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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-14057
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KINDRED HEALTHCARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 61-1323993
(State or other (I.R.S. Employer
jurisdiction of Identification Number)
incorporation or
organization)
680 South Fourth Street
Louisville, Kentucky 40202-2412
(Address of principal (Zip Code)
executive offices)
(502) 596-7300
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange on
Title of Each of Class which Registered
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None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.25 per share
Series A Warrants to Purchase Common Stock
Series B Warrants to Purchase Common Stock
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K ((S)229.405 of this chapter) is not contained herein, and
will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment of this Form 10-K. [X]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [_]
As of January 31, 2003, there were 17,648,857 shares of the Registrant's
common stock, $0.25 par value, outstanding. The aggregate market value of the
shares of the Registrant held by non-affiliates of the Registrant, based on the
closing price of such stock on the Nasdaq on June 28, 2002, was approximately
$325,138,000. For purposes of the foregoing calculation only, all directors and
executive officers of the Registrant have been deemed affiliates.
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [X] No [_]
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Shareholders to be held on May 22, 2003 are incorporated by reference into Part
III of this Form 10-K.
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TABLE OF CONTENTS
Page
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PART I
Item 1. Business............................................................................. 3
Item 2. Properties........................................................................... 42
Item 3. Legal Proceedings.................................................................... 42
Item 4. Submission of Matters to a Vote of Security Holders.................................. 45
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................ 47
Item 6. Selected Financial Data.............................................................. 48
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 49
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................... 73
Item 8. Financial Statements and Supplementary Data.......................................... 73
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. 74
PART III
Item 10. Directors and Executive Officers of the Registrant................................... 74
Item 11. Executive Compensation............................................................... 74
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters.................................................................. 74
Item 13. Certain Relationships and Related Transactions....................................... 76
Item 14. Controls and Procedures.............................................................. 76
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................... 77
2
PART I
Item 1. Business
GENERAL
Kindred Healthcare, Inc. provides long-term healthcare services primarily
through the operation of nursing centers and hospitals. At December 31, 2002,
our health services division operated 285 nursing centers (37,376 licensed
beds) in 32 states and a rehabilitation therapy business. Our hospital division
operated 65 hospitals (5,385 licensed beds) in 24 states and an institutional
pharmacy business. All references in this Annual Report on Form 10-K to
"Kindred," "our Company," "we," "us," or "our" mean Kindred Healthcare, Inc.
and, unless the context otherwise requires, its consolidated subsidiaries.
On April 20, 2001 (the "Effective Date"), we emerged from proceedings under
Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code")
pursuant to the terms of our Fourth Amended Joint Plan of Reorganization (the
"Plan of Reorganization"). On March 1, 2001, the United States Bankruptcy Court
for the District of Delaware (the "Bankruptcy Court") approved our Plan of
Reorganization. In connection with our emergence, we changed our name to
Kindred Healthcare, Inc. See "- Our Reorganization."
From the filing for protection under the Bankruptcy Code on September 13,
1999 through the Effective Date, we operated our businesses as a
debtor-in-possession subject to the jurisdiction of the Bankruptcy Court.
Accordingly, our consolidated financial statements have been prepared in
accordance with the American Institute of Certified Public Accountants
Statement of Position 90-7, "Financial Reporting by Entities in Reorganization
Under the Bankruptcy Code" ("SOP 90-7") and generally accepted accounting
principles applicable to a going concern, which assume that assets will be
realized and liabilities will be discharged in the normal course of business.
In connection with our emergence from bankruptcy, we reflected the terms of
the Plan of Reorganization in our consolidated financial statements by adopting
the fresh-start accounting provisions of SOP 90-7. Under fresh-start
accounting, a new reporting entity is deemed to be created and the recorded
amounts of assets and liabilities are adjusted to reflect their estimated fair
values. For accounting purposes, the fresh-start adjustments have been recorded
in our consolidated financial statements as of April 1, 2001. Since fresh-start
accounting materially changed the amounts previously recorded in our
consolidated financial statements, a black line separates the post-emergence
financial data from the pre-emergence data to signify the difference in the
basis of preparation of the financial statements for each respective entity.
As used in this Form 10-K, the term "Predecessor Company" refers to us and
our operations for periods prior to April 1, 2001, while the term "Reorganized
Company" is used to describe us and our operations for periods thereafter.
On May 1, 1998, Ventas, Inc. ("Ventas") completed the spin-off of its
healthcare operations to its stockholders through the distribution of our
former common stock (the "Spin-off"). Ventas retained ownership of
substantially all of its real property and leases such real property to us. In
anticipation of the Spin-off, we were incorporated on March 27, 1998 as a
Delaware corporation. For accounting purposes, the consolidated historical
financial statements of Ventas became our historical financial statements
following the Spin-off. Any discussion concerning events prior to May 1, 1998
refers to our businesses as they were conducted by Ventas prior to the Spin-off.
On September 28, 1995, The Hillhaven Corporation merged into us. On March
21, 1997, we acquired TheraTx, Incorporated ("TheraTx"), a provider of
rehabilitation and respiratory therapy program management services to nursing
centers and an operator of 26 nursing centers. On June 24, 1997, we acquired a
controlling interest in Transitional Hospitals Corporation, an operator of 19
long-term acute care hospitals located in 13 states. We completed the merger of
our wholly owned subsidiary into Transitional on August 26, 1997.
3
This Annual Report on Form 10-K includes forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). See "- Cautionary Statements."
RECENT DEVELOPMENTS
We operate 18 nursing centers in the state of Florida. As a result of
significantly increasing professional liability costs, these facilities
generated a pretax loss of approximately $68 million in 2002. In October 2002,
we announced our intentions to divest our nursing center operations in Florida.
On December 11, 2002, we entered into a non-binding letter of intent with
Senior Health Management, LLC ("SHM") to transfer the operations of our 18
skilled nursing facilities in Florida. Under the proposed transaction,
affiliates of Senior Health Properties-South, Inc. will sublease 16 of our 18
Florida facilities for an initial term of five years. The lease payments under
the subleases will be equal to the lease payments under the primary leases. We
will remain a primary guarantor under the primary leases. In addition, SHM's
designee will lease with an option to purchase the remaining two facilities we
own. SHM will enter into a management agreement with each of the subtenants and
tenants, as applicable, to manage the Florida facilities. Each of the
subtenants or tenants, as applicable, also will purchase certain personal
property assets related to the operations of the Florida facilities. We will
retain the working capital associated with all of our Florida facilities.
The parties continue to make progress in their negotiations of definitive
agreements related to the letter of intent but have not reached agreement at
this time. In addition to entering into a definitive agreement, the
consummation of a proposed transaction is subject to a number of material
conditions including, without limitation, the receipt of required approvals
from regulators, governmental entities and other third parties. We lease 15 of
the 18 Florida facilities from Ventas pursuant to the Master Lease Agreements
(as defined below). Although Ventas has previously publicly announced its
intention to work with us in facilitating a Florida exit strategy, Ventas has
informed us that it will object to the transaction unless it receives a
substantial and material consent fee and other lease concessions. We have
informed Ventas that this demand is improper. We believe that under the Master
Lease Agreements we have the ability to sublease 12 of these facilities without
Ventas's consent and that Ventas cannot unreasonably withhold its consent on
the remaining three facilities.
In addition, Ventas has informed the Florida licensure agency that it
believes the proposed sublease transaction is not permitted under its Master
Lease Agreements with us and has requested that the agency suspend further
processing of the necessary licensure applications for the change in ownership.
SHM and we have independently informed the Florida agency that Ventas's request
is improper and that it lacks the authority to make any such request. We
believe that the Florida agency is aware that it must continue to process the
change in ownership applications.
We are continuing to pursue the proposed sublease transaction and our
divestiture of the Florida facilities. If Ventas improperly interferes with the
completion of the proposed transaction or the divestiture of these facilities,
we will seek appropriate legal remedies against Ventas as well as damages for
the continuing losses sustained by us.
HEALTHCARE OPERATIONS
During 2002, we were organized into two operating divisions: the health
services division, which operates nursing centers and a rehabilitation therapy
business and the hospital division, which operates hospitals and an
institutional pharmacy business. We believe that the independent focus of each
division on the unique aspects and quality concerns of its business enhances
its ability to attract patients, improve operations and achieve cost
containment objectives.
4
HEALTH SERVICES DIVISION
Our health services division provides quality, cost-effective long-term care
through the operation of a national network of 285 nursing centers (37,376
licensed beds) located in 32 states and a rehabilitation therapy business as of
December 31, 2002. Through our nursing centers, we provide residents with
long-term care services, a full range of pharmacy, medical and clinical
services and routine services, including daily dietary, social and recreational
services. We also provide rehabilitation services, including physical,
occupational and speech therapies to our residents as well as to residents in
nursing facilities and other facilities operated by third parties.
At a number of our nursing centers, we offer specialized programs for
patients suffering from Alzheimer's disease and dementia. Within these nursing
centers, we provide quality care to these patients by dedicating to them
separate units run by teams of professionals that specialize in the unique
problems experienced by Alzheimer's and dementia patients. We believe that we
are a leading provider of nursing care to patients with Alzheimer's disease and
dementia, based on the specialization and size of our program for caring for
these patients.
We monitor and enhance the quality of care at our nursing centers through
the use of quality assurance and performance improvement committees as well as
family satisfaction surveys. Our quality assurance and performance improvement
committees oversee patient healthcare needs and patient and staff safety.
Physicians serve on these committees as medical directors and advise on
healthcare policies and practices. We conduct surveys of patients' families
periodically, and these surveys are reviewed by our performance improvement
committees at each facility to promote quality patient care. Substantially all
of our nursing centers are certified to provide services under the Medicare and
Medicaid programs. Our nursing centers have been certified because the quality
of our accommodations, equipment, services, safety, personnel, physical
environment and policies and procedures meet or exceed the standards of
certification set by those programs.
Health Services Division Strategy
Our goal is to become the provider of choice in the markets our health
services division serves, which we believe will allow us to increase our
patient census and enhance our payor mix. In addition, we have implemented
several initiatives to improve our quality and thereby enhance our
profitability. As appropriate, we may expand selectively our operations through
development and acquisition activities. The principal elements of our health
services division strategy are:
Providing Quality, Clinical-Based Services. The health services division is
focused on qualitative and quantitative clinical performance indicators with
the goal of providing quality care under the cost containment objectives
imposed by government and private payors. In an effort to continually improve
the quality of our services, we pursue aggressive plans to:
. hire and retain quality healthcare personnel by becoming the employer of
choice in the industry,
. establish improved processes to monitor and promote our patient care
objectives,
. integrate clinical advice of our chief medical officer and other
physicians into our operational procedures, and
. develop and enhance our internal training programs.
Enhancing Sales and Marketing Programs. We conduct our nursing center
marketing efforts, which focus on the quality of care provided at our
facilities, at the local market level through our nursing center
administrators, admissions coordinators and/or the facility-based sales and
marketing personnel. The marketing
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efforts of our nursing center personnel are supplemented by strategies provided
by our regional and district marketing staffs. In order to increase awareness
of our services and the provision of quality care, we:
. direct a targeted marketing effort at the elderly population, which we
believe is the fastest growing segment in the United States and which
will, therefore, provide the growth in our industry in the coming years,
and
. work to improve our relationships with local referral sources.
Increasing Operating Efficiency. The health services division continually
seeks to improve operating efficiency with a view to maintaining high-quality
care in an environment that demands an increasingly greater control of costs.
We believe that operating efficiency is critical in maintaining our position as
a leading provider of nursing center services in the United States. In our
effort to improve operating efficiency we have:
. centralized administrative functions such as accounting, payroll, legal,
reimbursement, compliance and human resources,
. developed a management information system to aid in financial reporting
as well as billing and collecting, and
. focused our efforts to hire and retain quality personnel.
Managing Efficient Delivery of Ancillary Services. We are dedicated to
providing quality nursing services to the residents in our facilities while at
the same time optimizing our operating efficiency. Our nursing centers
generally provide ancillary services, primarily rehabilitation services, to
their residents through the use of internal staff. We are continuing to refine
the delivery of ancillary services to external customers to maintain
profitability under the cost constraints of the prospective payment system.
Accordingly, over the last few years, the health services division terminated
many unprofitable external ancillary services contracts.
Expanding Selectively Through Acquisitions and Development Activities. We
believe that we have the strategic and financial ability to pursue
opportunities to expand our business through acquisitions and development
activities on a selective basis. We will evaluate development opportunities to
expand our operations, either through acquiring or leasing individual or small
portfolios of nursing facilities in selected markets or by managing the
operations of third parties. We also will evaluate opportunities to acquire
companies with operations in attractive markets.
6
Selected Health Services Division Operating Data
The following table sets forth certain operating data for the health
services division (dollars in thousands, except statistics):
Reorganized Company | Predecessor Company
------------------------- | -------------------------
Year Nine months | Three months Year
ended ended | ended ended
December 31, December 31, | March 31, December 31,
2002 2001 | 2001 2000
------------ ------------ | ------------ ------------
Nursing centers: |
Revenues................................. $ 1,854,131 $1,348,236 | $ 429,523 $ 1,675,627
Operating income......................... $ 226,284 $ 234,500 | $ 70,543 $ 278,738
Facilities in operation at end of period: |
Owned or leased........................ 278 282 | 278 278
Managed................................ 7 23 | 35 34
Licensed beds at end of period: |
Owned or leased........................ 36,573 36,926 | 36,469 36,466
Managed................................ 803 2,367 | 3,861 3,723
Patient days (a)......................... 11,383,328 8,583,270 | 2,804,982 11,580,295
Revenues per patient day (a)............. $ 163 $ 157 | $ 153 $ 145
Average daily census (a)................. 31,187 31,212 | 31,166 31,640
Occupancy % (a).......................... 84.7 84.9 | 85.2 86.1
Rehabilitation services: |
Revenues................................. $ 34,296 $ 27,451 | $ 10,695 $ 135,036
Operating income......................... $ 7,531 $ 8,112 | $ 690 $ 8,047
Other ancillary services: |
Operating income......................... $ 435 $ 508 | $ 250 $ 4,737
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(a) Excludes managed facilities.
The term "operating income" is defined as earnings before interest, income
taxes, depreciation, amortization, rent, corporate overhead, unusual
transactions and reorganization items. The term "licensed beds" refers to the
maximum number of beds permitted in the facility under its license regardless
of whether the beds are actually available for patient care. "Patient days"
refers to the total number of days of patient care provided for the periods
indicated. "Average daily census" is computed by dividing each facility's
patient days by the number of calendar days in the respective period.
"Occupancy %" is computed by dividing average daily census by the number of
licensed beds, adjusted for the length of time each facility was in operation
during each respective period.
Total assets of the health services division were $423 million and $393
million at the end of 2002 and 2001, respectively.
Sources of Nursing Center Revenues
Nursing center revenues are derived principally from the Medicare and
Medicaid programs and from private payment patients. Consistent with the
nursing center industry, changes in the mix of the health services division's
patient population among these three categories significantly affect the
profitability of our nursing center operations. Although Medicare and higher
acuity patients generally produce the most revenue per patient day,
profitability with respect to higher acuity patients is reduced by the costs
associated with the higher level of nursing care and other services generally
required by such patients.
7
The following table sets forth the approximate percentages of nursing center
patient days and revenues derived from the payor sources indicated:
Medicare Medicaid Private and other
--------------- --------------- ---------------
Patient Patient Patient
Period days Revenues days Revenues days Revenues
- ------ ------- -------- ------- -------- ------- --------
Year ended December 31, 2002....... 15% 33% 67% 48% 18% 19%
Nine months ended December 31, 2001 14 32 67 47 19 21
Three months ended March 31, 2001.. 15 31 66 47 19 22
Year ended December 31, 2000....... 13 28 67 49 20 23
For the year ended December 31, 2002, revenues of the health services
division totaled approximately $1.9 billion or 55% of our total revenues
(before eliminations).
Both governmental and private third party payors employ cost containment
measures designed to limit payments made to healthcare providers. Those
measures include the adoption of initial and continuing recipient eligibility
criteria which may limit payment for services, the adoption of coverage
criteria which limit the services that will be reimbursed and the establishment
of payment ceilings which set the maximum reimbursement that a provider may
receive for services. Furthermore, government reimbursement programs are
subject to statutory and regulatory changes, retroactive rate adjustments,
administrative rulings and government funding restrictions, all of which may
materially increase or decrease the rate of program payments to the health
services division for its services.
Medicare. The Medicare Part A program provides reimbursement for extended
care services furnished to Medicare beneficiaries who are admitted to nursing
centers after at least a three-day stay in an acute care hospital. Covered
services include supervised nursing care, room and board, social services,
physical, speech and occupational therapies, pharmaceuticals, supplies and
other necessary services provided by nursing centers.
The Balanced Budget Act of 1997 (the "Balanced Budget Act") established a
prospective payment system for nursing centers ("PPS") for cost reporting
periods beginning on or after July 1, 1998. Prior to the implementation of PPS,
nursing centers were reimbursed by Medicare based on the facility-specific,
reasonable direct and indirect costs of services provided to their patients.
All of our nursing centers adopted PPS on July 1, 1998. The payments received
under PPS cover all services for Medicare patients including all ancillary
services, such as respiratory therapy, physical therapy, occupational therapy,
speech therapy and certain covered pharmaceuticals.
Medicaid. Medicaid is a state-administered program financed by state funds
and matching federal funds. The program provides for medical assistance to the
indigent and certain other eligible persons. Although administered under broad
federal regulations, states are given flexibility to construct programs and
payment methods consistent with their individual goals. Accordingly, these
programs differ in many respects from state to state.
The health services division provides to eligible individuals
Medicaid-covered services consisting of nursing care, room and board and social
services. In addition, states may at their option cover other services such as
physical, occupational and speech therapies and pharmaceuticals. Prior to the
Balanced Budget Act, federal law, generally referred to as the "Boren
Amendment," required Medicaid programs to pay rates that were reasonable and
adequate to meet the costs incurred by an efficiently and economically operated
nursing center providing quality care and services in conformity with all
applicable laws and regulations. Despite the federal requirements,
disagreements frequently arose between nursing centers and states regarding the
adequacy of Medicaid rates. By repealing the Boren Amendment, the Balanced
Budget Act eased the restrictions on the states' ability to reduce their
Medicaid reimbursement levels for such services. Medicaid programs also are
subject to statutory and regulatory changes, administrative rulings,
interpretations of policy by the state agencies and certain government
8
funding limitations, all of which may materially increase or decrease the level
of program payments to nursing centers operated by the health services
division. We believe that the payments under many of these programs may not be
sufficient on an overall basis to cover the costs of serving certain patients
participating in these programs. In addition, budgetary pressures impacting a
number of states may further reduce Medicaid payments to our nursing centers
from current levels. Furthermore, the Omnibus Budget Reconciliation Act of
1987, as amended, mandates an increased emphasis on ensuring quality patient
care, which has resulted in additional expenditures by nursing centers.
Private Payment. The health services division seeks to maximize the number
of private payment patients admitted to its nursing centers, including those
covered under private insurance and managed care health plans. Private payment
patients typically have financial resources (including insurance coverage) to
pay for their monthly services and do not rely on government programs for
support.
We cannot assure you that payments under governmental and private third
party payor programs will remain at levels comparable to present levels or will
be sufficient to cover the costs allocable to patients eligible for
reimbursement pursuant to such programs. In addition, one or more of the
facilities operated by the health services division, or the provision of
services and supplies by the health services division, could fail to meet the
requirements for participation in such programs. We could be adversely affected
by the continuing efforts of governmental and private third party payors to
contain the cost of healthcare services. See "- Governmental Regulation -
Regulatory Changes" and "- Cautionary Statements."
9
Nursing Center Facilities
The following table lists by state the number of nursing centers and related
licensed beds we operated as of December 31, 2002:
Number of facilities
---------------------------------------------
Licensed Owned Leased from Leased from
State beds by us Ventas (2) other parties Managed Total
----- -------- ----- ----------- ------------- ------- -----
Alabama (1)....... 588 - 3 1 - 4
Arizona........... 823 - 5 1 - 6
California........ 2,262 4 11 3 1 19
Colorado.......... 695 - 4 1 - 5
Connecticut (1)... 983 - 8 - - 8
Florida (1)....... 2,543 2 15 1 - 18
Georgia (1)....... 1,053 1 5 1 - 7
Idaho............. 862 1 8 - - 9
Indiana........... 4,372 - 15 13 - 28
Kentucky (1)...... 2,055 1 12 4 - 17
Louisiana (1)..... 305 - - 1 1 2
Maine (1)......... 775 - 10 - - 10
Massachusetts (1). 4,181 - 31 3 3 37
Mississippi (1)... 125 - - 1 - 1
Missouri (1)...... 496 - - 3 - 3
Montana (1)....... 446 - 2 1 - 3
Nebraska (1)...... 163 - 1 - - 1
Nevada (1)........ 180 - 2 - - 2
New Hampshire (1). 512 - 3 - - 3
North Carolina (1) 2,764 - 19 4 - 23
Ohio (1).......... 2,005 - 11 4 - 15
Oregon (1)........ 254 - 2 - - 2
Pennsylvania...... 200 - 1 1 - 2
Rhode Island (1).. 201 - 2 - - 2
Tennessee (1)..... 2,669 - 4 12 - 16
Texas............. 443 - 1 1 - 2
Utah.............. 740 - 5 - 1 6
Vermont (1)....... 310 - 1 - 1 2
Virginia (1)...... 629 - 4 - - 4
Washington (1).... 993 1 9 - - 10
Wisconsin (1)..... 2,298 - 12 2 - 14
Wyoming........... 451 - 4 - - 4
------ -- --- -- - ---
Totals......... 37,376 10 210 58 7 285
====== == === == = ===
- --------
(1) These states have certificate of need regulations. See "- Governmental
Regulation - Federal, State and Local Regulation."
(2) See "- Master Lease Agreements."
Health Services Division Management and Operations
Each of our nursing centers is managed by a state-licensed administrator who
is supported by other professional personnel, including a director of nursing,
staff development professional (responsible for employee training), activities
director, social services director, business office manager and, in general,
physical, occupational and speech therapists. The directors of nursing are
state-licensed nurses who supervise our nursing staffs that include registered
nurses, licensed practical nurses and nursing assistants. Staff size and
composition
10
vary depending on the size and occupancy of each nursing center and on the type
of care provided by the nursing center. The nursing centers contract with
physicians who provide medical director services and serve on quality assurance
committees. We provide our facilities with centralized information systems,
human resources management, state and federal reimbursement assistance, state
licensing and certification maintenance, as well as legal, finance and
accounting, purchasing and facilities management support. The centralization of
these services improves efficiency and permits facility staff to focus on the
delivery of high quality nursing services.
Our health services division is managed by a divisional president and a
chief financial officer. Our nursing center operations are divided into four
geographic regions, each of which is headed by an operational vice president.
These four operational vice presidents report to the divisional president. The
clinical issues and quality concerns of the health services division are
managed by the division's chief medical officer and senior vice president of
clinical operations. District and/or regional staff in the areas of nursing,
dietary and rehabilitation services, state and federal reimbursement, human
resources management, maintenance, sales and financial services support the
health services division.
Quality Assessment and Improvement
Quality of care is monitored and enhanced by quality assurance and
performance improvement committees as well as family satisfaction surveys.
These committees oversee patient healthcare needs and patient and staff safety.
Additionally, physicians serve on these committees as medical directors and
advise on healthcare policies and practices. Regional and district nursing
professionals visit each nursing center periodically to review practices and
recommend improvements where necessary in the level of care provided and to
assure compliance with requirements under applicable Medicare and Medicaid
regulations. Surveys of patients' families are conducted from time to time in
which the families are asked to rate various aspects of service and the
physical condition of the nursing centers. These surveys are reviewed by
performance improvement committees at each facility to promote quality patient
care.
The health services division provides training programs for nursing center
administrators, managers, nurses and nursing assistants. These programs are
designed to maintain high levels of quality patient care.
Substantially all of our nursing centers are certified to provide services
under the Medicare and Medicaid programs. A nursing center's qualification to
participate in such programs depends upon many factors, such as accommodations,
equipment, services, safety, personnel, physical environment and adequate
policies and procedures.
Health Services Division Competition
Our nursing centers compete with other nursing centers and similar long-term
care facilities primarily on the basis of quality of care, reputation, their
location and physical appearance and, in the case of private patients, the
charges for our services. Some competitors are located in buildings that are
newer than those operated by us and may provide services that we do not offer.
Our nursing centers compete on a local and regional basis with other nursing
centers as well as with facilities providing similar services, including
hospitals, extended care centers, assisted living facilities, home health
agencies and similar institutions. The industry includes government-owned,
religious organization-owned, secular not-for-profit and for-profit
institutions. Many of these competitors have greater financial and other
resources than we do. Although there is limited, if any, price competition with
respect to Medicare and Medicaid patients (since revenues received for services
provided to such patients are based generally on fixed rates), there is
significant competition for private payment patients.
In addition, our health services division competes in the fragmented and
highly competitive ancillary services markets. Many nursing centers are
developing internal staff to provide these services, particularly in
11
response to the implementation of PPS. The primary competitive factors for the
ancillary services markets are quality of services, charges for services and
responsiveness to the needs of patients and families, and the facilities in
which the services are provided.
HOSPITAL DIVISION
Our hospital division primarily provides long-term acute care services to
medically complex patients through the operation of a national network of 65
hospitals (which includes three hospitals operated as general acute care
hospitals) with 5,385 licensed beds located in 24 states as of December 31,
2002. We opened our first long-term acute care hospital in 1985 and today
operate the largest network of long-term acute care hospitals in the United
States based on revenues. As a result of our commitment to the long-term acute
care business, we have developed a comprehensive program of care for medically
complex patients which allows us to deliver quality care in a cost-effective
manner. During 2002, the hospital division operated an institutional pharmacy
business, which focuses on providing a full array of institutional pharmacy
services to nursing centers and specialized care centers, including the nursing
centers we operate.
In addition to our long-term acute care hospitals, the hospital division
operates three hospitals as general short-term acute care hospitals. A number
of the hospital division's long-term acute care hospitals also provide
outpatient services. General acute care and outpatient services may include
inpatient services, diagnostic services, CT scanning, one-day surgery,
laboratory, X-ray, respiratory therapy, cardiology and physical therapy.
In our hospitals, we treat medically complex patients who suffer from
multiple systemic failures or conditions such as neurological disorders, head
injuries, brain stem and spinal cord trauma, cerebral vascular accidents,
chemical brain injuries, central nervous system disorders, developmental
anomalies and cardiopulmonary disorders. In particular, we have a core
competency in treating patients with pulmonary disorders. Medically complex
patients often are dependent on technology, such as mechanical ventilators,
total parental nutrition, respiratory or cardiac monitors and dialysis
machines, for continued life support. Approximately 50% of our patients may
require ventilator care during their length of stay. During 2002, the average
length of stay for patients in our long-term acute care hospitals was
approximately 40 days. Although the hospital division's patients range in age
from pediatric to geriatric, approximately 70% of these patients are over 65
years of age.
Our hospital division patients have conditions which require a high level of
monitoring and specialized care, yet may not need the services of a traditional
intensive care unit. Due to their severe medical conditions, these patients
generally are not clinically appropriate for admission to a nursing center and
their medical conditions are periodically or chronically unstable. By combining
selected general acute care services with the ability to care for medically
complex patients, we believe that our long-term acute care hospitals provide
their patients with high quality, cost-effective care.
Our long-term acute care hospitals employ a comprehensive program of care
for their medically complex patients which draws upon the talents of
interdisciplinary teams, including physician specialists. The teams evaluate
medically complex patients upon admission to determine treatment programs. Our
hospital division has developed specialized treatment programs focused on the
needs of medically complex patients. Where appropriate, the treatment programs
may involve the services of several disciplines, such as pulmonary medicine,
infectious disease and physical medicine.
Hospital Division Strategy
Our goal is to remain a leading operator of long-term acute care hospitals
in terms of both quality of care and operating efficiency. Our strategies for
achieving this goal include:
Maintaining High Quality of Care. The hospital division differentiates its
hospitals through its ability to care for medically complex patients in a
high-quality, cost-effective setting. We are committed to maintaining
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and improving the quality of our patient care by dedicating appropriate
resources to each facility and refining our clinical initiatives. In this
regard, we have taken the following measures to improve and maintain the
quality of care at our hospitals:
. established an integrated quality assessment and improvement program,
administered by our chief clinical officer, vice president of quality and
risk management and director of quality management, which encompasses
utilization review, quality improvement, infection control and risk
management.
. maintained a strategic outcomes program, which includes a concurrent
review of all of our patient population against quality screenings,
outcomes reporting and patient and family satisfaction surveys.
. implemented a program whereby our hospitals are reviewed by internal
quality auditors for compliance with standards of the Joint Commission on
Accreditation of Health Care Organizations (the "Joint Commission").
. committed to attracting the highest quality of professional staff within
each market. The hospital division believes that its future success will
depend in part upon its continued ability to hire and retain qualified
healthcare personnel.
. incorporated the clinical advice of our chief clinical officer, medical
advisory board and other physicians into our operational procedures.
. monitored licensure and certification compliance through a vice president
for quality and risk management.
Improving Operating Efficiency. The hospital division is continually
focused on improving operating efficiency and controlling costs while
maintaining quality patient care. Our hospital division seeks to improve
operating efficiencies and control costs by standardizing operations and
optimizing the skill mix of its staff based on the hospital's occupancy and the
clinical needs of its patients. The initiatives we have undertaken to control
our costs and improve efficiency include:
. managing labor costs by adjusting staffing to patient acuity and
fluctuations in census,
. centralizing administrative functions such as accounting, payroll, legal,
reimbursement, compliance and human resources,
. managing pharmacy costs through the use of formularies and evaluating
medical utilization through our pharmacy and therapeutic committees in
each hospital, and
. utilizing management information technology to aid in financial reporting
as well as billing and collecting.
Growing Through Business Development and Acquisitions. Our growth strategy
is focused on the development and expansion of our services:
. Hospital-in-Hospital. We look to partner with non-Kindred hospitals in
order to operate 30 to 40 long-term acute care hospital beds within the
partner hospital. Under such arrangements, we would lease space and
purchase a limited amount of ancillary services from our partners and
provide them with the option to discharge a portion of their clinically
appropriate patients into our care. During 2002, we opened two new
hospitals-in-hospitals with a total of 71 beds.
. Free-standing Hospitals. We seek to add free-standing hospitals in
certain strategic markets. We opened a new free-standing hospital in
Scottsdale, Arizona which contains 50 beds in May 2002.
. Growing Through Acquisitions. We seek growth opportunities through
strategic acquisitions in selected target markets. On April 1, 2002, we
acquired Specialty Healthcare Services, Inc. ("Specialty"), a private
operator of six long-term acute care hospitals with a total of 425 beds.
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Expanding Breadth of Industry Leadership. We are the leading provider of
long-term acute care to patients with pulmonary dysfunction. In addition, we
deliver other services in areas such as wound care, post surgical care, acute
rehabilitation and pain management. We intend to broaden our expertise beyond
pulmonary services and to leverage our leadership position in pulmonary care to
expand our market strength to other clinical services.
Increasing Higher Margin Commercial Volume. We typically receive
substantially higher reimbursement rates from commercial insurers than we do
from the Medicare and Medicaid programs. As a result, we work to expand
relationships with insurers to increase commercial patient volume. Each of our
hospitals employs case managers who focus on patient admissions and the
referral process.
Improving Relationships with Referring Providers. Substantially all of the
acute and medically complex patients admitted to our hospitals are transferred
to us by other healthcare providers such as general acute care hospitals,
intensive care units, managed care programs, physicians, nursing centers and
home care settings. Accordingly, we are focused on maintaining strong
relationships with these providers. In order to maintain these relationships,
we employ case managers who are responsible for coordinating admissions and
assessing the nature of services necessary for the proper care of the patient.
Case managers also are responsible for educating healthcare professionals from
referral sources as to the unique nature of the services provided by our
long-term acute care hospitals. Specifically, case managers train and educate
the staffs of referring institutions about long-term acute care hospital
services and the types of patients who could benefit from such services.
Selected Hospital Division Operating Data
The following table sets forth certain operating data for the hospital
division (dollars in thousands, except statistics):
Reorganized Company | Predecessor Company
------------------------- | -------------------------
Year Nine months | Three months Year
ended ended | ended ended
December 31, December 31, | March 31, December 31,
2002 2001 | 2001 2000
------------ ------------ | ------------ ------------
Hospitals: |
Revenues................................ $1,276,299 $822,935 | $271,984 $1,007,947
Operating income........................ $ 260,440 $157,613 | $ 54,778 $ 205,858
Facilities in operation at end of period 65 57 | 56 56
Licensed beds at end of period.......... 5,385 4,961 | 4,867 4,886
Patient days............................ 1,200,024 802,425 | 273,029 1,044,663
Revenues per patient day................ $ 1,064 $ 1,026 | $ 996 $ 965
Average daily census.................... 3,288 2,918 | 3,034 2,854
Occupancy %............................. 65.3 62.6 | 65.3 60.8
Pharmacy: |
Revenues................................ $ 257,782 $176,105 | $ 54,880 $ 204,252
Operating income........................ $ 23,531 $ 20,831 | $ 6,176 $ 7,421
Total assets of the hospital division were $581 million and $497 million at
the end of 2002 and 2001, respectively.
Sources of Hospital Revenues
The hospital division receives payment for its hospital services from third
party payors, including government reimbursement programs such as Medicare and
Medicaid and non-government sources such as commercial insurance companies,
health maintenance organizations, preferred provider organizations and
contracted providers. Patients covered by non-government payors generally will
be more profitable to the
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hospital division than those covered by the Medicare and Medicaid programs. The
following table sets forth the approximate percentages of the hospital patient
days and revenues derived from the payor sources indicated:
Medicare Medicaid Private and other
--------------- --------------- ---------------
Patient Patient Patient
Period days Revenues days Revenues days Revenues
- ------ ------- -------- ------- -------- ------- --------
Year ended December 31, 2002....... 70% 59% 11% 9% 19% 32%
Nine months ended December 31, 2001 67 57 13 9 20 34
Three months ended March 31, 2001.. 68 56 13 11 19 33
Year ended December 31, 2000....... 67 55 13 10 20 35
For the year ended December 31, 2002, revenues of the hospital division
totaled approximately $1.5 billion or 45% of our total revenues (before
eliminations).
Hospital Facilities
The following table lists by state the number of hospitals and related
licensed beds we operated as of December 31, 2002:
Number of facilities
-------------------------------------
Licensed Owned Leased from Leased from
State beds by us Ventas (2) other parties Total
----- -------- ----- ----------- ------------- -----
Arizona........... 159 - 2 1 3
California........ 801 4 6 1 11
Colorado.......... 68 - 1 - 1
Florida (1)....... 536 - 6 1 7
Georgia (1)....... 72 - - 1 1
Illinois (1)...... 545 - 4 1 5
Indiana........... 167 - 2 1 3
Kentucky (1)...... 374 - 1 - 1
Louisiana......... 168 - 1 - 1
Massachusetts (1). 86 - 2 - 2
Michigan (1)...... 400 - 2 - 2
Minnesota......... 92 - 1 - 1
Missouri (1)...... 227 - 2 - 2
Nevada (1)........ 144 1 1 - 2
New Mexico........ 61 - 1 - 1
North Carolina (1) 124 - 1 - 1
Ohio.............. 75 - - 1 1
Oklahoma.......... 59 - 1 - 1
Pennsylvania...... 229 - 2 3 5
South Carolina (1) 59 - - 1 1
Tennessee (1)..... 49 - 1 - 1
Texas............. 748 2 6 2 10
Washington (1).... 80 1 - - 1
Wisconsin......... 62 1 - - 1
----- - -- -- --
Totals......... 5,385 9 43 13 65
===== = == == ==
- --------
(1) These states have certificate of need regulations. See "- Governmental
Regulation - Federal, State and Local Regulation."
(2) See "- Master Lease Agreements."
15
Quality Assessment and Improvement
The hospital division maintains a strategic outcome program which includes a
concurrent review of all of its patient population against utilization and
quality screenings, as well as clinical outcomes data collection and patient
and family satisfaction surveys. In addition, each hospital has an integrated
quality assessment and improvement program administered by a director of
quality management which encompasses utilization review, quality improvement,
infection control and risk management. The objective of these programs is to
ensure that patients are admitted appropriately to our hospitals and that
quality healthcare is provided in a cost-effective manner.
The hospital division has implemented a program whereby its hospitals are
reviewed by internal quality auditors for compliance with standards of the
Joint Commission. The purposes of this internal review process are to (a)
ensure ongoing compliance with industry recognized standards for hospitals, (b)
assist management in analyzing each hospital's operations and (c) provide
consulting and educational programs for each hospital to identify opportunities
to improve patient care.
Hospital Division Management and Operations
Each of our hospitals has a fully credentialed, multi-specialty medical
staff to meet the needs of the medically complex, long-term acute patient. Each
of our hospitals offers a broad range of physician services including
pulmonology, internal medicine, infectious diseases, neurology, nephrology,
cardiology, radiology and pathology. In addition, each of our hospitals is
staffed with a multi-disciplinary team of healthcare professionals including: a
professional nursing staff trained to care for long-term acute patients,
respiratory, physical, occupational and speech therapists; pharmacists;
registered dietitians; and social workers.
Each hospital maintains a pre-admission assessment system to evaluate
clinical needs and other information in determining the appropriateness of each
patient referral. Upon admission, each patient's case is reviewed by the
hospital's interdisciplinary team to determine treatment programs. Where
appropriate, the treatment programs may involve the services of several
disciplines, such as pulmonary medicine, infectious disease and physical
medicine.
A hospital chief executive officer supervises and is responsible for the
day-to-day operations at each of our hospitals. Each hospital also employs a
chief financial officer who monitors the financial matters of each hospital,
including the measurement of actual operating results compared to budgets. In
addition, each hospital employs a chief operating officer to oversee the
clinical operations of the hospital and a director of quality management to
direct an integrated quality assurance program. We provide centralized services
in the areas of information systems design and development, training, human
resources management, reimbursement expertise, legal advice, technical
accounting support and purchasing and facilities management to each of our
hospitals. We believe that this centralization improves efficiency and allows
hospital staff to spend more time on patient care.
A divisional president and a chief financial officer manage the hospital
division. The operations of the hospitals are divided into four geographic
regions with each region headed by an operational vice president, each of whom
reports to the divisional president. During 2002, institutional pharmacy
operations were managed by a vice president who reported to the divisional
president. The clinical issues and quality concerns of the hospital division
are managed by the division's chief clinical officer.
Institutional Pharmacy Operations
Our institutional pharmacy operations are a leading provider of
pharmaceuticals and resident care products to the long-term industry. We
operated 30 institutional pharmacies at December 31, 2002 that serve
approximately 59,000 patients and residents of senior care facilities in 24
states. The facilities served by our institutional pharmacy operations include
skilled nursing facilities, assisted living facilities, psychiatric hospitals
and other institutional healthcare facilities.
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Our institutional pharmacy operations derive approximately 50% of their
revenues from state Medicaid programs and the balance from Medicare and other
third party payors. Beginning in 2003, the institutional pharmacy operations
will be operated as a separate operating division.
Hospital Division Competition
As of December 31, 2002, our hospitals were located in 42 geographic markets
in 24 states. In each geographic market, there are general acute care hospitals
which provide services comparable to those offered by our hospitals. In
addition, the hospital division believes that as of December 31, 2002 there
were approximately 300 hospitals in the United States certified by Medicare as
general long-term hospitals, some of which provide similar services to those
provided by the hospital division. Certain competing hospitals are operated by
not-for-profit, nontaxpaying or governmental agencies, which can finance
capital expenditures on a tax-exempt basis and receive funds and charitable
contributions unavailable to the hospital division.
Competition for patients covered by non-government reimbursement sources is
intense. The primary competitive factors in the long-term acute care business
include quality of services, charges for services and responsiveness to the
needs of patients, families, payors and physicians. Other companies have
entered the long-term acute care market with licensed hospitals that compete
with our hospitals. The competitive position of any hospital also is affected
by the ability of its management to negotiate contracts with purchasers of
group healthcare services, including private employers, managed care companies,
preferred provider organizations and health maintenance organizations. Such
organizations attempt to obtain discounts from established hospital charges.
The importance of obtaining contracts with preferred provider organizations,
health maintenance organizations and other organizations which finance
healthcare, and its effect on a hospital's competitive position, vary from
market to market, depending on the number and market strength of such
organizations.
Our institutional pharmacy services generally compete on price and quality
of the services provided. Several of the competitors of our pharmacy operations
are larger and more established service providers.
OUR REORGANIZATION
As a result of decreased Medicare and Medicaid reimbursement rates
introduced by the Balanced Budget Act and other issues associated with our
Company, we were unable to meet our then existing financial obligations,
including rent payable to Ventas and debt service obligations under our then
existing indebtedness. Accordingly, on September 13, 1999, we filed voluntary
petitions for protection under Chapter 11 of the Bankruptcy Code. From the date
of our bankruptcy filing until we emerged from bankruptcy on April 20, 2001, we
operated our businesses as a "debtor-in-possession" subject to the jurisdiction
of the Bankruptcy Court. On March 1, 2001, the Bankruptcy Court approved our
Plan of Reorganization. See note 2 of the notes to consolidated financial
statements.
Pursuant to our Plan of Reorganization, on the Effective Date of the Plan of
Reorganization:
. we issued to certain claimholders, including senior creditors and Ventas,
in exchange for their claims:
. an aggregate of $300 million of senior secured notes, bearing
interest at the London Interbank Offered Rate (as defined in the
agreement) plus 41/2%, which began accruing interest approximately
two quarters after the Effective Date,
. an aggregate of 15,000,000 shares of our common stock,
. an aggregate of 2,000,000 Series A warrants, and
. an aggregate of 5,000,000 Series B warrants,
17
. we entered into a new $120 million revolving credit facility to provide
us with working capital and to be used for other general corporate
purposes,
. we entered into amended and restated master lease agreements with Ventas
covering 210 of the nursing centers and 44 of the hospitals that we
operated,
. we entered into a registration rights agreement with Ventas and each
holder of 10% or more of our common stock following the exchange
described above, providing such holders with certain shelf, demand and
"piggy-back" registration rights, and
. our then existing senior indebtedness and debt and equity securities were
canceled.
As a result of the exchange described above, the holders of certain claims
acquired control of our Company and the holders of our pre-reorganization
common stock relinquished control.
In addition, in connection with our emergence from bankruptcy:
. we changed our name to Kindred Healthcare, Inc.,
. a new board of directors, including representatives of the principal
security holders following the exchange, was appointed, and
. effective April 1, 2001, we adopted fresh-start accounting in accordance
with SOP 90-7. This has resulted in the creation of a new reporting
entity for financial accounting reporting purposes and a revaluation of
our assets and liabilities to reflect their estimated fair values.
Because of the adoption of fresh-start accounting, amounts previously
recorded in our historical financial statements have changed materially.
As a result, our financial statements for periods after our emergence
from bankruptcy are not comparable in all respects to our financial
statements for periods prior to the reorganization.
MASTER LEASE AGREEMENTS
Under our Plan of Reorganization, we assumed our original master lease
agreements with Ventas and its affiliates and simultaneously amended and
restated the agreements into four new master leases (the "Master Leases").
Under the Master Leases, Ventas has a right to sever properties from the
existing leases in order to create additional leases, a device adopted to
facilitate its financing flexibility. In such circumstances, our aggregate
lease obligations remain unchanged. Ventas exercised this severance right with
respect to Master Lease No. 1 to create a new lease of 40 nursing centers (the
"CMBS Lease") and mortgaged these properties in connection with a securitized
mortgage financing. The CMBS Lease is in substantially the same form as the
other Master Leases with certain modifications requested by Ventas's lender and
required to be made by us pursuant to the Master Leases. The transaction closed
on December 12, 2001.
The following summary description of the Master Lease Agreements is
qualified in its entirety by reference to the Master Leases and the CMBS Lease
(collectively, the "Master Lease Agreements"), as filed with the Securities and
Exchange Commission (the "SEC").
Term and Renewals
Each Master Lease Agreement includes land, buildings, structures and other
improvements on the land, easements and similar appurtenances to the land and
improvements, and permanently affixed equipment, machinery and other fixtures
relating to the operation of the leased properties. There are several bundles
of leased properties under each Master Lease Agreement, with each bundle
containing approximately 7 to 12 leased properties. Other than the CMBS Lease,
which has only nursing center properties, each bundle contains both
18
nursing centers and hospitals. All leased properties within a bundle have base
terms ranging from 10 to 15 years beginning from May 1, 1998, subject to
certain exceptions.
At our option, all, but not less than all, of the leased properties in a
bundle may be extended for one five-year renewal term beyond the base term at
the then existing rental rate plus the then existing escalation amount per
annum. We may further extend for two additional five-year renewal terms beyond
the first renewal term at the greater of the then existing rental rate plus the
then existing escalation amount per annum or the then fair market value rental
rate. The rental rate during the first renewal term and any additional renewal
term in which rent due is based on the then existing rental rate will escalate
each year during such term(s) at the applicable escalation rate.
We may not extend the Master Lease Agreements beyond the base term or any
previously exercised renewal term if, at the time we seek such extension and at
the time such extension takes effect, (1) an event of default has occurred and
is continuing or (2) a Medicare/Medicaid event of default (as described below)
and/or a licensed bed event of default (as described below) has occurred and is
continuing with respect to three or more leased properties subject to a
particular Master Lease Agreement. The base term and renewal term of each
Master Lease Agreement are subject to termination upon default by us (subject
to certain exceptions) and certain other conditions described in the Master
Lease Agreements.
Rental Amounts and Escalators
Each Master Lease Agreement is commonly known as a triple-net lease or an
absolute-net lease. Accordingly, in addition to rent, we are required to pay
the following: (1) all insurance required in connection with the leased
properties and the business conducted on the leased properties, (2) certain
taxes levied on or with respect to the leased properties (other than taxes on
the net income of Ventas) and (3) all utilities and other services necessary or
appropriate for the leased properties and the business conducted on the leased
properties.
Under each Master Lease Agreement, the aggregate annual rent is referred to
as base rent. Base rent equals the sum of current rent and accrued rent. We are
obligated to pay the portion of base rent that is current rent, and unpaid
accrued rent will be paid as set forth below.
