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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______.
Commission file number: 001-14057
KINDRED HEALTHCARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 61-1323993
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
680 South Fourth Street
Louisville, KY 40202-2412
(Address of principal executive offices) (Zip Code)
(502) 596-7300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 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 [_]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Common Stock Outstanding at October 31, 2002
--------------------- -------------------------------
Common stock, $0.25 par value 17,648,857 shares
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1 of 46
KINDRED HEALTHCARE, INC.
FORM 10-Q
INDEX
Page
PART I. FINANCIAL INFORMATION ----
Item 1. Financial Statements:
Condensed Consolidated Statement of Operations:
Reorganized Company -- for the three months ended September 30, 2002 and
September 30, 2001; for the nine months ended September 30, 2002 and for the six
months ended September 30, 2001
Predecessor Company -- for the three months ended March 31, 2001.................... 3
Condensed Consolidated Balance Sheet:
Reorganized Company -- September 30, 2002 and December 31, 2001..................... 4
Condensed Consolidated Statement of Cash Flows:
Reorganized Company -- for the three months ended September 30, 2002 and
September 30, 2001; for the nine months ended September 30, 2002 and for the six
months ended September 30, 2001
Predecessor Company -- for the three months ended March 31, 2001.................... 5
Notes to Condensed Consolidated Financial Statements................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................... 40
Item 4. Controls and Procedures.............................................................. 40
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................................... 41
Item 6. Exhibits and Reports on Form 8-K..................................................... 43
2
KINDRED HEALTHCARE, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
| Predecessor
Reorganized Company | Company
----------------------------------------------- | ------------
Three months ended Nine months Six months | Three months
September 30, ended ended | ended
------------------ September 30, September 30, | March 31,
2002 2001 2002 2001 | 2001
-------- -------- ------------- ------------- | ------------
Revenues................................. $859,721 $768,680 $2,509,538 $1,539,444 | $752,409
-------- -------- ---------- ---------- | --------
Salaries, wages and benefits............. 487,397 436,196 1,433,318 868,378 | 427,649
Supplies................................. 108,335 97,089 315,080 193,132 | 94,319
Rent..................................... 68,327 65,233 201,756 129,813 | 76,995
Other operating expenses................. 191,520 123,000 452,862 250,655 | 126,701
Depreciation and amortization............ 18,287 16,768 52,396 32,654 | 18,645
Interest expense......................... 3,688 7,523 11,238 15,986 | 14,000
Investment income........................ (2,344) (3,210) (7,624) (6,648) | (1,919)
-------- -------- ---------- ---------- | --------
875,210 742,599 2,459,026 1,483,970 | 756,390
-------- -------- ---------- ---------- | --------
Income (loss) before reorganization items |
and income taxes....................... (15,489) 26,081 50,512 55,474 | (3,981)
Reorganization items..................... - - (5,520) - | (53,666)
-------- -------- ---------- ---------- | --------
Income (loss) before income taxes........ (15,489) 26,081 56,032 55,474 | 49,685
Provision (benefit) for income taxes..... (3,906) 11,282 25,775 24,186 | 500
-------- -------- ---------- ---------- | --------
Income (loss) from operations....... (11,583) 14,799 30,257 31,288 | 49,185
Extraordinary gain on extinguishment of |
debt................................... 1,427 - 1,427 1,396 | 422,791
-------- -------- ---------- ---------- | --------
Net income (loss)................... (10,156) 14,799 31,684 32,684 | 471,976
Preferred stock dividend requirements.... - - - - | (261)
-------- -------- ---------- ---------- | --------
Income (loss) available to common |
stockholders...................... $(10,156) $ 14,799 $ 31,684 $ 32,684 | $471,715
======== ======== ========== ========== | ========
Earnings (loss) per common share: |
Basic: |
Income (loss) from operations......... $ (0.66) $ 0.97 $ 1.75 $ 2.07 | $ 0.69
Extraordinary gain on extinguishment |
of debt............................. 0.08 - 0.08 0.09 | 6.02
-------- -------- ---------- ---------- | --------
Net income (loss)................... $ (0.58) $ 0.97 $ 1.83 $ 2.16 | $ 6.71
======== ======== ========== ========== | ========
Diluted:................................ |
Income (loss) from operations......... $ (0.66) $ 0.80 $ 1.59 $ 1.77 | $ 0.69
Extraordinary gain on extinguishment |
of debt............................. 0.08 - 0.07 0.08 | 5.90
-------- -------- ---------- ---------- | --------
Net income (loss)................... $ (0.58) $ 0.80 $ 1.66 $ 1.85 | $ 6.59
======== ======== ========== ========== | ========
Shares used in computing earnings (loss) |
per common share: |
Basic................................... 17,380 15,202 17,345 15,146 | 70,261
Diluted................................. 17,380 18,497 19,084 17,701 | 71,656
See accompanying notes.
3
KINDRED HEALTHCARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(Unaudited)
(In thousands, except per share amounts)
Reorganized Company
-------------------------
September 30, December 31,
2002 2001
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents................................................... $ 234,587 $ 190,799
Cash-restricted............................................................. 8,930 18,025
Insurance subsidiary investments............................................ 137,671 99,101
Accounts receivable less allowance for loss of $103,311 - September 30 and
$108,891 - December 31.................................................... 424,111 418,827
Inventories................................................................. 29,836 29,720
Other....................................................................... 61,171 75,501
---------- ----------
896,306 831,973
Property and equipment....................................................... 575,570 508,205
Accumulated depreciation..................................................... (96,365) (44,323)
---------- ----------
479,205 463,882
Goodwill..................................................................... 118,740 107,660
Other........................................................................ 103,345 105,359
---------- ----------
$1,597,596 $1,508,874
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................ $ 115,865 $ 100,473
Salaries, wages and other compensation...................................... 213,091 198,471
Due to third-party payors................................................... 30,046 37,285
Other accrued liabilities................................................... 143,024 138,571
Income taxes................................................................ 39,020 39,908
Long-term debt due within one year.......................................... 352 418
---------- ----------
541,398 515,126
Long-term debt............................................................... 162,023 212,269
Professional liability risks................................................. 208,735 136,764
Deferred credits and other liabilities....................................... 58,631 54,234
Commitments and contingencies
Stockholders' equity:
Common stock, $0.25 par value; authorized 175,000 shares -- September 30 and
39,000 shares -- December 31; issued 17,649 shares -- September 30 and
17,683 shares -- December 31.............................................. 4,412 4,421
Capital in excess of par value.............................................. 547,565 549,169
Deferred compensation....................................................... (8,213) (14,764)
Retained earnings........................................................... 83,045 51,655
---------- ----------
626,809 590,481
---------- ----------
$1,597,596 $1,508,874
========== ==========
See accompanying notes.
4
KINDRED HEALTHCARE, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(In thousands)
| Predecessor
Reorganized Company | Company
---------------------------------------------- | ------------
Three months |
ended Nine months Six months | Three months
September 30, ended ended | ended
------------------ September 30, September 30, | March 31,
2002 2001 2002 2001 | 2001
-------- -------- ------------- ------------- | ------------
Cash flows from operating activities: |
Net income (loss)........................................ $(10,156) $ 14,799 $ 31,684 $ 32,684 | $ 471,976
Adjustments to reconcile net income (loss) to net cash |
provided by operating activities: |
Depreciation and amortization........................... 18,287 16,768 52,396 32,654 | 18,645
Amortization of deferred compensation costs............. 1,682 2,064 5,588 3,982 | -
Provision for doubtful accounts......................... 3,804 7,565 11,305 16,305 | 6,305
Unusual transactions.................................... - (3,238) 525 (3,238) | -
Reorganization items.................................... - - (5,520) - | (53,666)
Extraordinary gain on extinguishment of debt............ (1,427) - (1,427) (1,396) | (422,791)
Other................................................... (253) (748) 352 (2,395) | 1,357
Change in operating assets and liabilities: |
Accounts receivable.................................... (62) (167) (3,610) (19,865) | (14,668)
Inventories and other assets........................... 6,592 1,750 9,658 12,704 | 12,476
Accounts payable....................................... (2,084) 4,742 5,091 1,708 | (10,845)
Income taxes........................................... 15,813 9,057 21,702 21,261 | 108
Due to third-party payors.............................. (217) 2,404 (7,239) (11,482) | 2,051
Other accrued liabilities.............................. 64,129 16,556 104,205 53,617 | 28,628
-------- -------- --------- -------- | ---------
Net cash provided by operating activities before |
reorganization items................................ 96,108 71,552 224,710 136,539 | 39,576
Payment of reorganization items............................ (808) (3,009) (4,484) (27,732) | (3,745)
-------- -------- --------- -------- | ---------
Net cash provided by operating activities............ 95,300 68,543 220,226 108,807 | 35,831
-------- -------- --------- -------- | ---------
|
Cash flows from investing activities: |
Purchase of property and equipment....................... (20,966) (17,586) (50,193) (43,225) | (22,038)
Acquisition of healthcare facilities..................... (214) - (45,765) - | -
Sale of investment in Behavioral Healthcare |
Corporation............................................. - - - 40,000 | -
Sale of other assets..................................... - 814 752 5,976 | -
Surety bond deposits..................................... - - 9,676 (300) | -
Net change in investments................................ (2,655) (4,768) (34,168) (50,753) | (28,178)
Other.................................................... (299) 327 (98) 492 | 224
-------- -------- --------- -------- | ---------
Net cash used in investing activities................ (24,134) (21,213) (119,796) (47,810) | (49,992)
-------- -------- --------- -------- | ---------
|
Cash flows from financing activities: |
Repayment of long-term debt.............................. (50,182) (151) (50,461) (59,537) | (4,355)
Payment of debtor-in-possession deferred financing |
costs................................................... - - - - | (100)
Payment of other deferred financing costs................ (365) - (1,375) - | -
Repurchase of common stock............................... (1,046) - (1,046) - | -
Other.................................................... 2,752 3,825 (3,760) (2,787) | (5,971)
-------- -------- --------- -------- | ---------
Net cash provided by (used in) financing |
activities.......................................... (48,841) 3,674 (56,642) (62,324) | (10,426)
-------- -------- --------- -------- | ---------
Change in cash and cash equivalents........................ 22,325 51,004 43,788 (1,327) | (24,587)
Cash and cash equivalents at beginning of period........... 212,262 102,823 190,799 155,154 | 184,642
-------- -------- --------- -------- | ---------
Cash and cash equivalents at end of period................. $234,587 $153,827 $ 234,587 $153,827 | $ 160,055
======== ======== ========= ======== | =========
|
Supplemental information: |
Interest payments........................................ $ 3,937 $ 254 $ 11,804 $ 1,204 | $ 2,606
Income tax payments (refunds)............................ (19,719) 2,179 4,073 2,928 | 392
See accompanying notes.
5
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
Business
Kindred Healthcare, Inc. ("Kindred" or the "Company") provides long-term
healthcare services primarily through the operation of nursing centers and
hospitals. At September 30, 2002, the Company's health services division
operated 288 nursing centers in 32 states and a rehabilitation therapy
business. The Company's hospital division operated 64 hospitals in 24 states
and an institutional pharmacy business.
On April 1, 2002, the Company expanded its national network of long-term
acute care hospitals by acquiring all of the outstanding stock of Specialty
Healthcare Services, Inc. ("Specialty"), a private operator of six long-term
acute care hospitals (the "Specialty Acquisition"). The operating results of
Specialty have been included in the unaudited condensed consolidated financial
statements of the Company since the date of acquisition.
Reorganization
On April 20, 2001, 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.
After 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 were prepared in accordance with the American
Institute of Certified Public Accountants Statement of Position 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 assumed that assets would be realized and liabilities would 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 were recorded in
the Company's 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 financial data to signify
the difference in the basis of presentation of the financial statements for
each respective entity.
As used in this Form 10-Q, 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.
Comparability of Financial Information
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
6
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION (Continued)
Comparability of Financial Information (Continued)
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 also were 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.
