subject to approval by the federal
district court. The settlement payment to the certified class will be $3
million, which will include the costs of administration and plaintiffs'
attorney fees, plus interest, and will be paid by the defendants' directors and
officers insurance carrier.
A shareholder derivative suit entitled Thomas G. White on behalf of Vencor,
Inc. and Ventas, Inc. v. W. Bruce Lunsford, et al., Case No. 98CI03669, was
filed on July 2, 1998 in the Jefferson County, Kentucky, Circuit Court. The
suit was brought on behalf of the Company and Ventas against certain current
and former executive officers and directors of the Company and Ventas. The
complaint alleges that the defendants damaged the Company and Ventas by
engaging in violations of the securities laws, engaging in insider trading,
fraud and securities fraud and damaging the Company's reputation and that of
Ventas. The plaintiff asserts that such actions were taken deliberately, in bad
faith and constitute breaches of the defendants' duties of loyalty and due
care. The complaint is based on substantially similar assertions to those made
in the class action lawsuit entitled A. Carl Helwig v. Vencor, Inc., et al.,
discussed above. The suit seeks unspecified damages, interest, punitive
damages, reasonable attorneys' fees, expert witness fees and other costs, and
any extraordinary equitable and/or injunctive relief permitted by law or equity
to assure that the Company and Ventas have an effective remedy. The Company
believes that the allegations in the complaint are without merit and intends to
defend this action vigorously.
F-45
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 21 - LITIGATION (Continued)
A class action lawsuit entitled Jules Brody v. Transitional Hospitals
Corporation, et al., Case No. CV-S-97-00747-PMP, was filed on June 19, 1997 in
the United States District Court for the District of Nevada on behalf of a
class consisting of all persons who sold shares of Transitional common stock
during the period from February 26, 1997 through May 4, 1997, inclusive. The
complaint alleges that Transitional purchased shares of its common stock from
members of the investing public after it had received a written offer to
acquire all of the Transitional common stock and without making the required
disclosure that such an offer had been made. The complaint further alleges that
defendants disclosed that there were "expressions of interest" in acquiring
Transitional when, in fact, at that time, the negotiations had reached an
advanced stage with actual firm offers at substantial premiums to the trading
price of Transitional's stock having been made which were actively being
considered by Transitional's Board of Directors. The complaint asserts claims
pursuant to Sections 10(b), 14(e) and 20(a) of the Exchange Act, and common law
principles of negligent misrepresentation, and names as defendants Transitional
as well as certain former senior executives and directors of Transitional. The
plaintiff seeks class certification, unspecified damages, attorneys' fees and
costs. In June 1998, the court granted the Company's motion to dismiss with
leave to amend the Section 10(b) claim and the state law claims for
misrepresentation. The court denied the Company's motion to dismiss the Section
14(e) and Section 20(a) claims, after which we filed a motion for
reconsideration. On March 23, 1999, the court granted the Company's motion to
dismiss all remaining claims and the case was dismissed. The plaintiff appealed
this ruling to the United States Court of Appeals for the Ninth Circuit. On
February 7, 2002, the Ninth Court affirmed the district court's dismissal of
the case.
In connection with the Company's Plan of Reorganization, the Company, Ventas
and the DOJ, acting on behalf of itself, the OIG and CMS, entered into a
government settlement, which resolved all known claims arising out of all known
investigations being made by the DOJ and the OIG including certain pending qui
tam, or whistleblower, actions. Under the Government Settlement, the Government
was required to move to dismiss with prejudice to the United States and the
relators (except for certain claims which will be dismissed without prejudice
to the United States in certain of the cases) the pending qui tam actions as
against any or all of the Company and the Company's subsidiaries, Ventas and
any current or former officers, directors and employees of either entity. The
last pending case, United States, et al., ex rel. Phillips-Minks, et al., v.
Transitional Corp., et al., was dismissed as to the Company's defendants by the
United States District Court for the Southern District of California on
December 21, 2001. All pending qui tam actions covered by the Government
Settlement have now been dismissed as against these defendants.
In connection with the Company's Spin-off from Ventas, liabilities arising
from various legal proceedings and other actions were assumed by the Company
and the Company agreed to indemnify Ventas against any losses, including any
costs or expenses, it may incur arising out of or in connection with such legal
proceedings and other actions. The indemnification provided by the Company also
covers losses, including costs and expenses, which may arise from any future
claims asserted against Ventas based on the former healthcare operations of
Ventas. In connection with the Company's indemnification obligation, the
Company assumed the defense of various legal proceedings and other actions.
Under the Company's Plan of Reorganization, the Company agreed to continue to
fulfill the Company's indemnification obligations arising from the Spin-off.