From the effective date of the Master Lease Agreements through April 30,
2004, base rent will equal the current rent. Under the Master Lease Agreements,
the annual aggregate base rent owed by us currently is $185.9 million. For the
period from May 1, 2001 through April 30, 2004, annual aggregate base rent
payable in cash will escalate at an annual rate of 31/2% over the prior period
base rent if certain revenue parameters are obtained. The Company paid rents to
Ventas approximating $184.3 million for the year ended December 31, 2002,
$135.6 million for the nine months ended December 31, 2001, $45.4 million for
the three months ended March 31, 2001, and $181.6 million for 2000.
Each Master Lease Agreement also provides that beginning May 1, 2004, the
annual aggregate base rent payable in cash will escalate at an annual rate of
2% (plus, upon the occurrence of certain events, an additional annual accrued
escalator amount of 11/2% of the prior period base rent) which will accrete
from year to year including an interest accrual at the London Interbank Offered
Rate plus 41/2% to be added to the annual accreted amount. This interest will
not be added to the aggregate base rent in subsequent years.
The unpaid accrued rent will become payable upon the refinancing of our
existing credit agreements or the termination or expiration of the applicable
Master Lease Agreement.
Reset Rights
During the one-year period commencing in July 2006, Ventas will have a
one-time option to reset the base rent, current rent and accrued rent under
each Master Lease Agreement to the then fair market rental of the leased
19
properties. Upon exercising this reset right, Ventas will pay us a fee equal to
a prorated portion of $5 million based upon the proportion of base rent payable
under the Master Lease Agreement(s) with respect to which rent is reset to the
total base rent payable under all of the Master Lease Agreements. The
determination of the fair market rental will be effectuated through the
appraisal procedures in the Master Lease Agreements.
Use of the Leased Property
The Master Lease Agreements require that we utilize the leased properties
solely for the provision of healthcare services and related uses and as Ventas
may otherwise consent. We are responsible for maintaining or causing to be
maintained all licenses, certificates and permits necessary for the leased
properties to comply with various healthcare regulations. We also are obligated
to operate continuously each leased property as a provider of healthcare
services.
Events of Default
Under each Master Lease Agreement, an "Event of Default" will be deemed to
occur if, among other things:
. we fail to pay rent or other amounts within five days after notice,
. we fail to comply with covenants, which failure continues for 30 days or,
so long as diligent efforts to cure such failure are being made, such
longer period (not over 180 days) as is necessary to cure such failure,
. certain bankruptcy or insolvency events occur, including filing a
petition of bankruptcy or a petition for reorganization under the
Bankruptcy Code,
. an event of default arising from our failure to pay principal or interest
on our senior secured notes or any other indebtedness exceeding $50
million,
. the maturity of the senior secured notes or any other indebtedness
exceeding $50 million is accelerated,
. we cease to operate any leased property as a provider of healthcare
services for a period of 30 days,
. a default occurs under any guaranty of any lease or the indemnity
agreements with Ventas,
. we or our subtenant lose any required healthcare license, permit or
approval or fail to comply with any legal requirements as determined by a
final unappealable determination,
. we fail to maintain insurance,
. we create or allow to remain certain liens,
. we breach any material representation or warranty,
. a reduction occurs in the number of licensed beds in a facility,
generally in excess of 10% (or less than 10% if we have voluntarily
"banked" licensed beds) of the number of licensed beds in the applicable
facility on the commencement date (a "licensed bed event of default"),
. Medicare or Medicaid certification with respect to a participating
facility is revoked and re-certification does not occur for 120 days
(plus an additional 60 days in certain circumstances) (a
"Medicare/Medicaid event of default"),
. we become subject to regulatory sanctions as determined by a final
unappealable determination and fail to cure such regulatory sanctions
within its specified cure period for any facility,
. we fail to cure a breach of any permitted encumbrance within the
applicable cure period and, as a result, a real property interest or
other beneficial property right of Ventas is at material risk of being
terminated, or
20
. we fail to cure the breach of any of the obligations of Ventas as lessee
under any existing ground lease within the applicable cure period and, if
such breach is a non-monetary, non-material breach, such existing ground
lease is at material risk of being terminated.
Remedies for an Event of Default
Except as noted below, upon an Event of Default under one of the Master
Lease Agreements, Ventas may, at its option, exercise the following remedies:
(1) after not less than ten days' notice to us, terminate the Master Lease
Agreement to which such Event of Default relates, repossess any leased
property, relet any leased property to a third party and require that we pay to
Ventas, as liquidated damages, the net present value of the rent for the
balance of the term, discounted at the prime rate,
(2) without terminating the Master Lease Agreement to which such Event of
Default relates, repossess the leased property and relet the leased property
with us remaining liable under such Master Lease Agreement for all obligations
to be performed by us thereunder, including the difference, if any, between the
rent under such Master Lease Agreement and the rent payable as a result of the
reletting of the leased property, and
(3) seek any and all other rights and remedies available under law or in
equity.
In addition to the remedies noted above, under the Master Lease Agreements,
in the case of a facility-specific event of default Ventas may terminate a
Master Lease Agreement as to the leased property to which the Event of Default
relates, and may, but need not, terminate the entire Master Lease Agreement.
Each of the Master Lease Agreements includes special rules relative to
Medicare/Medicaid events of default and licensed bed events of default. In the
event a Medicare/Medicaid event of default and/or a licensed bed event of
default occurs and is continuing (a) with respect to not more than two
properties at the same time under a Master Lease Agreement that covers 41 or
more properties and (b) with respect to not more than one property at the same
time under a Master Lease Agreement that covers 21 to and including 40
properties, Ventas may not exercise termination or dispossession remedies
against any property other than the property or properties to which the event
of default relates. Thus, in the event Medicare/Medicaid events of default and
licensed bed events of default would occur and be continuing (a) with respect
to one property under a Master Lease Agreement that covers less than 20
properties, (b) with respect to two or more properties at the same time under a
Master Lease Agreement that covers 21 to and including 40 properties, or (c)
with respect to three or more properties at the same time under a Master Lease
Agreement that covers 41 or more properties, then Ventas would be entitled to
exercise all rights and remedies available to it under the Master Lease
Agreements.
Assignment and Subletting
Except as noted below, the Master Lease Agreements provide that we may not
assign, sublease or otherwise transfer any leased property or any portion of a
leased property as a whole (or in substantial part), including by virtue of a
change of control, without the consent of Ventas, which may not be unreasonably
withheld if the proposed assignee (1) is a creditworthy entity with sufficient
financial stability to satisfy its obligations under the related Master Lease
Agreement, (2) has not less than four years experience in operating healthcare
facilities, (3) has a favorable business and operational reputation and
character and (4) has all licenses, permits, approvals and authorizations to
operate the facility and agrees to comply with the use restrictions in the
related Master Lease Agreement. The obligation of Ventas to consent to a
subletting or assignment is subject to the reasonable approval rights of any
mortgagee and/or the lenders under its credit agreement. We may sublease up to
20% of each leased property for restaurants, gift shops and other stores or
services customarily found in hospitals or nursing centers without the consent
of Ventas, subject, however, to there being no material alteration in the
character of the leased property or in the nature of the business conducted on
such leased property.
21
In addition, each Master Lease Agreement allows us to assign or sublease (a)
without the consent of Ventas, 10% of the nursing center facilities in each
Master Lease Agreement and (b) with Ventas's consent (which consent will not be
unreasonably withheld, delayed or conditioned), two hospitals in each Master
Lease Agreement, if either (i) the applicable regulatory authorities have
threatened to revoke an authorization necessary to operate such leased property
or (ii) we cannot profitably operate such leased property. Any such proposed
assignee/sublessee must satisfy the requirements listed above and it must have
all licenses, permits, approvals and other authorizations required to operate
the leased properties in accordance with the applicable permitted use. With
respect to any assignment or sublease made under this provision, Ventas agrees
to execute a nondisturbance and attornment agreement with such proposed
assignee or subtenant. Upon any assignment or subletting, we will not be
released from our obligations under the applicable Master Lease Agreement.
Subject to certain exclusions, we must pay to Ventas 80% of any
consideration received by us on account of an assignment and 80% (50% in the
case of existing subleases) of sublease rent payments (approximately equal to
revenue net of specified allowed expenses attributable to a sublease, and
specifically defined in the Master Lease Agreements), provided that Ventas's
right to such payments will be subordinate to that of our lenders.
Ventas will have the right to approve the purchaser at a foreclosure of one
or more of our leasehold mortgages by our lenders. Such approval will not be
unreasonably withheld so long as such purchaser is creditworthy, reputable and
has four years experience in operating healthcare facilities. Any dispute
regarding whether Ventas has unreasonably withheld its consent to such
purchaser will be subject to expedited arbitration.
GOVERNMENTAL REGULATION
Medicare and Medicaid
Medicare is a federal program that provides certain hospital and medical
insurance benefits to persons age 65 and over and certain disabled persons.
Medicaid is a medical assistance program administered by each state pursuant to
which healthcare benefits are available to certain indigent patients. Within
the Medicare and Medicaid statutory framework, there are substantial areas
subject to administrative rulings, interpretations and discretion that may
affect payments made under Medicare and Medicaid. A substantial portion of our
revenues are derived from patients covered by the Medicare and Medicaid
programs. See "- Health Services Division - Sources of Nursing Center Revenues"
and "- Hospital Division - Sources of Hospital Revenues."
Federal, State and Local Regulation
In the ordinary course of our business, we are subject regularly to
inquiries, investigations and audits by federal and state agencies that oversee
applicable healthcare regulations.
The extensive federal, state and local regulations affecting the healthcare
industry include, but are not limited to, regulations relating to licensure,
conduct of operations, ownership of facilities, addition of facilities,
allowable costs, services and prices for services, and the confidentiality and
security of health-related information. In particular, various laws including
antikickback, antifraud and abuse amendments codified under the Social Security
Act prohibit certain business practices and relationships that might affect the
provision and cost of healthcare services reimbursable under Medicare and
Medicaid, including the payment or receipt of remuneration for the referral of
patients whose care will be paid by Medicare or other governmental programs.
Sanctions for violating these antikickback, antifraud and abuse amendments
under the Social Security Act include criminal penalties, civil sanctions,
fines and possible exclusion from government programs such as Medicare and
Medicaid. The U.S. Department of Health and Human Services has issued
regulations that describe some of the conduct and business relationships
permissible under the antikickback amendments. The fact that a given business
arrangement does not fall within one of these safe harbors does not render the
arrangement per se illegal. Business arrangements of healthcare service
providers that fail to satisfy the applicable criteria, however, risk increased
scrutiny and possible sanctions by enforcement authorities.
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In addition, Section 1877 of the Social Security Act, which restricts
referrals by physicians of Medicare and other government program patients to
providers of a broad range of designated health services with which they have
ownership or certain other financial arrangements, was amended effective
January 1, 1995, to broaden significantly the scope of prohibited physician
referrals under the Medicare and Medicaid programs. Many states have adopted or
are considering similar legislative proposals, some of which extend beyond the
Medicaid program, to prohibit the payment or receipt of remuneration for the
referral of patients and physician self-referrals regardless of the source of
payment for the care. These laws and regulations are complex and limited
judicial or regulatory interpretation exists. We do not believe our
arrangements are in violation of these prohibitions. We cannot assure you,
however, that governmental officials charged with responsibility for enforcing
the provisions of these prohibitions will not assert that one or more of our
arrangements are in violation of such provisions.
The Balanced Budget Act also includes a number of antifraud and abuse
provisions. The Balanced Budget Act contains additional civil monetary
penalties for violations of the antikickback amendments discussed above and
imposes an affirmative duty on providers to ensure that they do not employ or
contract with persons excluded from the Medicare program. The Balanced Budget
Act also provides a minimum ten-year period for exclusion from participation in
federal healthcare programs for persons or entities convicted of a prior
healthcare offense.
The federal Health Insurance Portability and Accountability Act of 1996,
commonly known as "HIPAA," signed into law on August 21, 1996, amended, among
other things, Title XI of the U.S. Code (42 U.S.C. (S)1301 et seq.) to broaden
the scope of fraud and abuse laws to include all health plans, whether or not
they are reimbursed under federal programs. In addition, HIPAA also mandates
the adoption of regulations aimed at standardizing transaction formats and
billing codes for documenting medical services, dealing with claims submissions
and protecting the privacy and security of individually identifiable health
information. HIPAA regulations that standardize transactions and code sets
became final in the fourth quarter of 2000. These regulations require standard
formatting for healthcare providers, like us, that submit claims
electronically. We will be required to comply with HIPAA transaction and code
set standards by October 2003 since we have filed a plan with the U.S.
Department of Health and Human Services that demonstrates how we intend to
comply with the regulations by that deadline.
Final HIPAA privacy regulations were published in December 2000. These
privacy regulations apply to "protected health information," which is defined
generally as individually identifiable health information transmitted or
maintained in any form or medium, excluding certain education records and
student medical records. The privacy regulations seek to limit the use and
disclosure of most paper and oral communications, as well as those in
electronic form, regarding an individual's past, present or future physical or
mental health or condition, or relating to the provision of healthcare to the
individual or payment for that healthcare, if the individual can or may be
identified by such information. HIPAA provides for the imposition of civil or
criminal penalties if protected health information is improperly disclosed. We
must comply with the privacy regulations by April 14, 2003.
HIPAA's security regulations were finalized in February 2003. The security
regulations specify administrative procedures, physical safeguards and
technical services and mechanisms designed to ensure the privacy of protected
health information. We will be required to comply with the security regulations
by April 21, 2005.
We are currently evaluating the impact of compliance with HIPAA regulations,
but we have not completed our analysis or finalized the estimated costs of
compliance. We cannot assure you that our compliance with the HIPAA regulations
will not have an adverse affect on our financial position, results of
operations or liquidity.
We believe that the regulatory environment surrounding the long-term care
industry remains intense. State and federal governments continue to impose
extensive enforcement policies resulting in a significant number of
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inspections, citations of regulatory deficiencies and other regulatory
sanctions including terminations from the Medicare and Medicaid programs, bars
on Medicare and Medicaid payments for new admissions and civil monetary
penalties. Such sanctions could have a material adverse effect on our financial
position, results of operations and liquidity. We vigorously contest such
sanctions where appropriate; however, these cases can involve significant legal
expense and consume our resources.
Certificates of Need and State Licensing. Certificate of need, or CON,
regulations control the development and expansion of healthcare services and
facilities in certain states. Certain states also require regulatory approval
prior to certain changes in ownership of a nursing center or hospital. Certain
states that do not have CON programs may have other laws or regulations that
limit or restrict the development or expansion of healthcare facilities. We
operate nursing centers in 23 states and hospitals in 12 states that require
state approval for the expansion of our facilities and services under CON
programs. To the extent that CONs or other similar approvals are required for
expansion of the operations of our nursing centers or hospitals, either through
facility acquisitions, expansion or provision of new services or other changes,
such expansion could be affected adversely by the failure or inability to
obtain the necessary approvals, changes in the standards applicable to such
approvals or possible delays and expenses associated with obtaining such
approvals.
We are required to obtain state licenses to operate each of our nursing
centers and hospitals and to ensure their participation in government programs.
Once a nursing center or hospital becomes licensed and operational, it must
continue to comply with federal, state and local licensing requirements in
addition to local building and life-safety codes. All of our nursing centers
and hospitals have the necessary licenses.
Health Services Division
The development and operation of nursing centers and the provision of
healthcare services are subject to federal, state and local laws relating to
the adequacy of medical care, equipment, personnel, operating policies, fire
prevention, rate-setting and compliance with building codes and environmental
laws. Nursing centers are subject to periodic inspection by governmental and
other authorities to assure continued compliance with various standards,
continued licensing under state law, certification under the Medicare and
Medicaid programs and continued participation in the Veterans Administration
program. The failure to obtain, retain or renew any required regulatory
approvals or licenses could adversely affect nursing center operations
including its financial results.
Medicare and Medicaid and other Federal Regulations. The nursing centers
operated and managed by the health services division are licensed either on an
annual or bi-annual basis and generally are certified annually for
participation in Medicare and Medicaid programs through various regulatory
agencies that determine compliance with federal, state and local laws. These
legal requirements relate to the compliance with the laws and regulations
governing the operation of nursing centers including the quality of nursing
care, the qualifications of the administrative and nursing personnel, and the
adequacy of the physical plant and equipment. Federal regulations determine the
survey process for nursing centers that is followed by state survey agencies.
The state survey agencies recommended to the Centers for Medicare and Medicaid
Services ("CMS") the imposition of federal sanctions and impose state sanctions
on facilities for noncompliance with certain requirements. Available sanctions
include, but are not limited to, imposition of civil monetary penalties,
temporary suspension of payment for new admissions, appointment of a temporary
manager, suspension of payment for eligible patients and suspension or
decertification from participation in the Medicare and Medicaid programs.
We believe that substantially all of our nursing centers are in substantial
compliance with applicable Medicare and Medicaid requirements of participation.
In the ordinary course of business, however, the nursing centers periodically
receive statements of deficiencies from regulatory agencies. In response, the
health services division implements plans of correction to address the alleged
deficiencies. In most instances, the regulatory agency accepts the facility's
plan of correction and places the nursing center back into compliance with
24
regulatory requirements. In some cases, the regulatory agency may take a number
of adverse actions against the nursing center, including the imposition of
fines, temporary suspension of admission of new patients to the nursing center,
decertification from participation in the Medicaid and/or Medicare programs
and, in extreme circumstances, revocation of the nursing center's license.
The health services division also is subject to federal and state laws that
govern financial and other arrangements between healthcare providers. These
laws prohibit certain direct and indirect payments or fee-splitting
arrangements between healthcare providers that are designed to induce or
encourage the referral of patients to, or the recommendation of, a particular
provider for medical products and services. Such laws include the antikickback
amendments discussed above. These provisions prohibit, among other things, the
offer, payment, solicitation or receipt of any form of remuneration in return
for the referral of Medicare and Medicaid patients. In addition, some states
restrict certain business relationships between physicians and ancillary
service providers and some states prohibit business corporations from
providing, or holding themselves out as a provider of, medical care. Possible
sanctions for violation of any of these restrictions or prohibitions include
loss of licensure or eligibility to participate in reimbursement programs as
well as civil and criminal penalties. These laws vary considerably from state
to state.
In certain circumstances, federal law mandates that conviction for certain
abusive or fraudulent behavior with respect to one nursing center may subject
other facilities under common control or ownership to disqualification from
participation in the Medicare and Medicaid programs. In addition, some
regulations provide that all nursing centers under common control or ownership
within a state are subject to delicensure if any one or more of such facilities
are delicensed.
Hospital Division
Medicare and Medicaid and other Federal Regulations. The hospital division
is subject to various federal and state regulations. In order to receive
Medicare reimbursement, each hospital must meet the applicable conditions of
participation set forth by the U.S. Department of Health and Human Services
relating to the type of hospital, its equipment, personnel and standard of
medical care, as well as comply with state and local laws and regulations. We
have developed a management system to facilitate our compliance with these
various standards and requirements. Among other things, each hospital employs a
person who is responsible for an ongoing quality assessment and improvement
program. Hospitals undergo periodic on-site Medicare certification surveys,
which generally are limited in frequency if the hospital is accredited by the
Joint Commission. As of December 31, 2002, all of the hospitals operated by the
hospital division were certified as Medicare providers and 57 of such hospitals
also were certified by their respective state Medicaid programs. A loss of
certification could affect adversely a hospital's ability to receive payments
from the Medicare and Medicaid programs.
Since 1983, Medicare has reimbursed general short-term acute care hospitals
under a prospective payment system. Under the short-term prospective payment
system, Medicare inpatient costs are reimbursed based upon a fixed payment
amount per discharge using diagnosis related groups. The diagnosis-related
group payment under the short-term prospective payment system is based upon the
national average cost of treating a Medicare patient's condition. Although the
average length of stay varies for each diagnosis related group, the average
stay for all Medicare patients subject to the short-term prospective payment
system is approximately six days. An additional outlier payment is made for
patients with higher treatment costs. Outlier payments are only designed to
cover marginal costs. Accordingly, the short-term prospective payment system
creates an economic incentive for general short-term acute care hospitals to
discharge medically complex Medicare patients as soon as clinically possible.
Hospitals that are certified by Medicare as general long-term acute care
hospitals are excluded from the short-term prospective payment system. We
believe that the incentive for short-term acute care hospitals to discharge
medically complex patients as soon as clinically possible creates a substantial
referral source for our long-term acute care hospitals.
The Social Security Amendments of 1983 excluded certain hospitals, including
general long-term acute care hospitals such as we operate, from the short-term
hospital prospective payment system. A general long-term
25
acute care hospital has been defined as a hospital that has an average length
of stay greater than 25 days for all patients. Inpatient operating costs for
general long-term acute care hospitals have been reimbursed under the
cost-based reimbursement system, subject to a computed target rate per
discharge for inpatient operating costs established by the Tax Equity and
Fiscal Responsibility Act of 1982 ("TEFRA"). As discussed below, the Balanced
Budget Act made significant changes to the TEFRA provisions.
Prior to the Balanced Budget Act, Medicare operating costs per discharge in
excess of the computed target rate were reimbursed at the rate of 50% of the
excess, up to 10% of the computed target rate. Hospitals whose operating costs
were lower than the computed target rate were reimbursed their actual costs
plus an incentive. For cost reporting periods beginning on or after October 1,
1997, the Balanced Budget Act reduced the incentive payments to an amount equal
to 15% of the difference between the actual costs and the computed target rate,
but not to exceed 2% of the computed target rate. Costs in excess of the
computed target rate are still being reimbursed at the rate of 50% of the
excess, up to 10% of the computed target rate, but the threshold to qualify for
such payments was raised from 100% to 110% of the computed target rate.
Since the adoption of the Balanced Budget Act, a new provider will no longer
receive unlimited cost-based reimbursement for its first few years in
operation. Instead, for the first two years, it will be paid the lower of its
costs or 110% of the median of TEFRA's computed target rate for 1996, adjusted
for inflation. During this two-year period, new providers are not eligible to
receive TEFRA relief or the incentive payments discussed in the previous
paragraph.
As of December 31, 2002, all of our long-term acute care hospitals were
subject to TEFRA's computed target rate provisions. The reduction in TEFRA's
incentive payments has had a material adverse effect on our hospital division's
operating results. These reductions, which began between May 1, 1998 and
September 1, 1998 with respect to our hospitals, have had a material adverse
impact on hospital division revenues.
We also operate three hospitals as general acute care facilities that are
subject to the short-term acute care hospital prospective payment system and
are not subject to TEFRA's computed target rate provisions.
Medicare and Medicaid reimbursements generally are determined from annual
cost reports that we file, which are subject to audit by the respective agency
or fiscal intermediaries administering the programs. We believe that adequate
provisions for loss have been recorded to reflect any adjustments that could
result from audits of these cost reports.
Federal regulations provide that admission to and utilization of hospitals
by Medicare and Medicaid patients must be reviewed by peer review organizations
in order to ensure efficient utilization of hospitals and services. A peer
review organization may conduct such review either prospectively or
retroactively and may, as appropriate, recommend denial of payments for
services provided to a patient. The review is subject to administrative and
judicial appeals. Each of the hospitals operated by our hospital division
employs a clinical professional to administer the hospital's integrated quality
assurance and improvement program, including its utilization review program.
Peer review organization denials historically have not had a material adverse
effect on the hospital division's operating results.
The antikickback amendments discussed above prohibit certain business
practices and relationships that might affect the provision and cost of
healthcare services reimbursable under federal healthcare programs. Sanctions
for violating these amendments include criminal and civil penalties and
exclusion from federal healthcare programs. Pursuant to the Medicare and
Medicaid Patient and Program Protection Act of 1987, the U.S. Department of
Health and Human Services and the Office of the Inspector General specified
certain safe harbors that describe conduct and business relationships
permissible under the antikickback amendments. These safe harbor regulations
have resulted in more aggressive enforcement of the antikickback amendments by
the U.S. Department of Health and Human Services and the Office of the
Inspector General.
26
Section 1877 of the Social Security Act, commonly known as "Stark I," states
that a physician who has a financial relationship with a clinical laboratory
generally is prohibited from referring patients to that laboratory. The Omnibus
Budget Reconciliation Act of 1993 contains provisions, commonly known as "Stark
II," amending Section 1877 to expand greatly the scope of Stark I. Effective
January 1995, Stark II broadened the referral limitations of Stark I to
include, among other designated health services, inpatient and outpatient
hospital services. Under Stark I and Stark II, a "financial relationship" is
defined as an ownership interest or a compensation arrangement. If such a
financial relationship exists, the entity generally is prohibited from claiming
payment for services under the Medicare or Medicaid programs. Compensation
arrangements generally are exempted from Stark I and Stark II if, among other
things, the compensation to be paid is set in advance, does not exceed fair
market value and is not determined in a manner that takes into account the
volume or value of any referrals or other business generated between the
parties. These laws and regulations, however, are complex, and the industry has
the benefit of only limited judicial or regulatory interpretation. We believe
that business practices of providers and financial relationships between
providers have become subject to increased scrutiny as healthcare reform
efforts continue on federal and state levels.
Our institutional pharmacy operations are subject to regulation by the
various states in which business is conducted as well as by the federal
government. The pharmacies are regulated under the Food, Drug and Cosmetic Act
and the Prescription Drug Marketing Act, which are administered by the U.S.
Food and Drug Administration. Under the Comprehensive Drug Abuse Prevention and
Control Act of 1970, which is administered by the U.S. Drug Enforcement
Administration, dispensers of controlled substances must register with the Drug
Enforcement Administration, file reports of inventories and transactions and
provide adequate security measures. Failure to comply with such requirements
could result in civil or criminal penalties.
States generally require that a pharmacy operating within the state be
licensed by the state board of pharmacy. At December 31, 2002, we had the
necessary licenses for each pharmacy we operate. In addition, our pharmacies
are registered with the appropriate state and federal authorities pursuant to
statutes governing the regulation of controlled substances. In addition, we
believe we comply with all relevant requirements of the Prescription Drug
Marketing Act for the transfer and shipment of pharmaceuticals.
Joint Commission on Accreditation of Health Care Organizations. Hospitals
may receive accreditation from the Joint Commission, a nationwide commission
that establishes standards relating to the physical plant, administration,
quality of patient care and operation of medical staffs of hospitals.
Generally, hospitals and certain other healthcare facilities are required to
have been in operation at least six months in order to be eligible for
accreditation by the Joint Commission. After conducting on-site surveys, the
Joint Commission awards accreditation for up to three years to hospitals found
to be in substantial compliance with Joint Commission standards. Accredited
hospitals also are periodically resurveyed, at the option of the Joint
Commission, upon a major change in facilities or organization and after merger
or consolidation. As of December 31, 2002, all of the hospitals operated by the
hospital division were accredited by the Joint Commission. The hospital
division intends to seek and obtain Joint Commission accreditation for any
additional facilities it may purchase or lease and convert into long-term acute
care hospitals. We do not believe that the failure to obtain Joint Commission
accreditation at any hospital would have a material adverse effect on the
hospital division's results of operations.
Regulatory Changes
The Balanced Budget Act contained extensive changes to the Medicare and
Medicaid programs intended to reduce the projected amount of increase in
payments under those programs over a five-year period. Virtually all spending
reductions were derived from reimbursements to providers and changes in program
components. The Balanced Budget Act has affected adversely the revenues in each
of our operating divisions.
The Balanced Budget Act established PPS for nursing centers for cost
reporting periods beginning on or after July 1, 1998. All of our nursing
centers adopted PPS on July 1, 1998. During the first three years, the per
27
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 Balanced Budget Act also reduced payments made to our hospitals by
reducing TEFRA incentive payments, allowable costs for capital expenditures and
bad debts, and payments for services to patients transferred from a general
short-term acute care hospital. In addition, the Balanced Budget Act reduced
allowable costs for capital expenditures by 15%. These reductions have had a
material adverse impact on hospital revenues.
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 is mostly attributable to efforts by nursing centers to
reduce operating costs. As a result, many nursing centers have elected to
provide ancillary services to their patients through internal staff. In
response to PPS and a significant decline in the demand for ancillary services,
we realigned our former ancillary services division in 1999 by integrating the
physical rehabilitation, speech and occupational therapy businesses into the
health services division and assigning the institutional pharmacy business to
the hospital division. Our respiratory therapy and other ancillary businesses
were discontinued.
Various legislative and regulatory actions have provided a measure of relief
from the impact of the Balanced Budget Act. In November 1999, the Balanced
Budget Refinement Act (the "BBRA") was enacted. Effective April 1, 2000, the
BBRA (a) implemented a 20% upward adjustment in the payment rates for the care
of higher acuity patients, 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.
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 $38 million in 2002, $32 million in 2001 and $18
million in 2000.
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.
BIPA also extended the two-year moratorium on outpatient therapy limitations
for skilled nursing center patients under the BBRA through December 31, 2002.
On February 7, 2003, CMS instructed fiscal intermediaries to apply the therapy
limitations for all outpatient rehabilitation services in a prospective manner
beginning with claims submitted for dates of service on or after July 1, 2003.
For each subsequent year, the therapy limitation will be effective for the
entire calendar year.
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.
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Our nursing centers received reimbursement under the BBRA (including amounts
related to the 20% upward adjustment discussed above) of approximately $51
million in 2002, $47 million in 2001 and $21 million in 2000. Revenues
associated with BIPA aggregated approximately $32 million in 2002 and $30
million in 2001.
As previously discussed, certain Medicare reimbursement provisions under the
BBRA and BIPA expired as scheduled on October 1, 2002. Accordingly, Medicare
reimbursement to our nursing centers declined by approximately $35 per patient
day or $15 million in the fourth quarter of 2002, resulting in a material
reduction in nursing center operating income.
On October 1, 2002, the provision under the Balanced Budget Act reducing
allowable hospital capital expenditures by 15% expired. As a result, hospital
Medicare revenues increased by approximately $2 million in the fourth quarter
of 2002.
On August 30, 2002, CMS issued final regulations for the new prospective
payment system for long-term acute care hospitals ("LTAC PPS") that became
effective on October 1, 2002. Because of our Medicare cost reporting periods,
this new payment system will not become effective for all but two of our
long-term acute care hospitals until September 1, 2003.
As anticipated, LTAC PPS is based on discharge-based diagnosis related
groups ("DRG") similar to the system used to pay short-term acute care
hospitals. While the clinical system which groups procedures and diagnoses is
identical to the prospective payment system for short-term acute care
hospitals, the new payment system utilizes different rates and formulas. Three
types of payments will be used in the new system: (a) short stay outlier that
will provide for patients whose length of stay is less than 5/6th of the
average length of stay for that DRG, a payment based upon the lesser of (1) a
per diem based upon the average payment for that DRG, (2) the estimated costs
plus 20%, or (3) the full DRG payment; (b) DRG fixed payment which provides a
single payment for all patients with a given DRG, regardless of length of stay,
cost of care or place of discharge; and (c) high cost outlier that will provide
a partial coverage of costs for patients whose cost of care far exceeds the DRG
reimbursement. For patients in the high cost outlier category, Medicare will
reimburse 80% of the costs incurred above the DRG reimbursement plus a fixed
cost outlier threshold of $24,450 per discharge.
The new system provides for an adjustment for differences in area wages
resulting from salary and benefit variations. There also are additional rules
for payment for patients who are transferred from a long-term care hospital to
another healthcare setting and are subsequently re-admitted to the long-term
care hospital. The LTAC PPS payment rates also are subject to annual
adjustments.
The new system maintains long-term acute care hospitals as a distinct
provider type, separate from short-term acute care hospitals. Only providers
certified as long-term acute care hospitals may be paid under the new system.
To maintain certification under the new payment system, the average length of
stay of Medicare patients must be at least 25 days. Under the previous system,
compliance with the 25-day average length of stay threshold was based on all
patient discharges.
As previously noted, the new system became effective for cost reporting
periods beginning after October 1, 2002. As an alternative to the immediate
adoption of LTAC PPS, long-term acute care hospitals may elect to phase in the
new system over five years. These phase-in provisions will enable providers to
make the necessary operational changes over the next several years to support a
smooth clinical and financial transition to the new payment system.
Our hospitals currently receive interim cash payments under TEFRA as a
result of submitting interim and final patient bills twice each month. Under
LTAC PPS, a provider will choose one of two methods of receiving interim cash
payments: (1) by billing each patient at the earlier of the time of discharge
or 60 days from the time of admission or (2) by electing a periodic interim
payment methodology which estimates the total annual LTAC PPS reimbursement by
hospital and converts that amount into a bi-weekly cash payment. Either payment
system may negatively impact the hospital division's operating cash flows in
2003.
29
We continue to review the extensive regulations associated with the new LTAC
PPS. Based upon our analysis to date, we believe that the new system should not
have a material impact on our hospital operating results but may negatively
impact operating cash flows in the short term. These preliminary estimates are
based upon current patient acuity and expense levels in our hospitals. These
factors, among others, are subject to significant change. Slight variations in
patient acuity could significantly change Medicare revenues generated under
LTAC PPS. In addition, our hospitals may not be able to appropriately adjust
their operating costs as patient acuity levels change. As a result of these
uncertainties, we cannot predict the ultimate impact of the new LTAC PPS on our
hospital operating results and we cannot assure you that such regulations or
operational changes resulting from these regulations will not have a material
adverse impact on our financial position, results of operations or liquidity.
In addition, we cannot assure you that the new LTAC PPS will not have a
material adverse effect on revenues from non-government third party payors.
There continue to be legislative and regulatory proposals that would impose
further limitations on government and private payments to providers of
healthcare services. By repealing the Boren Amendment, the Balanced Budget Act
eased existing impediments on the ability of states to reduce their Medicaid
reimbursement levels. 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. In addition, budgetary pressures currently
impacting a number of states may further reduce Medicaid payments to our
nursing centers. Some states also are considering regulatory changes that
include a moratorium on the designation of additional long-term acute care
hospitals. Additionally, regulatory changes in the Medicaid reimbursement
system applicable to our 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.
We could be affected adversely by the continuing efforts of governmental and
private third party payors to contain healthcare costs. We cannot assure you
that payments under governmental and private third party payor programs and
Medicare supplemental insurance policies will remain at levels comparable to
present levels or will be sufficient to cover the costs allocable to patients
eligible for reimbursement pursuant to these programs. In addition, we cannot
assure you that the facilities operated by us, or the provision of services and
supplies by us, will meet the requirements for participation in such programs.
We cannot assure you that future healthcare legislation or other changes in
the administration or interpretation of governmental healthcare programs will
not have a material adverse effect on our financial position, results of
operations or liquidity.
CORPORATE INTEGRITY AGREEMENT
We have entered into a Corporate Integrity Agreement with the Office of the
Inspector General of the U.S. Department of Health and Human Services to
promote our compliance with the requirements of Medicare, Medicaid and all
other federal healthcare programs. Under the Corporate Integrity Agreement, we
have implemented a comprehensive internal quality improvement program and a
system of internal financial controls in our nursing centers, hospitals,
pharmacies and regional and corporate offices. We have retained sufficient
flexibility under the Corporate Integrity Agreement to design and implement the
agreement's requirements to enable us to focus our efforts on developing
improved systems and processes for providing quality care. Our failure to
comply with the material terms of the agreement could lead to suspension or
exclusion from further participation in federal healthcare programs. We believe
that many of the requirements of the Corporate Integrity Agreement are
necessary to achieve our patient care objectives and are similar to the
procedures used by other healthcare providers to comply with existing laws and
regulations.
The Corporate Integrity Agreement became effective on April 20, 2001 and
applies to us and our managed entities. The Corporate Integrity Agreement also
will apply to newly acquired facilities after a phase-in period of six months.
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As required by the Corporate Integrity Agreement, we have engaged the Long
Term Care Institute, Inc. to monitor and evaluate our quality improvement
program and report its findings to the Office of the Inspector General.
The Corporate Integrity Agreement includes compliance requirements which
obligate us to:
. adopt and implement written standards on federal healthcare program
requirements with respect to financial and quality of care issues.
. conduct training each year for all employees to promote compliance with
federal healthcare requirements. Currently, every employee will undergo a
minimum of one hour of general compliance training annually. We also will
provide annually at least three hours of specific training, tailored to
issues affecting employees with certain job responsibilities, as well as
a minimum of two hours of training for care-giving employees focused on
quality care. In addition, we will continue to operate our internal
compliance hotline.
. put in place a comprehensive internal quality improvement program, which
will include establishing committees at the facility, regional and
corporate levels to review quality-related data, direct quality
improvement activities and implement and monitor corrective action plans.
We focus on integrating compliance responsibilities with operational
functions. We recognize that our compliance with applicable laws and
regulations depends on individual employee action as well as our
operations. The Long Term Care Institute, Inc. has assisted in program
development and evaluates its integrity and effectiveness for the Office
of the Inspector General.
. enhance our current system of internal financial controls to promote
compliance with federal healthcare program requirements on billing and
related financial issues, including a variety of internal audit and
compliance reviews. We have retained an independent review organization
to evaluate the integrity and effectiveness of our internal systems. The
independent review organization will report annually its findings to the
Office of the Inspector General.
. notify the Office of the Inspector General within 30 days of our
discovery of any ongoing investigation or legal proceeding conducted or
brought by a governmental entity or its agents involving any allegation
that we have committed a crime or engaged in a fraudulent activity, and
within 30 days of our determination that we have received a substantial
overpayment relating to any federal healthcare program or any other
matter that a reasonable person would consider a potential violation of
the federal fraud and abuse laws or other criminal or civil laws related
to any federal healthcare program.
. submit annual reports to the Office of the Inspector General
demonstrating compliance with the terms of the Corporate Integrity
Agreement, including the findings of our internal audit and review
program.
The Corporate Integrity Agreement contains standard penalty provisions for
breach, which include stipulated cash penalties ranging from $1,000 per day to
$2,500 per day for each day we are in breach of the agreement. If we fail to
remedy our breach in the time specified in the agreement, we can be excluded
from participation in federal healthcare programs.
We submitted an implementation report to the Office of the Inspector General
in August 2001 and our annual report in September 2002.
INFORMATION SYSTEMS
Our information systems strategy is focused on utilizing technology to allow
us to operate efficiently and effectively under fixed reimbursement levels and
increased regulatory compliance requirements. Our information systems
activities are determined by the operational strategies and priorities of each
of our operating divisions.
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Our integrated financial system allows for timely monthly reporting of
financial results on a company-wide basis. In addition, extensive data
warehouse capabilities across each operating division allow us to access
sophisticated clinical and financial management information at a local,
regional and corporate level. We completed the implementation of a new
integrated human resources and payroll system in all of our facilities in 2002.
The information systems for the health services division provide support for
product line management and third party reimbursement. The resident care system
is an internally developed business application that captures patient
assessment data to ensure that minimum data set assessment forms are filed
accurately and timely with reimbursement sources in each state. Our clinical
care management system blends clinical and financial results within our data
warehouse to provide a decision support platform for delivering high quality
care in an economical manner. Our quality reporting system, based on the
quality indicators used by CMS, allows each facility to monitor and manage the
quality of care being delivered.
Our hospitals utilize ProTouch(TM), an internally developed electronic
patient medical record system that was designed specifically for the long-term
acute care environment. ProTouch(TM) is a software application that allows
nurses, physicians and other clinicians to enter clinical information during
the patient care delivery process and view an electronic patient chart. Various
clinical indicators are passed from ProTouch(TM) to our data warehouse to allow
analysis of risk-adjusted outcomes by patient populations and ultimately
develop best practices to improve patient care. Our information systems also
assist us in monitoring quality indicators at the facility, regional and
corporate levels.
To meet HIPAA regulations, we enhanced all of our billing systems to comply
with government-mandated standardized transaction code sets. We also are
updating our clinical and financial systems to comply with the patient data
privacy and security requirements.
Our information systems architecture provides a reliable, scalable
infrastructure that is based on personal computers in the facilities connected
by a wide-area network to our centralized data center in Louisville, Kentucky.
Our information system network allows us to operate and centrally monitor over
10,000 distributed personal computers and 1,300 servers on a continuous basis.
ADDITIONAL INFORMATION
Employees
As of December 31, 2002, we had approximately 40,600 full-time and 12,800
part-time and per diem employees. We had approximately 2,600 unionized
employees under 27 collective bargaining agreements as of December 31, 2002.
The healthcare industry currently is facing a shortage of qualified
personnel, such as nurses, certified nurse's assistants, nurse's aides,
therapists and other important providers of healthcare. As a result, we are
experiencing challenges in retaining qualified staff due to this high demand.
Our hospitals are particularly dependent on nurses for patient care. The
difficulty our nursing centers and hospitals are experiencing in hiring and
retaining qualified personnel has increased our average wage rate and forced us
to increase our use of contract nursing personnel. We may continue to
experience increases in our labor costs primarily due to higher wages and
greater benefits required to attract and retain qualified healthcare personnel.
Our ability to control labor costs will significantly affect our future
operating results.
Professional and General Liability Insurance
Our healthcare operations are primarily insured for professional and general
liability risks by our wholly owned limited purpose insurance subsidiary,
Cornerstone Insurance Company. Cornerstone insures initial losses
32
up to specified coverage levels per occurrence and in the aggregate. On a per
claim basis, coverages for losses in excess of those insured by Cornerstone are
maintained through unaffiliated commercial insurance carriers. Effective
November 30, 2000, Cornerstone insures all claims arising in Florida up to a
per occurrence limit without the benefit of any aggregate coverage limit
through unaffiliated commercial insurance carriers. Effective January 1, 2003,
Cornerstone insures all claims in all states up to a per occurrence limit
without the benefit of any aggregate coverage limit through unaffiliated
commercial insurance carriers.
We believe that our insurance is adequate in amount and coverage. There can
be no assurance that in the future such insurance will be available at a
reasonable price or that we will be able to maintain adequate levels of
professional and general liability insurance coverage.
Where You Can Find More Information
We file annual, quarterly and special reports, proxy statements and other
information with the SEC under the Exchange Act.
You also may read or obtain copies of this information in person or by mail
from the Public Reference Room of the SEC, 450 Fifth Street, N.W., Washington,
D.C. 20549. You may obtain information on the operation of the Public Reference
Room by calling the SEC at (800) SEC-0330. Please call the SEC at
1-800-SEC-0330 for further information on the public reference rooms. Our
filings with the SEC also are available to the public on the SEC's Internet web
site at http://www.sec.gov. You also may inspect reports, proxy statements and
other information about us at the office of the National Association of
Securities Dealers, Inc. at 1735 K Street, N.W., Washington, D.C. 20006.
Our filings with the SEC, including our Annual Report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments
thereto, are available free of charge on our website, through a link to the
SEC's website, as soon as reasonably practicable after they are electronically
filed with the SEC. Our website is www.kindredhealthcare.com. Information made
available on our website is not a part of this document.
CAUTIONARY STATEMENTS
Certain statements made in this Annual Report on Form 10-K and the documents
we incorporate by reference in this Annual Report include forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended and Section 21E of the Exchange Act. All statements regarding our
expected future financial position, results of operations, cash flows,
financing plans, business strategy, budgets, capital expenditures, competitive
positions, growth opportunities, plans and objectives of management and
statements containing the words such as "anticipate," "approximate," "believe,"
"plan," "estimate," "expect," "project," "could," "should," "will," "intend,"
"may" and other similar expressions, are forward-looking statements. Such
forward-looking statements are inherently uncertain, and you must recognize
that actual results may differ materially from our expectations as a result of
a variety of factors, including, without limitation, those discussed below.
Such forward-looking statements are based on management's current expectations
and include known and unknown risks, uncertainties and other factors, many of
which we are unable to predict or control, that may cause our actual results or
performance to differ materially from any future results or performance
expressed or implied by such forward-looking statements. These statements
involve risks, uncertainties and other factors discussed below and detailed
from time to time in our filings with the SEC. Factors that may affect our
plans or results include, without limitation:
. our ability to operate pursuant to the terms of our debt obligations and
the Master Lease Agreements,
. our ability to meet our rental and debt services obligations,
. adverse developments with respect to our results of operations or
liquidity,
33
. our ability to attract and retain key executives and other healthcare
personnel,
. increased operating costs due to shortages in qualified nurses and other
healthcare personnel,
. the effects of healthcare reform and government regulations,
interpretation of regulations and changes in the nature and enforcement
of regulations governing the healthcare industry,
. changes in the reimbursement rates or methods of payment from third party
payors, including the Medicare and Medicaid programs and the new LTAC PPS,
. national and regional economic conditions, including their effect on the
availability and cost of labor, materials and other services,
. our ability to control costs, including labor and employee benefit costs,
in response to the prospective payment systems, implementation of the
Corporate Integrity Agreement and other regulatory actions,
. our ability to comply with the terms of our Corporate Integrity Agreement,
. the effect of a restatement of our previously issued consolidated
financial statements,
. our ability to integrate operations of acquired facilities,
. the increase in the costs of defending and insuring against alleged
professional liability claims and our ability to predict the estimated
costs related to such claims, and
. our ability to successfully reduce (by divestiture or otherwise) our
exposure to professional liability claims in the state of Florida and
other states.
Many of these factors are beyond our control. We caution you that any
forward-looking statements made by us are not guarantees of future performance.
We disclaim any obligation to update any such factors or to announce publicly
the results of any revisions to any of the forward-looking statements to
reflect future events or developments.
Changes in the reimbursement rates or methods of payment from third party
payors, including the Medicare and Medicaid programs, or the implementation of
other measures to reduce reimbursement for our services could result in a
substantial reduction in our revenues and operating margins.
We depend on reimbursement from third party payors, including the Medicare
and Medicaid programs, for substantially all of our revenues. For the year
ended December 31, 2002, we derived approximately 73% of our total revenues
from the Medicare and Medicaid programs and approximately 27% from private
third party payors, such as commercial insurance companies, health maintenance
organizations, preferred provider organizations and contracted providers.