Recent Accounting Pronouncements
In July 2002, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 146 ("SFAS 146"),
"Accounting for Exit or Disposal Activities." SFAS 146 provides guidance
related to the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including costs related to
terminating a contract that is not a capital lease and certain involuntary
termination benefits. SFAS 146 supersedes Emerging Issues Task Force Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity" ("EITF No. 94-3") and requires liabilities
associated with exit and disposal activities to be expensed as incurred. SFAS
146 will be effective for exit and disposal activities of the Company that are
initiated after December 31, 2002.
In May 2002, the FASB issued SFAS No. 145 ("SFAS 145"), "Rescission of SFAS
Nos. 4, 44, 64, Amendment of SFAS 13, and Technical Corrections as of April
2002." SFAS 145 rescinds SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt," which required that gains and losses from
extinguishment of debt that were included in the determination of net income be
aggregated and, if material, classified as an extraordinary item, net of the
related income tax effect. Under SFAS 145, gains or losses from extinguishment
of debt should be classified as extraordinary items only if they meet the
criteria in Accounting Principles Board Opinion No. 30 ("APB 30"), "Reporting
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business." Applying the criteria in APB 30 will distinguish transactions that
are part of an entity's recurring operations from those that are unusual or
infrequent or that meet the criteria for classification as an extraordinary
item. SFAS 145 will be applicable to the Company for all periods beginning
after December 31, 2002. Any gains or losses on extinguishment of debt that
were classified as extraordinary items in prior periods that do not meet the
new criteria of APB 30 for classification as extraordinary items will be
reclassified to income from operations.
In October 2001, the FASB issued SFAS No. 144 ("SFAS 144"), "Accounting for
the Impairment or Disposal of Long-Lived Assets," which supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" and amends APB 30 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 cost of disposal. SFAS 144 eliminated the APB 30
requirements that discontinued operations be measured at net realizable value
and that estimated future operating losses be included under "discontinued
operations" in the financial statements before they occur. This new
pronouncement became effective for the Company on January 1, 2002.
7
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION (Continued)
Recent Accounting Pronouncements (Continued)
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. 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 became effective for the Company on January 1, 2002. In conformity with the
provisions of SFAS 142, the Company performed a transitional impairment test
for goodwill as of January 1, 2002. No write-down of the carrying value of
goodwill was required.
The following table adjusts reported net income and earnings per share for
the periods presented to exclude the amortization of goodwill (in thousands,
except per share amounts):
|
Reorganized Company | Predecessor Company
------------------------------------------------------------- | ------------------------------
Three months ended Six months ended | Three months ended
September 30, 2001 September 30, 2001 | March 31, 2001
------------------------------ ------------------------------ | ------------------------------
As Goodwill As As Goodwill As | As Goodwill As
reported amortization adjusted reported amortization adjusted | reported amortization adjusted
-------- ------------ -------- -------- ------------ -------- | -------- ------------ --------
Income from operations.... $14,799 $1,975 $16,774 $31,288 $3,949 $35,237 | $ 49,185 $2,509 $ 51,694
Net income................ 14,799 1,975 16,774 32,684 3,949 36,633 | 471,976 2,509 474,485
Earnings per common share: |
Basic: |
Income from |
operations............ $ 0.97 $ 0.13 $ 1.10 $ 2.07 $ 0.26 $ 2.33 | $ 0.69 $ 0.04 $ 0.73
Net income............. 0.97 0.13 1.10 2.16 0.26 2.42 | 6.71 0.04 6.75
Diluted: |
Income from |
operations............ $ 0.80 $ 0.11 $ 0.91 $ 1.77 $ 0.22 $ 1.99 | $ 0.69 $ 0.03 $ 0.72
Net income............. 0.80 0.11 0.91 1.85 0.22 2.07 | 6.59 0.03 6.62
Changes in the carrying amount of goodwill for the nine months ended
September 30, 2002 follow:
Health
services Hospital
division division Total
-------- -------- --------
Balances, January 1, 2002................................ $56,468 $51,192 $107,660
Specialty Acquisition.................................... - 28,951 28,951
Pre-emergence deferred tax valuation allowance adjustment (9,364) (8,507) (17,871)
------- ------- --------
Balances, September 30, 2002............................. $47,104 $71,636 $118,740
======= ======= ========
Other Information
The accompanying unaudited condensed consolidated financial statements do
not include all of the disclosures normally required by generally accepted
accounting principles or those normally required in annual reports on Form
10-K. Accordingly, these financial statements should be read in conjunction
with the audited consolidated financial statements of the Company for the year
ended December 31, 2001 filed with the Securities and Exchange Commission (the
"Commission") on Form 10-K.
8
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION (Continued)
Other Information (Continued)
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the Company's customary accounting practices
and the provisions of SOP 90-7. Management believes that the financial
information included herein reflects all adjustments necessary for a fair
presentation of interim results and, except for the items described in Notes 3
and 11 and those recorded in connection with fresh-start accounting, all such
adjustments are of a normal and recurring nature.
NOTE 2 - THIRD QUARTER ADJUSTMENTS
The Company's reported operating results for the third quarter of 2002 were
impacted materially by certain adjustments discussed below.
In September, the Company received approximately $12 million in connection
with a settlement of claims from a private insurance company that issued
Medicare supplemental insurance policies to patients of the Company's
hospitals. The $12 million payment covered services provided by certain of the
Company's hospitals from 1999 through 2001. The $12 million receipt was
recorded as income because the disputed amounts for these services had
previously been fully reserved in the Company's historical financial statements.
In the third quarter of 2002, the Company recorded $55 million of additional
costs for professional liability claims above its normal provision. The
additional costs were required based upon the results of a recently completed
regular quarterly independent actuarial valuation. Substantially all of the
additional claims costs are related to the Company's nursing center operations.
These changes in estimate related primarily to claims incurred in fiscal 2001
and 2002. The portion of the adjustment relating to a change in estimate for
claims incurred in fiscal 2001 approximated $25 million, while $30 million of
the adjustment related to a revision of the fiscal 2002 estimated cost for the
nine months ended September 30, 2002. Claims cost estimates for years prior to
fiscal 2001 remained relatively unchanged primarily as a result of certain
insurance agreements in effect for those periods.
Substantially all of the cost increase for 2001 related to an increase in
the average expected cost per claim. The total number of claims that are
ultimately expected to be incurred in 2001 remained relatively unchanged from
the previous estimate completed for the second quarter of this year. The
estimate for the 2002 liability claims cost was increased based upon the
revised 2001 cost trend, including an increase in the expected ultimate number
of claims to be incurred in 2002. Approximately two-thirds of the adjustments
for 2001 and 2002 related to the Company's operations in Florida. Based upon
the revised cost estimate for 2002 claims, the Company intends to accrue an
additional $10 million of professional liability claims cost above its
previously estimated provision for the fourth quarter of 2002, most of which
will be allocated to the nursing center business.
In response to the significant increases in professional liability costs in
Florida, the Company intends to divest its nursing center operations in
Florida. The Company operates 18 nursing centers in Florida, of which 15 are
leased from its primary landlord, Ventas, Inc. ("Ventas"). Any divestiture of
the Company's Florida nursing center operations would likely require the
approval of Ventas, the Company's lenders, various regulatory authorities and
other third parties.
NOTE 3 - REORGANIZATION ITEMS AND UNUSUAL TRANSACTIONS
Operating results for the nine months ended September 30, 2002 included
income of $5.5 million resulting from changes in estimates for accrued
professional and administrative costs related to the Company's emergence from
bankruptcy. Operating results for the nine months ended September 30, 2002 also
included a $525,000 lease termination charge for an unprofitable hospital.
9
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 3 - REORGANIZATION ITEMS AND UNUSUAL TRANSACTIONS (Continued)
Operating results for the three months ended September 30, 2001 included
income of $3.2 million related to the favorable resolution of certain
litigation related to a previously subleased nursing center facility.
NOTE 4 - SPECIALTY ACQUISITION
On April 1, 2002, the Company completed the Specialty Acquisition. The
transaction was financed through the use of existing cash. A summary of the
Specialty Acquisition follows (in thousands):
Fair value of assets acquired.... $ 63,030
Fair value of liabilities assumed (16,423)
--------
Net assets acquired............. 46,607
Cash acquired.................... (842)
--------
Net cash paid................... $ 45,765
========
The cost of the Specialty Acquisition resulted from negotiations with the
sellers that were based upon both the historical and expected future cash flows
of the enterprise. The purchase price paid in excess of the fair value of
identifiable net assets acquired aggregated $29 million. Additional adjustments
to the purchase price may occur through April 1, 2003 as a result of the
settlement of acquired working capital balances and contingent consideration in
accordance with the acquisition agreement.
The operating results of Specialty had no material effect on the Company's
consolidated operating results since the date of acquisition.
NOTE 5 - 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, 2001 (in thousands, except per share amounts):
Nine months ended
September 30,
2001
-----------------
Revenues.................. $2,291,853
Income from operations.... 41,859
Net income................ 43,255
Earnings per common share:
Basic:
Income from operations. $ 2.75
Net income............. 2.84
Diluted:
Income from operations. $ 2.43
Net income............. 2.51
The pro forma results exclude reorganization and extraordinary 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, 2001.
10
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 6 - 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):
| Predecessor
Reorganized Company | Company
---------------------------------------------- | ------------
Three months ended Nine months Six months | Three months
September 30, ended ended | ended
------------------ September 30, September 30, | March 31,
2002 2001 2002 2001 | 2001
-------- -------- ------------- ------------- | ------------
Medicare......... $348,066 $292,066 $1,034,750 $ 590,737 | $288,390
Medicaid......... 285,125 268,540 828,472 532,336 | 233,160
Private and other 242,745 223,272 694,450 446,865 | 245,532
-------- -------- ---------- ---------- | --------
875,936 783,878 2,557,672 1,569,938 | 767,082
Elimination...... (16,215) (15,198) (48,134) (30,494) | (14,673)
-------- -------- ---------- ---------- | --------
$859,721 $768,680 $2,509,538 $1,539,444 | $752,409
======== ======== ========== ========== | ========
NOTE 7 - EARNINGS PER SHARE
Earnings (loss) per common share are based upon the weighted average number
of common shares outstanding during the respective periods. Except for the
three months ended September 30, 2002, the diluted calculation of earnings per
common share for the Reorganized Company included the effect of 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 September 30, 2002, the diluted calculation of loss per common share for
the Reorganized Company excluded the effect of warrants, stock options and
non-vested restricted stock because their effect was anti-dilutive. For the
three months ended March 31, 2001, the diluted calculation of earnings per
common share for the Predecessor Company included the effect of its former
convertible preferred stock.
11
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 7 - EARNINGS PER SHARE (Continued)
A computation of earnings (loss) per common share follows (in thousands,
except per share amounts):
| Predecessor
Reorganized Company | Company
---------------------------------------------- | ------------
Three months ended Nine months Six months | Three months
September 30, ended ended | ended
----------------- September 30, September 30, | March 31,
2002 2001 2002 2001 | 2001
-------- ------- ------------- ------------- | ------------
Earnings (loss): |
Income (loss) from operations............ $(11,583) $14,799 $30,257 $31,288 | $ 49,185
Extraordinary gain on extinguishment of |
debt................................... 1,427 - 1,427 1,396 | 422,791
-------- ------- ------- ------- | --------
Net income (loss)........................ (10,156) 14,799 31,684 32,684 | 471,976
Preferred stock dividend requirements.... - - - - | (261)
-------- ------- ------- ------- | --------
Income (loss) available to common |
stockholders - basic computation....... (10,156) 14,799 31,684 32,684 | 471,715
Elimination of preferred stock dividend |
requirements upon assumed conversion |
of preferred stock..................... - - - - | 261
-------- ------- ------- ------- | --------
Net income (loss) - diluted |
computation............................ $(10,156) $14,799 $31,684 $32,684 | $471,976
======== ======= ======= ======= | ========
Shares used in the computation: |
Weighted average shares outstanding - |
basic computation...................... 17,380 15,202 17,345 15,146 | 70,261
Dilutive effect of warrants, employee |
stock options and non-vested restricted |
stock.................................. - 3,295 1,739 2,555 | -
Assumed conversion of preferred stock.... - - - - | 1,395
-------- ------- ------- ------- | --------
Adjusted weighted average shares |
outstanding - diluted computation...... 17,380 18,497 19,084 17,701 | 71,656
======== ======= ======= ======= | ========
Earnings (loss) per common share: |
Basic: |
Income (loss) from operations.......... $ (0.66) $ 0.97 $ 1.75 $ 2.07 | $ 0.69
Extraordinary gain on extinguishment |
of debt.............................. 0.08 - 0.08 0.09 | 6.02
-------- ------- ------- ------- | --------
Net income (loss).................... $ (0.58) $ 0.97 $ 1.83 $ 2.16 | $ 6.71
======== ======= ======= ======= | ========
Diluted: |
Income (loss) from operations.......... $ (0.66) $ 0.80 $ 1.59 $ 1.77 | $ 0.69
Extraordinary gain on extinguishment |
of debt.............................. 0.08 - 0.07 0.08 | 5.90
-------- ------- ------- ------- | --------
Net income (loss).................... $ (0.58) $ 0.80 $ 1.66 $ 1.85 | $ 6.59
======== ======= ======= ======= | ========
12
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 8 - 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 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.