See Note 19.
The Company is a party to certain legal actions and regulatory
investigations arising in the normal course of the Company's business. The
Company is unable to predict the ultimate outcome of pending litigation and
regulatory investigations. In addition, there can be no assurance that the DOJ,
CMS or other regulatory agencies will not initiate additional investigations
related to the Company's businesses in the future, nor can there be any
assurance that the resolution of any litigation or investigations, either
individually or in the aggregate, would not have a material adverse effect on
the Company's results of operations, liquidity or financial position. In
addition, the above litigation and investigations (as well as future litigation
and investigations) are expected to consume the time and attention of
management and may have a disruptive effect upon the Company's operations.
F-46
KINDRED HEALTHCARE, INC.
QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
(In thousands, except per share amounts)
2001 | 2001
-----------|--------------------------
Predecessor|
Company | Reorganized Company
-----------|--------------------------
First | Second Third Fourth
-----------|-------- -------- --------
Revenues............................................ $752,409 |$770,764 $768,680 $789,575
Net income: |
Income from operations........................... 49,185 | 16,489 14,799 16,054
Extraordinary gain on extinguishment of debt..... 422,791 | 1,396 - 2,917
Net income................................... 471,976 | 17,885 14,799 18,971
Earnings per common share: |
Basic: |
Income from operations......................... 0.69 | 1.09 0.97 0.99
Extraordinary gain on extinguishment of debt... 6.02 | 0.09 - 0.18
Net income................................... 6.71 | 1.18 0.97 1.17
Diluted: |
Income from operations......................... 0.69 | 1.00 0.80 0.83
Extraordinary gain on extinguishment of debt... 5.90 | 0.08 - 0.15
Net income................................... 6.59 | 1.08 0.80 0.98
Market prices (a)(b): |
High............................................. 0.08 | 51.00 67.90 59.50
Low.............................................. 0.01 | 22.25 46.00 45.89
2000
--------------------------------------
Predecessor Company
--------------------------------------
First Second Third Fourth
-------- -------- -------- --------
Revenues......................................... $715,456 $713,424 $717,253 $742,409
Net loss......................................... (18,564) (7,985) (29,357) (8,845)
Loss per common share:
Basic......................................... (0.27) (0.12) (0.42) (0.13)
Diluted....................................... (0.27) (0.12) (0.42) (0.13)
Market prices (b):
High.......................................... 0.24 0.13 0.13 0.09
Low........................................... 0.11 0.07 0.07 0.03
- --------
(a) Kindred common stock commenced trading on the OTC Bulletin Board on April
26, 2001 under the symbol "KIND." Kindred common stock was initially issued
on April 20, 2001 in connection with the Plan of Reorganization. Between
April 20, 2001 and April 26, 2001, there was no public market for Kindred
common stock. Kindred common stock has traded on the NASDAQ National Market
since November 8, 2001 under the ticker symbol of "KIND."
(b) The Company's former common stock was traded on the OTC Bulletin Board
under the ticker symbol of VCRIQ (formerly VCRI).
F-47
KINDRED HEALTHCARE, INC.
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
FOR THE NINE MONTHS ENDED DECEMBER 31, 2001, THE THREE MONTHS ENDED
MARCH 31, 2001 AND THE YEARS ENDED DECEMBER 31, 2000 AND 1999
(In thousands)
Additions
-------------------------
Balance at Charged to Balance
Beginning Costs and Deductions at End
of Period Expenses Acquisitions or Payments of Period
---------- ---------- ------------ ----------- ---------
Allowances for loss on accounts receivable:
Predecessor Company:
Year ended December 31, 1999.................... $106,471 $114,578 $ - $(40,994) $180,055
Year ended December 31, 2000.................... 180,055 28,911 - (69,521) 139,445
For the three months ended March 31, 2001....... 139,445 6,305 - (23,673) 122,077
- --------------------------------------------------------------------------------------------------------------
Reorganized Company:
For the nine months ended December 31, 2001..... 122,077 16,346 136 (29,668) 108,891
Allowances for loss on assets held for disposition:
Predecessor Company:
Year ended December 31, 1999.................... $ 77,926 $ 10,135(a) $ - $(13,245) $ 74,816
Year ended December 31, 2000.................... 74,816 2,405 - (52,377) 24,844
For the three months ended March 31, 2001....... 24,844 - - (8,221) 16,623
- --------------------------------------------------------------------------------------------------------------
Reorganized Company:
For the nine months ended December 31, 2001..... 16,623 - - (11,510) 5,113
- --------
(a) Included in unusual transactions related to corporate properties.
F-48