The Medicare and Medicaid programs are highly regulated and subject to
frequent and substantial changes. The Balanced Budget Act, which established a
plan to balance the federal budget by fiscal year 2002, contained extensive
changes to the Medicare and Medicaid programs intended to reduce significantly
the projected amount of increase in payments under those programs. The Balanced
Budget Act, among other things:
. substantially reduced Medicare reimbursement payments to our nursing
centers by establishing a prospective payment system covering
substantially all services provided to Medicare patients, including
ancillary services such as respiratory therapy, physical therapy,
occupational therapy, speech therapy and certain covered pharmaceuticals,
. reduced payments made to our hospitals by reducing TEFRA incentive
payments, allowable costs for capital expenditures and bad debts, and
payments for services to patients transferred from a general acute care
hospital, and
. repealed the federal payment standard for Medicaid reimbursement levels,
often referred to as the "Boren Amendment", for hospitals and nursing
centers.
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The BBRA, BIPA and various other regulatory actions provided a measure of
relief from the impact of the Balanced Budget Act. See "- Regulatory Changes."
However, a significant portion of Medicare reimbursement provisions under the
BBRA and BIPA expired as scheduled on October 1, 2002. Accordingly, Medicare
reimbursement to our nursing centers declined by approximately $35 per patient
day or $15 million in the fourth quarter of 2002, resulting in a material
reduction in nursing center operating income.
On August 30, 2002, CMS issued final regulations for the new LTAC PPS that
became effective on October 1, 2002. Because of our Medicare cost reporting
periods, this new payment system will not become effective for all but two of
our long-term acute care hospitals until September 1, 2003.
As anticipated, the new LTAC PPS is based on DRGs similar to the system used
to pay short-term acute care hospitals. While the clinical system which groups
procedures and diagnoses is identical to the prospective payment system for
short-term acute care hospitals, the new payment system utilizes different
rates and formulas. Three types of payments will be used in the new system: (a)
short stay outlier that will provide for patients whose length of stay is less
than 5/6th of the average length of stay for that DRG, a payment based upon the
lesser of (1) a per diem based upon the average payment for that DRG, (2) the
estimated costs plus 20%, or (3) the full DRG payment; (b) DRG fixed payment
which provides a single payment for all patients with a given DRG, regardless
of length of stay, cost of care or place of discharge; and (c) high cost
outlier that will provide a partial coverage of costs for patients whose cost
of care far exceeds the DRG reimbursement. For patients in the high cost
outlier category, Medicare will reimburse 80% of the costs incurred above the
DRG reimbursement plus a fixed cost outlier threshold of $24,450 per discharge.
The new system provides for an adjustment for differences in area wages
resulting from salary and benefit variations. There also are additional rules
for payment for patients who are transferred from a long-term care hospital to
another healthcare setting and are subsequently re-admitted to the long-term
care hospital. The LTAC PPS payment rates also are subject to annual
adjustments.
The new system maintains long-term acute care hospitals as a distinct
provider type, separate from short-term acute care hospitals. Only providers
certified as long-term acute care hospitals may be paid under the new system.
To maintain certification under the new payment system, the average length of
stay of Medicare patients must be at least 25 days. Under the previous system,
compliance with the 25-day average length of stay threshold was based on all
patient discharges.
As previously noted, the new system became effective for cost reporting
periods beginning after October 1, 2002. As an alternative to the immediate
adoption of LTAC PPS, long-term acute care hospitals may elect to phase in the
new system over five years. These phase-in provisions will enable providers to
make the necessary operational changes over the next several years to support a
smooth clinical and financial transition to the new payment system.
Our hospitals currently receive interim cash payments under TEFRA as a
result of submitting interim and final patient bills twice a month. Under LTAC
PPS, a provider will choose one of two methods of receiving interim cash
payments: (1) by billing each patient at the earlier of the time of discharge
or 60 days from the time of admission or (2) by electing a periodic interim
payment methodology which estimates the total annual LTAC PPS reimbursement by
hospital and converts that amount into a bi-weekly cash payment. Either payment
system may negatively impact the hospital division's operating cash flows in
2003.
We continue to review the extensive regulations associated with the new LTAC
PPS. Based upon our analysis to date, we believe that the new system should not
have a material impact on our hospital operating results but may negatively
impact operating cash flows in the short term. These preliminary estimates are
based upon current patient acuity and expense levels in our hospitals. These
factors, among others, are subject to significant change. Slight variations in
patient acuity could significantly change Medicare revenues generated under
LTAC PPS. In addition, our hospitals may not be able to appropriately adjust
their operating costs as patient acuity levels change. As a result of these
uncertainties, we cannot predict the ultimate impact of the new
35
LTAC PPS on our hospital operating results and we cannot assure you that such
regulations or operational changes resulting from these regulations will not
have a material adverse impact on our financial position, results of operations
or liquidity. In addition, we cannot assure you that the new LTAC PPS will not
have a material adverse effect on revenues from non-government third party
payors.
Following the transition to LTAC PPS, Medicare reimbursement to our
hospitals will be based on a fixed payment system. Operating margins in the
hospital division could be negatively impacted if we are unable to control our
operating costs.
There continue to be legislative and regulatory proposals that would impose
further limitations on government and private payments to providers of
healthcare services. By repealing the Boren Amendment, the Balanced Budget Act
eased existing impediments on the ability of states to reduce their Medicaid
reimbursement levels. 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. As additional states face budgetary issues, we
anticipate further pressure on Medicaid rates that could negatively impact
payments to our nursing centers and pharmacy operations.
In addition, private third party payors are continuing their efforts to
control healthcare costs through direct contracts with healthcare providers,
increased utilization review and greater enrollment in managed care programs
and preferred provider organizations. These private payors increasingly are
demanding discounted fee structures and the assumption by healthcare providers
of all or a portion of the financial risk.
We could be affected adversely by the continuing efforts of governmental and
private third party payors to contain healthcare costs. We cannot assure you
that reimbursement payments under governmental and private third party payor
programs and Medicare supplemental insurance policies will remain at levels
comparable to present levels or will be sufficient to cover the costs allocable
to patients eligible for reimbursement pursuant to these programs. Future
changes in the reimbursement rates or methods of third party payors, including
the Medicare and Medicaid programs, or the implementation of other measures to
reduce reimbursement for our services could result in a substantial reduction
in our net operating revenues. Our operating margins may continue to be under
pressure because of deterioration in pricing flexibility, changes in payor mix
and growth in operating expenses in excess of increases in payments by third
party payors. In addition, as a result of competitive pressures, our ability to
maintain operating margins through price increases to private patients is
limited. See "- Governmental Regulation."
Significant legal actions could subject us to increased operating costs and
substantial uninsured liabilities, which could materially and adversely affect
our financial position, results of operations and liquidity.
We have experienced substantial increases in both the number and size of
professional liability claims in recent years. In addition to large
compensatory claims, plaintiffs' attorneys increasingly are seeking significant
punitive damages and attorney's fees. As a result, professional liability costs
have become increasingly expensive and unpredictable. In addition, it has
become increasingly difficult to predict the estimated costs of such claims.
The increase in professional liability costs has been particularly onerous in
the state of Florida. See "- If we fail to divest our Florida nursing
facilities, our financial position, results of operations and liquidity will
continue to be materially adversely impacted."
For example, during 2002 we recorded significant additional costs for
professional liability claims, most of which related to our nursing center
operations. The additional costs were required based upon the results of our
regular quarterly independent actuarial valuations. Approximately 61% of our
nursing center professional liability costs in 2002 related to our operations
in Florida.
In Florida, professional liability costs for the long-term care industry
have become increasingly expensive and difficult to estimate. Many insurance
companies are exiting the state of Florida or severely restricting their
36
underwriting of long-term care professional liability insurance in that state.
Insurers have decided that they cannot provide coverage when faced with the
magnitude of losses and the explosive growth of claims in that state.
Accordingly, our overall professional liability costs per bed in Florida are
substantially higher than other states in which we operate and continue to
escalate. In 2001, the Florida legislature enacted certain tort reforms
relating to professional liability claims. We are currently unable to determine
what impact, if any, this legislation may have on our claims experience in
Florida.
We insure a substantial portion of our professional liability risks
primarily through a wholly owned limited purpose insurance subsidiary. The
limited purpose insurance subsidiary insures initial losses up to specified
coverage levels per occurrence and in the aggregate. On a per claim basis,
coverages for losses in excess of those insured by the limited purpose
insurance subsidiary are maintained through unaffiliated commercial insurance
carriers. Effective November 30, 2000, the limited purpose insurance subsidiary
insures all claims arising in Florida up to a per occurrence limit without the
benefit of any aggregate coverage limit through unaffiliated commercial
insurance carriers. Effective January 1, 2003, the limited purpose insurance
subsidiary insures all claims in all states up to a per occurrence limit
without the benefit of any aggregate coverage limit through unaffiliated
commercial insurance carriers. We maintain professional and general liability
insurance in amounts and coverage that management believes are sufficient for
our operations. However, our insurance might not cover all claims against us or
the full extent of our liability nor continue to be available at a reasonable
cost. Moreover, the costs of insurance coverage maintained with unaffiliated
commercial insurance carriers is expected to increase significantly. If we are
unable to maintain adequate insurance coverage or are required to pay punitive
damages which are uninsured, we may be exposed to substantial liabilities. We
also are subject to lawsuits under the federal False Claims Act for submitting
fraudulent bills for services to the Medicare and Medicaid programs. These
lawsuits, which may be initiated by whistleblowers, can involve significant
monetary damages, fines, attorney fees and the award of bounties to private
plaintiffs who successfully bring these suits, as well as to the government
programs.
If we fail to divest our Florida nursing facilities, our financial position,
results of operations and liquidity will continue to be materially adversely
impacted.
We operate 18 nursing centers in Florida. As a result of significantly
increasing professional liability costs, these facilities generated a pretax
loss of approximately $68 million in 2002. In October 2002, we announced our
intentions to divest our nursing center operations in Florida.
On December 11, 2002, we entered into a non-binding letter of intent with
SHM to transfer the operations of our 18 skilled nursing facilities in Florida.
Under the proposed transaction, affiliates of Senior Health Properties-South,
Inc. will sublease 16 of our 18 Florida facilities for an initial term of five
years. The lease payments under the subleases will be equal to the lease
payments under the primary leases. We will remain a primary guarantor under the
primary leases. In addition, SHM's designee will lease with an option to
purchase the remaining two facilities we own. SHM will enter into a management
agreement with each of the subtenants and tenants, as applicable, to manage the
Florida facilities. Each of the subtenants or tenants, as applicable, also will
purchase certain personal property assets related to the operations of the
Florida facilities. We will retain the working capital associated with all of
our Florida facilities.
The parties continue to make progress in their negotiations of definitive
agreements related to the letter of intent but have not reached agreement at
this time. In addition to entering into a definitive agreement, the
consummation of a proposed transaction is subject to a number of material
conditions including, without limitation, the receipt of required approvals
from regulators, governmental entities and other third parties. We lease 15 of
the 18 Florida facilities from Ventas pursuant to the Master Lease Agreements.
Although Ventas has previously publicly announced its intention to work with us
in facilitating a Florida exit strategy, Ventas has informed us that it will
object to the transaction unless it receives a substantial and material consent
fee and other lease concessions. We have informed Ventas that this demand is
improper. We believe that under the Master Lease Agreements we have the ability
to sublease 12 of these facilities without Ventas's consent and that Ventas
cannot unreasonably withhold its consent on the remaining three facilities.
37
In addition, Ventas has informed the Florida licensure agency that it
believes the proposed sublease transaction is not permitted under its Master
Lease Agreements with us and has requested that the agency suspend further
processing of the necessary licensure applications for the change in ownership.
SHM and we have independently informed the Florida agency that Ventas's request
is improper and that it lacks the authority to make any such request. We
believe that the Florida agency is aware that it must continue to process the
change in ownership applications.
We are continuing to pursue the proposed sublease transaction and our
divestiture of the Florida facilities. If Ventas improperly interferes with the
completion of the proposed transaction or the divestiture of these facilities,
we will seek appropriate legal remedies against Ventas as well as damages for
the continuing losses sustained by us.
If we are unsuccessful in divesting our Florida nursing center facilities,
our financial position, results of operations and liquidity will be materially
adversely impacted.
Our failure to pay rent, or Ventas's exercise of its right to reset the annual
aggregate minimum rent, under the Master Lease Agreements could materially
adversely affect our financial position, results of operations and liquidity.
We currently lease 210 of our 285 nursing centers and 43 of our 65 hospitals
from Ventas under our Master Lease Agreements. Our failure to pay the rent or
otherwise comply with a material provision of any of our Master Lease
Agreements with Ventas would result in an "Event of Default" under such Master
Lease Agreement. Upon an Event of Default, remedies available to Ventas
include, without limitation, terminating such Master Lease Agreement,
repossessing and reletting the leased properties and requiring us to remain
liable for all obligations under such Master Lease Agreement, including the
difference between the rent under such Master Lease Agreement and the rent
payable as a result of reletting the leased properties, or requiring us to pay
the net present value of the rent due for the balance of the term of such
Master Lease Agreement. The exercise of such remedies could have a material
adverse effect on our financial condition and our business.
In addition, the Master Lease Agreements provide Ventas with a one-time
option, that may be exercised by Ventas within one year from July 2006, to
reset the annual aggregate minimum rent under one or more of the Master Lease
Agreements to the then current fair market rental of the relevant leased
properties in exchange for a payment to us. Accordingly, if the operations or
value of our leased properties improve, the relevant fair market rental
likewise may increase over the current rental if the option is exercised. If
Ventas were to exercise this option, the potential increase in our annual
aggregate minimum rent payments could be so substantial as to have a material
adverse effect on our financial position, results of operations and liquidity.
See "- Master Lease Agreements."
We have limited operational and strategic flexibility since we lease
substantially all of our facilities.
We lease substantially all of our facilities from Ventas and other third
parties. Under our leases, we generally are required to operate continuously
our leased properties as a provider of healthcare services. In addition, these
leases generally limit or restrict our ability to assign the lease to another
party. Our failure to comply with these lease provisions would result in an
event of default under the leases and subject us to material damages, including
potential defaults under our credit agreements. Given these restrictions, we
may be forced to continue operating non-profitable facilities to avoid defaults
under our leases. See "- Master Lease Agreements."
We could experience significant increases to our operating costs due to
shortages of qualified nurses and other healthcare professionals.
The market for qualified nurses and other healthcare professionals is highly
competitive. We, like other healthcare providers, have experienced difficulties
in attracting and retaining qualified personnel such as nurses, certified
nurse's assistants, nurse's aides, therapists and other important providers of
healthcare. Our hospitals are
38
particularly dependent on nurses for patient care. The difficulty our nursing
centers and hospitals are experiencing in hiring and retaining qualified
personnel has increased our average wage rate and forced us to increase our use
of contract nursing personnel. We may continue to experience increases in our
labor costs primarily due to higher wages and greater benefits required to
attract and retain qualified healthcare personnel. Salaries, wages and benefits
were approximately 57% of our consolidated revenues for the year ended
December 31, 2002. Our ability to control labor costs will significantly affect
our future operating results.
Various states in which we operate nursing centers and hospitals have
established minimum staffing requirements or may establish minimum staffing
requirements in the future. For example, the state of Florida has enacted
legislation establishing certain minimum staffing requirements for nursing
centers operating in that state. We operate 18 nursing centers in Florida.
Since January 1, 2002, each Florida nursing center must satisfy certain minimum
hours of direct care per resident per day by both licensed nurses and certified
nursing assistants and certain minimum staff to patient ratios for both
licensed nurses and certified nurse assistants. The implementation of these
staffing requirements in Florida is not contingent upon any additional
appropriation of state funds in any budget act or other statute. Our ability to
satisfy such staffing requirements will depend upon our ability to attract and
retain qualified nurses, certified nurse's assistants and other staff. Failure
to comply with such minimum staffing requirements may result in the imposition
of fines or other sanctions. If states do not appropriate sufficient additional
funds (through Medicaid program appropriations or otherwise) to pay for any
additional operating costs resulting from such minimum staffing requirements,
our profitability may be adversely affected.
We may not be able to meet our substantial rent and debt service requirements.
A substantial portion of our cash flows from operations is dedicated to the
payment of rents related to our leased properties as well as interest on our
outstanding indebtedness. If we are unable to generate sufficient funds to meet
our obligations, we may be required to refinance, restructure or otherwise
amend some or all of such obligations, sell assets or raise additional cash
through the sale of our equity. We cannot assure you that such restructuring
activities, sales of assets or issuances of equity can be accomplished or, if
accomplished, would raise sufficient funds to meet these obligations. Our high
degree of leverage and related financial covenants:
. require us to dedicate a substantial portion of our cash flow to payments
on our rent and interest obligations, thereby reducing the availability
of cash flow to fund working capital, capital expenditures and other
general corporate activities,
. require us to pledge as collateral substantially all of our assets, and
. require us to maintain certain debt coverage and financial ratios at
specified levels, thereby reducing our financial flexibility.
These provisions:
. could have a material adverse effect on our ability to withstand
competitive pressures or adverse economic conditions (including adverse
regulatory changes),
. could affect adversely our ability to make material acquisitions, obtain
future financing or take advantage of business opportunities that may
arise, and
. increase our vulnerability to a downturn in general economic conditions
or in our business.
We conduct business in a heavily regulated industry, and changes in regulations
or violations of regulations may result in increased costs or sanctions that
reduce our revenues and profitability.
In the ordinary course of our business, we are subject regularly to
inquiries, investigations and audits by federal and state agencies that oversee
applicable healthcare regulations.
39
The extensive federal, state and local regulations affecting the healthcare
industry include, but are not limited to, regulations relating to licensure,
conduct of operations, ownership of facilities, addition of facilities,
allowable costs, services and prices for services, and the confidentiality and
security of health-related information. See "- Governmental Regulation." In
particular, various laws including antikickback, antifraud and abuse amendments
codified under the Social Security Act prohibit certain business practices and
relationships that might affect the provision and cost of healthcare services
reimbursable under Medicare and Medicaid, including the payment or receipt of
remuneration for the referral of patients whose care will be paid by Medicare
or other governmental programs. Sanctions for violating the antikickback,
antifraud and abuse amendments under the Social Security Act include criminal
penalties, civil sanctions, fines and possible exclusion from government
programs such as Medicare and Medicaid.
In addition, the Social Security Act broadly defines the scope of prohibited
physician referrals under the Medicare and Medicaid programs to providers with
which they have ownership or certain other financial arrangements. Many states
have adopted or are considering similar legislative proposals, some of which
extend beyond the Medicaid program, to prohibit the payment or receipt of
remuneration for the referral of patients and physician self-referrals
regardless of the source of the payment for the care. These laws and
regulations are complex and limited judicial or regulatory interpretation
exists. We cannot assure you that governmental officials charged with
responsibility for enforcing the provisions of these laws and regulations will
not assert that one or more of our arrangements are in violation of the
provisions of such laws and regulations.
We believe that the regulatory environment surrounding the long-term care
industry remains intense. State and federal governments continue to impose
intensive enforcement policies resulting in a significant number of
inspections, citations of regulatory deficiencies and other regulatory
sanctions including terminations from the Medicare and Medicaid programs, bans
on Medicare and Medicaid payments for new admissions and civil monetary
penalties. If we fail to comply with the extensive laws and regulations
applicable to our businesses, we could become ineligible to receive government
program reimbursement, suffer civil or criminal penalties or be required to
make significant changes to our operations. In addition, we could be forced to
expend considerable resources responding to an investigation or other
enforcement action under these laws or regulations. Furthermore, should we lose
licenses for a number of our facilities as a result of regulatory action or
otherwise, we could be in default under our Master Lease Agreements and our
credit agreements.
We are unable to predict the future course of federal, state and local
regulation or legislation, including Medicare and Medicaid statutes and
regulations, or the intensity of federal and state enforcement actions. Changes
in the regulatory framework and sanctions from various enforcement actions
could have a material adverse effect on our financial position, results of
operations and liquidity.
If we fail to attract patients and residents and compete effectively with other
healthcare providers, our revenues and profitability may decline.
The long-term healthcare services industry is highly competitive. Our
nursing centers compete on a local and regional basis with other nursing
centers and other long-term healthcare providers. Some of our competitors'
facilities are located in newer buildings and may offer services not provided
by us or are operated by entities having greater financial and other resources
than us. Our hospitals face competition from general acute care hospitals and
long-term hospitals that provide services comparable to those offered by our
hospitals. Many competing general acute care hospitals are larger and more
established than our hospitals. We may experience increased competition from
existing hospitals as well as hospitals converted, in whole or in part, to
specialized care facilities.
The long-term industry is divided into a variety of competitive areas that
market similar services. These competitors include nursing centers, hospitals,
extended care centers, assisted living facilities, home health agencies and
similar institutions. Our facilities generally operate in communities that also
are served by similar facilities operated by our competitors. Certain of our
competitors are operated by not-for-profit, non-taxpaying or
40
governmental agencies that can finance capital expenditures on a tax-exempt
basis and that receive funds and charitable contributions unavailable to us.
Our facilities compete based on factors such as our reputation for quality
care; the commitment and expertise of our staff and physicians; the quality and
comprehensiveness of our treatment programs; charges for services; and the
physical appearance, location and condition of our facilities. Our
institutional pharmacy services generally compete on price and quality of the
services provided. Several of the competitors to our pharmacy operations are
larger and more established service providers. We also compete with other
companies in providing rehabilitation therapy services. Many of these competing
companies have greater financial and other resources than we have. We cannot
assure you that increased competition in the future will not adversely affect
our financial position, results of operations or liquidity.
If we fail to comply with our Corporate Integrity Agreement, we could be
subject to severe sanctions.
We have entered into a Corporate Integrity Agreement with the Office of
Inspector General of the U.S. Department of Health and Human Services to
promote our compliance with the requirements of Medicare, Medicaid and all
other federal healthcare programs. On April 20, 2001, our Corporate Integrity
Agreement became effective. Under the Corporate Integrity Agreement, we must
implement a comprehensive internal quality improvement program and a system of
internal financial controls in our nursing centers, hospitals, pharmacies and
regional and corporate offices. We also are subject to extensive reporting
requirements under the Corporate Integrity Agreement pursuant to which we must
inform the Office of the Inspector General of the U.S. Department of Health and
Human Services of (1) the findings of our internal audit and review program,
(2) any investigations or legal proceedings brought or conducted by any
governmental entity involving an allegation that we have committed any crime or
engaged in any fraudulent activity, (3) any billing, reporting or other
practices or policies that have resulted in our receipt of any substantial
overpayment under any federal healthcare program and the corresponding
corrective plan that we have implemented, (4) certain "material deficiencies"
as defined in the Corporate Integrity Agreement, and (5) other
compliance-related matters addressed in the Corporate Integrity Agreement. The
Corporate Integrity Agreement will be effective for five years. A breach of the
Corporate Integrity Agreement could subject us to substantial monetary
penalties and exclusion from participation in the Medicare and Medicaid
programs. Any such sanctions could have a material adverse effect on our
financial position and results of operations. See "- Corporate Integrity
Agreement."
Financial information related to our post-emergence operations is limited.
Since we emerged from bankruptcy on April 20, 2001, there is limited
operating and financial data available from which to analyze our operating
results and cash flows based on the terms of our Plan of Reorganization. As a
result of fresh-start accounting, you also will be unable to compare
information reflecting our results of operations and financial position after
our emergence to prior periods.
Future acquisitions may use significant resources, may be unsuccessful and
could expose us to unforeseen liabilities.
We intend to selectively pursue acquisitions of nursing centers, long-term
acute care hospitals, pharmacies and other related healthcare operations.
Acquisitions may involve significant cash expenditures, debt incurrence,
additional operating losses, amortization of certain intangible assets of
acquired companies, dilutive issuances of equity securities and expenses that
could have a material adverse effect on our financial position, results of
operations and liquidity. Acquisitions involve numerous risks, including:
. difficulties integrating acquired operations, personnel and information
systems,
. diversion of management's time from existing operations,
. potential loss of key employees or customers of acquired companies, and
. assumption of the liabilities and exposure to unforeseen liabilities of
acquired companies, including liabilities for failure to comply with
healthcare regulations.
41
We cannot assure you that we will succeed in obtaining financing for
acquisitions at a reasonable cost, or that such financing will not contain
restrictive covenants that limit our operating flexibility. We also may be
unable to operate acquired facilities profitably or succeed in achieving
improvements in their financial performance.
Item 2. Properties
For information concerning the nursing centers and hospitals operated by us,
see "Business - Health Services Division - Nursing Center Facilities,"
"Business - Hospital Division - Hospital Facilities," and "Business - Master
Lease Agreements." We believe that our facilities are adequate for our future
needs in such locations.
Our corporate headquarters is located in a 287,000 square foot building in
Louisville, Kentucky.
We are subject to various federal, state and local laws and regulations
governing the use, discharge and disposal of hazardous materials, including
medical waste products. Compliance with these laws and regulations is not
expected to have a material adverse effect on us. It is possible, however, that
environmental issues may arise in the future which we cannot now predict.
Item 3. Legal Proceedings
Summary descriptions of various significant legal and regulatory activities
follow.
Our subsidiary, formerly named 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 on December 11, 1995. 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 SEC. The court granted
summary judgment for the defendants/counterclaimants and ruled that TheraTx
breached the shelf registration provision in the merger agreement, but
dismissed the defendants' remaining counterclaims. Additionally, the court
ruled after trial that defendants/counterclaimants were entitled to damages and
prejudgment interest in the amount of approximately $1.3 million and attorneys'
fees and other litigation expenses of approximately $700,000. We and the
defendants/counterclaimants both appealed the court's rulings. The United
States Court of Appeals for the Eleventh Circuit affirmed the trial court's
rulings in TheraTx's favor, with the exception of the damages award, and
certified the question of the proper calculation of damages under Delaware law
to the Delaware Supreme Court. The Delaware Supreme Court issued an opinion on
June 1, 2001, which sets forth a rule for determining such damages but did not
calculate any actual damages. On June 25, 2001, the Eleventh Circuit remanded
the action to the trial court to render a decision consistent with the Delaware
Supreme Court's ruling. On July 24, 2001, the defendants filed a Notice of
Bankruptcy Stay in the trial court.
On August 13, 2001, we and TheraTx filed an Objection and Complaint in an
action entitled Vencor, Inc. and TheraTx Inc. v. James W. Duncan, et al.,
Adversary Proceeding No. 01-6117 (MFW), in the Bankruptcy Court. The complaint
sought 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
sought 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.
On December 20, 2002 the parties reached a final settlement of the Duncan
dispute. Pursuant to that settlement agreement, we paid the defendants $2.1
million. This settlement did not impact our operating results because we had
previously recorded a provision for loss in a prior year. The parties filed
agreed stipulations to dismiss the Georgia litigation and the adversary
proceeding in the Bankruptcy Court, and both actions have now been dismissed.
42
We are pursuing various claims against private insurance companies who
issued Medicare supplemental insurance policies to individuals who became
patients of our hospitals. After the patients' Medicare benefits are exhausted,
the insurance companies become liable to pay the insureds' bills pursuant to
the terms of these policies. We have filed numerous collection actions against
various of these insurers to collect the difference between what Medicare would
have paid and the hospitals' usual and customary charges. These disputes arise
from differences in interpretation of the policy provisions and federal and
state laws governing such policies. Various courts have issued various rulings
on the different issues, most of which have been adverse to us. As discussed in
note 7 of the notes to consolidated financial statements, we received
approximately $12 million in connection with the settlement of one of these
claims in September 2002. While we intend to continue to pursue these claims
vigorously, the remaining value of these claims is not expected to be material.
A shareholder derivative suit entitled Thomas G. White on behalf of Vencor,
Inc. and Ventas, Inc. v. W. Bruce Lunsford, et al., Case No. 98CI03669, was
filed on July 2, 1998 in the Jefferson County, Kentucky, Circuit Court. The
suit was brought on behalf of us and Ventas against certain of our and Ventas's
current and former executive officers and directors. The complaint alleges that
the defendants damaged us and Ventas by engaging in violations of the
securities laws, engaging in insider trading, fraud and securities fraud and
damaging our reputation and that of Ventas. The plaintiff asserts that such
actions were taken deliberately, in bad faith and constitute breaches of the
defendants' duties of loyalty and due care. The complaint alleges that certain
of our 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 we and Ventas have an effective remedy. In October 2002, the
defendants filed a motion to dismiss for failure to prosecute the case. The
court granted the motion to dismiss but the plaintiff subsequently moved the
court to vacate the dismissal. The defendants filed an opposition to the
plaintiff's motion to vacate the dismissal, and the court has not yet ruled on
that motion. We believe that the allegations in the complaint are without merit
and intend to defend this action vigorously if the dismissal is vacated.
A putative 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 us and certain of our current and former
officers and directors 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 we were 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 us in Florida, and also because the statements reflected a
materially understated reserve for professional liability costs. The complaint
further alleges that as a result of the purportedly false and misleading
statements, the price of our 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
43
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; Paula Hillenbrand v. Kindred Healthcare, Inc., et al., Civil
Action No. 3:02CV-654-R; Marilyn Buck v. Kindred Healthcare, Inc., et al.,
Civil Action No. 3:02CV-732-S; and Eastside Holdings Ltd. v. Kindred
Healthcare, Inc., et al., Civil Action No. 3:02CV-617-H. All of these actions
have been consolidated by the District Court. We believe that the allegations
in all of these putative class action complaints are without merit, and we
intend to defend these lawsuits vigorously.
Three shareholder derivative suits entitled Elizabeth Sommerfeld v. Kindred
Healthcare, Inc., et al., Civil Action No. 02 CI 08476; Ilse Denchfield v.
Kindred Healthcare, Inc., et al., Civil Action No. 02 CI 09475; and Fedorka v.
Edward L. Kuntz, et al., Civil Action No. 03 CI 02015, were filed in November
2002, December 2002 and March 2003, respectively, in the Jefferson Circuit
Court in Kentucky. The complaints, which recite 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, attempt to assert a claim against the individual defendants for breach
of fiduciary duties for insider selling and misappropriation of information.
Specifically, the complaints allege that each of the individual defendants knew
that the price of our common stock would dramatically decrease when our
inadequate reserves for professional liability risks were disclosed and that
the individual defendants' sales of our common stock with knowledge of this
material non-public information constituted a breach of their fiduciary duties
of loyalty and good faith. The suits seek to impose a constructive trust in
favor of us for the amount of profits each of the individual defendants or
their firms may have received from their November 2001 sales of our common
stock, as well as attorneys' fees and other expenses. We believe that the
allegations in the complaints are without merit and we intend to defend these
actions vigorously.
We have been informed by the Kentucky Attorney General's Office that we and
certain of our present and former officers and employees are the subject of
several investigations into care issues at our Kentucky-based nursing
facilities that may lead to civil and/or criminal charges against us and/or the
individual officers and employees. Such charges include, but may not be limited
to, abuse or neglect of residents and Medicaid billing fraud related to the
alleged provision of substandard care. If civil or criminal charges are brought
against us and/or our officers and employees, they could result in material
civil damages, criminal penalties and fines, and possible exclusion of our
nursing facilities from the Medicare and Medicaid programs and related material
defaults under the Master Lease Agreements with Ventas. We believe that these
allegations are without merit and we intend to defend against them vigorously.
In connection with the Spin-off, liabilities arising from various legal
proceedings and other actions were assumed by us and we agreed to indemnify
Ventas against any losses, including any costs or expenses, it may incur
arising out of or in connection with such legal proceedings and other actions.
The indemnification provided by us also covers losses, including costs and
expenses, which may arise from any future claims asserted against Ventas based
on the former healthcare operations of Ventas. In connection with our
indemnification obligation, we assumed the defense of various legal proceedings
and other actions. Under the Plan of Reorganization, we agreed to continue to
fulfill our indemnification obligations arising from the Spin-off.
We are a party to various legal actions (some of which are not insured),
regulatory investigations and sanctions arising in the normal course of our
business. We are unable to predict the ultimate outcome of pending litigation
and regulatory investigations. In addition, there can be no assurance that the
U.S. Department of Justice, CMS or other state and federal enforcement and
regulatory agencies will not initiate additional investigations related to our
businesses in the future, nor can there be any assurance that the resolution of
any litigation or investigations, either individually or in the aggregate,
would not have a material adverse effect on our financial position, results of
operations or liquidity. 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 our
operations.
44
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are the names, ages (as of January 1, 2003) and present and
past positions of our current executive officers:
Name Age Position
---- --- --------
Edward L. Kuntz.......... 57 Chairman of the Board and Chief Executive Officer
Paul J. Diaz............. 41 President and Chief Operating Officer
Richard A. Lechleiter.... 44 Senior Vice President, Chief Financial Officer and Treasurer
William M. Altman........ 43 Senior Vice President of Compliance and Government Programs
Frank J. Battafarano..... 52 President, Hospital Division
Lane M. Bowen............ 52 President, Health Services Division
Richard E. Chapman....... 54 Chief Administrative and Information Officer and
Senior Vice President
James H. Gillenwater, Jr. 45 Senior Vice President, Planning and Development
Joseph L. Landenwich..... 38 Vice President of Corporate Legal Affairs and Corporate Secretary
Mark A. McCullough....... 41 President, Pharmacy Division
M. Suzanne Riedman....... 51 Senior Vice President and General Counsel
Edward L. Kuntz has served as our Chairman of the Board and Chief Executive
Officer since January 1999. He also served as our President until January 2002.
He served as our President, Chief Operating Officer and a director from
November 1998 to January 1999. Mr. Kuntz was Chairman and Chief Executive
Officer of Living Centers of America, Inc., a leading provider of long-term
healthcare, from 1992 to 1997. After leaving Living Centers of America, Inc.,
he served as an advisor and consultant to a number of healthcare services and
investment companies and was affiliated with Austin Ventures, a venture capital
firm. In addition, Mr. Kuntz served as Associate General Counsel and later as
Executive Vice President of ARA Living Centers, a long-term healthcare
provider, until the formation of Living Centers of America, Inc. in 1992.
Paul J. Diaz has served as our President and Chief Operating Officer since
January 2002. From 1996 to July 1998, he served in various executive capacities
with Mariner Health Group, Inc. ("Mariner Health"), a long-term healthcare
provider, most recently as Executive Vice President and Chief Operating
Officer. Prior to joining Mariner Health, Mr. Diaz was Chief Executive Officer
of Allegis Health Services, Inc., a long-term healthcare provider, where he
also previously served as Chief Financial Officer and General Counsel. Since
leaving Mariner Health and prior to joining our Company, he served as the
managing member of Falcon Capital Partners, LLC, a private investment and
consulting firm specializing in healthcare restructurings and as Chairman and
Chief Executive Officer of Capella Senior Living, LLC, a start-up venture to
provide long-term healthcare services.
Richard A. Lechleiter, a certified public accountant, has served as our
Senior Vice President, Chief Financial Officer and Treasurer since February
2002. He served as Vice President, Finance and Corporate Controller from April
1998 to February 2002 and also has served as Treasurer since July 1998. Mr.
Lechleiter served as Vice President, Finance and Corporate Controller of our
predecessor from November 1995 to April 1998. From June 1995 to November 1995,
he was Director of Finance for our predecessor. Mr. Lechleiter was Vice
President and Controller of Columbia/HCA Healthcare Corp. from September 1993
to May 1995, of Galen Health Care, Inc. from March 1993 to August 1993, and of
Humana Inc. from September 1990 to February 1993.
William M. Altman, an attorney, has served as our Senior Vice President of
Compliance and Government Programs since April 2002 and previously served as
Vice President of Compliance and Government Programs
45
since October 1999. He served as Operations Counsel in our law department from
April 1998 to September 1999. He held the same position with our predecessor
from June 1996 through April 1998. Prior to joining our predecessor, Mr. Altman
was in the private practice of law for ten years and held other consulting and
government positions in healthcare.
Frank J. Battafarano has served as our President, Hospital Division since
November 1998. He served as our Vice President of Operations from April 1998 to
November 1998. He held the same position with our predecessor from February
1998 to April 1998. From May 1996 to January 1998, Mr. Battafarano served as
Senior Vice President of the central regional office of our predecessor. From
January 1992 to April 1996, he served as an executive director and hospital
administrator for our predecessor.
Lane M. Bowen has served as our President, Health Services Division since
October 2002. He served as the Senior Vice President, Pacific Region of the
Health Services Division from September 2001 to October 2002. From January 2001
to September 2001, Mr. Bowen served as Senior Vice President, South Region of
the Health Services Division. From November 1995 to December 2000, he served as
Executive Vice President and Chief Operating Officer of Life Care Centers of
America, Inc., an operator of more than 200 skilled nursing centers.
Richard E. Chapman has served as our Chief Administrative and Information
Officer and Senior Vice President since January 2001. From April 1998 to
January 2001, he served as our Senior Vice President and Chief Information
Officer. Mr. Chapman served as Senior Vice President and Chief Information
Officer of our predecessor from October 1997 to April 1998. From March 1993 to
October 1997, he was Senior Vice President of Information Systems of
Columbia/HCA Healthcare Corp., Vice President of Galen Health Care, Inc. from
March 1993 to August 1993, and Vice President of Humana Inc. from September
1988 to February 1993.
James H. Gillenwater, Jr. has served as our Senior Vice President, Planning
and Development since April 1998. Mr. Gillenwater served as Senior Vice
President, Planning and Development of our predecessor from December 1996 to
April 1998. From November 1995 through December 1996, he served as Vice
President, Planning and Development of our predecessor and was Director of
Planning and Development from 1989 to November 1995.
Joseph L. Landenwich, an attorney and certified public accountant, has
served as our Vice President of Corporate Legal Affairs and Corporate Secretary
since November 1999. He served as Corporate Counsel from April 1998 to November
1999 and as Assistant Secretary from February 1999 to November 1999. Mr.
Landenwich also was Corporate Counsel with our predecessor from September 1996
to April 1998. Prior to joining our predecessor, Mr. Landenwich was in the
private practice of law for five years.
Mark A. McCullough, a certified public accountant, has served as our
President, Pharmacy Division since February 2003. From March 2001 to February
2003, he served as Vice President of Pharmacy and prior to that as Vice
President of Finance for our pharmacy operations from April 2000 to March 2001.
Mr. McCullough was the Controller of Jillians, Inc., a bar and restaurant
company, from September 1998 to December 1998 and the Director of Financial
Reporting for Catholic Health Initiatives, a healthcare provider, from December
1998 to March 2000. He also served as a Manager of Pharmacy Finance for us and
our predecessor from February 1997 to June 1998. Prior to February 1997, Mr.
McCullough also held senior financial positions with other healthcare providers
and practiced public accounting for nine years.
M. Suzanne Riedman, an attorney, has served as our Senior Vice President and
General Counsel since August 1999. She served as our Vice President and
Associate General Counsel from April 1998 to August 1999. Ms. Riedman held the
same positions with our predecessor from January 1997 to April 1998. She joined
our predecessor as counsel in September 1995 and became Associate General
Counsel in January 1996. Ms. Riedman served as counsel to another large
long-term healthcare provider in various capacities from 1990 to 1995. Prior to
that time, Ms. Riedman was in the private practice of law for 11 years.
46
As noted above, Mr. Diaz served as Executive Vice President and Chief
Operating Officer of Mariner Health until July 1998. On July 31, 1998, Paragon
Health Network, Inc., the predecessor to Mariner Post-Acute Networks, Inc.
("Mariner Post-Acute") acquired Mariner Health. Similar to us and several other
long-term healthcare providers, Mariner Post-Acute and substantially all of its
subsidiaries, including Mariner Health, filed voluntary petitions under Title
11 of the Bankruptcy Code in the United States Bankruptcy Court for the
District of Delaware on January 18, 2000.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
MARKET PRICE FOR COMMON STOCK
AND DIVIDEND HISTORY
Our common stock commenced trading on the OTC Bulletin Board on April 26,
2001 under the symbol "KIND." Our common stock was initially issued on April
20, 2001 in connection with our Plan of Reorganization. Between April 20, 2001
and April 26, 2001, there was no public market for our common stock. Since
November 8, 2001, our common stock has been quoted on the Nasdaq National
Market under the symbol "KIND." The prices in the table below, for the calendar
quarters indicated, represent the high and low sale prices for our common stock
as reported by the OTC Bulletin Board and the Nasdaq, as applicable, during
2002 and 2001. No cash dividends have been paid on the common stock during such
periods.
Sales price of
common stock
-------------
High Low
------ ------
2002
----
First Quarter........................ $51.70 $35.75
Second Quarter....................... $49.78 $40.38
Third Quarter........................ $44.44 $30.85
Fourth Quarter....................... $37.18 $10.23
High Low
------ ------
2001
----
Second Quarter (since April 26, 2001) $51.00 $22.25
Third Quarter........................ $67.90 $46.00
Fourth Quarter....................... $59.50 $45.89
Our debt instruments contain covenants that restrict, among other things,
our ability to pay dividends. Any determination to pay dividends in the future
will be dependent upon our results of operations, financial position,
contractual restrictions, restrictions imposed by applicable laws and other
factors deemed relevant by our Board of Directors.
The prices noted above represent inter-dealer prices, without retail
mark-up, mark-down or commission, and may not necessarily represent actual
transactions.
As of January 31, 2003, there were 560 holders of record of our common stock.
47
Item 6. Selected Financial Data
KINDRED HEALTHCARE, INC.
SELECTED FINANCIAL DATA
(In thousands, except per share amounts and statistics)
| Predecessor
Reorganized Company | Company
------------------------ | -----------
Year Nine | Three
ended months | months
December 31, ended | ended
2002 (a) December 31,| March 31,
------------ 2001 | 2001
Statement of Operations Data: |
Revenues.............................................. $ 3,357,822 $2,329,019 | $ 752,409
----------- ---------- | ----------
Salaries, wage and benefits........................... 1,924,439 1,316,581 | 427,649
Supplies.............................................. 424,177 295,598 | 94,319
Rent.................................................. 270,562 195,284 | 76,995
Other operating expenses.............................. 606,394 375,090 | 126,701
Depreciation and amortization......................... 71,356 50,219 | 18,645
Interest expense...................................... 14,373 21,740 | 14,000
Investment income..................................... (9,674) (9,285)| (1,919)
----------- ---------- | ----------
3,301,627 2,245,227 | 756,390
----------- ---------- | ----------
Income (loss) before reorganization items |
and income taxes..................................... 56,195 83,792 | (3,981)
Reorganization items.................................. (5,520) - | (53,666)
----------- ---------- | ----------
Income (loss) before income taxes..................... 61,715 83,792 | 49,685
Provision for income taxes............................ 28,389 36,450 | 500
----------- ---------- | ----------
Income (loss) from operations......................... 33,326 47,342 | 49,185
Extraordinary gain (loss) on extinguishment of debt, |
net of income taxes.................................. 1,427 4,313 | 422,791
Cumulative effect of change in accounting for |
start-up costs....................................... - - | -
----------- ---------- | ----------
Net income (loss)............................... $ 34,753 $ 51,655 | $ 471,976
=========== ========== | ==========
Earnings (loss) per common share: |
Basic: |
Income (loss) from operations....................... $ 1.92 $ 3.05 | $ 0.69
Extraordinary gain (loss) on extinguishment of debt. 0.08 0.28 | 6.02
Cumulative effect of change in accounting for |
start-up costs..................................... - - | -
----------- ---------- | ----------
Net income (loss)............................... $ 2.00 $ 3.33 | $ 6.71
=========== ========== | ==========
Diluted: |
Income (loss) from operations....................... $ 1.85 $ 2.59 | $ 0.69
Extraordinary gain (loss) on extinguishment of debt. 0.08 0.24 | 5.90
Cumulative effect of change in accounting for |
start-up costs..................................... - - | -
----------- ---------- | ----------
Net income (loss)............................... $ 1.93 $ 2.83 | $ 6.59
=========== ========== | ==========
Shares used in computing earnings (loss) per |
common share: |
Basic............................................... 17,361 15,505 | 70,261
Diluted............................................. 18,001 18,258 | 71,656
|
Financial Position: |
Working capital (deficit)............................. $ 338,160 $ 316,847 | $ 286,037
Assets................................................ 1,644,178 1,508,874 | 1,330,022
Long-term debt........................................ 162,008 212,269 | -
Long-term debt in default classified as current....... - - | -
Liabilities subject to compromise..................... - - | 1,278,223
Stockholders' equity (deficit)........................ 631,628 590,481 | (480,930)
|
Operating Data: |
Number of nursing centers: |
Owned or leased..................................... 278 282 | 278
Managed............................................. 7 23 | 35
Number of nursing center licensed beds: |
Owned or leased..................................... 36,573 36,926 | 36,469
Managed............................................. 803 2,367 | 3,861
Number of nursing center patient days (b)............. 11,383,328 8,583,270 | 2,804,982
Nursing center occupancy % (b)........................ 84.7 84.9 | 85.2
Number of hospitals................................... 65 57 | 56
Number of hospital licensed beds...................... 5,385 4,961 | 4,867
Number of hospital patient days....................... 1,200,024 802,425 | 273,029
Hospital occupancy %.................................. 65.3 62.6 | 65.3
Predecessor Company
-------------------------------------
Year ended December 31,
-------------------------------------
2000 1999 1998
----------- ----------- -----------
Statement of Operations Data:
Revenues.............................................. $ 2,888,542 $ 2,665,641 $ 2,999,739
----------- ----------- -----------
Salaries, wage and benefits........................... 1,623,955 1,566,227 1,753,023
Supplies.............................................. 374,540 347,789 340,053
Rent.................................................. 307,809 305,120 234,144
Other operating expenses.............................. 503,770 964,413 947,889
Depreciation and amortization......................... 73,545 93,196 124,617
Interest expense...................................... 60,431 80,442 107,008
Investment income..................................... (5,393) (5,188) (4,688)
----------- ----------- -----------
2,938,657 3,351,999 3,502,046
----------- ----------- -----------
Income (loss) before reorganization items
and income taxes..................................... (50,115) (686,358) (502,307)
Reorganization items.................................. 12,636 18,606 -
----------- ----------- -----------
Income (loss) before income taxes..................... (62,751) (704,964) (502,307)
Provision for income taxes............................ 2,000 500 76,099
----------- ----------- -----------
Income (loss) from operations......................... (64,751) (705,464) (578,406)
Extraordinary gain (loss) on extinguishment of debt,
net of income taxes.................................. - - (77,937)
Cumulative effect of change in accounting for
start-up costs....................................... - (8,923) -
----------- ----------- -----------
Net income (loss)............................... $ (64,751) $ (714,387) $ (656,343)
=========== =========== ===========
Earnings (loss) per common share:
Basic:
Income (loss) from operations....................... $ (0.94) $ (10.03) $ (8.47)
Extraordinary gain (loss) on extinguishment of debt. - - (1.14)
Cumulative effect of change in accounting for
start-up costs..................................... - (0.13) -
----------- ----------- -----------
Net income (loss)............................... $ (0.94) $ (10.16) $ (9.61)
=========== =========== ===========
Diluted:
Income (loss) from operations....................... $ (0.94) $ (10.03) $ (8.47)
Extraordinary gain (loss) on extinguishment of debt. - - (1.14)
Cumulative effect of change in accounting for
start-up costs..................................... - (0.13) -
----------- ----------- -----------
Net income (loss)............................... $ (0.94) $ (10.16) $ (9.61)
=========== =========== ===========
Shares used in computing earnings (loss) per
common share:
Basic............................................... 70,229 70,406 68,343
Diluted............................................. 70,229 70,406 68,343
Financial Position:
Working capital (deficit)............................. $ 267,161 $ 195,011 $ (682,569)
Assets................................................ 1,334,414 1,235,974 1,774,372
Long-term debt........................................ - - 6,600
Long-term debt in default classified as current....... - - 760,885
Liabilities subject to compromise..................... 1,260,373 1,159,417 -
Stockholders' equity (deficit)........................ (471,734) (406,022) 307,747
Operating Data:
Number of nursing centers:
Owned or leased..................................... 278 282 278
Managed............................................. 34 13 13
Number of nursing center licensed beds:
Owned or leased..................................... 36,466 36,912 36,701
Managed............................................. 3,723 1,661 1,661
Number of nursing center patient days (b)............. 11,580,295 11,656,439 11,939,266
Nursing center occupancy % (b)........................ 86.1 86.8 87.3
Number of hospitals................................... 56 56 57
Number of hospital licensed beds...................... 4,886 4,931 4,979
Number of hospital patient days....................... 1,044,663 982,301 947,488
Hospital occupancy %.................................. 60.8 56.9 54.0
- --------
(a) As discussed in note 1 of the notes to consolidated financial statements,
we adopted the provisions of SFAS No. 142 (as defined), "Goodwill and Other
Intangible Assets," which requires that goodwill should no longer be
amortized effective January 1, 2002.