The Company identified its segments in accordance with the aggregation
provisions of SFAS No. 131, "Disclosures About Segments of an Enterprise and
Related Information." The segment information is consistent with information
used by the Company in managing the Company's business and aggregates
businesses with similar economic characteristics.
The following table sets forth certain data by business segment (in
thousands):
| Predecessor
Reorganized Company | Company
----------------------------------------------- | ------------
Three months ended Nine months Six months | Three months
September 30, ended ended | ended
------------------ September 30, September 30, | March 31,
2002 2001 2002 2001 | 2001
-------- -------- ------------- ------------- | ------------
Revenues: |
Health services division: |
Nursing centers.......................... $470,676 $447,428 $1,393,536 $ 891,565 | $429,523
Rehabilitation services.................. 8,697 9,122 25,093 18,366 | 10,695
-------- -------- ---------- ---------- | --------
479,373 456,550 1,418,629 909,931 | 440,218
Hospital division: |
Hospitals................................ 330,910 268,578 950,116 544,690 | 271,984
Pharmacy................................. 65,653 58,750 188,927 115,317 | 54,880
-------- -------- ---------- ---------- | --------
396,563 327,328 1,139,043 660,007 | 326,864
-------- -------- ---------- ---------- | --------
875,936 783,878 2,557,672 1,569,938 | 767,082
Elimination of pharmacy charges to Company |
nursing centers........................... (16,215) (15,198) (48,134) (30,494) | (14,673)
-------- -------- ---------- ---------- | --------
$859,721 $768,680 $2,509,538 $1,539,444 | $752,409
======== ======== ========== ========== | ========
Income (loss) from operations: |
Operating income: |
Health services division: |
Nursing centers.......................... $ 25,453 $ 80,339 $ 187,249 $ 159,074 | $ 70,543
Rehabilitation services.................. 2,814 2,178 6,610 3,987 | 690
Other ancillary services................. 164 226 343 329 | 250
-------- -------- ---------- ---------- | --------
28,431 82,743 194,202 163,390 | 71,483
Hospital division: |
Hospitals................................ 70,979 49,809 192,879 105,494 | 54,778
Pharmacy................................. 5,616 7,002 17,357 13,038 | 6,176
-------- -------- ---------- ---------- | --------
76,595 56,811 210,236 118,532 | 60,954
Corporate overhead......................... (32,557) (30,397) (95,635) (57,881) | (28,697)
-------- -------- ---------- ---------- | --------
72,469 109,157 308,803 224,041 | 103,740
Unusual transactions....................... - 3,238 (525) 3,238 | -
Reorganization items....................... - - 5,520 - | 53,666
-------- -------- ---------- ---------- | --------
Operating income......................... 72,469 112,395 313,798 227,279 | 157,406
Rent......................................... (68,327) (65,233) (201,756) (129,813) | (76,995)
Depreciation and amortization................ (18,287) (16,768) (52,396) (32,654) | (18,645)
Interest, net................................ (1,344) (4,313) (3,614) (9,338) | (12,081)
-------- -------- ---------- ---------- | --------
Income (loss) before income taxes............ (15,489) 26,081 56,032 55,474 | 49,685
Provision (benefit) for income taxes......... (3,906) 11,282 25,775 24,186 | 500
-------- -------- ---------- ---------- | --------
$(11,583) $ 14,799 $ 30,257 $ 31,288 | $ 49,185
======== ======== ========== ========== | ========
13
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 8 - BUSINESS SEGMENT DATA (Continued)
| Predecessor
Reorganized Company | Company
---------------------------------------------- | ------------
Three months ended Nine months Six months | Three months
September 30, ended ended | ended
------------------ September 30, September 30, | March 31,
2002 2001 2002 2001 | 2001
------- ------- ------------- ------------- | ------------
Rent: |
Health services division: |
Nursing centers.......................... $42,765 $41,311 $126,149 $ 81,501 | $44,253
Rehabilitation services.................. 31 24 59 51 | 39
Other ancillary services................. - 1 - 4 | -
------- ------- -------- -------- | -------
42,796 41,336 126,208 81,556 | 44,292
Hospital division: |
Hospitals................................ 24,513 22,771 72,524 45,688 | 30,839
Pharmacy................................. 966 984 2,876 1,952 | 941
------- ------- -------- -------- | -------
25,479 23,755 75,400 47,640 | 31,780
Corporate.................................. 52 142 148 617 | 923
------- ------- -------- -------- | -------
$68,327 $65,233 $201,756 $129,813 | $76,995
======= ======= ======== ======== | =======
Depreciation and amortization: |
Health services division: |
Nursing centers.......................... $ 6,601 $ 5,713 $ 18,827 $ 10,768 | $ 7,219
Rehabilitation services.................. 10 2 24 13 | -
Other ancillary services................. - - - - | 129
------- ------- -------- -------- | -------
6,611 5,715 18,851 10,781 | 7,348
Hospital division: |
Hospitals................................ 6,994 5,742 19,993 11,432 | 5,457
Pharmacy................................. 600 476 1,771 923 | 627
------- ------- -------- -------- | -------
7,594 6,218 21,764 12,355 | 6,084
Corporate.................................. 4,082 4,835 11,781 9,518 | 5,213
------- ------- -------- -------- | -------
$18,287 $16,768 $ 52,396 $ 32,654 | $18,645
======= ======= ======== ======== | =======
Capital expenditures, excluding acquisitions: |
Health services division................... $ 6,498 $ 5,184 $ 13,342 $ 9,713 | $ 7,962
Hospital division.......................... 6,938 3,244 17,862 11,888 | 8,901
Corporate: |
Information systems...................... 6,474 7,841 16,436 10,976 | 3,496
Other.................................... 1,056 1,317 2,553 10,648 | 1,679
------- ------- -------- -------- | -------
$20,966 $17,586 $ 50,193 $ 43,225 | $22,038
======= ======= ======== ======== | =======
Reorganized Company
--------------------------
September 30, December 31,
2002 2001
------------- ------------
Assets:
Health services division. $ 444,090 $ 392,938
Hospital division........ 586,517 497,057
Corporate................ 566,989 618,879
---------- ----------
$1,597,596 $1,508,874
========== ==========
Goodwill:
Health services division. $ 47,104
Hospital division........ 71,636
----------
$ 118,740
==========
14
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 9 - INCOME TAXES
In connection with the reorganization, the Company realized a gain from the
extinguishment of certain indebtedness. This gain was not 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) net
operating loss carryforwards ("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 April 20, 2001 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 is
subject to certain limitations. Through September 30, 2002, approximately $41
million of cash flow benefits related to the previously discussed tax
attributes had been utilized by the Company.
NOTE 10 - INSURANCE RISKS
The Company insures a substantial portion of its professional liability
risks and, beginning in 2001, workers compensation risks through a wholly
owned, limited purpose insurance subsidiary. Provisions for loss for these
risks are based upon quarterly independent actuarially determined estimates.
The allowance for professional liability risks includes an estimate of the
expected cost to settle reported claims and an amount, based upon past
experiences, for losses incurred but not reported. These liabilities are
necessarily based upon 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. To the extent that subsequent expected ultimate
claims settlements vary from historical provisions for loss, future earnings
will be charged or credited.
The provision for professional liability risks, including the cost of
coverage maintained with unaffiliated insurance carriers, aggregated $108
million for the nine months ended September 30, 2002, $29 million for the six
months ended September 30, 2001 (Reorganized Company) and $13 million for the
three months ended March 31, 2001 (Predecessor Company).
The aggregate provision for workers compensation risks, including the cost
of coverage maintained with unaffiliated insurance carriers, aggregated $33
million for the nine months ended September 30, 2002, $19 million for the six
months ended September 30, 2001 (Reorganized Company) and $10 million for the
three months ended March 31, 2001 (Predecessor Company).
15
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 10 - INSURANCE RISKS (Continued)
A summary of the assets and liabilities related to insurance risks included
in the unaudited condensed consolidated balance sheet follows (in thousands):
Reorganized Company
---------------------------------------------------------------------
September 30, 2002 December 31, 2001
---------------------------------- ----------------------------------
Professional Workers Professional Workers
Liability Compensation Total Liability Compensation Total
------------ ------------ -------- ------------ ------------ --------
Assets:
Current:
Insurance subsidiary
investments................ $ 93,680 $43,991 $137,671 $ 69,877 $29,224 $ 99,101
Reinsurance recoverables..... 4,227 - 4,227 5,584 - 5,584
Deposits..................... - 918 918 - 1,640 1,640
-------- ------- -------- -------- ------- --------
97,907 44,909 142,816 75,461 30,864 106,325
Non-current:
Insurance subsidiary
investments................ 17,541 - 17,541 16,976 - 16,976
Reinsurance recoverables..... 9,251 - 9,251 8,840 - 8,840
Deposits..................... 3,400 - 3,400 3,400 - 3,400
Other........................ 316 273 589 313 1,491 1,804
-------- ------- -------- -------- ------- --------
30,508 273 30,781 29,529 1,491 31,020
-------- ------- -------- -------- ------- --------
$128,415 $45,182 $173,597 $104,990 $32,355 $137,345
======== ======= ======== ======== ======= ========
Liabilities:
Allowance for insurance risks:
Current...................... $ 26,234 $11,858 $ 38,092 $ 26,529 $ 7,982 $ 34,511
Non-current.................. 208,735 37,947 246,682 136,764 25,793 162,557
-------- ------- -------- -------- ------- --------
$234,969 $49,805 $284,774 $163,293 $33,775 $197,068
======== ======= ======== ======== ======= ========
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 was 5% and amounts equal to the discounted loss provision are
funded annually. The Company expects to fund approximately $45 million of the
professional liability adjustment discussed in Note 2 no later than the first
quarter of 2003. 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. The undiscounted
allowance for professional liability risks aggregated $250 million at September
30, 2002 and $176 million at December 31, 2001.
Provisions for loss for workers compensation risks retained by the insurance
subsidiary are not discounted and amounts equal to the loss provision are
funded annually.
NOTE 11 - LONG-TERM DEBT
On August 26, 2002, the Company announced that it had amended the terms of
its revolving credit facility and senior secured notes to allow for the
repurchase of up to $35 million of the Company's common stock. As
16
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 11 - LONG-TERM DEBT (Continued)
part of these amendments, the Company prepaid $50 million of the senior secured
notes. The amendments also allow for a $10 million increase in the Company's
annual capital expenditure limits beginning in fiscal 2003. The Company also
agreed to certain revised financial covenants. Other material terms of the
credit agreements, including maturities, repayment terms and rates of interest,
were unchanged.
In connection with the $50 million prepayment of senior secured notes, the
Company recorded an extraordinary gain on the extinguishment of debt
aggregating $1.4 million for the three months ended September 30, 2002.
In the second quarter of 2001, the Company prepaid the outstanding balance
in full satisfaction of its obligation under a loan repayment agreement with
the Centers for Medicare and Medicaid Services ("CMS"), resulting in an
extraordinary gain of $1.4 million.