(b) Excludes managed facilities.
48
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
You should read the following discussion together with the selected
financial data in Item 6 and our consolidated financial statements included in
this report.
Overview
We provide long-term healthcare services primarily through the operation of
nursing centers and hospitals. At December 31, 2002, our health services
division operated 285 nursing centers with 37,376 licensed beds in 32 states
and a rehabilitation therapy business. Our hospital division operated 65
hospitals with 5,385 licensed beds in 24 states and an institutional pharmacy
business.
On May 1, 1998, Ventas completed the Spin-off through the distribution of
our former common stock to its stockholders. Ventas retained ownership of
substantially all of its real property and leases this real property to us
under the Master Lease Agreements. In anticipation of the Spin-off, we were
incorporated on March 27, 1998. For accounting purposes, the consolidated
historical financial statements of Ventas became our historical financial
statements following the Spin-off.
From September 13, 1999 until April 20, 2001, we operated our businesses as
a debtor-in-possession subject to the jurisdiction of the Bankruptcy Court. On
April 20, 2001, the Plan of Reorganization became effective and we emerged from
bankruptcy with our current capital structure and amended Master Lease
Agreements with Ventas. In connection with our emergence from bankruptcy, we
changed our name to Kindred Healthcare, Inc.
Basis of Presentation
During the period in which we operated our businesses as a
debtor-in-possession, our consolidated financial statements were prepared in
accordance with SOP 90-7 and generally accepted accounting principles
applicable to a going concern, which assume that assets will be realized and
liabilities will be discharged in the normal course of business.
In connection with our emergence from bankruptcy, we reflected the terms of
the Plan of Reorganization in our consolidated financial statements by adopting
the fresh-start accounting provisions of SOP 90-7. Under fresh-start
accounting, a new reporting entity is deemed to be created and the recorded
amounts of assets and liabilities are adjusted to reflect their estimated fair
values. For accounting purposes, the fresh-start adjustments were recorded in
our consolidated financial statements as of April 1, 2001. Since fresh-start
accounting materially changed the amounts previously recorded in our
consolidated financial statements, a black line separates the post-emergence
financial data from the pre-emergence financial data to signify the difference
in the basis of preparation of the financial statements for each respective
entity. See note 3 of the notes to consolidated financial statements.
While the adoption of fresh-start accounting as of April 1, 2001 materially
changed the amounts previously recorded in our consolidated financial
statements, we believe that our business segment operating income prior to
April 1, 2001 is generally comparable to our business segment operating income
after April 1, 2001. However, our capital costs (rent, interest, depreciation
and amortization) prior to April 1, 2001 that were based on pre-petition
contractual agreements and historical costs are not comparable to those capital
costs recorded after April 1, 2001. In addition, our reported financial
position and cash flows for periods prior to April 1, 2001 generally are not
comparable to those for periods thereafter.
In connection with the implementation of fresh-start accounting, we recorded
an extraordinary gain of $423 million from the restructuring of our debt in
accordance with the provisions of the Plan of Reorganization. Other significant
adjustments also were recorded to reflect the provisions of the Plan of
Reorganization and the fair values of our assets and liabilities as of April 1,
2001. For accounting purposes, these transactions were reflected in our
operating results for the three months ended March 31, 2001.
49
Critical Accounting Policies
Our discussion and analysis of financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires the use of
estimates and judgments that affect the reported amounts and related
disclosures of commitments and contingencies. We rely on historical experience
and on various other assumptions that we believe to be reasonable under the
circumstances to make judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
may differ materially from these estimates.
We believe the following critical accounting policies, among others, affect
the more significant judgments and estimates used in the preparation of our
consolidated financial statements.
Revenue recognition
We have agreements with third party payors that provide for payments to our
nursing centers and hospitals. 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.
We provide care to patients in our hospitals covered by Medicare
supplemental insurance policies which generally become effective when a
patient's Medicare benefits are exhausted. Disputes related to the level of
payments to our hospitals have arisen with private insurance companies issuing
these policies as a result of different interpretations of policy provisions
and federal and state laws governing the policies. While we continue to pursue
favorable resolutions of these claims, we recorded provisions for loss
aggregating $7 million in 2002, $17 million in 2001 and $20 million in 2000.
A summary of revenues by payor type follows (in thousands):
Reorganized Company | Predecessor Company
------------------------- | ------------------------
Year Nine months | Three months Year
ended ended | ended ended
December 31, December 31, | March 31, December 31,
2002 2001 | 2001 2000
------------ ------------ | ------------ ------------
Medicare......... $1,377,457 $ 901,505 | $288,390 $1,050,758
Medicaid......... 1,122,295 799,428 | 233,160 925,356
Private and other 922,756 673,794 | 245,532 969,557
---------- ---------- | -------- ----------
3,422,508 2,374,727 | 767,082 2,945,671
Elimination...... (64,686) (45,708) | (14,673) (57,129)
---------- ---------- | -------- ----------
$3,357,822 $2,329,019 | $752,409 $2,888,542
========== ========== | ======== ==========
Collectibility of accounts receivable
Accounts receivable consist primarily of amounts due from the Medicare and
Medicaid programs, other government programs, managed care health plans,
commercial insurance companies and individual patients. Estimated provisions
for doubtful accounts are recorded to the extent it is probable that a portion
or all of a particular account will not be collected.
In evaluating the collectibility of accounts receivable, we consider a
number of factors, including the age of the accounts, changes in collection
patterns, the composition of patient accounts by payor type, the status of
50
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 $14 million for 2002, $16
million for the nine months ended December 31, 2001, $6 million for the three
months ended March 31, 2001 and $29 million for 2000.
Allowances for insurance risks
We insure a substantial portion of our 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 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 costs vary from historical provisions for loss, future earnings will be
charged or credited.
Provisions for loss for professional liability risks retained by our limited
purpose insurance subsidiary have been discounted based upon management's
estimate of long-term investment yields and independent actuarial estimates of
claim payment patterns. The interest rate used to discount funded professional
liability risks in each of the last three years was 5%. Amounts equal to the
discounted loss provision are funded annually. We do 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 $275
million at December 31, 2002 and $176 million at December 31, 2001. The
discounted allowance for professional liability risks recorded in our
consolidated financial statements aggregated $257 million at December 31, 2002
and $163 million at December 31, 2001.
During 2002, we recorded substantial cost increases related to professional
liability risks. A portion of these costs were not funded into our limited
purpose insurance subsidiary in 2002. Based upon actuarially determined
estimates, we will fund approximately $63 million into our limited purpose
insurance subsidiary on March 31, 2003 to satisfy fiscal 2002 funding
requirements.
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 our estimated and ultimate
actual number of claims or average cost per claim 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 December 31, 2002 would impact our operating
income by approximately $3 million.
The provision for professional liability risks, including the cost of
coverage maintained with unaffiliated commercial insurance carriers, aggregated
$145 million for 2002, $53 million for the nine months ended December 31, 2001,
$13 million for the three months ended March 31, 2001 and $53 million for 2000.
Provisions for loss for workers compensation risks retained by our limited
purpose insurance subsidiary are not discounted and amounts equal to the loss
provision are funded annually. The allowance for workers compensation risks
aggregated $53 million at December 31, 2002 and $34 million at December 31,
2001. The provision for loss for workers compensation risks, including the cost
of coverage maintained with unaffiliated commercial insurance carriers,
aggregated $44 million for 2002, $27 million for the nine months ended December
31, 2001, $10 million for the three months ended March 31, 2001 and $35 million
for 2000.
See notes 7 and 12 of the notes to consolidated financial statements.
51
Accounting for income taxes
The provision for income taxes is based upon our estimate of taxable income
or loss for each respective accounting period. We recognize an asset or
liability for the deferred tax consequences of temporary differences between
the tax bases of assets and liabilities and their reported amounts in the
financial statements. These temporary differences will result in taxable or
deductible amounts in future years when the reported amounts of the assets are
recovered or liabilities are settled. We also recognize as deferred tax assets
the future tax benefits from net operating and capital loss carryforwards.
There are significant uncertainties with respect to professional liability
costs and future Medicare payments to both our nursing centers and hospitals
which could affect materially the realization of certain deferred tax assets.
Accordingly, we have recognized deferred tax assets 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. We recognized deferred tax assets totaling $75 million at
December 31, 2002 and $32 million at December 31, 2001.
If all or a portion of the pre-reorganization deferred tax asset is realized
in the future, or considered "more likely than not" to be realized by us,
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. As described in note 11 of the
notes to consolidated financial statements, goodwill was reduced by $48 million
in 2002 and $45 million in 2001 related to the recognition of
pre-reorganization deferred tax assets.
Valuation of long-lived assets and goodwill
We regularly review the carrying value of certain long-lived assets and the
related identifiable intangible assets with respect to any events or
circumstances that indicate an impairment or an adjustment to the amortization
period is necessary. If circumstances suggest the recorded amounts cannot be
recovered, calculated based upon estimated future undiscounted cash flows, the
carrying values of such assets are reduced to fair value.
In assessing the carrying values of long-lived assets, we estimate future
cash flows at the lowest level for which there are independent, identifiable
cash flows. For this purpose, these cash flows are aggregated based upon the
contractual agreements underlying the operation of the facility or group of
facilities. Generally, an individual operating facility is considered the
lowest level for which there are independent, identifiable cash flows. However,
to the extent that groups of facilities are leased under a master lease
agreement in which the operations of a facility and compliance with the lease
terms are interdependent upon other facilities in the agreement (including our
ability to renew the lease or divest a particular property), we define the
group of facilities under the master lease as the lowest level for which there
are independent, identifiable cash flows. Accordingly, the estimated cash flows
of all facilities within a master lease are aggregated for purposes of
evaluating the carrying values of long-lived assets.
In connection with the June 2001 issuance of Statement of Financial
Accounting Standards ("SFAS") No. 142 ("SFAS 142"), "Goodwill and Other
Intangible Assets," we ceased the amortization of goodwill beginning on January
1, 2002. In lieu of amortization, we are required to perform an impairment test
for goodwill at least annually or more frequently if adverse events or changes
in circumstances indicate that the asset may be impaired. We perform our annual
impairment test at the end of each year. No impairment charge was recorded at
December 31, 2002 in connection with our annual impairment test.
Recent Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (the "FASB")
issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51." The primary objectives of
FIN 46 are to provide guidance on the identification of entities for which
control is achieved
52
through means other than through voting rights ("variable interest entities" or
"VIEs") and how to determine when and which business enterprise should
consolidate the VIE (the "primary beneficiary"). This new model for
consolidation applies to an entity in which either (1) the equity investors (if
any) do not have a controlling financial interest or (2) the equity investment
at risk is insufficient to finance that entity's activities without receiving
additional subordinated financial support from other parties. In addition, FIN
46 requires that both the primary beneficiary and all other enterprises with a
significant variable interest in a VIE make additional disclosures. The
provisions of FIN 46 will become effective for us in 2003. The adoption of FIN
46 is not expected to have an impact on our financial position, results of
operations or liquidity.
In December 2002, the FASB issued SFAS No. 148 ("SFAS 148"), "Accounting for
Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS 123."
SFAS 148 provides transitional guidance for recognizing an entity's voluntary
decision to change its method of accounting for stock-based employee
compensation to the fair-value method. In addition, SFAS 148 amends the
disclosure requirements of SFAS No. 123 ("SFAS 123"), "Accounting for
Stock-Based Compensation," so that entities will have to (1) make more
prominent disclosures regarding the pro forma effects of using the fair-value
method of accounting for stock-based compensation, (2) present those
disclosures in a more accessible format in the footnotes to the annual
financial statements, and (3) include those disclosures in interim financial
statements. We have elected not to change our method of accounting for
stock-based compensation under SFAS 123. The SFAS 148 transition and annual
disclosure provisions are effective for our fiscal year ended December 31, 2002.
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, an interpretation of FASB
Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34."
FIN 45 requires that upon issuance of a guarantee, the issuing entity must
recognize a liability for the fair value of the obligation it assumes under
that guarantee. FIN 45 requires disclosure about each guarantee even if the
likelihood of the guarantor having to make any payments under the guarantee is
remote. The provisions for initial recognition and measurement are effective on
a prospective basis for guarantees that are issued or modified after December
31, 2002. The disclosure provisions of FIN 45 are effective for accounting
periods ending after December 15, 2002. The adoption of FIN 45 is not expected
to have a material impact on our financial position, results of operations or
liquidity.
In July 2002, the FASB issued 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"
and requires liabilities associated with exit and disposal activities to be
expensed as incurred. SFAS 146 will be effective for exit and disposal
activities 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 us 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.
53
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 costs 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 us on January 1, 2002. The adoption of SFAS
144 did not affect our financial position or results of operations.
As previously discussed, the FASB issued in June 2001 SFAS 142, which
established 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 us on January 1, 2002.
In conformity with the provisions of SFAS 142, we performed a transitional
impairment test for goodwill as of January 1, 2002 and an annual impairment
test as of December 31, 2002. No write-down of the carrying value of goodwill
was required. In addition, amortization expense for 2002 was reduced by
approximately $6 million.
Regulatory Changes
The Balanced Budget Act contained extensive changes to the Medicare and
Medicaid programs intended to reduce the projected amount of increase in
payments under those programs over a five year period. Virtually all spending
reductions were derived from reimbursements to providers and changes in program
components. The Balanced Budget Act has affected adversely the revenues in each
of our operating divisions.
The Balanced Budget Act established PPS for nursing centers for cost
reporting periods beginning on or after July 1, 1998. All of our nursing
centers adopted PPS on July 1, 1998. During the first three years, the per diem
rates for nursing centers were based on a blend of facility-specific costs and
federal rates. Effective July 1, 2001, the per diem rates 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 Balanced Budget Act also reduced payments made to our hospitals by
reducing TEFRA incentive payments, allowable costs for capital expenditures and
bad debts, and payments for services to patients transferred from a general
short-term acute care hospital. In addition, the Balanced Budget Act reduced
allowable costs for capital expenditures by 15%. These reductions have had a
material adverse impact on hospital revenues.
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 is mostly attributable to efforts by nursing centers to
reduce operating costs. As a result, many nursing centers have elected to
provide ancillary services to their patients through internal staff. In
response to PPS and a significant decline in the demand for ancillary services,
we realigned our former ancillary services division in 1999 by integrating the
physical rehabilitation, speech and occupational therapy businesses into the
health services division and assigning the institutional pharmacy business to
the hospital division. Our respiratory therapy and other ancillary businesses
were discontinued.
Various legislative and regulatory actions have provided a measure of relief
from the impact of the Balanced Budget Act. In November 1999, the BBRA was
enacted. Effective April 1, 2000, the BBRA (a) implemented a
54
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.
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 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
$38 million in 2002, $32 million in 2001 and $18 million in 2000.
In December 2000, BIPA was enacted to provide up to $35 billion in
additional funding to the Medicare and Medicaid programs over the next five
years. Under BIPA, the nursing component for each 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 2002.
BIPA also extended the two-year moratorium on outpatient therapy limitations
for skilled nursing center patients under the BBRA through December 31, 2002.
On February 7, 2003, CMS instructed fiscal intermediaries to apply the therapy
limitations for all outpatient rehabilitation services in a prospective manner
beginning with claims submitted for dates of service on or after July 1, 2003.
For each subsequent year, the therapy limitation will be effective for the
entire calendar year.
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.
Our nursing centers received reimbursement under the BBRA (including amounts
related to the 20% upward adjustment discussed above) of approximately $51
million in 2002, $47 million in 2001 and $21 million in 2000. Revenues
associated with BIPA aggregated approximately $32 million in 2002 and $30
million in 2001.
As previously discussed, certain Medicare reimbursement provisions under the
BBRA and BIPA expired as scheduled on October 1, 2002. Accordingly, Medicare
reimbursement to our nursing centers declined by approximately $35 per patient
day or $15 million in the fourth quarter of 2002, resulting in a material
reduction in nursing center operating income.
On October 1, 2002, the provision under the Balanced Budget Act reducing
allowable hospital capital expenditures by 15% expired. As a result, hospital
Medicare revenues increased by approximately $2 million in the fourth quarter
of 2002.
On August 30, 2002, CMS issued final regulations for the new LTAC PPS that
became effective on October 1, 2002. Because of our Medicare cost reporting
periods, this new payment system will not become effective for all but two of
our long-term acute care hospitals until September 1, 2003.
As anticipated, LTAC PPS is based on DRGs similar to the system used to pay
short-term acute care hospitals. While the clinical system which groups
procedures and diagnoses is identical to the prospective payment system for
short-term acute care hospitals, the new payment system utilizes different
rates and formulas. Three types of payments will be used in the new system: (a)
short stay outlier that will provide for patients whose length of stay is less
than 5/6th of the average length of stay for that DRG, a payment based upon the
lesser of (1) a per diem based upon the average payment for that DRG, (2) the
estimated costs plus 20%, or (3) the full DRG payment; (b) DRG fixed payment
which provides a single payment for all patients with a given DRG,
55
regardless of length of stay, cost of care or place of discharge; and (c) high
cost outlier that will provide a partial coverage of costs for patients whose
cost of care far exceeds the DRG reimbursement. For patients in the high cost
outlier category, Medicare will reimburse 80% of the costs incurred above the
DRG reimbursement plus a fixed cost outlier threshold of $24,450 per discharge.
The new system provides for an adjustment for differences in area wages
resulting from salary and benefit variations. There also are additional rules
for payment for patients who are transferred from a long-term care hospital to
another healthcare setting and are subsequently re-admitted to the long-term
care hospital. The LTAC PPS payment rates also are subject to annual
adjustments.
The new system maintains long-term acute care hospitals as a distinct
provider type, separate from short-term acute care hospitals. Only providers
certified as long-term acute care hospitals may be paid under the new system.
To maintain certification under the new payment system, the average length of
stay of Medicare patients must be at least 25 days. Under the previous system,
compliance with the 25-day average length of stay threshold was based on all
patient discharges.
As previously noted, the new system became effective for cost reporting
periods beginning after October 1, 2002. As an alternative to the immediate
adoption of LTAC PPS, long-term acute care hospitals may elect to phase in the
new system over five years. These phase-in provisions will enable providers to
make the necessary operational changes over the next several years to support a
smooth clinical and financial transition to the new payment system.
Our hospitals currently receive interim cash payments under TEFRA as a
result of submitting interim and final patient bills twice each month. Under
LTAC PPS, a provider will choose one of two methods of receiving interim cash
payments: (1) by billing each patient at the earlier of the time of discharge
or 60 days from the time of admission or (2) by electing a periodic interim
payment methodology which estimates the total annual LTAC PPS reimbursement by
hospital and converts that amount into a bi-weekly cash payment. Either payment
system may negatively impact the hospital division's operating cash flows in
2003.
We continue to review the extensive regulations associated with the new LTAC
PPS. Based upon our analysis to date, we believe that the new system should not
have a material impact on our hospital operating results but may negatively
impact operating cash flows in the short term. These preliminary estimates are
based upon current patient acuity and expense levels in our hospitals. These
factors, among others, are subject to significant change. Slight variations in
patient acuity could significantly change Medicare revenues generated under
LTAC PPS. In addition, our hospitals may not be able to appropriately adjust
their operating costs as patient acuity levels change. As a result of these
uncertainties, we cannot predict the ultimate impact of the new LTAC PPS on our
hospital operating results and we cannot assure you that such regulations or
operational changes resulting from these regulations will not have a material
adverse impact on our financial position, results of operations or liquidity.
In addition, we cannot assure you that the new LTAC PPS will not have a
material adverse effect on revenues from non-government third party payors.
There continue to be legislative and regulatory proposals that would impose
further limitations on government and private payments to providers of
healthcare services. By repealing the Boren Amendment, the Balanced Budget Act
eased existing impediments on the ability of states to reduce their Medicaid
reimbursement levels. 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. In addition, budgetary pressures currently
impacting a number of states may further reduce Medicaid payments to our
nursing centers. Some states also are considering regulatory changes that
include a moratorium on the designation of additional long-term acute care
hospitals. Additionally, regulatory changes in the Medicaid reimbursement
system applicable to our 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.
56
We could be affected adversely by the continuing efforts of governmental and
private third party payors to contain healthcare costs. We cannot assure you
that payments under governmental and private third party payor programs and
Medicare supplemental insurance policies will remain at levels comparable to
present levels or will be sufficient to cover the costs allocable to patients
eligible for reimbursement pursuant to these programs. In addition, we cannot
assure you that the facilities operated by us, or the provision of services and
supplies by us, will meet the requirements for participation in such programs.
We cannot assure you that future healthcare legislation or other changes in
the administration or interpretation of governmental healthcare programs will
not have a material adverse effect on our financial position, results of
operations or liquidity.
57
Results of Operations
For the years ended December 31, 2002, 2001 and 2000
Since our adoption of fresh-start accounting had no material effect on the
comparability of our segment operating income, we have combined the respective
operating results of the Reorganized Company and the Predecessor Company for
fiscal 2001.
A summary of our operating data follows (dollars in thousands):
| Predecessor Predecessor
Reorganized Company | Company Combined Company
------------------------- | ------------ ------------ ------------
Year Nine months | Three months Year Year
ended ended | ended ended ended
December 31, December 31, | March 31, December 31, December 31,
2002 2001 | 2001 2001 2000
------------ ------------ | ------------ ------------ ------------
Revenues: |
Health services division: |
Nursing centers................. $1,854,131 $1,348,236 | $429,523 $1,777,759 $1,675,627
Rehabilitation services......... 34,296 27,451 | 10,695 38,146 135,036
Elimination..................... - - | - - (77,191)
---------- ---------- | -------- ---------- ----------
1,888,427 1,375,687 | 440,218 1,815,905 1,733,472
Hospital division: |
Hospitals....................... 1,276,299 822,935 | 271,984 1,094,919 1,007,947
Pharmacy........................ 257,782 176,105 | 54,880 230,985 204,252
---------- ---------- | -------- ---------- ----------
1,534,081 999,040 | 326,864 1,325,904 1,212,199
---------- ---------- | -------- ---------- ----------
3,422,508 2,374,727 | 767,082 3,141,809 2,945,671
Elimination of pharmacy charges to |
our nursing centers............. (64,686) (45,708) | (14,673) (60,381) (57,129)
---------- ---------- | -------- ---------- ----------
$3,357,822 $2,329,019 | $752,409 $3,081,428 $2,888,542
========== ========== | ======== ========== ==========
Operating income: |
Health services division: |
Nursing centers................. $ 226,284 $ 234,500 | $ 70,543 $ 305,043 $ 278,738
Rehabilitation services......... 7,531 8,112 | 690 8,802 8,047
Other ancillary services........ 435 508 | 250 758 4,737
---------- ---------- | -------- ---------- ----------
234,250 243,120 | 71,483 314,603 291,522
Hospital division: |
Hospitals....................... 260,440 157,613 | 54,778 212,391 205,858
Pharmacy........................ 23,531 20,831 | 6,176 27,007 7,421
---------- ---------- | -------- ---------- ----------
283,971 178,444 | 60,954 239,398 213,279
Corporate overhead................ (117,204) (85,239) | (28,697) (113,936) (113,823)
---------- ---------- | -------- ---------- ----------
401,017 336,325 | 103,740 440,065 390,978
Unusual transactions.............. 1,795 5,425 | - 5,425 (4,701)
Reorganization items.............. 5,520 - | 53,666 53,666 (12,636)
---------- ---------- | -------- ---------- ----------
$ 408,332 $ 341,750 | $157,406 $ 499,156 $ 373,641
========== ========== | ======== ========== ==========
58
| Predecessor Predecessor
Reorganized Company | Company Combined Company
------------------------- | ------------ ------------ ------------
Year Nine months | Three months Year Year
ended ended | ended ended ended
December 31, December 31, | March 31, December 31, December 31,
2002 2001 | 2001 2001 2000
------------ ------------ | ------------ ------------ ------------
Nursing Center Data: |
Revenue mix %: |
Medicare................ 33 32 | 31 32 28
Medicaid................ 48 47 | 47 47 49
Private and other....... 19 21 | 22 21 23
|
Patient days (a): |
Medicare................ 1,728,232 1,218,663 | 411,783 1,630,446 1,541,934
Medicaid................ 7,656,980 5,750,949 | 1,860,256 7,611,205 7,735,567
Private and other....... 1,998,116 1,613,658 | 532,943 2,146,601 2,302,794
----------- ---------- | ---------- ----------- -----------
11,383,328 8,583,270 | 2,804,982 11,388,252 11,580,295
=========== ========== | ========== =========== ===========
Revenues per patient day: |
Medicare................ $ 353 $ 349 | $ 325 $ 343 $ 303
Medicaid................ 116 111 | 109 111 106
Private and other....... 180 175 | 175 175 169
Weighted average...... 163 157 | 153 156 145
|
Hospital Data: |
Revenue mix %: |
Medicare................ 59 57 | 56 57 55
Medicaid................ 9 9 | 11 10 10
Private and other....... 32 34 | 33 33 35
|
Patient days: |
Medicare................ 835,597 534,583 | 185,731 720,314 704,152
Medicaid................ 134,822 103,377 | 34,872 138,249 134,754
Private and other....... 229,605 164,465 | 52,426 216,891 205,757
----------- ---------- | ---------- ----------- -----------
1,200,024 802,425 | 273,029 1,075,454 1,044,663
=========== ========== | ========== =========== ===========
|
Revenues per patient day: |
Medicare................ $ 907 $ 877 | $ 820 $ 862 $ 789
Medicaid................ 836 733 | 871 768 773
Private and other....... 1,767 1,693 | 1,703 1,696 1,693
Weighted average...... 1,064 1,026 | 996 1,018 965
- --------
(a) Excludes managed facilities.
59
Health Services Division-Nursing Centers
Revenues increased 4% in 2002 to $1.9 billion and 6% in 2001 to $1.8
billion. Our patient days in 2002 aggregated 11.4 million, relatively unchanged
from the prior year, while total patient days in 2001 declined 1.7% compared to
2000. On a same-store basis, patient volumes increased slightly in 2002 and
declined 1% in 2001 (including private census declines of 7% in both years).
Substantially all of the increase in revenues in both years was attributable
to increased Medicare and Medicaid funding and price increases to private
payors. Medicaid rates grew 4% in 2002 and 5% in 2001, while private rates rose
approximately 3% in both years.
Medicare revenues per patient day increased 3% in 2002 to $353 and 13% in
2001 to $343. The increase in Medicare funding was primarily attributable to
reimbursement increases associated with the BBRA and BIPA. As previously
discussed, the BBRA established, among other things, a 20% increase in Medicare
payment rates for higher acuity patients effective April 1, 2000 and a 4%
increase in all PPS payments beginning on October 1, 2000. Under the provisions
of BIPA, the nursing component of each RUG category was increased 16.66% over
the existing rates for skilled nursing care beginning on April 1, 2001. As a
result, the provisions of the BBRA increased Medicare reimbursement to our
nursing centers by approximately $51 million in 2002, $47 million in 2001 and
$21 million in 2000, while BIPA added $32 million of additional revenues in
2002 and $30 million in 2001. The expiration of certain Medicare reimbursement
provisions under the BBRA and BIPA on October 1, 2002 reduced fourth quarter
healthcare revenues by approximately $15 million.
Nursing center operating income declined 26% in 2002 to $226 million and
increased 9% in 2001 to $305 million. Operating margins were 12.2% in 2002
compared to 17.2% in 2001 and 16.6% in 2000. Despite increased revenues,
operating income in 2002 declined due to wage and benefit pressures and
substantial increases in professional liability costs. The improvement in
operating income in 2001 was primarily attributable to increased Medicare
funding.
Wage and benefit costs (including contract labor) increased 7% to $1.1
billion in 2002 and 14% to $1.0 billion in 2001. As a result of a highly
competitive marketplace for healthcare professionals, our average hourly wage
rates rose 5% in 2002 and 8% in 2001, while employee benefit costs (primarily
health and workers compensation costs) rose 14% in 2002 and 13% in 2001.
During 2002, we recorded significant increases in professional liability
costs in our nursing center business. These costs aggregated $127 million in
2002, $53 million in 2001 and $40 million in 2000. Approximately 61% of the
2002 costs related to our nursing centers in Florida. As a result of the
significant professional liability costs in Florida, pretax losses for these
nursing centers approximated $68 million in 2002. As previously announced, we
intend to divest our nursing center operations in Florida in 2003. See
"Business - Recent Developments."
Health Services Division-Rehabilitation Services
Revenues declined 10% in 2002 to $34 million and 72% in 2001 to $38 million.
The decline in revenues in 2001 was primarily attributable to the transfer of
all remaining rehabilitation services provided to our company-operated nursing
centers to the internal staff of those nursing centers on January 1, 2001.
Revenues for these services approximated $77 million in 2000. Revenues also
declined as a result of the elimination of unprofitable external contracts.
Operating income totaled $8 million in 2002 compared to $9 million in 2001
and $8 million in 2000. Substantially all of the operating income during these
periods resulted from contracts with external customers. Revenues in 2000 for
rehabilitation services provided to our own nursing centers approximated the
costs of these services. As a result, the operating results since 2000 do not
reflect any operating income related to intercompany transactions.
60
Health Services Division-Other Ancillary Services
Other ancillary services refers to certain ancillary businesses (primarily
respiratory therapy) that were discontinued as part of the realignment of our
former ancillary services division in the fourth quarter of 1999. Operating
results for 2000 reflected a $4 million favorable adjustment for doubtful
accounts resulting from collections from discontinued customer accounts.
Hospital Division-Hospitals
Revenues increased 17% in 2002 to $1.3 billion and 9% in 2001 to $1.1
billion. Aggregate patient days increased 12% in 2002 to 1.2 million and 3% in
2001 to 1.1 million. The acquisition of Specialty added approximately $66
million in revenues and 70,000 patient days in 2002. On a same-store basis,
revenues increased 9% in both 2002 and 2001 while patient days rose 4% in 2002
and 3% in 2001.
In addition to increased patient volumes, higher rates generally contributed
to growth in hospital revenues. Aggregate rates increased approximately 4% in
2002 and 6% in 2001. Private rates increased 4% in 2002 and were relatively
unchanged in 2001 compared to the prior year. As discussed in note 7 of the
notes to consolidated financial statements, private revenues in 2002 included a
$12 million favorable settlement of a dispute with a private insurance company
for services provided in prior years. Excluding the settlement, private rates
rose 1% in 2002 compared to 2001. Medicare revenues per patient day increased
5% in 2002 and 9% in 2001, while Medicaid rates improved 9% in 2002 and were
relatively unchanged in 2001 compared to the prior year.
Hospital operating income rose 23% in 2002 to $260 million and 3% in 2001 to
$212 million. Operating income in 2002 included the previously discussed $12
million favorable settlement, while the acquisition of Specialty increased 2002
operating income by approximately $9 million. Operating margins were 20.4% in
2002 compared to 19.4% in 2001 and 20.4% in 2000.
Wage and benefit costs (including contract labor) increased 19% to $654
million in 2002 and 12% to $552 million in 2001. Substantially all of the
growth in wages during 2002 and 2001 was attributable to wage rate pressures
and growth in patient volumes. As a result of a highly competitive marketplace
for healthcare professionals (particularly registered nurses), our average
hourly wage rates rose 7% in 2002 and 5% in 2001, while employee benefit costs
(primarily health and workers compensation costs) rose 25% in 2002 and 12% in
2001. As a result of labor shortages in certain markets, contract labor costs
increased to $40 million in 2002 from $29 million in 2001 and $20 million in
2000.
Professional liability costs were $17 million in 2002, $11 million in 2001
and $12 million in 2000.
Hospital Division-Pharmacy
Revenues increased 12% in 2002 to $258 million and 13% in 2001 to $231
million. The increase in both periods resulted primarily from growth in the
number of nursing center customers. At December 31, 2002, we provided pharmacy
services to nursing centers containing 58,800 licensed beds, including 30,000
licensed beds that we operate. The aggregate number of customer licensed beds
at December 31, 2001 totaled 55,100 compared to 50,000 at December 31, 2000.
Our pharmacies reported operating income of $24 million in 2002 compared to
$27 million in 2001 and $7 million in 2000. Despite increases in revenues,
pharmacy operating margins declined in 2002 to 9% from 12% in 2001. The cost of
goods sold as a percentage of revenues rose to 62% in 2002 from 60% in 2001,
primarily as a result of Medicaid reimbursement reductions in certain states
and increased utilization of higher cost drugs. Growth in pharmacy operating
income in 2001 resulted from increased revenues and an improvement in the ratio
of cost of goods sold to 60% in 2001 from 62% in 2000. We also substantially
improved our cash collections in 2001, resulting in a $8 million reduction in
the provision for doubtful accounts.
61
Intercompany pharmacy prices charged to our nursing centers (related
primarily to Medicare-eligible patients) were based on fixed per diem amounts
that are adjusted annually for inflation. Under this pricing arrangement, the
financial risks associated with increased pharmaceutical utilization are borne
by our pharmacies. Beginning in 2003, new intercompany fee-for-service pricing
arrangements will go into effect, thereby shifting the financial risks for
pharmaceutical utilization to our nursing centers.
Corporate Overhead
Operating income for our operating divisions excludes allocations of
corporate overhead. These costs aggregated $117 million in 2002 and $114
million in both 2001 and 2000. As a percentage of revenues (before
eliminations), corporate overhead totaled 3.4% in 2002, 3.6% in 2001 and 3.9%
in 2000.
Reorganization Items
Transactions related to our reorganization have been classified separately
in our consolidated statement of operations. Operating results for 2002
included income of approximately $6 million resulting from changes in estimates
for accrued professional and administrative costs recorded in the second
quarter related to our emergence from bankruptcy. Reorganization items
increased income from operations by approximately $54 million for the three
months ended March 31, 2001. As previously discussed, these adjustments were
required to reflect the provisions of the Plan of Reorganization and the fair
value of our assets and liabilities as of April 1, 2001. Reorganization costs
incurred in connection with the bankruptcy approximated $13 million in 2000.
Unusual Transactions
Operating results for each of the last three years included certain unusual
transactions. These transactions were included in other operating expenses in
the consolidated statement of operations for the respective periods in which
they were recorded.
2002
Operating results for 2002 included a $0.5 million lease termination charge
for an unprofitable hospital recorded in the second quarter and a $2 million
gain on the sale of a building recorded in the fourth quarter.
2001
Operating results for the nine months ended December 31, 2001 included a
gain of $3 million recorded in connection with our favorable resolution of a
legal dispute in the third quarter and a gain of $2 million in connection with
the resolution of a loss contingency related to a partnership interest in the
fourth quarter.
2000
Operating results for 2000 included a $5 million gain on the sale of a
closed hospital recorded in the second quarter and a $9 million write-off of an
impaired investment recorded in the third quarter.
Capital Costs
As previously discussed, the adjustments recorded in connection with
fresh-start accounting materially changed the recorded amounts for rent,
interest, depreciation and amortization in our consolidated statement of
operations since April 1, 2001. As a result, our capital costs after April 1,
2001 are not comparable to our capital costs prior to April 1, 2001.
Capital costs for periods subsequent to the adoption of fresh-start
accounting reflect the terms of the Plan of Reorganization and include the
effects of reduced rent obligations under the Master Lease Agreements and
62
interest costs incurred in connection with the debt obligations that we assumed
at the time of our emergence from bankruptcy. Depreciation and amortization
costs since our emergence from bankruptcy have been recorded based on asset
carrying amounts that were adjusted in fresh-start accounting to reflect fair
value on April 1, 2001.
During the pendency of our bankruptcy, we recorded the contractual amount of
interest expense related to our former $1.0 billion bank credit facility and
the rents due to Ventas under the pre-petition master lease agreements. No
interest costs were recorded related to our former $300 million 9 7/8%
Guaranteed Senior Subordinated Notes due 2005 since the filing of our
bankruptcy. Contractual interest expense not accrued for the $300 million
9 7/8% Guaranteed Senior Subordinated Notes totaled $7 million for the three
months ended March 31, 2001 and $30 million for 2000.
As discussed in note 1 of the notes to consolidated financial statements, we
adopted the provisions of SFAS 142, which, among other things, requires that
goodwill should no longer be amortized effective January 1, 2002. The adoption
of this new pronouncement increased 2002 net income by approximately $6 million.
Income Taxes
The provision for income taxes is based upon our estimate of taxable income
or loss for each respective accounting period and includes the effect of
certain non-taxable and non-deductible items, such as goodwill amortization and
the increase or decrease in the deferred tax valuation allowance.
We have reduced our net deferred tax assets by a valuation allowance to the
extent we do not believe it is "more likely than not" that the asset ultimately
will be realizable. If all or a portion of the pre-reorganization deferred tax
asset is realized in the future, or considered "more likely than not" to be
realizable by us, the goodwill recorded in connection with fresh-start
accounting will be reduced accordingly. If the goodwill is eliminated in full,
other intangible assets will then be reduced, with any excess treated as an
increase to capital in excess of par value. As of December 31, 2002, we had
reduced the valuation allowance established in fresh-start accounting by
approximately $93 million, resulting in a corresponding reduction to goodwill.
In connection with the reorganization, we 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, we
will be required, beginning with our 2002 taxable year, to reduce certain tax
attributes including (a) net operating losses, (b) certain tax credits and (c)
tax bases in assets in an amount equal to such gain on extinguishment. Our
reorganization on April 20, 2001 constituted an ownership change under Section
382 of the Internal Revenue Code and the use of any of our net operating losses
and tax credits generated prior to the ownership change may be subject to
certain limitations. Through December 31, 2002, we had realized approximately
$41 million of cash flow benefits related to the previously discussed tax
attributes.
Our net operating losses at December 31, 2002 aggregated $243 million. These
carryforwards expire in various amounts through 2021.
Consolidated Results
Income from operations aggregated $33 million in 2002, including $6 million
($3 million net of tax) of income related to certain reorganization items. We
reported income from operations of $47 million for the nine months ended
December 31, 2001, resulting from improved operating income and the significant
impact of the Plan of Reorganization. For the three months ended March 31,
2001, we reported income from operations of $49 million, including a gain of
$54 million recorded in connection with fresh-start accounting. For 2000, we
reported a net operating loss of $65 million, including $13 million of costs
incurred in connection with our restructuring activities.
Extraordinary gains from the early extinguishment of debt since our
emergence from bankruptcy aggregated $1 million in 2002 and $4 million for the
nine months ended December 31, 2001.
63
Fourth Quarter Operating Results
A summary of our income from operations follows (dollars in thousands):
Reorganized Company
------------------------
Three months Three months
ended ended
December 31, December 31,
2002 2001
------------ ------------
Income from operations:
Operating income:
Health services division:
Nursing centers........... $ 39,035 $ 75,426
Rehabilitation services... 921 4,125
Other ancillary services.. 92 179
-------- --------
40,048 79,730
Hospital division:
Hospitals................. 67,561 52,119
Pharmacy.................. 6,174 7,793
-------- --------
73,735 59,912
Corporate overhead.......... (21,569) (27,358)
-------- --------
92,214 112,284
Unusual transactions........ 2,320 2,187
-------- --------
Operating income.......... 94,534 114,471
Rent......................... (68,806) (65,471)
Depreciation and amortization (18,960) (17,565)
Interest, net................ (1,085) (3,117)
-------- --------
Income before income taxes... 5,683 28,318
Provision for income taxes... 2,614 12,264
-------- --------
$ 3,069 $ 16,054
======== ========
In the fourth quarter of 2002, we reported operating income of $95 million
and income from operations of $3 million. Operating income in the fourth
quarter of 2001 totaled $114 million and income from operations aggregated $16
million. Operating results for the fourth quarter of 2002 included the
following items:
Medicare reimbursement changes-As previously discussed, certain Medicare
reimbursement provisions under the BBRA and BIPA expired on October 1, 2002.
Accordingly, Medicare reimbursement to our nursing centers declined by
approximately $35 per patient day or $15 million in the fourth quarter of 2002,
resulting in a material reduction in nursing center operating income. See "-
Regulatory Changes."
On October 1, 2002, the provisions under the Balanced Budget Act reducing
allowable hospital capital expenditures by 15% expired. As a result, hospital
Medicare revenues increased by approximately $2 million in the fourth quarter
of 2002.
Professional liability risks-Based upon the results of the regular quarterly
independent actuarial valuation, we recorded additional professional liability
costs of $19 million in the fourth quarter of 2002, of which $10 million had
been previously announced at the time of our third quarter earnings release.
Aggregate professional liability costs in the fourth quarter of 2002 were $37
million compared to $24 million in the fourth quarter of 2001. Most of these
costs ($33 million in the fourth quarter of 2002 and $18 million in the fourth
quarter of 2001) were charged to our nursing center business.
64
Fourth quarter adjustments-Operating results in the fourth quarter of 2002
included certain other year-end adjustments. Incentive compensation costs were
reduced by approximately $3 million in the nursing center business and $6
million in corporate overhead in the fourth quarter. In addition, certain
operating expense accruals related to our information systems operations were
adjusted, reducing corporate overhead by approximately $4 million in the fourth
quarter of 2002.
Unusual items-As previously discussed, a gain of approximately $2 million on
the sale of a building was recorded in the fourth quarter of 2002.
Liquidity
Cash flows from operations before reorganization items aggregated $254
million for 2002, $191 million for the nine months ended December 31, 2001, $40
million for the three months ended March 31, 2001 and $194 million for 2000.
Operating cash flows for all periods were sufficient to fund reorganization
costs and capital expenditures.
Cash and cash equivalents totaled $244 million at December 31, 2002 while
funded long-term debt aggregated $162 million. Based upon our existing cash
levels, expected operating cash flows and capital spending, and the
availability of borrowings under our revolving credit facility, we believe we
have the necessary financial resources to satisfy our expected short-term
liquidity needs. There were no outstanding borrowings under our revolving
credit facility at December 31, 2002.
Operating cash flows in 2002 reflected a substantial improvement in
collection of accounts receivable, particularly Medicare receivables in our
hospitals. In addition, we accelerated the filing of our nursing center cost
reports in the fourth quarter of 2002, thereby increasing operating cash flows
by approximately $17 million. Aggregate outstanding accounts receivable days
improved to 45.6 at December 31, 2002 from 48.8 at December 31, 2001.
On September 1, 2003, substantially all of our hospitals will become subject
to the new LTAC PPS. In connection with the transition, the new system includes
certain regulations that will impact the method and timing of Medicare payments
to our hospitals that may increase substantially our Medicare accounts
receivable in the third and fourth quarters of 2003, thereby reducing our
operating cash flows. See " - Regulatory Changes."
As previously discussed, we recorded substantial cost increases related to
professional liability risks in 2002. A portion of these costs were not funded
into our limited purpose insurance subsidiary in 2002. Based upon actuarially
determined estimates, we will fund approximately $63 million into our limited
purpose insurance subsidiary on March 31, 2003 to satisfy fiscal 2002 funding
requirements.
Since our emergence from bankruptcy, we have reduced our long-term debt by
approximately $200 million. In August 2002, we repaid $50 million of long-term
debt through the use of existing cash. In the fourth quarter of 2001, we
completed the public offering of approximately 2.1 million shares of our common
stock. Proceeds from the offering aggregating $90 million were used to repay a
portion of our outstanding senior secured notes. In May 2001, we repaid
approximately $56 million in full satisfaction of our obligation owed to CMS
through the use of existing cash.
In connection with the emergence from bankruptcy, we entered into a
five-year $120 million revolving credit facility (including a $40 million
letter of credit subfacility) on April 20, 2001. Our revolving credit facility
constitutes a working capital facility for general corporate purposes including
payments related to our obligations under the Plan of Reorganization. Direct
borrowings under our revolving credit facility will bear interest, at our
option, at (a) prime (or, if higher, the federal funds rate plus 1/2%) plus 3%
or (b) the London Interbank Offered Rate (as defined in the agreement) plus 4%.
The revolving credit facility is collateralized by substantially all of our
assets, including certain owned real property. At December 31, 2002, there were
no outstanding borrowings under our revolving credit facility.
65
As part of our Plan of Reorganization, we also issued $300 million of senior
secured notes on April 20, 2001. Our senior secured notes have a maturity of
seven years and bear interest at the London Interbank Offered Rate (as defined
in the agreement) plus 4 1/2%. The interest on our $300 million senior secured
notes began to accrue in November 2001. For accounting purposes, we recorded
the appropriate interest costs from April 2001 to November 2001 and intend to
amortize the amount accrued during the interest-free period over the remaining
life of the debt. Our senior secured notes are collateralized by a second
priority lien on substantially all of our assets, including certain owned real
property.
The terms of our senior secured notes and our revolving credit facility
(inclusive of the amendments discussed below) include certain covenants which
limit our annual capital expenditures and limit the amount of debt we may incur
in financing acquisitions. In addition, these agreements restrict our ability
to transfer funds to the parent company or repurchase our common stock and
prohibit the payment of cash dividends to our stockholders.
In April 2002, we announced certain amendments to the terms of our revolving
credit facility and senior secured notes. The more significant changes to these
agreements allowed us to make acquisitions and investments in healthcare
facilities up to an aggregate amount of $130 million compared to $30 million
before the amendments. In addition, the amendments allowed us to borrow up to
$45 million under the revolving credit facility to finance future acquisitions
and investments in healthcare facilities. The amount of credit under the
revolving credit facility, which was reduced to $75 million in connection with
our equity offering in the fourth quarter of 2001, was restored to the $120
million level that was in effect prior to the offering. The amendments also
allowed us to pay cash dividends or repurchase our common stock in limited
amounts based upon certain annual liquidity calculations. Finally, we agreed to
certain revised financial covenants. Other material terms of the credit
agreements, including maturities, repayment terms and rates of interest, were
unchanged.
In August 2002, we announced certain other amendments to the terms of our
revolving credit facility and senior secured notes that allowed for the
repurchase of up to $35 million of our common stock. As part of these
amendments, we prepaid $50 million of the senior secured notes. In addition,
these amendments also allowed for a $10 million increase in our annual capital
expenditure limits beginning in fiscal 2003. We also agreed to certain revised
financial covenants. Other material terms of the credit agreements, including
maturities, repayment terms and rates of interest, were unchanged.
As discussed in note 13 of the notes to consolidated financial statements,
we amended certain financial covenants for periods after December 31, 2002
under our revolving credit facility and senior secured notes on March 19, 2003.
These amendments reflect the estimated future financial impact of certain
Medicare reimbursement reductions to our nursing centers that became effective
on October 1, 2002 and expected significant increases in professional liability
costs. In connection with the amendments, the previous amendments (as discussed
above) allowing us to repurchase our common stock, pay limited dividends and
increase annual capital expenditures beginning in fiscal 2003 were rescinded.
In addition, the amount of allowable acquisitions and investment in healthcare
facilities was reduced to $50 million from $130 million. As of December 31,
2002, we had expended approximately $30 million in allowable acquisitions and
investments in healthcare facilities. Other material terms of the credit
agreements, including maturities, repayment terms and rates of interest, were
unchanged.
At December 31, 2002, we were in compliance with the terms of our revolving
credit facility and our senior secured notes.
As previously discussed, we have recently experienced a significant increase
in professional liability costs. These costs are expected to continue to
increase in the foreseeable future, particularly in Florida. In addition, the
expiration of certain Medicare funding under the BBRA and BIPA on October 1,
2002 reduced the average Medicare rate received by our nursing centers by
approximately $35 per patient day (approximately $15 million in the fourth
quarter of 2002). Accordingly, we believe that the combined effect of these
changes in revenues and expenses will have a material adverse effect on our
financial position, results of operations and liquidity in the future. These
changes also could result in our inability to satisfy certain financial
covenants contained in our revolving credit facility and senior secured notes
in the future.
66
Future payments due under long-term debt agreements, lease obligations and
certain other contractual commitments as of December 31, 2002 follows (in
thousands):
Payments due by period
--------------------------------------------------------------------------------------
Letters of General
Senior Other Non-cancelable operating leases credit and unsecured
secured long-term ------------------------------ guarantees of creditor
Year notes debt Ventas (a) Other Total indebtedness obligations Total
- ---- -------- --------- ---------- -------- ---------- ------------- ----------- ----------
2003...... $ - $ 258 $ 185,896 $ 54,814 $ 240,710 $ 216 $5,210 $ 246,394
2004...... - 64 185,896 46,528 232,424 216 2,619 235,323
2005...... - 70 185,896 44,561 230,457 217 - 230,744
2006...... - 76 185,896 41,217 227,113 5,883 - 233,072
2007...... - 83 185,896 35,754 221,650 - - 221,733
Thereafter 160,500 1,215 442,604 161,111 603,715 - - 765,430
-------- ------ ---------- -------- ---------- ------ ------ ----------
Total... $160,500 $1,766 $1,372,084 $383,985 $1,756,069 $6,532 $7,829 $1,932,696
======== ====== ========== ======== ========== ====== ====== ==========
- --------
(a) See "Business - Master Lease Agreements - Rental Amounts and Escalators."
Capital Resources
Excluding acquisitions, capital expenditures totaled $84 million for 2002,
$65 million for the nine months ended December 31, 2001, $22 million for the
three months ended March 31, 2001 and $80 million in 2000. Excluding
acquisitions, capital expenditures could approximate $80 million in 2003. We
believe that our capital expenditure program is adequate to improve and equip
existing facilities. Capital expenditures in all periods were financed through
internally generated funds. At December 31, 2002, the estimated cost to
complete and equip construction in progress approximated $3 million.
During 2002, we expended $46 million to acquire Specialty. For the nine
months ended December 31, 2001, we expended $14 million to acquire previously
leased nursing centers.
In May 2001, we sold our investment in Behavioral Healthcare Corporation for
$40 million. Under the terms of our revolving credit facility and senior
secured notes, proceeds from the sale of assets will be available to fund
future capital expenditures for a period of approximately one year from the
sale. Any proceeds not expended during that period would be used to permanently
reduce the commitments under our revolving credit facility to as low as $75
million and repay any outstanding loans in excess of such commitment. Any
remaining proceeds would be used to repay loans under our senior secured notes.
Since our emergence from bankruptcy, funds derived from asset sales have been
used to repay long-term debt (approximately $22 million) and to fund capital
expenditures (approximately $21 million). For accounting purposes, we have
classified $2 million and $6 million of remaining funds from the sales of
assets as "cash-restricted" in our consolidated balance sheet at December 31,
2002 and December 31, 2001, respectively.
Related Party Transactions
Pursuant to the Plan of Reorganization, we issued to certain claimholders in
exchange for their claims an aggregate of (1) $300 million of our senior
secured notes, (2) 15,000,000 shares of common stock, (3) 2,000,000 Series A
warrants, and (4) 5,000,000 Series B warrants. Each of the Series A warrants
and the Series B warrants has a five-year term with an exercise price of $30.00
and $33.33 per share, respectively. As a result of the exchange described
above, the holders of certain claims acquired control of us and the holders of
our former common stock relinquished control.
In connection with the Plan of Reorganization, we also entered into a
registration rights agreement (the "Registration Rights Agreement") with
Appaloosa Management L.P., Franklin Mutual Advisers, LLC, Goldman, Sachs & Co.
and Ventas Realty, Limited Partnership (the "Rights Holders"). Mr. David A.
Tepper, one of our
67
directors, is the President of Appaloosa Management L.P. Mr. Tepper also is the
general partner of Appaloosa Management L.P. Mr. James Bolin, one of our
directors, was the Vice President and Secretary of Appaloosa Management L.P.
until October 2002. Mr. Michael J. Embler, one of our directors, is a Vice
President of Franklin Mutual Advisers, LLC.
The Registration Rights Agreement requires us to use our reasonable best
efforts to file, cause to be declared effective and keep effective for at least
two years or until all of the Rights Holders' shares of common stock or
warrants are sold, a "shelf" registration statement covering sales of such
Rights Holders' shares of common stock and warrants or, in the case of Ventas,
the distribution of some or all of the shares of our common stock that it owns
to the Ventas stockholders. We filed the shelf registration statement on Form
S-3 with the SEC on September 19, 2001. The shelf registration statement became
effective on November 7, 2001.
The Registration Rights Agreement also provides that, subject to certain
limitations, each Rights Holder has the right to demand that we register all or
a part of the common stock and warrants acquired by that Rights Holder pursuant
to the Plan of Reorganization, provided that the estimated market value of the
common stock and warrants to be registered is at least $10 million in the
aggregate or not less than 5% of the common stock and warrants. We are required
to use our reasonable best efforts to effect any such registration. Such
registrations will be at our expense, subject to certain exceptions.
In addition, under the Registration Rights Agreement, the Rights Holders
have certain rights to require us to include in any registration statement that
we file with respect to any offering of equity securities (whether for our own
account or for the account of any holders of our securities) such amount of
common stock and warrants as are requested by the Rights Holder to be included
in the registration statement, subject to certain exceptions. Such
registrations will be at our expense, subject to certain exceptions. As
discussed below, the parties to the Registration Rights Agreement participated
in our public equity offering in the fourth quarter of 2001.
Pursuant to Amendment No. 1 to the Registration Rights Agreement, dated as
of August 13, 2001, the parties to the Registration Rights Agreement agreed to
extend the deadline for us to file a "shelf" registration statement from 120
days to 150 days after the Effective Date. As noted above, we filed a shelf
registration statement with the SEC on September 19, 2001, and the shelf
registration statement was declared effective on November 7, 2001.
Pursuant to Amendment No. 2 to the Registration Rights Agreement, dated as
of October 22, 2001, the parties to the Registration Rights Agreement agreed to
an exception to certain restrictions in the Registration Rights Agreement to
allow Ventas to distribute up to 350,000 shares of our common stock that it
owns to its stockholders on or after December 24, 2001.
In the fourth quarter of 2001, we completed a public offering of
approximately 3.6 million shares of our common stock priced at $46.00 per
share. In the offering, we sold approximately 2.1 million newly issued shares
and certain of the holders of five percent or more of our common stock
participated in the offering as selling shareholders.
In connection with the Plan of Reorganization, we also entered into and
assumed several agreements with Ventas. In addition to our common stock
received by Ventas in the Plan of Reorganization, we amended and restated the
Master Lease Agreements with Ventas and paid Ventas a $4.5 million cash payment
in April 2001 as additional future rent. We also assumed and agreed to continue
to perform our obligations under various agreements (the "Spin-off Agreements")
entered into at the time of the Spin-off. Descriptions of the agreements with
Ventas are summarized below.
68
Master Lease Agreements and Related Transactions
Under the Plan of Reorganization, we assumed the original master lease
agreements with Ventas and its affiliates and simultaneously amended and
restated the agreements into four new master leases. See "Business -Master
Lease Agreements" for a summary of the Master Lease Agreements.
Transactions Associated with the Master Lease Agreements
During 2002, we entered into transactions with Ventas regarding certain
facilities leased under the Master Lease Agreements. These transactions are
described below.
Under one of the Master Lease Agreements, we lease from Ventas a nursing
center in Walpole, Massachusetts commonly known as Harrington House Nursing and
Rehabilitation Center (the "Kindred Walpole Facility"). Ventas owned the
Kindred Walpole Facility together with an adjacent independent/assisted living
facility (the "Third Party Walpole Facility") that was leased by a third party.
Ventas desired to convert the Kindred Walpole Facility and the Third Party
Walpole Facility into condominiums (the "Condominiumization") to permit the
third party to purchase the Third Party Walpole Facility from Ventas. Ventas
informed Kindred that the third party was seeking to make this purchase in
order to facilitate the financing of accommodations at the Third Party Walpole
Facility by the third party's residents.
The Kindred Walpole Facility was contained within the boundaries of one
condominium unit forming a part of the condominium and its appurtenant "limited
common elements" and the Third Party Walpole Facility was contained within the
boundaries of the other condominium unit forming a part of the condominium and
its appurtenant "limited common elements." In addition, a portion of the
property being subjected to the Condominiumization will, as a "general common
element," be the responsibility of a condominium association (the costs of
which are to be split evenly between the owners of each unit). With the
exception of the "general common elements," the owners of each unit will be
responsible for the maintenance and operation of such units and any "limited
common elements" appurtenant thereto.
In order to reflect that the Kindred Walpole Facility will be part of a
condominium, it was necessary to amend the Master Lease Agreement solely with
respect to the Kindred Walpole Facility. Following the Condominiumization, the
Master Lease Agreement will be subordinate to certain condominium documents. It
is not anticipated that this transaction will materially impact any other
rights or obligations (monetary or otherwise) with respect to the Kindred
Walpole Facility. We did not receive any consideration for this transaction
other than reimbursement by Ventas of attorney's fees and title examination
expenses directly related to the transaction. The Condominiumization
transaction was completed on December 19, 2002.
Under one of the Master Lease Agreements, we leased from Ventas a hospital
known as the Northern Virginia Community Hospital in Arlington, Virginia.
Ventas entered into an agreement dated as of May 31, 2002 with the Northern
Virginia Community Hospital, LLC ("NVCH") to sell the hospital to NVCH. Since
we were not generating a profit at the hospital, we agreed to terminate the
provisions of the Master Lease Agreement specifically as it relates to the
hospital and to transfer operating control of the hospital to NVCH. We also
entered into an operations transfer agreement, dated as of June 5, 2002, with
NVCH under which we transferred certain inventory, supplies, leases, contracts,
and operating control of the hospital to NVCH effective as of June 20, 2002.
Kindred received no portion of the sale proceeds, but rent and other lease
obligations specific to the hospital, were terminated subsequent to June 2,
2002. We further agreed to sell certain equipment to NVCH for $150,000.
Under one of the Master Lease Agreements, we lease from Ventas a hospital
known as the Kindred Hospital in Mansfield, Texas. In June 2000, the hospital
sustained severe water damage from an intensive rainstorm and all patients were
relocated to other facilities. We subsequently restored, but chose not to
reopen the hospital. We and Ventas entered into a Forbearance Agreement
pursuant to which Ventas agreed to forbear, until October 31,
69
2001, from declaring an event of default pursuant to the Master Lease Agreement
for our failure to reopen the hospital. Ventas made periodic extensions of the
Forbearance Agreement while we attempted to find a buyer or sublessee for the
hospital. Subsequently, we agreed to enter into negotiations to sublease the
hospital to an unrelated third party. The third party informed us that it
preferred to purchase the hospital rather than sublease it. In order to obtain
further extensions of the Forbearance Agreement, we agreed to pay Ventas a
$50,000 non-refundable extension fee. The third party subsequently entered into
a purchase and sale agreement with Ventas dated May 29, 2002 to purchase the
hospital. The third party subsequently terminated the purchase agreement on
June 25, 2002, agreed to reinstate the purchase agreement and then again
terminated the purchase agreement on July 9, 2002. Ventas then informed us that
we would be required to reopen the hospital on or prior to September 4, 2002.
We reopened the hospital on August 30, 2002.
Spin-off Agreements and other Arrangements Under the Plan of Reorganization
In order to govern certain of the relationships between us and Ventas after
the Spin-off and to provide mechanisms for an orderly transition, we entered
into the Spin-off Agreements with Ventas at the time of the Spin-off. Except as
noted below, the following agreements between Ventas and us were assumed by us
and certain of these agreements were simultaneously amended in accordance with
the terms of the Plan of Reorganization.
Tax Allocation Agreement and Tax Refund Escrow Agreement
The Tax Allocation Agreement, entered into at the time of the Spin-off, was
assumed by us under the Plan of Reorganization and then amended and
supplemented by the Tax Refund Escrow Agreement (as defined below). Both of
these agreements are described below.
The Tax Allocation Agreement provides that we will be liable for, and will
hold Ventas harmless from and against, (1) any taxes of Kindred and its then
subsidiaries (the "Kindred Group") for periods after the Spin-off, (2) any
taxes of Ventas and its then subsidiaries (the "Ventas Group") or the Kindred
Group for periods prior to the Spin-off (other than taxes associated with the
Spin-off) with respect to the portion of such taxes attributable to assets
owned by the Kindred Group immediately after completion of the Spin-off and (3)
any taxes attributable to the Spin-off to the extent that we derive certain tax
benefits as a result of the payment of such taxes. Under the Tax Allocation
Agreement, we would be entitled to any refund or credit in respect of taxes
owed or paid by us under (1), (2) or (3) above. Our liability for taxes for
purposes of the Tax Allocation Agreement would be measured by Ventas's actual
liability for taxes after applying certain tax benefits otherwise available to
Ventas other than tax benefits that Ventas in good faith determines would
actually offset tax liabilities of Ventas in other taxable years or periods.
Any right to a refund for purposes of the Tax Allocation Agreement would be
measured by the actual refund or credit attributable to the adjustment without
regard to offsetting tax attributes of Ventas.
Under the Tax Allocation Agreement, Ventas would be liable for, and would
hold us harmless against, any taxes imposed on the Ventas Group or the Kindred
Group other than taxes for which the Kindred Group is liable as described in
the above paragraph. Ventas would be entitled to any refund or credit for taxes
owed or paid by Ventas as described in this paragraph. Ventas's liability for
taxes for purposes of the Tax Allocation Agreement would be measured by the
Kindred Group's actual liability for taxes after applying certain tax benefits
otherwise available to the Kindred Group other than tax benefits that the
Kindred Group in good faith determines would actually offset tax liabilities of
the Kindred Group in other taxable years or periods. Any right to a refund
would be measured by the actual refund or credit attributable to the adjustment
without regard to offsetting tax attributes of the Kindred Group.
On the Effective Date, we entered into the Tax Refund Escrow Agreement and
First Amendment to the Tax Allocation Agreement (the "Tax Refund Escrow
Agreement") with Ventas governing our and Ventas's relative entitlement to
certain tax refunds received on or after September 13, 1999 by Ventas or us for
the tax periods prior to and including the Spin-off that each has received or
may receive in the future. The Tax Refund Escrow
70
Agreement amends and supplements the Tax Allocation Agreement. Under the terms
of the Tax Refund Escrow Agreement, refunds ("Subject Refunds") received on or
after September 13, 1999 by either Ventas or us with respect to federal, state
or local income, gross receipts, windfall profits, transfer, duty, value-added,
property, franchise, license, excise, sales and use, capital, employment,
withholding, payroll, occupational or similar business taxes (including
interest, penalties and additions to tax, but excluding certain refunds), for
taxable periods ending on or prior to May 1, 1998 ("Subject Taxes") were
deposited into an escrow account with a third party escrow agent on the
Effective Date.
The Tax Refund Escrow Agreement provides that each party shall notify the
other of any asserted Subject Tax liability of which it becomes aware, that
either party may request that asserted liabilities for Subject Taxes be
contested, that neither party may settle such a contest without the consent of
the other, that each party shall have a right to participate in any such
contest, and that the parties generally shall cooperate with regard to Subject
Taxes and Subject Refunds and shall mutually and jointly control any audit or
review process related thereto. The funds in the escrow account may be released
from the escrow account to pay Subject Taxes and as otherwise provided therein.
The Tax Refund Escrow Agreement provides generally that we and Ventas waive
their respective rights under the Tax Allocation Agreement to make claims
against each other with respect to Subject Taxes satisfied by the escrow funds,
notwithstanding the indemnification provisions of the Tax Allocation Agreement.
To the extent that the escrow funds are insufficient to satisfy all liabilities
for Subject Taxes that are finally determined to be due (such excess amount,
"Excess Taxes"), the relative liability of Ventas and Kindred to pay such
Excess Taxes shall be determined as provided in the Tax Refund Escrow
Agreement. Disputes under the Tax Refund Escrow Agreement, and the
determination of the relative liability of Ventas and Kindred to pay Excess
Taxes, if any, are governed by the arbitration provision of the Tax Allocation
Agreement.
Interest earned on the escrow funds or included in refund amounts received
from governmental authorities will be distributed equally to Ventas and us on
an annual basis. For the years ended December 31, 2002 and 2001, we have
recorded approximately $261,000 and $368,000, respectively, of interest income
related to the escrow funds. Any escrow funds remaining in the escrow account
after no further claims may be made by governmental authorities with respect to
Subject Taxes or Subject Refunds (because of the expiration of statutes of
limitation or otherwise) will be distributed equally to Ventas and us.
Agreement of Indemnity-Third Party Leases
In connection with the Spin-off, Ventas assigned its former third party
lease obligations (i.e., leases under which an unrelated third party is the
landlord) as a tenant or as a guarantor of tenant to us. The lessors of these
properties may claim that Ventas remains liable on these third party leases
assigned to us. Under the terms of the Agreement of Indemnity-Third Party
Leases, we have agreed to indemnify and hold Ventas harmless from and against
all claims against Ventas arising out of these third party leases. Under the
Plan of Reorganization, we assumed and agreed to fulfill our obligations under
the Agreement of Indemnity-Third Party Leases.
Agreement of Indemnity-Third Party Contracts
In connection with the Spin-off, Ventas assigned its former third party
guaranty agreements to us. Ventas may remain liable on these third party
guarantees assigned to us. Under the terms of the Agreement of Indemnity-Third
Party Contracts, we have agreed to indemnify and hold Ventas harmless from and
against all claims against Ventas arising out of these third party guarantees
assigned to us. The third party guarantees were entered into in connection with
certain acquisitions and financing transactions that occurred prior to the
Spin-off. Under the Plan of Reorganization, we assumed and agreed to fulfill
our obligations under the Agreement of Indemnity-Third Party Contracts.
71
Assumption of other Liabilities
In connection with the Spin-off, we agreed to assume and to indemnify Ventas
for any and all liabilities that may arise out of the ownership or operation of
the healthcare operations either before or after the date of the Spin-off. The
indemnification provided by us also covers losses, including costs and
expenses, which may arise from any future claims asserted against Ventas based
on these healthcare operations. In addition, at the time of the Spin-off, we
agreed to assume the defense, on behalf of Ventas, of any claims that were
pending at the time of the Spin-off, and which arose out of the ownership or
operation of the healthcare operations. We also agreed to defend, on behalf of
Ventas, any claims asserted after the Spin-off which arise out of the ownership
and operation of the healthcare operations. Under the Plan of Reorganization,
we assumed and agreed to perform our obligations under these indemnifications.
Other Transactions with Ventas
In 1992, a third party and our subsidiary as trustees of a trust (the
"Trust") leased to a related partnership a nursing center, the ground on which
the nursing center is located and the right to use the parking lot adjacent to
the nursing center. The ground lease expires in 2089. In connection with the
Spin-off, Ventas transferred, by bill of sale, its 50% general partnership
interest in the partnership to us, but inadvertently did not transfer its
interest in the Trust to us. On June 24, 2002 Ventas resigned as trustee of the
Trust, effective as of April 30, 1998, and we were appointed trustee of the
Trust. No payment was made to Ventas in connection with this transaction.
Other Related Party Transactions
Dr. Thomas P. Cooper, a nominee for election to the Board of Directors at
our shareholders meeting scheduled for May 22, 2003, is the Chairman, Chief
Executive Officer and shareholder of Vericare, Inc. ("Vericare"). Vericare has
contracts to provide mental health services to 15 skilled nursing facilities
operated by us. Under these contracts, Vericare bills the individual resident
or the appropriate third party payor for the services provided by Vericare.
Kindred does not pay Vericare for these services nor does Vericare make any
payments to Kindred related to these services.
During 2002, we paid approximately $318,600 for legal services rendered by
the law firm of Shaw Pittman LLP. The son of Edward L. Kuntz, our Chairman and
Chief Executive Officer, was employed by that firm through August 2002. We also
paid approximately $1,280,300 for legal services rendered by the law firm of
Reed Smith LLP. Mr. Kuntz's son has been employed as an associate of Reed Smith
since October 2002. The fees paid to Shaw Pittman and Reed Smith represent
approximately 1.5% and 5.9%, respectively, of the legal fees paid by us in
2002. It is anticipated that Reed Smith will provide legal services to us in
2003.
Other Information
Effects of Inflation and Changing Prices
We derive a substantial portion of our revenues from the Medicare and
Medicaid programs. In recent years, significant cost containment measures
enacted by Congress and certain state legislatures have limited our ability to
recover our cost increases through increased pricing of our healthcare
services. Medicare revenues in our nursing centers are subject to fixed
payments under PPS. Medicaid reimbursement rates in many states in which we
operate nursing centers also are based on fixed payment systems. Generally,
these rates are adjusted annually for inflation. However, these adjustments may
not reflect the actual increase in the costs of providing healthcare services.
In addition, by repealing the Boren Amendment, the Balanced Budget Act eased
existing impediments on the ability of states to reduce their Medicaid
reimbursement levels to our nursing centers. Medicare revenues in our hospitals
also have been reduced by the Balanced Budget Act.
Beginning in 2000, the BBRA provided a measure of relief to the Medicare
reimbursement reductions imposed by the Balanced Budget Act. Effective April 1,
2001, BIPA provided additional Medicare
72
reimbursement to our nursing centers and hospitals. The provisions of the BBRA
and BIPA have positively impacted our operating results in 2002 and 2001,
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 reduced our average Medicare rate paid to our
nursing centers by approximately $35 per patient day. In addition, we
experienced substantial increases in professional liability costs in our
nursing center business in 2002.
Management believes that our operating margins will continue to be under
pressure, particularly in our nursing center business, as the growth in
operating expenses, particularly professional liability, labor and employee
benefits costs, exceeds payment increases from third party payors. In addition,
as a result of competitive pressures, our ability to maintain operating margins
through price increases to private patients is limited.
Litigation
We are a party to certain material litigation. See note 21 of the notes to
consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The following discussion of our exposure to market risk contains
"forward-looking statements" that involve risks and uncertainties. The
information presented has been prepared utilizing certain assumptions
considered reasonable in light of information currently available to us. Given
the unpredictability of interest rates as well as other factors, actual results
could differ materially from those projected in such forward-looking
information.
Our only significant exposure to market risk is changes in the London
Interbank Offered Rate which affect the interest paid on our borrowings.
The following table provides information about our financial instruments
that are sensitive to changes in interest rates. The table presents principal
cash flows and related weighted average interest rates by expected maturity
date.
Interest Rate Sensitivity
Principal (Notional) Amount by Expected Maturity
Average Interest Rate
(Dollars in thousands)
Expected maturities Fair
-------------------------------------------- value
2003 2004 2005 2006 2007 Thereafter Total 12/31/02
----- ------ ------ ------ ------ ----------- -------- --------
Liabilities:
Long-term debt, including amounts
due within one year:
Fixed rate................... $258 $ 64 $ 70 $ 76 $ 83 $ 1,215 $ 1,766 $ 1,818
Average interest rate........ 9.7% 8.8% 8.8% 8.8% 8.8% 8.8%
Variable rate................ $ - $ - $ - $ - $ - $160,500 $160,500 $156,488
Average interest rate (a)
- --------
(a) Interest is payable, at our option, at one, two, three or six month London
Interbank Offered Rate plus 4 1/2%.
Item 8. Financial Statements and Supplementary Data
The information required by this Item 8 is included in appendix pages F-2
through F-51 of this Annual Report on Form 10-K.
73
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this Item other than the information set forth
above under Part I, "Executive Officers of the Registrant," is omitted because
we are filing a definitive proxy statement, which includes the required
information, pursuant to Regulation 14A not later than 120 days after the end
of the fiscal year covered by this Annual Report on Form 10-K. The required
information contained in our proxy statement is incorporated herein by
reference.
Item 11. Executive Compensation
The information required by this Item is omitted because we are filing a
definitive proxy statement, which includes the required information, pursuant
to Regulation 14A not later than 120 days after the end of the fiscal year
covered by this Annual Report on Form 10-K. The required information contained
in our proxy statement is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The information required by this Item, except as set forth below, is omitted
because we are filing a definitive proxy statement, which includes the required
information, pursuant to Regulation 14A not later than 120 days after the end
of the fiscal year covered by this Annual Report on Form 10-K. The required
information contained in our proxy statement is incorporated herein by
reference.
74
Securities Authorized for Issuance under Equity Compensation Plans
The following table represents aggregate equity compensation plan
information as of December 31, 2002 with respect to equity plans that (1) were
approved as part of our Plan of Reorganization or by our shareholders, and (2)
have not been approved, either in the Plan of Reorganization or by our
shareholders.
Equity Compensation Plan Information
Number of securities remaining
Number of securities to be available for future issuance
issued upon exercise of Weighted-average exercise under equity compensation
outstanding options, price of outstanding options, plans (excluding securities
warrants and rights warrants and rights reflected in column (a))
Plan Category (a) (b) (c)
- ------------- -------------------------- ----------------------------- ------------------------------
Equity compensation plans
approved in the Plan of
Reorganization or by
security holders (1)....... 1,290,601 (2) $33.04 1,315,959 (3)
Equity compensation plans not
approved in the Plan of
Reorganization or by
security holders (4)....... 78,000 (5) $38.60 122,000
--------- ---------
Total........................ 1,368,601 $33.36 1,437,959
========= =========
- --------
(1) The Kindred Healthcare, Inc. 2000 Stock Option Plan (the "2000 Stock Option
Plan") and Restricted Share Plan (the "Restricted Share Plan") were
approved as part of our Plan of Reorganization. The 2000 Stock Option Plan
also was ratified by our shareholders. The Kindred Healthcare, Inc. 2001
Stock Incentive Plan (the "2001 Incentive Plan") also is included in these
totals.
(2) Represents 525,401 shares of common stock underlying outstanding stock
options granted pursuant to the 2000 Stock Option Plan and 765,200 shares
of common stock underlying stock options granted pursuant to the 2001
Incentive Plan, but excludes outstanding restricted shares of common stock
awarded under the Restricted Share Plan.
(3) Includes 11,527 restricted shares of common stock available for issuance
under the Restricted Share Plan.
(4) The Stock Option Plan for Non-Employee Directors (the "Directors Plan") has
not been approved by our shareholders.
(5) Represents shares of common stock underlying stock options granted to
non-employee directors pursuant to the Directors Plan.
Description of Non-Stockholder Approved Equity Compensation Plan
Stock Option Plan for Non-Employee Directors
The Directors Plan provides for one-time grants of stock options with
respect to 10,000 shares of common stock to non-employee directors as well as
for annual grants of options with respect to 3,000 shares of common stock for
each year that the participant remains a non-employee director. Options granted
under the Directors Plan vest in four equal installments on each of the first
through fourth anniversaries of the date of grant, have an exercise price equal
to the fair market value of a share of common stock on the date of grant, and
expire after ten years.
If a participant ceases to be a director (1) because he or she was removed
from the Board, all options are canceled; (2) by reason of death or disability,
options that were exercisable at such time remain exercisable for one year
(unless they earlier expire); and (3) for any other reason, options that were
exercisable at such time remain exercisable for three months (unless they
earlier expire).
75
On exercise, the exercise price may be paid in cash, in common stock or a
combination of both. Options are not transferable during the lifetime of the
participant. The number of shares and the terms of outstanding options may be
adjusted in the event of certain corporate events. The Directors Plan may be
amended or terminated by the Board at any time.
Item 13. Certain Relationships and Related Transactions
The information required by this Item is omitted because we are filing a
definitive proxy statement, which includes the required information, pursuant
to Regulation 14A not later than 120 days after the end of the fiscal year
covered by this Annual Report on Form 10-K. The required information contained
in our proxy statement is incorporated herein by reference.
Item 14. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Within the 90 days prior to the date of this report, Kindred carried out an
evaluation under the supervision and with the participation of Kindred's
management, including the Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of Kindred's disclosure
controls and procedures. There are inherent limitations to the effectiveness of
any system of disclosure controls and procedures, including the possibility of
human error and the circumvention or overriding of the controls and procedures.
Accordingly, even effective disclosure controls and procedures can only provide
reasonable assurance of achieving their control objectives. Based upon and as
of the date of Kindred's evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the disclosure controls and procedures are
effective in all material respects to ensure that information required to be
disclosed in the reports Kindred files and submits under the Exchange Act are
recorded, processed, summarized and reported as and when required.
There have been no significant changes in our internal controls or in other
factors that could significantly affect our internal controls subsequent to the
date of the evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
76
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) Index to Consolidated Financial Statements and Financial Statement
Schedules:
Page
----
Report of Independent Accountants........................................................... F-2
Consolidated Financial Statements:
Consolidated Statement of Operations:
Reorganized Company-for the year ended December 31, 2002 and for the nine months
ended December 31, 2001
Predecessor Company-for the three months ended March 31, 2001 and for the year
ended December 31, 2000............................................................ F-3
Consolidated Balance Sheet:
Reorganized Company-December 31, 2002 and December 31, 2001.......................... F-4
Consolidated Statement of Stockholders' Equity (Deficit):
Reorganized Company-for the year ended December 31, 2002 and for the nine months
ended December 31, 2001
Predecessor Company-for the three months ended March 31, 2001 and for the year
ended December 31, 2000............................................................ F-5
Consolidated Statement of Cash Flows:
Reorganized Company-for the year ended December 31, 2002 and for the nine months
ended December 31, 2001
Predecessor Company-for the three months ended March 31, 2001 and for the year
ended December 31, 2000............................................................ F-6
Notes to Consolidated Financial Statements............................................... F-7
Quarterly Consolidated Financial Information (Unaudited)................................. F-50
Financial Statement Schedule (a):
Schedule II-Valuation and Qualifying Accounts:
Reorganized Company-for the year ended December 31, 2002 and for the nine months
ended December 31, 2001
Predecessor Company-for the three months ended March 31, 2001 and for the year
ended December 31, 2000............................................................ F-51
- --------
(a) All other schedules have been omitted because the required information is
not present or not present in material amounts.
77
(a)(2) Index to Exhibits:
Exhibit
number Description of document
- ------ -----------------------
2.1 Fourth Amended Joint Plan of Reorganization of Vencor, Inc. and Affiliated Debtors under
Chapter 11 of the Bankruptcy Code. Exhibit 2.1 to the Current Report on Form 8-K of the Company
dated March 19, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
2.2 Order Confirming the Fourth Amended Joint Plan of Reorganization of Vencor, Inc. and Affiliated
Debtors under Chapter 11 of the Bankruptcy Code, as entered by the United States Bankruptcy Court
for the District of Delaware on March 16, 2001. Exhibit 2.2 to the Current Report on Form 8-K of the
Company dated March 19, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
2.3 Stock Purchase Agreement by and among Specialty Healthcare Services, Inc., the Stockholders
Listed on Schedule I attached hereto and Kindred Healthcare, Inc. and Kindred Healthcare Operating,
Inc. dated as of April 1, 2002. Exhibit 2.1 to the Company's Form 10-Q for the quarterly period
ended March 31, 2002 (Comm. File No. 001-14057) is hereby incorporated by reference.
3.1 Amended and Restated Certificate of Incorporation of the Company. Exhibit 4.1 to the Company's
Registration Statement on Form S-3 filed August 31, 2001 (Comm. File No. 333-68838) is hereby
incorporated by reference.
3.2 Certificate of Amendment of Amended and Restated Certificate of Incorporation. Exhibit 3.1 to the
Company's Form 10-Q for the quarterly period ended March 31, 2002 (Comm. File No. 001-14057)
is hereby incorporated by reference.
3.3 Amended and Restated Bylaws of the Company.
4.1 Articles IV, IX, X and XII of the Restated Certificate of Incorporation of the Company is included in
Exhibit 3.1.
4.2 Warrant Agreement, dated as of April 20, 2001, between the Company and Wells Fargo Bank
Minnesota, National Association, as Warrant Agent (including forms of Series A Warrant Certificate
and Series B Warrant Certificate, respectively). Exhibit 4.1 to the Company's Form 8-A dated
April 20, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
4.3 The Company's 2000 Stock Option Plan. Exhibit 4.1 to the Company's Registration Statement on
Form S-8 (Reg. No. 333-59598) is hereby incorporated by reference.
4.4 The Company's Restricted Share Plan. Exhibit 4.2 to the Company's Registration Statement on
Form S-8 (Reg. No. 333-59598) is hereby incorporated by reference.
4.5 Kindred Healthcare, Inc. 2001 Stock Incentive Plan amended and restated as of February 12, 2002.
Exhibit 10.5 to the Company's Form 10-Q for the quarterly period ended March 31, 2002
(Comm. File No. 001-14057) is hereby incorporated by reference.
4.6 Kindred Healthcare, Inc. 2001 Stock Option Plan for Non-Employee Directors. Exhibit 4.2 to the
Company's Registration Statement on Form S-8 (Reg. No. 333-62022) is hereby incorporated by
reference.
4.7 Amendment No. One to Kindred Healthcare, Inc. 2001 Stock Option Plan for Non-Employee
Directors. Exhibit 4.7 to the Company's Form 10-Q for the quarterly period ended June 30, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.1 $120,000,000 Credit Agreement dated as of April 20, 2001, among Kindred Healthcare Operating,
Inc., the Company, the Lenders party thereto, the Swingline Bank party thereto, the LC Issuing Banks
party thereto, Morgan Guaranty Trust Company of New York, as Administrative Agent and
Collateral Agent and General Electric Capital Corporation, as Documentation Agent and Collateral
Monitoring Agent. Exhibit 10.1 to the Company's Form 10-Q for the quarterly period ended June 30,
2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
78
Exhibit
number Description of document
- ------ -----------------------
10.2 Amendment No. 1 dated as of November 28, 2001, under the $120,000,000 Credit Agreement dated
as of April 20, 2001 among Kindred Healthcare Operating, Inc., the Company, the Lenders,
Swingline Bank and LC Issuing Banks party thereto, JPMorgan Chase Bank (formerly named
Morgan Guaranty Trust Company of New York), as Administrative Agent and Collateral Agent, and
General Electric Capital Corporation, as Documentation Agent and Collateral Monitoring Agent.
Exhibit 10.2 to the Company's Form 10-K for the year ended December 31, 2001 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.3 Amendment No. 2 dated as of March 22, 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 10.1 to the Company's Form 10-Q for the quarterly period
ended March 31, 2002 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.4 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.
10.5 Amendment No. 4, dated as of March 19, 2003, 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
March 19, 2003 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.6 Credit Agreement Providing for the Issuance of $300,000,000 Senior Secured Notes due 2008 dated
as of April 20, 2001 among Kindred Healthcare Operating, Inc., the Company, the Lenders party
thereto and Morgan Guaranty Trust Company of New York, as Collateral Agent and Administrative
Agent. Exhibit 10.2 to the Company's Form 10-Q for the quarterly period ended June 30, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.7 Amendment No. 1 dated as of November 28, 2001, under the $300,000,000 Credit Agreement dated
as of April 20, 2001 among Kindred Healthcare Operating, Inc., the Company, the Lenders party
thereto and JPMorgan Chase Bank (formerly named Morgan Guaranty Trust Company of New
York), as Administrative Agent and Collateral Agent. Exhibit 10.4 to the Company's Form 10-K for
the year ended December 31, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.8 Amendment No. 2 dated as of March 22, 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 10.2
to the Company's Form 10-Q for the quarterly period ended March 31, 2002 (Comm. File
No. 001-14057) is hereby incorporated by reference.
79
Exhibit
number Description of document
- ------ -----------------------
10.9 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.
10.10 Amendment No. 4, dated as of March 19, 2003, 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 March 19, 2003 (Comm. File No. 001-14057) is
hereby incorporated by reference.
10.11 Registration Rights Agreement, dated April 20, 2001 among the Company and the Initial Holders (as
defined therein). Exhibit 10.1 to the Company's Form 8-A dated April 20, 2001 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.12 Amendment No. 1 to Registration Rights Agreement dated as of August 18, 2001 among the
Company and the Initial Holders (as defined therein). Exhibit 4.5 to the Company's Registration
Statement on Form S-3 filed August 31, 2001 (Comm. File No. 333-68838) is hereby incorporated by
reference.
10.13 Amendment No. 2 to Registration Rights Agreement dated as of October 22, 2001 among the
Company and the Initial Holders (as defined therein). Exhibit 4.6 to the Company's Registration
Statement on Form S-3 filed August 31, 2001 (Comm. File No. 333-68838) is hereby incorporated by
reference.
10.14 Trust Agreement between T. Rowe Price Trust Company and Kindred Healthcare, Inc. for Kindred
401(k) Plan.
10.15 Trust Agreement between T. Rowe Price Trust Company and Kindred Healthcare, Inc. for Kindred
and Affiliates 401(k) Plan.
10.16 Vencor Retirement Savings Plan Amended and Restated effective as of March 1, 2000. Exhibit 10.6
to the Company's Form 10-Q for the quarterly period ended March 31, 2000 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.17 Amendment No. 1 to the Vencor Retirement Savings Plan dated September 26, 2000. Exhibit 10.8 to
the Company's Form 10-Q for the quarterly period ended September 30, 2000 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.18 Amendment No. 2 to the Vencor Retirement Savings Plan. Exhibit 10.11 to the Company's
Form 10-K for the year ended December 31, 2001 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.19 Amendment No. 3 to the Kindred 401(k) Plan. Exhibit 10.12 to the Company's Form 10-K for the
year ended December 31, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.20 Amendment No. 4 to the Kindred 401(k) Plan.
10.21 Amendment No. 5 to the Kindred 401(k) Plan.
10.22 Amendment No. 6 to the Kindred 401(k) Plan.
10.23 Retirement Savings Plan for Certain Employees of Vencor and its Affiliates Amended and Restated
effective as of March 1, 2000. Exhibit 10.7 to the Company's Form 10-Q for the quarterly period
ended March 31, 2000 (Comm. File No. 001-14057) is hereby incorporated by reference.
80
Exhibit
number Description of document
- ------ -----------------------
10.24 Amendment No. 1 to the Retirement Savings Plan for Certain Employees of Vencor and its Affiliates
dated September 26, 2000. Exhibit 10.9 to the Company's Form 10-Q for the quarterly period ended
September 30, 2000 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.25 Amendment No. 2 to the Retirement Savings Plan for Certain Employees of Vencor and its Affiliates.
Exhibit 10.15 to the Company's Form 10-K for the year ended December 31, 2001 (Comm. File No.
001-14057) is hereby incorporated by reference.
10.26 Amendment No. 3 to the Kindred and Affiliates 401(k) Plan. Exhibit 10.16 to the Company's
Form 10-K for the year ended December 31, 2001 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.27 Amendment No. 4 to the Kindred and Affiliates 401(k) Plan.
10.28 Amendment No. 5 to the Kindred and Affiliates 401(k) Plan.
10.29 Amendment No. 6 to the Kindred and Affiliates 401(k) Plan.
10.30 Tax Allocation Agreement dated as of April 30, 1998 by and between Vencor, Inc. and Ventas, Inc.
Exhibit 10.9 to the Company's Form 10-Q for the quarterly period ended June 30, 1998 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.31 Agreement of Indemnity-Third Party Leases dated as of April 30, 1998 by and between Vencor, Inc.
and its subsidiaries and Ventas, Inc. Exhibit 10.11 to the Company's Form 10-Q for the quarterly
period ended June 30, 1998 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.32 Agreement of Indemnity-Third Party Contracts dated as of April 30, 1998 by and between Vencor,
Inc. and its subsidiaries and Ventas, Inc. Exhibit 10.12 to the Company's Form 10-Q for the quarterly
period ended June 30, 1998 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.33 Form of Indemnification Agreement between the Company and certain of its officers and employees.
Exhibit 10.31 to the Ventas, Inc. Form 10-K for the year ended December 31, 1995 (Comm. File
No. 1-10989) is hereby incorporated by reference.
10.34 Form of Indemnification Agreement between the Company and each member of its Board of
Directors dated October 29, 2001. Exhibit 10.21 to the Company's Form 10-K for the year ended
December 31, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.35 Amended and Restated Agreement and Plan of Merger. Appendix A to Amendment No. 2 to the
Ventas, Inc. Registration Statement on Form S-4 (Reg. No. 33-59345) is hereby incorporated by
reference.
10.36 Agreement and Plan of Merger dated as of February 9, 1997 among TheraTx, Incorporated, Vencor,
Inc. and Peach Acquisition Corp. ("Peach"). Exhibit (c)(1) to the Statement on Schedule 14D-1 of
Ventas, Inc. and Peach, dated February 14, 1997 (Comm. File No. 1-10989) is hereby incorporated
by reference.
10.37 Amendment No. 1 to Agreement and Plan of Merger dated as of February 28, 1997 among TheraTx,
Incorporated, Vencor, Inc. and Peach. Exhibit (c)(3) of Amendment No. 2 to the Statement on
Schedule 14D-1 of Ventas, Inc. and Peach, dated March 3, 1997 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.38 Asset Purchase Agreement between Transitional Hospitals Corporation and Behavioral Healthcare
Corporation, dated October 22, 1996. Exhibit 99.1 to the Current Report on Form 8-K of Transitional
dated October 22, 1996 (Comm. File No. 1-7008) is hereby incorporated by reference.
10.39 Agreement and Plan of Merger between Transitional Hospitals Corporation and Behavioral
Healthcare Corporation, dated October 22, 1996. Exhibit 99.2 to the Current Report on Form 8-K of
Transitional dated October 22, 1996 (Comm. File No. 1-7008) is hereby incorporated by reference.
81
Exhibit
number Description of document
- ------ -----------------------
10.40 First Amendment to Asset Purchase Agreement between Transitional Hospitals Corporation and
Behavioral Healthcare Corporation dated November 30, 1996. Exhibit 99.1 to the Current Report on
Form 8-K of Transitional dated December 16, 1996 (Comm. File No. 1-7008) is hereby incorporated
by reference.
10.41 Amendment to Agreement and Plan of Merger between Transitional Hospitals Corporation and
Behavioral Healthcare Corporation, dated November 30, 1996. Exhibit 99.2 to the Current Report on
Form 8-K of Transitional dated December 16, 1996 (Comm. File No. 1-7008) is hereby incorporated
by reference.
10.42* Vencor, Inc. Deferred Compensation Plan dated April 30, 1998. Exhibit 10.25 to the Company's
Registration Statement on Form S-4 (Reg. No. 333-57953) is hereby incorporated by reference.
10.43* Amendment No. 1 to the Vencor, Inc. Deferred Compensation Plan. Exhibit 10.2 to the Company's
Form 10-Q for the quarterly period ended March 31, 2001 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.44* Amendment No. 2 to the Vencor, Inc. Deferred Compensation Plan. Exhibit 10.4 to the Company's
Form 10-Q for the quarterly period ended March 31, 2002 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.45 Tax Refund Escrow Agreement and First Amendment to the Tax Allocation Agreement made and
entered into as of the 20th of April 2001 by and between the Company and each of its subsidiaries
and Ventas, Inc., Ventas Realty Limited Partnership and Ventas LP Realty, L.L.C. Exhibit 10.31 to
the Company's Form 10-K for the year ended December 31, 2001 (Comm. File No. 001-14057) is
hereby incorporated by reference.