NOTE 12 - 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. 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 (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'
17
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 12 - LITIGATION (Continued)
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 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. As
discussed in Note 2, the Company received approximately $12 million in
connection with the settlement of one of these claims in September 2002. The
Company intends to continue to pursue these claims vigorously.
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 alleges that certain of the Company's and Ventas's current
and former executive officers during a specified time frame violated Sections
10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act") by,
among other things, issuing to the investing public a series of false and
misleading statements concerning Ventas's 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's
revenues and successful acquisitions, the price of its 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's 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's 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 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.
In October 2002, the defendants filed a motion to dismiss for failure to
prosecute the case and are currently awaiting the court's ruling on that
motion. The Company believes that the allegations in the complaint are without
merit and intends to defend this action vigorously.
A purported class action lawsuit entitled Massachusetts State Carpenters
Pension Fund v. Kindred Healthcare, Inc., et al., Civil Action No.
3:02CV-600-J, was filed against the Company and certain current and former
officers and directors of the Company on October 16, 2002, in the United States
District Court for the Western District of Kentucky, Louisville Division. The
complaint alleges that from August 14, 2001 to October 10, 2002 the defendants
violated Sections 10(b) and 20(a) of the Exchange Act by, among other things,
issuing to the investing public a series of allegedly false and misleading
statements that inaccurately indicated that the Company was successfully
emerging from bankruptcy and implementing a growth plan. In particular, the
complaint alleges that these statements were materially false and misleading
because they failed to disclose that the 2001 Florida tort reform legislation
had resulted in a marked increase in claims against the Company in Florida, and
also because the statements reflected a materially understated reserve for
professional liability claims. The complaint further alleges that as a result
of the purportedly false and misleading statements, the price of the Company's
common stock was artificially inflated, the investing public was deceptively
induced to purchase the stock at those inflated prices, and the defendants
profited by selling shares at those prices. The suit
18
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 12 - LITIGATION (Continued)
seeks an unspecified amount of monetary damages plus interest, reasonable
attorneys' fees and other costs, and any other equitable, injunctive or other
relief that the court deems just and proper. After October 16, 2002, several
other purported class action complaints, which assert essentially similar
allegations as those contained in the Massachusetts State Carpenters Pension
Fund complaint discussed above, also were filed against the same defendants in
the United States District Court for the Western District of Kentucky,
Louisville Division, including but not limited to the cases entitled Mark
Ramsdell v. Kindred Healthcare, Inc., et al., Civil Action No. 3:02CV-625-R and
Paula Hillenbrand v. Kindred Healthcare, Inc., et al., Civil Action No.
3:02CV-654-R. The Company believes that the allegations in all of these
purported class action complaints are without merit, and it intends to defend
these lawsuits vigorously.
A shareholder derivative suit entitled Elizabeth Sommerfeld v. Kindred
Healthcare, Inc., et al., Civil Action No. 02 CI 08476, was filed in November
2002 in the Jefferson Circuit Court in Kentucky. The complaint, which recites
purported facts substantially similar to those set forth in the Massachusetts
State Carpenters Pension Fund putative class action and the other securities
fraud class actions discussed above, attempts to assert a claim against the
individual defendants for breach of fiduciary duties for insider selling and
misappropriation of information. Specifically, the complaint alleges that each
of the individual defendants knew that the price of the Company's common stock
would dramatically decrease when the truth regarding the Company's inadequate
reserves for professional liability risks was disclosed and that the individual
defendants' sales of the Company's common stock with knowledge of this material
non-public information was a breach of their fiduciary duties of loyalty and
good faith. The suit seeks to impose a constructive trust in favor of the
Company for the amount of profits each of the individual defendants or their
firms received from their November 2001 sales of the Company's common stock, as
well as reasonable attorneys' fees and other expenses. The Company believes
that the allegations in the complaint are without merit and intends to defend
this action vigorously.
In connection with the Company's spin-off from Ventas in 1998, 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 Plan of Reorganization, the Company agreed to continue
to fulfill its indemnification obligations arising from the spin-off.
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 U.S.
Department of Justice, CMS or other state and federal 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.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Cautionary Statement
This Form 10-Q includes forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Exchange Act, as amended. All statements regarding the Company's 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," "projected," "could," "should," "will," "intend," "may" and other
similar expressions, are forward-looking statements.
Such forward-looking statements are inherently uncertain, and stockholders
and other potential investors must recognize that actual results may differ
materially from the Company's 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 the Company is
unable to predict or control, that may cause the Company's 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 detailed from time to time in
the Company's filings with the Commission.
Factors that may affect the plans or results of the Company include, without
limitation, (a) the ability of the Company to operate pursuant to the terms of
its debt obligations and its master lease agreements with Ventas; (b) the
Company's ability to meet its rental and debt service obligations; (c) adverse
developments with respect to the Company's liquidity or results of operations;
(d) the ability of the Company to attract and retain key executives and other
healthcare personnel; (e) increased operating costs due to shortages in
qualified nurses and other healthcare professionals; (f) the effects of
healthcare reform and government regulations, interpretation of regulations and
changes in the nature and enforcement of regulations governing the healthcare
industry; (g) 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; (h) national and
regional economic conditions, including their effect on the availability and
cost of labor, materials and other services; (i) the Company's ability to
control costs, including labor and employee benefit costs, in response to the
prospective payment systems, implementation of the Company's Corporate
Integrity Agreement and other regulatory actions; (j) the ability of the
Company to comply with the terms of its Corporate Integrity Agreement; (k) the
effect of a restatement of the Company's previously issued consolidated
financial statements; (l) the Company's ability to integrate operations of
acquired facilities; (m) the increase in the costs of defending and insuring
against alleged patient care liability claims and the Company's ability to
predict the estimated costs related to such claims; and (n) the Company's
ability to successfully reduce (by divestiture or otherwise) its exposure to
professional liability claims in the state of Florida and other states. Many of
these factors are beyond the control of the Company and its management. The
Company cautions investors that any forward-looking statements made by the
Company are not guarantees of future performance. The Company disclaims 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.
General
The business segment data in Note 8 of the Notes to Condensed Consolidated
Financial Statements should be read in conjunction with the following
discussion and analysis.
The Company provides long-term healthcare services primarily through the
operation of nursing centers and hospitals. At September 30, 2002, the
Company's health services division operated 288 nursing centers (37,609
licensed beds) in 32 states and a rehabilitation therapy business. The
Company's hospital division operated 64 hospitals (5,344 licensed beds) in 24
states and an institutional pharmacy business.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
General (Continued)
On April 1, 2002, the Company completed the Specialty Acquisition. See Note
4 of the Notes to Condensed Consolidated Financial Statements.
On April 20, 2001, the Company and its subsidiaries emerged from the
proceedings under Chapter 11 of Title 11 of the Bankruptcy Code pursuant to the
terms of the Plan of Reorganization. From September 13, 1999 until April 20,
2001, 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 were prepared in accordance with SOP 90-7
and generally accepted accounting principles applicable to a going concern,
which assumed that assets would be realized and liabilities would 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 were recorded in
the Company's 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 financial data to signify
the difference in the basis of preparation of the financial statements for each
respective entity.
Comparability of Financial Information
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 $423 million from the restructuring of its
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 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.
Critical Accounting Policies
Management's discussion and analysis of financial condition and results of
operations are based upon the Company's unaudited condensed 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.
The Company relies on historical experience and on various other assumptions
that management believes 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.
The Company believes the following critical accounting policies, among
others, affect the more significant judgments and estimates used in the
preparation of the Company's unaudited condensed consolidated financial
statements.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Critical Accounting Policies (Continued)
Revenue recognition
The Company maintains agreements with third-party payors that provide for
payments to its 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 6 of the Notes to Condensed Consolidated Financial
Statements for a summary of revenues by payor type.
The Company's revenues are impacted significantly by the regulatory
environment in which the Company operates. See "Regulatory Changes."
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, 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. 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 $4 million and $8 million for
the three months ended September 30, 2002 and 2001, respectively, $11 million
for the nine months ended September 30, 2002, $16 million for the six months
ended September 30, 2001 (Reorganized Company) and $6 million for the three
months ended March 31, 2001 (Predecessor Company).
Allowances for insurance risks
The Company insures a substantial portion of its professional liability
risks and, beginning in 2001, workers compensation risks through a wholly
owned, limited purpose insurance subsidiary. Provisions for loss for these
risks are based upon quarterly independent actuarially determined estimates.
The allowance for professional liability risks includes an estimate of the
expected cost to settle reported claims and an amount, based upon past
experiences, for losses incurred but not reported. These liabilities are
necessarily based upon 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. To the extent that subsequent expected ultimate
claims settlements vary from historical provisions for loss, future earnings
will be charged or credited. See Notes 2 and 10 of the Notes to Condensed
Consolidated Financial Statements.
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 was 5% and amounts equal to the discounted loss provision are
funded annually. The Company expects to fund approximately $45 million of
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Critical Accounting Policies (Continued)
Allowances for insurance risks (Continued)
the professional liability adjustment discussed in Note 2 of the Notes to
Condensed Consolidated Financial Statements no later than the first quarter of
2003. 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. The undiscounted allowance
for professional liability risks aggregated $250 million at September 30, 2002
and $176 million at December 31, 2001.
Provisions for loss for workers compensation risks retained by the insurance
subsidiary are not discounted and amounts equal to the loss provision are
funded annually.
Changes in the number of professional liability claims and the increasing
cost to settle these claims significantly impact the allowance for professional
liability risks. A relatively small variance between the Company's estimated
and ultimate actual number of claims or average settlement costs could have a
material impact, either favorable or unfavorable, on the adequacy of the
allowance for professional liability risks. For example, a 1% variance in the
allowance for professional liability risks at September 30, 2002 would impact
the Company's operating income by approximately $2.3 million.
Accounting for 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
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.
There are significant uncertainties with respect to professional liability
costs and future Medicare payments to both the Company's nursing centers and
hospitals which could affect materially the realization of certain deferred tax
assets. Accordingly, the Company has recognized deferred tax assets to the
extent it is more likely than not they will be realized. A valuation allowance
is provided for deferred tax assets to the extent the realizability of the
deferred tax assets is uncertain. Deferred tax assets recognized by the Company
totaled $27 million at September 30, 2002.
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 the
Company, goodwill recorded in connection with fresh-start accounting will be
reduced accordingly. If goodwill is eliminated in full, any excess will be
treated as an increase to capital in excess of par value.
Valuation of long-lived assets and goodwill
The Company regularly reviews 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.
The Company recorded goodwill in connection with fresh-start accounting and
the Specialty Acquisition. In connection with the adoption of SFAS 142, the
Company ceased the amortization of goodwill beginning on
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Critical Accounting Policies (Continued)
Valuation of long-lived assets and goodwill (Continued)
January 1, 2002. In lieu of amortization, the Company is required to perform an
annual impairment test for goodwill. The Company will perform the annual
impairment test for 2002 at the end of the year. There can be no assurance that
the Company's consolidated operating results for 2002 or future projections may
not otherwise indicate an asset impairment at the time of the annual impairment
review. See Note 1 of the Notes to Condensed Consolidated Financial Statements.
Regulatory Changes
The Balanced Budget Act of 1997 (the "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 Budget Act has affected adversely the
revenues in each of the Company's operating divisions.
The Budget Act established a Medicare prospective payment system ("PPS") for
nursing centers for cost reporting periods beginning on or after July 1, 1998.
All of the Company's 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 are based solely on federal rates. The payments received under PPS
cover substantially all services for Medicare patients including all ancillary
services, such as respiratory therapy, physical therapy, occupational therapy,
speech therapy and certain covered pharmaceuticals.
The Budget Act also reduced payments made to the Company's hospitals by
reducing incentive payments pursuant to the Tax Equity and Fiscal
Responsibility Act of 1982 ("TEFRA"), allowable costs for bad debts and
payments for services to patients transferred from a general acute care
hospital. In addition, the Budget Act also reduced allowable costs for capital
expenditures by 15%. 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 ability to bill Medicare separately for ancillary services
provided 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 was 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,
the Company realigned its 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. The Company's respiratory therapy
and other ancillary businesses were discontinued.
Various legislative and regulatory actions provided a measure of relief from
the impact of the Budget Act. Effective April 1, 2000, the Balanced Budget
Refinement Act (the "BBRA") (a) implemented a 20% upward adjustment in the
payment rates for the care of higher acuity patients 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.
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Regulatory Changes (Continued)
The 20% upward adjustment in the payment rates for the care of higher acuity
patients under the BBRA will remain in effect until a revised Resource
Utilization Grouping ("RUG") payment system is established by CMS. On April 23,
2002, CMS announced that it will further delay the establishment of a revised
RUG classification system. Accordingly, the 20% upward adjustment for certain
higher acuity RUG categories set forth in the BBRA will be extended until the
RUG refinements are enacted. Nursing center revenues associated with the 20%
upward adjustment approximated $9 million in the third quarter of 2002.
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
RUG 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 RUG payment rates through September 30, 2002. In addition,
BIPA extended the two-year moratorium on therapy limitations for skilled
nursing center patients under the BBRA through December 31, 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.
The Company's nursing centers received reimbursement under the BBRA of
approximately $13 million in the third quarter of 2002 compared to
approximately $12 million in the third quarter of 2001. Revenues associated
with BIPA aggregated approximately $11 million in the third quarter of both
periods.
As previously discussed, certain Medicare reimbursement provisions under the
BBRA and BIPA expired as scheduled on October 1, 2002. If the expired
provisions under the BBRA and BIPA are not renewed or extended, Medicare
reimbursement to the Company's nursing centers is expected to decline by
approximately $15 million in the fourth quarter of 2002 compared to Medicare
reimbursement levels in the third quarter of 2002, resulting in a material
reduction in nursing center operating income.
On August 30, 2002, CMS issued final regulations for a prospective payment
system covering long-term acute care providers that became effective on October
1, 2002. Because of the Company's Medicare cost reporting periods, this new
payment system will not become effective for the Company's hospitals until
September 1, 2003. The Company continues to review the extensive regulations
associated with the new prospective payment system. Based on its analysis to
date, the Company believes that the new system will not have a material impact
on its hospital operating results. These preliminary estimates are based upon
current patient acuity and expense levels in the Company's hospitals. These
factors, among others, are subject to significant change. As a result, the
Company cannot predict the ultimate impact of the new prospective payment
system on the Company's hospitals and there can be no assurance that such
regulations or operational changes resulting from these regulations will not
have a material adverse impact on the Company's results of operations,
liquidity or financial position. In addition, there can be no assurance that
the new Medicare prospective payment system will not have a material adverse
effect on revenues from non-government third-party payors.
On October 1, 2002, the provision under the Budget Act reducing allowable
hospital capital expenditures by 15% expired. As a result, hospital Medicare
revenues should increase by approximately $2 million in the fourth quarter of
2002.
There continue to be legislative and regulatory proposals that would impose
more limitations on government and private payments to providers of healthcare
services. By repealing the Boren Amendment, the Budget Act
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Regulatory Changes (Continued)
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
care hospitals. Additionally, regulatory changes in the Medicaid reimbursement
system applicable to the Company's hospitals and pharmacies have been enacted
or are being considered. There also are legislative proposals including cost
caps and the establishment of Medicaid prospective payment systems for nursing
centers.
The Company could be affected adversely by the continuing efforts of
governmental and private third-party payors to contain healthcare costs. There
can be no assurance 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, there can be no assurance that
facilities operated by the Company, or the provision of services and supplies
by the Company, will meet the requirements for participation in such programs.
There can be no assurance that future healthcare legislation or other
changes in the administration or interpretation of governmental healthcare
programs will not have a material adverse effect on the Company's results of
operations, liquidity or financial position.
Results of Operations
Third Quarter 2002 compared to Third Quarter 2001
Significant Adjustments
The Company's reported operating results for the third quarter of 2002 were
impacted materially by certain adjustments discussed below.
In September, the Company received approximately $12 million in connection
with a settlement of claims from a private insurance company that issued
Medicare supplemental insurance policies to patients of the Company's
hospitals. The $12 million payment covered services provided by certain of the
Company's hospitals from 1999 through 2001. The $12 million receipt was
recorded as income because the disputed amounts for these services had
previously been fully reserved in the Company's historical financial statements.
In the third quarter of 2002, the Company recorded $55 million of additional
costs for professional liability claims above its normal provision. The
additional costs were required based upon the results of a recently completed
regular quarterly independent actuarial valuation. Substantially all of the
additional claims costs are related to the Company's nursing center operations.
These changes in estimate related primarily to claims incurred in fiscal 2001
and 2002. The portion of the adjustment relating to a change in estimate for
claims incurred in fiscal 2001 approximated $25 million, while $30 million of
the adjustment related to a revision of the fiscal 2002 estimated cost for the
nine months ended September 30, 2002. Claims cost estimates for years prior to
fiscal 2001 remained relatively unchanged primarily as a result of certain
insurance agreements in effect for those periods.
Substantially all of the cost increase for 2001 related to an increase in
the average expected cost per claim. The total number of claims that are
ultimately expected to be incurred in 2001 remained relatively unchanged from
the previous estimate completed for the second quarter of this year. The
estimate for the 2002 liability
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
Significant Adjustments (Continued)
claims cost was increased based upon the revised 2001 cost trend, including an
increase in the expected ultimate number of claims to be incurred in 2002.
Approximately two-thirds of the adjustments for 2001 and 2002 related to the
Company's operations in Florida. Based upon the revised cost estimate for 2002
claims, the Company intends to accrue an additional $10 million of professional
liability claims cost above its previously estimated provision for the fourth
quarter of 2002, most of which will be allocated to the nursing center business.
Including the effect of the previously discussed $55 million change in
estimate, aggregate professional liability costs were $73 million for the three
months ended September 30, 2002 and $14 million for the three months ended
September 30, 2001. Aggregate professional liability costs were $108 million
for the nine months ended September 30, 2002, $29 million for the six months
ended September 30, 2001 (Reorganized Company) and $13 million for the three
months ended March 31, 2001 (Predecessor Company).
In response to the significant increases in professional liability costs in
Florida, the Company intends to divest its nursing center operations in
Florida. The Company operates 18 nursing centers in Florida, of which 15 are
leased from its primary landlord, Ventas. Any divestiture of the Company's
Florida nursing center operations would likely require the approval of Ventas,
the Company's lenders, various regulatory authorities and other third parties.
While the Company has begun divestiture discussions with interested third
parties, there can be no assurance that the Company will successfully divest
its Florida nursing center operations or otherwise limit its professional
liability exposure. In addition, to the extent that the Company is successful
in divesting its Florida nursing center operations, management cannot predict
the cost to effect the divestiture (including, but not limited to, any
potential asset impairments) or the impact of divestiture activities on the
operating results of these facilities.
Health Services Division - Nursing Centers
Revenues increased 5% to $471 million in the third quarter of 2002 from $447
million in the same quarter of 2001. Average daily patient census was
relatively unchanged from the same period last year. Aggregate revenues per
patient day rose over 5% in the third quarter this year compared to the third
quarter of 2001. Medicaid revenues per patient day increased 5% in the third
quarter of 2002, while private rates grew 4% compared to the third quarter of
2001. Medicare revenues per patient day grew 4% to $361 in the third quarter of
2002 compared to $348 in the third quarter a year ago. Nursing center revenues
under the provisions of the BBRA approximated $13 million in the third quarter
of 2002 and $12 million in the third quarter of 2001. Revenues associated with
BIPA aggregated approximately $11 million in the third quarter of both periods.
As previously discussed, a substantial portion of the additional Medicare
reimbursement under the BBRA and BIPA expired on October 1, 2002. See
"Regulatory Changes."
Nursing center operating income was $25 million for the third quarter of
2002 compared to $80 million for the third quarter last year. Operating margins
for the third quarter of 2002 were 5.4%, compared to 18% in the same period
last year. Third quarter 2002 nursing center operating income included a charge
of approximately $51 million (net of reimbursement effect) related to the
previously discussed change in estimate related to professional liability
costs. Labor costs in the third quarter of 2002 grew approximately 7%, while
employee benefit costs rose to $63 million in the third quarter of 2002
compared to $56 million in the third quarter last year. The rise in labor and
benefit costs was primarily attributable to increased rates of pay necessary to
attract and retain qualified healthcare professionals.
Health Services Division - Rehabilitation Services
Revenues declined 5% to $9 million for the third quarter of 2002. Operating
income totaled $3 million for the third quarter this year compared to $2
million for the third quarter last year. The improvement in operating
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
Health Services Division - Rehabilitation Services (Continued)
income was primarily related to the collection of old customer accounts in 2002
that had been reserved in prior periods. While the health services division
will continue to provide rehabilitation services to nursing center customers,
revenues related to these services may continue to 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 the
Company's former ancillary services business in 1999.
Hospital Division - Hospitals
Revenues increased 23% to $331 million in the third quarter of 2002 from
$269 million in the same period a year ago. Reported revenues for the third
quarter of 2002 included $22 million resulting from the Specialty Acquisition
and $12 million related to the previously discussed accounts receivable
settlement. On a same-store basis, third quarter revenues increased 12% and
patient days grew 5%. The increase in same-store revenues was primarily
attributable to volume growth and 7% growth in aggregate revenues per patient
day. Same-store Medicare rates grew 6% while revenues per patient day from
private payors increased 9% from the third quarter of 2001.
Hospital operating income totaled $71 million in the third quarter of 2002
compared to $50 million for the third quarter last year. Operating margins were
21.4% in the third quarter this year compared to 18.5% in the same period a
year ago. Reported operating income for the third quarter of 2002 included $12
million related to the accounts receivable settlement and a charge of $3
million (net of reimbursement effect) related to the previously discussed
change in estimate related to professional liability costs. Excluding these
items, adjusted hospital operating income rose 24% to $62 million in the third
quarter of 2002 and the operating margin improved to 19.4%. The improvement in
operating income in the third quarter of 2002 resulted primarily from volume
growth, improved pricing, operating expense controls and the benefits of the
Specialty Acquisition. The Specialty Acquisition generated approximately $3
million of operating income in the third quarter of 2002.
Despite increases in operating income, the Company's hospitals continue to
experience labor cost pressures. Labor costs per patient day increased 5% to
$477 from $453 in the third quarter last year, while employee benefit costs per
patient day rose 12% to $76 from $69 a year ago. The rise in labor and benefit
costs was primarily attributable to increased rates of pay necessary to attract
and retain qualified nurses and other healthcare professionals. Contract labor
costs increased 14% in the third quarter of 2002 from the same period a year
ago.
Hospital Division - Pharmacy
Revenues increased 12% to $66 million in the third quarter of 2002 compared
to $59 million a year ago. The increase resulted primarily from growth in the
number of unaffiliated nursing center customers and price increases. At
September 30, 2002, the Company provided pharmacy services to nursing centers
containing 58,700 licensed beds, including 30,300 licensed beds operated by the
Company. At September 30, 2001, the Company provided pharmacy services to
nursing centers containing 54,300 licensed beds, including 30,200 licensed beds
operated by the Company.
Pharmacy operating income totaled $6 million in the third quarter of 2002
compared to $7 million in the same period of 2001. Despite increases in
revenues, pharmacy operating margins declined to 8.6% in the third quarter of
2002 compared to 11.9% for the third quarter last year. The cost of goods sold
as a percentage of revenues increased to 63.2% in the third quarter of 2002
from 58.9% in the third quarter of 2001, primarily as a result of Medicaid
reimbursement reductions in certain states and increased utilization of higher
cost drugs.
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
Corporate Overhead
Operating income for the Company's operating divisions excludes allocation
of corporate overhead. These costs aggregated $33 million in the third quarter
of 2002 and $30 million a year ago. Corporate overhead in the third quarter of
2002 included severance costs of approximately $1.3 million. As a percentage of
revenues (before eliminations), the overhead ratio was 3.7% in the third
quarter of 2002 compared to 3.9% in the same period of 2001.