10.46* Vencor, Inc. Supplemental Executive Retirement Plan dated January 1, 1998, as amended.
Exhibit 10.27 to the Company's Registration Statement on Form S-4 (Reg. No. 333-57953) is hereby
incorporated by reference.
10.47* Amendment No. Two to Supplemental Executive Retirement Plan dated as of January 15, 1999.
Exhibit 10.48 to the Company's Form 10-K for the year ended December 31, 1999 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.48* Amendment No. Three to Supplemental Executive Retirement Plan dated as of December 31, 1999.
Exhibit 10.49 to the Company's Form 10-K for the year ended December 31, 1999 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.49* Amendment No. 4 to the Vencor, Inc. Supplemental Executive Retirement Plan. Exhibit 10.3 to the
Company's Form 10-Q for the quarterly period ended March 31, 2001 (Comm. File No. 001-14057)
is hereby incorporated by reference.
10.50* Company's 2000 Long-Term Incentive Plan, dated effective as of January 1, 2001. Exhibit 10.46 to
the Company's Form 10-K for the year ended December 31, 2000 (Comm. File No. 001-14057) is
hereby incorporated by reference.
10.51* Amendment No. One to the Company's Long-Term Incentive Plan, dated effective as of June 21,
2001. Exhibit 10.12 to the Company's Form 10-Q for the quarterly period ended June 30, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.52* Kindred Healthcare, Inc. Short-Term Incentive Plan. Exhibit 10.3 to the Company's Form 10-Q for
the quarterly period ended March 31, 2002 (Comm. File No. 001-14057) is hereby incorporated by
reference.
10.53* Form of Kindred Healthcare Operating, Inc. Change-in-Control Severance Agreement. Exhibit 10.28
to the Company's Registration Statement on Form S-4 (Reg. No. 333-57953) is hereby incorporated
by reference.
82
Exhibit
number Description of document
- ------ -----------------------
10.54* Employment Agreement dated as of February 12, 1999 between Vencor Operating, Inc. and Edward
L. Kuntz. Exhibit 10.3 to the Company's Form 10-Q for the quarterly period ended March 31, 1999
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.55* Employment Agreement dated as of January 28, 2002 by and between Kindred Healthcare Operating,
Inc. and Paul J. Diaz. Exhibit 10.6 to the Company's Form 10-Q for the quarterly period ended
March 31, 2002 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.56* Change-in-Control Severance Agreement dated as of January 28, 2002 by and between Kindred
Healthcare Operating, Inc. and Paul J. Diaz. Exhibit 10.7 to the Company's Form 10-Q for the
quarterly period ended March 31, 2002 (Comm. File No. 001-14057) is hereby incorporated by
reference.
10.57* Employment Agreement dated as of July 28, 1998 between Vencor Operating, Inc. and Richard E.
Chapman. Exhibit 10.58 to the Company's Form 10-K for the year ended December 31, 1999
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.58* Amendment No. 1 to the Employment Agreement dated December 21, 2001 by and between Kindred
Healthcare Operating, Inc. and Richard E. Chapman. Exhibit 10.43 to the Company's Form 10-K for
the year ended December 31, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.59* Employment Agreement dated as of July 28, 1998 between Vencor Operating, Inc. and Frank J.
Battafarano. Exhibit 10.63 to the Company's Form 10-K for the year ended December 31, 1999
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.60* Amendment to Employment Agreement dated as of September 28, 1998 between Vencor Operating,
Inc. and Frank J. Battafarano. Exhibit 10.64 to the Company's Form 10-K for the year ended
December 31, 1999 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.61* Amendment No. 2 to Employment Agreement dated as of November 5, 1999 between Vencor
Operating, Inc. and Frank J. Battafarano. Exhibit 10.65 to the Company's Form 10-K for the year
ended December 31, 1999 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.62* Amendment No. 3 to the Employment Agreement dated December 21, 2001 by and between Kindred
Healthcare Operating, Inc. and Frank J. Battafarano. Exhibit 10.50 to the Company's Form 10-K for
the year ended December 31, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.63* Employment Agreement dated as of July 28, 1998 between Vencor Operating, Inc. and James H.
Gillenwater, Jr. Exhibit 10.66 to the Company's Form 10-K for the year ended December 31, 1999
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.64* Amendment No. 1 to Employment Agreement dated December 21, 2001 by and between Kindred
Healthcare Operating, Inc. and James H. Gillenwater, Jr. Exhibit 10.52 to the Company's Form 10-K
for the year ended December 31, 2001 (Comm. File No. 001-14057) is hereby incorporated by
reference.
10.65* Employment Agreement dated as of July 28, 1998 between Vencor Operating, Inc. and M. Suzanne
Riedman. Exhibit 10.67 to the Company's Form 10-K for the year ended December 31, 1999 (Comm.
File No. 001-14057) is hereby incorporated by reference.
10.66* Amendment to Employment Agreement dated as of September 28, 1998 between Vencor Operating,
Inc. and M. Suzanne Riedman. Exhibit 10.68 to the Company's Form 10-K for the year ended
December 31, 1999 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.67* Amendment No. 2 to Employment Agreement dated as of November 5, 1999 between Vencor
Operating, Inc. and M. Suzanne Riedman. Exhibit 10.69 to the Company's Form 10-K for the year
ended December 31, 1999 (Comm. File No. 001-14057) is hereby incorporated by reference.
83
Exhibit
number Description of document
- ------ -----------------------
10.68* Amendment No. 3 to Employment Agreement dated December 21, 2001 by and between Kindred
Healthcare Operating, Inc. and M. Suzanne Riedman. Exhibit 10.56 to the Company's Form 10-K for
the year ended December 31, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.69* Employment Agreement dated as of July 28, 1998 between Vencor Operating, Inc. and Richard A.
Lechleiter. Exhibit 10.70 to the Company's Form 10-K for the year ended December 31, 1999
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.70* Amendment to Employment Agreement dated as of September 28, 1998 between Vencor Operating,
Inc. and Richard A. Lechleiter. Exhibit 10.71 to the Company's Form 10-K for the year ended
December 31, 1999 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.71* Amendment No. 2 to Employment Agreement dated as of November 5, 1999 between Vencor
Operating, Inc. and Richard A. Lechleiter. Exhibit 10.72 to the Company's Form 10-K for the year
ended December 31, 1999 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.72* Amendment No. 3 to Employment Agreement dated December 21, 2001 by and between Kindred
Healthcare Operating, Inc. and Richard A. Lechleiter. Exhibit 10.60 to the Company's Form 10-K for
the year ended December 31, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.73* Employment Agreement dated as of December 21, 2001 between Kindred Healthcare Operating, Inc.
and William M. Altman. Exhibit 10.61 to the Company's Form 10-K for the year ended
December 31, 2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.74* Employment Agreement dated as of October 28, 2002 by and among Kindred Healthcare Operating,
Inc. and Lane M. Bowen.
10.75* Change-in-Control Severance Agreement dated as of October 28, 2002 by and between Kindred
Healthcare Operating, Inc. and Lane M. Bowen.
10.76 Separation Agreement and Release of Claims entered into by Richard A. Schweinhart and Kindred
Healthcare, Inc. Exhibit 10.8 to the Company's Form 10-Q for the quarterly period ended March 31,
2002 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.77 Separation Agreement and Release of Claims between Donald D. Finney and Kindred Healthcare,
Inc. Exhibit 10.3 to the Company's Form 10-Q for the quarterly period ended September 30, 2002
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.78 Amended and Restated Master Lease Agreement No. 1 dated as of April 20, 2001 for Lease Executed
by Ventas Realty, Limited Partnership, as Lessor and Vencor, Inc. and Vencor Operating, Inc. as
Tenant. Exhibit 10.4 to the Company's Form 10-Q for the quarterly period ended June 30, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.79 Amended and Restated Master Lease Agreement No. 2 dated as of April 20, 2001 for Lease Executed
by Ventas Realty, Limited Partnership, as Lessor and Vencor, Inc. and Vencor Operating, Inc. as
Tenant. Exhibit 10.5 to the Company's Form 10-Q for the quarterly period ended June 30, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.80 Amended and Restated Master Lease Agreement No. 3 dated as of April 20, 2001 for Lease Executed
by Ventas Realty, Limited Partnership, as Lessor and Vencor, Inc. and Vencor Operating, Inc. as
Tenant. Exhibit 10.6 to the Company's Form 10-Q for the quarterly period ended June 30, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.81 Amended and Restated Master Lease Agreement No. 4 dated as of April 20, 2001 for Lease Executed
by Ventas Realty, Limited Partnership, as Lessor and Vencor, Inc. and Vencor Operating, Inc. as
Tenant. Exhibit 10.7 to the Company's Form 10-Q for the quarterly period ended June 30, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
84
Exhibit
number Description of document
- ------ -----------------------
10.82 Master Lease Agreement dated as of December 12, 2001 by and among Ventas Realty, Limited
Partnership, as Lessor, and Kindred Healthcare, Inc. and Kindred Healthcare Operating, Inc., as
Tenants. Exhibit 10.66 to the Company's Form 10-K for the year ended December 31, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.83 Letter Agreement dated June 5, 2002 between Ventas Realty, Limited Partnership, Kindred
Healthcare, Inc. and Kindred Healthcare Operating, Inc. Exhibit 10.3 to the Company's Form 10-Q
for the quarterly period ended June 30, 2002 (Comm. File No. 001-14057) is hereby incorporated by
reference.
10.84 Second Specific Property Lease Amendment by and among Kindred Healthcare, Inc., Kindred
Healthcare Operating, Inc. and Ventas Realty, Limited Partnership.
10.85 Master Lease among Health Care Property Investors, Inc. and Health Care Property Partners,
collectively, as Lessors and Kindred Nursing Centers East, L.L.C., Kindred Nursing Centers West,
L.L.C. and Kindred Nursing Centers Limited Partnership, collectively, as Lessee, dated May 16,
2001. Exhibit 10.11 to the Company's Form 10-Q for the quarterly period ended June 30, 2001
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.86 Agreement and Plan of Reorganization between the Company and Ventas, Inc. Exhibit 10.1 to the
Company's Form 10, as amended, dated April 27, 1998 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.87 Cash Escrow Agreement dated April 20, 2001 by and among the Company, Ventas, Inc. and State
Street Bank and Trust Company, as Escrow Agent. Exhibit 10.8 to the Company's Form 10-Q for the
quarterly period ended June 30, 2001 (Comm. File No. 001-14057) is hereby incorporated by
reference.
10.88 Excess Stock Trust Agreement by and among the Company, as Settlor, Ventas, Inc., and State Street
Bank and Trust Company, N.A., as Trustee, dated April 20, 2001. Exhibit 10.9 to the Company's
Form 10-Q for the quarterly period ended June 30, 2001 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.89 Corporate Integrity Agreement between the Office of Inspector General of the Department of Health
and Human Services and Vencor, Inc. Exhibit 10.7 to the Company's Form 10-Q for the quarterly
period ended September 30, 2000 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.90 Other Debt Instruments--Copies of debt instruments for which the related debt is less than 10% of
total assets will be furnished to the SEC upon request.
21 List of Subsidiaries.
23.1 Consent of Independent Accountants.
99.1 Kindred Healthcare Code of Conduct.
99.2 Charter for the Audit and Compliance Committee of the Board of Directors of Kindred Healthcare,
Inc.
99.3 Charter for the Executive Compensation Committee of the Board of Directors of Kindred Healthcare,
Inc.
99.4 Charter for the Nominating and Governance Committee of the Board of Directors of Kindred
Healthcare, Inc.
99.5 Corporate Governance Guidelines.
99.6 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- --------
* Compensatory plan or arrangement required to be filed as an exhibit pursuant
to Item 15(c) of Annual Report on Form 10-K.
85
(b) Reports on Form 8-K.
We filed a Current Report on Form 8-K on October 11, 2002 announcing that we
would record approximately $55 million of additional professional liability
costs above our normal provision for the third quarter ended September 30,
2002. We also announced that we intended to accrue an additional $10 million of
professional liability costs above our normal provision for the fourth quarter
of 2002. In addition, we announced that we were aggressively pursuing
alternatives to reduce our professional liability exposures, including
divesting our nursing center operations in Florida.
We filed a Current Report on Form 8-K on October 23, 2002 announcing the
appointment of Lane M. Bowen as President of our Health Services Division. We
also filed a Current Report on Form 8-K on November 13, 2002 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
sent to the SEC as correspondence in connection with the filing of our
Quarterly Report on Form 10-Q for the third quarter of 2002.
In addition, we filed a Current Report on Form 8-K on December 11, 2002
announcing that we had entered into a non-binding letter of intent with Senior
Health Management, LLC to transfer the operations of our 18 skilled nursing
facilities in Florida.
(c) Exhibits.
The response to this portion of Item 15 is submitted as a separate section
of this Report.
(d) Financial Statement Schedules.
The response to this portion of Item 15 is included in appendix page F-51 of
this Report.
86
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Date: March 28, 2003
KINDRED HEALTHCARE, INC.
/s/ Edward L. Kuntz
By: __________________________________
Edward L. Kuntz
Chairman of the Board and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ James Bolin Director March 28, 2003
- -----------------------------
James Bolin
/s/ Michael J. Embler Director March 28, 2003
- -----------------------------
Michael J. Embler
/s/ Garry N. Garrison Director March 28, 2003
- -----------------------------
Garry N. Garrison
/s/ Isaac Kaufman Director March 28, 2003
- -----------------------------
Isaac Kaufman
/s/ John H. Klein Director March 28, 2003
- -----------------------------
John H. Klein
/s/ Edward L. Kuntz Chairman of the Board and March 28, 2003
- ----------------------------- Chief Executive Officer
Edward L. Kuntz (Principal Executive
Officer)
/s/ Richard A. Lechleiter Senior Vice President, Chief March 28, 2003
- ----------------------------- Financial Officer and
Richard A. Lechleiter Treasurer (Principal
Financial Officer)
/s/ John J. Lucchese Vice President, Finance and March 28, 2003
- ----------------------------- Corporate Controller
John J. Lucchese (Principal Accounting
Officer)
/s/ David A. Tepper Director March 28, 2003
- -----------------------------
David A. Tepper
87
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 annual report on Form 10-K of Kindred Healthcare, Inc.;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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 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 annual 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
annual report (the "Evaluation Date"); and
(c) presented in this annual 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
annual 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: March 28, 2003 /s/ Edward L. Kuntz
-------------------------
Edward L. Kuntz
Chairman of the Board and
Chief Executive Officer
88
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 annual report on Form 10-K of Kindred Healthcare, Inc.;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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 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 annual 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
annual report (the "Evaluation Date"); and
(c) presented in this annual 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
annual 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: March 28, 2003 /s/ Richard A. Lechleiter
-----------------------------
Richard A. Lechleiter
Senior Vice President, Chief
Financial Officer and
Treasurer
89
KINDRED HEALTHCARE, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
Page
----
Report of Independent Accountants......................................................... F-2
Consolidated Financial Statements:
Consolidated Statement of Operations:
Reorganized Company - for the year ended December 31, 2002 and for the nine months
ended December 31, 2001
Predecessor Company - for the three months ended March 31, 2001 and for the year
ended December 31, 2000............................................................ F-3
Consolidated Balance Sheet:
Reorganized Company - December 31, 2002 and December 31, 2001........................ F-4
Consolidated Statement of Stockholders' Equity (Deficit):
Reorganized Company - for the year ended December 31, 2002 and for the nine months
ended December 31, 2001
Predecessor Company - for the three months ended March 31, 2001 and for the year
ended December 31, 2000............................................................ F-5
Consolidated Statement of Cash Flows:
Reorganized Company - for the year ended December 31, 2002 and for the nine months
ended December 31, 2001
Predecessor Company - for the three months ended March 31, 2001 and for the year
ended December 31, 2000............................................................ F-6
Notes to Consolidated Financial Statements............................................. F-7
Quarterly Consolidated Financial Information (Unaudited)............................... F-50
Financial Statement Schedule (a):
Schedule II - Valuation and Qualifying Accounts:
Reorganized Company - for the year ended December 31, 2002 and for the nine months
ended December 31, 2001
Predecessor Company - for the three months ended March 31, 2001 and for the year
ended December 31, 2000............................................................ F-51
- --------
(a) All other schedules have been omitted because the required information is
not present or not present in material amounts.
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Kindred Healthcare, Inc.:
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Kindred Healthcare, Inc. and its subsidiaries at December 31, 2002
and 2001, and the results of their operations and their cash flows for the year
ended December 31, 2002, the nine months ended December 31, 2001, the three
months ended March 31, 2001 and the year ended December 31, 2000, in conformity
with accounting principles generally accepted in the United States of America.
In addition, in our opinion, the financial statement schedule listed in the
accompanying index presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 1 of the notes to consolidated financial statements, the
Company ceased amortizing goodwill effective January 1, 2002.
As more fully described in Notes 1 and 3 of the notes to consolidated financial
statements, the consolidated financial statements reflect the application of
fresh-start reporting as of April 1, 2001 and, therefore, consolidated
financial statements for periods after April 1, 2001 are not comparable in all
respects to consolidated financial statements for periods prior to such date.
/s/ PRICEWATERHOUSECOOPERS LLP
Louisville, Kentucky
March 24, 2003
F-2
KINDRED HEALTHCARE, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands, except per share amounts)
Reorganized Company | Predecessor Company
------------------------- | ------------------------
Year Nine months | Three months Year
ended ended | ended ended
December 31, December 31, | March 31, December 31,
2002 2001 | 2001 2000
------------ ------------ | ------------ ------------
Revenues............................................ $3,357,822 $2,329,019 | $752,409 $2,888,542
---------- ---------- | -------- ----------
Salaries, wages and benefits........................ 1,924,439 1,316,581 | 427,649 1,623,955
Supplies............................................ 424,177 295,598 | 94,319 374,540
Rent................................................ 270,562 195,284 | 76,995 307,809
Other operating expenses............................ 606,394 375,090 | 126,701 503,770
Depreciation and amortization....................... 71,356 50,219 | 18,645 73,545
Interest expense.................................... 14,373 21,740 | 14,000 60,431
Investment income................................... (9,674) (9,285) | (1,919) (5,393)
---------- ---------- | -------- ----------
3,301,627 2,245,227 | 756,390 2,938,657
---------- ---------- | -------- ----------
Income (loss) before reorganization items and |
income taxes...................................... 56,195 83,792 | (3,981) (50,115)
Reorganization items................................ (5,520) - | (53,666) 12,636
---------- ---------- | -------- ----------
Income (loss) before income taxes................... 61,715 83,792 | 49,685 (62,751)
Provision for income taxes.......................... 28,389 36,450 | 500 2,000
---------- ---------- | -------- ----------
Income (loss) from operations....................... 33,326 47,342 | 49,185 (64,751)
Extraordinary gain on extinguishment of debt, net of |
income taxes of $893 for 2002 and $2,700 for the |
nine months ended December 31, 2001............... 1,427 4,313 | 422,791 -
---------- ---------- | -------- ----------
Net income (loss).............................. 34,753 51,655 | 471,976 (64,751)
Preferred stock dividend requirements............... - - | (261) (1,046)
---------- ---------- | -------- ----------
Income (loss) available to common |
stockholders................................. $ 34,753 $ 51,655 | $471,715 $ (65,797)
========== ========== | ======== ==========
Earnings (loss) per common share: |
Basic: |
Income (loss) from operations.................... $ 1.92 $ 3.05 | $ 0.69 $ (0.94)
Extraordinary gain on extinguishment of debt..... 0.08 0.28 | 6.02 -
---------- ---------- | -------- ----------
Net income (loss).............................. $ 2.00 $ 3.33 | $ 6.71 $ (0.94)
========== ========== | ======== ==========
Diluted: |
Income (loss) from operations.................... $ 1.85 $ 2.59 | $ 0.69 $ (0.94)
Extraordinary gain on extinguishment of debt..... 0.08 0.24 | 5.90 -
---------- ---------- | -------- ----------
Net income (loss).............................. $ 1.93 $ 2.83 | $ 6.59 $ (0.94)
========== ========== | ======== ==========
Shares used in computing earnings (loss) per |
common share: |
Basic.............................................. 17,361 15,505 | 70,261 70,229
Diluted............................................ 18,001 18,258 | 71,656 70,229
See accompanying notes.
F-3
KINDRED HEALTHCARE, INC.
CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
Reorganized Company
------------------------
December 31, December 31,
2002 2001
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents................................................... $ 244,070 $ 190,799
Cash-restricted............................................................. 7,908 18,025
Insurance subsidiary investments............................................ 130,415 99,101
Accounts receivable less allowance for loss of $95,952 - 2002 and
$108,891 - 2001........................................................... 420,611 418,827
Inventories................................................................. 30,460 29,720
Other....................................................................... 86,852 75,501
---------- ----------
920,316 831,973
Property and equipment, at cost:
Land........................................................................ 32,211 28,560
Buildings................................................................... 285,734 243,011
Equipment................................................................... 272,399 221,380
Construction in progress.................................................... 21,600 15,254
---------- ----------
611,944 508,205
Accumulated depreciation.................................................... (115,373) (44,323)
---------- ----------
496,571 463,882
Goodwill less accumulated amortization of $5,742 - 2002 and 2001............. 88,259 107,660
Other........................................................................ 139,032 105,359
---------- ----------
$1,644,178 $1,508,874
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................ $ 124,466 $ 100,473
Salaries, wages and other compensation...................................... 220,124 198,471
Due to third party payors................................................... 25,177 37,285
Other accrued liabilities................................................... 150,020 138,571
Income taxes................................................................ 62,111 39,908
Long-term debt due within one year.......................................... 258 418
---------- ----------
582,156 515,126
Long-term debt............................................................... 162,008 212,269
Professional liability risks................................................. 211,771 136,764
Deferred credits and other liabilities....................................... 56,615 54,234
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.25 par value; authorized 1,000 shares;
none issued and outstanding............................................... - -
Common stock, $0.25 par value; authorized 175,000 shares - December 31, 2002
and 39,000 shares - December 31, 2001; issued 17,649 shares - December 31,
2002 and 17,683 shares - December 31, 2001................................ 4,412 4,421
Capital in excess of par value.............................................. 547,609 549,089
Deferred compensation....................................................... (6,967) (14,764)
Accumulated other comprehensive income...................................... 460 80
Retained earnings........................................................... 86,114 51,655
---------- ----------
631,628 590,481
---------- ----------
$1,644,178 $1,508,874
========== ==========
See accompanying notes.
F-4
KINDRED HEALTHCARE, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands)
Shares of common stock Par Capital Accumulated
---------------------- value in excess other Retained
Reorganized Predecessor common of par Deferred comprehensive earnings
Company Company stock value compensation income/(loss) (deficit)
----------- ----------- -------- --------- ------------ ------------- -----------
Predecessor Company:
Balances, December 31, 1999........ - 70,278 $ 17,570 $ 667,110 $ - $(32) $(1,090,670)
Comprehensive income (loss):
Net loss........................ (64,751)
Net unrealized investment
gains.......................... 55
Comprehensive loss.............
Issuance (forfeiture) of common
stock in connection with
employee benefit plans.......... (17) (5) 35
Preferred stock dividend
requirements.................... (1,046)
------ ------- -------- --------- -------- ---- -----------
Balances, December 31, 2000........ - 70,261 17,565 667,145 - 23 (1,156,467)
Comprehensive income:
Net income for the three
months ended March 31,
2001........................... 471,976
Net unrealized investment
gains.......................... 20
Comprehensive income...........
Preferred stock dividend
requirements.................... (261)
Other............................ (1)
Fresh-start accounting
adjustments..................... 15,000 (70,261) (13,815) (235,898) 684,752
------ ------- -------- --------- -------- ---- -----------
- ----------------------------------------------------------------------------------------------------------------------------------
Reorganized Company:
Balances, April 1, 2001............ 15,000 - 3,750 431,246 - 43 -
Comprehensive income:
Net income for the nine months
ended December 31, 2001........ 51,655
Net unrealized investment
gains.......................... 37
Comprehensive income...........
Proceeds from public offering of
common stock, net of fees and
expenses of $5,937.............. 2,077 519 89,087
Grant of non-vested restricted
stock and discounted common
stock options................... 400 100 21,362 (21,462)
Issuance of vested restricted
stock........................... 200 50 7,650
Deferred compensation
amortization.................... 6,698
Other............................ 6 2 (256)
------ ------- -------- --------- -------- ---- -----------
Balances, December 31, 2001........ 17,683 - 4,421 549,089 (14,764) 80 51,655
Comprehensive income:
Net income...................... 34,753
Net unrealized investment
gains, net of tax.............. 380
Comprehensive income...........
Repurchase of common stock, at
cost............................ (28) (7) (745) (294)
Deferred compensation
amortization.................... 6,778
Other............................ (6) (2) (735) 1,019
------ ------- -------- --------- -------- ---- -----------
Balances, December 31, 2002........ 17,649 - $ 4,412 $ 547,609 $ (6,967) $460 $ 86,114
====== ======= ======== ========= ======== ==== ===========
Total
---------
Predecessor Company:
Balances, December 31, 1999........ $(406,022)
Comprehensive income (loss):
Net loss........................ (64,751)
Net unrealized investment
gains.......................... 55
---------
Comprehensive loss............. (64,696)
Issuance (forfeiture) of common
stock in connection with
employee benefit plans.......... 30
Preferred stock dividend
requirements.................... (1,046)
---------
Balances, December 31, 2000........ (471,734)
Comprehensive income:
Net income for the three
months ended March 31,
2001........................... 471,976
Net unrealized investment
gains.......................... 20
---------
Comprehensive income........... 471,996
Preferred stock dividend
requirements.................... (261)
Other............................ (1)
Fresh-start accounting
adjustments..................... 435,039
---------
- ----------------------------------------------------------------------------------------------------------------------------------
Reorganized Company:
Balances, April 1, 2001............ 435,039
Comprehensive income:
Net income for the nine months
ended December 31, 2001........ 51,655
Net unrealized investment
gains.......................... 37
---------
Comprehensive income........... 51,692
Proceeds from public offering of
common stock, net of fees and
expenses of $5,937.............. 89,606
Grant of non-vested restricted
stock and discounted common
stock options................... -
Issuance of vested restricted
stock........................... 7,700
Deferred compensation
amortization.................... 6,698
Other............................ (254)
---------
Balances, December 31, 2001........ 590,481
Comprehensive income:
Net income...................... 34,753
Net unrealized investment
gains, net of tax.............. 380
---------
Comprehensive income........... 35,133
Repurchase of common stock, at
cost............................ (1,046)
Deferred compensation
amortization.................... 6,778
Other............................ 282
---------
Balances, December 31, 2002........ $ 631,628
=========
See accompanying notes.
F-5
KINDRED HEALTHCARE, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
Reorganized Company | Predecessor Company
------------------------- | ------------------------
Year Nine months | Three months Year
ended ended | ended ended
December 31, December 31, | March 31, December 31,
2002 2001 | 2001 2000
------------ ------------ | ------------ ------------
Cash flows from operating activities: |
Net income (loss)........................................ $ 34,753 $ 51,655 | $ 471,976 $ (64,751)
Adjustments to reconcile net income (loss) to net cash |
provided by operating activities: |
Depreciation and amortization........................... 71,356 50,219 | 18,645 73,545
Amortization of deferred compensation costs............. 6,778 6,698 | - -
Provision for doubtful accounts......................... 13,551 16,346 | 6,305 28,911
Deferred income taxes................................... (17,608) 12,263 | - -
Extraordinary gain on extinguishment of debt............ (1,427) (4,313) | (422,791) -
Unusual transactions.................................... (1,795) (5,425) | - 4,701
Reorganization items.................................... (5,520) - | (53,666) 12,636
Other................................................... 1,224 (4,655) | 1,357 17,166
Change in operating assets and liabilities: |
Accounts receivable.................................... (3,063) (31,001) | (14,668) (21,590)
Inventories and other assets........................... (11,303) 18,698 | 12,476 (20,154)
Accounts payable....................................... 11,887 (300) | (10,845) 15,639
Income taxes........................................... 44,626 17,582 | 108 2,961
Due to third party payors.............................. (12,108) (16,570) | 2,051 (4,278)
Other accrued liabilities.............................. 122,315 79,504 | 28,628 149,279
--------- --------- | --------- ---------
Net cash provided by operating activities before |
reorganization items................................ 253,666 190,701 | 39,576 194,065
Payment of reorganization items.......................... (4,987) (47,937) | (3,745) (8,525)
--------- --------- | --------- ---------
Net cash provided by operating activities............ 248,679 142,764 | 35,831 185,540
--------- --------- | --------- ---------
Cash flows from investing activities: |
Purchase of property and equipment....................... (84,071) (65,243) | (22,038) (79,988)
Acquisition of healthcare facilities..................... (45,931) (14,152) | - -
Sale of investment in Behavioral Healthcare Corporation.. - 40,000 | - -
Sale of other assets..................................... 752 7,933 | - 15,241
Surety bond deposits..................................... 9,676 (300) | - (4,647)
Net change in investments................................ (26,343) (27,973) | (28,178) (46,904)
Other.................................................... 64 809 | 224 1,731
--------- --------- | --------- ---------
Net cash used in investing activities................ (145,853) (58,926) | (49,992) (114,567)
--------- --------- | --------- ---------
Cash flows from financing activities: |
Repayment of long-term debt.............................. (50,570) (149,161) | (4,355) (18,696)
Payment of debtor-in-possession deferred financing costs. - - | (100) (1,226)
Payment of other deferred financing costs................ (1,375) - | - -
Issuance of common stock................................. 159 89,796 | - -
Repurchase of common stock............................... (1,046) - | - -
Other.................................................... 3,277 11,172 | (5,971) (14,759)
--------- --------- | --------- ---------
Net cash used in financing activities................ (49,555) (48,193) | (10,426) (34,681)
--------- --------- | --------- ---------
Change in cash and cash equivalents........................ 53,271 35,645 | (24,587) 36,292
Cash and cash equivalents at beginning of period........... 190,799 155,154 | 184,642 148,350
--------- --------- | --------- ---------
Cash and cash equivalents at end of period................. $ 244,070 $ 190,799 | $ 160,055 $ 184,642
========= ========= | ========= =========
Supplemental information: |
Interest payments........................................ $ 14,961 $ 3,847 | $ 2,606 $ 11,930
Income tax payments (refunds)............................ 1,371 6,605 | 392 (713)
Rental payments to Ventas, Inc........................... 184,327 135,609 | 45,401 181,603
See accompanying notes.
F-6
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ACCOUNTING POLICIES
Reporting Entity
Kindred Healthcare, Inc. ("Kindred" or the "Company") provides long-term
healthcare services primarily through the operation of nursing centers and
hospitals. The Company's health services division operates nursing centers and
a rehabilitation therapy business. The Company's hospital division operates
long-term acute care hospitals and an institutional pharmacy business.
On April 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 consolidated financial statements of the
Company since the date of acquisition.
On April 20, 2001 (the "Effective Date"), the Company and its subsidiaries
emerged from proceedings under Chapter 11 of Title 11 of the United States Code
(the "Bankruptcy Code") pursuant to the terms of the Company's Fourth Amended
Joint Plan of Reorganization (the "Plan of Reorganization"), as modified at the
confirmation hearing by the United States Bankruptcy Court for the District of
Delaware (the "Bankruptcy Court"). In connection with its emergence, the
Company changed its name to Kindred Healthcare, Inc.
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 assume that assets will be realized and liabilities will be
discharged in the normal course of business.
In connection with its emergence from bankruptcy, the Company reflected the
terms of the Plan of Reorganization in its consolidated financial statements by
adopting the fresh-start accounting provisions of SOP 90-7. Under fresh-start
accounting, a new reporting entity is deemed to be created and the recorded
amounts of assets and liabilities are adjusted to reflect their estimated fair
values. For accounting purposes, the fresh-start adjustments 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 data to signify the
difference in the basis of presentation of the financial statements for each
respective entity.
As used in these financial statements, the term "Predecessor Company" refers
to the Company and its operations for periods prior to April 1, 2001, while the
term "Reorganized Company" is used to describe the Company and its operations
for periods thereafter.
While the adoption of fresh-start accounting as of April 1, 2001 materially
changed the amounts previously recorded in the consolidated financial
statements of the Predecessor Company, management believes that the 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 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
F-7
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1 - ACCOUNTING POLICIES (Continued)
Reporting Entity (Continued)
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 were reflected in the operating results of the
Predecessor Company for the three months ended March 31, 2001.
On May 1, 1998, Ventas, Inc. ("Ventas") completed the spin-off of its
healthcare operations to its stockholders through the distribution of the
Company's former common stock (the "Spin-off"). Ventas retained ownership of
substantially all of its real property and leases such real property to the
Company. In anticipation of the Spin-off, the Company was incorporated on March
27, 1998 as a Delaware corporation. For accounting purposes, the consolidated
historical financial statements of Ventas became the Company's historical
financial statements following the Spin-off.
Basis of Presentation
The consolidated financial statements include all subsidiaries. Significant
intercompany transactions have been eliminated. Investments in affiliates in
which the Company has a 50% or less interest are accounted for by either the
equity or cost method.
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles and include amounts
based upon the estimates and judgments of management. Actual amounts may differ
from these estimates.
Impact of Recent Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (the "FASB")
issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51." The primary objectives of
FIN 46 are to provide guidance on the identification of entities for which
control is achieved through means other than through voting rights ("variable
interest entities" or "VIEs") and how to determine when and which business
enterprise should consolidate the VIE (the "primary beneficiary"). This new
model for consolidation applies to an entity in which either (1) the equity
investors (if any) do not have a controlling financial interest or (2) the
equity investment at risk is insufficient to finance that entity's activities
without receiving additional subordinated financial support from other parties.
In addition, FIN 46 requires that both the primary beneficiary and all other
enterprises with a significant variable interest in a VIE make additional
disclosures. The provisions of FIN 46 will become effective for the Company in
2003. The adoption of FIN 46 is not expected to have an impact on the Company's
financial position, results of operations or liquidity.
In December 2002, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 148 ("SFAS 148"), "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of SFAS 123." SFAS 148
provides transitional guidance for recognizing an entity's voluntary decision
to change its method of accounting for stock-based employee compensation to the
fair-value method. In addition, SFAS 148 amends the disclosure requirements of
SFAS No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation," so that
entities will have to (1) make more prominent disclosures regarding the pro
forma effects of using the fair-value method of accounting for stock-based
compensation, (2) present those disclosures in a more accessible format in the
footnotes to the annual financial statements, and (3) include those disclosures
in interim financial statements. The Company has elected not to change its
method of accounting for stock-based compensation under SFAS 123. The SFAS 148
transition and annual disclosure provisions are effective for the Company's
fiscal year ended December 31, 2002.
F-8
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1 - ACCOUNTING POLICIES (Continued)
Impact of Recent Accounting Pronouncements (Continued)
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, an interpretation of FASB
Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34".
FIN 45 requires that upon issuance of a guarantee, the issuing entity must
recognize a liability for the fair value of the obligation it assumes under
that guarantee. FIN 45 requires disclosure about each guarantee even if the
likelihood of the guarantor having to make any payments under the guarantee is
remote. The provisions for initial recognition and measurement are effective on
a prospective basis for guarantees that are issued or modified after December
31, 2002. The disclosure provisions of FIN 45 are effective for accounting
periods ending after December 15, 2002. The adoption of FIN 45 is not expected
to have a material impact on the Company's financial position, results of
operations or liquidity. See Note 15.
In July 2002, the FASB issued 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"
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 costs 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. The adoption
of SFAS 144 did not affect the Company's financial position or results of
operations.
As previously discussed, the FASB issued in June 2001 SFAS No. 142 ("SFAS
142"), "Goodwill and Other Intangible Assets," which established 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
F-9
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1 - ACCOUNTING POLICIES (Continued)
Impact of Recent Accounting Pronouncements (Continued)
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 and an annual impairment test as of December
31, 2002. No write-down of the carrying value of goodwill was required.
Amortization expense for 2002 was reduced by approximately $6.5 million as a
result of the adoption of SFAS 142.
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
------------------------------|-----------------------------------------------------------------
Nine months ended |
December 31, 2001 |Three months ended March 31, 2001 Year ended December 31, 2000
------------------------------|--------------------------------- -------------------------------
As Goodwill As | As Goodwill As As Goodwill As
reported amortization adjusted|reported amortization adjusted reported amortization adjusted
-------- ------------ --------|-------- ------------ -------- -------- ------------ --------
Income (loss) from |
operations............ $47,342 $5,742 $53,084 |$ 49,185 $2,509 $ 51,694 $(64,751) $11,658 $(53,093)
Net income (loss)...... 51,655 5,742 57,397 | 471,976 2,509 474,485 (64,751) 11,658 (53,093)
Earnings (loss) per |
common share: |
Basic: |
Income (loss) from |
operations......... $ 3.05 $ 0.37 $ 3.42 |$ 0.69 $ 0.04 $ 0.73 $ (0.94) $ 0.17 $ (0.77)
Net income (loss)... 3.33 0.37 3.70 | 6.71 0.04 6.75 (0.94) 0.17 (0.77)
Diluted: |
Income (loss) from |
operations......... $ 2.59 $ 0.32 $ 2.91 |$ 0.69 $ 0.03 $ 0.72 $ (0.94) $ 0.17 $ (0.77)
Net income (loss)... 2.83 0.32 3.15 | 6.59 0.03 6.62 (0.94) 0.17 (0.77)
Changes in the carrying amount of goodwill for the year ended December 31,
2002 follow:
Health
services Hospital
division division Total
-------- -------- --------
Balances, January 1, 2002................................. $ 56,468 $ 51,192 $107,660
Specialty Acquisition..................................... - 29,116 29,116
Pre-emergence deferred tax valuation allowance adjustments (25,423) (23,094) (48,517)
-------- -------- --------
Balances, December 31, 2002............................... $ 31,045 $ 57,214 $ 88,259
======== ======== ========
Reclassifications
Certain prior year amounts have been reclassified to conform with the
current year presentation.
Revenues
Revenues are recorded based upon estimated amounts due from patients and
third party payors for healthcare services provided, including anticipated
settlements under reimbursement agreements with Medicare, Medicaid and other
third party payors.
F-10
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1 - ACCOUNTING POLICIES (Continued)
Revenues (Continued)
A summary of revenues by payor type follows (in thousands):
Reorganized Company | Predecessor Company
------------------------- | ------------------------
Year Nine months | Three months Year
ended ended | ended ended
December 31, December 31, | March 31, December 31,
2002 2001 | 2001 2000
------------ ------------ | ------------ ------------
Medicare......... $1,377,457 $ 901,505 | $288,390 $1,050,758
Medicaid......... 1,122,295 799,428 | 233,160 925,356
Private and other 922,756 673,794 | 245,532 969,557
---------- ---------- | -------- ----------
3,422,508 2,374,727 | 767,082 2,945,671
Elimination...... (64,686) (45,708) | (14,673) (57,129)
---------- ---------- | -------- ----------
$3,357,822 $2,329,019 | $752,409 $2,888,542
========== ========== | ======== ==========
Cash, Cash Equivalents and Cash-Restricted
Cash, cash equivalents and cash-restricted include highly liquid investments
with an original maturity of three months or less when purchased.
Cash-restricted consists primarily of amounts related to patient trust
accounts, compensating balance arrangements with financial institutions and
amounts derived from the sale of assets available to repay debt or fund future
capital expenditures.
Insurance Subsidiary Investments
The Company maintains investments, consisting principally of money market
securities, primarily for the payment of claims and expenses related to
self-insured professional liability and workers compensation claims. These
investments have been categorized as available-for-sale and are reported at
fair value. The Company's insurance subsidiary investments are classified in
the accompanying consolidated balance sheet based upon their original
maturities. Unrealized gains and losses, net of deferred income taxes, are
reported as a component of accumulated other comprehensive income.
Accounts Receivable
Accounts receivable consist primarily of amounts due from the Medicare and
Medicaid programs, other government programs, managed care health plans,
commercial insurance companies and individual patients. Estimated provisions
for doubtful accounts are recorded to the extent it is probable that a portion
or all of a particular account will not be collected.
In evaluating the collectibility of accounts receivable, the Company
considers a number of factors, including the age of the accounts, changes in
collection patterns, the composition of patient accounts by payor type, the
status of ongoing disputes with third party payors and general industry
conditions.
Inventories
Inventories consist primarily of medical supplies and are stated at the
lower of cost (first-in, first-out) or market.
Property and Equipment
Depreciation expense, computed by the straight-line method, was $71.4
million for 2002, $44.2 million for the nine months ended December 31, 2001,
$16.0 million for the three months ended March 31, 2001 and
F-11
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1 - ACCOUNTING POLICIES (Continued)
Property and Equipment (Continued)
$60.9 million for 2000. Depreciation rates for buildings range generally from
20 to 45 years. Estimated useful lives of equipment vary from 5 to 15 years.
Goodwill
Effective January 1, 2000, the Company began amortizing goodwill using the
straight-line method principally over 20 years. Amortization expense recorded
for the nine months ended December 31, 2001, the three months ended March 31,
2001 and the year ended December 31, 2000 totaled $5.7 million, $2.5 million
and $11.7 million, respectively.
In accordance with SFAS 142, the Company ceased amortizing goodwill
beginning on January 1, 2002. In lieu of amortization, the Company is required
to perform an impairment test for goodwill at least annually or more frequently
if adverse events or changes in circumstances indicate that the asset may be
impaired. The Company performs its annual impairment test at the end of each
year. No impairment charge was recorded at December 31, 2002 in connection with
the annual impairment test.
To the extent the Company realizes net deferred tax assets related to the
pre-reorganization period, goodwill recorded in connection with fresh-start
accounting is reduced accordingly. In 2002 and 2001, the Company reduced
goodwill by $48.5 million and $44.6 million, respectively, related to
recognition of such deferred tax assets.
Long-Lived Assets
The Company regularly reviews the carrying value of certain long-lived
assets and the related identifiable intangible assets with respect to any
events or circumstances that indicate an impairment or an adjustment to the
amortization period is necessary. If circumstances suggest the recorded amounts
cannot be recovered, calculated based upon estimated future undiscounted cash
flows, the carrying values of such assets are reduced to fair value.
In assessing the carrying values of long-lived assets, the Company estimates
future cash flows at the lowest level for which there are independent
identifiable cash flows. For this purpose, these cash flows are aggregated
based upon the contractual agreements underlying the operation of the facility
or group of facilities. Generally, an individual facility is considered the
lowest level for which there are independent identifiable cash flows. However,
to the extent that groups of facilities are leased under a master lease
agreement in which the operations of a facility and compliance with the lease
terms are interdependent upon other facilities in the agreement (including the
Company's ability to renew the lease or divest a particular property), the
Company defines the group of facilities under the master lease as the lowest
level for which there are independent identifiable cash flows. Accordingly, the
estimated cash flows of all facilities within a master lease are aggregated for
purposes of evaluating the carrying values of long-lived assets.
Insurance Risks
Provisions for loss for professional liability risks and workers
compensation risks are substantially based upon independent actuarially
determined estimates. The provisions for loss related to professional liability
risks retained by the Company's wholly owned limited purpose insurance
subsidiary have been discounted based upon management's estimate of long-term
investment yields and independent actuarial estimates of claim payment
patterns. Provisions for loss for workers compensation risks retained by the
limited purpose insurance subsidiary are not discounted. To the extent that
subsequent expected ultimate claims costs vary from historical provisions for
loss, future earnings will be charged or credited. See Notes 7 and 12.
F-12
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1 - ACCOUNTING POLICIES (Continued)
Derivative Instruments
Prior to May 15, 2000, the Company was a party to interest rate swap
agreements that eliminated the impact of changes in interest rates on $100
million of outstanding floating rate debt. Each interest rate swap agreement
was associated with all or a portion of the principal balance of a specific
debt obligation. These agreements involved the exchange of amounts based on
variable rates for amounts based on fixed interest rates over the life of the
agreement, without an exchange of the notional amount upon which the payments
were based. The differential paid or received as interest rates changed was
accrued and recognized as an adjustment of interest expense related to the
debt, and the related amount payable to or receivable from counterparties was
included in accrued interest. The fair values of the swap agreements were not
recognized in the consolidated financial statements. Gains and losses on
terminations of interest rate swap agreements were deferred (included in other
assets) and amortized as an adjustment to interest expense over the remaining
term of the original contract life of the terminated swap agreement.
Earnings per Common Share
Basic earnings per common share are based upon the weighted average number
of common shares outstanding. No incremental shares are included in the 2000
calculation of the diluted loss per common share since the result would be
antidilutive.
Stock Option Accounting
The Company follows Accounting Principles Board Opinion No. 25 ("APB 25"),
"Accounting for Stock Issued to Employees", and related interpretations in
accounting for its employee stock options because the alternative fair value
accounting provided for under SFAS 123 requires the use of option valuation
models that were not developed for use in valuing employee stock options.
F-13
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1 - ACCOUNTING POLICIES (Continued)
Stock Option Accounting (Continued)
Pro forma information regarding net income and earnings per share determined
as if the Company had accounted for its employee stock options granted
subsequent to December 31, 1994 under the fair value method of SFAS 123 follows
(in thousands, except per share amounts):
Reorganized Company | Predecessor Company
------------------------- | ------------------------
Year Nine months | Three months Year
ended ended | ended ended
December 31, December 31, | March 31, December 31,
2002 2001 | 2001 2000
------------ ------------ | ------------ ------------
Income (loss) available to common |
stockholders, as reported......... $ 34,753 $51,655 | $471,715 $(65,797)
Adjustments: |
Stock-based employee compensation |
expense included in reported net |
income........................... 6,778 6,698 | - -
Stock-based employee compensation |
expense determined under fair |
value based method............... (10,797) (8,443) | 27,052 (5,499)
-------- ------- | -------- --------
Pro forma income (loss) available to |
common stockholders............... $ 30,734 $49,910 | $498,767 $(71,296)
======== ======= | ======== ========
|
Earnings (loss) per common share: |
As reported: |
Basic............................ $ 2.00 $ 3.33 | $ 6.71 $ (0.94)
Diluted.......................... $ 1.93 $ 2.83 | $ 6.59 $ (0.94)
Pro forma: |
Basic............................ $ 1.77 $ 3.22 | $ 7.10 $ (1.02)
Diluted.......................... $ 1.70 $ 2.71 | $ 6.96 $ (1.02)
The effects of applying SFAS 123 in the pro forma disclosures are not likely
to be representative of the effects on pro forma net income for future years
since variables such as stock option grants, cancelations and stock price
volatility included in the disclosures may not be indicative of future activity.