Capital Costs
Capital costs for the third quarter of 2002 and 2001 reflected the terms of
the Plan of Reorganization and included the effects of the Company's
restructured rent and debt obligations. Depreciation and amortization were
recorded based on asset carrying amounts that were adjusted in fresh-start
accounting to reflect fair value on April 1, 2001.
Interest expense in the third quarter of 2002, substantially all of which
related to the Company's floating rate senior secured notes, aggregated $4
million compared to $8 million in the same period last year. The reduction in
interest costs from last year's third quarter resulted from prepayments of
long-term debt and reductions in interest rates. At September 30, 2002, the
effective interest rate of the senior secured notes was 5.7%.
Investment income related to the Company's excess cash balances and
insurance subsidiary investments totaled $2 million in the third quarter of
2002 and $3 million in the third quarter of 2001.
As discussed in Note 1 of the Notes to Condensed Consolidated Financial
Statements, the Company adopted the provisions of SFAS 142, which, among other
things, required that goodwill should no longer be amortized effective January
1, 2002. The adoption of this new pronouncement decreased the third quarter
2002 net loss by approximately $2 million.
Consolidated Results
The Company reported a pretax loss from operations of $15 million for the
third quarter of 2002 compared to income of $26 million for the third quarter
of 2001. The income tax benefit recorded in the third quarter of 2002 reflected
an increase in the Company's annual effective tax rate resulting from a
reduction in estimated taxable income for the year. The loss from operations in
the third quarter of 2002 aggregated $12 million compared to income of $15
million in the third quarter of 2001.
Income from operations for the third quarter of 2001 included pretax income
of $3 million related to the favorable resolution of certain litigation related
to a previously subleased nursing center facility. Operating results for the
third quarter of 2002 reflected an extraordinary gain on extinguishment of debt
aggregating $1.4 million.
Liquidity
Cash flows from operations before reorganization items aggregated $96
million for the third quarter of 2002 compared to $72 million for the same
period a year ago. Operating cash flows in the third quarter of 2002 were
favorably impacted by a $20 million federal income tax refund. Operating cash
flows in both periods were sufficient to fund the Company's routine capital
expenditures. During both periods, the Company maintained excess cash balances.
In the third quarter of 2002, approximately $50 million of these balances were
used to prepay long-term debt.
29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity (Continued)
Cash and cash equivalents totaled $235 million at September 30, 2002 while
funded long-term debt aggregated $162 million. Based upon existing cash levels,
expected operating cash flows and capital spending, and the availability of
borrowings under the revolving credit facility, the Company believes that it
has the necessary financial resources to satisfy its expected short-term
liquidity needs. The Company expects to fund approximately $45 million of the
previously discussed professional liability adjustment no later than the first
quarter of 2003.
At September 30, 2002, the Company was in compliance with the terms of its
revolving credit facility and senior secured notes. As previously discussed,
the Company has recently experienced a significant increase in professional
liability costs. These costs are expected to continue to increase in the
foreseeable future, particularly in the state of Florida. In addition, the
expiration of certain Medicare funding under the BBRA and BIPA on October 1,
2002 will reduce the Company's average Medicare rate received by the Company's
nursing centers by approximately $35 per patient day or approximately $15
million in the fourth quarter of 2002. Accordingly, the Company believes that
the combined effect of these changes in revenues and expenses will have a
material adverse effect on the Company's operating cash flows, profitability
and liquidity in the future. These changes could result in the Company's
inability to satisfy certain financial covenants contained in its revolving
credit facility and senior secured notes in 2003.
On August 26, 2002, the Company announced that it had amended the terms of
its revolving credit facility and senior secured notes to allow for the
repurchase of up to $35 million of the Company's common stock. As part of these
amendments, the Company prepaid $50 million of the senior secured notes. The
amendments also allow for a $10 million increase in the Company's annual
capital expenditure limits beginning in fiscal 2003. The Company also agreed to
certain revised financial covenants. Other material terms of the credit
agreements, including maturities, repayment terms and rates of interest, were
unchanged.
Capital Resources
Capital expenditures, excluding acquisitions, totaled $21 million and $18
million for the three months ended September 30, 2002 and 2001, respectively.
Routine capital expenditures could approximate $75 million in 2002. Management
believes that its capital expenditure program is adequate to improve and equip
existing facilities.
Capital expenditures in both periods were financed through internally
generated funds. At September 30, 2002, the estimated cost to complete and
equip construction in progress approximated $7 million.
The terms of the Company's revolving credit facility and senior secured
notes include certain covenants which limit the Company's annual capital
expenditures. In addition, these agreements limit the Company's ability to
transfer funds to the parent company, repurchase common stock or pay cash
dividends.
Other Information
Effects of Inflation and Changing Prices
The Company derives a substantial portion of its revenues from the Medicare
and Medicaid programs. In recent years, significant cost containment measures
enacted by Congress and certain state legislatures have limited the Company's
ability to recover its cost increases through increased pricing of its
healthcare services. Medicare revenues in the Company's nursing centers are
subject to fixed payments under PPS. Medicaid reimbursement rates in many
states in which the Company operates nursing centers also are based on fixed
payment systems. Generally, these rates are adjusted annually for inflation,
but such rate increases may not
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Other Information (Continued)
Effects of Inflation and Changing Prices (Continued)
reflect the actual increase in the costs of providing services. In addition, by
repealing the Boren Amendment, the Budget Act eased existing impediments on the
ability of states to reduce their Medicaid reimbursement levels to the
Company's nursing centers. Medicare revenues in the Company's hospitals also
have been reduced by the Budget Act.
Beginning in 2000, the BBRA provided a measure of relief to the Medicare
reimbursement reductions imposed by the Budget Act. Effective April 1, 2001,
BIPA provided additional Medicare reimbursement to the Company's nursing
centers and hospitals. The provisions of the BBRA and BIPA have positively
impacted the Company's 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 RUG
category under BIPA expired on October 1, 2002. The expiration of these
provisions will reduce the Company's average Medicare rate paid to its nursing
centers by approximately $35 per patient day.
Management believes that the Company's operating margins will continue to be
under pressure, particularly in its nursing center business, as the growth in
operating expenses, particularly labor, employee benefits and professional
liability costs, exceeds payment increases from third-party payors. In
addition, as a result of competitive pressures, the Company's ability to
maintain operating margins through price increases to private patients is
limited.
Recent Accounting Pronouncements
In July 2002, the FASB issued SFAS 146 which provides guidance related to
the recognition, measurement, and reporting of costs that are associated with
exit and disposal activities, including costs related to terminating a contract
that is not a capital lease and certain involuntary termination benefits. SFAS
146 supersedes EITF No. 94-3 and requires liabilities associated with exit and
disposal activities to be expensed as incurred. SFAS 146 will be effective for
exit and disposal activities of the Company that are initiated after December
31, 2002.
In May 2002, the FASB issued SFAS 145 which requires, among other things, a
change in the classification of certain gains and losses related to the
extinguishment of debt. SFAS 145 will be applicable to the Company for all
periods beginning after December 31, 2002. Any gains or losses on
extinguishment of debt that were classified as extraordinary items in prior
periods that do not meet the new criteria of APB 30 for classification as
extraordinary items will be reclassified to income from operations.
Litigation
The Company is a party to certain material litigation. See Note 12 of the
Notes to Condensed Consolidated Financial Statements.
31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Condensed Consolidated Statement of Operations
(Unaudited)
(In thousands, except per share amounts)
Reorganized Company
------------------------------------------
2002
------------------------------------------
Nine months
First Second Third ended
Quarter Quarter Quarter September 30,
-------- -------- -------- -------------
Revenues.................................................. $811,244 $838,573 $859,721 $2,509,538
-------- -------- -------- ----------
Salaries, wages and benefits.............................. 467,401 478,520 487,397 1,433,318
Supplies.................................................. 101,314 105,431 108,335 315,080
Rent...................................................... 65,611 67,818 68,327 201,756
Other operating expenses.................................. 127,297 134,045 191,520 452,862
Depreciation and amortization............................. 16,696 17,413 18,287 52,396
Interest expense.......................................... 3,732 3,818 3,688 11,238
Investment income......................................... (1,880) (3,400) (2,344) (7,624)
-------- -------- -------- ----------
780,171 803,645 875,210 2,459,026
-------- -------- -------- ----------
Income (loss) before reorganization items and income taxes 31,073 34,928 (15,489) 50,512
Reorganization items...................................... - (5,520) - (5,520)
-------- -------- -------- ----------
Income (loss) before income taxes......................... 31,073 40,448 (15,489) 56,032
Provision (benefit) for income taxes...................... 12,895 16,786 (3,906) 25,775
-------- -------- -------- ----------
Income (loss) from operations.......................... 18,178 23,662 (11,583) 30,257
Extraordinary gain on extinguishment of debt.............. - - 1,427 1,427
-------- -------- -------- ----------
Net income (loss)...................................... $ 18,178 $ 23,662 $(10,156) $ 31,684
======== ======== ======== ==========
Earnings (loss) per common share:
Basic:
Income (loss) from operations.......................... $ 1.05 $ 1.36 $ (0.66) $ 1.75
Extraordinary gain on extinguishment of debt........... - - 0.08 0.08
-------- -------- -------- ----------
Net income (loss).................................... $ 1.05 $ 1.36 $ (0.58) $ 1.83
======== ======== ======== ==========
Diluted:
Income (loss) from operations.......................... $ 0.95 $ 1.21 $ (0.66) $ 1.59
Extraordinary gain on extinguishment of debt........... - - 0.08 0.07
-------- -------- -------- ----------
Net income (loss).................................... $ 0.95 $ 1.21 $ (0.58) $ 1.66
======== ======== ======== ==========
Shares used in computing earnings (loss) per common share:
Basic.................................................... 17,308 17,345 17,380 17,345
Diluted.................................................. 19,074 19,554 17,380 19,084
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Condensed Consolidated Statement of Operations (Continued)
(Unaudited)
(In thousands, except per share amounts)
| Reorganized Company
Predecessor | -----------------------------------------
Company | 2001
----------- | -----------------------------------------
First | Nine months
Quarter | Second Third Fourth ended
2001 | Quarter Quarter Quarter December 31,
----------- | -------- -------- -------- ------------
Revenues..................................... $752,409 | $770,764 $768,680 $789,575 $2,329,019
-------- | -------- -------- -------- ----------
Salaries, wages and benefits................. 427,649 | 432,182 436,196 448,203 1,316,581
Supplies..................................... 94,319 | 96,043 97,089 102,466 295,598
Rent......................................... 76,995 | 64,580 65,233 65,471 195,284
Other operating expenses..................... 126,701 | 127,655 123,000 124,435 375,090
Depreciation and amortization................ 18,645 | 15,886 16,768 17,565 50,219
Interest expense............................. 14,000 | 8,463 7,523 5,754 21,740
Investment income............................ (1,919) | (3,438) (3,210) (2,637) (9,285)
-------- | -------- -------- -------- ----------
756,390 | 741,371 742,599 761,257 2,245,227
-------- | -------- -------- -------- ----------
Income (loss) before reorganization items and |
income taxes............................... (3,981) | 29,393 26,081 28,318 83,792
Reorganization items......................... (53,666) | - - - -
-------- | -------- -------- -------- ----------
Income before income taxes................... 49,685 | 29,393 26,081 28,318 83,792
Provision for income taxes................... 500 | 12,904 11,282 12,264 36,450
-------- | -------- -------- -------- ----------
Income from operations.................... 49,185 | 16,489 14,799 16,054 47,342
Extraordinary gain on extinguishment of debt. 422,791 | 1,396 - 2,917 4,313
-------- | -------- -------- -------- ----------
Net income................................ 471,976 | 17,885 14,799 18,971 51,655
Preferred stock dividend requirements........ (261) | - - - -
-------- | -------- -------- -------- ----------
Income available to common |
stockholders............................ $471,715 | $ 17,885 $ 14,799 $ 18,971 $ 51,655
======== | ======== ======== ======== ==========
Earnings per common share: |
Basic: |
Income from operations.................... $ 0.69 | $ 1.09 $ 0.97 $ 0.99 $ 3.05
Extraordinary gain on extinguishment of |
debt.................................... 6.02 | 0.09 - 0.18 0.28
-------- | -------- -------- -------- ----------
Net income.............................. $ 6.71 | $ 1.18 $ 0.97 $ 1.17 $ 3.33
======== | ======== ======== ======== ==========
Diluted: |
Income from operations.................... $ 0.69 | $ 1.00 $ 0.80 $ 0.83 $ 2.59
Extraordinary gain on extinguishment of |
debt.................................... 5.90 | 0.08 - 0.15 0.24
-------- | -------- -------- -------- ----------
Net income.............................. $ 6.59 | $ 1.08 $ 0.80 $ 0.98 $ 2.83
======== | ======== ======== ======== ==========
Shares used in computing earnings per common |
share: |
Basic....................................... 70,261 | 15,090 15,202 16,210 15,505
Diluted..................................... 71,656 | 16,533 18,497 19,304 18,258
33
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Operating Data
(Unaudited)
(In thousands)
Reorganized Company
------------------------------------------
2002
------------------------------------------
Nine months
First Second Third ended
Quarter Quarter Quarter September 30,
-------- -------- -------- -------------
Revenues:
Health services division:
Nursing centers................................ $461,887 $460,973 $470,676 $1,393,536
Rehabilitation services........................ 7,830 8,566 8,697 25,093
-------- -------- -------- ----------
469,717 469,539 479,373 1,418,629
Hospital division:
Hospitals...................................... 296,442 322,764 330,910 950,116
Pharmacy....................................... 61,048 62,226 65,653 188,927
-------- -------- -------- ----------
357,490 384,990 396,563 1,139,043
-------- -------- -------- ----------
827,207 854,529 875,936 2,557,672
Elimination of pharmacy charges to Company nursing
centers......................................... (15,963) (15,956) (16,215) (48,134)
-------- -------- -------- ----------
$811,244 $838,573 $859,721 $2,509,538
======== ======== ======== ==========
Income (loss) from operations:
Operating income:
Health services division:
Nursing centers................................ $ 80,714 $ 81,082 $ 25,453 $ 187,249
Rehabilitation services........................ 1,913 1,883 2,814 6,610
Other ancillary services....................... 34 145 164 343
-------- -------- -------- ----------
82,661 83,110 28,431 194,202
Hospital division:
Hospitals...................................... 59,574 62,326 70,979 192,879
Pharmacy....................................... 5,672 6,069 5,616 17,357
-------- -------- -------- ----------
65,246 68,395 76,595 210,236
Corporate overhead............................... (32,675) (30,403) (32,557) (95,635)
-------- -------- -------- ----------
115,232 121,102 72,469 308,803
Unusual transactions............................. - (525) - (525)
Reorganization items............................. - 5,520 - 5,520
-------- -------- -------- ----------
Operating income............................... 115,232 126,097 72,469 313,798
Rent.............................................. (65,611) (67,818) (68,327) (201,756)
Depreciation and amortization..................... (16,696) (17,413) (18,287) (52,396)
Interest, net..................................... (1,852) (418) (1,344) (3,614)
-------- -------- -------- ----------
Income (loss) before income taxes................. 31,073 40,448 (15,489) 56,032
Provision (benefit) for income taxes.............. 12,895 16,786 (3,906) 25,775
-------- -------- -------- ----------
$ 18,178 $ 23,662 $(11,583) $ 30,257
======== ======== ======== ==========
34
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Operating Data (Continued)
(Unaudited)
(In thousands)
| Reorganized Company
Predecessor | -----------------------------------------
Company | 2001
----------- | -----------------------------------------
First | Nine months
Quarter | Second Third Fourth ended
2001 | Quarter Quarter Quarter December 31,
----------- | -------- -------- -------- ------------
Revenues: |
Health services division: |
Nursing centers......................... $429,523 | $444,137 $447,428 $456,671 $1,348,236
Rehabilitation services................. 10,695 | 9,244 9,122 9,085 27,451
-------- | -------- -------- -------- ----------
440,218 | 453,381 456,550 465,756 1,375,687
Hospital division: |
Hospitals............................... 271,984 | 276,112 268,578 278,245 822,935
Pharmacy................................ 54,880 | 56,567 58,750 60,788 176,105
-------- | -------- -------- -------- ----------
326,864 | 332,679 327,328 339,033 999,040
-------- | -------- -------- -------- ----------
767,082 | 786,060 783,878 804,789 2,374,727
Elimination of pharmacy charges to Company |
nursing centers......................... (14,673) | (15,296) (15,198) (15,214) (45,708)
-------- | -------- -------- -------- ----------
$752,409 | $770,764 $768,680 $789,575 $2,329,019
======== | ======== ======== ======== ==========
Income from operations: |
Operating income: |
Health services division: |
Nursing centers......................... $ 70,543 | $ 78,735 $ 80,339 $ 75,426 $ 234,500
Rehabilitation services................. 690 | 1,809 2,178 4,125 8,112
Other ancillary services................ 250 | 103 226 179 508
-------- | -------- -------- -------- ----------
71,483 | 80,647 82,743 79,730 243,120
Hospital division: |
Hospitals............................... 54,778 | 55,685 49,809 52,119 157,613
Pharmacy................................ 6,176 | 6,036 7,002 7,793 20,831
-------- | -------- -------- -------- ----------
60,954 | 61,721 56,811 59,912 178,444
Corporate overhead........................ (28,697) | (27,484) (30,397) (27,358) (85,239)
-------- | -------- -------- -------- ----------
103,740 | 114,884 109,157 112,284 336,325
Unusual transactions...................... - | - 3,238 2,187 5,425
Reorganization items...................... 53,666 | - - - -
-------- | -------- -------- -------- ----------
Operating income........................ 157,406 | 114,884 112,395 114,471 341,750
Rent....................................... (76,995) | (64,580) (65,233) (65,471) (195,284)
Depreciation and amortization.............. (18,645) | (15,886) (16,768) (17,565) (50,219)
Interest, net.............................. (12,081) | (5,025) (4,313) (3,117) (12,455)
-------- | -------- -------- -------- ----------
Income before income taxes................. 49,685 | 29,393 26,081 28,318 83,792
Provision for income taxes................. 500 | 12,904 11,282 12,264 36,450
-------- | -------- -------- -------- ----------
$ 49,185 | $ 16,489 $ 14,799 $ 16,054 $ 47,342
======== | ======== ======== ======== ==========
35
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Operating Data (Continued)
(Unaudited)
(In thousands)
Reorganized Company
-------------------------------------
2002
-------------------------------------
Nine months
First Second Third ended
Quarter Quarter Quarter September 30,
------- ------- ------- -------------
Rent:
Health services division:
Nursing centers........................... $41,286 $42,098 $42,765 $126,149
Rehabilitation services................... 14 14 31 59
------- ------- ------- --------
41,300 42,112 42,796 126,208
Hospital division:
Hospitals................................. 23,336 24,675 24,513 72,524
Pharmacy.................................. 942 968 966 2,876
------- ------- ------- --------
24,278 25,643 25,479 75,400
Corporate................................... 33 63 52 148
------- ------- ------- --------
$65,611 $67,818 $68,327 $201,756
======= ======= ======= ========
Depreciation and amortization:
Health services division:
Nursing centers........................... $ 6,077 $ 6,149 $ 6,601 $ 18,827
Rehabilitation services................... 8 6 10 24
------- ------- ------- --------
6,085 6,155 6,611 18,851
Hospital division:
Hospitals................................. 6,361 6,638 6,994 19,993
Pharmacy.................................. 543 628 600 1,771
------- ------- ------- --------
6,904 7,266 7,594 21,764
Corporate................................... 3,707 3,992 4,082 11,781
------- ------- ------- --------
$16,696 $17,413 $18,287 $ 52,396
======= ======= ======= ========
Capital expenditures, excluding acquisitions:
Health services division.................... $ 2,116 $ 4,728 $ 6,498 $ 13,342
Hospital division........................... 3,712 7,212 6,938 17,862
Corporate:
Information systems....................... 3,330 6,632 6,474 16,436
Other..................................... 710 787 1,056 2,553
------- ------- ------- --------
$ 9,868 $19,359 $20,966 $ 50,193
======= ======= ======= ========
36
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Operating Data (Continued)
(Unaudited)
(In thousands)
| Reorganized Company
Predecessor | ------------------------------------
Company | 2001
----------- | ------------------------------------
First | Nine months
Quarter | Second Third Fourth ended
2001 | Quarter Quarter Quarter December 31,
----------- | ------- ------- ------- ------------
Rent: |
Health services division: |
Nursing centers........................... $44,253 | $40,190 $41,311 $41,546 $123,047
Rehabilitation services................... 39 | 27 24 24 75
Other ancillary services.................. - | 3 1 - 4
------- | ------- ------- ------- --------
44,292 | 40,220 41,336 41,570 123,126
Hospital division: |
Hospitals................................. 30,839 | 22,917 22,771 22,883 68,571
Pharmacy.................................. 941 | 968 984 1,001 2,953
------- | ------- ------- ------- --------
31,780 | 23,885 23,755 23,884 71,524
Corporate................................... 923 | 475 142 17 634
------- | ------- ------- ------- --------
$76,995 | $64,580 $65,233 $65,471 $195,284
======= | ======= ======= ======= ========
Depreciation and amortization: |
Health services division: |
Nursing centers........................... $ 7,219 | $ 5,055 $ 5,713 $ 5,925 $ 16,693
Rehabilitation services................... - | 11 2 11 24
Other ancillary services.................. 129 | - - - -
------- | ------- ------- ------- --------
7,348 | 5,066 5,715 5,936 16,717
Hospital division: |
Hospitals................................. 5,457 | 5,690 5,742 6,087 17,519
Pharmacy.................................. 627 | 447 476 523 1,446
------- | ------- ------- ------- --------
6,084 | 6,137 6,218 6,610 18,965
Corporate................................... 5,213 | 4,683 4,835 5,019 14,537
------- | ------- ------- ------- --------
$18,645 | $15,886 $16,768 $17,565 $ 50,219
======= | ======= ======= ======= ========
|
Capital expenditures, excluding acquisitions: |
Health services division.................... $ 7,962 | $ 4,529 $ 5,184 $ 3,602 $ 13,315
Hospital division........................... 8,901 | 8,644 3,244 7,942 19,830
Corporate: |
Information systems....................... 3,496 | 3,135 7,841 9,290 20,266
Other..................................... 1,679 | 9,331 1,317 1,184 11,832
------- | ------- ------- ------- --------
$22,038 | $25,639 $17,586 $22,018 $ 65,243
======= | ======= ======= ======= ========
37
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Operating Data (Continued)
(Unaudited)
Reorganized Company
----------------------------------------------
2002
----------------------------------------------
Nine months
First Second Third ended
Quarter Quarter Quarter September 30,
---------- ---------- ---------- -------------
Nursing Center Data:
End of period data:
Number of nursing centers:
Owned or leased......................... 280 278 278
Managed................................. 14 10 10
---------- ---------- ----------
294 288 288
========== ========== ==========
Number of licensed beds:
Owned or leased......................... 36,615 36,620 36,592
Managed................................. 1,417 1,017 1,017
---------- ---------- ----------
38,032 37,637 37,609
========== ========== ==========
Revenue mix %:
Medicare.................................. 34 34 33 34
Medicaid.................................. 46 47 48 47
Private and other......................... 20 19 19 19
Patient days (excludes managed facilities):
Medicare.................................. 439,715 439,913 427,688 1,307,316
Medicaid.................................. 1,883,679 1,890,725 1,937,000 5,711,404
Private and other......................... 502,996 500,934 501,298 1,505,228
---------- ---------- ---------- ----------
2,826,390 2,831,572 2,865,986 8,523,948
========== ========== ========== ==========
Revenues per patient day:
Medicare.................................. $ 358 $ 358 $ 361 $ 359
Medicaid.................................. 114 113 116 114
Private and other......................... 179 178 181 180
Weighted average.......................... 163 163 164 163
Hospital Data:
End of period data:
Number of hospitals....................... 57 63 64
Number of licensed beds................... 4,961 5,276 5,344
Revenue mix % (a):
Medicare.................................. 58 61 60 60
Medicaid.................................. 10 8 9 9
Private and other......................... 32 31 31 31
Patient days:
Medicare.................................. 196,057 218,392 209,158 623,607
Medicaid.................................. 33,864 32,635 33,590 100,089
Private and other......................... 58,437 57,266 56,623 172,326
---------- ---------- ---------- ----------
288,358 308,293 299,371 896,022
========== ========== ========== ==========
Revenues per patient day (a):
Medicare.................................. $ 880 $ 893 $ 913 $ 896
Medicaid.................................. 880 811 831 841
Private and other......................... 1,609 1,768 1,764 1,713
Weighted average.......................... 1,028 1,047 1,065 1,047
- --------
(a) Excludes $12.1 million related to a favorable settlement with a private
insurance company recorded in the third quarter of 2002.