NOTE 2 - REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
On April 20, 2001, the Company and its subsidiaries emerged from bankruptcy
pursuant to the terms of the Plan of Reorganization. The Company and
substantially all of its subsidiaries filed voluntary petitions with the
Bankruptcy Court for protection under Chapter 11 of the Bankruptcy Code on
September 13, 1999.
Following emergence, the Company is continuing to resolve proofs of claims
filed in connection with the bankruptcy. On the Effective Date, the automatic
stay imposed by the Bankruptcy Code was terminated.
Plan of Reorganization
The Plan of Reorganization represents a consensual arrangement among Ventas,
the Company's former senior bank lenders (the "Senior Lenders"), holders of the
Company's former $300 million 9 7/8% Guaranteed Senior Subordinated Notes due
2005 (the "1998 Notes"), the U.S. Department of Justice (the "DOJ"), acting on
behalf of the U.S. Department of Health and Human Services' Office of the
Inspector General (the "OIG"), and the Centers for Medicare and Medicaid
Services ("CMS") (collectively, the "Government") and the advisors to the
official committee of unsecured creditors.
F-14
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2 - REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)
Plan of Reorganization (Continued)
The following is a summary of certain material provisions of the Plan of
Reorganization. The summary does not purport to be complete and is qualified in
its entirety by reference to all of the provisions of the Plan of
Reorganization as filed with the Securities and Exchange Commission ("SEC").
The Plan of Reorganization provided for, among other things, the following
distributions:
Senior Lender Claims-On the Effective Date, the Senior Lenders received new
senior subordinated secured notes aggregating $300 million, bearing interest at
the London Interbank Offered Rate ("LIBOR") (as defined in the agreement) plus
4 1/2%, with a maturity of seven years (the "Senior Secured Notes"). The
interest on the Senior Secured Notes began to accrue in November 2001 and, in
lieu of interest payments, the Company paid a $25.9 million obligation under
the Government Settlement (as defined below) within the first two full fiscal
quarters following the Effective Date as described below. In addition, holders
of the Senior Lender claims received an aggregate distribution of 9,826,092
shares of the new common stock of Kindred on the Effective Date.
Subordinated Noteholder Claims-The holders of the 1998 Notes and the
remaining $2.4 million of the Company's former 8 5/8% Senior Subordinated Notes
due 2007 (collectively, the "Subordinated Noteholder Claims") received, in the
aggregate, 3,675,408 shares of Kindred common stock on the Effective Date. In
addition, the holders of the Subordinated Noteholder Claims received warrants
issued by the Company for the purchase of an aggregate of 7,000,000 shares of
Kindred common stock, with a five-year term, comprised of warrants to purchase
2,000,000 shares at a price per share of $30.00 and warrants to purchase
5,000,000 shares at a price per share of $33.33 (collectively, the "Warrants").
Ventas Claim-Ventas received the following treatment under the Plan of
Reorganization:
On the Effective Date, the four master leases and a single facility lease
with Ventas were assumed and simultaneously amended and restated as of the
effective date of the Plan of Reorganization. The principal economic terms of
the Master Lease Agreements (as defined) are as follows:
(1) A decrease of $52 million in the aggregate minimum rent from the
annual rent as of May 1, 1999 to a new initial aggregate minimum rent of
$174.6 million (subject to the escalation described below).
(2) Annual aggregate minimum rent payable in cash will escalate at an
annual rate of 3 1/2% over the prior period annual aggregate minimum rent
for the period from May 1, 2001 through April 30, 2004. Thereafter, annual
aggregate minimum rent payable in cash will escalate at an annual rate of 2%
(plus, upon the occurrence of certain events, an additional annual accrued
escalator amount of 1 1/2% of the prior period annual aggregate minimum
rent) which will accrete from year to year (with an interest accrual at
LIBOR plus 4 1/2%). All accrued rent will be payable upon the repayment or
refinancing of the Senior Secured Notes, after which the annual aggregate
minimum rent payable in cash will escalate at an annual rate of 3 1/2% and
there will be no further accrual feature. The annual escalator in each
period is contingent upon the attainment of certain financial targets as
described in the Master Lease Agreements.
(3) A one-time option, that can be exercised by Ventas 5 1/4 years after
the Effective Date, to reset the annual aggregate minimum rent under one or
more of the Master Lease Agreements to the then current fair market rental
in exchange for a payment of $5 million (or a pro rata portion thereof if
fewer than all of the Master Lease Agreements are reset) to the Company.
(4) Under the Master Lease Agreements, the "Event of Default" provisions
also were substantially modified and provide Ventas with more flexibility in
exercising remedies for events of default.
F-15
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2 - REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)
Plan of Reorganization (Continued)
In addition to the Master Lease Agreements, Ventas received a distribution
of 1,498,500 shares of Kindred common stock on the Effective Date.
Ventas and the Company also entered into the Tax Refund Escrow Agreement and
First Amendment to the Tax Allocation Agreement as of the Effective Date that
provides for the escrow of approximately $30 million of federal, state and
local refunds until the expiration of the applicable statutes of limitation for
the auditing of the refund applications (the "Tax Refund Escrow Agreement").
The escrowed funds will be available for the payment of certain tax
deficiencies during the escrow period except that all interest paid by the
government in connection with any refund or earned on the escrowed funds will
be distributed equally to the parties. At the end of the escrow period, the
Company and Ventas will each be entitled to 50% of any proceeds remaining in
the escrow account.
All agreements and indemnification obligations between the Company and
Ventas, except those modified by the Plan of Reorganization, were assumed by
the Company as of the Effective Date.
United States Claims-The claims of the Government (other than claims of the
Internal Revenue Service and criminal claims, if any) were settled through a
government settlement with the Company and Ventas which was effectuated through
the Plan of Reorganization (the "Government Settlement").
Under the Government Settlement, the Company paid the Government a total of
$25.9 million as follows:
(1) $10 million was paid on the Effective Date, and
(2) an aggregate of $15.9 million was paid during the first two full
fiscal quarters following the Effective Date, plus accrued interest at the
rate of 6% per annum beginning as of the Effective Date.
Under the Government Settlement, Ventas agreed to pay the Government a total
of $103.6 million as follows:
(1) $34 million was paid on the Effective Date, and
(2) the remainder will be paid over five years, bearing interest at the
rate of 6% per annum beginning as of the Effective Date.
In addition, the Company agreed to repay the remaining balance of the
obligations owed to CMS (approximately $59 million as of the Effective Date)
pursuant to the terms previously agreed to by the Company (the "CMS Agreement").
As previously announced, the Company entered into a Corporate Integrity
Agreement with the OIG as part of the overall Government Settlement. The
Corporate Integrity Agreement became effective on the Effective Date. The
Government Settlement also provided for the dismissal of certain pending claims
and lawsuits filed against the Company.
General Unsecured Creditors Claims-The general unsecured creditors of the
Company will be paid the full amount of their allowed claims existing as of the
date of the Company's filing for protection under the Bankruptcy Code. These
amounts generally will be paid in equal quarterly installments over three years
beginning on September 30, 2001. The Company will pay interest on these claims
at the rate of 6% per annum from the Effective Date, subject to certain
exceptions. A convenience class of unsecured creditors, consisting of creditors
holding allowed claims in an amount less than or equal to $3,000, were paid in
full within 30 days of the Effective Date.
F-16
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2 - REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)
Plan of Reorganization (Continued)
Preferred Stockholder and Common Stockholder Claims-The holders of the
former preferred stock and common stock of the Company did not receive any
distributions under the Plan of Reorganization. The former preferred stock and
common stock were canceled on the Effective Date.
Other Significant Provisions-As of the Effective Date, a new board of
directors, including representatives of the principal security holders
following the Effective Date, was appointed.
A restricted share plan was approved under the Plan of Reorganization that
provided for the issuance of 600,000 shares of Kindred common stock to certain
key employees of the Company. The restricted shares are non-transferable and
subject to forfeiture until they have vested generally over a four-year period.
In addition, a new stock option plan was approved under the Plan of
Reorganization for the issuance of stock options for up to 600,000 shares of
Kindred common stock to certain key employees of the Company. The Plan of
Reorganization also approved a long-term incentive plan that provides cash
bonus awards to certain key employees on the attainment by the Company of
specified performance goals, and also provided for the continuation of the
Company's management retention plan and the payment of certain performance
bonuses on the Effective Date.
Matters Related to Emergence
On the Effective Date, the Company entered into a five-year $120 million
senior revolving credit facility (including a $40 million letter of credit
subfacility) (the "Credit Facility") which constitutes a working capital
facility for general corporate purposes including payments related to the
Company's obligations under the Plan of Reorganization. Direct borrowings under
the Credit Facility bear interest, at the option of the Company, at (a) prime
(or, if higher, the federal funds rate plus 1/2%) plus 3% or (b) LIBOR (as
defined in the agreement) plus 4%. The Credit Facility is collateralized by
substantially all of the assets of the Company and its subsidiaries, including
certain owned real property.
On the Effective Date, the Company filed a registration statement on Form
8-A with the SEC to register the Kindred common stock and Warrants under
Section 12(g) of the Securities Exchange Act of 1934 (the "Exchange Act").
NOTE 3 - FRESH-START ACCOUNTING
As previously discussed, the Company adopted the provisions of fresh-start
accounting as of April 1, 2001. In adopting fresh-start accounting, the Company
engaged an independent financial advisor to assist in the determination of the
reorganization value or fair value of the entity. The independent financial
advisor determined an estimated reorganization value of $762 million before
considering any long-term debt or other obligations assumed in connection with
the Plan of Reorganization. This estimate was based upon the Company's cash
flows, selected comparable market multiples of publicly traded companies,
operating lease obligations and other applicable ratios and valuation
techniques. The estimated total equity value of the Reorganized Company
aggregating $435 million was determined after taking into account the values of
the obligations assumed in connection with the Plan of Reorganization.
F-17
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3 - FRESH-START ACCOUNTING (Continued)
A reconciliation of fresh-start accounting recorded as of April 1, 2001
follows (in thousands):
Predecessor Reorganized
Company Fresh-start Company
-------------- -------------------------------------------- -------------
Debt
March 31, 2001 restructuring Adjustments Reclassifications April 1, 2001
-------------- ------------- ----------- ----------------- -------------
ASSETS
Current assets:
Cash and cash equivalents.................... $ 160,055 $ - $ (4,901)(i) $ - $ 155,154
Cash-restricted.............................. 11,008 (2,763)(a) 6,000 (i) - 14,245
Insurance subsidiary investments............. 90,617 - - - 90,617
Accounts receivable less allowance for loss.. 330,846 73,138 (b) - - 403,984
Inventories.................................. 29,132 - - - 29,132
Other........................................ 74,732 1,360 (a) - - 76,092
----------- --------- --------- --------- ----------
696,390 71,735 1,099 - 769,224
Property and equipment......................... 708,232 - (268,528)(j) - 439,704
Accumulated depreciation....................... (316,862) - 316,862 (j) - -
----------- --------- --------- --------- ----------
391,370 - 48,334 - 439,704
Reorganization value in excess of amounts
allocable to identifiable assets.............. - - 157,958 (k) - 157,958
Goodwill....................................... 156,765 - (156,765)(l) - -
Investment in affiliates....................... 7,824 - 40,282 (m) - 48,106
Other.......................................... 77,673 (7,668)(a) (1,823)(i) - 70,925
2,795 (c) (52)(j)
----------- --------- --------- --------- ----------
$ 1,330,022 $ 66,862 $ 89,033 $ - $1,485,917
=========== ========= ========= ========= ==========
LIABILITIES AND STOCKHOLDERS'
EQUITY (DEFICIT)
Current liabilities:
Accounts payable............................. $ 90,279 $ (2,264)(b) $ (4,030)(i) $ 1,602 (r) $ 85,587
Salaries, wages and other compensation....... 178,319 - (93)(i) 1,404 (r) 195,841
7,700 (n)
8,511 (o)
Due to third party payors.................... 47,773 (4,569)(b) - 10,651 (r) 53,855
Other accrued liabilities.................... 91,132 2,795 (c) 25,337 (o) 43,865 (r) 189,029
25,900 (d)
Income taxes................................. 2,850 - - 14,867 (r) 17,717
Long-term debt due within one year........... - - - 18,316 (r) 18,316
----------- --------- --------- --------- ----------
410,353 21,862 37,425 90,705 560,345
Long-term debt................................. - 300,000 (e) - 43,606 (r) 343,606
Professional liability risks................... 106,505 - - - 106,505
Deferred credits and other liabilities......... 14,128 - (1,777)(p) 28,071 (r) 40,422
Liabilities subject to compromise.............. 1,278,223 2,580 (a) (2,028)(i) (162,382)(r) -
(113,576)(b) (2,726)(p)
(902,755)(f)
(94,285)(g)
(3,051)(h)
Series A preferred stock (subject to compromise
at March 31, 2001)............................ 1,743 (1,743)(h) - - -
Stockholders' equity (deficit):
Reorganized Company common stock, par value.. - 3,750 (h) - - 3,750
Predecessor Company common stock, par value.. 17,565 - (17,565)(q) - -
Capital in excess of par value............... 667,144 431,289 (h) 17,565 (q) (684,752)(s) 431,246
Accumulated other comprehensive income....... 43 - - - 43
Retained earnings (accumulated deficit)...... (1,165,682) (11,651)(a) 5,427 (i) 684,752 (s) -
193,547 (b) 48,282 (j)
(25,900)(d) 157,958 (k)
(300,000)(e) (156,765)(l)
902,755 (f) 40,282 (m)
94,285 (g) (7,700)(n)
(430,245)(h) (33,848)(o)
4,503 (p)
----------- --------- --------- --------- ----------
(480,930) 857,830 58,139 - 435,039
----------- --------- --------- --------- ----------
$ 1,330,022 $ 66,862 $ 89,033 $ - $1,485,917
=========== ========= ========= ========= ==========
F-18
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3 - FRESH-START ACCOUNTING (Continued)
(a) To record the effect of the Tax Refund Escrow Agreement.
(b) To record the discharge of pre-petition accounts receivable, allowances
for loss and liabilities related to the Medicare program in connection
with the Government Settlement.
(c) To record deferred financing costs incurred in connection with the
Credit Facility and the Senior Secured Notes.
(d) To record the Government Settlement obligation.
(e) To record the issuance of the Senior Secured Notes.
(f) To record the discharge of indebtedness in accordance with the Plan of
Reorganization (in thousands):
Senior lender claims................ $510,908
Subordinated noteholder claims...... 302,391
Accrued interest.................... 99,185
Unamortized deferred financing costs (9,729)
--------
$902,755
========
(g) To write off accrued Ventas rent discharged in accordance with the Plan
of Reorganization.
(h) To record the issuance of Kindred common stock and Warrants and
eliminate the preferred stock (and related loans) and accrued dividends
of the Predecessor Company in accordance with the Plan of Reorganization.
(i) To record miscellaneous provisions of the Plan of Reorganization.
(j) To adjust the property and equipment to fair value and to write off
previously recorded accumulated depreciation.
(k) To record the reorganization value of the Company in excess of amounts
allocable to identifiable assets.
(l) To write off historical goodwill of the Predecessor Company.
(m) To adjust investment in affiliates to fair value.
(n) To record the value of the vested portion of restricted stock in
accordance with the Plan of Reorganization.
(o) To record reorganization costs consisting primarily of professional fees
and management compensation to be paid in accordance with the Plan of
Reorganization.
(p) To adjust allowances for loss related to property disposals and
non-income tax deficiencies.
(q) To eliminate the common stock of the Predecessor Company.
(r) To reclassify the pre-petition priority, secured and unsecured claims
that were assumed by the Company in accordance with the Plan of
Reorganization.
(s) To eliminate the historical accumulated deficit and adjust stockholders'
equity to reflect the fair value of the Company's total equity.
F-19
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 4 - PRO FORMA INFORMATION
The following unaudited pro forma condensed financial information gives
effect to the Plan of Reorganization assuming that the effective date occurred
on January 1, 2000 (in thousands, except per share amounts):
Year ended December 31,
-----------------------
2001 2000
---------- ----------
Revenues.................. $3,081,428 $2,888,542
Income from operations.... 57,600 16,540
Net income................ 61,913 16,540
Earnings per common share:
Basic:
Income from operations. $ 3.74 $ 1.09
Net income............. 4.02 1.09
Diluted:
Income from operations. $ 3.25 $ 0.99
Net income............. 3.49 0.99
The pro forma results exclude reorganization items recorded prior to April
1, 2001. The pro forma results are not necessarily indicative of the financial
results that might have resulted had the effective date of the Plan of
Reorganization occurred on January 1, 2000.
NOTE 5 - 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, including goodwill $ 63,123
Fair value of liabilities assumed................ (16,350)
--------
Net assets acquired............................. 46,773
Cash acquired.................................... (842)
--------
Net cash paid................................... $ 45,931
========
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 $29.1 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.
NOTE 6 - REORGANIZATION ITEMS AND UNUSUAL TRANSACTIONS
Reorganization Items
Transactions related to the Company's reorganization have been classified
separately in the consolidated statement of operations. Operating results for
2002 included income of $5.5 million resulting from changes in estimates for
accrued professional and administrative costs recorded in the second quarter
related to the Company's emergence from bankruptcy. Reorganization items
increased income from operations by $53.7 million for the three months ended
March 31, 2001. As previously discussed, these adjustments were
F-20
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 6 - REORGANIZATION ITEMS AND UNUSUAL TRANSACTIONS (Continued)
Reorganization Items (Continued)
required to reflect the provisions of the Plan of Reorganization and the fair
value of the Company's assets and liabilities as of April 1, 2001.
Reorganization costs incurred in connection with the bankruptcy were $12.6
million in 2000.
Unusual Transactions
Operating results for each of the last three years include certain unusual
transactions. These transactions were included in other operating expenses in
the consolidated statement of operations for the respective periods in which
they were recorded.
2002
Operating results for 2002 included a $0.5 million lease termination charge
for an unprofitable hospital recorded in the second quarter and a $2.3 million
gain on the sale of a building recorded in the fourth quarter.
2001
Operating results for the nine months ended December 31, 2001 included a
gain of $3.2 million recorded in connection with the Company's favorable
resolution of a legal dispute in the third quarter and a gain of $2.2 million
in connection with the resolution of a loss contingency related to a
partnership interest in the fourth quarter.
2000
Operating results for 2000 included a $4.5 million gain on the sale of a
closed hospital recorded in the second quarter and a $9.2 million write-off of
an impaired investment recorded in the third quarter.
NOTE 7 - SIGNIFICANT QUARTERLY ADJUSTMENTS
Third Quarter 2002
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
professional liability costs above its normal provision. The additional costs
were required based upon the results of the regular quarterly independent
actuarial valuation. Substantially all of the additional costs were related to
the Company's nursing center operations. 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 costs 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 with
unaffiliated commercial insurance carriers in effect for those periods.
F-21
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 7 - SIGNIFICANT QUARTERLY ADJUSTMENTS (Continued)
Third Quarter 2002 (Continued)
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 2002. The estimate
for 2002 professional liability costs 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.
Fourth Quarter 2002
In the fourth quarter of 2002, certain Medicare reimbursements expired on
October 1, 2002. Accordingly, Medicare reimbursement to the Company's nursing
centers declined by approximately $15 million in the fourth quarter of 2002,
resulting in a material reduction in nursing center operating income.
On October 1, 2002, the provisions under the Balanced Budget Act of 1997
reducing allowable hospital capital expenditures by 15% expired. As a result,
hospital Medicare revenues increased by approximately $2 million in the fourth
quarter of 2002.
Based upon the results of the regular quarterly independent actuarial
valuation, the Company recorded additional professional liability costs of $19
million in the fourth quarter of 2002, of which $10 million had been previously
announced at the time of the Company's third quarter earnings release.
Aggregate professional liability costs in the fourth quarter of 2002 were
$37 million compared to $24 million in the fourth quarter of 2001. Most of
these costs ($33 million in the fourth quarter of 2002 and $18 million in the
fourth quarter of 2001) were charged to the Company's nursing center business.
Operating results in the fourth quarter of 2002 included certain other
year-end adjustments. Incentive compensation costs were reduced by
approximately $3 million in the nursing center business and $6 million in
corporate overhead in the fourth quarter. In addition, certain operating
expense accruals related to the Company's information systems operations were
adjusted, reducing corporate overhead by approximately $4 million in the fourth
quarter of 2002.
F-22
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 8 - EARLY EXTINGUISHMENT OF DEBT
In connection with the restructuring of its debt in accordance with the
provisions of the Plan of Reorganization, the Company realized an extraordinary
gain of $422.8 million. For accounting purposes, this gain has been reflected
in the operating results of the Predecessor Company for the three months ended
March 31, 2001.
A summary of the extraordinary gain follows (in thousands):
Liabilities restructured:
Debt obligations:
Senior lender claims............................ $ 510,908
Subordinated noteholder claims.................. 302,391
Accrued interest................................ 99,185
Unamortized deferred financing costs............ (9,729)
----------
902,755
Amounts related to prior year Medicare cost reports 193,547
Accrued Ventas rent................................ 94,285
Other.............................................. (6,857)
----------
1,183,730
----------
Consideration exchanged:
Senior secured notes.............................. 300,000
Kindred common stock.............................. 368,339
Warrants.......................................... 66,700
Government settlement obligation.................. 25,900
----------
760,939
----------
$ 422,791
==========
On May 30, 2001, the Company prepaid the outstanding balance in full
satisfaction of its obligations under the CMS Agreement, resulting in an
extraordinary gain of $1.4 million. The transaction was financed through the
use of existing cash. In the fourth quarter of 2001, the Company prepaid $89.5
million of the Senior Secured Notes, resulting in an extraordinary gain of $2.9
million. The transaction was financed from proceeds of the public offering of
Kindred common stock.
In connection with a $50 million prepayment of the Senior Secured Notes, the
Company recorded an extraordinary gain on the extinguishment of debt
aggregating $1.4 million in the third quarter of 2002.
F-23
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9 - EARNINGS PER SHARE
Earnings per common share are based upon the weighted average number of
common shares outstanding during the respective periods. The diluted
calculation of earnings per common share for the Reorganized Company includes
the dilutive effect of the Warrants issued in connection with the Plan of
Reorganization and stock options and non-vested restricted stock issued under
various incentive plans. For the three months ended March 31, 2001, the diluted
calculation of earnings per common share for the Predecessor Company includes
the dilutive effect of its former convertible preferred stock.
A computation of the earnings per common share follows (in thousands, except
per share amounts):
Reorganized Company | Predecessor Company
------------------------- | ------------------------
Year Nine months | Three months Year
ended ended | ended ended
December 31, December 31, | March 31, December 31,
2002 2001 | 2001 2000
------------ ------------ | ------------ ------------
Earnings (loss): |
Income (loss) from operations........................ $33,326 $47,342 | $ 49,185 $(64,751)
Extraordinary gain on extinguishment of debt......... 1,427 4,313 | 422,791 -
------- ------- | -------- --------
Net income (loss).................................... 34,753 51,655 | 471,976 (64,751)
Preferred stock dividend requirements................ - - | (261) (1,046)
------- ------- | -------- --------
Income (loss) available to common stockholders - |
basic computation................................... 34,753 51,655 | 471,715 (65,797)
Elimination of preferred stock dividend requirements |
upon assumed conversion of preferred stock.......... - - | 261 -
------- ------- | -------- --------
Net income (loss) - diluted computation.............. $34,753 $51,655 | $471,976 $(65,797)
======= ======= | ======== ========
Shares used in the computation: |
Weighted average shares outstanding - basic |
computation........................................ 17,361 15,505 | 70,261 70,229
Dilutive effect of the Warrants, employee stock |
options and non-vested restricted stock............. 640 2,753 | - -
Assumed conversion of preferred stock................ - - | 1,395 -
------- ------- | -------- --------
Adjusted weighted average shares outstanding - |
diluted computation................................. 18,001 18,258 | 71,656 70,229
======= ======= | ======== ========
Earnings (loss) per common share: |
Basic: |
Income (loss) from operations...................... $ 1.92 $ 3.05 | $ 0.69 $ (0.94)
Extraordinary gain on extinguishment of debt....... 0.08 0.28 | 6.02 -
------- ------- | -------- --------
Net income (loss)................................. $ 2.00 $ 3.33 | $ 6.71 $ (0.94)
======= ======= | ======== ========
Diluted: |
Income (loss) from operations...................... $ 1.85 $ 2.59 | $ 0.69 $ (0.94)
Extraordinary gain on extinguishment of debt....... 0.08 0.24 | 5.90 -
------- ------- | -------- --------
Net income (loss)................................. $ 1.93 $ 2.83 | $ 6.59 $ (0.94)
======= ======= | ======== ========
F-24
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 10 - BUSINESS SEGMENT DATA
The Company operates two business segments: the health services division and
the hospital division. The health services division operates nursing centers
and a rehabilitation therapy business. The hospital division operates hospitals
and an institutional pharmacy business. The 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):
Reorganized Company | Predecessor Company
------------------------- | ------------------------
Year Nine months | Three months Year
ended ended | ended ended
December 31, December 31, | March 31, December 31,
2002 2001 | 2001 2000
------------ ------------ | ------------ ------------
Revenues: |
Health services division: |
Nursing centers........................................... $1,854,131 $1,348,236 | $429,523 $1,675,627
Rehabilitation services................................... 34,296 27,451 | 10,695 135,036
Elimination............................................... - - | - (77,191)
---------- ---------- | -------- ----------
1,888,427 1,375,687 | 440,218 1,733,472
Hospital division: |
Hospitals................................................. 1,276,299 822,935 | 271,984 1,007,947
Pharmacy.................................................. 257,782 176,105 | 54,880 204,252
---------- ---------- | -------- ----------
1,534,081 999,040 | 326,864 1,212,199
---------- ---------- | -------- ----------
3,422,508 2,374,727 | 767,082 2,945,671
Elimination of pharmacy charges to Company nursing centers. (64,686) (45,708) | (14,673) (57,129)
---------- ---------- | -------- ----------
$3,357,822 $2,329,019 | $752,409 $2,888,542
========== ========== | ======== ==========
Income (loss) from operations: |
Operating income: |
Health services division: |
Nursing centers.......................................... $ 226,284 $ 234,500 | $ 70,543 $ 278,738
Rehabilitation services.................................. 7,531 8,112 | 690 8,047
Other ancillary services................................. 435 508 | 250 4,737
---------- ---------- | -------- ----------
234,250 243,120 | 71,483 291,522
Hospital division: |
Hospitals................................................ 260,440 157,613 | 54,778 205,858
Pharmacy................................................. 23,531 20,831 | 6,176 7,421
---------- ---------- | -------- ----------
283,971 178,444 | 60,954 213,279
Corporate overhead........................................ (117,204) (85,239) | (28,697) (113,823)
---------- ---------- | -------- ----------
401,017 336,325 | 103,740 390,978
Unusual transactions...................................... 1,795 5,425 | - (4,701)
Reorganization items...................................... 5,520 - | 53,666 (12,636)
---------- ---------- | -------- ----------
Operating income......................................... 408,332 341,750 | 157,406 373,641
Rent....................................................... (270,562) (195,284) | (76,995) (307,809)
Depreciation and amortization.............................. (71,356) (50,219) | (18,645) (73,545)
Interest, net.............................................. (4,699) (12,455) | (12,081) (55,038)
---------- ---------- | -------- ----------
Income (loss) before income taxes.......................... 61,715 83,792 | 49,685 (62,751)
Provision for income taxes................................. 28,389 36,450 | 500 2,000
---------- ---------- | -------- ----------
$ 33,326 $ 47,342 | $ 49,185 $ (64,751)
========== ========== | ======== ==========
F-25
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 10 - BUSINESS SEGMENT DATA (Continued)
|
Reorganized Company | Predecessor Company
------------------------- | -------------------------
Year Nine months | Three months Year
ended ended | ended ended
December 31, December 31, | March 31, December 31,
2002 2001 | 2001 2000
------------ ------------ | ------------ ------------
Rent: |
Health services division: |
Nursing centers............ $ 169,242 $ 123,047 | $44,253 $176,802
Rehabilitation services.... 101 75 | 39 429
Other ancillary services... - 4 | - 114
---------- ---------- | ------- --------
169,343 123,126 | 44,292 177,345
Hospital division: |
Hospitals.................. 96,899 68,571 | 30,839 123,766
Pharmacy................... 4,106 2,953 | 941 3,614
---------- ---------- | ------- --------
101,005 71,524 | 31,780 127,380
Corporate................... 214 634 | 923 3,084
---------- ---------- | ------- --------
$ 270,562 $ 195,284 | $76,995 $307,809
========== ========== | ======= ========
Depreciation and amortization: |
Health services division: |
Nursing centers............ $ 25,446 $ 16,693 | $ 7,219 $ 27,896
Rehabilitation services.... 37 24 | - 4
Other ancillary services... - - | 129 613
---------- ---------- | ------- --------
25,483 16,717 | 7,348 28,513
Hospital division: |
Hospitals.................. 27,080 17,519 | 5,457 21,170
Pharmacy................... 2,387 1,446 | 627 2,098
---------- ---------- | ------- --------
29,467 18,965 | 6,084 23,268
Corporate................... 16,406 14,537 | 5,213 21,764
---------- ---------- | ------- --------
$ 71,356 $ 50,219 | $18,645 $ 73,545
========== ========== | ======= ========
Capital expenditures: |
Health services division.... $ 24,127 $ 13,315 | $ 7,962 $ 28,451
Hospital division........... 30,124 19,830 | 8,901 23,675
Corporate: |
Information systems........ 25,576 20,266 | 3,496 25,475
Other...................... 4,244 11,832 | 1,679 2,387
---------- ---------- | ------- --------
$ 84,071 $ 65,243 | $22,038 $ 79,988
========== ========== | ======= ========
Assets at end of period:
Health services division.... $ 422,713 $ 392,938
Hospital division........... 581,256 497,057
Corporate................... 640,209 618,879
---------- ----------
$1,644,178 $1,508,874
========== ==========
Goodwill:
Health services division.... $ 31,045 $ 56,468
Hospital division........... 57,214 51,192
---------- ----------
$ 88,259 $ 107,660
========== ==========
F-26
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 11 - INCOME TAXES
The provision for income taxes is based upon management's estimate of
taxable income or loss for each respective accounting period. The Company
recognizes an asset or liability for the deferred tax consequences of temporary
differences between the tax bases of assets and liabilities and their reported
amounts in the financial statements. These temporary differences will result in
taxable or deductible amounts in future years when the reported amounts of the
assets are recovered or liabilities are settled. The Company also recognizes as
deferred tax assets the future tax benefits from net operating and capital loss
carryforwards. A valuation allowance is provided for these deferred tax assets
if it is more likely than not that some portion or all of the net deferred tax
assets will not be realized.
Provision for income taxes consists of the following (in thousands):
Reorganized Company | Predecessor Company
------------------------- | -------------------------
Year Nine months | Three months Year
ended ended | ended ended
December 31, December 31, | March 31, December 31,
2002 2001 | 2001 2000
------------ ------------ | ------------ ------------
Current: |
Federal $ 39,564 $20,805 | $ - $ -
State.. 6,433 3,382 | 500 2,000
-------- ------- | ---- ------
45,997 24,187 | 500 2,000
Deferred (17,608) 12,263 | - -
-------- ------- | ---- ------
$ 28,389 $36,450 | $500 $2,000
======== ======= | ==== ======
Reconciliation of federal statutory tax expense to the provision for income
taxes follows (in thousands):
Reorganized Company | Predecessor Company
------------------------- | ------------------------
Year Nine months | Three months Year
ended ended | ended ended
December 31, December 31, | March 31, December 31,
2002 2001 | 2001 2000
------------ ------------ | ------------ ------------
Income tax expense (benefit) at |
federal rate............................ $21,600 $29,327 | $ 17,390 $(21,963)
State income tax expense (benefit), net of |
federal income tax expense (benefit).... 2,160 2,933 | 1,739 (2,197)
Goodwill amortization..................... - 2,211 | 999 3,997
Valuation allowance....................... - - | 685 12,222
Reorganization items...................... - - | (20,946) 7,372
Other items, net.......................... 4,629 1,979 | 633 2,569
------- ------- | -------- --------
$28,389 $36,450 | $ 500 $ 2,000
======= ======= | ======== ========
F-27
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 11 - INCOME TAXES (Continued)
A summary of deferred income taxes by source included in the consolidated
balance sheet at December 31 follows (in thousands):
Reorganized Company
---------------------------------------------
2002 2001
---------------------- ----------------------
Assets Liabilities Assets Liabilities
--------- ----------- --------- -----------
Property and equipment...................... $ 1,132 $ - $ 26,150 $ -
Insurance................................... 44,527 - 33,437 -
Doubtful accounts........................... 88,644 - 72,829 -
Compensation................................ 28,905 - 26,575 -
Net operating losses........................ 93,593 - 98,878 -
Other....................................... 55,665 2,144 39,649 1,918
--------- ------ --------- ------
312,466 $2,144 297,518 $1,918
====== ======
Reclassification of deferred tax liabilities (2,144) (1,918)
--------- ---------
Net deferred tax assets..................... 310,322 295,600
Valuation allowance......................... (234,861) (263,307)
--------- ---------
$ 75,461 $ 32,293
========= =========
Deferred income taxes totaling $32.1 million and $20.8 million at December
31, 2002 and 2001, respectively, were included in other current assets, and
deferred income taxes totaling $43.4 million and $11.5 million at December 31,
2002 and 2001, respectively, were included in other assets.
In connection with fresh-start accounting, the Company's assets and
liabilities were recorded at their respective fair values. Deferred tax assets
and liabilities were then recognized for the tax effects of the differences
between fair values and tax bases. In addition, deferred tax assets were
recognized for future tax benefits of net operating loss carryforwards ("NOLs")
and other deferred tax credits.
To the extent management believes the pre-emergence net deferred tax asset
will more likely than not be realized, a reduction in the valuation allowance
established in fresh-start accounting will be recorded. The reduction in this
valuation allowance will first reduce goodwill recorded in connection with
fresh-start accounting and other intangible assets, with any excess being
treated as an increase to capital in excess of par value. As of December 31,
2002 and 2001, the Company had reduced the valuation allowance established in
fresh-start accounting by approximately $48.5 million and $44.6 million,
respectively, resulting in a corresponding reduction to goodwill.
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 including (a) NOLs, (b) certain tax credits and
(c) tax bases in assets in an amount equal to such gain on extinguishment. The
reorganization of the Company on 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 may be
subject to certain limitations. Through December 31, 2002, the Company had
realized approximately $41 million of cash flow benefits related to the
previously discussed tax attributes.
The Company had NOLs of approximately $243 million and $257 million (after
the reductions in the attributes discussed above) at December 31, 2002 and
2001, respectively. These NOLs expire in various amounts through 2021.
F-28
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 12 - INSURANCE RISKS
The Company insures a substantial portion of its professional liability
risks and, beginning in 2001, workers compensation risks through a wholly owned
limited purpose insurance subsidiary. Provisions for loss for these risks are
based upon 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 costs vary from historical provisions for loss, future earnings will be
charged or credited. See Note 7.
The provision for loss for professional liability risks, including the cost
of coverage maintained with unaffiliated commercial insurance carriers,
aggregated $145 million for the year ended December 31, 2002, $53 million for
the nine months ended December 31, 2001, $13 million for the three months ended
March 31, 2001 and $53 million for the year ended December 31, 2000.
The provision for loss for workers compensation risks, including the cost of
coverage maintained with unaffiliated commercial insurance carriers, aggregated
$44 million for the year ended December 31, 2002, $27 million for the nine
months ended December 31, 2001, $10 million for the three months ended March
31, 2001 and $35 million for the year ended December 31, 2000.
A summary of the assets and liabilities related to insurance risks included
in the consolidated balance sheet at December 31 follows (in thousands):
Reorganized Company
---------------------------------------------------------------------
2002 2001
---------------------------------- ----------------------------------
Professional Workers Professional Workers
liability compensation Total liability compensation Total
------------ ------------ -------- ------------ ------------ --------
Assets:
Current:
Insurance subsidiary investments. $ 87,712 $42,703 $130,415 $ 69,877 $29,224 $ 99,101
Reinsurance recoverables......... 6,713 - 6,713 5,584 - 5,584
Deposits......................... - 926 926 - 1,640 1,640
-------- ------- -------- -------- ------- --------
94,425 43,629 138,054 75,461 30,864 106,325
Non-current:
Insurance subsidiary investments. 18,171 - 18,171 16,976 - 16,976
Reinsurance recoverables......... 6,160 - 6,160 8,840 - 8,840
Deposits......................... 7,380 1,270 8,650 3,400 - 3,400
Other............................ 319 249 568 313 1,491 1,804
-------- ------- -------- -------- ------- --------
32,030 1,519 33,549 29,529 1,491 31,020
-------- ------- -------- -------- ------- --------
$126,455 $45,148 $171,603 $104,990 $32,355 $137,345
======== ======= ======== ======== ======= ========
Liabilities:
Allowance for insurance risks:
Current.......................... $ 45,346 $12,230 $ 57,576 $ 26,529 $ 7,982 $ 34,511
Non-current...................... 211,771 40,756 252,527 136,764 25,793 162,557
-------- ------- -------- -------- ------- --------
$257,117 $52,986 $310,103 $163,293 $33,775 $197,068
======== ======= ======== ======== ======= ========
Provisions for loss for professional liability risks retained by the limited
purpose insurance subsidiary have been discounted based upon management's
estimate of long-term investment yields and independent actuarial
F-29
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 12 - INSURANCE RISKS (Continued)
estimates of claim payment patterns. The interest rate used to discount funded
professional liability risks in each of the last three years was 5%. Amounts
equal to the discounted loss provision are funded annually. The Company does
not fund the portion of professional liability risks related to estimated
claims that have been incurred but not reported. Accordingly, these liabilities
are not discounted. The undiscounted allowance for professional liability risks
aggregated $275 million at December 31, 2002 and $176 million at December 31,
2001.
Provisions for loss for workers compensation risks retained by the limited
purpose insurance subsidiary are not discounted and amounts equal to the loss
provision are funded annually.
NOTE 13 - LONG-TERM DEBT
Capitalization
A summary of long-term debt at December 31 follows (in thousands):
Reorganized Company
------------------
2002 2001
-------- --------
Senior Secured Notes due 2008 (effective floating rate 5.1%)..... $160,500 $210,500
Other............................................................ 1,766 2,187
-------- --------
Total debt, average life of 5 years (weighted average rate 5.2%) 162,266 212,687
Amounts due within one year...................................... (258) (418)
-------- --------
Long-term debt.................................................. $162,008 $212,269
======== ========
In April 2002, the Company announced that it had amended the terms of its
Credit Facility and Senior Secured Notes. The more significant changes to these
agreements allowed the Company to make acquisitions and investments in
healthcare facilities up to an aggregate amount of $130 million compared to $30
million before the amendments. In addition, the amendments allowed the Company
to borrow up to $45 million under the Credit Facility to finance future
acquisitions and investments in healthcare facilities. The amount of credit
under the Credit Facility, which was reduced to $75 million in connection with
the Company's equity offering in the fourth quarter of 2001, was restored to
the $120 million level that was in effect prior to the offering. The amendments
also allowed the Company to pay cash dividends or repurchase its common stock
in limited amounts based upon certain annual liquidity calculations. Finally,
the Company agreed to certain revised financial covenants. Other material terms
of the credit agreements, including maturities, repayment terms and rates of
interest, were unchanged.
In August 2002, the Company announced that it had amended the terms of the
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
allowed 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 March 2003, the Company announced it had amended certain financial
covenants for periods after December 31, 2002 under the Credit Facility and the
Senior Secured Notes. These amendments reflect the estimated future financial
impact of certain nursing center Medicare reimbursement reductions that became
effective on October 1, 2002 and expected significant increases in professional
liability costs. In connection with the amendments, the previous amendments (as
discussed above) allowing the Company to repurchase its
F-30
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 13 - LONG-TERM DEBT (Continued)
Capitalization (Continued)
common stock, pay limited dividends and increase annual capital expenditures
beginning in fiscal 2003 were rescinded. In addition, the amount of allowable
acquisitions and investment in healthcare facilities was reduced to $50 million
from $130 million. As of December 31, 2002, the Company had expended
approximately $30 million in allowable acquisitions and investments in
healthcare facilities. Other material terms of the credit agreements, including
maturities, repayment terms and rates of interest, were unchanged.
The terms of the Company's Senior Secured Notes and Credit Facility
(inclusive of the amendments discussed above) include certain covenants which
limit annual capital expenditures and limit the amount of debt that may be
incurred in financing acquisitions. In addition, these agreements restrict the
Company's ability to transfer funds to the parent company or repurchase its
common stock and prohibit the payment of cash dividends to stockholders.
Other Information
Scheduled maturities of long-term debt in years 2004 through 2007
approximate $64,000, $70,000, $76,000 and $83,000, respectively.
The estimated fair value of the Company's long-term debt was $158 million
and $213 million at December 31, 2002 and 2001, respectively, compared to
carrying amounts aggregating $162 million and $213 million.
In connection with the bankruptcy, the Company entered into a $100 million
debtor-in-possession financing agreement (the "DIP Financing"). The DIP
Financing was initially comprised of a $75 million tranche A revolving loan and
a $25 million tranche B revolving loan. Interest was payable at prime plus
2 1/2% on the tranche A loan and prime plus 4 1/2% on the tranche B loan. The
DIP Financing was terminated on the Effective Date.
The Company was a party to an interest rate swap agreement that eliminated
the impact of changes in interest rates on $100 million of floating rate debt
outstanding. The agreement provided for fixed rates on $100 million of floating
rate debt at 6.4% plus 3/8% to 1 1/8% and expired in May 2000. The fair value
of the swap agreements, or the estimated amount the Company would have paid to
terminate the agreements based on current interest rates, was not recognized in
the consolidated financial statements in 2000.
F-31
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14 - LEASES
The Company leases real estate and equipment under cancelable and
non-cancelable arrangements. Future minimum payments under non-cancelable
operating leases are as follows (in thousands):
Minimum payments
--------------------------
Ventas Other Total
-------- -------- --------
2003...... $185,896 $ 54,814 $240,710
2004...... 185,896 46,528 232,424
2005...... 185,896 44,561 230,457
2006...... 185,896 41,217 227,113
2007...... 185,896 35,754 221,650
Thereafter 442,604 161,111 603,715
NOTE 15 - CONTINGENCIES
Management continually evaluates contingencies based upon the best available
evidence. In addition, allowances for loss are provided currently for disputed
items that have continuing significance, such as certain third party
reimbursements and deductions that continue to be claims in current cost
reports and tax returns.
Management believes that allowances for losses have been provided to the
extent necessary and that its assessment of contingencies is reasonable.
Principal contingencies are described below:
Revenues-Certain third party payments are subject to examination by
agencies administering the various programs. The Company is contesting
certain issues raised in audits of prior year cost reports.
Professional liability risks-The Company has provided for loss for
professional liability risks based upon actuarially determined estimates.
Ultimate claims costs may differ from the provisions for loss. See Notes 7
and 12.
Guarantees of indebtedness-Letters of credit and guarantees of
indebtedness aggregated $6.5 million at December 31, 2002.
Income taxes-Under the terms of the Tax Refund Escrow Agreement, the
Company is contesting adjustments proposed by the Internal Revenue Service
for the years 1997 and 1998.
Litigation-The Company is a party to certain material litigation and
regulatory actions as well as various suits and claims arising in the
ordinary course of business. See Note 21.
Ventas indemnification-In connection with the Spin-off, 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. The Company also has agreed to
hold Ventas harmless from all claims against Ventas arising from third party
leases and guarantee arrangements entered into before the Spin-off. Under
the Plan of Reorganization, the Company agreed to continue to fulfill the
Company's indemnification obligations arising from the Spin-off.
F-32
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 15 - CONTINGENCIES (Continued)
Other indemnifications-In the ordinary course of business, the Company
enters into contracts containing standard indemnification provisions and
indemnifications specific to a transaction such as a disposal of an
operating facility. These indemnifications may cover claims against
employment-related matters, governmental regulations, environmental issues,
and tax matters, as well as patient, third party payor, supplier and
contractual relationships. Obligations under these indemnities generally
would be initiated by a breach of the terms of the contract or by a third
party claim or event. The Company regularly evaluates the probability of
incurring costs associated with these indemnifications and has provided for
expected losses that are probable.
NOTE 16 - CAPITAL STOCK
In April 2002, the stockholders of the Company approved an increase in the
number of authorized shares of common stock from 39,000,000 to 175,000,000. The
stockholders also approved an additional 1,200,000 shares of common stock that
could be issued under the Company's incentive compensation plans.
Public Equity Offering
In the fourth quarter of 2001, the Company completed a public offering of
approximately 2.1 million shares of Kindred common stock. The net proceeds from
the transaction aggregating $89.6 million were used to repay a portion of the
outstanding borrowings under the Senior Secured Notes.
Repurchase of Common Stock
In the third quarter of 2002, the Company repurchased 27,500 shares of
Kindred common stock at an aggregate cost of approximately $1 million.
Plan Descriptions
Since its emergence from bankruptcy, the Company has adopted plans under
which restricted stock awards and options to purchase Kindred common stock may
be granted to officers, directors and key employees. Shares authorized under
these plans aggregated 3.4 million and 2.2 million at December 31, 2002 and
2001, respectively. Exercise provisions vary, but most stock options are
exercisable in whole or in part beginning one to four years after grant and
ending five to ten years after grant.
Upon emergence, the Company granted 600,000 shares of restricted stock to
key employees of the Company. On the Effective Date, 200,000 shares of the
restricted stock valued at $7.7 million vested immediately. The remaining
400,000 shares of restricted stock vest over a four-year period from the date
of grant. In addition, the Company granted 964,400 options to purchase Kindred
common stock with an exercise price of $32.00 per share, less than the fair
market value of the Kindred common stock on the date of grant of $38.50 per
share.