38
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Operating Data (Continued)
(Unaudited)
| Reorganized Company
Predecessor | ---------------------------------------------
Company | 2001
----------- | ---------------------------------------------
First | Nine months
Quarter | Second Third Fourth ended
2001 | Quarter Quarter Quarter December 31,
----------- | ---------- ---------- ---------- ------------
Nursing Center Data: |
End of period data: |
Number of nursing centers: |
Owned or leased............ 278 | 280 280 282
Managed.................... 35 | 35 34 23
---------- | ---------- ---------- ----------
313 | 315 314 305
========== | ========== ========== ==========
Number of licensed beds: |
Owned or leased............ 36,469 | 36,746 36,729 36,926
Managed.................... 3,861 | 3,861 3,626 2,367
---------- | ---------- ---------- ----------
40,330 | 40,607 40,355 39,293
========== | ========== ========== ==========
Revenue mix %: |
Medicare..................... 31 | 32 31 31 32
Medicaid..................... 47 | 47 48 48 47
Private and other............ 22 | 21 21 21 21
|
Patient days (excludes managed |
facilities): |
Medicare..................... 411,783 | 417,065 399,441 402,157 1,218,663
Medicaid..................... 1,860,256 | 1,871,895 1,933,822 1,945,232 5,750,949
Private and other............ 532,943 | 533,792 542,284 537,582 1,613,658
---------- | ---------- ---------- ---------- ----------
2,804,982 | 2,822,752 2,875,547 2,884,971 8,583,270
========== | ========== ========== ========== ==========
Revenues per patient day: |
Medicare..................... $ 325 | $ 344 $ 348 $ 357 $ 349
Medicaid..................... 109 | 110 111 113 111
Private and other............ 175 | 176 174 174 175
Weighted average............. 153 | 157 156 158 157
|
Hospital Data: |
End of period data: |
Number of hospitals.......... 56 | 56 56 57
Number of licensed beds...... 4,867 | 4,867 4,867 4,961
|
Revenue mix %: |
Medicare..................... 56 | 56 56 59 57
Medicaid..................... 11 | 11 11 6 9
Private and other............ 33 | 33 33 35 34
|
Patient days: |
Medicare..................... 185,731 | 182,906 172,692 178,985 534,583
Medicaid..................... 34,872 | 34,799 35,098 33,480 103,377
Private and other............ 52,426 | 53,016 55,050 56,399 164,465
---------- | ---------- ---------- ---------- ----------
273,029 | 270,721 262,840 268,864 802,425
========== | ========== ========== ========== ==========
Revenues per patient day: |
Medicare..................... $ 820 | $ 839 $ 872 $ 920 $ 877
Medicaid..................... 871 | 872 807 511 733
Private and other............ 1,703 | 1,742 1,628 1,712 1,693
Weighted average............. 996 | 1,020 1,022 1,035 1,026
39
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion of the Company's 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 the Company. Given
the unpredictability of interest rates as well as other factors, actual results
could differ materially from those projected in such forward-looking
information.
The Company's only significant exposure to market risk relates to changes in
the London Interbank Offered Rate which affect the interest paid on its
borrowings.
The following table provides information about the Company's 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 9/30/02
---- ---- ---- ---- ---- ---------- -------- --------
Liabilities:
Long-term debt, including amounts due
within one year:....................
Fixed rate....................... $109 $258 $ 63 $ 69 $ 75 $ 1,301 $ 1,875 $ 1,828
Average interest rate............ 9.8% 9.7% 8.8% 8.8% 8.8% 8.8%
Variable rate.................... $ - $ - $ - $ - $ - $160,500 $160,500 $160,099
Average interest rate (a)
- --------
(a) Interest is payable, at the option of the Company, at the one, two, three
or six month London Interbank Offered Rate plus 4 1/2%.
ITEM 4. CONTROLS AND PROCEDURES
Based upon an evaluation, carried out under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, within 90 days prior to the
filing of this report, the Company's Chief Executive Officer and Chief
Financial Officer concluded that, as of the date of that evaluation, the
Company's disclosure controls and procedures are effective for gathering,
analyzing and disclosing the information the Company is required to disclose in
its reports under the Exchange Act.
There have been no significant changes in the Company's internal controls or
in other factors that could significantly affect the Company's internal
controls subsequent to the date of the evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
40
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Summary descriptions of various significant legal and regulatory activities
follow.
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 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. In September, the
Company announced that it received approximately $12 million in connection with
the settlement of one of these claims. The Company intends to continue to
pursue these claims vigorously.
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 alleges that certain of the Company's and Ventas's 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's 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's revenues and successful acquisitions,
the price of its 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's 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's
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 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. In October 2002, the
defendants filed a motion to dismiss for failure to prosecute the case and are
currently awaiting the court's ruling on that motion. The Company believes that
the allegations in the complaint are without merit and intends to defend this
action vigorously.
A purported class action lawsuit entitled Massachusetts State Carpenters
Pension Fund v. Kindred Healthcare, Inc., et al., Civil Action No.
3:02CV-600-J, was filed against the Company and certain current and former
officers and directors of the Company on October 16, 2002, in the United States
District Court for the Western District of Kentucky, Louisville Division. The
complaint alleges that from August 14, 2001 to October 10, 2002 the defendants
violated Sections 10(b) and 20(a) of the Exchange Act by, among other things,
issuing to the investing public a series of allegedly false and misleading
statements that inaccurately indicated that the Company was successfully
emerging from bankruptcy and implementing a growth plan. In particular, the
complaint alleges that these statements were materially false and misleading
because they failed to disclose that the 2001 Florida tort reform legislation
had resulted in a marked increase in claims against the Company in Florida, and
also because the statements reflected a materially understated reserve for
professional liability
41
PART II. OTHER INFORMATION (Continued)
Item 1. Legal Proceedings (Continued)
claims. The complaint further alleges that as a result of the purportedly false
and misleading statements, the price of the Company's common stock was
artificially inflated, the investing public was deceptively induced to purchase
the stock at those inflated prices, and the defendants profited by selling
shares at those prices. The suit seeks an unspecified amount of monetary
damages plus interest, reasonable attorneys' fees and other costs, and any
other equitable, injunctive or other relief that the court deems just and
proper. After October 16, 2002, several other purported class action
complaints, which assert essentially similar allegations as those contained in
the Massachusetts State Carpenters Pension Fund complaint discussed above, also
were filed against the same defendants in the United States District Court for
the Western District of Kentucky, Louisville Division, including but not
limited to the cases entitled Mark Ramsdell v. Kindred Healthcare, Inc., et
al., Civil Action No. 3:02CV-625-R and Paula Hillenbrand v. Kindred Healthcare,
Inc., et al., Civil Action No. 3:02CV-654-R. The Company believes that the
allegations in all of these purported class action complaints are without
merit, and it intends to defend these lawsuits vigorously.
A shareholder derivative suit entitled Elizabeth Sommerfeld v. Kindred
Healthcare, Inc., et al., Civil Action No. 02 CI 08476, was filed in November
2002 in the Jefferson Circuit Court in Kentucky. The complaint, which recites
purported facts substantially similar to those set forth in the Massachusetts
State Carpenters Pension Fund putative class action and the other securities
fraud class actions discussed above, attempts to assert a claim against the
individual defendants for breach of fiduciary duties for insider selling and
misappropriation of information. Specifically, the complaint alleges that each
of the individual defendants knew that the price of the Company's common stock
would dramatically decrease when the truth regarding the Company's inadequate
reserves for professional liability risks was disclosed and that the individual
defendants' sales of the Company's common stock with knowledge of this material
non-public information was a breach of their fiduciary duties of loyalty and
good faith. The suit seeks to impose a constructive trust in favor of the
Company for the amount of profits each of the individual defendants or their
firms received from their November 2001 sales of the Company's common stock, as
well as reasonable attorneys' fees and other expenses. The Company believes
that the allegations in the complaint are without merit and intends to defend
this action vigorously.
In connection with the Company's spin-off from Ventas in 1998, 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 Plan of Reorganization, the Company agreed to continue
to fulfill its indemnification obligations arising from the spin-off.
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 U.S.
Department of Justice, CMS or other state and federal 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.
42
PART II. OTHER INFORMATION (Continued)
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
10.1 Amendment No. 3, dated as of August 15, 2002, 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 The Chase
Manhattan Bank, successor-by-merger to 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 99.1 to the Company's Current
Report on Form 8-K dated August 26, 2002 (Comm. File No. 001-14057)
is hereby incorporated by reference.
10.2 Amendment No. 3, dated as of August 15, 2002, 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 The Chase Manhattan Bank, successor-by-merger
to Morgan Guaranty Trust Company of New York), as Administrative
Agent and Collateral Agent. Exhibit 99.2 to the Company's Current
Report on Form 8-K dated August 26, 2002 (Comm. File No. 001-14057)
is hereby incorporated by reference.
10.3 Separation Agreement and Release of Claims between Donald D. Finney
and Kindred Healthcare, Inc.
(b) Reports on Form 8-K:
On August 13, 2002, the Company filed a Current Report on Form 8-K
announcing that its principal executive officer and principal financial officer
had submitted to the Commission sworn statements pursuant to Commission Order
No. 4-460. On August 13, 2002, the Company filed an additional Current Report
on Form 8-K announcing that the certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 signed by Edward L. Kuntz, Chairman and Chief
Executive Officer, and Richard A. Lechleiter, Senior Vice President, Chief
Financial Officer and Treasurer, was provided to the Commission as
correspondence in connection with the Company's filing of its Quarterly Report
on Form 10-Q for the second quarter of 2002. On August 21, 2002, the Company
filed a Current Report on Form 8-K announcing the resignation of Donald D.
Finney as President of the Company's health services division. On August 26,
2002, the Company filed a Current Report on Form 8-K announcing that its Board
of Directors had approved the repurchase of up to $35 million of the Company's
common stock. In the same Form 8-K, the Company also announced that it had
amended its revolving credit facility and senior secured notes to permit the
stock repurchase. The Company also announced that as part of those amendments,
the Company prepaid $50 million of the senior secured notes and agreed to
certain other amendments to its revolving credit facility and senior secured
notes.
43
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KINDRED HEALTHCARE, INC.
Date: November 13, 2002 /s/ EDWARD L. KUNTZ
- ----------------------- --------------------------------------
Edward L. Kuntz
Chairman of the Board and
Chief Executive Officer
Date: November 13, 2002 /s/ RICHARD A. LECHLEITER
- ----------------------- --------------------------------------
Richard A. Lechleiter
Senior Vice President, Chief
Financial Officer and Treasurer
44
Certification Required By Rules 13a-14 and 15d-14
under the Securities Exchange Act of 1934
I, Edward L. Kuntz, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kindred Healthcare,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) of the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 13, 2002 /s/ EDWARD L. KUNTZ
----------------- -----------------------------
Edward L. Kuntz
Chairman of the Board and
Chief Executive Officer
45
Certification Required By Rules 13a-14 and 15d-14
under the Securities Exchange Act of 1934
I, Richard A. Lechleiter, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kindred Healthcare,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) of the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 13, 2002 /s/ RICHARD A. LECHLEITER
----------------- -----------------------------
Richard A. Lechleiter
Senior Vice President, Chief
Financial Officer and Treasurer
46