Unearned compensation under the restricted stock and discounted stock option
awards is amortized over the vesting period. Compensation expense related to
these awards approximated $6.8 million for 2002 and $6.7 million for the nine
months ended December 31, 2001.
F-33
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 16 - CAPITAL STOCK (Continued)
Plan Descriptions (Continued)
Activity in the various plans is summarized below:
Shares Weighted
under Option price average
option per share exercise price
---------- ---------------- --------------
Predecessor Company:
Balances, December 31, 1999....................... 8,042,679 $ 0.08 to $15.09 $ 5.50
Canceled or expired............................. (1,813,066) 0.39 to 14.93 6.98
----------
Balances, December 31, 2000....................... 6,229,613 0.08 to 15.09 5.07
Canceled or expired............................. (563,547) 3.81 to 9.80 5.22
Elimination of stock options in connection with
the Plan of Reorganization.................... (5,666,066) 0.08 to 15.09 5.06
----------
- -----------------------------------------------------------------------------------------------
Reorganized Company:
Balances, April 1, 2001........................... -
Granted......................................... 1,066,900 32.00 to 59.00 34.13
Canceled........................................ (96,800) 32.00 to 59.00 33.87
----------
Balances, December 31, 2001....................... 970,100 32.00 to 59.00 34.15
Granted......................................... 543,000 12.77 to 52.00 32.72
Exercised....................................... (4,967) 32.00 32.00
Canceled........................................ (139,532) 31.81 to 59.00 36.46
----------
Balances, December 31, 2002....................... 1,368,601 $12.77 to $59.00 $33.36
==========
A summary of stock options outstanding at December 31, 2002 follows:
Options outstanding Options exercisable
------------------------------------ ------------------------
Weighted
Number average Weighted Number Weighted
outstanding remaining average exercisable average
at December 31, contractual exercise at December 31, exercise
Range of exercise prices 2002 life price 2002 price
- ------------------------ --------------- ----------- -------- --------------- --------
$12.77 to $19.30.... 71,400 10 years $16.55 - $ -
$31.81 to $40.00.... 1,194,826 7 years 32.73 249,107 32.00
$45.60 to $59.00.... 102,375 9 years 52.39 18,250 53.70
--------- -------
1,368,601 7 years $33.36 267,357 $33.48
========= =======
Shares of Kindred common stock available for future grants were 1,426,432
and 629,900 at December 31, 2002 and 2001, respectively. Shares of Predecessor
Company common stock available for future grants were 6,001,333 at December 31,
2000.
Statement No. 123 Data
The Company follows APB 25 and related interpretations in accounting for its
employee stock options because, as discussed below, the alternative fair value
accounting provided for under SFAS 123 requires the use of option valuation
models that were not developed for use in valuing employee stock options.
F-34
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 16 - CAPITAL STOCK (Continued)
Statement No. 123 Data (Continued)
Pro forma information regarding net income and earnings per share determined
as if the Company had accounted for its employee stock options granted
subsequent to December 31, 1994 under the fair value method of SFAS 123 is
included in Note 1. The fair value of such options was estimated at the date of
grant using a Black-Scholes option valuation model with the following weighted
average assumptions: risk-free interest rate of 4.30% for 2002, 4.59% for 2001
and 5.90% for 2000; no dividend yield; expected term of six years and
volatility factors of the expected market price of the common stock of .47 for
2002, .43 for 2001 and .85 for 2000.
A Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restriction and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because the changes in the
subjective input assumptions can affect materially the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the respective vesting period. The
weighted average fair value of options granted during 2002 under a
Black-Scholes valuation model was $17.36 for options with an exercise price
equal to the market price on the date of grant. The weighted average fair value
of options granted during 2001 under a Black-Scholes valuation model was $17.64
for options issued with an exercise price less than the market price on the
date of grant and $28.08 for options with an exercise price equal to the market
price on the date of grant. There were no options granted during 2000.
NOTE 17 - EMPLOYEE BENEFIT PLANS
The Company maintains defined contribution retirement plans covering
employees who meet certain minimum eligibility requirements. Benefits are
determined as a percentage of a participant's contributions and generally are
vested based upon length of service. Retirement plan expense was $11.9 million
for 2002, $8.0 million for the nine months ended December 31, 2001, $3.0
million for the three months ended March 31, 2001 and $8.8 million for 2000.
Amounts equal to retirement plan expense are funded annually.
The Company also maintained a supplemental executive retirement plan
covering certain officers under which benefits were determined based primarily
upon participants' compensation and length of service with the Company. The
cost of the plan aggregated $287,000 for 2002, $155,000 for the nine months
ended December 31, 2001, $56,000 for the three months ended March 31, 2001 and
$300,000 for 2000. The plan was terminated in February 2001.
F-35
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 18 - ACCRUED LIABILITIES
A summary of other accrued liabilities at December 31 follows (in thousands):
Reorganized Company
-------------------
2002 2001
-------- --------
Professional liability risks $ 45,346 $ 26,529
Patient accounts............ 37,318 25,105
Taxes other than income..... 26,280 23,165
Accrued reorganization items 9,567 20,075
Other....................... 31,509 43,697
-------- --------
$150,020 $138,571
======== ========
NOTE 19 - RELATED PARTY TRANSACTIONS
Pursuant to the Plan of Reorganization, the Company issued to certain
claimholders in exchange for their claims an aggregate of (1) $300 million of
the Senior Secured Notes, (2) 15,000,000 shares of Kindred common stock, (3)
2,000,000 Series A warrants, and (4) 5,000,000 Series B warrants. Each of the
Series A warrants and the Series B warrants has a five-year term with an
exercise price of $30.00 and $33.33 per share, respectively. As a result of the
exchange described above, the holders of certain claims acquired control of the
Company and the holders of the Company's former common stock relinquished
control.
In connection with the Plan of Reorganization, the Company also entered into
a registration rights agreement (the "Registration Rights Agreement") with
Appaloosa Management L.P., Franklin Mutual Advisers, LLC, Goldman, Sachs & Co.
and Ventas Realty, Limited Partnership (the "Rights Holders"). Mr. David A.
Tepper, one of the Company's directors, is the President of Appaloosa
Management L.P. Mr. Tepper also is the general partner of Appaloosa Management
L.P. Mr. James Bolin, one of the Company's directors, was the Vice President
and Secretary of Appaloosa Management L.P. until October 2002. Mr. Michael J.
Embler, one of the Company's directors, is a Vice President of Franklin Mutual
Advisers, LLC.
The Registration Rights Agreement requires the Company to use its reasonable
best efforts to file, cause to be declared effective and keep effective for at
least two years or until all of the Rights Holders' shares of Kindred common
stock or Warrants are sold, a "shelf" registration statement covering sales of
such Rights Holders' shares of the Company's common stock and Warrants or, in
the case of Ventas, the distribution of some or all of the shares of the
Company's common stock that it owns to the Ventas stockholders. The Company
filed the shelf registration statement on Form S-3 with the SEC on September
19, 2001. The shelf registration statement became effective on November 7, 2001.
The Registration Rights Agreement also provides that, subject to certain
limitations, each Rights Holder has the right to demand that the Company
register all or a part of Kindred common stock and Warrants acquired by that
Rights Holder pursuant to the Plan of Reorganization, provided that the
estimated market value of the Kindred common stock and Warrants to be
registered is at least $10 million in the aggregate or not less than 5% of
Kindred common stock and Warrants. The Company is required to use its
reasonable best efforts to effect any such registration. Such registrations
will be at the Company's expense, subject to certain exceptions.
In addition, under the Registration Rights Agreement, the Rights Holders
have certain rights to require the Company to include in any registration
statement that it files with respect to any offering of equity securities
(whether for the Company's own account or for the account of any holders of the
Company's securities) such amount of Kindred common stock and Warrants as are
requested by the Rights Holder to be included in the
F-36
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
registration statement, subject to certain exceptions. Such registrations will
be at the Company's expense, subject to certain exceptions. As discussed below,
the parties to the Registration Rights Agreement participated in the Company's
public equity offering in the fourth quarter of 2001.
Pursuant to Amendment No. 1 to the Registration Rights Agreement, dated as
of August 13, 2001, the parties to the Registration Rights Agreement agreed to
extend the deadline for the Company to file a "shelf" registration statement
from 120 days to 150 days after the Effective Date. As noted above, the Company
filed a shelf registration statement with the SEC on September 19, 2001, and
the shelf registration statement was declared effective on November 7, 2001.
Pursuant to Amendment No. 2 to the Registration Rights Agreement, dated as
of October 22, 2001, the parties to the Registration Rights Agreement agreed to
an exception to certain restrictions in the Registration Rights Agreement to
allow Ventas to distribute up to 350,000 shares of Kindred common stock that it
owns to its stockholders on or after December 24, 2001.
In the fourth quarter of 2001, the Company completed a public offering of
approximately 3.6 million shares of Kindred common stock priced at $46.00 per
share. In the offering, the Company sold approximately 2.1 million newly issued
shares and certain of the holders of five percent or more of the Kindred common
stock participated in the offering as selling shareholders.
In connection with the Plan of Reorganization, the Company also entered into
and assumed several agreements with Ventas. In addition to Kindred common stock
received by Ventas in the Plan of Reorganization, the Company amended and
restated the Master Lease Agreements with Ventas and paid Ventas a $4.5 million
cash payment in April 2001 as additional future rent. The Company also assumed
and agreed to continue to perform its obligations under various agreements (the
"Spin-off Agreements") entered into at the time of the Spin-off. Descriptions
of the agreements with Ventas are summarized below.
Master Lease Agreements and Related Transactions
Under the Plan of Reorganization, the Company assumed its original master
lease agreements with Ventas and its affiliates and simultaneously amended and
restated the agreements into four new master leases (the "Master Leases").
Under the Master Leases, Ventas has a right to sever properties from the
existing leases in order to create additional leases, a device adopted to
facilitate its financing flexibility. In such circumstances, the Company's
aggregate lease obligations remain unchanged. Ventas exercised this severance
right with respect to Master Lease No. 1 to create a new lease of 40 nursing
centers (the "CMBS Lease") and mortgaged these properties in connection with a
securitized mortgage financing. The CMBS Lease is in substantially the same
form as the other Master Leases with certain modifications requested by
Ventas's lender and required to be made by the Company pursuant to the Master
Leases. The transaction closed on December 12, 2001.
The following summary description of the Master Lease Agreements is
qualified in its entirety by reference to the Master Leases and the CMBS Lease
(collectively, the "Master Lease Agreements"), as filed with the SEC.
Term and Renewals
Each Master Lease Agreement includes land, buildings, structures and other
improvements on the land, easements and similar appurtenances to the land and
improvements, and permanently affixed equipment, machinery and other fixtures
relating to the operation of the leased properties. There are several bundles
of leased
F-37
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Term and Renewals (Continued)
properties under each Master Lease Agreement, with each bundle containing
approximately 7 to 12 leased properties. Other than the CMBS Lease which has
only nursing center properties, each bundle contains both nursing centers and
hospitals. All leased properties within a bundle have base terms ranging from
10 to 15 years beginning from May 1, 1998, subject to certain exceptions.
At the Company's option, all, but not less than all, of the leased
properties in a bundle may be extended for one five-year renewal term beyond
the base term at the then existing rental rate plus the then existing
escalation amount per annum. The Company may further extend for two additional
five-year renewal terms beyond the first renewal term at the greater of the
then existing rental rate plus the then existing escalation amount per annum or
the then fair market value rental rate. The rental rate during the first
renewal term and any additional renewal term in which rent due is based on the
then existing rental rate will escalate each year during such term(s) at the
applicable escalation rate.
The Company may not extend the Master Lease Agreements beyond the base term
or any previously exercised renewal term if, at the time the Company seeks such
extension and at the time such extension takes effect, (1) an event of default
has occurred and is continuing or (2) a Medicare/Medicaid event of default (as
described below) and/or a licensed bed event of default (as described below)
has occurred and is continuing with respect to three or more leased properties
subject to a particular Master Lease Agreement. The base term and renewal term
of each Master Lease Agreement are subject to termination upon default by the
Company (subject to certain exceptions) and certain other conditions described
in the Master Lease Agreements.
Rental Amounts and Escalators
Each Master Lease Agreement is commonly known as a triple-net lease or an
absolute-net lease. Accordingly, in addition to rent, the Company is required
to pay the following: (1) all insurance required in connection with the leased
properties and the business conducted on the leased properties, (2) certain
taxes levied on or with respect to the leased properties (other than taxes on
the net income of Ventas) and (3) all utilities and other services necessary or
appropriate for the leased properties and the business conducted on the leased
properties.
Under each Master Lease Agreement, the aggregate annual rent is referred to
as base rent. Base rent equals the sum of current rent and accrued rent. The
Company is obligated to pay the portion of base rent that is current rent, and
unpaid accrued rent will be paid as set forth below.
From the effective date of the Master Lease Agreements through April 30,
2004, base rent will equal the current rent. Under the Master Lease Agreements,
the annual aggregate base rent owed by the Company currently is $185.9 million.
For the period from May 1, 2001 through April 30, 2004, annual aggregate base
rent payable in cash will escalate at an annual rate of 31/2% over the prior
period base rent if certain revenue parameters are obtained. The Company paid
rents to Ventas approximating $184.3 million for the year ended December 31,
2002, $135.6 million for the nine months ended December 31, 2001, $45.4 million
for the three months ended March 31, 2001, and $181.6 million for 2000.
Each Master Lease Agreement also provides that beginning May 1, 2004, the
annual aggregate base rent payable in cash will escalate at an annual rate of
2% (plus, upon the occurrence of certain events, an additional annual accrued
escalator amount of 11/2% of the prior period base rent) which will accrete
from year to year including an interest accrual at the London Interbank Offered
Rate plus 41/2% to be added to the annual accreted amount. This interest will
not be added to the aggregate base rent in subsequent years.
F-38
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Rental Amounts and Escalators (Continued)
The unpaid accrued rent will become payable upon the refinancing of the
Company's existing credit agreements or the termination or expiration of the
applicable Master Lease Agreement.
Reset Rights
During the one-year period commencing in July 2006, Ventas will have a
one-time option to reset the base rent, current rent and accrued rent under
each Master Lease Agreement to the then fair market rental of the leased
properties. Upon exercising this reset right, Ventas will pay the Company a fee
equal to a prorated portion of $5 million based upon the proportion of base
rent payable under the Master Lease Agreement(s) with respect to which rent is
reset to the total base rent payable under all of the Master Lease Agreements.
The determination of the fair market rental will be effectuated through the
appraisal procedures in the Master Lease Agreements.
Use of the Leased Property
The Master Lease Agreements require that the Company utilize the leased
properties solely for the provision of healthcare services and related uses and
as Ventas may otherwise consent. The Company is responsible for maintaining or
causing to be maintained all licenses, certificates and permits necessary for
the leased properties to comply with various healthcare regulations. The
Company also is obligated to operate continuously each leased property as a
provider of healthcare services.
Events of Default
Under each Master Lease Agreement, an "Event of Default" will be deemed to
occur if, among other things:
. the Company fails to pay rent or other amounts within five days after
notice,
. the Company fails to comply with covenants, which failure continues for
30 days or, so long as diligent efforts to cure such failure are being
made, such longer period (not over 180 days) as is necessary to cure such
failure,
. certain bankruptcy or insolvency events occur, including filing a
petition of bankruptcy or a petition for reorganization under the
Bankruptcy Code,
. an event of default arising from the Company's failure to pay principal
or interest on the Senior Secured Notes or any other indebtedness
exceeding $50 million,
. the maturity of the Senior Secured Notes or any other indebtedness
exceeding $50 million is accelerated,
. the Company ceases to operate any leased property as a provider of
healthcare services for a period of 30 days,
. a default occurs under any guaranty of any lease or the indemnity
agreements with Ventas,
. the Company or its subtenant lose any required healthcare license, permit
or approval or fail to comply with any legal requirements as determined
by a final unappealable determination,
. the Company fails to maintain insurance,
. the Company creates or allows to remain certain liens,
. the Company breaches any material representation or warranty,
F-39
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Events of Default (Continued)
. a reduction occurs in the number of licensed beds in a facility,
generally in excess of 10% (or less than 10% if the Company has
voluntarily "banked" licensed beds) of the number of licensed beds in the
applicable facility on the commencement date (a "licensed bed event of
default"),
. Medicare or Medicaid certification with respect to a participating
facility is revoked and re-certification does not occur for 120 days
(plus an additional 60 days in certain circumstances) (a
"Medicare/Medicaid event of default"),
. the Company becomes subject to regulatory sanctions as determined by a
final unappealable determination and fails to cure such regulatory
sanctions within its specified cure period for any facility,
. the Company fails to cure the breach of any permitted encumbrance within
the applicable cure period and, as a result, a real property interest or
other beneficial property right of Ventas is at material risk of being
terminated, or
. the Company fails to cure the breach of any of the obligations of Ventas
as lessee under any existing ground lease within the applicable cure
period and, if such breach is a non-monetary, non-material breach, such
existing ground lease is at material risk of being terminated.
Remedies for an Event of Default
Except as noted below, upon an Event of Default under one of the Master
Lease Agreements, Ventas may, at its option, exercise the following remedies:
(1) after not less than ten days' notice to the Company, terminate the
Master Lease Agreement to which such Event of Default relates, repossess any
leased property, relet any leased property to a third party and require that
the Company pay to Ventas, as liquidated damages, the net present value of
the rent for the balance of the term, discounted at the prime rate,
(2) without terminating the Master Lease Agreement to which such Event
of Default relates, repossess the leased property and relet the leased
property with the Company remaining liable under such Master Lease Agreement
for all obligations to be performed by the Company thereunder, including the
difference, if any, between the rent under such Master Lease Agreement and
the rent payable as a result of the reletting of the leased property, and
(3) seek any and all other rights and remedies available under law or in
equity.
In addition to the remedies noted above, under the Master Lease Agreements,
in the case of a facility-specific event of default Ventas may terminate a
Master Lease Agreement as to the leased property to which the Event of Default
relates, and may, but need not, terminate the entire Master Lease Agreement.
Each of the Master Lease Agreements includes special rules relative to
Medicare/Medicaid events of default and licensed bed events of default. In the
event a Medicare/Medicaid event of default and/or a licensed bed event of
default occurs and is continuing (a) with respect to not more than two
properties at the same time under a Master Lease Agreement that covers 41 or
more properties and (b) with respect to not more than one property at the same
time under a Master Lease Agreement that covers 21 to and including 40
properties, Ventas may not exercise termination or dispossession remedies
against any property other than the property or properties to which the event
of default relates. Thus, in the event Medicare/Medicaid events of default and
licensed bed events of default would occur and be continuing (a) with respect
to one property under a Master Lease Agreement that covers less than 20
properties, (b) with respect to two or more properties at the same time under a
Master Lease
F-40
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Remedies for an Event of Default (Continued)
Agreement that covers 21 to and including 40 properties, or (c) with respect to
three or more properties at the same time under a Master Lease Agreement that
covers 41 or more properties, then Ventas would be entitled to exercise all
rights and remedies available to it under the Master Lease Agreements.
Assignment and Subletting
Except as noted below, the Master Lease Agreements provide that the Company
may not assign, sublease or otherwise transfer any leased property or any
portion of a leased property as a whole (or in substantial part), including by
virtue of a change of control, without the consent of Ventas, which may not be
unreasonably withheld if the proposed assignee (1) is a creditworthy entity
with sufficient financial stability to satisfy its obligations under the
related Master Lease Agreement, (2) has not less than four years experience in
operating healthcare facilities, (3) has a favorable business and operational
reputation and character and (4) has all licenses, permits, approvals and
authorizations to operate the facility and agrees to comply with the use
restrictions in the related Master Lease Agreement. The obligation of Ventas to
consent to a subletting or assignment is subject to the reasonable approval
rights of any mortgagee and/or the lenders under its credit agreement. The
Company may sublease up to 20% of each leased property for restaurants, gift
shops and other stores or services customarily found in hospitals or nursing
centers without the consent of Ventas, subject, however, to there being no
material alteration in the character of the leased property or in the nature of
the business conducted on such leased property.
In addition, each Master Lease Agreement allows the Company to assign or
sublease (a) without the consent of Ventas, 10% of the nursing center
facilities in each Master Lease Agreement and (b) with Ventas's consent (which
consent will not be unreasonably withheld, delayed or conditioned), two
hospitals in each Master Lease Agreement, if either (i) the applicable
regulatory authorities have threatened to revoke an authorization necessary to
operate such leased property or (ii) the Company cannot profitably operate such
leased property. Any such proposed assignee/sublessee must satisfy the
requirements listed above and it must have all licenses, permits, approvals and
other authorizations required to operate the leased properties in accordance
with the applicable permitted use. With respect to any assignment or sublease
made under this provision, Ventas agrees to execute a nondisturbance and
attornment agreement with such proposed assignee or subtenant. Upon any
assignment or subletting, the Company will not be released from its obligations
under the applicable Master Lease Agreement.
Subject to certain exclusions, the Company must pay to Ventas 80% of any
consideration received by the Company on account of an assignment and 80% (50%
in the case of existing subleases) of sublease rent payments (approximately
equal to revenue net of specified allowed expenses attributable to a sublease,
and specifically defined in the Master Lease Agreements), provided that
Ventas's right to such payments will be subordinate to that of the Company's
lenders.
Ventas will have the right to approve the purchaser at a foreclosure of one
or more of the Company's leasehold mortgages by the Company's lenders. Such
approval will not be unreasonably withheld so long as such purchaser is
creditworthy, reputable and has four years experience in operating healthcare
facilities. Any dispute regarding whether Ventas has unreasonably withheld its
consent to such purchaser will be subject to expedited arbitration.
Transactions Associated with the Master Lease Agreements
During 2002, the Company entered into transactions with Ventas regarding
certain facilities leased under the Master Lease Agreements. These transactions
are described below.
F-41
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Transactions Associated with the Master Lease Agreements (Continued)
Under one of the Master Lease Agreements, the Company leases from Ventas a
nursing center in Walpole, Massachusetts commonly known as Harrington House
Nursing and Rehabilitation Center (the "Kindred Walpole Facility"). Ventas
owned the Kindred Walpole Facility together with an adjacent
independent/assisted living facility (the "Third Party Walpole Facility") that
was leased by a third party. Ventas desired to convert the Kindred Walpole
Facility and the Third Party Walpole Facility into condominiums (the
"Condominiumization") to permit the third party to purchase the Third Party
Walpole Facility from Ventas. Ventas informed Kindred that the third party was
seeking to make this purchase in order to facilitate the financing of
accommodations at the Third Party Walpole Facility by the third party's
residents.
The Kindred Walpole Facility was contained within the boundaries of one
condominium unit forming a part of the condominium and its appurtenant "limited
common elements" and the Third Party Walpole Facility was contained within the
boundaries of the other condominium unit forming a part of the condominium and
its appurtenant "limited common elements." In addition, a portion of the
property being subjected to the Condominiumization will, as a "general common
element," be the responsibility of a condominium association (the costs of
which are to be split evenly between the owners of each unit). With the
exception of the "general common elements," the owners of each unit will be
responsible for the maintenance and operation of such units and any "limited
common elements" appurtenant thereto.
In order to reflect that the Kindred Walpole Facility will be part of a
condominium, it was necessary to amend the Master Lease Agreement solely with
respect to the Kindred Walpole Facility. Following the Condominiumization, the
Master Lease Agreement will be subordinate to certain condominium documents. It
is not anticipated that this transaction will materially impact any other
rights or obligations (monetary or otherwise) with respect to the Kindred
Walpole Facility. The Company did not receive any consideration for this
transaction other than reimbursement by Ventas of attorney's fees and title
examination expenses directly related to the transaction. The
Condominiumization transaction was completed on December 19, 2002.
Under one of the Master Lease Agreements, the Company leased from Ventas a
hospital known as the Northern Virginia Community Hospital in Arlington,
Virginia. Ventas entered into an agreement dated as of May 31, 2002 with the
Northern Virginia Community Hospital, LLC ("NVCH") to sell the hospital to
NVCH. Since the Company was not generating a profit at the hospital, the
Company agreed to terminate the provisions of the Master Lease Agreement
specifically as it relates to the hospital and to transfer operating control of
the hospital to NVCH. The Company entered into an operations transfer
agreement, dated as of June 5, 2002, with NVCH under which the Company
transferred certain inventory, supplies, leases, contracts, and operating
control of the hospital to NVCH effective as of June 20, 2002. The Company
received no portion of the sale proceeds, but rent and other lease obligations
specific to the hospital were terminated subsequent to June 2, 2002. The
Company further agreed to sell certain equipment to NVCH for $150,000.
Under one of the Master Lease Agreements, the Company leases from Ventas a
hospital known as the Kindred Hospital in Mansfield, Texas. In June 2000, the
hospital sustained severe water damage from an intensive rainstorm and all
patients were relocated to other facilities. The Company subsequently restored,
but chose not to reopen the hospital. Ventas and the Company entered into a
Forbearance Agreement pursuant to which Ventas agreed to forbear, until October
31, 2001, from declaring an event of default pursuant to the Master Lease
Agreement for the Company's failure to reopen the hospital. Ventas made
periodic extensions of the Forbearance Agreement while the Company attempted to
find a buyer or sublessee for the hospital. Subsequently, the Company agreed to
enter into negotiations to sublease the hospital to an unrelated third party.
The third party informed the Company that it preferred to purchase the hospital
rather than sublease it. In order to
F-42
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Transactions Associated with the Master Lease Agreements (Continued)
obtain further extensions of the Forbearance Agreement, the Company agreed to
pay Ventas a $50,000 non-refundable extension fee. The third party subsequently
entered into a purchase and sale agreement with Ventas dated May 29, 2002 to
purchase the hospital. The third party subsequently terminated the purchase
agreement on June 25, 2002, agreed to reinstate the purchase agreement and then
again terminated the purchase agreement on July 9, 2002. Ventas then informed
the Company that it would be required to reopen the hospital on or prior to
September 4, 2002. The Company reopened the hospital on August 30, 2002.
Spin-off Agreements and other Arrangements Under the Plan of Reorganization
In order to govern certain of the relationships between the Company and
Ventas after the Spin-off and to provide mechanisms for an orderly transition,
the Company entered into the Spin-off Agreements with Ventas at the time of the
Spin-off. Except as noted below, the following agreements between Ventas and
the Company were assumed by the Company and certain of these agreements were
simultaneously amended in accordance with the terms of the Plan of
Reorganization.
Tax Allocation Agreement and Tax Refund Escrow Agreement
The Tax Allocation Agreement, entered into at the time of the Spin-off, was
assumed by the Company under the Plan of Reorganization and then amended and
supplemented by the Tax Refund Escrow Agreement (as defined below). Both of
these agreements are described below.
The Tax Allocation Agreement provides that the Company will be liable for,
and will hold Ventas harmless from and against, (1) any taxes of the Company
and its then subsidiaries (the "Kindred Group") for periods after the Spin-off,
(2) any taxes of Ventas and its then subsidiaries (the "Ventas Group") or the
Kindred Group for periods prior to the Spin-off (other than taxes associated
with the Spin-off) with respect to the portion of such taxes attributable to
assets owned by the Kindred Group immediately after completion of the Spin-off
and (3) any taxes attributable to the Spin-off to the extent that the Company
derives certain tax benefits as a result of the payment of such taxes. Under
the Tax Allocation Agreement, the Company would be entitled to any refund or
credit in respect of taxes owed or paid by the Company under (1), (2) or (3)
above. The Company's liability for taxes for purposes of the Tax Allocation
Agreement would be measured by Ventas's actual liability for taxes after
applying certain tax benefits otherwise available to Ventas other than tax
benefits that Ventas in good faith determines would actually offset tax
liabilities of Ventas in other taxable years or periods. Any right to a refund
for purposes of the Tax Allocation Agreement would be measured by the actual
refund or credit attributable to the adjustment without regard to offsetting
tax attributes of Ventas.
Under the Tax Allocation Agreement, Ventas would be liable for, and would
hold the Company harmless against, any taxes imposed on the Ventas Group or the
Kindred Group other than taxes for which the Kindred Group is liable as
described in the above paragraph. Ventas would be entitled to any refund or
credit for taxes owed or paid by Ventas as described in this paragraph.
Ventas's liability for taxes for purposes of the Tax Allocation Agreement would
be measured by the Kindred Group's actual liability for taxes after applying
certain tax benefits otherwise available to the Kindred Group other than tax
benefits that the Kindred Group in good faith determines would actually offset
tax liabilities of the Kindred Group in other taxable years or periods. Any
right to a refund would be measured by the actual refund or credit attributable
to the adjustment without regard to offsetting tax attributes of the Kindred
Group.
On the Effective Date, the Company entered into the Tax Refund Escrow
Agreement and First Amendment to the Tax Allocation Agreement (the "Tax Refund
Escrow Agreement") with Ventas governing the Company's
F-43
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Tax Allocation Agreement and Tax Refund Escrow Agreement (Continued)
and Ventas's relative entitlement to certain tax refunds received on or after
September 13, 1999 by Ventas or the Company for the tax periods prior to and
including the Spin-off that each has received or may receive in the future. The
Tax Refund Escrow Agreement amends and supplements the Tax Allocation
Agreement. Under the terms of the Tax Refund Escrow Agreement, refunds
("Subject Refunds") received on or after September 13, 1999 by either Ventas or
the Company with respect to federal, state or local income, gross receipts,
windfall profits, transfer, duty, value-added, property, franchise, license,
excise, sales and use, capital, employment, withholding, payroll, occupational
or similar business taxes (including interest, penalties and additions to tax,
but excluding certain refunds), for taxable periods ending on or prior to May
1, 1998 ("Subject Taxes") were deposited into an escrow account with a third
party escrow agent on the Effective Date.
The Tax Refund Escrow Agreement provides that each party shall notify the
other of any asserted Subject Tax liability of which it becomes aware, that
either party may request that asserted liabilities for Subject Taxes be
contested, that neither party may settle such a contest without the consent of
the other, that each party shall have a right to participate in any such
contest, and that the parties generally shall cooperate with regard to Subject
Taxes and Subject Refunds and shall mutually and jointly control any audit or
review process related thereto. The funds in the escrow account may be released
from the escrow account to pay Subject Taxes and as otherwise provided therein.
The Tax Refund Escrow Agreement provides generally that Ventas and the
Company waive their respective rights under the Tax Allocation Agreement to
make claims against each other with respect to Subject Taxes satisfied by the
escrow funds, notwithstanding the indemnification provisions of the Tax
Allocation Agreement. To the extent that the escrow funds are insufficient to
satisfy all liabilities for Subject Taxes that are finally determined to be due
(such excess amount, "Excess Taxes"), the relative liability of Ventas and the
Company to pay such Excess Taxes shall be determined as provided in the Tax
Refund Escrow Agreement. Disputes under the Tax Refund Escrow Agreement, and
the determination of the relative liability of Ventas and the Company to pay
Excess Taxes, if any, are governed by the arbitration provision of the Tax
Allocation Agreement.
Interest earned on the escrow funds or included in refund amounts received
from governmental authorities will be distributed equally to Ventas and the
Company on an annual basis. For the years ended December 31, 2002 and 2001, the
Company recorded approximately $261,000 and $368,000, respectively, of interest
income related to the escrow funds. Any escrow funds remaining in the escrow
account after no further claims may be made by governmental authorities with
respect to Subject Taxes or Subject Refunds (because of the expiration of
statutes of limitation or otherwise) will be distributed equally to Ventas and
the Company.
Agreement of Indemnity-Third Party Leases
In connection with the Spin-off, Ventas assigned its former third party
lease obligations (i.e., leases under which an unrelated third party is the
landlord) as a tenant or as a guarantor of tenant to the Company. The lessors
of these properties may claim that Ventas remains liable on these third party
leases assigned to the Company. Under the terms of the Agreement of
Indemnity-Third Party Leases, the Company has agreed to indemnify and hold
Ventas harmless from and against all claims against Ventas arising out of these
third party leases. Under the Plan of Reorganization, the Company assumed and
agreed to fulfill its obligations under the Agreement of Indemnity-Third Party
Leases.
F-44
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 - RELATED PARTY TRANSACTIONS (Continued)
Agreement of Indemnity-Third Party Contracts
In connection with the Spin-off, Ventas assigned its former third party
guaranty agreements to the Company. Ventas may remain liable on these third
party guarantees assigned to the Company. Under the terms of the Agreement of
Indemnity-Third Party Contracts, the Company has agreed to indemnify and hold
Ventas harmless from and against all claims against Ventas arising out of these
third party guarantees assigned to the Company. The third party guarantees were
entered into in connection with certain acquisitions and financing transactions
that occurred prior to the Spin-off. Under the Plan of Reorganization, the
Company assumed and agreed to fulfill its obligations under the Agreement of
Indemnity-Third Party Contracts.
Assumption of other Liabilities
In connection with the Spin-off, the Company agreed to assume and to
indemnify Ventas for any and all liabilities that may arise out of the
ownership or operation of the healthcare operations either before or after the
date of the Spin-off. The indemnification provided by the Company also covers
losses, including costs and expenses, which may arise from any future claims
asserted against Ventas based on these healthcare operations. In addition, at
the time of the Spin-off, the Company agreed to assume the defense, on behalf
of Ventas, of any claims that were pending at the time of the Spin-off, and
which arose out of the ownership or operation of the healthcare operations. The
Company also agreed to defend, on behalf of Ventas, any claims asserted after
the Spin-off which arise out of the ownership and operation of the healthcare
operations. Under the Plan of Reorganization, the Company assumed and agreed to
perform its obligations under these indemnifications.
Other Transactions with Ventas
In 1992, a third party and the Company's subsidiary as trustees of a trust
(the "Trust") leased to a related partnership a nursing center, the ground on
which the nursing center is located and the right to use the parking lot
adjacent to the nursing center. The ground lease expires in 2089. In connection
with the Spin-off, Ventas transferred, by bill of sale, its 50% general
partnership interest in the partnership to the Company, but inadvertently did
not transfer its interest in the Trust to the Company. On June 24, 2002 Ventas
resigned as trustee of the Trust, effective as of April 30, 1998, and the
Company was appointed trustee of the Trust. No payment was made to Ventas in
connection with this transaction.
Other Related Party Transactions
Dr. Thomas P. Cooper, a nominee for election to the Board of Directors at
the Company's shareholders meeting scheduled for May 22, 2003, is the Chairman,
Chief Executive Officer and shareholder of Vericare, Inc. ("Vericare").
Vericare has contracts to provide mental health services to 15 skilled nursing
facilities operated by the Company. Under these contracts, Vericare bills the
individual resident or the appropriate third party payor for the services
provided by Vericare. The Company does not pay Vericare for these services nor
does Vericare make any payments to the Company related to these services.
During 2002, the Company paid approximately $318,600 for legal services
rendered by the law firm of Shaw Pittman LLP. The son of Edward L. Kuntz,
Chairman and Chief Executive Officer of the Company, was employed by that firm
through August 2002. The Company also paid approximately $1,280,300 for legal
services rendered by the law firm of Reed Smith LLP. Mr. Kuntz's son has been
employed as an associate of Reed Smith since October 2002. The fees paid to
Shaw Pittman and Reed Smith represent approximately 1.5% and 5.9%,
respectively, of the legal fees paid by the Company in 2002. It is anticipated
that Reed Smith will provide legal services to the Company in 2003.
F-45
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 20 - FAIR VALUE DATA
A summary of fair value data at December 31 follows (in thousands):
Reorganized Company
-----------------------------------
2002 2001
----------------- -----------------
Carrying Fair Carrying Fair
value value value value
-------- -------- -------- --------
Cash and cash equivalents............ $244,070 $244,070 $190,799 $190,799
Cash-restricted...................... 7,908 7,908 18,025 18,025
Insurance subsidiary investments..... 148,586 148,586 116,077 116,077
Tax refund escrow investments........ 14,383 14,383 15,706 15,706
Long-term debt, including amounts due
within one year.................... 162,266 158,306 212,687 212,746
NOTE 21 - LITIGATION
Summary descriptions of various significant legal and regulatory activities
follow.
The Company's subsidiary, formerly named TheraTx, Incorporated ("TheraTx"),
is a plaintiff in a declaratory judgment action entitled TheraTx, Incorporated
v. James W. Duncan, Jr., et al., No. 1:95-CV-3193, filed in the United States
District Court for the Northern District of Georgia on December 11, 1995. 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 SEC. The court granted summary judgment for the defendants/counterclaimants
and ruled that TheraTx breached the shelf registration provision in the merger
agreement, but dismissed the defendants' remaining counterclaims. Additionally,
the court ruled after trial that defendants/counterclaimants were entitled to
damages and prejudgment interest in the amount of approximately $1.3 million
and attorneys' fees and other litigation expenses of approximately $700,000.
The Company and the defendants/counterclaimants both appealed the court's
rulings. The United States Court of Appeals for the Eleventh Circuit affirmed
the trial court's rulings in TheraTx's favor, with the exception of the damages
award, and certified the question of the proper calculation of damages under
Delaware law to the Delaware Supreme Court. The Delaware Supreme Court issued
an opinion on June 1, 2001, which sets forth a rule for determining such
damages but did not calculate any actual damages. On June 25, 2001, the
Eleventh Circuit remanded the action to the trial court to render a decision
consistent with the Delaware Supreme Court's ruling. On July 24, 2001, the
defendants filed a Notice of Bankruptcy Stay in the trial court.
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
sought 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
sought 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.
On December 20, 2002 the parties reached a final settlement of the Duncan
dispute. Pursuant to that settlement agreement, the Company paid the defendants
$2.1 million. This settlement did not impact the Company's operating results
because the Company had previously recorded a provision for loss in a prior
year. The parties filed agreed stipulations to dismiss the Georgia litigation
and the adversary proceeding in the Bankruptcy Court, and both actions have now
been dismissed.
F-46
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 21 - LITIGATION (Continued)
The Company is pursuing various claims against private insurance companies
who issued Medicare supplemental 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, most of which have been
adverse to the Company. As discussed in Note 7, the Company received
approximately $12 million in connection with the settlement of one of these
claims in September 2002. While the Company intends to continue to pursue these
claims vigorously, the remaining value of these claims is not expected to be
material.
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. The
court granted the motion to dismiss but the plaintiff subsequently moved the
court to vacate the dismissal. The defendants filed an opposition to the
plaintiff's motion to vacate the dismissal, and the court has not yet ruled on
that motion. The Company believes that the allegations in the complaint are
without merit and intends to defend this action vigorously if the dismissal is
vacated.
A putative 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 of the Company's
current and former officers and directors 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
F-47
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 21 - LITIGATION (Continued)
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 costs.
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; Paula Hillenbrand v. Kindred Healthcare, Inc., et al., Civil
Action No. 3:02CV-654-R; Marilyn Buck v. Kindred Healthcare, Inc., et al.,
Civil Action No. 3:02CV-732-S; and Eastside Holdings Ltd. v. Kindred
Healthcare, Inc., et al., Civil Action No. 3:02CV-617-H. All of these actions
have been consolidated by the District Court. The Company believes that the
allegations in all of these putative class action complaints are without merit,
and intends to defend these lawsuits vigorously.
Three shareholder derivative suits entitled Elizabeth Sommerfeld v. Kindred
Healthcare, Inc., et al., Civil Action No. 02 CI 08476; Ilse Denchfield v.
Kindred Healthcare, Inc., et al., Civil Action No. 02 CI 09475; and Fedorka v.
Edward L. Kuntz, et al., Civil Action No. 03 CI 02015 were filed in November
2002, December 2002 and March 2003, respectively, in the Jefferson Circuit
Court in Kentucky. The complaints, which recite 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, attempt to assert a claim against the individual defendants for breach
of fiduciary duties for insider selling and misappropriation of information.
Specifically, the complaints allege that each of the individual defendants knew
that the price of the Company's common stock would dramatically decrease when
the Company's inadequate reserves for professional liability risks were
disclosed and that the individual defendants' sales of the Company's common
stock with knowledge of this material non-public information constituted a
breach of their fiduciary duties of loyalty and good faith. The suits seek to
impose a constructive trust in favor of the Company for the amount of profits
each of the individual defendants or their firms may have received from their
November 2001 sales of the Company's common stock, as well as attorneys' fees
and other expenses. The Company believes that the allegations in the complaints
are without merit and the Company intends to defend these actions vigorously.
The Company has been informed by the Kentucky Attorney General's Office that
the Company and certain of its present and former officers and employees are
the subject of several investigations into care issues at the Company's
Kentucky-based nursing facilities that may lead to civil and/or criminal
charges against the Company and/or the individual officers and employees. Such
charges include, but may not be limited to, abuse or neglect of residents and
Medicaid billing fraud related to the alleged provision of substandard care. If
civil or criminal charges are brought against the Company and/or its officers
and employees, they could result in material civil damages, criminal penalties
and fines, and possible exclusion of the Company's nursing facilities from the
Medicare and Medicaid programs and related material defaults under the Master
Lease Agreements with Ventas. The Company believes that these allegations are
without merit and intends to defend against them vigorously.
In connection with the Spin-off, 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
F-48
KINDRED HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 21 - LITIGATION (Continued)
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 the Company's indemnification obligations arising from the Spin-off.
The Company is a party to various legal actions (some of which are not
insured), and regulatory investigations and sanctions arising in the normal
course of the Company's business. The Company is unable to predict the ultimate
outcome of pending litigation and regulatory investigations. In addition, there
can be no assurance that the DOJ, CMS or other state and federal enforcement
and 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 financial
position, results of operations or liquidity. In addition, the above litigation
and investigations (as well as future litigation and investigations) are
expected to consume the time and attention of management and may have a
disruptive effect upon the Company's operations.
F-49
KINDRED HEALTHCARE, INC.
QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
(In thousands, except per share amounts)
2002 (a)
--------------------------------------
Reorganized Company
--------------------------------------
First Second Third (b) Fourth (b)
-------- -------- --------- ----------
Revenues........................................ $811,244 $838,573 $859,721 $848,284
Net income (loss):
Income (loss) from operations.................. 18,178 23,662 (11,583) 3,069
Extraordinary gain on extinguishment of debt... - - 1,427 -
Net income (loss).......................... 18,178 23,662 (10,156) 3,069
Earnings (loss) per common share:
Basic:
Income (loss) from operations................ 1.05 1.36 (0.66) 0.18
Extraordinary gain on extinguishment of debt. - - 0.08 -
Net income (loss).......................... 1.05 1.36 (0.58) 0.18
Diluted:
Income (loss) from operations................ 0.95 1.21 (0.66) 0.18
Extraordinary gain on extinguishment of debt. - - 0.08 -
Net income (loss).......................... 0.95 1.21 (0.58) 0.18
Market prices (c):
High......................................... 51.70 49.78 44.44 37.18
Low.......................................... 35.75 40.38 30.85 10.23
2001 | 2001
-----------| --------------------------
Predecessor|
Company | Reorganized Company
-----------| --------------------------
First | Second Third Fourth
-----------| -------- -------- --------
Revenues........................................ $752,409 | $770,764 $768,680 $789,575
Net income: |
Income from operations......................... 49,185 | 16,489 14,799 16,054
Extraordinary gain on extinguishment of debt... 422,791 | 1,396 - 2,917
Net income................................. 471,976 | 17,885 14,799 18,971
Earnings per common share: |
Basic: |
Income from operations....................... 0.69 | 1.09 0.97 0.99
Extraordinary gain on extinguishment of debt. 6.02 | 0.09 - 0.18
Net income................................. 6.71 | 1.18 0.97 1.17
Diluted: |
Income from operations....................... 0.69 | 1.00 0.80 0.83
Extraordinary gain on extinguishment of debt. 5.90 | 0.08 - 0.15
Net income................................. 6.59 | 1.08 0.80 0.98
Market prices (c) (d) (e): |
High......................................... 0.08 | 51.00 67.90 59.50
Low.......................................... 0.01 | 22.25 46.00 45.89
- --------
(a) As discussed in note 1 of the notes to consolidated financial statements,
the Company adopted the provisions of SFAS 142 which requires that goodwill
should no longer be amortized effective January 1, 2002.
(b) See note 7 of the notes to consolidated financial statements for a
discussion of significant quarterly adjustments.
(c) Kindred common stock has traded on the Nasdaq National Market since
November 8, 2001 under the ticker symbol "KIND."
(d) Kindred common stock commenced trading on the OTC Bulletin Board on April
26, 2001 under the ticker symbol "KIND." Kindred common stock was initially
issued on April 20, 2001 in connection with the Plan of Reorganization.
Between April 20, 2001 and April 26, 2001, there was no public market for
the Kindred common stock.
(e) The Company's former common stock was traded on the OTC Bulletin Board
under the ticker symbol "VCRIQ" (formerly "VCRI").
F-50
KINDRED HEALTHCARE, INC.
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEAR ENDED DECEMBER 31, 2002, THE NINE MONTHS ENDED DECEMBER 31, 2001,
THE THREE MONTHS ENDED MARCH 31, 2001 AND THE YEAR ENDED DECEMBER 31, 2000
(In thousands)
Additions
-------------------------
Balance at Charged Balance at
beginning to costs Deductions end of
of period and expenses Acquisitions or payments period
---------- ------------ ------------ ----------- ----------
Allowance for loss on accounts receivable:
Predecessor Company:
Year ended December 31, 2000........... $180,055 $28,911 $ - $(69,521) $139,445
For the three months ended
March 31, 2001....................... 139,445 6,305 - (23,673) 122,077
- ------------------------------------------------------------------------------------------------------
Reorganized Company:
For the nine months ended
December 31, 2001.................... 122,077 16,346 136 (29,668) 108,891
Year ended December 31, 2002........... 108,891 13,551 - (26,490) 95,952
Allowance for loss on assets held for disposition:
Predecessor Company:
Year ended December 31, 2000........... $ 74,816 $ 2,405 $ - $(52,377) $ 24,844
For the three months ended
March 31, 2001....................... 24,844 - - (8,221) 16,623
- ------------------------------------------------------------------------------------------------------
Reorganized Company:
For the nine months ended
December 31, 2001.................... 16,623 - - (11,510) 5,113
Year ended December 31, 2002........... 5,113 - - (4,408) 705
F-51